{"filename":"897998_1995.txt","cik":"897998","year":"1995","section_1":"Item 1. Business of HL Funding Company, Inc.\nA. Organization\nHL Funding Company, Inc. (the Company or HLFC) offers and administers programs whereby participants obtain life insurance coverage from various ITT Hartford Group, Inc. affiliated insurance companies. Under the programs, insurance premiums are paid by participants through a series of loans from HLFC. Loans to participants are secured by participants' ownership in shares of regulated investment companies. The loans to participants are funded with proceeds from a loan arrangement with HLIC. All programs are ten years in length. Upon program conclusion, loan balances and accrued interest become due.\nHLFC is a corporation formed in the State of Connecticut on February 8, 1993. HLFC is a wholly owned subsidiary of Hartford Life Insurance Company (HLIC), which is ultimately a subsidiary of Hartford Fire Insurance Company (Hartford Fire) and ITT Hartford Group, Inc. HLFC's registration statement became effective on March 16, 1994.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company occupies office space in Simsbury, Ct, leased by Hartford Fire. Expenses associated with these offices are allocated on a direct and indirect basis to the life insurance subsidiaries of Hartford Fire.\nItem 3.","section_3":"Item 3. Legal Proceedings\nHLFC is not involved in any pending or threatened litigation in which claims for monetary damages are or would be asserted.\nPart II\nItem 5.","section_4":"","section_5":"Item 5. Market for HL Funding Company's Common Stock and Related Stockholder Matters\nAll of HLFC's outstanding shares are ultimately owned by Hartford Fire which is ultimately a subsidiary of ITT Hartford Group, Inc.\nHLFC has issued and outstanding 100 shares of common stock at a par value of $1 per share.\nItem 7.","section_6":"","section_7":"Item 7. Management's Narrative Analysis of Results of Operations\nFor the years ended December 31, 1995 and 1994, HL Funding Company, Inc. had losses of $171,027 and $243,825, respectively. The 1995 and 1994 losses reflect operating expenses for the accounting and administration of HLFC's programs exceeding net interest and program income in each year. Ten programs were sold during 1995 and a total of thirteen active programs existed as of December 31, 1995. At December 31, 1995, premium loans receivable were $189,361 and interest loans were $2,972.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nSee Index to Financial Statements.\nItem 9.","section_9":"Item 9. Disagreements on Accounting and Financial Disclosures\nNone.\nItem 14.","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"Item 14. Exhibits, Financial Statements, Schedules, and Reports on Form 8-K\n(a) Documents Filed (1) See Index to Financial Statements (2) See Exhibit Index (b) No reports on Form 8-K have been filed during the last quarter of 1995\nReport of Independent Public Accountants\nStatements of Income (Loss) for the years ended December 31, 1995 and December 31, 1994, and for the period from inception, February 8, 1993,to December 31, 1993\nBalance Sheets as of December 31, 1995 and December 31, 1994\nStatements of Changes in Stockholder's Equity for the years ended December 31, 1995 and December 31, 1994, and for the period from inception, February 8, 1993, to December 31, 1993\nStatements of Cash Flows for the years ended December 31, 1995 and December 31, 1994, and for the period from inception, February 8, 1993, to December 31, 1993\nNotes to Financial Statements -8\nAll schedules have been omitted because they are not applicable or the amounts are insignificant, immaterial or the information has been otherwise supplied in the financial statements or notes thereto.\nREPORT OF MANAGEMENT\nThe management of HL Funding Company, Inc. (the Company) 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.\nThe Company's financial statements are audited by Arthur Andersen LLP, independent public accountants. Management has made available to Arthur Andersen LLP the Company's financial records and related data and believes that the representations made to the independent public accountants are valid and complete.\nThe Company's system of internal controls is a major component of management's responsibility for the fair presentation of the financial statements. The internal controls, including accounting controls and the internal auditing program, are designed to provide reasonable assurance that the assets are safeguarded, transactions are executed in accordance with management's authorization and are properly recorded, and fraudulent financial reporting is prevented or detected.\nThe Company's internal controls provide for the careful selection and training of personnel and for appropriate segregation of responsibilities. The controls are documented in written codes of conduct, policies, and procedures that are communicated to the Company's employees. Management continually monitors the system of internal controls for compliance. The Company's internal auditors perform independent tests of accounting procedures and records to assess the overall effectiveness of the Company's internal controls. 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.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Stockholder and Board of Directors of HL Funding Company, Inc.:\nWe have audited the accompanying balance sheets of HL Funding Company, Inc. (a Connecticut corporation and wholly owned subsidiary of Hartford Life Insurance Company) as of December 31, 1995 and 1994, and the related statements of income (loss), changes in stockholder's equity and cash flows for each of the two years in the period then ended and for the period from inception, February 8, 1993, to 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 HL Funding Company, Inc. as of December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the two years in the period then ended, and for the period from inception, February 8, 1993, to December 31, 1993, in conformity with generally accepted accounting principles.\nARTHUR ANDERSEN LLP\nHartford, Connecticut March 25, 1996\nHL FUNDING COMPANY, INC.\nSTATEMENTS OF INCOME (LOSS)\nThe accompanying notes are an integral part of these financial statements.\nHL FUNDING COMPANY, INC. BALANCE SHEETS\nThe accompanying notes are an integral part of these financial statements.\nHL FUNDING COMPANY, INC. STATEMENTS OF CHANGES IN STOCKHOLDER'S EQUITY\nHL FUNDING COMPANY, INC. STATEMENTS OF CASH FLOWS\nThe accompanying notes are an integral part of these financial statements.\nHL FUNDING COMPANY, INC. NOTES TO FINANCIAL STATEMENTS December 31, 1995 and 1994\nNote 1 - Organization - ---------------------\nHL Funding Company, Inc. (HLFC) was formed in the State of Connecticut on February 8, 1993. HLFC is a wholly owned subsidiary of Hartford Life Insurance Company (HLIC). All of the outstanding shares of HLIC are ultimately owned by Hartford Fire Insurance Company (Hartford Fire), which is owned by ITT Hartford Group, Inc. On March 26, 1993, HLFC issued 100 shares ($1 par) of stock to HLIC for $100. On May 28, 1993 and September 30, 1994, additional capital contributions of $99,900 and $650,000, respectively, were made by HLIC.\nHLFC offers and administers programs whereby participants obtain life insurance coverage from HLIC and Hartford Life and Accident Insurance Company, an affiliate of HLIC. Under the programs, insurance premiums are paid on behalf of participants through a series of loans from HLFC. Loans to participants are secured by participants' ownership in shares of regulated investment companies. Premium loans receivable are funded with proceeds from a loan arrangement with HLIC. Programs can be up to ten years in length. Upon a program's conclusion, the related loan balances and accrued interest become due.\nManagement expects the administrative costs of issuing and maintaining the programs will be offset by: a) fees charged to program participants, b) interest charged to participants for insurance premium loans to the extent that the interest charged exceeds the cost to HLFC of obtaining funds to finance the programs, and c) interest income earned on investments held by HLFC. Through December 31, 1995, thirteen programs were sold.\nNote 2 - Significant Accounting Policies - ----------------------------------------\nThe accompanying financial statements have been prepared in accordance with generally accepted accounting principles.\nREVENUES AND EXPENSES Interest and fees from investments and premium loans receivable are recognized as revenue when earned. Expenses, which are primarily allocated from affiliates, are recognized when incurred.\nORGANIZATIONAL COSTS Organizational costs are amortized over a three year period.\nCASH AND CASH EQUIVALENTS Cash equivalents include an investment ($66,408 and $617,866 as of December 31, 1995 and 1994, respectively) in Hartford Liquid Asset Trust (see Note 3).\nUSE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nRECLASSIFICATIONS Certain prior year amounts have been reclassified to conform to the current year presentation.\nNote 3 - Transactions with Affiliates - -------------------------------------\nHLIC provides administrative services to HLFC, including use of its facilities and personnel, and allocates a portion of its expenses to HLFC. For the periods ended December 31, 1995, 1994 and 1993, this allocation was $207,150, $266,612 and $0, respectively.\nHLFC initially invested the capital contributions in Hartford Liquid Asset Trust, a short term investment pool of liquid securities, in which companies of the ITT Hartford Insurance Group, Inc. participate. Pursuant to the terms of the Trust Agreement, the purpose of the Trust is to invest funds in a less costly manner in assets which achieve a high level of current income as well as maintain liquidity and preserve capital. The Trust investments are restricted to cash and investments having a stated maturity date of 12 months or less from the date of purchase. Interest earned by the Trust is allocated to each participant based on their pro-rata share of principal contributions.\nHLFC's funds for financing the programs are obtained through a promissory note agreement with HLIC. The agreement allows HLIC to advance to HLFC funds in an amount up to $7,000,000. The interest rate for the note is equal to the 90 day LIBOR plus 125 basis points. The rate was 7.063% and 6.75% at December 31, 1995 and 1994, respectively. For the periods ended December 31, 1995, 1994 and 1993, interest expense was $5,462, $85, and $0, respectively.\nNote 4 - Fair Value of Financial Instruments - --------------------------------------------\nCash and cash equivalent, interest, fees and tax receivable, premium loans receivable and intercompany loan payable amounts reflected in the balance sheet approximate fair value.\nNote 5 - Income Taxes - ---------------------\nHLFC is included in ITT Hartford Group, Inc.'s consolidated U.S. Federal income tax return and remits to (receives from) ITT Hartford Group, Inc. a current income tax provision (benefit) computed in accordance with the tax sharing arrangements between ITT Hartford Group, Inc. and its subsidiaries. The effective tax rate in 1995 and 1994 approximated the U.S. Statutory tax rate of 35%. The provision (benefit) for income taxes was as follows:\nAs of December 31, 1995 and 1994, the deferred tax asset was primarily due to organizational expenses capitalized for tax return purposes until the start of business of HLFC. Income taxes paid were $ 0, $162 and $ 0 in 1995, 1994 and 1993, respectively.\nNote 6 - Premium Loans - ----------------------\nAll premium loans to participants are secured by participants' shares of mutual funds, which include open-end investment companies registered under the Investment Company Act of 1940. When loans are originated, customers must pledge mutual fund shares valued at 2.5 times the yearly premiums being financed. During the life of the loan, the fair market value of the collateralized mutual fund shares must equal at least 1.5 times the amount of the total loan, or the participant must pledge additional shares to achieve this level. The loan will be liquidated if the fair market value of the collateral-to-loan ratio falls below 1.3. Effective January 1, 1995, HL Funding Company, Inc. adopted Statement of Financial Accounting Standard Nos. 114 and 118, \"Accounting by Creditors for Impairment of a Loan.\" These standards change the method by which the allowance for loan losses is determined for impaired loans. Since all premium loans are secured by collateral, with fair market value exceeding the loan value, there was no impact to the financial position or future results of operations of HL Funding Company, Inc. as a result of the adoption of the new accounting standards on January 1, 1995.\nSIGNATURES\nPursuant to the requirements of section 13 or 15d of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nHL Funding Company\nMarch 25, 1995 by ------------------- ------------------- Date George R. Jay Secretary 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 identified.\nNo annual report or proxy material has been sent to the stockholder.\nII-1\nII-2","section_15":""}
{"filename":"67212_1995.txt","cik":"67212","year":"1995","section_1":"Item 1. Business.\nGENERAL\nMobile Gas Service Corporation (together with its subsidiaries, the \"Company\" or \"Registrant\", and exclusive of its subsidiaries, \"Mobile Gas\") was incorporated under the laws of the State of Alabama in 1933. The Company is engaged in the purchase, distribution, sale and transportation of natural gas to approximately 100,000 residential, commercial and industrial customers in southwest Alabama, including the City of Mobile and adjacent areas. The Company has increased its customer base from approximately 84,900 peak-month customers in fiscal 1989 through the acquisition of the gas distribution system of the City of Bayou La Batre in fiscal 1990, which added approximately 2,400 customers, and the acquisition of certain assets of the Utilities Board of the Town of Citronelle in fiscal 1993, which added almost 8,000 customers. Additional growth has been accomplished through marketing of Company services to new construction and existing households and businesses. The Company's service territory covers approximately 300 square miles. Mobile Gas is also involved in merchandise sales, specifically sales of natural gas appliances.\nMGS Energy Services, Inc. (\"MGS Energy\"), a wholly-owned subsidiary, was incorporated in March 1983. Through MGS Energy, the Company provides contract and consulting work for utilities and industrial customers. MGS Energy owns a 51% interest in Southern Gas Transmission Company (\"SGT\"), an Alabama general partnership which was formed in November 1991. SGT was established to provide transportation services to the facilities of Alabama River Pulp Company, Inc. During fiscal year 1992, SGT constructed and began operating a 50-mile pipeline from the facilities of Koch Gateway Pipeline Company (\"Koch\"), formerly United Gas Pipe Line Company, near Flomaton, Alabama to the facilities of Alabama River Pulp Company, Inc. in Claiborne, Alabama.\nMGS Storage Services, Inc. (\"MGS Storage\"), a wholly-owned subsidiary, was incorporated on December 4, 1991. MGS Storage and MGS Energy formed Bay Gas Storage Company, Ltd. (\"Bay Gas\"), an Alabama limited partnership, on January 13, 1992, with MGS Storage as general partner and MGS Energy as the initial limited partner. MGS Storage and MGS Energy initially held partnership interests of 87 1\/2% and 12 1\/2%, respectively, in Bay Gas. As of September 12, 1994, MGS Energy's 12 1\/2% limited partnership interest was transferred to Olin Corporation (\"Olin\"). Bay Gas provides for the storage and delivery of natural gas for Mobile Gas. Bay Gas also markets its storage services to other customers.\nMGS Marketing Services, Inc. (\"MGS Marketing\"), a wholly-owned subsidiary, was incorporated on March 5, 1993 to assist existing and potential customers in the purchase of natural gas.\nCUSTOMERS\nOf the approximately 100,000 customers of the Company, approximately 95% are residential customers. In the fiscal year ended September 30, 1995, approximately 66% of the Company's gas revenues came from residential customers, 15% from commercial sales, 8% from industrial sales and 11% from transportation services. Residential sales in 1995 accounted for approximately 14% of the total volume of gas delivered to the Company's customers, with commercial, industrial and transportation deliveries accounting for approximately 4%, 4% and 74%, respectively. The ten largest customers of the Company accounted for approximately 13% of the Company's gross margin in fiscal 1995, with the largest accounting for approximately 3%. For further information with respect to revenues from and deliveries to the various categories of the Company's customers, see Item 6, \"Selected Financial Data\".\nIn May 1995, the Company entered into a long-term contract with Tuscaloosa Steel Corporation to transport natural gas to a proposed new iron ore reduction facility to be located adjacent to downtown Mobile. When fully operational in 1997, that facility is expected to use approximately 35,000 MMBTU of gas per day, making Tuscaloosa Steel the largest volume user of natural gas on the Company's system. To fulfill its obligations under such contract, the Company will construct approximately five miles of new high pressure pipeline and upgrade certain other segments of its existing facilities, representing a capital commitment of nearly $10,000,000. The Company expects construction to be completed in mid-1997.\nGAS SUPPLY\nThe Company is directly connected to Mobil's natural gas processing plant in South Mobile county and to Shell's Yellowhammer Plant. Mobile Gas has contracted for a portion of its firm supply directly with these producers. For the fiscal year ended September 30, 1995, the Company obtained approximately 70% of its gas supply from sources located in the Mobile Bay area, with the balance being obtained from interstate sources.\nTo encourage more competition among natural gas suppliers, FERC issued Order 636 in 1992. Order 636 required interstate pipelines to unbundle or separate gas sales, transportation and storage services. With the implementation of Order 636, most pipelines discontinued their traditional merchant function resulting in each local distribution company becoming responsible for obtaining all of its gas supply in the open market. While unbundling of these services allows a local distribution company, such as Mobile Gas, more flexibility in selecting and managing the type of services required to provide its customers with the lowest possible priced gas while maintaining a reliable gas supply, it also places additional responsibility on a distribution company to obtain its natural gas supply in the open market on a timely basis to fulfill commitments during peak demand periods. The Company believes that the Bay Gas storage facility, which had already been planned by the Company prior to Order 636, will enhance its ability to respond to the changes in the industry brought about by Order 636.\nThe Company has a current peak day firm requirement of 129,870 MMBTUs. Firm supply needs of 80,000 MMBTU\/day are expected to be met through the withdrawal of gas from the storage facility owned by Bay Gas. The Company also has firm supply contracts with Mobil for 10,000 MMBTU\/day through October 31, 2000 and Shell for 13,000 MMBTU\/day through December 31, 1996, through the direct connections with their processing plants. Additionally, the Company has contracted for firm transportation and storage service (\"No-Notice Service\") for 26,870 MMBTU\/day from Koch under agreements extending to April 1, 1999. In conjunction with the No-Notice Service, the Company has contracted with Koch Gas Services, an affiliate of Koch, to provide firm gas supply to April 1, 1997.\nGAS STORAGE\nConstruction of the storage facility was completed in 1994. The cavern is designed to hold up to 3.7 BCF of natural gas. Approximately 1.3 BCF of the gas to be injected into the storage cavern, called \"base gas,\" will remain in the cavern to provide sufficient pressure to maintain cavern integrity, and the remainder, approximately 2.4 BCF, represents working storage capacity. Compressors are required to inject gas into the storage facility and, because the moisture content of stored gas must be lowered to reach the requisite standard for use, dehydrators are required to treat gas upon withdrawal.\nDuring 1995, a pipeline interconnect with Florida Gas Transmission, an interstate pipeline company, was completed. Bay Gas has also entered into an agreement with Koch for a pipeline interconnection which will further expand access to interstate markets. The Koch interconnect is expected to be completed in December 1995.\nMobile Gas entered into a Gas Storage Agreement with Bay Gas under which Bay Gas agreed to provide storage of approximately one-third of the working storage capacity for an initial period of 20 years. The cavern currently has sufficient injection and withdrawal capacity to meet the requirements of the Mobile Gas storage contract. Most of the storage facility's current injection capacity of 35,000 MMBTU\/day and withdrawal capacity of 107,000 MMBTU\/day will be utilized under the Mobile Gas storage contract, under which injection capacity of 15,000 MMBTU\/day and withdrawal capacity of 80,000 MMBTU\/day are committed to Mobile Gas. The unused injection and withdrawal capacity are not anticipated to be sufficient to allow Bay Gas to provide services to any substantial additional customers; however, Bay Gas has entered into several contracts to provide interruptible storage service.\nIn the event that additional customers contract for a substantial portion of the remaining capacity of the storage facility, the Company would expend additional funds to add injection and withdrawal capacity to serve such customers. There can be no assurance that Bay Gas will enter into any such contracts.\nUnder its agreements with Olin, Bay Gas has the right to develop up to 2 additional caverns on the property leased from Olin. Olin has the right, from the time of\ncommencement of operations at the storage facility until Bay Gas makes certain required payments to Olin prior to commencement of the construction of a second cavern, to increase its ownership interest in Bay Gas by an additional 12 1\/2%, by purchasing from MGS Storage such additional percentage at a price based on the book equity of MGS Storage in Bay Gas. The Company is unable to determine at this time whether additional caverns will be developed at the storage facility, but anticipates that an additional cavern would be considered if and when contracts are obtained for the entire capacity of the first cavern.\nCOMPETITION\nGas Distribution Competition. The Company is not in significant direct competition with respect to the retail distribution of natural gas to residential and small commercial customers within its service area. Electricity competes with natural gas for such uses as cooking, water heating and space heating.\nThe Company's large commercial and industrial customers either buy natural gas from the Company or have contracted with the Company for transportation of customer-owned gas. With certain limited exceptions the Company's rates are structured so that the gross margin is the same whether gas is sold or transported. Some industrial customers have the capability to use either fuel oil, coal, wood chips or natural gas, and choose their fuel depending upon a number of factors, including the availability and price of such fuels. In recent years, the Company has had adequate supplies so that interruptible industrial customers that are capable of using alternative fuels have not had supplies curtailed, and the price of natural gas has remained at levels such that, in most cases, these industrial customers have chosen to use natural gas rather than other fuels. The Company's rate tariffs include a competitive fuel clause which allows the Company to adjust its rates to certain large commercial and industrial customers in order to compete with alternative energy sources. However, there can be no assurance that the current competitive advantage of natural gas over alternative fuels will continue. See \"Rates and Regulation.\"\nDue to the close proximity of various pipelines and gas processing plants to the Company's service area, there exists the possibility that current or prospective customers could install their own facilities and connect directly to a supply source and thereby \"bypass\" the Company's service. The Company believes that because it has worked closely with major industrial customers to meet those customers' needs, and because of its ability to provide competitive pricing under its rate tariffs, none of the Company's customers have bypassed its facilities to date. Although there can be no assurance as to future developments, the Company intends to continue its efforts to reduce the likelihood of bypass by offering competitive rates and services to such customers.\nGas Storage Competition. A number of types of competitors may provide services like or in competition with those of Bay Gas. These include, among others, natural gas storage facilities, natural gas aggregators (who rebundle services ordered unbundled by FERC Order 636), and natural gas pipelines. Bay Gas believes that its strategic\ngeographic location and its ability to charge market-based rates for interstate storage services will enable it to effectively compete with such competitors. See \"Rates and Regulation.\"\nRATES AND REGULATION\nThe Company's natural gas distribution operations are under the jurisdiction of the Alabama Public Service Commission (\"APSC\"). The APSC approves rates which are intended to permit the recovery of the cost of service including a return on investment. Rates are determined by reference to rate tariffs approved by the APSC in traditional rate proceedings or, for certain large customers, on a case-by-case basis. In addition, pursuant to APSC order, rates for a limited number of large industrial customers are determined on a privately negotiated basis. The APSC also approves the issuance of debt and equity securities and has supervision and regulatory authority over service, equipment, accounting, and other matters.\nDuring the year ended September 30, 1995, the Company petitioned the APSC for an increase in rates. On November 27, 1995, the APSC approved an increase in rates designed to generate an additional $6,890,000 in annual revenues, excluding the effects of changes in the base price of gas. The increased rates went into effect on December 1, 1995. The rates for service rendered by the Company are on file with the APSC.\nThe Company's tariffs include a purchased gas adjustment clause which allows the Company to pass on to certain of its customers increases or decreases in gas costs from those reflected in its tariff charges. Adjustments under such clauses require periodic filings with the APSC but do not require a general rate proceeding. Under the purchased gas adjustment clause, the Company has a competitive fuel clause which gives it the right to adjust its rates to certain large customers in order to compete with alternative energy sources. Any margin lost as a result of competitive fuel clause adjustments is recoverable from its other customers.\nGas deliveries to certain industrial customers are subject to regulation by the APSC through contract approval. The operations of SGT, which consist only of intrastate transportation of gas, are also regulated by the APSC.\nBay Gas is a regulated utility governed under the jurisdiction of the APSC, which issued a Certificate of Public Convenience and Necessity to Bay Gas on May 4, 1992. As a regulated utility, Bay Gas' intrastate storage contracts are subject to APSC approval. Operation of the storage cavern and well-head equipment are subject to regulation by the Oil and Gas Board of the State of Alabama. On March 25, 1994, FERC issued an order approving Bay Gas' application for permission to charge market-based rates for interstate storage services. The FERC order enables Bay Gas to provide storage services to entities outside of the State of Alabama. Market-based rates allow Bay Gas to respond to market conditions and minimizes regulatory involvement in the setting of its rates for storage services.\nThe Company has been granted nonexclusive franchises to construct, maintain and operate a natural gas distribution system in the areas in which it operates. Except for the franchise granted by Mobile County, Alabama, which has no stated expiration date, the franchises have expiration dates, the earliest of which is in 2007. The Company has no reason to believe that the franchises will not be renewed upon expiration.\nSEASONAL NATURE OF BUSINESS\nThe nature of the Company's business is highly seasonal and temperature-sensitive. As a result, the Company's operating results in any given period reflect, in addition to other matters, the impact of weather, with colder temperatures resulting in increased sales by the Company. The substantial impact of this sensitivity to seasonal conditions is reflected in the Company's results of operations and the Company anticipates that it will continue to be so reflected in future periods.\nDue to the seasonality of the Company's business, the generation of working capital is greatly impaired during the summer months because of reduced gas sales. Cash needs during this period are generally met through short-term financing arrangements or the reduction of temporary investments as is common in the industry.\nENVIRONMENTAL ISSUES\nThe Company is subject to various federal, state and local laws and regulations relating to the environment, which have not had a material effect on the Company's financial position or results of operations.\nLike many gas distribution companies, prior to the widespread availability of natural gas, the Company manufactured gas for sale to its customers. In contrast to some other companies which operated multiple manufactured gas plants, the Company and its predecessor operated only one such plant, which discontinued operations in 1933. The process for manufacturing gas produced by-products and residuals, such as coal tar, and certain remnants of these residuals are sometimes found at former gas manufacturing sites.\nThe Company conducted a preliminary assessment in 1994 of its former gas plant site and has tested certain waters in the vicinity of the site. The Company developed and has implemented a plan for the site based on the advice of its environmental consultants, which involves securing and monitoring the site, and continued testing. Based on the results of tests to date, the Company does not believe that the site currently poses any threat to human health or the environment. While no conclusion can be reached at this time as to whether any further remedial action might ultimately be required, based on currently available information, it is believed that any costs with respect to the site are likely to be immaterial, and the Company has therefore established no reserve for such costs in its financial statements. The Company intends that, should further investigation or changes in environmental laws or regulations require material expenditures for investigation,\nremediation, or clean-up with regard to the site, it would apply to the APSC for appropriate rate recovery of such costs. However, there can be no assurance that the APSC would approve the recovery of such costs or the amount and timing of any such recovery.\nEMPLOYEES\nMobile Gas employed 270 full-time employees as of September 30, 1995. Of these, approximately 38% are represented by the Oil, Chemical and Atomic Workers International Union, Local No. 3-541. As of September 30, 1995 Bay Gas employed five full-time employees. The Company believes that it enjoys generally good labor relations.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nThe Company's properties consist of distribution, general, transmission, and storage plant. The distribution plant is located in Mobile County, Alabama and is used in the distribution of natural gas to the Company's customers. The distribution plant consists primarily of mains, services, meters and regulating equipment, all of which are adequate to serve the present customers. The distribution plant is located on property which the Company is entitled to use as a result of franchises granted by municipal corporations, or on easements or rights-of-way.\nThe general plant consists of land, structures (with aggregate floor space of approximately 118,000 square feet), office equipment, transportation equipment and miscellaneous equipment, all located in Mobile County, Alabama.\nThe transmission plant consists of a pipeline of approximately 50 miles and related surface equipment which is used in the transmission of natural gas by SGT and is located primarily in Monroe County, Alabama. The transmission plant is located on easements or rights-of-way.\nThe storage plant, consisting of an underground cavern for the storage of natural gas and related pipeline and surface facilities, is located primarily in Washington County, Alabama. The storage plant is constructed on a leasehold estate with an initial term of 50 years, which will expire in 2040, and which may be renewed at the Company's option for an additional term of 20 years.\nSubstantially all of the property of the Company is pledged as collateral for the long-term debt.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nFERC Order 636 permits pipelines to recover from their customers the transition costs of restructuring their services. On October 16, 1995, Koch filed tariff sheets which have been approved by the FERC to be effective November 1, 1995, which reflect recovery\nof transition costs over a two- year period through a reservation surcharge. Based on the reservation surcharge in Koch's tariff sheets and the Company's contract reservation volumes over the next two years, the Company's share of transition costs is estimated to be $43,000.\nTake-or-pay costs represent (i) Koch's costs of buying out gas contracts with its producer-suppliers (those contracts contain clauses requiring Koch either to take the gas or to pay for it even if not taken) and (ii) the costs of buying down Koch's commitments under those contracts. As a result of a take-or-pay settlement between Koch and its customers entered into during the year ended September 30, 1993, the Company recorded a liability of $860,000 during 1993. An additional liability of $679,000 was recorded during the year ended September 30, 1994 as a result of settlements filed in 1994 which resolved all take-or-pay cost recovery issues. The above settlements have been approved by the FERC, and the Company has recovered all take-or-pay costs from its customers as allowed by the APSC. During the year ended September 30, 1995, the Company paid all remaining unpaid take-or-pay costs as required by such settlements.\nAlthough the Company is not involved currently in material litigation, the Company may from time to time be involved in litigation in the ordinary course of its business.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nNot Applicable.\nExecutive Officers of the Registrant\nPursuant to General Instruction G(3) of Form 10-K, the following list is included as an unnumbered Item in Part I of this Report in lieu of being included in the proxy statement to be filed with the Securities and Exchange Commission.\nInformation relating to executive officers who are also directors and nominees for election as directors is included under the caption \"Election of Directors\" contained in the Company's definitive proxy statement with respect to its 1996 Annual Meeting of Stockholders and is incorporated herein by reference.\nThe following is a list of names and ages of all of the executive officers who are not also directors or nominees for election as directors of the Registrant indicating all positions and offices with the Registrant held by each such person and each such person's principal occupations or employment during the past five years. All such persons have been elected for terms expiring in January 1996. Officers serve at the pleasure of the Board of Directors of the Company.\n* Mr. Downing is the son-in-law of Gaylord C. Lyon, a Director of the Company.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Stock Equity and Related Stockholder Matters.\nThe Registrant's Common Stock, $2.50 par value, is traded on the NASDAQ National Market under the symbol \"MBLE\". As of December 15, 1995 there were 1,630 holders of record of the Company's common stock. Information regarding Common Stock dividends and the bid price range for Common Stock during the periods indicated is as follows:\nOver-the-counter quotations reflect inter-dealer prices without retail mark-up, mark-down or commissions and may not necessarily represent actual transactions.\nWhile the Board of Directors intends to continue the practice of paying dividends quarterly, amounts and dates of such dividends as may be declared will be dependent upon the Registrant's future earnings, financial requirements, and other factors.\nThe Registrant's long-term debt instruments contain certain debt to equity ratio requirements and restrictions on the payment of cash dividends and the purchase of shares of its capital stock. At September 30, 1995, under the most limiting of such provisions, retained earnings in the amount of $10,143,177 was unrestricted.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nNote: (1) The number of degrees that the daily mean temperature falls below 65 degrees F.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nTHE COMPANY\nThe Company's natural gas distribution operations are under the jurisdiction of the Alabama Public Service Commission (APSC). The Company's rate tariffs allow the cost of gas supplies and certain taxes to be passed through to customers. These costs, therefore, ultimately have little impact on the Company's earnings. Other costs, including a return on investment, must be recovered through rates approved in traditional rate proceedings. (See Note 13 to the Consolidated Financial Statements.)\nThe nature of the Company's distribution business is highly seasonal and temperature sensitive. As a result, in addition to other matters, the Company's operating results in any given period reflect the impact of weather through either increased or decreased sales volumes.\nBay Gas, which commenced operations in September 1994, is a regulated utility governed under the jurisdiction of the APSC and as such, Bay Gas' intrastate storage contracts are subject to APSC approval. In addition, by Federal Energy Regulatory Commission order, Bay Gas is permitted to charge market-based rates for interstate storage services.\nRESULTS OF OPERATIONS\nNET INCOME\nThe Company's net income for 1995 amounted to $4.0 million or $1.26 per share compared to $4.9 million or $1.78 per share for 1994. The 1995 decrease in net income reflects the impact of one of the warmest winters on record in 1995 compared to a 1994 winter that was 7.9% colder than normal. Earnings per share in 1995 were also impacted by the September 1994 issuance of 460,000 shares of Common Stock. The major portion of the proceeds from the stock issuance were invested into Bay Gas which, in its first year of operation, made only a limited contribution to net income. Currently, Bay Gas has a contract with Mobile Gas to provide firm storage services and contracts with third parties to provide interruptible storage services. Because certain construction would be required to provide storage services to significant additional customers, revenues from contracts with such customers, if any, would not have a significant positive effect on the company's earnings per share prior to fiscal 1997. There can be no assurance that Bay Gas will enter into any such contracts. By APSC order, any losses from Bay Gas will not be recoverable through increased rates to Mobile Gas customers.\nNet income of $4.9 million or $1.79 per share was reported for 1993. An increase from 1993 to 1994 in operating income of $902,000 was offset by an increase in interest expense of $885,000.\nOPERATING REVENUES\nGross revenues from the sale and transportation of natural gas totaled $56.2 million in 1995, $60.5 million in 1994, and $54.3 million in 1993. The decrease in 1995 gross revenues reflects the impact of warmer weather which was 27.5% warmer than 1994 and 21.8% warmer than normal. Gas volumes sold and delivered to temperature sensitive customers, who are primarily residential and small commercial customers, tend to fluctuate as a function of weather. Temperature sensitive volumes decreased 13.0% in 1995, which resulted in a $4.8 million or 10.1% decrease in revenues from these customers as compared to 1994. Offsetting the decrease in gas revenues from temperature sensitive customers was a 7.9% increase in gas volumes sold and delivered in 1995 to industrial and large commercial customers. Revenues from these customers increased $253,000 or 2.1% in 1995 as compared to 1994 as a result of increased plant utilization by such customers. Another offset to the decrease in revenue from temperature sensitive customers was the effect of the first full year of operation of Bay Gas. Non-intercompany revenues from Bay Gas operations increased $232,000 in 1995 as compared to 1994.\nThe increase in gross revenues for 1994 compared to 1993 reflects the effect of the first full year of operations of customers acquired from the Utilities Board of the Town of Citronelle (\"Citronelle\") in May 1993. These customers accounted for $2.7 million of the increase in revenues. Also contributing to the increase in revenues was the effect of weather which in 1994 was 14.0% colder than 1993 and 7.9% colder than normal. As a result of the colder weather and the acquisition of Citronelle, gas volumes sold and delivered to temperature sensitive customers in 1994 increased 12.2% as compared to 1993.\nMerchandise sales and jobbing revenues were $2.9 million in 1995, $2.8 million in 1994, and $2.5 million in 1993. The increases for both years resulted primarily from increased sales volumes.\nEXPENSES\nCost of gas decreased $6.9 million or 27.5% in 1995 compared to 1994. The 1995 decrease is primarily attributed to the Company's use of the Bay Gas storage facility, as opposed to interstate pipeline companies' facilities, for storage of gas which is used as a firm gas supply to ensure that a certain amount of gas supply is available during peak demand periods. Amounts paid to Bay Gas of $4.1 million for gas storage services, a component of gas costs, have been eliminated in consolidation. Another factor in the 1995 decrease is the 9.6% decrease in gas volumes sold to customers during 1995. Cost of gas increased $2.9 million or 12.8% in 1994 compared to 1993 as a result of factors discussed above which influenced gas revenues.\nCost of merchandise and jobbing decreased $49,000 or 2.2% in 1995 despite an increase in merchandise and jobbing revenue as a result of higher profit margins realized\non 1995 sales. Cost of merchandise and jobbing increased $248,000 or 12.7% primarily as a result of increased sales volumes reported in 1994.\nOperations expense increased $913,000 or 6.1% in 1995 as compared to 1994. Of this increase, $647,000 is attributed to the first full year of Bay Gas operations, with the remaining increase due to general inflation. Operations expense increased $1.2 million or 8.5% in 1994 compared to 1993 as a result of servicing additional customers acquired from Citronelle and the colder weather experienced in 1994. Also contributing to the 1994 increase were special promotional expenses.\nMaintenance expense increased $241,000, or 19.3% in 1994 compared to 1993. The 1994 increase resulted from the additional customers acquired from Citronelle and certain structural repairs made to buildings.\nDepreciation expense increased $1.0 million or 26.0% in 1995 compared to 1994 and $545,000 or 15.7% in 1994 compared to 1993. Increases for both years were due to continued growth in depreciable plant in service. Depreciation attributable to Bay Gas accounted for $776,000 of the increase in 1995, while assets acquired from Citronelle accounted for $393,000 of the increase in 1994.\nTaxes, other than income taxes, consist primarily of state and local taxes which are based on gross revenues and fluctuate accordingly. These taxes are passed through to customers and thus do not impact the Company's net income. Another component of taxes, other than income taxes, is taxes paid on property. Bay Gas property taxes and other taxes increased $362,000 as a result of the first full year of operations. As a result, taxes other than income taxes increased in 1995 compared to 1994 despite lower revenues in 1995.\nGross interest expense increased $66,000 or 1.2% in 1995 and $1.5 million or 37.3% in 1994. An increase in short-term borrowings accounted for the 1995 increase while the Company's issuance of $12 million of 7.48% Series First Mortgage Bonds in July 1993 and $22.5 million of 8.19% Guaranteed Senior Secured Notes (\"Bay Gas Notes\") during 1993 accounted for the increase in 1994. Interest on the Bay Gas Notes was capitalized during construction of the storage facility and is reflected in the allowance for borrowed funds used during construction, which has the effect of reducing net interest expense. As a result of the commencement of Bay Gas operations in September 1994, interest on the Bay Gas Notes was no longer capitalized during 1995, which increased net interest expense by $2.0 million.\nHigher interest income in 1993 results from earnings on the temporary investment of the funds received upon issuance of the two First Mortgage Bonds by the Company in advance of the funds being expended.\nIncome taxes fluctuated with the changes in pre-tax income. The Company's effective tax rates in 1995, 1994, and 1993 were 36.0%, 36.4% and 35.9% respectively. Income tax expense is detailed in Note 7 to the Consolidated Financial Statements.\nEFFECTS OF INFLATION\nInflation impacts the prices the Company must pay for labor and other goods and services required for operation, maintenance and capital improvements. Changes in purchased gas costs are passed through to customers in accordance with the approved provision of the Company's rate tariffs. Increases in other costs must be recovered through timely filings for rate relief.\nGAS SUPPLY\nA primary goal of the Company is to provide gas at the lowest possible cost while maintaining a reliable long-term supply. To accomplish this goal the Company has diversified its gas supply by constructing and purchasing pipelines to access the vast gas reserves in our area, both offshore and onshore. The Company has also contracted with certain of these sources for firm supply. In addition, the Company has completed construction of a storage cavern which provides for a major portion of the Company's peak day needs. The storage cavern commenced operations in September 1994 when the Company began to inject gas for storage. The diversification of sources gives the Company more flexibility to obtain gas at the most favorable prices. See Note 3 to the Consolidated Financial Statements for a discussion of certain gas supply issues.\nENVIRONMENTAL\nThe Company is subject to various federal, state, and local laws and regulations relating to the environment, which thus far have not had a material effect on the Company's financial position or results of operations. See Note 10 to the Consolidated Financial Statements for a discussion of certain environmental issues.\nCAPITAL RESOURCES AND LIQUIDITY\nThe Company's cash needs reflect the capital-intensive nature of its business. The following table briefly describes capital expenditures in the periods indicated:\nFiscal Years Ended September 30, (In thousands)\nThe Company generally relies on internally generated funds and short-term borrowings to meet working capital requirements and temporarily finance normal capital expenditures. Cash flows from operating activities were lower in 1995 as compared to 1994\ndue primarily to decreased net income and the change in operating assets and liabilities. These two factors which decreased cash flow were partially offset by an increase in depreciation in 1995. The fluctuation in operating assets and liabilities is generally the result of the timing of cash receipts and payments. Funds provided by operations totaled $8.9 million in 1995, representing 57% of the Company's cash needs during such period, the remainder of which was obtained through reduction of temporary investments and cash equivalents and by drawings upon the Company's revolving credit agreement. Funds provided by operations totaled $13.0 million in 1994, representing 40% of the Company's cash needs. Additional funding in 1994 was provided through reduction of temporary investments and by the issuance of 460,000 shares of Common Stock during September 1994. Funds provided by operations accounted for 24% of the Company's cash needs in 1993 with the remainder of the Company's cash needs provided by the issuance of long-term debt.\nIn 1993, additional financing was required for the $11.6 million purchase of a portion of the gas distribution system of Citronelle. Mobile Gas issued a $4.1 million 9%, 20-year unsecured note to Citronelle for the purchase and also issued $12.0 million in 7.48% Series First Mortgage Bonds due 2023, which funded the cash portion of the purchase price related to the Citronelle acquisition, as well as the early retirement of an aggregate principal amount of $4.4 million of the 8% Series First Mortgage Bonds due 1997 and the 9.35% Series First Mortgage Bonds due 1996.\nThe Bay Gas Storage facility is able to hold up to 3.7 billion cubic feet (\"BCF\") of natural gas, of which approximately 2.4 BCF represents working storage capacity and 1.3 BCF represents base gas to remain in the cavern to provide sufficient pressure to maintain cavern integrity. Capital costs as of September 30, 1995, which include an interconnect with Florida Gas Transmission, an interstate pipeline company, were approximately $33.3 million plus an additional $1.7 million for base gas. Funds for the development and construction of the Bay Gas storage facility have come from private issuance of the $22.5 million of Bay Gas Notes, pursuant to an Indenture of Mortgage which secures the Bay Gas Notes. Additional funds have come from cash equivalents on hand and Mobile Gas' issuance of 460,000 shares of Common Stock in September 1994, which generated net proceeds of $9.3 million.\nBay Gas has entered into an agreement with Koch Gateway Pipeline Company for a pipeline interconnection which will further expand access to interstate markets. Expected to be completed in December 1995 at a cost to Bay Gas of $1,000,000, this interconnect will be funded through an equity contribution from the Bay Gas partners to Bay Gas. Funds for such equity contribution by Mobile Gas will be obtained from short-term bank borrowings.\nCurrently, Bay Gas has a contract with Mobile Gas to provide storage of approximately one-third of the working storage capacity of the storage facility or approximately .8 BCF. Additionally, Bay Gas has entered into several contracts to provide interruptible storage service. Should Bay Gas enter into significant contracts to provide firm\nstorage services, additional equipment, which will consist primarily of compressors and dehydrators, will need to be added to give the storage facility sufficient injection and withdrawal capacity. The Company estimates that up to $6.7 million in capital expenditures, plus $850,000 for additional base gas (based on current costs) would be required to efficiently utilize all the remaining storage capacity of the storage facility. The Company ultimately intends to finance the cost of these additional facilities by issuing up to $7.5 million in debt under the Bay Gas Indenture and through an equity contribution from the Bay Gas partners to Bay Gas. Funds for such equity contribution by Mobile Gas would be obtained from short-term bank borrowings and funds provided by operations. The Company anticipates that additional base gas costs would also be financed from short-term bank borrowings.\nDuring 1995, Mobile Gas entered into a long-term contract with an industrial customer to transport gas to the customer's facility. In order to service the customer by mid 1997, an estimated $10 million in new facilities will be constructed by the Company. At September 30, 1995, $150,000 had been expended on constructing these facilities.\nIn addition to the cash requirements of Bay Gas, the Company anticipates fiscal 1996 capital expenditures related to the Company's regular construction program to be $6.4 million. Funds for the Company's cash needs other than Bay Gas are expected to come primarily from internal cash generation and draws upon the Company's unused committed lines of credit totaling $18.2 million at September 30, 1995. Management believes it has adequate financial flexibility to meet its anticipated cash needs in the foreseeable future.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nThe financial statements and financial statement schedules and the Independent Auditors' Report thereon filed as part of this report are listed in the \"Mobile Gas Service Corporation and Subsidiaries Index to Financial Statements and Schedules\" at Page, which follows 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 under the captions \"Election of Directors\" and \"Information Regarding the Board of Directors\" contained in the Company's definitive proxy statement with respect to its 1996 Annual Meeting of Stockholders is incorporated herein by reference.\nFor information with respect to executive officers of the Registrant, see \"Executive Officers of the Registrant\" at the end of Part I of this Report.\nInformation under the caption \"Reports Under Section 16 of the Securities and Exchange Act\" contained in the Company's definitive proxy statement with respect to its 1996 Annual Meeting of Stockholders is incorporated herein by reference.\nItem 11.","section_11":"Item 11. Executive Compensation.\nInformation under the caption \"Executive Compensation\" contained in the Company's definitive proxy statement with respect to its 1996 Annual Meeting of Stockholders is incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nInformation under the caption \"Security Ownership of Certain Beneficial Owners and Management\" contained in the Company's definitive proxy statement with respect to its 1996 Annual Meeting of Stockholders is incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nNot Applicable.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.\n(a), (d) Financial Statements and Financial Statement Schedules\nSee \"Mobile Gas Service Corporation and Subsidiaries Index to Financial Statements and Schedules\" at page , which follows Part IV hereof.\n(3) Exhibits - See Exhibit Index on pages E-1 through E-4.\n(b) No reports on Form 8-K were filed during the last quarter of the fiscal year ended September 30, 1995.\n(c) Exhibits filed with this report are attached 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.\nMOBILE GAS SERVICE CORPORATION ------------------------------ Registrant\nBy: \/s\/ Charles P. Huffman ------------------------------------- Charles P. Huffman, Vice President, 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:\nSignatures (Continued)\nMOBILE GAS SERVICE CORPORATION AND SUBSIDIARIES\nINDEX TO FINANCIAL STATEMENTS AND SCHEDULES\nINDEPENDENT AUDITORS' REPORT\nMobile Gas Service Corporation:\nWe have audited the accompanying consolidated balance sheets of Mobile Gas Service Corporation and subsidiaries as of September 30, 1995 and 1994 and the related consolidated statements of income, common stockholders' equity, and cash flows for each of the three fiscal years in the period ended September 30, 1995. Our audits also included the financial statement schedules listed in the Index referred to in Item 14. These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by Management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Mobile Gas Service Corporation and its subsidiaries at September 30, 1995 and 1994, and the results of their operations and their cash flows for each of the three fiscal years in the period ended September 30, 1995, 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 7 to the Consolidated Financial Statements, the Company changed its method of accounting for income taxes effective October 1, 1993.\n\/s\/ Deloitte & Touche LLP - ------------------------- Deloitte & Touche LLP\nMobile, Alabama October 31, 1995\nCONSOLIDATED BALANCE SHEETS\nASSETS\nSee Accompanying Notes to Consolidated Financial Statements\nCONSOLIDATED BALANCE SHEETS\nCAPITALIZATION AND LIABILITIES\nSee Accompanying Notes to Consolidated Financial Statements.\nCONSOLIDATED STATEMENTS OF INCOME\nSee Accompanying Notes to Consolidated Financial Statements.\npage CONSOLIDATED STATEMENTS OF CASH FLOWS\nSee Accompanying Notes to Consolidated Financial Statements.\nCONSOLIDATED STATEMENTS OF COMMON STOCKHOLDERS' EQUITY\nSee Accompanying Notes to Consolidated Financial Statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the accounts of Mobile Gas Service Corporation, its wholly-owned subsidiaries, MGS Energy Services, Inc., MGS Storage Services, Inc., MGS Marketing Services, Inc., its 87.5% owned partnership, Bay Gas Storage Company, Ltd. (Bay Gas), and its 51% owned partnership, Southern Gas Transmission Company (collectively the\"Company\"). All significant intercompany balances and transactions have been eliminated.\nPROPERTY, PLANT, AND EQUIPMENT\nThe cost of additions includes direct labor and materials, allocable administrative and general expenses, pension and payroll taxes, and an allowance for funds used during construction. The cost of depreciable property retired, plus cost of dismantling, less salvage, is charged to accumulated depreciation. Estimated interest cost associated with property under construction, based upon weighted average interest rate for short-term borrowings or the interest rate on borrowings for specific projects, is capitalized as an allowance for borrowed funds used during construction.\nMaintenance, repairs, and minor renewals and betterment of property are charged to operations.\nProvisions for depreciation are computed principally on straight-line rates for financial statement purposes and on accelerated rates for income tax purposes. Depreciation for financial statement purposes is provided at an annual rate averaging approximately 4% of depreciable property, excluding the gas storage facility which is depreciated at an annual rate averaging 2.7%.\nCASH EQUIVALENTS\nThe Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. Temporary investments, consisting of certificates of deposit, committed to be used for construction are excluded from cash equivalents.\nREVENUES AND GAS COSTS\nRates charged to gas customers are subject to the jurisdiction of the Alabama Public Service Commission (APSC). Increases or decreases in the cost of gas and certain other costs are passed through to customers in accordance with provisions in the Company's rate schedules. Any over or under recoveries of these costs are charged or credited to cost of gas and included in current assets or liabilities.\nRevenues from residential and commercial customers are recorded as meters are read on a cycle basis throughout each month. The commodity cost of purchased gas applicable to gas delivered to customers but not yet billed under the cycle billing method is deferred.\nINCOME TAXES\nBeginning October 1, 1993, the Company adopted the Statement of Financial Accounting Standards No. 109,\"Accounting for Income Taxes\" (\"SFAS 109\"). SFAS 109 required the Company to change to the asset and liability method of accounting for income taxes which required the establishment of deferred tax liabilities and assets, as measured by enacted tax rates, for all temporary differences caused when the tax basis of an asset or liability differs from that reported in the financial statements. Due to the regulated nature of the Company's utility business, the primary effect of adoption of this statement was recorded as a regulatory asset. The effect on income as a result of the adoption of this statement was not significant.\nFor fiscal year ended September 30, 1993, deferred income taxes are generally recorded for timing differences between book and taxable income. The tax effect of differences in book and tax depreciation related to pre-1981 property additions, however, was flowed through to income.\nInvestment tax credits realized after 1980 are deferred and amortized over the average life of the related property in accordance with regulatory treatment.\nRECLASSIFICATIONS\nCertain amounts in the prior year financial statements have been reclassified to conform with the 1995 financial statement presentation.\n2. DETAIL OF SELECTED BALANCE SHEET ACCOUNTS\nTHE FUNCTIONAL CLASSIFICATIONS FOR THE COST OF PROPERTY, PLANT, AND EQUIPMENT ARE AS FOLLOWS AT SEPTEMBER 30, (IN THOUSANDS):\nTHE COMPONENTS OF REGULATORY ASSETS ARE AS FOLLOWS AT SEPTEMBER 30, (IN THOUSANDS):\n3. REGULATORY MATTERS\nDESCRIPTION OF BUSINESS\nThe Company is engaged principally in the distribution of natural gas to residential, commercial, and industrial customers in South Alabama subject to regulation by the APSC. For the major portion of the Company's business, the APSC approves rates which are intended to permit the recovery of the cost of service including a return on investment. Gas deliveries to certain industrial customers are subject to regulation by the APSC through contract approval. In September 1994, Bay Gas completed the development and construction of a natural gas storage facility located in a salt dome near the north end of the Company's service area. As a separate utility regulated by the APSC, Bay Gas' intrastate storage contracts require APSC approval. In addition, by Federal Energy Regulatory Commission order, Bay Gas is permitted to charge market-based rates for interstate storage services. The Company is also engaged in various unregulated activities including the sale and financing of gas appliances, jobbing work, and contract and consulting work for utilities and industrial customers. Substantially all property, plant, and equipment is considered utility plant. Included in property, plant, and equipment are acquisition adjustments, net of amortization, of $9,203,000 and $9,592,000 at September 30, 1995 and 1994, respectively. Such acquisition adjustments are being amortized to cost of service over the lives of the assets acquired.\nFERC ORDER 636\nIn April 1992, the Federal Energy Regulatory Commission (FERC) issued Order 636 which requires pipeline companies to unbundle services such as transportation and storage from traditional merchant service and offer these services on a nondiscriminatory basis to all shippers of natural gas. The Company and Koch Gateway Pipeline Company (Koch), formerly United Gas Pipe Line Company, have entered into contracts, approved by the FERC and effective April 1, 1994, complying with Order 636 methodology. Approximately twenty percent of the Company's firm gas supply is delivered under such contracts. Pricing under the contracts in accordance with Order 636 has not had a material impact on the Company's cost of gas. The remaining firm gas supply for the Company is obtained from intrastate sources and the Company's own storage facility.\nOrder 636 permits pipelines to recover from their customers the transition costs of restructuring their services. On October 16, 1995, Koch filed tariff sheets, which have been approved by the FERC to be effective November 1, 1995, which reflect recovery of transition costs over a two-year period through a reservation surcharge. Based on the reservation surcharge in Koch's tariff sheets and the Company's contract reservation volumes over the next two years, the Company's share of transition costs is estimated to be $43,000.\nTAKE-OR-PAY COSTS\nAs a result of a take-or-pay cost settlement between Koch and its customers entered into during the year ended September 30, 1993, the Company recorded a liability of $860,000 during 1993. An additional liability of $679,000 was recorded during the year ended September 30, 1994 as a result of settlements filed in 1994 which resolved all take-or-pay cost recovery issues. The above settlements have been approved by the FERC, and the Company has recovered all take-or-pay costs from its customers as allowed by the APSC. During the year ended September 30, 1995, the Company paid all remaining unpaid take-or-pay costs as required by such settlements.\n4. CAPITAL STOCK\nIn January 1993, the stockholders approved the Mobile Gas Service Corporation 1992 Stock Option Plan (\"the Plan\") which provides for the granting of incentive stock options, non-qualified stock options, and stock appreciation rights to key employees. Under the Plan, 150,000 shares of the Company's authorized but unissued common stock have been reserved for issuance. No stock options or stock appreciation rights had been granted as of September 30, 1994. During the year ended September 30, 1995, 105,000 options were granted at an option price of $21.125, representing the market price on the date of the grant. Stock options become 25% exercisable on the first anniversary of the date of grant, and an additional 25% become exercisable each succeeding year. No stock options were exercised during 1995 and no stock options are exercisable at September 30, 1995. As of September 30, 1995, there remained 45,000 shares for which options may be granted under the Plan.\nAt September 30, 1995, 24,000 shares of the Company's authorized but unissued common stock were reserved for issuance under the Company's Dividend Reinvestment Plan.\n5. RESTRICTIONS ON RETAINED EARNINGS\nThe Company's long-term debt instruments contain certain debt to equity ratio requirements and restrictions on the payment of cash dividends and the purchase of shares of its capital stock. At September 30, 1995, under the most limiting provisions, retained earnings in the amount of $10,143,177 were unrestricted.\n6. LONG-TERM DEBT\nLONG-TERM DEBT CONSISTS OF THE FOLLOWING AT SEPTEMBER 30, (IN THOUSANDS):\nMaturities and sinking fund requirements on long-term debt in each of the five fiscal years subsequent to September 30, 1995 are as follows: 1996 - $1,719,000; 1997 -$2,068,000; 1998 - $2,180,000; 1999 - $2,100,000; and 2000 - $1,962,000.\nSubstantially all of the property of the Company is pledged as collateral for the long-term debt.\nAt September 30, 1995, the Company had a $20 million revolving credit agreement which expires in July 1997, with a group of banks. Drawings upon the agreement may be made as needed providing that the Company is in compliance with certain covenants in the revolving credit agreement and other loan agreements. The Company currently is in compliance with all such convenants. The Company pays a fee for its committed lines of credit rather than maintain compensating balances. The commitment fee is 0.125% of the average daily unborrowed amount during the annual period of calculation. Unused committed lines of credit at September 30, 1995 were $18.2 million. Short-term borrowings outstanding were $1.8 million with a weighted average interest rate of 6.875% at September 30, 1995. There were no short-term borrowings at September 30, 1994.\n7. INCOME TAXES\nTHE COMPONENTS OF INCOME TAX EXPENSE ARE AS FOLLOWS FOR THE YEARS ENDED SEPTEMBER 30, (IN THOUSANDS):\nTHE TAX EFFECT OF TIMING DIFFERENCES IS AS FOLLOWS FOR THE YEAR ENDED SEPTEMBER 30, (IN THOUSANDS):\nA RECONCILIATION OF INCOME TAX EXPENSE AND THE AMOUNT COMPUTED BY MULTIPLYING INCOME BEFORE INCOME TAXES BY THE STATUTORY FEDERAL INCOME TAX RATE FOR THE PERIODS INDICATED IS AS FOLLOWS FOR THE YEARS ENDED SEPTEMBER 30, (IN THOUSANDS):\nChanges in the deferred income taxes relating to utility operations arising from the adoption of SFAS 109 represent income taxes recoverable through future rates over the life of the related assets and liabilities. A regulatory asset of $1,569,000 and $1,736,000 at September 30, 1995 and 1994, respectively, has been recorded as a result of the increase in the net deferred tax liability related to utility operations. In accordance with the current rate making practices followed by the APSC, the tax effect of these differences is expected to be collected in customer rates when such taxes become payable.\nNo valuation allowance 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.\nTHE SIGNIFICANT TAX COMPONENTS OF THE COMPANY'S NET DEFERRED TAX LIABILITY AS OF SEPTEMBER 30, ARE (IN THOUSANDS)\n8. RETIREMENT PLANS AND OTHER BENEFITS\nThe Company has a noncontributory, defined benefit retirement plan covering substantially all of its employees. Benefits are based on the greater of amounts resulting from two different formulas: years of service and average compensation during the last five years of employment or years of service and compensation during the term of employment. The\"projected unit credit\" actuarial method was used to determine the service cost and actuarial liability. The Company annually contributes to the plan an amount deductible for Federal income tax purposes.\nNET PERIODIC PENSION COST INCLUDED THE FOLLOWING COMPONENTS FOR THE YEARS ENDED SEPTEMBER 30, (IN THOUSANDS):\nASSUMPTIONS USED IN THE ACTUARIAL COMPUTATIONS FOR THE YEARS ENDED SEPTEMBER 30 WERE:\nTHE FOLLOWING TABLE SETS FORTH THE PLAN'S FUNDED STATUS AND AMOUNT RECORDED IN THE FINANCIAL STATEMENTS AT SEPTEMBER 30, (IN THOUSANDS):\nThe Company's eligible employees may participate in the Employee Savings Plan or the Bargaining Unit Employee Savings Plan by investing a percentage of their compensation in the Plans with the Company matching a part of the employee investment. The Company's contributions for the years ended September 30, 1995, 1994, and 1993 were $177,000, $162,000, and $145,000, respectively.\n9. OTHER POSTEMPLOYMENT BENEFITS\nThe Company provides certain health care and life insurance benefits for retired employees. Substantially all employees may become eligible for such benefits if they retire under the provisions of the Company's retirement plan.\nThe Company is accruing costs over the expected service period of the employees. The\"projected unit credit\" actuarial method was used to determine the service cost and actuarial liability.\nNET PERIODIC POSTRETIREMENT BENEFIT COST INCLUDED THE FOLLOWING COMPONENTS FOR THE YEARS ENDED SEPTEMBER 30, (IN THOUSANDS):\nThe September 30, 1995 accumulated benefit obligation was determined using an assumed health care cost trend rate of 10.7% in 1995, gradually declining to 5.0% in the year 2006 and thereafter. The September 30, 1994 accumulated benefit obligation was determined using an assumed health care cost trend rate of 13.7% in 1994 which gradually declines to 6.5% in the year 2010 and thereafter. If the health care cost trend rate assumptions were increased by 1%, the accumulated postretirement benefit obligation as of September 30, 1995 would be increased by 10.7%. The effect of this change on the sum of the service cost and interest cost components would be an increase of 11.6%.\nTHE FOLLOWING TABLE SETS FORTH THE PLAN'S FUNDED STATUS AND AMOUNT RECORDED IN THE FINANCIAL STATEMENTS AT SEPTEMBER 30, (IN THOUSANDS):\nThe unrecognized net loss has resulted principally from a difference between estimated and actual health care costs.\nIn September 1991, the Company formed two voluntary employees' beneficiary association (VEBA) trusts to fund postretirement health and life insurance benefits. The Company's contributions to this plan in 1995, 1994 and 1993 were $218,000, $200,000 and $450,000, respectively.\nBeginning October 1, 1994, the Company adopted the Statement of Financial Accounting Standards No. 112,\"Employers' Accounting for Postemployment Benefits\" (\"SFAS 112\"). SFAS 112 required the Company to record the cost of providing postemployment benefits to former or inactive employees, their beneficiaries, and covered dependents after employment but before retirement. For the year ended September 30, 1995, the Company recorded a liability for postemployment benefits of $211,000 with a corresponding charge to regulatory assets. The regulatory asset is expected to be amortized to expense and will be recovered from customers through rates paid over a period to be determined by the APSC.\n10. COMMITMENTS AND CONTINGENCIES\nThe Company has contracts, which expire at various dates through the year 2000, for firm supplies of natural gas. A portion of firm supply requirements are expected to be met through the withdrawal of gas from the storage facility owned by Bay Gas. Mobile Gas Service Corporation has entered into a Gas Storage Agreement under which Bay Gas is to provide storage services for an initial period of 20 years which began in September 1994 with the commencement of commercial operations of the storage facility. The purchased gas adjustment provisions of the Company's rate schedules permit the recovery of gas costs from the Company's customers.\nThe Company is subject to various federal, state and local laws and regulations relating to the environment which have not had a material effect on the Company's financial position or results of operations.\nLike many gas distribution companies, prior to the widespread availability of natural gas, the Company manufactured gas for sale to its customers. In contrast to some other companies which operated multiple manufactured gas plants, the Company and its predecessor operated only one such plant, which discontinued operations in 1933. The process for manufacturing gas produced by-products and residuals, such as coal tar, and certain remnants of these residuals are sometimes found at former gas manufacturing sites.\nThe Company conducted a preliminary assessment in 1994 of its former gas plant site and has tested certain waters in the vicinity of the site. The Company developed and has implemented a plan for the site based on advice of its environmental consultants, which involves securing and monitoring the site, and continued testing. Based on the results of tests to date, the Company does not believe that the site currently poses any threat to human health or the environment. While no conclusion can be reached at this time as to whether any further remedial action might ultimately be required, based on currently available information, it is believed that any costs with respect to the site are likely to be immaterial, and the Company has therefore established no reserve for such costs in its financial statements. The Company intends that, should further investigation or changes in environmental laws or regulations require material expenditures for investigation, remediation, or clean-up with regard to the site, it would apply to the APSC for appropriate rate recovery of such costs. However, there can be no assurance that the APSC would approve the recovery of such costs or the amount and timing of any such recovery.\n11. ACQUISITION OF GAS SYSTEM\nOn May 13, 1993, the Company purchased a portion of the assets of the gas distribution system of the Utilities Board of the Town of Citronelle. The cost of the acquisition was $11.6 million. The purchase price consisted of cash and a $4.1 million 9% note payable over 20 years. The assets acquired, consisting primarily of utility plant, were recorded at their fair values using the purchase method of accounting. The acquired system serves approximately 8,000 customers in Mobile County, Alabama.\nThe following unaudited pro forma information for the year ended September 30, 1993 presents the consolidated results of operations of the Company and Citronelle as if the acquisition had occurred on October 1, 1992. The pro forma information is not necessarily indicative of the results of operations which would have actually been obtained during such period (in thousands, except per share data).\n12. QUARTERLY FINANCIAL DATA (UNAUDITED)\nQUARTERLY FINANCIAL DATA FOR 1995 AND 1994 IS SUMMARIZED AS FOLLOWS (IN THOUSANDS, EXCEPT PER SHARE DATA):\nThe pattern of quarterly earnings reflects a seasonal nature because weather conditions strongly influence operating results.\n13. SUBSEQUENT EVENT (UNAUDITED)\nDuring the year ended September 30, 1995, the Company petitioned the APSC for an increase in rates. Subsequent to year-end, the APSC approved an increase in rates designed to generate an additional $6,890,000 in annual revenues, excluding the effects of changes in the base price of gas. The increased rates went into effect on December 1, 1995.\nSCHEDULE II\nMOBILE GAS SERVICE CORPORATION AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS AND RESERVES YEARS ENDED SEPTEMBER 30, 1995, 1994 AND 1993 (in thousands)\nNOTES: (1) Accounts written off - net of recoveries.\nS-1 MOBILE GAS SERVICE CORPORATION EXHIBIT INDEX\nE-1\nE-2\nE-3\n*Filed herewith\n** Management contract or compensatory plan or arrangement\nE-4","section_15":""}
{"filename":"75439_1995.txt","cik":"75439","year":"1995","section_1":"ITEM 1. BUSINESS\nGeneral\nBell National Corporation (\"Bell National\" and together with its subsidiaries, the \"Company\") was incorporated in California on October 1, 1958. Through 1985, its principal subsidiary was Bell Savings and Loan Association (\"Bell Savings\"), a state chartered savings and loan association. On July 25, 1985, the Federal Home Loan Bank Board appointed the Federal Savings & Loan Insurance Corporation (\"FSLIC\") as receiver of Bell Savings. At the same time, the assets of Bell Savings were transferred to a new, unrelated, federally chartered mutual savings and loan association, Bell Federal. The FSLIC's appointment followed shortly after a determination that Bell Savings had a negative net worth. On August 20, 1985, Bell National filed a voluntary petition under Chapter 11 of the Bankruptcy Code. A Plan of Reorganization (the \"Plan\") was approved by the Bankruptcy Court, and became effective June 29, 1987.\nAfter emerging from bankruptcy proceedings in June 1987, and after a vote by shareholders to continue the operations of Bell National in October 1988, the Company reached an agreement (\"Stock Purchase Agreement\") with Milley Management Incorporated (\"MMI\"), a private investment firm, in 1989 whereby Bell National sold to a group of private investors Common Stock totaling approximately 41% of the outstanding voting shares on a fully diluted basis.\nOn June 15, 1990, Bell National purchased 100% of the common stock of Payne Fabrics, Inc. (\"Payne\"), a designer and distributor of decorative drapery and upholstery fabrics, for a purchase price of $6,493,000 and the issuance of stock appreciation rights. Bell National's other wholly owned subsidiaries, Bell Savings and Pacific Coast Holdings Insurance Company, have no operations or any significant assets or liabilities.\nPayne Business Summary\nPayne, a designer and distributor of high quality fabric and wall coverings since 1865, sells to the home furnishing industry. The Company's products include printed and plain textured drapery fabric, woven upholstery fabric, sheer-casement window fabrics, trimmings and wallpaper. The selection, design and distribution of decorative cut fabrics comprise approximately 90% of the Company's annual revenues. The Company also custom manufactures draperies and bedding items primarily for institutions; these sales represent the remaining 10% of total revenue.\nPayne keeps in stock more than 7,100 different fabrics, composed of as many as 1,520 patterns, of which roughly half represent exclusive Payne designs. Most patterns are produced in four to five color combinations. Payne's fabrics reflect classical and traditional patterns adapted to\ncontemporary color combinations and weave blends. The Company's product line offers the decorator the ability to purchase fabric from a single source.\nThe Company introduces approximately twenty collections, composed of 1,500 fabrics, or 20% of its product line each year in its fall and spring fabric introductions. Each fabric collection is organized around a common theme which is generally built upon in subsequent introductions as well as being designed to coordinate with other collections. The Company believes that its current number of fabrics and patterns represent an appropriate product mix for its targeted markets, the medium and upper price ranges, of the decorative cut fabric market. The Company plans to maintain its current level of patterns by retiring approximately the same number of patterns that it introduces each year in its semiannual collections. To facilitate the inventory reductions, the Company maintains an outlet store in Dayton, Ohio where remnant fabric pieces of less than five yards and obsolete inventory are sold.\nPayne focuses the price range of its products on the medium and high end of the market which represents approximately 60% of the entire decorative fabric market. Approximately 70% of the Company's fabric patterns are considered to be in the medium price range, with the remaining 30% in the upper price range.\nPayne's line is primarily targeted to interior designers. Interior designers are generally independent individuals whose taste and quality requirements can only be met with a unique high-quality fabric or wall covering. Payne currently services 12,000 U.S. based designers through a network of independent agents, independent mini-show rooms, company show rooms and company sales representatives. Payne's other major customers are hospitality and institutional agencies such as hotels, universities, government agencies and similar organizations responsible for facilities maintenance and decoration. Printed fabrics are also supplied to top quality furniture manufacturers for their production needs.\nThe Company markets its products principally through the use of four Company leased showrooms (including one located at the Company's Dayton facility), as well as sixteen U.S. and six foreign independent agent showrooms. The Company's leased showrooms feature Payne's fabric exclusively, whereas the independent and mini showrooms, which are operated by the Company's sales agents, display other fabric lines in addition to those of the Company. The Company believes that it is the dominant line for each of the independent showrooms, with the exception of those in Boston, Seattle, San Francisco and Los Angeles. In these showrooms it is the secondary line, after three fabric companies with products positioned in a higher price segment than the Company. Payne's showrooms are supported by nine Company salaried sales people and twenty-one independent commissioned sales agents.\nThe following sets forth Payne's sales by major product category for 1995, 1994 and 1993, respectively: Upholstery fabrics accounted for 29.0%, 32.5% and 33.0% of Payne's sales. The decrease in the upholstery sales percentage was due to an increase in trim sales, while upholstery sales declined slightly. Drapery fabric represented 30.5%, 29.7% and 30.6% of Payne's sales in 1995, 1994 and 1993, respectively. The slight increase in 1995 drapery fabric sales is the result of the Company's emphasis on adding new institutional customers to replace the loss in residential\ncustomers. The 1994 decrease in sales of drapery fabrics represents a continuing trend by consumers and decorators in the residential market toward \"hard\" window treatments such as mini blinds, window shades and a change in distribution from decorators to retail fabric discount stores. Supplies, consisting of trim, rods, etc., represented 16.2%, 15.7% and 14.4% in 1995, 1994 and 1993, respectively. The increase in the percentage of trim sales is attributable to customer acceptance of the product and decreasing sales of upholstery and draperies. A wider range of products and variety offered by Payne accounts for the increased trim sales.\nSources of Raw Materials\nMany of Payne's fabrics, wall coverings and woven fabrics are designed at its New York City design studio and are exclusive to Payne. Other fabrics sold by Payne are licensed under exclusive arrangements with independent designers. Product offerings are contracted for manufacture by a network of independently owned printing and weaving mills primarily located in the United States and Europe. Occasionally product is also provided from sources in Africa, Asia, as well as Central and South America.\nPayne's fabrics are printed by a variety of processes, such as hand-screening and rotary printing. The type of process used in the printing of a fabric is the major determinant of the cost of the product, the quality of the print design and the color schemes employed. The hand-screening process is typically used for the more expensive fabric products, as it gives a finer design and color imprint than is possible with a rotary printer.\nThe Company is not dependent on any one single source for the manufacture of its fabric or the printing of its designs. Sourcing of product from outside of the U.S. is subject to fluctuations in foreign currency exchange rates.\nLicenses\nThe Company has exclusive copyrights on all designs developed in its New York City studio. In addition, the Company obtains exclusivity on the sale of certain Company selected designs from the manufacturers. Although not evidenced by written agreements these manufacturers, by industry standards, have maintained exclusivity until notified otherwise by the original exclusive distributor.\nSeasonality\nNew product has traditionally been introduced in semi-annually in periods referred to as the spring and fall introductions because the timing has roughly coincided with these seasons. Sample lengths and books are produced to meet these introduction periods. The Company's sales have generally not been subject to significant seasonality fluctuations.\nCustomers\nThe Company's business is not dependent upon any single customer. The average customer sale is approximately three hundred dollars.\nCompetitive Conditions\nBecause the Company has the exclusive copyright, contract or exclusivity arrangements on the designs that it markets, there is no direct competition for the sale of those designs. However there are numerous competitors who market different fabric designs in the medium to high price range categories and are therefore in competition with the Company for a share of the decorative fabric market.\nThe Company's designs are influenced by current fashion, home furnishing lifestyles and consumer trends. The process from design inception to actual production takes approximately eighteen months. The Company believes that after production, six months are required before it can begin to determine a product's degree of success or failure.\nThe long time frame necessary for the design of exclusive fabrics gives rise to a greater risk of obsolescence for these products. Since Payne has to guarantee minimum order commitments from its source mills before it receives any market feedback on its product line, it runs the risk that it may misjudge the market, thus creating an exclusive product for which there may be little demand and for which it will have to hold significant inventory. When the fabric is not exclusive to Payne, reorder of open stock fabrics directly from its milling source alleviates the requirement that it carry the product in its own inventory.\nEmployees\nAs of December 31, 1995, the Company had a total of 89 full and part time employees (including officers). None of the employees are represented by a union.\nEnvironmental\nManagement believes that environmental compliance will have no material effect on capital expenditures, earnings and competitive position.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nPayne's leased facilities in Dayton, Ohio serve as their principal offices, storage and distribution facility, as well as housing an outlet store and a showroom. Payne's facility in Dayton includes a workroom where customer specified draperies and window appointments can be custom built. Bell National rents office space for its corporate headquarters in Orlando, Florida from Milley Management Incorporated. The Chairman of the Company is the President, Chairman and\nmajority shareholder of Milley Management Incorporated. In addition, certain of the other officers of the Company are also officers of Milley Management Incorporated.\nPayne also leases a New York City design studio. In addition, Payne leases various showroom facilities at which its product line is displayed. The showrooms are located in strategic cities that have provided strong acceptance, or potential acceptance, of Payne's line. Whenever possible, the showrooms are located in design centers that various furniture, fabric and design companies also use to display their goods and services. Designers, Payne's principal customers, often use these centers as a \"one stop\" approach to shopping for their needs. Location in these design centers provide Payne's line with maximum exposure to its principal customers. Loss of Payne's current locations, or inability to locate new facilities could negatively impact sales volume in the affected region. With the exception of these design center showrooms, facilities relocation would not affect the Company's operations.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThere are no material pending legal proceedings to which the Company is a party or of which any of their property is subject nor are there any proceedings known to be contemplated by government authorities against 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 shareholders during the fourth quarter of 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThere is presently no established public trading market for the common stock of the Company and trading activity is limited. The following dealers have indicated an interest in trading the stock on the Electronic Bulletin Board: Wedbush Securities, Inc.; Troster Singer Corporation; and Carr Securities Corporation.\nHolders\nAs of March 8, 1996 there were approximately 1,075 holders of record of Bell National's common stock.\nDividend History\nBell National does not pay a cash dividend and is not allowed to pay a dividend under term of its credit agreement with Bank One, Dayton, National Association. In the absence of such an agreement, it is likely that Bell National would retain its earnings for use in the development of its business.\nStock Transfer Agent\nThe Company's stock transfer agent is Continental Stock Transfer and Trust Co., 2 Broadway, New York, New York 10004. (212) 509-4000.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe selected financial data is derived from, and qualified by reference, to the audited Financial Statements and Notes included elsewhere in this Annual Report on Form 10-K.\nThe following table sets forth the selected financial data as of the dates shown and for the periods shown:\nBalance Sheet Data (dollars in thousands):\nStatement of Operations Data (dollars in thousands except per share amounts):\nYears Ended December 31, --------------------------------------------------- 1995 1994 1993 1992 1991 ---- ---- ---- ---- ----\nNet sales $ 13,653 $ 13,877 $ 14,107 $ 14,000 $ 13,715 Operating income 469 675 643 463 188 Net income (loss) before extraordinary item 48 177 198 25 321) Net income (loss) after extraordinary item 48 320 198 25 (321)\nNet income (loss) per share before extraordinary item .01 .03 .04 -- (.06) Net income (loss) per share after extraordinary item .01 .06 .04 -- (.06)\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\nRevenues and Expenses See Note 1 to the Consolidated Financial Statements for background on the Company. The Company's 1995, 1994 and 1993 revenues and expenses result from the operation of Payne, which was acquired in June 1990.\nThe Company's 1995 sales were $13,653,000 compared to sales of $13,877,000 in 1994. The 1995 sales decrease of $224,000 was attributable to decreased sales of drapery and upholstery fabrics partially offset by increased drapery fabrications sales. Gross profit decreased $328,000 from $6,854,000 in 1994 to $6,526,000 in 1995. The decrease in gross profit was due to the sales volume decrease and a 1.6% decrease in the gross profit percentage from 49.4% in 1994 to 47.8% in 1995. This is identifiable to the loss of high margin drapery and upholstery fabric sales somewhat replaced with the lower margin drapery fabrication sales. Selling, general and administrative expenses decreased $122,000 from $6,179,000 in 1994 to $6,057,000 in 1995. The decrease was identifiable to decreased stock appreciation rights accruals and decreased sample book amortization expense partly offset by increased sample length expense. During 1995 sample book amortization decreased as a result of a decrease in the total expenditures for deferred sample books during the three year period ended December 31, 1995 as compared to the three year period ended December 31, 1994. The increased sample length expense in 1995 over 1994 reflects the larger number of new products introduced year to year. As a result of the decrease in gross margin offset by a decrease in selling, general and administrative expense, operating income decreased by $206,000. The decrease in sales in 1995 reflects continuing weakness in the fabric market. Management believes that significant earnings growth is dependent upon an increase in sales. In comparison to prior years, both 1995 and 1994 sales are down.\nInterest expense increased $39,000 from $308,000 in 1994 to $347,000 in 1995 due mainly to the higher average debt balance in 1995. The provision for taxes decrease $117,000 to $29,000 in 1995 from $146,000 in 1994 due to the lower reported profit in 1995. Taking into account these items, 1995 income before extraordinary items was $48,000 in 1995, down $129,000 from 1994 income before extraordinary items of $177,000. In 1994 there was an extraordinary gain of $143,000, net of taxes, due to the retirement of the senior subordinated note. After taking this into account the net income in 1995 of $48,000 is down $272,000 from 1994 net income of $320,000. 1995 earnings per share were $0.01 versus $0.06 in 1994, however 1994 earnings per share included $0.03 from the non-recurring extraordinary item. Earnings per share before extraordinary items in 1995 were $0.01 versus $0.03 in 1994.\nThe Company's 1994 sales were $13,877,000 compared to sales of $14,107,000 in 1993. The sales decrease of $230,000 was attributable to a combined decrease in sales of drapery and upholstery fabrics along with a decrease in wallpaper fabrics. Gross profit decreased $148,000 in 1994 from $7,002,000 in 1993 to $6,854,000 in 1994. The decrease in gross profit was due to a combination of the sales volume decrease and a 0.2% decrease in the gross profit percentage from\n49.6% in 1993 to 49.4% in 1994. Selling, general and administrative expenses decreased $180,000 from $6,359,000 in 1993 to $6,179,000 in 1994. The decrease was almost entirely due to the drop is Payne's selling expenses of $344,000 consisting of a decrease in sample book amortization and lower showroom rent due to renegotiated lease terms. During 1994, sample book amortization decreased as a result of a decrease in expenditures for deferred sample books during the three year period ended December 31, 1994 as compared to the three year period ended December 31, 1993. The decrease in Payne's selling expense was partially offset by an increase in the corporate general and administrative expense of $180,000 due mainly to the increase in expense related to the SAR's accrual. As a result of the decrease in gross margin offset by a decrease in selling, general and administrative expense, operating income increased by $32,000. The company will continue to attempt to reduce costs but does not anticipate being able to find additional cost savings of the same magnitude in the future. The slight decrease in sales in 1994 and the continuing flat sales over the last few years reflects the continuing weakness in the fabric market.\nFurthermore interest expense decreased by $112,000 from $420,000 in 1993 to $308,000 in 1994 due mainly to a decrease in the subordinated debt interest as a result of the May 1994 prepayment partially offset by a $10,000 increase in bank interest. The provision for taxes increased by $132,000 from $14,000 in 1993 to $146,000 in 1994. This increase is a result of higher pre-tax income and a higher effective tax rate in comparison to 1993. Management has taken a conservative approach to reporting income taxes in the financial statement by eliminating the utilization of Federal net operating loss benefit carryforwards from the income tax provision calculation. As a result of the above, the Company recorded net income before the extraordinary item in 1994 of $177,000 ($0.03 per share) compared to a net income in 1993 of $198,000 ($0.04 per share). During 1994, the Company prepaid the senior subordinated note with a face value of $600,000 for $570,000, which was the book value net of the discount at the closing date. In connection with the prepayment, the holder of the note forgave all unpaid interest totaling $252,000 as of December 31, 1993. As a result of the interest forgiveness, the Company recorded an extraordinary item of $143,000 (net of $109,000 of tax). Earnings after this extraordinary item in 1994 were $320,000 or $.06 per share.\nThe Company's 1993 sales were $14,107,000 compared to sales of $14,000,000 in 1992. The sales increase of $107,000 was mainly attributable to an increase in sales of woven cut fabric used for furniture coverings and sales by Payne of fabric under a license and distribution agreement partially offset by a decline in wall covering and drapery fabric. Gross profit increased $76,000 in 1993 from $6,926,000 in 1992 to $7,002,000 in 1993. The increase in gross profit was due to the sales volume increase and a .1% increase in the gross profit percentage from 49.5% in 1992 to 49.6% in 1993. Selling, general and administrative expenses decreased $104,000 from $6,463,000 in 1992 to $6,359,000 in 1993 due to personnel related expense reductions.\nAs a result of the increase in gross margin and the decrease in selling, general and administrative expenses, operating income increased by 39% or $180,000 in 1993. Furthermore interest expense decreased by $25,000 from $445,000 in 1992 to $420,000 in 1993 due to a decrease in the average bank debt balance somewhat offset by an increase in subordinated debt interest due to the effect of the penalty rates on late payments of interest. As a result of the above, the Company\nrecorded net income in 1993 of $198,000 ($0.04 per share) compared to a net income in 1992 of $25,000 ($0.0 per share).\nThe Company has a remaining Goodwill balance net of amortization of $683,000 and $703,000 at December 31, 1995 and 1994. The Company believes this asset is fairly valued and continues to amortize it over a 40 year period. A determination contrary to this would require that the amortization period be shortened and profitability effected by an adjustment which could be as much as the then remaining balance. In the unlikely event of such an occurrence certain financial covenants of the Company's Revolving Agreement (see below) would likely be violated.\nThe Company is not a party to any derivative or interest swap agreement.\nLIQUIDITY AND CAPITAL RESOURCES\nAvailable Resources. The Company's consolidated unrestricted cash position at December 31, 1995 and December 31, 1994 was $0. The Company has instituted a cash management system whereby the net cash generated by operations is immediately used to reduce bank debt. The immediate reduction of outstanding debt provides the Company with a greater reduction in interest expense than could be offset with interest income from alternative investments. In the absence of the Agreement requiring such a system, the Company would continue to use excess funds to immediately reduce bank debt. A review of the financial statements, summary data, working capital and discussion of liquidity must take into consideration that the Company does not maintain any cash balances in any of its accounts by design. Working capital needs, when they arise, are met by daily borrowings.\nDuring 1995, the Company had cash flow from operations before working capital changes of $1,099,000. Working capital and other changes increased cash flow by $638,000 resulting in cash flow provided by operating activities of $1,737,000. The cash flow from operations and net borrowings under the bank credit facilities of $121,000 funded the spending for sample books of $1,727,000, property and equipment of $76,000, payment of deferred debt commitment fees of $52,000 and capital lease obligations of $3,000. On May 17, 1995 the Company entered into a new credit agreement (see below). Through May 17, 1995 the Company made scheduled monthly installment payments totaling $275,000 and borrowed $346,000 on the revolver loan facility with Bank of America, Illinois. On May 17, 1995 the Company borrowed $2,992,000 under its new credit agreement with Bank One, Dayton, N.A. to extinguish the then existing debt with Bank America, Illinois. The Company thereafter made scheduled quarterly installment payments totaling $200,000 and borrowed $250,000 on the new revolving loan facility. The increase in 1995 working capital was due primarily to decreases of $390,000 in inventory and increases of $312,000 in accounts payable.\nDuring 1994, the Company had cash flow from operations before working capital changes of $1,444,000. Working capital and other changes decreased cash flow by $401,000 resulting in cash flow provided by operating activities of $1,043,000. The cash flow from operations and net borrowing on the bank credit facility of $338,000 funded the spending for sample books of\n$784,000, property, plant and equipment of $24,000, the prepayment of the senior subordinated note in the amount of $570,000 and the payment of capital lease obligations of $3,000. The net borrowing on the bank credit facility consisted of scheduled monthly installment payments totaling $645,000 on the term loan facility, plus the increase in the term facility of $570,000, to prepay the senior subordinated note, and an increase in the revolver loan facility of $413,000. During 1994, working capital decreased primarily due to an increase in inventory of $605,000 due to the receipt of the spring line in the fourth quarter of 1994 that was greater than the spring line in the prior year.\nDuring 1993, the Company had cash flow from operations before working capital changes of $1,600,000. Working capital and other changes added $172,000 of cash flow to operations resulting in cash flow provided by operating activities of $1,772,000. The cash flow from operations funded the spending for sample books of $741,000, property, plant and equipment of $55,000, and repaid long term bank debt of $910,000, and capital leases obligations of $66,000. The repayment of long term bank debt consisted of scheduled monthly installments of $50,000 on the term loan facility and voluntary reductions in the revolver loan facility totaling $210,000. During 1993, current assets, primarily inventory increased by $284,000. Inventory increased due to the receipt of the spring line in the fourth quarter of 1993 that was greater than the spring line in the prior year. The increase in inventory was offset by a $450,000 increase in current liabilities, excluding the change in the current portion of long term debt and capitalized leases. The increase primarily related to accounts payable growth as a result of the increase in the inventory at year end.\nFuture Needs For and Sources of Capital. Management believes that cash to be provided by operations and funds available under the Revolving Agreement (see below) will be sufficient to fund the Company's, 1996 cash needs.\nAs of December 31, 1995, the Company is in compliance with all covenants of the Revolving Agreement.\nOn May 1 1995, the Company entered into a Revolving Credit Agreement with Bank One, Dayton, National Association (the \"Revolving Agreement\"). The terms of the Revolving Agreement provide for a total loan facility of $4,125,000 consisting of a term loan of $1,025,000, payable in seven quarterly installment of $100,000 and a balloon payment of $325,000 due on June 30, 1997. The remaining portion of the Revolving Agreement consists of a revolving line of credit, which matures three years from the loan closing date. Borrowings under the revolving line of credit are based on a percentage of Payne's eligible accounts receivable and a percentage of Payne's eligible inventory, as defined in the Revolving Agreement. The Revolving Agreement is collateralized by all of the assets of Payne, guaranteed by the Company and subject to certain restrictive covenants.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe consolidated financial statements of the Company for each of the fiscal years in the three-year period ended December 31, 1995, together with the report thereon of Ernst & Young LLP dated March 27, 1996, are filed as part of this report commencing on page.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nDuring 1995, 1994 and 1993, the Company neither changed its accountants nor reported a disagreement on Form 8-K on any matter of accounting principle or practice or financial statement disclosure.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY\nSet forth below is information regarding the executive officers and directors of Bell National, including information furnished by them as to principal occupations for the last five years, certain other directorships held by them, and their ages. Directors are elected to serve until the next annual meeting. Officers are elected annually by Bell National's Board of Directors and serve at the discretion of the Board, unless otherwise indicated.\nName Age Position\nAlexander M. Milley 43 Chairman and Secretary\nRobert C. Shaw 43 Director, President and Treasurer\nRaymond O'S. Kelly 61 Director\nNicholas E. Toussaint 58 Director\nThomas R. Druggish 40 Director and Chief Financial Officer\nAlexander M. Milley became Chairman of the Board of Directors and Secretary on November 20, 1989. Mr. Milley is the founder, president and majority shareholder of Milley Management Incorporated (\"MMI\"), a private investment and management consulting firm incorporated on September 25, 1990. Mr. Milley is also the founder and President of Winchester National, Inc. (\"Winchester\"), another private investment and management consulting firm. From August 1985 to May 1986, Mr. Milley was Chairman of Neoax, Inc. (\"Neoax\"), now an environmental services company known as EnviroSource, Inc. and then a diversified custom vehicle and precision metal\nmanufacturing company. Mr. Milley was Senior Vice President-Acquisitions from December 1983 until July 1986, of The Dyson-Kissner-Moran Corporation (\"DKM\"), a private investment company. Mr. Milley is Chairman of the Board, President and Chief Executive Officer of Azimuth Corporation (\"Azimuth\"), a producer of trade show exhibits and a distributor of fuses and aerospace fasteners, and Chairman and President of Cadmus Corporation (\"Cadmus\"), a management consulting firm. Each of Azimuth and Cadmus is a privately held company, a majority of the directors of which are officers of Winchester. Mr. Milley has been Chairman of the Board, Chief Executive Officer and President of ELXSI Corporation (\"ELXSI\") since September 1989. ELXSI owns and operates a chain of family restaurants in New England and a manufacturer of sewer inspection equipment incorporating video technology in Orlando, Florida.\nRobert C. Shaw became President, Treasurer and a Director on November 20, 1989, as well as serving as Chief Financial Officer from November 20, 1989 to June 17, 1990. Mr. Shaw has been a Vice President of MMI since March, 1989. Prior thereto, he was Vice President Berkeley Softworks, Incorporated (\"Berkeley\") from September 1987 to March 1989. From January 1987 to September 1987, he was Vice President, and July 1985 until January 1987, he was Director of Finance and Operations, at Ansa Software, Incorporated (\"Ansa\"). Berkeley and Ansa developed and produced personal computer software. Mr. Shaw has been Chief Financial Officer and Executive Vice President of ELXSI since September 1989.\nRaymond O'S. Kelly has been a Director since October 1987, and was a Vice President of the Company from October 1987 to November 1989. Since January 1, 1982, Mr. Kelly has been the President and Chief Executive of Raymond O'S. Kelly, Inc., a firm specializing in providing financial, tax advisory, and tax compliance services. Mr. Kelly has over thirty years of experience with international and domestic accounting firms.\nNicholas E. Toussaint has been a Director since October 1987, and served as President and Chief Executive of the Company from August 1985 to November 1989. Since 1979, Mr. Toussaint has been President of N.E. Toussaint & Associates, Ltd., a San Francisco consulting firm which advises banks, other institutions, and individuals concerning the feasibility of real estate investments. The firm specializes in planning corporate real estate portfolios, and in this connection, performs investment analysis. Mr. Toussaint has over twenty-five years of experience in real estate asset management, has held a senior management position with the Bank of California, and was a founding Director of a national bank and its associated bank holding company.\nThomas R. Druggish became a Director effective June 1, 1992 and became Chief Financial Officer of the Company on June 17, 1990. He currently serves as Vice President, Treasurer and Secretary of ELXSI, Secretary and Treasurer of MMI since September 1990. Prior thereto, Mr. Druggish was Assistant Controller at Borland International from April 1987 to December 1989. Borland, which acquired Ansa in September 1987, develops and markets personal computer software.\nVal G. Blaugh has served as President of Payne Fabrics, Inc. since its inception in July, 1988, when the assets of the Payne Fabrics Division of Stanley Interiors Corporation were purchased by Azimuth Corporation. From December 1983 to July, 1988, Mr. Blaugh was President of the Payne Fabrics Division of Stanley Interiors Corporation. Mr. Blaugh originally joined Payne Fabrics as a Vice President of Sales and Marketing in January 1977.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe following table sets forth the cash compensation of each of the most highly compensated executive officers of the Company and of all executive officers as a group during the years ended December 31, 1995, 1994 and 1993.\nSummary Compensation Table\nAnnual Compensation -------------------------------------- Name and Principal Other Annual Position Year Salary Bonus Compensation -------- ---- ------ ----- ------------\nRobert C. Shaw 1995 $ -- $ -- $ -- Director, President and 1994 -- -- -- Treasurer 1993 -- -- -- (1)\nVal G. Blaugh (2) 1995 102,000 -- 2,230 (3) President of Payne 1994 102,000 -- 1,570 (3) 1993 102,000 -- 1,170 (3)\n(1) Mr. Shaw had been retained as of November 20, 1989 under a employment agreement for three years, which expired in November 1992, at an annual compensation of $50,000. As specified in the agreement, the remaining balance of the compensation has been deferred by the Company. The amounts payable are reflected in the attached Consolidated Balance Sheets for the years ended December 31, 1995 and 1994.\n(2) Mr. Blaugh is a participant in the Company's defined benefit pension plan (see Note 7 to the Consolidated Financial Statements for more detail). As of January 1, 1995 his vested benefit was $281,000.\n(3) Represents calculated taxable value of leased vehicle used by Mr. Blaugh.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following table sets forth certain information regarding the ownership of Bell National's capital stock as of March 8, 1996 by (i) all those known by Bell National to be beneficial owners of more than 5% of the Common Stock, (ii) all Directors and highly compensated executive officers and (iii) all executive officers and Directors as a group. Ownership information is based upon information furnished by the respective beneficial owners. Of the 5,283,114 shares of common stock of Bell National outstanding on March 8, 1996, 696,570 of such shares of common stock have been designated \"Class 4-B shares\" (Class 4-B shares are essentially without value) pursuant to certain legal proceedings. Class 4-B shares do not have voting rights and are not entitled to any distributions from Bell National on liquidation or otherwise. James Grauer is currently the owner of all of the Class 4-B shares outstanding. Each person has sole voting and sole investment power with respect to the shares listed below and described in the footnotes to the table, below (or shares such power with his or her spouse). Percent of Name and Address Amount and Nature Voting of Beneficial Owner of Beneficial Ownership* Shares (1) - ------------------- ------------------------ -----------\nThe Airlie Group L.P. 453,176 9.9% 115 East Putnam Avenue Greenwich, CT 06830\nAlexander M. Milley 1,512,514 (2) 27.3% (Director, Chairman of the Board and Secretary) Milley & Company 4209 Vineland Road, Suite J-1 Orlando, FL 32811\nRobert C. Shaw, 37,084 0.8% (Director, President and Treasurer)\nRaymond O'S. Kelly 45,781 (3) 1.0% (Director)\nSanta Fe Mortgage and Development Company 648,485 14.1% Don Hancock Carol G. Avakian Hancock dba C.G.A. Avakian Co. Post Office Box 2540 Fair Oaks, CA 95628\nAll officers and directors** 1,595,379 (2) 28.8% as a group (3 persons)\n* To the best of the Company's knowledge each of the persons and group has sole voting and dispositive power with respect to the shares shown. (All such shares are held directly.)\n** The persons owning these shares, including Mr. Milley, may represent a group under section 13(d) of the Securities Exchange act of 1934, as amended. (1) These percentages are based upon 4,577,616 shares of common stock outstanding and entitled to vote (excluding Class 4-B shares).\n(2) Mr. Milley's ownership assumes the exercise of warrants for the purchase of 957,373 shares for the Company's Common Stock, which expire in 1999.\n(3) Consists entirely of shares held in trust for Mr. O'S. Kelly.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nBell National retained Alexander M. Milley, as Chairman of the Board and Secretary, and Robert C. Shaw, as President and Treasurer under the terms of the Stock Purchase Agreement and related Employment Agreements. The Employment Agreements, which became effective on November 20, 1989 and expired in November 1992, provided for annual compensation of $50,000 to Mr. Shaw and $20,000 to Mr. Milley, of which only a portion of Mr. Shaw's agreement was paid. Under the terms of the Employment Agreements, Mr. Shaw and Mr. Milley are free to pursue other business ventures, investments and personal matters as long as such activities do not unreasonably interfere with their respective obligations to Bell National.\nIn 1988, Mr. Toussaint was granted stock options to purchase 360,000 shares of common stock under the terms of Bell National's Stock Option Plan at $.30 per share. Under the same Stock Option Plan, Mr. Kelly, a Director, was also granted stock options to purchase 90,000 shares at $.30 per share. In November 1989, such options granted under the Bell National Stock Option Plan to Toussaint and Kelly as well as former directors, were canceled and replaced with Stock Appreciation Rights (\"SAR's\"). In general, the number of stock options previously granted were replaced with an equal number of SAR's. Each SAR entitles the holder to receive upon exercise an amount equal to the excess, if any, of the market value per share at the date of exercise over the exercise price of the SAR, plus any dividends or distributions per share made by Bell National prior to the exercise date. On November 15, 1995 Messrs. Kelly and Toussaint's SAR agreements were amended to extend the term of their agreements to November 20, 2001.\nOn June 15, 1990, Bell National completed the purchase of 83% of the stock of Payne from Azimuth Corporation (\"Azimuth\") for $6,493,000, which was based upon the net asset value of Payne as reflected on its unaudited balance sheet as of the close of business on June 3, 1990. Of the total purchase price paid to Azimuth, $600,000 was supported by a five-year senior subordinated note bearing interest at the rate of 10% per annum. The balance of the purchase price was paid in cash, partially with funds obtained under a bank credit agreement between Bell National and Continental Bank N.A. (the \"Bank\"). The principals of MMI currently owns 14% of Bell National's outstanding voting capital stock and would own 29% upon their full exercise of stock warrants currently held. Certain members of MMI, including among others, Alexander M. Milley and Robert S. Shaw, who are principals of MMI and the Chairman and President as well as Directors of Bell National, respectively, also own in the aggregate 16% of the outstanding voting and non-voting common stock of Azimuth. Messrs. Milley and Shaw, together with certain other members of MMI, also own approximately 4% of the combined classes of non-voting preferred stock of Azimuth. In addition, Messrs. Milley and Shaw are directors of Azimuth.\nIn connection with the acquisition of Payne, the remaining 17% of the outstanding capital stock was acquired from four individual stockholders, some of whom are current management employees of Payne. The Capital Stock was acquired pursuant to separate stock purchase agreements, each dated June 14, 1990, in exchange for an aggregate of 455,357 SAR's of Bell National. The aggregate number of SAR's issued in exchange for their Payne stock was determined based upon the initial investment paid by these individuals for their holdings in Payne stock in relation to the initial investment price paid by MMI for its shares of Bell National's common stock. SAR's were allocated among individuals in accordance with the ratio of the percentage of each individual's initial investment in Payne to the total investment of all four. The terms and conditions of the SAR's are set forth in stock appreciation rights agreements.\nBell National currently rents office space in Orlando, Florida from Milley Management Incorporated. Rent and administrative support expenses were approximately $120,000 in each of the years ended December 31, 1995 , 1994 and 1993. The Chairman of the Company is the President, Chairman and majority shareholder of Milley Management Incorporated. In addition, certain of the other officers of the Company are also officers of Milley Management Incorporated.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 10-K\nPage 1. Financial Statements Number (s) ----------\nReport of Independent Auditors Consolidated Balance Sheets at December 31, 1995 and 1994 to Consolidated Statements of Operations for the years ended December 31, 1995, 1994 and 1993 Consolidated Statements of Stockholders' Equity for the years ended December 31, 1995, 1994 and 1993 Consolidated Statements of Cash Flows for the years ended December 31, 1995, 1994 and 1993 to Notes to Consolidated Financial Statements to\n2. Financial Statement Schedules\nSchedule Page Number Description Number ------ ----------- ------\nVIII Valuation and Qualifying Accounts S-1\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 Number Description - ------ -----------\n2.1 Bell National Corporation Plan of Reorganization (Annex I). (Incorporated herein by reference to Item 1 of the Company's Annual Report on Form 10-K for the period from August 20, 1985 to December 31, 1985 and for the years ended December 31, 1986 and 1987 (File No. 3-935)).\n3.1 Restated Articles of Incorporation. (Incorporated herein by reference to Exhibit 3.1 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1988 (File No. 3-935)).\n3.2 Bylaws of the Company. (Incorporated herein by reference to Exhibit 3.2 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 (File No. 3-935)).\n4.1 Registration Rights Agreement dated as of November 20, 1989 among the Company, The Airlie Group L.P., Liberty Associates Limited Partnership, Winchester National, Inc., Alexander M. Milley, Alan D. Gordon, Kim G. Davis, Brian E. Kinsman, Kevin P. Lynch and Robert C. Shaw (collectively, the \"Purchasers\"). (Incorporated herein by reference to Exhibit 4.3 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 (File No. 3-935)).\n4.2 Warrant to purchase 957,373 shares of common stock of the Company issued by the Company on November 20, 1989 to Liberty Associates Limited Partnership. (Incorporated herein by reference to Exhibit 4.4 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 (File No. 3-935)).\n9.1 Voting Trust Agreement dated as of May 11, 1989 between Santa Fe and Mr. Nicholas E. Toussaint, as amended. (Incorporated herein by reference to Exhibit 9.1 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 (File No. 3-935)).\n10.1 Standstill Agreement between Bell National Corporation, Santa Fe Development and Mortgage Company, Inc., Donald Hancock, Carol G. Avakian Hancock, and Fred L. Harris, dated October 20, 1988. (Incorporated herein by reference to Exhibit 3.1 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1988 (File No. 3-935)).\n10.2 Stock Purchase Agreement dated as of August 17, 1989 by and among the Company and the Purchasers. (Incorporated herein by reference to Annex I of the Company's Proxy Statement dated October 2, 1989 delivered to shareholders of the Company in connection with a Special Meeting of Shareholders of Company held on November 3, 1989. (File No. 3-935)).\n10.3 Stock Appreciation Rights Agreement dated as of November 20, 1989 between the Company and Edward B. Collins. (Incorporated herein by reference to Exhibit 10.3 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 (File No. 3-935)).\n10.4 Stock Appreciation Rights Agreement dated as of November 20, 1989 between the Company and Charles J. Hart. (Incorporated herein by reference to Exhibit 10.4 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 (File No. 3-935)).\n10.5 Stock Appreciation Rights Agreement dated as of November 20, 1989 between the Company and Raymond O'S. Kelly. (Incorporated herein by reference to Exhibit 10.5 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 (File No. 3-935)).\n10.6 Stock Appreciation Rights Agreement dated as of November 20, 1989 between the Company and Edward K. Taapken. (Incorporated herein by reference to Exhibit 10.6 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 (File No. 3-935)).\n10.7 Stock Appreciation Rights Agreement dated as of November 20, 1989 between the Company and Nicholas E. Toussaint. (Incorporated herein by reference to Exhibit 10.7 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 (File No. 3-935)).\n10.8 Stock Appreciation Rights Agreement dated as of November 20, 1989 between the Company and John Vida. (Incorporated herein by reference to Exhibit 10.8 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 (File No. 3-935)).\n10.9 Stock Appreciation Rights Agreement dated as of November 20, 1989 between the Company and Robert A. Huret. (Incorporated herein by reference to Exhibit 10.9 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 (File No. 3-935)).\n10.10 Stock Appreciation Rights Agreement dated as of November 20, 1989 between the Company and Alan E. Rothenberg. (Incorporated herein by reference to Exhibit 10.10 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 (File No. 3-935)).\n10.11 Stock Purchase Agreement dated as of June 15, 1990 by and among the Company, as purchaser, and Azimuth Corporation, as seller. (Incorporated herein by reference to Exhibit 2(a) of the Company's Form 8-K filed June 15, 1990. (File No. 3-935)).\n10.12 Loan Agreement dated as of June 14, 1990 between the Company, the borrower, and Continental Bank N.A., the lender. (Incorporated herein by reference to Exhibit 10.12 of the Company's Form 8-K filed June 29, 1990. (File No. 3-935)).\n10.13 Stock Appreciation Rights Agreement dated as of June 14, 1990 between the Company and Val G. Blaugh. (Incorporated herein by reference to Exhibit 4 of the Company's Form 8-K filed June 15, 1990. (File No. 3-935)).\n10.14 Stock Appreciation Rights Agreement dated as of June 14, 1990 between the Company and Mark van der Kloet. (Incorporated herein by reference to Exhibit 4 of the Company's Form 8-K filed June 15, 1990. (File No. 3-935)).\n10.15 Stock Appreciation Rights Agreement dated as of June 14, 1990 between the Company and Roy D. Rafalco. (Incorporated herein by reference to Exhibit 4 of the Company's Form 8-K filed June 15, 1990. (File No. 3-935)).\n10.16 Stock Appreciation Rights Agreement dated as of June 14, 1990 between the Company and Jeffrey Pratt. (Incorporated herein by reference to Exhibit 4 of the Company's Form 8-K filed June 15, 1990. (File No. 3-935)).\n10.17 Employment Agreement between the Company and Alexander M. Milley dated November 20, 1989. (Incorporated herein by reference to Exhibit 10.17 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991 (File No. 3-935)).\n10.18 Employment Agreement between the Company and Robert C. Shaw dated November 20, 1989. (Incorporated herein by reference to Exhibit 10.18 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991 (File No. 3-935)).\n10.19 Revolving Credit Agreement, dated as of May 1, 1995, among Payne Fabrics, Inc., Bell National Corporation and Bank One, Dayton, National Association.\n10.20 SAR Agreement Extension, dated November 15, 1995, between the Company and Raymond O'S. Kelly.\n10.21 SAR Agreement Extension, dated November 15, 1995, between the Company and Nicholas E. Toussaint.\n21.1 Subsidiaries of the Company. (Incorporated herein by reference to the exhibits filed with the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990 (File No. 3-935)).\n27 Financial data schedule.\n(b) Reports on Form 8-K\nReports on Form 8-K filed during the fourth quarter of 1995.\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.\nBELL NATIONAL CORPORATION\nDate: March 20, 1996 BY: \/s\/ Alexander M. Milley ------------------------------------- Alexander M. Milley Chairman of the Board and Secretary\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.\nSignature Title Date - --------- ----- ----\n\/s\/ Alexander M. Milley Director, Chairman of the March 20, 1996 - --------------------------- Board and Secretary Alexander M. Milley Board and Secretary\n\/s\/ Robert C. Shaw Director, President and March 20, 1996 - --------------------------- Treasurer (Principal Robert C. Shaw Executive Officer)\n\/s\/ Raymond O'S. Kelly Director March 20, 1996 - --------------------------- Raymond O'S. Kelly\n\/s\/ Nicholas E. Toussaint Director March 20, 1996 - --------------------------- Nicholas E. Toussaint\n\/s\/ Thomas R. Druggish Director, Chief Financial March 20, 1996 - --------------------------- Officer (Principal Financial Thomas R. Druggish Officer and Accounting Officer)\nReport of Independent Auditors\nShareholders and Board of Directors Bell National Corporation\nWe have audited the accompanying consolidated balance sheets of Bell National Corporation and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1995. Our audits also included the financial statement schedule listed in the accompanying 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 Bell National Corporation and subsidiaries at December 31, 1995 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, 1995, 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\nDayton, Ohio March 27, 1996\nBELL NATIONAL CORPORATION Consolidated Balance Sheets (Dollars in Thousands)\nASSETS\nDecember 31, -------------------------- 1995 1994 ---- ---- Current assets:\nCash and cash equivalents $ -- $ --\nAccounts receivable, net 1,082 1,085\nInventory, net 4,083 4,473\nPrepaid expenses and other current assets 114 113 --------- ---------\nTotal current assets 5,279 5,671\nProperty and equipment, net 212 199\nGoodwill, net 683 703\nDeferred sample books, net 1,696 924\nOther assets 40 8 --------- ----------\n$ 7,910 $ 7,505 ======== ========\nThe accompanying notes are an integral part of these consolidated financial statements.\nBELL NATIONAL CORPORATION Consolidated Balance Sheets (Dollars in Thousands)\nLIABILITIES AND STOCKHOLDERS' EQUITY\nDecember 31, ------------------------ 1995 1994 ---- ----\nCurrent liabilities: Accounts payable $ 1,901 $ 1,589 Current portion of capitalized lease obligations 3 3 Current portion of long-term debt 400 300 Accrued compensation and employee benefits 449 515 Accrued expenses 381 335 ---------- ----------\nTotal current liabilities 3,134 2,742\nLong-term debt 2,642 2,621\nAccrued stock appreciation rights 356 356\nCapital lease obligations, less current portion 3 6\nOther liabilities 201 254 ---------- ---------- 6,336 5,979 Stockholders' equity: Common stock, no par value; authorized 12,000,000 shares, issued and outstanding 5,283,114 at December 31, 1995 and 5,283,114 at December 31, 1994 15,800 15,800\nAdditional paid-in capital 10 10\nAccumulated deficit (14,236) (14,284) --------- --------\nTotal stockholders' equity 1,574 1,526 --------- ---------\n$ 7,910 $ 7,505 ========= =========\nThe accompanying notes are an integral part of these consolidated financial statements.\nBELL NATIONAL CORPORATION Consolidated Statements of Operations (Amounts in Thousands, Except Share and Per Share Data)\nYear Ended December 31, ---------------------------------- 1995 1994 1993 ---- ---- ----\nNet sales $ 13,653 $ 13,877 $ 14,107\nCosts and expenses: Cost of sales 7,127 7,023 7,105 Selling, general and administrative 6,057 6,179 6,359 ---------- ---------- ----------\nOperating income 469 675 643\nOther income (expenses): Interest expense (347) (308) (420) Other (45) (44) 11 ---------- ---------- ----------\nIncome before income taxes and extraordinary item 77 323 212\nProvision for income taxes (29) (146) (14) ---------- ---------- ----------\nIncome before extraordinary item 48 177 198\nExtraordinary item, net of taxes of $109 -- 143 -- ---------- ---------- ----------\nNet Income $ 48 $ 320 $ 198 ========== ========== ==========\nEarnings per common share Income before extraordinary item $ .01 $ .03 $ .04 Extraordinary item -- .03 -- ---------- ---------- ---------- Net income $ .01 $ .06 $ .04 ========== ========== ========== Weighted average number of common shares outstanding 5,283,114 5,280,790 5,274,186 ========== ========== ==========\nThe accompanying notes are an integral part of these consolidated financial statements.\nBELL NATIONAL CORPORATION Consolidated Statements of Stockholders' Equity (Dollars in Thousands)\nThe accompanying notes are an integral part of these consolidated financial statements.\nBELL NATIONAL CORPORATION Consolidated Statements of Cash Flows (Dollars in Thousands)\nYear Ended December 31, ----------------------------- 1995 1994 1993 ---- ---- ----\nOperating activities:\nNet income $ 48 $ 320 $ 198 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 63 80 146 Amortization of goodwill 20 20 26 Amortization of deferred sample books 955 1,003 1,190 Accretion of discount on notes payable to Azimuth -- 14 30 Amortization of deferred debt commitment fee 20 17 16 Provision for doubtful accounts and sales returns (7) (10) (6)\n(Increase) decrease in assets: Accounts receivable 10 117 30 Inventory 390 (605) (293) Prepaid expenses and other current assets (1) (21) (15)\nIncrease (decrease) in liabilities: Accounts payable 312 (53) 584 Accrued compensation and employee benefits (66) 47 (132) Accrued expenses 46 (286) (2) SAR accrual -- 146 -- Other liabilities (53) 254 -- ------ ------ ------\nNet cash provided by operating activities 1,737 1,043 1,772 ------ ------ ------\nInvesting activities:\nAcquisition of property and equipment (76) (24) (55) Production and purchase of deferred sample books (1,727) (784) (741) ------ ------ ----\nNet cash used in investing activities (1,803) (808) (796) ------ ------ ----\nThe accompanying notes are an integral part of these consolidated financial statements.\nBELL NATIONAL CORPORATION Consolidated Statements of Cash Flows (Continued)\n(Dollars in Thousands)\nYear Ended December 31, ---------------------------------- 1995 1994 1993 ---- ---- ---- Financing activities:\nProceeds from the issuance of long-term debt 5,994 14,783 13,800 Principal payments on long-term debt (5,873) (15,015) (14,710) Principal payments on capital leases (3) (3) (66) Payment of deferred debt commitment fee (52) -- -- ------- ------- -------\nNet cash provided by (used in) financing activities 66 (235) (976) ------- ------- -------\nNet increase in cash and cash equivalents -- -- --\nCash and cash equivalents at beginning of year -- -- -- ------- ------- -------\nCash and cash equivalents at end of year $ -- $ -- $ -- ======= ======= =======\nSupplemental disclosures of cash flow information:\nCash paid during the year for: Interest $ 371 $ 267 $ 283 Income taxes 77 55 15\nThe accompanying notes are an integral part of these consolidated financial statements.\nBELL NATIONAL CORPORATION Notes To Consolidated Financial Statements December 31, 1995\nNOTE 1. The Company and Basis of Presentation\nBell National Corporation (\"Bell National\" and together with its subsidiaries the \"Company\") was incorporated in California on October 1, 1958. Through 1985, its principal subsidiary was Bell Savings and Loan Association (\"Bell Savings\"), a state chartered savings and loan association. On July 25, 1985, the Federal Home Loan Bank Board appointed the Federal Savings & Loan Insurance Corporation (\"FSLIC\") as receiver of Bell Savings. At the same time, the assets of Bell Savings were transferred to a new, unrelated, federally chartered mutual savings and loan association, Bell Federal. The FSLIC's action followed shortly after a determination that Bell Savings had a negative net worth. On August 20, 1985, Bell National filed a voluntary petition under Chapter 11 of the Bankruptcy Code. A plan of reorganization was approved by the Bankruptcy Court, and became effective June 29, 1987.\nOn June 15, 1990, Bell National purchased 100% of the common stock of Payne Fabrics, Inc. (\"Payne\"), a designer and distributor of decorative drapery and upholstery fabrics, for a purchase price of $6,493,000 and the issuance of stock appreciation rights. Bell National's other wholly-owned subsidiaries, Bell Savings and Pacific Coast Holdings Insurance Company, have no significant assets or liabilities .\nNOTE 2. Summary of Significant Accounting Policies\nPrinciples of Consolidation. The consolidated financial statements include Bell National and its wholly owned subsidiaries. All intercompany balances and transactions have been eliminated.\nUse of Estimates. The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.\nCash and Cash Equivalents. The Company has instituted a cash management system, whereby cash generated by operations is immediately used to reduce debt. Accordingly the Company maintains no cash or cash equivalents.\nInventories. Inventories are carried at the lower of cost (first-in, first-out) or market and consist totally of finished goods. The reserve for obsolete inventory at December 31, 1995 and 1994 is $106,000 and $132,000, respectively.\nProperty and Equipment. Property and equipment are stated at cost and are depreciated using the straight-line method over the assets' estimated useful lives. Principal useful lives are as follows:\nFurniture and fixtures 10 years Machinery and equipment 12 years Leasehold improvements Useful life or life of lease, whichever is shorter Computer equipment and software 5 years\nNormal maintenance and repairs are charged to expense as incurred, significant improvements are capitalized.\nGoodwill. Assets and liabilities related to the Payne business combination have been accounted for as a purchase transaction and were recorded at their respective fair values at the date of acquisition. Goodwill arising from the excess of the purchase cost, plus related acquisition expenses, over the fair value of aggregate net assets acquired is recorded as an asset and amortized on a straight-line basis over 40 years. Accumulated amortization at December 31, 1995 and 1994 is $135,000 and $115,000, respectively.\nThe Company has not yet adopted the provisions of SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, but believes the impact of adopting the standard will be immaterial to the results of operations.\nDeferred Sample Books. The cost of producing and purchasing sample books are initially recorded as an asset and amortized over a three year period, 20% in the year of manufacture and initial distribution and 40% in each of the two subsequent years. Accumulated amortization at December 31, 1995 and 1994 is $816,000 and $601,000, respectively. The Company prefers to produce these books internally due to cost advantages over outside vendor production. Distribution scheduling often requires the use of outside vendors causing a varying mix of sources for sample books from period to period. Costs included in the development of sample books include labor, material, freight and supplies. Labor including internal and subcontracted, together with fabric costs, constitute approximately 85% of total sample book costs.\nRevenue Recognition. The Company recognizes revenue upon shipment of product to customers.\nIncome Taxes. The Company follows the liability method 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 tax rates and laws that are expected to be in effect when the differences are expected to reverse. Valuation allowances are provided against deferred tax assets if it is more likely than not that the deferred tax assets will not be realized.\nIncome Per Common Share. Income per common share is computed using the weighted average number of common shares outstanding during the respective periods. The exercise of outstanding warrants, which are common stock equivalents, are not included in the computation as their effect would be antidilutive. The fully diluted per share calculation was anti-dilutive for each year.\nNOTE 3. Accounts Receivable\nAccounts receivable are net of allowances for sales returns and doubtful accounts of $69,000 and $76,000 at December 31, 1995 and 1994, respectively. The Company markets its decorative drapery and upholstery products principally to interior designers located throughout the United States.\nNOTE 4. Property and Equipment Property and equipment consists of the following at December 31:\n1995 1994 ------------ ------------ Furniture and fixtures $ 213,000 $ 201,000 Machinery and equipment 228,000 166,000 Leasehold improvements 153,000 151,000 Computer equipment and software 286,000 286,000 ------------ ------------ 880,000 804,000 Less accumulated depreciation and amortization 668,000 605,000 ------------ ------------ $ 212,000 $ 199,000 ============ ============\nNOTE 5. Long-Term Debt Long-term debt is summarized as follows at December 31:\n1995 1994 ------------ ------------ Bank revolving and term facility $ 3,042,000 $ 2,921,000 Less current portion 400,000 300,000 ------------ ------------ Long-term debt less current portion $ 2,642,000 $ 2,621,000 ============ ============\nAggregate maturities of long-term debt as of December 31, 1995 are as follows:\n1996 $ 400,000 1997 425,000 1998 2,217,000 ------------ $ 3,042,000\nOn May 1, 1995 the Company entered into a Revolving Credit Agreement with Bank One, Dayton, National Association (\"Revolving Agreement\"). The terms provide for a total loan facility of $4,125,000 consisting of a term loan of $1,025,000, payable in seven quarterly installment of $100,000 and a balloon payment of $325,000 due on June 1, 1997. The remaining portion of the Revolving Agreement consists of a revolving line of credit, which matures on June 1, 1998. Borrowings under the revolving line of credit are based on a percentage of Payne's eligible accounts receivable and a yet to be determined percentage of Payne's eligible inventory, as defined. The Revolving Agreement is collateralized by all of the assets of Payne, guaranteed by the Company and subject to restrictive covenants.\nAs of December 31, 1995, the Company is in compliance with all covenants under its existing loan facility.\nIn connection with the 1990 acquisition of Payne the Company entered into a $450,000 senior subordinated note, net of a $150,000 discount (the \"Note\"). The note which bore interest at 10% per\nNOTE 6. Leases\nFuture minimum lease payments under noncancelable operating leases as of December 31, 1995 are as follows:\n1996 $ 523,000 1997 534,000 1998 498,000 1999 479,000 2000 413,000 2001 and thereafter 635,000 ------------ Total $ 3,082,000 ============\nThe noncancelable operating leases are primarily for Payne's warehouse and office space and expire over the next nine years. Rent expense charged to operations for the year ended December 31, 1995, 1994 and 1993 was $472,000, $455,000 and $563,000, respectively.\nNOTE 7. Employee Pension Plans\nPayne has a defined benefit pension plan covering substantially all of its employees. The benefits are based on years of service and annual compensation of the employee calculated on the projected unit credit method. Payne makes annual contributions to the plan equal to the maximum amount that can be deducted for income tax purposes. No contributions were required for the years ended December 31, 1995, 1994 and 1993.\nEffective January 31, 1994, the plan was frozen and no additional benefits will accrue nor additional employees become eligible for the plan beyond that point. The individual employees currently eligible at that time became 100% vested in their accumulated benefits as of that date.\nThe following table sets forth the plan's funded status, amounts recognized in the Consolidated Balance Sheet at December 31, 1995 and 1994 and the net periodic pension cost recognized for the years then ended.\nDecember 31, -------------------------- 1995 1994 ----------- ----------- Actuarial present value of accumulated benefit obligation $ 1,689,000 $ 1,444,000\nProjected benefit obligation $ 1,689,000 $ 1,444,000 Plan assets at fair value 1,618,000 1,502,000 ----------- ----------- Plan assets in excess of (less than) projected benefit obligation (71,000) 58,000 Unrecognized net (gain) loss 93,000 (49,000) Unrecognized prior service gain -- -- Unrecognized transitional asset (51,000) (76,000) ----------- ---------- Net pension liability $ (29,000) $ (67,000) =========== ==========\nNet pension costs include the following components: Service cost $ -- $ 7,000 Interest on projected benefit obligation 119,000 127,000 Actual return on plan assets (132,000) (151,000) Other (25,000) (24,000) ----------- ---------- Net periodic pension (income) $ (38,000) $ (41,000) =========== ==========\nPlan assets consist primarily of fixed income securities, commingled investment funds, commercial paper, and short-term securities.\nThe following is a summary of significant actuarial assumptions used as of December 31:\n1995 1994 ----------- ----------- Discount rate 7.5% 8.5% Rate of increase in compensation levels 0.0% 0.0% Expected long-term rate of return on assets 9.0% 9.0%\nThe Company changed the assumed discount rate by adoption of the GATT pension provisions in 1995 resulting in the increase in the December 31, 1995 benefit obligation of $123,000.\nPayne maintains an employee retirement savings plan under Section 401(k) of the Internal Revenue Code. Under the terms of such plan, eligible employees may contribute up to 20% of their annual compensation, up to a ceiling of $9,240. The Plan allows Payne to make matching contributions. In 1995 and 1994 Payne made matching contributions of $27,988 and $7,782, respectively. Payne made no matching contribution to the plan in 1993 or 1992. Payne has the ability to activate sections of the plan in order to allow for discretionary contributions. As of December 31, 1995, such sections have not been activated.\nNOTE 8. Income Taxes\nThe effective income tax rates differed from the Federal Statutory income tax rates as follows for the year December 31:\n1995 1994 1993 --------- ---------- ---------\nStatutory Federal income tax expense $ (26,000) $ (195,000) $ (72,000) (Increase) Decrease resulting from: Effect of nondeductible expenses (16,000) (14,000) (43,000) Deferred tax benefits not recognized 42,000 -- -- Other -- -- (11,000) Utilization of tax loss carryforwards -- -- 126,000 State income tax expense (29,000) (46,000) (14,000) --------- ---------- --------- Reported Income tax expense $ (29,000) $ (255,000) $ (14,000) ========= ========== =========\nThe components of income tax expense are as follows:\n1995 1994 1993 --------- ---------- ---------\nCurrent federal income tax expense $ -- $ (209,000) $(120,000) Deferred benefit -- -- 120,000 State and local (29,000) (46,000) (14,000) --------- ---------- --------- $ (29,000) $ (255,000) $ (14,000) ========= ========== =========\nAt December 31, 1995, the Company has federal income tax net operating loss carryforwards (\"NOL's\") of approximately $115,000,000 which expire from 1996 through 2010. These NOL's primarily arose from income tax returns which were subject to rulings by the Bankruptcy Court. The Internal Revenue Service has objected to the Bankruptcy Court's ability to rule as to the amount and character of the carryforwards. In addition, under the Internal Revenue Code (\"IRC\"), the benefit of these NOL's could be limited, or eliminated, if the IRS determines there was an \"ownership change\" involving more than 50% of the Company's stock. There is risk that the Company does not meet the continuity of business requirements of the IRC. These matters create doubt as to whether these carryforwards will be utilized by the Company. For financial reporting purposes, the Company does not recognize the benefit of these NOL's.\nSignificant components of the Company's deferred tax asset and liability as of December 31 were as follows:\n1995 1994 ----------- ----------- Deferred tax assets related to: Net operating loss carryforwards $39,100,000 $39,100,000 Accrued stock appreciation rights 121,000 121,000 Reserve for obsolete inventory 36,000 45,000 Inventory 330,000 381,000 Accounts receivable reserves 24,000 26,000 Accrued vacation 30,000 40,000 Other 27,000 30,000 ----------- ---------- 39,668,000 39,683,000 Less valuation allowance 39,604,000 39,683,000 ----------- ---------- 64,000 60,000 Deferred tax liability related to: Depreciation 64,000 60,000 ----------- ---------- Net deferred tax asset $ -- $ -- =========== ==========\nThe Company has taken a conservative approach to the valuation of it's deferred assets and has recorded valuation allowances to offset the amount of the deferred tax asset in it entirety.\nNOTE 9. Stockholders' Equity\nOn November 20, 1989, Bell National sold 1,317,373 shares of common stock to a group of investors for approximately $443,000 or $0.34 per share. In addition, Bell National issued a warrant to acquire 957,373 shares of common stock. The warrant is exercisable through November 20, 1999 at $0.37 per share. The warrant agreement, among other things, provides for the repurchase of unexercised warrants. The obligation of Bell National is determined by multiplying the unexercised number of shares subject to the warrant by the excess of the current market price (as defined) per share of common stock and the current warrant price (as defined) per share of common stock. Since the exercise price of the warrant is greater than the fair market value of the stock at December 31, 1995 and 1994, no liability has been recorded for this obligation.\nIn addition to the warrant, the Company has issued, under various agreements, 1,470,357 stock appreciation rights (SAR's). 810,000 of these SAR's, are exercisable at $0.30 and expire in 1999. The remaining 660,357 SAR's, which include the 455,357 SAR's issued in connection with the acquisition of 17% of the outstanding shares of Payne common stock, have an exercise price of zero and are exercisable at varying exercise dates through June 1997. In general, each SAR entitles the holder to receive upon exercise an amount equal to the excess, if any, of the market value per share at the date of exercise over the exercise price of the SAR, plus any dividends or distributions per share made by Bell National prior to the exercise date. On November 15, 1995 the SAR\nagreements of Messrs. Kelly and Toussaint for 90,000 and 360,000 SAR's respectively, was amended to extend the termination date to November 20, 2001.\nDuring 1994, the Company issued 8,928 shares of Common Stock in connection with the exercise of vested SAR's that had a zero exercise price. The accrued value of such SAR's were transferred from the SAR liability to equity upon the exercise and the related stock issuance.\nAt December 31, 1995, 1994 and 1993 the value of all issued and outstanding SAR's has been estimated to be $356,000, $356,000 and $213,000, respectively.\nNOTE 10. Related Party Transactions\nThe Company currently rents corporate office space on a month-to-month basis in Orlando, Florida from Milley Management Incorporated, a private investment and management consulting firm. The Chairman and Secretary of the Company is the President and sole stockholder of Milley Management Incorporated. Rent and administrative support expenses were approximately $120,000 in each of the years ended December 31, 1995, 1994 and 1993, respectively.\nSCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS BELL NATIONAL CORPORATION AND SUBSIDIARIES (Dollars in Thousands)\nS-1\nExhibit Number Description Page No - ------ ----------- --------\n2.1 Bell National Corporation Plan of Reorganization (Annex I). (Incorporated herein by reference to Item 1 of the Company's Annual Report on Form 10-K for the period from August 20, 1985 to December 31, 1985 and for the years ended December 31, 1986 and 1987 (File No. 3-935)).\n3.1 Restated Articles of Incorporation. (Incorporated herein by reference to Exhibit 3.1 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1988 (File No. 3-935)).\n3.2 Bylaws of the Company. (Incorporated herein by reference to Exhibit 3.2 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 (File No. 3-935)).\n4.1 Registration Rights Agreement dated as of November 20, 1989 among the Company, The Airlie Group L.P., Liberty Associates Limited Partnership, Winchester National, Inc., Alexander M. Milley, Alan D. Gordon, Kim G. Davis, Brian E. Kinsman, Kevin P. Lynch and Robert C. Shaw (collectively, the \"Purchasers\"). (Incorporated herein by reference to Exhibit 4.3 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 (File No. 3-935)).\n4.2 Warrant to purchase 957,373 shares of common stock of the Company issued by the Company on November 20, 1989 to Liberty Associates Limited Partnership. (Incorporated herein by reference to Exhibit 4.4 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 (File No. 3-935)).\n9.1 Voting Trust Agreement dated as of May 11, 1989 between Santa Fe and Mr. Nicholas E. Toussaint, as amended. (Incorporated herein by reference to Exhibit 9.1 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 (File No. 3-935)).\n10.1 Standstill Agreement between Bell National Corporation, Santa Fe Development and Mortgage Company, Inc., Donald Hancock, Carol G. Avakian Hancock, and Fred L. Harris, dated October 20, 1988. (Incorporated herein by reference to Exhibit 3.1 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1988 (File No. 3-935)).\n10.2 Stock Purchase Agreement dated as of August 17, 1989 by and among the Company and the Purchasers. (Incorporated herein by reference to Annex I of the Company's Proxy Statement dated October 2, 1989 delivered to shareholders of the Company in connection with a Special Meeting of Shareholders of Company held on November 3, 1989. (File No. 3-935)).\n10.3 Stock Appreciation Rights Agreement dated as of November 20, 1989 between the Company and Edward B. Collins. (Incorporated herein by reference to Exhibit 10.3 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 (File No. 3-935)).\n10.4 Stock Appreciation Rights Agreement dated as of November 20, 1989 between the Company and Charles J. Hart. (Incorporated herein by reference to Exhibit 10.4 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 (File No. 3-935)).\n10.5 Stock Appreciation Rights Agreement dated as of November 20, 1989 between the Company and Raymond O'S. Kelly. (Incorporated herein by reference to Exhibit 10.5 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 (File No. 3-935)).\n10.6 Stock Appreciation Rights Agreement dated as of November 20, 1989 between the Company and Edward K. Taapken. (Incorporated herein by reference to Exhibit 10.6 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 (File No. 3-935)).\n10.7 Stock Appreciation Rights Agreement dated as of November 20, 1989 between the Company and Nicholas E. Toussaint. (Incorporated herein by reference to Exhibit 10.7 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 (File No. 3-935)).\n10.8 Stock Appreciation Rights Agreement dated as of November 20, 1989 between the Company and John Vida. (Incorporated herein by reference to Exhibit 10.8 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 (File No. 3-935)).\n10.9 Stock Appreciation Rights Agreement dated as of November 20, 1989 between the Company and Robert A. Huret. (Incorporated herein by reference to Exhibit 10.9 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 (File No. 3-935)).\n10.10 Stock Appreciation Rights Agreement dated as of November 20, 1989 between the Company and Alan E. Rothenberg. (Incorporated herein by reference to Exhibit 10.10 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 (File No. 3-935)).\n10.11 Stock Purchase Agreement dated as of June 15, 1990 by and among the Company, as purchaser, and Azimuth Corporation, as seller. (Incorporated herein by reference to Exhibit 2(a) of the Company's Form 8-K filed June 15, 1990. (File No. 3-935)).\n10.12 Loan Agreement dated as of June 14, 1990 between the Company, the borrower, and Continental Bank N.A., the lender. (Incorporated herein by reference to Exhibit 10.12 of the Company's Form 8-K filed June 29, 1990. (File No. 3-935)).\n10.13 Stock Appreciation Rights Agreement dated as of June 14, 1990 between the Company and Val G. Blaugh. (Incorporated herein by reference to Exhibit 4 of the Company's Form 8-K filed June 15, 1990. (File No. 3-935)).\n10.14 Stock Appreciation Rights Agreement dated as of June 14, 1990 between the Company and Mark van der Kloet. (Incorporated herein by reference to Exhibit 4 of the Company's Form 8-K filed June 15, 1990. (File No. 3-935)).\n10.15 Stock Appreciation Rights Agreement dated as of June 14, 1990 between the Company and Roy D. Rafalco. (Incorporated herein by reference to Exhibit 4 of the Company's Form 8-K filed June 15, 1990. (File No. 3-935)).\n10.16 Stock Appreciation Rights Agreement dated as of June 14, 1990 between the Company and Jeffrey Pratt. (Incorporated herein by reference to Exhibit 4 of the Company's Form 8-K filed June 15, 1990. (File No. 3-935)).\n10.17 Employment Agreement between the Company and Alexander M. Milley dated November 20, 1989. (Incorporated herein by reference to Exhibit 10.17 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991 (File No. 3-935)).\n10.18 Employment Agreement between the Company and Robert C. Shaw dated November 20, 1989. (Incorporated herein by reference to Exhibit 10.18 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991 (File No. 3-935)).\n10.19 Revolving Credit Agreement, dated as of May 1, 1995, among Payne Fabrics, Inc., Bell National Corporation and Bank One, Dayton, National Association.\n10.20 SAR Agreement Extension, dated November 15, 1995, between the Company and Raymond O'S. Kelly.\n10.21 SAR Agreement Extension, dated November 15, 1995, between the Company and Nicholas E. Toussaint.\n21.1 Subsidiaries of the Company. (Incorporated herein by reference to the exhibits filed with the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990 (File No. 3-935)).\n27 Financial data schedule.","section_15":""}
{"filename":"817383_1995.txt","cik":"817383","year":"1995","section_1":"ITEM 1. BUSINESS Introduction\nThe Company is a real estate investment trust engaged in the acquisition and operation of apartment communities in the Southwestern United States. At December 31, 1995, the Company owned 18 apartment communities, containing 2,683 units, located in Phoenix and Tucson, Arizona, Houston, Texas and Albuquerque, New Mexico. As of such date, the total book value of the apartments was $71.3 million, and the apartments were subject to first mortgage loans totaling $49.6 million. Each of the properties is owned by a wholly owned subsidiary of the Company and the first mortgage loans are generally non-recourse and non-cross collateralized. The Company also owned through joint ventures six apartment communities, containing 1,441 units, located in Phoenix and Tucson, Arizona. The Company's investments in the joint ventures totalled $3.0 million at December 31, 1995.\nPrior to 1993, the Company invested in mortgage assets (\"Mortgage Assets\") that entitled it to receive the excess cash flows from a pool of mortgage instruments over the required payments on the related structured financing. In early 1993, the Company determined to shift its focus to the acquisition, development and operation of apartment communities. The Company plans to hold the existing Mortgage Assets and use the cash flows for apartment acquisitions, operations, payment of dividends and other corporate purposes. At December 31, 1995, the Mortgage Assets had a carrying value of $11.9 million, of which $7.6 million were pledged as collateral for short-term borrowing of $4.5 million.\nPima Mortgage Limited Partnership (the \"Manager\") manages the day-to-day operations of the Company, subject to the supervision of the Company's Board of Directors, pursuant to the terms of a management agreement. The Company also has entered into property management agreements with Pima Realty Advisors, Inc. (the \"Property Manager\"), an affiliate of the Manager, for each of its current apartment properties.\nThe Company has elected to be taxed as a real estate investment trust (\"REIT\") pursuant to sections 856 through 860 of the Code. The Company generally will not be subject to tax on its income to the extent that it distributes its taxable income to its stockholders and it maintains its qualification as a REIT. See \"Business -- Federal Income Tax Considerations.\"\nThe Company was incorporated in the State of Maryland on June 18, 1987 and commenced its operations on August 26, 1987. The Company's Common Stock is listed on the American Stock Exchange under the symbol \"ASR.\" The Company effected a reserve stock split on July 7, 1995 under which one new share of common stock was issued in exchange for five shares of outstanding common stock. Accordingly, all data relating to the number of shares and per share amounts for prior periods have been adjusted to reflect the reverse stock split.\nThe principal executive offices of the Company and the Manager are located at 335 North Wilmot, Suite 250, Tucson, Arizona 85711, telephone number (520) 748-2111. Unless the context otherwise requires, the term Company means ASR Investments Corporation and its subsidiaries.\nOperating Policies And Strategies\nReal Estate Activities Introduction\nThe Company has developed various business objectives and operating, acquisition, financing and investment strategies and policies relative to its real estate activities. These policies and strategies have been determined by the directors of the Company and may be amended or revised from time to time at the discretion of the directors without a vote of the stockholders of the Company.\nBusiness Objectives\nThe Company's current business objectives are to increase the cash flow and value of its existing portfolio of apartment communities and to acquire additional communities.\nInvestment Policies\nThe Company's current portfolio consists of apartment communities in the southwestern region of the United States and investments in joint ventures that own apartment communities. The Company intends to continue to focus on apartment communities in this region. However, future investments, including the activities described below, are not limited (as to percentage of assets or otherwise) to any geographic area or any specific type of property. In this regard, the Company expand its current geographic focus and may acquire other types of income-producing properties, including hotels, motels, shopping centers and office buildings.\nThe Company believes that attractive opportunities continue to be available to acquire apartment communities. The Company may enter into agreements to acquire newly developed properties upon completion or upon achievement of certain specified occupancy rates. The Company also intends to develop new apartment communities for its own account or through joint ventures with others.\nThe Company may purchase or lease income-producing properties for long-term investment and improve its properties, or sell such properties, in whole or in part, when circumstances warrant. The Company also may participate with other entities in property ownership, through joint ventures or other types of co-ownership. Equity investments may be subject to existing mortgage financing and other indebtedness or such financing or indebtedness may be incurred in connection with acquiring investments. Any such financing or indebtedness will have a priority over the equity interest of the Company.\nWhile the Company will emphasize equity real estate investments in properties, it may, in its discretion, invest in mortgages and other real estate interests or make loans secured by mortgages on or interests in real estate properties. Its investments in mortgages may include participating or convertible mortgages if the Company concludes that it may benefit from the cash flow and\/or any appreciation potential in the value of the property. Such mortgages may be similar to equity participations.\nSubject to the percentage of ownership limitations and gross income tests necessary for REIT qualification (see \"Federal Income Tax Considerations\"), the Company also may invest in securities of concerns engaged in real estate activities or securities of other issuers. The Company in the future may acquire all or substantially all of the securities or assets of other REITs or similar entities when it believes such investments would be consistent with the Company's investment policies. In any event, the Company does not intend that its investments in securities will require the Company to register as an \"investment company\" under the Investment Company Act of 1940, and the Company intends to divest securities before any such registration would be required.\nAcquisitions In evaluating acquisitions, the Company considers such factors as: (i) the geographic location and type of property; (ii) the age, construction quality, condition and design of the property; (iii) the current and projected cash flow of the property and the potential to increase cash flow; (iv) the potential for capital appreciation of the property; (v) the terms of tenant leases, including the potential for rent increases; (vi) the potential for economic growth and the tax and regulatory environment of the community in which the property is located; (vii) the occupancy and demand by tenants for properties of similar type in the vicinity; and (viii) the prospects for liquidity through sale, financing or refinancing of the property.\nIn acquiring apartment properties, the Company generally seeks properties that (a) are available at prices below estimated replacement cost after initial renovations and improvements, or can be developed at a cost that is below the estimated value upon completion, (b) are well-located in their markets and (c) are capable of enhanced performance through intensive asset management and cosmetic improvements.\nOperating Strategies\nThe Company's operating strategies are to (i) achieve and maintain high occupancy and increase rental rates through effective leasing, reducing turnover rates and providing quality maintenance and services to maximize tenant satisfaction; (ii) manage operating expenses and achieve cost reductions through operating efficiencies and economies of scale generally inherent in the management of a large property portfolio in a specific region; and (iii) emphasize regular programs of repairs and capital improvements to enhance the properties' competitive advantages in their respective markets.\nFinancing Policies The Company intends to finance acquisitions with the most appropriate sources of capital, which may include undistributed funds from operations, the issuance of equity securities, the sale of assets, bank and other institutional borrowings and the issuance of debt securities. Future borrowings by the Company for acquisitions may be either on a secured or unsecured basis.\nThe Company also may incur indebtedness for purposes other than the acquisition of properties when the Company believes it is advisable to do so. For short-term purposes, the Company, from time to time, may arrange for short-term borrowings from banks or in the commercial paper market or otherwise. The Company also may arrange for long-term borrowings from institutional lenders or through public or private offerings or other means. The Company has no commitments from anyone with respect to any such borrowings, and there is no assurance that any such borrowings will be available.\nIn addition, the Company may incur debt secured by equity investments held in its portfolio. The Company may invest in properties subject to existing loans secured by mortgages, deeds of trust or similar liens on the properties, or such financing and other indebtedness may be incurred in connection with acquiring investments. The Company also may obtain other mortgage financing for unleveraged or underleveraged properties or may refinance properties acquired on a leveraged basis. The mortgage financings may be recourse, non- recourse or cross-collateralized. The Company does not have a policy limiting the number or amount of mortgages that may be placed on any particular property, but mortgage financing instruments usually limit additional indebtedness on such properties. The Company also may determine to finance acquisitions through the exchange of properties or issuance of stock or other securities.\nPolicies with Respect to Other Activities\nThe Company may make investments other than as previously described. The Company has authority to offer its Common Shares or other equity or debt securities in exchange for property and to repurchase or otherwise reacquire its Common Shares or any other securities and may engage in such activities in the future. The Company also may in the future make loans to joint ventures in which it participates. The Company will not engage in trading, underwriting or the agency distribution or sale of securities of other issuers. At all times, the Company intends to make investments in such a manner as to be consistent with the requirements of the Code to qualify as a REIT unless, because of circumstances applicable to the Company, changes in the Code (or changes in the regulations promulgated under the Code), the Company determines that it is no longer in the best interests of the Company to qualify as a REIT. The Company's policies with respect to such activities may be reviewed and modified from time to time by the Company without the vote of the stockholders.\nProperty Management\nThe Company has entered into property management agreements with Pima Realty Advisors, Inc. (the \"Property Manager\") for each of its current apartment communities. The Property Manager is an affiliate of the Manager. Each property management agreement, which has a current term through December 31, 1996, was approved by the Unaffiliated Directors. Under each agreement, the Property Manager provides the customary property management services at its cost without profit or distributions to its owners, subject to the maximum limitation of the prevailing management fee rates for similar properties in the market. The Property Manager currently manages over 5,000 apartment units, including those owned by the Company.\nThe Property Manager has developed computer, accounting, management, reporting and control systems to monitor property operations. Detailed annual budgets are prepared for each property. Monthly, quarterly and annual reports are prepared addressing occupancy rates, turnover ratios, budget variances, delinquencies and other operating information. Weekly reports are provided for each property detailing leasing and occupancy activities. The Property Manager also maintains and analyzes demographic resident data. Prior to entering into a lease, the Property Manager generally reviews the credit of the prospective tenant to attempt to minimize bad credit risks and identify tenants having a poor rental history. This information is intended to enable the Property Manager to identify and act quickly on specific conditions affecting individual properties.\nEach of the current properties is operated by a staff, including a resident manager and a maintenance and apartment preparation staff. Policies and procedures utilized at the property sites follow established federal and state laws and regulations, including lease contracts, on-site marketing procedures, credit collection and eviction standards. As a result of active onsite management and strict prospective tenant qualification standards, the Company expects to experience low rent loss to delinquencies or early lease terminations.\nIndividual property lease programs are structured to respond to local market conditions. The Company attempts to balance rent increases with high occupancy and stabilized turnover costs. None of the current properties is currently subject to rent control or rent stabilization regulations. Standard lease terms stipulate due dates for rent payments, late charges, no offset or withholding provisions, security deposits and damage reimbursement clauses and other provisions considered favorable to the Company.\nDevelopment of Properties\nIn March 1996, the Company commenced the development of a luxury apartment community located in Tempe, Arizona. The community is being built on 20 acres and is planned for 356 units with an average size of 919 square feet. The total estimated cost of the community is approximately $20 million, and the Company has obtained a construction loan for $15,350,000. The Company expects to have the first group of units available for rent near the end of 1996 and the community completed in the third quarter of 1997. As of December 31, 1995, the Company had invested $3.0 million.\nThe Company has acquired three other parcels of land for future development of apartment communities. The Company may develop or sell one or more of these parcels. As of December 31, 1995, the Company had invested $900,000.\nCurrent Properties\nAs of December 31, 1995, the Company owned 24 apartment communities consisting of 4,124 units located in Arizona, New Mexico and Texas. All of the apartment communities are owned directly by the Company with the exception of six which are owned through joint ventures with affiliates of Citicorp.\nThe apartment communities are \"garden apartments\" (two to three story apartments with ground level parking) with recreational facilities such as pools and clubhouses. They are well maintained and landscaped and are targeted at providing an attractive lifestyle at low to moderate rents. Average monthly rent at year end was $495 per month, with community averages ranging from $385 to $862.\nThe following table set forth certain information regarding the Company's existing apartment communities.\nMortgage Assets\nGeneral\nEach of the Company's Mortgage Assets entitle the Company to receive the excess of the cash flows (the \"Net Cash Flows\") on pools of residential mortgage loans and mortgage-backed certificates (collectively the \"Mortgage Instruments\") over the required payments on the related series of structured financing (the \"Structured Financing\") secured by such Mortgage Instruments. All of the Mortgage Instruments bear fixed interest rates and a portion of the Structured Financing bears variable interest rates that are adjusted monthly or quarterly. The Net Cash Flows result primarily from (i) the favorable spread between the interest rates on the Mortgage Instruments over those on the Structured Financing, (ii) reinvestment income on the funds collected on the Morgage Instruments before payment on the Structured Financing, (iii) any prepayments of the Mortgage Instruments that are not necessary for payments on the Structured Financing, and (iv) net proceeds from early redemption of Structured Financing. For most of the Mortgage Assets, the Company has the option to redeem the Structured\nFinancing (generally at par) after the specified conditions are met, generally when the outstanding balance of the Structured Financing declines below a specified amount or after a specified date. In such event, the Mortgage Instruments are sold and the net proceeds after redemption of the Structured Financing are remitted to the Company.\nAt December 31, 1995, the carrying value of the Company's Mortgage Assets was $11.9 million. The Company does not intend to acquire any additional Mortgage Assets, but plans to hold the existing Mortgage Assets and use the cash flows for apartment acquisitions, operations, payment of dividends and other corporate purposes.\nEach Structured Financing is issued in series consisting of several classes. Each series of Structured Financing generally constitutes a nonrecourse obligation of the Company, which is payable solely from the pledged Mortgage Instruments. Each series is structured so that the monthly payments on the pledged Mortgage Instruments, together with the reinvestment income at assumed rates, are sufficient to make the required interest and principal payments on the series on a timely basis. Principal and interest payments (including prepayments) on the Morgage Instruments are first applied to principal and interest payments on one or more classes of the Structured Financing according to the terms of the related indenture, and any excess cash flow is remitted to the Company. Factors Affecting Net Cash Flows\nThe Net Cash Flows represent both the return of and the return on the investment in the Mortgage Assets. Thus, Mortgage Assets are amortizing assets. The principal factors which influence the Net Cash Flows of a Mortgage Asset are as follows:\n(1) Other factors being equal, Net Cash Flows in each payment period tend to decline over the life a Structured Financing, because (a) as normal amortization of principal and principal prepayments occur on the Mortgage Instruments, the principal balances of the Mortgage Instruments are reduced; (b) the principal payments on the Mortgage Instruments generally are first used to pay the principal on the earlier, lower-yielding classes of such Structured Financing, thereby resulting in a reduction of the favorable spread between the interest rate on the Mortgage Instruments and the interest rates on the outstanding classes, and (c) the higher coupon Mortgage Instruments are likely to be prepaid faster, reinforcing the same effect.\n(2) The rate of prepayments on the Mortgage Instruments significantly affects the Net Cash Flows. Because prepayments shorten the life of the Mortgage Instruments, a higher rate of prepayments normally reduces overall Net Cash Flows. The rate of prepayments is affected by mortgage interest rates and other factors. Generally, increases in mortgage interest rates reduce prepayment rates, while decreases in mortgage interest rates increase prepayment rates. In addition, prepayments occuring during the early life of a Structured Financing have a more negative effect on Net Cash Flows than the same volume of prepayments have at a later date.\n(3) With respect to variable rate classes of the Structured Financing, increases in the interest rate index increase the interest payments and thus reduce or, in some instances, eliminate the Net Cash Flows, while decreases in the index decrease the interest payments and thus increase the Net Cash Flows.\n(4) The interest rate at which the monthly cash flow from the Mortgage Instruments may be reinvested until payment dates for the Structured Financing influences the amount of the Net Cash Flows unless such reinvestment income is not paid to the owner of the Mortgage Asset.\n(5) The administrative expenses, if any, of a series of Structured Financing may increase as a percentage of Net Cash Flows where some of such administrative expenses are fixed. In later years, it can be expected that fixed expenses will exceed the available cash flow. Although reserve funds generally are established to cover such shortfalls, there can be no assurance that such reserves will be sufficient to cover such shortfalls. The Company may be liable for administrative expenses relating to a series of Structured Financing if reserves prove to be insufficient. Moreover, any unanticipated liability or expenses with respect to the Structured Financing could adversely affect Net Cash Flows.\n(6) The Net Cash Flows from the early redemptions of a Mortgage Asset are determined by the principal balance and market value of the Mortgage Instruments. Generally, lower mortgage interest rates\nresult in higher market value for the Mortgage Instruments. Furthermore, when a Mortgage Asset is redeemed, there will not be any future Net Cash Flows from that Mortgage Asset. CAPITAL RESOURCES\nSubject to the terms of the Company's Bylaws, the availability and cost of borrowings, various market conditions and restrictions that may be contained in the Company's financing arrangements from time to time and other factors as described herein, the Company increases the amount of funds available for its activities with the proceeds of borrowings including mortgage loans, short-term borrowing and other credit arrangements. It can be anticipated that a substantial portion of the assets of the Company will be pledged to secure indebtedness incurred by the Company. Accordingly, such assets will not be available for distribution to the stockholders of the Company in the event of the Company's liquidation except to the extent that the value of such assets exceeds the amount of such indebtedness.\nThe Company has obtained a first mortgage loan for each of its 18 apartment communities. At December 31, 1995, the mortgage loans totalled $49.6 million, of which $46.0 million bears fixed interest rates that averaged 8.6% and $3.6 million bears a variable interest rate at the LIBOR rate plus 2.25%. In addition, each of the Company's joint ventures has obtained a first mortgage loan. The mortgage loans generally are non-recourse to the Company and are not cross-collateralized.\nThe Company also had outstanding short-term borrowings of $4.5 million at December 31, 1995 that were secured by Mortgage Assets with a total carrying value of $7.6 million. Under the short-term borrowings, if the value of the collateral (as estimated by the lender) declines, the Company is required to provide additional collateral or reduce the borrowed amount.\nDuring 1995, the Company used the proceeds from Mortgage Asset redemptions and short-term borrowing to prepay the notes payable secured by Mortgage Assets and the unsecured real estate notes payable. The Company plans to use the proceeds from Mortgage Asset redemptions in 1996 to reduce the short-term borrowing.\nThe Company's Bylaws provide that it may not incur indebtedness if, after giving effect to the incurrence thereof, aggregate indebtedness , secured and unsecured, would exceed 300% of the Company's net assets, on a consolidated basis, unless approved by a majority of the Unaffiliated Directors. For this purpose, the term \"net assets\" means the total assets (less intangibles) of the Company at cost, before deducting depreciation or other non-cash reserves, less total liabilities, as calculated at the end of each quarter in accordance with generally accepted accounting principles.\nThe Company may increase its capital resources by making additional offerings of its Common Stock or securities convertible into the Company's Common Stock. The actual or perceived effect of such offerings may be the dilution of the book value or earnings per share which may result in the reduction of the market price of shares of the Company's Common Stock. The Company is unable to estimate the amount, timing or nature of future sales of its Common Stock as such sales will depend upon market conditions and other factors. See \"Business -- Special Considerations -- Future Offerings of Common Stock.\"\nOperating Restrictions\nThe Company presently may not purchase commodities or commodity futures contracts (other than interest rate futures when used solely for hedging). The Company may not invest in unimproved real property or underwrite securities of other issuers. The foregoing restrictions may not be changed without the approval of the holders of a majority of the outstanding shares of the Company's Common Stock.\nExcept as otherwise restricted, the operating policy of the Company is controlled by its Board of Directors, which has the power to modify or alter such policy without the consent of the stockholders. Although the Company has no present intention of modifying its operating policies described herein, the Board of Directors in the future may conclude that it would be advantageous for the Company to do so.\nCompetition\nThere are numerous real estate companies, insurance companies, financial institutions, pension funds and other property owners that compete with the Company in seeking properties for acquisition and in attracting and retaining tenants. Employees\nThe Company currently has five full-time salaried employees.\nManagement Agreement\nThe Manager is an Arizona limited partnership. The Manager engages in the business of advising the Company with respect to various aspects of the Company's business and operations, managing the overall business and operations of the Company and representing the Company in its dealings with third parties. Jon A. Grove, Frank S. Parise, Jr. and Joseph C. Chan have been directors or officers of general partners of the Manager since its organization.\nTerms Of The Management Agreement\nThe Company and the Manager are parties to a Management Agreement with a term expiring on December 31, 1996, subject to annual extensions between the Company and the Manager. 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. In addition, the Company has the right to terminate the Management Agreement for cause in the event of (i) a breach by the Manager of any provision contained in the Management Agreement occurs; (ii) an order for relief is entered with respect to the Manager in an involuntary case under federal or state bankruptcy, insolvency or other similar laws; or (iii) the Manager (a) ceases or admits in writing its inability to pay its debts as they become due, or makes a general assignment for the benefit of or enters into an arrangement with creditors, (b) applies for or consents to the appointment of a receiver, trustee, assignee, custodian, liquidator or sequestrator, or proceedings seeking such appointment are commenced, (c) authorizes or files a voluntary petition in bankruptcy, or applies for or consents to the application of any bankruptcy, reorganization, arrangement, readjustment of debt, insolvency, dissolution, liquidation or other similar law, or proceedings to such end are instituted against the Manager, or (d) permits or suffers all or any substantial part of its properties or assets to be sequestered or attached by court order, or (iv) if any two of Messrs. Grove, Parise or Chan shall cease to be a director, officer or shareholder of at least one partner of the Manager or if they collectively cease to control the majority of the voting decisions of the Manager.\nThe Manager at all times is subject to the supervision of the Company's Board of Directors and has only such functions and authority as the Company may delegate to it. The Manager is responsible for the day-to-day operations of the Company and performs such services and activities relating to the assets and operations of the Company as may be appropriate, including:\n(a) serving as the Company's consultant with respect to formulation of investment criteria by the Board of Directors;\n(b) representing the Company in connection with the purchase of assets;\n(c) structuring financings of the Company;\n(d) furnishing reports and statistical and economic research to the Company regarding the Com- pany's activities and the services performed for the Company by the Manager;\n(e) providing the executive and administrative personnel, office space and services required in rendering services to the Company;\n(f) administering the day-to-day operations of the Company and performing and supervising the performance of such other administrative functions necessary in the management of the Company as may\nbe agreed upon by the Manager and the Board of Directors, including the collection of revenues, the payment of the Company's debts and obligations and maintenance of appropriate computer services to perform such administrative functions;\n(g) communicating on behalf of the Company with the holders of the equity and debt securities of the Company as required to satisfy the reporting and other requirements of any governmental bodies or agencies and to maintain effective relations with such holders;\n(h) counseling the Company in connection with policy decisions to be made by the Board of Directors; and\n(i) upon request by and in accordance with the direction of the Board of Directors, investing or reinvesting any money of the Company.\nManagement Fee\nThe Manager receives an annual management fee equal to 3\/8 of 1% of the \"Average Invested Assets\" of the Company and its subsidiaries for each year. The Management Agreement provides for a quarterly management fee, although the Board of Directors has approved payment of the management fee monthly, with adjustments made quarterly. The term \"Average Invested Assets\" for any period means the average of the aggregate book value of the consolidated assets of the Company and its subsidiaries before reserves for depreciation or bad debts or other similar non-cash reserves. In the event that the Management Agreement is terminated by the Company or is not renewed by the Company on terms at least as favorable to the Manager as the current Management Agreement, other than as a result of a termination by the Company for cause (as specified above and defined in the Management Agreement), the Manager will be entitled to receive from the Company the management fee that would have been payable by the Company to the Manager pursuant to such Management Agreement based on the investments made by the Company prior to the date on which the Management Agreement is so terminated (or not renewed) for the 12 full fiscal quarters beginning on the date of such termination (or failure to renew) as more fully described in the Management Agreement.\nThe management fee must be calculated by the Manager within 45 days after the end of each quarter, and such calculation must be promptly delivered to the Company for payment within 60 days of the end of each fiscal quarter, subject to adjustment at the end of the year.\nFor information relating to management fees, see Note 7 to consolidated financial statements.\nAdministration Fees\nThe Manager also performs certain analysis and other services in connection with the administration of the Structured Financing relating to the Company's Mortgage Assets, including working with the Master Servicer, if any, and the Company or the other Issuer to ensure proper servicing and administration. For such activities, the Company currently pays the Manager an annual administration fee of $10,000 for each Mortgage Asset acquired before 1991, $20,000 for the total Mortgage Assets acquired in 1991 and $20,000 for the total Mortgage Assets acquired in 1992.\nExpenses\nThe Manager is required to pay employment expenses of its personnel, rent, telephone, utilities and other office expenses (except those relating to a separate office or office facilities, if any, maintained by the Company or its subsidiaries, if any), and certain travel and miscellaneous administrative expenses of the Manager. The Company is required to pay all other expenses of operation (as set forth in the Management Agreement) up to an amount per year with respect to certain of such expenses equal to the greater of 2% of the Company's Average Invested Assets or 25% of the Company's Net Income for that year. Expenses in excess of such amount will be paid by the Manager, unless the Unaffiliated Directors determine that, based upon unusual or non-recurring factors, a higher level of expenses is justified for such fiscal year. In the event that the Company's operating expenses for any fiscal year total less than the greater of 2% of the Company's Average Invested Assets or 25% of its Net Income for that fiscal year, then, within 120 days after the end of such fiscal year, with the consent of the Unaffiliated Directors, the\nManager will be repaid all compensation previously reimbursed by the Manager to the Company on account of operating expenses having exceeded the greater of 2% of its Average Invested Assets or 25% of its Net Income during one or more prior fiscal years, except that the amount of any repayment of compensation to the Manager may not, when added to all other operating expenses of the Company for such fiscal year, exceed the greater of 2% of the Company's Average Invested Assets or 25% of its Net Income for that fiscal year. The Manager's right to repayment of previously reimbursed compensation will be cumulative, and the amount of previously reimbursed compensation which has not been repaid to the Manager will be carried forward to and be repaid to the Manager in subsequent fiscal years. Prior to any such repayment, the Unaffiliated Directors must determine that the Company's operating expenses which were in excess of the limitation set forth above in one or more prior fiscal years were reasonable when incurred in connection with the operations of the Company.\nRight of First Refusal\nThe Manager has granted the Company a right of first refusal, for as long as the Manager or an affiliate of the Manager acts as the Company's manager pursuant to the Management Agreement or any extension thereof, to purchase any assets held by the Manager or its affiliates prior to any sale, conveyance or other transfer, voluntarily or involuntarily, of such assets by the Manager or its affiliates. See \"Business -- Special Considerations -- Potential Conflicts of Interest.\"\nLimits of Responsibility\nPursuant to the Management Agreement, the Manager will not assume any responsibility other than to render the services called for thereunder and will not be responsible for any action of the Company's Board of Directors in following or declining to follow its advice or recommendations. The Manager, the partners of the Manager and any of their partners, directors, officers, stockholders and employees will not be liable to the Company, any other Issuer, any subsidiary of the Company, the Unaffiliated Directors, the Company's stockholders or any subsidiary's stockholders for acts performed in accordance with and pursuant to the Management Agreement, except by reason of acts constituting bad faith, willful misconduct, gross negligence or reckless disregard of their duties under the Management Agreement. The Company has agreed to indemnify the Manager, the partners of the Manager and any of their partners, directors, officers, stockholders and employees, with respect to all expenses, losses, damages, liabilities, demands, charges and claims arising from any of their acts or omissions not constituting bad faith, willful misconduct, gross negligence or reckless disregard of duties, performed in good faith in accordance with and pursuant to the Management Agreement. The Management Agreement does not limit or restrict the right of the Manager, the partners of the Manager or any of their partners, directors, officers, stockholders, employees or affiliates from engaging in any business or rendering services of any kind to any other person, including the purchase of, or rendering advice to others purchasing, assets which meet the Company's policies and criteria, except that the Manager (but not its partners or any of their partners, directors, officers, stockholders, employees or agents) is not permitted to provide any such services to any residential mortgage REIT other than the Company and its subsidiaries. The Manager has the right to subcontract with third parties, including affiliates of the Manager, to provide services to the Manager and the Company. Any payment of fees to such third parties will be the sole responsibility of the Manager.\nThe Subcontract Agreement\nThe Manager and American Southwest Financial Services (\"ASFS\"), Inc. are parties to a Subcontract Agreement pursuant to which ASFS performs certain services for the Manager in connection with the administration of the Structured Financing issued by any Issuer affiliated with ASFS with respect to which the Company owns the Mortgage Asset. Under the Subcontract Agreement, ASFS charges an administration fee for each series of Structured Financing of $12,500 per year. ASFS is a wholly-owned subsidiary of American Southwest Holdings, Inc., a privately held Arizona corporation engaged in the business of issuing and administering the Structured Financing. Jon A. Grove, Chairman and President of the Company, owns 12.5% of American Southwest Holdings, Inc.\nThe Subcontract Agreement extends through December 31, 1996. Thereafter, successive extensions, each for a period not to exceed one year, may be made by agreement between the Manager and ASFS.\nThe Subcontract Agreement may be terminated by either party upon six months prior written notice, except that the Manager may terminate the Subcontract Agreement at any time upon 60 days written notice in the event the Company no longer retains the Manager. In addition, the Manager has the right to terminate the Subcontract Agreement upon the happening of certain specified events, including a breach by ASFS of any provision contained in the Subcontract Agreement.\nThe Company has agreed to indemnify and hold harmless ASFS, its affiliates and their officers and directors from any action or claim brought or asserted by any party by reason of any allegation that ASFS or its affiliates is an affiliate or is otherwise accountable or liable for the debts or obligations of the Company or its affiliates. The Company has no affiliations, agreements or relationships with ASFS or its affiliates, except for (i) the Subcontract Agreement with ASFS, (ii) the indemnification granted by the Company to ASFS, its affiliates and their officers and directors against certain liabilities, (iii) one common director and officer and (iv) the indirect ownership by a general partner of the Manager of 12.5% of the voting stock of American Southwest Holdings, Inc.\nProperty Management Agreement\nThe Company has entered into property management agreements with Pima Realty Advisors, Inc. (the \"Property Manager\") for each of its current properties. The Property Manager is an affiliate of the Manager. Each property management agreement, which has a current term through December 31, 1996, was approved by the Unaffiliated Directors. Under the agreements, the Property Manager provides the customary property management services at its cost without profit or distributions to its owners, subject to the limitation of the prevailing management fee rates for similar properties in the market. The Property Manager currently manages over 5,000 apartment units, including those owned by the Company.\nThe Property Manager has developed computer, accounting, management, reporting and control systems to monitor property operations. Detailed annual budgets are prepared for each property. Monthly, quarterly and annual reports are prepared addressing occupancy rates, turnover ratios, budget variances, delinquencies and other operating information. Weekly reports are provided for each property detailing leasing and occupancy activities. The Property Manager also maintains and analyzes demographic resident data. Prior to entering into a lease, the Property Manager generally reviews the credit of the prospective tenant to attempt to minimize bad credit risks and identify tenants having a poor rental history. This information is intended to enable the Property Manager to identify and act quickly on specific conditions affecting individual properties.\nEach of the current properties is operated by a staff including a resident manager and a maintenance and apartment preparation staff. Policies and procedures utilized at the property sites follow established federal and state laws and regulations, including lease contracts, on-site marketing procedures, credit collection and eviction standards. As a result of active onsite management and strict prospective tenant qualification standards, the Company expects to experience low rent loss to delinquencies or early lease terminations.\nSpecial Considerations\nReal Estate Investment Considerations\nGeneral\nReal property investments are subject to varying degrees of risk. The yields available from equity investments in real estate depend on the amount of income earned and capital appreciation generated by the related properties as well as the expenses incurred. If the properties do not generate income sufficient to meet operating expenses, including debt service and capital expenditures, the Company's income will be adversely affected. Income from the properties may be adversely affected by the general economic climate (including unemployment rates), local conditions such as oversupply of competing properties or a reduction in demand for properties in the area, the attractiveness of the properties to tenants, competition from other available properties, the affordability of single family homes, the ability of the Company\nto provide adequate maintenance and insurance and increased operating costs (including real estate taxes). Certain significant expenditures associated with an investment in real estate (such as mortgage payments, real estate taxes and maintenance costs) generally are not reduced when circumstances cause a reduction in income from the investment. In addition, income from properties and real estate values are also affected by a variety of other factors, such as governmental regulations and applicable laws (including real estate, zoning and tax laws), interest rate levels and the availability of financing. Furthermore, real estate investments are relatively illiquid and, therefore, will tend to limit the Company's ability to vary its portfolio promptly in response to changes in economic or other conditions.\nPotential Environmental Liability\nUnder various federal, state and local laws, ordinances and regulations, an owner of real estate may be held liable for the costs of removal or remediation of certain hazardous or toxic substances located on or in the property. These laws often impose such liability without regard to whether the owner knew of, or was responsible for, the presence of the hazardous or toxic substances. The presence of such substances, or the failure to remediate such substances properly, may adversely affect the owner's ability to sell or rent the property or to borrow using the property as collateral. Other federal and state laws require the removal of damaged asbestos-containing material in the event of remodeling or renovation.\nAll of the current properties have been subject to a Phase I environmental site assessment and limited asbestos survey (which involve inspection without soil or groundwater analysis) by independent environmental consultants engaged by the Company at the time of acquisition. As a result of the findings of the Phase I environmental assessment, a Phase II assessment involving soil and groundwater testing was performed at four properties by independent environmental consultants. The assessment shows that the groundwater at one of the properties is contaminated. Based on the report of the environmental engineers, the Company believes that the contamination has been caused by a nearby service station and that the owner of the station has commenced clean up procedures under the direction of the local governmental authority. The Company has informed the local governmental authority of the groundwater contamination and asked the authority to expand the clean up procedures to include the Company's property. The Company believes that the environmental liability for its property would not have a material adverse effect on the Company's business or results of operations.\nThe Company has determined that there are minor amounts of asbestos-containing materials (\"ACMs\") in five of the Company's properties. The Company maintains an Operations and Maintenance Program that details operating procedures with respect to ACMs prior to any renovation and that requires periodic inspection by the Company's employees for any change in condition of existing ACMs.\nIn addition, the apartment site under development in Tempe, Arizona was formerly used for agricultural purposes and a portion of the site was used as the runway for a pesticide aerial application firm located adjacent to the apartment site. The site of the pesticide aerial application firm is currently a subject of remediation by the U.S. Enviromental Protection Agency (\"EPA\") and the Arizona Department of Enviromental Quality (\"ADEQ\"). Extensive soil tests on the apartment site revealed that a few samples contained minor amounts of toxaphene above the regulatory level. The Company engaged an independent environmental consulting firm to conduct a \"site specific risk assessment\" to evaluate the potential threat to human health based on exposures and conditions unique to the site. The consulting firm's report indicates that the potential threat is minimal and no further action is necessary prior to the development of the site as an apartment community. The EPA and ADEQ have not required the Company to take any remedial actions on the site. The agencies also have not informed the Company of any regulatory actions on the site.\nExcept as set forth above, the reports have not revealed any environmental liability, nor is the Company aware of any environmental liability, that the Company believes would have a material adverse effect on the Company's business, assets or results of operation. No assurance, however, can be given that these reports reveal all environmental liabilities, or that no prior owner created any material environmental condition not known to the Company or that future uses and conditions (including changes in\napplicable environmental laws and regulations) will not result in imposition of environmental liability. In the event the Company discovers a material environmental condition relating to any of its properties, the Company could be required to expend funds to remedy such condition.\nUninsured Loss\nThe Company will carry comprehensive liability, fire, flood (where applicable), extended coverage and rental loss insurance with policy specifications, limits and deductibles customarily carried for similar properties. There are, however, certain types of extraordinary losses (such as losses resulting from earthquakes) that may be either uninsurable or not economically insurable. Should an uninsured loss occur, the Company could lose its investment in and anticipated profits and cash flow from a property and would continue to be obligated on any mortgage indebtedness on the property.\nAmericans with Disabilities Act\nThe Company's properties must comply with Title III of the Americans with Disabilities Act (the \"ADA\") to the extent that the properties are \"public accommodations\" and\/or \"commercial facilities\" as defined by the ADA. Compliance with the ADA requirements could require removal of structural barriers to handicapped access in certain public access areas of the Company's properties, where such removal is readily achievable. The ADA does not, however, consider residential properties, such as apartment communities to be public accommodation or commercial facilities, except to the extent portions of such facilities, such as a leasing office, are open to the public. Noncompliance with the ADA could result in imposition of fines or an award of damages to private litigants. If required changes involve a greater expenditure than the Company currently anticipates, or if the changes must be made on a more accelerated basis than it anticipates, the Company's operations could be adversely affected. No specific regulations have been promulgated under the ADA and, thus, it is uncertain how enforcement of the ADA would affect specific building attributes. However, the Company believes that the properties comply with all present requirements under the ADA.\nFair Housing Amendments Act of 1988\nThe Fair Housing Amendments Act of 1988 (the \"FHA\") requires multifamily residential properties first occupied after March 13, 1991 to be accessible to the handicapped. Noncompliance with the FHA could result in the imposition of fines or an award of damages to private litigants. The Company believes that its properties that are subject to the FHA are in compliance with such law.\nRisks of Real Estate Development\nThe Company plans to seek selective opportunities for development. The real estate development business involves significant risks in addition to those involved in the acquisition, ownership and operation of established apartment communities. The development risks include the risks that construction financing may not be available on favorable terms for development, construction delays, construction costs in excess of the budgeted amounts, adverse changes in rental rates and occupancy rates in the market, and availability of long-term permanent financing upon completion.\nMarket Risks Relating To Mortgage Assets General\nThe results of the Company's operations depend, among other things, on the level of Net Cash Flows generated by the Company's Mortgage Assets. The Net Cash Flows vary primarily as a result of changes in mortgage prepayment rates, short-term interest rates, reinvestment income and borrowing costs, all of which involve various risks and uncertainties as set forth below. Prepayment rates, interest rates, reinvestment income and borrowing costs depend upon the nature and terms of the Mortgage Assets, the geographic location of the properties securing the mortgage loans included in or underlying the Mortgage Assets, conditions in financial markets, the fiscal and monetary policies of the United States Government and the Board of Governors of the Federal Reserve System, international economic and financial conditions, competition and other factors, none of which can be predicted with any certainty. See \"Management's Discussion and Analysis of Financial Conditions and Results of Operations -- General\" and \"Business -- Operating Policies and Strategies -- Net Cash Flows.\"\nThe projected rates of return to the Company on its Mortgage Assets will be based upon assumed levels of prepayments on the underlying Mortgage Instruments, assumed rates of interest or pass-through rates on the Structured Financings that bear variable interest rates, and assumed rates of reinvestment income and expenses with respect to such Structured Financing. The actual levels of interest rates on Structured Financing bearing variable interest rates, prepayment rates, reinvestment income and administration expenses will affect the level of the Company's Net Cash Flows. To the extent that the assumptions employed by the Company vary from actual experience, the actual Net Cash Flows received by the Company may vary significantly from those projected by the Company as to timing and amount over the lives of such Structured Financing and from one period to another, and such returns could be negative under certain circumstances.\nPrepayment Risks\nMortgage prepayments shorten the life of the Mortgage Instruments underlying the Company's Mortgage Assets, thereby reducing the overall Net Cash Flows and causing and inherent decline in the Company's income. Prepayments of Mortgage Instruments generally increase when then current mortgage interest rates fall below the interest rates on the fixed-rate mortgage loans included in such Mortgage Instruments. Conversely, prepayments decrease when then current mortgage interest rates exceed the interest rates on the mortgage loans included in such Mortgage Instruments. Prepayment experience also may be affected by the geographic location of the mortgage loans included in Mortgage Instruments, the types (whether fixed or adjustable rate) and assumability of such mortgage loans, conditions in the mortgage loan, housing and financial markets, and general economic conditions.\nInterest Rate Fluctuation Risks\nChanges in interest rates affect the performance of the Company and its Mortgage Assets. A portion of the outstanding Structured Financing bears variable interest rates. As of December 31, 1995, $65 million of the $882 million of the outstanding Structured Financing relating to the Company's Mortgage Assets bore variable interest rates. Consequently, changes in short-term interest rates significantly influence the Company's net income.\nRisks of Decline in Net Cash Flows and Income from Mortgage Assets\nThe Company's income derives primarily from the Net Cash Flows received on its Mortgage Assets, which decline over time. For both tax and accounting purposes, the Company's Net Cash Flows consist of two components -- one representing return of a portion of the purchase price of the Mortgage Asset (the \"Cost Component\") and one representing income on the investment (the \"Income Component\"). The Income Component will be highest in years immediately following the purchase of the Mortgage Asset and will decline over time. In addition, to the extent that actual mortgage prepayments or variable interest rates experienced exceed those assumed, this inherent decline in Net Cash Flows and income is accelerated.\nAs the Company has made the determination to reinvest the Net Cash Flows in income-producing properties which may have a lower current yield than Mortgage Assets, without regard to the mortgage prepayment rates and variable interest rates, the Company may report declining operating income over time without the effect of any gain or loss on the sale of the properties. See \"Business -- Special Considerations -- Competition.\"\nInability to Predict Effects of Market Risks\nBecause none of the above factors including changes in prepayment rates, interest rates, reinvestment income, expenses and borrowing costs are susceptible to accurate projection, the Net Cash Flows generated by the Company's Mortgage Assets, and thus distributions to the Company's stockholders, cannot be predicted.\nBorrowing Risks\nSubject to the terms of the Company's Bylaws, the availability and cost of borrowings, various market conditions, restrictions that may be contained in the Company's financing arrangements from time to time and other factors, the Company increases the amount of funds available for its activities with funds from\nborrowings including borrowings under loan agreements, repurchase agreements and other credit facilities. The Company's borrowings may bear fixed or variable interest rates, may require additional collateral in the event that the value of existing collateral declines on a market value basis and may be due on demand or upon the occurrence of certain events. To the extent that the Company's borrowings bear variable interest rates, changes in short-term interest rates will significantly influence the cost of such borrowings and can result in losses in certain circumstances. The Company also may increase the amount of its available funds through the issuance of debt securities.\nThe Company's Bylaws limit borrowings, to no more than 300% of the amount of its net assets (as described herein) unless borrowings in excess of that amount are approved by a majority of the Unaffiliated Directors (as defined herein). See \"Business -- Operating Policies and Strategies -- Capital Resources.\" Each of the Company's 18 apartment communities has been pledged to secure a first mortgage loan; such mortgage loans totalled $49.6 million at December 31, 1995. In addition, the Company had short-term borrowing of $4.5 million secured by Mortgage Assets having an aggregate carrying value of $7.6 million.\nNo assurance can be given as to the actual effect of borrowings by the Company.\nPledged Assets\nA substantial portion of the Company's assets currently are and in the future can be expected to be pledged to secure its borrowings. Therefore, such assets will not be available to the stockholders in the event of the liquidation of the Company except to the extent that the market value thereof exceeds the amounts due to the creditors. However, the market value of the Mortgage Assets is uncertain because the market for Mortgage Assets of the type owned by the Company is not well developed and fluctuates rapidly as the result of numerous market factors (including interest rates and prepayment rates) as well as the supply of and demand for such assets.\nCompetition\nThere are numerous real estate companies, insurance companies, financial institutions, pension funds and other property owners that compete with the Company in seeking properties for acquisition and in attracting and retaining clients.\nMarket Price Of Common Stock\nThe market price of the Company's Common Stock has been extremely sensitive to a wide variety of factors including the Company's operating results, dividend payments (if any), actual or perceived changes in short-term and mortgage interest rates and their relationship to each other, actual or perceived changes in mortgage prepayment rates, and any variation between the net yield on the Company's assets and prevailing market interest rates. It can be expected that the performance of the Company's income-producing properties will have an increasingly important effect on the market price of the Company's Common Stock. Any actual or perceived unfavorable changes in the real estate market and other factors may adversely affect the market price of the Company's Common Stock.\nFuture Offerings Of Common Stock\nThe Company in the future may increase its capital resources by making additional offerings of its Common Stock or securities convertible into its Common Stock. The actual or perceived effect of such offerings may be the dilution of the book value or earnings per share of the Company's Common Stock which may result in the reduction of the market price of the Company's Common Stock. The Company is unable to estimate the amount, timing or nature of future sales of its Common Stock as such sales will depend upon market conditions and other factors such as its need for additional equity, its ability to apply or invest the proceeds of such sales of its Common Stock, the terms upon which its Common Stock could be sold.\nManagement Fees\nThe Manager advises the Company with respect to various aspects of the Company's business and operations, manages the Company's overall business and operations, and represents the Company in its\ndealings with third parties pursuant to the terms of the Management Agreement. In the event that the Management Agreement is terminated by the Company or is not renewed by the Company on terms at least as favorable to the Manager as the current Management Agreement other than as a result of a termination by the Company for cause (as specified above and defined in the Management Agreement), the Manager will be entitled to receive from the Company the management fee that would have been payable by the Company to the Manager pursuant to such Management Agreement based on the investments made by the Company prior to the date on which the Management Agreement is so terminated (or not renewed) for the 12 full fiscal quarters beginning on the date of such termination (or failure to renew) as more fully described in the Management Agreement.\nPotential Conflicts Of Interest\nThe Company is subject to potential conflicts of interest arising from its relationship with the Manager, the Property Manager and ASFS under the \"Subcontract Agreement.\" The Management Agreement does not limit or restrict the right of the Manager, the partners of the Manager or any of their directors, officers or employees from engaging in any business or rendering services of any kind to any other person except that the Manager (but not its partners or their directors, officers or employees) are not permitted to provide any such services to any residential mortgage REIT other than the Company. The Company may purchase assets from entities which may be affiliates of the Manager. Although certain agreements and activities must be approved by the Unaffiliated directors (as described below), the day-to-day transactions between the Company and the Manager and the Property Manager are not subject to the specific pre-approval of the Unaffiliated Directors. See \"Business -- Management Agreement -- Terms of Management Agreement\" and \"Business -- Property Management Agreement.\"\nThe Company's Articles of Incorporation limit the liability of its directors and officers to the Company and its stockholders to the fullest extent permitted by Maryland law, and both the Company's Articles and Bylaws provide for indemnification of the directors and officers to such extent. The Management Agreement also limits the responsibilities and liabilities of the Manager, the partners of the Manager and any of their partners, directors, officers, stockholders and employees and provides for their indemnification against liabilities except in certain circumstances. See \"Business -- Management Agreement -- Terms of the Management Agreement -- Limits of Responsibility.\" The Property Management Agreement also limits the responsibilities and liabilities of the Property Manager. See \"Business -- Property Management Agreement.\" In addition, the Subcontract Agreement limits the responsibilities of ASFS and provides for the indemnification of ASFS, its affiliates and their directors and officers against various liabilities. See \"Business -- Management Agreement -- The Subcontract Agreement.\"\nCounsel to the Company has furnished, and in the future may furnish, legal services to the Manager, affiliates of the Manager and certain Issuers (including those affiliated with ASFS). There is a possibility that in the future the interests of certain of such parties may become adverse, and counsel may be precluded from representing one or all of such parties. If any situation arises in which the interests of the Company appear to be in conflict with those of the Manager, or its affiliates, additional counsel may be retained by one or more of the parties.\nWith a view toward protecting the interests of the Company's stockholders, the Bylaws of the Company provide that a majority of the Board of Directors (and a majority of each committee of the Board of Directors) must not be \"Affiliates\"of the Manager or \"Advisors,\" as these terms are defined in the Bylaws, and that the investment policies of the Company must be reviewed annually by these directors (the \"Unaffiliated Directors\"). Moreover, the annual renewals of the Management Agreement and the Property Management Agreement require the affirmative vote of a majority of the Unaffiliated Directors. In addition, a majority of such Unaffiliated Directors may terminate the Management Agreement or the Property Management Agreement at any time upon 60 days' notice. See \"Business -- The Management Agreement.\"\nCertain Consequences Of And Failure To Maintain Reit Status\nIn order to maintain its qualification as a REIT for federal income tax purposes, the Company must continually satisfy certain tests with respect to the sources of its income, the nature and diversification of\nits assets, the amount of its distributions to stockholders and the ownership of its stock. See \"Business -- Federal Income Tax Considerations -- Qualification of the Company as a REIT.\" Among other things, these restrictions may limit the Company's ability to acquire certain types of assets that it otherwise would consider desirable, limit the ability of the Company to dispose of assets that it has held for less than four years if the disposition would result in gains exceeding specified amounts, limit the ability of the Company to engage in hedging transactions that could result in income exceeding specified amounts, and require the Company to make distributions to its stockholders at times that the Company may deem it more advantageous to utilize the funds available for distribution for other corporate purposes (such as the purchase of additional assets or the repayment of debt) or at times that the Company may not have funds readily available for distribution.\nThe Company's operations from time to time generate taxable income in excess of its net income for financial reporting purposes. The Company also may experience a situation in which its taxable income is in excess of the actual cash receipts. See \"Business -- Federal Income Tax Considerations -- Activities of the Company.\" To the extent that the Company does not otherwise have funds available, either situation may result in the Company's inability to distribute substantially all of its taxable income as required to maintain its REIT status. See \"Business -- Federal Income Tax Considerations.\" Alternatively, the Company may be required to borrow funds to make the required distributions which could have the effect of reducing the yield to its stockholders, to sell a portion of its assets at times or for amounts that are not advantageous, or to distribute amounts that represent a return of capital which would reduce the equity of the Company. In evaluating assets for purchase, the Company considers the anticipated tax effects of the purchase including the possibility of any excess of taxable income over projected cash receipts.\nIf the Company should not qualify as a REIT in any tax year, it would be taxed as a regular domestic corporation and, among other consequences, distributions to the Company's stockholders would not be deductible by the Company in computing its taxable income. Any such tax liability could be substantial and would reduce the amount of cash available for distributions to the Company's stockholders. See \"Business -- Federal Income Tax Considerations.\" In addition, the unremedied 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 the four subsequent years.\nExcess Inclusions\nA portion of the dividends paid by the Company constitutes unrelated business taxable income to certain otherwise tax-exempt stockholders which will constitute a floor for the taxable income of stockholders not exempt from tax, and will not be eligible for any reduction (by treaty or otherwise) in the rate of income tax withholding in the case of nonresident alien stockholders. For 1995, the entire ordinary income portion ($0.29 per share) of the dividend was excess inclusion income. See \"Business -- Federal Income Tax Considerations -- Tax Consequences of Common Stock Ownership -- Excess Inclusion Rule.\"\nMarketability Of Shares Of Common Stock And Restriction On Ownership\nThe Company's Articles of Incorporation prohibit ownership of its Common Stock by tax-exempt entities that are not subject to tax on unrelated business taxable income and by certain other persons (collectively \"Disqualified Organizations\"). Such restrictions on ownership exist so as to avoid imposition of a tax on a portion of the Company's income from excess inclusions.\nProvisions of the Company's Articles of Incorporation also are designed to prevent concentrated ownership of the Company which might jeopardize its qualification as a REIT under the Code. Among other things, these provisions provide (i) that any acquisition of shares that would result in the disqualification of the Company as a REIT under the Code will be void, and (ii) that in the event any person acquires, owns or is deemed, by operation of certain attribution rules set out in the Code, to own a number of shares in excess of 9.8% of the outstanding shares of the Company's Common Stock (\"Excess Shares\"), the Board of Directors, at its discretion, may redeem the Excess Shares. In addition, the Company may refuse to effectuate any transfer of Excess Shares and certain stockholders, and proposed transferees of\nshares, may be required to file an affidavit with the Company setting forth certain information relating, generally, to their ownership of the Company's Common Stock. These provisions may inhibit market activity and the resulting opportunity for the Company's stockholders to receive a premium for their shares that might otherwise exist if any person were to attempt to assemble a block of shares of the Company's Common Stock in excess of the number of shares permitted under the Articles of Incorporation. Such provisions also may make the Company an unsuitable investment vehicle for any person seeking to obtain (either alone or with others as a group) ownership of more than 9.8% of the outstanding shares of Common Stock. Investors seeking to acquire substantial holdings in the Company should be aware that this ownership limitation may be exceeded by a stockholder without any action on such stockholder's part in the event of a reduction in the number of outstanding shares of the Company's Common Stock.\nFederal Income Tax Considerations\nQualification Of The Company As A Reit\nGeneral\nThe Company has made an election to be treated as a real estate investment trust (\"REIT\"). Thus, if the Company satisfies certain tests in each taxable year with respect to the nature of its income, assets, share ownership and the amount of its distributions, among other things, it generally should not be subject to tax at the corporate level on its income to the extent that it distributes cash in the amount of such income to its stockholders.\nGenerally, the unremedied failure of the Company to be treated as a REIT for any taxable year could materially and adversely affect the stockholders as net income of the Company would be taxed at ordinary corporate rate, and the Company would not receive a deduction for any dividends to the stockholders and thus cause a material reduction of the cash available for distribution to the stockholders as dividends.\nIn order to maintain its qualification as a REIT for federal income tax purposes, the Company must continually 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 summary discussion of those various 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.\nUnder 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. The 95% income test requires that at least 95% of the Company's gross income for the taxable year must be derived from the items of income that either qualify under the 75% test or are from certain other types of passive investments. Finally, the 30% income test requires the Company to 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 or swap agreements held for less than one year, and (3) property in \"prohibited transactions.\" A prohibited transaction is a sale or disposition of dealer property that is not foreclosure property or, under certain circumstances, a real estate asset held for at least four years.\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 equal to 100% of any excess nonqualifying income. See \"Business -- Federal Income Tax Considerations -- Taxation of the Company.\" There is no comparable safeguard that could protect against REIT disqualification as a 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 the income that satisfies the 75% income test. The composition and sources of the Company income should allow the Company to satisfy the income tests during each year of its existence. Certain short-term reinvestments, however, 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, the 75% income test, and\/or the 95% income test. The Company intends to monitor its reinvestments and hedging transactions closely to attempt 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), federal government securities and qualifying real estate assets. Qualifying real estate assets include interests in real property, and mortgages, equity interests in other REITs, any stock or debt instrument for so long as the income therefrom is qualified temporary investment income and, subject to certain limitations, interests in REMICs. The balance of the Company's assets may be invested without restriction, except that holdings of the securities of any one non-governmental issuer may not exceed 5% of the value of the Company's assets or 10% of the outstanding voting securities of that issuer.\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 will 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.\nDistributions\nEach taxable year the Company 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 noncash 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 if certain guidelines are followed. 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 Internal Revenue Service (\"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 to stockholders and certain interest and penalties to the IRS. The Company intends to make distributions to its stockholders on a basis that will allow the Company to satisfy the distribution requirement. In certain instances, however, the Company's pre-distribution taxable income may exceed its cash flow and the Company may have difficulty satisfying the distribution requirement. The Company intends to monitor closely the relationship between its pre-distribution taxable income and its cash flow. It is possible, although unlikely, that the Company may decide to terminate its REIT status as a result of any such cash shortfall. Such a termination would have adverse consequences to the stockholders. See \"Business -- Federal Income Tax Considerations -- Status of the Company as a REIT.\"\nThe Company has a net operating loss carryforward for income taxes (the \"NOL\") at December 31, 1995 of approximately $75 million. Under REIT tax rules, the Company is allowed to offset taxable income (except for Excess Inclusion Income) by the available NOL and thus, under most circumstances, is not currently required to make distributions to stockholders except for Excess Inclusion Income. The NOL expires in 2009 (1999 for state tax purposes).\nOwnership of the Company\nShares of the Company's Common Stock must be held by a minimum of 100 persons for at least 335 days in each 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 and certain other types of tax-exempt entities). 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. The Company's Articles of Incorporation contain repurchase provisions and transfer restrictions designed to prevent violation of the latter requirement. Therefore, the Company believes that its shares of Common Stock currently are owned by a sufficient number of unrelated persons to allow the Company to satisfy the ownership requirements for REIT qualification.\nTaxation of The Company\nFor any taxable year in which the Company qualifies and elects to be treated as a REIT under the Code, 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. Regardless of distributions to stockholders, however, the Company may become subject to a tax on certain types of income.\nThe Company uses the calendar year both for tax purposes and for financial reporting purposes. Due to the differences between tax accounting rules and generally accepted accounting principles, the Company's REIT Taxable Income will vary from its net income for financial reporting purposes.\nTax Consequences Of Common Stock Ownership\nThe federal income tax consequences of ownership in the Company's common is a complex matter and may vary depending on the income tax status of the stockholder. Accordingly, the following discussion is intended to be general in nature. Stockholders should consult their own tax advisors regarding the income tax considerations with respect to their investments in the Company.\nDividend Income\nDistributions to stockholders out of the Company's current or accumulated earnings and profits will be taxable as \"portfolio income\" in the year received and not as income from a passive activity. With respect to any dividend payable to stockholders of record as of a specified date prior to the end of the year, that dividend is deemed to have been received by the stockholder on December 31 if the dividend is paid in January of the following calendar year.\nThe Company's dividends are not eligible for the dividends-received deduction for corporations. If the Company's total distributions for a taxable year exceed its current and accumulated earnings and profits, a portion of each distribution will be treated first as a return of capital, reducing a stockholder's basis in his shares (but not below zero), and then as capital gain in the event such distributions are in excess of a stockholder's adjusted basis in his shares.\nDistributions properly designated by the Company as \"capital gain dividends\" will be taxable to the stockholders as long-term capital gain, to the extent those dividends do not exceed the Company's actual net capital gain for the taxable year, without regard to the stockholder's holding period for his shares. The Company will notify stockholders after the close of its taxable year regarding the portions of the distributions that constitute ordinary income, return of capital and capital gain. The Company also will notify shareholders regarding their reported share of excess inclusion income. See \"Excess Inclusion Rule\" below.\nThe total dividends of $2.00 per share for 1995 consists of ordinary income of $0.29 and return of capital of $1.71 per share.\nExcess Inclusion Rule\nOwnership by the Company of residual interests in REMICs may adversely affect the federal income taxation of the Company and of certain stockholders to the extent those residual interests generate \"excess inclusion income.\" The Company's excess inclusion income during a calendar quarter generally will equal the excess of its taxable income from residual interests in REMICs over its \"daily accruals\" with respect to those residual interests for the calendar quarter. The daily accruals are calculated by multiplying the adjusted issue price of the residual interest by 120 percent of the long-term federal interest rate in effect on the REMIC's startup date. It is possible that the Company will have excess inclusion income without associated cash. In taxable years in which the Company has both a net operating loss and excess inclusion income it will still have to report a minimum amount of taxable income equal to its excess inclusion income. In order to maintain its REIT status, the Company will be required to distribute at least 95 percent of its taxable income, even if its taxable income is comprised exclusively of excess inclusion income and otherwise has a net operating loss.\nIn general, each stockholder is required to treat the stockholder's allocable share of the portion of the Company's \"excess inclusions\" that is not taxable to the Company as an \"excess inclusion\" received by such stockholder. The portion of the Company's dividends that constitute excess inclusions typically will rise as the degree of leveraging of the Company's activities increase. Therefore, all or a portion of the dividends received by the stockholders may be excess inclusion income. Excess inclusion income will constitute unrelated business taxable income for tax-exempt entities and may not be used to offset deductions or net operating losses from other sources for most other taxpayers. For 1995, the entire ordinary income portion ($0.29 per share) of the dividend was excess inclusion income.\nTax-exempt Organizations As Stockholders\nThe Code requires a tax-exempt stockholder of the Company to treat as unrelated business taxable income its allocable share of the Company's excess inclusions. The Company is likely to receive excess inclusion income. See \"Excess Inclusion Rule,\" above. The Company's Common Stock may not be held by tax-exempt entities which are not subject to tax on unrelated business taxable income.\nTaxation Of Foreign Stockholders\nDistributions of cash generated by the Company in its operations that are paid to foreign persons generally will be subject to United States withholding tax rate at a rate of 30 percent or at a lower rate if a foreign person can claim the benefit of a tax treaty. Notwithstanding the foregoing, distributions made to foreign stockholders will not be subject to treaty withholding reductions to the extent of their allocable shares of the portion of the Company's excess inclusions that are not taxable to the Company for the period under review. It is expected that the Company will continue to have excess inclusions. Distributions to foreign persons of cash attributable to gain on the Company's sale or exchange of real properties, if any, generally will be subject to full United States taxation and withholding. If a foreign person holds more than five percent of the shares of the Company, gain from the sale of the person's shares could be subject to full United States taxation if the Company held any real property interests and was not a domestically controlled REIT.\nThe federal income taxation of foreign persons is a highly complex matter that may be affected by many considerations. Accordingly, foreign investors in the Company should consult their own tax advisors regarding the income and withholding tax considerations with respect to their investments in the Company. Foreign governments and organizations, and their instrumentalities, may not invest in the Company.\nBackup Withholding\nThe Company is required by the Code to withhold from dividends 20% of the amount paid to stockholders, unless the stockholder (i) files a correct taxpayer identification number with the Company, (ii) certifies as to no loss of exemption from backup withholding and (iii) otherwise complies with the applicable requirements of the backup withholding rules. The Company will report to its stockholders and\nthe IRS the amount of dividends paid during each calendar year and the amount of tax withheld, if any. Stockholders should consult their tax advisors as to the procedure for insuring that the Company dividends to them will not be subject to backup withholding.\nState And Local Taxes\nThe discussion herein concerns only the federal income tax treatment likely to be accorded the Company and its stockholders. No discussion has been provided regarding the state or local tax treatment of the Company and its stockholders. The state and local tax treatment may not conform to the federal income tax treatment described above and each investor should discuss such issues with his state and local tax advisor.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTY\nSee \"Business -- Operating Policies and Strategies -- Real Estate Activities -- Current Properties.\"\nThe principal executive offices of the Company and the Manager are located at 335 North Wilmot, Suite 250, Tucson, Arizona 85711, telephone (520) 748-2111.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nNot applicable.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNot applicable.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Company's Common Stock is listed and principally traded on the American Stock Exchange (\"AMEX\") under the symbol the \"ASR\". The following table sets forth for the periods indicated the high and low sales prices of the Company's Common Stock as reported by the AMEX and the cash dividends paid per share on the Company's Common Stock for the periods indicated.\nDividend High Low Per Share -------- ------- ------------- First quarter .....$20 $10 15\/16 $0.50 Second quarter ... 19 3\/8 16 1\/4 0.50 Third quarter ..... 20 1\/2 17 3\/4 0.50 Fourth quarter ... 18 3\/8 15 0.50 First quarter ..... 10 15\/16 7 1\/2 -- Second quarter ... 15 5 15\/16 -- Third quarter ..... 13 3\/4 6 1\/4 -- Fourth quarter ... 14 1\/16 9 3\/8 0.50 First quarter ..... 15 15\/16 10 -- Second quarter ... 10 15\/16 5 15\/16 -- Third quarter ..... 9 3\/8 6 1\/4 0.25 Fourth quarter ... 10 15\/16 7 1\/2 0.90\nOn March 21, 1996, the closing sales prices for shares of the Company's Common Stock on the AMEX Composite Tape was $16 1\/2 per share and the approximate number of holders of common shares was 2,000.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA (IN THOUSANDS EXCEPT FOR PER SHARE DATA)\nThe following selected financial data are qualified in its entirety by, and should be read in conjunction with, the consolidated financial statements and notes thereto appearing elsewhere herein. The data below have been derived from the audited consolidated financial statements of the Company.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nMANAGEMENT'S DISCUSSION AND ANALYSIS For the Years Ended December 31, 1995, 1994 and 1993\nGeneral\nIn 1993, the Company determined to become an apartment real estate investment trust. The Company continues to hold its mortgage assets and use the cash flows for apartment acquisitions and development, operations, payment of dividends and other corporate purposes.\nIn January 1994, the Company acquired its initial portfolio of seventeen apartment communities (2,461 units) located in Tucson, Arizona, Houston, Texas, and Albuquerque, New Mexico. The total cost was approximately $61,600,000 which was financed by non-recourse first mortgage loans of $45,700,000, seller carryback financing of $6,500,000 and cash of $9,400,000. In February 1995, the Company acquired a 222-unit apartment community in Mesa, Arizona for $6,356,000, which was financed with a $3,770,000 non-recourse first mortgage loan.\nIn addition to wholly owned apartment communities, the Company has acquired six apartment communities (1,441 units) in Phoenix and Tucson, Arizona through joint ventures with a pension plan affiliate of Citicorp. The Company is a 15% equity partner and managing member of the joint ventures. The Company receives between 15% and 51% of the net profits and cash flow depending on the performance of the joint ventures.\nThe operating income from apartments is affected primarily by rental rates, occupancy rates and operating expenses. Rental rates and occupancy rates are affected by the strength of the local economy, the local housing market and the supply of and demand for apartment communities.\nThe Company continues to own mortgage assets acquired prior to 1993 to generate cash flows for apartment acquisitions and development and other corporate purposes. These mortgage assets entitle the Company to receive the excess of the cash flow on pools of mortgage instruments over the required payments on a series of structured financings which they secure. Income and cash flows from mortgage assets are affected primarily by mortgage prepayment rates and short-term interest rates. Higher mortgage prepayment rates or higher short-term rates reduce the income and total cash flows over the life of the mortgage assets. Prepayment rates are affected primarily by mortgage interest rates. Mortgage assets are amortizing assets and the cash flows decline over time.\nIn 1993, mortgage interest rates dropped to their lowest level in twenty years and prepayment rates reached record levels. In 1994, mortgage interest rates increased and actual and anticipated prepayment rates decreased. In 1995, although prepayment rates increased because mortgage rates declined to near the 1993 lows by year end, they were well below the 1993 record levels.\nThe Company also has the option to cause the early redemption of the structured financings at par after specified conditions are met (generally when the structured financing is below a specified balance or after a specified date). In such event, the mortgage instruments are sold and the net proceeds after the redemption of the structured financing are remitted to the Company. Mortgage asset redemptions have the effect of accelerating the cash flows and increasing the value. Redemption transactions occur from time to time as specified conditions are met rather than on a monthly or quarterly basis, and the net proceeds are affected by the market price of the mortgage instruments. Thus, the cash flows and income from redemption transactions fluctuate significantly between periods. Mortgage asset redemptions reduce the cash flows and income in future periods.\nOn July 7, 1995, the Company completed a reverse stock split under which one new share of common stock was issued in exchange for five shares of outstanding stock. Accordingly, the number of common stock issued and all per share amounts for all years have been adjusted for the reverse stock split.\nResults of Operations\n1995 Compared to 1994\nIncome and expenses from real estate operations increased in 1995 due to the acquisition of an apartment community in February 1995 as well as new investments in joint ventures. Net operating income (before depreciation) from apartments (including the Company's share of results of the joint venture) for 1995 and 1994 was $7,651,000 and $7,119,000, respectively. On a same store basis, net operating income for 1995 decreased by 5% primarily due to a 10% increase in operating expenses and real estate taxes. The increase in operating expenses was caused by a decrease in occupancy rates from 94% in 1994 to 91% in 1995 (mostly in Tucson) which resulted in higher turnover, marketing and payroll expenses. The increase in expenses was mitigated by a 2% increase in rental and other income due to higher rental rates. Depreciation expenses increased due to acquisitions and capital expenditures incurred in 1994 and 1995.\nAs a result of amortization of the investment in and redemption of mortgage assets during 1994 and 1995, the average balance of mortgage assets decreased from $26,691,000 for 1994 to $14,827,000 for 1995. While the average prospective yield was 28% for 1995 compared with 24% for 1994, the prospective yield income decreased by $2,549,000. Income from redemptions in 1995 totaled $5,302,000 consisting of $2,882,000 from redemption of five mortgage assets and $2,420,000 from the reversal of the excess yield maintenance payment accrued in 1993 on notes payable. Income from redemptions of $4,263,000 in 1994 resulted from the redemption of four mortgage assets.\nOperating and administrative expenses increased in 1995 primarily due to an increase in expense accruals for stock appreciation rights of $381,000 (caused by higher stock price) and dividend equivalent payments on stock options of $600,000. The higher stock appreciation rights and dividend equivalent expenses were mitigated by a decrease in management fees of $170,000 in 1995 compared to 1994.\nInterest and other income decreased in 1995 due to the use of the cash held by trustee to prepay the notes payable secured by mortgage assets in February 1995. Interest expense on real estate mortgages increased due to the borrowing for the February 1995 purchase of an apartment community. Other interest expense decreased due to the prepayment of the notes payable secured by mortgage assets in February 1995 and the prepayment of the real estate notes in April 1995.\n1994 Compared to 1993\nThe Company had net income of $7,702,000 in 1994 compared with a net loss of $40.6 million in 1993. The income in 1994 resulted from operating income generated by the apartments and the existing mortgage assets.\nIn 1994, net operating income (before depreciation) from the apartments was $7,119,000 (including the Company's share of results of the joint ventures) which, after deducting related interest expense, amounted to an annualized return of 20% on the average invested equity. As a result of high demand, rental rates in the Company's apartment communities increased during 1994 by 10% in Tucson, 5% in Albuquerque and 2% in Houston while maintaining each apartment community's occupancy rate.\nProspective yield income from mortgage assets decreased due to a reduction of $18,916,000 in the net carrying value, mitigated by a higher yield in 1994 due to significantly lower mortgage prepayment rates. The average yield on the mortgage assets for 1994 was approximately 24%. The Company realized income in 1994 of $4,263,000 from the redemption of four mortgage assets and the sale of the underlying mortgage instruments. The provision for reserve for 1993 was due to the decrease in the estimated future cash flows of certain mortgage assets. The charge from the cumulative effect of accounting change in 1993 was due to adoption of SFAS No. 115 which resulted in the reduction of the net carrying values of substantially all of the mortgage assets to their estimated fair market values. Both the provision for reserve and the cumulative effect of accounting change were caused by very low mortgage interest rates which resulted in historically high levels of mortgage prepayment rates.\nInterest and other interest income increased due to higher interest rates on investments and a write down of a short-term investment ($254,000) in 1993.\nOperating expenses increased in 1994 due to the accrual in 1994 of expenses relating to the stock appreciation rights ($324,000) and dividend equivalent payments on the options and stock appreciation rights ($200,000), offset by a reduction in the 1994 management fees of $81,000, the Company's efforts to reduce operating expenses and a reduction in the 1993 expenses of $470,000 relating to the legal fees reimbursement from insurance carriers relating to legal fees relating to the class action suit settled in 1992.\nInterest expense on real estate mortgages increased because of the borrowing incurred in connection with acquisition of the apartments in January 1994. Other interest expense decreased due to a decrease in the notes payable secured by mortgage assets.\nLiquidity, Capital Resources and Commitments\nCash provided by operations in 1995 was lower than 1994 as $2,420,000 of the 1995 income from redemption related to the reversal of the yield maintenance payment which did not provide cash. Cash provided by operations in 1995 and 1994 were both higher than 1993 primarily due to the addition of real estate operations and redemption income.\nOperating cash flow (net of interest expense) from apartments was $3,264,000 for 1995 compared to $3,178,000 for 1994. Cash flow generated from mortgage assets was $13,854,000 during 1995 compared to $29,612,000 during 1994. As mortgage assets are amortizing assets, the cash flows generally decline over time as they are amortized or redeemed. The Company also realized higher cash flows from mortgage asset redemptions in 1994.\nIn 1995, the Company acquired (i) an apartment community for $6,241,000 which was financed by a first mortgage loan of $3,770,000; (ii) land for development of the Finisterra Apartments in Tempe, Arizona for $2,670,000 and (iii) two apartment communities through joint ventures for equity investments of $1,853,000. The Company reduced its borrowing in 1995 by (i) prepaying the notes secured by mortgage assets (net balance of $6,422,000 at December 31, 1994) and (ii) prepaying the unsecured real estate notes ($4,868,000 at December 31, 1994). The Company incurred short-term borrowing of $4,495,000 to fund a portion of these debt prepayments. The Company plans to use the cash flows from mortgage asset redemptions in 1996 to reduce the short-term borrowing.\nThe Company continues to rely on the cash flows from mortgage assets to fund its apartment acquisitions and development. A majority of the mortgage cash flows is from early redemptions and sales which in effect accelerate the cash flows and thus increase the present value. In March 1996, the\nCompany sold for $2.4 million a 40% interest in one mortgage asset anticipated to be redeemed in the second quarter, resulting in income of approximately $1.9 million. The subsequent redemption is expected to generate an additional cash flow of $3.6 million and income of $3.0 million.\nThe Company has prepared the following estimates of future cash flows from the mortgage assets. Cases 1, 2 and 3 assume that except for the early redemption of the mortgage asset in April as described in the preceding paragraph, there will be no further early redemptions of mortgage assets. The assumed interest rate and mortgage prepayment rates in Case 2 are the approximate interest rate and forecasts of prepayment rates made by market participants as of December 31, 1995. The estimates in Case 4 have been prepared using the same interest rate and mortgage prepayment rates as Case 2 except that each mortgage asset is assumed to be redeemed at the first available date and the underlying mortgages sold at the December 31, 1995 prices. Mortgage prepayment rates represent the average annual prepayment rate assumed for the underlying mortgage instruments. (Dollars in thousands.)\nCase 1 Case 2 Case 3 Case 4 ------- ------- ------- ------- Assumed one month LIBOR 4.0% 6.0% 8.0% 6.0% Assumed mortgage prepayments 21.3% 10.6% 6.9% 10.6% Average sale price of mortgages (% of par) 107.1%\nEstimated cash flows 1996 $12,148 $11,452 $10,746 $16,444 1997 4,527 4,120 3,541 11,642 1998 3,052 3,112 2,917 2,244 1999 2,116 2,368 2,398 13,223 2000 1,422 1,812 1,991 7,785 2001-2018 6,568 13,480 24,599 470 ------- ------- ------- ------- Total $29,833 $36,344 $46,192 $51,808 ======= ======= ======= =======\nThere can be no assurance that the actual interest and prepayment rates will be as assumed or that the prices of the mortgage instruments will remain at the assumed levels. Proceeds from redemptions are highly dependent on prices available upon sale of the mortgages as well as the timing of meeting the conditions for redemption (generally reduction of the structured financing to a specified percentage of the original balance or a specified date). As an example, if the average price assumed for mortgage sales in Case 4 above were to decrease by half (the average mortgage prices decreases to 103.5%), the estimated total cash flow in Case 4 would decline by $15,187,000 of which $3,257,000 would relate to 1996.\nThe Company has commenced the development of its Finisterra Apartment community in Tempe, Arizona. The total construction costs are estimated to be approximately $20,000,000. As of December 31, 1995, the Company has invested approximately $2,800,000. The Company has obtained a $15,350,000 construction loan. Construction is expected to be completed in mid-1997.\nAt December 31, 1995, the Company had unrestricted cash of $2,421,000. The Company intends to use such funds for acquisition of apartments, capital improvements on existing properties and working capital.\nEach of the apartment communities is pledged to secure a nonrecourse and non-cross collateralized first mortgage loan. The loans generally bear fixed interest rates which averaged 8.6% at December 31, 1995. The principal and interest payments on these loans are approximately $385,000 per month. In addition, the Company is required to deposit $55,000 per month with the lender to be used for specified capital replacement expenditures, property taxes and insurance premiums. At December 31, 1995, $2,122,000 was held by lenders.\nOther Information\nApartment leases generally are for terms of six to 12 months. Management believes that such short-term leases lessen the impact of inflation as a result of the ability to adjust rental rates to market levels as leases expire. To the extent that the inflation rate influences federal monetary policy and results in rising short-term interest rates or declines in mortgage interest rates, the timing of income and cash flows from the mortgage assets would be affected.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nReference is made to the financial statements, the report thereon, the notes thereto and the supplementary data commencing at page of this report, which financial statements, report, notes and data 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 required by this Item is incorporated herein by reference to the definitive proxy statement to be filed pursuant to Regulation 14A.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by this Item is incorporated herein by reference to the definitive proxy statement to be filed 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 the definitive proxy statement to be filed 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 the definitive proxy statement to be filed pursuant to Regulation 14A.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) Financial Statements and Financial Statement Schedules filed as part of this report: 1. Financial Statements of the Company -- as listed in the \"Index to Financial Statements and Financial Statement Schedule\" on page of this Annual Report Form 10-K. 2. Financial Statement Schedules -- Schedule III on page F- 15. No other schedules are required because of the absense of conditions under which they are required or because the information is given in the financial statements and notes beginning on page of this Annual Report on Form 10-K.\n(b) Exhibits\n(Footnotes to table on previous page) - ---------- (1) Incorporated herein by reference to Registrant's Registration Statement on Form S-11 (No. 33- 15232) filed August 19, 1987 and declared effective on August 19, 1987. (2) Incorporated herein by reference to Registrant's Registration Statement on Form S-11 (No. 33-20429) filed March 16, 1988 and declared effective on March 17, 1988. (3) Incorporated herein by reference to Registrant's Form 10-K for the year ended December 31, 1988 as filed with the Commission on or about March 30, 1989. (4) Incorporated herein by reference to Registrant's Registration Statement on Form S-3 (33-42923) filed on September 30, 1991 and declared effective on October 1, 1991. (5) Incorporated herein by reference to Registrant's Form 10-K for the year ended December 31, 1992. (6) Incorporated herein by reference to Registrant's Report on Form 8-K filed with the Commission on or about March 29, 1994.\n(c) Reports on Form 8-K: No Current Reports on Form 8-K were filed by the Company during the fourth quarter of 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.\nASR INVESTMENTS CORPORATION\nBy: \/s\/ JON A. GROVE ----------------------------------------------- Jon A. Grove\nDate: March 22, 1996\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.\nASR INVESTMENTS CORPORATION INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE\nINDEPENDENT AUDITORS' REPORT\nTo the Board of Directors and Stockholders of ASR Investments Corporation.\nWe have audited the accompanying consolidated balance sheets of ASR Investments Corporation as of December 31, 1995 and 1994, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1995. Our audit also included the financial statement schedule listed in the Index at Item 14. The financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 1995 and 1994, and the results of its operations and cash flows for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles. Also, in our opinion, such financial statement schedule, which 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\nTucson, Arizona February 19, 1996\nCONSOLIDATED BALANCE SHEETS December 31, 1995 and 1994\nSee Notes to Consolidated Financial Statements.\nCONSOLIDATED STATEMENTS OF OPERATIONS For the Years Ended December 31, 1995, 1994 and 1993 (In Thousands Except Per Share Amounts)\nSee Notes to Consolidated Financial Statements.\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY For the Years Ended December 31, 1995, 1994 and 1993 (In Thousands)\nSee Notes to Consolidated Financial Statements.\nCONSOLIDATED STATEMENTS OF CASH FLOWS For the Years Ended December 31, 1995, 1994 and 1993 (In Thousands)\nSee Notes to Consolidated Financial Statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS For the Years Ended December 31, 1995, 1994 and 1993\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBusiness - ASR Investments Corporation (the Company) is a real estate investment trust engaged in the acquisition and operation of apartment communities in the southwestern United States. At December 31, 1995, the Company owned 24 apartment communities (including six owned through joint ventures) located in Arizona, Texas and New Mexico. In addition, the Company continues to hold mortgage assets and use the cash flows for apartment acquisitions, operations, payment of dividends and other corporate purposes.\nPrinciples of Consolidation - The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. Investments in joint ventures are accounted on the equity method as the Company does not own a controlling interest. All significant intercompany balances and transactions have been eliminated in the consolidated financial statements.\nCommon Stock - On July 7, 1995, the Company effected a reverse stock split under which one new share of common stock was issued in exchange for five shares of outstanding stock. Accordingly, the consolidated financial statements reflect the reverse stock split and the number of common stock issued and the per share amounts have been adjusted for the reverse stock split for all years.\nReal Estate - Real estate is recorded at cost. Depreciation is computed on a declining balance basis over the estimated remaining useful lives of the assets, which are 27-1\/2 years for buildings and improvements and 7 years for furniture, fixture and equipment. Expenditures for ordinary maintenance and repairs are charged to operations as incurred, and significant renovations and improvements that improve or extend the useful life of the asset are capitalized. Rental income is recorded when due from tenants.\nDeferred Loan Costs - Deferred loan costs are amortized using the interest method over the terms of the related debt.\nMortgage Assets - The Company owns mortgage assets which entitle it to receive the excess of the cash flows on pools of mortgage instruments over the required payments on a series of structured financings which they secure. The Company also has the right to cause the early redemption of the structured financings under specified limited conditions; in such event, the mortgage instruments are sold and the net proceeds after the redemption of the structured financings are remitted to the Company. Redemption transactions occur from time to time as specified conditions are met rather than on a monthly or quarterly basis; therefore, the amount of net proceeds and the income from the redemption transactions fluctuates significantly between periods.\nPresentation and Income Recognition. Mortgage assets are stated at their net investment amounts. Income is recognized using the prospective yield method prescribed by EITF 89-4. Under this method, an effective yield is calculated at the beginning of an accounting period using the then net carrying value of the asset and the estimated future net cash flow assuming no early redemption. The estimated future net cash flow is calculated using variable interest rates and current projected mortgage prepayment rates for the underlying mortgages. The calculated yield is used to accrue income for the accounting period. Actual cash flow received is first applied to the accrued income and any remaining amount is used to reduce the carrying value of the asset. Income from early redemption is recognized when the transaction occurs.\nWrite-down or reserves for impairment. Prior to December 1993, the Company followed the practice of writing down the carrying value of a mortgage asset (including an allocated portion of the deferred hedging cost) to its estimated future cash flows. In December 1993, the Company adopted SFAS No. 115 which requires that the carrying value of a mortgage asset be written down to its estimated fair value when its estimated yield is less than a \"risk-free yield.\" As a result, the Company wrote down substantially all its mortgage assets in 1993 to their estimated fair value and recorded a charge of $21,091,000 which was reported as a cumulative effect of accounting change.\nIncome Taxes - The Company has elected to be taxed as a real estate investment trust (REIT) under the Internal Revenue Code of 1986, as amended. As a REIT, the\nCompany must distribute to its stockholders at least 95% of the higher of (i) its annual taxable income after the use of net operating loss carryforward or (ii) its annual excess inclusion income. Accordingly, no provision has been made for income taxes in the accompanying consolidated financial statements.\nEarnings Per Share - Earnings per share are computed using the weighted average number of shares of common stock and common stock equivalents (if dilutive) outstanding during the year.\nNew Accounting Standards - In October 1995, the Financial Accounting Standards Board issued SFAS No. 123, \"Accounting for Stock-Based Compensation.\" This Statement encourages, but does not require, companies to adopt a new accounting method for stock-based compensation awards. Beginning with 1996 financial statements, companies that do not adopt the new accounting method will be required to provide the disclosures required by the Statement for any awards made in 1995 and after. The Company, which currently follows APB Opinion No. 25, does not plan to adopt the new accounting method, and will provide the required disclosures in the 1996 financial statements.\nUse of Estimates - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect some of the amounts reported in the consolidated financial statements. Actual results could differ from those estimates.\nReclassifications - Certain reclassifications have been made to conform the prior years with the current year presentation.\n2. REAL ESTATE INVESTMENTS\nWholly Owned Apartments\nIn January 1994, the Company acquired its initial portfolio of seventeen apartment communities (2,461 units) located in Tucson, Arizona, Houston, Texas, and Albuquerque, New Mexico. In February 1995, the Company acquired a 222-unit apartment community in Mesa, Arizona. At December 31, 1995 and 1994, investment in apartments consisted of the following (in thousands):\n1995 1994 ---- ---- Land $ 15,514 $ 13,681 Building and Improvements 57,214 50,583 Accumulated Depreciation (4,687) (1,995) Restricted Cash and Deferred Loan fees 3,297 4,237 -------- -------- Apartments, net $ 71,338 $ 66,506 ======== ========\nInvestments in Joint Ventures\nThe Company has acquired six apartment communities (1,441 units) in Phoenix and Tucson, Arizona through joint ventures with a pension plan affiliate of Citicorp. The Company is a 15% equity partner and the managing partner or managing member of the joint ventures. The Company is entitled to receive between 15% and 51% of the total profits and cash flows depending on the financial performance of the joint ventures. The condensed combined financial statements for the joint ventures are as follows (in thousands):\nCondensed Combined Balance Sheets December 31, 1995 1994 ---- ---- Real estate, at cost net of depreciation $54,489 $23,778 Cash and other assets 2,133 1,424 ------- ------- Total Assets $56,622 $25,202 ======= ======= Notes payable $35,754 $15,644 Other liabilities 575 424 ------- ------- Total Liabilities 36,329 16,068 ------- -------\nEquity The Company 3,043 1,364 Joint venture partner 17,250 7,770 ------- ------- Total Equity 20,293 9,134 ------- ------- Total Liabilities and Equity $56,622 $25,202 ======= =======\nCondensed Combined Statement of Operations\nYears Ended December 31 ----------------------- 1995 1994 ---- ---- Revenues $ 7,014 $ 1,263 Operating expenses (3,110) (551) Depreciation (1,437) (283) Interest expense (2,338) (373) ------- ------- Net Income $ 129 $ 56 ======= ======= Allocation of Net Income The Company $ 19 $ 9 Joint Venture Partner $ 110 $ 47\nIn December 1994, the Company entered into a joint venture to develop and construct the Finisterra Apartments community in Tempe, Arizona. In April 1995, the Company acquired the land from the joint venture for $2,670,000 and terminated the joint venture. As of December 31, 1995, the investment in the Finisterra Apartments land was $2,732,000. The Company expects to begin construction in March 1996.\nOperating income from apartments is affected primarily by rental rates, occupancy rates and operating expenses. Rental rates and occupancy rates are affected by the strength of the local economy, the local housing market and the supply of and demand for apartment communities.\n3. MORTGAGE ASSETS\nIncome\nFor 1995 and 1994, the average carrying value of the mortgage assets was $14,827,000 and $26,691,000, respectively, and the average prospective yield was 28% and 24%, respectively. At December 31, 1995, the prospective yield was 29%. As discussed in Note 1, in 1993, a majority of the mortgage assets were not accounted for under the prospective yield method and the Company recorded substantial amount of reserves for write down.\nDuring 1995, the Company exercised its redemption rights on five mortgage assets for net proceeds of $6,438,000 and income of $2,882,000. Using proceeds from one of the redemptions, the Company prepaid its Secured Notes (see Note 4) and recorded income of $2,420,000 for the excess accrual of the yield maintenance payment on the Notes. The income has been included in income from redemptions of mortgage assets. During 1994, the Company exercised its redemption rights on four mortgage assets for net proceeds of $11,227,000 and income of $4,263,000.\nThe cash flows and prospective yield income are affected primarily by mortgage prepayment rates and short-term interest rates. Higher mortgage prepayment rates or higher short-term rates reduce the income and total cash flows over the life of the mortgage assets. Income from mortgage asset redemptions is affected by the timing of meeting the specified conditions for redemptions and the value of the underlying mortgage instruments. As a result, mortgage asset redemptions do not occur on a regular basis and the income can fluctuate significantly between periods. In addition, redemption of mortgage assets reduces the prospective yield income in future periods.\nHedging transactions\nIn 1992, the Company purchased \"Cap Agreements\" to protect against the negative effect on mortgage asset cash flows of increases in interest rates in 1994. The \"Cap Agreements,\" purchased for $2,459,000, called for payments to the Company equal to the excess of one-month LIBOR over 5.5% on specified dates during 1994 (generally monthly) times $240,000,000. The effect of the Cap Agreements was to provide that the interest paid on structured financing during 1994 did not exceed 5.5%.\nAlso in 1992, the Company executed short sales of Eurodollar Futures Contracts on the International Monetary Market exchange. The effect of the Futures Contracts was to \"fix\" the interest rate on $190,000,000 of the structured financings at approximately 6.75% for 1995. In 1993, the Company recorded losses of $4,168,000 on the\nFuture Contracts. In 1994, the Company closed out its Futures Contract position and realized a gain of $1,152,000 which was recorded as set forth below.\nBoth the Cap Agreements and Futures Contracts transactions were entered into as hedges against the interest rate impact on mortgage asset cash flows in 1994 and 1995. The cost of the Cap Agreements ($2,459,000) and the losses incurred on the Futures Contracts during 1993 ($4,168,000) were accounted for as additional costs of the mortgage assets and were written off in connection with the adoption of SFAS No. 115 in December 1993. Such amounts are included in the \"cumulative effect of accounting change\" in the accompanying consolidated statements of operations. The 1994 gain on the Futures Contracts ($1,152,000) was recorded as a reduction in the carrying value of the mortgage assets.\nBecause of (1) the decline in importance of mortgage assets as a result of the Company's emphasis on investments in apartments and (2) the decline in the amount of variable rate structured financing underlying the mortgage assets, the Company no longer plans to invest in similar hedging transactions and had no such investments at December 31, 1995 and 1994.\n4. NOTES PAYABLE\nReal estate notes payable\nThe apartment communities acquired in January 1994 were financed by first mortgage loans totaling $45,700,000 and seller carryback notes of $6,500,000. The first mortgage loans are nonrecourse and non-cross collateralized. They generally have a ten year term and bear fixed interest rates ranging from 8.5% to 10.1%, with a weighted average fixed rate of 8.6% at December 31, 1995 and 1994. The wholly owned 222-unit community in Mesa, Arizona, which was purchased in February 1995, was financed by a $3,770,000 first mortgage loan bearing interest at 225 basis points over three-month LIBOR. Amortization of deferred loan fees was $120,000 and $88,000 for 1995 and 1994\nThe seller carryback notes were unsecured, bore a fixed interest rate of 7.5% and were to be amortized over a three-year period ending February 1, 1997 with monthly principal and interest payments of $202,000. As provided for by the note agreements, the Company repaid the notes in 1995 at a discount of $311,000 which was recorded as a credit to income.\nThe scheduled maturities of the real estate notes payable are as follows (in thousands):\n1996 $ 773 1997 2,317 1998 440 1999 4,227 2000 552 2001-2004 41,324 ---- --------------- Total $ 49,633 ===============\nMortgage assets notes payable\nIn 1992, the Company issued $80,000,000 of Secured Notes (\"Notes\") at an interest rate of 9.02% per year. The Notes were collateralized by a majority of the Company's mortgage assets and funds held by the trustee (restricted cash). The Company was required to use the net proceeds from the redemptions of the mortgage interest to prepay the Notes at a premium. During 1994, the Company made prepayments of $10,355,000.\nIn February 1995, the Company used the proceeds from a mortgage asset redemption of $2,800,000, $393,000 of its cash and the funds held by the trustee to prepay the\nentire balance of the Notes. Accordingly, the funds held by the trustee ($21,583,000 at December 31, 1994) were presented as a reduction of the Notes balance in the consolidated balance sheets. Amortization of deferred loan cost was $549,000 for 1993.\nShort-term Borrowing\nAt December 31, 1995, the Company had borrowings under reverse repurchase agreements of $2,170,000 secured by five mortgage assets with a total carrying value of $2,645,000. The Company also had short-term borrowings of $2,325,000 secured by two mortgage assets with a total carrying value of $4,994,000. The interest rate averaged 6.55% during 1995 and 6.69% at December 31, 1995.\n5. STOCK OPTIONS\nThe Company has two stock option plans which are administered by the Board of Directors. The purpose of the plans is to provide a means of performance-based compensation to attract and retain directors and key personnel.\nUnder the plans, options to acquire a maximum of 140,000 shares of the Company's common stock may be granted at an exercise price not less than the fair market value of the stock. The options expire ten years after the date of grant. Upon exercise of the options, the Company can elect to distribute cash in lieu of shares.\nIn addition, in connection with the renewal of the management agreement for 1994, the Company and the Manager agreed to eliminate the incentive management fee provision and the Company granted to the partners of the Manager non-qualified options to purchase 309,800 shares of common stock and 90,200 shares of stock appreciation rights (\"SARs\") with an exercise price of $8.60 per share. The exercise price was 10% above the closing market price of the common stock on the grant date. The holders will also receive payments equal to the product of the per share dividend amount times the number of options and SARs outstanding. The options and SARs will expire in December 1998. As of December 31, 1995, all of the options and SARs are exercisable and none of them have been exercised. Upon exercise of the options, the Company can elect to distribute cash in lieu of shares.\nIn 1995, certain holders exercised options to purchase 50,496 shares by giving full recourse notes totaling $653,000 to the Company. The notes are secured by the shares of common stock issued and bear interest at the prime rate plus 1%. The notes are due on December 31, 1996 and can be repaid by giving the Company shares of common stock owned by the optionholders based on the then market price of the common stock.\nInformation on all stock options granted is summarized below:\nNumber Option of Price Shares Per Share ------ --------- Outstanding at December 31, 1993 403,141 $ 8.13-$20.90 Options and DERs canceled (4,901) 11.19-$20.00 Options granted 14,000 $11.25 Outstanding at ------- December 31, 1994 412,240 $8.13-$20.90\nOptions exercised (54,496) $11.25-13.13 Outstanding at ------- December 31, 1995 357,744 $8.13-$20.90 =======\n6. Fair Value of Financial Instruments\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 Values of Financial Instruments.\" Although management uses its best judgement in estimating the fair value of these instruments, there are inherent limitations in any estimation technique and the estimates are thus not necessarily indicative of the amounts which the Company could realize in a current transaction.\nBasis of Estimates\nMortgage Assets. The fair value of mortgage assets is generally dependent on interest rate and other economic factors, including (1) the characteristics of the asset, (2) estimates of future cash flows and (3) the discount rate used to calculate the present value of the cash flows. The market for the Company's mortgage assets is very illiquid and traded prices are determined on a privately negotiated basis. Thus, except for one mortgage asset which the Company has agreed to redeem in the second quarter of 1996 for total income of $4.9 million, the Company uses the carrying values as the estimated values.\nManagement believes, however, that it is meaningful to provide the following present value of the estimated cash flows using the interest rates and mortgage prepayment rates as of December 31, 1995. The estimates without redemptions assume that the mortgage assets are held until the stated maturity (with the exception of one mortgage asset which the Company has agreed to redeem in April 1996 for estimated net proceeds of $6,000,000). The estimates with redemptions assume that the Company would exercise the redemption rights at the earliest dates and sell the mortgage instruments at the estimated market prices as of December 31, 1995. (Dollars in thousands.)\nDiscount With Without Rate Redemptions Redemptions ---- ----------- ----------- 10% $41,442 $22,967 20% $34,032 $18,484 30% $28,595 $15,890 40% $24,505 $14,048 50% $21,354 $12,635\nReal Estate Notes Payable. The Company has used the carrying value of real estate notes payable as their fair value. At December 31, 1995, the interest rates on the Company's notes payable approximated the market rates for debt instruments with similar terms and maturities.\nShort-term borrowing. The Company has used the carrying value of short-term borrowing as its fair value as the interest rates are adjusted monthly and the maturity terms are less than one year.\nEstimated Fair Values (in thousands):\nCarrying Estimated Amount Fair Value ------ ---------- Mortgage assets $11,877 $16,777 Real estate notes payable 49,633 49,633 Short-term borrowing 4,495 4,495\n7. RELATED PARTY TRANSACTIONS\nSubject to the supervision of the Company's Board of Directors, Pima Mortgage Limited Partnership (the \"Manager\") manages the day-to-day operations of the Company pursuant to a management agreement which has a current term through December 31, 1996. Pursuant to the agreement, the Manager receives a base management fee of 3\/8 of 1% per annum of the Company's average invested assets before deduction for reserves and depreciation. The management fees for 1995, 1994 and 1993 were $374,000, $544,000, and $625,000, respectively.\nUnder the agreement, the Manager must reimburse the Company for any management fees received for the year to the extent that the operating expenses (as defined) for the year exceed the greater of 2% of the Company's average invested assets or 25% of its net income (as defined), unless the unaffiliated directors determine that a higher level of expenses is justified for such year. There were no such excess operating expenses in 1995, 1994 or 1993. Additionally, if the agreement is terminated without cause (as defined) or not renewed on terms as favorable to the Manager, the Manager will be entitled to receive the management fees relating to the invested assets purchased prior to the termination date, for a three-year period as if the agreement had remained in effect.\nUnder the agreement, the Manager also performs certain analyses and other services in connection with the administration of structured financing related to the Company's mortgage assets. For such services, the Company paid the Manager $216,000 for 1995, $247,500 for 1994, and $260,000 for 1993.\nAs discussed in Note 5, the Company and the Manager agreed to eliminate the incentive fee provision in the management agreement beginning with 1994. The Company granted to the owners of the Manager options and stock appreciation rights (\"SARs\") that provide for dividend equivalent payments based on the per share amounts of dividends paid on the common stock. In 1995 and 1994, the dividend equivalent payments were $800,000 and $200,000 which are included in operating expenses. As a result of the increase in the common stock price, the Company recorded an accrual for the SARs of $705,000 in 1995 and $324,000 in 1994, which amounts are included in operating expenses.\nThe Company has entered into a property management agreement with Pima Realty Advisors, Inc. the \"Property Manager\"), an affiliate of the Manager, for each of its apartment properties. Under the property management agreements, the Property Manager provides the customary property management services at its cost without profit or distributions to its owners, subject to the limitation of the prevailing management fee rates for similar properties in the market. The costs are allocated to the Company monthly based on the ratio of the number of units owned by the Company relative to the total apartment units managed by the Property Manager. The costs allocated to the Company for 1995 and 1994 were $417,000 and $184,000 respectively (net of an allocated credit of $246,000 applicable only in 1994), which were equal to approximately 3% and 1.4% of the real estate operating income.\n8. TAXABLE INCOME (LOSS) (unaudited)\nAs of December 31, 1995, the Company had an estimated net operating loss (\"NOL\") carryforward of $75,000,000 which can be used to offset taxable income other than excess inclusion income through 2009 (1999 for state taxes). Substantially all of the dividends for 1994 and 1993 constitute ordinary income. Approximately 14.5% of the 1995 dividend is ordinary income and 85.5% is a return of capital for income tax purposes. During 1995, 1994, and 1993, the Company had excess inclusion income from the residual interest in certain real estate mortgage investment conduits (\"REMICs\") which cannot be used to offset operating losses (including NOL carryforward) and deductions from other sources. Under the current tax law for REITs, excess inclusion income is required to be distributed as dividends. The estimated taxable income of $900,000 for 1995 represents excess inclusion income.\nNet income reported in the accompanying consolidated financial statements is different than the taxable income due to the reporting of some income and expense items in different periods for income tax purposes. The difference consists primarily of (1) reserves taken on mortgage assets in prior years which were not allowed for income taxes, (2) differences in income recognition methods on mortgage assets and (3) excess inclusion income for tax purposes. These timing differences will reverse in future years.\nTaxable income for 1995 is subject to change when the Company prepares and files its income tax returns. The taxable income amounts also are subject to adjustments, if any, resulting from audits of the Company's tax returns by the Internal Revenue Service.\n9. QUARTERLY FINANCIAL DATA (unaudited) (Dollars in Thousands Except Per Share Amounts) Net Income Dividend Total ---------------- Per Income Amount Per share share ------ ------ --------- ----- First $ 7,983 $ 3,359 $ 1.10 $ 0.50 Second 6,410 2,015 0.65 0.50 Third 4,798 570 0.18 0.50 Fourth 5,008 610 0.19 0.50\nFirst $ 5,263 $ 1,218 $ 0.56 $ -- Second 7,369 2,698 0.85 -- Third 6,228 2,074 0.65 -- Fourth 5,087 1,712 0.55 0.50\nFirst $ (9,069) $(11,174) $ (3.60) $ -- Second (1,126) (2,877) (0.95) -- Third 530 (1,320) (0.45) 0.25 Fourth (2,288) (25,199) (8.10) 0.90\nASR INVESTMENTS CORPORATION SCHEDULE III -- REAL ESTATE AND ACCUMULATED DEPRECIATION (in thousands)\nA summary of activity for real estate investments and accumulated depreciation is as follows:\n1995 1994 ---------- --------- Real Estate Investments: Balance, beginning of year $64,264 $ 0 Acquisitions .............. 6,358 61,593 Improvements .............. 2,106 2,671 Dispositions and other ... 0 0 ---------- --------- Balance, end of year .....$ 72,728 $64,264 ========== =========\nAccumulated Depreciation: Balance, beginning of year $ 1,995 $ 0 Depreciation .............. 2,692 1,995 Dispositions and other ... 0 0 ---------- --------- Balance, end of year .....$ 4,687 $ 1,995 ========== =========","section_15":""}
{"filename":"310205_1995.txt","cik":"310205","year":"1995","section_1":"ITEM 1. Business.\nSummary\nKFC National Purchasing Cooperative, Inc. (the \"Cooperative\"), was formed to serve as a national purchasing cooperative on behalf, and for the benefit, of Kentucky Fried Chicken (\"KFC\") retail outlet owners and operators, including KFC National Management Company (\"KFC Management\"), a subsidiary of KFC Corporation (\"KFCC\"). The Cooperative was incorporated under the General Corporation Law of the State of Delaware in September 1978. Effective in the first calendar quarter of 1992, through a newly formed subsidiary, the Cooperative commenced purchasing and distribution for owners and operators of KFC franchised retail outlets in Canada. The Cooperative sells primarily to independent KFCC-approved distributors in Canada similar to the way it does business in the United States. In November 1992, the Cooperative's members adopted amendments to its Certificate of Incorporation and Bylaws to provide for membership in the Cooperative by the International Association of Taco Bell Franchisees, Inc. (the \"IATBF\") and owners and operators of Taco Bell retail outlets. In addition, the Cooperative is actively developing business opportunities with retail outlet operators of other fast food concepts, including Long John Silver's, Dairy Queen, and Fazoli's. The Cooperative currently does business under the name of FoodService Purchasing Cooperative, Inc. The term \"Operator\" when used in this document includes (i) owners and operators of Taco Bell retail outlets, (ii) KFC Management and Pepsi-Cola Canada Ltd., and (iii) owners and operators of KFC franchised retail outlets.\nThe Cooperative makes volume purchases of various equipment, food, packaging, and other consumable or disposable supplies (\"Equipment and Supplies\") from manufacturers and suppliers for sale to Operators whether or not they are members of the Cooperative, as well as to independent distributors who supply Operators. The Cooperative endeavors to obtain low purchase prices by making volume purchase commitments at fixed prices and by assuming other procurement functions and risks that reduce the suppliers' costs. Cost savings will be dependent upon a number of factors, including the volume of purchases and resales to Operators and distributors, negotiation of favorable purchase agreements, competitive conditions and the amount of overhead expenses. In an effort to achieve additional cost savings, the Cooperative is actively working with its suppliers and distributor customers with electronic data interchange. The Cooperative hopes to achieve cost savings for its members; however, there can be no assurance that it will be able to do so on a sustained basis.\nThe Cooperative provides its members with advisory services related to the distribution of Equipment and Supplies, including industry data on distribution costs and service levels to enable the members to negotiate more effectively with distributors. The Cooperative also sponsors a Distributor Monitoring Program to enhance the system of independent distributors available to retail outlet operators.\nThe Cooperative, through its wholly-owned subsidiary, KFC Franchisee Insurance Program, Inc. (the \"Insurance Subsidiary\"), sponsors programs of property, casualty and workers' compensation insurance, and employee benefits, including life, health, long-term disability and dental coverages for owners and operators of fast food retail outlets. These programs are marketed through the Cooperative's indirect subsidiary, Kenco Insurance Agency, Inc. (the \"Insurance Agency\"). See \"OPERATIONS - INSURANCE PROGRAM.\"\nThe Cooperative has an equipment staging operation with warehousing facilities in Louisville, Kentucky.\nThe Cooperative has provided equipment financing from time to time under certain circumstances for KFC franchisee members. In 1987, the Cooperative initiated an equipment financing program to finance for franchisee members their\n- 3 -\npurchases from the Cooperative of equipment required for Operators to participate in KFC's introduction of two new menu items. In 1992, the Cooperative reactivated on a limited basis an equipment financing program to finance equipment purchases for KFC franchisee members participating in the KFC buffet bar, rotisserie chicken, and KFC signage rollouts. Although the Cooperative has now terminated its equipment financing program, it does actively help Operators obtain information concerning alternative financing options.\n\"Dairy Queen,\" \"Domino's Pizza,\" \"Long John Silver's,\" \"Taco Bell,\" \"Fazoli's,\" and \"KFC\" are registered trademarks of American Dairy Queen Corporation, Domino's Pizza, Inc., Long John Silver's, Inc., Taco Bell Corporation, Seed Restaurant Group Inc., and KFCC, respectively, and are used in these materials for identification purposes only. The Cooperative is an independent provider of products and is not affiliated with American Dairy Queen Corporation, Domino's Pizza, Inc., Long John Silver's Inc., Taco Bell Corporation, Seed Restaurant Group Inc., or KFCC, except that KFCC is a stockholder member of the Cooperative.\nHISTORY\nThe Cooperative was organized by KFCC and the National Franchisee Advisory Council (the \"NFAC\") with the objectives of: (i) obtaining Equipment and Supplies at the lowest prices; and (ii) having the procurement function on behalf of Operators of KFC retail outlets handled on an arm's-length basis rather than through KFCC. The organization of the Cooperative was an outgrowth of a feasibility study conducted by a consulting firm, engaged by KFCC in conjunction with the Equipment and Supply Committee of the NFAC. The consulting firm made recommendations about possible procurement alternatives to the then current KFC Master Supply Agreement mechanism.\nA primary premise upon which the Cooperative was founded was that greater cost savings for Operators in the purchase of Equipment and Supplies could be realized through one central procurement organization that made firm purchase commitments, took title to goods, and made sales to Operators and distributors, thereby relieving suppliers of certain costs of doing business with numerous, small volume purchasers. These costs include credit, sales, marketing, and billing expenses which would otherwise be expected to be reflected ultimately in higher prices charged by the suppliers. Purchase commitments made by the Cooperative also allow suppliers to plan production, purchase raw materials, and control inventory levels, thereby further providing suppliers with reduced costs.\nIn determining to organize the Cooperative, KFCC and the NFAC concluded that, notwithstanding the inherent administrative complexity of a member-controlled cooperative, the Cooperative better than any alternative, could meet five important criteria:\n- - Provide potential for lowest delivered cost of Equipment and Supplies;\n- - Promote confidence among Operators and KFCC that the best interests of the entire KFC system would be served;\n- - Minimize complexity of legal issues;\n- - Support high product quality and consistency and maintain service reliability; and\n- - Support competition among distributors and suppliers and allow for free selection of distributors and suppliers outside the central procurement system.\nIn August 1989, KFCC announced its intention to withdraw its support for the purchasing programs of the Cooperative and to begin in October 1989 direct purchasing from suppliers and distributing to KFCC-owned retail outlets through a wholly owned subsidiary of PepsiCo. The Cooperative's Board of Directors has\n- 4 -\napproved sales by the Cooperative through distributors and directly of equipment to certain other restaurant systems including Taco Bell. See \"OPERATIONS-PEPSICO\" and \"OPERATIONS -- EXPANSION OF SERVICES.\" In addition, through a newly formed subsidiary, the Cooperative commenced purchasing and distribution for owners and operators of KFC franchised retail outlets in Canada during fiscal 1992. See \"OPERATIONS -- CANADIAN OPERATIONS.\"\nOPERATING PRINCIPLE\nThe Cooperative is a central procurement organization which, among other functions, makes firm commitments to purchase Equipment and Supplies in its own name and at its own risk, and takes title to and sells the Equipment and Supplies to distributors and Operators. Members participate in establishing strategic procurement policies through the Cooperative's Board of Directors.\nThe success of the Cooperative depends on it being able to purchase and resell goods at prices that will attract the business of Operators and\/or their distributors. The Cooperative attempts to obtain the lowest possible purchase price by making firm commitments to purchase in large volumes and by assuming other procurement functions and risks, such as dealing with numerous purchasers, that should reduce the suppliers' costs.\nThe Cooperative provides the convenience of \"one-stop\" shopping for distributors and Operators which otherwise might be required to deal with a number of suppliers. The operation of the Cooperative also allows Operators to benefit from the Cooperative's full-time professional purchasing staff working solely for the benefit of Operators.\nOPERATIONS\nThe following is a description of the Cooperative's United States operations, primarily with respect to KFC and Taco Bell related activities. As the Cooperative expands its operations into territories outside of the United States and with other fast food concepts, the Cooperative intends to review these operations and offer programs substantially similar to those described below wherever feasible.\nPRICING POLICY\nThe primary objective of the Cooperative is to purchase and resell Equipment and Supplies to Operators and distributors at the lowest prices that can be achieved by volume purchase commitments and the assumption of other procurement functions and risks previously described. Consistent with this objective, the Cooperative marks up the purchased Equipment and Supplies by the least amount which it estimates to be sufficient to cover the Cooperative's costs and to provide for working capital and prudent levels of reserves. The Cooperative expects to maintain its minimal margins mark-up policy even though it has implemented a patronage dividend program. See Item 5. \"MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\"\nSEASONALITY\nThe Cooperative's sales reflect the somewhat seasonal nature of the volume of business done by Operators. Thus, the Cooperative's sales are generally expected to be at their relatively lowest levels during the winter months and are generally expected to be at their relatively highest levels in the summer months. However, because of the growth in the Cooperative's sales volume since it commenced operations as of March 1, 1980, no pattern of absolute, rather than relative, seasonal changes has emerged.\nEQUIPMENT AND SUPPLIES\nIn 1991 the Cooperative reorganized its purchasing and sales departments along divisional lines relative to its distributor customers rather than to the products. To provide the distributor customers with better service and focus the\n- 5 -\nCooperative's efforts in a more appropriate manner, the purchasing, customer service and distribution departments were realigned to provide better levels of service.\nAs of November 1, 1993, the Cooperative reorganized its operations with a focus on concepts versus products. The Cooperative has assigned general managers responsibilities for each significant fast food concept with which the Cooperative does business. These general managers are responsible for the success and expenses associated with their particular concept. Management believes this new focus will provide the needed expertise to provide the required level of customer service over a broad spectrum of customers.\nIn an effort to achieve additional cost savings, the Cooperative is actively coordinating its purchasing and distribution activities with its suppliers and distributor customers using the computer-to-computer exchange of business documents, i.e., electronic data interchange (\"EDI\"). Using EDI facilitates the timely and efficient execution of the Cooperative's purchases and sales.\nCORN PROGRAM\nThe Cooperative makes substantial purchase commitments for frozen cob corn on or about October 1, the beginning of a cob corn crop year, and takes physical delivery of the purchased cob corn shortly thereafter. The cob corn is stored by the Cooperative in freezer equipped storage facilities at various locations across the United States until resold to distributors or franchisees. For the crop year which commenced in October 1995, the Cooperative purchased or committed to purchase approximately 635,000 cases of cob corn for purchase prices totaling approximately $4,309,000.\nINSURANCE PROGRAM\nThe following is a description of the Cooperative's insurance programs for owners and operators of fast food retail outlets. During fiscal 1982, the Cooperative organized the Insurance Subsidiary to engage in activities related to a new KFC franchisee insurance program. The KFC franchisee insurance program was developed as a voluntary insurance program by the Association of Kentucky Fried Chicken Franchisees, Inc., and the Cooperative.\nThrough the Insurance Agency, the Cooperative currently offers two types of insurance coverage through different insurance carriers, one offering property, casualty, and workers' compensation coverage (the \"Property and Casualty Program\"), and the other offering employee benefits, including life, health, long-term disability and dental coverages (the \"Life and Health Program\"). The Cooperative, through its Insurance Subsidiary, is the sponsor of the two Programs. The Insurance Subsidiary's role in the two Programs is to monitor the Programs and the performance of its insurance carriers and to distribute general information about the Programs.\nThe Insurance Agency and its agents maintain Kentucky-resident insurance licenses and nonresident licenses in all states. The Insurance Agency is compensated for the administrative and operational activities it performs by receiving a commission from insurance companies providing policies to the franchisees. In fiscal 1995, the premium volume from the fully insured Property and Casualty Program was $8.2 million and for the Life and Health Program was $2.6 million.\nFINANCING PROGRAMS\nThe Cooperative has provided or facilitated equipment financing from time to time under certain circumstances for KFC franchisee members. On December 8, 1995, the Board of Directors of the Cooperative approved in principle a finance program for stockholder members co-sponsored by the National Cooperative Bank (the \"Bank\"). The program is subject to negotiation and execution of definitive agreements between the Cooperative and the Bank. The program currently contemplates up to $20,000,000 in loans to Cooperative members which range from\n- 6 -\n$100,000 to an individual maximum of $2,000,000. The program is expected to commence in early 1996. The Cooperative has agreed to guarantee from 10% to 25% of the declining balance of each loan based on the loan's risk classification. The estimated maximum exposure of the Cooperative based on the allocation of funds between loan classifications would be $3,500,000. The Bank has agreed to maintain a specific reserve equal to .125 basis points to .50 basis points of all interest paid based on the loan's classification which will be applied to losses prior to the Cooperative incurring any loss. The Bank will be responsible for substantially all legal and administrative requirements of the program.\nEQUIPMENT STAGING\nThe Cooperative offers equipment staging services, which involve the purchasing and warehousing of equipment by the Cooperative in an effort to consolidate equipment into packages for timely shipment to owners and operators of KFC, Taco Bell and other fast food retail outlets. The Cooperative has leased warehouse space in Louisville, Kentucky, for its equipment staging operation. See Item 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. Properties.\nThe Cooperative does not own any real property or warehousing facilities. The Cooperative currently leases approximately 47,761 square feet of office space at 950 Breckinridge Lane, in Louisville, Kentucky, for its executive offices under leases expiring on February 28, 1999. The Cooperative leases commercial frozen food warehouse facilities on a short-term basis in various locations in connection with its frozen cob corn purchase program. The Cooperative currently leases approximately 19,650 square feet of warehouse space in Louisville, Kentucky, for its equipment staging operation. The Canadian Subsidiary also leases approximately 1,400 square feet of office space in Mississauga, Ontario.\n- 12 -\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 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 II\nITEM 5.","section_5":"ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters\nNo market for the Cooperative's capital stock exists nor is any expected to develop. Described below are the Cooperative's dividend policy, patronage dividend program, and Membership Common Stock and Store Common Stock.\nDIVIDEND POLICY\nAlthough the Cooperative does not engage in business to generate profits, if in any year the revenues from Equipment and Supplies sales exceed expenses, the amortization of debt, and reasonable reserves, the Cooperative may distribute all or a portion of the excess to the holders of Store Common Stock as dividends or use the excess revenues to provide additional procurement-related services. While the Cooperative is not precluded from paying dividends, the principal purpose of the Cooperative is not to produce profits to be distributed. Prior to the implementation of the Cooperative's patronage dividend program, the Cooperative's Board of Directors declared a dividend of $25.00 per share of Store Common Stock which was paid on March 31, 1982. There is no current intention to pay any dividends in the future on Store Common Stock on a per share basis. The Cooperative will not pay dividends at any time on Membership Common Stock.\nThe Cooperative has established a patronage dividend program. See \"PATRONAGE DIVIDEND PROGRAM.\" The payment of dividends based upon patronage tends, of course, to reduce or eliminate funds available for dividends based upon the number of shares of Store Common Stock owned.\nPATRONAGE DIVIDEND PROGRAM\nINTRODUCTION\nAlthough the Cooperative does not engage in business to generate profits, it may nonetheless, in any fiscal year, generate revenues in excess of amounts needed to cover expenses, amortize indebtedness, and provide for reasonable reserves. Thus, even though the Cooperative endeavors to minimize markups on Equipment and Supplies to the least amount required to cover its anticipated costs of operations, the Cooperative may have funds available for distribution to members.\nIn 1982, the Cooperative implemented a program for the payment of patronage dividends to members on the basis of the value of business done by the Cooperative with regard to each member, respectively. At its August 23, 1994 meeting, the Cooperative's Board of Directors approved a change to the patronage dividend program. Beginning with fiscal 1995, through an amendment to Section 9.2 of its Bylaws set forth in its entirety herein, the Board of Directors is authorized to distribute as patronage dividends amounts determined in accordance with Section 9.2. Under the revised program, solely for purposes of determining the amount of patronage dividends distributable to a particular stockholder member, the Cooperative has established two separate pools of allocated net earnings for purposes of making patronage dividend determinations, the \"KFC Pool\" and the \"Taco Bell Pool,\" as defined in Section 9.2, such that patronage dividends to stockholder members operating Taco Bell retail outlets will be paid from the Taco Bell Pool and patronage dividends to stockholder members operating KFC outlets\n- 13 -\nwill be paid from the KFC Pool. In addition, in August 1994, the Cooperative's Board of Directors determined that the Cooperative would pay patronage dividends to its stockholder members, based separately for KFC stockholder members on pre-tax income available from the KFC Pool and for Taco Bell stockholder members based on pre-tax income available from the Taco Bell Pool, for the period from November 1, 1994, through October 31, 1995, in an aggregate amount equal to the lesser of (a) fifty percent (50%) of the Cooperative's total \"pre-tax income,\" as defined in the Cooperative's 1995 fiscal year budget, or (b) the amount of the Cooperative's total \"pre-tax income\" for fiscal 1995 reasonably allocable to sales with respect to which a patronage dividend is payable. In August 1995, the Board of Directors determined that a patronage dividend for fiscal 1996 would be paid on a formula similar to that adopted for fiscal 1995, except that the patronage dividend would be based upon 60% of \"pre-tax income,\" rather than 50%.\nThe Cooperative paid a patronage dividend totalling $888,000 in March 1994 for patronage in fiscal 1993. The Cooperative paid $569,000 in March 1995 for patronage in fiscal 1994. For patronage during fiscal 1995, a dividend totalling $1,246,000 is payable in March 1996. KFC-related sales volumes and net income were strong in fiscal 1995 primarily as a result of several KFC product promotions, while Taco Bell sales volumes reflected a 10% decrease from fiscal 1994 as a result of significantly lower beef prices. Therefore, most of the fiscal 1995 patronage dividend will be paid with respect to KFC patronage.\nBYLAW PROVISION\nThe Bylaw provision regarding patronage dividends is as follows:\nArticle IX Patronage Dividends\n9.1 Cooperative Basis. The Cooperative shall at all times be operated on a cooperative basis for the benefit of its stockholder members. The Cooperative shall always do more than fifty percent (50%) in value of its business with its stockholder members either directly or through distributors (\"participating distributors\") which shall have agreed to participate in the Cooperative's patronage dividend program for its stockholder members by entering into distributor participation agreements with the Cooperative in such form as the President shall prescribe from time to time. The Cooperative may operate on a for-profit basis with respect to non-members.\n9.2 Patronage Dividend Distributions.\n(a) The Board of Directors is authorized, after considering the Cooperative's need for capital and reserves, to distribute as patronage dividends directly to each stockholder member of the Cooperative amounts determined as set forth below. Solely for the purpose of determining the amount of patronage dividends distributable to a particular stockholder member of the Cooperative, the Cooperative's business with its stockholder members shall be segregated into two distinct pools: (i) the \"KFC Pool,\" under which shall be determined the net earnings of the Cooperative from business done by the Cooperative directly with stockholder members for use by the stockholder members in KFC retail outlets owned or operated by the stockholder members and the value of business done by the Cooperative with participating distributors resulting in resales by such distributors to such stockholder members for such use; and (ii) the \"Taco Bell Pool,\" under which shall be\n- 14 -\ndetermined the net earnings of the Cooperative from business done by the Cooperative directly with stockholder members for use by the stockholder members in Taco Bell retail outlets owned or operated by the stockholder members and the value of business done by the Cooperative with participating distributors resulting in resales by such distributors to such stockholder members for such use.\nThe amount distributable by the Cooperative as patronage dividends directly to each stockholder member of the Cooperative shall be based on\n(A) The ratio of\n(i) the value of business done by the Cooperative directly with such stockholder member for use by the stockholder member in KFC retail outlets owned or operated by the stockholder member and the value of business done by the Cooperative with participating distributors resulting in resales by such distributors to such stockholder member for such use, to\n(ii) the net earnings of the Cooperative in the KFC Pool, plus\n(B) The ratio of\n(i) the value of business done by the Cooperative directly with such stockholder member for use by the stockholder member in Taco Bell retail outlets owned or operated by the stockholder member and the value of business done by the Cooperative with participating distributors resulting in resale by such distributors to such stockholder member for such use, to\n(ii) the net earnings of the Cooperative in the Taco Bell Pool.\n(b) The distribution described in subparagraph (a), is among all stockholder members, shall be directly proportional for each taxable year of the Cooperative to the purchases by each stockholder member, whether such purchases are direct or through a participating distributor.\n9.3 Timing of Payment of Patronage Dividends. Each distribution of patronage dividends shall be made within the payment period beginning with the first day of a taxable year for which the Cooperative claims a deduction for patronage dividends paid in the form of such distributions and ending with the 15th day of the 9th month following the close of such taxable year.\n9.4 Character of Distributions. Twenty percent or more of the amount of each distribution shall be paid in cash or by a \"qualified check\" as defined in Section 1388(c)(4) of the Internal Revenue Code of 1986, as\n- 15 -\namended. All amounts of such distributions not paid in money or by \"qualified check\" shall be paid a \"qualified written notice of allocation\" as defined in Section 1388(c)(1) of the Internal Revenue Code of 1986, as amended.\n9.5 Consent to Stockholder Members. Membership in the Cooperative by stockholder members shall constitute a consent of each such member to include in its gross income the amount of any patronage dividend which is paid with respect to direct sales from the Cooperative, and indirect sales through participating distributors in money, \"qualified checks,\" \"qualified written notices of allocation\" or other property (except \"non-qualified written notices of allocation\" as defined in Section 1388(d) of the Internal Revenue Code of 1986, as amended) and which is received by it during the taxable year from the Cooperative. Each stockholder member of the Cooperative, through initiating or retaining its membership after adoption of this Article IX of these Bylaws, as amended from time to time, consents to be bound hereby. The provisions of this Article IX, as amended from time to time, shall be a contract between the Cooperative and each stockholder member as fully as though each stockholder member had signed a specific separate instrument in which the stockholder member agreed to be bound by all of the terms and provisions of this Article IX, as amended from time to time.\n9.6 Application of Patronage Dividends to Amounts Due the Cooperative. Notwithstanding any of the foregoing provisions of this Article IX, the portion of any patronage dividends which would otherwise be payable in cash under any provision of this Article IX to a stockholder member may be applied by the Cooperative to the payment of any indebtedness, the repayment of which is in default, owed to the Cooperative by any such stockholder member to the extent of such indebtedness instead of being distributed in cash, provided, however, that an amount equal to twenty percent (20%) (or, in the case of a stockholder member located in a jurisdiction to which the special withholding requirements of Sections 1441 or 1442 of the Internal Revenue Code of 1986, as amended, apply, thirty percent (30%)) of the total annual patronage dividends distributable for the applicable year to any such stockholder member shall nevertheless be paid in cash within the period set forth in Section 9.3 if any such stockholder member so requests in a writing received by the Cooperative within thirty (30) days of the first day of the Cooperative's fiscal year as established under Section 6.3.\nFEATURES OF PROGRAM\nThe patronage dividend program implemented pursuant to the Bylaw provision has the following, among other, features:\n1. Members who are United States residents must consent to report any patronage dividends received as gross income for federal income tax purposes. The Cooperative will file with the Internal Revenue Service a report, currently on Form 1099-PATR, of the amount of patronage dividends paid to each member. Members resident of countries other than the United States generally are subject to a flat United States tax of 30% on the amount of patronage dividends paid by the Cooperative. The Cooperative is required to withhold\n- 16 -\nthe 30% tax from the patronage dividend payment, unless the treaty between the United States and a particular country provides for a lower withholding rate. For example, a treaty between the United States and Canada provides for withholding at a 15% rate (although the Canadian member remains liable for the remaining 15% tax).\n2. While the Bylaw provision permits the Cooperative to operate on a \"for-profit basis\" with respect to non-members, the Cooperative has no intention of changing its pricing policy, as described above, pursuant to which the Cooperative endeavors to mark up prices on Equipment and Supplies by the least amount necessary.\n3. The validity of the Cooperative's allocation of participating distributor purchases to the distributors' respective customer Operators will depend upon the accuracy and timeliness of the records maintained by the distributors and provided to the Cooperative pursuant to agreements between the distributors and the Cooperative. The Cooperative anticipates that distributors serving members will perform the recordkeeping functions in an accurate and timely manner. However, the Cooperative cannot assume responsibility, as between the Cooperative and its members, for the information provided, or not provided, the Cooperative by distributors with respect to purchases by individual Operators.\n4. While the Cooperative is authorized to make distributions, in part, in a form other than cash, the Cooperative anticipates that in the foreseeable future any distributions would be solely in the form of cash, subject to offset as discussed below. In August 1993, the Cooperative's Board of Directors adopted Article 9.6 set forth above providing for a possible offset of a stockholder member's patronage dividend against the payment of any indebtedness to the Cooperative, the repayment of which is in default. As a matter of policy, the Cooperative currently notifies any franchisee against whose patronage dividend the Cooperative intends to offset against an obligation of its intention by certified mail return receipt requested, and the Cooperative will require any member requesting that 20% of any patronage dividend to be offset nevertheless be paid to the member in cash make the request by certified mail return receipt requested.\n5. KFC Management and Harman are eligible as are all other members to receive patronage dividends on the same basis as other members.\n6. Distributions of patronage dividends are based solely on patronage with the Cooperative and not on the basis of the number of shares of Store Common Stock owned by a member. The payment of dividends based on patronage with the Cooperative necessarily reduces or eliminates funds available for dividends based on the number of shares of Store Common Stock owned.\n7. Non-member Operators are ineligible to receive patronage dividends, just as they are ineligible to receive dividends on Store Common Stock.\n8. The treatment of the Cooperative's payment of patronage dividends under the federal income tax laws of the United States is not free from uncertainty. See \"UNITED STATES TAX ASPECTS OF THE PATRONAGE DIVIDEND PROGRAM.\" If favorable tax treatment of patronage dividends becomes unavailable, the Cooperative will reevaluate the patronage dividend program and may discontinue or modify it.\n9. If the Cooperative is liquidated, any funds available after redemption of Membership Common Stock will be distributed on the basis of past patronage with the Cooperative rather than number of shares of Store Common Stock owned.\n- 17 -\nUNITED STATES TAX ASPECTS OF THE PATRONAGE DIVIDEND PROGRAM\nThe United States Internal Revenue Code of 1986, as amended (the \"Code\"), provides that corporations \"operating on the cooperative basis\" generally may exclude from their taxable income amounts paid as \"patronage dividends.\" \"Patronage dividends\" are amounts paid to patrons (a) on the basis of the quantity or value of business done with or for such patron, (b) under an obligation of an organization to pay such amount, which obligation existed before the organization received the amount so paid, and (c) which is determined by reference to the net earnings of the organization from business done with or for its patrons. The patronage dividend program described above calls for the payment of patronage dividends, (a) to members with respect to their purchases of Equipment and Supplies from the Cooperative, (b) pursuant to an obligation to pay in the context of the provisions of the Bylaws set forth above, and (c) determined on the basis of the net earnings of the Cooperative from such business done with all of its members in accordance with Article 9.2. Accordingly, the Cooperative believes that its patronage dividend program meets the standards of the Code.\nThe Cooperative has been advised by the U.S. Internal Revenue Service that the Service will not issue a favorable advance ruling concerning the Cooperative's proposed exclusion from its taxable income of amounts paid as patronage dividends. Accordingly, there can be no assurance that the Cooperative's treatment will not be challenged on audit of the Cooperative's federal income tax returns. If such a challenge were successful, the Cooperative would be liable for taxes and interest for any amounts disallowed as exclusions from its taxable income.\nPATRONAGE DIVIDEND PROGRAM FOR CANADIAN STOCKHOLDERS\nThe payment of patronage dividends to members is based on the value of business done by the Cooperative with regard to each member. Because substantially all of the Cooperative's Canadian sales to Operators will be with the Canadian Subsidiary, and not with the Cooperative itself, the value of business done by Canadian stockholder members with the Cooperative will be minimal. The amount of the patronage dividend paid to Canadian stockholder members will be correspondingly minimal. The Cooperative, therefore, has determined to provide a sales allowance to Canadian stockholder members based on patronage with the Canadian Subsidiary. This allowance is intended to provide the Canadian stockholder members with a program based on Canadian sales similar to the current patronage dividend program. For fiscal 1996, the sales allowance will be based on fifty percent (50%) of the Canadian Subsidiary's net income. There can be no assurance that the Canadian Subsidiary's operations will be successful on a sustained basis and that any such price reduction program will continue.\nAs noted above in \"Features of Program,\" upon liquidation of the Cooperative any funds available after redemption of Membership Common Stock will be distributed on the basis of past patronage with the Cooperative rather than number of shares of Store Common Stock. In part, because such a liquidating distribution with respect to Canadian stockholders would be minimal, the Cooperative will enter into an agreement to repurchase any Canadian stockholder member's Store Common Stock at its original purchase price at any time after two years from the date of purchase. Under Delaware law, the Cooperative may not repurchase any shares of its common stock when the capital of the Cooperative is impaired or when such repurchase would cause any impairment of the capital of the Cooperative.\n- 18 -\nCAPITAL STOCK\nMembership Common Stock\nThe Cooperative is authorized to issue 2,000 shares of Membership Common Stock, no par value, of which 586 shares were issued and outstanding on October 31, 1995. The summary description of Membership Common Stock provisions which follows is subject in all respects to the Certificate of Incorporation and the Bylaws of the Cooperative.\nIssuance in Series. Membership Common Stock is offered and issued in series as indicated in the discussion below of Series A through Series Q. The Cooperative's Certificate of Incorporation also provides for nine Series of Membership Common Stock which are designated Series R through Series Z. The Board of Directors has no current specific intention to issue any shares of the Series R through Z Membership Common Stock and is prohibited from doing so without further amendment of the Bylaws.\nKFC Operators. Operators of KFC retail outlets, except for KFC Management, the NFAC, Harman and Scott's, are entitled to purchase one share of Membership Common Stock of Series A through Series G, inclusive, depending upon their being deemed to operate a KFC retail outlet in one or more of the states designated below:\nHarman has purchased one share of Series H Membership Common Stock. Scott's has purchased one share of Series I Membership Common Stock. Operators of KFC retail outlets in Foreign Territories are entitled to purchase one share of Series J Membership Common Stock. KFC Management has purchased one share of Series K Membership Common Stock and the NFAC has purchased one share of Series L Membership Common Stock. Operators of KFC retail outlets in Canada, including Pepsi-Cola Canada Ltd., are entitled to purchase one share of Series M Membership Common Stock.\nThe Series H and Series I Membership Common Stock held by Harman and Scott's, respectively, each provides for the election of one director and the series of such stock held by KFC Management and the NFAC each provide for the election of two directors. The Bylaws of the Cooperative provide that if Harman or Scott's at any time owns or operates fewer than 100 KFC outlets, or if KFC Management owns or operates fewer than 200 KFC outlets, then the share of Membership Common Stock owned by said Operator must be exchanged for one share of Membership Common Stock of such other Series as such Operator is otherwise eligible to purchase.\nTaco Bell Operators. Section 2.4 of the Cooperative's Bylaws designates Series N through Q as Series available to Taco Bell Franchisees. The IATBF is permitted to purchase Series N. Depending upon the number of shares of\n- 19 -\nStore Common Stock issued with respect to Taco Bell retail outlets (\"Taco Bell Store Common Stock\"), Taco Bell Operators will be issued and hold Series N, O, P or Q.\nIf less than 400 shares of Store Common Stock are issued and outstanding with respect to Taco Bell retail outlets, only Series N, which will also be held by the IATBF, will be issued to Taco Bell Operators. If and when 400 or more but less than 650 shares of Taco Bell Store Common Stock are issued and outstanding, Taco Bell Operators will hold Series O Membership Common Stock and only the IATBF will hold Series N Membership Common Stock. If and when 650 or more but less than 900 shares of Taco Bell Store Common Stock are issued and outstanding, then Taco Bell Operators will hold Series O or Series P Membership Common Stock (depending on the region in which the Stockholder Members' retail outlets are located), and the IATBF will hold Series N Membership Common Stock. If and when 900 or more shares of Taco Bell Store Common Stock are issued and outstanding, then Taco Bell Operators will hold Series O, P, or Q Membership Common Stock (depending on the region in which the Stockholder Members' retail outlets are located), and the IATBF will hold Series N Membership Common Stock.\nWhen the number of shares of Store Common Stock issued and outstanding with respect to Taco Bell retail outlets increases or decreases to the various thresholds described above, then the shares of Membership Common Stock held by Taco Bell Operators will automatically convert into the appropriate Series. Because of the possibility of this conversion, certificates representing shares of Membership Common Stock held by Taco Bell Operators will bear a legend indicating that there could be a conversion from one Series to another Series.\nThe various Series, number of shares of Store Common Stock required to trigger a conversion into a new Series and the various Taco Bell regions are set forth below:\nThe Taco Bell regions listed in Column 1 below include the areas set forth in the corresponding line(s) of Column 2 below.\n- 20 -\nVoting Rights. Each class of Series A through Series J and Series M stockholders of Membership Common Stock is entitled to elect one member of the Board of Directors, and Series K and Series L stockholders are entitled to elect two members of the Board of Directors; provided, however, that until and unless the holders of Series J and Series M Membership Common Stock hold 100 or more shares of Store Common Stock purchased or held with respect to retail outlets located in the specified region, the Series J or Series M member of the Board of Directors shall be nominated by a holder of Series J or Series M Membership Common Stock, as the case may be, but shall be elected by a plurality vote of all the shares of Membership Common Stock entitled to vote at the annual meeting of stockholders. In addition, when only Series N of the various Series N through Series Q of Membership Common Stock established for Taco Bell Operators is issued and outstanding, the IATBF will nominate an individual to serve as the Series N member of the Board of Directors, who is then elected by all stockholders holding shares of Series N Membership Common Stock. When and if shares of Series O, P and\/or Q are issued and outstanding, holders of those series will nominate and elect a director to represent their respective series. Each stockholder member is entitled to cast one vote to elect a member of the Board of Directors to represent its series except for the members of Series K and Series L, which are entitled to cast one vote to elect each of two members of the Board of Directors from their respective series. On all matters except the election of the Board of Directors, each holder of Membership Common Stock is entitled to cast one vote on each matter on which members are entitled to vote. The Bylaws provide that directors may be elected by a plurality of the Series entitled to elect such director. Unless otherwise provided by the Bylaws or required by law, the affirmative vote of two-thirds of the members present at a meeting at which a quorum is in attendance is necessary to decide in favor of any matter.\nDividend Rights. Dividends may not be declared or paid with respect to Membership Common Stock.\nLimitations on Ownership and Transfer; Redemption. Membership Common Stock may be issued only to persons who satisfy the membership requirements and no more than one share of such stock shall be issued to any one Operator, except for the limited circumstances described below. Section 2.3 of the Bylaws reflects the Cooperative's one franchisee, one vote principle for franchisees as applied to\n- 21 -\nmultiple franchises. See \"ISSUANCE IN SERIES.\" When a corporation, partnership or other entity is a franchisee Operator, the owner of more than 50% of the corporation, partnership or other entity is deemed to be the owner of the share of Membership Common Stock issued by the Cooperative. Where no person, corporation, partnership or other entity owns more than 50% of the outstanding ownership interest of a franchisee Operator, the owners of the corporation, partnership or other entity must designate among themselves who will be deemed to own the share of Membership Common Stock.\nSection 2.3 of the Cooperative's Bylaws concerns the Cooperative's determination of precisely who is entitled to vote certain shares of Membership Common Stock in situations involving individuals who, through different corporations, partnerships or other affiliations, may have an interest in more than one share of Membership Common Stock. The Bylaws provide that no person, firm or entity is entitled to own or have an interest in, directly or indirectly, more than one share of Membership Common Stock (the \"Base Share\"), except for (a) any interest a franchisee may have in the share of Membership Common Stock held by the NFAC, (b) any interest a franchisee may have in the share of Membership Common Stock held by the IATBF, (c) any interest which a franchisee may have in either (i) one (but only one) share of the Cooperative's Series A through I Membership Common Stock if a franchisee's Base Share is a share of the Cooperative's Series N through Q Membership Common Stock or (ii) one (but only one) share of the Cooperative's Series N through Q Membership Common Stock if a franchisee's Base Share is a share of the Cooperative's Series A through I Membership Common Stock, (d) if a franchisee's Base Share is not a share of the Cooperative's Series J Membership Common Stock, any interest a franchisee may have in one (but only one) share of the Series J Membership Common Stock, (e) if a franchisee's Base Share is not a share of the Cooperative's Series M Membership Common Stock, any interest a franchisee may have in one (but only one) share of the Series M Membership Common Stock, (f) any interest which KFC Management may have in Pepsi-Cola Canada Ltd.'s Series M share, and any interest which Pepsi-Cola Canada Ltd. may have in KFC Management's Series K share by reason of KFC Management and Pepsi-Cola Canada Ltd. each being subsidiaries or divisions of PepsiCo, and (g) any interest a franchisee may have in a share of Membership Common Stock held by a firm or entity in which the franchisee owns fifty percent or less and with respect to which the franchisee refrains from voting or participating in the voting of the share of Membership Common Stock.\nIf any holder of Membership Common Stock has ceased to be a member of the Cooperative because it is no longer an Operator or owns less than the required amount of Store Common Stock, such stock will be called for redemption at $10.00 per share. Under Delaware law, the Cooperative may not repurchase any shares of its common stock when the capital of the Cooperative is impaired or when such repurchase would cause any impairment of the capital of the Cooperative. Membership Common Stock may not be transferred to any person or entity other than the Cooperative.\nLiquidation Rights. In the event of any liquidation of the Cooperative or other disposition of its assets, the holders of Membership Common Stock would be entitled to receive $10.00 per share before any distributions to the holders of Store Common Stock are made. Any net assets remaining after the payment of the $10.00 per share to the holders of Membership Common Stock shall be distributed to holders of the Store Common Stock.\nGeneral. Membership Common Stock has no preemptive rights. The shares of Membership Common Stock are, when issued, duly authorized, validly issued and fully paid and nonassessable and the holders thereof will not be liable for any payment of the Cooperative's debts.\nStore Common Stock\nThe Cooperative is authorized to issue 10,000 shares of Store Common Stock, no par value, of which 5,779 shares were issued and outstanding on October 31, 1995. The summary description of Store Common Stock provisions which follows is subject in all respects to the Certificate of Incorporation and the Bylaws of the Cooperative.\n- 22 -\nVoting Rights. The holders of Store Common Stock are not thereby entitled to vote for directors, to participate in meetings or management of the Cooperative or to vote in any proceedings except in such statutory proceedings as to which their votes are required by law.\nDividend Rights. The holders of Store Common Stock are entitled to receive dividends if, when, and as declared by the Board of Directors. See \"DIVIDEND POLICY\" and \"PATRONAGE DIVIDEND PROGRAM.\"\nLimitations on Ownership and Transfer; Redemption. Store Common Stock may be issued only to persons who satisfy the stockholder membership requirements, and generally each member must purchase one share of Store Common Stock for each KFC or Taco Bell retail outlet which such member owns and operates. Only holders of record of a share of Membership Common Stock may purchase shares of Store Common Stock. Store Common Stock may be transferred to persons, firms or entities who qualify for membership in the Cooperative only if the Cooperative does not exercise its right of first refusal to purchase such shares. A member desiring to transfer one or more shares of Store Common Stock must first offer such shares to the Cooperative on the same terms and conditions to which the member has agreed with such other person, firm or entity making an offer to purchase said stock. If the Cooperative declines its right of first refusal or does not respond to the offer within 90 days, the member, within 60 days thereafter, may sell, assign or otherwise transfer the shares to the person, firm or entity making the offer to purchase the shares, provided such person, firm or entity qualifies for membership in the Cooperative. If the shares are not sold or otherwise transferred within the 60 day period referred to above, the shares may not be sold or transferred without the member again offering the shares to the Cooperative.\nPursuant to a policy adopted by the Cooperative's Board of Directors, the Cooperative is authorized to purchase, for not more than the amount of the member's equity per share at the end of the Cooperative's fiscal year next preceding the date of purchase, a certain number of shares of Store Common Stock in each of the Cooperative's fiscal quarters. The Cooperative therefor may, but generally has no obligation to, repurchase shares of Store Common Stock from a member which owns shares in excess of the number required for membership. In any event, the Cooperative has no intention of repurchasing substantial numbers of shares of Store Common Stock. For a discussion of a commitment by the Cooperative to repurchase from Canadian stockholders shares of Store Common Stock at the original purchase price, see \"Patronage Dividend Program - Patronage Dividend Program for Canadian Stockholders.\"\nLiquidation Rights. In the event of any liquidation of the Cooperative or other disposition of its assets, the holders of Store Common Stock shall be entitled to receive the net assets of the Cooperative remaining after payment of all debts and liabilities of the Cooperative and payment of $10.00 per share to the holders of Membership Common Stock. Liquidating distributions will be made on the basis of past patronage with the Cooperative rather than number of shares of Store Common Stock owned. See \"PATRONAGE DIVIDEND PROGRAM.\"\nGeneral. Store Common Stock has no preemptive or conversion rights. The shares of Store Common Stock are, when issued, duly authorized, validly issued and fully paid and nonassessable and the holders thereof will not be liable for any payment of the Cooperative's debts.\nReports to Stockholders\nThe Cooperative intends to send to its stockholders annual reports containing audited financial statements and quarterly reports containing unaudited financial statements.\n- 23 -\nITEM 6.","section_6":"ITEM 6. Selected Financial Data.\nSELECTED FINANCIAL DATA (DOLLARS IN THOUSANDS)\nITEM 7.","section_7":"ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nANALYSIS AND OPERATIONS\nFiscal Years Ended October 31, 1995, 1994, and 1993\nThe Cooperative offers supplies and most major equipment used principally by KFC and Taco Bell Operators. The Cooperative's increases in net sales and net income over the years have resulted primarily from increased sales volume, the expansion of product lines and services, and the addition of new customers.\nNet sales for fiscal 1995 were $537,116,000 compared to $528,010,000 for fiscal 1994, an increase of 1.7%. The increase in sales for fiscal 1995 was led by core business, primarily KFC-U.S. with an overall 8% increase from the prior year. KFC-U.S. food and packaging sales were up by 12%, while equipment sales were down by 23%. Dairy Queen sales were also up in fiscal 1995 by almost 14%, primarily food and packaging. New business for fiscal 1995 from Fazoli's added $4,200,000 in sales, primarily equipment. Sales by the Cooperative's Canadian subsidiary were down by 8% as a result of the withdrawal of KFC corporate stores in Canada that had previously combined their purchasing with the Canadian franchisees. Taco Bell also showed a 10% decrease in sales volume as a result of significantly lower beef prices, reducing prices paid directly by the Operators, but, in turn, reducing Cooperative sales on similar volumes. In addition to product savings, same store sales at Taco Bell restaurants were generally lower.\nNet sales for fiscal 1994 increased by 5% to $528,010,000. The increase is attributable to increased sales from concepts other than the Cooperative's core business with KFC and Taco Bell. Combined sales to KFC (U.S. and Canada) and Taco Bell Operators, representing 87% of total sales in fiscal 1994, were 1.3% lower in fiscal 1994 compared to fiscal 1993. KFC-U.S. sales for fiscal 1994 were down by 12% compared to fiscal 1993, driven primarily by lower equipment sales representing 8% of the decrease. KFC-U.S. equipment sales in fiscal 1993 were at a higher-than-normal level as a result of a rotisserie oven roll-out and new signage. Food and packaging sales through distributors for KFC-U.S. were also down by 4% in 1995, primarily attributable to pricing reductions on product lines. When the Cooperative meets its objective of lower store delivered costs, the impact of this reduction lowers sales dollar volumes, but delivers the total savings to Operators in the form of lower costs. The Canadian subsidiary's sales increased by 30% over fiscal 1993 sales, and Taco Bell sales reflected a 23% increase above fiscal 1993 sales. Sales volume growth in non-core business was led by increases from Dairy Queen and Long John Silver's. Both of these concepts reflected significant increases over\n- 24 -\nfiscal 1993, and as a result increased the non-core business components of sales to 13% of the total sales in fiscal 1994 versus 7% of total sales in 1993.\nThe operations of the Canadian subsidiary (in U.S. dollars) contributed approximately $49,700,000, $53,800,000, and $41,500,000 in sales in fiscal 1995, 1994, and 1993, respectively. The Canadian subsidiary contributed approximately $41,000, $42,000, and $40,000 in income before patronage dividend and income taxes in fiscal 1995, 1994, and 1993, respectively. As of October 31, 1995, 1994, and 1993, the Canadian subsidiary had identifiable assets (in U.S. dollars) of approximately $3,800,000, $4,200,000, and $3,200,000, respectively, consisting of accounts receivable, property and equipment, and amortizable costs.\nIncome before patronage dividend and income taxes for fiscal 1995 was $2,771,000, an increase of $1,428,000 over fiscal 1994. An increase in the gross profit on sales percentage to 2.5% in 1995, compared to 2.3% in 1994, combined with the lower provision for losses and only a small increase in expenses, provided the higher net income number.\nIncome before patronage dividend and income taxes for fiscal 1994 decreased from $2,055,000 in fiscal 1993 to $1,343,000 in 1994. Gross profit on sales for fiscal 1994 was relatively unchanged from fiscal 1993 at 2.3% and 2.2%, respectively. The majority of the decrease in the income before patronage dividend and income taxes for fiscal 1994 is from the increase in the provision for losses on receivables. The provision for losses increased by $502,000, representing management's concern over the potential collectibility of certain receivables. Income before patronage dividend and income taxes was also adversely affected by the costs associated with the development of new concept business. In fiscal 1994, the Cooperative focused significant efforts in developing a program for a fast food franchisee organization.\nOther income and expenses for fiscal 1995 increased by $99,000 compared to fiscal 1994. The significant difference is primarily attributable to the increase in interest income earned on overnight cash balances, offset by a decrease in service charges, reflecting the improvement in the past-due amounts.\nOther income and expenses for fiscal 1994 decreased by $133,000 from $322,000 in fiscal 1993 to $189,000 in fiscal 1994. The decrease is primarily attributable to decreases in service charges of $90,000 and miscellaneous income of $40,000.\nSelling, general and administrative expenses increased by $492,000 in fiscal 1995 compared to the prior year. A portion of the increase was attributable to costs associated with the development of a new concept, which, because of circumstances beyond the Cooperative's control, was suspended in midyear. The Cooperative has reorganized a portion of this business into the \"Horizon Group\" with the responsibility for consolidating the Cooperative's smaller-volume concepts, such as Long John Silver's and Fazoli's, under one management team. The combined revenues for the \"Horizon Group\" were approximately $22,000,000 for fiscal 1995.\nSelling, general and administrative expenses for fiscal 1994 increased to 1.92% as a percentage of sales versus 1.84% in fiscal 1993. The increase is primarily attributable to expenses associated with the development and promotion of a program for an additional fast food franchisee group for which sales were expected to be generated in fiscal 1995. As with the other new concepts added over the last few years, this new concept, once implemented, was expected to generate gross profits to absorb all of the operating expenses.\nThe volume of business added from the new concepts creates synergies in purchasing power and economies of scale, allowing the Cooperative to maintain and expand its level of service to all customers.\nThe Cooperative pays its member stockholders a patronage dividend based on a formula approved by the board of directors. In fiscal 1995 the dividend to be paid is $1,246,000, compared to $569,000 in fiscal 1994. The dividend in fiscal 1994 was lower than fiscal 1993, primarily as a result of a higher provision for losses in fiscal 1994.\n- 25 -\nNet income for fiscal 1995 was $909,000, an increase of $448,000 over fiscal 1994. Net income, similar to income before patronage dividend and taxes, is affected by the increased gross profit percentage and the reduction in the provision for losses.\nNet income for fiscal 1994 was $461,000 after a provision for patronage dividend of $569,000. The patronage dividend for fiscal 1994 is directly affected by the patronage sales and expenses. Patronage-based sales were $18,576,000 lower in fiscal 1994 compared to fiscal 1993. The patronage dividend is also directly affected by increased expenses, including the increased provision for losses incurred in fiscal 1994. The $502,000 increase in provision for losses was directly related to patronage-based revenues and customers. The calculation of patronage dividend for fiscal 1994 was based on a formula similar to fiscal 1993. In fiscal 1995, the patronage formula has been restructured to allow for separate pools for each patronage concept. For fiscal 1995, the patronage dividend will be calculated and allocated based on the earnings derived from the participating concepts, KFC and Taco Bell. Under the allocation formula, all expenses, including provisions for losses, will be allocated to each participating concept and the patronage dividend for each concept's stockholder members will be directly related to these results.\nTotal assets as of October 31, 1995 were $42,831,000, a slight increase from fiscal 1994 of $42,767,000. The asset mix was changed with a decrease in accounts receivable of $982,000 and a decrease in inventories of $1,261,000, offset by an increase in cash of $1,829,000 and an increase in notes receivable of $795,000. The increase in notes receivable was generated through a payoff agreement with a former distributor, secured by real estate.\nTotal assets as of October 31, 1994 decreased to $42,767,000 from $43,364,000 at October 31, 1993. The decrease is primarily associated with the reduction of inventory values of $1,286,000.\nINFLATION\nThe prices paid by the Cooperative for Equipment and Supplies are, of course, subject to the effects of inflation. In an effort to mitigate the effects of inflation on both the Cooperative and its customers, the Cooperative makes advance purchase commitments (but, except for certain items, such as cob corn, salsa, and equipment for staging, does not take delivery), at fixed prices, for the volume of Equipment and Supplies it anticipates selling within a reasonable period of time. The Cooperative has provided its customers with the benefit of forward purchase commitments on price-volatile commodities. By virtue of the Cooperative's pricing policy, which is to minimize the margin between the Cooperative's advance purchase costs and sales prices, and the Cooperative's purchase program, the effects of inflation on the Cooperative's financial condition may be less than on other businesses.\nCAPITAL EXPENDITURES\nIn fiscal 1995, the Cooperative invested approximately $242,000 in office furniture and equipment. Approximately $39,000 was expended to upgrade hardware and software for the mainframe computer. The balance was office equipment, including PCs and other functional equipment. The Cooperative is constantly evaluating the technical needs of the business in light of the demands of both customers and vendors. Given the Cooperative's business environment, the Cooperative believes that increased technology results in cost savings.\nLIQUIDITY AND CAPITAL RESOURCES\nThe working capital needs of the Cooperative for sales growth and the related accounts receivable, and for the corn and equipment inventories associated with the Cooperative's corn and equipment staging programs, have been met through a combination of (i) net income of $909,000 in fiscal 1995, which increased the retained earnings of the Cooperative, and (ii) combined bank financing, of which $3,877,000 was outstanding on October 31, 1995. The ability of the Cooperative's Board of Directors to increase or decrease the percentage of \"pre-tax income\" to be paid in patronage dividends is an additional potential source of liquid assets.\n- 26 -\nThe Cooperative's line of credit with its primary bank is currently $8,000,000 and is available to meet short-term working capital needs. The Cooperative's $8,000,000 line of credit expires on May 2, 1997. The Cooperative's line of credit with a national bank for cooperatives is currently $3,000,000 and expires on May 1, 1996. On October 31, 1995, the Cooperative had a total of $11,000,000 remaining credit available under these lines of credit. The Canadian subsidiary has established a line of credit for $4,000,000 (Canadian dollars) to provide working capital in support of that subsidiary. The Canadian line of credit expires May 16, 1996. The Cooperative has provided a guarantee for the payment to the bank.\nIn 1994, the Cooperative negotiated a long-term financing arrangement with its primary bank. Under the agreement, the Cooperative was provided a $3,000,000 term loan at a fixed interest rate of 6.95%. The loan requires monthly interest payments with the entire principal due on May 2, 1999. The costs associated with obtaining the new financing arrangements are being amortized over the term of the loan.\nThe Cooperative's net working capital at October 31, 1995 was $16,436,000, an increase of $625,000 since October 31, 1994. The changes in working capital for fiscal 1995 include (i) a decrease in accrued expenses of $2,027,000, (ii) a decrease in inventories of $1,261,000, and (iii) an increase of $677,000 in the patronage dividend accrual. The decrease in both the accrued expenses and inventories are associated with the timing of the acquisition of frozen corn for fiscal 1996. The Cooperative expects to be able to fund its business in fiscal 1996 with the capital resources available from its continuing operations and lines of credit as discussed above. If the Cooperative successfully expands its activities and adds new customers related to fast food concepts, the Cooperative may require an increase in its lines of credit on a temporary basis. Management believes that its current banking relationships will be able to provide for these possible increases.\nITEM 8.","section_7A":"","section_8":"ITEM 8. Financial Statements and Supplementary Data.\nSee accompanying Index to Consolidated Financial Statements and Schedule.\nITEM 9.","section_9":"ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.\nDuring the Registrant's last two fiscal years and any subsequent interim period, the Registrant has not had a principal accountant resign, decline to stand for re-election or be dismissed.\n- 27 -\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. Directors and Executive Officers of the Registrant.\nMANAGEMENT\nDIRECTORS AND OFFICERS\nThe Cooperative's Bylaws provide for a Board of Directors consisting of up to twenty voting members plus the Cooperative's President, who is a non-voting member. Up to nineteen directors will be elected by the holders of various series of Membership Common Stock. Each series of Membership Common Stock is generally entitled to elect one director, except that the NFAC and KFC Management are each entitled to elect two directors. One director (the \"Independent Director\") is nominated by the Board of Directors and elected by a plurality vote of the shares of all series of Membership Common Stock entitled to vote. The Independent Director must not be affiliated in any way with any Operator. With the exception of the President and the Independent Director, each director of the Cooperative must be a member of the Cooperative or a shareholder, officer, employee or partner of the entity which is a member of the Cooperative. Additionally, each director (other than the President and the Independent Director) must be a member or an officer, director, shareholder, employee or partner of the organization which is entitled to vote for such director. All voting members of the Board of Directors serve three-year staggered terms.\nFor a description of the Cooperative's directors and executive officers and certain related information, see Item 12. \"SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\"\nDuring the last five years, Messrs. Allen, Buckner, Dunafon, Giles, Harman, Henriquez, Houston, Marsella, Moss, Neal, Peck, Richards, Royster, White, and Young have been principally engaged in business as Operators, and Mr. Rhawn has been Chairman and owner of Rhawn Enterprises, Inc., a Louisville financial services holding company.\nDino DelNano has served as Director of Purchasing since 1993, and currently serves as Vice President of Purchasing, Poultry and Commodities. From 1985 to 1993, Mr. DelNano held various positions in purchasing with Church's Fried Chicken, Inc. and Popeye's Famous Fried Chicken and Biscuits, Inc.\nKenneth L. Hartung has served as a Vice President of the Cooperative since 1993. From 1991 to February 1993, Mr. Hartung was Vice President of Sales and Marketing for the E. S. Robbins Container Division. He had previously served as Vice President of Development of the Liqui-Box Corporation and in several positions, including Vice President of Marketing, with the B-Bar-B Corporation.\nThomas D. Henrion joined the staff of the Cooperative in March 1980 as its President and in 1993 also became Chief Executive Officer. In 1991, Mr. Henrion was elected to serve as a director of the National Cooperative Bank. Mr. Henrion also serves as a director of Wholesome and Hearty Foods, Inc.\nDale E. Holden has served as the Cooperative's Vice President of Sales since 1993, and currently serves as Vice President\/General Manager Taco Bell Sales, Customer Service and Distribution. From 1988 to 1993, Mr. Holden served in various capacities with McLane Foodservice Group or its affiliates, including as Vice President of National Accounts for the foodservice company.\nWilliam V. Holden has been Vice President of the Cooperative since 1989 and served as Controller of the Cooperative from 1985 until he was appointed Chief Financial Officer in 1991. Mr. Holden also serves the Cooperative as Assistant Treasurer.\nJudith L. Hollis has served in the Cooperative's sales division since 1991 and currently serves as Vice President\/General Manager of KFC Sales, Customer Service and Distribution. From 1990 until 1991, Ms. Hollis was Vice President of Marketing Resources Plus, a division of US West.\n- 28 -\nW. Thomas Hutcherson has served as the Cooperative's Vice President of Purchasing since 1994. He served as Vice President-Equipment Purchasing and Sales from 1982 until 1994.\nJohn W. Inwright has served as Vice President of Purchasing, managing the food and packaging division, since 1991. Mr. Inwright has served the Cooperative in its purchasing operations since 1984.\nRobert R. Lewis has served as Vice President of Management Information Services since 1994, and as Manager of the management information services of the Cooperative since 1988.\nJames M. Tilley has served the Cooperative since 1994 and currently serves as Vice President\/General Manager of the Horizon Group Sales, Customer Service and Distribution. Before July 1994, Mr. Tilley was Divisional Vice President of Training and Quality Leadership for Domino's Pizza, Inc. He held various positions with Domino's Pizza, Inc. from 1983 to 1994.\nGail J. Wilson has served in the Cooperative's Insurance division since 1992 and became Vice President of Insurance in 1994. From 1986 to 1991, Ms. Wilson was Product Manager for Progressive Insurance, Inc.\nExcept for Mr. Henrion, all officers of the Cooperative who are also directors serve in such offices on a limited, part-time basis without remuneration.\nSTANDING COMMITTEES\nThe Board of Directors of the Cooperative had four regular meetings in fiscal 1995 and no special meetings. The Board of Directors has five standing committees, each of which met four times during fiscal 1995: Executive, Personnel, Audit and Budget, Insurance, and Nominating.\nThe Executive Committee is comprised of Messrs. Allen, Harman, Neal, Peck and Royster. The Executive Committee, between the meetings of the Board and while the Board is not in session, has all the powers and may exercise all the duties of the Board of Directors in the management of the business of the Cooperative which may lawfully be delegated to it by the Board.\nThe Audit and Budget Committee is comprised of Messrs. Buckner, Giles, Henriquez, Moss, Neal and Young. The Audit and Budget Committee meets periodically with management and representatives of the Cooperative's independent accountants. The independent accountants have free access to the Committee and the Board of Directors. The Committee considers the scope, timing and fees for the annual audit and the results of audit examinations performed by the independent public accountants, including certain recommendations to improve the Cooperative's systems of accounting and internal controls, and the follow-up reports prepared by management of the Cooperative pursuant to such recommendations. The Committee reviews the Cooperative's annual budget before its consideration by the Board of Directors.\nThe Insurance Committee is comprised of Messrs. Allen, Dunafon, Richards and White. The Insurance Committee monitors the KFC Franchisee Insurance Program and, in conjunction with the Executive Committee, makes recommendations to the Board of Directors concerning the program.\nThe Nominating Committee is comprised of Messrs. Allen, Harman and Neal. The Nominating Committee makes recommendations to the Board of Directors concerning officer positions for the Cooperative. The Board of Directors considers the nomination of the Independent Director. Members of the Cooperative nominate their own candidates for director to represent their respective Series of Membership Common Stock.\nThe Personnel Committee is comprised of Messrs. Harman, Houston, Marsella, Peck, Rhawn and Royster. Pursuant to a former provision of the Cooperative's Bylaws, Mr. Peck, as Chairman of the Board, served as the Cooperative's Chief Executive Officer until May 1993; he received no compensation from the Cooperative\n- 29 -\nexcept for the reimbursement for expenses as provided below under \"COMPENSATION OF DIRECTORS.\" The Personnel Committee considers personnel policy and practices of the Cooperative and makes recommendations to the Board of Directors concerning the compensation of all officers.\nSECTION 16(A) COMPLIANCE\nSection 16(a) of the Securities Exchange Act of 1934, as amended, (the \"1934 Act\") requires the Cooperative's directors, executive officers and certain persons to file initial reports of ownership and reports of changes in ownership with the Securities and Exchange Commission (the \"SEC\"). The Cooperative believes that all such filing requirements were complied with in fiscal 1995.\nITEM 11.","section_11":"ITEM 11. Executive Compensation.\nThe following table shows all cash compensation paid by the Cooperative for the years ended October 31, 1995, 1994, and 1993 to the most highly compensated executive officers as to whom the total cash and cash-equivalent remuneration exceeded $100,000 during fiscal 1995.\nSUMMARY COMPENSATION TABLE\n(1) The Cooperative has established bonus programs for all officers under which, if they achieve certain objectives, they may receive a bonus of not greater than 40% of their base salaries. In addition, the fiscal 1994 amount for Mr. Henrion includes a one-time payment of $21,330 to Mr. Henrion pursuant to a letter agreement dated May 22, 1991, providing for such payment if Mr. Henrion remained employed by the Cooperative through February 15, 1994.\n(2) Includes employer contribution to the Cooperative's Thrift Plan and Money Purchase Pension Plan in fiscal 1995 as follows: Mr. Henrion $4,500 and $11,546, respectively; Mr. Hutcherson $3,382 and $8,249, respectively; Mr. Holden $3,078 and $7,453, respectively; Mr. Hartung $3,109 and $7,348, respectively; and Ms. Hollis $2,869 and $7,361, respectively. For Mr. Henrion, the fiscal 1995 amount includes $5,000, representing the value to Mr. Henrion of the Cooperative's payments with respect to the insurance policy described below.\n- 30 -\nIn addition, Mr. Henrion and the Cooperative have executed a Supplemental Benefits\/Consulting Agreement (the \"Supplemental Agreement\"), effective January 1, 1994, whereby Mr. Henrion will receive deferred compensation upon either his retirement or his voluntary or involuntary termination not for cause, as defined. The Cooperative's determination to enter into the Supplemental Agreement was primarily based on the Board of Directors' subjective sense of the value of Mr. Henrion's continued loyalty and service to the Cooperative, the Cooperative's desire to assist Mr. Henrion in providing for his retirement, as well as the contingencies of death and disability, and to provide Mr. Henrion with an incentive to provide advisory services to the Cooperative in a consulting capacity upon his eventual retirement.\nPursuant to the Supplemental Agreement, commencing upon his departure from the Cooperative (so long as his departure is not the result of a termination for cause) and for the duration of the \"Period\" as defined below, Mr. Henrion will receive monthly compensation equivalent at least to one-twelfth of 18% of his annual base compensation averaged over a three-year period (\"Averaged Annual Compensation\"). The Period will be a number of months equal to the number of months Mr. Henrion has worked for the Cooperative after January 1, 1994. In addition, for one year following the expiration of the Period, Mr. Henrion will receive, in equal monthly installments, an amount equal to his Averaged Annual Compensation. As of October 31, 1995, Mr. Henrion's Averaged Annual Compensation for purposes of the Supplemental Agreement was $175,805, with one-twelfth of 18% of this amount equal to $2,637.\nIf Mr. Henrion chooses to provide consulting services following his departure from the Cooperative, in lieu of the monthly supplemental retirement benefits at the annual rate of 18% of his Averaged Annual Compensation, he will receive monthly compensation equivalent to one-twelfth of 30% of his Averaged Annual Compensation for so long as he provides such consulting services. In any event, Mr. Henrion may not provide consulting services for longer than the Period or seven years, if the Period exceeds seven years. Mr. Henrion may elect to receive the supplemental retirement income described above in a lump sum payment of the present value of such income, in lieu of the monthly payments.\nThe Supplemental Agreement also provides Mr. Henrion with an increasing death benefit whole life split-dollar insurance policy in an initial face amount of $147,384 (the \"Policy\"). The Cooperative will pay the $10,000 annual premium on the Policy unless and until Mr. Henrion's employment ceases for any reason. The Cooperative has a 50% interest in the death benefits and cash value under the Policy. Should Mr. Henrion's employment terminate for any reason before his death, Mr. Henrion has the option of purchasing the Cooperative's interest in the Policy for 50% of its then cash value. If Mr. Henrion does not exercise his right to purchase the Cooperative's interest in the Policy, the Cooperative may either purchase Mr. Henrion's interest in the Policy for 50% of its then cash value or elect that the Policy be surrendered, in which case the cash value will be paid one-half to Mr. Henrion and one-half to the Cooperative.\nCOMPENSATION OF DIRECTORS\nNo director, other than the Independent Director, receives any remuneration from the Cooperative other than reimbursement for long distance travel, hotel accommodations, and $400 per board meeting for out-of-pocket expenses. The Independent Director receives an annual fee of $10,000, plus fees of $1,000 per board meeting attended.\n- 31 -\nITEM 12.","section_12":"ITEM 12. Security Ownership of Certain Beneficial Owners and Management.\nMANAGEMENT OF THE COOPERATIVE\nDirectors and Executive Officers\nThe following table lists, in addition to other information, the directors and executive officers of the Cooperative at December 31, 1995, their ages, their position with the Cooperative, their present principal occupations, and the number and percentages of shares of Store Common Stock beneficially owned, directly or indirectly, by each. The information provided with respect to the ages and number of shares beneficially owned is as of December 31, 1995.\n- 32 -\n- 33 -\n* KFC Management has purchased one share of Series K Membership Common Stock. On November 16, 1989, both directors representing KFC Management resigned as members of the Board of Directors. KFC Management has not taken any action to fill the two vacancies and has not indicated whether it will take any action in the future to fill the vacancies. The total number of shares of Store Common Stock listed as owned by directors and officers does not include the 2,028 shares of Store Common Stock believed by the Cooperative to be owned by KFC Management or affiliates, representing approximately 35.8% of the Store Common Stock outstanding.\n** Less than one-half of one percent.\n+ Mr. Neal has previously served on the Board of Directors of the Cooperative as one of the two directors representing NFAC, the holder of the Series L share of Membership Common Stock. He first began serving on the Board of Directors as a representative of Series E in February 1991.\n++ Each director, other than Messrs. Henrion and Rhawn, is, or is affiliated with a member which is, the owner of one share of Membership Common Stock. All directors and officers as a group (27 persons) own 15 shares of Membership Common Stock, 2.6 percent of the total number of Shares of Membership Common Stock outstanding. The Store Common Stock ownership reflects the number of shares which each director, other than Messrs. Henrion and Rhawn, owns or which is owned by the member with which the director is affiliated. Except as required by law, Store Common Stock has no voting rights. Messrs. Henrion and Rhawn are neither the owners, nor affiliates of owners, of any Membership or Store Common Stock.\n- 34 -\nITEM 13.","section_13":"ITEM 13. Certain Relationships and Related Transactions.\nTRANSACTIONS WITH STOCKHOLDERS, DIRECTORS AND OFFICERS\nAll present voting members of the Board of Directors, except the Independent Director, are Operators or represent Operators and have purchased or may purchase Equipment and Supplies from the Cooperative or from distributors who purchase from the Cooperative. All purchases by directors or their affiliates from the Cooperative are made on the same terms and conditions as purchases by any other Operator. Several Operators, including KFC Management, are also in the business of purchasing Equipment and Supplies for sale and distribution to other Operators and may purchase such Equipment and Supplies from the Cooperative. See Item 1 \"BUSINESS-\" \"HISTORY,\" \"OPERATING PRINCIPLE,\" \"OPERATIONS-- PRINCIPAL CUSTOMERS,\" \"PEPSICO\" and Note 7 of the \"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)(1) Financial Statements. See accompanying Index to Consolidated Financial Statements and Schedule.\n(a)(2) Financial Statement Schedules. See accompanying Schedule II - -- Valuation and Qualifying Accounts.\n(a)(3) Exhibits. Following is a list of Exhibits to this Form 10-K:\n*3.1 Certificate of Incorporation of Registrant, as amended.\n**3.2 Bylaws of Registrant, as amended.\n*4.1 Article IV of Certificate of Incorporation of Registrant, as amended, filed as Exhibit 3.1 to this Form 10-K.\n**4.2 Articles II, III, IV and IX of Bylaws of Registrant, as amended, filed as Exhibit 3.2 to this Form 10-K.\n**10.1 Loan and Security Agreement, dated May 6, 1994, between Registrant and Liberty National Bank and Trust Company of Louisville.\n***10.2 Employment Agreement between Thomas D. Henrion and the Registrant.\n***10.3 Lease, dated as of June 21, 1983, between Registrant, as Lessee, and General Electric Corporation, as Lessor, and amended on June 20, 1988.\n***10.4 Form of Distributor Participation Agreement between Registrant and various distributors.\n***10.5 Lease, dated April 8, 1988, between NTS\/Breckinridge, Ltd. d\/b\/a The Springs, as Lessor, and the Registrant, as Lessee.\n****10.6 Non-Competition and Consulting Agreement dated as of January 31, 1991, among Fred Jeffrey, Juliana Jeffrey and the Registrant.\n****10.7 Letter Agreement dated May 11, 1991, between Thomas D. Henrion and the Registrant.\n**10.8 Purchasing Affiliation Agreement dated as of June 15, 1994, between the International Franchisee Advisory Council, Inc., and the Registrant.\n**10.9 Supplemental Benefits\/Consulting Agreement between Thomas D. Henrion and the Registrant effective as of January 1, 1994.\n- 35 -\n10.10 Amendment No. 1 to Supplemental Benefits\/Consulting Agreement between Thomas D. Henrion and the Registrant effective January 1996.\n****21 Subsidiaries of the Registrant.\n24 Powers of Attorney.\n27 Financial Data Schedule.\n- ----------------------------- *Incorporated by reference to the Registrant's Annual Report on Form 10-K for the fiscal year ended October 31, 1992 [File No. 2-63640].\n**Incorporated by reference to the Post-Effective Amendment No. 2 to the Registration Statement on Form S-1 of the Registrant [File No. 33-56982]\n***Incorporated by reference to the Registration Statement on Form S-1 of the Registrant [File No. 33-33801]\n****Incorporated by reference to the Registrant's Annual Report on Form 10-K for the fiscal year ended October 31, 1991 [File No. 2-63640].\n(b) Reports on Form 8-K.\nNone.\n(c) Exhibits.\nThe exhibits listed in response to Item 14(a)(3) are filed as a part of this report.\n(d) Financial Statement Schedules.\nThe financial statement schedule listed in response to Item 14(a)(2) is filed as a part of this report.\n- 36 - KFC NATIONAL PURCHASING COOPERATIVE, INC. AND SUBSIDIARIES\nIndex to Consolidated Financial Statements and Schedules\nFinancial statement schedule for the years ended October 31, 1995, 1994 and 1993 is included herein:\nII - 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.\nIndependent Auditors' Report\nThe Board of Directors and Stockholders KFC National Purchasing Cooperative, Inc.:\nWe have audited the consolidated financial statements of KFC National Purchasing Cooperative, Inc. (d\/b\/a FoodService Purchasing Cooperative, Inc.) and subsidiaries as listed in the accompanying index. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule as listed in the accompanying index. These consolidated financial statements and financial statement schedule are the responsibility of the Cooperative'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 KFC National Purchasing Cooperative, Inc. and subsidiaries as of October 31, 1995 and 1994, and the results of their operations and their cash flows for each of the years in the three-year period ended October 31, 1995, 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\nLouisville, Kentucky December 4, 1995, except as to note 10, which is as of December 8, 1995\nKFC NATIONAL PURCHASING COOPERATIVE, INC. AND SUBSIDIARIES (d\/b\/a FoodService Purchasing Cooperative, Inc.) Consolidated Balance Sheets October 31, 1995 and 1994 (Dollars in thousands)\nSee accompanying notes to consolidated financial statements.\nKFC NATIONAL PURCHASING COOPERATIVE, INC. AND SUBSIDIARIES (d\/b\/a FoodService Purchasing Cooperative, Inc.)\nConsolidated Statements of Income\nYears ended October 31, 1995, 1994 and 1993\n(Dollars in thousands)\nSee accompanying notes to consolidated financial statements.\nKFC NATIONAL PURCHASING COOPERATIVE, INC. AND SUBSIDIARIES (d\/b\/a FoodService Purchasing Cooperative, Inc.)\nConsolidated Statements of Members' Equity\nYears ended October 31, 1995, 1994 and 1993\n(Dollars in thousands, except per share amounts)\nSee accompanying notes to consolidated financial statements.\nKFC NATIONAL PURCHASING COOPERATIVE, INC. AND SUBSIDIARIES (d\/b\/a FoodService Purchasing Cooperative, Inc.) Consolidated Statements of Cash Flows Years ended October 31, 1995, 1994 and 1993 (Dollars in thousands)\nSee accompanying notes to consolidated financial statements.\nKFC NATIONAL PURCHASING COOPERATIVE, INC. AND SUBSIDIARIES (d\/b\/a FoodService Purchasing Cooperative, Inc.) Notes to Consolidated Financial Statements October 31, 1995 and 1994\n(1) Basis of Presentation\nThe primary purpose of KFC National Purchasing Cooperative, Inc. (d\/b\/a FoodService Purchasing Cooperative, Inc.) and Subsidiaries (the Cooperative) is to operate as a central procurement organization, making volume purchases of various foods, equipment and supplies primarily for the benefit of Kentucky Fried Chicken (KFC) and Taco Bell retail operators and their distributors (see note 7).\nKFC Franchisee Purchasing of Canada, Inc., a wholly-owned subsidiary, is a procurement organization for the benefit of Canadian KFC retail operators and their distributors. Kenco Insurance Agency, Inc. sponsors and helps administer an insurance program primarily for KFC franchisees. KFC Franchisee Finance Company, Inc., another wholly-owned subsidiary, has provided financing for equipment purchases of KFC franchisees. In view of the overall nature of its operations, the Cooperative is considered to operate in a single industry segment. The more significant accounting policies of the Cooperative are as follows:\n(a) Consolidation\nThe accompanying financial statements include the accounts of KFC National Purchasing Cooperative, Inc. and its wholly-owned subsidiaries, KFC Franchisee Insurance Program, Inc. and its wholly-owned subsidiary, Kenco Insurance Agency, Inc., KFC Franchisee Purchasing of Canada, Inc., and KFC Franchisee Finance Company, Inc. All significant intercompany balances and transactions have been eliminated in consolidation.\n(b) Revenue Recognition\nThe Cooperative purchases a majority of merchandise for its customers from suppliers without taking physical possession of the products. The suppliers ship directly to the customers. The Cooperative takes title to the merchandise and assumes the risks related to taking title upon shipment to the customer based on purchase order terms. As a convenience, for accounting purposes, the Cooperative recognizes revenues and the related costs upon receipt of notification of shipment, primarily an invoice, from the supplier. Management believes the consistent application of this accounting method does not have a significant impact upon the consolidated financial statements.\n(Continued)\nKFC NATIONAL PURCHASING COOPERATIVE, INC. AND SUBSIDIARIES (d\/b\/a FoodService Purchasing Cooperative, Inc.)\nNotes to Consolidated Financial Statements\n(1) Basis of Presentation (Continued)\n(c) Inventories\nInventories are stated at the lower of cost or market. At October 31, 1995 and 1994, cost of inventories was primarily determined on the last-in, first-out (LIFO) method. If inventories were valued using the first-in, first-out (FIFO) method, they would have been approximately $91,000 and $207,000 higher at October 31, 1995 and 1994, respectively.\nDuring 1995 and 1994, LIFO inventory layers were reduced. This reduction resulted in charging lower inventory costs prevailing in previous years to cost of goods sold, thus reducing costs of goods sold by approximately $166,000 and $9,000 in 1995 and 1994, respectively, below the amount that would have resulted from replacing the liquidated inventory at end of year prices.\n(d) Checks Drawn in Excess of Bank Balance\nIncluded in accounts payable are checks drawn in excess of bank balance. Such amounts were $524,000 and $1,220,000 at October 31, 1995 and 1994, respectively.\n(e) Depreciation and Amortization Expense\nProvision for depreciation and amortization is made on the basis of the estimated useful lives of the assets. Principally, the double declining-balance method is used for depreciation of office equipment and the straight-line method is used for amortization of other assets.\nOther assets principally consist of the unamortized portion of non-competition agreements, goodwill and loan origination fees. The non-competition agreements are being amortized over 13 and 5 years. Goodwill is being amortized over 5 years. The loan origination fees are being amortized over 5 and 3 years.\n(f) Statement of Cash Flows\nFor purposes of the consolidated statements of cash flows, the Cooperative considers all short-term highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.\n(Continued)\nKFC NATIONAL PURCHASING COOPERATIVE, INC. AND SUBSIDIARIES (d\/b\/a FoodService Purchasing Cooperative, Inc.)\nNotes to Consolidated Financial Statements\n(1) Basis of Presentation (Continued)\n(g) Translation of Foreign Currency\nThe financial statements of KFC Franchisee Purchasing of Canada, Inc. are translated in accordance with Statement of Financial Accounting Standards No. 52, \"Foreign Currency Translation\". Foreign currency transaction gains and losses were not significant in 1995, 1994 and 1993.\n(h) Income Taxes\nIn February 1992, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\". Statement 109 requires a change from the deferred method of accounting for income taxes of APB Opinion 11 to the asset and liability method of accounting for income taxes. Under the asset and liability method of Statement 109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under Statement 109, the effect on deferred income tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.\nEffective November 1, 1993, the Cooperative adopted Statement 109. The cumulative effect of the change in the method of accounting for income taxes was not material and is recorded as a component of income tax expense in the 1994 consolidated statement of income.\nPursuant to the deferred method under APB Opinion 11, which was applied in 1993 and prior years, deferred income taxes are recognized for income and expense items that are reported in different years for financial reporting purposes and income tax purposes using the tax rate applicable for the year of the calculation. Under the deferred method, deferred taxes are not adjusted for subsequent changes in tax rates.\n(i) Reclassifications\nCertain reclassifications of 1994 and 1993 amounts have been made to conform to the 1995 presentation.\n(Continued)\nKFC NATIONAL PURCHASING COOPERATIVE, INC. AND SUBSIDIARIES (d\/b\/a FoodService Purchasing Cooperative, Inc.)\nNotes to Consolidated Financial Statements\n(2) Accounts Receivable and Significant Group Concentration of Credit Risk\nAs of October 31, 1995 and 1994, substantially all of the Cooperative's receivables are obligations of retail operators and their distributors. The Cooperative does not require collateral or other security on most of these accounts. The credit risk on these accounts is controlled through credit approvals, limits and monitoring procedures.\n(3) Borrowing Arrangements\nThe Cooperative has a $3,000,000 term note with its primary bank. Accounts receivable and other property are pledged as collateral. Terms require monthly interest payments, with a balloon principal payment due May 2, 1999. The outstanding balance accrues interest at an annual fixed rate of 6.95%. The carrying amount of this term note approximates its fair value at October 31, 1995.\nThe Cooperative has a line of credit of $8,000,000 with its primary bank, of which the entire amount was available on October 31, 1995. Accounts receivable and other property are pledged as collateral for borrowings under the line. Borrowings on the line of credit bear interest at an annual rate equal to the Federal Funds Rate plus 120 basis points (6.96% as of October 31, 1995). This line of credit expires on May 2, 1997.\nThe Cooperative has a $3,000,000 line of credit with a second bank, of which the entire amount was available as of October 31, 1995. Equipment accounts receivable and equipment inventory are pledged as collateral for borrowings under the line. Borrowings on this line of credit bear interest at LIBOR plus 140 basis points (7.23% as of October 31, 1995). This line of credit expires May 1, 1996.\nThe Cooperative has a $4,000,000 (Canadian dollars) line of credit with a Canadian bank, of which approximately $2,821,000 (Canadian dollars) is available at October 31, 1995. Accounts receivable of the Cooperative's Canadian subsidiary are pledged as collateral for borrowings under this line. Borrowings on this line of credit bear interest at an annual rate equal to the bank's prime lending rate with respect to Canadian dollar commercial loans made in Canada (8% as of October 31, 1995).\n(4) Patronage Dividend\nThe Board of Directors is authorized, after considering the Cooperative's need for capital and reserves, to distribute patronage cash dividends. The patronage dividend for 1995 is based upon shareholder members' retaining membership in the Cooperative through October 31, 1995 and the value of any purchase of equipment and supplies made from the Cooperative, or through participating distributors from November 1, 1994 through October 31, 1995. The patronage dividends for 1994 and 1993 were based upon similar facts as described in the preceding sentence.\n(Continued)\nKFC NATIONAL PURCHASING COOPERATIVE, INC. AND SUBSIDIARIES (d\/b\/a FoodService Purchasing Cooperative, Inc.)\nNotes to Consolidated Financial Statements\n(4) Patronage Dividend (Continued)\nThe Internal Revenue Code of 1986, as amended, provides that corporations \"operating on the cooperative basis\" generally may exclude from their taxable income amounts paid as patronage dividends.\n(5) Income Taxes\nAs discussed in note 1, the Cooperative adopted Statement 109 as of November 1, 1993 and the cumulative effect of this change was not significant. Prior years' financial statements have not been restated to apply the provisions of Statement 109.\nIncome tax expense for the years ended October 31, 1995, 1994 and 1993 consists of:\nA reconciliation of the difference between income tax expense computed at the Federal statutory rate of 34% and income tax expense follows:\n(Continued)\nKFC NATIONAL PURCHASING COOPERATIVE, INC. AND SUBSIDIARIES (d\/b\/a FoodService Purchasing Cooperative, Inc.)\nNotes to Consolidated Financial Statements\n(5) Income Taxes (Continued)\nFor the year ended October 31, 1993, deferred income tax expense results from timing differences in the recognition of income and expense for income tax and financial reporting purposes. The sources and tax effects of those timing differences are presented below:\nThe tax effects of temporary differences that give rise to significant portions of the deferred tax assets at October 31 are presented below:\nBased upon the level of historical taxable income and projections for future taxable income over the periods which the deferred tax assets are deductible, management believes it is more likely than not the Company will realize the benefits of these deductible differences. Accordingly, no valuation allowance for deferred tax assets was recorded as of November 1, 1993 (date of adoption) or October 31, 1995 and 1994.\n(6) Membership and Store Common Stock\nMembership common stock may be issued only to persons who satisfy shareholder membership requirements and no more than one share of such stock will be issued to any one person. Membership common stock may not be transferred to any person other than the Cooperative. In the event that a shareholder no longer qualifies for membership, the Cooperative is required to redeem such shareholder's membership common stock at a redemption price of $10.00 per share.\n(Continued)\nKFC NATIONAL PURCHASING COOPERATIVE, INC. AND SUBSIDIARIES (d\/b\/a FoodService Purchasing Cooperative, Inc.)\nNotes to Consolidated Financial Statements\n(6) Membership and Store Common Stock (Continued)\nStore common stock may be issued only to persons who satisfy the shareholder membership requirements and each shareholder member must generally purchase one share of store common stock for each KFC or Taco Bell retail outlet which such shareholder member owns and operates. Store common stock may be transferred to persons, firms or entities who qualify for membership in the Cooperative if the Cooperative does not exercise its right of first refusal to purchase such shares.\n(7) Major Customers\nThe Cooperative had sales to certain distributors in excess of 10% of net sales. One customer accounted for sales of approximately $127,000,000, $139,000,000 and $111,000,000 for the years ended October 31, 1995, 1994 and 1993, respectively. This customer's outstanding accounts receivable balances were approximately $7,183,000 and $8,767,000 at October 31, 1995 and 1994, respectively. Another customer accounted for sales of approximately $70,000,000 for the year ended October 31, 1995. This customer's outstanding accounts receivable balance was $4,285,000 at October 31, 1995.\n(8) Retirement Plan\nThe Cooperative has a thrift and profit-sharing plan and a money purchase pension plan which covers all employees who meet certain requirements as to age and length of service. The thrift and profit-sharing plan is funded under two allocation methods. The first is funded through a thrift plan agreement under Section 401(k) of the Internal Revenue Code whereby contributions made by those employees who elect to participate are matched, in accordance with plan guidelines and limitations, by the Cooperative. The second allocation, which covers all employees and was introduced in 1986, is funded by the Cooperative as determined by the Board of Directors, subject to certain limitations. The money purchase pension plan, established November 1, 1991, provides for a contribution amounting to 3.0% of eligible compensation in 1995, 3.3% in 1994, and 3.7% in 1993.\nThe Cooperative's combined contributions relating to these plans were approximately $416,000, $381,000 and $353,000 for 1995, 1994 and 1993, respectively.\n(Continued)\nKFC NATIONAL PURCHASING COOPERATIVE, INC. AND SUBSIDIARIES (d\/b\/a FoodService Purchasing Cooperative, Inc.)\nNotes to Consolidated Financial Statements\n(9) Commitments and Contingencies\nThe following is a schedule of future lease obligations:\nRental expense was approximately $664,000, $635,000 and $571,000 in 1995, 1994 and 1993, respectively.\nIn the ordinary course of business, the Cooperative becomes involved in various claims and legal actions. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on the Cooperative's consolidated financial statements.\nThe Cooperative endeavors to obtain the lowest purchase prices by making large volume purchase commitments at fixed prices and by assuming other procurement functions and risks that reduce the suppliers' cost. These commitments are made throughout the year based on anticipated demands of the restaurant operators, with terms usually of less than a year and conditions varying from product to product. Commitments made in the past have resulted in minimal losses. No significant losses are expected from existing commitments.\nOn January 31, 1991, the Cooperative acquired substantially all of the KFC-related business of Jeffrey Enterprises of Kentucky, Inc. (Enterprises). Before the acquisition, Enterprises had been a brokerage organization which had coordinated the sale of goods to operators and their distributors. The cost of the acquisition and the impact upon operations of the Cooperative was not material. In addition to the acquisition of the KFC-related business, the Cooperative entered into a consulting agreement with Fred Jeffrey, the president of Enterprises since its organization in 1975, providing for the consulting services of Mr. Jeffrey with respect to the business acquired, the Cooperative's strategic planning and as a liaison with operators. The consulting agreement provides for an annual salary of $70,000 and terminates December 31, 1998.\n(Continued)\nKFC NATIONAL PURCHASING COOPERATIVE, INC. AND SUBSIDIARIES (d\/b\/a FoodService Purchasing Cooperative, Inc.)\nNotes to Consolidated Financial Statements\n(10) Subsequent Event\nOn December 8, 1995, the Board of Directors of the Cooperative approved in principle a finance program for stockholder members co-sponsored by the National Cooperative Bank (the \"Bank\"). The program is subject to negotiation and execution of definitive agreements between the Cooperative and the Bank. The program currently contemplates up to $20,000,000 in loans to Cooperative members which range from $100,000 to an individual maximum of $2,000,000. The program is expected to commence in early 1996. The Cooperative has agreed to guarantee from 10% to 25% of the declining balance based on each loan's classification. The estimated maximum exposure of the Cooperative based on the allocation of funds between loan classifications would be $3,500,000. The Bank has agreed to maintain a specific reserve equal to .125 basis points to .50 basis points of all interest paid based on the loan's classification which will be applied to losses prior to the Cooperative incurring any loss. The Bank will be responsible for all legal and administrative requirements of the program.\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.\nKFC NATIONAL PURCHASING COOPERATIVE, INC.\nJanuary 29, 1996 By \/s\/ Thomas D. Henrion ------------------------- Thomas D. Henrion, 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 in the capacities and on the dates indicated.\nKFC NATIONAL PURCHASING COOPERATIVE, INC. AND SUBSIDIARIES (d\/b\/a FoodService Purchasing Cooperative, Inc.)\nSchedule II - Valuation and Qualifying Accounts\n(A) Uncollectible accounts and notes written off\nS-1","section_15":""}
{"filename":"810958_1995.txt","cik":"810958","year":"1995","section_1":"ITEM 1. BUSINESS - -----------------\nThe information appearing in the Annual Report under the caption \"Description of Business\" on page 43 is herein incorporated by reference.\nREGULATION AND SUPERVISION\nTHE CORPORATION\nThe Corporation is a one-bank holding company formed under the provisions of Section 3 of the Federal Reserve Act. The Corporation is under the direct supervision of the Federal Reserve Board and must comply with the reporting requirements of the Federal Bank Holding Company Act.\nA one-bank or multi-bank holding company is prohibited under Section 3 (a)(3) of the Act from acquiring either directly or indirectly 5% or more of the voting shares of any bank or bank holding company without prior Board approval. Additionally, Section 3 (a)(3) prevents, without prior Board approval, an existing bank holding company from increasing its ownership in an existing subsidiary bank unless a majority (greater than 50 percent) of the shares are already owned (Section 3 (a)(B) ). A bank holding company which owns more than 50 percent of a bank's shares may buy and sell those shares freely without Board approval, provided the ownership never drops to 50 percent or less. If the holding company owns 50 percent or less of a bank's shares, prior Board approval is required before such additional acquisition of shares takes place until ownership exceeds 50 percent.\nUnder current Pennsylvania law, which became effective March 4, 1990, bank holding companies located in any state may acquire banks and bank holding companies located in Pennsylvania provided that the laws of such state grant reciprocal rights to Pennsylvania bank holding companies and that 75% of the domestic deposits are located in a state granting reciprocity.\nTHE BANK\nThe Bank is a state chartered nonmember bank, supervised by and under the reporting requirements of the Pennsylvania Department of Banking and the Federal Deposit Insurance Corporation.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES - -------------------\nThe Bank fully owns fifteen (15) banking offices as listed below. All offices have been modernized to meet the demands for the Bank's services and to give a pleasant and comfortable atmosphere in which to conduct the Bank's business.\n1. Executive Offices - 90-92 Main Street, Wellsboro, PA 16901 2. Corporate Headquarters - Thompson Street, Ralston, PA 17763 3. 428 South Main Street, Athens, PA 18810 4. 111 Main Street, Dushore, PA 18614 5. Main Street, East Smithfield, PA 18817 6. Main Street, Elkland, PA 16920 7. Route 49, Knoxville, PA 16928 8. Main Street, Laporte, PA 18626 9. Route 15, Liberty, PA 16930 10. Route 220, Monroeton, PA 18832 11. RD 2, Sayre, PA 18840 12. Route 15, Tioga, PA 16946\n13. 428 Main Street, Towanda, PA 18848 14. Elmira and East Main Street, Troy, PA 16947 15. Route 6, Wysox, PA 18854\nAll offices offer a full range of banking services, except the Monroeton office, which does not offer safe deposit boxes.\nThere are no encumbrances against any of the properties owned by the Bank.\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 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 STOCK AND RELATED SHAREHOLDER - --------------------------------------------------------------------- MATTERS -------\nThe information appearing in the Annual Report under the caption \"Quarterly Share Data\" on page 39 and the \"Summary of Quarterly Financial Data\" on page 41 is herein incorporated by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA - --------------------------------\nThe \"Five Year Summary of Operations\" on page 40 of the Annual Report is herein incorporated by reference.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND - ------------------------------------------------------------------------\nRESULTS OF OPERATIONS ---------------------\nThe information appearing in the Annual Report under the caption \"Management's Discussion and Analysis of the Financial Condition and Results of Operations\" on pages 24 through 38, is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - ----------------------------------------------------\nThe Consolidated Financial Statements (and footnotes thereto) and the Summary of Quarterly Financial Data presented in the Annual Report is herein incorporated 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 - ------------------------------------------------------------\n(a) Identification of Directors. The information appearing under the caption \"Election of Directors\" on pages 2 through 4 of the Corporation's Proxy Statement dated March 18, 1996, is herein incorporated by reference.\n(b) Identification of Executive Officers. The information appearing under the caption \"Corporation's and Bank's Executive Officers\" on pages 4 through 6 of the Corporation's Proxy Statement dated March 18, 1996, is herein incorporated by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION - --------------------------------\nInformation appearing under the caption \"Executive Compensation\" on page 8 of the Corporation's Proxy Statement dated March 18, 1996, is herein incorporated by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - ------------------------------------------------------------------------\nInformation appearing under the caption \"Election of Directors\" on pages 2 through 4 and under the caption \"Corporation's and Bank's Executive Officers\" on pages 4 through 6 of the Corporation's Proxy Statement is herein incorporated by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND CERTAIN TRANSACTIONS - --------------------------------------------------------\nInformation appearing in footnote 12 to the Consolidated Financial Statements included on page 21 in the Annual Report is herein incorporated by reference.\nInformation appearing under the caption \"Certain Transactions\" on page 11 of the Corporation's Proxy Statement is herein incorporated by reference.\nPART IV -------\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K - --------------------------------------------------------------------------\n(a) (1). The following consolidated financial statements and reports are set forth in Item 8.\n(2). Financial statement schedules are either omitted because inapplicable or included in the financial statements or related notes. Individual financial statements of Bucktail Life Insurance Company, a consolidated subsidiary have been omitted, as neither the assets nor the income from continuing operations before taxes exceed ten percent of the consolidated totals.\n(3). Exhibits (numbered as in Item 601 of Regulation S-K)\n2. Plan of Acquisition, Reorganization, Arrangement, Liquidation or Succession Not applicable\n3. (i) Articles of Incorporation *\n3. (ii) Bylaws of the Registrant *\n4. Articles of Incorporation of the Registrant as Currently in effect *\n9. Voting Trust Agreement Not applicable\n10. Material Contracts Not applicable\n11. Statement re Computation of Per Share Earnings Not applicable\n12. Statements re Computation of Ratios Not applicable\n13. Annual Report to Shareholders\n16. Letter re Change in Certifying Accountant Not applicable\n18. Letter re Change in Accounting Principles Not applicable\n21. List of Subsidiaries 9\n22. Published Report Regarding Matters Submitted to Vote of Security Holders Not applicable\n23. Consents of Experts and Counsel Not applicable\n24. Power of Attorney Not applicable\n27. Financial Data Schedules None\n28. Information from Reports Furnished to State Insurance Regulatory Authorities Not applicable\n99. Additional Exhibits Not applicable\n(b) Reports on Form 8-K\nNo reports on Form 8-K were filed during the quarter ended December 31, 1995.\n*omitted in the interest of brevity\nSIGNATURES\nPursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nCITIZENS & NORTHERN CORPORATION\nMarch 20, 1996 By: WILLIAM K. FRANCIS \/s\/. - ------------------------- ----------------------------- Date William K. Francis 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.\nMarch 20, 1996 By: JAMES W. SEIPLER \/s\/. - ------------------------- ----------------------------- Date James W. Seipler Treasurer\nBOARD OF DIRECTORS\nJ. ROBERT BOWER \/s\/ . LAWRENCE F. MASE \/s\/ . ------------------------------- -------------------------------- J. Robert Bower Lawrence F. Mase\nR. ROBERT DECAMP \/s\/ . ROBERT J. MURPHY \/s\/ . ------------------------------- -------------------------------- R. Robert DeCamp Robert J. Murphy\nR. JAMES DUNHAM \/s\/ . EDWARD H. OWLETT, III \/s\/ . ------------------------------- -------------------------------- R. James Dunham Edward H. Owlett, III\nADELBERT E. ELDRIDGE \/s\/ . F. DAVID PENNYPACKER \/s\/ . ------------------------------- -------------------------------- Adelbert E. Eldridge F. David Pennypacker\nWILLIAM K. FRANCIS \/s\/ . LEONARD SIMPSON \/s\/ . ------------------------------- -------------------------------- William K. Francis Leonard Simpson\nLAURENCE R. KINGSLEY \/s\/ . HOWARD W. SKINNER \/s \/ . ------------------------------- -------------------------------- Laurence R. Kingsley Howard W. Skinner\nEDWARD L. LEARN \/s\/ . DONALD E. TREAT \/s\/ . ------------------------------- -------------------------------- Edward L. Learn Donald E. Treat\nJOHN H. MACAFEE \/s\/ . ------------------------------- John H. Macafee\nEXHIBIT INDEX\n3. (i) Articles of Incorporation of the Registrant as currently in effect are herein incorporated by reference to Exhibit D to Registrant's Form S-4, Registration Statement dated March 27, 1987.\n3. (ii) Bylaws of the Registrant as currently in effect are herein incorporated by reference to Exhibit E to Registrant's Form S-4, Registration Statement dated March 27, 1987\n4. Articles of Incorporation of the Registrant as currently in effect are herein incorporated by reference to Exhibit D to Registrant's Form S-4, Registration Statement dated March 27, 1987.\n10. Page 29 of Registrant's Form S-4, Registration Statement dated March 27, 1987, is herein incorporated by reference.\n13. Annual Report to Shareholders\n21. List of Subsidiaries\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nTo the Stockholders and Board of Directors of Citizens & Northern Corporation\nWe have audited the accompanying consolidated balance sheets of Citizens & Northern Corporation and subsidiaries (\"Corporation\") as of December 31, 1995 and 1994, and the related consolidated statements of income, changes in stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1995. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted accounting standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our 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 Citizens & Northern Corporation and subsidiaries as of December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\nAs discussed in Note 1 to the financial statements, the Corporation changed its method of accounting for securities and income taxes in 1993.\nWilliamsport, Pennsylvania January 22, 1996","section_15":""}
{"filename":"100307_1995.txt","cik":"100307","year":"1995","section_1":"ITEM 1. BUSINESS\nMark Twain Bancshares, Inc. (\"Company\") is a Missouri chartered multi-bank holding company which owns or controls substantially all the capital stock of three banks: Mark Twain Bank, which operates 20 separate banking locations in the metropolitan St. Louis areas; Mark Twain Kansas City Bank, which operates eleven separate locations in the metropolitan Kansas City bi-state area; and Mark Twain Illinois Bank, which operates four locations on the Illinois side of the St. Louis metropolitan area. The Company was organized in 1967.\nThe Company's subsidiaries encounter substantial competition in all of their banking and related financial service activities from other banking institutions and from an increasing number of non-banking financial institutions in its primary market areas.\nNon-Banking Subsidiaries\nThe Company wholly owns the following: Mark Twain Properties, Inc., which owns, holds under lease, or manages properties occupied by present banking centers; Mark Twain Community Development Corporation, which provides services and housing opportunities for low- to moderate-income persons; Tarquad Corporation, which acts as trustee of deeds of trust of which Company subsidiaries are the lenders and beneficiaries; and Mark Twain Asset Recovery, Inc., which acts as purchaser of certain assets acquired by subsidiary banks in the collection of loans.\nMark Twain Bank wholly owns Mark Twain Brokerage Services, Inc., a member of the National Association of Securities Dealers, which provides customers with complete brokerage services on all exchanges and provides the sale of various insurance company products. Mark Twain Bank and Mark Twain Kansas City Bank each wholly own a Mark Twain Real Estate Development Corporation subsidiary and a Mark Twain Community Development Corporation subsidiary.\nSupervision and Regulation\nThe Company is registered with and subject to regulation by the Board of Governors of the Federal Reserve System and is subject to the Missouri Bank Holding Company Act. All Company-owned non-bank subsidiaries are subject to regulation by the Board of Governors of the Federal Reserve System. The subsidiary state-chartered banks are subject to regulation and supervision by the banking regulators of the states in which the banking units are located and the states in which the bank is chartered. All subsidiary banks are subject to regulation by and are members of the Federal Deposit Insurance Corporation.\nThe earnings of the subsidiary banks are affected not only by competing financial institutions and general economic conditions, but also by the policies of various governmental regulatory authorities, and state and federal laws, particularly as they relate to powers authorized to banks and bank holding companies. The Company and all subsidiary banks are subject to the provisions of the Community Reinvestment Act. Mark Twain Brokerage Services, Inc., is subject to supervision and regulation by the National Association of Securities Dealers, Securities and Exchange Commission, Missouri Division of Securities, Missouri Division of Insurance, and Missouri Division of Finance, among others. The mortgage department is subject to supervision by Department of Housing and Urban Development, Federal Housing Authority, Veteran's Administration, Federal Home Loan Mortgage Corporation, Federal National Mortgage Association, and Government National Mortgage Association, among others, concerning mortgage lending.\nFurther information called for by this item is contained on pages 17 to 29 and Note 2 \"Acquisitions\" on page 36 of the Company's 1995 Annual Report to Shareholders and is incorporated by reference herein.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company leases its principal executive office which is located at 8820 Ladue Road, Ladue, Missouri. As of December 31, 1995, the Company conducts its business and operations\nout of 39 locations, which are either owned or leased, in the St. Louis bi-state, Kansas City bi-state and Chicago metropolitan areas. The Company's physical properties are in satisfactory condition and suitable and adequate for present operations.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company and its subsidiaries are parties to a number of lawsuits, most of which are considered routine litigation incidental to doing business. The Company, after consultation with legal counsel, does not expect the outcome of any litigation to have a material effect on its consolidated financial position.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThere were no matters submitted to a vote of security holders during the fourth quarter of 1995.\nNo family relationship exists among any of the Executive Officers of Registrant.\nEach officer of the Registrant is appointed to serve, at the pleasure of its Board of Directors, for the annual period next following the Annual Meeting of the Shareholders of the Registrant, and until his respective successor shall have been appointed and qualified. Certain officers were offered employment agreements; see Exhibit 10.9 below.\nNo officer of the Registrant was selected so to serve pursuant to any arrangement or understanding between him and any person other than the directors and one or more officers of Registrant acting solely in that capacity.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS\nAt December 31, 1995, there were approximately 2,500 holders of record of Common Stock. The information in Note 14, \"Restrictions of Subsidiary Dividends,\" on page 40 of the Company's 1995 Annual Report to Shareholders is incorporated by reference herein.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nInformation called for by this item is contained on page 16 of the Company's 1995 Annual Report to Shareholders and is incorporated by reference herein.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nInformation called for by this item is contained on pages 17 to 29 of the Company's 1995 Annual Report to Shareholders and is incorporated by reference herein.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nInformation called for by this item is contained on pages 30 to 46 of the Company's 1995 Annual Report to Shareholders and is incorporated by reference herein.\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 concerning directors, some of whom are executive officers of the Registrant, required by this item is set forth on pages 4 to 6 of the Company's Proxy Statement for its Annual Meeting to be held April 23, 1996 and is incorporated by reference herein.\nThe information concerning executive officers who are not directors of the Registrant required by this item is reported in Part I of this Form 10-K.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation called for by this item is contained on pages 9 to 16 and pages 18 to 19 of the Company's Proxy Statement for its Annual Meeting to be held April 23, 1996 and is incorporated by reference herein.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\n(a) Security Ownership of Certain Beneficial Owners - Information concerning persons who are known to own beneficially more than 5% of any class of the Company's voting shares on March 6, 1996 is contained on page 3 of the Company's Proxy Statement for its Annual Meeting to be held April 23, 1996, which is incorporated by reference herein.\n(b) Security Ownership of Management - Information called for by this item is contained on pages 7 to 9 of the Company's Proxy Statement for its Annual Meeting to be held April 23, 1996, and is incorporated by reference herein.\n(c) Changes in Control - 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\nInformation called for by this item is contained on page 19 of the Company's Proxy Statement for its Annual Meeting to be held April 23, 1996, which is incorporated by reference herein.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) (1) Financial Statements - The following consolidated financial statements of Mark Twain Bancshares, Inc. and Subsidiaries and the accountants' report thereon are incorporated by reference from the 1995 Annual Report to Shareholders of Mark Twain Bancshares, Inc.:\nConsolidated Balance Sheet - December 31, 1995 and 1994\nConsolidated Statement of Income - Years ended December 31, 1995, 1994 and 1993\nConsolidated Statement of Changes in Shareholders' Equity - Years ended December 31, 1995, 1994 and 1993\nConsolidated Statement of Cash Flows - Years ended December 31, 1995, 1994 and 1993\nNotes to Consolidated Financial Statements\n(a) (2) Financial Statement Schedules - All schedules are omitted because they are not applicable, or not required, or because the required information is included in the financial statements or the notes thereto.\n(a) (3) Exhibits\nExhibit 10 Material contracts:\nExhibit 10.1 - Mark Twain Bancshares, Inc. 1983 Incentive Stock Option Plan, as amended 4\/4\/84, 2\/11\/87, 3\/1\/90 and 2\/28\/95 (incorporated by reference from exhibit 10 of the Registrant's Form 10-K for the year ended December 31, 1994).\nExhibit 10.2 - Mark Twain Bancshares, Inc. 1992 Stock Option Plan, as amended 2\/28\/95 (restated electronically herewith pursuant to Regulation S-T, Item 102).\nExhibit 10.3 - Mark Twain Bancshares, Inc. 1995 Stock Option Plan, as amended 1\/12\/96.\nExhibit 10.4 - Mark Twain Bancshares, Inc. Executive Benefit Plan, as amended and restated 7\/1\/83 (incorporated by reference from exhibit 10 of the Registrant's Form 10-K for the year ended December 31, 1994).\nExhibit 10.5 - First Amendment to Mark Twain Bancshares, Inc. Executive Benefit Plan dated 8\/4\/92 (incorporated by reference from exhibit 10 of the Registrant's Form 10-K for the year ended December 31, 1994).\nExhibit 10.6 - Second Amendment to Mark Twain Bancshares, Inc. Executive Benefit Plan dated 10\/15\/93 (incorporated by reference from exhibit 10 of the Registrant's Form 10-K for the year ended December 31, 1994).\nExhibit 10.7 - Third Amendment to Mark Twain Bancshares, Inc. Executive Benefit Plan dated 10\/15\/93 (incorporated by reference from exhibit 10 of the Registrant's Form 10-K for the year ended December 31, 1994).\nExhibit 10.8 - Supplemental Executive Retirement Plan for Joseph N. Millard (incorporated by reference from exhibit 10 of the Registrant's Form 10-K for the year ended December 31, 1994).\nExhibit 10.9 - Form of Employment Agreements (incorporated by reference from exhibit 10 of the Registrant's Form 10-K for the year ended December 31, 1994):\nThe initial term of the Employment Agreements offered was for either 12, 18, or 24 months. The initial terms of the Employment Agreements offered to Executive Officers named in Part I of this Form were as follows:\nInitial Term of 24 months - Alvin Siteman, John P. Dubinsky, Peter F. Benoist, Keith Miller, W. Thomas Reeves and Frederick E. Zimmer.\nInitial Term of 18 months - Sandra Friedman Burnham, Nancy E. Graves, Timothy C. Peterson, Carl A. Wattenberg, Jr. and Thomas R. Wickenhauser.\nInitial Term of 12 months - Kevin J. Cody.\nExhibit 11 - Computation of Earnings Per Share.\nExhibit 13 - Portions of Mark Twain Bancshares, Inc.'s Annual Report to Shareholders for the year ended December 31, 1995.\nExhibit 21 - Subsidiaries of Mark Twain Bancshares, Inc.\nExhibit 23 - Consent of Independent Auditors.\nExhibit 27 - Financial Data Schedule.\nExhibit 99 - The Company's Proxy Statement dated March 18, 1996 for the Annual Meeting to be held April 23, 1996.\n(b) Reports on Form 8-K:\nThe Company filed a Form 8-K dated October 12, 1995 announcing earnings for the three and nine month periods ending September 30, 1995. The Company filed a Form 8-K dated January 16, 1996 announcing earnings for the three and twelve month periods ended December 31, 1995.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Bancshares has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized, in the County of St. Louis, and the State of Missouri, on the 20th day of March, 1996.\nMARK TWAIN BANCSHARES, INC.\n\/s\/ JOHN P. DUBINSKY ------------------------------------- John P. Dubinsky President and Chief Executive Officer (Principal Executive Officer)\nPursuant to the requirements of the Securities Act of 1934, this report has been signed below by the following persons in the capacities and on the date indicated.","section_15":""}
{"filename":"100759_1995.txt","cik":"100759","year":"1995","section_1":"ITEM 1. BUSINESS.\nUnimed Pharmaceuticals, Inc. and its consolidated subsidiaries (the Company) develops and markets prescription pharmaceutical products. Currently the Company promotes one approved drug and is developing others targeted for the HIV\/AIDS, endocrinology, and urology markets. The Company developed and promotes Marinol(R) through a specialty sales force in the U.S. to AIDS-treating physicians. Marinol is sold in international markets through the Company's foreign licensees. The Company is a Delaware corporation and is successor to a firm incorporated in 1948.\nThe Company's business strategy is to in-license and develop drugs that have, at a minimum, successfully completed milestones required to begin human clinical testing. The Company expects to acquire a diversified portfolio of late-stage development products in several therapeutic classes. During 1995, the Company licensed development and marketing rights to an anti-parasitic drug and two hormone replacement drugs that meet these criteria.\nThe Company expects to actively pursue new late-stage development in-licensing opportunities in the foreseeable future. In addition, the Company intends to acquire approved products that are or can be marketed in the U.S. After the close of 1995, the Company completed a private placement of its common stock, generating funds to be used primarily to accelerate product acquisition activities.\nThe Company believes that its focus on serving \"niche\" markets in which relatively few physicians treat affected patients, allows a small specialty sales force to reach the targeted physicians. The Company expects to expand its sales force as products are approved and new business opportunities arise.\nThe Company's products and clinical development supplies are manufactured through contractors, using specialized equipment, which in one case is owned by the Company. The Company believes that well qualified contract manufacturers are available to produce both currently marketed drugs and those now under development. Consequently, the Company expects to continue to utilize contract manufacturing in the foreseeable future.\nIn 1994, a new President and Chief Executive Officer was hired and a new business strategy was developed. In 1995, the Company stopped distributing several over-the-counter (OTC) nutritional and palliative care products, in order to concentrate on the prescription pharmaceutical market. For the same reason, the Company also converted its equity interest in Medisperse L.P. into a product royalty agreement.\nIn connection with the Company's in-licensing program, it entered into agreements in which the licensors provided the Company with non-refundable research and development payments.\nMARINOL (DRONABINOL)\nMarinol was first approved for marketing by the Food and Drug Administration (FDA) in 1985 for treating nausea and vomiting associated with cancer chemotherapy in patients failing to respond adequately to conventional antiemetic treatments. In 1992, the FDA approved for marketing a second indication for Marinol: treating anorexia associated with weight-loss in patients with AIDS.\nMarinol is given orally in a round soft gelatin capsule. The active ingredient, dronabinol, is a naturally occurring chemical found in Cannabis Sativa L. (marijuana). However, Marinol is chemically synthesized to maximize purity and consistency. Cannabinoid plants were among the first medicinals used by man, believed to be used over the last 5,000 years as stimulants, antidepressants and analgesics. Cannabinoids have been used as muscle relaxants to counter spasms, convulsions and insomnia. The Company began systematic study of the therapeutic properties of Marinol in the 1980s.\nUse of Marinol in Cancer\nMarinol has been shown to be an effective oral anti-emetic (relieving drug-induced nausea and vomiting) in numerous clinical studies involving large patient populations. The drug is believed to exert psychoactive effects through binding with cannabinol neural receptor sites in the brain. Marinol has been shown effective when used as a single agent or in combination with other anti-emetic therapies.\nUse of Marinol in AIDS\nA number of pharmaceuticals are being used to improve the nutritional status of the HIV-infected patient. Use of appetite stimulants to manage anorexia has expanded. Two pharmacologic agents are approved for marketing in this indication, Marinol and the progestational agent, Megace(R) Oral Suspension.\nInfection from the human immunodeficiency virus (HIV) has a largely irreversible and progressive effect on the nutritional status of the patient. Eventually the compromised status of the patient leads to profound weight-loss, known as HIV wasting syndrome. Studies of people with AIDS have shown a high correlation between weight-loss and death. Patients who have lost more than 34% of normal body mass have a high probability of death. Other studies have shown that malnutrition can impair T-cell immune function, gastrointestinal absorption and the body's response to infection. AIDS-treating physicians are becoming increasingly aware of the importance of monitoring and treating nutritional deficiencies.\nWeight-loss observed in AIDS is due to one or more of four known mechanisms: poor intestinal absorption, abnormal cellular utilization, increased energy requirements due to HIV and opportunistic infections, and inadequate dietary intake. In addition, recent studies suggest a high correlation between endocrine dysfunction (low testosterone serum levels) and weight-loss.\nLow serum levels of testosterone, known as hypogonadism, is the most common endocrine abnormality found in AIDS, affecting approximately 50% of male patients. This condition is believed to be associated with reduced protein biosynthesis or a slowdown in the body's replacement of muscle mass.\nMalnutrition is caused by inadequate caloric intake and affects as many as 80% of AIDS patients. It is observed clinically in response to anorexia (loss of appetite), intestinal malabsorption and starvation. The patient's metabolic rate also is reduced as a result of insufficient caloric intake. Usually, fat reserves and extracellular water are expended by the body before the loss of LBM (lean body mass). However, HIV infection, secondary infections and drug interactions deplete the body's reserves in AIDS patients. Abnormally low protein synthesis and cytokine production occur and immune parameters also are suppressed in malnourished individuals.\nIn 1987, the Company initiated clinical development of Marinol in treatment of weight-loss in cancer patients. The emerging AIDS pandemic led the Company to expand the clinical program and then concentrate on an AIDS application. A subsequent Phase III multi-center double-blind, placebo-controlled trial in AIDS patients with anorexia and weight-loss of at least five pounds demonstrated statistically significant improvement in patient's appetite by the fourth week of therapy. Patients in the study were permitted to continue treatment in an open-label study, in which there was sustained improvement in appetite. Treatment was well tolerated by most patients. The incidence of side-effects was decreased by dose reduction. This pivotal study also demonstrated clinical trends toward improvement in the patients' weight, mood and reduced nausea. The Company completed the multi-center Phase III clinical trial in early 1992, filed a New Drug Application in August 1992, and received approval to market from the FDA in December 1992.\nIn 1993, Megace Oral Suspension (megestrol acetate), a synthetic, antineoplastic and progestational drug, first used to treat advanced carcinoma of the breast, was approved for marketing as an appetite stimulant. Recently, recombinant human growth hormone has been tested as an agent to increase LBM. Thalidomide also is being tested in HIV wasting, due to its anti-TNF activity. TNF (tumor necrosis factor) may play a role in the pathogenesis of AIDS wasting.\nWith a growing potential arsenal of pharmacologic agents, AIDS-treating physicians increasingly monitor and treat patients with nutritional and hormonal imbalances. The patient's caloric intake has an impact on the effectiveness of anabolic agents used to treat endocrine dysfunction and HIV wasting syndrome. The Company believes that Marinol may be used successfully in combination with these agents. Combination clinical trials are planned.\nPRODUCT DEVELOPMENT\nNITAZOXANIDE\nIn June 1995, the Company entered into a licensing agreement with Romark Laboratories, L.C. (Romark), for the rights to Romark's know-how and patent rights covering certain products containing an anti-parasitic drug, Nitazoxanide, in the U.S., Canada, Australia and New Zealand (NTZ). The agreement with Romark provides for rights to oral and intravenous routes of administration for treatment of cryptosporidiosis. In addition, the Company has marketing rights to oral uses of NTZ for all indications and is investigating other therapeutic applications of the drug.\nPreliminary human clinical trials conducted outside the United States and sponsored by Romark demonstrated that NTZ showed effectiveness in treating patients with cryptosporidiosis. A Phase III clinical trial sponsored by a Romark licensee is under way in Mexico.\nIt is estimated that 15-20% of people with AIDS in the United States are infected with a single cell microscopic parasite, Cryptosporidium parvum (C. parvum). This protozoan inhabits the respiratory and gastrointestinal tracts of animals and, increasingly, humans. The first case in the U.S. was not reported in humans until 1976. In 1982, according to the Centers for Disease Control (CDC), the number of cases of C. parvum began to increase dramatically as part of the AIDS epidemic. The parasite is highly contagious through contact with infected humans. C. parvum has been found in the public water supply throughout the U.S., further exposing at-risk individuals.\nSymptoms of cryptosporidiosis include diarrhea, nausea, vomiting and weight-loss. The severity of symptoms varies with the degree of immunosuppression. In healthy people, the infection is self-limiting, lasting for a few days to four or more weeks. Patients with AIDS can be affected for months or even years. Currently there is no FDA approved drug to treat cryptosporidiosis.\nA Company-sponsored Phase II clinical trial is underway at Cornell Medical Center, in New York City, investigating the use of NTZ to treat cryptosporidiosis in 28 patients with AIDS. The purpose of the trial is to demonstrate safety and efficacy and identify the optimal dose. Enrollment is dependent upon patients meeting clinical entry criteria. These criteria include clinically defined AIDS, cryptosporidiosis and the absence of other gastrointestinal infections. Assuming safety and efficacy are demonstrated in the Phase II trial, the Company will initiate a multi-center Phase III clinical trial.\nThe FDA initially approved NTZ for Compassionate Use in up to 30 AIDS patients not meeting the clinical entry criteria for the Cornell Study, or not in geographical proximity to participate in the trial. The full 30 patient enrollment of the Compassionate Use program was completed and FDA subsequently authorized expanding enrollment to 100 patients.\nANDROGEL(TM) AND ANDROGEL(TM)-DHT\nDuring 1995, the Company acquired exclusive rights in the U.S., Canada and Mexico to develop and market topical gel formulations of testosterone and dihydrotestosterone (DHT), the principal active metabolite of testosterone in the human body. The gel formulations are applied to the arms or abdomen and absorbed through the skin into the blood stream. One of these drugs, DHT, is currently marketed in France and Belgium as treatment for low levels of testosterone (hypogonadism). This deficiency has been associated with\na variety of adverse effects, such as: impotence, lack of sex drive, muscle weakness, low bone density and HIV wasting syndrome (in AIDS patients).\nHypogonadism can be caused by a number of factors. They include: congenital abnormalities (e.g., Klinefelter's syndrome -- a condition in male newborns having an extra X chromosome); disease or injuries affecting the pituitary gland, hypothalamus, or testes; chronic illnesses (e.g., diabetes, kidney failure, AIDS); or declining testosterone production associated with aging (geriatric hypogonadism).\nWhile not as abrupt as the decline in estrogen levels women experience during menopause, studies suggest that testosterone levels may decline 30-40% in men from their late 40s to their early 70s. This hormonal change correlates with physical changes commonly observed in middle-aged men -- decreased bone and muscle mass; an increase in body fat; diminished energy, virility, fertility; and decreased sexual function.\nThe Company intends to initially focus clinical development on geriatric hypogonadal men and in AIDS patients with HIV wasting syndrome. The Company has begun this program in 1996.\nSERC(R)\nSERC (betahistine HCl) was developed by the Company in the 1960s. It is widely used around the world and supplied by several manufacturers. SERC generates an estimated $80 million in sales by these manufacturers. The majority of international sales come from Solvay-Duphar of the Netherlands. Through December 1995, the Company also generated sales of SERC through distributors in Canada, Australia and South Africa. SERC is not approved for sale in the United States.\nSubsequent to year-end 1995, the Company agreed to sell the SERC trademark in Canada, Australia and South Africa and to assign the Company's Canadian Serc approval and all of the Company's international distribution agreements to Solvay-Duphar. In return, the Company received a cash payment and access to certain clinical data, technical information and know-how that may be useful in obtaining marketing approval from FDA in the United States.\nSERC is a histamine analogue, given orally. It has two principal effects in the body: increasing blood supply to the brain and inner ear and a neurological effect in the brain. Animal studies have shown that capillary size increases three-fold and the speed of blood flow increases by 50% with use of the drug. Neurological research has demonstrated that SERC stops histamine binding to H3 receptors in pre-synaptic nerves, stimulating production of H1 receptors. This process is believed to regulate vasodilation (widening of blood vessels) and to increase permeability of minute capillaries in the inner ear.\nThe vascular and neural effects produced by SERC have been shown to reduce symptoms in vertigo. Vertigo is an unpleasant sensation of imbalance, spinning and disorientation. Nausea and vomiting are common and, during an acute attack, people experience feelings of panic and are emotionally traumatized. Patients may experience visual disorientation, ringing in the ears or hearing loss (which can be progressive).\nAcute recurrent vertigo can be caused by migraine, hypoglycemia (an abnormal decrease of sugar in the blood), head injuries, tumors and surgical trauma, but is more common in Meniere's disease, a degenerative nerve disorder of the inner ear. Vertigo also is associated with dizziness or giddiness, feelings of faintness, light-headedness or being unsteady on the feet.\nApproximately 44 million patients have used SERC outside the United States since 1976. Less than 200 cases of adverse events have been reported during this time, indicating SERC's excellent safety profile. The Company estimates that approximately three million people suffer from vertigo in the United States. In the U.S., vertigo and Meniere's disease are treated with vasodilators, anti-emetics and various sedatives. The Company believes there is a significant unmet need for a better therapeutic agent in this market.\nThe Company intends to use clinical data and expertise available from Solvay-Duphar to develop SERC in the United States. Solvay-Duphar has provided research and development funds to assist in the U.S. development program.\nMEDISPERSE\nIn November 1995, the Company exchanged its equity ownership in Medisperse, L.P. for rights to receive royalties on compounds developed using the proprietary Medisperse drug delivery technology in an amount at least as attractive as if Unimed remained in the partnership. The Company entered into the Medisperse limited partnership in 1988 with Sterilization Technical Services (STS) to commercialize a novel drug formulation and delivery technology that may allow for drug compounds with low solubility. The Company will make no further equity contributions. The Company is aiding in the search for licensees for further development of the Medisperse technology.\nMARKETING AND DISTRIBUTION\nThe Company's sales force details Marinol to AIDS-treating physicians in the United States, subject to the terms of a co-promotional agreement with Roxane Laboratories, Inc. (Roxane), a member of the Boehringer Ingelheim group of companies. Salespeople are located in territories throughout the U.S. with a high incidence of AIDS.\nThe Company's business strategy is to develop drugs for niche markets -- therapeutic areas such as HIV\/AIDS and endocrinology where fewer than 10,000 physicians manage the majority of patients. The Company hopes to leverage its presence in the HIV\/AIDS medical market with new FDA approvals from current clinical development programs. The Company intends to expand its sales and marketing resources as new products and new indications for current products become available. The Company plans to focus sales and marketing resources on U.S. markets and to pursue partnerships and corporate alliances to market its products abroad.\nMANUFACTURING\nManufacture of the Company's marketed product and drugs under development is done on a contract basis by third parties.\nThe NORAC Company, Inc. (NORAC) supplies Delta-9 tetrahydrocannabinol, the active ingredient in Marinol, to the Company. The Company owns the principal equipment used by NORAC to manufacture Delta-9. Delta-9 is synthesized and purified through a complex and time-consuming process. The loss of NORAC as a supplier could have a material adverse effect on the Company. Currently, the Company maintains a three-year supply of Delta-9.\nThe Company has supply agreements with Romark for NTZ, Besins for Androgel and Androgel-DHT, and Solvay-Duphar for SERC. Under these agreements, the Company purchases clinical supplies, and after approval by the FDA, finished drug products in accordance with the Company's specifications.\nCOMPETITION\nThere are many companies, both public and private, including well-known pharmaceutical companies, chemical companies and specialized genetic engineering companies, engaged in developing pharmaceuticals and biotechnology compounds for human therapeutic applications. Many of these companies have substantially greater financial, research and development, manufacturing, marketing and human resources than the Company, and represent significant competition. Such companies may succeed in developing products that are more effective or less costly than any developed by the Company and may also prove to be more successful in\nmanufacturing and marketing. The Company does not have a significant position in the pharmaceutical market.\nGOVERNMENT REGULATION\nThe FDA and comparable agencies in other countries impose substantial requirements on the introduction of therapeutic pharmaceutical products through lengthy and detailed laboratory and clinical testing procedures and other costly and time-consuming procedures. Satisfaction of these requirements typically takes a number of years and varies substantially based upon the type, complexity and novelty of the product. In general, the FDA approval process for pharmaceuticals involves the submission of an Investigational New Drug (IND) application following preclinical studies, clinical trials in humans to demonstrate the safety and efficacy of the product under the protocols set forth in the IND, and submission of preclinical and clinical data as well as other information to the FDA in an New Drug Application (NDA). The conduct of clinical trials requires substantial time and expense, and there is no assurance that the results of the trials will be sufficient to support the submission or the approval of an NDA. The failure of Unimed to receive FDA approval for its products under development would preclude the Company from marketing and selling newly developed products in the United States.\nPharmaceutical manufacturers are subject to extensive regulation by federal and state regulatory agencies. The Federal Food, Drug and Cosmetic Act, the Controlled Substance Act, and other federal statutes and regulations govern or influence the testing, manufacture, safety, labeling, storage, record-keeping, approval, advertising and promotion of pharmaceutical products. Noncompliance with applicable requirements can result in fines, recall and seizure of products, total or partial suspension of production, and governmental refusal to approve new products or indications. The manufacture and sale of Marinol also is regulated by the Drug Enforcement Agency (DEA) and by statutes and regulations promulgated by a number of states and foreign countries.\nPATENTS AND PROPRIETARY RIGHTS\nIn 1991, Marinol was designated as an Orphan Drug by the FDA for use as an appetite stimulant in patients with AIDS. Under the Orphan Drug Act of 1983, the Company has seven years of marketing exclusivity for this use in the U.S. The seven-year period began with receipt of marketing approval from the FDA in December 1992.\nNitazoxanide, when combined with a wetting agent, and optionally, a starch derivative, in an oral composition, is the subject of a patent and patent application. Unimed has certain rights with respect to those patents under its license agreement; however, Unimed does not now hold any patents directly, nor is there any other patent protection available for Unimed's other products. The Company has obtained an Orphan Drug Designation for the use of NTZ in the treatment of cryptosporidiosis in patients with AIDS.\nThe Company owns the Marinol and SERC trademarks in the U.S.\nEMPLOYEES\nThe Company has 16 full-time employees and one part-time employee. Unimed expects to add technical, sales and marketing, and administration staff to support development of the business. The Company believes employee relations are satisfactory and that it will be able to attract additional personnel as needed.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company leases approximately 5,000 square feet of executive office space in Buffalo Grove, Illinois, at an annualized cost of approximately $165,000, under a lease that expires in 1998. The Company also leased approximately 1,900 square feet of laboratory space in Mundelein, Illinois, at an annualized cost of $18,000 under a lease that expired December 31, 1995.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThe Company is not a party to any material 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.\nThe Company's Common Stock is traded on the over-the-counter market. Its Common Stock is quoted on the NASDAQ National Market System (NMS) under the symbol UMED. The following table lists the high and low closing prices of the Common Stock for the two most recent fiscal years.\nThe Company had approximately 1,225 holders of record of Common Stock on March 8, 1996. Unimed's Board of Directors anticipates the retention of all available earnings to support expected growth and does not anticipate payment of dividends in the foreseeable future.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nSelected financial data for all periods prior to December 31, 1995, have been restated to conform to the 1995 presentation. These restatements had no effect on net income (loss).\nResults for the fiscal year ended September 30, 1992, include a $2.5 million restructuring charge.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nINTRODUCTION\nIn late 1994, a new President and Chief Executive Officer was hired and a new business strategy was developed. Fiscal 1995 marks the first full year of Unimed operations under this strategy. The strategy includes increasing sales of Unimed's principal product, Marinol(R), implementation of cost control programs, and using the resulting positive cash flow as a foundation to purchase or acquire rights to additional pharmaceutical products under late-stage development or already on the market. In 1995, Unimed's gross sales increased to $9.7 million, a 12% increase over 1994 gross sales of $8.6 million. In addition, in 1995 the Company increased Marinol(R) gross sales by 19% over 1994, decreased total operating expenses 18% compared with 1994, and acquired rights to three late-stage development products.\nThe Company reported net income of $.09 per share in 1995 compared to net income of $.01 per share in 1994 and a net loss of $.14 per share in 1993.\nThe Company generated cash flow from operations of $1,640,000 and reported year-end cash, cash equivalents and short-term investments of $8,401,000. In 1996, the Company expects to concentrate on further commercializing Marinol(R) and to continue implementation of the Company's new business strategy, focusing on acquiring and developing new products that enhance the Company's total product portfolio.\nREVENUES\nFiscal 1995 Marinol(R) gross sales, marketed during the year as a refractory antiemetic in cancer chemotherapy and as an appetite stimulant in anorexia associated with weight loss in AIDS, increased 19% over 1994 levels, ending the year at $8,395,000. This compares with a 13% increase in sales growth for 1994 to $7,054,000. For the year ended December 31, 1995 and for all periods presented, the Company reclassified, for financial reporting purposes, a normally recurring provision for estimated Medicaid rebates on Marinol(R) sales. This provision for Medicaid rebates, previously reported as a cost of sales, has been reclassified as a reduction to gross sales. This change had no effect on gross profit or net income. Marinol(R) is marketed by the Company's licensee, Roxane Laboratories, Inc. Roxane maintains an approximately 55-person sales force engaged in both multi-source product distribution and ethical detailing activities. The Company maintains an eight-person specialty sales force detailing Marinol(R) only to AIDS-treating physicians. The Company reports the royalty income it receives from Roxane as revenues from Marinol(R) sales. Unimed continues to pursue opportunities to form international alliances to sell Marinol(R) outside of the U.S. During 1994, Marinol(R) was re-introduced in Canada for use as an antiemetic. Marinol(R) is currently under regulatory review in South Africa for use as an appetite stimulant and as an anti-emetic. Other regulatory submissions are expected in 1996. During 1995, Marinol(R) sales to countries outside the United States totaled approximately $134,000.\nSerc(R) is marketed by others in Canada and other international markets to treat recurrent vertigo. In early 1993, the Company entered into a new distribution agreement with Sanofi Winthrop Canada (Sanofi). In addition to Serc(R), the agreement provides for distribution of Marinol(R), as an antiemetic, and for registration of Marinol(R) as an appetite stimulant in patients with AIDS with the Health Protection Branch (Canadian equivalent of the FDA) and post-approval marketing rights in Canada. During 1995, Serc(R) sales decreased slightly to $1,049,000 from $1,060,000 in 1994. The Company believes Serc(R) to be a mature product in Canada. In January 1996, Unimed entered into an agreement with Solvay Duphar whereby Unimed licensed the rights to proprietary know-how and manufacturing for the drug SERC(R) in the U.S. As part of the agreement, the Company received a $1.4 million payment to help fund product development and for Unimed's product and trademark rights to SERC(R) in Canada, Australia and South Africa.\nDuring 1994, after analyzing market research results that suggested significant new resources would be required to build market share in the over-the-counter (OTC) business, the Company concluded that better opportunities exist in proprietary prescription drug development and marketing. Unimed ended active promotion of these products and stopped taking orders for these products in late December 1995. The OTC products, consisting of ONDROX and the MouthKote product line, generated gross sales of $279,000 during 1995. 1994 sales were $579,000.\nOther income (net of other expenses) increased 28% in 1995 because of growth in interest income. Interest income increased 70% to $430,000 due to higher cash balances and higher interest rates on short-term holdings. Other income increased 7% during fiscal 1994 relative to 1993, largely due to a slight growth in interest income. To reflect conversion of the Company's equity interest in the Medisperse partnership into the right to receive royalties on products developed using the Medisperse technologies, the Company reduced the Medisperse investment by $106,000. This was a noncash transaction.\nCOSTS AND EXPENSES\nCost of sales increased 8% from $2,958,000 in 1994 to $3,201,000 in 1995. The higher cost of sales was due to revenue growth from the Company's pharmaceutical products. 1994 cost of sales was slightly lower than 1993 cost of sales due to changes in product mix.\nTotal expenses in 1995 were $3.8 million, representing an 18% decrease from 1994 total expenses of $4.6 million. This was due primarily to a 50% reduction in sales and marketing expenses. Sales and marketing expenses also decreased between 1994 and 1993, lowering total expenses by 6%. Marinol promotional programs were unaffected by these reductions.\nOperating and administrative expenses for 1995 were approximately $2,129,000, a decrease of 3% from 1994. This decrease resulted in part from strong cost control programs introduced by management in late 1994, but also from the termination of active promotion of the OTC portfolio. Operating and administrative expenses were 17% higher in 1994 than in 1993. Part of the increase reflected having a full-time Chief Executive Officer in 1994 compared with 1993, when the Company's Chairman of the Board served as CEO without receiving cash compensation. Operating and administrative expenses as a percent of net sales were 29% in 1995 compared with 30% in 1994.\nSales and marketing expenses were $1,059,000 in 1995, compared to $2,113,000 in 1994. This decline in spending was primarily the result of ending aggressive promotion of the OTC product line and reducing the number of Unimed sales representatives.\nNet research and development expenses increased from $328,000 in 1994 to $618,000 in 1995. The increase was due to further development activities of Marinol(R) and new pharmaceutical development programs, including hiring additional personnel to manage these programs. This expense category increased by $35,000 from 1993 to 1994.\nLIQUIDITY AND CAPITAL RESOURCES\nAt December 31, 1995, the Company had cash, cash equivalents and short-term investments of $8,401,000, compared with $6,612,000 at December 31, 1994. During 1995, Unimed generated cash from operations of $1,640,000. The Company's working capital remained essentially unchanged from 1994. The Company expects to increase research and development expenditures in 1996, partially offsetting this increase with licensor's research and development payments.\nDuring 1995, the Company obtained approximately $250,000 from the exercise of stock options. In addition, in 1995 Unimed invested $600,000 for a 6% equity interest in Romark Laboratories, L.C.(Romark). Romark is the licensor of NTZ, used in the treatment of a broad spectrum of parasitic infections, including a potentially life-threatening infection in AIDS patients.\nInventories increased by $894,000, which includes $81,000 of inventory depreciation, at December 31, 1995 over 1994 levels, as the Company accepted annual delivery of Delta-9 tetrahydrocannabinol, the active component in Marinol(R), from its contract manufacturer. Marinol(R) inventories normally are depleted throughout the year until the delivery of the new annual production lot. The Company's distributor, Roxane, advances funds to Unimed required to maintain Marinol(R) inventories. The current liability, due to Roxane, is relieved on a quarterly basis from royalties remitted to the Company. The reduction in the quarter's royalty payment corresponds to the cost of Marinol(R) inventory sold during the quarter.\nOn February 29, 1996, the Company completed a private placement of 1.4 million unregistered shares of Common Stock at $6 per share, for $8.4 million. The Company anticipates that all of the net proceeds of\napproximately $7.5 million will be used to acquire currently marketed niche pharmaceutical products and acquire and further develop pharmaceutical products in late stages of clinical development.\nIn February 1996, The John N. Kapoor Trust exercised warrants to purchase 800,000 shares of the Company's Common Stock at an exercise price of $2.125, yielding $1.7 million to the Company.\nThe Company maintains adequate cash reserves and short-term investments to meet anticipated working capital, capital expenditure and business investment requirements.\nBACKLOG, SEASONALITY AND IMPACT OF INFLATION\nSales orders are typically filled shortly after receipt and, normally, do not result in a backlog. In general, the Company's products experience minor seasonal fluctuations. While raw material inputs to certain products are subject to price escalation, due to a limited number of suppliers, the complexity of manufacturing processes and regulatory procedures, the Company does not attribute this to inflation and does not anticipate inflation to have a significant impact on costs in the near future.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe consolidated financial statements and supplementary data are listed under Item 14 in this report.\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.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe following table summarizes the compensation for services to the Company for the fiscal year ended December 31, 1995, by the Chief Executive Officer and two highly compensated senior executive officers.\n- ------------------------- (1) Mr. Simes joined the Company on October 25, 1994. The 360,000 option shares granted in 1995 represents a new grant of 60,000 options on September 22, 1995, and a repricing of the 300,000 options granted in 1994. An employment agreement entered into between Mr. Simes and the Company provides for severance payments, upon termination, equal to his annual salary.\n(2) Mr. Riggs joined the Company on May 1, 1992. Effective November 1, 1995, Mr. Riggs began devoting 50% of his time to the Company. The 90,000 option shares granted in 1995 represents a new grant of 10,000 options on September 22, 1995, and a repricing of the 80,000 options granted in 1994.\n(3) Dr. Dudley joined the Company on December 12, 1994. An employment agreement entered into between Dr. Dudley and the Company provides for severance payments, upon termination, equal to 75% of his annual salary.\n(4) Represents the compensation portion of car allowances advanced to the executive officers listed above.\n(5) Represents the matching contribution ($4,620 per officer) made by the Company to the Unimed Pharmaceuticals, Inc. 401(k) Plan for each of the executive officers listed above. In addition to the Company 401(k) matching contribution, for Mr. Simes this amount represents insurance premiums paid ($4,018) by the Company for Mr. Simes, and the taxes ($1,932) associated with these premiums. For Dr. Dudley, this number represents the Company 401(k) matching contribution, expenses paid by the Company related to Dr. Dudley's relocation ($35,469), and the taxes associated with these relocation expenses ($11,676).\nThe following table sets forth information with respect to grants of options to purchase Common Stock granted to the Named Executive Officers during the fiscal year ended December 31, 1995:\nThe following table sets forth information with respect to stock options exercised during the fiscal year ended December 31, 1995 and the value at December 31, 1995 of unexercised stock options held by the Named Executive Officers:\n- ------------------------- * Represents the fair market value at December 31, 1995, of the Common Stock underlying the options minus the exercise price.\nThe following table shows stock options granted to the Named Executive Officers where the exercise price was adjusted (repriced) during the fiscal year ended December 31, 1995:\nDirectors who are not officers of the Company receive an annual stipend of $6,000 for serving on the Board and its committees, and additional $1,000 for each directors meeting they attend (excluding meetings held by telephone), $500 for each committee meeting they attend (excluding meetings held by telephone), and reimbursement of out-of-pocket expenses in connection with their attendance at directors meetings. The 1991 Stock Option Plan provides for a grant of options to purchase 10,000 shares of Common Stock to each new director who is not an officer on the date this person first becomes a director. The 1991 Stock Option Plan also provides for annual option grants of 7,500 shares of Common Stock to directors who are not officers.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\n- ------------------------- (1) Includes incentive stock options and non-qualified stock options exercisable within 60 days to purchase 160,000, 112,500, 42,328, 42,328, 41,170, 45,000, 17,500, and 15,000 shares of Common Stock held by Kapoor, Simes, Lempenau, Hunter, Weiser, Riggs, Holubow, and Dudley, respectively.\n(2) Includes 1,667,429 shares of Common Stock beneficially owned by the John N. Kapoor Trust, an \"affiliate\" of Dr. Kapoor. Includes 505,000 shares of Common Stock held by a limited partnership created for the benefit of Dr. Kapoor's family members, of which Dr. Kapoor is the General Partner.\n(3) Includes 2,100 shares of Common Stock owned of record by Mr. Hunter's wife.\n(4) See Footnotes 1 through 3.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nSee \"Note 13 -- Related Parties\" in the Notes to Consolidated Financial Statements included herein.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES AND REPORTS ON FORM 8-K.\n(a) and (d) Financial Statements\nSee Index to Consolidated Financial Statements and Schedules on page 28.\n(b) Reports on Form 8-K\nNone\n(c) Exhibits\n- ------------------------- * Filed herewith.\nUNIMED PHARMACEUTICALS, INC. AND SUBSIDIARIES\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE\nUNIMED PHARMACEUTICALS, INC. AND SUBSIDIARIES\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Stockholders and Board of Directors Unimed Pharmaceuticals, Inc.\nWe have audited the accompanying consolidated balance sheets of Unimed Pharmaceuticals, Inc. and Subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations, stockholders' equity and cash flows for the years ended December 31, 1995, 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 audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as 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 Unimed Pharmaceuticals, Inc. and Subsidiaries as of December 31, 1995 and 1994, and the consolidated results of their operations, stockholders' equity and cash flows for the years ended December 31, 1995, 1994 and 1993, in conformity with generally accepted accounting principles.\nCoopers & Lybrand L.L.P.\nCOOPERS & LYBRAND L.L.P.\nChicago, Illinois February 13, 1996, except for Note 14, as to which the date is February 29, 1996\nUNIMED PHARMACEUTICALS, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF OPERATIONS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSee accompanying notes to consolidated financial statements\nUNIMED PHARMACEUTICALS, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS DECEMBER 31, 1995 AND DECEMBER 31, 1994\nSee accompanying notes to consolidated financial statements\nUNIMED PHARMACEUTICALS, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSee accompanying notes to consolidated financial statements\nUNIMED PHARMACEUTICALS, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSee accompanying notes to consolidated financial statements\nUNIMED PHARMACEUTICALS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nUnimed Pharmaceuticals, Inc. (the Company) and its subsidiaries develop and market proprietary ethical pharmaceutical products in niche medical markets.\n(A) PRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the accounts of the Company and its subsidiaries after elimination of intercompany balances and transactions.\n(B) TRANSLATION OF FOREIGN CURRENCY AND RELATED MATTERS\nThe financial statements of the Company's foreign subsidiaries have been translated into U.S. dollars. Assets and liabilities of the subsidiaries have been translated using exchange rates in effect at the balance sheet date. The statements of operations have been translated using the average rates of exchange for the year. Adjustments resulting from the translations are accumulated in the stockholders' equity section of the consolidated balance sheets. Exchange gains or losses arising from the settlement of foreign currency transactions during the year are reflected in the consolidated statements of operations.\n(C) CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS\nCash and cash equivalents include liquid instruments purchased with original maturities of 90 or fewer days.\nThe Company has investments in short-term debt securities that have been classified under the provisions of SFAS No. 115 as held-to-maturity. Accordingly, these investments are measured at amortized cost and temporary unrealized gains or losses are not recognized.\n(D) INVENTORIES\nInventories are stated at the lower of cost (first-in, first-out) or market.\n(E) LEASEHOLD IMPROVEMENTS AND EQUIPMENT\nDepreciation is provided on a straight-line basis over the estimated useful lives of the applicable assets. Amortization of leasehold improvements is provided on a straight-line basis over the lesser of the estimated useful lives of improvements or the terms of the related leases. Expenditures for repairs and maintenance are charged to operations; replacements, renewals and betterments are capitalized. The cost and accumulated depreciation of assets retired or otherwise disposed of are eliminated from the accounts and any gains or losses on such dispositions are reflected in operations.\nUNIMED PHARMACEUTICALS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(F) INCOME TAXES\nDeferred tax liabilities and assets at the end of each period are determined using the tax rate expected to be in effect when taxes actually are paid or recovered. Accordingly, income tax expense will increase or decrease in the same period in which a change in the tax rates is enacted.\n(G) REVENUE RECOGNITION\nRevenues are recognized as earned in accordance with specific terms of each distribution, royalty and licensing agreement.\n(H) INCOME (LOSS) PER SHARE\nPrimary net income per share is computed by dividing net income by the weighted average number of common stock and common stock equivalents (when dilutive). Common stock equivalents include unexercised stock options and warrants. Fully diluted net income per share is computed based on the weighted average number of shares of common stock and common stock equivalents outstanding during the period, as if the common stock equivalents were converted into common stock at the beginning of the period.\n(I) MANAGEMENT ESTIMATES\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates.\n(J) ACCOUNTING FOR STOCK OPTIONS\nThe Company applies the provisions of Accounting Principles Board Opinion No. 25, \"Accounting for Stock Issued to Employees\", for its stock-based compensation program, and does not intend to adopt the fair value accounting rules as permitted by Statement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation\"(SFAS 123) which becomes effective for 1996. The Company intends to adopt the disclosure provision of SFAS 123 beginning in 1996.\n(K) RECLASSIFICATIONS\nCertain 1994 and 1993 amounts have been reclassified to conform to the 1995 presentation. These reclassifications had no effect on gross profit or net income (loss) for such periods.\n(2) INVENTORIES\nA summary of inventory components at December 31 follows:\nUNIMED PHARMACEUTICALS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(3) LEASEHOLD IMPROVEMENTS AND EQUIPMENT\nA summary of leasehold improvements and equipment at December 31 follows:\nThe Company has purchased and retains title to the majority of the equipment used by The NORAC Company, Inc. (NORAC) to manufacture Marinol (dronabinol). As of December 31, 1995 and 1994, the equipment had a net book value of $490,285 and $571,668, respectively.\n(4) PRODUCT DEVELOPMENT AND LICENSING AGREEMENTS\nRomark Laboratories, L.C.\nIn June 1995, the Company entered into a license agreement with Romark for the rights to develop and market NTZ, which treats a broad spectrum of parasitic infections, including a potentially life-threatening infection in AIDS patients. The agreement grants Unimed exclusive marketing rights to NTZ for all therapeutic indications for oral use in the United States, Canada, Australia and New Zealand. The Company also received rights to the IV formulations for use in treating cryptosporidiosos. In exchange for these exclusive marketing rights, Unimed will pay Romark royalties if Unimed receives regulatory approval to market NTZ. Romark will manufacture NTZ exclusively for Unimed in Unimed countries. To date, Unimed has invested $600,000 in Romark in exchange for a 6% equity interest in Romark. The Company will invest another $400,000 for an additional 4% equity interest in Romark as certain development milestones are met.\nBesins Iscovesco\nIn August 1995, Unimed entered into a licensing agreement with Besins Iscovesco (Besins) of Paris, France, for two products to treat testosterone deficiency in men. The products are gel formulations of testosterone, the natural male hormone, and dihydrotestosterone (DHT), which is the active metabolite of testosterone in the human body. Unimed acquired exclusive marketing rights to the testosterone products for all therapeutic indications in the United States, Canada and Mexico. In exchange for the license to the two testosterone products, Unimed issued Besins 72,600 Common shares and warrants to purchase 72,550 shares of Unimed Common Stock at $8.00 per share in 1995 and will issue Besins 72,500 Common shares in 1996. These rights have been included in other assets and will be amortized over 10 years after the products become available in the market. Besins will manufacture the products for Unimed, which will pay royalties to Besins if the products are approved for marketing. Besins was required to make two $500,000 payments to Unimed, to be applied to product development classified as deferred revenues as of December 31, 1995.\nSimultaneous to the signing of the Besins agreement, the Company recognized an other asset of approximately $585,000 in marketing\/property rights, which included a $280,000 payable that was paid through the issuance of the Company's Common Stock in January 1996.\nUNIMED PHARMACEUTICALS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nMedisperse Restructure Agreement\nIn November 1995, Unimed entered into a restructuring and royalty agreement relative to the Medisperse partnership. While Unimed withdrew (through its wholly owned subsidiary) as a general partner and also transferred its limited partnership interest, its financial investment in the partnership remains protected. It will receive royalties on any products that result from the Medisperse partnership in an amount at least as attractive as if Unimed remained in the partnership. The Company is aiding in the search for a licensee for further development of the Medisperse technology. Unimed has no future funding obligations associated with the partnership. As of December 31, 1995, the Company's investment in Medisperse was reduced by $106,000 to its net realizable value.\n(5) SHORT-TERM INVESTMENTS\nShort-term investments in debt securities, were as follows:\n(6) INCOME TAXES\nThe provision for income taxes is comprised of the following:\nIncome tax provisions from continuing operations differed from the taxes calculated at the statutory federal rate as follows:\nAt December 31, 1995, the Company has a tax loss carryforward of approximately $10,033,000 for federal income tax purposes, which expires in the years 2001 through 2010. The Company had a capital loss carryforward of approximately $380,000 that expired in 1995. The Company has available a research and development credit carryforward at December 31, 1995, of approximately $430,000, which expires in the years 2003 through 2010. Management has recorded a 100% valuation allowance against deferred tax assets as a result of unexpected future taxable income.\nUNIMED PHARMACEUTICALS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nThe effect of the components of net deferred taxes are as follows:\n(7) DISTRIBUTION, RESEARCH, ROYALTY AND LICENSING AGREEMENTS\nIn February 1986, the Company entered into a distribution agreement with Roxane, making Roxane the Company's exclusive distributor of Marinol in the United States. The Company and Roxane subsequently agreed that Puerto Rico is not part of the United States territory. Roxane distribution of Marinol began in July 1986 in the United States. From October 1991 through March 1993, Boehringer Ingelheim distributed Marinol in Canada. In March 1993, Sanofi Winthrop started to distribute Marinol in Canada under a separate agreement. The Roxane Marinol agreement sets forth a formula for the royalties paid on net sales of Marinol on an equal basis. The Sanofi agreement pays a royalty-based commission on net sales of 55% to Sanofi Winthrop and 45% to Unimed. Marinol gross sales were $8,395,292 (1995), $7,054,417 (1994) and $6,229,202 (1993). As of December 31, 1995 and 1994, trade receivables included $1,468,040 and $969,278, respectively, due from Roxane. Under a separate contract, Roxane has agreed to reimburse the Company for half of the external research costs incurred in further clinical development of Marinol. Roxane and Unimed have agreed to fund additional Marinol clinical trials for which budgeted costs have been mutually agreed upon. Such reimbursements shall not exceed $3 million without prior written approval by the parties. Roxane paid $92,334 (1995), $33,889 (1994) and $48,990 (1993) of these costs, which is netted against research and development expenses.\nIn November 1990, the Company entered into an inventory agreement with Roxane, under which Roxane will advance funds at no interest to the Company for the purpose of producing and maintaining a three-year raw material inventory of Marinol. Roxane advances funds to the Company for the Marinol encapsulation process as capsules are produced. Advances are offset as inventory is sold by Roxane.\nThe Company has various other licensing, marketing and distribution agreements typical to its business.\n(8) WARRANTS\nIn March 1991, The John N. Kapoor Trust (the Trust) purchased for $1.5 million, 1.2 million shares of the Company's Common Stock and warrants to purchase 800,000 shares of the Company's Common Stock at an exercise price of $2.125. These warrants, which would have expired March 31, 1996, contained certain antidilution provisions for adjustment of the exercise price and the number of warrants. If the Company were\nUNIMED PHARMACEUTICALS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nto issue Common Stock or securities convertible into Common Stock, the Trust, with certain specified exceptions, would have had the right to maintain its percentage ownership of the Common Stock of the Company and\/or a right of first refusal on all or any portion of the Common Stock proposed to be sold. These rights could not be exercised if this would cause the Trust and its affiliates to own more than 38% of Unimed's Common Stock, assuming exercise of the Trust Warrant. As of December 31, 1995, the 800,000 share warrant had not been exercised. The Trust had an option expiring February 24, 1993, to purchase 153,529 shares of Common Stock at a purchase price of $2.35 in satisfaction of its right to maintain ownership. The Trust exercised this option and shares were issued in April 1993. See \"Note 14 -- Subsequent Events\" in Notes to Consolidated Financial Statements.\nIn April 1992, the Company granted to LifeScience Corporation warrants to purchase 50,000 shares of Common Stock at an exercise price of $8.375 per share, with an expiration date of April 1, 1997. As of December 31, 1995, the 50,000 share warrant had not been exercised.\n(9) STOCK OPTIONS\n(A) INCENTIVE STOCK OPTION PLAN\nThe following summarizes transactions under the 1981 Incentive Stock Option Plan for the periods ended December 31, 1993, 1994 and 1995:\nAs of December 31, 1995, there were no stock options exercisable under the Plan.\n(B) 1991 STOCK OPTION PLAN\nUnder the 1991 Stock Option Plan (the Plan), 1,000,000 shares of the Company's Common Stock were reserved for granting stock options to directors, officers, and key employees and consultants of the Company and its subsidiaries. The holder of the option must remain in the continuous employ of the Company for at least one year from the date the option is granted before exercising any part of the option. Options expire 10 years from the date of grant or 90 days after termination of employment.\nUNIMED PHARMACEUTICALS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nThe following summarizes transactions under the Plan for the three years ended December 31, 1995:\nThrough December 31, 1995, options issued had an exercise price ranging from $2.75 to $9.25 per share, and as of December 31, 1995, there were 309,504 stock options exercisable. The Company repriced certain options to current market levels in 1994 and 1995.\n(C) OTHER STOCK OPTIONS\nIn November 1986, reflecting employment contracts with certain executives, the Company granted to these executives nonqualified options to purchase 220,000 shares of Common Stock through March 1999 at $15.00 per share as adjusted and amended. In January 1988, the exercise price of these options was changed to $5.38. In March 1991, the exercise price of those options was changed to $4.36, and the number of options was adjusted to 271,216 shares of Common Stock pursuant to certain antidilution provisions discussed below. In addition during March 1991, the Board of Directors extended the expiration date of the outstanding options to March 1999. Through December 31, 1995, 29,500 options had been exercised, none had been canceled, and 241,716 options were outstanding.\nIn March 1987, the Company granted to non-officer members of the Board of Directors nonqualified options to purchase an aggregate of 50,000 shares of Common Stock at $8.50 per share. In January 1988, the exercise price of these options was changed to $5.38. During fiscal 1991 and fiscal 1990, the options to purchase 10,000 and 20,000 of these shares, respectively, were canceled. In March 1991, the exercise price of those options remaining was changed to $4.36 and the number of options was adjusted to 24,656 shares of Common Stock, reflecting certain antidilution provisions discussed below. In addition, during March 1991, the Board of Directors extended the expiration date of the outstanding options to March 1999. There were no exercises or cancellations during 1993, 1994, or 1995.\nIn November 1989, additional nonqualified options to purchase 20,000 shares of Common Stock at $2.63 per share were granted to non-officer members of the Board. During fiscal 1991, the option to purchase 10,000 of these shares was canceled. In March 1991, the exercise price of the remaining options was changed to $2.35 and the number of options remaining was adjusted to 11,170 shares of Common Stock pursuant to certain antidilution provisions discussed below. In addition, during March 1991, the Board extended the expiration date of the outstanding options to March 1999. There were no exercises or cancellations during 1993, 1994, or 1995.\nUNIMED PHARMACEUTICALS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nIn March 1991, the Company granted to employees nonqualified options to purchase 120,000 shares of Common Stock at $3.00 per share. A majority of these options vest over four years. The option price was below the market price at the date of grant, and the Company has recognized the pro rata compensation expense representing the difference between the option price and fair market value at the date of grant of approximately $27,000 in 1993. As of December 31, 1995, 60,000 options had been exercised, 51,500 had been canceled and 8,500 options were outstanding.\nIn March 1991, the Company granted to past and present members of the Board nonqualified options to purchase 20,000 shares of Common Stock at $3.00 per share for prior years of service. The grant price was below the market price. The Company recognized a compensation expense at the date of grant of $35,000. There were no exercises or cancellations during 1993, 1994, or 1995.\nIn March 1991, the Company granted to non-officer members of the Board nonqualified options to purchase 20,000 shares of Common Stock at $4.75 per share. There were no exercises or cancellations during 1993, 1994, or 1995.\nIn addition during April, May and October 1991, the Company granted to employees nonqualified options to purchase 26,000 shares of Common Stock with exercise prices ranging from $4.25 to $7.75. As of December 31, 1995, 8,750 options had been exercised, 15,000 had been canceled and 2,250 options were outstanding.\nIn August 1992, the Company granted to John Kapoor, Chairman of the Board, nonqualified options to purchase 200,000 shares of Common Stock at $7.75 per share. There were no exercises or cancellations during 1993, 1994, or 1995.\nThe exercise price and number of shares of Common Stock which can be purchased upon the exercise of the nonqualified stock options are adjusted in the event of stock dividends, split-ups, combinations or exchanges of shares by recapitalization or reclassification. The exercise price and number of shares of Common Stock purchasable upon the exercise of certain nonqualified stock options also are adjusted in the case of the issuance of Common Stock by the Company (other than pursuant to the grant of stock options and restricted stock grants) below the then existing exercise price.\nThere are 528,292 shares of the Company's Common Stock reserved for these arrangements as of December 31, 1995.\n(10) RETIREMENT PLAN\nThe Company offers a discretionary 401(k)Plan (the Plan) to its employees. Under the Plan, employees may defer income on a tax exempt basis, subject to IRS limitation. All employees are eligible to participate in the Plan. Under the Plan, the Company may make discretionary matching contributions. Company contributions paid and expensed in 1995 totaled $42,901. There were no Company contributions to the Plan in 1994 or 1993.\n(11) COMMITMENTS\nThe Company is obligated for rental expense under a noncancellable operating lease relating to an office facility. Real estate taxes, insurance and maintenance expenses generally are Company obligations. Rental\nUNIMED PHARMACEUTICALS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nexpenses charged to operations were approximately $193,000 in 1995, $225,000 in 1994, and $155,000 in 1993. At December 31, 1995, approximate amounts committed for future fiscal years are as follows:\nManagement expects that in the normal course of business, leases that expire will be renewed or replaced by other leases.\nThe Company has an agreement with NORAC to purchase Delta-9, the raw material in Marinol. The Company has come to terms on a five-year extension to the agreement to December 31, 1999. Delta-9 is synthesized and purified through a complex and time-consuming process. NORAC is the Company's sole supplier of Delta-9. Currently, the Company maintains a three-year supply of Delta-9.\n(12) CONTINGENCIES\nThe pharmaceutical industry has traditionally experienced difficulty in maintaining product liability insurance coverage at desired levels. To date, no significant product liability suit has ever been filed against the Company. However, if a suit were filed and a judgment entered against the Company that significantly exceeded the policy limits, it could have a material adverse effect upon the Company's operations and financial condition.\n(13) RELATED PARTIES\nEJ Financial Enterprises, Inc. (EJ) is a healthcare investment and consulting company owned by the Company's chairman, an indirect majority stockholder. In addition to the distribution, research, royalty and licensing agreements discussed in Note 7 which were terminated, the Company and EJ currently have a consulting agreement, ending in 1996, which provides for EJ's assistance in the Company's product licensing, development and marketing efforts. The agreement can be cancelled by either party upon 30 days prior written notice. Expenditures under this agreement totaled approximately $50,000 (1995), $106,250 (1994) and $150,000 (1993).\nThe Company has an interest-bearing note of approximately $132,000 from one of the Company's officers. The note bears interest at a rate of 6% and is included in other assets.\n(14) SUBSEQUENT EVENTS\n(A) SERC(R) LICENSE AGREEMENT; SALE OF PRODUCT AND TRADEMARK RIGHTS\nThe Company entered into an agreement in January 1996 with Solvay Duphar of The Netherlands. Unimed licensed the rights to proprietary know-how and manufacturing for the drug SERC(R) (betahistine hydrochloride) in the United States. As part of the agreement, the Company received a $1.4 million payment to help fund product development and for Unimed's product and trademark rights to SERC(R) in Canada, Australia and South Africa. The Company will buy all requirements of Serc(R) from Solvay Duphar, and will pay a royalty on sales of Serc(R) in the United States, if the drug is approved for marketing.\nUNIMED PHARMACEUTICALS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(B) WARRANT EXERCISE\nIn February 1996, The John N. Kapoor Trust exercised warrants to purchase 800,000 shares of the Company's common stock at an exercise price of $2.125. These warrants, which yielded $1.7 million to the Company, were issued in March 1991 and were to expire March 31, 1996.\n(C) PRIVATE PLACEMENT OF COMMON STOCK\nOn February 29, 1996, the Company completed a private placement of 1.4 million unregistered shares of common stock at $6 per share, for $8.4 million. The Company will use its best efforts to file, within 30 days of the final closing, a registration statement with the Securities and Exchange Commission on Form S-3 covering the resale of the shares of Common Stock.\nREPORT OF INDEPENDENT ACCOUNTANTS\nON FINANCIAL STATEMENT SCHEDULE\nTo the Stockholders and Board of Directors Unimed Pharmaceuticals, Inc.\nOur report on the consolidated financial statements of Unimed Pharmaceuticals, Inc. 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 schedule listed in the index on page of this Form 10-K.\nIn our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.\nCoopers & Lybrand L.L.P.\nCOOPERS & LYBRAND L.L.P.\nChicago, Illinois February 13, 1996\nSCHEDULE II\nUNIMED PHARMACEUTICALS, INC. AND SUBSIDIARIES\nVALUATION AND QUALIFYING ACCOUNTS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nEXHIBIT 11\nUNIMED PHARMACEUTICALS, INC. AND SUBSIDIARIES\nCOMPUTATION OF INCOME (LOSS) PER SHARE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n- ------------------------- Note:\n(1) The fully diluted calculation is not presented in the 1994 and 1993 computations since they would have been antidilutive, as the resultant net income (loss) per share is the same as for primary net income (loss) per share.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the Undersigned, thereunder duly authorized.\nUNIMED PHARMACEUTICALS, INC.\nBy: \/s\/ STEPHEN M. SIMES\n------------------------------------ Stephen M. Simes President and Chief Executive Officer\nApril 1, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, 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":"9672_1995.txt","cik":"9672","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"ITEM 3. LEGAL PROCEEDINGS ________________________________________________________________________________ Due to the nature of its business, BAC is subject to various threatened or filed legal actions. Although the amount of the ultimate exposure, if any, cannot be determined at this time, BAC, based upon the advice of counsel, does not expect the final outcome of threatened or filed suits to have a material adverse effect on its financial position.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ________________________________________________________________________________\nNone.\nPART II\n================================================================================\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS ________________________________________________________________________________\nInformation on dividend restrictions, dividend payments, the principal market for and trading price of the Parent's common stock, and the number of holders of such stock is incorporated by reference from pages 16, 17, and 43, Note 24 on pages 79 through 81, and Note 26 on page 83 of the 1995 Annual Report to Shareholders.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA ________________________________________________________________________________\nSelected financial data is incorporated by reference from pages 16 and 17 of the 1995 Annual Report to Shareholders.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ________________________________________________________________________________\nManagement's Discussion and Analysis of Financial Condition and Results of Operations is incorporated by reference from pages 16 through 45 of the 1995 Annual Report to Shareholders.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ________________________________________________________________________________\nThe Report of Independent Auditors, the consolidated financial statements, and the notes to consolidated financial statements are incorporated by reference from pages 47 through 83 of the 1995 Annual Report to Shareholders. See Item 14 of this report for information concerning financial statements and schedules filed with this report.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE ________________________________________________________________________________\nNone.\nPART III\n================================================================================\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT ________________________________________________________________________________ Reference is made to the text under the captions, \"Executive Compensation, Benefits and Related Matters\" (excluding the material under the headings \"Report of Executive Personnel and Compensation Committee\" and \"Shareholder Return Performance Graph\" therein) and \"Item No. 1--Election of Directors\" in the Proxy Statement for the May 23, 1996 Annual Meeting of Shareholders of the Parent for incorporation of information concerning directors and persons nominated to become directors. Information concerning executive officers of the Parent as of March 1, 1996 is set forth below.\nRICHARD M. ROSENBERG relinquished his title as Chief Executive Officer on December 31, 1995 and his title as President on August 7, 1995. He was previously appointed Chairman and Chief Executive Officer of the Parent and the Bank on May 24, 1990, in addition to his title as President. He was appointed President of the Parent and the Bank on February 5, 1990. On April 22, 1992, Mr. Rosenberg relinquished his title as President, but was reappointed President on October 5, 1992.\nDAVID A. COULTER was appointed Chief Executive Officer of the Parent and the Bank on January 1, 1996, in addition to his title as President. He was appointed to the Board of Directors of the Parent and the Bank on October 2, 1995. He was appointed President of the Parent and the Bank on August 7, 1995. Previously he was Vice Chairman of the Parent and the Bank from February 1993 to August 1995. He was appointed Group Executive Vice President of the Bank on April 27, 1992. He was Executive Vice President of the Bank and head of the Bank's U.S. Corporate Group from 1990 to 1992.\n================================================================================\nKATHLEEN J. BURKE was appointed Vice Chairman of the Parent and the Bank on March 14, 1994, in addition to her title as Personnel Relations Officer of the Parent. She was appointed Executive Vice President and Personnel Relations Officer of the Parent and Executive Vice President of the Bank on April 22, 1992 and Group Executive Vice President of the Bank on April 27, 1992. Previously, she was Executive Vice President and Director of Human Resources of Security Pacific Corporation and its principal subsidiary, Security Pacific National Bank from 1989 to 1992.\nLUKE S. HELMS was appointed Vice Chairman of the Parent and the Bank on August 2, 1993. Previously, he was Chairman and Chief Executive Officer of Seafirst Corporation and SFNB from 1990 to 1993.\nJACK L. MEYERS was appointed Vice Chairman of the Parent and the Bank on October 4, 1993. He was appointed Chief Credit Officer of the Bank on September 3, 1993. He was Group Executive Vice President responsible for the Bank's Commercial Business Group from 1991 to 1993.\nMICHAEL J. MURRAY was appointed Vice Chairman of the Parent and the Bank on October 2, 1995. Previously, he was Group Executive Vice President responsible for the Bank's U.S. Corporate Group from September 1994 to September 1995. From 1993 to 1994, Mr. Murrary served as Vice Chairman of Continental. Previously, he was Executive Vice President and head of Corporate Banking for Continental from 1991 to 1993.\nMICHAEL E. O'NEILL was appointed Vice Chairman and Chief Financial Officer of the Parent and the Bank on December 4, 1995. Previously, he was Group Executive Vice President of the Bank and head of the Global Equity Investments Group from September 1994 to November 1995. From 1993 to 1994, Mr. O'Neill served as Chief Financial Officer of Continental. Previously, he was Chief of Staff of Capital Markets Investments and Trading for Continental from 1990 to 1993.\nTHOMAS E. PETERSON was appointed Vice Chairman of the Parent and the Bank on February 5, 1990. Previously, he was Executive Vice President of the Bank and head of Retail Banking from 1987 to 1990.\nMICHAEL E. ROSSI was appointed Vice Chairman of the Parent and the Bank on October 7, 1991. He was appointed Executive Vice President of the Parent on December 3, 1990, when he was also designated as the head of Credit Policy for the Bank.\nMARTIN A. STEIN was appointed Vice Chairman of the Parent and the Bank on April 27, 1992. He was appointed Executive Vice President of the Parent and the Bank on June 25, 1990. At the same time, he was appointed head of the BankAmerica Systems Engineering Group of the Bank.\nThe present term of office for the officers named above will expire on May 23, 1996 or on their earlier retirement, resignation, or removal. There is no family relationship among any such officers.\n================================================================================\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION ________________________________________________________________________________\nInformation concerning executive compensation is incorporated by reference from the text under the captions, \"Corporate Governance-Director Remuneration, Stock Ownership Guidelines, Retirement and Attendance\" and \"Executive Compensation, Benefits and Related Matters\" (excluding the material under the headings \"Report of the Executive Personnel and Compensation Committee\" and \"Shareholder Return Performance Graph\" therein) in the Proxy Statement for the May 23, 1996 Annual Meeting of Shareholders.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT ________________________________________________________________________________\nInformation concerning ownership of equity stock of the Parent by certain beneficial owners and management is incorporated by reference from the text under the caption, \"Security Ownership of Certain Beneficial Owners\" in the Proxy Statement for the May 23, 1996 Annual Meeting of Shareholders.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ________________________________________________________________________________\nInformation concerning certain relationships and related transactions with officers and directors is incorporated by reference from the text under the caption, \"Executive Compensation, Benefits and Related Matters\" (excluding the material under the headings \"Report of the Executive Personnel and Compensation Committee\" and \"Shareholder Return Performance Graph\" therein) in the Proxy Statement for the May 23, 1996 Annual Meeting of Shareholders.\nPART IV\n================================================================================\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K ________________________________________________________________________________\n(A)(1) FINANCIAL The report of independent auditors and the following STATEMENTS consolidated financial statements of BAC are incorporated herein by reference from the 1995 Annual Report to Shareholders. Page number references are to the 1995 Annual Report to Shareholders.\n________________________________________________________________________________\n(A)(2) FINANCIAL Schedules to the consolidated financial statements (Nos. I STATEMENT and II of Rule 9-07) for which provision is made in the SCHEDULES applicable accounting regulation of the Securities and Exchange Commission (Regulation S-X) are inapplicable and therefore, are not included.\nFinancial statements and summarized financial information of unconsolidated subsidiaries or 50% or less owned persons accounted for by the equity method are not included as such subsidiaries do not, either individually or in the aggregate, constitute a significant subsidiary.\n________________________________________________________________________________\n(A)(3) EXHIBITS\n================================================================================\n---------------------- \/a\/Management contract or compensatory plan, contract, or arrangement.\n---------------------- \/a\/Management contract or compensatory plan, contract, or arrangement. ________________________________________________________________________________\n(B)REPORTS ON During the fourth quarter of 1995, the Parent filed reports FORM 8-K on Form 8-K dated October 2, 1995, October 18, 1995 and November 14, 1995. The October 2, 1995 report filed, pursuant to Items 5 and 7 of the report, a copy of the Parent's press release titled \"BankAmerica Board Increases Preferred Stock Repurchase Authorization to $750 Million from $500 Million.\" The October 18, 1995 report filed, pursuant to Items 5 and 7 of the report, a copy of the Parent's press release titled \"BankAmerica Third Quarter Earnings.\" The November 14, 1995 report disclosed, pursuant to Item 5 of the report, the resignation of an individual as a member of the Parent's board of directors and as one of its executive officers. After the fourth quarter of 1995, the Parent filed reports on Form 8-K dated January 17, 1996, February 5, 1996, and March 4, 1996. The January 17, 1996 report filed, pursuant to Items 5 and 7 of the report, a copy of the Parent's press release titled \"BankAmerica Fourth Quarter Earnings.\" The February 5, 1996 report disclosed, pursuant to Item 5 of the report, the Parent board of directors' decision to increase the quarterly dividend on its common stock. The March 4, 1996 report filed, pursuant to Items 5 and 7 of the report, a copy of the Parent's press release titled \"BankAmerica Increases Stock Repurchase Program.\"\nSIGNATURES\n================================================================================\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nMarch 15, 1996 BANKAMERICA CORPORATION\nBy \/s\/ JAMES H. WILLIAMS ------------------------ (James H. Williams, Executive Vice President and Chief Accounting Officer)\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nA majority of the members of the Board of Directors.\n*By \/s\/ CHERYL SOROKIN ----------------------------------- (Cheryl Sorokin, Attorney-in-Fact)\nDated: March 15, 1996\nOther information about BankAmerica Corporation may be found in its quarterly Analytical Review and Form 10-Q and its Annual Report to Shareholders. These reports, as well as additional copies of this Form 10-K, may be obtained from:\nBank of America Corporate Public Relations #13124 P.O. Box 37000 San Francisco, CA 94137\nInformation Online -- To keep current online via the Internet, visit BankAmerica Corporation's home page on the World Wide Web (http:\/\/www.bankamerica.com) to view the latest information about the corporation and its products and services, or apply for a loan or credit card. Corporate disclosure documents filed with the Securities and Exchange Commission by BankAmerica Corporation and other companies can be obtained from the Securities and Exchange Commission's home page on the World Wide Web (http:\/\/www.sec.gov.)\n[LOGO OF BANKAMERICA APPEARS HERE]\n________________________________________________________________________________\n[LOGO OF RECYCLED NL-9 2-96 PAPER APPEARS HERE]\n================================================================================ EXHIBIT INDEX\n---------------------- \/a\/Management contract or compensatory plan, contract, or arrangement.\n---------------------- \/a\/Management contract or compensatory plan, contract, or arrangement.","section_15":""}
{"filename":"216430_1995.txt","cik":"216430","year":"1995","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 13 manufacturing plants in the United States and Europe. Through licensees, agents and direct exporters, Liqui-Box serves markets in many countries worldwide.\nDESCRIPTION OF PRINCIPAL PRODUCTS - The principal product of the Company is plastic packaging. Such packaging includes specialty plastic bags and plastic blow molded containers; injection molded plastic products used in liquid packaging and a variety of industrial and commercial plastic packaging films. In addition, the Company manufactures equipment for filling such packaging products (less than 2% of total net sales). 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 1995, the Company maintained its position 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 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 17%, 15% and 13% of total sales in 1995, 1994 and 1993, 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 1995, 1994 and 1993 were $1,265,000, $2,151,000 and $1,954,000, 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 14 and 15 [Management's Discussion and Analysis] and on Page 22 [Note 1, Accounting Policies, of the Notes to Consolidated Financial Statements] of the 1995 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 non food 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 809 individuals in its operations throughout the United States and in Europe on December 30, 1995. Approximately 11% 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 13% of consolidated net sales, less than 10% of consolidated income before taxes and 24% of consolidated identifiable assets as of and for the year ended December 30, 1995. European operations constituted 12% of net sales, less than 10% of consolidated income before taxes and 18% of identifiable assets as of and for the year ended December 31, 1994. Further information can be found on page 29 [Note 10 of the Notes to Consolidated Financial Statements] of the 1995 Annual Report and is incorporated herein by reference.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties:\nAt December 30, 1995, the Company owned or leased property at eighteen (18) locations for manufacturing, warehousing, and offices with a total of approximately 685,000 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 26, 1996, 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.\n(1) Samuel B. Davis has been Chairman of the Board, Chief Executive Officer and Treasurer since August, 1982. Mr. Davis became President in September, 1991 upon the retirement of Robert S. Hamilton.\n(2) Robert S. Hamilton has been Vice Chairman of the Board since July, 1989. Mr. Hamilton was President and Chief Operating Officer from April, 1984 to September, 1991 with a period of retirement from January, 1990 to May, 1990 and another period of retirement from September, 1991 until May 1995.\n(3) Peter J. Linn has been Secretary since April 1990. Mr. Linn was Senior Vice President from February, 1994 until April 1995. From January, 1983 to February, 1994, he held the position of Executive Vice President.\n(4) C. William McBee became a director in April, 1995. Mr. McBee became Vice President, Manufacturing in October, 1994. From February, 1994 to October, 1995, Mr. McBee was Vice President of Administration. Prior to February, 1994, Mr. McBee was a General Manager for Stone Container Corporation, Columbus, Indiana, a manufacturer of corrugated cardboard containers.\n(5) Juan Jose Perez became Vice President, Administration and an executive officer in October, 1995. Since October, 1994, Mr. Perez has held the position of General Counsel. Prior to October, 1994, Mr. Perez was a partner in the law firm of Schwartz, Kelm, Warren & Rameriez.\nPART IV\nItem 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 1995 Annual Report, are incorporated by reference in Item 8","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":"Item 14. (continued)\n(a) (3) Listing of Exhibits - The following exhibits are included in Item 14(c). The page number indicates the location of the exhibit in this Form 10-K.\n(b) No report on Form 8-K was filed during the fourteen weeks ended December 30, 1995. N\/A\n(c) Exhibits filed with this Annual Report on Form 10-K are attached hereto. See Index to Exhibits at page 12.\n(d) Financial Statement Schedules -- See Item 14.(a)(2)\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS (amounts rounded to the nearest thousand dollars)\nLIQUI-BOX CORPORATION AND SUBSIDIARIES\n(1) Uncollectible accounts written off, net of recoveries.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nLIQUI-BOX CORPORATION\n3\/28\/96 * Samuel B. Davis\nDate: ________________________ By: _________________________________ Samuel B. Davis Chairman of the Board, Chief Executive Officer, President, Treasurer 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.\n3\/28\/96 * Samuel B. Davis\nDate: ________________________ By: _________________________________ Samuel B. Davis Chairman of the Board, Chief Executive Officer, President, Treasurer and Director (Principal Executive and Financial Officer)\n3\/28\/96 * Jeanette A. Davis\nDate: ________________________ By: _________________________________ Jeanette A. Davis Director\n3\/28\/96 * Robert S. Hamilton\nDate: ________________________ By: _________________________________ Robert S. Hamilton Vice Chairman and Director\n3\/28\/96 * Peter J. Linn\nDate: ________________________ By: _________________________________ Peter J. Linn Secretary and Director\n3\/28\/96 * C. William McBee\nDate: ________________________ By: _________________________________ C. William McBee Director\n3\/28\/96 * Carl J. Aschinger, Jr.\nDate: ________________________ By: _________________________________ Carl J. Aschinger, Jr. Director\n3\/28\/96\nDate: ________________________ By: _________________________________ Russell M. Gertmenian Director\n3\/28\/96 * James B Holloway\nDate: ________________________ By: _________________________________ James B Holloway Controller\n- -----------------------\n\/S\/ Juan Jose Perez 3\/28\/96 Date: ________________________ *By: _________________________________ Juan Jose Perez Attorney in Fact\nREPORT OF INDEPENDENT AUDITORS\nThe Board of Directors Liqui-Box Corporation Worthington, Ohio\nWe have audited the accompanying consolidated balance sheet of Liqui-Box Corporation and subsidiaries as of December 31, 1994, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the two years in the periods ended December 31, 1994 and January 1, 1994. Our audits also included the financial statement schedule listed in the index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Liqui-Box Corporation and subsidiaries at December 31, 1994, and the consolidated results of their operations and their cash flows for each of the two years in the periods ended December 31, 1994 and January 1, 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\nColumbus, Ohio March 2, 1995\nIndex to Exhibits\nListing of Exhibits - The following exhibits are included in Item 14(c). The page number indicates the location of the exhibit in this Form 10-K.","section_15":""}
{"filename":"821536_1995.txt","cik":"821536","year":"1995","section_1":"Item 1. Business\nHEARx Ltd. (\"HEARx\" or the \"Company\") operates a network of hearing care centers which provide a full range of audiological products and services for the hearing impaired. The Company's strategy focuses on contracting with managed care and health insurance companies to provide to their members and beneficiaries high quality hearing care utilizing state-of-the-art facilities with a full range of diagnostic and rehabilitative services, qualified professional staff and hearing education learning programs. The Company also provides such quality hearing care to the general population at the Company's centers. The Company believes it is well positioned to successfully address the concerns of access, quality and cost of the managed care and insurance companies, the diagnostic needs of referring physicians and, ultimately, the hearing health needs of consumers. HEARx believes that such success requires the Company to offer convenient distribution points, uniform centers (meaning standardized personnel qualifications, testing formats, prices and ancillary services) and a documented quality control program.\nHEARx intends, as its ultimate goal, to establish a nationwide network of hearing care centers, located in metropolitan areas or in regions with high concentrations of elderly consumers who are more likely to need the Company's products and services. At the present time, HEARx operates 44 centers in New York, New Jersey and Florida. It also operates three company-owned centers situated in AARP Pharmacies located in Florida, Virginia and Oregon. The HEARx expansion strategy is controlled and deliberate, opening new centers to fulfill the requirements of new or existing providers pursuant to negotiated contracts between those providers and the Company.\nDuring the fiscal year ended December 29, 1995, HEARx derived its revenues from two primary sources: sales of hearing care products (approximately 87%, 89% and 94% of revenues for the fiscal years ended December 29, 1995, December 30, 1994, and September 30, 1993, respectively), and the provision of hearing care diagnostics related to diseases of the ear (approximately 13%, 11%\nand 6% of revenues for the fiscal years ended December 29, 1995, December 30, 1994, and September 30, 1993, respectively).\nHEARx was incorporated in Delaware on April 11, 1986.\nFacilities and Services\nEach HEARx center is staffed or supervised by a minimum of one professionally trained, licensed and certified audiologist and at least one patient care coordinator. The majority of the Company centers are located in conveniently accessible strip shopping centers and are typically 1,500 to 2,000 square feet in size. The Company's goal is to have all centers virtually identical in interior space design, exterior markings and signage. This uniform appearance helps reinforce the consistent service and quality the Company provides to customers at all locations. Each center provides comprehensive hearing services that include:\n* A facility equipped with soundproof testing booths and state-of-the- art testing equipment that meets or exceeds all state standards.\n* A full range of diagnostic and auditory-vestibular tests that assist the physician in the treatment of patients with hearing and balance disorders. Some of these services include auditory brainstem evoked potentials, electronystagmography and immittance audiometry.\n* An aural rehabilitation program available to all patients to help them better understand their disability.\n* A wide variety of hearing aid brands to meet the patient's needs.\n* A standardized medical reporting system for feedback to the referring physicians.\nProducts\nUnlike the national franchise organizations (Miracle Ear and Beltone) which sell only their own brand of hearing aid, HEARx has selected approximately six of the major worldwide manufacturers' products (Siemens, Rexton, 3M, GN Danavox, ReSound and Telex) to make available through the HEARx network in order to provide the best possible hearing care for HEARx customers.\nIn addition, HEARx offers a large selection of other hearing enhancement devices including telephone and television amplifiers, telecaptioners and decoders, pocket talkers, and specially adapted telephones, alarm clocks, doorbells and fire alarms. These products are sold in most of the centers and through a direct mail catalog.\nCustomers and Marketing\nApproximately 86% of HEARx's hearing aid sales in the fiscal year ended December 29, 1995, came either as a result of physician referrals or through contracts with various institutional buyers (such as health maintenance organizations, insurance companies, unions or AARP Pharmacy Service). The Company believes that its future growth depends on its ability to inform hearing impaired consumers of the importance of professional hearing testing\nand the availability of quality hearing devices. The Company expects to continue to establish relationships with health organizations and physicians that promote HEARx to the hearing impaired.\nBecause HEARx believes that hearing loss is a medical problem and not simply a \"retail opportunity\", the Company encourages all patients to see a physician prior to purchasing a hearing aid. All patients referred to HEARx from a physician receive a special discount intended to cover the cost of their medical visit. With this program, the Company believes it has established strong relationships with area physicians which represent a significant source of patient referrals. HEARx further maintains these relationships using its computerized medical reporting system to provide each referring physician a full report on each of their patient's visits to HEARx.\nHEARx's marketing plan focuses on educating both physicians and patients on the need for regular hearing testing and the importance of hearing aids and other assistive listening devices in improving qualify of life for the hearing impaired. The Company works to further its image as a provider of highly professional services, quality products, and comprehensive, post-sale consumer education. In connection with its marketing program, HEARx has developed a direct consumer marketing campaign which utilizes television, radio, newspaper and magazine advertisements, direct mailings, and company-operated free seminars on hearing and hearing loss.\nPhysician Marketing Program\nIn order to strengthen the relationship between referring physicians and HEARx, the Company signed a contract with Tufts University School of Medicine for the development of a program of Continuing Medical Education (\"CME\") related to hearing care and specifically directed to primary care physicians. It is anticipated that marketing of this program will begin during fiscal 1996. Physicians will receive CME credits when purchasing this program from Tufts. Tufts will receive compensation for each physician exam submitted for credit. The profits derived from the sale of this program will accrue 60% to Tufts and 40% to HEARx.\nGrowth Strategy\nCompany-owned Centers\nThe Company currently operates 44 centers located in Florida, New York, and New Jersey. It also operates three company-owned centers situated in AARP Pharmacies located in Florida, Virginia and Oregon. This represents a net increase over fiscal 1994 of twenty-two centers. Eleven of the new centers were opened in early January 1996 to fulfill the Company's contractual requirements with its new provider, Oxford Health Plans. The Company's current contracts contemplate ten additional centers in the immediate future. Over the next several years, HEARx's primary emphasis, depending on the availability of capital (see \"Management's Discussion of Results of Operations and Analysis of Financial Condition -- Liquidity and Capital Resources\"), will be opening additional (or selectively acquiring) Company-owned centers in these states. The Company's ultimate goal, where the population warrants, is to open \"clusters\" of four to six centers within a city or county in order to take advantage of certain operational and marketing efficiencies created by having multiple locations within a particular region.\nManaged Care and Institutional Contracts\nSince the beginning of 1991, the Company has entered into arrangements with institutional buyers relating to the provision of discounted hearing care products and services. HEARx believes that to implement successfully its growth strategy, contractual relationships with institutional buyers of hearing aids are essential. These institutions include managed care companies, health maintenance organizations, insurance companies, senior citizen buying groups and unions. By developing contractual arrangements for the referral of patients, marketing costs are kept to a minimum, and relationships with local area physicians are enhanced. Critical to providing care to the members of these groups is the availability of distribution sites, quality control and the standardization of products and services. The Company believes its system of high quality, standardized centers will be successful in meeting the needs of the patients and their providers.\nHEARx utilizes the concept of entering into provider agreements with health insurance or managed care organizations for the furnishing of hearing aids on three different bases: (a) Fee for service with a predetermined discount (all paid for by the patient); (b) a per capita basis, which is a fixed fee per patient per month, determined by the number of patients to be served and the amount to be paid by the insurance or managed care organization (the balance is paid by the individual member); or (c) an encounter basis where the Company is paid a fixed fee by the insurance or managed care organization for each hearing aid (the balanced is paid by the individual member).\nDistinguishing Features\nIntegral to the success of HEARx's strategy is the strengthening of consumer's confidence in the hearing care industry and the differentiation of HEARx from typical hearing aid dispensers. To that end, the Company has established several unique programs which are highlighted below:\nScientific Advisory Board\nHEARx has formed a Scientific Advisory Board consisting of some of the leading experts in otolaryngology and audiology in an effort to instill consumer confidence. Each of the five members of the Scientific Advisory Board is a highly-trained professional with extensive experience in the hearing field and is affiliated with prestigious universities and institutions. Company officials consult with members of this Board to keep the Company abreast of developments in otolaryngology and audiology and for advice as to the Company's overall business strategy. Additionally, the Scientific Advisory Board meets annually to review corporate planning and discuss improvements in any of the services or products which the Company offers. The Scientific Advisory Board also advises the Company with respect to the introduction of new or improved services or products, assists the Company in developing and reviewing quality assurance programs, and advises the Company as to the effect of any proposed or existing regulatory activity upon customers of the Company.\nThe current members of the Scientific Advisory Board and the area of Company operations with respect to which each consults are listed below:\nHearing Diseases\nHarold F. Schuknecht, M.D. Walter Augustus Lecompte Professor of Otology and Laryngology Harvard Medical School\nEmeritus Chief of Otolaryngology Massachusetts Eye and Ear Infirmary Boston, Massachusetts\nHearing Testing\nJames Jerger, Ph.D. Professor of Audiology Baylor College of Medicine and The Methodist Hospital\nDirector, Department of Audiology and Speech Pathology The Methodist Hospital Houston, Texas\nHearing Aids and Devices\nCharles I. Berlin, Ph.D. Professor of Otorhinolaryngology & Biocommunications Louisiana State University\nDirector, Kresge Hearing Research Laboratory of the South New Orleans, Louisiana\nProduct and Service Quality Assurance\nJerry L. Northern, Ph.D. Professor of Otolaryngology University of Colorado School of Medicine\nHead, Audiology Division University of Colorado School of Medicine Denver, Colorado\nProfessional and Government Relations\nDerald Brackmann, M.D. Member Otologic Medical Group, Inc.\nClinical Professor of Otolaryngology University of Southern California Los Angeles, California\nEach member presently receives compensation of $5,000 annually, payable in shares of Common Stock, as well as $1,000 in cash for attending each annual Scientific Advisory Board meeting.\nMedical Reporting and HEARx Data Link\nA computerized medical reporting system gives referring physicians the results of, and recommended action for, every patient examined at HEARx. To the Company's knowledge, no other dispenser or audiologist presently offers any referring physician similar computerized documentation. The Company believes that as hearing acuity and correction become an expected part of an individual's health profile, accurate records of past audiological test results, prescriptions and pathology should be available and accessible to those treating the patient. To address this need, the Company has developed a centralized computer data storage and retrieval system which provides information compiled from each HEARx center visit.\nCompetition\nThe hearing care industry is highly fragmented with approximately 11,000 practitioners providing testing and dispensing products and services. Roughly 2,500 of these practitioners are qualified audiologists working for hospitals or physicians, 2,000 of whom are licensed audiologists in private practice, and the remaining 6,500 are hearing aid specialists (individuals who may not have any formal training or qualifications). Industry surveys estimate that approximately 5% of all outstanding hearing aids are sold in physicians' offices, 40% are dispensed by qualified audiologists in private practice and the remaining are sold by hearing aid specialists.\nMost competitors are small retailers generally focusing on the sale of hearing aids without providing comprehensive audiometric testing and other professional services. Among the larger distributors of hearing aids are: (1) Bausch & Lomb, a hearing aid manufacturer whose distribution system is through a national network of over 1,000 franchised stores (Miracle Ear) including 400 located in Sears Roebuck & Co. stores; and (2) Beltone Electronics Corp., a privately-owned hearing aid manufacturer that distributes its products primarily through its network of approximately 600 franchised dealers. A statistically meaningful number of these stores and dealers are located in the areas the Company serves.\nHEARx believes that these networks will not, as presently operated, continue to be competitive with the Company's centers. These networks primarily offer hearing aids only and do not provide the comprehensive diagnostic services or ancillary products offered by the Company. More importantly, they do not use the services of audiologists in the majority of their centers. However, these networks are owned by companies having far greater resources than HEARx, and there can be no assurance that one or more of these competitors will not expand and change their operations to capture the market targeted by the Company. Nor can there be any assurance that the largely fragmented hearing care market cannot be successfully consolidated by the establishment of co-operatives, alliances, confederations or the like.\nManufacturers\nThe hearing aid manufacturing industry is highly competitive with approximately 40 manufacturers serving the worldwide market. Few manufacturers offer dramatic product differentiation, which further compounds the industry's competitive nature. The major hearing aid manufacturers include Bausch & Lomb, Beltone, Philips Electronics, Siemens, Starkey, 3M, GN Danavox and ReSound.\nRegulation\nFederal\nThe United States Food and Drug Administration (\"FDA\") is responsible for monitoring the hearing care industry. Currently there are only two regulations affecting the sale of hearing aids: 1) a physician's review and 2) a return policy. The FDA requires first time hearing aid purchasers to receive medical clearance from a physician prior to purchase; however, patients may sign a waiver in lieu of a physician's examination. In 1993, the State of Vermont petitioned the FDA to drop the waiver provision and mandate a physician visit. A final decision has never been generated. FDA hearings were held in Washington, D.C. in the fall of 1993 regarding changes for regulations affecting the hearing industry. New regulations were expected to be promulgated in 1995, but never took place. Although the FDA has mandated that states adopt a return policy for consumers offering them the right to return their products, generally within 3-30 days, HEARx offers its customers up to a 60-day return policy. The extension of HEARx's normal 30-day term is given to patients provided that the purchaser participates in the HEARx Educational Learning Program (H.E.L.P.).\nState\nMost states have established formal licensing boards that certify qualified audiologists or dispensers before they may begin their practice, though some states such as Massachusetts, New York and Colorado have no certification requirements. Inspection of facilities, quality control and advertising are largely unregulated at the State level.\nThe Company believes it is in material compliance with all applicable federal and state regulatory requirements.\nProduct and Professional Liability\nIn the ordinary course of its business, HEARx may be subject to product and professional liability claims alleging the failure of, or adverse effects claimed to have been caused by, products sold or services provided by the Company. The Company maintains insurance at a level which the Company believes to be adequate. A successful claim in excess of the policy limits of the Company's liability insurance could have a material adverse effect upon the Company. As the distributor of products manufactured by others, the Company believes it would properly have recourse against the manufacturer in the event of a product liability claim; however, there can be no assurance that recourse against a manufacturer by the Company would be successful.\nEmployees\nAt December 29, 1995, HEARx had approximately 134 full-time and 8 part-time employees.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nHEARx's corporate offices are located in 7,752 square feet of space in West Palm Beach, Florida. The lease covering such space provides for an annual rent of $65,892 with annual escalations ($69,768 in 1995). The lease is renewable yearly and expires in January 1999.\nAs of December 29, 1995, the Company operated twenty-eight centers in Florida as well as one center in Virginia and another center in Oregon. All of the locations are leased for one to six year terms pursuant to generally non- cancelable leases (with renewal options in some cases). Each center consists of between 900 and 3,200 square feet with annual base rents ranging from approximately $8,000 to $98,000. In addition, HEARx manages one audiology facility for a physician.\nThe Company believes its facilities are adequate and suitable for its current operations.\nItem 3.","section_3":"Item 3. Legal Proceedings\nNone\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNone.\nEXECUTIVE OFFICERS OF THE COMPANY\nThe following sets forth certain information as of the date hereof with respect to the Company's executive officers. They have been appointed to terms which will expire at the annual meeting of the Board of Directors held at the time of the 1996 Annual Meeting of Stockholders, or at the time their successors are duly elected and qualified:\nName and Position Age First Served as Officer - ------------------------------------------------- --- -----------------------\nPaul A. Brown, M.D 58 1986 Chairman of the Board, Chief Executive Officer and Director\nStephen J. Hansbrough 49 1993 President and Chief Operating Officer\nTommy E. Kee 47 1993 Vice President and Chief Financial Officer\nDavid W. Forman 54 1986 Vice President - Facilities Management & Secretary\nDonna L. Taylor 40 1993 Vice President - Operations\nThere are no family relationships among any of the executive officers and directors of the Company.\nPaul A. Brown, M.D., holds an A.B. from Harvard College and an M.D. from Tufts University School of Medicine. From 1970 to 1984, Dr. Brown was Chairman of the Board and Chief Executive Officer of MetPath Inc. (\"MetPath\"), a New Jersey-based corporation offering a full range of clinical laboratory services to physicians and hospitals, which he founded in 1967 while a resident in pathology at Columbia Presbyterian Medical Center in New York City. MetPath developed into the largest clinical laboratory in the world with over 3,000 employees and was listed on the American Stock Exchange prior to being sold to Corning Glass Works in 1982. In 1984, after leaving MetPath, Dr. Brown and a small group of investors founded SCI\/MED Advances Corporation, a venture capital, business development and management services company, but the company was ultimately unsuccessful in raising the $80 million in a public offering sought to commence this venture. Dr. Brown founded HEARx in 1986. Dr. Brown is formerly Chairman of the Board of Overseers of Tufts University School of Medicine as well as a member of the Board of Trustees, a member of the Visiting Committee of the Boston University School of Medicine and a part-time lecturer in pathology at Columbia University College of Physicians and Surgeons.\nStephen J. Hansbrough, President and Chief Operating Officer, joined HEARx in December 1993. Mr. Hansbrough has an extensive background in the retail arena. He served as Chairman and Chief Executive Officer of Dart Drug Stores until 1988. Subsequently, he had been an independent consultant specializing in turn-around and start-up operations primarily in the retail field.\nTommy E. Kee, Vice President and Chief Financial Officer, joined HEARx in September 1993. He holds a B.S. degree in accounting from the University of Tennessee and an M.B.A. from the University of Memphis. Prior to joining HEARx, Mr. Kee owned an international consulting business and served as Chief\nFinancial Officer for United Studios of America, Inc. from 1991 through 1993. From 1973 through 1991, he was Corporate Financial Director for the International Division of Holiday Inns, Inc., whereas he founded the International Finance and Accounting Department and directed the financial and accounting activities for the worldwide operations.\nDavid W. Forman holds a B.A. in Biology from the University of Ottawa. Prior to joining the Company in 1986, Mr. Forman served as the Vice President of Operations at SCI\/MED where he directed product research, development and production. From 1970 to 1985 he was employed by MetPath in various research, development and production capacities including Director of Operations. Prior to 1970, Mr. Forman served in the United States Navy as a Medical Laboratory Technologist.\nDonna L. Taylor, Vice President - Operations, holds an M.A. in Audiology and joined HEARx in July 1987. Ms. Taylor has an extensive background in establishing and developing Audiology and Hearing Aid Dispensing programs including a private ENT practice, Washington University Medical School in St. Louis from 1983 to 1985 and as an independent contractor.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters\nThe Common Stock of the Company was traded in the over-the-counter market during 1995; however, the stock is now trading on the American Stock Exchange, effective March 15, 1996, under the symbol of \"EAR\". For 1995, the prices were reported by the National Association of Securities Dealers, Inc., OTC Bulletin Board Service (\"NASDBB\") and the Common Stock traded under the symbol \"HRXL\".\nThe following table sets forth the high and low bid prices of the Common Stock in the over-the-counter market, as reported by NASDBB for the fiscal quarters indicated. Such prices reflect interdealer prices, without retail mark-up, mark-down or commissions and may not necessarily represent actual transactions:\nFiscal Quarter Common Stock -------------- -------------- High Low ------ ------ ---- First 23\/32 1\/4 Second 3\/8 1\/8 Third .56 1\/8 Fourth .71 .15\n---- First 1.44 .50 Second 1.44 7\/16 Third 1-5\/32 5\/16 Fourth 1-15\/32 .82\nAs of December 29, 1995, there were 742 holders of record of Common Stock. The Company estimates that included within the holders of record are approximately 3,271 beneficial owners of Common Stock.\nDividend Policy\nHEARx has never paid and does not intend to pay any dividends on the Common Stock in the foreseeable future but instead intends to retain any earnings for use in the Company's business operations.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe following selected financial data of the Company should be read in conjunction with the financial statements and notes thereto and the following Management's Discussion and Analysis of Financial Condition and Results of Operations. The financial data set forth on the next two pages have been derived from the audited financial statements of the Company:\nItem 7.","section_7":"Item 7. Management's Discussion of Results of Operations and Analysis of Financial Condition\nEffective December 31, 1993, the Company's fiscal year was changed from September 30 to the Friday nearest to December 31. Therefore, results are compared for the twelve months ended December 29, 1995, the twelve months ended December 30, 1994 and the twelve months ended September 30, 1993. A discussion of the results of operations and financial condition for the three months ended December 31, 1993 would not be meaningful if compared to the other periods. Accordingly, such discussion has not been included.\nYear ended December 29, 1995 vs. Year ended December 30, 1994, and Year ended December 30, 1994 vs. Year ended September 30, 1993\nResults of Operations\nFor the year ended December 29, 1995, the Company's revenues were $11,170,068, an increase of $6,838,920 or 158% from 1994. This increase resulted from the first year of revenue from the 18 Florida retail hearing aid centers acquired from Hearing Health Services, Inc. (\"HHS\"), plus revenues recognized from seven contracts with managed care companies signed in late 1994. Included in sales for the year ended December 29, 1995, are capitation revenues of $1,570,000 and approximately $2,330,000 for additional sales to members of the managed care companies. The Company has capitation contracts with certain managed care companies to provide hearing care services. Generally, these contracts provide for a set dollar discount (from $200 to $1,100) from published retail prices. As generally provided in these\ncontracts, the recipient can receive this discount once every three years. During the three years, any additional services or products purchased and the price of the services and products provided on the first visit over the group discount are the obligation of the recipient. 1994 revenues were $4,331,148 which represented a decrease of $3,003,919 or 41% from 1993. This decrease was primarily due to the restructuring and expense reduction program completed during 1994 in which 14 unprofitable centers were closed.\nCost of products sold for the year ended December 29, 1995 was $3,571,725, an increase of $1,980,549 or 124% from 1994. This increase was related to the increased sales volume from the 18 centers purchased in late 1994 from HHS and the increased volume generated from the seven managed care contracts. 1994 cost of products sold of $1,591,176 decreased by $1,261,189 or 44% from 1993 due to the 14 centers closed in 1994 as a result of the restructuring program. Cost of products sold as a percentage of sales was lower in 1995 compared to 1994 and 1993 mainly due to agreements with vendors in 1995 to reduce costs based on planned increases in future purchases.\nOperating expenses are comprised primarily of salaries, advertising and marketing expenses, real estate rents, and depreciation and amortization. Operating expenses totaled $9,529,061 for 1995 as compared to $4,734,622 for 1994, an increase of $4,794,439 or 101%. This increase was caused by the additional costs from the operation of the 18 centers that were purchased from HHS in late 1994. 1994 operating expenses totaled $4,734,622 as compared to $8,390,107 for 1993, a decrease of $3,655,485 or 44%. This decrease was caused by the closing of 14 centers in 1994 as well as the implementation of an expense reduction program which included the reduction of corporate overhead by the elimination of three officers' positions and numerous corporate positions.\nFourth Quarter Adjustments - Years ended December 29, 1995 and December 30, 1994 and Year ended September 30, 1993\nFourth quarter adjustments for 1995 were an increase in the allowance for doubtful accounts of $178,101 and the recording of additional public relations expense of $284,201.\nThere were no significant fourth quarter adjustments for the year ended December 30, 1994.\nOther than the provision of $1,427,827 for the estimated costs of closing of 14 centers and certain corporate restructuring expenses, losses in the fourth quarter of the year ended September 30, 1993 increased by $1,406,000 as a result of certain adjustments (some of which pertained to prior quarters) primarily related to correcting an intercompany account, adjusting the sales returns allowance account, adjusting various accruals and adjustments to allowance for doubtful accounts. The total closing provision and the fourth quarter adjustments contributed to an overall increase in the net loss of $2,833,287, or $.09 per share. The Company believes that the restructuring costs were necessary, in part, in response to the general downturn in the market caused by adverse national publicity affecting the industry at that time.\nDiscontinued Operations - Year ended September 30, 1993\nDuring September 1993, management formulated a plan to dispose of its Special Instrument Division so that it could concentrate its resources on its\nmain business. This Division had a loss of $316,507 in 1993 and had assets of $498,713 at September 30, 1993. Although the Company received a note for $450,000 upon the sale of the division in January, 1994, management felt the full amount of $498,713 should be reserved. Additional costs associated with closing this division were estimated to be $103,500, resulting in a net loss of $918,720 for 1993.\nLiquidity and Capital Resources\nHistorically, the Company's principal sources of funds have been borrowings from and stock purchases by its stockholders, private and public offerings of stock and warrants, and a commercial bank line of credit. During 1995, cash flow from financing activities consisted of a $1,500,000 private placement from individual investors, three institutional private placements for a total of $1,600,600, plus a short term loan from two investors for $1,100,000 and a loan of $270,000 from the principal shareholder. These funds were used to pay for the construction of 15 new centers in New York and New Jersey plus the payment of associated costs for the new point-of-sale and accounting computer systems.\nOn December 29, 1995, the Company had a working capital deficiency of $1,317,179 as compared to a working capital deficiency of $623,200 on December 30, 1994 of which $1,100,000 related to a short term loan from two investors. On December 29, 1995, the Company was in compliance with all covenants in its loan agreements.\nFuture sources of funds include funds generated from operations as well as the offer and sale of the Company's securities. In January 1996, the Company successfully completed a placement of 6,000 shares of 1996 Senior Preferred Stock and Common Stock purchase warrants for a total purchase price of $6,000,000, consisting of $4,900,000 in cash and the conversion of the $1,100,000 short term loan.\nDuring fiscal years 1995, 1994 and 1993, the Company has sustained losses. In January 1996, the Company took steps to correct its working capital deficit by completing a private placement with a total purchase price of $6,000,000 (see Footnote 3a). The Company believes it has the ability to raise additional funds, if needed, through the sales of its securities.\nManagement believes that the impact of the positive working capital from this transaction coupled with the estimated revenues to be generated from the new Northeast centers (see Footnote 3b) will be sufficient to cover any foreseeable 1996 operating deficit. To further positively impact cash flow, the Company entered into a trade financing agreement to provide its diagnostic equipment needs (see Footnote 3c).\nNet cash used in operating activities was $1,486,465 for the year ended December 29, 1995, as compared to $1,936,270 and $2,917,881 for the years ended December 30, 1994 and September 30, 1993. The decrease in the net cash used in operating activities for 1994 compared to 1993 was primarily due to a decrease in net loss of $4,392,531 offset by the decrease in the accrual for restructuring cost of $2,622,991.\nNet cash used by investing activities was $1,689,455 for the year ended December 29, 1995 as compared to cash provided of $175,206 for the year ended December 30, 1994, a net decrease of $1,864,661 between the two years. The decrease was primarily related to the purchase of property and equipment in 1995 due to the expansion of new centers in the Northeast ($610,188) and the\nimplementation of new computer and accounting systems ($872,454) for the Company. Net cash provided by investing activities was $175,206 for the year ended December 30, 1994, as compared to cash used of $1,492,840 during the year ended September 30, 1993, a net increase in cash of $1,668,046 between the two years. This increase was due primarily to fewer purchases of property and equipment in 1994 compared to 1993 and the loss from discontinued operations in 1993.\nNet cash provided by financing activities was $3,780,452 for the year ended December 29, 1995, as compared to $1,778,313 for the year ended December 30, 1994 and $4,207,283 for the year ended September 30, 1993. The increase in 1995 was related to additional private placements as well as additional loans of $1,370,000 plus the conversion of a vendor's accounts payable into debt. Net cash provided by financing activities in 1994 was $2,428,970 less than 1993 primarily due to a decrease of $731,391 in net proceeds from borrowings, and decrease in net proceeds from issuance of capital stock of $1,772,579.\nDuring 1993, cash flow from financing activities was the result of 3M's exercise of its right to purchase the Senior Preferred Stock Series D and G for a total of $2,000,000, net proceeds from a private warrant offering of $748,526, and the completion in October 1992 of a public warrant offering for $256,747. The funds were used principally to acquire the new centers in 1993 and for working capital.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nPage\nFinancial Statements:\nReport of Independent Certified Public Accountants....................... 17 Consolidated Balance Sheets at December 29, 1995 (Pro Forma and Actual) and December 30, 1994................................................ 18 Consolidated Statements of Operations for the years ended December 29, 1995, December 30, 1994, and September 30, 1993, and three months ended December 31, 1993.............................................. 20 Consolidated Statements of Changes in Stockholders' Equity (Capital Deficit) for the years ended December 29, 1995, December 30, 1994, and September 30, 1993, and three months ended December 31, 1993.................................................... 21 Consolidated Statements of Cash Flows for the years ended December 29, 1995, December 30, 1994, and September 30, 1993, and three months ended December 31, 1993............................. 28 Notes to Consolidated Financial Statements............................... 32\nFinancial Statement Schedules:\nFor the years ended December 29, 1995 and December 30, 1994, three months ended December 31, 1993, and the year ended September 30, 1993................................................. 51\nII Valuation Accounts............................................. 51\nReport of Independent Certified Public Accountants\nBoard of Directors HEARx Ltd. West Palm Beach, Florida\nWe have audited the accompanying consolidated balance sheets of HEARx Ltd. and Subsidiaries as of December 29, 1995 and December 30, 1994, and the related consolidated statements of operations, changes in stockholders' equity, (capital deficit) and cash flows for the years ended December 29, 1995, December 30, 1994 and September 30, 1993, and the three months ended December 31, 1993. We have also audited the schedule listed in the accompanying index. 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 and schedule are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements and schedule. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of HEARx Ltd. and Subsidiaries at December 29, 1995, December 30, 1994, and the results of their operations and their cash flows for the periods mentioned above, in conformity with generally accepted accounting principles.\nAlso, in our opinion, the schedule presents fairly, in all material respects, the information set forth therein.\nWest Palm Beach, Florida BDO Seidman, LLP April 5, 1996\nHEARx Ltd.\nNotes to Consolidated Financial Statements - -------------------------------------------------------------------------------\n1. The Company\nHEARx Ltd. (\"HEARx\" or \"the Company\"), a Delaware corporation, was organized in April 1986 for the purpose of creating a nationwide chain of retail centers (HEARX Centers) to serve the needs of the hearing impaired.\nChange in fiscal year-end\nEffective December 31, 1993, the Company changed its fiscal year-end from September 30 to the Friday nearest December 31.\n2. Summary of Significant Accounting Policies\nPrinciples of consolidation\nThe financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated.\nInventories\nInventories, which consist of hearing aids, special hearing devices and related items, are priced at the lower of cost (first-in, first-out) or market.\nProperty and equipment\nProperty and equipment are carried at cost. Depreciation of property and equipment are recorded on a straight-line basis over the estimated useful lives of the related property. Leasehold improvements are amortized over the shorter of the term of the lease or the useful life of the asset.\nSales return policy\nCustomers purchasing hearing aids are given a specific return period, usually 30 days, if dissatisfied with the product. The Company provides an allowance in accrued liabilities for returns based on prior experience. The return period can be extended to 60 days if the customer attends the Company's H.E.L.P. program.\nDeferred compensation\nThe value in excess of the selling price of shares of common stock granted to officers is being amortized over the vesting period of such shares.\nHEARx Ltd.\nNotes to Consolidated Financial Statements - -------------------------------------------------------------------------------\nWarranties\nHearing aids sold by the Company generally are covered by manufacturers' warranties.\nCapitation Revenue\nThe Company has capitation contracts with certain health care organizations under which the Company is paid an amount, per enrollee of the health maintenance organization, to provide a once every three years discount on certain hearing products and services. The amount paid to the Company by the healthcare organization is calculated on a per-capita basis and is referred to as capitation revenue.\nRevenue under capitation contracts is recorded based on estimates of utilization adjusted for actual utilization by the member populations of the health care organizations with whom the Company has contracted to provide hearing-care services.\nIncome Taxes\nDeferred taxes are provided for temporary differences arising from the differences between financial statement and income tax bases of assets and liabilities.\nNet loss per share of common stock\nNet loss per share of common stock was computed using the weighted average number of shares outstanding during the year.\nConvertible preferred stock, convertible subordinated debentures, stock options and stock warrants are excluded from the computation of earnings per share because the effect of their inclusion would be antidilutive.\nConsolidated statements of cash flows\nFor purposes of the Statement of Cash Flows, temporary cash investments which have a maturity of ninety days or less are considered cash equivalents.\nReclassifications\nCertain amounts in the 1994 financial statements have been reclassified in order to conform to the 1995 presentation.\nHEARx Ltd.\nNotes to Consolidated Financial Statements - -------------------------------------------------------------------------------\nEstimates\nThe preparation of the consolidated 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 at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\n3. Liquidity, Subsequent Events and Pro Forma Adjustment\nThe Company has sustained losses of $2,213,453, $2,105,635 and $6,498,166 for the years ended December 29, 1995, December 30, 1994 and September 30, 1993. At December 29, 1995 the Company has a working capital deficit of $1,317,179. In order to enable the Company to continue operations Management has taken certain actions including the raising of additional capital (see (a)) the signing of a contract with a health care provider in the Northeast (see (b)), and as more fully described in (c) the Company obtained financing from a vendor for the diagnostic equipment in the new centers. Management believes that the actions taken as outlined in 3(a), 3(b) and 3(c) will be sufficient to fund any foreseeable 1996 operating deficit.\n(a) On January 29, 1996, the Company completed a private placement of 6,000 shares, $1 par, of the 1996 Senior Preferred Stock and 10,909,090 Common Stock purchase warrants in consideration for $4.9 million of cash and the conversion of a $1.1 million note payable. The warrants are exercisable over five years at a price of $.55 per share. The 1996 Senior Preferred Stock may be redeemed by the Company for $6 million at any time. If not redeemed within four years, the investors will be entitled to exercise, for a one year period, warrants to purchase an additional 4,000,000 shares of Common Stock at an exercise price of $.55 per share. Under the terms of the 1996 Senior Preferred Stock, the investors generally have the right to approve future debt or equity offerings by the Company. In connection with the private placement, the Company issued warrants to purchase 2,250,000 shares of Common Stock at a price of $.63 per share to an investment banker as a placement fee. Additionally, the agreement provides that the Company will effect a 15 for 1 reverse stock split. Such stock split would require approval of the Board of Directors and the stockholders.\nHEARx Ltd.\nNotes to Consolidated Financial Statements - -------------------------------------------------------------------------------\nThe pro forma adjustments, to give effect to the issuance of the 6,000 shares of 1996 Senior Preferred Stock for consideration of the $4.9 million and the conversion of the $1.1 million note payable, as if it had occurred on December 29, 1995 are as follows:\n--------------------------------------------------------------------------- Assets Net increase in cash $ 4,492,000 ---------------------------------------------------------------------------\nLiabilities Decrease in current maturities of long-term debt: Investors note payable 1,100,000 Note payable to principal stockholder\/officer 100,000 Note payable to vendor 308,000 --------------------------------------------------------------------------- 1,508,000 ---------------------------------------------------------------------------\nStockholders' Equity Increase in 1996 Senior Preferred Stock (6,000) Increase in additional paid-in-capital (5,994,000) --------------------------------------------------------------------------- (6,000,000) --------------------------------------------------------------------------- $ -- ===========================================================================\n(b) During January and February, 1996, the Company opened 13 in a projected series of 25-30 new HEARx Centers in the New York and New Jersey area to provide hearing care to members of Oxford Health Plans and Select Providers, Inc. Management estimates this contract will generate $4.25 million in annual revenues in each of the next three years; however, it can be cancelled with ninety days notice by either party at any time.\n(c) On March 5, 1996, the Company completed a $2.5 million trade financing agreement with a vendor whereby the vendor will provide financing for the purchase of diagnostic equipment to be utilized by the Company's distribution network. A percentage of all hearing aid purchases by the Company from the supplier will be applied to repayment of financed amounts under the financing agreement.\n(d) On January 29, 1996, the principal stockholder\/officer converted his Series C Preferred Stock to 1,040,000 shares of Common Stock. In exchange for his waiver to receive payment of cumulative dividends due for the Series C Preferred Stock, the Company issued a promissory note in the amount of $214,666. For so long as shares of 1996 Senior Preferred Stock of the Company are outstanding, without the approval of the holders of a majority of the outstanding shares of 1996 Senior Preferred Stock, the principal of this promissory note shall not be payable. An additional promissory note was issued to the principal stockholder\/officer for $233,000 during January, 1996, representing $170,000 from 1995 short term advances plus accrued interest payable from previous years of $63,007. The\nHEARx Ltd.\nNotes to Consolidated Financial Statements - -------------------------------------------------------------------------------\nnote payable is due in three years and bears interest at 3 percent above prime.\n(e) On March 15, 1996, the Company's Common Stock was listed on the American Stock Exchange under the symbol of \"EAR\".\n(f) In January, 1996, the Company entered into an agreement to acquire the customer list and selected assets of Suffolk County Hearing Aid Center, Inc. for $150,000, 150,000 shares of Common Stock, and a five year note in the amount of $250,000 including interest. The note payable bears interest at 5-1\/2 percent and is payable in five annual installments of $50,000 beginning January 22, 1997.\n(g) For additional subsequent events see notes 4, 6A and 6E.\n4. Debt\nLong-term debt consists of the following:\n--------------------------------------------------------------------------- December 29, December 30, 1995 1994 ------------ ------------\nNote payable to principal stockholder, due April 1, 1997 bearing interest at prime plus 3% (11.75% at December 29, 1995) $1,675,000 $1,675,000 7% notes payable, to investors, due December 11, 1996 (see below) 1,100,000 -- Note payable to supplier, due January 31, 1999, interest at 12%, beginning 1996 (see below) 808,000 -- Note payable to supplier, collateralized by equipment, due December 31, 1996. No interest rate requirements provided purchase requirements are met. (Interest imputed at 6%). 460,517 903,910 Short term advances from principal stockholder (see below) 270,000 -- Other notes payable 146,313 248,074 Note payable, collateralized by certain equipment, due February 1, 1997. Interest rate of 7.25% at December 29, 1995. 43,450 71,394 ------------ ------------ 4,503,280 2,898,378 Less current portion 2,186,980 522,179 ------------ ------------ $2,316,300 $2,376,199 ============ ============ ---------------------------------------------------------------------------\nHEARx Ltd.\nNotes to Consolidated Financial Statements - -------------------------------------------------------------------------------\nThe approximate annual maturities of long-term debt for the years after December 29, 1995 are as follows:\n1996 $2,187,000 1997 1,831,000 1998 302,000 1999 152,000 Thereafter 31,000\nDuring December, 1995, two individuals loaned the Company $1,000,000 and $100,000 represented by short term notes payable. These notes payable were converted to preferred stock during January, 1996, in connection with the Company's private placement of $6 million of 1996 Senior Preferred Stock (see note 3 (a)).\nOn May 1, 1995, the Company reached an agreement with Minnesota Mining and Manufacturing Company (\"3M\") to convert $808,000 of accounts payable into long-term debt. This agreement provides for conversion of a portion of this long-term debt into equity upon the Company reaching certain product sales goals. The Company paid $308,000 in January 1996.\nDuring 1995, the principal stockholder\/officer advanced $270,000 to the Company. In January, 1996, $100,000 was repaid, and $170,000 of the advances were converted into a note payable bearing interest at prime plus 3%.\nDuring 1994, Convertible Subordinated Debentures (\"Debentures\") of $700,000, (including $538,750 outstanding at December 31, 1993, and an additional $161,250 issued during 1994, plus accrued interest payable of $27,682) were converted into 3,638,414 shares of Common Stock and warrants for the purchase of 1,050,000 shares of Common Stock at $1.00 per share until January 1, 2000 and $2.00 per share until January 1, 2004.\nDuring 1994, the principal stockholder loaned the Company $1.5 million and converted two other loans ($125,000 and $50,000) into a $1,675,000 note payable. $1.0 million of the proceeds were used to pay a bank line of credit. The remaining $500,000 was used for working capital purposes.\nHEARx Ltd.\nNotes to Consolidated Financial Statements - -------------------------------------------------------------------------------\n5. Property and Equipment and Leases\nProperty and equipment consist of the following:\nDecember 29, December 30, 1995 1994 ------------ ------------\nEquipment, furniture and fixtures $2,357,101 $1,975,857 Leasehold improvements 729,144 779,347 Computer systems 872,454 -- Leasehold improvements in progress 436,673 -- ------------ ------------ 4,395,372 2,755,204 Less accumulated depreciation 1,871,490 1,779,850 ------------ ------------ Net property and equipment $2,523,882 $ 975,354 ============ ============\nRemaining commitments under contracts in progress related to the northeast expansion (see Note 3(b)) totals $803,000.\nApproximate future minimum rental commitments under operating leases are as follows:\nYears following December 29, 1995 ---------------------------------------------------------------------------\n1996 $1,314,000 1997 941,000 1998 801,000 1999 651,000 2000 605,000 Thereafter 2,016,000 ------------ Total minimum lease payments $6,328,000 ============\nEquipment and building rent expense for the years ended December 29, 1995, December 30, 1994 and September 30, 1993 and three months ended December 31, 1993 was approximately:\nDecember September ---------------------------------------- ------------ 1995 1994 1993 1993 ------------ ------------ ------------ ------------\n$1,267,000 $ 930,000 $ 296,000 $1,151,000 ============ ============ ============ ============\nHEARx Ltd.\nNotes to Consolidated Financial Statements - -------------------------------------------------------------------------------\n6. Capital Deficit\nA. Senior Preferred Stock\nThe shares of Senior Preferred Stock have 100 votes per share and, unless otherwise required by Delaware law, vote with the holders of other shares of Common Stock as one class. The shares of Senior Preferred Stock have no right to dividends except pari passu with the Common Stock based on the number of shares of Common Stock into which they are then convertible when, as and if a dividend is declared by the Board of Directors. The Senior Preferred Stock is senior to the Common Stock and the Series C Preferred Stock and is pari passu with the 1994 Convertible Preferred Stock and the 1996 Senior Preferred Stock (discussed below).\nEach share of Senior Preferred Stock is convertible at the option of the holder into 100 shares of Common Stock. The shares of Senior Preferred Stock are automatically converted into shares of Common Stock upon the listing of the shares of Common Stock on the American or New York Stock Exchange. Upon the Company's listing on the American Stock Exchange on March 15, 1996, all shares of the Senior Preferred Stock automatically converted into shares of Common Stock, (see Note 3(e)).\n(i) Senior Series A and Senior Series B\nPursuant to an October 31, 1991 agreement with 3M, the Company agreed not to seek capital from any person, other than financial investors or through a public offering, as opposed to persons having an interest in the hearing aid industry, without 3M's prior written approval. The principal stockholder\/officer has agreed not to sell for five years any shares of Common Stock beneficially owned by himself or securities convertible into or exchangeable for Common Stock. He agreed to give 3M (a) a right of first refusal to purchase all or any portion of such shares or securities and (b) the right to approve any potential purchaser, which approval is not to be withheld unreasonably. The principal stockholder\/officer's agreement does not apply to the sale in the open market or gift of up to five percent of his security holdings (on a fully converted basis).\nSimultaneously with the execution of the Stock Purchase Agree- ment, 3M and the Company entered into a new arrangement in which 3M appointed the Company as 3M's exclusive distributor (with the exception of existing distributorships) for programmable hearing aids for a five year period ending December 31, 1997 with an option for 3M to renew for an additional five years. During 1995, this arrangement was modified in that the Company will no longer be the exclusive distributor of 3M products.\nHEARx Ltd.\nNotes to Consolidated Financial Statements - -------------------------------------------------------------------------------\n(ii) Transactions as to the Senior Series C are as follows:\nIn February 1991, the Company and 3M entered into an arrange- ment pursuant to which, among other things, the Company marketed 3M's \"Memory Mate\"[Trademark] brand hearing aids and certain other 3M hearing related products (on a non-exclusive basis). 3M furnished one of its \"Master-Fit\"[Trademark] hearing aid fitting systems in each of the Company's retail locations (valued at $50,000), and 3M paid the Company a test marketing fee of $300,000. In connection with these transactions, 3M was granted the right, in exchange for transfer of title to the fitting systems and agreement to forego repayment of the funds advanced as a test marketing fee, to acquire for a nominal consideration, 11,000 shares of Senior Series C. This has not been exercised by 3M.\n(iii) Transactions as to the Senior Series D and G are as follows:\nOn June 28, 1993, 3M exercised its right to acquire 14,926 shares of Senior Preferred Stock, Series D, par value $1.00 per share (\"Senior Series D\") for $1,000,000 and to acquire 14,926 shares of Senior Preferred Stock, Series G, par value $1.00 per share (\"Senior Series G\") for $1,000,000.\n(iv) Transactions as to Senior Series E are as follows:\nDuring 1993 and 1994, 3M paid $400,000 as a partial payment towards the exercise of Senior Preferred Stock, Series E, par value $1.00 per share (\"Senior Series E\"). On May 1, 1995, the Company and 3M agreed to and the Company did issue 6,472 shares of Senior Series E Stock in consideration for the $400,000.\nB. Series C Preferred Stock\nThe Series C Preferred Stock bears cumulative dividends at the rate of $5.60 per share per annum, payable quarterly, commencing June 30 1992, and is junior to the Senior Series Preferred Stock discussed above and the 1994 Convertible Preferred stock discussed below; it is senior to the Common Stock in the event of the liquidation, dissolution or winding up of the Company. The Series C Preferred Stock has 104 votes per share (1,040,000 votes total) and, except as otherwise required by Delaware law, votes with the holders of shares of Common Stock as one class. The Series C Preferred Stock may be redeemed at the sole option of the Company at a redemption price of $70 per share. During January, 1996, the Series C Preferred Stock was converted into 1,040,000 shares of Common Stock, and the cumulative dividends of $214,666 were converted into a promissory note.\nC. 1995 Placements\nDuring 1995, the Company completed a private placement of Common Stock for $1,500,000 from individual investors for a total of 2,427,184 shares of Common Stock with associated costs of $63,192. HEARx Ltd.\nNotes to Consolidated Financial Statements - -------------------------------------------------------------------------------\nThe Company also completed three Regulation S offerings totaling $1,600,600. Costs related to the offerings were $297,315. A total of 2,602,572 shares of Common Stock was issued in the transactions. The stock purchase agreement provides the investors warrants exercisable monthly through October 1996, The warrants allow the investors the right to purchase additional shares (based on a pre-set formula) at $.10 per share should the market price fall below $.85 per share.\nD. 1994 Common Stock Offerings\n$700,000 of subordinated debentures plus $27,682 in accrued interest payable were converted into 3,638,414 shares of Common Stock (see Note 4).\n$800,000 was received in a private placement of 4,000,000 shares of Common Stock and warrants to purchase 1,200,000 shares of Common Stock at $1.00 per share until January 1, 2000 and $2.00 per share until January 1, 2004 (see Note 6 F).\nThe Company received $500,000 in a private placement through the sale of 2,500,000 shares of Common Stock and warrants to purchase 750,000 shares of Common Stock at $1.00 per share until January 1, 2000 and at $2.00 per share until January 1, 2004.\nE. 1994 Convertible Preferred Stock\nIn connection with the acquisition described in Note 7, Hearing Health Services, Inc. (\"HHS\") was issued 2,500 shares of the Company's 1994 Convertible Preferred Stock, par value $1.00 per share. The 1994 Convertible Preferred Stock has 1,000 votes per share (2,500,000 votes total) and also has voting rights and powers equal to the voting rights and powers of the Common Stock. Each share is convertible at any time at the option of the holder. In connection with this business transaction, HHS also received warrants to purchase 2,500,000 shares of Common Stock at a price of $.25 per share with standard anti-dilution rights. These warrants were exercised on January 29, 1996, in a cashless exercise resulting in the issuance to HHS of 2,250,000 shares of Common Stock. On March 8, 1996, HHS converted all of its 1994 Convertible Preferred Stock into 2,500,000 shares of Common Stock.\nOn December 30, 1994, the Company and three limited partnerships affiliated with HHS (collectively the \"Investors\") entered into a stock purchase agreement pursuant to which the Investors purchased 2,500 shares of 1994 Convertible Preferred Stock, par value $1.00 per share at a total cash purchase price of $500,000 ($200 per share), paid on January 4, 1995. These shares have the same rights, privileges, and conversion features as the above mentioned shares of 1994 Convertible Preferred Stock. On March 8, 1996, the Investors converted all their 1994 Convertible Preferred stock into 2,500,000 shares of Common Stock.\nHEARx Ltd.\nNotes to Consolidated Financial Statements - -------------------------------------------------------------------------------\nF. Warrants\nAs discussed in Note 4, during 1994, the Company converted $700,000 of subordinated convertible debentures into 3,638,414 shares of Common Stock and 1,050,000 warrants to purchase the same number of shares of Common Stock at a price of $1.00 per share until January 1, 2000 and $2.00 per share until January 1, 2004. In connection with private placements, an additional 1,950,000 warrants were issued. In connection with the debenture conversions and the private placements, a combined 3,000,000 warrants were issued. The exercise price is $1.00 per share until January 1, 2000 and $2.00 per share until January 1, 2004. Each warrant may be called for redemption at a price of $.01 if the average of the closing prices of the Common Stock for a 60 calendar day period preceding the next date of call for redemption, is twice the then applicable exercise price.\nAs noted in (E) above, 2,500,000 warrants to purchase Common Stock were issued to HHS. These warrants were exercised in early 1996.\nOn January 22, 1993, the Company offered to the owners of the 1,106,250 warrants acquired in the Company's 1989 and 1991 private placements, the opportunity to exercise those warrants at a reduced price of $.80 per share and, simultaneously, to receive a new ten year, non-callable warrant to purchase an equal number of shares for $1.25 per share. During February and March 1993, 937,500 warrants were exercised for proceeds of $750,000. Costs associated with this offer were $1,474.\nThe aggregate number of shares reserved for issuance upon the exercise of warrants is 8,191,250 as of December 29, 1995. Exercise prices range from $.01 to $2.00, and are exercisable as follows:\nExpiration Number of ------------------------------------------ Warrants Outstanding Date Price -------------------------- -------------------- --------------------\n100,000 June 1996 1.00 100,000 December 1996 1.00 1,100,000 February, 1998 .01 118,750 September 1998 2.00 240,000 June 1999 .50 45,000 June 1999 .67 20,000 September 1999 1.50 30,000 December 1999 1.50 937,500 January 2003 1.25 2,250,000 January 2004 2.00 750,000 January 2004 2.00 2,500,000 December 2004 .25 --------------------------------------------------------------------- 8,191,250 =====================================================================\nHEARx Ltd.\nNotes to Consolidated Financial Statements - -------------------------------------------------------------------------------\n7. Business Acquisition\nOn December 30, 1994, the Company entered into a purchase agreement to acquire certain assets and assume certain liabilities of 18 Florida retail hearing aid centers from HHS for consideration consisting of 2,500 shares of 1994 Convertible Preferred Stock (conversion ratio of 1 preferred share to 1,000 common) valued at $200 per share ($500,000). In addition the Company incurred $116,686 of acquisition costs. The estimated fair value of the net assets acquired was $492,224, resulting in cost in excess of fair value of net assets acquired of $124,462. This amount is amortized over 15 years using the straight-line method. The acquisition was accounted for under the purchase method of accounting. Since the purchase occurred on December 30, 1994, the results of operations of the acquired centers are not included in the Company's operations for 1994. The following represents pro forma results of operations for the years ended December 30, 1994 and September 30, 1993, as if the acquisition had occurred at the beginning of those periods:\nDecember 30, September 30, 1994 1993 ------------ ------------\nNet sales $ 7,742,000 $11,065,000 Loss from operations (2,957,000) (5,509,000) Loss from continuing operations (3,243,000) (5,754,000) ============ ============ Loss from continuing operations per Common Share $(.08) $(.17) ============ ============\n8. Stock Option Plans\nA. Employee Stock Option Plans\n(i) Under the Company's 1987 plan, the Company's Board of Directors, or a committee thereof, is authorized to grant options to purchase up to an aggregate of 2,500,000 shares of the Company's Common Stock. Officers and other key employees of the Company, other than the principal stockholder and individuals who hold ten percent or more of the Company's Common Stock, are eligible to receive either incentive stock options or non-incentive stock options. The option price for non-incentive stock options may be any price determined by the Board of Directors or the Committee. The option price for incentive stock options may not be less than the fair market value of the shares at the time the option is granted.\n(ii) In June 1995, the Company's stockholders approved the adoption of the HEARx Ltd. 1995 Flexible Stock Plan (\"Flexible Stock Plan\"), pursuant to which a committee of the Board of Directors (whose members shall not receive awards under the 1995 Flexible Stock Plan or any other discretionary grant plans of the Company) may make awards to eligible participants in the form of stock options, stock appreciation rights, HEARx Ltd.\nNotes to Consolidated Financial Statements - -------------------------------------------------------------------------------\nrestricted stock, performance shares and other stock-based awards. The number of shares of Common Stock which may be issued in connection with awards under the 1995 Flexible Stock Plan may not exceed 2,500,000, plus an automatic annual increase of ten percent of the number of shares subject to the Plan as of the prior year.\n(iii) As of December 29, 1995, 122 employees of the Company held options under the Stock Option Plans permitting them to purchase 3,252,950 shares of Common Stock at prices ranging from $.20 to $1.35 per share. Options are exercisable for a period of nine years commencing one year following the date of grant and are exercisable in cumulative annual installments of 25 percent per year.\nThe following table sets forth the option activity for the years ended December 29, 1995, December 30, 1994 and September 30, 1993 and three months ended December 31, 1993.\nBeginning Ending Options Options Annual Issued and Issued and Activity Outstanding Granted Exercised Terminated Outstanding ------------ ----------- --------- --------- ------------ -----------\n1993 1,003,800 402,300 (2,750) (126,450) 1,276,900 Oct-Dec 1993 1,276,900 576,000 -- (61,100) 1,791,800 1994 1,791,800 1,619,850 -- (1,021,150) 2,390,500 1995 2,390,500 1,391,600 (278,650) (250,500) 3,252,950\nHEARx Ltd.\nNotes to Consolidated Financial Statements - -------------------------------------------------------------------------------\nNumber of Options ------------------------------------------------------ December September Exercise Price 1995 1994 1993 1993 ------------------- ------------ ------------ ------------ ------------ $ .200 815,050 1,012,450 -- -- .340 24,800 -- -- -- .375 37,800 48,800 72,900 79,900 .406 87,000 176,000 -- -- .438 -- -- 100,000 100,000 .470 4,300 13,050 92,050 103,050 .500 16,500 16,500 21,450 25,575 .531 378,700 445,400 576,000 -- .540 197,600 351,300 -- -- .625 12,000 12,000 16,000 20,000 .688 180,800 181,300 442,300 443,675 .700 1,000 4,000 24,000 24,000 .750 6,300 7,100 -- -- .781 17,400 34,200 106,100 112,100 .810 52,200 57,500 250,400 264,200 .835 111,600 -- -- -- .865 212,000 -- -- -- .875 25,900 26,900 86,600 100,400 1.210 1,024,800 -- -- -- 1.250 34,400 -- -- -- 1.310 8,800 -- -- -- 1.350 4,000 4,000 4,000 4,000 ------------ ------------ ------------ ------------ 3,252,950 2,390,500 1,791,800 1,276,900 ============ ============ ============ ============\nThe options are exercisable as follows:\nYears following December 29, 1995 ---------------------------------------------------------------------------\n1996 572,211 1997 851,563 1998 804,638 1999 676,638 2000 347,900 --------------------------------------------------------------------------- 3,252,950 ===========================================================================\nB. Non-employee Director Plan\nIn April 1993, the stockholders of the Company approved the adoption of the HEARx Ltd. Non-Qualified Stock Option Plan for Non-Employee Directors (\"Directors Plan\"). The purpose of the Directors Plan is to increase the proprietary interest of non-employee directors in the Company by granting non-qualified stock options that will promote long-term stockholder value. Grants under the Directors Plan may not HEARx Ltd.\nNotes to Consolidated Financial Statements - -------------------------------------------------------------------------------\nexceed 500,000 shares of Common Stock in the aggregate and may be granted until the Annual Meeting of Stockholders in 2003.\nEach year, upon election to the Board, each non-employee director shall be granted a 10-year non-qualified stock option (\"Option\") to acquire 15,000 shares of Common Stock. The exercise price shall be 100 percent of the fair market value of the shares as of the close of business on the business day immediately prior to the date on which the Option is granted. As of December 29, 1995, three non-employee directors hold options under the plan allowing them to purchase the following shares: 90,000 at $.6875; 45,000 shares at $.78125; 45,000 shares at $.34; and 45,000 shares at $1.25.\nC. Stock Bonus Plan\nThe Board of Directors has adopted a Stock Bonus Plan (\"Bonus Plan\"). It is the purpose of the Bonus Plan to create an incentive for senior management personnel to work to the very best of their abilities for the achievement of the Company's strategic objectives. To accomplish this purpose, the Board of Directors intends to award shares of Common Stock to eligible employees.\nThe Bonus Plan is administered by the Board of Directors. Participants in the Bonus Plan must be key executives of the Company or its subsidiaries who are determined by the Board of Directors to be important to the success of the Company. Members of the Board of Directors are not eligible to participate so long as the Board is administering the Bonus Plan. There are approximately nine persons eligible to participate in the Plan.\nThe aggregate number of shares of Common Stock which may be issued under the Bonus Plan may not exceed 500,000. A total of 115,138 and 22,727 shares were issued under this plan during the years ended December 29, 1995 and December 30, 1994, respectively.\nD. Other\nOn July 11, 1995, the Company granted options expiring ten years from date of grant to a consultant to purchase 700,000 shares of Common Stock at $1.00 a share. 58,333 optioned shares vested immediately, with the remaining shares to vest at a rate of 58,333 shares per month beginning August 1, 1995. None of these options have been exercised.\nOn July 1, 1994, the Company granted an option to the same consultant to purchase 600,000 shares at $.25 a share. These options vest at the rate of 50,000 shares per month beginning October 1, 1994. The consultant exercised 400,000 options in 1995 and 150,000 options in 1994. The remaining 50,000 options expire July 1, 1997.\nOn July 11, 1995, the Company granted an option to purchase 144,000 shares of Common Stock to an individual in exchange for consulting services to be rendered over a period to three years, beginning July 11, 1995. The option price is $1.00 per share, and the shares\nHEARx Ltd.\nNotes to Consolidated Financial Statements - -------------------------------------------------------------------------------\nvest at the rate of 4,000 shares per month beginning August 1, 1995. None of these options have been exercised.\nOn January 15, 1993, the Board of Directors granted the principal stockholder\/officer a ten year option in lieu of salary to acquire 100,000 shares of Common Stock at $2.00 per share.\n9. Restructuring Charges\nDuring the year ended September 30, 1993, the Company began formalizing a restructuring program designed to reduce costs, improve operating efficiencies and increase stockholder value. The program included the closings of selected locations and the elimination of certain corporate departments. The estimated restructuring cost of $1,427,287 included the costs of abandoning leased locations and severance pay. This amount is shown as a separate line item in the accompanying Statement of Operations. This restructuring program was completed during 1994 resulting in an increase in income of $124,511 for the remaining unused accrual.\n10. Discontinued Operations\nThe table below reflects the components of the loss from discontinued operations for the year ended September 30, 1993:\n--------------------------------------------------------------------------- Loss from operations $(316,507) Estimated loss on disposal (602,213) --------------------------------------------------------------------------- Total loss from discontinued operations $(918,720) ===========================================================================\nRevenues applicable to the discontinued operations prior to the date of discontinuance were $604,226 in 1993.\n11. Related Party Transactions\nIn addition to the related party transactions described in Notes 4 and 6, the following related party transactions occurred during 1995, 1994, and 1993:\nWorking capital funds were provided during fiscal 1995, 1994 and 1993 through periodic loans from the principal stockholder\/officer. Interest expense related to the principal stockholder\/officer was $198,181 for the year ended December 29, 1995, $120,139 for the year ended December 30, 1994, $2,380 for the three months ended December 31, 1993, and $113,511 for the year ended September 30, 1993. As of December 30, 1995, accrued interest of $81,931 is due on these loans.\nDuring each of the years 1995, 1994 and 1993, the principal stockholder\/officer received no cash compensation for services rendered to the Company. Under the terms of an agreement with the HEARx Ltd.\nNotes to Consolidated Financial Statements - -------------------------------------------------------------------------------\nCompany, the principal stockholder\/officer has elected to waive his right to annual cash compensation of $100,000 until the Company has experienced two successive quarters of profitability. In 1993, in lieu of cash compensation, the principal stockholder\/officer received options to purchase 100,000 shares at an exercise price of $2.00 per share. Such options have a term of 10 years. As the exercise price was in excess of fair market value, there was no charge to earnings. No options were granted to the principal stockholder\/officer in 1994 or 1995.\n12. Income Taxes\nThe Company and its subsidiaries file a consolidated income tax return. It has accounted for certain items (principally depreciation and deferred compensation) for financial reporting purposes in periods different from those for tax reporting purposes.\nDeferred tax assets are comprised of the following:\nDecember 1995 1994 ----------------------------------------------- ------------ ------------\nDepreciation $ 54,000 $ 63,000 Allowance for doubtful accounts 163,000 88,000 Net operating loss carryforward 9,658,000 8,979,000 ------------ ------------ 9,875,000 9,130,000 Less valuation allowance (9,875,000) (9,130,000) ------------ ------------ Net deferred tax asset $ -- $ -- ============ ============\nAt December 29, 1995, the Company had net operating loss carryforwards of approximately $25.7 million for both tax and financial reporting purposes. The losses are available for carryforward for a fifteen year period and will expire beginning in 2002. Any future significant changes in the ownership of the Company or its subsidiaries may limit the annual utilization of the tax net operating loss carryforwards.\n13. Significant Fourth Quarter Adjustments\nFourth quarter adjustments for 1995 were an increase in the allowance for doubtful accounts of $178,101 and the recording of additional public relations expense of $284,201.\nThere were no significant fourth quarter adjustments for fiscal 1994.\nIn the fourth quarter of fiscal 1993, the Company made certain adjustments (certain of which pertained to prior quarters) primarily related to correcting an intercompany account, adjusting the sales returns allowance account and adjusting various accruals, which had the effect of increasing the net loss $1,406,230 or $.05 a share. Additionally, a provision of HEARx Ltd.\nNotes to Consolidated Financial Statements - -------------------------------------------------------------------------------\n$1,427,827 was recorded for the estimated costs of closing fourteen (14) centers and the elimination of certain corporate departments (see Note 9). Further, discontinued operations recorded in the fourth quarter include its reserve for its note receivable of $450,000 along with a reserve for disposition of $103,500 (see Note 10).\n14. Fair Value of Financial Instruments\nThe Financial Accounting Standards Board (\"FASB\") has issued Statement of Financial Accounting Standards (\"SFAS\") No. 107 which requires the disclosure of fair value of financial instruments. The estimated fair value amounts have been determined by the Company's management using available market information and other valuation methods. However, considerable judgement is required to interpret market data in developing 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 market assumptions and\/or estimation methods may have a material effect on the estimated fair value amounts. Furthermore, the Company does not intend to dispose of a significant portion of its financial instruments and, thus, any aggregate unrealized gains or losses should not be interpreted as a forecast of future earnings and cash flows.\nSFAS No. 107 excludes certain financial instruments from its disclosure requirements, such as leases. In addition, disclosure of fair value estimates are not required for nonfinancial assets and liabilities, such as fixed assets, intangibles and anticipated future business. As a result, the following fair values are not comprehensive and therefore do not reflect the underlying value of the Company.\nThe following methods and assumptions were used in estimating fair value disclosures for financial instruments:\nCash and Cash Equivalents - the carrying amounts reported in the balance sheet approximate those assets' fair value.\nAccounts Receivable - the carrying amounts reported in the balance sheet approximate those assets' fair value.\nAccounts Payable, Accrued Expenses and Notes Payable - the carrying amounts reported in the balance sheet approximate those liabilities' fair value.\nHEARx Ltd.\nNotes to Consolidated Financial Statements - -------------------------------------------------------------------------------\nThe approximate carrying amounts and estimated fair values of the Company's financial instruments at December 29, 1995 are as follows:\n(In Thousands) -------------------------- Carrying Fair Amount Value ------------ ------------ Financial Assets: Cash and cash equivalents $ 933,539 $ 933,539 Accounts receivable 1,227,993 1,227,993\nFinancial Liabilities: Accounts payable and accrued expenses 2,217,132 2,217,132 Notes payable 4,503,280 4,503,280\n15. Recent Accounting Pronouncements\nSFAS No. 121 \"Accounting for the Impairment of Long-Lived Assets and Long- Lived Assets to be Disposed of\" provides guidance on how and when impairment losses are recognized on long-lived assets. This statement, when adopted, is not expected to have a material impact on the Company.\nSFAS No. 123 \"Accounting for Stock-Based Compensation\" establishes financial accounting and reporting for stock-based employee compensation plans. This statement was issued by the FASB during October 1995 and is effective for transactions entered into in fiscal years that begin after December 15, 1995. The Company has not yet determined the impact of this statement.\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\nThe information required by this Item for directors is set forth in the Company's 1996 Proxy Statement under the heading \"Election of Directors\" and is incorporated herein by this reference as if set forth in full.\nThe information required by this Item for executive officers is set forth in Part I of this report under the heading \"Executive Officers of the Company.\"\nItem 11.","section_11":"Item 11. Executive Compensation\nThe information required by this Item is set forth in the Company's 1996 Proxy Statement under the heading \"Election of Directors\" and is incorporated herein by this reference as if set forth in full.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThe information required by this Item is set forth in the Company's 1996 Proxy Statement under the heading \"Election of Directors\" and is incorporated herein by this reference as if set forth in full.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThe information required by this Item is set forth in the Company's 1996 Proxy Statement under the heading \"Election of Directors\" and is incorporated herein by this reference as if set forth in full.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Report on Form 8-K\n(a) (1) The following financial statements are filed as part of this report:\n(i) Consolidated Balance Sheets as of December 29, 1995 and December 30, 1994.\n(ii) Consolidated Statements of Operations for the years ended December 29, 1995, December 30, 1994 and September 30, 1993 and three months ended December 31, 1993.\n(iii) Consolidated Statements of Changes in Stockholders' Equity for the years ended December 29, 1995, December 30, 1994 and September 30, 1993 and three months ended December 31, 1993.\n(iv) Consolidated Statements of Cash Flows for the years ended December 29, 1995, December 30, 1994 and September 30, 1993 and three months ended December 31, 1993.\n(v) Notes to Consolidated Financial Statements.\n(2) The following financial statement schedules are filed as part of this report and are contained on page 55.\nSchedule II Valuation Accounts\n(3) Exhibits:\n3.1(a)* Restated Certificate of Incorporation of HEARx Ltd., as amended to February 8, 1988. [3.1(a)]\n3.1(b)*** Certificate dated August 8, 1991, of Designations, Preferences and Rights of the Company's Preferred stock, Series A and B. [3.1(b)]\n3.1.(c)*** Certificate dated October 29, 1991, of Designations, Preference and Rights of the Company's Senior Preferred Stock, Series A, B and C. [3.1(c)]\n3.1(d)** Certificate of Amendment dated December 23, 1991, of the Company's Restated Certificate of Incorporation. [3.1(d)]\n3.1(e)***** Certificate dated April 8, 1992, of Designation, Preference and Rights of the Company's Preferred Stock, Series C. [3.1(e)]\n3.1(f) Certificates of Correction to the Certificate of Incorporation, filed with the Delaware Office of the Secretary of State on January 25, 1996.\n3.1(g) Certificate of Designations, Preferences and Rights of Senior Preferred Stock, Series E, filed with the Delaware Office of the Secretary of State on January 25, 1996.\n3.1(h) Certificate of Designations, Preferences and Rights of 1996 Senior Preferred Stock, filed with the Delaware Office of the Secretary of State on January 26, 1996.\n3.2* By-Laws of HEARx, Ltd.\n4.1* Specimen of Certificate representing Common Stock.\n10.1* Form of Consulting Agreement, dated January 1, 1987, as of June 1, 1986, by and between HEARx Ltd. and each of the six members of the Company's Scientific Advisory Board. [10.1]\n# 10.2* Form of Directors' Restricted Stock Agreement, dated July 1, 1987, by and between HEARx Ltd. and each of Fred N. Gerard, David J. McLachlan and Daniel J. Miller, M.D. [10.3]\n# 10.3* HEARx Ltd. 1987 Stock Option Plan. [10.11]\n# 10.4* Current Form of Restricted Stock Agreement. [10.28(a)*]\n10.5*** Stock Purchase Agreement dated as of October 31, 1991, by and between Minnesota Mining and Manufacturing Company (\"3M\") and the Company and Exhibit A thereto, being the form of Certificate of Designations, Preferences and Rights of Senior Preferred Stock, Series A, B and C. [10.29]\n10.6*** (a) and (b) Warrant Certificates for Purchase of Stock of the Company each dated February 20, 1991, relating to 6,000 and 5,000 shares, respectively, of Senior Preferred Stock, Series C. [10.30]\n10.7***** Option to Purchase Agreement dated as of May 15, 1992, between 3M and the Company and Appendix A thereto, being the terms of the Senior Preferred stock, Series D, E and F. [10.33]\n# 10.8** (a) HEARx Ltd. Stock Option Plan for Non-Employee Directors and (b) Form of Option Agreement. [10.35]\n10.9**** Amendment dated January 6, 1993, to Option to Purchase Agreement dated May 15, 1992, between 3M and the Company. [10.45]\n10.10+ Amendment dated June 28, 1993, to Option to Purchase Agreement dated May 15, 1992, between 3M and the Company. [10.48]\n10.11+ Letter Agreement dated November 19, 1993, between 3M and the Company. [10.49]\n10.12++ Promissory Note dated January 4, 1994 by and between HEARx Ltd. and Audiology Sales & Service, Inc. [10.51]\n10.13++ Bill of Sale by and between HEARx Ltd., Seller, and Audiology Sales & Service, Inc., Buyer, dated March 8, 1994. [10.52]\n10.14++ Letter of Intent, dated November 14, 1994, between HEARx Ltd. and Av-Med. [10.62]\n10.15++ Bill of Sale and Asset Purchase Agreement by and between HEARx Ltd., Buyer, and Hearing Health Services, Inc., Seller, dated December 30, 1994. [10.64]\n10.16++ Agreement, dated January 4, 1995, between CareFlorida HealthCare Plans and HEARx Ltd. [10.65]\n10.17 Consolidated and Amended Loan Agreement by and among the Company, Siemens Hearing Instruments, Inc., and Rexton, Inc., dated effective January 1, 1995.\n10.18 Care Florida Agreement\n# 10.19+++ 1995 Flexible Employee Stock Plan\n10.20 Securities Purchase Agreement by and between the Company and Kew Capital Corporation, Ltd., dated as of June 29, 1995.\n10.21 Form of Offshore Securities Subscription Agreement entered into by and between the Company and each of Zanett Lombardier, Ltd., Harlow Enterprises, Inc., and Bruno Guazzoni, dated September 29, 1995, and October 19, 1995.\n10.22 Promissory Note in favor of Bruce M. Langone in the amount of $100,000 dated December 11, 1995.\n10.23 Promissory Note in favor of Kenneth G. Langone in the amount of $1,000,000 dated December 11, 1995.\n10.24 Agreement between the Company and Oxford Health Plans dated effective January 1, 1996, as amended by letter agreements dated February 21, 1996, and February 29, 1996.\n10.25 Stock Purchase Agreement and Registration Rights Agreement, each dated January 26, 1996, by and among the Company, Invemed Associates, Inc., and certain Investors therein named.\n10.26 Amended and Restated Promissory Note in favor of Paul A. Brown, M.D., in the amount of $1,675,000 dated January 26, 1996.\n10.27 Promissory Note in favor of Paul A. Brown, M.D., in the amount of $214,666 dated January 29, 1996.\n22 List of subsidiaries of HEARx Ltd.\n23(a) Consent of Independent Certified Public Accountants.\n27 Financial Data Schedule (provided for the information of the U.S. Securities and Exchange Commissio only) - ---------------\n# Denotes officer\/director compensation plan or arrangement.\n* Filed as an exhibit to the Company's Registration Statement on Form S-18 (Registration No. 33-17041-NY) as the exhibit number indicated in brackets and incorporated by reference herein.\n** Filed as an exhibit to Post-Effective Amendment No. 1 to the Company's Registration Statement on Form S-18 and incorporated by reference herein.\n*** Filed as an exhibit to the Company's Current Report on Form 8-K dated November 8, 1991, as the exhibit number indicated in brackets and incorporated by reference herein.\n**** Filed as an exhibit to the Company's Annual Report on Form 10-K for the year ended September 30, 1992, as the exhibit number indicated in brackets and incorporated by reference herein.\n***** Filed as an exhibit to the Company's Current Report on Form 8-K dated June 2, 1992, as the exhibit number indicated in brackets and incorporated by reference herein.\n+ Filed as an exhibit to the Company's Annual Report on Form 10-K for the year ended September 30, 1993, as the exhibit number indicated in brackets and incorporated by reference herein.\n++ Filed as an exhibit to the Company's Annual Report on Form 10-K for the year ended December 30, 1994, as the exhibit number indicated in brackets and incorporated by reference herein.\n+++ Filed as an exhibit to the Company's 1995 Proxy Statement, and incorporated by reference herein.\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.\nHEARx Ltd. (Registrant)\nDate: April 11, 1996 By: \/s\/ Paul A. Brown, M.D. ------------------------------------- Paul A. Brown, M.D. Chairman of the Board\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nSignature Title Date - ------------------------------ ------------------------------ ---------------\n\/s\/ Paul A. Brown, M.D. Chairman of the Board; April 11, 1996 - ------------------------------ Chief Executive Officer Paul A. Brown, M.D. and Director\n\/s\/ Stephen J. Hansbrough President and Chief April 11, 1996 - ------------------------------ Operating Officer Stephen J. Hansbrough\n\/s\/ Tommy E. Kee Vice President and Chief April 11, 1996 - ------------------------------ Financial Officer Tommy E. Kee\n\/s\/ David W. Forman Vice President - April 11, 1996 - ------------------------------ Facilities Management and David W. Forman Corporate Secretary\n\/s\/ Donna L. Taylor Vice President - Operations April 11, 1996 - ------------------------------ Donna L. Taylor\n\/s\/ Fred N. Gerard Director April 11, 1996 - ------------------------------ Fred N. Gerard\n\/s\/ David J. McLachlan Director April 11, 1996 - ------------------------------ David J. McLachlan\n\/s\/ Thomas W. Archibald Director April 11, 1996 - ------------------------------ Thomas W. Archibald\nEXHIBIT INDEX\nExhibit Number Description - -------------- --------------------------------------------------------------\n3.1(f) Certificates of Correction to the Certificate of Incorporation, filed with the Delaware Office of the Secretary of State on January 25, 1996.\n3.1(g) Certificate of Designations, Preferences and Rights of Senior Preferred Stock, Series E, filed with the Delaware Office of the Secretary of State on January 25, 1996.\n3.1(h) Certificate of Designations, Preferences and Rights of 1996 Senior Preferred Stock, filed with the Delaware Office of the Secretary of State on January 26, 1996.\n10.17 Consolidated and Amended Loan Agreement by and among the Company, Siemens Hearing Instruments, Inc., and Rexton, Inc., dated effective January 1, 1995.\n10.18 Care Florida letter agreement dated January 18, 1995.\n10.20 Securities Purchase Agreement by and between the Company and Kew Capital Corporation, Ltd., dated as of June 29, 1995.\n10.21 Form of Offshore Securities Subscription Agreement entered into by and between the Company and each of Zanett Lombardier, Ltd., Harlow Enterprises, Inc., and Bruno Guazzoni, dated September 29, 1995, and October 19, 1995.\n10.22 Promissory Note in favor of Bruce M. Langone in the amount of $100,000 dated December 11, 1995.\n10.23 Promissory Note in favor of Kenneth G. Langone in the amount of $1,000,000 dated December 11, 1995.\n10.24 Agreement between the Company and Oxford Health Plans dated August 10, 1995 (effective January 1, 1996), as amended by letter agreements dated February 21, 1996, and February 29, 1996.\n10.25 Stock Purchase Agreement and Registration Rights Agreement, each dated January 26, 1996, by and among the Company, Invemed Associates, Inc., and certain Investors therein named.\n10.26 Amended and Restated Promissory Note in favor of Paul A. Brown, M.D., in the amount of $1,675,000 dated January 26, 1996.\n10.27 Promissory Note in favor of Paul A. Brown, M.D., in the amount of $214,666 dated January 29, 1996.\n22 List of subsidiaries of HEARx Ltd.\n23(a) Consent of Independent Certified Public Accountants.\n27 Financial Data Schedule (provided for the information of the U.S. Securities and Exchange Commission only)","section_15":""}
{"filename":"824088_1995.txt","cik":"824088","year":"1995","section_1":"ITEM 1. BUSINESS.\nGENERAL\nGulf Exploration Consultants Inc. (\"the Company\") was incorporated under the laws of the State of Delaware on October 2, 1987. On September 15, 1988, the Company effected a roll-up transaction pursuant to which its wholly-owned subsidiaries Bengal Oil & Gas Corporation, a Colorado corporation, Gopher Exploration, Inc., a Texas corporation, GEC Texas, Inc. (formerly Gulf Exploration Consultants, Inc.), a Texas corporation, Dornoch Exploration, Inc., a Texas corporation and Vanderbilt Petroleum, Inc., a Delaware corporation, were rolled-up into the Company.\nIn 1988 and 1989, the Company incurred losses in the amount of $4.3 million and $4.1 million, respectively. These substantial losses eroded the Company's capital base and made it more difficult to obtain additional capital through borrowing or equity offerings. In addition, the Company had already incurred a substantial amount of debt. In 1990, in order to repay such debt the Company was forced to dispose of certain of its major oil and gas interests.\nAs of July 6, 1989, the National Association of Securities Dealers, Inc. (\"NASD\") delisted the Company's Common Stock from the NASDAQ Small-Cap Market because of the lack of active market makers registered to trade in the Company's securities.\nAn additional barrier to the Company's ability to obtain sufficient financing to fund its operations was the presence of a class of Preferred Stock of the Company which had a liquidation preference over the Company's Common Stock. Management determined that it would not be able to successfully obtain capital through the issuance of equity securities until it redeemed all of the Preferred Stock. Thus, over the period from 1990 through 1994, the Company redeemed all of the outstanding Preferred Stock. The Preferred Stock redemption, however, resulted in the Company disposing of all of its remaining significant oil and gas assets. Subsequent to the redemption the Company did not have any active business or operations.\nEMERGING MONEY\nIn December 1994, after engaging in negotiations with several other parties in an attempt to acquire a viable business opportunity for the Company, the Company issued 37,942,269 shares of its Common Stock in connection with the acquisition of a 100% interest in Emerging Money plc, a Republic of Ireland corporation (\"Emerging Money\"), from Minmet plc, a Republic of Ireland corporation (\"Minmet\"). Efforts were made to raise capital for developmental purposes and to have the Company's shares of Common Stock included for trading on the NASDAQ Small-Cap Market; however, the Company was not able to raise sufficient capital for such purposes. As a result of the Company's inability to raise sufficient capital, Minmet continued to fund Emerging Money's operations.\nMinmet formed Emerging Money in June 1994 to hold investments in companies which provide electronically distributed market information on the world's emerging capital markets. In December 1994, Minmet contributed its interest in Emerging Money to the Company in exchange for 37,942,269 shares of the Company's Common Stock. Emerging Money's principal operating subsidiary was Russiamoney Limited (\"Russiamoney\"), of which it held a 50% interest with the Investment & Analytical Centre of Moscow (the \"IAC\") owning the remaining 50% interest. The IAC is a Moscow based economic consultancy. In November 1995, the IAC terminated the arrangement as to Russiamoney because of non-payment by Emerging Money.\nEmerging Money has formed India Money Limited and South Africa Money Limited as subsidiaries; however, neither is actively engaged in business.\nRussiamoney is an information services company specializing in background analysis of financial, political and economic events in Russia's developing capital markets. Russiamoney obtains information from the IAC, which it translates, formats, edits and data processes. The processed information is then provided to Bloomberg Financial Markets system for world-wide transmission to the financial community.\nIn January and February 1995, Emerging Money hired two executives to oversee and develop Emerging Money's US sales and marketing presence and to develop new products. Despite the retention of such persons, Emerging Money incurred substantial losses.\nThe Company believes that the development of Emerging Money was curtailed for three reasons. First, Emerging Money was unable to meet its capital raising plan. It planned to raise $500,000 by January 1995, but was only able to raise $200,000 by March 1995. Second, sales of the existing Russiamoney services failed to grow at a significant level. Third, the retention of personnel placed further strains on Emerging Money's cash resources.\nBy September 1995, year to date losses had reached more than $600,000 and Minmet, which had already provided Emerging Money with more than $350,000 in funding, was unable to continue providing financial support.\nMICRON TRANSACTION\nAs a result of the inability of Minmet to continue funding Emerging Money and in order to discharge the loan notes of $100,000 each from Dennis Mensch (\"Mensch\") and DRM&S, Inc., now known as Osprey Investments Inc. (\"DRM&S\"), and to settle the loans advanced by Minmet to Emerging Money and the Company, the Board of Directors of the Company authorized, subject to stockholder approval, the transactions contemplated on behalf of the Company under (i) the Subscription Agreement and Option, dated December 7, 1995 (the \"Micron Subscription\"), among the Company, Minmet, Micron Ltd., a Republic of Ireland corporation (\"Micron\") and Emerging Money and (ii) the Letter Agreement, dated December 22, 1995 (the \"Letter Agreement\"), among the Company, Minmet, DRM&S and Mensch. (The transactions contemplated on behalf of the Company under the Micron Subscription and the Letter Agreement are collectively referred to herein as the \"Micron Transaction\").\nThe Micron Subscription relates to the acquisition by Micron of 3,954,545 newly issued shares of the common stock of Emerging Money. The acquisition would result in Micron owning 72.5% of the then outstanding shares of Emerging Money and the Company's ownership interest in Emerging Money would be reduced to 27.5% of Emerging Money shares then to be outstanding. In consideration for such Emerging Money shares, Micron has paid Emerging Money 39,546 Irish Pounds (US$ 63,293 equivalent as of December 31, 1995) and has paid on behalf of Emerging Money approximately US$ 80,000 which enabled Emerging Money to discharge certain agreed creditors. In addition, pending the closing, Micron is to pay or advance additional funds to creditors of Emerging Money to pay off certain liabilities and Micron shall have the right to control the management and finances of Emerging Money on a daily basis and to request Emerging Money to provide to Micron exclusive editing and administration services upon a fee basis. Furthermore, pursuant to the Micron Subscription, Micron controls marketing for Emerging Money's services and collects and is entitled to use in its sole discretion all revenues obtained from new subscribers. Revenues obtained from Russiamoney subscribers as of November 30, 1995 have been used by Emerging Money for working capital purposes. Micron has also been given the right to use all names, trademarks and copyrights used in connection with the business of Emerging Money or its subsidiaries on an exclusive basis. As of the entry into the Micron Subscription, neither the Company nor Emerging Money had sufficient capital to maintain the continuing operations of Emerging Money. In December 1995, Micron made a separate arrangement with the IAC as to the former operations of Russiamoney. Prior to the Micron Subscription, Micron had no relationship with the Company or Minmet.\nCORPORATE RESTRUCTURING\nIn March 1995, DRM&S and Mensch each invested $100,000 in the Company as part of a proposed \"bridge\" financing by the Company and were issued Promissory Notes (the \"Notes\"), payable on June 30, 1995 together with interest at the rate of 9% per annum. The bridge financing was never completed and a proposed private equity placement was never commenced by the Company.\nUpon the closing of the Micron Subscription, (i) each of DRM&S and Mensch will exchange its Notes for Common Stock of the Company amounting to 23.27%of the Common Stock then to be outstanding, (ii) the Company will transfer its 27.5% interest in Emerging Money to Minmet in exchange for shares of the Company's Common Stock presently owned by Minmet which would reduce Minmet's holding of the Company's Common Stock from 56.37% to 15.86% of the shares then to be outstanding (subject to adjustment if the valuation of the Emerging Money shares would exceed the valuation of the Common Stock to be exchanged) and the forgiveness of certain amounts due from the Company, (iii) the existing public stockholders of the Company will own the balance of the outstanding shares of Common Stock (or 37.6%) and (iv) the Company would have no further interest in Emerging Money nor any obligation for any liabilities of Emerging Money.\nUntil the Micron Transaction is consummated DRM&S and Mensch will remain creditors of the Company under the Notes and Minmet will remain the majority stockholder of the Company. If the Micron Transaction is not consummated, Minmet will reimburse DRM&S and Mensch for all payments made by each of them pursuant to the Letter Agreement.\nAfter the Micron Transaction, the Company will have no business activity; however its management will seek business opportunities for the Company. The intention is to identify and enter into an arrangement for a business which would present growth prospects to stockholders. The arrangement would be subject to approval by stockholders. Management plans to review possible acquisition prospects, but will not enter into any binding arrangement prior to the closing of the Micron Transaction. The Micron Subscription contains a non-competition covenant which restricts the Company from competing directly or indirectly in any business activities of the type carried on by Emerging Money and any of its subsidiaries at the closing of the Micron Transaction for a period of two years following such closing. Management has no plans to seek a business opportunity in the field of dissemination of financial information on emerging markets.\nThe Company plans to call a special meeting of stockholders in the near future for consideration of the Micron Transaction, the proposed corporate restructuring and such other matters as set forth in the notice of the meeting.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company having ceased to operate its oil and gas business had no continuing interest in any properties at December 31, 1995. The Company operates from leased premises in New York, New York, with some administrative functions carried on from an office in Dublin, Ireland. These premises are held on a week to week rent-free basis arrangement with the lessors. The lessor in New York is George Rieger, an officer and director of the Company, and the lessor in Dublin is Minmet.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is not a party, and property of the Company is not subject, to a material legal proceeding.\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 in the fourth quarter of 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANTS' COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe common stock, $.01 par value (the \"Common Stock\"), of the Company is traded in the over-the-counter market and the trading is inactive. Currently, there is no established public trading market for the Company's Common Stock. The Common Stock was deleted from the automated quotation system NASD on July 6, 1989 because there were no longer any active market makers registered to trade the securities.\nAs of December 31, 1995, there were approximately 1,424 stockholders of record of the Company's Common Stock.\nThe Company paid no dividends on the Common Stock in the fiscal years ended December 31, 1995, 1994 and 1993 and future dividend payments are dependent upon management's ability to acquire a profitable business into the Company. No dividend payments are expected in 1996.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe selected financial information set forth below has been taken from the consolidated financial statements of the Company included herein and from previously published consolidated financial statements of the Company not appearing herein. Such selected financial information should be read in conjunction with the consolidated financial statements of the Company.\nFor the year ended December 31 1995 1994 1993 ------------------- ---- ---- ----\nINCOME STATEMENT DATA:\nRevenues $ 64,034 $ 8,045 $ 224,285\nNet income (loss) ($712,694) $(106,562) $ 121,294\nNet income (loss) per common share ($0.01) $0.00 $0.00\nBALANCE SHEET DATA:\nTotal assets $ 85,938 $ 251,497 $ 111,491\nLong-term obligations $0 $ 5,035 $0\nNumber of shares 99,999,000 63,638,658 62,056,731\n1992 1991 ---- ---- INCOME STATEMENT DATA:\nRevenues $ 11,859 $ 26,294\nNet income (loss) ($ 15,442) $1,211,022\nNet income (loss) per common share $0.00 $0.00\nBALANCE SHEET DATA:\nTotal assets $ 369,446 $1,344,022\nLong-term obligations $0 $0\nNumber of shares 62,056,731 43,156,731\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nYEARS ENDED DECEMBER 31, 1995 AND 1994\nThe Company had a net loss in 1995 of $712,694 compared to net loss in 1994 of $106,562. Of the loss of $712,694, $128,957 was incurred by the Company and $583,737 was incurred by Emerging Money. The Company incurred the loss due to professional fees that were incurred in maintaining the Company and the cost of a full-time executive in the United States during the six-month period to June 30, 1995. Emerging Money's losses were incurred in developing its financial information on-line business.\nTechnical, general and administrative costs increased from $110,588 in 1994 to $700,672 in 1995 with the inclusion of the development stage costs of Emerging Money.\nInterest income amounted to $322 in 1995 compared to $948 in 1994 as the cash balances of the Company were reduced.\nYEARS ENDED DECEMBER 31, 1994 AND 1993\nThe Company had a net loss in 1994 of $106,562 compared to net income in 1993 of $121,294. The Company incurred the loss due to the high cost of professional fees that were necessarily incurred in maintaining the Company and preparing it for the acquisition of Emerging Money. The professional fees were incurred at a time when the level of activity in the Company was functioning at a low level.\nTechnical, general and administrative costs increased from $78,553 in 1993 to $110,588 as a result of the high level of professional fees.\nInterest income amounted to $948 in 1994 compared to $2,374 in 1993 as the cash balances of the Company were reduced.\nLIQUIDITY, CAPITAL RESOURCES AND GOING CONCERN ASSUMPTIONS\nBased on the financial position of the Company at December 31, 1995 significant doubt exists about the Company's ability to continue as a going concern as the Company has, exclusive of extraordinary items, suffered recurring losses over the past years and has sold all of its oil and gas revenue producing assets in order to retire certain debt on which it had defaulted. The Company was successful in eliminating all of its debt, at a substantial discount, in 1991, 1992 and 1993. The Company has also been successful in eliminating all of the liquidation preference associated with its preferred stock by repurchasing such stock. The elimination of this liquidation preference has allowed management the opportunity to seek out new business opportunities which culminated in 1994 with the acquisition of Emerging Money. Following the acquisition of Emerging Money the management team had been seeking to raise monies through debt or equity placements to fund the Company's present operations and future expansion.\nHowever the planned fund raising raised $200,000, $300,000 less than the targeted figure of $500,000. Emerging Money incurred significant losses in 1995 which forced management to seek outside funding to rescue Emerging Money. Negotiations to that end have been concluded and management have described above the arrangements being proposed to refinance Emerging Money and to reorganize the Company. See Item 1 of this Report.\nDue to the limited capital resources, management of the Company has been forced to liquidate certain subsidiaries of the Company. Management believes that the liquidation of these subsidiaries will not have an effect on its parent or affiliate companies. However, no assurance can be given that the parent or affiliate companies will not assume a contingent liability for the amount of subsidiary debt not fully extinguished in liquidation.\nNo assurance can be given that following the approval of the Micron Transaction and any reorganization that a new acquisition will be quickly effected, or, if effected, that the terms will be favorable or substantially non-dilutive to the stockholders of the Company, or that an active trading market would be created for the Common Stock.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nFinancial statements, financial statement schedules and supplementary data, listed under Item 14, are presented in a separate section of this Report beginning on Page.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nThe Company changed independent accountants from Arthur Andersen LLP to Berry Dunn McNeil and Parker in March 1995. Arthur Andersen had represented the Company through its Houston, Texas office to service more efficiently the Company's previous oil and gas business and continued as accountant after such business activities were terminated and the Company was inactive and had relocated its administrative base to New York. There were no disagreements with Arthur Andersen 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 following table lists the names, ages, positions, and periods of service with the Company of its directors and executive officers.\nServed as Director Name Age Since Position ---- --- ----------- --------\nL. George Rieger 56 1988 Chairman of the Board and President\nMichael H. Nolan 34 1995 Chief Financial Officer, Secretary and Director\nJeremy Metcalfe 56 1995 Director\nL. George Rieger has served as a director of the Company since June 1988 having been the sole director between May 15, 1993 and December 16, 1994, has been Chairman of the Board and the President of the Company since May 1993 and January 1993, respectively. In 1984, Mr. Rieger founded Rieger Robinson & Harrington, a private client investment business and has served as its Chairman of the Board since 1984. From 1979 to 1984, Mr. Rieger was employed by Morgan Stanley in the asset management division in New York.\nMichael H. Nolan, a chartered accountant in Ireland, has been the Chief Financial Officer of the Company since May 1994, Secretary and a director since December 1995. Since April 1994, he has also served as Finance Director of Minmet, which is engaged in mining. From 1989 through 1994, Mr. Nolan was an associate director of Equity and Corporate Finance plc, a London based investment company.\nJeremy Metcalfe has been a director of the Company since December 1995. He has served as the Chairman of the Board of Directors of Minmet since September 1995 and is also on the Board of Directors of several Minmet subsidiaries. Mr. Metcalfe has also served as a director of City Venture Properties Limited, a real estate brokerage firm since 1989 and has been senior partner in JP Metcalfe Associates, a corporate finance firm in Kent, England specializing in the venture capital industry since 1980.\nThe term of office of the directors is until the next annual meeting of stockholders or until his earlier resignation or his successor is duly elected and qualified.\nThe Board of Directors held three meetings during the 1995 fiscal year.\nThe Company does not have any standing audit, nominating or compensation committee of the Board of Directors or committees performing similar functions.\nNo director receives any compensation from the Company for serving in such position.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nCASH COMPENSATION\nNo executive officer of the Company received any compensation from the Company or any of its subsidiaries during 1995.\nSTOCK OPTION PLAN\nThe 1988 Stock Option Plan was terminated by the Board of Directors in January 1993. No options are outstanding under this Plan.\nITEM 12.","section_12":"ITEM 12. SECURITIES OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nSECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS\nThe following table sets forth as of April 15, 1996 the beneficial ownership of each person (including any \"group\" as that term is used in Section 13(d)(3) of the Securities Exchange Act of 1934, as amended) who is known by the Company to be the beneficial owner of more than 5% of any class of voting securities of the Company:\nAMOUNT AND NATURE OF PERCENT TITLE OF BENEFICIAL OF NAME CLASS OWNERSHIP CLASS ---- ------------ ---------- ------ Minmet plc Common Stock 52,735,246 56.4% 51\/52 Fitzwilliam Square Dublin 2, Ireland\nSecurity Ownership of Management\nThe following table sets forth as of March 31, 1996 the beneficial ownership of each class of equity securities of the Company of (I) each current director of the Company and (ii) all executive officers and directors of the Company as a group. Such information is based solely upon information provided by such persons to the Company.\nAMOUNT AND NATURE OF PERCENT TITLE OF BENEFICIAL OF NAME CLASS OWNERSHIP CLASS ---- --------- ---------- -------\nL. George Rieger Common Stock 0 0\nJeremy P. Metcalfe Common Stock 52,735,246 (1) 56.4%\nMichael H. Nolan Common Stock 52,735,246 (1) 56.4\nAll directors and Common Stock 52,735,246 (1) 56.4 executive officers as a group (3 persons)\n(1) Mr. Metcalfe and Mr Nolan represent Minmet on the Board of the Company. Mr. Metcalfe is Executive Chairman of Minmet and Mr. Nolan is Finance Director of Minmet.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nMichael H. Nolan, Chief Financial Officer, Secretary and a director of the Company, is the Finance Director of Minmet, and Jeremy Metcalfe, a Director of the Company, is the Chairman of the Board of Directors of Minmet. Minmet owns a majority of the outstanding shares of the Company's Common Stock. Pursuant to the Letter Agreement, Minmet will assume certain liabilities of the Company and exchange shares of the Company's Stock held by it for the Company's interest in Emerging Money as part of the Micron Transaction. Messrs. Nolan and Metcalfe have an indirect interest in the Micron Transaction and the exchange of the Emerging Money Shares by reason of their executive positions in Minmet. See Item 1 of this Report.\nThe Company uses offices premises rent-free in New York and in Dublin leased from George Rieger, Chairman of the Board and President of the Company, and Minmet, respectively. See Item 2 of this Report.\nAs at December 31, 1995, Minmet had advanced $31,192 and $361,930 to the Company and Emerging Money, respectively, and the Company had advanced $137,303 to Emerging Money. All these advances are unsecured and due on demand.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\nEXHIBIT NUMBER PAGE ---------------------------------------------------------------- (a)(1) Index to Financial Information:\nReport of Independent Public Accountants for 1995 and 1994\nConsolidated Balance Sheets as of December 31, 1995 and 1994\nConsolidated Statements of Operations for the years ended December 31, 1995 and 1994\nConsolidated Statements of Changes in Stockholder's Equity for the years ended December 31, 1995 and 1994\nConsolidated Statements of Cash Flows for the years ended December 31, 1995 and 1994\nNotes to Consolidated Financial Statements\nAll other supplemental schedules are omitted because they are not required.\n(a)(3) The following exhibits are filed herewith or incorporated by reference:\n3.1 Certificate of Incorporation of the Company. (Reference is made to Exhibit 3.1 to the Company's Registration Statement on Form S-1, Registration No. 33-20866).\n3.2 Bylaws of the Company. (Reference is made to Exhibit 3.2 to the Company's Registration Statement on Form S-1, Registration No. 33-20866).\n3.3 Certificate of Designations, Preferences and Rights of Serial Preferred Stock, $8.00 Cumulative Convertible Series A. (Reference is made to Exhibit 3.3 to the Company's Registration Statement on Form S-1, Registration No. 33-20866.)\n3.4 Certificate of Designations, Preferences and Rights of Serial Preferred Stock, $8.00 Cumulative Convertible Series B. (Reference is made to Exhibit 4.2 to Report on Form 8-K filed by the Company on January 11, 1989).\n3.5 Certificate of Designations, Preferences and Rights of Serial Preferred Stock, $4.00 Cumulative Convertible Series C. (Reference is made to Exhibit 4.1 to Report on Form 8-K filed by the Company on January 11, 1989).\n10.1 Agreement between the Company and Minmet plc relating to the purchase by the Company of Emerging Money plc dated December 16, 1994 (Reference is made to Exhibit 1 to Report on Form 8-K filed by the Company for an event of December 16, 1994.\n10.2 Agreement between the Company and Sampson Resources Company relating to the assignment of leases in Wyoming to Sampson.\n10.3 Agreement between the Company and Robert R. Hillery relating to the sale to Hillery of all the outstanding shares of Dornoch Inc. and GEC Texas Inc. in exchange for the cancellation of 6,446,375 shares of Common Stock held beneficially by Hillery in the Company.\n10.4 Subscription Agreement and Option, dated December 1995 among the Company, Minmet plc, Micron Ltd and Emerging Money Plc; (Reference is made to Exhibit 99.1 to Report on Form 8-K for an event of December 22, 1995).\n10.5 Letter Agreement dated December 22, 1995, among the Company, Minmet plc, DRM&S Inc. and Dennis Mensch (Reference is made to Exhibit 99.2 to Report on Form 8-K for an event of December 22, 1995).\n21 Subsidiaries (Reference is made to Exhibit 21 to Report on Form 10-K for fiscal year ended December 31, 1995).\n27 Financial Data Schedule.\nREPORTS ON FORM 8-K\nThe Company filed a report on Form 8-K for an event of December 22, 1995, detailing the appointment of directors, and a proposed recapitalization 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.\nGULF EXPLORATION CONSULTANTS, INC.\n\/s\/ L. George Rieger ---------------------------------- By: George Rieger, Chairman\nDate: May 14, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Company and in the capacities and on the dates indicated.\nSignature Title Date\n\/s\/ L. George Rieger -------------------------- Director May 14, 1996 L. George Rieger\n\/s\/ Jeremy P. Metcalfe -------------------------- Director May 14, 1996 Jeremy P. Metcalfe\n\/s\/ Michael H. Nolan -------------------------- Director and May 14, 1996 Michael H. Nolan Chief Financial Officer\nINDEPENDENT AUDITORS' REPORT\nGulf Exploration Consultants, Inc.\nWe have audited the accompanying consolidated balance sheets of Gulf Exploration Consultants, Inc. (a Delaware corporation) and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations, changes in stockholders' equity (deficit) and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Gulf Exploration Consultants, Inc. and subsidiaries as of December 31, 1995 and 1994, and the results of their operations and their cash flows for the years then ended, in conformity with generally accepted accounting principles.\nThe accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company has suffered recurring losses and has sold substantially all of its revenue producing assets in the oil and gas industry and does not have an operating business. This raises substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 1. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.\n\/s\/ Berry, Dunn, McNeil & Parker\nManchester, New Hampshire May 7, 1996\nGULF EXPLORATION CONSULTANTS, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\nDECEMBER 31, 1995 AND 1994\nASSETS\n1995 1994 ---- ----\nCURRENT ASSETS\nCash and cash equivalents $10,425 $ 26,586 Accounts receivable, net of reserve of $-0- IN 1995 and $9,000 in 1994 27,111 9,211\nPrepaid expenses - 13,636 Due from affiliate - 4,935 Other - 471 ------- -------\nTOTAL CURRENT ASSETS 37,536 54,839 ------- -------\nEQUIPMENT, AT COST Equipment, including assets acquired under capital leases ($15,058 in 1995 and 1994) 80,242 70,818 Less accumulated depreciation, including amortization applicable to assets acquired under capital leases ($6,791 IN 1995 and $839 in 1994) 31,840 8,552 ------- -------\nNET EQUIPMENT 48,402 62,266 ------- -------\nDEFERRED EXPENSES - 134,392 ------- --------\n$85,938 $251,497 ======= ========\n----------------------------------------------------------------- THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.\nLIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)\n1995 1994 ---- ---- CURRENT LIABILITIES\nAccounts payable $ 114,304 $ 85,715 Accrued expenses 34,655 57,570 Deferred income 36,347 8,192 Current portion of capital lease obligations 5,930 7,551 Due to affiliate 365,666 66,962 Other 246,900 6,813 ---------- ---------- Total current liabilities 803,802 232,803\nCapital lease obligations, excluding current portion - 5,035 ---------- ----------\nTOTAL LIABILITIES 803,802 237,838 ---------- ----------\nCOMMITMENTS AND CONTINGENCIES (Note 5)\nSTOCKHOLDERS' EQUITY (DEFICIT) Common stock of $.01 par value; 100,000,000 shares authorized, 99,999,000 shares issued and outstanding 999,990 999,990 Additional paid-in capital 6,449,789 6,449,789 Accumulated deficit (8,148,814) (7,436,120) Accumulated translation loss (18,829) - ----------- -----------\nTOTAL STOCKHOLDERS' EQUITY (DEFICIT) (717,864) 13,659 ----------- -----------\n$ 85,938 $ 251,497 ============ ===========\n------------------------------------------------------------------\nCONSOLIDATED STATEMENTS OF OPERATIONS\nYEARS ENDED DECEMBER 31, 1995 AND 1994\n1995 1994 ---- ----\nREVENUES Subscription income $ 60,504 $ - Other income 3,530 8,045 --------- --------- 64,034 8,045 --------- --------- OPERATING EXPENSES Oil and gas production costs - 4,967 Technical, general and administrative 700,672 110,588 Depreciation and amortization 76,378 - --------- --------- 777,050 115,555 --------- --------- LOSS FROM OPERATIONS (713,016) (107,510)\nInterest income 322 948 --------- ---------\nLOSS BEFORE INCOME TAX PROVISION (712,694) (106,562)\nIncome tax provision - - ---------- ---------\nNET LOSS $(712,694) $(106,562) ========== ==========\nNET LOSS PER COMMON SHARE Net loss $(0.01) $(0.00) ========= ========\n---------------------------------------------------------------- THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.\nGULF EXPLORATION CONSULTANTS, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)\nYEARS ENDED DECEMBER 31, 1995 AND 1994\nCommon Stock Additional ----------------- Paid-In Accumulated Shares Amount Capital Deficit -------- ---------- ---------- -----------\nBALANCE, DECEMBER 31, 1993 62,056,731 $620,567 $6,783,482 $(7,329,558)\nStock issuance for acquisition 37,942,269 379,423 (333,693) -\nNet loss - - - (106,562) ----------- --------- ------------ ----------\nBALANCE, DECEMBER 31, 1994 99,999,000 999,990 6,449,789 (7,436,120)\nAccumulated translation loss - - - -\nNet loss - - - (712,694) ----------- --------- ------------ ---------- BALANCE, DECEMBRER 31, 1995 99,999,000 999,990 6,449,789 (8,148,814) =========== ========= ============ ==========\nAccumulated Translation Total Stockholders' Loss Equity (Deficit) ------------ ---------------\nBALANCE, DECEMBER 31, 1993 $ - $ 74,491\nStock issuance for acquisition - 45,730\nNet loss - (106,562) ----------- ---------\nBALANCE, DECEMBER 31, 1994 - 13,659\nAccumulated translation loss (18,829) (18,829)\nNet loss - (712,694) ----------- --------- BALANCE, DECEMBER 31, 1995 $ (18,829) $(717,864) =========== =========\n------------------------------------------------------------------------\nTHE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.\nGULF EXPLORATION CONSULTANTS, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nYEARS ENDED DECEMBER 31, 1995 AND 1994\n1995 1994 ---- ---- CASH FLOWS FROM OPERATING ACTIVITIES Net loss $(712,694) $(106,562) Adjustments to reconcile net loss to net cash provided (used) by operating activities Depreciation and amortization 76,378 - Decrease in deferred expenses 72,961 - Accumulated translation loss (18,829) - (Increase) decrease in Accounts receivable and other (8,429) - Receivables from related parties 4,935 - Prepaid expenses 13,636 - Increase (decrease) in Accounts payable 28,589 (1,085) Accrued expenses (22,915) 27,570 Payables to related parties 298,704 (10,000) Deferred income 28,155 - Other 240,087 - -------- --------- NET CASH PROVIDED (USED) BY OPERATING ACTIVITIES 578 (90,077) -------- ---------\nCASH FLOWS FROM INVESTING ACTIVITIES Cash from purchased subsidiary - 5,172 Purchase of equipment (9,424) - Proceeds from sale of property, plant and equipment - 12,000 -------- ------- NET CASH PROVIDED (USED) BY INVESTING ACTIVITIES (9,424) 17,172 -------- --------\nCASH FLOWS FROM FINANCING ACTIVITIES Payments on capital lease obligations (7,315) - -------- --------\nNET DECREASE IN CASH AND CASH EQUIVALENTS (16,161) (72,905)\nCASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 26,586 99,491 -------- --------\nCASH AND CASH EQUIVALENTS, END OF YEAR $ 10,425 $ 26,586 ========= =========\n-------------------------------------------------------------------------- THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.\nGULF EXPLORATION CONSULTANTS, INC. AND SUBSIDIARIED\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1995 AND 1994\nNATURE OF BUSINESS ------------------\nGulf Exploration Consultants, Inc., a Delaware corporation (Gulf), was formed on October 2, 1987. Gulf completed a series of transactions on September 15, 1988, whereby it acquired all of the outstanding stock of Bengal Oil and Gas Corporation, a Colorado corporation (Bengal), Dornoch Exploration, Inc., a Texas corporation (Dornoch), GEC-Texas, Inc. (formerly Gulf Exploration Consultants, Inc.), a Texas corporation (GEC), Gopher Exploration, Inc., a Texas corporation (Gopher) and Vanderbilt Petroleum, Inc., a Delaware corporation (Vanderbilt). As a result of these transactions, Gulf and its consolidated subsidiaries (collectively referred to as the Company) became a publicly owned company engaged primarily in the businesses of oil and gas exploration, development and production.\nOn December 16, 1994, the Company acquired all the outstanding stock of Emerging Money, PLC (Emerging Money), an Irish corporation which was a development stage enterprise. With this acquisition, the Company ceased its involvement in the oil and gas business and was involved in the provision of a subscription-based English language information service specializing in providing background analysis of the world's emerging capital market. In 1994, Emerging Money's activities were focused on the Russian market and conducted its activities through a joint venture (Russiamoney Limited), 50% owned, and whose financial activities are consolidated with Emerging Money. This acquisition is accounted for under the purchase method of accounting. Due to the immateriality of the activity between December 16, 1994 and December 31, 1994, Emerging Money's operations for this period are not reflected in the consolidated financial statements, however, the acquisition has been reflected as of December 31, 1994 (see Note 7). Proforma disclosures are not deemed necessary due to the subsidiary being a development stage enterprise.\nOn November 30, 1995, due to continuing losses in Emerging Money, the directors of the Company negotiated an agreement to dispose of its interest in the subscription-based English language information business. Consequently, the Company has no operating business subsequent to November 30, 1995. Note 2 summarizes the terms and conditions of the Company's disposition of its subscription-based English language information business.\n1. GOING CONCERN ASSUMPTION ------------------------\nThe accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. However, substantial doubt exists about its ability to continue as a going concern as the Company has suffered recurring losses, has sold substantially all of its revenue producing assets in the oil and gas industry in order to retire certain debt on which it had defaulted and has disposed of its only operating business, as discussed above. The accompanying consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. Management's current plans are to secure shareholder agreement for the disposal of Emerging Money (see Note 2) and thereafter acquire an operating corporate entity. However, no assurance can be given that these strategies will be effected, or, if effected, that the terms will be favorable or non-dilutive to the stockholders of the Company.\nManagement of the Company is also liquidating certain other wholly- owned subsidiaries of Gulf. Management of the Company believes that the liquidation of the subsidiaries will not have an effect on Gulf or the affiliate companies. However, no assurance can be given that Gulf or the affiliate companies will not assume a contingent liability for the amount of the subsidiary debt not fully extinguished in liquidation.\n2. AGREEMENTS TO DISPOSE OF EMERGING MONEY ---------------------------------------\nThe Company has entered into agreements which, if approved by the Company's stockholders, will transfer 100% of the Company's interest in Emerging Money to creditors of the Company, effective December 1, 1995. In exchange for the transfer, the Company's creditors have agreed to discharge their debt. If stockholder approval is not accomplished, 100% of the Company's interest in Emerging Money will be transferred, effective December 1, 1995, in partial settlement of debt and the remaining debt would still be payable.\n3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ------------------------------------------\nCONSOLIDATION -------------\nAll subsidiaries of Gulf are 100% owned and accordingly are consolidated with Gulf and all intercompany activity has been eliminated. The result of Emerging Money's joint venture investment is consolidated with Emerging Money's activity due to the control it exercises over the joint venture. Since the joint venture had a loss and negative net worth as of December 31, 1995, no value is attributed to the minority interest.\nUSE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS -----------------------------------------------------------\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nEQUIPMENT ---------\nEquipment purchased is depreciated by the straight-line method over the estimated useful lives of the respective assets. Equipment acquired under capital leases is amortized by the straight-line method over the estimated useful lives of the respective assets.\nINCOME TAXES ------------\nDeferred income taxes are recognized for income and expense items that are reported for financial statement purposes in different years than for income tax purposes.\nCASH AND CASH EQUIVALENTS -------------------------\nFor purposes of reporting the statements of cash flows, the Company considers all cash accounts, which are not subject to withdrawal restrictions or penalties, and all highly liquid investments with a maturity of three months or less to be cash equivalents.\nINCOME RECOGNITION ------------------\nIncome is recognized when earned. Prepaid subscription fees are included in liabilities as deferred income.\nCredit is extended at regular terms without collateral after the Company performs appropriate credit investigations.\nTRANSLATION OF FOREIGN CURRENCIES ---------------------------------\nAssets and liabilities recorded in functional currencies other than U.S. dollars are translated into U.S. dollars at the year-end rate of exchange. Revenue and expenses are translated at the weighted-average exchange rates for the year. The resulting translation adjustments are charged or credited directly to a separate component of stockholders' equity. Gains or losses from foreign currency transactions, such as those resulting from the settlement of receivables or payables denominated in foreign currency, are included in the earnings of the current period.\nNET LOSS PER COMMON SHARE -------------------------\nNet loss per common share is based on the weighted average number of common shares outstanding during each year. The weighted average number of common shares outstanding for 1995 and 1994 was 99,999,000 and 63,638,658, respectively.\n4. INCOME TAXES ------------\nGulf, Bengal, Dornoch, GEC, Gopher and Vanderbilt each filed separate federal tax returns through December 31, 1989. A consolidated U.S. federal income tax return was filed by the Company for 1990 using a December 31 fiscal year end. Consolidated income tax returns will be filed for years subsequent to 1990. See Note 5 for status of returns filed.\nEffective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes, which requires deferred income taxes to be provided for the expected tax effects of differences between the financial statement and tax bases of assets and liabilities. As a result of adopting the cumulative effect of the change in accounting principle, the Company has a deferred tax asset which is attributable primarily to net operating loss carryforwards. Since, at this time, it is more probable than not that the deferred tax asset will not be realized, a valuation allowance for the entire amount has been recorded.\nAs of December 31, 1995, the Company had net operating loss carryforwards of approximately $5 million. The benefits of the carryforward will begin to expire in 2003. These carryforwards exclude net operating loss carryforwards of merged companies as of September 15, 1988 because the availability of such carryforwards to benefit future operations is limited.\n5. COMMITMENTS AND CONTINGENCIES -----------------------------\nAs of May 7, 1996, the Company has not filed certain federal and state income tax returns for the years ended 1991, 1992, 1993, 1994 and 1995. It is management's intent to file the required tax returns in 1996. Management believes penalties for late filing will not be material to the financial statements.\n6. CAPITAL LEASES --------------\nThe following is a schedule of the future minimum lease payments under the capital leases together with the present value of the net minimum lease payments as of December 31, 1995:\nYear ending December 31: 1996 $6,207 ------ Minimum lease payments 6,207 Less amount representing interest (6.10%) 277 ------\nPresent value of net minimum lease payments (of which $5,930 is included in current liabilities) $5,930 ======\n7. BUSINESS COMBINATION --------------------\nOn December 16, 1994, Gulf Exploration Consultants, Inc. issued 37,942,269 shares of $.01 par value common stock for 100% of the outstanding stock of Emerging Money, PLC, an Irish corporation. Gulf acquired Emerging Money from MINMET, PLC, an Irish corporation, which, after its sale of Emerging Money, owns 52.7% of Gulf's common stock. Consequently, this business combination is being accounted for under the purchase method of accounting. Emerging Money's activity between December 16, 1994 and December 31, 1994 is not material to the financial statements and is not shown in the statements of operations or cash flows.\nEmerging Money, through its 50% ownership investment in Russiamoney Limited, is a development stage enterprise which was incorporated on February 24, 1994. For financial statement reporting purposes, Russiamoney Limited is consolidated with Emerging Money. No value has been attributed to the minority interest due to the venture's negative net worth as of December 31, 1994.\nThe results of operations for Emerging Money for 1994 are as follows:\nSubscription income $6,183 Net loss $183,470 Net loss per share $0.00\n8. DEFERRED EXPENSES -----------------\nThe deferred expenses as of December 31, 1994 consist of expenses associated with the creation of Emerging Money's proprietary database and software, which it developed in 1994. The database and software developed is an integral part of the subscription revenue to be generated in the future. Accordingly, the costs have been capitalized and amortized over 60 months, beginning January 1, 1995. The amounts were written off as of December 31, 1995 because Emerging Money is no longer entitled to the revenue stream generated by the assets (see Note 2).\n9. CASH FLOW INFORMATION\nNoncash investing activities consisted of the following as of December 31, 1994:\nPurchase of subsidiary Fair market value of assets acquired Cash and cash equivalents $ 5,172 Accounts receivable 9,211 Prepaid expenses 13,636 Due from affiliate 4,935 Other assets 471 Equipment, net 62,266 Deferred expenses 134,392 ------- Value of assets acquired 230,083 ------- Liabilities assumed Accounts payable and accrued expenses 79,800 Deferred income 8,192 Capital lease obligations, current 7,551 Due to affiliate 76,962 Other 6,813 Capital lease obligations, long-term 5,035 ------- 184,353 -------\nInvestment in subsidiary $ 45,730 =======\nNoncash financing activities consisted of the following as of December 31, 1994:\n37,942,269 shares of common stock were issued in connection with the acquisition of the subsidiary.\n10. DUE TO AFFILIATE ----------------\nThe amounts due to affiliate is due MINMET, PLC which owns 52.7% of the Company. No interest is due on these amounts.\n11. OTHER LIABILITIES -----------------\nIncluded in other liabilities is $200,000 advanced by two entities who are parties to the agreement discussed in Note 2. The interest amount is not being sought nor accrued, pending stockholder approval of these agreements.\nAnother $46,900 has been advanced by a party to those agreements to allow the Company to pay some of its liabilities.\n12. DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS ----------------------------------------------------\nThe Company's financial instruments consist of cash, short-term trade receivables and payables, and long-term debt. The carrying value of all instruments approximate their fair value.\nEXHIBIT INDEX\nExhibit Description ------- -----------\n27 Financial Data Schedule","section_15":""}
{"filename":"814460_1995.txt","cik":"814460","year":"1995","section_1":"ITEM 1. BUSINESS\nPaineWebber Equity Partners Three Limited Partnership (the \"Partnership\") is a limited partnership formed in May 1987 under the Uniform Limited Partnership Act of the State of Virginia to invest in a diversified portfolio of existing, newly-constructed or to-be-built income-producing operating properties such as apartments, shopping centers, hotels, office buildings and industrial buildings. The Partnership sold approximately $50,468,000 in Limited Partnership Units, at $1,000 per Unit, from January 4, 1988 to September 1, 1989 pursuant to a Registration Statement on Form S-11 filed under the Securities Act of 1933 (Registration No. 33-14489). Limited Partners will not be required to make any additional capital contributions.\nAs of March 31, 1995, the Partnership owned, through joint venture partnerships, interests in the operating properties set forth in the following table:\nName of Joint Venture Date of Name and Type of Property Acquisition Type of Location Size of Interest Ownership (1)\nDeVargas Center Joint Venture retail 4\/19\/88 Fee ownership of land DeVargas Mall shopping and improvements Santa Fe, New Mexico center on (through joint venture) 18.3 acres with 248,000 net leasable square feet\nPortland Pacific Associates thirteen 9\/20\/88 Fee ownership of land Two one-, two- and improvements Willow Grove Apartments and three- (through joint venture) Beaverton, Oregon story apartment buildings on 6.2 acres with 119 units\nRichmond Paragon Partnership six-story 9\/26\/88 Fee ownership of land One Paragon Place Office office and improvements Building building (through joint venture) Richmond, Virginia on 8.2 acres with 146,614 net leasable square feet\nColony Plaza General retail 1\/18\/90 Fee ownership of land Partnership shopping and improvements Colony Plaza Shopping Center center on (through joint venture) Augusta, Georgia 33.33 acres with 216,712 net leasable square feet\n(1)See Notes to the Financial Statements filed with this Annual Report for descriptions of the agreements through which the Partnership has acquired these operating investment properties.\nThe Partnership's investment objectives are to invest the proceeds raised from the offering of limited partnership units in a diversified portfolio of income-producing properties in order to: (i) preserve and protect the Limited Partners' capital, (ii) provide the Limited Partners with quarterly cash distributions, a portion of which will be sheltered from current federal income tax liability, and (iii) achieve long-term capital appreciation in the value of the Partnership's investment properties. Through March 31, 1995, the Limited Partners have received cumulative cash distributions of approximately $20,210,000. Quarterly distributions were paid at the rate of 8% per annum on invested capital from inception through the quarter ended September 30, 1991. The distributions were reduced to 5% per annum effective for the quarter ended December 31, 1991 and were paid at that rate through the quarter ended June 30, 1994. Effective for the quarter ended September 30, 1994, the distribution rate was reduced to 2% per annum. A substantial portion of the distributions paid to date has been sheltered from current federal income tax liability. In addition, the Partnership retains an ownership interest in all four of its original investment properties.\nThe Partnership's success in meeting its capital appreciation objective will depend upon the proceeds received from the final liquidation of the investments. The amount of such proceeds will ultimately depend upon the value of the underlying investment properties at the time of their liquidation, which cannot presently be determined. While real estate values for commercial office buildings and retail shopping centers have generally stabilized over the past 12 to 24 months, the current market values of the Partnership's commercial office building and two retail shopping centers are estimated to be below their acquisition prices due to the residual effects of the overbuilding which occurred in the late 1980's and, in the case of the office building, the trend toward corporate downsizing and restructurings which occurred in the wake of the last national recession. The market for multi-family residential properties throughout the country continued to show signs of improvement during fiscal 1995, as the ongoing absence of significant new construction activity further improved upon the supply and demand characteristics facing existing properties. Management believes that overall real estate market conditions will improve further in the near term. With respect to the Partnership's office building and shopping center investments, it remains to be seen whether conditions will improve sufficiently during the current market cycle to bring the market values back to or above the amounts of the Partnership's original investments. Management's plans are presently to hold the majority of the investment properties for long-term investment purposes and to direct the management of the operations of the properties to maximize their long-term values.\nAll of the Partnership's investment properties are located in real estate markets in which they face significant competition for the revenues they generate. The apartment complex competes with numerous projects of similar type generally on the basis of price and amenities. Apartment properties in all markets also compete with the local single family home market for prospective tenants. Despite this competition, the lack of significant new construction of multi-family housing over the past 2-to-3 years has allowed the oversupply which existed in most markets to be absorbed, with the result being a gradual improvement in occupancy levels and effective rental rates and a corresponding increase in property values. The Partnership's shopping centers and office building investments also compete for long-term commercial tenants with numerous projects of similar type generally on the basis of price, location and tenant improvement allowances.\nThe Partnership has no property investments located outside the United States. The Partnership is engaged solely in the business of real estate investment, therefore presentation of information about industry segments is not applicable.\nThe Partnership has no employees; it has however, entered into an advisory agreement with PaineWebber Properties Incorporated (PWPI), which is responsible for the day-to-day operations of the Partnership. PWPI is a wholly-owned subsidiary of PaineWebber Incorporated (PWI), a wholly-owned subsidiary of PaineWebber Group Inc. (PaineWebber). The managing general partner of the Partnership is Third Equity Partners, Inc. (the `Managing General Partner''), a wholly owned subsidiary of PWI. The associate general partners of the Partnership (the `Associate General Partners') are PaineWebber Partnerships, Inc., a wholly owned subsidiary of PaineWebber and Properties Associates 1988 L.P., a Virginia limited partnership. The general partner of Properties Associates 1988, L.P. is PAM Inc., a wholly owned subsidiary of PWPI. The officers of PaineWebber Partnerships, Inc. and PAM Inc. are also officers of the Managing General Partner.\nThe terms of transactions between the Partnership and affiliates of the Managing General Partner are set forth in Items 11 and 13 below to which reference is hereby made for a description of such terms and transactions.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Partnership has acquired interests in four operating properties through joint venture partnerships. These joint venture partnerships and the related properties are referred to under Item 1 above to which reference is made for the name, location and description of the properties.\nOccupancy figures for each fiscal quarter during 1995, along with an average for the year, are presented below for each property:\nPercent Occupied At Fiscal 6\/30\/94 9\/30\/94 12\/31\/94 3\/31\/95 Average\nDeVargas Mall 85% 84% 86% 90% 86%\nWillow Grove Apartments 97% 97% 97% 95% 97%\nOne Paragon Place 96% 98% 98% 99% 98%\nColony Plaza Shopping Center 96% 96% 96% 96% 96%\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIn November 1994, a series of purported class actions (the \"New York Limited Partnership Actions\") were filed in the United States District Court for the Southern District of New York concerning PaineWebber Incorporated's sale and sponsorship of various limited partnership investments, including those offered by the Partnership. The lawsuits were brought against PaineWebber Incorporated and Paine Webber Group Inc. (together \"PaineWebber\"), among others, by allegedly dissatisfied partnership investors. In March 1995, after the actions were consolidated under the title In re PaineWebber Limited Partnership Litigation, the plaintiffs amended their complaint to assert claims against a variety of other defendants, including Third Equity Partners, Inc. and Properties Associates 1988, L.P. (`PA1988''), which are General Partners of the Partnership and affiliates of PaineWebber. On May 30, 1995, the court certified class action treatment of the claims asserted in the litigation.\nThe amended complaint in the New York Limited Partnership Actions alleges that, in connection with the sale of interests in PaineWebber Equity Partners Three Limited Partnership, PaineWebber, Third Equity Partners, Inc. and PA1988 (1) failed to provide adequate disclosure of the risks involved; (2) made false and misleading representations about the safety of the investments and the Partnership's anticipated performance; and (3) marketed the Partnership to investors for whom such investments were not suitable. The plaintiffs, who purport to be suing on behalf of all persons who invested in PaineWebber Equity Partners Three Limited Partnership, also allege that following the sale of the partnership interests, PaineWebber, Third Equity Partners, Inc. and PA1988 misrepresented financial information about the Partnership's value and performance. The amended complaint alleges that PaineWebber, Third Equity Partners, Inc. and PA1988 violated the Racketeer Influenced and Corrupt Organizations Act (\"RICO\") and the federal securities laws. The plaintiffs seek unspecified damages, including reimbursement for all sums invested by them in the partnerships, as well as disgorgement of all fees and other income derived by PaineWebber from the limited partnerships. In addition, the plaintiffs also seek treble damages under RICO. The defendants' time to move against or answer the complaint has not yet expired.\nPursuant to provisions of the Partnership Agreement and other contractual obligations, under certain circumstances the Partnership may be required to indemnify Third Equity Partners, Inc., PA1988 and their affiliates for costs and liabilities in connection with this litigation. The General Partners intend to vigorously contest the allegations of the action, and believe that the action will be resolved without material adverse effect on the Partnership's financial statements, taken as a whole.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone. PART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE PARTNERSHIP'S LIMITED PARTNERSHIP INTERESTS AND RELATED SECURITY HOLDER MATTERS\nAt March 31, 1995, there were 3,793 record holders of Units in the Partnership. There is no public market for the Units, and it is not anticipated that a public market for the Units will develop. The Managing General Partner will not redeem or repurchase Units.\nReference is made to Item 6","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nPAINEWEBBER EQUITY PARTNERS THREE LIMITED PARTNERSHIP FOR THE YEARS ENDED MARCH 31, 1995, 1994, 1993, 1992 AND 1991 (IN THOUSANDS EXCEPT FOR PER UNIT DATA) Years ended March 31,\n1995 1994 1993 1992 1991 [S] [C] [C] [C] [C] [C]\nRevenues $ 1,450 $ 1,273 $ 1,309 $ 1,362 $ 1,289\nOperating loss $(1,420) $(1,378) $(1,284) $ (1,085) $ (989)\nPartnership's share of unconsolidated ventures' income $ 593 $ 222 $ 658 $ 1,241 $ 1,410\nNet income (loss) $ (827) $(1,156) $ (626) $ 156 $ 421\nNet income (loss) per Limited Partnership Unit $ (16.21) $ (22.66) $(12.27) $ 3.05 $ 8.26\nCash distributions per Limited Partnership Unit $ 35.00 $ 50.00 $ 50.00 $ 72.50 $ 80.00\nTotal assets $40,333 $43,667 $45,673 $ 47,231 $49,800\nNotes payable and accrued interest $16,707 $17,304 $15,604 $ 14,024 $12,647\nThe above selected financial data should be read in conjunction with the consolidated financial statements and related notes appearing elsewhere in this Annual Report.\nThe above net income (loss) and cash distributions per Limited Partnership Unit are based upon the 50,468 Limited Partnership Units outstanding during each year.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nLIQUIDITY AND CAPITAL RESOURCES\nThe Partnership offered Units of Limited Partnership Interests to the public from January 1988 to September 1989 pursuant to a Registration Statement filed under the Securities Act of 1933. The offering raised gross proceeds of approximately $50,468,000. The Partnership also received $10,500,000 from the proceeds of zero coupon loans, as discussed further below and in Note 6 to the accompanying financial statements. The loan proceeds, net of financing expenses of $352,000, were used to pay offering and organization costs, acquisition fees, and acquisition-related expenses of the Partnership, in addition to financing a portion of the Partnership's cash reserves. The Partnership originally invested approximately $49,041,000 (net of acquisition fees of $2,523,000) in four operating investment properties through joint venture partnerships. As of March 31, 1995, the Partnership retained its ownership interest in all four of these properties, which consist of two retail shopping centers, one office building, and one multi-family apartment complex. During fiscal 1995, management continued negotiations with the lenders of the Partnership's zero coupon loans as part of an overall strategy to refinance these loans, which were originally incurred to finance the Partnership's public offering costs. This strategy is aimed at preventing the further accumulation of accrued interest by replacing the outstanding obligations with conventional financing which would require the payment of interest and principal on a current basis. As a result of this expected additional debt service, there will be a reduction in current cash flows from the properties to the Partnership. In addition, there is an ongoing need to use a portion of the earnings from the operating properties to fund planned capital work at the Partnership's three commercial properties. This work includes capital enhancements, tenant improvements and leasing commissions at each of these properties. As previously reported, the reduction in cash flows from the properties, combined with the aforementioned capital needs, resulted in the reduction of the quarterly distribution rate from 5% per annum to 2% beginning with the payment made on November 15, 1994 for the quarter ended September 30, 1994. Distributions are expected to continue to be paid at a rate of 2% throughout fiscal 1996, unless actual results of operations, economic conditions or other factors differ substantially from the assumptions used in setting the planned distribution rate.\nDuring the fourth quarter of fiscal 1995, the Partnership closed on the first of the three required refinancing transactions involving the zero coupon loans. In March 1995, the zero coupon loan secured by the Willow Grove Apartments, which had an outstanding balance of $2,473,000, was repaid in full from the proceeds of a new $3,600,000 loan to the Willow Grove joint venture. The new mortgage loan is secured by the Willow Grove Apartments, bears interest at a rate of 9.59% and requires monthly principal and interest payments of approximately $32,000 through maturity, in March 2002. Excess refinancing proceeds of approximately $1,050,000 were distributed to the Partnership and were added to the balance of cash reserves. In order to facilitate this refinancing transaction, in January 1995 the Partnership paid the Willow Grove co-venturer $233,000 to buy-out its joint venture interest. The Willow Grove joint venture agreement restricted the Partnership's ability to refinance the property's zero coupon loan with debt in excess of $2.5 million without the co- venture partner's consent, which it had been unwilling to grant. The Partnership desired to employ the additional borrowing capacity of the Willow Grove asset in order to secure the funds necessary to complete the One Paragon Place refinancing discussed further below. In addition to affording the Partnership the flexibility to proceed with its refinancing plans, the buyout of the co-venturer's interest gives the Partnership complete control over the venture's operations and eventual disposition decisions with respect to the operating investment property. The former co-venture partner has been retained in a property management capacity under a contract which is cancellable for any reason upon 30 days' written notice from the Partnership. The Willow Grove Apartments averaged 97% occupancy during fiscal 1995. In addition, with an overall market vacancy factor of only 4%, the use of rental concessions in the Beaverton area (a suburb of Portland, Oregon) has diminished. As a result, effective rental rates have increased slightly. Management expects further improvement in such market conditions in the near term.\nAt March 31, 1995, the zero coupon loan secured by the Colony Plaza shopping center had an outstanding balance of $6,933,000. The loan is scheduled to mature in December of 1996, at which time approximately $8,290,000 would be due. Management is presently in discussions with various lenders to refinance the Colony Plaza note payable. At the same time, management has been working with Wal-Mart on the logistics of a possible expansion of its store at Colony Plaza. During fiscal 1995, management learned that the cost of completing construction for the expansion was more than Wal-Mart had originally budgeted. Concerns over these estimated construction costs resulted in delays in the decision to proceed with the original expansion concept, which involved an increase in the size of the Wal-Mart store from its current 82,000 square feet to 120,000 square feet. Management has been working with Wal-Mart to review various alternatives to the original expansion plan, including the possibility of an expansion of the current store to a \"superstore\" configuration. Over the past 3 to 4 years, Wal-Mart has significantly changed its prototype store concept, requiring larger stores with additional expansion space to accommodate increasing per store sales volume. More recently, Wal-Mart has begun building \"superstores\", which contain up to 200,000 square feet and include a grocery store component in addition to a Wal-Mart discount store. This practice reflects a broader trend among many retailers to emphasize larger properties and to close smaller, more marginal stores. Under the lease terms of the center's existing grocery tenant, the Partnership would need to obtain this tenant's consent to permit the opening of an additional grocery operation at the shopping center. Since a Wal-Mart superstore would compete directly with the existing grocery's operation, this tenant has expressed initial reluctance to grant such consent. Moreover, subsequent to year-end, management has learned that Wal- Mart's preference appears to be to construct a superstore at another identified site in the Augusta market and to vacate Colony Plaza upon the completion of construction. In the event that Wal-Mart proceeds with such plans, the construction of a new superstore is not likely to be completed until sometime in calendar 1997. In the event Wal-Mart does vacate the center, it would remain obligated to pay rent and its share of operating expenses through the term of its lease, which expires in March 2009. However, the loss of the center's principal anchor tenant would likely adversely affect the Partnership's ability to retain existing tenants and to lease vacant space at the center. Since the loan-to-value ratio of the debt to be refinanced on Colony Plaza is relatively high, the status of the Wal-Mart anchor store at the center could be critical to the refinancing efforts. Nonetheless, the Partnership is moving forward with its refinancing efforts in an attempt to take advantage of the favorable current interest rate environment. Management remains cautiously optimistic that the recent strong operating performance of the center and the favorable local market characteristics will enable the Partnership to refinance the zero coupon loan obligation despite the uncertainty regarding Wal-Mart's future tenancy at Colony Plaza. The Partnership has been in negotiations with the existing lender on the zero coupon loan secured by One Paragon Place regarding conversion of this note to a conventional current-pay loan and is also seeking possible replacement financing. Management has requested from the lender a four-year extension of the maturity date and terms which would include a reduced rate of interest on the balance of the loan going forward. Both the Partnership's modification proposal or any refinancing transaction would require a paydown of approximately $1.3 million on the outstanding debt balance in order to satisfy lender loan-to- value ratio requirements. The Partnership has sufficient funds to make such a principal paydown as a result of the Willow Grove refinancing transaction described above. The zero coupon loan secured by the One Paragon Place Office Building, in the initial principal amount of $5,000,000, had an outstanding balance as of March 31, 1995 of approximately $9,774,000 and is scheduled to mature in November of 1995, at which time approximately $10,386,000 would be due. Management expects to close on a loan modification or refinancing transaction by the second quarter of fiscal 1996. One Paragon Place averaged 98% occupancy for fiscal 1995. The suburban Richmond, Virginia office market continues to strengthen with high occupancy levels and improving rental rates as a result of the absence of significant new construction. Rental income from One Paragon Place increased by 5% over the previous fiscal year. As part of an ongoing maintenance program, the property's management team completed a number of capital improvements including recarpeting several floors during fiscal 1995. Over the next year, management expects to spend approximately $82,000 to continue capital improvements as well as to pay for certain possible tenant improvements and leasing commissions on the small remaining vacant space. In addition, subsequent to year-end one of the property's major tenants negotiated a buyout of its lease obligation with respect to approximately one-half of its current space of approximately 53,000 square feet. Under the terms of the buyout agreement, the tenant will pay a current market rental rate on its remaining 27,000 square feet through the remainder of its lease term, which runs through July 1998. In addition, the tenant agreed to continue to pay rent through May 1995 on the 26,000 square feet of vacated space and will pay a lump sum of $500,000 to the joint venture, which should be sufficient to cover the expected costs of re-leasing the space. Since annual market rental rates are presently above this tenant's former lease rate by approximately $2 per square foot, overall cash flow from the property will increase once replacement tenants are secured. Management expects to be able to re-lease this space quickly given the property's favorable competitive position in this strengthening market.\nAs further discussed in Note 5 to the accompanying financial statements, in January 1995 the Lessee of the Colony Plaza master lease agreement entered into a settlement agreement with the Partnership which terminated the master lease agreement. At the time of the purchase of the operating investment property, the Partnership entered into a master lease agreement with the seller of the operating property and certain other affiliates of the co-venturer (the \"Guarantors\"). Under the terms of the master lease, the Guarantors guaranteed for a period of three years from the date that the shopping center achieved a specified occupancy level that aggregate net cash flow from all non-anchor tenants would not be less than the aggregate pro-forma net cash flow from non- anchor tenants projected at time of the purchase. During 1991, the Lessee defaulted on its obligation under the master lease and the Partnership received an amount of cash collateral to apply to future obligations. The remaining balance of the cash collateral was exhausted in January 1992. Through December 31, 1994, no other amounts had been received toward the Lessee's obligation under the master lease, resulting in an outstanding balance due of approximately $618,000. The January 1995 settlement agreement terminated the master lease effective December 31, 1994. The original termination date of the master lease agreement was to have been February 27, 1997. In accordance with the settlement agreement, on January 27, 1995 the Partnership received a cash payment of approximately $348,000 toward the outstanding obligation of $618,000 discussed above. In addition, the Partnership received a promissory note from the Lessee in the amount of $160,000 which will accrue interest at 8.5% and is due December 31, 1997. The Lessee also assigned its rights to certain future development and leasing fees which will be credited against the outstanding balance of the promissory note if earned. The remaining master lease obligation, after the cash payment and the promissory note, was forgiven under the terms of the settlement agreement.\nThe DeVargas Mall experienced a positive trend in occupancy during the second half of fiscal 1995, ending the year at 90% after dropping to a low of 84% as of the end of the second quarter. However, a tenant occupying approximately 16,000 square feet plans to vacate the Mall in early fiscal 1996. During the upcoming year the DeVargas joint venture has budgeted approximately $777,000 for capital items primarily related to tenant improvements and leasing costs which might be required if the venture is successful in obtaining tenants to lease the majority of the available space at the Mall. There are two significant lease proposals currently pending with regard to the available space, one for 30,000 square feet and another for 20,000 square feet, which, if successfully executed, would accomplish management's leasing objectives and effectively bring the Mall to full occupancy. Over the past 2 years, management has been successful in altering the tenant roster at the Mall to obtain a more complementary mix of retailers. Funding of the required tenant improvements would likely be accomplished by means of additional advances under the lines of credit provided by the Partnership's co-venture partner. To date, the co- venturer has provided financing in the amount of approximately $3 million to fund prior expansion and leasing costs. The venture pays interest on such advances at the rate of prime plus 1%.\nDuring fiscal 1995, the Partnership received distributions totaling approximately $3,791,000 from its four operating investment properties (including approximately $1,402,000 from the consolidated joint venture). Theseproperty distributions represent the primary source of future liquidity for the Partnership prior to the sales or refinancings of its operating investment properties. The Partnership's sources of liquidity are expected to be sufficient to meet its needs on a both short-term and long-term basis. At March 31, 1995, the Partnership and its consolidated joint venture had available cash and cash equivalents of approximately $3,824,000. These funds will be utilized for the working capital requirements of the Partnership, distributions to partners, refinancing expenses related to the Partnership's zero coupon loans and to fund capital enhancements and tenant improvements for the operating investment properties, if necessary, in accordance with the respective joint venture agreements.\nRESULTS OF OPERATIONS 1995 Compared to 1994\nThe Partnership reported a net loss of $827,000 for the year ended March 31, 1995, as compared to a net loss of $1,156,000 for the prior year. The decrease in net loss can be primarily attributed to an increase in rental revenues from the consolidated Colony Plaza joint venture and an increase in the Partnership's share of unconsolidated ventures' income. The increase in rental revenues at Colony Plaza, of $129,000, was mainly due to the full 12 month effect of the leasing gains achieved at the center during the prior year. Colony Plaza began calendar 1993 with an occupancy level of 91%. Occupancy had increased to 96% by the beginning of calendar 1994 and remained at 96% throughout the year. An increase in interest expense of $165,000 offset the increase in Colony Plaza revenues and caused an increase in the Partnership's operating loss of approximately $42,000 for fiscal 1995. Interest expense on the Partnership's zero coupon loans continued to increase in fiscal 1995 due to the effects of the semi-annual compounding. As discussed further above, management is involved in refinancing negotiations at the present time and expects that overall interest costs will be lowered upon the completion of the contemplated transactions. The Partnership's share of unconsolidated ventures' income increased by $371,000 over fiscal 1994. Improved operating results at the Willow Grove Apartments and the One Paragon Place Office Building contributed significantly to this favorable change. The increased occupancy and rental rates during the year at both properties were the primary contributors to the $419,000 increase in combined rental revenues for calendar 1994. In addition, the calendar 1993 results reflected a $236,000 loss on disposal of tenant improvements from the One Paragon Place joint venture due to certain tenants vacating the property prior to their lease expirations. No such losses were reported for calendar 1994. Although revenues at DeVargas Mall did increase slightly over the past year, the increase in expenses more than off set the revenue gains contributing to a lower net income in fiscal 1995. Interest expense showed the sharpest rise over fiscal 1994 as a result of the higher outstanding balances on the joint venture's line of credit borrowings referred to above. Borrowings under the lines of credit from the co-venturer for calendar 1994 totalled approximately $1 million, which was used to fund costs associated with tenant improvements and leasing expenses at the property. Depreciation expense at the DeVargas Mall and the One Paragon Office Building also increased as a result of the significant property and tenant improvements that have taken place over the past two years.\n1994 Compared to 1993\nThe Partnership's net loss increased by $530,000 for the year ended March 31, 1994 when compared to fiscal 1993. This change was the result of a decline in the Partnership's share of unconsolidated ventures' income coupled with an increase in the operating loss of the Partnership.\nThe increase in the Partnership's operating loss of $93,000 was mainly the result of an increase in interest expense on the Partnership's zero coupon loans combined with a decrease in revenues. Interest expense on the Partnership's zero coupon loans increased by $120,000 for the year ended March 31, 1994 due to the semi-annual compounding effect referred to above. Revenues decreased due to a decline in rental revenues at the Colony Plaza Shopping Center and a decrease in interest income due to lower average cash balances and interest rates in fiscal 1994. Rental revenues decreased slightly at Colony Plaza, despite an increase in occupancy, due to a small decline in market rental rates. Nonetheless, the property's tenant roster stabilized during fiscal 1994, as evidenced by the decline in bad debt expense. In fact, revenues net of bad debt expense actually increased when compared to fiscal 1993. An increase in Partnership general and administrative expenses also contributed to the increase in operating loss in fiscal 1994. General and administrative expenses increased by approximately $31,000, mainly due to certain costs incurred in connection with an independent valuation of the Partnership's operating properties which was commissioned in conjunction with management's ongoing refinancing efforts.\nThe Partnership's share of unconsolidated ventures' income decreased by approximately $437,000 when compared to the year ended March 31, 1993. A large portion of this decline was the result of a decrease in combined rental revenues. At the One Paragon Place Office Building, rental revenues were lower during fiscal 1994 partly due to the full twelve-month effect of a number of lease rollovers that were renewed at market rents during fiscal 1993. As of fiscal 1993 market rents had declined significantly in the Richmond market since the time of the property's acquisition. The large decrease in revenues at One Paragon Place was partially offset by an increase in rental revenues at both the Willow Grove Apartments and DeVargas Mall. In addition, combined operating expenses increased for the year ended March 31, 1994 due to generally higher repairs and maintenance expenses. Also, depreciation expense increased mainly due to charges related to tenant improvement costs capitalized at the One Paragon Place joint venture during fiscal 1994 and 1993.\n1993 Compared to 1992 For the year ended March 31, 1993, the Partnership reported a net loss of $626,000, as compared to net income of $156,000 in fiscal 1992. This unfavorable change in the Partnership's net operating results was caused primarily by a decrease in the Partnership's share of unconsolidated ventures' income as well as an increase in the operating loss of the Partnership.\nThe Partnership's operating loss increased by $199,000 in fiscal 1993 when compared to fiscal 1992. This increase was primarily the result of an increase of $202,000 in interest expense on the Partnership's outstanding zero coupon loans. Interest expense on the Partnership's zero coupon loans increased due to the aforementioned semi-annual compounding effect. The net operating results of the Partnership's consolidated joint venture, Colony Plaza General Partnership, remained relatively unchanged compared to fiscal 1992.\nThe Partnership's share of unconsolidated ventures' income declined by $582,000 in fiscal 1993 when compared to fiscal 1992. The major portion of this decrease was the result of the non-cash write-off of certain capitalized tenant improvements at the One Paragon Place Office Building. A loss of $476,000 was recorded on these improvements in fiscal 1993, which were replaced during the year. Another portion of the decrease in unconsolidated ventures' income can be attributed to an increase in depreciation expense at the DeVargas Center Joint Venture. Depreciation expense increased at DeVargas due to the expansion of the Mall's movie cinema in fiscal 1993.\nInflation\nThe Partnership completed its seventh full year of operations in fiscal 1995. The effects of inflation and changes in prices on the Partnership's operating results to date have not been significant. Inflation in future periods may increase revenues as well as operating expenses at the Partnership's operating investment properties. Some of the existing leases with tenants at the Partnership's three commercial investment properties contain rental escalation and\/or expense reimbursement clauses based on increases in tenant sales or property operating expenses. Rental rates at the Partnership's one residential investment property can be adjusted to keep pace with inflation, to the extent market conditions allow, as the leases, which are short-term in nature, are renewed or turned over. Such increases in rental income would be expected to at least partially offset the corresponding increases in Partnership and property operating expenses.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe financial statements and supplementary data are included under Item 14 of this Annual Report.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone. PART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE PARTNERSHIP\nThe Managing General Partner of the Partnership is Third Equity Partners, Inc., a Delaware corporation, which is a wholly owned subsidiary of PaineWebber Group Inc. (\"PaineWebber\"). The Associate General Partners of the Partnership are PaineWebber Partnerships, Inc., a wholly owned subsidiary of PaineWebber and Properties Associates 1988 L.P., a Virginia limited partnership. The general partner of Properties Associates 1988, L.P. is PAM Inc., a wholly owned subsidiary of PaineWebber Properties Incorporated (\"PWPI\"). The officers of PaineWebber Partnerships, Inc. and PAM Inc. are also officers of the Managing General Partner. The Managing General Partner has overall authority and responsibility for the Partnership's operations.\n(a) and (b) The names and ages of the directors and principal executive officers of the Managing General Partner of the Partnership are as follows:\nDate elected Name Office Age to Office\nLawrence A. Cohen President and Chief Executive Officer 41 5\/15\/91 Albert Pratt Director 84 2\/27\/87 * J. Richard Sipes Director 48 6\/9\/94 Walter V. Arnold Senior Vice President and Chief Financial Officer 47 2\/27\/87 * James A. Snyder Senior Vice President 49 7\/6\/92 John B. Watts III Senior Vice President 42 6\/6\/88 David F. Brooks First Vice President and Assistant Treasurer 52 2\/27\/87 * Timothy J. Medlock Vice President and Treasurer 33 6\/1\/88 Thomas W. Boland Vice President 32 12\/1\/91 *\nThe date of incorporation of the Managing General Partner.\n(c) There are no other significant employees in addition to the directors and executive officers mentioned above.\n(d) There is no family relationship among any of the foregoing directors or executive officers of the Managing General Partner of the Partnership. All of the foregoing directors and executive officers have been elected to serve until the annual meeting of the Managing General Partner.\n(e) All of the directors and officers of the Managing General Partner hold similar positions in affiliates of the Managing General Partner, which are the corporate general partners of other real estate limited partnerships sponsored by PWI. The business experience of each of the directors and principal executive officers of the Managing General Partner is as follows:\nLawrence A. Cohen is President and Chief Executive Officer of the Managing General Partner and President and Chief Executive Officer of PWPI, which he joined in January 1989. He is also a member of the Board of Directors and the Investment Committee of PWPI. From 1984 to 1988, Mr. Cohen was First Vice President of VMS Realty Partners where he was responsible for origination and structuring of real estate investment programs and for managing national broker- dealer relationships. He is a member of the New York Bar and is a Certified Public Accountant.\nAlbert Pratt is a Director of the Managing General Partner, a Consultant of PWI and a general partner of the Associate General Partner. Mr. Pratt joined PWI as Counsel in 1946 and since that time has held a number of positions including Director of both the Investment Banking Division and the International Division, Senior Vice President and Vice Chairman of PWI and Chairman of PaineWebber International, Inc.\nJ. Richard Sipes is a Director of the Managing General Partner and a Director of the Adviser. Mr. Sipes is an Executive Vice President at PaineWebber. He joined the firm in 1978 and has served in various capacities within the Retail Sales and Marketing Division. Before assuming his current position as Director of Retail Underwriting and Trading in 1990, he was a Branch Manager, Regional Manager, Branch System and Marketing Manager for a PaineWebber subsidiary, Manager of Branch Administration and Director of Retail Products and Trading. Mr. Sipes holds a B.S. in Psychology from Memphis State University.\nWalter V. Arnold is a Senior Vice President and Chief Financial Officer of the Managing General Partner and Senior Vice President and Chief Financial Officer of PWPI, which he joined in October 1985. Mr. Arnold joined PWI in 1983 with the acquisition of Rotan Mosle, Inc. where he had been First Vice President and Controller since 1978, and where he continued until joining PWPI. Mr. Arnold is a Certified Public Accountant licensed in the state of Texas.\nJames A. Snyder is a Senior Vice President of the Managing General Partner and a Senior Vice President and Member of the Investment Committee of the Adviser. Mr. Snyder re-joined the Adviser in July 1992 having served previously as an officer of PWPI from July 1980 to August 1987. From January 1991 to July 1992, Mr. Snyder was with the Resolution Trust Corporation where he served as the Vice President of Asset Sales prior to re-joining PWPI. From February 1989 to October 1990, he was President of Kan Am Investors, Inc., a real estate investment company. During the period August 1987 to February 1989, Mr. Snyder was Executive Vice President and Chief Financial Officer of Southeast Regional Management Inc., a real estate development company.\nJohn B. Watts III is a Senior Vice President of the Managing General Partner and a Senior Vice President of the Adviser which he joined in June 1988. Mr.Watts has had over 16 years of experience in acquisitions, dispositions and finance of real estate. He received degrees of Bachelor of Architecture, Bachelor of Arts and Master of Business Administration from the University of Arkansas.\nDavid F. Brooks is a First Vice President and Assistant Treasurer of the Managing General Partner and a First Vice President and an Assistant Treasurer of PWPI, which he joined in March 1980. From 1972 to 1980, Mr. Brooks was an Assistant Treasurer of Property Capital Advisors, Inc. and also, from March 1974 to February 1980, the Assistant Treasurer of Capital for Real Estate, which provided real estate investment, asset management and consulting services.\nTimothy J. Medlock is a Vice President and Treasurer of the Managing General Partner and Vice President and Treasurer of PWPI, which he joined in 1986. From June 1988 to August 1989, Mr. Medlock served as the Controller of the Managing General Partner and PWPI. From 1983 to 1986, Mr. Medlock was associated with Deloitte Haskins & Sells. Mr. Medlock graduated from Colgate University in 1983 and received his Masters in Accounting from New York University in 1985.\nThomas W. Boland is a Vice President of the Managing General Partner and a Vice President and Manager of Financial Reporting of PWPI, which he joined in 1988. From 1984 to 1987 Mr. Boland was associated with Arthur Young & Company. Mr. Boland is a Certified Public Accountant licensed in the state of Massachusetts. He holds a B.S. in Accounting from Merrimack College and an M.B.A. from Boston University.\n(f) None of the directors and officers was involved in legal proceedings which are material to an evaluation of his or her ability or integrity as a director or officer. (g) Compliance With Exchange Act Filing Requirements:\nThe Securities Exchange Act of 1934 requires the officers and directors of the Managing General Partner, and persons who own more than ten percent of the Partnership's limited partnership units, to file certain reports of ownership and changes in ownership with the Securities and Exchange Commission. Officers, directors and ten- percent beneficial holders are required by SEC regulations to furnish the Partnership with copies of all Section 16(a) forms they file.\nBased solely on its review of the copies of such forms received by it, the Partnership believes that, during the year ended March 31, 1995, all filing requirements applicable to the officers and directors of the Managing General Partner and ten-percent beneficial holders were complied with.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe directors and officers of the Partnership's Managing General Partner receive no current or proposed remuneration from the Partnership.\nThe General Partners are entitled to receive a share of Partnership cash distributions and a share of profits and losses. These items are described in Item 13.\nThe Partnership paid cash distributions to the Limited Partners on a quarterly basis at a rate of 8% per annum on invested capital from inception through the quarter ended September 30, 1991 and at a rate of 5% per annum on invested capital from October 1, 1991 to June 30, 1994. Starting July 1, 1994 cash distributions have been paid at a rate of 2% per annum on invested capital. However, the Partnership's Limited Partnership Units are not actively traded on any organized exchange and, accordingly, no accurate price information exists for these Units. Therefore, a presentation of historical Unitholder total returns would not be meaningful.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\n(a) The Partnership is a limited partnership issuing Units of limited partnership interest, not voting securities. All the outstanding stock of the Managing General Partner and PaineWebber Partnerships, Inc. is owned by PaineWebber. Properties Associates 1988 L.P. is a Virginia limited partnership, certain limited partners of which are also officers of the Managing General Partner. No limited partner is known by the Partnership to own beneficially more than 5% of the outstanding interests of the Partnership.\n(b) The directors and officers of the Managing General Partner do not directly own any Units of limited partnership interest of the Partnership. No director or officer of the Managing General Partner or PaineWebber Partnerships, Inc., nor any limited partner of Properties Associates 1988, L.P., possesses a right to acquire beneficial ownership of Units of limited partnership interest of the Partnership.\n(c) There exists no arrangement, known to the Partnership, the operation of which may, at a subsequent date, result in a change in control of the Partnership.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe General Partners of the Partnership are Third Equity Partners, Inc. (the \"Managing General Partner\"), a wholly-owned subsidiary of PaineWebber Group Inc. (\"PaineWebber\"), PaineWebber Partnerships, Inc. and Properties Associates 1988 L.P. PaineWebber Partnerships, Inc. is also a wholly owned subsidiary of PaineWebber and Properties Associates 1988, L.P. is a Virginia limited partnership.\nThe general partner of Properties Associates 1988, L.P. is PAM Inc., a wholly owned subsidiary of PaineWebber Properties Incorporated (\"PWPI\"). The officers of PaineWebber Partnerships, Inc. and PAM Inc. are also officers of the Managing General Partner. Affiliates of the General Partners will receive fees and compensation determined on an agreed-upon basis, in consideration of various services performed in connection with the sale of the Units and the acquisition, management, financing and disposition of Partnership properties. The Managing General Partner and its affiliates are reimbursed for their direct expenses relating to the offering of Units, the administration of the Partnership and the acquisition and operations of the Partnership's operating property investments.\nIn connection with the acquisition of properties, PWPI received acquisition fees totalling 5% of the gross proceeds from the sale of Partnership Units. PWPI earned acquisition fees totalling approximately $2,523,000. Acquisition fees have been capitalized as part of the cost of the investment on the accompanying balance sheet.\nAll distributable cash, as defined, for each fiscal year shall first be distributed quarterly in the ratio of 99% to the Limited Partners and 1% to the General Partners until the Limited Partners have received an amount equal to an 8% noncumulative annual return on their adjusted capital contributions through December 31, 1989 and 7.5% on the adjusted capital contributions thereafter. The General Partners will then receive distributions until they have received an amount equal to 1.01% of all distributions to all partners and PWPI has received Asset Management Fees equal to 3.99% of all distributions to all partners. The balance will be distributed 95% to the Limited Partners, 1.01% to the General Partners and 3.99% to PWPI as its Asset Management Fee. Asset Management Fees are recorded as an expense on the Partnership's statement of operations, while the distributions to the General Partners and the Limited Partners are recorded as reductions to their respective capital accounts on the balance sheet. All sale or refinancing proceeds shall be distributed in varying proportions to the Limited and General Partners, as specified in the Partnership Agreement.\nTaxable income (other than from capital transactions) in each taxable year will be allocated to the Limited Partners and the General Partners in proportion to the amounts of distributable cash distributed to them in, or with respect to, that year. If there are no distributions of distributable cash, then taxable income shall be allocated 98.94802625% to the Limited Partners and 1.0519375% to the General Partners. All tax losses (other than from capital transactions) will be allocated 98.94802625% to the Limited Partners and 1.0519375% to the General Partners. Taxable income or tax loss arising from a sale or refinancing of investment properties shall be allocated to the Limited Partners and the General Partners in proportion to the amounts of sale or refinancing proceeds to which they are entitled; provided that the General Partners shall be allocated at least 1% of taxable income, gain, loss, deduction or credit arising from a sale or refinancing. If there are no sale or refinancing proceeds, tax loss or taxable income from a sale or refinancing shall be allocated 99% to the Limited Partners and 1% to the General Partner. Allocations of the Partnership's operations between the General Partners and the Limited Partners for financial accounting purposes have been made in conformity with the allocations of taxable income or tax loss.\nPWPI has specific management responsibilities; to administer day-to-day operations of the Partnership, and to report periodically the performance of the Partnership to the Managing General Partner. PWPI is paid an asset management fee, as described above, for services rendered. As a result of a reduction in the distributions to the Limited Partners in fiscal 1992, PWPI has not earned any asset management fees since May of 1991. In connection with the sale of each property, PWPI may receive a disposition fee as calculated per the terms of the Partnership Agreement. An affiliate of the Managing General Partner performs certain accounting, tax preparation, securities law compliance and investor communications and relations services for the Partnership. The total costs incurred by this affiliate in providing such services are allocated among several entities, including the Partnership. Included in general and administrative expenses for the year ended March 31, 1995 is $102,000, representing reimbursements to this affiliate of the Managing General Partner for providing such services to the Partnership.\nThe Partnership uses the services of Mitchell Hutchins Institutional Investors, Inc. (\"Mitchell Hutchins\") for the managing of cash assets. Mitchell Hutchins is a subsidiary of Mitchell Hutchins Asset Management, Inc., an independently operated subsidiary of PaineWebber. Mitchell Hutchins earned fees of $6,000 (included in general and administrative expenses) for managing the Partnership's cash assets for the year ended March 31, 1995. Fees charged by Mitchell Hutchins are based on a percentage of invested cash reserves which varies based on the total amount of invested cash which Mitchell Hutchins manages on behalf of PWPI.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) The following documents are filed as part of this report:\n(1) and (2) Financial Statements and Schedules:\nThe response to this portion of Item 14 is submitted as a separate section of this Report. See Index to Financial Statements and Financial Statement Schedules at page.\n(3) Exhibits:\nThe exhibits on the accompanying index to exhibits at page IV-3 are filed as part of this Report.\n(b) No reports on Form 8-K were filed during the last quarter of fiscal 1995.\n(c) Exhibits\nSee (a)(3) above.\n(d) Financial Statement Schedules\nThe response to this portion of Item 14 is submitted as a separate section of this Report. See Index to Financial Statements and Financial Statement Schedules at page.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Partnership has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nPAINEWEBBER EQUITY PARTNERS THREE LIMITED PARTNERSHIP\nBy: Third Equity Partners, Inc. Managing General Partner\nBy: \/s\/ Lawrence A. Cohen Lawrence A. Cohen President and Chief Executive Officer\nBy: \/s\/ Walter V. Arnold Walter V. Arnold Senior Vice President and Chief Financial Officer\nBy: \/s\/ Thomas W. Boland Thomas W. Boland Vice President\nDated: June 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 Partnership and in the capacities and on the dates indicated.\nBy:\/s\/ Albert Pratt Date: June 23, 1995 Albert Pratt Director\nBy: \/s\/ J. Richard Sipes Date: June 23, 1995 J. Richard Sipes Director\nANNUAL REPORT ON FORM 10-K ITEM 14(A)(3)\nPAINEWEBBER EQUITY PARTNERS THREE LIMITED PARTNERSHIP\nINDEX TO EXHIBITS Page Number in the Report Exhibit No. Description of Document Or Other Reference\n(3) and (4)Prospectus of the Partnership Filed with the Commission dated January 4, 1988, as pursuant to Rule 424(c) supplemented, with particular and incorporated herein reference to the Restated by reference. Certificate and Agreement of Limited Partnership\n(10) Material contracts previously Filed with the Commission filed as exhibits to registration pursuant to Section 13 or statements and amendments thereto 15(d) of the Securities of the registrant together with all Act of 1934 and incorporated such contracts filed as exhibits of herein by reference. previously filed Forms 8-K and Forms 10-K are hereby incorporated herein by reference.\n(13) Annual Report to Limited Partners No Annual Report for the fiscal year 1995 has been sent to the Limited Partners. An Annual Report will be sent to the Limited Partners subsequent to this filing.\n(22) List of subsidiaries Included in Item I of Part I of this Report Page I-1, to which reference is hereby made.\nANNUAL REPORT ON FORM 10-K ITEM 14(A)(1) AND (2) AND ITEM 14(D)\nPAINEWEBBER EQUITY PARTNERS THREE LIMITED PARTNERSHIP\nINDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nReference PAINEWEBBER EQUITY PARTNERS THREE LIMITED PARTNERSHIP:\nReports of independent auditors\nConsolidated balance sheets as of March 31, 1995 and 1994\nConsolidated statements of operations for the years ended March 31, 1995, 1994 and 1993\nConsolidated statements of changes in partners' capital (deficit) for the years ended March 31, 1995, 1994 and 1993\nConsolidated statements of cash flows for the years ended March 31, 1995, 1994 and 1993\nNotes to consolidated financial statements\nSchedule III - Real Estate and Accumulated Depreciation\nCOMBINED JOINT VENTURES OF PAINEWEBBER EQUITY PARTNERS THREE LIMITED PARTNERSHIP:\nReports of independent auditors\nCombined balance sheets as of December 31, 1994 and 1993\nCombined statements of operations for the years ended December 31, 1994, 1993 and 1992\nCombined statements of changes in venturers' capital for the years ended December 31, 1994, 1993 and 1992\nCombined statements of cash flows for the years ended December 31, 1994, 1993 and 1992\nNotes to combined financial statements\nSchedule III - Real Estate and Accumulated Depreciation\nOther schedules have been omitted since the required information is not present or not present in amounts sufficient to require submission of the schedule, or because the information required is included in the financial statements, including the notes thereto.\nREPORT OF INDEPENDENT AUDITORS\nTo The Partners PaineWebber Equity Partners Three Limited Partnership:\nWe have audited the accompanying consolidated balance sheets of PaineWebber Equity Partners Three Limited Partnership as of March 31, 1995 and 1994, and the related consolidated statements of operations, changes in partners' capital (deficit) and cash flows for each of the three years in the period ended March 31, 1995. These financial statements are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements based on our audits. We did not audit the financial statements of the DeVargas Center Joint Venture (DeVargas) (an unconsolidated venture) or the Colony Plaza General Partnership (Colony Plaza) (a consolidated venture). The Partnership's financial statements reflect the Partnership's equity investment in DeVargas and the total assets of Colony Plaza on a combined basis of $20,064,000 and $21,110,000 at March 31, 1995 and 1994, respectively, and the Partnership's equity in DeVargas' net income and Colony's net income on a combined basis of $1,011,000, $968,000 and $835,000 for the years ended March 31, 1995, 1994 and 1993, respectively. Those statements were audited by other auditors whose reports have been furnished to us, and our opinion, insofar as it relates to data included for DeVargas and Colony Plaza, is based solely on the reports of the other auditors.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits, and the reports of the other auditors, provide a reasonable basis for our opinion.\nAs more fully described in Note 6, mortgage debt secured by the operating investment property owned by Richmond Paragon Partnership (a joint venture investee) is scheduled to mature in November 1995.\nIn our opinion, based on our audits and the reports of the other auditors, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of PaineWebber Equity Partners Three Limited Partnership at March 31, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended March 31, 1995 in conformity with generally accepted accounting principles. Also, in our opinion, based on our audits and the report of the other auditors, 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\nBoston, Massachusetts June 28, 1995\nDELOITTE & TOUCHE LLP Suite 2300 333 Clay Street Houston, Texas 77002-4196\nINDEPENDENT AUDITORS' REPORT\nDeVargas Center Joint Venture:\nWe have audited the accompanying balance sheets of DeVargas Center Joint Venture (the \"Joint Venture\") as of December 31, 1994 and 1993, and the related statements of income, venturers' 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 Joint Venture's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion such financial statements present fairly, in all material respects, the financial position of the Joint Venture at December 31, 1994 and 1993, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1994 in conformity with generally accepted accounting principles.\n\/s\/ DELOITTE & TOUCHE LLP DELOITTE & TOUCHE LLP\nFebruary 22, 1995\nPRICE WATERHOUSE LLP 160 Federal Street Boston, MA 02110\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Partners of Colony Plaza General Partnership\nIn our opinion, the accompanying balance sheets and the related statements of operations, of changes in partners' capital and of cash flows present fairly, in all material respects, the financial position of Colony Plaza General Partnership (the \"Partnership\") at December 31, 1994 and 1993, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Partnership's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the 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 our opinion expressed above.\nOur audits were conducted for the purpose of forming an opinion on the basic financial statements taken as a whole. The Schedule of Distributable Funds is presented for purposes of additional analysis and is not a required part of the basic financial statements. Such information has been subjected to the auditing procedures applied in the audits of the basis financial statements and, in our opinion, is fairly stated in all material respects in relation to the basic financial statements taken as a whole.\n\/S\/ PRICE WATERHOUSE LLP PRICE WATERHOUSE LLP\nFebruary 3, 1995\nPAINEWEBBER EQUITY PARTNERS THREE LIMITED PARTNERSHIP\nCONSOLIDATED BALANCE SHEETS March 31, 1995 and 1994 (In Thousands, except for per Unit data)\nASSETS\n1995 1994 Operating investment property, at cost: Land $ 3,720 $ 3,720 Building and improvements 9,446 9,785 13,166 13,505 Less accumulated depreciation (1,811) (1,443) 11,355 12,062\nInvestments in unconsolidated joint ventures, at equity 24,930 29,936 Cash and cash equivalents 3,824 1,501 Accrued interest and other receivables (net of allowance for doubtful accounts of $1 and $49 in 1995 and 1994, respectively) 64 38 Accounts receivable - affiliates 7 7 Prepaid expenses 7 7 Deferred expenses (net of accumulated amortization of $358 and $305 in 1995 and 1994, respectively) 146 116 $40,333 $43,667\nLIABILITIES AND PARTNERS' CAPITAL\nNotes payable and accrued interest $16,707 $17,304 Accounts payable and accrued expenses 38 30 Tenant security deposits 9 9 Advances from consolidated ventures 158 292 Total liabilities 16,912 17,635\nPartners' capital: General Partners: Capital contributions 1 1 Cumulative net income 1 10 Cumulative cash distributions (210) (192)\nLimited Partners ($1,000 per unit; 50,468 Units issued): Capital contributions, net of offering costs 43,669 43,669 Cumulative net income 170 988 Cumulative cash distributions (20,210) (18,444) Total partners' capital 23,421 26,032 $40,333 $43,667\nSee accompanying notes.\nPAINEWEBBER EQUITY PARTNERS THREE LIMITED PARTNERSHIP\nCONSOLIDATED STATEMENTS OF OPERATIONS\nFor the years ended March 31, 1995, 1993 and 1993 (In Thousands, except for per Unit data)\n1995 1994 1993 REVENUES: Rental income and expense reimbursements $1,347 $1,218 $1,240 Interest income 103 55 69 1,450 1,273 1,309\nEXPENSES: Interest expense 1,921 1,756 1,644 Property operating expenses 140 128 117 Bad debt expense 21 13 79 Real estate taxes 71 69 70 General and administrative 342 310 279 Depreciation and amortization 375 375 404 2,870 2,651 2,593\nOperating loss (1,420) (1,378) (1,284)\nPartnership's share of unconsolidated ventures' income 593 222 658 NET LOSS $ (827) $(1,156) $ (626)\nNet loss per Limited Partnership Unit $(16.21) $(22.66) $(12.27)\nCash distributions per Limited Partnership Unit $ 35.00 $ 50.00 $ 50.00\nThe above per Limited Partnership Unit information is based upon the 50,468 Limited Partnership Units outstanding during each year. See accompanying notes.\nPAINEWEBBER EQUITY PARTNERS THREE LIMITED PARTNERSHIP\nCONSOLIDATED STATEMENTS OF CHANGES IN PARTNERS' CAPITAL (DEFICIT) For the years ended March 31, 1995, 1994 and 1993 (In Thousands)\nGeneral Limited Partners Partners Total\nBalance at March 31, 1992 $(110) $33,022 $32,912\nCash distributions (26) (2,523) (2,549)\nNet loss (7) (619) (626)\nBALANCE AT MARCH 31, 1993 (143) 29,880 29,737\nCash distributions (26) (2,523) (2,549)\nNet loss (12) (1,144) (1,156)\nBALANCE AT MARCH 31, 1994 (181) 26,213 26,032\nCash distributions (18) (1,766) (1,784)\nNet loss (9) (818) (827) BALANCE AT MARCH 31, 1995 $(208) $23,629 $23,421\nSee accompanying notes.\nPAINEWEBBER EQUITY PARTNERS THREE LIMITED PARTNERSHIP\nCONSOLIDATED STATEMENTS OF CASH FLOWS For the years ended March 31, 1995, 1994 and 1993 Increase (Decrease) in Cash and Cash Equivalents (In Thousands)\n1995 1994 1993\nCash flows from operating activities: Net loss $ (827) $ (1,156) $ (626) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Partnership's share of unconsolidated ventures' income (593) (222) (658) Depreciation and amortization 375 375 404 Interest expense 1,921 1,756 1,644 Changes in assets and liabilities: Restricted cash - - 2 Accrued interest and other receivables (26) 10 26 Accounts receivable - affiliates - - (7) Deferred expenses (10) (12) (15) Accounts payable - affiliates - (56) 5 Accounts payable and accrued expenses 8 (64) 19 Other payable - - (2) Tenant security deposits - 9 - Advances from consolidated ventures (134) 109 15 Total adjustments 1,541 1,905 1,433 Net cash provided by operating activities 714 749 807\nCash flows from investing activities: Additional investments in unconsolidated joint ventures (342) (666) (661) Additions to operating investment property (9) (75) (34) Receipt of master lease payments 348 - 2 Distributions from unconsolidated joint ventures 5,941 2,027 2,437 Net cash provided by investing activities 5,938 1,286 1,744\nCash flows from financing activities: Cash distributions to partners (1,784) (2,549) (2,549) Deferred loan expenses (73) - - Repayment of principal and interest on note payable (2,472) - - Net cash used for financing activities (4,329) (2,549) (2,549)\nNet increase (decrease) in cash and cash equivalents 2,323 (514) 2\nCash and cash equivalents, beginning of year 1,501 2,015 2,013\nCash and cash equivalents, end of year $ 3,824 $ 1,501 $ 2,015\nCash paid during the year for interest $ 1,022 $ - $ -\nSee accompanying notes.\n1. Organization\nPaineWebber Equity Partners Three Limited Partnership (the \"Partnership\") is a limited partnership organized pursuant to the laws of the State of Virginia in May 1987 for the purpose of investing in a diversified portfolio of existing, newly-constructed or to-be-built income-producing real properties. The Partnership authorized the issuance of Partnership Units (the \"Units\") at $1,000 per Unit, of which 50,468 were subscribed and issued between January 1988 and September 1989.\n2. Summary of Significant Accounting Policies\nThe accompanying financial statements include the Partnership's investment in three unconsolidated joint venture partnerships each of which owns an operating property. The Partnership accounts for its investments in the unconsolidated joint ventures using the equity method because the Partnership does not have majority voting control. Under the equity method the ventures are carried at cost adjusted for the Partnership's share of the ventures' earnings or losses and distributions. All of the unconsolidated joint venture partnerships are required to maintain their accounting records on a calendar year basis for income tax reporting purposes. As a result, the Partnership recognizes its share of the earnings or losses from the unconsolidated joint ventures based on financial information which is three months in arrears to that of the Partnership. See Note 4 for a description of the unconsolidated joint venture partnerships.\nOperating investment property at March 31, 1995 and 1994 represents the real estate assets of the Colony Plaza General Partnership (see Note 5), a joint venture in which the Partnership has a controlling interest. For financial reporting purposes the joint venture is consolidated with the\nPartnership. The joint venture has a December 31 year-end for tax and financial reporting purposes. As a result, the Partnership also reports the results of the consolidated joint venture based on financial information of the venture which is three months in arrears to that of the Partnership. All material transactions between the Partnership and the joint venture have been eliminated upon consolidation, except for lag-period cash transfers. Such lag period cash transfers are accounted for as advances from consolidated ventures on the accompanying balance sheet.\nThe Partnership has reviewed FAS No. 121 ``Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets To Be Disposed Of''which is effective for financial statements for years beginning after December 15, 1995, and believes this new pronouncement will not have a material effect on the Partnership's financial statements.\nThe operating investment property of the consolidated joint venture is carried at the lower of cost, reduced by certain guaranteed master lease payments (see Note 5) and accumulated depreciation, or net realizable value. The net realizable value of a property held for long-term investment purposes is measured by the recoverability of the Partnership's investment through expected future cash flows on an undiscounted basis, which may exceed the property's current market value. The net realizable value of a property held for sale approximates its current market value, as determined on a discounted cash flow basis. The operating investment property was considered to be held for long-term investment purposes as of March 31, 1995 and 1994. Depreciation expense is computed using the straight-line method over an estimated useful life of forty years for the building. Depreciation expense for the improvements and personal property is calculated using the 150% declining balance and straight-line methods, with a half year convention in the year of acquisition and disposition, over estimated useful\nlives of 20 and 12 years, respectively. Costs and fees (including the acquisition fee paid to PWPI) related to the acquisition of the property have been capitalized and are included in the cost of the operating investment property. Minor maintenance and repair expenses are charged to expense. Major improvements are capitalized. Tenant improvements are capitalized and amortized over the term of the respective lease agreements.\nDeferred expenses include legal fees of $49,000 incurred in connection with the organization of the Partnership. These expenses have been fully amortized using the straight-line method over a sixty-month term. As of March 31, 1995 and 1994, deferred expenses also include costs associated with the notes payable described in Note 6 of $425,000 and $352,000, respectively, and leasing commissions associated with the operating investment property of $30,000 and $20,000, respectively. Deferred loan costs are being amortized using the straight-line method over the respective terms of the notes payable. Such amortization expense is included in interest expense on the accompanying statements of operations. Leasing commissions are amortized using the straight-line method over the term of the lease, generally 3 - 5 years.\nFor purposes of reporting cash flows, the Partnership considers all highly liquid investments with original maturities of 90 days or less to be cash equivalents.\nNo provision for income taxes has been made. The liability for income taxes is that of the individual partners rather than the Partnership.\nCertain prior year amounts have been reclassified to conform to the current year presentation.\n3. The Partnership Agreement and Related Party Transactions\nThe General Partners of the Partnership are Third Equity Partners, Inc. (the \"Managing General Partner\"), a wholly-owned subsidiary of PaineWebber Group Inc. (\"PaineWebber\"), PaineWebber Partnerships, Inc. and Properties Associates 1988 L.P. PaineWebber Partnerships, Inc. is also a wholly owned subsidiary of PaineWebber and Properties Associates 1988, L.P. is a Virginia limited partnership. The general partner of Properties Associates 1988, L.P. is PAM Inc., a wholly owned subsidiary of PaineWebber Properties Incorporated (\"PWPI\"). The officers of PaineWebber Partnerships, Inc. and PAM Inc. are also officers of the Managing General Partner. Affiliates of the General Partners will receive fees and compensation determined on an agreed-upon basis, in consideration of various services performed in connection with the sale of the Units and the acquisition, management, financing and disposition of Partnership properties. The Managing General Partner and its affiliates are reimbursed for their direct expenses relating to the offering of Units, the administration of the Partnership and the acquisition and operations of the Partnership's real property investments.\nIn connection with the acquisition of properties, PWPI received acquisition fees totalling 5% of the gross proceeds from the sale of Partnership Units. PWPI earned acquisition fees totalling approximately $2,523,000. Acquisition fees have been capitalized as part of the cost of the investment on the accompanying balance sheet.\nAll distributable cash, as defined, for each fiscal year shall first be distributed quarterly in the ratio of 99% to the Limited Partners and 1% to the General Partners until the Limited Partners have received an amount equal to an 8% noncumulative annual return on their adjusted capital contributions through December 31, 1989 and 7.5% of the adjusted capital\ncontributions thereafter. The General Partners will then receive distributions until they have received an amount equal to 1.01% of all distributions to all partners and PWPI has received Asset Management Fees equal to 3.99% of all distributions to all partners. The balance will be distributed 95% to the Limited Partners, 1.01% to the General Partners and 3.99% to PWPI as its Asset Management Fee. Asset Management Fees are recorded as an expense on the Partnership's statement of operations, while the distributions to the General Partners and the Limited Partners are recorded as reductions to their respective capital accounts on the balance sheet. All sale or refinancing proceeds shall be distributed in varying proportions to the Limited and General Partners, as specified in the Partnership Agreement.\nTaxable income (other than from capital transactions) in each taxable year will be allocated to the Limited Partners and the General Partners in proportion to the amounts of distributable cash distributed to them in, or with respect to, that year. If there are no distributions of distributable cash, then taxable income shall be allocated 98.94802625% to the Limited Partners and 1.0519375% to the General Partners. All tax losses (other than from capital transactions) will be allocated 98.94802625% to the Limited Partners and 1.0519375% to the General Partners. Taxable income or tax loss arising from a sale or refinancing of investment properties shall be allocated to the Limited Partners and the General Partners in proportion to the amounts of sale or refinancing proceeds to which they are entitled; provided that the General Partners shall be allocated at least 1% of taxable income, gain, loss, deduction or credit arising from a sale or refinancing. If there are no sale or refinancing proceeds, tax loss or taxable income from a sale or refinancing shall be allocated 99% to the Limited Partners and 1% to the General Partner. Allocations of the Partnership's operations between the General Partners and the Limited Partners for financial\naccounting purposes have been made in conformity with the allocations of taxable income or tax loss.\nPWPI has specific management responsibilities; to administer day-to-day operations of the Partnership, and to report periodically the performance of the Partnership to the Managing General Partner. PWPI is paid an asset management fee, as described above, for services rendered. As a result of a reduction in the distributions to the Limited Partners in fiscal 1992, PWPI has not earned any asset management fees since May of 1991. In connection with the sale of each property, PWPI may receive a disposition fee as calculated per the terms of the Partnership Agreement.\nIncluded in general and administrative expenses for the years ended March 31, 1995, 1994 and 1993 is $102,000, $105,000 and $120,000, respectively, representing reimbursements to an affiliate of the Managing General Partner for providing certain financial, accounting and investor communication services to the Partnership.\nThe Partnership uses the services of Mitchell Hutchins Institutional Investors, Inc. (\"Mitchell Hutchins\") for the managing of cash assets. Mitchell Hutchins is a subsidiary of Mitchell Hutchins Asset Management, Inc., an independently operated subsidiary of PaineWebber. Mitchell Hutchins earned fees of $6,000, $4,000 and $6,000 (included in general and administrative expenses) for managing the Partnership's cash assets for the years ended March 31, 1995, 1994 and 1993, respectively.\n4. Investments in Unconsolidated Joint Venture Partnerships\nThe Partnership has investments in three unconsolidated joint ventures which are accounted for on the equity method in the Partnership's financial\nstatements. As discussed in Note 2, these joint ventures report their operations on a calendar year.\nCondensed combined financial statements of these joint ventures, for the periods indicated, are as follows.\nCONDENSED COMBINED BALANCE SHEETS December 31, 1994 and 1993 (in thousands)\nAssets 1994 1993\nCurrent assets $ 667 $ 528 Operating investment property, net 32,639 33,770 Other assets 882 798 $34,188 $35,096\nLiabilities and Venturers' Capital\nCurrent liabilities $ 416 $ 610 Other liabilities 2,951 1,890 Partnership's share of combined venturers' capital 28,149 29,746 Co-venturers' share of combined venturers' capital 2,672 2,850 $34,188 $35,096\nCONDENSED COMBINED SUMMARY OF OPERATIONS For the years ended December 31, 1994, 1993 and 1992\n(in thousands)\n1994 1993 1992\nRental revenues and expense recoveries $ 5,195 $ 4,776 $ 5,139 Interest and other income 12 17 14 5,207 4,793 5,153\nProperty operating expenses 1,508 1,414 1,336 Depreciation and amortization 2,101 1,866 1,798 Real estate taxes 252 299 306 Administrative and other 411 444 400 Interest expense 213 124 74 Loss on disposal - 236 476 4,485 4,383 4,390 Net income $ 722 $ 410 $ 763\nNet income: Partnership's share of combined income $ 613 $ 242 $ 678 Co-venturers' share of combined income 109 168 85 $ 722 $ 410 $ 763\nReconciliation of Partnership's Investment March 31, 1995 and 1994 (in thousands)\n1995 1994\nPartnership's share of capital at December 31, as shown above $28,149 $29,746 Excess basis due to investment in ventures (1) 472 492 Timing differences (2) (3,691) (302) Investments in unconsolidated joint ventures, at equity at March 31 $24,930 $29,936\n(1)At March 31, 1995 and 1994, the Partnership's investment exceeds its share of the joint venture capital accounts by $472,000 and $492,000, respectively. This amount, which represents expenses incurred by the Partnership in connection with acquiring its joint venture interests, is being amortized on a straight-line basis over the estimated useful life of the related investment properties.\n(2)The timing differences between the Partnership's share of venturers' capital and its investments in joint ventures consist of capital contributions made to the joint ventures and cash distributions received from joint ventures during the period from January 1 to March 31 in each year. These differences result from the lag in reporting period discussed in Note 2. The majority of the timing difference in fiscal 1995 can be attributed to a cash distribution from the Willow Grove joint venture in the net amount of $3,522,000 from the March 1995 refinancing transaction discussed further below and in Note 6.\nReconciliation of Partnership's Share of Operations For the years ended March 31, 1995, 1994 and 1993 (in thousands)\n1995 1994 1993\nPartnership's share of operations, as shown above $ 613 $ 242 $ 678 Amortization of excess basis (20) (20) (20) Partnership's share of unconsolidated ventures' income $ 593 $ 222 $ 658\nInvestments in unconsolidated joint ventures, at equity is the Partnership's net investment in the joint venture partnerships. These joint ventures are subject to partnership agreements which determine the distribution of available funds, the disposition of the ventures' assets and the rights of the partners, regardless of the Partnership's percentage ownership interest in the venture. Substantially all of the Partnership's investments in these joint ventures are restricted as to distributions.\nInvestments in unconsolidated joint ventures, at equity on the balance sheet at March 31, is comprised of the following unconsolidated joint venture investments (in thousands): 1995 1994\nDeVargas Center Joint Venture $ 8,314 $ 8,910 Portland Pacific Associates Two 524 3,958 Richmond Paragon Partnership 16,092 17,068\n$24,930 $29,936\nThe cash distributions received from the Partnership's unconsolidated joint venture investments during fiscal 1995, 1994 and 1993 are as follows (in thousands):\n1995 1994 1993\nDeVargas Center Joint Venture $ 867 $ 864 $ 864 Portland Pacific Associates Two 3,972 345 338 Richmond Paragon Partnership 1,102 818 1,235 $ 5,941 $ 2,027 $ 2,437\nA description of the ventures' properties and the terms of the joint venture agreements are summarized as follows:\nDeVargas Center Joint Venture\nOn April 19, 1988 the Partnership acquired an interest in DeVargas Center Joint Venture (the \"joint venture\"), a Texas Joint Venture organized in accordance with a joint venture agreement between the Partnership and WRI\/DeVargas Inc. (the \"co-venturer\"). The joint venture was organized to own and operate the DeVargas Mall, an existing retail shopping mall located in Santa Fe, New Mexico. The property consists of approximately 248,000 net rentable square feet on approximately 18.3 acres of land. The aggregate cash investment by the Partnership for its investment was $11,354,960 (including an acquisition fee of $505,000 paid to PWPI and certain closing costs of $49,960). The Partnership's co-venture partner is an affiliate of Weingarten Realty Investors.\nPer the terms of the joint venture agreement, net cash flow from operations of the joint venture will be distributed in the following order of priority: (1) the Partnership and co-venturer will each be repaid accrued interest and principal on any optional loans made to the joint venture, (2) the Partnership will receive a cumulative preference return payable each quarter, of 8% annual simple interest on its capital contribution of $10,800,000, (3) the co-venturer will receive a cumulative return of 8% annual simple interest on its capital contribution of $3,285,000, (4) thereafter, any remainder will be distributed 50% to the Partnership and 50% to the co-venturer.\nProceeds from the sale or refinancing of the property will be distributed in the following order of priority: (1) the Partnership will receive the aggregate amount of its cumulative 8% annual preferred return not previously paid, (2) the co-venturer will receive its unpaid 8% cumulative preference (3) the Partnership will receive an amount equal to the Partnership's net investment, (4) the co- venturer will receive an amount equal to the co-venturer's net investment (5) the Partnership and co-venturer will each receive proceeds equal to 10% of their capital contributions, (6) thereafter, any remaining proceeds will be distributed 50% to the Partnership and 50% to the co-venturer.\nTaxable income from operations will be allocated to the Partnership and co- venturer in the same proportion as cash distributions with any remaining income being allocated 50% to the Partnership and 50% to the co-venturer. Tax losses from operations will be allocated to the Partnership and co-venturer to the extent of and in the ratio of their positive capital balances with any remaining losses being allocated 50% to the Partnership and 50% to the co-venturer. Net income or loss for financial reporting purposes has been allocated in accordance with the allocations of taxable income or tax loss.\nThe joint venture has entered into a management contract and a leasing contract with an affiliate of the co-venturer which is cancellable at the option of the Partnership upon the occurrence of certain events. The annual management fee is 4% of gross rents collected and a 4% commission on any new leases.\nThe co-venturer has issued two nonrecourse promissory notes to the joint venture to finance the leasing and operations of the Mall. The first note dated January 1990 allows the joint venture to borrow up to $3,000,000 to fund capital costs associated with leasing of the shopping center. The second note dated December 1992 allows the joint venture to borrow up to $553,000 to fund capital costs associated with an expansion and additional leasing of the shopping center. Both notes bear interest at 1% above the floating prime rate established by Texas Commerce Bank National Association. Outstanding accrued interest on the first note is due and payable on a monthly basis with the principal due January 1996. Principal payments of $4,608 and accrued interest on the second note is due and payable on a monthly basis, with the remaining accrued interest and principal due November 2002. As of December 31, 1994, the principal balances of the notes payable to the co-venturer aggregated $2,951,000.\nPortland Pacific Associates Two\nOn September 20, 1988 the Partnership acquired an interest in Portland Pacific Associates Two, the general partnership formed to own and operate Willow Grove Apartments, a 119-unit apartment complex situated on 6.2 acres of land in Beaverton, Oregon. The aggregate cash investment by the Partnership for its investment was $5,068,167 (including an acquisition fee of $252,000 paid to PWPI and certain closing costs of $16,167). The Partnership's original co-venture partner was an affiliate of Pacific Union Investment Company.\nOn January 27, 1995, the Partnership purchased 99% of the co-venture partner's interest in the joint venture for $233,000. The remaining 1% interest of the co-venturer was assigned to Third Equity Partners, Inc. (`TEP''), the Managing General Partner of the Partnership, in return for a release from any further obligations or duties called for under the terms of the joint venture agreement. As a result, the Partnership has assumed full control over the affairs of the joint venture. Because this transaction was completed after the joint venture's year-end, the change in control will not be reflected in the presentation of the Partnership's financial statements until the first quarter of fiscal 1996. For fiscal 1995, the venture continues to be accounted for under the equity method. In fiscal 1996, the assets, liabilities, results of operations and cash flows of the joint venture will be presented on a consolidated basis in the financial statements of the Partnership.\nThe Amended and Restated Joint Venture Agreement provides that net cash flow (as defined) shall be distributed in the following order of priority: (i) First, to the Partnership until the Partnership has received a cumulative non- compounded return of 10% on its net investment of $4,800,000 plus any additional contributions made; (ii) Second, any remaining net cash flow shall be distributed to the partners in proportion to their venture interests (99% to the Partnership and 1% to TEP).\nUnder the terms of the Amended and Restated Joint Venture Agreement, taxable income from operations in each year shall be allocated first to the Partnership until the Partnership has been allocated an amount equal to a 10% cumulative non-compounded return on the Partnership's net investment plus any additional contributions. Any remaining taxable income shall be allocated 99% to the Partnership and 1% to TEP. All tax losses from operations shall be allocated 99% to the Partnership and 1% to TEP. Allocations of income or loss for\nfinancial accounting purposes have been made in accordance with the allocations of taxable income or tax loss.\nNet profits and losses arising from a capital transaction shall be allocated among the venture partners under the specific provisions of the Amended and Restated Joint Venture Agreement. Any net proceeds available to the venture, arising from the sale, refinancing or other disposition of the property, after the payment of all obligations to the mortgage lenders and the repayment of certain advances from the Partnership shall be distributed to the venture partners in proportion to their positive capital account balances after the allocation of all gains or losses.\nIf additional cash is required in connection with the operation of the Joint Venture, the venture partners shall contribute such required funds in proportionate amounts as may be determined by the venture partners at such time.\nIn March 1995, the joint venture obtained a $3,600,000 mortgage note payable, secured by the Willow Grove Apartments, which bears interest at 9.59%. Principal and interest payments of $31,678 are due monthly through March of 2002 at which time the entire unpaid balance of principal and interest is due. The loan was issued to the joint venture and, accordingly, is recorded on the venture's books. The net proceeds from the financing transaction of approximately $3,522,000 were remitted to the Partnership as a distribution. The Partnership used $2,473,000 to pay off an outstanding note payable which encumbered the property (see Note 6). The remaining proceeds were added to the Partnership's cash reserves.\nThe Partnership originally entered into a Management Agreement with an affiliate of the former co-venturer which was cancellable at the option of the Partnership upon the occurrence of certain events. The annual management fee\nwas equal to 5% of gross rents collected. The former co-venture partner has been retained in a property management capacity for the same annual fee under a contract which is cancellable for any reason upon 30 days' written notice from the Partnership.\nRichmond Paragon Partnership\nOn September 26, 1988, the Partnership acquired an interest in Richmond Paragon Partnership, a Virginia general partnership that owns and operates One Paragon Place, a six-story office building located on approximately 8.2 acres of land in Richmond, Virginia with 146,614 square feet of net leasable area. The Partnership is a general partner in the joint venture. The aggregate cash investment by the Partnership for its investment was $21,108,383 (including an acquisition fee of $1,031,000 paid to PWPI and certain closing costs of $42,447). The Partnership's co-venture partner is an affiliate of The Paragon Group. The property is encumbered by a mortgage loan with an outstanding balance of $9,774,000 as of March 31, 1995. Such mortgage loan is scheduled to mature in November 1995 (see Note 6).\nPer the terms of the joint venture agreement, net cash flow from operations of the joint venture is to be distributed as follows: (1) the Partnership shall receive a cumulative annual preferred return payable monthly equal to 9.0% on the Partnership's Net Investment of $20,000,000 (\"the Partnership's Preferred Return\"), (2) the Partnership and the co-venturer will receive a return equal to the prime rate of interest plus 1% on any additional capital contributions, as defined, and (3) any additional net cash flow will be distributed 75% to the Partnership and 25% to the co-venturer.\nTaxable income from operations will be allocated in accordance with the net cash flow distributions described above. Tax losses from operations will be\nallocated to the Partnership and the co-venturer in proportion to their respective positive capital accounts up to the sum of such positive capital accounts and thereafter 75% to the Partnership and 25% to the co-venturer.\n5. Operating investment property\nThe Partnership owns a controlling interest in the Colony Plaza General Partnership, described below, and therefore presents the assets, liabilities, and results of operations of this joint venture on a consolidated basis in its financial statements. Colony Plaza General Partnership was formed to acquire and operate Colony Plaza Shopping Center located in Augusta, Georgia. The shopping center is a 217,000 square foot complex which was acquired by the Partnership on January 18, 1990. Wyatt Ventures, Inc. (\"Co-Venturer\") and the Partnership are the partners of Colony Plaza General Partnership. The Partnership has a 99% ownership interest in the General Partnership and the Co- Venturer has a 1% ownership interest in the General Partnership. The Partnership purchased the operating investment property for $13,889,890 (including an acquisition fee paid to PWPI of $653,000 and $176,890 of closing costs) from Wyatt Development Company, an affiliate of the Co-Venturer. The property is encumbered by a mortgage loan with an outstanding balance of $6,933,000 as of March 31, 1995 (see Note 6).\nTaxable income from operations (other than gains resulting from sale or disposition of the property) shall be allocated to the Partnership and the Co- Venturer to the extent of cash distributions paid to the partners for a given fiscal year and in the same ratio as those distribution payments. In the event that there are no distributable funds, taxable income will be allocated 99% to the Partnership and 1% to the Co-Venturer. Tax losses from the operations of the shopping center (other than from sale or disposition) shall be allocated each fiscal year between the Partnership and the Co-Venturer to the extent of\nand in the ratio of the positive balances in their respective capital accounts. Any remaining losses will be allocated 99% to the Partnership and 1% to the Co- Venturer. Net income or loss for financial reporting purposes will be allocated in accordance with the allocations of taxable income or tax loss.\nAllocation of gains and losses from sales or dispositions of the property will be allocated to the partners based on formulas set forth in the Partnership Agreement.\nDistributable funds and net proceeds from sale or refinancing is to be distributed as follows: (1) to repay interest and principal on optional loans; (2) 100% to the Partnership until it has earned a 9.55% per annum cumulative preferred return on the Partnership's net investment of $13,060,000; (3) to the Partnership until it has received distributable funds of $13,713,000 and (4) the remaining balance 99% to the Partnership and 1% to the Co-Venturer. The Partnership's Preferred Return is treated as a distribution and is recorded as a reduction to the partner's capital account on the accompanying financial statements. As of December 31, 1994, the cumulative preferred return payable to the Partnership was $930,500.\nIf additional cash is required for any reason in connection with operations of the Joint Venture, it may be provided by either the Partnership or the Co- Venturer as optional loans. If both parties choose to make option loans to the Venture, they will be in the same ratio as ownership interest, 99:1. The rate of interest on such loans shall equal the rate announced by the First National Bank of Boston as its prime rate plus 1%, but not in excess of the maximum rate of interest permitted by applicable law. As of December 31, 1994, no optional loans had been made by the venturers.\nAt the time of the purchase of the operating investment property, the Partnership entered into a master lease agreement with the seller of the operating property and certain other affiliates of WVI (the \"Guarantors\"). Under the terms of the master lease, the Guarantors guaranteed for a period of three years from the date that the shopping center achieved a specified occupancy level that aggregate net cash flow from all non-anchor tenants would not be less than the aggregate pro-forma net cash flow from non-anchor tenants projected at time of the purchase. During 1991, the Lessee defaulted on its obligation under the master lease and the Partnership received an amount of cash collateral to apply to future obligations. The remaining balance of the cash collateral was exhausted in January 1992. Through December 31, 1994, no other amounts had been received toward the Lessee's obligation under the master lease, resulting in an outstanding balance due of approximately $618,000. In January 1995, the Lessee entered into a settlement agreement with the Partnership which terminated the master lease agreement effective December 31, 1994. The original termination date of the master lease agreement was to have been February 27, 1997. In accordance with the settlement agreement, on January 27, 1995 the Partnership received a cash payment of approximately $348,000 toward the outstanding obligation of $618,000 discussed above. In addition, the Partnership received a promissory note from the Lessee in the amount of $160,000 which will accrue interest at 8.5% and is due December 31, 1997. The Lessee also assigned its rights to certain future development and leasing fees which will be credited against the outstanding balance of the promissory note if earned. The remaining master lease obligation, after the cash payment and the promissory note, was forgiven under the terms of the settlement agreement. Master lease income is recorded as a reduction of the carrying value of the operating property on the accompanying balance sheet. Accordingly, the joint venture will record any payments under the note when received as a reduction in the property's carrying value.\nThe following is a summary of property operating expenses for the years ended December 31, 1994, 1993 and 1992 (in thousands):\n1994 1993 1992\nCommon area maintenance $ 42 $ 46 $ 34 Utilities 13 13 14 Insurance 17 17 10 Management fees 40 33 31 Professional fees 14 14 13 Administrative and other 14 5 15 $ 140 $ 128 $ 117\n6. Notes payable\nNotes payable and accrued interest on the books of the Partnership at March 31, 1995 and 1994 consist of the following (in thousands):\n1995 1994\n10.72% nonrecourse loan payable to an insurance company, which is secured by the One Paragon Place operating investment property. All interest and principal is due at maturity, on November 23, 1995. Interest is compounded semi-annually. Accrued interest at March 31, 1995 and 1994 amounted to $4,774 and $3,805, respectively. See discussion below. $ 9,774 $ 8,805\n10.5% nonrecourse loan payable to a finance company, which is secured by the Colony Plaza operating investment property. All interest and principal is due at maturity, on December 29, 1996. Interest is compounded semi- annually. Accrued interest at March 31, 1995 and 1994 amounted to $2,883 and $2,208, respectively. 6,933 6,258\n10.5% nonrecourse loan payable to a finance company, which was secured by the Willow Grove operating investment property. The note had a term of seven years and bore interest at 10.5% per annum compounded semi- annually. Interest and principal totalling $2,968 was to be due and payable by the Partnership at maturity, on December 29, 1996. Accrued interest through March 31, 1994 amounted to $791. See discussion below. - 2,241 $16,707 $17,304\nThe Partnership is currently in negotiations with the existing lender on the note secured by One Paragon Place regarding conversion of this note to a conventional current-pay loan and is also seeking possible replacement financing. Management is requesting from the lender a four-year extension of the maturity date and terms which would include a reduced rate of interest on the balance of the loan going forward. Both the Partnership's modification proposal or any refinancing transaction would require a paydown of approximately $1 million on the outstanding debt balance in order to satisfy lender loan-to- value ratio requirements. The Partnership has sufficient funds to make such a principal paydown, however no firm commitments exist as of the date of this report to refinance the outstanding debt obligation or extend the maturity date beyond November 1995. This situation raises substantial doubt about the ability of the One Paragon Place joint venture to continue as a going concern. The financial statements of the venture do not include any adjustments that might result from the outcome of this uncertainty. The total assets, total liabilities, gross revenues and total expenses of the One Paragon Place joint venture included in the 1994 condensed combined balance sheet and summary of operations in Note 4 are $16,447,000, $91,000, $1,970,000 and $1,911,000, respectively.\nThe loan secured by the Willow Grove Apartments was repaid in full in March 1995 from the proceeds of a new first mortgage loan issued to the Willow Grove joint venture and secured by the venture's operating investment property. Such loan, in the initial principal amount of $3,600,000, bears interest at 9.59% and requires monthly principal and interest payments of $31,679 from April 1995 through maturity in March 2002. The loan was issued directly to the joint venture and, accordingly the liability is reflected on the venture's books. The net proceeds from the financing transaction were distributed to the Partnership.\nThe portion of the proceeds that was not used to repay the prior first mortgage loan on Willow Grove was added to the Partnership's cash reserves.\n7. Rental revenues\nThe Colony Plaza General Partnership derives rental income from leasing shopping center space. All of Colony Plaza's leasing agreements are operating leases expiring in one to twenty years. Base rental income of $1,212,000, $1,109,000 and $1,123,000 was earned during the years ended December 31, 1994, 1993 and 1992, respectively. The following is a schedule of minimum future lease payments from noncancellable operating leases as of December 31, 1994 (in thousands):\nYears ending December 31:\n1995 $1,205 1996 $1,112 1997 $1,010 1998 $ 892 1999 $ 739 Thereafter $5,842\nTotal minimum future lease payments do not include percentage rentals due under certain leases, which are based upon lessees' sales volumes. No percentage rentals have been earned to date. Tenant leases also require lessees to pay all or a portion of real estate taxes, insurance and common area costs.\nDuring the year ended December 31, 1994, base rental income of approximately $839,000 (69% of total base rental income) was received from the three anchor tenants of the operating property, as detailed below.\nRental Percent of Total Anchor tenant Income earned Rental income\nWal-Mart Stores, Inc. $ 336,000 27% Piggly Wiggly, d\/b\/a Foodmax $ 288,000 24% Goody's Family Clothes, Inc. $ 215,000 18%\nNo other tenant accounted for more than 10% of rental income during the year.\n8. Contingencies\nThe Partnership is involved in certain legal actions. The Managing General Partner believes these actions will be resolved without material adverse effect on the Partnership's financial statements, taken as a whole.\n9. Subsequent Event\nOn May 15, 1995 the Partnership distributed $252,332 to the Limited Partners and $2,549 to the General Partners for the quarter ended March 31, 1995.\nSchedule III - Real Estate and Accumulated Depreciation\nREPORT OF INDEPENDENT AUDITORS\nThe Partners PaineWebber Equity Partners Three Limited Partnership:\nWe have audited the combined balance sheets of the Combined Joint Ventures of PaineWebber Equity Partners Three Limited Partnership as of December 31, 1994 and 1993, and the related combined statements of operations, changes in venturers' capital and cash flows for each of the three years in the period ended December 31, 1994. Our audits also included the financial statement schedule 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. We did not audit the financial statements of DeVargas Center Joint Venture, which statements reflect 39% of the combined total assets of the Combined Joint Ventures of PaineWebber Equity Partners Three Limited Partnership at December 31, 1994 and 1993, and 46%, 49% and 42% of the combined revenues of the Combined Joint Ventures of PaineWebber Equity Partners Three Limited Partnership for the years ended December 31, 1994, 1993 and 1992, respectively. Those statements were audited by other auditors, whose report has been furnished to us, and our opinion, insofar as it relates to data included for DeVargas Center Joint Venture, 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\nreasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits, and the report of other auditors, provide a reasonable basis for our opinion.\nAs more fully described in Note 6, mortgage debt secured by the Richmond Paragon Partnership's operating investment property is scheduled to mature in November 1995.\nIn our opinion, based on our audits and the report of other auditors, the financial statements referred to above present fairly, in all material respects, the combined financial position of the Combined Joint Ventures of PaineWebber Equity Partners Three Limited Partnership at December 31, 1994 and 1993, and the combined 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 the report of other auditors, 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 ERNST & YOUNG LLP\nBoston, Massachusetts\nFebruary 22, 1995\nDELOITTE & TOUCHE LLP Suite 2300 333 Clay Street Houston, Texas 77002-4196\nINDEPENDENT AUDITORS' REPORT\nWe have audited the accompanying balance sheets of DeVargas Center Joint `Joint Venture'') as of December 31, 1994 and 1993, and the\nWe conducted our audits in accordance with generally accepted auditing\nIn our opinion such financial statements present fairly, in all material\n\/S\/ DELOITTE & TOUCHE LLP DELOITTE & TOUCHE LLP\nCOMBINED JOINT VENTURES OF PAINE WEBBER EQUITY PARTNERS THREE LIMITED PARTNERSHIP\nCOMBINED BALANCE SHEETS December 31, 1994 and 1993\n(In Thousands)\nASSETS\n1994 1993\nCurrent assets: Cash and cash equivalents $ 493 $ 329 Escrowed cash 54 19 Accounts receivable and prepaid expenses 120 180 Total current assets 667 528\nOperating investment properties, at cost: Land 7,223 7,223 Buildings and improvements 33,082 32,175 Furniture and equipment 2,794 2,655 Construction in progress 24 213 43,123 42,266 Less accumulated depreciation (10,484) (8,496) 32,639 33,770\nDeferred rents receivable 442 371 Deferred expenses and other assets, net of accumulated amortization of $514 and $401 in 1994 and 1993 440 427 $34,188 $35,096\nLIABILITIES AND VENTURERS' CAPITAL\nCurrent liabilities: Accounts payable and accrued liabilities $ 59 $ 68 Accounts payable - affiliates 95 256 Real estate taxes payable 14 14 Distributions payable to partners 96 120\nAdvances from partners 92 92 Other current liabilities 60 60 Total current liabilities 416 610\nNotes payable - affiliate 2,951 1,890\nVenturers' capital 30,821 32,596 $34,188 $35,096\nSee accompanying notes.\nCOMBINED JOINT VENTURES OF PAINE WEBBER EQUITY PARTNERS THREE LIMITED PARTNERSHIP\nCOMBINED STATEMENTS OF OPERATIONS For the years ended December 31, 1994, 1993 and 1992 (In Thousands)\n1994 1993 1992\nREVENUES: Rental income and expense recoveries $ 5,195 $ 4,776 $ 5,139 Interest and other income 12 17 14 5,207 4,793 5,153 EXPENSES: Depreciation and amortization 2,101 1,866 1,798 Real estate taxes 252 299 306 Interest expense 213 124 74 Management fees 209 179 206 Utilities 286 282 266 Repairs and maintenance 1,013 953 864 Administrative and other 411 444 400 Loss on disposal - 236 476\n4,485 4,383 4,390\nNET INCOME $ 722 $ 410 $ 763\nSee accompanying notes.\nPAINEWEBBER EQUITY PARTNERS THREE LIMITED PARTNERSHIP\nCOMBINED STATEMENTS OF CHANGES IN VENTURERS' CAPITAL For the years ended December 31, 1994, 1993 and 1992 (In Thousands)\nPaineWebber Equity Partners Three Limited Partnership Co-Venturers Total\nBalance at December 31, 1991 $32,008 $ 3,225 $35,233\nCapital contributions 717 - 717\nCash distributions (2,428) (255) (2,683)\nNet income 679 84 763\nBALANCE AT DECEMBER 31, 1992 30,976 3,054 34,030\nCapital contributions 560 - 560\nCash distributions (2,033) (371) (2,404)\nNet income 243 167 410\nBALANCE AT DECEMBER 31, 1993 29,746 2,850 32,596\nCapital contributions 184 - 184\nCash distributions (2,394) (287) (2,681)\nNet income 613 109 722\nBALANCE AT DECEMBER 31, 1994 $ 28,149 $ 2,672 $30,821\nSee accompanying notes.\nCOMBINED JOINT VENTURES OF PAINE WEBBER EQUITY PARTNERS THREE LIMITED PARTNERSHIP COMBINED STATEMENTS OF CASH FLOWS For the years ended December 31, 1994, 1993 and 1992 Increase (Decrease) in Cash and Cash Equivalents (In Thousands)\n1994 1993 1992 Cash flows from operating activities: Net income $ 722 $ 410 $ 763 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 2,101 1,866 1,798 Loss on disposal of equipment - 236 476 Changes in assets and liabilities: Accounts receivable and prepaid expenses 60 (54) (13) Deferred rents receivable (71) 228 (201) Deferred expenses and other assets (135) (175) (214) Accounts payable and accrued liabilities (9) (31) (129) Accounts payable - affiliates (161) (20) 3 Real estate taxes payable - (4) 1\nOther current liabilities - (1) (40) Total adjustments 1,785 2,045 1,681 Net cash provided by operating activities 2,507 2,455 2,444\nCash flows from investing activities: Escrowed cash (35) (5) 40 Collection of note receivable 9 1 - Additions to operating investment properties (857) (1,077) (1,516) Net cash used in investing activities (883) (1,081) (1,476)\nCash flows from financing activities: Proceeds from capital contributions 184 560 717 Proceeds from issuance of notes payable to affiliate 1,061 382 973 Advances from partners - 1 254 Retirement of debt - (60) - Debt costs incurred - - (2) Cash distributed to venturers (2,705) (2,427) (2,648) Net cash used in financing activities (1,460) (1,544) (706)\nNet increase (decrease) in cash and cash equivalents 164 (170) 262\nCash and cash equivalents at beginning of year 329 499 237\nCash and cash equivalents at end of year $ 493 $ 329 $ 499\nCash paid during the year for interest $ 201 $ 124 $ 66\nSee accompanying notes.\n1. Summary of significant accounting policies\nOrganization\nThe accompanying financial statements of the Combined Joint Ventures of PaineWebber Equity Partners Three Limited Partnership (Combined Joint Ventures) include the accounts of DeVargas Center Joint Venture (DeVargas), a Virginia limited partnership; Portland Pacific Associates Two (Willow Grove Apartments), a California general partnership; and Richmond Paragon Partnership (One Paragon Place), a Virginia general partnership.\nThe financial statements of the Combined Joint Ventures have been prepared based on the periods that PaineWebber Equity Partners Three Limited Partnership (PWEP3) has held an interest in the individual Joint Ventures.\nThe dates of PWEP3's acquisition of interests in the Joint Ventures are as follows:\nDate of Acquisition Joint Venture of Interest\nDeVargas Center April 18, 1988 Portland Pacific Associates Two September 20, 1988 Richmond Paragon Partnership September 26, 1988\nBasis of Presentation\nThe financial statements of the joint ventures are presented in a combined format due to the nature of the relationship between each of the Joint Ventures and PWEP3.\nOperating investment properties\nThe operating investment properties are carried at the lower of cost, reduced by accumulated depreciation, or net realizable value. The net realizable value of a property held for long-term investment purposes is measured by the recoverability of the investment from expected future cash flows on an undiscounted basis, which may exceed the property's current market value. The net realizable value of a property held for sale approximates its market value. All of the operating investment properties owned by the Combined Joint Ventures were considered to be held for long- term investment purposes as of December 31, 1994 and 1993.\nDepreciation is generally computed using the straight-line method based on the estimated useful life of the buildings, improvements and furniture and equipment, generally five to forty years. Certain of the furniture and equipment is depreciated over seven and five years, respectively, using the double-declining balance method. Repairs and maintenance are charged to\nexpense. Major replacements are capitalized, and the replaced asset and accumulated depreciation are removed from the accounts. The Combined Joint Ventures recognized losses of $236,755 on disposals of building improvements which were replaced during the year ended December 31, 1993. \"Mandatory Payments\" from the co-venture partner in Richmond Paragon Partnership to pay PWEP3's preferred distribution or to cover operating deficits are not reimbursable to the co-venturer and are treated as reductions to the cost basis of the operating investment property. Mandatory payments amounted to $174,157 through the end of the guaranty period.\nThe Combined Joint Ventures have reviewed FAS No. 121 `Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets To Be Disposed Of'' which is effective for financial statements for years beginning after December 15, 1995, and believes this new pronouncement will not have a material effect on the Combined Joint Ventures' financial statements.\nDeferred expenses\nDeferred expenses include capitalized guaranty fees, organization costs, lease costs and loan expenses. Guaranty fees and organization costs have been amortized using the straight-line method over three and five years, respectively. Deferred leasing costs and loan expenses are generally amortized on a straight-line basis over the term of the leases and the term of the loans, respectively.\nCash and cash equivalents\nFor purposes of the statement of cash flows, the Combined Joint Ventures consider all highly liquid investments with original maturity dates of 90 days or less to be cash equivalents.\nReclassifications\nCertain prior year amounts have been reclassified to conform to the current year presentation.\nRevenue recognition\nRental revenue is recognized on a straight-line basis over the life of the related lease agreements for the commercial properties owned by DeVargas Center Joint Venture and Richmond Paragon Partnership. Deferred rents receivable of $442,000 and $371,000 at December 31, 1994 and 1993, respectively, represent the difference between the revenue recorded on the straight-line method and the payments made in accordance with the lease agreements.\nIncome tax matters\nNo provision for income taxes has been provided because the tax effects of the Joint Ventures are reportable by the individual partners.\nEscrow accounts\nCertain Joint Venture Agreements provide that PWEP3 can direct the property manager to establish and periodically fund escrow cash accounts for payment of real estate taxes and insurance premiums. As of December 31, 1994, no such direction has been given to the property managers.\nCapital reserve\nThe One Paragon Place Joint Venture Agreement provides that a reserve for future capital expenditures be established and administered by the Manager of the property. The Joint Venture is to pay periodically into the capital reserve an agreed upon amount (as defined) as funds are available after paying all expenses and PWEP3's preferred distribution during the guaranty period. As of December 31, 1994, no amounts were required to be paid into the capital reserve.\nEscrowed Cash\nEscrowed cash consists primarily of tenants security deposits.\n2. Joint Ventures\nSee Note 4 to the financial statements of PWEP3 included in this Annual Report for a more detailed description of the joint venture partnerships. Descriptions of the ventures' properties are summarized below:\na. DeVargas Center Joint Venture\nThe joint venture owns and operates the DeVargas Mall consisting of an existing retail shopping mall located in Santa Fe, New Mexico. The property consists of approximately 248,000 net rentable square feet on approximately 18.3 acres of land.\nb. Portland Pacific Associates Two\nThe partnership owns and operates Willow Grove Apartments, a 119-unit apartment complex located on 6.2 acres of land in Beaverton, Oregon.\nc. Richmond Paragon Partnership\nThe partnership owns and operates One Paragon Place, a six-story office building located on approximately 8.2 acres of land in Richmond, Virginia, with 146,614 square feet of net leasable area.\nThe following description of the joint venture agreements provides certain general information.\nAllocations of net income and loss\nThe agreements generally provide that net income (other than those resulting from sales or other dispositions of the projects) will be allocated to PWEP3 in the same proportions as actual cash distributions from operations (as defined in the Joint Venture Agreements). The agreement in the Portland Pacific Associates Two partnership provides for the allocation of net income or loss after specific allocation of interest expense on partnership advances. Losses are generally allocated to the partners in proportion to their ownership interests or positive capital account balances.\nGains or losses resulting from sales or other dispositions of the projects shall be allocated according to the formulas provided in the Joint Venture Agreements.\nDistributions\nDistributable funds from DeVargas are determined quarterly and distributed in the following priority: (1) repayment of any accrued interest and principal on loans; (2) a cumulative return of 8% annual simple interest on PWEP3's capital contribution of $10,800,000; (3) a cumulative return of 8% annual simple interest on the co-venturer's capital contribution of $2,700,000 ($3,285,000 subsequent to September 25, 1990) and (4) the remaining distributable funds shall be distributed 50% to PWEP3 and 50% to the co-venturer.\nThe Portland Pacific agreement provides that net cash flow available for distribution, as defined, is allocated first to PWEP3 until it has received its preferred return, as defined, which is cumulative to the extent of the then-current fiscal year. PWEP3's preferred return is 9% simple interest on its Net Investment of $4,800,000 for the three-year period commencing on September 20, 1988 (the \"Guaranty Period\"), 9.50% on its Net Investment for the fourth year, and 10% on its Net Investment thereafter. Second, 50% is be distributed to PWEP3 to pay any accrued preference, and 37.5% to PWEP3 and 12.5% to the co-venturer. Then, of the remaining net cash flow, 50% is to be distributed to the property manager to pay any unpaid subordinated management fees, and 37.5% to PWEP3 and 12.5% to the co-venturer. See the discussion in Note 8 regarding the subsequent transfer of partnership interest which will affect these distribution priorities in 1995.\nThe Richmond Paragon Joint Venture Agreement provides that PWEP3 will receive from net cash flow cumulative preferred distributions, payable monthly, equivalent to 9% per annum on its net investment of $20,000,000 through and until the termination and dissolution of the Partnership. Any remaining net cash flow is to be distributed first to the partners as a return equal to the prime rate of interest plus 1% on any additional capital\ncontributions made to fund current cash needs of the joint venture and then is to be distributed 75% to PWEP3 and 25% to the co-venturer. The joint venture agreement further provided that during the first three years of operations (the guaranty period), if cash flow was insufficient to cover operating deficits and to pay PWEP3's preferred distribution, the co-venture was required to pay to the joint venture such amounts as were necessary to fund such operating deficits and provide for the payment of PWEP3's preferred distribution. Payments made by the co-venturer under these provisions are called \"mandatory payments\" (see Note 1). The guaranty period expired in September 1991.\nDistributions of net proceeds upon the sale or disposition of the projects shall be made in accordance with formulas provided in the joint venture agreements.\n3. Related Party Transactions\nManagement fees\nThe joint ventures entered into management contracts with affiliates of the co-venturers which are cancellable at the option of PWEP3 upon the occurrence of certain events. The management fees generally range from 4 to 5% of gross rents collected.\nAccounts payable - affiliates\nAccounts payable - affiliates at December 31, 1994 and 1993 consist primarily of accrued interest on notes payable to the co-venturer in the DeVargas joint venture (see Note 4), organization costs payable to PWEP3, and management fees and reimbursements payable to the property managers.\nCharges from Portland Pacific Co-Venturer\nAccounting fees of $3,849, $8,043 and $7,609 were paid or owed to the co- venture partner of the Portland Pacific joint venture in 1994, 1993 and 1992, respectively.\n4. Notes payable - affiliate\nA promissory note payable to the co-venture partner of the DeVargas Center Joint Venture, dated January 25, 1990, allows the Joint Venture to borrow up to $3,000,000 and bears interest at 1% above the floating prime rate established by Texas Commerce Bank National Association (9.5% at December 31, 1994). Outstanding accrued interest is due and payable on a monthly basis, and the principal is due on January 25, 1996. The outstanding principal balance of this note was $2,513,013 and $1,549,765 at December 31, 1994 and 1993, respectively. A second promissory note payable to the DeVargas co-venturer due November 2002 allows the joint venture to borrow up to $553,000 and also bears interest at 1% above the prime rate. The outstanding principal balance of this note, which was issued in November 1992, was $437,792 and $340,902 at December 31, 1994 and 1993 respectively. Principal payments of $4,608 and accrued interest are due and payable on a monthly basis, beginning December 1992. The proceeds from these notes have been utilized to fund capital costs associated with leasing and operating the DeVargas Mall.\n5. Advances from partners\nAdvances from partners at December 31, 1994 includes amounts payable to the partners of Portland Pacific Associates Two in the amounts of $73,182 for PWEP3 and $18,295 for the co-venturer. The advances bear a preferred return accounted for as interest at the rate then applicable to the PWEP3 Preference return (10% for each of the three years in the period ended December 31, 1994). Interest expense related to these advances was $9,148, $9,148 and $4,089 for the years ended December 31, 1994, 1993 and 1992, respectively. This interest expense has been specifically allocated to each partner in the statement of changes in venturers' capital. Payments of interest totalling $9,148, $9,148 and $3,312 were made during 1994, 1993 and 1992, respectively. The advances are payable out of cash flow available for distribution, if any.\n6. Encumbrances on operating investment properties\nAs allowed under a provision of the Portland Pacific Partnership Agreement, PWEP3 borrowed funds that were secured by a deed of trust and the assignment of leases on the operating investment property of the Portland Pacific general partnership. At December 31, 1994, the amount outstanding on this borrowing was $2,183,000. The borrowing accrued interest at 10.5% annually, with the accrued interest being added to the principal balance. The borrowing was scheduled to mature in December 1996, at which time total principal and accrued interest of $2,968,000 was to become due and payable by PWEP3. In March 1995, this borrowing was repaid in full through a $3,600,000 loan made directly to Portland Pacific Associates Two. Such loan is secured by a first mortgage on the venture's operating investment property, bears interest at 9.59% per annum, and requires monthly principal and interest payments of $31,679 from April 1995 through maturity in March 2002. The proceeds of this financing transaction were distributed to PWEP3 per the agreement of the partners.\nPWEP3 also borrowed funds, under a provision in the joint venture agreement, secured by a deed of trust and the assignment of leases on the operating investment property of the Richmond Paragon General Partnership. The borrowing accrues interest at 10.72% annually with the accrued interest being added to the principal balance. The borrowing matures in November of 1995, at which time total principal and accrued interest of approximately $10,386,000 becomes due and payable by PWEP3. At December 31, 1994, the amount outstanding on this borrowing was $9,480,000. PWEP3 is currently in negotiations with the existing lender on the note secured by One Paragon Place regarding conversion of this note to a conventional current-pay loan and is also seeking possible replacement financing. Management of PWEP3 is requesting from the lender a four-year extension of the maturity date and terms which would include a reduced rate of interest on the balance of the loan going forward. Both the modification proposal or any refinancing transaction would require a paydown of approximately $1 million on the outstanding debt balance in order to satisfy lender loan-to-value ratio requirements. PWEP3 has sufficient funds to make such a principal paydown, however no firm commitments exist as of the date of this report to refinance the outstanding debt obligation or extend the maturity date beyond November 1995. This situation raises substantial doubt about the ability of the One Paragon Place joint venture to continue as a going concern. The financial statements of the venture do not include any adjustments that might result from the outcome of this uncertainty. The total assets, total liabilities, gross revenues and total expenses of the One Paragon Place joint venture included in the 1994 combined balance sheet and statement of operations $16,447,000, $91,000, $1,970,000 and $1,911,000, respectively.\nThe borrowings described above are direct obligations of PWEP3 and, accordingly, do not appear in the accompanying financial statements.\n7. Leases\nMinimum rental revenues to be recognized by the DeVargas Mall and One Paragon Place joint ventures on the straight-line basis in the future on noncancellable operating leases are as follows (in thousands):\nYear ended December 31:\n1995 $ 3,462 1996 3,420 1997 2,711 1998 1,889 1999 926 Thereafter 6,049 $ 18,457\nThe future minimum lease payments do not include estimates for contingent rentals due under the terms of certain leases at the DeVargas Mall. Such contingent rentals aggregated $898,000, $937,000 and $791,000 in 1994, 1993 and 1992, respectively.\n8. Subsequent Events\nIn January 1995, PWEP3 acquired 99% of the co-venturer's interest in Portland Pacific Associates Two in return for a cash payment of approximately $233,000. Such cash consideration included repayment in full of the advances from the co-venturer described in Note 5. The remaining 1% of co-venturer's interest was assigned to Third Equity Partners, Inc., an\naffiliate of PWEP3, in return for a release from any further obligations or duties called for under the terms of the joint venture agreement. As a result of this transaction, the original co-venturer no longer has any equity interest in the joint venture. Pacific Union Property Services, an affiliate of the original co-venturer, continues to manage the property pursuant to a management contract which is cancellable upon 30 days' written notice.\nSchedule III - Real Estate and Accumulated Depreciation","section_15":""}
{"filename":"8598_1995.txt","cik":"8598","year":"1995","section_1":"ITEM 1. BUSINESS\nAuto-Graphics, Inc. provides software products and processing services to information and database publishers. These products and services are used to create, maintain and distribute information databases through printed and\/or electronic reference products. Electronic products include Compact Disc (CD- ROM) and Client\/Server software systems(Internet\/Web).\nThe Company provides state and local government customers with products and outsourced services to maintain, publish and distribute bibliographic databases of library holdings and to manage interlibrary loan systems. Traditional commercial and corporate publishers use the Company's services to produce and distribute print and electronic products such as dictionaries, encyclopedias, Bibles, price catalogs and other reference works.\nIn recent years, Auto-Graphics has made a major investment in the development of online client\/server software products and client-shared Internet\/Web services. In 1993, the Company launched the development of an umbrella concept called Impact\/ONLINE[tm] for Internet distribution services. This capability has been successfully applied to a range of applications including the outsourcing by several statewide library consortia to Auto-Graphics of complete system design, development, management, maintenance and operation of a web site for each customer. During the last eighteen months, the Company has received orders for five statewide and three regional Impact\/ONLINE[tm] systems comprising over 1,500 libraries.\nThe Company's Impact\/ONLINE[tm] products include:\nImpact\/ONLINE WebPAC[tm] enables patrons, directly from home, school and office to search a database over the Internet using any Web Browser such as Netscape Navigator or Microsoft Explorer.\nImpact\/ONLINE ILL[tm] automates initiation, tracking and management of interlibrary borrowing and lending.\nImpact\/ONLINE CAT[tm] for creating and maintaining the bibliographic database.\nImpact\/NET[tm] for configuring, installing and managing Internet resources.\nImpact\/ACCESS[tm] for patron access to licensed commercial databases.\nImpact\/SLims[tm], a small library information management system, which operates on a personal computer and integrates patron access catalog, circulation control and inventory management.\nThe Company's software products and processing services continue to leverage technology and experience gained over more than 45 years of service to publishers most of whom continue to distribute information via print and CD- ROM media. Auto-Graphics provides standard and custom products and services for database management, electronic composition and CD-ROM search and retrieval. These software products include:\nSGML Smart Editor System(SES) provides publishers with full editorial capabilities to create and maintain data in SGML format.\nImpact[tm]\/CD-ROM is a system to provide search and retrieval capabilities for CD-ROMs.\nImpact[tm]\/SGML upgrades CD products to Windows and operates on SGML formatted data files.\nA specialized database service for the wholesale heating, ventilation, air conditioning and refrigeration(HVACR) industry is provided in conjunction with Datacat, Inc., which is 50 percent owned by Auto-Graphics. The Company is a supplier of software and production services to Datacat for HVACR parts catalogs. (See Note 1 of \"Notes to Financial Statements.\")\nCompany Background\nThe Company was formed in 1950 and incorporated in 1960 in the state of California. No single customer represents more than 10% of net sales. Management believes that the loss of any single customer or vendor would not have a material adverse effect on the business of the Company. Hardware sales are not material to the Company's business, representing less than 10% of sales, and are not considered important to the future of the Company.\nBacklog cannot be stated in a useful manner, as contracts are normally statements of specifications and unit prices rather than total sales volume.\nThe software and computerized database processing services business is highly competitive. There are no definitive market share statistics available. The Company first introduced computerized database services in 1964, and believes that it has been offering such services longer than any of its existing competitors. Many competitors are smaller and local in character, but some are larger and national with greater financial resources than the Company. Contracts for computerized database publishing services and the purchase\/lease of equipment are typically awarded according to the results of market pricing, competitive bidding, technical capability and past performance.\nMarketing Offices\/Employees\nThe Company has marketing representatives and service centers located in California, Connecticut, Illinois, Maryland, Massachusetts, Missouri, and New Jersey. The Company currently employs approximately 120 persons.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company leases its corporate office and production facilities constituting approximately 29,000 square feet located at 3201 Temple Avenue, Pomona, California 91768. The facility has been custom designed for the Company's purposes, is fully utilized and should be adequate for the Company's needs for the foreseeable future. The facility is currently leased to the Company through June 1996 under the first of two five-year renewal options. (See Note 6 of \"Notes to Financial Statements\" and Item 13. \"Certain Relationships and Related Transactions.\")\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\nThe Company's Common Stock ($.10 par value) is traded in the over-the-counter market under the symbol \"AUGR\" (Cusip Number 05272510). The quotations as published by the National Quotation Bureau, Inc. represent the highest and lowest bid and asked prices quoted by broker\/dealers making a market in the Company's Common Stock. Prices quoted do not include retail markup, markdown or commissions and may not reflect actual transactions in shares of the Company's stock.\nAs of December 31, 1995, the number of holders of record of the Company's Common Stock was 265. The Company has never paid a cash dividend and there are no plans to do so in the near future. (See Note 3 of \"Notes to Financial Statements\" for information as to the loan restriction on the payment of cash dividends.)\nNo cash dividends have been declared.\nITEM 7.","section_5":"","section_6":"","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND \t RESULTS OF OPERATIONS\nGeneral and Future Business Trends\nLiquidity and Capital Resources\nThe Company has a revolving credit agreement with a bank, under which borrowings are secured by accounts receivable, whereby the Company may borrow against its eligible accounts receivable up to a maximum of $1,000,000 ($1,000,000 available at December 31, 1995). Management believes that the current line of credit, which is renewed annually in May, will again be renewed in 1996, and is sufficient to handle cyclical working capital needs. (See Note 2 of \"Notes to Financial Statements.\")\nThe Company also has a capital line of credit agreement with the bank providing for maximum borrowings of $2,250,000 ($4,000 available at December 31, 1995). The capital line of credit may be used for the purchase of equipment and software, and financing of up to $500,000 in internal software development costs. The bank line of credit is renewed annually in May, and management believes that the current line of credit will again be renewed in 1996. Management does not currently believe that increased credit will be required to finance planned capital expenditures in 1996 which are estimated at $1,000,000, to be used to upgrade computers, production equipment and for software development. (See Note 3 of \"Notes to Financial Statements.\")\nIn 1993, the Company initiated several major new product (software) development programs. Estimated investments in the Company's SGML Smart Editor System and Impact[tm]\/SGML CD-ROM may exceed $500,000 and enhance competitiveness of the product with new features. In addition, the Company announced and initiated the development of the next generation of the Impact[tm] product line called Impact\/ONLINE[tm]. Impact\/ONLINE[tm] has been released and now includes modules for public access catalogs, online cataloging, interlibrary loan, and access via Internet to other databases. The estimated investment in Impact\/ONLINE[tm] may total $1,000,000. Funding for these investments is expected to be provided by a combination of internally generated funds, bank financing, and possibly additional outside capital investment.\nResults of Operations\n1995 net sales increased $394,000 to $9,559,000. The increase in sales was due to market acceptance of the Company's new products: SGML Smart Editor System, Impact[tm]\/SGML CD-ROM and Impact\/ONLINE[tm] products. Sales prices remained flat and in some cases declined due to competitive pressures in some markets. Gross margins continued to improve to 38.2% in 1995, up from 32.3% in 1994 due to the new products, continuing cost reduction measures and productivity gains. The Company's focus on improving marketing and sales resulted in higher selling expenses up $596,000 for additional sales management and sales personnel, promotional and administrative expenses. 1995 net income improved to $194,000 a 23% increase and earnings per share improved 39% to $0.16 due partially to stock repurchases. Working capital declined in 1995 due to higher accounts payable at year-end and higher than average customer deposits. Cash flow from operations improved to $1,623,000 in 1995, up 84% from $881,000 in 1994. Improvements in liquidity and reduced leverage are expected in 1996.\n1996 net sales revenues (excluding equipment) are expected to improve due to the Company's new products. The favorable mix of expected product sales, implemented cost reduction measures and productivity improvements should result in higher earnings and improved cash flow from operations in 1996.\nImpact of Inflation\nHistorical dollar accounting does not reflect changing costs for operations, the future cost for expansion and the changing purchasing power of the dollar. Inflation generally impacts the Company in a negative manner, as prices cannot be adjusted quickly due to the contract nature of the business, while costs of personnel, materials and other purchases tend to escalate more rapidly. However, inflation is not anticipated to have a material effect on the Company's business in the near future.\nAdopted and Pending Financial Accounting Standards\nIn March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, which the Company adopted beginning in 1995. The standard establishes principles of financial accounting and reporting for situations where information indicates that a company might be unable to recover, through future operations or sale, the carrying amount of long-lived assets, identifiable intangibles, and goodwill related to those assets. With the adoption of this Standard, the Company is required to review long-lived assets, identifiable intangibles, and related goodwill to determine whether any indicators of impairment are present and, if present to recognize an impairment loss based on the excess of the carrying amount of the assets over their fair market value. See Note 1 of \"Notes to Financial Statements.\"\n1995 as compared to 1994\nLiquidity and Capital Resources\nWorking capital decreased $429,000 in 1995. Accounts receivable decreased by $73,000. The average collection period for accounts receivable was unchanged at 70 days in 1995 and 1994. Long-term debt was increased by $210,000. The revolving credit line borrowings were zero in 1995 and 1994. Capital expenditures increased in 1995 to $1,559,000, up from $919,000 in 1994, an increase of 70%.\nResults of Operations\nNet Sales increased $394,000 or 4.3%.\nCost of Sales decreased $297,000 or 5%. Gross Margin increased from 32.3% in 1994 to 38.2% of net sales in 1995.\nSales, General & Administrative Expenses increased $596,000 or 23.6% in 1995 as a result of increased sales and marketing expense for additional sales personnel, new product promotions and a reorganization of the sales and marketing departments. As a percentage of sales, SG&A increased to 32.7% in 1995 from 27.6% in 1994.\nOther Income reflects interest income, royalties, and cost recovery from tenants for facilities and services provided by the Company.\nNet Interest Expense increased $30,000 or 16% in 1995 due to higher interest rates on higher average borrowings during the year.\nNet Income increased $36,000 from $158,000 in 1994 to $194,000 or 23% in 1995 and earnings per share increased to $0.16 per share in 1995 up from $0.12 per share in 1994, a 39% increase.\n1994 as compared to 1993\nLiquidity and Capital Resources\nWorking capital increased $324,000 in 1994. Accounts receivable increased by $182,000. The average collection period for accounts receivable was unchanged at 70 days in 1994 and 1993. Long-term debt increased by $104,000. The revolving credit line was reduced to zero in 1994 and 1993. Capital expenditures were $919,000 in 1994.\nResults of Operations\nNet Sales decreased $513,000 or 5.3%.\nCost of Sales decreased $725,000 or 10.5%. Gross Margin increased from 28.4% in 1993 to 32.3% of net sales in 1994.\nSales, General & Administrative Expenses increased $139,000 or 5.8% in 1994 as a result of the Company's increased focus on sales and marketing, and new product promotion. As a percentage of sales, SG&A increased to 27.6% in 1994 from 24.7% in 1993.\nOther Income reflects interest income, royalties, and cost recovery from tenants for facilities and services provided by the Company.\nNet Interest Expense declined $14,000 or 7% in 1994 due to lower average borrowings.\nNet Income increased $26,000 from $132,000 in 1993 to $158,000 or 20% in 1994 and earnings per share increased to $0.12 per share in 1994.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS\n\tREPORT OF INDEPENDENT AUDITORS\nThe Board of Directors and Stockholders Auto-Graphics, Inc.\nWe have audited the accompanying balance sheets of Auto-Graphics, Inc. as of December 31, 1995 and 1994, and the related statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1995. 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 Auto-Graphics, Inc. at December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\nERNST & YOUNG LLP\nRiverside, California March 12, 1996\n[FN] NOTES TO FINANCIAL STATEMENTS December 31, 1995, 1994, and 1993\n1. Summary of significant accounting policies and description of business.\nDescription of Business\nAuto-Graphics, Inc. provides software products and processing services to information and database publishers. These products and services are used to create, maintain and distribute information databases through printed and\/or electronic reference products. Electronic products include Compact Disc (CD- ROM) and Client\/Server software systems(Internet\/Web).\nUnbilled Production Costs\nCosts associated with work in process inventory including labor, materials, supplies, and overhead (excluding selling, general and administrative expenses) are stated at the lower of cost or net realizable value and are removed from inventory on an average unit cost basis.\nFinished Goods\nFinished goods inventory consists primarily of computer and CD-ROM equipment held for sale and related spare parts and is stated at the lower of average cost or market.\nEquipment and Leasehold Improvements\nDepreciation and Amortization\nDepreciation commences in the year the asset is placed in and\/or available for service or sale based on the half-year convention method. Depreciation is based on the straight-line method over the estimated useful life of the asset or revenue ratio method. Depreciation and amortization was $1,002,000 in 1995 ($961,000 in 1994 and $975,000 in 1993). The following estimated useful lives are generally observed for the respective asset categories:\nEquipment - 5 to 15 years Computer software - 5 to 7 years (see below) Furniture and fixtures - 5 to 10 years Leasehold improvements - the lesser of 5 to 15 years or the lease term\nCertain costs incurred related to the development and purchase of computer software are capitalized and amortized in accordance with Statement of Financial Accounting Standards No. 86. Amortization is based on a ratio of current and future revenues (the ratio method). In 1995, $964,000 was capitalized ($517,000 in 1994 and $284,000 in 1993), of which $124,000 was purchased software and $840,000 was the cost of internally developed software. Equipment and leasehold improvements include computer software with an unamortized balance of approximately $2,125,000 at December 31, 1995 and approximately $1,548,000 in 1994. Amortization of computer software was approximately $387,000 in 1995, $337,000 in 1994, and $284,000 in 1993.\nOther Assets\nInvestment in Datacat, Inc.\nIn 1990, the Company acquired a 50% interest in Datacat, Inc. Datacat was formed to market a new technology developed by the Company for the production of parts catalogs for the wholesale heating, ventilation and air conditioning, and refrigeration (HVACR) industry. The investment has been accounted for using the equity method wherein equity in the losses of Datacat have been offset against investments in and advances to Datacat and the balance reduced to zero. Losses in excess of investments and advances of approximately $125,000 have not been recognized and will be applied to subsequent earnings as they are realized. The Company has not guaranteed the obligations of Datacat, and is not presently obligated to provide any further financial support to Datacat beyond that already provided.\nPrepaid Database Assets\nCertain non-recurring incremental and direct production costs are incurred to initially implement new computerized databases for customers. These costs are associated with providing billable repetitive services and\/or projects for specific customers over contract periods exceeding one year. The costs are stated at the lower of cost or estimated net realizable value and are charged to cost of sales over the contract period which services will be provided, generally three to six years. Management believes it is probable that these costs will be recovered from related future revenues. The current portion of estimated Prepaid Database Assets ($69,000 in 1995, $69,000 in 1994, and $48,000 in 1993) is included in Unbilled Production Costs.\nLong-Lived Assets\nIn March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 121, Accounting for the Impairment of Long-Lived Assets, which the Company adopted beginning of 1995. The Standard requires the Company to review the carrying amount of long-lived assets, identifiable intangibles, and related goodwill to determine whether any indicators of impairment are present. At December 31, 1995 the Company's review of it's long-lived assets showed no indications of loss or impairment and, therefore, has not had a material effect on the Company's financial position or results of operations. \t Income Recognition\nRevenues are recognized as services are rendered or when finished goods are shipped to customers. Certain future software support costs are accrued in accordance with AICPA Statement of Position (SOP) 91-1. The financial statements are prepared using management estimates and assumptions in conformity with generally accepted accounting principles and AICPA Statement of Position (SOP) 94-6.\nNet Income Per Share\nPer share calculations are based on the weighted average number of shares of common stock outstanding during each year.\n2. Note Payable to Bank.\nThe Company has a revolving credit agreement under which borrowings are secured by accounts receivable, whereby the Company may borrow against its eligible accounts receivable up to a maximum of $1,000,000 ($1,000,000 available at December 31, 1995) with interest at .5% above the bank prime rate (9.0% at December 31, 1995). The credit facility is renewable annually in May. There was no outstanding balance at December 31, 1995 or December 31, 1994. During the year ended December 31, 1995, the approximate average borrowings outstanding were $241,000 ($386,000 in 1994), the approximate weighted average interest rate was 9.3% (7.9% in 1994, and the maximum amount of month-end borrowings outstanding was $675,000 ($700,000 in 1994). The averages were computed based on the borrowings outstanding and the applicable interest rate at the end of each month. There are no compensating balance requirements, commitment fees or note guarantors. This agreement contains the same loan covenants as the equipment line of credit note payable. At December 31, 1995, the Company was in compliance with its loan covenants.\n3. Long-term Debt.\nThe capital line of credit note payable at December 31, 1995 provides for maximum borrowings of $2,250,000 for the purchase of equipment and software, and financing of up to $500,000 in internal software development costs. The unused portion ($4,000 at December 31, 1995) of the capital line of credit is subject to renewal of the capital line of credit facility annually in May. Among other requirements, the capital line of credit note payable requires the Company to maintain minimum ratios of current assets to current liabilities, debt to equity and cash flow to debt service, minimum working capital and equity amounts, limits capital expenditures and capital lease obligations and prohibits the payment of cash dividends. There are no commitment fees, compensating balance requirements or note guarantors. At December 31, 1995, the Company was in compliance with its loan covenants.\nIn June, 1995, the Company entered into a stock repurchase agreement with a former employee and officer of the Company, whereby the Company agreed to purchase and retire, in 1995, 115,000 of 141,000 shares of Company stock owned by the stockholder. The total transaction cost of $230,000 will be paid in four annual installments beginning in 1995 plus interest of 5.5% per annum ($65,000 paid in June 1995, and $55,000 to be paid in June 1996, 1997 and 1998).\n4. Taxes Based on Income.\nInvestment tax credits are accounted for using the flow-through method. There was no investment tax credit carryforward available for tax purposes at December 31, 1995. Statutory federal income tax rates used are 34% in 1995, 1994 and 1993.\nIn December 1991, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes, which the Company adopted at the beginning of 1993. The Standard requires that the Company use the liability method of accounting for income taxes. Adopting the Standard has not had a material effect on the Company's financial position or results of operations.\n5. Commitments and Contingencies.\nThe Company incurred total facilities and equipment lease and rental expense of approximately $486,000 in 1995, $443,000 in 1994, and $449,000 in 1993. The Company is obligated under certain noncancellable operating leases for office facilities and equipment.\nApproximate minimum lease commitments (in thousands) are as follows:\n\t\t Operating Year Leases\n1996 $ 250 1997 26 1998 17\nTotal minimum lease payments $ 293\n6. Related Party Transactions.\nThe Company leases its corporate office and production facility from a limited partnership owned by two principal officer\/stockholders of the Company payable at $37,345 per month (plus expenses and applicable increases based on the consumer price index) through June 1996 under the first of two five-year renewal options. The five-year lease with options, which was entered into in June 1986, was approved and authorized by the independent members of the Company's Board of Directors. (See Item 13. \"Certain Relationships and Related Transactions.\")\nDuring 1995, the Company sold processing services of $529,000 to Datacat, Inc. for resale to Datacat's customers. At December 31, 1995, net accounts receivable from and advances to this affiliate totaled $73,000. (See Note 1 of \"Notes to Financial Statements.\")\nThe Company entered into a stock repurchase agreement with a former employee and officer of the Company, Douglas K. Bisch, whereby the Company agreed to purchase and retire, over a seven year period, 156,000 of 171,000 shares of Company stock owned by Mr. Bisch. The total transaction cost of $825,000 includes stock, non-competition and consulting fees. In January 1995, the Company purchased and retired the first block of 15,600 shares.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND \t 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 table sets forth the names and ages of, and the positions and offices within the Company presently held by, all directors and executive officers of the Company:\nName Age Position\nDouglas K. Bisch 74 Director. Has served in management capacities for \t\t\t\t more than ten years. Robert H. Bretz 52 Director and Assistant Secretary. Attorney who has \t\t\t\t acted as the Company's outside general \t\t\t\t legal counsel for more than ten years. Robert S. Cope 60 Director, President and Treasurer. Has served in \t\t\t\t those capacities for more than ten years.\nDirectors serve until their successors are elected and qualified at the annual meeting of stockholders. All executive officers serve at the discretion of the Company's Board of Directors.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nA definitive Proxy Statement will be filed with the Securities and Exchange Commission (\"the Commission\") pursuant to Regulation 14A within 120 days after the close of the Company's most recent calendar year and, accordingly, Item 11 is incorporated by reference to said definitive Proxy Statement. The Proxy Statement includes information covering this item under the caption \"Compensation of Executive Officers.\"\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nA definitive Proxy Statement will be filed with the Securities and Exchange Commission (\"the Commission\") pursuant to Regulation 14A within 120 days after the close of the Company's most recent calendar year and, accordingly, Item 12 is incorporated by reference to said definitive Proxy Statement. The Proxy Statement includes information covering this item under the caption \"Security Ownership of Certain Beneficial Owners and Management\" and \"Nominees for Election as Directors.\"\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nA definitive Proxy Statement will be filed with the Securities and Exchange Commission (\"the Commission\") pursuant to Regulation 14A within 120 days after the close of the Company's most recent calendar year and, accordingly, Item 13 is incorporated by reference to said definitive Proxy Statement. The Proxy Statement includes information covering this item under the caption \"Certain Relationships and Related Transactions.\"\n\tPART 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 and exhibits:\n(1) Financial Statements: See Item 8. \"Financial Statements.\"\n(2) All schedules are omitted since the required information is not present or not present in amounts sufficient to require submission of the schedule, or because the information required is included in the financial statements, including the notes thereto.\n(3) Exhibits:\n3.1 Articles of Incorporation of Auto-Graphics, Inc., as amended \t (incorporated by reference as filed with the SEC as Exhibit 3.1 to \t Item 14(a) in the registrant's Annual Report on Form 10-K for the \t fiscal year ended December 31, 1989).\n3.2 Bylaws, as amended (incorporated by reference as filed with the SEC \t as Exhibit 3.2 to Item 14(a) in the registrant's Annual Report on \t Form 10-K for the fiscal year ended December 31, 1989).\n10.1 Second Amended and Restated Revolving Credit Agreement, Accounts and \t Equipment, between THE BANK OF CALIFORNIA, N.A. and AUTO-GRAPHICS, \t INC. dated August 28, 1992 (incorporated by reference as filed with \t the SEC as Exhibit 10.1 to Item 14(a) in the registrant's Annual \t Report on Form 10-K for the fiscal year ended December 31, 1992).\n10.2 Equipment Revolving Note between THE BANK OF CALIFORNIA, N.A. and \t AUTO-GRAPHICS, INC. dated August 28, 1992 (incorporated by \t reference as filed with the SEC as Exhibit 10.2 to Item 14(a) in the \t registrant's Annual Report on Form 10-K for the fiscal year ended \t December 31, 1992).\n10.3 Revolving Credit Note between THE BANK OF CALIFORNIA, N.A. and \t AUTO-GRAPHICS, INC. dated June 13, 1994 (incorporated by reference \t as filed with the SEC as Exhibit 10.3 to Item 14(a) in the \t registrant's Annual Report on Form 10-K for the fiscal year ended \t December 31, 1994).\n10.4 Security Agreement (Accounts) between THE BANK OF CALIFORNIA, N.A. \t and AUTO-GRAPHICS, INC. dated June 13, 1994 (incorporated by \t reference as filed with the SEC as Exhibit 10.4 to Item 14(a) in \t the registrant's Annual Report on Form 10-K for the fiscal year \t ended December 31, 1994).\n10.5 Amendment to Second Amended and Restated Revolving Credit Agreement, \t Accounts and Inventory, between THE BANK OF CALIFORNIA, N.A. and \t AUTO-GRAPHICS, INC. dated January 27, 1995.\n10.6 Modification to Equipment Revolving Note between THE BANK OF \t CALIFORNIA, N.A. and AUTO-GRAPHICS, INC. dated June 13, 1994 \t (incorporated by reference as filed with the SEC as Exhibit 10.6 to \t Item 14(a) in the registrant's Annual Report on Form 10-K for the \t fiscal year ended December 31, 1994).\n10.7 Agreement between Gannam\/Kubat Publishing, Inc. and Auto-Graphics, \t Inc. regarding Datacat, Inc. dated June 12, 1990 (incorporated by \t reference as filed with the SEC as Exhibit 10.6 to Item 14(a) in the \t registrant's Annual Report on Form 10-K for the fiscal year ended \t December 31, 1990).\n10.8 Lease Agreement between 664 Company and Auto-Graphics, Inc. dated \t May 27, 1986 (incorporated by reference as filed with the SEC as \t Exhibit 10.7 to Item 14(a) in the registrant's Annual Report on Form \t 10-K for the fiscal year ended December 31, 1990).\n10.9 Agreement by, between and among Auto-Graphics, Inc. and Douglas K. \t and Ruth T. Bisch executed February 15, 1995 (incorporated by \t reference as filed with the SEC as Exhibit 10.9 to Item 14(a) in the \t registrant's Annual Report on Form 10-K for the fiscal year ended \t December 31, 1994).\n10.10 Amendment to Second Amended and Restated Revolving Credit Agreement, \t Accounts and Inventory, between THE BANK OF CALIFORNIA, N.A. and \t AUTO-GRAPHICS, INC. dated June 9, 1995.\n10.11 Amendment to Second Amended and Restated Revolving Credit Agreement, \t Accounts and Inventory, between THE BANK OF CALIFORNIA, N.A. and \t AUTO-GRAPHICS, INC. dated July 3, 1995.\n10.12 Amendment to Second Amended and Restated Revolving Credit Agreement, \t Accounts and Inventory, between THE BANK OF CALIFORNIA, N.A. and \t AUTO-GRAPHICS, INC. dated September 30, 1995.\n10.13 Stock Purchase Agreement by, between and among Auto-Graphics, Inc. \t and Cary A. and Geri W. Marshall executed June 13, 1995.\n(b) The Company has not filed any reports on Form 8-K during the last quarter of the period covered by this Report.\n(c) The following document is filed herewith for information purposes, but is not part of this Annual Report, except as otherwise indicated: None.\n(d) 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.\nAUTO-GRAPHICS, INC. (Registrant)\nDate: 3\/25\/95 By ss\/ Robert S. Cope \t\t\t Robert S. Cope, President, Treasurer \t\t\t 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 capacity and on the dates indicated.\nDate: 3\/25\/95 By ss\/ Robert S. Cope \t\t\t Robert S. Cope, President, Treasurer \t\t\t and Director\nDate: 3\/25\/95 By ss\/ Daniel E. Luebben \t\t\t Daniel E. Luebben, Secretary and \t\t\t Chief Financial Officer\nDate: 3\/25\/95 By ss\/ Robert H. Bretz \t\t\t Robert H. Bretz, Director","section_15":""}
{"filename":"49573_1995.txt","cik":"49573","year":"1995","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 1994, Pepsi General became an international company when it began operations in a newly franchised area of northern and western Poland. This market, when fully developed, will serve approximately 18 million people. In 1995, approximately 86 percent of Pepsi General's domestic 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 Tea and others account for the remaining 14 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 one-quarter 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 1,250 routes domestically and 204 in Poland. 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 1995, Pepsi General continued to expand its product line by adding several new flavors to its Ocean Spray juice and the Lipton Tea lines. Increased marketing efforts in several of the recent product additions, such as the Slice flavors, Wild Cherry Pepsi, Caffeine Free Mountain Dew, All Sport and Big Red, produced a sales increase of 41 percent in 1995 for these products. In July, 1995, Pepsi General acquired the assets of the Cedar Rapids, Iowa franchise, which increased case sales by 0.8 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. The inability of these suppliers to deliver concentrate or other products to Pepsi General could adversely affect operating results significantly. 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 60 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 few years in Poland. Pepsi General expects to incur operating losses over the next two or three years as this new venture is developed, but does not expect that such losses will be material to the consolidated operating results of Whitman. In 1995, its first full year of operations, Pepsi General's Poland operations sold 8.8 million cases of product from ten distribution facilities.\nMIDAS\nMidas provides automotive exhaust, brake and suspension services through approximately 2,600 franchised and company-owned Midas shops in the United States, Canada, France, Belgium, Austria, Switzerland, Spain, Italy, Australia, New Zealand, Taiwan, 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 automotive 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 heating, ventilating and air conditioning (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 1995, 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. In Mexico, Hussmann 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. During 1995, Hussmann expanded its operations in South America with an acquisition of a 75 percent interest in a small manufacturer in Chile. 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 two manufacturing plants and a network of sales, service, and installation depots located throughout the country. Hussmann's branch service and distribution network in the United Kingdom is believed to be 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 and has a 55 percent interest in the Luoyang Refrigeration Machinery Factory, China's leading producer of refrigeration systems and food display cases. The joint venture began 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 PROTOCOL(tm), a unique refrigeration system which is chloroflourocarbon (CFC) and hydrochloroflourocarbon (HCFC) free, and less expensive to install and operate than conventional systems. Hussmann had exclusive use of the PROTOCOL(tm) compressor technology through 1994; however, the loss of exclusivity has not significantly affected Hussmann's business in 1995. One of Hussmann's strengths is its research and development center, where the PROTOCOL(tm) 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 new generations of cases and systems. The dollar amount of firm backlog at December 31, 1995 was $173.0 million, compared with $136.2 million at December 31, 1994. Substantially all such backlog is expected to be shipped 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 16,841 persons worldwide as of December 31, 1995. 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 million. In January, 1996, Pneumo Abex executed a Consent Decree with the EPA agreeing to implement remediation of areas associated with the former Portsmouth facility operations. Pneumo Abex and Whitman have brought suit against other PRPs previously identified by the EPA which did not execute the Consent Decree. Whitman management is optimistic that the cost of implementation of the remedy required by the Consent Decree will be less than the estimated cost set forth in the Amended ROD, and that a portion of the remediation costs will be allocated to other PRPs, most of whom are financially viable. 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-Kelly 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 or the results of operations.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES.\nPepsi General's facilities include seven bottling plants, three combination bottling\/canning plants, three canning plants and 68 distribution facilities, including ten distribution facilities in Poland. Approximately 15 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 five warehouses in Canada, of which two are owned and 16 are leased. At December 31, 1995, Midas operated 142 Midas Muffler Shops in the United States, 32 Midas Muffler Shops in Canada and 188 Midas Muffler Shops in seven other foreign countries. Hussmann operates 11 owned and 9 leased manufacturing facilities in the United States, Canada, Mexico, China, Chile and the United Kingdom. There are 5 owned and 44 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, in the opinion of management, are expected to have a material adverse effect on Whitman's results of operations or financial condition. 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 1995 and 1994.\nCommon ---------------------------- High Low Dividend -------- -------- -------- 1995: 1st quarter $ 19.375 $ 15.625 $ 0.085 2nd quarter 19.375 17.500 0.095 3rd quarter 21.625 18.625 0.095 4th quarter 23.375 20.125 0.095 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\nThere were 19,302 shareholders of record at December 31, 1995.\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 Company's cash flow from continuing operations remained strong, although declining by $18.3 million in 1995 to $193.3 million. The reduction was principally a result of increased levels of working capital (defined as receivables and inventories, less accounts payable), principally reflecting increased levels of business. The cash used in discontinued operations principally reflected expenses related to settlement of certain legal claims as well as environmental expenses of previously sold subsidiaries. In 1995, the Company continued to invest for its future growth and productivity. Capital spending on new plant and equipment expanded sharply to $174.8 million, up 37.2 percent over 1994 and nearly double such expenditures in 1993. In addition, the Company spent over $60 million to acquire three companies and several Midas shops, including the Pepsi-Cola franchise in Cedar Rapids, Iowa in July, 1995. The Company also invested $18.6 million in Pepsi General's joint manufacturing facility in Poland. Capital spending in 1996 is expected to remain near 1995 expenditure levels. Purchases of and proceeds from sale of investments principally related to the Company's insurance subsidiary, which provides certain levels of insurance for Whitman's various operating companies. Funds provided by the operating companies are invested by the insurance subsidiary and proceeds from sales are used by the insurance subsidiary to pay insurable claims. A substantial portion, however, of the purchases and sales of such investments represent reinvestment of assets as such investments mature. Changes in the amount of net purchases was not considered significant. As a result of spending over $250 million in capital investment and new companies and joint ventures, the Company increased its net borrowings in 1995 by $105.6 million. The Company issued $278.4 million of long-term debt (see Note 4), which was used partially to pay off $147.8 million of debt which came due in 1995. The Company purchased 1,034,726 shares of its common stock at a cost of $18.8 million and the Company received $12.8 million from the exercise of 995,944 stock options during 1995. The increase in common dividends reflected the increase in the quarterly rate from $.085 to $.095 per share, effective with the July 1, 1995 regular dividend. In spite of the sharp increase in capital spending, and investments in new companies and joint ventures, the Company's financial condition remained strong, principally reflecting the strong operating cash flow. At December 31, 1995, the Company had $300 million available under a contractual revolving credit facility and a $200 million commercial paper program, of which $185 million was available. The Company has $121.7 million of debt, including $15 million of debt under the commercial paper program, that comes due in 1996. The Company expects to use a portion of its anticipated free cash flow to reduce its debt and to refinance the remainder through use of its revolving credit agreements or its commercial paper program, or through issuance of additional debt as market conditions warrant. The Company believes that with its strong free cash flow, the 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. 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:\n1995 compared with 1994\nFor a description of the Company's major products and services and its principal markets, reference is made to Part I, Item 1, Business, and to Note 12, Segment Reporting, to the Consolidated Financial Statements. Sales and revenues increased by $287.7 million, or 10.8%, in 1995 to a total of $2,946.5 million. Pepsi General's revenues increased by $192.6 million in 1995, a 15.3 percent increase over 1994. Included were $34.8 million of revenues from the Pepsi General operations in Poland, compared with only $0.8 million in 1994, which reflected the start-up of such operations in late 1994. Unit case volume (which represents approximately 88 percent of total domestic sales) in the U.S. increased by 5.6 percent over 1994, including 0.8 percent from the Cedar Rapids, Iowa franchise which was purchased in July, 1995. The remaining increase in domestic unit volume was principally in the core Pepsi brands. The average net selling price per case increased by approximately 6 percent in 1995, as Pepsi General attempted to recover substantial increases in product and packaging costs. Midas' revenues increased by $32.9 million in 1995, up 6.1 percent, to $576.1 million. Approximately two-thirds of the increase came from Midas' European operations, where approximately one-half of the increase was attributable to higher exchange rates. The higher foreign revenues also reflected an increase in the number of company-owned shops, as Midas continues its shop expansion program in Europe. U.S. revenues increased by 2.7 percent, and reflected increased revenues from company-owned shops, higher product sales, and increased royalty and rent-related revenues. Hussmann's revenues increased by $62.2 million in 1995, a 7.2 percent increase, to $921.7 million. The increase in sales was principally in Hussmann's North American operations, reflecting improved demand for its product lines. Included in these sales were $33.6 million of revenues of companies acquired during the year, but this increase was offset by lower revenues (down $38.7 million) from Hussmann's Mexican operations. The reduction in Mexico reflected both the devaluation of the peso and the sharp decline in the Mexican economy. The Company's gross profit margin declined from 35.9 percent in 1994 to 34.8 percent in 1995. This unfavorable variance was principally caused by higher product and packaging costs (primarily aluminum can costs, which increased by approximately 25 percent) at Pepsi General. In addition, Hussmann experienced some margin reductions, reflecting continuing competitive pricing pressure and changes in sales mix. Midas' margins improved modestly. Selling, general and administrative (S,G&A) expenses increased by $54.3 million in 1995, or 8.9 percent, compared with the 10.8 percent increase in sales. As a result, S,G&A expenses, as a percentage of sales, declined to 22.5 percent in 1995, down from 22.9 percent in 1994. Pepsi General's and Hussmann's S,G&A expenses grew at rates less than their respective revenue growth, while Midas' expenses grew at a faster percentage than revenues, principally in Europe where the increase reflected, among other items, the effects of higher exchange rates as well as an increase in the number of company-owned shops. Amortization expense increased slightly in 1995, principally reflecting goodwill associated with recent acquisitions. Operating income increased by 4.7 percent to $342.3 million in 1995, compared with a 10.8 percent increase in revenues. Operating margins, as a percent of sales, declined to 11.6 percent in 1995, down from 12.3 percent in 1994. Pepsi General's operating income amounted to $197.7 million in 1995, $12.2 million, or 6.6 percent, above last year's performance. Included in the results were operating losses of $11.3 million in Poland, principally representing start-up costs, compared with operating losses of $2.7 million in 1994. The increase in operating earnings in the U.S. principally reflected the benefits of the improved volumes and higher prices. Pepsi General's margins, however, were affected adversely by the sharp increase in aluminum can costs. Midas' operating earnings totaled a record $82.5 million, and exceeded last year's performance by $7.3 million, or 9.7 percent. The improved performance was principally in their U.S. operations and reflected the benefits of higher product shipments, as well as higher royalty and rental revenues. Midas' foreign operating results increased modestly, reflecting improved results in France, Spain and Australia, offset by additional start- up expenses as Midas continues to expand its company-owned shop network in Europe. The operating results at Hussmann were down $3.8 million, or 4.6 percent, to $78.7 million in 1995. Operating earnings in Mexico were $12.4 million below 1994, reflecting the peso devaluation and the deterioration of economic conditions in Mexico. Excluding Mexico, North American operating results were up 12.5 percent over 1994, reflecting the benefits of higher volumes. Acquisitions in China, Chile and the U.K. contributed approximately $2 million to operating earnings in 1995. Interest expense increased by $3.5 million in 1995, principally reflecting higher debt levels. Interest income was unchanged, as the amounts of invested funds did not change significantly during the year. Other expense, net declined from $25.2 million in 1994 to $14.4 million in 1995. The change primarily related to modest gains on asset dispositions in 1995, compared with losses on similar transactions in 1994. There were no gains or losses that were individually significant. Foreign currency gains also were not significant.\n1994 compared with 1993\nSales and revenues increased by $129.1 million to $2,658.8 million in 1994, a 5.1 percent increase over 1993. 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 Tea 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 (3.0%) 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.\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, 1996, filed pursuant to Section 14 (a) of the Securities Exchange Act of 1934, as amended. The executive officers of Whitman and their ages as of March 1,1996 were as follows:\nAge Position ----- ------------------------------------------ Bruce S. Chelberg 61 Chairman and Chief Executive Officer Thomas L. Bindley 52 Executive Vice President Frank T. Westover 57 Senior Vice President-Controller Lawrence J. Pilon 47 Senior Vice President-Human Resources Gerald A. McGuire 64 Corporate Vice President; President and Chief Executive Officer, Pepsi-Cola General Bottlers, Inc. John R. Moore 60 Corporate Vice President; President and Chief Executive Officer, Midas International Corporation J. Larry Vowell 55 Corporate Vice President; President and Chief Executive Officer, Hussmann Corporation Charles H. Connolly 61 Vice President-Corporate Affairs and Investor Relations William B. Moore 54 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.\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, 1996, 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, 1996, 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, 1995, 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, 1995.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on the 22nd day of March, 1996.\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, 1996.\nSignature Title --------- -----\n* Bruce S. Chelberg Chairman and Chief Executive Officer and ---------------------- 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* Herbert M. Baum Director ---------------------- HERBERT M. BAUM\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 Director March 22, 1996 ---------------------- PIERRE S. du PONT\n* Archie R. Dykes Director ---------------------- ARCHIE R. DYKES\n---------------------- Director 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\nFINANCIAL INFORMATION\nFOR INCLUSION IN ANNUAL REPORT ON FORM 10-K\nFISCAL YEAR ENDED DECEMBER 31, 1995\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, 1995, 1994 and 1993\nConsolidated Balance Sheets at December 31, 1995 and December 31, 1994\nConsolidated Statements of Cash Flows for the years ended December 31, 1995, 1994 and 1993\nConsolidated Statements of Shareholders' Equity for the years ended December 31, 1995, 1994 and 1993\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. Actual results could differ from these estimates. 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, 1995 and 1994, 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, 1995. 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, 1995 and 1994, and the results of their operations and their cash flows for each of the years in the three- year period ended December 31, 1995 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 15, 1996\nWhitman Corporation and Subsidiaries CONSOLIDATED STATEMENTS OF INCOME For the years ended December 31 (in millions)\n1995 1994 1993 -------- -------- --------\nSales and revenues $2,946.5 $2,658.8 $2,529.7 Cost of goods sold 1,921.3 1,704.7 1,625.0 -------- -------- -------- Gross profit 1,025.2 954.1 904.7 Selling, general and administrative expenses 664.1 609.8 582.3 Amortization expense 18.8 17.5 17.1 -------- -------- -------- Operating income 342.3 326.8 305.3 Interest expense (74.6) (71.1) (96.2) Interest income 6.4 6.4 12.8 Other expense, net (14.4) (25.2) (9.7) Unrealized investment loss -- (24.2) -- -------- -------- -------- Income before income taxes 259.7 212.7 212.2 Income tax provision 107.4 88.1 90.7 -------- -------- -------- Income from continuing operations before minority interest 152.3 124.6 121.5 Minority interest 18.8 18.2 15.1 -------- -------- -------- Income from continuing operations 133.5 106.4 106.4 Loss from discontinued operations after taxes (Note 2) -- (3.2) -- 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 $ 133.5 $ 103.2 $ 78.2 ======== ======== ======== Average number of common shares outstanding 106.2 106.2 107.5 ======== ======== ======== INCOME (LOSS) PER COMMON SHARE (IN DOLLARS): Continuing operations $ 1.26 $ 1.00 $ 0.99 Discontinued operations -- (0.03) -- Extraordinary loss on early debt retirement -- -- (0.04) Cumulative effect of change in accounting principle -- -- (0.22) -------- -------- -------- Net income $ 1.26 $ 0.97 $ 0.73 ======== ======== ======== Cash dividends per common share $ 0.37 $ 0.33 $ 0.29 ======== ======== ========\nThe following notes are an integral part of these statements.\nWhitman Corporation and Subsidiaries CONSOLIDATED BALANCE SHEETS As of December 31 (in millions) 1995 1994 -------- -------- ASSETS: Current assets: Cash and cash equivalents $ 53.3 $ 71.3 Receivables - net of allowance for doubtful accounts of $5.7 million in 1995 and $7.9 million in 1994 378.5 362.5 Inventories: Raw materials and supplies 84.5 73.8 Work in process 48.1 41.2 Finished goods 134.5 118.6 -------- -------- Total inventories 267.1 233.6 Other current assets 62.2 40.3 -------- -------- Total current assets 761.1 707.7 Investments 253.7 222.6 Property (at cost): Land 71.2 63.5 Buildings and improvements 340.0 308.4 Machinery and equipment 945.6 833.3 -------- -------- Total property 1,356.8 1,205.2 Accumulated depreciation and amortization (659.3) (591.4) -------- -------- Net property 697.5 613.8 Intangible assets, net of accumulated amortization of $143.7 million in 1995 and $123.6 million in 1994 568.8 524.3 Other assets 82.2 67.0 -------- -------- Total assets $2,363.3 $2,135.4 ======== ========\nThe following notes are an integral part of these statements.\nWhitman Corporation and Subsidiaries CONSOLIDATED BALANCE SHEETS As of December 31 (in millions) 1995 1994 -------- -------- LIABILITIES AND SHAREHOLDERS' EQUITY: Current liabilities: Short-term debt, including current maturities of long-term debt $ 93.8 $ 90.0 Accounts and dividends payable 248.6 238.7 Income taxes payable 9.2 10.6 Accrued expenses: Salaries and wages 46.4 40.2 Interest 21.2 26.6 Other expenses 88.4 77.0 -------- -------- Total current liabilities 507.6 483.1 Long-term debt 828.2 723.0 Deferred income taxes 33.4 15.6 Other liabilities 141.0 154.9 Minority interest 225.3 206.2 Shareholders' equity: Common stock (no par, 250.0 million shares authorized; 105.2 million outstanding at December 31, 1995 and 105.0 million outstanding at December 31, 1994) 427.8 413.2 Retained income 336.6 239.9 Cumulative translation adjustment (80.3) (51.8) Unrealized investment gain 9.7 1.3 Treasury stock (66.0) (50.0) -------- -------- Total shareholders' equity 627.8 552.6 -------- -------- Total liabilities and shareholders' equity $2,363.3 $2,135.4 ======== ========\nThe following notes are an integral part of these statements.\nWhitman Corporation and Subsidiaries CONSOLIDATED STATEMENTS OF CASH FLOWS For the years ended December 31 (in millions) 1995 1994 1993 ------ ------ ------ CASH FLOWS FROM OPERATING ACTIVITIES: Income from continuing operations $133.5 $ 106.4 $106.4 Adjustments to reconcile to net cash provided by operating activities: Depreciation and amortization 108.3 98.0 95.5 Unrealized investment loss -- 24.2 -- Other 11.6 23.9 24.0 Changes in assets and liabilities, net of acquisitions and dispositions: Increase in receivables (21.9) (11.7) (43.2) Increase in inventories (35.1) (10.3) (7.1) Increase in payables 17.5 5.7 21.8 Net change in other assets and liabilities (20.6) (24.6) 15.9 ------ ------ ------ Net cash provided by continuing operations 193.3 211.6 213.3 Net cash used by discontinued operations (19.7) (5.8) (29.8) ------ ------ ------ Net cash provided by operating activities 173.6 205.8 183.5 ------ ------ ------ CASH FLOWS FROM INVESTING ACTIVITIES: Capital investments (174.8) (127.4) (88.7) Proceeds from sales of property 12.5 18.2 14.3 Companies acquired, net of cash acquired (60.5) -- -- Investments in joint ventures (18.6) (4.5) -- Purchases of investments (221.4) (168.8) (211.2) Proceeds from sales of investments 213.4 156.9 180.2 ------ ------ ------ Net cash used in investing activities (249.4) (125.6) (105.4) ------ ------ ------ CASH FLOWS FROM FINANCING ACTIVITIES: Net borrowings from (repayment of) bank lines of credit and commercial paper (27.5) (41.1) 83.6 Proceeds from issuance of long-term debt 278.4 231.9 263.3 Repayment of long-term debt (147.8) (221.1) (430.8) Net increase in short-term debt 2.5 -- -- Issuance of common stock 12.8 6.0 2.2 Treasury stock purchases (18.8) (42.5) (3.9) Common dividends (38.8) (34.8) (31.1) ------ ------ ------ Net cash provided by (used in) financing activities 60.8 (101.6) (116.7) ------ ------ ------ Effects of exchange rate changes on cash and cash equivalents (3.0) (0.3) (0.9) ------ ------ ------ Change in cash and cash equivalents (18.0) (21.7) (39.5) Cash and cash equivalents at beginning of year 71.3 93.0 132.5 ------ ------ ------ Cash and cash equivalents at end of year $ 53.3 $ 71.3 $ 93.0 ====== ====== ======\nThe following notes are an integral part of these statements.\nWhitman Corporation and Subsidiaries CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY\nThe following notes are an integral part of these statements.\nWhitman Corporation and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SIGNIFICANT 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, on at least an annual basis, the carrying value of its goodwill by reviewing undiscounted cash flows by operating units. If the sum of the projected undiscounted cash flows over the remaining lives of the related assets does not exceed the carrying value of the related goodwill, goodwill would be adjusted for the difference between the fair value and the carrying value of such goodwill. The Company does not believe there has been any material impairment 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 $46.8 million ($29.9 million after tax) 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 (IRS), which included some large potential claims for issues related to previously discontinued operations. As a result of these settlements, the Company has restored $26.7 million to income for 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) 1995 1994 1993 ------ ------ ------ Current: Federal $ 72.6 $ 82.1 $ 63.1 Foreign 11.8 16.3 14.0 State and local 10.0 13.6 10.6 ------ ------ ------ Total current 94.4 112.0 87.7 ====== ====== ====== Deferred: Federal 9.7 (21.4) 3.2 Foreign 0.4 (1.6) 1.4 State and local 2.9 (0.9) (1.6) ------ ------ ------ Total deferred 13.0 (23.9) 3.0 ------ ------ ------ Income tax provision $107.4 $ 88.1 $ 90.7 ====== ====== ======\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:\n1995 1994 1993 -------------- ------------- ------------- (dollars in millions) Amount % Amount % Amount % ------- ----- ------- ----- ------- ----- Income tax expense computed at statutory rate $ 90.9 35.0 $ 74.4 35.0 $ 74.3 35.0 State income taxes, net of federal income tax benefit 8.4 3.2 8.3 3.9 5.9 2.8 Higher foreign effective tax rates 5.8 2.2 4.1 1.9 5.2 2.4 Goodwill amortization 5.2 2.0 5.1 2.4 4.7 2.2 Other items, net (2.9) (1.0) (3.8) (1.8) 0.6 0.3 ------ ----- ------ ----- ------ ----- Income tax provision $ 107.4 41.4 $ 88.1 41.4 $ 90.7 42.7 ====== ===== ====== ===== ====== =====\nPretax income from foreign operations amounted to $18.9 million, $31.6 million, and $30.7 million in 1995, 1994 and 1993, respectively. U.S. income taxes have not been provided on the undistributed income ($105.2 million) of the Company's foreign subsidiaries which currently is not intended to be remitted to the U.S. The IRS 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 were 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 in 1994 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) 1995 1994 ------- ------- Deferred tax assets: Provision for closed and sold businesses $ 33.9 $ 39.9 Lease transactions 17.8 19.3 Self-insurance provisions 18.6 16.3 Postretirement benefit accruals 11.9 12.4 Other 36.3 41.6 ------- ------- Total deferred tax assets 118.5 129.5 ------- ------- Deferred tax liabilities: Property, plant and equipment 71.0 68.2 Pensions 8.8 8.7 Intangibles 9.2 7.5 Other 50.5 48.6 ------- ------- Total deferred tax liabilities 139.5 133.0 ------- ------- Net deferred tax liability $ 21.0 $ 3.5 ======= ======= Net deferred tax liability (asset) included in: \"Other current assets\" $ (12.4) $ (12.1) \"Deferred income taxes\" 33.4 15.6 ------- ------- Net deferred tax liability $ 21.0 $ 3.5 ======= =======\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.\n4. DEBT\nDebt at December 31 consisted of the following:\n(in millions) 1995 1994 ------- ------- 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 100.0 100.0 7.6% notes due 2015 100.0 -- 8.3% notes due 2007 100.0 -- 7.5% notes due 2001 75.0 75.0 Notes due 1996, effective interest rate 6.3% 70.0 70.0 8.1% notes due 1997 50.5 -- Notes due 1998, effective interest rate 6.7% 40.0 40.0 Term loan agreements and note due 1996 through 2000, effective interest rates 6.1% to 8.3% 85.0 104.9 Swiss franc bonds and notes due 1995, exchanged for U.S. dollar liabilities at 12.4% -- 50.0 Canadian notes due 1995, exchanged for U.S. dollar liabilities at 12.2% -- 38.1 Commercial paper and revolving credit borrowings due 1996, effective interest rate 6.2% 15.0 42.5 Obligations under capital leases 17.4 17.7 Other 12.3 15.6 ------- ------- Total debt 926.7 815.3 Less: Amount due within one year 93.8 90.0 Unamortized discount 4.7 2.3 ------- ------- Total long-term debt $ 828.2 $ 723.0 ======= =======\nThe Company maintains a $200 million commercial paper program and had $15 million and $30 million of commercial paper outstanding under this program at December 31, 1995 and 1994, 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 2000. There were no borrowings under the revolving credit facility at December 31, 1995, while there were borrowings of $12.5 million under such commitments at December 31, 1994. The fees payable on the unused portion of such commitments are not significant. At December 31, 1995, the entire $300 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) maturing in 1997 through 2000, are: $66.9 million, $41.4 million, $11.2 million, and $106.7 million, respectively. At December 31, 1995, $27.9 million of the currently maturing notes have been reclassified 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 $1.6 million, $1.9 million and $2.1 million for 1995, 1994 and 1993, respectively, relating to liabilities under capital lease agreements. Interest capitalized during periods of construction was not significant. At December 31, 1995, collateral of $40.4 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 and forward rate contracts 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. During 1995, the Company also entered into several forward rate agreements. The agreements outstanding at December 31, 1995 are summarized as follows:\nEffective Notional Effective Interest Related Debt Issue - Amount Maturity Interest Rate Financial Instrument: (in millions) of Swaps Rate Paid Received ---------- ---------- ---------- ---------\n7.5% notes due 2003 - Interest rate swap $ 125.0 1996 5.5% 5.2%\n6.5% notes due 2006 - Interest rate swap $ 40.0 1997 5.5% 5.2%\n7.5% notes due 2003 - Forward rate agreement $ 125.0 1996 6.1% 5.9%\n6.5% notes due 2006 - Forward rate agreement $ 40.0 1996 6.2% 5.9%\nThe notional amounts related to the Company's interest rate swap transactions and forward rate agreement activity for 1994 and 1995 are summarized as follows (in millions):\nInterest Rate Forward Rate Swaps Agreements ------------------ ------------------ Pay Pay Pay Pay Fixed Variable Fixed Variable ------ -------- ------ --------\nBalance, January 1, 1994 $ 65.0 $125.0 $ -- $ -- ------ ------ ------ ------ New contracts -- 40.0 -- -- Expired contracts (65.0) -- -- -- ------ ------ ------ ------ Balance, December 31, 1994 -- 165.0 -- -- ------ ------ ------ ------ New contracts -- -- 225.0 -- Expired contracts -- -- (60.0) -- ------ ------ ------ ------ Balance, December 31, 1995 $ -- $165.0 $165.0 $ -- ====== ====== ====== ======\nWhitman's interest rate hedging programs increased the annual weighted average cost of debt from 8.2 percent to 8.3 percent in 1995, from 8.7 percent to 9.0 percent in 1994 and from 8.8 percent to 9.3 percent in 1993. Interest expense was increased by $1.5 million in 1995, $2.1 million in 1994 and $5.4 million in 1993 as a result of these hedging programs. The Company also had 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 outstanding at December 31, 1994, and its related interest payments had been hedged in U.S. dollars. Under the hedge agreements, in January, 1995, the Company repaid the 138.2 million Swiss franc debt at an effective exchange rate of 2.764 Swiss francs per U.S. dollar ($50.0 million), compared to the actual exchange rate of 1.288 Swiss francs per U.S. dollar ($107.3 million). Additionally, in February, 1995, the Company repaid 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 the actual 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 less than $0.1 million in 1995, and by $0.3 million and $7.0 million in 1994 and 1993, respectively. Consequently, the impact of hedging had no material effect on the weighted average cost of borrowing in 1995 or 1994, and would have lowered the weighted average cost of borrowing to 8.6 percent from 9.3 percent in 1993. At December 31, 1995, the Company had $123.9 million in floating rate debt exposure (including notional principal on interest rate swap agreements). Substantially all of the floating rate exposure is related to six month LIBOR rates. If the six month LIBOR rates increased by 50 basis points (0.50 percent), the Company's 1995 interest expense related to the floating rate debt outstanding during 1995 would have increased by an additional $1.0 million. In addition, the Company had no borrowings outstanding under its revolving credit facility and $15 million in commercial paper outstanding at December 31, 1995. The relevant indices for revolving credit and commercial paper borrowings are generally one month LIBOR and the commercial paper composite rate. If these rates increased by 50 basis points, the Company's 1995 interest expense would have increased by $0.2 million, based upon the weighted average outstanding revolving credit and commercial paper borrowings. 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 agreements. 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 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 floating rate debt as of December 31, 1995 approximated its carrying value. The fixed rate debt of the Company had a carrying value of $802.8 million and a fair market value of $848.3 million at December 31, 1995. The fair market value of the fixed rate debt was based on quotes from financial institutions for instruments with similar characteristics and upon discounting future cash flows. The fair market value owed by the Company related to its derivative instruments, which was based on quotes from financial institutions for instruments with similar characteristics, was $0.2 million at December 31, 1995.\n6. PENSION AND OTHER POSTRETIREMENT PLANS\nCOMPANY SPONSORED DEFINED BENEFIT PENSION PLANS. Substantially all of the Company's U.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 1995, 1994 and 1993 included the following components:\n(in millions) 1995 1994 1993 ------- ------- ------- Service cost - benefits earned during period $ 7.7 $ 7.5 $ 7.7 Interest cost on projected benefit obligation 17.9 16.4 16.4 Actual return on assets (37.8) (6.3) (28.0) Net amortization and deferral 18.4 (12.2) 10.2 ------ ------ ------- Total net periodic pension cost $ 6.2 $ 5.4 $ 6.3 ====== ====== =======\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:\n1995 1994 1993 ------- ------- ------- Discount rate 8.5% 7.0% 7.5% Expected long-term rate of return on assets 9.5% 10.0% 10.0% Rates of increase in compensation levels 6.0% 4.5% 5.0%\nThe following table reconciles the pension plans' funded status to the amounts recognized in the Company's balance sheets as of December 31, 1995 and 1994:\n1995 1994 ------------------------ ---------------------- Assets Accumulated Assets Accumulated Exceed Benefits Exceed Benefits Accumulated Exceed Accumulated Exceed Benefits Assets Benefits Assets ----------- ----------- ----------- -----------\n(in millions) Actuarial present value of benefit obligation (measured as of September 30): Vested benefit obligation $(155.0) $ (40.1) $(148.5) $ (33.2) ======= ======= ======= ======= Accumulated benefit obligation (162.1) (46.2) (149.9) (34.8) ======= ======= ======= ======= Projected benefit obligation (189.5) (49.5) (175.5) (38.3) Plan assets at fair market value (measured as of September 30) 209.3 40.7 199.6 29.5 ------- ------- ------- ------- Plan assets in excess of (less than) projected benefit obligation 19.8 (8.8) 24.1 (8.8) ------- ------- ------- ------- Unrecognized net asset at transition to SFAS No. 87 (3.2) (0.4) (3.8) (0.1) Unrecognized prior service cost 13.9 5.7 15.7 4.8 Unrecognized net loss (gain) (7.7) 2.6 (10.9) 1.0 Additional liability required to recognize minimum liability -- (5.7) -- (2.9) ------- ------- ------- ------- Prepaid (accrued) pension cost recognized on balance sheets $ 22.8 $ (6.6) $ 25.1 $ (6.0) ======= ======= ======= =======\nThe principal economic assumptions used in determining the above benefit obligations were: discount rates of 7.5 percent and 8.5 percent in 1995 and 1994, respectively, and rates of increase in future compensation levels of 5.0 percent and 6.0 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 $10.5 million, $9.7 million and $8.1 million in 1995, 1994 and 1993, 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 $5.5 million, $4.8 million and $5.0 million in 1995, 1994 and 1993, 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 1995, 1994 and 1993 included the following components:\n(in millions) 1995 1994 1993 ------ ------ ------ Service cost-benefits earned during the period $ 0.2 $ 0.3 $ 0.4 Interest cost on accumulated postretirement benefit obligation 2.2 2.2 2.9 Net amortization and deferral (0.7) 0.4 -- ------ ----- ------ Net periodic postretirement benefit cost $ 1.7 $ 2.9 $ 3.3 ====== ===== ======\nThe principal economic assumptions used in the determination of net periodic cost of postretirement benefits other than pensions included the following:\n1995 1994 1993 ------------ ------------ ------------ Discount rate 8.5% 7.0% 7.5% Rate of increase in compensation levels 6.0% 4.5% 5.0% Rate of increase in the per capita cost of covered 9.9% in 1995 10.3% in 1994 11.0% in 1993 health care benefits decreasing decreasing decreasing gradually gradually gradually to 6.5% by to 5.0% by to 5.5% by the year 2006 the year 2006 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, 1995 and 1994 was as follows:\n(in millions) 1995 1994 ------ ------ Actuarial present value of accumulated postretirement benefit obligation: Retirees $ 25.6 $ 22.1 Fully eligible active plan participants 0.5 1.0 Other active plan participants 3.0 3.3 ------ ------ Total 29.1 26.4 ------ ------ Plan assets at fair market value -- -- Accumulated postretirement benefit obligation in excess of plan assets 29.1 26.4 Unrecognized net gain 8.8 12.9 Unrecognized prior service cost 0.2 (0.2) ------ ------ Accrued postretirement benefit cost $ 38.1 $ 39.1 ====== ======\nThe principal economic assumptions used in determining the above benefit obligations were as follows:\n1995 1994 ------------ ------------ Discount rate 7.5% 8.5% Rate of increase in compensation levels 5.0% 6.0% Rate of increase in the per capita cost 9.5% in 1996 9.9% in 1995 of covered health care benefits decreasing decreasing gradually gradually to 5.5% by to 6.5% by the year 2006 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, 1995 by $2.3 million and net periodic postretirement benefit cost for 1995 by $0.1 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 $6.0 million, $5.5 million, and $5.4 million in 1995, 1994 and 1993, respectively.\n7. LEASES\nAt December 31, 1995, 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 ------- -------- 1996 $ 2.8 $ 53.1 1997 2.6 46.5 1998 2.5 40.9 1999 2.4 32.1 2000 2.4 26.6 Thereafter 18.7 121.9 ------ ------ Total minimum lease payments 31.4 $ 321.1 ====== Less imputed interest 14.0 ------ Present value of minimum lease payments $ 17.4 ======\nMinimum payments under operating leases have not been reduced by $127.7 million of sublease rental income which is due in the future under noncancellable subleases. Total rent expense applicable to operating leases amounted to $36.3 million, $33.2 million and $29.0 million in 1995, 1994 and 1993, respectively. These amounts have been reduced by sublease rental income of $22.2 million, $21.4 million and $21.2 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, 1993 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 --------- ------------------ Granted 926,400 18.250 - 19.438 Exercised or surrendered for SARs (1,014,328) 6.937 - 18.250 Recaptured or terminated (14,500) 12.875 - 18.250 --------- ------------------ Balance, December 31, 1995 5,601,765 $10.288 - $19.438 ========= ==================\nAt December 31, 1995, 3,989,066 shares were exercisable and 5,512,110 shares were available for future grants. The Company granted 98,900, 110,200 and 91,900 restricted shares of stock in 1995, 1994 and 1993, respectively, to key members of management under the Plan. At December 31, 1995, there were 191,640 restricted shares of stock outstanding under the 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) 1995 1994 1993 ------ ------ ------ Interest paid $ 78.9 $ 61.0 $ 82.0 Interest received (6.6) (6.8) (13.4) Income taxes paid 99.3 115.4 75.2 Income tax refunds (26.4) (8.6) --\nDetails of businesses acquired in purchase transactions in 1995 were as follows:\n(in millions) 1995 ------ Fair value of assets acquired $ 85.4 Liabilities assumed (13.0) ------ Cost of acquisition 72.4 Notes issued to sellers (7.4) Common stock issued to sellers (2.7) Cash and cash equivalents acquired (1.8) ------ Net cash paid for acquisitions $ 60.5 ======\nThe Company acquired several companies in 1995, including a Pepsi-Cola franchise in Cedar Rapids, Iowa, a Hussmann equipment distributor in Chile, the remaining 50 percent interest in a refrigeration manufacturer and distributor in the United Kingdom, and 10 Midas muffler shops from a previous franchisee, at a total cost of $60.5 million. All such acquisitions were accounted for as purchases, and the operating results include such acquisitions from the dates of purchase. The effects of these acquisitions, had they been made as of January 1, 1995, would not have been significant to operating results. In 1995, the Company issued 126,700 shares of its common stock with a value of $2.7 million in connection with the acquisition of a group of Midas shops from the former franchisee.\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 $20 million to $40 million, or possibly more. As a result of its continuing evaluation of potential exposure for environmental liabilities, the Company provided $46.8 million in 1994 through a charge to discontinued operations (see Note 2). At December 31, 1995, the Company had approximately $40 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 or the results of operations. 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 or the results of operations.\n12. SEGMENT REPORTING\nThe Company is engaged in three distinct businesses: Pepsi-Cola soft drinks and other beverages; Midas automotive services; and Hussmann refrigeration systems and equipment. Selected financial information related to these business segments is shown below:\nDepreciation and Capital amortization investments -------------------- -------------------- (in millions) 1995 1994 1993 1995 1994 1993 ------ ------ ------ ------ ------ ------ Pepsi General $ 60.0 $ 53.7 $ 52.9 $110.4 $ 66.0 $ 45.0 Midas 18.1 16.4 15.5 34.3 28.7 24.4 Hussmann 19.6 17.3 16.5 29.3 32.7 19.2 Eliminations & other 10.6 10.6 10.6 0.8 -- 0.1 ------ ------ ------ ------ ------ ------ Total before corporate administrative expenses $108.3 $ 98.0 $ 95.5 $174.8 $127.4 $ 88.7 ====== ====== ====== ====== ====== ======\nSelected geographical information is presented below:\nEquity in net income and net assets of the Company's foreign operations amounted to $5.2 million and $215.5 million, respectively, in 1995, $16.7 million and $180.8 million in 1994, and $15.5 million and $157.2 million in 1993. 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 -------- -------- ------- -------- -------- 1995: From continuing operations: Sales $594.4 $734.7 $827.1 $790.3 $2,946.5 - ---------------------------------------------------------------------------- Gross profit 211.3 263.7 292.0 258.2 1,025.2 - ---------------------------------------------------------------------------- Income from continuing operations 14.0 38.0 47.5 34.0 133.5 - ---------------------------------------------------------------------------- Income per share: Continuing operations $ 0.13 $ 0.36 $ 0.45 $ 0.32 $ 1.26 - ---------------------------------------------------------------------------- Net income $ 0.13 $ 0.36 $ 0.45 $ 0.32 $ 1.26 - ---------------------------------------------------------------------------- 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 - ----------------------------------------------------------------------------\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. By year-end 1994, the market value had recovered by $2.1 million. During 1995, the market value of Northfield increased another $13.0 million. Such unrealized gains have been credited, on after-tax bases, to shareholders' equity in 1994 and 1995, respectively.\nWhitman Corporation SELECTED FINANCIAL DATA\n(A) 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\nEXHIBITS\nFOR INCLUSION IN ANNUAL REPORT ON FORM 10-K\nFISCAL YEAR ENDED DECEMBER 31, 1995\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 Change in Control Agreement dated November 17, 1995. (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.. (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 & Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994 under the indicated Exhibit number.","section_15":""}
{"filename":"841687_1995.txt","cik":"841687","year":"1995","section_1":"Item 1. Business\nGeneral\nFiduciary Capital Partners, L.P. (the \"Fund\" or the \"Registrant\") is a limited partnership organized under the laws of the State of Delaware on October 20, 1988. The managing general partner of the Fund is FCM Fiduciary Capital Management Company, a Delaware general partnership (the \"Managing General Partner\" or \"FCM\"). The independent general partners of the Fund are Norman J. Peer, Robert H. Arnold, and E. Bruce Fredrikson (the \"Independent General Partners\"). (The Managing Partner and the Independent General Partners are collectively referred to herein as the \"General Partners.\")\nThe general partners of the Managing General Partner are FCM Fiduciary Capital Corporation, a Delaware corporation, Mezzanine Capital Corporation, a Delaware corporation and an affiliate of PaineWebber Incorporated, and Paul Bagley. Paul Bagley owns 100% of the stock of FCM Fiduciary Capital Corporation.\nThe Managing General Partner serves as investment adviser (\"Investment Adviser\") to the Fund and is responsible for the identification of all investments made by the Fund and all other investment advisory services necessary for the operation of the Fund in carrying out its investment objectives and policies. The Independent General Partners oversee the investment activities of the Investment Adviser.\nThe Fund has elected to operate as a business development company under the Investment Company Act of 1940, as amended. The investment objective of the Fund is to provide current income and capital appreciation by investing primarily in subordinated debt and related equity securities issued as the mezzanine financing of privately structured, friendly leveraged buyouts, leveraged acquisitions and leveraged recapitalizations. A separate fund, Fiduciary Capital Pension Partners, L.P., a Delaware limited partnership (\"FCPP\") was also formed on October 20, 1988 for tax-exempt investors with investment objectives, policies and restrictions similar to those of the Fund. The Fund and FCPP co-invest in the investments; however, each fund is accounted for separately.\nOn January 26, 1990, the Fund and its affiliate, FCPP (collectively, the \"Funds\"), began a public offering of their units of limited partnership interests (the \"Units\"). The Units were registered pursuant to a Registration Statement on Form N-2 under the Securities Act of 1933, as amended.\nThe Funds collectively held three closings for the sale of the Units during the period from August 14, 1990 through October 18, 1990. As a result of the closings, the Funds sold 65,898 Units representing an aggregate purchase price of $65,898,000. Of these amounts, 36,102 Units representing an aggregate purchase price of $36,102,000 and 29,796 Units representing an aggregate purchase price of $29,796,000 were received by the Fund and FCPP, respectively.\nA special meeting of the Fund's Limited Partners was held on October 1, 1993. At the meeting, the Limited Partners approved the extension of the Fund's investment period until December 31, 1995 and the adoption of a fundamental policy of periodic unit repurchases. In connection with the adoption of the repurchase policy, each $1,000 Unit was redenominated into fifty $20 Units. After giving effect to this redenomination, the Fund had 1,805,100 Units outstanding as of October 1, 1993.\nPursuant to the terms of the repurchase policy, the Fund will annually offer to repurchase from its Limited Partners up to 7.5% of its outstanding Units for an amount equal to the current net asset value per Unit, net of a fee (not to exceed 2%) to be retained by the Fund to offset expenses incurred in connection with the repurchase offer. If the number of tendered Units in any year exceeds 7.5% of the outstanding Units, the Fund's General Partners may vote to repurchase up to an additional 2% of the outstanding Units.\nRepurchases of Units since the adoption of the plan can be summarized as follows:\nEach fund's participation in the following portfolio investments is in proportion to the amount of capital that each fund had available for investment at the time each investment was acquired. All amounts shown in this report with respect to investments represent only the Fund's proportionate share of the amounts involved.\nPortfolio Investments\nAs of December 31, 1995, the Fund held portfolio investments in nine Managed Companies, with an aggregate cost of approximately $16.7 million. As of December 31, 1995, the Fund had no investments in Non-Managed Companies. Managed Companies are those to which significant managerial assistance is offered.\nDuring the year ended December 31, 1995, the Fund exercised the warrants it held in Protection One, Inc. (\"Protection One\"), acquired a new portfolio investment in R.B.M. Precision Metal Products, Inc. (\"RBM\") and acquired two follow-on investments in Canadian's Corp. (\"Canadian's\") at a total cost of approximately $3.2 million.\nThe Fund's subordinated debt investment in Protection One Alarm Monitoring, Inc. (\"Protection One Alarm\") was prepaid during 1995. In addition, the Fund sold its subordinated debt investment in KB Alloys, Inc. (\"KB Alloys\"), all of its Carr-Gottstein Foods Co. (\"Carr-Gottstein\") and Protection One common stock and a portion of its KEMET Corporation (\"KEMET\") common stock during 1995. In the aggregate, the Fund received approximately $10.1 million in proceeds, including applicable prepayment premiums, from these transactions.\nThe Fund's investment period ended on December 31, 1995. Although the Fund is permitted to make additional investments in existing portfolio companies after 1995, the Fund is no longer permitted to acquire investments in new portfolio companies, except to fund commitments made prior to December 31, 1995.\nAs of December 31, 1995, the Fund had committed to make new portfolio investments in Atlas Environmental, Inc. (\"Atlas\"), Monaco Finance, Inc. (\"Monaco\") and Advantage Funding Group, Inc. (\"Advantage\"). In addition, the Fund had agreed in principle to a financial restructuring of its LMC Operating Corp. (\"LMC\") investment, which involves a conversion of the Fund's existing subordinated debt and warrants into preferred stock and a follow-on investment in LMC for the purchase of new common stock. If these investments were ultimately funded at the expected amounts, the Fund would have utilized all of the capital that was available for investment as of December 31, 1995.\nAs discussed below, the Atlas and LMC investments were acquired by the Fund during January and February 1996, respectively. The proposed Monaco investment is still subject to various contingencies. The proposed Advantage investment was abandoned during 1996. The portion of the Fund's available capital that had been reserved for the Advantage investment is now reserved to fund the Fund's 1996 annual repurchase offer.\nNew Portfolio Investments in 1995\nR.B.M. Precision Metal Products, Inc. On May 24, 1995, the Fund invested $1,430,800 in RBM. The investment consisted of $1,460,000 of 13.00% Senior Subordinated Secured Notes due May 24, 2002, with warrants to acquire common stock.\nRBM, headquartered in Colorado Springs, Colorado, is a manufacturer of precision sheet metal enclosures, chassis and assemblies for business machines. Its principal customer is Hewlett Packard.\nFollow-On Investments in 1995\nCanadian's Corp. During September 1994, the Fund invested $2,077,000 in Canadian's and its parent company, Canadian's Holdings, Inc. (\"Canadian's Holdings\"). The investment consisted of (a) $1,876,000 of Canadian's 13.50% Subordinated Notes with warrants to acquire common stock and (b) $268,000 of Canadian's Holdings 12.00% Exchangeable Redeemable Debentures that are convertible into Canadian's common stock. Both the Notes and the Debentures also bear contingent additional interest to be computed under specified formulas. Canadian's emerged from Chapter 11 bankruptcy proceedings in conjunction with the restructuring in which the Fund participated.\nDuring December 1994, the Fund made a follow-on investment of $895,310 in Canadian's and Canadian's Holdings. The investment consisted of (a) $857,000 of Canadian's 13.50% Subordinated Notes with warrants to acquire common stock and (b) $66,000 of Canadian's Holdings 12.00% Exchangeable Redeemable Debentures that are convertible into Canadian's common stock. Both the Notes and Debentures also bear contingent additional interest to be computed under specified formulas. The proceeds from the Fund's investment was used by Canadian's as a portion of the capital needed to finance the acquisition of store leases, a computer system, point-of-sale terminals and store fixtures from The Ormonds Shops, Inc., a retailer operating under the protection of the federal bankruptcy laws.\nDuring May 1995, the Fund made a second follow-on investment of $133,000 in Canadian's. The investment consisted of $147,778 of floating rate Promissory Notes, with warrants to purchase common stock. The Funds and certain of Canadian's equity investors provided loans to the company in order to fund working capital shortages at the company.\nDuring September 1995, the Fund made a third follow-on investment of $1,630,834 in Canadian's. This investment consisted of a Collateralized Loan Guarantee earning interest at 13.75% and stock in Canadian's Holdings. In addition, the Fund received stock in Canadian's Holdings for all of the existing warrants previously held by the Fund. This debt investment is senior to all of Canadian's other debt, except for its revolving credit facility.\nCanadian's, headquartered in Fairfield, New Jersey, is a specialty retailer of moderately priced junior women's apparel and accessories.\nAs discussed in Item 7 of this Report, \"Management's Discussion and Analysis of Financial Condition and Results of Operations\", on February 21, 1996, Canadian's and Canadian's Holdings both filed for Chapter 11 bankruptcy protection. The Fund has written its Candian's investment down to a negligible amount at December 31, 1995.\nDispositions of Portfolio Investments in 1995\nKEMET Corporation The Fund acquired various subordinated debt and equity investments in KEMET and its subsidiary, KEMET Electronics Corporation (\"KEMET Electronics\"), during 1991 and 1993.\nDuring October 1992, KEMET completed an initial public offering (\"IPO\") of its common stock.\nThe stock trades on the NASDAQ National Market System under the symbol \"KMET\". During June 1993, KEMET Electronics prepaid its subordinated notes which the Fund held following the successful completion of a secondary stock offering. As of December 31, 1993, the Fund continued to hold the common stock and warrants of KEMET, representing a total of 164,619 shares.\nDuring 1994, the Fund exercised its warrants and sold 71,895 shares of the common stock, realizing total sales proceeds of $1,528,731. As of December 31, 1994, the Fund owned 92,724 shares of KEMET common stock.\nThe Fund periodically sold additional shares of KEMET common stock during 1995. During February 1995, the Fund sold 10,547 shares at an average net sales price of approximately $31.00. During April and May 1995, the Fund sold 44,920 shares at an average net sales price of approximately $43.93. During July 1995, the Fund sold 9,587 shares at an average net sales price of approximately $67.47. Following a two-for-one stock split, an additional 27,396 shares were sold during November 1995 at an average net sales price of approximately $34.91. The Fund has 27,944 shares of KEMET stock remaining as of December 31, 1995. The Fund's cost basis in its KEMET stock is approximately $.35 per share. At December 31, 1995, the stock closed at $24.00 (an average of the closing bid and ask prices).\nKEMET, headquartered in Greenville, South Carolina, is a leading manufacturer and distributor of both solid tantalum and monolithic ceramic capacitors used as components in circuit boards.\nProtection One Alarm Monitoring, Inc. During 1993, the Fund invested $1,083,000 in Protection One Alarm and its parent company, Protection One. The investment consisted of $1,083,000 aggregate principal amount of 12.00% Senior Subordinated Notes due November 1, 2003, with warrants to purchase common stock in the parent company.\nDuring September 1994, Protection One completed an IPO of its common stock. The stock trades on the NASDAQ National Market System under the symbol \"ALRM\". During May 1995, Protection One Alarm prepaid the $1,083,000 of 12.00% Senior Subordinated Notes that the Fund held, at par, along with a prepayment premium of $54,150.\nDuring July 1995, the Fund exercised the warrants it held, receiving 18,194 shares of Protection One common stock. During November 1995, the Fund sold all of its Protection One stock, receiving $146,589 of sales proceeds.\nProtection One is a Portland, Oregon-based security alarm company operating in five western states.\nCarr-Gottstein Foods Company During 1990, the Fund purchased subordinated notes and common stock in Carr-Gottstein. During July 1993, Carr-Gottstein prepaid the subordinated notes following a sucessful IPO of its common stock. The stock trades on the New York Stock Exchange under the symbol \"CGF\".\nThe Fund continued to hold 178,934 shares of Carr-Gottstein common stock until 1995. During October 1995, Carr-Gottstein announced that it was offering to purchase up to 7,500,000 (approximately 49%) of its outstanding shares at a purchase price of $11.00 per share. The day before the offer, the stock was trading at $6.125 per share. The Fund tendered all of its 178,934 shares, of which 89,268 shares were repurchased by the Company for a total consideration of $981,948. The Fund sold its remaining shares in the open market shortly after the tender offer was completed. The Fund received a total of $468,426 for the remaining 89,666 shares.\nCarr-Gottstein has been the leading food and drug retailer in Alaska since 1915 and is the largest private employer in Alaska.\nKB Alloys, Inc. During 1993, the Fund invested $3,488,282 in KB Alloys. The investment consisted of $3,561,003 aggregate principal amount of 20.00% Senior Subordinated Notes due June 30,\n2001. KB Alloys is required to pay 13.00% interest currently, while the remaining 7.00% of the interest may be deferred at the borrower's option. During any period in which the payment of interest is deferred, the interest rate on the notes increases from 20.00% to 21.00%. To date, KB Alloys has elected to defer payment of the interest.\nDuring December 1995, the Fund sold these notes to an unrelated institutional investor at a price of $4,002,044. As described above, KB Alloys was paying current interest on these notes at a rate of 13% per annum and, in addition, the Fund was accruing a deferred interest component at a rate of 8% per annum. The accrued deferred interest totaled $728,027 at the date of the sale. The sales price was less than the sum of the amortized cost of the notes and the total accrued interest, resulting in a book loss of $230,483. This book loss was recorded in the financial statements as an adjustment of interest income.\nKB Alloys, headquartered in Reading, Pennsylvania, is a leading North American manufacturer of aluminum master alloys. Master alloys are added during the production of aluminum to enhance or supply physical properties and to function as a hardener, refiner or promoter of electrical conductivity. The company has manufacturing facilities in Kentucky and Washington.\n1995 Commitments Funded During 1996\nAtlas Environmental, Inc. On January 25, 1996, the Fund invested $3,855,398 in Atlas. The investment consists of $3,934,080 of 13.5% Senior Subordinated Secured Notes due January 19, 2003, with warrants to acquire 407,659 shares of common stock. The warrants have an exercise price of $8.00 per share. The Atlas common stock is currently traded over the counter on a limited basis with quotations provided via the OTC Bulletin Board under the symbol \"ATEV\".\nAtlas, headquartered on Plantation Florida, is a holding company that owns and manages companies in certain segments of the environmental services industry.\nLMC Operating Corp. On June 10, 1994, the Fund invested $2,551,920 in LMC. The investment consisted of $2,604,000 of 13.00% Senior Subordinated Notes due May 31, 1999 with warrants to acquire common stock.\nLMC paid the 1995 interest payments on the Senior Subordinated Notes held by the Fund out of an escrow account which was established and funded in connection with the Fund's acquisition of the notes. The escrow account was established to fund the interest payments in the event LMC was otherwise unable to fund the payment.\nOn February 9, 1996, the Fund participated in a financial restructuring of its LMC investment. The Fund converted its existing LMC subordinated debt and warrants into preferred stock and agreed to make a follow-on investment for the purchase of $545,454 of new common stock. As a result of the restructuring, the Fund increased its ownership of LMC from approximately 13% to approximately 27%.\nLMC, headquartered in Logan, Utah, is the leading U.S. manufacturer of light track vehicles. These vehicles are primarily used as snow-groomers and have several alternative uses including infrastructure development and maintenance in remote locations, right-of-way cleanup, search and rescue and military troop deployment. Primary purchasers of the vehicles include ski resorts, utility companies and various governmental agencies.\nOther Portfolio Investments\nNeodata Services, Inc. (\"Neodata Services\") During 1991, the Fund purchased subordinated notes in Neodata Services and warrants to purchase common stock of Neodata Corporation (\"Neodata\"), the parent company of Neodata Services.\nDuring 1992, Neodata raised additional equity via a rights offering to existing shareholders. The Fund elected to purchase additional common stock in the rights offering in order to maintain its existing ownership position in Neodata.\nDuring May 1993, Neodata Services prepaid the subordinated notes that the Fund held following a successful refinancing of the Company's debt at a lower interest rate.\nDuring November 1994, Neodata's stockholders approved a recapitalization of the company. Pursuant to the terms of the recapitalization plan, the Fund received a combination of 10.00% Class A convertible preferred stock and new common stock in exchange for its old common stock and warrants.\nThe Neodata stock was written down to a negligible amount at March 31, 1995. The Fund has consistently valued this investment based upon a multiple of Neodata's cash flow. Because Neodata's long-term debt presently provides for the accrual, rather than current payment, of interest, the Company's debt has grown to a level which now exceeds the Fund's valuation.\nNeodata, headquartered in Louisville, Colorado, is the largest contract fulfillment company in the world and a leader in providing fulfillment and marketing services to the magazine publishing industry.\nHuntington Holdings, Inc. During 1992, the Fund purchased subordinated notes and warrants to purchase common stock in Huntington. During February 1994, Huntington prepaid the subordinated notes that the Fund held.\nThe Fund continued to hold the warrants to purchase common stock until 1996. During December 1995, Huntington entered into a letter of intent, under the terms of which all Huntington stock would be sold for cash. The sale was consummated during February 1996. The Fund's share of the actual sales proceeds totaled $1,511,364, of which $1,320,711 was received during February 1996. The balance is being held in escrow to fund various transaction expenses and potential contingent purchase price adjustments, and as collateral for potential claims of the buyer with respect to representations made by the selling shareholders, including the Fund. The escrow amount must be maintained for a two year period. The Fund valued the Huntington warrants at December 31, 1995 at an amount approximately equal to 75% of the ultimate sales proceeds (not including the Fund's share of the escrow) due to the inherent uncertainty that existed at that time as to whether the sale would actually be consummated.\nPursuant to the terms of the Fund's agreement with Huntington, under certain circumstances the number of shares issuable upon exercise of the warrants held by the Fund increased periodically. The last such increase occurred on August 1, 1995 when the Fund received the rights to an additional 33.6 shares.\nHuntington, headquartered in Huntington, Indiana, is one of the largest manufacturers and marketers of maintenance and cleaning chemicals in North America. Huntington produces a wide range of intermediate and final-stage cleansers, sterilants and disinfectants for use by hospitals, schools, nursing homes and various industries.\nAmity Leather Products Co. During 1992, the Fund purchased subordinated notes, warrants to purchase Class B common stock and Class A common stock in Amity. During August 1994, Amity prepaid the subordinated notes that the Fund held.\nThe Fund continues to hold the Class A common stock and the warrants to purchase Class B common stock. As of December 31, 1995, the Fund had recorded $872,172 of net unrealized appreciation in the value of its remaining Amity investment.\nAmity manufactures men's and ladies' fine personal leather goods and distributes these products to department stores, mass merchandisers and company-owned Wallet Works stores. Amity markets its\nproducts under the brand names of Rolfs, Amity and LaGarde. Headquartered in West Bend, Wisconsin, the Company was founded in 1915 and was family-controlled prior to a management buyout in 1992.\nElgin National Industries, Inc. (\"Elgin\") During 1993, the Fund invested $6,726,339 in Elgin and its parent company, ENI Holding Corp. (\"ENI\"). The investment consisted of (a) $6,087,185 of Elgin's 13.00% Senior Subordinated Notes due September 1, 2001 with warrants to purchase common stock in ENI and (b) $711,971 of ENI 10.00% preferred stock and (c) $48,927 of ENI common stock.\nThe Fund continues to hold its entire investment in Elgin and ENI. As of December 31, 1995, the Fund had recorded $161,379 of unrealized appreciation in the ENI preferred stock.\nElgin, headquartered in Chicago, Illinois, is a diversified industrial company that is organized into three distinct segments. The Industrial Products Group manufactures specialty industrial threaded fasteners. The Manufacturing Group manufactures machinery and equipment for niches in coal and other mineral processing markets. The Engineering and Construction Group provides a full range of engineering, design and construction management services, including serving as a general contractor under turn-key design and build contracts.\nMobile Technology, Inc. (\"MTI\") During 1991, the Fund purchased subordinated notes in MTI and various equity securities in MTI's parent company, MTI Holdings, Inc.\nThe Fund stopped accruing interest on the MTI notes that it held, effective October 1, 1992. During the fall of 1992, MTI notified its lenders that it would probably be unable to meet its debt amortization and interest obligations during 1993. In January 1993, MTI confirmed its inability to pay and commenced restructuring negotiations with its various lenders outside of bankruptcy proceedings. These restructuring negotiations were successfully completed and the restructuring was consummated during July 1994. Pursuant to the terms of the restructuring, the Fund and MTI's other subordinated lenders exchanged their subordinated notes for common stock in a new holding company, MTI Holdings II, Inc. (\"MTI II\"), which now owns 100% of MTI. The Fund also received a minimal number of additional shares of MTI II common stock on December 28, 1994 in connection with the liquidation of MTI Holdings, Inc., the original holding company.\nThe Fund recognized a realized loss of $3,987,656 during 1994 as a result of the restructuring. The Fund also recorded an unrealized loss of $249,766 in the value of the MTI II stock as of December 31, 1994.\nMTI is a provider of magnetic resonance imaging and computed tomography mobile shared-services.\nCompetition\nThe Fund competes with other entities having similar investment objectives. In addition, because all investments are selected and managed exclusively by the Investment Adviser on behalf of the Fund, any other entities that compete with the Investment Adviser for mezzanine investments, therefore, indirectly compete with the Fund. These competitors include other leveraged acquisition partnerships, other business development companies, investment partnerships and corporations, small business investment companies, and large industrial and financial companies investing directly or through affiliates and individuals. Some of these competitors have more experience with investments similar to those sought by the Funds, greater financial resources and more personnel than the Funds and\/or the Investment Adviser. To the extent that there is more competition for investments, the yield available to mezzanine investors may decrease.\nEmployees\nThe Fund has no employees. As discussed above, the Managing General Partner manages the Fund's investments, subject to the supervision of the Independent General Partners, and performs services on behalf of the Fund. The General Partners are entitled to certain fees and reimbursements of certain out-of-pocket expenses incurred in connection with the performance of these management services. See Item 10 of this Report, \"Directors and Executive Officers of the Registrant\" and Item 13 of this Report, \"Certain Relationships and Related Transactions\".\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Fund does not own or lease any physical properties.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThere are no material legal proceedings pending directly against the Fund.\nAs previously reported, FCM, the Managing General Partner of the Fund, had been named as a defendant in a class action lawsuit against PaineWebber Incorporated (\"PaineWebber\") and a number of its affiliates concerning its sale of 70 different limited partnerships and other direct investment programs, including the offering of the Units. Plaintiffs in the lawsuit allege, among other things, that the defendants violated federal securities laws and committed common law fraud in the marketing of direct investments.\nOn May 30, 1995, the United States District Court for the Southern District of New York entered an order certifying the class and dismissing the class action against FCM without prejudice. PaineWebber and Mezzanine Capital Corporation, a minority general partner in FCM and an affiliate of PaineWebber, remain as defendants.\nDuring January 1996, PaineWebber signed a memorandum of understanding with the plaintiffs in the class action outlining the terms under which the parties have agreed to settle the case. Pursuant to that memorandum of understanding, PaineWebber irrevocably deposited $125 million into an escrow fund under the supervision of the United States District Court for the Southern District of New York to be used to resolve the litigation in accordance with a definitive settlement agreement and plan of allocation that the parties expect to submit to the court for its consideration and approval within the next several months. Until a definitive settlement and plan of allocation is approved by the court, there can be no assurance what, if any, payment or non-monetary benefits will be made available to unitholders in the Fund.\nDuring February 1996, approximately 150 plaintiffs filed an action in Sacramento, California Superior Court against PaineWebber Incorporated and various affiliated entities concerning the plaintiffs' purchase of various limited partnership interests. The complaint alleges, among other things, that PaineWebber and its related entities committed fraud by selling or promoting limited partnership investments that were unsuitable for the plaintiffs and by overstating the benefits, understating the risks and failing to state material facts concerning the investments. The complaint seeks compensatory damages of $15 million plus punitive damages.\nThe Fund was not named as a defendant in either lawsuit. However, pursuant to certain contractual arrangements between FCM and PaineWebber in connection with the offering of the Units, the Fund may be required to indemnify PaineWebber and its affiliates for their costs and liability in connection with any class action claims relating to the Fund. FCM believes that the Fund's exposure with respect to the indemnity will not have any material adverse effect on the Fund's 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 the Limited Partners of the Fund, through the solicitation of proxies or otherwise, during the fourth quarter of the fiscal year ended December 31, 1995.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters\nThere is no organized trading market for the purchase and sale of the Units and certain measures have been adopted and implemented to assure that no such organized trading market will develop.\nThe Fund's Limited Partners adopted a periodic unit repurchase plan during 1993. Pursuant to the terms of the repurchase policy, the Fund will annually offer to purchase from its Limited Partners, up to 7.5% of its outstanding Units for an amount equal to the current net asset value per Unit, net of a fee (not to exceed 2%) to be retained by the Fund to offset expenses incurred in connection with the repurchase offer. If the number of tendered Units in any year exceeds 7.5% of the outstanding Units, the Fund's General Partners may vote to repurchase up to an additional 2% of the outstanding Units.\nRepurchases of Units since the adoption of the plan can be summarized as follows:\nAs of March 1, 1996, the number of Limited Partners of record was approximately 1,950.\nThe Fund made the following distributions to its partners with respect to 1994 and 1995:\n*Includes distributions to the Managing General Partner in an amount equal to 1.0% of the total distribution.\nCash distributions for 1994 were paid out of current net investment income (71.0%) and gains from capital transactions (29.0%). Cash distributions for 1995 were paid entirely out of current net investment income.\nThe Fund expects 1996 distributions, beginning with the distribution payable during May 1996, to be made at a 6% distribution rate ($.30 per Unit per quarter) or greater. The Fund's investment period ended on December 31, 1995. Although the Fund is permitted to make additional investments in existing portfolio companies after 1995, the Fund is no longer permitted to acquire investments in new portfolio companies, except to fund commitments made prior to December 31, 1995. This will impact the amount of the Fund's quarterly distributions for 1996 and subsequent years because all proceeds from future dispositions or maturities of investments will be distributed to investors, except to the extent the cash is needed to fund the annual repurchase offer or to fund any follow-on investments that the Fund may make in existing portfolio companies.\nAs of December 31, 1995, the Fund had committed to make three new portfolio investments. In addition, the Fund had agreed in principle to a financial restructuring of LMC, which involves a conversion of the Fund's existing subordinated debt and warrants into preferred stock and a follow-on investment in LMC for the purchase of new common stock.\nAs discussed above in Item 1 of this Report, \"Business\", one of the committed investments was acquired during January 1996, and a second investment is still pending (subject to various contingencies). In addition, the follow-on investment in LMC was made during February 1996. The third committed investment was abandoned. The portion of the Fund's available capital that had been reserved for the abandoned investment is now reserved to fund the Fund's 1996 annual repurchase offer.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe following selected financial data of the Fund has been derived from the financial statements for the indicated periods. The information set forth below should be read in conjunction with the Fund's financial statements and notes thereto and \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" included in Items 8 and 7, respectively, of this Report.\n- ---------------\n(1) Effective October 1, 1993, each $1,000 Unit was redenominated into fifty $20 Units. All amounts shown for prior years have been restated to give effect to this redenomination.\n(2) Calculated using the weighted average number of Units outstanding during the years ended December 31, 1995, 1994 and 1993 of 1,513,503, 1,669,129 and 1,791,201, respectively.\n(3) Distribution amounts are reflected during the year in which the cash for the distribution was generated. A portion of the actual cash distributions are paid subsequent to such year.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nLiquidity and Capital Resources\nDuring 1990, the Fund completed a public offering of its Units. Net offering proceeds available to the Fund, after deducting commissions and other offering costs, totaled $31,860,015.\nThe Fund has authority to borrow funds for operational purposes. To date, however, the Fund has not borrowed any funds and it has no established credit arrangements.\nThe Fund's Limited Partners adopted a periodic unit repurchase plan during 1993. Pursuant to the terms of the repurchase policy, the Fund will annually offer to purchase from its Limited Partners, up to 7.5% of its outstanding Units for an amount equal to the current net asset value per Unit, net of a fee\n(not to exceed 2%) to be retained by the Fund to offset expenses incurred in connection with the repurchase offer. If the number of tendered Units in any year exceeds 7.5% of the outstanding Units, the Fund's General Partners may vote to purchase up to an additional 2% of the outstanding Units.\nRepurchases of Units since the adoption of the plan can be summarized as follows:\nAs of December 31, 1995, the Fund held portfolio investments in nine Managed Companies, with an aggregate cost of approximately $16.7 million. These portfolio investments, which were made from net offering proceeds and the reinvestment of proceeds from the sale of other portfolio investments, represent approximately 56.7% of the Fund's net assets. When acquired, these portfolio investments generally consisted of high-yield subordinated debt, linked with an equity participation or a comparable participation feature. These securities were typically issued in private placement transactions and were subject to certain restrictions on transfer or sale, thereby limiting their liquidity. A number of the portfolio companies have prepaid their subordinated debt that the Fund held. In addition, three of the portfolio companies have successfully completed IPOs of their stock. The Fund has sold the stock it held in these three compainies, except for a portion of its KEMET stock.\nAs of December 31, 1995, the Fund's remaining assets were invested in short-term commercial paper. These funds are available for investment, for distribution to the partners or to fund the annual repurchase offer.\nDuring the year ended December 31, 1995, the Fund exercised the Protection One warrants it held, acquired a new portfolio investments in RBM and acquired two follow-on investments in Canadian's at a total cost of approximately $3.2 million.\nThe Fund's subordinated debt investment in Protection One Alarm was prepaid during 1995. In addition, the Fund sold its subordinated debt investment in KB Alloys, all of its Carr-Gottstein and Protection One common stock and a portion of its KEMET common stock during 1995. In the aggregate, the Fund received approximately $10.1 million in proceeds, including applicable prepayment premiums, from these transactions.\nAccrued interest receivable decreased $487,356 from $627,846 at December 31, 1994 to $140,490 at December 31, 1995. This decrease resulted primarily from the sale of the Fund's subordinated debt investment in KB Alloys during 1995 and the placing of the LMC subordinated debt on non-accrual status effective December 1, 1995. Under the terms of KB Alloys notes, a portion of the interest could be deferred at KB Alloys' option. As of December 31, 1994, KB Alloys had elected to defer payment of $462,634 of interest, which was included in the accrued interest receivable amount at December 31, 1994. As discussed below, the Fund stopped accruing interest on the LMC subordinated debt as a result of a commitment made by the Fund during November 1995 to exchange its LMC debt investment for LMC preferred stock as part of a financial restructuring of LMC.\nOther assets decreased $655,805, from $659,011 at December 31, 1994 to $3,206 at December 31, 1995. The balance at December 31, 1994 included a $645,148 receivable from the sale of KEMET common stock during December 1994. This amount was received by the Fund during January 1995. This decrease also resulted from a small decrease in prepaid expenses and the amortization of deferred organization expenses.\nPrepaid interest income decreased from $60,146 at December 31, 1994 to zero at December 31, 1995. This prepaid interest income was related to the Canadian's 13.50% Subordinated Notes, which required interest to be paid quarterly, in advance, to the Fund. Effective June 1, 1995, the notes were amended to provide for the interest to be paid monthly, in advance, on the first day of each month. The Fund placed these notes on non-accrual status effective December 1, 1995.\nDistributions payable to partners decreased $267,630, from $694,068 at December 31, 1994 to $426,438 at December 31, 1995. This decrease resulted primarily from a decrease in the quarterly distribution rate from $.45 per Unit to $.30 per Unit. The decrease also reflects a decrease in the number of outstanding Units as a result of the repurchase of Units by the Fund during November 1995.\nFor 1995, the Fund declared cash distributions to its partners in the aggregate amount of $1,814,573. The distributions were paid in four equal (on a per-Unit basis) quarterly payments during the months of May, August and November 1995 and February 1996. Each of the distributions was equal to an annualized rate equal to 6% of contributed capital ($.30 per Unit) and were paid entirely out of current net investment income.\nThe Fund expects 1996 distributions, beginning with the distribution payable during May 1996, to be made at a 6% distribution rate ($.30 per Unit per quarter) or greater. The Fund's investment period ended on December 31, 1995. Although the Fund is permitted to make additional investments in existing portfolio companies after 1995, the Fund is no longer permitted to acquire investments in new portfolio companies, except to fund commitments made prior to December 31, 1995. This will impact the amount of the Fund's quarterly distributions for 1996 and subsequent years because all proceeds from future dispositions or maturities of investments will be distributed to investors, except to the extent the cash is needed to fund the annual repurchase offer or to fund any follow-on investments that the Fund may make in existing portfolio companies.\nAs of December 31, 1995, the Fund had committed to make three new portfolio investments. In addition, the Fund had agreed in principle to a financial restructuring of LMC, which involves a conversion of the Fund's existing subordinated debt and warrants into preferred stock and a follow-on investment in LMC for the purchase of new common stock.\nAs discussed above in Item 1 of this Report, \"Business\", one of the committed investments was acquired during January 1996, and a second investment is still pending (subject to various contingencies). In addition, the follow-on investment in LMC was made during February 1996. The third committed investment was abandoned. The portion of the Fund's available capital that had been reserved for the abandoned investment is now reserved to fund the Fund's 1996 annual repurchase offer.\nFCM had been named as a defendant in a class action lawsuit brought in March 1995 against PaineWebber Incorporated and a number of it affiliates concerning the sale of 70 different limited partnerships and other direct investment programs. During May 1995, the Court entered an order certifying the class and dismissing the class action against FCM without prejudice.\nDuring January 1996, PaineWebber signed a memorandum of understanding with the plaintiffs in the class action outlining the terms under which the parties have agreed to settle the case. Pursuant to that memorandum of understanding, PaineWebber irrevocably deposited $125 million into an escrow fund under the supervision of the United States District Court for the Southern District of New York to be used to resolve the litigation in accordance with a definitive settlement agreement and plan of allocation which the parties expect to submit to the court for its consideration and approval within the next several months. Until a definitive settlement and plan of allocation is approved by the court, there can be no assurance what, if any, payment or non-monetary benefits will be made available to unitholders in the Fund.\nA similar, though smaller, suit was filed against PaineWebber and various affiliated entities (not including FCM) during February 1996 in a California state court.\nFCM believes that this litigation will be resolved without any material adverse effect on the Fund's financial condition.\nResults of Operations\nInvestment Income and Expenses\nThe Fund's investment income consists primarily of interest income earned from the various debt investments which have been acquired by the Fund. Major expenses include the investment advisory fee, fund administration fee, professional fees and administrative expenses.\n1995 Compared to 1994\nThe Fund's net investment income was $2,037,186 for the year ended December 31, 1995 on total investment income of $2,668,846 as compared to net investment income of $2,126,889 on total investment income of $2,801,746 for the prior year. Net investment income per limited partnership unit increased from $1.26 to $1.33, and the ratio of net investment income to average net assets increased from 7.06% to 7.19% for the year ended December 31, 1995 in comparison to the prior year.\nAlthough total net investment income decreased from 1994 to 1995, net investment income per limited partnership unit increased. This occurred because of a decrease in the weighted average number of limited partnership units outstanding, which resulted from the repurchase of Units by the Fund during both November 1994 and 1995.\nNet investment income for the year ended December 31, 1995 decreased primarily as a result of a decrease in investment income. The negative effect of the decrease in investment income was partially offset by a decrease in total expenses.\nInvestment income decreased $132,900, or 4.7%, for the year ended December 31, 1995 in comparison to the prior year. This decrease resulted primarily from the $230,483 loss on the sale of the receivable for deferred interest due from KB Alloys, which was recorded as a reduction of interest income. In addition, there was a decrease from 1994 to 1995 in the amount of the Fund's average net assets and the Fund stopped accruing interest on its subordinated debt investments in Canadian's and LMC (see discussion below). The negative effect of these three items was partially offset by higher interest rates on both the Fund's temporary and subordinated debt investments.\nThe Fund had average net assets of approximately $28.3 million during the year ended December 31, 1995 as compared to approximately $30.1 million during the prior year. This 6.0% decrease in average net assets occurred primarily as a result of the Fund's repurchase of its Units during both November 1994 and 1995. The negative effect of the repurchase of Units was partially offset by net gains achieved with respect to the Fund's investments (primarily the KEMET common stock).\nTotal expenses decreased $43,197, or 6.4%, for the year ended December 31, 1995 in comparison to the prior year. This percentage decrease was greater than the 6.0% decline in the Fund's average net assets from 1994 to 1995. This decrease resulted primarily from decreases in investment advisory fees and other expenses. The investment advisory fees decreased as a result of the repurchase of Units during November 1994 and 1995 and the realization during July 1994 of the loss on the Fund's MTI investment. Both the repurchase of Units and the realization of the MTI loss decreased the amount of the Fund's available capital (as defined in the Partnership Agreement) which is the base with respect to which the investment advisory fees are calculated. Other expenses decreased primarily as a result of a decrease in consulting fees. These decreases were partially offset by an increase in professional fees.\n1994 Compared to 1993\nThe Fund's net investment income was $2,126,889 for the year ended December 31, 1994 on total investment income of $2,801,746 as compared to net investment income of $2,400,016 on total investment income of $3,132,724 for the prior year. Net investment income per limited partnership unit decreased from $1.33 to $1.26, and the ratio of net investment income to average net assets decreased from 7.34% to 7.06% for the year ended December 31, 1994 in comparison to the prior year.\nNet investment income for the year ended December 31, 1994 decreased primarily as a result of a decrease in investment income. The negative effect of the decrease in investment income was partially offset by a decrease in total expenses.\nInvestment income decreased $330,978, or 10.6%, for the year ended December 31, 1994 in comparison to the prior year. This decrease resulted primarily from a decrease of approximately 7.9% in the Fund's average net assets. The decrease in average net assets was primarily a result of the repurchase of Units by the Fund during both November 1993 and 1994. In addition, there was an increase from 1993 to 1994 in the relative portion of the Fund's total net assets that were invested in lower-yielding temporary investments and non-income producing equity investments and a decrease in the portion invested in higher-yielding subordinated debt investments. The negative effect of these items was partially offset by higher interest rates obtained in recent months on the Fund's temporary investments.\nTotal expenses decreased $57,851, or 7.9%, for the year ended December 31, 1994 in comparison to the prior year. This aggregate decrease was equal to the percentage decline in the Fund's average net assets from 1993 to 1994. The decrease resulted primarily from decreases in investment advisory fees, professional fees and other expenses. The investment advisory fees decreased as a result of the repurchase of Units during November 1993 and 1994 and the realization during July 1994 of the loss on the Fund's MTI investment. Both the repurchase of Units and the realization of the MTI loss decreased the amount of the Fund's available capital (as defined in the Partnership Agreement), which is the base with respect to which the investment advisory fees are calculated. The decrease in professional fees and other expenses resulted primarily from legal fees and other costs incurred during 1993 in connection with the preparation of the proxy and consent solicitation.\nNet Realized Gain (Loss) on Investments\nThe Fund realized gains of $1,089,907 during the year ended December 31, 1993, net losses of $2,532,109 during the year ended December 31, 1994 and gains of $4,588,421 during the year ended December 31, 1995.\nThe realized gains for 1993 consisted of gains, including applicable prepayment premiums, resulting from the prepayment by Neodata, KEMET Electronics and Carr-Gottstein of subordinated notes which were held by the Fund. During 1994, the Fund realized gains, including applicable prepayment premiums, resulting from the prepayment by Huntington and Amity of subordinated notes that were held by the Fund and the sale of a portion of the KEMET common stock that was held by the Fund. The Fund also recognized a substantial realized loss as a result of MTI's financial restructuring which occurred during 1994.\nThe realized gains for 1995 resulted from the following transactions:\nOn February 28, 1995, the Fund sold 10,547 shares of KEMET common stock. The Fund received $326,324 of sales proceeds, resulting in a realized gain of $318,852.\nDuring April and May 1995, the Fund sold an additional 44,920 shares of KEMET common stock. The Fund received $1,973,532 of sales proceeds, resulting in realized gains of $1,941,692.\nOn May 17, 1995, Protection One prepaid its $1,083,000 of 12.00% Senior Subordinated Notes that were carried by the Fund at an amortized cost of $997,917. The Fund received $1,137,150 of proceeds, including a prepayment premium, resulting in a realized gain of $139,233.\nOn July 25, 1995, the Fund sold 9,587 shares of KEMET common stock. The Fund received $646,873 of sales proceeds, resulting in a realized gain of $640,078.\nOn October 13, 1995, Carr-Gottstein announced that it was offering to purchase approximately 49% of its outstanding shares at a purchase price of $11.00 per share. The day before the offer, the stock was trading at $6.125 per share. The Fund tendered all of its 178,934 shares, of which 89,268 shares were repurchased by the company for a total amount of $981,948. The Fund sold its remaining shares in the open market shortly after the tender offer was completed. The Fund received $468,462 for the remaining 89,666 shares. In total, the Fund realized a gain of $555,708 from the disposition of its Carr-Gottstein stock.\nOn November 6, 1995, the Fund sold 27,396 shares of KEMET common stock. The Fund received $956,326 of sales proceeds resulting in a realized gain of $946,617.\nDuring November 1995, the Fund sold all of its Protection One common stock. The Fund received $146,589 of sales proceeds resulting in a realized gain of $46,241.\nOn December 4, 1995, the Fund sold the $3,561,003 of KB Alloys Senior Subordinated Term Notes it held to an unrelated institutional investor at a price of $4,002,044. KB Alloys was paying current interest on these notes at a rate of 13% per annum and, in addition the Fund was accruing a deferred interest component at a rate of 8% per annum. At the date of the sale, the notes had an amortized cost of $3,504,500 and accrued deferred interest totaled $728,027. Thus, the sales price was $230,483 less than the sum of the amortized cost of the notes and the accrued deferral interest. The $230,483 was recorded as an adjustment to interest income.\nNet Unrealized Gain (Loss) on Investments\nFCM values the Fund's portfolio investments on a weekly basis utilizing a variety of methods. For securities that are publicly traded and for which market quotations are available, valuations are set by the closing sales, or an average of the closing bid and ask prices, as of the valuation date.\nFair value for securities that are not fully traded in any liquid public markets or that are privately held are determined pursuant to valuation policies and procedures that have been approved by the Independent General Partners and subject to their supervision. There is a range of values that are reasonable for such investments at any particular time. Each such investment is valued initially based upon its original cost to the Fund (\"cost method\"). The cost method is used until significant developments affecting the portfolio company provide a basis for use of an appraisal valuation. Appraisal valuations are based upon such factors as the portfolio company's earnings, cash flow and net worth, the market prices for similar securities of comparable companies and an assessment of the portfolio company's future financial prospects. In a case of unsuccessful operations, the appraisal may be based upon liquidation value. Appraisal valuations are necessarily subjective. The Fund also may use, when available, third-party transactions in a portfolio company's securities as the basis of valuation (\"private market method\"). The private market method will be used only with respect to completed transactions or firm offers made by sophisticated, independent investors.\nPrior to 1992, the Fund had recorded cumulative net unrealized gain on investments of $458,556. During 1993, the Fund recorded $548,663 of unrealized gain and $802,365 of unrealized loss on investments. In addition, the Fund disposed of investments during 1993 with respect to which the Fund had recorded $656,407 of unrealized gain during prior years. Therefore, at December 31, 1993, the Fund had net unrealized loss on investments of $451,553.\nDuring 1994, the Fund recorded $2,085,990 of unrealized gain and $1,274,817 of unrealized loss on investments. In addition, the Fund disposed of investments during 1994 with respect to which the Fund had recorded $3,545,061 of net unrealized loss during prior years. Therefore, at December 31, 1994, the Fund had net unrealized gain on investments of $3,904,681.\nThe net decrease in unrealized gain on investments during 1995 and the cumulative net unrealized loss on investments at December 31, 1995, consisted of the following components:\nThe Neodata stock was written down to a negligible amount at March 31, 1995. The Fund has consistently valued this investment based upon a multiple of Neodata's cash flow. Because Neodata's long-term debt presently provides for the accrual, rather than current payment, of interest, the Company's debt has grown to a level which now exceeds the Fund's valuation.\nKEMET completed an IPO of its common stock on October 21, 1992. KEMET also declared a two-for-one stock split effective September 20, 1995. The stock, which trades on the NASDAQ National Market System, closed at $24.00 (an average of the closing bid and ask prices) on December 31, 1995. This price is up from the closing price (as restated for the two-for-one stock split) of $14.6875 on December 31, 1994. Based on the $24.00 closing trading price of the common stock, the 27,944 shares of common stock that the Fund held at December 31, 1995 had a market value of $670,656.\nDuring December 1995, Huntington entered into a letter of intent, under the terms of which all Huntington stock would be sold for cash. The sale was consummated during February 1996. The Fund's share of the actual sales proceeds totaled $1,511,364, of which $1,320,711 was received during February 1996. The balance is being held in escrow to fund various transaction expenses and potential contingent purchase price adjustments, and as collateral for potential claims of the buyer with respect to representations made by the selling shareholders, including the Fund. While the escrow amount must be maintained for a two year period, certain of the sellers' representations will survive for longer periods of time, which could result in the Fund being required to reimburse the purchaser for certain costs and expenses after the escrow is released. The Fund valued the Huntington warrants at December 31, 1995 at an amount approximately equal to 75% of the ultimate sales proceeds (not including the Fund's share of the escrow) due to the inherent uncertainty that existed at that time as to whether the sale would actually be consummated.\nThe Amity warrants and common stock were written up in value during 1995 to bring Amity's valuation more in line with the valuation of comparable companies in its industry.\nThe ENI Holding Corp. preferred stock is being written up in value quarterly to reflect the amount of the cumulative 10% preferential dividend that is accruing with respect to the preferred stock.\nThe MTI II common stock was written down in value at December 31, 1994 based upon an independent third party valuation of the company which was obtained by MTI's management.\nLMC has experienced significant operating difficulties since the Fund acquired its LMC investment during 1994. LMC's majority owner has taken a number of steps to improve LMC's operating and financial performance. These steps included hiring new senior management and significantly reducing staff. The majority owner has also contributed a significant amount of additional capital. However, it is anticipated that it will take some time for the company to regain its previous market position and return to profitability.\nDuring 1995, the majority owner requested that the Fund convert its subordinated debt and warrants to preferred stock and make a follow-on investment of $545,454 in order to help fund new product development. The Fund agreed to the proposed restructuring, which was consummated during February 1996. As a result of the restructuring, the Fund increased its ownership percentage from approximately 13% to approximately 27%. Due to LMC's operational difficulties and the fact that the Fund will now own equity securities rather than debt securities, the Fund wrote its LMC investment down by $540,800 during November 1995.\nCanadian's is a women's specialty retailer, which had 53 stores on the East Coast, including stores in the New York City and Philadelphia metropolitan areas. As widely reported in the business press, retailers almost universally experienced extremely disappointing sales during the 1995 holiday season. Women's specialty retailers were especially hard hit. This situation was exacerbated by severe winter weather which hampered store operations from Boston to Washington, D.C. As a result, a number of apparel retailers have filed for bankruptcy.\nCanadian's did not escape the retailing downturn and experienced significant operating problems. These problems culminated in Canadian's filing for Chapter 11 bankruptcy protection on February 21, 1996. As discussed in the Fund's previous filings, Canadian's had embarked on a significant cost cutting program during the fall of 1995, which included closing marginal stores and reducing general and administrative costs. However, these measures were not sufficient to offset the negative impact of the unusually bad holiday season. The Fund expects to recover little, if any, of its Canadian's investment. As a result of these developments, the Fund wrote its Canadian's investment down to a negligible amount at December 31, 1995.\nFCM continually monitors both the Fund's portfolio companies and the markets, and continually evaluates the decision to hold or sell its traded securities.\nInflation and Changing Prices\nInflation has had no material impact on the operations or financial condition of the Fund from inception through December 31, 1995. However, inflation and changing prices, in addition to other factors, may effect the value and the eventual selling price of the Fund's investments.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nFIDUCIARY CAPITAL PARTNERS, L.P.\nList of Financial Statements\nAll schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission have been omitted because (1) the information required is disclosed in the financial statements and notes thereto; (2) the schedules are not required under the related instructions; or (3) the schedules are inapplicable.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Partners of Fiduciary Capital Partners, L.P.:\nWe have audited the accompanying balance sheets of Fiduciary Capital Partners, L.P. (a Delaware limited partnership) as of December 31, 1995 and 1994, including the schedule of investments as of December 31, 1995, and the related statements of operations, cash flows and changes in net assets for each of the three years in the period ended December 31, 1995 and the selected per unit data and ratios for the five years then ended. These financial statements and per unit data and ratios are the responsibility of the partnership's managing general partner. Our responsibility is to express an opinion on these financial statements and per unit data and ratios based on our audits.\nWe conducted our audits in accordance 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 per unit data and ratios 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 as of December 31, 1995 and 1994, by correspondence with the custodian. An audit also includes assessing the accounting principles used and significant estimates made by management, as 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 and selected per unit data and ratios referred to above present fairly, in all material respects, the financial position of Fiduciary Capital Partners, L.P. as of December 31, 1995 and 1994, and the results of its operations, its cash flows and the changes in its net assets for each of the three years in the period ended December 31, 1995, and the selected per unit data and ratios for the five years then ended, in conformity with generally accepted accounting principles.\nAs discussed in Note 2, the financial statements include investment securities valued at $12,731,160 at December 31, 1995 (53.9% of net assets) and $19,079,860 at December 31, 1994 (67.3% of net assets) whose values have been estimated by the managing general partner in the absence of readily ascertainable market values. However, because of the inherent uncertainty of valuation, the managing general partner's estimate of values may differ significantly from the values that would have been used had a ready market existed for the securities and the differences could be material.\n\/s\/ Arthur Andersen LLP\nDenver, Colorado February 6, 1996.\nFIDUCIARY CAPITAL PARTNERS, L.P. SCHEDULE OF INVESTMENTS DECEMBER 31, 1995\nThe accompanying notes to financial statements are an integral part of this schedule.\nFIDUCIARY CAPITAL PARTNERS, L.P. SCHEDULE OF INVESTMENTS (CONTINUED) DECEMBER 31, 1995\nThe accompanying notes to financial statements are an integral part of this schedule.\nFIDUCIARY CAPITAL PARTNERS, L.P.\nSCHEDULE OF INVESTMENTS (CONTINUED)\nDECEMBER 31, 1995\n(1) The KEMET Corporation common stock trades on the NASDAQ National Market System.\n(2) Pursuant to the terms of the Fund's agreement with Huntington Holdings, Inc., under certain circumstances the number of shares issuable upon exercise of the warrants held by the Fund will increase periodically. The most recent such increase occurred on August 1, 1995 when the Fund received the right to an additional 33.6 shares. (Note 15)\n(3) The notes will amortize in eight equal quarterly installments of $760,898 commencing on 11\/30\/99.\n(4) The notes will amortize as follows: $32,623 on 9\/01\/97, $33,683 on 12\/01\/97, $34,777 on 3\/01\/98, $35,908 on 6\/01\/98, $37,075 on 9\/01\/98, $38,280 on 12\/01\/98, $39,524 on 3\/01\/99 and $2,352,130 on 5\/31\/99. The accrual of interest on the notes was discontinued by the Fund effective December 1, 1995. In addition, the Fund has agreed to restructure its LMC investment. The restructuring will involve a conversion of the Fund's existing subordinated debt and warrants into preferred stock and a follow-on investment in LMC for the purchase of new common stock. (Notes 12 and 13)\n(5) The notes will amortize in twelve equal quarterly installments of $227,750 commencing on 12\/01\/99. The notes also bear contingent additional interest to be computed under a specified formula. The accrual of interest on the notes was discontinued by the Fund effective December 1, 1995. (Notes 12 and 15)\n(6) The debentures are convertible into Canadian's Holdings, Inc. common stock. The accrual of interest on the debentures was discontinued by the Fund effective April 1, 1995. (Notes 12 and 15)\n(7) The notes bear interest equal to the prime rate, plus 5%. The accrual of interest on the notes was discontinued by the Fund effective October 1, 1995. (Notes 12 and 15)\n(8) The notes will amortize in three equal annual installments of $486,667 commencing on 5\/24\/00.\n* Non-income producing security.\nThe accompanying notes to financial statements are an integral part of this schedule.\nFIDUCIARY CAPITAL PARTNERS, L.P.\nBALANCE SHEETS - DECEMBER 31, 1995 AND 1994\nThe accompanying notes to financial statements are an integral part of these financial statements.\nFIDUCIARY CAPITAL PARTNERS, L.P.\nSTATEMENTS OF OPERATIONS\nFOR EACH OF THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nThe accompanying notes to financial statements are an integral part of these financial statements.\nFIDUCIARY CAPITAL PARTNERS, L.P.\nSTATEMENTS OF CASH FLOWS\nFOR EACH OF THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nThe accompanying notes to financial statements are an integral part of these financial statements.\nFIDUCIARY CAPITAL PARTNERS, L.P.\nSTATEMENTS OF CHANGES IN NET ASSETS\nFOR EACH OF THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nThe accompanying notes to financial statements are an integral part of these financial statements.\nFIDUCIARY CAPITAL PARTNERS, L.P.\nSELECTED PER UNIT DATA AND RATIOS (1)\nFOR EACH OF THE YEARS ENDED\nDECEMBER 31, 1995, 1994, 1993, 1992 AND 1991\n- ------------ (1) Effective October 1, 1993, each $1,000 limited partnership unit was redenominated into fifty $20 limited partnership units. All amounts shown for prior periods have been restated to give effect to this redenomination.\n(2) Calculated using the weighted average number of limited partnership units outstanding during the years ended December 31, 1995, 1994 and 1993 of 1,513,503, 1,669,129 and 1,791,201, respectively.\nThe accompanying notes to financial statements are an integral part of these selected per unit data and ratios.\nFIDUCIARY CAPITAL PARTNERS, L.P.\nNOTES TO FINANCIAL STATEMENTS\nDECEMBER 31, 1995 AND 1994\n1. ORGANIZATION AND PURPOSE\nFiduciary Capital Partners, L.P. (the \"Fund\"), a Delaware limited partnership, was formed on October 20, 1988 to operate as a business development company under the Investment Company Act of 1940. The Fund's operations commenced on August 14, 1990.\nFCM Fiduciary Capital Management Company (\"FCM\"), the Managing General Partner of, and the investment adviser to, the Fund, is responsible, subject to the supervision of the Independent General Partners, for overseeing and monitoring the Fund's investments.\nThe investment objective of the Fund is to provide current income and capital appreciation by investing primarily in subordinated debt and related equity securities issued as the mezzanine financing of privately structured, friendly leveraged buyouts, leveraged acquisitions and leveraged recapitalizations. These investments are referred to herein as \"portfolio investments\". Managed companies are those to which significant managerial assistance is offered.\nAs set forth in the Partnership Agreement, the Fund's investment period ended on December 31, 1995. Although the Fund is permitted to make additional investments in existing portfolio companies, the Fund is no longer permitted to acquire investments in new portfolio companies, except to fund commitments made prior to December 31, 1995. (See Note 13.)\nA separate fund, Fiduciary Capital Pension Partners, L.P. (\"FCPP\"), was also formed on October 20, 1988 for tax-exempt investors with investment objectives, policies and restrictions similar to those of the Fund. While the Fund and FCPP have co-invested in each of the portfolio investments, each fund is accounted for separately. Each fund's participation in the portfolio investments is in proportion to the amount of capital that each fund had available for investment at the time each investment was acquired. Certain expenses are allocated between the funds based on the amount of each fund's total capital. The accompanying financial statements include only the activities of the Fund.\n2. SIGNIFICANT ACCOUNTING POLICIES\nAccounting Method The Fund maintains its accounting records, prepares financial statements and files its tax returns using the accrual method of accounting.\nValuation of Investments FCM values the Fund's investments on a weekly basis utilizing a variety of methods. For securities that are publicly traded and for which market quotations are available, valuations are set by the closing sales, or an average of the closing bid and asked prices, as of the valuation date. The Fund discounts these closing market prices between 5% and 20% to reflect lack of liquidity, if the Fund's securities are subject to legal or contractual trading restrictions, or to reflect the potential market impact which could result from the sale of the securities, if the Fund and FCPP combined own a material percentage of the outstanding securities. The amount of the discount varies based upon the type of restriction, the time remaining on the restriction and the size of the holding.\nFair value for securities that are not fully traded in any liquid public markets or that are privately held are determined pursuant to valuation policies and procedures which have been approved by the Independent General Partners and subject to their supervision. There is a range of values that are reasonable for such investments at any particular time. Each such investment is valued initially based\nFIDUCIARY CAPITAL PARTNERS, L.P.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nDECEMBER 31, 1995 AND 1994\nupon its original cost to the Fund (\"cost method\"). Debt securities with attached warrants for the purchase of common stock are initially recorded at a discount from face value equal to the estimated relative value of the warrants at date of investment. The discount is amortized to income as an adjustment to yield from the debt securities. Face value less unamortized discount represents the \"amortized cost\" of the debt securities.\nThe cost method is used until significant developments affecting the portfolio company provide a basis for use of an appraisal valuation. Appraisal valuations are based upon such factors as the portfolio company's earnings, cash flow and net worth, the market prices for similar securities of comparable companies and an assessment of the portfolio company's future financial prospects. In a case of unsuccessful operations, the appraisal may be based upon liquidation value. Appraisal valuations are necessarily subjective. The Fund also may use, when available, third-party transactions in a portfolio company's securities as the basis of valuation (\"private market method\"). The private market method is used only with respect to completed transactions or firm offers made by sophisticated, independent investors.\nTemporary investments with maturities of less than 60 days are stated at amortized cost, which approximates market value. Under this method, temporary investments are valued at cost when purchased and thereafter a constant proportionate amortization of any discount or premium is recorded until maturity of the investment.\nCash and Cash Equivalents The Fund considers investments in money market funds to be cash equivalents.\nInterest Receivable on Notes Notes are placed on non-accrual status in the event of a default (after any applicable grace period expires) or if FCM determines that there is no reasonable expectation of collecting the interest.\nIncome Taxes No provision for income taxes has been made in the financial statements because taxes on Fund income are the responsibility of the individual partners rather than the Fund.\nInvestment Transactions The Fund records portfolio investment transactions on the date on which it obtains an enforceable right to demand the securities or payment thereof and records temporary investment transactions on the trade date. Realized gains and losses on investments are determined on the basis of specific identification for both accounting and tax purposes.\n3. ALLOCATIONS OF PROFITS, LOSSES AND CASH DISTRIBUTIONS\nPursuant to the Partnership Agreement, all income derived from temporary investments will be distributed and allocated 99% to the Limited Partners and 1% to FCM. Net investment income will, in general, be distributed and allocated: (i) 99% to the Limited Partners and 1% to FCM until the Limited Partners have received a cumulative non-compounded preferred return of 9% per annum on their capital contributions to the Fund, then (ii) 70% to the Limited Partners and 30% to FCM until FCM has received 10% of all current and prior distributions and allocations, and thereafter, (iii) 90% to the Limited Partners and 10% to FCM.\nFIDUCIARY CAPITAL PARTNERS, L.P.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nDECEMBER 31, 1995 AND 1994\nProceeds from capital transactions will, in general, be distributed and allocated: (i) 99% to the Limited Partners and 1% to FCM until the Limited Partners have received a cumulative, non-compounded preferred return of 9% per annum on their capital contribution to the Fund from net investment income, capital transactions, or both, then (ii) 100% to the Limited Partners until they have received a return of their capital contributions to the Fund, and thereafter, (iii) 80% to the Limited Partners and 20% to FCM.\nAll cash distributions and earnings since the inception of the Fund have been allocated 99% to the Limited Partners and 1% to FCM.\n4. CAPITAL CONTRIBUTIONS\nUpon formation of the Fund, FCM contributed $4,000 for its general partner interest in the Fund. Units of limited partnership interest (\"Units\") were then sold in a public offering. The Fund held three closings between August 14, 1990 and October 18, 1990, receiving gross offering proceeds of $36,102,000. Commissions and other offering costs were charged against proceeds resulting in net capital contributions from Limited Partners of $31,860,015.\n5. PERIODIC UNIT REPURCHASE PLAN\nThe Fund's Limited Partners adopted a periodic unit repurchase plan during 1993. Pursuant to the terms of the repurchase policy, the Fund will annually offer to repurchase from its Limited Partners, up to 7.5% of its outstanding Units for an amount equal to the current net asset value per Unit, net of a fee (not to exceed 2%) to be retained by the Fund to offset expenses incurred in connection with the repurchase offer. If the number of tendered Units in any year exceeds 7.5% of the outstanding Units, the Fund's General Partners may vote to repurchase up to an additional 2% of the outstanding Units.\nRepurchases of Units since the adoption of the plan can be summarized as follows:\n6. INVESTMENT ADVISORY FEES\nAs compensation for its services as investment adviser, FCM receives a subordinated monthly fee at the annual rate of 1% of the Fund's available capital, as defined in the Partnership Agreement. Investment advisory fees of $228,980, $274,085 and $316,113 were incurred by the Fund for 1995, 1994 and 1993, respectively.\nFIDUCIARY CAPITAL PARTNERS, L.P.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nDECEMBER 31, 1995 AND 1994\n7. FUND ADMINISTRATION FEES\nAs compensation for its services as fund administrator, FCM receives a monthly fee at the annual rate of .45% of net proceeds available for investment, as defined in the Partnership Agreement. Fund administration fees of $143,370 were incurred each year by the Fund during 1995, 1994 and 1993. FCM is also reimbursed, subject to various limitations, for administrative expenses incurred in providing accounting and investor services to the Fund. The Fund reimbursed FCM for administrative expenses of $80,147, $80,269 and $81,695 for 1995, 1994 and 1993, respectively.\n8. INDEPENDENT GENERAL PARTNER FEES AND EXPENSES\nAs compensation for services rendered to the Fund, each of the Independent General Partners receives from the Fund and FCPP an annual fee of $30,000, payable monthly in arrears, together with all out-of-pocket expenses. Each fund's allocation of these fees and expenses is based on the relative number of outstanding Units. Fees and expenses of $58,015, $57,620 and $55,687 were incurred by the Fund for 1995, 1994 and 1993, respectively.\n9. OTHER RELATED PARTY TRANSACTIONS\nFCM and its affiliates are entitled to reimbursement of certain direct expenses paid on behalf of the Fund. Such reimbursable expenses amounted to $172,443, $175,297 and $242,719 during 1995, 1994 and 1993, respectively.\n10. PORTFOLIO INVESTMENTS\nThe Fund's portfolio investments consist primarily of high-yield private placement securities issued as the mezzanine financing of privately structured, friendly leveraged buyouts, leveraged acquisitions and leveraged recapitalizations, and are generally linked with an equity participation. The risk of loss upon default by an issuer is greater than with investment grade securities because high-yield securities are generally unsecured and are usually subordinated to other creditors of the issuer. Also, these issuers usually have higher levels of indebtedness and are more sensitive to adverse economic conditions than investment grade issuers. Most of these securities are subject to resale restrictions and generally there is no quoted market for such securities.\nAlthough the Fund cannot eliminate the risks associated with its investments in these high-yield securities, it has established risk management procedures. The Fund subjects each prospective investment to rigorous analysis, and makes only those investments that are recommended by FCM and that meet the Fund's investment guidelines or that have otherwise been approved by the Independent General Partners. The Fund also has procedures in place to continually monitor its portfolio companies.\nAs of December 31, 1995, the Fund held portfolio investments in nine Managed Companies, with an aggregate cost of approximately $16.7 million. During the year ended December 31, 1995, the Fund exercised the Protection One, Inc. warrants it held, acquired a new portfolio investment in R.B.M. Precision Metal Products, Inc. and acquired two follow-on investments in Canadian's Corp. (\"Canadian's\") at a total cost of approximately $3.2 million.\nFIDUCIARY CAPITAL PARTNERS, L.P.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nDECEMBER 31, 1995 AND 1994\nThe Fund's subordinated debt investment in Protection One Alarm Monitoring, Inc. was prepaid during 1995. In addition, the Fund sold its subordinated debt investment in KB Alloys, Inc., all of its Carr-Gottstein Foods Co. and Protection One, Inc. common stock and a portion of its KEMET Corporation common stock during 1995. The Fund received $10,141,691 in proceeds, including applicable prepayment premiums, resulting in aggregate realized gains of $4,588,421.\nThe Fund has pledged the common stock and warrants it owns in Amity Leather Products Co. (\"Amity\") as collateral for Amity's corporate debt. None of the Fund's other portfolio investments have been pledged or otherwise encumbered.\n11. UNREALIZED GAIN (LOSS) ON INVESTMENTS\nAs of December 31, 1994, the Fund had recorded net unrealized gain on investments of $3,904,681. During 1995, the Fund recorded $777,782 of unrealized gain and $5,622,311 of unrealized loss on investments. In addition, the Fund disposed of investments during 1995 with respect to which the Fund had recorded $2,335,481 of net unrealized gain during prior years. Therefore, at December 31, 1995, the Fund had net unrealized loss on investments of $3,275,329.\n12. NON-ACCRUAL STATUS OF INVESTMENTS\nIn accordance with the Fund's accounting policies, the Fund stopped accruing interest on (i) the Canadian's Holdings, Inc. Exchangeable Redeemable Debentures effective April 1, 1995, (ii) the Canadian's Promissory Notes effective October 1, 1995, (iii) the Canadian's Subordinated Notes effective December 1, 1995 and (iv) the LMC Operating Corp. (\"LMC\") Senior Subordinated Notes effective December 1, 1995.\n13. COMMITMENTS AND CONTINGENCIES\nAs of December 31, 1995, the Fund had issued commitments to make new portfolio investments in Atlas Environmental, Inc. (\"Atlas\"), Monaco Finance, Inc. (\"Monaco\") and Advantage Funding Group, Inc. (\"Advantage\"). In addition, the Fund had agreed in principle to a restructuring of its LMC investment, which involves a conversion of the Fund's existing subordinated debt and warrants into preferred stock and a follow-on investment in LMC for the purchase of new common stock.\nOn January 25, 1996, the Fund closed the investment in Atlas, a non-managed company, at a cost of $3,855,398. The investment consists of $3,934,080 of 13.5% Senior Subordinated Secured Notes due January 19, 2003, with warrants to acquire 407,659 shares of common stock. The warrants have an exercise price of $8.00 per share. The Atlas common stock is currently traded over the counter on a limited basis with quotations provided via the OTC Bulletin Board under the symbol \"ATEV\".\nThe proposed Advantage investment was abandoned during January 1996. The portion of the Fund's available capital that had been reserved for this investment is now reserved to fund the Fund's 1996 annual repurchase offer.\nFIDUCIARY CAPITAL PARTNERS, L.P.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nDECEMBER 31, 1995 AND 1994\nThe Fund may not ultimately fund both of the remaining commitments since each of the commitments is subject to various contingencies.\nFCM had been named as a defendant in a class action lawsuit brought in March 1995 against PaineWebber Incorporated and a number of its affiliates concerning the sale of 70 different limited partnerships and other direct investment programs. During May 1995, the Court entered an order certifying the class and dismissing the class action against FCM without prejudice.\nDuring January 1996, PaineWebber signed a memorandum of understanding with the plaintiffs in the class action outlining the terms under which the parties have agreed to settle the case. Pursuant to that memorandum of understanding, PaineWebber irrevocably deposited $125 million into an escrow fund under the supervision of the United States District Court for the Southern District of New York to be used to resolve the litigation in accordance with a definitive settlement agreement and plan of allocation which the parties expect to submit to the court for its consideration and approval within the next several months. Until a definitive settlement and plan of allocation is approved by the court, there can be no assurance what, if any, payment or non-monetary benefits will be made available to unitholders in the Fund.\nFCM believes that this litigation will be resolved without any material adverse effect on the Fund's financial condition.\n14. RECONCILIATION TO INCOME TAX METHOD OF ACCOUNTING\nThe following is a reconciliation of the net increase in net assets resulting from operations in the accompanying financial statements to the taxable income reported for federal income tax purposes:\nFIDUCIARY CAPITAL PARTNERS, L.P.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nDECEMBER 31, 1995 AND 1994\nThe following is a reconciliation of the amount of the Fund's net assets as shown in the accompanying financial statements and the tax bases of the Fund's net assets:\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 with respect to accounting or financial disclosure issues during 1995 or 1994.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nThe Fund has no directors or executive officers. The General Partners of the Fund jointly manage and control the affairs of the Fund and have general responsibility and authority in all matters affecting its business.\nFCM serves as Investment Adviser to the Fund and is responsible for the identification of all investments made by the Fund and all other investment advisory services necessary for the operation of the Fund in carrying out its investment objectives and policies. The Investment Committee of FCM is responsible for approval of all investment decisions of FCM with respect to the Fund and consists of seven members. Five of the seven members are appointed by FCM Fiduciary Capital Corporation (\"FCC\") and two are appointed by Mezzanine Capital Corporation (\"MCC\"). The current members of the Investment Committee are Paul Bagley, W. Duke DeGrassi and Michael G. Rafferty, appointed by FCC; and Gerald F. Goertz, Jr. and Clifford B. Wattley, appointed by MCC. Election of two additional members to the Investment Committee by FCC remains undetermined as of the date of this Report. The Independent General Partners oversee the investment activities of the Investment Adviser.\nInformation concerning the directors and executive officers of the Managing General Partner (and of its partners) and the Independent General Partners is as follows:\nFCM Fiduciary Capital Management Company (a Delaware general partnership, the partners of which are FCM Fiduciary Capital Corporation, Mezzanine Capital Corporation and Paul Bagley)\nPaul Bagley, age 53, is Chairman, Chief Executive Officer and an Investment Committee Member of FCM Fiduciary Capital Management Company. For more than twenty years prior to October 1988, Mr. Bagley was engaged in investment banking activities with Shearson Lehman Hutton Inc. (\"Shearson\") and its predecessor, E.F. Hutton & Company Inc. (\"E.F. Hutton\"). During such time, he served in various capacities with Shearson and E.F. Hutton, including Executive Vice President and Director, Managing Director, Head of Direct Investment Origination and Manager of Corporate Finance. Mr. Bagley serves as a director and member of the Executive Committee of America First Financial and Chairman of the Board of Directors of Silver Screen Management, Inc. Mr. Bagley also serves as a Director of EurekaBank, whose parent, America First Financial Fund is NASDAQ listed. As of January 19, 1995, Mr. Bagley became the President and Chief Executive Officer of Laidlaw Holdings, Inc. and is the managing partner of an investment partnership which controls substantial ownership of Laidlaw Holdings, Inc. Mr. Bagley also serves as President of American National Security, the managing general partner of Security Income Trust L.P.\nW. Duke DeGrassi, age 49, is the President and an Investment Committee Member of FCM Fiduciary Capital Management Company. From May 1988 to December 1993, Mr. DeGrassi was a Corporate Vice President with PaineWebber Incorporated. From 1986 and until joining PaineWebber, Mr. DeGrassi was a Vice President in the Direct Investments Group at Shearson Lehman Hutton Inc.\nPrior to that, Mr. DeGrassi spent seventeen years as a financial executive in the energy business, working both domestically and in foreign operations. Mr. DeGrassi received a Bachelor of Business Administration in accounting from the University of Texas at Austin in 1969.\nCharles R. Gwirtsman, age 42, is a Senior Vice President of FCM Fiduciary Capital Management Company. From May 1988 to December 1993, Mr. Gwirtsman was a Corporate Vice President with PaineWebber Incorporated. Prior to joining PaineWebber Incorporated, Mr. Gwirtsman had been an Associate, since 1986, in the Direct Investments Group with Shearson Lehman Hutton Inc. Prior to joining Shearson, Mr. Gwirtsman was employed as a Financial Analyst at the United Bank of Denver, National Association during 1986. From 1980 to 1984, he served as a Senior Consultant for Admins, Inc., a computer software firm in Cambridge, Massachusetts, engaging in the design and implementation of large financial data processing systems. Mr. Gwirtsman received his Bachelor of Arts degree from Columbia University in 1975 and a Masters of Business Administration from the University of Denver in 1986.\nDonald R. Jackson, age 46, is a Senior Vice President, Treasurer, Assistant Secretary, Chief Financial and Accounting Officer and Compliance Officer of FCM Fiduciary Capital Management Company. From January 1990 to June 1994, Mr. Jackson was a Corporate Vice President with PaineWebber Incorporated, where he was involved in the financial administration of various publicly and privately offered investment programs. During 1989, Mr. Jackson was self-employed. Immediately prior to that he was a First Vice President in the Direct Investments Group with Shearson Lehman Hutton Inc. From 1972 to 1986, Mr. Jackson was associated with the accounting firm of Arthur Andersen & Co., serving as a partner from 1981 to 1986. He received a Bachelor of Science degree in accounting in 1971 from the University of Denver and is a Certified Public Accountant.\nFCM Fiduciary Capital Corporation\nFor information regarding Paul Bagley, W. Duke DeGrassi, Charles R. Gwirtsman and Donald R. Jackson see the above section concerning the management of FCM Fiduciary Capital Management Company.\nMezzanine Capital Corporation\nGerald F. Goertz, Jr., age 38, is the President and a Director of Mezzanine Capital Corporation. Mr. Goertz joined PaineWebber Incorporated in December 1990 and holds the position of Senior Vice President and Director of Private Investments. Prior to joining PaineWebber Incorporated, Mr. Goertz was associated with CG Realty Advisors and The Freeman Company. He received his Bachelor of Arts degree in Business Administration in 1979 from Vanderbilt University and his Juris Doctorate and Masters of Business Administration from Memphis State University in 1982.\nClifford B. Wattley, age 46, is a Vice President, Assistant Secretary and Director of Mezzanine Capital Corporation. Mr. Wattley is a Corporate Vice President with PaineWebber Incorporated, having joined the firm in 1986. He also was employed previously by Paine, Webber, Jackson & Curtis from 1979 to 1980. From 1986 to 1992, Mr. Wattley participated in PaineWebber's Principal Transactions Group. From 1992, Mr. Wattley has been a member of the Private Investment Department. He holds a Bachelor of Science degree in engineering from Columbia University and a Masters in Business Administration from Harvard University.\nStephen R. Dyer, age 36, is a Vice President, Assistant Secretary and Director of Mezzanine Capital Corporation. He joined PaineWebber Incorporated in June 1988 as a Divisional Vice President and is currently a Corporate Vice President. Prior to joining PaineWebber Incorporated, Mr. Dyer had been employed, since June 1987, as an Assistant Vice President in the Retail National Products Group of L.F. Rothschild & Co. Incorporated. Prior to joining L.F. Rothschild he was employed, beginning in January 1985, as an Associate in the Real Estate Department of Thomson McKinnon Securities Inc. From July 1981 to August 1983, Mr. Dyer was on the audit staff of the accounting firm of Arthur Young & Company. He received his Bachelor of Science degree in Accounting in 1981 from Boston College and a Masters of Business Administration from Indiana University in December 1984. Mr. Dyer is a Certified Public Accountant.\nJoseph P. Ciavarella, age 40, is a Vice President, Secretary, Treasurer and Chief Financial and Accounting Officer of Mezzanine Capital Corporation. He joined PaineWebber Incorporated in May 1994. Prior to joining PaineWebber Incorporated, he was affiliated with Aviation Capital Group in the area of aircraft finance. Mr. Ciavarella was associated with Intergrated Resources, Inc. from 1983 to 1993 as a corporate officer as well as a senior officer in various subsidiaries in the equipment leasing aircraft finance and venture capital areas. Mr. Ciavarella has a Bachelor of Business Administration degree in Accounting from Hofstra University and is a Certified Public Accountant.\nIndependent General Partners\nA. Norman J. Peer\nNorman J. Peer, age 59, has been an Independent General Partner since 1990. Mr. Peer is a partner in the Woodbridge, New Jersey law firm of Wilentz, Goldman & Spitzer. Prior to 1988, he was a partner of the New York law firm of Satterlee, Stephens, Burke & Burke. Mr. Peer also served two years of active duty with the U.S. Navy as an Assistant Guided Missile Officer (1958-1960) and served in the U.S. Navy Reserve (1960-1970) reaching the rank of Lieutenant Commander. He is a director of Hudson Club, Inc., (restaurant and retail development). Mr. Peer served as the Municipal Court Judge in Atlantic Highlands, NJ from 1972 until 1988. Mr. Peer has a B.A. degree from Villanova University and a J.D. degree from Fordham University School of Law.\nB. Robert H. Arnold\nRobert H. Arnold, age 51, has been an Independent General Partner since 1992. Mr. Arnold is President of R.H. Arnold & Co., Inc., a New York-based investment banking firm he founded in 1989. R.H. Arnold & Co. specializes in providing financial advisory services on corporate mergers, acquisitions, divestitures and restructurings and in assisting emerging and medium-sized companies in the private placement of equity and debt securities. Prior to forming R.H. Arnold & Co., Mr. Arnold was Executive Vice President of Cambrian Capital Corporation, an investment banking firm he co-founded in\n1987. Before establishing Cambrian Capital, Mr. Arnold was associated with Merrill Lynch & Co. During his tenure at Merrill Lynch, Mr. Arnold held positions in its Capital Markets Group, in both the investment banking and the institutional sales areas, and at the senior corporate level, including Treasurer of Merrill Lynch & Co. Mr. Arnold received his B.S., M.S. and Ph.D. degrees from Northwestern University with majors in finance and accounting.\nC. E. Bruce Fredrikson\nE. Bruce Fredrikson, age 57, has been an Independent General Partner since 1992. Dr. Fredrikson is a Professor of Finance at Syracuse University School of Management where he has taught since 1966 and has previously served as Chairman of the Finance Department. Dr. Fredrikson has a bachelor's degree in economics from Princeton University and a master's degree in business administration and a Ph.D. in finance from Columbia University. Dr. Fredrikson serves as a director of Innodata Corporation and Global Market Information, Inc., both of which are NASDAQ listed.\nCompliance with Section 16(a) of the Exchange Act\nBased solely upon a review of Forms 3 and 4 furnished to the Fund during 1995 and 1996, and written representations by the persons listed above, the Fund has not identified any such person that failed to file on a timely basis the forms required by Section 16(a) of the Exchange Act for fiscal year 1995.\nItem 11.","section_11":"Item 11. Executive Compensation\nNo compensation was paid by the Fund to the officers and directors of the General Partners during 1995. See Item 13 of this Report, \"Certain Relationships and Related Transactions\" for a description of the compensation and fees paid to the General Partners and their affiliates by the Fund during 1995.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\n(a) As of the date hereof, no person is known by the Fund to be the beneficial owner of more than 5% of the Units of the Fund. The Fund has no directors or officers, and none of the General Partners of the Fund owns any Units.\nThe name and address of the Managing General Partner is as follows:\nFCM Fiduciary Capital Management Company 410 17th Street, Suite 400 Denver, Colorado 80202\n(b) No directors or officers of FCM Fiduciary Capital Management Company, FCM Fiduciary Capital Corporation or Mezzanine Capital Corporation and no Independent General Partners owned any Units as of March 1, 1996.\n(c) The Fund knows of no arrangements, the operation of the terms of which may at a subsequent date result in a change in control of the Fund.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThe Fund may co-invest in portfolio investments with FCPP, under certain terms and conditions, pursuant to a co-investment order issued by the Securities and Exchange Commission. The Funds have co-invested in the past and are continuing to do so. See Item 1 of this Report, \"Business\", for a description of these co-investments.\nThe General Partners and their affiliates have received, or will receive, certain types of compensation, fees or other distributions in connection with the operations of the Fund. The fees and compensation were determined in accordance with the applicable provisions of the Partnership Agreement.\nFollowing is a summary of the amounts paid, or payable, to the General Partners and their affiliates for 1995.\nInvestment Advisory Fees As compensation for its services as investment adviser, FCM receives a subordinated monthly fee at the annual rate of 1% of the Fund's available capital, as defined in the Partnership Agreement. During 1995, FCM earned investment advisory fees of $228,980.\nFund Administration Fees As compensation for its services as fund administrator, FCM receives a monthly fee at an annual rate of .45% of net proceeds available for investment, as defined in the Partnership Agreement. During 1995, FCM earned fund administration fees of $143,370. The Fund also reimbursed FCM for $80,147 of administrative expenses incurred in providing accounting and investor services to the Fund during 1995.\nIndependent General Partner Fees and Expenses As compensation for services rendered to the Fund, each of the Independent General Partners receives from the Fund and FCPP an annual fee of $30,000, payable monthly in arrears, together with all out-of-pocket expenses. Each fund's allocation of these fees and expenses is based on the relative number of outstanding Units. Fees and expenses of $58,015 were incurred by the Fund during 1995.\nAccountable Expenses FCM and its affiliates are entitled to reimbursement of certain direct expenses paid on behalf of the Fund. During 1995, such reimbursable expenses amounted to $172,443.\nPartnership Interest FCM received cash distributions of $18,146 as their allocable share of distributions for 1995. In addition, $(5,544) of the Fund's net investment income and net loss on investments for 1995 was allocated to FCM.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\n(a) and (d) The following documents are filed as part of this Report:\n1. Financial Statements: See List of Financial Statements in Item 8.\n2. Financial Statement Schedules: None.\n(b) The Partnership did not file any reports on Form 8-K during the fourth quarter of the fiscal year ended December 31, 1995.\n(c) Exhibits required to be filed.\n___________________ * Not filed herewith. In accordance with Rule 12b-32 of the General Rules and Regulations under the Securities Exchange Act of 1934, reference is made to the document previously filed with the Commission which is incorporated herein by reference.\n___________________ * Not filed herewith. In accordance with Rule 12b-32 of the General Rules and Regulations under the Securities Exchange Act of 1934, reference is made to the document previously filed with the Commission which is incorporated herein by reference.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nDated: March 25, 1996\nFIDUCIARY CAPITAL PARTNERS, L.P. (Registrant)\nBy: FCM FIDUCIARY CAPITAL MANAGEMENT COMPANY its Managing General Partner\nBy: \/s\/ W. Duke DeGrassi --------------------------------- W. Duke DeGrassi President\nBy: \/s\/ Donald R. Jackson --------------------------------- Donald R. Jackson Senior Vice President, Treasurer and Chief Financial and Accounting Officer\nBy: NORMAN J. PEER Independent General Partner\n\/s\/ Norman J. Peer ---------------------------------\nBy: ROBERT H. ARNOLD Independent General Partner\n\/s\/ Robert H. Arnold ---------------------------------\nBy: E. BRUCE FREDRIKSON Independent General Partner\n\/s\/ E. Bruce Fredrikson ---------------------------------\nPursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following person on behalf of the Registrant and in the capacities indicated on March 25, 1996.\nSIGNATURE OF THE SOLE DIRECTOR OF THE MANAGING GENERAL PARTNER OF FCM FIDUCIARY CAPITAL MANAGEMENT COMPANY (A DELAWARE GENERAL PARTNERSHIP), MANAGING GENERAL PARTNER OF THE REGISTRANT.\nExhibit Index\n- ------------------- * See Item 14(c) for statement of location of exhibits incorporated by reference.\nE-1","section_15":""}
{"filename":"791446_1995.txt","cik":"791446","year":"1995","section_1":"ITEM 1. BUSINESS. ------ --------\n(A) GENERAL DEVELOPMENT OF BUSINESS -------------------------------\nTrump Plaza Associates (the \"Partnership\") owns and operates the Trump Plaza Hotel and Casino (\"Trump Plaza\"), a luxury casino hotel located on The Boardwalk in Atlantic City, New Jersey. The Partnership was organized in June 1982 as a general partnership under the laws of the State of New Jersey. Trump Plaza Funding, Inc. (the \"Company\") was incorporated on March 14, 1986 as a New Jersey corporation and was originally formed solely to raise funds through the issuance and sale of its debt securities for the benefit of the Partnership. Trump Plaza Holding Associates (\"Holding\") was formed in February 1993 as a New Jersey general partnership for the purpose of raising funds through the issuance and sale of its Units (as defined).\nThe partners in the Partnership are Holding, which has a 99% interest in the Partnership, and the Company, which has a 1% interest in the Partnership. Donald J. Trump (\"Trump\"), by virtue of his ownership of the Company, Holding and Trump Plaza Holding Inc. (\"Holding Inc.\"), which owns a 1% partnership interest in Holding, is the beneficial owner of 100% of the equity interest in the Partnership. The two partners in Holding are Trump and Holding Inc. Holding Inc. acts as the managing general partner of Holding. Holding has no assets other than its equity interest in the Partnership. The Company is the managing general partner of the Partnership.\nOn June 24, 1993, the Partnership, the Company and certain affiliated entities completed a refinancing (the \"Refinancing\") of their debt and equity interests. The purpose of the Refinancing was (i) to repay, in full, the mortgage indebtedness and certain other indebtedness issued as part of the restructuring (the \"Restructuring\") of the indebtedness of the Partnership and the Company pursuant to a prepackaged plan of reorganization (the \"Plan\") under chapter 11 of the Bankruptcy Code of 1978, as amended, effective as of May 29, 1992, (ii) to repurchase the preferred stock interest in Trump Plaza not owned by Trump and (iii) to repay certain personal indebtedness of Trump. The Refinancing included (i) the offering (the \"Mortgage Note Offering\") by the Company of $330 million in aggregate principal amount of its 10-7\/8% Mortgage Notes due 2001 (the \"Mortgage Notes\") and (ii) the offering (the \"Units Offering\" and, together with the Mortgage Note Offering, the \"Offerings\") by Holding of 12,000 Units (the \"Units\") consisting of an aggregate of $60 million in principal amount of 12-1\/2% Pay- in-Kind Notes due 2003 (the \"PIK Notes\") and 12,000 warrants (the \"Warrants\") to acquire an aggregate of $12 million in principal amount of PIK Notes. Each of the Warrants entitles the holder to\nacquire $1,000 principal amount of PIK Notes for no additional consideration. The partnership agreement of the Partnership was amended and restated to alter certain procedures and to effectuate the consummation of the Offerings. See \"-- Narrative Description of Business -- The Refinancing and Restructuring.\"\nThe Mortgage Notes are senior indebtedness of the Company. The Company and the Partnership are subject to restrictions on the incurrence of additional indebtedness. The Mortgage Notes are unconditionally guaranteed by the Partnership. The Guarantee ranks pari passu in right of payment with all existing and future senior indebtedness of the Partnership. The PIK Notes are secured by Holding's equity interest in the Partnership. Holders of the PIK Notes and the Warrants are not creditors of the Partnership and, consequently, have no recourse to the assets of the Partnership if an event of default should occur thereunder. Accordingly, the PIK Notes are structurally subordinated to the indebtedness of the Partnership, including the Mortgage Notes.\nAs of December 31, 1994, the Company's debt consisted of approximately $326,234,000 (net of discount) outstanding of its Mortgage Notes. As of December 31, 1994, Holding's debt consisted of approximately $71,756,000 of PIK Notes and $12 million of deferred warrant obligations. As of December 31, 1994, the Partnership's debt consisted of a non-recourse promissory note to the Company in the amount of $326,234,000 (net of discount) and approximately $6 million of other indebtedness. The Partnership has unconditionally guaranteed the Mortgage Notes.\n(B) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS ---------------------------------------------\nThe Partnership operates in only one industry segment. See the Financial Statements of the Company and the Partnership included elsewhere herein.\n(C) NARRATIVE DESCRIPTION OF BUSINESS ---------------------------------\nGENERAL\nThe Partnership owns and operates Trump Plaza, a luxury casino hotel located in Atlantic City, New Jersey. Trump Plaza, with its 73,000 square foot casino, first class guest rooms and other luxury amenities, has both a \"Four Star\" Mobil Travel Guide rating and a \"Four Diamond\" American Automobile Association (\"AAA\") rating. Management believes that these ratings reflect the high quality amenities and services that Trump Plaza provides to its casino patrons and hotel guests. Trump Plaza is conveniently located on The Boardwalk, at the end of the main highway into Atlantic City and is one of the first\ncasino hotels visible from that approach. Management believes that the central location of Trump Plaza, with its accessibility to \"drive in\" and \"walk in\" patrons, is highly advantageous to Trump Plaza. In addition, the Casino Reinvestment Development Authority (\"CRDA\") is currently overseeing the development of a \"tourist corridor\" which will link The Boardwalk with downtown Atlantic City and, when completed, will feature an entertainment and retail complex of up to 800,000 square feet. Trump Plaza will be located at the end of the tourist corridor by The Boardwalk.\nTrump Plaza seeks to attract casino patrons who tend to wager more frequently and in larger denominations than the typical Atlantic City gaming patron (a \"high-end\" patron). This strategy is accomplished, in part, through the attractiveness of the facility, which is enhanced by routinely attending to the aesthetics of the casino and other public areas in Trump Plaza. In addition, Trump Plaza provides a consistency in the conduct of play of its table games that serious gaming patrons seek. Finally, Trump Plaza offers a broad selection of dining choices (including four gourmet restaurants), headline entertainment, deluxe accommodations and other amenities and services.\nFACILITIES AND AMENITIES\nThe casino in Trump Plaza currently offers 89 table games and 2,076 slot machines. In addition to the casino, Trump Plaza consists of a 31-story tower with 555 guest rooms, including 62 suites. Trump Plaza's hotel capacity will increase to a total of 904 guest rooms as a result of the renovation of 349 rooms at the Boardwalk Expansion Site. The facility also offers 10 restaurants, a 750-seat cabaret theater, four cocktail lounges, 28,000 square feet of convention, ballroom and meeting room space, a swimming pool, tennis courts and a health spa.\nThe entry level of Trump Plaza includes a cocktail lounge, two gift shops, a deli, a coffee shop, an ice cream parlor and a buffet. The casino level houses the casino, a fast food restaurant, an exclusive slot lounge for high-end patrons and a new ocean front baccarat gaming area. There is also an enclosed skywalk which connects Trump Plaza at the casino level with the Atlantic City Convention Center.\nTrump Plaza's guest rooms are located in a tower which affords most guest rooms a view of the ocean. While rooms are of varying size, a typical guest room consists of approximately 400 square feet. Trump Plaza also features 23 one-bedroom suites, 21 two-bedroom suites and 18 \"Super Suites.\" The Super Suites are located on the top two floors of the tower and offer luxurious accommodations and 24-hour butler and maid service. The Super\nSuites and certain other suites are located on the \"Club Level\" which requires guests to use a special elevator key for access, and contains a lounge area (the \"Club Level Lounge\") that offers food and bar facilities.\nTrump Plaza is connected by an enclosed pedestrian walkway to a 10- story parking garage, which can accommodate approximately 2,650 cars, and contains 13 bus bays, a comfortable lounge, a gift shop and waiting area (the \"Transportation Facility\"). The Transportation Facility provides patrons with immediate access to the casino, and is located directly off of the main highway into Atlantic City.\nBUSINESS STRATEGY\nGENERAL. After a period of turnover in management in 1994, the Partnership has hired a new president and chief operating officer for Trump Plaza, as well as several other senior managers. The new management team at Trump Plaza is dedicated to continuing Trump Plaza's longstanding commitment to maintaining high quality amenities, while at the same time pursuing an aggressive new strategy focusing on strategic expansion and customer service.\nA primary element of the Trump Plaza business strategy is to seek to attract patrons who tend to wager more frequently and in larger denominations than the typical Atlantic City gaming customer. Such high-end players typically wager $5 or more per play in slots and $25 or more per play in table games. In order to attract more high-end gaming patrons to Trump Plaza in a cost-effective manner, the Partnership has refocused its marketing efforts. Commencing in 1991, the Partnership substantially curtailed costly \"junket\" marketing operations which involved attracting groups of patrons to the facility on an entirely complimentary basis (e.g., by providing free air fare, gifts and room accommodations). In the fall of 1992, the Partnership decided to de-emphasize marketing efforts directed at \"high roller\" patrons from the Far East, who tend to wager $50,000 or more per play in table games. In each case the Partnership determined that the potential benefit derived from these patrons did not outweigh the high costs associated with attracting such players and the resultant volatility in the results of operations of Trump Plaza. This shift in marketing strategy has allowed the Partnership to focus its efforts on attracting the high-end players.\nIn addition, Trump Plaza's new management team has launched a variety of new initiatives designed to increase the level of casino gaming activity. These initiatives include targeted marketing and advertising campaigns directed to select\ngroups of customers in the corridor that extends from Washington, D.C. to Boston and includes New York City and Philadelphia, the introduction of new slot machines and table games and the addition of bill acceptors on slot machines.\nGAMING ENVIRONMENT. Trump Plaza also pursues a continuous preventative maintenance program that emphasizes the casino, hotel rooms and public areas in Trump Plaza. These programs are designed to maintain the attractiveness of Trump Plaza to its gaming patrons. Trump Plaza continuously monitors the configuration of the casino floor and the games it offers to patrons with a view towards making changes and improvements. Trump Plaza's casino floor has clear, large signs for the convenience of patrons. As new games have been approved by the Casino Control Commission (\"CCC\"), the Partnership has integrated such games into its casino operations to the extent it deems appropriate.\nIn recent years, there has been an industry trend towards fewer table games and more slot machines. For the Atlantic City casino industry, revenue from slot machines increased from 54.6% of the industry gaming revenue in 1988 to 66.9% of the industry gaming revenue in 1994. Trump Plaza experienced a similar increase, with slot revenue increasing from 51.2% of gaming revenue in 1988 to 64.7% of the industry gaming revenue in 1994. In response to this trend, Trump Plaza has devoted more of its casino floor space to slot machines. In April 1993, Trump Plaza removed 12 table games from the casino floor and replaced them with 75 slot machines. Moreover, as part of its program to attract high-end slot players, the Partnership created \"Fifth Avenue Slots,\" a partitioned portion of the casino floor that includes approximately 70 slot machines (most of which provide for $5 or more per play), an exclusive lounge for high-end patrons and other amenities.\n\"COMPING\" STRATEGY. In order to compete effectively with other Atlantic City casino hotels, the Partnership offers complimentary drinks, meals, room accommodations and\/or travel arrangements to its patrons (\"complimentaries\" or \"comps\"). Trump Plaza's policy on complimentaries is to provide comps primarily to patrons with a demonstrated propensity to wager at Trump Plaza.\nENTERTAINMENT. Trump Plaza offers headline entertainment, as well as other entertainment and revue shows as part of its strategy to attract high-end and other patrons. Trump Plaza offers headline entertainment weekly during the summer and monthly during the off-season, and also features other entertainment and revue shows.\nPLAYER DEVELOPMENT\/CASINO HOSTS. The Partnership currently employs gaming representatives in New Jersey, New York and other states, as well as several international representatives, to promote Trump Plaza to prospective gaming patrons. Player development personnel host special events, offer incentives and contact patrons directly in an effort to attract high-end table game patrons from the United States, Canada and South America. Trump Plaza's casino hosts assist patrons on the casino floor, make room and dinner reservations and provide general assistance. They also solicit Trump Card (the frequent player slot card) sign-ups in order to increase the Partnership's marketing base.\nPROMOTIONAL ACTIVITIES. The Trump Card, a player identification card, constitutes a key element in Trump Plaza's direct marketing program. Slot machine players are encouraged to register for and utilize their personalized Trump Card to earn various complimentaries based upon their level of play. The Trump Card is inserted during play into a card reader attached to the slot machine for use in computerized rating systems. The Company's computer systems record data about the cardholder, including playing preferences, frequency and denomination of play and the amount of gaming revenues produced.\nTrump Plaza designs promotional offers, conveyed via direct mail and telemarketing, to patrons expected to provide revenues based upon their historical gaming patterns. Such information is gathered on slot wagering by the Trump Card and on table game wagering by the casino game supervisors. Promotional activities include the mailing of vouchers for complimentary slot play. Trump Plaza also utilizes a special events calendar (e.g., birthday parties, sweepstakes and special competitions) to promote its gaming operations.\nThe Partnership conducts slot machine and table game tournaments in which cash prizes are offered to a select group of players invited to participate in the tournament based upon their tendency to play. Such players tend to play at their own expense during \"off-hours\" of the tournament. At times, tournament players are also offered special dining and entertainment privileges that encourage them to remain at Trump Plaza.\nBUS PROGRAM. Trump Plaza has a bus program, which transports approximately 2,400 gaming patrons per day during the week and 3,500 per day on the weekends. The Partnership's bus program offers incentives and discounts to certain scheduled and chartered bus customers. Trump Plaza's Transportation Facility contains 13 bus bays and is connected by an enclosed pedestrian walkway to Trump Plaza. The Transportation Facility provides\npatrons with immediate access to the casino, and contains a comfortable lounge area for patrons waiting for return buses.\nCREDIT POLICY. Historically, Trump Plaza has extended credit to certain qualified patrons. For the years ended December 31, 1994, 1993 and 1992, credit play as a percentage of total dollars wagered was approximately 17%, 18% and 28%, respectively. As part of the Partnership's new business strategy and in response to the general economic downturn in the Northeast, Trump Plaza has imposed stricter standards on applications for new or additional credit and has reduced credit to international patrons. Such stricter standards in the extension of credit have contributed to the reduction of credit play as a percentage of total dollars wagered and has led to improved quality of the credit extended.\nATLANTIC CITY MARKET\nGaming in Atlantic City started in May 1978 when the first casino hotel opened for business. Since 1978, gaming in Atlantic City has grown from one casino to 12 casinos as of December 31, 1994, with approximately $3.4 billion of casino industry revenue generated in 1994, a 4% increase over 1993 revenues of $3.3 billion, despite the effects of unfavorable winter weather in the first quarter of 1994. From 1989 to 1994, total casino revenues in Atlantic City have increased 22%. See \"-- Competition.\"\nAtlantic City is near many densely populated metropolitan areas. The primary area served by Atlantic City casino hotels is the corridor that extends from Washington, D.C. to Boston and includes New York City and Philadelphia. Within this primary area, Atlantic City may be reached by automobile or bus. Principal arteries lead into Atlantic City from the metropolitan New York area and from the Baltimore\/Washington, D.C. area, both of which are approximately three hours away by automobile. Atlantic City can also be reached by air and rail transportation, although most patrons arrive by automobile or bus.\nHistorically, Atlantic City has suffered from inadequate rail and air transportation. As a result, a majority of Atlantic City gaming patrons travel from the mid-Atlantic and northeast regions of the United States by automobile or bus. The State of New Jersey is in the process of implementing a $124 million capital plan to upgrade the Atlantic City International Airport and Atlantic City Expressway. Despite the expansion of the Atlantic City International Airport, however, access to Atlantic City by air is still limited by a lack of regularly scheduled flights and by inadequate terminal\nfacilities. The lack of adequate transportation infrastructure has limited the expansion of the Atlantic City gaming industry's geographic patron base and the attractiveness of Atlantic City to major conventions.\nIn February 1993, the State of New Jersey broke ground for a new $250,000,000 Convention Center on a 30.5-acre site adjacent to the Atlantic City Expressway. Targeted to open in January 1997, the new Convention Center will house approximately 500,000 square feet of exhibit space along with 45 meeting rooms totalling nearly 110,000 square feet. The building will include a 1,600-car underground garage and an indoor street linking the Convention Center to the existing Rail Terminal. The new Convention Center has been designed to serve as the centerpiece of Atlantic City's renaissance as a favorable meeting destination.\nEXPANSION SITES\nManagement has determined to expand the Partnership's facilities. The purpose of such an expansion is to increase the casino floor space and to add additional gaming units. Any such expansion will require various regulatory approvals, including the approval of the CCC. Furthermore, the Casino Control Act requires that additional guest rooms be put in service within a specified time period after any such casino expansion. As discussed below, the Partnership has begun the planned expansion of its hotel facilities at the Boardwalk Expansion Site (as defined). If the Partnership completed any casino expansion and subsequently did not complete the requisite number of additional guest rooms within the specified time period, the Partnership might have to close all or a portion of the expanded casino in order to comply with regulatory requirements, which could have a material adverse effect on the results of operations and financial condition of the Partnership.\nBOARDWALK EXPANSION SITE. In 1993, the Partnership received the approval of CCC, subject to certain conditions, for the expansion of the Trump Plaza hotel facilities on a 2.0-acre parcel of land located adjacent to Trump Plaza on The Boardwalk upon which there is located an approximately 349-room hotel, which was, at the time, closed to the public and in need of substantial renovation and repair (the \"Boardwalk Expansion Site\"). In June 1993, Trump and the lender holding mortgage liens on the Boardwalk Expansion Site negotiated the terms of a restructuring of loans of approximately $52.0 million of principal and accrued interest secured by the liens on the Boardwalk Expansion Site. On June 24, 1993, the date the Offerings were consummated, Trump transferred title to the Boardwalk Expansion Site to the lender in exchange for a\nreduction in Trump's indebtedness to such lender, with a further reduction of Trump's indebtedness if the Partnership assumed the Boardwalk Expansion Site Lease (as defined). On such date, the lender leased the Boardwalk Expansion Site to Trump (the \"Boardwalk Expansion Site Lease\") for a term of five years, which expires on June 30, 1998, during which time Trump is obligated to pay the lender $260,000 per month in lease payments.\nOn June 24, 1993, the Partnership also acquired a five-year option to purchase the Boardwalk Expansion Site (the \"Boardwalk Expansion Site Purchase Option\"). In October 1993, the Partnership assumed the leases associated with the Boardwalk Expansion Site. In addition, the Partnership has a right of first offer (the \"Right of First Offer\") upon any proposed sale of all or any portion of the Boardwalk Expansion Site during the term of the Boardwalk Expansion Site Purchase Option. Until such time as the Boardwalk Expansion Site Purchase Option is exercised or expires, the Partnership is obligated to pay the net expenses associated with the Boardwalk Expansion Site. During the year ended December 31, 1994, the Partnership incurred $4.9 million of such expenses. Under the Boardwalk Expansion Site Purchase Option, the Partnership has the right to acquire the Boardwalk Expansion Site for a purchase price of $27.0 million through 1995, increasing by $1.0 million annually thereafter until expiration on June 30, 1998. Under the terms of the Boardwalk Expansion Site Purchase Option, if the Partnership defaults in making payments due under the Boardwalk Expansion Site Purchase Option, the Partnership would be liable to the grantor of the Boardwalk Expansion Site Purchase Option for the sum of (a) the present value of all remaining payments to be made by the Partnership pursuant to the Boardwalk Expansion Site Purchase Option during the term thereof and (b) the cost of demolition of all improvements then located at the Boardwalk Expansion Site.\nAs of December 31, 1994, the Partnership had capitalized approximately $11.7 million in construction costs related to the Boardwalk Expansion Site including a $1 million consulting fee paid to Trump. Management does not currently anticipate that it will be in a position to exercise the Boardwalk Expansion Site Purchase Option prior to 1996 due, in part, to limitations on its ability to incur additional indebtedness. If the Partnership is unable to finance the purchase price of the Boardwalk Expansion Site pursuant to the Boardwalk Expansion Site Purchase Option, any amounts expended with respect to the Boardwalk Expansion Site, including payments under the Boardwalk Expansion Site Purchase Option and the Boardwalk Expansion Site Lease, if assumed, and any improvements thereon would inure to the benefit of the owner of the Boardwalk Expansion Site and not to the Partnership. In such event, the Partnership might have to close all or a portion of the expanded casino in order to comply with regulatory requirements, which could have a material adverse effect on the results of operations and financial condition of the Partnership.\nThe Partnership's ability to acquire the Boardwalk Expansion Site pursuant to the Boardwalk Expansion Site Purchase Option is dependent upon its ability to obtain financing to acquire the property and is subject to the approval of the CCC. See \"-- Gaming and Other Laws and Regulations.\" The ability to incur such indebtedness is also restricted by the Mortgage Note Indenture and the PIK Note Indenture and would require the consent of certain of Trump's personal creditors. The Partnership's ability to complete development of the Boardwalk Expansion Site is dependent upon its ability to use existing cash on hand and\ngenerate cash flow from operations sufficient to fund development costs. No assurance can be given that such cash on hand will be available to the Partnership for such purposes or that it will be able to generate sufficient cash flow from operations. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources.\" Pursuant to the Right of First Offer, the Partnership has ten days after receiving written notice from the grantor of the proposed sale to commit to exercise the Right of First Offer. If the Partnership commits to exercise the Right of First Offer, it has ten days from the date of the commitment to deposit $3,000,000 with the grantor, to be credited towards the purchase price or to be retained by the grantor if the closing, through no fault of the grantor, does not occur within ninety days (or, subject to certain conditions, 120 days) of the date of the commitment. There can be no assurance that the Partnership would have the liquidity necessary to exercise its Right of First Offer on a timely basis should it be required. In addition, exercise of the Boardwalk Expansion Site Purchase Option or the Right of First Offer requires the consent of certain of Trump's personal creditors, and there can be no assurance that such consent will be obtained at the time the Partnership desires to exercise the Boardwalk Expansion Site Purchase Option or such right of first offer. The CCC has required that the Partnership exercise the Boardwalk Expansion Site Purchase Option or the Right of First Offer therein no later than July 1, 1995. The Partnership intends to request a waiver of this requirement; however, no assurance can be given that such waiver will be granted or that any condition imposed by the CCC would be acceptable to the Partnership. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources.\"\nManagement is in the process of renovating the hotel at the Boardwalk Expansion Site. When completed, the hotel will have approximately 349 rooms, including a retail space fronting The Boardwalk, and 15,000 square feet of proposed gaming space on the second floor. As a result of this expansion, upon approval by the CCC, the Partnership will be permitted to increase Trump Plaza's casino floor space to 90,000 square feet. The Partnership added approximately 9,000 square feet in April 1994, 1,000 square feet in July 1994 and 3,000 square feet in December 1994. At December 31, 1994, the total casino floor space was 73,000 square feet. The Partnership has begun construction at the Boardwalk Expansion Site (pursuant to rights granted to the Partnership by the lender and the lessee under the Boardwalk Expansion Site Lease) prior to acquiring title thereto pursuant to the Boardwalk Expansion Site Purchase Option. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources.\"\nAcquisition of the Boardwalk Expansion Site by the Partnership would under certain circumstances (provided there are no events of default under the Boardwalk Expansion Site Lease or the Boardwalk Expansion Site Purchase Option and provided that\ncertain other events had not theretofore or do not thereafter occur) discharge Trump's obligation to such lender in full. Management believes that the Boardwalk Expansion Site will be useful to the operation of Trump Plaza as the site of the future expansion of the Partnership's hotel operations. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources.\"\nIn September 1993, Trump entered into a sublease agreement (the \"Time Warner Sublease\") with Time Warner Entertainment Company, L.P. (\"Time Warner\") for a period of ten years with the sublessee's option to renew the sublease for a ten-year period. Under this agreement, Time Warner agreed to sublease the entire first floor of the retail space (approximately 17,000 square feet) located at the Boardwalk Expansion Site for a new Warner Brothers Studio Store. In October 1993, the Partnership assumed Trump's duties and obligations under the Time Warner Sublease. In July 1994, Time Warner opened its second largest Warner Brothers Studio Store at the Boardwalk Expansion Site pursuant to the Time Warner Sublease. Management believes that the store will be a major attraction on The Boardwalk and will increase the flow of patrons through the casino. The remaining portion of the Boardwalk Expansion Site will be used for a new entranceway to Trump Plaza, directly off the Atlantic City Expressway, as well as a public park and parking facilities for Trump Plaza patrons.\nThe Partnership is obligated to either pay a tax to the CRDA of 2.5% of its gross casino revenues or to obtain investment tax credits in an amount equal to 1.25% of its gross casino revenues. The Partnership obtained approval from the CRDA for up to $14.1 million of investment tax credits with respect to the acquisition and construction of improvements to the Boardwalk Expansion Site described herein and the related demolition of certain structures on the Boardwalk Expansion Site. Due to the fact that the Partnership has begun construction at the Boardwalk Expansion Site, pursuant to rights granted to the Partnership by its lessor, the Partnership has received approximately $1,519,000 in such CRDA credit as of December 31, 1994. There can be no assurance, however, that such credits would be sufficient to defray a significant portion of the total project costs.\nTRUMP REGENCY. In June 1989, Trump Crystal Tower Associates Limited Partnership, a New Jersey limited partnership wholly-owned by Trump, acquired from Elsinore Shore Associates all of the assets constituting the former Atlantis Casino Hotel (\"Atlantis\"), which is located on The Boardwalk adjacent to the Atlantic City Convention Center on the opposite side from Trump Plaza and is otherwise referred to herein as the Trump Regency. Prior to such acquisition, all of the Atlantis' gaming operations were discontinued. The facility was renamed the Trump Regency Hotel and leased to the Partnership, which operated it solely as a non-casino hotel. As part of the Restructuring, the lease was terminated and the Partnership issued to Chemical Bank (\"Chemical\"), the assignee of rents payable under such lease, a promissory note in the original principal amount of $17.5 million (the \"Regency Note\"). At such time, title to the Trump Regency was transferred by Trump to ACFH Inc. (\"ACFH\"), a wholly owned subsidiary of Chemical. Since that time, the Trump Regency has been operated by ACFH as a non-casino hotel. The Partnership repaid the Regency Note with a portion of the proceeds of the Refinancing.\nIn December 1993, Trump entered into an option agreement (the \"Original Chemical Option Agreement\") with Chemical and ACFH. The Original Chemical Option Agreement granted to Trump an option to purchase (i) the Trump Regency (including the land, improvements and personal property used in the operation of the hotel) and (ii) certain promissory notes made by Trump and\/or certain of his affiliates and payable to Chemical (the \"Chemical Notes\") which are secured by certain real estate assets located in New York, unrelated to the Partnership, including one note dated July 20, 1987, as amended by First Allonge to the note dated as of November 16, 1988 and as further amended by Second Allonge to the note dated as of August 8, 1988 in the original principal amount of $80,000,000 made by Trump to a predecessor of Chemical (the \"Trump Note\"). As of December 31, 1994, the aggregate amount owed by Trump and his affiliates under the Chemical Notes (none of which constitutes an obligation of the Partnership) was approximately $65.8 million, of which the aggregate amount owing under the Trump Note was $35.9 million.\nThe aggregate purchase price payable for the assets subject to the Original Chemical Option Agreement was $80 million. Under the terms of the Original Chemical Option Agreement, $1 million was required to be paid for the option by January 5, 1994. In addition, the Original Chemical Option Agreement provided for an expiration of the option on May 8, 1994, subject to an extension until June 30, 1994 upon payment of an additional $250,000 on or before May 8, 1994. The Original Chemical Option Agreement did not allocate the purchase price\namong the assets subject to the option or permit the option to be exercised for some, but not all, of such assets.\nIn connection with the execution of the Original Chemical Option Agreement, the Partnership was to make the initial $1,000,000 payment, and, in consideration of such payment to be made by the Partnership, Trump agreed with the Partnership that, if Trump is able to acquire the Trump Regency pursuant to the exercise of the option, he would make the Trump Regency available for the sole benefit of the Partnership on a basis consistent with the Partnership's contractual obligations and requirements. Trump further agreed that the Partnership would not be required to pay any additional consideration to Trump in connection with any assignment to the Partnership of the option to purchase the Trump Regency. On January 5, 1994, the Partnership obtained the approval of the CCC to make the $1 million payment, and the payment was made on that date.\nOn June 16, 1994, Trump, Chemical and ACFH amended and restated the Original Chemical Option Agreement (the \"First Amended Chemical Option Agreement\"). The First Amended Chemical Option Agreement provided for an extension of the expiration of the option through September 30, 1994, upon payment of $250,000. Such payment was made on June 27, 1994. The First Amended Chemical Option Agreement also provided for a $60 million option price for the Trump Regency and the Trump Note, and a separate $20 million option price for the other Chemical Notes. On August 30, 1994, Trump, Chemical and ACFH entered into an amendment to the First Amended Chemical Option Agreement (the \"Second Amended Chemical Option Agreement\"). The Second Amended Chemical Option Agreement provided for an extension of the expiration of the option through March 31, 1995 upon the payment of $50,000 per month for the period October through December 1994, and $150,000 per month for the period January through March 1995. The Partnership received the approval of the CCC and has made such payments. On March 6, 1995, Trump, Chemical and ACFH entered into an amendment to the Second Amended Chemical Option Agreement (the \"Third Amended Chemical Option Agreement\"). The Third Amended Chemical Option Agreement provides for an extension of the expiration of the option through August 31, 1995 upon the payment of $100,000 per month for the period April through August 1995. The Partnership received the approval of the CCC on March 22, 1995 to make such payment. As a condition to the Third Amended Chemical Option Agreement, Trump must (i) obtain the approval of the CCC by July 1, 1995 for the transactions contemplated by the exercise of the options set forth in the Third Amended Chemical Option Agreement and for the financing to be used in connection with the acquisition of Trump Regency and other assets in connection with the exercise of the options set forth in the Third Amended Chemical Option Agreement; and (ii) file with the Securities and Exchange Commission (the \"SEC\") by April 1, 1995 a registration statement relating to\nthe financing necessary to complete the transactions contemplated by the exercise of the options set forth in the Third Amended Chemical Option Agreement.\nAs of December 31, 1994, $1,550,000, representing option payments, is included in other assets in the accompanying Consolidated Financial Statements. If the option is exercised pursuant to the Third Amended Chemical Option Agreement, option payments through March 31, 1995 are available to offset the $60 million option price.\nCOMPETITION\nTrump Plaza competes primarily with other casinos located in Atlantic City, New Jersey, and also competes, or will compete, with facilities in the northeastern and mid-Atlantic regions of the United States at which casino gaming or other forms of wagering are currently, or may in the future be, authorized. To a lesser extent, Trump Plaza faces competition from gaming facilities nationwide, including land based, cruise line, riverboat and dockside casinos located in Mississippi, Nevada, Louisiana, Iowa, Puerto Rico, the Bahamas and other locations inside and outside the United States and from other forms of legalized gaming in New Jersey and in its surrounding states such as lotteries, horse racing (including off-track betting), jai alai, bingo and dog racing and from illegal wagering of various types.\nCompetition in the Atlantic City casino hotel market is intense. At present, there are 12 casino hotels located in Atlantic City, including Trump Plaza, all of which compete for patrons. In addition, there are several sites on The Boardwalk and in the Atlantic City Marina area on which casino hotels could be built in the future, although the Partnership is not aware of any current development of such sites by third parties.\nCasinos in Atlantic City must be located in approved hotel facilities which offer dining, entertainment and other guest facilities. In addition, the approved hotel facilities must have a prescribed number of qualified sleeping units depending on the size of the casino space. Competition among casino hotels is based primarily upon promotional allowances, advertising, the attractiveness of the casino area, service, quality and price of rooms, food and beverages, restaurant, convention and parking facilities and entertainment. In order to compete effectively with all other Atlantic City casino hotels, the Partnership offers complimentary beverages, meals, room accommodations and\/or travel arrangements to its preferred customers, as well as cash bonuses and other incentives pursuant to approved coupon programs.\nIn addition, Trump Plaza faces competition from casino facilities operated by federally recognized Native American tribes. Pursuant to the Indian Gaming Regulatory Act (\"IGRA\"), which was passed by Congress in 1988, any state which permits casino style gaming (even if only for limited charity purposes) is required to negotiate gaming compacts with federally recognized Native American tribes. Under IGRA, Native American tribes enjoy comparative freedom from regulation and taxation of gaming operations, which provides them with an advantage over their competitors, including the Partnership.\nIn 1991, the Mashantucket Pequot Nation opened a casino facility in Ledyard, Connecticut, located in the far eastern portion of such state, an approximately three-hour drive from New York City. In February 1992, the Mashantucket Pequot Nation initiated 24 hour gaming, and in January 1993, slot machines were added at such facility, and the facility currently contains over 3,100 slot machines. The Mashantucket Pequot Nation has announced various expansion plans, including its intention to build another casino in Ledyard together with hotels, restaurants and a theme park. There can be no assurance that any continued expansion of gaming operations by the Mashantucket Pequot Nation would not have a materially adverse impact on the Partnership's operations.\nA group in New Jersey calling itself the \"Ramapough Indians\" has applied to the U.S. Department of the Interior to be recognized formally as a Native American tribe, which recognition would permit it to require the State of New Jersey to negotiate a gaming compact under IGRA. In 1993, the Bureau of Indian Affairs denied the Ramapough Indians Federal recognition. Similarly, a group in Cumberland County, New Jersey calling itself the \"Nanticoke Lenni Lenape\" tribe has filed a notice of intent with the Federal Bureau of Indian Affairs seeking Federal recognition as a Native American tribe. Also, it has been reported that a Sussex County, New Jersey businessman has offered to donate land he owns there to the Oklahoma-based Lenape\/Delaware Indian Nation which originated in New Jersey and already has Federal tribal status but does not have a reservation in the state. In addition, in July 1993, the Oneida Nation opened a casino featuring 24-hour table gaming and electronic gambling systems, but without slot machines, near Syracuse, New York and have announced a desire to open gaming facilities elsewhere in New York. Representatives of the St. Regis Mohawk Nation signed a gaming compact with New York State officials for the opening of a casino, without slot machines, in the northern portion of the state close to the Canadian border. The St. Regis Mohawk casino could be operational as early as August, 1995. The Mohegan Nation, a tribe in Connecticut, received Federal recognition in March of 1994 and, in May of that year, executed a gaming compact\nwith the State of Connecticut that was approved by the Secretary of the Interior in December 1994. The Mohegan Nation is scheduled to open a casino in southeastern Connecticut in the next few years. Other Native American Nations are seeking Federal recognition, land and negotiation of gaming compacts in New York, Pennsylvania, Connecticut and other nearby states.\nLegislation permitting other forms of casino gaming has been proposed, from time to time, in various states, including those bordering New Jersey. Six states have presently legalized riverboat gambling while others are considering its approval, including Pennsylvania. Several states are considering or have approved large scale land-based casinos. Harrah's Jazz Company is scheduled to open and operate a casino in New Orleans, Louisiana in May of 1995. Additionally, Las Vegas experienced significant expansion in 1993 and 1994 with additional capacity planned and currently under construction. The Partnership's operations could be adversely affected by such competition, particularly if casino gaming were permitted in jurisdictions near or elsewhere in New Jersey or other states in the Northeast. In December 1993, the Rhode Island Lottery Commission approved the addition of slot machine games on video terminals at Lincoln Greyhound Park and Newport Jai Alai, where poker and blackjack have been offered for over two years. Currently, casino gaming, other than Native American gaming, is not allowed in other areas of New Jersey or in Connecticut, New York or Pennsylvania. To the extent that legalized gaming becomes more prevalent in New Jersey or other jurisdictions, competition would intensify. In particular, a proposal has been introduced to legalize gaming in Philadelphia and other locations in Pennsylvania.\nIn addition, legislation has from time to time been introduced in the New Jersey State Legislature relating to types of statewide legalized gaming, such as video games with small wagers. To date, no such legislation has been enacted. The Partnership is unable to predict whether any such legislation, if enacted, would have a material adverse impact on the results of operations or financial condition of the Partnership.\nTHE REFINANCING AND RESTRUCTURING\nTHE REFINANCING. In connection with the Refinancing, the proceeds of the Units Offering were distributed to Trump. Trump used $35 million of such proceeds to purchase stock of the Company, which used such funds, together with a portion of the proceeds of the Mortgage Note Offering, to redeem the Company's outstanding stock units (the \"Stock Units\"), each consisting of (i) one share of the Company's 9.34% Participating Cumulative Redeemable Preferred Stock (the \"Preferred Stock\"), liquidation preference $25 per share, par value $1 per share, and (ii) one\nshare of the Company's common stock (the \"Common Stock\"), par value $.00001 per share. The remaining $25 million of the proceeds of the Units Offering were distributed to Trump as part of a special distribution (the \"Special Distribution\"). Trump used the Special Distribution primarily to reduce his personal indebtedness and to satisfy certain property tax obligations with respect to real estate owned by him. Out of the proceeds of the Mortgage Note Offering, $225 million was used to redeem all of the Bonds (as defined).\nIn connection with the Offerings, the Company formed Holding, a New Jersey general partnership, for the purpose of offering the Units. Trump contributed to Holding his equity ownership interest in the Partnership and became the sole beneficial owner of Holding.\nAlso in connection with the Offerings, the Company became the managing general partner of the Partnership as of June 18, 1993 upon its merger with TP\/GP Corp., a New Jersey corporation (\"TP\/GP\"), which had been the managing general partner of the Partnership until such date. Holding and the Company, both of which became wholly-owned by Trump upon such merger, became the sole partners of the Partnership.\nTHE RESTRUCTURING. In 1991, the Partnership began to experience a liquidity problem. Management believes that the Partnership's liquidity problem was attributable, in part, to an overall deterioration in the Atlantic City gaming market, as indicated by reduced rates of casino revenue growth for the industry for the two prior years, aggravated by an economic recession in the Northeast and the Persian Gulf War. Comparatively excessive casino gaming capacity in Atlantic City, due in part to the opening of the Trump Taj Mahal Casino Resort (the \"Taj Mahal\") in April 1990, may also have contributed to the Partnership's liquidity problem.\nIn order to alleviate its liquidity problem, on May 29, 1992 (the \"Effective Date\"), the Partnership and the Company restructured their indebtedness pursuant to the Plan. The purpose of the Restructuring was to improve the amortization schedule and extend the maturity of the Partnership's indebtedness by (i) eliminating the sinking fund requirement on the Company's 12-7\/8% First Mortgage Bonds, due 1998 (the \"Original Bonds\"), (ii) extending the maturity and lowering the interest rate on the Original Bonds, (iii) reducing the aggregate principal amount of such indebtedness from $250 million to $225 million, and (iv) eliminating certain other indebtedness by reconstituting such debt in part as Bonds (as defined) and in part as Stock Units. The Restructuring was necessitated by the Partnership's inability to either generate cash flow or obtain\nadditional financing sufficient to make the scheduled sinking fund payment on the Original Bonds.\nOn the Effective Date, the Company, which theretofore had no interest in the Partnership, received a 50% beneficial interest in TP\/GP, and the Company and TP\/GP were admitted as partners of the Partnership. The Company issued $225 million principal amount of the Company's 12% Mortgage Bonds due 2002 (the \"Bonds\") and approximately three million Stock Units to certain creditors. Pursuant to the terms of the partnership agreement of the Partnership, the Company was issued the Preferred Stock. TP\/GP became the managing general partner of the Partnership, and through its Board of Directors, managed the affairs of the Partnership until its merger into the Company on June 24, 1993.\nUpon consummation of the Plan, each holder of $1,000 principal amount of Original Bonds and such other indebtedness received (i) $900 principal amount of Bonds, (ii) 12 Stock Units and (iii) certain cash payments.\nAs a result of the Refinancing, the Company redeemed the Stock Units, consisting of the Company's Common Stock and Preferred Stock and Trump became the sole beneficial owner of the Company's Common Stock. The Company also retired the outstanding principal amount and interest on the Bonds. In addition, TP\/GP was merged into the Company and the Company became the managing general partner of the Partnership.\nCONFLICTS OF INTEREST\nTrump is a 100% beneficial owner of Trump's Castle Casino Resort (\"Trump's Castle\") subject to certain litigation warrants and a 50% beneficial owner of the Taj Mahal (collectively, the \"Other Trump Casinos\"), and is the sole beneficial owner of TC\/GP, Inc., an entity that as of December 31, 1994 has provided certain services to Trump's Castle; prior thereto, Trump's Castle Management Corp., an entity solely owned by Trump, provided management services to Trump's Castle. Under certain circumstances, Trump could increase his beneficial interest in Taj Mahal to 100%. In addition, Trump has a personal services agreement with the partnership that owns the Taj Mahal pursuant to which he receives substantial compensation based, in part, on the financial results of the Taj Mahal. The Other Trump Casinos compete directly with each other and with other Atlantic City casino hotels, including Trump Plaza. Trump could under certain circumstances have an incentive to operate the Other Trump Casinos to the competitive detriment of the Partnership. Nicholas L. Ribis, the Chief Executive Officer of the Partnership, is also the chief executive officer of the\npartnerships that own the Other Trump Casinos, and Mr. Robert M. Pickus and Mr. John P. Burke, officers of the Partnership, are also executive officers of each of the partnerships that own the Other Trump Casinos. In addition, Messrs. Trump, Ribis and Burke serve on the governing bodies of the partnerships that own the Other Trump Casinos. As a result of Trump's interests in three competing Atlantic City casinos, the common chief executive officer and other common officers, a conflict of interest may be deemed to exist by reason of such persons' access to information and business opportunities possibly useful to any or all of such casinos. Although no specific procedures have been devised for resolving conflicts of interest confronting, or which may confront, Trump, such persons and the Other Trump Casinos, Messrs. Trump, Ribis, Pickus and Burke have informed the Company that they will not engage in any activity which they reasonably expect will harm Trump Plaza or is otherwise inconsistent with their fiduciary obligations to the Partnership. See \"Certain Relationships and Related Transactions.\"\nEMPLOYEES AND LABOR RELATIONS\nThe Partnership has approximately 3,800 employees of whom approximately 1,100 are covered by collective bargaining agreements. Management believes that its relationships with its employees are satisfactory. Certain of the Partnership's employees must be licensed or registered under the Casino Control Act. See \"-- Gaming and Other Laws and Regulations --Employees.\" The Company has no employees.\nIn April 1993, the National Labor Relations board found that the Partnership had violated the National Labor Relations Act (the \"NLRA\") in the context of a union organizing campaign by table game dealers of the Partnership in association with the Sports Arena and Casino Employees Union Local 137, a\/w Laborers' International Union of North America, AFL-CIO (\"Local 137\"). In connection with such finding, the Partnership was ordered to refrain from interfering with, restraining, or coercing employees in the exercise of the rights guaranteed them by Section 7 of the NLRA, to notify its employees of such rights and to hold an election by secret ballot among its employees regarding whether they desire to be represented for collective bargaining by Local 137. The election was held on May 20 and 21, 1994 and the vote, which has been certified by the NLRB, was in favor of management and against representation by Local 137.\nSEASONALITY\nThe gaming industry in Atlantic City traditionally has been seasonal, with its strongest performance occurring from May through September, and with December and January showing\nsubstantial decreases in activity. Revenues have been significantly higher on Fridays, Saturdays, Sundays and holidays than on other days.\nGAMING AND OTHER LAWS AND REGULATIONS\nThe following is only a summary of the applicable provisions of the Casino Control Act and certain other laws and regulations. It does not purport to be a full description thereof and is qualified in its entirety by reference to the Casino Control Act and such other laws and regulations.\nIn general, the Casino Control Act contains detailed provisions concerning, among other things: the granting of casino licenses; the suitability of the approved hotel facility, and the amount of authorized casino space and gaming units permitted therein; the qualification of natural persons and entities related to the casino licensee; the licensing of certain employees and vendors of casino licensees; rules of the games; the selling and redeeming of gaming chips; the granting and duration of credit and the enforceability of gaming debts; management control procedures, accounting and cash control methods and reports to gaming agencies; security standards; the manufacture and distribution of gaming equipment; equal employment opportunity for employees of casino operators, contractors of casino facilities and others; and advertising, entertainment and alcoholic beverages.\nCASINO CONTROL COMMISSION. The ownership and operation of casino\/hotel facilities in Atlantic City are the subject of strict state regulation under the Casino Control Act. The CCC is empowered to regulate a wide spectrum of gaming and non-gaming related activities and to approve the form of ownership and financial structure of not only a casino licensee, but also its entity qualifiers and intermediary and holding companies.\nOPERATING LICENSES. The Partnership was issued its initial casino license on May 14, 1984. On April 19, 1993, the CCC renewed the Partnership's casino license through June 30, 1995, and on March 15, 1993 approved Trump as a natural person qualifier through May 1995. In March 1995, the Partnership's license renewal proceedings were consolidated with the Other Trump Casinos. The Partnership, as consolidated with the Other Trump Casinos for license renewal purposes, intends to apply during March 1995 for a renewal of its casino license for the period through June 30, 1999 and renewal of the approval of Trump as a natural person qualifier for the license term. It is anticipated that the CCC will conduct a plenary hearing for renewal of the Partnership's casino license in June 1995. No assurance can be given that the CCC will renew the casino license\nor, if it does so, as to the conditions it may impose, if any, with respect thereto.\nCASINO LICENSEE. No casino hotel facility may operate unless the appropriate license and approvals are obtained from the CCC, which has broad discretion with regard to the issuance, renewal, revocation and suspension of such licenses and approvals, which are non-transferable. The qualification criteria with respect to the holder of a casino license include its financial stability, integrity and responsibility; the integrity and adequacy of its financial resources which bear any relation to the casino project; its good character, honesty and integrity; and the sufficiency of its business ability and casino experience to establish the likelihood of a successful, efficient casino operation. The casino license currently held by the Partnership is renewable for periods of up to four years. The CCC may reopen licensing hearings at any time, and must reopen a licensing hearing at the request of the New Jersey Division of Gaming Enforcement (the \"Division\").\nTo be considered financially stable, a licensee must demonstrate the following ability: to pay winning wagers when due, to achieve a gross operating profit; to pay all local, state and federal taxes when due, to make necessary capital and maintenance expenditures to insure that it has a superior first-class facility, and to pay, exchange, refinance or extend debts which will mature or become due and payable during the license term.\nIn the event a licensee fails to demonstrate financial stability, the CCC may take such action as it deems necessary to fulfill the purposes of the Casino Control Act and protect the public interest, including: issuing conditional licenses, approvals or determinations; establishing an appropriate cure period, imposing reporting requirements; placing restrictions on the transfer of cash or the assumption of liability; requiring reasonable reserves or trust accounts; denying licensure; or appointing a conservator. See \"-- Gaming and Other Laws and Regulations -- Conservatorship.\"\nThe Partnership believes that it has adequate financial resources to meet the financial stability requirements of the CCC for the foreseeable future.\nPursuant to the Casino Control Act, CCC regulations and precedent, no entity may hold a casino license unless each officer, director, principal employee, person who directly or indirectly holds any beneficial interest or ownership in the licensee, each person who in the opinion of the CCC has the ability to control or elect a majority of the board of directors\nof the licensee (other than a banking or other licensed lending institution which makes a loan or holds a mortgage or other lien acquired in the ordinary course of business) and any lender, underwriter, agent or employee of the licensee or other person whom the CCC may consider appropriate, obtains and maintains qualification approval from the CCC. Qualification approval means that such person must, but for residence, individually meet the qualification requirements as a casino key employee. See \" --Gaming and Other Laws and Regulations -- Employees.\" Pursuant to a condition of its casino license, payments by the Partnership to or for the benefit of any related entity or partner are subject to prior CCC approval; and, if the Partnership's cash position falls below $5.0 million for three consecutive business days, the Partnership must present to the CCC and the Division evidence as to why it should not obtain a working capital facility in an appropriate amount.\nCONTROL PERSONS. An entity qualifier or intermediary or holding company, such as Holding, Holding Inc. and the Company, is required to register with the CCC and meet the same basic standards for approval as a casino licensee; provided, however, that the CCC, with the concurrence of the Director of the Division, may waive compliance by a publicly-traded corporate holding company with the requirement that an officer, director, lender, underwriter, agent or employee thereof, or person directly or indirectly holding a beneficial interest or ownership of the securities thereof individually qualify for approval under casino key employee standards so long as the CCC and the Director of the Division are, and remain, satisfied that such officer, director, lender, underwriter, agent or employee is not significantly involved in the activities of the casino licensee, or that such security holder does not have the ability to control the publicly-traded corporate holding company or elect one or more of its directors. Persons holding five percent or more of the equity securities of such holding company are presumed to have the ability to control the company or elect one or more of its directors and will, unless this presumption is rebutted, be required to individually qualify. Equity securities are defined as any voting stock or any security similar to or convertible into or carrying a right to acquire any security having a direct or indirect participation in the profits of the issuer.\nFINANCIAL SOURCES. The CCC may require all financial backers, investors, mortgagees, bond holders and holders of notes or other evidence of indebtedness, either in effect or proposed, which bears any relation to the casino project, publicly-traded securities of an entity which holds a casino license or is an entity qualifier, subsidiary or holding company of a casino licensee (a \"Regulated Company\"), to qualify as financial sources. In the past, the CCC has waived the qualification\nrequirement for holders of less than 15% of a series of publicly traded mortgage bonds so long as the bonds remained widely distributed and freely traded in the public market and the holder had no ability to control the casino licensee. The CCC may require holders of less than 15% of a series of debt to qualify as financial sources even if not active in the management of the issuer or the casino licensee.\nINSTITUTIONAL INVESTORS. An institutional investor (\"Institutional Investor\") is defined by the Casino Control Act as any retirement fund administered by a public agency for the exclusive benefit of federal, state or local public employees; investment company registered under the Investment Company Act of 1940, as amended; collective investment trust organized by banks under Part Nine of the Rules of the Comptroller of the Currency; closed end investment trust; chartered or licensed life insurance company or property and casualty insurance company; banking and other chartered or licensed lending institution; investment advisor registered under the Investment Advisers Act of 1940, as amended; and such other persons as the CCC may determine for reasons consistent with the policies of the Casino Control Act.\nAn Institutional Investor may be granted a waiver by the CCC from financial source or other qualification requirements applicable to a holder of publicly-traded securities, in the absence of a prima facie showing by the Division that there is any cause to believe that the holder may be found unqualified, on the basis of CCC findings that: (i) its holdings were purchased for investment purposes only and, upon request by the CCC, it files a certified statement to the effect that it has no intention of influencing or affecting the affairs of the issuer, the casino licensee or its holding or intermediary companies; provided, however, that the Institutional Investor will be permitted to vote on matters put to the vote of the outstanding security holders; and (ii) if (x) the securities are debt securities of a casino licensee's holding or intermediary companies or another subsidiary company of the casino licensee's holding or intermediary companies which is related in any way to the financing of the casino licensee and represent either (A) 20% or less of the total outstanding debt of the company, or (B) 50% or less of any issue of outstanding debt of the company, (y) the securities are equity securities and represent less than 10% of the equity securities of a casino licensee's holding or intermediary companies, or (z) the securities so held exceed such percentages, upon a showing of good cause. There can be no assurance, however, that the CCC will make such findings or grant such waiver and, in any event, an Institutional Investor may be required to produce for the CCC or the Division upon request, any document or information which bears any relation to such debt or equity securities.\nGenerally, the CCC requires each institutional holder seeking waiver of qualification to execute a certification to the effect that (i) the holder has received the definition of Institutional Investor under the Casino Control Act and believes that it meets the definition of Institutional Investor; (ii) the holder purchased the securities for investment purposes only and holds them in the ordinary course of business; (iii) the holder has no involvement in the business activities of, and no intention of influencing or affecting the affairs of the issuer, the casino licensee or any affiliate; and (iv) if the holder subsequently determines to influence or affect the affairs of the issuer, the casino licensee or any affiliate, it shall provide not less than 30 days' prior notice of such intent and shall file with the CCC an application for qualification before taking any such action. If an Institutional Investor changes its investment intent, or if the CCC finds reasonable cause to believe that it may be found unqualified, the Institutional Investor may take no action with respect to the security holdings, other than to divest itself of such holdings, until it has applied for interim casino authorization (see \"Interim Casino Authorization\" below) and has executed a trust agreement pursuant to such an application.\nOWNERSHIP AND TRANSFER OF SECURITIES. The Casino Control Act imposes certain restrictions upon the issuance, ownership and transfer of securities of a Regulated Company and defines the term \"security\" to include instruments which evidence a direct or indirect beneficial ownership or creditor interest in a Regulated Company including, but not limited to, mortgages, debentures, security agreements, notes and warrants. Each of the Company, Holding, Holding Inc. and the Partnership are deemed to be a Regulated Company, and instruments evidencing a beneficial ownership or creditor interest therein, including partnership interest, are deemed to be the securities of a Regulated Company.\nIf the CCC finds that a holder of such securities is not qualified under the Casino Control Act, it has the right to take any remedial action it may deem appropriate including the right to force divestiture by such disqualified holder of such securities. In the event that certain disqualified holders fail to divest themselves of such securities, the CCC has the power to revoke or suspend the casino license affiliated with the Regulated Company which issued the securities. If a holder is found unqualified, it is unlawful for the holder (i) to exercise, directly or through any trustee or nominee, any right conferred by such securities, or (ii) to receive any dividends or interest upon such securities or any remuneration, in any form, from its affiliated casino licensee for services rendered or otherwise.\nWith respect to non-publicly-traded securities, the Casino Control Act and CCC regulations require that the corporate charter or partnership agreement of a Regulated Company establish a right in the CCC of prior approval with regard to transfers of securities, shares and other interests and an absolute right in the Regulated Company to repurchase at the market price or the purchase price, whichever is the lesser, any such security, share or other interest in the event that the CCC disapproves a transfer. With respect to publicly-traded securities, such corporate charter or partnership agreement is required to establish that any such securities of the entity are held subject to the condition that, if a holder thereof is found to be disqualified by the CCC, such holder shall dispose of such securities.\nINTERIM CASINO AUTHORIZATION. Interim casino authorization is a process which permits a person who enters into a contract to obtain property relating to a casino operation or who obtains publicly-traded securities relating to a casino licensee to close on the contract or own the securities until plenary licensure or qualification. During the period of interim authorization, the property relating to the casino operation or the securities are held in trust.\nWhenever any person enters into a contract to transfer any property which relates to an ongoing casino operation, including a security of the casino licensee or a holding or intermediary company or entity qualifier, under circumstances which would require that the transferee obtain licensure or be qualified under the Casino Control Act, and that person is not already licensed or qualified, the transferee is required to apply for interim casino authorization. Furthermore, the closing or settlement date in the contract may not be earlier than the 121st day after the submission of a complete application for licensure or qualification together with a fully executed trust agreement in a form approved by the CCC. If, after the report of the Division and a hearing by the CCC, the CCC grants interim authorization, the property will be subject to a trust. If the CCC denies interim authorization, the contract may not close or settle until the CCC makes a determination on the qualifications of the applicant. If the CCC denies qualification, the contract will be terminated for all purposes and there will be no liability on the part of the transferor.\nIf, as the result of a transfer of publicly traded securities of a licensee, a holding or intermediary company or entity qualifier of a licensee or a financing entity of a licensee, any person is required to qualify under the Casino Control Act, that person is required to file an application for licensure or qualification within 30 days after the CCC\ndetermines that qualification is required or declines to waive qualification. The application must include a fully executed trust agreement in a form approved by the CCC or, in the alternative, within 120 days after the CCC determines that qualification is required, the person whose qualification is required must divest such securities as the CCC may require in order to remove the need to qualify.\nThe CCC may grant interim casino authorization where it finds by clear and convincing evidence that: (i) statements of compliance have been issued pursuant to the Casino Control Act; (ii) the casino hotel is an approved hotel in accordance with the Casino Control Act; (iii) the trustee satisfies qualification criteria applicable to key casino employees, except for residency and casino experience; and (iv) interim operation will best serve the interests of the public.\nWhen the CCC finds the applicant qualified, the trust will terminate. If the CCC denies qualification to a person who has received interim casino authorization, the trustee is required to endeavor, and is authorized, to sell, assign, convey or otherwise dispose of the property subject to the trust to such persons who are licensed or qualified or shall themselves obtain interim casino authorization.\nWhere a holder of publicly-traded securities is required, in applying for qualification as a financial source or qualifier, to transfer such securities to a trust in application for interim casino authorization and the CCC thereafter orders that the trust become operative: (i) during the time the trust is operative, the holder may not participate in the earnings of the casino hotel or receive any return on its investment or debt security holdings; and (ii) after disposition, if any, of the securities by the trustee, proceeds distributed to the unqualified holder may not exceed the lower of their actual cost to the unqualified holder or their value calculated as if the investment had been made on the date the trust became operative.\nAPPROVED HOTEL FACILITIES. The CCC may permit a licensee, such as the Partnership, to increase its casino space if the licensee agrees to add a prescribed number of qualifying sleeping units within two years after the commencement of gaming operations in the additional casino space. However, if the casino licensee does not fulfill such agreement due to conditions within its control, the licensee will be required to close the additional casino space, or any portion thereof that the CCC determines should be closed.\nAgreements to lease an approved hotel building or the land under the building must be for a durational term exceeding\n30 years, concern 100% of the entire approved hotel building or the land upon which it is located and include a buy-out provision conferring upon the lessee the absolute right to purchase the lessor's entire interest for a fixed sum in the event that the lessor is found by the CCC to be unsuitable. The CCC may waive any of the foregoing requirements for good cause. The Partnership intends to apply for a ruling that good cause exists to waive the 30-year requirement. There can be no assurances that the CCC will grant such a waiver.\nLICENSE FEES. The CCC is authorized to establish annual fees for the renewal of casino licenses. The renewal fee is based upon the cost of maintaining control and regulatory activities prescribed by the Casino Control Act, and may not be less than $200,000 for a two-year casino license. Additionally, casino licensees are subject to potential assessments to fund any annual operating deficits incurred by the CCC or the Division. There is also an annual license fee of $500 for each slot machine maintained for use or in use in any casino.\nGROSS REVENUE TAX. Each casino licensee is also required to pay an annual tax of 8% on its gross casino revenues. For the years ended December 31, 1994, 1993 and 1992, the Partnership's gross revenue tax was approximately $21.0 million, $21.3 million and $21.0 million, respectively, and its license, investigation, and other fees and assessments totalled approximately $4.2 million, $4.0 million and $4.7 million, respectively.\nINVESTMENT ALTERNATIVE TAX OBLIGATIONS. An investment alternative tax imposed on the gross casino revenues of each licensee in the amount of 2.5% is due and payable on the last day of April following the end of the calendar year. A licensee is obligated to pay the investment alternative tax for a period of 25 years. Estimated payments of the investment alternative tax obligation must be made quarterly in an amount equal to 1.25% of estimated gross revenues for the preceding three-month period. Investment tax credits may be obtained by making qualified investments or by the purchase of bonds issued by the CRDA. CRDA bonds may have terms as long as fifty years and bear interest at below market rates, resulting in a value lower than the face value of such CRDA bonds.\nFor the first ten years of its obligation, the licensee is entitled to an investment tax credit against the investment alternative tax in an amount equal to twice the purchase price of bonds issued to the licensee by the CRDA. Thereafter, the licensee is (i) entitled to an investment tax credit in an amount equal to twice the purchase price of such bonds or twice the amount of its investments authorized in lieu of such bond\ninvestments or made in projects designated as eligible by the CRDA and (ii) has the option of entering into a contract with the CRDA to have its tax credit comprised of direct investments in approved eligible projects which may not comprise more than 50% of its eligible tax credit in any one year.\nFrom the moneys made available to the CRDA, the CRDA is required to set aside $100,000,000 for investment in hotel development projects in Atlantic City undertaken by a licensee which result in the construction or rehabilitation of at least 200 hotel rooms by December 31, 1996. These monies shall be used to fund up to 35% of the cost to casino licensees of expanding their hotel facilities to provide additional hotel rooms which are required to be available upon the opening of the Atlantic City Convention Center and a portion of which will be required to be dedicated to convention events. The CRDA has determined at this time that eligible casino licensees will receive 27% of the cost of additional hotel rooms out of these monies set aside and may, in the future, determine to increase the percentage to an amount no greater than 35%.\nMINIMUM CASINO PARKING CHARGES. As of July 1, 1993, each casino licensee was required to pay the New Jersey State Treasurer a $1.50 charge for every use of a parking space for the purpose of parking, garaging or storing motor vehicles in a parking facility owned or leased by a casino licensee or by any person on behalf of a casino licensee. This amount is paid into a special fund established and held by the New Jersey State Treasurer for the exclusive use of the CRDA. The Partnership currently charges its parking patrons $2.00 in order to make its required payment to the New Jersey State Treasurer and cover related expenses. Amounts in the special fund will be expended by the CRDA for economic development projects of a revenue producing nature that foster the redevelopment of Atlantic City.\nCONSERVATORSHIP. If, at any time, it is determined that the Partnership, the Company, Holding Inc. or Holding has violated the Casino Control Act or that any of such entities cannot meet the qualification requirements of the Casino Control Act, such entity could be subject to fines or the suspension or revocation of its license or qualification. If the Partnership's license is suspended for a period in excess of 120 days or revoked or if the CCC fails or refuses to renew such casino license, the CCC could appoint a conservator to operate and dispose of the Partnership's casino hotel facilities. A conservator would be vested with title to all property of the Partnership relating to the casino and the approved hotel subject to valid liens and\/or encumbrances. The conservator would be required to act under the direct supervision of the CCC and would be charged with the duty of conserving, preserving and, if permitted, continuing the operation of the casino hotel. During the period of the conservatorship, a former or suspended casino\nlicensee is entitled to a fair rate of return out of net earnings, if any, on the property retained by the conservator. The CCC may also discontinue any conservatorship action and direct the conservator to take such steps as are necessary to effect an orderly transfer of the property of a former or suspended casino licensee.\nEMPLOYEES. Certain employees of the Partnership must be licensed by or registered with the CCC, depending on the nature of the position held. Casino employees are subject to more stringent requirements than non-casino employees and must meet applicable standards pertaining to financial stability, integrity and responsibility, good character, honesty and integrity, business ability and casino experience and New Jersey residency. These requirements have resulted in significant competition among Atlantic City casino operators for the services of qualified employees.\nGAMING CREDIT. The Partnership's casino games are conducted on a credit as well as cash basis. Gaming debts arising in Atlantic City in accordance with applicable regulations are enforceable in the courts of the State of New Jersey. The extension of gaming credit is subject to regulations that detail procedures which casinos must follow when granting gaming credit and recording counter checks which have been exchanged, redeemed or consolidated.\nCONTROL PROCEDURES. Gaming at Trump Plaza is conducted by trained and supervised personnel. The Partnership employs extensive security and internal controls. Security checks are made to determine, among other matters, that job applicants for key positions have had no criminal history or associations. Security controls utilized by the surveillance department include closed circuit video camera to monitor the casino floor and money counting areas. The count of moneys from gaming also is observed daily by representatives of the CCC.\nOTHER LAWS AND REGULATIONS. The United States Department of the Treasury has adopted regulations pursuant to which a casino is required to file a report of each deposit, withdrawal, exchange of currency, gambling tokens or chips, or other payments or transfers by, through, or to such casino which involve a transaction in currency of more than $10,000 per patron, per gaming day. Such reports are required to be made on forms prescribed by the Secretary of the Treasury and are filed with the Commissioner of the Internal Revenue Service (the \"Service\"). In addition, the Partnership is required to maintain detailed records (including the names, addresses, social security numbers and other information with respect to its gaming\ncustomers) dealing with, among other items, the deposit and withdrawal of funds and the maintenance of a line of credit.\nIn the past, the Service had taken the position that gaming winnings from table games by nonresident aliens were subject to a 30% withholding tax. The Service, however, subsequently adopted a practice of not collecting such tax. Recently enacted legislation exempts from withholding tax table game winnings by nonresident aliens, unless the Secretary of the Treasury determines by regulation that such collections have become administratively feasible.\nAs the result of an audit conducted by the U.S. Department of Treasury, Office of Financial Enforcement, the Partnership was alleged to have failed to timely file the \"Currency Transaction Report by Casino\" in connection with 65 individual currency transactions in excess of $10,000 during the period from October 31, 1986 to December 10, 1988. The Partnership paid a fine of $292,500 in connection with these violations. The Partnership has revised its internal control procedures to ensure continued compliance with these regulations.\nOn April 5, 1994, the Occupational Safety and Health Administration (\"OSHA\") proposed a regulation that would require, inter alia, that employers who permit smoking in workplaces establish designated smoking areas, permit smoking only in such areas, and assure that designated smoking areas be enclosed, exhausted directly to the outside, and maintained under negative pressure sufficient to contain tobacco smoke within the designated area. The Partnership has estimated construction costs to build enclosed, exhausted, negative-pressure smoking rooms in Trump Plaza to be $1.5 million for its casino and $2.5 million for its restaurants. The Partnership has also estimated construction costs to provide negative-pressure exhaust systems for Trump Plaza hotel rooms to be $1,500 per room; however, management believes that it is highly unlikely that the regulation, if promulgated, would require hotel rooms to be equipped with exhaust systems if smoking is prohibited in the rooms during housekeeping and maintenance activities. If the regulation is promulgated and is applicable to Trump Plaza hotel rooms, the number of rooms that would be affected is not known at this time.\nThe Partnership is subject to other federal, state and local regulations and, on a periodic basis, must obtain various licenses and permits, including those required to sell alcoholic beverages in the State of New Jersey as well as in other jurisdictions. Management believes all required licenses and permits necessary to conduct business of the Partnership have been obtained for operations in the State of New Jersey.\n(D) FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND EXPORT SALES ------------------------------------------------\nNot applicable.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES. ------ ----------\nThe Partnership owns and leases several parcels of land in and around Atlantic City, New Jersey, each of which is used in connection with the operation of Trump Plaza and each of which is subject to the liens of the Note Mortgage and Guarantee Mortgage (collectively, the \"Mortgages\") and certain other liens. The \"Note Mortgage\" and related assignments of assets encumber the real property owned and leased by the Partnership and substantially all of the Partnership's other assets, all of which constitute Trump Plaza and its related properties, which secures the non-recourse promissory note (the \"Partnership Note\") of the Partnership issued to the Company in exchange for the Company's lending to the Partnership the proceeds of the Mortgage Note Offering. In exchange for the use of such proceeds, the Company has assigned the Note Mortgage and the Partnership Note to the Trustee. The \"Guarantee Mortgage\" is the mortgage on and related assignments of the assets of the Partnership described above, senior to the lien of the Note Mortgage, which secures the Partnership's non-recourse guarantee (the \"Guarantee\") of the Mortgage Notes. The Mortgage Note Indenture, the Note Mortgage and the Guarantee Mortgage are herein collectively referred to as the \"Mortgage Note Agreements.\"\nCASINO PARCEL\nTrump Plaza is located on The Boardwalk in Atlantic City, New Jersey, next to the Atlantic City Convention Center. It occupies the entire city block (approximately 2.38 acres) bounded by The Boardwalk, Mississippi Avenue, Pacific Avenue and Columbia Place (the \"Casino Parcel\").\nThe Casino Parcel consists of four tracts of land, one of which is owned by the Partnership and three of which are leased to the Partnership pursuant to three non-renewable Ground Leases, each of which expires on December 31, 2078 (each, a \"Ground Lease\"). Trump Seashore Associates, Seashore Four Associates and Plaza Hotel Management Company (each, a \"Ground Lessor\") are the owners\/lessors under such respective Ground Leases (respectively, the \"TSA Lease,\" \"SFA Lease\" and \"PHMC Lease\"; the land which is subject to the Ground Leases (which includes Additional Parcel 1, as hereinafter defined) is referred to collectively as the \"Leasehold Tracts\" and individually as a \"Leasehold Tract\"). Trump Seashore Associates and Seashore Four Associates are\nbeneficially owned by Trump and are, therefore, affiliates of the Company and the Partnership.\nOn August 1, 1991, as security for indebtedness owed to a third party, Trump Seashore Associates transferred its interest in the TSA Lease to United States Trust Company of New York (\"UST\"), as trustee for the benefit of such third party creditor. The trust agreement among UST, Trump Seashore Associates and such creditor provides that the trust shall terminate on the earlier of (i) August 1, 2012 or (ii) the date on which such third party creditor certifies to UST that all principal, interest and other sums due and owing from Trump Seashore Associates to such third party creditor have been paid.\nTrump Seashore Associates is currently negotiating with its third party lender for the extension or refinancing of the indebtedness described above, which debt matured on October 29, 1993. The lender has agreed to forebear from pursuing remedies under such loan through April 1995, while such refinancing negotiations are taking place. The Mortgage Note Agreements provide that, upon such refinancing, the refinancing lender shall consent to the execution of an agreement between TSA and the Partnership providing, among other matters, for certain protections for holders of Mortgage Notes in the event of a default arising under the TSA Lease.\nWhile the transfer to UST of Trump Seashore Associates' interest in the TSA Lease was primarily a financing transaction to provide the third-party creditor with a potentially enhanced security interest, because of the transfer of such interest to UST, it is not certain that the TSA Lease would be deemed to be held by an affiliate of the Partnership and, therefore, even if the agreement described above is executed by TSA, the holders of the Mortgage Notes and the PIK Notes may not have the benefit of any such agreement regarding the TSA Lease.\nThe SFA Lease and the PHMC Lease each contain options pursuant to which the Partnership may purchase the Leasehold Tract covered by such Ground Lease at certain times during the term of such Ground Lease under certain circumstances. Upon any refinancing of the mortgage indebtedness which currently encumbers the fee interest in the TSA Lease Leasehold Tract, including any refinancing resulting from the on-going negotiations described above, the TSA Lease will be amended to confirm the existence thereunder of the purchase options, or provide for an additional option grant, in each case substantially similar to those currently set forth in the other Ground Leases. The purchase price pursuant to each option is specified in the applicable Ground Lease.\nThe Ground Leases are \"net leases\" pursuant to which the Partnership, in addition to the payment of fixed rent, is responsible for all costs and expenses with respect to the use, operation and ownership of the Leasehold Tracts and the improvements now, or which may in the future be, located thereon, including, but not limited to, all maintenance and repair costs, insurance premiums, real estate taxes, assessments and utility charges.\nThe improvements located on the Leasehold Tracts are owned by the Partnership during the terms of the respective Ground Leases and upon the expiration of the term of each Ground Lease (for whatever reason), ownership of such improvements will vest in the Ground Lessor. Subject to the provisions of the Mortgage Note Agreements, the Partnership has the right to improve the Leasehold Tracts, alter, demolish and\/or rebuild the improvements constructed thereon, and remove any personal property and movable trade fixtures therefrom.\nThe Ground Leases provide that each Ground Lessor may encumber its fee estate with mortgage liens, but any such fee mortgage will not increase the rent under the applicable Ground Lease and must be subordinate to such Ground Lease. Accordingly, any default by a Ground Lessor under any such fee mortgage (including that mortgage encumbering the TSA Lease parcel, for which refinancing negotiations are on-going) will not result in a termination of the applicable Ground Lease but would permit the fee mortgagee to bring a foreclosure action and succeed to the interests of the Ground Lessor in the fee estate, subject to the Partnership's leasehold estate under such Ground Lease. Each Ground Lease also specifically provides that the Ground Lessor may sell its interest in the applicable Leasehold Tract, but any such sale would be made subject to the Partnership's interest in the applicable Ground Lease.\nThe Mortgages are subject and subordinate to each of the Ground Leases. Accordingly, if a Ground Lease were to be terminated while such Mortgages were outstanding, the lien of the Mortgages would be extinguished as to the applicable Leasehold Tract. The Ground Leases, however, contain certain provisions to protect the Mortgage Note Trustee and the holders of the Mortgage Notes from such an occurrence, including the following: (i) no cancellation, surrender, acceptance of surrender or modification of a Ground Lease is binding on the Mortgage Note Trustee or affects the lien of the Mortgages without the Mortgage Note Trustee's prior written consent, (ii) the Mortgage Note Trustee is entitled to a copy of any notices (including notices of default) sent by a Ground Lessor to the Partnership, has the right to perform any term or condition of the Ground Lease to be performed by the Partnership and can cure any defaults, (iii) if\nany default is not remedied within the applicable grace period specified in the Ground Lease, then before the Ground Lessor exercises its rights under the Ground Lease or any statute, the Mortgage Note Trustee has an additional period of time within which to cure, or commence the curing of, the default and (iv) upon any termination of a Ground Lease, the Ground Lessor must enter into a new lease, on substantially the same terms as the applicable Ground Lease, with the Mortgage Note Trustee if requested within a specified period of time. In the event of a default by the Partnership under a Ground Lease, however, notwithstanding any additional cure period granted to the Mortgage Note Trustee, there can be no assurance that the Mortgage Note Trustee will take action to cure the default, will have sufficient time to cure the default or will otherwise be able to take advantage of such provisions. If the Ground Lease were then terminated and a new lease entered into, the Mortgage Note Trustee would nevertheless remain obligated to cure all pre-existing defaults as a condition to obtaining such new lease.\nIf a bankruptcy case is filed by or commenced against a Ground Lessor under applicable bankruptcy law, the trustee in bankruptcy in a liquidation or reorganization case under the applicable bankruptcy law, or a debtor-in- possession in a reorganization case under the applicable bankruptcy law, has the right, at its option, to assume or reject the Ground Lease of the debtor- lessor (subject, in each case, to court approval). If the Ground Lease is assumed, the rights and obligations of the Partnership thereunder, and the rights of the Mortgage Note Trustee as leasehold mortgagee under the Mortgage Note Agreements, would continue in full force and effect. If the Ground Lease is rejected, the Partnership would have the right, at its election, either (i) to treat the Ground Lease as terminated, in which event the lien of the Mortgages on the leasehold estate created thereby would be extinguished, or (ii) to continue in possession of the land and improvements under the Ground Lease for the balance of the term thereof and at the rental set forth therein (with a right to offset against such rent any damages caused by the Ground Lessor's failure to thereafter perform its obligations under such Ground Lease). The Mortgage Note Agreements provide that if a Ground Lease is rejected, the Partnership assigns to the Trustee its rights to elect whether to treat the Ground Lease as terminated or to remain in possession of the leased premises.\nIn the case of the Ground Leases, the rejection of a Ground Lease by a trustee in bankruptcy or debtor-lessor (as debtor-in-possession) may result in termination of any options to purchase the fee estate of the debtor-lessor and the Mortgage Note Trustee's option (as leasehold mortgagee as described above), if the Ground Lease is terminated to enter into a new\nlease directly with the lessor. In addition, under an interpretation of New Jersey law, it is possible that a court would regard such options as separate contracts and, therefore, severable from the Ground Lease. In such event, the trustee in bankruptcy or debtor-lessor (as debtor-in-possession) could assume the Ground Lease, while rejecting some or all of such options under the Ground Lease.\nPARKING PARCELS\nThe Partnership owns a parcel of land (the \"Garage Parcel\") located across the street from the Casino Parcel and along Pacific Avenue in a portion of the block bounded by Pacific Avenue, Mississippi Avenue, Atlantic Avenue and Missouri Avenue. The Partnership has constructed on the Garage Parcel a 10-story parking garage capable of accommodating approximately 2,650 cars and which includes offices and a bus transportation center with bays accommodating up to 13 buses at one time. An enclosed pedestrian walkway from the parking garage accesses Trump Plaza at the casino level. Parking at the parking garage is available to Trump Plaza's guests, as well as to the general public. Two of the tracts comprising a portion of the Garage Parcel are subject to a first mortgage on the Partnership's fee interest in such tract. As of December 31, 1994, such mortgage had an approximate outstanding principal balance of $3.8 million.\nThe Partnership leases, pursuant to the PHMC Lease, a parcel of land located on the northwest corner of the intersection of Mississippi and Pacific Avenues consisting of approximately 11,800 square feet (\"Additional Parcel 1\") and owns another parcel on Mississippi Avenue adjacent to Additional Parcel 1 consisting of approximately 5,750 square feet (the \"Bordonaro Parcel\"). The Bordonaro Parcel is encumbered by a first mortgage having an outstanding principal balance, as of December 31, 1994, of approximately $130,000. Additional Parcel 1 and the Bordonaro Parcel are presently paved and used for surface parking.\nThe Partnership also owns five unimproved parcels of land, aggregating approximately 43,300 square feet, and sub-leases one parcel consisting of approximately 3,125 square feet. All of such parcels are contiguous and are located along Atlantic Avenue, in the same block as the Garage Parcel. They are used for signage and surface parking for employees of Trump Plaza and are not encumbered by any mortgage liens other than those of the Mortgages.\nWAREHOUSE PARCEL\nThe Partnership owns a warehouse and office facility located in Egg Harbor Township, New Jersey containing approximately 64,000 square feet of space (the \"Egg Harbor Parcel\"). The Egg Harbor Parcel is encumbered by a first mortgage having an outstanding principal balance, as of December 31, 1994, of approximately $1.6 million.\nBOARDWALK EXPANSION SITE\nSee \"Business -- Narrative Description of Business -- Expansion Sites -- Boardwalk Expansion Site.\"\nSUPERIOR MORTGAGES\nThe liens securing the indebtedness on the Garage Parcel, the Bordonaro Parcel and the Egg Harbor Parcel (all of such liens are collectively called the \"Existing Senior Mortgages\") are all senior to the liens of the Mortgages. The principal amount currently secured by such Existing Senior Mortgages as of December 31, 1994 is in the aggregate, approximately $5.5 million.\nIf the Partnership were to default in the payment of the indebtedness secured by any of the Existing Senior Mortgages or default in the performance of any of the other obligations thereunder, and the holder of an Existing Senior Mortgage were to commence a foreclosure action, the debt owed to the holder of such Existing Senior Mortgage, together with the debt owed to the holder of any other Existing Senior Mortgage which is also then being foreclosed, would have to be satisfied before the holders of the Mortgage Notes would realize any proceeds from the sale of the portion of the property encumbered thereby. If the Company and the Partnership default in the payment of the Mortgage Notes or any other obligation under the Mortgages, and the Mortgage Note Trustee elects to foreclose under the Mortgages, the Mortgage Note Trustee will receive the proceeds of the sale of the collateral under the Mortgage Note Indenture (the \"Collateral\") subject to the rights of the holders of any Existing Senior Mortgages. The purchaser of the Collateral at any such foreclosure sale would take title to the Collateral subject to, to the extent not foreclosed upon, the Existing Senior Mortgages.\nIn addition to the Existing Senior Mortgages, the Partnership may, under certain circumstances, borrow up to $25 million to pay for certain expansion site costs which may be secured by a lien on the expansion site superior to the lien of the Mortgages thereon.\nThe Partnership has financed or leased and from time to time will finance or lease its acquisition of furniture, fixtures and equipment. The lien in favor of any such lender or lessor may be superior to the liens of the Mortgages.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS. ------ -----------------\nThe Partnership, its partners, certain members of its former Executive Committee, and certain of its employees, have been involved in various legal proceedings. In general, the Partnership has agreed to indemnify such persons and entities against any and all losses, claims, damages, expenses (including reasonable costs, disbursements and counsel fees) and liabilities (including amounts paid or incurred in satisfaction of settlements, judgments, fines and penalties) incurred by them in said legal proceedings. Such persons and entities are vigorously defending the allegations against them and intend to vigorously contest any future proceedings.\nPENTHOUSE LITIGATION\nOn April 3, 1989, BPHC Acquisition, Inc. and BPHC Parking Corp. (collectively, \"BPHC\") filed a third-party complaint (the \"Complaint\") against the Partnership and Trump. The Complaint arose in connection with the action entitled Boardwalk Properties, Inc. and Penthouse International Ltd. v. BPHC Acquisition, Inc. and BPHC Parking Corp., which was instituted on March 20, 1989 in the New Jersey Superior Court, Chancery Division, Atlantic County.\nThe suit arose in connection with the conditional sale by Boardwalk Properties, Inc. (\"BPI\") (or, with respect to certain of the property, BPI's agreement to sell) to Trump of BPI's fee and leasehold interests in (i) the Boardwalk Expansion Site, (ii) an approximately 4.2-acre parcel of land located on Atlantic Avenue, diagonally across from Trump Plaza's parking garage (the \"Columbus Plaza Site\") which was then owned by an entity in which 50% of the interests were each owned by BPHC and BPI and (iii) an additional 1,462-square foot parcel of land located within the area of the Boardwalk Expansion Site (the \"Bongiovanni Site\"). Prior to BPI entering into its agreement with Trump, BPI had entered into agreements with BPHC which provided, among other things, for the sale to BPHC of the Boardwalk Expansion Site, as well as BPI's interest in the Columbus Plaza Site, assuming that certain contingencies were satisfied by a certain date. Additionally, by agreement between BPHC and BPI, in the event BPHC failed to close on the Boardwalk Expansion Site, BPHC would convey to BPI the Bongiovanni Site. Upon BPHC's failure to close on the Boardwalk Expansion Site, BPI entered into its agreement\nwith Trump pursuant to which it sold the Boardwalk Expansion Site to Trump and instituted a lawsuit against BPHC for specific performance to compel BPHC to transfer to BPI, BPHC's interest in the Columbus Plaza and Bongiovanni Sites, as provided for in the various agreements between BPHC and BPI and in the agreement between BPI and Trump.\nThe Complaint alleges that the Partnership and\/or Trump engaged in the following activities: civil conspiracy, violations of the New Jersey Antitrust Act, violations of the New Jersey RICO statute, malicious interference with contractual relations, malicious interference with prospective economic advantage, inducement to breach a fiduciary duty and malicious abuse of process. The relief sought in the Complaint included, among other things, compensatory damages, punitive damages, treble damages, injunctive relief, the revocation of all of the Partnership's and Trump's casino licenses, the revocation of the Partnership's current Certificate of Partnership, the revocation of any other licenses or permits issued to the Partnership and Trump by the State of New Jersey, and a declaration voiding the conveyance by BPI to Trump of BPI's interest in the Boardwalk Expansion Site as well as BPI's and\/or Trump's rights to obtain title to the Columbus Plaza Site.\nThe Partnership and Trump filed an answer denying all liability and alleging that all of BPHC's claims are without merit. On November 9, 1990, BPHC filed an application to amend its counterclaims against BPI and the Complaint, which amendment sought to withdraw all of BPHC's affirmative claims for equitable relief and thereby limit such claims to monetary damages. On December 20, 1990, the Superior Court entered an Order permitting BPHC to withdraw its affirmative demands for equitable relief.\nTrial of the Penthouse litigation was bifurcated into issues of liability and damages, with liability issues to be tried first. On March 25, 1993, after trial on issues of liability, the Superior Court rendered a decision rejecting all of BPHC's claims in the Complaint. On October 13, 1993, the court entered a judgment dismissing with prejudice all claims against Trump and the Partnership. On November 19, 1993, the Court entered an Order confirming that the October 13, 1993 judgment in favor of Trump and the Partnership was a final judgment. That Order was further confirmed by Order of the Appellate Division entered March 3, 1994. A final judgment disposing of all claims between BPI and BPHC was entered on May 10, 1994.\nBPHC and BPI have settled all claims between them. BPHC is pursuing its appeal as to Trump and the Partnership but only as to its claims of interference with contract and prospective\neconomic advantage and of inducing BPI to breach its fiduciary duty to BPHC. All other claims raised in BPHC's complaint as to Trump and the Partnership and dismissed by the October 13, 1993 judgment have been finally determined in favor of Trump and the Partnership. BPHC has filed its appeal brief, and according to the briefing schedule currently in effect, the answering brief of Trump and the Partnership is due to be filed April 20, 1995 and BPHC's reply brief is due May 9, 1995.\nOn January 9, 1991, BPHC instituted suit against Trump, the Partnership, BPI, Penthouse International Ltd. and Robert C. Guccione in the United States District Court for the District of New Jersey. This action is virtually identical to the state court action described above. The Partnership and Trump filed an answer denying all liability and alleging that all of BPHC's claims are without merit. In April 1993, the Partnership filed a motion to dismiss certain claims based on the favorable decision in the state court action. In May 1993, the court issued an order to show cause, scheduling a hearing for June 1993 to determine whether certain claims of the plaintiff's amended complaint should be dismissed with prejudice. On July 15, 1993, the court acted favorably on the Partnership's motion and dismissed the action in its entirety. The order of dismissal was appealed to the United States Court of Appeals for the Third Circuit. On April 20, 1994, that Court affirmed the order of dismissal and, because the time within which to take any further appeals has elapsed, the order of dismissal is final and unappealable.\nOTHER LITIGATION\nVarious legal proceedings are now pending against the Partnership. The Partnership considers all such proceedings to be ordinary litigation incident to the character of its business and not material to its business or financial condition. The majority of such claims are covered by liability insurance (subject to applicable deductibles), and the Partnership believes that the resolution of these claims, to the extent not covered by insurance, will not, individually or in the aggregate, have a material adverse effect on the financial condition or results of operations of the Partnership.\nThe Partnership is also a party to various administrative proceedings involving allegations that it has violated certain provisions of the Casino Control Act. The Partnership believes that the final outcome of these proceedings will not, either individually or in the aggregate, have a material adverse effect on the Partnership or on the ability of the Partnership to otherwise retain or renew any casino or other licenses required under the Casino Control Act for the operation of Trump Plaza.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS ------ TO A VOTE OF SECURITY HOLDERS. -----------------------------\nNo matters were submitted by the Registrants to their security holders for a vote during the fourth quarter of 1994.\nPART II -------\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON ------ EQUITY AND RELATED STOCKHOLDER MATTERS. --------------------------------------\n(a) There is no established public trading market for the Company's outstanding Common Stock.\n(b) As of December 31, 1994, Trump was the sole holder of record of the Company's Common Stock.\n(c) The Company has not paid any cash dividends on its Common Stock. The Mortgage Note Indenture restricts the ability of the Company and the Partnership, and the PIK Note Indenture restricts the ability of the Partnership, to declare or pay dividends and make other distributions. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources.\"\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA. ------ -----------------------\nSELECTED FINANCIAL INFORMATION\nThe following table sets forth historical financial information of the Partnership for each of the five years ended December 31, 1994. This information should be read in conjunction with the financial statements of the Partnership and related notes included elsewhere in this Report and \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\n(1) Net loss for the year ended December 31, 1990 includes income of $2.4 million resulting from the settlement of a lawsuit relating to a boxing match. Net loss for the year ended December 31, 1991 includes a $10.9 million charge associated with rejection of the Regency Lease and $4.0 million of costs associated with certain litigation. Net loss for 1992 includes $1.5 million of costs associated with certain litigation. Net income (loss) for 1994 and 1993 includes $4.9 and $3.9 million, respectively, of costs associated with the Boardwalk Expansion Site.\n(2) Long-term debt of $225 million at December 31, 1991 had been classified as a current liability.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF ------ FINANCIAL CONDITION AND RESULTS OF OPERATIONS. ---------------------------------------------\nGENERAL\nThe Company was incorporated on March 14, 1986 as a New Jersey Corporation, and was originally formed solely to raise funds through the issuance and sale of its debt securities for the benefit of the Partnership. The Partnership experienced liquidity problems that culminated in the Restructuring in May 1992, where, as part of a prepackaged plan of reorganization under chapter 11 of the U.S. Bankruptcy Code consummated on May 29, 1992, the Company became a partner of the Partnership and issued approximately three million Stock Units, each comprised of one share of Preferred Stock and one share of Common Stock. On June 25, 1993 the Company issued and the Partnership guaranteed $330,000,000 of Mortgage Notes (for net proceeds of $325,687,000) and Holding, issued 12,000 Units consisting of an aggregate of $60,000,000 of PIK Notes, together with Warrants to acquire an additional $12,000,000 of PIK Notes at no additional cost. Holding has no other assets or business other than its 99% equity interest in the Partnership. The Company owns the remaining 1% interest in the Partnership. The combined proceeds of the Offerings, together with cash on hand, were used substantially as follows: (i) $225.0 million of such proceeds were used to repay the Partnership's Promissory Note to the Company in the principal amount of $225.0 million, which proceeds were then used by the Company to redeem the Bonds; (ii) $12.0 million was used to repay the Regency Note (see \"Item 13. Certain Relationships and Related Transactions -- Trump Regency\"); (iii) $40.0 million was distributed to the Company (which used such funds, together with $35.0 million from the Units Offering distributed to Trump and paid to the Company, to redeem its Stock Units); (iv) approximately $17.3 million was used to pay the expenses incurred in connection with the Offerings; and (v) approximately $52.5 million was used to make the Special Distribution to Trump, which was used by Trump primarily to pay certain personal indebtedness. No portion of the net proceeds was retained by Holding, the Company or the Partnership for working capital purposes.\nResults of operations of the Partnership through December 31, 1992 were affected by the Restructuring, which resulted in an extraordinary loss of $38.2 million for the year ended December 31, 1992. The Partnership's business is highly competitive, and any future expansions by the Mashantucket Pequot Nation or new gaming ventures by other Native American tribes or other persons in the northeastern or mid-Atlantic region of the United States could have a material adverse effect on the Trump Plaza's future financial condition and results of operations. In addition, casino gaming is already permitted in a number of other\njurisdictions. Increased competition in the casino gaming industry generally could have a materially adverse impact on the Partnership as it seeks to expand into new jurisdictions.\nIn August 1990, the Partnership entered into a triple net lease with an affiliate pursuant to which the Partnership began operating the Trump Regency as a non-casino hotel. From August 1990 to September 1992, losses attributable to the Trump Regency aggregating approximately $14.1 million adversely affected the results of operations of the Partnership. Pursuant to the Restructuring, the Partnership ceased operating the Trump Regency as of September 30, 1992. Subsequent to September 30, 1992, revenues and expenses of Trump Regency are not included in the Partnership's results of operations.\nThe financial information presented below reflects the results of operations of the Partnership. Since the Company and Holding have no business operations other than their interest in the Partnership, their results of operations are not discussed below.\nRESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1994 AND 1993\nGaming revenues were $261.5 million for the year ended December 31, 1994, a decrease of $2.6 million or 1.0% from gaming revenues of $264.1 million for 1993, although revenues increased for the industry generally in Atlantic City for the year ended 1994 compared to the year ended 1993. This decrease in gaming revenues consisted of a reduction in both table games and slot revenues. These results were impacted by a number of major ice and snow storms throughout the northeastern United States, during the three months ended March 31, 1994, which severely restricted travel in the region. Bad weather also impacted the Atlantic City markets' results for the three months ended March 31, 1993; however, the weather during the comparable period in 1994 was much more severe. The decrease in gaming revenues was also due in part to disruptions caused by an expansion of the casino floor which created inefficiencies in the operation of the casino floor by temporarily disrupting the normal flow of patrons upon entrance to the casino, as well as detracting from the overall appearance of the casino floor. Also, in 1994 Trump Plaza experienced turnover of certain key management positions which had a negative impact on operations. This negative impact was mitigated toward the end of 1994 as new management was hired and began implementing new policies and marketing programs.\nSlot revenues were $168.7 million for the year ended December 31, 1994, a decrease of $1.8 million or 1.1%, from slot revenues of $170.5 million in 1993. This decrease was due in part to the sensitivity of slot revenues to certain of the factors specified in the foregoing paragraph. The Partnership\nelected to discontinue certain progressive slot programs, thereby reversing certain accruals into revenue which had the effect of improving slot revenue by $0.6 million for the year ended December 31, 1994.\nTable games revenues were $92.8 million for the year ended December 31, 1994, a decrease of $0.8 million or 0.9% from table games revenues of $93.6 million in 1993. This decrease was primarily due to a reduction in table games drop (i.e., the dollar value of chips purchased) by $26.7 million or 4.3% for the year ended December 31, 1994 from 1993, offset by an increase in the table game hold percentage to 15.5% (the percentage of table drop retained by the Partnership) for the year ended December 31, 1994 from 14.9% in 1993.\nDuring the year ended December 31, 1994, gaming credit extended to customers was approximately 17% of overall table play. At December 31, 1994, gaming receivables amounted to approximately $13.7 million, with allowances for doubtful gaming receivables of approximately $8.5 million.\nOther revenues were $66.9 million for the year ended December 31, 1994, a decrease of $2.3 million or 3.3%, from other revenues of $69.2 million in 1993. Other revenues include revenues from rooms, food and beverage and miscellaneous items. This decrease in other revenues primarily reflects decreases in food and beverage revenue resulting from changes in bus couponing.\nPromotional allowances were $33.3 million for the year ended December 31, 1994, an increase of $0.5 million or 1.5%, from $32.8 million in 1993. This increase is attributable to increased marketing and promotional activities.\nGaming costs and expenses were $139.5 million for the year ended December 31, 1994, an increase of $2.6 million, or 1.9%, from gaming costs and expenses of $136.9 million in 1993. This increase was primarily due to increased marketing costs attributable to an expanded marketing program that was instituted toward the end of 1994. The marketing programs consisted of increased bus programs and direct marketing activities. The increase in marketing costs was offset by decreased gaming taxes associated with the decreased levels of gaming activity.\nGeneral and administrative expenses of $73.1 for the year ended December 31, 1994 increased $1.5 million or 2.1% from $71.6 million in 1993. This increase resulted primarily from $1.1 million in cash associated with donations to the CRDA for the year ended December 31, 1994.\nIncome from operations was $43.4 million for the year ended December 31, 1994, a decrease of $6.2 million or 12.5% from income from operations of $49.6 million for 1993.\nNet interest expense was $48.2 million for the year ended December 31, 1994, an increase of $8.3 million, or 20.8% from net interest expense of $39.9 million in 1993. This increase is primarily attributable to increased interest expenses associated with the Mortgage Notes and PIK Notes which were outstanding for all of 1994.\nOther non-operating expense was $4.9 million (including $3.1 million of leasing costs) for the year ended December 31, 1994, an increase of $1.0 million or 25.6% from other non-operating expense of $3.9 million (including $0.8 million of leasing costs) in 1993. This increase is directly attributable to twelve months of costs associated with the Boardwalk Expansion Site. See \"Note 6 to the Financial Statements --Commitments and Contingencies -- The Boardwalk Expansion Site.\"\nRESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1993 AND 1992\nGaming revenues were $264.1 million for the year ended December 31, 1993, a decrease of $1.4 million or 0.5% from gaming revenues of $265.4 million in 1992. This decrease in gaming revenues consisted of a reduction in table games revenues, which was partially offset by an increase in slot revenues. These results were impacted by major snow storms during February and March, which severely restricted travel in the region. The decrease in revenues was also attributable, in part, to the revenues derived from \"high roller\" patrons from the Far East during 1992, which did not recur in 1993, due in part to the decision to de-emphasize marketing efforts directed at \"high roller\" patrons from the Far East and also to the effects of the adverse economic conditions in that region.\nSlot revenues were $170.5 million for the year ended December 31, 1993, an increase of $1.0 million or 0.6%, from slot revenues of $169.5 million in 1992. The Partnership elected to discontinue certain progressive slot jackpot programs thereby reversing certain accruals into revenues which had the effect of improving slot revenue by $4.1 million for the year ended December 31, 1992. Excluding the aforementioned adjustment, slot revenues would have resulted in a $5.0 million or 3.0% improvement over 1992. The Partnership believes that its improvement in slot revenues reflects its intensified slot marketing efforts directed towards patrons who tend to wager more\nper slot play and general growth in the industry. See \"Business -- Narrative Description of Business -- Business Strategy.\"\nTable games revenues were $93.6 million for the year ended December 31, 1993, a decrease of $2.3 million or 2.4% from table games revenues of $95.9 million in 1992. This decrease was primarily due to a reduction in table games drop (i.e., the dollar value of chips purchased) by 9.2% for the year ended December 31, 1993 from 1992, offset by an increase in the table games hold percentage to 14.9% (the percentage of table drop retained by the Partnership) for the year ended December 31, 1993 from 13.9% in 1992. The reduction in table game drop was due to the large dollar amounts wagered during 1992 by certain foreign customers.\nDuring the year ended December 31, 1993, gaming credit extended to customers was approximately 18.0% of overall table play. At December 31, 1993, gaming receivables amounted to approximately $16.0 million, with allowances for doubtful gaming receivables of approximately $10.4 million.\nOther revenues were $69.2 million for the year ended December 31, 1993, a decrease of $4.1 million or 5.6%, from other revenues (excluding revenues from Trump Regency) of $73.3 million in 1992. Other revenues include revenues from rooms, food and beverage and miscellaneous items. The decrease in other revenues primarily reflects a $2.1 million adjustment to the outstanding gaming chip liability in 1992, (this amount had been offset in gaming cost and expenses with a specific reserve provision for casino uncollectible accounts receivable) as well as decreases in food and beverage revenues attendant to reduced levels of gaming activity, and reduced promotional allowances.\nPromotional allowances were $32.8 million for the year ended December 31, 1993, a decrease of $2.1 million or 5.9%, from promotional allowances of $34.9 million in 1992. This decrease is primarily attributable to a reduction in table gaming activity as well as the Partnership's focusing its marketing efforts during the period towards patrons who tend to wager more frequently and in larger denominations.\nGaming costs and expenses were $136.9 million for the year ended December 31, 1993, a decrease of $9.4 million, or 6.4%, from gaming costs and expenses of $146.3 million in 1992. This decrease was primarily due to a $4.8 million decrease in gaming bad debt expense as well as decreased promotional and operating expenses and taxes associated with decreased levels of gaming activity and revenues from 1992.\nOther costs and expenses were $24.8 million for the year ended December 31, 1993 an increase of $1.1 million or 4.7%, from other costs and expenses of $23.7 million in 1992.\nGeneral and administrative expenses were $71.6 million for the year ended December 31, 1993, a decrease of $3.8 million, or 5.1%, from general and administrative expenses of $75.5 million in 1992. This decrease resulted primarily from a $2.4 million real estate tax charge resulting from a reassessment by local authorities of prior years' property values incurred during 1992 and overall cost reductions related to cost containment efforts.\nIncome from operations was $49.6 million for the year ended December 31, 1993, an increase of $7.0 million or 16.4% from income from operations (excluding the operations of Trump Regency and before restructuring costs) of $42.6 million for 1992. In addition to the items described above, 1993 costs and expenses were lower as a result of the absence of the Restructuring costs and the expenses associated with the Trump Regency which were incurred in 1992.\nNet interest expense was $39.9 million for the year ended December 31, 1993, an increase of $8.5 million, or 27.2% from net interest expense of $31.4 million in 1992. This is attributable to the interest expense associated with the Offerings.\nOther non-operating expenses were $3.9 million for the year ended December 31, 1993, an increase of $2.4 million or 164.9% from non-operating expense of $1.5 million in 1992. This increase is directly attributable to costs associated with the Boardwalk Expansion Site. See \"Note 6 to the Financial Statements -- Commitments and Contingencies -- The Boardwalk Expansion Site.\"\nThe Offerings resulted in an extraordinary gain of $4.1 million for the year ended December 31, 1993, which reflects the excess of carrying value of the Regency Hotel obligation over the amount of the settlement payment, net of related prepaid expenses. The Restructuring resulted in an extraordinary loss of $38.2 million for the year ended December 31, 1992 consisting of the effects of stating the Bonds and Preferred Stock issued at fair value and the write off of certain deferred financing charges and costs.\nLIQUIDITY AND CAPITAL RESOURCES\nTHE PARTNERSHIP. Cash flow from operating activities is the Partnership's principal source of liquidity. For the year ended December 31, 1994, net cash from operating activities was $20.0 million. The decrease of $2.0 million in net cash provided\nby operating activities as compared to the comparable period in 1993 reflects reduced income from operations and interest on the Mortgage Notes, which were outstanding for all of 1994.\nCapital expenditures of $20.5 million for the year ended December 31, 1994 increased approximately $10.4 million from 1993 and was primarily attributable to the casino expansion, purchase of additional slot machines, construction of the new baccarat pit for Trump Plaza and refurbishing costs associated with the Boardwalk Expansion Site. These expenditures were financed from funds generated from operations. Management believes that funds from operations will be sufficient to complete the development of the Boardwalk Expansion Site. Additional borrowings will be necessary to exercise the Boardwalk Expansion Site Purchase Option. Capital expenditures for 1993 and 1992 were $10.1 million and $8.6 million, respectively. Previously, the Partnership made significant capital expenditures which concentrated on the renovation of the casino floor and certain restaurants, hotel rooms and the hotel lobby. See \"Business --Narrative Description of Business -- Facilities and Amenities.\"\nCurrent maturities of long-term debt were $3.0 million and $1.6 million, as of December 1994 and December 1993, respectively. Management believes that this debt will be paid by cash from operating activities.\nAt December 31, 1994, the Partnership had a combined working capital deficit totalling $6.0 million, compared to a working capital deficit of $1.5 million at December 31, 1993.\nIn 1993, the Partnership received the approval of the CCC, subject to certain conditions, for the expansion of its hotel facilities at the Boardwalk Expansion Site. As part of an expansion, management has determined to renovate rooms at the Boardwalk Expansion Site. As a result of such expansion, the Partnership will be permitted to increase Trump Plaza's casino floor space to 90,000 square feet. The Partnership added approximately 9,000 square feet in April 1994, 1,000 square feet in July 1994 and 3,000 square feet in December 1994. At December 31, 1994, the total casino floor space was 73,000 square feet. See \"Business -- Narrative Description of Business -- Expansion Sites -- Boardwalk Expansion Site.\"\nThe Partnership currently leases one parcel and subleases the other parcel which together comprise the Boardwalk Expansion Site. Pursuant to the Boardwalk Expansion Site Purchase Option, which expires on June 30, 1998, the Partnership may purchase both the fee and leasehold interests in the Boardwalk Expansion Site. Until such time as the Boardwalk Expansion Site Purchase Option is exercised or expires, the Partnership will be obligated to pay the net expenses associated with the Boardwalk Expansion Site, including, without limitation, current real estate taxes (approximately $1.2 million per year based upon current assessed valuation) and annual lease payments of $3.1 million per year. See \"Business -- Narrative Description of Business -- Expansion Sites -- Boardwalk Expansion Site.\"\nAs of December 31, 1994, the Partnership had capitalized approximately $11.7 million in construction costs related to the Boardwalk Expansion Site including a $1 million consulting fee paid to Trump. The Partnership's ability to acquire the Boardwalk Expansion Site pursuant to the Boardwalk Expansion Site Purchase Option is dependent upon its ability to obtain financing to acquire the property and is subject to the approval of the CCC. See \"Business --Narrative Description of Business--Expansion Sites--Boardwalk Expansion Site\" and \"Business--Narrative Description of Business--Gaming and Other Laws and Regulations.\"\nPursuant to the terms of a Services Agreement (as defined) with TPM (as defined), in consideration for services provided, the Partnership pays TPM each year an annual fee of $1.0 million in equal monthly installments, and reimburses TPM on a monthly basis for all reasonable out-of-pocket expenses incurred by TPM in performing its obligations under the Services Agreement, up to certain amounts. Under the Services Agreement, approximately $1.3 million and $1.2 million were charged to expense for the years ended December 31, 1994 and 1993, respectively.\nThe Mortgage Note Indenture restricts the ability of the Company and the Partnership, and the PIK Note Indenture restricts the ability of the Partnership to declare or pay dividends and make distributions to its partners, including restrictions relating to the achievement of certain financial ratios. Subject to the satisfaction of these restrictions, the Partnership may make distributions to its partners with respect to their Partnership interests. Neither the Company nor Holding has an available bank line of credit as of the date hereof.\nTHE COMPANY. The Company's sole source of liquidity is, and will be, payments made by the Partnership in respect of the Partnership Note securing the Company's indebtedness, and distributions from the Partnership, if any, in respect of its Partnership interest.\nHOLDING. Holding has no business operations other than that associated with holding its partnership interest in the Partnership and as issuer of the PIK Notes and Warrants. Holding's sole source of liquidity is from distributions in respect of its interest in the Partnership. Prior to the Units Offering, Holding did not have any long-term or short-term indebtedness; upon consummation of the Units Offering on June 25, 1993, Holding issued $72.0 million of indebtedness comprised of $60.0 million of PIK Notes and $12.0 million of deferred warrant obligations. Holding's indebtedness will increase upon exercise of the Warrants and upon the issuance of additional PIK Notes in lieu of cash interest paid on the PIK Notes. As of December 31, 1994, the Partnership issued, in lieu of cash, a total of\n$11,756,000 in PIK Notes to satisfy its semi-annual PIK Note interest obligations.\nSEASONALITY\nThe gaming industry in Atlantic city is seasonal, with the heaviest activity at Trump Plaza occurring during the period from May through September. Consequently, the Partnership's operating results during the two quarters ending in March and December would not likely be as profitable as the two quarters ending in June and September.\nINFLATION\nThere was no significant impact on the Partnership's operations as a result of inflation during 1994, 1993 and 1992.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. ------ -------------------------------------------\nAn index to the financial statements and required financial statement schedules is set forth at Item 14.\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. ------- --------------------------------\nMANAGEMENT\nPrior to the merger of TP\/GP into the Company, management of the affairs of the Partnership was vested in TP\/GP. As of June 18, 1993, the date of such merger, the Company became the managing partner of the Partnership. As of such date, the Company was granted full authority to do all things deemed necessary or desirable of the operations, business and affairs of the Partnership.\nAs currently constituted, the Board of Directors of each of the Company and Holding consists of Messrs. Trump, Nicholas L. Ribis, Wallace B. Askins and Don M. Thomas. In addition, Holding Inc. acts as the managing partner of Holding. Trump is currently the sole beneficial owner of the Partnership, the Company, Holding and Holding Inc.\nPursuant to the PIK Note Indenture and the Mortgage Note Indenture, the Company and Holding Inc. are each required to have at least two Independent Directors (as such term is defined by the American Stock Exchange, Inc.). The prior approval of the majority of the Company's Independent Directors will be required before the Partnership can engage in certain affiliate transactions.\nSet forth below, are the names, ages, positions and offices held with the Company, Holding and the Partnership and a brief account of the business experience during the past five years of each member of the Board of Directors and the executive officers of the Company, Holding and the Partnership.\nDonald J. Trump - Mr. Trump, 48 years old, is Chairman of the Board of Directors, President and Treasurer of the Company, the managing general partner of the Partnership. Trump was a 50% shareholder, Chairman of the Board of Directors, President and Treasurer of TP\/GP, the managing general partner of the Partnership prior to its merger into the Company in June 1993. Trump was Chairman of the Executive Committee and President of the Partnership from May 1986 to May 1992 and was a general partner of the Partnership until June 1993. Trump has been a director and President of Holding Inc. and a partner in Holding since February 1993. Trump has been Chairman of the Board of Partner Representatives of Trump's Castle Associates, the partnership that owns Trump's Castle (\"TCA\"), since May 1992; and was Chairman of the Executive Committee of TCA from June 1985 to May 1992. In addition, Trump is the managing general partner of TCA. Trump was Chairman of the Executive Committee of Trump\nTaj Mahal Associates, the Partnership that owns the Taj Mahal (\"TTMA\") from June 1988 to October 1991; and has been Chairman of the Board of Directors of the managing general partner of TTMA since October 1991; President and sole director of Trump Boardwalk Realty Corp. since May 1986; and President of the Trump Organization, which has been in the business, through its affiliates and subsidiaries, of acquiring, developing and managing real estate properties for more than the past five years. Trump was a member of the board of directors of Alexander's Inc. from 1987 to March 1992.\nNicholas L. Ribis - Mr. Ribis, 50 years old, has been the Chief Executive Officer of the Partnership since February 1991 and a member of the Executive Committee of the Partnership from April 1991 to May 29, 1992 and was a director and Vice President of TP\/GP from May 1992 until its merger into the Company in June 1993. Mr. Ribis has been Vice President of the Company since February 1995 and Vice President of Holding Inc. since February 1995. Mr. Ribis serves as the Chairman of the Atlantic City Casino Association. He has also been Chief Executive Officer of TCA and TTMA since March 1991; member of the executive committee of TCA from April 1991 to May 1992; member of the Board of Partner Representatives of TCA since May 1992; member of the executive committee of TTMA from April 1991 to October 1991; and member of the board of directors of the managing general partner of TTMA since October 1991. From January 1980 to January 1991, Mr. Ribis was Senior Partner in, and since February 1991, is Counsel to, the law firm of Ribis, Graham & Curtin, which serves as New Jersey legal counsel to all of the above-named companies, and certain of their affiliated entities, including the Company.\nBarry J. Cregan - Mr. Cregan, 41 years old, has been Chief Operating Officer of the Partnership since September 19, 1994. Since February 21, 1995, Mr. Cregan has been Vice President of the Company and Holding Inc. Prior to accepting these positions, from April 1992 to September 1994, Mr. Cregan was President of The Plaza Hotel in New York. From March 1991 to April 1992, he was Vice President of Hotel Operations at Trump's Castle in Atlantic City. From June 1989 until March 1991, Mr. Cregan was an executive with Hyatt.\nWallace B. Askins - Mr. Askins, 64 years old, has been a director of the Company and Holding Inc. since April 11, 1994, and has been a partner representative of the Board of Partner Representatives of Trump's Castle Associates since May 1992. Mr. Askins served as a director of TC\/GP from May 1992 to December 1993. From 1987 to November 1992, Mr. Askins served as Executive Vice President, Chief Financial Officer and as a director of Armco Inc. Mr. Askins also serves as a director of EnviroSource, Inc.\nDon M. Thomas - Mr. Thomas, 63 years old, has been the Senior Vice President of Corporate Affairs of the Pepsi-Cola Bottling Co. of New York since January 1985. Mr. Thomas was the Acting Chairman, and a Commissioner, of the CRDA from 1985 through 1987, and a Commissioner of the CCC from 1980 through 1984. From 1974 through 1980, Mr. Thomas served as Vice President, General Counsel of the National Urban League. From 1966 through 1974, Mr. Thomas served in various capacities with Chrysler Corporation rising to the level of President-Auto Dealerships. Mr. Thomas was an attorney with American Airlines from 1957 through 1966. Mr. Thomas was a director of TP\/GP until its merger into the Company in June 1993 and has been a director of the Company since June 1993. Mr. Thomas is an attorney licensed to practice law in the State of New York.\nFrancis X. McCarthy, Jr. - Mr. McCarthy, 42 years old, was Vice President of Finance and Accounting of TP\/GP from October 1992 until June 1993, the date of TP\/GP's merger into the Company, has been Executive Vice President, Finance Administration since June 1994 and was Senior Vice President of Finance and Administration of the Partnership from August 1990 to June 1994; Chief Accounting Officer of the Company since May 1992; Vice President and Chief Financial Officer of the Company since July 1992 and Assistant Treasurer of the Company since March 1991. Mr. McCarthy previously served in a variety of financial positions for Greater-Bay Hotel and Casino, Inc. from June 1980 through August 1990.\nJohn P. Burke - Mr. Burke, 47 years old, has been corporate treasurer of the Partnership since October 1991; corporate treasurer of TCA since October 1991; Vice President of The Trump Organization since September 1990; and member of the board of directors of TTMA since October 1991. Mr. Burke was an Executive Vice President and Chief Administrative Officer of Imperial Corporation of America from April 1989 through September 1990. From May 1980 through April 1989, Mr. Burke was Executive Vice President and Chief Financial Officer of Tamco Enterprises, Inc.\nRobert M. Pickus - Mr. Pickus, 40 years old, has been the Executive Vice President of Corporate and Legal Affairs of the Partnership since February 16, 1995. From December 1993 to February 1995, Mr. Pickus was the Senior Vice President and General Counsel of the Partnership and, since April 1994, he has been the Vice President and Assistant Secretary of the Company and Assistant Secretary of Holding Inc. He was the Senior Vice President and Secretary of Trump's Castle Funding, Inc. from June 1988 until December 1993 and General Counsel of TCA from June 1985 to June 1988. Mr. Pickus was also Secretary of Trump's\nCastle Hotel & Casino, Inc., an entity beneficially owned by Trump, from October 1991 until December 1993.\nFred A. Buro - Mr. Buro, 38 years old, has been the Senior Vice President of Marketing of the Partnership since May 1994. Mr. Buro previously served as the President of Casino Resources, Inc., a casino marketing, management and development organization from 1991 through 1994. Prior to that, Mr. Buro served from 1984 through 1991 as the President of a professional services consulting firm.\nJames A. Rigot - Mr. Rigot, 43 years old, has been Executive Vice President of Casino Operations of the Partnership since November 1994. Mr. Rigot served as Vice President of Casino Operations of TropWorld Casino and Entertainment Resort from July 1989 through November 1994. From January 1989 through July 1989, Mr. Rigot was Assistant Casino Manager of Resorts Casino Hotel. Mr. Rigot also served as Executive Host of the Partnership from September 1983 through January 1989 and as a Pit Boss at Harrah's Hotel Casino (in Atlantic City) from October 1980 through September 1983.\nKevin S. Smith - Mr. Smith, 38 years old, has been the Vice President, General Counsel of the Partnership since February 1995. From February 1992 to February 1995 Mr. Smith was associated with Cooper Perskie April Niedelman Wagenheim & Levenson, an Atlantic City law firm specializing in trial litigation as a certified criminal trial attorney by the New Jersey Supreme Court. From 1989 until February 1992, Mr. Smith handled criminal trial litigation for the State of New Jersey, Department of Public Defender, assigned to the Cape May and Atlantic County Conflict Unit.\nShinji Tanaka - Mr. Tanaka, 47 years old, has been Executive Vice President of Hotel Operations of the Partnership since January 1995 and was Vice President of Hotel Operations and Food & Beverage of the Partnership from June 1994 to January 1995. Mr. Tanaka was Director of Hotel and Food and Beverage Operations at TropWorld Casino and Entertainment Resort from August 1986 through February 1994. Mr. Tanaka also held various management positions with Hilton Hotels, including the Waldorf-Astoria and Capitol Hilton, from 1973 through October 1985.\nAll of the persons listed above have been qualified or licensed by the CCC.\nThe employees of the Partnership serve at the pleasure of the Company, the managing general partner of the Partnership, subject to any contractual rights contained in any employment agreement. The officers of the Company serve at the pleasure of the Board of Directors of the Company. The officers of Holding Inc. serve at the pleasure of the board of directors of that company.\nDonald J. Trump and Nicholas L. Ribis served as either executive officers and\/or directors of TTMA and its affiliated entities when such parties filed their petition for reorganization under chapter 11 of the Bankruptcy Code on July 17, 1991. The Second Amended Joint Plan of Reorganization of such parties was confirmed on August 28, 1991, and was declared effective on October 4, 1991. Donald J. Trump, Nicholas L. Ribis, Robert M. Pickus and John P. Burke also served as Executive Committee members, officers, and\/or directors of TCA and its affiliated entities, at the time such parties filed a petition for reorganization under chapter 11 of the Bankruptcy Code on March 9, 1992. The First Amended Joint Plan of Reorganization of such parties was confirmed on May 5, 1992, and declared effective on May 29, 1992. Donald J. Trump, Nicholas L. Ribis and John P. Burke served as either executive officers and\/or directors of the Partnership and its affiliated entities when such parties filed their petition for reorganization under chapter 11 of the Bankruptcy Code in March 1992. The First Amended Joint Plan of Reorganization of such parties was confirmed on April 30, 1992, and was declared effective on May 29, 1992. Trump was a partner of Plaza Operating Partners Ltd. when it filed a petition for reorganization under chapter 11 of the Bankruptcy Code on November 2, 1992. The plan of reorganization for Plaza Operating Partners Ltd. was confirmed on December 11, 1992 and declared effective in January 1993. John P. Burke was Executive Vice President and Chief Administrative Officer of Imperial Corporation of America (\"Imperial\"), a thrift holding company whose major subsidiary, Imperial Savings, was seized by the Resolution Trust Corporation in February 1990. Subsequently, in February 1990, Imperial filed a petition for reorganization under chapter 11 of the Bankruptcy Code.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION. ------- ----------------------\nCOMPENSATION\nHolding, the Company and the Partnership do not offer their executive officers stock option or stock appreciation right plans, long-term incentive plans or defined benefit pension plans.\nThe following table sets forth compensation paid or accrued during the years ended December 31, 1994, 1993 and 1992 to the Chief Executive Officer, each of the four most highly compensated executive officers of the Partnership whose cash compensation, including bonuses and deferred compensation, exceeded $100,000 for the year ended December 31, 1994 and two additional individuals whose employment with the Company terminated in 1994.\nExecutive Officers of the Company do not receive any additional compensation for serving in such capacity. Compensation accrued during one year and paid in another is recorded under the year of accrual. Information relating to long-term compensation is inapplicable and has therefore been omitted from the table.\nSummary Compensation Table\n(1) Represents the dollar value of annual compensation not properly categorized as salary or bonus, including amounts reimbursed for income taxes and director's fees. Following SEC rules, perquisites and other personal benefits are not included in this table if the aggregate amount of that compensation is the lesser of either $50,000 or 10% of the total of salary and bonus for that officer.\n(2) Represents vested and unvested contributions made by the Partnership under the Trump Plaza Hotel and Casino Retirement Savings Plan. Funds accumulated for an employee, which consist of a certain percentage of the employee's compensation plus Partnership contributions equalling 50% of the participant's contributions, are retained until termination of employment, attainment of age 59 1\/2 or financial hardship, at which time the employee may withdraw his or her vested funds.\n(3) Mr. Ribis devotes approximately one-third of his professional time to the affairs of the Partnership. Mr. Ribis is also employed as the chief executive officer of the Other Trump Casinos; his compensation from the Other Trump Casinos is not included in the table.\n(4) Mr. Cregan commenced employment with the Partnership in September 1994.\n(5) Mr. Pickus commenced employment with the Partnership in December 1993.\n(6) Mr. Rigot commenced employment with the Partnership in November 1994.\n(7) Mr. DeSanctis, former President and Chief Operating Officer of Trump Plaza resigned in March 1994.\n(8) Mr. Velardo, former Vice President of Casino Operations of the Partnership until March 1994 and Chief Operating Officer from March 1994 to April 1994.\nEMPLOYMENT AGREEMENTS\nThe Partnership has an employment agreement with Nicholas L. Ribis pursuant to which Mr. Ribis acts as Chief Executive Officer of the Partnership. The agreement, which expires in September 1996, provides for an annual salary of $550,000. The salary increases by ten percent for each of the second and third years of the agreement. Upon execution of the employment agreement, Mr. Ribis received a $250,000 signing bonus. In the event the Partnership, or any entity which acquires substantially all of the equity interests or assets of the Partnership, proposes to engage in an offering of common shares to the public, the Partnership and Mr. Ribis have agreed to negotiate new compensation arrangements which shall include equity participation for Mr. Ribis. Mr. Ribis is also chief executive officer of TTMA and TCA, the partnerships that own the Other Trump Casinos, and receives compensation from such entities for such services. Mr. Ribis devotes approximately one-third of his professional time to the affairs of the Partnership. All other executive officers of the Partnership, except Mr. Burke, devote substantially all of their time to the business of the Partnership.\nThe Partnership and the Company have an employment agreement with Barry J. Cregan (the \"Cregan Agreement\") pursuant to which Mr. Cregan acts as Chief Operating Officer of the Partnership. The Cregan Agreement, which expires on September 18, 1996, provides for an annual base salary of $600,000 during the first year and an annual base salary of $700,000 during the second year. In addition, Mr. Cregan has an option to extend the Cregan Agreement for one additional year at an annual base salary of $750,000 during such third year of employment. In addition to base salary, Mr. Cregan shall also receive certain other benefits as provided for in the Cregan Agreement. Pursuant to the Cregan Agreement, Mr. Cregan devotes all of his professional time to the Partnership. In the event that the Partnership or the Company terminates Mr. Cregan's employment for Cause (as defined in the Cregan Agreement), the Partnership shall pay Mr. Cregan all compensation earned to the date of such termination. In the event Mr. Cregan terminates the Cregan Agreement for Good Cause (as defined therein), the Partnership shall pay Mr. Cregan all compensation, reimbursements and benefits provided for therein (i) due as of the date of such termination and (ii) payable under the Cregan Agreement from such date of termination through the date of expiration.\nThe Partnership has an employment agreement with James A. Rigot (the \"Rigot Agreement\") pursuant to which Mr. Rigot acts as Executive Vice President of Casino Operations of the Partnership. The Rigot Agreement, which expires on November 30, 1997, provides for a bonus of $100,000 upon commencement of employment, an annual base salary of $250,000, with any bonus and increases in\nsalary provided in the Partnership's sole and absolute discretion, however, at no time shall such salary be less than $250,000. In addition to salary, Mr. Rigot shall also receive certain other benefits as provided for in the Rigot Agreement. Pursuant to the Rigot Agreement, Mr. Rigot devotes all of his professional time to the Partnership. In the event that the Partnership terminates the Rigot Agreement (i) because Mr. Rigot's CCC license is terminated or (ii) because Mr. Rigot has committed an act constituting Cause (as defined therein), the Partnership shall pay to Mr. Rigot all compensation earned to the date of such termination. In the event that the Partnership terminates the Rigot Agreement for any other reason, the Partnership shall offer to pay Mr. Rigot an amount equal to twelve months of Mr. Rigot's then current salary, which offer, if accepted, will constitute complete satisfaction of all obligations and liabilities arising out of the Rigot Agreement.\nThe Partnership has an employment agreement with Kevin S. Smith, Esq. (the \"Smith Agreement\") pursuant to which Mr. Smith acts as the Vice President\/General Counsel of the Partnership. The Smith Agreement, which expires on February 9, 1998, provides for an annual base salary of $110,000, with any bonus and increases in salary provided in the Partnership's sole and absolute discretion. In addition to salary, Mr. Smith shall also receive certain other benefits as provided for in the Smith Agreement. Pursuant to the Smith Agreement, Mr. Smith devotes all of his professional time to the Partnership. In the event that the Partnership or Mr. Smith terminates the Smith Agreement, the Smith Agreement provides for various types of severance compensation based on the circumstances surrounding the termination. The severance compensation provided for in the Smith Agreement shall, in no case, exceed one year's salary, including benefits.\nThe Partnership has a severance agreement with Robert M. Pickus, Esq., who is the Executive Vice President of Corporate and Legal Affairs of the Partnership. The agreement provides that upon Mr. Pickus' termination other than for cause (as defined in the severance agreement) or loss of his casino key employee license from CCC, the Partnership will pay Mr. Pickus a severance payment equal to the amount of his salary at its then current rate for a period of one year, which is anticipated to be in excess of $150,000.\nThe Partnership had an employment agreement with Kevin DeSanctis, former President and Chief Operating Officer of Trump Plaza. The agreement was terminated upon the resignation of Mr. DeSanctis. Mr. DeSanctis received $200,769 of salary and $128,720 in bonus in 1994.\nThe Partnership had an employment agreement with Ernest E. East, Esq., former Senior Vice President of Administration and Corporate Affairs of the Partnership. The agreement was terminated upon Mr. East's resignation in August 1994. Mr. East received $101,407 of salary, and $156,000 in board fees in 1994.\nThe Partnership had an employment agreement with William Velardo that expired in March 1994. Mr. Velardo served as the Vice President of Casino Operations of the Partnership until March 1994 and as the Chief Operating Officer of the Partnership from March 1994 to April 1994. Mr. Velardo received $173,700 of salary and severance payments in 1994.\nAll of the above agreements provide for discretionary bonuses and\/or signing bonuses.\nCOMPENSATION OF DIRECTORS\nEach director of the Company, receives an annual fee of $50,000 and $2,000 per meeting attended, plus reasonable out-of-pocket expenses incurred in attending any meeting of the Board of Directors of the Company.\nEach director of TP\/GP, other than Trump, received an annual fee of $50,000 and $2,000 per meeting attended, plus reasonable out-of-pocket expenses incurred in attending any meeting of the board of directors of TP\/GP. In addition, each member of the TP\/GP Audit Committee received a fee of $1,500 for each meeting attended. TP\/GP, the former managing general partner of the Partnership, was merged with and into the Company in June 1993.\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\nHolding does not have a compensation committee and its officers serve without separate compensation.\nIn general, the compensation of executive officers of the Partnership is determined by the Board of Directors of the Company, composed of Donald J. Trump, Nicholas L. Ribis, Wallace B. Askins and Don M. Thomas. The compensation of Nicholas L. Ribis is set forth in his employment agreement with the Partnership, pursuant to which the Partnership has delegated the responsibility over certain matters, such as bonuses, to Trump. See \"-- Employment Agreements.\" No officer or employee of Trump Plaza, other than Mr. Ribis, who serves on the Board of Directors of the Company, participated in the deliberations of the Board of Directors of the Company concerning executive compensation. Executive officers of the Company do not receive any additional compensation for serving in such capacity.\nThe SEC requires registrants to disclose the existence of any other corporation in which both (i) an executive officer of the registrant serves on the board of directors and\/or compensation committee, and (ii) a director of the registrant serves as an executive officer. Messrs. Ribis and Burke, executive officers of the Partnership, have served on the board of directors of other entities in which members of the Board of Directors of the Company (namely, Messrs. Trump and Ribis) served and continue to serve as executive officers. Management believes that such relationships have not affected the compensation decisions made by the Board of Directors of the Company in the last fiscal year.\nMessrs. Ribis and Burke serve on the board of directors of Taj Mahal Holding Corp., which holds an indirect equity interest in TTMA, the partnership that owns the Taj Mahal, of which Messrs. Trump and Ribis are executive officers. Such persons also serve on the board of directors of TM\/GP Corporation (a subsidiary of Taj Mahal Holding Corp.), the managing general partner of TTMA, of which Messrs. Trump and Ribis are executive officers. Mr. Ribis is compensated by TTMA for his services as its chief executive officer.\nMr. Ribis also serves on the board of directors of Trump Taj Mahal Realty Corp. (\"Taj Realty Corp.\"), which leases certain real property to TTMA, of which Trump is an executive officer. Trump, however, does not receive any compensation for serving as an executive officer of Taj Realty Corp. Mr. Ribis receives compensation from TCA for acting as its chief executive officer.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN ------- BENEFICIAL OWNERS AND MANAGEMENT. --------------------------------\nTrump has owned 100% of the Common Stock since June 25, 1993. Trump has sole voting and investment power regarding the Common Stock owned by him.\nIn connection with the PIK Note Offering which was consummated on June 25, 1993, TP\/GP was merged with and into the Company, and the Company became the managing general partner of the Partnership. Trump contributed his interest in the Partnership to Holding, which is beneficially-owned by Trump. Since such date, the Company and Holding have been the sole partners in the Partnership.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS ------- AND RELATED TRANSACTIONS. ------------------------\nAlthough the Partnership has not fully considered all of the areas in which it intends to engage in transactions with affiliates of the partners, it is free to do so, subject to certain restrictions. Payments to affiliates in connection with any such transactions are governed by the provisions of the Mortgage Note Indenture and the PIK Note Indenture which generally require that such transactions be on terms as favorable to the Partnership as would be obtainable from an unaffiliated party, and requires the approval of a majority of the Independent Directors of the Company for certain affiliated transactions.\nThe Partnership has joint property insurance coverage with TCA, TTMA and other entities affiliated with Trump for which the annual premium paid by the Partnership was $247,000 for the twelve months ended May 1994.\nThe Partnership leased from TTMA certain office facilities located in Pleasantville, New Jersey. In 1993 and 1992, lease payments by the Partnership to TTMA totalled approximately $30,000 and $138,000, respectively. Such lease terminated on March 19, 1993, and the Partnership vacated the premises. Through February 1, 1993, the Partnership also leased from Trump approximately 120 parking spaces at the Boardwalk Expansion Site for approximately $5.50 per parking space per day, with payments under such arrangement for the year ended December 31, 1993 and December 31, 1992 totalling $21,000 and $227,000, respectively.\nThe Partnership also leased portions of its warehouse facility located in Egg Harbor Township, New Jersey to TCA until January 31, 1994; lease payments by TCA to the Partnership totalled $6,000, $15,000 and $14,000 in 1994, 1993 and 1992, respectively.\nTrump and Trump Boardwalk collectively own 100% of the interests in Seashore Four. Seashore Four is the fee owner of a parcel of land constituting a portion of the Casino Parcel, which it leases to the Partnership pursuant to the SFA Lease, a long-term, triple-net lease. Seashore Four was assigned the lessor's interest in the existing SFA Lease in connection with its acquisition of fee title to such parcel from a non- affiliated third party in November 1983. The SFA Lease was entered into by the Partnership with such third party on an arm's-length basis. The Partnership recorded rental expenses of approximately $900,000, $900,000 and $900,000 in 1994, 1993 and 1992, respectively, concerning rent owed to Seashore Four.\nTrump and Trump Seashore Associates, Inc. collectively own 100% of the interests in Trump Seashore Associates (\"Trump Seashore\"). Trump Seashore is the fee owner of a parcel of land constituting a portion of the Casino Parcel, which it leases to the Partnership pursuant to the Trump Seashore Lease, a long-term, triple-net lease. In July 1988, Trump Seashore exercised a $10 million option to purchase the fee title to such parcel from a non-affiliated third party. In connection therewith, Trump Seashore was assigned the lessors' interest in the Trump Seashore Lease, which interest has, however, been transferred to UST. See \"Properties.\" The Partnership paid rental payments to Trump Seashore of approximately $1.0 million, $1.0 million and $1.0 million in 1994, 1993 and 1992, respectively.\nThe Partnership has separately agreed to reimburse Trump for any payments which he may make under (i) a note (the \"Harrah's Note\") for which Trump and the Partnership are co-makers and which constitutes part of the redemption price for Harrah's Atlantic City, Inc.'s (\"HAC\") prior interests in the Partnership and Seashore Four, which were redeemed in 1986, pursuant to a redemption agreement dated as of March 11, 1986 (the \"Redemption Agreement\"); and (ii) his or Trump Boardwalk's indemnity of HAC under the Redemption Agreement, insofar as it relates to the Partnership. Trump and Trump Boardwalk have agreed to assign to the Partnership any payment either receives pursuant to HAC's and The Promus Companies Incorporated's (HAC's parent corporation) indemnity, insofar as it relates to the Partnership. The Harrah's Note was repaid by the Partnership on May 16, 1993.\nThe financial statements of the Company included herein include a provision for Federal income taxes, based on distributions from the Partnership relating to the Company's Preferred Stock which was redeemed on June 25, 1993. The Company will be reimbursed for such income taxes by the Partnership in the amount of $3.8 million when due.\nBOARDWALK EXPANSION SITE\nSee \"Business -- Narrative Description of Business --Expansion Sites -- Boardwalk Expansion Site\" and \"Management's Discussion and Analysis of Financial Condition and Results of Operation -- Liquidity and Capital Resources.\"\nTRUMP REGENCY\nSee \"Business -- Narrative Description of Business --Expansion Sites -- Trump Regency.\"\nSERVICES AGREEMENT\nOn June 24, 1993, the Partnership and Trump Plaza Management Corp. (\"TPM\") entered into an Amended and Restated Services Agreement (the \"Services Agreement\") pursuant to which TPM is required to provide to the Partnership, from time to time when reasonably requested, consulting services on a non- exclusive basis, relating to marketing, advertising, promotional and other similar and related services (the \"Services\") with respect to the business and operations of the Partnership. In addition, the Services Agreement contains a non-exclusive \"license\" of the \"Trump\" name. TPM is not required to devote any prescribed amount of time to the performance of its duties. In consideration for the Services, the Partnership pays TPM an annual fee of $1.0 million in equal monthly installments. In addition to such annual fee, the Partnership reimburses TPM on a monthly basis for all reasonable out-of-pocket expenses incurred by TPM in performing its obligations under the Services Agreement. The Partnership paid TPM $1,288,000, $1,247,000 and $708,000 in 1994, 1993 and 1992, respectively, for the Services. Pursuant to the Services Agreement, the Partnership will agree to hold TPM, its officers, directors and employees harmless from and against any loss arising out of or in connection with the performance of the Services and to hold Trump harmless from and against any loss arising out of the license of the \"Trump\" name.\nINDEMNIFICATION AGREEMENTS\nThe directors of the Company have entered into separate indemnification agreements (collectively, the \"Indemnification Agreements\") with the Partnership pursuant to which such persons are afforded the full benefits of the indemnification provisions of the partnership agreement of the Partnership. The Partnership has also entered into an Indemnification Trust Agreement with an Indemnification Trustee (the \"Trust Agreement\") pursuant to which the sum $100,000 has been deposited by the Partnership with the Indemnification Trustee for the benefit of the directors of the Company and the Class B Directors of TP\/GP serving prior to the Offerings to provide a source for indemnification for such persons if the Partnership or the Company, as the case may be, fails to immediately honor a demand for indemnification by such persons. In connection with the Offerings, the Indemnification Agreements with the directors of the Company and the Class B Directors of TP\/GP were amended to provide, among other things, the Partnership would maintain directors' and officers' insurance covering such persons during the term of the Indemnification Agreements; provided, however, that if such insurance would not be available on a commercially practicable basis, the Partnership could, in lieu of obtaining such insurance, annually deposit an amount in the Indemnification Trust Fund equal to $500,000 for\nthe benefit of such directors; provided, further, that deposits relating to the failure to obtain such insurance shall not exceed $2.5 million.\nPART IV -------\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT ------- SCHEDULES, AND REPORTS ON FORM 8-K. ----------------------------------\n(a) FINANCIAL STATEMENTS. See the Index to Financial Statements immediately following the signature pages.\n(b) REPORTS ON FORM 8-K. The Registrants did not file any reports on Form 8-K during the last quarter of the year ended December 31, 1994.\n(c) EXHIBITS.\nExhibit No. Description of Exhibit ----------- ----------------------\n3.1(1) Amended and Restated Certificate of Incorporation of the Company.\n3.1.1(8) Form of Second Amended and Restated Certificate of Incorporation of the Company.\n3.2(1) Amended and Restated By-Laws of the Company.\n3.3(1) Amended and Restated Certificate of Incorporation of TP\/GP.\n3.4(1) Amended and Restated By-Laws of TP\/GP.\n3.5(8) Certificate of Incorporation of Holding Inc.\n3.6(8) By-Laws of Holding Inc.\n3.7(9) Second Amended and Restated Partnership Agreement of the Partnership.\n3.8(8) Partnership Agreement of Holding.\n3.8.1(8) Amendment No. 1 to the Partnership Agreement of Holding.\n3.9(8) Agreement and Plan of Merger between TP\/GP and the Company.\n4.1(9) Mortgage Note Indenture, among the Company, as issuer, the Partnership, as guarantor, and the Mortgage Note Trustee, as trustee.\n4.2(9) Indenture of Mortgage, between the Partnership, as Mortgagor, and the Company, as Mortgagee (the Note Mortgage.\n4.3(9) Assignment Agreement between the Company and the Mortgage Note Trustee.\n4.4(9) Assignment of Operating Assets from the Partnership to the Company.\n4.5(9) Assignment of Leases and Rents from the Partnership to the Company.\n4.6(9) Indenture of Mortgage between the Partnership and the Mortgage Note Trustee (the Guarantee Mortgage).\n4.7(9) Assignment of Leases and Rents from the Partnership to the Mortgage Note Trustee.\n4.8(9) Assignment of Operating Assets from the Partnership to the Mortgage Note Trustee.\n4.9(9) The Partnership Note.\n4.10(9) Mortgage Note (included in Exhibit 4.1).\n4.11(9) Pledge Agreement of the Company in favor and for the benefit of the Mortgage Note Trustee.\n4.12(9) PIK Note Indenture between Holding, as Issuer, and the PIK Note Trustee, as trustee.\n4.13(9) PIK Note (included in Exhibit 4.12).\n4.14(8) Warrant Agreement.\n4.15(8) Warrant (included in Exhibit 4.14).\n4.16(8) Pledge Agreement of Holding in favor and for the benefit of the PIK Note Trustee.\n10.1-10.6 Intentionally omitted.\n10.7(12) Employment Agreement between the Partnership and Barry Cregan.\n10.8-10.9 Intentionally omitted.\n10.10(4) Agreement of Lease, dated as of July 1, 1980, by and between SSG Enterprises, as lessor and Atlantic City Seashore 2, Inc., as lessee, as SSG Enterprises' interest has been assigned to Seashore Four, and as Atlantic City Seashore 2, Inc.'s interest has been, through various assignments, assigned to the Partnership (with schedules).\n10.11(4) Agreement of Lease, dated July 11, 1980, by and between Plaza Hotel Management Company, as lessor, and Atlantic City Seashore 3, Inc., as lessee, as Atlantic City Seashore 3, Inc.'s interest has been, through various assignments, assigned to the Partnership (with schedules).\n10.12(4) Agreement of Lease, dated as of July 1, 1980, by and between Magnum Associates and Magnum Associates II, as lessor and Atlantic City Seashore 1, Inc., as lessee, as Atlantic City Seashore 1, Inc.'s interest has been, through various assignments, assigned to the Partnership (with schedules).\n10.13-10.15 Intentionally omitted.\n10.16(2) Trump Plaza Hotel and Casino Retirement Savings Plan effective as of November 1, 1986.\n10.17-10.20 Intentionally omitted.\n10.21(5) Assignment of Lease, dated as of July 28, 1988, by and between Magnum Associates and Magnum Associates II, as assignor, Trump Seashore Associates, as assignee, and the Partnership, as lessee.\n10.22-10.23 Intentionally omitted.\n10.24(5) Employment Agreement, dated January 28, 1991, between the Partnership and Kevin DeSanctis.\n10.24.1(7) Amendment to Employment Agreement, dated August 6, 1992, between the Partnership and Kevin DeSanctis.\n10.25 Intentionally omitted.\n10.26(1) Employment Agreement, dated as of June 1, 1992 between the Partnership and Ernest E. East.\n10.27(3) Employment Agreement, dated as of March 13, 1991 between the Partnership and William Velardo.\n10.28(3) Option Agreement, dated as of February 2, 1993 between Trump and the Partnership.\n10.29(8) Appraisal of Trump Plaza by Appraisal Group International, dated March 5, 1993.\n10.30(6) Amended and Restated Services Agreement between the Partnership and Trump.\n10.31(1) Working Capital Facility between the Partnership and Belmont Fund, L.P.\n10.31.1(8) Mortgage and Security Agreement of the Partnership in favor of Belmont Fund, L.P.\n10.31.2(8) Assignment of Rents and Leases: by the Partnership to Belmont Fund L.P., dated May 29, 1992.\n10.31.3(8) Assignment of Operating Assets: by the Partnership to Belmont Fund L.P., dated May 29, 1992.\n10.32.1(8) Mortgage: from Trump, Nominee to Emil F. Aysseh, Trustee dated January 12, 1983.\n10.32.2(8) Mortgage: from Trump, Nominee to Emil F. Aysseh, Trustee dated June 23, 1983.\n10.32.3(8) Mortgage Consolidation, Modification, and Extension Agreement: dated June 23, 1983.\n10.32.4(8) Partial Assignment of Mortgage: (1\/3 interest) by Alfred Aysseh to New Canaan Bank Trust Company.\n10.32.5(8) Partial Assignment of Mortgage: (1\/3 interest) by New Canaan Bank and Trust Company to Alfred Aysseh.\n10.32.6(8) Assignment of Mortgage: Emil F. Aysseh, Trustee to Community National Bank and Trust Company of New York.\n10.32.7(8) Mortgage Note and Mortgage Modification Agreement: by and between Emil F. Aysseh, Trustee and Donald J. Trump, Nominee dated January 10, 1992.\n10.33(8) Mortgage: from Donald J. Trump, Nominee to Albert Rothenberg and Robert Rothenberg, dated October 3, 1983.\n10.34(8) Mortgage: made by Harrah's Associates to Adeline Bordonaro, dated January 28, 1986.\n10.35(8) Mortgage: made by the Partnership to The Mutual Benefit Life Insurance Company, dated October 5, 1990.\n10.35.1(8) Collateral Assignment of Leases: made by the Partnership to The Mutual Benefit Life Insurance Company, dated October 5, 1990.\n10.36-10.37 Intentionally omitted.\n10.38(11) Employment Agreement between the Partnership and Nicholas L. Ribis.\n10.39(11) Severance Agreement between the Partnership and Robert M. Pickus.\n10.40 Employment Agreement, dated February 7, 1995, between the Partnership and Kevin S. Smith.\n10.41 Employment Agreement, dated November 21, 1994, between the Partnership and James A. Rigot.\n10.42 Option and Right of First Offer Agreement between the Partnership and Missouri Boardwalk Inc., dated as of June 24, 1993.\n10.43 Lease between Trump and Missouri Boardwalk Inc., dated as of June 24, 1993.\n10.44 Sublease between Trump and Missouri Boardwalk Inc., dated June 24, 1993.\n10.45 Option Agreement among Trump, ACFH and Chemical, dated December 17, 1993.\n10.45.1 Amended and Restated Option Agreement among Trump, ACFH and Chemical, dated June 16, 1994.\n10.45.2 First Amendment to Amended and Restated Option Agreement among Trump, ACFH and Chemical, dated August 30, 1994.\n10.45.3 Second Amendment to Amended and Restated Option Agreement among Trump, ACFH and Chemical, dated March 6, 1995.\n24 Power of Attorney of directors and certain officers of the Company, Holding and the Partnership (included in the signature pages).\n27.1 Financial Data Schedule for Trump Plaza Funding, Inc.\n27.2 Financial Data Schedule for Trump Plaza Holding Associates.\n27.3 Financial Data Schedule for Trump Plaza Associates. -------------\n(1) Incorporated herein by reference to the Exhibit to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1992.\n(2) Incorporated herein by reference to the identically numbered Exhibit in the Company's Annual Report on Form 10-K for the year ended December 31, 1986.\n(3) Incorporated herein by reference to the identically numbered Exhibit in the Company's Annual Report on Form 10-K for the year ended December 31, 1992.\n(4) Incorporated herein by reference to the identically numbered Exhibit in the Company's Registration Statement on Form S-1, Registration No. 33-4604.\n(5) Incorporated herein by reference to the identically numbered Exhibit in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990.\n(6) Previously filed in Holding's Registration Statement on Form S- 1, Registration No. 33-58608.\n(7) Incorporated herein by reference to the Exhibit to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1992.\n(8) Incorporated herein by reference to the identically numbered Exhibit in the Registration Statement of the Company and the Partnership on Form S-1, Registration No. 33-58602.\n(9) Incorporated herein by reference to the identically numbered Exhibit in Holding's Registration Statement on Form S-1, Registration No. 33-58608.\n(10) Previously filed in the Registration Statement of the Company and the Partnership on Form S-1, Registration No. 33-58602.\n(11) Incorporated herein by reference to the identically numbered Exhibit in the Annual Report of the Company and Holding on Form 10-K for the year ended December 31, 1993.\n(12) Incorporated herein by reference to the identically numbered Exhibit in the Quarterly Report of the Company and Holding on Form 10-Q for the quarter ended September 30, 1994.\n(d) FINANCIAL STATEMENT SCHEDULES. See the Index to Financial Statements immediately following the signature pages.\nPARTNERSHIP SIGNATURE\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Partnership has duly caused this Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized this 29th day of March, 1995.\nTRUMP PLAZA ASSOCIATES\nBy: Trump Plaza Funding, Inc. Its: Managing General Partner\n\/s\/ Donald J. Trump ----------------------------- By: Donald J. Trump Title: President\nPursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report has been signed on the subsequent pages by the persons listed therein in the capacities and on the dates indicated for Trump Plaza Funding, Inc. and Trump Plaza Holding Associates, the general partners of the Partnership.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, each Registrant has duly caused this Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized this 29th day of March, 1995.\nTRUMP PLAZA FUNDING, INC.\n\/s\/ Donald J. Trump ------------------------------- By: Donald J. Trump Title: President and Treasurer\nTRUMP PLAZA HOLDING ASSOCIATES\nBy: Trump Plaza Holding, Inc. Its Managing General Partner\n\/s\/ Donald J. Trump ------------------------------- By: Donald J. Trump Title: President\nPOWER OF ATTORNEY\nEACH PERSON WHOSE SIGNATURE APPEARS BELOW CONSTITUTES AND APPOINTS DONALD J. TRUMP AND NICHOLAS L. RIBIS, AND EACH OF THEM, WITH FULL POWER TO ACT WITHOUT THE OTHER, HIS TRUE AND LAWFUL ATTORNEY-IN-FACT AND AGENT, WITH FULL POWER OF SUBSTITUTION AND RESUBSTITUTION, FOR HIM AND IN HIS NAME, PLACE AND STEAD, IN ANY AND ALL CAPACITIES, TO SIGN ANY AND ALL AMENDMENTS TO THIS ANNUAL REPORT, AND TO FILE THE SAME, WITH ALL EXHIBITS THERETO, AND OTHER DOCUMENTS IN CONNECTION THEREWITH, WITH THE SECURITIES AND EXCHANGE COMMISSION, GRANTING UNTO SAID ATTORNEYS-IN-FACT AND AGENTS, AND EACH OF THEM, FULL POWER AND AUTHORITY TO DO AND PERFORM EACH AND EVERY ACT AND THING REQUISITE AND NECESSARY TO BE DONE, AS FULLY TO ALL INTENTS AND PURPOSES AS HE MIGHT OR COULD DO IN PERSON HEREBY RATIFYING AND CONFIRMING ALL THAT SAID ATTORNEYS-IN-FACT AND AGENTS OR ANY OF THEM, OR HIS OR THEIR SUBSTITUTE OR SUBSTITUTES, MAY LAWFULLY DO OR CAUSE TO BE DONE BY VIRTUE HEREOF.\nPursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:\nSignature Title Date --------- ----- ----\nTRUMP PLAZA FUNDING, INC.\nBy: \/s\/ Donald J. Trump March 29, 1995 ---------------------------- Donald J. Trump Principal Executive Officer and Director\nBy: \/s\/ Francis X. McCarthy, Jr. March 29, 1995 ---------------------------- Francis X. McCarthy, Jr. Principal Financial and Accounting Officer\nBy: \/s\/ Nicholas L. Ribis March 29, 1995 ---------------------------- Nicholas L. Ribis Director\nBy: \/s\/ Wallace B. Askins March 29, 1995 ------------------------------- Wallace B. Askins Director\nBy: \/s\/ Don M. Thomas March 29, 1995 ---------------------------- Don M. Thomas Director\nPursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:\nSignature Title Date --------- ----- ----\nTRUMP PLAZA HOLDING ASSOCIATES\nBy: Trump Plaza Holding, Inc. Its Managing General Partner\nBy: \/s\/ Donald J. Trump March 29, 1995 ---------------------------- Donald J. Trump Principal Executive Officer and Director\nBy: \/s\/ Francis X. McCarthy, Jr. March 29, 1995 ---------------------------- Francis X. McCarthy, Jr. Principal Financial and Accounting Officer\nBy: \/s\/ Nicholas L. Ribis March 29, 1995 ---------------------------- Nicholas L. Ribis Director\nBy: \/s\/ Wallace B. Askins March 29, 1995 ------------------------------- Wallace B. Askins Director\nBy: \/s\/ Don M. Thomas March 29, 1995 ---------------------------- Don M. Thomas Director\nOther Schedules are omitted for the reason that they are not required or are not applicable, or the required information is shown in the consolidated financial statements or notes thereto.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo Trump Plaza Funding, Inc.:\nWe have audited the accompanying balance sheets of Trump Plaza Funding, Inc. (a New Jersey Corporation) as of December 31, 1994 and 1993, and the related statements of income, 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 management of Trump Plaza Funding, Inc. 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 Trump Plaza Funding, 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.\nARTHUR ANDERSEN LLP\nRoseland, New Jersey February 18, 1995\nTRUMP PLAZA FUNDING, INC. BALANCE SHEETS DECEMBER 31, 1994 AND 1993\nASSETS ------\nLIABILITIES AND CAPITAL -----------------------\nThe accompanying notes to financial statements are an integral part of these balance sheets.\nTRUMP PLAZA FUNDING, INC. STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\nThe accompanying notes to financial statements are an integral part of these statements.\nTRUMP PLAZA FUNDING, INC. STATEMENTS OF CAPITAL FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\nThe accompanying notes to financial statements are an integral part of these statements.\nTRUMP PLAZA FUNDING, INC. STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\nThe accompanying notes to financial statements are an integral part of these statements.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo Trump Plaza Holding Associates and Trump Plaza Associates:\nWe have audited the accompanying consolidated balance sheets of Trump Plaza Holding Associates (a New Jersey general partnership) and Trump Plaza Associates (a New Jersey general partnership) as of December 31, 1994 and 1993, and the related consolidated statements of operations, capital (deficit) and cash flows for each of the three years in the period ended December 31, 1994. These consolidated financial statements, and the schedule referred to below, are the responsibility of the management of Trump Plaza Holding Associates and Trump Plaza Associates. 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 Trump Plaza Holding Associates and Trump Plaza Associates 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 schedule listed in the index to the financial statements and schedules 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 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 basis financial statements taken as a whole.\nARTHUR ANDERSEN LLP\nRoseland, New Jersey February 18, 1995\nTRUMP PLAZA HOLDING ASSOCIATES AND TRUMP PLAZA ASSOCIATES CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1994 AND 1993\nThe accompanying notes to financial statements are an integral part of these consolidated statements.\nTRUMP PLAZA HOLDING ASSOCIATES AND TRUMP PLAZA ASSOCIATES CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\nThe accompanying notes to financial statements are an integral part of these consolidated statements.\nTRUMP PLAZA HOLDING ASSOCIATES AND TRUMP PLAZA ASSOCIATES CONSOLIDATED STATEMENTS OF CAPITAL (DEFICIT) FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\nThe accompanying notes to financial statements are an integral part of these consolidated statements.\nTRUMP PLAZA HOLDING ASSOCIATES AND TRUMP PLAZA ASSOCIATES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\nThe accompanying notes to financial statements are an integral part of these consolidated statements.\nTRUMP PLAZA HOLDING ASSOCIATES AND TRUMP PLAZA ASSOCIATES CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\nThe accompanying notes to financial statements are an integral part of these consolidated statements.\nTRUMP PLAZA FUNDING, INC. TRUMP PLAZA HOLDING ASSOCIATES AND TRUMP PLAZA ASSOCIATES NOTES TO FINANCIAL STATEMENTS\n(1) ORGANIZATION\nThe accompanying financial statements include those of Trump Plaza Funding, Inc. (the \"Company\"), a New Jersey General Corporation as well as those of Trump Plaza Holding Associates (\"Holding\"), a New Jersey General Partnership, and its 99% owned subsidiary, Trump Plaza Associates (the \"Partnership\"), a New Jersey General Partnership, which owns and operates Trump Plaza Hotel and Casino (\"Trump Plaza\") located in Atlantic City, New Jersey. The Company owns the remaining 1% interest in the Partnership. Holding's sole source of liquidity is distributions in respect of its interest in the Partnership.\nAll significant intercompany balances and transactions have been eliminated in the accompanying consolidated financial statements. The minority interest in the Partnership has not been separately reflected in the consolidated financial statements of Holding since it is not material.\nThe Company was incorporated on March 14, 1986 and was originally formed solely to raise funds through the issuance and sale of its debt securities for the benefit of the Partnership. As part of a Prepackaged Plan of Reorganization under Chapter 11 of the U.S. Bankruptcy code consummated on May 29, 1992, the Company became a partner of the Partnership and issued approximately three million Stock Units, each comprised of one share of Preferred Stock and one share of Common Stock of the Company. On June 25, 1993, the Stock Units were redeemed with a portion of the proceeds of the Company's 10 7\/8% Mortgage Notes due 2001 (the \"Mortgage Notes\") as well as Holding's Units.\nHolding was formed in February 1993 for the purpose of raising funds for the Partnership. On June 25, 1993, Holding completed the sale of 12,000 Units (the \"Units\"), each Unit consisting of $5,000 principal amount of 12 1\/2% Pay-In-Kind Notes, due 2003 (the \"PIK Notes\"), and one Warrant to acquire $1,000 principal amount of PIK Notes (collectively with the Mortgage Note Offering, the \"Offerings\"). The PIK Notes and the Warrants are separately transferable. Holding has no other assets or business other than its 99% equity interest in the Partnership.\nThe Partnership was organized in June 1982. Prior to the date of the consummation of the Offerings, the Partnership's three partners were TP\/GP, the managing general partner of the Partnership, the Company and Donald J. Trump (\"Trump\"). On June 25, 1993, Trump\ncontributed his interest in TP\/GP to the Company and TP\/GP merged with and into the Company. The Company then became the managing general partner of the Partnership. In addition, Trump contributed his interest in the Partnership to Holding, and the Company and Holding, each of which are wholly owned by Trump, became the sole partners of the Partnership.\n(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nGaming Revenues and Promotional Allowances\nGaming revenues represent the net win from gaming activities which is the difference between amounts wagered and amounts won by patrons. The retail value of accommodations, food, beverage and other services provided to customers without charge is included in gross revenue and deducted as promotional allowances. The estimated departmental costs of providing such promotional allowance are included in gaming costs and expenses as follows:\nDuring 1994 and 1992, certain Progressive Slot Jackpot Programs were discontinued which resulted in $585,000 and $4,100,000, respectively, of related accruals being taken into income.\nInventories\nInventories of provisions and supplies are carried at the lower of cost (weighted average) or market.\nProperty and Equipment\nProperty and equipment is carried at cost and is depreciated on the straight- line method using rates based on the following estimated useful lives:\nBuildings and building improvements 40 years Furniture, fixtures and equipment 3-10 years Leasehold improvements 10-40 years\nInterest associated with borrowings used to finance construction projects has been capitalized and is being amortized over the estimated useful lives of the assets.\nLand Rights\nLand rights represent the fair value of such rights, at the time of contribution to the Partnership by the Trump Plaza Corporation, an affiliate of the Partnership. These rights are being amortized over the period of the underlying operating leases which extend through 2078.\nIncome Taxes\nThe Company, Holding and the Partnership adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS No. 109\"), effective January 1, 1993. Adoption of this new standard did not have a significant impact on the respective statements of financial condition or results of operations. SFAS No. 109 requires recognition of deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method deferred tax liabilities and assets are determined based on the difference between the financial statement and the tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse.\nThe accompanying financial statements of the Company include a provision for Federal income taxes, based on distributions from the Partnership relating to the Company's Preferred Stock which was redeemed on June 25, 1993. The Company will be reimbursed for such income taxes by the Partnership. The accompanying consolidated financial statements of Holding and the Partnership do not include a provision for Federal income taxes since any income or losses allocated to its partners are reportable for Federal income tax purposes by the partners.\nUnder the New Jersey Casino Control Commission regulations, the Partnership is required to file a New Jersey corporation business tax return. Accordingly, a provision (benefit) for state income taxes has been reflected in the accompanying consolidated financial statements of Holding and the Partnership.\nThe Partnership's deferred state income taxes result primarily from differences in the timing of reporting depreciation for tax and financial statement purposes.\nStatements of Cash Flows\nFor purposes of the statements of cash flows, the Company, Holding and the Partnership consider all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents. The following supplemental disclosures are made to the statements of cash flows.\n(3) LONG-TERM DEBT\nLong-term debt consists of the following:\n(A) On June 25, 1993 the Company issued $330,000,000 principal amount of 10 7\/8% Mortgage Notes, due 2001, net of discount of $4,313,000. Net proceeds of the offering were used to redeem all of the Company's outstanding $225,000,000 principal amount 12% Mortgage Bonds, due 2002 and together with other funds (see (B) Pay-In-Kind Notes) all of the Company's Stock Units, comprised of $75,000,000 liquidation preference participating cumulative redeemable Preferred Stock with associated shares of Common Stock, to repay $17,500,000 principal amount 9.14% Regency Note due 2003, to make a portion of a distribution to Trump to pay certain personal indebtedness, and to pay transaction expenses.\nThe Mortgage Notes mature on June 15, 2001 and are redeemable at any time on or after June 15, 1998, at the option of the Company or the Partnership, in whole or in part, at the principal amount plus a premium which declines ratably each year to zero in the year of maturity. The Mortgage Notes bear interest at the stated rate of 10 7\/8% per annum from the date of issuance, payable semi-annually on each June 15 and December 15, commencing December 15, 1993 and are secured by substantially all of the Partnership's assets. The accompanying consolidated financial statements reflect interest expense at the effective interest rate of 11.12% per annum.\nThe Mortgage Note Indenture contains certain covenants limiting the ability of the Partnership to incur indebtedness, including indebtedness secured by liens on Trump Plaza. In addition, the Partnership may, under certain circumstances, incur up to $25.0 million of indebtedness to finance the expansion of its facilities, which indebtedness may be secured by a lien on the Boardwalk Expansion Site (see Note 6 Commitments And Contingencies) senior to the liens of the Note Mortgage and Guarantee Mortgage thereon. The Mortgage Notes represent the senior indebtedness of the Company. The Partnership Note and the Guarantee rank pari passu in right of payment with all existing and future senior indebtedness of the Partnership.\nThe Mortgage Notes, the Partnership Note, the Note Mortgage, the Guarantee and the Guarantee Mortgage are non-recourse to the partners of the Partnership, to the shareholders of the Company and to all other persons and entities (other than the Company and the Partnership), including Trump. Upon an event of default, holders of the Mortgage Notes would have recourse only to the assets of the Company and the Partnership.\n(B) On June 25, 1993 Holding issued $60,000,000 principal amount of 12 1\/2% PIK Notes, due 2003, together with Warrants to acquire an additional $12,000,000 of PIK Notes at no additional cost.\nThe Warrants are exercisable following the earlier of certain triggering events or June 15, 1996.\nThe PIK Notes mature on June 15, 2003 and bear interest at the rate of 12 1\/2% per annum from the date of issuance, payable semi-annually on each June 15 and December 15, commencing December 15, 1993. At the option of Holding, interest is payable in whole or in part, in cash or, in lieu of cash, through the issuance of additional PIK Notes valued at 100% of their principal amount. The ability of Holding to pay interest in cash on the PIK Notes is entirely dependent on the ability of the Partnership to distribute available cash, as defined, to Holding for such purpose.\nAs of December 31, 1994 the Partnership has elected to issue in lieu of cash a total of $11,756,000 in PIK Notes to satisfy its semi-annual PIK Note interest obligation.\nThe PIK Notes are structurally subordinate to the Company's Mortgage Notes and any other indebtedness of the Partnership and are secured by a pledge of Holding's 99% equity interest in the Partnership. The indenture to which the PIK Notes were issued (the \"PIK Note Indenture\") contains covenants prohibiting Holding from incurring additional indebtedness and engaging in other activities, and other covenants restricting the activities of the Partnership substantially similar to those set forth in the Mortgage Note Indenture. The PIK Notes and the Warrants are non- recourse to the Partners of Holding, including Trump, and to all other persons and entities (other than Holding). Upon an event of default, holders of PIK Notes or Warrants will have recourse only to the assets of Holding which consist solely of its equity interest in the Partnership.\n(C) Interest on these notes are payable with interest rates ranging from 10.0% to 11.0%. The notes are due at various dates between 1995 and 1998 and are secured by real property.\nThe aggregate maturities of long-term debt in each of the years subsequent to 1994 are:\n(4) LEASES\nThe Partnership leases property (primarily land), certain parking space, and various equipment under operating leases. Rent expense for the years ended December 31, 1994, 1993 and 1992 was $3,613,000, $4,338,000 and $4,361,000, respectively, of which $1,900,000, $2,513,000 and $2,127,000, respectively, relates to affiliates of the Partnership.\nFuture minimum lease payments under the noncancelable operating leases are as follows:\nCertain of these leases contain options to purchase the leased properties at various prices throughout the leased terms. At December 31, 1994, the aggregate option price for these leases was approximately $58,000,000.\nIn October 1993, the Partnership assumed the Boardwalk Expansion Site Lease and related expenses which are included in the above lease commitment amounts. In connection with the Offerings, the Partnership acquired a five-year option to purchase the Boardwalk Expansion Site. See \"Note 6 to the Financial Statements --Commitments and Contingencies -- The Boardwalk Expansion Site.\"\n(5) EXTRAORDINARY GAIN (LOSS) AND NON-OPERATING EXPENSE\nThe excess of the carrying value of a note obligation over the amount of the settlement payment net of related prepaid expenses in the amount of $4,120,000 has been reported as an extraordinary gain for the year ended December 31, 1993.\nThe extraordinary loss for the year ended December 31, 1992 consists of the effect of stating the Bonds and Preferred Stock issued at fair value as compared to the carrying value of these securities and the write off of certain deferred financing charges and costs.\nNon-operating expense in 1992 included $1,462,000 of legal expenses relating to litigation associated with the Boardwalk Expansion Site. In 1994 and 1993 these costs included $4,931,000 and $3,873,000, respectively, in costs associated with the Boardwalk Expansion Site (see Note 6-Commitments and Contingencies Future Expansion), net of miscellaneous non-operating credits.\n(6) COMMITMENTS AND CONTINGENCIES\nCasino License Renewal\nThe operation of an Atlantic City hotel and casino is subject to significant regulatory controls which affect virtually all of its operations. Under the New Jersey Casino Control Act (the \"Act\"), the Partnership is required to maintain certain licenses.\nIn April 1993, the New Jersey Casino Control Commission (\"CCC\") renewed the Partnership's license to operate Trump Plaza. This license must be renewed in June 1995, is not transferable and will include a review of the financial stability of the Partnership. Upon revocation, suspension for more than 120 days, or failure to renew the casino license, the Act provides for the mandatory appointment of a conservator to take possession of the hotel and casino's business and property, subject to all valid liens, claims and encumbrances.\nLegal Proceedings\nThe Partnership, its Partners, certain members of its former Executive Committee, and certain of its employees, have been involved in various legal proceedings. In general, the Partnership has agreed to indemnify such persons against any and all losses, claims, damages, expenses (including reasonable costs, disbursements and counsel fees) and liabilities (including amounts paid or incurred in satisfaction of settlements, judgements, fines and penalties ) incurred by them in said legal proceedings. Such persons and entities are vigorously defending the allegations against them and intend to vigorously contest any future proceedings.\nVarious legal proceedings are now pending against the Partnership. The Partnership considers all such proceedings to be ordinary litigation incident to the character of its business. The Partnership believes that the resolution of these claims will not, individually or in the aggregate, have a material adverse effect on its financial condition or results of operations.\nThe Partnership is also a party to various administrative proceedings involving allegations that it has violated certain provisions of the Act. The Partnership believes that the final\noutcome of these proceedings will not, either individually or in the aggregate, have a material adverse effect on its financial condition, results of operations or on the ability of the Partnership to otherwise retain or renew any casino or other licenses required under the Act for the operation of Trump Plaza.\nCasino Reinvestment Development Authority Obligations\nPursuant to the provisions of the Act, the Partnership, commencing twelve months after the date of opening of Trump Plaza in May 1984, and continuing for a period of twenty-five years thereafter, must either obtain investment tax credits (as defined in the Casino Control Act), in an amount equivalent to 1.25% of its gross casino revenues, or pay an alternative tax of 2.5% of its gross casino revenues, (as defined in the Casino Control Act). Investment tax credits may be obtained by making qualified investments or by the purchase of bonds at below market interest rates from the Casino Reinvestment Development Authority (\"CRDA\"). The Partnership is required to make quarterly deposits with the CRDA based on 1.25% of its gross revenue. For the years ended December 31, 1994, 1993 and 1992, the Partnership charged to operations $838,000, $1,047,000 and $645,000, respectively, to give effect to the below market interest rates associated with CRDA bonds that have either been issued or are expected to be issued from funds deposited.\nIn connection with the Boardwalk Expansion Site (see below), the CRDA has approved the use of up to $1,519,000 in deposits made by the Partnership for site improvements. Such deposits are being capitalized as part of property and equipment as funds are appropriated by the CRDA.\nConcentrations of Credit Risks\nIn accordance with casino industry practice, the Partnership extends credit to a limited number of casino patrons, after extensive background checks and investigations of credit worthiness. At December 31, 1994 approximately 28% of the Partnership's casino receivables (before allowances) were from customers whose primary residence is outside the United States, with no significant concentration in any one foreign country.\nThe Boardwalk Expansion Site\nIn 1993, the Partnership received the approval of the CCC, subject to certain conditions, for the expansion of its hotel facilities (the \"Boardwalk Expansion Site\"). On June 25, 1993, Trump transferred title of the Boardwalk Expansion Site to a lender in exchange for a reduction in indebtedness to such lender in an amount equal to the sum of the fair market value of the Boardwalk Expansion Site and all rent payments made to such lender by Trump\nunder the Boardwalk Expansion Site Lease. At that time, the lender leased the Boardwalk Expansion Site to Trump (the \"Boardwalk Expansion Site Lease\") for a term of five years, which expires on June 30, 1998, during which time Trump is obligated to pay the lender $260,000 per month in lease payments. In October 1993, the Partnership assumed the Boardwalk Expansion Site Lease and related expenses.\nOn June 25, 1993, the Partnership acquired a five-year option to purchase the Boardwalk Expansion Site (the \"Boardwalk Expansion Site Purchase Option\"). In addition, the Partnership has a right of first refusal upon any proposed sale of all or any portion of the Boardwalk Expansion Site during the term of the Boardwalk Expansion Site Purchase Option. Until such time as the Boardwalk Expansion Site Purchase Option is exercised or expires, the Partnership will be obligated, from and after the date it entered into the Boardwalk Expansion Site Purchase Option, to pay the net expenses associated with the Boardwalk Expansion Site. During 1994, the Partnership incurred $4.9 million of such expenses. Under the Boardwalk Expansion Site Purchase Option, the Partnership has the right to acquire the Boardwalk Expansion Site for a purchase price of $27.0 million through 1995, increasing by $1.0 million annually thereafter until expiration on June 30, 1998. The CCC has required that the Partnership exercise the Boardwalk Expansion Site Purchase Option or its right of first refusal no later than July 1, 1995. The Partnership intends to request a waiver of this requirement; however, no assurance can be given that such waiver will be granted or that any condition imposed by the CCC would be acceptable to the Partnership. If the Partnership defaults in making payments due under the Boardwalk Expansion Site Purchase Option, the Partnership would be liable to the lender for the sum of (a) the present value of all remaining payments to be made by the Partnership pursuant to the Boardwalk Expansion Site Purchase Option during the term thereof and (b) the cost of demolition of all improvements then located on the Boardwalk Expansion Site.\nAs of December 31, 1994, the Partnership had capitalized approximately $11.7 million in construction costs related to the Boardwalk Expansion Site including a $1 million consulting fee paid to Trump (Note 8). The Partnership's ability to acquire the Boardwalk Expansion Site pursuant to the Boardwalk Expansion Site Purchase Option is dependent upon its ability to obtain financing to acquire the property. The ability to incur such indebtedness is restricted by the Mortgage Note Indenture and the PIK Note Indenture and requires the consent of certain of Trump's personal creditors. The Partnership's ability to develop the Boardwalk Expansion Site is dependent upon its ability to use existing cash on hand and generate cash flow from operations sufficient to fund development costs. No assurance can be given that such cash on\nhand will be available to the Partnership for such purposes or that it will be able to generate sufficient cash flow from operations. In addition, exercise of the Boardwalk Expansion Site Purchase Option or the right of first refusal requires the consent of certain of Trump's personal creditors, and there can be no assurance that such consent will be obtained at the time the Partnership desires to exercise the Boardwalk Expansion Site Purchase Option or such right.\nThe accompanying consolidated financial statements do not include any adjustments that may be necessary should the Partnership be unable to exercise the Boardwalk Expansion Site Purchase Option.\n(7) EMPLOYEE BENEFIT PLANS\nThe Partnership has a retirement savings plan (the \"Plan\") for its nonunion employees under Section 401(K) of the Internal Revenue Code. Employees are eligible to contribute up to 15% of their earnings to the Plan and the Partnership will match 50% of an eligible employee's contributions up to a maximum of 4% of the employee's earnings. The Partnership recorded charges of $848,000, $765,000 and $699,000 for matching contributions for the years ended December 31, 1994, 1993 and 1992, respectively.\nThe Partnership provides no other material, post-retirement or post-employment benefits.\n(8) TRANSACTIONS WITH AFFILIATES\nDue to\/from Affiliates\nAmounts due to affiliates was $206,000 and $97,000 as of December 31, 1994 and 1993, respectively. The Partnership leases warehouse facility space to Trump Castle Associates. Lease payments of $6,000, $15,000 and $14,000 were received from Trump Castle Associates in 1994, 1993 and 1992, respectively.\nThe Partnership leased office space from Trump Taj Mahal Associates, which terminated on March 19, 1993. Lease payments of $30,000 and $138,000 were paid to Trump Taj Mahal Associates in 1993 and 1992, respectively.\nThe Partnership leases two parcels of land under long-term ground leases from Seashore Four Associates and Trump Seashore Associates. In 1994, 1993 and 1992, the Partnership paid $900,000, $900,000 and $900,000, respectively, to Seashore Four Associates, and paid $1,000,000, $1,000,000 and $1,000,000 in 1994, 1993 and 1992, respectively, to Trump Seashore Associates.\nServices Agreement\nPursuant to the terms of a Services Agreement with Trump Plaza Management Corp. (\"TPM\"), a corporation beneficially owned by Donald J. Trump, in consideration for services provided, the Partnership pays TPM each year an annual fee of $1.0 million in equal monthly installments, and reimburses TPM on a monthly basis for all reasonable out-of-pocket expenses incurred by TPM in performing its obligations under the Services Agreement, up to certain amounts. Under this Agreement, approximately $1.3 million, $1.2 million and $708,000 was charged to expense for the years ended December 31, 1994, 1993 and 1992, respectively.\nTrump Regency Option\nIn December 1993, Trump entered into an option agreement (the \"Original Chemical Option Agreement\") with Chemical Bank (\"Chemical\") and ACFH Inc. (\"ACFH\") a wholly owned subsidiary of Chemical. The Original Chemical Option Agreement granted to Trump an option to purchase (i) the Trump Regency Hotel (including the land, improvements and personal property used in the operation of the hotel) (\"Trump Regency\") and (ii) certain promissory notes made by Trump and\/or certain of his affiliates and payable to Chemical (the \"Chemical Notes\") which are secured by certain real estate assets located in New York, unrelated to the Partnership.\nThe aggregate purchase price payable for the assets subject to the Original Chemical Option Agreement was $60 million. Under the terms of the Original Chemical Option Agreement, $1 million was required to be paid for the option by January 5, 1994. In addition, the Original Chemical Option Agreement provided for an expiration of the option on May 6, 1994, subject to an extension until June 30, 1994 upon payment of an additional $250,000 on or prior to May 6, 1994. The Original Chemical Option Agreement did not allocate the purchase price among the assets subject to the option or permit the option to be exercised for some, but not all of such assets.\nIn connection with the execution of the Original Chemical Option Agreement, Trump agreed with the Partnership that, if Trump is able to acquire Trump Regency pursuant to the exercise of the option, he would make Trump Regency available for the sole benefit of the Partnership on a basis consistent with the Partnership's contractual obligations and requirements. Trump further agreed that the Partnership would not be required to pay any additional consideration to Trump in connection with any assignment of the option to purchase Trump Regency. On January 5, 1994, the Partnership obtained the approval of the CCC to make the $1 million payment, which was made on that date.\nOn June 16, 1994, Trump, Chemical and ACFH entered into, amended and restated the Original Chemical Option Agreement, (the \"First Amended Chemical Option Agreement\"). The First Amended Chemical Option Agreement provided for an extension of the expiration of the Option through September 30, 1994, upon payment of $250,000. Such payment was made on June 27, 1994. The First Amended Chemical Option Agreement also provided for a $60 million option price for Trump Regency and one of the Chemical Notes. On August 30, 1994, Trump, Chemical and ACFH entered into an amendment to the First Amended Chemical Option Agreement (the \"Second Amended Chemical Option Agreement\"). The Second Amended Chemical Option Agreement provides for an extension of the expiration of the Option through March 31, 1995 upon the payment of $50,000 a month for the period October through December 1994, and $150,000 a month for the period January through March 1995. The Partnership received the approval of the CCC and has made such payments.\nAs of December 31, 1994, $1,550,000, representing option payments, is included in other assets in the accompanying consolidated balance sheet. If the option is exercised, these amounts are available to offset the $60 million option price.\nOther Payments to Donald J. Trump\nDuring 1994, the Partnership paid to Trump $1,000,000 under a Construction Management Service Agreement. The payment was made for construction management services rendered by Trump with respect to the Boardwalk Expansion Site. This payment was approved prior to disbursement by the CCC and has been classified in construction in process in the accompanying consolidated balance sheet as of December 31, 1994.\nDuring 1994, the Partnership also paid Trump a commission of approximately $572,000 for securing a retail lease at Trump Plaza.\nThe commission has been capitalized and is being amortized to expense over the 10-year term of the lease.\n(9) FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe carrying amount of the following financial instruments of the Company, Holding and the Partnership approximates fair value, as follows: (a) cash and cash equivalents, accrued interest receivables and payables are based on the short term nature of these financial instruments. (b) CRDA bonds and deposits are based on the allowances to give effect to the below market interest rates.\nThe estimated fair values of other financial instruments are as follows:\nThe fair values of the PIK and Mortgage Notes are based on quoted market prices obtained by the Partnership from its investment advisor.\nThere are no quoted market prices for other notes payable and a reasonable estimate could not be made without incurring excessive costs.\nSCHEDULE II\nTRUMP PLAZA HOLDING ASSOCIATES AND TRUMP PLAZA ASSOCIATES VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\n(A) Write-off of uncollectible accounts.\n(B) Write-off of allowance applicable to contribution of CRDA deposits.","section_15":""}
{"filename":"357329_1995.txt","cik":"357329","year":"1995","section_1":"Item 1. Business - ----------------\nBalcor Pension Investors-III (the \"Registrant\") is a limited partnership formed in 1982 under the laws of the State of Illinois. The Registrant raised $118,738,000 from sales of Limited Partnership Interests. The Registrant's operations consisted of investment in wrap-around mortgage loans and, to a lesser extent, other junior mortgage loans and first mortgage loans. The Registrant also currently operates two properties acquired through foreclosure, and holds minority joint venture interests in two additional properties. All financial information included in this report relates to this industry segment.\nThe Registrant originally funded thirty-two loans collateralized by twenty-eight properties. A portion of Mortgage Reductions generated by repayments was reinvested in five additional loans. The remainder was added to working capital reserves. As a result of repayments, foreclosures and wrap-around notes received as a portion of the sale price for three property dispositions, the Registrant has five loans in its portfolio as of December 31, 1995. Eleven properties were acquired through foreclosures and two loans were reclassified to investment in joint ventures with affiliates. The Registrant sold nine of these properties and has two properties and two investments in joint ventures with affiliates in its portfolio as of December 31, 1995. See Item 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties for additional information.\nOperationally, existing apartment properties continued to register occupancy percentages in the 90s, with average rents rising at an annual rate of between 3 and 4 percent. Apartments are still considered one of the top real estate asset classes in terms of performance. However, some markets are experiencing new construction of rental units which, if unrestrained, could impact the performance of existing properties. Most of the new construction is aimed at the two segments of the rental market which are growing the fastest: low-income households and upper-income households who prefer to rent rather than own. Of all the major asset classes, apartments typically display the least volatility in terms of property values.\nShopping centers are the most troubled asset class in real estate currently. Unlike other asset classes, construction of power shopping centers, those with a preponderance of \"big box\" retailers, occurred at a brisk pace during the early 1990s, and now a shake-out of retailers is taking place. Retailers posted lackluster sales in 1995, particularly in the latter half of the year, and similar results are expected for 1996. The slight rise in interest rates in 1995 also contributed to low sales growth in interest rate sensitive sectors such as automobiles and home furnishings. Nevertheless, retail properties are particularly unique, and those with strong tenant alignments should better weather the current slowdown. In the long-term, however, retail real estate is also vulnerable to technological changes (e.g. home shopping) which could drastically alter the retail distribution system.\nWith virtually no new construction over the past few years, the national office market has experienced consistently rising occupancy rates and, recently, rising rental rates. Investor interest has also returned, typically preferring suburban buildings over their downtown counterparts. Except for properties built for a specific tenant, the economic feasibility of new construction in most markets is still several years away. Build-to-suit construction for large companies currently in leased space could restrict office appreciation rates\nover the next few years. In addition, increased vacancies could result from companies who restructure their workforce in order to reduce their occupancy costs.\nThe General Partner believes that the market for multifamily housing properties has become increasingly favorable to sellers of these properties. As a result the General Partner is exploring an acceleration of its strategy to sell the Registrant's residential property. Additionally, the General Partner will explore the sale of its commercial properties over the next year if market conditions are favorable.\nActivity for the purchase of limited partnership interests (\"tender offers\") has increased in real estate limited partnerships generally. Many of these tender offers have been made by investors seeking to make a profit from the purchase of the interests. In the event a tender offer is made for interests in the Registrant, the General Partner will issue a response to Limited Partners expressing the General Partner's opinion regarding the offer. Certain administrative costs will be incurred to respond to a tender offer. The General Partner cannot predict with any certainty what impact a tender offer will have on the operations or management of the Registrant.\nIn November 1993, the Registrant placed the Bannockburn Executive Plaza loan in default and the borrower filed for protection under the U.S. Bankruptcy Code. In February 1995, a plan of reorganization related to this loan was confirmed by the Bankruptcy Court. See Item 7. Liquidity and Capital Resources for additional information.\nDuring 1995, the Registrant received repayments on two loans receivable. See Item 7. Liquidity and Capital Resources for additional information.\nDuring 1995, the Registrant sold two properties. See Item 7. Liquidity and Capital Resources for additional information.\nThe Registrant, by virtue of its ownership of real estate acquired through foreclosure, 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 Mortgage Advisors-II, 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. Properties - ------------------\nAs of December 31, 1995, the Registrant owns the two properties described below:\nLocation Description of Property - -------- -----------------------\nLoveland, Colorado * Orchards Shopping Center: a shopping center containing 167,779 square feet located on 24.01 acres.\nAustin, Texas The Woods Apartments: a 278-unit apartment complex located on 13 acres.\n* This property is held subject to a mortgage loan.\nThe Registrant also holds minority joint venture interests in the Brookhollow\/Stemmons Office Building located in Dallas, Texas, and the Perimeter 400 Center Office Building located in Fulton County, Georgia. See Note 9 of Notes to Financial Statements for additional information.\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 - -------------------------\nWilliams class action - -------------------------\nIn February 1990, a proposed class-action complaint was filed, Paul Williams and Beverly Kennedy, et al. vs. Balcor Pension Investors, et al., Case No.: 90-C-0726 (U.S. District Court, Northern District of Illinois). The Registrant, the General Partner, seven affiliated limited partnerships (together with the Registrant, the \"Related Partnerships\") and other affiliates are the defendants. The complaint alleges violations of Federal securities laws as to the adequacy and accuracy of disclosure of information in the offering of limited partnership interests in the Related Partnerships and alleges breach of fiduciary duty, fraud, negligence and violations under the Racketeer Influenced and Corrupt Organizations Act. The complaint seeks compensatory and punitive damages. The defendants subsequently filed a counterclaim asserting claims of fraud and breach of warranty against certain plaintiffs, as well as a request for declaratory relief regarding the defendants' rights to be indemnified for their expenses incurred in defending the litigation. The defendants seek to recover for damage to their reputations and business as well as costs and attorneys' fees in defending the claims.\nIn May 1993, the Court issued an order denying the plaintiffs' motion for class certification based principally on the inadequacy of the individual plaintiffs representing the proposed class. However, the Court gave plaintiffs leave to propose new individual class representatives. Upon the defendants' motion, the Court ordered plaintiffs' counsel to pay $75,000 to the defendants and $25,000 to the Court for costs incurred with the class certification motion, which amounts continue to be outstanding.\nIn July 1994, the Court granted plaintiffs' motion certifying a class relating to the Federal securities fraud claims. The class certified by the Court includes only the original investors in the Related Partnerships. The defendants filed a motion for reconsideration in opposition to the class certification, which was denied in December 1994. The Court approved the Notice of Class Action in August 1995 which was sent to potential members of the class in September 1995.\nThe defendants intend to continue vigorously contesting this action. Management of each of the defendants believes they have meritorious defenses to contest\nthe claims. It is not determinable at this time whether or not an unfavorable decision in this action would have a material adverse impact on the Registrant.\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 1995.\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. For information regarding previous distributions, see Financial Statements, Statements of Partners' Capital, and Item 7. - Liquidity and Capital Resources, below.\nAs of December 31, 1995, the number of record holders of Limited Partnership Interests of the Registrant was 10,640.\nItem 6.","section_6":"Item 6. Selected Financial Data - ------------------------------- Year ended December 31, ----------------------------------------------------------- 1995 1994 1993 1992 1991 ----------- ----------- ----------- ----------- ----------- Total income $7,464,674 $7,904,391 $6,125,896 $6,728,618 $8,254,515 Recovery of losses on loans, real estate and accrued interest receivable 756,370 None None None None Provision for losses on loans, real estate and accrued inter- est receivable 756,370 600,000 2,720,000 3,750,000 3,215,500 Income before net gains on sales of assets 6,001,706 6,379,013 2,541,797 2,166,157 4,458,722 Net income 8,542,352 6,498,855 3,141,300 2,166,157 4,458,722 Net income per average number of Limited Partner- ship Interests outstanding 34.90 26.35 12.68 8.72 17.87 Total assets 48,074,826 77,868,675 81,568,277 86,628,240 87,612,905 Mortgage notes payable 1,666,291 7,153,074 8,436,279 10,997,864 9,234,008 Distributions per Limited Partner- ship Interest(A) 132.12 34.35 20.00 22.50 30.00\n(A) These amounts include distributions of original capital of $109.12 and $16.85 per Limited Partnership Interest for the years 1995 and 1994, respectively.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and - ----------------------------------------------------------------------- Results of Operations - --------------------- Operations - ----------\nSummary of Operations - ---------------------\nDuring 1995 and 1994, Balcor Pension Investors-III (the \"Partnership\") sold two properties and received repayments on four loans. The Partnership also acquired The Woods Apartments through foreclosure in July 1994. The combined effect of these events, especially the recognition of gains on the sales of the properties, resulted in an increase in net income during 1995 as compared to 1994.\nThe provision for potential losses on loans, real estate and accrued interest receivable was lower during 1994 as compared to 1993. In addition, during 1993, the Partnership recognized its share of a loss provision related to a decline in the fair value of a property in which it holds a minority joint venture interest. The combined effect of these events resulted in an increase in net income during 1994 as compared to 1993. Further discussion of the Partnership's operations is summarized below.\n1995 Compared to 1994 - ---------------------\nThe repayment of the Colony Apartments loan in August 1995, the prepayment of the Continental Park and North Morris Estates loans in June and November 1994, respectively, and the foreclosure of The Woods Apartments in July 1994 resulted in a decrease in net interest income on loans receivable during 1995 as compared to 1994.\nThe Partnership has two non-accrual loans at December 31, 1995 which are collateralized by Carmel on Providence Apartments and Bannockburn Executive Plaza. For non-accrual loans, income is recorded only as cash payments are received from the borrower. The funds advanced by the Partnership for these two loans total approximately $6,200,000, representing approximately 6% of original funds advanced. During 1995, the Partnership received cash payments of net interest income totaling approximately $346,000 on the Carmel on Providence loan. The Partnership would have received approximately $295,000 of net interest income under the terms of the original loan agreement. Of the net interest income received, $48,000 relates to costs incurred by the Partnership prior to the borrower's bankruptcy filing, which have been added to the principal of the loan and which accrue interest, payable by the borrower on a quarterly basis. In addition, $564,000 was received on the Bannockburn Executive Plaza loan in 1995. This loan originally matured in January 1994 but was subsequently extended to December 1997.\nProvisions are charged to income when the General Partner believes an impairment has occurred, either in a borrower's ability to repay the loan or in the value of the collateral property. Determinations of fair value are made\nperiodically on the basis of performance under the terms of the loan agreement and assessments of property operations. Determinations of fair value represent estimations based on many variables which affect the value of real estate, including economic and demographic conditions. See Note 2(d) of Notes to Financial Statements for further information regarding the Partnership's accounting policies related to the determination of the fair value of its loans and real estate held for sale. The Partnership recognized provisions of $756,370 and $600,000 in 1995 and 1994, respectively, related to certain of its loans. In addition, during 1995, the Partnership recognized recoveries of $756,370 related to certain other loans to provide for changes in the estimate of their fair value. During 1995, allowances of $1,070,329 related to the Colony loan were written off in connection with the repayment of the loan and during 1994 allowances of $3,715,406 related to the Continental Park loan were written off in connection with the repayment of the loan at a discount.\nOperations of real estate held for sale represent the net operations of those properties acquired by the Partnership through foreclosure. At December 31, 1995, the Partnership was operating The Woods Apartments and the Orchards Shopping Center. Original funds advanced by the Partnership total approximately $6,678,000 for these properties. The Partnership acquired The Woods Apartments in July 1994, and this property generated income during 1995. In addition, operations improved at the Orchards Shopping Center during 1995 due to increased occupancy levels and decreased interest expense resulting from the paydown of the first mortgage loan in connection with the sale of the Orchards Office Building in September 1994. The combined effect of these events resulted in an increase in income from real estate held for sale during 1995 as compared to 1994. The 1995 sales of the Crossings Shopping Center and the Candlewyck Apartments, which were generating income, partially offset the above increase.\nParticipation in income of joint ventures with affiliates represents the Partnership's 27.5% and 12.68% shares of income from the Brookhollow\/Stemmons and Perimeter 400 Center office buildings, respectively. During 1995, the Partnership recognized $247,500 and $84,322 as its share of the recovery of provisions related to the change in the estimates of the fair values of the Brookhollow\/Stemmons and Perimeter 400 Center office buildings, respectively, which resulted in an increase in the participation in income during 1995 as compared to 1994. Increased reimbursements from tenants for real estate taxes, common area maintenance and tenant construction at the Brookhollow\/Stemmons Office Building also contributed to the increase in income.\nProceeds received in connection with the 1995 and 1994 loan repayments and property sales were invested when received and resulted in an increase in interest income on short-term investments during 1995 as compared to 1994. Higher average interest rates earned on short-term investments also contributed to the increase. Portions of these proceeds were distributed to Limited Partners in 1995 and January 1996.\nThe Partnership's loans generally bear interest at contractually-fixed interest rates. Some loans also provide for additional interest in the form of participations, usually consisting of either a share in the capital appreciation of the property securing the Partnership's loan and\/or a share in the increase of the gross income of the property above a certain level. Participation income was recognized during 1994 in connection with the North Morris Estates and Carmel on Providence loans.\nDecreases in legal expenses and reduced mortgage servicing fees due to the repayment of four loans during 1995 and 1994 and the foreclosure of The Woods\nApartments in 1994 resulted in a decrease in administrative expenses during 1995 as compared to 1994.\nDuring 1995, the Partnership recognized gains of $717,900 and $1,822,746 in connection with the sales of the Crossings Shopping Center and the Candlewyck Apartments, respectively. During 1994, the Partnership recognized a gain of $119,842 on the sale of the Orchards Office Building.\n1994 Compared to 1993 - ---------------------\nIncreased interest income was received from the borrowers of the Bannockburn Executive Plaza, Carmel on Providence and The Woods loans during 1994. In addition, the Partnership purchased The Woods underlying loan in December 1993 which reduced interest expense on loans payable. Finally, the Partnership received additional interest and a prepayment fee in connection with the North Morris Estates loan repayment in November 1994. As a result, net interest income on loans receivable increased during 1994 as compared to 1993. The prepayment of the Airport III Industrial Park and the Continental Park loans in November 1993 and June 1994, respectively, reduced interest income which partially offset this increase.\nThe Partnership had two non-accrual loans at December 31, 1994 which are collateralized by Carmel on Providence Apartments and Bannockburn Executive Plaza. The funds advanced by the Partnership for these two loans total approximately $6,200,000, representing approximately 6% of original funds advanced. During 1994, the Partnership received cash payments of net interest income totaling approximately $244,000 on the Carmel on Providence loan. The Partnership would have received approximately $288,000 of net interest income under the terms of the original loan agreement. In addition, $585,000 was received on the Bannockburn Executive Plaza loan. This loan originally matured in January 1994 but was subsequently extended to December 1997.\nThe Partnership recognized a provision of $2,000,000 related to its loans in 1993. In addition, during 1993, the Partnership recognized a provision of $720,000 related to the Partnership's real estate held for sale to provide for changes in the estimate of the fair value of the Riverview Office Building.\nAt December 31, 1994, the Partnership was operating the Candlewyck and The Woods apartment complexes and the Crossings and Orchards shopping centers. Original funds advanced by the Partnership totaled approximately $14,378,000 for these properties. Operating expenses decreased at the Crossings Shopping Center due to decreased maintenance and repair expense and decreased real estate tax expense resulting from a reduction in the assessed property value. Operating expenses also decreased at the Orchards Shopping Center due to the completion of roof repairs during 1993. In addition, the Partnership acquired The Woods Apartments in July 1994, which generated income. Finally, the Riverview Office Building and the Villa Verde Apartments, which generated income, were sold in September and November 1993, respectively. The combined effect of these events resulted in an increase in income from real estate held for sale during 1994 as compared to 1993.\nParticipation in income (loss) of joint ventures with affiliates represents the Partnership's 27.5% and 12.68% shares of income (loss) from the Brookhollow\/Stemmons and Perimeter 400 Center office buildings, respectively. During 1993, the Partnership recognized its share of a loss provision related to a decline in the fair value of the Brookhollow\/Stemmons Office Building.\nThis, combined with decreased leasing costs and increased average occupancy levels and rental rates at the Perimeter 400 Center Office Building during 1994, were the primary reasons for the recognition of income during 1994 as compared to a loss in 1993.\nProceeds were received in 1993 in connection with the settlement of the Kensington loan, the refinancing of the Villa Verde loan and the sales of the Riverview Office Building, Villa Verde Apartments and vacant land adjacent to the Orchards Shopping Center. A portion of these proceeds were distributed in April 1994. The remainder of these proceeds, along with the proceeds received in 1994 from the prepayment of the Continental Park and North Morris Estates loans and the sale of the Orchards Office Building, were invested in short-term interest-bearing instruments. This, along with higher interest rates resulted in an increase in interest income on short-term investments during 1994 as compared to 1993.\nParticipation income was recognized during 1993 in connection with the Airport III Industrial Park, North Morris Estates and Carmel on Providence loans.\nAn increase in accounting and portfolio management fees resulted in an increase in administrative expenses during 1994 as compared to 1993. This increase was partially offset by a decrease in legal fees and mortgage servicing fees resulting from the prepayment of the Airport III Industrial Park, Continental Park and North Morris Estates loans and the foreclosure of The Woods Apartments\nDuring 1993, the Partnership recognized a net gain totaling $599,503 on the sales of the vacant land adjacent to the Orchards Shopping Center, the Riverview Office Building and the Villa Verde Apartments.\nLiquidity and Capital Resources - -------------------------------\nThe cash position of the Partnership decreased as of December 31, 1995 when compared to December 31, 1994 primarily due to special distributions made to Limited Partners in April, July and October 1995. The Partnership generated cash flow totaling approximately $5,256,000 from its operating activities primarily as a result of the net interest income earned on its loans receivable, the operations of its properties, and the interest received on its short-term investments, net of the payment of administrative expenses. The Partnership received funds from investing activities primarily due to the receipt of proceeds of approximately $13,591,000 related to the repayment of the Colony and Rivergate loans and proceeds of approximately $10,394,000 related to the sales of the Crossings Shopping Center and Candlewyck Apartments. The Partnership's financing activities consist of the payment of distributions totaling approximately $30,292,000 to the Partners, the repayment of the mortgage notes payable of approximately $3,546,000 related to the sale of Candlewyck Apartments, repurchases of Limited Partnership Interests at a cost of approximately $1,426,000 and principal payments on underlying loans and mortgage notes payable totaling approximately $1,135,000. The Partnership also made a special distribution to Limited Partners from Mortgage Reductions in January 1996 as described below.\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. The Partnership defines cash flow generated from its properties as an amount equal to the property's revenue receipts less property related expenditures, which\ninclude debt service payments. During 1995 and 1994, the Orchards Shopping Center and The Woods Apartments generated positive cash flow. The Crossings Shopping Center, which was sold in January 1995, generated positive cash flow during 1994 and prior to its sale in 1995. However, the Candlewyck Apartments, which was sold in August 1995, generated positive cash flow in 1994 and a marginal deficit prior to its sale in 1995. The Brookhollow\/Stemmons and Perimeter 400 Center office complexes, properties in which the Partnership holds minority joint venture interests, generated positive cash flow during 1995 and 1994.\nAs of December 31, 1995, The Woods Apartments and the Orchards Shopping Center have occupancy rates of 93% and 83%, respectively. Many rental markets continue to remain extremely competitive; therefore, the General Partner's goals are to maintain high occupancy levels, while increasing rents where possible, and to monitor and control operating expenses and capital improvement requirements at the properties. The General Partner will also examine the terms of the mortgage loan collateralized by one of its properties, and may refinance or, in certain instances, use Partnership reserves to repay the loan.\nThe General Partner believes that the market for multifamily housing properties has become increasingly favorable to sellers of these properties. As a result, the General Partner is exploring an acceleration of its strategy to sell the Partnership's residential property. Additionally, the General Partner will explore the sale of its commercial properties over the next year if market conditions are favorable.\nChanging interest rates can impact real estate values in several ways. Generally, declining interest rates may lower the cost of capital allowing buyers to pay more for a property whereas rising interest rates may increase the cost of capital and lower the price of real estate. Lower interest rates may increase the probability that borrowers may seek prepayment of the Partnership's loans whereas rising interest rates decrease the yields on the loans and make prepayment less likely.\nCertain borrowers have failed to make payments when due to the Partnership for more than ninety days and, accordingly, these loans have been placed on non-accrual status (income is recorded only as cash payments are received). The General Partner has negotiated with some of these borrowers regarding modifications of the loan terms and has instituted foreclosure proceedings under certain circumstances. Such foreclosure proceedings may be delayed by factors beyond the General Partner's control such as bankruptcy filings by borrowers and state law procedures regarding foreclosures. Further, certain loans made by the Partnership have been restructured to defer and\/or reduce interest payments where the properties collateralizing the loans were generating insufficient cash flow to support property operations and debt service.\nDuring February 1995, a plan of reorganization related to the Bannockburn Executive Plaza loan was confirmed by the Bankruptcy Court effective March 1995. Pursuant to the plan, the maturity date of the loan was extended to December 1, 1997 and the loan will continue to bear interest at 14.5% per annum with a pay rate of 9% per annum. The maturity of the underlying loan was also extended to December 1, 1997, and the borrower was required to pay $232,031 directly to the holder of the underlying loan to reduce the principal balance of the loan. In addition, the borrower is required to remit all excess cash flow from property operations on a monthly basis directly to the holder of the underlying loan to further reduce the principal balance of the loan. Excess\ncash flow of $189,628 was remitted to the holder of the underlying loan during 1995.\nIn August 1995, the borrower of the $16,750,000 Colony Apartments wrap-around loan repaid the loan. The Partnership received proceeds of approximately $8,301,516 which is comprised of the funds advanced on the loan ($6,501,516) and the amount representing the difference between the funds advanced by the Partnership and the outstanding principal balance on the underlying loan in accordance with the original loan terms. In addition, the borrower repaid the underlying mortgage note payable which had a balance of $7,378,155. Allowances in the amount of $1,070,329 were written off in connection with the repayment of the loan.\nIn October 1995, the Rivergate Apartments first mortgage loan matured and in December 1995, the borrower repaid the loan. The Partnership received proceeds of $5,255,154 which represented the outstanding principal balance of the loan.\nIn January and August 1995, the Partnership sold the Crossings Shopping Center and the Candlewyck Apartments in all cash sales for $2,650,000 and $10,000,000, respectively. The purchaser of the Crossings Shopping Center took title to the property subject to the existing $1,793,760 first mortgage loan. From the proceeds of the Candlewyck sale, the Partnership repaid the outstanding amounts due under the first, second, and third mortgage loans, which totaled $3,545,699. See Note 12 of Notes to Financial Statements for additional information.\nDistributions to Limited Partners can be expected to fluctuate for various reasons. Generally, distributions are made from Cash Flow generated by interest and other payments made by borrowers under the Partnership's mortgage loans. Loan prepayments and repayments can initially cause Cash Flow to increase as prepayment premiums and participations are paid; however, thereafter prepayments and repayments will have the effect of reducing Cash Flow. If such proceeds are distributed, Limited Partners will have received a return of capital and the dollar amount of Cash Flow available for distribution thereafter can be expected to decrease. Distribution levels can also vary as loans are placed on non-accrual status, modified or restructured and, if the Partnership has taken title to properties through foreclosure or otherwise, as a result of property operations.\nThe Partnership made four distributions totaling $132.12, $34.35 and $20.00 per Interest in 1995, 1994 and 1993, respectively. See Statement of Partners' Capital for additional information. Distributions were comprised of $23.00 of Cash Flow and $109.12 of Mortgage Reductions in 1995 and $17.50 of Cash Flow and $16.85 of Mortgage Reductions in 1994 and $20.00 of Cash Flow in 1993. The distribution of Mortgage Reductions in 1995 and 1994 resulted from loan repayments and property sales. Cash Flow distributions increased between 1995 and 1994 due to the payment of a special distribution of $7.00 per Interest from Cash Flow reserves in October 1995. Cash Flow distributions decreased in 1994 from 1993 due to the loan repayments and property sales.\nIn January 1996, the Partnership paid $6,402,354 to Limited Partners representing the quarterly distribution for the fourth quarter of 1995 of $4.00 of Cash Flow per Interest and a special distribution of $22.96 per Interest, representing Mortgage Reductions received primarily from the Rivergate loan repayment. The Partnership also paid $79,159 to the General Partner as its distributive share of the Cash Flow distributed for the fourth quarter of 1995 and $26,386 as its contribution to the Early Investment Incentive Fund.\nIncluding the January 1996 distribution, the Partnership has distributed $667.88 per $500 Interest, of which $450.80 represents Cash Flow from operations and $217.08 represents a return of Original Capital.\nThe Partnership expects to continue making cash distributions from the Cash Flow generated by the receipt of mortgage payments and from property operations, less payments on the underlying loans and administrative expenses. The General Partner believes the Partnership has retained an appropriate amount of working capital to meet cash or liquidity requirements which may occur.\nDuring 1995, the General Partner on behalf of the Partnership used amounts placed in the Early Investment Incentive Fund to repurchase 5,882 Interests from Limited Partners at a total cost of $1,426,239.\nIn 1995, the Financial Accounting Standards Board issued Statement No. 121 \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of\" which establishes accounting standards for impairment of long lived assets and long lived assets to be disposed of. This statement has been adopted by the Partnership as of January 1, 1995, and did not have a material impact on the financial position or results of operations of the Partnership.\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 sale 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 Financial Statement Schedules 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.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and - ----------------------------------------------------------------------- Financial Disclosure - --------------------\nOn September 14, 1995 the Registrant approved the engagement of Coopers & Lybrand L.L.P. as its independent auditors for the fiscal year ending December 31, 1995 to replace the firm of Ernst & Young LLP, who were dismissed as auditors of the Registrant effective September 14, 1995. The General Partner of the Registrant approved the change in auditors.\nThe reports of Ernst & Young LLP on the Registrant's financial statements for the past two fiscal years did not contain an adverse opinion or a disclaimer of opinion and were not qualified or modified as to uncertainty, audit scope, or accounting principles.\nIn connection with the audits of the Registrant's financial statements for each of the two fiscal years ended December 31, 1994, and in the subsequent interim\nperiod, there were no disagreements with Ernst & Young LLP on any matters of accounting principles or practices, financial statement disclosure, or auditing scope and procedures which, if not resolved to the satisfaction of Ernst & Young LLP would have caused Ernst & Young LLP to make reference to the matter in their report.\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 Mortgage Advisors-II, 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 ----- -------- Chairman, President and Chief Thomas E. Meador Executive Officer Senior Vice President Alexander J. Darragh Senior Vice President Josette V. Goldberg Senior Vice President Alan G. Lieberman Senior Vice President, Chief Brian D. Parker Financial Officer, Treasurer and Assistant Secretary Senior Vice President John K. Powell, Jr.\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. He is also Senior Vice President of American Express Company and is responsible for its real estate operations worldwide. 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.\nAlexander J. Darragh (February 1955) joined Balcor in September 1988 and is responsible for due diligence analysis and real estate advisory services for Balcor and American Express Company. He also has supervisory responsibility for Balcor's environmental matters. Mr. Darragh received masters' degrees in Urban Geography from Queen's University and in Urban Planning from Northwestern University.\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 MIS functions. 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 Balcor's property sales and capital markets functions. Mr. Lieberman is a Certified Public Accountant.\nBrian D. Parker (June 1951) joined Balcor in March 1986 and, as Chief Financial Officer and Chief Accounting Officer, is responsible for Balcor's financial, legal and treasury functions. He is a Director of The Balcor Company. 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 portfolio and asset management matters relating to Balcor's partnerships. Mr. Powell also has supervisory responsibility for Balcor's risk management and investor services functions. He received a Master of Planning degree from the University of Virginia. Mr. Powell 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.\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 1995.\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 8 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 Mortgage Advisors-II and its officers own as a group or individually the following Limited Partnership Interests of the Registrant:\nAmount Beneficially Title of Class Owned Percent of Class -------------- ------------- ----------------\nLimited Partnership Interest 5 Interests Less than 1%\nRelatives and affiliates of the officers and partners of the General Partner do not own any additional interests.\n(c) The Registrant is not aware of any arrangement, 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 3 of Notes to Financial Statements for information relating to the Partnership Agreement and the allocation of distributions and profits and losses.\nSee Note 8 of Notes to Financial Statements for information relating to transactions with affiliates.\n(c) No management person is indebted to the Registrant.\n(d) The Registrant has no outstanding agreements with any promoters.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statements and Financial Statement Schedules, - -------------------------------------------------------------------------- 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 of Limited Partnership, and the Amended and Restated Certificate of Limited Partnership of Balcor Pension Investors-III, previously filed as Exhibits 3(a) and 3(b), respectively, to Amendment No. 2 to the Registrant's Registration Statement on Form S-11 dated May 20, 1982 (Registration No. 2-75938), and as Exhibits 3(a) and 3(b), respectively, to the Registrant's Registration Statement on Form S-11 dated November 2, 1982 (Registration No. 2-80123), are hereby incorporated herein by reference.\n(4) Form of Subscription Agreement, previously filed as Exhibit 4(a) to Amendment No. 2 to the Registrant's Registration Statement on Form S-11 dated May 20, 1982 (Registration Statement No. 2-75938) and as previously filed as Exhibit 4(a) to Registrant's Registration Statement on Form S-11 dated November 2, 1982 (Registration No. 2-80123), 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. 0-11129) are incorporated herein by reference.\n(16) Letter from Ernst & Young LLP dated September 19, 1995 regarding the change in the Registrant's certifying accountant previously filed as Exhibit 16 to the Registrant's Report on Form 8-K\/A dated October 27, 1995 (Commission File No. 0-11129) is hereby incorporated herein by reference.\n(27) Financial Data Schedule of the Registrant for 1995 is attached hereto.\n(b) Reports on Form 8-K: A Current Report on Form 8-K\/A dated October 27, 1995, amending the Current Report on Form 8-K dated September 19, 1995 reporting a\nchange in the Registrant's certifying accountant, was filed (Commission File No. 0-11129).\n(c) Exhibits: See Item 14(a)(3) above.\n(d) Financial Statement Schedules: 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.\nBALCOR PENSION INVESTORS-III\nBy: \/s\/Brian D. Parker ------------------------------------- Brian D. Parker Senior Vice President, and Chief Financial Officer (Principal Accounting and Financial Officer) of Balcor Mortgage Advisors-II, the General Partner\nDate: March 29, 1996 -------------- Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nSignature Title Date - ---------------------- ------------------------------------------------\nPresident and Chief Executive Officer (Principal Executive Officer) of Balcor Mortgage \/s\/Thomas E. Meador Advisors-II, the General Partner March 29, 1996 -------------------- -------------- Thomas E. Meador Senior Vice President, and Chief Financial Officer (Principal Accounting and Financial Officer) of Balcor Mortgage \/s\/Brian D. Parker Advisors-II, the General Partner March 29, 1996 - -------------------- -------------- Brian D. Parker\nReport of Independent Accountants\nReport of Independent Auditors\nFinancial Statements:\nBalance Sheets, December 31, 1995 and 1994\nStatements of Partners' Capital, for the years ended December 31, 1995, 1994 and 1993\nStatements of Income and Expenses, for the years ended December 31, 1995, 1994 and 1993\nStatements of Cash Flows, for the years ended December 31, 1995, 1994 and 1993\nNotes to Financial Statements\nFinancial Statement Schedules 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 Pension Investors-III:\nWe have audited the accompanying balance sheet of Balcor Pension Investors-III (An Illinois Limited Partnership) as of December 31, 1995 and the related statements of partners' capital, income and expenses, and cash flows 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 also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our 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 Balcor Pension Investors-III at December 31, 1995, and the results of its operations and its cash flows for the year then ended in conformity with generally accepted accounting principles.\nCOOPERS & LYBRAND L.L.P.\nChicago, Illinois March 27, 1996\nREPORT OF INDEPENDENT AUDITORS\nTo the Partners of Balcor Pension Investors-III:\nWe have audited the accompanying balance sheet of Balcor Pension Investors-III (An Illinois Limited Partnership) as of December 31, 1994 and the related statements of partners' capital, income and expenses, and cash flows for each of the two 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 Balcor Pension Investors-III at December 31, 1994, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 1994, in conformity with generally accepted accounting principles.\nERNST & YOUNG LLP\nChicago, Illinois March 6, 1995\nBALCOR PENSION INVESTORS-III (AN ILLINOIS LIMITED PARTNERSHIP)\nBALANCE SHEETS December 31, 1995 and 1994\nASSETS\n1995 1994 ------------- ------------- Cash and cash equivalents $ 11,344,948 $ 18,445,509 Cash and cash equivalents - Early Investment Incentive Fund 302,437 21,171 Escrow deposits 127,004 427,562 Escrow deposits - restricted 899,929 Accounts and accrued interest receivable 222,417 286,756 Prepaid expenses 31,897 Deferred expenses, net of accumulated amortization of $40,618 in 1995 and $28,120 in 1994 21,870 34,368 ------------- ------------- 12,050,573 20,115,295 ------------- ------------- Investment in loans receivable: Loans receivable - wrap-around and first mortgages 53,030,966 75,491,676\nLess: Loans payable - underlying mortgages 33,761,548 42,548,988 Allowance for potential loan losses 3,943,630 5,013,959 ------------- ------------- Net investment in loans receivable 15,325,788 27,928,729\nReal estate held for sale 14,214,705 23,801,567\nInvestment in joint ventures with affiliates 6,483,760 6,023,084 ------------- ------------- 36,024,253 57,753,380 ------------- ------------- $ 48,074,826 $ 77,868,675 ============= =============\nLIABILITIES AND PARTNERS' CAPITAL\nAccounts payable $ 101,455 $ 119,483 Due to affiliates 36,011 110,862 Other liablilities, principally real estate taxes and escrow deposits 534,113 1,541,327 Security deposits 89,848 120,870 Mortgage notes payable 1,666,291 7,153,074 ------------- ------------- Total liabilities 2,427,718 9,045,616 ------------- ------------- Limited Partners' capital (237,476 Interests issued) 52,908,205 74,843,430 Less Interests held by Early Investment Incentive Fund (16,090 at December 31,1995 and 10,208 at December 31,1994) (6,040,849) (4,614,610) ------------- ------------- 46,867,356 70,228,820 General Partner's deficit (1,220,248) (1,405,761) ------------- ------------- Total partners' capital 45,647,108 68,823,059 ------------- ------------- $ 48,074,826 $ 77,868,675 ============= =============\nThe accompanying notes are an integral part of the financial statements.\nBALCOR PENSION INVESTORS-III (AN ILLINOIS LIMITED PARTNERSHIP)\nSTATEMENTS OF PARTNERS' CAPITAL for the years ended December 31, 1995, 1994 and 1993\nPartners' Capital (Deficit) Accounts -------------- -------------- ------------- General Limited Total Partner Partners -------------- -------------- -------------\nBalance at December 31, 1992 $ 73,140,058 $ (1,386,661) $ 74,526,719\nRepurchase of 956 Limited Partnership Interests (351,782) (351,782) Cash distributions to: Limited Partners (A) (4,584,286) (4,584,286) General Partner (395,792) (395,792) Net income for the year ended December 31, 1993 3,141,300 235,598 2,905,702 -------------- -------------- ------------- Balance at December 31, 1993 70,949,498 (1,546,855) 72,496,353\nRepurchase of 1,316 Limited Partnership Interests (434,007) (434,007) Cash distributions to: Limited Partners (A) (7,844,967) (7,844,967) General Partner (346,320) (346,320) Net income for the year ended December 31, 1994 6,498,855 487,414 6,011,441 -------------- -------------- ------------- Balance at December 31, 1994 68,823,059 (1,405,761) 70,228,820\nRepurchase of 5,882 Limited Partnership Interests (1,426,239) (1,426,239) Cash distributions to: Limited Partners (A) (29,836,901) (29,836,901) General Partner (455,163) (455,163) Net income for the year ended December 31, 1995 8,542,352 640,676 7,901,676 -------------- -------------- ------------- Balance at December 31, 1995 $ 45,647,108 $ (1,220,248) $ 46,867,356 ============== ============== =============\n(A) Summary of cash distributions paid per Limited Partnership Interest:\n1995 1994 1993 -------------- -------------- -------------\nFirst Quarter $ 4.00 $ 5.50 $ 5.00 Second Quarter 29.00 20.85 5.00 Third Quarter 35.94 4.00 5.00 Fourth Quarter 63.18 4.00 5.00\nThe accompanying notes are an integral part of the financial statements.\nBALCOR PENSION INVESTORS-III (AN ILLINOIS LIMITED PARTNERSHIP)\nSTATEMENTS OF INCOME AND EXPENSES for the years ended December 31, 1995, 1994 and 1993\n1995 1994 1993 -------------- -------------- ------------- Income: Interest on loans receivable $ 7,163,288 $ 10,162,922 $ 10,535,990 Less interest on loans payable - underlying mortgages 3,700,302 4,280,261 4,916,217 -------------- -------------- ------------- Net interest income on loans receivable 3,462,986 5,882,661 5,619,773 Income from operations of real estate held for sale 1,478,073 804,434 599,785 Participation in income (loss) of joint ventures with affiliates 859,887 438,608 (482,783) Interest on short-term investments 907,358 543,293 283,425 Participation income 235,395 105,696 Recovery of losses on loans, real estate and accrued interest receivable 756,370 -------------- -------------- ------------- Total income 7,464,674 7,904,391 6,125,896 -------------- -------------- -------------\nExpenses: Provision for potential losses on loans, real estate and accrued interest receivable 756,370 600,000 2,720,000 Administrative 706,598 925,378 864,099 -------------- -------------- ------------- Total expenses 1,462,968 1,525,378 3,584,099 -------------- -------------- -------------\nIncome before gain on sales of real estate 6,001,706 6,379,013 2,541,797 Gain on sales of real estate 2,540,646 119,842 599,503 -------------- -------------- ------------- Net income $ 8,542,352 $ 6,498,855 $ 3,141,300 ============== ============== =============\nNet income allocated to General Partner $ 640,676 $ 487,414 $ 235,598 ============== ============== ============= Net income allocated to Limited Partners $ 7,901,676 $ 6,011,441 $ 2,905,702 ============== ============== ============= Net income per average number of Limited Partnership Interests outstanding (226,389 in 1995, 228,132 in 1994 and 229,084 in 1993) $ 34.90 $ 26.35 $ 12.68 ============== ============== =============\nThe accompanying notes are an integral part of the financial statements.\nBALCOR PENSION INVESTORS-III (AN ILLINOIS LIMITED PARTNERSHIP)\nSTATEMENTS OF CASH FLOWS for the years ended December 31, 1995, 1994 and 1993\n1995 1994 1993 -------------- -------------- ------------- Operating activities: Net income $ 8,542,352 $ 6,498,855 $ 3,141,300 Adjustments to reconcile net income to net cash provided by operating activities: Gain on sales of real estate (2,540,646) (119,842) (599,503) Participation in (income) loss of joint ventures with affiliates (859,887) (438,608) 482,783 Recovery of losses on loans, real estate and accrued interest receivable (756,370) Provision for potential losses on loans, real estate and accrued interest receivable 756,370 600,000 2,720,000 Amortization of deferred expenses 12,498 12,498 254,853 Accrued interest income due at maturity (201,260) Collection of accrued interest income due at maturity 449,978 Net change in: Escrow deposits 300,558 (52,534) 309,617 Escrow deposits - restricted 899,929 338,709 (300,814) Accounts and accrued interest receivable 64,339 203,867 258,361 Prepaid expenses (31,897) Accounts payable (18,028) (103,000) (628,108) Due to affiliates (74,851) 48,261 7,298 Other liabilities (1,007,214) (178,291) 352,786 Security deposits (31,022) 47,120 (39,794) -------------- -------------- ------------- Net cash provided by operating activities 5,256,131 6,857,035 6,207,497 -------------- -------------- -------------\nThe accompanying notes are an integral part of the financial statements.\nBALCOR PENSION INVESTORS-III (AN ILLINOIS LIMITED PARTNERSHIP)\nSTATEMENTS OF CASH FLOWS for the years ended December 31, 1995, 1994 and 1993 (Continued)\n1995 1994 1993 -------------- -------------- ------------- Investing activities: Capital contributions to joint venture partners - affiliates $ (78,147) $ (316,577) Distributions from joint venture partners - affiliates $ 399,211 227,855 4,294 Loan fundings (12,379) Collection of principal payments on loans receivable 13,590,567 11,511,219 2,045,070 Additions to real estate (60,698) (256,770) (107,172) Proceeds from sales of real estate 10,856,240 1,200,000 3,736,019 Costs incurred in connection with sales of real estate (461,794) (49,586) (325,277) Costs incurred in connection with real estate acquired through foreclosure (40,471) -------------- -------------- ------------- Net cash provided by investing activities 24,323,526 12,514,100 5,023,978 -------------- -------------- -------------\nFinancing activities: Distributions to Limited Partners (29,836,901) (7,844,967) (4,584,286) Distributions to General Partner (455,163) (346,320) (395,792) (Increase) decrease in cash and cash equivalents - Early Investment Incentive Fund (281,266) 4,612 54,553 Payment of deferred expenses (172,580) Repurchase of Limited Partnership Interests (1,426,239) (434,007) (351,782) Principal payments on underlying loans payable (987,626) (1,178,094) (1,369,417) Repayment of mortgage notes payable (3,545,699) (4,798,550) Proceeds from issuance of mortgage note payable 4,298,400 Principal payments on mortgage notes payable (147,324) (1,283,205) (334,887) -------------- -------------- ------------- Net cash used in financing activities (36,680,218) (11,081,981) (7,654,341) -------------- -------------- -------------\nNet change in cash and cash equivalents (7,100,561) 8,289,154 3,577,134 Cash and cash equivalents at beginning of year 18,445,509 10,156,355 6,579,221 -------------- -------------- ------------- Cash and cash equivalents at end of year $ 11,344,948 $ 18,445,509 $ 10,156,355 ============== ============== =============\nThe accompanying notes are an integral part of the financial statements.\nBALCOR PENSION INVESTORS-III (An Illinois Limited Partnership)\nNOTES TO FINANCIAL STATEMENTS\n1. Nature of the Partnership's Business:\nBalcor Pension Investors-III is engaged principally in the operation of residential and retail real estate and investment in wrap-around and first mortgage loans located in various markets within the United States.\n2. Accounting Policies:\n(a) The preparation of the financial statements in conformity with generally accepted accounting principles requires the General Partner 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 vary from those estimates.\n(b) The Partnership records wrap-around mortgage loans at the face amount of the mortgage instrument which includes the outstanding indebtedness of the borrower under the terms of the underlying mortgage obligations. The underlying mortgage obligations are recorded as a reduction of the wrap-around mortgage loan and the resulting balance represents the Partnership's net advance to the borrower. The Partnership is responsible for making periodic payments to the underlying mortgage lenders only to the extent that payments as required by the wrap-around mortgage agreement are received by the Partnership from the borrower.\n(c) Income on loans is recorded as earned in accordance with the terms of the related loan agreements. The accrual of interest is discontinued when a loan becomes ninety days contractually delinquent or sooner when, in the opinion of the General Partner, an impairment has occurred in the value of the collateral property securing the loan. Income on non-accrual loans or loans which are otherwise not performing in accordance with their terms is recorded on a cash basis.\nVarious loan agreements provide for participation by the Partnership in increases in value of the collateral property when the loan is repaid or refinanced. In addition, certain loan agreements allow the Partnership to receive a percentage of rental income exceeding a base amount. Participation income is reflected in the accompanying Statements of Income and Expenses when received.\nIncome from operations of real estate held for sale is reflected in the accompanying Statements of Income and Expenses net of related direct operating expenses.\n(d) Loan losses on mortgage notes receivable are charged to income and an allowance account is established when the General Partner believes the loan balance will not be recovered. The General Partner assesses the collectibility of each loan on a periodic basis through a review of the collateral property operations, the property value and the borrower's ability to repay the loan. Upon foreclosure, the loan, net of the allowance, is transferred to real estate held for sale after the fair value of the property, less costs of disposal is\nassessed. Upon the transfer to real estate held for sale, a new basis in the property is established.\nEffective January 1, 1995 the Partnership adopted Statement of Financial Accounting Standards, No. 121 (SFAS 121), (\"Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of\"). Under SFAS 121, the General Partner periodically assesses, but not less than on an annual basis, the fair value of its real estate properties held for sale. The General Partner estimates the fair value of its properties by dividing the property's expected net operating income by a risk adjusted rate of return or by applying a discounted cash flow analysis both of which consider economic and demographic conditions in the market. Changes in the property's fair value is recorded by an adjustment to the property allowance account and is recognized in the income statement as an increase or decrease through recovery income or a provision for loss in the period the change in fair value is determined. The General Partner considers the methods referred to above to result in a reasonable measurement of a property's fair value, unless other factors affecting the property's value indicate otherwise.\n(e) Investment in joint ventures with affiliates represents the Partnership's percentage interests, under the equity method of accounting, in joint ventures with affiliated partnerships. 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 income or loss.\n(f) Deferred expenses consist of leasing commissions which are amortized over the life of each respective lease, and financing fees which are amortized over the terms of the respective loan agreements.\n(g) Revenue is recognized on an accrual basis in accordance with generally accepted accounting principles. Income from operating leases with significant abatements and\/or scheduled rent increases is recognized on a straight line basis over the respective lease term. Service income includes reimbursements from operating costs such as real estate taxes, maintenance and insurance and is recognized as revenue in the period the applicable costs are incurred.\n(h) The Financial Accounting Standard Board's Statement No. 107, \"Disclosures About Fair Value of Financial Instruments\", requires disclosure of fair value information about financial instruments for which it is practicable to estimate that value. Since quoted market prices are not available for the Partnership's financial instruments, fair values have been based on estimates using present value techniques. These techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, may not be realized in immediate settlement of the instrument. Statement No. 107 does not apply to all balance sheet items and excludes certain financial instruments and all non-financial instruments such as real estate and investment in joint ventures from its disclosure requirements.\n(i) The Partnership records repurchases of Interests by the Early Investment Incentive Fund as a reduction of Limited Partners' Capital (see Note 3 of Notes to Financial Statements). Cash and cash equivalents not yet utilized to repurchase Interests, but which are part of the Early Investment Incentive Fund, are classified as restricted assets of the Partnership.\n(j) Cash and cash equivalents include all unrestricted, highly liquid investments with an original maturity of three months or less. Cash and cash equivalents are held or invested primarily in one issuer of commercial paper.\n(k) The Partnership is not liable for Federal income taxes as each partner recognizes his proportionate share of the Partnership income or loss in his tax return; therefore, no provision for income taxes is made in the financial statements of the Partnership.\n(l) Mortgage servicing fees have been reclassified and are included in administrative expenses during 1995. This reclassification has also been made to the previously reported 1994 and 1993 financial statements to conform with the classification used in 1995. This reclassification has not changed the 1994 and 1993 results.\n3. Partnership Agreement:\nThe Partnership was organized on January 22, 1982. The Partnership Agreement provides for Balcor Mortgage Advisors-II to be the General Partner and for the admission of Limited Partners through the sale of Limited Partnership Interests at $500 per Interest, 237,476 of which were sold on or prior to November 10, 1982, the termination date of the offering.\nFor financial statement purposes, profits and losses are allocated 92.5% to the Limited Partners, of which 2.5% relates to the Early Investment Incentive Fund, and 7.5% to the General Partner.\nTo the extent that Cash Flow is distributed, distributions will be made as follows: (i) 90% of such Cash Flow will be distributed to the Limited Partners, (ii) 7.5% of such Cash Flow will be distributed to the General Partner, and (iii) 2.5% of such Cash Flow will be set aside in a separate account for repurchase of Interests and for payment on dissolution of the Partnership to investors who subscribed prior to December 31, 1982 (\"Early Investors\") if necessary for them to receive an amount equal to their Original Capital plus a specified cumulative return based on the date of investment. Amounts, if any, remaining in the account after the Early Investors have received their cumulative return will be distributed 90% to all Limited Partners and 10% to the General Partner.\nAmounts placed in the Early Investment Incentive Fund may, at the sole discretion of the General Partner and subject to certain limitations as set forth in the Partnership Agreement, be used to repurchase Interests from existing Limited Partners. During 1995, 5,882 Interests were repurchased at a cost of $1,426,239. All repurchases of Interests have been made at 95% of the then current valuation of such Limited Partnership Interests at the previous quarter end less any distributions made after the previous quarter end. Distributions of Cash Flow and Mortgage Reductions pertaining to any repurchased Interests are paid to the Early Investment Incentive Fund. To the extent that amounts in the Early Investment Incentive Fund are not utilized to repurchase Interests, such amounts are invested in short-term interest-bearing instruments with earnings thereon credited to this account.\n4. Investment in Loans Receivable:\nLoans receivable and loans payable at December 31, 1995 consisted of the following: Loans Receivable ------------------------------------------------- Current Current Original Final Mortgage Monthly Interest Funding Maturity Property Balances(A) Payments Rate Date Date - -------------- ----------- -------- -------- ------- --------- Wrap-around Mortgages: Apartments: Carmel on Providence(B) $ 3,200,000 $ 34,333 12.875% 1982 1997 Pepper Square 3,300,000 27,500 10.00 1989 1996 Office Buildings: Bannockburn Executive Plaza (B)(C) 8,305,966 75,750 9.00 1982 1997 Seafirst Financial Center 32,425,000 268,955 9.95 1982 1997 Corporate Campus I 5,800,000 44,467 9.20 1988 1998 ----------- Total $53,030,966 ===========\nLoans Payable --------------------------------------- Underlying Current Current Due Mortgage Monthly Interest Date Property Balances Payments Rate Loan - -------------- ----------- -------- -------- ------- Apartments: Carmel on Providence $1,243,826 $17,777 9.50% 1997 Pepper Square 1,827,184 19,760 9.25 1996 Office Buildings: Bannockburn Executive Plaza 3,485,138 44,677 9.75 1997 Seafirst Financial Center 24,601,470 231,196 9.75 1997 Corporate Campus I 2,603,930 29,934 9.50 1998 ----------- Total $33,761,548 ===========\n(A) All loans are wrap-around mortgage loans.\n(B) This loan is on non-accrual status; therefore income is recorded only as cash payments are received from the borrower.\n(C) During February 1995, a plan of reorganization was confirmed by the Bankruptcy Court effective March 1995 which extended the maturity date of this loan and the underlying mortgage loan payable to December 1997. This loan will continue to bear interest at 14.5% per annum with a pay rate of 9% per annum based on the outstanding principal. Unpaid interest will be waived by the Partnership if this loan is repaid on or prior to maturity assuming no previous\nuncured defaults. In addition, the borrower was required to pay $232,031 directly to the holder of the underlying loan. The borrower is also required to remit all excess cash flow from property operations on a monthly basis directly to the holder of the underlying loan to further reduce the principal balance of the loan. Excess cash flow of $189,628 was remitted to the holder of the underlying loan during 1995.\nLoans which have been classified as non-accrual as a result of delinquency or other noncompliance with terms of loan agreements aggregated $11,505,966 and $11,927,625 at December 31, 1995 and 1994, respectively.\nUnder certain circumstances, the General Partner has entered into negotiations with borrowers which resulted in a reduction of interest rates, periodic payments or the modification of other loan terms. Loans whose monetary terms have been restructured amounted to $38,225,000 at December 31, 1995 and 1994. Non-accrual loans and loans which have been restructured are hereinafter referred to as impaired loans.\nNet interest income relating to all of the impaired loans except for The Woods Apartments loan would have been approximately $2,025,000 in 1995, $1,915,000 in 1994 and $3,787,000 in 1993. Net interest income from impaired loans included in the accompanying Statements of Income and Expenses amounted to approximately $2,001,000 ($2,002,000 cash basis) in 1995, $1,958,000 ($1,877,000 cash basis) in 1994 and $2,375,000 in 1993.\nThe Woods Apartments loan was placed on non-accrual status in 1988. During May 1992, an extension of the maturity of the loan receivable and underlying loan was completed. The maturity dates were extended to June 1993 and July 1993, respectively. The borrower failed to repay either of the loans and the Partnership obtained title to the property through a non-judicial foreclosure in July 1994. The Partnership received net interest income of approximately $653,000 and $301,000 in 1994 and 1993, respectively.\nImpaired loans totaled $49,730,966 and $50,152,625 at December 31, 1995 and 1994, respectively. Impaired loans of $41,425,000 had related allowances for losses of $3,943,630, and the $8,305,966 impaired loan had no allowance for losses in 1995. The impaired loan of $38,225,000 had a related allowance for losses of $3,654,000 in 1994 and $11,927,625 of impaired loans had no allowances for losses in 1994.\nThe average recorded investments in impaired loans during the years ended December 31, 1995 and December 31, 1994 were approximately $49,942,000 and $60,136,000, respectively.\n5. Allowances for Losses on Loans and Real Estate Held for Sale:\nActivity recorded in the allowances for losses on loans and real estate held for sale during the three years ended December 31, 1995 is described in the table below.\n1995 1994 1993 ------------ ------------- ------------ Loans: Balance at beginning of year $5,013,959 $ 8,129,365 $ 8,129,365\nRecovery of provision previously charged to income (756,370) None None Provision charged to income 756,370 600,000 2,000,000 Direct write-off of loans against allowance (1,070,329) (3,715,406) (2,000,000) ------------- ------------ ------------ Balance at the end of the year $3,943,630 $ 5,013,959 $ 8,129,365 ============= ============ ============\nReal Estate Held for Sale: Balance at beginning of year None None None Provision charged to income None None $ 720,000 Direct write-off of real estate held for sale against allowance None None (720,000) ------------ ------------- ------------ Balance at the end of the year None None None ============ ============= ============\n6. Mortgage Notes Payable:\nThe mortgage notes payable at December 31, 1995 and 1994 consisted of the following:\nCarrying Carrying Amounts Amounts of Notes of Notes Current Current Final Estimated at at Monthly Interest Maturity Balloon Property 12\/31\/95 12\/31\/94 Payments Rate Date Payment - ---------------- ---------- --------- -------- -------- ------ --------- Apartments: Candlewyck (A) $1,313,768 1,065,228 1,274,175 Shopping Centers: Crossings (B) 1,793,760 Orchards $1,666,291 1,706,143 $16,334 9.25% 1997 $1,587,000 ---------- ----------\nTotal $1,666,291 $7,153,074 ========== ==========\n(A) In August 1995, this property was sold. See Note 12 of Notes to Financial Statements for additional information.\n(B) In January 1995, this mortgage note payable was assumed by the purchaser in connection with the sale of this property. See Note 12 of Notes to Financial Statements for additional information.\nThe Partnership's loan described above requires current monthly payments of principal and interest.\nReal estate held for sale with an aggregate carrying value of $6,691,000 at December 31, 1995 was pledged as collateral for repayment of the mortgage note.\nDuring the years ended December 31, 1995, 1994 and 1993, the Partnership incurred interest expense on mortgage notes payable of $463,817, $780,047, and $1,531,785, respectively, and paid interest of $463,817, $780,047, and $1,526,182, respectively.\nFuture annual maturities of the above mortgage note payable are approximately as follows:\n1996 $ 44,000 1997 1,622,000\n7. Management Agreements:\nAs of December 31, 1995, both properties owned by the Partnership are under management agreements with a third-party management company. These management agreements provide for annual fees of 5% of gross operating receipts for the residential property and 3% to 6% of gross operating receipts for the commercial property.\n8. Transactions with Affiliates:\nFees and expenses paid and payable by the Partnership to affiliates are:\nYear Ended Year Ended Year Ended 12\/31\/95 12\/31\/94 12\/31\/93 -------------- -------------- -------------- Paid Payable Paid Payable Paid Payable ------ ------- ------ ------- ------ -------\nMortgage servicing fees $ 52,651 $ 2,392 $ 88,396 $ 4,839 $104,581 $ 8,437 Property management fees None None 238,090 None 333,195 18,262 Reimbursement of expenses to the General Partner at cost: Accounting 61,773 8,041 74,803 30,698 71,203 5,880 Data processing 23,072 2,369 41,023 9,216 41,726 10,010 Investor communica- tion 10,247 None 27,664 8,893 20,499 1,693 Legal 20,531 2,751 16,094 9,316 14,911 1,231 Portfolio management 116,877 20,400 84,441 38,103 62,738 16,384 Other 12,555 58 26,381 9,797 8,518 704\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; however, the General Partner is reimbursed for program expenses. The Partnership paid premiums to the deductible insurance program of $32,357, $46,538, and $31,861 for 1995, 1994 and 1993, respectively.\nAllegiance Realty Group, Inc., an affiliate of the General Partner, managed all of the Partnership's properties until the affiliate was sold to a third-party in November 1994.\n9. Investments in Joint Ventures with Affiliates:\nIn 1990 and 1991, the Partnership and certain affiliates acquired title to the Brookhollow\/Stemmons and Perimeter 400 Center office buildings, respectively. Profits and losses, all capital contributions and distributions are allocated in accordance with the participants' original funding percentages. The Partnership's sharing percentages for the Brookhollow\/Stemmons and Perimeter 400 Center office buildings are 27.5% and 12.68%, respectively. During 1993, the Partnership recognized a loss of $771,873 as its share of the reduction in the carrying values of the properties. During 1995, the Partnership recognized $331,822 as its share of the recoveries of provisions related to the change in the estimates of the fair value of the properties. These amounts are included in the Partnership's participation in income (loss) of joint ventures with affiliates. In addition, during 1995, 1994, and 1993 the Partnership received distributions from these joint ventures totaling $399,111, $227,855, and $4,294, respectively, and made contributions of $78,147 and $316,577 in 1994 and 1993, respectively.\nThe following information has been summarized from the financial statements of the joint ventures:\n1995 1994 1993 ----------- ---------- ------------ Net investment in real estate as of December 31 $36,015,862 $34,174,946 $34,008,955 Total liabilities as of December 31 451,150 391,765 510,366 Total income 7,588,538 7,319,405 6,834,797 Net income before recovery (provision) 3,052,398 2,733,148 1,295,097 Recovery (provision) for potential loss 1,565,000 None (3,165,000) Net income (loss) 4,617,398 2,733,148 (1,869,903)\n10. Real Estate Held for Sale:\nThe Partnership acquired The Woods Apartments through foreclosure in July 1994. The Partnership recorded the cost of the property at $7,198,171. This amount represented the outstanding loan balance plus accrued interest receivable. In 1994 the Partnership increased the basis of The Woods Apartments by $8,066 for certain receivables, escrows and costs incurred in connection with the foreclosure. At the date of foreclosure, the property was transferred to real estate held for sale at its fair value, net of allowances previously recorded.\n11. Discounted Prepayments of Loans Receivable:\n(a) In August 1995, the borrower of the $16,750,000 Colony Apartments wrap-around loan repaid the loan. The Partnership received proceeds of approximately $8,301,516 and the borrower repaid the $7,378,155 underlying mortgage loan. The remaining wrap-around loan receivable balance, net of the underlying mortgage payable balance, were written off against the previously established allowance for losses in connection with the prepayment of the loan.\n(b) In June 1994, the borrower of the $12,767,949 Continental Park wrap-around loan prepaid the loan at a discount. The Partnership received proceeds of approximately $4,873,085 and the borrower repaid the $4,143,890 underlying mortgage loan. The remaining wrap-around loan receivable balance, net of the underlying mortgage payable balance, and escrow liabilities of $35,568 were written off against the previously established allowance for potential loan losses in connection with the prepayment of the loan.\n12. Sale of Real Estate:\nThe Partnership sold the Crossings Shopping Center and Candlewyck Apartments during 1995, the Orchards Office Building during 1994, and the Villa Verde Apartments, Riverview Office Building and vacant land adjacent to the Orchards Shopping Center during 1993 in separate all cash sales for $12,650,000, $1,200,000 and $8,025,000, respectively. From the proceeds of the Candlewyck Apartments sale, the Partnership paid $3,545,699 to the third party mortgage holders in full satisfaction of the property's mortgage loans. From the proceeds of the 1994 Orchards Office Building sale, the Partnership repaid $1,000,000 of the first mortgage loan. The Partnership continues to own the Orchards Shopping Center. The purchasers of the Crossings Shopping Center and the Villa Verde Apartments took title subject to the existing first mortgage loans which had balances of $1,793,760 and $4,288,981, respectively. The carrying value of the real estate sold during 1995, 1994 and 1993 totaled $9,647,560, $1,030,572 and $7,100,220, respectively. For financial statement purposes, the Partnership recognized net gains of $2,540,646, $119,842 and $599,503 from the sale of the real estate during 1995, 1994 and 1993, respectively.\n13. Contingency:\nThe Partnership is currently involved in a lawsuit whereby the Partnership, the General Partner and certain affiliates have been named as defendants alleging certain federal securities law violations with regard to the adequacy and accuracy of disclosures of information concerning the offering of the Limited Partnership Interests of the Partnership. The defendants continue to vigorously contest this action. While a plaintiff class has been certified, no determination of the merits have been made. It is not determinable at this time whether or not an unfavorable decision in this action would have a material adverse impact on the Partnership. Management of each of the defendants believes that they have meritorious defenses to contest the claims.\n14. Fair Value of Financial Instruments:\nThe carrying amounts and fair values of the Partnership's financial instruments at December 31, 1995 are as follows:\nThe carrying value of cash and cash equivalents, accounts and accrued interest receivable and accounts and accrued interest payable approximates fair value.\nBased on borrowing rates available to the Partnership at the end of 1995 for loans receivable and mortgage loans with similar terms and maturities, the fair value of the loans receivable and mortgage notes payable approximates the carrying value.\nThe fair value for the Partnership's investments in loans receivable and mortgage notes payable was estimated using discounted cash flow analyses. The discount rates were based upon rates at the end of 1995 comparable to those the\nPartnership could receive or charge in the commercial real estate lending market with terms and maturities comparable to the Partnership's loans receivable and mortgage notes it presently holds.\n15. Subsequent Event:\nIn January 1996, the Partnership paid $6,402,354 to Limited Partners representing the regular quarterly distribution of available Cash Flow of $4.00 per Interest for the fourth quarter of 1995 and a special distribution of $22.96 per Interest representing Mortgage Reductions received primarily from the Rivergate loan repayment.","section_15":""}
{"filename":"354888_1995.txt","cik":"354888","year":"1995","section_1":"ITEM 1. BUSINESS\nCyCare Systems, Inc. (the \"Company\"), founded in 1967 and incorporated in 1969, is a leading provider of information systems, related support services and electronic data interchange (EDI) services to the health care industry, including physicians, medical group practices, academic practice centers and integrated delivery networks. The Company's services and systems are based primarily on open-systems architecture using software developed or acquired by the Company to improve the productivity and profitability of its customers. Applications include appointment scheduling, patient and member registration information, business office management, electronic claims processing, patient care and patient accounting.\nINDUSTRY BACKGROUND\nThe Company estimates that there are over 570,000 physicians in private practice and approximately 148,000 medical practices in the United States. The economic pressures and informational demands upon physicians and medical practices have increased significantly during the past decade. At the same time, the increased power and decreased cost of computers have made computers an effective information processing solution for a broader range of medical practices. Approximately 70% of physician practices now use computers or computer services for at least some of their information processing requirements.\nThe demand for more comprehensive and accurate information processing solutions is expected to continue. Health care cost containment efforts have greatly increased the amount and complexity of required information. At the same time, increased competition has resulted in a greater focus on demonstrating the quality of care delivered to patients. Practice management systems help providers reduce the costs and improve the quality of delivering health care services by automating patient care and administrative processes, ensuring timely access to relevant information, streamlining the storage and retrieval of information, and matching patient needs with available resources.\nThe ongoing pressure to contain health care costs is also changing the structure of health care providers and their practice management system requirements. Over the next several years, the majority of practicing physicians are expected to be channeled into ever enlarging networks, group practices, HMOs, and integrated delivery systems (IDS). In addition, the number of third-party payer organizations has increased. At the same time, federal and state governments, which are estimated to be responsible for approximately 30% of physician claims for patient charges as a result of Medicare, Medicaid and other programs, have imposed pricing and reimbursement regulations that significantly complicate billing procedures and increase the information a medical practice must maintain with respect to its patients. Furthermore, health care payers are increasingly transferring the economic risk of health care delivery to providers by shifting from the traditional fee-for-service reimbursement model to managed care reimbursement models, such as payment based on capitation. Under capitation, providers are paid an annual fixed fee per individual to deliver all health care services required by that individual. This reimbursement model encourages health care providers to modify their emphasis from not only treating illness, but also to maintaining wellness. The expansion in the number of managed care and third-party payer organizations, as well as additional governmental regulation and the change in reimbursement models, has greatly increased the complexity of pricing practices, billing procedures and reimbursement policies impacting medical practices. These trends are prompting dramatic change in, and ultimately major expenditures for, physician practice management information systems.\nOther factors also are increasing the demand for more comprehensive and accurate information systems. The growing administrative burdens placed on medical practices have caused physicians to join together in group practices to share administrative costs and achieve economies of scale. The Company believes the movement toward group practices has accelerated the trend toward automation as group practices require the greater efficiency and productivity of an automated system. Not only has there been a movement toward group practices, more recently group practices have been coming together to form larger group practices. In addition, hospitals and insurance companies are buying and\/or managing physician practices and networking them into one common system. The general increase in the size and complexity of medical practices has resulted in a greater need for analysis of data and production of timely management information reports which allow physicians and other health care providers to reach informed conclusions regarding the quality and appropriateness of various procedures and practices.\nTechnological advances have made more comprehensive, cost-effective computer solutions available to physician practices. While early systems concentrated principally on patient billing and collection activities, systems are now available which record and store clinical information, automate the processing of insurance and third-party payer claims, and integrate the operations of physician practices with larger health care organizations such as hospitals, HMOs and management service organizations (MSO). The Company believes that these various factors will cause medical practices to seek additional and more comprehensive computer-based solutions for their information processing needs.\nSTRATEGY\nThe Company's goal is to be the leading provider of physician practice management systems and services. The Company's strategy includes the following key elements:\n* Provide a Strong and Integrated Product Line. In 1993, the Company upgraded its large-group product, the CS3000, the first client\/server system in this market segment. In 1994, the Company introduced a new small-group product, the Windows(TM)-based SpectraMED(TM). In 1995, the Company began shipping its comprehensive medical records product, CS-CIS, that has a complete data repository, drug interaction reporting, imaging and outcomes reporting capabilities. The Company will continue to enhance these products and to develop new applications that address the rapidly changing requirements of today's health care environment.\n* Provide a Full Range of Transaction Processing Services. The Company currently offers electronic transactions (EDI) such as claims processing, remittance advices, eligibility checking and encounter data. Additional capabilities include statement processing and paper claims for those insurance carriers without electronic submission capabilities.\n* Provide Systems Integration Services. The Company's strategy is to provide the core practice management system solution using its open-system architecture, then use its integration expertise to build state-of-the-art communication networks to tie in ancillary systems such as pharmacies, labs, radiology departments, etc. and in today's IDS environment, hospitals.\n* Expand National Direct Sales Organization. The Company plans to expand its direct sales organization to market to a larger number of medical practices, MSOs, IDSs, and practice management consultants.\n* Strategic Acquisitions. The Company continually evaluates the acquisition of products, services and businesses that are similar or complementary to those offered by the Company. Many of these potential acquisitions would allow the Company to expand its customer base or provide new technologies to existing and future customers. Consistent with this strategy, in December 1995, the Company acquired Richard D. Jugel and Company. This acquisition provided the Company with the ability to process UB-92 (hospital-based) claims electronically.\nPRODUCTS AND SERVICES\nThe Company's strategy is implemented through two primary business units: Group Practice and CyData, Inc.\nGroup Practice\nThe Company's Group Practice business unit has served physician groups and other ambulatory care organizations for over 28 years, and it maintains a 20 percent market share in group practices with 25 or more physicians. This business unit is uniquely positioned with a comprehensive range of software applications and services that meet the information processing requirements of smaller practices that are consolidating into larger groups, and for groups that are affiliating with each other to form IDSs. Business solutions offered are in the areas of patient information and registration, business office management, third-party management, electronic claims clearing, prepaid managed care, appointment scheduling and clinical information. In addition to systems, support services such as account management, systems integration and networking, education and training, installation and documentation are also offered. In 1995, this business unit had revenues of $47.7 million versus $40.5 million and $36.5 million in 1994 and 1993, respectively. In 1995, 71% of these revenues were recurring.\nThe Company developed its Group Practice products, with the exception of SpectraMED, using client\/server based technology to eliminate the dependence on proprietary technology and enable the Company to add and refine applications as technology changes. The hardware platform chosen to run the Company's products is Hewlett Packard's HP 9000, Series 800 business server. This RISC-based platform provides excellent scalability and has one of the best price\/performance ratios in the industry.\nCyCare System 3000(TM) (CS3000) . The CS3000 was introduced in late 1993 and is designed for group practices with 12 or more physicians. The CS3000 is a UNIX-based client\/server system that features point and click interface technology and optimum flexibility through open-systems architecture which allows integrated access to data from a variety of sources throughout the organization. The CS3000 is designed to improve physician\/provider productivity and personnel utilization of its customers. Modules included are patient information and registration, managed care, scheduling and business office management. The patient information and registration module gives instant access to patient, guarantor and insurance coverage information that can be used throughout the product. The system's managed care module is designed to support capitated contracting from both the provider and the payer perspectives and the scheduling module is designed to maximize productivity by automating test schedules, examinations, and procedures. Business office management features are designed to maximize revenue and minimize staffing requirements.\nClinical Information System (CS-CIS). In August 1995, the Company signed a relicensing agreement with Wang Laboratories, Inc. to market Wang's fully functional electronic medical records systems. CS-CIS is a client\/server system that will run on any industry standard 486 or Pentium PC. Its relational database can share data with every database that is compliant with open-systems standards. Because CS-CIS was implemented for open-systems, it interfaces smoothly with multiple UNIX platforms running Novell Netware. CS-CIS fully integrates the entire practice from the front desk to the examining room, regardless of medical specialty, and stores all patient data in a clinical information repository. CS-CIS doesn't replace the CS3000, or any other practice management system; instead, the systems work in tandem to form a sophisticated information network for the ambulatory environment. CS-CIS is designed for the way physicians work intuitively. During an encounter, the physician can check test results or enter information with a pen on digital forms that look like familiar paper forms. Referrals, prescriptions and other ancillary services can be ordered electronically in one easy step. The practice realizes the increased efficiencies as lower overhead and increased profits in a managed care environment.\nEnterprise-wide Scheduling (CS-ES). The Company is currently developing an enterprise-wide scheduling product known as CS-ES. CS-ES is a state-of-the-art achievement based on a sophisticated SQL database for easy access to information. On-line help and user-friendly graphical interface employing Microsoft(R) Windows(TM) cut training time and enable the user to move easily throughout the system. As physician groups combine to form integrated delivery networks, the ability to schedule patient appointments for numerous resources becomes extremely critical to both the cost and quality of care. The CS-ES will allow the physician practice to schedule and coordinate appointments for multiple resources, specialties or departments. Additional features include: daily patient lists, resource usage and no-show reports, patient reminder letters, identification of credit risks, copays, referring physicians, and preauthorization.\nSpectraMED. In February 1994, the Company began shipments of SpectraMED, the first full spectrum practice management and patient care solution designed to use the Microsoft(R) Windows(TM) operating system. This state-of-the-art software solution addresses the practice management needs of individual providers and groups of up to 12 physicians. This product offers features such as electronic medical records, live audio and video records that can be stored in the SpectraMED patient file, patient names\/alerts, the ability to maintain multiple fee schedules and simplified ad-hoc reporting. SpectraMED is designed to take full advantage of all the EDI and statement processing capabilities of the Company's CyData subsidiary.\nCyData, Inc.\nIn 1992, the Company formed a wholly-owned subsidiary named CyData, Inc., that provides solutions to accelerate cash flow, maximize productivity, reduce administrative costs and improve profitability. More than 25 percent of the nation's traditional group practices have streamlined operations through CyData's electronic data interchange (EDI) services, including on-line and roster eligibility, claims, encounters, remittance advice and statement processing. CyData's revenues, including intercompany transaction processing revenues, were $19.0 million, $17.0 million and $13.6 million in 1995, 1994 and 1993, respectively. Intercompany transaction processing revenues were $5.7 million, $5.5 million and $5.1 million in 1995, 1994 and 1993, respectively. These revenues were 100% recurring in 1995. CyData has also initiated a special marketing effort called the Participating Payer Program. Insurance payers that join the Participating Payer Program have agreed to absorb most if not all of the physician's costs to process claims electronically. In return, the payers enjoy a cost savings from reduced paper claims processing. Currently, the clearinghouse formats, edits and processes over four million claims per month.\nElectronic Data Interchange. CyData provides a complete financial processing solution. From the moment a patient walks in the door, health care providers can confirm if a patient is eligible for treatment (on-line or roster eligibility). After providing treatment, the physician or hospital can submit insurance claims or encounter information daily to CyData where it will be edited, formatted to the payer's unique specifications and transmitted to one of the over 500 insurance carriers that accept electronic claims from CyData. The amount the insurer will pay (remittance advice) can be electronically transmitted back to the provider for updating of accounts receivable, without rekeying of data. Physicians and hospitals can then collect the final amount owed by sending a statement to the patient using CyData's statement processing capabilities, as described below.\nStatement Processing. CyData also provides a statement processing service to medical groups to assist with patient billing. Groups submit, via electronic transmission or computer tape, billing information to the Corporate Information Center in Dubuque, Iowa. CyData then prints and mails statements. Processing five million statements each month, the Company has the facilities to process statements more inexpensively and efficiently than the groups can do themselves.\nSOFTWARE LICENSING, DEVELOPMENT AND PROTECTION\nThe Company does not sell its software to customers. The Company licenses its software to all distributed and in-house\/turnkey customers. The standard license agreement provides that, for a specified fee, a customer is granted the non-transferable right to use the Company's software products. Distributed customers are charged lower license fees than non-distributed customers. The Company's initial software licenses are associated with related hardware and all sales are accounted for as systems sales.\nThe Company has implemented an innovative software pricing philosophy, Living Software, in the Group Practice business unit. The Company licenses software to customers at a flat rate, including all services and future upgrades. Because of this structure and because \"living software\" minimizes customer's initial cash flow, brand loyalty is enhanced. This pricing philosophy shifts a portion of the initial software license fee into recurring revenue over the life of the contract and allows customers to protect their investment in software. A portion (usually 10%) of the Company's initial license fee is payable upon execution of a license agreement, with the remainder payable upon delivery and testing of the software. License agreements contain provisions designed to prevent disclosure and unauthorized use of the Company's products. Clients sign license agreements for continuing software use, support and enhancements, generally for a period of three to five years.\nComputer software is subject to rapid changes as a result of internal and external forces, particularly in the rapidly-changing health care market. Internally, changing needs of the customer require software to be flexible, easily modified or completely revised to meet the customer's needs. External factors, such as technological changes in hardware and changing requirements of outside parties (like insurance carriers) may necessitate software enhancements or modifications. To meet these needs, the Company maintains a staff of systems analysts and programmers in Dubuque, Iowa; Omaha, Nebraska; and Scottsdale, Arizona to develop and enhance its products. The Company has also contracted programming from outside sources from time to time. The Company has a number of significant projects currently in development, including: enterprise-wide scheduling, new EDI processes, and various upgrades to CS3000 and CS-CIS.\nThe Company capitalizes certain software development costs, primarily coding and testing, which meet recoverability tests. The capitalized costs are then amortized over future periods or written down to their net realizable value, if recoverability tests are not met. Once a software package is developed, the expenses associated with its licensing generally are limited to marketing, installation, support, product updates and administration.\nNet research and development expenses were $4.3 million (7% of revenues) in 1995, $4.1 million (8% of revenues) in 1994, and $4.2 million (9% of revenues) in 1993. The Company anticipates that these expenditures will continue to be approximately 8% of revenues.\nApplication software generally cannot be patented. Instead, the Company relies upon contract, trade secret and copyright laws to protect its proprietary knowledge. Customers sign agreements restricting use to their own operations and prohibiting disclosure to third parties. Furthermore, customers generally are not provided with the Company's software source code. Company-prepared manuals are marked as protected under copyright laws. In addition, employees are notified of the confidential nature of the Company's proprietary information and trade secrets and are required to sign non-disclosure agreements. Regardless of these restrictions, it may be possible for competitors to obtain the Company's trade secrets. The Company will seek to protect its rights and to enforce the non-disclosure provisions of its agreements. The names \"CyCare\" and \"CyData\" and their associated logos are trademarks of the Company.\nEQUIPMENT SALES AND RENTALS AND SOURCES OF SUPPLY\nThrough agreements with equipment manufacturers, the Company sells and leases various minicomputers, personal computers, video display terminals and peripheral equipment used in the Company's systems. While customers could purchase or lease identical equipment from other sources, they have not generally done so.\nMost components of CyCare's distributed processing and in-house\/turnkey systems, such as IBM mainframes and personal computers, Hewlett-Packard minicomputers and personal computers, Bull Worldwide Information Systems, Inc. minicomputers, Link and Wyse video display terminals and Cincom Systems, Inc. database management software, are purchased from single sources. While alternative sources of minicomputers, video display terminals and software are available to the Company, additional time would be required to adapt the equipment to the Company's requirements. In addition, the use of alternative sources might necessitate redesign or recoding of the Company's application software and could result in some interruption of the delivery of systems. The Company believes its relationships with its suppliers are good. Periodically, the Company reevaluates the equipment and software purchased from suppliers. The Company has entered into a value-added agreement with Hewlett Packard to purchase equipment for resale to its customers.\nINSTALLATION, SUPPORT AND TRAINING\nThe Company maintains an extensive customer service organization. Specialists assist customers in installation or conversion and provide ongoing support. Services performed by such specialists include planning system options and determining software required, assisting file conversion, implementing operating procedures, training, planning the equipment environment and coordinating with other departments. Other personnel handle the day-to-day contact with the customer concerning such items as requests for supplies, special processing runs, additional services and problem determination. Technical support personnel provide continuing enhancements and improvements to the Company's software and assist customers in communicating with equipment manufacturers. They also furnish custom programming to customers, usually charged on a time and material basis.\nInstallation of a system normally commences upon execution of a contract, with installation completed in two to three weeks for SpectraMED clients, and two to six months for CS3000 clients. The equipment supplier installs the hardware used by distributed and in-house\/turnkey customers. Installation of software may occur in phases, but initial processing usually begins within two months.\nInitial training on the use of the system is generally included in the cost of the system. In addition, the customer is provided with a user manual describing the features of the system and how to use it effectively. The Company also provides continuing classes to update and train the customer personnel at regional training facilities. The Company periodically schedules state and national user meetings and executive forums, which allow an exchange of ideas and techniques among customers and provide the Company with ideas for future enhancements and products.\nCLIENTS, MARKETING AND BACKLOG\nThe Company markets its Group Practice products for large physician groups and CyData products and services through sales representatives located in nine offices throughout the country. The Company currently has 24 direct sales people, plus 17 sales support personnel with specific product expertise and 5 telemarketing individuals. The Company's sales representatives are experienced in the computer service field and knowledgeable about the Company's products and services, and are supported by a marketing and technical staff. The Company's SpectraMED product is marketed through a nationwide network of over 150 independent dealers that is supported by the Company's marketing and technical support staffs.\nThe Company's customers are principally located throughout the United States. Revenues generated in Canada represent less than 1% of total revenues and are considered insignificant. In 1995, the Company's Canadian subsidiary was dissolved and financial transaction reporting and operational activities were assumed by the Company.\nThe Company's services and systems are directed at different health care markets as categorized by its strategic business units. Services and systems have been designed to meet the specific requirements for each of these markets.\nThe Company's backlog for equipment sales and software licenses was $1,355,000 at March 22, 1996 and $4,890,000 at March 17, 1995. All of the March 22, 1996 backlog is expected to be filled in the current fiscal year.\nCOMPETITION\nCompetition is intense in the market served by the Company. The industry is highly fragmented and includes numerous competitors. The Company believes that the most important factors in a potential customer's evaluation of its services and systems are reliability, functional\/technical capabilities, price, future flexibility, data security, support services and cost effectiveness. The Company continues to focus on increasing customer satisfaction as a method of improving potential customers' perceptions and adding value to its products. Improvement has been seen based on the increased number of customer reference sites and customer retention. The Company believes it is one of the largest providers of computer information processing services and systems to physicians and medical group practices. Competitors include other computer service companies, equipment manufacturers and consulting firms, some of which are substantially larger and have greater financial, marketing and personnel resources than the Company. Neither the Company nor any competitor is believed by the Company to have a 10% or greater share of the current market.\nCOMMUNICATION NETWORK AND DATA SECURITY\nThe Company supplies its services through a nationwide data communications network consisting of leased and WATS telephone lines. Data stations or video display terminals located on customer premises are connected through one of these networks to the Company's computer facility.\nComputer accessibility is critical to the success of an on-line system, such as the Company's shared system. In 1995, the Company's computer facility was operational for over 99% of the Company's customers' normal working hours.\nCyCare has a diagnostic system which monitors its leased telephone lines to detect sources of degradation in data received. The Company maintains a remote diagnostic system for problem solving and training customer personnel. This system allows the Company's technical personnel to immediately communicate with a customer's computer rather than having to visit the customer's location.\nThe Company maintains confidentiality and security due to the nature of the information it processes. The Company restricts data access for shared customers, restricts physical access to its computer facility and requires its employees to sign agreements acknowledging the confidentiality of information processed. Customer information is duplicated and transferred to an off-site location on a daily basis.\nEMPLOYEES\nAs of March 8, 1996, the Company employed approximately 486 persons, including 46 sales representatives, 144 employees engaged in providing installation services and continuing support and 106 systems analysts and programmers involved in research and development and continuing maintenance of CyCare's systems and programs, the balance being administrative, operations and clerical employees.\nSystems analysts and programmers are in short supply and, consequently, competition for such personnel is intense. The Company believes that its future success will be dependent in part upon recruiting and retaining qualified technical personnel as well as other employees. CyCare considers its employee relations to be good.\nGOVERNMENT REGULATION\nThe health care industry is subject to changing political, economic and regulatory influences that may affect the procurement practices and operation of health care facilities. During the past several years, the health care industry has been subject to an increase in governmental regulation of, among other things, reimbursement rates and certain capital expenditures. Many lawmakers have announced that they intend to propose programs to reform the U.S. health care system. These programs may contain proposals to increase governmental involvement in health care, lower reimbursement rates or otherwise change the operating environment for the Company's customers. Health care providers may react to these proposals and the uncertainty surrounding such proposals by curtailing or deferring investments, including those for the Company's products and related services. Cost containment measures instituted by health care providers as a result of regulatory reform or otherwise could result in greater selectivity in the allocation of capital funds. Such selectivity could have an adverse effect on the Company's ability to sell its products and related services. The Company cannot predict with any certainty what impact, if any, such proposals or health care reforms might have on its business, financial condition and results of operations.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's principal processing and development operation is located in approximately 114,000 square feet of a nine-story commercial office building in Dubuque, Iowa, purchased by the Company in September 1986. In 1994, the Company refinanced the building and it is currently subject to a mortgage being amortized over five years with payments ending in April 1999. The building has approximately 215,000 leasable square feet. Space not needed by CyCare will continue to be leased to other tenants. The Company leases approximately 33,000 square feet for its corporate headquarters in Scottsdale, Arizona. The Company also leases office space in various United States cities for terms generally not exceeding five years. Offices are located in Atlanta, Chicago, Dallas, Minneapolis, Omaha, San Diego and Bedminster, New Jersey and are equipped to service all aspects of the Company's business. The Company considers these facilities to be adequate for its present and anticipated needs.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nAs of the date hereof, there are no legal proceedings pending against or involving the Company that in the opinion of management could result in a materially adverse change in the business or financial condition of the Company.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\nITEM 4a. EXECUTIVE OFFICERS OF THE REGISTRANT\nName Age Position with the Company - ---- --- -------------------------\nJim H. Houtz 60 Chairman of the Board of Directors, President and Chief Executive Officer David H. Koeller 48 President of Group Practice Mark R. Schonau 39 Chief Financial Officer, Secretary\/Treasurer Bill W. Childs 56 Senior Vice President Randy L. Skemp 39 Senior Vice President Carolyn S. Haupert 52 Senior Vice President\nMr. Houtz has been Chief Executive Officer since founding the Company in 1967, and has served as a director since its incorporation in 1969. In January 1994, he was also named President of the Company.\nMr. Koeller joined the Company in 1970 and has held various positions in operations and client services. He was named Vice President - Operations in 1979, Senior Vice President - Operations, Corporate Information Center in 1986, and Executive Vice President - Group Practice Systems in 1989. In October 1990, he was named Executive Vice President - Technical Services and Development. In January 1994, he was named President of Group Practice.\nMr. Schonau joined the Company in May 1988, as Corporate Controller. In November 1988, he was appointed Secretary\/Treasurer. In 1989, he was appointed Chief Financial Officer. Prior to joining the Company, he was a Senior Manager with Ernst & Whinney (currently Ernst & Young LLP).\nMr. Childs joined the Company in April 1995 as Senior Vice President. From 1984 until his employment by the Company in 1995, Mr. Childs was President and Chief Executive Officer of Health Data Analysis, Inc., a health care publishing and consulting organization.\nMr. Skemp joined the Company in January 1983, as an Operations Supervisor. In 1985, Mr. Skemp was named to Manager of Credit Union Sales and Telemarketing. In 1988, he assumed the position of Director of Commercial and Distribution Services in Data Clearing and in 1990 was named Director of Account Management for the central and eastern regions of the United States. In January 1993, Mr. Skemp was named Vice President and then Senior Vice President in May 1994.\nMs. Haupert joined the Company in August 1974 and has held various management positions. She was named Manager of Clinical Development in 1983; Director-Application Support in May 1985; Director of Product Development in January 1988, and Director of Data Clearing Products and Services in June 1991. Ms. Haupert was named Vice President in January 1993 and subsequently named Senior Vice President in January 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nCertain information in response to this item is incorporated herein by reference from \"Shareholder Information\" on page 27 of the Annual Shareholders' Report.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nInformation in response to this item is incorporated herein by reference from \"Eleven - Year Comparison of Selected Financial Data\" on page 26 of the Annual Shareholders' Report.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nInformation in response to this item is incorporated herein by reference from \"Management's Discussion and Analysis\" on pages 12 and 13 of the Annual Shareholders' Report.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nInformation in response to this item is incorporated herein by reference from the \"Consolidated Financial Statements\" on pages 14 through 24 of the Annual Shareholders' Report.\n\"Quarterly Results\" on page 24 of the Annual Shareholders' Report 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\nCertain information in response to this item is incorporated herein by reference from \"Election of Directors\" on pages 1 and 2 and \"Compliance with Section 16(a) under the Securities Exchange Act of 1934\" on page 15 of the Proxy Statement and from \"Executive Officers of the Registrant\" in Part I of this report.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nCertain information in response to this item is incorporated herein by reference from \"Board Compensation Committee Report on Executive Compensation,\" \"Performance Graph,\" \"Summary Compensation Table,\" \"Director Compensation,\" \"Option\/SAR Grants in Last Fiscal Year,\" \"Aggregated Option\/SAR Exercises in Last Fiscal Year and FY-End Option\/SAR Values,\" and \"Employment Contracts and Termination of Employment and Change-in-Control Arrangements\" on pages 8 through 14 of the Proxy Statement.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation in response to this item is incorporated herein by reference from \"Security Ownership of Certain Beneficial Owners and Management\" on page 7 of the Proxy Statement.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation in response to this item is incorporated herein by reference from \"Certain Relationships and Related Transactions\" on pages 14 and 15 of the Proxy Statement.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a)(1) Financial Statements\n(3)Information with respect to this item is contained in Item 14(c) hereof and is incorporated herein by reference.\n(b) Reports on Form 8-K\nNone\n(c) Exhibits\n(a) Management contract or compensatory plan or arrangement required to be filed as an exhibit pursuant to Item 14(c) of Form 10-K.\n(b) Confidential treatment granted as to portions thereof.\n(c) Confidential treatment requested as to portions thereof.\ni Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1988.\nii Incorporated by reference to the Company's Report on Form 8-K dated May 9, 1989.\niii Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1989.\niv Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1985.\nv Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1991.\nvi Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1992.\nvii Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1993.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nCYCARE SYSTEMS, INC.\nDATE: March 26, 1996 \/s\/ Mark R. Schonau ------------------- Mark R. Schonau Chief Financial Officer, Secretary and Treasurer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on March 26, 1996 by the following persons on behalf of the Registrant and in the capacities indicated.\nSignature Capacity\n\/s\/ Jim H. Houtz Director, Chairman of the Board of ------------------------------- Directors, President and Chief Jim H. Houtz Executive Officer\n\/s\/ Mark R. Schonau Chief Financial Officer, ------------------------------- Secretary and Treasurer Mark R. Schonau\n\/s\/ Frank H. Bertsch Director ------------------------------- Frank H. Bertsch\n\/s\/ Richard J. Burgmeier Director ------------------------------- Richard J. Burgmeier\n------------------------------- Director A. Theodore Engkvist\n\/s\/ James L. Schamadan, M.D. Director ------------------------------- James L. Schamadan, M.D.\nSchedule II CYCARE SYSTEMS, INC. AND SUBSIDIARIES\nVALUATION AND QUALIFYING ACCOUNTS\n- ---------- (a) Uncollectible accounts written off, net of recoveries. (b) Software product capitalization, goodwill, and intangibles written off in connection with the Company's strategic redirection. (c) Deductions relating to payments on lease. (d) Software product capitalization, goodwill, intangibles and accounts receivable written off in connection with the sale of the Company's Practice Management business unit. (e) Remove fully amortized accounts.","section_15":""}
{"filename":"780859_1995.txt","cik":"780859","year":"1995","section_1":"Item 1. Business\n(a) General Development of the Business.\nIndiana Energy, Inc. (Indiana Energy or the company) is a publicly owned holding company with subsidiaries in the natural gas distribution business and related services. It was incorporated under the laws of the state of Indiana on October 24, 1985, and has seven direct and indirect subsidiaries.\nIndiana Gas Company, Inc. (Indiana Gas), the principal subsidiary and business entity of the holding company, is an operating public utility engaged in the business of providing gas utility service in the state of Indiana.\nAll of the outstanding capital stock of Terre Haute Gas Corporation (Terre Haute) and Richmond Gas Corporation (Richmond) was acquired by Indiana Energy on July 31, 1990. Both companies were operating public utilities engaged in the business of providing gas distribution services in Indiana. On January 21, 1991, Indiana Gas acquired from Indiana Energy all the outstanding capital stock of Terre Haute and Richmond. While these companies technically exist as separate corporate entities, their business operations have been combined with Indiana Gas' operations and the companies do business under the name of Indiana Gas.\nIndiana Energy has a wholly-owned subsidiary, IEI Investments, Inc., which was formed to group the operations and financing of nonregulated businesses and segregate them from the regulated businesses. IEI Investments has two subsidiaries, IGC Energy, Inc., and Energy Realty, Inc. On December 29, 1992, IGC Energy, Inc. sold its majority interest in EnTrade Corporation to Tenneco Gas. EnTrade was a natural gas marketing and related services company with industrial and utility customers primarily in the eastern and midwestern United States. On November 1, 1994, IGC Energy formed a natural gas marketing subsidiary, Indiana Energy Services, Inc. (IES), which provides natural gas services to large-volume industrial and commercial customers, as well as to small local distribution companies and other natural gas marketing companies. IES provides its customers with gas supply, pipeline transportation services and gas management services including nomination services, balancing services and load forecasting. IGC Energy also has an investment in Loggins, Inc., a distributor of flexible gas pipe and of products for distributing and using natural gas. The other subsidiary of IEI Investments is Energy Realty, Inc., a real estate company that owns a warehouse facility which is leased to Indiana Gas. Energy Realty also is a limited partner in two affordable housing complexes.\n(c) Narrative Description of the Business.\nAt September 30, 1995, Indiana Gas supplied gas to about 455,000 residential, commercial and industrial customers in 281 communities in 48 of the 92 counties in the state of Indiana. The service area has a population of approximately 2 million and contains diversified manufacturing and agriculture-related enterprises. The principal industries served include automotive parts and accessories, feed, flour and grain processing, metal castings, aluminum products, gypsum products, electrical equipment, metal specialties and glass.\nThe largest communities served include Muncie, Anderson, Lafayette-West Lafayette, Bloomington, Terre Haute, Marion, New Albany, Columbus, Jeffersonville, New Castle and Richmond. Indiana Gas does not serve in Indianapolis, although its general office is located in that city.\nFor the fiscal year ended September 30, 1995, residential customers provided 60 percent of revenues, commercial 20 percent and industrial 20 percent. At such date, approximately 98 percent of Indiana Gas' customers used gas for space heating, and space heating revenues from these customers for the fiscal year were 80 percent of total operating revenues. Sales of gas are seasonal and strongly affected by variations in weather conditions. During the fiscal year ended September 30, 1995, Indiana Gas added approximately 11,300 residential and commercial customers.\nIndiana Gas sells gas directly to residential, commercial and industrial customers at approved rates. Indiana Gas also transports gas through its pipelines at approved rates to commercial and industrial customers which have purchased gas directly from producers, or through brokers and marketers. The total volumes of gas provided to both sales and transportation customers is referred to as throughput.\nGas transported on behalf of end-use customers in fiscal 1995 represented 30 percent (33,312 MDth) of throughput compared to 26 percent (30,125 MDth) in 1994 and 11 percent (12,307 MDth) in 1993. Although revenues are lower, rates for transportation generally provide the same margins as would have been earned had the gas been sold under normal sales tariffs.\nAs a result of a series of FERC orders, including Order No. 636, Indiana Gas now purchases all of its natural gas from producers, brokers and marketers on both short-term and medium-term contracts. Indiana Gas also has contracts with pipelines for storage and transportation of natural gas.\nRates for gas services purchased from interstate pipeline suppliers are governed by tariffs which are subject to adjustment and approval by the Federal Energy Regulatory Commission (FERC) in accordance with the Natural Gas Act. Prices for gas purchased from gas producers and marketers are determined by market conditions. Indiana Gas' rates and charges, terms of service, accounting matters, issuance of securities, and other operational matters are regulated by the Indiana Utility Regulatory Commission (IURC).\nAdjustments to Indiana Gas' rates and charges related to the cost of gas are made through gas cost adjustment (GCA) procedures established by Indiana law and administered by the IURC. The IURC has applied the statute authorizing the GCA procedures to reduce rates when necessary so as to limit utility operating income, after adjusting to normal weather, to the level authorized in the last general rate order. On November 9, 1995, the IURC approved a settlement agreement which provided, among other things, an increase in Indiana Gas' authorized utility operating income from $51.1 million to $54.2 million beginning in fiscal 1996. (See Item 7, 1996 Settlement Agreement.)\nInformation regarding environmental matters affecting the company is incorporated herein by reference to Item 7, Environmental Matters.\nIndiana Gas had 1,084 full-time employees and 36 part- time employees as of September 30, 1995.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Property\nIndiana Energy owns no properties.\nThe properties of Indiana Gas are used for the purchase, production, storage and distribution of gas and are located primarily within the state of Indiana. As of September 30, 1995, such properties included approximately 10,164 miles of distribution mains; 467,540 meters; seven reservoirs currently being used for the underground storage of purchased gas with approximately 107,074 acres of land held under storage easements; 9,478,039 Dth of gas in company-owned underground storage with a daily deliverability of 138,860 Dth; 19,953,511 Dth of gas in contract storage with a daily deliverability of 235,170 Dth; and five liquefied petroleum (propane) air-gas manufacturing plants with a total daily capacity of 36,700 Dth of gas.\nIndiana Gas' capital expenditures during the fiscal year ended September 30, 1995, amounted to $54.9 million.\nItem 3.","section_3":"Item 3. Legal Proceedings\nSee Item 8, Note 9 for litigation matters involving insurance carriers pertaining to Indiana Gas' former manufactured gas plants and storage facilities.\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 ended September 30, 1995, to a vote of security holders.\nItem 4a.Executive Officers of the Company\nAs of September 30, 1995, the following individuals were Executive Officers of the company:\nPart II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters\nThe common stock of the company is listed on the New York Stock Exchange. The ranges of high and low sales prices reported in the New York Stock Exchange composite tape and dividends paid on these shares for fiscal 1994 and 1995 are shown in the following table:\nFiscal Year 1994 High Low Dividend First Quarter $23 5\/8 $19 1\/2 $.25 1\/2 Second Quarter $23 1\/4 $ 19 $.25 1\/2 Third Quarter $20 7\/8 $ 18 $.25 1\/2 Fourth Quarter $20 1\/8 $18 3\/8 $.26 1\/2\nFiscal Year 1995 High Low Dividend First Quarter $21 7\/8 $17 1\/2 $.26 1\/2 Second Quarter $20 5\/8 $17 3\/4 $.26 1\/2 Third Quarter $20 3\/4 $17 5\/8 $.26 1\/2 Fourth Quarter $ 22 $18 1\/2 $.27 1\/2\nCash dividends on common stock are considered quarterly by the board of directors and historically have been paid on March 1, June 1, September 1 and December 1 of each year. At the end of fiscal 1995, there were 10,855 individual and institutional investors who were shareholders of record.\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\nResults of Operations\nThe majority of Indiana Energy, Inc.'s (the company) consolidated earnings are from the operations of its gas distribution subsidiary, Indiana Gas Company, Inc. Nonutility income includes IGC Energy, Inc., Energy Realty, Inc. and Indiana Energy Services, Inc., indirect wholly-owned subsidiaries of Indiana Energy. Also included in nonutility income is EnTrade Corporation's operations through December 29, 1992, and the fiscal 1993 gain on the sale of EnTrade. Though Indiana Energy will continue to consider nonutility opportunities for investment, its principal business is expected to continue to be gas distribution. The following discussion of operating results relates primarily to the operations of Indiana Gas.\nEarnings Net income decreased in fiscal 1995 when compared to fiscal 1994 due to weather that was 15 percent warmer than last year. This decrease was partially offset by lower operation and maintenance expenses, as well as the addition of new residential and commercial customers.\nWhile net income for fiscal 1994 was approximately the same as fiscal 1993, utility income increased 21 percent ($6.1 million) when compared to the previous year. The increase reflected weather that was 4 percent colder than the previous year, the addition of new residential and commercial customers and a decrease in operation and maintenance expenses. Net income for fiscal 1993 included the net gain on the sale of EnTrade of $7.1 million, or 33 cents per average share. Utility income, net income and earnings per average share of common stock for the last three fiscal years are summarized below:\n1995 1994 1993 Utility income (millions of dollars) $32.1 $34.6 $28.5 Net income (millions of dollars) $33.0 $34.4 $34.6 Earnings per average share of common stock $1.46 $1.53 $1.62\nDividends On July 28, 1995, the board of directors of the company increased the quarterly dividend on common stock to 27 1\/2 cents per share from 26 1\/2 cents per share. This resulted in total dividends paid in 1995 of $1.07 compared to $1.03 in 1994. This is the 23rd consecutive year that the company's dividends paid on common stock increased over the previous year.\nMargin (Revenues Less Cost of Gas) In 1995, margin decreased 5 percent ($9 million) when compared to 1994. The decrease reflects weather that was 15 percent warmer than last year and 13 percent warmer than normal, offset somewhat by the addition of new residential and commercial customers.\nIn 1994, margin increased 5 percent ($8.6 million) when compared to 1993. The increase reflected weather that was 4 percent colder than the previous year and 2 percent colder than normal, as well as the addition of new residential and commercial customers.\nIn 1995, total system throughput (combined sales and transportation) decreased 6 percent (6.8 MMDth) when compared to last year. In 1994, throughput increased 4 percent (4.9 MMDth) when compared to 1993. Indiana Gas' rates for transportation generally provide the same margins as are earned on the sale of gas under its sales tariffs. Approximately one-half of total system throughput represents gas used for space heating and is affected by weather.\nTotal average cost per dekatherm of gas purchased (average commodity and demand) decreased to $2.53 in 1995 from $2.89 in 1994. The decrease is due primarily to lower commodity costs associated with decreased demand for gas during the very warm winter this fiscal year.\nTotal average cost per dekatherm of gas purchased for 1994 was about the same as 1993. Increased fixed costs per dekatherm associated with pipeline rate cases and the restructuring prescribed by Federal Energy Regulatory Commission (FERC) Order No. 636 were offset by lower commodity costs.\nOperating Expenses Operation and maintenance expenses decreased approximately $6.4 million in 1995 when compared to 1994. The decrease is primarily attributable to lower expenses for labor and related benefits, distribution mains and services, advertising and outside services. The declining operation and maintenance expenses reflect management's efforts to control costs in response to very warm weather.\nOperation and maintenance expenses decreased approximately $2.3 million in 1994 when compared to 1993. The decrease was primarily attributable to labor and related costs which were lower than the levels in 1993 when additional operation and maintenance projects were in progress.\nDepreciation and amortization expense increased in 1995 and 1994 as the result of additions to utility plant to serve new customers and to maintain dependable service to existing customers.\nFederal and state income taxes decreased in 1995 due to lower taxable utility income. Federal and state income taxes increased in 1994 due to higher taxable utility income.\nTaxes other than income taxes decreased in 1995 due to lower gross receipts tax expense resulting from decreased revenue. Property tax expense for 1995 remained approximately the same as compared to 1994. Taxes other than income taxes increased in 1994 as the result of increased property tax expense, due to higher property tax rates and higher assessed values, and as the result of higher gross receipts tax expense.\nInterest Expense Interest expense decreased in 1995 due to a decrease in average debt outstanding, slightly offset by an increase in interest rates. Interest expense decreased in 1994 due to slightly lower interest rates.\nSale of EnTrade On December 29, 1992, IGC Energy sold its interest in EnTrade, a marketer of gas supplies to industrial and utility customers, for approximately $13.9 million. The transaction resulted in a net gain after tax of $7.1 million, or 33 cents per average common share, and was included in nonutility income in fiscal 1993.\nOther Operating Matters\nGas Cost Adjustment Adjustments to Indiana Gas' rates and charges related to the cost of gas are made through gas cost adjustment (GCA) procedures established by Indiana law and administered by the Indiana Utility Regulatory Commission (IURC). The GCA passes through increases and decreases in the cost of gas to Indiana Gas' customers dollar for dollar.\nIn addition, the IURC has applied the statute authorizing the GCA procedures to reduce rates when necessary so as to limit utility operating income, after adjusting to normal weather, to the level authorized in the last general rate order (see Indiana Legislative Matters).\n1996 Settlement Agreement As provided in the previous year's settlement agreement among Indiana Gas, the Office of Utility Consumer Counselor (OUCC) and a group of large-volume users, the OUCC performed an investigation during fiscal 1995 to consider an increase to Indiana Gas' authorized utility operating income. These parties then entered a series of negotiations designed to increase Indiana Gas' opportunity to earn on its recent capital investments while avoiding the necessity of a general rate filing. As a result of these negotiations, the IURC approved on November 9, 1995, a settlement agreement which provided, among other things, for the following: (1) an increase in Indiana Gas' authorized utility operating income from $51.1 million to $54.2 million beginning in fiscal 1996; (2) with certain specified exceptions, Indiana Gas may not file a petition to increase its base rates until November 15, 1996; and (3) an agreement to a number of operational and other service enhancements for large-volume customers.\nEnvironmental Matters Indiana Gas is currently conducting environmental investigations and work at certain sites that were the locations of former manufactured gas plants. It is seeking to recover the costs of the investigations and work from insurance carriers, other potentially responsible parties (PRPs) and customers. On May 3, 1995, Indiana Gas received an order from the IURC in which the Commission concluded that the costs incurred by Indiana Gas to investigate and, if necessary, clean-up former manufactured gas plant sites are not utility operating expenses necessary for the provision of service and, therefore, are not recoverable as operating expenses from utility customers. The order is being appealed. The IURC order has had no immediate impact on Indiana Gas' earnings since settlements with insurers of $11.9 million exceed Indiana Gas' share of environmental liability recorded to date. For further information regarding the status of investigation and remediation of the sites, PRPs, financial reporting and ratemaking, see Item 8, Note 9.\nFederal Energy Regulatory Commission Matters In accordance with FERC Order No. 636, Indiana Gas' pipeline service providers have made a number of filings to restructure services. Indiana Gas' pipeline service providers are seeking from customers, including Indiana Gas, recovery of certain costs related to the transition to restructured services.\nOn April 12, 1995, Indiana Gas received an order from the IURC allowing full recovery through the quarterly GCA process of all FERC Order No. 636 transition costs, including those transition costs previously deferred. Indiana Gas has estimated and recorded total transition costs of approximately $12 million.\nPostretirement Benefits Other Than Pensions Effective October 1, 1993, Indiana Gas adopted Statement of Financial Accounting Standards No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions (SFAS 106). SFAS 106 requires accounting for the costs of postretirement health care and life insurance benefits on the accrual basis. This means the costs of benefits paid in the future are recognized during the years that an employee provides service to Indiana Gas rather than the \"pay-as-you-go\" (cash) basis (see Item 8, Note 7).\nOn May 3, 1995, the IURC issued an order authorizing Indiana Gas to recover the costs related to postretirement benefits other than pensions under the accrual method of accounting consistent with SFAS 106. Amounts accrued prior to the order have been deferred as allowed by the IURC. While this order is consistent with the IURC's rulings for other utilities within the state of Indiana and with the ratemaking treatment of the majority of regulatory jurisdictions outside of Indiana, the Office of Utility Consumer Counselor is appealing the order.\nIncome Taxes Effective October 1, 1993, Indiana Gas adopted Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (SFAS 109). Indiana Gas previously used the deferred method of accounting for income taxes as prescribed by Accounting Principles Bulletin Opinion No. 11. SFAS 109 requires the use of the liability method, which effectively results in a reduction in previously provided deferred income taxes to reflect the current statutory corporate tax rate.\nDue to the effects of regulation, Indiana Gas is not permitted to recognize the effect of a tax rate change as income but is required to reduce tariff rates to return the \"excess\" deferred income taxes to ratepayers over the remaining life of the properties that give rise to the taxes. Therefore, the cumulative effect of a change in accounting principle upon the initial application of SFAS 109 resulted in no impact on earnings.\nIndiana Legislative Matters On April 26, 1995, the Indiana General Assembly enacted Senate Enrolled Act No. 637, which provides new flexibility to the IURC for future regulation of Indiana utilities and modifies the application of the earnings test.\nThe new law recognizes that competition is increasing in the provision of energy services and that flexibility in the regulation of energy services providers is essential to the well-being of the state, its economy and its citizens. Under the law, an energy utility can present to the IURC a broad range of proposals from performance-based ratemaking to complete deregulation of a utility's operations. The law gives the IURC the authority to adopt alternative regulatory practices, procedures, and mechanisms and establish rates and charges that are in the public interest, and will enhance or maintain the value of the energy utility's retail energy services or property. It also provides authority to the IURC to establish rates and charges based on market or average prices that use performance-based rewards or penalties, or which are designed to promote efficiency in the rendering of retail energy services.\nThe IURC applies the Indiana statute authorizing the GCA procedures to reduce rates when necessary so as to limit utility operating income to the level authorized in the last general rate order. On a quarterly basis, this earnings test is performed by comparing Indiana Gas' authorized utility operating income to its actual utility operating income (weather normalized) for the previous 12 months. In the past, one-fourth of the amounts over the authorized utility operating income would be refundable to Indiana Gas' customers each quarter. The new law revises the earnings test to provide that no refund be paid to the extent a utility has not earned its authorized utility operating income over the previous 60 months (or during the period since the utility's last rate order, if longer). The revised test provides Indiana Gas a greater opportunity to earn its authorized utility operating income over the long term.\nNew Accounting Standard In March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121, Accounting for the Impairment of Long-Lived Assets and Long- Lived Assets to be Disposed Of. This statement imposes stricter criteria for regulatory assets by requiring that such assets be probable of future recovery at each balance sheet date. Indiana Gas anticipates adopting this standard on October 1, 1996, and does not expect that the adoption will have a material impact on its financial position or results of operations based on the current regulatory structure in which it operates. This conclusion may change in the future as competitive factors influence pricing in this industry.\nLiquidity and Capital Resources New construction to provide service to a growing customer base and normal system maintenance and improvements will continue to require substantial capital expenditures. Indiana Gas' goal is to internally fund approximately 75 percent of its capital expenditure program. This will help Indiana Gas to maintain its high creditworthiness. The long-term debt of Indiana Gas is currently rated Aa3 by Moody's Investors Service and AA- by Standard & Poor's Corporation.\nTotal capital required to fund both capital expenditures and refinancing requirements for 1994 and 1995, along with estimated amounts for 1996 through 1998, are as follows:\nIn 1995, 77 percent of Indiana Gas' capital expenditures was provided by funds generated internally (utility income less dividends plus charges to utility income not requiring funds). In 1994, 75 percent of capital expenditures was provided by funds generated internally. External funds required for the 1995 construction program were obtained primarily through Indiana Gas' medium-term note program as discussed below.\nCapitalization objectives for Indiana Gas are 55-65 percent common equity and preferred stock and 35-45 percent long-term debt. Consolidated capitalization ratios are generally expected to be similar to those of Indiana Gas, but may vary from time to time, depending on particular business opportunities. The company's common equity component was 61 percent of total capitalization at September 30, 1995.\nOn October 28, 1994, $3 million of the outstanding 9 3\/8 % Series M, First Mortgage Bonds were retired.\nOn April 5, 1995, Indiana Gas filed with the Securities and Exchange Commission (SEC) a prospectus supplement for the offering of its Medium-Term Notes, Series E (Notes) with an aggregate principal amount of up to $55 million. The Notes were registered under the existing shelf registration statement filed November 20, 1992, with the SEC with respect to the issuance of up to $90 million in aggregate principal amount of debt securities ($35 million was previously withdrawn from this shelf as a result of the December 9, 1992, issuance of 6 5\/8 %, Series D Notes). Indiana Gas plans to issue the Notes from time to time through 1997. The Notes, when issued, will be due not less than nine months and not more than 40 years from the date of issue, and will bear interest at a fixed or variable rate as negotiated between the purchaser and Indiana Gas. The net proceeds from the sale of the Notes will be used to finance, in part, the refunding of long-term debt, Indiana Gas' continuing construction program and for other corporate purposes. During June 1995, $20 million in aggregate principal amount of the Notes were issued as follows: $5 million of 7.15% Notes due March 15, 2015; $5 million of 6.31% Notes due June 10, 2025; and $10 million of 6.53% Notes due June 27, 2025.\nOn July 28, 1995, Indiana Energy's board of directors authorized Indiana Energy to repurchase up to 700,000 shares of its outstanding common stock. The repurchases will be made over time in open-market transactions.\nThe nature of Indiana Gas' business creates large short-term cash working capital requirements primarily to finance customer accounts receivable, unbilled utility revenues resulting from cycle billing, gas in underground storage and capital expenditures until permanently financed. Short-term borrowings tend to be greatest during the heating season when accounts receivable and unbilled utility revenues are at their highest. Depending on cost, commercial paper or bank lines of credit are used as sources of short-term financing. Indiana Gas' commercial paper is rated P-1 by Moody's and A-1+ by Standard & Poor's. Long-term financial strength and flexibility require maintaining throughput volumes, controlling costs and, if absolutely necessary, securing timely increases in rates to recover costs and provide a fair and reasonable return to shareholders.\nItem 8.","section_7A":"","section_8":"Item 8.Financial Statements and Supplementary Data\nManagement's Responsibility for Financial Statements\nThe management of the company is responsible for the preparation of the consolidated financial statements and the related financial data contained in this report. The financial statements are prepared in conformity with generally accepted accounting principles and follow accounting policies and principles applicable to regulated public utilities.\nThe integrity and objectivity of the data in this report, including required estimates and judgements, are the responsibility of management. Management maintains a system of internal controls and utilizes an internal auditing program to provide reasonable assurance of compliance with company policies and procedures and the safeguard of assets.\nThe board of directors pursues its responsibility for these financial statements through its audit committee, which meets periodically with management, the internal auditors and the independent auditors, to assure that each is carrying out its responsibilities. Both the internal auditors and the independent auditors meet with the audit committee, with and without management representatives present, to discuss the scope and results of their audits, their comments on the adequacy of internal accounting controls and the quality of financial reporting.\n\/s\/Niel C. Ellerbrook Niel C. Ellerbrook Vice President and Treasurer and Chief Financial Officer\nReport of Independent Public Accountants\nTo the Shareholders and Board of Directors of Indiana Energy, Inc.:\nWe have audited the accompanying consolidated balance sheets and schedules of long-term debt of Indiana Energy, Inc. (an Indiana corporation) and subsidiary companies as of September 30, 1995, and 1994, and the related consolidated statements of income, common shareholders' equity and cash flows for each of the three years in the period ended September 30, 1995. 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 Indiana Energy, Inc. and subsidiary companies, as of September 30, 1995, and 1994, and the results of their operations and their cash flows for each of the three years in the period ended September 30, 1995, in conformity with generally accepted accounting principles.\n\/s\/Arthur Andersen LLP Arthur Andersen LLP\nIndianapolis, Indiana October 26, 1995\nNotes to Consolidated Financial Statements\n1. Summary of Significant Accounting Practices\nA. Consolidation The consolidated financial statements include the accounts of Indiana Energy, Inc. (the company) and its wholly and majority-owned subsidiaries, after elimination of intercompany transactions. The consolidated financial statements separate the regulated utilities, which consist of Indiana Gas Company, Inc., Terre Haute Gas Corporation and Richmond Gas Corporation, from nonutility operations. These regulated utilities, which are doing business as Indiana Gas, provide natural gas and transportation services to a diversified base of customers in 281 communities in 48 of Indiana's 92 counties. The nonutility income includes EnTrade Corporation's operations through December 29, 1992, as well as the fiscal 1993 gain on the sale of EnTrade (see Note 2). IGC Energy, Inc., Energy Realty, Inc. and Indiana Energy Services, Inc., indirect wholly-owned subsidiaries of Indiana Energy, are also included in nonutility income.\nInvestments in limited partnerships and in the common stock of less than majority-owned affiliates are accounted for on the equity method.\nB. Utility Plant and Depreciation Except as described below, utility plant is stated at the original cost and includes allocations of payroll-related costs and administrative and general expenses, as well as an allowance for the cost of funds used during construction. When a depreciable unit of property is retired, the cost is credited to utility plant and charged to accumulated depreciation together with the cost of removal, less any salvage. No gain or loss is recognized upon normal retirement.\nProvisions for depreciation of utility property are determined by applying straight-line rates to the original cost of the various classifications of property. The average depreciation rate was approximately 4.1 percent for all periods reported.\nCost in excess of underlying book value of acquired gas distribution companies is reflected as a component of utility plant and is being amortized primarily over 40 years.\nC. Unamortized Debt Discount and Expense Indiana Gas was authorized as part of an August 17, 1994, order from the Indiana Utility Regulatory Commission (IURC) to amortize over a 15-year period the debt discount and expense related to new debt issues and future premiums paid for debt reacquired in connection with refinancing. Debt discount and expense for issues in place prior to this order are being amortized over the lives of the related issues. Premiums paid prior to this order for debt reacquired in connection with refinancing are being amortized over the life of the refunding issue. Gains or losses realized from reacquisition of debt for sinking fund purposes are included in \"Other\" on the Consolidated Statements of Income.\nD. Cash Flow Information For the purposes of the Consolidated Statements of Cash Flows, the company considers cash investments with an original maturity of three months or less to be cash equivalents. Cash paid during the periods reported for interest and income taxes were as follows:\nDuring fiscal 1993, IGC Energy sold its interest in EnTrade for approximately $13.9 million of Tenneco Inc. common stock, which was subsequently sold for approximately the same amount (see Note 2). There were no other significant non-cash activities.\nE. Revenues To more closely match revenues and expenses, Indiana Gas records revenues for all gas delivered to customers but not billed at the end of the accounting period.\nF. Gas in Underground Storage Based on the cost of purchased gas during September 1995, the cost of replacing the current portion of gas in underground storage was less than last-in, first-out cost at September 30, 1995, by approximately $286,000.\nG. Refundable or Recoverable Gas Cost The cost of gas purchased and refunds from suppliers, which differ from amounts recovered through rates, are deferred and are being recovered or refunded in accordance with procedures approved by the IURC.\nH. Allowance For Funds Used During Construction An allowance for funds used during construction (AFUDC), which represents the cost of borrowed and equity funds used for construction purposes, is charged to construction work in progress during the period of construction and included in \"Other\" on the Consolidated Statements of Income. An annual AFUDC rate of 7.5 percent was used for all periods reported.\nThe table below reflects the total AFUDC capitalized and the portion of which was computed on borrowed and equity funds for all periods reported.\nTHOUSANDS 1995 1994 1993 AFUDC - borrowed funds $215 $355 $ 579 AFUDC - equity funds 176 290 486 Total AFUDC capitalized $391 $645 $1,065\nI. Reclassifications Certain reclassifications have been made in the company's financial statements of prior years to conform to the current year presentation. These reclassifications have no impact on previously reported net income.\nJ. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\n2. Sale of EnTrade On December 29, 1992, IGC Energy sold its interest in EnTrade, a marketer of gas supplies to industrial and utility customers, for approximately $13.9 million. The transaction resulted in a net gain after tax of $7.1 million, or 33 cents per average share, and has been included in nonutility income in fiscal 1993. EnTrade's net operations through the date of sale are reflected separately on the income statement for all periods reported.\nPro forma operating results for Indiana Energy, assuming the sale of EnTrade occurred as of the beginning of 1993, are shown in the following table.\nTHOUSANDS (Except Per Share Data) 1993 Utility income $28,534 Nonutility income (loss) $ (448) Net income $27,801 Earnings per average share of common stock $ 1.30\n3. Fair Value of Financial Instruments\nThe estimated fair values of the company's financial instruments were as follows:\nCertain methods and assumptions must be used to estimate the fair value of financial instruments. Because of the short maturity of cash and cash equivalents and notes payable, the carrying amounts approximate fair values for these financial instruments. The fair value of the company's long-term debt was estimated based on the quoted market prices for the same or similar issues or on the current rates offered to the company for debt of the same remaining maturities.\nUnder current regulatory treatment, call premiums on reacquisition of long-term debt are generally recovered in customer rates over the life of the refunding issue or over a 15-year period (see Note 1C). Accordingly, any reacquisition would not be expected to have a material effect on the company's financial position or results of operations.\n4. Short-Term Borrowings\nIndiana Gas has board of director approval to borrow up to $100 million under bank lines of credit. Indiana Gas has available committed lines of credit up to $55 million with approximately $2 million outstanding at September 30, 1995. These lines of credit are renewable annually and require fees based on the amounts of the lines. In addition, Indiana Gas has available uncommitted lines of credit with similar arrangements which allow it to borrow up to its board approved amount. Notes payable to banks bore interest at rates negotiated with the bank at the time of borrowing.\nBank loans outstanding during the reported periods were as follows:\nIn addition, Energy Realty had a $3.8-million bank loan outstanding at year end related to the purchase of a warehouse facility that is leased to Indiana Gas.\n5. Long-Term Debt\nDuring the year, the following activity took place with respect to long-term debt.\nOn October 28, 1994, $3 million of the outstanding 9 3\/8% Series M, First Mortgage Bonds were retired.\nDuring June 1995, Indiana Gas issued $20 million in aggregate principal amount of its Medium-Term Notes, Series E (Notes) as follows: $5 million of 7.15% Notes due March 15, 2015; $5 million of 6.31% Notes due June 10, 2025; and $10 million of 6.53% Notes due June 27, 2025. The net proceeds from the sale of the Notes will be used to finance, in part, the refunding of long-term debt, Indiana Gas' continuing construction program and for other corporate purposes.\nConsolidated maturities and sinking fund requirements on long-term debt subject to mandatory redemption during the five years following 1995 are $267,000 in 1996, $1,220,000 in 1997, $36,225,000 in 1998, $11,230,000 in 1999 and $1,236,000 in 2000.\n6. Capital Stock\nOn July 28, 1995, Indiana Energy's board of directors authorized Indiana Energy to repurchase up to 700,000 shares of its outstanding common stock. The repurchases will be made over time in open-market transactions.\nCommon stock dividends of the company may be reinvested under a Dividend Reinvestment and Stock Purchase Plan. Common shares purchased in connection with the plan are currently being acquired through the open market.\nThe company has an Executive Restricted Stock Plan for the principal officers of the company and its subsidiary companies. Shares issued are original issue shares of the company, carry transferability restrictions and are subject to forfeiture provisions according to the terms of the plan.\nThe company also has a Directors' Restricted Stock Plan through which non-employee directors receive one-third of their combined compensation (exclusive of attendance fees) as directors of the company and Indiana Gas in shares of the company's common stock subject to certain restrictions on transferability. They may also elect to receive the remaining two-thirds of their combined compensation (exclusive of attendance fees) in cash or in shares of the company's common stock which are not subject to restrictions on transferability other than those imposed by federal and state laws.\nAdditionally, under the terms of Indiana Gas' retirement savings plan (see Note 7), eligible participants may direct a specified percentage of their compensation to be invested in shares of the company's common stock.\nAt September 30, 1995, the shares of the company's common stock reserved for issuance under each of those plans were as follows:\nDividend Reinvestment and Stock Purchase Plan 566,737 Executive Restricted Stock Plan 375,026 Directors' Restricted Stock Plan 55,046 Indiana Gas Retirement Savings Plan 877,190\nDividends on the common stock of Indiana Gas are payable out of the unreserved and unrestricted retained earnings of Indiana Gas. There are certain provisions in the Indiana Gas Indenture, under which the first mortgage bonds of Indiana Gas have been created and issued, restricting the payment of dividends on the Indiana Gas common stock. Such restrictions could affect the company's ability to pay dividends on its common stock. None of the retained earnings of Indiana Gas are presently subject to any such restrictions.\nOn July 25, 1986, the board of directors of the company declared a dividend distribution of one common share purchase right for each outstanding share of common stock of the company. The distribution was made to shareholders of record August 11, 1986. In addition, one right has been and will be distributed for each share issued following August 11, 1986. Each right entitles the registered holder to purchase from the company one share of common stock at a price of $35 per share, subject to certain adjustments described in the rights agreement. The rights become exercisable only when a person or group acquires beneficial ownership of 20 percent or more of the company's common stock or announces a tender or exchange offer for 30 percent or more of the company's common stock.\nIf this happens, each holder of a right, except the acquiring group or person, will have the right to receive, upon exercise, that number of shares of the company's common stock having a market value of two times the exercise price if:\n1. any person or group becomes the beneficial owner of 30 percent or more of the company's common stock;\n2. a 20 percent or more acquiring person engages in one of a number of self-dealing transactions specified in the rights agreement; or\n3. the company were acquired in a merger in which the company were the surviving corporation and its common stock were not changed or exchanged.\nIn addition, if the company is involved in a merger or other business combination transaction, in which more than 50 percent of its assets or earning power is sold, each holder of a right will have the right to receive, upon exercise at the current exercise price of the right, that number of shares of common stock of the acquiring company having a market value of two-times the exercise price of the right. The company may redeem the rights in whole, but not in part, at a price of $.017 per right at any time prior to the time an acquiring person has acquired a 20 percent beneficial ownership of the company's outstanding common stock. Unless extended, the rights will expire on August 11, 1996.\nIndiana Gas and Indiana Energy have authorized and unissued shares of preferred stock of 4.2 million and 4 million, respectively. On December 1, 1992, Indiana Gas redeemed all 200,000 shares of its issued and outstanding 8.55% Cumulative Preferred Stock at $104.66 per share with accrued dividends. The redemption premium of $932,000 was charged to retained earnings.\n7. Retirement Plans and Other Postretirement Benefits\nEffective October 1, 1994, Indiana Gas merged its retirement savings plan for bargaining employees into its retirement savings plan for non-bargaining employees. The primary objective for this action is to reduce the level of resources required to administer two plans. The combined retirement savings plan is a defined contribution plan which is qualified under sections 401(a) and 401(k) of the Internal Revenue Code. Under the terms of the retirement savings plan, eligible participants may direct a specified percentage of their compensation to be invested in shares of the company's common stock or various investment funds. Participants in the retirement savings plan have, subject to prescribed limitations, matching company contributions made to the plan on their behalf, plus a year-end lump sum company contribution. During 1995, 1994 and 1993, Indiana Gas made contributions of $2,335,000, $2,386,000 and $2,270,000, respectively.\nIndiana Gas also has two non-contributory defined benefit retirement plans that cover all employees meeting certain minimum age and service requirements. Benefits are determined by a formula based on the employee's base earnings (highest five consecutive years out of the last 10 consecutive years prior to actual retirement date), years of participation in the plan and the employee's age at retirement.\nIndiana Gas has an unfunded supplemental retirement plan for certain management employees. Benefits are determined by a formula based on 65 percent of the participant's average monthly earnings, less benefits received under the company's pension and savings plans and the participant's primary Social Security benefits.\nThe Indiana Gas defined benefit retirement plan assets are under custody of trustees and consist of actively managed stock and bond portfolios, as well as short-term investments. It is Indiana Gas' funding policy to maintain the pension plans on an actuarially sound basis. Under this policy, funding was $143,000 in 1995, $1,110,000 in 1994, and $1,223,000 in 1993. Funding decreased in 1995 as a result of plan contributions being restricted by the full funding limitation. As permitted by the Statement of Financial Accounting Standards No. 71, Accounting for the Effects of Certain Types of Regulation, the company recognizes pension expense based on funding as allowed for ratemaking purposes.\nThe calculation of pension expense is as follows:\nThe following table reconciles the plans' SFAS 87 funded status at September 30 with amounts recorded in the company's financial statements. Certain assets and obligations of the plans are deferred and recognized in the financial statements in subsequent periods.\nThe weighted-average discount rate used in determining the actuarial present value of the SFAS 87 projected benefit obligation was 8 percent. The expected long-term rate of return on assets was 9 percent. The average rate of increase in future compensation levels used ranged from 5 to 5.5 percent. These rates were used for all years reported. The average future service of plan participants used to compute amortization of the net assets existing at the date of initial application of SFAS 87 is approximately 17 years.\nIn addition to providing pension benefits, Indiana Gas presently provides postretirement health care and life insurance benefits to full-time employees who have completed 10 years of service and retire from the company. The plan pays stated percentages of most reasonable and necessary medical expenses incurred by retirees, after subtracting payments by other providers and after a stated deductible has been met. These benefits are principally self-insured. Currently, Indiana Gas does not fund this postretirement plan. During fiscal 1995, Indiana Gas approved a plan change whereby employees retiring after January 1, 1996, will be required to make a contribution toward their retiree medical benefits provided by the plan. The monthly contribution for retiree medical coverage will be based on a comparison of the actual increase in Indiana Gas' health care costs and the Consumer Price Index (CPI). Cost increases that are higher than the general rate of inflation, as measured by the CPI, will be paid for by retirees. The impact of this plan change on the unrecognized transition obligation as of September 30, 1995, is shown below in the table reconciling the plan's funded status to the accrued postretirement benefit cost.\nEffective October 1, 1993, Indiana Gas adopted Statement of Financial Accounting Standards No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions (SFAS 106). SFAS 106 requires accounting for the costs of postretirement health care and life insurance benefits on the accrual basis. This means the costs of benefits paid in the future are recognized during the years that an employee provides service to Indiana Gas rather than the \"pay-as-you- go\" (cash) basis. Indiana Gas has elected to amortize the unfunded transition obligation as of October 1, 1993, of approximately $55 million over a period of 20 years.\nOn May 3, 1995, the IURC issued an order authorizing Indiana Gas to recover the costs related to postretirement benefits other than pensions under the accrual method of accounting consistent with SFAS 106. Amounts accrued prior to the order have been deferred as allowed by the IURC. While this order is consistent with the IURC's rulings for other utilities within the state of Indiana and with the ratemaking treatment of the majority of regulatory jurisdictions outside of Indiana, the Office of Utility Consumer Counselor is appealing the order.\nPostretirement benefit cost recognized for 1995 and 1994 consisted of the following components:\nPrior to fiscal 1994, Indiana Gas recognized postretirement benefit costs on the pay-as-you-go (cash) basis. Postretirement benefit cost recognized for fiscal year 1993 was approximately $2,855,000.\nThe following table reconciles the plan's funded status to the accrued postretirement benefit cost as reflected on the balance sheet as of September 30, 1995, and 1994:\nThe assumed health care cost trend rate for medical gross eligible charges used in measuring the accumulated postretirement benefit obligation as of September 30, 1995, was 9.3 percent for fiscal 1996. This rate is assumed to decrease gradually through fiscal 2003 to 5.5 percent and remain at that level thereafter. The assumed CPI rate, relating to the plan's cost sharing provisions for future retirees, was 3.5 percent. Taking into consideration the plan's cost sharing provisions which were in place at September 30, 1995, a 1-percent increase in the assumed health care cost trend rates for each future year produces approximately a $1.6-million increase in the accumulated postretirement benefit obligation as of September 30, 1995. A 1-percent increase in the assumed health care cost trend rates for each future year produces approximately an $873,000 increase in the annual aggregate of the service and interest cost components of postretirement benefit cost. This amount, which is based on assumptions as of October 1, 1994, has not yet been reduced by the impact of the plan's cost sharing provisions. The weighted-average discount rate used in determining the accumulated postretirement benefit obligation was 8 percent.\n8. Commitments\nEstimated capital expenditures for 1996 are $58.8 million. Total lease expense was $2,811,000 in 1995, $2,595,000 in 1994 and $2,846,000 in 1993.\nLease commitments are $2,217,000 in 1996, $1,303,000 in 1997, $1,213,000 in 1998, $547,000 in 1999, $406,000 in 2000 and $682,000 in total for all later years. Included in these amounts is an operating lease between Indiana Gas and Energy Realty with payments of approximately $464,000 annually that extends through August 1998. There are no leases that extend beyond 2002. Indiana Gas has storage and supply contracts that range from one month to eight years.\n9. Environmental Costs\nIn the past, Indiana Gas and others, including former affiliates, and\/or previous landowners, operated facilities for the manufacturing of gas and storage of manufactured gas. These facilities are no longer in operation and have not been operated for many years. In the manufacture and storage of such gas, various byproducts were produced, some of which may still be present at the sites where these manufactured gas plants and storage facilities were located. Management believes, and the IURC has found that, those operations were conducted in accordance with the then- applicable industry standards. However, under currently applicable environmental laws and regulations, Indiana Gas, and the others, may now be required to take remedial action if certain byproducts are found above a regulatory threshold at these sites.\nIndiana Gas has identified the existence, location and certain general characteristics of 26 gas manufacturing and storage sites. Removal activities have been conducted at two sites and a remedial investigation\/feasibility study (RI\/FS) is nearing completion at one of the sites under an agreed order between Indiana Gas and the Indiana Department of Environmental Management. Indiana Gas and others are assessing, on a site-by-site basis, whether any of the remaining 24 sites require remediation, to what extent it is required and the estimated cost. Preliminary assessments (PAs) have been completed on all but one of the sites. Site investigations (SIs) have been completed at 19 sites and supplemental site investigations (SSIs) have been conducted at 15 sites. Based upon the site work completed to date, Indiana Gas believes that a level of contamination that may require some level of remedial activity may be present at a number of the 24 sites. Indiana Gas is currently conducting groundwater monitoring at many of the sites. Indiana Gas has not begun an RI\/FS at additional sites, but expects to conduct further investigation and evaluation in the future.\nBased upon the work performed to date, Indiana Gas has accrued remediation and related costs for the two sites where remedial activities are taking place. PA\/SI, SSI and groundwater monitoring costs have been accrued for the remaining sites where appropriate. Estimated RI\/FS costs and the costs of certain remedial actions that may likely be required have also been accrued. Costs associated with environmental remedial activities are accrued when such costs are probable and reasonably estimable. Indiana Gas does not believe it can provide an estimate of the reasonably possible total remediation costs for any site prior to completion of an RI\/FS and the development of some sense of the timing for implementation of the potential remedial alternatives, to the extent such remediation is required. Accordingly, the total costs which may be incurred in connection with the remediation of all sites, to the extent remediation is necessary, cannot be determined at this time.\nIndiana Gas has been pursuing recovery from three separate sources for the costs it has incurred and expects to incur relating to the 26 sites. Those sources are insurance carriers, potentially responsible parties (PRPs) and recovery through rates from retail gas customers. On April 14, 1995, Indiana Gas filed suit against a number of insurance carriers for payment of claims for investigation and clean-up costs already incurred, as well as for a determination that those carriers are obligated to pay these costs in the future. Presently, that suit is set for trial to begin October 21, 1996, in the United States District Court for the Northern District of Indiana in Fort Wayne, Indiana. Indiana Gas has obtained cash settlements from some of the defendant insurance carriers and, as a result, those carriers have been dismissed from the suit.\nIndiana Gas has also completed the process of identifying PRPs for each site. PRPs include two financially viable utilities, PSI Energy, Inc. (PSI) and Northern Indiana Public Service Company (NIPSCO). PSI has been identified as a PRP at 19 of the sites. Indiana Gas is presently in negotiations with PSI to determine PSI's share of responsibility. With the help of outside counsel, Indiana Gas has prepared estimates of PSI's and other PRP's share of environmental liabilities which may exist at each of the sites based on equitable principles derived from case law or applied by parties in achieving settlements. NIPSCO has been identified as an additional PRP at five of these 19 sites. On September 27, 1995, Indiana Gas reached an agreement with NIPSCO which provides for a coordination of efforts and a sharing of investigation and clean-up costs incurred and to be incurred at the five sites in which they both have an interest. The cost sharing estimates of PSI and other PRPs, and the NIPSCO agreement, have been utilized by Indiana Gas to record a receivable from PRPs for their share of the liability for work performed by Indiana Gas to date, as well as to accrue Indiana Gas' proportionate share of the estimated cost related to work not yet performed. The receivable from PRPs of $3.4 million is reflected in Accounts Receivable on the Consolidated Balance Sheet at September 30, 1995.\nIn January 1992, Indiana Gas filed a petition with the IURC seeking regulatory authority for, among other matters, recovery through rates of all costs Indiana Gas incurs in complying with federal, state and local environmental regulations in connection with past gas manufacturing activities. On May 3, 1995, the IURC concluded that the costs incurred by Indiana Gas to investigate and, if necessary, clean-up former manufactured gas plant sites are not utility operating expenses necessary for the provision of utility service and, therefore, are not recoverable as operating expenses from utility customers. The decision was contrary to rulings in other states where utility regulatory commissions have issued orders on the subject. The precedent cited by the IURC was a ruling related to a cancelled nuclear power plant which, unlike manufactured gas plants, never provided service to the public. Management believes applying the nuclear power plant issue to Indiana Gas' case was an incorrect application of the law and has appealed the decision to the Indiana Court of Appeals. Under the schedule of the Indiana Court of Appeals, briefing of the issues is expected to occur during the spring of 1996. The Commission did indicate that during Indiana Gas' next rate case it would be appropriate to quantify the effect of the investigation and clean-up activities as part of the business risk to be considered by the Commission in establishing the overall rate of return to be allowed.\nIndiana Gas has recorded $11.4 million for its share of environmental costs to date. As a result of its pursuit of recovery of costs from PRPs and insurance carriers, Indiana Gas has secured settlements from insurers of approximately $11.9 million. Amounts recovered in excess of its share of costs to date have been deferred. The May 3, 1995, order of the IURC has had no immediate impact on Indiana Gas' earnings since settlements with insurers exceed Indiana Gas' share of environmental liability recorded to date.\nThe impact on Indiana Gas' financial position and results of operations of complying with federal, state and local environmental regulations related to former manufactured gas plant sites is contingent upon several uncertainties. These include the costs of any compliance activities which may occur and the timing of the actions taken, the impact of joint and several liability upon the magnitude of the contingency, the outcome of proceedings which challenge the IURC ruling on recovery of costs from customers, as well as any additional recoveries of environmental and related costs from insurance carriers. Although there can be no assurance of success, to the extent possible Indiana Gas will continue to manage the manufactured gas plant remediation program so that amounts received from insurance carriers and PRPs will be sufficient to fund all such costs.\n10. Order No. 636 Transition Costs\nIn accordance with Federal Energy Regulatory Commission (FERC) Order No. 636, Indiana Gas' pipeline service providers have made a number of filings to restructure services. Indiana Gas' pipeline service providers are seeking from customers, including Indiana Gas, recovery of certain costs related to the transition to restructured services.\nOn April 12, 1995, Indiana Gas received an order from the IURC allowing full recovery through the quarterly GCA process of all FERC Order No. 636 transition costs, including those transition costs previously deferred. Indiana Gas has estimated and recorded total transition costs of approximately $12 million.\n11. Income Taxes\nThe components of consolidated income tax expense, including tax on the gain on the sale of EnTrade in 1993 and amounts in \"Other\" on the Consolidated Statements of Income, were as follows:\nEffective income tax rates were 34.47 percent, 34.08 percent and 37.23 percent of pretax income for 1995, 1994 and 1993, respectively. This compares with a combined federal and state income tax statutory rate of 37.93 percent for 1995 and 1994 and 37.69 percent for 1993. Individual components of these rate differences are not significant except investment tax credit which amounted to (1.8%) for all periods reported.\nDeferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Deferred income taxes are provided for taxes not currently payable due to, among other things, the use of various accelerated depreciation methods, shorter depreciable lives and the deduction of certain construction costs for tax purposes. Taxes deferred in prior years are being charged and income credited as these tax effects reverse. The provisions for the deferred tax effects relating to the excess of tax-over- book depreciation amounted to $4,031,000 in 1995, $2,852,000 in 1994 and $2,073,000 in 1993.\nEffective October 1, 1993, Indiana Gas adopted Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (SFAS 109). Indiana Gas previously used the deferred method of accounting for income taxes as prescribed by Accounting Principles Bulletin Opinion No. 11. SFAS 109 requires the use of the liability method, which effectively results in a reduction in previously provided deferred income taxes to reflect the current statutory corporate tax rate.\nDue to the effects of regulation, Indiana Gas is not permitted to recognize the effect of a tax rate change as income but is required to reduce tariff rates to return the \"excess\" deferred income taxes to ratepayers over the remaining life of the properties that give rise to the taxes. Therefore, the cumulative effect of a change in accounting principle upon the initial application of SFAS 109 resulted in no impact on earnings. Under SFAS 109, Indiana Gas has recorded a net regulatory liability for approximately $3.8 million on its balance sheet as of September 30, 1995, related to deferred taxes.\nSignificant components of Indiana Gas' net deferred tax liability as of September 30, 1995, and 1994 are as follows:\nTHOUSANDS 1995 1994 Deferred tax liabilities: Accelerated depreciation $45,902 $41,652 Property basis differences 18,560 18,140 Acquisition adjustment 6,664 6,853 Other (4,791) 2,654 Deferred tax assets: Deferred investment tax credit (4,590) (4,943) Regulatory income tax liability (1,440) (1,815) Less deferred income taxes related to current assets and liabilities 4,791 (2,654) Balance as of September 30 $65,096 $59,887\nInvestment tax credits have been deferred and are being credited to income over the life of the property giving rise to the credit. The Tax Reform Act of 1986 eliminated investment tax credits for property acquired after January 1, 1986.\n12. Long-Lived Assets\nIn March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121, Accounting for the Impairment of Long-Lived Assets and Long- Lived Assets to be Disposed Of. This statement imposes stricter criteria for regulatory assets by requiring that such assets be probable of future recovery at each balance sheet date. Indiana Gas anticipates adopting this standard on October 1, 1996, and does not expect that the adoption will have a material impact on its financial position or results of operations based on the current regulatory structure in which it operates. This conclusion may change in the future as competitive factors influence pricing in this industry.\n13. Summarized Financial Data (Unaudited)\nSummarized quarterly financial data (in thousands of dollars except per share amounts) for 1995 and 1994 are as follows:\nNote: Because of the seasonal factors that significantly affect the companies' operations, the results of operations for interim periods within fiscal years are not comparable.\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\nExcept for the list of the executive officers, which can be found in Part I, Item 4(a) of this report, the information required to be shown in this part for Item 10, Directors and Executive Officers of the Registrant is incorporated by reference here from the registrant's definitive proxy statement. That statement was prepared according to Regulations 14A and S-K and filed electronically with the Securities and Exchange Commission on December 7, 1995.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe information required to be shown in this part for Item 11, Executive Compensation, is incorporated by reference here from the registrant's definitive proxy statement. That statement was prepared according to Regulations 14A and S-K and filed electronically with the Securities and Exchange Commission on December 7, 1995.\nItem 12.","section_12":"Item 12. Securities Ownership of Certain Beneficial Owners and Management\nThe information required to be shown in this part for Item 12, Securities Ownership of Certain Beneficial Owners and Management is incorporated by reference here from the registrant's definitive proxy statement. That statement was prepared according to Regulations 14A and S-K and filed electronically with the Securities and Exchange Commission on December 7, 1995.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThe information required to be shown in this part for Item 13, Certain Relationships and Related Transactions is incorporated by reference here from the registrant's definitive proxy statement. That statement was prepared according to Regulations 14A and S-K and filed electronically with the Securities and Exchange Commission on December 7, 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 Location in 10-K\nReport of Independent Public Accountants Item 8\nConsolidated Statements of Income - 1995, 1994 and 1993 Item 8\nConsolidated Statements of Cash Flows - 1995, 1994 and 1993 Item 8\nConsolidated Balance Sheets at September 30, 1995 and 1994 Item 8\nConsolidated Statements of Common Shareholders' Equity - 1995, 1994 and 1993 Item 8\nConsolidated Schedules of Long-Term Debt as of September 30, 1995 and 1994 Item 8\nNotes to Financial Statements Item 8\n(a)-2 Financial Statement Schedules\nReport of Independent Public Accountants on Schedules\nSchedule II. Valuation and Qualifying Accounts - 1995, 1994 and 1993\n(a)-3 Exhibits\nSee Exhibit Index\n(b) Reports on Form 8-K\nNone filed during the fourth quarter of fiscal 1995.\nEXHIBIT INDEX\nExhibit No. Description Reference\n2-A Amended and Restated Exhibit 2-A to Agreement and Plan of Indiana Reorganization, dated Energy's 1989 as of November 6, Annual Report 1989, and amended as on Form 10-K. of December 1, 1989, among Indiana Energy, Inc., IEI Acquisition Corporation and Richmond Gas Corporation.\n2-B Second Amendment to Exhibit 2-B to Agreement and Plan of Indiana Reorganization among Energy's Indiana Energy, Inc., Current Report IEI Acquisition on Form 8-K Corporation and dated July 31, Richmond Gas 1990, and filed Corporation dated as August 15, of July 31, 1990. 1990.\n2-C Amended and Restated Exhibit 2-B to Agreement of Merger, Indiana dated as of November Energy's 1989 6, 1989, and amended Annual Report as of December 1, on Form 10-K. 1989, among Indiana Energy, Inc., IEI Acquisition Corporation and Richmond Gas Corporation.\n2-D Amended and Restated Exhibit 2-C to Stock Exchange Indiana Agreement, dated as of Energy's 1989 November 6, 1989, and Annual Report amended as of December on Form 10-K. 1, 1989, between Indiana Energy, Inc. and Indiana Gas & Chemical Corporation.\n2-E Second Amendment to Exhibit 2(e) to Stock Exchange Indiana Agreement between Energy's Indiana Energy, Inc. Current Report and Indiana Gas & on Form 8-K Chemical Corporation dated July 31, dated as of July 31, 1990 and filed 1990. August 15, 1990.\n2-F Acquisition Agreement Exhibit 10-N of dated October 26, Indiana Gas 1990, between Indiana Company, Inc.'s Energy and Indiana Gas 1990 Annual Company, Inc. Report on Form 10-K.\n2-G Acquisition Agreement Exhibit 1 to dated as of December Indiana 28, 1992, between Energy's Tennessee Gas Pipeline Current Report Company, Tenneco on Form 8-K Merger Company, dated December EnTrade Corporation 29, 1992, and and the filed January Interestholders listed 13, 1993. on Exhibit A thereto.\n3-A Amended and Restated Exhibit 3-A to Articles of Indiana Incorporation. Energy's 1993 Annual Report on Form 10-K.\n3-B Code of By-Laws, as Filed herewith. amended.\n4-A Applicable provisions Exhibit 3-A to of Indiana Energy's Indiana Amended and Restated Energy's 1993 Articles of Annual Report Incorporation, as on Form 10-K. amended, as set forth as Exhibit 3-A above.\n4-B Amended and Restated Exhibit 1 to Rights Agreement Indiana between Indiana Energy Energy's and Continental Bank, Amendment on N.A. (Now First Form 8 to Form Chicago Trust Company 8-A of New York), as Registration Rights Agent, dated as Statement filed of July 30, 1986, and on April 16, amended and restated 1990. as of December 8, 1989.\n4-C Indenture dated as of Indiana Gas September 1, 1950, Company, Inc.'s between Indiana Gas Registration and Merchants National No. 2-77620 Bank & Trust Company (pages 6-8 of of Indianapolis (now the Prospectus National City Bank, on Form S-16 Indiana), as trustee contained (\"Trustee\"), and therein), to twelve supplemental Registration indentures thereto. No. 2-40825 (Exhibit Nos. 2- A through 2-H), to Registration No. 2-52734 (Exhibit No. 2- C), to Registration No. 2-68469 (Exhibit No. 2- J), to Registration No. 2-77620 (Exhibit No. 4- 0), to Registration No. 33-1262 (Exhibit No. 4K), to the 1985 Annual Report on Form 10-K (Exhibit 4) and to the 1986 Annual Report on Form 10-K (Exhibit No. 4-D).\n4-D Indenture dated Exhibit 4(a) to February 1, 1991, Indiana Gas between Indiana Gas Company, Inc.'s and Continental Bank, Current Report National Association. on Form 8-K dated February 1, 1991, and filed February 15, 1991; First Supplemental Indenture thereto dated as of February 15, 1991, (incorporated by reference to Exhibit 4(b) to Indiana Gas Company, Inc.'s Current Report on Form 8-K dated February 1, 1991, and filed February 15, 1991); Second Supplemental Indenture thereto dated as of September 15, 1991, (incorporated by reference to Exhibit 4(b) to Indiana Gas Company, Inc.'s Current Report on Form 8-K dated September 15, 1991, and filed September 25, 1991); Third Supplemental Indenture thereto dated as of September 15, 1991 (incorporated by reference to Exhibit 4(c) to Indiana Gas Company, Inc.'s Current Report on Form 8-K dated September 15, 1991 and filed September 25, 1991);Fourth Supplemental Indenture thereto dated as of December 2, 1992, (incorporated by reference to Exhibit 4(b) to Indiana Gas Company, Inc.'s Current Report on Form 8-K dated December 1, 1992, and filed December 8, 1992); and Officers' Certificate pursuant to dated as of April 5, 1995, (incorporated by reference to Exhibit 4(a) to Indiana Gas Company, Inc.'s Current Report on Form 8-K dated and filed April 5, 1995).\n10-A Employment Agreement Exhibit 10-A to among Indiana Energy, Indiana Inc., Indiana Gas Energy's 1990 Company, Inc., and Annual Report Lawrence A. Ferger on Form 10-K. effective January 1, 1990.\n10-B Employment Agreement Exhibit 10-C to among Indiana Energy, Indiana Inc., Indiana Gas Energy's 1990 Company, Inc., and Annual Report Niel C. Ellerbrook, on Form 10-K. effective January 1, 1990.\n10-C Employment Agreement Exhibit 10-D to between Indiana Gas Indiana Company, Inc., and Energy's 1990 Paul T. Baker Annual Report effective January 1, on Form 10-K. 1990.\n10-D Employment Agreement Exhibit 10-E to between Indiana Gas Indiana Company, Inc., and Energy's 1990 Anthony E. Ard Annual Report effective January 1, on Form 10-K. 1990.\n10-E Employment Agreement Exhibit 10-F to among Indiana Energy, Indiana Inc., Indiana Gas Energy's 1990 Company, Inc., and Annual Report Carl L. Chapman on Form 10-K. effective January 1, 1990.\n10-F Termination Benefits Exhibit 10-F to Agreement, dated July Indiana 29, 1994, among Energy's 1994 Indiana Energy, Inc., Annual Report Indiana Gas Company, on Form 10-K. Inc. and Lawrence A. Ferger.\n10-G Termination Benefits Exhibit 10-G to Agreement, dated July Indiana 29, 1994, among Energy's 1994 Indiana Energy, Inc., Annual Report Indiana Gas Company, on Form 10-K. Inc. and Paul T. Baker.\n10-H Termination Benefits Exhibit 10-H to Agreement, dated July Indiana 29, 1994, among Energy's 1994 Indiana Energy, Inc., Annual Report Indiana Gas Company, on Form 10-K. Inc. and Niel C. Ellerbrook.\n10-I Termination Benefits Exhibit 10-I to Agreement, dated July Indiana 29, 1994, among Energy's 1994 Indiana Energy, Inc., Annual Report Indiana Gas Company, on Form 10-K. Inc. and Anthony E. Ard.\n10-J Termination Benefits Exhibit 10-J to Agreement, dated July Indiana 29, 1994, among Energy's 1994 Indiana Energy, Inc., Annual Report Indiana Gas Company, on Form 10-K. Inc. and Carl L. Chapman.\n10-K Executive Compensation Exhibit 10-K to Deferral Plan Indiana effective December 1, Energy's 1994 1994. Annual Report on Form 10-K.\n10-L Directors Compensation Exhibit 10-M to Deferral Plan Indiana effective January 1, Energy's 1994 1995. Annual Report on Form 10-K.\n10-M Executive Restricted Exhibit A to Stock Plan effective Indiana October 1, 1987, as Energy's Proxy amended. Statement filed on December 4, 1987; First Amendment to Indiana Energy, Inc. Executive Restricted Stock Plan (incorporated by reference to Exhibit 10-A to Indiana Energy's 1991 Annual Report on Form 10-K.)\n10-N Indiana Energy, Inc. Exhibit 10-D to Annual Management Indiana Incentive Plan Energy's 1987 effective October 1, Annual Report 1987. on Form 10-K.\n10-O Indiana Energy, Inc. Indiana Directors' Restricted Energy's Stock Plan, as amended Definitive and restated on Proxy Statement October 25, 1991. filed on December 6, 1991.\n10-P Exhibit 10-P schedules all material gas contracts which are in effect between Indiana Gas Company, Inc. and the suppliers listed. The gas contracts within each type are substantially identical in all material respects and at least one of each type of contract has been or is filed as indicated. The schedule details all material aspects in which a contract may differ from the contract filed.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULES\nTo Indiana Energy, Inc.:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in Item 8, in this Form 10-K, and have issued our report thereon dated October 26, 1995. 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.\n\/s\/ Arthur Andersen LLP ARTHUR ANDERSEN LLP\nIndianapolis, Indiana October 26, 1995\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.\nINDIANA ENERGY, INC.\nDated December 20, 1995 \/s\/Lawrence A. Ferger Lawrence A. Ferger, 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.","section_15":""}
{"filename":"788329_1995.txt","cik":"788329","year":"1995","section_1":"ITEM 1. BUSINESS\nJohnson Worldwide Associates, Inc. and its subsidiaries (the \"Company\") are engaged in the manufacture and marketing of recreational products. Until the third quarter of fiscal 1994, the Company also manufactured and marketed marking systems products. In July 1993, the Company announced its intention to sell its marking systems business and, in accordance with this decision, the marking systems business is presented as a discontinued operation in the Company's Consolidated Financial Statements. Additional information regarding the marking systems business is set forth at Note 3 to the Consolidated Financial Statements on page 22 in the Company's 1995 Annual Report, which is incorporated herein by reference. Financial information for the foreign and domestic operations of the Company's recreational business is set forth at Note 13 to the Consolidated Financial Statements on page 26 in the Company's 1995 Annual Report which is incorporated herein by reference.\nThe Company's primary focus is on marketing and product innovation and design to achieve strong brand names and consumer recognition. Research and development activities for each of the Company's principal businesses emphasize new products and innovations to differentiate the Company's products from those of its competitors.\nThe Company is controlled by Samuel C. Johnson, members of his family and related entities.\nRECREATIONAL PRODUCTS\nFISHING AND CAMPING PRODUCTS\nThe Company's fishing and camping products include MINN KOTA electric fishing motors and accessories, MITCHELL reels and rods, JOHNSON reels, BEETLE SPIN soft body lures, JOHNSON spoons, DECKHAND electric boat anchor systems, EUREKA! and CAMP TRAILS tents and backpacks, OLD TOWN canoes and kayaks, CARLISLE paddles, SILVA compasses, and JACK WOLFSKIN camping tents, backpacks and outdoor clothing. In 1995, the Company acquired the SPIDERWIRE product line, giving it an entry into the \"superline\" segment of the fishing line market. The Company also acquired the NEPTUNE TECHNOLOGIES product line of electric motors and power accessories, which expands its range of such products.\nThe overall fishing and camping markets in which the Company competes have grown modestly in recent years. The Company believes it has been able to maintain its share of most markets primarily as a result of the Company's emphasis on marketing and product innovation. Research and development emphasizes new products and innovations to provide demonstrable product differentiation and expanded product lines. Consumer advertising and promotion include advertising on regional television and in outdoor, general interest and sports magazines, in-store displays and sponsorship of fishing tournaments. Packaging and point-of-purchase materials are used to increase consumer appeal and sales.\nELECTRIC FISHING MOTORS. The Company manufactures, under its MINN KOTA and NEPTUNE names, battery powered motors used on fishing boats and other boats for quiet trolling power or primary propulsion. The Company's MINN KOTA and NEPTUNE motors and related accessories are sold primarily in the United States through large retail store chains such as K-Mart and Wal Mart, through catalogs, such as Bass Pro Shops, and through marine dealers.\nFISHING LINE. The Company purchases, through a third-party manufacturer, its SPIDERWIRE and SPIDERWIRE FUSION products, which have performance characteristics superior to those of monofilament fishing line. SPIDERWIRE competes in the \"superline\" segment of the fishing line category, while the recently introduced SPIDERWIRE FUSION is positioned at the high end of the monofilament market. These products are sold through large retail store chains, catalogs and specialty stores.\nRODS AND REELS. The Company markets JOHNSON fishing reels, which are primarily closed-face reels, as well as MITCHELL reels, which are open-faced reels. Reels are sold individually and in rod and reel combinations, primarily through large retail store chains in the United States and Canada and specialty fishing shops in Europe. The Company's closed-face reels compete in a segment of the U.S. fishing reel market which is dominated by larger manufacturers. Marketing support for the Company's reels is focused on building brand names, emphasizing product features and innovations and on developing specific segments of the reel market through advertising in national outdoor magazines, through trade and consumer support at retail and through sponsorship of fishing tournaments.\nLURE PRODUCTS. The Company's artificial lure products consist of BEETLE SPIN soft body lures, and JOHNSON spoons. These products are sold primarily through large retail store chains.\nTENTS AND BACKPACKS. The Company's EUREKA! and CAMP TRAILS tents and backpacks compete primarily in the mid- to high-price range of their respective markets and are sold in the United States through independent sales representatives primarily to sporting goods stores, catalog and mail order houses and camping and backpacking specialty stores. Marketing of the Company's tents and backpacks is focused on building the EUREKA! and CAMP TRAILS brand names and establishing the Company as a leader in product design and innovation. The Company's tents and backpacks are produced by off-shore manufacturing sources.\nThe Company markets both EUREKA! camping and commercial tents. The Company's camping tents have outside self-supporting aluminum frames allowing quicker and easier set-up, a design approach first introduced by the Company. Most of the EUREKA! tents are made from breathable nylon. The Company's commercial tents include party tents and tents for fairs. Party tents are sold primarily to general rental stores while other commercial tents are sold directly to tent erectors. Commercial tents are manufactured by the Company in the United States.\nCAMP TRAILS backpacks consist primarily of internal and external frame backpacks for hiking and mountaineering. The Company's line of CAMP TRAILS backpacks also includes soft back bags, day packs and travel packs. JACK WOLFSKIN, a German marketer of camping tents, backpacks and outdoor clothing, distributes its products primarily through camping and backpacking specialty stores in Germany with additional distribution in other European countries and the United States and, under license, in Japan.\nCANOES AND KAYAKS. The Company's watercraft are sold under the OLD TOWN name and consist of whitewater, tripping, touring and general recreational purpose canoes for the high quality and mid-price segments of the canoe market and recreational and higher performance kayaks. The Company has developed a proprietary roto-molding process for manufacturing polyethylene canoes to compete in the higher volume mid-priced range of the market. These canoes maintain many of the design and durability characteristics of higher priced canoes. The Company also manufactures canoes from fiberglass, ROYALEX (ABS) and wood. The Company's canoes are sold primarily to sporting goods stores, catalog and mail order houses such as L. L. Bean, canoe specialty stores and marine dealers in the United States and Europe. The United States' market for canoes is relatively constant, but the Company believes, based on industry data, that it is the leading manufacturer of canoes in the United States in unit and dollar sales. CARLISLE PADDLES,\na manufacturer of composite canoe paddles, supplies certain paddles that are sold with the Company's canoes as well as supplying paddles which are distributed through the same channels as the Company's watercraft.\nDIVING AND MARINE PRODUCTS\nDIVING. The Company believes that it is one of the world's largest manufacturers and distributors of underwater diving products which it sells under the SCUBAPRO and SNORKELPRO names. The Company markets a full line of snorkeling and underwater diving equipment including regulators, stabilizing jackets, tanks, depth gauges, masks, fins, snorkels, diving electronics and other accessories. SCUBAPRO products are marketed to the high quality, premium priced segment of the market. The Company maintains a marketing policy of limited distribution and sells primarily through independent specialty diving shops worldwide. These diving shops generally provide a wide range of services to divers, including instruction and repair service. SCUBAPRO products are marketed primarily in Europe, the United States and the Pacific Basin.\nThe Company focuses on maintaining SCUBAPRO as the market leader in innovations and new products. The Company maintains a research and development staff both in the United States and Italy and has obtained several patents on SCUBAPRO products and features. Consumer advertising focuses on building the SCUBAPRO brand name and position as the high quality and innovative leader in the industry. The Company advertises its SCUBAPRO equipment in diving magazines and through in-store displays.\nThe Company maintains manufacturing and assembly facilities in the United States and Italy. The Company procures a number of its rubber and plastic products and components from offshore sources.\nMARINE PRODUCTS. The Company is a leading supplier in Europe of marine products and accessories primarily for sailing, which are sold under the PLASTIMO name. PLASTIMO products and accessories include safety products (such as buoyancy vests and inflatable life rafts), mooring products (such as anchors, fenders and ladders), navigational equipment (such as cockpit instruments, automatic pilots and compasses) and jib reefing systems. PLASTIMO products are sold to a lesser extent in the United States and other markets worldwide.\nThe Company's line of AIRGUIDE marine, weather and automotive instruments are distributed primarily in the United States through large retail store chains and original equipment manufacturers.\nSALES BY CATEGORY\nThe following table depicts net sales of continuing operations by major product category:\nSales to Wal Mart Stores, Inc. and its affiliated entities totaled $34,902,000 in 1995. No customer accounted for 10% or more of sales in 1994 or 1993.\nINTERNATIONAL OPERATIONS\nSee Note 13 to the Consolidated Financial Statements on page 26 of the Company's 1995 Annual Report which is incorporated herein by reference, for financial information comparing the Company's domestic and international operations.\nRESEARCH AND DEVELOPMENT\nThe Company commits significant resources to research and new product development. The Company expenses research and development costs as incurred. The amounts expended by the Company in connection with research and development activities for each of the last three fiscal years are set forth in the Consolidated Statements of Operations on page 17 of the Company's 1995 Annual Report which is incorporated herein by reference.\nCOMPETITION\nThe markets for most of the Company's products are quite competitive. The Company believes its products compete favorably on the basis of product innovation, product performance and strong marketing support, and to a lesser extent, price.\nEMPLOYEES\nAt September 29, 1995, the Company had approximately 1,336 employees working in its businesses. The Company considers its employee relations to be excellent.\nPATENTS, TRADEMARKS AND PROPRIETARY RIGHTS\nThe Company owns no single patent which is material to its business as a whole. However, the Company holds several patents, principally for diving products and roto-molded canoes and has filed several applications for patents. The Company also has numerous trademarks and trade names which the Company considers important to its business.\nSOURCES AND AVAILABILITY OF MATERIALS\nThe Company's products use materials that are generally in adequate supply. In 1995, however, the Company experienced shortages in the supply of magnets, which are key components used in its electric motors. The shortage of magnets hindered the Company's ability to meet customer demand for its electric motor products. The magnet supply situation has been resolved.\nSEASONALITY\nThe Company's business is seasonal. The following table shows total net sales and operating profit of the Company's continuing operations for each quarter, as a percentage of the total year. An inventory writedown of $5.4 million is included as a component of the fourth quarter operating loss in 1994. A restructuring charge of $13.0 million is included as a component of the fourth quarter operating loss in 1993.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nPursuant to General Instruction of G(3) of Form 10-K, the following list is included as an unnumbered Item in Part I of this report in lieu of being included in the Company's Proxy Statement for the January 24, 1996 Annual Meeting of Shareholders.\nMr. Crabb, age 52, became President and Chief Executive Officer in January 1994. He served as President and Chief Operating Officer of the Company from 1992 to January 1994. Mr. Crabb served as Executive Vice President-Regional Director, Consumer Products, Europe of S.C. Johnson and Son, Inc. (\"SCJ\") from 1990 to 1992 and from 1984 to 1990 was Vice President-Regional Director of Asia\/Pacific of SCJ. Mr. Crabb joined SCJ in 1970.\nMr. Blime, age 54, became a Vice President of the Company and President of JWA Europe in 1993. From 1982 to 1993, Mr. Blime was President and Directeur General of Mitchell Sports, S.A., a subsidiary of the Company since 1990.\nMr. Inslee, age 57, became Vice President-Human Resources of the Company in 1991. From 1988 to 1991, Mr. Inslee was Director of Human Resources of the Company. He was Director of Personnel at SCJ from 1981 to 1988. Mr. Inslee joined SCJ in 1960.\nMr. Schmidt, age 39, became Senior Vice President of the Company in May 1995 and has been Chief Financial Officer, Secretary and Treasurer of the Company since July 1994. From July 1994 until May 1995, Mr. Schmidt was a Vice President of the Company. From 1988 to July 1994, he was a partner in the firm of KPMG Peat Marwick LLP.\nMs. Johnson-Leipold, age 38, became Executive Vice President - North American Businesses of the Company in October 1995. From 1992 until October 1995, she was Vice President - Consumer Marketing Services - Worldwide of SCJ and from 1988 to 1992 she was Director of Marketing Services of SCJ.\nThere are no family relationships between the above executive officers.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company maintains both leased and owned manufacturing, warehousing, distribution and office facilities throughout the world.\nThe Company's manufacturing processes are primarily assembly operations and the Company prefers to lease rather than own facilities to maintain operational flexibility and control the investment of financial resources in property. See Note 6 to the Consolidated Financial Statements on Page 23 of the Company's 1995 Annual Report for a discussion of lease obligations.\nThe Company believes that its facilities are well maintained and have a capacity adequate to meet the Company's current needs.\nThe Company's principal manufacturing locations and distribution centers are:\nThe Company's Marking Systems' principal locations were:\nThe Company's corporate headquarters is located in Mount Pleasant, Wisconsin. The Company's mailing address is Sturtevant, Wisconsin.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is subject to various legal actions and proceedings in the normal course of business, including those related to environmental matters. Although litigation is subject to many uncertainties and the ultimate exposure with respect to these matters cannot be ascertained, management does not believe the final outcome will have a significant effect on the Consolidated Financial Statements.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThere were no matters submitted to a vote of security holders during the last quarter of the year ended September 29, 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nInformation with respect to this item is included on pages 23, 25, 26 and 28 and the inside back cover of the Company's 1995 Annual Report and is incorporated herein by reference.\nThere is no public market for the Registrant's Class B Common Stock. However, the Class B Common Stock is convertible at all times at the option of the holder into shares of Class A Common Stock on a share for share basis. As of November 15, 1995, the Company had 791 Holders of Record of its Class A Common Stock and 71 Holders of Record of its Class B Common Stock.\nThe Company has never paid a dividend on its Common Stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nInformation with respect to this item is included on page 28 of the Company's 1995 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\nInformation with respect to this item is included on pages 13 to 15 of the Company's 1995 Annual Report and is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe following consolidated financial statements and supplemental data of the registrant and subsidiaries, included on pages 16 through 28 of the Company's 1995 Annual Report, are herein incorporated by reference:\nConsolidated Balance Sheets - September 29, 1995 and September 30, 1994 Consolidated Statements of Operations - Years ended September 29, 1995, September 30, 1994 and October 1, 1993 Consolidated Statements of Shareholders' Equity - Years ended September 29, 1995, September 30, 1994 and October 1, 1993 Consolidated Statements of Cash Flows - Years ended September 29, 1995, September 30, 1994 and October 1, 1993 Notes to Consolidated Financial Statements Independent Auditors' Report Five Year Financial Summary\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nInformation with respect to this item, except for information on the Executive Officers which appears at the end of Part I of this report, is included in the Company's January 24, 1996 Proxy Statement under the headings \"Election of Directors\" and \"Other Matters\" and is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation with respect to this item is included in the Company's January 24, 1996 Proxy Statement under the heading \"Executive Compensation\" and is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation with respect to this item is included in the Company's January 24, 1996 Proxy Statement under the heading \"Stock Ownership of Management and Others\" and is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation with respect to this item is included in the Company's January 24, 1996 Proxy Statement under the heading \"Certain Transactions\" and is incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\nA. The following documents are filed as a part of this Form 10-K:\n1. Financial Statements:\nIncluded in Item 8 of Part II of this Form 10-K are the following Consolidated Financial Statements, related notes thereto, and independent auditors' report which are incorporated herein by reference from the 1995 Annual Report: Consolidated Balance Sheets - September 29, 1995 and September 30, 1994 Consolidated Statements of Operations - Years ended September 29, 1995, September 30, 1994 and October 1, Consolidated Statements of Shareholders' Equity - Years ended September 29, 1995, September 30, 1994 and October 1, Consolidated Statements of Cash Flows - Years ended September 29, 1995, September 30, 1994 and October 1, Notes to Consolidated Financial Statements Independent Auditors' Report Five Year Financial Summary\n2. Financial Statement Schedules and Independent Auditors' Report:\nIncluded in Part IV of this Form 10-K is the following financial statement schedule and independent auditors' report: Independent Auditors' Report Schedule II - Valuation and Qualifying Accounts All other schedules are omitted because they are not applicable, are not required or equivalent information has been included in the Consolidated Financial Statements or notes thereto.\n3. Exhibits\nSee Exhibit Index on page 17.\nB. Reports on Form 8-K:\nOn May 26, 1995, the Company filed a Current Report on Form 8-K dated May 11, 1995 to reflect (under Item 2 of Form 8-K) the Company's acquisition of the assets of the SpiderWireO product line of Safari Land Ltd., Inc. On July 25, 1995, the Company filed an amendment on Form 8-K\/A to the Company's Current Report on Form 8-K dated May 11, 1995. The report, as amended, included (under Item 7 of Form 8-K) the following financial statements: Statement of Assets Acquired as of March 31, 1995, Statements of Revenues and Direct Operating Expenses for the year ended September 30, 1994 and the six months ended March 31, 1995, Pro Forma Condensed Consolidated Balance Sheet as of March 31, 1995 and Pro Forma Condensed Consolidated Statements of Operations for the year ended September 30, 1994 and for the six months ended March 31, 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, in the Town of Mount Pleasant and State of Wisconsin, on the 12th day of December, 1995.\nJOHNSON WORLDWIDE ASSOCIATES, INC. (Registrant)\nBy \/S\/ JOHN D. CRABB -------------------------------- John D. Crabb President and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, the report has been signed by the following persons in the capacities indicated on the 12th day of December, 1995.\nINDEPENDENT AUDITORS' REPORT\nShareholders and Board of Directors Johnson Worldwide Associates, Inc.:\nUnder date of November 8, 1995, we reported on the consolidated balance sheets of Johnson Worldwide Associates, Inc. and subsidiaries as of September 29, 1995 and September 30, 1994, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the years in the three year period ended September 29, 1995, as contained in the 1995 Annual Report. These consolidated financial statements and our report thereon are incorporated by reference in the Annual Report on Form 10-K for the fiscal year 1995. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related consolidated financial statement schedule as listed in Item 14A. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement schedule based on our audits.\nIn our opinion, such a 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 Milwaukee, Wisconsin November 8, 1995\nJOHNSON WORLDWIDE ASSOCIATES, INC. AND SUBSIDIARIES\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS\n(thousands)\n______________________________ (1) Includes the impact of foreign currency fluctuations on these balance sheet accounts.","section_15":""}
{"filename":"776734_1995.txt","cik":"776734","year":"1995","section_1":"Item 1. Business. America First Tax Exempt Mortgage Fund Limited Partnership (the \"Registrant\" or the \"Partnership\") was formed as a limited partnership on November 11, 1985, under the Delaware Revised Uniform Limited Partnership Act to acquire a portfolio of federally tax-exempt participating first mortgage loans to provide construction and\/or permanent financing of multifamily residential apartments. The Registrant's business objectives are to provide its investors: (i) safety and preservation of capital; (ii) regular distributions of tax-exempt interest; and, (iii) potential for an enhanced tax-exempt yield as a result of a participation interest in the net cash flow and net capital appreciation of the real estate financed by the Registrant.\nThe Registrant registered a total of 15,000,000 Beneficial Unit Certificates (BUCs) representing assignments of limited partnership interests with the Securities and Exchange Commission and sold a total of 9,979,128 BUCs at $20 per BUC for a total net capital contribution of $185,511,989 after the payment of certain organization and offering costs.\nThe Registrant acquired 14 tax-exempt mortgage loans with an aggregate principal amount equal to $177,196,000. At December 31, 1995, the Registrant continued to hold seven of these mortgage loans with a carrying value, net of allowance for loan losses, equal to $66,026,000.\nThe tax-exempt mortgage loans that the Registrant had acquired were issued by various state and local housing authorities to provide for the construction and\/or permanent financing of 14 multifamily housing properties located in 10 states. The Registrant subsequently acquired seven of the properties (each, an \"Acquired Property\") through foreclosure or in lieu of foreclosure of the tax-exempt mortgage loans collateralized thereby. The Acquired Properties were transferred to America First REIT, Inc. (the \"REIT\") on June 1, 1993. Under the terms of the remaining mortgage loans, the principal amounts do not amortize over their terms. The mortgage loans provide for the payment of base interest to the Registrant and for the payment of contingent interest based upon net cash flow and net capital appreciation of the underlying real estate properties. Therefore, the return to the Registrant depends upon the economic performance of the real estate which collateralizes its remaining mortgage loans. For this reason, the Registrant's investments are dependent on the economic performance of such real estate and may be considered to be in competition with other income-producing real estate of the same type in the same geographic areas.\nA description of the seven tax-exempt mortgage loans held by the Registrant at December 31, 1995, (and the properties collateralizing such loans) appears in Note 5 of the Notes to Financial Statements filed in response to Item 8 hereof.\nThe Registrant is engaged solely in the business of providing financing for the acquisition and improvement of real estate. Accordingly, the presentation of information about industry segments is not applicable and would not be material to an understanding of the Registrant's business taken as a whole.\nThe Registrant has no employees. Certain services are provided to the Registrant by employees of America First Companies L.L.C. which is the general partner of the general partner of the Registrant, and the Registrant reimburses America First Companies L.L.C. for such services at cost. The Registrant is not charged, and does not reimburse, for the services performed by managers and officers of America First Companies L.L.C..\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties. The Registrant had invested in 14 tax-exempt mortgage loans collateralized by first mortgages on multifamily housing properties. Descriptions of the properties collateralizing the mortgage loans held by the Registrant at December 31, 1995, appear in Note 5 of the Notes to Financial Statements filed in response to Item 8 hereof.\nItem 3.","section_3":"Item 3. Legal Proceedings. There are no material pending legal proceedings to which the Registrant is a party or to which any of its property is subject.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders. No matter was submitted during the fourth quarter of the fiscal year ended December 31, 1995, to a vote of the Registrant's security holders.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.\n(a) Market Information. The BUCs trade on The NASDAQ Stock Market under the trading symbol \"AFTXZ.\" The following table sets forth the high and low final sale prices for the BUCs for each quarterly period from January 1, 1994 through December 31, 1995.\n(b) BUC Holders. The approximate number of BUC holders on December 31, 1995, was 6,556.\n(c) Distributions. Cash distributions are being made on a monthly basis. Total cash distributions paid or accrued to BUC Holders during the fiscal years ended December 31, 1995, and December 31, 1994, equaled $5,388,730. The cash distributions paid per BUC during the fiscal years ended December 31, 1995, and December 31, 1994, were as follows:\nSee Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, for information regarding the sources of funds used for cash distributions and for a discussion of factors, if any, which may adversely affect the Registrant's ability to make cash distributions at the same level in 1996 and thereafter.\nItem 6.","section_6":"Item 6. Selected Financial Data. Set forth below is selected financial data for the Partnership. The information set forth below should be read in conjunction with the Financial Statements and Notes thereof filed in response to Item 8 hereof.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nLiquidity and Capital Resources\nThe Partnership originally acquired 14 tax-exempt mortgage loans, the proceeds of which were used to provide construction and\/or permanent financing for 14 multifamily housing properties. On June 1, 1993, the Partnership transferred to America First REIT, Inc. (REIT) seven real estate properties acquired in foreclosure. At December 31, 1995, the Partnership continued to hold seven tax-exempt mortgage loans with a carrying value, net of allowance for loan losses, equal to $66,026,000.\nThe following table shows the various occupancy levels of the properties financed by the Partnership at December 31, 1995.\nThe principal amounts of the tax-exempt mortgage loans do not amortize over their terms. The tax-exempt mortgage loans provide for the payment of base interest at a fixed rate. In addition, the Partnership may earn contingent interest based on a participation in the net cash flow and net sale or refinancing proceeds from the real estate collateralizing the tax-exempt mortgage loans. Currently, the interest payments received on the tax-exempt mortgage loans and interest on temporary cash investments represent the principal sources of the Partnership's income and distributable cash. The Partnership may draw on the reserve to pay operating expenses or to supplement cash distributions to Beneficial Unit Certificate (BUC) Holders.\nDistributions to BUC Holders currently consist of interest received from mortgage loans, interest on temporary cash investments and withdrawals from reserves. For the year ended December 31, 1995, a net amount of $298,938 of undistributed income was placed in reserves. The total amount held in reserves at December 31, 1995, was $1,073,700. Future distributions to BUC Holders will depend upon the amount of base and contingent interest received on the mortgage loans, the size of the reserves established by the Partnership and the extent to which withdrawals are made from reserves.\nThe Partnership believes that cash provided by operating activities and, if necessary, withdrawals from the Partnership's reserves will be adequate to meet its short-term and long-term liquidity requirements, including the payments of distributions to BUC Holders. The Partnership has no other internal or external sources of liquidity. Under the terms of the Partnership agreement, the Partnership is not authorized to enter into short-term or long-term debt financing arrangements or issue additional BUCs to meet short-term and long-term liquidity requirements.\nDISTRIBUTIONS\nCash distributions paid or accrued per BUC were as follows:\nOn May 7, 1993, the Partnership announced the formation of a subsidiary company, America First REIT, Inc., a real estate investment trust. On June 1, 1993, the Partnership transferred the seven real estate properties acquired in settlement of loans along with related debt, cash, and certain of the Partnership's other assets and liabilities to the REIT in exchange for all of the issued and outstanding shares of the REIT's common stock. Thereafter, the Partnership distributed all shares of the REIT to the BUC Holders in the ratio of one share of REIT stock for every four BUCs they held as of the record date, May 21, 1993. The Partnership continues to hold seven tax-exempt mortgage loans in its portfolio and cash distributions are expected to continue on a monthly basis at the annualized rate of $.54 per BUC.\nAsset Quality\nIt is the policy of the Partnership to make a periodic review of the real estate collateralizing the Partnership's mortgage loans in order to establish, when necessary, valuation reserves on mortgage loans. A reserve is established for the difference between the recorded investment in the mortgage loan and the fair value of the underlying collateral. The fair value of the collateral is based on management's best estimate of the net realizable value of the properties; however the ultimate realized values may vary from these estimates. The net realizable value of the properties is determined based on the discounted estimated future cash flows from the properties, including estimated sales proceeds. The calculation of discounted estimated future cash flows includes certain variables such as the assumed inflation rates for rents and expenses, capitalization rates and discount rates. These variables are supplied to the Partnership by an independent real estate appraisal firm based upon local market conditions for each property. In certain cases, additional factors such as the replacement value of the property or comparable sales of similar properties are also taken into consideration. The allowance is periodically reviewed and adjustments are made to the allowance when there are significant changes in the estimated net realizable value of the underlying collateral.\nBased on the foregoing methodology, valuations and reviews performed during 1995 indicated that the mortgage loans recorded on the balance sheet at December 31, 1995, required no adjustments to the carrying amounts.\nAt December 31, 1995, five of the Partnership's seven tax-exempt mortgage loans were classified as nonperforming. The loans will continue to be classified as nonperforming until such time that the properties collateralizing the mortgage loans generate sufficient net cash flow to bring the mortgage loans fully current as to interest payments. The Partnership has a limited amount of influence in controlling the operations of the properties.\nWoodbridge Apartments of Bloomington III\nWoodbridge Apartments of Bloomington III, located in Bloomington, Indiana, had an average occupancy rate of 93% during 1995, compared to 96% during 1994. Interest is recognized as income on this loan on the modified cash basis. Interest earned in 1995 was $1,139,764 compared to $1,103,086 in 1994 and was approximately $69,000 more than the amount needed to pay the base interest in 1995. The increase in interest earned from 1994 to 1995 is primarily the result of additional interest paid out of the property's cash reserves. The net operating income of the property increased slightly (approximately .7%) from 1994 to 1995.\nAshley Pointe at Eagle Crest\nAshley Pointe at Eagle Crest, located in Evansville, Indiana, had an average occupancy rate of 96% during 1995, compared to 93% during 1994. Interest is recognized as income on this loan on the modified cash basis. Interest earned in 1995 was $417,517 compared to $402,385 in 1994 and was approximately $152,000 less than the amount needed to pay the base interest in 1995. The increase in interest earned from 1994 to 1995 is the result of an increase in cash flow generated by the property resulting from an increase in rental income due to an increase in average occupancy. This increase was partially offset by higher property improvement expenses due to painting the exterior of the property.\nWoodbridge Apartments of Louisville II\nWoodbridge Apartments of Louisville II, located in Louisville, Kentucky, had an average occupancy rate of 93% during 1995, compared to 96% during 1994. Interest is recognized as income on this loan on the modified cash basis. Interest earned in 1995 was $782,501 compared to $797,958 in 1994. Although the Partnership received approximately $20,000 more than the amount needed to pay the base interest in 1995, the cash flow generated by the property was approximately $15,000 less in 1995 compared to 1994. This decrease is the result of a decrease in average occupancy and an increase in operating expenses, primarily personnel costs.\nNorthwoods Lake Apartments\nNorthwoods Lake Apartments, located in Duluth, Georgia, had an average occupancy rate of 97% during 1995, compared to 98% during 1994. Interest is recognized as income on this loan on the modified cash basis. Interest earned by the Partnership in 1995 was $1,932,146 compared to $1,831,556 in 1994 but was approximately $214,000 less than the amount needed to pay the base interest. The increase in interest earned from 1994 to 1995 is due to an increase in the net operating income generated by the property in 1995 compared to 1994. This increase is due to an increase in rental revenue resulting from rental rate increases which was partially offset by increased operating expenses consisting primarily of increases in real estate taxes and personnel costs.\nAshley Square\nAshley Square, located in Des Moines, Iowa, had an average occupancy rate of 98% during 1995, compared to 97% during 1994. Interest is recognized as income on this loan on the modified cash basis. Interest earned in 1995 was $476,308 compared to $427,388 in 1994 but was approximately $76,000 less than the amount needed to pay the base interest in 1995. The increase in interest earned from 1994 to 1995 is due to an increase in rental income resulting from an increase in average occupancy and a decrease in operating expenses primarily due to a decrease in property improvements.\nShoals Crossing\nShoals Crossing, located in Atlanta, Georgia, had an average occupancy rate of 95% during 1995, compared to 96% during 1994. The property was current on its interest payments throughout 1995 and debt service on the mortgage loan was generally made from property cash flow. However, withdrawals of approximately $51,000 were made from the property's cash reserves to keep interest payments current. Withdrawals from reserves were made because the net operating income generated by the property in 1995 was approximately $26,000 less than 1994. This decrease is due to increases in property improvements, personnel and utilities expenses which more than offset an increase in rental income resulting from increases in rental rates.\nArama Apartments\nArama Apartments, located in Miami, Florida, had an average occupancy rate of 99% during 1995 and 1994. Interest on this loan, at the base interest rate, is current. In addition, $166,940 of contingent interest was earned in 1995 compared with $211,319 in 1994. The decrease in contingent interest is due to a decrease of approximately $102,000 in the net operating income for the property from 1994 to 1995. This decrease is a result of a slight decrease in rental income and an increase in operating expenses primarily due to an increase in repairs and maintenance expenses.\nResults of Operations\nThe Partnership ended its tenth full year of operations on December 31, 1995. Due to the transfer of real estate and related debt to the REIT on June 1, 1993, the 1995 and 1994 financial statements do not reflect any real estate operations; the 1993 financial statements only reflect five months of real estate operations. The table below compares the results of operations for each year shown.\nMortgage investment income during 1995 was approximately $186,000 greater than 1994. This increase is attributable to increased cash flow from Northwoods Lake Apartments of $101,000, Ashley Square of $49,000, Woodbridge Apts. of Bloomington III of $36,000 and Ashley Pointe at Eagle Crest of $15,000 offset by a decrease from Woodbridge Apartments of Louisville II of $15,000. The increases in cash flow are generally attributable to increases in rental income due to an increase in average occupancy and\/or rental rate increases. See the discussion of each property in the Asset Quality section for additional information.\nMortgage investment income during 1994 was approximately $512,000 greater than 1993. This increase is attributable to increased cash flow from Northwoods Lake Apartments of $275,000, Woodbridge Apts. of Bloomington III of $127,000, Woodbridge Apts. of Louisville II of $105,000 and Ashley Square of $14,000 offset by a decrease in cash flow from Ashley Pointe at Eagle Crest of $9,000. The increase in cash flow from Northwoods Lake Apartments is due to the Partnership receiving twelve monthly interest payments in 1994 whereas the prior owner withheld two monthly payments in 1993. The increase in cash flow from Woodbridge Apts. of Bloomington III and Woodbridge Apts. of Louisville II is primarily attributable to increases in rental income and decreases in repairs and maintenance expenses. The increase in cash flow from Ashley Square is due to an increase in rental income due to an increase in rental rates offset by an overall increase in operating expenses. The decrease in cash flow from Ashley Pointe at Eagle Crest is due to overall increased operating expenses.\nThe decrease in contingent interest income of $44,379 from 1994 to 1995 and the increase of $18,976 from 1993 to 1994 are attributable to cash flow fluctuations from the Arama Apartments. The decrease in contingent interest income from 1994 to 1995 is a result of a decrease in rental income and an increase in operating expenses primarily due to an increase in repairs and maintenance expenses. The increase in contingent interest income from 1993 to 1994 is attributable to an increase in net operating income due to higher rental income resulting from an increase in rental rates which was partially offset by higher real estate operating expense.\nThe increase in interest income on temporary cash investments of $18,273 is attributable to an increase in the amount of undistributed income held in reserves and to slightly higher interest rates. The decrease in interest income on temporary cash investments of $7,654 from 1993 to 1994 is attributable to withdrawals made from Partnership reserves during 1994.\nGeneral and administrative expenses increased $107,488 from 1994 to 1995 primarily due to increases in salaries and related expenses and insurance expense which were partially offset by decreases in printing and investor servicing expenses. General and administrative expenses decreased $555,270 from 1993 to 1994 due primarily to the transfer of the properties to the REIT and the distribution of the REIT shares to the BUC Holders on June 1, 1993.\nDue to the transfer of real estate and related debt to the REIT on June 1, 1993, the 1995 and 1994 financial statements do not reflect any real estate operations and the 1993 financial statements only reflect five months of real estate operations. Accordingly rental income, real estate operating expenses, depreciation and interest expenses all decreased from 1993 to 1994.\nThe table below segregates the results of operations for the Partnership's tax-exempt mortgage lending activities and real estate operations for each year shown.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data. The Financial Statements of the Registrant are set forth in Item 14 hereof and are incorporated herein by reference. In addition the Financial Statements of Northwood Lake Apartments, L.P. are set forth in Item 14 hereof and are incorporated herein by reference. The financial statements of Northwood Lake Apartments, L.P. are included pursuant to SAB Topic 1I.\nItem 9.","section_9":"Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure. There were no disagreements with the Registrant's independent accountants on accounting principles and practices or financial disclosure during the fiscal years ended December 31, 1995 and 1994.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant. The Registrant has no directors or officers. Management of the Registrant consists of the general partner of the Registrant, America First Capital Associates Limited Partnership Two (\"AFCA\") and its general partner, America First Companies L.L.C.. The following individuals are the managers and officers of America First Companies L.L.C., and each serves for a term of one year.\nName Position Held Position Held Since\nMichael B. Yanney Chairman of the Board, 1985 President, Chief Executive Officer and Manager\nMichael Thesing Vice President, Secretary, 1985 Treasurer and Manager, Chief Financial and Accounting Officer\nWilliam S. Carter, M.D. Manager 1994 George Kubat Manager 1994 Martin Massengale Manager 1994 Alan Baer Manager 1994 Gail Walling Yanney Manager 1996\nMichael B. Yanney, 62, is the Chairman and Chief Executive Officer of various affiliates of AFCA which manage public investment funds which have raised over $1.3 billion since 1984. From 1977 until the organization of the first such fund in 1984, Mr. Yanney was principally engaged in the ownership and management of commercial banks. Mr. Yanney also has investments in private corporations engaged in a variety of businesses. From 1961 to 1977, Mr. Yanney was employed by Omaha National Bank and Omaha National Corporation (subsequently merged into FirsTier Financial, Inc.), where he held various positions, including the position of Executive Vice President and Treasurer of the holding company. Mr. Yanney also serves as a member of the boards of directors of Burlington Northern Sante Fe Corporation, Forest Oil Corporation, MFS Communications Company, Inc., Lozier Corporation, Mid-America Apartment Communities, Inc., and PKS Information Services Inc..\nMichael Thesing, 41, has been Vice President and Chief Financial Officer of affiliates of AFCA since July 1984. From January 1984 until July 1984 he was employed by various companies controlled by Mr. Yanney. He was a certified public accountant with Coopers & Lybrand from 1977 through 1983.\nWilliam S. Carter, M.D., 69, is a retired physician. Dr. Carter practiced medicine for 30 years in Omaha, Nebraska, specializing in otolaryngology (disorders of the ears, nose and throat).\nGeorge Kubat, 50, is the President and Chief Executive Officer of Phillips Manufacturing Co., an Omaha, Nebraska, based manufacturer of drywall and construction materials. Prior to assuming that position in November 1992, Mr. Kubat was a certified public accountant with Coopers & Lybrand in Omaha, Nebraska from 1969. He was the tax partner in charge of the Omaha office from 1981 to 1992.\nMartin Massengale, 62, is the President Emeritus of the University of Nebraska. Prior to becoming President in 1991, he served as Interim President from August 1989, as Chancellor of the University of Nebraska-Lincoln from June 1981 through December 1990 and as Vice Chancellor for Agriculture and Natural Resources from 1976 to 1981. Prior to that time, he was a professor and associate dean of the College of Agriculture at the University of Arizona. Dr. Massengale currently serves on the board of directors of Woodmen Accident & Life Insurance Company.\nAlan Baer, 73, is presently Chairman of Alan Baer & Associates, Inc., a management company located in Omaha, Nebraska. He is also Chairman of Lancer Hockey, Inc., Baer Travel Services, Wessan Telemarketing, Total Security Systems, Inc. and several other businesses. Mr. Baer is the former Chairman and Chief Executive Officer of the Brandeis Department Store chain which was, until its acquisition, one of the larger retailers in the Midwest. Mr. Baer has also owned and served on the board of directors of several banks in Nebraska and Illinois.\nGail Walling Yanney, 60, is a retired physician. Dr. Walling practiced anesthesia and was most recently the Executive Director of the Clarkson Foundation until October of 1995. In addition, she is a former director of Firstier Bank, N.A., Omaha. Ms. Yanney is the wife of Michael Yanney.\nItem 11.","section_11":"Item 11. Executive Compensation. Neither the Registrant nor AFCA has any directors or officers. None of the managers or executive officers of America First Companies, L.L.C. (the general partner of AFCA) receives compensation from the Registrant and AFCA receives no reimbursement from the Registrant for any portion of their salaries. Remuneration paid by the Registrant to the Registrant's general partner pursuant to the terms of its limited partnership agreement during the year ended December 31, 1995 is described in Note 6 of the Notes to the Financial Statements filed in response to Item 8 hereof.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\n(a) No person is known by the Registrant to own beneficially more than 5% of the Registrant's BUCs.\n(b) No manager or officer of America First Companies, L.L.C. and no partner of AFCA owns any BUCs.\n(c) LBI Group Inc. is the special limited partner of AFCA, with the right to become the managing general partner of AFCA, or to designate another corporation or other entity as the managing general partner, upon the happening of any of the following events: (1) the commission of any act which, in the opinion of LBI Group Inc., constitutes negligence, misfeasance or breach of fiduciary duty on the part of the managing general partner; (2) the dissolution, insolvency or bankruptcy of the managing general partner or the occurrence of such other events which cause the managing general partner to cease to be a general partner under Delaware law; or, (3) the happening of an event which results in the change in control of the managing general partner whether by operation of law or otherwise.\nThere exists no other arrangement known to the Registrant the operation of which may, at any subsequent date, result in a change in control of the Registrant.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions. The general partner of the Registrant is AFCA and the sole general partner of AFCA is America First Companies L.L.C..\nExcept as described herein, the Registrant is not a party to any transaction or proposed transaction with AFCA , America First Companies L.L.C. or with any person who is: (i) a manager or executive officer of America First Companies L.L.C.; (ii) a nominee for election as a manager of America First Companies L.L.C.; (iii) an owner of more than 5% of the BUCs; or, (iv) a member of the immediate family of any of the foregoing persons.\nDuring 1995, the Registrant paid or reimbursed AFCA $565,149 or America First Companies L.L.C. for certain costs and expenses incurred in connection with the operation of the Registrant, including legal and accounting fees and investor communication costs, such as printing and mailing charges. See Note 6 to Notes to Financial Statements filed in response to Item 8 hereof for a description of these costs and expenses.\nThe Registrant has entered into property management agreements with America First Properties Management, Inc. (the \"Manager\") with respect to the day-to-day operation of Ashley Square and Northwoods Lake Apartments. Such property management agreements provide that the Manager is entitled to receive a management fee equal to a stated percentage of the gross revenues generated by the property under management. Management fees payable to the Manager range from 4.5% to 5% of gross revenues. Because the Manager is an affiliate of AFCA the management fees payable by the Registrant to the Manager may not exceed the lesser of (i) the rates that the Registrant would pay an unaffiliated manager for similar services in the same geographic location or (ii) the Manager's actual cost for providing such services. During the year ended December 31, 1995, the Registrant paid the Manager property management fees of $202,166.\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:\n1A. Financial Statements of the Registrant. The following financial statements of the Registrant are included in response to Item 8 of this report:\nIndependent Accountants' Report dated March 22, 1996.\nBalance Sheets of the Registrant as of December 31, 1995, and December 31, 1994.\nStatements of Income of the Registrant for the years ended December 31, 1995, December 31, 1994, and December 31, 1993.\nStatements of Partners' Capital of the Registrant for the years ended December 31, 1995, December 31, 1994, and December 31, 1993.\nStatements of Cash Flows of the Registrant for the years ended December 31, 1995, December 31, 1994, and December 31, 1993.\nNotes to Financial Statements of the Registrant.\nB. Financial Statements of Northwood Lake Apartments (the \"Property\"). The following financial statements of the Property are included in response to Item 8 of this report:\nIndependent Accountants' Report dated January 26, 1996.\nBalance Sheet of the Property as of December 31, 1995.\nStatement of Income of the Property for the year ended December 31, 1995.\nStatement of Partners' Capital of the Property for the year ended December 31, 1995.\nStatement of Cash Flows of the Property for the year ended December 31, 1995.\nNotes to Financial Statements of the Property.\n2. Financial Statement Schedules. The information required to be set forth in the financial statement schedules is shown in the Notes to Financial Statements filed in response to Item 8 hereof.\n3. Exhibits. The following exhibits were filed as required by Item 14(c) of this report. Exhibit numbers refer to the paragraph numbers under Rule 601 of Regulation S-K:\n3. Articles of Incorporation and Bylaws of America First Fiduciary Corporation Number Five (incorporated herein by reference to Form S-11 Registration Statement filed August 30, 1985, with the Securities and Exchange Commission by America First Tax Exempt Mortgage Fund Limited Partnership (Commission File No. 2-99997)).\n4(a).Agreement of Limited Partnership dated November 11, 1985, (incorporated herein by reference to Form 10-K dated December 31, 1986, filed pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 by America First Tax Exempt Mortgage Fund Limited Partnership (Commission File No. 0-14314)).\n4(b).Form of Certificate of Beneficial Unit Certificate (incorporated by reference to Form S-11 Registration Statement filed August 30, 1985 with the Securities and Exchange Commission by America First Tax Exempt Mortgage Fund Limited Partnership (Commission File No. 2-99997)).\n24. Power of Attorney.\n(b) The Registrant did not file any reports on Form 8-K during the last quarter of the period covered by this report.\nIndependent Accountants' Report\nTo the Partners America First Tax Exempt Mortgage Fund Limited Partnership:\nWe have audited the accompanying balance sheets of America First Tax Exempt Mortgage Fund Limited Partnership as of December 31, 1995 and 1994, and the related statements of income, partners' capital and cash flows for each of the three years in the period ended December 31, 1995. 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 America First Tax Exempt Mortgage Fund Limited Partnership as of December 31, 1995, and 1994, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\nOmaha, Nebraska March 22, 1996 Coopers & Lybrand L.L.P.\nAMERICA FIRST TAX EXEMPT MORTGAGE FUND LIMITED PARTNERSHIP BALANCE SHEETS\nAMERICA FIRST TAX EXEMPT MORTGAGE FUND LIMITED PARTNERSHIP STATEMENTS OF INCOME\nAMERICA FIRST TAX EXEMPT MORTGAGE FUND LIMITED PARTNERSHIP STATEMENTS OF PARTNERS' CAPITAL FROM DECEMBER 31, 1992 TO DECEMBER 31, 1995\nAMERICA FIRST TAX EXEMPT MORTGAGE FUND LIMITED PARTNERSHIP STATEMENTS OF CASH FLOWS\nAMERICA FIRST TAX EXEMPT MORTGAGE FUND LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995\n1. ORGANIZATION\nAmerica First Tax Exempt Mortgage Fund Limited Partnership (the Partnership) was formed on November 11, 1985, under the Delaware Revised Uniform Limited Partnership Act for the purpose of acquiring a portfolio of federally tax-exempt participating first mortgage loans collateralized by income-producing real estate consisting of multifamily residential apartments. The Partnership will terminate on December 31, 2015, unless terminated earlier under the provisions of the Partnership Agreement. The General Partner of the Partnership is America First Capital Associates Limited Partnership Two (AFCA 2).\nOn May 7, 1993, the Partnership announced the formation of a subsidiary company, America First REIT, Inc., a real estate investment trust. On June 1, 1993, the Partnership transferred the seven real estate properties acquired in settlement of loans along with related debt, cash, and certain of the Partnership's other assets and liabilities to the REIT in exchange for all of the issued and outstanding shares of the REIT's common stock. Thereafter, the Partnership distributed all shares of the REIT to the BUC Holders in the ratio of one share of REIT stock for every four BUCs they held as of the record date, May 21, 1993.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nA)Method of Accounting The financial statements of the Partnership are prepared on the accrual basis of accounting in accordance with generally accepted accounting principles.\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nB)Investment in Tax-Exempt Mortgage Loans The Partnership records its investment in tax-exempt mortgage loans at cost. Accrual of mortgage interest income is excluded from income, when, in the opinion of management, collection of such interest is doubtful. This interest is recognized as income when it is received.\nC)Allowance for Loan Losses The allowance for loan losses is a valuation reserve which has been established at a level that management feels is adequate to absorb potential losses on outstanding loans. Reserves are established for loans which the Partnership considers impaired. Loans are considered impaired when it is probable that the Partnership will be unable to collect amounts due according to the contractual terms of the loan agreements. Based on this analysis, all loans were considered impaired at December 31, 1995. A reserve is established for the difference between the recorded investment in the mortgage loan and the fair value of the underlying collateral. Financial Accounting Standard (FAS) No. 114 \"Accounting by Creditors for Impairment of a Loan\" had no effect on the Partnership's financial statements.\nThe fair value of the collateral is based on management's best estimate of the net realizable value of the properties; however the ultimate realized values may vary from these estimates. The net realizable value of the properties is determined based on the discounted estimated future cash flows from the properties, including estimated sales proceeds. The calculation of discounted estimated future cash flows includes certain variables such as the assumed inflation rates for rents and expenses, capitalization rates and discount rates. These variables are supplied to the Partnership by an independent real estate appraisal firm based upon local market conditions for each property. In certain cases, additional factors such as the replacement value of the property or comparable sales of similar properties are also taken into consideration. The allowance is periodically reviewed and adjustments are made to the allowance when there are significant changes in the estimated net realizable value of the underlying collateral.\nAMERICA FIRST TAX EXEMPT MORTGAGE FUND LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995\nD)Depreciation Depreciation on the real estate properties prior to the transfer to the REIT is based on the estimated useful life of the property (27 1\/2 years) using the straight-line method.\nE)Income Taxes No provision has been made for income taxes since the Beneficial Unit Certificate (BUC) Holders are required to report their share of the Partnership's taxable income for federal and state income tax purposes. The tax basis of the Partnership's assets and liabilities exceeded the reported amounts by $11,053,597 at December 31, 1995, and December 31, 1994.\nF)Temporary Cash Investments Temporary cash investments are invested in federally tax-exempt securities purchased with an original maturity of three months or less.\nG)Net Income per BUC Net income per BUC has been calculated based on the number of BUCs outstanding (9,979,128) for all years presented.\n3. PARTNERSHIP INCOME, EXPENSES AND CASH DISTRIBUTIONS\nThe Partnership Agreement contains provisions for the distribution of Net Interest Income and Net Residual Proceeds and for the allocation of income and expenses for tax purposes among AFCA 2 and BUC Holders. Income and expenses will be allocated to each BUC Holder on a monthly basis based on the number of BUCs held by each BUC Holder as of the last day of the month for which such allocation is to be made. Distributions of Net Interest Income and Net Residual Proceeds will be made to each BUC Holder of record on the last day of each distribution period based on the number of BUCs held by each BUC Holder as of such date.\nNet Interest Income, as defined in the Limited Partnership Agreement, in each distribution period will be distributed 99% to the BUC Holders and 1% to AFCA 2 until the BUC Holders have received distributions of Net Interest Income equal to a cumulative noncompounded annual return of 11% on their Adjusted Capital Contributions, as defined in the Limited Partnership Agreement, at which point all remaining Net Interest Income for such distribution period will be distributed 90% to the BUC Holders and 10% to AFCA 2.\nThe portion of Net Residual Proceeds, as defined in the Limited Partnership Agreement, representing a return of principal will be distributed 100% to the BUC Holders. The portion of Net Residual Proceeds representing contingent interest will be distributed 100% to the BUC Holders until the BUC Holders have received distributions from all sources which represent a return of $20 per BUC plus an amount equal to a cumulative noncompounded annual return of 11% on their Adjusted Capital Contributions. Any remaining Net Residual Proceeds representing contingent interest will be allocated 100% to AFCA 2 to the extent of 10% of all Net Residual Proceeds representing contingent interest distributed to all parties exclusive of the following described amounts. Thereafter, any remaining Net Residual Proceeds representing contingent interest will be distributed 90% to BUC Holders and 10% to AFCA 2. Notwithstanding the foregoing, Net Interest Income representing contingent interest and Net Residual Proceeds representing contingent interest in an amount equal to .9% per annum of the principal amount of the mortgage loans on a cumulative basis will be distributed 75% to the BUC Holders and 25% to AFCA 2.\nLiquidation Proceeds, as defined in the Limited Partnership Agreement, remaining after repayment of any debts or obligations of the Partnership (including loans from AFCA 2) and after the establishment of any reserve AFCA 2 deems necessary, will be distributed to AFCA 2 and BUC Holders to the extent of positive balances in their capital accounts. Any remaining Liquidation Proceeds will be distributed in the same manner as the Net Residual Proceeds.\nCash distributions are presently made on a monthly basis, but may be made quarterly if AFCA 2 so elects. The cash distributions included in the financial statements represent the actual cash distributions made during each year and the cash distributions accrued at the end of each year.\nAMERICA FIRST TAX EXEMPT MORTGAGE FUND LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995\n4. PARTNERSHIP RESERVE ACCOUNT\nThe Partnership maintains a reserve account which totaled $1,073,700 at December 31, 1995. The reserve account was established to maintain working capital for the Partnership and is available to supplement distributions to BUC Holders or for any other contingencies related to the ownership of the mortgage loans and the operation of the Partnership.\n5. INVESTMENT IN TAX-EXEMPT MORTGAGE LOANS\nThe mortgage loans are issued by various state and local governments, their agencies and authorities to finance the construction or rehabilitation of income-producing real estate properties. However, the mortgage loans do not constitute an obligation of any state or local government, agency or authority and no state or local government, agency or authority is liable on them, nor is the taxing power of any state or local government pledged to the payment of principal or interest on the mortgage loans. The mortgage loans are nonrecourse obligations of the respective owners of the properties. The sole source of the funds to pay principal and interest on the mortgage loans is the net cash flow or the sale or refinancing proceeds from the properties. Each mortgage loan, however, is collateralized by a first mortgage on all real and personal property included in the related property and an assignment of rents.\nThe mortgage loans provide for the payment of base interest and for the payment of additional contingent interest out of a portion of the net cash flow of the properties or out of a portion of the sale or refinancing proceeds from the properties, subject to various priority payments. The principal of the mortgage loans will not be amortized during the terms of the mortgage loans, but will be required to be repaid in lump sum payments at the expiration of their terms. The Partnership has the right to require prepayment of any mortgage loan at any time after the tenth year of such mortgage loan and each mortgage loan will be prepaid to the Partnership by its terms on the first day of its thirteenth year. The mortgage loans are due and payable upon the sale of the related properties. Accordingly, the Partnership does not expect to hold any mortgage loan for more than 12 years. The Partnership may waive compliance with any of the terms of the mortgage loans.\nAMERICA FIRST TAX EXEMPT MORTGAGE FUND LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995\nDescriptions of the tax-exempt mortgage loans owned by the Partnership at December 31, 1995, are as follows:\n1 In addition to the base interest rates shown, the notes bear additional contingent interest as defined in each revenue note which, when combined with the base interest, is limited to a cumulative, noncompounded amount not greater than 16% per annum. The Partnership received additional contingent interest from Arama Apartments of $166,940 in 1995, $211,319 in 1994 and $192,343 in 1993.\n2 Nonperforming loans are loans which are not fully current as to interest payments. The amount of foregone interest on nonperforming loans was $442,279 in 1995, $606,921 in 1994 and $1,051,772 in 1993.\nAMERICA FIRST TAX EXEMPT MORTGAGE FUND LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995\nUnaudited combined condensed financial information of the properties collateralizing the Partnership's investment in tax-exempt mortgage loans is as follows:\nAFCA 2 received from property owners administrative fees of $54,450, $54,450 and $54,456 in 1995, 1994 and 1993, respectively. Since these fees are not Partnership expenses, they have not been reflected in the accompanying financial statements. In addition, pursuant to the Limited Partnership Agreement, AFCA 2 is entitled to an administrative fee from the Partnership in the event the Partnership becomes the equity owner of a property by reason of foreclosure. The amount of such fees paid to AFCA 2 was $188,569 for 1993. The Partnership has not paid any administrative fees subsequent to June 1, 1993, when all foreclosed properties were transferred to the REIT. AFCA 2 was entitled to receive approximately $359,000 in administrative fees from the Partnership for the year ended December 31, 1989. The payment of these fees, which has been deferred by AFCA 2, is contingent upon, and will be paid only out of future profits realized by the Partnership from the disposition of assets. This amount will be recorded as an expense by the Partnership when it is probable that these fees will be paid.\nAn affiliate of AFCA 2 was retained to provide property management services for Ashley Square and Northwoods Lake Apartments. The fees for services provided represent the lower of (i) costs incurred in providing management of the property, or (ii) customary fees for such services determined on a competitive basis, and amounted to $202,166 in 1995, $164,490 in 1994 and $144,285 in 1993. Property management fees of $190,661 were paid from January 1, 1993, through May 31, 1993, for the properties transferred to the REIT.\nThe Partnership incurred expenses in conjunction with the distribution of REIT stock totaling $259,627 in 1993 ($173,103 was paid by an affiliate and reimbursed by the Partnership and $86,524 was paid directly by the Partnership).\nAMERICA FIRST TAX EXEMPT MORTGAGE FUND LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995\n7. Summary of Unaudited Quarterly Results of Operations\nThe BUCs are quoted on the NASDAQ National Market System under the symbol AFTXZ. The high and low quarterly prices of the BUCs shown were compiled from the Monthly Statistical Reports provided to the Partnership by the National Association of Securities Dealers, Inc. and represent final sale prices.\nNORTHWOOD LAKE APARTMENTS, L.P. \t(A Georgia Limited Partnership) \t \tFINANCIAL STATEMENTS\n\tDECEMBER 31, 1995\n-i- T A B L E O F C O N T E N T S\nPage\nAUDITORS' REPORT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1\nFINANCIAL STATEMENTS\nBALANCE SHEET. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2\nSTATEMENT OF INCOME (UNAUDITED). . . . . . . . . . . . . . . . . . . . .\t 3\nSTATEMENT OF CHANGES IN PARTNERS' EQUITY (DEFICIT) (UNAUDITED). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . \t\t3\nSTATEMENT OF CASH FLOWS (UNAUDITED). . . . . . . . . . . . . . . . . . . . \t\t4\nNOTES TO FINANCIAL STATEMENTS. . . . . . . . . . . . . . . . . . . . . . .\t 5-6\n-ii- To the Partners Northwood Lake Apartments, L.P. Omaha, Nebraska\nINDEPENDENT AUDITORS' REPORT\nWe have audited the accompanying balance sheet of Northwood Lake Apartments, L.P., (a Georgia Limited Partnership), (\"the Partnership\"), as of December 31, 1995. This financial statement is the responsibility of the Partnership's management. Our responsibility is to express an opinion on this financial statement based on our audit.\nExcept as discussed in the following paragraph, we 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 balance sheet is free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the balance sheet. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall balance sheet presentation. We believe that our audit provides a reasonable basis for our opinion.\nThis was our first audit of the Partnership's balance sheet, and, in accordance with management's instructions, we did not extend our auditing procedures to enable us to express, and we do not express, an opinion on the consistency of application of accounting principles with the preceding year. Because we were not engaged to audit the statements of income, retained earnings, and cash flows, we did not extend our auditing procedures to enable us to express an opinion on results of operations and cash flows for the year ended December 31, 1995. Accordingly, we express no opinion on them.\nIn our opinion, the balance sheet referred to above presents fairly, in all material respects, the financial position of Northwood Lake Apartments, L.P., as of December 31, 1995, in conformity with generally accepted accounting principles.\nThe accompanying balance sheet has been prepared assuming that the Partnership will continue as a going concern. As discussed in Note 8 to the financial statements, the Partnership has experienced recurring losses from operations and has a working capital and a net capital deficiency that raise substantial doubt about the Partnership's ability to continue as a going concern. The accompanying financial statements do not include any adjustments that might result from the outcome of this uncertainty.\nMueller, Prost, Purk & Willbrand, P.C. January 26, 1996\t Certified Public Accountants\nFINANCIAL STATEMENTS\nNORTHWOOD LAKE APARTMENTS, L.P. (A Georgia Limited Partnership) BALANCE SHEET DECEMBER 31, 1995\nThe Notes to Financial Statements are an integral part of this statement\nNORTHWOOD LAKE APARTMENTS, L.P. (A Georgia Limited Partnership) STATEMENT OF INCOME (UNAUDITED) FOR THE YEAR ENDED DECEMBER 31, 1995\nNORTHWOOD LAKE APARTMENTS, L.P. STATEMENT OF CHANGES IN PARTNERS' EQUITY (DEFICIT) (UNAUDITED) FOR THE YEAR ENDED DECEMBER 31, 1995\nThe Notes to Financial Statements are an integral part of this statement NORTHWOOD LAKE APARTMENTS, L.P. (A Georgia Limited Partnership) STATEMENT OF CASH FLOWS (UNAUDITED) FOR THE YEAR ENDED DECEMBER 31, 1995\nThe Notes to Financial Statements are an integral part of this statement \t\nNORTHWOOD LAKE APARTMENTS, L.P. (A Georgia Limited Partnership) NOTES TO FINANCIAL STATEMENTS\nNOTE 1 \tORGANIZATION\nNorthwood Lake Apartments, L.P., a Georgia Limited Partnership, (the \"Partnership\"), was formed on February 22, 1993, pursuant to the terms of an Agreement of Limited Partnership (the \"Agreement\") for the purpose of acquiring and operating the Northwood Lake Apartments complex, a 492-unit apartment complex located in Duluth, Georgia (the \"Project\"). The Partnership will dissolve on December 31, 2013, unless sooner dissolved pursuant to any provision of the Partnership agreement.\nThe general partner of the Partnership is First Communities Equities, Inc., a Georgia corporation, which owns a 1% interest. As the limited partner with a 99% interest, Robert L. Johnston's liability is limited to his total amount of capital contributions. The net income or loss of the Partnership is allocated among the partners in accordance with their respective percentage interests.\nNOTE 2 \tSUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nMethod of Accounting\nThe accompanying financial statements have been prepared on the accrual basis of accounting. The Project reports its operating results for income tax purposes on the cash basis. No provision for income taxes is made because any liability for income taxes is that of the individual partners and not that of the Project.\nUse of Estimates\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from estimated amounts.\n\t\tConcentration of Credit Risk\nThe Project maintains the majority of its cash balances in one financial institution. The balances are insured by the Federal Deposit Insurance Corporation up to $100,000. At December 31, 1995, the Project's uninsured cash balances totaled $178,125.\nBad Debts (Unaudited)\nThe Project records bad debts using the allowance for doubtful accounts method. No bad debt expense was recorded for the period ended December 31, 1995.\n\t\tProperty and Equipment (Unaudited)\nProperty and equipment are recorded at cost. Major additions and improvements are capitalized to the property accounts while replacements, maintenance and repairs which do not improve or extend the useful life of the respective assets are expensed currently.\nDepreciation is calculated using the straight-line method over estimated useful lives ranging from 10 to 40 years. The total depreciation expensed in 1995 was $677,363.\nNOTE 3\t STATEMENT OF CASH FLOWS (UNAUDITED)\nFor purposes of the statement of cash flows, the Project considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.\nCash paid during the year for:\nInterest...............................................\t$\t\t1,932,147 NORTHWOOD LAKE APARTMENTS, L.P. (A Georgia Limited Partnership) NOTES TO FINANCIAL STATEMENTS (CONTINUED)\nNOTE 4\t RESTRICTED DEPOSITS AND FUNDED RESERVES\nTaxes and insurance escrow reserves, consisting of money market funds, are maintained under the control of the mortgage note holder for the benefit of the Project in an interest-bearing account with a federally insured financial institution. Disbursements from the escrow are for real estate taxes and insurance premiums. Interest earned on the funds is transferred to operating cash quarterly.\nReserve for Replacements are maintained under the control of the mortgage noteholder for the benefit of the Project in an interest bearing account with a federally insured financial institution. The mortgage requires a monthly payment of $5,260 to be used for future major capital improvements to the Project.\nNOTE 5\t ACCRUED INTEREST PAYABLE\nSince 1990, the Project's cash flows have been insufficient to pay the base interest due on the mortgage payable. The $2,094,629 accrued interest payable at December 31, 1995, represents the cumulative shortfall to date.\nNOTE 6\t MORTGAGE PAYABLE\nThe financing of the condominium complex has been provided by America First Tax Exempt Mortgage Fund Limited Partnership, utilizing proceeds of the Multi-Family Mortgage Revenue Note, Series 1985, issued by the Housing Authority of the City of Buford, Georgia.\nThe note is secured by a Deed of Trust on the income producing property, assignment of rents and a security agreement. The note, amended as of April 1, 1991, has a term of 10 years from the date of the amendment. The note bears interest at 8.5% and contingent interest at 16%. The accrued base interest will be paid according to the priority of cash flows set forth in the amended note. Any contingent interest that is not paid will be deferred without interest and paid in arrears.\nNOTE 7\t MANAGEMENT FEE TRANSACTIONS (UNAUDITED)\nThe Project is required to pay America First Properties Management, Inc. a management fee of 4.5% of gross collected receipts. Management fees amounted to $162,552 for the year ended December 31, 1995. Included in accounts payable at December 31, 1995, is $8,645 due to America First Properties Management, Inc.\nAmerica First Properties Management, Inc., also charges an administrative service charge of $1 per unit per month to offset the costs of providing management and administrative services to the Project. Administrative service charges for 1995 are $15,567.\nNOTE 8\t GOING CONCERN CONSIDERATIONS\nThe Partnership has recurring losses, a working capital deficiency and a $3,647,052 deficit in partners' capital at December 31, 1995. In addition, the mortgage payable is delinquent and accrued interest is not being paid in full each year. These considerations raise substantial doubt about the Partnership's ability to continue as a going concern for a reasonable period of time.\nManagement has stated that the mortgagee has elected not to foreclose on the mortgage due to current satisfaction of yield and a desire to keep the bonds current. Furthermore, although there is a large interest accrual, the mortgagee has no intention of accelerating the debt.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nAMERICA FIRST TAX EXEMPT MORTGAGE FUND LIMITED PARTNERSHIP\nBy America First Capital Associates Limited Partnership Two, General Partner of the Registrant\nBy America First Companies L.L.C., General Partner of America First Capital Associates Limited Partnership Two\nBy \/s\/ Michael Thesing Michael Thesing, Vice President\nDate: March 27, 1996\nPursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nDate: March 27, 1996 By \/s\/ Michael B. Yanney* Michael B. Yanney, Chairman of the Board, President, Chief Executive Officer and Manager\nDate: March 27, 1996 By \/s\/ Michael Thesing Michael Thesing, Vice President, Secretary, Treasurer and Manager, (Chief Financial and Accounting Officer)\nDate: March 27, 1996 By \/s\/ William S. Carter, M.D.* William S. Carter, M.D., Manager\nDate: March 27, 1996 By George Kubat, Manager\nDate: March 27, 1996 By \/s\/ Martin Massengale* Martin Massengale, Manager\nDate: March 27, 1996 By \/s\/ Alan Baer* Alan Baer, Manager\nDate: March 27, 1996 By \/s\/ Gail Walling Yanney* Gail Walling Yanney Manager\n*By Michael Thesing, Attorney-in-Fact\n\/s\/ Michael Thesing Michael Thesing\nEXHIBIT 24\nPOWER OF ATTORNEY\nPOWER OF ATTORNEY\nThe undersigned hereby appoints Michael Thesing as his agent and attorney-in-fact for the purpose of executing and filing all reports on Form 10-K relating to the year ending December 31, 1995, and any amendments thereto, required to be filed with the Securities and Exchange Commission by the following persons:\n\t\tAmerica First Tax-Exempt Mortgage Fund Limited Partnership \t\tAmerica First Tax-Exempt Mortgage Fund 2 Limited Partnership \t\tAmerica First Participating\/Preferred Equity Mortgage Fund \t\tAmerica First PREP Fund 2 Limited Partnership \t\tAmerica First PREP Fund 2 Pension Series Limited Partnership \t\tCapital Source L.P. \t\tCapital Source II L.P.\nIN WITNESS WHEREOF, the undersigned has executed this Power of Attorney on the 10th day of March, 1996.\n\t\t\t\t\t\t\t \/s\/ Michael B. Yanney \t\t\t\t\t\t\tMichael B. Yanney\nPOWER OF ATTORNEY\nThe undersigned hereby appoints Michael Thesing as his agent and attorney-in-fact for the purpose of executing and filing all reports on Form 10-K relating to the year ending December 31, 1995, and any amendments thereto, required to be filed with the Securities and Exchange Commission by the following persons:\n\t\t America First Tax-Exempt Mortgage Fund Limited Partnership \t\t America First Tax-Exempt Mortgage Fund 2 Limited Partnership \t\tAmerica First Participating\/Preferred Equity Mortgage Fund \t\tAmerica First PREP Fund 2 Limited Partnership \t\tAmerica First PREP Fund 2 Pension Series Limited Partnership\nIN WITNESS WHEREOF, the undersigned has executed this Power of Attorney on the 2nd day of March, 1996.\n\t\t\t\t\t\t\t \/s\/ William S. Carter \t\t\t\t\t\t\tWilliam S. Carter, M.D.\nPOWER OF ATTORNEY\nThe undersigned hereby appoints Michael Thesing as his agent and attorney-in-fact for the purpose of executing and filing all reports on Form 10-K relating to the year ending December 31, 1995, and any amendments thereto, required to be filed with the Securities and Exchange Commission by the following persons:\n\t\t America First Tax-Exempt Mortgage Fund Limited Partnership \t\tAmerica First Tax-Exempt Mortgage Fund 2 Limited Partnership \t\tAmerica First Participating\/Preferred Equity Mortgage Fund \t\tAmerica First PREP Fund 2 Limited Partnership \t\tAmerica First PREP Fund 2 Pension Series Limited Partnership\nIN WITNESS WHEREOF, the undersigned has executed this Power of Attorney on the 25th day of March, 1996.\n\t\t\t\t\t \/s\/ Gail Walling Yanney \t\t\t\t\t\t\tGail Walling Yanney\nPOWER OF ATTORNEY\nThe undersigned hereby appoints Michael Thesing as his agent and attorney-in-fact for the purpose of executing and filing all reports on Form 10-K relating to the year ending December 31, 1995, and any amendments thereto, required to be filed with the Securities and Exchange Commission by the following persons:\n\t\t America First Tax-Exempt Mortgage Fund Limited Partnership \t\tAmerica First Tax-Exempt Mortgage Fund 2 Limited Partnership \t\tAmerica First Participating\/Preferred Equity Mortgage Fund \t\tAmerica First PREP Fund 2 Limited Partnership \t\tAmerica First PREP Fund 2 Pension Series Limited Partnership\nIN WITNESS WHEREOF, the undersigned has executed this Power of Attorney on the 2nd day of March, 1996.\n\t\t\t\t\t\t\t \/s\/ Martin Massingale \t\t\t\t\t\t\tMartin Massingale\nPOWER OF ATTORNEY\nThe undersigned hereby appoints Michael Thesing as his agent and attorney-in-fact for the purpose of executing and filing all reports on Form 10-K relating to the year ending December 31, 1995, and any amendments thereto, required to be filed with the Securities and Exchange Commission by the following persons:\n\t\t America First Tax-Exempt Mortgage Fund Limited Partnership \t\tAmerica First Tax-Exempt Mortgage Fund 2 Limited Partnership \t\tAmerica First Participating\/Preferred Equity Mortgage Fund \t\tAmerica First PREP Fund 2 Limited Partnership \t\tAmerica First PREP Fund 2 Pension Series Limited Partnership\nIN WITNESS WHEREOF, the undersigned has executed this Power of Attorney on the 3rd day of March, 1996.\n\t\t\t\t\t\t\t \/s\/ Alan Baer \t\t\t\t\t\t\tAlan Baer","section_15":""}
{"filename":"37755_1995.txt","cik":"37755","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nFuron(R) designs, develops and manufactures highly engineered components made primarily from specially formulated high performance polymer materials. Most of Furon's products are designed and engineered to meet specific requirements of customers in the industrial process, transportation, industrial equipment, electronics and healthcare industries.\nThe Company has historically expanded its operations through the acquisition and further development of businesses which manufacture and sell components to original equipment manufacturers and which possess similar technologies and serve similar markets. On January 31, 1995 the Company complemented the CHR(TM) brand of products that it acquired in 1989 with the acquisition of Custom Coating & Laminating Corporation's business devoted to the manufacture and sale of customized and standard specialty engineered products which rely on surface chemistry technology. (See Note 10 of the \"Notes to Consolidated Financial Statements\" for additional information concerning this acquisition.)\nIn addition to its acquisition activities, the Company has developed its business through the introduction of new product lines and improvements in its existing products and capabilities and operational methodologies. For example, in addition to the reorganization of its operations described below, the Company believes that its World Class Performance program continues to improve its operations through improved product quality and performance features, improved customer service, minimization of waste, manufacturing costs and inventories, reduced cycle times and increased employee productivity and involvement. Further, the Company continues to focus its technology center on the development of proprietary polymer compounds that can be used to produce high margin, differentiated polymer products.\nIn January 1992, the Company announced a restructuring program designed to improve profitability and sharpen the Company's focus on its higher margin materials technology operations and other primary objectives and strengths. An integral component of the restructuring was the divestiture of six businesses which were determined to no longer fit the Company's long-term strategic objectives. The Company sold two of the businesses in fiscal 1993 and three in fiscal 1994 and is pursuing the sale of the remaining business. For additional information concerning the restructuring program, see Note 2 of the \"Notes to Consolidated Financial Statements.\"\nFuron was incorporated in California in 1957 and changed its name from \"The Fluorocarbon Company\" to \"Furon Company\" in January 1990. Unless the context otherwise requires, the terms \"Furon\" and the \"Company\" are used in this report to refer to Furon Company and its subsidiaries.\n- ------------------ (R)Furon is a registered trademark and (TM) CHR is a trademark of the Company.\nOPERATIONS\nHistorically, the Company has conducted its operations in independent business units developed and organized around manufacturing capabilities and products and grouped from time to time based on varying product, market or other criteria. As part of the restructuring program, the Company began reorganizing its operations around its customers and strategic industries, rather than products, by introducing a new organizational structure that provided a flatter organization. This eliminated certain levels of operating group management and established a more market oriented focus by combining businesses to maximize the synergies of business units with complementary products and manufacturing capabilities. In fiscal 1995, the Company consolidated the diverse independent business unit operations into one Furon operating unit that is organized around customers in the industrial process, transportation, industrial equipment, electronics and healthcare industries. The Company believes that its current organizational structure will enable it to better serve its customers and grow its customer base, eliminate redundancies and other inefficiencies, and more fully leverage its technologies and other capabilities.\nMARKETS AND PRODUCTS\nThe Company principally serves the industrial process, transportation, industrial equipment, electronics and healthcare industries, offering the following FURON(R) brand products: CHR(TM) pressure sensitive tapes, solid and sponge silicone rubber, PTFE and silicone coated fabrics, and release liners; DEKORON(R) control and instrumentation cable and wire, self-regulating heating and fiber optics cable; FELSTED(R) cables, control cables, and control systems; FLEXSEAL(TM) spiral wound and heat exchange metallic gaskets; FLOMED(TM) silicone rubber molded and extruded healthcare products; OMNISEAL(R) spring energized PTFE seals, lip seals, hydraulic seals, and metallic O-rings and C-rings; RULON(R) high performance polymer materials and molded, extruded and machined bearings and other components made from those materials; SYNFLEX(R) hydraulic hose, specialty hose, and tubing, couplings and accessories; UNITHERM(R) heated hose and steam traced, preinsulated and electrical traced tubing; and FURON(R) generic fabricated and extruded high performance plastic components, fluid handling products, and custom fabricated composite, urethane and polyimide foam components.\nFuron's sales are generated primarily by its own salespersons located in most major industrial areas. The remaining sales are made by independent manufacturers' representatives and distributors. Most of the Company's customers are original equipment manufacturers, commercial or industrial construction companies or firms servicing the maintenance and replacement parts market or distributors to these markets. The Company's business is not dependent upon a single customer, or a few customers, and no single customer accounted for more than 5% of Furon's sales volume during any of the last three fiscal years. (For certain financial information concerning the Company's foreign and domestic operations and export sales, see Note 9 of the \"Notes to Consolidated Financial Statements.\")\n- ------------------ (R)FURON, DEKORON, FELSTED, OMNISEAL, RULON, SYNFLEX and UNITHERM are registered trademarks, and (TM)CHR, FLEXSEAL and FLOMED are trademarks, of the Company.\nCOMPETITION\nThe Company competes with a large number of companies, some of which have greater financial resources, but none of which competes with the Company in more than a limited number of products. Depending on the product, the principal competitive factors for Furon are materials capability, engineering, design and process technology, quality, reliability and the ability to meet delivery dates. The Company believes that trade secrets are important to its proprietary products. To protect its trade secrets, the Company requires all salaried employees to enter into confidentiality agreements. While the Company holds many patents and trademarks with varying degrees of significance to its operations, the Company's business is not dependent upon any particular one.\nBACKLOG OF ORDERS\nFuron's backlog of unfilled orders at January 28, 1995 was $50,629,000 and $49,798,000 at January 29, 1994, a 2% increase. The backlog for continuing operations increased 5% to $49,785,000 at the end of fiscal 1995, from $47,450,000 the prior year. The increases in backlog reflect demand from most all industry groups served with the exception of the aerospace and commercial aircraft marketplace, whose orders were virtually flat. The most significant increases in orders resulted from strong demand in chemical processing, transportation and mobile equipment markets.\nIt is estimated that substantially all of Furon's backlog of orders at January 28, 1995 will be filled during the next 12 months, except for approximately $35,000 of backlog which is scheduled to be filled during the subsequent 12-month period. The lead time between receipt of orders and shipment of products, other than products for commercial aircraft, is typically a matter of weeks. Although many of Furon's orders contain cancellation clauses, Furon has seldom experienced significant cancellations of orders.\nRAW MATERIALS\nFuron purchases its raw materials, ranging from polymer resins to component parts, from numerous suppliers. The top resins used by the Company are PTFE and related resins, Nylon 11 sold under the trade name Rilsan(R), and silicone polymers. The Company purchases its requirements for PTFE and related resins and silicone polymers from the major suppliers of those resins, while Atochem Polymers is the Company's sole source for Rilsan. Rilsan is used primarily in the production of heavy duty air brake tubing. Alternative sources of material which can be substituted for Rilsan are available in the event a shortage of Rilsan develops.\nRESEARCH AND DEVELOPMENT\nFor information concerning the amounts spent by the Company during the last three fiscal years on research and development activities, see Note 1 of the \"Notes to Consolidated Financial Statements.\"\nEMPLOYEES\nAt January 28, 1995, Furon employed 2,217 persons. Furon considers its employee relations to be good.\n- ------------------ (R)Rilsan is a registered trademark of Atochem Polymers.\nENVIRONMENTAL LAWS\nThe Company from time to time incurs investigation, remedial response, voluntary clean-up and other costs associated with environmental matters. As of January 28, 1995, the Company's reserves for environmental matters totaled approximately $2,400,000. These reserves primarily relate to environmental costs associated with facilities that have been sold or closed. While neither the timing nor the amount of the ultimate costs associated with environmental matters can be determined, management does not expect those matters to have a material adverse effect on the capital expenditures, earnings or competitive position of the Company.\nOne of the Company's subsidiaries has been notified by the Environmental Protection Agency that it has been named as a potentially responsible party in connection with the cleanup of hazardous wastes at two sites, the Solvents Recovery Service of New England site in Southington, Connecticut (notified in June 1992), and the Gallups Quarry site in Plainfield, Connecticut (notified in April 1993). Since these matters are in their preliminary stages, no assurance can be given at this time concerning the ultimate outcome. However, based on preliminary investigations to determine the nature of the subsidiary's potential liability and the estimated amount of remedial costs necessary to clean up the sites, the Company presently does not expect these matters to have a material adverse effect on its consolidated financial position or results of operations. For information concerning an additional environmental proceeding in which the subsidiary is involved, see \"Legal Proceedings\" at Item 3 (Part I) of this report.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company currently manufactures its products at 23 plants of which 20 are in the United States, 2 in Belgium and 1 in England. Furon believes that its facilities are suitable for its business and adequate for its present needs, and that appropriate additional or substitute space is available, if needed, to accommodate physical expansion of the business in the foreseeable future. Certain information regarding the Company's plants is set forth below.\n(1) Assumes that existing renewal options are exercised. For further information concerning the Company's lease commitments, see Note 5 of the \"Notes to Consolidated Financial Statements.\"\n(2) Plants owned by the Company; all other plants listed above are leased.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is from time to time named as a defendant in various lawsuits. The Company vigorously defends all lawsuits brought against it, unless a reasonable settlement appears appropriate. The Company believes that the ultimate resolution of the actions currently pending should not have a material adverse effect on its consolidated financial condition.\nOn January 18, 1995, the Company and CHR Industries, Inc., a wholly owned subsidiary of the Company (\"CHR\"), were served with a civil complaint filed in the Superior Court of the State of Connecticut by the State's Commissioner of Environmental Protection. The plaintiff alleges that certain aspects of CHR's container management, discharges, record keeping and training violated the State's water pollution control laws and hazardous waste laws. The complaint seeks substantial penalties and injunctive relief from further violations of these laws. CHR is pursuing settlement negotiations with the State and expects to resolve this matter for an amount between $75,000 and $140,000 and appropriate injunctive relief.\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 year ended January 28, 1995.\nOFFICERS OF FURON\nFuron's executive and other officers are as follows:\nOTHER OFFICERS\nAll officers of the Company are elected annually by and serve at the pleasure of the Board of Directors. There are no family relationships among any of Furon's officers.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nThe Company's Common Stock has traded on the New York Stock Exchange under the trading symbol \"FCY\" since March 8, 1995. Previously, it traded on the NASDAQ National Market System under the trading symbol \"FCBN.\" As of March 20, 1995, the Company had approximately 1,211 holders of record of its Common Stock. The following table sets forth for the periods indicated (i) the high and low closing sale prices per share of the Company's Common Stock as reported by NASDAQ and (ii) the amount per share of cash dividends paid by the Company with respect to its Common Stock.\nFuture dividends will be considered by the Board of Directors taking into account the Company's profit levels and capital requirements as well as financial and other conditions existing at the time.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following selected consolidated financial data for the five years in the period ended January 28, 1995 should be read in conjunction with, and is qualified by, the more detailed information and consolidated financial statements included in Item 8 (Part II), \"Consolidated Financial Statements and Supplementary Data.\"\nITEM 6. SELECTED FINANCIAL DATA (CONTINUED)\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\nNet sales during fiscal year 1995 were 9% higher than in fiscal year 1994. When removing the effect of the businesses held for sale, sales increased 14%. The increases came from most all industry groups served with the exception of the aerospace and commercial aircraft marketplace, whose sales were virtually flat. The most significant increases in revenue resulted from strong demand in chemical processing, transportation and mobile equipment markets. Thermoplastic wire and cable, as well as truck controls and brake hose, hydraulic, pneumatic and paint hose, bearing and seals and tubing products were particularly strong. European operations also contributed with improved sales. A healthier economy in Europe provided improved demand across all product lines, and coupled with stronger foreign currency rates resulted in increased dollar sales.\nWhen comparing fiscal 1994, consolidated sales were 5% lower than in fiscal 1993. However, when removing the effect of the divested businesses, sales increased slightly.\nThe gross profit percentage for fiscal year 1995 has improved from 28.2% to 30.2% as compared to the prior fiscal year. The improvement in gross margin is primarily attributable to the Company's focus on increasing productivity and cost reduction. All components of cost of sales benefited this improved margin. When removing the impact of the business held for sale, the gross profit percentage improved from 29.2% to 30.7%. Most of this improvement is attributable to lower material and overhead costs as a percentage of sales. The gross profit percentage decreased from 28.7% in fiscal year 1993 to 28.2% in fiscal year 1994. This decrease was the result of increased material usage offset somewhat by reductions in variable overhead. When removing the effect of the divested business gross profit decreased from 30.4% in fiscal year 1993 to 29.2% in fiscal year 1994.\nSelling, general and administrative expenses as a percentage of sales were 24.8%, 23.3% and 23.9% for fiscal years 1995, 1994 and 1993, respectively. A portion of the increase is due to increased selling expense as the Company put forth significant efforts to improve its customer and market focus. General and administrative expenses have increased over the prior year mainly as a result of the implementation of the new operating structure, as discussed in Item 1 under \"Operations\". Significant expenditures include professional fees incurred in connection with various consulting projects, travel, communications and early phase out of information systems impacted by implementing the new strategy. Additionally, general and administrative expense was affected by costs associated with the search and evaluation of potential acquisition candidates. Research and development costs were up as the Company increased its focus on new product development.\nInterest expense decreased by 28% in fiscal year 1995 as compared to fiscal year 1994. Lower expense is due to a $6 million decrease in amounts owing under the Company's bank credit facility. Interest expense decreased 21% in fiscal year 1994 as compared to fiscal year 1993 for the same reason.\nPretax results of operations improved 36% from a profit of $13.0 million in fiscal year 1994 to a profit of $17.6 million in fiscal year 1995. This significant improvement in profitability is the result of higher sales volumes and substantially lower manufacturing cost as a percentage of sales. This combination, and a sustained reduction of interest expense, was more than enough to offset increased operating expenses incurred with implementing the new operating structure and strategy.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS (CONTINUED)\nSales from divested businesses represent 3%, 7%, and 12% of the revenue for fiscal years 1995, 1994 and 1993, respectively. Included in other expense (income) net, is the elimination of $500,000 and $363,000 of pretax profit from fiscal year 1995 and 1994, respectively, and $162,000 pretax loss from fiscal year 1993 for the divested businesses.\nThe Company's effective tax rate for fiscal year 1995 was 35% as compared to 37% in fiscal year 1994 and 42% in fiscal year 1993. The lower effective tax rate in fiscal 1995, as compared to fiscal year 1994, was primarily due to a reduction of the effect of foreign taxes as well as increased tax benefits from the Company's export sales corporation. The lower effective tax rate for the fiscal year 1994, as compared to fiscal year 1993, was primarily due to an increase in tax benefits realized from the amortization of certain intangibles, acquired in 1990, as a result of a resolution of an Internal Revenue Service audit.\nLIQUIDITY AND CAPITAL RESOURCES\nDuring fiscal year 1995, cash provided by operations decreased 62% over fiscal year 1994, to approximately $7.9 million. The decrease is primarily due to cash used to fund noncash working capital increases of $18.3 million ($2.8 million source of cash in fiscal 1994). The significant components of this change was the growth of both accounts receivable and inventory over the respective prior years. Heavy volume of shipments in late January and a build up of stock to improve response time are primarily responsible. Additionally, income taxes payable decreased as a result of cash settlements for various prior years' (1988-1991) Internal Revenue Service audits.\nOn January 28, 1995 the Company's working capital was $54.7 million, an increase of $3.1 million from the prior year. The Company's ratio of current assets to current liabilities was approximately 2.2:1. Capital expenditures totaled $12.9 million and were primarily for renovating existing facilities, leasehold improvements or replacement of existing equipment in addition to implementation of the new operating systems to support the structure referred to above. Bank borrowings were further reduced during the year by $6 million.\nThe Company continues to believe that it generates sufficient cash flow from its operations to finance near and long-term internal growth, capital expenditures and the principal and interest payments on its long-term debt. The Company will continue to evaluate its employment of capital resources including asset management and other sources of financing.\nOn January 31, 1995 the Company acquired certain assets of Custom Coating & Laminating Corporation. The Company paid $24 million ($18 million of which was borrowed under the Company's unsecured revolving facility), assumed certain liabilities approximating $2.4 million, and may pay up to an additional $4 million based on product sales over the next three fiscal years.\nThe Company continually reviews possible acquisitions and should the Company make a substantial acquisition, it would require the utilization of the remaining $30 million (as of January 28, 1995, and $12 million after the acquisition noted above) available from its existing credit facility or financing from other sources.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nLIQUIDITY AND CAPITAL RESOURCES (CONTINUED)\nOne of the Company's subsidiaries has been notified by the Environmental Protection Agency that it has been named as a potentially responsible party in connection with the cleanup of hazardous wastes at two sites, the Solvents Recovery Service of New England site in Southington, Connecticut (notified in June 1992), and the Gallups Quarry site in Plainfield, Connecticut (notified in April 1993). Since these matters are in their preliminary stages, no assurance can be given at this time concerning the ultimate outcome. However, based on preliminary investigations to determine the nature of the subsidiary's potential liability and the estimated amount of remedial costs necessary to clean up the sites, the Company presently does not expect these or other known matters to have a material adverse effect on its consolidated financial position, results of operations or liquidity.\nITEM 8.","section_7A":"","section_8":"ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nREPORT OF INDEPENDENT AUDITORS\nBoard of Directors and Stockholders Furon Company\nWe have audited the accompanying consolidated balance sheets of Furon Company as of January 28, 1995 and January 29, 1994, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended January 28, 1995. 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 Furon Company at January 28, 1995 and January 29, 1994, and the consolidated results of its operations and its cash flows for each of the three years in the period ended January 28, 1995, 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\nOrange County, California March 8, 1995\nFURON COMPANY CONSOLIDATED STATEMENTS OF INCOME\nSee accompanying notes.\nFURON COMPANY CONSOLIDATED BALANCE SHEETS ASSETS\nSee accompanying notes.\nFURON COMPANY CONSOLIDATED BALANCE SHEETS LIABILITIES AND STOCKHOLDERS' EQUITY\nSee accompany notes.\nFURON COMPANY CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY\nIN THOUSANDS, EXCEPT SHARE AMOUNTS - ------------------------------------------------------------------- YEARS ENDED JANUARY 28, 1995, JANUARY 29, 1994 AND JANUARY 30, 1993\nSee accompanying notes.\nFURON COMPANY CONSOLIDATED STATEMENTS OF CASH FLOWS\nSee accompanying notes.\nFURON COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS JANUARY 28, 1995\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBasis of Presentation\nThe consolidated financial statements include the accounts of Furon Company and its subsidiaries, all of which are wholly owned. All significant intercompany transactions have been eliminated. Certain reclassifications have been made to prior year amounts in order to be consistent with the current year presentation.\nConsolidated Statements of Cash Flows\nExcess cash is invested in income-producing investments including commercial paper, money market accounts, overnight repurchase agreements and short-term certificates of deposit with original maturities of less than three months. These investments are stated at cost which approximates market. Included in other income is interest and dividend income from investments of $677,000, $490,000, and $198,000 in fiscal 1995, 1994 and 1993, respectively.\nInterest paid in fiscal 1995, 1994 and 1993 was $2,451,000, $3,536,000, and $4,170,000, respectively.\nIncome taxes paid in fiscal 1995, 1994 and 1993 was $8,500,000, $1,800,000, and $2,700,000, respectively.\nInventories\nInventories, stated at the lower of cost (first-in, first-out) or market, are summarized as follows:\nProperty, Plant and Equipment\nDepreciation is provided on the straight-line method over the following estimated useful lives:\nFURON COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS JANUARY 28, 1995\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)\nConcentration of Credit Risk\nConcentrations of credit risk with respect to trade receivables are limited due to the large number of customers comprising the Company's customer base, and their dispersion across many different geographical regions. At January 28, 1995, the Company had no significant concentrations of credit risk.\nResearch and Development Costs\nResearch and development costs are expensed as incurred. Total research and development expense, including application engineering, for fiscal 1995, 1994 and 1993 was $7,125,000, $6,103,000, and $6,259,000, respectively, and is included in selling, general and administrative expenses in the consolidated statements of income. Continuous research and development is necessary for the Company to maintain its competitive position.\nIntangible Assets\nIntangible assets acquired in business combinations, net of accumulated amortization, are summarized as follows:\nGoodwill is amortized over periods ranging from 25 to 40 years. Other intangible assets are amortized over periods ranging from 5 to 25 years. Generally, goodwill is not deductible for income tax purposes, while the Company does receive a tax benefit for amortization of other intangible assets.\nTranslation of Foreign Currencies\nForeign subsidiary financial statements are translated into U.S. dollars in accordance with FASB Statement No. 52, \"Foreign Currency Translations.\" The resulting cumulative foreign currency translation adjustment is reported separately in stockholders' equity. Transaction gains and losses included in results of operations were not significant in fiscal 1995, 1994 and 1993. The functional currency of the Company's foreign operations is the respective local currency.\nNet Income Per Share\nNet income per share is based on the weighted average number of common shares outstanding and common share equivalents resulting from dilutive stock options outstanding in each of the three years in the period ended January 28, 1995. The number of shares used in the computation was 8,992,926, 8,859,200 and 8,681,606, respectively.\nFURON COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS JANUARY 28, 1995\n2. RESTRUCTURING CHARGES\nDuring fiscal 1992, the Company implemented a comprehensive restructuring program designed to improve profitability and improve the Company's focus on its primary objectives and strengths. Accordingly, a pretax charge of $23.7 million, primarily related to the estimated loss on the disposal of six of the Company's businesses which did not meet its long-term strategy and product line divestitures, was recorded. Two of the businesses were sold in fiscal 1993, three were sold in fiscal 1994, and one business continues to be held for sale.\nAs of January 28, 1995, the remaining reserve was approximately $5.2 million ($7.9 million at January 29, 1994). The change in the reserve during fiscal 1995 was primarily attributable to payments on consulting and non-compete agreements and abandoned leases related to the divested businesses. These payments have been offset by $500,000 of income earned from the business held for sale which has been deferred until the ultimate disposal of the business. The remaining reserve relates primarily to the expected loss on the sale of the remaining business, environmental remediation contingencies, consulting and non-compete obligations, and lease commitments from unutilized facilities related to the divested businesses.\nThe net assets of the business held for sale, carried at their estimated net realizable value, are included in other current and long-term assets and the other remaining reserves are included in other current and long-term liabilities in the accompanying consolidated balance sheet.\nFURON COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS JANUARY 28, 1995\n3. INCOME TAXES\nThe provision (benefit) for income taxes for the three years ended January 28, 1995 consists of the following:\nFURON COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS JANUARY 28, 1995\n3. INCOME TAXES (CONTINUED)\nThe provision (benefit) for income taxes differs from the amount computed by applying the statutory income tax rate for the following reasons:\nFURON COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS JANUARY 28, 1995\n3. INCOME TAXES (CONTINUED)\nSignificant components of the Company's deferred tax liabilities and assets are as follows:\nApplicable U.S. income and foreign withholding taxes have not been provided on undistributed earnings of certain foreign subsidiaries and affiliates aggregating $6,000,000 at January 28, 1995. Management's intention is to reinvest such undistributed earnings outside the United States for an indefinite period except for distributions upon which incremental U.S. income taxes would not be material. Any withholding taxes ultimately paid, which could approximate $300,000, may be recoverable as foreign tax credits in the United States.\nFURON COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS JANUARY 28, 1995\n3. INCOME TAXES (CONTINUED)\nDuring the fourth quarter of fiscal 1995 the Company resolved the Internal Revenue Service audit for fiscal years 1988 and 1989 relating to the purchase price allocation of an acquisition made in fiscal 1988. This resolution did not have a material effect on the Company's financial position or results of operations.\nDuring the fourth quarter of fiscal 1994 the Company resolved the Internal Revenue Service audit for fiscal years 1990 and 1991. It was determined that the Company had provided sufficient income tax expense for the resolution of the 1990 and 1991 audits as of fiscal 1993, and beginning with fourth quarter fiscal 1994, the Company has decreased the taxes provided for the issues resolved in this audit.\n4. LONG-TERM DEBT\nOn January 28, 1994, the Company amended and restated its loan agreement with a syndicate of banks. The amended agreement provides the Company with a 364-day $30,000,000 unsecured revolving facility and a four-year $26,750,000 unsecured term facility. Under the terms of the agreement, the Company may borrow at the prevailing prime rate or at a rate based on the LIBOR rate. Any amount which may be outstanding on the revolving facility at the end of the Company's fiscal year will convert to a term loan payable in equal installments over two years. In addition, the Company pays a commitment fee of 1\/4% on the unused portion of the revolving facility, and is subject to performance grid pricing based upon a Fixed Charge Coverage Ratio.\nAt January 28, 1995, the balance of the term facility totaled $20,750,000. There were no borrowings outstanding under the revolving facility. Borrowing rates during the year ranged from 3.88% to 6.69% (6.69% at January 28, 1995). The commitment under the term facility reduces by $2,000,000 each quarter and expires on August 29, 1997.\nIn order to reduce the impact of changes in interest rates on its variable rate borrowings, the Company entered into an 8-year Interest Rate Swap agreement with a commercial bank in August 1988. The notional amount of the swap, which decreases $2,000,000 each quarter, totaled $14,000,000 at January 28, 1995. The swap agreement effectively changes the Company's interest rate on the majority of its variable borrowings to a fixed interest rate of 9.938% plus a 3\/4% spread.\nDue to the fact that the swap agreement increases the effective rate of the Company's borrowings, the Company is not exposed to credit risk in the event of nonperformance by the other parties to the interest rate swap agreement. The fair market value of this off balance sheet instrument as determined by an independent third party at January 28, 1995 is $407,000.\nFURON COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS JANUARY 28, 1995\n4. LONG-TERM DEBT (CONTINUED)\nLong-term debt is summarized as follows:\n5. COMMITMENTS AND CONTINGENCIES\nAt January 28, 1995, the Company is obligated under non-cancelable leases of real property and equipment used in its operations for minimum annual rentals plus insurance and taxes. Amounts payable under these obligations are as follows:\nCertain leases contain escalation provisions for periodic adjustments based on certain indices. Rental expense for the three years in the period ended January 28, 1995 was $7,956,000, $7,952,000, and $7,924,000, respectively.\nAt January 28, 1995, the Company is obligated under irrevocable letters of credit totaling $3,225,000.\nFURON COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS JANUARY 28, 1995\n5. COMMITMENTS AND CONTINGENCIES (CONTINUED)\nAt January 28, 1995, the Company had approximately $1.5 million of foreign currency hedge contracts outstanding consisting of over-the-counter forward contracts. The contracts reflect the selective hedging of the Belgium Franc with varying maturities up to six months. Net unrealized gains\/losses from hedging activities were not material as of January 28, 1995.\nThe Company is currently involved in litigation arising in the normal course of business. Management of the Company is of the opinion that such litigation will not have a material effect on the Company's consolidated financial position or results of operations.\nThe Company from time to time incurs investigation, remedial response, voluntary clean-up and other costs associated with environmental matters. As of January 28, 1995, the Company's reserves for environmental matters totaled approximately $2,400,000. These reserves primarily relate to environmental costs associated with facilities that have been sold or closed. While neither the timing nor the amount of the ultimate costs associated with environmental matters can be determined, management does not expect those matters to have a material adverse effect on the Company's consolidated financial position or results of operations.\nOne of the Company's subsidiaries has been notified by the Environmental Protection Agency that it has been named as a potentially responsible party in connection with the cleanup of hazardous wastes at two sites, the Solvents Recovery Service of New England site in Southington, Connecticut (notified in June 1992), and the Gallups Quarry site in Plainfield, Connecticut (notified in April 1993). Since these matters are in their preliminary stages, no assurance can be given at this time concerning the ultimate outcome. However, based on preliminary investigations to determine the subsidiary's potential liability and the estimated amount of remedial costs necessary to clean up the sites, the Company presently does not expect these matters to have a material adverse effect on its consolidated financial position or results of operations.\nFURON COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS JANUARY 28, 1995\n6. STOCKHOLDERS' EQUITY\nStock Incentive Plan\nUnder the Company's 1982 Stock Incentive Plan, the Compensation Committee, appointed by the Board of Directors, is authorized to grant awards to any officer or key employee of the Company. Awards granted can take the form of non-qualified stock options, stock appreciation rights, restricted stock awards (RSAs), performance share awards, stock depreciation rights and tax-offset bonuses. A maximum of 1,650,000 shares of common stock may be issued under the plan. Options are granted at a price equal to 100% of the fair market value at the date of grant and become exercisable not earlier than six months after the award date and vest at a rate of 25% per year. The options shall remain exercisable until the expiration date but not later than ten years after the award date.\nAt January 28, 1995, 143,165 RSAs have been granted (of which 14,900 have been canceled). The issuance of these RSAs resulted in $1,892,000 (net of cancellations) of unearned compensation which is being amortized over the five year period in which the awards vest.\nThe following summarizes stock option transactions under the Stock Incentive Plan for the year ended January 28, 1995:\nFURON COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS JANUARY 28, 1995\n6. STOCKHOLDERS' EQUITY (CONTINUED)\nShareholders' Rights Plan\nOn March 21, 1989, the Board of Directors authorized the distribution of one right for each outstanding share of common stock under the Shareholders' Rights Plan. The rights which were distributed on May 23, 1989, become exercisable ten business days after (i) a person has acquired or obtained the right to acquire 20% or more of the Company's general voting power without approval by the Board of Directors, or (ii) a tender or exchange offer which would make a person the beneficial owner of 30% or more of the Company's general voting power, whichever is earlier. When exercisable, each right entitles the shareholder to purchase one-fourth of a share of common stock at a price of $13.75, subject to adjustment. In the event the Company engages in certain business combinations or a 20% shareholder engages in certain transactions with the Company, each holder of a right (other than those of the acquiring person) shall have the right to receive, upon the exercise thereof and payment of four times the then current exercise price, that number of shares of Common Stock of the surviving Company's common stock which at the time of such transaction would have a market value of two times such price paid.\n7. EMPLOYEE BENEFIT PLANS\nThe Company and its subsidiaries sponsor various qualified plans which cover substantially all of its domestic employees including a profit- sharing\/retirement plan, an employee stock ownership plan, and an employee stock purchase plan. The Company also sponsors a nonqualified defined benefit plan covering certain employees.\nProfit-Sharing\/Retirement Plan\nThe trusteed profit-sharing\/retirement plan provides for an employee salary deferral contribution, a company matching contribution and a company primary contribution. Under the deferral provisions (401K), eligible employees are permitted to contribute up to 10% of gross compensation to the profit-sharing\/retirement plan. For amounts up to 8% of the employees' gross compensation the Company will match the employee's contribution at a rate determined by the Board of Directors. Under the company primary contribution provision, each eligible employee will receive a contribution to the profit-sharing\/retirement plan based on a percentage of qualified wages as determined based on the Company's performance. Total Company contributions for the years ended January 28, 1995, January 29, 1994 and January 30, 1993 were $1,528,000, $1,336,000, and $1,356,000, respectively.\nFURON COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS JANUARY 28, 1995\n7. EMPLOYEE BENEFIT PLANS (CONTINUED)\nEmployee Stock Ownership Plan\nThe Company sponsors an Employee Stock Ownership Plan (ESOP) covering substantially all of its employees (subject to certain limitations). The Company annually contributes amounts sufficient to cover principal and interest on loans made to the ESOP as determined by the Board of Directors.\nPrior to December 31, 1992, the Company loaned the ESOP $3,666,000 ($2,304,000 outstanding at January 28, 1995) to purchase 311,000 shares of stock, at interest rates ranging from 7.83% to 9.12%. The loans are payable in ten annual installments of principal and interest. In fiscal 1995 the Company loaned the ESOP $808,125 to purchase 45,000 shares of stock from a former officer and director of the Company, at interest rates ranging from 7.45% to 7.67%. These loans are payable in ten annual installments of principal and interest, beginning in fiscal 1996. Shares are released and allocated to participant accounts annually as loan repayments are made.\nIn fiscal 1995, the Company adopted the provisions of AICPA Statement of Position No. 93-6 (the SOP) which requires that compensation expense be measured based on the fair value of the shares over the period the shares are earned. In addition, the SOP requires that dividends paid on unallocated shares held by the ESOP are reported as a reduction of accrued interest or as compensation expense rather than a charge to retained earnings, and shares not yet committed to be released are not considered outstanding in the calculation of earnings per share. As allowed by the SOP, the Company has elected not to apply the SOP's provisions to shares acquired prior to fiscal 1994. As such, compensation expense related to such shares is measured based on the historical cost of the shares, dividends have been deducted as a charge to retained earnings and the unallocated shares are considered outstanding in the calculation of earnings per share. The adoption of the SOP did not have a material impact on the consolidated financial statements.\nOf the leveraged shares acquired prior to fiscal 1994, 94,465 and 195,160 are allocated and unallocated, respectively, at January 28, 1995. Of the leveraged shares acquired in fiscal 1995, there were no allocated shares, 1,883 committed-to-be-released shares, and 43,117 unallocated shares at January 28, 1995. The fair value of unallocated shares acquired in fiscal 1995 was $949,000 at January 28, 1995. Total compensation cost recognized by the Company during fiscal 1995, 1994 and 1993, which consists of the annual contribution and plan administrative costs, net of dividend income on unallocated and forfeited shares, totaled $528,000, $339,000, and $423,000, respectively.\nFURON COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS JANUARY 28, 1995\n7. EMPLOYEE BENEFIT PLANS (CONTINUED)\nEmployee Stock Purchase Plan\nEffective November 1, 1994 the Company adopted an Employee Stock Purchase Plan to provide substantially all employees who have completed one year of service an opportunity to purchase shares of its common stock through payroll deductions, up to 10% of eligible compensation. Annually, on October 31, participant account balances are used to purchase shares of stock at the lesser of 85 percent of the fair market value of shares on November 1 (grant date) or October 31 (exercise date). The aggregate number of shares purchased by an employee may not exceed 5,000 shares annually (subject to limitations imposed by the Internal Revenue Code). The stock purchase plan expires on October 31, 2004. A total of 200,000 shares are available for purchase under the plan. There were no shares issued under the plan during fiscal 1995.\nSupplemental Executive Retirement Plan\nIn fiscal 1987, the Company adopted an unfunded executive defined benefit retirement plan for certain key officers of the Company, which provides for benefits which supplement those provided by the Company's other retirement plans. Benefits payable under the plan are based upon compensation levels and length of service of the participants.\nIn accordance with FASB Statement No. 87, \"Employers' Accounting for Pensions,\" the Company has recorded an additional liability of $1,156,000 and $862,000 in fiscal 1995 and 1994, respectively, which represents the excess of the accumulated benefit obligation over previously recognized accrued pension costs. In 1994 the Company recorded an intangible asset to reflect the additional liability. In 1995, the excess of additional pension liability over the unrecognized net transition obligation has been recorded as a component of stockholders' equity.\nFURON COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS JANUARY 28, 1995\n7. EMPLOYEE BENEFIT PLANS (CONTINUED)\nActuarial present value of benefit obligations:\nNet periodic pension costs for fiscal 1995, 1994 and 1993 were as follows:\nFURON COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS JANUARY 28, 1995\n8. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)\nFURON COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS JANUARY 28, 1995\n9. SEGMENT INFORMATION\nThe Company designs, develops and manufactures highly engineered components made primarily from specially formulated high performance polymer materials, a single business segment.\nThe following table provides information as to the geographic areas in which the Company does business.\n10. SUBSEQUENT EVENTS\nOn January 31, 1995, the Company acquired certain assets of Custom Coating & Laminating Corporation. The Company paid $24 million ($18 million of which was borrowed under the Company's unsecured revolving facility), assumed certain liabilities approximating $2.4 million, and may pay up to an additional $4 million based upon future product sales over the next three fiscal years.\nPART III\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNone.\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nInformation in response to this Item is incorporated herein by reference from the Company's definitive Proxy Statement for the Annual Meeting of Shareholders to be held on June 6, 1995. Information concerning the Company's executive officers is included in Part I.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation in response to this Item is incorporated herein by reference from the Company's definitive Proxy Statement for the Annual Meeting of Shareholders to be held on June 6, 1995.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation in response to this Item is incorporated herein by reference from the Company's definitive Proxy Statement for the Annual Meeting of Shareholders to be held on June 6, 1995.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation in response to this Item is incorporated herein by reference from the Company's definitive Proxy Statement for the Annual Meeting of Shareholders to be held on June 6, 1995.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.\nPART IV (CONTINUED)\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. (CONTINUED)\nAll other schedules have been omitted since the required information is not present or not present in amounts sufficient to require the submission of the schedules, or because the information required is included in the consolidated financial statements or the notes thereto.\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:\nNo reports on Form 8-K were filed during the last quarter of the period covered by this report.\nFURON COMPANY SCHEDULE VIII--VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED JANUARY 28, 1995, JANUARY 29, 1994 AND JANUARY 30, 1993\nFURON COMPANY INDEX TO EXHIBITS\n* A management contract or compensatory plan or arrangement.\nFURON COMPANY INDEX TO EXHIBITS (CONTINUED)\n* A management contract or compensatory plan or arrangement.\nw FURON COMPANY INDEX TO EXHIBITS (CONTINUED)\nSIGNATURES AND POWER OF ATTORNEY\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf on March 21, 1995 by the undersigned, thereunto duly authorized.\nFURON COMPANY\nBy: \/S\/ MONTY A. HOUDESHELL \/S\/ KOICHI HOSOKAWA -------------------------------- ------------------------------------ Monty A. Houdeshell Koichi Hosokawa Vice President, Chief Financial Controller 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. Each person whose signature appears below hereby authorizes and appoints J. Michael Hagan, Terrence A. Noonan, and Monty A. Houdeshell as attorneys-in-fact and agents, each acting alone, to execute and file with the applicable regulatory authorities any amendment to this report on his behalf individually and in each capacity stated below.\n\/S\/ J. MICHAEL HAGAN \/S\/ COCHRANE CHASE - ------------------------------------- ------------------------------------ J. Michael Hagan Cochrane Chase Chairman of the Board Director, March 21, 1995 (Principal Executive Officer), March 21, 1995\n\/S\/ TERRENCE A. NOONAN \/S\/ H. DAVID BRIGHT - ------------------------------------- ------------------------------------ Terrence A. Noonan H. David Bright President and Director, March 21, 1995 Director, March 21, 1995\n\/S\/ PETER CHURM \/S\/ WILLIAM D. CVENGROS - ------------------------------------- ------------------------------------ Peter Churm William D. Cvengros Chairman Emeritus, March 21, 1995 Director, March 21, 1995\n\/S\/ MONTY A. HOUDESHELL - ------------------------------------- ------------------------------------ Monty A. Houdeshell William E. Eckhardt Vice President, Chief Financial Director, March 21, 1995 Officer and Treasurer, March 21, 1995\n\/S\/ KOICHI HOSOKAWA \/S\/ R. DAVID THRESHIE - ------------------------------------- ------------------------------------ Koichi Hosokawa R. David Threshie Controller, March 21, 1995 Director, March 21, 1995\n\/S\/ BRUCE E. RANCK ------------------------------------ Bruce E. Ranck Director, March 21, 1995\nFURON COMPANY INDEX TO EXHIBITS\n* A management contract or compensatory plan or arrangement.\nFURON COMPANY INDEX TO EXHIBITS (CONTINUED)\n* A management contract or compensatory plan or arrangement.\nFURON COMPANY INDEX TO EXHIBITS (CONTINUED)","section_15":""}
{"filename":"835176_1995.txt","cik":"835176","year":"1995","section_1":"Item 1. Business\nGeneral\nOn July 1, 1988, Lydall, Inc., a Delaware corporation (\"Lydall\"), distributed to all its stockholders of record at the close of business on June 10, 1988, all of the issued and outstanding Common Stock of Corcap, Inc. (\"Corcap\" or the \"Company\"), a newly formed holding company incorporated in Nevada in June 1988, on the basis of one share of Corcap Common Stock for each share of Lydall Common Stock held on the record date (the \"Distribution\"). Upon its effectiveness, the Distribution separated Lydall and Corcap into two independent companies.\nCorcap succeeded to the elastomer products business previously operated by Lydall. The business was operated by Corcap through its wholly-owned subsidiary, Acadia Polymers, Inc. (\"Acadia\"), which Corcap sold on July 1, 1991. Corcap also succeeded to an equity interest in CompuDyne Corporation, a Pennsylvania corporation (\"CompuDyne\"), previously owned by Lydall.\nAs a result of the dispositions of assets by Corcap in 1990 and 1991, Corcap is no longer engaged in the rubber and elastomer products business.\nPursuant to a Post Distribution Agreement, dated as of July 1, 1988, which Corcap and Lydall entered into as part of the spin-off of Corcap's predecessor, Acadia Polymers, from Lydall in 1988, certain obligations and liabilities between Lydall and Corcap were allocated. Lydall and Corcap had been in dispute over certain of their obligations and liabilities under the Post-Distribution Agreement. Lydall claimed that Corcap owed it $881 thousand under the Post-Distribution Agreement as a result of settlements Lydall had reached with the Internal Revenue Service for each of the tax years from 1983-1989. Separately, Lydall acknowledged owing Corcap $60 thousand under the Post-Distribution Agreement as a result of certain retrospective insurance adjustments made through 1995.\nOn March 25, 1996 Lydall and Corcap entered into a Settlement Agreement (the \"Settlement Agreement\") dated as of March 25, 1996 pursuant to which Corcap transferred 120,000 shares of CompuDyne Common Stock, par value $.75 per share (\"CompuDyne Common Stock\") to Lydall in settlement of certain claims.\nUnder the Settlement Agreement, each of Lydall and Corcap released all obligations arising out of such claims by the transfer from Corcap to Lydall of 120,000 shares of CompuDyne Common Stock. In addition, Corcap agreed to indemnify Lydall for all liabilities Lydall may incur in connection with its former ownership of property in Dayville, Connecticut which Corcap sold in July 1995 and which had previously been used in connection with Acadia's operations. The Post-Distribution Agreement had obligated Corcap to indemnify Lydall for certain environmental claims. In all other respects, the Post-Distribution Agreement continues in effect.\nAs part of the Settlement Agreement, Lydall required as a condition to signing, that CompuDyne enter into a registration rights agreement with Lydall obligating CompuDyne to register the Transferred Shares upon demand of Lydall two years following the date of the Agreement or in a \"piggyback registration\" at any time upon the proposed registration by CompuDyne of its stock. In order to induce CompuDyne to enter into such agreement, Corcap agreed to issue an option (the \"Option\") to CompuDyne to purchase 16,666 shares of CompuDyne Common Stock at an exercise price of $.01 per share exercisable immediately for a period of two years under a Stock Transfer Agreement, dated as of March 25, 1996 between Corcap and CompuDyne (the \"Option Agreement\").\nConcurrent with the execution of the Settlement Agreement, Corcap and certain directors and former officers of Corcap, Messrs. Millard H. Pryor, Jr. and David W. Clark, Jr. entered into an agreement whereby Messrs. Pryor and Clark forgave an accrued obligation for compensation in the amount of $314 thousand.\nOn September 15, 1995 Corcap contributed 224,000 shares of CompuDyne Common Stock to satisfy Corcap's minimum funding obligations for the 1992, 1993 and 1994 Plan Years of its employee pension plans: Plan 1A and Plan 6B under Section 412 of the Internal Revenue Code of 1986, as amended (the \"Code\"). The Constituent Plans comprise, and are administered through a single trust: the Corcap, Inc. Pooled Pension Investment Trust (the \"Trust\"). Corcap contributed 143,600 shares of CompuDyne Common Stock to Plan 1A and 80,400 shares of CompuDyne Common Stock to Plan 6B. The making of such contributions in property may constitute a \"prohibited transaction\" within the meaning of Section 4975 of the Code and Section 406 of the Employee Retirement Income Security Act of 1974, as amended (\"ERISA\"). Corcap filed an application with the Department of Labor (\"DoL\") seeking Prohibited Transaction Exemptions with respect to the transfer of the Shares of Common Stock to each of the respective Plans conditional upon the DoL granting the relief sought under the Prohibited Transaction Exemption application. On January 25, 1996 the DoL informed the Company that the application was denied. A further conversation with the DoL reopened the application and with the submission of additional supporting information, it is now expected to be approved. In the event that DoL does not grant relief sought under the application for the Prohibited Transaction Exemption, the Trustee of the Constituent Plans will promptly return the shares to Corcap. The agreement of the PBGC to settle the pension plans' underfunding liability will include the additional 224,000 CompuDyne shares if the DoL does not approve the application.\nIn March, 1996, in anticipation of termination of the Corcap Pension Plan 1A and the Corcap Pension Plan 6B (collectively the \"Plans\"), the PBGC and Corcap reached a preliminary agreement whereby the PBGC agreed to accept an additional 188,660 shares of CompuDyne Common Stock in satisfaction of the Plans' underfunding liabilities to the PBGC. The agreement is subject to final documentation and signature, which is expected to be completed during April 1996.\nIn January 1996 the Internal Revenue Service (\"IRS\") sent the Company a penalty for its failure to make timely payments to the Constituent Plans in the amount of $52 thousand. The Company is attempting to negotiate a waiver of the penalty with the IRS as part of the assumption of the Constituent Plans by the PBGC.\nOn August 21, 1995 CompuDyne, an affiliate of Corcap, entered into and consummated a Stock Purchase Agreement by and among CompuDyne, Martin A. Roenigk and Alan Markowitz (Messrs. Roenigk and Markowitz are, collectively, the \"Sellers\") and MicroAssembly Systems, Inc. (\"MicroAssembly\"), pursuant to which CompuDyne issued to the Sellers 1,260,460 shares of its Convertible Preference Stock, Series D (\"Preference Stock\") in exchange for all of the Sellers' shares of capital stock of MicroAssembly, which shares represented all of MicroAssembly's issued and outstanding capital stock. The issuance by CompuDyne of the Preference Stock, together with the issuance of certain Notes, as defined below, and certain options to purchase common stock, all as described below and in accordance with the terms of the Stock Purchase Agreement, are referred to as the \"Transaction\". Of the 1,260,460 Shares of Preference Stock issued to the Sellers, 945,345 shares were issued to Mr. Roenigk, and 315,115 shares were issued to Mr. Markowitz. The Preference Stock has rights to vote on a share for share basis with the Company's common stock on all corporate issues other than the election of directors; it is also convertible to common stock on a share for share basis at any time prior to redemption by CompuDyne. On March 29, 1996, the holders of the Preference Stock waived their rights to mandatory redemption by CompuDyne. For the election of directors, each share of Preference Stock is entitled to 1\/3.08 of a vote as compared to the Company's common stock, which is entitled to one vote per share. Pursuant to the terms of the Preference Stock, each share of Preference Stock will be entitled to one vote per share with respect to the election of directors, effective as of August 1, 1996, unless the Board of Directors of the Company, in its sole and absolute discretion, approves a resolution prior to such date prohibiting such change in voting rights, in which case each share of Preference Stock will continue to have 1\/3.08 vote per share. In the event the Board of Directors of the Company continue to approve such a resolution, on May 1, of each subsequent year, each share of preference stock will continue to have 1\/3.08 vote for directors.\nAs part of the Transaction, in return for $400 thousand paid to CompuDyne at the closing, CompuDyne issued to the Sellers Senior Convertible Promissory Notes (the \"Notes\") in the aggregate principal amount of $400 thousand, which Notes are convertible, prior to redemption by CompuDyne, into CompuDyne Common Stock at a conversion rate of $1.50 per share of common stock, or 266,667 shares of common stock if the entire principal amount of the Notes is converted. Of the $400 thousand principal amount of Notes issued, $300 thousand principal amount of the Notes was issued to Mr. Roenigk, and $100 thousand principal amount of the Notes was issued to Mr. Markowitz. As described in a report filed by the Sellers with the Securities and Exchange Commission and with the Company pursuant to Section 13(d) of the Securities Exchange Act of 1934, the source of the Sellers' $400 thousand investment in the Company was personal funds.\nOn August 21, 1995, Quanta Systems Corporation (\"Quanta\"), a wholly-owned subsidiary of CompuDyne, transferred all of the assets and liabilities of Quanta's Suntec division to Suntec Service Corporation, a newly-formed corporation (\"Suntec\"), in return for (i) all of Suntec's issued and outstanding common stock and (ii) Suntec's agreement to pay to Quanta a royalty of 2% of Suntec's net sales and other revenues for thirty (30) years from the date of the closing. Quanta then sold all of Suntec's Common Stock to Norman Silberdick, who resigned on that date as CompuDyne's Chairman, President, CEO and Director.\nAs a further part of the Transaction, Norman Silberdick, Corcap's Chairman, President and Chief Executive Officer, resigned as such and as a director of the Company on August 21, 1995. Corcap's Board of Directors elected Mr. Roenigk to fill Mr. Silberdick's seat on the Board of Directors. In recognition of Mr. Roenigk's agreement to serve on the Board of Directors and in order to facilitate the consummation of the Transaction, Corcap issued to him options to purchase up to 450,000 shares of the Company's Common Stock for $.15 per share. The options are divided into two tranches, one of 300,000 shares and the other of 150,000 shares. The option for the 300,000 shares shall expire on August 20, 1996 (\"Option I\"). Exercise of the options for the entire 300,000 shares available under and in accordance with the terms of Option I is a precondition to the availability of the options for the remaining 150,000 shares, which remaining options expire on August 20, 2005. Upon consummation of the Transaction, Corcap's executive officers are, respectively, John E. Sundman, Chairman, Diane W. Burns, President, and Elaine Chen, Treasurer and Chief Financial Officer. On March 25, 1996, the Board of Directors approved a resolution to reduce the option price per share to $.01.\nPrior to the Transaction, Mr. Roenigk held 70,000 shares of Corcap Common Stock, which is approximately 2.4% of Corcap's voting shares. Upon the exercise of his options to purchase the 450,000 additional shares of Corcap's Common Stock, Mr. Roenigk would hold approximately 15.4% of its Common Stock.\nOn August 21, 1995, Corcap purchased 150,000 shares of CompuDyne Common Stock for $.40 per share in accordance with the terms of a Warrant issued by CompuDyne to Corcap on March 10, 1993 and amended as of April 1, 1993 and August 15, 1995.\nIn payment of the purchase price for the Warrant Shares, Corcap executed a promissory note for $60 thousand payable to CompuDyne (the \"Corcap Promissory Note\"). The Corcap Promissory Note bears interest on the unpaid principal at the annual rate of eight percent (8%). Payment of the unpaid principal of the Corcap Promissory Note and on all accrued and unpaid interest thereon is due on August 21, 2000. The Note is secured by the 150,000 shares of CompuDyne Common Stock.\nCorcap exercised the right to acquire the Warrant Shares in connection with and as a result of CompuDyne's issuance of (i) 1,260,460 shares of Series D Preference Stock to Messrs. Roenigk and Markowitz which shares are convertible by the holders into 1,260,460 of CompuDyne Common Stock, (ii) $400 thousand principal amount of Senior Convertible Promissory Notes to Messrs. Roenigk and Markowitz, which promissory notes are convertible by the holders into 266,667 shares of CompuDyne Common Stock, and (iii) option to purchase 200,000 shares of CompuDyne Common Stock to Mr. Roenigk at an exercise price of $1.50 per share, all pursuant to a certain Stock purchase agreement by and among Messrs. Roenigk and Markowitz and MicroAssembly Systems, Inc. (the \"Stock Purchase Agreement\").\nOn June 3, 1993, the Corcap Board of Directors authorized the sale over time of shares of its holdings of CompuDyne Common Stock under Rule 144. In 1993 Corcap sold 27,000 shares of CompuDyne Common Stock, 40,500 shares in 1994 and 40,500 shares in 1995.\nOn July 14, 1995, Corcap entered into a purchase and sale agreement with Fabrilock Inc., a newly formed corporation, whereby Fabrilock purchased the Dayville Property in exchange for 20% of Fabrilock's issued and outstanding shares and the assumption by Fabrilock of the cost of the environmental remediation of the property estimated to be between $58 thousand and $248 thousand. Fabrilock manufactures specialty non-woven textiles. Corcap recorded an environmental reserve for $248 thousand in the third quarter of 1994. According to the purchase and sale agreement, five years after the sale of the Dayville Property, Fabrilock would have the right to repurchase 50% of Corcap's holding of Fabrilock shares for $675 thousand and Corcap would then have the right to require Fabrilock to purchase the remaining 50% of the Fabrilock shares for $675 thousand. The purchase price for the shares would be reduced by the amount of environmental remediation costs incurred by Fabrilock in excess of $100 thousand. In the third quarter of 1995 Corcap reduced its reserve for environmental remediation.\nIn connection with the sale of the Dayville property, Corcap entered into an agreement entitled 300 Lake Road Environmental Remediation Escrow Fund Agreement (\"Remediation Agreement\") whereby Corcap deposited 27,000 shares of CompuDyne Common Stock to be used in part with contributions from Fabrilock to fund the environmental remediation and clean-up of the Dayville Property. Corcap retains all attendant rights of ownership of such shares other than the right to transfer them during the pendency of the clean-up process. Beginning with the calendar quarter ending September 30, 1995 the Escrow Agent will, ten days prior to the end of each calendar quarter, return to Corcap 4,000 shares of CompuDyne Common Stock for the purpose of Corcap selling such shares pursuant to the provisions of Rule 144, and Corcap is required to deposit into the escrow fund the proceeds of such sale. Corcap is obligated to contribute additional shares of CompuDyne Common Stock to the escrow fund, if necessary, so that the fair market of the CompuDyne Common Stock in the fund, based upon the average bid and asked price of such stock for the six months prior to the determination, is not less than 75% of:(i) $70 thousand, less (ii) the cash proceeds deposited into the escrow fund by Corcap in return for shares released by the Escrow Agent for sale by Corcap as described above (the result of such calculation referred to as the \"Stock Adjustment Value\"). If the aggregate fair market value of the CompuDyne Common Stock in the escrow fund, determined as set forth, should, at any six month valuation exceed 125% of the Stock Adjustment Value, the Escrow Agent shall return sufficient shares to Corcap such that the fair market value of the CompuDyne Common Stock in the escrow fund shall equal the Stock Adjustment Value. Upon certification that the environmental remediation and clean-up have been completed, the Escrow Agent shall return to Corcap, among other things, the shares of CompuDyne Common Stock in the escrow fund at that time.\nCertain retirees of the Dayville plant had received voluntary medical and life insurance payments from Corcap which ceased in 1991 when Corcap was unable to continue to make these payments. The retirees retained counsel and made a claim against the Company asserting that the Company was liable for the medical insurance payments as well as certain life insurance claims. The Company denied the claim that it was liable since it made voluntary payments. In February 1996, the Company reached an agreement with counsel and the Union for certain retirees of the Dayville plant to transfer 22,500 shares of CompuDyne Common Stock to the retirees upon the signing of the settlement agreement.\nA certain commercial real estate broker who was contracted by the Company to assist in the sale of the Dayville property agreed to a negotiated fee as a result of the Fabrilock transaction. Thereafter the Company and the broker have agreed to payment of the fee by accepting 6% of the shares (120) of Fabrilock held by Corcap.\nCorcap's remaining assets are CompuDyne Common Stock and Fabrilock Common Stock. In the third quarter of 1988, Corcap began to include the accounts of CompuDyne in its consolidated financial statements as a result of the significant control which Corcap exercised over the operations of CompuDyne. As a result of the above described transactions Corcap's ownership of CompuDyne decreased from 35% of the issued and outstanding shares of CompuDyne Common Stock at December 31, 1994 to 24.7% as of December 31, 1995. After assuming (i) the conversion of 1,260,460 shares of Series D Preference Stock to Messrs. Martin A. Roenigk and Alan Markowitz, which shares are convertible by the holders into 1,260,460 shares of CompuDyne Common Stock, (ii) the conversion of $400 thousand principal amount of Senior Convertible Promissory Notes to Messrs. Roenigk and Markowitz which promissory notes are convertible by the holders into 266,667 shares of CompuDyne common stock and, (iii) the exercise of an option to purchase 200,000 shares of CompuDyne Common Stock issued by the Company to Mr. Roenigk at an exercise price of $1.50 per share, as part of the Transaction and (iv) the purchase of an additional 56,250 shares of CompuDyne Common Stock on August 1, 1996 by certain members of CompuDyne management pursuant to a Stock Purchase Agreement, dated August 1, 1993, between CompuDyne and such members of management, assuming certain conditions are met and (v) the exercise of stock options for 25,000 shares of CompuDyne Common Stock issued to an officer of CompuDyne and (vi) the issuance of an option to CompuDyne to purchase 16,666 shares of CompuDyne Common Stock, Corcap's ownership will be decreased to 12% on a fully diluted basis.\nTherefore, as a result, Corcap is deemed to no longer \"control\" CompuDyne and no longer consolidates its financial statements with CompuDyne. The investment will be carried at its book value and will be accounted for by the equity method of accounting. Also as a result, Corcap is deemed to be a \"transient investment company\" as provided in Rule 3a-2 under the Investment Company Act of 1940, as amended (the \"1940 Act\"). Since Corcap's only holdings are investment securities of entities it does not control, it would be deemed to be an investment company subject to the reporting, filing and operating requirements of the 1940 Act but for Rule 3a-2. Such rule provides that a company is deemed not to be an investment company during a period of time not to exceed one year provided that the company has a bona fide intent to be engaged primarily, as soon as is reasonably possibly (in any event by the termination of such period of time), in a business other than that of an investment company. The Board of Directors is exploring the following in order to comply with Rule 3a-2 by the one-year deadline, or August 21, 1996:\n1. Liquidation of the Fabrilock and\/or CompuDyne investments, with the proceeds to be reinvested in new operations.\n2. The merger of Corcap with another company in a stock exchange.\n3. Liquidation of Corcap, either voluntarily or through a bankruptcy filing. If this option is adopted, it is unlikely that Corcap could afford the cost of a voluntary liquidation, including a special shareholder vote.\nCompuDyne is currently not paying dividends. Consequently, Corcap does not have any source of revenue or cash flow (see \"Management's Discussion and Analysis-Liquidity\"). Despite the efforts of Corcap to resolve its unfunded pension liabilities with the PBGC, the successful settlement of its liability with Lydall with the former officers of the Company, and the pending settlement of the Dayville retirees suit, Corcap's Board of Directors continues to consider various options that may enable the Company to meet its obligations and to serve the best interests of its shareholders. However, the status of being a transient investment company as described above may force liquidation of the Company.\nOn July 27, 1994 Clipper, Corcap Eastern, Inc. (\"CE\") a wholly owned subsidiary of Corcap, and Quanta entered into an agreement. Under this agreement, CE as lessor under a lease to Clipper for the Dayville Property, terminated the lease in consideration for which Clipper cancelled a promissory note from CE to Clipper in the amount of $1.774 million and released a mortgage securing such note. As further consideration for the termination of the lease, Clipper forgave a further $250 thousand of debt owing from Quanta to Clipper under the Clipper Loan.\nAs part of the foregoing transaction and as consideration for Corcap causing CE to terminate the lease, CompuDyne entered into an agreement with Corcap to provide to Corcap certain management services and use of office facilities and to absorb the cost of certain legal services for a period of four years without charge to Corcap. As part of the settlement with Lydall, Corcap agreed to limit this support to $1 thousand per month for 24 months.\nAs a result of the sale of MicroAssembly Systems, Inc to CompuDyne on December 15, 1995 the corporate offices of CompuDyne and Corcap were moved to MicroAssembly Systems, Inc., 120 Union Street, Willimantic CT.\nCorcap currently has no employees, however, there are three employees of CompuDyne who are from time to time engaged in handling the various administrative responsibilities for Corcap but are compensated by CompuDyne.\nCorcap formerly operated an elastomer products business which was sold in 1991. The results of Corcap are accounted for as discontinued operations in the Balance Sheet and the consolidated Statements of Operation in the financial statements due to the divestment of the Acadia segment on July 1, 1991. Financial results for periods prior to that date have been restated.\nCompuDyne Investment .................... In the third quarter of 1988, Corcap began including the accounts of CompuDyne in its consolidated financial statements as a result of the significant control which Corcap exercised over the operations of CompuDyne. Beginning with the September 30, 1995 quarter Corcap's investment in CompuDyne is no longer being consolidated in the financial statements of Corcap. The investment will be carried at its book value and will be accounted for by the equity method of accounting.\nInformation related to CompuDyne's business, products, customer and distribution systems, competition, backlog, research and development and employees is set forth under the caption \"Business\" in CompuDyne's Annual Report on Form 10-K for the fiscal year ended December 31, 1995. Historical information on CompuDyne has been consolidated in Corcap's financial statements for the years 1993, 1994 and for the six months ended June 30, 1995.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe principal property of Corcap and its subsidiaries, excluding CompuDyne, are situated at the following locations and have the following characteristics:\nApproximate Primary Owned or Square Feet Location Purpose Leased of Space ........................ .............. ......... .......... Willimantic, Connecticut Administrative Leased (1) 200\n(1) In December 1995 Corcap moved to offices of MicroAssembly Systems.\nThe Willimantic office is used for administrative functions.\nItem 3.","section_3":"Item 3. Legal Proceedings\nOn March 10, 1986, the United States Environmental Protection Agency (\"EPA\") notified a subsidiary of Corcap (then a subsidiary of Lydall) and 34 other entities that they may be potentially responsible for response costs under the Comprehensive Environmental Response Compensation and Liability Act (\"CERCLA\") in connection with the release of hazardous substances at a landfill located in Michigan City, Indiana (\"Landfill\"). On November 10, 1987, the EPA notified the subsidiary of Corcap that it and other entities identified in the above atter also may be potentially responsible for the EPA's response costs in connection with a property located adjacent to the Landfill, known as the Lin-See Property. The EPA has indicated that it intends to expand the Landfill matter to encompass the Lin-See Property. No specific money claim has been made to the subsidiary of Corcap by the EPA with regard to the Landfill matter or the Lin-See Property, and the total cost of the remediation is not yet known. The preliminary indications are that the subsidiary's contribution to the waste volume at the Landfill, if any, was approximately 0.286% of the total volume. Under the terms of the Post-Distribution Agreement, Corcap and Lydall will share any loss which may be sustained in these matters based on the ratio of the total market value of the outstanding capital stock of each company at the time the actual liability is determined. As of December 31, 1995, Corcap's proportionate share of any liability would have been less than 1%.\nA wholly-owned subsidiary of Corcap received a preliminary report in May, 1989 from an environmental consulting firm that certain substances are present in the soil at the Dayville Property as a consequence of past operations. Corcap's tenant had been exploring the nature and distribution of those substances to determine what remediation action was to be required. On July 1, 1991, Corcap's subsidiary leased the property to Clipper and, in connection therewith, Clipper agreed to assume responsibility for up to $500 thousand of remediation costs. Continued site work and remediation analysis had been conducted by environmental engineers contracted by Corcap, on behalf of Clipper. On July 27, 1994 Clipper's responsibility for environmental costs ended upon the termination of the lease in consideration of their cancellation of a mortgage to Corcap. A final study plan was prepared for review by the Connecticut Department of Environmental Protection to ascertain the costs of remediation which concluded with a range of $58 thousand to $250 thousand. Thereafter Corcap established a reserve of $248 thousand in the third quarter of 1994. On July 14, 1995, Corcap entered into a purchase and sale agreement with Fabrilock Inc., a newly formed corporation, whereby Fabrilock purchased the Dayville property in exchange for 20% of Fabrilock's issued and outstanding shares and the assumption by Fabrilock of the cost of the environmental remediation of the property estimated to be between $58 thousand and $248 thousand. Under the terms of the purchase and sale agreement any environmental costs in excess of $100 thousand would reduce the repurchase price of the shares which are $1.35 million. Corcap reduced its reserve for the environmental liability in the third quarter ended September 30, 1995. Also in connection with the property Corcap deposited 27,000 shares of CompuDyne Common Stock in an Environmental Escrow Fund to be used to fund the projected clean-up costs.\nDuring the third quarter of 1991, a wholly-owned subsidiary of Corcap, Corcap Virginia Inc. (formerly Acadia Virginia, Inc.), received notification that it may be a potential responsible party under the North Carolina General Statutes in connection with the closure and abatement of the Seaboard Chemical Corporation site located in Jamestown, North Carolina. Preliminary information supplied by the North Carolina Department of Environment, Health and Natural Resources indicates that, during the fall of 1986 and early 1987, a subsidiary of Lydall, which was part of its Elastomer Products Group, may have shipped approximately .0001016% of the aggregate waste material located at the site. In connection with the spinoff of Corcap from Lydall on July 1, 1988, Corcap succeeded to the businesses and operations that were formerly conducted by the Elastomer Products Group of Lydall, and Corcap agreed to indemnify Lydall with respect to liabilities arising out of the conduct of the elastomer products business prior to the spinoff. During the third quarter of 1994 Corcap received a pro-rata invoice from the consulting engineer for the site for approximately $500. In March 1996, Corcap received a final settlement proposal from the engineers for $5 thousand.\nOn July 1, 1988, as noted previously, Corcap was spun off from Lydall as a separate public company and succeeded to the ownership and operations of the elastomer products businesses previously carried on by Lydall. As part of the spin-off transaction, Corcap and Lydall entered into a five- year Post-Distribution Agreement (the \"Post-Distribution Agreement\") which subsequently has been amended from time to time. As amended, the Post-Distribution Agreement obligates Corcap to indemnify Lydall with respect to liabilities (if any) incurred by Lydall after the spin-off which arise out of the conduct of the elastomer products businesses by Lydall prior to the spin-off or by Corcap after the spin-off or out of the prior ownership or operation by Lydall of any asset transferred to Corcap in the spin-off as well as for certain insurance claims and other liabilities, and requires Lydall to indemnify Corcap with respect to liabilities (if any) sustained by Corcap after the spin-off as a result of the conduct of Lydall of any asset which was a component of its fiber materials businesses as well as for certain other liabilities. Liability for claims from previously discontinued operations not related to the continuing operations of either company which may arise in the future are shared by the companies on a formula basis. During 1991, Corcap management was advised that the IRS was auditing Lydall's tax returns for certain years in which Corcap's former Acadia subsidiaries were part of Lydall. On March 25, 1996 Lydall and Corcap entered into a Settlement Agreement (the \"Settlement Agreement\") dated as of March 25, 1996 pursuant to which Corcap transferred 120,000 shares of CompuDyne Common Stock, par value $.75 per share (\"CompuDyne Common Stock\") to Lydall in settlement of certain claims.\nPursuant to the Post Distribution Agreement the claim that Corcap owed it $881 thousand under the Post-Distribution Agreement as a result of settlements Lydall had reached with the Internal Revenue Service for each of the tax years from 1983-1989 was settled. Separately, Lydall acknowledged owing Corcap $60 thousand under the Post-Distribution Agreement as a result of certain retrospective insurance adjustments made through 1995. Under the Settlement Agreement, each of Lydall and Corcap released all obligations arising out of such claims by the transfer from Corcap to Lydall of 120,000 shares of CompuDyne Common Stock. In addition, Corcap agreed to indemnify Lydall for all liabilities Lydall may incur in connection with its former ownership of property in Dayville, Connecticut which Corcap sold in July 1995 and which had previously been used in connection with Acadia's operations. The Post- Distribution Agreement had obligated Corcap to indemnify Lydall for certain environmental claims. In all other respects, the Post- Distribution Agreement continues in effect.\nCertain retirees of the Dayville plant had received voluntary medical and life insurance payments from Corcap which ceased in 1991 when Corcap was unable to continue to make these payments. The retirees retained counsel and made a claim against the Company asserting that the Company was liable for the medical insurance payments as well as certain life insurance claims. The Company denied the claim that it was liable since it made voluntary payments. In February 1996, the Company reached an agreement with the Union and counsel for certain retirees of the Dayville plant to transfer 22,500 shares of CompuDyne Common Stock to the Retirees upon the signing of the settlement agreement.\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\nCorcap Common Stock is traded in the over-the-counter market and is quoted on the OTC Bulletin Board, an inter-dealer quotation medium maintained by the National Association of Securities Dealers, Inc., under the symbol \"CCPN\". There were 2,946 common shareholders of record as of January 30, 1996.\nThe following table sets forth the high and low sales prices of Corcap Common Stock from March 31, 1994 to the present on the over-the counter market. Over-the-counter market quotations reflect inter-dealer prices, without retail mark-up, mark-down or commissions and may not necessarily reflect actual transactions. Corcap management is aware of only two companies making a market in Corcap Common Stock, Bishop Rosen and Company and Carr Securities. On March 12, 1996 the high and low bids per share for Corcap Common Stock as quoted on the OTC Bulletin Board were $.01 and $.01.\nQuarter Ended High Low\nMarch 31, 1995 $ .14 $ .14 June 30, 1995 .14 .0625 September 30, 1995 .125 .125 December 31, 1995 .125 .01\nMarch 31, 1994 $ .1875 $ .0625 June 30, 1994 .0625 .0625 September 30, 1994 .0625 .03125 December 31, 1994 .14 .03125\nCorcap has never paid cash dividends to its shareholders and its Board of Directors does not anticipate doing so in the foreseeable future.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe following is a consolidated summary of operations of Corcap, its subsidiaries and CompuDyne for the years ended December 31, 1995, 1994, 1993, 1992 and 1991. The information in the table below is based upon the audited consolidated financial statements of Corcap and its subsidiaries for the years indicated appearing elsewhere in this annual report and in prior annual reports on Form 10-K filed by Corcap with the SEC, and should be read in conjunction therewith and the notes thereto. For the years ended December 31, 1991-1994 CompuDyne Corporation was consolidated in the financial results of Corcap. In 1995 CompuDyne Corporation was consolidated through June 30, 1995, thereafter the results are for the activities of Corcap only.\n(In thousands except per share data):\nThe information required by this item for CompuDyne is set forth under the caption \"Selected Financial Information\" in CompuDyne's Annual Report on Form 10-K for the fiscal year ended December 31, 1995 filed as Exhibit 28.1 hereto. 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\nIn the third quarter of 1988, Corcap began including the accounts of CompuDyne in its consolidated financial statements as a result of the significant control which Corcap exercised over the operations of CompuDyne. Beginning with the September 30, 1995 quarter Corcap's investment in CompuDyne is no longer being consolidated in the financial statements of Corcap. The investment will be carried at its book value and will be accounted for by the equity method of accounting.\nFinancial Condition at December 31, 1995 ........................................ On July 1, 1991, pursuant to an Asset Purchase Agreement dated that date, Acadia and other related companies that were all subsidiaries of Corcap, sold certain of their assets and their elastomer and rubber products business to Clipper. As a result of a series of transactions in July and August 1995 Corcap's ownership of CompuDyne has been reduced to 12% on a fully diluted basis and further its ownership of the Dayville plant was sold for a 20% interest in Fabrilock, Inc. Therefore all of Corcap's transactions are accounted for as discontinued operations. See Note 10 to the consolidated financial statements.\nCorcap's consolidated working capital deficiency, which includes $ 1.681 million and $881 thousand of net current liabilities of discontinued operations at December 31, 1995 and 1994, respectively, was increased to $1.681 million at December 31, 1995 from $491 thousand at December 31, 1994. The increase in the working capital deficiency of $1.2 million was primarily due to the effect of not consolidating CompuDyne $410 thousand, the recording of the additional tax liability from Corcap of $382 thousand and losses from the sale of the Dayville property of $937 thousand offset by gains of $448 thousand on the transfer of CompuDyne Common Stock to the Constituent Pension Plans.\nCorcap's continued existence is dependent upon the value of its share ownership in CompuDyne Common Stock and Fabrilock and the decisions that the Board of Directors make with regard to Corcap's being a transient investment company and certain decisions to be made by the Board of Directors as described below.\nAt December 31, 1994, debt levels were increased by $60 thousand to $60 thousand representing a Note to CompuDyne for the exercise of a warrant to purchase 150,000 shares of CompuDyne Common Stock. See Note 4 to the Consolidated Financial Statements.\nAs discussed under \"Results of Operations\", Corcap had income from continuing operations entirely from CompuDyne's operations through June 30, 1995 of $104 thousand. CompuDyne's discontinued operations had a loss of $246 thousand through June 30, 1995 and Corcap's discontinued operations produced a loss of $727 thousand which was attributable to the effect of selling the Dayville Property for a 20% interest in the shares of Fabrilock, Inc. of $937 thousand which was offset by a reversal of a reserve for environmental remediation costs of $232 thousand and gains on the sale of CompuDyne shares which were transferred to the Constituent Pension Plans of $448 thousand. Corcap also recorded an additional tax liability from Lydall of $382 thousand for additional assessments in connection with an Internal Revenue Service audit.\nCorcap's Continued Existence\nDue to the disposition of assets in 1990, 1991 and 1995, Corcap's remaining assets are CompuDyne Common Stock and Fabrilock, Inc Common Stock. As a result, Corcap is deemed to be a \"transient investment company\" as provided in Rule 3a-2 under the Investment Company Act of 1940, as amended (the \"1940 Act\"). Since Corcap's only holdings are investment securities of entities it does not control, it would be deemed to be an investment company subject to the reporting, filing and operating requirements of the 1940 Act but for Rule 3a-2. Such rule provides that a company is deemed not to be an investment company during a period of time not to exceed one year provided that the company has a bona fide intent to be engaged primarily, as soon as is reasonably possible (in any event by the termination of such period of time), in a business other than that of an investment company. The Board of Directors is exploring the following in order to comply with Rule 3a-2 by the one-year deadline, or August 21, 1996:\n1. Liquidation of the Fabrilock and\/or CompuDyne investments, with the proceeds to be reinvested in new operations.\n2. The merger of Corcap with another company in a stock exchange.\n3. Liquidation of Corcap, either voluntarily or through a bankruptcy filing. If this option is adopted, it is unlikely that Corcap could afford the cost of a voluntary liquidation, including a special shareholder vote.\nCompuDyne is currently not paying dividends. Consequently, Corcap does not have any source of revenue or cash flow other than the sale of assets (see \"Management's Discussion and Analysis-Liquidity\"). Despite the efforts of Corcap to resolve its unfunded pension liabilities with the PBGC, the successful settlement of its liability with Lydall and with the former officers of the Company, pending settlement of the Dayville retirees suit, the Board of Directors of Corcap continues to consider various options that may enable Corcap to meet its obligations and to serve the best interests of its shareholders. However, the status of being a transient investment company as described above may force liquidation of the Company.\nResults of Operations - 1995 compared with 1994 ............................................... Due to the change in the consolidation of CompuDyne into Corcap's results for the third and fourth quarters of 1995 the only operations that are comparable are discontinued operations. For the year the effect of CompuDyne was to reflect earnings from continuing operations of $104 thousand through June 30, 1995 compared with $2.065 million for the year ended December 31, 1994. Discontinued operations produced income of $712 thousand for the year ended December 31, 1994 compared with a loss from discontinued operations of $924 thousand in 1995. The principal reasons for the change of $1.7 million was the effect of the restatement of the Suntec division of CompuDyne as a discontinued operation $613 thousand, the forgiveness of debt by Clipper for the Dayville property of $1.8 million, an increase in the environmental reserve of $250 thousand and other operating costs of the Dayville property and administrative expenses of $350 thousand.\nResults of Operations - 1994 compared with 1993 ............................................... Income from continuing operations before extraordinary items of $2.065 million in 1994 compares with income from continuing operations before extraordinary items of $253 thousand in 1993. The increase in income from continuing operations of $1.812 million was due to the net insurance proceeds of $1.389 million from the death of Frank Kelley, a larger profit than normal at Quanta Systems $176 thousand and adjustments of certain accruals $263 thousand.\nCompuDyne's net sales, which increased from $9.6 million in 1993 to $9.7 million in 1994, a 1% increase, were comprised of service revenue, telemetry and data acquisition product sales at Quanta. Quanta's service revenue in 1994 was $8.7 million, $600 thousand more than 1993. The increase in service revenue was attributable to increases in task spending on other government contracts. Service revenue represented 90% of 1994 revenues compared to 84% of 1993 revenues. DCS sales decreased $400 thousand between 1994 and 1993.\nQuanta's product sales at its Data Control Systems division of $1.0 million was $400 thousand lower than 1993 as a result of a decline in bookings resulting from defense spending reductions and delays DCS incurred bringing new products into the market. The Company reduced the costs of its product operations in reaction to the decline in business and has spent considerable time and effort in developing new commercial products. During 1994 DCS continued the development of its automatic power controller (\"APC\") and sold several units. DCS also continued the development of its high speed satellite test modem QPSK Model 7500 and sold two units. DCS finished the year with a strong backlog of $600 thousand. Gross margins decreased $298 thousand from $1.9 million, 20% of sales, in 1993 to $1.6 million, 16% of sales, in 1994. The primary reason was DCS which had a margin decline of $376 thousand due to lower volume and higher costs which was offset by higher gross profit at Quanta of $77 thousand. The increase at Quanta was due to higher volume but at lower margins.\nTotal 1994 selling, general and administrative expenses decreased $397 thousand from 1993 levels. The Company decreased its expenses at Quanta Systems, DCS and Corporate.\nThe Company undertook research and development activities to develop new products for the telecommunications industry. Research and development expenditures were $66 thousand during the fiscal year ended December 31, 1994 compared with $113 thousand in 1993.\nTotal interest expense for 1994 was $21 thousand or $104 thousand lower than 1993 levels of $125 thousand. The decline was due to the repayment of all outstanding debt.\nInterest income for 1994 was $28 thousand, or an increase of $14 thousand from 1993's interest income of $14 thousand. The increase was due to a larger amount of invested funds.\nOther income increased $1.560 million from $102 thousand in 1993 to $1.662 million in 1994. The Kelley life insurance proceeds amounted to $1.389 million. CompuDyne also reduced certain accruals totaling $115 thousand and reversed its workmen's compensation accrual after receiving a final refund from the insurance carrier, $148 thousand.\nExtraordinary income of $523 thousand resulted from debt forgiveness from Clipper of $413 thousand and from deferred compensation beneficiaries $110 thousand compared with debt forgiveness in 1993 of $161 thousand primarily due to a settlement of its lease obligation at 90 State House Square in Hartford.\nLiquidity ......... Due to depressed economic conditions within the automotive industry, poor operating results and tight liquidity, Corcap sold the operating assets of its wholly-owned subsidiaries, the Acadia Companies, on July 1, 1991. As a result of this transaction, Corcap is no longer engaged in the rubber and elastomer products business which was its only significant line of business prior to the sale. Corcap's remaining assets are its ownership of CompuDyne Common Stock and Fabrilock, Inc. common stock.\nCorcap's Liquidity .................. Corcap's continued existence is totally dependent on its investment in CompuDyne. On June 3, 1993, the Corcap Board of Directors authorized the sale of shares of its holdings of CompuDyne Common Stock under Rule 144. In 1993 Corcap sold 27,000 shares of CompuDyne Common Stock, 40,500 shares in 1994 and 40,500 shares in 1995. This has been the only means by which Corcap is able to generate any cash to meet its obligations. Corcap's investment in Fabrilock is illiquid.\nRecently Issued Accounting Standard ................................... In October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation.\" The new standard defines a fair value method of accounting for stock-based employee compensation plans. Under this method, compensation costs is measured based on the fair value of the stock award when granted and is recognized as an expense over the service period, which is usually the vesting period. This standard will be effective for the Company beginning in 1996 and requires measurement of awards made beginning in 1995.\nThe new standard permits companies to continue to account for equity transactions with employees under existing accounting rules, but requires disclosure in a note to the financial statements of the pro forma net income and earnings per share as if the company had applied the new method of accounting. The Company intends to implement these disclosure requirements beginning 1996. Adoption of the new standard will not impact reported net income or cash flows.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data .................................................... The consolidated financial statements of Corcap, Inc. and its subsidiaries are listed in Item 14(a).\nAdditional information for CompuDyne is set forth under the caption \"Financial Statements and Supplementary Data\", in CompuDyne's Annual Report on Form 10-K for its fiscal year ended December 31, 1995 filed as Exhibit 28.1 hereto and such information is incorporated herein by reference.\nItem 9.","section_9":"Item 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure\nSee report on Form 8-K - Notice of change of Auditors filed on January 3, 1996.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nDirectors ......... Pursuant to the Bylaws of the Company, the Board of Directors has fixed the number of directorships at four. The following sets forth certain information concerning each Director.\nDavid W. Clark, Jr. 57. Mr. Clark is Chairman of the Audit Committee. He is a Managing Director of Pryor & Clark Company, an investment holding company. Until his resignation in June 1992, he served as President, Chief Operating Officer and Treasurer of Corcap. He has served as a Director of Corcap since June 1988. From October 1985 until his resignation in June 1992, he was the President and Chief executive Officer of CompuDyne. He has served as a Director of CompuDyne since 1985. Prior to becoming President of Corcap, Mr. Clark had been employed by Lydall, Inc. for more than five years, most recently as President. He also serves as a Director of Acme United Corporation (manufacturing), and Checkpoint Systems, Inc. (manufacturing).\nMillard H. Pryor, Jr. 62. Mr. Pryor is a member of the Executive and Pension Committees. He is a Managing Director of Pryor & Clark Company, an investment holding company. He presently serves as a member of the Pension Committee of the Corcap Board. From June 1988 until his resignation in June 1993, Mr. Pryor held the position of Chairman of the Board of Corcap. He also held the position of Chief Executive Officer of Corcap from June 1988 until his resignation in June 1992. He has served as a Director of Corcap since June 1988. From October 1985 until his resignation in June 1993, he served as Vice-Chairman of the board of Directors of CompuDyne, and from June 1991 until his resignation in June 1992, Treasurer of CompuDyne. He has served as a Director of CompuDyne since October 1985. Until October 1991, Mr. Pryor was the Chairman and, until July 1988, the Chief Executive Officer of Lydall, Inc. (manufacturing) for more than five years. He is a director of The Hartford Funds (financial services), Pacific Scientific Company (manufacturing), and Infodata Systems, Inc. (computer software).\nMartin A. Roenigk, 53. Mr. Roenigk is a member of the Executive and Pension Committees. He was elected to the Board of Directors in August 1995 to fill the vacancy created by the resignation of Director, Norman Silberdick. He has served as the Chairman, Chief Executive Officer and President of CompuDyne since August 1995. Since March, 1991, he has served as President of MicroAssembly Systems, Inc., (\"MicroAssembly\"), (manufacturing). He has also served as Vice President of Travelers Corporation (insurance) until December, 1993.\nJohn E. Sundman, 69. Mr. Sundman is a member of the Executive and Audit Committees. He was appointed Chairman by the Board of Directors in August 1995 filling the vacancy caused by the resignation of Norman Silberdick. He has served as a Director of Corcap since June 1988. Prior to his retirement, which became effective May 1, 1991, Mr. Sundman served as a Vice President of Corcap, a position which he assumed as of November 30, 1989. Prior to that time Mr. Sundman served as Vice President-Finance, Treasurer and Chief Financial Officer of Corcap from June 1988 until November 30, 1989. Mr. Sundman served as Vice President- Finance, Treasurer and Chief Financial Officer of Lydall, Inc. from 1978 to 1988 and also served as a Lydall director from 1979 to 1989. He also served as Senior Vice President of CompuDyne from June 1988 to November 1989. He is a Director of Allis-Chalmers Corporation (manufacturing).\nExecutive Officers. .................. Diane W. Burns, 54. Ms. Burns was appointed President by the Board of Directors in August 1995,filling the vacancy caused by the resignation of Norman Silberdick. From June 1988 to her resignation in August 1995, Ms. Burns served as Secretary of the Company. She has also served as Secretary of CompuDyne, since 1991. Prior to June 1988 Ms. Burns served as Assistant Treasurer of Lydall, Inc., (manufacturing) since 1985.\nI. Elaine Chen, 43 Ms. Chen was appointed Chief Financial Officer in August 1995, filing the vacancy caused by the resignation of Norman Silberdick. Since March 1995 she has served as Chief Financial Officer of CompuDyne. Prior to that time she was the Controller of CompuDyne since February 1995.\nItem 11.","section_11":"Item 11. Executive Compensation ................................ Corcap currently has no employees. However, there are three employees of CompuDyne who are engaged in handling the various administrative responsibilities for Corcap, but are compensated by CompuDyne.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThe following table lists, to the Company's knowledge, the ownership of Common Stock of the Company, if any, on March 27, 1996, and the nature of such ownership, for each of the Company's current Directors and for all officers and Directors of Corcap as a group and for each person who owns in excess of 5 percent of Corcap's common stock. Unless otherwise noted, each holder has sole voting and dispositive power with respect to the shares listed.\nSee Notes to Consolidated Financial Statements.\nCorcap, Inc. and Subsidiaries Consolidated Statements of Operations (In Thousands, except per share data)\nSee Notes to Consolidated Financial Statements.\nSee Notes to Consolidated Financial Statements.\nCorcap, Inc. and Subsidiaries Consolidated Statements of Changes in Stockholders' Deficit\nFor the years ended December 31, 1995, 1994 and 1993\nSee Notes to Consolidated Financial Statements. Corcap, Inc. and Subsidiaries Notes to Consolidated Financial Statements\n1. Organization\nEffective July 1, 1988, all of the issued and outstanding common shares of Corcap, Inc. (\"Corcap\" or the \"Company\") were distributed to the stockholders of Lydall, Inc. (\"Lydall\"), a publicly-owned corporation (the \"Distribution\"), pursuant to a special dividend previously declared by Lydall's Board of Directors. Approximately $24 million of net assets were transferred from Lydall to Corcap. Prior to that, Corcap's operations and investments were managed through Lydall. As part of the spin-off transaction, Corcap and Lydall entered into a five-year Post- Distribution Agreement (the \"Post-Distribution Agreement\") which subsequently has been amended from time to time. As amended, the Post- Distribution Agreement obligates Corcap to indemnify Lydall with respect to liabilities (if any) incurred by Lydall after the spin-off which arise out of the conduct of the elastomer products businesses by Lydall prior to the spin-off or by Corcap after the spin-off or out of the prior ownership or operation by Lydall of any asset transferred to Corcap in the spin-off as well as for certain insurance claims and other liabilities, and requires Lydall to indemnify Corcap with respect to liabilities (if any) sustained by Corcap after the spin-off as a result of the conduct of Lydall of any asset which was a component of its fiber materials businesses as well as for certain other liabilities. Liability for claims from previously discontinued operations not related to the continuing operations of either company which may arise in the future are shared by the companies on a formula basis.\nCorcap was incorporated on June 6, 1988. Contributed capital represents the net assets and the net results of operations through June 6, 1988 from the businesses transferred from Lydall to Corcap as well as capital transactions since that date. The accumulated deficit represents losses attributable to operations since the date of incorporation.\nNature of Business Through June 30, 1995, the Company operated in two business segments: engineering and security services and the manufacture of telemetry and telecommunications equipment. During the six months ended June 30, 1995 and the years ended December 31, 1994, and 1993, sales to the U.S. Federal Government amounted to 86%, 90% and 84%, respectively, of the Company's total net sales. No other single customer accounted for greater than 10% of the Company's net sales.\nCorcap's Continued Existence Due to the disposition of assets in 1990, 1991 and 1995, Corcap's remaining assets are CompuDyne Common Stock and Fabrilock, Inc Common Stock. As a result, Corcap is deemed to be a \"transient investment company\" as provided in Rule 3a-2 under the Investment Company Act of 1940, as amended (the \"1940 Act\"). Since Corcap's only holdings are investment securities of entities it does not control, it would be deemed to be an investment company subject to the reporting, filing and operating requirements of the 1940 Act but for Rule 3a-2. Such rule provides that a company is deemed not to be an investment company during a period of time not to exceed one year provided that the company has a bona fide intent to be engaged primarily, as soon as is reasonably possibly (in any event by the termination of such period of time), in a business other than that of an investment company. The Board of Directors is exploring the following in order to comply with Rule 3a-2 by the one-year deadline, or August 21, 1996:\n1. Liquidation of the Fabrilock and\/or CompuDyne investments, with the proceeds to be reinvested in new operations.\n2. The merger with Corcap with another company in a stock exchange.\n3. Liquidation of Corcap, either voluntarily or through a bankruptcy filing. If this option is adopted, it is unlikely that Corcap could afford the cost of a voluntary liquidation, including a special shareholder vote.\nCompuDyne is currently prohibited under state law from paying any dividends because its assets do not exceed its liabilities. Consequently, Corcap does not have any source of revenue or cash flow\n2. Significant Accounting Policies\nPrinciples of consolidation. ........................... The accompanying consolidated financial statements include the accounts of Corcap, its wholly-owned subsidiaries, and its investment in CompuDyne Corporation (\"CompuDyne\") for the years 1993, 1994 and from January 1, 1995 through June 30, 1995 at which time it was deemed that Corcap no longer had significant control of CompuDyne. As of July 1, 1995, Corcap accounts for its investment in CompuDyne by the equity method of accounting. Significant intercompany transactions have been eliminated in the consolidated financial statements for the aforementioned periods.\nConsolidation of CompuDyne Corporation. ...................................... Three directors of Corcap are also directors of CompuDyne. Corcap has included the accounts of CompuDyne in Corcap's consolidated financial statements in light of the control exerted by interlocking managements for the six months ended June 30, 1995, and the years ended December 31, 1994 and 1993 . As a result, through June 30, 1995 Corcap has recognized 100% of CompuDyne's losses since the second quarter of 1989. At December 31, 1995, 1994 and 1993 Corcap held 24.7%, 35% and 40.7%, respectively, of CompuDyne's Common Stock outstanding. Effective July 1, 1995 Corcap's investment in CompuDyne is no longer being consolidated in the financial statements of Corcap. The investment is carried at carried at zero due to its past losses and is accounted for by the equity method of accounting.\nOn August 21 1995, Quanta Systems Corporation (\"Quanta\"), a wholly-owned subsidiary of CompuDyne, transferred all of the assets and liabilities of Quanta's Suntec division to Suntec Service Corporation, a newly-formed corporation (\"Suntec\") in return for (i) all of Suntec's issued and outstanding Common Stock and (ii) Suntec's agreement to pay to Quanta a royalty of 2% of Suntec's net sales and other revenues for thirty (30) years from the date of the closing. Quanta then sold all of Suntec's Common Stock to Norman Silberdick, who resigned on that date as CompuDyne's Chairman, President, CEO and Director. Suntec is engaged in the business of telemarketing home improvements in the middle Atlantic states. As a result of the sale of Suntec, the balance sheet and statement of operations for Corcap have been restated to reflect the treatment of Suntec as a discontinued operation for the years ended December 31, 1993 and 1994 and for the six months ended June 30, 1995.\nUse of Estimates. ................ Certain estimates used by management are susceptible to significant changes in the economic environment. These include estimates of percentage-of-completion on long term contracts and valuation allowances for contracts accounts receivable. Each of these estimates, as well as the related amounts reported in the financial statements, are sensitive to near-term changes in the factors used to determine them. A significant change in any one of those factors could result in the determination of amounts different than those reported in the financial statements. Management believes that as of December 31, 1995, the estimates used in the financial statements are adequate based on the information currently available.\nInventories. ........... Inventories are valued at the lower of cost (first-in, first-out) or market.\nDepreciation and amortization. ............................. Plant, property and equipment are depreciated over their estimated useful lives on the straight-line method for financial statement purposes. Leasehold improvements are amortized on a straight-line basis over the term of the lease or the life of the asset, whichever is shorter. Maintenance and repair costs are charged to operations as incurred; major renewals and betterments are capitalized.\nIncome taxes. ............ Effective January 1, 1993 the Company adopted Statement of Financial Accounting Standards No. 109 (SFAS 109), \"Accounting for Income Taxes\". Under SFAS 109 deferred income taxes are recognized for the future tax consequences of differences between tax bases of assets and liabilities and financial reporting amounts, based upon enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to amounts expected to be realized. Income tax expense is the tax payable for the period and the change during the period in deferred tax assets and liabilities. The adoption of SFAS 109 had no impact on operations for any of the periods presented.\nCorcap and its wholly-owned subsidiaries file a consolidated federal income tax return. CompuDyne and its domestic subsidiaries file a consolidated federal income tax return.\nRevenue recognition. ................... Revenue under cost reimbursement contracts is recognized to the extent of costs incurred to date plus a proportionate amount of the fee earned. Revenue under time and materials contracts are recognized to the extent of billable rates times hours delivered plus materials expense incurred. Revenues from fixed price contracts are recognized under the percentage of completion method. Revenues from the sale of manufactured products are recognized based on shipment date. Provisions for estimated losses on uncompleted contracts are recognized in the period such losses are determined.\nNet income (loss) per common share. .................................. Net income (loss) per common share is based on the weighted average number of common shares outstanding during the period, including the effect of common stock equivalents and stock awards where such effect would be dilutive.\nCash and cash equivalents. ......................... Cash and cash equivalents include amounts invested in accounts which are readily convertible to known amounts of cash with a maturity of three months or less at the time of purchase. The Company invests any available cash balance in overnight funds which are concentrated in one commercial bank. The Company has not experienced any losses on its cash and cash equivalents.\nReclassifications. ................. Certain reclassifications have been made in the 1994 and 1993 financial statements to conform to the 1995 presentation.\n3. Long-term Debt\nIn May 1994, CompuDyne negotiated a modification to the Loan Agreement (\"Clipper Agreement\") Quanta had with JM Clipper Polymers Corporation (\"Clipper\") whereby the Company agreed to pay $1 million in full satisfaction of its debt of $1.163 million. On May 17, 1994 CompuDyne made a payment of $700 thousand, established six quarterly payments of $50 thousand for the balance due and terminated its working capital line of credit of $150 thousand with Clipper. Clipper further agreed to surrender its warrant to purchase 100,000 shares of CompuDyne Corporation Common Stock upon final payment of the outstanding debt which occurred in November 1994.\nIn July 1994 Clipper, Corcap Eastern, Inc. (\"CE\") a wholly owned subsidiary of Corcap, and Quanta entered into an agreement. Under this agreement, CE as lessor under a lease to Clipper for property located in Dayville, Connecticut (the \"Dayville Property\"), terminated the lease in consideration for which Clipper cancelled a promissory note from CE to Clipper in the amount of $1.774 million and released a mortgage securing such note. The $1.774 million of debt forgiveness is included in income from discontinued operations for 1994. As further consideration for the termination of the lease, Clipper forgave an additional $250 thousand of debt owing from Quanta to Clipper under the Clipper Agreement. Quanta's indebtedness to Clipper under the Clipper Agreement had thereby been reduced to $50 thousand, payable in five quarterly installments of $10 thousand commencing on September 30, 1994 and ending on September 30, 1995. In July 1991, the Dayville real estate and buildings were leased to Clipper under a \"triple net\" lease at an annual rental of $250 thousand, with an option to renew for one additional ten-year term and an additional option to purchase the facility for an amount equal to the principal amount of the mortgage plus $100 thousand.\nAs part of the foregoing transaction and as consideration for Corcap causing CE to terminate the lease, CompuDyne entered into an agreement with Corcap to provide to Corcap management services and use of office facilities and to absorb the cost of certain legal services for a period of four years without charge to Corcap. In connection with the Lydall settlement, Corcap agreed to limit this obligation to $1 thousand per month for 24 months.\nOn October 4, 1994, Clipper, CompuDyne and Corcap entered into a letter agreement that provided for $20 thousand of obligations by Clipper for environmental costs associated with the Dayville property be offset against indebtedness due Clipper from Quanta. CompuDyne in turn reduced the amount of moneys due it from Corcap for $20 thousand and Corcap then established a liability for the environmental costs.\nOn November 18, 1994, CompuDyne obtained a $350 thousand secured working capital line of credit agreement with the Asian American Bank and Trust Company of Boston, Massachusetts. As part of the agreement the Company paid off the Clipper loan in full and the Clipper Warrant was surrendered. At December 31, 1994 CompuDyne had no outstanding debt.\nCorcap required, as a condition to its conversion of the Preferred Stock to CompuDyne Common Stock and the relinquishment and waiver of accrued dividends on the Preferred Stock, that CompuDyne issue a warrant (the \"Corcap Warrant\") for 150,000 shares of CompuDyne Common Stock to Corcap. The Exercise price of the Corcap Warrant is $.40 per share. On August 21, 1995, Corcap purchased the 150,000 shares of CompuDyne common stock for $.40 per share in accordance with the terms of a Warrant issued by CompuDyne to Corcap on March 10, 1993 and amended as of April 1, 1993 and August 15, 1995. In payment of the purchase price of the Warrant Shares, Corcap executed a promissory note for $60 thousand payable to CompuDyne (the \"Corcap Promissory Note\") which is included in net non-current liabilities of discontinued operations at December 31, 1995 in the consolidated balance sheet. The Corcap Promissory Note bears interest on the unpaid principal at the annual rate of eight percent (8%). Payment of the unpaid principal of the Corcap promissory note and on all accrued and unpaid interest thereon is due on August 21, 2000.\n4. Lydall Settlement\nOn December 12, 1992, Lydall presented an invoice to Corcap, under the Post-Distribution Agreement (described in Note 1), for $499 thousand representing final taxes and interest due to the IRS as a result of an audit of Corcap entities for the years 1983 through 1988. The $499 thousand was recorded as a liability and was included in net current liabilities of discontinued operations in the balance sheet at December 31, 1994. In July 1994, Lydall informed Corcap that as a result of an audit of Corcap entities for the years 1987-1989 Lydall had calculated that Corcap's share of the current assessment was an additional $382 thousand. Lydall presented Corcap with an invoice for that amount in July 1995. As a result, Corcap recorded an additional $382 thousand liability in 1995.\nOn March 25, 1996 Lydall and Corcap entered into a Settlement Agreement (the \"Settlement Agreement\") pursuant to which Corcap transferred 120,000 shares of CompuDyne Common Stock, par value $.75 per share (\"CompuDyne Common Stock\") to Lydall in settlement of certain claims.\nUnder the Settlement Agreement, each of Lydall and Corcap released all obligations arising out of such claims by the transfer from Corcap to Lydall of 120,000 shares of CompuDyne Common Stock. In addition, Corcap agreed to indemnify Lydall for all liabilities Lydall may incur in connection with its former ownership of property in Dayville, Connecticut which Corcap sold in July 1995 and which had previously been used in connection with Acadia's (a former subsidiary of Corcap) operations. The Post-Distribution Agreement had obligated Corcap to indemnify Lydall for certain environmental claims. In all other respects, the Post- Distribution Agreement continues in effect.\nAs a result of this settlement, in which Corcap's carrying value of its CompuDyne Common Stock was zero, Corcap will recognize a gain on this settlement of debt of $881 thousand in 1996.\n5. Accounts Receivable December 31, $ Thousands 1994\nU.S. Government Contracts: Billed $ 390 Unbilled 644 ....... Total Contracts $ 1,034\nSubstantially all of the U.S. Government billed and unbilled receivables are derived from cost reimbursable or time-and-material contracts. Unbilled receivables include retainages of approximately $125 thousand at December 31, 1994.\nDirect sales to the U.S. Federal Government for the years ended December 31, 1994 and 1993 were $9.0 million and $8.3 million, respectively, or 90% and 84% of the Company's total net sales from continuing operations for the same years. No other single customer accounted for greater than 10% of the Company's net sales.\nContract costs for services provided to the U.S. Government, including indirect expenses, are subject to audit by the Defense Contract Audit Agency. All contract revenues are recorded in amounts expected to be realized upon final settlement. In the opinion of management, adequate provisions have been made for adjustments, if any, that may result from the government audits.\nSubstantially all of CompuDyne's government related business is with the U.S. Department of Defense, primarily one major contract, the NISE East contract that was awarded to Quanta in March 1992 as a one-year contract with four one-year renewal options. The contract has been renewed through September 30, 1996. Net sales under the NISE East contract totaled $6.9 million in 1994. Although most of Quanta's contracts are subject to audit, it does not believe such audits will result in any material adjustments to the financial statements. There are no balances for 1995 as CompuDyne is no longer consolidated in the results of Corcap.\n6. CompuDyne Investment\nOn November 12, 1992 the CompuDyne Board authorized the issuance of 300,000 shares of Common Stock to key employees of CompuDyne and Quanta at a price of $.40 per share, the fair market value at such time. In January 1993, the Board subsequently authorized the issuance of an additional 200,000 shares of Common Stock to a key employee at the same price and on the same terms as those authorized on November 12, 1992. These authorizations were formalized in Stock Purchase Agreements, dated August 1, 1993, under which the employees may purchase an aggregate of 125,000 shares on August 1, 1993, 1994, 1995 and 1996, provided certain conditions are met including continued employment by CompuDyne, by paying cash for such shares or by giving the Company a five-year non-recourse promissory note, collateralized by the stock and bearing interest at 2% per annum over the rate designated by the First National Bank of Maryland as its prime commercial rate. The Stock Purchase Agreements further provide that within 90 days of any Change of Control of CompuDyne, as defined, the employees will be entitled to purchase all of the shares of CompuDyne Common Stock not yet purchased under such Agreements by delivering a written notice to CompuDyne. On August 1, 1993, August 1, 1994 and August 1, 1995 an aggregate of 306,250 shares of CompuDyne Common Stock were issued to management, (the \"Management Shares\") in exchange for promissory notes pursuant to the Stock Purchase Agreements. In August 1995 as part of the agreement to acquire Suntec, Norman Silberdick, former Chairman and President of CompuDyne, returned 60,000 shares to CompuDyne in exchange for the cancellation of the promissory notes securing those shares thereby reducing the amount of shares issued to 246,250. Mr. Silberdick also cancelled his right to receive 50,000 shares on August 1, 1995. The number of shares to be issued to management was also reduced by 37,500 shares representing the amount of shares allocable to one officer who resigned during 1994. The remaining 56,250 shares issuable to management will be offered to such employees over the next year in equal amounts at $.40 per share so long as such persons are employed by the Company.\nDuring 1993 and 1994 and 1995, Corcap sold 27,000, 40,500 and 40,500 shares respectively, of its holdings of CompuDyne Common Stock under Rule 144 of the Securities Act of 1933.\nOn August 31, 1993, the officers of Corcap and certain members of the Corcap Board agreed to sell an aggregate of 66,666 shares of CompuDyne Common Stock to Messrs. Antoine Dominic, who was then Executive Vice- President, Chief Financial Officer and a director of Corcap and CompuDyne, Millard Pryor, a director of Corcap and CompuDyne, and David Clark, a director of Corcap and CompuDyne. Mr. Dominic made an informal loan of $25 thousand to Corcap and Messrs. Pryor and Clark each made informal loans of $12.5 thousand to Corcap with the understanding that, subject to the approval by the Board of Directors of Corcap, such loans would be repaid in full by the transfer by Corcap of 33,333 shares of CompuDyne Common Stock to Mr. Dominic, 16,667 shares to Mr. Pryor and 16,666 shares to Mr. Clark. The Corcap Board subsequently approved these actions on October 6, 1993. The shares were transferred in October 1993. The primary reason for the sale of the shares was the necessity of obtaining $50 thousand cash on August 31, 1993 to settle a $348 thousand obligation owing to one of Corcap's creditors. Corcap owed $348 thousand of accrued rent under an office lease for space it occupied at 90 State House Square, Hartford, Connecticut when its lease ended September 30, 1993. Management of Corcap was able to negotiate a settlement of its $348 thousand past due rent to the landlord, for $50 thousand. The terms of the settlement required full payment of the $50 thousand by August 31, 1993. As of September 30, 1993, the expiration date of the lease, CompuDyne's share of the unpaid rent liability on its records was $186 thousand. CompuDyne agreed to pay half of the settlement ($25 thousand) by reducing the receivable that Corcap owes CompuDyne for expenses unrelated to rent by $25 thousand. Since August 1992, CompuDyne had been occupying all the space at 90 State House Square, Hartford Connecticut and had been absorbing all the rent. Prior to August 1992, it occupied and paid for half the space. Corcap currently leases the office space on a month-to-month tenancy and sublets such space to CompuDyne which is obligated to pay the entire monthly rental of $2.250 thousand.\nOn September 1, 1993 the Compensation and Stock Option Committee of the Board of Directors of CompuDyne granted Antoine Dominic options (the \"Dominic Options\") to purchase 91,667 shares of CompuDyne Common Stock at a price of $.75 per share under its 1986 Stock Incentive Compensation Plan. On December 14, 1994 Mr. Dominic resigned and subsequently did not exercise his options which expired January 31, 1995 in accordance with the provisions of the plan.\nOn August 21, 1995 CompuDyne entered into and consummated a Stock Purchase Agreement by and among CompuDyne, Martin A. Roenigk and Alan Markowitz (Messrs. Roenigk and Markowitz are, collectively, the \"Sellers\") and MicroAssembly Systems, Inc. (\"MicroAssembly\"), pursuant to which CompuDyne issued to the Sellers 1,260,460 shares of its Convertible Preference Stock, Series D (\"Preference Stock\") in exchange for all of the Sellers' shares of capital stock of MicroAssembly, which shares represented all of MicroAssembly's issued and outstanding capital stock. The issuance by CompuDyne of the Preference Stock, together with the issuance of certain Notes, as defined below, and certain options to purchase common stock, all as described below and in accordance with the terms of the Stock Purchase Agreement, are referred to as the \"Transaction\". Of the 1,260,460 Shares of Preference Stock issued to the Sellers, 945,345 shares were issued to Mr. Roenigk, and 315,115 shares were issued to Mr. Markowitz. The Preference Stock has rights to vote on a share for share basis with the Company's Common Stock on all corporate issues other than the election of directors; it is also convertible to common stock on a share for share basis at any time prior to redemption by CompuDyne. On March 29, 1996, the holders of the Preference Stock waived their rights to mandatory redemption by CompuDyne. For the election of directors, each share of Preference Stock is entitled to 1\/3.08 of a vote as compared to the Company's Common Stock, which is entitled to one vote per share.\nAs part of the Transaction, in return for $400 thousand paid to CompuDyne at the closing, CompuDyne issued to the Sellers Senior Convertible Promissory Notes (the \"Notes\") in the aggregate principal amount of $400 thousand, which Notes are convertible, prior to redemption by CompuDyne, into CompuDyne Common Stock at a conversion rate of $1.50 per share of Common Stock, or 266,667 shares of common stock if the entire principal amount of the Notes is converted. Of the $400 thousand principal amount of Notes issued, $300 thousand principal amount of the Notes was issued to Mr. Roenigk, and $100 thousand principal amount of the Notes was issued to Mr. Markowitz. As described in a report filed by the Sellers with the Securities and Exchange Commission and with the Company pursuant to Section 13(d) of the Securities Exchange Act of 1934, the source of the Sellers' $400 thousand investment in the Company was personal funds.\nAs a result of the above described transactions Corcap's ownership of CompuDyne decreased from 35% of the issued and outstanding shares of CompuDyne Common Stock at December 31, 1994 to 24.7% as of December 31, 1995. After assuming (i) the conversion of 1,260,460 shares of Series D Preference Stock to Messrs. Martin A. Roenigk and Alan Markowitz, which shares are convertible by the holders into 1,260,460 shares of CompuDyne Common Stock, (ii) the conversion of $400 thousand principal amount of Senior Convertible Promissory Notes to Messrs. Roenigk and Markowitz which promissory notes are convertible by the holders into 266,667 shares of CompuDyne Common Stock and, (iii) the exercise of an option to purchase 200,000 shares of CompuDyne Common Stock issued by the Company to Mr. Roenigk at an exercise price of $1.50 per share, all pursuant to certain Stock Purchase Agreements by and among CompuDyne, Messrs. Roenigk and Markowitz and MicroAssembly Systems, Inc. (the \"Stock Purchase Agreement\") and (iv) a Stock Purchase Agreement, dated August 1, 1993, between CompuDyne and three members of management whereby such persons may purchase up to an additional 56,250 shares of CompuDyne Common Stock on August 1, 1996 assuming certain conditions are met and (v) the exercise of stock options for 25,000 shares of CompuDyne Common Stock issued to an officer of CompuDyne, and (vi) the issuance of an option to CompuDyne to purchase 16,666 shares of CompuDyne Common Stock, Corcap's ownership will be decreased to 12% on a fully diluted basis.\nThe following represents summarized financial information for CompuDyne as of and for the year ended December 31, 1995. The financial activity of CompuDyne for the six months ended June 30, 1995 has been consolidated in Corcap's Financial Statements as of December 31, 1995.\n($ thousands)\nAs of December 31, 1995 ....................... Current assets $ 3,241 Long-term assets 1,792\nTotal Assets $ 5,033\nCurrent liabilities $ 2,536 Long-term liabilities 1,130\nTotal liabilities $ 3,666\nShareholders equity $ 1,367\nYear Ended December 31, 1995 ............................ Net sales $ 10,308 Expenses (10,573) Income tax benefit 55 Loss on discontinued operations ( 453)\nNet Loss $( 663)\n7. Investment in Fabrilock, Inc.\nOn July 14, 1995, Corcap entered into a purchase and sale agreement with Fabrilock Inc., a newly formed corporation, whereby Fabrilock purchased the Dayville Property in exchange for 20% of Fabrilock's issued and outstanding shares and the assumption by Fabrilock the costs of the environmental remediation of the property not to exceed $100 thousand. Fabrilock manufactures specialty non-woven textiles. Corcap had recorded an environmental reserve for $248 thousand in the third quarter of 1994. According to the purchase and sale agreement, five years after the sale of the Dayville Property, Fabrilock would have the right to repurchase 50% of Corcap's holding of Fabrilock shares for $675 thousand and Corcap would then have the right to require Fabrilock to purchase the remaining 50% of the Fabrilock shares for $675 thousand. The purchase price for the shares would be reduced by the amount of environmental remediation costs incurred by Fabrilock in excess of $100 thousand. In the third quarter of 1995 Corcap reduced its reserve for environmental remediation as the estimated liability was expected to be below $100 thousand based upon the environmental consultant's results.\nIn connection with the sale of the Dayville property, Corcap entered into an agreement entitled 300 Lake Road Environmental Remediation Escrow Fund Agreement (\"Remediation Agreement\") whereby Corcap deposited 27,000 shares of CompuDyne Common Stock to be used in part with contributions from Fabrilock to fund the environmental remediation and clean-up of the Dayville Property. Corcap retains all attendant rights of ownership of such shares other than the right to transfer them during the pendency of the clean-up process. Beginning with the calendar quarter ending September 30, 1995 the Escrow Agent will, ten days prior to the end of each calendar quarter, return to Corcap 4,000 shares of CompuDyne Common Stock for the purpose of Corcap selling such shares pursuant to the provisions of Rule 144, and Corcap is required to deposit into the escrow fund the proceeds of such sale. Corcap is obligated to contribute additional shares of CompuDyne Common Stock to the escrow fund, if necessary, so that the fair market of the CompuDyne Common Stock in the fund, based upon the average bid and asked price of such stock for the six months prior to the determination, is not less than 75% of:(i) $70 thousand, less (ii) the cash proceeds deposited into the escrow fund by Corcap in return for shares released by the Escrow Agent for sale by Corcap as described above (the result of such calculation referred to as the \"Stock Adjustment Value\"). If the aggregate fair market value of the CompuDyne Common Stock in the escrow fund, determined as set forth, should, at any six month valuation exceed 125% of the Stock Adjustment Value, the Escrow Agent shall return sufficient shares to Corcap such that the fair market value of the CompuDyne Common Stock in the escrow fund shall equal the Stock Adjustment Value. Upon certification that the environmental remediation and clean-up have been completed, the Escrow Agent shall return to Corcap, among other things, the shares of CompuDyne Common Stock in the escrow fund at that time.\nCertain retirees of the Dayville plant had received voluntary medical and life insurance payments from Corcap which ceased in 1991 when Corcap was unable to continue to make these payments. The retirees retained counsel and made a claim against the Company asserting that the Company was liable for the medical insurance payments as well as certain life insurance claims. The Company denied the claim that it was liable since it made voluntary payments. In February 1996, the Company reached an agreement with counsel and the Union for certain retirees of the Dayville plant to transfer 22,500 shares of CompuDyne Common Stock to the Retirees upon the signing of the settlement agreement.\nA certain commercial real estate broker who was contracted by the Company to assist in the sale of the Dayville property agreed to a negotiated fee as a result of the Fabrilock transaction. The Company and the broker have agreed to payment of the fee by accepting 6% of the shares (120) of Fabrilock held by Corcap.\n8. Other Contingencies\nCorcap has no long term operating leases. Rent expense under operating leases for CompuDyne for the six months ended June 30, 1995 and the years ended December 31, 1994 and 1993 were $200 thousand, $466 thousand and $409 thousand, respectively.\nOn March 10, 1986, the United States Environmental Protection Agency (\"EPA\") notified a subsidiary of Corcap, (then a subsidiary of Lydall) and 34 other entities that they may be potentially responsible for response costs under the Comprehensive Environmental Response Compensation and Liability Act (\"CERCLA\") in connection with the release of hazardous substances at a landfill located in Michigan City, Indiana (\"Landfill\"). On November 10, 1987, the EPA notified the subsidiary of Corcap that it and other entities identified in the above matter also may be potentially responsible for the EPA's response costs in connection with a property located adjacent to the Landfill, known as the Lin-See Property. The EPA has indicated that it intends to expand the Landfill matter to encompass the Lin-See Property. No specific money claim has been made to the subsidiary of Corcap by the EPA with regard to the Landfill matter or the Lin-See Property, and the total cost of the remediation is not yet known. The preliminary indications are that the subsidiary's contribution to the waste volume at the Landfill, if any, was approximately 0.286% of the total volume. Under the terms of the Post-Distribution Agreement, Corcap and Lydall will share any loss which may be sustained in these matters based on the ratio of the total market value of the outstanding capital stock of each company at the time the actual liability is determined. As of December 31, 1994, Corcap's proportionate share of any liability would have been less than 1%.\nDuring the third quarter of 1991, a wholly-owned subsidiary of Corcap, Corcap Virginia Inc. (formerly Acadia Virginia, Inc.), received notification that it may be a potential responsible party under the North Carolina General Statutes in connection with the closure and abatement of the Seaboard Chemical Corporation site located in Jamestown, North Carolina. Preliminary information supplied by the North Carolina Department of Environment, Health and Natural Resources indicates that, during the fall of 1986 and early 1987, a subsidiary of Lydall, which was part of its Elastomer Products Group, may have shipped approximately .0001016% of the aggregate waste material located at the site. In connection with the spinoff of Corcap from Lydall on July 1, 1988, Corcap succeeded to the businesses and operations that were formerly conducted by the Elastomer Products Group of Lydall, and Corcap agreed to indemnify Lydall with respect to liabilities arising out of the conduct of the elastomer products business prior to the spinoff. During the third quarter of 1994 Corcap received a pro-rata invoice from the consulting engineer for the site for approximately $500. In March 1996, Corcap received a final settlement from the engineers for $5 thousand.\nCorcap and its subsidiaries are party to certain legal actions and inquiries for environmental and other matters resulting from the normal course of business. Although the total amount of liability with respect to these matters cannot be ascertained, management of the Company believes that any resulting liability will not have a material effect on its financial position.\n9. Net Liabilities of Discontinued Operations\nRemaining assets and liabilities of discontinued operations consisted of the following items at December 31, 1995 and 1994:\n$ Thousands 1995 1994\nFixed Assets, primarily land $ - $ 1,044 Investments 139 - Net current liabilities (1,681) (1,823) Notes payable due after one year (60) - Deferred pension liability (344) (102)\n(1,946) (881) Less current portion (1,681 (881) Net non-current liabilities of discontinued operations $ 265 $ -\n10. Pension Plans\nCorcap contributed to two defined benefit pension plans for certain Corcap employees. Prior to June 30, 1991, benefits for salaried employees were based on eligible compensation and for hourly employees were based on hours of service. Plan benefits were frozen under both defined benefit plans effective July 1, 1991. The pension cost shown for the year ended December 31, 1992 reflects the elimination of additional benefit accruals after this date. As a result of the benefit freeze, the plans experienced a \"curtailment gain\" as defined under Financial Accounting Standards Statement No. 88 which resulted in a direct reduction in pension cost for 1991.\nThe following items are the components of net pension cost:\nFor the years ended December 31, $ Thousands 1995 1994 1993\nService cost--benefits earned during the year $ - $ - $ - Interest cost on projected benefit obligation 315 308 309 Actual return on plan assets (400) (71) (411) Net amortization and deferral 88 (245) 82\nNet pension cost $ 3 $ (8) $ (20)\nPlan assets include investments in bank accounts, bonds and guaranteed insurance contracts. The actuarial computations, which use the \"projected unit credit\" method and the \"unit credit\" method assumed a discount rate on benefit obligations of 7.3% and an expected long-term rate of return on plan assets of 9.0% for 1995 and a discount rate on benefit obligations of 8.3% and an expected long-term rate of return on plan assets of 9% for 1994. No annual compensation increase is used in 1995 as the plan is frozen.\nDuring 1992, Corcap was unable to make the last required quarterly payment to the Plans nor any quarterly payments during 1993 and 1994. The required payment was not made within 8 1\/2 months after the close of the Plan year, or September 15, 1993, which caused the Plans to have an unwaived funding deficiency with respect to the unpaid quarterly amounts, subjecting Corcap to excise tax liability under the Internal Revenue Code of 1986, as amended, of at least 10% of the funding deficiency. On March 21, 1995 Corcap filed an application with the Internal Revenue Service requesting a waiver of the minimum funding standard.\nOn September 15, 1995 Corcap contributed 224,000 shares of CompuDyne Common Stock to satisfy Corcap's minimum funding obligations for the 1992, 1993 and 1994 Plan Years of its employee pension plans: Plan 1A and Plan 6B under Section 412 of the Internal Revenue Code of 1996, as amended (the \"Code\"). The Constituent Plans comprise, and are administered through, a single trust: the Corcap, Inc. Pooled Pension Investment Trust (the \"Trust\"). Corcap contributed 143,600 shares of CompuDyne Common Stock to Plan 1A and 80,400 shares of CompuDyne Common Stock to Plan 6B. The making of such contributions in property may constitute a \"prohibited transaction\" within the meaning of section 4975 of the Code and Section 406 of the Employee Retirement Income Security Act of 1974, as amended (\"ERISA\"). Corcap filed an application with the Department of Labor (\"DoL\") seeking Prohibited Transaction Exemptions with respect to the transfer of the Shares of Common Stock to each of the respective Constituent Plans. The contribution of the shares was made contingent upon said exemption being granted. On January 25, 1996 the DoL informed the Company that the application was denied. A further conversation with the DoL reopened the application and with the submission of additional supporting information, it is now expected to be approved. In the event that DoL does not grant relief sought under the application for the Prohibited Transaction Exemption, the Trustee of the Constituent Plans will promptly return the shares to Corcap. The agreement of the PBGC to settle the pension plans' underfunding liability will include the additional 224,000 CompuDyne shares if the DoL does not approve the application.\nIn March 1996, in anticipation of termination of the Corcap Pension Plan 1A and the Corcap Pension Plan 6B (collectively the \"Plans\"), the PBGC and Corcap reached a preliminary agreement whereby the PBGC agreed to accept an additional 188,660 shares of CompuDyne Common Stock in satisfaction of the Plans' underfunding liabilities to the PBGC. The agreement is subject to final documentation and signature, which is expected to be completed during April, 1996.\nIn January 1996 the Internal Revenue Service (\"IRS\") sent the Company a penalty for its failure to make timely payments to the Constituent Plans in the amount of $52 thousand. The Company is attempting to negotiate a waiver of the penalty with the IRS as part of the assumption of the Constituent Plans by the PBGC.\nThe following table presents a reconciliation of the funded status of the plans:\nDecember 31, $ Thousands 1995 1994\nActuarial present value of benefit obligations: Vested $4,368 $3,954 Non-vested - - Accumulated benefit obligation 4,368 3,954 Additional benefits related to assumed future compensation levels - -\nProjected benefit obligations 4,368 3,954 Plan assets at fair market value 3,836 3,311\nProjected benefit obligations in excess of plan assets (532) (643) Unrecognized net assets (312) (365) Unrecognized net losses 1,200 919 Additional minimum liability (888) (554) Accrued pension cost included in net discontinued operations liability $ (532) $ (643)\nKolux Pension Plan .................. In March 1987, CompuDyne ceased its Kolux plant operations resulting in a curtailment of the defined benefit pension plan covering certain plant employees. As of December 31, 1994, the actuarial present value of accumulated plan benefits was estimated to be $761 thousand, based upon a 8% interest rate assumption; the 1984 Unisex Mortality table with a five year age setback for females; and the February 28, 1994 (latest actuarial valuation) employee database projected forward to December 31, 1994. All benefits under the plan are fully vested. The projected market value of plan assets as of December 31, 1994 was $432 thousand. Accordingly, the plan's unfunded accrued liability as of December 31, 1994 of $329 thousand has been reflected in the balance sheet as accrued pension costs in net current liabilities of discontinued operations.\n11. Restricted Stock Awards and Stock Options\nAwards under Corcap's Stock Incentive Compensation Plan may be made in the form of restricted stock awards, stock options, or stock bonus awards. Restricted stock awards are grants of a specific number of shares of Corcap Common Stock to key employees if they continue to work for the Company for a certain number of years. Stock options enable key employees to purchase a specified number of shares of Common Stock at some future date at the market value on the date of grant. Stock bonus awards are grants of a specific number of shares of Corcap Common Stock having no restrictions. These awards are made to employees in recognition of extraordinary accomplishments. In June 1993, the Board of Directors terminated the 1988 Stock Incentive Compensation Plan. The termination of the Plan did not affect any awards or grants of options under the Plan all of which shall continue in force in accordance with their terms.\nAt December 31, 1995, all of the outstanding options for 2,500 shares of Corcap stock were exercisable under the terms of the Plan.\nOn August 21, 1995 in connection with Mr. Roenigk's sale of MicroAssembly to CompuDyne, Corcap issued to him options to purchase up to 450,000 shares of the Company's Common Stock for $.15 per share. The options are divided into two tranches, one of 300,000 shares and the other of 150,000 shares. The option for the 300,000 shares shall expire on August 20, 1996 (\"Option I\"). Exercise of the options for the entire 300,000 shares available under and in accordance with the terms of Option I is a precondition to the availability of the options for the remaining 150,000 shares, which remaining options expire on August 20, 2005. On March 25, 1996, the Board of Directors approved a resolution to reduce the option price per share to $.01.\n12. Deferred Compensation\nIn connection with various acquisitions, Corcap assumed obligations to pay deferred compensation to certain former employees. Estimates of the net present value of such future benefits are recorded as current liabilities of discontinued operations in the amount of $314 thousand. Concurrent with the execution of the Settlement Agreement with Lydall dated March 25, 1996 (See Note 4), Corcap and certain directors and former officers of Corcap, Messrs. Millard H. Pryor, Jr. and David W. Clark, Jr. entered into an agreement whereby Messrs. Pryor and Clark agreed to forgive an accrued obligation for compensation in the amount of $314 thousand. The forgiveness of this obligation will be reflected as additional capital contributions in the first quarter of 1996.\nCompuDyne maintains a 401(k) Retirement Savings Plan in which all employees are eligible to participate after completing one year of service. Participants may make before tax contributions of up to 15% of their annual compensation subject to Internal Revenue Service limitations. CompuDyne matches employee contributions up to the first 2% contributed. CompuDyne's contribution amounted to $45 thousand and $49 thousand for the years ended December 31, 1994, and 1993, respectively.\n13. Income Taxes\nDue to significant pretax and tax losses since the formation of Corcap, Corcap is not subject to federal taxation. State taxes of approximately $0 thousand, $5 thousand and $5 thousand were incurred during 1995, 1994 and 1993, respectively.\nThe tax effects of the primary temporary differences giving rise to the Company's deferred tax asset at December 31, 1995 and December 31, 1994 are summarized as follows:\nDecember 31, December 31 1995 1994\nTax depreciation in excess of book $ 0 $ (242) Accrued expenses and deferred compensation 0 260 Tax operating loss carryforward 3,113 2,818\n3,113 2,836 Valuation allowance (3,113) (2,836) $ - $ -\nCorcap's net operating loss carryforwards as of December 31, 1995 are $9.7 million. If not utilized, these losses will expire between during the years 2004 to 2009. Due to the significant change in the ownership of the Company, the utilization of the aforementioned loss carryforwards could be substantially limited. The Company also has carryforwards available for alternative minimum tax purposes which do not differ significantly from regular net operating loss carryforwards.\n14. Industry Segment Information\nThrough June 30, 1995, the Company operated in two business segments: engineering and security services and the manufacture of telemetry and telecommunications equipment. During the six months ended June 30, 1995 and the years ended December 31, 1994, and 1993, sales to the U.S. Federal Government amounted to 86%, 90% and 84%, respectively, of the Company's total net sales. No other single customer accounted for greater than 10% of the Company's net sales. Revenues and related costs from government services during the three years ended December 31, 1994 and 1993 and the six months ended June 30, 1995 are detailed below:\n($ Thousands) December 31, 1995 December 31, 1994 December 31, 1993\nRevenues $ 4,293 $ 8,691 $ 8,128 Cost of Services 3,729 7,326 6,840 Gross Profit 564 1,365 1,288 Operating Profit 268 794 617\nTotal Assets 1,458 702 596 Depreciation - 10 26\nCapital Expenditures - - -\nRevenues and related costs from telemetry and telecommunications products during the three years ended December 31, 1995, 1994 and 1993 are detailed below:\n($ Thousands) December 31, 1995 December 31, 1994 December 31, 1993\nRevenues $ 322 $ 1,008 $ 1,443 Cost of Services 264 787 847 Gross Profit 58 221 596 Operating Profit (73) (15) 75\nTotal Assets 789 688 534\nDepreciation - 887 10\nCapital Expenditures - - -\nThere were no revenues from Corporate activities. Costs related to corporate activities for the three years ended December 31, 1995, 1994 and 1993 are detailed below:\n($ Thousands) December 31, 1995 December 31, 1994 December 31, 1993\nOperating loss $ (69) $ (385) $ (413)\nTotal Assets - 392 584\nDepreciation - - -\nCapital Expenditures - - -\n15. Recently Issued Accounting Standard\nIn October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation.\" The new standard defines a fair value method of accounting for stock-based employee compensation plans. Under this method, compensation costs is measured based on the fair value of the stock award when granted and is recognized as an expense over the service period, which is usually the vesting period. This standard will be effective for the Company beginning in 1996 and requires measurement of awards made beginning in 1995.\nThe new standard permits companies to continue to account for equity transactions with employees under existing accounting rules, but requires disclosure in a note to the financial statements of the pro forma net income and earnings per share as if the company had applied the new method of accounting. The Company intends to implement these disclosure requirements beginning 1996. Adoption of the new standard will not impact reported net income or cash flows.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Corcap, Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nCorcap, Inc.\nBy \/s\/ I. Elaine Chen, April 15, 1996 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 Corcap, Inc. and in the capacities and on the dates indicated.\n\/s\/David W. Clark, Jr. April 15, 1996 s\/sJohn E. Sundman April 15, 1996 David W. Clark, Jr. Date John E. Sundman Date Director Director\n\/s\/ Martin A. Roenigk April 15, 1996 s\/sMillard H. Pryor, Jr. April 15,1996 Martin A. Roenigk Date Millard H. Pryor, Jr. Date Director Director\nCORCAP, INC.\nINDEX TO EXHIBITS\n22.1 List of subsidiaries of the registrant and states of incorporation is filed herewith.\n28.1 Annual Report on Form 10-K of CompuDyne Corporation for the fiscal year ended December 31, 1995.\n28.2 Settlement Agreement with Lydall, Inc. and Corcap, Inc.\n28.3 Settlement Agreement with the Pension Benefit Guaranty Corporation.\n28.4 Option Agreement between Corcap and CompuDyne dated March 25, 1996\nEXHIBIT 22\nSUBSIDIARIES OF THE REGISTRANT\nPercentage of voting securities Incorporated owned by under the immediate Name laws of Parent parent\nCorcap, Inc. Nevada Registrant Corcap Polymers, Inc. Nevada Corcap, Inc. 100% Corcap Corcap Eastern, Inc. Nevada Corcap, Inc. 100% Corcap Polymers Corcap Central, Inc. Indiana Corcap, Inc. 100% Corcap Polymers Corcap Virginia, Inc. Delaware Corcap, Inc. 100% Corcap Polymers Corcap Irongate, Inc. Delaware Corcap, Inc. 100% Corcap Virginia Nacol, Inc. Connecticut Corcap, Inc. 100% Corcap Corcap Midwest, Inc. Indiana Nacol, Inc. 100% Nacol\nNote: All subsidiaries of the Registrant as of December 31, 1992, are included in the consolidated financial statements of the Registrant.\nEffective July 31, 1991 the names of the subsidiaries of the Registrant were changed to comply with the purchase agreement dated July 1, 1991 between JM Clipper and the Registrant.","section_13":"","section_14":"","section_15":""}
{"filename":"96021_1995.txt","cik":"96021","year":"1995","section_1":"ITEM 1. BUSINESS\nSysco Corporation (together with its subsidiaries and divisions hereinafter referred to as \"SYSCO\" or the \"Company\") is engaged in the marketing and distribution of a wide range of food and related products to the foodservice or \"away-from-home-eating\" industry. The foodservice industry consists of two major customer segments -- \"traditional\" and \"chain restaurants\". Traditional foodservice customers include restaurants, hospitals, schools, hotels and industrial caterers. SYSCO's chain restaurant customers include regional pizza and national hamburger, chicken and steak chain operations.\nServices to the Company's traditional foodservice and chain restaurant customers are supported by similar physical facilities, vehicles, materials handling equipment and techniques, and marketing, merchandising and operating staffs.\nCUSTOMERS AND PRODUCTS\nThe traditional foodservice segment includes businesses and organizations which prepare and serve food to be eaten away from home. Products distributed by the Company include a full line of frozen foods, such as meats, fully prepared entrees, fruits, vegetables and desserts, and a full line of canned and dry goods, fresh meats, imported specialties and fresh produce. The Company also supplies a wide variety of nonfood items, including paper products such as disposable napkins, plates and cups; tableware such as china and silverware; restaurant and kitchen equipment and supplies; medical and surgical supplies; and cleaning supplies. SYSCO distributes both nationally-branded merchandise and products packaged under its own private brands.\nThe Company believes that prompt and accurate delivery of orders, close contact with customers and the ability to provide a full array of products and services to assist customers in their foodservice operations are of primary importance in the marketing and distribution of products to the foodservice industry. SYSCO offers daily delivery to certain customer locations and has the capability of delivering special orders on short notice. Through its more than 8,700 sales, marketing and service representatives, the Company keeps informed of the needs of its customers and acquaints them with new products. SYSCO also provides ancillary services relating to its foodservice distribution such as providing customers with product usage reports and other data, menu-planning advice, contract services for installing kitchen equipment, installation and service of beverage dispensing machines and assistance in inventory control.\nNo single traditional foodservice customer accounted for as much as 5% of SYSCO's sales for its fiscal year ended July 1, 1995. Approximately 5% of traditional foodservice sales during fiscal 1995 resulted from a process of competitive bidding. There are no\nmaterial long-term contracts with any traditional foodservice customer that may not be cancelled by either party at its option.\nThe Company's SYGMA Network operations specialize in customized service to chain restaurants, which service is also provided to a lesser extent by many of the Company's traditional foodservice operations. SYSCO's sales to the chain restaurant industry consist of a variety of food products necessitated by the increasingly broad menus of chain restaurants. The Company believes that consistent product quality and timely and accurate service are important factors in the selection of a chain restaurant supplier. No chain restaurant customer accounted for as much as 3% of SYSCO's sales for its fiscal year ended July 1, 1995, and there are no material long-term contracts with any chain restaurant customer that may not be cancelled by either party at its option.\nSYSCO does not record sales on the basis of the type of foodservice industry customer, but based upon available information, the Company estimates that sales by type of customer during the past three fiscal years were as follows:\nSOURCES OF SUPPLY\nSYSCO estimates that it purchases from thousands of independent sources, none of which accounts for more than 5% of the Company's purchases. These sources of supply consist generally of large corporations selling brand name and private label merchandise and independent private label processors and packers. Generally, purchasing is carried out on a decentralized basis through centrally developed purchasing programs (see \"Corporate Headquarters' Services and Controls\" below) and direct purchasing programs established by the Company's various operating subsidiaries and divisions. The Company continually develops relationships with suppliers but has no material long-term purchase commitments with any supplier.\nACQUISITIONS AND DIVESTITURES\nSince its formation as a Delaware corporation in 1969 and commencement of operations in March 1970, SYSCO has grown both through internal expansion of existing operations and acquisitions of formerly independent companies. The shareholders of nine companies exchanged their stock for SYSCO common stock at the formation of the Company, and through the end of fiscal 1995, fifty-one companies have been acquired, as follows:\nOn August 20, 1993 SYSCO purchased Ritter Sysco Food Services, Inc. (formerly Ritter Food Corporation) of Elizabeth, New Jersey, a full-line foodservice distributor to customers in New Jersey, metropolitan New York, western Connecticut and the Philadelphia, Pennsylvania area.\nCORPORATE HEADQUARTERS' SERVICES AND CONTROLS\nSYSCO's corporate staff, consisting of approximately 700 persons, provides a number of services to the Company's operating divisions and subsidiaries. These persons possess experience and expertise in, among other areas, accounting and finance, cash management, data processing, employee benefits, engineering and insurance. Also provided are legal, marketing and tax compliance services as well as warehousing and distribution services which provide assistance in space utilization, energy conservation, fleet management and work flow.\nThe corporate staff also administers a consolidated product procurement program engaged in the task of developing, obtaining and assuring consistent quality food and nonfood products. The program covers the purchasing and marketing of SYSCO(R) Brand merchandise, as well as private label and national brand merchandise, encompassing substantially all product lines. The Company's operating subsidiaries and divisions may participate in the program at their option.\nCAPITAL IMPROVEMENTS\nTo maximize productivity and customer service, the Company continues to construct and modernize its distribution facilities. During fiscal 1995, 1994 and 1993, approximately $202,000,000, $161,000,000, and $128,000,000, respectively, were invested in facility expansions, fleet additions and other capital asset enhancements. The Company estimates its capital expenditures in fiscal 1996 should be in the range of $210,000,000 to $230,000,000. During the three years ended July 1, 1995, capital expenditures have been financed primarily by internally generated funds, the Company's commercial paper program and bank borrowings.\nEMPLOYEES\nAs of July 1, 1995, the Company had approximately 28,100 employees, 23% of whom are represented by unions, primarily the International Brotherhood of Teamsters. Contract negotiations are handled locally with monitoring and assistance by the corporate staff. Collective bargaining agreements covering approximately 49% of the Company's union employees expire during fiscal 1996. SYSCO considers its labor relations to be satisfactory.\nCOMPETITION\nThe business of SYSCO is competitive with numerous companies engaged in foodservice distribution. While competition is encountered primarily from local and regional distributors, a few companies compete with SYSCO on a national basis.\nThe Company believes that, although price and customer contact are important considerations, the principal competitive factor in the foodservice industry is the ability to deliver a wide range of quality products and related services on a timely and dependable basis. Although SYSCO has less than 10% of the foodservice industry market in the United States, SYSCO believes, based upon industry trade data, that its sales to the \"away-from-home-eating\" industry are the largest of any foodservice distributor. While adequate industry statistics are not available, the Company believes that in most instances its local operations are among the leading distributors of food and related nonfood products to foodservice customers in their respective trading areas.\nDEBT ISSUANCE\nIn June 1995, the Company issued $150,000,000 principal amount of 6 1\/2% Senior Notes due June 15, 2005. These notes, which were priced at 99.4% of par, are unsecured, not redeemable prior to maturity and are not subject to any sinking fund requirement. The notes were issued under a $500,000,000 shelf registration filed with the Securities and Exchange Commission in June 1995. No other securities have been issued under the shelf registration.\nGENERAL\nExcept for the SYSCO(R) trademark, the Company does not own or have the right to use any patents, trademarks, licenses, franchises or concessions, the loss of which would have a materially adverse effect on the operations or earnings of the Company.\nSYSCO is not engaged in material research activities relating to the development of new products or the improvement of existing products. The Company has completed an internally developed project that involves the redesign and development of the computer operating systems through which SYSCO's operating companies will process, control and report the results of all transactions. Installation will continue company-wide through the next several years and such installations are expected to provide the basis for business expansion over this period without having a material adverse effect on the business or operations of the Company. The costs of this project will be amortized over future earnings as completed portions of the project are put into use.\nThe Company's distribution facilities have tanks for the storage of diesel fuel and other petroleum products which are subject to laws regulating such storage tanks. Other federal, state and local provisions relating to the protection of the environment or the discharge of materials do not materially impact the Company's use or operation of its facilities. The Company anticipates that compliance with these laws will not have a material effect on the capital expenditures, earnings or competitive position of SYSCO and its subsidiaries.\nSales of the Company do not generally fluctuate on a seasonal basis, and therefore, the business of the Company is not deemed to be seasonal.\nThe Company operates 103 facilities within the United States and two in Canada.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nAs of July 1, 1995 the table below shows the number of distribution facilities and self-serve centers occupied by the Company in each state or province and the aggregate cubic footage devoted to cold and dry storage.\nThe Company owns approximately 219,491,000 cubic feet of its distribution facilities and self-serve centers (or 85% of the total cubic feet), and the remainder is occupied under leases expiring at various dates from fiscal 1996 to 2015, exclusive of renewal options. Certain of the facilities owned by the Company are either subject to mortgage indebtedness or industrial revenue bond financing arrangements totaling $65,983,000 at July 1, 1995. Such mortgage indebtedness and industrial revenue bond financing arrangements mature at various dates.\nFacilities in Newark, New Jersey; Jackson, Mississippi; San Antonio, Texas; Louisville, Kentucky; Cleveland, Ohio; Detroit, Michigan; Cincinnati, Ohio; Austin, Texas; and Harrisonburg, Virginia (which in the aggregate account for approximately 14% of total sales) are operating near maximum capacity and the Company is currently constructing or planning replacements or expansions for these distribution facilities. The Company is planning to complete construction of full service distribution facilities near Milwaukee, Wisconsin and Tampa, Florida during fiscal 1996.\nThe Company's fleet of approximately 4,800 delivery vehicles consists of tractor and trailer combinations, vans and panel trucks, most of which are either wholly or partially refrigerated for the transportation of frozen or perishable foods. The Company owns approximately 93% of these vehicles and leases the remainder.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nSYSCO is engaged in various legal proceedings which have arisen but have not been fully adjudicated. These proceedings, in the opinion of management, will not have a material adverse effect upon the consolidated balance sheets or results of operations of the Company when ultimately concluded.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone\nITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT\nThe following are the executive officers of the Company, each of whom holds the office opposite his name below until the meeting of the Board of Directors immediately preceding the next Annual Meeting of Stockholders or until his successor has been elected or qualified. Executive officers who are also directors, serve as directors until the expiration of their term which is the Annual Meeting of Stockholders in the calendar year specified in parentheses or until his successor has been elected and qualified.\nEach of the executive officers listed above has been employed by the Company, or a subsidiary or division of the Company, in an executive capacity throughout the past five years.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe principal market for SYSCO's Common Stock is the New York Stock Exchange. The table below sets forth the high and low sales prices per share for SYSCO's Common Stock as reported on the New York Stock Exchange Composite Tape and the cash dividends paid for the periods indicated.\nThe approximate number of shareholders of SYSCO's Common Stock as of July 1, 1995 was 21,100.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA\nItem 7.","section_7":"Item 7.\nMANAGEMENT DISCUSSION AND ANALYSIS\nLIQUIDITY AND CAPITAL RESOURCES\nSYSCO provides marketing and distribution services to foodservice customers throughout the contiguous United States and western Canada. The company intends to continue to expand its market share through profitable sales growth and constant emphasis on the development of its consolidated buying programs. The company also strives to increase the effectiveness of its marketing associates and the productivity of its warehousing and distribution activities. These objectives require continuing investment. SYSCO's resources include cash provided by operations and access to capital from financial markets.\nSYSCO has a stock repurchase program which is used primarily to offset shares issued from time to time in conjunction with various employee benefit plans and conversions of Liquid Yield Option Notes. The number of shares acquired and their cost for the past three years was 2,100,000 shares for $53,166,000 in fiscal 1995, 3,000,000 shares for $80,131,000 in fiscal 1994 and 7,200,000 shares for $180,343,000 in fiscal 1993.\nSYSCO's operations generate a significant amount of cash which is used to fund the company's investment in facilities, fleet and other equipment required to meet its customers' needs and provide for growth. Net cash generated from operating activities was $336,903,000 in 1995, $282,515,000 in 1994 and $257,165,000 in 1993. Expenditures for facilities, fleet and other equipment were $201,577,000 in 1995, $161,485,000 in 1994 and $127,879,000 in 1993. Expenditures in fiscal 1996 should be in the range of $210,000,000 to $230,000,000.\nIn June 1995, SYSCO issued 6.5% senior notes totaling $150,000,000 due June 15, 2005. These notes, which were priced at 99.4% of par, are unsecured, not redeemable prior to maturity and are not subject to any sinking fund requirement. The notes were issued under a $500,000,000 shelf registration filed with the Securities and Exchange Commission in June 1995. No other securities have been issued under the shelf registration.\nThe net cash provided by operations less cash utilized for capital expenditures, the stock repurchase program, cash dividends and other uses resulted in long-term debt of $541,556,000 at July 1, 1995. About 71% of the total debt is at fixed rates averaging 7.42% and 29% of the total debt is at floating rates averaging 6.01%. Long-term debt to capitalization is 28% at July 1, 1995, down from the 30% at July 2, 1994 and at July 3, 1993. SYSCO continues to have borrowing capacity available and alternative financing arrangements are evaluated as appropriate.\nSYSCO has a commercial paper program which is currently supported by a $300,000,000 bank credit facility. During fiscal 1995, 1994 and 1993, commercial paper and bank borrowings ranged from approximately $146,200,000 to $425,100,000, $184,900,000 to $415,100,000 and $87,500,000 to $292,500,000, respectively.\nIn summary, SYSCO believes that through continual monitoring and management of assets together with the availability of additional capital in the financial markets, it will meet its cash requirements while maintaining proper liquidity for normal operating purposes.\nSALES\nThe annual increases in sales of 11% in 1995 and 9% in 1994 result from several factors. Sales in fiscal 1995 and 1994 were affected by the relatively modest growth in the U.S. economy, as well as in the foodservice industry. After adjusting for food price increases and adjusting for acquisitions in fiscal 1994, real sales growth was about 9% in 1995 and 7% in 1994. The cost of SYSCO's foodservice products is estimated to have averaged an increase of about 2% from the beginning to the end of fiscal 1995 compared to an increase of approximately 1.9% in fiscal 1994. Industry sources estimate the total foodservice market experienced real growth of approximately 3% in calendar 1994 and 2.3% in calendar 1993.\nSales for fiscal 1993 through 1995 were as follows:\nA comparison of the sales mix in the principal product categories during the last three years is presented below:\nA comparison of sales by type of customer during the last three years is presented below:\nCOST OF SALES\nCost of sales increased about 11% in 1995 and 9% in 1994. These increases were generally in line with the increases in sales. The rate of increase is influenced by SYSCO's overall customer and product mix as well as economies realized in product acquisition.\nOPERATING EXPENSES\nOperating expenses include the costs of warehousing and delivering products as well as selling and administrative expenses. These expenses as a percent of sales for the 1995, 1994 and 1993 fiscal years were 14.3%, 14.3% and 14.2%, respectively. Changes in the percentage relationship of operating expenses to sales result from an interplay of several economic influences. Inflationary increases in operating costs generally have been offset through improved productivity.\nINTEREST EXPENSE\nInterest expense increased $2,307,000 or approximately 6% in fiscal 1995 as compared to a decrease of $2,732,000 or approximately 7% in fiscal 1994. The increase in fiscal 1995 is due primarily to increased borrowings and rates, while the decrease in fiscal 1994 was due primarily to the expiration of an interest rate swap in December 1993. Interest capitalized during the past three years was $2,833,000 in 1995, $1,313,000 in 1994 and $1,315,000 in 1993.\nOTHER INCOME, NET\nOther income increased $467,000 or about 27% in fiscal 1995 and decreased $381,000 or about 18% in fiscal 1994. Changes between the years result from fluctuations in miscellaneous activities including gains and losses on the sale of old facilities.\nEARNINGS BEFORE INCOME TAXES\nEarnings before income taxes rose $50,036,000 or approximately 14% above fiscal 1994, which had increased $35,605,000 or approximately 11% over the prior year. Additional sales and realization of operating efficiencies contributed to the increases.\nPROVISION FOR INCOME TAXES\nThe effective tax rate for 1995 was approximately 40% compared to 41% in 1994 and 39% in 1993. In August 1993 the Omnibus Budget Reconciliation Act of 1993 became effective. This legislation increased the top corporate tax rate from 34% to 35% effective January 1, 1993. Consequently, in the first quarter of fiscal 1994 SYSCO had a charge to earnings for taxes of $4,900,000 relating to transactions and events through July 3, 1993. About $3,300,000 of the charge relates to an increase in deferred taxes and $1,600,000 relates to the retroactivity of the tax rate increase to January 1, 1993. The effective tax rate for fiscal 1994, excluding the effect of the $4,900,000 charge, was 40%.\nNET EARNINGS\nFiscal 1995 represents the nineteenth consecutive year of increased earnings for SYSCO. Net earnings for the year rose $35,072,000 or approximately 16% above fiscal 1994, which had increased $14,945,000 or approximately 7% over the prior year. After adjusting for the $4,900,000 catch-up tax provision in fiscal 1994, net earnings in 1995 increased about 14% over 1994. Excluding the impact of the extra week in fiscal 1993 and the increased tax rate in fiscal 1994, net earnings increased approximately 14% in 1994 over 1993.\nDIVIDENDS\nThe quarterly dividend rate of eleven cents per share was established in November 1994 when it was increased from the nine cents per share set in November 1993.\nRETURN ON SHAREHOLDERS' EQUITY\nThe return on average shareholders' equity for 1995, 1994 and 1993 was approximately 19%, 18% and 18%, respectively. Since inception SYSCO has averaged in excess of a 16% return on shareholders' equity.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nSYSCO CORPORATION AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS JULY 1, 1995\nFinancial Statements:\nAll other schedules are omitted because they are not applicable or the information is set forth in the consolidated financial statements or notes thereto.\nFinancial Statements of the Registrant are omitted because the Registrant is primarily an operating company and all subsidiaries are wholly-owned.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone\nREPORT OF MANAGEMENT ON INTERNAL ACCOUNTING CONTROLS\nThe management of SYSCO is responsible for the preparation and integrity of the consolidated financial statements of the Company. The accompanying consolidated financial statements have been prepared by the management of the Company, in accordance with generally accepted accounting principles, using management's best estimates and judgment where necessary. Financial information appearing throughout this Annual Report is consistent with that in the consolidated financial statements.\nTo help fulfill its responsibility, management maintains a system of internal controls designed to provide reasonable assurance that assets are safeguarded against loss or unauthorized use and that transactions are executed in accordance with management's authorizations and are reflected accurately in the Company's records. The concept of reasonable assurance is based on the recognition that the cost of maintaining a system of internal accounting controls should not exceed benefits expected to be derived from the system. SYSCO believes that its long-standing emphasis on the highest standards of conduct and ethics, embodied in comprehensive written policies, serves to reinforce its system of internal controls. The Company's operations review function monitors the operation of the internal control system and reports findings and recommendations to management and the Board of Directors. It also oversees actions taken to address control deficiencies and seeks opportunities for improving the effectiveness of the system.\nArthur Andersen LLP, independent public accountants, has been engaged to express an opinion regarding the fair presentation of the Company's financial condition and operating results. As part of their audit of the Company's financial statements, Arthur Andersen LLP considered the Company's system of internal controls to the extent they deemed necessary to determine the nature, timing and extent of their audit tests.\nThe Board of Directors oversees the Company's financial reporting through its Audit Committee which consists entirely of outside directors. The Board, after a recommendation from the Audit Committee, selects and engages the independent public accountants annually. The Audit Committee reviews both the scope of the accountants' audit and recommendations from both the independent public accountants and the internal operations review function for improvements in internal controls. The independent public accountants have free access to the Audit Committee and from time to time confer with them without management representation.\nSYSCO recognizes its responsibility to conduct business in accordance with high ethical standards. This responsibility is reflected in a comprehensive code of business conduct that, among other things, addresses potentially conflicting outside business interests of Company employees and provides guidance as to the proper conduct of business activities. Ongoing communications and review programs are designed to help ensure compliance with this code.\nThe Company believes that its system of internal controls is effective and adequate to accomplish the objectives discussed above.\n\/s\/ BILL M. LINDIG \/s\/ JOHN K. STUBBLEFIELD, JR. - ------------------------------------- ------------------------------- Bill M. Lindig John K. Stubblefield, Jr. President and Chief Executive Officer Senior Vice President and Chief Financial Officer\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nBoard of Directors and Shareholders Sysco Corporation\nWe have audited the accompanying consolidated balance sheets of Sysco Corporation (a Delaware corporation) and subsidiaries as of July 1, 1995 and July 2, 1994, and the related statements of consolidated results of operations, shareholders' equity and cash flows for each of the three years in the period ended July 1, 1995. 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Sysco Corporation and subsidiaries as of July 1, 1995 and July 2, 1994, and the results of their operations and their cash flows for each of the three years in the period ended July 1, 1995, in conformity with generally accepted accounting principles.\nOur audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule listed in Item 14(a) 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.\n\/s\/ Arthur Andersen LLP - ------------------------ Arthur Andersen LLP\nHouston, Texas August 2, 1995\nCONSOLIDATED BALANCE SHEETS\nSee Summary of Accounting Policies and Additional Financial Information.\nCONSOLIDATED RESULTS OF OPERATIONS\nSee Summary of Accounting Policies and Additional Financial Information.\nCONSOLIDATED SHAREHOLDERS' EQUITY\nSee Summary of Accounting Policies and Additional Financial Information.\nCONSOLIDATED CASH FLOWS\nSee Summary of Accounting Policies and Additional Financial Information.\nSUMMARY OF ACCOUNTING POLICIES\nBUSINESS AND CONSOLIDATION\nSYSCO Corporation (SYSCO) is engaged in the marketing and distribution of a wide range of food and related products to the foodservice or \"away-from-home-eating\" industry. These services are performed from 67 distribution facilities for approximately 255,000 customers located in the 37 states where facilities are situated and in 11 adjacent states. The company also has one facility in Vancouver, British Columbia, which services customers in that area. The accompanying financial statements include the accounts of SYSCO and its subsidiaries. All significant intercompany transactions and account balances have been eliminated.\nEarnings of acquisitions recorded as purchases are included in SYSCO's results of operations from the date of acquisition.\nINVENTORIES\nInventories consist of food and related products held for resale and are valued at the lower of cost (first-in, first-out method) or market.\nPLANT AND EQUIPMENT\nCapital additions, improvements and major renewals are classified as plant and equipment and are carried at cost. Depreciation is recorded using the straight-line method which reduces the book value of each asset in equal amounts over its estimated useful life. Maintenance, repairs and minor renewals are charged to earnings when they are incurred. Upon the disposition of an asset, its accumulated depreciation is deducted from the original cost, and any gain or loss is reflected in current earnings.\nApplicable interest charges incurred during the construction of new facilities are capitalized as one of the elements of cost and are amortized over the assets' estimated useful lives. Interest capitalized during the past three years was $2,833,000 in 1995, $1,313,000 in 1994 and $1,315,000 in 1993.\nGOODWILL AND INTANGIBLES\nGoodwill and intangibles represent the excess of cost over the fair value of tangible net assets acquired and are amortized over 40 years using the straight-line method. Accumulated amortization at July 1, 1995, July 2, 1994 and July 3, 1993 is $50,935,000, $43,120,000 and $35,416,000, respectively.\nCOMPUTER SYSTEMS DEVELOPMENT PROJECT\nSYSCO has capitalized direct costs incurred in connection with an internal computer systems development project. The capitalization of these costs began once it was reasonably certain that the new system would be completed and would fulfill its intended use. Costs of $17,593,000, $29,658,000 and $14,094,000 were capitalized during fiscal 1995, 1994 and 1993, respectively. Amounts capitalized will be amortized over future earnings as completed portions of the project are put into use. Accumulated amortization at July 1, 1995 was $232,000.\nINSURANCE PROGRAM\nSYSCO maintains a self-insurance program covering portions of workers' compensation and general and automobile liability costs. The amounts in excess of the self-insured levels are fully insured. Self-insurance accruals are based on claims filed and an estimate for significant claims incurred but not reported.\nINCOME TAXES\nSYSCO follows the liability method for deferred income taxes as required by the provisions of Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes.\"\nCASH FLOW INFORMATION\nFor cash flow purposes, cash includes cash equivalents such as time deposits, certificates of deposit and all highly liquid instruments with original maturities of three months or less.\nADDITIONAL FINANCIAL INFORMATION\nINCOME TAXES\nThe income tax provisions consist of the following:\nIncluded in the income taxes charged to earnings are net deferred tax provisions of $23,417,000 in 1995, $23,292,000 in 1994 and $13,281,000 in 1993. The provisions result from the effects of net changes during the year in deferred tax assets and liabilities arising from 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 are as follows:\nThe company has enjoyed taxable earnings during each year of its twenty-six year existence and knows of no reason such profitability should not continue. Consequently, the company believes that it is more likely than not that the entire benefit of existing temporary differences will be realized and therefore no valuation allowance has been established for deferred assets.\nThe effective tax rate was 40% in 1995, 41% in 1994 and 39% in 1993 and an analysis is as follows:\nALLOWANCE FOR DOUBTFUL ACCOUNTS RECEIVABLE\nThe allowance for doubtful accounts receivable was $16,001,000 as of July 1, 1995, $15,999,000 as of July 2, 1994 and $15,122,000 as of July 3, 1993. Customer accounts written off, net of recoveries, were $15,986,000 or .13% of sales, $17,291,000 or .16% of sales and $13,163,000 or .13% of sales for fiscal years 1995, 1994 and 1993, respectively.\nSHAREHOLDERS' EQUITY\nEarnings per share have been computed by dividing net earnings by 182,779,806 in 1995, 184,338,616 in 1994 and 186,745,576 in 1993, which represents the weighted average number of shares of common stock outstanding during those respective years.\nIn May 1986, the Board of Directors adopted a Warrant Dividend Plan designed to protect against those unsolicited\nattempts to acquire control of SYSCO that the Board believes are not in the best interest of the shareholders. The Plan, as adjusted, provides for a dividend distribution of one-fourth of one Preferred Stock Purchase Right (Right) for each outstanding share of SYSCO common stock. Each Right may be exercised to purchase one one-hundredth of a share of newly created Series A Junior Participating Preferred Stock at an exercise price of $135, subject to adjustment. The Rights will not be exercisable until a party either acquires 20% of the company's common stock or makes a tender offer for 20% or more of its common stock. In the event of a merger or other business combination transaction, each Right effectively entitles the holder to purchase $270 worth of stock of the surviving company for a purchase price of $135.\nThe Rights expire on May 30, 1996 and may be redeemed before expiration by the company at a price of $.05 per Right until a party acquires 20% of the company's common stock or thereafter under certain circumstances. As a result of the Rights distribution, 600,000 of the 1,500,000 authorized preferred shares have been reserved for issuance as Series A Junior Participating Preferred Stock.\nPLANT AND EQUIPMENT\nA summary of plant and equipment, including the related accumulated depreciation, appears below:\nDEBT\nAt July 1, 1995 and July 2, 1994 SYSCO had $1,181,000 and $5,247,000, respectively, of short-term bank borrowings. The level of such borrowings fluctuates during the year based on working capital requirements.\nSYSCO's long-term debt is comprised of the following:\nThe principal payments required to be made on long-term debt during the next five years are shown below:\nSYSCO has a $300,000,000 revolving loan agreement maturing in 2000 which currently supports the company's commercial paper program. The commercial paper borrowings at July 1, 1995 were $144,510,000. The Liquid Yield Option Notes have no periodic interest payments, will yield 6.25% if held to maturity, and can be converted into SYSCO common stock at a conversion rate of 24.512 shares per note. Each note, which initially sold for $397.27 per $1,000 of face value at maturity, has an accreted value at July 1, 1995 of $565.01 per $1,000 of face value.\nIn June 1995, SYSCO issued 6.5% senior notes totaling $150,000,000 due June 15, 2005. These notes, which were priced at 99.4% of par, are unsecured, not redeemable prior to maturity and are not subject to any sinking fund requirement. The notes were issued under a $500,000,000 shelf registration filed with the Securities and Exchange Commission in June 1995. No other securities have been issued under the shelf registration.\nThe Industrial Revenue Bonds have varying structures. Final maturities range from one to thirty-one years and certain of the bonds provide SYSCO the right to redeem (a call) at various dates. These call provisions generally provide the bondholder a premium in the early call years, declining to par value as the bonds approach maturity. Certain bonds have provisions whereby the holder may require SYSCO to purchase or redeem the bonds (a put) under certain circumstances. If certain of these bonds are purchased from bondholders, they can be remarketed at the then prevailing interest rates.\nLong-term debt at July 1, 1995 was $541,556,000, of which 71% is at fixed rates averaging 7.42% with an average life of eight years, while the remainder is financed at floating rates averaging 6.01%. Certain loan agreements contain typical covenants to protect noteholders including provisions to maintain tangible net worth and funded indebtedness at specified levels.\nThe fair value of SYSCO's long-term debt is estimated based on the quoted market prices for the same or similar issues or on the current rates offered to the company for debt of the same remaining maturities. The fair value of long-term debt approximates $584,000,000 at July 1, 1995.\nAs part of normal business activities, SYSCO issues letters of credit through major banking institutions as required by certain vendor and insurance agreements. As of July 1, 1995 and July 2, 1994 letters of credit outstanding were $29,664,000 and $30,664,000, respectively. As of July 1, 1995 SYSCO has not entered into any significant derivative or other off-balance-sheet financing arrangements.\nLEASES\nAlthough SYSCO normally purchases assets, it has obligations under capital and operating leases for certain distribution facilities, vehicles and computers. Total rental expense under operating leases was $32,105,000, $31,089,000 and $27,506,000 in fiscal 1995, 1994 and 1993, respectively. Contingent rentals, subleases, assets and obligations under capital leases are not significant.\nAggregate minimum lease payments under existing non-capitalized long-term leases are as follows:\nSTOCK OPTION PLANS\nEMPLOYEE INCENTIVE STOCK OPTION PLAN\nThe Employee Incentive Stock Option Plan adopted in fiscal 1982 provided for the issuance of options to purchase SYSCO common stock to officers and key personnel of the company and its subsidiaries at the market price at date of grant, as adjusted for stock splits. No further grants will be made under this plan which expired in November 1991 and was replaced by the 1991 Stock Option Plan.\nThe following summary presents information with regard to incentive options under this plan:\n1991 STOCK OPTION PLAN\nThe 1991 Stock Option Plan was adopted in fiscal 1992 and reserves 3,000,000 shares of SYSCO common stock for options to directors, officers and key personnel of the company and its subsidiaries at the market price at date of grant. This plan provides for the issuance of options which are qualified as incentive stock options under the Internal Revenue Code of 1986, options which are not so qualified and stock appreciation rights. To date, the company has issued stock options but no stock appreciation rights under this plan.\nThe following summary presents information with regard to options issued under the 1991 plan:\nNON-EMPLOYEE DIRECTORS STOCK OPTION PLAN\nIn December 1994, the Board of Directors adopted, subject to the approval of the shareholders at the annual meeting in November 1995, a non-employee directors stock option plan which permits the issuance of up to 200,000 shares of common stock to directors who are not employees of SYSCO. Under this plan options to purchase common stock, at the fair market\nvalue on the date of the grant, are granted to each non-employee director annually, provided certain earnings goals are met. As of July 1, 1995, options for 18,000 shares had been contingently granted to nine non-employee directors under this plan.\nEMPLOYEE BENEFIT PLANS\nSYSCO and each of its subsidiaries have defined benefit and defined contribution retirement plans for their employees. Also, the company contributes to various multi-employer plans under collective bargaining agreements.\nThe defined benefit pension plans pay benefits to employees at retirement using formulas based on a participant's years of service and compensation. The defined contribution 401(k) plan provides that under certain circumstances the company may make matching contributions of up to 50% of the first 6% of a participant's compensation. SYSCO's contribution to this plan was $4,254,000 in 1995, $8,163,000 in 1994 and $2,901,000 in 1993.\nThe funded status of the defined benefit plans is as follows:\nThe projected unit credit method was used to determine the actuarial present value of the accumulated benefit obligation and the projected benefit obligation. The discount rate used was 8% in 1995 and 7.75% in 1994 and 1993 and the rate of increase in future compensation levels used was 5.5% in each year. The expected long-term rate of return on assets used was 9% in 1995, 10% in 1994 and 12% in 1993. The plans invest primarily in marketable securities and time deposits.\nNet pension costs were as follows:\nSYSCO also has a Management Incentive Plan that compensates key management personnel for specific performance achievements. The awards under this plan were $16,545,000 in 1995, $12,508,000 in 1994 and $11,725,000 in 1993. In addition to receiving benefits under the company's defined benefit plan, participants in the Management Incentive Plan will\nreceive benefits upon retirement under a Supplemental Executive Retirement Plan. This plan is a nonqualified, unfunded supplementary retirement plan. In order to meet its obligations under this plan, SYSCO maintains life insurance policies on the lives of the participants with carrying values of $40,200,000 at July 1, 1995 and $33,199,000 at July 2, 1994. SYSCO is the sole owner and beneficiary of such policies. The periodic pension costs of this plan were $3,659,000 in 1995 and $3,109,000 in 1994. The actuarially determined accumulated benefit obligation for this plan included in accrued expenses was $19,004,000 at July 1, 1995 and $16,558,000 at July 2, 1994. After taking into consideration the effect of future compensation increases, the projected benefit obligation of this plan was $27,046,000 at July 1, 1995 and $23,941,000 at July 2, 1994.\nSYSCO has an Employees' Stock Purchase Plan which permits employees (other than directors) who have been employed for at least one year to invest by means of periodic payroll deductions in SYSCO common stock at 85% of the closing price on the last business day of each fiscal quarter. During 1995, 584,526 shares of SYSCO common stock were purchased by the participants as compared to 579,916 purchased in 1994 and 538,923 purchased in 1993. The total number of shares which may be sold pursuant to the plan may not exceed 12,000,000 shares of which 1,106,553 remained available at July 1, 1995.\nAt the beginning of fiscal 1994, SYSCO implemented SFAS 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" This statement requires that the cost of retiree benefits other than pensions be recognized in the financial statements during the years the employee provides services. In the prior years, the company's portion of the cost of these benefits has been expensed under the pay-as-you-go method. SYSCO provided, through December 31, 1994, postretirement health care benefits to eligible retired employees and their dependents. This accounting change had no significant effect on net earnings or financial condition in fiscal 1994.\nNet periodic postretirement benefit costs were as follows:\nThe components of the postretirement benefit obligation, included in accrued expenses at July 1, 1995 and July 2, 1994 were:\nThe discount rate used to determine the accumulated postretirement benefit obligation was 7.75% in 1995 and 8% in 1994. A health care cost trend rate is not used in the calculations because SYSCO subsidizes the cost of postretirement medical coverage by a fixed dollar amount with the retiree responsible for the cost of coverage in excess of the subsidy, including all future cost increases.\nAt the beginning of fiscal 1995, SYSCO implemented SFAS 112, \"Employers' Accounting for Postemployment Benefits,\" which requires that accrual accounting be used for the cost of certain obligations to be paid to former or inactive employees after employment but before retirement. Such obligations include salary continuation, disability, severance and workers' compensation. This accounting change had no significant effect on net earnings or financial condition in fiscal 1995.\nCONTINGENCIES\nSYSCO is engaged in various legal proceedings which have arisen but have not been fully adjudicated. These proceedings, in the opinion of management, will not have a material adverse effect upon the consolidated financial position or results of operations of the company when ultimately concluded.\nQUARTERLY RESULTS (UNAUDITED)\nFinancial information for each quarter in the years ended July 1, 1995 and July 2, 1994:\nPART III\nExcept as otherwise indicated, the information required by Items 10, 11, 12 and 13 is included in the Company's definitive proxy statement which will be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934 no later than 120 days after the close of the 1995 fiscal year, and said proxy statement is hereby incorporated by reference thereto.\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nInformation concerning Executive Officers is included in Part I (Item 4A) of this Form 10-K (page 8).\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\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) The following documents are filed, or incorporated by reference, as part of this Form 10-K:\n1. All financial statements. See index to Consolidated Financial Statements on page 14 of this Form 10-K.\n2. Financial Statement Schedule. See page 14 of this Form 10-K.\n3. Exhibits.\n3(a) Restated Certificate of Incorporation, as amended, hereby incorporated by reference to Form 10-K for the year ended June 29, 1991.\n3(b) Bylaws, as amended.\n4(a) Competitive Advance and Revolving Credit Facility Agreement dated as of July 27, 1988, as amended February 14, 1989 and May 1, 1989 hereby incorporated by reference to the Form 10-K for the year ended July 1, 1989.\nAgreement and Third Amendment to Competitive Advance and Revolving Credit Facility and Modification of Notes dated as of January 2, 1990 hereby incorporated by reference to Form 10-K for the year ended June 30, 1990.\nAgreement and Fourth Amendment to Competitive Advance and Revolving Credit Facility Agreement, dated as of January 31, 1994 hereby incorporated by reference to Form 10-K for the year ended July 2, 1994.\nAGREEMENT AND FIFTH AMENDMENT TO COMPETITIVE ADVANCE AND REVOLVING CREDIT FACILITY AGREEMENT, DATED AS OF NOVEMBER 15, 1994.\n4(b) Sysco Corporation Note Agreement dated as of June 1, 1989 hereby incorporated by reference to the Form 10-K for the year ended July 1, 1989.\n4(c) Indenture, dated as of October 1, 1989, between Sysco Corporation and Chemical Bank, Trustee, hereby incorporated by reference to Registration Statement on Form S-3 (File No. 33-31227).\n4(d) Indenture, dated as of June 15, 1995, between Sysco Corporation and First Union National Bank of North Carolina, Trustee, hereby incorporated by reference to Registration Statement on Form S-3 (File No. 33-60023).\n10(a) AMENDED AND RESTATED SYSCO CORPORATION EXECUTIVE DEFERRED COMPENSATION PLAN\n10(b) Amended and restated Sysco Corporation Supplemental Executive Retirement Plan incorporated by reference to Form 10-K for the year ended July 3, 1993.\n10(c) Sysco Corporation Employee Incentive Stock Option Plan incorporated by reference to the Form S-8 filed under the Securities Act of 1933, as amended, dated April 1, 1987, as amended.\n10(d) Sysco Corporation Amended and Restated Management Incentive Plan incorporated by reference to Form 10-K for the year ended July 2, 1994.\n10(e) SYSCO CORPORATION 1995 MANAGEMENT INCENTIVE PLAN (SUBJECT TO APPROVAL BY STOCKHOLDERS AT THE 1995 ANNUAL MEETING).\n10(f) Sysco Corporation 1991 Stock Option Plan incorporated by reference to Form 10-K for the year ended June 27, 1992.\n10(g) SYSCO CORPORATION NON-EMPLOYEE DIRECTORS STOCK OPTION PLAN (SUBJECT TO APPROVAL BY STOCKHOLDERS AT THE 1995 ANNUAL MEETING).\n11 STATEMENT RE COMPUTATION OF PER SHARE EARNINGS\n21 SUBSIDIARIES OF THE REGISTRANT\n23 INDEPENDENT PUBLIC ACCOUNTANTS' CONSENT\n27 FINANCIAL DATA SCHEDULE\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, Sysco Corporation has duly caused this Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized, on this 1st day of September, 1995.\nSYSCO CORPORATION\nBy \/s\/ BILL M. LINDIG ------------------------------------- Bill M. Lindig 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 indicated and on the date indicated above.\nPRINCIPAL EXECUTIVE, FINANCIAL & ACCOUNTING OFFICERS:\nDIRECTORS:\nSYSCO CORPORATION AND SUBSIDIARIES\nSCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS\n(1) Allowance accounts added from acquisitions. (2) Customer accounts written off, net of recoveries. (3) Allowance accounts deducted due to sales of businesses.\nS-1\nSECURITIES AND EXCHANGE COMMISSION\nWASHINGTON, D.C. 20549\nFORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OF THE SECURITIES EXCHANGE ACT OF 1934\nFor the Fiscal Year Ended July 1, 1995 Commission File No. 1-6544\nSYSCO CORPORATION\n(Exact Name of Registrant as Specified in its Charter)\nEXHIBITS\nINDEX TO EXHIBITS","section_15":""}
{"filename":"16590_1995.txt","cik":"16590","year":"1995","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":"61478_1995.txt","cik":"61478","year":"1995","section_1":"Item 1. BUSINESS\nADC designs, manufactures and markets transmission, enterprise networking and connectivity products for use in broadband global networks. The Company's wide range of products employ fiber, hybrid fiber coax, wireless and traditional copper-based technologies. The Company's customers include: public network providers, which consist of all seven of the Regional Bell Operating Companies (RBOCs), other telephone companies, long distance carriers, wireless service providers, the major cable TV operators and other domestic public network providers; private and governmental network providers (such as various large business customers and governmental agencies); international network operators; and major telecommunications Original Equipment Manufacturers (OEMs). The Company's products enable these network providers to build and upgrade their networks to support increasing user demand for voice, data and video services.\nAs used in this report, the terms \"Company\" and \"ADC\" refer to ADC Telecommunications, Inc. and its wholly owned subsidiaries, unless the context otherwise requires; and 1993, 1994 and 1995 refer to the Company's fiscal years ended October 31, 1993, 1994 and 1995, respectively.\nINDUSTRY BACKGROUND\nSince the 1970's, the telecommunications equipment industry has grown and changed substantially, primarily as a result of continuous technological development; increased demand for the transmission of data and video traffic and the convergence of all network traffic into integrated multimedia services over public and private networks; and a changing regulatory and competitive environment. The Company believes that these trends will continue to drive changes in the telecommunications equipment industry for the foreseeable future.\nSeveral important technological developments have spurred the evolution of the telecommunications equipment industry. One important technological change has been the deployment of fiber optic transmission systems. In a fiber optic system, lasers transmit voice, data and video traffic in the form of analog or digital coded light pulses through glass fibers. The increasing shift to fiber optic transmission systems has been principally due to the ability of fiber optics to carry large volumes of information at high speeds, its insensitivity to electromagnetic interference and the high transmission quality made possible by the physical properties of light.\nThe development of cost-effective digital technology has allowed greater capacity (or speed) in network transmission and has resulted in an increasing trend over the past decade to replace analog technology in copper, fiber and wireless transmission networks. In analog technology, information is converted to a voltage or current wave form for processing or transmission. In digital technology, information is converted to digital bits and then processed or transmitted using computer based components. Very high-speed digital technology developments such as cell based Asynchronous Transfer Mode (ATM) technologies and Synchronous Optical NETwork (SONET) technologies have enabled network providers to transmit increasing amounts of data and video communications.\nAnother important technological change in the telecommunications marketplace is the use of integrated circuits in both public and private telecommunications networks, facilitating significantly more complex networks. Network equipment utilizing integrated circuits is increasingly performing the high speed switching, network performance monitoring, network management, information compression, data translation and other complex functions required to address expanding users' needs.\nMore recently, wireless technology developments are having an impact on the telecommunications equipment industry. There has been substantial growth in wireless communications such as cellular telephone services, and significant preparations for increasing use of satellite-based services, personal communications services (PCS) and Multichannel, Multipoint Distribution Systems (MMDS) for wireless cable services. This growth has been spurred by the convenience of mobility and the limits of wireline infrastructure. In particular, in countries without reliable or extensive wireline systems, wireless service could ultimately provide the primary service platform for both mobile and fixed telecommunications applications, because of the potential savings in installation time and cost. The Company believes that in future years the continuing development of wireless communications technology could substantially extend the reach of current communications networks.\nDemands on network infrastructure have grown substantially in the past decade. Networks increasingly are required to transmit a combination of data and video for the purpose of communicating information, conducting business and delivering entertainment. In addition, both public and private network customers are requesting the convergence of their voice, data and video traffic into integrated multimedia services transmitted over one network. Such demands have prompted the development and use of \"broadband\" networks, which feature the improved reliability and increased speed of transmission generally required for data and video transmission over the network. Specifically, the industry term \"broadband\" refers to all transmission speeds of T1 (1.544 million bits per second) and higher. Growth in broadband network applications has fueled increased infrastructure investment by network operators in order to expand network capacity and provide new applications and services to meet users' needs.\nThe evolution in technology and user needs has been accompanied by changes in the domestic and international regulatory environment. Since the divestiture of the AT&T regional operating companies in 1984, the RBOCs have been prevented from manufacturing equipment for use in telecommunications networks. As the RBOCs have embarked on aggressive expansion plans, significant opportunities have been created for independent telecommunications equipment manufacturers such as the Company. The policy of deregulation currently being followed by the Federal Communications Commission and other important regulatory agencies throughout the world has increased opportunities for independent companies to supply products and services within public telephone system markets and within private voice, data and video communications markets. Although the ultimate impact is uncertain, current telecommunications legislation being discussed in the U.S. Congress may result in new competitors, including the RBOCs, entering the telecommunications equipment market.\nOutside the United States, the telecommunications equipment market has also expanded and changed significantly in recent years, as network users have increasingly demanded access to voice, data and video communications capabilities. Many countries without reliable or extensive wireline systems are seeking to develop and enhance their telecommunications infrastructure. This growth in demand for network services and infrastructure has been accompanied by changes in the international regulatory environment. In many countries, government operated telecommunications monopolies are being converted to private network services providers, and competition among such carriers may intensify.\nThe Company believes that \"broadband global networking,\" or the emerging series of worldwide broadband networks, represents a key enabling capability for meeting the information needs of network users. The addition of high speed data and video traffic has driven the need for broadband infrastructure and has enabled the creation of a wide range of new applications, including video on demand, distance learning, telecommuting and remote medical imaging. The Company participates in this emerging broadband global network market by providing a broad variety of equipment, services and integrated product solutions.\nSTRATEGY\nADC's strategy is to capitalize on opportunities in the evolving global telecommunications market by providing equipment, services and integrated solutions for its customers' voice, data and video telecommunications networks. ADC's broad range of products addresses key areas of the telecommunications network infrastructure, and these products are used to connect physical networks, access network services, transport network traffic and manage networks. ADC's diverse product offerings address the needs of its many customers which include the RBOCs, other telephone companies, long distance carriers, wireless service providers, the major cable TV operators, other public network providers, private network providers and telecommunications OEMs. Key components of the Company's strategy include:\n* Focus on Broadband Network Opportunities. In recent years, broadband requirements for both public and private networks have grown significantly. Accordingly, ADC is focusing its product development and marketing efforts on opportunities in emerging broadband networks. In the public network market, broadband deployment has been driven by telephone and cable television providers seeking to establish the infrastructure required to offer video, telephony, entertainment, Internet access and other interactive services to residential customers over a single network. In the private network market, broadband requirements have been driven by the growth of voice, data and video applications utilizing increasing amounts of bandwidth. Examples of products developed by ADC to target these opportunities include the Company's Homeworx- TM- system, which has been designed to enable telephone and cable television companies to provide a range of voice, video and data services to residential customers; the Soneplex-Registered Trademark- product, which allows public network providers to cost effectively deliver and manage broadband services over the public network for their business customers; and the AAC-3-TM- ATM access concentrator, which is being developed to allow customers to gain access to switched voice, data and video traffic on public networks from their private networks.\n* Provide End-to-End Network Solutions. ADC offers a broad line of telecommunications equipment that addresses customers' key network needs from the central office, through the local loop (the portion of a network that connects a subscriber's equipment to a local central office), into the customer premise and across enterprise networks. Through internal development and acquisitions, ADC has formed its expertise in three major network areas: transmission, enterprise networking and broadband connectivity. ADC is currently enhancing its network management and systems integration capability to enable it to offer customers more complete solutions to their network needs.\n* Leverage Technological Capabilities Across Product Groups. ADC has developed substantial expertise in fiber optics, broadband, video and wireless technologies. The Company has built these core competencies through internal development, acquisitions, joint ventures and technology licensing arrangements. ADC's strategy is to leverage these core competencies across its product groups in order to develop new product architectures and network management tools for its customers' evolving voice, data and video network needs in various market areas. An example of this effort is the continuing development of the Company's wireless technologies for use in converging wired and wireless applications such as potential wireless local loop products.\n* Expand International Presence. ADC believes that significant growth in the telecommunications equipment market will occur outside the United States as a result of deregulation and the need of many foreign countries to substantially expand or enhance their telecommunications services. ADC's strategy is to expand its international presence by increasing its international sales and marketing resources, leveraging its existing customer relationships, developing additional international distribution channels and seeking strategic alliances and acquisitions.\n* Pursue Strategic Alliances and Acquisitions. ADC has sought and will continue to seek alliances and acquisitions to: (i) add key technologies that it can leverage across its businesses, (ii) broaden its product offerings, (iii) enter attractive new markets and (iv) expand or enhance its distribution channels. Recent examples of such alliances and acquisitions include: ADC's OEM joint development efforts with Nokia Telecommunications, the infrastructure arm of Finland-based Nokia Corporation, to develop system solutions for the global cable TV and telecommunications markets; its partnerships with Bellcore and Objective System Integrators (OSI) to jointly develop element manager systems for ADC's Homeworx system; ADC's investment in and development alliance with NetComm Limited of Sydney, Australia, in the area of cable modems; its joint marketing relationship with Hitachi Telecom (USA) which includes ADC's Homeworx and Soneplex broadband access products and Hitachi's SONET and ATM equipment; ADC's technology exchanges with Fore Systems and Bay Networks in the public network ATM access product area; its investment in and development alliance with Optivision for MPEG-1 and MPEG-2 compression technology; and its acquisition of Australia-based AOFR Pty. Ltd. in the fiber optic couplers area.\nPRODUCT GROUPS\nThe Company's products can be categorized into three general functional groups: (i) transmission, (ii) enterprise networking and (iii) broadband connectivity. These product groups accounted for 31%, 22% and 47%, respectively, of the Company's net sales for the year ended October 31, 1995. Each of these product groups is discussed below.\nTRANSMISSION\nADC's transmission products provide electronic and optical signal generation within predominantly public networks. Certain of the transmission products also provide access to the network in order to monitor, test and reroute circuits within telecommunications transmission systems. ADC's transmission products are designed for use in copper-based, coax-based, fiber- based or wireless transmission networks and are sold to telephone companies, cable TV companies, other public network providers and to users of private voice, data and video networks. Transmission products include fiber optic video delivery products, other high speed voice, data and video delivery and access platforms, wireless microcell systems, test and monitoring systems and digital repeaters. Certain of the Company's transmission products are described below.\nDV6000-TM- and Other Fiber Video Delivery Equipment. The DV6000 system transmits a variety of signal types using a high speed, uncompressed digital format (2.4 billion bits per second) over fiber in the super trunking portions of broadcast and interactive video networks. This system is used in significant public residential broadband networks, such as Viacom Cable's San Francisco Bay Area video backbone network and the regional headend network in Florida of TCI Cablevision of Florida, Inc. ADC's PixlNet-TM- multipoint videoconferencing system provides a public network switched digital video system for user-initiated video conference management. The PixlNet system is currently being tested in customer field trials. The Company also manufactures various analog video transmission systems used in cable TV and broadcast applications and interactive systems for distance learning and campus interconnects.\nHomeworx Access Transport Platform. The Company's Homeworx access transport platform is a customer loop transmission system for small business and residential customers utilizing hybrid fiber coax technology. The Homeworx system has been designed for deployment on video-only, integrated video and telephony and telephony-only broadband networks provided by telephone operating companies, cable TV companies and other telecommunications common carriers. The Homeworx system has been selected for video-only use in the residential broadband networks of Ameritech Corporation, Southern New England Telephone Corporation, MediaOne, Cox Cable Communications, Inc. and Cable Bahamas. The enhanced telephony version of the Homeworx system has commenced test trials with a limited number of customers. Also, Optus Vision Pty. Ltd. in Australia has elected to use the telephony capability of the integrated video and telephony Homeworx system in its residential broadband network, and the Company currently plans to begin shipping this product in commercial volumes in the third quarter of 1996. Additionally, the system is being tested by several of the Company's public network provider customers both in the United States and internationally.\nSoneplex Service Delivery Platform. The Company's Soneplex platform is an intelligent loop access platform enabling public network providers to deliver T1-based services over copper or fiber for business customers. The Company's Soneplex family of platforms and modules employ electrical-to-optical conversion for transport of voice, data and video over fiber facilities and High bit-rate Digital Subscriber Line (HDSL) transmission technology for transport of high bandwidth services over copper-based systems. Soneplex products also integrate remote provisioning, circuit performance monitoring and test access capabilities to help public network carriers provide reliable service at a low operational cost. The Company has under development new modules and capabilities for the Soneplex platform, including SONET internetworking.\nCityWide-TM- Products. The Company's family of CityWide wireless systems products includes the CityCell- Registered Trademark- radio frequency and wideband digital microcells for adding and extending cellular communication coverage, primarily in large urban areas. The CityCell microcell has been commercially deployed by six RBOC cellular network providers. The Company's CityRad-TM- air-to-air re-radiator with traffic level monitoring is designed to extend wireless coverage without adding microcells. Late in 1995, the Company introduced three new advanced intelligent network wireless network solutions to its CityWide product family, a multi-sectored digital microcell, an in-building distributed antenna system and a mini base station and mobile switching center product. These products are expected to enter customer field trials by second quarter 1996 and to be commercially released later in the year.\nTest and Monitoring Systems. The Company manufactures a variety of remote digital test and performance monitoring products for copper-based and fiber- based systems.\nDigital Repeaters. The Company's copper-based digital repeaters are used primarily in central office applications to regenerate digital signals that have degraded because of transmission over long distances.\nSONET and ATM Equipment. The Company has entered into a joint marketing arrangement with an OEM partner under which the Company has the exclusive right to market its partner's SONET and ATM equipment that support advanced high speed data and video applications, primarily in public networks. The Company's partner will market the Company's Homeworx and Soneplex broadband access systems.\nENTERPRISE NETWORKING\nADC's enterprise networking products provide interconnection and transmission of voice, data and video signals within a private network and also provide access to the public network. These products are designed for use in copper-based, fiber optic and wireless networks and are sold to users of private voice, data and video networks, either directly or through telecommunications common carriers or Value Added Resellers (VARs). Enterprise Networking products include public network access equipment, internetworking products and data network management products. Certain of the Company's enterprise networking products are described below.\nPublic Network Access Equipment. The Company manufactures a family of Channel Service Unit (CSU) and Data Service Unit (DSU) products which are used to interconnect digitally the public network and the private network. This equipment monitors circuits and provides system protection and other network management functions. Certain of these products also enable the customer to test the performance of its voice network and allow connection of voice, data and video circuits. These products support T1 and T3 (44.6 million bits per second) services and a variety of data protocols, including Frame Relay, Switched Multi-megabit Data Service (SMDS) and ATM. During 1995, the Company began commercial shipment of its AAC-1-TM- and AAC-3 ATM access concentrators which adapt, aggregate, multiplex and manage all voice, data and video signals in various speeds, technologies and protocols for transport over T1 and T3 speed ATM networks, respectively. Recently, the Company has entered into agreements with ATM equipment suppliers such as FORE Systems and Bay Networks to integrate ADC's ATM adaptation and concentration technologies into the two companies' ATM switching and routing products and to jointly market ADC's ATM access concentrators. In addition, the company has made other interoperability announcements of its ATM equipment with local service provider Ameritech and long distance carriers Wiltel, Inc. and Sprint.\nInternetworking Products. Internetworking products include fiber optic backbones used to transport high speed multiple voice, data and video signals simultaneously over private networks and link Local Area Networks (LAN), mainframes, minicomputers, personal computers, telephone systems and video equipment with diverse protocols within private networks or over the public network; intelligent wiring hub products which interconnect workstations, personal computers and terminals, utilizing many different LAN protocols and types of cables; and network management systems.\nPatch\/Switch System and PatchMate-TM- Module. The Company's Patch\/Switch system is a data network management product which provides access to and monitors, tests and reconfigures digital data circuits and permits local or remote switching to alternate circuits or backup equipment. This system is modular, permitting the user to select and combine the particular functions desired in a system. The PatchMate module is a manually operated electromechanical device used to gain access to the network in order to monitor, test and reconfigure digital data circuits.\nRecognizing changes in the competitive environment for LAN equipment, during 1995 the Company realigned its Kentrox and Fibermux subsidiaries into one business unit to better address the industry trend toward integration of LAN and Wide Area Network (WAN) technologies and products. This group combines LAN and WAN expertise in order to develop, manufacture and distribute advanced network access and transport products for use in current and future broadband enterprise networks. The Company recorded a charge of $3.9 million related to a personnel reduction at the Fibermux facility and other expenses resulting from the realignment. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and Note 2 of \"Notes to Consolidated Financial Statements.\"\nBROADBAND CONNECTIVITY\nADC's broadband connectivity products provide the physical contact points for connecting different telecommunications system components and gaining access to telecommunications system circuits for the purpose of installing, testing, monitoring or reconfiguring such circuits within global public and private networks. These products are sold to the RBOCs, other telephone companies, long distance carriers, other public network providers such as cable TV companies, private network providers and telecommunications OEMs. The Company's broadband connectivity products are designed for use in copper-based, coax, fiber optic or wireless transmission networks. Broadband connectivity products include various network access\/connection devices for copper and coax networks, various network access\/connection devices for fiber optic networks, modular fiber optic cable routing systems, broadband infrastructure database management systems and outside plant cabinets and enclosures. Certain of the Company's broadband connectivity products are described below.\nJacks, Plugs and Patch Cords. Jacks and plugs are the basic components used to gain access to copper telecommunications circuits for testing and maintenance. Patch cords are wires or cables with a plug on each end. ADC incorporates its jacks, plugs and patch cords into its own products and also sells them in component form, primarily to OEMs. These components are generally manufactured to industry-recognized compatibility and reliability standards as off-the-shelf items.\nJackfields and Patch Bays. A jackfield is a module containing an assembly of jacks wired to terminal blocks or connectors and used by telecommunications companies to gain access to copper communication circuits for testing or patching the circuits. ADC manufactures jackfields in both longframe and bantam formats, including prewired and connectorized models. When testing a large number of circuits, series of jackfields are combined in specialized rack assemblies, which often may include test modules. These are called patch bays. ADC manufactures a range of jackfields and patch bays in various configurations. Certain of these jackfields are specialized for use in audio and visual transmission networks in the broadcast industry.\nDSX Products. ADC manufactures digital signaling cross-connect (DSX) modules and bays which are jackfields and patch bays designed to gain access to and cross-connect digital copper circuits for both voice and data transmission. Since the introduction of DSX products in 1977, the Company has continued to expand and refine its DSX product offerings, and has become a leading manufacturer of products for the mechanical termination and interconnection of digital circuits used in voice and data transmission. The DS-3 Digital Distribution Point (DDP) product family within the DSX product group are mechanical alternatives to hard-wiring equipment used for cable management and circuit access in software based digital cross-connect systems.\nTerminal Block and Frame Products. Terminal blocks are molded plastic blocks with contact points used to facilitate multiple wire interconnections. ADC manufactures a wide variety of terminal blocks. The Company's cross-connect frames are terminal block assemblies used to connect the external wiring of a telecommunications network to the internal wiring of a\ntelephone operating company central office or to interconnect various pieces of equipment within a telephone company.\nVideo Signal Distribution Products. During 1995, ADC developed and began initial shipment of a series of Video Signal Distribution (VSD) products designed to meet the unique performance requirements of Radio Frequency (RF) video transmission over coax cable. This product family includes a series of splitter\/combiner panels, a series of video jacks and panels which monitor, patch and provide a test access point and an analog video interface system panel designed for on-demand testing.\nFiber Optic Patch Cords and Cable Assemblies. Fiber optic patch cords are functionally similar to copper patch cords and are the basic components used to gain access to fiber telecommunications circuits for testing, maintenance, cross-connection and configuration purposes. The Company's LightTracer-TM- fiber optic patch cords provide immediate identification of fiber optic connections. The Company incorporates its fiber optic patch cords and cable assemblies into its own products and also sells them in component form.\nFiber Optic Couplers. Fiber optic couplers are passive connection devices used in fiber optic transmission systems to conform to the stringent environmental, reliability, performance and mechanical standards required in global broadband network and test equipment markets. These products, which include optical splitters and wavelength division multiplexers, were added during 1995 through an acquisition of AOFR Pty. Ltd. in Australia and enable efficient and cost- effective deployment of broadband networks.\nFiber Distribution Panels and Frames. Fiber distribution panels and frames are functionally similar to copper jackfields and frames designed with special considerations of fiber optic properties. They also provide interconnection points between fiber optic cables entering a building and fiber optic cables connected to fiber optic equipment within the building.\nFiberGuide -Registered Trademark- System. The FiberGuide system is a modular routing system which provides a segregated, protected method of storing and routing fiber patch cords and cables within buildings.\nOutside Plant Products. Outside plant (OSP) products consist of cabinets and other enclosures configured to locate and integrate the functions of passive fiber optic equipment and electronic transmission systems outside the telephone central office\/cable TV headend switching and transmission facilities. The Company's OSP products provide flexible network management, remote transmission capability and environmental protection for various telecommunications topologies and architectures. OSP products designed for broadband residential loop applications also provide power supply and coaxial splicing and tapping functions.\nMultimedia Systems Products. Multimedia systems products consist of integrated systems from several ADC product areas designed specifically for integrated voice, data and video applications such as distance learning, business, medical and government networks.\nBroadband Network Management and Test Solutions. During 1995, ADC released the first phase of its hardware and software products designed to document, manage and test physical layer integrity and signal quality in broadband network transmission systems. Additional phases of these systems are expected to be released during 1996.\nThe Company also provides engineer, furnish and install (EF&I) services, consisting of layout and installation of new telecommunications networks, modification of existing networks or the addition of equipment to existing networks. The Company sells its EF&I services primarily to telephone operating companies, other common carriers and users of private telecommunications networks. Building from this expertise, ADC is introducing a complete systems integration service to its customers in 1996. ADC's systems integration services are divided into three unique areas, technical service design and management, operations and implementation and training and documentation services.\nSALES AND MARKETING\nADC sells its products to customers in three primary markets: (i) the United States public telecommunications network market, which consists of all seven of the RBOCs, other telephone companies, long distance carriers, wireless service providers, the major cable TV operators and other domestic public network providers; (ii) the private and governmental voice, data and video network market in the United States, such as various large business customers and governmental agencies that own and operate their own voice, data and video networks for internal use; and (iii) the international public and private network market. The public, private\/governmental and international market segments accounted for 58%, 24% and 18%, respectively of the Company's net sales for the year ended October 31, 1995; 57%, 28% and 15%, respectively, of the Company's net sales for the year ended October 31, 1994; and 56%, 28%, and 16%, respectively, of the Company's net sales for the year ended October 31, 1993. The Company also sells product for each of these customer groups to the major telecommunications OEMs.\nPurchases of products by public network providers and the OEMs which supply such companies have accounted for the largest portion of the Company's net sales in recent periods. The Company's transmission and broadband connectivity products for public network providers are primarily located in central transmission facilities (such as telephone company network central offices, cable TV company network supertrunks and headend offices, and wireless network base stations, all of which contain the equipment used in switching and transmitting incoming and outgoing circuits). Increasingly, portions of the Company's public network transmission systems are located in the public network outside plant facilities (outside the central transmission buildings) and on customers' premises. The Company's private and governmental network customers generally purchase the Company's enterprise-wide communications systems and public network access equipment for installation in the networks located at their premises.\nThe Company also markets its products outside the United States primarily to telephone operating companies and cable TV companies for public telecommunications networks located in Canada, Europe, the Pacific Rim, Australia and Central and South America.\nA majority of the Company's sales are made by a direct sales force, and the Company maintains sales offices throughout the United States as well as in Canada, Europe, the Pacific Rim, Australia and Central and South America. The Company's products are sold in the United States by approximately 108 field sales representatives located in 20 sales offices throughout the country, and by several dealer organizations and distributors. The Company sells its products to foreign customers through 41 employee field salespersons, eight foreign independent sales representatives and 73 foreign distributors, as well as through United States public and private network providers who also distribute outside the United States.\nThe Company has a customer service group that supports field sales personnel and is responsible for application engineering, customer training, entering orders and supplying delivery status information, and a field service engineering group that provides on-site service to customers.\nRESEARCH AND DEVELOPMENT\nThe Company believes that its future success depends on its ability to adapt to the rapidly changing telecommunications environment, to maintain its significant expertise in core technologies and to continue to meet and anticipate its customers' needs. The Company continually reviews and evaluates technological changes affecting the telecommunications market and invests substantially in applications-based research and development. The Company is committed to an ongoing program of new product development that combines internal development efforts with acquisitions, joint ventures and licensing or marketing arrangements relating to new products and technologies from sources outside the Company.\nIn recent periods, increasingly significant portions of new telecommunications equipment purchased by public network providers and private network customers have utilized fiber optic transmission technology and have employed digital technology. In the future, these telecommunications network equipment purchasing trends will include increasingly sophisticated, software intensive, switching and network management systems. In addition, there has been significantly increased demand for wireless communications services and higher speed transmission technologies. As a result, the Company's internal and external product development activities are directed at the integration of fiber optic technology into additional products, the continuing development of its Homeworx system for telephony, data and integrated video, telephony and data applications, the development of network systems software, the continuing development of wireless products, the incorporation of ATM technology into voice, data and video products for both public and private telecommunications networks and the addition of video compression technology to its product line. The Company is also developing copper and fiber optic products for applications in the local loop.\nNew product development often requires long-term forecasting of market trends, development and implementation of new processes and technologies and a substantial capital commitment. As a result of these and other factors, development and customer acceptance of new products is inherently uncertain, and there can be no assurance that such products will be developed on a timely basis or achieve market acceptance.\nCOMPETITION\nCompetition in the telecommunications equipment industry is intense, and the Company believes that competition may increase substantially with the deployment of broadband networks and potential regulatory changes. Many of the Company's foreign and domestic competitors have more extensive engineering, manufacturing, marketing, financial and personnel resources than those of the Company. The Company's transmission products are competitive with products offered by several other companies, including AT&T Network Systems, Northern Telecom, Inc. and Motorola, Inc. The Company's enterprise networking products are competitive with the products of a number of other companies, two of which (Bay Networks, Inc. and Cabletron Systems Inc.) are dominant in its intelligent wiring hub markets, and the Company's products face both strong price competition and pressure from alternative distribution strategies utilized by these other companies. The Company's broadband connectivity products are competitive with the products offered by numerous other companies, including AT&T Network Systems and Switchcraft, Inc., a subsidiary of Raytheon Company. In addition, the Company faces increasing competition from a number of other smaller competitors, none of which is dominant at this time.\nThe rapid technological developments within the telecommunications industry have resulted in frequent changes to the Company's group of competitors. The Company believes its success in competing with other manufacturers of telecommunications products depends primarily on its engineering, manufacturing and marketing skills, the price, quality and reliability of its products and its delivery and service capabilities. While the market for the Company's products has not historically been characterized by significant price competition, the Company may face increasing pricing pressures from current and future competitors in certain or all of the markets for its products.\nThe Company believes that technological change, the increasing addition of data, video and other services to integrated multimedia networks, continuing regulatory change and industry consolidation or new entrants will continue to cause rapid evolution in the competitive environment of the telecommunications equipment market, the full scope and nature of which is difficult to predict at this time. Increased competition could result in price reductions, reduced margins and loss of market share by the Company. The Company believes industry regulatory change may create new opportunities for suppliers of telecommunications equipment. The Company expects, however, that such opportunities may attract increased competition from others as well. In addition, the Company expects that AT&T Network Systems will continue to be a major supplier to the RBOCs, and compete more extensively outside the RBOC market. The Company also believes that the rapid technological changes which characterize the telecommunications industry will continue to make the markets in which the Company competes attractive to new entrants. There can be no assurance that the Company will be able to compete successfully with its existing or new competitors or that competitive pressures faced by the Company will not materially and adversely affect its business, operating results and financial condition.\nMANUFACTURING AND SUPPLIES\nThe Company manufactures a wide variety of products which are fabricated, assembled and tested in its own facilities or in subcontracted facilities. To seek to reduce costs, the Company also takes advantage of off-shore assembly and sourcing. The manufacturing process for the Company's electronic products consists primarily of assembly and testing of electronic systems built from fabricated parts, printed circuit boards and electronic components. The manufacturing process for the Company's electromechanical products consists primarily of fabrication of jacks, plugs, and other basic components from raw materials, assembly of components and testing. The Company's sheet metal, plastic molding, stamping and machining capabilities permit the Company to configure components to customer specifications.\nThe Company purchases raw materials and component parts, consisting primarily of copper wire, optical fiber, steel, brass, nickel-steel alloys, gold, plastics, printed circuit boards, solid state components, discrete electronic components and similar items, from several suppliers. Although a few of the components used by the Company are single sourced, the Company has experienced no significant difficulties to date in obtaining adequate quantities of these raw materials and component parts.\nPROPRIETARY RIGHTS\nThe Company owns a number of United States and foreign patents relating to its products. These patents, in the aggregate, constitute a valuable asset of the Company. The Company, however, believes that its business is not dependent upon any single patent or any group of related patents.\nThe Company has registered the initials ADC alone and in conjunction with specific designs as trademarks in the United States and various foreign countries.\nEMPLOYEES\nAs of October 31, 1995, there were 2,984 persons employed by the Company. The Company considers relations with its employees to be good.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nThe Company's corporate headquarters are currently located in three leased buildings in Minnetonka, Minnesota. The Company also leases facilities in Minnetonka for its Minnesota fiber optic operations and for the engineering, product management, manufacturing and manufacturing support operations for certain of its transmission products.\nThe Company owns two buildings in Bloomington, Minnesota, which house manu facturing and manufacturing support operations, two facilities in LeSueur, Minnesota, which are used for electromechanical assembly and warehouse space and another building in Bloomington, Minnesota, which is leased to an unaffiliated company. The Company expects to complete, by May 1, 1996, the construction of a distribution center on approximately eight acres\nof undeveloped land which it owns in Shakopee, Minnesota. In addition, the Company owns approximately 38 acres of undeveloped land in Eden Prairie, Minnesota.\nThe Company owns a facility in Portland, Oregon, which serves as the office and manufacturing facility for certain of its enterprise networking products and leases space in Chatsworth, California, for certain other of its enterprise networking operations. The Company leases space in Meriden, Connecticut, Wallingford, Connecticut, and Waseca, Minnesota, as the office, manufacturing and research and development facilities for certain of its transmission products. The Company leases space in Fyshwick, Australian Capital Territory, Australia, which serves as the office and manufacturing facility for certain of its broadband connectivity operations.\nThe Company leases space in Richardson, Texas, for an engineering development center and leases sales office facilities in the United States, Canada, Mexico, Venezuela, the United Kingdom, Belgium, Germany, Australia and Singapore. The Company leases additional warehouse space on a short term basis from time to time to meet its needs.\nLeases for the Company's headquarters, sales offices and manufacturing facilities expire at different times through 2004 and are generally renewable on a fixed term or a month-to-month basis. The Company believes that the facilities used in its operations are adequate.\nFor information regarding encumbrances on the Company's properties, see Note 4 to the Consolidated Financial Statements included in Part II, Item 8, of this report.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nNone.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nExecutive officers of the Company are elected by the Board of Directors. The Company's executive officers were last elected as executive officers on February 28, 1995, except Mssrs. Brown and Granger were elected to their positions March 23, 1995. Messrs. Cadogan, Davis and Reily have served in various capacities with the Company for more than five years. Biographical information regarding the other named officers follows.\nMr. Gilbert joined the Company in June 1992. Prior to November 1994 he was Vice President and General Manager, Access Group for six months and Vice President Engineering for two years. From 1991 to 1992 he was Vice President of Research and Development at Make Systems, Inc., a manufacturer of a network design and analysis tool. From 1990 to 1991 Mr. Gilbert was Assistant Vice President of Software Engineering for Vitalink Communications Corporation, a manufacturer of data communications equipment.\nMr. Lawrence joined the Company in March 1994. Prior to such time he was employed by Sprint Corporation for twelve years, most recently as President and CEO of United Telephone of Florida. From 1989 to 1992 he was Senior Vice President Operations of US Sprint.\nMr. Brown joined the Company in March 1995. Prior to such time he was President of ATx Telecom Systems Inc., a provider of enabling network technology solutions in the fiber optic\/SONET transmission systems environments. From 1992 to 1994 he was Senior Vice President and General Manager of Teleport Communications Group, a provider of alternate local exchange services to commercial customers. From 1990-1991 he was President and Chief Operating Officer of Alcatel Network Systems.\nMr. Granger joined the Company in March 1995. Prior to such time he was employed by Sprint\/United Telephone of Florida and Sprint\/Centel of Florida as Vice President of Consumer Markets. His previous positions for Sprint\/United Telephone of Florida included Vice President of Marketing from 1991 to 1993 and Assistant Vice President of Marketing from 1989 to 1991.\nMr. Martin joined the Company in September 1994. Prior to such time he was employed by Ascom Timeplex, a manufacturer of data and telecommunications equipment, most recently as Vice President, Technical Marketing. His previous positions included Vice President China Business Development and Vice President U.S. Sales. From 1987 to 1990 he was the Chief Executive Officer of Broadband Telesystems, until that company was acquired by Ascom Timeplex.\nMr. Roehrick joined the Company in January 1995. Prior to such time he was employed by Cray Research, Inc., a manufacturer of large scale computers, most recently as Controller. From 1992 to 1993 he was Assistant Controller, and from 1989 to 1991 he was Director of Accounting.\nMr. Switz joined the Company in January 1994. Prior to such time he was employed by Burr-Brown Corporation, a manufacturer of precision micro- electronics, from 1988, most recently as Vice President, Chief Financial Officer and Director, Ventures and Systems Business.\nPART II\nItem 5.","section_5":"Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Company's Common Stock, $.20 par value, is traded on the Nasdaq National Market under the symbol \"ADCT.\" The following table sets forth the high and low sale prices for each quarter during the years ended October 31, 1995 and 1994, as reported on that system. All prices have been restated to reflect a two-for-one stock split effected in the form of a 100% stock dividend in February 1995.\nNo cash dividends have been declared or paid during the past five years. The Company currently anticipates that it will retain any future earnings for use in its business and does not anticipate paying any cash dividends in the foreseeable future. The Company's revolving credit agreements have certain restrictions on the payment of cash dividends. As of October 31, 1995, there were approximately 2,665 holders of record of the Common Stock.\nItem 6.","section_6":"Item 6. SELECTED CONSOLIDATED FINANCIAL DATA\nThe following is a summary of certain consolidated statement of income and balance sheet information of ADC Telecommunications, Inc. and subsidiaries for the five years ended October 31, 1995. This summary should be read in conjunction with the consolidated financial statements and notes thereto appearing elsewhere in this report. All share and per share amounts have been restated to reflect a two-for-one stock split effected in the form of a 100% stock dividend in June 1993 and an additional two-for-one stock split effected in the form of a 100% stock dividend in February 1995.\n- ---------------- (1) An extraordinary charge of $1,450,000 (or $.03 per share), net of income taxes, recorded in the quarter ended January 31, 1994, represents the charge to clean up and repair the damage from an earthquake at the Company's facility in California.\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nOverview\nThe Company offers a broad range of products to address key areas of the telecommunications network infrastructure. To meet its customers' needs, the Company offers equipment, services and integrated solutions within the following general functional product groups: transmission, enterprise networking and broadband connectivity. The Company's transmission products are sold primarily to public network providers in the United States and internationally. The Company's enterprise networking products are sold primarily to private voice, data and video network providers around the world. The Company's broadband connectivity products are sold to both public and private network providers.\nHistorically, the Company's principal product offerings have generally consisted of copper-based and fiber-based products designed to address the needs of its customers for transmission, enterprise networking and connectivity on traditional telephony networks. With the growth of multimedia applications and the associated development of enhanced voice, data and video services, the Company's more recent product offerings and research and development efforts have increasingly focused on emerging technologies and applications relating to the broadband telecommunications equipment market. The market for broadband telecommunications equipment is evolving and rapidly changing. There can be no assurance that the Company's new or enhanced products will meet with market acceptance or be profitable.\nThe Company's operating results may fluctuate significantly from quarter to quarter due to several factors. The Company's expense levels are based in part on expectations of future revenues. If revenue levels in a particular period do not meet expectations, operating results will be adversely affected. In addition, the Company's results of operations are subject to seasonal factors. The Company historically has experienced a stronger demand for its products in the fourth fiscal quarter, primarily as a result of customer budget cycles and Company year-end incentives, and has experienced a weaker demand for its products in the first fiscal quarter, primarily as a result of the number of holidays during late November, December and early January and a general industry slowdown during that period.\nResults of Operations\nThe percentage relationships to net sales of certain income and expense items for the three years ended October 31, 1995, and the percentage changes in these income and expense items between years are contained in the following table:\nNet Sales: The following table sets forth the Company's net sales for the three years ended October 31, 1995, for each of the functional product groups described above (dollars in thousands):\nNet sales were $586.2 million and $448.7 million for the years ended October 31, 1995 and 1994, reflecting 30.6% and 22.6% annual increases, respectively. The 1995 increase in net sales predominantly reflects the 77.9% and 23.7% increases in sales of transmission and broadband connectivity products, respectively. The 1994 increase over 1993 net sales of $366.1 million resulted from the above increases in all three product groups.\nThe Company's 77.9% and 49.4% growth in net sales of transmission products during 1995 and 1994, respectively, predominately reflects increased sales of fiber optic transmission systems to public telecommunications network providers. If the Company's transmission systems introduced within the last three years and continuing transmission product enhancements meet with reasonable market acceptance, the Company anticipates that net sales of transmission products will grow as a percentage of the Company's total net sales.\nNet sales of broadband connectivity products increased 23.7% and 10.2% during 1995 and 1994, respectively, reflecting the Company's success in selling these products into new global broadband market applications. Within the broadband connectivity product group, net sales of ADC's digital signaling cross-connect (DSX) modules and bays have declined as a percentage of total net sales to 23.9% in 1995, from 27.2% in 1994 and 28.7% in 1993. The Company believes that future sales of DSX and other copper connectivity products will continue to account for a substantial portion of the Company's revenues, although these products may continue to decline as a percentage of total net sales primarily due to the ongoing evolution of technologies in the telecommunications marketplace.\nReflecting increased sales of fiber optic products in both the transmission and broadband connectivity product groups, net sales of fiber optic products represented 40.6%, 34.8% and 34.2% of total net sales in 1995, 1994 and 1993, respectively.\nNet sales of enterprise networking products increased 3.3% and 29.1% during 1995 and 1994, respectively. These increases reflect significant growth in net sales of public network access equipment, partially offset by decreases in net sales of Local Area Network (LAN) equipment. The decline in LAN sales was most noticeable during 1995. Recognizing changes in the competitive environment for LAN equipment, the Company has realigned its Kentrox and Fibermux subsidiaries into the Enterprise Networking Group to better address the industry trend toward integration of LAN and Wide Area Network (WAN) technologies and products.\nGross Profit. During 1995, 1994 and 1993, the gross profit percentages were 48.5%, 50.7% and 51.2% of net sales, respectively. The 1995 and 1994 declines in gross profit percentages primarily resulted from the continuing change in product sales mix toward sales of newer, lower margin products which address emerging broadband applications. Future gross profit percentages will continue to be affected by the mix of products the Company sells, the timing of new product introductions and manufacturing volume, among other factors.\nOperating Expenses: Total operating expenses for the years ended October 31, 1995, 1994 and 1993 were $203.8 million, $162.9 million and $137.1 million, representing 34.8%, 36.4% and 37.4% of net sales, respectively. The increases in absolute dollars of operating expenses during 1995 and 1994 were due primarily to the expanded operations associated with\nhigher revenue levels and, in the year ended October 31, 1995, a charge of $3.9 million related primarily to a personnel reduction at the Fibermux facility resulting from the realignment of the Company's enterprise networking operations. The decreases in operating expenses as a percentage of net sales during 1995 and 1994 reflect the Company's ability to leverage operating expenses against revenue levels.\nDevelopment and product engineering expenses were $66.5 million, $49.0 million and $41.0 million for the years ended October 31, 1995, 1994 and 1993, respectively, reflecting increases of 35.7% during 1995 and 19.5% during 1994. These increases resulted from substantial product development efforts in each of the Company's three functional product groups. The Company believes that, given the rapidly changing technology and competitive environment in the telecommunications equipment industry, continued commitment to product development efforts will be required for the Company to remain competitive. Accordingly, the Company intends to continue to allocate substantial resources to product development for each of its three functional product groups. However, the Company recognizes the need to balance the cost of product development with expense control and remains committed to carefully managing the rate of increase of such expenses.\nSelling and administration expenses were $130.3 million, $110.8 million and $93.3 million for the years ended October 31, 1995, 1994 and 1993, respectively, reflecting increases of 17.6% during 1995 and 18.7% during 1994. These increases resulted from selling activities associated with new product introductions and additional personnel costs related to expanded operations.\nOther Income (Expense), Net: For the year ended October 31, 1995, the significant net interest income (expense) category represented net interest income on cash balances. (See \"Liquidity and Capital Resources\" below for a discussion of cash levels.)\nIncome Taxes: See Note 7 to the Consolidated Financial Statements included in Part II, Item 8","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nADC Telecommunications, Inc. and Subsidiaries Index to Consolidated Financial Statements\n(A) Statement of Registrant\nNo separate financial statements of the Company's subsidiaries are included herein because the Company is primarily an operating company and its subsidiaries are wholly-owned.\n(B) Consolidated Statements\nReport of Independent Public Accountants 26\nConsolidated Statements of Income for the years ended October 31, 1995, 1994 and 1993 27\nConsolidated Balance Sheets as of October 31, 1995 and 1994 28\nConsolidated Statements of Stockholders' Investment for the years ended October 31, 1995, 1994 and 1993 29\nConsolidated Statements of Cash Flows for the years ended October 31, 1995, 1994 and 1993 30\nNotes to Consolidated Financial Statements 31\nAll schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission have been omitted as not required, not applicable or the information required has been included elsewhere in the financial statements and related notes.\n(C) Supplemental Financial Information -- Unaudited 39\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo ADC Telecommunications, Inc.: We have audited the accompanying consolidated balance sheets of ADC TELECOMMUNICATIONS, INC. AND SUBSIDIARIES as of October 31, 1995 and 1994, and the related consolidated statements of income, stockholders' investment and cash flows for each of the three years in the period ended October 31, 1995. 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 ADC Telecommunications, Inc. and subsidiaries as of October 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended October 31, 1995, in conformity with generally accepted accounting principles.\nARTHUR ANDERSEN LLP\nMinneapolis, Minnesota December 13, 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\nADC TELECOMMUNICATIONS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(1) Summary of Significant Accounting Policies\nPrinciples of Consolidation: The consolidated financial statements include the accounts of ADC Telecommunications, Inc. (a Minnesota corporation) and its wholly owned subsidiaries, referred to collectively herein as the Company. All significant intercompany transactions and balances have been eliminated in consolidation.\nCash Equivalents: Cash equivalents primarily represent short-term investments in commercial paper with maturities of three months or less. These investments are reflected in the accompanying consolidated balance sheets at cost, which approximates fair value.\nInventories: Inventories include material, labor and overhead and are stated at the lower of first-in, first-out cost or market.\nProperty and Equipment: Property and equipment are recorded at cost and depreciated using the straight-line method over estimated useful lives of three to thirty years or, in the case of leasehold improvements, over the term of the lease, if shorter. Both straight-line and accelerated methods of depreciation are used for income tax purposes.\nGoodwill: The excess of the cost of acquired businesses over the fair value of the net assets acquired is being amortized on a straight-line basis over 25 years. Management periodically assesses the amortization period and recoverability of the carrying amount of goodwill based upon an estimate of future cash flows from related operations.\nResearch and Development Costs: The Company's policy is to expense all research and development costs in the period incurred.\nIncome Taxes: The Company utilizes the liability method of accounting for income taxes. Deferred tax liabilities or assets are recognized for the expected future tax consequences of temporary differences between the book and tax bases of assets and liabilities.\nEarnings Per Share: Earnings per share is computed using the weighted average number of common shares outstanding during the year, after consideration of the dilutive effect of stock options and restricted stock awards.\nForeign Currency Translation: The Company accounts for translation of foreign currency in accordance with the provisions of SFAS No. 52. The resulting translation adjustments are recorded directly to a separate component of stockholders' investment.\nThe functional currency for the Company's foreign operations is the applicable local currency. Prior to 1995 the Company's primary functional currency was the U.S. dollar. The functional currency changed because of substantial changes in the Company's foreign operations.\nNew Accounting Pronouncements:\nSFAS No. 121 - Accounting for the Impairment of Long-lived Assets and for Long- lived Assets to be Disposed of, requires impairment losses on long-lived assets to be recognized when an asset's book value exceeds its expected future cash flows (undiscounted). The Company anticipates adopting this standard on November 1, 1996 and does not expect that adoption will have a material impact on the financial position or results of operations of the Company.\nSFAS No. 123 - Accounting for Stock-Based Compensation, encourages, but does not require, a fair value based method of accounting for employee stock options or similar equity instruments. As permitted under the new standard, the Company will continue to account for employee stock options under APB No. 25. The pro-forma disclosures required by this standard will be adopted on November 1, 1996.\n(2) Consolidated Income Statement Information\nExport Sales: Export sales were $106,416,000, $67,113,000 and $58,919,000 during 1995, 1994 and 1993, respectively.\nOther Income (Expense), Net:\nPersonnel Reduction: During the quarter ended April 30, 1995, the Company initiated a realignment of its Kentrox and Fibermux subsidiaries into one business unit. The Company recorded a charge of $3,914,000 in conjunction with the realignment, related primarily to a personnel reduction. The realignment terminated approximately 100 Fibermux employees primarily in sales, administration and engineering. Substantially all termination benefits are expected to be paid by December 31, 1995.\nExtraordinary Item: The building that serves as headquarters for Fibermux suffered damage as a result of the earthquake that struck Los Angeles on January 17, 1994. The facility sustained damages of $2,300,000 ($1,450,000 after the $850,000 tax benefit). All operations resumed by February 8, 1994.\n(3) Consolidated Balance Sheet Information\n(4) Debt\nThe Company has a revolving, unsecured credit agreement with four banks which permits borrowings up to $40,000,000 through December 31, 1996, primarily at prevailing market rates of interest. There were no borrowings outstanding under this agreement at October 31, 1995 and 1994.\nAs of October 31, 1995 and 1994, the Company had a mortgage note payable of $410,000 and $810,000, respectively, collateralized by certain land, buildings and equipment. The note is payable in annual installments of approximately $400,000 through 1996 and bears interest at the rate of 7.55%.\n(5) Employee Benefit Plans\nPension Plan: The Company maintains a defined benefit plan covering a majority of its employees. The plan is funded in accordance with the requirements of Federal laws and regulations. Plan assets consist of fixed income securities and a managed portfolio of\nequity securities.\nPension expense included the following components:\nThe rate of compensation increase used to measure the projected benefit obligation was 5% for all three years. The expected long-term rate of return on plan assets was 9%.\nThe following table sets forth the funded status of the plan as of October 31:\nThe Company also maintains supplemental defined benefit retirement plans for members of the Board of Directors and for certain officers. The cost of these plans was $458,000, $352,000 and $210,000 during 1995, 1994 and 1993, respectively.\nRetirement Savings Plan: The Company maintains a Retirement Savings Plan for employees who have completed one year of service. The Company contributes 1% of wages and, depending on Company performance, partially matches employee contributions to the Plan up to 6% of wages. Employees are fully vested in all\ncontributions. The Company's contributions to the plan totaled $7,504,000, $6,778,000 and $3,210,000 during 1995, 1994, and 1993, respectively. A portion of the Company's cash contributions is invested in the Company's stock by the Plan's trustee.\nStock Award Plans: The Company maintains a Stock Incentive Plan to grant certain stock awards, including stock options at fair market value and restricted shares, to key employees of the Company.\nThe Company also maintains a Nonemployee Director Stock Option Plan in order to enhance the ability to attract and retain the services of experienced and knowledgeable outside directors. This plan provides for granting of a maximum of 220,000 non-qualified stock options at fair market value.\nThe Company issued shares of common stock to certain employees which are restricted as to their transferability through September 27, 1998. The market value of such stock at the date of issuance is being amortized over the restricted period. The unamortized amount of the resulting deferred compensation is recorded as a reduction of stockholders' investment. In addition, the Company awarded stock retention bonuses which provide for cash payments to offset the personal income taxes incurred upon the lapsing of stock restriction. The compensation expense associated with this plan was $516,000, $3,213,000, and $1,938,000 in 1995, 1994 and 1993, respectively.\nThe following schedule summarizes activity in the plans:\nDuring 1993, options for 949,474 shares were exercised at prices ranging from $3 to $9 per share.\n(6) Capital Stock\nAuthorized Stock: On November 28, 1995, the Board of Directors approved a resolution to increase the authorized number of common shares from 100,000,000 to 300,000,000, subject to shareholder approval. The Company is also authorized to issue 10,000,000 shares of no par value preferred stock. As of October 31, 1995, none of the preferred shares were issued.\nStock Split: On January 24, 1995, the Company declared a two-for-one stock split effected in the form of a 100% stock dividend paid February 28, 1995, to stockholders of record as of February 15, 1995. The share and per share information in the accompanying financial statements has been adjusted to reflect the effect of the dividend.\nStock Offering: On June 14, 1995, the Company completed a secondary public offering of 6,325,000 shares of its common stock at $30 per share. The net proceeds from the offering were $181,754,000, which will be used for general corporate purposes, including working capital, capital expenditures and possible acquisitions or strategic alliances.\nShareholder Rights Plan: On November 28, 1995, the Board of Directors amended and restated the Company's Shareholder Rights Plan that was originally adopted during 1986. Under the original Plan, the Board of Directors declared a dividend of one right for each outstanding share of the Company's common stock. The Plan, as amended, provides that if any person or group acquires 15% or more of the Company's common stock, each Right not owned by such person or group will entitle its holder to purchase, at the Right's then-current purchase price ($125 for each one-half share of the Company's common stock at November 28, 1995), common stock of the Company having a value of twice the Right's purchase price. The Rights would not be triggered, however, if the acquisition of 15% or more of the Company's common stock is pursuant to a tender offer or exchange for all outstanding shares of the Company's common stock which is determined by the Board of Directors to be fair and in the best interests of the Company and its shareholders. The Rights are redeemable at $0.01 any time prior to the time they become exercisable. The Rights will expire on November 28, 2005, if not previously redeemed or exercised.\n(7) Income Taxes\nThe components of the provision for income taxes are as follows:\nThe provision for foreign income taxes is based upon foreign pretax earnings of approximately $1,547,000, $1,563,000 and $1,120,000 during 1995, 1994 and 1993, respectively.\nThe Company records a reduction in income taxes payable for qualifying tax credits in the year in which they occur. The benefit for deferred taxes is primarily due to timing differences in the tax deductibility of employee benefit plan costs, depreciation and certain accrued expenses and reserves which are not yet deductible for income tax purposes.\nThe effective income tax rate differs from the Federal statutory rate as follows:\nDeferred tax assets (liabilities) of the Company as of October 31 are comprised of the following:\nThe Company's Federal income tax returns for the years prior to 1994 have been audited and completely settled. Management believes that adequate provision for income taxes has been made for all years through 1995.\n(8) Commitments and Contingencies\nOperating Leases: A portion of the Company's operations are conducted using leased equipment and facilities. These leases are non-cancelable and renewable with expiration dates ranging through the year 2004. The rental expense included in the accompanying consolidated statements of income was $5,676,000, $5,411,000, and $5,347,000 for 1995, 1994, and 1993 respectively.\nThe following is a schedule of future minimum rental payments required under all non-cancelable operating leases as of October 31, 1995:\n(In Thousands) 1996 $ 5,514 1997 4,683 1998 4,226 1999 3,598 2000 and thereafter 4,429 ------- $22,450 =======\nContingencies: There are no legal proceedings pending against or involving the Company which, in the opinion of management, will have a material adverse effect on the Company's financial position or results of operations.\nChange of Control: The Board of Directors has approved the extension of certain employee benefits, including salary continuation to key employees, in the event of a change of control of the Company. The Board has retained the flexibility to cancel such provisions under certain circumstances.\nItem 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nSee Part I of this Report for information with respect to executive officers of the Company. Pursuant to General Instruction G(3), reference is made to the information contained under the captions \"Election of Directors\" and \"Section 16(a) Reporting\" in the Company's definitive proxy statement for its 1996 Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission on or before February 27, 1996, which information is incorporated herein.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION\nPursuant to General Instruction G(3), reference is made to the information contained under the caption \"Executive Compensation\" (except for the information set forth under the subcaption \"Compensation and Organization Committee Report on Executive Compensation,\" which is not incorporated herein) in the Company's definitive proxy statement for its 1996 Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission on or before February 27, 1996, which information is incorporated herein.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nPursuant to General Instruction G(3), reference is made to the information contained under the caption \"Security Ownership of Certain Beneficial Owners and Management\" in the Company's definitive proxy statement for its 1996 Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission on or before February 27, 1996, which information is incorporated herein.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nPursuant to General Instruction G(3), reference is made to the information contained in the last paragraph under the caption \"Election of Directors -- Compensation of Directors\" in the Company's definitive proxy statement for its 1996 Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission on or before February 27, 1996, which information is incorporated herein.\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 are included in Part II, Item 8 of this Annual Report on Form 10-K:\nReport of Independent Public Accountants. Consolidated Statements of Income for the years ended October 31, 1995, 1994 and 1993. Consolidated Balance Sheets as of October 31, 1995 and 1994. Consolidated Statements of Changes in Stockholders' Investment for the years ended October 31, 1995, 1994 and 1993. Consolidated Statements of Cash Flows for the years ended October 31, 1995, 1994 and 1993. Notes to Consolidated Financial Statements. Supplemental Financial Information (Unaudited).\n2. FINANCIAL STATEMENT SCHEDULES\nAll schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission have been omitted as not required or not applicable, or the information required has been included elsewhere in the financial statements and related notes.\n3. LISTING OF EXHIBITS\nExhibit Number Description 3-a Restated Articles of Incorporation of ADC Telecommunications, Inc., as amended to date. (Incorporated by reference to Exhibit 4(b) of the Company's Registration Statement on Form S-8 dated March 11, 1994, for the Company's 1994 Employee Stock Purchase Plan.)\n3-b Composite Restated Bylaws of ADC Telecommunications, Inc., as amended to date. (Incorporated by reference to Exhibit 3-b to the Company's Annual Report on Form 10-K for the fiscal year ended October 31, 1989.)\n4-a Specimen certificate for shares of Common Stock of ADC Telecommunications, Inc. (Incorporated by reference to Exhibit 4-a to the Company's Quarterly Report on Form 10-Q for the quarter ended July 31, 1989.)\nExhibit Number Description 4-b Restated Articles of Incorporation of ADC Telecommunications, Inc., as amended to date. (Incorporated by reference to Exhibit 4(b) of the Company's Registration Statement on Exhibit Form S-8 dated March 11, 1994, for the Company's 1994 Employee Stock Purchase Plan.)\n4-c Composite Restated Bylaws of ADC Telecommunications, Inc., as amended to date (Incorporated by reference to Exhibit 3-b to the Company's Annual Report on Form 10-K for the fiscal year ended October 31, 1989.)\n4-d Second Amended and Restated Rights Agreement, amended and restated as of November 28, 1995, between ADC Telecommunications, Inc. and Norwest Bank Minnesota, N.A. (amending and restating the Rights Agreement dated as of September 23, 1986, as amended and restated as of August 16, 1989), which includes as Exhibit A thereto the form of Right Certificate. (Incorporated by reference to Exhibit 4 to the Company's Form 8-K dated December 11, 1995.)\n10-a* Stock Option and Restricted Stock Plan, restated as of January 26, 1988. (Incorporated by reference to Exhibit 10-a to the Company's Quarterly Report on Form 10-Q for the quarter ended April 30, 1988.)\n10-b* Amendment to Stock Option and Restricted Stock Plan dated as of September 26, 1989. (Incorporated by reference to Exhibit 10-e to the Company's Annual Report on Form 10-K for the fiscal year ended October 31, 1989.)\n10-c* The ADC Telecommunications, Inc. 1991 Stock Incentive Plan, as amended. (Incorporated by reference to Exhibit 10-a to the Company's Quarterly Report on Form 10-Q for the quarter ended January 31, 1993.)\n10-d* Access Platform System Management Incentive Plan for the fiscal year ended October 31, 1994. (Incorporated by reference to Exhibit 10-a to the Company's Quarterly Report on Form 10-Q for the quarter ended July 31, 1994.)\n10-e* ALS Management Incentive Plan for the fiscal year ended October 31, 1994. (Incorporated by reference to Exhibit 10-b to the Company's Quarterly Report on Form 10-Q for the quarter ended July 31, 1994.)\n10-f* Business Development Management Incentive Plan for the fiscal year ended October 31, 1994. (Incorporated by reference to Exhibit 10-c to the Company's Quarterly Report on Form 10-Q for the quarter ended July 31, 1994.)\n10-g* Cable Management Management Incentive Plan for the fiscal year ended October 31, 1994. (Incorporated by reference to Exhibit 10-d to the Company's Quarterly Report on Form 10-Q for the quarter ended July 31, 1994.)\nExhibit Number Description 10-h* Corporate Management Incentive Plan for the fiscal year ended October 31, 1994. (Incorporated by reference to Exhibit 10-e to the Company's Quarterly Report on Form 10-Q for the quarter ended July 31, 1994.)\n10-i* Fibermux Management Incentive Plan for the fiscal year ended October 31, 1994. (Incorporated by reference to Exhibit 10-f to the Company's Quarterly Report on Form 10-Q for the quarter ended July 31, 1994.)\n10-j* International Management Incentive Plan for the fiscal year ended October 31, 1994. (Incorporated by reference to Exhibit 10-g to the Company's Quarterly Report on Form 10-Q for the quarter ended July 31, 1994.)\n10-k* Kentrox Management Incentive Plan for the fiscal year ended October 31, 1994. (Incorporated by reference to Exhibit 10-h to the Company's Quarterly Report on Form 10-Q for the quarter ended July 31, 1994.)\n10-l* Vice President of Sales and Customer Service Management Incentive Plan for the fiscal year ended October 31, 1994. (Incorporated by reference to Exhibit 10-i to the Company's Quarterly Report on Form 10-Q for the quarter ended July 31, 1994.)\n10-m* Senior Vice President Transmission Group Management Incentive Plan for the fiscal year ended October 31, 1994. (Incorporated by reference to Exhibit 10-j to the Company's Quarterly Report on Form 10-Q for the quarter ended July 31, 1994.)\n10-n* Transmission Management Incentive Plan for the fiscal year ended October 31, 1994. (Incorporated by reference to Exhibit 10-k to the Company's Quarterly Report on Form 10-Q for the quarter ended July 31, 1994.)\n10-o* Transmission Product and Marketing Management Management Incentive Plan for the fiscal year ended October 31, 1994. (Incorporated by reference to Exhibit 10-l to the Company's Quarterly Report on Form 10-Q for the quarter ended July 31, 1994.)\n10-p* Transmission Product and Marketing Management (International) Management Incentive Plan for the fiscal year ended October 31, 1994. (Incorporated by reference to Exhibit 10-m to the Company's Quarterly Report on Form 10-Q for the quarter ended July 31, 1994.)\n10-q* Access Platform Systems Incentive Plan Fiscal Year 1995. (Incorporated by reference to Exhibit 10-b to the Company's Quarterly Report on Form 10-Q for the quarter ended January 31, 1995.)\nExhibit Number Description 10-r* ALS Management Incentive Plan Fiscal Year 1995. (Incorporated by reference to Exhibit 10-c to the Company's Quarterly Report on Form 10-Q for the quarter ended January 31, 1995.)\n10-s* Broadband Connectivity Copper Management Incentive Plan Fiscal Year 1995. (Incorporated by reference to Exhibit 10-d to the Company's Quarterly Report on Form 10-Q for the quarter ended January 31, 1995.)\n10-t* Broadband Connectivity Fiber Management Incentive Plan Fiscal Year 1995. (Incorporated by reference to Exhibit 10-e to the Company's Quarterly Report on Form 10-Q for the quarter ended January 31, 1995.)\n10-u* Broadband Connectivity Management Incentive Plan Fiscal Year 1995. (Incorporated by reference to Exhibit 10-f to the Company's Quarterly Report on Form 10-Q for the quarter ended January 31, 1995.)\n10-v* Corporate Management Incentive Plan Fiscal Year 1995. (Incorporated by reference to Exhibit 10-g to the Company's Quarterly Report on Form 10-Q for the quarter ended January 31, 1995.)\n10-w* Fibermux President Management Incentive Plan Fiscal Year 1995. (Incorporated by reference to Exhibit 10-h to the Company's Quarterly Report on Form 10-Q for the quarter ended January 31, 1995.)\n10-x* International Management Incentive Plan Fiscal Year 1995. (Incorporated by reference to Exhibit 10-i to the Company's Quarterly Report on Form 10-Q for the quarter ended January 31, 1995.)\n10-y* Kentrox Management Incentive Plan Fiscal Year 1995. (Incorporated by reference to Exhibit 10-j to the Company's Quarterly Report on Form 10-Q for the quarter ended January 31, 1995.)\n10-z* Network Services Management Incentive Plan Fiscal Year 1995. (Incorporated by reference to Exhibit 10-k to the Company's Quarterly Report on Form 10-Q for the quarter ended January 31, 1995.)\n10-aa* Transmission Group Management Incentive Plan Fiscal Year 1995. (Incorporated by reference to Exhibit 10-l to the Company's Quarterly Report on Form 10-Q for the quarter ended January 31, 1995.)\n10-bb* Vice President of Sales and Customer Service Management Incentive Plan Fiscal Year 1995. (Incorporated by reference to Exhibit 10-m to the Company's Quarterly Report on Form 10-Q for the quarter ended January 31, 1995.)\nExhibit Number Description 10-cc* Wireless Management Incentive Plan Fiscal Year 1995. (Incorporated by reference to Exhibit 10-n to the Company's Quarterly Report on Form 10-Q for the quarter ended January 31, 1995.)\n10-dd* Supplemental Executive Retirement Plan Agreement for William J. Cadogan, dated as of November 1, 1990, between ADC Telecommunications, Inc. and William J. Cadogan. (Incorporated by reference to Exhibit 10-ee to the Company's Annual Report on Form 10-K for the fiscal year ended October 31, 1993.)\n10-ee* ADC Telecommunications, Inc. Change in Control Severance Pay Plan Statement and Summary Plan Description. (Incorporated by reference to Exhibit 10-q to the Company's Annual Report on Form 10-K for the fiscal year ended October 31, 1989.)\n10-ff* Compensation Plan for Directors of ADC Telecommunications, Inc., restated as of December 31, 1988. (Incorporated by reference to Exhibit 10-b to the Company's Quarterly Report on Form 10-Q for the quarter ended January 31, 1989.)\n10-gg* First Amendment of the Compensation Plan for Directors of ADC Telecommunications, Inc. restated as of December 31, 1988. (Incorporated by reference to Exhibit 10-s to the Company's Annual Report on Form 10-K for the fiscal year ended October 31, 1989.)\n10-hh* ADC Telecommunications, Inc. Directors' Supplemental Retirement Plan dated as of January 23, 1990. (Incorporated by reference to Exhibit 10-m to the Company's Annual Report on Form 10-K for the fiscal year ended October 31, 1990.)\n10-ii* ADC Telecommunications, Inc. Nonemployee Director Stock Option Plan. (Incorporated by reference to Exhibit 19-b of the Company's Quarterly Report on Form 10-Q for the quarter ended April 30, 1991.)\n10-jj* ADC Telecommunications, Inc. Deferred Compensation Plan, dated as of November 1, 1978. (Incorporated by reference to Exhibit 10-n to the Company's Annual Report on Form 10-K for the fiscal year ended October 31, 1990.)\n10-kk* ADC Telecommunications, Inc. Excess Benefits Plan, dated as of January 1, 1985. (Incorporated by reference to Exhibit 10-o to the Company's Annual Report on Form 10-K for the fiscal year ended October 31, 1990.)\n10-ll* ADC Telecommunications, Inc. 401(k) Excess Plan, dated as of September 1, 1990. (Incorporated by reference to Exhibit 10-p to the Company's Annual Report on Form 10-K for the fiscal year ended October 31, 1990.)\nExhibit Number Description 10-mm Lease, dated March 1, 1986, between ADC Telecommunications, Inc. and Metro International Ltd. as amended. (Incorporated by reference to Exhibit 10- w to the Company's Annual Report on Form 10-K for the fiscal year ended October 31, 1991.)\n10-nn Renewal of Lease, dated July 9, 1990, between ADC Telecommunications, Inc. and Metro International General Partner Canada, Inc. (Incorporated by reference to Exhibit 10-z to the Company's Annual Report on Form 10-K for the fiscal year ended October 31, 1990.)\n10-oo Lease Agreement, dated August 21, 1990, between Minnetonka Corporate Center I Limited Partnership and ADC Telecommunications, Inc. (Incorporated by reference to Exhibit 10-x to the Company's Annual Report on Form 10-K for the fiscal year ended October 31, 1990.)\n10-pp Lease Agreement, dated October 26, 1990, between Lutheran Brotherhood and ADC Telecommunications, Inc. (Incorporated by reference to Exhibit 10-w to the Company's Annual Report on Form 10-K for the fiscal year ended October 31, 1990.)\n10-qq Sublease Agreement, dated October 31, 1990, between Seagate Technology, Inc. and ADC Telecommunications, Inc. (Incorporated by reference to Exhibit 10-y to the Company's Annual Report on Form 10-K for the fiscal year ended October 31, 1990.)\n10-rr Lease, dated February 25, 1991, between American Lightwave Systems, Inc. and 999 Research Parkway, Inc. (Incorporated by reference to Exhibit 10-t to the Company's Annual Report on Form 10-K for the fiscal year ended October 31, 1991.)\n10-ss Lease, dated December 18, 1992, between Fibermux Corporation and Greenville Dallas Delaware, Inc. (Incorporated by reference to Exhibit 10-dd to the Company's Annual Report on Form 10-K for the fiscal year ended October 31, 1993.)\n10-tt Lease, dated August 2, 1993, between ADC Telecommunications, Inc. and Engelsma Limited Partnership. (Incorporated by reference to Exhibit 10-cc to the Company's Annual Report on Form 10-K for the fiscal year ended October 31, 1993.)\n10-uu Lease, dated September 30, 1993, between American Lightwave Systems, Inc. and 999 Research Parkway, Inc. (Incorporated by reference to Exhibit 10- bb to the Company's Annual Report on Form 10-K for the fiscal year ended October 31, 1993.)\nExhibit Number Description 10-vv Sublease, dated as of February 21, 1995, between Seagate Technology, Inc. and ADC Telecommunications, Inc. (Incorporated by reference to Exhibit 10-a of the Company's Quarterly Report on Form 10-Q for the quarter ended April 30, 1995.)\n10-ww Lease, dated July 17, 1995, between Centract VI LLC and ADC Video Systems, Inc. (Incorporated by reference to Exhibit 10-a of the Company's Quarterly Report on Form 10-Q for the quarter ended July 31, 1995.)\n21-a Subsidiaries of the Company.\n23-a Consent of Independent Public Accountants to the incorporation of their report dated December 13, 1995, included in this Form 10-K, into the Company's previously filed Registration Statements, File Nos. 2-83584, 33-22654, 33-40356, 33-40357, 33-52635, 33-52637, 33-58407, 33-58409 and 33-59445.\n24-a Powers of attorney.\n27-a Financial Data Schedule.\nThere have been excluded from the exhibits filed with this report instruments defining the rights of holders of long-term debt of the Company where the total amount of the securities authorized under such instruments does not exceed 10% of the total assets of the Company. The Company hereby agrees to furnish a copy of any such instruments to the Commission upon request.\n(b) Reports on Form 8-K\nNo reports on Form 8-K were filed by the Company during the quarter ended October 31, 1995.\n(c) See Exhibit Index and Exhibits attached to this report.\n(d) See Financial Statement Schedules included in Part II, Item 8 of this report.\n__________________ * Management contract or compensatory plan or arrangement required to be filed as an Exhibit to the 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.\nADC TELECOMMUNICATIONS, INC.\nDated: December 28, 1995 By: \/s\/ William J. Cadogan William J. Cadogan Chairman of the Board, President, Chief Executive Officer 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.\n\/s\/ William J. Cadogan Chairman of the Board, President, William J. Cadogan Chief Executive Officer and Chief Operating Officer (principal executive officer)\n\/s\/ Robert E. Switz Vice President, Chief Financial Officer Robert E. Switz (principal financial officer)\n\/s\/ Charles T. Roehrick Vice President and Controller Charles T. Roehrick (principal accounting officer)\nDated: December 28, 1995\nJames C. Castle, Ph.D.* Director Thomas E. Holloran* Director B. Kristine Johnson* Director Charles W. Oswald* Director Alan E. Ross* Director Jean-Pierre Rosso* Director Donald M. Sullivan* Director Warde F. Wheaton* Director John D. Wunsch* Director\n*By \/s\/ David F. Fisher David F. Fisher Attorney-in-fact\nADC TELECOMMUNICATIONS, INC. Annual Report on Form 10-K For the Fiscal Year Ended October 31, 1995\nEXHIBIT INDEX\nExhibit Number Description Page 3-a Restated Articles of Incorporation of ADC Telecommunications, N\/A Inc., as amended to date. (Incorporated by reference to Exhibit 4(b) of the Company's Registration Statement on Form S-8 dated March 11, 1994, for the Company's 1994 Employee Stock Purchase Plan.)\n3-b Composite Restated Bylaws of ADC Telecommunications, Inc., N\/A as amended to date (Incorporated by reference to Exhibit 3-b to the Company's Annual Report on Form 10-K for the fiscal year ended October 31, 1989.)\n4-a Specimen certificate for shares of Common Stock of ADC N\/A Telecommunications, Inc. (Incorporated by reference to Exhibit 4-a to the Company's Quarterly Report on Form 10-Q for the quarter ended July 31, 1989.)\n4-b Restated Articles of Incorporation of ADC Telecommunications, N\/A Inc., as amended to date. (Incorporated by reference to Exhibit 4(b) of the Company's Registration Statement on Form S-8 dated March 11, 1994, for the Company's 1994 Employee Stock Purchase Plan.)\n4-c Composite Restated Bylaws of ADC Telecommunications, Inc., as N\/A amended to date (Incorporated by reference to Exhibit 3-b to the Company's Annual Report on Form 10-K for the fiscal year ended October 31, 1989.)\n4-d Second Amended and Restated Rights Agreement, amended and N\/A restated as of November 28, 1995, between ADC Telecommunications, Inc. and Norwest Bank Minnesota, N.A. (amending and restating the Rights Agreement dated as of September 23, 1986, as amended and restated as of August 16, 1989), which includes as Exhibit A thereto the form of Right Certificate. (Incorporated by reference to Exhibit 4 to the Company's Form 8-K dated December 11, 1995.)\n10-a Stock Option and Restricted Stock Plan, restated as of N\/A January 26, 1988. (Incorporated by reference to Exhibit 19-a to the Company's Quarterly Report on Form 10-Q for the quarter ended April 30, 1988.)\nExhibit Number Description Page 10-b Amendment to Stock Option and Restricted Stock Plan dated as N\/A of September 26, 1989. (Incorporated by reference to Exhibit 10-e to the Company's Annual Report on Form 10-K for the fiscal year ended October 31, 1989.)\n10-c The ADC Telecommunications, Inc. 1991 Stock Incentive Plan, N\/A as amended. (Incorporated by reference to Exhibit 10-a to the Company's Quarterly Report on Form 10-Q for the quarter ended January 31, 1993.)\n10-d Access Platform System Management Incentive Plan for the N\/A fiscal year ended October 31, 1994. (Incorporated by reference to Exhibit 10-a to the Company's Quarterly Report on Form 10-Q for the quarter ended July 31, 1994.)\n10-e ALS Management Incentive Plan for the fiscal year ended N\/A October 31, 1994. (Incorporated by reference to Exhibit 10-b to the Company's Quarterly Report on Form 10-Q for the quarter ended July 31, 1994.)\n10-f Business Development Management Incentive Plan for the fiscal N\/A year ended October 31, 1994. (Incorporated by reference to Exhibit 10-c to the Company's Quarterly Report on Form 10-Q for the quarter ended July 31, 1994.)\n10-g Cable Management Management Incentive Plan for the fiscal N\/A year ended October 31, 1994. (Incorporated by reference to Exhibit 10-d to the Company's Quarterly Report on Form 10-Q for the quarter ended July 31, 1994.)\n10-h Corporate Management Incentive Plan for the fiscal year ended N\/A October 31, 1994. (Incorporated by reference to Exhibit 10-e to the Company's Quarterly Report on Form 10-Q for the quarter ended July 31, 1994.)\n10-i Fibermux Management Incentive Plan for the fiscal year ended N\/A October 31, 1994. (Incorporated by reference to Exhibit 10-f to the Company's Quarterly Report on Form 10-Q for the quarter ended July 31, 1994.)\n10-j International Management Incentive Plan for the fiscal year N\/A ended October 31, 1994. (Incorporated by reference to Exhibit 10-g to the Company's Quarterly Report on Form 10-Q for the quarter ended July 31, 1994.)\n10-k Kentrox Management Incentive Plan for the fiscal year ended N\/A October 31, 1994. (Incorporated by reference to Exhibit 10-h to the Company's Quarterly Report on Form 10-Q for the quarter ended July 31, 1994.)\nExhibit Number Description Page 10-l Vice President of Sales and Customer Service Management N\/A Incentive Plan for the fiscal year ended October 31, 1994. (Incorporated by reference to Exhibit 10-i to the Company's Quarterly Report on Form 10-Q for the quarter ended July 31, 1994.)\n10-m Senior Vice President Transmission Group Management Incentive N\/A Plan for the fiscal year ended October 31, 1994. (Incorporated by reference to Exhibit 10-j to the Company's Quarterly Report on Form 10-Q for the quarter ended July 31, 1994.)\n10-n Transmission Management Incentive Plan for the fiscal year N\/A ended October 31, 1994. (Incorporated by reference to Exhibit 10-k to the Company's Quarterly Report on Form 10-Q for the quarter ended July 31, 1994.)\n10-o Transmission Product and Marketing Management Management N\/A Incentive Plan for the fiscal year ended October 31, 1994. (Incorporated by reference to Exhibit 10-l to the Company's Quarterly Report on Form 10-Q for the quarter ended July 31, 1994.)\n10-p Transmission Product and Marketing Management (International) N\/A Management Incentive Plan for the fiscal year ended October 31, 1994. (Incorporated by reference to Exhibit 10-m to the Company's Quarterly Report on Form 10-Q for the quarter ended July 31, 1994.)\n10-q Access Platform Systems Incentive Plan Fiscal Year 1995. N\/A (Incorporated by reference to Exhibit 10-b to the Company's Quarterly Report on Form 10-Q for the quarter ended January 31, 1995.)\n10-r ALS Management Incentive Plan Fiscal Year 1995. (Incorporated N\/A by reference to Exhibit 10-c to the Company's Quarterly Report on Form 10-Q for the quarter ended January 31, 1995.)\n10-s Broadband Connectivity Copper Management Incentive Plan Fiscal N\/A Year 1995. (Incorporated by reference to Exhibit 10-e to the Company's Quarterly Report on Form 10-Q for the quarter ended January 31, 1995.)\n10-t Broadband Connectivity Fiber Management Incentive Plan Fiscal N\/A Year 1995. (Incorporated by reference to Exhibit 10-e to the Company's Quarterly Report on Form 10-Q for the quarter ended January 31, 1995.)\n10-u Broadband Connectivity Management Incentive Plan Fiscal Year N\/A 1995. (Incorporated by reference to Exhibit 10-g to the Company's Quarterly Report on Form 10-Q for the quarter ended January 31, 1995.)\nExhibit Number Description Page 10-v Corporate Management Incentive Plan Fiscal Year 1995. N\/A (Incorporated by reference to Exhibit 10-g to the Company's Quarterly Report on Form 10-Q for the quarter ended January 31, 1995.)\n10-w Fibermux President Management Incentive Plan Fiscal Year 1995. N\/A (Incorporated by reference to Exhibit 10-h to the Company's Quarterly Report on Form 10-Q for the quarter ended January 31, 1995.)\n10-x International Management Incentive Plan Fiscal Year 1995. N\/A (Incorporated by reference to Exhibit 10-i to the Company's Quarterly Report on Form 10-Q for the quarter ended January 31, 1995.)\n10-y Kentrox Management Incentive Plan Fiscal Year 1995. N\/A (Incorporated by reference to Exhibit 10-j to the Company's Quarterly Report on Form 10-Q for the quarter ended January 31, 1995.)\n10-z Network Services Management Incentive Plan Fiscal Year 1995. N\/A (Incorporated by reference to Exhibit 10-k to the Company's Quarterly Report on Form 10-Q for the quarter ended January 31, 1995.)\n10-aa Transmission Group Management Incentive Plan Fiscal Year 1995. N\/A (Incorporated by reference to Exhibit 10-l to the Company's Quarterly Report on Form 10-Q for the quarter ended January 31, 1995.)\n10-bb Vice President of Sales and Customer Service Management N\/A Incentive Plan Fiscal Year 1995. (Incorporated by reference to Exhibit 10-m to the Company's Quarterly Report on Form 10-Q for the quarter ended January 31, 1995.)\n10-cc Wireless Management Incentive Plan Fiscal Year 1995. N\/A (Incorporated by reference to Exhibit 10-n to the Company's Quarterly Report on Form 10-Q for the quarter ended January 31, 1995.)\n10-dd Supplemental Executive Retirement Plan Agreement for William N\/A J. Cadogan, dated as of November 1, 1990, between ADC Telecommuni- cations, Inc. and William J. Cadogan. (Incorporated by reference to Exhibit 10-ee to the Company's Annual Report on Form 10-K for the fiscal year ended October 31, 1993.)\n10-ee ADC Telecommunications, Inc. Change in Control Severance Pay N\/A Plan Statement and Summary Plan Description. (Incorporated by reference to Exhibit 10-q to the Company's Annual Report on Form 10-K for the fiscal year ended October 31, 1989.)\nExhibit Number Description Page 10-ff Compensation Plan for Directors of ADC Telecommunications, N\/A Inc., restated as of December 31, 1988. (Incorporated by reference to Exhibit 19-b to the Company's Quarterly Report on Form 10-Q for the quarter ended January 31, 1989.)\n10-gg First Amendment of the Compensation Plan for Directors of ADC N\/A Telecommunications, Inc. restated as of December 31, 1988. (Incorporated by reference to Exhibit 10-s to the Company's Annual Report on Form 10-K for the fiscal year ended October 31, 1989.)\n10-hh ADC Telecommunications, Inc. Directors' Supplemental Retirement N\/A Plan dated as of January 23, 1990. (Incorporated by reference to Exhibit 10-m to the Company's Annual Report on Form 10-K for the fiscal year ended October 31, 1990.)\n10-ii ADC Telecommunications, Inc. Nonemployee Director Stock Option N\/A Plan. (Incorporated by reference to Exhibit 19-b of the Company's Quarterly Report on Form 10-Q for the quarter ended April 30, 1991.)\n10-jj ADC Telecommunications, Inc. Deferred Compensation Plan, dated N\/A as of November 1, 1978. (Incorporated by reference to Exhibit 10-n to the Company's Annual Report on Form 10-K for the fiscal year ended October 31, 1990.)\n10-kk ADC Telecommunications, Inc. Excess Benefits Plan, dated as of N\/A January 1, 1985. (Incorporated by reference to Exhibit 10-o to the Company's Annual Report on Form 10-K for the fiscal year ended October 31, 1990.)\n10-ll ADC Telecommunications, Inc. 401(k) Excess Plan, dated as of N\/A September 1, 1990. (Incorporated by reference to Exhibit 10-p to the Company's Annual Report on Form 10-K for the fiscal year ended October 31, 1990.)\n10-mm Lease, dated March 1, 1986, between ADC Telecommunications, N\/A Inc. and Metro International Ltd. as amended. (Incorporated by reference to Exhibit 10-w to the Company's Annual Report on Form 10-K for the fiscal year ended October 31, 1991.)\n10-nn Renewal of Lease, dated July 9, 1990, between ADC Telecom- N\/A munications, Inc. and Metro International General Partner Canada, Inc. (Incorporated by reference to Exhibit 10-z to the Company's Annual Report on Form 10-K for the fiscal year ended October 31, 1990.)\nExhibit Number Description Page 10-oo Lease Agreement, dated August 21, 1990, between Minnetonka N\/A Corporate Center I Limited Partnership and ADC Telecommunications, Inc. (Incorporated by reference to Exhibit 10-x to the Company's Annual Report on Form 10-K for the fiscal year ended October 31, 1990.)\n10-pp Lease Agreement, dated October 26, 1990, between Lutheran N\/A Brotherhood and ADC Telecommunications, Inc. (Incorporated by reference to Exhibit 10-w to the Company's Annual Report on Form 10-K for the fiscal year ended October 31, 1990.)\n10-qq Sublease Agreement, dated October 31, 1990, between Seagate N\/A Technology, Inc. and ADC Telecommunications, Inc. (Incorporated by reference to Exhibit 10-y to the Company's Annual Report on Form 10-K for the fiscal year ended October 31, 1990.)\n10-rr Lease, dated February 25, 1991, between American Lightwave N\/A Systems, Inc. and 999 Research Parkway, Inc. (Incorporated by reference to Exhibit 10-t to the Company's Annual Report on Form 10-K for the fiscal year ended October 31, 1991.)\n10-ss Lease, dated December 18, 1992, between Fibermux Corporation N\/A and Greenville Dallas Delaware, Inc. (Incorporated by reference to Exhibit 10-dd to the Company's Annual Report on Form 10-K for the fiscal year ended October 31, 1993.)\n10-tt Lease, dated August 2, 1993, between ADC Telecommunications, N\/A Inc. and Engelsma Limited Partnership. (Incorporated by reference to Exhibit 10-cc to the Company's Annual Report on Form 10-K for the fiscal year ended October 31, 1993.)\n10-uu Lease, dated September 30, 1993, between American Lightwave N\/A Systems, Inc. and 999 Research Parkway, Inc. (Incorporated by reference to Exhibit 10-bb to the Company's Annual Report on Form 10-K for the fiscal year ended October 31, 1993.)\n10-vv Sublease, dated as of February 21, 1995, between Seagate N\/A Technology, Inc. and ADC Telecommunications, Inc. (Incorporated by reference to Exhibit 10-a of the Company's Quarterly Report on Form 10-Q for the quarter ended April 30, 1995.)\n10-ww Lease, dated July 17, 1995, between Centract VI LLC and N\/A ADC Video Systems, Inc. (Incorporated by reference to Exhibit 10-a of the Company's Quarterly Report on Form 10-Q for the quarter ended July 31, 1995.)\nExhibit Number Description Page 21-a Subsidiaries of the Company xx\n23-a Consent of Independent Public Accountants to the incorporation xx of their report dated December 13, 1995, included in this Form 10-K, into the Company's previously filed Registration Statements, File Nos. 2-83584, 33-22654, 33-40356, 33-40357, 33-52635, 33-52637, 33-58407, 33-58409 and 33-59445.\n24-a Powers of attorney. xx\n27-a Financial Data Schedule. xx","section_15":""}
{"filename":"738830_1995.txt","cik":"738830","year":"1995","section_1":"Item 1 Business\nCheyenne Software, Inc. (\"Cheyenne\", the \"Registrant\" or the \"Company\"), formed in 1983, is engaged in the development, sale and support of software products for use in microcomputers and computer systems mainly for Local Area Network (LAN) and, more recently, Wide Area Network (WAN) applications. Cheyenne's key technical product strategy is to employ the network file server's high performance capabilities based on the client\/server model.\nThe Company's products provide key services to administrators and users of computer networks, in the following categories:\na) Network Data Storage Management - includes ARCserve, HSM and JETserve b) Network Security - includes InocuLAN c) Network Management - includes Monitrix d) Network Communications - includes FAXserve and Bit products\nIn July, 1995, Cheyenne established three divisions based upon operating system platforms, a NetWare division, a Windows\/NT division and a UNIX division. By focusing on serving the needs of each platform, the Company expects to align its activities closer to its channels of distribution, strategic partners and customers. Cheyenne has network data storage management products for these major and other platforms. With respect to other product categories, Cheyenne has products which support some of these major and other platforms.\nSoftware Products - -----------------\nA brief description of key Cheyenne software products follows below.\nNetwork Data Storage Management - -------------------------------\nApproximately 88.6% of Cheyenne's revenues for the fiscal year ended June 30, 1995 (\"FY95\") relate to the ARCserve(R) product line. The last major enhancement for the NetWare platform was at the end of the fourth quarter of the fiscal year ended June 30, 1993 (\"FY93\"). A major enhancement for the NetWare platform is anticipated by the end of calendar year 1995. A Microsoft NT version was released in FQ395. ARCserve\/Open for UNIX was extended in FY95 to support additional UNIX operating systems.\nARCserve(R) for NetWare Version 4.x - -----------------------------------\nARCserve DOS Edition provides fully automated data management services for Novell networks. ARCserve consists of the ARCserve Server, a VAP or NLM (NetWare Loadable Module) that resides on a computer server. It also includes ARCserve Manager, a workstation front-end that lets the user execute or schedule services to be performed by the VAP or NLM. This client\/server architecture lets the user perform centralized data backup without a dedicated workstation and gives users simultaneous access to data management services while it enhances security for the network. The VAP or NLM performs backup and restore for the entire network while remaining completely in the background. ARCserve allows hardware to operate at its optimum speed. Data is sent directly from the file server to attached storage devices without traveling over the network. ARCserve offers flexibility in media and device selection. It supports most available SCSI and QIC-02 tape drives, disk and optical hardware, and a wide variety of host adapters.\nARCserve includes Auto Pilot Tape Management, an invisible operator which guides the user through tape management, rotation, and labeling. The Disk Grooming option frees up valuable disk space by moving outdated files to tape automatically. For disaster recovery, AutoPilot's Quick Recover feature restores the system or a designated file to any specified date. Also\nincluded is a File Tracking System and Quick File Access. The user queries the system to locate a backup session or specific file, and ARCserve prompts the user to mount the tapes needed to perform the restore. For preventive maintenance, ARCserve's Tape Usage Database gives the user factual information on the condition of tapes. This enables the user to make educated decisions about tape usage and tape retirement. ARCserve 4.x is compatible with NetWare 3.X and 4.X.\nARCserve(R) for NetWare Version 5.x - ------------------------------------\nARCserve Windows Edition maintains the same innovative functions as ARCserve 4.x DOS Edition and adds new functionality. Whether the user has a small single-server or a large multiserver network environment, ARCserve Windows Edition will back up all NetWare servers, DOS, Windows, OS\/2, and MacIntosh workstations and certain UNIX workstations, as well as certain database servers.\nUsing the Microsoft Windows 3.1 Graphical User Interface (GUI), ARCserve Windows Edition manages backup easily. Parallel Streaming simultaneously processes backup and\/or restore operations to seven devices chained on one SCSI adapter. ARCserve supports most industry standard SCSI and QIC-02 tape drivers and a wide variety of host adapters. Messages notify the user in a timely manner if any problems occur, and are configurable on a per job basis using the ARCserve Manager. ARCserve integrates with Cheyenne's InocuLAN to ensure virus-free backups and sends alert messages and reports via facsimile with Cheyenne's FAXserve.\nARCserve(R) for Windows NT Version 2.x - --------------------------------------\nIn FQ3\/95, Cheyenne began to ship ARCserve for NT Version 1.0. The product offers the same comprehensive, high performance features found in ARCserve for NetWare Windows Edition. It functions as an operating system service, rather than as an application, permitting system-wide backups to be scheduled and performed, regardless of user log-in. Once ARCserve for NT schedules the backup, the control is given to the Windows NT operating system. A maximum level of security is therefore obtained because the need to remain connected to the server during the backup process is eliminated. This product also includes a virus scanning engine for Cheyenne's InocuLAN for Windows NT anti-virus software to further provide high data integrity. Version 2.x began to ship in late FQ4\/95.\nARCserve(R)\/Open - ----------------\nARCserve(R)\/Open provides fully automated data management services for certain UNIX environments. The software operates natively in a UNIX environment that does not include a Novell network. It offers automation, reliability and performance to the UNIX back-up operation, which can be performed in the background or in real time. ARCserve(R)\/Open has been available since September 1992. The product line was extended to include platform support for additional UNIX operating systems in FY95.\nARCserve(R) for MacIntosh - -------------------------\nIn the third quarter of the fiscal year ended June 30, 1994 (\"FY94\"), Cheyenne began to ship ARCserve for MacIntosh. The product offers backup and restore for stand-alone and networked MacIntosh computers.\nARCserve(R) Options - -------------------\nShipments of the Tape Changer and Stacker software modules for ARCserve (NLM only), providing fully automated, high capacity NetWare data storage and management commenced toward the end of the fiscal year ended June 30, 1992 (\"FY92\").\nAgent options for MacIntosh and UNIX workstations including IBM AIX, HP\/UX, DEC Ultrix, SunSoft Solaris, Univel and Unixware are available for ARCserve (NLM only). They give the user a single source for effective data management in multiple operating system environments.\nThe DBagent options for ARCserve (including agents for NetWare Btrieve, SQL, Oracle and Gupta) provide on-line backup of mission critical databases on the network. Traditionally, databases that are continuously on-line or \"active\" have been difficult to backup completely, as they are constantly being modified.\nHSM - ---\nCheyenne HSM Hierarchical Storage Management is a process of automatically and transparently migrating data across a hierarchy of storage media. Infrequently accessed files typically are moved from primary storage on a server hard drive to more cost effective storage media, including optical and tape storage. While HSM systems have been available for mainframe environments, they are just now being recognized as critical to managing storage in large networked environments.\nIn FQ3\/95, Cheyenne began to ship Cheyenne Hierarchical Storage Manager 1.0, a fully automated storage product for NetWare 3.11, 3.12 and 4.x servers. In FQ2\/95, Cheyenne acquired an HSM for UNIX product from NETstor, discussed below. The NetWare and UNIX HSM products are used in combination with ARCserve for NetWare and ARCserve\/Open.\nJETserve(TM) - ------------\nJETserve is a high-performance data disaster recovery solution that provides fast, image-based backup and data restore services. Combined with RAID fault tolerance, the product offers a high level of data protection for large volumes of mission-critical data residing on NetWare superservers. The product is based on technology purchased from NetFrame, discussed below. Cheyenne is currently developing versions of JETserve for the NT and UNIX markets. The JETserve product can be used in combination with ARCserve, as well as an independent product.\nARCsolo(R) - ----------\nARCsolo for DOS backs up and restores a workstation and, if necessary, the file server. The user can also back up and restore other network workstations by using any mapping facility. ARCsolo for Windows was introduced in FQ2\/94, with similar features as ARCsolo for DOS, but it has a \"Windows\" front end. ARCsolo for OS\/2 was introduced in late FY94. It provides reliable backup and restore for OS\/2 workstations and LAN servers. ARCsolo supplements ARCserve and maintains the same tape format.\nNetwork Security - ----------------\nInocuLAN(R) for NetWare - -----------------------\nInocuLAN protects a file server, networked PC's, and stand-alone PC's from computer viruses. Shipments of the product started during June 1992. Version 3.0 with a Windows front end began shipping in FQ1\/95.\nThe server-based module of InocuLAN is an NLM. This NLM scans servers for known viruses, completely in the background at user-defined intervals. Small resident programs (TSR's) in workstations or stand-alone PCs provide immunity and prevention from known and unknown viruses. The hard drive, floppy disk, and other storage media are scanned for viruses by InocuLAN.\nInocuLAN enforces security from the file server; a user cannot access the network on an unprotected workstation. Since the user can distribute InocuLAN software updates from the file server, the tedious process of updating each workstation individually is eliminated. When InocuLAN detects a virus, it alerts the user by network broadcast, MHS message, or pager. The user often may be able to remove the virus from the infected file and restore that file to its original state. Backup, restore, and notification of corruption of critical hard disk area is also provided.\nInocuLAN(R) for NT - ------------------\nIn FQ4\/95, Cheyenne began to ship InocuLAN for Windows NT Version 1.x. The product has been optimized for Windows NT and functions as a 32-bit operating system service. The product offers anti-virus protection for all files residing on Windows NT, as well as the PC's and MacIntosh workstation attached to the network.\nNetwork Management - ------------------\nMonitrix(R) - -----------\nMonitrix is an intuitive inventory, monitoring and documenting solution for network management. Running NetWare 3.11, 3.12, and 4.x, Monitrix takes advantage of the MSWindows 3.1 interface and provides the centralized tools which enable effective LAN\/WAN management.\nAsset Management accurately tracks and accounts computer hardware and software assets; supporting both networked nodes and isolated workstations without a TSR. Monitrix automatically inventories NetWare file servers and DOS, Window, OS\/2, and MacIntosh workstations, offering analysis of current and future computing needs. Administrators can easily construct network sensors to identify vital system thresholds, including file server utilization, network traffic, volume status and disk space, and buffer and memory usage. If any threshold is crossed, specified users are notified through a Robust Alert System. Monitrix also obtains and graphs IPX, SPC, System and CPU trends for timely network analysis. All statistics can be documented via built-in or customized reports.\nNetwork Communications - ----------------------\nFAXserve(TM) - ------------\nFAXserve provides secure, easy-to-use, economical facsimile services for a Novell network operating system. The user prepares a document at the workstation in DOS, Windows, or E-Mail applications, and schedules where and when it should be sent. FAXserve also lets the user create and send documents with any CAS application. Shipments of this product started during the first quarter of FY93. Shipments of the latest version, V3.0, commenced in FQ4\/95.\nFAXserve takes full advantage of the server's power. It eliminates the need for a dedicated workstation or proprietary hardware. In addition, the fax device can be shared by all users. FAXserve improves the quality of outgoing faxes and sends documents electronically to the destination's fax device. With FAXserve, the user can reduce communication costs by scheduling unattended fax transmissions during less costly off-peak hours.\nBit Products - ------------\nThis product line was acquired from Bit Software, Inc. and has been significantly modified. It consists of stand-alone communications (voice, data, fax) products with peer-to-peer networking capabilities aimed at the work group computing market.\nIn connection with its adoption of a divisional structure (NetWare, NT and Unix) described above, the FAXserve and Bit products, which previously formed the product line for Cheyenne Communications, Inc., a wholly-owned subsidiary of Cheyenne, were recently consolidated with Cheyenne's operations.\nChannels of Distribution - ------------------------\nA. DISTRIBUTORS - Cheyenne's distributors are independent companies ------------ with multiple sales and stocking locations, which sell computer-related hardware and software products, principally to value-added-resellers (VAR's). Cheyenne provides sales and technical training to its distributors; such distributors cooperatively advertise and promote Cheyenne's products. Cheyenne has entered into non-exclusive agreements with each distributor. Most distributor agreements have one year\nterms, may be canceled by either party upon 30-60 days' notice, provide for the exchange of inventory by Cheyenne within 90 days of delivery and contain no minimum purchase requirements by the distributor. Presently, Cheyenne's key distributors and their territories include (listed alphabetically):\nIn FY95, one distributor accounted for more than 10% of Cheyenne's total sales. Such distributor accounted for 14.4% of revenues by purchasing $18,393,000 of standard products from the Company.\nSales through distributors (excluding Japan) have increased in FY92, FY93, FY94 and FY95 as follows:\nDistribution Sales ($ Thousands)\nTerritory FY92 FY93 FY94 FY95 ------------- -------- -------- -------- -------- North America $ 5,040 $ 15,785 $ 37,028 $ 41,089 Europe 4,158 16,792 33,696 45,394 ROW 510 1,888 4,097 7,640 -------- -------- -------- -------- $ 9,708 $ 34,465 $ 74,821 $ 94,123 ======== ======== ======== ========\nThe above increases were mainly due to:\na) An expanding LAN market; b) Better recognition and acceptance of Cheyenne's products in the LAN marketplace; c) Increased advertising, training, sales and customer support; d) A broader product line; e) The increased availability of foreign language-translated products; and f) The addition of new distributors, particularly outside the United States.\nTo support the growing sales in North America, the Company added 15 sales and marketing personnel in FY95. Cheyenne now has regional sales offices in Atlanta, Chicago, Dallas, Seattle and San Diego and Ontario, Canada.\nIn Europe, sales and service centers were added in the U.K. and Germany during FY93 to augment the Company's European presence and to support sales efforts out of its French office. The number of full time European employees grew from 40 to 76 in FY95.\nThe Company rapidly expanded sales in the rest of the world (ROW) by adding new distributors during FY95. Sales and service centers were added in FY95 in Australia, Brazil, Mexico, Singapore and Taiwan, in addition to Miami, FL (the U.S. base for Cheyenne's ROW sales), added in FY94. Singapore now serves as the Company's base for Asia (excluding Japan) and the Company has relocated there a key manager from the United States to oversee expansion in this area. Employees directly supporting ROW sales increased to 10 in FY95 from 2 in FY94 (the Company also has retained 2 sales consultants in ROW).\nAlthough the Japanese networking market is still relatively small, Cheyenne's management believes the potential is significant. In February 1993, the Company formed a subsidiary in Tokyo (Cheyenne KK) which now has 21 full time employees. Subsequent to June 30, 1995, Cheyenne repurchased the 40 shares (5%) of capital stock of Cheyenne KK it did not own for an immaterial amount. In FY95, Cheyenne entered into OEM agreements with Fujitsu LTD. and Mitsubishi and a letter of intent with NEC in Japan. Sales in Japan have increased in FY92, FY93, FY94 and FY95 as follows:\nJapan Sales (In Thousands) --------------------------\nFY92 FY93 FY94 FY95 ---- ---- ---- ---- $65 $725 $2,341 $7,828\nB. ORIGINAL EQUIPMENT MANUFACTURERS (OEM) - Since Cheyenne's products -------------------------------------- have the ability to add value and capability to hardware products such as computers, tape drives, data storage devices, etc., a number of hardware producers have bundled Cheyenne products with their products. As a consequence, Cheyenne has entered into many OEM agreements with producers of computer and computer-related equipment.\nManagement believes that its OEM agreements have made a significant contribution to the growth in the Company's unit sales, because of the enhanced market penetration and visibility that resulted from the investments in advertising and promotion that OEM companies normally undertake. There are more than 20 OEM agreements currently in force. No one OEM relationship produced more than 5% of Cheyenne's revenues in FY95. Total OEM revenues, excluding those of Bit, were $7.9 million or about 35% of total revenues in FY92, were $13.3 million or about 23% of total revenues in FY93, were $13.3 million or about 14% of total revenues in FY94, and were $15.3 million or about 12% of total revenues in FY95. During the last two years, as Cheyenne's ARCserve product has become more readily available throughout the world via Distribution, the need for OEM customers to bundle the product has lessened. Distributors now bundle ARCserve with many different hardware devices and provide the value-added services to customers that were previously the responsibility of the OEM. As a result of this change in the marketplace, Distributor sales have grown more rapidly than OEM sales.\nBelow is a brief description of Cheyenne's major OEM agreements listed alphabetically.\n1) Compaq - In FY93, Cheyenne optimized ARCserve 4.0 for use with ------ Compaq's full family of System Pro\/XL network servers. Shipments to Compaq started in FQ4\/93. This enhanced the relationship between Cheyenne and Compaq, which began in FY92 when the two companies created a Technical Support Alliance.\nIn FQ1\/95 Cheyenne announced an agreement with Compaq which provides for the distribution of ARCserve 4.x and 5.x on Smartstart CD-ROM. During FQ1\/95, Compaq began shipping software CD's with each ProLiant and ProSignia server. The Smartstart CD includes ARCserve 5.01 for NetWare, Windows Edition and ARCserve 4.05 for NetWare, DOS Edition. This agreement represents the first CD-ROM distribution of ARCserve and appears to mark the beginning of a general change in the way the Company's software will be distributed throughout the world. In FQ395, Compaq also began distribution of ARCserve for NT on SmartStart CD-ROM.\n2) Computer Associates - A technology and marketing partnership with ------------------- Computer Associates (\"CA\") was established in FQ4\/93 which enables CA to employ Cheyenne's extensive LAN storage technology with all CA's OS\/2 based network backup and archiving systems. Cheyenne's agent technology provides common access to a diverse list of network clients such as Windows, DOS, OS\/2 and UNIX. Cheyenne is providing CA-Unicenter with complete support for the storage media that clients depend upon in networks of PCs. In FQ1\/96, Cheyenne announced the expansion of its relationship with CA by establishing a technology partnership to integrate Cheyenne's multi-platform storage management software with the CA-Unicenter environment. As a result, CA-Unicenter users will have access to a wide variety of essential data and storage services including disaster recovery, data protection, hierarchical storage management, and on-line database backup\/restore for the NetWare, Windows NT and UNIX operating system environments. The final terms of the expanded relationship will be subject to a definitive agreement, currently being negotiated.\n3) Hewlett Packard - In FY95, HP's Bristol division and Cheyenne --------------- entered into an agreement to bundle ARCserve with HP's SureStore tape drives as HP's premier solution. HP offers ARCserve for NetWare, ARCsolo for Windows and ARCsolo for OS\/2 under the agreement. HP has offered Cheyenne products in previous years under earlier agreements.\n4) IBM - In FQ3\/93, Cheyenne and EduQuest, the IBM Educational Systems --- Company entered into an OEM relationship in which ARCserve is being bundled with IBM's 4mm and 8mm DAT Tape drives. EduQuest specializes in the development and marketing of technology solutions designed for elementary and secondary school levels (K-12) which assist teachers and administrators in improving the quality of education for America's children. During FY94, Cheyenne furthered its relationship with IBM by becoming a Business Partner with the Personal Software Products group although no significant revenues have resulted from this relationship.\n5) Intel - An agreement was signed during June 1991 jointly to develop ----- a specialized LAN storage management system entitled Storage Express in which Cheyenne's ARCserve technology is included. The product was introduced to the marketplace during September 1992. A non-refundable advance against future royalties was earned by Cheyenne. Additional royalties were earned during FY94 and FY95 when ongoing shipments of Storage Express exceeded those covered by the original advance. Also, additional small non-recurring fees were earned by Cheyenne as Intel incorporated Cheyenne's most current technology in its Storage Express product.\nC. MAJOR ACCOUNTS - During FY92, the Company initiated a Major Account -------------- sales program in which Cheyenne sales employees directly call on LAN administrators of Fortune 1000 companies. These potential customers can buy Cheyenne product through local value-added resellers (VAR's), distributors or directly from Cheyenne. Many large companies have found it convenient to deal directly with Cheyenne on a \"site license\" basis in which the Company provides a \"golden master\" disk that enables the customer to produce Cheyenne's software product, as needed.\nRevenues from these type of sales in FY94 were $1,534,000 and grew to $3,108,000 in FY95.\nD. DIRECT SALES - The Company in FY95 expanded its work force focusing ------------ on direct sales of upgrades and other products. The Company also has contracted with outside third parties to assist in this direct marketing and sales project. This project, initiated with an outside company, began in FQ494. The project increased sales of Cheyenne's secondary products, as well as upgrades and sales directly to end-users. The costs associated with this project are relatively high compared to revenues thus far.\nFY95 Acquisitions - -----------------\nOn December 19, 1994, the Company acquired certain assets and assumed certain liabilities of NETstor, Inc. (NETstor), a developer of Hierarchical Storage Management software products for the UNIX computer platform in the network storage management market, for $1,150,000 of cash and $200,000 of additional future contingent payments. The acquisition has been accounted for as a purchase and the operating results of NETstor are included in the consolidated statement of earnings from the date of acquisition. In connection with the acquisition, the Company in FQ295 recorded a $547,000 expense for purchased research and development and $94,000 of capitalized software, which is included in other assets and is being amortized on a straight line basis over two years.\nOn March 30, 1995, the Company acquired the DataJET product line and certain other assets and assumed certain liabilities of NetFRAME Systems, Inc. (NetFRAME). DataJET is an image based, high performance software backup product for NetWare file servers. Cheyenne made an $801,000 cash payment for DataJET and will pay royalties to NetFRAME based on the Company's sales of products utilizing the DataJET technology. The acquisition has been accounted for as a purchase. In connection with the acquisition, the Company in FQ395 recorded a $704,000 expense for purchased research and development.\nThe technological feasibility of the in-process technology related to the NETstor and DataJET product acquisitions was not yet established at the dates of acquisition and the technology has no alternative use.\nResearch & Development - ----------------------\nCheyenne primarily develops its software products internally. However, outside contractors and third party publishers are used for the development or supply of software that provides certain aspects of some products.\nCheyenne's industry is characterized by rapid technological change, resulting in continuing pressure for price\/performance improvements in response to advances in computer software and hardware technology. Cheyenne believes that its future success will depend, in large part, on its ability to enhance and develop its software products satisfactorily to meet specific market needs and to maintain its technological leadership. As noted above, Cheyenne has introduced products that function in many different operating system environments. ARCserve(R) and related Cheyenne software products currently offer users the ability to back up the data from Microsoft DOS, Windows and NT, MacIntosh and certain UNIX workstations connected to a Novell NetWare network. A substantial portion of Cheyenne revenues are derived from products that work in the Novell NetWare network operating system environment. Novell faces increasing competition from a number of sources in the network environment, including Microsoft. Microsoft may enjoy certain competitive advantages over Novell, which may enable Microsoft to compete effectively against Novell in the market for network operating systems. As a result, sales of Cheyenne products into the Novell network marketplace may be affected.\nIn FY95, Cheyenne began to ship a version of ARCserve(R) that operates natively in the Microsoft NT environment, which offers users the ability to back up data from Microsoft NT servers and workstations not connected to a Novell NetWare network. Some of Cheyenne's competitors also offer native Microsoft NT backup. The market for Microsoft NT backup products is in the early stages of development and it is too soon to predict whether Cheyenne will obtain market share in the NT market similar to the Company's market share in the NetWare market. Cheyenne is also developing anti-virus and communications software products for the NT marketplace. Failure to succeed in the NT market could have a material adverse affect on Cheyenne's operating results, especially if NT becomes the dominant network operating system.\nCheyenne has developed hierarchical storage management products for the NetWare and UNIX markets. Cheyenne also continues to develop backup products directed at the UNIX operating system environment, some of which natively operate in those environments. UNIX operating systems are now increasingly competitive with Novell NetWare and Microsoft NT operating systems. Cheyenne's competitive position in these markets is presently insignificant, but is expected by the Company to improve during the next few years.\nThere can be no assurance that Cheyenne's efforts to develop Microsoft NT, additional UNIX and other products will be technologically successful, that any resulting products will achieve market acceptance or that Cheyenne will elect to develop software products for the operating environments that ultimately are accepted by the marketplace. The failure to do so may have a materially adverse affect on the Company.\nThe computer software industry has experienced delays in its product development and 'debugging' efforts, and Cheyenne has experienced such delays and could experience additional delays in the future. Significant delays in developing, completing or shipping new or enhanced products and\/or the inability of such products to perform as expected could adversely affect Cheyenne in a number of ways, including a loss of competitiveness of Cheyenne's products, negative publicity and delayed purchasing decisions, and could, therefore, adversely affect Cheyenne's financial results. Furthermore, it can be expected that as products become more complex, development cycles will become longer and more expensive.\nCheyenne intends to continue the use of strategic acquisitions to provide certain technology for its overall product strategy. Cheyenne completed two acquisitions during FY95 and anticipates the acquisition of other companies and products in the future. In addition to the significant business risks associated with acquisitions, which include the failure to combine the companies in an efficient and timely manner, the failure to coordinate research and development and sales efforts, the failure to retain key personnel and the failure to integrate the acquired products into Cheyenne's product mix, Cheyenne may incur significant acquisition expenses for legal, accounting and financial advisory services and other costs related to the combination of the companies. These costs, when added to the consideration paid to the Sellers, may have a significant adverse impact on Cheyenne's profitability and financial resources.\nThe R&D staff at the end of FY95 increased to 130 engineers, programmers and documentation specialists from 94 at the end of FY94. This group is responsible for developing new software products and enhancing, documenting and supporting existing software products. In addition, a group of 55 engineers\/testers are employed in testing and quality control of Cheyenne software products versus 32 last year.\nTechnical Support - -----------------\nThe technical and customer support staff that is responsible for training OEM customers, distributors, resellers and end-users, as well as responding to all technical questions from customers throughout the world, now numbers 136 employees versus 80 last year. The expenses associated with technical support were reclassified at the end of FY95 from Research and Development to cost of goods sold. Prior periods have been restated.\nSales and Marketing - -------------------\nFluctuations in Purchasing Patterns - -----------------------------------\nChanges in purchasing patterns of one or more of Cheyenne's major customers could result in material fluctuations in quarterly operating results. Cheyenne's major customers are large, sophisticated businesses which make their own independent purchasing decisions. The timing of new product announcements and introductions by Cheyenne could also have an impact on the purchasing patterns of Cheyenne's major customers. Typically, the personal computer industry experiences some seasonal variations in demand, with weaker sales in the summer months (FQ1) because of customers' vacations and planned shutdowns. This seasonality is more pronounced in Europe.\nQuarterly results are difficult to predict until the end of each quarter and may fluctuate significantly from quarter to quarter. Substantially all of Cheyenne's revenue in each quarter results from orders booked in that quarter because lead times for delivery of Cheyenne's products are typically very short. The difficulty in predicting quarterly revenues is also increased by the fact that a high percentage of Cheyenne's revenues are earned in the third month of each fiscal quarter and tend to be concentrated in the latter half of that month.\nSignificant Customers - ---------------------\nOne distributor accounted for greater than 10% of the Company's revenues in FY95 (14%), FY94 (17%) and FY93 (14%). At June 30, 1995, this customer accounted for 26% of Cheyenne's outstanding net trade accounts receivable. The loss of this customer, or any of the other major distributors of Cheyenne's products or their failure to pay for products purchased, could have a material adverse affect on Cheyenne's operating results.\nReturns and Exchanges; Price Protection - ---------------------------------------\nLike other manufacturers of computer software and hardware products, Cheyenne is exposed to the risk of product returns and exchanges from its distributors. Cheyenne's exchange policy generally allows its distributors, subject to certain limitations, to exchange purchased products. Although certain major distributors and OEM's have return rights, most of Cheyenne's contracts provide for no or only limited return rights.\nThe risk of product returns and exchanges may increase if the demand for new products introduced by Cheyenne is lower than Cheyenne anticipates at the time of introduction. Should any new product experience a high rate of bugs or performance difficulties, Cheyenne could experience product returns and exchanges, unexpected warranty expenses and lower than expected revenues in a particular quarter.\nIndividual end users may return products to Cheyenne through dealers and distributors within 90 days from the date of purchase. Cheyenne offers a 30 day money back guarantee for certain direct purchases from Cheyenne by individual end users. Such returns have historically been minimal.\nAlthough Cheyenne believes that it provides an adequate allowance for sales returns and exchanges in its financial statements, there can be no assurance that actual sales returns and exchanges in the future will not exceed Cheyenne's allowance. Product returns or exchanges materially in excess of recorded allowances could result in a material adverse affect on operating results. In FY95, Cheyenne increased the allowance for sales returns and exchanges due to, among other things, new product releases and product upgrades in FY95.\nCheyenne is also exposed to the impact on its distributors of list price reductions by Cheyenne of its products. As with many other suppliers, Cheyenne provides many of its distributors with some price protection in the event that Cheyenne reduces the list price of its products. Distributors are usually offered some credit for the impact of a list price reduction on the expected revenue from Cheyenne's products in the distributors' inventories at the time of the price reduction. Through June 30, 1995, there have been no price reductions on Cheyenne products and therefore no credits have been issued for list price reductions. However, there can be no assurance that in the future there will not be credits for price protection.\nNew Channels - ------------\nAs noted above, a substantial portion of Cheyenne's revenues are derived from products that function in a Novell NetWare operating environment. Cheyenne has introduced products that work in different operating environments, such as Microsoft NT, UNIX and MacIntosh. Some of these type products are not sold in Cheyenne's traditional channel of distribution. The success of these products will therefore in part be determined by Cheyenne's ability to develop and maintain relationships with new channels of distribution. There can be no assurance that Cheyenne will be able to develop these relationships or that such relationships, if developed, will be successful.\nCheyenne at the end of FY95 had 205 full time employees devoted to its worldwide sales and marketing activities versus 153 people last year. In addition, four of the Company's senior executives spend a significant portion of their time supporting this activity.\nCheyenne participated in more than 200 trade shows and similar events around the world in FY95 and advertised in many of the industry trade journals. New brochures, new product packaging designs and direct mail advertising programs were also developed and utilized to support the sales campaigns during FY95.\nCompetition - -----------\nCheyenne operates in a highly competitive market for computer software products. The success of a product depends upon two factors: (i) the fundamental quality of the product, i.e., whether it carries out the functions that the user expects, smoothly and efficiently; and (ii) the strength of the company marketing and supporting the product. Management is confident that Cheyenne produces high quality products, as demonstrated by the fact that the products which have come to market continue to be favorably reviewed by trade publications and to achieve growing acceptance by major OEM accounts, distributors and end-users.\nThe market for network backup computer software is becoming more competitive. This competition is likely to intensify as current competitors expand their product lines and\/or enter into relationships with large companies and new companies enter the market. While the Company believes its products are still technologically superior to the competition, many competitors now offer features once only offered by Cheyenne and offer some features not offered by Cheyenne. Novell, Microsoft, IBM and other network operating systems vendors may also offer increased backup functionality in future versions of their respective products. In such event, the market for Cheyenne's ARCserve(R) could be materially adversely impacted.\nWhile discounts are typically granted from the suggested retail price for most computer software, price competition has not been a major factor to date in the high performance end of the network backup software business in which Cheyenne primarily competes, although price competition in that segment of the market has increased. Significant price competition currently exists in the low performance sector of that market. In FY94, Cheyenne introduced an OEM network backup product into the low performance sector. The introduction of this product into the low performance sector may have adversely affected sales of Cheyenne's high performance product. Cheyenne believes that price competition, with its attendant reduced profit margins, may also emerge as a more significant factor in the high performance sector. Some of Cheyenne's competitors also have significantly greater financial resources, research and development, marketing resources and customer support organizations than Cheyenne.\nThe competitors of Cheyenne include computer companies which develop software for use with their own equipment and software development companies such as Novell, Inc., Computer Associates International, Inc., IBM, Palindrome, a subsidiary of Seagate Corporation, Sterling Software, Symantec Corporation, Tecmar, EMC Corp., Microsoft Corp., Arcada Software, a subsidiary of Connor Peripherals, Intel, Legato Systems, Inc. and other software developers. Some of these competitors license and distribute Cheyenne technology.\nProprietary Information, Patents and Trademarks - -----------------------------------------------\nCheyenne currently relies on copyright, trade secret and trademark law, as well as provisions in its license, distribution and other agreements in order to protect its intellectual property rights. Cheyenne has registered certain patents in the United States and has other United States patents pending and intends to file further patent applications. No assurance can be given that any Cheyenne patent will provide protection for Cheyenne's competitive position or that the patents pending will be issued or, if issued, will provide protection for Cheyenne's competitive position. Although Cheyenne intends to protect patent rights vigorously, there can be no assurance that these measures will be successful. Additionally, no assurance can be given that the claims on any patents held by Cheyenne will be sufficiently broad to protect Cheyenne's technology.\nIn addition, no assurance can be given that any patents issued to Cheyenne will not be challenged, invalidated or circumvented or that the rights granted thereunder will provide competitive advantages to Cheyenne. The loss of patent protection\non Cheyenne's technology or the circumvention of its patent protection by competitors could have a material adverse effect on Cheyenne's ability to compete successfully in its business.\nThe software industry is characterized by frequent litigation regarding copyright, patent and other intellectual property rights. Cheyenne believes that its products, trademarks and other proprietary rights do not infringe on the proprietary rights of third parties. There can, however, be no assurance that third parties will not assert claims against Cheyenne with respect to existing or future products or that licenses will be available on reasonable terms, or at all, with respect to any third party technology. Cheyenne receives such claims from time to time. In the event of litigation to determine the validity of any third party claims, such litigation could result in significant expense to Cheyenne and divert the efforts of Cheyenne's technical and management personnel, whether or not such litigation is determined in favor of Cheyenne.\nIn the event of an adverse result in any such litigation, Cheyenne could be required to expend significant resources to develop non-infringing technology or to obtain licenses to the technology which is the subject of the litigation. There can be no assurance that Cheyenne would be successful in such development or that any such licenses would be available. In addition, the laws of certain countries in which Cheyenne's products are or may be developed, manufactured or sold may not protect Cheyenne's products and intellectual property rights to the same extent as the laws of the United States.\nAs set forth and further disclosed in Item 3 (Legal Proceedings), Cheyenne (along with some of its competitors) is the subject of a patent litigation suit.\nExecutive officers and employees have agreed to assign to Cheyenne certain technical and other information and patent rights, if any, acquired by them during their employment by Cheyenne. Executive officers and employees have also agreed not to use or disclose any confidential information for a period of at least one year following the termination of their employment.\nCheyenne applied for and received Federal Trademark Registrations for Cheyenne(R) in 1986, for ARCserve(R) and Monitrix(R) in FY90, for InocuLAN(R) in FY94 and for ARCsolo(R) in FY95. Certain other Cheyenne marks have been registered or applied for registration in the United States and other countries.\nEmployees - ---------\nAs of June 30, 1995, Cheyenne employed 621 persons, consisting of 15 in production, shipping and receiving, 130 engineers, programmers and documentation specialists, 55 engineers\/testers responsible for quality assurance, 136 employees providing technical and customer support, 205 in Sales and Marketing (including Europe), 59 in administration and accounting and 21 full time employees at Cheyenne KK in Tokyo. Last year, the Company employed a total of 430 persons on a worldwide basis. None of Cheyenne's employees are represented by a labor union. Cheyenne considers its relations with its employees to be satisfactory.\nPast Relationships - ------------------\nCheyenne entered into the microcomputer distribution business in July 1987 via the acquisition of F.A. Computer Technologies, Inc. which then sold shares to the public in 1988 and then merged with Gates Distributing, Inc., forming Gates\/FA Distributing, Inc. (\"Gates\/FA\").\nIn a secondary offering, Cheyenne sold 801,710 common shares of Gates\/FA on June 17, 1992. The Company sold an additional 100,000 common shares of Gates\/FA on February 3, 1993. At that time, Cheyenne's ownership of Gates\/FA was reduced from 49% to 21.35% of the outstanding shares of common stock of Gates\/FA. Thereafter, Cheyenne reflected its investment in Gates\/FA in its consolidated financial statements using the equity method of accounting. On August 29, 1994, Cheyenne exchanged its remaining 1,348,290 shares of Gates\/FA common stock for 798,996 common shares of Arrow Electronics, Inc. (\"Arrow\"), a public company. In FY95, the contribution to net income from the Gates\/FA equity ownership was therefore only approximately 0.2% of net income.\nThe Arrow transaction qualified as a tax-free exchange and resulted in a pre-tax gain of $21,232,000 for financial reporting purposes. After the transaction, Cheyenne owned approximately 2% of Arrow's outstanding common stock. The Company therefore accounted for its investment in Arrow common stock under the cost method of accounting. In FY95, Cheyenne sold its 798,996 shares of Arrow common stock for $30,324,000, which resulted in a net loss of $11,000.\nItem 2","section_1A":"","section_1B":"","section_2":"Item 2 Properties - ----------------------\nThe main offices of Cheyenne were moved from 55 Bryant Avenue, Roslyn, New York to 3 Expressway Plaza, Roslyn Heights, New York during FY93. Due to the Company's rapid expansion, the original lease at 3 Expressway Plaza for 33,000 square feet has been expanded to 44,000 square feet. The basis of the new master lease for 3 Expressway Plaza started January 1, 1993. As of June 30, 1994, the average annual rental expense for the remaining four and a half year term is approximately $1,049,000 per year, exclusive of electricity, certain real estate tax escalations and other related costs.\nIn FY95, Cheyenne entered into a lease for a building located at 2000 Marcus Avenue, Lakes Success, New York. The facility is 100,000 square feet. The lease commenced on June 1, 1995 and the average annual rental expense for the seven year term is $1,316,000 per year, exclusive of electricity, certain real estate taxes, escalations and other related costs.\nThe Company leases additional facilities, including facilities in Atlanta, Chicago, Austin, Dallas, Miami, Seattle, San Diego, Fremont, Minneapolis, and Canada, France, Germany, the United Kingdom, Japan, Brazil, Mexico, Taiwan and Singapore.\nItem 3","section_3":"Item 3 Legal Proceedings - ----------------------------\nNeither Cheyenne nor any of its subsidiaries is a party to any material pending legal proceedings, other than routine litigation incidental to the business, and other than as set forth below:\n1) Coldata, Incorporated v. Cheyenne Software, Inc. ------------------------------------------------\nAn action was commenced in July 1991, in the Supreme Court of the State of New York, County of Nassau, entitled \"Coldata, Incorporated v. Cheyenne Software, Inc.\" Coldata, Incorporated (\"Coldata\") alleged, among other things, that Cheyenne failed to complete the detailed design specifications and implementation schedule for the development of a particular computer program (called \"CAAMS\"), and therefore, breached the agreement between the parties. Coldata also alleged that Cheyenne breached its fiduciary duties to Coldata by failing to develop and market CAAMS and by its participation in other unrelated software projects to the exclusion of Coldata.\nOn February 17, 1995, the parties settled this lawsuit and Cheyenne, in connection therewith, paid Coldata $170,000. Neither party admitted any liability in connection with the settlement.\n2) In re Cheyenne Software, Inc. Securities Litigation --------------------------------------------------- Master File No. 94 Civ. 2771 (TCP)\nOn or about June 11, 1994, a securities fraud class action complaint, entitled Bell v. Cheyenne Software, Inc., et al., was filed in the United States --------------------------------------- District Court for the Eastern District of New York. The lawsuit names as defendants the Company and several of its officers and directors. In the following weeks, several other similar lawsuits were filed in the Eastern District of New York. The actions allege securities fraud claims under Sections 10(b) and 20 of the Securities Exchange Act of 1934, and seek compensatory damages on behalf of all the shareholders who purchased shares between approximately January 24, 1994 and approximately June 17, 1994, as well as attorneys' fees and costs. The gravamen of the actions is that the Company and the individual defendants made misrepresentations and omissions to the public, which caused the Company's stock to be artificially inflated. The suits rely on what is known as the \"fraud on the market\" theory of liability.\nOn July 20, 1994, the Court ordered that all of the actions be consolidated under the caption of In re Cheyenne Software, Inc. Securities ---------------------------------------- Litigation. On March 8, 1995, plaintiffs filed an Amended Complaint. On - ---------- March 23, 1995, plaintiffs served a Motion\nfor Class Certification. The Company has contested certain aspects of that Motion, and the Court has yet to issue a ruling. On April 11, 1995, the Company served a Motion to Dismiss certain of the claims alleged in the Amended Complaint. The Motion to Dismiss is expected to be heard in Fall, 1995.\nThe defendants deny any and all liability and intend to vigorously defend against the claims.\n3) Rand v. Oxenhorn, et al. ------------------------ Delaware Chancery Court (New Castle County) No. 13583\nOn or about June 27, 1994, a shareholder derivative complaint, entitled Rand v. Oxenhorn, et al., was filed in the Court of Chancery for the State of - ------------------------ Delaware in and for New Castle County. The lawsuit, purportedly filed derivatively on behalf of the Company, names as defendants eleven of its present or former officers and directors. The complaint's factual allegations are similar to those of In re Cheyenne Software, Inc. Securities Litigation --------------------------------------------------- described above. However, instead of securities fraud claims, the action alleges that the defendants breached their fiduciary obligations to the Company. The suit seeks a variety of compensatory damages as well as attorneys fees.\nOn August 19, 1994, the defendants filed a motion to dismiss on the grounds that (1) the plaintiff failed to comply with the pleading and demand requirements of a derivative action and (2) the pleadings fail to state a claim upon which relief may be granted. On October 14, 1994, and before defendants' motion to dismiss was ruled on, an amended complaint was filed only naming as defendants six of Cheyenne's officers or directors. Cheyenne filed a motion to dismiss the Amended Complaint on the same grounds listed above on February 16, 1995.\nThe defendants deny any and all liability and intend to vigorously defend against the claims.\n4) SEC Formal Private Investigation --------------------------------\nOn June 28, 1994, the SEC commenced an informal inquiry into Cheyenne. On or about April 14, 1995, the SEC advised the Company that it had issued a Formal Order of Private Investigation of the Company. The Private Investigation is a continuation of the informal inquiry. The Formal Order, among other things, enables the SEC to utilize its subpoena powers to obtain relevant information from third parties as well as the Company. The Private Investigation relates to possible violations of federal securities laws. The Company has been cooperating and will continue to cooperate fully with the SEC.\n5) JWANCO, Inc., et al. v. Cheyenne Software, Inc. et al. ------------------------------------------------------ California Superior Court (County of Alameda) No. H-183331-1\nOn or about May 2, 1995, plaintiffs JWANCO, Inc. (formerly known as Bit Software, Inc.), Jonathan Wan, Yau Ki Chuck, Norman Chan, David Law and David Wong filed an action in the Superior Court of California in and for the County of Alameda against the Company, Cheyenne Communications, Inc., a wholly owned subsidiary of the Company, and several of its officers, directors and employees. The action alleges breach of contract, fraud, wrongful termination, negligent infliction of emotional distress, and a number of other related torts. The essence of the allegations is that the defendants breached agreements and defrauded JWANCO, Inc., and the individual plaintiffs in connection with the Company's acquisition of certain assets and assumption of certain liabilities of Bit Software, Inc. on May 19, 1994. These allegations are substantially similar to those In re Cheyenne Software, Inc. Securities Litigation described above. In --------------------------------------------------- addition, the Complaint alleges, on behalf of plaintiff Jonathan Wan only, wrongful termination and a variety of other causes of action relating to the employment and termination of the employment of Jonathan Wan by Cheyenne Communications. The defendants have removed the action to the United States District Court, and have moved to transfer it to New York. Management of the Company, based on advice of outside legal counsel, does not believe that the ultimate resolution of this lawsuit will have a material adverse affect on the financial position or results of operations of the Company.\nAlthough no answer has yet been filed, the defendants deny any and all liability and intend to vigorously defend against the claims.\n6) PCPC v. Cheyenne Software, Inc. ------------------------------- United States District Court (District of Delaware) Case No.\nOn May 19, 1995, Personal Computer Peripherals Corporation (\"PCPC\") filed a lawsuit in the United States District Court for the District of Delaware, Case No. 95-301(SLR), naming Cheyenne, Legato Systems, Inc., Arcada Software, Artisoft, Palindrome (a subsidiary of Seagate) and Symantec as defendants. PCPC alleges infringement of patent No. 5,135,065, entitled \"Backup Computer Program for Networks\" issued to PCPC on July 21, 1992. PCPC is seeking an injunction against infringement of its patent, treble damages, attorneys' fees and other damages. On July 10, 1995, Cheyenne answered the complaint and denied any and all liability. Cheyenne intends to vigorously defend against the claims. Management of the Company, based on advice of outside legal counsel, does not believe that the ultimate resolution of this lawsuit will have a material adverse affect 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.\nPART II -------\nItem 5","section_5":"Item 5 Market for Registrant's Common Stock and Related Matters - -------------------------------------------------------------------\n(a) Commencing March 20, 1990, the Registrant's common stock was traded on the American Stock Exchange (the \"AMEX\") under the symbol of \"CYE\". From July 7, 1986, through the opening of business on March 28, 1994, the common stock was listed on the Pacific Stock Exchange under the symbol \"CYE\". From October 3, 1985 through March 20, 1990, the common stock was quoted on the National Association of Securities Dealers Automated Quotation System (NASDAQ) under the symbol \"CHEY\".\nThe following table sets forth the high and low sales prices for the period July 1, 1993 through June 30, 1995, as reported by the AMEX. The high and low sales prices for the period July 1, 1993 through June 30, 1995 have been adjusted to reflect the 1994 Stock Split paid on March 29, 1994 (as described below).\nQUARTER ENDED HIGH LOW ------------- ---- ---\nSeptember 30, 1993 $ 26.83 $ 19.25 December 31, 1993 25.58 17.67 March 31, 1994 30.33 16.92 June 30, 1994 28.38 7.00\nSeptember 30, 1994 $ 13.38 $ 7.75 December 31, 1994 13.88 9.13 March 31, 1995 17.75 13.25 June 30, 1995 20.00 12.38\nAt a meeting held on February 10, 1994 (the \"1994 Stock Split\") and a meeting held on February 23, 1993 (the \"1993 Stock Split\"), the Board of Directors of Cheyenne declared separate three-for two stock splits payable in the form of 50% stock dividends with respect to the issued and outstanding shares of common stock. The 1994 Stock Split was paid on March 29, 1994 to stockholders of record at the close of business on March 1, 1994 and the 1993 Stock Split was paid on April 8, 1993 to stockholders of record at the close of business on March 12, 1993.\nNo fractional shares were distributed in connection with either stock split. Each stockholder of record whose total number of shares was not exactly divisible by two, received cash in lieu of fractional shares. The cash was in an amount equal to one-half of the fair market value of a share of common stock after giving effect to the stock split. Such market value was determined on the basis of 66-2\/3% of the closing price of Cheyenne's Common Stock reported for the American Stock Exchange composite transactions on each record date.\n(b) As of September 20, 1995, the number of holders of record of the Company was 877.\n(c) Cheyenne has never paid a cash dividend on its common stock. The declaration and payment of future cash dividends by Cheyenne will be determined by the Board of Directors in light of conditions then existing, including Cheyenne's earnings, financial condition, capital requirements, and other circumstances. It is the present policy of Cheyenne's Board of Directors to retain cash and any earnings for the operation and expansion of the Company and, therefore, it is not anticipated that cash dividends will be paid on its common stock in the foreseeable future even if legally permissible.\n(d) On February 23, 1995, Cheyenne announced that the Board of Directors had authorized management to purchase up to 4,000,000 shares of the Company's outstanding common stock. Purchases are dictated by overall financial and market conditions and other factors affecting the operations of the Company.\nDuring FY95, Cheyenne purchased 2,035,000 shares of its common stock for approximately $30,458,000, at prices ranging from approximately $13.50 to $17.25 per share.\nItem 6","section_6":"Item 6 Selected Financial Data (2) - --------------------------------------\nThe following information has been summarized from the Registrant's consolidated financial statements included elsewhere in this Annual Report on Form 10-K and should be read in connection with such consolidated financial statements and the related notes thereto.\nItem 7","section_7":"Item 7 Management's Discussion and Analysis of Financial Condition and - ---------------------------------------------------------------------------- Results of Operations ---------------------\nDespite lower than expected sales in FQ195, sales for FY95 increased 31%. Operating income as a percentage of sales in FY95 (30%) fell from FY94 (46%). This decrease resulted from an increase in operating expenses of 68% over the same time period, primarily consisting of increased expenditures for research and development and selling and marketing. The Company views these expenditures as strategic investments necessary to expand product offerings and to increase market acceptance and penetration of its products.\nSuch investments are further necessitated by increased competition. Cheyenne has several key competitors, many of which compete with Cheyenne only in specific segments of the market for network essentials. Cheyenne competes across many segments of the network data storage management market, as well as certain segments of the network security and network communications markets. Development of these markets requires significant resources. The Company believes these investments in broader market segments will result in long term competitive advantages and establish Cheyenne as a leader in this overall market and further establish Cheyenne as the leader in the enterprise network backup market.\nOne of the greatest challenges for Cheyenne is to respond quickly and effectively to market changes. The expected significant growth of Microsoft NT network operating systems will affect the market for Cheyenne's products. The Company has proven itself as the leader in the NetWare network operating systems backup market. The Company now intends to be a major factor in the NT market and also to increase its presence in the UNIX markets as well as maintaining its leadership position in the NetWare market.\nAn important change in the software industry also continues. Presently, almost all software products are delivered in shrink-wrapped packages. New techniques, such as electronic distribution (bulletin boards) and CD-ROM are being increasingly considered as the mechanism to deliver software products to the end-user. It is possible that, during this potential transition phase, software revenues may be negatively affected on a short-term basis. Cheyenne experienced such a negative affect on revenues in the first quarter of FY95 when one of its key OEM customers began distribution of Cheyenne and other software products on CD-ROM. Other customers are considering such methods which could create further short-term fluctuations in revenue.\nMarket changes create opportunity for the Company. It also creates increased volatility as success is dictated by successful development and market acceptance of new products and responding to changes in distribution mechanisms. Cheyenne is confident that its strong technology and market acceptance will result in continued long term success.\nResults of Operation - --------------------\nThe following table includes a summary of each item from the consolidated statements of earnings as a percentage of revenues. Please refer to this table while reading the following discussion.\nYear Ended June 30, 1995 Compared to Year Ended June 30, 1994* - --------------------------------------------------------------\nRevenues - --------\nCheyenne's revenues increased 31% in FY95 over FY94 to $127,927,000 from $97,737,000.\nA detailed breakdown of sales is shown in Table 2\nAs shown, North America Distribution sales increased 11% in FY95, European Distribution sales increased 35%, Rest of World Distribution sales increased 86% (from a low base) and sales to Japan grew 234% (from a low base). The significant increase in distribution sales is attributed to an expanding LAN market, better recognition and acceptance of Cheyenne products in the LAN marketplace, a broader product line, the addition of new distributors, particularly international distributors, and the increased availability of foreign language-translated products. OEM sales increased 15% in FY95, but decreased as a percentage of consolidated sales to 12.0% in FY95 from 13.6% in FY94. Cheyenne distributors around the world are now offering the Company's software products in configurations similar to, and competitive with, those offered by the OEM channel. This trend resulted in increased sales to Cheyenne distributors at the expense of OEM sales. Major Account sales were up 103%, as a result of increased penetration into Fortune 1000 companies. The Company believes that its salespersons also initiated significant sales to Major Account customers that were booked and handled by Cheyenne resellers and distributors and thus were classified as Distribution sales.\nPlease Refer to Table 1 - ----------------------- Gross Profit - ------------\nGross profit represents revenues less cost of sales. In FY95, technical support costs were reflected in cost of sales rather than Research & Development as in previous periods. All past periods have been restated to make them comparable with FY95. Cost of sales consists primarily of technical support costs, production costs, manuals, packaging, order fulfillment, product costs, shipping costs and royalties paid (when applicable) to third parties under licensing agreements. The gross profit margin decreased to 83.0% in FY95 from 88.1% in FY94, primarily due to a significant increase in technical support costs. Excluding technical support costs, FY95 versus FY94 gross margins would have been 90.3% versus 91.0%.\nPurchased Research and Development - ----------------------------------\nIn connection with the acquisition of NETstor, Inc., the Company recorded a $547,000 expense for purchased research and development in FQ295. In connection with the acquisition of the DataJET product line from NetFRAME Systems, Inc., the Company recorded a $704,000 expense for purchased research and development in FQ395. The technological feasibility of the in-process technology was not yet established at the dates of acquisition and the technology had no alternative use.\nResearch & Development (\"R&D\") - ------------------------------\nR&D expenses increased 69% in FY95 versus FY94. Since sales only increased 31%, R&D as a percentage of sales increased from 9.2% in FY94 to 11.9% in FY95. The increase was due to the Company's significantly broader product line that must be further developed and supported by Cheyenne's engineering and technical personnel. Therefore, additional engineers were added during FY95. The percentage increase in R&D was much greater than the percentage sales increase since developing new and enhancing existing products has become an increasingly more sophisticated and complicated task, requiring even higher manpower levels. The Company believes this investment in a large R&D staff will provide a long-term competitive advantage.\nSelling and Marketing Expenses - ------------------------------\nSelling expenses increased 74% in FY95 over FY94 and increased as a percentage of sales to 32.2% from 24.3%. The increase was mainly due to additional sales and marketing personnel, particularly in Europe, where less sales support from the Company's traditional distributors is anticipated as new distributors enter this market competing more on price and less on service. Also, expanded marketing programs and promotions and increased expenditures on direct sales to end-users of upgrades, etc. were factors in the increase.\nGeneral and Administrative Expenses (G&A) - -----------------------------------------\nG&A expenses include the costs of the finance department, human resources, legal, audit, reception, office and facilities management, rent, utilities, employee benefits, depreciation and amortization, etc. G&A expenses increased 34% in FY95 over FY94, and slightly increased as a percentage of sales to 8.4% from 8.3%. The main factor was increases in legal fees arising from the class action securities litigation and the SEC Formal Private Investigation. Higher depreciation costs were also incurred, due to increases in investments in capital equipment and facilities throughout the world. The cost of an expanded intellectual property protection program and start-up costs in new countries were also factors in increased G&A expenses.\nInterest Income - ---------------\nInterest income for the year increased to $3,437,000 up from $1,668,000 in FY94. The gain was due to increased cash, cash equivalents and investment balances, most of which was generated from operations, and the exercise of stock options. Cash, cash equivalents and investments grew to $71,435,000 at June 30, 1995 from $69,431,000 at the end of FY94. The Company employs the services of three outside fixed income investment managers to manage its portfolio of mainly tax exempt bonds.\nOther Gains - -----------\nIn connection with its sale of Gates F\/A shares, Cheyenne realized a pre-tax gain of $21,232,000 in FQ195 for financial reporting purposes.\nProvision for Income Taxes - --------------------------\nThe provision for income taxes for FY95 was $24,255,000 or 38.6% of pretax income. Excluding the Federal and State increases in the rate due to the excess tax gain on the sale of Gates\/FA shares, the effective income tax rate for FY95 would have been approximately 34%. Such rate is lower than the combined Federal and State statutory rate due mainly to the benefits from the Company's Foreign Sales Corp. (FSC), tax exempt investment income and R&D tax credits.\nEquity in Earnings of Gates\/FA - ------------------------------\nThe equity in earnings of Gates\/FA in FY95 was $85,000 versus $1,572,000 in FY94, because in FQ195, Cheyenne exchanged its 1,348,290 shares of Gates\/FA common stock for 798,996 shares of Arrow common stock. Prior to its sale of the Arrow shares, Cheyenne accounted for its Arrow investment under the cost method of accounting.\nPer Share Data - --------------\nThe net income per share in FY95 was $0.97 per share, including a one time net gain, net of income taxes, of 26 cents per share, as a result of the exchange of Gates\/FA shares for Arrow shares and the write-off of purchased R & D related to the two acquisitions in FY95, versus $0.82 per share in FY94. The weighted average number of common shares and equivalents outstanding decreased to 39,617,000 shares versus 39,877,000 shares last year. The number of shares decreased mainly due to the share repurchase program discussed above, although this was offset by an increase in shares due to stock option exercises, new stock option grants and the increase in share price in FY95.\nYear Ended June 30, 1994 Compared to Year Ended June 30, 1993* - --------------------------------------------------------------\nPlease refer to Table 1 and Table 2.\nRevenues - --------\nCheyenne's revenues increased 72% in FY94 over FY93 to $97,737,000 from $56,694,000. As previously mentioned, the Company's results have been restated for the acquisition in May, 1994 of Bit Software, Inc. accounted for as a pooling of interests. The increase in revenues in FY94 was primarily for the same reasons noted for FY95.\nGross Profit - ------------\nAfter reclassification of technical support expenses to cost of sales in FY94 and FY93, the gross profit margin increased to 88.1% in FY94 from 87.9% in FY93.\nResearch & Development - ----------------------\nAfter reclassification of technical support expenses to cost of sales in FY94 and FY93, R&D expenses increased 87% in FY94 versus FY93. Since sales only increased 72%, R&D as a percentage of sales increased from 8.5% in FY93 to 9.1% in FY94. The increase was due to the Company's significantly broader product line that must be further developed and supported by Cheyenne's engineering and technical personnel. Therefore, additional engineers were added during FY94. The percentage increase in R&D and technical personnel was much greater than the percentage sales increase since developing new and enhancing existing products has become an increasingly more sophisticated and complicated task, requiring even higher manpower levels.\nSelling and Marketing Expenses - ------------------------------\nSelling expenses increased 140% in FY94 over FY93 and increased as a percentage of sales to 24.3% from 17.4%. The increase was mainly due to additional sales and marketing personnel.\nGeneral and Administrative Expenses (G&A) - -----------------------------------------\nG&A expenses increased 21% in FY94 over FY93, but decreased as a percentage of sales to 8.2% from 11.7%. The main reason for the decrease was that many G&A expense items such as rent, telephone and utilities which were fully charged to G&A in past years, were also allocated to R&D and Selling and Marketing expenses in FY94 due to the increased significance of these functions. If this expense allocation change was also made to FY93 amounts, the G&A percentage for FY93 would have been similar to the percentage for FY94. Legal and accounting expenses relative to the Bit acquisition are included in FY94 expenses, and depreciation and amortization in FY94 increased to $1,792,000 versus $802,000 in FY93. The increase was due to expenditures relating mainly to the purchase of computers, test equipment and furniture and fixtures in expanded offices throughout the world.\nInterest Income - ---------------\nInterest income for FY94 increased to $1,668,000 up from $871,000 in FY93. The gain was due to increased cash, cash equivalents and investment balances, most of which was generated from operations, and the exercise of stock options. Cash, cash equivalents and investments grew to $69,431,000 at June 30, 1994 from $36,101,000 at the end of FY93.\nOther Gains - -----------\nDuring FQ494, the Company settled a lawsuit with Legato Systems, Inc. for $649,000, net of related expenses, arising out of an advertisement placed by Legato. In addition, the Company had an insignificant gain from the sale of shares in a minor investment. The gain in FY93 relates to the gain on the sale of a portion of the Company's investment in Gates\/FA.\nProvision for Income Taxes - --------------------------\nThe provision for income taxes for FY94 was $16,742,000 or 34.0% of pretax income. This effective income tax rate was lower than the expected Federal and State effective rate of approximately 38% due mainly to the benefit from the Foreign Sales Corp. (FSC) the Company formed on July 1, 1992, tax exempt investment income and R&D tax credits.\nEquity in Earnings of Gates\/FA - ------------------------------\nThe equity in earnings of Gates\/FA in FY94 was $1,572,000 versus $1,399,000 in FY93.\nPer Share Data - --------------\nThe net income per share in FY94 was $0.82 per share versus $0.53 per share in FY93. The weighted average number of common shares and equivalents outstanding increased to 39,877,000 shares in FY94 versus 38,992,000 shares in FY93. The number of shares increased mainly due to stock option exercises plus shares issued in the Bit Software acquisition.\nLIQUIDITY AND CAPITAL RESOURCES - -------------------------------\nThe Company has no debt and $71,202,000 in cash, cash equivalents and investments as of June 30, 1995. Cash, cash equivalents and investments increased during FY95 due to cash generated from operations of $13,326,000 (net of an approximate $12,000,000 income tax payment related to the sale of Arrow common stock) and $1,520,000 of cash received from the exercise of employee stock options. All accounts payable are current, and accounts receivable collections average about 77 days, versus 72 days at the end of FY94. Net accounts receivables increased 34% versus FY94 on a sales increase of 31%. Cheyenne received approximately $30,324,000 in cash in connection with the sale of 798,996 shares of Arrow common stock in FY95. Cheyenne paid out approximately $30,458,000 of cash in connection with the repurchase of 2,035,000 of its shares in FY95.\nCapital expenditures were $10,974,000 in FY95 versus $5,290,000 in FY94. The largest type of capital expenditure was for computers and software for the Company's increased number of personnel. Cheyenne also made significant investments in equipment, furniture, fixtures, test equipment, new computers, new communications and MIS equipment on a worldwide basis. Further increases in capital expenditures are expected in FY96 as the Company adds additional office space and begins to utilize the facility at 2000 Marcus Avenue noted above. Management believes its current cash and investment position coupled with anticipated cash flow from operations, will be more than adequate to meet anticipated cash requirements in FY96. No financing for current operations will be required during the near future.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data. - -----------------------------------------------------\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on - ------- ------------------------------------------------ Accounting and Financial Disclosure. ------------------------------------\nNone.\nPART III --------\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant. - -------- ---------------------------------------------------\nIncorporated herein by reference is the information to appear under the caption \"Election of Directors\" in the Registrant's definitive proxy statement for its Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission not later than October 30, 1995.\nItem 11.","section_11":"Item 11. Executive Compensation. - -------- -----------------------\nIncorporated herein by reference is the information to appear under the caption \"Executive Compensation\" in the Registrant's definitive proxy statement for its Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission not later than October 30, 1995.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management. - -------- ---------------------------------------------------------------\nIncorporated herein by reference is the information to appear under the caption \"Principal Stockholders; Shares Held by Management\" in the Registrant's definitive proxy statement for its Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission not later than October 30, 1995.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions. - -------- -----------------------------------------------\nIncorporated herein by reference is the information to appear under the caption \"Certain Transactions\" in the Registrant's definitive proxy statement for its Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission not later than October 30, 1995.\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:\n1. Consolidated Financial Statements ---------------------------------\nSee the Index to Consolidated Financial Statements included in Item 8 of this Report for a description of the consolidated financial statements filed as part of this Report.\n2. Financial Statement Schedules ----------------------------- See the Index to Consolidated Financial Statements included in Item 8 of this Report for a description of the financial statement schedules filed as part of this Report.\n3. Exhibits incorporated by reference or filed with this Report:\nNumber Exhibits - ----- --------\n3.1 Certificate of Incorporation of Cheyenne, as amended. (See Exhibit 4.1).\n3.2 Restated By-laws of the Registrant, incorporated herein by reference to Exhibit 2 to Cheyenne's Current Report on Form 8-K, dated December 2, 1986.\n3.3 Restated By-Laws of Cheyenne as of October 7, 1993.\n4.1 Certificate of Incorporation of Cheyenne, incorporated herein by reference to Exhibit 3.1 to Cheyenne's Registration Statement on Form S-1, No. 33-8113 (\"Cheyenne's 1986 Registration Statement\").\n4.2 Certificate of Amendment of the Certificate of Incorporation of Cheyenne (increase in authorized capital stock), incorporated herein by reference to Exhibit 3.1 to Cheyenne's 1986 Registration Statement.\n4.3 Certificate of Amendment of the Certificate of Incorporation of Cheyenne (limited personal liability for Directors for monetary damages) incorporated herein by reference to Exhibit 1 to Cheyenne's Current Report on Form 8-K, dated December 2, 1986.\n4.4 Certificate of Amendment of the Certificate of Incorporation of Cheyenne.\n_10.1.3 Employment Agreement between Cheyenne and Eli Oxenhorn, dated October 1, 1991.\n@10.1.4 Amendment to Employment Agreement between Cheyenne and Eli Oxenhorn, dated October 7, 1993.\n<10.5.2 Employment Agreement between Cheyenne and Alan Kaufman, dated January 1, 1993.\n@10.5.3 Amendment to Employment Agreement between Cheyenne and Alan Kaufman, dated October 7, 1993.\n10.10 Incentive Stock Option Plan, incorporated herein by reference to Exhibit 10.9 to Cheyenne's 1986 Registration Statement.\n10.11 Form of Non-Qualified Stock Option, incorporated herein by reference to Exhibit 10.10 to Cheyenne's 1986 Registration Statement.\n+10.13.3 Letter Agreement, dated September 19, 1990, between Cheyenne and Bartony Realty, for additional space at 55 Bryant Avenue, Roslyn, New York.\n^10.13.4 Letter Agreements, dated February 25, 1991 and June 3, 1991, between Cheyenne and Dr. Richard Linchitz, for additional space at 55 Bryant Avenue, Roslyn, New York.\n_10.13.5 Lease, dated June 30, 1992, between Cheyenne and LKM Expressway Plaza Limited Partnership, as amended.\n<10.13.7 First Modification of Lease Agreement, dated February 1, 1993, between Cheyenne and LKM Expressway Plaza Limited Partnership.\n<10.13.8 Lease, dated August 31, 1993, between Cheyenne and Plaza North Company.\n@10.13.9 Second Modification of Lease Agreement, dated October 25, 1993, between Cheyenne and LKM Expressway Plaza Limited Partnership.\n<10.42.3 Employment Agreement between Cheyenne and Elliot Levine, dated September 1, 1992.\n@10.42.4 Amendment to Employment Agreement between Cheyenne and Elliot Levine, dated October 7, 1993.\n10.42.5 Amendment to Employment Agreement between Cheyenne and Elliot Levine, dated October 24, 1994.\n10.42.6 Amendment to Employment Agreement between Cheyenne and Elliot Levine, dated August 30, 1995.\n10.52 Cheyenne's 1987 Non-Qualified Stock Option Plan, incorporated herein by reference to Cheyenne's Proxy Statement, Commission File No. 1-9189, for the Annual Meeting of Stockholders held on December 1, 1987.\n10.53 Cheyenne's 1989 Incentive Stock Option Plan, incorporated herein by reference to Cheyenne's Proxy Statement, Commission File No. 1-9189, for the Annual Meeting of Stockholders held on November 30, 1989.\n^10.54 Employment Agreement between Cheyenne and ReiJane Huai, dated September 5, 1991.\n@10.54.1 Amendment to Employment Agreement between Cheyenne and ReiJane Huai, dated October 7, 1993.\n^10.55 Deferred Compensation Agreement between Cheyenne and Elliot Levine.\n^10.56 Cheyenne 401(K) Plan.\n@10.57.1 Employment Agreement between Cheyenne and James P. McNiel, dated May 4, 1992.\n@10.57.2 Amendment to Employment Agreement between Cheyenne and James P. McNiel, dated October 7, 1993.\n<10.59 Deferred Compensation Agreement between Cheyenne and ReiJane Huai.\n<10.61 Employment Agreement between Cheyenne and Lisa Merkin, dated September 27, 1993.\n10.62 Cheyenne's 1992 Stock Option Plan for Outside Directors, incorporated by reference to Exhibit C to Cheyenne's Proxy Statement, dated November 5, 1992, Commission File No. 1-9189, for the Annual Meeting of Stockholders held on December 16, 1992.\n<10.63 Cheyenne's 1987 Non-Qualified Stock Option Plan, as amended.\n<10.64 Cheyenne's 1989 Incentive Stock Option Plan, as amended.\n@10.65 Cheyenne Communications, Inc. 1993 Stock Option Plan for Directors.\n@10.66 Consulting and Noncompetition Agreement between Cheyenne and Eli Oxenhorn.\n10.67 Employment Agreement between Cheyenne and Michael B. Adler, Esq., dated July 1, 1995.\n10.68 Employment Agreement between Cheyenne and Yuda Doron, dated June 8, 1995.\n10.69 Employment Agreement between Cheyenne and Doris Granatowski, dated November 16, 1994.\n10.70 Lease Agreement between Cheyenne and Elan Associates, dated December 20, 1994.\n10.71 Cheyenne's 1987 Non-Qualified Stock Option Plan, as amended during the fiscal year ended June 30, 1995.\n10.72 Cheyenne's 1989 Incentive Stock Option Plan, as amended during the fiscal year ended June 30, 1995.\n21. Subsidiaries of the Company.\n23. Consent of KPMG Peat Marwick LLP.\n27. Financial Data Schedule.\n\/ Option information reflects three-for-two stock splits effected on March 25, 1992, April 8, 1993 and March 29, 1994 by Cheyenne.\n+ Incorporated herein by reference to the correspondingly numbered Exhibit to Cheyenne's Annual Report on Form 10-K, for the year ended June 30, 1990.\n^ Incorporated herein by reference to the correspondingly numbered Exhibit to Cheyenne's Annual Report on Form 10-K, for the year ended June 30, 1991.\n_ Incorporated herein by reference to the correspondingly numbered Exhibit to Cheyenne's Annual Report on Form 10-K, for the year ended June 30, 1992.\n< Incorporated herein by reference to the correspondingly numbered Exhibit to Cheyenne's Annual Report on Form 10-K, for the year ended June 30, 1993.\n@ Incorporated herein by reference to the correspondingly numbered Exhibit to Cheyenne's Annual Report on Form 10-K, for the year ended June 30, 1994.\n_________________\n(b) Reports on Form 8-K:\nNone\nIndependent Auditors' Report ----------------------------\nShareholders and Board of Directors Cheyenne Software, Inc. and Subsidiaries:\nWe have audited the consolidated financial statements of Cheyenne Software, Inc. and subsidiaries as listed in the accompanying index. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule 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 Cheyenne Software, Inc. and subsidiaries as of June 30, 1995 and 1994 and the results of their operations and their cash flows for each of the years in the three-year period ended June 30, 1995 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 11(b) to the consolidated financial statements, the Company is a defendant in a class action lawsuit. The ultimate outcome of the litigation cannot presently be determined. Accordingly, no provision for any liability that may result upon adjudication has been recognized in the accompanying consolidated financial statements.\nKPMG PEAT MARWICK LLP\nJericho, New York August 18, 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.\nCHEYENNE SOFTWARE, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\nJune 30, 1995\n(1) Business and Significant Accounting Policies --------------------------------------------\nBusiness --------\nCheyenne Software, Inc. and its subsidiaries (Cheyenne or the Company) are engaged in the development, sale and support of software products for use in microcomputers and computer systems mainly for Local Area Network (LAN) and Wide Area Network (WAN) applications.\nOn July 1, 1992, Cheyenne Software International, Inc., a wholly-owned subsidiary operating as a foreign sales corporation (FSC), was incorporated in the U.S. Virgin Islands. On February 1, 1993, the Company commenced operations of a 95% owned Japanese subsidiary, Cheyenne Software KK, to produce and market certain of the Company's products in Japan. Subsequent to June 30, 1995, the Company acquired the 5% minority interest in Cheyenne Software KK for a nominal amount. During fiscal 1995 and 1994, Cheyenne established wholly owned subsidiaries in France, Germany, the United Kingdom and Canada to provide sales and support of its software products in those countries.\nIn February 1993, Cheyenne acquired the net assets of Applied Programming Technologies, Inc. (APT) for 214,286 shares of the Company's common stock. The acquisition was accounted for as a pooling of interests. Revenues and net earnings of APT for years prior to the acquisition are insignificant in relation to the Company's consolidated results. Accordingly, prior year's consolidated financial statements were not restated for this acquisition.\nOn May 19, 1994, Cheyenne acquired the net assets of Bit Software Inc. (Bit), which develops and markets communication software products, for 140,590 shares of the Company's common stock. The acquisition was accounted for as a pooling of interests. Accordingly, the consolidated financial statements have been restated for all periods prior to the merger. Prior to the merger, Bit used a fiscal year ending December 31. Accordingly, the restated financial statements combine the Company's June 30, 1994 and 1993 financial statements with Bit's June 30, 1994 and December 31, 1993 financial statements, respectively. Bit's revenue for the six months ended December 31, 1993 was $2,675,000, Bit had no transactions during that period which changed stockholders' equity and Bit's results of operations for that period were approximately breakeven, thus there was no adjustment to retained earnings from changing its fiscal year. There were no intercompany transactions between Cheyenne and Bit.\nSeparate results of the combining entities for the years ended June 30, 1994 and 1993 are as follows (in thousands):\n1994 1993 ---- ---- Revenues: Cheyenne $92,863 50,735 Bit 4,874 5,959 ----- -----\n$97,737 56,694 ====== ======\nNet income (loss):\nCheyenne 32,699 20,628 Bit (161) 22 ------ ------\n$32,538 20,650 ======= ======\n(Continued)\nCHEYENNE SOFTWARE, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\nOn December 19, 1994, the Company acquired certain assets and assumed certain liabilities of NETstor, Inc. (NETstor), a developer of Hierarchical Storage Management software products for the UNIX computer platform in the network storage management market, for $1,150,000 of cash and $200,000 of additional future contingent payments. The acquisition has been accounted for as a purchase and the operating results of NETstor are included in the consolidated statement of earnings from the date of acquisition. In connection with the acquisition, the Company recorded a $547,000 expense for purchased research and development and $94,000 of capitalized software which is included in other assets in the accompanying balance sheet and is being amortized on a straight line basis over two years.\nOn March 30, 1995, the Company acquired the DataJET product line and certain other assets and assumed certain liabilities of NetFRAME Systems, Inc. (NetFRAME). DataJET is an image based, high performance software backup product for NetWare file servers. Cheyenne made cash payments aggregating $801,000 for DataJET and will pay royalties to NetFRAME based on the Company's sales of products utilizing the DataJET technology. The acquisition has been accounted for as a purchase. In connection with the acquisition, the Company recorded a $704,000 expense for purchased research and development.\nThe technological feasibility of the in-process technology related to the NETstor and DataJET product acquisitions was not yet established at the dates of acquisition and the technology had no alternative use. The revenues and net earnings for NETstor and the DataJET product for the years prior to the acquisition were insignificant compared to the Company's consolidated results.\nConsolidation Policy --------------------\nThe consolidated financial statements include the accounts of Cheyenne Software, Inc. and its majority-owned subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation.\nRevenue and Profit Recognition ------------------------------\nThe Company recognizes revenue from software licenses and sales and the sale of upgrades or enhancements to customers at delivery provided no significant vendor and post-contract customer support (PCS) obligations remain and collectibility of the resulting receivables is probable. Revenue attributable to PCS included in site-license agreements, primarily consisting of free upgrades for a specified period, is deferred and recognized over the period it is earned. Development fee income is recognized ratably during the software development period and royalty income is recognized when earned. The Company provides a liability for future PCS (primarily telephone customer support) related to revenue recorded, which is included in accrued liabilities in the accompanying balance sheets. The Company also provides for estimated product returns and exchanges, rebates and co-op advertising costs, which are reflected as reductions to accounts receivable in the accompanying balance sheets since the Company grants credits for such items. The provision for returns and exchanges reduces revenues and the provision for co-op advertising is included in sales and marketing expenses. Technical support costs are included in cost of sales.\n(continued)\nCHEYENNE SOFTWARE, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\nCash Equivalents ----------------\nThe Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents.\nInvestments -----------\nEffective July 1, 1994, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\". This Statement requires that investments in such securities be designated as trading, held-to-maturity or available-for-sale. Trading securities are reported at fair value with unrealized gains and losses recognized in earnings. Available-for-sale securities are reported at fair value with unrealized gains and losses included in shareholders' equity. Securities which are classified as held-to-maturity are reported at amortized cost. The adoption of SFAS No.115 had no effect on the Company's consolidated statement of earnings for the year ended June 30, 1995 and the prior years' financial statements were not restated.\nWhile it is the Company's general intent to hold securities until maturity, management will occasionally sell particular securities for cash flow purposes. Accordingly, at June 30, 1995, all the Company's investments have been classified as available for sale.\nInvestment in Gates\/FA ----------------------\nAs discussed in note 2(b), on August 29, 1994 Cheyenne sold its remaining shares of Gates F\/A common stock in exchange for Arrow Electronics, Inc. (Arrow) common stock. Cheyenne accounted for its investment in Gates\/FA using the equity method of accounting, which reflected the cost of the Company's investment adjusted for its proportionate share of the net income or loss and capital transactions of Gates\/FA.\nFixed Assets ------------\nFixed assets are stated at cost. Amortization of leasehold improvements is provided for over the lesser of the term of the related leases or the estimated life of the assets, and depreciation of equipment, furniture and fixtures, and purchased computer software is provided for over their estimated useful lives. The straight-line method is used for financial reporting purposes, and an accelerated method is used, where applicable, for income tax purposes.\nSoftware Development Costs --------------------------\nCosts associated with the development and enhancement of proprietary software are expensed as incurred. Such costs that could be capitalized pursuant to FASB Statement No.86 are immaterial due to the short period of time and minimal costs incurred between when the Company's products reach technological feasibility and when they are available for general release to the public.\nIncome Taxes ------------\nEffective July 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (SFAS 109). SFAS 109 requires deferred tax assets and liabilities to ____ (Continued)\nCHEYENNE SOFTWARE, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\nbe 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 realized 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. Prior year's financial statements were not restated to apply the provisions of SFAS 109 and its adoption did not have a significant impact on the Company's net earnings for the year ended June 30, 1994.\nPursuant to the deferred method under APB 11, which was applied in fiscal 1993, deferred income taxes were recognized for income and expense items that were reported in different years for financial reporting purposes and income tax purposes using the tax rate applicable for the year of the calculation. Under the deferred method, deferred taxes were not adjusted for subsequent changes in tax rates.\nCommon Stock ------------\nCheyenne's Certificate of Incorporation was amended on December 15, 1994 to increase the number of authorized shares of common stock from 50,000,000 to 75,000,000.\nEarnings Per Share ------------------\nNet income per share is based on the weighted average number of shares of common stock and common stock equivalents (stock options) outstanding. All references to number of shares and per share data have been restated for all periods presented to reflect the three-for-two stock splits (note 6).\nForeign Currency Translation ----------------------------\nAssets and liabilities of the Company's foreign subsidiaries have been translated at rates of exchange at the end of the period. Revenues and expenses have been translated at the weighted average rates of exchange in effect during the period. Gains and losses resulting from translation are accumulated as a separate component of stockholders' equity.\nTreasury Stock --------------\nOn February 23, 1995, the Board of Directors of the Company authorized management to purchase up to 4,000,000 shares of the Company's outstanding common stock. Purchases are dictated by overall financial and market conditions and other factors affecting the operations of the Company. During fiscal 1995, Cheyenne purchased 2,035,000 shares of its common stock for approximately $30,458,000, at prices ranging from approximately $13.50 to $17.25 per share. Treasury stock is recorded at cost.\nReclassification ----------------\nCertain prior year information has been reclassified to conform with the 1995 presentation format.\n(Continued)\nCHEYENNE SOFTWARE, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\n(b) On August 29, 1994, Cheyenne exchanged its remaining 1,348,290 shares of Gates\/FA common stock for 798,996 common shares of Arrow, a public company. The transaction qualified as a tax-free exchange and resulted in a pre-tax gain of $21,232,000 for financial reporting purposes. After the transaction, Cheyenne owned approximately 2% of Arrow's outstanding common stock. Accordingly, the Company accounted for its investment in Arrow common stock under the cost method of accounting.\n(c) During the third and fourth quarters of fiscal 1995, Cheyenne sold its Arrow common stock for $30,324,000, which resulted in a net loss of approximately $11,000.\n(3) Investments -----------\nAt June 30, 1995, the amortized costs and related fair values of investments are as follows (in thousands):\nOf the above investments, $15,088, $240 and $40,522 are included in the balance sheet captions \"short-term investments\", \"other assets\" and \"long-term investments\", respectively.\n(Continued)\nCHEYENNE SOFTWARE, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\nThe contractual maturities of debt securities at amortized cost are as follows:\nAt the time the Company implemented SFAS 115 during the first quarter of fiscal 1995, management decided to classify certain investments as held-to-maturity due to its having the positive intent and ability to hold those securities to maturity. During the fourth quarter of fiscal 1995, the Company sold a portion of its securities classified as held-to-maturity prior to their maturity dates to purchase treasury stock. The amortized cost of these securities was approximately $16,683,000 and the net realized gain amounted to approximately $5,000.\nProceeds from the sale of available-for-sale securities (Arrow common stock; note 2(c)) was approximately $30,324,000 in fiscal 1995, which resulted in a net realized loss of approximately $11,000.\nShort-term investments at June 30, 1994 consisted of the following:\nFair Cost value ---- -----\nMunicipal debt $ 39,509 38,887 U.S. Treasury bills and notes 5,849 5,849 Preferred securities 5,704 5,704 Corporate debt 4,485 4,480 Government agencies debt 2,255 2,173 ----- -----\n$ 57,802 57,093 ====== ======\n(Continued)\nCHEYENNE SOFTWARE, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\n(4) Fixed Assets ------------\nFixed assets consist of the following:\nJune 30, ---------------- 1995 1994 ---- ---- (In thousands)\nComputer equipment $ 14,143 6,871 Purchased computer software 3,083 818 Leasehold improvements 1,646 972 Office equipment 2,175 1,508 Furniture and fixtures 2,049 1,559 Trade show equipment 586 317 ------- ------- 23,682 12,045 Less accumulated depreciation and amortization 7,171 3,478 ------- -------\n$ 16,511 8,567 ======= =======\n(5) Income Taxes ------------\nIncome tax expense consists of:\nCurrent Deferred Total ------- -------- ----- (In thousands) 1995: Federal $ 21,249 (906) 20,343 State 3,306 (172) 3,134 Foreign 778 -- 778 ------- ------- -------\n$ 25,333 (1,078) 24,255 ======= ======= =======\n1994: Federal 13,714 720 14,434 State 2,226 82 2,308 ------- ------- -------\n$ 15,940 802 16,742 ======= ======= ======= 1993: Federal 8,942 (34) 8,908 State 1,608 (6) 1,602 ------- ------- -------\n$ 10,550 (40) 10,510 ======= ======= =======\n(Continued)\nCHEYENNE SOFTWARE, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\nThe tax effects of temporary differences that give rise to significant portions of the Company's deferred tax asset and liability at June 30, 1995 and 1994 are as follows:\nManagement of the Company has determined, based upon historical pre-tax earnings and expected taxable income in the future, that it is more likely than not that the Company will realize its deferred tax assets and therefore, no valuation allowance is warranted.\nThe following is a reconciliation of the provision for income taxes to the \"expected\" amounts computed by applying the statutory Federal income tax rate to the Company's income before income taxes:\n(Continued)\nCHEYENNE SOFTWARE, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\n(6) Stock Splits ------------\nOn February 10, 1994, the Company's Board of Directors declared a three-for-two stock split, payable in the form of a 50% stock dividend (1994 Stock Split) which was distributed on March 29, 1994 to holders of record on March 1, 1994. On February 23, 1993, the Company's Board of Directors declared a three-for-two stock split payable in the form of a 50% stock dividend (1993 Stock Split) which was distributed on April 8, 1993 to holders of record on March 12, 1993.\nThe par value of the additional 12,812,458 and 7,792,516 shares of common stock issued in connection with the 1994 and 1993 Stock Splits, respectively, was transferred to common stock from additional paid-in capital. All references to number of shares (except shares authorized), per share data and stock option plan data have been restated for all periods presented to reflect the stock splits.\n(7) Stock Options -------------\n1984 Incentive Stock Option Plan --------------------------------\nCheyenne adopted an incentive stock option plan (1984 Plan) and has reserved 1,687,500 shares for issuance to key employees. Options are not exercisable until two years after their grant and expire if not exercised within five years. The number of shares that may be exercised under the option are limited, on a cumulative basis, to not more than 25% in the first year in which they become exercisable, 50% in the second year, and 100% thereafter. Options may not be granted at less than the fair market value of the underlying shares at date of grant.\n1989 Incentive Stock Option Plan --------------------------------\nCheyenne has adopted an incentive stock option plan (1989 Plan) and has reserved 4,806,250 shares, as amended, for issuance to key employees. Options are not exercisable until two years after their grant and expire if not exercised within five years. The 1989 Plan was amended during fiscal 1995 to increase the maximum term for which options are exercisable from five to seven years. The number of shares that may be exercised under the option are limited, on a cumulative basis, to not more than 25% in the first year in which they become exercisable, 50% in the second year, and 100% thereafter. Options may not be granted at less than the fair market value of the underlying shares at the date of grant. The option price may be paid in cash or with previously owned stock.\nNonqualified Stock Option Plan ------------------------------\nIn December 1987, a nonqualified stock option plan (1987 Plan) was adopted and 4,237,500 common shares have been reserved, as amended, for issuance to officers, directors and employees of the Company at such exercise prices, in such amounts, and upon such terms and conditions, as determined by the Option Committee of the Board of Directors. Option prices may be paid in cash or with previously owned common stock.\nThe 1987 Plan was amended in fiscal 1995 to include consultants as eligible for grants under the 1987 Plan and the maximum term for which options are exercisable was increased from five to seven years.\nCHEYENNE SOFTWARE, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\nDirectors' Plan ---------------\nIn fiscal 1993, a stock option plan for outside directors (Directors' Plan) was adopted and 405,000 common shares have been reserved for issuance to members of the Board of Directors who are not employees (Outside Directors). Pursuant to the plan, each Outside Director will receive options to purchase 16,875 shares of common stock on January 1 of each calendar year that such director serves the Company in such capacity, commencing January 1, 1993. All stock options granted under the Directors' Plan are immediately exercisable. The exercise price per share of each option will be equal to the fair market value of the shares of common stock on the date of grant. Each option granted under the Directors' Plan expires upon the earlier of five years following the date of grant or one year following the date an Outside Director ceases to serve in such capacity, provided that the option is exercised within the five years after the date of its grant. No grants may be made under the Directors' Plan subsequent to the earlier to occur of January 2, 1997 or the issuance of common stock or exercise of options pursuant to the Directors' Plan equal to the maximum number of shares of common stock reserved for under the Directors' Plan.\nOther Stock Options -------------------\nDuring the year ended June 30, 1993, certain key personnel exercised nonqualified stock options to purchase 388,125 shares of common stock at $1.19 per share. In addition, during the years ended June 30, 1994 and 1993, certain directors exercised nonqualified stock options to purchase 67,500 and 286,875 shares of common stock, respectively, at $1.41 per share.\nA summary of activity under the 1984 Plan, 1989 Plan, the 1987 Plan, and the Directors' Plan, which have all been restated to reflect the stock splits, is as follows:\n(Continued)\nCHEYENNE SOFTWARE, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\nAt June 30, 1995, 1,129,151 options were exercisable and options to purchase 1,831,728 shares were available for future grant under all stock option arrangements. The exercise prices of all nonqualified stock options were equal to the fair market value of the underlying shares at date of grant.\n(8) Operating Leases ----------------\nCheyenne leases office facilities under noncancellable operating leases. The leases expire through 2003 and are subject to escalation clauses for taxes and other expenses. Future minimum rentals required as of June 30, 1995 are as follows:\nYear ending June 30: 1996 $ 2,579,000 1997 3,368,000 1998 3,204,000 1999 2,920,000 2000 2,274,000 Thereafter 3,496,000 -----------\n$ 17,841,000 ===========\nRent expense was $1,995,000, $1,121,000 and $592,000 for the years ended June 30, 1995, 1994 and 1993, respectively.\n(9) Employee Benefit Plans ----------------------\nEffective May 1, 1991, Cheyenne established a voluntary savings and defined contribution plan under Section 401(k) of the Internal Revenue Code. This plan covers all employees meeting certain eligibility requirements. For the years ended June 30, 1995, 1994 and 1993, Cheyenne provided a matching contribution of $242,000, $142,000 and $82,000, respectively, which was equal to 25% of each participant's contribution up to a maximum of 16% of annual compensation. Employees are 100% vested in their own contributions and become fully vested in the employer contributions after 3 years. The Company does not provide its employees any other postretirement or postemployment benefits.\n(10) Business and Credit Concentrations and Export Sales ---------------------------------------------------\nThe majority of the Company's customers are original equipment manufacturers and distributors of computer equipment and software. There was one customer that accounted for greater than 10% of the Company's revenues in fiscal 1995 (14%), fiscal 1994 (17%) and fiscal 1993 (14%). At June 30, 1995, there were four customers which accounted for more than five percent of the Company's outstanding accounts receivable, aggregating 40% of accounts receivable.\n(Continued)\nCHEYENNE SOFTWARE, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\nExport sales by geographic area are as follows (in thousands):\n1995 1994 1993 ---- ---- ----\nEurope $48,802 35,156 20,584 Canada 2,219 3,159 2,052 Rest of World 8,580 4,099 1,900 ------ ------ ------\n$59,601 42,414 24,536 ====== ====== ======\n(11) Legal and Other Matters -----------------------\n(a) In fiscal 1994, the Company received $649,000 in settlement of a lawsuit, net of related expenses, from Legato Corp. arising out of an advertisement placed by Legato, which is included in other gains in the accompanying consolidated statement of earnings.\n(b) In June 1994, a securities fraud class action complaint was filed against the Company and several of its officers and directors. The actions allege securities fraud claims under Section 10(b) and 20 of the Securities Exchange Act of 1934 whereby it was alleged that the Company and the individual defendants made misrepresentations and omissions to the public which caused the Company's stock to be artificially inflated, and seek compensatory damages on behalf of all the shareholders who purchased shares between approximately January 24, 1994 and approximately June 17, 1994, as well as attorneys' fees and costs. In addition, there is a shareholder derivative complaint alleging that certain officers and directors breached their fiduciary obligations to the Company. The defendants deny any and all liability and intend to vigorously defend against the claims. The ultimate outcome of the litigation cannot presently be determined. Accordingly, no provision for any liability that may result upon adjudication has been recognized in the accompanying consolidated financial statements.\nOn or about April 14, 1995, the Securities and Exchange Commission (SEC) advised the Company that it had issued a Formal Order of Private Investigation of the Company related to possible violations of federal securities laws, which was the continuation of an informal inquiry which began in June 1994. The Company has been cooperating with the SEC.\n(c) In May 1995, JWANCO, Inc. (formerly known as Bit Software, Inc.), and various related individuals filed an action against the Company, Cheyenne Communications, Inc., a wholly owned subsidiary of the Company, and several of its officers, directors and employees. The action alleges breach of contract, fraud, wrongful termination, negligent infliction of emotional distress and a number of other related torts. The essence of the allegations is that the defendants breached agreements and defrauded JWANCO, Inc., and the individual plaintiffs in connection with the Company's acquisition of certain assets and assumption of certain liabilities of Bit Software, Inc. on May 19, 1994. These allegations are substantially similar to those described in note 11(b) above. In addition, the complaint alleges, on behalf of one individual plaintiff only, wrongful termination and a variety of other causes of action relating to his employment and termination of the employment by the Company. Management of the Company, based on advice from its legal counsel, does not believe that the ultimate resolution of this lawsuit will have a material adverse effect on the financial position or results of operations of the Company.\nCHEYENNE SOFTWARE, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\n(d) In May 1995, Personal Computer Peripherals Corporation (PCPC) filed an action against the Company and five other defendants alleging patent infringement. Cheyenne has filed its answer to the complaint in which it denied patent infringement on its part and in which it asserted affirmative defenses and counterclaims. The relief sought by the complaint is a preliminary and permanent injunction, a judgment of willful infringement, an accounting of sales, revenues and profits, unspecified damages to be trebled, reasonable attorney's fees and other related costs. Management of the Company, based on advice from its legal counsel, does not believe that the ultimate resolution of this lawsuit will have a material adverse effect on the financial position or results of operations of the Company.\n(12) Interim Financial Information (Unaudited) -----------------------------------------\nThe following is a summary of selected quarterly financial data for the fiscal years ended June 30, 1995 and 1994 (in thousands, except per share data):\n(1) Uncollectible amounts written off, net of recoveries.\nS-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.\nCHEYENNE SOFTWARE, INC.\nDate: September 27, 1995 By:\/s\/ ReiJane Huai --------------------------------- ReiJane Huai, Chairman of the Board, President and Chief Executive Officer (principal executive officer)\nDate: September 27, 1995 By:\/s\/ Elliot Levine --------------------------------- Elliot Levine, Executive Vice President, Senior Financial Officer and Treasurer (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.\nSeptember 27, 1995 \/s\/ Rino Bergonzi -------------------------------------- Rino Bergonzi, Director\nSeptember 27, 1995 \/s\/ Richard F. Kramer -------------------------------------- Richard F. Kramer, Director\nSeptember 27, 1995 \/s\/ Bernard D. Rubien -------------------------------------- Bernard D. Rubien, Director\nSeptember 27, 1995 \/s\/ Ginette Wachtel -------------------------------------- Ginette Wachtel, Director","section_15":""}
{"filename":"41077_1995.txt","cik":"41077","year":"1995","section_1":"ITEM 1. BUSINESS Georgia-Pacific Corporation (together with its subsidiaries herein referred to as the \"Corporation\") was organized in 1927 under the laws of the State of Georgia.\nInformation pertaining to the Corporation's business, including industry segments, set forth under the captions \"Building Products,\" \"Pulp and Paper,\" \"Management's Discussion and Analysis,\" Note 2 of the Notes to Financial Statements, \"Sales and Operating Profits by Industry Segment,\" and \"Operating Statistics\" of the Corporation's 1995 Annual Report to Shareholders is incorporated herein by reference.\nTIMBER RESOURCES Information pertaining to the Corporation's timber resources set forth under the captions \"Building Products - Forest Resources\" and \"Operating Statistics\" of the Corporation's 1995 Annual Report to Shareholders is incorporated herein by reference.\nMINERAL RESOURCES Information pertaining to the Corporation's gypsum resources set forth under the caption \"Building Products - Gypsum Products\" of the Corporation's 1995 Annual Report to Shareholders is incorporated herein by reference.\nENVIRONMENT Information pertaining to environmental issues and the Corporation's expenditures for pollution control facilities and equipment set forth under the captions \"Environment,\" \"Management's Discussion and Analysis - Investment Activities\" and Note 10 of the Notes to Financial Statements of the Corporation's 1995 Annual Report to Shareholders is incorporated herein by reference.\nEMPLOYEES Information pertaining to persons employed by the Corporation set forth under the caption \"Management's Discussion and Analysis - Other\" of the Corporation's 1995 Annual Report to Shareholders is incorporated herein by reference.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES Information pertaining to the number of manufacturing facilities as of December 31, 1995 and capacity and historical production volumes as of December 31, 1995 by plant type set forth under the caption \"Operating Statistics\" of the Corporation's 1995 Annual Report to Shareholders is incorporated herein by reference.\nInformation concerning the Corporation's timber and mineral resources is presented under Item 1 of this Form 10-K.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS The information contained in Note 10 of the Notes to Financial Statements of the Corporation's 1995 Annual Report to Shareholders (\"Note 10\") is incorporated herein by reference.\nENVIRONMENTAL PROCEEDINGS Pursuant to the rules of the Securities and Exchange Commission, the Corporation is required to describe environmental proceedings to which a governmental authority is a party and which involve potential monetary sanctions, exclusive of interest and costs, of at least $100,000. Following are descriptions of the legal proceedings meeting this criteria.\nAs last reported in the Corporation's Quarterly Report on Form 10-Q for the quarter ended March 31, 1995, about July 20, 1992, the Corporation received from the Environmental Protection Agency (\"EPA\") a Notice of Violation (\"NOV\") alleging past violations of a construction permit regulating air emissions at the Corporation's Gaylord, Michigan facility. On March 31, 1993, the Corporation received a second NOV alleging past violations at the same facility. In addition, the State of Michigan has issued three letters alleging violations of the facility's opacity limits. The Corporation recently reached an agreement in principle with the U. S. Department of Justice, the EPA, and the State of Michigan to settle these claims and all others relating to the facility, which will entail payment of a $700,000 fine and the installation by the Corporation of air emission controls at the Gaylord facility. The Corporation is presently negotiating the final terms and conditions of the Consent Agreement.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS During the fourth quarter of 1995, there were no matters 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 COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Information with respect to the Market for the Corporation's Common Equity and Related Stockholder Matters set forth under the captions \"Highlights,\" Note 12 of the Notes to Financial Statements and \"Investor Information\" of the Corporation's 1995 Annual Report to Shareholders is incorporated herein by reference. As of the close of business on March 7, 1996, the Corporation's common stock price was $67.25, and there were approximately 42,900 record holders of its Common Stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA Information with respect to Selected Financial Data set forth under the captions \"Selected Financial Data - Operations\" and \"Selected Financial Data - Financial Position, End of Year\" of the Corporation's 1995 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 Information with respect to Management's Discussion and Analysis set forth under the caption \"Management's Discussion and Analysis\" of the Corporation's 1995 Annual Report to Shareholders is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Information with respect to Financial Statements and Supplementary Data as set forth under the captions \"Statements of Income,\" \"Statements of Cash Flows,\" \"Balance Sheets,\" \"Statements of Shareholders' Equity,\" \"Notes to Financial Statements\" and \"Report of Independent Public Accountants\" of the Corporation's 1995 Annual Report to Shareholders is incorporated herein by reference.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE There have been no changes in or disagreements with accountants on accounting and financial disclosure within the twenty-four months prior to the date of the most recent financial statements filed as part of the 1995 Annual Report on Form 10-K.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information with respect to Directors of the Corporation and disclosure pursuant to Item 405 of Regulation S-K is incorporated herein by reference to the Corporation's Notice of 1996 Annual Meeting of Shareholders and Proxy Statement expected to be dated March 22, 1996.\nExecutive Officers of the Registrant\nThe executive officers of the Corporation are as follows:\nAlston D. Correll has been Chief Executive Officer of Georgia-Pacific since May 1993, and Chairman since December 1993. He served as President and Chief Operating Officer of the Corporation from August 1991 until May 1993, and President and Chief Executive Officer from May 1993 until December 1993. Mr. Correll served as Executive Vice President - Pulp and Paper from April 1989 through July 1991.\nW. E. Babin has been Executive Vice President - Pulp and Paper since January 1993. Prior to that time, Mr. Babin served as Executive Vice President - Pulp and Paperboard from May 1992 to January 1993, Senior Vice President - Containerboard and Packaging from January 1991 to May 1992, and Group Vice President - Containerboard and Packaging from February 1990 to January 1991.\nJohn F. McGovern has been Executive Vice President - Finance since September 1995, and Chief Financial Officer since February 1994. He served as Senior Vice President - Finance from January 1993 until September 1995, Vice President - Finance from 1983 until January 1993, and Treasurer from March 1992 to October 1993.\nDavis K. Mortensen has been Executive Vice President - Building Products since 1989.\nJames E. Bostic, Jr. has been Senior Vice President - Environmental, Government Affairs and Communications since February 1995. Prior to that time, he served as Group Vice President - Communication Papers from April 1992 through January 1995, Group Vice President - Butler Paper and Mail-Well from January 1992 to April 1992, and Vice President - Butler Paper and Mail-Well from January 1991 to January 1992. In addition, Mr. Bostic was General Manager, Commercial Products and Systems Division, from 1990 to 1991.\nGerard R. Brandt has been Senior Vice President - Human Resources since February 1995. Prior to that time, he served as Group Vice President - Packaged Products from July 1993 through January 1995, Group Vice President - Butler Paper and Mail-Well from May 1992 to July 1993, Vice President - Butler Paper and Mail- Well from April 1992 to May 1993, and Vice President - Communication Papers Manufacturing from May 1990 to April 1992.\nDonald L. Glass has been Senior Vice President - Building Products Manufacturing and Sales since 1991 and served as Senior Vice President - Building Products Manufacturing from 1989 to 1991.\nJames F. Kelley joined the Corporation as Senior Vice President - Law and General Counsel in December 1993. Prior to that time, he was a partner in the law firm of Jones, Day, Reavis & Pogue.\nClint M. Kennedy has been Senior Vice President - Pulp, Bleached Board and Logistics since February 1995. Prior to that time, he served as Group Vice President - Pulp and Bleached Board from July 1992 through January 1995 and Vice President - Sales and Marketing, Pulp and Bleached Board from May 1990 to July 1992.\nMaurice W. Kring has been Senior Vice President - Containerboard and Packaging since February 1994. Prior to that time, he served as Group Vice President - Containerboard and Packaging from July 1993 until February 1994 and Group Vice President - Packaged Products from 1987 to July 1993.\nGeorge A. MacConnell has been Senior Vice President - Distribution and Millwork since February 1993 and served as Senior Vice President - Distribution and Specialty Operations from 1989 to February 1993.\nJohn F. Rasor has been Senior Vice President - Forest Resources since February 1995. Prior to that time, he served as Group Vice President - Forest Resources from May 1992 through January 1995, Group Vice President - Timber from January 1992 to May 1992, Vice President - Forest Resources from 1991 to January 1992, and Vice President - Eastern Wood Products Manufacturing Division from 1989 to 1991.\nDavid W. Reynolds has been Senior Vice President - Administration since February 1995. Prior to that time, he served as Senior Vice President - Human Resources and Administration from 1989 through January 1995.\nLee M. Thomas has been Senior Vice President - Paper since February 1995. Prior to that time, he served as Senior Vice President - Environmental, Government Affairs and Communications from February 1994 through January 1995, and Senior Vice President - Environmental and Government Affairs from March 1993 through January 1994. Prior to joining the Corporation in March 1993, Mr. Thomas served as Chairman and Chief Executive Officer of Law Companies Environmental Group, Inc. (an engineering and environmental services company) from 1989 until March 1993.\nJames E. Terrell was elected Vice President of the Corporation in January 1991 and has served as Controller since 1989.\nThe Corporation's Board of Directors elects officers of the Corporation who hold the offices to which they are elected until the next annual organizational meeting of the Board. The Compensation Committee determines the compensation of officers who are also directors of the Corporation, and makes recommendations to the Board of Directors regarding compensation for all other officers of the Corporation. The amount of compensation is then determined by the Board of Directors based on such recommendation. There are no other arrangements or understandings between the respective officers and any other person pursuant to which such officers are elected.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION Information with respect to Executive Compensation is incorporated herein by reference to the Corporation's Notice of 1996 Annual Meeting of Shareholders and Proxy Statement expected to be dated March 22, 1996.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Information with respect to Security Ownership of Certain Beneficial Owners and Management is incorporated herein by reference to the Corporation's Notice of 1996 Annual Meeting of Shareholders and Proxy Statement expected to be dated March 22, 1996.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Information with respect to Certain Relationships and Related Transactions is incorporated herein by reference to the Corporation's Notice of 1996 Annual Meeting of Shareholders and Proxy Statement expected to be dated March 22, 1996.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) The following documents are filed as a part of this Annual Report for Georgia-Pacific Corporation and subsidiaries:\n(1) The Financial Statements, Notes to Financial Statements and the Report of Independent Public Accountants dated February 9, 1996 listed below are incorporated herein by reference to the Corporation's 1995 Annual Report to Shareholders:\nStatements of Income for the years ended December 31, 1995, 1994 and 1993.\nStatements of Cash Flows for the years ended December 31, 1995, 1994 and 1993.\nBalance Sheets as of December 31, 1995 and 1994.\nStatements of Shareholders' Equity for the years ended December 31, 1995, 1994 and 1993.\nNotes 1 through 12 of the Notes to Financial Statements\nReport of Independent Public Accountants\n(2) Financial Statement Schedules:\nReport of Independent Public Accountants as to Schedule\nII Valuation and Qualifying Accounts for the years ended December 31, 1995, 1994 and 1993.\nSchedules other than that listed above are omitted because they are not required, are inapplicable or the information is otherwise shown in the financial statements or notes thereto.\n(3) Exhibits\nThe exhibits required to be filed as part of this Annual Report on Form 10-K are as follows:\nNUMBER DESCRIPTION\n2.1 Asset Purchase Agreement between Domtar Inc. and Georgia-Pacific Corporation dated November 8, 1995 (Filed as Exhibit 2.1 to the Corporation's Quarterly Report on Form 10-Q for the quarter ended September 30, 1995, and incorporated herein by this reference thereto).\n2.2 Share Purchase Agreement between Domtar Industries Inc., Domtar Gypsum Inc., Domtar Inc. and Georgia- Pacific Corporation dated November 8, 1995 (Filed as Exhibit 2.2 to the Corporation's Quarterly Report on Form 10-Q for the quarter ended September 30, 1995, and incorporated herein by this reference thereto).\n3.1 Articles of Incorporation, restated as of October 30, 1989 (Filed as Exhibit 3.1 to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1994, and incorporated herein by this reference thereto).\n3.2 Bylaws as amended to date (Filed as Exhibit 3.2 to the Corporation's Quarterly Report on Form 10-Q for the quarter ended March 31, 1994, and incorporated herein by this reference thereto).\n4.1(i) Credit Agreement, dated as of June 30, 1993, among Georgia-Pacific Corporation, as borrower, the lenders named therein, and Bank of America National Trust and Savings Association, as agent (Filed as Exhibit 4.1(i) to the Corporation's Quarterly Report on Form 10-Q for the quarter ended June 30, 1993, and incorporated herein by this reference thereto).\n4.1(ii) Amendment No. 1 to Credit Agreement, dated as of November 30, 1994, among Georgia-Pacific Corporation, the lenders named therein and Bank of America National Trust and Savings Association, as agent (Filed as Exhibit 4.1(ii) to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1994, and incorporated herein by this reference thereto).\n4.2 In reliance upon Item 601(b)(4)(iii) of Regulation S-K, various instruments defining the rights of holders of long-term debt of the Corporation are not being filed herewith because the total of securities authorized under each such instrument does not exceed 10% of the total assets of the Corporation. The Corporation hereby agrees to furnish a copy of any such instrument to the Commission upon request.\n4.3 Rights Agreement, dated as of July 31, 1989, between Georgia-Pacific Corporation and First Chicago Trust Company of New York, with form of Rights Certificate attached as Exhibit A (Filed as Exhibit 4.3 to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1994, and incorporated herein by the reference thereto).\n4.4(i) Indenture, dated as of March 1, 1983, between Georgia- Pacific Corporation and The Chase Manhattan Bank (National Association), Trustee (Filed as Exhibit 4(a) to the Corporation's Registration Statement on Form S-3 dated May 9, 1990, and incorporated herein by this reference thereto).\n4.4(ii) First Supplemental Indenture, dated as of July 27, 1988, among Georgia-Pacific Corporation, The Chase Manhattan Bank (National Association), Trustee, and Morgan Guaranty Trust Company of New York (Filed as Exhibit 4.4(ii) to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1992, and incorporated herein by this reference thereto).\n10.1 Directors Group Life Insurance Program (Filed as Exhibit 10.1 to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1993, and incorporated herein by this reference thereto).*\n10.2(i) Executive Retirement Agreement (Officers Retirement Plan) (Filed as Exhibit 10.2(i) to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1991, and incorporated herein by this reference thereto).*\n10.2(ii) Amendment No. 1 to Executive Retirement Agreement (Officers Retirement Plan) (Filed as Exhibit 10.2(ii) to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1991, and incorporated herein by this reference thereto).*\n10.2(iii) Executive Retirement Agreement (Officers Retirement Plan), as amended, as in effect after January 1, 1992 (Filed as Exhibit 10.2(iii) to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1992, and incorporated herein by this reference thereto).*\n*Management contract or compensatory plan or arrangement required to be filed pursuant to Item 14(c) of this Annual Report on Form 10-K.\n10.2(iv) Executive Retirement Agreement of James F. Kelley (entered into December 6, 1993). (Filed as Exhibit 10.2 (v) to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1994, and incorporated herein by this reference thereto).*\n10.3(i) Key Salaried Employees Group Insurance Plan - Pre-1987 Group (As Amended and Restated Effective January 1, 1987) (Filed as Exhibit 10.3(i) to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1991, and incorporated herein by this reference thereto).*\n10.3(ii) Amendment No. 1 (Effective January 1, 1991) to the Key Salaried Employees Group Insurance Plan - Pre-1987 Group (As Amended and Restated Effective January 1, 1987) (Filed as Exhibit 10.3(ii) to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1991, and incorporated herein by this reference thereto).*\n10.3(iii) Key Salaried Employees Group Insurance Plan - Post-1986 Group (Effective January 1, 1987) (Filed as Exhibit 10.3(iii) to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1991, and incorporated herein by this reference thereto).*\n10.3(iv) Amendment No. 1 (Effective January 1, 1991) to the Key Salaried Employees Group Insurance Plan - Post-1986 Group (Effective January 1, 1987) (Filed as Exhibit 10.3(iv) to the Corporation's Annual Report on Form 10- K for the year ended December 31, 1991, and incorporated herein by this reference thereto).*\n10.3(v) Amendment No. 2 to the Key Salaried Employees Group Insurance Plan - Post-1986 Group (effective January 1, 1987) (Filed as Exhibit 10.3(v) to the Corporation's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993, and incorporated herein by this reference thereto).*\n*Management contract or compensatory plan or arrangement required to be filed pursuant to Item 14(c) of this Annual Report on Form 10-K.\n10.3(vi) Amendment No. 3 to the Key Salaried Employees Group Insurance Plan - Post-1986 Group (effective August 1, 1994) (Filed as Exhibit 10.3(vi) to the Corporation's Quarterly Report on Form 10-Q for the quarter ended June 30, 1994, and incorporated herein by this reference thereto).*\n10.4 Directors Retirement Program (Filed as Exhibit 10.4 to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1991, and incorporated herein by this reference thereto).*\n10.5(i) 1990 Long-Term Incentive Plan (Filed as Exhibit 10.8 to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1990, and incorporated herein by this reference thereto).*\n10.5(ii) Amendment No. 1 to 1990 Long-Term Incentive Plan (Filed as Exhibit 10.8(ii) to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1991, and incorporated herein by this reference thereto).*\n10.6 1994 Management Incentive Plan (Filed as Exhibit 10.11 to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1993, and incorporated herein by this reference thereto).*\n10.7 1995 Economic Value Incentive Plan (Filed as Exhibit 10.10 to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1994, and incorporated herein by this reference thereto).*\n10.8(i) 1995 Shareholder Value Incentive Plan (Filed as Exhibit 10.11(i) to the Corporation's Annual Report on Form 10- K for the year ended December 31, 1994, and incorporated herein by this reference thereto).*\n10.8(ii) Amendment No. 1 to 1995 Shareholder Value Incentive Plan.*\n10.8(iii) Form of Shareholder Value Incentive Stock Option (Filed as Exhibit 10.11(ii) to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1994, and incorporated herein by this reference thereto).*\n*Management contract or compensatory plan or arrangement required to be filed pursuant to Item 14(c) of this Annual Report on Form 10-K.\n10.9(i) Outside Directors Stock Plan, adopted March 17, 1995 (Filed as Exhibit 10.12 to the Corporation's Quarterly Report on Form 10-Q for the quarter ended March 31, 1995, and incorporated herein by this reference thereto).*\n10.9(ii) Receivables Purchase Agreement dated as of June 1, 1990, among Georgia-Pacific Corporation, as the Seller, and Asset Securitization Cooperative Corporation, Corporate Asset Funding Company, Inc., Falcon Asset Securitization Corporation and Matterhorn Capital Corporation, as the Purchasers, and Canadian Imperial Bank of Commerce, as the Administrative Agent (Filed as Exhibit 10.17(i) to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1990, and incorporated herein by this reference thereto).\n10.9(iii) Receivables Purchase Agreement dated as of June 1, 1990, among Georgia-Pacific Corporation, as the Seller, and Canadian Imperial Bank of Commerce, Citibank, N.A. and The First National Bank of Chicago, as the Secondary Purchasers, and Matterhorn Capital Corporation and Canadian Imperial Bank of Commerce, as the Administrative Agent (Filed as Exhibit 10.17(ii) to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1990, and incorporated herein by this reference thereto).\n10.10(i) Agreement, effective as of March 15, 1993, among Georgia-Pacific Corporation, Hercules Incorporated, and Lee M. Thomas (Filed as Exhibit 10.13 to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1994, and incorporated herein by this reference thereto).\n10.10(ii) First Addendum to Agreement, effective as of February 1, 1995, among Georgia-Pacific Corporation, Hercules Incorporated, and Lee M. Thomas (Filed as Exhibit 10.13(ii) to the Corporation's Quarterly Report on Form 10-Q for the quarter ended March 31, 1995, and incorporated herein by this reference thereto).\n11 Statements of Computation of Per Share Earnings.\n12 Statements of Computation of Ratio of Earnings to Fixed Charges.\n*Management contract or compensatory plan or arrangement required to be filed pursuant to Item 14(c) of this Annual Report on Form 10-K.\n13 Portions of Georgia-Pacific Corporation's 1995 Annual Report to Shareholders. Such Report is not deemed to be filed with the Commission as part of this Annual Report on Form 10-K, except for the portions thereof expressly incorporated by reference.\n21 Subsidiaries.\n23 Consent of Independent Public Accountants.\n24 Powers of Attorney.\n27 Financial Data Schedule.\n99 Parts 2 and 3 of Article 11 of the Georgia Business Corporation Code (successor to Articles 11 and 11A of the Georgia Business Corporation Code and Section 14-2- 230 through 14-2-235 and 14-2-235 through 14-2-238 of the Official Code of Georgia Annotated) (Filed as Exhibit 28 to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1990, and incorporated herein by this reference thereto).\n(b) Reports on Form 8-K\nThe Corporation filed Current Reports on Form 8-K dated October 20, 1995, in which it reported under Item 5 - \"Other Events,\" December 8, 1995, in which it reported under Item 5 - \"Other Events\" and Item 7 - \"Financial Statements, Pro Forma Financial Information and Exhibits,\" and December 12, 1995, in which it reported under Item 5 - \"Other Events.\"\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nGEORGIA-PACIFIC CORPORATION (Registrant)\nBy: \/s\/ A. D. Correll -------------------------- (A. D. Correll, Chairman and Chief Executive Officer)\nDate: March 12, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, 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*As Attorney-in-Fact for the Directors or Officers by whose names an asterisk appears.\nReport of Independent Public Accountants as to Schedule\nTo the Shareholders and the Board of Directors of Georgia-Pacific Corporation:\nWe have audited in accordance with generally accepted auditing standards, the financial statements of Georgia-Pacific Corporation incorporated by reference in this Form 10-K, and have issued our report thereon dated February 9, 1996. Our audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. Schedule II is the responsibility of the Corporation'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.\n\/S\/ARTHUR ANDERSEN LLP ARTHUR ANDERSEN LLP Atlanta, Georgia February 9, 1996\nGEORGIA-PACIFIC CORPORATION AND SUBSIDIARIES SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994, AND 1993\n(Millions)\n(1)Includes $2 million deducted with the sale of Butler Paper Company assets and $9 million of accounts written off. (2)Recoveries of accounts previously written off. (3)Accounts written off.\nGEORGIA-PACIFIC CORPORATION\nINDEX TO EXHIBITS FILED WITH THE ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1995\nNUMBER DESCRIPTION\n2.1 Asset Purchase Agreement between Domtar Inc. and Georgia-Pacific Corporation dated November 8, 1995 (Filed as Exhibit 2.1 to the Corporation's Quarterly Report on Form 10-Q for the quarter ended September 30, 1995, and incorporated herein by this reference thereto).\n2.2 Share Purchase Agreement between Domtar Industries Inc., Domtar Gypsum Inc., Domtar Inc. and Georgia-Pacific Corporation dated November 8, 1995 (Filed as Exhibit 2.2 to the Corporation's Quarterly Report on Form 10-Q for the quarter ended September 30, 1995, and incorporated herein by this reference thereto).\n3.1 Articles of Incorporation, restated as of October 30, 1989 (Filed as Exhibit 3.1 to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1994, and incorporated herein by this reference thereto).\n3.2 Bylaws as amended to date (Filed as Exhibit 3.2 to the Corporation's Quarterly Report on Form 10-Q for the quarter ended March 31, 1994, and incorporated herein by this reference thereto).\n4.1(i) Credit Agreement, dated as of June 30, 1993, among Georgia-Pacific Corporation, as borrower, the lenders named therein, and Bank of America National Trust and Savings Association, as agent (Filed as Exhibit 4.1(i) to the Corporation's Quarterly Report on Form 10-Q for the quarter ended June 30, 1993, and incorporated herein by this reference thereto).\n4.1(ii) Amendment No. 1 to Credit Agreement, dated as of November 30, 1994, among Georgia-Pacific Corporation, the lenders named therein and Bank of America National Trust and Savings Association, as agent (Filed as Exhibit 4.1(ii) to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1994, and incorporated herein by this reference thereto).\n4.2 In reliance upon Item 601(b)(4)(iii) of Regulation S-K, various instruments defining the rights of holders of long-term debt of the Corporation are not being filed herewith because the total of securities authorized under each such instrument does not exceed 10% of the total assets of the Corporation. The Corporation hereby agrees to furnish a copy of any such instrument to the Commission upon request.\n4.3 Rights Agreement, dated as of July 31, 1989, between Georgia-Pacific Corporation and First Chicago Trust Company of New York, with form of Rights Certificate attached as Exhibit A (Filed as Exhibit 4.3 to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1994, and incorporated herein by the reference thereto).\n4.4(i) Indenture, dated as of March 1, 1983, between Georgia-Pacific Corporation and The Chase Manhattan Bank (National Association), Trustee (Filed as Exhibit 4(a) to the Corporation's Registration Statement on Form S-3 dated May 9, 1990, and incorporated herein by this reference thereto).\n4.4(ii) First Supplemental Indenture, dated as of July 27, 1988, among Georgia-Pacific Corporation, The Chase Manhattan Bank (National Association), Trustee, and Morgan Guaranty Trust Company of New York (Filed as Exhibit 4.4(ii) to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1992, and incorporated herein by this reference thereto).\n10.1 Directors Group Life Insurance Program (Filed as Exhibit 10.1 to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1993, and incorporated herein by this reference thereto).\n10.2(i) Executive Retirement Agreement (Officers Retirement Plan) (Filed as Exhibit 10.2(i) to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1991, and incorporated herein by this reference thereto).\n10.2(ii) Amendment No. 1 to Executive Retirement Agreement (Officers Retirement Plan) (Filed as Exhibit 10.2(ii) to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1991, and incorporated herein by this reference thereto).\n10.2(iii) Executive Retirement Agreement (Officers Retirement Plan), as amended, as in effect after January 1, 1992 (Filed as Exhibit 10.2(iii) to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1992, and incorporated herein by this reference thereto).\n10.2(iv) Executive Retirement Agreement of James F. Kelley (entered into December 6, 1993). (Filed as Exhibit 10.2(v) to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1994, and incorporated herein by this reference thereto).\n10.3(i) Key Salaried Employees Group Insurance Plan - Pre-1987 Group (As Amended and Restated Effective January 1, 1987) (Filed as Exhibit 10.3(i) to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1991, and incorporated herein by this reference thereto).\n10.3(ii) Amendment No. 1 (Effective January 1, 1991) to the Key Salaried Employees Group Insurance Plan - Pre-1987 Group (As Amended and Restated Effective January 1, 1987) (Filed as Exhibit 10.3(ii) to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1991, and incorporated herein by this reference thereto).\n10.3(iii) Key Salaried Employees Group Insurance Plan - Post-1986 Group (Effective January 1, 1987) (Filed as Exhibit 10.3(iii) to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1991, and incorporated herein by this reference thereto).\n10.3(iv) Amendment No. 1 (Effective January 1, 1991) to the Key Salaried Employees Group Insurance Plan - Post-1986 Group (Effective January 1, 1987) (Filed as Exhibit 10.3(iv) to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1991, and incorporated herein by this reference thereto).\n10.3(v) Amendment No. 2 to the Key Salaried Employees Group Insurance Plan - Post-1986 Group (effective January 1, 1987) (Filed as Exhibit 10.3(v) to the Corporation's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993, and incorporated herein by this reference thereto).\n10.3(vi) Amendment No. 3 to the Key Salaried Employees Group Insurance Plan - Post-1986 Group (effective August 1, 1994) (Filed as Exhibit 10.3(vi) to the Corporation's Quarterly Report on Form 10-Q for the quarter ended June 30, 1994, and incorporated herein by this reference thereto).\n10.4 Directors Retirement Program (Filed as Exhibit 10.4 to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1991, and incorporated herein by this reference thereto).\n10.5(i) 1990 Long-Term Incentive Plan (Filed as Exhibit 10.8 to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1990, and incorporated herein by this reference thereto).\n10.5(ii) Amendment No. 1 to 1990 Long-Term Incentive Plan (Filed as Exhibit 10.8(ii) to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1991, and incorporated herein by this reference thereto).\n10.6 1994 Management Incentive Plan (Filed as Exhibit 10.11 to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1993, and incorporated herein by this reference thereto).\n10.7 1995 Economic Value Incentive Plan (Filed as Exhibit 10.10 to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1994, and incorporated herein by this reference thereto).\n10.8(i) 1995 Shareholder Value Incentive Plan (Filed as Exhibit 10.11(i) to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1994 and incorporated therein by this reference thereto).\n10.8(ii) Amendment No. 1 to 1995 Shareholder Value Incentive Plan. (1)\n10.8(iii) Form of Shareholder Value Incentive Stock Option (Filed as Exhibit 10.11(ii) to the Corporation's Annual Report Form 10-K for the year ended December 31, 1994, and incorporated herein by this reference thereto).\n10.9(i) Outside Directors Stock Plan, adopted March 17, 1995 (Filed as Exhibit 10.12 to the Corporation's Quarterly Report on Form 10-Q for the quarter ended March 31, 1995, and incorporated herein by this reference thereto).\n10.9(ii) Receivables Purchase Agreement dated as of June 1, 1990, among Georgia-Pacific Corporation, as the Seller, and Asset Securitization Cooperative Corporation, Corporate Asset Funding Company, Inc., Falcon Asset Securitization Corporation and Matterhorn Capital Corporation, as the Purchasers, and Canadian Imperial Bank of Commerce, as the Administrative Agent (Filed as Exhibit 10.17(i) to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1990, and incorporated herein by this reference thereto).\n10.9(iii) Receivables Purchase Agreement dated as of June 1, 1990, among Georgia-Pacific Corporation, as the Seller, and Canadian Imperial Bank of Commerce, Citibank, N.A. and The First National Bank of Chicago, as the Secondary Purchasers, and Matterhorn Capital Corporation and Canadian Imperial Bank of Commerce, as the Administrative Agent (Filed as Exhibit 10.17(ii) to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1990, and incorporated herein by this reference thereto).\n10.10(i) Agreement, effective as of March 15, 1993, among Georgia-Pacific Corporation, Hercules Incorporated, and Lee M. Thomas (Filed as Exhibit 10.13 to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1994, and incorporated herein by this reference thereto).\n10.10(ii) First Addendum to Agreement, effective as of February 1, 1995, among Georgia-Pacific Corporation, Hercules Incorporated, and Lee M. Thomas (Filed as Exhibit 10.13(ii) to the Corporation's Quarterly Report on Form 10-Q for the quarter ended March 31, 1995, and incorporated herein by this reference thereto).\n11 Statements of Computation of Per Share Earnings. (1)\n12 Statements of Computation of Ratio of Earnings to Fixed Charges. (1)\n13 Portions of Georgia-Pacific Corporation's 1995 Annual Report to Shareholders. Such Report is not deemed to be filed with the Commission as part of this Annual Report on Form 10-K, except for the portions thereof expressly incorporated by reference.(1)\n21 Subsidiaries. (1)\n(1) Filed via EDGAR\n23 Consent of Independent Public Accountants. (1)\n24 Powers of Attorney. (1)\n27 Financial Data Schedule. (1)\n99 Parts 2 and 3 of Article 11 of the Georgia Business Corporation Code (successor to Articles 11 and 11A of the Georgia Business Corporation Code and Section 14-2-230 through 14-2-235 and 14-2-235 through 14-2- 238 of the Official Code of Georgia Annotated) (Filed as Exhibit 28 to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1990, and incorporated herein by this reference thereto).\n(1) Filed via EDGAR","section_15":""}
{"filename":"786557_1995.txt","cik":"786557","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company leases space in all of one and a portion of two other facilities in Princeton, New Jersey and owns a manufacturing facility in Indianapolis, Indiana.\nThe Company currently leases a building of approximately 50,000 square feet that houses its scientific laboratories, manufacturing facilities and certain offices in the Princeton Forrestal Center located near Princeton, New Jersey. The lease, with an initial term of twelve years, commenced January 1, 1995, and the Company has options to renew for up to an additional ten years. Lease payments for the year ended December 31, 1995 totaled approximately $568,000. Future lease payments are subject to certain contractual escalations. The Company also leases approximately 28,500 square feet of office space located in the Princeton Forrestal Center. The lease commenced March 1, 1993, with an initial lease term of ten years. Payments under this lease for the year ended December 31, 1995 totaled approximately $597,000. In January, 1995, the Company entered into a three year lease for approximately 13,200 square feet of office\/warehouse space near its corporate offices. The Company also rents office space in London, England and Paris, France.\nIn July, 1992, the Company purchased a pharmaceutical manufacturing facility of approximately 55,000 square feet located on 26 acres of land located in Indianapolis, Indiana. The Company is retrofitting and equipping certain portions of the facility to manufacture ABELCETTM. See \"Manufacturing\" and \"Management's Discussion and Analysis of Financial Condition and Results of Operations ---- Liquidity and Capital Resources.\"\nItem 3.","section_3":"Item 3. Legal Proceedings\nRecent intellectual property litigation is described under \"Business-Patents and Proprietary Technology\".\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\n(a) Market Information\nThe Company's Common Stock is traded on the Nasdaq National Market System under the symbol LIPO. The following table sets forth for the periods indicated the high and low sale price for the Common Stock:\nHIGH LOW 4th Quarter $21.750 $13.000 3rd Quarter 17.750 10.125 2nd Quarter 11.500 8.375 1st Quarter 13.375 7.875\n4th Quarter 10.750 6.375 3rd Quarter 8.125 4.750 2nd Quarter 6.500 4.875 1st Quarter 7.750 5.875\n(b) Holders\nAt December 31, 1995, there were approximately 1401 stockholders of record of the Company's Common Stock.\n(c) Dividends\nThe Company has not paid any cash dividends on its Common Stock since its inception and does not anticipate paying any cash dividends on the Company's Common Stock in the foreseeable future. The declaration and payment of Common Stock dividends, if any, is within the discretion of the Board of Directors and will depend, among other things, upon future earnings, the operating and financial condition of the Company, its capital requirements, and general business conditions.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe following table sets forth consolidated financial data with respect to the Company for each of the five years in the period ending December 31, 1995. The information set forth below 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 included elsewhere herein.\nCONSOLIDATED STATEMENTS OF OPERATIONS DATA: Year Ended December 31, 1995 1994 1993 1992 1991 (In thousands, except per share figures) Product Sales $ 6,164 $ -- $ -- $ -- $ -- Collaborative research and development revenues 6,589 5,831 4,877 5,767 5,938 Licensing and other fees -- 50 541 312 319 Interest and investment income 2,964 4,559 7,624 4,810 2,575\nTotal revenues 15,717 10,440 13,042 10,889 8,832\nCost of goods sold 2,304 -- -- -- -- Research and development expenses 30,149 31,713 25,072 15,000 9,326 Selling, general and administrative expenses 18,631 12,072 10,193 5,488 3,586 Interest expense 294 308 254 76 6\nTotal expenses 51,378 44,093 35,519 20,564 12,918\nNet loss (35,661) (33,653) (22,477) (9,675) (4,086)\nPreferred Stock dividends (5,348) (5,348) (5,348) -- --\nNet loss applicable to Common Stock $(41,009) $(39,001) $(27,825)$ (9,675)$ (4,086)\nNet loss per share applicable to Common Stock $ (1.50) $ (1.64) $ (1.18)$ (.43)$ (.22)\nWeighted average number of ommon shares outstanding 27,293 23,850 23,536 22,384 18,221\nCONSOLIDATED BALANCE SHEETS DATA: December 31, 1995 1994 1993 1992 1991 (In thousands)\nCash and marketable securities(1) $72,333 $ 72,157 $119,743 $76,399 $45,678 Working capital 53,119 51,7463 102,139 71,910 43,604 Total assets 105,926 93,196 139,632 92,756 50,803 Total long-term liabilities 4,104 5,917 7,696 2,986 607 Accumulated deficit (144,520) (108,859) (75,206) (52,729) (43,054) Total stockholders' equity(2) 89,832 78,353 122,347 83,200 46,861\n(1)Includes restricted cash of $6,642, $4,880 and $4,748 in 1995, 1994 and 1993, respectively. See Note 1 of Notes to Consolidated Financial Statements. (2)In 1993, the Company adopted the provisions of Financial Accounting Standard 115 \"Accounting for Certain Investments in Debt and Equity Securities.\" The effect of this adoption was to increase Total stockholders' equity by $650 in 1993 and reduce Total stockholders' equity by $5,033 and $543 in 1994 and 1995 respectively.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nOVERVIEW\nThe Liposome Company, Inc. (the \"Company\") is a leading biotechnology company engaged in the discovery, development and commercialization of proprietary lipid and liposome-based pharmaceuticals for the treatment, prevention and diagnosis of inadequately treated, life-threatening illnesses. ABELCETTM (amphotericin B lipid complex injection), the Company's first commercialized product, has been approved for marketing for certain indications in the United States, United Kingdom, Spain, Luxembourg and Iceland and is the subject of marketing application filings in several other countries. In addition to ABELCETTM, the Company's other lead products are TLC C-53 and TLC D-99. TLC C-53, liposomal prostaglandin E1, is being developed primarily for the treatment of acute respiratory distress syndrome (\"ARDS\"). Patients are being accrued into a pivotal Phase III clinical study for the treatment of ARDS. TLC D-99, liposomal doxorubicin, is being developed in conjunction with a corporate sponsor primarily as a first line treatment for metastatic breast cancer. TLC D-99 is currently being studied in two Phase III clinical trials. The Company also has a continuing discovery research program which concentrates primarily on the treatment of cancer and inflammatory conditions.\nRESULTS OF OPERATIONS\nRevenues\nTotal revenues for the year ended December 31, 1995 were $15,717,000, an increase of $5,277,000 or 50.5% as compared to the year ended December 31, 1994. Revenues in 1994 were $10,440,000, a decrease of $2,602,000 or 20.0% compared to the 1993 level. The primary components of revenues for the Company are collaborative research and development revenues, interest and investment income and commencing in 1995, product sales.\nIn May, 1995 the Company filed a New Drug Application (\"NDA\") with the U.S. Food and Drug Administration (\"FDA\") for ABELCET. The application was given a priority review, and in November, ABELCET was cleared for marketing by the FDA for the treatment of aspergillosis in patients who have failed on or who are intolerant of conventional amphotericin B. Initial U.S. shipments of ABELCET were made in December. In February, 1995, the Company received approval from the Medicines Control Agency of the United Kingdom to market ABELCET for the second line treatment of severe systemic fungal infections. During 1995, the Company received similar approvals in Spain, Luxembourg and Iceland. In the U.S. as well as the U.K., the Company is marketing ABELCET with its own sales force as it intends to do in several other countries. Product sales for 1995 amounted to $6,164,000 of which sales to international customers totaled $3,010,000. There were no product sales in 1994 or 1993.\nCollaborative research and development and other revenues were $6,589,000 for 1995, which was $708,000 or 12.0% higher than 1994 revenues. Collaborative research and development and other revenues were $5,881,000 for 1994, which was $463,000 or 8.5% higher than 1993. The Company earned its collaborative research and development revenues from two corporate sponsors, Pfizer, Inc (\"Pfizer\") and Schering A.G. (Berlin), in 1995, 1994 and 1993. The Company is continuing development of its liposomal doxorubicin product TLC D-99 with Pfizer as its corporate sponsor. The agreement between the Company and Schering A.G. was terminated on March 29, 1995.\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued)\nInterest and investment income for the years ended December 31, 1995, 1994, and 1993 was $2,964,000, $4,559,000, and $7,624,000, respectively. Interest and investment income in 1995 decreased by $1,595,000 or 35.0% from 1994. Interest and investment income in 1994 was $3,065,000 or 40.2% less than that in 1993. During the second and third quarters of 1995 and the first quarter of 1993 the Company raised capital through the sale of equity securities. Net proceeds to the Company from these sales were $43,191,000 and $65,735,000, respectively. No significant amounts of capital were raised during 1994. Fluctuations in interest and investment income are primarily due to the significant changes in the level of cash balances the Company had available for investment as a result of these financings, the operating losses and dividend and capital expenditures incurred and the rates of interest earned on the investment portfolio.\nThe components of revenue can increase or decrease significantly based upon the level of product sales and the level of cost reimbursement under research collaborations, the possible initiation of new licensing agreements and, in the case of interest and investment income, the level of cash balances available for investment and the rate of interest earned and gains and losses, if any, realized on the sale of such investments.\nExpenses\nTotal expenses for 1995, 1994 and 1993 were $51,378,000, $44,093,000 and $35,519,000, respectively. Expenses in 1995 increased 16.5% compared to 1994 and expenses in 1994 were 24.1% greater than in 1993. The Company's expenses consist primarily of research and development expenditures to perform basic research, conduct pre-clinical and clinical studies and other related product development activities, manufacture supplies of product for such testing, and prosecute applications to test and market products before various government regulatory authorities. General and administrative expenses are incurred to support the Company's operating activities. Selling expenses are incurred to market and sell the Company's commercial products. In 1995, cost of sales were incurred for the manufacture and distribution of ABELCETTM. The Company expects its aggregate expenses to continue to increase due to increased product sales as well as increased clinical trial and development costs associated with the progression of its lead proprietary products through late stage development.\nResearch and development expenses of $30,149,000 for 1995 decreased $1,564,000 or 4.9% over 1994. This decrease is primarily attributable to the shift in certain manufacturing costs from research and development (to manufacture clinical supplies of ABELCETTM) to cost of sales and product inventory. This decline was partially offset by increased spending for TLC C-53 as this product progressed into phase III clinical trials during 1995. As in prior years, costs associated with the development of TLC D-99 were reimbursed by Pfizer.\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued)\nResearch and development expenses of $31,713,000 for 1994 increased $6,641,000 or 26.5% over 1993. The primary components of this increase were the costs related to ABELCETTM, TLC C-53 and TLC D-99, reflecting higher expenditures associated with the Company's products progressing to late stages of development; increased staffing levels to support the manufacturing facility located in Princeton, which began operations in early 1994; and the expansion of the Company's medical, regulatory, and biostatistical departments to develop and conduct increased clinical trial activity. In February, 1994, the Company announced that it had suspended further development of Maitec(R), its liposomal gentamicin product, in order to focus its resources on its other products.\nSelling, general and administrative expenses in 1995 were $18,631,000, an increase of $6,559,000 or 54.3% over 1994. The primary components of the increase were costs attributable to expanding the Company's international sales and marketing programs as well as preparation for the commencement of U.S. marketing activities. By year-end 1994, the Company had filed applications to market ABELCET in seventeen countries, and approval to market in the United Kingdom was received in February, 1995. Approval to market ABELCETTM in the U.S. was received in November, 1995.\nSelling, general and administrative expenses in 1994 were $12,072,000, an increase of $1,879,000 or 18.4% over 1993. The primary component of the increase were costs associated with the start up of the international sales and marketing operations in anticipation of launching ABELCET.\nInterest expense for 1995, 1994, and 1993 was $294,000, $308,000, and $254,000, respectively. Interest expense is mainly comprised of the costs associated with capital leases that funded machinery and construction costs at the Princeton manufacturing facility and mortgage interest related to the Indianapolis, Indiana, manufacturing facility.\nPreferred Stock Dividends\nIn January 1993, the Company completed the issuance of 2,760,000 Depositary Shares representing 276,000 shares of Series A Cumulative Convertible Exchangeable Preferred Stock with a cumulative dividend of 7.75%. The Company has declared and paid in arrears dividends of $5,348,000 on such Preferred Stock annually since issuance. These dividends are included as part of the Company's net loss applicable to Common Stock and net loss per share of Common Stock.\nNet Loss, Net Loss Applicable to Common Stock and Net Loss Per Share of Common Stock\nThe net loss of $35,661,000 for 1995 increased by $2,008,000 or 6.0% compared to 1994. This increase in net loss was due to the increases in total expenses of $7,285,000, and total revenues of $5,277,000. The net loss applicable to Common Stock was $41,009,000 in 1995 and $39,001,000 in 1994 as a result of the operational factors discussed above and the declaration of $5,348,000 of Preferred Stock dividends in each year. The net loss per common share was $1.50 per share for 1995 compared to $1.64 in 1994. The total loss per share of $1.50 comprises $.20 for Preferred Stock dividends and the remainder, $1.30, for the current year net loss.\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued)\nAlthough the net loss applicable to Common Stock increased in 1995 compared to 1994, the net loss per share decreased as the Company, during 1995, sold an aggregate of 4,950,000 shares of Common Stock. The impact of these sales increased the weighted average shares outstanding by 3,021,000.\nThe net loss of $33,653,000 for 1994 increased by $11,176,000 or 49.7% compared to 1993. This increase in net loss was due to the increase in total expenses of $8,574,000, in conjunction with a decrease in total revenues of $2,602,000. The net loss applicable to Common Stock was $39,001,000 in 1994 and $27,825,000 in 1993 as a result of the operational factors discussed above and the declaration of $5,348,000 of Preferred Stock dividends in each year. The net loss per common share increased by $.46 per share to $1.64 per share for 1994. The total loss per share of $1.64 comprises $.23 for Preferred Stock dividends and the remainder, $1.41, for the current year net loss.\nLiquidity and Capital Resources\nThe Company had $72,333,000 in cash reserves as of December 31, 1995. The cash reserves include cash and cash equivalents of $3,937,000, short-term investments of $50,451,000, long-term investments of $11,303,000 and restricted cash of $6,642,000. The cash reserves increased $176,000 from 1994 due to capital raised during the year, reduced by the use of funds for operations, capital acquisitions, Preferred Stock dividend payments and the current market value adjustment to investments to comply with the Statement of Financial Accounting Standards (\"SFAS\") No. 115, Accounting for Certain Investments in Debt and Equity Securities. The cumulative effect at December 31, 1995 of SFAS No. 115 was a net unrealized loss of $543,000. In connection with certain financing arrangements, the Company is required to maintain minimum cash balances, of which the largest requirement is $20,000,000. The Company invests its excess cash in a diversified portfolio of high-grade marketable and United States Government-backed securities.\nDuring 1995, cash used by operations increased to $37,020,000 as compared to $32,407,000 in 1994. The 1995 change in cash used was primarily due to the increase in net loss versus 1994 combined with the increase in other current assets, primarily inventory of marketable product and receivables from product sales. This was partially offset by increases in depreciation and amortization, along with accrued expenses and accounts payable. Funding required for operating activities during 1995 was derived from cash raised from the sale of Common Stock, existing cash balances and the sales of investments as well as from product sales, revenues from corporate sponsors, interest income, and the exercise of stock options. Facility and equipment expenditures increased in 1995 compared to 1994, reflecting funds expended to retrofit the Indianapolis facility to manufacture ABELCETTM. The Company expects the total cost of this project to be approximately $13,000,000.\nAt December 31, 1995, the Company had approximately $134,000,000 of operating loss carryforwards, $3,200,000 of research and development credit carryforwards and $45,000 of investment tax credit carryforwards. These carryforwards expire in the years 1996 through 2010. The timing and manner in which these losses are used may be limited as a result of certain ownership changes that occurred pursuant to Internal Revenue Service regulations under Section 382.\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued)\nThe Company expects to finance its operations from, among other things, the commercial sale of ABELCETTM, the proceeds received from payments under research and development agreements, interest earned on investments and the liquidation of certain investments. Funds may also be provided to the Company by leasing arrangements for capital expenditures. The Company expects to fund Preferred Stock dividends from existing cash reserves. The Company believes that its available cash and marketable securities, revenues from product sales, research and development reimbursements and interest income will be sufficient to meet its expected operating, cash flow and capital expenditures requirements for the intermediate term.\nThe Company has called for redemption 50% of its Series A Cumulative Convertible Exchangeable Preferred Stock represented by Depositary Shares effective March 25, 1996 at a price of $26.40 per Depositary Share plus accrued and unpaid dividends. It is also possible that the Company will in the future, call the remaining 50% of the Preferred Stock. Each Depositary Share represents 1\/10 of a share of Preferred Stock and is convertible into 1.9455 shares of Common Stock. Should the price of the Company's Common Stock on the redemption date exceed $13.57 plus an amount equal to unpaid dividends (the \"trigger price\") the Company would expect substantially all of the holders of Depositary Shares called for redemption to convert such Depositary Shares into Common Stock. However, should the value of the Common Stock be below the trigger price on the redemption date, substantially all of the holders of redeemed Depositary Shares would be expected to surrender such shares for redemption. Approximately $36.4 million, plus unpaid dividends, would be required to satisfy redemption requirements of the shares called for redemption should all of such shares be submitted for redemption.\nIn connection with the call of the Preferred Stock, the Company has entered into a standby purchase agreement for Depositary Shares that are submitted for redemption, if any. Should Depositary Shares be submitted for redemption, the standby purchasers would purchase from the Company, subject to certain conditions, the number of shares of Common Stock that would have been issuable upon conversion of such redeemed Depositary Shares. The purchase price received from the standby purchasers will reimburse the Company for the redemption price paid for the redeemed Depositary Shares. The Company expects to fund such redemption requirements not satisfied by the standby purchase agreement, if any, from its cash and marketable securities portfolio.\nThe Financial Accounting Standards Board has issued Statement of Financial Accounting Standards No. 123 \"Accounting for Stock Based Compensation\" (\"SFAS 123\"). In October 1995, SFAS 123 established financial and reporting standards for stock based compensation plans. The Company anticipates adopting the disclosure only provision of this standard during 1996.\nThe Financial Accounting Standards Board, has issued SFAS No. 121 \"Accounting for the Impairment of Assets to be Disposed of\" which is required to be implemented in 1996. The Company does not anticipate any material impact for the adoption of this standard.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nReference is made to the Consolidated Balance Sheets, Consolidated Statements of Operations, Consolidated Statements of Stockholders' Equity, Consolidated Statements of Cash Flow, Notes to Consolidated Financial Statements, Financial Statement Schedule and Independent Accountants Reports appearing in Item l4(a) of this Form l0-K.\nItem 9.","section_9":"Item 9. Disagreements on Accounting and Financial Disclosure\nNone.\nPART III\nItem l0. Directors and Executive Officers of the Registrant\nInformation required under this Item relating to executive officers of the Company is included in a separate item captioned \"Executive Officers\" contained in Part I of this report. Information required under this Item relating to the directors of the Company will be contained in the Company's Proxy Statement for the l996 Annual Meeting, the relevant portions of which are incorporated herein by reference.\nItem ll. Executive Compensation\nInformation required under this Item will be contained in the Company's Proxy Statement for the l996 Annual Meeting, the relevant portions of which are incorporated herein by reference.\nItem l2. Security Ownership of Certain Beneficial Owners and Management\nInformation required under this Item will be contained in the Company's Proxy Statement for the l996 Annual Meeting, the relevant portions of which are incorporated herein by reference.\nItem l3. Certain Relationships and Related Transactions\nInformation required under this Item will be contained in the Company's Proxy Statement for the l996 Annual Meeting, the relevant portions of which are incorporated herein by reference.\nPART IV\nItem l4. Exhibits, Financial Statement Schedules and Reports on Form 8-K\n(a) l. Financial Statements\nConsolidated financial statements and financial statement schedule listed in the accompanying index are filed herewith.\n2. Exhibits\nSee Exhibit Index included elsewhere in this Report.\n(b) Reports on Form 8-K\nNo reports on Form 8-K have been filed during the last quarter of the period covered by this report.\n(Item l4(a)1 and 14(a)2)\nPage\nConsolidated Financial Statements\nReport of independent accountants 31\nConsolidated balance sheets at December 3l, l995 and l994 32\nConsolidated statements of operations for each of the three years in the period ended December 3l, l995 33\nConsolidated statements of stockholders' equity for each of the three years in the period ended December 3l, l995 34\nConsolidated statements of cash flows for each of the three years in the period ended December 3l, l995 35\nNotes to consolidated financial statements 36-47\nReport of independent accountants on financial statement schedule 48\nFinancial statement schedule 49\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Stockholders of The Liposome Company, Inc.:\nWe have audited the consolidated balance sheets of The Liposome Company, Inc. and Subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1995. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of The Liposome Company, Inc. and Subsidiaries as of December 31, 1995 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, 1995, in conformity with generally accepted accounting principles.\nAs discussed in Note 1 to the consolidated financial statements, in 1993 the Company changed its method of accounting for certain investments in debt and equity securities.\nPrinceton, New Jersey February 2, 1996\nCoopers & Lybrand L.L.P.\nTHE LIPOSOME COMPANY, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS (In thousands except share data)\nASSETS December 31, Current assets: 1995 1994 Cash and cash equivalents $ 3,937$ 2,369 Short-term investments 50,451 55,487 Accounts receivable, net of allowance for doubtful accounts ($200,000 for 1995) 6,799 1,618 Inventories 3,543 748 Prepaid Expenses 333 419 Other current assets 46 31 Total current assets 65,109 60,672\nLong-term investments 11,303 9,421 Property, plant and equipment, net 22,400 17,686 Restricted cash 6,642 4,880 Intangibles, net 472 537\nTotal assets $105,926$ 93,196\nLIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 1,839$ 1,112 Accrued expenses and other current liabilities 7,002 4,698 Current obligations under capital leases 1,509 1,476 Current obligations under note payable 303 303 Preferred Stock dividends payable 1,337 1,337 Total current liabilities 11,990 8,926\nLong-term obligations under capital leases 2,616 4,126 Long-term obligations under note payable 1,488 1,791 Total liabilities 16,094 14,843\nCommitments and contingencies\nStockholders' equity: Capital stock: Preferred Stock, par value $.0l; 2,400,000 authorized; 275,700 shares of Series A Cumulative Convertible Exchangeable Preferred Stock outstanding (liquidation preference of $68,925,000) 3 3 Common Stock, par value $.0l; 60,000,000 shares authorized; 29,950,031 and 23,982,849 shares issued and outstanding 299 240 Additional paid-in capital 234,545 192,003 Net unrealized investment loss (543) (5,033) Foreign currency translation adjustment 48 (1) Accumulated deficit (144,520)(108,859) Total stockholders' equity 89,832 78,353\nTotal liabilities and stockholders' equity $105,926$ 93,196\nSee accompanying notes.\nTHE LIPOSOME COMPANY, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF OPERATIONS (In thousands except per share figures)\nYear Ended December 31,\n1995 1994 1993\nProduct Sales $ 6,164 $ -- $ --\nCollaborative research and development and other revenues 6,589 5,881 5,418\nInterest and investment income, net 2,964 4,559 7,624\nTotal revenues 15,717 10,440 13,042\nCost of Goods Sold 2,304 -- --\nResearch and development expense 30,149 31,713 25,072\nSelling, general and administrative expense 18,631 12,072 10,193\nInterest expense 294 308 254\nTotal expenses 51,378 44,093 35,519\nNet loss (35,661) (33,653) (22,477)\nPreferred Stock dividends (5,348) (5,348) (5,348)\nNet loss applicable to Common Stock $(41,009) $(39,001) $(27,825)\nNet loss per share applicable to Common Stock $ (1.50) $ (1.64) $ (1.18)\nWeighted average number of common shares outstanding 27,293 23,850 23,536\nSee accompanying notes.\nTHE LIPOSOME COMPANY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (In thousands except share figures)\nShares Additional Preferred Common Par Stock Stock Value Balance, December 3l, l992 -- 23,478,410 $ 235\nIssuance of stock: For cash 276,000 -- 3 To 401K plan -- 24,390 -- Exercise of stock options -- 202,634 2 Dividends on Preferred Stock -- -- Net unrealized investment gain -- -- -- Foreign currency translation adjustment -- -- -- Net loss for 1993 -- -- -- Balance, December 31, 1993 276,000 23,705,434 240 196,655\nIssuance of stock: To 401K plan -- 31,254 -- Exercise of stock options -- 246,161 3 Dividends on Preferred Stock -- -- Net unrealized investment loss -- -- -- Foreign currency translation adjustment -- -- -- Net loss for 1994 -- -- -- Balance, December 31, 1994 276,000 23,982,849 243\nIssuance of stock: For cash -- 4,950,000 49 To 401K plan -- 23,672 -- Exercise of stock options -- 987,674 10 Conversion of Preferred Stock (300) 5,836 -- Dividends on Preferred Stock -- -- Net unrealized investment gain -- -- -- Foreign currency translation adjustment -- -- -- Net loss for 1995 -- -- -- Balance, December 31, 1995 275,700 29,950,031 $ 302\nTotal Paid-in Accumulated Stockholders' Capital Other Deficit Equity $135,687 $ 7 $ (52,729) $ 83,200 65,732 -- -- 65,735 182 -- -- 182 402 -- -- 404 (5,348) -- -- (5,348) - -- 650 -- 650 - -- 1 -- 1 - -- -- (22,477) (22,477) 658 (75,206) 122,347 196 -- -- 196 500 -- -- 503 (5,348) -- -- (5,348) - -- (5,683) -- (5,683) - -- (9) -- (9) - -- -- (33,653) (33,653) 192,003 (5,034) (108,859) 78,353 43,143 -- -- 43,192 199 -- -- 199 4,548 -- -- 4,558 - -- -- -- -- (5,348) -- -- (5,348) - -- 4,490 -- 4,490 - -- 49 -- 49 - -- -- (35,661) (35,661) $234,545 $ (495) $(144,520) $ 89,832\nSee accompanying notes.\nTHE LIPOSOME COMPANY, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) Year Ended December 31, 1995 1994 1993 Cash flows from operating activities: Net loss $(35,661) $(33,653)$(22,477) Adjustments to reconcile net loss to net cash used by operating activities: Depreciation and amortization 3,409 3,145 1,622 Other 199 196 222 Changes in assets and liabilities: Accounts receivable, net (5,181) (983) (542) Inventory (2,795) (534) (170) Prepaid expenses 86 238 455 Other current assets (15) (11) 341 Accounts payable 634 (2,195) 880 Accrued expenses and other current liabilities 2,304 1,390 721\nNet cash used by operating activities (37,020) (32,407) (18,948)\nCash flows from investing activities: Purchases of short and long-term investments (51,990) (38,284)(205,982) Sales of short and long-term investments 59,634 78,019 170,067 Restricted cash (1,762) (132) (4,748) Purchases of property, plant and equipment (7,965) (2,896) (7,651)\nNet cash (used)\/provided by investing activities (2,083) 36,707 (48,314)\nCash flows from financing activities: Net proceeds from issuance of stock 43,192 -- 65,735 Exercises of stock options 4,558 503 404 Principal payments under note payable (303) (303) (302) Receipt of proceeds from capital lease obligations -- -- 7,496 Principal payments under capital lease obligations (1,477) (1,444) (450) Preferred Stock dividend payments (5,348) (5,348) (4,011)\nNet cash provided\/(used) by financing activities 40,622 (6,592) 68,872\nEffects of exchange rate changes on cash 49 (9) 1\nNet (decrease)\/increase in cash and cash equivalents 1,568 (2,301) 1,611\nCash and cash equivalents at beginning of year 2,369 4,670 3,059\nCash and cash equivalents at end of year $ 3,937 $ 2,369 $ 4,670\nSee accompanying notes.\nTHE LIPOSOME COMPANY, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:\nBUSINESS:\nThe Liposome Company, Inc. (the \"Company\") is a leading biotechnology company engaged in the discovery, development and commercialization of proprietary lipid and liposome-based pharmaceuticals for the treatment, prevention and diagnosis of inadequately treated, life-threatening illnesses. ABELCETTM (amphotericin B lipid complex injection), the Company's first commercialized product, has been approved for marketing for certain indications in the United States, United Kingdom, Spain, Luxembourg and Iceland and is the subject of marketing application filings in several other countries. In addition to ABELCETTM, the Company's other lead products are TLC C-53 and TLC D-99. TLC C-53, liposomal prostaglandin E1, is being developed primarily for the treatment of acute respiratory distress syndrome (\"ARDS\"). Patients are being accrued into a pivotal Phase III clinical study for the treatment of ARDS. TLC D-99, liposomal doxorubicin, is being developed in conjunction with a corporate sponsor primarily as a first line treatment for metastatic breast cancer. TLC D-99 is currently being studied in two Phase III clinical trials. The Company also has a continuing discovery research program which concentrates primarily on the treatment of cancer and inflammatory conditions.\nFINANCIAL STATEMENT PRESENTATION:\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.\nCONSOLIDATED FINANCIAL STATEMENTS:\nThe consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany transactions and balances are eliminated in consolidation.\nREVENUE RECOGNITION:\nRevenue from product sales is recognized upon transfer of title to unrelated third parties. Payments for collaborative research and development are generally received in advance and are recognized as revenue, ratably, as the research and development is performed. Licensing fees, royalty and hurdle payments are recognized in the period earned.\nTHE LIPOSOME COMPANY, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS----(CONTINUED)\nDEPRECIATION AND AMORTIZATION:\nBuilding and building improvements, furniture and fixtures, and machinery and equipment are depreciated by the straight-line method over their estimated useful lives ranging from three to twenty years. Leasehold improvements and machinery and equipment under capital leases are amortized by the straight-line method over the lesser of their estimated useful lives or the terms of the related leases. Purchased patents are amortized by the straight-line method over their life as determined by the country of issuance. The Company periodically reviews the realizability of its patents.\nCASH EQUIVALENTS:\nThe Company considers all highly liquid investments with maturities of three months or less as cash equivalents.\nINVESTMENTS:\nOn December 31, 1993, the Company adopted the provisions of the Statement of Financial Accounting Standards (\"SFAS\") No. 115, Accounting for Certain Investments in Debt and Equity Securities. This Statement requires certain investments in debt and equity securities to be reported at current fair value.\nShort-term investments represent marketable securities available for current operations, all of which have been classified as available for sale, while long- term investments represent marketable securities available for expected capital acquisitions. These investments, which are all investment grade, are stated at fair value, determined at December 31, 1995.\nFor the years ended December 31, 1995 and 1994, investment income includes gross realized gains of $0 and $150,000, and realized losses of $489,000 and $0, respectively. At December 31, 1995 and 1994, investments included gross unrealized gains of $6,500 and $7,000 and losses of $549,000 and $5,040,000, respectively. The fair values of debt securities maturing within one year and after one year but less than five years, amounted to approximately $5,800,000 and $45,000,000, respectively. Gains and losses are calculated on the specific identification method.\nRESTRICTED CASH:\nThe Company has entered into certain financing arrangements that require the issuance of letters of credit that are partially collateralized by certain securities. The aggregate amount of these securities are segregated and identified as restricted cash. The Company is also required to maintain minimum cash balances in connection with certain of these financings.\nINVENTORIES:\nInventories are carried at the lower of actual cost or market and cost is accounted for on the first-in first-out (FIFO) basis.\nTHE LIPOSOME COMPANY, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS----(CONTINUED)\nCONCENTRATION OF CREDIT RISK:\nThe Company's significant concentrations of credit risk are with its cash and investments and its accounts receivable. The investment portfolio consists of investment grade securities or better as defined by the appropriate rating institution. Product related accounts receivable in the United States are generally with major distributors and internationally with hospitals. The Company provides credit to its customers on an uncollateralized basis after evaluating their credit status.\nNET LOSS PER SHARE APPLICABLE TO COMMON STOCK:\nNet loss per share applicable to Common Stock is computed based on the weighted average of the Common Stock shares outstanding using the treasury method. Common Stock equivalents are not included in the computation of weighted average shares outstanding since the effect would be anti-dilutive.\nRECLASSIFICATION:\nCertain reclassifications have been made to the prior year financial statement amounts to conform with the presentation in the current year financial statements.\nFOREIGN CURRENCY TRANSACTIONS:\nGenerally Consolidated Balance Sheet amounts have been translated using exchange rates in effect at the balance sheet dates and the translation adjustments have been included in the foreign currency translation adjustment as a separate component of Consolidated Stockholders' Equity. Amounts related to transactions in the Consolidated Statements of Operations have been translated using the average exchange rates in effect each year and transaction gains and losses have been included therein. During 1995 the Company realized $49,000 in foreign currency transaction losses. There was no gain or loss realized in 1994 or 1993.\nRESEARCH AND DEVELOPMENT EXPENSES:\nThe research and development expenses of the Company, which are expensed as incurred, include those efforts related to collaborative research and development agreements, development of the Company's proprietary products and general research. The expenses include, but are not limited to, medical, biostatistical, regulatory, manufacturing of clinical products and scientific support costs.\nTHE LIPOSOME COMPANY, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS----(CONTINUED)\n2. STOCKHOLDERS' EQUITY:\nPREFERRED STOCK:\nIn January 1993, the Company completed an offering of 2,760,000 Depositary Shares, each of which represents one-tenth of a share of Series A Cumulative Convertible Exchangeable Preferred Stock carrying a 7 3\/4% dividend rate. The liquidation value is $25.00 per Depositary Share, plus accrued and unpaid dividends. Each Depositary Share is convertible at any time into shares of the Company Common Stock at a conversion price of $12.85 per share of Common Stock, which is equivalent to a conversion rate of 1.9455 shares of Common Stock for each Depositary Share. At December 31, 1995, 2,757,000 shares of Preferred Stock remained outstanding and 5,363,744 shares of Common Stock have been reserved for conversion of Depositary Shares into Common Stock. The Preferred Stock is redeemable at the option of the Company, in whole or in part, on and after January 15, 1996 initially at an amount equivalent to $26.40 per Depositary Share and thereafter at prices declining to an amount equivalent to $25.00 per Depositary Share on and after January 15, 2003, plus, in each case, all accrued and unpaid dividends thereon. Proceeds to the Company from this offering were $66,240,000, net of underwriter fees. Additional stock issuance costs, including professional, registration, filing and printing fees of approximately $505,000 were also incurred in connection with this offering.\nPREFERRED STOCK DIVIDENDS:\nSince issuance, the Board of Directors of the Company has declared and paid quarterly cash dividends on the Series A Cumulative Convertible Exchangeable Preferred Stock at a prorated dividend rate of $.484375 per Depositary Share. Dividend payments in 1995, 1994 and 1993 totaled $5,348,000, $5,348,000 and $4,011,000, respectively. An additional dividend payment of $1,337,000 was paid on January 15, 1996 to stockholders of record on January 2, 1996.\nCOMMON STOCK:\nIn April, 1995 the Company sold 3,450,000 shares of its Common Stock pursuant to an underwritten offering. Proceeds received pursuant to the offering were $28,762,000, net of underwriters' fees, professional, registration, filing and printing fees.\nIn August, 1995 the Company sold 1,500,000 shares of Common Stock to an institutional investor. Gross proceeds received were $15,000,000. Stock issuance costs, including financial advisory, professional, registration and filing fees of approximately $571,000 were incurred in connection with the sale.\nTHE LIPOSOME COMPANY, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS----(CONTINUED)\n3. STOCK OPTION PLANS:\nThe Company has several stock option plans available for the issuance of incentive stock options and non-qualified stock options (''NQSO''). These options are designed to attract and retain key employees, directors and consultants. As of December 31, 1995, the Company had outstanding grants of 4,139,921 shares and 1,541,818 shares available for grants, totaling 5,681,739 shares of Common Stock reserved for stock option grants.\nOptions are granted at fair market value. These options generally become exercisable in ratable installments over a five-year period and are exercisable over ten years. Options under the 1991 Non-Employee Directors NQSO Plan (\"Directors' Plan\") are automatically granted upon appointment to the Board of Directors and annually on July 1 of each year to such non-employee Directors. Such initial grants vest over a five year period and subsequent annual grants vest in one year. Activity under all stock option plans for 1993, 1994 and 1995 is summarized as follows:\nNUMBER OF SHARES PRICE RANGE PER SHARE Outstanding December 31, 1992 3,088,641 Granted 1,243,587 $ 5.75---- $11.75 Exercised (202,634) .75---- 3.625 Forfeited (261,339) 1.0625---- 16.50\nOutstanding December 31, 1993 3,868,255 Granted 1,049,370 5.75----10.1875 Exercised (246,161) 2.036---- 8.00 Forfeited (446,641) .85---- 21.25\nOutstanding December 31, 1994 4,224,823 Granted 1,124,775 8.25---- 20.875 Exercised (987,674) 8.75----20.9375 Forfeited (222,003) 1.0625---- 17.00\nOutstanding at December 31, 1995 4,139,921\nExercisable at December 31, 1995 1,790,4391.03 ---- 20.875\nThe Financial Accounting Standards Board has issued Statement of Financial Accounting Standards No. 123 \"Accounting for Stock Based Compensation\" (\"SFAS 123\"). In October 1995, SFAS 123 established financial and reporting standards for stock based compensation plans. The Company anticipates adopting the disclosure only provision of this standard during 1996.\nTHE LIPOSOME COMPANY, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS----(CONTINUED)\n4. PROPERTY, PLANT AND EQUIPMENT:\nProperty, plant and equipment consists of the following: 1995 1994 Building and building improvements $ 2,778,000$ 2,778,000 Land and land improvements 423,000 423,000 Furniture and fixtures 1,581,000 1,574,000 Machinery and equipment 11,462,000 9,082,000 Leasehold improvements and other 4,999,000 4,597,000 Construction in process 7,539,000 2,269,000 Machinery and equipment under capital lease 7,496,000 7,496,000 Total property, plant and equipment 36,278,000 28,219,000 Less: Accumulated depreciation and amortization (13,878,000)(10,533,000) Net property, plant and equipment $22,400,000$17,686,000\n5. INVENTORIES:\nThe components of inventory are as follows: 1995 1994 Finished goods $2,273,000 $ 0 Work in process 139,000 0 Raw Materials 761,000 611,000 Supplies 370,000 137,000 $3,543,000 $748,000\n6. COMMITMENTS AND CONTINGENCIES:\nOperating Leases:\nTotal rental expense for property, plant and equipment was approximately $1,449,000, $1,618,000 and $1,139,000 for 1995, 1994 and 1993, respectively.\nThe Company's future minimum lease payments under noncancelable operating leases at December 31, 1995 are as follows:\n1996 $1,443,000 1997 1,412,000 1998 764,000 1999 568,000 2000 568,000 2001 and thereafter 4,028,000 Total $8,783,000\nCAPITAL LEASES:\nOn July 1, 1993 the Company entered into an agreement which provided for equipment lease financing of $7,496,000. The lease is collaterized by $4,310,000 in standby letters of credit provided under a letter of credit agreement which is collaterized by AAA rated securities owned by the Company. The Company is required to maintain a minimum balance of $20,000,000 in cash and marketable securities, including those securities securing the letters of credit, in connection with the lease financing.\nTHE LIPOSOME COMPANY, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS----(CONTINUED)\nThe following is a schedule by year of future minimum payments under capital leases together with the present value of the minimum lease payments and the capital lease portion of certain classes of property as of December 31, 1995:\n1996 $1,584,000 1997 1,584,000 1998 1,085,000 1999 -- 2000 -- 2001 and thereafter -- Total minimum lease payments 4,253,000 Less: Amount representing interest (128,000) Present value of minimum lease payments $4,125,000\nCLASSES OF PROPERTY:\nMachinery $4,205,000 Leasehold improvements 3,291,000 Total machinery and leasehold improvements 7,496,000 Less: Accumulated amortization (3,613,000) Net machinery and leasehold improvements $3,883,000\n7. LONG-TERM DEBT:\nOn July 24, 1992, The Liposome Manufacturing Company, Inc., a wholly-owned subsidiary of The Liposome Company, Inc., entered into a mortgage-backed note to partially fund the purchase of a pharmaceutical manufacturing facility in Indianapolis, Indiana. The principal will be paid in equal installments of $25,225 each month plus accrued interest. The note payments will be completed on November 1, 2001. The interest rate, based on the prime rate plus 1\/2%, has a floor and ceiling of 6% and 10%, and was 9.25% at December 31, 1995. The note is guaranteed by The Liposome Company, Inc. and the mortgage lending institution is holding a $1,000,000 AAA rated security owned by The Liposome Company, Inc. as collateral for the note. The Company is required to maintain a minimum balance of $10,000,000 in cash and marketable securities, including those securities collaterizing the letter of credit in connection with the financing.\nThe Liposome Manufacturing Company's principal repayment obligations as of December 31, 1995 are as follows:\n1996 $ 303,000 1997 303,000 1998 303,000 1999 303,000 2000 303,000 2001 and thereafter 276,000 Subtotal 1,791,000 Less: Current portion (303,000) Total $1,488,000\nTHE LIPOSOME COMPANY, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS----(CONTINUED)\n8. SUPPLEMENTAL INFORMATION:\nACCRUED EXPENSES AND OTHER CURRENT LIABILITIES: The components of accrued expenses and other current liabilities are as follows:\n1995 1994 Accrued expenses for preclinical and clinical programs $2,871,000$2,068,000 Accrued legal fees 284,000 344,000 Accrued wages and vacation 909,000 433,000 Taxes payable 468,000 -- Unearned contract income 183,000 -- Other 2,287,000 1,853,000 Total $7,002,000 $4,698,000\nSTATEMENT OF CASH FLOW:\n1995 1994 1993 Supplemental disclosure of cash flow information: Cash paid during the year for interest $291,000$310,000$251,000\nTHE LIPOSOME COMPANY, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS----(CONTINUED)\n9. INCOME TAXES:\nThe Company accounts for income taxes in accordance with the provisions of Statement of Financial Accounting Standards No. 109 \"Accounting for Income Taxes\" (\"SFAS 109\"). SFAS 109 requires recognition of deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax liabilities and assets are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The Company provides a valuation allowance against the net deferred tax debits due to the uncertainty of realization. The increase in the valuation allowance for the year ended December 31, 1995 was $12,010,000.\nTemporary differences and carryforwards which gave rise to the deferred tax assets and liabilities at December 31, 1995 are as follows:\nDeferred Tax Deferred Tax Assets Liabilities Depreciation $655,000 -- Net unrealized investment loss 185,000 -- State taxes (net of Federal benefit) 6,861,000 -- Amortization 1,084,000 -- Net operating losses - Federal 45,640,000 -- Other 593,000 -- Tax credits 3,202,000 --\nSubtotal 58,220,000 --\nValuation allowance - Federal (51,358,000) -- Valuation allowance - State (6,862,000) --\nTotal deferred taxes $ -- $ --\nTemporary differences and carryforwards which gave rise to the deferred tax assets and liabilities at December 31, 1994 are as follows:\nDeferred Tax Deferred Tax Assets Liabilities Depreciation $ 517,000 -- Net unrealized investment loss 1,711,000 -- State taxes (net of Federal benefit) 5,533,000 -- Amortization 709,000 -- Net operating losses - Federal 34,480,000 -- Other 355,000 -- Tax credits 2,905,000 --\nSubtotal 46,210,000 --\nValuation allowance - Federal (40,677,000) -- Valuation allowance - State (5,533,000) --\nTotal deferred taxes $ -- $ --\nTHE LIPOSOME COMPANY, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS----(CONTINUED)\nAt December 31, 1995, the Company had approximately $134,000,000 of net operating loss carryforwards, $45,000 of investment tax credit carryforwards, and $3,200,000 of research and development credit carryforwards. These carryforwards expire in the periods 1996 through 2010. The timing and manner in which these losses are used may be limited as a result of certain ownership changes which occurred as provided by IRS Regulations under Section 382.\n10. GEOGRAPHIC SEGMENT DATA\nThe Company's operations are classified into two geographic areas: Domestic (United States) and International (primarily Western Europe). Financial Data (in thousands of dollars) for the years 1995, 1994, and 1993 is as follows:\nYear Ended December 31, 1995\nDomestic International Total Sales to unaffiliated Customers $ 3,154 $ 3,010 $ 6,164 Collaborative research and development revenues 6,589 -- 6,589 Interest and investment income, net 2,959 5 2,964 Total Revenue 12,702 3,015 15,717\nNet loss (34,407) (1,254) (35,661)\nIdentifiable assets at December 31, 1995 104,817 $ 1,109 105,926\nYear Ended December 31, 1994\nSales to unaffiliated Customers -- -- -- Collaborative research and development revenues 5,831 -- 5,831 Interest and investment income, net 4,609 -- 4,609 Total Revenue 10,440 -- 10,440\nNet loss (33,653) -- (33,653)\nIdentifiable assets at December 31, 1995 92,909 287 93,196\nYear Ended December 31, 1993 Sales to unaffiliated Customers -- -- -- Collaborative research and development revenues 4,877 -- 4,877 Interest and investment income, net 8,165 -- 8,165 Total Revenue 13,042 -- 13,042\nNet loss (22,477) -- (22,477)\nIdentifiable assets at December 31, 1995$139,632$ -- $139,632\nTHE LIPOSOME COMPANY, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS----(CONTINUED)\n11. SAVINGS AND INVESTMENT RETIREMENT PLAN:\nEffective January 1, 1988, the Company adopted a 401(k) Profit Sharing Plan and Trust (\"401(k) Plan\") for eligible employees and their beneficiaries. All employees are eligible to participate in the plan once they become full-time employees and work a minimum of 1,000 hours per plan year. The 401(k) Plan provides for employee contributions through a salary reduction election. Employer discretionary matching contributions are determined annually by the Company and vest over a maximum of a five year period of service. For the plan years ended December 31, 1995, 1994 and 1993 the Company's discretionary matching was based on a percentage of salary reduction elections in the form of the Company's Common Stock.\n12. MAJOR CUSTOMER AND RESEARCH AND DEVELOPMENT REVENUE DATA\nIn the United States, the Company sells ABELCETTM to national and regional wholesalers who, in turn resell the product to hospitals and other service providers. Internationally, sales are primarily made directly to hospitals.\nFor the years ended December 31, 1995, 1994 and 1993, sales to wholesalers or other customers in excess of 10% of the Company's product revenues in any year were as follows:\n1995 1994 1993 Customer A 17% -- -- Customer B 14% -- -- Customer C 12% -- --\nThe Company has entered into various collaborative research and development contracts. The Company earned substantially all of its research and development revenues from two corporate sponsors in 1995, 1994 and 1993. Corporate sponsors who contributed 10% or more of the Company's total revenues, pursuant to collaborative agreements and licensing and other fees as reported in the statements of operations, in any year were as follows:\n1995 1994 1993 A $5,743,000 $4,694,000 $4,497,000 B 753,000 1,116,000 333,000\nTHE LIPOSOME COMPANY, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS----(CONTINUED)\n13. SUMMARY OF QUARTERLY FINANCIAL DATA (UNAUDITED):\nSummarized quarterly financial data (in thousands of dollars, except for per share data for the years ended December 31, 1995, and 1994 is as follows:\nQuarter\nFirst Second Third Fourth\nTotal revenues $ 1,853 $ 3,717 $ 3,496 $ 6,651\nTotal expenses 12,186 12,544 12,223 14,425\nNet loss (10,333) (8,827) (8,727) (7,774)\nPreferred Stock dividends (1,337) (1,337) (1,337) (1,337)\nNet loss applicable to Common Stock...............$(11,670)$(10,164)$(10,064) $(9,111)\nNet loss per share applicable to Common Stock $ (.49) $ (.38) $ (.35) $ (.31)\nWeighted average shares outstanding 24,050 26,407 28,959 29,676\nQuarter\nFirst Second Third Fourth\nTotal revenues $ 3,036 $ 2,941 $ 2,446 $ 2,017\nTotal expenses 9,874 11,084 11,127 12,008\nNet loss (6,838) (8,143) (8,681) (9,991)\nPreferred Stock dividends (1,337) (1,337) (1,337) (1,337)\nNet loss applicable to Common Stock...............$(8,175)$(9,480) $(10,018) $(11,328)\nNet loss per share applicable to Common Stock $ (.34) $ (.40) $ (.42) $ (.48)\nWeighted average shares outstanding 23,715 23,812 23,916 23,958\nNet loss per share of Common Stock amounts are calculated independently for each of the quarters presented. The sum of the quarters may not equal the full year amounts.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE\nTo the Board of Directors and Stockholders of The Liposome Company, Inc.:\nOur report on the consolidated financial statements of The Liposome Company, Inc. and Subsidiaries is included in Item 14","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"","section_15":""}
{"filename":"355797_1995.txt","cik":"355797","year":"1995","section_1":"Item 1. Business - ----------------\nBalcor Realty Investors Ltd.-82 (the \"Registrant\") is a limited partnership formed in 1981 under the laws of the State of Illinois. The Registrant raised $74,133,000 from sales of Limited Partnership Interests. The Registrant's operations currently 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 fourteen real property investments. The Registrant has since disposed of eleven of these properties. As of December 31, 1995, the Registrant owned the three properties described under \"Properties\" (Item 2). The Partnership Agreement provides that the proceeds of any sale or refinancing of the Registrant's properties will not be reinvested in new acquisitions.\nOverall, the investment real estate market saw gradual improvement over the last year. This improvement has taken place in an environment of generally low interest rates and little or no new supply, parameters which may not exist in the next few years. Demand for real estate space, while projected to improve in line with the overall economy, is also vulnerable to external forces. The major challenges facing the real estate industry today include increased international competition, corporate restructurings, new computer and communications technologies, an aging population and potential revisions of the tax code. In addition, the increased flow of capital to real estate through new vehicles such as commercial mortgage-backed securities and REITs could spur new construction at unsupportable levels, as well as impact existing property values.\nOperationally, existing apartment properties continued to register occupancy percentages in the 90s, with average rents rising at an annual rate of between 3 and 4 percent. Apartments are still considered one of the top real estate asset classes in terms of performance. However, some markets are experiencing new construction of rental units which, if unrestrained, could impact the performance of existing properties. Most of the new construction is aimed at the two segments of the rental market which are growing the fastest: low-income households and upper-income households who prefer to rent rather than own. Of all the major asset classes, apartments typically display the least volatility in terms of property values.\nThe General Partner had previously advised the Limited Partners that its strategy was to sell the Registrants remaining assets over the next two years. The General Partner also stated that the timing of the liquidation could be lengthened or shortened due to changes in market conditions, economic factors, interest rates and unforeseen events. Since November 1995, the General Partner believes that the market for multifamily housing properties has become increasingly favorable to sellers of these properties. This belief is based on the results of the sales and marketing activities of various other Registrants affiliated with the Registrant. These favorable market conditions are in part attributable to the increasing strength of the capital markets and the re-entry of REITs into the acquisition market. The General Partner intends to begin marketing the Registrants remaining properties for sale. If the current market conditions for sales remain favorable and the General Partner can obtain\nappropriate sales prices, the Registrant's liquidation strategy may be accelerated.\nThe Registrant received notice of an unsolicited offer for the purchase of limited partnership interests (\"tender offer\") in November 1995. The tender offer was made by Walton Street Capital Acquisition Co. L.L.C. (\"Walton Street\"). Walton Street stated that their primary motive in making the offer was to make a profit from the purchase of the interests. Walton Street acquired 8.71 % of the total interests outstanding in the Registrant and assigned the interests to its affiliate, WIG 82 Partners. The Registrant incurred administrative costs in responding to the tender offer.\nThe Registrant received notice of an unsolicited offer for the purchase of limited partnership interests (\"tender offer\") on March 11, 1996. The tender offer was made by Metropolitan Acquistition VII, L.L.C. (\"Metropolitan\"). Metropolitan is an affiliate of Insignia Financial Group, Inc., which provides property management services to all of of the Registrant's properties. Metropolitan stated that their primary motive in making the offer is to make a profit from the purchase of the interests. Metropolitan is seeking to acquire up to 30% of the total interests outstanding in the Registrant. The Registrant will incur administrative costs in responding to the tender offer and may incur additional costs if additional tender offers are made in the future.\nDuring 1995, the wrap-around note received in connection with the sale of the Meridian Hills Court Apartments was repaid in full. See Note 4 of Notes to Financial Statements 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-XI, the General Partner of the Registrant, and its affiliates perform services for the Registrant. The Registrant currently has no employees engaged in its operations.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties - ------------------\nAs of December 31, 1995, the Registrant owns the three properties described below:\nLocation Description of Property ------------------------------- Austin, Texas * Balcones Woods Apartments: a 384-unit apartment complex located on approximately 23 acres.\nAtlanta, Georgia Eagles Pointe Apartments: a 252-unit apartment complex located on approximately 25 acres.\nSan Antonio, Texas Songbird Apartments, Phase I and Phase II: a 262-unit apartment complex located on approxi- mately 13 acres.\n* Owned by the Registrant through a joint venture with the seller.\nEach of the above properties is held subject to various mortgage loans.\nIn the opinion of the General Partner, the Registrant has provided for adequate insurance coverage for its real estate investment properties.\nSee Note 7 of Notes to Financial Statements for other information regarding real property investments.\nItem 3.","section_3":"Item 3. Legal Proceedings - -------------------------\nIn 1981, a joint venture consisting of the Registrant as general partner and the seller as limited partner (the \"Joint Venture\") acquired the Balcones Woods Apartments. In 1983, an affiliate of the seller (together, the \"Seller\") sold another property to a joint venture affiliated with the Registrant (the \"Affiliate\"). In 1987, the Joint Venture and the Affiliate filed suit against the Seller, two principals of the Seller and other parties in the 285th District Court, Bexar County, Texas, Case No.: 87-CI-11919, DO Associates, et al. vs. ADC Development Co., et al seeking to recover amounts from the Seller under the management and guarantee agreements and for construction defects at the properties.\nThe case went to trial in April 1992 and the jury found for the Joint Venture and the Affiliate on certain counts and against them on other counts. The jury awarded the Joint Venture $205,860 and the Affiliate $195,654, which was less than requested. The Joint Venture and the Affiliate filed a notice of appeal in October 1993, in the Fourth Court of Appeals, State of Texas, San Antonio (Appeal No.: 04-93-00718-CV). In January 1995, a motion was filed in the Appellate Court to stay the appeal so that settlement discussions could proceed. In February 1996, a settlement was completed pursuant to which the Seller has paid the Joint Venture and the Affiliate $216,750 and $208,250, respectively.\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 1995.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Stockholder - ------------------------------------------------------------------------- Matters - -------\nThere has not been an established public market for Limited Partnership Interests and it is not anticipated that one will develop; therefore, the market value of the Limited Partnership Interests cannot reasonably be determined. For information regarding distributions, see Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.\nAs of December 31, 1995, the number of record holders of Limited Partnership Interests of the Registrant was 7,875.\nItem 6.","section_6":"Item 6. Selected Financial Data - -------------------------------\nYear ended December 31, --------------------------------------------------------- 1995 1994 1993 1992 1991 ---------- ---------- ----------- ----------- -----------\nTotal income $7,524,577 $8,392,007 $ 9,010,969 $12,403,715 $15,242,595\nIncome (loss) before net gains on sales of assets, write- off of real estate commissions and extraordinary items 759,384 (100,170) (950,479) (1,003,918) (2,428,716)\nNet income (loss) 4,003,564 5,423,112 3,749,327 7,502,993 (2,058,204)\nNet income (loss) per Limited Part- nership Interest 53.06 72.48 50.58 100.74 (26.18)\nTotal assets 20,030,290 26,891,815 34,122,065 44,314,508 57,514,920\nMortgage notes payable 23,603,034 28,823,037 40,714,714 51,853,415 70,438,350\nDistributions per Limited Partner- ship Interest (A) 72.95 3.45 None None None\n(A) This amount includes distributions of original capital of $63.50 per Limited Partnership Interest during the year 1995.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and - ----------------------------------------------------------------------- Results of Operations - ---------------------\nOperations - ----------\nSummary of Operations - ---------------------\nBalcor Realty Investors Ltd.-82 (the \"Partnership\") recognized net gains on sales of properties during 1993, 1994, 1995 and recognized an extraordinary gain during 1993 in connection with the forgiveness of debt related to a property sale. The timing of these transactions, resulted in a decrease in net income in 1995 as compared to 1994 and an increase in net income in 1994 as compared to 1993. Further discussion of the Partnership's operations is summarized below.\n1995 Compared to 1994 - ---------------------\nThe sales of the Bemis Square Shopping Center and the Via El Camino Apartments in February and May 1994, respectively, resulted in decreases in rental and service income, interest expense on mortgage notes payable, depreciation, amortization, property operating expenses, and property management fees during 1995 as compared to 1994. The Partnership also recognized gains in connection with the sales of these properties during 1994.\nAn increase in rental revenue at the three remaining properties due to higher rental and occupancy rates partially offset the above decrease in rental and service income during 1995 as compared to 1994.\nInterest on short-term investments increased during 1995 as compared to 1994 due to an increase in interest rates earned on short-term investments.\nDuring 1994, a liability related to tenant improvements at one of the disposed properties was written-off and recognized as other income in the financial statements.\nThe February 1995 repayment of the Meridian Hills Court Apartments wrap-around note caused a decrease in interest income on wrap-around note receivable during 1995 when compared to 1994. In addition during 1995, the Partnership recognized the final portion of the deferred gain related to this installment sale. This gain had been deferred from 1986, when the property had been sold for a cash down payment plus the wrap-around note.\nThe repayment by the Partnership of the mortgage note payable related to the Songbird Phases I and II Apartments in June 1994 and the assumption by the borrower of the mortgage note payable related to the Meridian Hills Court Apartments wrap-around note in February 1995, further contributed to the decrease in interest expense on mortgage notes payable.\nDecreased expenditures at the Eagles Pointe and Balcones Woods Apartments relating to roof repairs and interior improvements further contributed to the decrease in property operating expenses in 1995.\n1994 Compared to 1993 - ---------------------\nThe sales of the Southgate and Bemis Square shopping centers and the Via El Camino Apartments in June 1993, February 1994 and May 1994, respectively, resulted in decreases in rental and service income, interest expense on mortgage notes payable, depreciation, property operating expenses, real estate taxes and property management fees during 1994 as compared to 1993. The Partnership recognized gains in connection with these property dispositions and recognized a loss from the May 1993 sale of the 1400 North Lake Shore Drive Apartment Building, which had been in receivership since June 1992. The Partnership also recognized an extraordinary gain in 1993 due to the forgiveness of debt on the 1400 North Lake Shore Drive Apartment Building.\nAn increase in rental revenue during 1994 at the Eagles Pointe Apartments due to higher rental rates partially offset the above decrease in rental and service income.\nThe proceeds received from the October 1993 refinancings of the Balcones Woods and Songbird Phases I and II apartment complexes and the above-mentioned property sales, resulted in an increase in funds available during 1994 for short-term investments. This increase in available funds, combined with higher interest rates, resulted in an increase in interest income on short-term investments during 1994 when compared to 1993.\nAn increase in the interest rate in accordance with the terms of the Meridian Hills Court Apartments wrap-around note resulted in an increase in interest income on wrap-around note receivable during 1994 when compared to 1993.\nA reduction in the interest rate in October 1993 on the note payable related to the Songbird Phases I and II Apartments, and the subsequent repayment of this note in June 1994, further contributed to the decrease in interest expense on mortgage notes payable.\nA decrease in expenditures for painting and floor and wall covering upgrades at the Eagles Pointe Apartments during 1994 further contributed to the decrease in property operating expense. An increase in landscaping, painting, insurance and leasing costs at the Balcones Woods Apartments and higher insurance expense, and real estate tax consulting fees at the Songbird Phases I and II Apartments during 1994 substantially offset the decrease in property operating expenses due to the above mentioned property disposition.\nHigher accounting costs resulted in an increase in administrative expenses during 1994 when compared to 1993.\nLiquidity and Capital Resources - -------------------------------\nThe cash position of the Partnership decreased as of December 31, 1995 as compared to December 31, 1994. The operating activities of the Partnership include the cash flow from operations of the properties as discussed below, and interest income received on the wrap-around note receivable and short-term investments, partially offset by administrative costs. The net cash flow provided by investing activities represents the net proceeds from the repayment of the Meridian Hills Court Apartments wrap-around note receivable. Financing activities included quarterly distributions to Limited Partners including\nspecial distributions in April and October 1995, principal payments on mortgage notes payable, and capital improvement escrow activity.\nThe Partnership classifies the cash flow performance of its properties as either positive, a marginal deficit or a significant deficit, each after consideration of debt service payments unless otherwise indicated. A deficit is considered to be significant if it exceeds $250,000 annually or 20% of the property's rental and service income. The Partnership defines cash flow generated from its properties as an amount equal to the property's revenue receipts less property related expenditures, which include debt service payments. During 1995 and 1994, the Balcones Woods and Songbird Phases I and II apartment complexes generated positive cash flow. The Eagles Pointe Apartments generated positive cash flow during 1995 and a marginal cash flow deficit during 1994. The improvement in cash flow at Eagles Pointe was due primarily to a decrease in repair and maintenance expenditures. The Bemis Square Shopping Center generated positive cash flow and the Via El Camino Apartment Complex generated a marginal cash flow deficit prior to their respective sales in 1994. As of December 31, 1995, the occupancy rates of the Partnership's properties ranged from 91% to 99%.\nWhile certain of the Partnership's properties have improved the General Partner continues to pursue a number of actions aimed at improving the cash flow of the Partnership's properties including improving property operating performance, and seeking rent increases where market conditions allow.\nThe General Partner had previously advised the Limited Partners that its strategy was to sell the Partnership's remaining assets over the next two years. The General Partner also stated that the timing of the liquidation could be lengthened or shortened due to changes in market conditions, economic factors, interest rates and unforeseen events. Since November, 1995, the General Partner believes that the market for multifamily housing properties has become increasingly favorable to sellers of these properties. This belief is based on the results of the sales and marketing activities of various other partnerships affiliated with the Partnership. These favorable market conditions are in part attributable to the increasing strength of the capital markets and the re-entry of REITs into the acquisition market. The General Partner intends to begin marketing the remaining properties in the Partnership for sale. If the current market conditions for sales remain favorable and the General Partner can obtain appropriate sales prices, the Partnership's liquidation strategy may be accelerated.\nEach of the Partnership's properties is owned through the use of third-party mortgage loan financing and, therefore, the Partnership is subject to the financial obligations required by such loans. The Partnership has no third party financing which matures prior to 1998.\nDistributions to Limited Partners were reinstated beginning with the second quarter 1994 distribution. The Partnership made two distributions in 1994 totaling $3.45 and four distributions in 1995 totaling $72.95. Distributions were comprised of $9.45 of Net Cash Receipts and $63.50 of Net Cash Proceeds in 1995, and $3.45 of Net Cash Receipts in 1994. The quarterly distributions from Net Cash Receipts increased in 1995 as compared to 1994 due to improved operations of the Partnership's properties. In addition, the Partnership made special distributions of $63.50 per Interest in 1995 from the Meridian Hills wrap-around note repayment and from Net Cash Proceed reserves.\nIn January 1996, the Partnership made a distribution of $296,532 ($4.00 per Interest) to the holders of Limited Partnership Interests representing a regular quarterly distribution of Net Cash Receipts of $3.00 per Interest for the fourth quarter of 1995, and Net Cash Proceeds of $1.00 per Interest from Net Cash Proceed reserves. Including the January 1996 distribution, investors have received distributions of Net Cash Receipts of $30.90 and Net Cash Proceeds of $374.50, totaling $405.40 per $1,000 Interest, as well as certain tax benefits. The General Partner expects to continue making quarterly distributions to Limited Partners based on the current performance of the Partnership's properties. However, continued distributions will depend on cash flow from the Partnership's properties, the maintenance of adequate reserves and proceeds from future property sales, as to all 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 all of their original capital.\nIn 1995, the Financial Accounting Standards Board issued Statement No. 121 \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of\" which establishes accounting standards for impairment of long-lived assets and long-lived assets to be disposed of. This statement has been adopted by the Partnership as of January 1, 1995, and did not have a material impact on the financial position or results of operations of the Partnership.\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. The 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, 1995 December 31, 1994 ------------------------ ------------------------ Financial Tax Financial Tax Statements Returns Statements Returns ----------- ----------- ----------- ----------- Total assets $20,030,290 $17,642,989 $26,891,815 $28,024,973 Partners' capital (deficit): General Partner (3,773,519) (4,899,423) (3,843,930) (5,177,262) Limited Partners (485,660) (1,747,056) 989,189 3,067,569 Net income (loss): General Partner 70,411 581,966 50,224 1,330,149\n(A) Limited Partners 3,933,153 593,373 5,372,888 6,521,930 (A) Per Limited Partnership Interest 53.06 8.00 72.48 87.98\n(A) Includes a net long term capital gain of $8,404,796 for 1994.\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-XI, 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 Senior Vice President Alexander J. Darragh Senior Vice President Josette V. Goldberg Senior Vice President Alan G. Lieberman Senior Vice President, Chief Brian D. Parker Financial Officer, Treasurer and Assistant Secretary Senior Vice President John K. Powell, Jr.\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. He is also Senior Vice President of American Express Company and is responsible for its real estate operations worldwide. 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.\nAlexander J. Darragh (February 1955) joined Balcor in September 1988 and is responsible for due diligence analysis and real estate advisory services for Balcor and American Express Company. He also has supervisory responsibility for Balcor's environmental matters. Mr. Darragh received masters' degrees in Urban Geography from Queen's University and in Urban Planning from Northwestern University.\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 MIS functions. 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 Balcor's property sales and capital markets functions. Mr. Lieberman is a Certified Public Accountant.\nBrian D. Parker (June 1951) joined Balcor in March 1986 and, as Chief Financial Officer and Chief Accounting Officer, is responsible for Balcor's financial, legal and treasury functions. He is a Director of The Balcor Company. 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 portfolio and asset management matters relating to Balcor's partnerships. Mr. Powell also has supervisory responsibility for Balcor's risk management and investor services functions. He received a Master of Planning degree from the University of Virginia. Mr. Powell 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.\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 1995.\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 Balcor Partners - XI, 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 9 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) The following entity is the sole Limited Partner which owns beneficially more than 5% of the outstanding Limited Partnership Interests of the Registrant:\nName and Amount and Address of Nature of Percent Beneficial Beneficial of Title of Class Owner Ownership Class - ----------------------------------------------------------------------------- Limited WIG 82 6,457 8.71% Partnership Partners Limited Interests Chicago, Partnership Illinois Interests\n(b) Neither Balcor Partners-XI nor its officers or partners own any Limited Partnership Interests of the Registrant.\nRelatives and affiliates of the officers and partners of the General Partner own 25 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 3 of Notes to Financial Statements for information relating to the Partnership Agreement and the allocation of distributions and profits and losses.\nSee Note 9 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 Schedule, and Reports on Form 8-K - ------------------------------------------------------------------------ (a) (1 & 2) See Index to Financial Statements and Financial Statement Schedule in this Form 10-K.\n(3) Exhibits:\n(3) The Amended and Restated Agreement of Limited Partnership set forth as Exhibit 3 to Post-Effective Amendment No. 1 to the Registrant's Registration Statement on Form S-11 dated January 15, 1982 (Registration No. 2-74358), is incorporated herein by reference.\n(4) Certificate of Limited Partnership set forth as Exhibit 4.1 to Amendment No. 1 to the Registrant's Registration Statement on Form S-11 dated December 11, 1981 (Registration No. 2-74358), 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. 0-11127) are incorporated herein by reference.\n(10) Material Contracts:\n(i) The Agreement of Sale of Via El Camino Apartments, Phoenix, Arizona, included as Exhibit 2 to the Registrant's Report on Form 8-K dated April 13, 1994 is incorporated herein by reference.\n(27) Financial Data Schedule of the Registrant for 1995 is attached hereto.\n(b) Reports on Form 8-K: No reports on Form 8-K were filed during the quarter ended December 31, 1995.\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 LTD.-82\nBy: \/s\/Brian D. Parker --------------------------- Brian D. Parker Senior Vice President, and Chief Financial Officer (Principal Accounting and Financial Officer) of Balcor Partners-XI, the General Partner\nDate: March 29, 1996 ------------------\nPursuant to the requirements of the Securities Exchange Act of 1934, 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-XI, \/s\/Thomas E. Meador the General Partner March 29, 1996 - -------------------- -------------- Thomas E. Meador\nSenior Vice President, and Chief Financial Officer (Principal Accounting and Financial Officer) of Balcor Partners-XI, the \/s\/Brian D. Parker General Partner March 29, 1996 - -------------------- -------------- Brian D. Parker\nINDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE\nReport of Independent Accountants\nFinancial Statements:\nBalance Sheets, December 31, 1995 and 1994\nStatements of Partners' Deficit, for the years ended December 31, 1995, 1994 and 1993\nStatements of Income and Expenses, for the years ended December 31, 1995, 1994 and 1993\nStatements of Cash Flows, for the years ended December 31, 1995, 1994 and 1993\nNotes to Financial Statements\nFinancial Statement Schedule:\nIII - Real Estate and Accumulated Depreciation, as of December 31, 1995\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 Ltd.-82:\nWe have audited the financial statements and the financial statement schedule of Balcor Realty Investors Ltd.-82 (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 Ltd.-82 at December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, 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 23, 1996\nBALCOR REALTY INVESTORS LTD.-82 (An Illinois Limited Partnership)\nBALANCE SHEETS December 31, 1995 and 1994\nASSETS\n1995 1994 ------------- ------------- Cash and cash equivalents $ 1,585,311 $ 4,292,726 Restricted investments 1,230,000 1,230,000 Escrow deposits 790,489 1,149,063 Accounts and accrued interest receivable 17,823 112,860 Prepaid expenses 66,598 Wrap-around note receivable 6,150,000 Deferred gain on sale of property (3,244,180) Deferred expenses, net of accumulated amortization of $164,686, in 1995 and $175,843 in 1994 490,194 569,532 ------------- ------------- 4,180,415 10,260,001 ------------- ------------- Investment in real estate: Land 3,452,798 3,452,798 Buildings and improvements 25,174,333 25,174,333 ------------- ------------- 28,627,131 28,627,131 Less accumulated depreciation 12,777,256 11,995,317 ------------- ------------- Investment in real estate, net of accumulated depreciation 15,849,875 16,631,814 ------------- ------------- $ 20,030,290 $ 26,891,815 ============= =============\nLIABILITIES AND PARTNERS' (DEFICIT) CAPITAL\nAccounts payable $ 40,387 $ 140,229 Due to affiliates 20,633 97,841 Accrued liabilities, principally real estate taxes 490,554 520,304 Escrow liabilities 39,877 Security deposits 134,861 125,268 Mortgage notes payable 23,603,034 28,823,037 ------------- ------------- Total liabilities 24,289,469 29,746,556 ------------- ------------- Limited Partners' (deficit) capital (74,133 Interests issued and outstanding) (485,660) 989,189 General Partners' deficit (3,773,519) (3,843,930) ------------- ------------- Total partners' deficit (4,259,179) (2,854,741) ------------- ------------- $ 20,030,290 $ 26,891,815 ============= =============\nThe accompanying notes are an integral part of the financial statements.\nBALCOR REALTY INVESTORS LTD.-82 (An Illinois Limited Partnership)\nSTATEMENTS OF PARTNERS' DEFICIT for the years ended December 31, 1995, 1994 and 1993\nPartners' (Deficit) Capital Accounts ----------------------------------------- General Limited Total Partner Partners ------------- ------------- -------------\nBalance at December 31, 1992 $(11,771,422) $ (3,893,628) $ (7,877,794)\nNet income (loss) for the year ended December 31, 1993 3,749,327 (526) 3,749,853 ------------- ------------- ------------- Balance at December 31, 1993 (8,022,095) (3,894,154) (4,127,941)\nCash distributions to Limited Partners(A) (255,758) (255,758)\nNet income for the year ended December 31, 1994 5,423,112 50,224 5,372,888 ------------- ------------- ------------- Balance at December 31, 1994 (2,854,741) (3,843,930) 989,189\nCash distributions to Limited Partners(A) (5,408,002) (5,408,002)\nNet income for the year ended December 31, 1995 4,003,564 70,411 3,933,153 ------------- ------------- ------------- Balance at December 31, 1995 $ (4,259,179) $ (3,773,519) $ (485,660) ============= ============= =============\n(A) Summary of cash distributions paid per Limited Partnership Interest:\n1995 1994 1993 ------------- ------------- ------------- First Quarter $ 1.725 None None Second Quarter $ 41.725 None None Third Quarter $ 3.000 $ 1.725 None Fourth Quarter $ 26.500 $ 1.725 None\nThe accompanying notes are an integral part of the financial statements.\nBALCOR REALTY INVESTORS LTD.-82 (An Illinois Limited Partnership)\nSTATEMENTS OF INCOME AND EXPENSES for the years ended December 31, 1995, 1994 and 1993\n1995 1994 1993 ------------- ------------- ------------- Income: Rental and service $ 7,127,459 $ 7,188,617 $ 8,304,686 Interest on short-term investments 304,405 247,640 145,095 Interest on wrap-around notes receivable 92,713 655,750 561,188 Other income 300,000 ------------- ------------- ------------- Total income 7,524,577 8,392,007 9,010,969 ------------- ------------- ------------- Expenses: Interest on mortgage notes payable 2,067,794 2,834,551 3,766,507 Depreciation 781,939 849,210 1,066,030 Amortization of deferred expenses 79,338 93,449 84,659 Property operating 2,387,812 3,167,857 3,428,446 Real estate taxes 615,826 649,662 711,189 Property management fees 341,872 358,941 424,476 Administrative 490,612 538,507 480,141 ------------- ------------- ------------- Total expenses 6,765,193 8,492,177 9,961,448 ------------- ------------- ------------- Income (loss) before net gains on sales of properties and extra- ordinary item 759,384 (100,170) (950,479) Net gains on sales of properties 3,244,180 5,523,282 367,183 ------------- ------------- ------------- Income (loss) before extraordinary item: 4,003,564 5,423,112 (583,296) Extraordinary item: Gain on forgiveness of debt 4,332,623 ------------- ------------- ------------- Net income $ 4,003,564 $ 5,423,112 $ 3,749,327 ============= ============= ============= Income (loss) before extraordinary item allocated to General Partner $ 70,411 $ 50,224 $ (43,852) ============= ============= ============= Income (loss) before extraordinary item allocated to Limited Partner $ 3,933,153 $ 5,372,888 $ (539,444) ============= ============= ============= Income (loss) before extraordinary item Per Limited Partnership Interest (74,133 issued and outstanding) $ 53.06 $ 72.48 $ (7.28) ============= ============= ============= Extraordinary item allocated to General Partner None None $ 43,326 ============= ============= ============= Extraordinary item allocated to Limited Partners None None $ 4,289,297 ============= ============= ============= Extraordinary item per Limited Partnership Interest (74,133 issued and outstanding) None None $ 57.86 ============= ============= ============= Net income (loss) allocated to General Partner $ 70,411 $ 50,224 $ (526) ============= ============= ============= Net income allocated to Limited Partners $ 3,933,153 $ 5,372,888 $ 3,749,853 ============= ============= ============= Net income per Limited Partnership Interest (74,133 issued and outstanding) $ 53.06 $ 72.48 $ 50.58 ============= ============= =============\nThe accompanying notes are an integral part of the financial statements.\nBALCOR REALTY INVESTORS LTD.-82 (An Illinois Limited Partnership)\nSTATEMENTS OF CASH FLOWS for the years ended December 31, 1995, 1994 and 1993\n1995 1994 1993 ------------- ------------- ------------- Operating activities: Net income $ 4,003,564 $ 5,423,112 $ 3,749,327 Adjustments to reconcile net income to net cash provided by or used in operating activities: Gains on sales of properties (3,244,180) (5,523,282) (367,183) Gain on forgiveness of debt (4,332,623) Other income (300,000) Depreciation of properties 781,939 849,210 1,066,030 Amortization of deferred expenses 79,338 93,449 84,659 Net change in: Escrow deposits 42,541 84,996 (582,707) Accounts and accrued interest receivable 95,037 (26,409) 3,678 Prepaid expenses (66,598) Accounts payable (99,842) 12,849 (168,041) Due to affiliates (77,208) 30,910 (21,742) Accrued liabilities (29,750) (258,448) 23,538 Escrow liabilities (39,877) 26,251 2,838 Security deposits 9,593 (17,489) 3,487 ------------- ------------- ------------- Net cash provided by or used in operating activities 1,454,557 395,149 (538,739) ------------- ------------- ------------- Investing activities: Proceeds from repayment of wrap-around note received in connection with sale of real estate 1,342,445 Proceeds from sales of properties 7,897,882 11,664,858 Payment of selling costs (320,159) (120,599) Improvements to properties (266,691) Purchase of restricted investments (1,230,000) ------------- ------------- ------------- Net cash provided by investing activities 1,342,445 7,577,723 10,047,568 ------------- ------------- ------------- Financing activities: Distributions to Limited Partners (5,408,002) (255,758) Repayment of mortgage notes payable (5,530,000) (23,686,375)\nRepayment of mortgage note payable - affiliate (2,323,345) Proceeds from refinancings of mortgage notes payable 16,925,000 Principal payments on mortgage notes payable (412,448) (436,214) (352,338) Funding of capital improvement escrows (135,675) (129,200) (740,758) Disbursements from capital improvement escrows 451,708 545,754 33,285 Payment of deferred expenses (626,381) ------------- ------------- ------------- Net cash used in financing activities (5,504,417) (8,128,763) (8,447,567) ------------- ------------- ------------- Net change in cash and cash equivalents (2,707,415) (155,891) 1,061,262 Cash and cash equivalents at beginning of year 4,292,726 4,448,617 3,387,355 ------------- ------------- ------------- Cash and cash equivalents at end of year $ 1,585,311 $ 4,292,726 $ 4,448,617 ============= ============= =============\nThe accompanying notes are an integral part of the financial statements.\nBALCOR REALTY INVESTORS LTD.-82 (An Illinois Limited Partnership)\nNOTES TO FINANCIAL STATEMENTS\n1. Nature of the Partnership's Business:\nBalcor Realty Investors Ltd.-82 is engaged principally in the operation of residential real estate located in Austin, Texas, San Antonio, Texas and Atlanta, Georgia.\n2. Accounting Policies:\n(a) The preparation of the financial statements in conformity with generally accepted accounting principles requires the General Partner 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 vary from those estimates.\n(b) Depreciation expense is computed using straight-line and accelerated methods. Rates used in the determination of depreciation are based upon the following estimated useful lives:\nYears -----\nBuildings and improvements 20 to 30 Furniture and fixtures 5\nDepreciation expense for tenant improvements was 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.\nInterest incurred while properties were under construction was capitalized.\nAs properties are sold, the related costs and accumulated depreciation are removed from the respective accounts. Any gain or loss on disposition is recognized in accordance with generally accepted accounting principles. Deferred gains on sales of properties result from prior year sales being recorded under the installment method. Gains are recognized (based on the gross profit percentage) as future sales proceeds are collected.\n(c) Effective january 1, 1995 the partnership adopted Statement of Financial Accounting Standards, No. 121 (SFAS 121), \"Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of.\" Under SFAS 121, the Partnership records its investments in real estate at the lower of cost or fair value, and periodically assesses, but not less than on an annual basis, possible impairment to the value of its properties. The General Partner estimates the fair value of its properties by dividing the property's expected net operating income by a risk adjusted rate of return which considers economic and demographic conditions in the market. In the event the General Partner determines an impairment in value has occurred, and the carrying amount of the real estate asset will not be recovered, a provision is recorded to reduce the carrying basis of the property to its estimated fair value. The General Partner\nconsiders the method referred to above to result in a reasonable measurement of a property's fair value, unless other factors affecting the property's value indicate otherwise.\n(d) Deferred expenses consist of financing fees which are amortized over the terms of the respective agreements.\n(e) Cash and cash equivalents include all highly liquid investments with an original maturity of three months or less when purchased.\n(f) The Financial Accounting Standard Board's Statement No. 107, \"Disclosures About Fair Value of Financial Instruments\", requires disclosure of fair value information about financial instruments for which it is practicable to estimate that value. Since quoted market prices are not available for the Partnership's financial instruments, fair values have been based on estimates using present value techniques. These techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, may not be realized in immediate settlement of the instrument. Statement No. 107 does not apply to all balance sheet items and excludes certain financial instruments and all non-financial instruments such as real estate and investment in joint ventures from its disclosure requirements.\n(g) The Partnership is not liable for Federal income taxes and each partner recognizes his proportionate share of the Partnership income or loss in his tax return; therefore, no provision for income taxes is made in the financial statements of the Partnership.\n(h) Revenue is recognized on an accrual basis in accordance with generally accepted accounting principles.\n(i) A reclassification has been made to the previously reported 1994 and 1993 financial statements to conform with the classification used in 1995. This reclassification has not changed the 1994 and 1993 results.\n3. Partnership Agreement:\nThe Partnership was organized during June 1981. The Partnership Agreement provides for Balcor Partners-XI to be the General Partner and for the admission of Limited Partners through the sale of up to 75,000 Limited Partnership Interests at $1,000 per Interest, 74,133 of which were sold on or prior to May 29, 1982, the termination date of the offering.\nThe Partnership Agreement generally provides that the General Partner will be allocated 5% of the profits and losses. Profits and losses from property dispositions will be allocated 1% to the General Partner and 99% to Limited Partners. One hundred percent of Net Cash Receipts available for distribution shall be distributed to the holders of Interests. In addition, there shall be accrued for the benefit of the General Partner as its distributive share from operations, an amount equivalent to approximately 5% of the total Net Cash Receipts being distributed, which will be paid only out of Net Cash Proceeds. The payment of this amount to the General Partner is subordinated to the return to holders of Interests of their Original Capital plus a 3% per annum Cumulative Distribution on Adjusted Original Capital, as described below. Under certain circumstances, the General Partner may also participate in the Net Cash Proceeds from (i) the refinancing of Partnership properties and\n(ii) the sale of Partnership properties. When and as the Partnership sells or refinances its properties, the Net Cash Proceeds resulting therefrom, which are available for distribution, will be distributed only to holders of Interests until such time as holders of Interests have received an amount equal to their Original Capital plus a 3% per annum Cumulative Distribution on Adjusted Original Capital. Thereafter, the General Partner will receive 15% of further distributed Net Cash Proceeds. Such distribution will include the accrued distributive share from operations.\n4. Wrap-around Note Receivable:\nIn February 1995, the Partnership received $1,342,445 as payment in full on the wrap-around note that had been received in connection with the sale of the Meridian Hills Court Apartments. This note had matured in November 1994, but the Partnership granted the borrower an extension. The amount received represented the wrap-around note balance of $6,150,000, less the underlying mortgage note balance which was $4,807,555 at the time of the repayment. The liability for the underlying mortgage note was assumed by the purchaser of the property. As a result of this repayment, the Partnership recognized the remaining deferred gain of $3,244,180 from the property sale in its 1995 financial statements. The Partnership had recognized interest income related to this wrap-around note during 1995, 1994 and 1993.\n5. Mortgage Notes Payable:\nMortgage notes payable at December 31, 1995 and 1994 consisted of the following:\nSee note (A) following.\n(A) In February 1995, the note which wraps around the mortgage note payable was repaid in full. The liability for the underlying mortgage note was assumed by the purchaser of the property. See Note 4 of Notes to Financial Statements for additional information.\nReal estate with an aggregate carrying value of $15,849,875 at December 31, 1995 was pledged as collateral for repayment of mortgage loans.\nThe Partnership's loans described above require current monthly payments of principal and interest.\nThe Partnership incurred and paid interest expense on non-affiliated mortgage notes payable of $2,067,794, $2,792,114 and $3,551,828 during 1995, 1994 and 1993, respectively.\nFuture annual maturities of the above mortgage notes payable during each of the next five years are approximately as follows:\n1996 $ 442,000 1997 465,000 1998 7,167,000 1999 348,000 2000 376,000\n6. Management Agreements:\nAs of December 31, 1995, all of the properties owned by the Partnership are under management agreements with a third-party management company. These management agreements provide for annual fees of 5% of gross operating receipts.\n7. Seller's Participation in Joint Venture:\nThe Balcones Woods Apartments is owned by a joint venture between the Partnership and the seller. Consequently, the property seller retains an interest in the property through its interest in the joint venture. All assets, liabilities, income and expenses of the joint venture are included in the financial statements of the Partnership with the appropriate adjustment, if any, for the seller's participation in the joint venture.\n8. 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 income for 1995 in the financial statements is $2,828,225 more than the tax income of the Partnership for the same period.\n9. Transactions with Affiliates:\nFees and expenses paid and payable by the Partnership to affiliates are:\nYear Ended Year Ended Year Ended 12\/31\/95 12\/31\/94 12\/31\/93 ----------------- ----------------- ----------------- Paid Payable Paid Payable Paid Payable ------ --------- ------ --------- ------ --------- Property manage- ment fees None None $336,869 None $424,534 $35,260 Reimbursement of expenses to General Partner, at cost: Accounting $48,142 $4,054 66,482 $25,801 58,691 4,849 Data processing 23,877 1,627 44,605 10,907 32,306 6,148 Investor com- munications 6,608 None 20,355 5,898 18,645 1,541 Legal 21,721 2,539 10,594 8,392 15,634 1,292 Portfolio management 109,487 12,306 65,643 39,974 77,270 16,561 Other 8,284 107 12,668 6,869 15,490 1,280\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; however, the General Partner is reimbursed for expenses. The Partnership paid premiums to the deductible insurance program of $52,047, $66,189, and $46,181 in 1995, 1994 and 1993, respectively.\nAllegiance Realty Group, Inc., an affiliate of the General Partner, managed all of the Partnership's properties until the affiliate was sold to a third party in November 1994.\nIn June 1994, the Partnership used cash reserves to repay the $2,323,345 note payable related to the Songbird Phases I and II Apartments which was outstanding from Balcor Real Estate Holdings, Inc., an affiliate of the General Partner. The Partnership incurred interest expense of $42,437 and $214,679 and paid interest expense of $72,120 and $206,003 on this loan during 1994 and 1993, respectively.\nThe Partnership was required to post a $1,230,000 letter of credit as additional collateral for the Eagles Pointe Apartments mortgage note payable. An affiliate of the General Partner originally had been providing a guarantee for this letter of credit. During 1993, the Partnership pledged $1,230,000 from its cash reserves as cash collateral for the letter of credit in place of the affiliate's guarantee. 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 this amount accumulates for the benefit of the Partnership.\n10. Property Sales:\n(a) In May 1994, the Partnership sold the Via El Camino Apartments for $7,150,000. From the proceeds of the sale, the Partnership paid $5,530,000 in full satisfaction of the property's first mortgage loan. The basis of the property sold was $3,841,250, net of accumulated depreciation of $2,536,427. For financial statement purposes, the Partnership recognized a gain of $3,147,866 from the sale of the property.\n(b) In February 1994, the Partnership sold the Bemis Square Shopping Center, including a leasehold interest in a portion of the land, for $4,350,000. The purchaser assumed the existing first mortgage loan of $3,602,118. The basis of the property sold was $1,815,309, net of accumulated depreciation of $1,579,016. For financial statement purposes, the Partnership recognized a gain of $2,375,416 from the sale of the property.\n(c) In June 1993, the Partnership sold the Southgate Shopping Center for $2,600,000. The purchaser assumed the existing first mortgage loan of $2,135,142. The basis of the property sold was $1,736,952, net of accumulated depreciation of $1,335,655. For financial statement purposes, the Partnership recognized a gain of $832,295 from the sale of the property.\n(d) In May 1993, the Partnership sold the 1400 North Lake Shore Drive Apartment Building for $11,200,000. The Partnership paid net proceeds of $11,110,154 after selling costs in full satisfaction of the outstanding first mortgage loan, accrued interest and real estate tax advances due to an affiliate of the General Partner. In March 1993, the first mortgage loan was purchased by this affiliate, which had also advanced the funds in April 1993 to pay the delinquent real estate taxes on the property. The balance of the first mortgage loan was $13,000,000 and the accrued interest expense and real estate taxes totaled $2,442,777, net of escrows of $200,372 withheld by the first mortgage holder. For financial statement purposes, the Partnership recognized an extraordinary gain of $4,332,623 relating to the forgiveness of debt. The basis of the property was $11,575,266, net of accumulated depreciation of $927,147. For financial statement purposes, a loss of $465,112 was recognized from the sale of the property.\n11. Extraordinary Item:\nThe Partnership recognized an extraordinary gain on forgiveness of debt in 1993 related to the 1400 North Lake Shore Drive Apartment Building. See Note 10 for additional information.\n12. Fair Value of Financial Instruments\nThe carrying amounts and fair values of the Partnership's financial instruments at December 31, 1995 are as follows:\nThe carrying value of cash and cash equivalents, accounts and accrued interest receivable, accounts payable and restricted investments approximate fair value.\nBased on borrowing rates available to the Partnership at the end of 1995 for mortgage loans with similar terms and maturities, the fair value of the mortgage notes payable approximates the carrying value.\n13. Subsequent Event:\n(a) In January 1996, the Partnership made a distribution of $296,532 ($4.00 per Interest) to the holders of Limited Partnership Interests representing a quarterly distribution of Net Cash Receipts of $3.00 per Interest for the fourth quarter of 1995 and a special distribution of $1.00 per Interest from Net Cash Proceeds reserves.\n(b) The Partnership reached a settlement with the seller of the Balcones Woods Apartments in February 1996. In connection with this settlement, the partnership received $216,750 representing amounts due from the seller under the management and guarantee agreement as well as construction defects at the property.\nBALCOR REALTY INVESTORS LTD.-82 (An Illinois Limited Partnership)\nSee notes (a) through (e) following.\nBALCOR REALTY INVESTORS LTD.-82 (An Illinois Limited Partnership)\nSee notes (a) through (e) following.\nBALCOR REALTY INVESTORS LTD.-82 (An Illinois Limited Partnership)\nNOTES TO SCHEDULE III\n(a) Consists of legal fees, appraisal fees, title costs, other related professional fees and capitalized construction period interest.\n(b) The aggregate cost of land for Federal income tax purposes is $3,052,213 and the aggregate cost of buildings and improvements for Federal income tax purposes is $23,414,026. The total of these is $26,466,239.\n(c) Reconciliation of Real Estate ----------------------------- 1995 1994 1993 ---------- ---------- ---------- Balance at beginning of year $28,627,131 $38,399,133 $53,707,462 Additions during year: Capital improvements 266,691\nDeductions during year: Cost of real estate sold (9,772,002) (15,575,020) ----------- ----------- ----------- Balance at end of year $28,627,131 $28,627,131 $38,399,133 =========== =========== ===========\nReconciliation of Accumulated Depreciation ------------------------------------------ 1995 1994 1993 ----------- ---------- -----------\nBalance at beginning of year $11,995,317 $15,261,550 $16,458,322 Depreciation expense for the year 781,939 849,210 1,066,030\nAccumulated depreciation of real estate sold (4,115,443) (2,262,802) ----------- ------------ ------------ Balance at end of year $12,777,256 $11,995,317 $15,261,550 =========== ============ ============\n(d) See descriptions of mortgage notes payable in Note 5 of Notes to Financial Statements.\n(e) Depreciation expense is computed based upon the following estimated useful lives:\nYears -----\nBuildings and improvements 20 to 30 Furniture and fixtures 5\nDepreciation expense for tenant improvements is computed using a straight-line method over the term of the lease.","section_15":""}
{"filename":"318779_1995.txt","cik":"318779","year":"1995","section_1":"ITEM 1 -- BUSINESS\nGENERAL\nTHE COMPANY\nCalifornia Bancshares, Inc. (the \"Company\") was incorporated under the laws of the State of California in 1969, reincorporated under the laws of Delaware in 1971 and was approved as a bank holding company under the Bank Holding Company Act (\"BHC Act\") by the Federal Reserve Board in 1971. It was known as Alameda Bancorporation until 1990 and as Northern California Community Bancorporation (\"NCCBI\") from then until its merger with Mission-Valley Bancorp in 1991. The Company has ten (10) banking subsidiaries: Alameda First National Bank, The Bank of Milpitas, N.A., The Bank of San Ramon Valley, Centennial Bank (which was subsequently merged into Alameda First National Bank in 1996), Commercial Bank of Fremont, Community First National Bank, Concord Commercial Bank, Lamorinda National Bank, Modesto Banking Company and Westside Bank, collectively (the \"Banks\").\nThe Company also has three (3) non-banking subsidiaries: CBI Mortgage, which engages primarily in the origination of real estate loans for investors, Island Bancorp. Leasing, Inc., which engaged primarily in the leasing of imported automobiles but is currently inactive, and LNB Corp. which serves as a third-party trustee for deeds of trust originated or held by the Banks. The Company owns 100% of the issued and outstanding capital stock of the subsidiaries.\nThe Company itself does not engage in any business activities other than ownership of the above-mentioned subsidiaries and provides accounting, data processing and other management services to its subsidiaries.\nBUSINESS OF THE BANKS\nGENERAL\nThe Banks conduct their business through thirty-six (36) offices located throughout Alameda, Contra Costa, Santa Clara, San Joaquin and Stanislaus counties, in Northern California. They offer individuals and businesses services commonly associated with full-service banking institutions, with the exception of international banking and trust services. Eight of the Banks are members of the Federal Reserve System (the \"FRS\"). The deposits of each depositor of each of the Banks are insured by the Federal Deposit Insurance Corporation (the \"FDIC\") up to $100,000.\nThe Banks also maintain correspondent relationships with a number of major banks located within California.\nEMPLOYEES\nAt December 31, 1995 the Company and its subsidiaries had 564 full-time and 185 part-time employees. None of the Company's employees are presently represented by a union or covered under a collective bargaining agreement.\nCOMPETITION\nThe banking business in California generally, and in the Company's and its subsidiaries' primary service areas specifically, is highly competitive with respect to loans and deposits and is dominated by a relatively small number of major banks with many offices operating over a wide geographic area. Among the advantages such major banks have over the Company and its subsidiaries is their ability to finance wide ranging advertising campaigns and to allocate their investment assets to regions of highest yield and demand. Such banks offer certain services such as trust services and international banking services which are not offered directly by the Banks (but are offered indirectly through correspondent institutions) and, by virtue of their greater total capitalization (legal lending limits to an individual customer are limited to a percentage of a bank's total capital accounts), such banks have\nsubstantially higher lending limits than the Banks. Other entities, both governmental and private, seeking to raise capital through the issuance and sale of debt or equity securities, as well as money market mutual funds, also provide competition for the Banks in the acquisition of deposits. These competitors include savings and loan associations, finance companies, money market funds, brokerage houses, credit unions and non-financial institutions.\nSUPERVISION AND REGULATION\nThe Company, as a bank holding company, is subject to regulation under the BHC Act, as amended and is registered with the Federal Reserve Board under the BHC Act. The acquisition of more than 5% of the voting shares of any bank (not already majority owned) requires the prior approval of the Federal Reserve Board. The BHC Act also prohibits the Federal Reserve Board from approving an application which would result in the Company acquiring all or substantially all the assets or more than 5% of the voting shares of any bank (not already majority owned) located outside of California unless an acquisition of such bank by a California-based bank holding company is specifically authorized by the laws of the state in which the bank is located. The laws of several states permit such acquisitions. The BHC Act also prohibits the Company, with certain exceptions, from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company which is not a bank and from engaging in any business other than that of banking, managing and controlling banks or furnishing services to its Banks, except that the Company may engage in, and may own shares of companies engaged in, certain businesses found by the Federal Reserve Board to be so closely related to banking \"as to be a proper incident thereto.\" The BHC Act does not place territorial restrictions on the activities of non-bank subsidiaries of bank holding companies. The Company is required by the BHC Act to file annual reports of its operations with the Federal Reserve Board and is subject to examination by the Federal Reserve Board.\nThe Banks, as subsidiaries of the Company within the meaning of Section 23A of the Federal Reserve Act, are subject to certain restrictions on loans to the Company or its non-bank subsidiaries, or investments in the stock or other securities of the Company or its non-bank subsidiaries and on advances to any borrower collateralized by such stock or other securities. Further, the Banks are also subject to certain restrictions on most types of transactions with the Company or its non-bank subsidiaries, requiring that the terms of such transactions be substantially equivalent to terms of similar transactions with non-affiliated firms.\nFour of the Banks are national banks and six are California state-chartered banks. State banks are subject to regulation, supervision and regular examination by the California State Banking Department (the \"Department\"). Four of the state-chartered Banks are members of the FRS and are also subject to regulation, supervision and examination by the Federal Reserve Board. Two of the state-chartered banks are subject to regulation, supervision and examination by the FDIC. National banks are chartered by and are subject to regulation, supervision and examination by the Office of the Comptroller of the Currency (the \"OCC\"). The regulations of these agencies govern most aspects of the Banks' business, including the making of periodic reports by the Banks and the Banks' activities relating to investments, loans, borrowings, certain check-clearing activities, branching, mergers and acquisitions, reserves against deposits and numerous other areas.\nRegulations and policies of the Federal Reserve Board require the Company to serve as a source of financial and managerial strength to its Banks. It is the Federal Reserve Board's policy that a bank holding company should stand ready to use available resources to provide adequate capital funds to a subsidiary bank during periods of financial stress or adversity and should maintain the financial flexibility and capital-raising capacity to obtain additional resources for assisting a subsidiary bank. Under certain conditions, the Federal Reserve Board may conclude that certain actions of a bank holding company, such as payment of cash dividends, would constitute an unsafe and unsound practice because they violate the Federal Reserve Board's \"source of financial and managerial strength\" doctrine.\nThe Company is a legal entity separate and distinct from the Banks. The principal source of the Company's revenues is dividends and management fees received from the Banks. Various statutory provisions limit the amount of dividends the Banks can pay without regulatory approval, and various regulations also restrict the payment of dividends.\nIn 1989, Congress enacted a law that purports to make banks liable to the FDIC for expenses the FDIC incurs in the case of either its provision of financial assistance to, or the failure of, any affiliated bank. Under that law, the Banks could theoretically be held liable to the FDIC in the event of financial assistance to, or failure of, any other Bank, and that liability could be substantial enough to cause the surviving Banks either to require financial assistance from the FDIC or to cause the failure of such Banks.\nOn December 19, 1991, comprehensive legislation was enacted that reforms the regulation and supervision of banks and bank holding companies. Among the more significant aspects of the legislation is a requirement that federal regulators prescribe standards relating to internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, employee, director and principal shareholder compensation, fees and benefits, standards specifying a maximum ratio of classified assets to capital, minimum earnings sufficient to absorb losses without impairing capital, and to the extent possible, a minimum ratio of market value to book value of publicly traded shares of bank holding companies, such as the Company. The legislation also provides for a system of early intervention by the regulators and prompt corrective action at troubled banks. Under that system, a bank may not pay dividends if its capital fails to meet any required minimum and will be expected to submit to its regulator an acceptable plan to restore its capital to adequate levels. While a bank is undercapitalized, its regulator may preclude its growth, require its recapitalization through the sale of shares, require its acquisition or merger, prohibit its parent from paying dividends, and require divestitures by its parent, including divestiture of the bank itself. Its parent holding company will be expected to guarantee that the bank will comply with the bank's capital restoration plan until the bank has been adequately capitalized, on average, for four consecutive quarters, unless the parent is to accept loss or closure of the bank by regulators. This 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 compliance with all applicable capital standards.\nIf the bank does not submit an acceptable capital restoration plan or if its parent holding company does not guarantee such plan, the regulators will be required to take one or more actions, including requiring recapitalization of the bank through its sale of securities or forced sale or merger, restricting transactions with affiliates, restricting interest rates paid on deposits, restricting asset growth, restructuring activities, replacing management of the bank, prohibiting deposits from correspondent banks, requiring prior approval of dividends by the holding company, and requiring divestiture. The law requires the regulators, in such cases, to require the sale of securities by the bank or to force a sale or merger of the bank, to restrict affiliate transactions, and to restrict interest rates unless the regulator determines that these actions would not resolve the problems of the bank at the least possible long-term loss to the Bank Insurance Fund of the FDIC. The law also limits advances to any undercapitalized bank by any Federal Reserve Bank from being outstanding more than 60 days in any 120-day period unless the head of the bank regulatory agency certifies that, giving due regard to economic conditions and circumstances in the market in which the bank operates, the bank is not expected to become critically undercapitalized and is not expected to be placed in conservatorship or receivership. None of the Company's Banks are undercapitalized.\nThe foregoing references to applicable statutes and regulations are brief summaries thereof, which do not purport to be complete and are qualified in their entirety by reference to such statutes and regulations.\nFrom time to time various bills are introduced in the United States Congress which could result in additional or in less regulation of the business of the Company and the Banks. It cannot be predicted whether any such legislation will be adopted or how such adoption would affect the business of the Company and Banks.\nThe Federal Reserve Board has established risk-based capital guidelines for bank holding companies. The guidelines define Tier 1 Capital and Total Capital. Tier 1 Capital consists of common and qualifying preferred shareholders' equity, before unrealized gains and losses on available-for-sale debt securities and minority interests in equity accounts of consolidated subsidiaries, less goodwill, other nonqualifying intangibles, excess deferred tax assets and 50% of investments in unconsolidated subsidiaries. Total Capital consists of, in addition to Tier 1 Capital, mandatory convertible debt, preferred stock not qualifying as Tier 1 Capital, subordinated and other qualifying term debt and a portion of the allowance for loan losses less the remaining 50% of investments in unconsolidated subsidiaries. The Tier 1 component must comprise at least 50% of qualifying Total Capital. Risk-based capital ratios are calculated with reference to risk-weighted assets, as outlined by bank supervisory authorities, which include both on and off-balance sheet exposures. The minimum required qualifying Total Capital ratio is 8%, of which at least 4% must consist of Tier 1 Capital. As of December 31, 1995, the Company's Tier 1 Capital and Total Capital ratios were 12.03% and 13.28%, respectively.\nThe Federal Reserve Board has adopted a \"minimum leverage ratio\" which requires bank holding companies to maintain Tier 1 Capital of at least 3% of adjusted quarterly average assets, although the Federal Reserve Board may require a higher ratio depending upon the rating of the bank holding company and its expected growth. Regulations issued by the FDIC to implement the 1991 legislation referred to above establish five levels of capitalization for banks; any bank with a Tier 1 Capital ratio of 6%, Total Capital ratio of 10% and a leverage ratio of 5% is considered to be \"well capitalized.\" As of December 31, 1995, the Company's leverage ratio was 7.98%, and all of the Banks had leverage ratios exceeding 6.0%.\nIMPACT OF ECONOMIC CONDITIONS AND MONETARY POLICIES\nThe earnings and growth of the Company are and will be affected by general economic conditions, both domestic and international, and by the monetary and fiscal policies of the United States Government and its agencies, particularly the Federal Reserve Board. One function of the Federal Reserve Board is to regulate the national supply of bank credit in order to mitigate recessionary and inflationary pressures. Among the instruments of monetary policy used to implement those objectives are open market transactions in United States Government securities, changes in the discount rate on member bank borrowings and changes in reserve requirements held by depository institutions. The monetary policies of the Federal Reserve Board have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future. However, the effect, if any, of such policies on the future business and earnings of the Company cannot be accurately predicted.\nRIEGLE-NEAL INTERSTATE BANKING AND BRANCHING EFFICIENCY ACT OF 1994\nINTERSTATE BANKING AND BRANCHING. The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 was signed by President Clinton on September 29, 1994. Generally, provisions of this Act authorize interstate banking and interstate branching, subject to certain state options.\n- Interstate acquisition banks will be permitted in all states on and after September 29, 1995; state law cannot vary this rule. However, states may continue to prohibit acquisition of banks that have been in existence less than five years and interstate chartering of new banks.\n- Interstate mergers of affiliated or unaffiliated banks will be permitted June 1, 1997, unless a state adopts legislation before June 1, 1997 to \"opt out\" of interstate merger, provided any limitations do not discriminate against out-of-state banks. Individual states may enact legislation to permit interstate mergers earlier than that date.\n- Interstate acquisition of branches will be permitted to a bank only if the law of the state where the branch is located expressly permits interstate acquisition of a branch without acquiring the entire bank.\n- Interstate DE NOVO branching will be permitted to a bank only if a state adopts legislation to \"opt in\" to interstate de novo branching authority.\nLIMITATIONS ON CONCENTRATIONS. An interstate banking application may not be approved if the applicant and its depository institution affiliates would control more than 10% of insured deposits nationwide or more than 30% of insured deposits in the state in which the bank to be acquired is located. These limits do not apply to mergers solely between affiliates. States may waive the 30% cap on a nondiscriminatory basis. Nondiscriminatory state caps on deposit market share of a depository institution and its affiliates are not affected.\nAGENCY AUTHORITY. A bank subsidiary of a bank holding company will be authorized to receive deposits, renew time deposits, close loans, service loans and receive payments on loans as an agent for a depository institution affiliate without being deemed a branch of the affiliate. A bank will not be permitted to engage, as agent for an affiliate, in any activity as agent that it could not conduct as a principal, or to have an affiliate, as its agent, conduct any activity that it could not conduct directly, under federal or state law.\nHOST STATE REGULATION. Out-of-state banks seeking to acquire or establish a branch will be required to comply with any nondiscriminatory filing requirements of the host state where the branch is located. The host state may set notification and reporting requirements for a branch of an out-of-state bank. A branch of an out-of-state bank will be subject to all of the laws of the host state regarding interstate branching, consumer protection, fair lending and community reinvestment. A branch of an out-of-state bank will not be permitted to conduct any activities at the branch that are not permissible for a bank chartered by the host state.\nCOMMUNITY REINVESTMENT ACT. Community Reinvestment Act (\"CRA\") evaluations will be required for each state in which an interstate bank has a branch. Interstate banks will be prohibited from using out-of-state branches \"primarily for the purpose of deposit production\". Federal banking agencies are required to adopt regulations by June 1, 1997 to ensure that interstate branches are being operated with a view to the needs of the host communities.\nFOREIGN BANKS. Foreign banks will be able to branch to the same extent as U.S. domestic banks. Interstate branches acquired by foreign banks will be subject to the CRA to the extent the acquired branch was subject to CRA before the acquisition.\nCALIFORNIA LAW\nOn September 28, 1995, California's Governor Wilson signed a bill enacting state legislation in accordance with authority under the Riegle-Neal Act. This new state law permits banks headquartered outside California to acquire or merge with California banks that have been in existence for at least five years, and thereby establish one or more California branch offices. An out-of-state bank may not enter California by acquiring one or more branches of a California bank or other operations constituting less than the whole bank. The law authorizes waiver of the 30% limit on state-wide market share for deposits as permitted by the Riegle-Neal Act. This law also authorizes California state-licensed banks to conduct certain banking activities (including receipt of deposits and loan payments and conducting loan closings) on an agency basis on behalf of out-of-state banks and to have out-of-state banks conduct similar agency activities on their behalf.\nBefore this new legislation, California law allowed California banks and bank holding companies to be acquired by banking organizations in other states on a reciprocal basis (i.e., provided the other state's laws permitted California banking organizations to acquire banking organizations in that state on substantially the same terms and conditions applicable to banking organizations whose operations were principally conducted within that state).\nEXPOSURE TO AND MANAGEMENT RISK\nThe Federal Reserve Board and OCC have announced proposals to examine bank holding companies and national banks with respect to their exposure to and management of different categories of risk. Categories of risk identified by the Federal Reserve Board include legal risk, operational risk, market risk, credit risk, liquidity risk and reputation risk. Categories of risk identified by the OCC include interest rate risk, price risk, foreign exchange risk, transaction risk, compliance risk, strategic risk, credit risk, liquidity risk, and reputation risk. If adopted, this approach would cause bank regulators to focus on risk management procedures, rather than simply examining every asset and transaction. This approach, if adopted, would supplement rather than replace existing rating systems based on evaluation of an institution's capital, assets, management, earnings and liquidity. Although the FDIC has not announced its intention to adopt this approach to risk evaluation, it is likely that the different bank regulatory agencies will eventually adopt similar approaches to this issue. No assurance can be given as to the effect, if any, that this examination approach would have on the Company.\nSTATE BANK SALES OF NON-DEPOSIT INVESTMENT PROCEDURES\nSecurities activities of state non-member banks, as well as the activities of their subsidiaries and affiliates, are governed by guidelines and regulations issued by the securities and financial institution regulatory agencies. These agencies have 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, as well as the potential for mismanagement of sales programs which could expose a bank to liability under the antifraud provisions of federal securities laws.\nAccordingly, the agencies have issued guidelines that require, among other things, the establishment of a compliance and audit program to monitor a bank's mutual funds sales activities and its compliance with applicable federal securities laws; the provision of full disclosures to customers about the risks of such investments, including the possible loss of the customer's principal investment; and the conduct of securities activities of bank subsidiaries or affiliates in separate and distinct locations. In addition, the guidelines prohibit bank employees involved in deposit-taking activities from selling investment products or giving investment advice. Banks are also required to establish a qualitative standard for the selection and marketing of the investments offered by the bank, and to maintain appropriate documentation regarding the suitability of investments recommended to bank customers.\nACCOUNTING CHANGES\nIn October 1995, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 123 (SFAS No. 123), \"Accounting for Stock-Based Compensation\". This Statement establishes an alternative method for accounting for stock based compensation plans and encourages employers to adopt the new method in place of the provisions of Accounting Principles Board Opinion (APB No. 25), \"Accounting for Stock Issued to Employees\". SFAS No. 123 establishes a fair value based accounting method for stock-based compensation arrangements. Companies may continue to apply the accounting provisions of APB No. 25 in determining net income; however, they must apply the disclosure requirements of SFAS No. 123.\nThe recognition provisions may be adopted immediately and apply to all awards granted after the beginning of the fiscal year in which the recognition provisions are first applied. The disclosure requirements of this Statement are effective January 1, 1996. Management believes the adoption of this Statement will not have a material effect on the financial condition of the Company.\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2 -- PROPERTIES\nTHE COMPANY\nThe principal offices of the Company are located at 100 Park Place, Suite 140, San Ramon, California. The Company leases these offices under an agreement which expires in 1999. The lease provides for a three-year option to extend. The Company is uncertain as to the likelihood of exercising this option in the future.\nThe data processing and certain administration functions of the Company are located at the former headquarters of the Company at 2320 Blanding Avenue, Alameda, California, a two story freestanding structure. This facility is owned by Alameda First National Bank.\nOf the thirty-six (36) banking locations and one (1) nonbanking location, twelve (12) banking facilities are owned by the respective banking subsidiaries and twenty-five (25) are leased by the respective banking subsidiaries and nonbank subsidiary. The lease agreements expire between the years 1996 and 2015 and have a variety of renewal options.\nConsideration regarding renegotiated lease provisions, space needs and other significant factors are all considered in determing extension of leases.\nITEM 3","section_3":"ITEM 3 -- LEGAL PROCEEDINGS\nNeither the Company nor any of its subsidiaries is a party to, nor is any of their property the subject of, any material pending legal proceedings other than ordinary routine litigations incidental to their respective businesses nor are any such proceedings known 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 in the fourth quarter of 1995.\nPART II\nITEM 5","section_5":"ITEM 5 -- MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS\nThe Company's common stock trades on the Nasdaq Stock Market under the symbol CABI.\nThe following table sets forth the high, low and closing sales prices of the Company's common stock, as reported on Nasdaq. Also set forth in this table are the dividends declared in each of the periods presented.\nAs of December 31, 1995 there were approximately 4,620 holders of record of the Company's common stock.\nThe Company presently intends to continue the policy of paying regular quarterly cash dividends. Future dividends will depend upon the earnings of the Company and management's assessment of the future need for funds by its subsidiaries and other factors. For information regarding restrictions on the payment of dividends, see Note 10 of the Notes to Consolidated Financial Statements.\nITEM 6","section_6":"ITEM 6 -- SELECTED FINANCIAL DATA\nThe following table sets forth certain selected consolidated financial data of the Company for each year of the five year period ended December 31, 1995 and should be read in conjunction with Consolidated Financial Statements and Management's Discussion and Analysis of Financial Condition and Results of Operations presented herein.\nFIVE YEAR SELECTED FINANCIAL DATA\nITEM 7","section_7":"ITEM 7 -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nCalifornia Bancshares, Inc. (Company) is a bank holding company, having ten banking subsidiaries; Alameda First National Bank, The Bank of Milpitas, N.A., The Bank of San Ramon Valley, Centennial Bank (which was subsequently merged with Alameda First National Bank in 1996), Commercial Bank of Fremont, Community First National Bank, Concord Commercial Bank, Lamorinda National Bank, Modesto Banking Company and Westside Bank (collectively, the Banks), and three nonbanking subsidiaries, CBI Mortgage, Island Bancorp Leasing, Inc. (Island) and LNB Corp.\nThe Banks each provide depository, lending and various specialized services to the business, professional and consumer sectors of their communities. The Banks also offer installment note collection, issue cashier's checks and money orders, sell traveler's checks and provide other customary banking services, except for international banking and trust services.\nCBI Mortgage engages primarily in the origination of real estate loans for investors. Island engaged primarily in the leasing of imported automobiles but is currently inactive. LNB Corp. serves as a third-party trustee for deeds of trust originated by the Banks.\nSUBSEQUENT EVENT\nOn February 11, 1996, the Company signed a definitive agreement for U.S. Bancorp to acquire the Company. Under the terms of the agreement, which is subject to approval by regulators and the Company's shareholders, the Company will be merged into U.S. Bancorp, and each share of the Company's common stock will be converted into .95 shares of U.S. Bancorp common stock. The total value, which can change based on U.S. Bancorp's stock price, is approximately $327 million, or $32.53 for each share of the Company's common stock, based on U.S. Bancorp's closing price of $34.25 on the last trading day preceding the announcement of the agreement. As of March 19, 1996, U.S. Bancorp's closing price was $33.00. In connection with the agreement, the Company granted U.S. Bancorp an option to acquire 19.9% of the Company's stock, which could become exercisable under certain circumstances.\nThe proposed transaction is expected to be accounted for using the purchase method of accounting and is expected to be completed during the second half of 1996.\nOVERVIEW\nNet income in 1995 was $18.0 million ($1.80 per share) compared with $11.6 million ($1.24 per share) in 1994 and $8.8 million ($0.94 per share) in 1993.\nThe return on average assets was 1.23% in 1995, 1.07% in 1994 and 0.89% in 1993. Return on average shareholders' equity for these same periods was 14.57%, 10.63% and 8.52%, respectively.\nConsolidated assets at December 31, 1995 reached $1.57 billion compared with $1.33 billion at December 31, 1994. Total loans were $1.03 billion, up $117 million or 12.8% at year end 1995 compared to $913 million at December 31, 1994. Total deposits increased $246 million or 20.9% to $1.43 billion at December 31, 1995 compared to $1.18 billion at December 31, 1994.\nThe following discusses significant areas that have affected the Company's results of operations for the years ended December 31, 1995, 1994 and 1993 and financial position at December 31, 1995 compared with December 31, 1994. The discussion should be read in conjunction with the Consolidated Financial Statements and related Notes appearing elsewhere herein.\nACQUISITIONS\nOn June 30, 1995, the Company acquired all of the outstanding shares of First Community Bankshares, Inc. (FCB), the holding company for Centennial Bank. This acquisition was accounted for as a purchase and accordingly, the results of operations are included in the Company's consolidated financial statements from the acquisition date. Centennial Bank was merged with another of the\nCompany's bank subsidiaries in February 1996. On January 31, 1995, the Company acquired Bank of Livermore (Livermore), in a transaction accounted for as a pooling-of-interests. Livermore is not material to the consolidated financial condition or operating results of the Company, and therefore, prior period balances have not been restated. However, 1995 amounts were adjusted to reflect the transaction as if it had occurred January 1, 1995. Livermore was subsequently merged with another of the Company's bank subsidiaries during 1995. On December 2, 1994, the Company acquired Old Stone Bank of California, F.S.B. (Old Stone), which was merged into an existing subsidiary in 1994. This transaction was accounted for using the purchase method. Subsequent to the acquisition, the results of operations of Old Stone were combined with those of the Company's. On March 31, 1994, the Company acquired MBC Corp. and its banking subsidiary, Modesto Banking Company, in a transaction accounted for as a pooling-of-interests. The Company's consolidated financial statements were restated to combine the accounts of MBC Corp. with those of the Company.\nRESULTS OF OPERATIONS\nNET INTEREST INCOME\nNet interest income is defined as the difference between interest income and amortized fees on earning assets less interest expense paid on interest-bearing liabilities. Net interest income on a taxable-equivalent basis for 1995 was $73.5 million compared with $58.1 million in 1994 and $49.7 million in 1993.\nThe increase in net interest income between 1995 and 1994 is primarily attributable to increases in loan volume. Average loans outstanding in 1995 were $986.8 million, up $342.6 million or 53.2% compared to 1994. A significant portion of this increase was attributable to the Company's acquisitions. Partially offsetting this increased volume in earning assets in 1995 is a substantial increase in the Company's interest-bearing liabilities during 1995 compared to 1994 which was also largely acquisition related. The net interest margin, which is net interest income on a taxable-equivalent basis as a percentage of average earning assets decreased to 5.39% in 1995 compared to 5.78% in 1994 and 5.47% in 1993. While the yield in the Company's earning assets have improved by 64 basis points between 1995 and 1994 this increase did not keep pace with the rates paid on interest-bearing liabilities, which increased 116 basis points between these same periods. The increase in the net interest margin in 1994 compared to 1993 was attributable primarily to increases in volumes and yields on loans and to a lesser extent, decreases in rates paid on interest-bearing liabilities.\nThe following table presents the Company's consolidated average balance sheets, including average yields and rates on a taxable-equivalent basis for the years ended December 31, 1995, 1994 and 1993.\n- ------------------------------ (1) Interest income is presented on a taxable-equivalent basis. The taxable-equivalent adjustments, were based on a marginal tax rate of 35%.\n(2) Nonaccrual loans are included in total loans, but are not material to this presentation.\n(3) Net interest margin is calculated as net interest income on a taxable-equivalent basis divided by average earning assets.\nThe following table details the approximate effect, on a taxable-equivalent basis, in net interest income of volume and rate changes for 1995 compared to 1994 and 1994 compared to 1993. The change in interest due to both rate and volume has been allocated to change due to rate and change due to volume in proportion to the relationship of absolute dollar amounts of change in each.\nPROVISION FOR LOAN LOSSES\nThe provision for loan losses in 1995 was $1.5 million, compared with $1.9 million in 1994 and $3.4 million in 1993. The provision for loan losses, which is charged to operations, is based on credit losses, management's ongoing evaluation of the portfolio risk and economic conditions. The decrease in the Company's provision for loan losses between these periods reflects the general economic improvement in the Company's primary service areas. The Company has experienced a substantial reduction in net chargeoffs, which declined to $1.8 million in 1995 from $3.1 million in 1994 and $2.8 million in 1993.\nNONINTEREST INCOME\nNoninterest income for 1995 was $9.5 million, compared with $7.5 million in 1994 and $8.8 million in 1993. The components of noninterest income were as follows:\nThe increase in service charge income and other fee income between 1995 and 1994 was primarily acquisition related. The increase in this fee income between 1994 and 1993 is attributable to the Company modifying its service charge schedule of fees and sales fees on mutual funds and annuities which were first introduced in the fourth quarter of 1993.\nNONINTEREST EXPENSE\nTotal noninterest expense was $50.8 million in 1995, $44.0 million in 1994 and $40.5 in 1993. The ratio of noninterest expense to operating revenue, on a taxable-equivalent basis, excluding securities transactions was 61.2%, 67.0% and 69.6% for 1995, 1994 and 1993 respectively.\nThe following table presents the major components of noninterest expense for the years ended December 31, 1995, 1994 and 1993.\nThe increase in salaries and benefits in 1995 compared to 1994 is directly related to the Company's expansion, primarily acquisition related. The Company's full-time equivalent staff numbered approximately 637 at December 31, 1995; this compares with 631 at December 31, 1994 and 546 at September 30, 1994 (number of full-time equivalent employees prior to the 1994 year-end acquisition of Old Stone). The increase in 1994 salaries and benefits compared to 1993 was primarily due to standard merit and promotional increases.\nThe Company benefited from the significant reduction in premiums paid to the FDIC for deposit insurance during 1995. Effective June 30, 1995 the FDIC lowered the amount of the premiums assessed to all well capitalized insured banks from $.23 per $100 in deposits to $.04 per $100 in deposits. The FDIC has further lowered this assessment in 1996 to a flat assessment rate of $2,000 per well capitalized insured bank per year.\nThere were no other material events, other than the Company's growth, both internal and through acquisitions that had a significant effect on the Company's noninterest expense between 1994 compared to 1995 and 1993 compared to 1994.\nINCOME TAXES\nThe provision for income taxes was $11.4 million, $6.7 million and $4.2 million in 1995, 1994 and 1993, respectively. The effective tax rates for these periods were 38.7%, 36.5% and 32.4%, respectively. The increases in the Company's effective tax rate for these periods is primarily attributable to the decrease in nontaxable income relative to the Company's earnings.\nFINANCIAL CONDITION\nSECURITIES\nThe Company's securities portfolio increased $41.0 million or 13.8% between December 31, 1994, and December 31, 1995. Increases in the securities portfolio related to acquisitions were $54.0 million. Excluding these transactions the Company had 1995 maturities and repayments totalling $107.9 million, sales of $8.8 million and purchases of $103.3 million.\nAt December 31, 1995 and 1994, the held to maturity securities portfolio had an estimated unrealized gain of $1.0 million and an unrealized loss of $12.5 million, respectively.\nAt December 31, 1995, the available for sale securities portfolio had an unrealized pretax gain of $373,000. At December 31, 1994, the available for sale securities portfolio had an unrealized pretax loss of $721,000. The unrealized gain or loss on available for securities is reported on a net of tax basis as a separate component of shareholders' equity. At December 31, 1995 the unrealized gain on securities classified as available for sale, net of tax was $219,000, compared with an unrealized net loss of $421,000 at December 31, 1994.\nThe improvement in the market value of the Company's total securities portfolio between December 31, 1994 and 1995, was predominately due to the improved market valuation of its mortgage-backed securities. As interest rates declined during 1995, these securities, as well as the Company's other securities, increased in market value.\nThe following tables set forth the amortized cost and estimated market values of securities at the dates indicated.\nThe amortized cost and estimated market values of securities at December 31, 1995 by contractual maturity are shown on the following table. Actual maturities will differ from contractual maturities because borrowers have the right to call or prepay obligations with or without call or prepayment penalties.\nFor asset\/liability purposes, the Company monitors these securities with consideration of prepayment assumptions. Yields have been calculated by dividing the taxable-equivalent interest income, including discount or premium, by book value. Yields on nontaxable securities of states and political subdivisions were presented on a taxable-equivalent basis using a marginal tax rate of 35%.\nLOAN PORTFOLIO\nThe Company's lending activities are geographically concentrated in Northern California, specifically the San Francisco Bay Area and Central Valley. The loan portfolio mix consists primarily of commercial, industrial and agricultural loans, real estate construction and land development loans, residential and commercial real estate mortgages, consumer installment loans and individual lines of credit. The following table sets forth the breakdown of loans outstanding by type at the dates indicated.\nThe Company's loan portfolio increased $117.3 million or 12.8% at December 31, 1995 compared to December 31, 1994. The increase was primarily due to 1995 acquisitions.\nThe Company has historically been active in financing the construction and development of residential properties. This portion of the loan portfolio increased $25.9 million (25.9%) at December 31, 1995 compared to December 31, 1994. Although a significant percentage of the Company's nonperforming loans come from this portion of the portfolio, the Company has not historically suffered any material losses in this area.\nLoans secured by 1 - 4 family residential properties decreased $3.8 million (1.1%) in 1995 compared to 1994. This decrease was primarily attributable to loan repayments on single family residences secured by first deeds of trust. The Company acquired a significant portion of these loans (approximately $240 million) in connection with the Old Stone acquisition during 1994. These loans have experienced an accelerated level of repayments and refinancings during 1995 due to favorable market rates.\nOther real estate mortgages, the majority of which are commercial properties, are another active market for the Company. The underwriting standards and administrative guidelines regarding these\ncredits are specific and stringent. These loans are generally owner occupied business properties that are limited to specific types of properties. This portion of the portfolio increased $50.1 million (26.8%) during 1995 compared to 1994.\nCommercial, industrial and agricultural loans increased $24.7 million (15.5%) at December 31, 1995 compared to December 31, 1994. This segment of the portfolio consists of secured and unsecured lines of credit for the operation and expansion needs of small and middle-market businesses and professionals, including inventory, accounts receivable and equipment. Agricultural loans consist of loans to finance agricultural production and other loans to farmers. Agricultural loans that are secured by real estate (farmland) are included in other real estate mortgages.\nConsumer loans increased by $20.5 million (17.2%) at December 31, 1995 compared to December 31, 1994. The consumer loan portfolio consists of automobile loans, personal lines of credit to individuals and other personal loans.\nInherent in any loan portfolio are risks associated with certain types of loans. The Company's objective is to limit these risks through strict loan policies and review procedures. Included in these policies are specific loan-to-value limitations as to various categories of real estate related loans. The Company has also established policies to limit the degree of portfolio concentration in any product type or to any individual borrower.\nAt December 31, 1995 there was no concentration of loans in any single category that was not otherwise disclosed in the loan portfolio table previously.\nThe following table presents information for selected loans concerning loan maturities and sensitivity to change in the loan portfolio as well as the total of all such loans due after one year that have fixed or floating interest rates at December 31, 1995.\nALLOWANCE FOR LOAN LOSSES\nThe following table summarizes the changes in the Company's allowance for loan losses for the years indicated.\nNet charge-offs decreased $1.3 million or 41.5% during 1995 compared to 1994 which increased $247,000 (8.7%) compared to 1993. An improved economy and successful collection efforts were major factors contributing to lower charge-off levels.\nThe Company's determination of the allowance for loan losses and the corresponding provision for loan losses is based on various judgments and assumptions including, but not limited to, general economic conditions, the composition of the loan portfolio, prior loss experience and estimates of potential future losses. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Banks' allowances for loan losses.\nOn January 1, 1995, the Company adopted Statement of Financial Accounting Standards No. 114 (SFAS No. 114), \"Accounting by Creditors for Impairment of a Loan\", as amended by SFAS No. 118 (collectively referred to as SFAS No. 114), on a prospective basis. These Statements address the accounting treatment of certain impaired loans and amend SFAS No. 5 and 15. However, these Statements do not address the overall adequacy of the allowance for loan losses and do not apply to large groups of smaller-balance homogeneous loans unless they have been involved in a restructuring.\nA loan is considered impaired, within the scope of SFAS No. 114, when, based on current information and events, it is probable that the Company will be unable to collect principal or interest due according to the contractual terms of the original loan agreement.\nThe Company measures the impairment of a loan when and while a loan is on nonaccrual or the loan has been restructured. The amount of impairment is calculated by the Company using discounted cash flows, except when the source of repayment for the loan is through the liquidation of the underlying collateral. For these loans, the net realizable value of the collateral (current fair value less estimated costs to sell) is used in place of discounted cash flows. If the measurement of the impaired loan is less than the recorded investment in the loan, the Company recognizes such impairment by creating or adjusting the existing allowance for loan losses. If full collection is uncertain, cash receipts are applied first to principal, then to recovery of amounts previously charged-off, then to interest income. An analysis of the Company's recorded investment in impaired loans and the related SFAS No. 114 allowance for loan losses at December 31, 1995 is presented in Note 1, Allowance for Loan Losses, in the Notes to the Consolidated Financial Statements.\nThe Company performs a quarterly assessment to determine the appropriate level of the allowance for loan losses. This process uses a series of allocation methods including specific credit allocations for individual loans and historical loss experience for each loan category and degree of criticism within each category. The total of these allocations is then supplemented by the unallocated portion of the allowance for loan losses. Based on management's analysis of the Company's overall allowance for loan losses, management believes that the provision for loan losses for 1995 is appropriate. It is management's opinion that the allowance for loan losses at December 31, 1995, is adequate to provide for potential losses in the current loan portfolio. No assurances can be given that adverse economic conditions or other factors will not result in increased losses in the Company's loan portfolio. The allocation of the allowance for loan losses (\"Allocation\") and the ratio of the loan category to outstanding loans (\"Ratio\") are summarized in the following table.\n- -------------------------- (1) The unallocated portion of the allowance is evaluated as part of the overall evaluation of the adequacy of the allowance and takes into consideration various loan portfolio risk factors, including loan growth and concentrations, lending policies, delinquency trends and general economic conditions. This amount and any unabsorbed portion of the allocated allowance is also available for any of the above listed loan categories.\nThe allowance for loan losses should not be interpreted as an indication that charge-offs in the future will occur in these amounts or proportions, or that the allocation indicates future charge-off trends. Furthermore, the portion allocated to each loan category is not the total amount available for future losses that might occur within such categories.\nNONACCRUAL, RESTRUCTURED AND PAST DUE LOANS AND FORECLOSED ASSETS\nThe following table presents the Company's nonaccrual and restructured loans and foreclosed assets as well as loans past due 90 days and still accruing interest, covering a five year period.\nClassification of a loan as nonaccrual or restructured does not necessarily indicate the loan is not performing with respect to collection of principal and interest nor does it mean that the principal of the loan is uncollectible in whole or in part.\nLoans are placed on nonaccrual status when full collectibility of principal or interest is uncertain or when principal or interest is past due for 90 days (unless the loan is well secured and in the process of collection). From the time a loan is placed on nonaccrual status, interest previously accrued but not collected is reversed and charged against interest income. Any interest or principal payments received on a nonaccrual loan are normally applied as a principal reduction. A nonaccrual loan may be restored to accrual status when none of its principal and interest is past due and unpaid or when it otherwise becomes well secured and in the process of collection. In a case where a borrower experiences financial difficulties and the Company makes certain concessionary modifications to contractual terms (i.e., the reduction of either interest or principal or other such modifications that the Company would not otherwise consider), the loan is classified as a restructured loan. If the borrower is not able to meet the revised payment schedule and the loan becomes delinquent, the loan is placed on nonaccrual status.\nForeclosed assets include property acquired through foreclosure. These properties are carried at the lower of (i) fair value less estimated costs to sell or (ii) the recorded cost of the asset. Upon foreclosure, any necessary write-downs are charged to the allowance for loan losses. The difference between cost and fair value less estimated cost to sell, if lower, is recorded as a valuation allowance. Subsequent declines in the fair value of the property are recorded as an addition to the valuation allowance.\nManagement is not aware of any significant potential problem loans which have not otherwise been disclosed as a nonaccrual or restructured loan at December 31, 1995, in which there is known information about possible credit problems of a borrower that has caused management to have serious doubts as to the ability of such borrowers to comply with the present loan repayment terms.\nDEPOSITS\nTotal deposits increased $246.2 million or 20.9% at December 31, 1995 compared to December 31, 1994. Average daily deposits, along with the average rates paid thereon, for the years ended December 31, 1995, 1994 and 1993 are summarized in the following table.\nThe total amount held in the accounts of any single depositor is not material in relationship to total deposits.\nSummarized below, by time remaining until maturity, are the amount of outstanding time certificates of deposit issued in the amounts of $100,000 or more:\nASSET\/LIABILITY MANAGEMENT\nThe Company has separate policies and guidelines for managing the Company's balance sheet and off-balance sheet activities which are incorporated and considered integral parts of the asset\/ liability management process. Certain policies may be governed and implemented by committees or persons other than the Asset\/Liability Committee (ALCO) as directed by the Board of Directors. Overall asset\/liability management encompasses the management and monitoring of asset quality, liquidity and capital needs and interest rate risk.\nINTEREST RATE RISK\nOne of the principal objectives of asset\/liability management is to manage the risks associated with changing interest rates and their impact on earnings. The ALCO regularly evaluates and sets predetermined limits on the sensitivity of each Bank's net interest income to changes in interest rates.\nInterest rate risk can be viewed from a variety of perspectives, including the sensitivity of earnings to rate movements and the sensitivity of the market value of the Company's equity to changes in interest rates. One way to measure how a change in interest rates will impact net interest income in specific time frames is through a cumulative gap analysis. Traditional gap analysis represents interest rate risk in terms of the mismatch between the stated repricing of the Company's earning assets and interest-bearing liabilities within defined time periods. As shown in the following\ntable, at December 31, 1995, the cumulative one-year contractual gap for the Company was a negative $77.4 million, or (5.4%) of earning assets. In other words, 5.4% of the Company's interest-bearing liabilities has the potential to reprice or mature more quickly than its earning assets in one year.\n- ------------------------ (1) The nonmarket column consists of Federal Reserve Bank stock\n(2) The nonmarket column consists of nonaccrual loans of $12,373\nOver the short period (one year or less) changes in interest rates affect net interest income to the extent that there is a timing difference between the repricing of assets and liabilities. For instance, if more liabilities than assets reprice during a time period, such as the Company's gap analysis indicates, given a rising rate environment, net interest income will have a tendency to decrease if the assets and liabilities reprice in rate by approximately the same amount. Conversely, if an institution is considered to be asset sensitive, or as having a positive gap, when the amount of its liabilities maturing or repricing is less than the amount of its assets also maturing or repricing during the same period, net interest income would benefit from a rising rate environment.\nHowever, shortcomings are inherent in a simplified gap analysis that may result in an institution with a nominally negative gap having interest rate behavior associated with an asset sensitive balance sheet. For example, although certain assets and liabilities may have similar maturities or periods to\nrepricing, they may react in different degrees to changes in market interest rates. Furthermore, repricing characteristics of certain assets and liabilities vary substantially within a given time period. In the event of a change in interest rates, prepayment and early withdrawal levels could also deviate significantly from those assumed in calculating gap. The Company attempts to quantify these characteristics by taking into account the expected repricing or maturities of earning assets and funding sources, as opposed to their contractual maturities.\nBecause net interest income is not necessarily a conclusive indication of an institution's ongoing net worth, a second measure of interest rate risk - the market value of portfolio equity (MVPE) is important. This measure attempts to quantify the ongoing worth of the institution by considering all cash flows, regardless of their timing, and discounting these back to the present. The difference between the discounted assets less the discounted liabilities is the present value of equity or the economic measure of the institution's net worth.\nThese two approaches to interest rate risk measurement are complementary and are used in tandem by the individual Banks to provide a more complete picture of the interest rate risk associated with their balance sheets. Included in the Company's Asset\/Liability Management Policy are limitations on the maximum volatility each Bank may undertake associated with possible interest rate movement.\nLIQUIDITY\nLiquidity is defined as the Company's ability to provide funds to meet customers' loan and deposit needs and to fund operations in the most timely and cost effective basis. The Company's liquidity is measured and managed on an individual bank basis. The holding company (parent) is funded primarily by dividends and management fee income from its subsidiaries.\nCore deposits have historically provided the Company with funding sources. The Company also utilizes repurchase agreements. In addition, the Banks have informal federal funds borrowing arrangements with correspondent banks to meet unforeseen deposit outflows. At December 31, 1995 and December 31, 1994, the Company's loan to deposit ratio was 72.3% and 77.4%, respectively.\nCAPITAL\nThe Company reviews various capital adequacy ratios on a quarterly basis to ensure that each banking subsidiary and the consolidated Company are within established internal and external guidelines. The Company and its banking subsidiaries are subject to risk-based capital regulations.\nThese guidelines are used to evaluate capital adequacy and are based on an institution's balance sheet risk and off-balance sheet risk. Current regulations define capital adequacy into five categories; well capitalized, adequately capitalized, undercapitalized, significantly under capitalized and critically undercapitalized. Each of these capital categories have predefined risk-based capital ratio minimums. At December 31, 1995 and December 31, 1994, the capital ratios of the Company exceeded the \"well capitalized\" threshold as prescribed by banking regulators. An institution's deposit insurance premiums are determined through a matrix based on the institution's capital category and supervisory subgroup. Any reduction in an institution's capital category can significantly increase premiums.\nThe following table presents the Company's capital positions at December 31, 1995 and December 31, 1994, including the risk-based capital ratio and leverage ratio.\nCONSOLIDATED QUARTERLY FINANCIAL INFORMATION\nThe following quarterly financial information for 1995 and 1994 is unaudited. In the opinion of management, all adjustments necessary to present fairly the results of operations for the periods shown have been made.\nITEM 8","section_7A":"","section_8":"ITEM 8 -- FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nSee index to Financial Statements and Schedules included on page 29 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\n(a) DIRECTORS.\nSet forth below are the names and ages of the directors of the Company, the principal occupations at present and for the past five years of each director, certain directorships held by each, and the year since which the director has been continuously a director of the Company. Except as otherwise indicated below, each director has been engaged in the indicated principal occupation or employment for more than the past five years. The information set forth in the following table has been furnished to the Company by the respective directors.\n(b) EXECUTIVE OFFICERS OF THE REGISTRANT.\n(c) OFFICER AND DIRECTOR REPORTS.\nNone.\nITEM 11","section_11":"ITEM 11 -- EXECUTIVE COMPENSATION\nInformation regarding executive compensation will be included in the Company's Proxy Statement to be filed with the SEC by April 30, 1996, under the caption \"EXECUTIVE COMPENSATION.\" Such information is incorporated herein by reference.\nITEM 12","section_12":"ITEM 12 -- SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe security ownership of certain beneficial owners and of management will be included in the Company's Proxy Statement to be filed with the SEC by April 30, 1996, under the caption \"STOCK OWNERSHIP OF MANAGEMENT.\" Such information is incorporated herein by reference.\nITEM 13","section_13":"ITEM 13 -- CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation regarding certain transactions to which the Company or its subsidiaries and directors or executive officers of the Company have been a party will be included in the Company's Proxy Statement to be filed with the SEC by April 30, 1996, under the caption \"TRANSACTIONS WITH DIRECTORS, EXECUTIVE OFFICERS AND OTHERS.\" Such information is incorporated herein by reference.\nPART IV\nITEM 14","section_14":"ITEM 14 -- EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) 1. Financial Statement Schedule\nThe following is an index of the financial statements filed in this report.\nCONSOLIDATED FINANCIAL STATEMENTS\n2. All of the schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are either not required under the related instruction, the required information is contained elsewhere in the Form 10-K, or the schedules are inapplicable and therefore have been omitted.\n3. Exhibits are listed on Exhibit Index on pages 32-33 of this report on Form 10-K.\n(b) Reports of Form 8-K\nNo reports on Form 8-K were filed by the Company during the last quarter of 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 20, 1996 CALIFORNIA BANCSHARES, INC. (Registrant)\nBy: ____\/S\/__JOSEPH P. COLMERY________ Joseph P. Colmery 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.\nCALIFORNIA BANCSHARES, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEET\nASSETS\nThe accompanying notes are an integral part of these consolidated financial statements.\nCALIFORNIA BANCSHARES, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENT OF INCOME\nThe accompanying notes are an integral part of these consolidated financial statements.\nCALIFORNIA BANCSHARES, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY\nThe accompanying notes are an integral part of these consolidated financial statements.\nCALIFORNIA BANCSHARES, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENT OF CASH FLOWS\nThe accompanying notes are an integral part of theses consolidated financial statements.\nCALIFORNIA BANCSHARES, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENT OF CASH FLOWS -- CONTINUED\nThe accompanying notes are an integral part of theses consolidated financial statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The consolidated financial statements of California Bancshares, Inc. (Company) and subsidiaries are prepared in conformity with generally accepted accounting principles and prevailing practices within the banking industry. The following is a summary of the significant accounting and reporting policies.\nCONSOLIDATION\nThe consolidated financial statements include the accounts of the Company, its bank subsidiaries (Banks): Alameda First National Bank, The Bank of Milpitas, N.A., The Bank of San Ramon Valley, Centennial Bank, Commercial Bank of Fremont, Community First National Bank, Concord Commercial Bank, Lamorinda National Bank, Modesto Banking Company and Westside Bank; and its non-bank subsidiaries: CBI Mortgage, LNB Corp. and Island Bancorp Leasing, Inc. Significant inter-company accounts and transactions have been eliminated in consolidation.\nSECURITIES\nThe Company's securities portfolio includes U.S. Treasury securities and other government agency securities, mortgage-backed securities, state, county and municipal securities and Federal Reserve Bank stock. Securities are accounted for according to their purpose and holding period. Realized gains and losses are recorded in noninterest income using the specific identification method. The Company classifies its securities portfolio in accordance with Statement of Financial Accounting Standards No. 115 (SFAS No. 115), \"Accounting for Certain Investments in Debt and Equity Securities\".\nSecurities are classified as \"available for sale\" when the Company intends to hold the securities for an indefinite period of time. These securities are carried at fair value, with unrealized gains or losses, net of applicable taxes, reported as a separate component of shareholders' equity. Declines in the value of securities that are considered other than temporary are recorded in noninterest income as a loss on securities.\nSecurities acquired with the positive intent and ability to hold to maturity are classified as \"held to maturity\". These securities are carried at historical cost, adjusted for amortization of premium and accretion of discount to maturity or, in the case of mortgage-backed securities, over the estimated life of the security.\nLOANS\nLoans held for investment are stated at the principal amount outstanding less unearned income, while loans held for sale are carried at the lower of cost or market on an aggregate basis. Market is based upon quoted market rates. Interest income on loans, other than discounted loans, is accrued daily based on the outstanding loan balance. Interest income on discounted loans is accrued based on a method that approximates the interest method.\nAll nonrefundable loan origination fees, net of related costs, are deferred and amortized, using the interest method, over the term of the loan.\nIt is management's policy to place a loan on nonaccrual status when principal or interest is past due for 90 days (unless the loan is well secured and in the process of collection). Classification of a loan as nonaccrual does not necessarily indicate the loan is not performing with respect to collection of principal and interest nor does it mean that the principal of the loan is uncollectible in whole or in part. A loan may also be classified as nonaccrual if the borrower's financial condition deteriorates resulting in uncertainty as to the amounts or timing of future cash flows to service the loan. This can occur regardless of whether the loan is performing according to its contractual terms. From the time a loan is placed on nonaccrual status, interest is recorded only when cash is received, and any interest income previously accrued but not collected is reversed.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) ALLOWANCE FOR LOAN LOSSES\nThe allowance for loan losses is maintained at a level adequate to cover potential losses which may exist in the portfolio. The evaluation of the allowance is an ongoing process involving many factors including current and projected economic conditions, portfolio composition and prior loss experience.\nWhile management uses available information to recognize losses on loans, future additions to the allowance 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 Banks' allowances based on their judgment of information available to them at the time of their examination.\nOn January 1, 1995, the Company adopted SFAS No. 114, \"Accounting by Creditors for Impairment of a Loan\", as amended by SFAS No. 118 (collectively referred to as SFAS No. 114), on a prospective basis. These Statements address the accounting treatment of certain impaired loans and amend SFAS No. 5 and 15. However, these Statements do not address the overall adequacy of the allowance for loan losses and do not apply to large groups of smaller-balance homogeneous loans unless they have been involved in restructuring.\nA loan is considered impaired, within the scope of SFAS No. 114, when based on current information and events, it is probable that the Company will be unable to collect principal or interest due according to the contractual terms of the loan. For a loan that has been restructured the contractual terms of the loan refer to the contractual terms of the original loan agreement.\nThe Company measures the impairment of a loan when and while a loan is on nonaccrual or the loan has been restructured. The amount of impairment is calculated by the Company using discounted cash flows, except when the source of repayment for the loan is through the liquidation of the underlying collateral. For these loans, the net realizable value of the collateral (current fair value less estimated costs to sell) is used in place of discounted cash flows. If the measurement of the impaired loan is less than the recorded investment in the loan, the Company recognizes such impairment by creating or adjusting the existing allowance for loan losses. If full collection is uncertain, cash receipts are applied first to principal, then to recovery of amounts previously charged off, then to interest income.\nThe following table presents the recorded investment in impaired loans and the related SFAS No. 114 allowance for loan losses at December 31, 1995:\nThe Company's average investment in impaired loans during 1995 was $10.8 million.\nFORECLOSED ASSETS\nForeclosed assets are recorded in other assets at the lower of cost or fair value less estimated costs to sell. Fair value is determined by independent appraisals. Upon foreclosure any necessary writedowns are charged to the allowance for loan losses. Any subsequent writedowns to the carrying value that may be required are charged to operations and recorded in a valuation reserve. Expenses for holding costs are charged to operations as incurred. At December 31, 1995 and 1994, the Company had $3.2 million and $2.4 million, respectively, in foreclosed assets.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) PREMISES AND EQUIPMENT\nPremises, equipment and leasehold improvements are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are computed on a straight-line basis over the estimated useful lives of the related assets, which are generally between three and thirty years, or the lease term. Cost of improvements are capitalized. Maintenance, repairs and minor improvements are expensed as incurred.\nINCOME TAXES\nThe Company and its subsidiaries file a consolidated Federal tax return and a combined California franchise tax return. Income taxes are calculated by individual subsidiaries as though each subsidiary had filed a separate return. Payments or refunds between the Company and its subsidiaries are made on this basis.\nThe Company computes its income taxes for financial statement purposes using the asset and liability method. Under the asset\/liability method deferred tax assets and liabilities are recognized for the expected future tax consequences of existing differences between financial reporting and tax reporting bases of assets and liabilities, as well as for operating losses and tax credit carryforwards, using enacted tax laws and rates. Deferred tax expense represents the net change in the deferred tax asset or liability balance during the year. This amount, together with income taxes currently payable or refundable for the current year, represents the total income tax expense for the year.\nBENEFIT PLANS\nThe Company and its subsidiaries have a profit sharing-salary deferral plan which covers substantially all employees with one year of continuous service. Contributions to the profit sharing portion of the plan are made at the discretion of the Board of Directors. In the salary deferral portion of the plan, the Company matches one-half of the employee's 401(k) plan contributions up to 2% of their annual salary.\nPER SHARE CALCULATIONS\nEarnings per common share are calculated using the weighted average number of common shares outstanding during the years presented. Exercise of outstanding stock options would not have had a material dilutive effect on earnings per share.\nCASH FLOWS\nFor purposes of reporting cash flows, cash and cash equivalents include cash and due from banks and federal funds sold. Generally, federal funds sold are sold for one business day.\nGOODWILL\nGoodwill, which represents the excess of purchase price over fair value of net assets acquired is amortized on a straight line basis over the expected periods to be benefited, generally five to fifteen years. The Company assesses the recoverability of this intangible asset by determining whether the amortization of the goodwill balance over its remaining life can be recovered through undiscounted future operating cash flows of the acquired operations. The amount of goodwill impairment, if any, is measured based on projected discounted future operating cash flows using a discount rate reflecting the Company's average cost of funds. The assessment of the recoverability of goodwill will be impacted if estimated future operating cash flows are not achieved.\nNegative goodwill, which represents the excess of the fair value of net assets acquired over the purchase price, is accreted to income on a straight line basis over five years.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) USE OF ESTIMATES\nThe management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities to prepare these financial statements in conformity with generally accepted accounting principles. Actual results could differ from those estimates.\nRECLASSIFICATIONS\nCertain amounts for prior years have been reclassified to conform with the 1995 presentation.\n(2) ACQUISITIONS On June 30, 1995, the Company acquired all of the outstanding shares of First Community Bankshares, Inc. (FCB), the holding company for Centennial Bank. FCB had assets of $118 million at June 30, 1995. This acquisition was accounted for as a purchase and accordingly, the results of operations, which are not material to the consolidated financial statements, are included in the Company's consolidated financial statements from the acquisition date. FCB's assets and liabilities were revalued to reflect the estimated fair value at the time of acquisition. The total cost of the acquisition was $16.25 million in cash. The excess of the purchase price over fair value of net assets acquired was $5.1 million.\nOn January 31, 1995, the Company completed the acquisition of Bank of Livermore (Livermore), which was subsequently merged with another of the Company's subsidiaries. Livermore had $71 million in total assets at December 31, 1994. The Company issued 633,908 shares of common stock valued at approximately $10.9 million at the time of the transaction. The acquisition of Livermore was accounted for as a pooling-of-interests. Livermore is not material to the financial condition or operating results of the Company, and therefore, prior period balances were not restated. However, 1995 amounts were adjusted to reflect the transaction as if it had occurred January 1, 1995.\nOn December 2, 1994, the Company acquired Old Stone Bank of California, F.S.B. (Old Stone). The transaction was a taxable acquisition of all of the outstanding stock of Old Stone by a subsidiary bank of the Company. The consideration for the purchase was $16.7 million paid in cash at closing. The acquisition was recorded under the purchase method of accounting and accordingly, the Company's consolidated financial statements include Old Stone's results of operations beginning December 2, 1994. Old Stone's assets and liabilities were revalued to reflect the estimated fair value at the time of acquisition. The purchase accounting valuations resulted in negative goodwill in the amount of $3.4 million, which will amortize over a five year period.\nOn March 31, 1994, the Company acquired MBC Corp. (MBC) and its banking subsidiary, Modesto Banking Company. Each share of MBC common stock outstanding on March 31, 1994, was converted into .7271 shares of the Company's common stock. The Company issued approximately 1,478,000 shares of common stock and cash in lieu of fractional shares for all of the outstanding shares of MBC. The consolidated financial statements of the Company give effect to the merger, which has been accounted for as a pooling-of-interests. Accordingly, the accounts of MBC have been combined with those of the Company for all periods presented.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(3) SECURITIES The amortized cost and estimated market values of securities at December 31, 1995 and 1994 are as follows:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(3) SECURITIES (CONTINUED)\nProceeds from sales of securities during 1995, 1994 and 1993 were $8.8 million, $9.0 million and $13.3 million, respectively.\nSecurities carried at approximately $44.9 million and $48.5 million, at December 31, 1995 and 1994, respectively, were pledged to collateralize public deposits and other deposits as required by law.\n(4) LOANS AND ALLOWANCE FOR LOAN LOSSES A summary of the major categories of the loan portfolio at December 31, 1995 and 1994 is shown in the following table. Most of the Company's business activity is with customers located within Northern California. The majority of the Company's portfolio of real estate construction and land development loans consisted of loans to contractors who specialize in single family residential construction. Real estate mortgages encompass a variety of real estate secured loans, including residential mortgage loans and commercial loans secured by real estate. Commercial, industrial and agricultural loans are unsecured and secured loans and lines of credit for the operation and expansion needs of business, including inventory, agricultural production, accounts receivable and equipment. Consumer loans are primarily automobile loans. The following is a summary of loans by category:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(4) LOANS AND ALLOWANCE FOR LOAN LOSSES (CONTINUED) The following is a summary of transactions in the allowance for loan losses account:\nThe Company had nonaccrual and restructured loans of $14.9 million, $13.0 million and $11.4 million at December 31, 1995, 1994 and 1993, respectively. Foregone interest was $1.2 million, $665,000 and $670,000 for the related periods.\n(5) PREMISES AND EQUIPMENT The following is a summary of the major classifications of premises and equipment:\nThe Company leases certain premises under agreements expiring between the years 1996 and 2015. Future minimum rental payments as of December 31, 1995 are as follows:\nRental expense included in occupancy expense for 1995, 1994 and 1993 was $1.5 million, $1.1 million and $973,000 (net of rental income of $736,000, $624,000 and $666,000), respectively.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(6) INCOME TAXES The provision for income taxes reflected in the consolidated statement of income consisted of the following:\nThe provision for income taxes differs from the amount computed by applying the statutory Federal income tax rate to income before taxes. The reasons for these differences are as follows:\nAt December 31, 1995, accrued taxes were comprised of current taxes payable of $786,000 and deferred tax assets of $11.4 million. At December 31, 1994, accrued taxes consisted of current taxes payable of $819,000 and deferred tax assets of $13.9 million.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(6) INCOME TAXES (CONTINUED) Significant components of deferred tax assets are presented below:\nAmounts for the current year are based upon estimates and assumptions as of the date of this report and could vary significantly from amounts shown on the tax returns as filed. Accordingly, the variances from the amounts previously reported for 1994 are primarily a result of adjustments to conform to tax returns as filed.\nAs indicated in Note 2, Acquisitions, the Company completed the acquisition of Old Stone in 1994 and Livermore and FCB in 1995. In connection with these acquisitions, cumulative temporary differences reflecting the difference between the tax basis and assigned values of assets and liabilities resulted in net deferred tax assets of $9.0 million, $750,000 and $870,000 for Old Stone, Livermore and FCB, respectively, being recorded on the balance sheet.\nDuring 1995, management evaluated the deferred tax assets recognized under SFAS 109 and determined that the valuation allowance of $317,000 established in connection with the acquisition of Old Stone was no longer necessary. It is currently anticipated that the total amount of deferred tax assets are more likely than not to be realized through recovery of previously paid federal taxes and by claiming deductions against future taxable income.\nThe Tax Reform Act of 1986 and the California Conformity Act of 1987 impose substantial restrictions on the utilization of net operating loss carryforwards if an \"ownership change\", as\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(6) INCOME TAXES (CONTINUED) defined in the Internal Revenue Code, has occurred. Accordingly, the Company has determined its ability to utilize its net operating loss carryforwards pursuant to the limitations set forth in the Code resulting from the acquisition of Old Stone. At December 31, 1995, the Company had approximately $3.3 million of deferred tax assets related to that portion of net operating loss carryforwards which are expected to be utilized through the year 2005.\nDuring 1995, the Company agreed to pay additional tax assessments proposed by the California Franchise Tax Board principally related to the tax treatment of direct financing leases in its tax returns for the years 1977 through 1979, 1983 and 1984. The resolution of the dispute did not have a material effect on the Company's financial position.\n(7) STOCK OPTION PLANS The Company grants options to purchase shares of its common stock to officers and key employees through a stock incentive plan (employee plan). In addition, the Company offers options to purchase shares of common stock to directors of the Company and its subsidiaries (director plan). Options granted under both plans are protected against dilution by stock splits and other changes in capitalization.\nOptions awarded under the two plans by the Board of Directors allow the recipients to purchase shares of the Company's common stock at a price not less than the fair market value of the stock at the time the option is granted. The employee plan reserved 2,126,231 shares for issuance and had 1,418,628 shares available for grant at December 31, 1995 while the director plan reserved 262,760 shares for issuance and had 28,528 shares available for grant at December 31, 1995.\nThe following is a summary of changes in employee and director plan options outstanding.\nOf the 677,554 options outstanding 324,144 are currently exercisable.\nIn addition to options, the employee plan allows for awards of restricted shares, stock units and stock appreciation rights. No such awards have been granted.\n(8) EMPLOYEE BENEFITS The Company has a profit sharing\/salary deferral plan. The Company contributed $660,000, $594,000 and $440,000 to the plan in 1995, 1994 and 1993, respectively.\nIn October 1995, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 123 (SFAS No. 123), \"Accounting for Stock-Based Compensation\". This Statement establishes an alternative method for accounting for stock based-compensation plans and encourages employers to adopt the new method in place of the provisions of Accounting Principles Board Opinion (APB No. 25), \"Accounting for Stock Issued to Employees\". SFAS No. 123 establishes a\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(8) EMPLOYEE BENEFITS (CONTINUED) fair value based accounting method for stock-based compensation arrangements. Companies may continue to apply the accounting provisions of APB No. 25 in determining net income; however, they must apply the disclosure requirements of SFAS No. 123.\nThe recognition provisions may be adopted immediately and apply to all awards granted after the beginning of the fiscal year in which the recognition provisions are first applied. The disclosure requirements of this Statement are effective January 1, 1996. Management believes the adoption of this Statement will not have a material effect on the financial condition of the Company.\n(9) OTHER OPERATING EXPENSE Components of other operating expense, including all expense categories which exceeded one percent of total operating income in at least one of the periods presented are outlined below:\n(10) REGULATORY RESTRICTIONS The Company is subject to regulation under the Bank Holding Company Act of 1956 and to regulation by the Federal Reserve Board. The regulations require the maintenance of cash reserve balances at the Federal Reserve Bank and limit the extension of credit to affiliates by the Banks. The average reserve balance maintained in accordance with such requirements for the years ended December 31, 1995 and 1994 was $9.6 million and $9.2 million, respectively.\nThe Banks are also restricted by banking regulations that limit the transfer of funds by the Banks to the Company and its nonbank subsidiaries including dividends that can be paid to the Company. At December 31, 1995, the Banks could pay dividends of $5.5 million (subject to minimum capital and other requirements) without prior written approval of banking regulators. The Banks' combined shareholders' equity at December 31, 1995 was $116.3 million.\nThe Banks are subject to regulation by the Federal Reserve Board and the Office of the Comptroller of the Currency, as well as the California State Banking Department and the FDIC. Each of the Banks' deposits are insured by the Federal Deposit Insurance Corporation up to the maximum limits allowed.\n(11) COMMITMENTS AND CONTINGENCIES In the normal course of business there are outstanding various commitments to extend credit, letters of credit and contingent liabilities that are not reflected in the consolidated financial statements. While no related losses are anticipated, such instruments do involve elements of credit and interest rate risk in excess of amounts recorded in the consolidated balance sheet. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(11) COMMITMENTS AND CONTINGENCIES (CONTINUED) 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 amount does not necessarily represent future cash requirements. Standby and commercial letters of credit are written conditional commitments issued by the Banks to guarantee the performance of a customer to a third party. Letters of credit have fixed expiration dates and require payment of a fee. When making commitments or issuing letters of credit, the Banks evaluate each customer's creditworthiness on a case-by-case basis. The same credit policies are used in making commitments and conditional obligations as are used for on-balance sheet instruments. The Banks control the credit risk of these transactions through credit approvals, credit limits, and monitoring procedures. The amount of collateral obtained, if deemed necessary, is based on management's credit evaluation of the customer. Exposure to credit loss, in the event of nonperformance by the other party to the financial instrument, for commitments to extend credit and letters of credit is represented by the contractual notional amount of those instruments. Approximate amounts of these financial instruments are summarized below:\n(12) CALIFORNIA BANCSHARES, INC. (PARENT COMPANY ONLY)\nThe Balance Sheet, Statement of Income and Statement of Cash Flows for California Bancshares, Inc. (Parent Company Only) are shown below:\nBALANCE SHEET\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(12) CALIFORNIA BANCSHARES, INC. (PARENT COMPANY ONLY) (CONTINUED)\nSTATEMENT OF INCOME\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(12)CALIFORNIA BANCSHARES, INC. (PARENT COMPANY ONLY) (CONTINUED)\nSTATEMENT OF CASH FLOWS\nFor purposes of reporting cash flows, cash and cash equivalents are comprised solely of cash on deposit with the subsidiary banks.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(13) DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amounts and estimated fair values of the Company's financial instruments are as follows:\nThese estimated fair values do not necessarily represent actual amounts that may be realized upon any sale or liquidation of the related assets or liabilities. In addition, these values do not give effect to discounts to fair value which may occur when financial instruments are sold in large quantities. The fair value presented above represent the Company's best estimate of fair value using the following methodologies:\nCASH AND SHORT TERM INVESTMENTS\nFor cash and short term investments, the carrying amount is a reasonable estimate of fair value.\nSECURITIES\nFor securities available for sale and held to maturity, fair values are primarily based on quoted market prices.\nLOANS\nThe fair value of loans 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.\nDEPOSIT LIABILITIES\nThe fair value of noninterest-bearing and interest-bearing demand accounts, savings accounts and money market deposits is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities.\nCOMMITMENTS TO EXTEND CREDIT, STANDBY LETTERS OF CREDIT\nThe fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements, and the present credit worthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of guarantees and letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties at the reporting date.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(14) PROPOSED ACQUISITION OF CALIFORNIA BANCSHARES, INC. BY U.S. BANCORP On February 11, 1996, the Company signed a definitive agreement for U.S. Bancorp to acquire the Company. Under the terms of the agreement, which is subject to approval by regulators and the Company's shareholders, the Company will be merged into U.S. Bancorp, and each share of the Company's common stock will be converted into .95 shares of U.S. Bancorp common stock. The total value, which can change based on U.S. Bancorp's stock price, is approximately $327 million, or $32.53 for each share of the Company's common stock, based on U.S. Bancorp's closing price of $34.25 on the last trading day preceding the announcement of the agreement. In connection with the agreement, the Company granted U.S. Bancorp an option to acquire 19.9% of the Company's stock, which could become exercisable under certain circumstances. The proposed transaction is expected to be accounted for using the purchase method of accounting and is expected to be completed during the second half of 1996.\nINDEPENDENT AUDITORS' REPORT\nKPMG PEAT MARWICK LLP\nThe Board of Directors and Shareholders of California Bancshares, Inc.:\nWe have audited the accompanying consolidated balance sheet of California Bancshares, Inc. and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statement of income, changes in shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1995. 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 California Bancshares, Inc. and subsidiaries as of December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1995 in conformity with generally accepted accounting principles.\n\/s\/ KPMG Peat Marwick LLP\nOakland, California January 17, 1996, except as to Note 14, which is as of February 12, 1996","section_15":""}
{"filename":"62741_1995.txt","cik":"62741","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nMarshall & Ilsley Corporation (\"M&I\" or the \"Corporation\"), incorporated in Wisconsin in 1959, is a registered bank holding company under the Bank Holding Company Act of 1956, as amended (the \"BHCA\"), and a registered savings and loan holding company under the Home Owners' Loan Act of 1933, as amended (\"HOLA\"). As of December 31, 1995, M&I had consolidated total assets of approximately $13.3 billion and consolidated total deposits of approximately $10.3 billion, making M&I the second largest bank holding company headquartered in Wisconsin. The executive offices of M&I are located at 770 North Water Street, Milwaukee, Wisconsin 53202 (telephone number (414) 765-7801).\nM&I's principal assets are the stock of its bank and nonbank subsidiaries and the assets of its Data Services Division (\"M&I Data Services\"). M&I's subsidiaries include 29 commercial banks, one savings association and a number of companies engaged in businesses that the Federal Reserve Board (the \"FRB\") has determined to be closely-related or incidental to the business of banking. M&I provides its subsidiaries with financial and managerial assistance in such areas as budgeting, tax planning, compliance assistance, asset and liability management, investment administration and portfolio planning, business development, advertising and human resources management.\nM&I's bank and savings association subsidiaries provide a full range of banking services to individuals, businesses and governments throughout Wisconsin and the Phoenix, Arizona metropolitan area. These subsidiaries offer retail, institutional, international, business and correspondent banking, investment and trust services through the operation of 236 banking offices in Wisconsin and 12 offices in Arizona. M&I Marshall & Ilsley Bank (\"M&I Bank\"), M&I's largest bank subsidiary with consolidated assets as of December 31, 1995 of approximately $4.0 billion, is the third largest bank in Wisconsin.\nM&I Data Services is a major supplier of financial and data processing services and software to banking, financial and related organizations. M&I Data Services provides services and software to over 500 financial institution customers in the United States, as well as institutions in numerous foreign countries. M&I's nonbank subsidiaries operate a variety of bank-related businesses, including those providing investment management services, insurance services, trust services, equipment lease financing, commercial and residential mortgage banking, venture capital, brokerage services and financial advisory services. M&I Investment Management Corp. offers a full range of asset management services to M&I's trust company subsidiaries, the Marshall Funds and other individual, business and institutional customers. M&I's trust company subsidiaries provide trust and employee benefit plan services to customers in Wisconsin, Arizona and Florida. M&I First National Leasing Corp. leases a variety of equipment and machinery to large and small businesses. M&I Mortgage Corp. originates, purchases, sells and services residential mortgages. The Richter-Schroeder Company originates and services long-term commercial real estate loans for institutional investors. M&I Capital Markets Group, Inc. provides venture capital, financial advisory and strategic planning services to customers, including assistance in connection with the private placement of securities, raising funds for expansion, leveraged buy-outs, divestitures, mergers and acquisitions and small business investment company transactions. M&I Brokerage Services, Inc., a broker-dealer registered with the National Association of Securities Dealers and the Securities and Exchange Commission, provides brokerage and other investment related services to a variety of retail and commercial customers.\nOn February 1, 1995, M&I acquired the Bank of Burlington, Burlington, Wisconsin, which had total assets of approximately $180 million at the acquisition date. On July 1, 1995, M&I acquired Citizens Bancorp of Delavan, Inc., Delavan, Wisconsin, and on July 2, 1995, M&I acquired Sharon State Bank, Sharon, Wisconsin, which were merged and became the M&I Bank of Delavan with combined assets of $123 million at the merger date.\nPRINCIPAL SOURCES OF REVENUE\nThe table below shows the amount and percentages of M&I's total consolidated operating income resulting from interest and fees on loans, interest on investment securities and fees for data processing services for each of the last three years:\nM&I business segment information is contained in Note 19 of the Notes to the Consolidated Financial Statements contained in Item 8 hereof.\nCOMPETITION\nM&I and its subsidiaries face substantial competition from hundreds of competitors in the markets they serve, some of which are larger and have greater resources than M&I. M&I's bank subsidiaries compete for deposits and other sources of funds and for credit relationships with other banks, savings associations, credit unions, finance companies, mutual funds, life insurance companies (and other long-term lenders) and other financial and non-financial companies located both within and outside M&I's primary market area, many of which offer products functionally equivalent to bank products. M&I's non-bank operations compete with numerous banks, finance companies, data servicing companies, leasing companies, mortgage bankers, brokerage firms, financial advisors, trust companies, mutual funds and investment bankers in Wisconsin and throughout the United States.\nThe market for the banking technology services offered by M&I Data Services is national in scope. In any given geographic area, M&I Data Services' competitors vary in size and include national, regional and local operations. While historically the bank data processing industry has been highly decentralized, there is an accelerating trend toward consolidation in the industry, resulting in fewer companies competing over larger geographic regions. As consolidation continues, successful companies in this business are likely to increase substantially in size as the scale of activity necessary to compete increases.\nEMPLOYEES\nAs of December 31, 1995, M&I and its subsidiaries employed in the aggregate approximately 9,079 full and part-time employees. M&I considers employee relations to be excellent. None of the employees of M&I and its subsidiaries are represented by a collective bargaining group.\nSUPERVISION AND REGULATION\nAs a registered bank holding company and savings and loan holding company, M&I is subject to regulation and examination by the FRB under the BHCA and the Office of Thrift Supervision (\"OTS\") under HOLA. M&I's state bank subsidiaries are subject to regulation and examination by the Wisconsin Office of the Commissioner of Banking, or in the case of M&I Thunderbird Bank, the Arizona State Banking Department, and the FRB (for state banks which are members of the Federal Reserve System) or the Federal Deposit Insurance Corporation (\"FDIC\") (for state banks which are not members of the Federal Reserve System). M&I's national bank subsidiary is subject to regulation and examination by the Office of the Comptroller of the Currency. M&I's savings association subsidiary is subject to regulation and examination by\nthe Wisconsin Office of the Commissioner of Savings and Loans and the OTS. In addition, all of M&I's bank subsidiaries are subject to examination by the FDIC and other federal agencies.\nUnder FRB policy, M&I is expected to act as a source of financial strength to each of its bank subsidiaries and to commit resources to support each bank subsidiary in circumstances when it might not do so absent such requirements. In addition, there are numerous federal and state laws and regulations which regulate the activities of M&I and its bank subsidiaries, including requirements and limitations relating to capital and reserve requirements, permissible investments and lines of business, transactions with affiliates, loan limits, mergers and acquisitions, issuances of securities, dividend payments, extensions of credit and branch banking. The federal regulatory agencies have implemented provisions of the Federal Deposit Insurance Corporation Improvement Act of 1991 by creating standards for when they will take prompt corrective action if a depository institution fails to maintain a certain capital level within specified categories ranging from \"critically undercapitalized\" to \"well capitalized.\" Information regarding capital requirements for bank holding companies and tables reflecting M&I's regulatory capital position at December 31, 1995 can be found in Note 13 of the Notes to the Consolidated Financial Statements contained in Item 8 hereof.\nUnder the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, the restrictions on interstate acquisitions have been abolished effective September 29, 1995. Now, adequately capitalized and managed bank holding companies from any state may acquire banks and bank holding companies located in any other state, subject to certain conditions. In addition, banks may create interstate branching networks on or after June 1, 1997 in states that do not opt out of the legislation, or prior to such date in states that opt into the legislation early. The Financial Reform, Recovery and Enforcement Act of 1989 provides that a bank holding company's controlled insured depository institutions are liable for any loss incurred by the FDIC in connection with the default of or any FDIC-assisted transaction involving an affiliated insured bank or savings association.\nThe laws and regulations to which M&I are subject are constantly under review by Congress, regulatory agencies and state legislatures. These laws and regulations may be changed dramatically in the future, which could affect the ability of bank holding companies to engage in certain activities such as nationwide banking, securities underwriting and insurance, as well as the amount of capital that banks and bank holding companies must maintain, premiums paid for deposit insurance and other matters directly affecting earnings. It is not certain which changes will occur, if any, or the effect such changes will have on the profitability of M&I, its ability to compete effectively, or the composition of the financial services industry.\nThe earnings and business of M&I and the M&I bank subsidiaries are affected by the general economic and political conditions in the United States and abroad and by the monetary and fiscal policies of various federal agencies. The FRB impacts the competitive conditions under which M&I operates by determining the cost of funds obtained from money market sources for lending and investing and by exerting influence on interest rates and credit conditions. In addition, legislative and economic factors can be expected to have an ongoing impact on the competitive environment within the financial services industry. The impact of fluctuating economic conditions and federal regulatory policies on the future profitability of M&I and its subsidiaries cannot be predicted with certainty.\nThe foregoing references to applicable laws, statutes, regulations and legislation are brief summaries thereof which do not purport to be complete and are qualified in their entirety by reference to such statutes, regulations and legislation.\nSELECTED STATISTICAL INFORMATION\nStatistical information relating to M&I and its subsidiaries on a consolidated basis is set forth as follows:\n(1) Average Balance Sheets and Analysis of Net Interest Income for each of the last three years is included in Item 7, Management's Discussion and Analysis of Financial Position and Results of Operations.\n(2) Analysis of Changes in Interest Income and Interest Expense for each of the last two years is included in Item 7, Management's Discussion and Analysis of Financial Position and Results of Operations.\n(3) Nonaccrual, Past Due and Restructured Loans for each of the last five years is included in Item 7, Management's Discussion and Analysis of Financial Position and Results of Operations.\n(4) Summary of Loan Loss Experience for each of the last five years is included in Item 7, Management's Discussion and Analysis of Financial Position and Results of Operations.\n(5) Return on Average Shareholders' Equity, Return on Average Assets and other statistical ratios for each of the last five years can be found in Item 6, Selected Financial Data.\nThe following tables set forth certain statistical information relating to M&I and its subsidiaries on a consolidated basis.\nINVESTMENT SECURITIES\nThe amortized cost of M&I's consolidated investment securities at December 31 of each year are:\nThe maturities, at amortized cost, and weighted average yields (for tax-exempt obligations on a fully taxable basis assuming a 35% tax rate) of investment securities at December 31, 1995 are (in thousands):\nTYPES OF LOANS\nM&I's consolidated loans, classified by type, at December 31 of each year are:\nLOAN BALANCES AND MATURITIES DECEMBER 31, 1995 DOLLAR AMOUNTS IN THOUSANDS\nThe analysis of loan maturities at December 31, 1995, and the rate structure for the categories indicated are:\nNotes: (1) Scheduled repayments are reported in the maturity category in which the payments are due based on the terms of the loan agreements. Demand loans, loans having no stated schedule of repayments and no stated maturity, and overdrafts are reported as due in one year or less.\nNONACCRUAL, PAST DUE AND RESTRUCTURED LOANS\nGenerally, a loan is placed on nonaccrual if payment of interest is more than 60 days delinquent and the loan has been determined by management to be a \"problem\" loan. In addition, loans which are past due 90 days or more as to interest or principal are also placed on non-accrual. Exceptions to these rules are generally only for loans fully collateralized by readily marketable securities or other relatively risk free collateral.\nPOTENTIAL PROBLEM LOANS\nAt December 31, 1995, the Corporation had $23,623 of loans for which payments are presently current, but the borrowers are experiencing serious financial problems. These loans are subject to constant management attention and their classification is reviewed on a quarterly basis.\nOTHER INTEREST BEARING ASSETS\nAt December 31, 1995, the Corporation's commercial finance subsidiary had $4,093 of corporate debt investment securities on nonaccrual status. The gross interest that would have been recorded in 1995 under the original terms amounted to $413. There was no interest income recorded during 1995 with respect to such debt securities.\nDEPOSITS\nThe average amount of and the average rate paid on selected deposit categories for each of the years ended December 31 is as follows:\nThe maturity distribution of time deposits issued in amounts of $100,000 and over and outstanding at December 31, 1995 (in thousands) is:\nAt December 31, 1995, time deposits issued by foreign offices totalled $44,847.\nSHORT-TERM BORROWINGS\nInformation related to M&I's funds purchased and security repurchase agreements for the last three years is as follows (in thousands):\nSUMMARY OF LOAN LOSS EXPERIENCE\nThe following should be read in conjunction with Item 7, Management's Discussion and Analysis of Financial Position and Results of Operations.\nThe Corporation's evaluation of the adequacy of the allowance for loan losses broadly consists of two levels of analysis. The first level focuses primarily on assessments of specific credits, as described more fully below. The second more general level of analysis focuses on categories of similar type loans and portfolio segments (e.g., commercial\/individual; real estate\/non-real estate; geographical regions related to the locations of affiliate banks). These methodologies include multiple analytical approaches which are viewed together to assess overall reserve and provision levels. The analyses consider, among other factors, historical loss experience, current and anticipated economic conditions, loan portfolio trends, portfolio composition by segment, assigned credit grades, and estimates of potential loss exposures.\nThe loan portfolios of the Corporation's affiliate banks and leasing subsidiary are subject to continual management oversight and quarterly analyses. Management's analyses are based on the Corporation's credit grading system which classifies loans in a manner similar to that of bank regulatory examiners, with estimates of probable and potential losses derived. Management's assigned credit grades and quarterly portfolio analyses are subject to independent monitoring by the Corporation's credit review group, which also performs periodic portfolio reviews at each affiliate. The credit review group prepares reports on the results of its evaluations of affiliate loan portfolios, which together with quarterly analyses of credit exposure provided by affiliate management, serve as the basis for determining the adequacy of the allowance for loan losses.\nManagement utilizes the above-described reserve analysis approaches to determine the overall adequacy of the allowance for loan losses. Management's overall assessment is based on its view of the loan portfolio as consisting of commercial business loans, real estate loans, personal loans, and direct financing leases. Industrial development revenue bonds are viewed as commercial real estate loans.\nDuring 1995, consolidated net charge-offs increased to $9.3 million, representing $14.6 million of charge-offs, offset by $5.3 million of recoveries. The 1995 net charge-off level closely parallels the levels of 1992 and 1993, which were above the unusually low 1994 level of $4.6 million, but below the higher than historic net charge-off level experienced in 1991. Gross charge-off levels declined from 1991 through 1994 and although 1995 levels increased, they remained at the second lowest level during the five-year period. Recovery levels in 1991, 1993 and 1994 were relatively consistent, and contrast to a higher level of recoveries in 1992 and a lower level of recoveries in 1995. Recoveries in 1992 were unusually high due to the collection of a large commercial loan charge-off recorded in 1990. The generally positive net charge-off levels experienced during the post-1991 period reflect the relative strength of the Wisconsin economy and stabilization in the Arizona economy and real estate levels. The Corporation's Arizona-based loan portfolio represents approximately 3% of the total portfolio.\nThe Corporation's 1995 provision level of $16.2 million is consistent with the 1994 general provision level of $16.0 million, not including the $8.9 million special provision taken in 1994. The special provision, which was charged to expense, was utilized to conform Valley's loan valuation policies with those of the Corporation, after consummation of the merger. The 1994 and 1995 general provision levels are lower than the previous three years. The resulting 1995 year-end reserve level is $161 million, or 1.82% of total loans, which compares to the year-end 1994 reserve level of 1.75%. The increasing reserve levels in 1991 through 1995 reflect the Corporation's favorable net charge-off experience and the inherent cyclical nature of economic conditions and related credit impacts. In addition, the 1995 reserve level of 1.82% reflects a reduction in loan volume due to the securitization of mortgage loans and related transfer of a portion of the loan loss reserve to a recourse reserve. The year-end 1995 reserve level is considered adequate given uncertainties regarding the economic conditions in the country and the Corporation's primary service areas.\nThe Corporation's 1995 charge-off and recovery levels across portfolio sectors generally reflect the current stability of the Wisconsin and Arizona economies. These conditions contrast with 1990 and 1991 when conditions were generally less favorable and weaknesses in economic conditions and real estate values significantly impacted the Corporation's Arizona-based portfolio, resulting in higher than historic levels of\nlosses. The 1995 charge-off level for commercial loans was above the abnormally low 1994 level, but below 1991-1993 levels. During the 1991-1995 period, commercial loan recoveries generally declined, with the exception of 1992 when a large recovery occurred relating to a 1990 charge-off. The higher 1992 recovery and the abnormally low 1994 gross charge-offs, resulted in small net commercial loan recoveries in 1992 and 1994. The 1995 charge-off for construction real estate loans, decreased from the 1994 peak. The losses were offset by negligible recoveries and continue to be relatively immaterial. The 1995 charge-offs for real estate mortgages, which decreased to the lowest level in five years, were offset by lower than normal recoveries. Resulting net charge-offs increased from 1993 and 1994 levels, but remained below 1991 and 1992 levels. The 1995 charge- off and recovery levels for personal loans increased above 1993 and 1994 levels, but remained below 1991 and 1992 levels. The 1995 charge-offs for the Corporation's lease financing portfolio approximated 1993 and 1994 levels, remaining below 1991 and 1992 levels. Offsetting recoveries continued to decrease from their 1993 peak, resulting in 1995 net charge-offs which were slightly below the five-year average.\nThe Corporation's charge-off and provision levels for 1996 are expected to continue to be largely dependent on economic conditions in the Corporation's primary service areas. While general economic conditions continue to be relatively stable, should national or regional conditions deteriorate, the Corporation's Wisconsin and Arizona markets may be adversely affected. Absent deterioration in these conditions, total charge-offs for 1996 are not currently expected to vary significantly from 1995 levels. Offsetting recoveries are currently expected to decrease slightly from 1995 levels as a result of the general decline in gross charge-offs in recent years. At the present time, there are no material loans which are known or believed to be in imminent danger of deteriorating or defaulting which are currently expected to give rise to material charge-offs; however, loss levels can be significantly impacted by a few large loans which could deteriorate unexpectedly or be adversely impacted by economic conditions. Based on current conditions, commercial loan losses for 1996 are expected to approximate normal historic levels, remaining below peak 1990 and 1991 levels. Commercial real estate loans continue to be highly vulnerable to regional economic conditions and real estate values; however, based on current conditions, real estate and construction loan losses for 1996 are not currently expected to vary significantly from 1995 levels. Based on the current portfolio size, composition and experience, personal loan losses for 1996 are expected to approximate normal historic levels, remaining below the peak level experienced in 1991. However, the Corporation is not immune to the potential impacts of national trends in retail credit delinquencies and collections. At the present time, direct lease financing losses for 1996 are expected to approximate historic levels; however, actual losses could be impacted by portfolio growth, fraud, or unanticipated weaknesses in industry segments within the portfolio.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nM&I and M&I Bank occupy offices on all or portions of 16 floors of a 21-story building located at 770 North Water Street, Milwaukee, Wisconsin. A subsidiary of M&I Bank owns the building and its adjacent 10-story parking lot and leases the remaining floors to a professional tenant. In addition, various subsidiaries of M&I lease commercial office space in downtown Milwaukee office buildings near the 770 North Water Street facility. M&I Bank also owns or leases various branch offices located in Milwaukee and in surrounding suburban communities. M&I has 28 subsidiary banks and one savings association located in cities throughout Wisconsin. M&I Thunderbird Bank, a wholly-owned bank subsidiary of M&I, is located in Phoenix, Arizona and has 12 offices in Phoenix and the surrounding Maricopa County communities. The subsidiary banks and savings association occupy modern facilities which are owned or leased. M&I owns a data processing facility located in Brown Deer, a suburb of Milwaukee, from which M&I Data Services conducts data processing activities. Properties leased by M&I for M&I Data Services also include commercial office space in Brown Deer, a data processing site in Oak Creek, Wisconsin, and processing centers and sales offices in various cities throughout the United States.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nM&I is not currently involved in any material pending legal proceedings other than litigation of a routine nature and various legal matters which are being defended and handled in the ordinary course of business.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNot applicable.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nSTOCK LISTING\nM&I's common stock is traded under the symbol \"MRIS\" in the NASDAQ National Market System, and quotations are supplied by the National Association of Securities Dealers.\nCommon dividends declared and the price range for M&I's common stock for each of the last five years can be found in Item 8, Consolidated Financial Statements, Quarterly Financial Information.\nA discussion of the regulatory restrictions on the payment of dividends can be found under Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, and in Note 13 to Item 8, Consolidated Financial Statements.\nHOLDERS OF COMMON EQUITY\nAt December 31, 1995, M&I had approximately 18,659 record holders of its Common Stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nCONSOLIDATED SUMMARY OF EARNINGS YEARS ENDED DECEMBER 31 ($000'S EXCEPT SHARE DATA)\nCONSOLIDATED SUMMARY OF EARNINGS -- CONTINUED YEARS ENDED DECEMBER 31 ($000'S EXCEPT SHARE DATA)\n- --------------- * Not restated for acquisitions accounted for as a pooling of interests.\n** See Exhibit 12 for detailed computation of these ratios.\nCONSOLIDATED AVERAGE BALANCE SHEETS YEARS ENDED DECEMBER 31 ($000'S EXCEPT SHARE DATA)\n- --------------- * Not restated for acquisitions accounted for as pooling of interests.\n** Nonaccrual loans, restructured loans, and loans past due 90 days or more.\n*** Restated for 3 for 1 stock split.\nYIELD & COST ANALYSIS (TAX EQUIVALENT BASIS) YEARS ENDED DECEMBER 31\n- --------------- * Not restated for acquisitions accounted for as pooling of interests.\n** Nonaccrual loans, restructured loans, and loans past due 90 days or more.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL POSITION AND RESULTS OF OPERATIONS\nFor 1995, the Corporation reported net income of $193.3 million compared to $105.9 million in 1994. Fully diluted net income per share in 1995 was $1.90 compared to $1.04 in the prior year. The return on average assets and average equity in 1995 was 1.52% and 16.41%, respectively, and 0.85% and 9.65%, respectively, for the year ended December 31, 1994.\nNet income for 1994 included $64.0 million of charges and extraordinary items related to the Corporation's merger with Valley Bancorporation (Valley), which occurred during the second quarter of 1994.\nExcluding the above noted merger related charges, net operating income and fully diluted earnings per share for 1994 would have been $169.9 million and $1.65, respectively.\nThe following table summarizes the unusual items reported in the second quarter of 1994 adjusted for merger related gains realized in the third and fourth quarter of 1994 and its impact on net income.\nINCOME STATEMENT COMPONENTS AS A PERCENT OF AVERAGE TOTAL ASSETS\nThe table below presents a summary of the major elements of the income statement for 1995, 1994, and 1993. Each of the elements is stated as a percent of average total assets outstanding for the respective year and, where appropriate, is converted to a fully taxable equivalent basis (FTE). The results exclude the after-tax merger related charges reported in 1994.\nNET INTEREST INCOME\nNet interest income for 1995 was $491.5 million compared to $491.2 million in 1994, an increase of $0.3 million. The benefit from the increase in rates earned and the slight increase in the volume of average earning assets, primarily loans, was offset by the increase in rates paid on interest bearing liabilities and the negative impact of the change in liability mix.\nAverage earning assets increased $282.2 million or 2.5% in 1995 compared to the same period last year. Average loan growth of $317.3 million or 3.6% was somewhat offset by the decline in average other earning assets, primarily investment securities, of $35.1 million.\nAverage interest bearing liabilities increased $235.4 million or 2.6% in 1995 compared to 1994. Average interest bearing deposits increased $11.1 million while average short-term borrowings decreased $129.6 million or 13.4% since last year. The decrease in average short-term borrowings together with the decrease in noninterest bearing deposits of $71.8 million or 3.5%, resulted in an increase in average long-term borrowings from $447.3 million in 1994 to $801.2 million in 1995, an increase of $353.9 million or 79.1%.\nIn conjunction with the Valley merger in 1994, the Corporation completed certain required and voluntary branch divestitures. During the third and fourth quarters of 1994, approximately $300 million of deposits and $200 million of loans were sold. The effect of these divestitures was somewhat mitigated by 1995 acquisitions which were accounted for as purchases. The Bank of Burlington, with deposits of $149 million and loans of $113 million, was acquired on February 1, 1995. In July 1995, Citizens Bancorp of Delavan, Inc. and Sharon State Bank were acquired, which had combined deposits of $82.6 million and combined loans of $72.5 million.\nThe growth and composition of the Corporation's average loan portfolio for the current year and prior two years are reflected below:\nDuring the third quarter of 1995, the Corporation began converting adjustable rate mortgage loans (ARMs) into Federal National Mortgage Association (FNMA) ARM pool securities to enhance liquidity. Approximately $455 million of ARM loans were securitized and transferred to investment securities available for sale in 1995. A fee of 7.5 basis points is required to guarantee the securities which had and will have a negative impact on net interest income. The Corporation estimates that approximately $100 million of ARM loans may be securitized in 1996. Average residential real estate loan growth and average total consolidated loan growth for 1995 versus 1994 would have been 7.6% and 4.5% before the securitizations.\nThe growth and composition of the Corporation's average deposits for the current year and prior two years are reflected below:\nDuring the third quarter of 1994, the Corporation began offering a money market index account to attract new deposits. The average balance of the money market index account was approximately $956 million in 1995. Since inception, this product has generated approximately $668 million of new deposits. The remaining balances were the result of disintermediation from the Corporation's other deposit accounts. The average rate paid on the index account was approximately 200 basis points higher than the tier equivalent nonindexed money market account in 1995.\nThe net interest margin as a percent of average earning assets declined 10 basis points from 4.40% in 1994 to 4.30% in 1995. The yield on interest earning assets increased 74 basis points while the cost of interest bearing liabilities increased 107 basis points.\nLoan growth and the increase in loan yields of 76 basis points account for 87% of the increase in interest on earning assets in 1995 compared to 1994. The remainder of the increase was primarily attributable to higher yields in other earning assets, particularly taxable investment securities.\nThe increase in average cost of deposits and short-term borrowings represent 83% of the 1995 versus 1994 increase in interest paid on interest bearing liabilities. The average cost of savings and interest bearing demand deposits increased 88 basis points and the average cost of other time deposits increased 110 basis points in 1995 compared to the prior year. The average cost of short-term borrowings increased 161 basis points. The increase in the volume of long-term borrowings, offset by a 13 basis point decline in the average cost of this category, contributed approximately $23.2 million of the increase in interest paid on interest bearing liabilities.\nDuring the second quarter of 1994, the Corporation's banking subsidiaries began offering Bank Notes. The Bank Notes, issued for a two-year term at floating interest rates indexed to LIBOR, provide an additional funding source along with those traditionally available to our banking affiliates. In 1995, the average amount and average cost of these notes were $415 million and 6.20% compared to $138.4 million and 5.21% in 1994.\nThroughout 1995 and 1994, the Corporation was not involved in derivative activity that would impact net interest margins or interest rate sensitivity or risk. Financial derivative instruments which are straightforward and involve little complexity may be used on a limited basis in the future.\nThe possible continuing lack of deposit and earning asset growth, and shift of deposit mix into higher cost categories, may continue to put pressure on the interest margin.\nNet interest income was $491.2 million in 1994, an increase of $10.9 million or 2.3% from $480.3 million earned in 1993. The benefit of the increase in average earning assets was partially offset by the slight decline in the yield on average earning assets and increased volume of higher cost short-term and long-term borrowings fueled in part by the decline in average deposits.\nAverage earning assets increased $377.5 million or 3.4% in 1994 compared to the prior year. Average loans increased $530.4 million or 6.5% and was the primary contributor to average earning asset growth. The decline in other earning assets, primarily investment securities, was due to the funding of loan growth.\nDuring 1994, the Corporation experienced a shift in its deposit mix. Noninterest bearing deposits increased $54.1 million or 2.7%, however, this increase did not offset the decline in interest bearing deposits, which declined $158.7 million in 1994. Core interest bearing deposits increased $79.6 million while certificates of deposit and other time deposits declined $238.3 million.\nDuring the third quarter of 1994, the Corporation prepaid $53 million of Valley's long-term Series A 9.86% and Series B 9.97% senior unsecured notes and refinanced the notes with the Corporation's medium-term notes which had an average cost of 7.46% in 1994.\nThe net interest margin as a percentage of average earning assets declined from 4.48% in 1993 to 4.40% in 1994. The average yield on interest earning assets was 7.27% in 1994, a decrease of 6 basis points compared to 1993. The total investment yield declined 40 basis points due to the maturity of higher yielding securities. The total cost of interest bearing liabilities remained relatively unchanged. While the decline in the cost of deposits had a favorable impact on the net interest margin, the lack of deposit growth resulted in the use of higher cost short-term and long-term borrowings to meet funding needs. Average short-term borrowings increased $323.0 million and the average cost of such borrowings increased 130 basis points in 1994 compared to the prior year. The increase in the average volume of long-term borrowings, primarily Bank Notes, negatively impacted the net interest margin despite the 166 basis point decline in the cost of such borrowings.\nAVERAGE BALANCE SHEETS AND ANALYSIS OF NET INTEREST INCOME\nThe Corporation's consolidated average balance sheets, interest earned and interest paid, and the average interest rates earned and paid for each of the last three years are presented below (dollars in thousands):\n- --------------- Notes:\n(1) Fully taxable equivalent basis, assuming a Federal income tax rate of 35%, and excluding disallowed interest expense.\n(2) Loans on a nonaccrual status have been included in the computation of average balances.\nANALYSIS OF CHANGES IN INTEREST INCOME AND INTEREST EXPENSE\nThe effect on interest income and interest expense due to volume and rate changes in 1995 and 1994 are outlined below. Changes not due solely to either volume or rate are allocated to rate (dollars in thousands):\n- --------------- Notes:\n(1) Fully taxable equivalent basis, assuming a Federal income tax rate of 35%, and excluding disallowed interest expense.\nPROVISION FOR LOAN LOSSES AND CREDIT QUALITY\nThe provision for loan losses in 1995 amounted to $16.2 million compared to $24.9 million in 1994. The 1994 provision included an additional loan loss provision of $8.9 million which was recorded at the time of the Valley merger to conform Valley's loan valuation policies with those of the Corporation.\nNonperforming assets at December 31, 1995 were $70.5 million compared to $70.1 million reported at December 31, 1994. Nonaccrual loans, the largest component of nonperforming assets, increased $5.8 million when compared to December 31, 1994 while loans past due 90 days or more and renegotiated loans decreased $1.1 million and $0.9 million, respectively. Nonaccrual commercial loans and leases increased $4.8 million or 48.1% while nonaccrual commercial real estate loans declined $3.1 million or 15.5% at December 31, 1995 when compared to last year. Nonaccrual residential real estate continued its upward trend and amounted to $15.7 million, an increase of $4.2 million since December 31, 1994. At December 31, 1995, other real estate owned, which is down $3.5 million from the prior year, includes approximately $2.4 million of closed branch facilities.\nNet charge-offs in 1995 amounted to $9.3 million or .10% of average loans compared to $4.5 million or .05% for the prior year.\nThe allowance for loan losses amounted to $161.4 million or 1.82% of total loans at December 31, 1995 compared to $154.0 million or 1.75% of total loans at December 31, 1994. The coverage of the allowance for loan losses to nonperforming loans decreased slightly from 265% at December 31, 1994 to 261% at the end of the current year.\nAs part of the ARM loan securitization previously discussed, approximately $2.3 million of loan loss reserve balances were transferred to a specific investment reserve to cover estimated losses based on the Corporation's experience with these types of loans. The Corporation has agreed to guarantee the first 4% of the loan pools securitized through FNMA against loss.\nSince the third quarter of 1995, nonperforming assets increased $0.9 million which was primarily due to an increase of $1.1 million in loans past due 90 days or more. Also affecting total nonperforming assets were net charge-offs in the fourth quarter which amounted to $5.3 million and was $4.6 million higher than the third quarter of 1995. The increased net charge-offs were primarily related to commercial loans.\nCONSOLIDATED CREDIT QUALITY INFORMATION\nDECEMBER 31 ($000'S)\nMAJOR CATEGORIES OF NONACCRUAL LOANS ($000'S)\nRECONCILIATION OF CONSOLIDATED ALLOWANCE FOR LOAN LOSSES ($000'S)\n- --------------- (1) The amount of the provision for loan losses charged to operating expense for the year ended December 31, 1995, is the amount necessary to bring the allowance for loan losses at December 31, 1995, to a level believed adequate by management to absorb current estimated potential losses in the loan portfolio. Management's determination of the adequacy of the allowance is based on a continual review of the loan portfolio, loan loss experience, economic conditions, growth and composition of the portfolio, and other relevant factors. As a result of management's continual review, the allowance is adjusted through provisions for loan losses charged against income.\nOTHER INCOME\nTotal other income was $424.2 million for the year ended December 31, 1995 compared to $361.5 million earned in the prior year. Our financial services affiliates were the major contributors to the increase.\nM&I Data Services (Data Services), the Corporation's data processing division, reported data processing revenue of $213.9 million compared to $159.4 million for the year ended December 31, 1994, an increase of $54.5 million or 34.2%. Processing and conversion revenue increased $30.0 million or 23.4% while buy out fees related to terminated contracts (which can vary from year to year) increased $4.3 million and amounted to $6.3 million for the year ended December 31, 1995. Software related revenue increased $18.5 million. Approximately 60% of the increase is attributable to the December, 1994 acquisition of Software Alliance.\nTrust fees amounted to $64.2 million, an increase of $4.5 million or 7.5% compared to $59.7 million earned in 1994. An increase in the overall market value of trust assets along with increased revenue from outsourcing services more than offset the revenue decline due to pricing compressions.\nOther customer services declined $6.3 million in 1995 compared to the prior year. Fees on loans declined $1.3 million or 6.5% while other commission and fees declined $2.2 million or 4.9% in the current year when compared to 1994. Service charges on deposit accounts declined $2.9 million and amounted to $51.0 million for the year ended December 31, 1995.\nNet securities gains amounted to $4.6 million for the year ended December 31, 1995 compared to net securities losses of $5.8 million for the year ended December 31, 1994. During 1995, Capital Markets Group realized securities gains of $7.2 million offset in part by $4.0 million of realized and unrealized securities losses as compared to securities gains of $2.3 million in 1994 and securities losses of $0.3 million. The Corporation also sold certain equity securities carried in the available for sale category and realized a net gain of $1.3 million in 1995 and $0.9 million in 1994. Excluding the $7.3 million of securities losses taken at the time of the Valley merger, 1994 net securities gains amounted to $1.5 million.\nOther miscellaneous income amounted to $30.8 million for the year ended December 31, 1995, slightly lower than that reported in the prior year. The Corporation adopted the new accounting standard on mortgage servicing rights in the third quarter of 1995 which resulted in a $2.4 million increase in other income. This increase was offset by lower gains on the sale of other real estate owned and lower insurance commissions revenue. Revenue from property and casualty insurance commissions declined $2.8 million due to the sale of that line of business in the later part of 1994.\nTotal other income amounted to $361.5 million in 1994, a decline of $10.4 million when compared to $371.9 million reported in 1993. Excluding the $7.3 million of securities losses taken as part of the Valley acquisition, other income declined $3.1 million in 1994 compared to the prior year. Data processing revenue increased $24.4 million or 18.1% in 1994 while trust revenues declined $1.5 million for the same period. Other customer service revenue declined $7.4 million in 1994 compared to 1993 primarily due to lower service charges on deposit accounts. The higher interest rate environment in 1994 caused higher earnings credits to be given to commercial deposit accounts. The decline in revenue from the origination and sale of mortgage loans in 1994 accounted for a majority of the decrease in fees on loans and other miscellaneous income.\nSecurities losses in 1994 amounted to $5.8 million compared to a net gain of $8.3 million in 1993. Excluding the securities losses taken at the time of the Valley acquisition, net securities gains amounted to $1.5 million in 1994. Capital Markets Group realized net gains of $2.0 million in 1994 compared to $3.3 million in 1993. The Corporation also sold certain equity securities and realized a gain of $0.9 million in 1994 and $4.2 million in 1993.\nOTHER EXPENSE\nTotal other expense amounted to $599.6 million in 1995 compared to $660.0 million in 1994. As noted earlier, several one time charges were recorded in 1994. A merger\/restructuring charge of $75.2 million reflected the costs associated with executive contracts, a reduction in work force, and other items related to the merger. Also taken at that time were other miscellaneous charges of $8.5 million which represented goodwill\nand other real estate write downs and other accrual related adjustments. Total other expense for 1994, excluding the above noted items, would have been $576.3 million.\nSalaries and benefits expense amounted to $343.7 million, an increase of $19.7 million or 6.1%, in 1995 compared to the prior year. The increase was due primarily to Data Services.\nAt December 31, 1995, Data Services had approximately 2,600 employees compared to 2,200 employees at December 31, 1994. A portion of the increase was due to Data Service's acquisition of Software Alliance and a New England data center. Our banking affiliates experienced a decline in salaries and benefits expense.\nUpon consummation of the merger in 1994, the Valley pension plan was curtailed and in 1995, the plan was fully terminated through cash distributions and\/or purchases of annuities. The 1994 curtailment expense of $2.3 million is classified as a merger\/restructuring cost while the pension termination expense of $1.8 million is included in salaries and benefits expense for 1995.\nNet occupancy expense in 1995 declined $0.9 million due primarily to the branch divestitures which occurred during 1994. This benefit was somewhat offset by increased occupancy costs incurred by Data Services through its New England data center acquisition and a full year of operating a secondary processing site.\nEquipment expense amounted to $65.5 million in 1995 compared to $59.6 million for 1994. The 1995 acquisition of the New England data center, a secondary processing site which became operational late in the fourth quarter of 1994, and CPU and other equipment upgrades by Data Services were the primary reasons for the increase.\nThe decline in payments to regulatory agencies of $10.6 million in 1995 when compared to 1994 is due to the reduction in FDIC insurance premium rates which declined from $.23 per $1,000 of insured deposits to $.04 on June 1, 1995.\nSupplies and printing expense which amounted to $15.7 million in 1995 increased $1.3 million when compared to the prior year. This increase is the result of higher data processing revenue experienced in 1995.\nProfessional services expense amounted to $18.7 million for the year ended December 31, 1995 compared to $12.5 million in the prior year. Approximately $4.7 million of the increase was due to costs incurred for technological assistance in software development, such as Data Service's data warehouse project. Approximately $1.1 million of the remaining increase represents costs incurred in connection with the ARM loan securitization program previously discussed.\nOther miscellaneous expense amounted to $89.1 million in 1995 compared to $96.1 million in 1994. Excluding $7.4 million of charges taken in conjunction with the Valley merger, other miscellaneous expense for 1994 amounted to $88.7 million. Travel and software costs for Data Services increased $4.8 million over the prior year. In addition, the acquisitions of Software Alliance and the New England data center resulted in an increase in intangibles amortization expense of $3.7 million in 1995 compared to 1994. This category of expense is also affected by the capitalization of costs, net of amortization, associated with software development and data processing conversions. Including the professional services expense increase of $4.7 million, the amount of software development costs, net of amortization, in 1995 was $8.0 million higher than the amount reported in 1994. The impact of conversion activity, net of amortization, was to increase miscellaneous expense by $1.0 million in 1995 compared to the prior year.\nTotal other expense amounted to $660.0 million in 1994 compared to $569.6 million in 1993. Excluding the one-time merger related items of $83.7 million, 1994 total other expenses amounted to $576.3 million, an increase of $6.7 million or 1.2% when compared to 1993. The minimal expense growth is attributable to the cost savings achieved by the Corporation in 1994 due to the merger. Salaries and Benefits expense increased only 1.0% due primarily to the elimination of duplicate job functions at the time of the Valley merger. Occupancy expense increased $0.2 million in 1994 compared to 1993 due to the sale of branch facilities in the second half of 1994. Equipment expense, which increased 2.9% in 1994 when compared to the prior year, was associated with Data Services need for more computer capacity, data storage devices, and other processing\nequipment. This increased cost did not totally offset the cost savings associated with the merger. The other miscellaneous category of expense was affected by the $7.4 million of merger related charges in 1994.\nINCOME TAX PROVISION\nThe provision for income taxes was $106.6 million in 1995 compared to $73.4 million in 1994 and $93.2 million in 1993. The increase in the 1995 provision levels is due to higher taxable income offset in part by a $2.3 million research and experimental tax credit related to software development. The 1994 provision for taxes was impacted by certain nondeductible expenses associated with the Valley combination. The effective tax rate was 35.54% in 1995, 43.74% in 1994, and 35.22% in 1993.\nASSET\/LIABILITY MANAGEMENT\nAsset\/Liability management 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. These strategies determine the characteristics and mix of the balance sheet. They affect net interest margins, maturity patterns, interest rate sensitivity and risk, as well as resource allocations.\nThe Corporation combines the active management of the balance sheet position over interest rate cycles to confine interest rate risk within prudent parameters. Financial derivative instruments may be used on a limited basis and are generally straightforward and involve little complexity. We position the balance sheet in a manner which will match asset and liability repricing schedules to insulate our net interest margin from cyclical swings in interest rates, while consciously matching or mismatching discretionary asset and liability repricing schedules to take advantage of interest rate swings over short periods of time.\nAdequate funding sources are maintained through a full line of deposit and short-term borrowing products, competitively priced to a diversified customer base. Asset diversification provides a proper mix of variable and fixed rate loans, while investment decisions are primarily designed to balance the overall interest rate risk in the balance sheet. Liquidity is provided through marketability and an appropriate schedule of maturing investments.\nA portion of demand deposits are considered rate sensitive under the following assumptions. A core amount of demand deposits is calculated at the beginning of each year. This core number is the average of the previous six months actual and upcoming twelve months forecasted balances. The core balance is considered nonrate sensitive and classified as a nonrate sensitive liability in the \"1 year +\" time frame. Actual demand deposit balances are compared to the core balance monthly. The difference, positive or negative, is considered rate sensitive and classified as a rate sensitive liability. At December 31, 1995, $261 million of demand deposits were classified as rate sensitive in the \"1-30 Days\" time frame. In addition, a percentage of various interest-bearing accounts are classified (rate sensitive or nonrate sensitive) according to assumptions which approximate the extent to which the rates on these accounts are expected to increase (decrease) relative to a change in the general level of interest rates.\nASSET\/LIABILITY MANAGEMENT ($ IN MILLIONS)\nCAPITAL RESOURCES\nShareholders' equity was $1.26 billion at December 31, 1995 compared to $1.06 billion at December 31, 1994. This increase was primarily due to retained net income, the issuance of 2.8 million common shares for the acquisition of three banking affiliates and a $55.3 million increase in the net unrealized gain on investment securities available for sale.\nThe Corporation and its affiliates continue to have a strong capital base and the Corporation's regulatory capital ratios are significantly above the defined minimum regulatory ratios. At December 31, 1995, the Corporation had a total risk-based capital ratio of 14.04% and an 11.71% core capital to risk-based asset ratio. Selected leverage capital ratios must also be maintained. The Corporation's leverage ratio at December 31, 1995 of 9.07% was substantially in excess of the minimum guidelines.\nThe Corporation's subsidiaries, primarily its banking subsidiaries, are restricted by regulations from making dividend distributions above prescribed amounts. In addition, banking subsidiaries are limited in making loans and advances to the Corporation. At December 31, 1995, approximately $87 million and $45 million were available for distribution without regulatory approval from the Corporation's banking and nonbanking subsidiaries, respectively.\nUnder Federal Reserve Board policy, the Corporation is expected to act as a source of financial strength to each subsidiary bank and to commit resources to support each subsidiary bank in circumstances when it might not do so absent such policy.\nIn May of 1994, $16.4 million of 8.5% convertible subordinated notes were converted into 1,870,057 shares of common stock. As provided for in the note agreement, the noteholder, subsequent to conversion, exchanged the common shares acquired by conversion of the debt for 163,630 shares of Series A preferred stock.\nThe Corporation has a Stock Repurchase Program which was approved by the Corporation's Board of Directors in April 1993 and reaffirmed in October 1994. In October 1994, the Board of Directors also authorized an increase in the number of shares to be repurchased from 9.0 million shares to 15.1 million shares. The shares are being acquired in anticipation of the remaining conversion of the Corporation's 8.5% convertible subordinated notes, to fund the on-going program to deliver or have available shares of common stock for stock option and other employee benefit plans and other corporate needs. During 1995, the Corporation purchased 2.7 million shares and has cumulatively purchased 12.5 million shares since inception of the program.\nThe Corporation has filed registration statements with the Securities & Exchange Commission to issue medium term unsecured and subordinated series notes. These issues may have maturities which range from nine (9) months to 30 years from the date of issue at a fixed or floating rate. As of December 31, 1995, approximately $177 million of medium term notes and approximately $560 million of bank notes can be issued. This allows the Corporation to maintain ready access to funding sources for general corporate purposes which include, but are not limited to, refinancing existing corporate and bank debt as it matures, and other corporate needs.\nITEM 8.","section_7A":"","section_8":"ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA FOR YEARS ENDED DECEMBER 31, 1995, 1994, AND 1993\nCONSOLIDATED BALANCE SHEETS DECEMBER 31 ($000'S EXCEPT SHARE DATA)\nThe accompanying notes are an integral part of the Consolidated Financial Statements.\nCONSOLIDATED STATEMENTS OF INCOME YEARS ENDED DECEMBER 31 ($000'S EXCEPT SHARE DATA)\nThe accompanying notes are an integral part of the Consolidated Financial Statements.\nCONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31 ($000'S)\nThe accompanying notes are an integral part of the Consolidated Financial Statements.\nCONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY ($000'S EXCEPT SHARE DATA)\nThe accompanying notes are an integral part of the Consolidated Financial Statements.\nCONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY ($000'S EXCEPT SHARE DATA)\nThe accompanying notes are an integral part of the Consolidated Financial Statements.\nCONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY ($000'S EXCEPT SHARE DATA)\nThe accompanying notes are an integral part of the Consolidated Financial Statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1995, 1994, AND 1993 ($000'S EXCEPT SHARE DATA)\nMarshall & Ilsley Corporation (\"M&I\" or the \"Corporation\") is a bank and savings and loan holding company that provides financial services to a wide variety of corporate, institutional, government and individual customers through 28 banks and one savings association located in Wisconsin and one bank in Arizona. Based on total revenues, banking is M&I's largest business and includes personal property lease financing; investment management and advisory services; commercial and residential mortgage banking; venture capital and financial advisory services; trust services to residents of Wisconsin, Arizona and Florida; and brokerage services. M&I also provides financial and data processing services and software sales through the Data Services Division of the Corporation. M&I's largest affiliates and principal operations are in Wisconsin; however, it has activities in other markets, particularly in certain neighboring midwestern states, and in Arizona and Florida.\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nEstimates -- 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 reported periods. Actual results could differ from those estimates.\nConsolidation principles -- The Consolidated Financial Statements include the accounts of Marshall & Ilsley Corporation and all subsidiaries. All significant intercompany balances and transactions are eliminated in consolidation. Certain amounts in the 1994 and 1993 Consolidated Financial Statements have been reclassified to conform with the 1995 presentation.\nCash and cash equivalents -- For purposes of the Consolidated Financial Statements, the Corporation defines cash equivalents as short-term investments which have an original maturity of three months or less and are readily convertible into cash.\nSecurities -- Securities, when purchased, are designated as Trading, Investment Securities Held to Maturity, or Investment Securities Available for Sale and remain in that category until they are sold or mature. The specific identification method is used in determining the cost of securities sold.\nInvestment Securities Held to Maturity are carried at cost, adjusted for amortization of premiums and accretion of discounts. Investment Securities Available for Sale are carried at fair value with fair value adjustments and the related income tax effects reported as a separate component of shareholders' equity as prescribed by Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" Short-term Investments, other than Trading Securities, are carried at cost, which approximates market value. Trading Securities are carried at market value, with adjustments to the carrying value reflected in the Consolidated Statements of Income.\nLoans -- Interest on loans, other than direct financing leases, is recognized as income based on the loan principal outstanding during the period. Unearned income on direct financing leases is recognized over the lease term on a basis that results in an approximate level rate of return on the lease investment. Loans are generally placed on nonaccrual status when they are past due 90 days as to either interest or principal. When a loan is placed on nonaccrual status, previously accrued and uncollected interest is charged to interest income on loans. A nonaccrual loan may be restored to an accrual basis when interest and principal payments are brought current and collectibility of future payments is not in doubt.\nThe Corporation defers and amortizes fees and certain incremental direct costs, primarily salary and employee benefit expenses, over the contractual term of the loan or lease as an adjustment to the yield. The unamortized net fees and costs are reported as part of the loan balance outstanding.\nAllowance for loan losses -- The allowance for loan losses is maintained at a level believed adequate by management to absorb estimated potential losses in the loan portfolio. Management's determination of the\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED DECEMBER 31, 1995, 1994, AND 1993 ($000'S EXCEPT SHARE DATA)\nadequacy of the allowance is based on a continual review of the loan portfolio, loan loss experience, economic conditions, growth and composition of the portfolio, and other relevant factors. As a result of management's continual review, the allowance is adjusted through provisions for loan losses charged against income.\nPremises and equipment -- Premises and equipment are recorded at cost and depreciated principally on the straight-line method with annual rates varying from 2% to 10% for buildings and 10% to 35% for equipment. Maintenance and repairs are charged to expense and betterments are capitalized.\nOther real estate owned -- Other real estate owned includes assets that have been acquired in satisfaction of debts or bank branch premises held for sale. Other real estate is recorded at the lower of cost or fair value, less estimated selling costs, at the date of transfer. Valuation adjustments required at the date of transfer for assets acquired in satisfaction of debts are charged to the allowance for loan losses, whereas any valuation adjustments on premises are reported in other expense. Subsequent to transfer, other real estate owned is carried at the lower of cost or fair market value, less estimated selling costs, based upon periodic evaluations. Rental income from properties and gains on sales are included in other income, and property expenses, which include carrying costs, required valuation adjustments and losses on sales, are recorded in other expense.\nMortgage servicing -- Normal fees related to the servicing of mortgage loans are recorded as income when payments are received from mortgagors. Mortgage loans held for sale to investors are carried at the lower of cost or market, determined on an aggregate basis, based on outstanding firm commitments received for such loans or on current market prices.\nData processing services -- Direct costs associated with the production of computer software which will be marketed or used in data processing operations are capitalized and amortized on the straight-line method over the estimated economic life of the product, generally four years. Direct costs associated with customer system conversions to the data services operations are capitalized and amortized on the straight-line method over the terms, generally five to seven years, of the related servicing contract. Routine maintenance of software products, design costs and development costs incurred prior to establishment of a product's technological feasibility are expensed as incurred. Net unamortized capitalized costs were $34,984 at December 31, 1995, and $21,696 at December 31, 1994. Amortization expense was $7,122, $6,960, and $4,668, for 1995, 1994, and 1993, respectively.\nIntangibles -- Unamortized intangibles resulting from acquisitions, primarily goodwill, core deposit premiums, purchased data processing contract rights and mortgage servicing rights were $77,376 at December 31, 1995 and $64,171 at December 31, 1994. The Corporation recognizes as separate assets rights to service mortgage loans when purchased or originated and sold with servicing retained in accordance with Statement of Financial Accounting Standards No. 122, \"Accounting for Mortgage Servicing Rights\" (SFAS 122) which was adopted by the Corporation in 1995. The Corporation allocates the cost of mortgage loans to the mortgage servicing rights and the loans based on their estimated relative fair values. Mortgage servicing rights are amortized over the periods during which the corresponding mortgage servicing revenues are anticipated to be generated. The Corporation periodically evaluates and measures impairment of capitalized mortgage servicing rights and recognizes impairment, if required, through a valuation allowance. For purposes of evaluating and measuring impairment, the Corporation stratifies the mortgage servicing rights based on loan term which the Corporation considers the predominant risk characteristic of the underlying loans. The impact of adopting SFAS 122 was not material and no valuation allowance was required for any individual stratum at December 31, 1995. Purchased data processing contract rights represent the costs to acquire the rights to data processing and software distribution. Such costs are generally amortized over the average contract lives, which range from 5 to 8 years. The other intangibles are amortized principally on the straight-line method over periods ranging from 6 to 25 years. Total amortization expense was $10,708, $9,176 and $7,204 for 1995, 1994 and 1993, respectively. The Corporation continually evaluates whether later events and circumstances have occurred to indicate that intangibles should be evaluated for possible impairment and utilizes estimates of undiscounted net income over the remaining life to measure recoverability.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED DECEMBER 31, 1995, 1994, AND 1993 ($000'S EXCEPT SHARE DATA)\nThe Corporation also has negative goodwill included in other liabilities, the majority of which, arose from an acquisition in 1992. Negative goodwill amounted to $10,811 and $12,387 at December 31, 1995 and 1994, respectively. The negative goodwill is being accreted on a straight-line basis over a period of 10 years and amounted to $1,576 in 1995, 1994 and 1993.\nForeign exchange contracts -- Foreign exchange contracts include such commitments as foreign currency spot, forward, future and, to a much lessor extent, option contracts. Foreign exchange contracts and the premiums on options written or sold are carried at market value, with realized and unrealized gains and losses included in other income.\nNet income per share -- Primary net income per share is computed using the weighted average number of common shares outstanding plus common equivalent shares issuable upon the assumed conversion of the preferred stock outstanding and shares issuable under outstanding stock option plans. The average number of common and common equivalent shares used in computing primary net income per share was 98,757,047 in 1995, 99,420,070 in 1994, and 102,672,361 in 1993.\nFully diluted net income per share also includes dilution resulting from the assumed conversion of the convertible notes. The average number of shares used in the computation of fully diluted net income per share was 102,954,823 in 1995, 104,051,365 in 1994, and 108,874,600 in 1993.\n2. BUSINESS COMBINATIONS\nOn May 31, 1994, Valley Bancorporation (\"Valley\") merged with and into the Corporation in a tax-free reorganization accounted for as a pooling of interests. Accordingly, prior year financial statements have been restated to give effect to this transaction. In accordance with the terms of the merger, each share of Valley Common Stock was converted into the right to receive 1.72 shares of the Corporation's Common Stock (approximately 35.7 million shares).\nA reconciliation of net interest income and net income of the Corporation as previously reported to the amounts for that period in the accompanying Consolidated Financial Statements as restated for the 1994 pooling of interests is as follows:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED DECEMBER 31, 1995, 1994, AND 1993 ($000'S EXCEPT SHARE DATA)\nThe Corporation has also consummated the following business combinations:\nThe results of operations for the acquired companies accounted for as purchases are included in the Consolidated Financial Statements from the dates of acquisition. The pro forma impact on net income from acquisitions is not material.\n3. MERGER\/RESTRUCTURING\nCertain one-time expenses associated with the 1994 merger with Valley are shown in the Consolidated Statements of Income as Merger\/Restructuring and consist of the following:\nThe executive contracts accrual was the present value of the amounts contractually due to certain Valley executives under their former employment contracts. During 1995 and 1994, payments of $0.2 million and $10.2 million respectively, were made.\nEmployee severance costs represented the planned general reduction in work force resulting from the merger and restructuring activities which affected all employee groups. Approximately $8.6 million of severance costs were paid in 1994 and the remainder was substantially paid in 1995.\nDuplicative computer and software write-offs were the capitalized costs of Valley's own internal data processing center which was closed. System conversion and standardization costs represent the costs associated with the one-time conversion and standardization of Valley's records to the Corporation's data processing systems.\nInvestment advisors and legal, accounting and other professional fees represent fees paid to consummate the merger.\nLease terminations and equipment disposals represent the costs to terminate branch office and other corporate facilities leases, equipment leases and the disposal of equipment.\nNet gain on sale of duplicative facilities and voluntary divestitures represents the gain or loss from the sale of duplicative branch offices and other corporate facilities which were owned. The Corporation voluntarily\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED DECEMBER 31, 1995, 1994, AND 1993 ($000'S EXCEPT SHARE DATA)\ndivested four bank branches with deposits of approximately $34 million and certain portions of its insurance agencies.\nOther charges include the one-time expenses associated with the curtailment of certain Valley defined benefit plans, approximately $3.3 million, costs to eliminate duplicate customer accounts, unusable capitalized inventory, and other costs not deemed to be realizable due to the merger.\nThere have not been any material adjustments to the liabilities subsequent to the initial recognition which occurred during the second quarter of 1994.\n4. EXTRAORDINARY ITEMS\nDuring the third and fourth quarters of 1994, the Corporation realized extraordinary gains from the sale of certain bank branches with deposits of $267 million which were required to be divested in conjunction with the regulatory approvals obtained for the merger with Valley.\nDuring the third quarter of 1994, the Corporation prepaid $53 million of Valley's long-term debt consisting of the senior unsecured notes, Series A 9.86% due in 1994 and Series B 9.97% due in 1995. In accordance with the note agreements, a prepayment premium was paid in connection with the early retirement of the debt. The debt was refinanced with the Corporation's medium-term notes.\nThe following table summarizes these 1994 transactions:\n5. CASH AND DUE FROM BANKS\nAt December 31, 1995, $133,652 of cash and due from banks was restricted, primarily due to requirements of the Federal Reserve System to maintain certain reserve balances.\n6. OTHER SHORT-TERM INVESTMENTS\nOther short-term investments at December 31 were:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED DECEMBER 31, 1995, 1994, AND 1993 ($000'S EXCEPT SHARE DATA)\n7. SECURITIES\nThe book and market values of securities at December 31 were:\nThe unrealized gains and losses of securities at December 31 were:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED DECEMBER 31, 1995, 1994, AND 1993 ($000'S EXCEPT SHARE DATA)\nThe book value and market value of securities by contractual maturity at December 31, 1995 were:\nThe gross realized gains and losses amounted to $8,821 and $4,266 in 1995, $3,499 and $9,251 in 1994, and $8,552 and $218 in 1993, respectively.\nAt December 31, 1995, securities with a value of approximately $364,340 were pledged to secure public deposits, short-term borrowings, and for other purposes required by law.\nDuring 1995, approximately $455 million of adjustable rate mortgage loans were securitized and transferred to investment securities available for sale. Approximately $2,275 of the allowance for loan losses was transferred to a specific investment reserve to cover estimated losses based on the Corporation's experience with these types of financial instruments. The Corporation has agreed to guarantee the first 4% of the loan pools securitized through a government agency against potential loss. These are noncash transactions for purposes of the Consolidated Statements of Cash Flows.\nOn December 1, 1995, the Corporation transferred and reclassified approximately $182.8 million of investment securities previously classified as held to maturity to available for sale after reassessing the appropriateness of the classification of all investment securities held at that time in accordance with SFAS 115 and the Financial Accounting Standards Board's, \"A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities.\"\n8. LOANS\nLoans at December 31 were:\nThe Corporation's lending activities are concentrated primarily in the Midwest. Approximately 3% of its portfolio consists of loans granted to customers located in Arizona. The Corporation had $3,103 in foreign credits at December 31, 1995. The Corporation's loan portfolio consists of business loans extending across many industry types, as well as loans to individuals. As of December 31, 1995, total loans to any group of\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED DECEMBER 31, 1995, 1994, AND 1993 ($000'S EXCEPT SHARE DATA)\ncustomers engaged in similar activities and having similar economic characteristics, as defined by standard industrial classifications, did not exceed 10% of total loans.\nThe Corporation evaluates the credit risk of each customer on an individual basis and, where deemed appropriate, collateral is obtained. Collateral varies by individual loan customer but may include accounts receivable, inventory, real estate, equipment, deposits, personal and government guaranties, and general security agreements. Access to collateral is dependent upon the type of collateral obtained. On an on-going basis, the Corporation monitors its collateral and the collateral value related to the loan balance outstanding.\nAn analysis of loans outstanding to directors and officers, including their related interests, of the Corporation and its significant subsidiaries for 1995 is presented below. All of these loans were made in the ordinary course of business with normal credit terms, including interest rates and collateral. The beginning balance has been adjusted to reflect the activity of newly-appointed directors and executive officers and directors and executive officers of subsidiaries previously not considered significant.\nLoans to Directors & Executive Officers:\n9. ALLOWANCE FOR LOAN LOSSES\nAn analysis of the allowance for loan losses follows:\nAs of December 31, 1995, and 1994, nonaccrual loans totalled $50,598 and $44,766, respectively.\nDuring the second quarter of 1994, a loan loss provision of $8,950 was charged to expense, after consummation of the merger with Valley, to conform Valley's loan valuation policies with those of the Corporation.\nIn May 1993 and October 1994, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards No. 114, \"Accounting by Creditors for Impairment of a Loan\" and SFAS No. 118, an amendment to SFAS No. 114 (collectively \"SFAS 114\"). These new standards require that a loan's value be measured, and if appropriate, a valuation reserve established, when it has been determined that\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED DECEMBER 31, 1995, 1994, AND 1993 ($000'S EXCEPT SHARE DATA)\nthe loan is impaired and loss is probable. At December 31, 1995 the Corporation's recorded investment in impaired loans and the related valuation allowance are as follows:\nThe recorded investment in impaired loans for which no allowance is required is net of applications of cash interest payments and net of previous direct writedowns of $4,325 against the loan balance outstanding. The required valuation allowance is included in the allowance for loan losses in the consolidated balance sheet at December 31, 1995.\nThe average recorded investment in total impaired loans and leases for the year ended December 31, 1995 amounted to $52,827.\nInterest payments received on impaired loans and leases are recorded as interest income, unless collection of the remaining recorded investment is doubtful, at which time payments received are recorded as reductions of principal. During 1995, interest income recognized on total impaired loans amounted to $3,594. The gross income that would have been recognized had such loans and leases been performing in accordance with their original terms would have been $8,430 for the same period.\n10. PREMISES AND EQUIPMENT\nThe composition of premises and equipment at December 31 was:\nDepreciation expense was $45,153 in 1995, $43,006 in 1994, and $42,417 in 1993.\nThe Corporation leases certain of its facilities and equipment. Rent expense under such operating leases was $21,702 in 1995, $20,567 in 1994, and $20,420 in 1993, respectively.\nThe future minimum lease payments under operating leases that have initial or remaining noncancellable lease terms in excess of one year for 1996 through 2000 are $9,124, $8,770, $8,146 $7,132 and $4,884, respectively.\nIn March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121 (SFAS 121), \"Accounting for the impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.\" This standard, which must be adopted in 1996, requires long-lived impaired assets\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED DECEMBER 31, 1995, 1994, AND 1993 ($000'S EXCEPT SHARE DATA)\nto be carried at fair value and all long-lived assets to be disposed of to be reported at the lower of carrying amount or fair value less cost to sell.\nSFAS 121 prescribes a cash flow test for recoverability whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. For purposes of SFAS 121, assets include certain identifiable intangibles and goodwill if the asset tested for recoverability was acquired in a business combination accounted for using the purchase method.\nThe Corporation does not anticipate that SFAS 121 will have a material impact on the consolidated financial statements.\n11. SHORT-TERM BORROWINGS\nShort-term borrowings at December 31 were:\nUnused lines of credit primarily to support commercial paper borrowings were $40,000 at December 31, 1995 and 1994.\n12. LONG-TERM BORROWINGS\nLong-term borrowings at December 31 were:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED DECEMBER 31, 1995, 1994, AND 1993 ($000'S EXCEPT SHARE DATA)\nThe 8.5% convertible subordinated notes (the \"Notes\") require semi-annual interest payments and are convertible at the option of the holder into common stock at a conversion price of $8.75. The holder has the right to exchange common stock, acquired by conversion of the Notes or otherwise, for Series A convertible preferred stock (\"Series A\"). The holder may own up to 24.9% (computed as the percentage of common shares owned directly or indirectly through conversion privileges) of the Corporation's outstanding common stock and convertible securities, but may not own directly more than 5% of the Corporation's outstanding common stock. Except under limited circumstances, the holder may not sell, transfer or otherwise dispose of the Notes or common stock acquired by conversion, and then, only under prescribed conditions and subject to the Corporation's right of first refusal.\nA portion of the Notes qualify as equity contract notes as defined by the applicable guidelines of the Board of Governors of the Federal Reserve System. The Notes require the holder to take common stock (or other equity securities) in lieu of cash in satisfaction of the claim for principal repayment, unless the Corporation sells new common stock (or certain other equity securities) and dedicates the proceeds thereof to the redemption or retirement of the Notes.\nDuring 1994, $16,363 of the Notes were converted by the holder into 1,870,057 shares of the Corporation's common stock. The common stock acquired by conversion of the Notes was exchanged for 163,630 shares of the Corporation's Series A convertible preferred stock. These are noncash transactions for purposes of the Consolidated Statements of Cash Flows.\nThe 6.375% subordinated notes are not redeemable prior to maturity and qualify as \"Tier 2\" or supplementary capital for regulatory capital purposes. Interest is payable semiannually.\nThe Corporation has filed registration statements with the Securities and Exchange Commission to issue medium-term unsecured and unsubordinated series notes. These issues may have maturities which range from 9 months to 30 years from the date of issue, at a fixed or floating rate.\nAt December 31, 1995, medium-term Series B notes outstanding amounted to $47,330. Such notes mature in 1996 through 1998 and have fixed interest rates of 6.05% to 8.65%. No additional borrowings may occur under the Series B notes. There were $122,870 of medium-term Series C notes outstanding at December 31, 1995. The medium-term Series C notes have fixed interest rates of 6.74% to 7.84% and mature in 1996 and 1997. Approximately $27,130 of unissued Series C notes are remaining and available to be issued in the future. There have been no issuances of the $150 million Series D notes.\nThe bank notes represent unsecured general obligations of the Corporation's banking subsidiaries (\"Issuing Banks\"). Each of the Corporation's banking subsidiaries is a potential Issuing Bank which may issue bank notes with maturities ranging from 30 days to 15 years at a fixed or floating rate up to a maximum of $1.0 billion aggregate principal amount outstanding at any time. The bank notes are offered through certain designated agents and are offered and sold only to institutional investors. The bank notes are sole obligations of the respective Issuing Banks and are not obligations of or guaranteed by the Corporation. The amount outstanding at December 31, 1995 represents the aggregate borrowings of 14 banking subsidiaries and mature at various times in 1996 and 1997. Each bank note outstanding has a floating rate which is based on LIBOR plus 1\/16 which ranged from 5.81% to 6.00% at December 31, 1995. Interest is payable and the interest rate is reset monthly.\nThe nonrecourse notes are reported net of prepaid interest and represent borrowings by the leasing subsidiary from banks and other financial institutions. These notes have a weighted average interest rate of 8.65% at December 31, 1995 and are due in installments over varying periods through 2001. Lease financing receivables at least equal to the amount of the notes are pledged as collateral.\nThe mortgages are secured by land and buildings with a net book value of $8,650 at December 31, 1995.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED DECEMBER 31, 1995, 1994, AND 1993 ($000'S EXCEPT SHARE DATA)\nScheduled maturities of long-term borrowings are: $296,756, $14,116, $6,273 and $975 for 1997 through 2000, respectively.\n13. SHAREHOLDERS' EQUITY\nThe Corporation has 5,000,000 shares of preferred stock authorized, of which the Board of Directors has designated 3,000,000 shares as Series A convertible, with a $100 value per share for conversion purposes. Series A is nonvoting preferred stock. The same cash dividends will be paid on Series A as would have been paid on the common stock exchanged for Series A. Series A has the same restrictions on sale as are applicable to the 8.5% convertible subordinated notes.\nThe holder of the 8.5% convertible subordinated notes has the option through 1997 to exchange common stock of the Corporation for Series A. If the common stock is acquired by the holder in conversion of the notes, the exchange ratio is one share of Series A for 11.43 shares of common stock. If acquired otherwise, the exchange ratio is one share of Series A, valued at $100, to the holder's weighted average purchase price per common share. Also, the holder has the option to convert Series A into common stock at the same ratio that the common stock was exchanged for Series A. The Corporation has issued 348,944 shares of its Series A convertible preferred stock in exchange for 3,832,957 shares of common stock.\nThe preferred stock is treated as a common stock equivalent in all per share calculations.\nThe Corporation has a Stock Repurchase Program which was approved by the Corporation's Board of Directors in April, 1993 and reaffirmed in October, 1994. In October 1994, the Board of Directors also authorized an increase in the number of shares to be repurchased from 9.0 million shares to 15.1 million shares. The shares are being acquired in anticipation of the conversion of the Corporation's 8.5% convertible subordinated notes, to fund the on-going program to deliver or have available shares of common stock for stock option and other employee benefit plans and other corporate needs. During 1995, the Corporation purchased 2.7 million shares and has cumulatively purchased 12.5 million shares since inception of the program.\nFederal banking regulatory agencies have established capital adequacy rules which take into account risk attributable to balance sheet assets and off-balance sheet activities. All banks and bank holding companies must meet a minimum total risk-based capital ratio of 8%. Of the 8% required, half must be comprised of core capital elements defined as Tier 1 capital. The federal banking agencies also have adopted leverage capital guidelines which banking organizations must meet. Under these guidelines, the most highly rated banking organizations must meet a minimum leverage ratio of at least 3% Tier 1 capital to total assets, while lower rated banking organizations must maintain a ratio of at least 4% to 5%.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED DECEMBER 31, 1995, 1994, AND 1993 ($000'S EXCEPT SHARE DATA)\nThe Corporation's risk-based capital and leverage ratios are as follows:\nAll of the Corporation's banking subsidiaries' risk-based capital and leverage ratios meet or exceed the defined minimum requirements.\nBanking subsidiaries are restricted by banking regulations from making dividend distributions above prescribed amounts and are limited in making loans and advances to the Corporation. At December 31, 1995, the retained earnings of subsidiaries available for distribution as dividends without regulatory approval was approximately $131,998.\n14. INCOME TAXES\nTotal income tax expense for the years ended December 31, 1995, 1994 and 1993 was allocated as follows:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED DECEMBER 31, 1995, 1994, AND 1993 ($000'S EXCEPT SHARE DATA)\nThe current and deferred portions of the provision for income taxes were:\nThe following is a reconciliation between the amount of the provision for income taxes and the amount of tax computed by applying the statutory Federal income tax rate (35%):\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED DECEMBER 31, 1995, 1994, AND 1993 ($000'S EXCEPT SHARE DATA)\nThe tax effects of temporary differences that give rise to significant elements of the deferred tax assets and deferred tax liabilities at December 31, are as follows:\nThe amount of income tax expense (benefit) related to net securities gains or losses amounted to $1,762, ($2,171) and $3,103, in 1995, 1994, and 1993, respectively.\n15. STOCK OPTION AND RESTRICTED STOCK PLANS\nThe Corporation has Executive Stock Option and Restricted Stock Plans which provide for the grant of nonqualified and incentive stock options, stock appreciation rights and rights to purchase restricted shares to key employees at prices ranging from not less than the par value of the common shares to the fair market value of the shares at the date of grant.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED DECEMBER 31, 1995, 1994, AND 1993 ($000'S EXCEPT SHARE DATA)\nActivity relating to common stock options was:\nOptions exercisable at December 31, 1995 and 1994, were 4,949,541 and 4,825,426, respectively. Shares reserved for the granting of additional options at December 31, 1995 were 1,735,961.\nThere were 5,000 restricted stock purchase rights outstanding at December 31, 1995 and 13,000 restricted stock purchase rights outstanding at December 31, 1994. During 1995, 26,000 stock purchase rights were exercised and 3,000 purchase rights were exercised in 1994.\nRestrictions on stock issued pursuant to the exercise of stock purchase rights lapse within a seven-year period. Accordingly, the compensation related to issuance of the rights is deferred and amortized over the vesting period. Unamortized deferred compensation is reflected as a reduction of shareholders' equity.\nAggregate compensation expense related to stock purchase rights was $611, $747, and $1,008 in 1995, 1994, and 1993, respectively.\nThe Corporation also has a Long-term Incentive Plan (the \"Plan\"). Under the Plan, performance units may be awarded from time to time. Once awarded, additional performance units will be credited to each participant based on dividends paid by the Corporation on its common stock. At the end of a designated vesting period, participants will receive an amount, either in cash, common stock or some combination thereof, equal to some percent (0%-275%) of the initial performance units credited plus those additional units credited as dividends based on the established performance criteria. During 1995, 91,700 units and in 1994, 156,500 units were awarded to certain executives of the Corporation. The vesting period is three years from the date the performance units were awarded. Based on the performance criteria, without regard to the vesting, no amount would be due to the participants at December 31, 1995.\nIn October, 1995 the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123 (SFAS 123), \"Accounting for Stock-Based Compensation.\" This standard, which must be adopted in 1996, establishes financial accounting and reporting standards for stock-based employee compensation plans such as stock options, restricted stock plans and stock appreciation rights.\nSFAS 123 defines a fair value based method of accounting for employee stock option or similar equity instruments. Under the fair value based method, compensation cost is measured at the grant date based on the fair value of the award using an option-pricing model that takes into account the stock price at the grant date, the exercise price, the expected life of the option, the volatility of the underlying stock, expected dividends and the risk-free interest rate over the expected life of the option. The resulting compensation cost is recognized over the service period, which is usually the vesting period.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED DECEMBER 31, 1995, 1994, AND 1993 ($000'S EXCEPT SHARE DATA)\nCurrently compensation cost is measured and accounted for using the intrinsic value based method of accounting prescribed in Accounting Principles Board Opinion No. 25 (APBO 25), \"Accounting for Stock Issued to Employees.\" Under the intrinsic value based method, compensation cost is the excess, if any, of the quoted market price of the stock at grant date or other measurement date over the amount paid to acquire the stock.\nThe largest difference between SFAS 123 and APBO 25 as it relates to the Corporation is the amount of compensation cost attributable to the Corporation's fixed stock option plans. Under APBO 25, no compensation cost is recognized for fixed stock option plans because the exercise price is equal to the quoted market price at the date of grant and therefore, there is no intrinsic value. SFAS 123 compensation cost would equal the fair value of the options granted.\nThis standard permits entities to continue to measure compensation cost for such plans using the accounting method prescribed by APBO 25 as long as pro forma disclosures of net income and earnings per share are presented as if the fair value based method of accounting as defined in SFAS 123 had been applied.\nThe Corporation has not yet determined whether it will adopt the SFAS 123 method of accounting or continue APBO 25 accounting with the required disclosures. However, based on the fixed stock option grants in 1995, the impact of adopting the SFAS 123 accounting would be immaterial to the consolidated financial statements.\n16. EMPLOYEE RETIREMENT AND HEALTH PLANS\nThe Corporation has a defined contribution retirement plan and an incentive savings plan for substantially all employees. The retirement plan provides for a guaranteed contribution to eligible participants equal to 2% of compensation. At the Corporation's option, a profit sharing amount may also be contributed and may vary from year to year up to a maximum of 6% of eligible compensation. Under the incentive savings plan, employee contributions, up to 6% of eligible compensation, are matched up to 50% by the Corporation based on the Corporation's return on equity as defined by the plan. Total expense relating to these plans was $23,883, $21,631 and $17,771 in 1995, 1994 and 1993, respectively.\nThe Corporation also has supplemental retirement plans to provide retirement benefits to certain of its key executives. Total expense relating to these plans amounted to $1,023 in 1995, $910 in 1994, and $2,703 in 1993.\nValley maintained a trusteed defined benefit retirement plan which covered substantially all its employees. Upon consummation of the merger in 1994, the plan was curtailed and in 1995, was fully terminated through cash distributions and\/or purchases of annuities. The following table reflects the plan's funded status and amounts recognized in the financial statements at December 31:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED DECEMBER 31, 1995, 1994, AND 1993 ($000'S EXCEPT SHARE DATA)\nThe net pension cost for 1994 and 1993, included the following components:\nDuring 1995, expense of $1,789 was recorded in conjunction with the termination of the Valley plan.\nThe expense associated with the curtailment is classified as Merger\/Restructuring and the termination expense is included in salaries and employee benefits in the Consolidated Statements of Income.\nThe following assumptions were used in determining the projected benefit obligation:\nThe Corporation sponsors a defined benefit health plan that provides health care benefits to all eligible current and retired employees. The plan is contributory, with contributions adjusted periodically such that participants contribute approximately 40% of the cost of health care benefits. The plan also contains other cost-sharing features such as deductibles and coinsurance. Retiree eligibility is dependent upon age, years of service, and participation in the health plan during active service. The plan is not funded.\nValley provided postretirement health care benefits to retired employees. These benefits were subject to deductibles, copayment provisions and other limitations. Only those employees retiring on or before December 31, 1994 were eligible for such benefits. As part of the merger, all former Valley employees became eligible to participate in the Corporation's postretirement health plan. The Corporation did not recognize years of service with Valley prior to the merger.\nThe components of the accumulated postretirement benefit obligation (APBO) reconciled with the amount recognized in the Corporation's Consolidated Balance Sheets at December 31, were:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED DECEMBER 31, 1995, 1994, AND 1993 ($000'S EXCEPT SHARE DATA)\nNet periodic postretirement benefit cost for the years ended December 31, 1995, 1994 and 1993 includes the following components:\nFor measurement purposes, the assumed health care cost trend rate was 11% and 12% in 1995 and 1994, respectively, and gradually declines to 5.5% in the year 2022.\nThe health care cost trend rate assumption has a significant effect on the amounts reported. An increase in the assumed health care cost trend rate of one percentage point would increase the APBO at December 31, 1995 by $7,569 and increase 1995 postretirement benefit expense by $564.\n17. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK\nFinancial instruments with off-balance sheet risk at December 31 were:\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 and may require payment of a fee. The majority of the Corporation's commitments to extend credit generally provide for the interest rate to be determined at the time the commitment is utilized. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.\nThe Corporation evaluates each customer's credit worthiness on an individual basis. Collateral obtained, if any, upon extension of credit, is based upon management's credit evaluation of the customer. Collateral requirements and the ability to access collateral is generally similar to that required on loans outstanding as discussed in Note 8.\nStandby and commercial letters of credit are contingent commitments issued by the Corporation to support the financial obligations of a customer to a third party. Standby letters of credit are issued to support\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED DECEMBER 31, 1995, 1994, AND 1993 ($000'S EXCEPT SHARE DATA)\npublic and private financing, and other financial or performance obligations of customers. Commercial letters of credit are issued to support payment obligations of a customer as buyer in a commercial contract for the purchase of goods. Letters of credit have maturities which generally reflect the maturities of the underlying obligations. The credit risk involved in issuing letters of credit is the same as that involved in extending loans to customers. If deemed necessary, the Corporation holds various forms of collateral to support letters of credit.\nMortgage loans sold with recourse are pools of residential mortgage loans sold to government agencies subject to certain underwriting requirements. If the loans do not meet the underwriting requirements of the government agencies, the Corporation may be required to reacquire the loans.\nForeign exchange contracts are commitments to purchase or deliver foreign currency at a specified exchange rate. The Corporation enters into foreign exchange contracts primarily in connection with trading activities to enable customers involved in international trade to hedge their exposure to foreign currency fluctuations and to minimize the Corporation's own exposure to foreign currency fluctuations resulting from the above. Foreign exchange contracts include such commitments as foreign currency spot, forward, future and, to a much lesser extent, option contracts. The risks in these transactions arise from the ability of the counterparties to perform under the terms of the contracts and the risk of trading in a volatile commodity. The Corporation actively monitors all transactions and positions against predetermined limits established on traders and types of currency to ensure reasonable risk taking.\nThe Corporation's market risk from unfavorable movements in currency exchange rates is minimized by essentially matching commitments to deliver foreign currencies with commitments to purchase foreign currencies.\nAt December 31, 1995, the Corporation's foreign currency positions resulting from foreign exchange contracts by major currency was as follows ($000's US):\nThese amounts do not represent the actual credit or market exposure.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED DECEMBER 31, 1995, 1994, AND 1993 ($000'S EXCEPT SHARE DATA)\n18. FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe book values and estimated fair values for on and off-balance sheet financial instruments as of December 31, 1995 and 1994 are reflected below:\nBALANCE SHEET FINANCIAL INSTRUMENTS ($ IN MILLIONS)\nWhere readily available, quoted market prices were utilized by the Corporation. If quoted market prices were not available, fair values were based on estimates using present value or other valuation techniques. These techniques were 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. SFAS 107 excludes certain financial instruments and all nonfinancial assets and liabilities from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Corporation.\nThe following methods and assumptions were used in estimating the fair value for financial instruments.\nCASH AND SHORT-TERM INVESTMENTS\nThe carrying amounts reported for cash and short-term investments approximates the fair values for those assets.\nTRADING AND INVESTMENT SECURITIES\nFair value is based on quoted market prices or dealer quotes. See Note 7, Securities, for additional information.\nLOANS\nLoans that reprice or mature within three months of December 31 were assigned fair values based on their book value. Market values were used on performing loans where available. Most remaining loan balances\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED DECEMBER 31, 1995, 1994, AND 1993 ($000'S EXCEPT SHARE DATA)\nwere assigned fair values based on a discounted cash flow analysis. The discount rate was based on the treasury yield curve, with rate adjustments for credit quality, cost and profit factors.\nDEPOSITS\nThe fair value for demand deposits or any interest bearing deposits with no fixed maturity date was considered to be equal to the carrying value. Time deposits with defined maturity dates were considered to have a fair value equal to the book value if the maturity date was within three months of December 31. The remaining time deposits were assigned fair values based on a discounted cash flow analysis using discount rates which approximate interest rates currently being offered on time deposits with comparable maturities.\nBORROWINGS\nShort-term borrowings are carried at cost which approximates fair value. The Corporation has convertible debt (see Note 12) for which fair value was considered to be the current market value of the shares that would be issued in a full conversion. Other long-term debt was generally valued using a discounted cash flow analysis with a discount rate based on current incremental borrowing rates for similar types of arrangements or, if not readily available, based on a build up approach similar to that used for loans and deposits. Long-term borrowings include their related current maturities.\nOFF-BALANCE SHEET FINANCIAL INSTRUMENTS ($ IN MILLIONS)\nFair values of loan commitments and letters of credit have been estimated based on the equivalent fees, net of expenses, that would be charged for similar contracts and customers at December 31.\nForeign exchange contracts are carried at market value (U.S. dollar equivalent of the underlying contract). The fair value of options written\/purchased are based on the market value of the premium paid as of the reporting date.\nSee Note 17 for additional information on off-balance sheet financial instruments.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED DECEMBER 31, 1995, 1994, AND 1993 ($000'S EXCEPT SHARE DATA)\n19. BUSINESS SEGMENTS\nThe following table reflects certain information regarding our banking and data processing businesses:\nOur banking operations provide traditional banking products along with trust, mortgage banking, leasing, and venture capital services. M&I Data Services, a division of the Corporation, provides data processing, software, and other related services to both affiliated and unaffiliated customers. In addition, a Valley affiliate provided similar services and other operational support to affiliated customers and merged with M&I Data Services upon consummation of the merger.\nRevenues from affiliated customers are charged at rates available to and transacted with unaffiliated customers.\nOperating profit is pretax net income. Depreciation and amortization expense for the banking services business amounted to $8,189, $40,733, and $30,378 in 1995, 1994, and 1993, respectively, and for M&I Data Services amounted to $38,978 in 1995, $31,224 in 1994, and $26,680 in 1993.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED DECEMBER 31, 1995, 1994, AND 1993 ($000'S EXCEPT SHARE DATA)\n20. CONDENSED FINANCIAL INFORMATION -- PARENT CORPORATION ONLY\nCONDENSED BALANCE SHEETS DECEMBER 31\nScheduled maturities of long-term borrowings are $69,981 in 1996, $143,980 in 1997, $7,895 in 1998, $2,863 in 1999 and $75 in 2000.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED DECEMBER 31, 1995, 1994, AND 1993 ($000'S EXCEPT SHARE DATA)\nCONDENSED STATEMENTS OF INCOME YEARS ENDED DECEMBER 31\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED DECEMBER 31, 1995, 1994, AND 1993 ($000'S EXCEPT SHARE DATA)\nCONDENSED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31\nQUARTERLY FINANCIAL INFORMATION (UNAUDITED) ($000'S EXCEPT SHARE DATA)\nFollowing is unaudited financial information for each of the calendar quarters during the years ended December 31, 1995 and 1994.\nQUARTERLY FINANCIAL INFORMATION (UNAUDITED) -- CONTINUED ($000'S EXCEPT SHARE DATA)\nPRICE RANGE OF STOCK (LOW AND HIGH BID)\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Shareholders and the Board of Directors of Marshall & Ilsley Corporation:\nWe have audited the accompanying consolidated balance sheets of Marshall & Ilsley Corporation (a Wisconsin corporation) and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of income, shareholders' equity and cash flows for the years ended December 31, 1995, 1994 and 1993. 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 consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Marshall & Ilsley Corporation and subsidiaries as of December 31, 1995 and 1994, and the results of their operations and cash flows for the years ended December 31, 1995, 1994 and 1993, in conformity with generally accepted accounting principles.\nAs discussed in note one to the consolidated financial statements, effective January 1, 1994, the Corporation changed its method of accounting for certain investments in debt and equity securities.\n\/s\/ Arthur Andersen LLP\nMilwaukee, Wisconsin, January 26, 1996\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nIncorporated herein by reference to M&I's definitive proxy statement for the Annual Meeting of Shareholders to be held on April 23, 1996, except for information as to executive officers which is set forth in Part I of this report.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nIncorporated herein by reference to M&I's definitive proxy statement for the Annual Meeting of Shareholders to be held on April 23, 1996.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nIncorporated herein by reference to M&I's definitive proxy statement for the Annual Meeting of Shareholders to be held on April 23, 1996.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nIncorporated herein by reference to M&I's definitive proxy statement for the Annual Meeting of Shareholders to be held on April 23, 1996.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nMARSHALL & ILSLEY CORPORATION\nBy: \/s\/ J.B. Wigdale -------------------------------------- J.B. Wigdale Chairman of the Board\nDate: February 26, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated:\nDirectors: Richard A. Abdoo, Oscar C. Boldt, J.P. Bolduc, Wendell F. Bueche, G.H. Gunnlaugsson, Burleigh E. Jacobs, Jack F. Kellner, D.J. Kuester, Edward L. Meyer, Jr., Don R. O'Hare, San W. Orr, Jr., Peter M. Platten III, Stuart W. Tisdale, J.B. Wigdale, James O. Wright and Gus A. Zuehlke.\n- --------------- * Pursuant to authority granted by powers of attorney, copies of which are filed herewith.\nMARSHALL & ILSLEY CORPORATION\nINDEX TO EXHIBITS (ITEM 14(a)3)\nITEM\n(2) Agreement and Plan of Merger dated as of September 19, 1993, between M&I and Valley Bancorporation, incorporated by reference to M&I's Current Report on Form 8-K dated September 19, 1993 (as amended by M&I's Current Report on Form 8-K\/A dated September 19, 1993), SEC File No. 0-1220\n(3) (a) Restated Articles of Incorporation, incorporated by reference to M&I's Quarterly Report on Form 10-Q for the quarter ended June 30, 1994, SEC File No. 0-1220\n(b) By-laws, as amended\n(4) (a) Indenture between M&I and Chemical Bank (as successor to Manufacturers Hanover Trust Company) dated as of November 15, 1985 (\"Senior Indenture\"), incorporated by reference to M&I's Registration Statement on Form S-3 (Registration No. 33-21377), as supplemented by the First Supplemental Indenture to the Senior Indenture dated as of May 31, 1990, incorporated by reference to M&I's Current Report on Form 8-K dated May 31, 1990, and as supplemented by the Second Supplemental Indenture to the Senior Indenture dated as of July 15, 1993, incorporated by reference to M&I's Quarterly Report on Form 10-Q for the quarter ended June 30, 1993, SEC File No. 0-1220\n(b) Form of Medium Term Notes, Series B, issued pursuant to the Senior Indenture, incorporated by reference to M&I's Current Report on Form 8-K dated May 31, 1990, SEC File No. 0-1220\n(c) Form of Medium Term Notes, Series C, and Series D issued pursuant to the Senior Indenture, included in Exhibit 4(a)\n(d) Indenture between M&I and Chemical Bank dated as of July 15, 1993 (\"Subordinated Indenture\"), incorporated by reference to M&I's Quarterly Report on Form 10-Q for the quarter ended June 30, 1993, SEC File No. 0-1220\n(e) Form of Subordinated Note issued pursuant to the Subordinated Indenture, included in Exhibit 4(d)\n(f) Investment Agreement between M&I and The Northwestern Mutual Life Insurance Company dated August 30, 1985, incorporated by reference to M&I's Current Report on Form 8-K dated May 20, 1985, SEC File No. 0-1220\n(g) Subordinated Convertible Note Agreement between The Northwestern Mutual Life Insurance Company dated December 31, 1985, incorporated by reference to M&I's Current Report on Form 8-K dated May 20, 1985, SEC File No. 0-1220\n(h) Form of Convertible Subordinated Note, incorporated by reference to M&I's Current Report on Form 8-K dated May 20, 1985, SEC File No. 0-1220\n(i) Designation of Rights and Preferences of holders of Series A Preferred Stock, incorporated by reference to M&I's Current Report on Form 8-K dated May 20, 1985, SEC File No. 0-1220\n(10) (a) 1983 Executive Stock Option and Restricted Stock Plan, as amended, incorporated by reference to M&I's Annual Report on Form 10-K for the fiscal year ended December 31, 1987, SEC File No. 0-1220*\n(b) 1985 Executive Stock Option and Restricted Stock Plan, as amended, incorporated by reference to M&I's Annual Report on Form 10-K for the fiscal year ended December 31, 1987, SEC File No. 0-1220*\n(c) M&I Marshall & Ilsley Bank Supplementary Retirement Benefits Plan, incorporated by reference to M&I's Annual Report on Form 10-K for the fiscal year ended December 31, 1983, SEC File No. 0-1220*\n(d) Directors Deferred Compensation Plan, adopted on February 14, 1985, incorporated by reference to M&I's Annual Report on Form 10-K for the fiscal year ended December 31, 1984, SEC File No. 0-1220*\n(e) Consulting Agreement and Supplemental Retirement Plan dated as of October 1, 1986 between M&I and Mr. J.A. Puelicher, incorporated by reference to M&I's Annual Report on Form 10-K for the fiscal year ended December 31, 1986, SEC File No. 0-1220*\n(f) Amendment to Consulting Agreement and Supplemental Retirement Plan dated as of August 13, 1992, between M&I and Mr. J.A. Puelicher, incorporated by reference to M&I's Annual Report on Form 10-K for the fiscal year ended December 31, 1993, SEC File No. 0-1220*\n(g) Deferred Compensation Trust between Marshall & Ilsley Corporation and Bessemer Trust Company dated April 28, 1987, as amended, incorporated by reference to M&I's Annual Report on Form 10-K for the fiscal year ended December 31, 1988, SEC File No. 0-1220*\n(h) 1986 Non-Qualified Stock Option Plan of M&I and related Stock Option Agreement between M&I and Mr. J.A. Puelicher, incorporated by reference to M&I's Annual Report on Form 10-K for the fiscal year ended December 31, 1986, SEC File No. 0-1220*\n(i) Form of employment agreements, dated November 5, 1990, between M&I and Messrs. Gunnlaugsson, Kuester, Strelow and Wigdale incorporated by reference to M&I's Annual Report on Form 10-K for the fiscal year ended December 31, 1990, SEC File No. 0-1220*\n(j) Employment agreement, dated November 5, 1990, between M&I and Mr. Michael A. Hatfield incorporated by reference to M&I's Annual Report on Form 10-K for the fiscal year ended December 31, 1990, SEC File No. 0-1220*\n(k) Employment agreement, dated as of November 5, 1990, between M&I and Mr. Delgadillo, incorporated by reference to M&I's Annual Report on Form 10-K for the fiscal year ended December 31, 1993, SEC File No. 0-1220*\n(l) Restricted Stock Plan of Marshall & Ilsley Corporation, incorporated by reference to M&I's Annual Report on Form 10-K for the fiscal year ended December 31, 1988, SEC File No. 0-1220*\n(m) 1989 Executive Stock Option and Restricted Stock Plan, incorporated by reference to M&I's Annual Report on Form 10-K for the fiscal year ended December 31, 1988, as amended by M&I's Annual Report on Form 10-K for the fiscal year ended December 31, 1990, SEC File No. 0-1220*\n(n) Marshall & Ilsley Corporation Nonqualified Retirement Benefit Plan, incorporated by reference to M&I's Annual Report on Form 10-K for the fiscal year ended December 31, 1991, SEC File No. 0-1220*\n(o) Marshall & Ilsley Corporation Supplemental Retirement Benefits Plan, incorporated by reference to M&I's Annual Report on Form 10-K for the fiscal year ended December 31, 1991, SEC File No. 0-1220*\n(p) Marshall & Ilsley Trust Company Supplemental Retirement Benefits Plan, incorporated by reference to M&I's Annual Report on Form 10-K for the fiscal year ended December 31, 1991, SEC File No. 0-1220*\n(q) Supplemental Retirement Agreement dated December 10, 1992, between M&I and Mr. J.A. Puelicher, incorporated by reference to M&I's Annual Report on Form 10-K for the fiscal year ended December 31, 1992, SEC File No. 0-1220*\n(r) Amendment to Supplemental Retirement Agreement dated December 16, 1993, between M&I and Mr. J.A. Puelicher, incorporated by reference to M&I's Annual Report on Form 10-K for the fiscal year ended December 31, 1993, SEC File No. 0-1220*\n(s) Marshall & Ilsley Corporation 1993 Executive Stock Option Plan, as amended*\n(t) Marshall & Ilsley Corporation 1994 Long-Term Incentive Plan for Executives, incorporated by reference to M&I's Proxy Statement for the 1994 Annual Meeting of Shareholders, SEC File No. 0-1220*\n(u) Marshall & Ilsley Corporation 1995 Directors Stock Option Plan, incorporated by reference to M&I's Proxy Statement for the 1995 Annual Meeting of Shareholders, SEC File No. 0-1220*\n(v) Marshall & Ilsley Corporation Assumption Agreement dated May 31, 1994 assuming rights, obligations and interests of Valley Bancorporation under various stock option plans, incorporated by reference to M&I's Registration Statement on Form S-8 (Reg. No. 33-53897)*\n(w) Valley Bancorporation 1992 Incentive Stock Plan, incorporated by reference to Valley Bancorporation's Proxy Statement for the 1992 Annual Meeting of Shareholders (the \"Valley 1992 Proxy Statement\")*\n(x) Valley Bancorporation 1992 Outside Directors' Stock Option Plan, incorporated by reference to the Valley 1992 Proxy Statement*\n(y) Valley Bancorporation 1988 Nonqualified Stock Option Plan, incorporated by reference to Valley Bancorporation's Proxy Statement for the 1988 Annual Meeting of Shareholders*\n(z) Valley Bancorporation 1986 Amended and Restated Stock Option Plan, incorporated by reference to Valley Bancorporation's Proxy Statement for the 1987 Annual Meeting of Shareholders*\n(aa) Employment agreement between M&I and Mr. Peter M. Platten, III, incorporated by reference to M&I's Registration Statement on Form S-4 (Reg. No. 33-51753)*\n(bb) Letter agreement dated January 25, 1994 between Valley Bancorporation and Mr. Peter M. Platten, III incorporated by reference to M&I's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, SEC File No. 0-1220*\n(cc) Employment agreement, dated as of December 14, 1995, between M&I and Ms. Patricia R. Justiliano*\n(11) Computation of Net Income Per Common Share\n(12) Computation of Ratio of Earnings to Fixed Charges\n(21) Subsidiaries\n(23) Consent of Arthur Andersen LLP\n(24) Powers of Attorney\n(27) Financial Data Schedule\nM&I will provide a copy of any instrument defining the rights of holders of long-term debt to the Commission upon request.\n_____________________\n*Management contract or compensatory plan or arrangement.","section_15":""}
{"filename":"48638_1995.txt","cik":"48638","year":"1995","section_1":"Item 1. Business\n(a) Description of Business\nHoughton Mifflin Company (the \"Company\") was incorporated in 1908 in Massachusetts as the successor to a partnership formed in 1880. Antecedents of the partnership date back to 1832. The Company has two significant subsidiaries: McDougal Littell Inc., Evanston, Illinois, publishes educational materials for the secondary school market; and The Riverside Publishing Company, Chicago, Illinois, publishes assessment materials for the educational and clinical testing markets. The Company's principal business is publishing, and its operations are classified into two industry segments: (1) textbooks and other educational materials and services for the school and college markets; and (2) general publishing, including fiction, nonfiction, children's books, and dictionary and reference materials in a variety of formats and media. In this description of the Company's business, all subsidiaries are treated as part of the Company.\nIn October 1995, the D.C. Heath and Company (\"Heath\") division of Raytheon Company was acquired in a purchase transaction for $452.9 million in cash. Heath is a publisher of textbooks and supplemental materials for the elementary and secondary school and college markets. Heath's operating results from the date of acquisition have been included in the educational publishing segment of the Company's consolidated financial statements.\nIn June 1995, the Company recorded special charges related to a decision to outsource existing distribution operations. These charges consisted primarily of termination benefit costs, warehouse closing costs, and inventory relocation expenses. In February 1996, the Company announced the reassumption of the distribution function maintained at its Geneva, Illinois facility. This warehouse will continue to service the elementary and secondary textbook and college product distribution operations. The distribution operations for Riverside and Trade & Reference will continue to be managed by a third party.\nIn March 1994, the Company's former Software Division successfully completed an initial public offering. The Company retained an equity interest in the successor company, INSO Corporation (\"INSO\"), of approximately 40%. In August 1995, INSO completed a new public offering of 1.2 million shares of common stock which reduced the Company's ownership interest to approximately 36%. INSO declared a stock split in the form of a 100% stock dividend to be paid in September 1995. All INSO share references have been restated to reflect the effects of the stock split. Up to 3.8 million of the Company's INSO shares have been used to collateralize the principal owed from the issuance of the 6% Exchangeable Notes due in 1999 (\"SAILS\").\n(b) Financial information about the industry segments\nFinancial information about the Company's industry segments is set forth in Note 14 to the Consolidated Financial Statements (Part II, Item 8) under the heading \"Segment Information\" on page 30 herein, and in the schedule \"Five-Year Financial Summary\" on page 6 herein.\n(c) Narrative description of business\nFor the Company, the business of publishing is the shaping of ideas, information, and instructional methods into various media that satisfy the lifelong need for people to learn, gain proficiency, and be entertained. The Company seeks out, selects, and generates worthwhile concepts and then enhances their value and accessibility through creative development, design, production (performed by outside suppliers), marketing, sales, and distribution. While the Company's works have been published principally in the form of printed materials, many programs or works are published in other formats including computer software, laser discs, CD-ROM, and other electronic and multimedia products.\nTextbooks and other educational materials and services\nThis industry segment includes textbooks and instructional materials, materials for measuring achievement and aptitude, clinical\/special needs assessment testing products, computer-assisted as well as computer-managed instructional programs on all educational levels, computer tools and operating systems for the college market, and a computer-based career and college guidance information system in versions for both junior and senior high school students. The principal markets in this segment are elementary and secondary schools and two- and four-year colleges. Major regional sales offices are located in Illinois, Texas, Georgia, New Jersey, and California. The Company is required by certain states to use state textbook depositories for the distribution of educational materials. Textbooks and materials for the elementary market are sold by the School Division; sales for the secondary school market are made by McDougal Littell Inc. (\"McDougal\"); the educational and clinical testing materials markets are serviced by The Riverside Publishing Company (\"Riverside\"); and the two- and four-year higher education markets are serviced by the College Division. Heath elementary, secondary, and college materials will be sold by the School Division, McDougal, and College Division, respectively. All operating divisions have their own dedicated sales forces. In 1995, the Company outsourced the distribution operations of all product components in the educational segment. In December 1995, the Company\nannounced the creation of a new operating unit within the educational segment whose focus will be the development and sale of products for the supplementary instructional market that complement the Company's elementary and secondary publications. Existing School, McDougal, and Heath products, including reference, audio visual and display materials, workbooks and manipulatives will be used as a foundation for the unit Great Source Education Group, which was incorporated as a subsidiary in February, 1996. The division will operate independently with its own editorial staff and sales force and will be located in Wilmington, Massachusetts. In February 1996, the Company announced that it will resume control of distribution operations for the shipment of product components for the School Division, McDougal, and College Division from its Geneva, Illinois facility.\nGeneral publishing\nThis industry segment includes trade books of fiction and nonfiction for adults and children, dictionaries and other reference works. The principal markets for trade books and reference works in this segment are retail stores. The sales volume for trade books and reference works may vary significantly from year to year based on the success of one or more titles. In addition, book reprint rights are sold to paperback publishers, book clubs, and publishers in the U.S. and internationally. Reference and dictionary materials are also sold to schools, colleges, office supply distributors, and businesses. In 1995, the Trade & Reference Division announced the launch of a new imprint, \"Houghton Mifflin Interactive,\" whose principal initiative is the development of CD-ROM titles for sale in the multimedia consumer product markets. These products will be created from new and existing Houghton Mifflin titles, and will include children's, reference and adult hobby titles. The Trade & Reference Division's publications are sold by its own sales force, as well as the Company's other divisional sales forces, commission agents, and wholesalers. Major corporate sales and support offices are maintained in Massachusetts and New York. On June 1, 1995, the distribution operations for trade products were outsourced to Publishers Resources Inc.'s facilities located near Nashville, Tennessee. The former office and warehouse facility located in Burlington, Massachusetts was closed and the property sold in November 1995.\nCompany business as a whole\nThe availability of printing and binding capacity and raw materials continued at satisfactory levels throughout the year. The availability of adequate high quality paper supplies has tightened during 1995; however the Company has had available to it adequate sources to meet production requirements at competitive prices. The Company is not dependent upon any one supplier. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" set forth on page 7 herein.\nThe Company's principal businesses are seasonal and consist of sales predominately to schools and colleges with approximately 70% of sales normally occuring in the second and third quarters as purchases are made for the school year which begins in September. Third-quarter results are material to full-year performance with the Company realizing more than 40% of its net sales and substantially all of its net income during the third quarter. The acquisitions of Heath and McDougal have not materially changed the seasonal nature of the Company's net sales or operating profits. See \"Summary of Quarterly Results of Operations (unaudited)\" for the two-year period ended December 31, 1995, set forth on page 32 herein.\nSales of educational materials are cyclical as a result of purchasing patterns that are based on both the academic year and the textbook adoption process. Approximately one-half of the United States school population adopts new elementary and secondary school textbooks on a statewide basis for a particular subject every five to seven years. The increase in the number of states adopting elementary and secondary school products provided for increased sales opportunities in 1995. It is expected that 1996 will offer more limited sales opportunities for state-wide adoption. The loss of a single customer or a few customers would not have a materially adverse effect on the business of the Company, but as discussed above, the timing of adoption opportunities may affect year-to-year revenue performance.\nThe Company's products are sold in highly competitive markets due to the extensive consolidations that have occurred in the publishing industry in recent years. The major competitive factors in the industry are believed to be quality of product and customer service. The elementary and secondary school market is concentrated in approximately 10 significant publishers; in the college book market the Company competes with 10 significant publishers. In the diverse trade and juvenile book markets, approximately 60% of the estimated $6 to $7 billion total industry sales is shared by 10 major publishers including Houghton Mifflin.\nAt December 31, 1995, the Company employed approximately 2,350 people.\nThe Company anticipates no substantial expenditures for compliance with environmental laws or regulations.\n(d) Financial information about foreign and export sales\nOperations in foreign countries were substantially reduced in 1992 with the sale of the Gollancz publishing and distribution businesses in the United Kingdom and school publications of the Company's Canadian subsidiary. Export sales are not at present significant to either of the Company's two business segments.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company's principal executive office is currently located at 222 Berkeley Street, Boston, Massachusetts.\nThe following table describes the approximate building areas and principal uses of the significant operating properties of the Company and its subsidiaries at December 31, 1995. The Company believes that its owned and leased properties are suitable and adequate for its present and anticipated business needs, satisfactory for the uses to which each is put, and in general fully utilized.\nThe years of expiration on leased premises are as follows:\nBoston, Massachusetts 2007 Dallas, Texas 2005 Chicago, Illinois 1996 Evanston, Illinois 2004 Wilmington, Massachusetts 2005 Atlanta, Georgia 1998 New York, New York 2004 St. Charles, Illinois 2006 Princeton, New Jersey 1999\n* Lease agreement entered into in February 1996 for expansion of 56,000 square feet into premises adjacent to existing corporate headquarters.\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 Company's security holders during the last quarter of its fiscal year ended December 31, 1995.\nExecutive Officers of the Company\nExecutive officers are elected by the Board of Directors to serve annual terms.\nBelow is a brief account of the business experience of each executive officer during the past five years. Each executive officer has been employed by the Company for more than five years with the exception of Mr. Bursma, Ms. Deegan, Mr. Lindgren, Ms. McGee, Mr. Oswald, Ms. Smith, Ms. Strothman, and Mr. Tyler.\nNader F. Darehshori 1991--Chairman, President, and Chief Executive Officer\nAlbert Bursma, Jr. 1995--Executive Vice President, President, Great Source Education Group, Inc.* 1994--Executive Vice President, D.C. Heath and Company; President, School Division (D.C. Heath and Company was a publisher not affiliated with the Company prior to its acquisition on October 31, 1995.)\nGail Deegan ** 1996--Executive Vice President, Chief Financial Officer, and Treasurer 1995--Senior Vice President, Regulatory and Government Affairs, NYNEX 1994--Vice President and Chief Finanical Officer, New England Telephone, a wholly-owned subsidiary of NYNEX\nMargaret L. Doherty 1994--Senior Vice President, Human Resources\nElizabeth L. Hacking 1993--Senior Vice President, Strategic Development 1993--Vice President, Strategic Development 1992--Vice President, Higher Education Planning, Research, and Development, College Division\nMichael J. Lindgren 1995--Vice President, Controller, and Treasurer 1994--Vice President and Controller 1994--Divisional Vice President and Controller 1993--Director of Planning & Analysis, ITT Sheraton\n1992--Director of Accounting and Management Reporting, ITT Sheraton (ITT Sheraton is a hotel and real estate subsidiary of ITT Corporation, primarily an insurance and financial services holding company not affiliated with the Company)\nJulie A. McGee 1995--Executive Vice President 1994--Senior Vice President 1994--President, McDougal Littell\/Houghton Mifflin Inc.* 1991--President, McDougal, Littell & Company (McDougal, Littell & Company was a publisher not affiliated with the Company prior to its acquisition on March 1, 1994.)\nJohn H. Oswald 1993--Executive Vice President 1992--President, The Riverside Publishing Company* 1992--Vice President 1991--Executive Vice President for Sales, Customer Service, and Operations for The Psychological Corporation of Harcourt Brace Jovanovich, Inc. (a publisher not affiliated with the Company)\nGary L. Smith 1991--Senior Vice President, Administration\nJune Smith 1994--Executive Vice President 1992--Vice President, Editorial Director, College Division 1991--Editorial Director and Publisher--College Division of McGraw-Hill, Inc. (a publisher not affiliated with the Company)\nWendy Strothman 1996--Executive Vice President, Trade & Reference Division 1995--Vice President, Publisher, Adult Trade and Reference 1995--Director, Beacon Press (a publisher not affiliated with the Company)\nJohn E. Tyler 1993--Senior Vice President, Chief Technology Officer 1992--Vice President, Information Technology, Seattle Times (a publisher not affiliated with the Company)\nPaul D. Weaver 1989--Senior Vice President, Clerk, Secretary, and General Counsel\nWilliam J. Wisneski 1992--Executive Vice President, School Publishing 1991--Senior Vice President; President, The Riverside Publishing Company*\n* A subsidiary of the Company ** Ms. Deegan became Executive Vice President, Chief Financial Officer, and Treasurer on February 26, 1996, at which time she resigned as a Director of the Company.\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 traded on the New York Stock Exchange. As of February 29, 1996, the approximate number of holders of common stock of the Company was 5,121.\nInformation about stock prices and dividends paid per share is set forth under the heading \"Stock Prices and Dividends Paid Per Share\" presented below:\nHOUGHTON MIFFLIN COMPANY\nSTOCK PRICES AND DIVIDENDS PAID PER SHARE (Unaudited)\n1995 1994 ------------------------ -------------------------- Dividend Dividend High Low Paid High Low Paid ----- ----- ------ ----- ----- -------- First quarter $47.13 $39.75 $.225 $53.00 $40.63 $.215 Second quarter 54.75 45.88 .225 48.25 38.88 .215 Third quarter 52.88 44.88 .240 46.13 36.13 .215 Fourth quarter 46.75 39.63 .240 47.88 40.63 .225 ---- ------ Year $.930 $.870 ==== ======\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe response to this item is set forth below under the heading \"Five-Year Financial Summary.\"\nHOUGHTON MIFFLIN COMPANY\nFive-Year Financial Summary\nIn October 1995, the Company completed the acquisition of D.C. Heath and Company from Raytheon Company in a purchase transaction (See Note 2). As a result, certain charges of $49.3 million ($30.0 million after-tax, or $2.17 per share) were recorded in 1995 associated with the integration of the Heath business.\nAn after-tax gain of $7.8 million, or $.56 per share, was recognized in 1995 in connection with an additional public offering of 1.2 million shares made by INSO. In 1994, the Company recognized an after-tax gain of $22.8 million, or $1.65 per share, in connection with the initial public offering of INSO Corporation, the successor company to the former Software Division.\nIn March 1994, the Company acquired the assets of McDougal, Littell & Company in a purchase transaction (See Note 2).\nIn 1992, the Company adopted the provision of SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" and SFAS No. 109, \"Accounting for Income Taxes.\"\nIn 1992, the Company recognized a loss associated with the sale of certain foreign operations.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations for the three years ended December 31, 1995.\nOn October 31, 1995, the Company acquired D.C. Heath and Company (\"Heath\") for net cash consideration of $452.9 million. On March 1, 1994, the Company acquired McDougal, Littell & Company (\"McDougal\") for net cash consideration of $130.3 million. These acquisitions have been accounted for as purchases and, accordingly, the operating results of Heath and McDougal are included in the Company's consolidated financial statements from the date of acquisition.\nNet sales in 1995 increased $45.9 million, or 9.5%, to $529.0 million from 1994 net sales of $483.1 million. The educational publishing segment's net sales increased by $54.4 million, or 14.0%, in 1995 from net sales of $387.4 million in 1994. The increase in revenues is primarily due to the increased adoption opportunities in 1995 and $17.8 million in incremental revenue as a result of the Heath acquisition. The general publishing segment net sales of $87.2 million in 1995 decreased $8.4 million, or 8.8%, from 1994 net sales of $95.6 million. The decrease in net sales for 1995 primarily resulted from the absence of sales from the former Software Division, lower distribution revenues, lower revenues from weaker front list titles, and additional provisions for book returns.\nNet sales of $483.1 million in 1994 increased $20.1 million, or 4.3%, from 1993 net sales of $463.0 million. The educational publishing segment's net sales of $387.4 million in 1994 increased by $30.2 million, or 8.5%, over net sales of $357.2 million in 1993. Net sales from McDougal of $62.4 million more than offset a net sales decrease from other educational publishing segment components. The general publishing segment's net sales of $95.6 million in 1994 decreased by $10.1 million, or 9.6%, from net sales of $105.8 million in 1993. The decrease in net sales in 1994 primarily reflected the disposition of the Company's former Software Division, which successfully completed an initial public offering in March 1994. General publishing segment sales were up slightly in comparison to 1993 with removal of the former Software Division's sales from both year's results.\nThe Company's operating loss for 1995 was $13.1 million compared to operating income of $53.5 million recorded in 1994, while the operating income recorded in 1994 was a 4.1% increase from the $51.4 million recorded in 1993. Included in these operating results were $56.3 million, $6.5 million and $10.6 million of special charges for 1995, 1994 and 1993, respectively.\nThe 1995 special charges include $49.3 million of charges related to the integration of the Heath operations and $7.0 million resulting from the decision to outsource the Company's distribution function. The charges related to Heath include $32.9 million for inventory and plate adjustments based on strategic decisions made and actions taken subsequent to the acquisition, $9.3 million for integration of administrative and sales functions and $7.1 million for indirect costs of the acquisition. The distribution-related charges include $3.0 million for closing costs and the disposal of assets, $2.9 million for severance, and $1.1 million for consulting and inventory relocation.\nThe 1994 special charges included $3.5 million for corporate and divisional staff reductions, $2.0 million for consolidation of Company-owned and leased facilities, and $1.0 million for disposal of assets.\nThe 1993 special charges included $7.5 million for the realignment of corporate and divisional responsibilities and workforce reductions, $.9 million for the sale of a California warehouse facility and related costs, and $2.2 million to relocate and consolidate Boston area operations in a new location.\nThe after-tax cost of the $56.3 million, $6.5 million, and $10.6 million in special charges was $34.3 million ($2.48 per share), $4.0 million ($.29 per share), and $6.6 million ($.48 per share) for 1995, 1994, and 1993, respectively.\nThe educational publishing segment's operating income decreased by $4.4 million or 6.5% in 1995 on a sales increase of 14.0%. The general publishing segment recorded a loss from ongoing operations in 1995 of $8.5 million, a decrease of $15.8 million from 1994, on a revenue decrease of $6.6 million or 7.0%. The Company's general corporate expenses increased 2.5% to $16.0 million in 1995 from the $15.6 million reported in 1994.\nThe educational publishing segment's operating income decreased by $.7 million, or 1%, in 1994 on a sales increase of 8.5%. The general publishing segment's income from ongoing operations in 1994 decreased 12.6%, to $7.3 million from the $8.3 million recorded in 1993. The Company's general corporate expenses declined $3.3 million, or more than 17%, to $15.6 million in 1994 from the $18.9 million reported in 1993. This reduction was due in part to the restructuring actions taken in 1994 and prior years.\nIn connection with the initial public offering by the former Software Division, INSO Corporation (\"INSO\"), the Company recognized in 1994 a gain of $36.2 million ($22.8 million after tax, or $1.65 per share). In 1995, INSO completed an additional public offering of 1.2 million common shares at approximately $33 per share; as a result, the Company's equity ownership has been reduced to approximately 36%. The Company recorded a non-cash gain of $13.1 million ($7.8 million after tax, or $.56 per share) in 1995, representing the Company's portion of the increase in the net assets of INSO as a result of this offering.\nNet interest expense increased $6.5 million, or almost 100%, in 1995 due to the $345 million of commercial paper and bank financing obtained for the Heath acquisition, the $126.6 million SAILS issuance and a full year of interest on the $100 million of 7.125% 10 year notes issued in April 1994 (\"Notes\") to finance the McDougal acquisition. Net interest expense increased nearly $4.2 million in 1994 from the $2.3 million reported in 1993 due to the debt service requirements of the $100 million Notes used to finance the McDougal acquisition.\nThe Company's effective tax rate for 1995 was approximately 37% compared to approximately 38% for 1994 and 36% for 1993. The reduction in the effective tax rate in 1995 is primarily due to the combination of a 41% tax rate applied to the gain on the equity transactions of INSO offsetting the 39% tax rate used on the loss from operations. The increase in 1994 over the 1993 effective tax rate reflects the impact of federal tax law changes enacted in 1993 which became effective on January 1, 1994, and the intangible asset amortization expense related to the McDougal acquisition.\nThe consolidated net loss in 1995 was $7.2 million, or $.52 per share. These results included the previously discussed after-tax gain recognized in connection with the sale of additional common shares by INSO Corporation, of $7.8 million ($.56 per share), and the after-tax special charges of $34.3 million ($2.48 per share). Consolidated net income in 1994 was $51.2 million, or $3.70 per share including the previously discussed after- tax gain, recognized in connection with the public offering of the Company's former Software Division, of $22.8 million ($1.65 per share), the after-tax special charges of $4.0 million ($.29 per share), and an extraordinary item of $1.2 million ($.09 per share), related to the early extinguishment of debt. Consolidated net income in 1993 was $30.4 million or $2.20 per share, including the previously discussed after-tax special charges of $6.6 million ($.48 per share), and an extraordinary item of $1.0 million ($.07 per share), related to the early extinguishment of long-term debt.\nTextbooks and Other Educational Materials\nThe educational publishing segment's net sales of $441.8 million were $54.4 million higher than the $387.4 million in 1994 an increase of 14.0%. In elementary and secondary school publishing, the School Division and McDougal contributed an increase of $35.8 million, reflecting the increase in adoption opportunities as well as the expected leverage from a dedicated secondary school sales force. Net sales of $17.8 million from Heath, acquired on October 31, 1995, also contributed to the increase. The Riverside Publishing Company (\"Riverside\") reported a sales increase of 4.7% over 1994. The educational testing market continues a shift from norm- referenced standardized tests to customized criterion-referenced tests. The transition continues to affect Riverside as it develops its expertise in criterion-referenced tests and diversifies its product base to include more clinical and guidance assessment products. The College Division, which continues to compete in a difficult industry, reported a 2.1% decrease in net sales from 1994. The acquisition of Heath and its college business is expected to significantly increase the revenues for the combined college business in 1996.\nNet sales of $387.4 million from the educational publishing segments in 1994 were $30.2 million higher than the $357.2 million reported in 1993, an increase of 8.5%. Net sales of $62.4 million from McDougal, acquired on March 1, 1994, more than offset a net sales decrease from other educational publishing segment components. School Division sales, exclusive of McDougal, decreased 14%, or $30.4 million, compared to 1993 mainly due to the existence of significant state adoption opportunities in 1993 for elementary school reading products. The decrease in School Division revenues was partially offset by the open-territory sales of reading and the Company's new elementary school mathematics program. Riverside reported a sales increase of 6.9% over 1993. The College Division reported a 6.7% decrease in net sales from 1993 primarily due to 1993's favorable returns experience. Gross sales of college product increased slightly in 1994.\nOperating income for the educational publishing segment decreased $4.4 million, or 6.5%, to $63.8 million from the $68.2 million reported in 1994. The resulting operating margin for 1995 decreased to 14.4% from 17.6% in 1994. The decrease in the operating margin is primarily due to increased development spending, the incremental Heath operating losses, and higher distribution costs. Development spending for School and McDougal increased $15.4 million, or approximately 60%, reflecting the investment in new programs for adoption opportunities in 1997 through 1999. Programs under development included Houghton Mifflin Reading: Invitations to Literacy(C) 1996, Houghton Mifflin Social Studies(C) 1997, and McDougal Littell The Language of Literature(C) 1997. Selling and administrative costs increased approximately 9.5%, reflecting the incremental Heath costs and a full year of McDougal costs, including the intangible asset amortization. Additionally, outsourcing of distribution at the Geneva, Illinois, facility posed problems for the Company in 1995. Distribution costs increased $6.5 million in 1995 and service to the Company's customers was not acceptable. In February 1996, the Company announced that it was re-assuming control over the distribution function maintained at its Geneva, Illinois, facility.\nOperating income for the educational publishing segment in 1994 decreased $.7 million to $68.2 million from the $68.9 million reported in 1993. The resulting operating margin for 1994 decreased to 17.6% from 19.3% in 1993. Selling and administrative costs increased approximately 17%, reflecting the incremental costs of the\nMcDougal acquisition and 1995 adoption opportunities. Excluding the effect of the McDougal acquisition, the educational publishing segment's selling and administrative expenses would have declined approximately $1.8 million. This decrease is due in large part to the restructuring actions taken in 1994 and prior years. The decrease in the segment's operating income and margin also reflects a 36% decrease from 1993 in the College Division's operating income.\nGeneral Publishing\nCompared with 1994's net sales from ongoing operations, adjusted for the sale of the former Software Division, the general publishing segment's net sales in 1995 decreased $6.6 million, or 7.0%, to $87.2 million. The revenue decrease was primarily due to a decline in revenue contribution from the adult book list and lower distribution revenues. The general publishing segment's loss from ongoing operations was $8.5 million, compared to income of $7.3 million in 1994. There was a $7.5 million non-cash charge recorded in the fourth quarter of 1995, to increase reserves for author advances, inventory obsolescence, and book returns. In addition to these charges, the division reported an operating loss from its new imprint, Houghton Mifflin Interactive. Distribution costs increased by $1.6 million for actions required during the transition to outsourced distribution. That transition is now complete and the Burlington, Massachusetts, facility formerly used for general publishing distribution has been sold.\nNet sales from ongoing operations, excluding software, in 1994 increased $1.6 million, or 1.7%, to $93.8 million from 1993's level of $92.2 million. Net sales of reference products increased 4%, distribution revenues increased sharply, juvenile sales were flat, and adult trade sales were down 6% compared to 1993.\nThe general publishing segment's income from ongoing operations was $7.3 million in 1994 compared to $8.3 million in 1993. The decrease in 1994's operating income reflects slightly higher manufacturing and selling costs. There were no material charges to operating income in either 1994 or 1993 for royalty advances to authors.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company's principal businesses are seasonal, with approximately 70% of net sales normally reported in the second and third quarters. The first and fourth quarters historically have contributed approximately 10% and 20%, respectively, of the Company's annual net sales. The acquisitions of Heath and McDougal have not materially changed the seasonal nature of the Company's net sales.\nThe revenue seasonality also affects the Company's operating cash flow. A net cash deficit from all the Company's activities is normally incurred through the middle of the third quarter. This deficit is funded through the draw-down of cash and marketable securities, supplemented by short-term borrowings, principally commercial paper.\nIn October 1995, the Company acquired Heath, a leading publisher of elementary, secondary, and college educational products, for $452.9 million in net cash, including investment advisory and other third-party costs. The total acquisition cost was financed through a combination of existing cash balances, $145 million in commercial paper, and $200 million in bank financing. The Company has a currently effective registration statement with the Securities and Exchange Commission for the issuance of up to $300 million in debt securities. It is intended that a portion of the proceeds from the issuance will be used as permanent financing for the Heath acquisition. In March 1996, under this registration statement, the Company issued $125 million of 7% Notes due 2006. In March 1996 the Company also issued $100 million of the medium-term notes available. These notes were issued with a weighted average interest rate of 6.0% and a weighted average maturity of 2.6 years. The proceeds from these issuances were used to repay $100 million of the unsecured bank facility and $125 million of the commercial paper borrowings.\nIn March 1994, the Company acquired McDougal, a leading publisher of educational products, for $130.3 million in net cash, including investment advisory and other third party costs. The total acquisition cost was financed through a combination of existing cash balances and a public debt offering of $100 million of 7.125% Notes due 2004.\nThe Company's former Software Division successfully completed an initial public offering in March 1994. In connection with the public offering, the Company received a pre-tax cash dividend of $32.9 million from INSO, the successor company. In 1995, the Company recorded a non-cash gain of $13.1 million as a result of INSO's additional public offering of 1.2 million shares at approximately $33 per share. This non-cash gain represents the Company's portion of the increase in the net assets of INSO as a result of this offering. The Company has pledged up to 3.8 million shares of INSO Corporation common stock as the collateral for the redemption of the 6% Exchangeable Notes (SAILS) due 1999, that were issued in August 1995. At maturity, the principal amount of each SAILS will be mandatorily exchanged for a number of shares of INSO common stock, or at the Company's option, cash with an equal value. The number of shares which could be issued in exchange will be dependent on INSO's market share price at the time of the redemption. The Company will record as\nadditional non-cash interest expense, over the life of the SAILS, the excess of the current INSO stock price over the maximum redemption price at maturity. The additional non-cash interest expense to be recorded through August 1999, based upon INSO's December 31, 1995 stock price, is $10.1 million. If the Company chooses to redeem the SAILS with shares of INSO common stock, it would record a gain representing the excess of the redemption amount over the book value of the Company's investment in INSO. The Company's ownership percentage of INSO after this redemption would be less than 20%. The remaining non-pledged INSO shares may be sold by the Company, subject to certain restrictions, as market conditions and events warrant.\nThe Company had $145 million in short-term borrowings outstanding at December 31, 1995. There were no short-term borrowings outstanding at December 31, 1994. Average short-term borrowings increased in 1995 primarily due to $145 million in commercial paper financing for the Heath acquisition, the increase in seasonal borrowing needs as a result of including a full year of operations for McDougal, and the incremental impact of funding Heath operations for the final two months of 1995. Average short-term borrowings increased in 1994 compared to 1993 primarily due to the bridge financing of $100 million for the McDougal acquisition, higher seasonal borrowing requirements, and the early redemption in March 1994 and June 1993 of $25 million of 8.78% senior notes which were scheduled to mature in 1997 and 1994, respectively. The Company financed the March 1994 redemption of the senior notes with a combination of the INSO dividend and operating cash. The June 1993 redemption was financed with commercial paper. The Company's average short-term borrowings (exclusive of the commercial paper used to refinance the June 1993 senior notes redemption) were $13.6 million, $8.9 million, and $3.9 million in 1995, 1994, and 1993, respectively.\nAt December 31, 1995, the Company's debt (including the short-term borrowings for the Heath acquisition) was $570.8 million as compared with $100 million (discounted value $99.4 million) at the end of 1994. The Company's percentage of debt to total capitalization (debt plus stockholders' equity) was 71.0% at the end of 1995 as compared to 28.9% at the end of 1994. The increase in the percentage is principally due to the $345 million in commercial paper and bank financing which partially funded the Heath acquisition, and the $126.6 million SAILS issuance. The capitalization percentage at December 31, 1995 decreases to 64.6% excluding the short-term borrowings.\nThe Company's cash and marketable securities position at the end of 1995 was $17.3 million, compared to $47.2 million at the end of 1994. Net cash from operations in 1995 decreased $54.2 million from 1994, primarily due to the increase in inventories and the additional seasonal operating losses from the acquisition of Heath. Although net cash from operating activities increased $6.3 million in 1994, due primarily to the McDougal acquisition, the Company's year-end cash and cash equivalents decreased $36.9 million.\nNet cash required for investing activities (excluding proceeds from marketable securities) increased by $371.3 million in 1995. This increase primarily resulted from the $452.9 million acquisition of Heath. Net cash required for investing activities (excluding proceeds from marketable securities) increased by $97.5 million in 1994. This increase resulted from the $130.3 million acquisition of McDougal offset by the $32.9 million dividend received from INSO.\nThe Company's financing activities contributed $459.6 million in 1995, $26.2 million in 1994, and required $10.9 million in 1993. The increase in financing sources in 1995 was a result of the incremental borrowings of $345 million used to finance the Heath acquisition and the $126.6 million SAILS issuance. Financing activity outflows in 1995 included $12.0 million less to repurchase stock than in 1994. The 1994 increase in financing sources included proceeds from the 2004 Notes. Financing activity outflows in 1994 included $51.6 million to retire debt and the repurchase of $12.3 million more common stock than in 1993.\nIn 1995, the Company continued the reorganization of certain administrative and corporate functions begun in 1991, culminating in the actions resulting in the special charges taken in the second quarter of 1995, first quarter of 1994, and the second quarter of 1993 related to workforce changes and distribution consolidation and outsourcing. These actions, as well as other measures taken over the past four years, are expected to continue to reduce costs and increase efficiency. The Company remains committed to further investment in new technology and enhancement of existing technology now used in the publishing process. These efforts are expected to yield further operating and publishing cost savings, as well as to free up capital to pay down debt and to invest in new product development.\nThe Company believes that its cash and marketable securities position, along with funds generated from operating activities and borrowing facilities, will be sufficient to meet total cash requirements for the foreseeable future, including the refinancing of the borrowings from the Heath acquisition. The periodic use of the short-term debt market, primarily commercial paper, for seasonal liquidity needs will continue. The average seasonal borrowings in 1996 are expected to be higher than undertaken over the past three years due in part to the addition of Heath's seasonal operations.\nIMPACT OF INFLATION AND CHANGING PRICES\nAlthough inflation is currently well below that of prior years, which has benefited recent Company results, particularly in the area of manufacturing costs, there are offsetting costs. The Company's ability to adjust selling\nprices always has been limited by competitive factors and long-term contractual arrangements which either prohibit price increases or limit the amount by which prices may be increased. The combination of a weak domestic economy and low inflation results in lower tax receipts at the state and local level, which adversely affects the funding and buying patterns for textbooks and other educational materials.\nIn 1994, the Company started to experience higher prices for paper goods which continued into 1995. Although there has been some softness in recent prices for certain paper products, the Company anticipates that the trend to higher prices will continue as the demand for high quality paper continues to outpace the available supply.\nThe most significant Company investments affected by inflation include book plates, other property, plant, and equipment and inventories. The last-in, first-out (LIFO) method is used to value substantially all inventory and, therefore, the cost of inventory charged against income approximates replacement value. The incremental replacement cost expense amounted to $5.2 million in 1995 as compared with $.6 million in 1994.\nThe Company's publishing business does not require a high level of investment in property, plant, and equipment. Such net assets represented 3.1% of consolidated assets at December 31, 1995. The Company's net investment at the end of 1995 in capitalized book plates for educational and reference works represented approximately 8.6% of total assets. The Company continues to commit funds to new publishing areas through both acquisitions and internal growth.\nManagement believes that by valuing its inventory using the LIFO method, continuing to emphasize technological improvements, and quality control, the Company can continue to moderate the impact of inflation on its operating results and financial position.\n\"Safe Harbor\" Statement under Private Securities Litigation Reform Act of 1995: Statements in this report that are not historical facts may be forward-looking statements that are subject to a variety of risks and uncertainties. There are a number of important factors that could cause actual results to differ materially from those expressed in any forward-looking statements made by the Company. These factors include, but are not limited to, (i) the highly seasonal and cyclical nature of the Company's educational sales; (ii) variable funding in school systems throughout the nation, resulting in both cancellation of planned purchases of educational materials and shifts in timing of purchases; (iii) changes in purchasing patterns in elementary, secondary, and college markets; (iv) regulatory changes which would affect the purchase of educational materials and services; (v) severe increases in paper prices; and (vi) other factors detailed from time to time in the Company's filings with the Securities and Exchange Commission.\nItem 8.","section_7A":"","section_8":"Item 8. Consolidated Financial Statements and Supplementary Data\nIndex to Consolidated Financial Statements\nSupplementary Data\nSummary of Quarterly Results of Operations (unaudited) are presented on page 32.\nMANAGEMENT'S RESPONSIBILITY FOR FINANCIAL STATEMENTS\nThe management of Houghton Mifflin Company is responsible for all information and representations contained in the financial statements and other sections of this annual report. Management is also responsible for the internal consistency of such information and representations. In preparing the financial statements it is necessary for management to make informed judgments and estimates and to select accounting principles which it believes are in accordance with generally accepted accounting principles appropriate in the circumstances.\nIn meeting its responsibility for the reliability of the financial statements, management relies on the Company's internal control systems and procedures. In designing such control procedures, management recognizes that errors or irregularities may nevertheless occur and that estimates and judgments are needed to assess and balance the relative costs and expected benefits of controls. However, management believes that the Company's accounting controls do provide reasonable assurance that assets are safeguarded and that transactions are properly recorded and executed in accordance with corporate policy and management's authorization. As a further safeguard, the Company has a program of internal audits and appropriate follow-up by management.\nThe financial statements have been audited by the Company's independent auditors, Ernst & Young LLP, in accordance with generally accepted auditing standards. In connection with its audit, Ernst & Young LLP develops and maintains an understanding of the Company's accounting and financial controls, and conducts such tests and related procedures as it deems necessary to render its opinion on the financial statements. The adequacy of the Company's internal financial controls and the accounting principles employed in financial reporting are under the general surveillance of the Audit Committee of the Board of Directors, consisting of five outside directors. The independent auditors and internal auditors have free and direct access to the Audit Committee and meet with the committee periodically to discuss accounting, auditing, and financial reporting matters.\nThe Company has distributed to its employees a statement regarding, among other things, potentially conflicting outside business interests of employees, and proper conduct of domestic and international business activities. It has developed and instituted additional internal controls and audit procedures designed to prevent or detect violations of these policies. Management believes this provides reasonable assurance that its operations meet a high standard of business conduct.\nNader F. Darehshori Gail Deegan Chairman, President, Executive Vice President, Chief and Chief Executive Officer Financial Officer, and Treasurer\nREPORT OF INDEPENDENT AUDITORS\nThe Board of Directors and Stockholders Houghton Mifflin Company\nWe have audited the accompanying consolidated balance sheets of Houghton Mifflin Company as of December 31, 1995 and 1994, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1995. 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 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 Houghton Mifflin Company at December 31, 1995 and 1994, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, 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\nBoston, Massachusetts January 23, 1996, except for Note 4, as to which the date is March 7, 1996\nHOUGHTON MIFFLIN COMPANY Consolidated Balance Sheets\nSee accompanying Notes to Consolidated Financial Statements.\nHOUGHTON MIFFLIN COMPANY Consolidated Balance Sheets\nSee accompanying Notes to Consolidated Financial Statements.\nHOUGHTON MIFFLIN COMPANY Consolidated Statements of Operations\nSee accompanying Notes to Consolidated Financial Statements.\nHOUGHTON MIFFLIN COMPANY Consolidated Statements of Cash Flows\nSee accompanying Notes to Consolidated Financial Statements.\nHOUGHTON MIFFLIN COMPANY Consolidated Statements of Stockholders' Equity\nSee accompanying Notes to Consolidated Financial Statements.\nSee accompanying Notes to Consolidated Financial Statements.\nHOUGHTON MIFFLIN COMPANY Notes to Consolidated Financial Statements\nNote 1. Significant Accounting Policies\nPrinciples of consolidation: The consolidated financial statements include the accounts of Houghton Mifflin Company (\"the Company\") and its wholly-owned subsidiaries. All material intercompany accounts and transactions are eliminated in consolidation.\nInvestment in 20% to 50% owned entities are accounted for on the equity method. The Company uses the income statement method to account for issuances of common stock by a subsidiary. Under this method gains and losses on issuance of stock by a subsidiary are recognized in the income statement.\nCertain amounts in the prior years' financial statements have been reclassified to conform to the current year presentation.\nCash and cash equivalents: Cash and cash equivalents consist primarily of cash in banks and highly liquid investment securities that have maturities of three months or less when purchased. The carrying amount approximates fair value due to the short-term maturity of these instruments.\nMarketable securities and time deposits available-for-sale: Marketable securities included in current assets consist of instruments with original maturities of three months or greater. The securities held consist primarily of tax-exempt municipal certificates, government agency obligations, and time deposits and are stated at fair value, which approximates cost due to the short maturity of the instruments. The fair values are estimated based on quoted market prices.\nMarketable securities included in other assets are classified as \"Other investments and long-term receivables\" for consolidated financial statement purposes. These investments, which consist of equity securities, are carried at market value. Unrealized holding gains and losses are recognized as a reduction in stockholders' equity.\nBook returns: A provision for estimated future book returns is made at time of sale, and consists of the sales value less related inventory value and royalty costs.\nInventories: Inventory balances at December 31, 1995 and 1994 are as follows:\nIn thousands 1995 1994 - --------------- ------- -------- Finished goods $120,120 $55,174 Work in process 8,733 4,460 Raw materials 11,074 2,027 ----- ------ $139,927 $61,661 ===== ======\nInventories are stated at the lower of cost or market (replacement cost for raw materials, net realizable value for other inventories). The last-in, first-out (LIFO) method is used to determine the cost of inventory. If the cost of all inventories had been determined by the first-in, first-out method (FIFO), which approximates replacement cost, inventory values at December 31, 1995 and 1994, would have been higher by $23.1 and $20.0 million, respectively.\nDuring 1994, inventory quantities were reduced, excluding the impact of the McDougal acquisition. These reductions resulted in the liquidation of certain LIFO layers carried at costs which were lower than the cost of current purchases. The effect of the reductions was to lower cost of goods sold by $2.4 million and to increase net earnings for 1994 by $1.5 million, or $.11 per share.\nProperty, plant, and equipment: Property, plant, and equipment are recorded at cost and depreciated over the estimated useful lives of the underlying assets. Depreciable lives range from three to forty years. Depreciation and amortization are provided on a straight-line method for buildings, leasehold and land improvements; and accelerated methods for machinery and equipment.\nBalances of major classes of assets and allowances for depreciation and amortization at December 31, 1995 and 1994, are as follows:\nIn thousands 1995 1994 - ------------------------------------------------ ------- --------- Land and land improvements $ 2,046 $ 2,640 Buildings and building equipment 19,169 18,560 Machinery and equipment 57,444 50,225 Leasehold improvements 8,079 6,318 ----- ------- Total 86,738 77,743 Less allowances for depreciation and amortization (53,859) (47,921) ----- ------- Property, plant and equipment, net $ 32,879 $ 29,822 ===== =======\nMaintenance and repair costs are charged to expense as incurred, and renewals and improvements that extend the useful life of the assets are capitalized. Depreciation expense was approximately $8.8 million in 1995; $8.6 million in 1994; and $7.2 million in 1993.\nBook plates: The Company's investment in book plate costs is capitalized and depreciated on an accelerated basis over three years, except for trade and some reference publication costs, which are expensed when incurred. Depreciation expense was approximately $32.9 million in 1995; $29.1 million in 1994; and $29.6 million in 1993.\nIncome taxes: Income taxes are provided based on the liability method of accounting pursuant to Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes.\" Deferred income taxes are recorded to reflect the tax benefits and consequences of future years differences between the tax bases of assets and liabilities and their financial reporting amounts.\nIntangible assets: Intangible assets at December 31, 1995 and 1994, consist of the following:\nIn thousands 1995 1994 - ------------------------------ ------- --------- Goodwill $473,786 $113,268 Publishing rights 18,523 15,530 Other 5,891 5,730 ----- ------- Total 498,200 134,528 Less: accumulated amortization (23,449) (10,120) ----- ------- Intangibles, net $474,751 $124,408 ===== =======\nPurchased editorial publishing rights are amortized on a straight-line basis over the estimated economic life of the titles or contracts, but do not exceed 15 years. The excess of cost over net assets acquired, or goodwill, is amortized on a straight-line basis over periods that do not exceed 25 years. The carrying value of goodwill is periodically reviewed to determine the recoverability based upon projected undiscounted net cash flows over the remaining life of the related business unit or purchased assets. If the analysis indicates that impairment has occurred, the book value is written down to the undiscounted net cash flow amount. Intangible asset amortization expense was approximately $10.7 million in 1995; $6.7 million 1994; and $2.1 million in 1993.\nIn 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 121, \"Accounting for the Impairment of Long-lived Assets and for Long-lived Assets to be Disposed Of\" for fiscal years beginning after December 15, 1995. The Company intends to adopt SFAS 121 in 1996, and does not expect the impact on its financial position or its results of operations to be material.\nBenefits trust: The trust assets consist primarily of 650,000 shares of the Company's common stock purchased from the Company's treasury shares at quoted market price in 1992. The trust is available to fund certain compensation and benefit plan obligations. The common stock is carried at market value with changes in share price from prior reporting periods reflected as an adjustment to capital in excess of par value.\nEarnings per share: Earnings per share are based on the weighted average number of common shares deemed outstanding. Shares of common stock held in the benefits trust and common stock equivalents, such as employee stock options, are evaluated for inclusion in the earnings per share calculation under the treasury stock method and have had no dilutive effect.\nRisks and Uncertainties Organization: The Company's business is publishing and it operates primarily in the domestic market in two industry segments. Based on sales, the Company's largest segment is textbooks and other educational materials and services for the school and college market. The other segment is general publishing in a wide variety of topics, formats, and media. The principal markets for textbooks and other educational materials and services are\nelementary and secondary schools and two- and four-year colleges. The principal market for trade books and reference works in the general publishing segment is retail stores.\nUse of estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. The significant estimates that affect the financial statements include, but are not limited to, book returns, recoverability of advances to authors, and amortization periods and recoverability of long-term assets such as book plates and intangibles.\nNote 2. Acquisitions\nThe Company acquired D.C. Heath and Company (\"Heath\"), a leading publisher of high school, elementary, and college textbooks, on October 31, 1995 for approximately $452.9 million. The acquisition was financed through a combination of operating cash and $345.0 million in indebtedness. The acquisition was accounted for as a purchase and the net assets and results of operations have been included in the consolidated financial statements since the date of acquisition. The purchase price has been preliminarily allocated on the basis of the estimated fair market value of the assets acquired and the liabilities assumed. The costs of purchased editorial rights and the excess of the net assets acquired, or goodwill, are being amortized on a straight-line basis over a period that averages twenty years.\nIn conjunction with the Heath acquisition, certain charges were recorded in the fourth quarter of 1995 for indirect costs incurred as a result of the acquisition ($7.1 million), costs related to the integration of the administrative and sales functions ($9.3 million), and provisions to adjust the carrying values of certain inventory and book plates based on strategic decisions made subsequent to the acquisition ($32.9 million). The integration costs include the costs to consolidate certain administrative and sales functions of the combined businesses as well as training and other similar costs. After completion of the transaction, the Company evaluated its publishing programs and direction and concluded that assets relating to certain overlapping or duplicative programs should be adjusted based upon the estimated future revenues of the combined companies.\nOn March 1, 1994, McDougal, Littell & Company (\"McDougal\"), a leading publisher of elementary and secondary school textbooks, was acquired for $130.3 million. Initial financing was through a combination of operating cash and $100 million in short-term bank debt, which was repaid on April 5, 1994, with the proceeds from a $100 million public debt offering. The acquisition was accounted for as a purchase and the net assets and results of operations have been included in the consolidated financial statements since the date of acquisition. The purchase price has been allocated on the basis of the estimated fair market value of the assets acquired and the liabilities assumed. The excess of the net assets acquired, or goodwill, is being amortized on a straight-line basis over twenty years.\nThe following unaudited summary pro forma information combines the consolidated results of operations as if Heath and McDougal had been acquired as of January 1, 1994. The pro forma financial information is not necessarily indicative of the operating results that would have occurred had the Heath and McDougal acquisitions been consummated as of the assumed dates, nor are they necessarily indicative of future results of operations.\nYears ended December 31, 1995 1994 - --------------------------------------- ------ ------- In millions, except per share amounts Net sales $705.5 $664.9 Income (loss) before extraordinary item (14.9) 29.8 Net income (loss) (14.9) 28.6 Net income (loss) per share $(1.08) $ 2.06\nIn a separate closing, the Company intends to take possession of the outstanding shares of Heath Canada. It is expected that this closing will take place in 1996. The pro forma financial information above presents the results of operations as if the Heath Canada acquisition had been made as of January 1, 1994.\nNote 3. Taxes on Income 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. The significant components of the net deferred tax assets are shown in the following table:\nIn thousands 1995 1994 - ------------------------------------ ------ -------- Tax asset-related: Pension and postretirement benefits $16,300 $13,610 Publishing expenses 22,840 5,614 Allowance for book returns 1,084 1,259 Deferred compensation 1,700 2,254 Other, net 2,936 661 ---- ------ 44,860 23,398 ---- ------ Tax liability-related: Depreciation expense (4,655) (1,758) Deferred income (789) (1,079) ---- ------ (5,444) (2,837) ---- ------ Net deferred tax assets $39,416 $20,561 ==== ======\nAt December 31, 1995 and 1994, net deferred tax assets represented approximately 4% of total consolidated assets. The net deferred tax asset balance is stated at prevailing statutory income tax rates. The Company currently does not anticipate any change in valuation methodology applied to the determination of net deferred tax assets.\nSignificant components of the provision (benefit) for income taxes attributable to income before taxes and extraordinary items consist of the following:\nIn thousands 1995 1994 1993 - ---------------- ------- ------ -------- Current: Federal $ 13,201 $23,711 $15,715 State and other 2,669 5,719 3,522 ----- ---- ------ Total current 15,870 29,430 19,237 Deferred: Federal (16,246) 2,653 (1,398) State and other (3,825) 627 (189) ----- ---- ------ Total deferred (20,071) 3,280 (1,587) ----- ---- ------ $ (4,201) $32,710 $17,650 ===== ==== ======\nThe reconciliation of the income tax rate computed at the U.S. federal statutory tax rate to reported income tax expense (benefit) attributable to income before taxes and extraordinary items is as follows:\n1995 1994 1993 ----- ---- ------ Federal statutory rate 35.0% 35.0% 35.0% State income taxes, net of federal benefit 4.6 4.6 4.6 Nondeductible goodwill amortization (19.8) 2.2 -- Foreign losses .8 (0.1) (0.5) Tax-exempt income 10.2 (0.7) (0.5) Non-deductible meals and entertainment (4.9) .7 .6 Life insurance 5.2 (0.5) -- Other 5.6 (2.8) (3.2) --- -- ---- Effective tax rate 36.7% 38.4% 36.0% === == ====\nAs a result of the SAILS transaction, the Company is likely to record a gain on the redemption of these debt securities. Accordingly, in 1995, the Company is providing deferred taxes on the undistributed earnings of INSO. Accumulated undistributed earnings of INSO on which taxes have not been provided were approximately $2.0 million at December 31, 1995 and 1994.\nNote 4. Debt and Borrowing Agreements\nThe Company had $400 million in unsecured credit facilities available at December 31, 1995, which was supported by commitment fees. There was $200 million outstanding under this facility at December 31, 1995, at a weighted average borrowing rate of 6.19%. A line of credit of $25 million was available at December 31, 1994, for direct borrowings or as support for the issuance of commercial paper.\nA summary of debt at December 31 is as follows:\nOn October 31, 1995, $345 million in credit facilities were drawn upon to fund the initial purchase of Heath from Raytheon Company. These borrowings were subsequently paid off with $200 million in proceeds from a $300 million five-year credit facility and the issuance of $145 million in commercial paper. On December 11, 1995, the Company filed a registration statement with the Securities and Exchange Commission for the offering of $300 million in debt securities. It is intended that a portion of the proceeds from the draw-down of the shelf financing will be used as permanent funding for the Heath acquisition. In March 1996, the Company issued $125 million of long-term debt at 7.0% maturing in 2006 and $100 million of medium-term notes. These notes were issued at a weighted average interest rate of 6.0% and a weighted average maturity of 2.6 years. The proceeds from these issuances were used to pay down part of the commercial paper and the credit facility.\nAfter the issuances described above, required principal payments of debt outstanding at December 31, 1995 are: $19.6 million in 1996, $40 million in 1997 and 1998, $146.7 million in 1999, $100 million in 2000 and $224.5 million thereafter.\nIn August 1995, the Company completed a public offering of 6% Exchangeable Notes Due in 1999 (Stock Appreciation Income-Linked Securities, or \"SAILS\") at a principal amount of $34 per SAILS at issue. Net proceeds of approximately $126.6 million were used for general corporate purposes, including the repayment of seasonal borrowings and the partial funding of the acquisition of Heath (See Note 2). At maturity, the SAILS will be exchangeable for shares of INSO common stock, or at the Company's option, cash in lieu of shares. If the SAILS are redeemed with shares of INSO common stock, a gain representing the excess of the redemption amount over the book value of the Company's investment in INSO would be recorded. The number of INSO shares that would be exchanged for the SAILS depends, in part, on the fair market value of the INSO stock price on the redemption date. If the fair market value is $34 per share, 3.8 million shares of INSO would be exchanged. As the price of INSO common stock increases, the Company is obligated to exchange fewer INSO shares to redeem the SAILS. If the price of INSO common stock is $39.44 or higher at the redemption date, the Company would redeem the SAILS with 3.3 million shares of INSO common stock. The Company will record as non-cash interest expense over the remaining term of the SAILS, the excess of the market value of the current INSO common stock price over the maximum redemption price of $39.44 per INSO share. Given the INSO quoted closing stock price at December 29, 1995, incremental non-cash interest expense of approximately $2.75 million would be recorded in 1996.\nIn April 1994, the Company issued $100 million of 7.125% non-callable unsecured notes (\"Notes\") through a public debt offering. The Notes mature on April 1, 2004 and were priced at 99.4 to yield an effective rate of 7.21%. The proceeds from the issuance were applied to repay the $100 million short-term credit facilities used as bridge financing in the March 1994 acquisition of McDougal, Littell & Company (\"McDougal\").\nIn March 1994, the Company completed an early redemption of $25 million of 8.78% senior notes scheduled to mature in March 1997. The extraordinary refinancing cost of $1.2 million, or $.09 per share, was net of an income tax benefit of $.8 million. The Company financed the early redemption of the senior notes with operating cash and a portion of the dividend received from INSO.\nIn June 1993, an early redemption of $25 million of 8.78% senior notes due to mature in December 1994 was completed. The extraordinary refinancing cost of $1.0 million, or $.07 per share, was net of an income tax benefit of $.6 million. The Company financed the early redemption of the senior notes with commercial paper.\nThe Company enters into transactions involving financial instruments for purposes of managing its exposure to interest rate risks and funding costs. Through the use of interest rate products, such as interest rate swap agreements and interest rate locks, the Company can achieve a predetermined mix of fixed and floating rate debt. In connection with the Company's issuance of debt securities through the draw-down of the $300 million shelf registration, a forward interest rate lock agreement was entered into with a counterparty for the\nnotional principal amount of $100 million at 5.995%. Any amount received or paid under this aggreement will be recorded as a yield adjustment to interest expense, recognized over the term of the debt.\nAn interest rate swap agreement covering interest payments for $25 million in notional debt was in place at December 31, 1994, whereby the Company paid semi-annual interest on the notional $25 million principal amount at a variable rate related to the six-month London Interbank Offering Rate (LIBOR) and received semi-annual interest on the notional principal at 8.78%. The swap rate at December 31, 1994, was 9.5%. The net interest settlements were recognized as an adjustment to interest expense. The Company exited the rate swap in May 1995 by making a payment of $.5 million. This amount had been previously reserved.\nNote 5. Retirement Plans\nThe Company has a noncontributory, trusteed defined benefit pension plan that covers substantially all employees. Plan benefits are generally determined by years of service, the final five years compensation during active employment, and age. The funding policy is to contribute amounts subject to minimum funding standards set forth by the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code. The plan's assets consist principally of common stocks, fixed income securities, investment in registered investment companies, and cash and cash equivalents.\nPension expense for 1995, 1994, and 1993 included the following components:\nThe following table sets forth the Plan's funded status at December 31:\nThe actuarial assumption changes made in 1994 were applied to the determination of the September 30, 1994 benefit obligation valuations. The impact on pension expense was recognized in 1994 and was not material.\nDue to workforce changes in 1993, there was a reduction in the defined benefit pension obligation. A pre-tax expense reduction of $1.2 million ($.7 million after-tax, or $.05 per share) was recorded in the fourth quarter of 1993 in accordance with Statement of Financial Accounting Standard No. 88, \"Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans.\"\nIn addition, the Company maintains a defined contribution benefit plan, the Retirement Savings Plan, which conforms to Section 401(k) of the Internal Revenue Code, and covers substantially all of the Company's employees. Participants may elect to contribute up to 15% of their compensation subject to an annual limit of $9,240 in 1995 to ten funds: seven equity funds, two fixed income funds, and a fund invested solely in the Company's common stock.\nThe Company currently matches an employee's contribution to the Retirement Savings Plan in amounts up to 3% of employee compensation. The contribution expense, which is invested solely in shares of the Company's common stock, amounted to approximately $1.8 million in 1995; $1.8 million in 1994; and $1.7 million in 1993.\nNote 6. Postretirement Benefits\nThe Company provides postretirement medical benefits to retired full-time, non-union employees hired before April 1, 1992, who have provided a minimum of 10 years of service and attained age 55.\nUnder the terms of the benefits trust agreement formed in 1992, proceeds from the periodic sale of assets by the trustee, cash dividends received, and other trust earnings may be used to pay designated compensation and benefit plan obligations, including retiree health care benefit costs. The assets in the benefits trust consist principally of the Company's common stock. The fair value of the benefits trust net assets was $27.9 million and $29.5 million, at December 31, 1995, and 1994, respectively.\nThe following table presents the postretirement benefit liability recognized in the statement of financial position at December 31:\nIn thousands 1995 1994 - --------------------------------------------- ------ -------- Accumulated postretirement benefit obligation: Retirees $19,318 $18,344 Fully eligible active plan participants 3,243 1,828 Other active participants 3,562 2,777 ---- ------ 26,123 22,949 Unrecognized net gain 745 719 Unrecognized prior service cost 16 1,196 ---- ------ Accrued postretirement benefit liability $26,884 $24,864 ==== ======\nNet periodic postretirement benefit cost includes the following components for the twelve months ended December 31:\nIn thousands 1995 1994 1993 - ----------------------------------------------- ----- ----- ------ Service cost $ 349 $ 354 $ 426 Interest cost 1,676 1,786 1,859 Amortization of unrecognized prior service cost (68) (67) -- --- --- ---- Net periodic postretirement benefit cost $1,957 $2,073 $2,285 === === ====\nAssumptions used in the actuarial computations were as follows for the twelve months ended December 31:\n1995 1994 1993 --- --- ----- Weighted average discount rate 7.9% 7.8% 8.0% Medical inflation trend rate 8.0% 9.0% 13.0%\nThe changes to the discount and inflation rates reflect stable long-term interest rates and a moderation of health care costs experienced over the past two years. At December 31, 1995, the medical care cost trend rate was assumed to decline one percent per annum to a projected ultimate heath care cost trend rate of 5.0% in 1998 and thereafter.\nThe assumed medical inflation trend rate can significantly influence postretirement liabilities and expenses. An increase of one percent in the assumed medical inflation rate would increase 1995 net periodic postretirement expense by approximately $.1 million, and increase the accumulated postretirement benefit obligation as of December 31, 1995 by $2.1 million. The Company expects to reduce the discount rate to 7.25% and the health care inflation rate to 7% for 1996.\nNote 7. Stock Options\nThe Company maintains two stock option plans, the 1992 Stock Compensation Plan and the 1995 Stock Compensation Plan. Options outstanding include some granted under the 1992 plan, under which no further options may be granted. The Company has authorized 900,000 common shares under the 1995 Stock Compensation Plan for the granting of incentive and non-qualified stock options, awards of restricted or bonus stock, or other performance awards to eligible employees and non-employee members of the Board of Directors and shares issued to Directors as part of their compensation. Recipients of restricted stock awards may not sell or transfer the shares until the restricted period lapses provided that shares have not been forfeited due to termination of employment. During the restriction period, the recipient is entitled to the right to vote and receive dividends. In 1995, grants of 10,766 shares of restricted stock were made, of which 10,080 remained outstanding at December 31, 1995. The Plans provide that the option price shall not be less than the fair market value of the shares on the date of grant. Options granted under all plans become exercisable at such times as the Compensation & Nominating Committee has determined, but not later than ten years from the date of the grant.\nThe Company accounts for its stock compensation arrangements under APB 25, \"Accounting for Stock Issued to Employees,\" and intends to continue to do so.\nIn August 1994, pursuant to the 1994 Executive Stock Purchase Plan, whose purpose was to increase stock ownership of the Company's Executive Officers, the Company granted 124,272 options under the 1992 Stock Compensation Plan to certain corporate officers for exercise at the then market price of $42.625. These options were exercisable only on the date granted and stock was issued from the treasury shares. A note was obtained from the officers and collateralized by the stock. In addition, each participant has entered into a risk sharing agreement which, among other things, limits the gains and losses associated with the stock in the event of a future sale (See Note 13).\nIncome tax benefits are realized from the exercise or early disposition of certain stock options. This benefit results in a decrease in current income taxes payable and an increase in capital in excess of par value.\nTransactions involving outstanding stock options under these plans were as follows:\nOption Price Per Number of Share on Grant Shares Date ------------- ------------------ Options outstanding at January 1, 1993 258,443 $22.25-$49.25 Granted 196,000 44.63 Exercised (94,486) 23.88-44.63 Cancelled\/Expired (14,240) 23.88-44.63 ----------- ---------------- Options outstanding at December 31, 1993 345,717 22.25-49.25 Granted 490,772 37.50-47.50 Exercised (174,475) 22.25-44.63 Cancelled\/Expired (40,040) 23.88-49.25 ----------- ---------------- Options outstanding at December 31, 1994 621,974 23.88-47.50 Granted 297,000 41.63-50.88 Exercised (70,698) 23.88-47.50 Cancelled\/Expired (21,700) 35.25-45.75 ----------- ---------------- Options outstanding at December 31, 1995 826,576 $23.88-$50.88 =========== ================ Exercisable at December 31, 1994 234,805 Exercisable at December 31, 1995 352,763 Available for grant at December 31, 1994 84,628 Available for grant at December 31, 1995 598,000\nNote 8. Special and Restructuring Charges\nIn 1995, the Company incurred special charges to outsource existing warehousing and distribution operations. In 1994, the Company substantially completed the reorganization of certain administrative and corporate functions begun in 1991. These actions, as well as other measures taken over the past four years, are expected to hold down operating costs and increase efficiency. A summary of the principal actions taken in 1995, 1994, and 1993, and the related costs is set forth in the table below:\nYears ended December 31, 1995 1994 1993 - ------------------------------------------ ------- ------- --------- In thousands, except per share amounts Severance $2,850 $3,560 $ 7,500 Facilities sale and consolidation 2,788 1,982 900 Inventory relocation 315 -- -- Disposal of tangible and intangible assets 250 971 -- Consulting 830 -- -- Headquarters relocation -- -- 2,160 ----- ----- ------- 7,033 6,513 10,560 Income tax benefit 2,743 2,475 3,960 ----- ----- ------- Net charge to operations $4,290 $4,038 $ 6,600 ===== ===== ======= Per share cost $ .31 $ .29 $ .48 ===== ===== =======\nThe Company eliminated approximately 345 positions as a result of these actions. As of December 31, 1995, approximately $12.6 million had been paid to employees in the form of salary continuance and other benefits related to these restructurings. The remaining liability of $1.3 million at December 31, 1995 for the remaining termination benefit obligations is expected to be fully paid in 1996. There were no material differences between the amounts accrued above and the payments against the liabilities recognized.\nIn connection with the acquisition of Heath, a non-recurring charge of $49.3 million ($30.0 after-tax, $2.17 per share) was recognized. This charge is principally comprised of integration costs, indirect costs of the acquisition,\nand adjustments to reflect strategic decisions made and actions taken subsequent to the acquisition to state certain inventories and book plates at estimated net realizable values (See Note 2).\nNote 9. Preferred Stock Purchase Plan\nIn December 1988, the Company adopted a Stockholders' Rights Plan and declared a dividend distribution of one Right for each outstanding share of common stock. The Rights are attached to the common stock and do not have voting or dividend rights, and until they become exercisable, can have no dilutive effect on Company earnings. Each Right, when exercisable, entitles the holder to purchase at an exercise price of $125 one one-thousandth of a share of Series A Junior Participating Preferred Stock. The Rights will become exercisable after a person or group has acquired ownership of 20% or more of the outstanding common stock, or the commencement of a tender or exchange offer that would result in a person or group owning 30% or more of the common stock, or the determination by the Continuing Directors that a person or group which has acquired a substantial amount (at least 15%) of the outstanding common stock is an Adverse Person (as defined in the Rights Agreement). Any declaration by the Continuing Directors that a person is an Adverse Person, any acquisition of 30% or more of the outstanding common stock (except pursuant to an offer the Outside Directors have determined is fair to, and in the best interest of, the Company and its stockholders), and certain mergers, sales of assets, or other \"self-dealing\" transactions with a holder of 20% or more of the outstanding common stock, may entitle each Right holder, other than the potential acquirer, to receive upon exercise of each Right an amount of common stock, or common stock of the acquirer in the case of certain mergers or sales of assets, having a market value equal to twice the exercise price of the Right. In general, the Company may redeem the Rights in whole at a price of $.05 per Right at any time prior to the tenth day after a person or group acquires 20% or more of the outstanding common stock. The Company may not redeem the Rights if the Continuing Directors have declared someone to be an Adverse Person. The Rights will expire in December 1998.\nNote 10. Commitments and Contingencies\nOperating lease obligations The Company has leases for various real property, office facilities, and warehouse equipment which expire at various dates. Certain leases contain renewal and escalation clauses for a proportionate share of operating expenses.\nThe future minimum rental commitments under all noncancelable leases for real estate and equipment are payable as follows:\nYears In thousands - -------------------------------- ------------- 1996 $ 13,058 1997 11,835 1998 11,229 1999 10,387 2000 9,900 Thereafter 48,727 ----------- Total minimum lease payments $105,136 ===========\nRent expense, net of sublease income, was approximately $13.0 million in 1995; $11.6 million in 1994; and $9.9 million in 1993.\nCommitment In February 1996, the Company agreed to lease an additional 56,000 square feet of office space located adjacent to the corporate headquarters. The annual lease commitment is approximately $1.4 million and will expire in February 2007.\nOther obligations In August 1994, the Company sold in a private placement 2,000 put warrants on 200,000 shares of its common stock. Each warrant obligated the Company to purchase 100 shares of Common Stock at $38.00 per share if the counterparty exercised in August 1995. The total exercise price of $7.6 million was reflected in the financial statements at December 31, 1994, as a provisional liability with the offset as a reduction of capital in excess of par value. The sale proceeds of $.4 million were included in capital in excess of par value. The options expired unexercised in 1995, and the liability was reclassified to capital in excess of par value.\nContingencies The Company is involved in ordinary and routine litigation incidental to its business. There are no such matters pending that the Company expects to be material in relation to its financial condition or results of operations.\nNote 11. Software Division Public Offering\nIn March 1994, the Company's former wholly-owned Software Division, a developer of software tools for proofreading, reference, and information management, completed an initial public offering of 6.9 million shares at an offering price of $7.50 per share for total consideration of $51.8 million. In connection with the public offering, the Company received a cash dividend of $32.9 million from the newly-formed successor company, INSO. An after-tax gain of $22.8 million, or $1.65 per share, was recognized in connection with the public offering. Deferred taxes were recognized on the transaction. Upon completion, the assets, businesses and employees of the Software Division were transfered to INSO. The Company retained an ownership interest of approximately 40% in the successor company subsequent to the transfer. Up to 3.8 million of the Company's INSO shares have been used to collateralize the principal owed from the issuance of the 6% SAILS (See Note 4). In addition, the Company and INSO had entered into a services agreement whereby certain general administrative services were provided by the Company and reimbursed by INSO. A portion of the facilities leased by the Company were placed under a subleasing agreement which was terminated in May of 1995.\nDuring 1995, the Company's Trade & Reference Division sold to INSO certain properties and rights relating to the Information Please(R) almanac product line for $3.3 million. At the time of the sale, the Company held a 40% equity stake in INSO, and accordingly, $1.3 million of the gain was deferred. This deferred gain will be recognized as income by the Company over a period of three years.\nIn August 1995, INSO completed an additional public offering of 1.2 million shares of common stock at a net offering price of approximately $33.00 for total consideration of approximately $39.6 million. As a result, the Company's equity ownership has been reduced to approximately 36%. A gain of $13.1 million, $7.8 million after-tax, or $.56 per share, was recorded representing the Company's portion of the increase in INSO's net assets. On September 1, 1995, INSO effected a two-for-one common stock split in the form of a 100% stock dividend. All INSO share references have been restated to reflect the effects of the stock split.\nNote 12. Disclosures about Fair Value of Financial Instruments\nThe carrying amounts and estimated fair values of the Company's financial instruments as of December 31, 1995 and 1994 are as follows:\nThe fair values of financial instruments are estimates based upon market conditions and perceived risks at December 31, 1995 and 1994, and require varying degrees of management judgment. The fair values of the financial instruments presented may not be indicative of their future values. The following methods and assumptions were used to estimate the fair value of each class of financial instrument:\nCash, Cash Equivalents, Marketable Securities, and Commercial Paper The carrying amount approximates fair value due to the short-term maturity of the instruments.\nInvestments The fair value of the Company's investments is estimated based on the quoted market prices for these securities at December 31, 1995 and 1994. The fair value of the pledged 3.3 million shares of the investment in INSO has been reduced to $39.44 per share to reflect the threshold appreciation price. This is the maximum amount the Company can realize upon redemption of the SAILS (See Note 4).\nLong-term Debt The fair value of the Company's $100 million 7.125% Notes fixed rate long-term debt is estimated based on the quoted market prices for the issue. The fair value of the SAILS is based upon the quoted market price of the underlying INSO shares multiplied by the shares necessary to redeem the issuance.\nThe carrying amount of the credit facility approximates fair value because of the renewing feature of the facility.\nOff-Balance-Sheet Financial Instruments Gains (Losses) The fair value of interest rate swap and interest rate lock agreements (used for purposes other than trading) is the estimated amount that the Company would pay to terminate the agreement taking into account interest rates and the credit-worthiness of the swap counterparty. There were no interest rate swap agreements outstanding at December 31, 1995. There were no interest rate lock agreements outstanding at December 31, 1994. At December 31, 1994, reserves to offset part of the cost of terminating the interest rate swap agreement were established. The Company does not enter into speculative or leveraged derivative transactions.\nNote 13. Related Parties\nThe Company presently holds notes receivable for a total of $5.8 million from certain corporate officers and members of the Board of Directors. The Company provided financing in 1994 to effect the purchase of an aggregate of 138,272 shares of the Company's common stock pursuant to the 1994 Executive Stock Purchase Plan and the 1994 Non-Employee Director Stock Purchase Plan at the fair market value on August 24, 1994, of $42.625 per share. The loans bear an interest rate of 8% and are due in the fourth quarter of 1999. Loans made to officers are collateralized by the shares of common stock purchased and supported by a risk sharing agreement which provides, among other things, for the Company to share in 50% of the gain on any shares sold before the third anniversary, and to share in 50% of the loss on any shares sold after the third anniversary. Loans provided to members of the Board of Directors are unsecured. A director who sell shares purchased with Company financing is responsible for 100% of any resulting loss. The notes receivable are shown as a reduction in stockholders' equity in the consolidated financial statements. In 1995, the Company recognized approximately $.4 million in interest income in connection with the outstanding loans.\nNote 14. Segment Information\nThe Company's principal business is publishing and is divided into two segments: (a) textbooks and other educational materials and services for the school and college markets; and (b) general publishing, including fiction, nonfiction, software, children's books, and reference materials.\nA comparative summary of segment information for the years 1995, 1994, and 1993 appears below. Net corporate expenses include certain corporate officer compensation costs, certain system development costs, certain occupancy costs, stockholder reporting expenses, legal costs, and consulting fees. Corporate assets are principally cash and cash equivalents, marketable securities, and deferred income taxes.\nSUMMARY OF QUARTERLY RESULTS OF OPERATIONS (Unaudited, in thousands of dollars except per share amounts)\nThe above quarterly information indicates the seasonal fluctuations of the Company's educational publishing business.\nThe second quarter of 1995 and the first quarter of 1994 include charges related to the Company's corporate and domestic publishing operations which are of an unusual nature. Note 8 to the consolidated financial statements describes the transactions and related financial statement impact.\nThe fourth quarter of 1995 includes an after-tax charge of $30.0 million related to the D.C. Heath acquisition. Note 2 describes this transaction.\nThe first quarter of 1994 includes an after-tax gain of $22.8 million, or $1.65 per share, in connection with the initial public offering of INSO, the successor company to the Company's former Software Division. The third quarter of 1995 includes an estimated after-tax gain of $8.9 million, or $.64 per share, due to an additional public offering of 1.2 million shares of INSO common stock. The fourth quarter of 1995 includes an after-tax loss of $1.1 million, or $.08 per share, as an adjustment to the previously recorded estimated gain. Note 11 to the consolidated financial statements describes these transactions.\nIn the first quarter of 1994, the Company completed an early redemption of $25 million of 8.78% senior notes due March 1997. The extraordinary loss of $1.2 million, or $.09 per share, is net of an income tax benefit of $.8 million. Note 4 to the consolidated financial statements describes the transaction.\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 is incorporated herein by reference to the Proxy Statement for the 1996 Annual Meeting of Stockholders (the \"1996 Proxy Statement\"), and information with respect to Executive Officers is set forth following Part I, Item 4 of this report under the heading \"Executive Officers of the Company\" on pages 4 and 5 herein.\nItem 11.","section_11":"Item 11. Executive Compensation\nIncorporated herein by reference to the 1996 Proxy Statement.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nIncorporated herein by reference to the 1996 Proxy Statement.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nIncorporated herein by reference to the 1996 Proxy Statement.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statements and Schedule, and Reports on Form 8-K\n(a) 1. Consolidated Financial Statements are listed in the accompanying Index to Consolidated Financial Statements on page 12.\n2. Financial Statement Schedule for the three years ended December 31, 1995:\nII -- Consolidated Valuation and Qualifying Accounts Page 34\nAll other Schedules have been omitted because the required information is included in the consolidated financial statements or notes thereto or they are not required submissions.\n3. The Exhibits listed in the accompanying Index to Exhibits set forth on page 36 herein, are filed as part of this Report, and are included only on the Form 10-K filed with the Securities and Exchange Commission.\n(b) Reports on Form 8-K filed in the fourth quarter of 1995\nThe Registrant filed two reports on Form 8-K in the fourth quarter of 1995:\nReport dated October 6, 1995, reporting on the Company's definitive agreement to acquire D.C. Heath and Company from Raytheon Company.\nReport dated November 15, 1995, reporting on the Company's completion of the acquisition of D.C. Heath and Company from Raytheon Company.\nHOUGHTON MIFFLIN COMPANY SCHEDULE II--CONSOLIDATED VALUATION ACCOUNTS\nYears ended December 31, 1995, 1994, and 1993 (In thousands of dollars)\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nHOUGHTON MIFFLIN COMPANY Registrant\nBy: \/s\/ Nader F. Darehshori ------------------------------------- Nader F. Darehshori Chairman of the Board, President, and Chief Executive Officer\nMarch 14, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated:\nHOUGHTON MIFFLIN COMPANY INDEX TO EXHIBITS (Item 14(a)(3))","section_15":""}
{"filename":"808013_1995.txt","cik":"808013","year":"1995","section_1":"ITEM 1. BUSINESS OF THE REGISTRANT\nGENERAL-BACKGROUND - ------------------\nNorth American Technologies Group, Inc. (\"NATK\" or the \"Company\") conducts business through four principal business groups, EET, Inc. (onsite decontamination of buildings and equipment contaminated with polychlorinated biphenyls (\"PCBs\"), radioactive isotopes or other toxic materials utilizing EET's patented TechXTract(TM) system), Industrial Pipe Fittings, Inc. (manufactures and distributes transition fittings for high-density polyethylene (\"HDPE\") pipe), GAIA Technologies, Inc. (manufactures and distributes porous pipe and rubber\/plastic composite support pads for air conditioning condensers), and other separate NATK operating units (dealing with the commercial development of several environmentally related and hydrocarbon upgrading technologies). Unless the context requires otherwise, the term \"Company\" refers to North American Technologies Group, Inc. and its subsidiaries and affiliates. The Company was organized as of December 24, 1986 under the laws of the State of Delaware.\nPrior to the acquisitions in 1995 of EET, IPF and GAIA, the Company had been a development-stage company engaged in the development, acquisition and application of technologies with possible applications in various industries, including environmental services and energy .\nThe business of the Company was expanded during the first quarter of 1995 with the Company's acquisition by merger of EET. The Company issued 1,770,729 shares of the Company's Common Stock and 71,000 Common Stock Purchase Warrants in connection with the merger. EET was formed in 1993 when it completed the purchase of certain patents and proprietary environmental decontamination technologies and processes from EnClean, Inc., a Texas-based public company. Prior to its acquisition by the Company, EET was owned by approximately forty shareholders, including Tim Tarrillion, the current CEO and President of the Company, and Judith Knight Shields, the current Senior Vice President, CFO and Treasurer of the Company. EET and the Company were not affiliated prior to the acquisition of EET. According to the audited financial statements for the full year prior to the merger (1994), EET incurred a loss of $880,822 on revenues of $1,426,748. The acquisition of EET has been accounted for as a \"pooling of interests.\" Accordingly, the Company's consolidated financial statements have been restated to include the accounts of EET from its inception, August 23, 1993. See \"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\"\nFurther expansion of its business has also been accomplished by the Company's acquisition of IPF and GAIA. In June 1995, the Company acquired by merger IPF, a Houston, Texas-based manufacturer and distributor of proprietary and standard thermoplastic fittings for the mining, environmental and water works industries formerly owned by David Daniels, a director and officer of the Company, and two other unrelated individuals. See \"CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\" The Company issued 1,300,000 shares of the Company's Common Stock in connection with the merger. IPF has been in\nbusiness since 1994 and according to internally generated financial statements provided to the Company for due diligence review, had revenues in 1994 of approximately $500,000. The acquisition of IPF has been accounted for as a \"pooling of interests.\" Accordingly, the Company's consolidated financial statements have been restated to include the accounts of IPF from its inception, January 1, 1994. See \"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\"\nEffective as of December 29, 1995, the Company acquired substantially all of the assets of GAIA, a manufacturer of porous pipe, synthetic construction materials and other products using recycled rubber and plastics. The acquired assets consist of a number of patented and proprietary technologies and other business assets (including among others certain equipment, inventory and raw materials) relating to the use of recycled rubber and plastics for the manufacture and distribution of porous pipe, synthetic construction materials and certain other products with advanced structural properties, together with substantially all other business assets of GAIA relating thereto. The consideration paid for the assets of GAIA included (i) the issuance of 1,666,667 shares of the Company's Common Stock, (ii) the payment of $305,500 in cash, (iii) the issuance of a 90-day promissory note by the Company in the principal amount of $1,050,000, (iv) the forgiveness of certain debt obligations (together with all interest owed thereon) owed by GAIA to the Company of approximately $1,881,400, and (v) the assumption of $194,000 in liabilities.\nIn addition, the Company entered into a Crosstie Purchase Option and Loan Agreement pursuant to which it acquired an option (the \"Crosstie Purchase Option\") to purchase all of the capital stock of TIETEK, INC., a Texas corporation (\"TieTek\"), which is owned by three individuals, two of whom are officers of GAIA. The Company may exercise the Crosstie Purchase Option during a two-year period (which period may be extended for an additional year under certain circumstances) by forgiving all then-outstanding indebtedness under the Crosstie Loan referred to below, and paying certain royalty payments based on products to be sold by TieTek for a fifteen-year period after the exercise of the Crosstie Purchase Option. In connection with the sale of the GAIA assets, TieTek received the right to use certain of the patented and proprietary technologies included in the GAIA assets to develop synthetic railroad crossties and certain other related products.\nThe Company also agreed in the Crosstie Purchase Option and Loan Agreement to lend up to $1,500,000 (the \"Crosstie Loan\") to TieTek, the proceeds of which loan are to be used in connection with developing the synthetic railroad crossties. As of December 31, 1995, the Company has lent to TieTek an aggregate of approximately $220,000 of such Crosstie Loan amount. The Crosstie Loan is collateralized by a pledge of, and lien on, all of TieTek's assets and capital stock, and 666,667 of the shares of the Company's Common Stock.\nThe acquisition of GAIA has been accounted for under the purchase method of accounting with the results of operations of GAIA to be included in the consolidated results of operations of the Company from the effective date of the acquisition (December 29, 1995). The Company has not given any accounting effect to the Crosstie Purchase Option because given the early stage of testing management believes that the exercise of such option is not, as of the date of this Report, probable of occurrence.\nMANAGEMENT RESTRUCTURING - ------------------------\nSince the beginning of 1995, the Company has undergone a major restructuring of its management group. This restructuring was primarily a result of the acquisition of EET and the merging of EET's existing management personnel into NATK. Included in EET's management was Tim B. Tarrillion, who was named President and Chief Executive Officer of NATK once the merger with EET was completed. When the previous Chairman of NATK's Board of Directors resigned in July 1995, Mr. Tarrillion was also named to the position of Chairman. EET's management group also included Mike Bonem, who is currently the President of EET, Ron Borah, who was the inventor of TechXtract(TM) and is currently Vice President of Technology for NATK, and Mr. Klaus Schwitzgebel, who is currently NATK's Director of Research. Prior to EET, these individuals had worked with Mr. Tarrillion when he was President and Chief Operating Officer of EnClean, Inc. (\"EnClean\"). EnClean was a publicly traded company that Mr. Tarrillion had co- founded in 1984 which grew to over $100 million in revenues by 1992. It was an industrial and environmental services company that was acquired by Rust International in 1993.\nIn addition to the executives that came to NATK through the EET acquisition, Mr. Tarrillion also hired two individuals (Donovan Boyd, Chief Operating Officer, and Judy Shields, Chief Financial Officer) who had also worked with him at EnClean. Thus, most of NATK's new management team has worked for EET, EnClean, or both. The new management team of NATK was further augmented when Mr. William Aldrich and Dr. Henry Sullivan, each a senior GAIA management team member, became employees of NATK in connection with the acquisition of GAIA. In addition, the NATK management team includes Mr. David Daniels, who was a member of NATK's management team prior to 1995, as a director and Executive Vice President of the Company as well as President of IPF.\nThe Company's new management team provides a base of experience on which NATK can build:\n. The team has worked together before in building EnClean from $1 million in sales to over $100 million annually. As such, it understands the entrepreneurial nature and needs of small enterprises, but also understands the need for and knows how to implement professional management systems as the company grows. It has direct management experience in the needs of start-up operations.\n. The team has experience in growing by acquisition, as it grew EnClean by effecting thirteen different acquisitions in an eight-year period. Because of this experience they understand the requirements for successful integration of new companies, including understanding market trends, the customer's perspective of the products, the need for a common and centralized accounting system, and sound operating management.\n. The team is comprised of individuals who have a broad background and experience in several scientific and technical fields. It includes four chemical engineers, two chemists, several other engineers\/scientists, and two Ph.D.'s, all who have diverse experience in the technical and business aspects of energy,\nenvironmental, polymer and other industries. This combination allows the team to understand both the technical and market aspects of new technologies.\n. The management group has implemented a strategic planning process to manage the diverse set of businesses that will comprise the new NATK. This team successfully used this planning process at EnClean to manage forty different profit centers each with a wide range of services, market conditions, and customers.\n. The management group is very comfortable with the reporting requirements of a public company and in dealing with the various components of Wall Street, inasmuch as it successfully completed an initial public offering at EnClean and managed EnClean as a public company prior to its acquisition by Rust International.\n. The team has operated in the environmental and energy industries for the past twenty years and has gained valuable experience in understanding the critical needs of both industries. Through direct experience, it believes it knows where potential problems exist and what segments need to be avoided because of structural forces that will dictate low profitability.\nDESCRIPTION OF BUSINESS AND TECHNOLOGIES - ----------------------------------------\nThe Company's strategy is to acquire and internally develop businesses that are based on proprietary technologies, proprietary manufacturing processes and\/or defendable market positions. These businesses will be commercially developed to provide a mix of products, services and licensing arrangements to a range of customers in the natural resources, energy, environmental and related industries.\nCertain of the Company's businesses have been commercialized to varying extent while others remain in the development stage. EET's TechXTract(TM) and Waste Management businesses, IPF's manufacturing and distribution of transition and related fittings businesses, and GAIA's porous pipe and A\/C pad businesses, are contributing to the revenue growth of the Company. NATK's Oleofilter(TM) is expected to contribute to the Company's 1996 revenues. The railroad crosstie Product line and the BioKatT(TM) technology are still in the development stage and may add to the Company's growth at some time in the future. The commercial development of the Company's BioTreat system and the Terrazyme have currently been suspended pending improvement in the economics of the soil remediation market.\nThe following chart provides a summary of all of the Company's businesses and technologies, together with their respective operational functions and current status of commercialization:\nEET'S TECHXTRACT(TM) PROCESS - ----------------------------\nDuring March 1995, the Company acquired a decontamination process known as TechXtract(TM) in connection with its acquisition of EET. TechXtract(TM) is a patented technology that permits the extraction of subsurface contaminants without destroying the surface or substrate. Management believes that this technology is unique in its ability to remediate contaminated porous surfaces where surface cleaning is ineffective or insufficient, and physical (destructive) processes are unacceptable or uneconomical.\nThe TechXtract(TM) technology can be used to remove a wide variety of contaminants from porous surfaces and substrates. This is made possible through tailoring of the chemistry and process for individual contaminant(s) and other project-specific factors. Although the technology has focused on those contaminants which are particularly difficult to remove and which have extremely low acceptable levels for clean-up, the Company believes that modifications can be made in the technology to treat other types of contaminants.\nThe technology has been utilized in removing all types of polychlorinated biphenyls (\"PCBs\") from an array of substrates. The United States Environmental Protection Agency (\"EPA\") has established a clean-up standard in respect of PCB's of 10 mg\/100 cm\/2\/. Areas and equipment that have been cleaned using the TechXtract(TM) technology are routinely sampled and tested by independent laboratories which have verified that the contaminant extraction process has been successful in achieving levels of extraction that meet the EPA's clean-up standard.\nEET has also demonstrated TechXtract(TM)'s ability to extract radioactive contaminants for the Department of Energy and several other customers. EET has either demonstrated or developed chemistry and applications for the deradiation of concrete floors and walls, metal working equipment, tools, lead bricks\/shielding, clothing, internal piping, evaporation basins, and holding tanks. Deradiation has been effective on both surface and fixed contaminants, as verified by surface smears and by alpha, beta\/gamma, and x-ray detectors.\nIn addition to the other categories of contaminants, EET has successfully modified its technology to address the other hazardous constituents on the EPA's list. As with the other contaminants, the process is most applicable when reduction to below regulatory levels will result in substantial economic benefits to the customer due to opportunities for \"delisting\" or nonhazardous disposal.\nEET's patent application for the TechXtract(TM) Process has received approval from the United States Patent and Trademark Office. In addition, EET is seeking patent protection for several chemical formulations associated with the TechXtract(TM) process. See \"Patents and Proprietary Rights.\" EET has developed certain base blends which are effective for a wide range of contaminants, but can make special formula modifications if required. EET is also pursuing potential market opportunities for the TechXtract(TM) technology and formulation in commercial and retail cleaning applications and for the removal of scale in downhole oil drilling and production piping systems.\nWhen TechXtract(TM) is used, liability is reduced for the customer in two ways. First, the low volume of waste produced in itself decreases liability. Second, if the customer's other remediation option is total disposal, then incineration of solids is not an alternative. With incineration of the waste liquids from the TechXtract(TM) Process, hydrocarbon based contaminants are completely destroyed and the generator receives a \"certificate of destruction\" from the licensed incinerator. Furthermore, once the contaminants are removed from the facility or piece of equipment, they may be able to be delisted as a hazardous waste and therefore, only the site may be able to be given a clean closure status by the EPA or appropriate state regulatory agency. The TechXtract(TM) process has been used with approval of or has been used as evidence given to several EPA regions to meet PCB cleanup standards. The TechXtract(TM) process was recently included in the remediation plan relating to a consent decree to cleanup PCBs from a series of gas compressor stations owned and operated a major U.S. gas transmission company.\nManagement believes the TechXtract(TM) Process compares favorably to competing processes. The chemicals used in some surface cleaning processes are inherently hazardous, tend to require much higher volumes, and are ineffective on subsurface contamination. Scarification and other physical processes produce large volumes of waste (particularly if there is significant\nsubsurface contamination), create airborne hazards, and therefore, only move the problem to another location.\nThe TechXtract(TM) Process has been employed in a number of commercial projects. Prior to its acquisition by the Company, the TechXtract(TM) Process had been used in over 200 successful projects. The projects range from the removal of PCB contamination from concrete floors and walls of a major steel company in the Midwest, to the deradiation of fixed radionuclides at the DOE Nuclear Production and Research Facility in Oak Ridge, Tennessee. In addition, the TechXtract(TM) process has been selected for a test demonstration by the EPA as part of the EPA's Superfund Innovative Technology Evaluation (Site) Program.\nEET'S WASTE MANAGEMENT SERVICES - -------------------------------\nEET's Waste Management Services (\"WMS\") is a service group providing expertise and project personnel in the identification, packaging, documentation, transportation and disposal of hazardous and special wastes for government, environmental consulting\/engineering firms, and industry. These services include identification and characterization of unknown wastes, waste consolidation, drum handling, lab packing, and remediation and decontamination of sites and facilities. WMS provides 40-hour Occupational Safety and Health Act (\"OSHA\") certified project managers and environmental technicians who can mobilize quickly and economically to the customer's location. The skills and credentials of WMS field personnel are also complimentary to those of TechXtract(TM) field personnel, and can provide extra capacity for peaks in the TechXtract(TM) business of EET.\nThe need for WMS services originates with the Resource Conservation and Recovery Act (\"RCRA\"), enacted in 1976 and amended in 1984. This Act is the fundamental driving force behind proper handling and disposal of wastes, and the associated civil and criminal penalties causing manufacturing companies to consider its requirements seriously. This Act created numerous service industries, including the range of services currently provided by WMS. In general, waste management service companies, like WMS, were formed with the knowledge required for compliance and handling of hazardous waste, and to assist smaller waste generators in the complex analytical and documentation requirements of waste disposal. It is management's belief that EET's WMS enjoys a defendable niche and a set of distinctive competencies in the central Texas waste management business.\nEET's WMS group also has a research laboratory and staff that performs research and analysis to support other EET\/NATK project activities. This group can also employ other technologies based on processes for the reduction, removal and stabilization of environmental contaminants in soil, wastewater or groundwater. In this regard, EET has four water and soil treatment patents which have not yet been commercialized to any great extent. However, one commercial system, based on one of these EET patents, for removing metals from a waste stream generated by a plating facility, is currently in use. Furthermore, several feasibility projects using techniques from the soil fixation patent are pending. NATK is currently developing a plan to determine the long term commercial opportunities for these technologies. Finally, EET's research staff is also used for internal and government-funded research projects relating to NATK's current and future technologies.\nINDUSTRIAL PIPE FITTINGS - ------------------------\nIn June 1995 the Company acquired Industrial Pipe Fittings, Inc. (\"IPF\"), a privately-held Houston-based manufacturing and distribution company. IPF manufactures and distributes both proprietary and standard thermoplastic fittings for the high density polyethylene pipe business. In its first year of operation (1994), IPF generated over $500,000 in revenues. IPF principally markets to the industrial, mining and water works industries. The acquisition was accounted for as a pooling of interests by the Company effective June 30, 1995 and, as such, historical financial statements of the Company have been restated to include the financial effects of IPF from the date of its inception, January 1, 1994.\nIPF manufactures and distributes products that relate primarily to the high-density polyethylene (\"HDPE\") market. IPF currently fabricates metallic connectors for various HDPE applications. It also manufactures four types of quick connect fittings (Victaulic, Gheen, Camlock, Bauer) as well as threaded, weld-end and flanged adaptor fittings. IPF also stocks and distributes related thermoplastic products which complement the use of its existing line of manufactured fittings. IPF has recently expanded its product line to include internally fabricated large diameter HDPE elbows, tees and wyes, as well as a high quality line of tapping saddles obtained through an exclusive distribution agreement with Alprene SAS of Bologna, Italy.\nThe domestic market for HDPE pipe resins is currently estimated by industry trade organizations to exceed $6 billion annually. The domestic market for HDPE related fittings and supplies is estimated by IPF's management to exceed $1.5 billion. Because of the number of applications of polyethylene, the market is expanding world wide, particularly in Central and South America.\nIPF currently markets its products within a two tier plan. First, IPF has alliances with approximately 100 distributors that cover most of the North and South American Continents. IPF management believes that this creates greater marketing capacity than could be realized through inside sales efforts only. Secondly, IPF offers customized engineering and specification writings for many end-user applications. At times, this gives IPF exclusivity on large projects that use many of IPF's currently existing product lines.\nIPF currently utilizes a modular based assembly procedure for manufacturing. Most internally manufactured components are made directly from raw materials and are stocked in appropriate quantities based on demand. Final assembly for large orders is typically done on a per order basis with most shipments of finished goods occurring within days after receipt of a purchase order. IPF management is committed to expanding manufacturing capacity through increased integration and automation. IPF also carries a certain amount of finished goods inventory for quick shipment and to support its distribution of the tapping saddle product line.\nIPF has recently completed the expansion of its manufacturing facilities by adding two more buildings and thus, tripled the size of its operations. One building will now house all inventoried items, and the other building will add to IPF's manufacturing floor space. Since being acquired by NATK, IPF has also further upgraded its manufacturing capabilities with the purchase of a Computer Number Controlled (\"CNC\") lathe, a Vertical Turret Lathe (\"VTL\"), and a large diameter \"YTL\" fabrication machine. Management believes that once the YTL machine becomes fully operational, it\nwill give IPF capabilities that few companies have. This machine not only allows the Company to fabricate large diameter fittings of any specification, but the DIPS (Ductile Iron Pipe Size) capabilities of the equipment gives IPF a significant advantage because currently only few competitors can produce these fittings. In addition, this generation of YTL machine is unique in that it provides a way to produce every style of fabricated fittings in any diameter, its full body insert clamps eliminate deflection, it has the ability to make any angled mitered joint, and its computer data logger provides a physical record of all fuses made.\nGAIA TECHNOLOGIES - -----------------\nGAIA TECHNOLOGIES' PRODUCTS - ---------------------------\nGAIA's technologies utilize a combination of new and recycled thermoplastics mixed under pressure with crumbed rubber made from discarded vehicle tires or virgin synthetic (vulcanized) rubber scraps. The rubber and plastic are uniformly mixed in the feed preparation stage, where additives may be used to enhance certain physical properties. The mix is then subjected to mechanical work and pressures, which increase the temperature and melt the plastic, basically \"gluing\" the rubber particles and plastics together. The precise proportions of each of the raw materials used vary greatly based upon the desired characteristics of the end product. As the volume of rubber particles decreases and the proportion of thermoplastics increases, the resulting product becomes less flexible, rapidly loses its porosity, and ultimately becomes impervious and rigid rather than flexible. Certain aspects of this technology, including formulations and manufacturing techniques, are covered by six existing patents and the Company will continue to pursue additional patents as improvements or new innovations are made. However, additional protection for these technologies, over and above these patents, is afforded by the significant amount of practical know-how possessed by GAIA and its management that could only be replicated through significant investment of time and money. The GAIA technologies are currently being applied to produce porous pipe and building materials (currently A\/C pads). These technologies could also be used to produce synthetic railroad crossties through a licensing agreement and joint development program with TieTek.\nPOROUS PIPE - -----------\nGAIA manufactures and sells porous pipe as an integral part of an underground, integrated and engineered distribution network for commercial irrigation. The Company's management believes that GAIA's porous pipe has unique physical, structural and fluid dynamic properties. When used in underground irrigation systems, porous pipe promotes increased crop field, weed control and water conservation. A properly engineered and installed subsurface irrigation system using porous pipe can deliver water, oxygen, nutrients, pesticides and other agricultural chemicals to the root system of a crop.\nGAIA's patented technology and proprietary manufacturing process for its porous pipe converts a mixture of rubber from recycled tires and thermoplastic raw materials into a flexible pipe that is a continuous cylindrical membrane of rubber-plastic polymeric alloy. The process is scientifically controlled to provide a consistent network of capillary pathways through the pipe walls, resulting in a slow, steady and uniform osmotic weep rate when water flows through the pipe at low pressure.\nPorous pipe is a recent commercial irrigation development, spawned by the concern and expense of conventional watering systems and their inefficient application of water. Underground irrigation using porous pipes has numerous advantages over above ground watering. With above ground systems, water must enter soil and penetrate through the root zone to benefit plants, a pathway that is often lengthy or difficult. Underground irrigation systems pump water through piping systems, delivering water directly to root structures. In addition, nutrients, air, herbicides and\/or insecticides can be directly delivered to the subsurface root zone.\nThe efficiency of subsurface porous piping is multi-faceted. Conventional irrigation systems waste significant amounts of valuable water to evaporation and distribution losses, and require disruptive above ground canals or piping structures. Empirical tests show that underground irrigation consumes as much as 30% less water than its alternatives. Application of farm chemicals is equipment intensive and can result in the waste and environmental impacts from runoff. With porous pipe, simple mixing and injection systems allow for 100% retention in targeted root zones. Porous piping systems can also be effective for introducing aerated water, or even air, and can be used for effluent treating, bioremediation and fish farming.\nGAIA has sold over 28 million feet of porous pipe, over the past five years, for use in subsurface irrigation systems in the domestic and international markets. GAIA has licensing agreements for the manufacture and sales of porous pipe with companies in Japan and Spain. In addition, GAIA has an agreement with a group in Florida for the development of porous pipe use in commercial landscaping projects. International sales of the product are currently handled through sales agents in target countries and markets. The product is currently being manufactured for GAIA by a company in St. Francisville, Louisiana, pursuant to a tolling agreement.\nBUILDING MATERIALS-AIR CONDITIONER BASE PADS - --------------------------------------------\nThe substitution of synthetic materials for naturally derived building materials provide many opportunities for application of GAIA's technologies. Potential opportunities exist for new products because of the potential shortages of natural raw materials, the proven application of the technology to make a range of products, and the almost unlimited number of product possibilities. Currently, GAIA has proven mold designs and compositions for a number of product shapes, including its first product in this category -- support pads for outside air conditioning condenser units.\nOriginal equipment manufacturers of air conditioning units deliver approximately five million units annually in the United States alone. When each unit is installed, it typically requires a support pad. At a price of $15-20 per pad, this implies a market size of over $50 million per year. This market is an ideal opportunity for GAIA building material products, since its design is relatively simple yet visible in almost every new construction project. The GAIA product has clear competitive advantages over cement (the traditional pad) and competing synthetics. Distribution agreements are already in place for this product in Texas and in the southeastern U.S. market. The product is currently being manufactured for GAIA by a company in St. Francisville, Louisiana pursuant to a tolling agreement. Sales of this product in the first quarter of 1996 have been somewhat limited by the production capabilities of this new manufacturing system; however, management believes that these start-up problems will be\ncorrected in the near term and production rates should meet design rates as those problems are solved.\nExtension of GAIA's air-conditioning pad business into other construction materials is a natural evolution, particularly in applications requiring rectangular shapes and strong resistance to breakage under impact or weight. Currently, GAIA is investigating the possibility of developing new products for this market, including pallets, oil field mats, roofing shingles, industrial flooring, marine decking and transformer pads.\nRAILROAD CROSSTIES - ------------------\nA key potential new product for the use of GAIA's technologies is a composite railroad crosstie. As part of the purchase of GAIA Technologies, Inc., NATK has the exclusive rights to acquire Tietek, which currently is working to perfect a prototype synthetic crosstie. The techniques used for these prototypes are based on GAIA's technologies and initial indications are that the prototypes can function and perform with similar characteristics to a wood tie with regard to toughness, density, elasticity and flexibility. Preliminary testing and evaluation on this product was originally accomplished during 1994 at the Discas Laboratory in Waterbury, Connecticut and was followed by a period of theoretical modeling based on the Discas results. The Polymer Processing Institute in Hoboken, New Jersey was engaged to confirm the properties of the prototypes. The prototype composite railroad crossties that were tested were compounded rubber-plastic mixtures, enhanced by additives and foaming agents. They were extruded on a twin screw extruder that was fed with raw materials that were specifically mixed to generate a product with properties indicative of those required in railroad crosstie service.\nBased on those preliminary results, a major U.S. railroad is working with GAIA and Tietek to complete a pilot run of up to 1,000 composite crossties for deployment under its own tracks and for use in a battery of independent tests, including accelerated aging tests. This paid production run should result in validation of the attractive characteristics of this product, including both installation and service aspects. The first units from this production run are currently being tested by an independent testing facility at the University of Illinois at Urbana. The railroad intends to install these prototype crossties in a variety of locations, examining their performance under heavy, light and turning traffic. TieTek currently leases manufacturing space from a plastics manufacturer for product development and production of the crosstie prototypes. If this product proves to have strong commercial application, the Company would exercise its purchase option and add to its own manufacturing capabilities for the production of these synthetic crossties.\nWhen and if a commercial product is realized in the domestic crosstie market, there would be natural extensions of this technology to other markets, including the international market, and to similar products. As such, GAIA is currently examining the potential for sales to other rail systems, international marketing and licensing opportunities, and the potential for similarly extruded products such as marine pilings and telephone poles.\nThe Company's exercise of the Crosstie Purchase Option is dependent upon the completion of the testing program described above and confirmation of the commercial potential for synthetic crossties. As a result, the Company has not given effect, from an accounting point\nof view, to the Crosstie Purchase Option since, as of the date of this Report, it can not be said to be probable of occurrence.\nOTHER NATK TECHNOLOGIES - -----------------------\nOLEOFILTER(TM) SYSTEM - ---------------------\nThe Oleofilter(TM) System is a patented system developed by Exxon Research and Engineering Corp. (\"Exxon\") in conjunction with SEREP a French engineering company. During 1995, the Company and Exxon executed a licensing agreement whereby the Company has full future rights to the Oleofilter(TM) System in exchange for a one-time licensing fee paid to Exxon. In addition, the Company has negotiated an agreement with SEREP to provide the Company with drawings, filter material and other commercial and technical know-how which the Company is using to manufacture and market the Oleofilter(TM) System.\nThe Oleofilter(TM) System is a patented oil\/water separation system based on combining an amine-coated ceramic chip technology with a gravimetric separator design that permits both separation of mechanical oil\/water emulsions and provides reduction and recovery of dissolved hydrocarbons. The Oleofilter(TM) System has various applications, including the treatment of contaminated ground water, bilge and ballast waters, water produced from off- shore drilling platforms and other oil\/water mixtures. The Oleofilter(TM) System competes with many other products\/companies designed to meet the requirements of this market. Before selection, each system is judged on its ability to meet specific cleanup standards, complexity of operations, cost of operations, flexibility to changing conditions and initial capital cost of the system. Management believes the Oleofilter(TM) System compares favorably to other competing products, especially in the areas of meeting cleanup standards, ease of operation, low maintenance cost and flexibility to adapt to changing inlet conditions.\nApplication of the Oleofilter(TM) System was successfully demonstrated by the Company in 1994 in conjunction with tests at a superfund site administered by the EPA as part of the EPA's Superfund Innovative Technology Evaluation (\"SITE\") Program. These test results indicated a positive application of this technology in connection with the removal of emulsified oils from water. Other testing efforts have validated the efficacy of the Oleofilter(TM) System. The U.S. Coast Guard currently certifies a number of the Company's models as compliant with international standards for filtration of offshore discharge, as well as applicable U.S. law. In addition, test results from an internationally recognized water test center indicate a high degree of confidence in oil\/water separation within certain input parameters.\nAlthough the Company had limited success in selling units directly through a prior sublicense arrangement, there are many such units that are in use throughout the world that were sold by prior licensees. Management believes that the Oleofilter(TM) System can accomplish its stated technical objectives and that the Company can market the system on a commercial basis under its new agreement with Exxon. Current marketing indicate interest by several potential customers. As a result, the Company currently has presented price quotations and\/or proposals to potential customers for several Oleofilter(TM) systems. The cumulative value of price quotations and proposals currently outstanding exceeds $1 million. However, to date, the Company has been unable to yield any revenues from the sale or application of its Oleofilter(TM) System and\nmanagement can make no assurances that any revenues will result from the quotes and proposals currently outstanding.\nTHE BIOKATT(TM) PROCESS - -----------------------\nThe Biocatalytic Hydrocarbon Upgrade Process (the \"BioKatT(TM) Hydrocarbon Process\") is based on enzyme technologies that the Company believes may catalytically alter the molecular structure of long chain hydrocarbons and simultaneously reduce the sulphur and metal content of the treated hydrocarbons. Development of this technology to date has focused on the upgrading of heavy, sulfurous crude oils. Although other companies are pursuing technologies to biologically upgrade crude oil and\/or other petroleum fractions, management believes that the manner in which the BiokatT(TM) Hydrocarbon Process uses the catalytic properties of enzymes distinguishes itself from other competing processes. However, given that the specifics of competing processes are not well defined and are not known to the general industry, the Company cannot completely judge the effectiveness of BioKatT(TM) versus these other processes.\nThe BioKatT(TM) technology was originally developed by NATK through work related to its other environmental remediation technologies based on certain enzyme solutions and formulations. In the past, NATK has spent over $1 million in its attempts to develop and commercialize this technology. BioKatT(TM) was the main technology of interest at the time that NATK's new management team took over. The new management team set out to reverify this technology with its own laboratory facilities and staff at EET's WMS laboratories. This reverification has just recently been completed and has given NATK the data it needed to approach several major oil companies concerning a joint research and commercialization project for this technology. NATK has recently received indications of interest in such a program from several major oil companies. Under such a program, NATK would be reimbursed for the time its employees spend assisting the oil company partner in researching and developing the BioKatT(TM) technology for their own potential applications. If successfully commercialized it is anticipated that NATK would receive a small royalty from that partner and be free to market the proven technology to other potential customers. If the technology does prove to have commercial application, the long-term financial effects on NATK could be very substantial, but such benefits, if any, are extremely difficult to estimate at this time. Still, since the potential economic benefits of BioKatT(TM) are so large and laboratory tests have continued to show consistent positive results, the Company intends to pursue BioKatT(TM) development and its ultimate commercialization, if the Company can attract a capable research partner and the technical results continue to be positive.\nBIOTREAT(TM) AND TERRAZYME(TM) TECHNOLOGIES - -------------------------------------------\nThe BioTreat(TM) and Terrazyme(TM) technologies rely to varying extent upon enzyme and microbe technologies. The principal objective of these two technologies is, through the use of novel or proprietary systems and application of specific enzymes, to secure the remediation of hydrocarbon contaminated soils and other hydrocarbon\/solid waste streams.\nThe Biotreat(TM) System involves the treatment of soils in a variety of methods and multiple steps that ultimately rely on microbes and other bacteria to destroy hydrocarbons (oil) contained in the contaminated soils. This is done in conjunction with a mechanical process that\ninvolves tilling the soils to achieve maximum penetration and concentration of the microbes and bacteria, and provide microbes with sufficient oxygen and nutrients to live and reproduce.\nThe Terrazyme(TM) System is a mechanical system that uses enzymes and\/or other chemistries in conjunction with a process developed by the Company to separate hydrocarbons and segregate different size fractions of soils and sludges. Contaminated soils are fed into the machinery through a mechanical screw or augur feed. As the contaminated material travels up the screw feed it is sprayed with a mixture of enzymes, water and\/or other chemicals.\nThese two technologies have been used in a variety of projects or field tests over the last several years. In most cases, the technologies have shown some effectiveness, have performed technically and have met the expectations of the Company. It should be noted, however, each of these technologies have certain limits and parameters within which they are either effective or ineffective. In addition, the current economic factors and disposal options affecting the soil remediation market limit the commercial viability of these two technologies. Thus, until there is a significant change in the economic parameters related to the soil remediation market, the Company has suspended funding any additional commercialization efforts pertaining to these two technologies. However, the company could revitalize its commercialization efforts if changes in the market place so dictate.\nCOMPETITION - -----------\nThe Company and its operating groups operate in many different segments of the energy, environmental, natural resources, and related industries. Essentially all of the segments in which the company operates are highly competitive. As such, the Company competes with a large number of companies in substantially all of the markets into which it sells its products and services. The competitors tend to be different for each of the Company's technologies. Many of these competitors are local operations servicing a limited geographic area; however, in various service lines, there are a few large national and regional competitors which have significantly greater resources than the Company.\nAs an example, it is estimated that there are over 1,000 companies directly involved in providing some type of environmental remediation services in the United States. These companies would compete (to varying extent) with the Company in areas of TechXtract(TM), BioTreat(TM) and Terrazyme(TM). Further, it is estimated that 35 of these companies account for 65% of the revenue generated in this business segment. Clearly, this market is dominated by companies with significantly larger resources than the Company, including Rust International, Bectel, Fluor, OHM, Morrison Knudson and many others. Similar competition and competitor profiles exist for all of the Company's technologies and businesses.\nGOVERNMENTAL REGULATIONS - ------------------------\nState and federal governments have enacted and amended numerous environmental protection laws in response to public concerns about the environment. The operations of the Company and its customers are subject to these evolving laws and related regulations. The principal federal environmental laws that the Company believes are applicable to itself and its customers include The Clean Water Act, The Comprehensive Environmental Response,\nCompensation, and Liability Act of 1980 (\"CERCLA\"), The Resource Conservation and Recovery Act of 1976 (\"RCRA\"), The Pollution Prevention Act of 1990, and the Superfund Amendments and Reauthorization Act (\"SARA\"). Most of these laws have state counterparts which are generally at least as stringent as federal laws. The Company believes that this regulatory framework creates the demand for products that control the release of hazardous substances into the environment or facilitate the clean-up of contaminated soils and waters.\nThe Clean Water Act or its state counterparts permit the discharge of pollutants into the waters of the United States only in accordance with the terms of a National Pollutant Discharge Elimination System Permit. Similarly, the discharge of pollutants by generators into a sanitary sewer system that leads to a local Publicly Owned Treatment Works (\"POTW\") is regulated by state and local laws and by local permitting requirements, as are the discharges by the POTW's themselves of their waste streams onto land or into surface water bodies.\nRCRA provides a comprehensive framework for the regulation of the generation and transportation of solid and hazardous waste, as well as for the treatment, storage and disposal of such waste. RCRA is intended to provide a \"cradle to grave\" system for the control of hazardous waste; that is, regulation of wastes from the time they are generated until they are properly disposed of. Both civil and criminal liability may be imposed on parties that fail to comply with RCRA's requirements. RCRA requires that hazardous waste generators, transporters or operators of hazardous waste treatment, storage and disposal facilities, meet strict standards set by governmental agencies, and in certain instances, obtain and comply with RCRA permits.\nThe Pollution Prevention Act of 1990 establishes pollution prevention as a national objective, naming it a primary goal wherever feasible. According to this Act, where pollution cannot be prevented, material should be recycled, reduced or minimized in an environmentally safe manner.\nCERCLA and SARA (the \"Superfund\" laws) provide for the investigation and remediation of hazardous waste sites. Under Superfund, parties who own or operate sites or facilities contaminated by hazardous substances or who have generated hazardous substances or which have arranged for the transportation or disposal of hazardous substances may be subject to strict, joint and several liability for the investigation and remediation of contamination associated with those hazardous substances. Superfund's remedy selection process includes a preference for innovative technology as well as technology which reduces the volume of waste materials. Regulations under Superfund require that any hazardous substances remaining on-site meet: (i) applicable; and (ii) relevant and appropriate regulatory requirements. This may create an incentive to utilize technologies that can potentially recycle hazardous waste, transform such waste into non-hazardous by-products or reduce waste volumes. Under SARA, parties engaged in Superfund or RCRA remedial actions may, in certain circumstances, be able to use an environmental technology without the need to conform with all aspects of the permit application procedures that would otherwise be required under RCRA, the Clean Air Act, or other applicable environmental laws.\nMany of the same federal and state laws and regulations that affect the Company's customers may also directly regulate the Company's own operations or create potential liabilities for the Company. With respect to permits and permitting requirements, the Company's own\noperations include the use of small amounts of various hazardous substances, both in the use of its processes and the testing of those processes on various waste streams and the testing and maintenance of the Company's processes and technologies in the field. Because the handling, use, treatment and storage of disposal of hazardous substances and waste are a highly regulated activity, many of these activities require the procurement of federal, state or local government permits and approvals.\nObtaining and maintaining these permits and approvals generally require strict compliance with exacting regulatory requirements. Accordingly, permit applications are subject to denials, and the permits themselves are subject to suspension, modification or revocation for failure to meet applicable requirements. The failure by the Company to obtain a permit or to comply with permit requirements in its operations could potentially subject the Company to liabilities under the various federal, state, or environmental laws. Similarly, the failure by the Company's customers to obtain such permits or approvals, or to comply with permit requirements could subject them to environmental liabilities as well and could affect the demand for the Company's services and products. If existing environmental laws and regulations are amended, interpreted or enforced differently than at present, or if new environmental laws or regulations are enacted or promulgated, the Company or its customers may be required to obtain additional permits or approvals or modify their handling, use, treatment, storage or disposal of hazardous substances or waste. Failure to comply with such laws could have a material impact on the demand for the Company's products and services or could subject the Company or its customers to unanticipated and material penalties.\nAlthough the Company does not generate streams of waste, the Company, like its customers, may be potentially subject to environmental liabilities with respect to the investigation or clean-up of hazardous waste sites. Regulatory agencies may argue, for example, that in instances where the Company's system is utilized to treat hazardous waste, the Company would be potentially liable under the Superfund law, as an \"owner\" or \"operator\" of a \"facility\" for any releases of hazardous substances from that system, even if the Company did not cause the release, and even if the Company was not negligent. Although the Company believes that the risk is minimal that the Company would ever be found by a court or regulatory agency to be liable for the investigation or clean-up of a hazardous waste site, the cost associated with such a finding could be substantial.\nIn addition, the Company is also potentially liable for damages suffered by its customers or others under environmental laws and regulations, indemnification provisions of certain contracts with customers, or various tort or contract law theories in the event that there are liabilities arising from the failure or malfunction of the design, construction or operation of any of the Company's systems or processes. Although the Company does maintain liability insurance, there can be no assurances that such insurance would cover any or all environmental tort or contract liabilities that could potentially be imposed on the Company. There can be no assurance that the Company will not be adversely affected by a claim by a governmental agency or by a private party regarding environmental or related liabilities.\nThe Company has developed plans to take appropriate measures to reduce its exposure to Superfund liability, including, implementing strict operational guidelines for the handling and disposal of contaminated waste, as well as seeking contractual protection from its customers.\nSALES, MARKETING AND JOINT VENTURE AGREEMENTS - ---------------------------------------------\nAs a result of the acquisitions that were effected by the Company in 1995, the subsequent restructuring of the Company's management, and the evolution of a new operating strategy for NATK, the Company's approach to sales and marketing has changed significantly during 1995. The Company now has a sales and marketing strategy for each of its businesses designed to meet the needs of the structure of their specific market and industry. To varying extent and depending on the specific needs of the market, the Company now employs or anticipates using a full range of sales and marketing techniques, including an internal sales staff, manufacturers representatives, licensees, finders' incentive programs, joint ventures, advertising and other promotional programs. In addition, the Company has developed an in-depth strategic marketing and sales plan for each of its products and services and operating units. Sales targets for each product and service have been established and all marketing and sales programs are assessed against their ability to meet those targets. The Company anticipates that it will continue to evolve its sales and marketing strategy as its products and services continue to expand and its new technologies become more accepted in the marketplace. The following is a summary of the Company's sales and marketing strategy by business or technology.\nHistorically, the Company had attempted to market its technologies through teaming arrangements and joint ventures with select partners in specified geographic regions. In addition, through its officers, directors and consultants, the Company actively engaged in ad hoc sales and marketing efforts directed towards governmental agencies, branches of the defense department and private industry. The Company's limited capital resources, in the past, precluded its ability to finance the development and staffing of an internal sales force. However, the Company's new strategy, new management, and stronger financial structure now allows the Company to implement a much broader and stronger sales and marketing plan as outlined above. As such, the Company's historical joint ventures and teaming arrangements will play a much smaller role in marketing the Company's products and services in the future. The Company believes that it is likely only a small portion of its future revenues will be generated by its existing joint ventures. However, new joint ventures developed in the future may offer new opportunities for sales and product development and will be used when deemed favorable for the Company.\nIn addition, the Company's joint ventures and teaming arrangements, in the past, were motivated as a financing strategy. In certain instances, joint venture partners paid the Company for the exclusive right to market its technologies in specified areas. Since the Company's resources were somewhat limited, these arrangements were often undertaken as a means to secure additional working capital for the Company. In other cases, no advance payments were made, however, the joint venture partner agreed to fund certain operating or other expenses of the ventures. Regardless of the purpose behind their initial formation, the Company's past joint venture arrangements have, to date, generated no material revenues or made any technical progress. Management does not believe that its past joint ventures will add any significant opportunities in the future, and is not actively operating any of these joint ventures at this time.\nPATENTS AND PROPRIETARY RIGHTS - ------------------------------\nThe Company is the beneficiary of patent protection on the Oleofilter(TM) and TechXtract(TM) Process. In addition, EET holds four other patents on environmental treatment technologies that may have commercial value but have not yet produced any significant revenue. Furthermore, GAIA holds six patents on the compounding, molding and extrusion of shapes and structures using recycled polymers. These technologies form the basis for manufacturing products which GAIA has sold historically or which are under development. In addition, the Company intends to apply for patents for other of its technologies as they are developed, if such patent protection is available and advantageous to the Company. Beyond these current or future patents, there is currently no patent protection for any other of the Company's products or technologies. While the Company believes it possesses proprietary rights to some of its other products and technologies including unpatented trade secrets and know-how, and that its continuing technological innovations will enable it to maintain a competitive position in the manufacture and use of its products and services, no assurances can be given that others will not independently develop substantially equivalent proprietary information and technology or otherwise gain access to the Company's trade secrets or disclose such technology, nor can the Company assure that it can meaningfully protect its unpatented trade secrets. As used in this context and throughout this Report, \"proprietary information\" refers to technology, mechanical configurations, chemical information or formulations, processes, applications techniques and\/or other know-how developed by the Company and its employees or consultants.\nWARRANTY - --------\nTypically, the Company provides its services and technologies on an \"as is\" or \"best efforts\" basis. As such, no warranty is expressed or implied. However, in some cases, some limited \"warranties\" do apply. For example, EET provides its TechXtract(TM) services on a \"guaranteed results\" basis. That is, EET must decontaminate to a preset, verifiable level or the customer will not be required to pay. However, once the cleanup standard is met, no future guarantee is given or required. In only very limited instances, has EET not been paid for the work in connection with this guarantee, amounting to $10,000 in the aggregate. Although the Company has not developed a warranty policy for its Oleofilter(TM), it is likely that some type of limited mechanical warranty may be required. For both GAIA and IPF, the Company does assume some responsibility that the products they manufacture will perform as indicated in company literature. If the products are used as instructed and fail, the Company, at times, will replace the product at no cost to the customer. To date, such replacement of failed or discarded\nproducts has not been significant. In addition, the Company carries product liability insurance when it is deemed necessary. Management believes its product liability insurance is sufficient for its purposes and warranty issues are not significant.\nHUMAN RESOURCES - ---------------\nThe Company currently employs 48 full-time employees and consultants. Eight of the employees are in management, eight in administrative and accounting, two in research and development, six in sales, and twenty-four in operations. Ten of the Company's employees have employment agreements. None of its employees are covered by collective bargaining agreements. All of the Company's personnel, as well as companies with which it has an ongoing relationship, however, are covered by non-circumvention, non-disclosure agreements over the Company's technologies. The Company believes that its relations with its employees are good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company leases 7,860 square feet in Houston, Texas for its corporate headquarters which provides executive offices for the Company and its two subsidiaries, EET and GAIA. This lease expires in September 2000, and has monthly rent obligations of $5,895 through September 1996, $7,860 through September 1997, and $10,480 thereafter.\nIn addition to its offices at the corporate headquarters, EET has two facilities in Austin, Texas: 8,900 square feet for its research laboratory and administrative offices leased through March 1998, with a monthly rental of $5,600; and a 1,500-square-foot warehouse where supplies and equipment are stored with a monthly rental of $800. EET also leases a small office in northern Indiana and an additional office\/warehouse in Oak Ridge, Tennessee.\nIPF has 9,000 square feet of manufacturing, warehouse and office space in an industrial area in southwest Houston. The monthly rental for these facilities is $2,900.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nKellert et al. v. Mail Boxes Etc., USA, Inc., et al is an action commenced --------------------------------------------------- in November 1988 in the New York State Supreme Court for New York County by one of the former franchisees of MBE against the Company, MBE and several individual officers and former officers of the Company. Plaintiff alleged that the Company failed to provide plaintiff with an offering prospectus in violation of New York State franchise law and made false representations regarding revenues, earnings and profits from both existing and new franchise centers. Plaintiff sought damages in excess of $425,000. The Court recently granted the Company's motion to dismiss the action based upon the plaintiff's failure to prosecute the action. The Plaintiff responded by filing a motion to reinstate the action, which is now before the Court.\nWinch v. North American Technologies, Inc., et al. On or about April 23, -------------------------------------------------- 1993, Douglas Winch commenced an action against North American Technologies, Inc. (\"NAT\"), a wholly owned Canadian subsidiary of the Company, Peter W. Fisher, a former officer and director of NAT's predecessor corporation, John H. McPhedran and J.H. & J.K.M. Corporation, Ltd. This is an action for specific performance of an alleged agreement between NAT and the plaintiff for\nthe delivery of 200,000 common shares of NAT and damages for failure to provide such shares on a timely basis.\nThe plaintiff has claimed against all defendants damages in the amount of Cdn. $1.5 million, punitive and exemplary damages in the amount of Cdn. $200,000 and an interlocutory injunction to prevent the defendants from trading in the shares of NAT pending a final disposition of the action. The proceeding is pending as of the date of this Report. The plaintiff has indicated that he intends to amend his Statement of Claim. Because the outcome of this matter cannot presently be determined, no adjustments have been made to the consolidated financial statements.\nThomas W. Reid v. North American Gold Corp. and Karr Capital, Inc., is a ------------------------------------------------------------------- matter commenced in July 1993 in the 134th Judicial District Court of Dallas County, Texas, by Thomas Reid against North American Gold Corp., which was the corporate predecessor of NAT, a wholly owned subsidiary of the Company. Mr. Reid alleges in his complaint that he was denied the right to purchase 150,000 shares of stock of North American Gold Corp. for $.50 per share. Mr. Reid sued for conveyance of the stock or alternatively for damages, plus attorneys' fees. Mr. Reid's claim is based upon a letter dated July 17, 1991, purportedly signed by Mr. Robert Ciccarelli as President of Karr Capital, an unrelated Canadian corporation. Discovery is ongoing, and management cannot evaluate the Company's exposure at this time.\nNorth American Technologies Group, Inc. v. BioTrace International, Inc. is ----------------------------------------------------------------------- an arbitration proceeding before the American Arbitration Association. On January 15, 1992, the Company entered into a License Agreement with BioTrace International, Inc. (\"BioTrace\") wherein the Company received the exclusive rights to purchase a certain propriety stabilized enzyme. Pursuant to the License Agreement, 90,000 shares of Common Stock of the Company were placed into escrow for the benefit of BioTrace. During the second quarter of 1993, management of the Company discovered that BioTrace had violated the agreement by selling the enzyme to competitors of the Company. In response to this violation, and because the enzyme proved to be ineffective, the Company terminated the agreement.\nIn September 1993, BioTrace brought suit against the escrow agent in the Federal District Court for the Northern District of Illinois in Chicago seeking delivery of the 90,000 shares of Common Stock of the Company which were being held in escrow pursuant to the License Agreement. The escrow agent brought the Company into the case as a third-party defendant. In March 1994, the Company was successful in terminating the federal court proceeding and compelling arbitration before the American Arbitration Association. In addition to vigorously defending itself against the claim of BioTrace, the Company is requesting reimbursement of approximately $200,000 which was previously forwarded to BioTrace, return of the 90,000 shares of Company Common Stock, and other consequential damages. The arbitration proceedings were completed in February 1996 and the Company is awaiting the arbitrators' decision.\nNorth American Technologies Group, Inc. and North Environmental Group, Inc. --------------------------------------------------------------------------- v. James E. Impero, Robyn Impero, Val Weaver and The Impero Family Trust. On - ------------------------------------------------------------------------ April 10, 1995, the Company and its subsidiary, North American Environmental Group, Inc., filed a lawsuit in the District Court of Harris County, Texas against James Impero, a former officer and director of\nthe Company and Val Weaver, an officer of a subsidiary of the Company. The Company is seeking a temporary injunction, permanent injunction and substantial monetary damages based on claims against Mr. Impero which include breaches of his fiduciary duties of care, loyalty and obedience, tortious acts against the Company and defamation of the Company's business reputation. The Company's claims against Mr. Weaver include the breach of his fiduciary duties of care, loyalty and tortious acts against the Company based on his alleged aid to Impero in many of Impero's activities. The Company alleges that Mr. Impero usurped corporate opportunities, diverted business from the Company, and subsequent to his resignation, he has made damaging statements about the Company. In apparent response to this lawsuit, Mr. Impero and Mr. Weaver each filed a lawsuit against the Company and other parties in June 1995 in the U.S. District Court in Maryland. Mr. Weaver also filed a lawsuit against the Company in a state court in Maryland. The lawsuit filed by Mr. Impero has been dismissed. The lawsuit filed by Mr. Weaver in the U.S. District Court in Maryland has been remanded to Texas. No activity in the lawsuit filed in Maryland state court has occurred pending an appeal by Mr. Weaver's attorney.\nIf the foregoing litigation is decided against the Company, it could 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 PRICE OF AND DIVIDENDS ON THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nMARKET INFORMATION - ------------------\nThe Company's Common Stock is traded on the over-the-counter market and listed on the National Association of Securities Dealers, Inc. Automated Quotation System (\"NASDAQ\") under the symbol \"NATK.\" The following table sets forth, for the periods indicated, the range of high and low bid prices of the Common Stock as reported by the National Quotation Bureau.\n_________________________\nHOLDERS - -------\nRecords of the Company's stock transfer agent indicate that as of March 31, 1996, the Company had approximately 340 record holders of its Common Stock. A significant number of the shares of the Company are held by financial institutions in \"street name.\" Inquiry of brokerage sources leads management to believe that it is likely that the Company has more than 2,300 stockholders.\nDIVIDENDS - ---------\nThe Company has not paid any cash dividends to date and does not anticipate or contemplate paying cash dividends in the foreseeable future. It is the present intention of management to utilize all available funds for working capital of the Company.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following table sets forth historical financial information for the Company and should be read in conjunction with the Financial Statements and the Notes thereto and\nManagement's Discussion and Analysis of Financial Condition and Results of Operations which are contained elsewhere in this Report.\n1. Selected financial data of the Company for the periods after 1991 are after recapitalization. 2. After giving effect to the issuance of the Series E and F Convertible Preferred Stock issued in March and April 1996; reflects payment of debt obligations of $1,050,000 from the net proceeds. 3. Figures based on one for fifteen reverse stock split. 4. Increase over prior period is principally due to the exercise of options for NAT Common Stock.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nBACKGROUND AND BASIS OF PRESENTATION\nPrior to the acquisitions in 1995 of EET, IPF and GAIA, the Company was a development stage company engaged in the development, acquisition and application of technologies in the environmental and energy industries. Until such acquisitions, the Company had limited revenues, consisting primarily of payments for demonstration projects.\nThe Company ended its development stage status by virtue of its acquisitions on March 7, 1995 of EET, on June 30, 1995 of IPF, and on December 29, 1995 of GAIA. EET's TechXTract(TM) Process has been used in over 200 successful projects and has generated for EET revenues of approximately $1,900,000 from its inception through December 31, 1995. In addition, EET generated revenues of approximately $1,500,000 from environmental services in the same period which were not related to the TechXTract(TM) Process. IPF generated revenues of approximately $1,400,000 from its inception through December 31, 1995. GAIA's patented process for manufacturing products from recycled rubber began generating revenues for the Company in the first quarter of 1996.\nThe acquisitions of EET and IPF were accomplished through mergers pursuant to which an aggregate of 3,070,729 shares of the Company's Common Stock and 71,000 common stock purchase warrants were issued to former EET and IPF security holders. The acquisition of substantially all the assets of GAIA was accomplished for the following consideration: (a) issuance of 1,666,667 shares of the Company's Common Stock, (b) payment of $305,500 in cash, (c) the issuance of a 90-day promissory note by the Company in the principal amount of $1,050,000, (d) forgiveness of certain debt obligations (together with all interest owed thereon) owed by GAIA to the Company of approximately $1,881,400; and (e) assumption of approximately $194,000 in account payable obligations.\nThe acquisitions of EET and IPF have been accounted for as poolings-of- interests. Accordingly, the Company's consolidated financial statements have been restated to include the\naccounts of EET and IPF from their respective dates of inception, August 1993 and January 1994. The acquisition of GAIA has been accounted for under the purchase method of accounting. Accordingly, the consolidated results of operations of the Company do not include the operations of GAIA, which will be included in future results of operations from the effective date of the acquisition, December 29, 1995.\nLIQUIDITY AND CAPITAL RESOURCES\nSince its inception, the Company has financed its operations primarily through private placements of its equity securities and convertible debentures, short-term loans and proceeds received from the exercise of its warrants and options to acquire its securities. The Company continued to use the placement of such securities during 1995 and through April 8, 1996 to generate the cash needed to fund its operating losses and capital requirements, and to complete the acquisition of GAIA. Specifically, during 1995 the Company used net cash of $4,333,000 for operating activities and $3,440,000 for investing activities, while the net cash proceeds from financing activities was $4,840,000. The debt and equity transactions for 1995 and through April 8, 1996 are described below.\nCOMMON STOCK - ------------\nThe Company received net proceeds of approximately $2,110,000 from the sale of the Company Common Stock throughout 1995.\n13 1\/2% CONVERTIBLE SUBORDINATED NOTES - --------------------------------------\nIn September 1995, the Company received cash proceeds of $2,700,000 from the placement of its convertible subordinated notes (the \"Notes\") and warrants to acquire 2,700,000 shares of the Company's Common Stock (the \"Note Warrants\"). The Notes bear interest at 13 1\/2% per annum, which is payable semi-annually but may be deferred during the first three years at the option of the Company. The principal amount of the Note plus the deferred interest, if any, is convertible at the option of the holders into shares of the Company's Common Stock at a conversion price of $1.00 per share, subject to certain adjustments, at any time after September 22, 1996 and prior to maturity on September 22, 2000. Repayment of the unconverted portion of the principal amount is due in one balloon payment on September 22, 2000. The indebtedness evidenced by the Notes is subordinated to certain existing and future indebtedness of the Company.\nOn April 8, 1996, the Notes and the Note Warrants were converted into 27,000 shares of the Company's Series F Convertible Preferred Stock (\"Series F Shares\") and new warrants to purchase 2,700,000 shares of the Company's Common Stock. See discussion below. The Company elected to defer the interest payment relating to the Notes that was due on March 22, 1996. However, interest of approximately $198,000 (which includes the deferred interest) was paid to the note holders on April 8, 1996 in conjunction with the conversion into the Series F Shares.\nApproximately $1,035,000 of the net proceeds received from the Notes was used to fund a loan to GAIA prior to its acquisition on December 29, 1995. This loan was forgiven as part of the purchase price consideration.\nSERIES D CONVERTIBLE PREFERRED STOCK - ------------------------------------\nOn December 28, 1995, the Company received net proceeds of $750,000 from the issuance of 30 shares of Series D Convertible Preferred Stock (\"Series D Shares\"). The holders of the Series D Shares are entitled to dividends, payable quarterly at a per annum rate of $3,750 per Series D Share and certain liquidation preferences. At the option of the holder, the Series D Shares may be converted into the Company's Common Stock using a conversion rate computed as the lesser of (a) a calculated value utilizing a discount to the market price, as defined, of the Company's Common Stock, or (b) $.875 per share. One-third of the Series D Shares were converted in mid-March 1996 into 414,800 shares of the Company's Common Stock. Another one-third can be converted in mid-April 1996, with all remaining Series D Shares available for conversion by the end of May 1996. At March 31, 1996, the Company owed dividends of approximately $28,000 to the holders of the Series D Shares.\nApproximately $305,500 of the proceeds received from the Series D Shares was used to complete the acquisition of GAIA on December 29, 1995.\nSERIES E CONVERTIBLE PREFERRED STOCK - ------------------------------------\nIn February and March 1996, the Company received net proceeds of $1,218,750 from the issuance of 50 shares of Series E Convertible Preferred Stock (\"Series E Shares\"). The holders of the Series E Shares have certain liquidation preferences and are not entitled to any dividends. At the option of the holder, the Series E Shares may be converted into the Company's Common Stock using a conversion rate computed as the lesser of (a) a calculated value utilizing a discount to the market price, as defined, of the Company's Common Stock, or (b) $1.50 per share. One-fourth of the Series E Shares can be converted after August 1996, with another one-fourth available for conversion every three months thereafter.\nSERIES F CONVERTIBLE PREFERRED STOCK - ------------------------------------\nOn April 8, 1996, the Company issued 82,000 share of Series F Convertible Preferred Stock (\"Series F Shares\") and warrants to acquire 8,200,000 shares of the Company's Common Stock (the \"Series F Warrants\"). Cash proceeds of $5,500,000 was received for 55,000 Series F Shares and 5,500,000 Series F Warrants. The remaining 27,000 Series F Shares and 2,700,000 Series F Warrants were issued in exchange for the surrender of the Notes and the Note Warrants. See discussion above. The Series F Warrants have an exercise price of $1.00 per share, subject to certain adjustments, and expire on April 8, 2004.\nDividends accrue on the Series F Shares at a per annum rate of $13.50 per share and are payable semi-annually. The Company may elect to defer and accrue dividend payments during the first three years, in which case, each holder may elect to receive payment of the dividend in the form of additional Series F Shares. The holders of the Series F Shares have certain liquidation preferences. The Series F Shares may be converted into Company Common Stock at the option of the holder using a conversion rate, subject to certain adjustments, of $1.00 per share. On or after April 8, 2001, the Series F Shares can be converted at the holder's option at the lower of (a) the then-current conversion price, or (b) a calculated value utilizing a discount to\nthe market price, as defined, of the Company's Common Stock. The Company may redeem the Series F Shares at face value on or after April 8, 2004.\nEach Series F Share entitles the holder thereof to the number of votes equal to the number of shares of Common Stock into which such Series F Share may be converted from time to time. In addition, the Company has agreed to cause its Board of Directors to be increased to nine positions, four of which may be filled by nominees selected by the holders of the Series F Shares.\nThe preferred stock purchase agreement and the certificate of designation for the Series F Shares contain covenants which, if breached by the Company, provide for certain remedies. Certain of these covenants are considered outside of the Company's control. These covenants include, among other things, that the Company obtain a minimum net worth, as defined in the agreement, by December 31, 2000. For breach of these covenants that are outside of the Company's control the remedy allows the Series F holders to convert their shares into the Company's Common Stock using a conversion rate computed as the lesser of (a) the conversion price, as adjusted; or (b) a calculated value utilizing a discount to the market price, as defined. Also, the stock purchase agreement contains certain covenants that are considered within the control of the Company. These covenants, among other things, require the delivery of financial information and restrict the Company from incurring additional debt if, immediately upon incurrence of such debt, the Company's debt to equity ratio exceeds a certain ratio, as defined by the agreement. For breach of these covenants that are within the Company's control the remedies allow the Series F holders to elect a majority of the Company's Board of Directors and to either (1) convert their shares into the Company's Common Stock using a conversion rate computed as the lesser of (a) the conversion price, as adjusted; or (b) a calculated value utilizing a discount to the market price, as defined; or (2) request the Company to redeem their shares. If the Series F holders elect redemption, the shares will be redeemed at the greater of (a) the fair market value, as defined; or (b) the initial purchase price, plus unpaid dividends and interest, if any. At the Company's option, the shares may be redeemed with cash or a three year promissory note.\nOf the proceeds received from the Series F Shares, $1,050,000 was used to repay the outstanding principal balance on the note issued on December 29, 1995 to GAIA Holdings, Inc. related to the acquisition of the assets of GAIA. The Company has an additional 18,000 Series F Shares that are authorized and could be issued for consideration of $1,800,000 under the same terms and conditions through May 15, 1996.\nAs a result of the financing transactions described above, the Company believes it has sufficient cash available to finance the Company's operations during 1996. As shown in the pro forma balance sheet, as of December 31, 1995, the Company had a pro forma cash balance of $5,902,000, pro forma working capital of $5,337,000 and pro forma stockholders' equity of $10,505,000. Depending upon the availability of traditional secured debt financing for both working capital and capital expenditures, and the amount of cash needed to consummate future acquisitions, if any, the cash received from these equity placements could provide operating capital through 1997.\nTRANSACTIONS RELATING TO EURO SCOTIA FUNDING LIMITED - ----------------------------------------------------\nIn April 1993, the Company had invested $2,554,859 with Euro Scotia Funding Limited (ESF) in exchange for a secured note receivable, which the Company could call upon thirty days notice to ESF. Through April 1994, income from the note was generated from the management, by ESF, of investments in various margin transactions involving U.S. and other governmental debt securities, currency forward exchange contracts and certain corporate debt and equity securities. Under the terms of the note, the Company and ESF shared equally in trading profits. For the years ended December 31, 1995, 1994 and 1993, the Company recognized interest income totaling $283,966, $85,832 and $523,623, respectively, and trading profits for the years ended December 31, 1994 and 1993, totaling $512,312 and $2,169,672, respectively.\nEffective December 31, 1994, the Company renegotiated the terms of the note receivable from ESF. Under the new agreement, ESF was to repay the note in ten semi-annual installments of $327,885, plus interest at 10% per annum, commencing July 1, 1995. ESF elected, as permitted under the agreement, to prepay as of December 31, 1994 the earliest payments using the amounts owed to it by the Company for borrowings under the line of credit agreement and for services rendered. At December 31, 1994, the face value of the original note plus accrued interest receivable totaled $3,278,857, borrowings under the line of credit plus accrued interest\npayable totaled $356,473, and amounts owed to ESF for services totaled $121,621. The net balance of $2,800,763 was reflected on the consolidated balance sheet at December 31, 1994.\nThe note was to be collateralized by $3,200,000 in U.S. Treasury obligations held by a third-party brokerage firm for the benefit of the Company. ESF had signed an irrevocable power of attorney to the Company giving it the ability to seize the collateral in the event of a default, provided that such default was not cured within thirty days after written notice. In addition, there were irrevocable instructions provided to the brokerage firm stating that ESF would be allowed to trade the securities constituting the collateral. However, the securities had to be substituted with U.S. treasuries, and the value of such securities could not fall below the lesser of $3,200,000 or 110% of the outstanding principal balance on the note.\nThe semi-annual payment due January 1996, in accordance with the note agreement was not paid by ESF. During the fourth quarter of 1995, the Company learned that the brokerage firm that holds the collateral for the ESF note and an affiliate of ESF were named as defendants in a lawsuit filed by the Florida Department of Insurance in which it is alleged, among other things, that such brokerage firm issued false account confirmations. The Company also learned that such brokerage firm has applied for withdrawal as a registered broker\/dealer in a number of states, including the state in which such securities were to have been held.\nIn early 1996, the Company also learned that the United States Securities and Exchange Commission sought and was granted in late December 1995, a temporary restraining order against certain affiliates of ESF in the United States District court for the District of Colorado that, among other things, froze investor funds of the defendants and certain of their affiliates, and required each such party to prevent the disposition, transfer or other disposal of any of their funds or other assets then held by them, under their control or over which they exercise investment or other authority.\nAfter learning of the lawsuit, the Company unsuccessfully attempted to gain reliable information about the existence and value of the securities that were to have been held for the Company's benefit in connection with the ESF note. Accordingly, as of December 31, 1995, the Company decided to write-off the note receivable of $2,800,763 and accrued interest recognized during 1995 of $283,966, for a total loss of $3,084,729.\nThe Company has made demand for payment of the ESF note, in accordance with the agreement and is exploring other legal remedies available against ESF and the brokerage firm charged with holding the collateral for the note.\nACQUISITIONS - ------------\nDuring 1995 the Company completed three acquisitions: EET, IPF and GAIA. The aggregate consideration paid for these acquisitions was (a) 4,737,396 shares of the Company's Common Stock; (b) $305,500 cash; (c) forgiveness of amounts due to the Company of $1,881,400; (d) issuance of a 90-day promissory note of $1,050,000; (e) 71,000 warrants to purchase Company Common Stock; and (f) assumption of approximately $194,000 in account payable obligations. In addition, as a result of the acquisition of EET, the Company advanced\ncash to EET for it to repay certain outstanding debt obligations totaling $612,500. The Company also redeemed EET's outstanding preferred stock of $305,000.\nSimultaneous with the acquisition of GAIA, the Company entered into a Crosstie Purchase Option and Loan Agreement with TieTek, Inc. (\"TieTek\")., a newly formed corporation owned by three individuals, two of whom are officers of the Company's new subsidiary, GAIA Technologies, Inc. Pursuant to this agreement, the Company is obligated to lend up to $1,500,000 (the \"Crosstie Loan\") to TieTek for it to use in the development of an alternative railroad crosstie manufactured from recycled rubber using GAIA's patented and proprietary technologies. Amounts advanced to TieTek bear interest at 10%, and are due two years after the earlier of (a) the date on which the Company provides notice to TieTek that it will not exercise its option to purchase all the capital stock of TieTek (the \"Crosstie Purchase Option\"), or (b) the expiration of the Crosstie Purchase Option Period, which is a two year period unless extended by one year upon the occurrence of certain events. The consideration for acquiring TieTek utilizing the Crosstie Purchase Option would be the forgiveness of all the then- outstanding indebtedness under the Crosstie Loan and payment of certain royalties based on certain products sold by TieTek over a fifteen-year period. As of December 31, 1995, the Company had advanced $220,000 under the Crosstie Loan. The Crosstie Loan is collateralized by a pledge of, and a lien on, all of TieTek's assets and capital stock, and 666,667 shares of the Company's Common Stock.\nOTHER - -----\nIn January 1996, an officer and director of the Company loaned $250,000 to IPF under the terms of a promissory note. The note bears interest at 13% per annum, requires monthly payments of $5,700 and matures in January 1999. Proceeds from the note were used by IPF to purchase a machine for fabricating wyes, tees and els. The equipment purchased serves as collateral for the note.\nThe Company entered into an agreement with its former Chairman of the Board in July 1995, as amended in December 1995, which provides for, among other things, a payment of $250,000 in settlement of his five-year employment contract, payable in bi-weekly installments of $11,538 beginning in January 1996.\nThe Company is a defendant in several legal actions which, if decided against the Company, could have a material adverse effect on the financial condition of the Company.\nNEW ACCOUNTING PRONOUNCEMENTS - -----------------------------\nIn March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121 \"Accounting for Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of (SFAS No. 121). SFAS No. 121 requires, among other things, that impairment losses on assets to be held and gains or losses from assets that are expected to be disposed of, be included as a component of income from continuing operations. The Company will adopt SFAS No. 121 in 1996 and its implementation is not expected to have a material effect on the consolidated financial statements.\nIn October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation\" (SFAS No. 123). SFAS No. 123 encourages entities to adopt the fair value method in place of the provisions of Accounting Principles Board Opinion No. 25, \"Accounting for Stock Issued to Employees\" (APB No. 25), for all arrangements under which employees receive shares of stock or other equity investments of the employer or the employer incurs liabilities to employees in amounts based on the price of its stock. The Company does not anticipate adopting the fair value method encouraged by SFAS No. 123 and will continue to account for such transactions in accordance with APB No. 25. However, the Company will be required to provide additional disclosures beginning in 1996 providing pro forma effects as if the Company had elected to adopt SFAS No. 123.\nRESULTS OF OPERATIONS\nANALYSIS OF YEARS ENDED DECEMBER 31, 1995 (\"1995\") AND DECEMBER 31, 1994 (\"1994\")\nThe total net loss for 1995 of $7,340,000 reflects an increase of $2,404,000 from the 1994 net loss of $4,936,000. This increase in net loss occurred despite an increase in revenues and gross profits due to an increase in selling, general and administrative expenses and an increase in other expenses. Specifically, revenues increased $697,000, generating an increase in gross profits of $131,000; selling, general and administrative expenses increased $1,313,000; research and development expenses decreased $910,000; and other expenses increased $2,249,000, each as described in detail below.\nREVENUES - --------\nThe increase in revenues of $697,000 in 1995 reflects increased sales volume by both IPF and EET. IPF's growth in monthly shipments is reflected in its revenue increase of $400,000. EET contributed to the balance of the revenue growth by increasing sales of its services $297,000 in 1995. Revenue increases are attributable to increased marketing efforts undertaken in 1995 by each of the Company's principal operating units. Prices for the Company's products and services remained stable during 1995. The Company expects revenues to increase significantly in 1996 due to the commencement in the first quarter of commercial sales of GAIA's air conditioning condenser support pads and increased management attention to marketing now that the Company's business restructuring is substantially complete. While market acceptance of the support pad is encouraging, such revenues may be limited by plant capacity. Furthermore, the Company's revenues from its TechXTract(TM) Process remain subject to uncertainties caused by the difficulties associated with the project nature of its past business strategy and with marketing to governmental units such as the Department of Energy. As a result, the Company is evaluating additional opportunities for commercial revenues of the TechXTract(TM) Process.\nGROSS PROFIT - ------------\nAlthough revenues increased 36%, the gross profit percentage decreased from 41% in 1994 to 35% in 1995. This decrease in gross profit was due primarily to lower margins\nexperienced earlier in 1995 by EET which resulted from higher than anticipated out-of-town expenses and contract labor costs on certain projects undertaken and completed by EET in 1995 as compared with 1994.\nSELLING, GENERAL AND ADMINISTRATIVE EXPENSES - --------------------------------------------\nSelling, general and administrative expenses increased $1,313,000 during 1995 compared with 1994 primarily as a result of the effect of increased legal fees, the expenses associated with the management restructuring completed in 1995, and the addition of new officers to the Company, each as described below.\nLegal fees increased $550,000 in 1995, reflecting the effect of increased outside counsel costs and other direct expenses associated with management's decision to actively pursue the resolution of several outstanding lawsuits, including the arbitration hearings that concluded in February 1996 relating to Bio Trace International, Inc. and the activity early in 1995 relating to the lawsuit against a former officer and director of the Company. Neither of these lawsuits should contribute significantly to legal expenses in 1996. Another factor for the increase in fees relates to the acquisition of EET and IPF. Since each acquisition was accounted for as a pooling-of interest, all related costs were expensed in the consolidated statement of loss for 1995.\nRestructuring costs attributed to an increase of $500,000 in 1995. This consisted of the one-time accruals and or payments for the following: (a) $250,000 for settlement of the five-year employment contract of the former Chairman of the Company; (b) $100,000 in severance costs for seven employees no longer with the Company; (c) $50,000 in facility closing costs or for the termination of equipment rental contracts; and (d) $100,000 in consulting contracts and related expenses that were terminated in 1995.\nThe Company also employed two new officers in late March and early April 1995. Including relocation costs and prorated salary amounts, the addition of these employees accounted for an increase of approximately $250,000 in 1995.\nRESEARCH AND DEVELOPMENT EXPENSES - ---------------------------------\nResearch and development expenses decreased $910,000 in 1995 due primarily as a result of decreased lab testing fees and the termination or completion of various consulting arrangements. Research and development expenses should continue to decrease in 1996 to reflect management's focus on the commercialization of its existing products. However, the Company is expecting to spend in excess of $350,000 a year on research and development to support the Company's technologies.\nOTHER INCOME AND EXPENSE - ------------------------\nOther income and expense increased from expense of $864,000 in 1994 to expense of $3,112,000 in 1995. This was primarily due to the write-off of the ESF note receivable and related accrued interest totaling $3,804,729 and the related decrease in investment income from $512,000 to $0 for the same periods. See Liquidity and Capital Resources for discussion relating to the ESF note receivable.\nDISCONTINUED OPERATIONS - -----------------------\nDiscontinued operations for 1994 reflect the results of operations for the analytical services division of EET which was discontinued in July 1994. Accordingly, no loss from discontinued operation was incurred in 1995.\nANALYSIS OF YEARS ENDED DECEMBER 31, 1994 (\"1994\") AND DECEMBER 31, 1993 (\"1993\")\nThe total net loss for 1994 of $4,936,000 reflects an increase of $3,433,000 from the 1993 net loss of $1,503,000. This increase in loss occurred despite increased revenues and gross profits and decreased expenses due to the significant decrease in other income. Specifically, revenues increased $1,677,000, generating an increase in gross profits of $700,000; expenses decreased $15,000; other income decreased $4,025,000; and loss from discontinued operations increased $124,000. These changes are addressed individually below.\nREVENUES AND GROSS PROFIT - -------------------------\nThe increase of $1,677,000 in 1994 reflects increased revenues from a full year of operations of EET in 1994 compared with only four months in 1993, and the operations of IPF which began its business in January 1994. The increase in sales volume from 1993 to 1994 generated an increase in gross profit for 1994 of $700,000. The gross profit percentage increased from 35% in 1993 to 41% in 1994, reflecting improved margins from EET during its first full year of operations.\nEXPENSES - --------\nExpenses decreased $15,000 in 1994, consisting of an increase in selling, general and administrative expenses of $305,000 and a decrease in research and development expenses of $320,000.\nOTHER INCOME AND EXPENSE - ------------------------\nOther income and expense decreased $4,025,000 from income of $3,161,000 in 1993 to expense of $864,000. Of this decrease, (a) $2,068,000 can be attributed to a reduction in investment income and interest income relating to the Company's investment with ESF, as discussed under Liquidity and Capital Resources; (b) $1,200,000 relates to the change from recognition of $600,000 income in 1993 from the sale of marketing rights to the recognition of $600,000 as write-off of investment in 1994 when the stock received in consideration for the marketing rights was determined to be worthless; and (c) $751,000 relates to the increase in loss from the abandonment of mining properties in 1994.\nDISCONTINUED OPERATIONS - -----------------------\nIn 1994, EET entered into a formal plan to dispose of its analytical operations. These discontinued operations contributed to a loss of $116,000 in 1994, compared to a gain of $7,000 in 1993.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nFinancial statements and supplementary data are included in Items 14(a) and (b) of this Report and are incorporated by reference thereto.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS\nDIRECTORS AND EXECUTIVE OFFICERS - --------------------------------\nThe Directors and Executive Officers of the Company are listed below.\nAll directors of the Company hold office until the next annual meeting of stockholders or until their successors are duly elected and qualified. There are currently no committees of the Board. Executive officers hold office at the pleasure of the Board of Directors.\nBIOGRAPHIES - -----------\nTIM B. TARRILLION\nMr. Tim B. Tarrillion became Chief Executive Officer, President and a Director of the Company on March 7, 1995. Mr. Tarrillion was most recently the President and Founder of EET. Prior to starting EET, Mr. Tarrillion was co- founder, President and Chief Operating Officer of EnClean, Inc., a public company which was listed on NASDAQ. EnClean provided\nindustrial and environmental cleaning services to companies in the refining, petrochemical, steel, paper and utility industries. After growing to over $100 million in revenue with 40 locations nationwide, EnClean was bought by and merged into Rust International in 1993.\nMr. Tarrillion holds an MBA from Harvard University and a Masters Degree and Bachelors Degree in Chemical Engineering from Rice University. Mr. Tarrillion has significant experience in the environmental field. Mr. Tarrillion received the 1991 Merrill Lynch, Inc. Magazine's Entrepreneurial award for the Houston area in connection with his role in building EnClean from $1 million in sales in 1984 to more than $100 million in 1992.\nDONOVAN W. BOYD\nMr. Donovan W. Boyd joined the Company as Senior Vice President in April 1995, and was appointed Chief Operating Officer in July, 1995. Prior to his position with the Company, Mr. Boyd was Vice President of Sales and Marketing for the Industrial Services division of Rust International. In that capacity he was responsible for more than $400 million in annual sales throughout the United States. Before Rust, Mr. Boyd was a Regional Vice President with EnClean, Inc. He holds a Bachelor's Degree in Chemical Engineering from Tulane University and an MBA from Harvard University.\nDAVID M. DANIELS\nMr. David M. Daniels joined the Company in July 1994, after working with the Company as a consultant for several years. He currently holds the position of Executive Vice President, Secretary and Director. Mr. Daniels also serves as President of IPF. Prior to his current position with the Company, Mr. Daniels was employed by Dean Witter Reynolds for 10 years, of which he held the position of Vice President for 8 years. Mr. Daniels holds a Bachelors Degree in Finance from the University of Houston, as well as an Associate Degree from Georgia Military Academy.\nJUDITH KNIGHT SHIELDS\nMs. Judith Knight Shields joined the Company in March 1995. Ms. Shields currently holds the position of Senior Vice President-Finance, Chief Financial Officer and Treasurer. Prior to her current position with the Company, Ms. Shields was Vice President of Mergers and Acquisitions and subsequently Controller, with EnClean, Inc. Her ten years of experience prior to joining EnClean, Inc. were in public accounting and venture capital. She graduated summa cum laude from Texas A&M University with a Bachelors Degree in Accounting and is a Certified Public Accountant.\nINVOLVEMENT IN CERTAIN LEGAL PROCEEDINGS - ----------------------------------------\nTo the best of the Company's knowledge, there have been no events under any state or federal bankruptcy laws, no criminal proceedings, no judgments, orders, decrees or injunctions entered against any officer or director, and no violations of federal or state securities or commodities laws material to the ability and integrity of any director or executive officer during the past five years .\nCOMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT - -------------------------------------------------\nTo the knowledge of the Company, each of the Company's directors, executive officers and 10% beneficial owners has complied with the requirements of Section 16(a) of the Securities and Exchange Act of 1934 except that Mr. Tarrillion, Mr. Boyd and Ms. Shields each were one month late in filing their Form 4 upon the amendment of their respective stock option agreements in December 1995.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe following table sets forth a summary of the compensation paid or accrued for the years 1993 through 1995 by the Corporation to or for the benefit of the named executive officers.\nSUMMARY COMPENSATION TABLE\/(1)\/\n________________________________\n\/(1)\/ Based upon the fiscal years ended December 31, 1995, 1994 and 1993. \/(2)\/ Mr. Parrott resigned as Chairman and Director on July 28, 1995. \/(3)\/ Payment of $15,000 a month for consulting services in August through December 1995. \/(4)\/ Mr. Tarrillion became Chief Executive Officer, President and a Director of the Company on March 7, 1995. \/(5)\/ Payments received in January and February 1995 as a consultant to the Company. \/(6)\/ Mr. Daniels became a Director during August 1994 and became an Executive Vice President, and Secretary of the Company during January 1995. \/(7)\/ Mr. Boyd's employment began on April 1, 1995. \/(8)\/ Payments made to relocate Mr. Boyd to Houston, Texas. \/(9)\/ Ms. Shield's employment began on March 20, 1995.\nSTOCK OPTIONS\nThe following table sets forth for each of the named executive officers regarding the grant of stock options by the Company in the 1995 fiscal year and their potential realizable values. No stock appreciation rights have been granted to employees.\n_________________________\n\/(1)\/ The aggregate value of the 23,477,285 outstanding shares of Common Stock of the Company on December 31, 1995, assuming a share price of $.53 on December 29, 1995, was approximately $12,400,000. If the Common Stock appreciates at a compound rate of 5% per year over the option term, the aggregate value of all such shares would be approximately $19,200,000, an increase of $6,800,000 for all stockholders. Similarly, if the Common Stock appreciates at a compound rate of 10% per year over the nine-year option term, the aggregate value of all such shares would be approximately $29,300,000, an increase of $16,900,000 for all stockholders. The purpose of providing this information is to indicate the total potential stockholder gain over the term of the options comparable to the potential gain shown for the options.\nThe following table sets forth for each of the named executive officers information regarding stock options exercised by such officers during the 1995 fiscal year, together with the number and value of stock options held at 1995 fiscal year-end, each on an aggregated basis.\n_________________\n\/(1)\/ Market value of underlying securities at year-end ($.53), minus the exercise price.\nEMPLOYMENT AGREEMENTS - ---------------------\nIn February 1995, the Company entered into employment agreements with Mr. Tarrillion, Mr. Boyd, Mr. Daniels and Ms. Shields.\nMr. Tarrillion's employment agreement provides for a base salary of $180,000, plus bonuses and cost of living increases, and stock options to purchase 500,000 shares of the Company's Common Stock which vest over four years commencing on March 31, 1996. His agreement has a term of five years.\nMr. Boyd's employment agreement provides for a base salary of $135,000, plus bonuses and cost of living increases, as well as options to purchase 300,000 shares of the Company's Common Stock which vest over a period of four years commencing March 31, 1996. His agreement has a term of five years.\nMr. Daniels' employment agreement provides for a base salary of $135,000, plus bonuses and cost of living increases, as well as options to purchase 200,000 shares of the Company's Common Stock which vest over a period of four years commencing March 31, 1996. His agreement has a term of five years.\nMs. Shields' employment agreement provides for a base salary of $120,000, plus bonuses and cost of living increases, as well as options to purchase 300,000 shares of the Company's Common Stock which vest over a period of four years, commencing on March 31, 1996. Her agreement is for a term of five years.\nSTOCK OPTIONS AND WARRANTS - --------------------------\nThe Company presently has no formal stock option plan. However, through December, 1995 the Company has granted options to purchase 4,900,000 shares of the Company's common stock. Of these 3,550,000 are outstanding to current and former employees, have option prices ranging from $1.00 to $2.50, vest 20% to 25% per year, and have terms ranging from four to five years after vesting. The remaining options were granted to current or past note holders or consultants. Options to purchase 600,000 shares relate to one certain note agreement, have option prices ranging from $1.50 to $2.50, and expire in November 1997. The remaining options have prices ranging from $.75 to $1.75 and expire September 1996 through September 1999.\nIncluded in these options to employees are 1,900,000 granted to current or former directors of the Company and 300,000 granted to other executive officers of the Company.\nIn addition, at December 31, 1995, the Company has outstanding warrants to purchase approximately 5,280,000 shares of the Company's common stock. These originated from debt and equity placements, the merger with EET, and certain consulting arrangements. Of these warrants, 2,700,000 have a $1.00 warrant price and expire in September 2000; 1,900,000 have a $2.00 warrant price and expire in December 1997; 200,000 have a warrant price of $1.50 and expire July 1998 through December 1999; 75,000 have a warrant price of $2.25 and expire in June 1996; 75,000 have a warrant price of $3.30 and expire in April 1996; 50,000 have warrant prices of $4.50 to $6.00 and expire in January 1998; 130,000 have a warrant price of $.75 and expire in December 1998; and 150,000 have a warrant price of $1.00 and expire in August 1998.\nIn connection with the issuance of the Series E Convertible Preferred Stock in March 1996, the Company issued 250,000 warrants with an exercise price of $1.00 that expire in 1999. In connection with the issuance of the Series F Convertible Preferred Stock in April 1996, the Company issued 8,200,000 warrants with an exercise price of $1.00 that expire in 2004. Of these warrants, 5,500,000 were new and 2,700,000 were issued in exchange for 2,700,000 warrants that were surrendered as part of the transaction.\nDIRECTORS' FEES - ---------------\nThe directors of the Company receive no fees or other compensation in connection with their service as directors.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following table sets forth information with respect to the securities holdings of all persons which the Company, by virtue of filings with the Securities and Exchange Commission, has reason to believe may be deemed the beneficial owners of more than 5% of the Company's outstanding common stock as of December 31, 1995. Also set forth in the table is the beneficial\nownership of all of the Company's outstanding common stock as of such date by all officers and directors, individually and as a group.\n\/(1)\/ Based upon 23,477,285 shares outstanding at December 31, 1995.\n\/(2)\/ Includes 530,500 shares and 50,000 common stock purchase warrants received by Mr. Tarrillion in conjunction with a merger transaction between the Company and EET in March, 1995. Also includes 91,130 shares owned through a profit sharing plan for the benefit of Mr. Tarrillion. Does not include options to purchase 500,000 shares of the Company's common stock which will not commence vesting until March 31, 1996, which were received in conjunction with the EET merger. Also does not include 51,000 shares received by trusts on behalf of Mr. Tarrillion's minor children in connection with the EET merger which are held by an independent trustee as to which Mr. Tarrillion disclaims any beneficial ownership.\n\/(3)\/ Includes 600,000 shares received by Mr. Daniels in conjunction with a merger transaction between the company and IPF in June 1995. Includes options to purchase 120,000 shares of the Company's common stock. Does not include options to purchase 180,000 shares\nwhich do not commence vesting until January 1, 1996 or options to purchase 200,000 shares that do not commence vesting until March 31, 1996.\n\/(4)\/ Includes 10,000 shares received by Ms. Shields and her husband in connection with the merger transaction between the Company and EET in March, 1995, but does not include options to purchase 300,000 shares that do not commence vesting until March 31, 1996.\n\/(5)\/ Of these shares, 1,625,000 are \"contingent escrow shares\" which may be canceled if certain performance criteria are not met. Although these shares have been treated as outstanding for purposes of this schedule, they shall be released to the owner thereof, if, and only if, the Company shall be acquired prior to December 31, 1996 (whether by merger, share exchange involving more than 80% of its outstanding securities, or a sale of all or substantially all of its assets) for a purchase price exceeding $250,000,000.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nADVANCES FROM DIRECTORS, OFFICERS AND CERTAIN AFFILIATES. - -----------------------------------------------------------\nMr. John W. Parrott, former Chairman of the Company, and Mr. Thom Robinson, former Chief Executive Officer and Director of the Company, each own 33 1\/3% of the issued and outstanding shares of Gold Spinners International, Inc. (\"GSI\"). From its inception through 1992, the Company was advanced an aggregate of $42,600 from GSI. During 1993, the Company repaid $40,000 of the advances and was advanced an additional $281,381, resulting in aggregate unpaid advances of $281,382. During 1994, the Company repaid all of the advances to GSI.\nThrough a corporate affiliate, Mr. Robinson also advanced the Company $670,000 during 1993, of which the Company repaid $493,500, leaving aggregate unpaid advances of $176,500 at the end of 1993. During 1994, this affiliate provided additional advances of $335,000 to the Company and was repaid $522,500 of the advances, thus, leaving a balance of $11,000 as of December 31, 1994.\nCONSULTING AGREEMENT WITH JOHN W. PARROTT - -----------------------------------------\nEffective as of July 28, 1995, John W. Parrott terminated his employment agreement with the Company and entered into a consulting agreement (the \"Consulting Agreement\"). The Consulting Agreement provides that Mr. Parrott will provide advice to the Company with respect to the Company's transition in management and certain litigation and financing matters through December 31, 1995. Pursuant to the Consulting Agreement, Mr. Parrott will receive $15,000 a month through December 31, 1995 for his consulting services, and a payment in settlement of his five-year employment contract of $250,000, payable in bi- weekly payments of $11,538 beginning January 12, 1996.\nTRANSACTIONS WITH DIRECTORS, OFFICERS AND CERTAIN AFFILIATES - ------------------------------------------------------------\nIn January 1996, an officer and director of the Company loaned $250,000 to IPF under the terms of a promissory note. The note bears interest at 13% per annum, requires monthly payments of $5,700 and matures in January 1999. Proceeds from the note were used by IPF to\npurchase a machine for fabricating wyes, tees and els. The equipment purchased serves as collateral for the note.\nCertain corporate affiliates of James Impero, a former officer and director of the Company, entered into a sublicense agreement with the Company during March 1994 pursuant to which these affiliates assigned and conveyed to the Company the exclusive marketing rights to the Oleofilter\/TM\/ System that such affiliates had directly licensed from Exxon. Pursuant to that sublicense, the Company paid those affiliates a license fee of $50,000 during 1994 and $50,000 in January 1995.\nIn June 1995, the Company acquired by merger IPF, a company owned by Mr. David Daniels, a director and officer of the Company and two other individuals who were subsequently hired by the Company. The Company issued 1,300,000 shares of the Company's Common Stock in conjunction with the merger, 600,000 of which were issued to Mr. Daniels. Mr. Daniels was also released from a personal guaranty of certain debts of IPF in the amount of $50,000. The Company also agreed to repay certain outstanding loans made by Mr. Daniels to IPF on or before December 31, 1995. The outstanding balance of such loans at December 31, 1995, was $120,000. Mr. Daniels was repaid the $120,000 by Mr. Tarrillion. IPF then executed a note in the amount of $120,000 due to Mr. Tarrillion. The note bears interest at twelve (12%) percent per annum, and is due January 31, 1997. Further, Mr. Daniels entered into an amendment to his existing employment agreement with the Company to serve as President of IPF.\nThe Company has employment agreements with Messrs. Tarrillion, Boyd and Daniels, and Ms. Shields.\nThe Company has granted certain options and warrants to directors and officers of the Company.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\nA. INDEX OF FINANCIAL STATEMENTS\nProvided at Page of this Report\nB. FINANCIAL STATEMENT SCHEDULES\nAll 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.\nD. REPORTS ON FORM 8-K\nReport dated January 12, 1996 reporting the acquisition of GAIA, as amended by a Form 8-K\/A dated January 31, 1996 to provide financial statements of the acquired business.\nSIGNATURES ----------\nPursuant to the requirements of Section 13 or 15(d) of the Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nNORTH AMERICAN TECHNOLOGIES GROUP, INC.\nDated: April 15, 1996 \/s\/ Tim B. Tarrillion By:__________________________________ Tim B. Tarrillion Chief Executive Officer\n\/s\/ Judith Knight Shields By:__________________________________ Judith Knight Shields Principal Financial and Accounting Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this Form 10-K has been signed by the following persons in the capacities and on the dates indicated.\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS --------------------------------------------------\nNorth American Technologies Group, Inc. Houston, Texas\nWe have audited the accompanying consolidated balance sheets of North American Technologies Group, Inc. as of December 31, 1995 and 1994, and the related consolidated statements of loss, stockholders' equity and cash flows for the each of the three years in the period ended December 31, 1995. 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 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 North American Technologies Group, Inc. at December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles.\n\/s\/ BDO Seidman, LLP\nBDO Seidman, LLP\nHouston, Texas March 14, 1996 (Except for Notes 7(a), 8(a) and 20, which are as of April 8, 1996)\nNORTH AMERICAN TECHNOLOGIES GROUP, INC. CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1995 AND 1994\nSee accompanying notes to consolidated financial statements.\nNORTH AMERICAN TECHNOLOGIES GROUP, INC. CONSOLIDATED STATEMENTS OF LOSS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSee accompanying notes to consolidated financial statements.\nNORTH AMERICAN TECHNOLOGIES GROUP, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSee accompanying notes to consolidated financial statements.\nNORTH AMERICAN TECHNOLOGIES GROUP, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSee accompanying notes to consolidated financial statements\nNORTH AMERICAN TECHNOLOGIES GROUP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nINCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS\nSee accompanying notes to consolidated financial statements.\nNORTH AMERICAN TECHNOLOGIES GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBUSINESS AND BASIS OF PRESENTATION\nThe accompanying consolidated financial statements include the accounts of North American Technologies Group, Inc., (NATK) and the accounts of subsidiaries in which the corporation directly or indirectly owns more than 50% of the voting stock as of the end of each year. All significant intercompany accounts and transactions have been eliminated. North American Technologies Group, Inc., its subsidiaries and affiliates are referred to herein as the Company.\nDuring March and June 1995, the Company acquired 100% of the outstanding stock of EET, Inc. (EET) and Industrial Pipe Fittings, Inc. (IPF). In addition, in December 1995, the Company acquired certain assets of GAIA Technologies, Inc. and its affiliates (collectively GAIA) (see Note 2(a)). The acquisition of EET and IPF were accounted for as pooling-of-interests, and accordingly, the financial statements have been restated to include the historical financial results of EET and IPF (see Note 2). In addition, as a result of the acquisition of EET and IPF, the consolidated financial statements which had previously been presented as a development stage enterprise have been restated and reclassified to conform the prior years' data to the current presentation.\nNATK was incorporated December 24, 1986, in the state of Delaware as Mail Boxes Coast to Coast (MBCC). Prior to March 1992, MBCC was a franchisee for Mail Boxes, Etc. USA, Inc. and from inception incurred significant operating losses. As a result, between March and June 1992, MBCC undertook a series of transactions that resulted in the disposition of all of the operating assets and liabilities of MBCC, and the acquisition of 58.7% of the outstanding common stock of North American Technologies, Inc. (NAT), a company engaged in developing technologies related to the environmental clean-up industry and reclamation of natural resources. For accounting purposes, NAT was considered the continuing entity, and the transactions were accounted for as a recapitalization of NAT followed by the issuance of new NAT shares of common stock for the net assets of MBCC.\nOn January 29, 1993, MBCC changed its name to North American Technologies Group, Inc. On November 5, 1993, North American Technologies Group, Inc. acquired the remaining 41.3% minority interest of NAT (see Note 11). This transaction was recorded at book value of MBCC.\nTHE COMPANY\nThe Company and its wholly-owned subsidiaries are engaged in the development, acquisition and application of technologies which management believes have applications in various industries. The Company through EET provides on-site decontamination of buildings and equipment contaminated with polycholorinated biphenyls, radioactive isotopes or other toxic materials utilizing EET's patented TechXTract system. IPF manufactures and distributes proprietary and standard transition products (custom pipe, pipe fittings and valves). GAIA manufactures and distributes porous pipes used for irrigation purposes and alternative building materials, such as air-conditioner base pads, made from recycled rubber and thermoplastic. All other wholly-owned or majority owned subsidiaries of the Company are not significant or are inactive.\nINVENTORIES\nInventories are valued at the lower of cost (first-in, first-out) or market. Costs includes material costs, direct labor, and applied overhead.\nNORTH AMERICAN TECHNOLOGIES GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nPATENTS AND PURCHASED TECHNOLOGIES\nPatents and purchased technologies are stated at cost, less accumulated amortization. Patent costs and purchased technologies are being amortized by the straight-line method over their remaining lives, ranging from two to sixteen years.\nINTANGIBLE ASSETS\nGoodwill represents the excess of the purchase price over the fair market value of net asset received in business combinations accounted for by the purchase method. Goodwill is being amortized by the straight-line method over twenty years. The Company analyzes goodwill periodically to determine whether any impairment has occurred in the carrying value. Based upon the anticipated future undiscounted cash flows from operations, in the opinion of Company management, there has been no impairment.\nOther intangible assets are comprised of non-compete agreements and organization costs and are stated at cost, less accumulated amortization. The non-compete agreements are being amortized by the straight-line method over the life of the agreements, seven years. The organization costs are being amortized by the straight-line method over five years.\nINVESTMENT IN JOINT VENTURE\nThe Company's investment in its 50% owned joint venture is accounted for using the equity method of accounting; whereby, the investment is carried at cost and adjusted for the Company's proportionate share of undistributed earnings or losses.\nPROPERTY, EQUIPMENT AND LEASEHOLD IMPROVEMENTS\nProperty and equipment are stated at cost. Leasehold improvements are amortized over the term of the lease. Fixed assets are depreciated by the straight-line method for financial reporting purposes and accelerated methods for tax reporting purposes over their estimated useful lives, ranging from three to fifteen years.\nINCOME TAXES\nDeferred taxes result from temporary differences between the financial statement and income tax basis of assets and liabilities (see Note 15). The Company adjusts the deferred tax asset valuation allowance based on judgments as to future realization of the deferred tax benefits supported by demonstrated trends in the Company's operating results.\nRESEARCH AND DEVELOPMENT\nExpenditures for research and development of products and processes and for the operation of pilot projects are charged to expense as incurred.\nLOSS PER COMMON SHARE\nThe loss per common share is computed by dividing the loss by the weighted average number of common shares outstanding and common stock equivalents, if dilutive.\nREVENUE RECOGNITION\nService revenues are recognized as services are performed. Such revenues also include the cost of services subcontracted to third parties that are reimbursed to the Company by its customers. Product revenues are recognized when the products are shipped.\nNORTH AMERICAN TECHNOLOGIES GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nCASH EQUIVALENTS\nThe Company considers all highly liquid instruments purchased with an initial maturity of three months or less to be cash equivalents.\nMANAGEMENT'S ESTIMATES AND ASSUMPTIONS\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported periods. Actual results could differ from those estimates.\nNEW ACCOUNTING PRONOUNCEMENTS\nIn March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121 \"Accounting for Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of (SFAS No. 121). SFAS No. 121, requires, among other things, that impairment losses on assets to be held and gains or losses from assets that are expected to be disposed of, be included as a component of income from continuing operations. The Company will adopt SFAS No. 121 in 1996 and its implementation is not expected to have a material effect on the consolidated financial statements.\nIn October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation\" (SFAS No. 123). SFAS No. 123 encourages entities to adopt the fair value method in place of the provisions of Accounting Principles Board Opinion No. 25, \"Accounting for Stock Issued to Employees\" (APB No. 25), for all arrangements under which employees receive shares of stock or other equity investments of the employer or the employer incurs liabilities to employees in amounts based on the price of its stock. The Company does not anticipate adopting the fair value method encouraged by SFAS No. 123 and will continue to account for such transactions in accordance with APB No. 25. However, the Company will be required to provide additional disclosures beginning in 1996 providing pro forma effects as if the Company had elected to adopt SFAS No. 123.\nCONCENTRATION OF CREDIT RISK\nAt December 31, 1995, the Company's cash in a financial institution exceeded the federally insured deposit limit by $330,424. The Company extends credit to its customers in various industries, including petrochemical, construction, mining, waterworks and environmental, and there is no concentration of credit risk.\nNOTE 2 - ACQUISITIONS\n(a) On December 29, 1995, the Company acquired certain tangible and intangible assets of GAIA Technologies, Inc. and certain affiliates (collectively GAIA), for a total purchase price of $4,041,500, pursuant to the purchase agreement dated December 29, 1995. The purchase price was paid as follows: (1) $2,186,903 in cash; (2) a note payable of $1,050,000; (3) 1,666,667 shares of the Company's common stock; (4) assumption of $194,000 of liabilities; and (5) transactional costs totalling $111,011. Prior to the closing, the Company had advanced GAIA $1,881,400 under debt agreements bearing interest at 10%. At closing, the outstanding advances and accrued interest were forgiven as part of the cash portion of the purchase price. See Note 7 for terms of the note payable portion of the purchase price. The agreement provides for royalty payments on certain products sold by the Company for a period of up to 15 years. The Company is not currently manufacturing any products subject to the royalty provisions.\nNORTH AMERICAN TECHNOLOGIES GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nAs part of the transaction, the Company granted to TieTek, Inc. (TieTek) an exclusive license to develop the railroad crosstie business using certain patents and technologies purchased from GAIA and currently owned by the Company. TieTek is owned by three individuals, two of whom are officers of the Company's subsidiary, GAIA. The Company has a two year exclusive right and option to purchase TieTek if the Company satisfies certain funding obligations over the next two years. The Company entered into a loan agreement to provide TieTek up to $1,500,000 to be used exclusively for the development of the crosstie technology. See Note 4 for the terms of the loan agreement.\nThe GAIA acquisition was accounted for as a purchase, and accordingly, the purchase price has been allocated to the assets acquired based on their estimated fair value at the date of acquisition. The excess of the purchase price over the estimated fair value of the assets acquired has been recorded as goodwill, which will be amortized over twenty years. The estimated fair value of assets acquired are as follows:\nThe operating results of GAIA are not included in the accompanying statements of loss since the purchase occurred on December 29, 1995. The following pro forma summary presents the effect on the statements of loss for the year ended December 31, 1995 and the preceding year, as if the purchase had occurred at the beginning of 1994, after giving effect to certain adjustments, including depreciation, amortization, interest expense and legal expense, penalties and other expense associated with liabilities not assumed.\nThese pro forma results have been prepared for comparative purposes only and do not purport to be indicative of what would have occurred had the acquisition been made as of these dates or of results which may occur in the future.\nNORTH AMERICAN TECHNOLOGIES GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(b) On March 7, 1995, the Company acquired EET, Inc. (EET), a Texas corporation, pursuant to an Agreement and Plan of Merger dated February 7, 1995. On June 30, 1995, the Company acquired Industrial Pipe Fittings, Inc. (IPF), a Texas corporation, pursuant to an Agreement and Plan of Merger dated June 22, 1995. To effect these acquisitions, the Company issued an aggregate of 3,070,729 shares of the Company's common stock and warrants (issued to replace EET's outstanding stock purchase warrants) to purchase up to 71,000 shares of the Company's common stock.\nThe EET and IPF acquisitions were accounted for as a pooling-of-interest, accordingly, the accompanying consolidated financial statements for the years ended December 31, 1994 and 1993 have been restated to include the financial position and operations of EET and IPF.\nOperating results of the separate companies for the years prior to the merger were:\nThe dividends on EET preferred stock are reflected as minority interest in net loss (income) of subsidiary in the consolidated statement of operations for the years ended December 31, 1995 and 1994.\n(c) On August 31, 1993, EET acquired certain assets and assumed certain liabilities from Enclean, Inc., at a total cost of $923,827. The acquisition was accounted for as a purchase and, accordingly, the operations of the acquired business are included in the Company's results of operations from August 31, 1993. The accounts of the acquired business are included in the Company's balance sheet at the fair market value of the assets acquired net of liabilities assumed as of the purchase date. The excess of cost over the fair market value of the net assets acquired has been assigned to goodwill and is being amortized over twenty years on a straight-line basis commencing with date of acquisition.\nNORTH AMERICAN TECHNOLOGIES GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 3 - INVENTORIES\nAt December 31, 1995 and 1994, inventories consisted of the following:\nNOTE 4 - NOTES RECEIVABLE\nAt December 31, 1995 and 1994, notes receivable consisted of the following:\n(a) In April 1993, the Company had invested $2,554,859 with Euro Scotia Funding Limited (ESF) in exchange for a secured note receivable, which the Company could call upon thirty days notice to ESF. Through April 1994, income from the note was generated from the management, by ESF, of investments in various margin transactions involving U.S. and other governmental debt securities, currency forward exchange contracts and certain corporate debt and equity securities. Under the terms of the note, the Company and ESF shared equally in trading profits. For the years ended December 31, 1995, 1994 and 1993, the Company recognized interest income totalling $283,966, $85,832 and $523,623, respectively, and trading profits for the years ended December 31, 1994 and 1993, totalling $512,312 and $2,169,672, respectively.\nEffective December 31, 1994, the Company renegotiated the terms of the note receivable from ESF. Under the new agreement, ESF was to repay the note in ten semi-annual installments of $327,885, plus interest at 10% per annum, commencing July 1, 1995. ESF elected, as permitted under the agreement, to prepay as of December 31, 1994 the earliest payments using the amounts owed to it by the Company for borrowings under the line of credit agreement (see Note 7(c)) and for services rendered. At December 31, 1994, the face value of the original note plus accrued interest receivable totalled $3,278,857, borrowings under the line of credit plus accrued interest payable totalled $356,473, and amounts owed to ESF for services totalled $121,621. The net balance of $2,800,763 was reflected on the consolidated balance sheet at December 31, 1994.\nNORTH AMERICAN TECHNOLOGIES GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nThe note was to be collateralized by $3,200,000 in U.S. Treasury obligations held by a third-party brokerage firm for the benefit of the Company. ESF had signed an irrevocable power of attorney to the Company giving it the ability to seize the collateral in the event of a default, provided that such default was not cured within thirty days after written notice. In addition, there were irrevocable instructions provided to the brokerage firm stating that ESF would be allowed to trade the securities constituting the collateral. However, the securities had to be substituted with U.S. treasuries, and the value of such securities could not fall below the lesser of $3,200,000 or 110% of the outstanding principal balance on the note.\nThe semi-annual payment due January 1996, in accordance with the note agreement was not paid by ESF. During the fourth quarter of 1995, the Company learned that the brokerage firm that holds the collateral for the ESF note and an affiliate of ESF were named as defendants in a lawsuit filed by the Florida Department of Insurance in which it is alleged, among other things, that such brokerage firm issued false account confirmations. The Company also learned that such brokerage firm has applied for withdrawal as a registered broker\/dealer in a number of states, including the state in which such securities were to have been held.\nIn early 1996, the Company also learned that the United States Securities and Exchange Commission sought and was granted in late December 1995, a temporary restraining order against certain affiliates of ESF in the United States District court for the District of Colorado that, among other things, froze investor funds of the defendants and certain of their affiliates, and required each such party to prevent the disposition, transfer or other disposal of any of their funds or other assets then held by them, under their control or over which they exercise investment or other authority.\nAfter learning of the lawsuit, the Company unsuccessfully attempted to gain reliable information about the existence and the value of the securities that were to have been held for the Company's benefit in connection with the ESF note. Accordingly, as of December 31, 1995, the Company decided to write-off the note receivable of $2,800,763 and accrued interest recognized during 1995 of $283,966, for a total loss of $3,084,729.\nThe Company has made demand for payment of the ESF note, in accordance with the agreement and is exploring its other options against ESF and the brokerage firm charged with holding the collateral for the note.\n(b) On December 29, 1995, the Company, in association with the acquisition of GAIA (see Note 2(a)), has provided TieTek with a credit facility that allows TieTek to borrow a maximum of $1,500,000 to be used exclusively for the development of the crosstie technology. The loan bears interest at 10% and is due two years after the earlier of (1) the date the Company provides notice that they will not exercise their option or (2) the expiration of the option period. The loan is collateralized by TieTek's assets, capital stock and 666,667 shares of the Company's common stock issued for the purchase of GAIA.\nNOTE 5 - PROPERTY AND EQUIPMENT\nAt December 31, 1995 and 1994, major classes of property and equipment consist of:\nNORTH AMERICAN TECHNOLOGIES GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 6 - INVESTMENT IN JOINT VENTURE\nEffective January 1, 1995, the Company entered into a joint venture agreement with a non-affiliated company. The Company has a 50% ownership interest in the joint venture which is accounted for using the equity method of accounting and is included in other assets. The joint venture performed a demonstration project for a major environmental company which documented the Terrazyme system to be effective in cleaning certain waste streams for recycle and reuse. In December 1995, the Company suspended any additional funding of the joint venture pending the results of a current test project and the development of waste streams sufficient to justify further investment. During 1995, the Company had contributed cash totalling $210,829 and equipment valued at $200,000. The Company's share of net loss from the joint venture for the year ended December 31, 1995 totalled $231,712.\nThe following is a summary of financial position at December 31, 1995, and results of operations of the joint venture for the year ended December 31, 1995:\nThe net income (loss) from affiliates totalling $50,000 and $(233,846) for 1994 and 1993, respectively, represents the Company's share of net income (loss) from a joint venture which was terminated in June 1994.\nNOTE 7 - SHORT-TERM BORROWINGS\nAt December 31, 1995 and 1994, short-term borrowing were as follows:\n(a) The Company issued the note payable in association with the purchase of GAIA (see Note 2(a)). The note is due March 28, 1996, including interest at 12% and is collateralized by all assets acquired from GAIA. On March 26,1996, an amendment to the note was executed to extend the maturity date to April 15, 1996. The note was paid in full upon the issuance of the Series F convertible preferred stock on April 8, 1996, see Note 20.\nNORTH AMERICAN TECHNOLOGIES GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(b) Borrowings outstanding under EET's $500,000 line of credit with a bank. The borrowings bear interest at the bank's prime plus 2%. This agreement was repaid and terminated when the Company acquired EET.\n(c) In January 1994, the Company entered into an agreement with ESF which provided for a line of credit. As additional consideration for the loan, the Company issued ESF 200,000 shares of common stock with a quoted market price totalling $650,000. Effective December 31, 1994, the Company and the lender agreed to terminate the agreement, cancel the related common shares and offset all outstanding borrowings plus accrued interest totalling $356,473 against the note receivable owed to the Company by the lender (see Note 4(a)).\nThe Company's weighted average short-term borrowing rate for the years ended December 31, 1995 and 1994 were 10.2% and 10.5%, respectively.\nNOTE 8 - LONG-TERM DEBT\nAt December 31, 1995 and 1994, long-term debt is as follows:\n(a) In September 1995, the Company borrowed $2,700,000 from issuance of convertible subordinated debentures and stock warrants to acquire 2,700,000 shares of the Company's common stock at an exercise price of $1 per share. The notes bear interest at 13.5% per annum, which is payable semi-annually beginning March 1996, but may be deferred during the first three years at the option of the Company. The principal amount of the notes and any deferred interest is convertible at the holder's option into the Company's common stock at $1.00 per share, subject to anti-dilution provisions, as defined, any time after September 1996, through the maturity date of September 2000. Any portion of the debt that has not been converted is due in September 2000. The notes are subordinated to all existing and future senior indebtedness of the Company.\nAs part of the closing on the Series F preferred stock in April 1996, the holders of the subordinated debentures converted the $2,700,000 principal balance of their notes into 27 shares of Series F convertible preferred stock. Interest on the subordinated debentures through the closing of $198,000 was paid prior to the conversion (see Note 20).\nNORTH AMERICAN TECHNOLOGIES GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(b) In January 1996, the note payable and accrued interest was converted into 248,131 shares of the Company's common stock in accordance with the original terms of the agreement. Accordingly, the note has been classified as long-term at December 31, 1995.\n(c) The debentures are convertible into the Company's common stock by dividing the principal balance by 75% of the average trading price of the stock during the ten days preceding conversion.\n(d) In August 1994, the Company borrowed $500,000, bearing interest at 8% per annum, from an individual lender. The loan matures in August 1999. The Company may prepay the loan with a penalty amounting to 2% of the principal balance for each year the prepayment precedes the scheduled maturity date. The loan is convertible into shares of the Company's common stock at $1.50 per share which exceeded the fair market value at the date of the agreement. However, if the Company elects to prepay the loan when the market price is below $1.50 per share, the lender has the option to convert the loan into shares of common stock at a 15% discount from the then-current market price.\n(e) The note payable to an officer of the Company is unsecured, bears interest at 12% payable monthly, and is due on January 31, 1997.\nNOTE 9 - RELATED PARTY TRANSACTIONS\nAt December 31, 1995, the Company had accrued $250,000 in settlement of the former Chairman of the Board's five-year employment agreement. The settlement is payable in bi-weekly payments of $11,538, beginning January 12, 1996. From July 1995 through December 1995, the former Chairman was a consultant to the Company and was paid $15,000 a month.\nIncluded in long-term debt at December 31, 1995, is a note payable to an officer of the Company (see Note 8). The Company incurred no interest expense on this note for 1995.\nAt December 31, 1994, notes payable stockholders consisted of various unsecured notes payable to stockholders of the Company. The notes are due on demand and bear interest at 8% per annum. Interest expense for the years ended 1995, 1994 and 1993 totalled $10,849, $28,933 and $8,889, respectively.\nSimultaneously, with the purchase of GAIA, certain former officers of GAIA became officers of the Company. In addition, the former stockholders of GAIA have the right to select an individual as director of the Company. See Notes 7 and 2(a), for note payable and other transactions with GAIA in association with the purchase of certain assets.\nIn 1994, $290,000 of notes payable to the stockholders of EET were converted to preferred stock. In 1995, the preferred stock was redeemed as a result of the acquisition of EET (see Note 10).\nNORTH AMERICAN TECHNOLOGIES GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 10 - MINORITY INTEREST\nThe minority interest shown on the consolidated balance sheets are comprised of the following at December 31:\nNOTE 11 - STOCKHOLDERS' EQUITY\nOn December 28, 1995, the Company issued 30 shares of Series D convertible preferred stock (Series D) for $750,000. The Series D holders are entitled to quarterly cumulative dividends totalling $3,750 per year per share of preferred stock and certain liquidation preferences. At the option of the Series D holders, the preferred stock may be converted into the Company's common stock using a conversion rate computed as the lesser of (a) a calculated value utilizing a discount to market as defined or (b) $.875 per share. The Series D stock can not be converted until March 11, 1996, at which time one third is eligible for conversion, with the remaining two thirds eligible for conversion in April and May 1996. In March 1996, 10 shares of Series D convertible preferred stock were converted into 414,800 shares of the Company's common stock.\nDuring 1994, the Company issued 220 shares of Series A convertible preferred stock (Series A) for net proceeds totalling $2,024,000. Each share of Series A was convertible into the Company's common stock at a conversion rate equal to $10,000 divided by 77% of the closing bid price of the Company's common stock on the conversion date, per share. During 1994, Series A holders elected to convert 170 shares for 1,219,751 shares of the Company's common stock. In 1994, as an inducement not to convert any further Series A shares, the Company issued 15 shares of Series B and C convertible preferred stock to the holders of the Series A shares. The Series B and C preferred stock were issued with conversion terms identical to those of the Series A. The Company realized no proceeds from the issuance of the Series B and C preferred shares. During 1995, all remaining Series A, B and C preferred stock were converted into 424,506 shares of the Company's common stock.\nDuring 1995 and 1994, 3,500 and 1,000 shares, respectively, of $3.50 convertible preferred stock of the Company's majority-owned subsidiary 522728 Alberta, Ltd. were converted into 350,000 and 100,000 shares, respectively, of the Company's common stock which was issued from treasury stock.\nDuring 1993, the Company purchased the minority interest in one of its majority-owned subsidiaries (NAT). In accordance with a plan of arrangement with the minority stockholders, each majority stockholder received one share of the Company's common stock in exchange for two shares of the subsidiary's stock held by the minority stockholders. The Company issued 4,443,147 shares of treasury stock and 1,034,626 shares of common stock for the purchase of the minority interest and recorded the transaction at book value of the subsidiary.\nNORTH AMERICAN TECHNOLOGIES GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nIn association with the Company's purchase of the remaining minority interest of the subsidiary described above, 3,250,000 shares were subject to escrow; 1,625,000 shares are \"Class I Escrow Shares\" and 1,625,000 shares are \"Class II Escrow Shares.\" These shares are treated as contingent shares, and accordingly, have been excluded from weighted average shares in the computation of loss per common shares.\nThe provisions relating to the \"Class I Escrow Shares\" were not met, and these shares were retired effective December 31, 1994. The \"Class II Escrow Shares\" shall be released if the Company shall be acquired prior to December 31, 1996 for a purchase price exceeding $250,000,000. At December 31, 1995, these shares are held in escrow.\nAt December 31, 1995, the Company had common stock reserved for future issuance as follows:\nNOTE 12 - INVESTMENT - SALE OF MARKETING RIGHTS\nIn February 1993, the Company sold rights to market its environmental technologies throughout Canada, excluding the Provinces of Alberta and Saskatchewan. In exchange, the Company received 600,000 common shares of Katlor Environmental Technologies, Inc. (Katlor), a publicly traded Canadian corporation. Such shares were restricted for a period of one year from the date of the transaction. At the time of the transactions, unrestricted common shares of Katlor had a quoted market value of Canadian $2.32 per share (U.S. $1.83). Because the shares received represent such a large percentage (8.1%) of the outstanding common shares of Katlor and because the shares could not be sold for a period of one year, management of the Company assigned a value of U.S. $600,000 (U.S. $1.00 per share) to the transactions. For the year ended December 31, 1993, the Company had recorded a gain of $600,000 from the sale of marketing rights in the consolidated statement of loss.\nDuring the fourth quarter of 1994, the market price of the Katlor shares experienced a dramatic decline and, subsequently, Katlor filed for bankruptcy protection. There has been no public trading in Katlor common stock since December 31, 1994. Due to the current bankruptcy filing and because management believes it is unlikely that the Company will be able to recognize any proceeds from its investment, the balance of $600,000 was written off and recorded as a loss in the statement of loss for the year ended December 31, 1994.\nNOTE 13 - MINING ASSETS\nDuring 1993, the Company abandoned its claim to certain properties in Canada and, accordingly, wrote off its investment in those properties amounting to $43,251. In 1994, the Company decided not to pursue further development of any of its mining properties and, accordingly, wrote off the remainder of its investment in those properties totalling $794,314.\nNORTH AMERICAN TECHNOLOGIES GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 14 - DISCONTINUED OPERATIONS\nEffective July 29, 1994, EET entered into a formal plan to dispose of its analytical services operations. On July 29, 1994, EET sold the fixed assets of the analytical division to a third party. All remaining assets and liabilities, which consisted of accounts receivable and accrued liabilities, were retained by the Company. This is considered a discontinued operation. No gain or loss on the disposal of the discontinued segment was incurred because the analytical services operations did not continue beyond July 29, 1994 and there was no gain or loss on the disposal of the assets.\nNOTE 15 - INCOME TAXES\nDeferred taxes are determined based on the temporary differences between the financial statement and income tax basis of assets and liabilities as measured by the enacted tax rates which will be in effect when these differences reverse.\nThe components of deferred income tax assets at December 31, 1995 and 1994, were as follows:\nAt December 31, 1995, the Company has net operating loss carryforwards for federal income tax purposes totalling approximately $11,429,000 which, if not utilized, will expire as follows:\nThe figures above are stated on a consolidated basis. Federal tax laws only permit the use of net operating loss carryforwards by the individual entities that originally sustained the losses.\nNORTH AMERICAN TECHNOLOGIES GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 16 - STOCK OPTIONS AND WARRANTS\nThe Company has not adopted a formal stock option plan, however, as of December 31, 1995, by approval of the Board of Directors, the Company has granted the following stock options: approximately 3,550,000 options to directors, officers and employees and approximately 1,350,000 options to consultants and in connection with financing transactions.\nAll of the options to directors, officers and employees are exercisable at prices that range from $1.00 to $2.50, which equaled or exceeded the market price per share at the date granted. These options generally vest over a four or five year period and expire five years after vesting. All options issued to consultants and in connection with financing transactions are exercisable at prices that range from $.75 to $2.50, which equalled or exceeded the market price per share at the date granted. These options primarily vest immediately and expire through the year 1999.\nAs of December 31, 1995, the Company has issued stock warrants totalling 5,278,916 primarily in connection with financing transactions. These warrants are exercisable at prices that range from $.75 to $6.00 per share, which equaled or exceeded the market price per share at the date of grant, and expire through the year 2000.\nAt December 31, 1995, the Company had stock options and warrants available for exercise totalling 2,375,000 and 5,278,916, respectively, at exercisable prices ranging from $.75 to $6.00.\nNOTE 17 - COMMITMENTS AND CONTINGENCIES\nThe Company rents equipment and office space under operating leases on both long and short-term basis. Rent expense amounted to approximately $168,000, $156,000 and $259,000, for the years ended December 31, 1995, 1994 and 1993, respectively.\nMinimum annual rentals under non-cancelable operating leases of more than one year in duration are as follows:\nAt December 31, 1995, the Company had employment contracts that provide for payments of approximately $1,090,000 annually through 1999.\nAt December 31, 1995, the Company had an outstanding letter of credit totalling $200,000. The letter of credit is collateralized by a certificate of deposit and expires June 1, 1996.\nNORTH AMERICAN TECHNOLOGIES GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nIn November 1988, a suit was filed against MBCC, the predecessor to the Company, by a former franchisee. The plaintiff alleged that the Company failed to provide the plaintiff with an offering prospectus and made false representations. The suit claims damages in excess of $425,000. The court recently granted the Company's motion to dismiss the action based upon the plaintiff's failure to prosecute the action. The plaintiff responded by filing a motion to reinstate the action, which is now before the court. The Company intends to vigorously defend against this action.\nIn April 1993, an individual brought an action against NAT and other defendants, which seeks delivery of 200,000 shares of common stock of NAT and damages amounting to $1.7 million (CND) for failure to provide the shares on a timely basis. The Company intends to vigorously defend against this action.\nIn July 1993, an individual brought action against North American Gold Corp. (predecessor to NAT) and a brokerage firm for the conveyance of 150,000 shares of North American Gold Corp. at $.50 per share or alternatively, for damages and attorney fees. The claim is based upon a letter dated July 17, 1991, purportedly signed by the president of the brokerage firm named in the suit. The Company intends to vigorously defend against this action.\nUnder a 1992 license agreement, the Company received exclusive rights to purchase a certain proprietary stabilized enzyme. During the second quarter of 1993, management discovered that the licensor had violated the agreement by selling the enzyme to its competitors. In response to this violation and because the enzyme proved to be ineffective, the Company terminated the agreement. In September 1993, the licensor brought suit in federal court for delivery of 90,000 common shares of NATK which were being held in escrow under the terms of the license agreement. The Company was successful in terminating the federal court proceedings and thereby requiring arbitration before the American Arbitration Association. The arbitration proceedings were completed in February 1996, and the Company is awaiting the arbitrator's decision.\nIn April 1995, the Company filed a lawsuit against a former officer and director of the Company. In late 1994, the Company commenced an investigation of this former director's activities, and on January 23, 1995, requested and received his resignation. The Company's claims against him are based on actions taken both before and after his resignation and include breaches of duties owed by him to the Company, torts against the Company and defamation of the Company's business reputation. The Company has requested relief in the form of a temporary injunction, permanent injunction and other damages. In June 1995, the former officer filed a counter lawsuit against the Company and other parties, which has been dismissed. The lawsuit also includes claims against a former officer of a subsidiary of the Company. The claims against him include breach of duties owed by him to the Company and torts against the Company, based on his alleged aid to the former officer and director. This individual has filed a counter lawsuit against the Company and other parties.\nIf the foregoing litigation is decided against the Company, it could have a material adverse effect on the financial conditions of the Company.\nNOTE 18 - SUPPLEMENTAL CASH FLOW INFORMATION\nDuring the year ended December 31, 1995, the Company paid interest totalling approximately $25,000. For the years ended December 31, 1994 and 1993, the Company paid no interest.\nDuring 1995, the Company issued shares of common stock for the acquisition of EET and IPF totalling 3,070,729. These acquisitions have been accounted for as pooling-of-interests (see Note 2(b)). Accordingly, these non-cash transactions have been recorded in the years the acquired companies were organized due to the restatement of the Company's consolidated financial statement.\nDuring 1995, in association with the purchase of GAIA, the Company issued 1,666,667 shares of common stock, issued debt of $1,050,000 and assumed liabilities of $194,000.\nNORTH AMERICAN TECHNOLOGIES GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDuring 1995, the Company contributed equipment with a book value totalling $200,000 to a 50% owned joint venture.\nIn 1995 and 1994, the Company issued 125,000 and 20,000 shares, respectively, of the Company's common stock for compensation and services provided totalling $55,000 and $31,260, respectively.\nIn 1993, the Company sold marketing rights (see Note 12) in exchange for common stock valued at $600,000.\nIn 1993, the Company acquired the remaining minority interest in a subsidiary through the issuance of 4,443,147 common shares held in the treasury and 1,034,626 newly issued common shares. The transaction was recorded at net book value or $743,017.\nNOTE 19 - BUSINESS SEGMENTS\nThe Company has two reportable business segments, as noted below:\nEnvironmental Group: Environmental services and energy resource reclamation, including enzyme processes, mechanical systems and bioremedial technologies.\nManufacturing and Distribution Group: Manufactures and distributes proprietary and standard products (custom pipe, pipe fittings and valves). Manufactures and distributes porous pipe, wood substitution and alternative building materials made from recycled rubber and thermoplastics.\nNORTH AMERICAN TECHNOLOGIES GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 20 - SUBSEQUENT EVENTS\nIn January 1996, an officer and director of the Company loaned $250,000 to IPF under the terms of a promissory note. The note bears interest at 13%, requires monthly payments of $5,700, matures January 1999 and is collateralized by equipment. Proceeds from the note were used to purchase equipment.\nSubsequent to year end, the Company issued 50 shares of Series E convertible preferred stock (Series E) for net proceeds of $1,218,750. The Series E holders have certain liquidation preferences, and are not entitled to any dividends. At the option of the Series E holders, the preferred stock may be converted into the Company's common stock using a conversion rate computed as the lesser of (a) a calculated value utilizing a discount to the market price, as defined or (b) $1.50 per share. One-fourth of the Series E shares can be converted after August 1996, with another one-fourth available for conversion every three months thereafter. In addition, the Company at its option may redeem any of the Series E preferred stock still outstanding on or after February 16, 1999 at $25,000 per share.\nOn April 8, 1996, the Company issued 82,000 shares of Series F convertible preferred stock (Series F) and stock purchase warrants to purchase 8,200,000 shares of the Company's common stock (Series F Warrants). Cash proceeds of $5,500,000 were received for issuance of 55,000 Series F shares and 5,500,000 Series F Warrants. The remaining 27,000 Series F shares and 2,700,000 Series F Warrants were issued in exchange for the surrender of the 13.5% convertible subordinated debentures and the warrants (see Note 8(a)). The Series F Warrants have an exercise price of $1.00 per share, subject to certain adjustments, and expire on April 8, 2004.\nDividends accrue on the Series F shares at a per annum rate of $13.50 per share and are payable semi-annually. The Company may elect to defer and accrue dividend payments during the first three years, in which case, each holder may elect to receive payment of the dividend in the form of additional Series F shares. All accrued but unpaid dividends shall accrue interest at a rate of 13.5%. The holders of the Series F shares have certain liquidation preferences. The Series F shares may be converted into the Company's common stock at the option of the holder using a conversion rate, subject to certain adjustments, of $1.00 per share. On or after April 8, 2001, the Series F shares can be converted at the holder's option using the lesser of (a) the current conversion price; or (b) a calculated value utilizing a discount to the market price, as defined. Subject to certain conversion rights, the Company may redeem the Series F shares at a face value on or after April 8, 2004.\nNORTH AMERICAN TECHNOLOGIES GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nEach Series F share entitles the holder to voting privileges equal to the number of shares of common stock into which such Series F share may be converted from time to time. In addition, the Company has agreed to cause its Board of Directors to be increased to nine positions, four of which may be filled by nominees selected by the holders of the Series F shares.\nThe preferred stock purchase agreement and the certificate of designation for the Series F shares contain covenants which, if breached by the Company, provide for certain remedies. Certain of these covenants are considered outside of the Company's control. These covenants include, among other things, that the Company obtain a minimum net worth, as defined in the agreement, by December 31, 2000. For breach of these covenants that are outside of the Company's control the remedy allows the Series F holders to convert their shares into the Company's common stock using a conversion rate computed as the lesser of (a) the conversion price, as adjusted; or (b) a calculated value utilizing a discount to the market price, as defined. Also, the stock purchase agreement contains certain covenants that are considered within the control of the Company. These covenants, among other things, require the delivery of financial information and restrict the Company from incurring additional debt if, immediately upon incurrence of such debt, the Company's debt to equity ratio exceeds a certain ratio, as defined by the agreement. For breach of these covenants that are within the Company's control the remedies allow the Series F holders to elect a majority of the Company's Board of Directors and to either (1) convert their shares into the Company's common stock using a conversion rate computed as the lesser of (a) the conversion price, as adjusted; or (b) a calculated value utilizing a discount to the market price, as defined; or (2) request the Company to redeem their shares. If the Series F holders elect redemption, the shares will be redeemed at the greater of (a) the fair market value, as defined; or (b) the initial purchase price, plus unpaid dividends and interest, if any. At the Company's option, the shares may be redeemed with cash or a three year promissory note.\nThe proceeds of the Series E and Series F preferred stock issuances will be used to repay certain debt, accrued interest, and to meet general working capital needs. Because of the significance of the Series E and Series F preferred stock issuances, a pro forma balance sheet presentation has been provided to show the effect of the issuances of the Series E and Series F preferred stock, repayment of certain debt and accrued interest, and the exchange of debt for Series F preferred stock, as if such events occurred at December 31, 1995.","section_15":""}
{"filename":"719488_1995.txt","cik":"719488","year":"1995","section_1":"ITEM 1. DESCRIPTION OF BUSINESS\nGENERAL\nFWB Bancorporation (the \"Corporation\"), headquartered in Rockville, Maryland and incorporated in the State of Maryland in 1983, is a Maryland bank holding company registered with and subject to the regulation and supervision of the Board of Governors of the Federal Reserve System (\"FRB\") under the Bank Holding Company Act of 1956, as amended (the \"Act\"). A majority of the Corporation's outstanding stock is owned by women. The Corporation's operations primarily consist of managing the operations of FWB Bank (the \"Bank\"), its wholly-owned banking subsidiary. The Bank is a Maryland chartered commercial bank formed in 1979 and subject to the regulation and supervision of the Maryland State Bank Commissioner (the \"Commissioner\") and the Federal Deposit Insurance Corporation (the \"FDIC\"). As of December 31, 1995, FWB Bank had 30 employees, all of which were full time. The executive offices of the Corporation and the Bank are located at 1800 Rockville Pike, Rockville, Maryland 20852 and its telephone number is (301) 770-1300.\nBUSINESS OF THE BANK\nThe Bank, in addition to its headquarters in Rockville, has branch offices in Bethesda and Germantown, Maryland. The Bank is a full-service community- oriented commercial bank serving small-to-medium sized businesses, professionals, and individuals in the Washington, DC metropolitan area.\nThe Bank offers a full range of commercial and retail banking services, including commercial and consumer loan and deposit products suited to businesses and professional and consumer customers. Commercial products include working capital loans, letters of credit, lines of credit, and real estate loans, along with deposit products to support the business needs of the customer. Consumer products include home equity loans, automobile and other personal loans, overdraft protection through \"Chek-Gard\", home improvement loans, mortgage loans and deposit products including checking, savings, certificates of deposit, and individual retirement accounts. The Bank operates three Automated Teller Machines, one at each of its office locations. The Bank is a member of the Internet shared automated teller system, the MOST(R) system, PLUS, and the Exchange systems, providing 24 hour access to funds.\nThe Bank's mission is to provide a high level of personal service to the local community and also to participate in community service within the Montgomery County and the Washington, D.C. metropolitan area. The Bank competes with local and regional commercial banks, savings associations, mutual savings banks, credit unions, money market brokers, and other financial institutions that provide loan and deposit relationships. The Bank competes with these other institutions for customers by offering competitive products and services, interest rates, and delivery of quality service and expertise.\nLENDING ACTIVITIES\nThe Bank's lending activities are broken into three broad types of loan categories consisting of commercial, real estate and consumer loans. The overall size and composition of the loan portfolio depends upon the market demand for credit and management's requirements for liquidity, asset quality and profitability.\nThe composition of the Bank's loan portfolio is shown on the following table.\nA. LOANS OUTSTANDING BY TYPE AT DECEMBER 31 (IN THOUSANDS)\nThe table which follows shows contractual maturities and interest sensitivities of loans in the Portfolio by type of loans as of December 31, 1995. The Bank's experience indicates that some loans will be renewed or prepaid prior to scheduled maturity.\nB. MATURITIES AND SENSITIVITY TO CHANGES IN INTEREST RATES (IN THOUSANDS)\nREAL ESTATE MORTGAGE AND CONSTRUCTION LOANS\nThe Bank makes a wide variety of mortgage loan products available to businesses and individuals. Residential mortgages are made through the Bank's mortgage lending division, with numerous pricing, term and structuring options available. The Bank makes home equity lines of credit available to homeowners for a variety of purposes, with rates based upon the prime rate published in The --- Wall Street Journal, as well as fixed rate home equity term loans for a variety - ------------------- of purposes including home improvement. These loans are typically secured by 1- to 4-family, owner occupied homes in the Washington, D.C. metropolitan area. Commercial mortgages are made available to businesses and individuals for the purchase or re-finance of commercial properties such as office buildings, apartment buildings and industrial buildings located in the Washington, D.C. metropolitan area. These commercial mortgages generally have adjustable rates of interest based upon the prime rate as published in The Wall Street Journal, ----------------------- or tied to an index of U.S. Government securities, have maturities of five years or less and have amortizations of 15-30 years. The Bank does not generally make fixed-rate loans with maturities greater than 15 years for its own portfolio.\nOn a limited basis, the Bank makes loans to businesses and individuals to finance the acquisition, development and construction of real estate. Generally, the loans are made to entities that are constructing the property for their own use and have qualified for permanent financing prior to beginning construction. The Bank's construction loans generally have adjustable rates of interest based on the prime rate as published in The Wall Street Journal, with terms not ----------------------- generally exceeding one year.\nCOMMERCIAL LOANS\nThe Bank makes commercial loans primarily to small- to medium-sized businesses, professionals, and other individuals who desire specialized and personalized financial services. The Bank offers a variety of commercial lending products, including revolving lines of credit, letters of credit, working capital loans, and loans to finance accounts receivable, inventory, and equipment. The Bank's commercial loans generally have adjustable rates of interest based on either the Bank's base lending rate or the prime rate, with terms not generally exceeding five years. Revolving lines of credit generally do not exceed terms of one year. Commercial loans are generally secured by accounts receivable, inventory, other business assets, or real estate.\nCONSUMER LOANS\nThe Bank makes consumer (installment) loans to individuals for a variety of personal and household purposes. Such loans generally are at fixed rates for terms of up to five years.\nDELINQUENCIES AND NON-ACCRUAL LOANS\nAll delinquencies over five days are reviewed by loan officers and management on a weekly basis. Delinquencies greater than 30 days are reviewed by the Board of Directors on a monthly basis. The Bank's loan policy states that the transfer of a loan to non-accrual status will occur when there is a deterioration in the financial condition of the borrower and\/or of collateral such that the collectability of principal and interest is in question or when a loan becomes contractually 90 days past due, unless, based upon management's judgment, the loan is well secured and in the process of collection. When a loan is placed on non-accrual status, all accrued but unpaid interest is reversed from income and future payments are treated as cash income when received. Refer to the schedule of non-performing assets and past-due loans on page 4.\nCollection Policy. The loan officer who services a borrower's loan is ----------------- responsible for monitoring the borrower's financial condition and reviewing the file on a regular basis. If the loan becomes delinquent, the officer is responsible for the collection of the loan. A past due notice is generally sent when a loan becomes 15 days past due. Thereafter, the account officer makes contact with the borrower on a regular basis as necessary. The officer is responsible for keeping the Bank's management up to date on their collection efforts and new developments regarding the loan's status. As stated above, the Bank's past due reports are reviewed by management on a weekly basis. When a loan becomes 90 days delinquent it is to be transferred to non-accrual status based on the non-accrual guidelines stated above.\nClassified Assets. The Bank reviews the loan portfolio on an ongoing basis ----------------- to detect and identify loans that show a deterioration in the borrower's financial condition or collateral values. Each loan is rated through a criteria and classification system based on the quality of the loan. There are eight ratings that can be assigned to a loan. These ratings are reviewed on an annual basis. These ratings are intended to be identical to the ratings used by the Bank's regulatory agencies. Of the eight ratings, the first four are generally referred to as \"pass\" loans, the fifth as \"special mention\" loans and the sixth, seventh, and eighth as \"substandard,\" \"doubtful,\" and \"loss.\" When the Bank classifies loans as either \"substandard\" or \"doubtful,\" it is required to establish a specific allowance for loss in an amount deemed prudent by management. When the Bank classifies a loan as \"loss\" it is required to establish a specific allowance equal to 100% of the amount or to charge-off the amount against the allowance for credit losses. In addition to these specific allowances, the Bank maintains a general allocation which represents loss allowances\nwhich have been established to recognize the inherent risk associated with lending activities but have not been allocated to particular loans. The Bank's determination as to the classification of its assets and the amount of its allowance for credit losses is subject to review by the FDIC and the Commissioner which can require the establishment of additional general or specific loss allowances.\nThe Bank maintains a Watch List of all loans rated special mention or worse. The Watch List includes, among other things, basic information on the loan, its risk rating, allowance percentage allocated to the loan and the dollar amount of the allowance specifically reserved against the loan. All changes in risk rating assignments must be approved by the chief lending officer. Changes also are made on a monthly basis upon the recommendation of the loan officer responsible for the loan. The Watch List is reviewed by the Board of Directors on a monthly basis.\nOTHER REAL ESTATE OWNED\nOther real estate owned represents assets acquired in satisfaction of loans either by foreclosure, deeds taken in lieu of foreclosure or by in substance foreclosure. In substance foreclosures include loans where the borrower has little or no equity in the collateral and it is doubtful that the borrower can rebuild equity in the foreseeable future.\nProperties acquired are recorded at the lower of cost or fair value minus estimated selling costs at the time of acquisition with any deficiency charged to the allowance for credit losses. Thereafter, costs incurred to operate or carry the properties are charged to operating expense. Gains and losses resulting from the final disposition of the properties are included in non- interest expense. Any reductions in value as determined by periodic re-appraisal of the property, or other means, is either charged to operations or reserved against the property by an allowance which is funded by a charge to operations.\nGenerally, the Bank obtains appraisals annually by state licensed or certified appraisers for each property owned at acquisition, and evaluates each property's value regularly thereafter.\nC. NON-PERFORMING ASSETS AND PAST DUE LOANS (IN THOUSANDS)\nALLOWANCE FOR CREDIT LOSSES\nThe allowance for credit losses is established through a provision for credit losses based on management's evaluation of the risk inherent in the loan portfolio and the general economy. This evaluation, which includes a review of the loan portfolio, considers, among other things, the estimated net realizable value of the underlying collateral, economic conditions, historical loan loss experience, and other factors. The adequacy of this allowance is reviewed by management on a quarterly basis and subsequently reviewed by the Board of Directors. Although the Bank attempts to maintain an allowance adequate to cover potential losses, there can be no assurance that future losses will not exceed the Bank's allowance.\nSUMMARY OF LOAN LOSS EXPERIENCE AND ALLOWANCE FOR CREDIT LOSSES (DOLLARS IN THOUSANDS)\nINVESTMENT ACTIVITY\nThe Corporation's investment policy is implemented by the Investment Committee, which is comprised of selected Board members and management. The investments are chosen primarily to provide and maintain adequate liquidity and to generate a positive return on investments without undue interest or credit risk. Investments are generally made with the intent to hold them until maturity. The Corporation invests in various types of liquid assets, including United States Treasury obligations and securities of Federal Government agencies and sponsored entities, certain certificates of deposit, Federal funds, and other qualifying liquid investments. At December 31, 1995, the Corporation had $8,014,773 outstanding in the investment portfolio and $12,000 in other investments. Refer to Note 3 of the Notes to the Consolidated Financial Statements contained in Item 7 hereof for the carrying and fair values of the investment securities portfolio. The investment portfolio is accounted for in accordance with FAS 115 which was implemented as of December 31, 1993. Refer to Management's Discussion and Analysis in Item 6 hereof for a discussion of certain investments.\nDEPOSIT ACTIVITIES\nThe Bank offers a wide range of deposit products with varying rates and terms to meet the banking needs of both individuals and business customers in the community. The Bank offers checking, interest checking, money market accounts, savings, and individual retirement accounts (\"IRAs\"). The Bank also offers a variety of certificates of deposit with maturities of three months to five years.\nThe average balance of deposits and average interest paid during the years 1995, 1994 and 1993 can be found in the Three Year Average Consolidated Balance Sheet contained in Item 6 hereof.\nA. CERTIFICATES OF DEPOSIT OF OVER $100,000 BY MATURITY AT DECEMBER 31, (IN THOUSANDS)\nBORROWINGS\nThe average amounts of borrowings outstanding during 1995, 1994 and 1993 and the approximate weighted average interest rate thereon is contained in the Three-Year Average Consolidated Balance Sheet in Item 6 hereof.\nSUPERVISION AND REGULATION\nThe Corporation is a bank holding company within the meaning of the Act and is registered as such with the FRB. The Corporation is required to file with the FRB an annual report and such other information as the FRB may require pursuant to the Act. The Corporation is subject to regulation and examination by the FRB, which may also examine any of the Corporation's subsidiaries.\nThe 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 FRB to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. The Act generally requires prior approval by the FRB of the acquisition by a bank holding company of more than five percent of the voting shares of any bank. With certain exceptions, the Act prohibits a bank holding company 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, unless the FRB determines by order or regulation that the activities of the company whose shares are to be acquired are so closely related to banking or managing or controlling banks as to be a proper incident thereto. Some of the principal activities that the FRB has determined by regulation to be so closely related to banking are: (i) making or servicing loans; (ii) performing certain data processing services; (iii) providing securities brokerage services; (iv) acting as fiduciary, investment or financial advisor; (v) leasing personal or real property where the lease serves as the functional equivalent of a loan; (vi) making investments in corporations or projects designed primarily to promote community welfare; and (vii) acquiring a savings and loan association.\nSubsidiary banks of a bank holding company are subject to certain quantitative restrictions imposed by the Federal Reserve Act on any extension of credit to, or purchase of assets from, or guarantee or letter of credit on behalf of the bank holding company or its subsidiaries, and on the investment in or acceptance of stocks or securities of such holding company or its subsidiaries as collateral for loans. In addition, provisions of the Federal Reserve Act and FRB regulations limit the amounts of, and establish required procedures and credit standards with respect to, loans and other extensions of credit to officers, directors, and principal shareholders of the Holding Company and its subsidiaries, and related interests of such persons. Moreover, subsidiaries of bank holding companies are prohibited from engaging in certain tie-in arrangements (with the holding company or any of its subsidiaries) in connection with any extension of credit, lease or sale of property or furnishing of services.\nAs a state-chartered commercial bank, the Bank is subject to regulation and examination primarily by the Commissioner but also by the FDIC. These agencies, as well as Federal and State law, extensively regulate various aspects of the Bank's business including permissible types and amounts of loans, investments and other activities, capital adequacy (by requiring minimum capital ratios), branching, and the safety and soundness of banking practices. Both the Commissioner and the FDIC have substantial authority to regulate unsafe or unsound practices and violations of law including cease and desist orders, removal of directors and officers, civil money penalties and, ultimately, appointment of a receiver or conservator. Banking regulations restrict transactions by banks owned by a bank holding company, including: (1) loans to and certain purchases from the parent holding company, principal shareholders, officers, directors, and their affiliates; (2) investments by the subsidiary bank in the shares or securities of the parent bank holding company (or any other nonbank affiliates); and (3) acceptance of such shares or securities as collateral for loans to any borrower. The Bank's regulators also may review other transactions, such as payments of management fees by subsidiary banks to affiliated companies. The Bank is subject to legal limitations on the frequency and amount of dividends that can be paid to the Corporation. Under Maryland banking regulations, the Bank may not declare a cash dividend except out of undivided profits, or from its surplus in excess of 100% of its required capital stock with the prior approval of the Commissioner, both after providing for due and accrued expenses, losses, interest and taxes. In addition, the FDIC may restrict the ability of the Bank to pay dividends if such payments would constitute an unsafe or unsound banking practice. Also, State and Federal laws regulate the amount of voting stock of a bank or bank holding company that a person may acquire without prior approval.\nUnder Federal Reserve Board regulations, the Bank is required to maintain noninterest-earning reserves against its transaction accounts (primarily interest checking and regular checking accounts). The Federal Reserve Board regulations generally require that, for 1995, reserves of 3% must be maintained against aggregate transaction accounts of $54.0 million or less (subject to adjustment by the Federal Reserve Board) and an initial reserve of $1.62 million plus 10% (subject to adjustment by the Federal Reserve Board between 8% and 14% and was reduced to 10% effective April 1, 1992) against that portion of total transaction accounts in excess of $54.0 million. The first $4.2 million of otherwise reservable balances (subject to adjustments by the Federal Reserve Board) are exempted from the reserve requirements. Since the amount of the Bank's transaction accounts are below the $54.0 million, the Bank is currently subject to the 3% reserve requirement for maintaining reserves. Because required reserves must be maintained in the form of either vault cash, a noninterest-bearing account at a Federal Reserve Bank, or a pass-through account as defined by the FRB, the effect of this reserve requirement is to reduce the Bank's interest-earning assets.\nEFFECT OF GOVERNMENTAL ACTION\nOperating results of the Corporation and the Bank are affected by the policies of various regulatory, fiscal and monetary authorities including the FRB. Major functions of the FRB, in addition to those set out under Supervision and Regulation above, are to regulate the supply of bank credit and to deal generally with economic conditions within the United States, including efforts to combat recessionary economic conditions and to curb inflationary pressures. The instruments of monetary policy employed by the FRB for these purposes influence in various ways the overall levels of bank loans and extensions of credit, investments and deposits as well as the interest rate paid on liabilities and received on earning assets. The implementation of these policies has had a significant effect on the operating results of bank holding companies and banks in the past and will continue to do so in the future. In view of changing conditions within the national economy as well as the uncertain effects of actions by regulatory, fiscal, and monetary authorities, no prediction can be made as to possible future changes in interest rates, deposit levels or loan demand, or their effect on the business and earnings of the Corporation and the Bank. Also, it cannot be predicted whether or in what manner the operation of the Corporation and the Bank may be effected by any pending or future Federal or state legislative actions.\nCOMMUNITY REINVESTMENT\nUnder the Community Reinvestment Act (\"CRA\"), as implemented by FDIC regulations, a financial institution has a continuing and affirmative obligation consistent with its safe and sound operation to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution's discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA. The CRA requires the FDIC, in connection with its examination of a bank, to assess the institution's record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications by such institution. The CRA rating system identifies four levels of performance that may describe an institution's record of meeting community needs: outstanding, satisfactory, needs to improve and substantial noncompliance. The CRA also requires all institutions to make public disclosure of their CRA ratings. The Bank received a \"Satisfactory\" CRA rating in its most recent examination.\nCAPITAL MAINTENANCE\nThe FDIC has issued regulations that require banks with deposits insured by the Bank Insurance Fund (\"BIF\"), such as the Bank, to maintain minimum levels of capital. The regulations establish a minimum leverage capital requirement of not less than 3% core capital to total average assets for banks in the strongest financial and managerial condition, with a CAMEL Rating of 1 (the highest examination rating of the FDIC for banks). For all other banks, the minimum leverage capital requirement is 3% plus an additional cushion of at least 100 to 200 basis points. Core capital is comprised of the sum of common stockholders' equity, noncumulative perpetual preferred stock (including any related surplus) and minority interests in consolidated subsidiaries, minus all intangible assets (other than qualifying mortgage servicing rights and purchased credit card relationships). At December 31, 1995, the Bank's ratio of core capital to total average assets equalled 9.36%, which exceeded the minimum leverage requirement.\nThe FDIC also requires that banks meet a risk-based capital standard. The risk-based capital standard requires the maintenance of total capital (which is defined as core capital and supplementary capital) to risk-weighted assets of 8 % and core capital to risk-weighted assets of 4%. In determining the amount of risk-weighted assets, all assets, plus certain off balance sheet items are multiplied by a risk-weight of 0% to 100%, based on the risks the FDIC believes are inherent in the type of asset or item. The components of core capital are equivalent to those discussed earlier under the 3% leverage requirement. The components of supplementary capital currently include cumulative perpetual preferred stock, certain other preferred stock, mandatory convertible debt securities, subordinated debt and intermediate term preferred stock, and allowance for loan and lease losses. Allowance for loan and lease losses included in supplementary capital is limited to a maximum of 1.25% of risk- weighted assets. Overall, the amount of capital counted toward supplementary capital cannot exceed 100% of core capital. Federal law also prohibits a bank from paying a dividend if it will not meet applicable capital requirements after the payment.\nAt December 31, 1995, the Bank's total capital to risk-weighted assets was 15.90% and the Bank's core capital to risk-weighted assets was 14.65%, both exceeding the FDIC risk-based capital requirement.\nPROMPT CORRECTIVE ACTION\nThe Federal Deposit Insurance Corporation Improvement Act of 1991 (the \"FDICIA\") established a system of prompt corrective action to resolve the problems of undercapitalized institutions. The FDIC, FRB, Office of the Comptroller of the Currency (\"OCC\") and OTS have adopted final rules, effective December 19, 1992, which require such regulators to take certain supervisory actions against undercapitalized institutions, the severity of which depends upon the categories consisting of \"well capitalized,\" \"adequately capitalized,\" \"undercapitalized,\" \"significantly undercapitalized,\" and \"critically undercapitalized.\" Regulatory action taken will depend on the level of capitalization of the institution and may range from restrictions on capital distributions and dividends to seizure of the institution. Generally, subject to narrow exceptions, FDICIA authorizes the banking regulators to specify the ratio of tangible capital to assets at which an institution becomes critically undercapitalized and requires that ratio to be no less than 2% of assets. The FDICIA also allows the regulator to downgrade an institution if the institution is determined to be in an unsafe or unsound condition or to be engaging in unsafe or unsound practices. Such a downgrading may result in an otherwise \"adequately capitalized\" institution with other problems being subject to supervisory actions as if it were classified as \"undercapitalized.\"\nThe final rule adopted by the FDIC, on September 15, 1992, to implement the prompt corrective action section of the FDICIA, generally provides that an insured institution that has total risk-based capital of less than 8%, core capital of less than 4%, or a leverage ratio that is less than 4% would be considered to be \"undercapitalized,\" an insured institution that has total risk- based capital less than 6%, core capital of less than 3%, or a leverage ratio that is less than 3% would be considered to be \"significantly undercapitalized,\" and an insured institution that is \"undercapitalized,\" \"significantly undercapitalized,\" or \"critically undercapitalized\" becomes immediately subject to certain regulatory restrictions, including, but not limited to, restrictions on growth, investment activities, capital distributions and affiliate transactions. The filing of a capital restoration plan, which must be guaranteed by any parent holding company, is also required. In addition, \"critically undercapitalized\" institutions must receive prior written approval from the FDIC to engage in any material transaction other than the normal course of business. Subject to a narrow exception, a receiver or conservator must be appointed for any critically undercapitalized institution within 90 days after it becomes critically undercapitalized.\nINSURANCE OF DEPOSIT ACCOUNTS\nThe FDIC has established a risk-based deposit insurance premium assessment system for insured depository institutions. Under the system, the assessment rate for an insured depository institution depends on the assessment risk classification assigned to the institution by the FDIC, which is determined by the institution's capital level and supervisory evaluations. Institutions are assigned to one of three capital groups -- well-capitalized, adequately capitalized or undercapitalized -- based on the data reported to regulators for the date closest to the last day of the seventh month preceding the semi-annual assessment period. Well-capitalized institutions are institutions satisfying the following capital ratio standards: (i) total risk-based capital ratio of 10.0% or greater; (ii) Tier 1 risk-based capital ratio of 6.0% or greater; and (iii) Tier 1 leverage ratio of 5.0% or greater. Adequately capitalized institutions are institutions that do not meet the standards for well-capitalized institutions but that satisfy the following capital ratio standards: (i) total risk-based capital ratio of 8.0% or greater; (ii) Tier 1 risk-based capital ratio of 4.0% or greater; and (iii) Tier 1 leverage ratio of 4.0% or greater. Undercapitalized institutions consist of institutions that do not qualify as either well-capitalized or adequately capitalized institutions. Within each capital group, institutions are assigned to one of three subgroups on the basis of supervisory evaluations by the institution's primary supervisory authority and such other information as the FDIC determines to be relevant to the institution's financial condition and the risk posed to the deposit insurance fund. Subgroup A consists of financially sound institutions with only a few minor weaknesses. Subgroup B consists of institutions that demonstrate weaknesses that, if not corrected, could result in significant deterioration of the institution and increased risk of loss to the deposit insurance fund. Subgroup C consists of institutions that pose a substantial probability of loss to the deposit insurance fund unless\neffective corrective action is taken. For the semi-annual period beginning June 30, 1995, the assessment rate for BIF-insured institutions, such as the Bank, was lowered to between 0.04% and .31% of insured deposits from 0.23% to 0.31% of insured deposits and was subsequently reduced to the statutory minimum of $1,000 for the most highly rated banks for the semi-annual period beginning January 1, 1996. The Bank was notified that its assessment rate for the first six months of 1996 is 0.03%.\nSupervision, regulation and examination of the Bank and the Corporation by the bank regulatory agencies are intended primarily for the protection of depositors rather than for holders of Bank or Corporation stock.\nUnder the Federal Deposit Insurance Act (the \"FDI Act\"), insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC. The management of the Bank does not know of any practice, condition or violation that might lead to termination of deposit insurance.\nCOMPETITION\nIn order to compete effectively, the Bank relies substantially on local commercial and consumer activity; personal contacts by its directors, officers, other employees and shareholders; personalized services; and its reputation in the communities it serves.\nThe Bank presently competes within its market area with numerous bank subsidiaries of larger bank holding companies, including the subsidiaries of regional bank holding companies with principal operations in states other than Maryland. It also competes with numerous independent banks, thrift institutions, credit unions, and various other nonbank financial companies.\nThe banking business in Maryland generally, and the Bank's primary service areas specifically, are highly competitive with respect to both loans and deposits. As noted above, the Bank competes with many larger banking organizations that have offices over a wide geographic area. These larger institutions have certain inherent advantages, such as the ability to finance wide ranging advertising campaigns and promotions and to allocate their investment assets to regions offering the highest yield and demand. They also offer services such as international banking, which are not offered directly by the Bank (but could be offered indirectly through correspondent institutions); and by virtue of their larger total capitalization (legal lending limits to an individual consumer or corporation are limited to a percentage of the Bank's total capital accounts), such banks have substantially higher lending limits than does the Bank. Other entities, both governmental and in private industry, raise capital through the issuance and sale of debt and equity securities and thereby indirectly compete with the Bank in the acquisition of deposits.\nIn addition to competing with other commercial banks and thrift institutions, commercial banks such as the Bank compete with nonbank financial institutions for funds. For instance, yields on corporate and government debt and equity securities affect the ability of commercial banks to attract and hold deposits. Commercial banks also compete for available funds with money market instruments, which are not subject to interest rate ceilings. Such money market funds have provided substantial competition to banks for deposits, and it is anticipated they may continue to do so in the future.\nThe Act was recently amended by the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the \"Riegle-Neal Act\"), which significantly eased applicable restrictions on interstate banking. The Riegle Neal Act permits the FRB to approve an application of an adequately capitalized and adequately managed bank holding company to acquire control of, or acquire all or substantially all of the assets of, a bank located in a state other than such holding company's home state, without regard to whether the transaction is prohibited by the laws of any state. The FRB may not approve the acquisition of bank that has not been in existence for the minimum time period (not exceeding five years) specified by the statutory law of the host state. The Riegle-Neal Act also prohibits the FRB\nfrom approving an application if the applicant (and its depository institution affiliates) controls or would control more than 10% of the insured deposits in the United States or 30% or more of the deposits in the target bank's home state or in any state in which the target bank maintains a branch. The Riegle-Neal Act does not affect the authority of states to limit the percentage of total insured deposits in the state which may be held or controlled by a bank or bank holding company to the extent such limitation does not discriminate against out- of-state banks or bank holding companies. The effect of the Riegle-Neal Act may be to increase competition within the State of Maryland among banking and thrift institutions located in Maryland and from banking companies located anywhere in the country.\nThe Riegle-Neal Act also authorizes the federal banking agencies, effective June 1, 1997, to approve interstate merger transactions without regard to whether such transaction is prohibited by the law of any state, unless the home state of one of the banks opts out of the Riegle-Neal Act by adopting a law after the date of enactment of such Act and prior to June 1, 1997 that applies equally to all out-of-state banks and expressly prohibits merger transactions involving out-of-state banks.\nThe State of Maryland had previously enacted reciprocal interstate banking statutes that authorized banks and thrift institutions, and their holding companies, in Maryland to be acquired by regional banks and thrift institutions, or their holding companies, in designated states, and permitted Maryland banks and thrift institutions, and their holding companies, to acquire banks and thrift institutions in designated states, if such jurisdictions have enacted reciprocal statutes. A majority of the jurisdictions designated in the interstate banking statutes have enacted legislation authorizing interstate transactions in one form or another. In 1995, the State of Maryland adopted legislation allowing out of state financial institutions to merge with Maryland banks and to establish branches in Maryland, subject to certain limitations. The effect of the federal and Maryland legislation may be to increase competition within the State of Maryland among banking and thrift institutions located in Maryland and from the major regional bank holding companies that acquire institutions in Maryland, most of which are larger than the Bank.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. DESCRIPTION OF PROPERTY\nThe main office of the Corporation and the Bank is located at Twinbrook Square, 1800 Rockville Pike, Rockville, Maryland. The premises are leased under an agreement which expires in 1999. The Bank leases its two branches; the Germantown location is operating under a lease which expires in 2005 and the Bethesda location operates under a lease which expires in 2002. The Bank considers these properties suitable and adequate for current operations. During 1995, the Bank incurred rental expenses for properties totaling $244,244. Refer to Note 5--\"Property and Equipment\" on page 17 of the Annual Report, which is hereby incorporated by reference.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Bank filed suit against two borrowers (the \"Borrowers\") on January 28, 1992 in the Circuit Court for Montgomery County seeking a judgment of $421,921.28 for the principal plus interest and late charges owed to the Bank on the Borrowers' note (the \"Note\"). In addition, the Bank sought and received a prejudgment attachment of an account in the name of the Borrowers held at Shearson Lehman Brothers which was pledged as collateral for the loan. In May 1992, the Borrowers filed for protection under Chapter 11 of the United States Bankruptcy Code.\nA motion by the Borrowers in the Bankruptcy proceeding seeking relief from the automatic stay to pursue the action in state court was granted and in December 1992 the Borrowers filed answers and counterclaims in both the State Court and Bankruptcy actions. The counterclaims alleged that the Bank breached its contract with the Borrowers when it allegedly indicated in 1990 that it would not extend the Note for the 6-month period provided for in the Note; the Bank intentionally misrepresented the ability of the Borrowers to hypothecate the Shearson Lehman account; the Bank intentionally interfered with the Borrowers' contracts; and the Bank violated Section 1-302 and 5-807 of the Maryland Financial Institutions Code. In the Bankruptcy action, the Borrowers also alleged\nthat the Bank violated the Equal Credit Opportunity Act (\"ECOA\"). The Bankruptcy Court dismissed the ECOA counterclaim with prejudice and other counterclaims without prejudice to be resolved in the State Court litigation.\nIn 1993, the Borrowers filed a complaint against the Bank in the Bankruptcy case requesting that proceeds of the Shearson Lehman account be turned over to the Borrowers to fund a bankruptcy plan. The Bank filed a counterclaim for a declaratory judgment that the Bank has a perfected security interest in the account and for dismissal of the complaint. (The Borrowers' complaint for turnover and the Bank's counterclaim may be referred to collectively as the \"Turnover Action\"). The Bankruptcy Court granted summary judgment in favor of the Bank in the Turnover Action, ruling that the Bank has a perfected security interest in the account. The Bankruptcy Court also denied motions for reconsideration filed by the Borrowers and their counsel. The Bankruptcy Court subsequently ruled in favor of the Bank and in March 1996, the proceeds from the Shearson Lehman account were received by the Bank.\nOn or about August 15, 1994, the Borrowers' bankruptcy was converted to a Chapter 7 proceeding. A Chapter 7 Trustee has been appointed to liquidate the assets of the estate. The Bank has submitted an offer to the Trustee for the settlement of the State Court litigation, which offer is under review by the Trustee.\nNote 10--\"Litigation\" on page 18 of the Annual Report is hereby incorporated 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 the Corporation's security holders during the quarter ended December 31, 1995, through solicitation of proxies or otherwise.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThis section entitled \"Market for the Common Equity and Related Stockholder Matters\" on page 7 of the Annual Report is hereby incorporated by reference. For information regarding regulatory restrictions on the Bank's, and, therefore, the Corporation's payment of dividends, see Note 9 -- \"Regulatory Matters and Restrictions\" on page 18 of the Annual Report, which hereby is incorporated by reference.\nITEM 6.","section_6":"ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION\nThe section entitled \"Selected Financial Data\" on page 1 of the Annual Report and the section entitled \"Management's Discussion and Analysis\" on pages 2 through 7 in the Annual Report are hereby incorporated by reference.\nITEM 7.","section_7":"ITEM 7. FINANCIAL STATEMENTS\nThe Consolidated Financial Statements, Notes to Consolidated Financial Statements and Independent Auditors' Report on pages 8 through 20 in the Annual Report, which are listed under Item 13 herein, are incorporated herein by reference. The remaining information appearing in the Annual Report is not deemed to be filed as part of this Report, except as expressly provided herein.\nITEM 8.","section_7A":"","section_8":"ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable.\nPART III\nITEM 9.","section_9":"ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16 (A) OF THE EXCHANGE ACT\nThe information relating to the Directors and Executive Officers of the Corporation on pages 2 through 4 of the Corporation's definitive proxy statement for the Corporation's 1996 Annual Meeting of Stockholders (the \"Proxy Statement\") is hereby incorporated by reference.\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. EXECUTIVE COMPENSATION\nThe section entitled \"Executive Compensation and Other Benefits\" on pages 5 and 6 of the Proxy Statement are hereby incorporated by reference.\nITEM 11.","section_11":"ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nPage 2 of the Proxy Statement relating to security ownership of certain beneficial owners and management is hereby incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe section entitled \"Certain Transactions\" on page 6 of the Proxy Statement is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K\n(a) The following financial statements of the Corporation included in the Annual Report to stockholders for the year end December 31, 1995 are incorporated by reference in item 7 of this Report. The remaining information appearing in the Annual Report to stockholders is not deemed to be filed as part of this Report except on expressly provided herein. The following financial statements are filed as part of this Report:\nConsolidated Balance Sheets at December 31, 1995 and 1994\nConsolidated Statements of Income (Loss) for the Years Ended December 31, 1995, 1994 and 1993\nConsolidated Statements of Changes in Stockholders' Equity for the Years Ended December 31, 1995, 1994 and 1993\nConsolidated Statements of Cash Flows for the Years Ended December 31, 1995, 1994 and 1993\nNotes to Consolidated Financial Statements\nIndependent Auditors' Report\nAll financial statement schedules are omitted as the required information is inapplicable or the information is presented in the consolidated financial statements or related notes which are incorporated by reference in item 7 hereof.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Corporation has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nFWB BANCORPORATION \/s\/ STEVEN COLLIATIE -------------------------------------- Steven Colliatie Date: March 27, 1996 President and Chief Executive Officer\nIn accordance with 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:\nINDEX TO EXHIBITS\n______________\n* Incorporated herein by reference from the Registrant's Annual Report on Form 10-KSB for the year ended December 31, 1994 (File No. 0-16187).\n(b) The Corporation did not file a report on Form 8-K during the last quarter of the period covered by this report.","section_14":"","section_15":""}
{"filename":"761860_1995.txt","cik":"761860","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nIP Timberlands, Ltd. (the 'Registrant') is a Texas limited partnership formed by International Paper Company ('International Paper') to succeed to substantially all of International Paper's forest resources business. The Registrant's forest resources business includes the marketing and sale of forest products for use as sawlogs, poles and pulpwood. In addition, the Registrant may sell or exchange portions of its forestlands and may acquire additional properties for cash, additional units or other consideration.\nThe Registrant operates through IP Timberlands Operating Company, Ltd., a Texas limited partnership ('IPTO'), in which the Registrant holds a 99% limited partner's interest. IP Forest Resources Company ('IPFR'), a wholly owned subsidiary of International Paper, is the managing general partner of the Registrant and IPTO, and International Paper is the special general partner of both. A further discussion of the Registrant's organization appears on pages 2 and 14 of the Annual Report to Unitholders (the 'Annual Report'), which information is incorporated herein by reference.\nDESCRIPTION OF PRINCIPAL PRODUCTS\nThe Registrant's forestlands include merchantable forest products inventory, approximately 60% of which consists of commercial softwoods, principally Douglas fir in the Pacific Northwest, southern pine in the South, and spruce and fir in the Northeast. A variety of hardwoods account for the remaining 40% of the inventory.\nThe Registrant sells forest products to International Paper for use in its pulp mills and wood products plants and to third party customers.\nA discussion of the Registrant's harvest plan is presented on page 8 of the Annual Report, which information is incorporated herein by reference.\nCOMPETITION AND COSTS\nLog and wood fiber consuming facilities tend to purchase raw materials within relatively small geographic areas, generally within a 100-mile radius. Competitive factors within a market area generally include price, species, grade and proximity to wood-consuming facilities. The Registrant competes in the log and wood fiber market with numerous private industrial and nonindustrial forestland owners as well as with the U.S. government, principally the U.S. Forest Service and the Bureau of Land Management. Litigation involving endangered species and environmental concerns has caused a decline in government forest products sales volumes and market share in recent years and has resulted in additional demand and higher prices for private forestland owners.\nMany factors influence the Registrant's competitive position, including costs, prices, product quality and services.\nMARKETING\nConsistent with International Paper's experience prior to the contribution of its forestlands to the Registrant, the Registrant has annually sold forest products from its lands to more than 579 purchasers other than International Paper. No customer accounted for more than 10% of annual revenues for the years 1995 and 1994.\nDuring 1995, 1994 and 1993, International Paper's facilities consumed approximately 31%, 30% and 30%, respectively, of the logs and wood fiber harvested from the Registrant's forestlands, which represented approximately 11%, 10% and 12%, respectively, of its manufacturing facilities' requirements during such periods. International Paper does not anticipate any change in its policy of relying on the Registrant's forestlands as an important source of raw material for its manufacturing facilities, although it is unable to predict what portion of its requirements will be purchased from the Registrant in the future. In addition to sales to International Paper for use in its manufacturing facilities, the Registrant sells trees to International Paper that are harvested and resold by International Paper to unaffiliated purchasers as logs, poles or pulpwood.\nAdditional information on marketing activities, including related parties and major customers, appears on pages 8, 14 and 15 of the Annual Report, which information is incorporated herein by reference.\nENVIRONMENTAL PROTECTION AND SUSTAINABLE FOREST MANAGEMENT\nManagement of the Registrant's forestlands to protect the environment and maintain the health of its forestlands is a continuing commitment of the Registrant. The Registrant expends considerable efforts to comply with regulatory requirements and applicable best management practices regarding the use of pesticides, protection of wetlands, protection of wildlife and biodiversity and minimization of stream sedimentation and soil erosion. From time to time the Registrant volunteers to, or may be required to, clean up certain solid waste sites, on its forestlands, created by the general public. Forests are managed in accordance with the Registrant's and International Paper's Sustainable Forestry Guidelines which were developed in 1995 based on the American Forest and Paper Association's Sustainable Forestry Principles, which were adopted by International Paper and the Registrant in 1994. Environmental protection and forest management costs and capital expenditures have not been significant and are not expected to be significant in the future.\nEMPLOYEES\nThe Registrant does not have officers or directors. Instead, officers and directors of IPFR perform all management functions for the Registrant. In most respects, the Registrant conducts the business formerly conducted by the Forestlands Division of International Paper. Consequently, the employees of International Paper or its subsidiaries formerly assigned to such division continue to carry out the activities of the Registrant. These employees continue to be employees of International Paper and in some cases are employed solely for the conduct of the Registrant's business.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nFORESTLANDS\nForestlands include approximately 5.4 million acres owned in fee (excluding any interest in underlying minerals) and approximately 541,000 acres held under long-term deeds and leases (terms of three years or longer). These forestlands are located in 14 states in three major regions of the United States. In the Pacific Northwest, forestlands are located in Oregon and Washington, including approximately 303,000 acres owned in fee and approximately 1,100 acres covered by deeds and leases. In the southern and southeastern United States, forestlands are located in seven states, including approximately 3,607,000 acres owned in fee and approximately 538,000 acres held under long-term deeds and leases. In the Northeast, forestlands are located in Maine, New York, Pennsylvania, Vermont and New Hampshire, including approximately 1,466,000 acres owned in fee and approximately 1,500 acres held under long-term deeds and leases. The deeds and leases held by the Registrant generally do not include deeds and leases on government lands in the western United States nor deeds and leases with terms of less than three years, which are generally managed by International Paper in connection with short-term wood procurement for its manufacturing facilities.\nIn March 1996, the Registrant signed a contract to sell a 98% general partnership interest in a subsidiary partnership owning all of Registrant's Western region assets. Additional information on the sale of the Western assets appears on pages 8, 10 and 16 of the Annual Report, which information is incorporated herein by reference.\nCAPITAL INVESTMENTS\nDiscussion of the Registrant's capital investments can be found on pages 9 and 10 of the Annual Report, which information is incorporated herein by reference.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIPTO and International Paper are parties to a lawsuit involving a long-term lease on 113,000 acres of forestlands in Mississippi. The lessors sought to have the lease terminated and IPTO enjoined from further operation on the properties, as well as approximately $18 million in alleged damages, plus alleged statutory and trebling damages in excess of $450 million.\nTrial in the Mississippi state court case has been stayed pending the determination of the value for the purchase option relating to the lease lands located in Mississippi. Over IPTO's objections, a panel of appraisers set the value of the lands on October 20, 1995 at $38.5 million. On December 19, 1995, the Hinds County Circuit Court affirmed the award. IPTO and International Paper believe the value of the purchase option should have been determined by arbitration process and that the appraised value is excessive. IPTO and International Paper\nhave filed a notice of appeal with the Mississippi Supreme Court. On February 15, 1996, the purchase option relating to the Mississippi lease was assigned from IPTO to International Paper.\nThe Registrant is involved in various legal proceedings incidental to its business. While any proceeding or litigation has an element of uncertainty, the Registrant believes that the outcome of any lawsuit or claim that is pending or threatened, or all of them combined, will not have a material adverse effect on its consolidated financial position or results of operations.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended December 31, 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe market and cash distribution data on the Registrant's Class A Depositary Units are set forth below and on pages 2 and 17 of the Annual Report and are incorporated herein by reference.\nAs of March 25, 1996, there were 3,206 holders of record of the Registrant's Class A Depositary Units.\nSet forth below are the market price ranges for each quarter of 1995 and 1994 for the Class A Depositary Units on the New York Stock Exchange Composite Index.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nSelected financial data for 1995, 1994 and 1993 is set forth on page 1 of the Annual Report and is incorporated herein by reference. Selected financial data for 1992 and 1991 is as follows (in thousands, except per unit data):\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nManagement's review and comments on the consolidated financial statements are set forth on pages 8 through 10 of the Annual Report and are incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe Registrant's consolidated financial statements, the notes thereto and the report of independent public accountants are set forth on pages 11 through 16 and 18 of the Annual Report and are incorporated herein by reference.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nFORWARD-LOOKING INFORMATION\nTHIS 1995 ANNUAL REPORT ON FORM 10-K CONTAINS CERTAIN FORWARD-LOOKING STATEMENTS CONCERNING REGISTRANT'S BUSINESS PROSPECTS, POSSIBLE DECLINES IN DISTRIBUTIONS AND THE PRICE OF THE CLASS A UNITS. OVERALL MARKET CONDITIONS COULD INFLUENCE THE EXPECTED PRICE DECLINE OF THE CLASS A UNITS AND THE POSSIBILITY OF A DECLINE IN THE DISTRIBUTION TO CLASS A UNITHOLDERS.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe directors and executive officers of IPFR(1) and their business experiences are as set forth below:\nJOHN A. GEORGES, 65, Chairman and Chief Executive Officer of IPFR since 1985(2). He has been chairman and chief executive officer of International Paper Company since 1985. He is a director of AK Steel Holding Corporation, International Paper Company, Ryder Systems, Inc., Scitex Corporation Ltd. and Warner-Lambert Company. He is a member of The Business Council and the Policy Committee of the Business Roundtable. He is a board member of The Business Council of New York State, a member of the Trilateral Commission, the President's Advisory Committee for Trade Policy and Negotiations and president of the University of Illinois Foundation.\nDirector since January 8, 1985.\n**THOMAS C. GRAHAM, 69, Chairman of the Board of AK Steel Corporation since 1994, and previously thereto he was also the Chief Executive Officer. He was elected to the aforementioned posts concurrent with the formation of AK Steel Holding Corporation, a publicly held corporation which emerged from the privately-held Armco Steel Company, L.P. in April of 1994. He had been named president and chief executive officer of Armco Steel in June 1992. He was formerly chairman and chief executive officer of Washington Steel Corporation\nuntil he assumed his current position in 1992. He was vice chairman--steel and diversified group and executive director of USX Corporation from 1986 to 1991. He joined the former U.S. Steel Corporation as vice chairman and chief operating officer--steel and related resources in 1983. Prior to that time he served as president and chief executive officer of Jones & Laughlin Steel Corporation. He is a director of Hershey Foods Corporation and International Paper Company.\nDirector since April 12, 1994.\n**ARTHUR G. HANSEN, 71, Educational Consultant. He was director of research of the Hudson Institute from 1987 to 1988, chancellor of the Texas A&M University System from 1982 to 1986, president of Purdue University from 1971 to 1982 and president of Georgia Institute of Technology from 1969 to 1971. He is a director of American Electric Power Company, Inc. and International Paper Company. He is a member of the National Academy of Engineering, a Commissioner of the Indiana Commission for Higher Education and a fellow of the American Association for the Advancement of Science.\nDirector since February 1, 1990.\n**JANE C. PFEIFFER, 63, Management Consultant. She is a director of Ashland, Inc., International Paper Company, J.C. Penney Company, Inc. and The Mutual Life Insurance Company of New York. She is a trustee of the Conference Board, The University of Notre Dame, the Overseas Development Council and a member of The Council on Foreign Relations.\nDirector since January 13, 1988.\n**ROGER B. SMITH, 70, former Chairman and Chief Executive Officer of General Motors Corporation from 1981 to 1990, when he retired. He is a director of Citicorp, International Paper Company, Johnson & Johnson and PepsiCo, Inc. He is a member of The Business Council and is a trustee of the Michigan Colleges Foundation, Inc. and the Sloan Foundation.\nDirector since April 12, 1994.\n- ------------------ (1) Managing General Partner of the Registrant.\n(2) Mr. Georges has announced his retirement as a director and Chairman and Chief Executive Officer of IPFR, effective March 31, 1996. Mr. John T. Dillon has been elected to succeed Mr. Georges as a director and Chairman and Chief Executive Officer of IPFR, effective April 1, 1996.\n** Member of the Audit Committee of IPFR. The Audit Committee reviews policies and practices of the Registrant dealing with various matters (including accounting and financial practices) as to which conflicts of interest with the special general partner may arise. The Audit Committee consists of nonemployee directors of IPFR.\nEXECUTIVE OFFICERS AS OF MARCH 31, 1995 INCLUDING NAME, AGE, OFFICES AND POSITIONS HELD*, AND BUSINESS EXPERIENCE DURING THE PAST FIVE YEARS\nEDWARD J. KOBACKER, 57, president since August 1992. He was general manager and group executive of the kraft paper group of International Paper from 1987 to 1992, when he assumed his current position and was elected vice president and general manager--forestlands division of International Paper.\nFREDERICK L. BLEIER, 47, treasurer and controller since July 1993; controller from 1991. He has been sector controller-forest products of International Paper since July 1993. He was director-corporate accounting of International Paper from 1990 to 1993. He joined International Paper as manager-financial reporting in 1988.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe four nonemployee directors of IPFR receive a retainer of $7,000 per year plus a fee of $1,200 for each IPFR Board and committee meeting attended. These fees are paid by IPFR. The Registrant has no employees. All management and services are performed by International Paper on behalf of the Registrant. International Paper pays the personnel used in the Registrant's business, with certain expenses reimbursed to it by the Registrant.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe Registrant knows of no one owning beneficially more than five percent (5%) of the Registrant's Class A Depositary Units except International Paper, which owns approximately eighty-four percent (84%). The following table shows, as of March 25, 1996, the number of Class A Depositary Units in the Registrant beneficially owned (as defined by the Securities and Exchange Commission) or otherwise claimed by current IPFR directors and by all IPFR directors and executive officers as a group (if no name appears, no Class A Depositary Units are owned or claimed).\n- ------------------ (1) Ownership shown includes securities over which the individual has or shares, directly or indirectly, voting or investment powers, including units owned by a spouse or relatives and ownership by trusts for the benefit of such\nrelatives, as required to be reported by the Securities and Exchange Commission. Certain individuals may disclaim beneficial ownership of some of these units, but they are included for the purpose of computing the holdings and the percentages of Class A Depositary Units owned.\nThe certificate of incorporation of IPFR ('IPFR Charter') provides for two classes of common stock: Class A Common Stock and Class B Common Stock, of which International Paper is the sole owner. The Class B Common Stock possesses exclusive voting rights and the holder or holders thereof are entitled to cumulative voting for the election of directors of IPFR. Except with respect to voting rights, the Class B Common Stock of IPFR is equal in all other respects to the Class A Common Stock of IPFR. However, the Class B Common Stock represents only .00005 of 1% of the total authorized Common Stock of IPFR, all of which has been issued and is outstanding.\nThe IPFR Charter further provides that in the event International Paper owns, or as a result of certain events would own, less than 50% of either the outstanding Class A Depositary Units or Class B Depositary Units, then (i) International Paper must sell all of the shares of Class B Common Stock to the directors of IPFR, on a pro rata\n- ------------------ * Officers of IPFR are elected to hold office until the next annual meeting of the board of directors and until election of successors, subject to removal by the board.\nbasis, at a price equal to $100.00 per share in cash; (ii) any director who does not purchase his pro rata shares of Class B Common Stock must resign; and (iii) the directors of IPFR are then required, as soon as practicable but not later than the next annual meeting of stockholders of IPFR, to vote or cause their shares of Class B Common Stock to be voted to elect a Board of Directors of IPFR comprised entirely of persons who are not employees, officers, directors or affiliates of International Paper or of any affiliate of International Paper (other than IPFR). Each director of IPFR is further required to execute a voting trust agreement, pursuant to which the Class B Common Stock will be held and voted, and a stockholders' agreement, pursuant to which transfer of ownership in the Class B Common Stock is restricted to persons who are directors of IPFR. In order to maintain the independence of IPFR's Board of Directors, the IPFR Charter further provides that (i) each director, upon resigning as a director of IPFR, must sell his shares of Class B Common Stock to IPFR, and (ii) each subsequent director elected to replace any director so resigning must similarly purchase shares of Class B Common Stock and enter into the voting trust agreement and stockholders' agreement described above. International Paper believes that the foregoing arrangement for the possible ownership of the Class B Common Stock of IPFR assists in reducing the potential for conflicts of interests should International Paper's ownership of units decrease significantly.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nA description of certain relationships and related transactions is set forth on pages 14 through 16 of the Annual Report and is incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\nEXHIBITS\n(13) 1995 Annual Report to Unitholders of the Registrant\n(24) Power of Attorney\n(27) Financial Data Schedule\nREPORTS ON FORM 8-K\nA Current Report on Form 8-K was filed on February 2, 1996, as amended February 21, 1996.\nFINANCIAL STATEMENT SCHEDULES\nThe consolidated balance sheets as of December 31, 1995 and 1994, and the related consolidated statements of earnings and cash flows for each of the three years in the period ended December 31, 1995, together with the report thereon of Arthur Andersen LLP, dated February 13, 1996, appearing on pages 11 through 16 and 18 of the Annual Report, are incorporated herein by reference. With the exception of the aforementioned information and the information incorporated by reference in Items 1, 2, 5 through 8, and 13, the Annual Report is not to be deemed filed as part of this report.\nSIGNATURES\nPURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.\nIP TIMBERLANDS, LTD.\nBy: IP Forest Resources Company (as managing general partner)\nBy: JAMES W. GUEDRY JAMES W. GUEDRY, VICE PRESIDENT AND SECRETARY\nMarch 29, 1996\nPURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED:\n[IP TIMBERLANDS, LTD. LOGO]\nPRINTED ON HAMMERMILL PAPERS, ACCENT OPAQUE, 50 LBS. HAMMERMILL PAPERS IS A DIVISION OF INTERNATIONAL PAPER","section_15":""}
{"filename":"846657_1995.txt","cik":"846657","year":"1995","section_1":"ITEM 1. BUSINESS\nBACKGROUND\nGENERAL\nEljer Industries, Inc. through its subsidiaries (\"Eljer Industries\" or, together with its subsidiaries, the \"Company\") is a leading manufacturer of high quality building products for residential construction, commercial construction and repair and remodeling 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, the Company is a leading manufacturer of prefabricated chimneys and venting systems. During fiscal years 1994, 1993 and 1992, revenues from sales of plumbing products comprised approximately 64%, 59% and 54%, respectively, of the Company's net sales, with the balance derived from the sale of HVAC products.\no NORTH AMERICAN OPERATIONS\nEljer Plumbingware, a division of Eljer Manufacturing, Inc. (\"Eljer Manufacturing\"), a wholly-owned subsidiary of Eljer Industries, 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\"), a wholly-owned subsidiary of Eljer Manufacturing.\nU.S. Brass manufactures and markets a full range of faucets, plumbing supplies, connectors and polybutylene plumbing systems in the United States. On May 23, 1994, U.S. Brass filed a voluntary petition for reorganization under Chapter 11 of the Federal Bankruptcy Code (the \"Bankruptcy Code\") in the United States Bankruptcy Court for the Eastern District of Texas (the \"Bankruptcy Court\"). See \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" in Item 7 and Note 2 to the Consolidated Financial Statements in Item 8 for discussion.\nSelkirk and Dry, each divisions of Eljer Manufacturing, manufacture and market HVAC products, including registers, grilles, venting systems, prefabricated chimneys, air diffusers and fireplaces. Combined, Selkirk and Dry, along with a Selkirk subsidiary in Canada (\"Selkirk\/Dry\"), are a market leader for registers, grilles and venting systems in North America.\nIn February 1995, the Company formed Industrias Eljer de Mexico, S.A. de C.V., (\"Eljer de Mexico\") under the laws of Mexico. Eljer de Mexico is 99% owned by Eljer Manufacturing and 1% owned by Selkirk Canada U.S.A., Inc., a wholly-owned subsidiary of Eljer Industries. It is expected that Eljer de Mexico will engage in certain assembly and packaging operations on behalf of the Company in Ojinaga, Chihuahua, Mexico, although it has not commenced any operations.\no EUROPEAN OPERATIONS\nThe Company has European subsidiaries operating primarily in Germany and the United Kingdom (\"Selkirk Europe\"). Selkirk 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 these products in Europe, and also sells its 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 considered by the Company to be 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 the 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. Under Household's ownership, various Eljer businesses operated as subsidiaries or as divisions of subsidiaries of Household. On April 14, 1989, all the outstanding shares of common stock of Eljer Industries were distributed to holders of Household common stock (the \"spin-off\").\nDESCRIPTION OF BUSINESS\nPRODUCTS\nPlumbing Fixtures. Eljer Plumbingware manufactures and markets enameled cast iron and vitreous china plumbing fixtures, including toilets, lavatories, sinks and bathtubs for residential and commercial applications. 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 and colors in response to changing style trends and develops new products. Eljer Plumbingware has been a leader in developing and manufacturing low water consumption 1.6 gallon toilets, which are statutorily mandated throughout the United States. Eljer Plumbingware offers a broad line of such products.\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.\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 ranging from competitively priced bathroom faucets to high-end luxury models (Valley Plus). The Valley products also include kitchen faucets, such as a pull-out spray model. Eljer Plumbingware markets, under the Eljer trademark, faucets manufactured by U.S. Brass that complement its fixture line. U.S. Brass also manufactures several private label faucets for large retailers. 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. Polybutylene plumbing systems using acetal fittings (the \"Qest system\"), manufactured and sold for residential site-built installations from 1979 through 1986 and for other installations from about 1975 through 1990, have been the subject of litigation. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" in Item 7, and Notes 2 and 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 North America and in 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 Sel-Aire trademarks and in Canada under the Lloydaire trademark. They are also sold in 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. Sales through retail channels accounted for approximately 37% of net plumbing sales in 1994.\nThe Company markets, through agents and direct salesmen, 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 fluctuations in remodeling and repair activities. The housing market is cyclical and is affected by, among other things, interest rates, consumer confidence and the availability of mortgage loans. The repair and remodeling markets are less cyclical, providing a different source of demand for plumbing products and reducing the Company's reliance on new home construction. Both housing starts and the repair and remodeling market experienced increases in 1994, although many published forecasts indicate a softening of housing starts in 1995. The other 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 these factors varying among products and markets. The Company, 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. The Company also is a supplier in the faucet market, in which there are numerous major domestic and import manufacturers, several of which are substantially larger than the Company.\nHVAC. The Company's 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. The Company believes that eastern Europe markets, as they convert to natural gas, represent 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. The Company 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 plastic, including polybutylene resin. Due to increased demand in 1994 for brass by the automotive and plumbing industries, and a strike affecting a major brass supplier, the Company has experienced some difficulty in obtaining required quantities of brass from its existing suppliers. Accordingly, the Company has begun purchasing brass from alternate sources. While this has resulted in some delays in filling orders, no other impact is anticipated. Polybutylene resin is currently produced domestically only by Shell Chemical Company (\"Shell Chemical\"), a subsidiary of Shell Oil Company. The Company has not experienced difficulty in obtaining\npolybutylene resin from Shell Chemical as needed. Other materials are, and have been, readily available from several sources.\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.\nFOREIGN AND DOMESTIC OPERATIONS\nSee Note 15 to the Consolidated Financial Statements in Item 8 for geographic segment financial data.\nGENERAL\nCustomers. The Company 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 the Company.\nBacklog of Orders and Inventory. The backlog of unshipped factory orders at the end of fiscal years 1994 and 1993 was approximately $19.8 million and $15.3 million, respectively. The increase is primarily due to increased orders for polybutylene plumbing systems, and a brass rod shortage which has slowed the order fill rate on brass fittings. The Company expects that all the orders in backlog at the end of fiscal year 1994 will be shipped during 1995. The Company must carry inventory of certain products to meet rapid delivery requirements of its customers.\nEmployees. The Company employs approximately 4,200 people, approximately 1,600 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. 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. The Company's other collective bargaining agreements, including the contract for its largest plant in Ford City, Pennsylvania, which expires in May 1995, have expiration dates ranging from 1995 to 1997. In general, relations with employees have been satisfactory.\nPatents and Trademarks. The Company 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 the Company.\nOther. No material portion of the Company's operations is subject to renegotiation of profits or termination of contracts at the election of the federal government. The Company's operations, taken as a whole, 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 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 the Company, separated by the operating unit or subsidiary which operates the facility. Except as indicated in the table, all the plants are owned by the Company.\n------------ (1) Leased until 2066 (2) Leased until 1999 (3) Leased until 1998\nIn general, the manufacturing facilities for plumbing products are in good condition and are operating at capacities which range from approximately 50% to 100%.\nThe manufacturing facilities for gas vents and chimney systems are presently operating at approximately 80% capacity, except the Canadian plant, 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 90% capacity. Each of these facilities is in good condition.\nAll Selkirk\/Dry and Eljer Plumbingware properties, with the exception of the Salem, Ohio, plant secure the Company's 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 Notes 3 and 7 to the Consolidated Financial Statements in Item 8 for further discussion.\nIn addition to the foregoing, the Company owns or leases a number of warehouse distribution centers throughout the United States.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nU.S. Brass\nU.S. Brass is involved in significant legal proceedings including a number of claims which involve Qest systems manufactured and sold by U.S. Brass. On May 23, 1994, U.S. Brass filed a voluntary petition for reorganization under Chapter 11 of the Bankruptcy Code. See \"Liquidity and Capital Resources\" in Item 7 and Note 2 to the Consolidated Financial Statements in Item 8 for discussion of the litigation and the related bankruptcy proceeding.\nHousehold Litigation\nAs previously disclosed, the Company is currently involved in litigation with Household relating to the spin-off. Household filed an action in the Delaware Chancery Court on February 5, 1993, against Eljer Industries, Eljer Manufacturing and U.S. Brass seeking declaratory relief. U.S. Brass has since been dismissed from the case. Following a finding by the Delaware Chancery Court that it had no subject matter jurisdiction, that action was transferred to the Delaware Superior Court for trial on the merits, where it remains pending. On March 9, 1995, the Company's motion to dismiss or stay the action was denied. Discovery is proceeding in that action, but no trial date has been set.\nOn February 11, 1993, Eljer Industries and Eljer Manufacturing filed a breach of contract action against Household in the District Court of Dallas County, Texas, based upon Household's alleged 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 spin-off. The Company is preparing for trial in the Texas action and a trial date has been set for the week of July 10, 1995.\nEnvironmental Proceedings\nThe Company operates plants that may generate hazardous and nonhazardous waste, disposal of which is subject to federal and state regulation. 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 Company facilities have been required to implement programs to remedy the effects of past waste disposal. Not all plants have been the focus of comprehensive environmental studies. Except as described below, the Company is not aware of any 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. 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 $13.8 million at the end of 1994 (see discussion of individual sites provided below) pertaining to environmental, health and safety matters which the Company believes are adequate. Although the timing of the related payments is uncertain, the Company believes that a substantial portion of the payments will be made over the next three years.\nSalem and Marysville, Ohio, Facilities. The Company and the Ohio Environmental Protection Agency (\"Ohio EPA\") previously reached agreement on a proposed closure plan for the Company's Salem, Ohio, facility and the Company submitted the proposed closure plan on April 30, 1993. The Company has not yet received either approval of, or comments on, the proposed closure plan. Through 1993, the Company paid $1.6 million to complete an interim closure of the subject area and accruals of approximately $1.8 million for additional closure and post-closure costs expected in future periods are recorded at yearend 1994, which the Company believes are adequate. No activity related to closure or post-closure clean-up of the Salem, Ohio, facility had a material adverse impact on the Company's 1994 liquidity or results of operations and none is expected.\nAs disclosed in last year's Form 10-K, the Company has submitted a closure plan for its Marysville, Ohio, facility to the Ohio EPA, which has not yet commented on the plan. The Marysville, Ohio, facility was closed in 1987. If it is approved in its current form, the Company's environmental consultants estimate that\nthe cost of implementing the closure plan, including post-closure care, will be approximately $9.4 million. However, the ultimate cost to complete closure and post-closure activities at the facility will depend to a large extent on the remediation technology ultimately agreed upon by the Ohio EPA. The Company has previously established accruals which it believes will be adequate to provide for the cost to implement its closure plan. However, there is no assurance that the plan will be approved without making additional revisions or modifications. Although no estimate can be made, in the event the closure plan is not approved, the cost of remediation could have a material impact on future operating results or financial position.\nNone of the costs of clean-up and closure of the Salem and Marysville sites have been discounted. The Company discounted the post-closure costs of these sites over a 20 to 30 year period using a discount rate of 5%. The aggregate undiscounted amount of these liabilities at yearend 1994 was approximately $3.3 million, of which the discounted amount of approximately $1.8 million was accrued. The Company's environmental consultants estimate that the payments associated with these postclosure costs for each of the first five years after the closures are completed will be approximately $128,000 per year with aggregate payments of approximately $2.7 million over the remaining 15 to 25 years.\nAfter March 1992, the Company was unable to demonstrate financial responsibility for closure, post-closure care and third-party liability with respect to the Salem site and the Marysville site. On September 30, 1994, the U.S. Department of Justice (the \"DOJ\") proposed payment by the Company of a cash penalty of $175,000, with an additional fine of $912,000 to be held in abeyance pending completion of the site closure activities, for failure to meet the financial assurance requirements. The deferred amount would then be waived if the Company continues to comply with the financial responsibility requirements of the December 1990 consent decree with the United States Environmental Protection Agency (the \"U.S. EPA\") relating to the Salem site. On October 19, 1994, the Company accepted the DOJ offer pending agreement on a modification to the 1990 consent decree which has not yet been reached. The Company has established accruals which it believes adequate to provide for the $175,000 cash penalty assessed. The Company believes it currently meets its financial responsibility requirements regarding the Salem site although Ohio EPA has recently asserted that the Company has not posted sufficient collateral to cover the cost of post-closure care. The Company disputes the Ohio EPA's contention and intends to resolve this issue prior to entering into final agreement with the DOJ on the penalties discussed above.\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. Subsequently, the Company received correspondence from the Ohio EPA threatening to escalate enforcement action against the Company and, in October 1994, the Company received correspondence from the Ohio Attorney General threatening commencement of a lawsuit for failure to meet the financial assurances section of the Ohio Administrative Code. The Company is currently negotiating the matter with the Ohio Attorney General's office and the Ohio EPA and may be required to place $8.5 million in cash in a trust which will be used to pay for the clean-up at the Marysville site in order to meet the financial assurance requirements for this site. Ohio statutes permit the Ohio Attorney General to seek penalties of up to $10,000 per day for violations of its regulations and makes the reckless violation of its regulations a felony. If a settlement is not reached, the Ohio Attorney General might argue that the Company has been out of compliance with two separate financial assurance requirements since March 1992. The Company continues to believe that it has legitimate defenses to the imposition of any penalties and intends to vigorously defend against such penalties, but cannot currently estimate what penalties, if any, may be imposed on the Company if it is ultimately found to have violated the Ohio regulations. Accordingly, no specific accrual has been established to provide for such penalties.\nAs reported in the Company's 1993 Form 10-K, the Company has negotiated with the DOJ and the U.S. EPA a settlement for alleged violations of the Clean Water Act for unpermitted discharge of wastewater streams at the Salem, Ohio, plant. The settlement calls for the payment of a $300,000 cash penalty and the performance of certain remediation work estimated to cost approximately $690,000. The specific terms and conditions of the settlement remain to be negotiated. The Company has previously established accruals which it believes are adequate to cover these costs.\nSuperfund Sites. 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.\nAs disclosed in the Company's 1993 Form 10-K, certain 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. Through notifications from the U.S. EPA, the Company believes its total liabilities related to Superfund sites to be immaterial (approximately $220,000 at yearend 1994) if liability and contributions are assessed in an equitable manner among all responsible parties. The Company has established accruals which it believes are adequate to provide for any liabilities it may have with respect to these sites.\nAtlanta, Georgia, Site. As previously disclosed, in October 1991, Eljer Manufacturing sold a facility located in Atlanta, Georgia to joint venture partners Toto Ltd., Mitsui & Co., Ltd. and Mitsui & Co. (USA), Inc. (\"Toto and Mitsui\"). Toto and Mitsui subsequently asserted that Eljer Manufacturing is responsible under the indemnification provisions included in the Purchase and Sale Agreement to remediate alleged contamination at the sold facility. Under the agreement, Eljer Manufacturing's liability for remediation costs is limited to $750,000. Eljer Manufacturing has notified the prior owner of the facility, JP Industries, Inc., (\"JP Industries\") that it may be liable to Eljer Manufacturing for indemnity under the provisions of Eljer Manufacturing's purchase agreement with JP Industries. Eljer Manufacturing does not believe that any remediation at the Atlanta site is necessary and no estimate of a liability, if any, can be made at this time. In addition, no estimate can be made of the amount, if any, that Eljer Manufacturing may receive from JP Industries.\nWilson, North Carolina, Site. In anticipation of the 1994 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 benzene and methylene chloride. 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, the direction of groundwater flow and the Company's understanding that trichloroethene has never been used at the plant, it is presently the Company's belief that any trichloroethene on the property originated from off-site sources. The Company does not believe it is responsible for remediation of any trichloroethene which may be present at the site. However, the Company retains responsibility under the indemnification provisions included in the Purchase and Sale Agreement to remediate benzene and methylene chloride that exceed maximum levels allowed by North Carolina law. While the cost to comply with the Company's indemnity obligations is estimated at $509,000 based on the use of traditional remediation methods, the Company hopes to receive approval from the state of North Carolina to pursue alternative remediation methods which would substantially reduce these costs. The Company has established accruals which it believes are adequate to provide for the costs of investigation and remediation, if any.\nProposition 65. As previously disclosed, Eljer Industries, Eljer Manufacturing, U.S. Brass and approximately 15 other manufacturers and sellers of residential and commercial brass faucets are defendants in lawsuits brought by the Attorney General of the State of California and the Natural Resources Defense Council and the Environmental Law Foundation alleging violations of California's Safe Drinking Water and Toxic Enforcement Act of 1986 (\"Proposition 65\"). The lawsuits allege that U.S. Brass and Eljer Manufacturing did not label their faucets in conformity with Proposition 65. The lawsuits further allege that U.S. Brass and Eljer Manufacturing knowingly discharged or released lead into drinking water in violation of Proposition 65, which discharge and exposure allegedly arose out of leaching of lead into drinking water from leaded brass faucets manufactured by the defendants. The California trial court has ruled in the case brought by the California Attorney General that no cause of action has been stated to support the claim that faucets leach lead into drinking water. That ruling has been appealed to the California Court of Appeal. As part of a proposal to settle these lawsuits, U.S. Brass has developed a faucet manufactured from bismuth brass as opposed to leaded brass. If a settlement is reached, it is expected that the Company and\nU.S. Brass will begin selling the bismuth brass faucets in California as well as continuing to sell its leaded brass faucets with appropriate Proposition 65 labeling. Additionally, the Company and U.S. Brass are currently attempting to negotiate a settlement concerning any penalties that might be due as a result of the failure of the Company and U.S. Brass to properly label faucets sold in California in accordance with Proposition 65 and for the alleged violation of the discharge requirements. The Company does not expect the resolution of these lawsuits to have a material adverse effect on its financial condition or results of operations. Claims have been filed in the U.S. Brass bankruptcy totalling $6 million related to this matter. The Company disputes these claims and expects to file an objection to them in the Bankruptcy Court. The outcome of the claims against U.S. Brass will be dependent on the final plan of reorganization (\"Plan\"). See Note 2 to the Consolidated Financial Statements in Item 8 for discussion. The Company and U.S. Brass currently label their faucets in accordance with Proposition 65.\nInsurance. The Company has recently made claims to its applicable insurance carriers under certain insurance policies for any amounts paid in the past or for which it may become obligated to pay in the future in connection with various environmental matters. The Company cannot predict the amount, if any, of insurance proceeds that may be received as a result of these environmental claims. No receivables from insurance carriers have been recorded related to environmental matters.\nAdditional information regarding legal proceedings of the Company is set forth herein in Notes 2, 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 shareholders of Eljer Industries during the fourth quarter of fiscal year 1994.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER 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 1994 and 1993. This information is based on selling prices as reported by the New York Stock Exchange.\nHOLDERS\nAt March 24, 1995, there were approximately 9,095 holders of record of common stock.\nDIVIDENDS\nNo dividends were declared in fiscal 1994 or 1993. 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 U.S. credit agreement. See Notes 3 and 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. 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 1, 1995 (\"1994\"), compared with year ended January 2, 1994 (\"1993\")\nNet sales increased 4.8% or $18.5 million over the 1993 level resulting in the strongest sales performance since 1990. The increase was the result of strong performances in substantially all North American markets where the Company continued to benefit from an improved housing economy and penetration of its traditional channels of distribution and retail chains. 1994 sales of products in North America increased $27.3 million or 8.7% over the 1993 level. As anticipated, European sales continued to decline during 1994, dropping $8.8 million or 11.8% despite a $1.6 million favorable exchange rate impact due to the weakening U.S. dollar.\nGross profit margins decreased to 27.8% in 1994 compared to 28.2% in 1993. The decline was the result of a significant reduction in the level of sales of higher margin products in Europe, where the market has remained soft, primarily offset by improved margins on the Company's plumbing products due to increased volume and improved product mix. The Company has recently completed reengineering the European operations to reduce costs and anticipates that the benefits of these changes, as well as expected modest economic strengthening, should improve the European results in 1995, although raw material price increases will limit this improvement. The reengineering consisted primarily of the relocation\nof the Company's operations in Germany to its plants in the United Kingdom. Costs related to the restructuring were approximately $867,000 in 1994 and were covered by accruals established in 1991. Cash flows from European operations are sufficient to cover the cash flow usage resulting from this reengineering of operations.\nGross profit margins for 1994 improved in North America to 26.5% from 25.6% in 1993. This was primarily attributable to production efficiencies and better cost absorption associated with increased volume. Maintenance of this level of gross profit margin in 1995 will be dependent on the U.S. economy, particularly the housing economy, and the ability of the Company to pass on raw material price increases to its customers.\nTotal selling and administrative expenses for 1994 were $865,000 or 1.1% higher than the 1993 level ($81.8 million in 1994; $80.9 million in 1993) primarily as a result of increased sales incentives and commissions due to higher sales volume, partially offset by lower advertising costs. Litigation costs continued to increase in 1994, rising $1.6 million over the 1993 level. The higher costs relate primarily to the Chapter 11 bankruptcy proceeding of U.S. Brass. See Note 2 to the Consolidated Financial Statements in Item 8","section_7A":"","section_8":"Item 8.\nThe Official Polybutylene Creditor's Committee (the \"PB Committee\") has alleged that Eljer Industries, Eljer Manufacturing and Household may be liable for Qest system claims under principles of alter ego and related theories of liability. On January 30, 1995, the Bankruptcy Court denied the PB Committee's motion to file a proposed complaint on behalf of U.S. Brass against the Company to determine whether the Company should be held liable for certain debts of U.S. Brass based on alter ego liability. The PB Committee has filed a notice of appeal from that ruling. Since the filing of U.S. Brass' bankruptcy petition, the PB Committee and certain co-defendants in the Qest system litigation have asserted that Eljer Industries and Eljer Manufacturing are also directly liable for damages arising from the design, manufacture and marketing of the Qest system.\nWhile the Company may explore settlement alternatives on these issues in the context of U.S. Brass' bankruptcy proceeding, including possible contributions of cash, Eljer Industries' stock, or other consideration to a U.S. Brass Plan, the Company will continue to vigorously contest, absent a settlement, any such claims of derivative or direct liability. However, if such derivative or direct claims were successfully asserted against Eljer Industries or Eljer Manufacturing and a settlement is not achieved during the pendency of the U.S. Brass bankruptcy proceeding, it could, depending upon the availability of insurance coverage for costs and indemnity, have a material adverse effect on the Company's liquidity and financial condition and on its ability to continue to meet its financial obligations. At this time, the number and magnitude of Qest system related claims that may be generated in connection with the U.S. Brass bankruptcy are unknown and an estimate cannot be made. A proposed Plan was filed with the Bankruptcy Court on March 22, 1995. See Note 2 to the Consolidated Financial Statements in Item 8 for additional discussion. No assurances can be given that the reorganization of U.S. Brass will successfully be concluded or, if it is concluded, what the effects to U.S. Brass, Eljer Industries and Eljer Manufacturing would be. (See also Notes 2 and 13 to the Consolidated Financial Statements in Item 8.) The resolution of the U.S. Brass bankruptcy could involve the Company losing its control over U.S. Brass. The possibility also exists that settlement of claims against the Company (as discussed in Note 2 to the Consolidated Financial Statements in Item 8) could, among other things, result in a change in the Company's equity structure. These matters create a substantial doubt about the Company's ability to continue as a going concern in its present consolidated form.\nITEM 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 1, 1995, and January 2, 1994, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended January 1, 1995. 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 3 to the accompanying consolidated financial statements, the Company will be required to make up to an $11 million term debt payment on December 29, 1995, and the remaining $67.5 million in term debt will become due on April 30, 1996. Management's current projections indicate that there will not be sufficient cash flows from operations to fund the April 1996 obligation. The Company intends to explore some manner of debt restructuring or extension of existing debt prior to the April 1996 U.S. Term Debt maturity date. Neither the Company nor any of its subsidiaries has any commitment with respect to restructuring or other sources of financing or extension of existing debt and management has indicated that there can be no assurance that any such commitment or extension can be obtained prior to the U.S. Term Debt maturity date.\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 1, 1995 and January 2, 1994, and the results of their operations and their cash flows for each of the three years in the period ended January 1, 1995 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 further in Note 2 to the consolidated financial statements, 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. In addition, the nature and extent of the insurance coverage related to potential losses arising from these claims and lawsuits are currently being contested by several of the insurance carriers. In order to systematically resolve these matters, on May 23, 1994, U.S. Brass filed a voluntary petition for reorganization under Chapter 11 of the Federal Bankruptcy Code. The resolution of the U.S. Brass bankruptcy could involve the Company losing its control over U.S. Brass. The possibility also exists that settlement of claims against the Company could, among other things, result in a change in the Company's equity structure. If the Company is not successful in resolving these claims in the U.S. Brass bankruptcy proceeding, it will be required to litigate those claims in the forums in which they may be brought. The ultimate outcome of these matters is uncertain at this time and could have a material, adverse impact on the financial position and results of operations of the Company. These matters create a substantial doubt about the Company's ability to continue as a going concern in its present consolidated form. Management's plans in regard to these matters are described in Note 2. The consolidated financial statements do not include any adjustments or reclassifications 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 LLP\nDallas, Texas, March 28, 1995\nELJER INDUSTRIES, INC. CONSOLIDATED STATEMENTS OF INCOME (IN THOUSANDS, EXCEPT PER SHARE DATA)\nThe accompanying notes to consolidated financial statements are an integral part of these statements.\nELJER INDUSTRIES, INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA)\nThe accompanying notes to consolidated financial statements are an integral part of these statements.\nELJER INDUSTRIES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)\nThe accompanying notes to consolidated financial statements are an integral part of these statements.\nELJER INDUSTRIES, INC. CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (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, together with its subsidiaries, 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.\nFiscal Year\nThe Company reports on a 52-53 week fiscal year ending on the Sunday nearest to December 31. Fiscal year 1994 had 52 weeks, which ended on January 1, 1995. Fiscal years 1993 and 1992 had 52 and 53 weeks, respectively, which ended on January 2, 1994 and January 3, 1993, 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. Depreciation and amortization expense was $9.1 million, $10.8 million and $9.7 million for 1994, 1993 and 1992, respectively.\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)\ndisclosure of the fair market value of off- and on-balance-sheet financial instruments. The carrying value of all financial instruments, including long-term and short-term debt, cash and temporary cash investments and restricted cash, approximates their fair value at yearend.\nCost of Businesses Acquired\nCost in excess of net tangible assets acquired (\"goodwill\") is amortized using the straight-line method over 40 years. The Company continually evaluates whether events and circumstances have occurred that indicate the remaining useful life of goodwill may warrant revision or that the remaining balance of goodwill may not be recoverable. When factors indicate that goodwill should be evaluated for possible impairment, the Company uses an estimate of the related operating income over the remaining life of the goodwill in measuring whether the goodwill is recoverable. The amortization recorded for 1994, 1993 and 1992 was $433,000, $443,000 and $583,000, respectively. The amount of accumulated amortization was $6.0 million and $5.8 million at the end of 1994 and 1993, 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 consists of plumbing wholesalers and retail outlets primarily in North America. Heating, ventilating and air conditioning products are 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 1994.\nThe Company places its temporary cash investments with financial institutions it considers credit worthy, and does not believe significant credit risk exists with respect to these securities at the end of 1994.\nThe FASB issued SFAS No. 119, \"Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments\", effective for financial statements issued for fiscal years ending after December 15, 1994. SFAS No. 119 requires new disclosures about derivatives and other financial instruments. At yearend 1994, the Company was not a party to any derivative contracts.\nForeign Currency Translation\nThe Company has foreign subsidiaries operating 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 Shareholders' Equity.\nELJER INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nIn 1994, 1993 and 1992, the Company also had net foreign currency transaction gains (losses) which approximated $78,000, $(120,000) and $762,000, respectively, and which are included in Other Expense, net.\nEnvironmental Matters\nThe Company records a liability for environmental matters when it is probable that a liability has been incurred and the amount can be reasonably estimated. With the exception of applicable amounts representing current liabilities, these amounts are recorded as Other Liabilities. The amounts recorded represent the estimated costs of remediation. The Company does not discount environmental liabilities for a specific clean-up site to reflect the time value of money unless the aggregate amount of the obligation and the amount and timing of the cash payments for that site are fixed or reliably determined. The litigation expenses relating to environmental matters are accrued separately as incurred. At the time a liability is recorded, amounts recoverable from third parties, if any, would be recorded as an asset. When required, the Company may make capital improvements to establish or maintain compliance with environmental regulations. Such capital expenditures would be subject to the same accounting policies as all other Properties and Equipment. The costs associated with investigation and assessment of environmental compliance are expensed as incurred. See Note 13 for discussion of Environmental Matters.\nChanges in Accounting Principles\nDuring the first quarter of 1994, the Company adopted the provisions of FASB Interpretation No. 39 (\"FIN 39\"). FIN 39 requires the Company to present separately in its Consolidated Balance Sheets its contingent liabilities which can be estimated and the related recoverable assets. Accordingly, the Consolidated Balance Sheet and Consolidated Statement of Cash Flows for 1993 have been reclassified to conform to the 1994 presentation. The resulting asset is a component of Other current assets in the accompanying Consolidated Balance Sheets.\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 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.\nELJER INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\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) BANKRUPTCY OF UNITED STATES BRASS CORPORATION:\nOn May 23, 1994, (the \"Petition Date\") the Company's indirect, wholly-owned subsidiary, United States Brass Corporation (\"U.S. Brass\") filed a voluntary petition for reorganization under Chapter 11 of the Federal Bankruptcy Code (the \"Bankruptcy Code\") in the United States Bankruptcy Court for the Eastern District of Texas (the \"Bankruptcy Court\"). The purpose of the filing is to resolve systematically the issues resulting from the Qest polybutylene plumbing systems (the \"System\" or the \"Qest system\") and related litigation and to seek confirmation of a plan of reorganization (the \"Plan\") which, among other things, provides for the payment, satisfaction and discharge of all claims against U.S. Brass involving the Qest system. U.S. Brass is conducting its business and managing its properties as a debtor-in-possession under Section 1108 of the Bankruptcy Code subject to the supervision and orders of the Bankruptcy Court.\nQest System Litigation\nSince 1975, U.S. Brass or its predecessor Qest Products, Inc. has engaged in the manufacture and sale of Qest systems. U.S. Brass is a defendant (together in some cases with Eljer Industries, Eljer Manufacturing, Inc. (\"Eljer Manufacturing\"), Qest Products, Inc. and Household), in a number of lawsuits arising out of the manufacture and sale of the Qest systems for residential site-built applications between 1979 and 1986 and for manufactured housing, including mobile homes and recreational vehicle applications between 1975 and 1990. The Qest system litigation led U.S. Brass to file for Chapter 11 bankruptcy protection in May 1994. The Bankruptcy filing is discussed more fully below. The Company does not currently engage and has never engaged in the manufacture and sale of the Qest system, except through U.S. Brass; although, as discussed more fully below, direct claims allegedly arising out of the manufacture and sale of the Qest system have been made against Eljer Industries and Eljer Manufacturing.\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 (\"Celanese\"), a unit of Hoechst Celanese Corporation (\"Hoechst Celanese\") and the manufacturer of a resin from which U.S. Brass 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 involve Systems that began to leak after installation, although a limited number of claims involve Systems that have not leaked. 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, although recent allegations have been made that the polybutylene pipe is subject to premature failure. U.S. Brass stopped selling Celcon fittings for residential site-built construction after 1986 and for mobile homes and recreation vehicles after 1990. In 1988 U.S. Brass began using Shell Duraflex PB4137 resin (\"PB4137 Resin\") to extrude polybutylene pipe. The Company believes copper and brass insert fittings and polybutylene pipe extruded from PB4137 Resin have performed satisfactorily. U.S. Brass continues to manufacture and sell Qest systems with this polybutylene pipe using copper and brass insert fittings.\nELJER INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nAs of the Petition Date, U.S. Brass had judgments against it related to these lawsuits of approximately $3.2 million, which were covered by previously established accruals. These accruals remain at the end of 1994 since all Qest system litigation against U.S. Brass has been stayed pending the outcome of the bankruptcy proceeding.\nU.S. Brass did not, for the most part, sell Qest systems directly to homeowners, but instead sold components of its Qest system to plumbing wholesalers and distributors who in turn sold those products to plumbing contractors. The plumbing contractors used, in whole or in part, Qest system components (fittings, pipe and accessories), assembled those components into plumbing systems, and installed those plumbing systems in homes and other buildings. In many cases it is believed that plumbing contractors mixed components from U.S. Brass and other manufacturers to assemble the plumbing systems they installed. Although newly discovered data has recently been collected that may permit a calculation of the number of Qest system installations using Celcon fittings, such data has not yet been analyzed and an accurate estimate of Qest system installations has not yet been made.\nSimilarly, data is not currently available to permit U.S. Brass to estimate accurately the number of installations that have failed or the number of claims regarding installations that have been settled to date. Settlements have been entered into by a number of parties, including U.S. Brass. However, U.S. Brass does not have access to all of the settlement data. Through the Petition Date, approximately 109 Qest system lawsuits involving approximately 30,000 residential claims, remained pending, not including purported class members in certain class action lawsuits pending in Arizona, California and Nevada. Through this same period, U.S. Brass had paid approximately $63 million in settlements related to its Qest system of which approximately $50 million has been reimbursed by the Company's primary and excess insurance carriers. Some of the insurance reimbursements made to U.S. Brass have been paid under a reservation of rights (see Insurance Coverage below).\nBetween 1988 and July 1991 U.S. Brass, Shell Chemical and Hoechst Celanese participated in a toll-free consumer hotline for homeowners with Qest system claims. U.S. Brass, Shell Chemical and Hoechst Celanese shared the cost of repairs and replacements (the \"Sharing Agreement\") until July 1991 when U.S. Brass withdrew its participation. Shell Chemical and Hoechst Celanese have settled and continue to settle cases and repair or replace Qest systems for which they contend that U.S. Brass was or is partially responsible under the Sharing Agreement. As of February 7, 1995, Shell Chemical and Hoechst Celanese claim that they have expended approximately $59 million under the Sharing Agreement on behalf of U.S. Brass. U.S. Brass disputes the validity of the Sharing Agreement and the validity of the claimed amount. Shell Chemical and Hoechst Celanese have not provided U.S. Brass with sufficient information to support this amount, which, if ultimately proven to be a liability of U.S. Brass, should be subject to coverage by insurance and will be subject to treatment in U.S. Brass' bankruptcy discussed below.\nIn December 1993, Celanese filed suit in New Jersey state court against U.S. Brass, Eljer Manufacturing and Household seeking damages arising out of the sale of raw materials used in the manufacture of the Celcon acetal fittings used in the Qest system and out of the Sharing Agreement. In May 1994 Shell Chemical filed an action against U.S. Brass, Eljer Manufacturing and Household in New Jersey state court seeking damages arising out of the Sharing Agreement. These actions have been transferred to the Bankruptcy Court where they remain pending on a motion by Shell Chemical and Celanese to sever the claims against Household and remand those claims back to New Jersey state court.\nAs discussed above, an estimate of additional liability related to Qest system litigation cannot be made. However, as a result of the uncertainties related to the availability of insurance coverage and the ultimate outcome of the bankruptcy proceeding, U.S. Brass recorded a $21.9 million unusual charge against\nELJER INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nearnings in 1994 which reduced its net book value to zero. Additional descriptions of the insurance coverage, the U.S. Brass bankruptcy and its potential impact on the Company are discussed below.\nInsurance Coverage\nAlthough insurance carriers have paid a substantial portion of the claims made to date by U.S. Brass, since 1985 the Company has been involved in litigation with its insurance carriers concerning coverage for Qest system litigation. In 1992 the United States Court of Appeals for the Seventh Circuit issued an opinion holding that the policy period of coverage of a Qest system claim is triggered by the date of installation of the System as opposed to the date when the leak occurs. The 1992 favorable decision is significant because most of the Company's insurance policies purchased after 1987 generally exclude coverage for certain Qest system claims. However, significant insurance coverage litigation remains pending and the Seventh Circuit opinion is not necessarily binding on all insurance carriers issuing coverage to the Company. In addition, some reimbursement of insurance payments may be ultimately required for payments made under reservations of rights, retrospective premium adjustments or indemnification agreements. An estimate of this amount cannot be made as it is dependent on the outcome of the litigation described below.\nVarious insurance carriers filed state court actions in Illinois and one in California state court seeking declaratory relief that they are not obligated to provide insurance coverage for Qest system litigation. These actions were removed to the Bankruptcy Court for the Northern District of Illinois (the \"Illinois Bankruptcy Court\") soon after U.S. Brass filed its Chapter 11 petition. On November 11, 1994, the Illinois Bankruptcy Court denied U.S. Brass' motion to transfer venue to the U.S. District Court for the Eastern District of Texas and granted the insurer's motion to abstain from hearing the case and to remand to the state courts. U.S. Brass has appealed the ruling of the Illinois Bankruptcy Court to the U.S. District Court for the Northern District of Illinois. The Illinois Bankruptcy Court has suspended the operation of the remand order pending the resolution of the appeal. The Illinois cases remain subject to the bankruptcy automatic stay. Additionally, on June 14, 1994, U.S. Brass filed a complaint commencing an adversary action in the Bankruptcy Court against all insurance companies involved in the Illinois state court actions as well as one additional carrier. This action was dismissed by the Bankruptcy Court on the basis of the earlier-filed litigation that was pending in Illinois. U.S. Brass has appealed the ruling of the Bankruptcy Court to the U.S. District Court for the Eastern District of Texas. Because this litigation is in the early stages and because it is not possible to predict the outcome of its appeals, it is not possible to estimate the amount of insurance proceeds, if any, that U.S. Brass will ultimately recover for Qest system claims.\nOther Litigation\nAs previously disclosed, U.S. Brass has filed an appeal with the United States Court of Appeals for the Tenth Circuit of the $1.2 million judgment against U.S. Brass entered in 1993 involving a modified crimping tool used in the installation of the Qest system. At yearend 1994, U.S. Brass had adequate accruals established related to this judgment. Any judgment that may ultimately be obtained in this case will be an unsecured claim in U.S. Brass' bankruptcy proceeding and paid in accordance with the provisions of the Plan.\nStatus of U.S. Brass Bankruptcy Proceeding\nThe filing of its voluntary Chapter 11 petition acted as an automatic stay of certain litigation and other actions against U.S. Brass or its property. Among other things, the automatic stay applies to the commencement or continuation of federal, administrative or other actions or proceedings against U.S. Brass that were or could have been commenced before the Chapter 11 case was filed or to recover a claim\nELJER INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nagainst U.S. Brass that arose before the case was filed. Consequently, U.S. Brass' creditors are prohibited from attempting to collect prepetition debts without the consent of the Bankruptcy Court. Any creditor may seek relief from the stay by making a motion to the Bankruptcy Court. U.S. Brass believes the automatic stay extends also to claims made in those lawsuits filed against the Company, Eljer Manufacturing and Household, based upon alter ego and related theories of liability (see Claims Against the Company discussion below). U.S. Brass contends that under bankruptcy law, such claims are property of U.S. Brass by reason of its Chapter 11 filing.\nOn March 22, 1995, Eljer Industries, Eljer Manufacturing, and U.S. Brass filed with the Bankruptcy Court a proposed Plan for U.S. Brass under chapter 11 of the Bankruptcy Code. The Plan provides for, among other things, the liquidation and treatment of claims against U.S. Brass involving the Qest system through a trust to be established under the Plan. The Plan provides that the trust will be assigned rights under certain historical insurance policies maintained for the benefit of Eljer Manufacturing, U.S. Brass and, in some cases, Eljer Industries. Most of the insurance carriers which provided these policies are involved in the litigation described in Insurance Coverage above. The proceeds of other litigation are also expected to help fund the trust. The Plan also provides that other persons, subject to Bankruptcy Court approval, may make contributions to the trust. Shell Chemical has proposed a settlement wherein it would contribute up to $200 million to the trust. The Plan provides that holders of claims involving the Qest system will be prevented, through an injunction, from pursuing any such claims against Eljer Industries, Eljer Manufacturing, U.S. Brass and any other person who makes a contribution to the trust as approved by the Bankruptcy Court. Each holder of a general unsecured claim (other than Qest system claims) may either receive an immediate one time cash payment of 50% of its claim or receive 100% over time. Under the Plan, Eljer Manufacturing will retain its equity interest in U.S. Brass if the Bankruptcy Court determines, in connection with the confirmation of the Plan, that all classes of claims are paid in full or have accepted the Plan. Otherwise, the Plan provides that the existing equity interest in U.S. Brass will be cancelled, and the new equity interests in U.S. Brass will be transferred to the trust to be held for sale within 120 days of the Plan's effective date. If such an event occurs, Eljer Manufacturing could reacquire U.S. Brass through a successful bid at the time of such sale. The proposed disclosure statement (\"Disclosure Statement\") submitted with the Plan is subject to approval by the Bankruptcy Court and the proposed Plan is subject to a vote of U.S. Brass' creditors. Any other party is free to file its own Plan with the Bankruptcy Court, although no party has done so. No hearing on the proposed Disclosure Statement has been set and it is not known when the Plan will be submitted to creditors for voting.\nIt is not presently possible to predict the outcome of the proposed Plan. It is also not presently possible to estimate the ultimate number or dollar value of Qest system claims that may be filed and allowed in the bankruptcy case (see discussion of Claims Filed in the U.S. Brass Bankruptcy Proceeding below). In addition, because of the uncertainties related to the insurance litigation, it is not presently possible to estimate the value of the assets that may be available to satisfy any claims that may be filed and allowed. There is a possibility that the Company would lose all or some of its equity interest in U.S. Brass if the Bankruptcy Court does not determine that claimants will receive 100% satisfaction of their allowed claims. In the event the Company loses all or some of its equity interest in U.S. Brass, the Company might be able to repurchase its equity interest in U.S. Brass through the payment of additional consideration, although there can be no assurances that other bidders for U.S. Brass would not emerge or that the Company would have sufficient resources with which to pay for U.S. Brass. Accordingly, the resolution of the U.S. Brass bankruptcy could involve the Company losing its control over U.S. Brass. The possibility also exists that settlement of claims against the Company (see Claims Against the Company discussion below) could, among other things, result in a change in the Company's equity structure. These matters create a substantial doubt about the Company's ability to continue as a going concern in its present consolidated form.\nELJER INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nClaims Filed in the U.S. Brass Bankruptcy Proceeding\nIn a bankruptcy proceeding, the Bankruptcy Court establishes a date by which all claims against the debtor must be filed (the \"Bar Date\"). The Bar Date for non-Qest system creditors of U.S. Brass was March 1, 1995. U.S. Brass or other parties may seek extensions of this Bar Date. Under the proposed Plan, there is no Bar Date for creditors who hold claims relating to the Qest system.\nAs of March 1, 1995, approximately 1,000 claims had been filed with the Bankruptcy Court, asserting the aggregate amount of approximately $1.5 billion, consisting primarily of alleged Qest system related damages. Additional claims may be filed. Many claims are disputed or based on contingencies that have not occurred. Additional claims have been made which do not specify the amount of damages. Any party to the bankruptcy, including U.S. Brass, may object to a filed claim. Following such an objection, the claim will be allowed only in an amount as determined by the Bankruptcy Court. U.S. Brass has not yet reviewed all of the claims filed, but expects that it will file objections to many of the claims. The outcome of such objections cannot be predicted and the number or value of claims that may be allowed by the Bankruptcy Court cannot be estimated at this time. As discussed above, an estimate of additional liability related to Qest system litigation cannot be made. However, as a result of the uncertainties related to the availability of insurance coverage and the ultimate outcome of the bankruptcy proceeding, U.S. Brass recorded a $21.9 million unusual charge against earnings in 1994 which reduced its net book value to zero. U.S. Brass intends on adjusting its litigation reserves during the course of the bankruptcy in order to maintain an equity balance of zero.\nClaims Against The Company\nThe Official Polybutylene Creditors' Committee (the \"PB Committee\") has alleged that Eljer Industries, Eljer Manufacturing and Household may be liable for Qest system claims under principals of alter ego and related theories of liability. On January 30, 1995, the Bankruptcy Court denied the PB Committee's motion to file a proposed complaint on behalf of U.S. Brass against the Company to determine whether the Company should be held liable for certain debts of U.S. Brass based on alter ego liability. The PB Committee has filed a notice of appeal from that ruling.\nCertain parties have alleged that claims exist against Eljer Manufacturing and Eljer Industries relating to the Qest system. Approximately 54 lawsuits representing approximately 30,000 homes have been filed in state or federal courts in 8 different states that name Eljer Industries and\/or Eljer Manufacturing (or its predecessor HMI), in addition to U.S. Brass or other parties, as defendants. These claims include allegations of direct and alter ego liability. The Company does not believe that they have merit and will vigorously defend such charges, although no assurances can be given that the Company will prevail if such lawsuits are ultimately tried. As such, the Company cannot estimate the amount, if any, for which it may ultimately be liable. The Company may attempt to resolve such claims in the U.S. Brass bankruptcy through the contribution of consideration which could take the form of cash, securities of the Company or other consideration. However, no assurances can be given that those settlement attempts will prove successful nor can estimates be given as to the value of the consideration that might ultimately be offered in an attempt to settle those claims. If the Company is not successful in resolving these claims in the U.S. Brass bankruptcy proceeding, it will be required to litigate those claims in the forums in which they may be brought.\nSelected Financial Data\nUnder the Bankruptcy Code, claims against U.S. Brass that were or could have been commenced prior to the Petition Date are stayed while U.S. Brass continues business operations as a debtor-in-\nELJER INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\npossession. Certain of these claims are reflected as Prepetition liabilities subject to compromise on the Consolidated Balance Sheets. Additional claims (liabilities subject to compromise) may arise subsequent to the Petition Date resulting from rejection of executory contracts or unexpired leases, and from the determination by the Bankruptcy Court, or from the agreement of parties in interest, to allow claims for contingencies and other disputed amounts. U.S. Brass will continue to evaluate the claims filed in the bankruptcy proceeding and may make adjustments in Prepetition liabilities subject to compromise. U.S. Brass received approval from the Bankruptcy Court to pay or otherwise honor certain of its prepetition obligations, including its secured working capital facility, employee wages, commissions, sales incentive programs, existing product warranties and outstanding checks. U.S. Brass participates in various intercompany transactions with its parent, Eljer Manufacturing and an affiliated Canadian company and, at the end of 1994, U.S. Brass had a net affiliate receivable of approximately $2.5 million.\nSelected financial data for U.S. Brass are as follows (in thousands):\nCash payments of reorganization items made since the Petition Date are immaterial.\n(3) LIQUIDITY AND CAPITAL RESOURCES:\nFinancing Agreements\nThe Company experienced an increase in short-term borrowings during 1994 related mainly to the debtor-in-possession financing agreement (the \"DIP Financing Agreement\") secured by U.S. Brass, and the new revolving credit facility (the \"Revolver\") at Eljer Manufacturing discussed below. The Company reduced its long-term borrowings by a total of $20.8 million in 1994.\nELJER INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nOn October 17, 1994, Eljer Manufacturing entered into the Revolver with Congress Financial Corp. (\"Congress\"). Under the terms of the Revolver, Congress may advance up to $35 million to Eljer Manufacturing based upon a percentage of eligible accounts receivable and subject to certain criteria. Advances by Congress are secured primarily by the accounts receivable of Eljer Manufacturing. The expiration date of the Revolver is October 17, 1997. The Revolver may be renewed annually thereafter. Approximately $13.0 million of the borrowings from the Revolver was used to repay all amounts outstanding under the Company's prior accounts receivable sale program. An additional $7.5 million of the borrowings was used to repay a portion of the Company's U.S. term debt agreement (the \"U.S. Term Debt\") pursuant to an amendment which allowed Eljer Manufacturing to enter into the Revolver. Eljer Manufacturing also was required to accelerate a $4.0 million principal repayment of U.S. Term Debt which was originally scheduled for December 30, 1994. After making these payments and $8.3 million of scheduled U.S. Term Debt payments in 1994, the remaining U.S. Term Debt balance at yearend 1994 was $78.5 million compared to $98.3 million at yearend 1993. No additional U.S. Term Debt principal reductions are required until the $11.0 million required payment due December 29, 1995, which may be reduced by amounts paid related to certain environmental matters. The balance of the U.S. Term Debt is due April 30, 1996. The interest rate under the U.S. Term Debt was the prime rate, plus a margin of 3.0% (or 11.5%) at the end of 1994 and will be increased by 0.5% at six month intervals to maturity.\nThe Company intends to explore some manner of debt restructuring or extension of existing debt prior to the April 1996 U.S. Term Debt maturity date. Neither the Company nor any of its subsidiaries has any commitment with respect to restructuring or other sources of financing or extension of existing debt and there can be no assurance that any such commitment or extension can be obtained prior to the U.S. Term Debt maturity date. Failure to obtain such a commitment or extension or failure to pay the term debt when due would constitute an event of default thereunder, and would give the lenders the right, if they elect to do so, to foreclose on the collateral which constitutes essentially all the domestic assets of the Company (except that pledged under the Revolver and assets of U.S. Brass), including the stock of its foreign subsidiaries. Failure to pay the term debt when due, would also be an event of default under the Revolver.\nU.S. Brass\nAs previously disclosed, and as discussed extensively in Note 2, on May 23, 1994, U.S. Brass filed a voluntary petition for reorganization under Chapter 11 of the Bankruptcy Code in the Bankruptcy Court. On June 28, 1994, U.S. Brass entered into the DIP Financing Agreement with Congress, which had provided secured financing for working capital purposes prior to the Petition Date. Pursuant to the DIP Financing Agreement, Congress agreed to provide loans and advances in an amount not to exceed $20 million when added to the outstanding amount of advances made by Congress prior to the Petition Date. At yearend 1994, the outstanding principal amount of such advances was approximately $7.9 million. Unused availability was approximately $6.6 million with an additional $1.8 million available for professional fees, payment of which is subject to Bankruptcy Court approval. U.S. Brass believes that it will have sufficient cash resources and financing to meet trade obligations and cover operating and reorganization expenses during 1995 and intends to pay all post-Petition Date operating expenses (including trade obligations) in the ordinary course of business.\nRestricted Cash\nRestricted cash relates to cash that is legally restricted as to its use. At yearend 1994 and 1993, the Company had several components of restricted cash. Approximately $6.0 million and $6.3 million at yearend 1994 and 1993, respectively, of the restricted cash balance relates to the reimbursement, from an insurance carrier under a reservation of rights, 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 U.S. Term Debt only for the\nELJER INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\npayment of settlements, judgments, appeal bonds and deposits, attorneys' fees, and related expenses in the Qest system and other litigation. In addition, the Company maintained restricted cash balances of approximately $11.3 million and $9.7 million at yearend 1994 and 1993, respectively, to secure letters of credit.\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 $57.6 million and $46.1 million at the end of 1994 and 1993, respectively.\nIf inventories valued on the LIFO method had been valued at their current cost, they would have been $10.2 million and $8.4 million higher at the end of 1994 and 1993, respectively.\nIn 1994, LIFO inventory quantities increased, causing cost of goods sold to be approximately $1.8 million higher than if inventories had been valued at their current cost. During 1993 and 1992 inventory quantities were reduced which resulted in liquidations of LIFO inventory quantities carried at lower costs prevailing in prior years as compared with the cost of 1993 and 1992 purchases, the effect of which decreased cost of goods sold by approximately $732,000 and $390,000, respectively.\nThe Company recorded a $5 million accrual for inventory discontinued in 1991. Charges against accruals in 1994, 1993 and 1992 were approximately $468,000, $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):\nELJER INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(6) ACCRUED EXPENSES:\nAccrued expenses consisted of the following (in thousands):\n(7) DEBT:\nShort-Term Facilities\nAs discussed in Note 3, Eljer Manufacturing entered into the Revolver, for up to $35 million based upon a percentage of accounts receivable and subject to certain criteria, with Congress during 1994. The Revolver requires maintenance of various covenants related to information requests, additional indebtedness, and other non-financial requirements. Eljer Manufacturing was in compliance with all such covenants at yearend 1994. At the end of 1994, the outstanding principal amounts of advances were approximately $22.1 million and unused availability was approximately $6.7 million. Additional restrictive covenants are placed on the Company if the unused availability amount falls below $3.5 million. Interest is calculated based upon the prime rate per annum plus an additional 1% unless Eljer Manufacturing elects to convert a portion of the prime rate loans to Eurodollar rate loans, which have an interest rate of LIBOR plus an additional 3%. Yearend 1994 interest rates were approximately 9.19% on approximately $9.0 million of Eurodollar rate based loans, and 9.5% on approximately $13.1 million of prime rate based loans.\nAs discussed in Notes 2 and 3, on May 23, 1994, U.S. Brass filed a voluntary petition for reorganization under Chapter 11 of the Bankruptcy Code, and on June 28, 1994, entered into the DIP Financing Agreement with Congress for up to $20 million borrowings based on a percentage of accounts receivable and inventories and subject to certain criteria. As security for the financing under the DIP Financing Agreement, which expires in June 1996, the Bankruptcy Court authorized U.S. Brass to grant first priority liens and security interests to Congress over certain present and future accounts receivable and inventory of U.S. Brass generated on and after the Petition Date and certain other assets. The DIP Financing Agreement requires the maintenance of certain financial covenants, including tangible net worth, working capital and capital expenditure requirements. At the end of 1994, U.S. Brass was in compliance with all covenants under the DIP Financing Agreement. The total principal amounts owed by U.S. Brass related to the DIP Financing Agreement and the previous financing agreement at yearend 1994 and 1993 were approximately $7.9 million and $3.9 million, respectively. Interest related to these agreements is the prime rate per annum plus an additional 2%, or 10.5% and 8.0% at yearend 1994 and 1993, respectively. In addition, $300,000 and $100,000 in facility fees and closing costs were paid in 1994 and 1993, respectively.\nThe Company's Selkirk subsidiary in the United Kingdom is party to a credit 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 $7.3 million. The revolver, which expires in September 1997,\nELJER INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nis 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 debt discussed below. There were no balances outstanding at yearend 1994 and 1993 under this facility. Commitment fees are calculated at 0.75% per annum payable quarterly and in arrears on any undrawn portion of the revolving credit facility. In addition, the Company's Selkirk subsidiary in Germany had unsecured credit lines with German banks totaling approximately $4.8 million, of which approximately $4.0 million was available at yearend 1994. 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 1994 and 1993 was approximately $780,000 and $1.2 million, respectively. Interest on debt outstanding at annual yearend rates ranged from 8.5% to 9.5% in 1994 and 9.0% to 10.25% in 1993.\nAt yearend 1994 and 1993, the weighted average interest rates on outstanding short-term borrowings were approximately 9.7% and 8.3%, respectively.\nLong-Term Facilities\nLong-term debt consisted of the following (in thousands):\nThe Company's U.S. Term Debt and related agreements were amended in October 1994. See Note 3 for discussion.\nAs discussed above, the Company's Selkirk subsidiary in the United Kingdom is party to financing arrangements with a European bank which includes a revolving credit facility (discussed above) and a term debt portion. 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 margin of between 1.5% to 1.75% based upon the ratio of operating cash flows 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 Company's subsidiaries in the United Kingdom as defined in the facility agreement.\nBoth the foreign and domestic term debt are subject to certain financial covenants with which the Company was in compliance at yearend 1994. These covenants include tangible net worth, operating cash\nELJER INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nflow 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 U.S. Term Debt.\nAggregate maturities of long-term debt and capital lease obligations for each of the next five years and thereafter are as follows (in thousands):\nCash paid for interest during 1994, 1993 and 1992 was $14.2 million, $14.2 million and $14.5 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):\nELJER INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nThe projected benefit obligations assumed an annual discount rate of 8.0% to 8.5% in 1994 and 7.5% to 9.0% in 1993. The annual rate of compensation increase ranged from 4.0% to 7.0% in 1994 and in 1993. The expected long-term annual rate of return on plan assets, which consists primarily of mutual funds, was 8.5% to 9.5% in 1994 and 8.5% to 10% in 1993. 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 available to all domestic employees 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 $742,000 in 1994, $715,000 in 1993 and $666,000 in 1992.\n(9) OTHER POSTRETIREMENT BENEFITS:\nThe Company sponsors a welfare benefit plan which provides for certain health care and life insurance postretirement benefits to certain retired employees in the United States. Life insurance and comprehensive medical benefits are available to certain active employees who, immediately upon retirement, receive a pension under the Company's retirement plan. Postretirement benefits are also continued for certain former employees who are currently receiving Company pension benefits. Generally, the medical program covers dependents of retirees in addition to former employees. Retiree contributions are required in the case of medical benefits for most retirees and their eligible 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 plan's combined funded status reconciled with the amount shown in the Company's financial statement at the end of 1994 and 1993 (in thousands). Since the Company funds the plan on a \"pay-as-you-go\" basis, the Company's postretirement health care plan is underfunded.\nELJER INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNet periodic postretirement benefit cost for 1994, 1993 and 1992 included the following components (in thousands):\nFor measurement purposes, health care cost trend rates for various services varied from 9.0% in 1994, 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 1994 by $4.5 million, and the aggregate of the service and interest cost components of net postretirement health care cost for 1994 by $494,000. The weighted-average discount rate used in determining the accumulated postretirement benefit obligation at the end of 1994 and 1993 was 8.25% and 7.0%, 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 7,129,626 shares outstanding at yearend 1994. Treasury stock totaled 57,249 and 94,549 shares at the end of 1994 and 1993, 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.\nELJER INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\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 \"Incentive 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 distribution of the Company's stock to holders of Household's stock in April 1989 (the \"spin-off\"). These Options have special terms as to exercisability and purchase prices based on the value of the Options forfeited.\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 Incentive Plan. During 1993, 350,000 additional shares were made available. As of the end of 1994 there were 231,283 shares available for grant under the Incentive Plan.\nELJER INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(11) INCOME TAXES:\nIncome (Loss) Before Taxes and Income Tax (Benefit) Expense in 1994, 1993 and 1992 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 taxesreflect the impact of \"temporary differences\" between amounts of assets and liabilities for financial reporting and tax purposes as measured using enacted tax rates.\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 1994 and 1993 are as follows:\nAt the end of 1994 and 1993, valuation allowances were provided for the net deferred tax assets as required under SFAS No. 109. The valuation allowance increased approximately $4.1 million and $674,000 during 1994 and 1993, respectively.\nThe Company had a tax basis alternative minimum tax credit carryforward of approximately $1.2 million at yearend 1994, which is available to reduce future federal income taxes. The Company had a net operating loss carryforward of $620,000 at yearend 1994 for domestic federal income tax purposes.\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)\nA $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 $640,000 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 $8.8 million of undistributed earnings of foreign subsidiaries at the end of 1994, 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 1994 due to the availability of foreign tax credits.\nUnder an agreement with Household, the Company is entitled to the tax deduction, if it can be utilized, associated with certain liabilities 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. An estimate of approximately $20.8 million of the liabilities for which the Company may receive a benefit remain at yearend 1994. The Company's portion of these liabilities at the end of 1994 approximates $8.0 million. These payments would have no impact on the financial results of the Company if it were subject to statutory tax rates; however, an impact did occur due to the Company's alternative minimum tax or taxable loss position in the years presented. A total of $1.2 million, $1.3 million and $4.6 million of such payments were made in 1994, 1993 and 1992, respectively. The impact of future payments will be dependent on the tax paying position of the Company.\nNet cash refunds related to income taxes in 1994 were $4.0 million. Cash paid for income taxes in 1993 and 1992 was $3.6 million and $7.0 million, respectively.\n(12) LEASES:\nRental expense under operating leases was $5.6 million, $6.2 million and $6.3 million in 1994, 1993 and 1992, respectively.\nFuture minimum lease commitments under noncancelable operating leases at the end of 1994 were as follows (in thousands):\n(13) CONTINGENCIES:\nQest System Litigation\nThe Company is involved in certain litigation related to Qest polybutylene plumbing systems. See Note 2 for discussion.\nELJER INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nEnvironmental Matters\nThe Company operates plants that may generate hazardous and nonhazardous waste, disposal of which is subject to federal and state regulation. 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 Company facilities have been required to implement programs to remedy the effects of past waste disposal. Not all plants have been the focus of comprehensive environmental studies. Except as described below, the Company is not aware of any 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. 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 $13.8 million at the end of 1994 (see discussion of individual sites and summary table provided herein) pertaining to environmental, health and safety matters which the Company believes are adequate. Although the timing of the related payments is uncertain, the Company believes that a substantial portion of the payments will be made over the next three years.\nSalem and Marysville, Ohio, Facilities. The Company and the Ohio Environmental Protection Agency (\"Ohio EPA\") previously reached agreement on a proposed closure plan for the Company's Salem, Ohio, facility and the Company submitted a revised closure plan on April 30, 1993. The Company has not yet received either approval of, or comments on, the revised closure plan. The Company has paid $1.6 million to complete an interim closure of the subject area and accruals of approximately $1.8 million for additional closure and post-closure costs expected in future periods are recorded at yearend 1994, which the Company believes are adequate. No activity related to closure or postclosure of the Salem, Ohio, facility had a material adverse impact on the Company's 1994 liquidity or results of operations and none is expected.\nAs disclosed in last year's Form 10-K, the Company has submitted a closure plan for its Marysville, Ohio, facility to the Ohio EPA, which has not yet commented on the plan. The Marysville, Ohio, facility was closed in 1987. If it is approved in its current form, the Company's environmental consultants estimate that the cost of implementing the closure plan, including post-closure care, will be approximately $9.4 million. However, the ultimate cost to complete closure and post-closure activities at the facility will depend to a large extent on the remediation technology ultimately agreed upon by the Ohio EPA. The Company has previously established accruals which it believes will be adequate to provide for the cost to implement its closure plan. However, there is no assurance that the plan will be approved without making additional revisions or modifications. Although no estimate can be made, in the event the closure plan is not approved, the cost of remediation could have a material impact on future operating results or financial position.\nNone of the costs of clean-up and closure of the Salem and Marysville sites have been discounted. The Company discounted the post-closure costs of these sites over a 20 to 30 year period using a discount rate of 5%. The aggregate undiscounted amount of these liabilities at yearend 1994 was approximately $3.3 million, of which the discounted amount of approximately $1.8 million was accrued. The Company's environmental consultants estimate that the payments associated with these postclosure costs for each of the first five years after the closures are completed will be approximately $128,000 per year with aggregate payments of approximately $2.7 million over the remaining 15 to 25 years.\nAfter March 1992, the Company was unable to demonstrate financial responsibility for closure, post-closure care and third-party liability with respect to the Salem site and the Marysville site. On September 30, 1994, the U.S. Department of Justice (the \"DOJ\") proposed payment by the Company of\nELJER INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\na cash penalty of $175,000, with an additional fine of $912,000 to be held in abeyance pending completion of the site closure activities. The deferred amount would then be waived if the Company continues to comply with the financial responsibility requirements of the December 1990 consent decree with the United States Environmental Protection Agency (the \"U.S. EPA\") relating to the Salem site. On October 19, 1994 the Company accepted the DOJ offer pending agreement on a modification to the 1990 consent decree which has not yet been reached. The Company has established accruals which it believes adequate to provide for the $175,000 cash penalty assessed. The Company currently meets its financial responsibility requirements regarding the Salem site although Ohio EPA has recently asserted that the Company has not posted sufficient collateral to cover the cost of post-closure care. The Company disputes the Ohio EPA's contention and intends to resolve this issue prior to entering into final agreement with the DOJ on the penalties discussed above.\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. Subsequently, the Company received correspondence from the Ohio EPA threatening to escalate enforcement action against the Company, and in October 1994, the Company received correspondence from the Ohio Attorney General threatening commencement of a lawsuit for failure to meet the financial assurances section of the Ohio Administrative Code. The Company is currently negotiating the matter with the Ohio Attorney General's office and the Ohio EPA and may be required to place $8.5 million in cash in a trust which will be used to pay for the clean-up at this site to meet the financial assurance requirements. Ohio statutes permit the Ohio Attorney General to seek penalties of up to $10,000 per day for violations of its regulations and makes the reckless violation of its regulations a felony. If a settlement is not reached, the Ohio Attorney General might argue that the Company has been out of compliance with two separate financial assurance requirements since March 1992. The Company continues to believe that it has legitimate defenses to the imposition of any penalties and intends to vigorously defend against such penalties, but cannot currently estimate what penalties, if any, may be imposed on the Company if it is ultimately found to have violated the Ohio regulations. Accordingly, no specific accrual has been established to provide for such penalties.\nAs reported in the Company's 1993 Form 10-K, the Company has negotiated with the DOJ and the U.S. EPA a settlement for alleged violations of the Clean Water Act for unpermitted discharge of wastewater streams at the Salem, Ohio plant. The settlement calls for the payment of a $300,000 cash penalty and the performance of certain remediation work estimated to cost approximately $690,000. The specific terms and conditions of the settlement remain to be negotiated. The Company has previously established accruals which it believes are adequate to cover these costs.\nSuperfund Sites. 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.\nAs disclosed in the Company's 1993 Form 10-K, certain 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. Through notifications from the U.S. EPA, the Company believes its total liabilities related to Superfund sites to be immaterial (approximately $220,000 at year end 1994) if liability and contributions are assessed in an equitable manner among all responsible parties. The Company has established accruals which it believes are adequate to provide for any liabilities it may have with respect to these sites.\nELJER INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nAtlanta, Georgia, Site. As previously disclosed, in October 1991, Eljer Manufacturing sold a facility located in Atlanta, Georgia to joint venture partners Toto Ltd., Mitsui & Co., Ltd. and Mitsui & Co. (USA), Inc. (\"Toto and Mitsui\"). Toto and Mitsui subsequently asserted that Eljer Manufacturing is responsible under the indemnification provisions included in the Purchase and Sale Agreement to remediate alleged contamination at the sold facility. Under the agreement, Eljer Manufacturing's liability for remediation costs is limited to $750,000. Eljer Manufacturing has notified the prior owner of the facility, JP Industries, Inc., (\"JP Industries\") that it may be liable to Eljer Manufacturing for indemnity under the provisions of Eljer Manufacturing's purchase agreement with JP Industries. Eljer Manufacturing does not believe that any remediation at the Atlanta site is necessary and no estimate of a liability, if any, can be made at this time. In addition, no estimate can be made of the amount, if any, that Eljer Manufacturing may receive from JP Industries.\nWilson, North Carolina, Site. In anticipation of the 1994 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 benzene and methylene chloride. 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, the direction of groundwater flow and the Company's understanding that trichloroethene has never been used at the plant, it is presently the Company's belief that any trichloroethene on the property originated from off-site sources. The Company does not believe it is responsible for remediation of any trichloroethene which may be present at the site. However, the Company retains responsibility under the indemnification provisions included in the Purchase and Sale Agreement to remediate benzene and methylene chloride that exceed maximum levels allowed by North Carolina law. While the cost to comply with the Company's indemnity obligations is estimated at $509,000 based on the use of traditional remediation methods, the Company hopes to receive approval from the state of North Carolina to pursue alternative remediation methods. The Company has established accruals which it believes are adequate to provide for the costs of investigation and remediation, if any.\nProposition 65. As previously disclosed, Eljer Industries, Eljer Manufacturing, U.S. Brass and approximately 15 other manufacturers and sellers of residential and commercial brass faucets are defendants in lawsuits brought by the Attorney General of the State of California and the Natural Resources Defense Council and the Environmental Law Foundation alleging violations of California's Safe Drinking Water and Toxic Enforcement Act of 1986 (\"Proposition 65\"). The lawsuits allege that U.S. Brass and Eljer Manufacturing did not label their faucets in conformity with Proposition 65. The lawsuits further allege that U.S. Brass and Eljer Manufacturing knowingly discharged or released lead into drinking water in violation of Proposition 65, which discharge and exposure allegedly arose out of leaching of lead into drinking water from leaded brass faucets manufactured by the defendants. The California trial court has ruled in the case brought by the California Attorney General that no cause of action has been stated to support the claim that faucets leach lead into drinking water. That ruling has been appealed to the California Court of Appeal. As part of a proposal to settle these lawsuits, U.S. Brass has developed a faucet manufactured from bismuth brass as opposed to leaded brass. If a settlement is reached, it is expected that the Company and U.S. Brass will begin selling the bismuth brass faucets in California as well as continuing to sell its leaded brass faucets with appropriate Proposition 65 labeling. Additionally, the Company and U.S. Brass are currently attempting to negotiate a settlement concerning any penalties that might be due as a result of the failure of the Company and U.S. Brass to properly label faucets sold in California in accordance with Proposition 65 and for the alleged violation of the discharge requirements. The Company does not expect the resolution of these lawsuits to have a material adverse effect on its financial condition or results of operations. Claims have been filed in the U.S. Brass bankruptcy totalling $6 million related to this matter. The Company disputes these claims and expects to file an objection to them in the Bankruptcy Court. The\nELJER INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\noutcome of the claims against U.S. Brass will be dependent on the final Plan. See Note 2 for discussion. The Company and U.S. Brass currently label their faucets in accordance with Proposition 65.\nFollowing is a summary of environmental contingencies (in thousands):\nThe Company has recently made claims to its applicable insurance carriers under certain insurance policies for any amounts paid in the past or for which it may become obligated to pay in the future in connection with various environmental matters. The Company cannot predict the amount, if any, of insurance proceeds that may be received as a result of these environmental claims. No receivables from insurance carriers have been recorded related to environmental matters.\nKowin and Related Litigation\nOn June 10, 1994, the United States Supreme Court denied the petition for certiorari filed by Eljer Manufacturing in the previously disclosed Kowin Development Company (\"Kowin\") litigation. The litigation resulted from a failed manufacturing joint venture in the People's Republic of China (the \"PRC Joint Venture\") in which Kowin held a 25% interest. On June 30, 1994, a final judgment was entered and Kowin was paid approximately $11.6 million of the $13.2 million cash bond previously posted by Eljer Manufacturing for this litigation. Approximately $1.6 million of related amounts previously paid, plus interest thereon, was returned to the Company. The amount of the judgment and related costs were included in an extraordinary charge against earnings in 1992.\nOn October 24, 1994, the American Arbitration Association arbitrator hearing Croft Investments, Ltd. (\"Croft\") v. Eljer Manufacturing, a\/k\/a HMI and Eljer Industries (the \"Croft Arbitration\") dismissed all claims filed by Croft. Croft was an affiliate of Kowin in the PRC Joint Venture. On January 31, 1995, counsel for Croft executed a stipulation confirming that Croft will not\nELJER INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\ncontest that ruling by the arbitrator in the Croft Arbitration. As a result, on February 7, 1995, Eljer Industries and Eljer Manufacturing filed a joint motion to dismiss the appeal previously filed with the United States Court of Appeals for the Ninth Circuit on Croft's ability to prosecute the Croft Arbitration which was subsequently granted.\nThe approximately $1.2 million judgment against Eljer Manufacturing entered in the People's Republic of China and previously disclosed, remains subject to an appeal, but is outstanding and unpaid. Based upon advice of counsel, Eljer Manufacturing continues to believe it has substantial procedural defenses against any effort to enforce this judgment in the United States. Eljer Manufacturing believes its $1.2 million accrual is adequate to provide for any liability ultimately incurred in this matter. Additionally, as previously disclosed, in 1988 Simonds Industries, Inc. purchased HMI's interest in the PRC Joint Venture and may have liability for a portion of the amount awarded; however, no estimate can be made of the amount, if any, that Eljer Manufacturing may receive from Simonds Industries, Inc.\nOn October 24, 1994, Winston and Dorothy Ko, the owners of Kowin and Croft, filed a complaint in the Circuit Court of Cook County, Illinois seeking individual damages in an action entitled Winston Ko and Dorothy Ko v. Eljer Industries, Inc., et al. Plaintiffs have claimed approximately $24 million in damages for alleged losses on their real estate investments, and also seek unspecified exemplary and punitive damages, and unspecified damages for alleged injury to their reputations, for emotional distress and for lost profits on their real estate investments. Eljer Industries, Eljer Manufacturing and related individual defendants have filed a motion to dismiss the complaint. If the case is ultimately litigated, the Company believes that it has adequate defenses and should prevail. Accordingly, no accrual has been established for this contingency.\nOther Matters\nAs previously disclosed, the Consumer Product Safety Commission (\"CPSC\") has initiated an investigation under Section 15 of the Consumer Product Safety Act (the \"Act\") as to whether a vent pipe product manufactured by Chevron Chemical Company's Plexco Performance Pipe Division poses a substantial product hazard under the Act. The vent is used to exhaust combustion gases from mid-and high-efficiency small water boilers and central heating furnaces. Eljer Manufacturing's Selkirk Metalbestos division (\"Selkirk\") distributed the Plexco vent pipe from mid-1990 until the end of 1993. Selkirk began manufacturing and selling its own vent pipe product in January 1994. Selkirk has responded to informal requests for information from the CPSC and has also sent samples, as requested, of its own vent pipe product. The status, as well as the scope and extent of the CPSC investigation are unknown. However, by law, the CPSC may direct repair, replacement or refund of any product that it believes poses a substantial product hazard. In Canada, use of Plexco and similar vent pipe has been restricted to certain applications by provincial authorities pending further investigation. Selkirk believes that its vent product does not exhibit the same characteristics as the Plexco product, but is continuing to test and monitor its product. Therefore, no accrual for this contingency has been made.\n(14) RELATIONSHIP WITH HOUSEHOLD:\nThe Company is currently involved in litigation with its former parent, Household, relating to the spin-off in April 1989. Household filed an action in the Delaware Chancery Court on February 5, 1993 against the Company, Eljer Manufacturing and U.S. Brass seeking declaratory relief. Following a finding by the Delaware Chancery Court that it had no subject matter jurisdiction, that action was transferred to the Delaware Superior Court for trial on the merits where it remains pending. On March\nELJER INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n9, 1995, the Delaware Superior Court denied the Company's motion to dismiss or stay the Delaware action. The Company may appeal that decision. Discovery is proceeding in that action, but no trial date has been set.\nOn February 11, 1993, the Company and Eljer Manufacturing filed a breach of contract action against Household in the District Court of Dallas County, Texas, 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. The Company is preparing for trial in the Texas action and a trial date has been set for the week of July 10, 1995.\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):\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 20, 1995, sets forth certain information with respect to the directors of the Registrant and is incorporated herein by reference. Certain information\nwith 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 20, 1995, 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 20, 1995, 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 20, 1995, 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 16.\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(4) REPORTS ON FORM 8-K\nNone.\nSubsequent Reports on Form 8-K\nNone.\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 23, 1995. Our report on the consolidated financial statements includes an explanatory paragraph with respect to the substantial doubt about the Company's ability to continue as a going concern in its present consolidated form due to the issues arising from the Qest polybutylene plumbing systems manufactured and sold by the Company's indirect, wholly-owned subsidiary, United States Brass Corporation. Our report on the consolidated financial statements also includes an emphasis of matter paragraph regarding the Company's term debt, which expires on April 30, 1996. These matters are discussed in Notes 2 and 3 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 in 1992 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 schedule listed in the index to Item 14 is the responsibility of the Company's management and is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic 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\nDallas, Texas, March 28, 1995\nELJER INDUSTRIES, INC. SCHEDULE 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.\nDated: March 29, 1995 ELJER INDUSTRIES, INC. ----------------\nBy: \/s\/Henry W. Lehnerer ---------------------------- 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":"766748_1995.txt","cik":"766748","year":"1995","section_1":"Item 1. Business\nPower Test Investors Limited Partnership (\"Partnership\") is a New York limited partnership which was formed in January 1985 to invest in and become the limited partner in Power Test Realty Company Limited Partnership (\"Operating Partnership\"), also a New York limited partnership. The Operating Partnership was formed to acquire, own, lease and sell or dispose of certain of the assets (\"Getty Oil Assets\") constituting the tangible assets (other than petroleum product inventories) used in the petroleum marketing operations of Getty Oil Company (\"Getty Oil\") and Getty Refining and Marketing Company (the name of which was changed to Texaco Refining and Marketing Inc. (\"TRMI\")) located in the Northeastern and Mid-Atlantic states. The general partner of the Partnership and the Operating Partnership is CLS General Partnership Corp. (\"General Partner\"), a Delaware corporation. The three shareholders of the General Partner are the principal shareholders of Getty Petroleum Corp. (See Item 10).\nOn February 1, 1985, the Operating Partnership purchased the Getty Oil Assets for approximately $68 million from TRMI. The Operating Partnership principally leases such assets to Getty Petroleum Corp. either directly or indirectly through wholly-owned subsidiaries of Getty Petroleum Corp.\nAs limited partner of the Operating Partnership, the Partnership contributed 99% of the capital of the Operating Partnership and shares pro rata with the General Partner (which contributed the remaining 1% of the capital of the Operating Partnership), in the same proportion as each partner's capital contribution bears to the aggregate of all partners' capital contributions, in the financial and tax attributes of the Operating Partnership. During 1985, the Partnership sold, by means of a pro rata rights offering, Units of Limited Partnership Interests (\"Units\") to holders of common stock of Getty Petroleum Corp. Holders of the Units are the limited partners (together with the principal holders, as disclosed in Item 12), (\"Limited Partners\") of the Partnership, contributing approximately 79% of the capital of the Partnership, and share pro rata with the General Partner (which initially contributed approximately 21% of the capital of the Partnership) in the financial and tax attributes of the Partnership. In 1990 and 1991, the General Partner purchased 38,933 and 46,000 Units, respectively, further increasing its ownership of the Partnership to approximately 22.3%.\nThe financial results of the Operating Partnership (and, derivatively, the Partnership) are based on the rental revenues received from Getty Petroleum Corp. in respect of the Getty Oil Assets, and are therefore materially dependent upon the ability of Getty Petroleum Corp. to meet its obligations under the leases and subleases of the Getty Oil Assets. (For information concerning Getty Petroleum Corp., see reports filed pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934, Commission File No. 1-8059.) Reference is made to Note 5 of Notes to Consolidated Financial Statements filed with this Annual Report, for a schedule of minimum lease payments to be received in each of the next five years under leases in effect at December 31, 1995.\nCertain employees of Getty Petroleum Corp. perform services for the Partnership (See Item 13 and Note 5 of Notes to Consolidated Financial Statements). The Partnership does not have any employees.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nAs of December 31, 1995, the Operating Partnership owned 291 gasoline service stations located in Connecticut (25), Delaware (11), Maine (6), Maryland (3), Massachusetts (41), New Hampshire (7), New Jersey (81), New York (56), Pennsylvania (51), Rhode Island (9) and Vermont (1). Each of the service stations is leased to Getty Petroleum Corp. which either operates or subleases the service stations. The Operating Partnership also owned five petroleum distribution terminals located in Connecticut, New Jersey, New York (2) and Rhode Island. The distribution terminals are leased to a wholly-owned subsidiary of Getty Petroleum Corp. The service station and distribution terminal leases each have an initial 15 year term expiring on January 31, 2000 and Getty Petroleum Corp. has the option, but is not obligated, to extend the leases for up to five consecutive extended terms of ten years each.\nThe Operating Partnership purchased marketing equipment from TRMI on February 1, 1985 and leased the equipment to a wholly-owned subsidiary of Getty Petroleum Corp. The marketing equipment consisted of personal property and equipment, including pumps, tanks and furniture. The initial term of the marketing equipment lease expired on January 31, 1995 and provided for a rental of $200,000 per annum. The lease with respect to certain of the underground storage tanks and related equipment, which are scheduled to be replaced or upgraded by the end of 1998 due to environmental regulations, has been renewed through December 31, 1998 for a rental of $59,271 per annum.\nThe Operating Partnership is the lessee under a ground lease expiring on May 14, 1999 covering a distribution terminal located in South Portland, Maine, which it had subleased to a wholly-owned subsidiary of Getty Petroleum Corp. through December 14, 1995. Effective December 15, 1995, the terminal was subleased by the Operating Partnership to an unrelated third party through May 14, 1999. The sublessee has the option to purchase the Operating Partnership's interest in the ground lease and improvements at the terminal at decreasing amounts through the term of the sublease. The ground lease and the sublease contain provisions for additional renewal periods subject to mutual agreement.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe Partnership is not subject to any material pending legal proceedings nor were any such proceedings terminated during the fourth quarter of 1995.\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 1995.\nPART II.\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Unitholder Matters\nThe Units are transferable and trade from time to time on the over the counter market. There is no active market and the Partnership does not currently intend to apply to have the Units listed for trading on any securities exchange.\nAs of December 31, 1995, there were 593 holders of record of limited partnership interests in the Partnership.\nItem 6.","section_6":"Item 6. Selected Financial Data\nSet forth below is selected financial data for the Partnership and the Operating Partnership as of and for each of the five years in the period ended December 31, 1995.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nThe Partnership was formed to invest in and become the limited partner in the Operating Partnership. The Partnership's financial position and results of operations are dependent on the operating results of the Operating Partnership. Since the Operating Partnership has leased substantially all of its properties to Getty Petroleum Corp., the Operating Partnership's operating results and ability to fulfill its obligations are primarily dependent on Getty Petroleum Corp.'s ability to make all required rental payments.\nThe operations of the Operating Partnership principally consist of leasing to Getty Petroleum Corp. the assets which were acquired on February 1, 1985 from TRMI. The leases are principally for initial periods of fifteen years expiring on January 31, 2000 (subject to multiple renewal periods through 2050) and provide for aggregate annual rental payments of approximately $10,330,000 as of December 31, 1995 (See Note 5 of Notes to Consolidated Financial Statements).\nThe decrease in rental income for the year ended December 31, 1995 as compared to the prior year was due to the sale of certain properties.\nOther income for the years ended December 31, 1995 and 1994 principally represents gains on dispositions of properties and interest income. During 1995, the Operating Partnership sold fourteen service stations to Getty Petroleum Corp. for an aggregate amount of $4,591,114 or eleven times the aggregate annual rentals of $417,374, which resulted in a net gain of $3,128,372 to the Partnership. During 1995, the New Haven terminal and a service station property were subject to partial condemnations resulting in the taking of certain of the land. The condemnation awards were allocated to the Operating Partnership and Getty Petroleum Corp. in accordance with the formula set forth in the lease. The condemnations resulted in a net gain to the Partnership of $175,977. During 1994, the Operating Partnership sold five service stations to Getty Petroleum Corp. for an aggregate amount of $1,131,119 or eleven times the aggregate annual rentals of $102,829, which resulted in a net gain of $658,532 to the Partnership. Other income for the year ended December 31, 1993 principally represents interest income.\nGeneral and administrative expense in 1995 amounted to $935,000, an increase of $226,000 as compared to 1994, primarily due to state and local taxes levied at the partnership level.\nInterest expense in 1995 amounted to $3,651,000, an increase of $98,000 as compared to 1994. The increase in 1995 was primarily due to a payment of $279,000 to terminate an interest rate swap agreement in connection with the refinancing of a mortgage loan. The increase was partially offset by a reduction in the Operating Partnership's outstanding mortgage balances and lower interest rates as a result of the refinancing. Interest expense in 1994 amounted to $3,553,000, a decrease of $137,000 as compared to 1993. The net decrease from 1993 to 1994 was principally due to a reduction in the Operating Partnership's outstanding mortgages.\nOn October 31, 1995, the Operating Partnership refinanced a mortgage loan which was payable through January 1, 1997. The loan had an outstanding balance of $31,845,000 at an interest rate of prime. The refinanced loan provides for interest at LIBOR plus 1.125% to 1.75 % per annum, depending on the Funded Debt Ratio, as defined, of Getty Petroleum Corp. (LIBOR plus 1.375 % or 7.35% at December 31, 1995). The Partnership expects that the refinancing and termination of the interest rate swap agreement will result in interest savings of approximately $900,000 in 1996 as compared to 1995.\nOn January 3, 1996, the Operating Partnership repaid a mortgage loan in the amount of $3,696,000 which was originally payable through January 1, 2000 at an interest rate of 10.125%. In connection with the repayment, the Operating Partnership borrowed $1,500,000 on an unsecured basis at LIBOR plus 1.5%.\nThe General Partner's share of the Operating Partnership's income for each of the periods presented has been reflected as \"Income applicable to minority interest\" in the consolidated statements of income.\nInflation will not have a significant impact in future periods on property operating expenses since the long-term leases with Getty Petroleum Corp. are \"net leases\" and contain provisions which cover increases in real estate taxes and other charges related to the properties and equipment.\nOn November 9, 1995, the Partnership announced that it may purchase in the market from time to time through March 15, 1996 up to 150,000 of its Units at prices not to exceed $8.00 per Unit. In June 1995, the Partnership had offered to purchase Units for $7.50 per unit. Through March 15, 1996, the Partnership purchased 9,912 Units at an aggregate cost of $76,897.\nAt December 31, 1995, cash and cash equivalents amounted to $5,755,000, of which $2,196,000 was used in connection with the refinancing in January 1996 and $2,896,000 which was restricted under the terms of the mortgage loan. Restricted funds of $1,896,000 may be used to acquire additional properties or to reduce the outstanding loan balance. Cash in excess of operating and debt service requirements for the years ended December 31, 1995, 1994 and 1993 was principally distributed to unitholders in the form of quarterly cash distributions which aggregated $.74 per unit each of the years. In 1996, the Partnership anticipates that it will continue to make quarterly cash distributions to holders of Units.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nPage ------ Report of Independent Accountants 11\nConsolidated Financial Statements: Balance Sheets - December 31, 1995 and 1994 12\nStatements of Income - for the years ended December 31, 1995, 1994 and 1993 13\nStatements of Cash Flows - for the years ended December 31, 1995, 1994 and 1993 14\nNotes to Consolidated Financial Statements 15 - 22\nSchedule III - Real Estate and Accumulated Depreciation as of December 31, 1995 23 - 24\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 a Board of Directors.\nCLS General Partnership Corp., as General Partner, manages the affairs of the Partnership and Operating Partnership. The executive officers of the General Partner are:\nOfficer Name Title Since ---- ----- ----- Leo Liebowitz President and Treasurer 1985 Milton Safenowitz Executive Vice President and Assistant Secretary 1985 Milton Cooper Secretary and Assistant Treasurer 1985\nMessrs. Liebowitz, Safenowitz and Cooper are the sole Shareholders and Directors of the General Partner.\nThe background and experience of these individuals is as follows:\nLeo Liebowitz, age 68, is President and Chief Executive Officer of Getty Petroleum Corp. and has been a director of Getty Petroleum Corp. since 1971. Mr. Liebowitz has extensive experience in acquiring, managing and leasing gasoline service stations and distribution terminals.\nMilton Safenowitz, age 68, has been a director of Getty Petroleum Corp. since 1971 and was Executive Vice President of Getty Petroleum Corp. until January 31, 1990. Mr. Safenowitz has extensive experience in acquiring, managing and leasing gasoline service stations and distribution terminals.\nMilton Cooper, age 67, has been a director of Getty Petroleum Corp. since 1971 and was Vice President of Getty Petroleum Corp. until June 18, 1992. He is also Chairman of the Board of Kimco Realty Corporation, a real estate investment trust. Mr. Cooper has extensive experience in acquiring, developing, leasing and financing commercial real estate properties.\nManagement is not aware of any family relationships between any of the foregoing executive officers.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe Partnership has not paid and does not propose to pay any compensation or retirement benefits to the officers of the General Partner.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nName of Units Beneficially Owned Percent Beneficial Owner December 31, 1995 (1) of Class - - ----------------- --------------------------------- -------- Leo Liebowitz 1,235,007 Units of general and limited partnership interests (2) 19.00%\nMilton Safenowitz 1,333,721 Units of general and limited partnership interests (3) 20.51%\nMilton Cooper 534,403 Units of general and limited partnership interests (4) 8.22%\nDirectors and officers as 3,103,131 Units of general and a Group limited partnership interests (5) 47.73%\n(1) With the exception of Units owned by Leo Liebowitz and Milton Safenowitz whose addresses are care of Getty Petroleum Corp., 125 Jericho Turnpike, Jericho, New York 11753 and Milton Cooper whose address is care of Kimco Realty Corporation, 333 New Hyde Park Road, New Hyde Park, New York 11042, Management knows of no other person owning of record or beneficially more than 5% of the outstanding Units.\n(2) Includes 562,576 Units held as general partnership interests, 35,069 Units owned by the General Partner and 171,150 Units held by his wife. Excludes 512,535 Units held by his children, for which Mr. Liebowitz disclaims beneficial ownership.\n(3) Includes 657,174 Units held by The Milton Safenowitz Irrevocable Trust, of which Mr. Safenowitz is the beneficiary. Also includes 557,400 Units held as general partnership interests, 34,746 Units owned by the General Partner and 84,401 Units held by The Marilyn Safenowitz Irrevocable Trust, of which Mr. Safenowitz's wife is the beneficiary. Excludes 296,766 Units held by his children, for which Mr. Safenowitz disclaims beneficial ownership.\n(4) Includes 242,527 Units held as general partnership interests, 15,118 Units owned by the General Partner, 11,439 Units held by a Retirement Fund of which he is a beneficiary and 40,500 Units held by a charitable foundation of which he is the President. Excludes 127,630 Units held by his wife and 28,356 Units held by his children and grandchildren, for which Mr. Cooper disclaims beneficial ownership.\n(5) Includes 1,362,503 Units held as general partnership interests referred to in notes (2), (3) and (4) above.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThe Operating Partnership paid $646,000 to Getty Petroleum Corp. for management services and other expenses during the year ended December 31, 1995.\nAlso see Note 5 of Notes to Consolidated Financial Statements with regard to the leases and other related party transactions between the Operating Partnership and Getty Petroleum Corp.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Partners of Power Test Investors Limited Partnership:\nWe have audited the consolidated financial statements and the consolidated financial statement schedule of Power Test Investors Limited Partnership (a New York limited partnership) and Subsidiary, as listed in Item 14(a) of this Form 10-K. These financial statements and financial statement schedule are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Power Test Investors Limited Partnership and Subsidiary as of December 31, 1995 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, 1995 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 consolidated financial statements taken as a whole, presents fairly, in all material respects, the information required to be included therein.\nCOOPERS & LYBRAND L.L.P. New York, New York February 23, 1996.\nPOWER TEST INVESTORS LIMITED PARTNERSHIP (a New York limited partnership) CONSOLIDATED BALANCE SHEETS December 31, 1995 and 1994\n1995 1994 ---- ---- ASSETS\nCash and cash equivalents (Note 2) $5,754,500 $2,523,681\nNet investment in direct financing leases (Notes 4 and 5) 4,767,144 5,747,246\nFixed assets, at cost, net of accumulated depreciation (Notes 3, 4 and 5) 29,913,036 31,903,386\nDeferred charges, net of accumulated amortization of $2,492,569 and $2,332,576, respectively 432,564 285,159 ----------- ----------- $40,867,244 $40,459,472 =========== ===========\nLIABILITIES AND PARTNERS' CAPITAL\nAccrued liabilities, primarily interest $277,453 $358,438\nMortgages payable (Note 4) 35,456,493 37,908,888\nCommitments (Note 5)\nPartners' capital, 6,501,577 and 6,510,975 units of general and limited partnership interests outstanding, respectively (Notes 2 and 6) 5,133,298 2,192,146 ----------- ----------- $40,867,244 $40,459,472 =========== ===========\nSee accompanying notes.\nPOWER TEST INVESTORS LIMITED PARTNERSHIP (a New York limited partnership) CONSOLIDATED STATEMENTS OF INCOME for the years ended December 31, 1995, 1994 and 1993\n1995 1994 1993 ---- ---- ---- Revenues (Note 5):\nRental income $8,826,750 $9,138,669 $9,171,653\nInterest on direct financing leases 1,031,447 1,177,423 1,289,524\nOther income 3,533,222 772,158 85,393 ---------- ---------- ---------- 13,391,419 11,088,250 10,546,570 ---------- ---------- ----------\nExpenses:\nInterest (Note 4) 3,651,452 3,553,091 3,690,314\nGeneral and administrative (Note 5) 934,658 708,482 694,626\nDepreciation and amortization 924,029 906,428 908,772\nIncome applicable to minority interest 80,952 59,625 53,086 ---------- ---------- ---------- 5,591,091 5,227,626 5,346,798 ---------- ---------- ----------\nNet income $7,800,328 $5,860,624 $5,199,772 ========== ========== ==========\nNet income per unit $1.20 $0.90 $0.80 ========== ========== ==========\nDistributions per unit $0.74 $0.74 $0.74 ========== ========== ==========\nWeighted average units outstanding 6,509,712 6,510,975 6,510,975 ========== ========== ==========\nSee accompanying notes.\nPOWER TEST INVESTORS LIMITED PARTNERSHIP (A New York limited partnership) CONSOLIDATED STATEMENTS OF CASH FLOWS for the years ended December 31, 1995, 1994 and 1993\n1995 1994 1993 ---- ---- ----\nCash flows from operating activities:\nNet income $7,800,328 $5,860,624 $5,199,772\nAdjustments to reconcile net income to net cash provided by operating activities:\nDepreciation and amortization 924,029 906,428 908,772\nAmortization of investment in direct financing leases 728,785 617,939 519,656\nGain on dispositions of fixed assets (3,304,349) (658,532) -\nMinority interest 80,952 59,625 53,086\nChanges in assets and liabilities:\nIncrease in deferred charges (307,398) - -\nIncrease (decrease) in accrued liabilities (80,985) 22,649 (21,902) ----------- ---------- ----------\nNet cash provided by operating activities 5,841,362 6,808,733 6,659,384 ----------- ---------- ----------\nCash flows from investing activities:\nProceeds from dispositions of fixed assets 4,781,980 1,131,119 - ----------- ---------- ----------\nNet cash provided by investing activities 4,781,980 1,131,119 - ----------- ---------- ----------\nCash flows used in financing activities:\nMortgage principal payments (2,452,395) (2,531,595) (1,486,888)\nCash distributions (4,867,343) (4,868,150) (4,868,150)\nPurchase of partnership units (72,785) - - ----------- ---------- ----------\nNet cash used in financing activities (7,392,523) (7,399,745) (6,355,038) ----------- ---------- ----------\nNet increase in cash and cash equivalents 3,230,819 540,107 304,346\nCash and cash equivalents at beginning of year 2,523,681 1,983,574 1,679,228 ----------- ---------- ----------\nCash and cash equivalents at end of year (Note 2) $5,754,500 $2,523,681 $1,983,574 =========== ========== ==========\nSupplemental disclosure of cash flow information Cash paid during the year for interest $3,718,824 $3,556,886 $3,711,016\nSee accompanying notes.\nPOWER TEST INVESTORS LIMITED PARTNERSHIP (a New York limited partnership) NOTES to CONSOLIDATED FINANCIAL STATEMENTS\n1. Organization:\nPower Test Investors Limited Partnership, a New York limited partnership (\"Partnership\"), was formed in January 1985 to invest in and become the limited partner in Power Test Realty Company Limited Partnership (\"Operating Partnership\"), also a New York limited partnership. The operations of the Operating Partnership principally consist of leasing to Getty Petroleum Corp. the marketing and distribution assets which were acquired on February 1, 1985 from Texaco Refining and Marketing Inc. Since the Operating Partnership has leased substantially all of its properties to Getty Petroleum Corp., the Operating Partnership's operating results and ability to fulfill its obligations are primarily dependent on Getty Petroleum Corp.'s ability to make all required rental payments. CLS General Partnership Corp. (\"General Partner\") is the general partner of the Partnership and of the Operating Partnership.\nThe Limited Partners of the Partnership contributed approximately 79% of the capital of the Partnership and share pro rata with the General Partner (which initially contributed approximately 21% of the capital of the Partnership) in the financial and tax attributes of the Partnership. The Partnership contributed 99% of the capital of the Operating Partnership and shares pro rata with the General Partner (which contributed the remaining 1% of the capital of the Operating Partnership) in the financial and tax attributes of the Operating Partnership. In 1990 and 1991, the General Partner purchased 38,933 and 46,000 units, respectively, of limited partnership interests further increasing its ownership of the Partnership as of December 31, 1995 to approximately 22.3%.\n2. Summary of Significant Accounting Policies:\nThe consolidated financial statements include the accounts of the Partnership and the Operating Partnership. All significant intercompany accounts and transactions have been eliminated.\nThe General Partner's share of the Operating Partnership's income for the periods ended December 31, 1995, 1994 and 1993 has been reflected as \"Income applicable to minority interest\" in the accompanying consolidated statements of income. As of December 31, 1995 and 1994, the General Partner's minority interest amounted to $45,229 and $14,305, respectively, which is included in \"Partners' Capital\" in the accompanying consolidated balance sheets (See Note 6).\nCondensed summarized financial information for the Operating Partnership as of December 31, 1995 and 1994 and for the years then ended is as follows:\n1995 1994 ---- ---- Total assets (principally property leased to Getty Petroleum Corp.) $40,629,375 $40,081,693 Total liabilities (principally mortgages payable) 35,695,750 38,238,882 Total revenues (leasing activities) 9,858,197 10,316,092 Net income 8,090,814 5,959,287\nRevenue Recognition:\nRevenue is derived principally from the lease of marketing and distribution assets to Getty Petroleum Corp. under long-term leases.\nLeases are accounted for as operating or direct financing leases. Rentals from operating leases are recognized in equal monthly amounts over the related lease terms. Revenue under direct financing leases is recognized over the lease term using the interest method which produces a constant periodic rate of return on the net investment in the leased property.\nCash and Cash Equivalents:\nThe Partnership considers highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. As of December 31, 1995, $1,896,000 of cash is restricted for the acquisition of additional properties or the repayment of debt. In addition, the Operating Partnership is required under the terms of its mortgage loan agreement to maintain cash balances or other investments of at least $1,000,000 through December 31, 1998 and $500,000 thereafter.\nNet Investment in Direct Financing Leases:\nNet investment in direct financing leases represents the remaining investment in leased assets accounted for as direct financing leases. The investment is reduced by the receipt of lease payments, net of interest income earned, amortized over the life of the lease.\nDeferred Charges:\nDeferred charges, which consist of refinancing costs, are being amortized on a straight-line basis through November 1, 2000, the term of the related debt agreement.\nFixed Assets:\nWhen fixed assets are sold or retired, the cost and related accumulated depreciation are eliminated from the respective accounts and any gain or loss is credited or charged to income. Depreciation of fixed assets is computed on the straight-line method and is provided by charges to income over their estimated useful lives.\nPOWER TEST INVESTORS LIMITED PARTNERSHIP (a New York limited partnership) NOTES to CONSOLIDATED FINANCIAL STATEMENTS, continued\n3. Fixed Assets:\nFixed assets consist of the following:\nDepreciable 1995 1994 Life (Years) ---- ---- ------------ Land $26,070,642 $27,229,298 Buildings 12,094,092 12,293,495 16 Machinery and equipment 10,464,261 10,640,615 6 Furniture and fixtures 263,848 263,848 6 ----------- ----------- 48,892,843 50,427,256 Less, accumulated depreciation (18,979,807) (18,523,870) ----------- ----------- $29,913,036 $31,903,386 =========== ===========\n4. Mortgages Payable:\nMortgages payable consist of the following:\n1995 1994 ---- ---- Mortgage payable through November 1, 2000 (a) $31,759,998 $33,516,404 Mortgage payable through January 1, 2000 (b) 3,696,495 4,392,484 ----------- ----------- $35,456,493 $37,908,888 =========== ===========\n(a) On October 31, 1995, the Operating Partnership refinanced a mortgage loan which was originally payable through January 1, 1997. In connection with the refinancing, $279,000 was paid to terminate an interest rate swap agreement, which amount is included in \"Interest Expense\" in the accompanying consolidated statement of income for the year ended December 31, 1995. The refinanced loan bears interest at LIBOR plus 1.125 % to 1.75% per annum, depending on the Funded Debt Ratio of Getty Petroleum Corp. (LIBOR plus 1.375 % or 7.35% at December 31, 1995). Principal payments are $85,000 per month through December 1, 1999 and $175,000 per month thereafter through October 1, 2000.\nPOWER TEST INVESTORS LIMITED PARTNERSHIP (a New York limited partnership) NOTES to CONSOLIDATED FINANCIAL STATEMENTS, continued\nThe balance of the loan of $25,929,998 is due on November 1, 2000. Additional principal payments are due upon disposition of properties collateralizing the loan. The mortgage is collateralized by substantially all of the Operating Partnership's properties. The terms of the mortgage loan agreement include certain restrictions which relate to, among other things, the maintenance of a minimum debt service ratio and the incurrence of additional indebtedness.\n(b) Mortgage loan fully repaid on January 3, 1996. On January 3, 1996, the Operating Partnership entered into a $1,500,000 unsecured note agreement with a bank due January 1, 1998. The note bears interest at LIBOR plus 1.5 %. Principal payments are $62,500 per month commencing on February 1, 1996.\nAggregate principal payments in subsequent years relating to mortgages payable are as follows:\n1996 $ 3,903,995 1997 1,770,000 1998 1,082,500 1999 1,020,000 2000 27,679,998 ----------- $35,456,493 ===========\n5. Leases and Related Party Transactions:\nAt December 31, 1995, the Operating Partnership owned 291 gasoline service station properties and five petroleum product distribution terminals (\"Fee Properties\"), marketing equipment and a leasehold interest in a petroleum distribution terminal (\"Leased Property\"). The Operating Partnership leases the Fee Properties to Getty Petroleum Corp. on a long-term net lease basis principally in the Northeastern and Middle Atlantic states. The Fee Property leases have an initial 15 year term expiring on January 31, 2000 and Getty Petroleum Corp. has the option, but is not obligated, to extend the leases for up to five consecutive extended terms of ten years each. The marketing equipment lease had an initial term of ten years which expired on January 31, 1995. Such lease was renewed through December 31, 1998 for a rental of $59,271 per annum. The Leased Property was subleased to Getty Petroleum Corp. through December 14, 1995 and thereafter to an unrelated third party.\nPOWER TEST INVESTORS LIMITED PARTNERSHIP (a New York limited partnership) NOTES to CONSOLIDATED FINANCIAL STATEMENTS, continued\nFuture minimum rentals due to the Operating Partnership under operating and direct financing leases as of December 31, 1995 are as follows:\nDirect Operating Financing Years ending December 31, Leases Leases Total - - ------------------------- ----------- ---------- ----- 1996 $ 8,639,265 $1,690,632 $10,329,897 1997 8,640,865 1,690,632 10,331,497 1998 8,640,865 1,690,632 10,331,497 1999 8,418,927 1,690,632 10,109,559 2000 694,799 140,886 835,685 ----------- ---------- ----------- $35,034,721 $6,903,414 $41,938,135 =========== ========== ===========\nThe components of the net investment in direct financing leases as of December 31, 1995 and 1994 are as follows:\n1995 1994 ---- ----\nMinimum lease payments receivable $ 6,903,414 $ 9,056,182 Less, unearned income (2,136,270) (3,308,936) ----------- ----------- $ 4,767,144 $ 5,747,246 =========== ===========\nThe net investment in direct financing leases as of December 31, 1995 and 1994 is comprised of the following:\n1995 1994 ---- ---- Land $ 34,930 $ 34,930 Buildings 5,421,335 5,713,563 Equipment 2,896,409 3,028,760 ----------- ----------- 8,352,674 8,777,253 Less, amortization of investment in direct financing leases (3,585,530) (3,030,007) ----------- ----------- $ 4,767,144 $ 5,747,246 =========== ===========\nPOWER TEST INVESTORS LIMITED PARTNERSHIP (a New York limited partnership) NOTES to CONSOLIDATED FINANCIAL STATEMENTS, continued\nDuring the periods ended December 31, 1995, 1994 and 1993, the Operating Partnership paid $646,000, $622,000 and $598,000, respectively, to Getty Petroleum Corp. for management services and other expenses.\nDuring 1995, the Operating Partnership sold fourteen service stations to Getty Petroleum Corp. for an aggregate amount of $4,591,114 or eleven times the aggregate annual rentals of $417,374, which resulted in a net gain of $3,128,372 to the Partnership. During 1995, the New Haven terminal and a service station property were subject to partial condemnations resulting in the taking of certain of the land. The condemnation awards were allocated to the Operating Partnership and Getty in accordance with the formula set forth in the lease. The condemnations resulted in a net gain to the Partnership of $175,977. During 1994, the Operating Partnership sold five service stations to Getty Petroleum Corp. for an aggregate amount of $1,131,119 or eleven times the aggregate annual rentals of $102,829, which resulted in a net gain of $658,532 to the Partnership. Sales proceeds from dispositions of properties amounted to eleven times annual rentals in accordance with the terms of the lease agreement with Getty Petroleum Corp.\nThe net gains resulting from the dispositions of properties have been reflected in \"Other income\" in the accompanying consolidated statements of income.\nPOWER TEST INVESTORS LIMITED PARTNERSHIP (a New York limited partnership) NOTES to CONSOLIDATED FINANCIAL STATEMENTS, continued\n6. Partners' Capital:\nTotal General Limited Partners' Partner (a) Partners (b) Capital ----------- ------------ ----------\nBalance, December 31, 1992 $ 85,495 $ 669,844 $755,339\nPartnership net expenses (11,752) (41,112) (52,864)\nPartnership's share of Operating Partnership's net income 1,167,698 4,084,938 5,252,636\nDistributions to unitholders (1,071,103) (3,747,019) (4,818,122)\nIncome applicable to minority interest in excess of distributions 3,058 - 3,058 ---------- ---------- ---------- Balance, December 31, 1993 173,396 966,651 1,140,047\nPartnership net expenses (8,679) (30,359) (39,038)\nPartnership's share of Operating Partnership's net income 1,311,537 4,588,125 5,899,662\nDistributions to unitholders (1,071,103) (3,747,019) (4,818,122)\nIncome applicable to minority interest in excess of distributions 9,597 - 9,597 ---------- ---------- ---------- Balance, December 31, 1994 414,748 1,777,398 2,192,146\nPartnership net expenses (46,590) (162,944) (209,534)\nPartnership's share of Operating Partnership's net income 1,780,995 6,228,867 8,009,862\nDistributions to unitholders (1,071,103) (3,746,212) (4,817,315)\nPurchase of partnership units - (72,785) (72,785)\nIncome applicable to minority interest is excess of distributions 30,924 - 30,924 ---------- ---------- ---------- Balance, December 31, 1995 $1,108,974 $4,024,324 $5,133,298 ========== ========== ==========\n(a) The three individual shareholders of the General Partner are also directors and the principal shareholders of Getty Petroleum Corp., and in the case of Mr. Liebowitz, the President and Chief Executive Officer of Getty Petroleum Corp.\nPOWER TEST INVESTORS LIMITED PARTNERSHIP (a New York limited partnership) NOTES to CONSOLIDATED FINANCIAL STATEMENTS, continued\n(b) The Partnership initially offered to holders of record of common stock of Getty Petroleum Corp. rights to subscribe to units of limited partnership interests in the Partnership. In addition, the Limited Partners include the three individuals who are the shareholders of the General Partner.\nThe Partnership allocates all income, profits, losses, deductions, credits and items of tax preference, and makes distributions to its partners on a pro rata basis. Distributions to the partners in respect of their Partnership interests shall be made at such times, in such amounts and in cash or property as the General Partner in its sole discretion shall determine.\nOn November 9, 1995, the Partnership announced that it may purchase in the market from time to time through March 15, 1996 up to 150,000 of its units at prices not to exceed $8.00 per unit. In June 1995, the Partnership had offered to purchase units for $7.50 per unit. Through December 31, 1995, the Partnership purchased 9,398 units at an aggregate cost of $72,785.\n7. Income Taxes:\nThe accompanying consolidated statements of income do not reflect a provision for income taxes as the income of the Partnership is not subject to federal income taxes at the partnership level but is includable in the individual tax returns of the partners.\nNet income for financial statement purposes of $7,800,328, $5,860,624 and $5,199,772 for the years ended December 31, 1995, 1994 and 1993, respectively, differs from the taxable income of $8,532,948, $6,418,813 and $5,561,865 reported by the Partnership on its tax return for the same respective periods, principally due to differences in the method of computing depreciation and amortization expense and the recognition of rental income.\nPOWER TEST INVESTORS LIMITED PARTNERSHIP (a New York limited partnership) Schedule III - REAL ESTATE and ACCUMULATED DEPRECIATION as of December 31, 1995\nProperty Under -------------- Direct Operating Financing Leases Leases Total ----------- ----------- ------- Initial cost to Operating Partnership (a):\nLand $30,960,758 $ 38,000 $30,998,758 Buildings 14,072,669 6,348,784 20,421,453 Equipment 13,680,238 3,379,513 17,059,751 ----------- ----------- ----------- Total initial cost 58,713,665 9,766,297 68,479,962\nAcquisition costs capitalized (b) 680,976 113,259 794,235 Debt discount allocated (5,530,964) (919,910) (6,450,874) ----------- ----------- ----------- Net initial cost (a) 53,863,677 8,959,646 62,823,323 Retirements or sales (4,970,834) (606,972) (5,577,806) ----------- ----------- ----------- Gross assets at December 31, 1995 (c) (d) (e) 48,892,843 8,352,674 57,245,517 Accumulated depreciation (f) (18,979,807) - (18,979,807) Amortization of investment in direct financing leases - (3,585,530) (3,585,530) ----------- ----------- ----------- Net assets $29,913,036 $ 4,767,144 $34,680,180 =========== =========== ===========\n(a) Acquired on February 1, 1985.\n(b) Acquisition costs include legal fees, appraisal fees, title costs and other related professional fees.\n(c) See Notes 3 and 5 of Notes to Consolidated Financial Statements.\n(d) As of December 31, 1995, the Operating Partnership owned 291 gasoline service station properties located in Connecticut (25), Delaware (11), Maine (6), Maryland (3), Massachusetts (41), New Hampshire (7), New Jersey (81), New York (56), Pennsylvania (51), Rhode Island (9) and Vermont (1) and five petroleum distribution terminals located in Connecticut, New Jersey, New York (2) and Rhode Island.\n(e) The aggregate cost of real estate for Federal income tax purposes is $57,501,598.\n(f) Buildings are depreciated over 16 years. See Notes 2 and 3 of Notes to Consolidated Financial Statements.\nPOWER TEST INVESTORS LIMITED PARTNERSHIP (a New York limited partnership) Schedule III - REAL ESTATE AND ACCUMULATED DEPRECIATION as of December 31, 1995\nProperty Under -------------- Direct Operating Financing Leases Leases Total ----------- ----------- -----------\nBalance at December 31, 1992 $50,863,441 $ 8,937,811 $59,801,252\nRetirements or sales - - - ----------- ----------- ----------- Balance at December 31, 1993 50,863,441 8,937,811 59,801,252\nRetirements or sales (436,185) (160,558) (596,743) ----------- ----------- ----------- Balance at December 31, 1994 50,427,256 8,777,253 59,204,509\nRetirements or sales (1,534,413) (424,579) (1,958,992) ----------- ----------- ----------- Balance at December 31, 1995 $48,892,843 $ 8,352,674 $57,245,517 =========== =========== ===========\nAccumulated Accumulated Depreciation Amortization of of Direct Operating Financing Leases Leases Total ----------- ---------- ------\nBalance at December 31, 1992 $17,053,406 $ 1,941,880 $18,995,286\nAdditions 773,748 519,656 1,293,404 Retirements or sales - - - ----------- ----------- ----------- Balance at December 31, 1993 17,827,154 2,461,536 20,288,690\nAdditions 771,404 617,939 1,389,343 Retirements or sales (74,688) (49,468) (124,156) ----------- ----------- ----------- Balance at December 31, 1994 18,523,870 3,030,007 21,553,877\nAdditions 764,036 728,785 1,492,821 Retirements or sales (308,099) (173,262) (481,361) ----------- ----------- ----------- Balance at December 31, 1995 $18,979,807 $ 3,585,530 $22,565,337 =========== =========== ===========\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K:\nPage ---- (a) (1) Financial Statements:\nReport of Independent Accountants 11\nConsolidated Financial Statements: Balance Sheets - December 31, 1995 and 1994 12\nStatements of Income - for the years ended December 31, 1995, 1994 and 1993 13\nStatements of Cash Flows - for the years ended December 31, 1995, 1994 and 1993 14\nNotes to Consolidated Financial Statements 15 - 22\n(a) (2) Schedule:\nIII - Real Estate and Accumulated Depreciation as of December 31, 1995 23 - 24\nAll other schedules are omitted for the reason that they are either not required, not applicable, not material or the information is included in the consolidated financial statements and notes thereto.\n(a) (3) Exhibits:\nDesignation of Exhibit in this Annual Report on Form 10-K Description of Exhibit - - ------------- ----------------------\n3.1 Articles of Incorporation of CLS General Partnership Corp. (Incorporated herein by reference to Exhibit 3.1 of the Exhibits filed with the Registrant's Registration Statement on Form S-11 (Registration No. 2- 97195)).\n3.2 By-laws of CLS General Partnership Corp. (Incorporated herein by reference to Exhibit 3.2 of the Exhibits filed with the Registrant's Registration Statement on Form S-11 (Registration No. 2-97195)).\n4.1 Certificate and Agreement of Limited Partnership of Power Test Investors Limited Partnership. (Incorporated herein by reference to Exhibit 4.1 of the Exhibits filed with the Registrant's Registration Statement on Form S- 11 (Registration No. 2-97195)).\n4.2 Certificate and Agreement of Limited Partnership of Power Test Realty Company Limited Partnership. (Incorporated herein by reference to Exhibit 4.2 of the Exhibits filed with the Registrant's Registration Statement on Form S-11 (Registration No. 2-97195)).\n4.3 Amendment No. 1 to Certificate and Agreement of Limited Partnership of Power Test Investors Limited Partnership. (Incorporated herein by reference to Exhibit 4.3 of the Exhibits filed with the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1986 (Commission File No. 0-14557)).\n4.4 Amendment No. 1 to Certificate and Agreement of Limited Partnership of Power Test Realty Company Limited Partnership. (Incorporated herein by reference to Exhibit 4.4 of the Exhibits filed with the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1986 (Commission File No. 0-14557)).\n10.1 Loan Agreement dated February 1, 1985 between The Chase Manhattan Bank, N.A., and Power Test Realty Company Limited Partnership and related Note. (Incorporated herein by reference to Exhibit 10.1 of the Exhibits filed with the Registrant's Registration Statement on Form S-11 (Registration No. 2-97195)).\n10.1 (a) Note Modification Agreement dated January 22, 1986 amending the Loan Agreement dated February 1, 1985 and related Note (10.1), Collateral Assignment and Security Agreement (10.2) and Form of Mortgage (10.3) between The Chase Manhattan Bank, N.A., and Power Test Realty Company Limited Partnership. (Incorporated herein by reference to Exhibit 10.1 (a) of the Exhibits filed with the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1985 (Commission File No. 2-97195)).\n10.2 Collateral Assignment and Security Agreement dated February 1, 1985 between Power Test Realty Company Limited Partnership and The Chase Manhattan Bank, N.A. (Incorporated herein by reference to Exhibit 10.2 of the Exhibits filed with the Registrant's Registration Statement on Form S-11 (Registration No. 2-97195)).\n10.3 Form of Mortgage from Power Test Realty Company Limited Partnership, as Mortgagor, to The Chase Manhattan Bank, N.A., as Mortgagee, dated as of February 1, 1985. (Incorporated herein by reference to Exhibit 10.3 of the Exhibits filed with the Registrant's Registration Statement on Form S-11 (Registration No. 2-97195)).\n10.4 Promissory Note of Power Test Realty Company Limited Partnership to Texaco Refining and Marketing Inc. dated February 1, 1985. (Incorporated herein by reference to Exhibit 10.4 of the Exhibits filed with the Registrant's Registration Statement on Form S-11 (Registration No. 2-97195)).\n10.5 Security Agreement dated February 1, 1985 between Power Test Realty Company Limited Partnership and Texaco Refining and Marketing Inc. (Incorporated herein by reference to Exhibit 10.5 of the Exhibits filed with the Registrant's Registration Statement on Form S-11 (Registration No. 2-97195)).\n10.6 Form of Mortgage and Security Agreement from Power Test Realty Company Limited Partnership, as Mortgagor, to Texaco Refining and Marketing Inc., as Mortgagee, dated February 1, 1985. (Incorporated herein by reference to Exhibit 10.6 of the Exhibits filed with the Registrant's Registration Statement on Form S-11 (Registration No. 2- 97195)).\n10.7 Asset Purchase Agreement between Getty Petroleum Corp. (formerly Power Test Corp.) and Texaco Inc., Getty Oil Company, and Getty Refining and Marketing Company, dated December 21, 1984. (Filed as Exhibit 2(a) to Getty Petroleum Corp.'s (formerly Power Test Corp.) Current Report on Form 8-K dated February 19, 1985 (Commission File No. 0-6386) and incorporated herein by reference).\n10.8 Form of Real Property Leases between Power Test Realty Company Limited Partnership, as Lessor, and Getty Petroleum Corp. (formerly Power Test Corp.) (either directly or indirectly through a wholly-owned subsidiary), as Lessee, each dated February 1, 1985. (Filed as Exhibit 2(e) to Getty Petroleum Corp.'s (formerly Power Test Corp.) Current Report on Form 8-K dated February 19, 1985 (Commission File No. 0- 6386) and incorporated herein by reference).\n10.9 Rolling Stock Lease between Power Test Realty Company Limited Partnership, as Lessor, and Power Test Petro Corp. (a wholly- owned subsidiary of Getty Petroleum Corp. (formerly Power Test Corp.)), as Lessee, dated February 1, 1985. (Filed as Exhibit 2(f) to Getty Petroleum Corp.'s (formerly Power Test Corp.) Current Report on Form 8-K dated February 19, 1985 (Commission File No. 0-6386) and incorporated herein by reference).\n10.10 Equipment Lease between Power Test Realty Company Limited Partnership, as Lessor, and Getty Petroleum Corp. (formerly Power Test Corp.) as Lessee, dated February 1, 1985. (Filed as Exhibit 2(g) to Getty Petroleum Corp.'s (formerly Power Test Corp.) Current Report on Form 8-K dated February 19, 1985 (Commission File No. 0-6386) and incorporated herein by reference).\n10.11 Guaranty of Getty Petroleum Corp. (formerly Power Test Corp.) of lease obligations of Getty Terminals Corp. (formerly Clay Oil Terminals Inc.), as lessee, to Power Test Realty Company Limited Partnership, as lessor. (Incorporated herein by reference to Exhibit 10.11 of the Exhibits filed with the Registrant's Registration Statement on Form S-11 (Registration No. 2-97195)).\n10.12 Guaranty of Getty Petroleum Corp. (formerly Power Test Corp.) of lease obligations of Power Test Petro Corp., as lessee, to Power Test Realty Company Limited Partnership, as lessor. (Incorporated herein by reference to Exhibit 10.12 of the Exhibits filed with the Registrant's Registration Statement on Form S-11 (Registration No. 2-97195)).\n10.13 Newark Terminal Agreement among Texaco Refining and Marketing Inc., Power Test Realty Company Limited Partnership and The Chase Manhattan Bank, N.A., dated February 1, 1985. (Incorporated herein by reference to Exhibit 10.13 of the Exhibits filed with the Registrant's Registration Statement on Form S-11 (Registration No. 2-97195)).\n10.14 Easement and ECRA Agreement among Texaco Refining and Marketing Inc., Texaco Inc., Power Test Realty Company Limited Partnership and Getty Petroleum Corp. (formerly Power Test Corp.), dated February 1, 1985. (Incorporated herein by reference to Exhibit 10.14 of the Exhibits filed with the Registrant's Registration Statement on Form S-11 (Registration No. 2-97195)).\n10.15 Promissory Note of Power Test Realty Company Limited Partnership to Peoples Bank, N.A., dated July 30, 1985. (Incorporated herein by reference to Exhibit 10.15 of the Exhibits filed with the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1985 (Commission File No. 2-97195)).\n10.16 Promissory Note of Power Test Realty Company Limited Partnership to John Hancock Mutual Life Insurance Company dated December 19, 1985. (Incorporated herein by reference to Exhibit 10.16 of the Exhibits filed with the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1985 (Commission File No. 2-97195)).\n10.17 Note Modification Agreement dated April 18, 1986 between Getty Petroleum Corp. and Power Test Realty Company Limited Partnership. (Incorporated herein by reference to Exhibit 10.17 of the Exhibits filed with the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 1986 (Commission File No. 0-14557)).\n10.18 Promissory Note made as of April 18, 1986 between Getty Petroleum Corp. and Power Test Realty Company Limited Partnership. (Incorporated herein by reference to Exhibit 10.18 of the Exhibits filed with the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1986 (Commission File No. 0-14557)).\n10.19 Agreement extending maturity date of Promissory Note made as of April 18, 1986 between Getty Petroleum Corp. and Power Test Realty Company Limited Partnership. (Incorporated herein by reference to Exhibit 10.19 of the Exhibits filed with the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1986 (Commission File No. 0- 14557)).\n10.20 Loan Agreement between Power Test Realty Company Limited Partnership and Bank of New England, N.A. dated as of December 10, 1986. (Incorporated herein by reference to Exhibit 10.20 of the Exhibits filed with the Registrants's Annual Report on Form 10-K for the fiscal year ended December 31, 1986 (Commission File No. 0-14557)).\n10.21 Hazardous Waste and PMPA Indemnification Agreement dated as of December 10, 1986 among Getty Petroleum Corp., Power Test Realty Company Limited Partnership and Bank of New England, N.A. (Incorporated herein by reference to Exhibit 10.21 of the Exhibits filed with the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1986 (Commission File No. 0-14557)).\n10.22 Mortgage Rider attached to all Forms of Mortgages dated December 10, 1986 between Power Test Realty Company Limited Partnership (the \"Mortgagor\") and Bank of New England, N.A. (the \"Mortgagee\"), filed in all the various states, none of which contain provisions of substance. (Incorporated herein by reference to Exhibit 10.22 of the Exhibits filed with the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1986 (Commission File No. 0-14557)).\n10.23 Note Agreement dated as of December 1, 1986 between Power Test Realty Company Limited Partnership and Massachusetts Mutual Life Insurance Company. (Incorporated herein by reference to Exhibit 10.23 of the Exhibits filed with the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1986 (Commission File No. 0- 14557)).\n10.24 Guaranty Agreement dated as of December 1, 1986 of Getty Petroleum Corp. regarding distribution terminal leases between Power Test Realty Company Limited Partnership and Getty Terminals Corp. (Incorporated herein by reference to Exhibit 10.24 of the Exhibits filed with the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1986 (Commission File No. 0-14557)).\n10.25 Mortgage and Security Agreement dated as of December 1, 1986 from Power Test Realty Company Limited Partnership to Massachusetts Mutual Life Insurance Company for the East Providence, Rhode Island terminal, which is identical to the Mortgage and Security Agreements for the four other terminals mortgaged under the Note Agreement. (Incorporated herein by reference to Exhibit 10.25 of the Exhibits filed with the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1986 (Commission File No. 0-14557)).\n10.26 Amendment No. 1 dated November 30, 1989 to Loan Agreement between Power Test Realty Company Limited Partnership and Bank of New England, N.A. dated December 10, 1986. (Incorporated herein by reference to Exhibit 10.26 of the Exhibits filed with the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 (Commission File No. 0-14557)).\n10.27 Amended and Restated Loan Agreement dated as of October 31, 1995 between Power Test Realty Company Limited Partnership and Fleet Bank of Massachusetts, N.A., as successor to Bank of New England, N.A. (Incorporated herein by reference to Exhibit 10.27 of the Exhibits filed with the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1995 (Commission File No. 0-14557)).\n10.28 Note Agreement dated as of January 3, 1996 between Power Test Realty Company Limited Partnership and Chemical Bank. (Incorporated herein by reference to Exhibit 10.28 of the Exhibits filed with the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1995 (Commission File No. 0-14557))\n27 Financial Data Schedule.\n(b) Report 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.\nPower Test Investors Limited Partnership ----------------------------------------- (Registrant)\nBy \\s\\ Leo Liebowitz ----------------------------------------------------- Leo Liebowitz, President, Treasurer and a Director of CLS General Partnership Corp., the General Partner (Principal Financial and Accounting Officer)\nDate March 28, 1996 --------------\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and the dates indicated.\nBy \\s\\ Milton Safenowitz ------------------------------------------------------ Milton Safenowitz, Executive Vice President, Assistant Secretary and a Director of CLS General Partnership Corp., the General Partner\nDate March 28, 1996 --------------\nBy \\s\\ Milton Cooper ------------------------------------------------------------ Milton Cooper, Secretary, Assistant Treasurer and a Director of CLS General Partnership Corp., the General Partner\nDate March 28, 1996 --------------\nEXHIBIT INDEX\nPower Test Investors Limited Partnership\nAnnual Report on Form 10-K for the year ended December 31, 1995 -----------------------------------------------------------------\nBegins on Exhibit No. Description Sequential Page No. - - ----------- ----------- ------------------- 3.1 Articles of Incorporation of Incorporated by reference to Exhibit CLS General Partnership Corp. 3.1 of the Exhibits filed with the Registrant's Registration Statement on Form S-11 (Registration No. 2-97195).\n3.2 By-laws of CLS General Incorporated by reference to Exhibit Partnership Corp. 3.2 of the Exhibits filed with the Registrant's Registration Statement on Form S-11 (Registration No. 2-97195).\n4.1 Certificate and Agreement of Incorporated by reference to Exhibit Limited Partnership of Power 4.1 of the Exhibits filed with the Test Investors Limited Registrant's Registration Statement on Partnership. Form S-11 (Registration No. 2-97195).\n4.2 Certificate and Agreement of Incorporated by reference to Exhibit Limited Partnership of Power 4.2 of the Exhibits filed with the Test Realty Company Limited Registrant's Registration Statement on Partnership. Form S-11 (Registration No. 2-97195).\n4.3 Amendment No. 1 to Certificate Incorporated by reference to Exhibit and Agreement of Limited 4.3 of the Exhibits filed with the Partnership of Power Test Registrant's Quarterly Report on Investors Limited Partnership. Form 10-Q for the quarter ended September 30, 1986 (Commission File No. 0-14557).\n4.4 Amendment No. 1 to Certificate Incorporated by reference to Exhibit and Agreement of Limited 4.4 of the Exhibits filed with the Partnership of Power Test Registrant's Quarterly Report on Realty Company Limited Form 10-Q for the quarter ended Partnership. September 30, 1986 (Commission File No. 0-14557).\n10.1 Loan Agreement dated Incorporated by reference to Exhibit February 1, 1985 between The 10.1 of the Exhibits filed with the Chase Manhattan Bank, N.A., Registrant's Registration Statement and Power Test Realty Company on Form S-11 (Registration No. 2-97195). Limited Partnership and related Note.\n10.1(a) Note Modification Agreement Incorporated by reference to Exhibit dated January 22, 1986 10.1(a) of the Exhibits filed with amending the Loan Agreement the Registrant's Annual Report on Form dated February 1, 1985 and 10-K for the fiscal year ended related Note (10.1), December 31, 1985 (Commission File No. Collateral Assignment and 2-97195). Security Agreement (10.2) and Form of Mortgage (10.3) between The Chase Manhattan Bank, N.A.,and Power Test Realty Company Limited Partnership.\n10.2 Collateral Assignment and Incorporated by reference to Exhibit Security Agreement dated 10.2 of the Exhibits filed with the February 1, 1985 between Registrant's Registration Statement on Power Test Realty Company Form S-11 (Registration No. 2-97195). Limited Partnership and The Chase Manhattan Bank, N.A.\n10.3 Form of Mortgage from Power Incorporated by reference to Exhibit Test Realty Company Limited 10.3 of the Exhibits filed with the Partnership, as Mortgagor, Registrant's Registration Statement on to The Chase Manhattan Bank, Form S-11 (Registration No. 2-97195). N.A., as Mortgagee, dated as of February 1, 1985.\n10.4 Promissory Note of Power Incorporated by reference to Exhibit Test Realty Company Limited 10.4 of the Exhibits filed with the Partnership to Texaco Registrant's Registration Statement on Refining and Marketing Inc. Form S-11 (Registration No. 2-97195). dated February 1, 1985.\n10.5 Security Agreement dated Incorporated by reference to Exhibit February 1, 1985 between 10.5 of the Exhibits filed with the Power Test Realty Company Registrant's Registration Statement on Limited Partnership and Form S-11(Registration No. 2-97195). Texaco Refining and Marketing Inc.\n10.6 Form of Mortgage and Security Incorporated by reference to Exhibit Agreement from Power Test 10.6 of the Exhibits filed with Realty Company Limited Partner- Registrant's Registration Statement on ship, as Mortgagor, to Texaco Form S-11 (Registration No. 2-97195). Refining and Marketing, Inc., as Mortgagee, dated February 1, 1985.\n10.7 Asset Purchase Agreement Filed as Exhibit 2(a) to Getty Petroleum between Getty Petroleum Corp. Corp.'s (formerly Power Test Corp.) (formerly Power Test Corp.) Current Report on Form 8-K dated and Texaco Inc., Getty Oil February 19, 1985 (Commission File No. Company, and Getty Refining 0-6386) and incorporated herein by and Marketing Company, reference. dated December 21, 1984.\n10.8 Form of Real Property Leases Filed as Exhibit 2(e) to Getty Petroleum between Power Test Realty Corp.'s (formerly Power Test Corp.) Company Limited Partnership, Current Report on Form 8-K dated as Lessor, and Getty Petroleum February 19, 1985 (Commission File No. Corp. (formerly Power Test 0-6386) and incorporated herein by Corp.) (either directly or reference. indirectly through a wholly- owned subsidiary), as Lessee, each dated February 1, 1985.\n10.9 Rolling Stock Lease between Filed as Exhibit 2(f) to Getty Petroleum Power Test Realty Company Corp.'s (formerly Power Test Corp.) Limited Partnership, as Current Report on Form 8-K dated Lessor, and Power Test February 19, 1985 (Commission File No. Petro Corp. (a wholly- 0-6386) and incorporated herein by owned subsidiary of Getty reference. Petroleum Corp.), as Lessee, dated February 1, 1985.\n10.10 Equipment Lease between Power Filed as Exhibit 2(g) to Getty Petroleum Test Realty Company Limited Corp.'s (formerly Power Test Corp.) Partnership, as Lessor, and Current Report on Form 8-K dated Getty Petroleum Corp. (formerly February 19, 1985 (Commission File No. Power Test Corp.) as Lessee, 0-6386) and incorporated herein by dated February 1, 1985. reference.\n10.11 Guaranty of Getty Petroleum Incorporated by reference to Exhibit Corp. (formerly Power Test 10.11 of the Exhibits filed with the Corp.) of lease obligations Registrant's Registration Statement on of Getty Terminals Corp. Form S-11 (Registration No. 2-97195). (formerly Clay Oil Terminals Inc.), as lessee, to Power Test Realty Company Limited Partnership, as lessor.\n10.12 Guaranty of Getty Petroleum Incorporated by reference to Exhibit Corp. (formerly Power Test 10.12 of the Exhibits filed with the Corp.) of lease obligations Registrant's Registration Statement on of Power Test Petro Corp., Form S-11 (Registration No. 2-97195). as lessee, to Power Test Realty Company Limited Partnership, as lessor.\n10.13 Newark Terminal Agreement Incorporated by reference to Exhibit among Texaco Refining and 10.13 of the Exhibits filed with the Marketing Inc., Power Registrant's Registration Statement on Test Realty Company Limited Form S-11 (Registration No. 2-97195). Partnership and The Chase Manhattan Bank, N.A., dated February 1, 1985.\n10.14 Easement and ECRA Agreement Incorporated by reference to Exhibit among Texaco Refining and 10.14 of the Exhibits filed with the Marketing Inc., Texaco Inc., Registrant's Registration Statement on Power Test Realty Company Form S-11 (Registration No. 2-97195). Limited Partnership and Getty Petroleum Corp. (formerly Power Test Corp.), dated February 1, 1985.\n10.15 Promissory Note of Power Incorporated by reference to Exhibit Test Realty Company Limited 10.15 of the Exhibits filed with the Partnership to Peoples Bank, Registrant's Annual Report on Form 10-K N.A., dated July 30, 1985. for the fiscal year ended December 31, 1985 (Commission File No. 2-97195).\n10.16 Promissory Note of Power Test Incorporated by reference to Exhibit Realty Company Limited 10.16 of the Exhibits filed with the Partnership to John Hancock Registrant's Annual Report on Form 10-K Mutual Life Insurance Company for the fiscal year ended December 31, dated December 19, 1985. 1985 (Commission File No. 2-97195).\n10.17 Note Modification Agreement Incorporated by reference to Exhibit dated April 18, 1986 between 10.17 of the Exhibits filed with the Getty Petroleum Corp. and Registrant's Quarterly Report on Form Power Test Realty Company 10-Q for the quarter ended March 31, Limited Partnership. 1986 (Commission File No. 0-14557).\n10.18 Promissory Note made as of Incorporated by reference to Exhibit April 18, 1986 between Getty 10.18 of the Exhibits filed with the Petroleum Corp. and Power Registrant's Quarterly Report on Form Test Realty Company Limited 10-Q for the quarter ended June 30, 1986 Partnership. (Commission File No. 0-14557).\n10.19 Agreement extending maturity Incorporated by reference to Exhibit date of Promissory Note made 10.19 of the Exhibits filed with the as of April 18, 1986 between Registrant's Quarterly Report on Form Getty Petroleum Corp. and 10-Q for the quarter ended September 30, Power Test Realty Company 1986 (Commission File No. 0-14557). Limited Partnership.\n10.20 Loan Agreement between Power Incorporated by reference to Exhibit Test Realty Company Limited 10.20 of the Exhibits filed with the Partnership and Bank of New Registrant's Annual Report on Form 10-K England, N.A. dated as of for the fiscal year ended December 31, December 10, 1986. 1986 (Commission File No. 0-14557).\n10.21 Hazardous Waste and PMPA Incorporated by reference to Exhibit Indemnification Agreement 10.21 of the Exhibits filed with the dated as of December 10, Registrant's Annual Report on Form 10-K 1986 among Getty Petroleum for the fiscal year ended December 31, Corp., Power Test Realty 1986 (Commission File No. 0-14557). Company Limited Partnership and Bank of New England, N.A.\n10.22 Mortgage Rider attached to Incorporated by reference to Exhibit all Forms of Mortgages dated 10.22 of the Exhibits filed with the December 10, 1986 between Registrant's Annual Report on Form 10-K Power Test Realty Company for the fiscal year ended December 31, Limited Partnership (the 1986 (Commission File No. 0-14557). \"Mortgagor\") and Bank of New England, N.A. (the \"Mortgagee\"), filed in all the various states, none of which contain provisions of substance.\n10.23 Note Agreement dated as of Incorporated by reference to Exhibit December 1, 1986 between 10.23 of the Exhibits filed with the Power Test Realty Company Registrant's Annual Report on Form 10-K Limited Partnership and for the fiscal year ended December 31, Massachusetts Mutual Life 1986 (Commission File No. 0-14557). Insurance Company.\n10.24 Guaranty Agreement dated Incorporated by reference to Exhibit as of December 1, 1986 of 10.24 of the Exhibits filed with the Getty Petroleum Corp. Registrant's Annual Report on Form 10-K regarding distribution terminal for the fiscal year ended December 31, leases between Power Test 1986 (Commission File No. 0-14557). Realty Company Limited Partnership and Getty Terminals Corp.\n10.25 Mortgage and Security Agreement Incorporated by reference to Exhibit dated as of December 1, 1986 10.25 of the Exhibits filed with the from Power Test Realty Company Registrant's Annual Report on Form 10-K Limited Partnership to for the fiscal year ended December 31, Massachusetts Mutual Life 1986 (Commission File No. 0-14557). Insurance Company for the East Providence Rhode Island terminal, which is identical to the Mortgage and Security Agreements for the four other terminals mortgaged under the Note Agreement.\n10.26 Amendment No. 1 dated Incorporated by reference to Exhibit November 30, 1989 to Loan 10.26 of the Exhibits filed with the Agreement between Power Registrant's Annual Report on Form 10-K Test Realty Company Limited for the fiscal year ended December 31, Partnership and Bank of New 1989 (Commission File No. 0-14557). England, N.A. dated December 10, 1986.\n10.27 Amended and Restated Loan Incorporated by reference to Exhibit Agreement dated as of 10.27 of the Exhibits filed with the October 31, 1995 between Registrant's Annual Report on Form 10-K Power Test Realty Company for the fiscal year ended December 31, Limited Partnership and 1995 (Commission File No. 0-14557). Fleet Bank of Massachusetts, N.A., as successor to Bank of New England, N.A.\n10.28 Note Agreement dated as of Incorporated by reference to Exhibit January 3, 1996 between 10.28 of the Exhibits filed with the Power Test Realty Company Registrant's Annual Report on Form 10-K Limited Partnership and for the fiscal year ended December 31, Chemical Bank. 1995 (Commission File No. 0-14557).\n27 Financial Data Schedule 40","section_15":""}
{"filename":"812699_1995.txt","cik":"812699","year":"1995","section_1":"Item 1 - Business - -----------------\nHometown Bancorporation, Inc. (the \"Company\") was incorporated under the laws of the State of Delaware on April 14, 1987 to operate principally as a bank holding company for The Bank of Darien (the \"Bank\"). On July 21, 1987, each share of the Bank's outstanding common stock was exchanged for one share of Common Stock, par value $1.00, of the Company. In 1987, the Company sold 1,285,000 shares of common stock to the public. Net proceeds from the offering totalled $10,962,000. The Bank is the sole subsidiary of the Company. The business of the Company consists of ownership of the capital stock of the Bank.\nThe Bank began operations in 1985. On December 1, 1989, the second office of the Bank opened in Westport, Connecticut.\nIn April 1992, the Bank assumed all of the deposits and purchased certain assets of The Norwalk Bank which had been declared insolvent and for which the Federal Deposit Insurance Corporation (the \"FDIC\") had been appointed as receiver.\nThe Bank engages in the commercial banking business tailored to meet the needs of the residents and businesses of Darien and Westport, Connecticut, and the surrounding areas. The Bank offers a broad range of deposit accounts with emphasis on serving the needs of individuals, small and medium-sized businesses and professionals. The Bank does not currently offer trust services or international banking services.\nThe Bank faces strong competition from numerous existing Connecticut and out-of-state bank holding companies, commercial banks, savings banks and savings and loan associations which have been in business for many years and have established customer bases and which may provide a greater range of services than the Bank. Competition also comes from other businesses which provide financial services, including consumer finance companies, credit unions, factors, mortgage brokers, insurance companies, securities brokerage firms, money market mutual funds and private lenders. Many of these competitors are substantially larger than the Bank and have greater lending limits, serve larger geographic markets and have larger customer bases than the Bank.\nOver time, intense market demands, economic pressures and significant legislative and regulatory actions have eroded banking industry classifications which were once clearly defined and have increased competition among banks as well as other financial institutions. This increase in competition has forced banks and other financial service institutions to diversify their services and become more cost effective as a result of competition with one another and with new types of financial service companies, including non-bank competitors. These events have resulted in increasing homogeneity in the financial services offered by banks and other financial institutions.\nThe Company is registered as a bank holding company under the Bank Holding Company Act of 1956, which regulates and limits the activities of the Company. In general, the Company and its subsidiaries are prohibited from engaging in or acquiring direct or indirect control of any company engaged in nonbanking activities unless such activities are so closely related to banking as to be a proper incident thereto. In addition, the Company must obtain the prior approval of the Board of Governors of the Federal Reserve System (the \"Federal Reserve Board\") to acquire control of any bank; to acquire, with certain exceptions, more than 5% of the outstanding voting stock of any other company; or to merge or consolidate with another bank holding company.\nFederal antitrust laws also place limitations on the acquisition of additional banks and other businesses.\nThe Company is an \"affiliate\" of the Bank, within the meaning of the Federal Reserve Act and of FDIC regulations, which impose certain restrictions on loans by the Bank to affiliates, on investments in their stock or securities, and on taking their stock or securities as collateral for loans to any borrower. The Company and the Bank are subject to examination by the Federal Reserve Board.\nThe FDIC's enforcement powers have been significantly expanded under the Federal Deposit Insurance Corporation Improvements Act of 1991 (\"FDICIA\"), many provisions of which became effective as of December 19, 1992. The types of actions which may be taken by the FDIC under the statute vary depending upon, among other things, the institution's placement in one of five categories, based on capital position, ranging from \"well capitalized\" to \"critically undercapitalized,\" and on its financial condition and prospects generally. As of December 31, 1995, the Bank believes that it was \"well capitalized\" within the meaning of FDICIA.\nThe Bank is subject to federal and state laws applicable to banks and is subject to regulation and examination by the Banking Commissioner of Connecticut (the \"Commissioner\") and the FDIC. Effective in January, 1996, the Bank became party to an informal agreement among itself, the Commissioner and the FDIC. The agreement requires, among other things, the submission of written plans to the Commissioner and the FDIC and periodic written progress reports. At this time all such plans have been submitted.\nUnder Connecticut law, state bank and trust companies and other banking institutions are no longer prohibited from opening offices in Darien. Connecticut law permits the acquisition of Connecticut banks or Connecticut bank holding companies by out-of-state bank holding companies with the prior approval of the Commissioner. In 1994, federal legislation was passed which would permit nationwide branching by banks beginning in 1996. While state legislatures can elect not to have this statute apply to their states, the Connecticut legislature has not, as of the date hereof, taken any action which would\nprevent the new federal law from applying in Connecticut. The Company cannot assess the impact of this legislation or the action of the banking authorities on the Bank but anticipates that it will likely result in increased competition.\nOn January 27, 1989, the Federal Reserve Board issued its final risk based capital guidelines for banks and bank holding companies. The rule currently requires a minimum ratio of total capital to risk weighted assets of 8%. The Company's consolidated and the Bank's ratios of total capital to risk weighted assets at December 31, 1995 were 16.36% and 15.46%, respectively.\nThere are no concentrations of the Bank's loans within a single industry or group of related industries. However, approximately 71% and 15% of the Bank's loans outstanding at December 31, 1995 were collateralized by residential and commercial real estate, respectively.\nThere are no major concentrations of the Bank's deposits made by an individual or small group of individuals such that the loss of any one of which would have a material adverse effect on the Bank's financial position and\/or liquidity.\nThe Bank offers a broad range of consumer and commercial banking services, with emphasis on serving the needs of individuals, small and medium- sized businesses and professionals in its service area. The deposit accounts, both consumer and commercial, which the Bank offers include checking accounts, interest-bearing \"NOW\" accounts, insured money market accounts, certificates of deposit, savings accounts, Individual Retirement Accounts and Keogh Accounts. Other services include credit cards, money orders, travelers' checks and access to an automated teller network.\nThe Bank offers real estate loans to individuals including mortgages, home improvement, bridge loans and home equity lines of credit. Other personal loans include overdraft lines of credit and loans for automobiles, boats, tuition and for the purchase of marketable securities. Loans offered to small and medium-sized businesses include, accounts receivable financing, unsecured and secured loans to service companies, manufacturers, wholesalers, retailers and professionals doing business in the region.\nThe Bank offers both fixed rate and adjustable rate mortgages for the purchase or refinancing of residences. The Bank's adjustable rate mortgages have generally provided for annual adjustments of interest based on an index of U.S. government securities. The maximum interest rate increase per year on the Bank's variable rate mortgages is 2% and the maximum increase over the life of the mortgage is 6%. Both the fixed rate and the adjustable rate mortgages offered or purchased by the Bank generally have terms of either fifteen or thirty years, although the Bank will consider any other maturity requested by the borrower. Mortgages may be sold to the secondary market.\nThe Bank makes commercial loans to smaller and medium-sized local businesses and professionals, generally for working capital purposes or to finance the purchase of real estate or equipment. Such loans are usually made at a floating interest rate based on the Bank's \"prime rate.\" The interest rate on such loans changes whenever the prime rate changes.\nThe Bank makes a variety of types of personal loans, including automobile, boat, credit card and other installment loans. While the Bank offers fixed rates on some of its consumer loans, most of its consumer loans, with the exception of credit cards, have variable interest rates. Consumer loans account for approximately 5% of the Bank's loan portfolio.\nThe Bank has developed relationships with other banks to provide services requested by the Bank's customers which the Bank does not currently make available. The Bank will request other banks to participate in loans to customers where the loan amounts exceed the Bank's policies or legal lending limits.\nThe Bank's market for deposits is concentrated in Darien, Norwalk, Stamford and Westport, Connecticut. Its lending area includes principally the cities of Stamford and Norwalk, Connecticut and the towns of Darien, Greenwich, Westport, New Canaan, Wilton and Weston, Connecticut.\nThe Bank has no material patents, trademarks or licenses.\nThe Bank spent $30,000, $1,000 and $16,000 on market research during the years ended December 31, 1995, 1994 and 1993, respectively.\nCompliance by the Bank with federal, state and local provisions which have been enacted or adopted regulating or otherwise relating to the discharge of materials into the environment is not expected to have any material effect upon the capital expenditures, earnings and competitive position of the Bank.\nThe number of persons employed by the Bank is 89. The Company has no employees who are not also employees of the Bank.\nWhile the business of the Bank is generally not seasonal, there may be times of the year when mortgage origination activity is stronger than at other times.\nThe Bank does not engage in material operations in foreign countries and a material portion of its revenues is not derived from customers in foreign countries.\nItem 2","section_1A":"","section_1B":"","section_2":"Item 2 - Properties - -------------------\nThe Bank leases a building at 20 West Avenue, Darien, Connecticut, for a term ending in May, 2010. The building serves as the headquarters of the Company and the Bank, and as the Darien banking office. The Company and the Bank currently lease approximately 18,250 square feet. The Company and the Bank occupy approximately 13,500 square feet and sublease approximately 4,750 square feet at $21 per square foot.\nThe Bank leases a portion of a building at 90 Post Road East, Westport, Connecticut, for a ten-year period with an option for two successive terms of five years each. The lease, which began in November, 1989, is for the Bank's Westport Regional Branch Office and covers approximately 4,000 square feet.\nItem 3","section_3":"Item 3 - Legal Proceedings - --------------------------\nThere are no material pending legal proceedings to which the Company or the Bank is a party or of which any of their property is subject.\nItem 4","section_4":"Item 4 - Submission of Matters to a Vote of Security Holders - ------------------------------------------------------------\nDuring the fourth quarter of 1995, no matter was submitted to a vote of stockholders of the Company.\nItem 4A - Executive Officers of the Registrant - ----------------------------------------------\nThe following table sets forth the names of all executive officers of the Company or the Bank, their ages and all positions held by them with the Company or the Bank.\nName Age Title - ---- --- -----\nDouglas D. Milne, III 44 Chairman of the Board of the Company and the Bank\nKevin E. Gage 36 President and Chief Executive Officer of the Company and the Bank\nPeter T. Hovey 48 Senior Vice President and Senior Lending Officer of the Bank\nAlbert T. Jaronczyk 44 Senior Vice President, Treasurer and Chief Financial Officer of the Company and the Bank\nChristine J. Scholtz 44 Senior Vice President and Senior Credit Officer of the Bank\nInformation concerning the business experience of Messrs. Milne and Gage is included under \"Election of Directors\" in the Company's Proxy Statement for its 1996 Annual Meeting of Stockholders (the \"1996 Proxy\") and is incorporated herein by reference.\nPrior to becoming Senior Vice President and Senior Lending Officer of the Bank in January, 1996, Mr. Hovey served as Vice President with National Westminster Bank in Connecticut for more than five years.\nPrior to becoming Senior Vice President and Chief Financial Officer of the Company and the Bank in August, 1995, Mr. Jaronczyk served as Chief Financial Officer of The Bank of Great Neck for more than five years.\nMs. Scholtz has been employed by the Bank for more than 5 years.\nAll of the executive officers were elected at the organization meeting of the Board of Directors of the Company in May, 1995 except for Messrs. Jaronczyk and Hovey who were elected to their positions by the Boards of Directors of the Company and the Bank in August, 1995 and January, 1996, respectively. The term of office of each extends until the organization meeting of the Board of Directors of the Company or the Bank, as the case may be, following the next annual meeting of shareholders. None of the executive officers has been elected pursuant to any arrangement with any other person.\nThere is no family relationship between any executive officer and another executive officer. None of the executive officers is involved in any legal proceeding requiring disclosure pursuant to Item 401(f) of Regulation S-K of the Securities and Exchange Commission.\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 included in the NASDAQ National Market System (symbol: HTWN). The following table sets forth for the periods indicated the range of high and low sales prices by quarter as reported by NASDAQ. The Company did not pay any dividends on its common stock during 1995 or 1994. The Company has approximately 485 stockholders of record.\n1995 Low High 1994 Low High ---- --- ---- ---- --- ----\nFirst Quarter $ 9.50 $11.75 First Quarter $10.00 $14.50 Second Quarter 9.50 12.625 Second Quarter 12.00 14.50 Third Quarter 10.00 13.00 Third Quarter 12.00 13.875 Fourth Quarter 12.25 14.25 Fourth Quarter 9.25 14.00\nDuring 1990, the Company adopted a Common Shares Rights Agreement designed to protect stockholders of the Company from abusive takeover tactics by declaring a dividend of one right on each outstanding share of Common Stock.\nSubject to certain conditions, the rights will be exercisable only if a person or a group (an \"Acquiring Person\") (i) acquires or obtains the right to acquire 14.5% or more of the outstanding Common Stock of the Company, or (ii) commences or announces an intention to make a tender offer or exchange offer that will result in the Acquiring Person's obtaining 14.5% or more of the outstanding Common Stock of the Company. Upon the occurrence of any of the foregoing events, each holder of a right will be entitled to purchase from the Company one share of its Common Stock at an exercise price of $20.00 per share, subject to adjustment ( the \"Purchase Price\"). Before that time, the rights trade with the Common Stock but thereafter they become separately tradeable.\nSubsequently, in the event (i) the Company is the surviving corporation in a merger with an Acquiring Person and its Common Stock is not changed or exchanged, (ii) an Acquiring Person engages in a specified \"self- dealing\" transaction such as certain preferential sales, transfers or exchanges of Company assets or securities, special compensation or unfair loans, (iii) a person obtains 15% or more of the Common Stock of the Company other than pursuant to a tender offer deemed fair by the Board of Directors or (iv) an Acquiring Person's ownership is increased by more than 1% by any event, then the holder of a right, other than those held by an Acquiring Person, will be entitled to purchase from the Company for the Purchase Price a number of shares of Common Stock of the Company with a market value equal to twice the Purchase Price. Similarly, in the event (i) the Company is acquired in a merger or other business combination in which the Company is not the survivor or in which the outstanding Common Stock of the Company is changed or exchanged or (ii) 50% or more of the consolidated assets or earning power of the Company is sold other than in transactions in the ordinary course of business, each holder of a right, other than those held by an Acquiring Person, will be entitled to purchase from the corporation acquiring the Company, for the Purchase Price, a number of shares of common stock of the acquiring corporation with a market value equal to twice the\nPurchase Price.\nThe rights are redeemable at the option of the Company for one cent per right (subject to adjustment) up to the tenth day (or such later date determined by the Board of Directors) after the accumulation of 14.5% or more of the Company's shares by an Acquiring Person if such redemption is approved by both the Board of Directors of the Company and the majority of the Board of Directors of the Company not affiliated with an Acquiring Person. The rights expire on the earliest of September 20, 2000, the redemption or exchange of the rights or the consummation of an acquisition of the Company satisfying certain conditions.\nItem 6","section_6":"Item 6 - Selected Financial Data - --------------------------------\nSet forth below is selected financial data for the Company for the years ended December 31, 1995, 1994, 1993, 1992 and 1991.\nHometown Bancorporation, Inc. Selected Financial Data (thousands of dollars except per share amounts)\nItem 7","section_7":"Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations -------------------------------------------------\nThe Company earned $1,309,000 or $.75 per share for the year ended December 31, 1995. This compares to earnings of $1,049,000 or $.60 per share and $2,364,000 or $1.38 per share for the years ended December 31, 1994 and 1993, respectively. The results for 1993 included the one-time cumulative effect of the adoption of the Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"FAS 109\"), of $1,125,000 or $.66 per share.\nResults of operations\nThe Company's results of operations depend primarily on enhancing net interest income, limiting credit losses as reflected through the provision for loan losses, maximizing other operating income and controlling other operating expenses. The Company's other operating income is generated primarily from fees and service charges, net gains on the sale of investment securities and fees generated from mortgages originated and sold to the secondary market. The Company's principal operating expenses are salaries and benefits, occupancy, FDIC insurance, depreciation, advertising and marketing expenses and other general and administrative expenses. The Company's results of operations are also significantly affected by prevailing economic conditions, particularly changes in market interest rates and government policies and regulations concerning, among other things, monetary and fiscal affairs, housing and financial institutions.\nNet interest income is the difference between the income earned on loans and investments, the results of interest rate swaps and interest expense on deposits and borrowings. Interest income on loans and investments is a function of the balances outstanding during the period, the rates earned on such loans and investments and the amortization of fees earned on loans recorded. Interest expense is a function of the amount of deposits and borrowings outstanding during the period and the rates paid on such amounts.\nNet interest income\nNet interest income increased $523,000 or 7.6% during 1995 versus 1994 due to an increase in net average interest earning assets and an improvement in net interest margin to 3.58% in 1995 compared to 3.44% in 1994. The improvement in net interest margin for 1995 was the result of an improved rate spread and increase in net non-interest bearing liabilities and capital. Net interest income increased $580,000 or 9.2% during 1994 versus 1993, due to an increase in net average interest earning assets offset by a decrease of net interest margins to 3.44% in 1994, from 3.59% in 1993.\nThe following tables set forth for the periods indicated, the average balances of interest earning assets and interest bearing liabilities and the interest earned or paid thereon expressed in dollars and rates, with the changes for each category analyzed as to the impact of rates and volume.\n(1) The rate volume analysis reflects the changes in net interest income arising from changes in interest rates and from asset and liability volume, including mix. The change in interest attributable to volume includes changes in interest attributable to mix.\n(2) Includes non-accruing loans.\n(3) Favorable\/(unfavorable) fluctuations.\n(4) Yields are calculated at historical cost and excludes the effect of unrealized gain or (loss) on Investment Available-for-Sale.\nProvision for loan losses and allowance for loan losses\nThe Company maintains an allowance for loan losses. The allowance is recorded through a periodic provision for loan losses, which is charged to operations based on management's assessment of such loan related factors as risk, including collateral and liquidation value of that collateral, loan type, economic conditions and other pertinent factors.\nThe Company, in its assessment of the allowance for loan losses, utilizes a risk rating system. This system involves an ongoing review of the loan portfolio that culminates in loans being assigned a risk factor based upon various credit criteria. If the review indicates a possibility that some portion of the loan may result in a loss, a specific allowance is established for the amount of the estimated loss. If the review indicates that it is probable that some portion of the loan will result in a loss, that portion of the loan is charged-off as a reduction of the loan and the allowance for loan losses balance. In determining the allowance for loan losses for the balance of the portfolio, loans are classified as to industry and collateral type with risk assessments made for each category of loans. Reserve requirements are then established for each category and provided for in the allowance for loan losses.\nDuring 1995 the Company provided to the allowance for loan losses $75,000 or .03% of average total assets as compared to $75,000 or .04 % of average total assets and $360,000 or .19% of average total assets during 1994 and 1993, respectively. Improved loan portfolio performance and reserve coverage enabled the Company to reduce the level of the provision for loan losses from 1993 to 1994.\nAt December 31, 1995, non-performing loans were $1,475,000 or 1.39% of total gross loans as compared to $851,000 or 1.09% of gross loans and $1,583,000 or 1.78% of gross loans at December 1994 and 1993, respectively. Net loan charge-offs for the years ended December 31, 1995, 1994 and 1993 were $227,000 or .28% of average loans, $711,000 or 0.83% of average loans and $280,000 or 0.31% of average loans, respectively.\nOn December 31, 1995, 1994 and 1993 restructured and non-performing loans were $544,000, $865,000 and $1,238,000, respectively. Performing loans past due 90 days or more as to principal and or interest at December 31, 1995, 1994 and 1993 were $2,000, $11,000 and $475,000, respectively.\nThe ratio of the Company's allowance for loan losses to total loans at December 31, 1995, 1994 and 1993 was 2.71%, 3.85% and 4.09%, respectively. The Company's ratio of the allowance for loan losses to nonperforming loans at December 31, 1995, 1994 and 1993 was 195%, 353% and 230%, respectively. The Company's ratio of the allowance for loan losses to nonperforming assets at December 31, 1995, 1994 and 1993 was 139%, 161% and 128%, respectively.\nThe following schedule reflects the allocation of the allowance for loan losses at December 31, 1995 and 1994.\nHometown Bancorporation, Inc. Allocation of the Allowance for Loan Losses (thousands of dollars)\n- ------------------------------------------------------------------------- December 31, 1995 1994 - ------------------------------------------------------------------------- % of Loans % of Loans in Each in Each Balance at end of year Category to Category to applicable to: Amount Total Loans Amount Total Loans - ------------------------------------------------------------------------- Real estate mortgage $1,807 85% $2,337 82% Commercial 841 9% 541 11% Installment 225 5% 108 6% Real estate construction 10 1% 18 1% - ------------------------------------------------------------------------- $2,883 100% $3,004 100% ========================================================================= - -------------------------------------------------------------------------\nOther operating income\nDeposit and other service charge income decreased $22,000 or 3% to $687,000 in 1995 compared to 1994 and increased $8,000 or 1% to $709,000 during 1994. The decrease in deposit and other service charge income reflects decreased deposit account activity in 1995.\nMortgage origination fees (fees generated from mortgages originated and sold to the secondary market) during 1995, 1994 and 1993 were $459,000, $507,000 and $893,000, respectively. The decreases during years 1995 and 1994 were due to the decrease in mortgage origination volume as a result of the increase in interest rates throughout the period which discouraged mortgage refinancing activity.\nOther income included in other operating income was $248,000 which reflected a $113,000, or 84%, increase over 1994. This increase is primarily due to $98,000 in net gains on the disposal of other real estate owned during 1995. The remaining increase results from increased service charge revenues on the Company's Merchant program. The Merchant program provides efficient and cost effective credit card processing services to the Company's retail merchant customers.\nOther operating expenses\nA 3% increase in salary and benefit expense for 1995 in the amount of $94,000 is attributed to an increase in the number of full-time equivalent employees during 1995 and normal scheduled employee raises. This compares with a $362,000 or 14% increase in 1994 as compared to 1993, which primarily related to an increase in medical\ninsurance premiums and other benefits, and to an increase in the number of full-time equivalent employees during 1994. The average number of full-time equivalent employees at December 31, 1995, 1994 and 1993 were 80, 79 and 77, respectively.\nProfessional fees increased by $558,000 to $663,000 in 1995 from $105,000 in 1994. This increase is attributed to fees that were incurred in connection with the Company's internal investigation during 1995 related to certain accounting errors and irregularities which led to a restatement of earnings for the years ended 1992 through 1994. During 1994, professional fees increased $4,000 or 4%, from $101,000 for 1993, and reflects the normal level of business expense for those periods.\nFDIC insurance premiums decreased $176,000 or 46% during 1995 to $210,000, from $386,000 during 1994. During 1994, premiums decreased $17,000 or 4% from $403,000 during 1993. Effective June, 1995, The FDIC reduced premiums charged to its member banks as a result of the Bank Insurance Fund's meeting certain mandated recapitalization requirements. The decline in premium expense for 1995 relates primarily to this reduction in the Bank Insurance Fund premium rate assessed the Company, net of premiums on a net increase in deposit balances outstanding on average for 1995. The decrease during 1994 was due to a decrease in the premium amounts charged by the FDIC due to the Bank's improved capital classification.\nDepreciation and amortization expense decreased $75,000, or 19% during 1995, from $396,000 in 1994. The decrease during 1995 was due to fixed assets which were fully depreciated in excess of new fixed asset additions for 1995. Depreciation and amortization expense increased to $396,000 during 1994, up $51,000 or 15% from 1993 when total depreciation and amortization expense was $345,000. The increase during 1994 was primarily attributable to fixed asset expenditures required to upgrade the Bank's computer systems.\nAdvertising and marketing expenses increased $12,000 or 5% from $250,000 in 1994 to $262,000 in 1995. The increase during 1995 was due to increased advertising and marketing programs for the Bank's loan products during our 10th Anniversary year. Programs were geared to celebrate the anniversary and improve name recognition in the communities served. During the period from 1993 to 1994 Advertising and marketing expenses increased $50,000 or 25% from $200,000 in 1993. The increase during 1994 was also related to increased advertising and marketing aimed at the Company's loan products.\nForeclosure expenses and the cost of other real estate owned consist of legal, property management and appraisal expenses relating to the foreclosure of property securing loans and the maintenance of other real estate owned acquired through foreclosure. During 1995, foreclosure expenses and the cost of other real estate owned increased $23,000 or 19% from $120,000 in 1994 to $143,000 in 1995. The increase reflects the increased costs of holding OREO property in inventory and the costs associated with maintenance, marketing and disposal of such properties. The significant period to period decline in such properties held at year end and positive earnings previously reported on the disposals of such properties validate the increased costs to carry such inventory. During 1994, foreclosure expenses and the cost of other real estate owned declined $63,000 or 34% from $183,000 in 1993 to $120,000 during 1994.\nOther expense included in Other operating expenses increased $143,000 or 11% to $1,478,000 in 1995 as compared with $1,335,000 for 1994. Increased costs relating to consultants fees, software maintenance expense for systems upgrades and director fees account for the increase in 1995. Other operating expenses - other increased $213,000 or 19% to $1,335,000 during 1994. The increase is attributable to variable expenses such as data processing and postage which increased as a result of the Bank's 14% growth in assets during 1994.\nIncome Taxes\nThe Company recorded income tax provisions of $497,000, $593,000 and $800,000 for the years ended December 31, 1995, 1994 and 1993, respectively. Net income for the year ended December 31, 1993 included the cumulative effect of an accounting change of $1,125,000 or $.66 per share fully-diluted due to the adoption of FAS 109.\nNote 10 to the Consolidated Financial Statements contains additional income tax information.\nLiquidity and capital resources\nAn important element in evaluating the Company's performance and potential performance is its liquidity position and the maturity of its short- and long-term assets and liabilities. Asset liquidity is achieved through the continuous maturity of earning assets. Liability liquidity is available through deposit growth, maturity structure and access to borrowed funds.\nTotal assets of the Company increased to $229 million at December 31, 1995, a $15 million or 7% increase from December 31, 1994 when total assets were $214 million. Total loans were $106 million at December 31, 1995, a $28 million increase from December 31, 1994 when total loans were $78 million.\nThe Bank is a member of the Federal Home Loan Bank of Boston (the \"FHLBB\"). As a member of the FHLBB, the Bank has access to a flexible source of short- and long-term liquidity (approximately $80 million) and to interest rate risk management programs. In addition, the FHLBB's Triple-A status make it a financially stable and reliable provider of wholesale correspondent banking services.\nThe growth in assets during 1995 was funded by a $16 million increase in short-term borrowings from the FHLBB and offset by a $4.7 million decline in deposits during 1994.\nThe Company's funding sources consisted principally of deposits from individuals and businesses in its service area. Total deposits at December 31, 1995 were $178.0 million, a $4.7 million or 3% decrease in deposits from December 31, 1994.\nAsset and liability management\nAs part of the Company's asset and liability management policy, the Company, through the Bank's Asset and Liability Management Committee, has strived to minimize its interest rate and liquidity risk. Interest rate risk is minimized by entering into variable rate loans and investments. Commercial, real estate mortgage and real estate construction loans are predominately floating rate loans tied to changes in the prime rate of interest. Residential mortgages held in the Company's portfolio generally reprice annually if there is a shift in the underlying United States Treasury Securities Index, subject to a two percentage point maximum increase or decrease at each reprice date. Generally, fixed rate loans are funded through matched deposits. The investment portfolio maintains a position in U. S. Agency ARM securities which also reprice with the Constant Maturity Treasury (CMT) index. These securities are subject to periodic two percentage point limits on changes from the then current coupon. Finally, interest rate risk is controlled on a total portfolio basis striving to manage the \"gap\" position of the Company, the difference between interest sensitive assets and liabilities repricing within a given time frame. Liquidity risk is managed through the matching of investment, loan and deposit maturities and through accessing other funding sources for short-term liquidity needs.\nThe following table illustrates the repricing schedule of the Company's interest earning assets and interest bearing liabilities for future time periods as of December 31, 1995 and the principal period in which they mature (or which, in the case of mortgage-backed securities, they are expected to be repaid) or the period in which their rates are eligible to reprice. The repricing schedule of mortgage-backed securities is an estimate of when such securities will be repaid based upon past repayment rates experienced by the Company. In preparing the table, it was assumed that prime rate commercial loans will reprice immediately. The maturity schedules included in Notes 3, 4 and 6 to the Consolidated Financial Statements reflect contractual maturity only, without consideration of anticipated prepayment of mortgage-backed securities and the periodic repricing of variable rate loans and investments. The Company anticipates that its short and long-term liquidity and net interest income will not be adversely affected by changes\nin the interest rate environment due to the relatively short-term maturity and repricing of its investment, loan and deposit portfolios.\nHometown Bancorporation, Inc. Repricing Schedule (thousands of dollars)\nInvestments\nThe Company adopted FAS 115, Accounting for Certain Investments in Debt and Equity Securities, as of December 31, 1993, which requires the classification of debt and equity securities into one of three categories: held-to-maturity; available-for-sale; or trading. Held-to-maturity securities are reported at amortized cost and available-for-sale securities are reported at fair market value, with unrealized gains and losses excluded from earnings and reported as a separate component of stockholders' equity. The Company does not have a trading portfolio and does not anticipate creating a trading portfolio in the near future. In December, 1995 the Company reclassified $21,776,000 in Investments-Held-To-Maturity to Investments-Available-for-Sale as described in note 4 to the Financial Statements.\nThe Company's investment portfolio decreased $14,331,000 to $108,796,000 at December 31, 1995, an 11.6% decrease from December 31, 1994, when total investments were $123,127,000. The decrease in investments reflects a shift of funds\ninto loans during 1995. Currently, the Company invests in taxable U.S. government and U.S. government agency securities (primarily mortgage-backed securities, collaterialized mortgage obligations and U.S. government agency bonds) as well as other mortgage-backed securities rated AA or better.\nIt is the Company's policy to maintain asset and liability interest sensitivity matching through adjustments to the investment portfolio and to provide for the liquidity needs of the Company. The policy also provides for balancing return while minimizing risks.\nThe amortized cost and fair values of investment securities together with average yield by maturity at December 31, 1995 and 1994 are shown below. Mortgage backed securities are not reported by their contractual maturities as they are subject to prepayment. These securities are reported by their average life to maturity.\nThe fair market value of investments is based on quoted market prices and\/or dealer quotes.\nHometown Bancorporation, Inc. Consolidated Statement of Changes in Stockholders' Equity (thousands of dollars)\n(1) Prior to the adoption of FAS 115 on December 31, 1993\nThe accompanying notes are an integral part of the consolidated financial statements.\nHometown Bancorporation, Inc. Notes to the Consolidated Financial Statements\nNOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nThe accounting and reporting policies of Hometown Bancorporation, Inc. (the \"Company\") and its subsidiary conform to generally accepted accounting principles and general practices within the banking industry. The following footnotes describe the most significant of these policies.\nIn preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported assets and liabilities as of the date of the consolidated balance sheet. The same is true of revenues and expenses reported for the period. Actual results could differ significantly from those estimates.\nPrinciples of Consolidation\nThe consolidated financial statements include the accounts of the Company and its wholly owned subsidiary, The Bank of Darien (the \"Bank\"). All significant intercompany balances and transactions have been eliminated in consolidation.\nInvestment Securities\nIn May 1993, the Financial Accounting Standards Board (the \"FASB\") issued Statement No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" (\"FAS 115\"). Prior to December 31, 1993, all investment securities were carried at historical cost adjusted for amortization of premiums and accretion of discounts. The Company adopted FAS 115 effective December 31, 1993.\nInvestment securities for which management has the positive intent and ability to hold to maturity are classified as \"held-to-maturity\" and are carried at cost net of unamortized premiums and discounts.\nInvestments not classified as \"held-to-maturity\" (investments that may be sold prior to maturity as part of asset\/liability management, liquidity or in response to other factors) are classified as \"available-for- sale\" and are carried at fair value, with the change in fair value excluded from earnings and reported as a separate component of stockholders' equity.\nThe Company does not have a trading portfolio and does not anticipate creating a trading portfolio in the near future.\nGains and losses on sales of investment securities are reported as a separate component of the Consolidated Statement of Income and are computed using the\nHometown Bancorporation, Inc. Notes to the Consolidated Financial Statements (continued)\nspecific identification method. Securities transactions are recorded on a trade date basis.\nEquipment and Leasehold Improvements\nEquipment and leasehold improvements are carried at cost less accumulated depreciation and amortization. Depreciation is computed based on estimated useful lives of equipment using straight line methods. Leasehold improvements are amortized ratably over the shorter of estimated service lives or the terms of the leases. Major renewals and betterments are capitalized and recurring repairs and maintenance are charged to income. Gains and losses on dispositions of assets are included in income as realized.\nOther Real Estate Owned\nReal estate acquired in foreclosure (or considered to be in- substance foreclosure) of loans is valued at the lower of the loan value or fair value less estimated selling costs. At the time of foreclosure the excess, if any, of the loan value over the fair value less estimated selling costs is charged to the allowance for loan losses. Subsequent to the time of foreclosure, a decline in the value of the foreclosed properties is recognized as provision for other real estate owned losses. Other expenditures not recoverable from the anticipated sale are charged to foreclosure expenses and costs of other real estate owned, as incurred.\nLoans\nLoans are reflected at the principal amount outstanding net of unearned income and the allowance for loan losses. Interest on loans is calculated by using the simple-interest method on the daily balances of the principal amounts outstanding.\nAccrual of interest on loans is generally discontinued when a loan becomes contractually past-due by 90 days or more with respect to principal or interest, or earlier when full, timely collection of interest and principal becomes uncertain. When a loan is placed on nonaccrual status, all interest previously accrued but not collected is generally reversed against income. When a loan is placed on nonaccrual status, all interest is then recognized only to the extent the cash is received, provided in the judgment of management, the loan is estimated to be fully collectible as to both principal and interest.\nLoans held for sale which are included in Other Assets are carried at the lower of cost or market value.\nAllowance for Loan Losses\nHometown Bancorporation, Inc. Notes to the Consolidated Financial Statements (continued)\nThe allowance for loan losses is established through charges against income and is maintained at a level considered adequate to provide for potential loan losses based on management's evaluation of inherent risks in the loan portfolio. When a loan, or a portion of a loan, is considered uncollectible it is charged against the allowance for loan losses. Recoveries of loans previously charged-off are credited to the allowance for loan losses when cash is received.\nManagement's evaluation of the allowance for loan losses is based on a continuing review of the loan portfolio, which includes many factors, including identification and review of individual problem situations that may affect the borrower's ability to repay the loan; review of overall portfolio quality through an analysis of current charge-offs, delinquency, and nonperforming loan data; review of regulatory authority examinations and their evaluation of loans; an assessment of current and expected economic conditions; and changes in the size and character of the loan portfolio.\nLoan Commitment and Origination Fees and Costs\nFees and direct origination costs of loans and mortgage-backed securities are deferred and the net fee or cost is recognized in interest income using the level yield method in accordance with Statement of Financial Accounting Standards No. 91 (\"FAS 91\"). Net deferred fees and costs applicable to prepayments are recognized in interest income at the time of prepayment.\nDisclosure About Fair Values of Financial Instruments\nThe estimated fair values of financial instruments as presented throughout the footnotes, have been determined by management using available market information and appropriate valuation methodologies. However, considerable judgment is 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 Bank 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.\nDerivatives\nThe Company enters into interest rate swap transactions as a means of reducing its interest rate exposure on specific assets or liabilities. The Company's derivative activities are all end-user related and the Company has no transactions classified as trading. The periodic net settlements on interest rate swap agreements are recorded as an adjustment to interest income on investments on an accrual basis.\nHometown Bancorporation, Inc. Notes to the Consolidated Financial Statements (continued)\nStatement of Cash Flows\nFor purposes of reporting cash flows, the Company defines cash and cash equivalents as cash and due from banks, federal funds sold, and interest bearing deposits in banks with original maturities of three months or less.\nIncome Taxes\nIn February 1992, the FASB issued Statement No. 109, \"Accounting for Income Taxes\" (\"FAS 109\"). FAS 109 requires that income taxes be accounted for under the asset and liability method. Under the asset and liability method, deferred tax assets and liabilities are recognized for 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. Deferred tax assets are reduced, through a valuation allowance, if necessary, by the amount of such benefits that is not expected to be realized based on current available evidence. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the settlement date. The Company prospectively adopted FAS 109 effective January 1, 1993 and the effect of the adoption is discussed in Note 10.\nEarnings Per Share Calculations\nNet income per common share is computed by dividing net income by the weighted average number of common shares outstanding for each period presented plus the dilution effect of stock options.\nDividends\nThe Company does not currently pay dividends. However, if the Company were to pay dividends, Connecticut law restricts the payment of dividends by the Bank to the Company except from \"net profits\" (as defined). Although the restriction does not apply to the payment of dividends by the bank holding company, the Company's ability to pay dividends is dependent on its receiving dividends from the Bank.\nNOTE 2 - RESTRICTED CASH BALANCES\nRegulations of the Federal Reserve Board require depository institutions to maintain a portion of their deposits in the form of either cash or deposits with the Federal Reserve Bank which are noninterest bearing and not available for investment purposes. At December 31, 1995 and 1994 the Company maintained $3,157,000 and $3,070,000, respectively, at the Federal Reserve Bank.\nHometown Bancorporation, Inc. Notes to the Consolidated Financial Statements (continued)\nNOTE 3 - LOANS\nMajor classifications of loans at December 31, 1995 and 1994 were as follows:\nDecember 31, 1995 1994 - --------------------------------------------------------------------------- (thousands of dollars) Real estate mortgage $90,545 $64,203 Commercial 9,214 8,597 Real estate construction 1,060 754 Installment 5,471 4,390 - --------------------------------------------------------------------------- 106,290 77,944\nAllowance for loan losses (2,883) (3,004) - --------------------------------------------------------------------------- $103,407 $74,940 ===========================================================================\nThe estimated fair market value of loans at December 31, 1995 and 1994 was $103.1 million and $73.4 million, respectively. The estimated fair market value of loans is estimated based on present values using applicable risk-adjusted spreads to the U.S. Treasury curve to approximate current entry-value interest rates. No adjustment was made to the entry value interest rates for changes in credit of performing commercial loans for which there are no known credit concerns.\nManagement segregates loans in appropriate risk categories. Management believes that the risk factor embedded in the entry-value interest rates, along with the general reserves applicable to the performing commercial loan portfolio, for which there are no known credit concerns, results in a fair valuation of such loans on an entry-value basis.\nFinal contractual loan maturities and rate sensitivity of the loan portfolio at December 31, 1995 were as follows:\nWithin One to After One Five Five Year Years Years Total - ------------------------------------------------------------------------------ (thousands of dollars) Real estate mortgage $12,012 $11,614 $66,919 $90,545 Commercial 4,517 3,083 1,614 9,214 Real estate construction 772 288 - 1,060 Installment 159 3,119 2,193 5,471 - ------------------------------------------------------------------------------ $17,460 $18,104 $70,726 $106,290 ============================================================================== Loans at fixed interest rates $2,746 $4,514 $9,619 $16,879 Loans at variable interest rates 14,714 13,590 61,107 89,411 - ------------------------------------------------------------------------------ $17,460 $18,104 $70,726 $106,290 ==============================================================================\nAt December 31, 1995 and 1994 the Company was not accruing interest on loans having outstanding balances of $1,475,000 and $851,000 or 1.39% and 1.09% of the respective year's gross loan balance. Had these non-accrual loans been current, including any portion charged-off during 1995, gross income on these loans for 1995 and\n1994 would have been $167,000 and $99,000, respectively. Interest income actually recorded on these loans totaled $22,000 and $61,000, respectively.\nLoans to officers, employees and directors (and companies in which they have a 10 percent or more beneficial ownership) aggregated $2,246,000 and $1,675,000 at December 31, 1995 and 1994, respectively. During 1995, aggregate additions and paydowns to related party loans were $1,019,000 and $448,000, respectively. These loans were made in the ordinary course of business as to the loan amount, rate of interest and payment terms. All loans to officers, employees and directors were current as of December 31, 1995.\nTransactions in the allowance for loan losses during 1995, 1994 and 1993 are summarized as follows:\nDecember 31, 1995 1994 1993 - ---------------------------------------------------------------------- (thousands of dollars) Balance at beginning of period $3,004 $3,640 $3,111 Charge-offs: Commercial loans (23) (44) (22) Real estate mortgage loans (302) (693) (264) Installment loans (22) (6) (39) - ---------------------------------------------------------------------- Total charge-offs (347) (743) (325) - ---------------------------------------------------------------------- Recoveries: Commercial loans 15 18 21 Real estate mortgage loans 93 4 17 Installment loans 12 10 7 - ---------------------------------------------------------------------- Total recoveries 120 32 45 - ---------------------------------------------------------------------- Net charge-offs (227) (711) (280) - ---------------------------------------------------------------------- Provision for loan losses 75 75 360 Loan purchase 31 - 449 - ---------------------------------------------------------------------- Balance at end of period $2,883 $3,004 $3,640 ====================================================================== Net charge-offs to average loans 0.28% 0.83% 0.31% ======================================================================\nThe Company adopted Statement of Financial Accounting Standards No. 114, \"Accounting for Creditors for Impairment of a Loan,\" (\"FAS 114\")and Statement of Financial Accounting Standards No. 118, \"Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures,\" (\"FAS 118\")as of January 1, 1995. FAS 114 requires that certain impaired loans be measured based on the present value of expected future cash flows discounted at the loan's original effective interest rate. As a practical expedient, impairment may be measured based on the loan's observable market price or the fair value of the collateral. If the value of the loan is less than the recorded investment, the impairment is recorded through a valuation allowance.\nHometown Bancorporation, Inc. Notes to the Consolidated Financial Statements (continued)\nThe Company had previously measured the allowance for loan losses for impaired loans using methods similar to those prescribed in FAS 114 and FAS 118. As a result of adopting these statements, no additional allowance for loan losses was required as of January 1, 1995. Impaired loans having recorded book value of $2,989,000 at December 31, 1995 and $2,947,000 at December 31, 1994 have been recognized in conformity with FAS 114 as amended by FAS 118. The average recorded investment in impaired loans during 1995 and 1994 was $2,961,000 and $3,562,000, respectively. The total allowance for loan losses related to these loans was $823,000 and $762,000 at December 31, 1995 and 1994, respectively. This allowance is included in the allowance for loan losses on the Balance Sheet. Interest income on impaired loans of $162,000 and $192,000 were recognized for cash payments received in 1995 and 1994, respectively.\nLoans having carrying values of $268,000 and $442,000 were transferred to other real estate owned in 1995 and 1994, respectively.\nThe Company is not committed to lend additional funds to debtors whose loans have been modified or are considered impaired.\nNOTE 4-INVESTMENT SECURITIES\nThe amortized cost and estimated fair values of investments held- to-maturity and available-for-sale together with gross unrealized gains and losses at December 31, 1995 and 1994, are shown below:\nThe Company realized net securities gains of $26,000, $46,000 and $27,000 in 1995, 1994, and 1993, respectively. Cost for investments sold was determined on a specific identification basis.\nAt December 31, 1995 and December 31, 1994 there was $2,923,000 and $2,484,000, respectively, in U.S. Treasury and other securities pledged to secure municipal deposits as required by law.\nOn November 15, 1995, the FASB issued a special report entitled, \"A Guide to Implementation of Statement No. 115 on Accounting for Certain Investments in Debt and Equity Securities, Questions and Answers\" (\"the Guide\"). The Guide permitted a one-time reassessment and related reclassifications from the held-to-maturity category (no later than December 31, 1995) that will not call into question the intent of the enterprise to hold other debt securities until maturity in the future. On December 21, 1995, the Company performed a reassessment of its investment and mortgage-backed securities portfolio which resulted in a reclassification of $21,776,000 of investment securities from held-to-maturity to available-for-sale. The impact upon the Company's financial condition resulting from this transfer was not material. There was no impact on the Company's results from operations resulting from this transfer.\nThe amortized cost and estimated fair value of investment securities at December 31, 1995, by maturity, are presented in the table below. Mortgaged backed securities are reported by the average life to maturity.\nDecember 31, 1995 (thousands of dollars) ===============================================================================\nAmortized Estimated Average Investments held-to-maturity Cost Fair Value Yield - ------------------------------------------------------------------------------- U.S. Agency Mortgage-Backed Securities Due in 1 year or less $ 2,994 $ 2,987 5.41% Due after 1 but within 5 years 2,711 2,718 6.70% - ------------------------------------------------------------------------------- Subtotal 5,705 5,705 6.02% - ------------------------------------------------------------------------------- Other U.S. Agency Obligations Due after 1 but within 5 years 2,946 2,880 6.19% - ------------------------------------------------------------------------------- Subtotal 2,946 2,880 6.19% - ------------------------------------------------------------------------------- Other Mortgage-Backed Securities Due after 1 but within 5 years 2,239 2,137 5.56% Due after 5 but within 10 years 4,210 4,041 6.95% - ------------------------------------------------------------------------------- Subtotal 6,449 6,178 6.47% - ------------------------------------------------------------------------------- Total investments held-to-maturity $15,100 $14,763 6.25% ===============================================================================\nAmortized Estimated Average Investments available-for-sale Cost Fair Value Yield - ------------------------------------------------------------------------------- U.S. Treasury Securities Due in 1 year or less $3,016 $3,019 5.52% - ------------------------------------------------------------------------------- Subtotal 3,016 3,019 5.52% - ------------------------------------------------------------------------------- U.S. Agency Mortgage-Backed Securities Due in 1 year or less 134 133 7.03% Due after 1 but within 5 years 51,751 51,808 6.55% Due after 5 years but within 10 years 9,115 8,855 6.05% Due after 10 years 1,985 1,919 6.27% - ------------------------------------------------------------------------------- Subtotal 62,985 62,715 6.47% - ------------------------------------------------------------------------------- Other U.S. Agency Obligations Due after 1 but within 5 years 3,478 3,564 7.27% - ------------------------------------------------------------------------------- Subtotal 3,478 3,564 7.27% - ------------------------------------------------------------------------------- Other Mortgage-Backed Securities Due after 1 but within 5 years 19,520 19,422 6.68% Due after 5 but within 10 years 3,301 3,259 8.82% - ------------------------------------------------------------------------------- Subtotal 22,821 22,681 7.09% - ------------------------------------------------------------------------------- Federal Home Loan Bank Stock 1,717 1,717 6.70% - ------------------------------------------------------------------------------- Total investments available-for-sale $ 94,017 $ 93,696 6.62% ===============================================================================\nNOTE 5-EQUIPMENT AND LEASEHOLD IMPROVEMENTS\nThe major components of fixed assets at December 31, 1995 and 1994 were as follows:\nDecember 31, 1995 1994 - ----------------------------------------------------------------------------- (thousands of dollars) Leasehold improvements $1,523 $1,491 Furniture and equipment 1,830 1,712 - ----------------------------------------------------------------------------- 3,353 3,203 Less: Accumulated depreciation and amortization (1,897) (1,576) - ----------------------------------------------------------------------------- $1,456 $1,627 =============================================================================\nNOTE 6-DEPOSITS\nIncluded in total interest bearing deposits are certificates of deposit in amounts of $100,000 and over. These certificates and their remaining maturities at December 31, 1995 and 1994 are as follows:\nDecember 31, 1995 1994 - ----------------------------------------------------------------------------- (thousands of dollars) Three months or less $3,669 $5,203 Over three, through six months 2,992 3,287 Over six, through twelve months 2,993 461 Over twelve months 1,300 400 - ----------------------------------------------------------------------------- $10,954 $9,351 =============================================================================\nInterest expense incurred on deposits during 1995, 1994, and 1993 was as follows:\nFor the Year Ended December 21, 1995 1994 1993 - ----------------------------------------------------------------------------- (thousands of dollars) NOW and money market accounts $2,261 $1,907 $1,869 Other time deposits 2,853 1,941 1,368 Certificates of deposit of $100 or over 609 274 242 Savings 448 337 344 - ----------------------------------------------------------------------------- $6,171 $4,459 $3,823 =============================================================================\nThe estimated fair value of total deposits at December 31, 1995 and 1994 was $177.9 million and $183.1 million, respectively. The estimated fair value of demand deposits, savings accounts and money market deposits is the amount payable on demand at December 31, 1995 and 1994. The estimated fair value of fixed-maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities.\nHometown Bancorporation, Inc. Notes to the Consolidated Financial Statements (continued)\nNOTE 7 - SHORT-TERM BORROWINGS\nShort-term Borrowings consist of federal funds purchased (variable rate overnight advances) and fixed rate term advances from the Federal Home Loan Bank (\"FHLB\"). At December 31, 1995 and 1994, the Company had federal funds purchased outstanding of $22,116,000 and $11,681,000, respectively. The interest rates on these overnight advances at December 31, 1995 and 1994 were 6.40% and 6.16%, resectively.\nFixed rate term advances from the FHLB consist of the following at December 31, 1995 and 1994:\nMaturity Date Interest Rate 1995 1994 - -------------------------------------------------------------------------- May 3, 1995 4.22% $ - $5,000,000 February 23, 1996 6.30% 5,000,000 - May 23, 1996 6.39% 5,000,000 - - -------------------------------------------------------------------------- Totals $10,000,000 $5,000,000 ==========================================================================\nThe weighted average rate for total short-term borrowings was 6.21% and 5.30% on average daily outstanding balances of $23,638,000 and $25,568,000 for the year ended December 31, 1995 and 1994, respectively. The estimated value of short-term borrowings is based upon the outstanding borrowings discounted at current market rates.\nNOTE 8 - COMMITMENTS AND RENTAL EXPENSE\nThe Company leases its premises and other property under noncancelable agreements requiring minimum monthly rentals through their remaining terms. The total minimum commitment at December 31, 1995 under the leases are as follows:\nDue in the year ending 1996 $671 December 31, 1997 653 (thousands of dollars) 1998 650 1999 644 2000 and after 5,490 - ---------------------------------------------------------------------- $8,108 ======================================================================\nEffective May 1, 1995, the Company entered into a lease modification agreement with its landlord concerning its home office location in Darien, Connecticut. The modification reduced annual rentals by $38,000 per annum effective June 1, 1995, and extends the term of the lease 37 months to May 31, 2010. The net increase in lease outlay in current dollars over the term of the lease is $1,173,000. This modification is reflected in the above summary.\nHometown Bancorporation, Inc. Notes to the Consolidated Financial Statements (continued)\nTotal occupancy and equipment rental expense was $617,000, $610,000, and $603,000 for the years ended December 31, 1995, 1994, and 1993, respectively\nNOTE 9-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, standby letters of credit, and interest rate swaps. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the Consolidated Financial Statements. The contractual 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 standby letters of credit is represented by the contractual or notional amount of those instruments. For interest rate swap transactions, the contractual or notional amounts do not represent exposure to credit loss. The Company manages the credit risk of its interest rate swap agreements through credit approvals, limits, and monitoring procedures.\nA summary of the contractual amount or notional value of off- balance-sheet financial instruments as of December 31, 1995 and 1994 is as follows:\nDecember 31, 1995 1994 - --------------------------------------------------------------------------- (thousands of dollars) Interest rate swap agreements $34,000 $34,000 Commitments to extend credit: Unused lines of credit 12,614 10,905 Commercial real estate 1,486 874 Other 11,284 8,673 Standby letters of credit 108 102\nInterest rate swap agreements are used by the Company to manage its interest rate risk. These agreements involve the exchange of fixed and variable interest rate payments based upon a notional principal amount and maturity date. The risk associated with these agreements arises from the potential of the counterparties' failure to meet the terms of the agreements. However, the Company does not anticipate nonperformance by the counterparties.\nCommitments to extend credit are agreements to lend to a customer provided there is no violation of any condition in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since it is possible that some of the commitments could expire without being drawn upon, the total commitment amounts outstanding at December 31, 1995 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\nnecessary by the Company upon extension of credit is based on management's credit evaluation of the customer.\nStandby letters of credit are obligations to make payments under certain conditions to meet contingencies related to customers' contractual agreements and are subject to the same risk, credit review, and approval process as loans. Letters of credit are primarily used to enhance credit for private borrowing arrangements and to guarantee a customer's financial performance. The credit risk involved in issuing standby letters of credit is essentially the same as that involved in extending loan facilities to customers.\nThe estimated fair value of interest rate swap agreements, at December 31, 1995 and 1994 were $(127,000), $(683,000), respectively. Financial instruments, such as commitments to extend credit and Standby Letters of Credit, generally are not sold or traded, and estimated fair values are not readily available. However, the fair value of commitments to extend credit and standby letters of credit is based on fees charged to enter into similar agreements with comparable credit risks and the current creditworthiness of the counterparties. Commitments to extend credit issued by the Company are generally short-term in nature and, if drawn upon, are issued under current market terms and conditions for credits with comparable risks.\nAt December 31, 1995 and 1994, there was no significant unrealized appreciation or depreciation on these financial instruments.\nNOTE 10-INCOME TAXES\nThe Company adopted FAS 109 effective January 1, 1993 and the cumulative effect of this change is reported in the 1993 Consolidated Income Statement.\nIncome tax expense for the three years ended December 31, 1995, 1994 and 1993 consisted of the following components:\nDecember 31, 1995 1994 1993(a) - ----------------------------------------------------------------------------- (thousands of dollars) Current Federal $379 $435 $416 State 135 137 120 Deferred Federal (87) (37) 144 State 70 58 120 - ----------------------------------------------------------------------------- $497 $593 $800 =============================================================================\n(a) Excludes the cumulative effect of the adoption of FAS 109.\nA reconciliation setting forth the differences between the effective tax rate of the Company and the U.S. statutory federal tax rate is as follows:\nHometown Bancorporation, Inc. Notes to the Consolidated Financial Statements (continued)\n- ---------------------------------------------------------------------------- December 31, 1995 1994 1993 - ---------------------------------------------------------------------------- U.S. statutory rate 34.0% 34.0% 34.0% State income tax, net of federal benefit 7.5% 7.8% 7.8% Release of valuation allowance (14.9%) (11.6%) (2.7%) Goodwill amortization 1.0% 1.0% 1.0% Other, net - 4.9% (0.9%) - ---------------------------------------------------------------------------- 27.6% 36.1% 39.2% ============================================================================\nDeferred tax asset and liabilities included in other assets at December 31, 1995 and 1994 consist of the following:\nNet deferred tax asset: December 31, 1995 1994 (thousands of dollars) Loan loss reserve $702 $817 OREO reserves 40 139 Net deferred loan fees 6 48 Depreciation 48 48 Foreclosure costs 26 51 Unrealized loss on IAFS 133 - Other, net 60 27 - ---------------------------------------------------------------------- 1,015 1,130 Valuation allowance (100) (290) - ---------------------------------------------------------------------- Net deferred tax asset $915 $840 =======================================================================\nHometown Bancorporation, Inc. Notes to the Consolidated Financial Statements (continued)\nNOTE 11-PARENT COMPANY ONLY FINANCIAL STATEMENTS Presented below are the condensed financial statements of Hometown Bancorporation, Inc. (parent company). The consolidated financial statements should be read in conjunction with these statements.\n- ---------------------------------------------------------------------- Hometown Bancorporation, Inc. (parent company only) Balance Sheet - ---------------------------------------------------------------------- December 31, 1995 1994 - ---------------------------------------------------------------------- (thousands of dollars) Assets Cash due from Bank $473 $348 Investment in subsidiary 16,257 12,195 Other assets 95 - - ---------------------------------------------------------------------- Total assets $16,825 $12,543 ====================================================================== Liabilities and Stockholders' Equity Accrued expenses and other liabilities 6 6 - ---------------------------------------------------------------------- Total stockholders' equity 16,819 12,537 - ---------------------------------------------------------------------- Total liabilities and stockholders' equity $16,825 $12,543 ======================================================================\nHometown Bancorporation, Inc. (parent company only) Statement of Income - ------------------------------------------------------------------------------ December 31, 1995 1994 1993 - ------------------------------------------------------------------------------ (thousands of dollars except per share amounts) Equity in undistributed income of subsidiary $1,346 $1,139 $2,465 - ------------------------------------------------------------------------------ Total income 1,346 1,139 2,465 Legal expenses 8 30 21 Other expenses 29 60 80 - ------------------------------------------------------------------------------ Total expenses 37 90 101 - ------------------------------------------------------------------------------ Net income $1,309 $1,049 $2,364 - ------------------------------------------------------------------------------ Net income per share $ .75 $ .60 $ 1.38 ============================================================================== Hometown Bancorporation, Inc. (parent company only) Statement of Cash Flows - ------------------------------------------------------------------------------ December 31, 1995 1994 1993 - ------------------------------------------------------------------------------ (thousands of dollars) Cash Flows From Operating Activities: Net income $1,309 $1,049 $2,364 Equity in undistributed income of subsidiary (1,346) (1,139) (2,465) Net change in other liabilities - 6 - Net change in other assets (95) 20 (14) Other, net - 2 2 - ------------------------------------------------------------------------------ Net cash used in operating activities (132) (62) (113) - ------------------------------------------------------------------------------ Cash Flows From Financing Activities Proceeds from exercise of stock options 257 98 381 - ------------------------------------------------------------------------------ Net cash provided by financing activities 257 98 381 - ------------------------------------------------------------------------------ Net increase in cash 125 36 268 Cash at the beginning of the year 348 312 44 - ------------------------------------------------------------------------------ Cash at the end of the year $ 473 $ 348 $ 312 ==============================================================================\nHometown Bancorporation, Inc. Notes to the Consolidated Financial Statements (continued)\nNOTE 12-STOCK OPTION PLAN On April 14, 1987, the Company adopted an incentive and non- qualified stock option plan under which 250,000 shares of common stock were reserved. Options granted become exercisable between the grant date and five years after the grant date and expire 10 years after the grant date. Under the plan, the option price of incentive options shall not be less than 100% of the fair market value of the Company's Common Stock on the date the option is granted. The number of shares under option, the exercise price per share and the aggregate thereof outstanding, granted, exercised and cancelled or expired during the years ended December 31, 1995, 1994 and 1993 are summarized as follows:\n- ------------------------------------------------------------------------------ Average Shares Option Price - ------------------------------------------------------------------------------ Options outstanding at December 31, 1992 211,000 $4.41 Granted 16,000 $7.50 Exercised (60,800) $6.38 Cancelled or expired (7,200) $6.41 - ------------------------------------------------------------------------------ Options outstanding at December 31, 1993 159,000 $3.93 Granted 13,500 $12.50 Exercised (20,900) $4.73 Cancelled or expired (3,000) $6.42 - ------------------------------------------------------------------------------ Options outstanding at December 31, 1994 148,600 $4.54 Granted 19,500 $11.00 Exercised (26,300) $3.65 Cancelled or expired (12,200) $10.43 - ------------------------------------------------------------------------------ Options outstanding at December 31, 1995 129,600 $5.14 - ------------------------------------------------------------------------------\nIn 1995, the Company adopted the 1995 Omnibus Stock Incentive Program pursuant to which an additional 100,000 shares of authorized but unissued Common Stock were reserved. Under this program, incentive stock options, non-qualified stock options, stock appreciation rights and stock awards may be granted. Options would become exercisable between six months from the date of grant and the date determined at the time of grant. Under the program, the option price of incentive options shall not be less than 100% of the fair market value of the Company's Common Stock on the date the option is granted, and the option price of non-qualified options shall not be less than 85% of such fair market value. As of December 31, 1995, no benefits had been awarded under this program.\nAt December 31, 1995, options for 105,370 shares were exercisable and 111,400 shares were available for granting additional options under the two current plans combined.\nHometown Bancorporation, Inc. Notes to the Consolidated Financial Statements (continued)\nNOTE 13-QUARTERLY FINANCIAL DATA (UNAUDITED) (A) - ----------------------------------------------------------------------------- 1995 Quarter Ended Mar. 31 June 30 Sept. 30 Dec. 31 Total (thousands of dollars except per share amounts) Interest income $3,710 $3,830 $3,812 $3,728 $15,080 Net interest income 1,844 1,857 1,868 1,843 7,412 Provision for loan losses 25 - 25 25 75 Net income 370 476 13 450 1,309 Net income per share $.21 $.27 $.01 $.26 $.75\n1994 Quarter Ended Mar. 31 June 30 Sept. 30 Dec. 31 Total (thousands of dollars except per share amounts) Interest income $2,842 $3,048 $3,380 $3,432 $12,702 Net interest income 1,670 1,704 1,805 1,710 6,889 Provision for loan losses 25 - 25 25 75 Net income 387 290 329 43 1,049 Net income per share $.22 $.17 $.19 $.02 $.60\n(A) See note 16 below.\nNOTE 14-FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe following is a summary of the fair values of financial instruments which are disclosed throughout the footnotes to the Consolidated Financial Statements.\n- ----------------------------------------------------------------------------- December 31, 1995 1994 - ----------------------------------------------------------------------------- Carring Fair Carrying Fair (thousands of dollars) Amount Value Amount Value - ----------------------------------------------------------------------------- Financial Assets: Cash and due from banks $9,891 $9,891 $8,549 $8,549 Investments available-for-sale (Note 4) 93,823 93,823 76,854 76,854 Investments held-to-maturity (Note 4)(A) 15,100 14,763 46,273 44,965 Net loans (Note 3) 103,407 103,138 73,474 73,474 Financial Liabilities: Deposits (Note 6) 178,000 177,935 182,731 183,075 Short-term borrowings (Note 7) 32,116 32,064 16,681 16,726 Off-Balance Sheet (Note 8): Interest rate swap agreements (127) (127) - (683) Commitments to extend credit - - - - Standby letters of credit - - - -\n(A) Excludes effect of interest rate swap agreements.\nNOTE 15 - EMPLOYEE BENEFIT PLAN\nThe Bank maintains a qualified deferred compensation plan under Section 401(k) of the Internal Revenue Code. Under the plan, employees may elect to defer up to 17% of their salary, subject to Internal Revenue Code limits. The Bank contributes a matching 100% of the first 1% of employee contributions and 25% of the next 5% of employee contributions to a combined maximum match of $3,000 per employee, per\nyear. The plan covers substantially all full-time employees. Bank contributions to the plan amounted to $35,613, $35,056, and $22,239 for 1995, 1994, and 1993 respectively.\nNOTE 16 - RESTATEMENT OF FINANCIAL STATEMENTS\nOn August 25, 1995 the Audit Committee of the Company concluded an investigation of accounting errors and irregularities which were initially discovered in July 1995. Based upon the findings of the investigation, the Board of Directors of the Company concluded that the errors and irregularities resulted from the activities of a former employee who manipulated records and circumvented controls. The results of such actions required the restatement of financial statements for the years ended December 31, 1992 through 1994. The cumulative after-tax effects of these adjustments reduced shareholders' equity as of December 31, 1994 by $1,368,000.\nEarnings per share before extraordinary credit and cumulative effect of accounting change was reduced by $.54, $.08, and $.16 for 1994, 1993 and 1992, respectively. Earnings per share after extraordinary credit and cumulative effect of accounting change and extraordinary credit was reduced by $.54, $.10, and $.28 for 1994, 1993 and 1992, respectively.\n1177 Avenue of the Americas Telephone 212 596 7000 New York, NY 10036 Facsimile 212 596 8910\nPRICE WATERHOUSE LLP\nREPORT OF INDEPENDENT ACCOUNTANTS\nJanuary 25, 1996\nTo the Stockholders and Board of Directors of Hometown Bancorporation, Inc.\nIn our opinion, the accompanying consolidated balance sheet and the related consolidated statements of income, of changes in stockholders' equity and of cash flows, after the restatement discussed in Note 16, present fairly, in all material respects, the financial position of Hometown Bancorporation, Inc. and its subsidiary (the \"Company\") at December 31, 1995 and 1994, and the results of their operations and cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe our audits provide a reasonable basis for the opinion expressed above.\nAs discussed in Note 1 to the Consolidated Financial Statements, the Company changed its method of accounting for investment securities and income taxes in 1993.\nPRICE WATERHOUSE LLP\nItem 9 - Changes in and Diagreements with Accountants on Accounting and Financial Disclosure\nThere is no event reportble under this item, except as has been previously reported (as defined in Rule 12b-2 under the Securities Exchange Act of 1934) in the Company's Current Report on Form 8-K dated March 5, 1996.\nPART III\nITEM 10 - Directors and Executive Officers of the Registrant\nDirectors of the Company.\nThe information required by this item appears under the caption \"Election of Directors\" in the 1996 Proxy. Such information is incorporated by reference and made a part hereof.\nExecutive Officers of the Company\nThe information required by this item apppears in Item 4A hereof.\nItem 11 - Executive Compensation\nThe information required by this item appears under the caption, \"Compensation of Directors and Executive Officers\" in the 1996 Proxy. Such information is incorporated herein by reference and made a part hereof.\nSince the Company qualifies as a \"small business issuer,\" as defined by Item 10 (a)(1) of Regulation S-B, information incorporated by reference to the 1996 Proxy in response to this item contains the disclosure required by paragraphs (b), (c)(1), (c)(2)(i)-(v), (d), (e), (g), (h), (i)(1) and (2) of Item 402 of Regulation S-K.\nItem 12 - Security Ownership of Certain Beneficial Owners and Management\nThe information required by this item appears under the caption \"Voting Securities and Principal Holders\" in the 1996 Proxy. Such information is incorporated herein by reference and made a part hereof.\nItem 13 - Certain Relationships and Related Transactions\nThe information required by this item appears under the caption \"Certain Relationships and Related Transactions\" in the 1996 Proxy. Such information is incorporated herein by reference and made a part hereof.\nItem 14 - Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(a) The following documents are filed as part of this report and appear on the pages indicated:\n(1) Financial Statements: Page in this Form 10-K\nConsolidated Balance Sheet as of December 31, 1995 and 1994 23\nConsolidated Statement of Income for the Years Ended December 31, 1995, 1994 and 1993 24\nConsolidated Statement of Changes in Stockholders' Equity for the Years Ended December 31, 1995, 1994 and 1993 25\nConsolidated Statement of Cash Flows for the Years Ended December 31, 1995, 1994 and 1993 26\nNotes to the Consolidated Financial Statements 27\nReport of Independent Accountants 44\n(2) Financial Statement Schedules\nAll schedules are omitted because they are not applicable.\n(3) Exhibits\nExhibit No. Description\n3.1 The Company's Certificate of Incorporation (incorporated by reference to Exhibit 3(a) the Company's Registration Statement on Form S-4 [Commission File Number 33-13466] filed on June 15, 1987).\n3.2 By-laws of the Company (incorporated by reference to Exhibit 3(b) to the Company's Registration Statement on Form S-4 [Commission File Number 33-13466] filed on June 15, 1987).\n4 Common Shares Rights Agreement dated as of September 20, 1990 (incorporated by reference to Exhibit 4 to the Company's Current Report on Form 8-K dated September 20, 1990 [Commission File Number 0-16272]).\n10.1 Hometown Bancorporation, Inc. 1987 Stock Option Plan (incorporated by reference to Exhibit 10(iii)(A)(b) to the Company's Registration Statement on Form S-4 [Commission File Number 33-13466] filed on June 15, 1987).\n10.2 Hometown Bancorporation, Inc. 1995 Omnibus Stock Incentive Program (incorporated by reference to Exhibit 10(1) to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1995 [Commission File Number 0-16272]).\n10.3 Lease dated as of January 29, 1987 between NJM Realty Limited Partnership and the Bank (incorporated by reference to Exhibit 10(ii)(D)(b) to the Company's Registration Statement on Form S-4 [Commission File Number 33-13466] filed on June 15, 1987).\n10.4 Lease Modification Agreement dated as of May 1, 1995, between NJM Realty Limited Partnership and the Bank (incorporated by reference to Exhibit 10(3) to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1995 [Commission File Number 0-16272]).\n10.5 Lease dated as of June 8, 1989 beetween Old Town Hall, Inc. and the Bank (incorporated by reference to Exhibit 10.4 to the Company's Annual Report on Form 10-K for the year ended December 31, 1989 [Commission File Number 0-16272]).\n10.6 Description of the Bank's Officer Incentive Plan (incorporated by reference to Exhibit 10.5 to the Company's Annual Report on Form 10-K for the year ended December 31, 1989 [Commission File Number 0-16272]).\n10.7 Employment Agreement executed January 2, 1991 between the Bank and Kevin E. Gage, as amended by Amendment No. 1 thereto dated as of November 18, 1993 (incorporated by reference to Exhibit 10.6 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993 [Commission File Number 0-16272]).\n10.8 Amendment No. 2, dated as of June 16, 1995, to Employment Agreement dated as of January 2, 1991 among the Company, the Bank and Kevin E. Gage (incorporated by reference to Exhibit 10(2) to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1995 [Commission File Number 0-16272]).\n11 Statement of Computation of Earnings Per Share.\n21 Subsidiaries of the Company (incorporated by reference to Exhibit 21 to the Company's Annual Reporton Form 10-K for the year ended December 31, 1993 [Commission File Number 0-16272]).\n23 Consent of Independent Accountants.\n24 Powers of Attorney\n27 Financial Data Schedule.\nSignatures\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nHometown Bancorporation, Inc.\nBy: \/s\/ Kevin E. Gage -------------------------------------- Kevin E. Gage President and Chief Executive Officer\nDated: March 29, 1996\nPursuant to the requirements of the Securities Exchange Act 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.\nName Title - ---- -----\nDouglas D. Milne, III Chairman of the Board ) and Director ) ) Kevin E. Gage President and Chief ) Executive Officer and ) Director ) ) Richard A. Allen Director ) ) Louis T. Hagopian Director ) ) Arnold H. Libner Director ) By \/s\/ Kevin E. Gage ) ------------------ ) Kevin E. Gage Joseph G. McIntyre, Jr. Director ) Attorney-in-Fact ) Robert O. White Director ) March 29, 1995 ) Albert T. Jaronczyk Senior Vice President ) and Chief Financial ) Officer (Principal ) Accounting Officer) )\nExhibit Index\nExhibit No. Description - ----------- -----------\n3.1 The Company's Certificate of Incorporation (incorporated by reference to Exhibit 3(a) the Company's Registration Statement on Form S-4 [Commission File Number 33-13466] filed on June 15, 1987).\n3.2 By-laws of the Company (incorporated by reference to Exhibit 3(b) to the Company's Registration Statement on Form S-4 [Commission File Number 33-13466] filed on June 15, 1987).\n4 Common Shares Rights Agreement dated as of September 20, 1990 (incorporated by reference to Exhibit 4 to the Company's Current Report on Form 8-K dated September 20, 1990 [Commission File Number 0-16272]).\n10.1 Hometown Bancorporation, Inc. 1987 Stock Option Plan (incorporated by reference to Exhibit 10(iii)(A)(b) to the Company's Registration Statement on Form S-4 [Commission File Number 33-13466] filed on June 15, 1987).\n10.2 Hometown Bancorporation, Inc. 1995 Omnibus Stock Incentive Program (incorporated by reference to Exhibit 10(1) to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1995 [Commission File Number 0-16272]).\n10.3 Lease dated as of January 29, 1987 between NJM Realty Limited Partnership and the Bank (incorporated by reference to Exhibit 10(ii)(D)(b) to the Company's Registration Statement on Form S-4 [Commission File Number 33-13466] filed on June 15, 1987).\n10.4 Lease Modification Agreement dated as of May 1, 1995, between NJM Realty Limited Partnership and the Bank (incorporated by reference to Exhibit 10(3) to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1995 [Commission File Number 0-16272]).\n10.5 Lease dated as of June 8, 1989 beetween Old Town Hall, Inc. and the Bank (incorporated by reference to Exhibit 10.4 to the Company's Annual Report on Form 10-K for the year ended December 31, 1989 [Commission File Number 0-16272]).\n10.6 Description of the Bank's Officer Incentive Plan (incorporated by reference to Exhibit 10.5 to the Company's Annual Report on Form 10-K for the year ended December 31, 1989 [Commission File Number 0-16272]).\n10.7 Employment Agreement executed January 2, 1991 between the Bank and Kevin E. Gage, as amended by Amendment No. 1 thereto dated as of November 18, 1993 (incorporated by reference to Exhibit 10.6 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993 [Commission File Number 0-16272]).\n10.8 Amendment No. 2, dated as of June 16, 1995, to Employment Agreement dated as of January 2, 1991 among the Company, the Bank and Kevin E. Gage (incorporated by reference to Exhibit 10(2) to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1995 [Commission File Number 0-16272]).\n11 Statement of Computation of Earnings Per Share.\n21 Subsidiaries of the Company (incorporated by reference to Exhibit 21 to the Company's Annual Reporton Form 10-K for the year ended December 31, 1993 [Commission File Number 0-16272]).\n23 Consent of Independent Accountants.\n24 Powers of Attorney\n27 Financial Data Schedule.","section_7A":"","section_8":"","section_9":"Item 9 - Changes in and Diagreements with Accountants on Accounting and Financial Disclosure\nThere is no event reportble under this item, except as has been previously reported (as defined in Rule 12b-2 under the Securities Exchange Act of 1934) in the Company's Current Report on Form 8-K dated March 5, 1996.\nPART III\nITEM 10","section_9A":"","section_9B":"","section_10":"ITEM 10 - Directors and Executive Officers of the Registrant\nDirectors of the Company.\nThe information required by this item appears under the caption \"Election of Directors\" in the 1996 Proxy. Such information is incorporated by reference and made a part hereof.\nExecutive Officers of the Company\nThe information required by this item apppears in Item 4A hereof.\nItem 11","section_11":"Item 11 - Executive Compensation\nThe information required by this item appears under the caption, \"Compensation of Directors and Executive Officers\" in the 1996 Proxy. Such information is incorporated herein by reference and made a part hereof.\nSince the Company qualifies as a \"small business issuer,\" as defined by Item 10 (a)(1) of Regulation S-B, information incorporated by reference to the 1996 Proxy in response to this item contains the disclosure required by paragraphs (b), (c)(1), (c)(2)(i)-(v), (d), (e), (g), (h), (i)(1) and (2) of Item 402 of Regulation S-K.\nItem 12","section_12":"Item 12 - Security Ownership of Certain Beneficial Owners and Management\nThe information required by this item appears under the caption \"Voting Securities and Principal Holders\" in the 1996 Proxy. Such information is incorporated herein by reference and made a part hereof.\nItem 13","section_13":"Item 13 - Certain Relationships and Related Transactions\nThe information required by this item appears under the caption \"Certain Relationships and Related Transactions\" in the 1996 Proxy. Such information is incorporated herein by reference and made a part hereof.\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 and appear on the pages indicated:\n(1) Financial Statements: Page in this Form 10-K\nConsolidated Balance Sheet as of December 31, 1995 and 1994 23\nConsolidated Statement of Income for the Years Ended December 31, 1995, 1994 and 1993 24\nConsolidated Statement of Changes in Stockholders' Equity for the Years Ended December 31, 1995, 1994 and 1993 25\nConsolidated Statement of Cash Flows for the Years Ended December 31, 1995, 1994 and 1993 26\nNotes to the Consolidated Financial Statements 27\nReport of Independent Accountants 44\n(2) Financial Statement Schedules\nAll schedules are omitted because they are not applicable.\n(3) Exhibits\nExhibit No. Description\n3.1 The Company's Certificate of Incorporation (incorporated by reference to Exhibit 3(a) the Company's Registration Statement on Form S-4 [Commission File Number 33-13466] filed on June 15, 1987).\n3.2 By-laws of the Company (incorporated by reference to Exhibit 3(b) to the Company's Registration Statement on Form S-4 [Commission File Number 33-13466] filed on June 15, 1987).\n4 Common Shares Rights Agreement dated as of September 20, 1990 (incorporated by reference to Exhibit 4 to the Company's Current Report on Form 8-K dated September 20, 1990 [Commission File Number 0-16272]).\n10.1 Hometown Bancorporation, Inc. 1987 Stock Option Plan (incorporated by reference to Exhibit 10(iii)(A)(b) to the Company's Registration Statement on Form S-4 [Commission File Number 33-13466] filed on June 15, 1987).\n10.2 Hometown Bancorporation, Inc. 1995 Omnibus Stock Incentive Program (incorporated by reference to Exhibit 10(1) to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1995 [Commission File Number 0-16272]).\n10.3 Lease dated as of January 29, 1987 between NJM Realty Limited Partnership and the Bank (incorporated by reference to Exhibit 10(ii)(D)(b) to the Company's Registration Statement on Form S-4 [Commission File Number 33-13466] filed on June 15, 1987).\n10.4 Lease Modification Agreement dated as of May 1, 1995, between NJM Realty Limited Partnership and the Bank (incorporated by reference to Exhibit 10(3) to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1995 [Commission File Number 0-16272]).\n10.5 Lease dated as of June 8, 1989 beetween Old Town Hall, Inc. and the Bank (incorporated by reference to Exhibit 10.4 to the Company's Annual Report on Form 10-K for the year ended December 31, 1989 [Commission File Number 0-16272]).\n10.6 Description of the Bank's Officer Incentive Plan (incorporated by reference to Exhibit 10.5 to the Company's Annual Report on Form 10-K for the year ended December 31, 1989 [Commission File Number 0-16272]).\n10.7 Employment Agreement executed January 2, 1991 between the Bank and Kevin E. Gage, as amended by Amendment No. 1 thereto dated as of November 18, 1993 (incorporated by reference to Exhibit 10.6 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993 [Commission File Number 0-16272]).\n10.8 Amendment No. 2, dated as of June 16, 1995, to Employment Agreement dated as of January 2, 1991 among the Company, the Bank and Kevin E. Gage (incorporated by reference to Exhibit 10(2) to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1995 [Commission File Number 0-16272]).\n11 Statement of Computation of Earnings Per Share.\n21 Subsidiaries of the Company (incorporated by reference to Exhibit 21 to the Company's Annual Reporton Form 10-K for the year ended December 31, 1993 [Commission File Number 0-16272]).\n23 Consent of Independent Accountants.\n24 Powers of Attorney\n27 Financial Data Schedule.\nSignatures\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nHometown Bancorporation, Inc.\nBy: \/s\/ Kevin E. Gage -------------------------------------- Kevin E. Gage President and Chief Executive Officer\nDated: March 29, 1996\nPursuant to the requirements of the Securities Exchange Act 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.\nName Title - ---- -----\nDouglas D. Milne, III Chairman of the Board ) and Director ) ) Kevin E. Gage President and Chief ) Executive Officer and ) Director ) ) Richard A. Allen Director ) ) Louis T. Hagopian Director ) ) Arnold H. Libner Director ) By \/s\/ Kevin E. Gage ) ------------------ ) Kevin E. Gage Joseph G. McIntyre, Jr. Director ) Attorney-in-Fact ) Robert O. White Director ) March 29, 1995 ) Albert T. Jaronczyk Senior Vice President ) and Chief Financial ) Officer (Principal ) Accounting Officer) )\nExhibit Index\nExhibit No. Description - ----------- -----------\n3.1 The Company's Certificate of Incorporation (incorporated by reference to Exhibit 3(a) the Company's Registration Statement on Form S-4 [Commission File Number 33-13466] filed on June 15, 1987).\n3.2 By-laws of the Company (incorporated by reference to Exhibit 3(b) to the Company's Registration Statement on Form S-4 [Commission File Number 33-13466] filed on June 15, 1987).\n4 Common Shares Rights Agreement dated as of September 20, 1990 (incorporated by reference to Exhibit 4 to the Company's Current Report on Form 8-K dated September 20, 1990 [Commission File Number 0-16272]).\n10.1 Hometown Bancorporation, Inc. 1987 Stock Option Plan (incorporated by reference to Exhibit 10(iii)(A)(b) to the Company's Registration Statement on Form S-4 [Commission File Number 33-13466] filed on June 15, 1987).\n10.2 Hometown Bancorporation, Inc. 1995 Omnibus Stock Incentive Program (incorporated by reference to Exhibit 10(1) to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1995 [Commission File Number 0-16272]).\n10.3 Lease dated as of January 29, 1987 between NJM Realty Limited Partnership and the Bank (incorporated by reference to Exhibit 10(ii)(D)(b) to the Company's Registration Statement on Form S-4 [Commission File Number 33-13466] filed on June 15, 1987).\n10.4 Lease Modification Agreement dated as of May 1, 1995, between NJM Realty Limited Partnership and the Bank (incorporated by reference to Exhibit 10(3) to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1995 [Commission File Number 0-16272]).\n10.5 Lease dated as of June 8, 1989 beetween Old Town Hall, Inc. and the Bank (incorporated by reference to Exhibit 10.4 to the Company's Annual Report on Form 10-K for the year ended December 31, 1989 [Commission File Number 0-16272]).\n10.6 Description of the Bank's Officer Incentive Plan (incorporated by reference to Exhibit 10.5 to the Company's Annual Report on Form 10-K for the year ended December 31, 1989 [Commission File Number 0-16272]).\n10.7 Employment Agreement executed January 2, 1991 between the Bank and Kevin E. Gage, as amended by Amendment No. 1 thereto dated as of November 18, 1993 (incorporated by reference to Exhibit 10.6 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993 [Commission File Number 0-16272]).\n10.8 Amendment No. 2, dated as of June 16, 1995, to Employment Agreement dated as of January 2, 1991 among the Company, the Bank and Kevin E. Gage (incorporated by reference to Exhibit 10(2) to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1995 [Commission File Number 0-16272]).\n11 Statement of Computation of Earnings Per Share.\n21 Subsidiaries of the Company (incorporated by reference to Exhibit 21 to the Company's Annual Reporton Form 10-K for the year ended December 31, 1993 [Commission File Number 0-16272]).\n23 Consent of Independent Accountants.\n24 Powers of Attorney\n27 Financial Data Schedule.","section_15":""}
{"filename":"51434_1995.txt","cik":"51434","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nInternational Paper Company,* a New York corporation incorporated in 1941 as the successor to the New York corporation of the same name organized in 1898, is a worldwide producer of printing and writing papers, paperboard and packaging and wood products; and distributes paper and office supply products in the United States, Europe and the Pacific Rim. It also produces pulp, laminated products, and specialty products, including photosensitive films and papers, nonwovens, chemicals and minerals.\nIn the United States, the Company operates 24 pulp and paper mills, 52 converting and packaging plants, 29 wood products facilities, 15 specialty panels and laminated products plants and six nonwoven products facilities. Production facilities in Europe, Asia, Latin America and Canada include 14 pulp and paper mills, 30 converting and packaging plants, two wood products facilities, four specialty panels and laminated products plants and four nonwoven products facilities.\nThe Company distributes fine paper, printing and industrial products and building materials, primarily manufactured by other companies, through over 300 distribution branches located primarily in the United States. In addition, the Company produces photosensitive films and papers and photographic equipment (three U.S. and six international locations) and specialty chemicals (seven U.S. and three international locations), and engages in domestic oil and gas and real estate activities.\nThrough its acquisition of Carter Holt Harvey, the Company, primarily in New Zealand and Australia, operates seven mills producing pulp and paper, packaging and tissue products, 32 converting and packaging facilities, 49 wood products manufacturing and distribution facilities, and nine building products plants. Carter Holt Harvey distributes paper and packaging products through 18 distribution branches located in New Zealand and Australia. In New Zealand, Carter Holt Harvey controls approximately 800,000 acres of forestlands.\nIn January 1995, the Company acquired the assets of two Michigan-based paper distributors, Carpenter Paper Company and Seaman-Patrick Paper Company. In March 1994, the Company, through a subsidiary, acquired from Brierley Investments Limited (Brierley) an additional 8 percent interest in Carter Holt Harvey Limited (Carter Holt Harvey), a major New Zealand forest and paper products company with substantial assets in Chile. The purchase increased the Company's ownership of Carter Holt Harvey to 24 percent. In April 1995, the Company acquired from Brierley their remaining 131.8 million shares of Carter Holt Harvey for NZ$470 million (approximately $316 million). Further in April 1995, an additional 325.8 million Carter Holt Harvey shares were acquired by the Company through a subsidiary in open-market purchases for NZ$3.80 per share (approximately $834 million) bringing the Company's total ownership in Carter Holt Harvey to 50.2% on a fully diluted basis. Beginning May 1, 1995, Carter Holt Harvey was consolidated in the financial statements of the Company. The Company in September 1995, acquired Micarta, the high pressure laminates business of Westinghouse located in Hampton, South Carolina and in October 1995, acquired the inks and adhesives resin business of DSM located in Niort, France.\nIn July 1994, the Company, through a subsidiary, acquired certain assets of Papelera Kif and Ogi Papel, distributors of printing papers in Juarez and Chihuahua, Mexico. In December 1994, the Company completed a merger with Kirk Paper Corporation, a paper distributor located in Downey, California using the pooling-of-interests accounting method, and acquired additional stock of Zanders Feinpapiere AG.\nIn April 1993, the Company acquired certain assets of the Los Angeles-based Ingram Paper Company, a distributor of industrial and fine printing papers. In December, J.B. Papers, Inc., a paper distribution company located in Union, N.J., was purchased. Also in December, the assets of Monsanto Company's Kentucky-based Fome-Cor division, a manufacturer of polystyrene foam products, were acquired.\nAll of the 1995, 1994 and 1993 acquisitions, except the merger with Kirk Paper Corporation, were accounted for using the purchase method. The pro-forma consolidated results of operations reflecting the 1995 acquisitions are presented on page 58 of the Company's 1995 Annual Report to Shareholders (the \"Annual Report\"), which information is incorporated herein by reference. The effects of the 1994 and 1993 mergers and acquisitions, both individually and in the aggregate, were not significant to the Company's consolidated financial statements.\nA further discussion of mergers and acquisitions can be found on pages 44, 57 and 58 of the Company's Annual Report, which information is incorporated herein by reference.\n- ------------------ * Unless otherwise indicated by the context, the terms 'Company' and 'International Paper' are used interchangeably to describe International Paper Company and its consolidated subsidiaries.\nFrom 1991 through 1995, International Paper's capital expenditures approximated $6.2 billion, excluding mergers and acquisitions. These expenditures reflect continuing efforts to improve product quality and environmental performance, lower costs, expand production capacity, and acquire and improve forestlands. Capital spending in 1995 was approximately $1.5 billion and is budgeted to be approximately $1.4 billion in 1996. A further discussion of capital expenditures can be found on pages 44 and 45 of the Annual Report, which information is incorporated herein by reference.\nThe Company, which owns a majority interest in IP Timberlands, Ltd., a Texas limited partnership (IPT), controlled approximately 6.0 million acres of forestlands in the United States at December 31, 1995. IPT was formed to succeed to substantially all of International Paper's forest products business for the period 1985 through 2035, unless earlier terminated. Through its subsidiary Carter Holt Harvey, the Company controls approximately 800,000 acres of forestlands in New Zealand.\nIn March 1996, IPT signed a contract to sell a 98% general partnership interest in a subsidiary partnership owning all of IPT's Western region assets, which includes approximately 300,000 acres of forestlands in Oregon and Washington. IPT will retain a 1% limited partner's interest and a preferred interest of approximately $135 million. IP Forest Resources Company, the managing general partner of IPT will own another 1% interest.\nIn March 1996, the Company completed its announced merger with Federal Paper Board. For a further discussion of this merger, see pages 44 and 58 of the Company's Annual Report, which information is incorporated herein by reference.\nFINANCIAL INFORMATION CONCERNING INDUSTRY SEGMENTS\nThe financial information concerning industry segments is set forth on pages 10, 18, 24, 34, 40, 45 and 50 of the Annual Report, which information is incorporated herein by reference.\nFINANCIAL INFORMATION ABOUT INTERNATIONAL AND DOMESTIC OPERATIONS\nThe financial information concerning international and domestic operations and export sales is set forth on page 49 of the Annual Report, which information is incorporated herein by reference.\nCOMPETITION AND COSTS\nDespite the size of the Company's manufacturing capacities for paper, paperboard, packaging and pulp products, the markets in all of the cited product lines are large and highly fragmented. The markets for wood and specialty products are similarly large and fragmented. There are numerous competitors, and the major markets, both domestic and international, in which the Company sells its principal products are very competitive. These products are in competition with similar products produced by others, and in some instances, with products produced by other industries from other materials.\nMany factors influence the Company's competitive position, including prices, costs, product quality and services. Information on the impact of prices and costs on operating profits is contained on pages 10, 18, 24, 34, 40 and 44 through 48 of the Annual Report, which information is incorporated herein by reference.\nMARKETING AND DISTRIBUTION\nPaper and packaging products are sold through the Company's own sales organization directly to users or converters for manufacture. Sales offices are located throughout the United States as well as internationally. Significant volumes of products are also sold through paper merchants and distributors, including facilities in the Company's distribution network.\nThe Company's U.S. production of lumber and plywood is marketed through independent and Company-owned distribution centers. Specialty products are marketed through various channels of distribution.\nDESCRIPTION OF PRINCIPAL PRODUCTS\nThe Company's principal products are described on pages 5 through 41 of the Annual Report, which information is incorporated herein by reference.\nProduction of major products for 1995, 1994 and 1993 was as follows:\nPRODUCTION BY PRODUCTS (UNAUDITED)\n- ------------------ (1) This excludes market pulp purchases of approximately 700,000 tons annually. (2) A significant portion of this tonnage was fabricated from paperboard and paper produced at the Company's own mills and included in the containerboard, bleached packaging board and industrial papers figures in this table. (3) Panels include plywood and oriented strand board. (4) Includes amounts for Carter Holt Harvey as applicable from May 1, 1995. (5) Certain reclassifications and adjustments have been made to current and prior-year amounts.\nRESEARCH AND DEVELOPMENT\nThe Company operates research and development centers at Sterling Forest, New York; Mobile, Alabama; Erie, Pennsylvania; Kaukauna, Wisconsin; Binghamton, New York; South Walpole, Massachusetts; St. Charles, Illinois; Orange Park, Florida; Holyoke, Massachusetts; Odenton, Maryland; Mobberley, United Kingdom; Morley, United Kingdom; Munich, Germany; Fribourg, Switzerland; Saint-Priest, France; Annecy, France; a regional center for applied forest research in Bainbridge, Georgia; a forest biotechnology center in Rotorua, New Zealand; and several product laboratories. Research and development activities are directed to short-term, long-term and technical assistance needs of customers and operating divisions; process, equipment and product innovations; and improvement of profits through tree generation and propagation research. Activities include studies on improved forest species and management; innovation and improvement of pulping, bleaching, chemical recovery, papermaking and coating processes; innovation and improvement of photographic materials and processes, printing plates, pressroom\/plate chemistries and plate processors; reduction of environmental discharges; re-use of raw materials in manufacturing processes; recycling of consumer and packaging paper products; energy conservation; applications of computer controls to manufacturing operations; innovations and improvement of products; and development of various new products. Product development efforts specifically address product safety as well as the minimization of solid waste. The cost to the Company of its research and development operations was $110.8 million in 1995, $102.6 million in 1994 and $94.7 million in 1993.\nENVIRONMENTAL PROTECTION\nControl over pollutants discharged into the air, water and groundwater to avoid significant adverse impacts on the environment and achieve 100% compliance with applicable law and regulations is a continuing objective of the Company. The Company has invested substantial funds to modify facilities to assure compliance with applicable environmental quality laws and plans to make substantial capital expenditures for these purposes in the future. The Company expects the pending merger with Federal to increase environmental expenditures. The amount of these expenditures will be determined after the merger is completed. The discussions in the following paragraphs are based on International Paper facilities at the end of 1995.\nA total of $108 million was spent in 1995 to control pollutant releases into the air and water and to assure environmentally sound disposal of solid and hazardous waste. The Company expects to spend approximately $175 million in 1996 for similar capital programs. Amounts to be spent for environmental control facilities in future years will depend on new laws and regulations, changes in legal requirements and changes in environmental concerns. Taking these uncertainties into account, the Company's preliminary estimate for additional environmental appropriations during the period 1997 through 1998 is in the range of $390 million to $650 million.\nIn December 1993, the United States Environmental Protection Agency (EPA) proposed new pulp and paper mill standards for air emissions and water discharges to be met three years after final promulgation. This proposal is known as 'Cluster Rulemaking.' EPA also promulgated regulations implementing the Great Lakes Initiative ('GLI') covering water quality and permitting implementation procedures. Future spending will be heavily influenced by the final Cluster rules and, in the case of the GLI, on how the individual Great Lakes states implement the program. In 1994, the Company estimated future capital spending to comply with the Cluster Rulemaking and the GLI to be between $700 million and $1.5 billion depending upon the methods and deadlines allowed by the final regulations to meet requirements. There have been extensive discussions with the Congress and EPA over the last two years but, there have been no publicly announced changes to the proposed 'Cluster' regulations. Nevertheless, there is reason to expect that changes will soon be announced and that these estimates will be adjusted downward, and will occur over a longer time frame than the three years in the current proposal. In 1994, the Company estimated that annual operating costs, excluding depreciation, would increase between $60 million and $120 million when these regulations are fully implemented. This estimate will also be adjusted to the extent the EPA makes moderating changes.\nThe Company expects the significant effort it has made in the analysis of environmental issues and the development of environmental control technology to enable it to keep costs for compliance with environmental regulations at, or below, industry averages.\nA further discussion of environmental issues can be found on pages 43, 47 and 48 of the Annual Report, which information is incorporated herein by reference.\nAs of December 31, 1995, $916 million of industrial and pollution control revenue bonds, secured by Company contractual obligations, were outstanding in 57 political subdivisions of various states, counties and municipalities, primarily to finance environmental control projects located at or in conjunction with the Company's plants in those subdivisions. It is contemplated that additional industrial revenue bonds will be issued from time to time to finance other environmental control projects, provided tax law changes do not curtail the Company's access to the municipal bond market.\nEMPLOYEES\nAs of December 31, 1995, the Company had approximately 81,500 employees, of whom approximately 51,000 were located in the United States and the remainder overseas. Of the domestic employees, approximately 33,000 are hourly employees, approximately 15,000 of whom are represented by the United Paperworkers International Union.\nDuring 1995, new labor agreements were reached at the Erie and Georgetown Mills. Currently, negotiations are still in progress at the Hudson River Mill.\nDuring 1996, labor agreements are scheduled to be negotiated at the following mills: Gardiner, Pineville, Texarkana, Thilmany, Ticonderoga and Woronoco. During 1997, labor agreements are scheduled to be negotiated at the following mills: Mobile, Riverdale, Oswego, Millers Falls, and Vicksburg.\nDuring 1995, labor agreements expired at 11 packaging plants, four specialty products plants and four distribution operations. Multi-year labor agreements were negotiated at each location except three packaging plants, one specialty products plant and two distribution operations where negotiations were still in progress at year end. One land and timber operation has a contract open from a previous year.\nRAW MATERIALS\nFor information as to the sources and availability of raw materials essential to the Company's business, see Item 2","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nFORESTLANDS\nThe principal raw material used by International Paper is wood in various forms. At December 31, 1995, IPT, a limited partnership in which the Company has a majority ownership interest, controlled approximately 5.9 million acres of forestlands in the U.S. while an additional 0.1 million acres are held under short-term leases to International Paper. In March 1996, IPT signed a contract to sell a 98% general partnership interest in a subsidiary partnership owning all of IPT's Western region assets, which includes approximately 300,000 acres of forestlands in Oregon and Washington.\nDuring 1995, such forestlands supplied 1.5 million cords of roundwood to the Company's U.S. facilities. This amounted to the following percentages of the roundwood requirements of its mills and forest products facilities: 12% in its Northern mills, 16% in its Southern mills and none in its Western mill. The balance was acquired from other private industrial and nonindustrial forestland owners, as well as the United States government. In addition, 3.4 million cords of IPT's wood were sold to other users in 1995.\nIn November 1994, the Company adopted the Sustainable Forestry Principles developed by the American Forest and Paper Association in August 1994.\nMILLS AND PLANTS\nA listing of the Company's production facilities can be found in Appendix I hereto, which information is incorporated herein by reference.\nThe Company's facilities are in good operating condition and are suited for the purposes for which they are presently being used. The Company continues to study the economics of modernizing or adopting other alternatives for higher cost facilities. Further discussions of new mill and plant projects can be found on pages 44 and 45 of the Annual Report, which information is incorporated herein by reference.\nCAPITAL INVESTMENTS AND DISPOSITIONS\nGiven the size, scope and complexity of its business interests, International Paper continuously examines and evaluates a wide variety of business opportunities and planning alternatives, including possible acquisitions and sales or other dispositions of properties. Planned capital investments for 1996, as of December 31, 1995, are set forth on pages 44 through 46 and 58 of the Annual Report, which information is incorporated herein by reference.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nDIOXIN LITIGATION\nOn June 11, 1993, a lawsuit purporting to be a class action was filed by individuals against the Company, Dow Chemical and individual employees of both companies in the 18th Judicial District of Louisiana seeking compensatory and punitive damages of an unspecified amount, alleging that the Company polluted Staulkinghead Creek and all waterways south thereof, by discharging chemicals, including dioxin, from its Bastrop, Louisiana mill. The case was removed to the U.S. District Court for the Middle District of Louisiana. On June 22, 1994, the Court entered an order dismissing Dow and its employees from the case. The Plaintiff appealed this ruling challenging among other things federal jurisdiction. The Fifth Circuit Court of Appeals ruled in favor of the defendants on all issues and returned the case to the Federal District Court. The case is still before that court for the determination of class certification.\nBeginning in November of 1990, the Company was named as a defendant in 88 lawsuits by individuals filed in state or federal court in Mississippi alleging that it has polluted and damaged the Pascagoula, Leaf and\nEscatawpa Rivers by releasing dioxin and over 40 other chemicals into those rivers. Georgia-Pacific was initially named in most of these suits but an order severing it from the Company in all the then pending cases was entered on September 15, 1992. Following the severance order, nine of the state cases were removed from state court to Federal District Court for the Southern District of Mississippi. Of the nine cases that were removed four were dismissed and the remaining five were resolved by summary judgments in favor of the Company.\nOn May 24, 1993, a wrongful death action was filed in Mississippi state court against the Company claiming the decedent's death was related to exposure to hazardous and toxic substances from the Moss Point mill. The lawsuit also included the independent survivorship claims of the widow. The complaint raised claims similar to those in the previously-filed lawsuits and also contained specific allegations relating to the disposal of sludge by the mill. The plaintiff sought compensatory damages of $1 million and punitive damages of $20 million. The case was removed to the U.S. District Court for the Southern District of Mississippi. In August of 1995 the federal court granted the Company's motion for summary judgment and this case is now concluded.\nAll of the 64 cases that had been pending in the Mississippi state court had been consolidated before one judge. Pursuant to a scheduling order a bellwhether trial with six plaintiffs was set for trial in November, 1995. However, prior to trial, the court granted the Company's motions for summary judgment against those specific plaintiffs. Thereafter the Company filed similar motions for summary judgment in some of the remaining cases. These motions were granted on March 4, 1996, resulting in the dismissal of 29 cases and 3,094 plaintiffs. The Company has filed or will file similar motions in all the remaining cases.\nIn summary, taking into account various dismissals, there are 36 cases pending in state court and none in Federal Court for a total of 36 Mississippi cases as of March 5, 1996. In these cases, there are a total of 1,981 plaintiffs seeking compensatory and punitive damages and injunctive relief. While any of this litigation has an element of uncertainty, the Company believes that in the very near future it will prevail on its motions for summary judgment, thereby eliminating all the remaining cases. The Company further believes that the outcome of any of these proceedings, lawsuits or claims, pending or threatened, or all of them combined, will not have a materially adverse effect on the consolidated financial position or results of operations.\nOTHER LITIGATION\nOn October 14, 1993, the Town of Jay, Maine assessed a penalty of $394,000 against the Company's Androscoggin mill for violations of its air permit under the Town's Environmental Control and Improvement Ordinance attributable to excess emissions of particulate from one of the mill's lime kilns, as well as violations of certain reporting requirements. The Town's penalty assessment was appealed. On September 28, 1994, the Maine Superior Court vacated most of the penalty the Town had assessed, leaving $22,000 in place but providing the Town with the opportunity to reassess the penalty on four violations. The Town appealed this decision to the Maine Supreme Judicial Court, the State's highest court, sitting as the Law Court. By decision, dated October 6, 1995, the Law Court affirmed the decision of the Superior Court. On October 20, 1995, the Town asked the Law Court to reconsider its decision. On November 10, 1995, the Law Court denied the Town's request.\nThe Maine Department of Environmental Protection proposed on October 15, 1992 that the Androscoggin mill enter into an Administrative Consent Agreement and Enforcement Order and pay a civil penalty of $217,892 because the particulate emissions from the same lime kiln which was the subject of the foregoing proceeding with the Town of Jay, had exceeded the limits in the state air license. On March 9, 1994, the State commenced an action in the Maine Superior Court but no specific amount is claimed in the complaint. With the conclusion of the litigation with the Town of Jay, settlement discussions with the State have resumed.\nOn September 26, 1994, the EPA issued a Complaint and Compliance Order alleging that a facility in Gulfport, Mississippi owned and operated by Arizona Chemical Company ('Arizona'), wholly owned subsidiary of the Company, violated regulations governing the burning of hazardous waste fuel in an industrial boiler. The Complaint sought a civil penalty of $712,350. On September 29, 1995, Arizona settled the matter on terms which included a civil penalty of $442,150.\nThe United States Attorney's Office for the Southern District of Mississippi and EPA Region IV, are investigating Arizona through a Federal Grand Jury. Arizona has been informed that it is a target of the investigation, which relates to environmental issues at Arizona facilities in Gulfport and Picayune, Mississippi. Arizona is cooperating with the investigation. EPA criminal investigators have interviewed some of Arizona's current and former employees with respect to the foregoing matters and several have testified before the Federal Grand Jury. The Company and Arizona have also received Federal Grand Jury subpoenas seeking production of documents relating to these matters, and have complied with the subpoenas. We are unable to predict the outcome of the investigation.\nThe Company's majority owned subsidiary, Carter Holt Harvey has an indirect shareholding of 30.05% in Chile's largest industrial company, Copec. This shareholding is held through Carter Holt Harvey's joint venture in Los Andes with Inversiones Socoroma S.A., a Chilean investment company ('Socoroma'). In late 1993, Carter Holt Harvey commenced several actions in Chilean courts challenging certain corporate governance documents of Los Andes, as well as agreements between Carter Holt Harvey's subsidiary and Socoroma. In December 1994, Socoroma commenced an arbitration action seeking to expel Carter Holt Harvey from Los Andes at a price which is less than the carrying value. Although the Company believes that the eventual resolution of this Carter Holt Harvey litigation should not have a material adverse effect on the Company, the actual resolution of each of these actions cannot be predicted because of the uncertainties involved in the litigation and arbitration proceedings.\nIn 1989, Masonite Corporation, a wholly-owned subsidiary of the Company ('Masonite'), modified a production line to make a new product at a facility in Ukiah, California. The facility obtained the necessary Authority to Construct permits from the appropriate State authority. In May 1992 the EPA, Region 9, issued an order alleging that an additional Prevention of Significant Deterioration permit was required for the new product line. On January 18, 1995, a consent decree which resolves this matter was lodged with the U.S. District Court for the Northern District of California. The consent decree includes a civil penalty of $600,000. The consent decree was challenged by a citizen's group and the decree has not yet been entered by the court.\nA lawsuit purporting to be a nationwide class action was filed against the Company and Masonite, on December 27, 1994 in Mobile County Circuit Court, Mobile, Alabama. This lawsuit alleges that hardboard siding, which is used as exterior cladding for residential dwellings and is manufactured by Masonite, fails prematurely, allowing moisture intrusion. It is further alleged that the presence of moisture in turn causes the failure of the structure underneath the siding. The class, which has been certified, consists of all owners of homes in the United States having Masonite hardboard siding. It is impossible to know how many homes may have this siding, but it is estimated that there are hundreds of thousands. The Company and Masonite were unsuccessful in their attempt to remove the case to the Federal District Court for the Southern District of Alabama on diversity grounds. The case has been remanded to the Mobile County Circuit Court. The Company and Masonite feel that there are valid defenses to this case and will vigorously defend all claims asserted by the Plaintiff. While any litigation has an element of uncertainty it is believed that the outcome of these proceedings and lawsuit will not have a materially adverse effect on its consolidated financial position or results of operations.\nAs of March 30, 1996, there were no other pending judicial proceedings, brought by governmental authorities against the Company, for alleged violations of applicable environmental laws or regulations. The Company is engaged in various administrative proceedings that arise under applicable environmental and safety laws or regulations, including approximately 68 active proceedings under the Comprehensive Environmental Response, Compensation and Liability Act ('CERCLA') and comparable state laws. Most of these proceedings involve the cleanup of hazardous substances at large commercial landfills that received waste from many different sources. While joint and several liability is authorized under the CERCLA, as a practical matter, liability for CERCLA cleanups is allocated among the many potential responsible parties. Based upon previous experience with respect to the cleanup of hazardous substances and upon presently available information, the Company believes that it has no or de minimus liability with respect to 26 of these sites; that liability is not likely to be significant at 26 sites; and that estimates of liability at 16 of these sites is likely to be significant but not material to the Company's consolidated financial position or results of operations.\nThe Company is also involved in other contractual disputes, administrative and legal proceedings and investigations of various types. While any litigation, proceeding or investigation has an element of uncertainty, the Company believes that the outcome of any proceeding, lawsuit or claim that is pending or threatened, or all of them combined, will not have a materially adverse effect on its consolidated financial position or results of operations.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNo matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended December 31, 1995.\nSPECIAL ITEM. EXECUTIVE OFFICERS OF THE COMPANY.\nINTERNATIONAL PAPER COMPANY EXECUTIVE OFFICERS AS OF FEBRUARY 29, 1996\nINCLUDING NAME, AGE, OFFICES AND POSITIONS HELD(1) AND BUSINESS EXPERIENCE DURING THE PAST FIVE YEARS\nJOHN A. GEORGES, 65, chief executive officer and chairman of the board of directors of the Company since 1985(2).\nJOHN T. DILLON, 57, president and chief operating officer(3). He was executive vice president-packaging since 1987, until he assumed his current position in 1995.\nW. MICHAEL AMICK, 55, executive vice president, forest products and industrial packaging. He was vice president and group executive-specialty industrial papers from 1988 to 1992, when he became president-International Paper-Europe. He assumed his current position in February 1996.\nJAMES P. MELICAN, 55, executive vice president-legal and external affairs. He assumed his current position in 1991.\nDAVID W. OSKIN, 53, executive vice president-consumer packaging and specialty industrial papers since 1995. He held the position of senior vice president from 1988 to 1992, when he became the chief executive officer and managing director of Carter Holt Harvey Limited of New Zealand until his current position.\nC. WESLEY SMITH, 56, executive vice president-printing papers. He was elected president-International Paper Europe in 1989 and assumed his present position in 1992.\nMILAN J. TURK, 57, executive vice president-specialty businesses. He was vice president and group executive-specialty products from 1990 until 1993, when he became senior vice president-specialty products. He assumed his current position in February, 1996.\nROBERT M. BYRNES, 58, senior vice president-human resources since 1989.\nMARIANNE M. PARRS, 51, senior vice president and chief financial officer since 1995. She was controller-printing papers from 1985 to 1993 and then held the position of staff vice president-tax until 1995.\nANDREW R. LESSIN, 53, vice president and controller since 1995. Prior thereto he was the controller since 1990.\nWILLIAM B. LYTTON, 47, vice president and general counsel. He was vice president and general counsel for GE Aerospace from 1990 to 1993; vice president and associate general counsel for Martin Marietta from 1993 to 1995; and vice president and general counsel for Lockheed Martin Electronics from 1995 to 1996. He assumed his current position in 1996.\n- ------------------ (1) Executive officers of International Paper are elected to hold office until the next annual meeting of the board of directors following the annual meeting of shareholders and until election of successors, subject to removal by the board.\n(2) Mr. Georges has announced his retirement as Chairman and Chief Executive Officer of the Company, effective March 31, 1996. He will continue as a director of the Company.\n(3) On April 1, 1996, Mr. Dillon will become the Chairman and Chief Executive Officer of the Company.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nDividend per share data on the Company's common stock and the high and low sale prices for the Company's common stock for each of the four quarters in 1995 and 1994 are set forth on page 68 of the Annual Report and are incorporated herein by reference.\nAs of March 22, 1996, there were 33,719 holders of record of the Company's common stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe comparative columnar table showing selected financial data for the Company is set forth on pages 66 and 67 of the Annual Report and is incorporated herein by reference.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nManagement's review and comments on the consolidated financial statements are set forth on pages 10, 18, 24, 34, 40 and 44 through 48 of the Annual Report and are incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe Company's consolidated financial statements, the notes thereto and the reports of the independent public accountants and Company management are set forth on pages 51 through 65 of the Annual Report and are incorporated herein by reference.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNone.\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nThe directors of the Company and their business experience are set forth on pages 8 through 11 of the Company's Notice of 1996 Annual Meeting and Proxy Statement, dated March 29, 1996 (the 'Proxy Statement') and are incorporated herein by reference. The discussion of executive officers of the Company is included in Part I under 'Executive Officers of the Company.'\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nA description of the compensation of the Company's executive officers is set forth on pages 13, 14 and 16 through 19 of the Proxy Statement and is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe Company knows of no one owning beneficially more than five percent (5%) of the Company's common stock other than the State Street Bank and Trust Co., N.A., as Trustee of the Company's Salaried Savings Plan and Retirement Savings Plan, respectively, which in the aggregate own 7.68% of the Company's shares of common stock as of December 31, 1995. State Street Bank and Trust Co., N.A. holds 8.46% of the Company's common stock and disclaims beneficial ownership of the Company's common stock it holds as Trustee for the Company's benefit plans. The table showing ownership of the Company's common stock by directors and by directors and executive officers as a group is set forth on pages 6 and 7 of the Proxy Statement, which information is incorporated herein by reference.\nIn 1989, the Company announced that it had authorized the purchase, from time to time, of additional shares of its common stock for use in the Company's benefit and shareholder plans and for general corporate purposes. As of December 31, 1995, 9.8 million common shares may be repurchased under this program.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nNone, other than those described under Item 11.\nFORWARD-LOOKING INFORMATION\nTHIS 1995 ANNUAL REPORT ON FORM 10-K CONTAINS CERTAIN FORWARD-LOOKING STATEMENTS CONCERNING PROJECTED COST SAVINGS AND PROFITABILITY OF INTERNATIONAL PAPER. ACTUAL RESULTS MAY DIFFER BASED ON UNANTICIPATED CHANGES IN THE U.S. AND INTERNATIONAL ECONOMIES, PRICING AND DEMAND FOR THE COMPANY'S PRODUCTS, RAW MATERIAL COSTS, LOWER THAN ANTICIPATED SAVINGS FROM RESTRUCTURING AND 'WRITE-OFF' CHARGES, OR LOWER THAN EXPECTED EFFICIENCIES FROM HIGH-PERFORMANCE WORK SYSTEMS AND OTHER PRODUCTIVITY AND COST-OF-QUALITY INITIATIVES.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\nEXHIBITS:\n(10) (a) Form of Termination Agreement, Tier I* (b) Form of Termination Agreement, Tier II* (c) Form of Termination Agreement, Tier III* (d) Revolving Credit Agreement, dated January 24, 1995** (11) Statement of Computation of Per Share Earnings (12) Computation of Ratio of Earnings to Fixed Charges (13) 1995 Annual Report to Shareholders of the Company (21) List of Significant Subsidiaries (22) Proxy Statement, dated March 29, 1996 (23) Consent of Independent Public Accountants (24) Power of Attorney (27) Financial Data Schedule (99) (a) Management Incentive Plan* (b) Long-Term Incentive Compensation Plan* (c) Unfunded Savings Plan for Senior Managers** (d) Non-Funded Deferred Compensation Plan for Non-Employee Directors**\n- ------------------ * Previously filed in the Annual Report on Form 10-K, for the year ended December 31, 1992.\n** Previously filed in the Annual Report on Form 10-K for the year ended December 31, 1994.\nREPORTS ON FORM 8-K\nCurrent Reports on Form 8-K were filed by the Company on November 13, 1995, December 5, 1995, February 1, 1996, February 15, 1996, March 8, 1996 and March 27, 1996.\nFINANCIAL STATEMENT SCHEDULES\nThe consolidated balance sheets as of December 31, 1995 and 1994 and the related consolidated statements of earnings, cash flows and common shareholders' equity for each of the three years ended December 31, 1995 and the related Notes to Consolidated Financial Statements, together with the report thereon of Arthur Andersen LLP, dated February 13, 1996, appearing on pages 51 through 65 of the Annual Report, are incorporated herein by reference. With the exception of the aforementioned information and the information incorporated by reference in Items 1, 2 and 5 through 8, the Annual Report is not to be deemed filed as part of this report. The following additional financial data should be read in conjunction with the financial statements in the Annual Report. Schedules not included with this additional financial data have been omitted because they are not applicable, or the required information is shown in the financial statements or notes thereto.\nADDITIONAL FINANCIAL DATA 1995, 1994 AND 1993\nReport of Independent Public Accountants on Financial Statement Schedule ... 13\nConsolidated Schedule: II -- Valuation and Qualifying Accounts................................ 14\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE\nTO INTERNATIONAL PAPER COMPANY:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in the Company's 1995 Annual Report to Shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated February 13, 1996. Our audits were made for the purpose of forming an opinion on those statements taken as a whole. The schedule listed in the accompanying index is the responsibility of the Company's management and is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. The schedule has been subjected to the auditing procedures applied in 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 York, N.Y. February 13, 1996\nSCHEDULE II\nINTERNATIONAL PAPER COMPANY AND CONSOLIDATED SUBSIDIARIES SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS (IN MILLIONS)\n- ------------------ (A) Primarily write-offs, less recoveries, of accounts determined to be uncollectible.\nSIGNATURES\nPURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.\nINTERNATIONAL PAPER COMPANY\nBy: JAMES W. GUEDRY JAMES W. GUEDRY, SECRETARY\nMarch 29, 1996\nPURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, 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 - ---------------------------------------- ---------------------- -------------- JOHN A. GEORGES Chairman of the Board, March 29, 1996 (JOHN A. GEORGES) Chief Executive Officer and Director\nJOHN T. DILLON* President and Director March 29, 1996 (JOHN T. DILLON)\nC. WESLEY SMITH* Executive Vice March 29, 1996 (C. WESLEY SMITH) President and Director\nWILLARD C. BUTCHER* Director March 29, 1996 (WILLARD C. BUTCHER)\nROBERT J. EATON* Director March 29, 1996 (ROBERT J. EATON)\nSTANLEY C. GAULT* Director March 29, 1996 (STANLEY C. GAULT)\nTHOMAS C. GRAHAM* Director March 29, 1996 (THOMAS C. GRAHAM)\nARTHUR G. HANSEN* Director March 29, 1996 (ARTHUR G. HANSEN)\nDONALD F. MCHENRY* Director March 29, 1996 (DONALD F. MCHENRY)\nPATRICK F. NOONAN* Director March 29, 1996 (PATRICK F. NOONAN)\nJANE C. PFEIFFER* Director March 29, 1996 (JANE C. PFEIFFER)\nEDMUND T. PRATT, JR.* Director March 29, 1996 (EDMUND T. PRATT, JR.)\nNAME TITLE DATE - ---------------------------------------- ---------------------- -------------- CHARLES R. SHOEMATE* Director March 29, 1996 (CHARLES R. SHOEMATE)\nROGER B. SMITH* Director March 29, 1996 (ROGER B. SMITH)\nMARIANNE M. PARRS Senior Vice President March 29, 1996 (MARIANNE M. PARRS) and Chief Financial Officer\nANDREW R. LESSIN Vice President and March 29, 1996 (ANDREW R. LESSIN) Controller and Chief Accounting Officer\n*By JAMES W. GUEDRY (JAMES W. GUEDRY, ATTORNEY-IN-FACT)\nAPPENDIX I\n1995 LISTING OF FACILITIES\nPRINTING PAPERS BUSINESS PAPERS, COATED PAPERS AND PULP Domestic: Mobile, Alabama Selma, Alabama (Riverdale Mill) Camden, Arkansas Pine Bluff, Arkansas Bastrop, Louisiana (Louisiana Mill) Springhill, Louisiana (C & D Center) Jay, Maine (Androscoggin Mill) Miller Falls, Massachusetts West Springfield, Massachusetts Westfield, Massachusetts (C & D Center) Woronoco, Massachusetts Moss Point, Mississippi Natchez, Mississippi Corinth, New York (Hudson River Mill) Ticonderoga, New York Hamilton, Ohio Erie, Pennsylvania Lock Haven, Pennsylvania Georgetown, South Carolina\nInternational: Cali, Colombia Coloto, Colombia Clermont-Ferrand, France (Corimex Mill) Docelles, France (Lana Mill) Grenoble, France (Lancey and Pont De Claix Mills) Maresquel, France Saillat, France Saint Die, France (Anould Mill) Strasbourg, France (La Robertsau Mill) Bergisch Gladbach, Germany (Gorhrsmuhle Mill)\nDuren, Germany (Reflex Mill) Kinleith, New Zealand Mataura, New Zealand Kwidzyn, Poland\nPACKAGING CONTAINERBOARD Domestic: Mansfield, Louisiana Pineville, Louisiana Vicksburg, Mississippi Oswego, New York Gardiner, Oregon\nInternational: Arles, France Kinleith, New Zealand Penrose, New Zealand\nCORRUGATED CONTAINER Domestic: Mobile, Alabama Russellville, Arkansas Carson, California Modesto, California San Jose, California Stockton, California Putnam, Connecticut Auburndale, Florida Chicago, Illinois Shreveport, Louisiana Springhill, Louisiana Detroit, Michigan Minneapolis, Minnesota Geneva, New York Tallman, New York Statesville, North Carolina Cincinnati, Ohio Wooster, Ohio Mount Carmel, Pennsylvania Georgetown, South Carolina Nashville, Tennessee Dallas, Texas Edinburg, Texas El Paso, Texas Delavan, Wisconsin Fond du Lac, Wisconsin\nInternational: Las Palmas, Canary Islands Suva, Fiji Arles, France Chalon-sur-Saone, France Chantilly, France Creil, France LePuy, France Mortagne, France Guadeloupe, French West Indies Bellusco, Italy Catania, Italy Pedemonte, Italy Pomezia, Italy San Felice, Italy Auckland, New Zealand Christchurch, New Zealand Dunedin, New Zealand Feilding, New Zealand Hamilton, New Zealand Hastings, New Zealand Invercargill, New Zealand Levin, New Zealand Nelson, New Zealand Barcelona, Spain Bilbao, Spain Valladolid, Spain Winsford, United Kingdom\nFiber Converting Plants Auckland, New Zealand Nelson, New Zealand\nBLEACHED BOARD Domestic: Pine Bluff, Arkansas Moss Point, Mississippi Georgetown, South Carolina Texarkana, Texas\nInternational: Whaketane, New Zealand\nLIQUID PACKAGING Domestic: Turlock, California Plant City, Florida Atlanta, Georgia Cedar Rapids, Iowa Kansas City, Kansas Framingham, Massachusetts Kalamazoo, Michigan Raleigh, North Carolina Philadelphia, Pennsylvania\nInternational: Itu, Brazil Edmonton, Alberta, Canada London, Ontario, Canada Longueuil, Quebec, Canada Santiago, Dominican Republic Perugia, Italy Kingston, Jamaica Tokyo, Japan Seoul, Korea Taipei, Taiwan Caracas, Venezuela\nA-1\nFOLDING CARTON Domestic: Clinton, lowa Hopkinsville, Kentucky Cincinnati, Ohio Richmond, Virginia\nInternational: Auckland, New Zealand Christchurch, New Zealand Palmerston North, New Zealand\nLABEL Commerce, California Bowling Green, Kentucky\nKRAFT PAPER Mobile, Alabama Camden, Arkansas Moss Point, Mississippi\nGROCERY BAGS & SACKS Mobile, Alabama Jackson, Tennessee\nMULTIWALL BAGS Domestic: Camden, Arkansas Pittsburg, Kansas Wilmington, Ohio\nInternational: Auckland, New Zealand Palmerston North, New Zealand\nPLASTIC PACKAGING Domestic: Janesville, Wisconsin\nInternational: Santiago, Chile Auckland, New Zealand Christchurch, New Zealand Hamilton, New Zealand Hastings, New Zealand Wellington, New Zealand\nDISTRIBUTION WHOLESALE AND RETAIL DISTRIBUTION (303 distribution branches) ResourceNet International Domestic: Stores Group Chicago, Illinois 142 locations nationwide Dillard Paper Greensboro, North Carolina 21 branches in the Middle Atlantic States and Southeast Dixon Paper Company Denver, Colorado 12 branches in the West and Midwest Specialty Business Group Erlanger, Kentucky 12 branches in New England and Middle Atlantic States, Midwest, South and West Ingram Paper City of Industry, California 7 locations in the Southwest and Hawaii\nKirk Paper Company Downey, California 4 locations in the West, Southwest, and Northwest Leslie Paper Minneapolis, Minnesota 12 locations in the Midwest Northeast Region Erlanger, Kentucky 43 branches in New England, Middle Atlantic States, Midwest and District of Columbia Western Pacific Portland, Oregon 2 locations in the Northwest Western Paper Company Overland Park, Kansas 23 branches in the West, Midwest and South\nInternational: Chihuahua, Chihuahua, Mexico 3 locations\nOther International: Aussedat Rey France Distribution S.A., Pantin, France Recom Papers Nijmegen, Netherlands Scaldia Papier BV, Nijmegen, Netherlands Aalbers Paper Products Veenendaal, Netherlands Paper Merchant, Warehousing and Distribution Centers, 15 locations in New Zealand and 3 locations in Australia\nFOREST PRODUCTS FORESTLANDS Domestic: Approximately 6.0 million acres in the South, Northeast and Northwest\nInternational: Approximately 800,000 acres in New Zealand\nWOOD PRODUCTS Domestic: Maplesville, Alabama Tuscaloosa, Alabama Gurdon, Arkansas Leola, Arkansas Whelen Springs, Arkansas DeRidder, Louisiana Springhill, Louisiana Morton, Mississippi Wiggins, Mississippi Joplin, Missouri Pleasant Hill, Missouri Madison, New Hampshire Pilot Rock, Oregon Sampit, South Carolina Henderson, Texas Mineola, Texas Nacogdoches, Texas New Boston, Texas Danville, Virginia Building Products Ukiah, California Lisbon Falls, Maine Laurel, Mississippi Towanda, Pennsylvania Fiberboard Spring Hope, North Carolina Marion, South Carolina Particleboard Stuart, Virginia Waverly, Virginia Slaughter Dallas, Texas 2 branches in the Southwest and Northwest\nA-2\nInternational: INTAMASA Cella, Spain Masonite Africa Limited Estcourt Plant Myrtleford, New South Wales, Australia Mt. Druit, New South Wales, Australia Benella, Victoria, Australia Auckland, New Zealand Kopu, New Zealand Kumeu, New Zealand Marton, New Zealand Nelson, New Zealand Putaruru, New Zealand Rangiora, New Zealand Rotorua, New Zealand Taupo, New Zealand Thames, New Zealand Topuni, New Zealand Tokoroa, New Zealand Building Supply Retail Outlets, 34 branches in New Zealand\nREALTY PROJECTS Haig Point Plantation Daufuskie Island, South Carolina\nSPECIALTY PRODUCTS TISSUE Mills: Box Hill, Victoria, Australia Myrtleford, Victoria, Australia Kawerau, New Zealand\nPlants: Box Hill, Victoria, Australia Clayton, Victoria, Australia Keon Park, Victoria, Australia Auckland, New Zealand (three plants) Christchurch, New Zealand Te Rapa, New Zealand\nNONWOVENS Domestic: Athens, Georgia Griswoldville, Massachusetts Walpole, Massachusetts Lewisburg, Pennsylvania Bethune, South Carolina Green Bay, Wisconsin\nInternational: Liege, Belgium Toronto, Ontario, Canada Yokohama, Japan San Jose Ituebide, Mexico\nIMAGING PRODUCTS Domestic: Jacksonville, Florida Holyoke, Massachusetts Binghamton, New York\nInternational: Melbourne, Australia Saint-Priest, France Munich, Germany Mobberley, Great Britain Morley, Great Britain Fribourg, Switzerland\nCHEMICALS Domestic: Panama City, Florida Pensacola, Florida Port St. Joe, Florida Oakdale, Louisiana Springhill, Louisiana Gulfport, Mississippi Picayune, Mississippi\nInternational: Niort, France Sandarne, Sweden Greaker, Norway\nPETROLEUM Alvin, Texas Houston, Texas Midland, Texas Orange, Texas\nSPECIALTY PANELS Domestic: Chino, California Ukiah, California Cordele, Georgia Glasgow, Kentucky Louisville, Kentucky Monticello, Kentucky (2 plants) Odenton, Maryland Laurel, Mississippi Statesville, North Carolina Tarboro, North Carolina Towanda, Pennsylvania Hampton, South Carolina Waverly, Virginia Oshkosh, Wisconsin\nInternational: Pori, Finland Bergerac, France (Couze Mill) Ussel, France Barcelona, Spain (Durion Mill)\nBUILDING PRODUCTS FLOORING Sydney, New South Wales, Australia\nINSULATION Minto, New South Wales, Australia Sydney, New South Wales, Australia Auckland, New Zealand Christchurch, New Zealand\nROOFING Corona, California Auckland, New Zealand\nSINKWARE AND ALUMINIUM PRODUCTS Adelaide, South Australia Auckland, New Zealand\nSPECIALTY PAPERS Thilmany Knoxville, Tennessee Kaukauna, Wisconsin Nicolet De Pere, Wisconsin Jay, Maine (Androscoggin Mill) Akrosil Domestic: Menasha, Wisconsin Lancaster, Ohio International: Toronto, Canada Limburg, Netherlands\nA-3\n[LOGO]\nPRINTED ON HAMMERMILL PAPERS ACCENT OPAQUE, 50 LBS. HAMMERMILL PAPERS IS A DIVISION OF INTERNATIONAL PAPER.","section_15":""}
{"filename":"751683_1995.txt","cik":"751683","year":"1995","section_1":"Item 1. BUSINESS\nGeneral Development of Business. Columbia Lease Income Fund A L.P. (the \"Partnership\") is a limited partnership organized under the provisions of the Delaware Revised Uniform Limited Partnership Act on August 13, 1984. At December 31, 1995, TLP Columbia Management Corporation (\"TCMC\"), a wholly-owned subsidiary of its parent company, TLP Leasing Programs, Inc. (\"TLP\"), is the sole General Partner of the Partnership. TLP is a wholly-owned subsidiary of CMI Holding Co. CMI Holding Co. is a wholly-owned subsidiary of Continental Information Systems Corporation, which emerged from protection under Chapter 11 of the Federal Bankruptcy Code (\"Chapter 11\") on December 21, 1994 (see Item 3. Legal Proceedings.).\nOn January 9, 1996, TLP Holding LLC purchased all the common stock of TLP from CMI Holding Co. Under the new ownership, it is expected that TLP will continue to operate in the same manner of business as it has in the past.\nBy the Agreement Relating to the Admission of TCMC as an Additional General Partner of Certain Limited Partnerships dated June 30, 1993 (the \"Agreement\"), as referenced in Form 8-K filing dated June 30, 1993, the then current and now former General Partner of the Registrant, Meridian-Columbia Management Corporation (\"Meridian-CMC\"), agreed to admit TCMC as a co-General Partner (see Management Agreement below).\nPursuant to the above Agreement and as referenced in Form 8-K filing dated November 30, 1993, Meridian-CMC, co-General Partner withdrew, effective November 30, 1993, as co-General Partner pursuant to Article II Section 2.4(b) of the Limited Partnership Agreement (see Withdrawal of Meridian-CMC below.) Meridian-CMC, a wholly-owned subsidiary of Meridian Leasing Corporation (\"Meridian\") was admitted as an additional General Partner of the Partnership on November 2, 1989. TM-Columbia Management Corporation (\"TMC\"), a wholly-owned subsidiary of Thomson McKinnon Inc. (\"TMI\") was a General Partner from August 13, 1984 until October 14, 1990 when TMC voluntarily withdrew from the Partnership.\nThe Partnership is engaged in the business of: (i) acquiring certain types and kinds of primarily new, but also used, equipment consisting principally of IBM peripheral devices for large and small data processing systems, fully configured small processing systems, computer terminals and other information processing devices (\"Equipment\"); and (ii) leasing Equipment primarily pursuant to a series of short-term net operating leases, with an initial lease in effect or committed to at the time of acquisition with a lessee which is a publicly or privately-held company considered creditworthy by the General Partner, generally a \"Fortune 1000\" company or subsidiary, bank, insurance company or utility (lower credit criteria may be used for remarketed Equipment users).\nThe Partnership has acquired Equipment using funds from non-recourse borrowings. Such borrowings may equal up to 80% of the aggregate purchase price of all Equipment acquired, but generally will not exceed 50%. The Partnership is intended to provide Limited Partners of the Partnership (the \"Limited Partners\") with quarterly cash distributions from revenue derived from Equipment and leases thereof.\nThe Partnership also intends to reinvest a portion of its cash from operations, and a substantial portion of any available cash from sales or refinancings, in additional Equipment during its first nine years of operations, provided that distributions are made to Limited Partners in amounts sufficient to pay their federal income tax liability (assuming each Limited Partner is in a 30% federal income tax bracket) created by such operations, sales or refinancings.\nUntil such time as the General Partner determines that it would be advisable to sell all or some of the Equipment, the Partnership will endeavor to keep the Equipment on lease pursuant to a series of short-term net operating leases. It is currently anticipated that all of the Equipment will be disposed of, and the Partnership will be terminated, in or about the year 2000, although the Partnership agreement provides for a term ending in the year 2010. In addition, the General Partner may cause the Partnership to dispose of all of the Equipment and to liquidate at any time after the Partnership's tenth year of operations.\nGeneral Partner. The General Partner, among other things, (i) determines and revises, as and when it deems necessary, a list of Equipment and equipment lease characteristics, which make an item of Equipment suitable for acquisition by the Partnership; (ii) makes all final decisions regarding, among other things, the Partnership's acquisition, financing, refinancing, leasing, re-leasing or sale of Equipment; (iii) independently verifies certain types of information concerning selected Equipment and the leases therefore; and (iv) maintains books and records concerning Equipment in addition to those maintained by Suppliers (as defined below in Supplier Agreements). The General Partner advises and supervises Suppliers generally with respect to: (a) locating, evaluating and negotiating the acquisition of Equipment; (b) negotiating the terms of leases for Equipment; (c) negotiating the terms of Partnership debt obligations; (d) negotiating re-leases or sales of Equipment upon the expiration or earlier termination of the leases thereof; (e) supervising the payment of, or collecting of, rentals from Partnership lessees; (f) supervising, monitoring and auditing the payment of all personal property, use and sales taxes applicable to Equipment; (g) inspecting Equipment; (h) maintaining liaison with lessees, and generally supervising lessees to assure that Equipment is being properly operated and maintained; (i) supervising maintenance of Equipment; (j) supervising and coordinating the acquisition of casualty, liability and other types of insurance relating to Equipment; and (k) monitoring performance by Partnership lessees of their obligations under their leases of Equipment.\nThe General Partner is entitled to receive acquisition fees for locating, evaluating, selecting, negotiating and closing acquisitions of Equipment. The acquisition fee generally equals 2.5% of the purchase price paid by the Partnership for each item of Equipment acquired; provided, however, that the total amount of all acquisition fees paid to the General Partner(s) over the life of the Partnership shall not exceed 15% of the total capital contributions received by such Partnership. In addition, the General Partner is entitled to receive an equipment management fee for its active management of Equipment and a subordinated resale fee for arranging the sale of Equipment. The equipment management fee equals up to 6% of gross rental payments payable with respect to Equipment for the quarter for which such payment is made, except for Equipment subject to certain leases referred to in the Partnership agreement as \"Full Payout Leases\", for which the equipment management fee shall not exceed 2% of the gross rental payments. The resale fee equals the lesser of (i) 3% of the sales proceeds or (ii) one-half of the competitive equipment sales commission. In addition, the General Partner is entitled to receive reimbursement for the administrative services necessary for the prudent operation of the Partnership.\nSupplier Agreements. Certain of the General Partner's responsibilities are performed by equipment leasing companies (\"Suppliers\") with experience in the business of owning, leasing and managing equipment. Suppliers perform these services pursuant to agreements with the General Partner (\"Supplier Agreements\"), subject to the General Partner's supervision. Pursuant to the admission of TCMC as a co-General Partner and the withdrawal of Meridian-CMC as discussed above, TCMC has agreed to the existing supplier agreements as executed by Meridian. Meridian has entered into Supplier Agreements with Meridian and Meridian Sales and Leasing, Inc., (\"MSL\") (formerly Thomson McKinnon Sales and Leasing Inc.). MSL was a wholly-owned subsidiary of TMI until June 22, 1988, at which time it was acquired by Meridian. The General Partner may also enter into agreements for the purchase of specific items of Equipment with other leasing companies.\nPursuant to the Supplier Agreements, each Supplier is responsible, subject to the supervision of the General Partner, for the performance of certain general and day-to-day management services of the Partnership, including acquisition, management and reporting services, which services generally are performed at the Supplier's sole cost and expense, in a commercially reasonable manner and with no less care than would be given to other equipment owned, leased or managed by the Supplier or any of its affiliates.\nUnder the Supplier Agreements, compensation for locating, managing and reselling equipment is paid to each Supplier in amounts deducted from the corresponding compensation payable by the Partnership to the General Partner. Generally, a Supplier's compensation for such services equals 80% of the acquisition fee, 50% of the management fee and 50% of the resale fee. MSL's resale fees will be subordinated to the same extent as resale fees earned by the General Partner.\nA Supplier may also be entitled to receive incentive fees in the following circumstances: (i) if it locates a possible transaction which meets the General Partner's criteria for acceptable Partnership investments and the Equipment subject to the possible transaction is purchased by the Partnership; and (ii) if it benefits the Partnership by obtaining a lease for Equipment with a better than market rental rate, a loan to acquire Equipment at a lower than market interest rate, Equipment at a lower than market purchase price, favorable payment terms from the vendor, or a combination of the foregoing.\nWithdrawal of Meridian-CMC. During 1993, Meridian-CMC notified TCMC of its desire to voluntarily withdraw as co-General Partner of the Partnership. To withdraw as a general partner, the Partnership agreement requires: (i) there is remaining at least one other general partner who is willing to continue the operations of the Partnership; (ii) the Partnership shall have received an opinion of Counsel to the Partnership to the effect that such withdrawal will not constitute a termination of the Partnership or otherwise materially adversely affect the status of the Partnership for federal income tax purposes; and (iii) the Limited Partners shall have received at least sixty days notice of the general partner's intention to withdraw. As previously discussed, TCMC was admitted as co-General Partner on June 30, 1993 and has been exercising management control over the Partnership since that date and intends to continue operating in that capacity. Meridian-CMC withdrew from the Partnership effective November 30, 1993. TMC, the former co-General Partner with Meridian-CMC, voluntarily withdrew from the Partnership on October 14, 1990.\nManagement Agreement. Prior to the Agreement Relating to the Admission of TCMC as an Additional General Partner of Certain Limited Partnerships dated June 30, 1993 (the \"Agreement\"), TCMC (the \"New General Partner\") agreed on April 1, 1993 to assume overall responsibility, subject to final approval and ultimate authority of Meridian-CMC (the \"Former General Partner\"), for administration, management and operation of the Partnership and the Other Columbia Lease Income Funds (\"CLIF\") Partnerships (see Related Parties and Conflicts of Interest below) except that TCMC has no responsibility for communicating with the Limited Partners or making distributions to the Limited Partners or Meridian-CMC prior to November 30, 1993.\nAs compensation for these services under the above Agreement, all fees and cash distributions derived from the Partnership's operations to which the General Partner is entitled and which accrues on and after April 1, 1993, including but not limited to, Distributable Cash From Operations and Distributable Cash From Sales or Refinancings (as those terms are defined in the Partnership Agreements) shall be allocated to the New General Partner. All management fees for rents received on or after April 1, 1993 that relate to the period on or before March 31, 1993 shall be allocated to the Former General Partner. The New General Partner is to remit such fees to the Former General Partner as they are paid after April 1, 1993. Prior to the New General Partner's admission, the Former General Partner was entitled to receive 100% of the acquisition fees, management fees and resale fees (net of amounts payable to Suppliers) until the agreed upon threshold was reached; thereafter, all acquisition fees and 60% of management fees and resale fees (net of amounts payable to Suppliers) were allocated based upon a sharing agreement with TMC.\nTCMC was formed on April 1, 1993 for the specific purpose of being admitted as the new general partner, managing the Partnership and the Other CLIF Partnerships (see Related Parties and Conflicts of Interest below) and discharging the administrative duties of the Former General Partner. TLP Leasing Programs, Inc., has extensive experience administering numerous publicly-held limited partnerships owning leased equipment.\nRelated Parties and Conflicts of Interest. The General Partner serves or has served as a general partner of Columbia Lease Income Fund B L.P. (\"CLIF I-B\"), Columbia Lease Income Fund II-A L.P. (\"CLIF II-A\"), Columbia Lease Income Fund II-B L.P. (\"CLIF II-B\"), Columbia Lease Income Fund II-C L.P. (\"CLIF II-C\"), Columbia Lease Income Fund II-D L.P. (\"CLIF II-D\"), and Columbia Lease Income Fund II-E L.P. (\"CLIF II-E\"), which have investment objectives similar to that of the Partnership. CLIF II-A and CLIF I-B were terminated during the year as of August 31, 1995 and December 29, 1995, respectively. For additional information regarding CLIF II-B, CLIF II-C, CLIF II-D, and CLIF II-E (the \"Other CLIF Partnerships\"), reference is made to Form 10-K of each such partnership for the year ended December 31, 1995.\nCertain affiliates of the General Partner, including TLP, are engaged in business activities that are directly in competition with the Partnership, and are expected to continue to engage in additional business activities which will be competitive with the Partnership. The General Partner, in good faith, devotes time to the affairs of the Partnership as it deems necessary, in its sole discretion, to fulfill its fiduciary obligation and other obligations under the Partnership agreement.\nCompetition for opportunities to acquire, lease, re-lease and sell equipment exists between and among the Partnership and the General Partner, one or more Suppliers and their affiliates, the Other CLIF Partnerships and other partnerships and entities formed by the General Partner, or its affiliates.\nIf the Partnership and any other partnership with which the General Partner is affiliated are seeking to acquire the same equipment, conflicts of interest may arise as to which entity should acquire that equipment. In such situations, the General Partner will analyze the portfolio of equipment already purchased by, and investment objectives of, each such entity, and will make its decision as to which entity will purchase the equipment based upon such factors, among others, as: (a) the amount and origin (that is, net proceeds, Cash From Operations or Cash From Sales or Refinancings) of cash available in each such entity and the length of time such funds have been available; (b) the liabilities of each such entity; (c) the effect of such acquisition on the diversification of each such entity's equipment portfolio by the type of equipment; (d) the estimated income tax consequences to each such entity from such acquisition and each such entity's needs for current and future income; (e) the cash distribution and reinvestment objectives of each such entity; (f) the lessee and credit diversification (geographically or by industry) of each such entity's equipment portfolio; and (g) the policy of each entity relating to leverage.\nIn allocating equipment, the General Partner may conclude that it is in the best interest of the Partnership to own equipment jointly with one or more of the Other CLIF Partnerships. Such joint venture agreements have been negotiated in the past and additional joint venture agreements may be negotiated in the future.\nRisks of Ownership and Operation of Equipment. The Partnership's ability to attain its investment objectives is subject to various risks associated with ownership and operation of the Equipment. In certain respects, the success of the Partnership will depend upon the residual value of, the demand for, the viability of the manufacturers of, and the ability of the Partnership to remarket Equipment. Equipment leasing is subject to, among other things, the risk of credit losses, technological and economic obsolescence, physical deterioration and malfunction, and the risk of defaults by lessees and purchasers of Equipment. Technological developments can adversely affect the ability of the Partnership to obtain renewal or new leases for, or to sell, Equipment. No combination of management ability, experience, knowledge, care or scientific approach can avoid the inherent possibilities of loss.\nOther risk factors include: (i) changes in technology, whereby the introduction of an entirely new technology could lead to a radical reduction in, or the complete elimination of, the value of certain Equipment and make Equipment difficult, or impossible, to re-lease or to sell; (ii) the residual (i.e., continuing) values of Equipment which, in turn, will affect the return on the Partnership's equity investments, and will depend on factors neither controlled nor controllable by the Partnership, such as: the quality, condition, technology and timing of the acquisition of Equipment; the cost of comparable new equipment; the General Partner's ability to forecast technological changes which may adversely affect the value of Equipment; and market factors; (iii) the potential inability of the Partnership to keep all of the Equipment fully leased at rentals which, together with any anticipated sale proceeds or salvage value, will provide an acceptable rate of return on its equity investment in Equipment resulting from: general economic conditions, including inflation and the availability of financing; fluctuations in supply and demand for various types of equipment resulting from, among other things, technological obsolescence; faster than expected introduction of replacement technology; unanticipated manufacturers' price reductions; changes in tax laws which may increase the desirability of owning rather than leasing equipment; and increases in operating expenses borne by the Partnership, if any, which cannot be transferred to lessees or matched by commensurate increases in lease revenues; (iv) competition from other lessors; competition from full payout leases, which generally are written for a longer term and at a lower rental rate than the operating leases to be offered by the Partnership; competition from equipment manufacturers and their financing subsidiaries which have the capacity to offer users alternatives to the purchase of nearly every type of equipment; and competition from numerous other potential investors, including limited partnerships organized and managed similarly to the Partnership, seeking to purchase equipment subject either to operating leases or full payout leases, many of which have greater financial resources and more experience than the Partnership and the General Partner and some of which may be willing to purchase or lease Equipment at rates less favorable to the lessor thereof due to different residual value assumptions, required rates of return or other factors; (v) changes in marketing policies, such that benefits derived from lease credit (i.e., applying lease payments as a credit toward purchase of equipment) and volume discounts which permit the Partnership to purchase Equipment at a cost lower than its fair market value could be eliminated, thus making it more difficult for the Partnership to successfully compete as a lessor of Equipment; and (vi) defaults by lessees which may cause Equipment to be returned to the Partnership at a time when the Partnership may be unable to arrange promptly for its re-lease or sale on terms satisfactory to the General Partner or on any terms, thus resulting in the loss of anticipated revenues and the inability of the Partnership to recover all or a portion of its equity investment in the Equipment and to repay the non-recourse debt, if any, secured by such Equipment and the rentals therefrom.\nThree lessees, Eaton Corporation, Northern Indiana Public Service Company and Sports & Recreation, Incorporated, lease equipment in which the related rental payments exceed 10% of total rental income. The related rental payments comprise 16.11%, 10.50% and 19.94%, respectively, of the total rental income for the year ended December 31, 1995. Eaton Corporation, Northern Indiana Public Service Company and Sports & Recreation, Incorporated lease equipment comprising 41.48%, 10.17% and 18.30%, respectively, of the total equipment portfolio at December 31, 1995.\nForeign Operations and Segment Data. The Partnership has not engaged, and does not intend to engage, in material operations in foreign countries, nor is a material portion of the Partnership's revenue intended to be derived from customers in foreign countries. Since the Partnership will engage only in equipment leasing, no industry segment information is provided herein.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nAt December 31, 1995, the Partnership owned computer equipment with a depreciated cost basis of $155,784, subject to existing leases. All purchases of computer equipment are subject to a 2.5% acquisition fee paid to the General Partner.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nThere are no material pending legal proceedings to which the Partnership is a party or of which any of its equipment or leases is the subject; however, see Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. and note 12 to the financial statements included in Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. of this report regarding voluntary bankruptcy proceedings and the reorganization involving certain affiliates of the Corporate General Partner involved in those proceedings.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\nPART II\nItem 5.","section_5":"Item 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nMarket Information. There is no established public market for the Limited Partnership Units (\"Units\"), and it is not anticipated that any such market will develop. Although under no obligation to do so, Prudential Securities, Inc. has offered to attempt to match and sell Units with unsolicited requests to buy Units, but may discontinue this service at any time. Limited Partners also have a limited right to request the Partnership to repurchase Units for cash at a discount from net asset value. To date, no such requests have been accepted by the Partnership.\nHolders. Except for the General Partner's interest, the only class of equity held in the Partnership is Units of Limited Partnership Interest. As of December 31, 1995, 1,690 Limited Partners owned the 24,383 issued and outstanding Units.\nDividends. Cash distributions are made to Limited Partners and to the General Partner on a quarterly basis from available funds in accordance with the Partnership agreement. Cash distributions to the General Partner are further subject to the Management Agreement between TCMC and TLP. Cash distributions are derived from (1) Distributable Cash From Operations and (2) Distributable Cash From Sales or Refinancings. \"Distributable Cash From Operations\" means cash from operations, as reduced by (i) amounts which the General Partner determines (through the ninth anniversary of the Partnership's final closing date) shall be reinvested in additional Equipment and which ultimately are so reinvested, (ii) payments of all accrued but unpaid equipment management fees (to the extent that payment thereof is required by the Partnership agreement to be deferred), and (iii) after Payout, payments of all accrued but unpaid subordinated resale fees. \"Distributable Cash From Sales or Refinancings\" means cash from sales or refinancings, as reduced by (i) amounts which the General Partner determines (through the ninth anniversary of the Partnership's final closing date) shall be reinvested in additional Equipment and which ultimately are so reinvested, (ii) payments of all accrued but unpaid equipment management fees, and (iii) after Payout, payments of all accrued but unpaid subordinated resale fees.\nEach distribution of Distributable Cash From Operations of the Partnership shall be allocated 95% to the Limited Partners and 5% to the General Partner. Any Distributable Cash From Sales or Refinancings from gains and losses shall be allocated 99% to the Limited Partners and 1% to the General Partner until \"Payout\" has occurred. \"Payout\" means the time when the aggregate amount of all distributions to the Limited Partners of Distributable Cash From Operations and of Distributable Cash From Sales or Refinancings equals the aggregate amount of the Limited Partners' original invested capital plus a cumulative 8% annual return (compounded daily) on their aggregate unreturned capital contributions invested capital (calculated from the beginning of the first full fiscal quarter following the Partnership's closing date). Thereafter, 85% will be distributed to the Limited Partners and 15% to the General Partner, subject to certain adjustments. Including the distribution for the fourth quarter of 1995 made February 15, 1996, the cumulative distributions to date are $586.49 per Unit. This cumulative distribution per Unit amount represents 59.47% of Payout. It is not anticipated that Payout will occur as of the liquidation of this Partnership.\nDistributable Cash From Operations, if any, and Distributable Cash From Sales or Refinancings, if any, are distributed within 60 days after the completion of each of the first three fiscal quarters of the Partnership's December 31 fiscal year, and within 120 days after the completion of each fiscal year beginning after the first full fiscal quarter following the Partnership's final closing date.\nDuring the fiscal year ended December 31, 1995, the Partnership distributed Distributable Cash From Operations and Distributable Cash From Sales or Refinancings aggregating $426,704 to Limited Partners as follows:\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA\nThe following table sets forth selected financial information regarding the Partnership's operations and financial position at the dates and for the periods shown. This information should be used in conjunction with the financial statements and notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations, which are included in Items 7. and 8. below.\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nResults of Operations.\nThe following discussion relates to Partnership's operations for the year ended December 31, 1995, in comparison to the years ended December 31, 1994 and 1993.\nThe Partnership realized net income of $25,822, $176,143 and $234,125 for the years ended December 31, 1995, 1994 and 1993, respectively. Rental income on operating leases decreased $198,845 or 28% and $163,020 or 18% in 1995 and 1994, respectively. The decrease in rental income each year is due to lower rental rates obtained on equipment lease extensions and remarketings after the initial lease term has expired and due to a decrease in the size of the equipment portfolio. Earned income on direct financing leases declined each year as more of the minimum lease payment, as calculated using the rate implicit in the lease, was allocated to the recovery of the fair market value of the equipment at the inception of the lease. There are no existing direct financing leases as of December 31, 1995. Interest income decreased $2,081 and $12,779, for the years ended December 31, 1995 and 1994, respectively, as a result of lower average short-term investment balances held each year.\nTotal costs and expenses decreased 10% and 18% in 1995 and 1994, respectively, compared to prior periods. The decrease in costs and expenses is primarily due to the decrease in depreciation expense offset by the increase in net loss on sale of equipment in the current year. Depreciation expense decreased each year due to a large portion of the equipment portfolio becoming fully depreciated and a reduction in the overall equipment portfolio. Included in depreciation expense in 1995 is a provision for $11,279 to properly reflect the equipment portfolio's net realizable value during the year. The current year net loss on sale of equipment is attributed to sales of equipment carrying higher net book values. In comparison, the Partnership realized a net gain on sale of equipment of $14,651 in 1994 due to the sale of equipment carrying lower net book values. Management fees have decreased in the current year as a result of the decline in rental income. Management fees increased slightly in 1994 over 1993 due to the successful collection efforts on delinquent rent receivables during 1994. General and administrative expenses increased in 1995 by 16% over 1994. A major factor contributing to this increase is that salaries and expenses of the partnership accounting and reporting personnel, of the General Partner, which are reimbursable by the various partnerships under management are being allocated over a diminishing number of partnerships. The General Partner managed 15 partnerships in 1995, 19 partnerships in 1994 and 21 partnerships in 1993. Interest expense decreased each year as a result of the payoff and paydown of long-term debt during 1995 and 1994, respectively. General and administrative expenses remained relatively flat between 1994 and 1993. The Partnership decreased its provision for doubtful accounts by $6,200 in 1995 due to successful collection efforts on delinquent accounts, as compared to the establishment of the provision in the amount of $7,229 in the prior year.\nThe Partnership recorded net income per Limited Partnership Unit of $1.00, $6.86 and $9.12 for the years ended December 31, 1995, 1994 and 1993, respectively.\nLiquidity and Capital Resources.\nFor the year ended December 31, 1995, rental revenue generated from operating leases was the primary source of funds for the Partnership. As equipment leases terminate, the General Partner determines if the equipment will be extended to the same lessee, remarketed to another lessee, or if it is less marketable, sold. This decision is made upon analyzing which option would generate the most favorable results.\nRental income on operating leases will continue to decrease due to two factors. The first factor is the rate obtained when the original leases expire and are remarketed at a lower rate. Typically, the remarketed rates are lower due to the decrease in useful life of the equipment. Secondly, the increasing change of technology in the computer industry usually decreases the demand for older equipment, thus increasing the possibility of obsolescence. Both of these factors together will cause remarketed rates to be lower than original rates. This decrease however, should not affect the Partnership's ability to meet its future cash requirements. To the extent that future cash flows should be insufficient to meet the Partnership's operating expenses and liabilities, additional funds could be obtained through the sale of equipment, or a reduction in the rate of cash distributions. Future rental revenues from operating leases amount to $370,956 and are to be received over the next two years (see note 6 to the financial statements).\nFor the year ended December 31, 1995, the Partnership's investing activities resulted in equipment sales with a depreciated cost basis of $102,855, generating $14,881 in sales proceeds. The Partnership has no material capital expenditure commitments, and will not purchase equipment in the future as the Partnership has reached the end of its reinvestment period.\nThe Partnership's financing activities resulted in the payoff of long-term debt of $37,801 during the year ended December 31, 1995.\nCash distributions paid in the first quarter of 1996 are currently at an annual level of 2% per Limited Partnership Unit, or $10.00 per Limited Partnership Unit. During 1995, the Partnership distributed or declared a total of $17.50 per Limited Partnership Unit, of which $1.00 per Unit represents income and $16.50 per Unit represents a return of capital. For the quarter ended December 31, 1995, the Partnership declared a cash distribution of $64,166, of which $3,208 was allocated to the General Partner and $60,958 was allocated to the Limited Partners. The distribution will be made on February 15, 1996. The Partnership expects to continue paying at or near this level. The effects of inflation have not been significant to the Partnership and are not expected to have a material impact in future periods.\nOn January 9, 1996, TLP Holding LLC purchased all the common stock of TLP from Holding. Under the new ownership, it is expected that TLP will continue to operate in the same manner of business as it has in the past.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nIndependent Auditors' Report\nTo the Partners of Columbia Lease Income Fund A L.P.:\nWe have audited the accompanying balance sheets of Columbia Lease Income Fund A L.P. (a Delaware Limited Partnership) as of December 31, 1995 and 1994, and the related statements of operations, partners' equity (deficit) and cash flows for each of the years in the three-year period ended December 31, 1995. In connection with our audits of the financial statements, we have also audited the accompanying financial statement schedule II for each of the years in the three-year period ended December 31, 1995. These financial statements and this financial statement schedule are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements and this 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 Columbia Lease Income Fund A L.P. as of December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 1995, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.\nKPMG Peat Marwick LLP\nBoston, Massachusetts March 15, 1996\nCOLUMBIA LEASE INCOME FUND A L.P. (A Delaware Limited Partnership)\nBalance Sheets December 31, 1995 and 1994\nSee accompanying notes to financial statements.\nCOLUMBIA LEASE INCOME FUND A L.P. (A Delaware Limited Partnership)\nStatements of Operations For the Years Ended December 31, 1995, 1994 and 1993\nSee accompanying notes to financial statements.\nCOLUMBIA LEASE INCOME FUND A L.P. (A Delaware Limited Partnership)\nStatements of Partners' Equity (Deficit) For the Years Ended December 31, 1995, 1994 and 1993\nSee accompanying notes to financial statements.\nCOLUMBIA LEASE INCOME FUND A L.P. (A Delaware Limited Partnership)\nStatements of Cash Flows For the Years Ended December 31, 1995, 1994 and 1993\nSee accompanying notes to financial statements.\nCOLUMBIA LEASE INCOME FUND A L.P. (A Delaware Limited Partnership)\nNotes to Financial Statements December 31, 1995, 1994 and 1993\n(1) Organization\nColumbia Lease Income Fund A L.P. (the \"Partnership\") was formed under the Delaware Revised Uniform Limited Partnership Act on August 13, 1984. The purpose of the Partnership is to acquire certain types and kinds of new and used equipment which are leased to third parties. The Partnership has the right to borrow up to 80% of the aggregate purchase price of all equipment acquired, but anticipates borrowing no more than 50%. The Partnership agreement provides for the Partnership to continue until December 31, 2010, although the General Partner may cause the Partnership to dispose of all of the equipment and to liquidate at any time after the Partnership's tenth year of operations.\nAt December 31, 1995, TLP-Columbia Management Corporation (\"TCMC\"), a wholly-owned subsidiary of TLP Leasing Programs, Inc. (\"TLP\"), is the sole General Partner of the Partnership. TCMC was admitted as a co-General Partner of the Partnership on June 30, 1993 and has exercised control over the Partnership since that date. Pursuant to TCMC's admission, Meridian-Columbia Management Corporation (\"Meridian-CMC\") voluntarily withdrew as co-General Partner of the Partnership, effective November 30, 1993. TM-Columbia Management Corporation (\"TMC\"), a wholly-owned subsidiary of Thomson McKinnon Inc. (\"TMI\"), was a General Partner from August 13, 1984 until October 14, 1990 when TMC voluntarily withdrew from the Partnership. Meridian-CMC was admitted as a General Partner of the Partnership on November 2, 1989.\nThe General Partner has contributed $1,000 to the Partnership. The subscription period for the Partnership commenced on October 26, 1984 and terminated on February 4, 1985. Admissions of Limited Partners occurred as follows:\n(2) Significant Accounting Policies\nGeneral\nThe Partnership's records are maintained on a accrual basis of accounting so that revenues are recognized as earned and expenses are recognized as incurred. Assets and liabilities are those of the Partnership and do not include any assets and liabilities of the individual partners. 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.\nCOLUMBIA LEASE INCOME FUND A L.P. (A Delaware Limited Partnership)\nNotes to Financial Statements\nCash and Cash Equivalents\nThe Partnership considers cash and short-term investments with original maturities of three months or less to be cash and cash equivalents.\nAllowance for Doubtful Accounts\nThe financial statements include allowances for estimated losses on receivable balances. The allowances for doubtful accounts are based on past write off experience and an evaluation of potential uncollectible accounts within the current receivable balances. Receivable balances which are determined to be uncollectible are charged against the allowance and subsequent recoveries, if any, are credited to the allowance. At December 31, 1995 and 1994, the allowance for doubtful accounts included in rents receivable was $2,426 and $1,397, respectively, and $60,000 and $220,000 included in accounts receivable - affiliates, respectively.\nIncome Taxes\nNo provision for federal income taxes has been made as the liability for such taxes is that of the Partners rather than that of the Partnership. Taxable (loss) income, as reported on Schedule K-1, Form 1065 \"Partner's Share of Income, Credits, Deductions, etc.\", was $(80,035), $211,399 and $19,161 in 1995, 1994 and 1993, respectively (see note 10).\nEquipment on Operating Leases\nThe Partnership has determined that its equipment leases are properly classified as either operating leases or direct financing leases. Under the operating method of accounting for leases, the leased equipment is recorded as an asset at cost including acquisition fees and other expenses related to the purchase of equipment. Equipment placed in service prior to January 1, 1990 is depreciated on a straight-line basis over five years to its estimated salvage value. Equipment placed in service after January 1, 1990 and prior to July 1, 1993 is depreciated on a straight-line basis over the term of the lease to its estimated residual value at the end of the lease. Equipment placed in service on or after July 1, 1993 is depreciated using an accelerated method over an economic life of five years. The effect of this change in depreciation method is not material to the 1993 financial statements. The Partnership's policy is to periodically review the estimated fair market value of its equipment to assess the recoverability of its undepreciated cost. In accordance with this policy, the Partnership records a charge to depreciation expense in instances when the net book value of equipment exceeds its net realizable value. Included in depreciation expense in 1995 is a provision for $11,279 to properly reflect the equipment portfolio's net realized value during the year. Rental income is determined on the basis of rental payments due under the terms of the lease.\nNet Investment in Direct Financing Leases\nUnder the direct finance method of accounting for leases, the cost of the equipment, including acquisition fees and other expenses related to the purchase, is recorded as the net investment in direct financing leases (\"net investment\"). Earned income over the term of the lease consists of the excess of lease payments over equipment cost less the residual. Earned income is recognized monthly as a constant percentage return on the net investment.\nCOLUMBIA LEASE INCOME FUND A L.P. (A Delaware Limited Partnership)\nNotes to Financial Statements\n(3) Investment Property\nAt December 31, 1995, the Partnership owned computer equipment with a depreciated cost basis of $155,784, subject to existing leases. All purchases of computer equipment are subject to a 2.5% acquisition fee paid to the General Partner.\n(4) Conflicts of Interest and Related Party Transactions\nCompensation to General Partner\nThe General Partner has ultimate responsibility for the management of the Partnership's business. Such management includes the acquisition, lease, re-lease and sale of Partnership equipment, the responsibility to arrange for non-recourse debt financing for Partnership equipment, and the performance of general administration and accounting activities.\nThe General Partner is entitled to receive (1) acquisition fees of 2.5% of the purchase price paid by the Partnership for each item of equipment acquired; (2) equipment management fees of up to 6% of gross rental payments received with respect to the Partnership's equipment, except for equipment subject to certain leases referred to in the Partnership agreement as \"Full Payout Leases\", for which the equipment management fee shall not exceed 2% of the gross rental payments; and (3) subordinated resale fees not to exceed 3% of the proceeds derived from the sale of Partnership equipment. The General Partner and its affiliates may also receive reimbursement for the administrative services necessary for the prudent operation of the Partnership, subject to certain limitations.\nFees, commissions and other expenses paid or accrued by the Partnership to the General Partner or affiliates of the General Partner for the years ended December 31, 1995, 1994 and 1993 are as follows:\nThe management agreement signed in 1993 between Meridian-CMC and TCMC and the Agreement Relating to the Admission of TCMC as an Additional General Partner of Certain Limited Partnerships dated June 30, 1993 resulted in definitive sharing arrangements between Meridian-CMC and TCMC related to acquisition fees, equipment management fees, resale fees and General Partner distributions. These sharing agreements remain unaffected by Meridian-CMC's withdrawal as a General Partner of the Partnership.\nCOLUMBIA LEASE INCOME FUND A L.P. (A Delaware Limited Partnership)\nNotes to Financial Statements\nUnder the terms of the Partnership Agreement, the General Partner is entitled to an equipment acquisition fee of 2.5% of the purchase price paid by the Partnership for the equipment. The General Partner is also entitled to a management fee equal to 6% of the monthly rental billings, paid quarterly. In addition, the Partnership reimburses the General Partner and its affiliates for certain expenses incurred by them in connection with the operation of the Partnership.\nCompensation to Suppliers\nThe General Partner has contracted with several independent leasing companies (collectively, the \"Suppliers\") which perform most of the marketing and financing activities. Agreements with Suppliers provide for compensation to each Supplier in amounts which are deducted from the above corresponding compensation payable by the Partnership to the General Partner.\nConflicts of Interest\nThe General Partner, the Suppliers and their affiliates are engaged directly and indirectly in the business of acquiring, leasing, re-leasing and selling equipment and have formed or sponsored or are acting as the general partner of, and in the future may form or sponsor or act as the general partner of, other investment entities which may have the same or similar investment objectives.\n(5) Net Investment in Direct Financing Leases\nThere are no future minimum lease payments outstanding as of December 31, 1995 as all of the remaining direct financing leases expired during 1995.\nThe components of the net investment in direct financing leases at December 31, 1994 were as follows:\nCOLUMBIA LEASE INCOME FUND A L.P. (A Delaware Limited Partnership)\nNotes to Financial Statements\n(6) Equipment on Operating Leases\nEquipment on operating leases is comprised primarily of computer peripheral devices, small data processing systems\/attachments and computer terminals purchased from Suppliers.\nFuture minimum lease payments to be received as of December 31, 1995 under existing noncancelable operating leases are as follows:\n1996 $ 302,604 1997 68,352 --------------\n$ 370,956 ==============\nThree lessees, Eaton Corporation, Northern Indiana Public Service Company and Sports & Recreation, Incorporated, lease equipment in which the related rental payments exceed 10% of total rental income. The related rental payments comprise 16.11%, 10.50% and 19.94%, respectively, of the total rental income for the year ended December 31, 1995. Eaton Corporation, Northern Indiana Public Service Company and Sports & Recreation, Incorporated lease equipment comprising 41.48%, 10.17% and 18.30%, respectively, of the total equipment portfolio at December 31, 1995.\n(7) Distributions to Partners\nFor the years ended December 31, 1995, 1994 and 1993, declaration of Distributable Cash were as follows: Limited Partners\nEach distribution of Distributable Cash From Operations of the Partnership shall be allocated 95% to the Limited Partners and 5% to the General Partner. Any Distributable Cash From Sales or Refinancings from gains and losses shall be allocated 99% to the Limited Partners and 1% to the General Partner until \"Payout\" has occurred. \"Payout\" means the time when the aggregate amount of all distributions to the Limited Partners of Distributable Cash From Operations and of Distributable Cash From Sales or Refinancings equals the aggregate amount of the Limited Partners' original invested capital plus a cumulative 8% annual return (compounded daily) on their aggregate unreturned capital contributions invested capital (calculated from the beginning of the first full fiscal quarter following the Partnership's closing date). Thereafter, 85% will be distributed to the Limited Partners and 15% to the General Partner, subject to certain adjustments. Including the distribution for the fourth quarter of 1995 made February 15, 1996, the cumulative distributions to date are $586.49 per Unit. This cumulative distribution per Unit amount represents 59.47% of Payout. It is not anticipated that Payout will occur as of the liquidation of this Partnership. Distributions to partners in excess of net income represent a return of capital. See note 9 regarding General Partner distributions which have been returned to the Partnership during the current and prior years.\nCOLUMBIA LEASE INCOME FUND A L.P. (A Delaware Limited Partnership)\nNotes to Financial Statements\n(8) Net Income or Loss per Unit\nNet income for financial reporting purposes is allocated to partners in the same proportions as Distributable Cash From Operations is distributed to partners. Net loss for financial reporting purposes is allocated to partners in the same proportions as Distributable Cash From Sales or Refinancings to partners. Net income or loss per Unit is calculated based on the Limited Partners' share of net income or loss and the number of Units outstanding.\n(9) Reallocation of Capital Accounts\nUnder the terms of the Partnership agreement, the amount of deficit capital account that any General Partner can be required to fund upon termination of the Partnership is limited to a percentage of the capital contributed by the Limited Partners (the \"Maximum Deficit\"). Consequently, the General Partner's equity has been adjusted to reflect this limitation, with a corresponding adjustment to the Limited Partners' equity. TMC and Meridian-CMC agreed that once they collectively received $500,000 of General Partner distributions from the Partnership and the Other CLIF Partnerships subsequent to October 24, 1989, they would return their distributions to the Partnership until the Maximum Deficit had been eliminated. TMC and Meridian-CMC received a total of $500,000 via the May 15, 1991 distribution.\nTo the extent that the General Partner's distributions less its allocation of net income or loss has exceeded or does in the future exceed the Maximum Deficit, a memo account will be created for this excess. If, in the future, net income allocated to the General Partner exceeds distributions, this excess will be credited to the Limited Partners until the memo account has been reduced to zero.\nCOLUMBIA LEASE INCOME FUND A L.P. (A Delaware Limited Partnership)\nNotes to Financial Statements\n(10) Reconciliation of Financial Statement Net (Loss) Income to Taxable Income to Partners\nA reconciliation of financial statement net (loss) income to taxable income to partners is as follows for the years ended December 31, 1995, 1994 and 1993:\nLosses for federal tax purposes are allocated 99% to Limited Partners and 1% to the General Partner. Profits for federal tax purposes are allocated in the same manner as losses if the Partnership has cumulative taxable losses from inception and are allocated 95% to the Limited Partners and 5% to the General Partner if the Partnership has cumulative taxable profits.\nCOLUMBIA LEASE INCOME FUND A L.P. (A Delaware Limited Partnership)\nNotes to Financial Statements\n(11) Equipment Joint Venture\nOn October 7, 1985, the Partnership entered into a joint venture agreement with Columbia Lease Income Fund B L.P. (\"CLIF I-B\"), an affiliated limited partnership, whereby the Partnership and CLIF I-B each share an interest of 50% in the capital and profits of certain equipment with an original aggregate cost of $1,535,548. Such equipment was subject to a lease with a term of 24 months with one lessee. From 1987 to 1994, portions of the equipment with an original aggregate cost of $1,484,723 were sold for aggregate sales proceeds of $144,415. As of December 31, 1995, the remaining equipment with an original aggregate cost of $50,825 was sold for aggregate sales proceeds of $2,075. No other equipment joint ventures remain at December 31, 1995.\n(12) Bankruptcy of Continental Information Systems Corporation\nOn January 13, 1989 (\"Petition Date\"), Continental Information Systems Corporation (\"Continental\"), CMI Holding Co. (\"Holding\"), CMI Corporation, CIS Corporation (\"CIS\"), and certain of their affiliates (collectively, the \"Debtors\") voluntarily petitioned for relief under Chapter 11 of the United States Bankruptcy Code (\"Chapter 11\"), and thereafter continued in the management and operation of their businesses and property as Debtors In Possession until October 25, 1989, when the United States Bankruptcy Court (the \"Court\") confirmed the appointment of James P. Hassett as Chapter 11 trustee (the \"Trustee\") of the Debtors. TLP Leasing Programs, Inc. (\"TLP\"), the parent company of TLP-Columbia Management Corporation (\"TCMC\"), is a wholly-owned subsidiary of Holding, but did not file under Chapter 11. TCMC has continued to manage and provide services for the Partnership in accordance with the Partnership Agreement, as they have in the past. Holding became a wholly-owned subsidiary of CIS pursuant to a Court ordered settlement on July 20, 1993.\nOn November 29, 1994, the Court confirmed the Trustee's proposed Joint Plan of Reorganization dated October 4, 1994, and the Debtors emerged from Chapter 11 bankruptcy protection on December 21, 1994.\n(13) Subsequent Events\nOn January 9, 1996, TLP Holding LLC purchased all the common stock of TLP from Holding. Under the new ownership, it is expected that TLP will continue to operate in the same manner of business as it has in the past.\nCOLUMBIA LEASE INCOME FUND A L.P. (A Delaware Limited Partnership)\nSchedule II - Valuation and Qualifying Accounts and Reserves\nItem 9.","section_9":"Item 9.Changes in and Disagreements with Accountants on Accounting and Financial Statement Disclosures.\nNone.\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\nThe Partnership has no Directors or Officers. As indicated in Item 1. of this report, the General Partner of the Partnership is TCMC. Under the Partnership Agreement, the General Partner is solely responsible for the operation of the Partnership's properties, and the Limited Partners have no right to participate in the control of such operations. The names and ages of the Directors and Executive Officers of the General Partner are as follows:\nTLP Columbia Management Corporation\n(c) Identification of certain significant persons\nSee Item 10. (a-b)\n(d) Family relationship\nNo family relationship exists between any of the foregoing Directors or Officers.\n(e) Business experience\nArthur P. Beecher is President of TCMC and President and Director of TLP. He is also President and Assistant Secretary of CIS Management Services Corporation (\"CISMS\"). Prior to joining TLP, Mr. Beecher was an Officer of Computer Systems of America, Inc. in Boston, Massachusetts, most recently as Vice President, Finance and Administration since 1975. Mr. Beecher holds a B.S. from Boston University and is a Certified Public Accountant.\nThomas J. Prinzing is a Director of TLP and CISMS. On December 18, 1995, Mr. Prinzing was elected President, Chief Executive Officer and Director of Continental Information Systems Corporation (\"CISC\"). Mr. Prinzing is also the President of CIS Air Corporation, a position he has held since 1991. From 1984 to 1991 he was Senior Vice President and Chief Financial Officer of CIS. Mr. Prinzing has an Honors Bachelor of Commerce degree of the University of Windsor and is a Certified Public Accountant.\nFrank J. Corcoran is Director, Vice President, Treasurer and Clerk of TLP, and is also Vice President, Treasurer and Clerk of CISMS. Mr. Corcoran is Senior Vice President, Chief Financial Officer, Treasurer and Director of CIS and a Vice President and Treasurer of Holding. Prior to joining CIS in November 1994, he was with Unisys Finance Corporation, from 1985 to 1994, most recently as the Vice President and General Manager. Mr. Corcoran holds a B.S. from Wayne State University, a M.S. in Taxation from Walsh College and is a Certified Public Accountant.\n(f) Involvement in certain legal proceedings\nThe Partnership is not aware of any legal proceedings against any Director or Executive Officer of the General Partner which may be important for the evaluation of any such person's ability and integrity.\nItem 11.","section_11":"Item 11. Management Remuneration and Transactions.\n(a), (b), (c), (d), and (e): The Officers and Directors of the General Partner receive no current or proposed direct remuneration in such capacities, pursuant to any standard arrangements or otherwise, from the Partnership. In addition, the Partnership has not paid and does not propose to pay any options, warrants or rights to the Officers and Directors of the General Partner. There exists no remuneration plan or arrangement with any Officer or Director of the General Partner resulting from the resignation, retirement or any other termination. See note 4 to the financial statements included in Item 8. of this report for a description of the remuneration paid by the Partnership to the General Partner and its affiliates during 1995, 1994 and 1993.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Owners and Management.\nBy virtue of its organization as a Limited Partnership, the Partnership has no outstanding securities possessing traditional voting rights. However, as provided for in Section 13.2 of the Amended Agreement of Limited Partnership (subject to Section 13.3), a majority interest of the Limited Partners have voting rights with respect to:\n1. Amendment of the Limited Partnership Agreement;\n2. Termination of the Partnership;\n3. Removal of the General Partner; and\n4. Approval or disapproval of the sale of substantially all the assets of the Partnership.\nNo person or group is known by the General Partner to own beneficially more than 5% of the Partnership's 24,383 outstanding Limited Partnership Units as of December 31, 1995.\nBy virtue of its organization as a Limited Partnership, the Partnership has no Officers or Directors. See also note 1 to the financial statements included in Item 8. and Item 10. of this report.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nSee Items 1., 8. note (4), 11. and 12. above for information concerning transactions with TCMC and Meridian-CMC and their affiliates.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nCOLUMBIA LEASE INCOME FUND A L.P. (Registrant)\nBy: TLP COLUMBIA MANAGEMENT CORPORATION, its General Partner\nDate: March 28, 1996\nBy: Arthur P. Beecher, President","section_14":"","section_15":""}
{"filename":"107833_1995.txt","cik":"107833","year":"1995","section_1":"ITEM 1. BUSINESS\nA. GENERAL\nWPS Resources Corporation\nWPS Resources Corporation (\"Company\"), a Wisconsin Corporation, was incorporated on December 3, 1993 as a subsidiary of Wisconsin Public Service Corporation (\"WPSC\"). On September 1, 1994, the Company, in a share-for-share exchange of common stock, acquired all of the common stock of WPSC, $4 par value, and issued to the former shareholders of WPSC shares of the Company's common stock, $1 par value. The Company operates as a holding company with both regulated (utility) and non-regulated business units. The Company is the parent of WPSC, a regulated electric and gas utility, and WPSC's non- regulated subsidiary, WPS Leasing, Inc. At December 31, 1995, WPSC represented 92% and 97% of the Company's consolidated revenues and assets, respectively. At January 1, 1995, there were four non-regulated subsidiaries of the Company, WPS Energy Services, Inc. (\"ESI\"), WPS Power Development, Inc. (\"PDI\"), Packerland Energy Services, Inc. (\"Packerland\"), and WPS Communications, Inc. (\"Communications\"). On January 3, 1995, Packerland was merged into ESI in an effort to consolidate the marketing of energy and related services. On December 14, 1995, Communications was merged into WPSC.\nWisconsin Public Service Corporation\nAt December 31, 1995, WPSC served at retail 360,977 electric customers and 204,726 gas customers in an 11,000 square mile service territory in Northeastern Wisconsin and an adjacent part of Upper Michigan. Additionally, WPSC provides wholesale, full or partial requirements electric service, either directly or indirectly, to 11 municipal utilities, 2 Rural Electrification Administration financed electric cooperatives, and a privately held utility. About 98% of operating revenues in the year 1995 were derived from Wisconsin customers and 2% from Michigan customers. Of total revenues in 1995, 74% were from electric operations and 26% from gas operations. Of total electric revenues, 92% were from retail sales and 8% were from wholesale sales.\nWPSC's retail service areas are principally protected in Wisconsin by indeterminate permits secured by statute, and in the state of Michigan by franchises granted by municipalities.\nB. ELECTRIC MATTERS\nINDUSTRY RESTRUCTURING. The Federal Energy Regulatory Commission (\"FERC\"), in March 1995, issued a notice of proposed rulemaking which would: (1) require all utilities under the FERC's jurisdiction, including WPSC, to file non-discriminatory, open access transmission tariffs which would be available to all wholesale buyers and sellers of electric energy, (2) require utilities to take service under the\ntariffs for their own wholesale sales and purchases of electric energy, and (3) provide utilities with an opportunity to recover stranded costs (i.e., unrecovered investment in facilities that are no longer economical to operate). When implemented, this regulatory initiative might force investor-owned utilities to separate their generation, transmission, and distribution functions in order to create a level playing field where they can compete with municipal utilities, cooperatives, independent power producers, energy marketers, and brokers.\nWPSC is developing and implementing strategies to deal with the FERC's March 29, 1995 Notice of Proposed Rulemaking on transmission access and stranded investment. WPSC will develop a separate internal transmission group to meet the Proposed Rulemaking's functional unbundling requirement. WPSC has also filed comparable transmission access tariffs which have been accepted for use, subject to refund. Comparable transmission access tariffs, as defined by FERC, provide transmission access to other parties on the same terms and conditions that WPSC provides transmission service to itself. Approval of these tariffs are contingent upon a number of considerations including FERC's final rulemaking expected later in 1996.\nIn December 1995, the Public Service Commission of Wisconsin (\"PSCW\") outlined its plan for restructuring the electric industry in Wisconsin. Utilities are required to develop detailed plans illustrating how they plan to separate generation, transmission, distribution, and energy services functions into separate business units and establish transfer prices for use between the business units.\nUnder the PSCW plan, the competitive market for new generation would be enhanced by modifying the present bidding process and replacing the Advance Plan process with a \"strategic evaluation\" process. The PSCW also concluded that the economic benefits and responsiblities of existing generation belong to present customers.\nThe PSCW would continue transmission regulation by retaining control over planning and siting of transmission facilities. To limit the market power of current transmission owners, the PSCW proposes moving either to appointment of an independent transmission system operator or to organization of a single state-wide transmission system.\nAs part of its continuing assessment of retail access, the PSCW would establish broad pricing reforms for customer segments and quality of service standards. The PSCW would retain jurisdiction over low income programs, the winter moratorium on disconnection, demand- side management, renewables, and research and development funding. A Public Benefits Advisory Board would be formed to advise the PSCW on conservation and renewable resource issues.\nThe Wisconsin Legislature is not expected to consider electric restructuring until 1997. In the meantime, the PSCW, utility companies, various advocacy groups, and utility customers will continue to dialogue in an effort to reach a consensus on when and how to introduce retail competition into the electric marketplace. The\nPSCW timetable would provide all retail electric customers with energy supply choices by 2001.\nTwo major mergers were announced in the WPSC region during 1995. Wisconsin Energy Corporation and Northern States Power Company announced that they are taking steps to form Primergy; and Wisconsin Power and Light Company plans to join with IES Industries, Inc. and Interstate Power Company to form Interstate Energy Corporation. WPSC is following these developments closely and is taking the actions necessary to assure WPSC's continued access to the bulk power markets.\nELECTRIC OPERATIONS. The largest communities served at retail with electricity are the cities of Green Bay, Oshkosh, Wausau, and Stevens Point.\nWPSC owns 33.1% of the outstanding capital stock of Wisconsin River Power Company (\"River Power\"). The business of River Power consists of the ownership and operation of two dams and related hydroelectric plants on the Wisconsin River having an aggregate installed capacity of about 35,000 Kw. The output of the hydroelectric plants is sold, at the sites of the plants, to the three companies which own the outstanding capital stock substantially in proportion to their stock ownership interests.\nGENERATING CAPACITY. Coordinated planning for generation and transmission is a function of the Wisconsin Upper Michigan Systems of which WPSC is a member along with Madison Gas and Electric Company (\"MG&E\"), Upper Peninsula Power Company, Wisconsin Electric Power Company (\"WEPCO\"), Wisconsin Power and Light Company (\"WP&L\"), and Wisconsin Public Power, Inc. (\"WPPI\"). Existing and planned interconnections with other neighboring utilities provide a further means of sharing reserve capacities and interchanging energy.\nWPSC's maximum net load in 1995 was 1,743,000 Kw which occurred on July 13. The maximum net load was made up of 1,670,000 Kw of net native load and 73,000 Kw of firm capacity sales to other utilities (maximum net load in past 10-K reports included only net native load). At the time of the maximum net load, owned generating capability was 1,833,100 Kw and, including firm purchases and sales to other utilities, WPSC's reserve margin was 8.0%. Without the firm sales, that were committed only for 1995, WPSC's reserve margin would have been 12.8%. WPSC's future reserves, also adjusted for firm purchases and sales and planned capacity additions, are estimated to be above the planning criteria of a 15% minimum reserve in 1996 and 1997. See Part I, Item 2, PROPERTIES, at page 25 for information concerning generating facilities.\nIn November 1995, WPSC signed a 25-year agreement to purchase power from Polsky Energy Corporation (\"Polsky\"), an independent power producer proposing to build a plant adjacent to the Nicolet Paper Company mill in DePere, Wisconsin. The first phase of the project calls for completion of a 179-megawatt combustion turbine facility in 1999. The second phase, scheduled to be in service in 2004, converts the facility to a combined cycle unit and increases the total capacity to 232 megawatts.\nThe Polsky project is in the second stage of a two-stage Certificate of Public Convenience and Necessity (\"CPCN\") permitting process prescribed by the PSCW. In the first stage of the CPCN process, the Rhinelander Energy Center (\"REC\") was selected as the best of 13 project proposals to meet WPSC's future electrical needs. The Polsky project, which was ranked second, became the primary project in August of 1995 when the REC project was canceled due to Rhinelander Paper Company, Inc.'s termination of negotiations to receive steam from the REC. As a result of this cancellation, in September 1995 WPSC wrote off its entire investment in the REC project. The charge, which totaled $2.7 million ($1.6 million after tax), was recorded as other expense, reducing net income by $.07 per share.\nConstruction of the Polsky project is contingent upon PSCW approval in stage two of the CPCN process. The PSCW has stated that during stage two of the CPCN proceedings, evidence of the need for the facility will be considered. A final decision on stage two of the CPCN for the Polsky project is expected in 1997.\nADVANCE PLAN. In December of 1995, the PSCW approved the Advance Plan 7 order. The transmission and generation plans submitted by WPSC in Advance Plan 7 were approved. The Advance Plan order provides that WPSC provide cost effective demand-side energy management programs. The order stresses use of renewable resources such as wind and biomass and the statewide development of design and feasibility of increased use of solar water heating and the use of natural light in new building design.\nKEWAUNEE NUCLEAR POWER PLANT. The Kewaunee Nuclear Power Plant (\"Kewaunee\") is operated by WPSC. WPSC has a 41.2% ownership interest in Kewaunee which it owns jointly with two other utilities. The Kewaunee operating license expires in 2013.\nThe steam generator tubes at Kewaunee are susceptible to corrosion characteristics seen throughout the nuclear industry. During the first quarter of 1995, Kewaunee was shut down for scheduled maintenance and refueling. Inspection of the steam generators revealed increased levels of tube degradation. Prior to the shutdown, the equivalent of approximately 12% of the tubes in the steam generators were plugged with no loss of capacity. When the plant was returned to service in May 1995, approximately 21% of the tubes were plugged, resulting in an initial capacity reduction of approximately 4%. Approximately half of this lost capacity has been recovered through operating modifications. The ultimate small reduction in capacity did not affect earnings in 1995 because of operating and maintenance cost savings and reserve capacity recovery efforts at Kewaunee.\nAs a result of the need to keep Kewaunee cost competitive and to address the repair or replacement of the steam generators, the owners of Kewaunee have been and are continuing to evaluate various alternatives to deal with the potential future loss of capacity resulting from the continuing degradation of the steam generator tubes. As part of this evaluation, the following actions are being taken:\n(a) A request has been submitted to the Nuclear Regulatory Commission (\"NRC\") to redefine the pressure boundary point of the repaired steam generator tubes (sleeved tubes), which have been removed from service by plugging, in order to allow the return of many of the sleeved tubes to service. If the request is granted, and even if additional degraded tubes would be discovered during the next planned shutdown in the fall of 1996, Kewaunee should be able to return to near full capacity at that time.\n(b) A request will be submitted to the NRC to allow the owners to pursue welded repair technologies to repair existing sleeved tubes in an effort to return plugged tubes to service. Although welded tube repair technologies exist, such technologies have not yet been approved by the NRC.\n(c) Continuing evaluations are being performed with respect to the economics of replacing the steam generators. Replacement of steam generators is estimated to cost approximately $100 million, exclusive of additional purchase power costs associated with an extended shutdown.\n(d) WPSC is evaluating the need to accelerate the collection of funds for decommissioning and the recovery of existing investment.\nWPSC believes Kewaunee can remain cost competitive and generate economically until the expiration of the operating license in 2013, but that it is probable that this cannot be achieved without replacement of the steam generators. There are many uncertainties which may impact the future operations of Kewaunee such as steam generator tube damage and degradation rates, development of repair technologies, regulatory approvals, and changes in power generation economics which can lead to continued repair strategies, a steam generator replacement decision, or a decision to retire Kewaunee earlier than the year 2013.\nAs operator of Kewaunee and based on our current view of future energy prices, WPSC believes it is prudent to seek prompt regulatory approval to replace the steam generators. A consensus in this regard has not been reached with the other owners of Kewaunee and will be the subject of further discussion. Steam generator replacement, in the opinion of WPSC management, would reduce the financial risks that would be associated with an unplanned shutdown due to continued steam generator degradation.\nOperating and maintenance costs at Kewaunee have been reduced more than 25% over the last three years. Continued reduction of costs, while not sacrificing safety, is planned to keep Kewaunee cost competitive. The NRC continues to rate Kewaunee superior (Category 1) in all areas: maintenance, operations, engineering, and plant support.\nIf Kewaunee remains in operation until expiration of the operating license, physical decommissioning is expected to occur during the period 2014 to 2021 with additional expenditures being\nincurred during the period 2022 to 2050 related to the storage of spent nuclear fuel at the site. In July 1994, the PSCW issued an order covering all Wisconsin utilities with nuclear generation. The order standardizes cost escalation assumptions used in determining decommissioning liabilities. Based on this methodology, and considering other assumption changes, Kewaunee decommissioning costs are estimated to be $376 million in current dollars and $1,905 million in year-of-expenditure dollars. WPSC's share of Kewaunee decommissioning costs are estimated to be $155 million in current dollars and $785 million in year-of-expenditure dollars. These costs are recovered currently in customer rates and deposited in external trusts. As of December 31, 1995, the external trusts totaled $82.1 million.\nSpent fuel is currently stored at Kewaunee. The existing capacity of the spent fuel storage facility will enable storage of the projected quantities of spent fuel through April 2001. WPSC is evaluating options for the storage of additional quantities beyond 2001. Several technologies are available. An investment of approximately $2.5 million in the early 2000s could provide additional storage sufficient to meet spent fuel storage needs until expiration of the current operating license in 2013.\nThe Low-Level Radioactive Waste Policy Act of 1980 specifies that states may enter into compacts to provide for regional low-level waste disposal facilities. Wisconsin is a member of the Midwest Low Level Radioactive Waste Compact. The state of Ohio has been selected as the host state for the Midwest Compact and is proceeding with the preliminary phases of site selection. In July 1995, the Barnwell, South Carolina, disposal facility again began to accept low-level radioactive waste materials from outside its region.\nThe Kewaunee capability factor was 83.1% in 1995, compared to a projected industry average of 84.5%.\nFUEL SUPPLY. WPSC's electric generation mix in 1995 compared to 1994 was: steam plants (coal), 63.7%, up from 62.6%; steam plant (nuclear), 13.5%, down from 14.5%; hydro, 2.6%, unchanged from 2.6%; combined natural gas and fuel oil, .9%, up from .7%; and purchased power, 19.3%, down from 19.6%. Purchased power represents short-term energy purchases.\nWPSC has reduced overall fuel costs for the sixth consecutive year. Fuel costs in 1995 compared with 1994, expressed in dollars per million Btu, were: nuclear, $.50, up from $.49; coal, $1.18, down from $1.31; natural gas, $2.29, down from $2.77; and No. 2 fuel oil, $4.35, up from $4.15.\nIn 1996, WPSC will purchase all of the coal for its solely-owned plants from Western sources. Delivery of coal at the Pulliam plant is via railroad or lake vessel and at the Weston, Columbia, and Edgewater plants via railroad.\nThe Pulliam and Weston power plants burn Powder River Basin sub-bituminous coal. WPSC has a long-term contract with one coal supplier that is expected to provide approximately two-thirds of the\nprojected 1996 coal requirements for Unit 3 at Weston. The coal contract will provide low sulfur Powder River Basin coal for a term ending in 2016. The remainder of the coal for solely-owned generating facilities will be purchased under short-term agreements of two years or less.\nDuring 1991, WPSC bought out the coal supply agreement with NERCO Coal Company (\"NERCO\") and the corresponding rail transportation contracts with the Soo Line and the Wisconsin Central (\"Railroads\"). WPSC paid approximately $34 million to NERCO and the Railroads as compensation for relief of all contractual obligations. The PSCW has ruled that the railroad and coal contract buyout costs may be recovered in customer rates subject to a benefits test. In the Wisconsin jurisdiction, the remaining unamortized buyout costs of $7.7 million will be recovered during 1996. FERC issued a conditional order on November 15, 1994 allowing recovery of all but approximately $3.6 million of NERCO buyout costs through a monthly surcharge rate over the period January 1993 through December 2005. The portion of the $3.6 million disallowance allocable to the FERC jurisdiction has not been determined. Management believes it is likely that the disallowance allocable to the FERC jurisdiction will not exceed the $625,000 write-off taken in 1993 in anticipation of the disallowance. WPSC will accrue and recover carrying charges on the unrecovered balance.\nWPSC also has a 31.8% ownership share in Columbia and a 31.8% ownership share in the Edgewater Unit 4, both of which are operated by WP&L which has coal procurement responsibilities for these units. Columbia, with two 527-megawatt units, uses coal from the Wyoming- Montana coal fields. The entire low sulfur coal supply for Units 1 and 2 is supplied from the Southern Powder River Basin under short-term contracts of one to three years. Edgewater uses a blend of bituminous and sub-bituminous Powder River Basin coal both of which are acquired under short-term contracts.\nThe supply of nuclear fuel for Kewaunee requires the purchase of uranium concentrates, the conversion of uranium concentrates to uranium hexafluoride, enrichment of the uranium hexafluoride, and fabrication of the enriched uranium into usable fuel assemblies. After a region of spent fuel (approximately one-third of the nuclear fuel assemblies in the reactor) is removed from the reactor, it is placed in temporary storage in a spent fuel pool at the plant site. Permanent storage is addressed below. There are presently no operating facilities in the United States that are reprocessing commercial nuclear fuel. A discussion of the nuclear fuel supply for Kewaunee follows:\n(a) Requirements for uranium are met through spot or contract purchases. An inventory policy, which takes advantage of economical spot market purchases of uranium, results in WPSC maintaining inventories sufficient for up to two reactor reloads of fuel, excluding in-process uranium.\n(b) Uranium hexafluoride from inventory and from spot market purchases was used to satisfy converted material requirements in 1995. WPSC intends to purchase future\nconversion services on the spot market unless it can negotiate economical long-term contracts with primary suppliers.\n(c) In 1995, enrichment services were not required. However, future services will be procured from COGEMA, Inc. pursuant to a contract executed in 1983 and last amended in 1995. Enrichment services are also purchased from the United States Enrichment Corporation (\"USEC\") under the terms of the utility services contract which is in effect for the life of Kewaunee. WPSC is committed to take 70% of its annual enrichment requirements in 1997 and, in alternate years thereafter, from the Enrichment Corporation.\n(d) Fuel fabrication services through March 15, 2001 are covered by contract with Siemens Power Corporation.\n(e) Beyond the stated periods set forth above, additional contracts for uranium concentrates, conversion to uranium hexafluoride, enrichment, fabrication, and spent fuel storage will have to be procured. WPSC anticipates the prices for the foregoing will modestly increase.\nPursuant to the Nuclear Waste Policy Act of 1982 (\"Nuclear Policy Act\"), the U. S. Department of Energy (\"DOE\") entered into a contract with WPSC to accept, transport, and dispose of spent nuclear fuel beginning no later than January 31, 1998. It is likely that the DOE will delay the acceptance of spent nuclear fuel beyond 1998. A fee to offset the costs of the DOE's disposal for all spent fuel used since April 7, 1983 has been assessed by the DOE at one mill per net kilowatt hour of electricity generated and sold by Kewaunee. An additional one-time fee was paid to the DOE for disposal of spent nuclear fuel used to generate electricity prior to April 7, 1983.\nThe Nuclear Policy Act provides that both the federal government and the nuclear utilities fund the decontamination and decommissioning of the three gaseous diffusion plants in the United States. Utility contributions will be collected through a special assessment based on a utility's percentage of uranium enrichment services purchased through the date of enactment compared to total enrichment sales by the DOE. The owners of Kewaunee are required to pay approximately $19.2 million in current dollars over a period of 15 years. At December 31, 1995, the remaining liability was $14.4 million of which WPSC's share was $5.9 million. The payments are subject to adjustment for inflation.\nIn 1995, Yankee Atomic Electric Company (\"Yankee Atomic\") received a United States Court of Federal Claims decision that Yankee Atomic was entitled to a refund of $3 million paid to the Uranium Enrichment Decontamination and Decommissioning Fund. The court ruled that by entering into contracts with utilities, the government agreed to charge certain prices for uranium enrichment services that could not be legislatively changed after performance and payment were completed. The Yankee Atomic decision addresses only a refund to Yankee Atomic. Based on the Yankee Atomic decision, WPSC is investigating options and actions available.\nUtility customers of the United States Enrichment Corporation (\"USEC\") have challenged the pricing of enrichment services, by the USEC, subsequent to the Energy Policy Act of 1992. The position of the utilities is that the charges by the USEC are higher than the terms of the contracts originally entered into with the DOE. WPSC is investigating the situation to determine actions available.\nOTHER MATTERS. The Company is seeking FERC \"marketer\" status. This status will give WPSC, ESI, and PDI the flexibility to sell energy and capacity at market rates rather than only at cost-based rates. ESI and PDI have received PSCW approval of \"marketer\" status. WPSC would also have to receive PSCW approval for this status.\nWPSC faces increased competition in the wholesale power market. This may result in the loss of certain wholesale customers and reduced margins. WPSC intends to compete aggressively to retain wholesale load and to secure new wholesale load.\nIn October 1992, Wisconsin Public Power, Inc. (\"WPPI\") notified WPSC that it was ending its agreement to purchase power effective in October 1997. WPPI is a wholesale customer which buys 66 megawatts of electricity from WPSC for resale to municipal utilities in Algoma, Eagle River, New Holstein, Sturgeon Bay, and Two Rivers. WPPI entered into an agreement to buy power from another Wisconsin utility during the 1997-2009 period.\nAs a result of a bidding process, WPSC has been selected to serve the power needs of the Oconto Electric Cooperative for the period of May 1996 through April of 2005. It is expected that a contract will be signed in 1996. The peak demand for Oconto Electric Cooperative is 17 megawatts.\nAlthough 11% of electric revenues come from sales to 20 paper mills, resulting in a relatively high and favorable load factor, there is no single customer or small group of customers, the loss of which would have a materially adverse effect on the electric business of WPSC under the current regulatory environment.\nWPSC has begun construction of a jointly owned 138 Kv transmission line extending from New London to Stevens Point. WPSC's share of the 60-mile transmission project will cost approximately $14.9 million. The remaining $9.6 million cost of the project is the responsibility of WEPCO and WP&L. Completion of the project is expected by early 1997.\nWPSC is awaiting a ruling from the PSCW regarding the Wausau to Abbotsford transmission project, which is part of a larger transmission interface project with Northern States Power Company, consisting of the reconstruction of approximately 23 miles of 115 Kv transmission line. WPSC's share of the cost of the project is estimated to be $4.2 million.\nApplications for relicensing of WPSC's Caldron Falls, High Falls, Johnson Falls, Sandstone Rapids, Potato Rapids, Peshtigo, Grand Rapids, and Jersey Projects were submitted to the FERC in December 1991. These licenses, representing 30 megawatts of\nhydroelectric generating capacity, expired in December 1993. Application to the FERC for relicensing of WPSC's Wausau Project was submitted in June 1993. The license for this project expired in June of 1995 and represents 5,400 kilowatts of capacity. Since the FERC had not considered WPSC's applications at the license expiration dates, the licenses have been extended on an annual basis until FERC acts on the applications.\nElectric research and development expenditures totaled $2.6 million for 1995, $2.3 million for 1994, and $2.1 million for 1993. These expenditures were made for WPSC sponsored projects and were primarily charged to electric operations.\nELECTRIC FINANCIAL SUMMARY. The following table sets forth the revenues, operating income, and identifiable assets attributable to electric utility operations:\nYEAR ENDED DECEMBER 31 -------------------------- 1995 1994 1993 ---- ---- ---- (Thousands) Electric Operating Revenues $489,628 $480,816 $493,256\nOperating Income, Including Allowance For Funds Used During Construction $ 98,556 $ 95,392 $106,160\nIdentifiable Assets $926,888 $937,481 $938,951\nSee Note 8 in Notes to Consolidated Financial Statements.\nPAGE\nC. GAS MATTERS\nINDUSTRY RESTRUCTURING. The re-regulation of the natural gas business on the federal level prompted the PSCW to begin examining the future regulation of the natural gas distribution business in Wisconsin. In mid-September 1995, the PSCW tentatively concluded that once a class of customers has access to the competitive marketplace, they will be expected to purchase gas from unregulated suppliers and, possibly, lose the utility option for gas supply. Utilities would only transport gas to such customers. The PSCW also tentatively concluded that utilities could be required to offer unbundled pricing and service choices to their natural gas customers.\nThe Michigan Public Service Commission (\"MPSC\") initiated a similar process to look at gas industry restructuring by forming a committee of interested parties which will consider changes in the gas cost recovery mechanism, service unbundling, curtailment issues, and storage issues. The MPSC opened a formal docket on this issue and began prehearings in February 1996.\nOTHER MATTERS. At December 31, 1995, WPSC provided natural gas distribution service to 199,577 customers in 149 cities, villages, and towns in Northeastern Wisconsin and 5,028 customers in and around Menominee, Michigan. The principal Wisconsin cities served include Green Bay, Oshkosh, Sheboygan, Marinette, Two Rivers, Stevens Point, and Rhinelander. The principal Michigan city is Menominee.\nWPSC transported 62,634,059 dekatherms of gas of which 38,042,369 dekatherms were for resale during the year ended December 31, 1995. At the end of 1995, WPSC had 117 end-user customers who purchased their gas directly from suppliers and contracted with transporters, including WPSC, to transport the gas to their points of use. A total of 24,591,690 dekatherms was transported for these customers. Load loss due to fuel switching has been minor because customers have been able to purchase transportation gas from suppliers at competitive prices.\nBecause WPSC has a purchased gas adjustment provision as part of its customer rates, it recovers all of its purchased gas costs from customers. This allows WPSC to receive the same margin (gas revenues less cost of gas) on therm sales to similar customers who purchase natural gas from WPSC as it receives from transportation customers. The PSCW has opened a docket on the purchased gas adjustment clause. Hearings are anticipated to begin in March 1996.\nWPSC has created a gas supply portfolio to match its gas load profile at the lowest reasonable cost. The portfolio is based on 20-year gas peak day and annual sales forecasts and is structured to place WPSC in an optimum gas purchasing position. WPSC has entered into 16 gas supply contracts with 14 suppliers with terms from 3 months to 5 years with domestic suppliers and 10 years with Canadian suppliers. There are 8 years remaining on the contracts with Canadian suppliers. The gas is competitively priced based on a monthly spot price index. The gas supply contracts contain a gas inventory charge as well as corporate warranties to assure gas deliverability for the term of the contract.\nPeak day design requirements of 347,827 dekatherms per day are based on a 1995-1996 peak day forecast. An additional 4,245 dekatherms per day, or 1.2%, of reserve capacity allows for growth and any unforeseen need. Peak day requirements will be served by 124,707 dekatherms per day from transportation gas, and 223,120 dekatherms per day from storage gas. WPSC has access to 11.3 billion cubic feet of storage capacity in Michigan. Storage gas is purchased and stored during the summer for redelivery during the heating season. WPSC has purchased 0.25 billion cubic feet of underground salt dome storage in the production area to protect against a supply area gas shortage (e.g., wellhead freeze-offs).\nWPSC transports gas from Louisiana, the Gulf of Mexico, the Texas-Oklahoma Panhandle area, and Canada under contracts with ANR Pipeline Company (\"ANR\") for domestic gas and Viking Gas Transmission Company (\"Viking\") for Canadian supplies. On November 1, 1993, FERC Order 636 became effective for ANR. Order 636 prohibits pipeline companies (such as ANR) from bundling gas merchant services with transportation services. Thus, Order 636 shifts gas supply responsibilities to local distribution companies (such as WPSC) while the pipeline companies continue to transport gas owned by others. Pipeline transportation rates are governed by tariffs subject to adjustment by the pipeline companies with the approval of the FERC. As a result of restructuring under Order 636, effective November 1, 1993, WPSC contracted for its pro rata share of pipeline capacity from each of ANR's three supply areas: Southeast, Southwest, and Canada. The initial term of each contract was for ten years with the right to extend in five-year increments. There are eight years remaining on these capacity contracts. In addition, WPSC has pre-existing capacity with Viking for delivery of Canadian gas for a remaining term of two years with a right to extend.\nOrder 636 mandates a straight fixed-variable rate design which loads all fixed costs into the reservation charge and all variable costs into the commodity charge. Based on rates effective May 1, 1994, pipeline company reservation charges for 1995 totaled $41.3 million. WPSC also utilizes ANR's no-notice service to accommodate load swings caused by unexpected system requirements such as weather changes.\nOn December 30, 1995, in FERC Docket No. RP96-106-000, ANR filed its seventh annual reconciliation of the take-or-pay buyout\/buydown costs recovered through monthly charges. These costs, representing 75% of ANR's total take-or-pay buyout\/buydown costs paid to their gas suppliers, are being passed on to ANR's customers, including WPSC. WPSC's remaining fixed charge obligation for the take-or-pay docket outstanding is $48,195. Monthly fixed charge payments and volumetric payments are scheduled to be made through April 1998. All such costs are expected to be recovered from customers pursuant to established policies of the PSCW and the MPSC.\nANR, as a result of its FERC Order 636 compliance filing, will recover various transition costs from its customers, including WPSC. WPSC expects to recover ANR transition costs in future customer rates. These costs include purchased gas adjustment costs of which WPSC's share is approximately $2.7 million. In addition, ANR has upstream\npipeline capacity costs of between $58 million and $248 million of which WPSC's share is approximately 10%. The exact amount cannot be determined at this time.\nWPSC is currently being billed for ANR's above-market costs of gas purchases from the Dakota Gasification Plant. The potential total amount of these billings is undetermined at this time. The 1995 allocation of these costs was $2.7 million, and the 1996 allocation is expected to be $2.0 million. WPSC, as part of the Wisconsin Distributors Group (\"WDG\"), is contesting the legality of the Dakota Gasification Plant costs provision and is paying these costs under protest subject to refund. A FERC hearing took place in 1995 and the Administrative Law Judge made an initial decision on December 29, 1995. This initial decision was in favor of the WDG on the three major issues; price for coal gas, purchase volume obligations, and the transportation of gas rate. While refunds are possible from this decision, FERC has to approve the decision and any additional legal or settlement actions. The amount or timing of any refunds cannot be determined at this time.\nOn April 29, 1994, ANR filed its Reconciliation Report of activity under its previously effective Gas Inventory Charge (\"GIC\"). As a result, WPSC received a GIC refund of $4.7 million of the $9.0 million WPSC had previously paid. WPSC and WDG intervened and protested at FERC the results of the formula used to allocate the refunds. Hearings on Docket RP89-161-030 are scheduled to begin on May 14, 1996. WPSC expects to recover additional refund dollars which would be passed on to WPSC customers.\nOn November 29, 1993, ANR filed for a general rate increase in RP94-43-000. WPSC, WDG, and other parties intervened and protested the filing. Extensive discovery has taken place and hearings are scheduled to begin on January 31, 1996. Intervenors are proposing to reduce ANR's cost of service by up to $100 million per year, which could result in a significant rate decrease. Final settlement could take up to two years.\nThe Company has established a non-regulated subsidiary, WPS Energy Services, Inc. (\"ESI\"), to market natural gas, other fuels, and related services to transportation customers.\nWPSC is a member of the WDG which utilizes a Washington, D.C. legal counsel to monitor FERC activities and advise the group. The group files testimony and interventions in cases that impact its members. WPSC is also advised by the same Washington, D.C. legal counsel. WPSC files interventions in cases to protect its interests as they may be different from those of the group.\nAll of WPSC's Wisconsin retail natural gas rates contain a purchased gas adjustment clause which provides for tracking changes for wholesale costs and an annual true-up of such costs. The PSCW reaffirmed this purchased gas adjustment clause\/true-up mechanism in WPSC's 1994 rate order. WPSC's Michigan retail rates include a gas cost recovery plan under procedures authorized by the MPSC in 1983. Both the PSCW and the MPSC have approved mechanisms to allow for full\nrecovery of take-or-pay and transition related costs which the FERC has authorized ANR to pass on to its customers.\nWPSC's aggressive program to connect new natural gas customers resulted in the addition of about 7,300 new residential customers in 1995. Growth in number of natural gas customers comes from the addition of new customers in existing service areas and from the acquisition of new natural gas distribution franchises. At December 31, 1995, two applications for new gas distribution franchises were pending before the PSCW.\nWPSC uses gas for power generation in peaking turbines and for ignition and flame stabilization at its Weston Unit 3 and Pulliam generating plants.\nA special tariff has been approved by the PSCW to enable WPSC to encourage customers, who could by pass WPSC's distribution system and connect directly to a cross-country pipeline company, to continue to be a WPSC customer. Only one industrial customer is currently using this tariff. The impact of customers by passing WPSC's distribution system is considered minimal, at this time.\nGAS FINANCIAL SUMMARY. The following table sets forth the amounts of revenues, operating income, and identifiable assets attributable to gas utility operations:\nYEAR ENDED DECEMBER 31 ------------------------ 1995 1994 1993 ---- ---- ---- (Thousands)\nGas Operating Revenues $230,220 $192,979 $187,376\nOperating Income, Including Allowance For Funds Used During Construction $ 9,851 $ 10,419 $ 10,691\nIdentifiable Assets $240,463 $191,349 $184,880\nSee Note 8 in Notes to Consolidated Financial Statements.\nD. UNREGULATED BUSINESS ACTIVITIES\nThe Company's non-regulated subsidiaries include WPS Energy Services, Inc. (\"ESI\") and WPS Power Development, Inc. (\"PDI\"). ESI is a diversified energy company organized to offer electric and gas marketing, real-time energy management, project management, and energy consulting services. Within energy consulting, ESI offers evaluation of base-line facility energy requirements, preparation of electric and gas cost studies, analysis of energy rates, and evaluation of power supply and generation options to wholesale and retail customers in the unregulated energy marketplace.\nESI made two investments in October 1995. It acquired an interest in a producing gas reserve operation and acquired Fuel Services Group, a gas marketing operation. While these are not large acquisitions, they are initial efforts to enhance growth opportunities.\nPDI is a company organized to participate in the development of electric generation projects and to provide services to the unregulated electric power generation industry. Services include acquisition and investment analyses; project development, engineering, and management services; and operations and maintenance services with particular emphasis in cogeneration, distributed generation, and repowering projects.\nThe Company's non-regulated subsidiaries did not have a material impact on the Company's 1995 earnings per share.\nE. ENVIRONMENTAL MATTERS\nGENERAL. WPSC is subject to regulation with regard to the impact of its operations on air and water quality and solid waste disposal, and may be subject to regulation with regard to other environmental considerations by various federal, state, and local authorities. The application of federal and state restrictions to protect the environment involves or may involve review, certification or issuance of permits by various federal and state authorities, including the U. S. Environmental Protection Agency (\"EPA\") and the Wisconsin Department of Natural Resources (\"DNR\"). Such restrictions, particularly in regard to emissions into the air and water and solid waste disposal, may limit, prevent or substantially increase the cost of the operation of WPSC's generating facilities and may require substantial investments in new equipment at existing installations. They may also require substantial investments for proposed new projects and may delay or prevent authorization and completion of the projects. WPSC cannot forecast other effects of all such regulation upon its generating, transmission, and other facilities, or its operations, but believes that it is presently meeting existing requirements.\nAIR QUALITY. The plants which WPSC operates are in compliance with all current sulfur dioxide, nitrogen oxide, and particulate emission standards.\nThe Federal Clean Air Act Amendments of 1990 (\"Act\") were enacted in 1990. The Act required reductions in sulfur dioxide in 1995 (Phase I) to meet limitations based on an emission rate of 2.5 pounds per million Btu multiplied by a historical generation baseline for Pulliam Unit 8 and Edgewater Unit 4 generating units. The Act requires further reductions beginning in the year 2000 (Phase II). The year 2000 limits are based on an emission rate of 1.2 pounds per million Btu multiplied by a historical generation baseline for all generating units. WPSC's generating facilities met the year 2000 standard in 1995. WPSC achieved compliance with Wisconsin and federal sulfur dioxide emission limitations by switching to low sulfur coal.\nBecause of the emission allowance system included in the Act, operations during Phase I are expected to produce surplus allowances which are expected to be available to aid in compliance with the requirements of Phase II. To the extent WPSC determines that it will have allowances available beyond its own requirements in both Phase I and Phase II, it will consider the sale of these excess allowances. The PSCW has ordered that profits from the sale of allowances be used to benefit utility customers.\nThe Act also requires the installation of low nitrogen oxide burners on several units. Low nitrogen oxide burners were installed at Pulliam Unit 8 early in 1994. Phase I of the Act allows units smaller than 100 megawatts, such as Pulliam Unit 7, to be designated Phase I units, thus building up sulfur dioxide credits. Having made this election, low nitrogen oxide burners were installed on Pulliam Unit 7 in 1994. Low nitrate oxide emissions from Pulliam Units 7 and 8 and Weston Unit 3 are averaged with Weston Units 1 and 2. This averaging plan generates additional emission allowances in Phase I and locks in Phase I nitrogen oxide limits for these units. This should reduce Phase II compliance costs.\nExpenditures of $3 million to $5 million are projected through 1999 to assure continued federal and Wisconsin emission compliance under all normal operating conditions at Pulliam and Weston. Based on past experience, it is anticipated that expenditures related to sulfur dioxide and nitrogen oxide emission compliance will be recoverable in customer rates.\nAir toxic provisions in the Act will not be applied until the EPA conducts a three-year study to determine if those standards need to be applied to utilities.\nWATER QUALITY. WPSC is subject to regulation by the EPA and the DNR with respect to thermal and other discharges from WPSC's power plants into Lake Michigan and other waters of Wisconsin. Permits were reissued to WPSC for its Pulliam and Weston power plants. Various portions of those permits were challenged. These challenges have not been formally resolved, although many of the issues raised in the challenges have been resolved through informal discussions with the DNR, additional testing by WPSC, and regulatory changes. Under Wisconsin law, the challenged portions of the permits are stayed, and the administrative review process is completed. It is not anticipated that any of the outstanding issues will have a material cost associated with them.\nGAS PLANT CLEANUP. WPSC is currently investigating the need for environmental cleanup of eight manufactured gas plant sites which it previously operated. WPSC engaged an environmental consultant to develop cleanup cost estimates for the seven sites at which either a Phase I or Phase II site investigation has been completed. The estimated cleanup cost range for each of the seven sites are; Green Bay from $4.1 to $5.3 million, Two Rivers from $3.9 to $4.0 million, Oshkosh from $3.3 to $4.5 million, Marinette from $5.6 to $6.8 million, Sheboygan I from $2.7 to $3.9 million, Sheboygan II from $12.2 to $13.4 million, and Stevens Point from $1.4 to $1.9 million. The estimates assume excavation of contaminated soils, thermal treatment of soils, disposal of treatment residuals, on-site groundwater extraction and treatment, and post-cleanup monitoring for a minimum of 3 and a maximum of 10 or 25 years, depending on site conditions. The cost estimate for six of the sites (Green Bay, Two Rivers, Oshkosh, Marinette, Sheboygan I, and Sheboygan II) assumes, in addition to those items noted previously, removal and disposal of contaminated river sediments. The consultant has yet to perform a detailed investigation of the Menominee site and comparable information on this site is not available. WPSC used the estimate for the Stevens Point site as a basis for making a projection of $1.5 to $1.9 million on cleanup costs at the Menominee site, if cleanup is required. Both sites are relatively small and are not located adjacent to rivers.\nThe range of future investigation and cleanup costs for all eight sites is estimated to be from $34.7 million to $41.7 million. Remediation expenditures would be made over the next 33 years. WPSC has recorded as a liability with an offsetting deferred charge (i.e., a regulatory asset) of $41.7 million, which represents WPSC's current estimate of cleanup costs for all eight sites. The liability, as presently calculated, represents a $14.8 million increase from the December 31, 1994 liability of $26.9 million. Based on discussions with regulators and a recent rate order in Wisconsin, management believes that these costs, but not the carrying costs associated with the deferred charges, will be recoverable in future customer rates.\nAs additional investigations and initial remedial actions are completed, these estimates may be adjusted and these adjustments could be significant. Other factors that can affect these estimates are changes in remedial technology and regulatory requirements. The estimates presented above do not take into consideration any recovery from insurance carriers or other third parties which WPSC is pursuing.\nSee also Part I, Item 3, LEGAL PROCEEDINGS, at page 26, for discussion of the Sheboygan Gas Plant and Oshkosh Gas Plant sites.\nOTHER SOLID WASTE DISPOSAL. On December 1, 1986, WPSC received notice from EPA-Region V that it was one of 832 potentially responsible parties (\"PRP\") for the cleanup of Maxey Flats Waste Disposal Site. Documents obtained to date indicate that WPSC contributed 0.0162% of the waste disposed of at the site. A remedial investigation and feasibility study has been completed. At this time, the cost of the remedial action and EPA oversight is estimated to be about $77.5 million. The EPA has offered a buyout agreement to de minimis PRPs. Although a final agreement with payment has not been\nexecuted, WPSC's buyout cost is expected to be $28,000. While liability for cleanup under the Comprehensive Environmental Response, Compensation, and Liability Act (\"Superfund\") program is joint and several, the amounts paid by the PRPs are usually related to their volumetric contribution of waste to the site.\nIn November 1986, WPSC was notified by the DNR that it was one of the several PRPs involved in the Holtz & Krause Landfill located in Wausau, Wisconsin. WPSC disposed of 12,516 cubic yards of non-hazardous office waste and construction debris at the site. This represents 1.02% of the total amount of waste at the site. The landfill is currently only being addressed by the DNR, and the current work is not being conducted as part of the EPA's Superfund program. The DNR selected a remedy which was estimated to cost a total of $11 million to $12 million and has been substantially completed within that budget. The DNR agreed to contribute approximately $4.5 million toward the remedy. The amount allocated to WPSC, $37,163, was paid to the cleanup fund in October 1993. The DNR has indicated that it will pursue a cost-recovery action against entities that did not settle with the Holtz & Krause PRP Group. In 1994, WPSC entered into a Consent Decree that acknowledges the payment of the settlement amount, requires the settling parties to clean up the site, and requires the state to pay its agreed upon contribution. In addition, WPSC entered into a \"buyout\" agreement with the larger contributors of waste to the site in which the larger contributors agreed to indemnify WPSC for any cost overruns up to a total site remedial cost of $20 million. If site remedial costs exceed $20 million, the cost allocation may be reopened. Most of the site work was completed in 1994.\nIn March 1987, WPSC was notified by the EPA that it was a PRP for the cost of cleaning up the Rose Chemical site in Holden, Missouri. Based on records that are available, a small amount of polychlorinated biphenyl material, about 39,000 pounds, was sent to the site. WPSC has signed a participation agreement for the cleanup and contributed $60,192 which is based on the volumetric contribution of waste and the expected total cleanup cost. The cleanup has been substantially completed and WPSC has received a refund of $40,980.\nIn November 1988, WPSC received notice from the DNR that the Sherman Street property located in Wausau, Wisconsin, had levels of lead contamination present. Based on an investigation conducted by a neighboring business, Wausau Steel, this contamination originated on an adjacent Wausau Steel property. The cleanup of the property by Wausau Steel has been completed and approved by the DNR.\nIn January 1995, WPSC was notified that the EPA was seeking to recover $775,442 from several companies (not including WPSC) that sent waste drums to the J. K. Drum site in New London, Wisconsin. WPSC's records indicate that it contributed drums to the site which it believes were empty. WPSC has signed a settlement agreement with the group of responsible parties, named by the EPA, which required payment of an allocation of $2,489 to the group of responsible parties.\nF. REGULATORY MATTERS\nGENERAL. Utility rates, service, and securities issues of WPSC are subject to regulation by the PSCW and the MPSC, and WPSC is subject to regulation of its wholesale electric rates, hydroelectric projects, and certain other matters by the FERC. It is also subject to limited regulation by local authorities. WPSC follows Statement of Financial Accounting Standard No. 71, Accounting for the Effects of Certain Types of Regulation, and its financial statements reflect the effects of the different ratemaking principles of the various jurisdictions. These include the PSCW, 90% of revenues, the MPSC, 2% of revenues, and the FERC, 8% of revenues. The operation of Kewaunee is subject to the jurisdiction of the U. S. Nuclear Regulatory Commission.\nIn the Wisconsin jurisdiction, the rate process has been changed effective in 1995 such that retail electric and natural gas rates will be set every two years, rather than annually as has been the practice in the past. The earliest that the rates, which took effect on January 1, 1995, could change would be for the year 1997. Customer rates are set based on forecasted expenses and capital costs.\nWisconsin retail rates include an electric fuel-adjustment clause based on a \"cost variance range approach\". This range is based on a specific estimated fuel cost for the forecast year. If WPSC's actual fuel costs fall outside this range, a hearing may be held and an adjustment to rates may result. Automatic fuel-adjustment clauses are used for FERC wholesale-electric and Michigan retail-electric portions of WPSC's business. WPSC has a purchased-gas-adjustment clause which allows it to pass on to all classes of gas customers changes in the cost of gas purchased from its suppliers, subject to PSCW and MPSC review.\nCUSTOMER RATE MATTERS. On January 1, 1995, in the Wisconsin jurisdiction, WPSC retail electric customers received an average rate reduction of 2.6% which amounted to an annual rate reduction of $10.6 million. WPSC's largest industrial customers received rate reductions averaging between 3.7% and 4.1%. With the implementation of a new two-year rate cycle in Wisconsin, these rates are effective for years 1995 and 1996. Wisconsin natural gas rates and rates in the FERC and Michigan jurisdictions remained unchanged.\nThe Company's return on common equity was 11.7% and 11.4%, respectively, for 1995 and 1994. The Company's returns on common equity are determined in large part by the returns authorized for WPSC by the PSCW. The authorized returns were 11.5% and 11.3%, respectively, for 1995 and 1994, before giving consideration to earnings on deferred investment tax credits.\nINDUSTRY RESTRUCTURING. See Part I, Item 1B, ELECTRIC MATTERS - Industry Restructuring, at page 1, and Part I, Item 1C, GAS MATTERS - Industry Restructuring, at page 12, for discussions of electric and gas utility restructuring.\nACCOUNTING DEVELOPMENTS. See Part II, Item 7, MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION, at page 36, for a discussion of accounting developments.\nIn addition, the staff of the U. S. Securities and Exchange Commission has questioned certain of the current accounting practices of the electric utility industry regarding the recognition, measurement, and classification of nuclear decommissioning costs for nuclear generation facilities in the financial statements of electric utilities. In response to these questions, the Financial Accounting Standards Board has agreed to review the accounting for nuclear decommissioning costs. If current electric utility industry accounting practices for such decommissioning are changed the annual provisions for decommissioning could increase and the estimated cost for decommissioning could be recorded as a liability rather than as accumulated depreciation. WPSC does not believe that such changes, if required, would have an adverse effect on results of operations due to its current and future ability to recover decommissioning costs through customer rates.\nThe PSCW certified new straight-line depreciation rates which became effective January 1, 1994 concurrent with the implementation of new customer rates. The result was a reduction in annual depreciation expense of approximately $5.8 million.\nRegulatory assets represent probable future revenue associated with certain costs which will be recovered from customers through the ratemaking process. Regulatory liabilities represent costs previously collected that are refundable in future rates. At December 31, 1995, regulatory assets and liabilities amounted to $111.1 million and $50.0 million, respectively. Based on prior and current rate treatment of such deferred charges, management believes it is probable that WPSC will continue to recover these costs from ratepayers. Pursuant to a PSCW rate order, effective January 1, 1995, WPSC is to recover approximately $23.6 million of deferred regulatory costs each year.\nDIVIDEND RESTRICTIONS. WPSC is restricted by a PSCW order to paying normal common stock dividends of no more than 109% of the previous year's common stock dividend without prior notice to the PSCW. Also, Wisconsin law prohibits WPSC from making loans to the Company and its non-regulated subsidiaries and from guaranteeing their obligations.\nEffective January 15, 1996, a special common stock dividend of $11,000,000 was declared by WPSC to be paid to the Company, the parent holding company. The special dividend will allow WPSC's equity capitalization ratio to remain at approximately 54%, as approved by the PSCW for ratemaking. The dividend was paid in January 1996.\nG. CAPITAL REQUIREMENTS\nThe Company's subsidiary, WPSC, requires large investment in capital assets. Most of the Company's significant capital requirements relate to WPSC construction expenditures.\nAnticipated construction expenditures for WPSC for 1996 are $78.8 million and construction expenditures for 1997 and 1998 combined are anticipated to total $135.6 million. The $78.8 million of 1996 construction expenditures includes $46.3 million for electric construction, $9.2 million for nuclear fuel, $15.4 million for gas construction, and $7.9 million for other construction expenditures. WPSC also anticipates $8.8 million of expenditures related to unit trains to be leased through WPSC's subsidiary WPS Leasing.\nThe Company has no plans in 1996, 1997, or 1998 for permanent financing, although project financing may occur in the non-utility subsidiaries.\nH. EMPLOYEES\nAt December 31, 1995, the Company, including subsidiaries, employed 2,547 persons. Of this number, 2,517 employees were employed by WPSC.\nOf the employees of WPSC, 1,979 were considered electric and 538 were considered gas utility employees, respectively. Approximately 1,116 WPSC employees are represented by Local 310 of the International Union of Operating Engineers (\"Union\"). The current agreement between the Union and WPSC runs through October 1997. There has never been a strike against WPSC by its employees.\nPAGE\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe following table includes information about electric generation facilities of WPSC (including those jointly-owned):\n(a) Based on 1995 winter capacity (through February 1996).\n(b) This plant contains six units. Pulliam Unit 3 (28.2 MW) is out of service for maintenance, but would be available with a seven-month notice.\n(c) This plant contains three units. Two units burn only coal and the other can burn coal or natural gas.\n(d) These facilities are jointly-owned. Kewaunee is operated by WPSC. WP&L is operator of the Columbia and Edgewater units. The capacity indicated is WPSC's portion of total plant capacity based on percent of ownership.\n(e) WPSC and the Marshfield Electric and Water Department jointly own 113,300 kilowatts of combustion turbine peaking capacity which WPSC operates. The capacity included is WPSC's portion of total plant capacity based on percent of ownership.\nWPSC owns 51 transmission substations with a transformer capacity of 5,253,000 kva; 107 distribution substations with a transformer capacity of 3,527,485 kva; and 20,392 route miles of electric transmission and distribution lines. Gas properties include\napproximately 3,777 miles of main, 63 gate and city regulator stations, and 189,642 services. All gas facilities are located in Wisconsin except for distribution facilities in and near the city of Menominee, Michigan.\nSubstantially all of WPSC's utility plant is subject to a first mortgage lien.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nSHEBOYGAN GAS PLANT. In November 1990, WPSC was notified by the DNR that it may be a PRP for environmental contamination found on property next to the Sheboygan River previously used by WPSC for the gasification of coal in the City of Sheboygan, Wisconsin (the \"Sheboygan II Gas Plant\"). WPSC last used the property for this purpose in approximately 1930. In 1966, the property was sold and is now owned by the City of Sheboygan. The DNR has offered WPSC the opportunity to investigate and remediate the property under an agreement with Wisconsin as opposed to having the site handled by the EPA as part of the larger Sheboygan River and Harbor Superfund site. WPSC, the City of Sheboygan, and Wisconsin have negotiated an agreement for performing the work, and therefore, Wisconsin, and not the EPA, will be handling this matter.\nAn initial study was completed on the site which confirmed the presence of contaminants that appear to be related to the Sheboygan II Gas Plant. A Phase II investigation was recommended by the environmental consultant to determine more precisely the scope of the contamination and to determine if any contamination is migrating from off-site and whether sediments are impacted. This Phase II investigation has been substantially completed. WPSC and the City of Sheboygan will negotiate an allocation of the costs associated with cleanup of the site. Based on the Phase II study, it is believed that the cost of cleanup for the Sheboygan II Gas Plant site could be as much as $13.4 million. The estimates presented above do not take into consideration any recovery from insurance carriers or other third parties which WPSC is pursuing.\nOSHKOSH GAS PLANT. In April 1992, WPSC received an order from the DNR directing it to complete an investigation and implement remedial activities on property owned by WPSC in the City of Oshkosh, Wisconsin. Previously, WPSC had operated a manufactured gas plant on the property from 1883 until 1946. A challenge to the order was filed on May 8, 1992, and WPSC and the DNR have negotiated the terms of a consent order. An environmental consultant conducted an investigation in late 1993 and a more detailed investigation in 1994, with sediment sampling conducted in 1995. Based on these investigations, the cost of remediation is estimated to be as much as $4.5 million. The City of Oshkosh has claimed that contaminated groundwater from the former gas plant property has migrated onto city-owned land. WPSC has agreed to stay the statute of limitations that may be applicable to the City of Oshkosh's claim in order to avoid the filing of a lawsuit by the City of Oshkosh. WPSC is continuing to evaluate the validity of the City of Oshkosh's claim as additional data is received. The estimates\npresented above do not take into consideration any recovery from insurance carriers or other third parties which WPSC is pursuing.\nIncorporated herein by reference are the descriptions of the various proceedings relating to environmental matters described under E. ENVIRONMENTAL MATTERS, Part I, Item 1E at page 18.\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.\nPAGE\nITEM 4A. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nInformation about outside directors is omitted for the reason that such information will be included in a proxy statement for the Annual Meeting of Shareholders of the Company which is scheduled to be held on May 2, 1996.\nReflected in the information above are the officer changes, announced by the Company, effective January 1, 1996: Daniel A. Bollom (age 59) assumed the position of Chairman and Chief Executive Officer, Larry L. Weyers (age 50) assumed the position of President and Chief Operating Officer, and Francis J. Kicsar (age 56) assumed the position of Secretary replacing Robert H. Knuth (Assistant Vice President- Secretary), who retired December 31, 1995.\nReflected in the information above are the officer changes, announced by WPSC, effective January 1, 1996: Daniel A. Bollom (age 59) assumed the position of Chairman and Chief Executive Officer, Larry L. Weyers (age 50) assumed the position of President and Chief Operating Officer, and Francis J. Kicsar (age 56) assumed the position of Secretary replacing Robert H. Knuth (Assistant Vice President- Secretary), who retired December 31, 1995.\nNOTE: All ages for the Company and WPSC are as of December 31, 1995. None of the executives listed above for the Company or for WPSC are related by blood, marriage, or adoption to any of the other officers listed or to any director of the Registrant. Each officer shall hold office until his or her successor shall have been duly elected and qualified, or until his or her death, resignation, disqualification, or removal.\nPAGE\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nWPS RESOURCES CORPORATION COMMON STOCK Two-Year Comparison (1)\nDividends Share Data Per Share Price Range - ---------- --------- -----------------\n1995 High Low ------ ------ 1st Quarter $ .455 29-3\/4 26-3\/4\n2nd Quarter .455 29-7\/8 27-7\/8\n3rd Quarter .465 30-3\/4 28-1\/8\n4th Quarter .465 34-1\/4 30-1\/4 ------ Total $1.84\n1st Quarter $ .445 33-5\/8 28\n2nd Quarter .445 30-3\/4 27-3\/8\n3rd Quarter .455 30-3\/8 27\n4th Quarter .455 28-3\/8 26-1\/4 ------ Total $1.80\n- -----\n(1) The dividends paid to public shareholders for the first three quarters of 1994 were paid by WPSC. As a result of the reorganization described in Part I, Item 1A, WPS RESOURCES CORPORATION, at page 1, the dividends for the fourth quarter of 1994 and for all subsequent quarters were paid by the Company.\nWPSC, the Company's principal subsidiary, is restricted by a PSCW order to paying normal common stock dividends of no more than 109% of the previous year's common stock dividend without prior notice to the PSCW.\nEffective January 15, 1996 a special common stock dividend of $11,000,000 was declared by WPSC to be paid to the Company, the parent holding company. The special dividend will allow WPSC's equity capitalization ratio to remain at approximately 54% as approved by the PSCW for ratemaking. The dividend was paid in January 1996.\nCommon Stock\nListed on the New York and Chicago Stock Exchanges\nTicker Symbol: WPS\nTransfer Agent and Registrar:\nFirstar Trust Company P.O. Box 2077 Milwaukee, Wisconsin 53201\nAs of December 31, 1995, there were 24,341 common stock shareholders of record.\nSee also Items 6 and 8 below.\nPAGE\nPAGE\nITEM 7.","section_6":"","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION OF WPS RESOURCES CORPORATION AND WISCONSIN PUBLIC SERVICE CORPORATION\nRESULTS OF OPERATIONS\nWPS Resources Corporation (\"the Company\") is a holding company. Approximately 92% and 97% of the Company's 1995 revenues and assets, respectively, are derived from Wisconsin Public Service Corporation (\"WPSC\"), an electric and gas utility.\nOverview of 1995 Compared to 1994\nEarnings per share increased 5.0% from $2.21 in 1994 to $2.32 in 1995. The most significant reasons for this change were higher electric margins due to burning less expensive low sulfur coal and increased sales volume.\n1995 Compared to 1994\nElectric Operations\nElectric margins increased by $13.4 million (see table below), or 4.0%, due primarily to increased sales volumes and decreased coal costs which were partially offset by a 2.6% Wisconsin retail rate reduction effective January 1, 1995.\n================================================================= ELECTRIC MARGINS ($000) 1995 1994 1993 - ----------------------------------------------------------------- Revenues $489,000 $480,816 $493,256 Fuel and purchases 144,451 149,642 144,754 - ----------------------------------------------------------------- Margins $344,549 $331,174 $348,502 ================================================================= Sales (kWh 000) 10,978,131 10,552,017 10,150,913 =================================================================\nThe Public Service Commission of Wisconsin (\"PSCW\") allows WPSC to pass on to its customers, through a fuel adjustment clause, changes in the cost of fuel and purchased power within a specified range. WPSC is required to file an application to adjust rates either higher or lower when costs are plus or minus 2% from forecasted costs.\nElectric operating revenues increased $8.2 million, or 1.7%. Electric revenues were higher due to a 4.0% increase in kilowatt-hour (\"kWh\") sales. This was partially offset by a 2.6% decrease in retail Wisconsin rates that took effect on January 1, 1995. Residential and commercial and industrial kWh sales increased 5.9% and 4.9%, respectively, due to warmer summer weather and customer growth. Wholesale kWh sales decreased .4% due primarily to lower demand by WPSC's largest wholesale customer.\nElectric fuels and purchases decreased $5.2 million, or 3.5%. Coal-related costs decreased $12.1 million, or 11.4%, due to burning less expensive low sulfur coal. However, this was partially offset by increased coal-fired generation of $4.8 million, or 5.4%, and higher purchased power of $1.0 million, or 2.5%, due to warmer weather and increased plant outages resulting from maintenance at certain plants.\nGas Operations\nGas margins increased by $3.7 million (see table below), or 6.7%, due to WPSC customer growth and colder weather and increased sales attributable to WPS Energy Services, Inc. (\"ESI\"), an energy marketing subsidiary which began operations in 1994. ESI's sales reduced overall margin per therm for the Company, since the margin on \"commodity sales\" is lower than the margin on WPSC's gas distribution sales.\n================================================================= GAS MARGINS ($000) 1995 1994 1993 - ----------------------------------------------------------------- Revenues $229,925 $192,979 $187,376 Purchase costs 170,236 137,014 133,347 - ----------------------------------------------------------------- Margins $ 59,689 $ 55,965 $ 54,029 ================================================================= Volume (Therms 000) 910,149 632,972 568,515 =================================================================\nThe PSCW allows WPSC to pass on to customers, through a purchased gas adjustment clause, changes in the cost of gas.\nGas operating revenues increased $36.9 million, or 19.1%. The $36.9 million increase is comprised of a $44.3 million increase in revenues attributable to sales by ESI and an offsetting decrease of $7.4 million at WPSC due to lower gas costs.\nGas purchased for resale showed a net increase of $33.2 million, or 24.2%. Gas purchases increased $43.3 million due to ESI's sales and were offset by lower gas costs at WPSC of $10.1 million.\nOther Revenues\nOther operating revenues increased $.9 million from 1994. This represents consulting, construction, and investment revenue from ESI and WPS Power Development, Inc. (\"PDI\"), a company organized to participate in the development of electric generation projects and to provide services to the unregulated electric power generation industry.\nOther\nOther operating expenses increased $5.5 million, or 3.7%. The majority of this increase is attributable to increased operating expenses at ESI and PDI.\nDepreciation and decommissioning expense increased $9.2 million or 16.4%. There were two primary factors for this increase. The first factor was an increase in decommissioning funding of $5.0 million that was reflected in customer rates which became effective January 1, 1995. The second factor was additional decommissioning expense recorded to offset a $1.1 million gain on the decommissioning portfolio discussed below and $2.4 million in higher trust earnings.\nThere were three significant nonrecurring items impacting other income in 1995. First, a $1.6 million pretax gain was realized on the decommissioning portfolio from the sale of certain investments. Second, $1.2 million in insurance proceeds was received as the result of the death of a retired WPSC executive. Third, these gains were partially offset by a $2.7 million loss resulting from cancellation of the Rhinelander Energy Center project.\n1994 Compared to 1993\nElectric margins declined by $17.3 million, or 5.0%, primarily due to reduced electric rates.\nElectric operating revenues decreased $12.4 million, or 2.5%, primarily due to a 4.2% reduction in Wisconsin retail rates which took effect January 1, 1994. Electric revenues also were reduced .5% in May 1994 as a result of reduced fuel costs. These decreases were partially offset by a 4.0% increase in kWh sales. Residential and commercial and industrial kWh sales increased\nPAGE\n2.4% and 4.9%, respectively, due to a warmer summer and customer growth. Wholesale kWh sales increased 3.0%.\nElectric fuels and purchases increased $4.9 million, or 3.4%, reflecting increased sales, offset in part by reduced production costs. Electric production fuels decreased $3.0 million, or 2.7%, even though generation was up 1.3%. This decrease in fuel costs per kWh of 5.4% was primarily the result of purchasing less expensive coal on the spot market. Purchased power costs were higher by $7.9 million, or 25.8%. This was the result of a 19.9% increase in kWh purchases due to the severe cold weather in the first quarter of the year which forced WPSC to purchase expensive spot market electricity, and the Soo Line railroad strike during the second half of the year which impacted WPSC's ability to operate its coal-fired units.\nGas margins increased by $1.9 million, or 3.6%, due to customer growth.\nMaintenance expense decreased $1.6 million, or 3.1%, due to lower maintenance activity at the Kewaunee Nuclear Power Plant (\"Kewaunee\") and due to less electric transmission and distribution maintenance.\nDepreciation and decommissioning expenses decreased $4.2 million, or 7.0%. The primary cause was a rate order from the PSCW which took effect January 1, 1994 reducing the annual depreciation provision by an estimated $5.8 million. This was offset by higher decommissioning expense of approximately $1.1 million.\nFederal and state income taxes decreased $3.0 million, or 9.4%, due to lower earnings.\nBALANCE SHEET\n1995 Compared to 1994\nCustomer receivables and accrued utility revenues increased $28.0 million as a result of colder than normal weather experienced in December 1995.\nEnvironmental remediation liabilities increased $14.8 million due to higher estimates for gas plant site cleanup based on additional studies completed in 1995.\nFINANCIAL CONDITION\nWPSC requires large investments in capital assets used to deliver electric and gas services. As a result, most of the Company's capital requirements relate to WPSC's construction expenditures. WPSC maintains good liquidity levels and a financial condition considered to be strong by analysts. Internally-generated funds closely approximate the utility's cash requirements. No external funding difficulties are anticipated. Pre-tax interest coverage was 4.0 times for the year ended December 31, 1995. WPSC's bond ratings are AA+ (Standard & Poor's), Aa2 (Moody's), and AA+ (Duff & Phelps).\nWPSC is restricted by a PSCW order from paying normal common stock dividends of more than 109% of the previous year's common stock dividends without PSCW approval. Also, Wisconsin law prohibits WPSC from making loans to the Company and its subsidiaries and from guaranteeing their obligations. On January 15, 1996, a special common stock dividend of $11 million was declared by WPSC to be paid to the Company. The special dividend allows WPSC's equity capitalization ratio to remain at approximately 54%, the level approved by the PSCW in a recent rate case. The dividend was paid in January 1996.\nFor the three-year period 1996 to 1998, internally-generated funds at WPSC should exceed construction expenditures, estimated at $216 million, by $38 million. These expenditures are comprised of $140 million for electric construction, $20 million for nuclear fuel, $35 million for gas construction, and $21 million for other construction expenditures.\nIn early 1996, WPS Leasing, Inc. (\"Leasing\"), a subsidiary of WPSC, expects to purchase an additional unit train for approximately $8.8 million. This purchase will be funded with long-term debt. Leasing expects to refinance the current loan from the Company with funds from an external source. As of December 31, 1995, the current loan was $6.1 million and carried an interest rate of 8.76%.\nWPSC received a two-year rate order from the PSCW which became effective January 1, 1995. Previously, rate orders\nPAGE\nwere issued annually. This new rate order decreased electric retail rates by 2.6% while retail gas rates remained at current levels. This order also increased the authorized rate of return on common equity from 11.3% to 11.5%.\nStatement of Financial Accounting Standards (\"SFAS\") No. 121, Accounting for the Impairment of Long-Lived Assets to be Disposed Of, became effective in March 1995. This statement imposes a stricter criterion for regulatory assets by requiring that such assets be probable of future recovery at each balance sheet date. The Company will adopt this standard on January 1, 1996 and does not expect that adoption will have a material impact on the financial position or results of operations based on the current regulatory structure. This conclusion may change in the future as competitive factors influence wholesale and retail pricing in the electric and gas industries and as regulatory policy regarding recovery of stranded investment is developed.\nSFAS No. 123, Accounting for Stock-Based Compensation, becomes effective in 1996. This statement permits, but does not require, companies to change their accounting for stock based compensation. This statement also requires additional disclosures. The Company expects to adopt only the disclosure provision of the statement.\nPlans to construct the Rhinelander Energy Center (\"REC\") were canceled in 1995. The REC would have been a 123-megawatt cogeneration facility and would have provided steam and electricity to the Rhinelander Paper Company, Inc. (\"Rhinelander\") in Rhinelander, Wisconsin and electricity to WPSC's customers. Plans for the REC were originally announced in August of 1992. Following an in-depth financial analysis and a lengthy negotiation process, Rhinelander terminated negotiations. WPSC and Rhinelander had been negotiating since November of 1994 when the PSCW selected the REC as the best project from 13 proposals to meet WPSC's future electrical needs.\nAs a result of this cancellation, WPSC signed a 25-year agreement in November 1995 to purchase power from Polsky Energy Corporation (\"Polsky\"), an independent power producer proposing to build a plant adjacent to the Nicolet Paper Company mill in De Pere, Wisconsin. This was the second project chosen by the PSCW from the 13 proposals referred to above. The first phase of the project calls for the completion of a 179-megawatt combustion turbine facility in 1999. The second phase, scheduled to be in service in 2004, converts the facility into a combined cycle unit and increases the total capacity to 232 megawatts.\nThe Polsky project is in the second stage of a two-stage Certificate of Public Convenience and Necessity (\"CPCN\") permitting process prescribed by the PSCW. Construction of the Polsky project is contingent upon a PSCW determination in Stage 2 of the CPCN process that WPSC will need the electric capacity provided by the proposed plant. A recent WPSC load forecast suggests that this capacity may not be needed. A final decision on Stage 2 of the CPCN for the Polsky project is expected in 1997. If the PSCW approves the Polsky project, it will be accounted for as a capitalized lease, based on the criteria set forth in SFAS No. 13, Accounting for Leases. This would result in the Company recording a plant asset of approximately $110 million, with an offsetting amount of long-term debt.\nTRENDS\nWPSC follows SFAS No. 71, Accounting for the Effects of Certain Types of Regulation, and its financial statements reflect the effects of the different ratemaking principles followed by the various jurisdictions regulating the utility. These include the PSCW, 90% of revenues, the Michigan Public Service Commission (\"MPSC\"), 2% of revenues, and the Federal Energy Regulatory Commission (\"FERC\"), 8% of revenues. In addition, Kewaunee is regulated by the Nuclear Regulatory Commission (\"NRC\"). Environmental matters are primarily governed by the Environmental Protection Agency and the Wisconsin Department of Natural Resources.\nThe single most important development in the electric utility industry is the trend toward increased competition brought about by a combination of new legislation, changing regulation, and market forces.\nTransmission access, mandated by the Energy Policy Act of 1992, and increased competition in the wholesale power segment of the business have put pressure on profit margins. Certain segments of the industry could become deregulated. Low-cost energy producers, such as WPSC, are in a position to benefit from competitive markets.\nIn March 1995, the FERC issued a notice of proposed rulemaking which would: (1) require utilities under the FERC's jurisdiction, including WPSC, to file non-discriminatory open access transmission tariffs which would be available to all wholesale buyers and sellers of electric energy, (2) require utilities to take service under the tariffs for their own wholesale sales and purchases of electric energy, and (3) provide utilities with an opportunity to recover stranded costs (i.e., unrecovered investment in facilities that are no longer economical to operate). When implemented, this regulatory initiative might force investor-owned utilities to separate generation, transmission, and distribution functions in order to create a level playing field where they can compete with municipal utilities, cooperatives, independent power producers, energy marketers, and brokers.\nAs a result, WPSC is developing and implementing strategies to deal with transmission access and potential stranded investment. WPSC will develop a separate internal transmission group to fulfill the functional unbundling requirement. WPSC has also filed comparable transmission access tariffs which have been accepted for use, subject to refund. Comparable transmission access tariffs, as defined by the FERC, provide transmission access to other parties on the same terms and conditions that WPSC provides transmission service to itself. Approval of these tariffs is contingent upon a number of considerations including the FERC's final rulemaking expected later in 1996.\nIn December 1995, the PSCW outlined its plan for restructuring the electric industry in Wisconsin. Utilities are required to develop detailed plans illustrating how they plan to separate generation, transmission, distribution, and energy service functions into separate business units and establish transfer prices for use between the business units.\nUnder the PSCW plan, the competitive market for new generation would be enhanced by modifying the present bidding process and replacing the Advance Plan process with a \"strategic evaluation\" process. The PSCW also concluded that the economic benefits and responsibilities of existing generation belong to present customers.\nThe PSCW would continue transmission regulation by retaining control over planning and siting of transmission facilities. To limit the market power of current transmission owners, the PSCW proposes moving either to appointment of an independent transmission system operator or to organization of a single state-wide transmission system.\nAs part of its continuing assessment of retail access, the PSCW would establish broad pricing reforms for customer segments and quality of service standards. The PSCW would retain jurisdiction over low income programs, the winter moratorium on disconnection, demand-side management, renewables, and research and development funding. A Public Benefits Advisory Board would be formed to advise the PSCW on conservation and renewable resource issues.\nThe Wisconsin Legislature is not expected to consider electric restructuring until 1997. In the meantime, the PSCW, utility companies, various advocacy groups, and utility customers will continue to dialogue in an effort to reach a consensus on when and how to introduce competition into the electric marketplace. The PSCW timetable would provide all retail electric customers with energy supply choices by 2001.\nFERC Order 636 prompted the PSCW to examine the regulation of the natural gas distribution business in Wisconsin. In September 1995, the PSCW tentatively concluded that once a class of\ncustomers has access to the competitive marketplace, they will be expected to purchase gas from unregulated suppliers, and that utilities could be required to offer unbundled pricing and service choices to their natural gas customers. These PSCW issues will be the subject of additional hearings in 1996. These issues are of particular interest to larger customers.\nThe MPSC initiated a similar process to address gas industry restructuring by forming a committee of interested parties to consider changes in the gas cost recovery mechanism, service unbundling, curtailment issues, and storage issues. In June 1996, the committee is expected to furnish the MPSC with a report identifying issues and recommending restructuring alternatives.\nAs a result of the changes occurring in the electric industry, several mergers have been announced in the region, and are in the process of seeking regulatory approval.\nWPSC is currently investigating the need for environmental cleanup of eight manufactured gas plant sites which it previously operated. WPSC engaged an environmental consultant to develop cleanup cost estimates for the seven sites at which either a Phase I or Phase II site investigation had been completed. The estimated cleanup cost ranges in current dollars for each of the seven sites are: Green Bay from $4.1 to $5.3 million, Two Rivers from $3.9 to $4.0 million, Oshkosh from $3.3 to $4.5 million, Marinette from $5.6 to $6.8 million, Sheboygan I from $2.7 to $3.9 million, Sheboygan II from $12.2 to $13.4 million, and Stevens Point from $1.4 to $1.9 million. The estimates assume excavation of contaminated soils, thermal treatment of soils, disposal of treatment residuals, on-site groundwater extraction, and treatment and post-cleanup monitoring for 25 years. The cost estimates for six of the sites (Green Bay, Two Rivers, Oshkosh, Marinette, Sheboygan I, and Sheboygan II) assume, in addition to those items previously noted, removal and disposal of contaminated river sediments. The consultant has yet to perform a detailed investigation of the Menominee site; therefore, comparable information on this site is not available. WPSC used the estimate for the Stevens Point site as a basis for making a projection of $1.5 to $1.9 million on cleanup costs at the Menominee site. Both sites are relatively small and are not located adjacent to rivers.\nThe range of future investigation and cleanup costs for all eight sites is estimated to be from $34.7 million to $41.7 million. Remediation expenditures would be made over the next 33 years. WPSC has recorded a liability with an offsetting regulatory asset, which represents WPSC's current estimate of cleanup costs for all eight sites. The liability represents a $14.8 million increase from the December 31, 1994 estimate of $26.9 million as a result of information obtained in the new 1995 studies. Based on discussions with regulators and a recent rate order in Wisconsin, management believes that these costs (but not the carrying costs associated with the amounts expended) will be recoverable in future customer rates after the amounts are expended.\nAs additional investigations and initial remedial actions are completed, these estimates may be adjusted and these adjustments could be significant. Other factors that can affect these estimates are changes in remedial technology and regulatory requirements. The estimates presented above do not take into consideration any recovery from insurance carriers or other third parties which WPSC is pursuing. Due to the anticipated regulatory treatment, adjustments to the estimated liability do not have an immediate impact on net income.\nIn addition, WPSC has been notified that it is a minor participant in a number of waste disposal site cleanup efforts. However, no significant costs are anticipated to clean up these sites.\nFederal Clean Air Act Amendments (\"the Act\") were enacted in 1990. The Act establishes stringent sulfur dioxide and nitrogen oxide emission limitations. Wisconsin previously had enacted laws to limit sulfur emissions. Today, WPSC meets the sulfur dioxide emission standards scheduled to take effect in the year 2000 as a result of switching to lower-sulfur fuels. However, some additional capital expenditures will be required to\nupgrade existing equipment and to monitor emission levels. These expenditures are estimated to be in the range of $3 to $5 million between 1996 and 1999.\nIn 1995, WPSC initiated a new demand-side management(\"DSM\") program which involves loans and shared savings. Prior to 1995, DSM expenditures were recovered from all customers. The new program provides that those who benefit from energy-saving programs will finance them. As of December 31, 1995, WPSC had $44.1 million of deferred DSM expenditures which will be recovered in future customer rates.\nThe Kewaunee Nuclear Power Plant (\"Kewaunee\") is operated by WPSC. WPSC has a 41.2% ownership interest in Kewaunee which it owns jointly with two other utilities. Kewaunee is operating with a license which expires in 2013.\nOperating and maintenance costs at Kewaunee have been reduced more than 25% over the last three years. Continued reduction of costs, while not sacrificing safety and reliability, is planned to keep Kewaunee cost competitive. The NRC recently rated Kewaunee superior (Category 1) in all areas: maintenance, operations, engineering, and plant support.\nThe steam generator tubes at Kewaunee are susceptible to corrosion characteristics seen throughout the nuclear industry. During the first quarter of 1995, Kewaunee was shutdown for scheduled maintenance and refueling. Inspection of the steam generators revealed increased levels of tube degradation. Prior to the shutdown, the equivalent of approximately 12% of the tubes in the steam generators were plugged with no loss of capacity. When the plant was returned to service in May 1995, approximately 21% of the tubes were plugged, resulting in an initial capacity reduction of approximately 4%. Approximately half of this lost capacity has been recovered through operating modifications. The ultimate small reduction in capacity did not affect earnings in 1995 because of operating and maintenance cost savings and capacity recovery efforts at Kewaunee.\nAs a result of the need to keep Kewaunee cost competitive and to address the repair or replacement of the steam generators, the owners of Kewaunee have been and are continuing to evaluate various alternatives to deal with the potential future loss of capacity resulting from the continuing degradation of the steam generator tubes. As part of this evaluation, the following actions are being taken:\n(a) A request has been submitted to the NRC to redefine the pressure boundary point of the repaired steam generator tubes (sleeved tubes), which have been removed from service by plugging, in order to allow the return of many of the sleeved tubes to service. If the request is granted, and even if additional degraded tubes would be discovered during the next planned shutdown in the fall of 1996, Kewaunee should be able to return to near full capacity at that time.\n(b) A request will be submitted to the NRC to allow the owners to pursue welded repair technologies to repair existing sleeved tubes in an effort to return plugged tubes to service. Although welded tube repair technologies exist, such technologies have not yet been approved by the NRC.\n(c) Continuing evaluations are being performed with respect to the economics of replacing the steam generators. Replacement of steam generators is estimated to cost approximately $100 million, exclusive of additional purchase power costs associated with an extended shutdown.\n(d) WPSC is evaluating the need to accelerate the collection of funds for decommissioning and the recovery of existing investment.\nWPSC believes Kewaunee can remain cost competitive and generate economically until the expiration of the operating license in 2013, but that it is probable that this cannot be achieved without replacement of the steam generators. There are many uncertainties which may impact the future operations of Kewaunee such as steam generator tube damage and degradation rates, development of repair technologies, regulatory approvals, and changes in power generation economics which can lead to continued repair strategies, a steam generator replacement decision, or a decision to retire Kewaunee earlier than the year 2013.\nAs operator of Kewaunee and based on our current view of future energy prices, WPSC believes it is prudent to seek prompt regulatory approval to replace the steam generators. A consensus in this regard has not been reached with the other owners of Kewaunee and will be the subject of further discussion. Steam generator replacement, in the opinion of WPSC management, would reduce the financial risks that would be associated with an unplanned shutdown due to continued steam generator degradation.\nIMPACT OF INFLATION\nCurrent financial statements are prepared in accordance with generally accepted accounting principles and report operating results in terms of historic cost. They provide a reasonable, objective, and quantifiable statement of financial results; but they do not evaluate the impact of inflation. Under rate treatment prescribed by the utility's regulatory commissions, projected operating costs are recoverable in revenues. Because forecasts are prepared assuming inflation, the majority of inflationary effects on normal operating costs are recoverable in rates. However, in these forecasts, WPSC is only allowed to recover the historic cost of plant via depreciation.\nAlthough new rates will not be implemented in 1996 due to the new two-year rate order policy in the Wisconsin jurisdiction, management believes inflation will be offset by the impact of customer growth and increased productivity.\n- --------------------------------------------------------------------- Description of Graphs Accompanying Management Discussion and Analysis - ---------------------------------------------------------------------\nHeading ------- Return on Common Equity 1991-1995 Percent\nScale ----- The scale is shown on right side of the graph running from 0 to 14 percent in increments of two.\nData Values ----------- There is a bar for each year from 1991 through 1995. The values are 13.1, 13.2, 13.1, 11.4, and 11.7, respectively, for the years 1991 through 1995.\nExplanation of Graph -------------------- The Company's returns on common equity are determined in large part by the returns authorized for WPSC by the PSCW. The authorized returns were 13.1%, 12.8%, 12.3%, and 11.5%, respectively, before giving consideration to earnings on deferred investment tax credits.\n- ---------------------------------------------------------------------\nHeading ------- Electric Steam Fuel Costs 1991-1995 Cents per million Btu\nScale ----- The scale is shown on the right side of the graph running from 0 to 160 in increments of 20.\nData Values ----------- There is a bar for each year from 1991 through 1995. The values are 147.532, 136.965, 121.949, 116.782, and 106.320, respectively, for the years 1991 through 1995.\n- ---------------------------------------------------------------------\nHeading ------- Electric Sales 1991-1995 Megawatt-Hours (Thousands)\nScale ----- The scale is shown on the right side of the graph running from 0 to 12 in increments of 2.\nData Values ----------- There is a bar for each year from 1991 through 1995. The values are 9,568, 9,747, 10,151, 10,552, and 10,978, respectively, for the years 1991 through 1995.\n- ---------------------------------------------------------------------\nHeading ------- Gas Deliveries 1991-1995 Therms (Millions)\nScale ----- The scale is shown on the right side of the graph running from 0 to 700 in increments of 100.\nData Values ----------- There is a bar for each year 1991 through 1995. Each bar has two parts, a lower black part that represents gas transported for others, and an upper part that represents natural gas sold to customers.\nThe data values for the lower black portion of the bars are 229, 233, 221, 234, and 242, respectively, for the years 1991 through 1995.\nThe data values for the entire bar are 314, 313, 348, 399, and 669, respectively, for the years 1991 through 1995.\nPAGE\nPAGE\nPAGE\nPAGE\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nWPS RESOURCES CORPORATION AND WISCONSIN PUBLIC SERVICE CORPORATION\nE. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1--Summary of Significant Accounting Policies\n(a) Nature of Operations--WPS Resources Corporation (\"the Company\") is a holding company. Approximately 92% and 97% of the Company's 1995 revenues and assets, respectively, are derived from Wisconsin Public Service Corporation (\"WPSC\"), an electric and gas utility. The Company's primary business is the supply and distribution of electric power and natural gas in its franchised service territory. The Company also markets natural gas and energy-related services in nonregulated markets and has made several energy-related investments.\nThe preparation of the Company's 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 the 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.\n(b) Acquisitions--In the fourth quarter of 1995, WPS Energy Services, Inc. (\"ESI\") acquired interests in a producing gas reserves operation and in a gas marketing operation. The acquisitions have been accounted for under the purchase method of accounting. The price paid in excess of the fair value of identifiable assets acquired for the gas marketing operation is being amortized over a five-year period.\n(c) Consolidation--The consolidated financial statements include the Company and its wholly-owned subsidiaries, ESI, WPS Power Development, Inc. (\"PDI\"), WPSC, and WPSC's wholly-owned subsidiary, WPS Leasing, Inc. All significant intercompany transactions and accounts have been eliminated.\n(d) Commodity Hedging Agreements--One of the Company's subsidiaries, ESI, enters into various agreements to hedge against price fluctuations in the cost of gas to be purchased for delivery under its fixed price gas sales contracts. The intent of this program is to lock in margins on gas sales contracts. Gains and losses on these agreements are recognized as decreases or increases in the cost of gas when the related designated gas purchase takes place.\nThe agreements outstanding at December 31, 1995, hedge anticipated gas purchases through October 1996. The value of notional volumes of gas under such agreements using year-end market prices was $8.4 million as of December 31, 1995.\n(e) Utility Plant--Utility plant is stated at the original cost of construction which includes an allowance for funds used during construction (\"AFUDC\"). Approximately 50% of retail jurisdictional construction work in progress (\"CWIP\"), except for major new generating facilities which earn AFUDC on the full amount, is subject to AFUDC using a rate based on WPSC s overall cost of capital. For 1995, the retail AFUDC rate was approximately 10.3%.\nAFUDC is recorded on wholesale jurisdictional electric CWIP at debt and equity percentages specified in the Federal Energy Regulatory Commission (\"FERC\") Uniform System of Accounts. For 1995, this rate was approximately 5.9%.\nSubstantially all of WPSC's utility plant is subject to a first mortgage lien.\n(f) Property Additions, Maintenance, and Retirements of Utility Plant--The cost of renewals and betterments of units of property (as distinguished from minor items of property) is capitalized as an addition to the utility plant accounts. The cost of units of property retired, sold, or otherwise disposed of, plus removal costs, less salvage, are charged to the accumulated provision for depreciation. No profit or loss is recognized in connection with ordinary retirements of utility property units. Maintenance and repair costs and replacement and renewal costs associated with items not qualifying as units of property are generally charged to operating expense.\nNonutility property follows a similar policy with the exception of gains and losses which are recognized in connection with ordinary retirements.\nIn October 1993, WPSC sold, at cost, a 32% interest in a combustion turbine to a municipality for $7.8 million.\n(g) Depreciation--Straight-line composite depreciation expense is recorded over the estimated useful life of utility property and includes estimated salvage and cost of removal. These rates have been approved by the Public Service Commission of Wisconsin (\"PSCW\"). Effective January 1, 1994, depreciation rates were revised based on new estimates which decreased annual depreciation expense from the 1993 level by approximately $5.8 million. This decrease was considered in setting customer rates effective January 1, 1994. These rates remained in effect for 1995.\nNonutility property is depreciated using straight-line depreciation, with depreciation lives ranging from five to ten years.\n(h) Nuclear Decommissioning--Nuclear decommissioning costs are accrued over the estimated service life of the Kewaunee Nuclear Power Plant (\"Kewaunee\"), currently recovered from customers in rates, and deposited in external trusts. Such costs totaled $9.0 million, $4.0 million, and $2.4 million for 1995, 1994, and 1993, respectively. In July 1994, the PSCW issued a generic order covering utilities with nuclear generation. This order standardizes the escalation assumptions used in determining nuclear decommissioning liabilities. The undiscounted amount of WPSC's decommissioning costs estimated to be expended between the years 2014 to 2050 are $785 million. Long-term after-tax earnings of 5.5% are assumed. As of December 31, 1995, the accumulated provision for depreciation and decommissioning included accumulated provisions for decommissioning totaling $82.1 million.\nWPSC's share of Kewaunee decommissioning costs is estimated to be $155 million in current dollars based on a site- specific study performed in 1992 using immediate dismantlement as the method of decommissioning. This estimate is in accordance with a generic decommissioning order from the PSCW. As of December 31, 1995, the external trusts totaled $82.1 million. Unrealized gains in the qualified trust are reflected, net of tax, in the trust with the offset to the decommissioning reserve, since decommissioning expense will be recognized as the gains are realized. For the nonqualified trust, unrealized gains are reflected in the trust, net of tax, with the offset an increase to stockholders' equity.\nDepreciation expense includes decommissioning costs recovered in customer rates and a charge to offset earnings from the external trusts. Trust earnings totaled $4.8 million, $2.4 million, and $3.5 million for the years ended December 31, 1995, 1994, and 1993, respectively.\n(i) Nuclear Fuel--The cost of nuclear fuel is amortized to electric production fuel expense based on the quantity of heat produced for the generation of electric energy by Kewaunee. The costs amortized to electric fuel expense (which assume no salvage values for uranium or plutonium) include an amount for ultimate disposal and are recovered through current rates. As required by the Nuclear Waste Policy Act of 1982, a contract has been signed with the\nDepartment of Energy (\"DOE\") for the ultimate storage of the fuel, and quarterly payments based on generation are being made to the DOE for fuel storage. Interim storage space for spent nuclear fuel is provided at Kewaunee, and expenses associated with this storage are recognized as current operating costs. Currently, there is on-site storage capacity for spent fuel through the year 2013. As of December 31, 1995 and 1994, the accumulated provisions for nuclear fuel totaled $142.8 million and $136.5 million, respectively.\n(j) Cash and Equivalents--The Company considers short-term investments with an original maturity of three months or less to be cash equivalents.\n(k) Revenue and Customer Receivables--WPSC accrues revenues related to electric and gas service, including estimated amounts for service rendered but not billed.\nAs of December 31, 1995, energy conservation loans to customers amounting to $3.2 million are included in customer receivables and in investments and other assets.\nAutomatic fuel adjustment clauses are used for FERC wholesale-electric and Michigan Public Service Commission (\"MPSC\") retail-electric portions of WPSC's business. The PSCW retail-electric portion of the business uses a \"cost variance range approach.\" This range is based on a specific estimated fuel cost for the forecast year. If WPSC's actual fuel costs fall outside this range, a hearing may be held and an adjustment to future rates may result. WPSC has a purchased-gas-adjustment clause which allows it to pass on to all classes of gas customers changes in the cost of gas purchased from its suppliers, subject to PSCW and MPSC review.\nWPSC is required to provide service and grant credit to customers within its defined service territory and is precluded from discontinuing service to residential customers during certain periods of the year. WPSC continually reviews its customers' credit-worthiness and obtains deposits or refunds deposits accordingly. WPSC is permitted to recover bad debts in utility rates.\nApproximately 11% of WPSC's total revenues are from companies in the paper products industry.\n(l) Regulatory Assets and Liabilities--WPSC is subject to the provisions of Statement of Financial Accounting Standard (\"SFAS\") No. 71, Accounting for the Effects of Certain Types of Regulation. Regulatory assets represent probable future revenue, such as demand-side management (\"DSM\"), associated with certain incurred costs which will be recovered from customers through the ratemaking process. Regulatory liabilities represent costs previously collected that are refundable in future customer rates. The following\nregulatory assets and liabilities were reflected in the Consolidated Balance Sheets as of December 31:\nAs of December 31, 1995, most of WPSC's regulatory assets are being recovered through rates charged to customers over periods ranging from two to ten years. WPSC does not begin recovering environmental remediation costs before cash payments are made. Pursuant to a PSCW rate order, effective January 1, 1995, WPSC began recovering approximately $23.6 million of regulatory assets per year.\nBased on prior and current rate treatment of such costs, management believes it is probable that WPSC will continue to recover from ratepayers the regulatory assets described above.\nSee notes (1)(n) and (1)(o) for specific discussion of pension and deferred tax regulatory liabilities, and note (7) for discussion of environmental-remediation deferred costs.\n(m) Investments and Other Assets--Investments in affiliates and other investments are immaterial and their income is included in other income and deductions using the equity method of accounting. Other assets include prepaid pension assets, operating deposits for jointly-owned plants, the cash surrender value of life insurance policies, and the long-term portion of energy conservation loans to customers.\n(n) Employee Benefit Plans--WPSC has non-contributory retirement plans covering substantially all employees under which annual contributions are made to an irrevocable trust established to provide retired employees with a monthly payment if conditions relating to age and length of service have been met. The plans are fully funded, and no contributions were made in 1995, 1994, or 1993. Prior to January 1, 1993, the PSCW required the recognition of the funded amounts for ratemaking purposes. Concurrent with a rate order, effective January 1, 1993, WPSC began recovering\npension costs in customer rates under SFAS No. 87, Employers' Accounting for Pensions, and began returning to ratepayers, over five years, the cumulative excess of amounts recovered from customers over SFAS No. 87 costs.\nThe following table sets forth the plans' funded status and expense (income).\nWPSC also offers medical, dental, and life insurance benefits to employees, retirees, and their dependents. The expenses for active employees are expensed as incurred. Prior to 1993, WPSC expensed amounts related to post- retirement health and welfare plans to the extent that such amounts were funded to external trusts.\nEffective January 1, 1993, and concurrent with a rate order, WPSC adopted SFAS No. 106, Employers' Accounting for Post- Retirement Benefits Other Than Pensions, which requires the cost of post-retirement benefits for employees to be accrued as expense over the period in which the employee renders service and becomes eligible to receive benefits. In adopting SFAS No. 106, WPSC elected to recognize the\ntransition obligation for current and future retirees over 20 years.\nSince 1981, WPSC has been funding amounts to irrevocable trusts as allowed for income tax purposes. These funded amounts have been expensed and recovered through customer rates. The non-administrative plan is a collectively bargained plan and, therefore, is tax exempt. The investments in the trust covering administrative employees are subject to federal unrelated business income taxes at a 39.6% tax rate, while the non-administrative trust is tax exempt.\nThe tables below set forth the plans' accrued post- retirement benefit obligation (\"APBO\") and the expense provisions.\nThe assumed before tax expected long-term return on investments and the discount rate used to measure the APBO under SFAS No. 106 are consistent with rates used to calculate the pension plans' funded status and expense under SFAS No. 87. Only the administrative plan is subject to federal income taxes which are reflected in the expense and funding status. The assumed health care cost trend rates for 1996 are 10.0% for medical and 8.5% for dental, decreasing to 6.0% and 5.0%, respectively, by the year 2006. Increasing each of the medical and dental cost trend rates by 1.0% in each year would increase the total APBO as of December 31, 1995 by $21.1 million and the total net periodic post-retirement benefit cost for the year then ended by $4.0 million.\nAs of December 31, 1995, WPSC had approximately 1,100 retirees eligible to receive health care benefits.\nConcurrent with a rate order which was effective January 1, 1994, WPSC adopted SFAS No. 112, Employers' Accounting for Post-Employment Benefits, which establishes accounting and reporting standards for post-employment benefits other than those covered by SFAS Nos. 87 and 106. In connection therewith, WPSC expensed in 1994 the transition obligation of $1.8 million and recovered this cost through its customer rates.\nWPSC has a leveraged Employee Stock Ownership Plan and Trust (\"ESOP\") that held 2,191,873 shares of Company common stock (market value of approximately $74.5 million) at December 31, 1995. At that date, the ESOP also had loans guaranteed by WPSC and secured by common stock.\nPrincipal and interest on the loans are to be paid through WPSC contributions and through dividends on Company common stock held by the ESOP. Shares in the ESOP are allocated to participants as the loans are repaid. Tax benefits from dividends paid to the ESOP are recognized as a reduction in WPSC's cost of providing service to customers. The PSCW has allowed WPSC to include in cost of service an additional employer contribution to the plan. The net effect of the tax benefits and of the employee contribution is an approximately equal sharing of benefits of the program between customers and employees.\n(o) Income Taxes--Effective January 1, 1993, WPSC adopted the liability method of accounting for income taxes as prescribed by SFAS No. 109, Accounting for Income Taxes. Under the liability method, deferred income tax liabilities are established based upon enacted tax laws and rates applicable to the periods in which the taxes become payable. The adoption of this accounting standard had an insignificant impact on the Company's net income. The excess deferred income taxes, resulting from taxes provided at rates greater than current rates, and the previously unrecorded deferred income taxes, have been recorded as a net regulatory liability to be refunded to customers in future years. Such net regulatory liability totaled $30.9 million as of December 31, 1995.\nThe effective income tax rates are computed by dividing total income tax expense, including investment tax credit restored, by the sum of such expense and net income. Previously deferred investment tax credits are being restored over the life of the related utility plant. The components of income tax expense are set forth in the tables on the following page.\nAs of December 31, 1995 and 1994, the Company had the following significant temporary differences that created deferred tax assets and liabilities:\nNOTE 2--Short-Term Debt and Lines of Credit\nTo provide short-term borrowing flexibility and security for commercial paper outstanding, the Company and its subsidiaries maintain bank lines of credit. Most of these lines of credit require a fee.\nThe following information relates to short-term debt and lines of credit for the years indicated:\nNOTE 3--Jointly-Owned Facilities\nInformation regarding WPSC's share of major jointly-owned electric generating facilities in service at December 31, 1995 is set forth below.\nWPSC's share of direct expenses for these plants is included in the corresponding operating expenses in the consolidated statements of income, and WPSC has supplied its own financing for all jointly-owned projects.\nNOTE 4--Long-Term Debt\nSinking fund requirements on first mortgage bonds may be satisfied by the deposit of cash or reacquired bonds with the trustee and, for certain series, by the application of net expenditures for bondable property in an amount equal to 166-2\/3% of the annual requirements.\nAll series requiring the deposit of cash or reacquired bonds for sinking fund purposes have been satisfied to maturity. For those series requiring unpledged property to satisfy sinking fund requirements, the Company has adequate unpledged property to satisfy the requirement for at least ten years.\nIn 1998, $50 million of 5-1\/4% bonds will mature.\nHistorically, gains or losses resulting from the settlement of long-term debt obligations have been deferred as required by regulators.\nNOTE 5--Common Equity\nEffective in September 1994, the Company assumed responsibility for the Dividend Reinvestment and Stock Purchase Plan (\"DRP\"). On September 18, 1995, the DRP was substantially revised and renamed the Stock Investment Plan (\"SIP\"). Prior to September 1994, WPSC issued new shares to meet DRP requirements. During 1993, 50,818 new shares of common stock were issued under the DRP. In April 1993, WPSC stopped issuing common stock under the DRP and began purchasing common stock on the open market for these requirements. The SIP purchases common stock on the open market for shareholder and employee purchases.\nAt December 31, 1995, the Company had $308.0 million of retained earnings available for dividends; however, WPSC is restricted by a PSCW order to paying normal common stock dividends of no more than 109% of the previous year's common stock dividend without PSCW approval. Also, Wisconsin law prohibits WPSC from making loans to the Company and its subsidiaries and from guaranteeing their obligations. On January 15, 1996 a special common stock dividend of $11 million was declared by WPSC to be paid to the Company. The special dividend allows WPSC's equity capitalization ratio to remain at approximately 54%, as approved by the PSCW for ratemaking. The dividend was paid to the Company in January 1996.\nNOTE 6--Fair Value of Financial Instruments\nThe following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:\nCash, Short-Term Investments, Energy Conservation Loans, Notes Payable, and Outstanding Commercial Paper: The carrying amount approximates fair value due to the short maturity of those investments and obligations.\nNuclear Decommissioning Trusts: The value of WPSC's nuclear decommissioning trust investments are recorded at market value.\nLong-Term Debt, Preferred Stock, and ESOP Loan Guarantees: The fair value of WPSC's long-term debt, preferred stock, and ESOP loan guarantees are estimated based on the quoted market price for the same or similar issues or on the current rates offered to WPSC for debt of the same remaining maturity.\nThe estimated fair values of the Company's financial instruments as of December 31 were:\nNOTE 7--Commitments and Contingencies\nCoal Contracts\nTo ensure a reliable, low-cost supply of coal, WPSC entered into certain long-term contracts that have take-or-pay obligations totaling $238.9 million from 1996 through 2016. The obligations are subject to force majeure provisions which provide WPSC other options if the specified coal does not meet emission limits which may be mandated in future legislation. In the opinion of management, any amounts paid under the take-or-pay obligations described above would be legitimate costs of service subject to recovery in customer rates.\nPurchased Power\nWPSC has several take-or-pay contracts related to purchased power, for either capacity or energy. These contracts total $29.2 million through April 1997. Management expects to recover these costs in future customer rates.\nGas Costs\nWPSC also has natural gas supply and transportation contracts that require total demand payments of $358.3 million through October 2003. Management believes that these costs will be recoverable in future customer rates.\nANR Pipeline Company (\"ANR\"), WPSC's primary pipeline supplier, filed with the FERC for approval to recover a portion of certain take-or-pay costs it incurred from renegotiating its long-term gas contracts. As a result of the filing, ANR was allowed to recover a portion of these costs from its customers. WPSC began paying its share of these take-or-pay costs to ANR in 1989, thereby enabling it to recover these costs directly from customers through its purchased-gas-adjustment clause. In March 1991, the FERC approved a settlement under which WPSC will pay ANR monthly take-or-pay amounts. Additional take-or-pay claims by ANR may be filed with FERC. To date, the PSCW has granted WPSC\nrecovery of all ANR take-or-pay costs. All current direct bill take-or-pay liabilities have been satisfied.\nIn April 1992, the FERC issued Order No. 636 (\"Order\") which requires natural gas pipelines to restructure their sales and transportation services. As a result of this Order, WPSC was obligated to pay for a portion of ANR's transition costs incurred to comply with the Order. At December 31, 1995, WPSC has paid in full the liability for these transition costs. Though there may be additional costs, which could be significant, the amount and timing of these costs are unknown at this time. Management expects to recover these costs in future customer rates.\nWPSC will be billed $2.0 million in 1996 for its allocable share of ANR's above-market costs of gas purchases from the Dakota Gasification Plant. WPSC is protesting the legality of these costs which could total $27.2 million through 2009. WPSC recovers these costs in its purchased gas adjustment clause.\nNuclear Liability\nThe Price-Anderson Act provides for the payment of funds for public liability claims arising out of a nuclear incident. In the event of a nuclear incident involving any of the nation's licensed reactors, WPSC is subject to a proportional assessment which is approximately $32.7 million per incident, not to exceed $4.1 million per incident, per calendar year. These amounts represent WPSC's 41.2% ownership share in Kewaunee.\nNuclear Plant Operation\nDue primarily to tube degradation in the steam generators of the jointly-owned Kewaunee Nuclear Power Plant and the current economics of the power generation market, it may not be cost effective to continue operating Kewaunee until the expiration of the operating license in 2013. The owners of Kewaunee continue to evaluate whether to invest the approximate $100 million to replace the steam generators. Should the owners decide to retire Kewaunee early, management believes that all Kewaunee costs will be recoverable in customer rates.\nClean Air Regulations\nIn 1990, the Federal Clean Air Act Amendments (\"Act\") were signed into law. The Act requires WPSC to meet new emission limits for sulfur dioxide and nitrogen oxide in 1995 (Phase I) and in the year 2000 (Phase II). Since Wisconsin had already mandated reduced sulfur dioxide emissions by 1993, which were lower than the federal levels mandated for 1995, WPSC was already working on lowering emissions. WPSC has complied cost effectively with both the Federal and Wisconsin sulfur dioxide laws primarily through fuel-switching. WPSC has been in compliance with the Wisconsin sulfur dioxide limits and the Federal Phase II limits since 1994.\nThe final Federal regulations for nitrogen oxide are not known at this time; however, based on draft rules, WPSC expects to make\nadditional capital expenditures in the range of $3.0 million to $5.0 million between 1996 and 1999 for Wisconsin and Federal air quality compliance. Management believes that all costs incurred to comply with these laws will be recoverable in future customer rates.\nManufactured Gas Plant Remediation\nWPSC is currently investigating the need for environmental cleanup of eight manufactured gas plant sites which it previously operated. WPSC engaged an environmental consultant to develop cleanup cost estimates for the seven sites at which either a Phase I or Phase II site investigation had been completed. The estimated cleanup cost ranges in current dollars for each of the seven sites are: Green Bay from $4.1 to $5.3 million, Two Rivers from $3.9 to $4.0 million, Oshkosh from $3.3 to $4.5 million, Marinette from $5.6 to $6.8 million, Sheboygan I from $2.7 to $3.9 million, Sheboygan II from $12.2 to $13.4 million, and Stevens Point from $1.4 to $1.9 million. The estimates assume excavation of contaminated soils, thermal treatment of soils, disposal of treatment residuals, on-site groundwater extraction, and treatment and post-cleanup monitoring for 25 years. The cost estimate for six of the sites (Green Bay, Two Rivers, Oshkosh, Marinette, Sheboygan I, and Sheboygan II) assume, in addition to those items noted previously, removal and disposal of contaminated river sediments. The consultant has yet to perform a detailed investigation of the Menominee site, and comparable information on this site is not available. WPSC used the estimate for the Stevens Point site as a basis for making a projection of $1.5 million to $1.9 million on cleanup costs at the Menominee site. Both sites are relatively small and are not located adjacent to rivers.\nThe range of future investigation and cleanup costs for all eight sites is estimated to be from $34.7 million to $41.7 million. Remediation expenditures would be made over the next 33 years. WPSC has recorded a liability with an offsetting regulatory asset of $41.7 million, which represents WPSC's current estimate of cleanup costs for all eight sites. The liability represents a $14.8 million increase from the December 31, 1994 estimate of $26.9 million, as a result of new information obtained in the 1995 studies. Based on discussions with regulators and a recent rate order in Wisconsin, management believes that these costs, but not the carrying costs associated with amounts expended, will be recoverable in future customer rates after amounts are expended.\nAs additional investigations and initial remedial actions are completed, these estimates may be adjusted, and these adjustments could be significant. Other factors that can affect these estimates are changes in remedial technology and regulatory requirements. The estimates presented above do not take into consideration any recovery from insurance carriers or other third parties which WPSC is pursuing. Due to the anticipated regulatory treatment, adjustments to the estimated liability do not have an immediate impact on net income.\nLong-Term Power Supply\nIn November 1995, WPSC signed a 25-year agreement to purchase power from Polsky Energy Corporation (\"Polsky\"), an independent power producer proposing to build a cogeneration facility and sell the electrical power to WPSC. Polsky is in the second stage of a two-stage Certificate of Public Convenience and Necessity (\"CPCN\") permitting process prescribed by the PSCW. Construction of the Polsky project is contingent upon PSCW determination in stage two of the CPCN process that WPSC will need the electric capacity which would be provided by the proposed plant. A recent WPSC load forecast suggests the capacity may not be needed. A final decision is expected in 1997. If the PSCW approves the Polsky project, it will be accounted for as a capitalized lease. This would result in the Company recording a plant asset of approximately $110 million, with an offsetting amount of long-term debt.\nFuture Expenditures\nManagement estimates 1996 utility plant construction expenditures to be approximately $78.8 million. DSM expenditures are estimated to be $25.8 million, of which approximately $15.0 million will be deferred and amortized over the next ten years consistent with rate recovery.\nNOTE 8--Segments of Business\nThe table set forth below presents information for the respective years pertaining to the Company's operations segmented by lines of business. The gas segment includes the nonutility operations of ESI which commenced operations in 1994.\nITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nWPS RESOURCES CORPORATION\nF. REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo WPS Resources Corporation:\nWe have audited the accompanying consolidated balance sheets and consolidated statements of capitalization of WPS Resources Corporation (a Wisconsin corporation) and subsidiaries as of December 31, 1995 and 1994, 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, 1995. 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 WPS Resources Corporation and subsidiaries as of December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles.\nAs discussed in notes (1)(n) and (1)(o) to the consolidated financial statements, effective January 1, 1993, WPS Resources Corporation changed its method of accounting for post-retirement benefits other than pensions and income taxes.\nMilwaukee, Wisconsin, January 25, 1996 ARTHUR ANDERSEN LLP\nPAGE\nPAGE\nPAGE\nPAGE\nPAGE\nITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nWISCONSIN PUBLIC SERVICE CORPORATION\nL. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nThe Notes to Consolidated Financial Statements for Wisconsin Public Service Corporation are incorporated in the Notes to Consolidated Financial Statements for WPS Resources Corporation at page 47 of this report.\nITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nWISCONSIN PUBLIC SERVICE CORPORATION\nM. REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo Wisconsin Public Service Corporation:\nWe have audited the accompanying consolidated balance sheets and consolidated statements of capitalization of Wisconsin Public Service Corporation (a Wisconsin corporation) and subsidiary as of December 31, 1995 and 1994, 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, 1995. 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 Wisconsin Public Service Corporation and subsidiary as of December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles.\nAs discussed in notes (1)(n) and (1)(o) to the consolidated financial statements, effective January 1, 1993, Wisconsin Public Service Corporation changed its method of accounting for post-retirement benefits other than pensions and income taxes.\nMilwaukee, Wisconsin, January 25, 1996 ARTHUR ANDERSEN LLP\nITEM 9.","section_9":"ITEM 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nAll information required by Part III, with the exception of information concerning executive officers which appears in Item 4A of Part I hereof, is incorporated by reference to the Company's proxy statement for the Annual Meeting of Shareholders scheduled to be held on May 2, 1996.\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 this report:\n(1) The following financial consolidated statements are included in Part II at Item 8 above:\nDESCRIPTION PAGES IN 10-K ----------- -------------\nWPS RESOURCES CORPORATION\nConsolidated Statements of Income and 42 Retained Earnings for the three years ended December 31, 1995, 1994, and 1993\nConsolidated Balance Sheets as of 43 December 31, 1995 and 1994\nConsolidated Statements of Capitalization 45 as of December 31, 1995 and 1994\nConsolidated Statements of Cash Flows 46 for the three years ended December 31, 1995, 1994, and 1993\nNotes to Consolidated Financial Statements 47\nReport of Independent Public Accountants 64\nWISCONSIN PUBLIC SERVICE CORPORATION\nConsolidated Statements of Income and 65 Retained Earnings for the three years ended December 31, 1995, 1994, and 1993\nConsolidated Balance Sheets as of 66 December 31, 1995 and 1994\nConsolidated Statements of Capitalization 68 as of December 31, 1995 and 1994\nConsolidated Statements of Cash Flows 69 for the three years ended December 31, 1995, 1994, and 1993\nConsolidated Statements of Retained Earnings 70\nNotes to Consolidated Financial Statements 71\nReport of Independent Public Accountants 72\n(2) Financial statement schedules.\nThe following financial statement schedules are included in Part IV of this report. Schedules not included herein have been omitted because they are not applicable or the required information is shown in the financial statements or notes thereto.\nDESCRIPTION PAGES IN 10-K ----------- -------------\nSchedule III. Condensed Parent Company Only Financial Statements\nReport of Independent Public 93 Accountants\nStatements of Income and Retained 94 Earnings\nBalance Sheets 95\nStatements of Cash Flows 96\nNotes 97\n(3) All exhibits, including those incorporated by reference.\nPAGE\n3A Restated Articles of Incorporation of the Company. (Incorporated by reference from Appendix B to Amendment No.1 to the Company's Registration Statement on Form S-4, filed February 28, 1994 [Reg. No. 33-52199]).\n3B By-Laws of the Company. (Incorporated by reference to Exhibit 3B to the Company's Registration Statement on Form S-4, filed February 8, 1994 [Reg. No. 33-52199]).\n4A Copy of First Mortgage and Deed of Trust, dated as of January 1, 1941 from Wisconsin Public Service Corporation to First Wisconsin Trust Company, Trustee (Incorporated by reference to Exhibit 7.01 - File No. 2-7229); Supplemental Indenture, dated as of November 1, 1947 (Incorporated by reference to Exhibit 7.02 - File No. 2-7602); Supplemental Indenture, dated as of November 1, 1950 (Incorporated by reference to Exhibit 4.04 - File No. 2-10174); Supplemental Indenture, dated as of May 1, 1953 (Incorporated by reference to Exhibit 4.03 - File No. 2-10716); Supplemental Indenture, dated as of October 1, 1954 (Incorporated by reference to Exhibit 4.03 - File No. 2-13572); Supplemental Indenture, dated as of December 1, 1957 (Incorporated by reference to Exhibit 4.03 - File No. 2-14527); Supplemental Indenture, dated as of October 1, 1963 (Incorporated by reference to Exhibit 2.02B - File No. 2-65710); Supplemental Indenture, dated as of June 1, 1964 (Incorporated by reference to Exhibit 2.02B - File No. 2-65710); Supplemental Indenture, dated as of November 1, 1967 (Incorporated by reference to Exhibit 2.02B - File No. 2-65710); Supplemental Indenture, dated as of April 1, 1969 (Incorporated by reference to Exhibit 2.02B - File No. 2-65710); Fifteenth Supplemental Indenture, dated as of May 1, 1971 (Incorporated by reference to Exhibit 2.02B - File No. 2-65710); Sixteenth Supplemental Indenture, dated as of August 1, 1973 (Incorporated by reference to Exhibit 2.02B - File No. 2-65710); Seventeenth Supplemental Indenture, dated as of September 1, 1973 (Incorporated by reference to Exhibit 2.02B - File No. 2-65710); Eighteenth Supplemental Indenture, dated as of October 1, 1975 (Incorporated by reference to Exhibit 2.02B - File No. 2-65710); Nineteenth Supplemental Indenture, dated as of February 1, 1977 (Incorporated by reference to Exhibit 2.02B - File No. 2-65710); Twentieth Supplemental Indenture, dated as of July 15, 1980 (Incorporated by reference to Exhibit 4B to Form 10-K for the year ended December 31, 1980); Twenty-First Supplemental Indenture, dated as of December 1, 1980 (Incorporated by reference to Exhibit 4B to Form 10-K for the year ended December 31, 1980); Twenty-Second Supplemental Indenture dated as of April 1, 1981 (Incorporated by reference to Exhibit 4B to Form 10-K for the year ended December 31, 1981); Twenty-Third Supplemental Indenture, dated as of February 1, 1984 (Incorporated by\nreference to Exhibit 4B to Form 10-K for the year ended December 31, 1983); Twenty-Fourth Supplemental Indenture, dated as of March 15, 1984 (Incorporated by reference to Exhibit 1 to Form 10-Q for the quarter ended June 30, 1984); Twenty-Fifth Supplemental Indenture, dated as of October 1, 1985 (Incorporated by reference to Exhibit 1 to Form 10-Q for the quarter ended September 30, 1985); Twenty-Sixth Supplemental Indenture, dated as of December 1, 1987 (Incorporated by reference to Exhibit 4A-1 to Form 10-K for the year ended December 31, 1987); Twenty-Seventh Supplemental Indenture, dated as of September 1, 1991 (Incorporated by reference to Exhibit 4 to Form 8-K filed September 18, 1991); Twenty-Eighth Supplemental Indenture, dated as of July 1, 1992 (Incorporated by reference to Exhibit 4B - File No. 33-51428); Twenty-Ninth Supplemental Indenture, dated as of October 1, 1992 (Incorporated by reference to Exhibit 4 to Form 8-K filed October 22, 1992); Thirtieth Supplemental Indenture, dated as of February 1, 1993 (Incorporated by reference to Exhibit 4 to Form 8-K filed January 27, 1993); Thirty-First Supplemental Indenture, dated as of July 1, 1993 (Incorporated by reference to Exhibit 4 to Form 8-K filed July 7, 1993); Thirty-Second Supplemental Indenture, dated as of November 1, 1993 (Incorporated by reference to Exhibit 4 to Form 10-Q for the quarter ended September 30, 1993). All references to periodic reports are to those of Wisconsin Public Service Corporation (File No. 1-3016).\n10A Copy of Joint Power Supply Agreement among Wisconsin Public Service Corporation, Wisconsin Power and Light Company, and Madison Gas and Electric Company, dated February 2, 1967 (Incorporated by reference to Exhibit 4.09 in File No. 2-27308).\n10B Copy of Joint Power Supply Agreement (Exclusive of Exhibits) among Wisconsin Public Service Corporation, Wisconsin Power and Light Company, and Madison Gas and Electric Company dated July 26, 1973 (Incorporated by reference to Exhibit 5.04A in File No. 2-48781).\n10C Copy of Basic Generating Agreement, Unit 4, Edgewater Generating Station, dated June 5, 1967, between Wisconsin Power and Light Company and Wisconsin Public Service Corporation (Incorporated by reference to Exhibit 4.10 in File No. 2-27308).\n10C-1 Copy of Agreement for Construction and Operation of Edgewater 5 Generating Unit, dated February 24, 1983, between Wisconsin Power and Light Company, Wisconsin Electric Power Company, and Wisconsin Public Service Corporation (Incorporated by reference to Exhibit 10C-1 to\nForm 10-K of Wisconsin Public Service Corporation for the year ended December 31, 1983 [File No. 1-3016]).\n10C-2 Amendment No. 1 to Agreement for Construction and Operation of Edgewater 5 Generating Unit, dated December 1, 1988 (Incorporated by reference to Exhibit 10C-2 to Form 10-K of Wisconsin Public Service Corporation for the year ended December 31, 1988 [File No. 1-3016]).\n10D Copy of revised Agreement for Construction and Operation of Columbia Generating Plant among Wisconsin Public Service Corporation, Wisconsin Power and Light Company, and Madison Gas and Electric Company, dated July 26, 1973 (Incorporated by reference to Exhibit 5.07 in File No. 2-48781).\n10E Copy of Guaranty and Agreements and Note Agreements for Wisconsin Public Service Corporation Employee Stock Ownership Plan and Trust (ESOP) dated November 1, 1990 (Incorporated by reference to Exhibits 10.1 and 10.2 to Form 8-K of Wisconsin Public Service Corporation filed November 2, 1990 [File No. 1-3016]).\nExecutive Compensation Plans and Arrangements\n10F-1 Copy of Form of Deferred Compensation Agreement (Plan 008) with certain executive officers of Wisconsin Public Service Corporation. (Incorporated by reference to Exhibit 10F-1 to Form 8 of Wisconsin Public Service Corporation, amending Form 10-K for the year ended December 31, 1992 [File No. 1-3016]).\n10F-2 Copy of Form of Supplemental Benefits and Deferred Compensation Agreement (Plan 009) with certain executive officers of Wisconsin Public Service Corporation including the named executive officers of the registrant, as defined by item 402(a)(3) of Regulation S-K. (Incorporated by reference to Exhibit 10F-2 to Form 8 of Wisconsin Public Service Corporation, amending Form 10-K for the year ended December 31, 1992 [File No. 1-3016]).\n10F-3 Copy of Form of Deferred Compensation Agreement (Plan 010) with certain executive officers of Wisconsin Public Service Corporation. (Incorporated by reference to Exhibit 10F-3 to Form 8 of Wisconsin Public Service Corporation, amending Form 10-K for the year ended December 31, 1992 [File No. 1-3016]).\n10F-4 Copy of Form of Director Deferred Compensation Agreement (Plan 011) with certain non-employee directors of Wisconsin Public Service Corporation. (Incorporated by reference to Exhibit 10F-4 to Form 8 of Wisconsin Public\nService Corporation, amending Form 10-K for the year ended December 31, 1992 [File No. 1-3016]).\n10F-5 Copy of WPS Resources Corporation Form of Deferred Compensation Agreement with executives and non-employee directors effective January 1, 1996. (Incorporated by reference to Exhibit 4 to a WPS Resources Corporation - Wisconsin Public Service Corporation Registration Statement on Form S-8 filed December 19, 1995 [Reg No. 33-65167]).\nEXHIBIT NUMBER DESCRIPTION OF DOCUMENT PAGES IN 10-K - ------- ----------------------- -------------\n11A Statement regarding computation of per share earnings (Not applicable).\n12 Statement regarding computation of ratios (Not applicable).\n13 Annual report to security holders (Not applicable).\n18 Letter regarding change in accounting principles (Not applicable).\n19 Previously unfiled documents (None).\n22 Subsidiaries of the Registrant. 81\n24.1 Consent of Independent Public Accountants. 82\n25 Powers of Attorney. 83\n27 Financial Data Schedule. WPS Resources Corporation 91 Wisconsin Public Service Corporation 92\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.\nWPS RESOURCES CORPORATION AND WISCONSIN PUBLIC SERVICE CORPORATION\n(Registrant)\nBy \/s\/ D. A. Bollom -------------------------------- D. A. Bollom Chairman and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nSignature Title Date - ----------------------------------------------------------------------\nA. Dean Arganbright Director March 8, 1996 Michael S. Ariens Director Richard A. Bemis Director M. Lois Bush Director Robert C. Gallagher Director By \/s\/ D. A. Bollom Kathryn M. Hasselblad-Pascale Director ------------------------- James L. Kemerling Director D. A. Bollom Larry L. Weyers Director Attorney-in-Fact\n\/s\/ D. A. Bollom Principal Executive March 8, 1996 - --------------------------------Officer and Director D. A. Bollom\n\/s\/ P. D. Schrickel Principal Financial March 8, 1996 - --------------------------------Officer P. D. Schrickel\n\/s\/ D. L. Ford Principal Accounting March 8, 1996 - --------------------------------Officer D. L. Ford\nA. REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULE III - CONDENSED PARENT COMPANY ONLY FINANCIAL STATEMENTS\nTo WPS Resources Corporation:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements of WPS Resources Corporation included in this Form 10-K, and have issued our report thereon dated January 25, 1996. Our report on the consolidated financial statements includes an explanatory paragraph with respect to the change in the methods of accounting for income taxes and post- retirement benefits other than pensions in 1993 as discussed in Notes 1(n) and 1(o) to the consolidated financial statements.\nOur audit was made for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. Supplemental Schedule III is the responsibility of the Company's management and is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic consolidated financial statements. This schedule has been subjected to the auditing procedures applied in the 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.\nMilwaukee, Wisconsin, January 25, 1996 ARTHUR ANDERSEN LLP\nPAGE\nSchedule III - Condensed Parent Company Financial Statements\nWPS Resources Corporation (Parent Company Only)\nNotes to Parent Company Financial Statements Year Ended December 31, 1995\nThe following are supplemental notes to the WPS Resources Corporation (parent company only) financial statements and should be read in conjunction with the WPS Resources Corporation Consolidated Financial Statements and Notes thereto included herein:\nSUPPLEMENTAL NOTES\nNote 1 WPS Resources Corporation (the \"Company\") was formed in December 1993, as a wholly-owned subsidiary of Wisconsin Public Service Corporation (\"WPSC\"). Effective September 1994, pursuant to a one-for-one share exchange, the Company acquired all of the common stock of WPSC. The accompanying condensed financial statements reflect the equity income, and cash dividends from subsidiaries subsequent to the September 1994, share exchange.\nNote 2 The Company has a note receivable from WPSC totaling $6.1 million and bearing interest at 8.76%. The note is to be repaid in monthly payments of $51,670 through January 2015. The Company also has a note receivable from WPS Energy Services, Inc. (\"ESI\") totaling $1.9 million and bearing interest at 7-7\/8%. The note is to be repaid in quarterly payments of $69,076 through October 2005.\nNote 3 Prior to the one-for-one share exchange, WPSC contributed $2.0 million in cash to WPSR to fund operations.","section_15":""}
{"filename":"851588_1995.txt","cik":"851588","year":"1995","section_1":"Item 1. Business\nGeneral\nGiddings & Lewis, Inc. (the \"Company\") is a leading global designer and producer of highly-engineered, high-precision, industrial automation systems, including automated machine tools, smart manufacturing systems, flexible transfer lines, assembly automation systems, measuring systems, industrial controls, and related products and services. The Company's products are supplied primarily to the automotive, construction, aerospace, defense, appliance, energy and electronics industries and are manufactured at the Company's thirteen facilities located in the United States, Canada, England and Germany.\nThe Giddings & Lewis name has been continuously present in the Company's domestic markets for over 100 years. The Company was a public company from 1937 until 1982, when its businesses were acquired by United Dominion Industries, Inc. (\"United Dominion\"). In July 1989, United Dominion sold its interest in the Company through a public offering. On October 31, 1991, the Company acquired Cross & Trecker Corporation (\"Cross & Trecker\"), a manufacturer of machine tools and related factory equipment. The acquisition was accounted for as a purchase and the operations of Cross & Trecker have been included in the Company's financial statements since the date of acquisition. On April 24, 1995, the Company acquired through a wholly owned subsidiary all of the issued and outstanding shares of capital stock of Fadal Engineering Company, Inc. (\"Fadal\") and the land and building in Chatsworth, California used by Fadal in the operation of its business. The net cash consideration paid by the Company in this transaction was $179,579,000, which amount includes $1,550,000 of direct acquisition costs. The acquisition was accounted for as a purchase and the operations of Fadal have been included in the Company's financial statements since the date of acquisition. The operations of Fadal are included in the Company's Automation Technology Group.\nThe Company's overall business strategy is to continue to strengthen its position within the global industrial automation marketplace by providing customers with a creative, single source for a broad range of manufacturing products and services. The key ongoing elements of the Company's business strategy are to (i) continue to implement a focused customer-oriented marketing approach, (ii) expand and extend the Company's product lines, and (iii) aggressively expand its international franchise.\nThe Company operates in a single business segment, industrial automation products, and is organized into four major operating groups: Automation Technology, Integrated Automation, Automation Measurement and Control, and European Operations. Net sales attributed to each of the Company's operating groups for each of the last three years are shown in the following table:\nProducts\nThe Automation Technology Group, the Integrated Automation Group and the Automation Measurement and Control Group sell products from the automation technology, integrated automation and automation measurement and control product lines, respectively. The European Operations Group sells products from all three product lines. Each of the Company's product lines is described below.\nAutomation Technology. The Company's automation technology product line consists of highly-engineered, high-precision, computer numerically controlled machine tools and associated products and services. Revenues from this product line were 41.2%, 32.0% and 35.6% of total revenues for 1995, 1994 and 1993, respectively. The following are the most significant products in this product line:\nHorizontal and Vertical Machining Centers, which, through the use of automatic tool changers, can mill, drill, bore, tap and ream primarily metal parts of various shapes and sizes, in programmable sequences;\nHorizontal and Vertical Lathes, which cut round parts from metal and other materials;\nHorizontal Boring, Drilling, and Milling Machines, which perform the same functions as horizontal machining centers, but do not have automatic tool changers;\nCellular and Flexible Manufacturing Systems, which utilize material handling systems and Company-produced computer numerical controls and software, and prefixtured pallets to integrate several machine tools to form a cellular system or to integrate many machine tools to form a flexible manufacturing system;\nFixtures and Cutting Tools, which are used to hold and to cut, drill, or bore metal and other parts; and\nDrill Point Grinders, which grind specialized drill points including a helical point which has superior drilling capabilities.\nWith the exception of the Fadal product line, substantially all of the Company's major machine tools and fixtures are custom engineered to meet specific customer requirements and, accordingly, have a high engineering component in their selling prices. Although these products are produced in a variety of sizes, the historic focus and strength of this product line has been large, highly-engineered, high-precision metal-cutting machine tools such as those used to manufacture major parts for jet engines and construction equipment. Trading on the Company's name and reputation, these products occupy the premium-priced segment of the market. Fadal's product line includes eleven models of small computer numerically controlled vertical machining centers for use in industrial machine shops. The Company produces the majority of the computer numerical controls and related software incorporated into its products. The Company's cutting tools and drill point grinders are primarily sold to standard specifications.\nVirtually all of the Company's automated machine tools are computer numerically controlled. They are designed to operate largely unattended and are programmable to perform machining functions on a wide variety of metal parts and other materials. Such standalone machines may be combined with several pallets (on which parts in process are positioned for machining) and pallet changers to increase production flow. The next step in automation is to permit a part to be processed by one machine and automatically transferred to another machine for further work. The Company provides this capability through cellular and flexible manufacturing systems that integrate the functions of several standalone machines with the use of automated transport systems and Company-produced cell managers and software. Since 1982, the Company has designed its machine tools and their pallets to be compatible with each other so that its established customer base can integrate new machines with existing machines.\nStandalone machines have historically dominated the Company's machine tool sales, accounting for approximately 65%, 37% and 48% of automation technology product line revenues in 1995, 1994 and 1993, respectively. Cellular and flexible manufacturing systems accounted for approximately 5%, 21% and 14% of automation technology product line revenues in the same respective years. Included in such cellular and flexible manufacturing percentages is a certain volume of standalone sales to customers which create or enlarge machining cells by integrating the new machines with existing machines.\nThe Company's revenues from post-sale services and parts are primarily associated with its automation technology product line. Services include training, maintenance, repair, remanufacturing and retrofitting, and accounted for approximately 23%, 33% and 32% of automation technology product line sales in 1995, 1994 and 1993, respectively. Sales of such services and parts are at higher gross margins than the machine tools themselves and have historically been less sensitive to industry cyclicality than the sale of new equipment.\nThe other products in the automation technology product line primarily consist of gray iron and ductile castings which are produced for the Company's requirements as well as for sales to outside customers. Through its foundry in Menominee, Michigan, the Company produces gray iron and ductile castings of up to 35 tons, typically cast from unique patterns supplied by the Company and its customers and maintained at the foundry.\nIntegrated Automation. The Company engineers, manufactures and sells flexible transfer lines, flexible machining systems and special machining systems. The Company is also a leading domestic designer and manufacturer of custom automated assembly systems, including dials, synchronous and non-synchronous transport systems and special handling, testing and measuring systems and complete multi-unit automatic production systems. These products are for use in the automotive industry, as well as the major appliance and other high volume industries. Integrated automation product line revenues for 1995, 1994 and 1993 accounted for 49.9%, 57.9% and 53.5%, respectively, of total revenues for the Company.\nThe Company's flexible transfer lines are a combination of individual work stations arranged in the required sequence, connected by work transfer devices and integrated with interlocked controls. All types of machining operations, such as drilling, tapping, reaming, boring and milling are efficiently and economically combined on transfer machines. Dial, rotary, in-line and pallet-type are among the different types of flexible transfer line equipment supplied by the Company. Flexible transfer lines have traditionally been used in the automotive industry for producing identical components at high production rates with minimal manual part handling and are applicable to other industries with high volume requirements. Flexible transfer lines accounted for approximately 63.9%, 65.9% and 64.2% of integrated automation product line revenues in 1995, 1994 and 1993, respectively.\nThe Company's automated assembly systems are used to assemble a variety of products, including automotive airbags, household appliances, wing spars for commercial airlines, and automotive engines and transmissions. The nonsynchronous assembly systems are used to integrate independent self-powered assembly stations with a continuous conveyor line and consist of three principal types of stations: manual stations, which only require that a part be placed on a pallet; dedicated stations, which perform multiple actions on a family of parts; and robotic stations, which can be programmed to perform many functions on a number of parts. Robotics incorporated in the Company's automated assembly systems are not produced by the Company. Each automated assembly system is custom engineered by the Company to meet a customer's specific requirements, with standardized components normally accounting for only 10% to 15% of any system. Automated assembly systems accounted for approximately 22.4%, 27.2% and 23.1% of integrated automation product line revenues in 1995, 1994 and 1993, respectively.\nThe integrated automation product line also includes broach and piston turning machines. Both are metalcutting machines. Broach machines are used to push or pull a multi-tooth cutting tool or the workpiece in relation to each other to remove material. Broach machines have the ability to rough and finish in one pass thereby increasing productivity. As the name implies, piston turning machines are used to manufacture pistons. The machine is unique in that it is capable of producing the complex shapes required in piston manufacturing.\nAutomation Measurement and Control. The Company designs and manufactures a comprehensive line of dimensional measurement products. These include coordinate measurement machines, gaging products and metrological instruments. The Company is a leader in the implementation of flexible measurement systems, which can be supplied either on a standalone basis or as an integral part of manufacturing systems. The Company also provides a wide range of services, including gage certification services. In addition, the Company supplies a broad range of industrial control products, including programmable industrial computers, computer numerical controls, servo drive systems, operator interface systems and specialized software solutions. These products are designed for use both with the Company's products and the products of other manufacturers. Automation measurement and control product line revenues were 8.9%, 10.1% and 10.9% of total revenues for the Company in 1995, 1994 and 1993, respectively.\nCustomers, Sales, and Distribution\nThe Company's products and manufacturing systems are sold primarily to the automotive, construction, aerospace, defense, appliance, energy and electronics industries. Typically, the ten largest customers are large multi-national companies that account for approximately 50% to 60% of the Company's total sales, although the composition of these customers varies from year to year. One customer, Ford Motor Company, accounted for approximately 6.3%, 15.9% and 29.7% of the Company's sales in 1995, 1994 and 1993, respectively. For the same periods, Chrysler Corporation accounted for approximately 23.2%, 14.2% and 4.4% of sales, respectively.\nA network of sales representatives\/distributors is used to sell the Company's products on a worldwide basis. The sales representative\/distributor network is assisted and supervised by Company sales managers located in key market areas. The Company's direct sales force is paid a salary plus commission and its distributors are paid on a commission-only basis.\nSales Arrangements\nThe Company sells substantially all of its products under fixed price contracts. These contracts are priced after the Company analyzes, among other things, material, labor, overhead and custom engineering costs involved in the contract.\nFixed price contracts entail the risk of cost overruns. The risk of such overruns typically increases in proportion to the complexity and uniqueness of the engineering and manufacturing tasks involved under any particular contract. There can be no assurance that the Company will not be adversely affected by significant cost overruns on its fixed price contracts.\nA substantial portion of the products manufactured by the Company involves long lead times from receipt of a customer order to the shipment of a completed machine. Under the terms of its sales contracts, and consistent with industry practice, the Company receives most of its sales price upon shipment of the product.\nManufacturing Capacity\nThe Company manufactures its products at thirteen facilities with its primary facilities located in Fond du Lac and Janesville, Wisconsin; Fraser and Port Huron, Michigan; Dayton, Ohio; Chatsworth, California; Knowsley, England; and Wendlingen, Germany. The Fond du Lac facility currently operates three shifts a day, five days a week. The Janesville facility is currently operating three shifts, six days a week. The Fraser and Port Huron facilities are currently operating two shifts a day, six days a week. The Dayton facility is currently operating three shifts, five days a week. The Chatsworth facility is currently operating two shifts, six days a week. The Knowsley and Wendlingen facilities are currently operating two shifts a day, five days a week. Overtime charges at the Company's facilities are not material.\nProduct Line Competition\nAutomation Technology. The market for machine tools is highly competitive, with substantial competition from both U.S. and foreign manufacturers. Competition is mainly from manufacturers of the same types of machines produced by the Company. However, manufacturers of different machine types, certain customers, and third party integrators are also competitors. Principal competitive factors for machine tools include product performance, delivery, price and service. The Company's Menominee, Michigan foundry competes with a number of foundries in its respective market area.\nIntegrated Automation. The traditional customer base for domestic flexible transfer line sales has been the major automobile manufacturers. This limited customer base and the large scope of the projects involved have made this a very competitive market. The size of the projects has resulted in a competitive environment where the major competitors are large and often have established relationships with their customers. Foreign competitors have obtained limited business in this market which had been traditionally dominated by domestic suppliers. The international customer base for flexible transfer lines includes all major European, Asian and U.S. transplant automobile manufacturers. This market exhibits the same competitive characteristics as the U.S. market. However, the Company believes that its established presence in the European flexible transfer line market and its manufacturing capabilities in Germany and England leave the Company favorably positioned to compete effectively in this market.\nThe domestic market for automated assembly systems is also competitive. Competitive factors for automated assembly systems include engineering concepts, pricing, product performance and delivery. Approximately 70 North American companies have been identified as competitors for the type of automated assembly systems supplied by the Company. Many of these competitors specialize in a specific type of assembly system and compete mainly on a regional basis. The automated assembly systems manufactured by the Company are substantially custom engineered products and are purchased largely by both major corporations and small independent companies based in the U.S. Due to the nature of its products and its customer base, the Company believes that to date it has not faced significant foreign competition in automated assembly systems. In the international market, the Company believes that the relationships already established in the European automotive market will provide new opportunities for sales of automated assembly systems.\nAutomation Measurement and Control. The markets for the automation measurement and control product line is highly competitive. Currently, the Company believes that it is among the top five coordinate measurement producers in the world. This market has become increasingly global in nature with significant competition coming from foreign producers. Principal competitive factors for coordinate measurement systems include quality, delivery time, service and price.\nEstablished customer relationships and customer preference for a standardized control produced by one manufacturer has hindered the Company's ability to penetrate some of the larger segments in the market for industrial control products. The Company believes that it has successfully pursued niche and non-traditional markets in the broad motion control marketplace as exemplified by sales to robotics, photographic equipment and packaging equipment manufacturers.\nRaw Materials\nBecause the Company manufactures most of the parts used in its products, the basic raw materials used in the Company's production are iron and steel. The Company's foundry produces gray iron and ductile castings which are major parts in its machine tools. Certain components are purchased, such as sheet metal, robotics, electric motors, bearings, steel castings and electronic and electrical components. All such materials and components used are available from a number of sources. The Company is not dependent on any supplier that cannot be readily replaced and has not experienced difficulty in obtaining necessary purchased materials.\nPatents and Trademarks\nThe Company possesses rights under a number of domestic and foreign patents and trademarks relating to its products and business. While the Company considers that patents and trademarks are important in the operation of its business, its business is not dependent on any single patent or trademark or group of patents or trademarks.\nResearch, Development and Custom Engineering\nAs of December 31, 1995, the Company had 48 employees in its engineering departments engaged, wholly or partly, in activities relating to Company-sponsored research, 37 of whom have college engineering degrees. Another 450 employees were actively involved in product development, custom engineering and software development. Of these, 172 have college degrees in engineering. A summary of research and product development expenditures for the last three years is shown in the following table:\nResearch, Development and Custom Engineering Expenditures (in thousands)\n1995 1994 1993 Research and development expense pertaining to new products or significant improvements to existing products . . . . . . . . $ 3,183 $ 3,857 $ 4,064\nAll other product development and engineering expenditures related to ongoing refinements, improvements of existing products, and custom engineering . . . . . 57,212 63,541 53,349 ------ ------ ------ Total expenditures for research, product development, and engineering . . . . . . . . . . . $60,395 $67,398 $57,413 ====== ====== ======\nEmployees\nAs of December 31, 1995, the Company had 3,967 employees, of whom 2,106 were hourly employees and 1,861 were salaried employees. At the Company's Dayton, Ohio facility, 104 employees are covered by a collective bargaining agreement expiring in June 1996. Also, at the facility in Tecumseh, Canada, 16 employees are covered by a collective bargaining agreement expiring in September 1996. The Company's remaining collective bargaining agreements expire at various times from 1997 through 1998. The Company considers its employee relations to be good.\nExecutive Officers\nThe following table sets forth certain information, as of March 1, 1996, regarding the executive officers of the Company. All executive officers serve at the pleasure of the Board of Directors.\nName Age Position\nJoseph R. Coppola 65 Chairman, Chief Executive Officer and Director\nRichard C. Kleinfeldt 54 Vice President - Finance, Secretary and Director Heinz G. Anders 62 Group Vice President and General Manager-European Operations\nDouglas E. Barnett 36 Vice President and Corporate Controller Carmine F. Bosco 49 Group Vice President and General Manager - Automation Measurement and Control Group\nName Age Position\nPhilip N. Ciarlo 44 Group Vice President and General Manager - Integrated Automation Group Todd A. Dillmann 40 Corporate Counsel and Assistant Secretary\nRobert N. Kelley 45 Vice President - Administration\nMichael R. Melzer 50 Treasurer\nStephen M. Peterson 46 Group Vice President and General Manager - Fadal Engineering Company, Inc.\nJames B. Simon 54 Group Vice President and General Manager - Automation Technology Group\nJoseph R. Coppola has served as Chairman of the Board and Chief Executive Officer of the Company since July 1993. From 1983 to 1993, Mr. Coppola was Senior Vice President of Manufacturing Services for Cooper Industries, Inc.\nRichard C. Kleinfeldt has served as Vice President-Finance of the Company since May 1989 and as Secretary since July 1989. Mr. Kleinfeldt has been employed by the Company since 1964.\nHeinz G. Anders has served as Group Vice President and General Manager of the Company's European Operations since February 1994. From 1981 until assuming his current position, Mr. Anders was Managing Director for Deutsche Gardner-Denver GmbH & Co. in Westhausen, Germany.\nDouglas E. Barnett has served as Vice President and Corporate Controller since January 1996. Prior thereto, Mr. Barnett had been Treasurer of the Company since February 1991. Prior to joining the Company in 1991, Mr. Barnett had been an investment banker with The First Boston Corporation since 1989.\nCarmine F. Bosco has served as Group Vice President and General Manager - Automation Measurement and Control since joining the Company in June 1995. Prior thereto he spent twenty years working for Ingersoll-Rand Company where he served as Vice President and General Manager of the Aro Fluid Products division since 1990.\nPhilip N. Ciarlo has served as Group Vice President and General Manager - Integrated Automation since December 1995. Prior thereto he served as Vice President and General Manager of the Company's Assembly Automation Operations from June 1994 to December 1995. Prior to joining the Company in June 1994, Mr. Ciarlo was Manager Plant Operations for Martin Marietta from April 1993 to June 1994. He served in various management positions with General Electric Corporation for twenty years prior to that.\nTodd A. Dillmann has served as Corporate Counsel and Assistant Secretary of the Company since January 1, 1995 and as Corporate Counsel since November 1, 1991. Prior to that he was Director of Legal Services for Kearney & Trecker Corporation.\nRobert N. Kelley has served as Vice President - Administration of the Company since July 1991. Prior thereto, Mr. Kelley was Vice President of Human Resources and Administration of Premier Refractories & Chemicals, Inc. since June 1989.\nMichael R. Melzer has served as Treasurer of the Company since January 1996. Prior thereto he served as Vice President of Financial Services of the Company since September 1993. From February 1993 until August 1993, Mr. Melzer served as Vice President of Technical Services - Automation Technology. From November 1991 until January 1993, Mr. Melzer served as Vice President - West Allis Operations for the Automation Technology Group. Prior to the Company's acquisition of Cross & Trecker in 1991, Mr. Melzer had served in various financial and operations positions with Kearney & Trecker Corporation.\nStephen M. Peterson has served as Group Vice President and General Manager - Fadal Engineering Company, Inc. since May 1995. Prior thereto he served as Vice President - Worldwide Sales of the Company since December 1990. He has been an employee of the Company since 1969.\nJames B. Simon has served as Group Vice President - Automation Technology since December 1994 and prior thereto Mr. Simon had been Vice President - Engineering\/Total Quality of the Company since 1989. Mr. Simon has been an employee of the Company since 1965.\nBacklog\nInformation about backlog is contained under \"Management's Discussion and Analysis\" on pages 14 to 18 of the Company's 1995 Annual Report to Shareholders and such information is hereby incorporated herein by reference. In some instances involving automotive customers, bookings are awarded and included in the backlog with the formal purchase orders obtained at a later time. Such practice is standard in the industry and the Company has historically experienced no significant cancellation of such bookings. At December 31, 1995, these bookings amounted to $14 million.\nForeign Operations and Export Sales\nInformation about the Company's foreign operations and export sales is contained in Note 11 of Notes to Consolidated Financial Statements on page 33 of the Company's 1995 Annual Report to Shareholders and such information is hereby incorporated herein by reference.\nEnvironmental Matters\nThe Company and the industry in which it competes are subject to environmental laws and regulations concerning emissions to the air, discharges to waterways and the generation, handling, storage, transportation, treatment and disposal of waste materials. It is the Company's policy to comply with all applicable environmental, health and safety laws and regulations. These\nlaws and regulations are constantly evolving and it is difficult to predict accurately the effect they will have on the Company in the future. The Company does not presently anticipate that compliance with currently applicable environmental regulations and controls will significantly affect its competitive position, capital spending or earnings during 1996. For further information on environmental matters, see Item 3 of this Annual Report on Form 10-K.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe following table sets forth certain information, as of December 31, 1995, relating to the Company's principal facilities. See \"Manufacturing Capacity.\" All of the real property listed is owned by the Company.\nProperties\nApproximate Approximate Floor Area Land Area in Square Location in Acres Feet Principal Uses\nChatsworth, CA 6.8 206,000 Design and manufacture of automated machine tools\nFond du Lac, WI 24.3 457,000 General offices and design and manufacture of automated machine tools, tools and accessories\nFond du Lac, WI 15.4 102,000 Design and manufacture of computer-based electronic control units and production of related software\nJanesville, WI 12.3 227,000 Design and manufacture of automated assembly systems\nJanesville, WI 5.5 82,000 Design and manufacture of automated assembly systems\nDayton, OH 19.8 294,000 Design and manufacture of measurement systems\nFraser, MI 31.1 244,000 Design and manufacture of machining systems\nWarren, MI 1.9 24,000 Manufacture of machine components\nPort Huron, MI 12.5 143,000 Design and manufacture of special machine tools\nApproximate Approximate Floor Area Land Area in Square Location in Acres Feet Principal Uses\nMenominee, MI 7.0 142,000 Manufacture of castings\nTecumseh, Canada 9.0 70,000 Manufacture of machining systems\nWendlingen, Germany 11.5 257,000 Design and manufacture of machining systems\nKnowsley, England 5.7 125,000 Design and manufacture of machining systems\nThe Company also owns one other facility with floor space of approximately 23,000 square feet. The Company is currently in the process of selling this facility.\nItem 3.","section_3":"Item 3. Litigation\nThe Company is involved in various environmental matters, including matters in which the Company and certain of its subsidiaries have been named as potentially responsible parties under the Comprehensive Environmental Response Compensation and Liability Act (\"CERCLA\"). These matters include a soil and water contamination matter at the Company's former West Allis, Wisconsin facility. In 1992, the Company was notified by the Wisconsin Department of Natural Resources (\"WDNR\") of contamination at the West Allis site. In 1994, the Company sold most of the site, including the manufacturing facility. The Company has made substantial progress on the implementation of a WDNR approved clean-up plan on the nine acre portion of the site that was not sold.\nThe Company has established accruals for all environmental contingencies of which management is currently aware in accordance with generally accepted accounting principles. In establishing these accruals, management considered (a) reports of environmental consultants retained by the Company, (b) the costs incurred to date by the Company at sites where clean-up is presently ongoing and the estimated costs to complete the necessary remediation work remaining at such sites, (c) the financial solvency, where appropriate, of other parties that have been responsible for effecting remediation at specified sites, and (d) the experience of other parties who have been involved in the remediation of comparable sites. The accruals recorded by the Company with respect to environmental matters have not been reduced by potential insurance or other recoveries and are not discounted. Although the Company has and will continue to pursue such claims against insurance carriers and other responsible parties, future potential recoveries remain uncertain and, therefore, were not recorded as a reduction to the estimated gross environmental liabilities. Based on the foregoing and given current information, management believes that future costs in excess of the amounts accrued on all presently known and quantifiable environmental contingencies will not be material to the Company's financial position or results of operations.\nIn another matter, a Michigan Department of Natural Resources (now known as the Michigan Department of Environmental Quality) investigation into alleged environmental violations at the Company's Menominee, Michigan facility resulted in the issuance of criminal complaints against the Company and two of its employees in November 1994. The complaints, which are\npending in Menominee County, Michigan district and circuit courts, generally focus on alleged releases of hazardous substances and the alleged illegal treatment and disposal of hazardous waste. In these actions, the State of Michigan is seeking, among other relief, monetary sanctions as specified by applicable law. Two civil lawsuits are also pending which seek unspecified damages based on allegations of improper disposal and emissions at this facility. The Company is vigorously defending itself against all charges and allegations. Information presently available to the Company does not enable it to reasonably quantify potential civil or criminal penalties, or remediation costs, if any, related to these matters.\nThe Company is also involved in other litigation and proceedings, including product liability claims. In the case of product liability, the Company is partially self-insured and has accrued for all claim exposure for which a loss is probable and reasonably estimable. Based on current information, management believes that future costs in excess of the amounts accrued for all such existing litigation will not be material to 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 matters were submitted to a vote of shareholders during the quarter ended December 31, 1995.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters\nThe portion of page 18 under the caption \"Market Prices and Dividends\" which describes the market for the Company's Common Stock, $.10 par value, and Note 5 of Notes to Consolidated Financial Statements on pages 26 and 27 which describes restrictions on dividends and which are contained in the Company's 1995 Annual Report to Shareholders are hereby incorporated herein by reference in response to this Item.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe information set forth in the table on page 13 of the Company's 1995 Annual Report to Shareholders under the caption \"Five-Year Summary\" is hereby incorporated herein by reference in response to this Item.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nThe information set forth on pages 14 through 18 in the Company's 1995 Annual Report to Shareholders under the caption \"Management's Discussion and Analysis\" is hereby incorporated herein by reference in response to this Item.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe consolidated statements of income, cash flows and changes in shareholders' equity for each of the years in the three-year period ended December 31, 1995, and the related consolidated balance sheets of the Company as of December 31, 1995 and 1994, together with the related notes thereto and the report of independent auditors, all set forth on pages 19 through 34 of the Company's 1995 Annual Report to Shareholders, are hereby incorporated herein by reference in response to this Item.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nThere have been no changes in or disagreements with the Company's independent auditors regarding accounting and financial disclosure required to be reported pursuant to this Item.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nPursuant to Instruction G, the information required by this Item with respect to directors and Section 16 compliance is hereby incorporated herein by reference from the information under the captions entitled \"Election of Directors\" and \"Miscellaneous-Other Matters\" set forth in the Company's definitive Proxy Statement for its 1996 Annual Meeting of Shareholders (\"Proxy Statement\")*. Information with respect to the executive officers of the Company appears in Part I, pages 9 through 11, of this Annual Report on Form 10-K.\n* The Proxy Statement will be filed with the Securities and Exchange Commission pursuant to Regulation 14A within 120 days after the end of the Company's fiscal year.\nItem 11.","section_11":"Item 11. Executive Compensation\nPursuant to Instruction G, the information required by this Item is hereby incorporated herein by reference from the information under the captions entitled \"Board of Directors-Director Compensation\" and \"Executive Compensation\" set forth in the Proxy Statement; provided, however, that the subsection entitled \"Executive Compensation - Report on Executive Compensation\" shall not be deemed to be incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nPursuant to Instruction G, the information required by this Item is hereby incorporated herein by reference from the information under the caption entitled \"Principal Shareholders\" set forth in the Proxy Statement.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nPursuant to Instruction G, the information required by this Item is hereby incorporated by reference herein from the information under the caption entitled \"Election of Directors\" set forth 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 - The financial statements listed in the accompanying index to financial statements and financial statement schedules are incorporated by reference in this Annual Report on Form 10-K.\n2. Financial statement schedules - The financial statement schedule listed in the accompanying index to financial statements and financial statement schedules is filed as part of this Annual Report on Form 10-K.\n3. Exhibits - The exhibits listed in the accompanying index to exhibits 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 were filed by the Company during the quarter ended December 31, 1995.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on March 15, 1996.\nGIDDINGS & LEWIS, INC.\nBy \/s\/ Joseph R. Coppola Joseph R. Coppola 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 indicated on March 15, 1996.\nName Title\n\/s\/ Joseph R. Coppola Chairman, Chief Executive Joseph R. Coppola Officer and Director (Principal Executive Officer)\n\/s\/ Richard C. Kleinfeldt Vice President - Finance, Richard C. Kleinfeldt Secretary and Director (Principal Financial and Accounting Officer)\n\/s\/ Albert J. Baciocco, Jr. Director Albert J. Baciocco, Jr.\n\/s\/ John A. Becker Director John A. Becker\n\/s\/ Ruth M. Davis Director Ruth M. Davis\nName Title\n\/s\/ Clyde H. Folley Director Clyde H. Folley\n\/s\/ Benjamin F. Garmer, III Director Benjamin F. Garmer, III\n\/s\/ John W. Guffey, Jr. Director John W. Guffey, Jr.\n\/s\/ Ben R. Stuart Director Ben R. Stuart\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nPage\nAnnual Report Form 10-K to Shareholders\nConsolidated statements of income for each of the three years in the period ended December 31, 1995 - 19 Consolidated statements of cash flows for each of the three years in the period ended December 31, 1995 - 20\nConsolidated balance sheets at December 31, 1995 and 1994 - 21 Consolidated statements of changes in shareholders' equity for each of the three years in the period ended December 31, 1995 - 22\nNotes to consolidated financial statements - 23-33\nReport of Independent Auditors - 34 Consolidated financial statement schedule:\nII - Valuation and qualifying accounts 20 -\nAll other financial statement schedules are omitted because 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.\nSchedule II\nGIDDINGS & LEWIS, INC.\nCONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS\nYears ended December 31, 1995, 1994 and 1993 (in thousands)\nBalance Balance at Additions at beginning charged to end of Classification of year expense Deductions year\nReceivables - Allowance for doubtful accounts:\n1995 $ 922 $ 999 $ (85) $1,836\n1994 973 172 (223) 922\n1993 1,115 334 (476) 973\nInventories - Allowance for obsolescence and loss:\n1995 $7,378 $2,913 $(2,815) $7,476\n1994 5,900 2,553 (1,075) 7,378\n1993 5,003 2,730 (1,833) 5,900\nE-1\nINDEX TO EXHIBITS\nExhibit No. Exhibit Description\n(2.1) Stock Purchase Agreement by and among Giddings & Lewis, Inc., Bike Corp., Fadal Engineering Company, Inc., David E. de Caussin and Myrtle Rosalie de Caussin, trustees of the David and Myrtle de Caussin Family Trust - 1988, and Larry F. de Caussin and Elsie Margaret de Caussin, trustees of the Larry and Elsie de Caussin Family Trust - 1988, dated as of April 24, 1995 [Incorporated by reference to Exhibit 2.1 to Giddings & Lewis, Inc.'s Current Report on Form 8-K, dated April 24, 1995]\n(2.2) Agreement of Purchase and Sale by and between Giddings & Lewis, Inc., Bike Corp. and 20701 Plummer Street, Ltd., dated as of April 24, 1995 [Incorporated by reference to Exhibit 2.2 to Giddings & Lewis, Inc.'s Current Report on Form 8-K, dated April 24, 1995]\n(3.1) Restated Articles of Incorporation of Giddings & Lewis, Inc., as amended to date [Incorporated by reference to Exhibit 3.2 to Giddings & Lewis, Inc.'s Quarterly Report on Form 10-Q for the quarter ended October 1, 1995]\n(3.2) By-Laws of Giddings & Lewis, Inc., as amended to date [Incorporated by reference to Exhibit 3.2 to Giddings & Lewis, Inc.'s Quarterly Report on Form 10- Q for the quarter ended July 4, 1993]\n(4.1) Article IV of the Restated Articles of Incorporation of Giddings & Lewis, Inc., as amended to date [Incorporated by reference to Exhibit 3.2 to Giddings & Lewis, Inc.'s Quarterly Report on Form 10- Q for the quarter ended October 1, 1995]\n(4.2) Credit Agreement among Giddings & Lewis, Inc., Giddings & Lewis GmbH, Giddings & Lewis AG, the Institutions from time to time party thereto as Lenders, the Institutions from time to time party thereto as Issuing Banks, Citicorp North America, Inc., as Agent, and Citicorp Investment Bank Limited, as London Agent, dated as of December 21, 1992. [Incorporated by reference to Exhibit 4.2 to Giddings & Lewis, Inc.'s Annual Report on Form 10-K for the year ended December 31, 1992]\n(4.3) Amendment to Credit Agreement among Giddings & Lewis, Inc., Giddings & Lewis GmbH, Giddings & Lewis Ltd., the Institutions from time to time party thereto as Lenders, the Institutions from time to time party thereto as Issuing Banks, Citicorp North America, Inc., as Retiring Agent, Citibank N.A., as Agent, Citicorp Investment Bank Limited, as Retiring London Agent, and Citibank International plc, as an Agent, dated as of December 21, 1994 [Incorporated by reference to Exhibit 4.3 to Giddings & Lewis, Inc.'s Annual Report on Form 10-K for the year ended December 31, 1994]\nE-2\n(4.4) Amendment No. 2 and Consent to Credit Agreement among Giddings & Lewis, Inc., Giddings & Lewis GmbH, Giddings & Lewis Ltd. and the Institutions from time to time party thereto as Agent and Lenders, dated as of April 24, 1995 [Incorporated by reference to Exhibit 4.3 to Giddings & Lewis, Inc.'s Current Report on Form 8-K, dated April 24, 1995]\n(4.5) Indenture between Giddings & Lewis, Inc. and Firstar Trust Company, as Trustee, dated as of August 7, 1995 [Incorporated by reference to Exhibit 4.1 to Amendment No. 1 to Giddings & Lewis, Inc.'s Registration Statement on Form S-3 (Registration No. 33-61237)]\n(4.6) Officer's Certificate, dated as of September 26, 1995, relating to Giddings & Lewis, Inc.'s 7-1\/2% Notes due 2005 [Incorporated by reference to Exhibit 4 to Giddings & Lewis, Inc.'s Current Report on Form 8-K, dated September 26, 1995]\n(4.7) Rights Agreement, dated as of August 23, 1995, between Giddings & Lewis, Inc. and Firstar Trust Company [Incorporated by reference to Exhibit 4.1 to Giddings & Lewis, Inc.'s Current Report on Form 8-K, dated August 23, 1995]\n(10.1)* Giddings & Lewis, Inc. 1989 Stock Option Plan [Incorporated by reference to Exhibit 4.1 to Giddings & Lewis, Inc.'s Form S-8 Registration Statement (Registration No. 33-31951)]\n(10.2)* Giddings & Lewis, Inc. 1989 Restricted Stock Plan [Incorporated by reference to Exhibit 4.1 to Giddings & Lewis, Inc.'s Form S-8 Registration Statement (Registration No. 33-31950)]\n(10.3)* Giddings & Lewis, Inc. Independent Director Stock Based Incentive Plan [Incorporated by reference to Exhibit 10.4 to Giddings & Lewis, Inc.'s Form S-4 Registration Statement (Registration No. 33-43061)]\n(10.4)* Giddings & Lewis, Inc. 1993 Stock and Incentive Plan [Incorporated by reference to Exhibit 4.1 to Giddings & Lewis, Inc.'s Form S-8 Registration Statement (Registration Statement No. 33-64936)]\n(10.5)* Form of Key Executive Employment and Severance Agreement (covering officers other than Joseph R. Coppola) [Incorporated by reference to Exhibit 10.5 to Giddings & Lewis, Inc.'s Annual Report on Form 10-K for the year ended December 31, 1993]\nE-3\n(10.6)* Employment Agreement, dated June 30, 1993, by and between Giddings & Lewis, Inc. and Joseph R. Coppola [Incorporated by reference to Exhibit 10.1 to Giddings & Lewis, Inc.'s Quarterly Report on Form 10- Q for the quarter ended October 3, 1993]\n(10.7)* Key Executive Employment and Severance Agreement, dated as of October 27, 1993, by and between Giddings & Lewis, Inc. and Joseph R. Coppola [Incorporated by reference to Exhibit 10.6 to Giddings & Lewis, Inc.'s Quarterly Report on Form 10-Q for the quarter ended October 3, 1993]\n(10.8)* Employment Agreement by and between Heinz Anders and Giddings & Lewis GmbH, dated as of January 12, 1994 [Incorporated by reference to Exhibit 10.8 to Giddings & Lewis, Inc.'s Annual Report on Form 10-K for the year ended December 31, 1994]\n(10.9)* Management Incentive Compensation Program [Incorporated by reference to Exhibit 10.9 to Giddings & Lewis, Inc.'s Annual Report on Form 10-K for the year ended December 31, 1993]\n(10.10)* Supplemental Executive Retirement Plan (covering officers of the Company other than Joseph R. Coppola) [Incorporated by reference to Exhibit 10.10 to Giddings & Lewis, Inc.'s Annual Report on Form 10-K for the year ended December 31, 1993]\n(10.11)* Supplemental Retirement Program for Joseph R. Coppola [Incorporated by reference to Exhibit 10.12 to Giddings & Lewis, Inc.'s Annual Report on Form 10-K for the year ended December 31, 1993]\n(10.12)* Giddings & Lewis, Inc. Deferred Compensation Plan for Non-Employee Directors [Incorporated by reference to Exhibit 10.13 to Giddings & Lewis, Inc.'s Annual Report on Form 10-K for the year ended December 31, 1993]\n(10.13)* Giddings & Lewis, Inc. Deferred Compensation Plan and Trust Agreement [Incorporated by reference to Exhibit 10.14 to Giddings & Lewis, Inc.'s Annual Report on Form 10-K for the year ended December 31, 1993]\n(13) Portions of the 1995 Annual Report to Shareholders that are incorporated by reference herein\n(21) List of Subsidiaries of Giddings & Lewis, Inc.\n(23) Consent of Ernst & Young LLP\n(27) Financial Data Schedule\nE-4\n(99) Proxy Statement for the 1996 Annual Meeting of Shareholders\n[The Proxy Statement for the 1996 Annual Meeting of Shareholders will be filed with the Securities and Exchange Commission under Regulation 14A within 120 days after the end of the Company's fiscal year; except to the extent incorporated by reference, the Proxy Statement for the 1996 Annual Meeting of Shareholders shall not be deemed to be filed with the Securities and Exchange Commission as part of this Annual Report on Form 10-K]\n____________ * A management contract or compensatory plan or arrangement.","section_15":""}
{"filename":"30117_1995.txt","cik":"30117","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL - -------\nPratt Hotel Corporation, a Delaware corporation, and its subsidiaries (\"PHC\") are engaged primarily in the ownership, operation and management of casino\/hotels and hotels in the United States and Puerto Rico; the management of a riverboat gaming and entertainment facility located in Aurora, Illinois (the \"Aurora Casino\") and providing consulting services to a gaming and lodging facility in Tunica County, Mississippi (the \"Tunica Casino\"). Approximately 20% of PHC's outstanding common shares are listed and traded on the American Stock Exchange under the symbol PHC. The remaining 80% of the common shares of PHC are owned by Hollywood Casino Corporation (\"HCC\"), a Delaware corporation with approximately 47% of its outstanding common shares listed and traded on the NASDAQ under the symbol HWCC. The remaining outstanding HCC common shares are owned by certain general partnerships and trusts controlled by Jack E. Pratt, Edward T. Pratt, Jr. and William D. Pratt and by other family members (collectively, the \"Pratt Family\"). HCC also owns the Aurora Casino and the Tunica Casino.\nPPI Corporation (\"PPI\") is a wholly owned subsidiary of PHC which owns various entities related to PHC's Atlantic City gaming operations. Included herein as wholly owned subsidiaries of PPI are: GB Property Funding Corp., the issuer of $185 million of 10 7\/8% First Mortgage Notes, due 2004 (the \"10 7\/8% First Mortgage Notes\"), PRT Funding Corp., the issuer of $85 million of 11 5\/8% senior notes, due 2004 (the \"PRT Funding Notes\"); New Jersey Management, Inc. (\"NJMI\"), which manages the operations of the Sands; Pratt Management, L.P. (\"PML\"), which manages the operations of the Aurora Casino; Pratt Casino Corporation (\"PCC\"), which earns consulting fees from the Tunica Casino; and Greate Bay Hotel and Casino, Inc. (\"GBHC\"), which owns the Sands Hotel and Casino in Atlantic City, New Jersey (the \"Sands\"), which generates a substantial majority of PHC's consolidated revenues. The Sands is not affiliated with the Sands Hotel and Casino in Las Vegas, Nevada. PHC is also engaged to a lesser extent in the casino gaming business in Puerto Rico and the management of hotels in the United States.\nThe principal executive offices of PHC are located at Two Galleria Tower, Suite 2200, 13455 Noel Road, Dallas, Texas 75240, telephone (214) 386- 9777.\nTHE SANDS - ---------\nIn addition to an ongoing capital improvements program designed to maintain the appearance and attractiveness of the Sands facilities through periodic remodelings and renovations, a number of significant projects have been undertaken to enhance the Sands' operations. Such projects have included the expansion of gaming space from the original 32,000 square feet in 1981 to the present 75,000 square feet; the construction of an adjacent multi-level parking garage to attract drive-in patrons; the completion of an elevated, enclosed, one-way moving sidewalk (the \"People Mover\") connecting the Sands to the Boardwalk; and the renovation of an adjacent nine-story office building for use as administrative offices.\nThe Sands has begun a phased introduction of a motion picture theme (the \"Hollywood Theme\") currently used by other gaming facilities managed by subsidiaries of PHC on behalf of HCC. The Hollywood Theme incorporates designs inspired by famous movies, displays of motion picture memorabilia and movie themed gaming, entertainment and dining areas. Management believes the timelessness and flexibility of the Hollywood Theme will have particular appeal to Atlantic City casino patrons who tend to visit frequently. Implementation of the Hollywood Theme, which will be accomplished as part of the ongoing capital improvements program, began with the 1995 openings of the \"Epic Buffet,\" a highly themed food and\nbeverage facility, and the Hollywood Casino(R) Studio Store, a highly themed retail complex. The conversion is expected to be completed in 1997.\nBusiness Strategy. The Sands' success in the highly competitive ----------------- Atlantic City market is attributable to its depth of experienced management, its marketing strategy of seeking higher-value repeat patrons, an ongoing capital improvements program, and its use of sophisticated casino information technology to monitor and control certain casino operations and to target marketing efforts toward frequent visitors while limiting costly mass promotions. Traditionally, the Sands has been successful in its marketing efforts toward the high end, frequent table game and slot patron through its offering of private, limited- access facilities and related amenities to premium patrons. While the Sands is continuing to maintain its position in this segment, the completion of the Sands' expansion in 1994 has allowed the Sands to broaden its appeal to the mass drive-in patron for continued growth in this market segment.\nGenerally, the Sands has three types of patrons: high-end patrons, drive-in patrons, and bus patrons. High-end patrons have gaming budgets of $5,000 or more per visit, drive-in patrons typically live within a 200 mile radius of the Sands and utilize the Sands' parking garage and bus patrons are generally day-travelers who purchase \"ticket coin packages\" which include bus transportation to and from the casino and a specified amount of coins to use in the casino.\nThe marketing strategy of the Sands is to attract higher-value, repeat patrons who return frequently and typically have larger gaming budgets than other patrons who do not gamble regularly. The Sands will continue its strategy to attract these segments through its focus of capital dollars in its high-end slot product and conversion to the Hollywood Theme. The Sands' facilities and programs, including the Plaza Club and the Island Club, have been designed to appeal principally to these target patrons.\nIn implementing the Sands' marketing and operating strategy, the Sands uses proprietary casino information technology developed by Advanced Casino Systems Corporation (\"ACSC\"), an affiliate of GBHC. This technology includes ACSC's table game and slot machine monitoring systems which enable the Sands to track and rate patron play through the use of a casino player's card. These systems provide management with the key characteristics of patron play as slot machines and table games are connected with its data base monitoring system. When patrons use the casino player's card at slot machines or table games, the information is immediately available to management and allows management to implement marketing programs to recognize and reward patrons during their visits to the casino. Such promotions and complimentaries include free meals, hotel accommodations, retail merchandise, parking and sweepstakes giveaways based on slot machine patrons' gross wagering. Management believes that its ability to reward its customers on a \"same-visit\" basis is valuable in developing a loyal base of higher value patrons. ACSC's systems also allow the Sands to monitor, analyze and control the granting of gaming credit, promotional expenses and other marketing costs. ACSC also has developed a system that the Sands utilizes to capture and maintain patron information necessary in implementing its casino players' card and other data base marketing programs.\nManagement uses its data bases to focus its marketing efforts on patrons who have been identified as higher value patrons. Management believes that its process of identifying higher value patrons, encouraging participation in its casino player's card program and tailoring promotions and special events to cater to this market segment enhances the profitability of the Sands.\nThe Sands also markets to the \"mass\" casino patron market segment through various forms of advertising media as well as through group and bus tour packages. Once new patrons are introduced to the Sands' gaming facilities and the casino player's card program, management uses its data base capabilities to direct market to these patrons in an attempt to convert them into higher value patrons.\nCompetition. The Sands faces intense competition from the 11 other ----------- existing Atlantic City casinos. According to reports of the New Jersey Casino Control Commission (the \"Casino Commission\"), the twelve Atlantic City casinos currently offer over 950,000 square feet of gaming space. Several companies have recently announced plans to build and operate additional casino\/hotels over the next few years. For example, Mirage Resorts and Circus Circus have jointly submitted a proposal to the city for an approximately $1 billion resort complex consisting of two casinos, two 2,000 room hotels, several theaters and an upscale shopping concourse. In addition, other individuals have submitted applications and have been qualified in New Jersey to hold casino licenses. Legislation enacted during 1993 requires the allocation of $100 million of Casino Reinvestment Development Authority (\"CRDA\") funds and credits to subsidize the construction of new hotel rooms by casinos in Atlantic City. The CRDA is a governmental agency which administers the statutorily mandated investments made by casino licensees. Competitors of the Sands which have the financial resources and that can currently access such funds and are capable of physically expanding their facilities so as to take advantage of such subsidy may benefit disproportionately from such recently enacted legislation. Plans have been announced by other casino operators to complete in excess of 3,400 rooms within the required subsidy period. In addition, management expects that many casinos will expand their gaming facilities as a result of recent Atlantic City regulations which allow casinos to increase the number of slot machines and which allow poker in conjunction with wagering on simulcast horse racing and keno. The expansion of existing gaming facilities and the addition of new casinos could significantly increase the competitiveness of the Atlantic City market.\nNew Jersey requires newly constructed casino\/hotel facilities to have a minimum of 500 hotel rooms. This requirement, along with the high initial capital investment required to develop and open a new casino\/hotel in Atlantic City, may prove a deterrent to additional new competitors in the market.\nIn this highly competitive environment, each property's relative success is affected by a great many factors that relate to its location and facilities. These include availability and number of parking facilities, hotel accommodations, proximity to the Boardwalk, proximity to other casino\/hotels, and access to the main expressway entering into Atlantic City. GBHC believes its operating strategy and facilities have enabled it to compete effectively against most other Atlantic City casino\/hotels, many of which have greater sources of funding for capital improvements and financial resources for marketing and promotional budgets than GBHC.\nManagement estimates that a significant amount of the Sands' revenues is derived from patrons living within a 120 mile radius of Atlantic City, New Jersey, particularly from southeastern Pennsylvania, northern New Jersey and metropolitan New York City. If casino gaming were to be legalized in those areas or in other venues that are more convenient to those areas, it could have a material adverse effect on the Sands. Gaming is currently conducted on Indian lands in nearby states, including the Foxwoods Casino in Connecticut and the Turning Stone Casino in Oneida, New York near Syracuse.\nIndustry Developments. A number of significant changes to the --------------------- regulations governing the casino industry have been initiated and approved by New Jersey regulators since 1991, beginning with the implementation of 24-hour gaming on a limited basis, the introduction of new types of games, greater flexibility in the allocation of a facility's floor space and relief in employee licensing requirements. During 1992, additional regulatory changes were adopted which resulted in 24-hour gaming without limitation, increased the allowable number of slot machines on the casino floor and approved new casino games including poker in conjunction with wagering on simulcast horse racing and keno.\nAdditional deregulation of the industry occurred in 1995 with the enactment of legislation amending the New Jersey Casino Control Act (the \"Casino Act\"). Among other things, the amendments allow an increase from 50,000 to 60,000 square feet of casino space for the minimum required 500 hotel rooms, eliminate any licensing requirements for certain hotel employees, provide for temporary licensing for all casino employees, increase the maximum renewal period of casino licenses for up to four years, permit the square footage of simulcast space to be considered in determining the permissible density of slot machines, and eliminate\nbusiness and experience requirements for employee licensing. The legislation also removes the ownership limit of three casino licenses per person.\nPartly as a result of such regulatory changes, the Atlantic City gaming industry has continued to grow. Revenues have increased from $3.3 billion in 1993 to $3.4 billion in 1994 (an increase from the previous year of 3.7%) and to $3.7 billion in 1995 (an increase from the previous year of 9.5%). The 1995 increase resulted primarily from an overall expansion of gaming space to approximately 950,000 square feet at the end of 1995 from approximately 925,000 square feet at the end of 1994, and a rebound in revenues from the first two months of 1994 which were negatively impacted by severe weather.\nCasino\/hotel operators have also benefited in recent years from a trend toward increased slot play as slot machines have increasingly become more popular than table games with loyal and frequent patrons, as well as with recreational and other casual visitors. Casino operators have also been catering increasingly to slot patrons through new forms of promotions and incentives such as slot machines which are linked between the various casinos to pay out a pooled jackpot and more attractive gaming machines. Slot machines generally produce higher margins and profitability than table games because they require less labor and have lower operating costs. As a result, slot machine revenue growth has significantly outpaced table game revenue growth in recent years to the point where for 1995 slot win accounted for approximately 68.7% of total Atlantic City gaming win. Table games remain important, however, in catering to the higher-end segment of gaming patrons as well as in adding to the gaming ambience and providing a varied gaming experience.\nCasino Credit. Casino operations are conducted on both a credit and a ------------- cash basis. Gaming debts arising in Atlantic City in accordance with applicable regulations are enforceable under New Jersey law. For the three years ended December 31, 1995, gaming credit extended to Sands' customers accounted for approximately 28.9% of overall table game wagering, while table game wagering accounted for approximately 25.7% of overall casino wagering during the period. At December 31, 1995 and 1994, gaming receivables amounted to $26.1 million and $26.5 million, respectively, before allowances for uncollectible gaming receivables amounting to $16.4 million and $15.2 million, respectively. Management of the Sands believes that the allowances for uncollectible gaming receivables are adequate.\nLicense Agreement. PHC entered into a 99-year license agreement (the ----------------- \"Sands License Agreement\") during 1987 to use the trade name \"Sands\" in Atlantic City, New Jersey. GBHC pays an annual royalty of 3% of gross room charges, as defined in the Sands License Agreement. Such charges amounted to $288,000 during each of the years ended December 31, 1995 and 1994 and $294,000 during the year ended December 31, 1993.\nEmployees and Labor Relations. In Atlantic City, all casino ----------------------------- employees, except certain hotel employees, must be licensed under the Casino Act. Due to the seasonality of the operations of the Sands, the number of employees varies during the course of the year. At December 31, 1995, there were approximately 3,400 employees at the Sands. The Sands has collective bargaining agreements with two unions that represent approximately 1,000 hotel employees, substantially all of whom are represented by the Hotel, Restaurant Employees and Bartenders International Union, AFL-CIO, Local 54. The collective bargaining agreements expire in September 1999. Management considers its labor relations to be good.\nPRATT MANAGEMENT, L.P. - ---------------------\nPML manages the Aurora Casino pursuant to the Aurora Casino Management Contract, which was executed in June 1991 and has an initial term of 99 years. PML acts as the sole and exclusive agent in the supervision, direction and control of the management of the Aurora Casino and any additions or expansions thereof.\nPML receives a quarterly base management fee generally equal to 5% of operating revenues (as defined in the agreement). However, for so long as certain indebtedness of HCC remains outstanding, payment of the base services fee is (i) subject to a maximum of $5.5 million in any consecutive 12 month period; (ii) subordinate to payment of interest on the HCC indebtedness and certain other indebtedness; and (iii) conditioned upon compliance with indentures governing such indebtedness.\nPML also receives an incentive fee equal to 10% of gross operating profit (as defined in the agreement). However, for as long as certain HCC indebtedness remains outstanding, the incentive fee may not be paid until Gross Operating Cash Flow (as defined in the agreement) is at least $25 million for any consecutive 12 month period.\nThe Aurora Casino Management Contract can be terminated by either party upon 45 days prior written notice in the event of the other party's material breach of the agreement, inability to pay debts generally as they become due, bankruptcy or other similar proceedings, action to suspend normal business operations, or imposition of any materially adverse levy or judgment. Furthermore, PML has the right to terminate if the HCC subsidiary which owns the Aurora Casino fails to furnish funds required for PML to manage the Aurora Casino or fails to compensate or reimburse PML. In such case, PML is entitled to liquidated damages in an amount equal to 10 times the aggregate base services fee and incentive fee earned by PML in the preceding fiscal year.\nTHE AURORA CASINO - -----------------\nThe Aurora Casino commenced operations on June 17, 1993 and is one of only four casinos currently operating within 50 miles of downtown Chicago. The Aurora Casino currently consists of two multi-level riverboat casinos containing an aggregate of approximately 32,100 square feet of gaming space with approximately 945 slot machines and approximately 60 table games. The Aurora Casino also includes an approximately 64,000 square foot land-based Pavilion through which patrons board the facility's two riverboat casinos via enclosed passenger loading ramps. The highly themed Pavilion features a glass-domed, four-story atrium with two grand staircases, two upscale lounges, two gourmet restaurants, a large buffet and a snack bar. Patrons of the Aurora Casino are offered valet parking or may self-park in either a multi-level parking garage that accommodates approximately 840 cars or other available surface parking.\nIn order to enhance the operating performance of the Aurora Casino, HCC recently completed a number of improvements to the Aurora facility. The first phase of this project was completed on May 10, 1995 with the opening of a 10,000 square foot expansion of one of the Aurora Casino's riverboats. Management believes that prior to the expansion, the Aurora Casino's gaming facilities were capacity constrained during peak periods, which limited the property's operating performance. The casino expansion increased the Aurora Casino's gaming space by approximately 45% to the current 32,100 square feet, allowed the facility to offer patrons the maximum number of gaming positions permitted by Illinois gaming regulations in a spacious, highly-themed setting and permitted the addition of over 235 slot machines. HCC also completed a renovation of the Aurora Casino's second riverboat casino in September 1995. This renovation included the installation of new interior decor more extensively utilizing HCC's Hollywood Theme and the reconfiguration of the gaming area to provide a more spacious and comfortable setting. In addition to expanding and improving the Aurora Casino's gaming space, HCC recently completed an extensive redesign of the Epic Buffet, a highly themed food and beverage facility.\nHCC has also begun construction of a new five-story, approximately 500-space parking garage directly across the street from the Pavilion. Management believes that this approximately 60% increase in covered parking capacity will significantly enhance access to the Aurora Casino since a majority of the facility's patrons arrive by car. The parking garage will contain approximately 1,500 square feet of retail space and will be connected to the Pavilion through a climate controlled tunnel. This retail space is planned as a \"Hollywood Casino(R) Studio Store,\" a highly themed store selling logo items licensed from motion picture studios as well\nas first-run movies on videocassette. HCC has agreed with the City of Aurora and the Aurora Metropolitan Exposition, Auditorium and Office Building Authority (\"ACCA\") to jointly construct the parking garage and to also renovate ACCA's existing North Island Center banquet and meeting facilities. The renovation of the banquet and meeting facilities will allow the Aurora Casino to cater to groups of up to 450 people. Construction commenced in September 1995 and is scheduled to be completed by July 1996.\nBusiness Strategy. The Aurora facility's primary market is the ----------------- affluent suburbs north and west of Chicago. Based on a sampling of its patrons, management believes that the casino drew approximately 44% of its patrons from such suburbs during 1995. Approximately 7.1 million people live within a 40- mile radius and approximately 11.6 million people live within a 100-mile radius of the Aurora Casino. The facility is easily accessible from major highways, can be reached from downtown Chicago in approximately 50 minutes by train with an average of 20 trips a day, and is approximately 30 miles from O'Hare International Airport. The four operating Chicago-area casinos, including the Aurora Casino, have approximately 132,000 square feet of combined gaming space. No additional casinos may be licensed in Illinois without the passage of new state legislation.\nThe Aurora Casino's riverboats currently depart from their landings for between 13 and 14 cruises daily, commencing at various times from 8:30 a.m. until 4:30 a.m. This schedule may be varied, based on experience and seasonal factors. Once passengers board, they are permitted to game during the half hour prior to the time the riverboat departs. After the excursion, passengers are permitted to game for another half hour before new passengers board, for a total of up to three hours of gaming per cruise. In addition, Illinois regulations permit dockside gaming if the riverboat captain reasonably determines that it is unsafe to cruise due to inclement weather, mechanical or structural problems or river icing. During dockside gaming, the Aurora riverboats operate on their normal schedules and passengers may leave the vessels at any time but may board only during the half hour prior to the regularly scheduled start of the cruise.\nThe Aurora Casino employs a marketing strategy designed to take advantage of its proximity to the affluent northern and western suburbs of Chicago and the large population base of the Chicago metropolitan area. Management uses the patron data base information developed through ACSC's systems to focus its marketing efforts on patrons who have been identified through the system as having the characteristics of a higher value patron. Given the limited number of gaming positions available on each daily casino excursion, management believes that its process of identifying the premium patron, encouraging participation in its casino players' card program and tailoring promotions and special events to cater to this market segment will enhance the profitability.\nThe Aurora Casino also markets to the \"mass\" casino patron market segment through various forms of advertising media as well as through group and bus tour packages. Once new patrons are introduced to the gaming facility and the casino players' card program, management uses its data base capabilities to direct market to these patrons in an attempt to convert them into higher value patrons.\nManagement believes that the Aurora Casino's facilities, in particular its highly themed dockside Pavilion and its close proximity to the city-owned Paramount Theatre, a 1,900-seat art deco theatre in which HCC features headliner entertainment, are appealing to both the premium and mass casino patron markets. Entertainers who have appeared include Frank Sinatra, Tom Jones, Ann-Margaret, the Temptations, Howie Mandel, Willie Nelson and the Bolshoi Ballet.\nCompetition. The gaming industry is highly fragmented and ------------ characterized by a high degree of competition among a large number of participants, some of which have greater financial and other resources than HCC. Competitive gaming activities include land-based casinos, dockside casinos, riverboat casinos, video lottery terminals, Indian gaming and other forms of legalized gaming in the United States and other jurisdictions. Casino gaming is currently permitted in a number of states, including Colorado, Illinois, Indiana, Iowa, Louisiana, Mississippi, Missouri, Montana, Nevada, New Jersey and South Dakota, and in\nWindsor, Ontario, Canada, as well as on Native American Indian lands in certain states. Other jurisdictions may legalize gaming in the near future. Several states have proposals to legalize gaming either introduced or being prepared for introduction to their state legislatures. In addition, established gaming jurisdictions could award additional gaming licenses or permit the expansion of existing gaming operations. New or expanded operations by other persons can be expected to increase competition and could have a material adverse impact on the Aurora Casino.\nThe Illinois Riverboat Gambling Act and the rules promulgated by the Illinois Gaming Board thereunder (the \"Riverboat Act\") authorizes only ten owner's licenses for riverboat gaming operations in Illinois and permits a maximum of 1,200 gaming positions (as defined by the Illinois Gaming Board) at any time for each of the ten licensed sites. All authorized owner's licenses have been granted and no additional licenses or gaming positions can be permitted without further state legislation. Four riverboat sites, including the Aurora Casino, are currently licensed in Illinois within 50 miles of downtown Chicago. Two of these riverboat sites are in Joliet, approximately 42 miles southwest of downtown Chicago, and a third is in Elgin, Illinois, approximately 20 miles from Aurora, 45 miles from downtown Chicago and amid the affluent northern and western suburbs. The next closest operating casinos other than the aforementioned casinos are in Milwaukee, Wisconsin, approximately 90 miles from downtown Chicago, and in Peoria, and Rock Island, Illinois, approximately 160 miles from downtown Chicago. Additional gaming sites could eventually be located in the Chicago area. Management understands that legislation may be introduced in the Illinois legislature to authorize one or more land-based and\/or riverboat casinos in downtown Chicago and\/or the granting of additional casino licenses elsewhere in Illinois including within the Aurora Casino's principal market. The Management also anticipates increased competition from up to five riverboat operations in northwestern Indiana, which is within 25 miles of downtown Chicago, including the potential operations of three operators who were recently awarded licenses to operate riverboat casinos in northwestern Indiana under Indiana gaming regulations. Increased competition from casinos in Indiana may result in greater competition for patrons from the downtown Chicago market and from the suburban Chicago market. Native American Indian tribes are seeking to open casino facilities in northwestern Indiana and Michigan under the Indian Gaming Regulatory Act. The opening of additional casinos proximate to Chicago could have a material adverse impact on the Aurora Casino.\nCasino Credit. Casino operations are conducted on both a credit and a ------------- cash basis. Gaming debts arising in Aurora in accordance with applicable regulations are enforceable under Illinois law. For the year ended December 31, 1995, gaming credit extended to customers accounted for approximately 13% of overall table game wagering, while table game wagering accounted for approximately 57% of overall casino wagering during the period. At December 31, 1995, gaming receivables amounted to $2.3 million before allowances for uncollectible gaming receivables which amounted to $603,000. Management of the Aurora Casino believes that the allowances for uncollectible gaming receivables are adequate.\nEmployees and Labor Relations. In Aurora, all casino employees must ----------------------------- be licensed by the Illinois Gaming Board. At December 31, 1995 there were approximately 1,740 employees at the Aurora Casino, none of whom are represented under collective bargaining agreements. Management considers its labor relations to be good.\nTHE TUNICA CASINO CONSULTING AGREEMENT - --------------------------------------\nPCC, through its ownership and management of the Sands and through its management of the Aurora Casino, has certain casino management experience and expertise which the Tunica Casino as a newly established business did not have. In order to utilize PCC's experience and expertise, the Tunica Casino entered into a consulting agreement with PCC as of January 1, 1994. The agreement has a term of 10 years and provides, among other things, for PCC to advise and consult the Tunica Casino on any matters relating to business and for monthly payments of $100,000 to PCC for its performance thereunder. The Tunica Casino is also obligated to reimburse PCC for its direct costs and expenses incurred under the agreement.\nCASINO REGULATION - -----------------\nNEW JERSEY\nCasino gaming is strictly regulated in Atlantic City under the Casino Act and the rules and regulations of the Casino Commission, which affect virtually all aspects of the operations of the Sands. The laws, rules and regulations affecting Atlantic City gaming operations concern primarily the financial stability, integrity and character of casino operators, their employees, their debt and equity security holders and others financially interested in casino operations; the nature of casino\/hotel facilities; the operation methods (including rules of games and credit granting procedures); and financial and accounting practices used in connection with casino operations. A number of these regulations require practices that are different from those in many casinos in Nevada and elsewhere, and some of these regulations result in casino operating costs greater than those in comparable facilities in Nevada and elsewhere.\nCasino Licenses. The Casino Act requires that all casino operations --------------- be licensed by the Casino Commission and that all employees (except for certain non-casino job positions), major shareholders and other persons or entities financially interested in the casino operation be either licensed or approved by the Casino Commission. A license is not transferable and may be revoked or suspended under certain circumstances by the Casino Commission. A plenary license authorizes the operation of a casino with the games authorized in an operation certificate issued by the Casino Commission, and the operation certificate may be issued only on a finding that the casino conforms to the requirements of the Casino Act and applicable regulations and that the casino is prepared to entertain the public. Under such determination, GBHC and NJMI have been issued plenary casino licenses, and PHC has been approved as a holding company of a casino licensee.\nThe plenary license issued to GBHC to own and operate the Sands was renewed by the Casino Commission in September 1994 and extended through September 30, 1996. Terms of the current license require GBHC to comply with periodic financial reporting requirements and to obtain prior Casino Commission approval of certain cash transfers to affiliates. Due to a corporate restructuring completed in February 1994, the Casino Commission determined that NJMI was a new entity. Accordingly, the term for the first two renewals of its casino license is limited to one year and its current license expires September 30, 1996.\nThe Casino Act provides for a casino license fee of not less than $200,000 based upon the cost of the investigation and consideration of the license application, and a renewal fee of not less than $100,000 or $200,000 for a one year or four year renewal, respectively, based upon the cost of maintaining control and regulatory activities. In addition, a licensee must pay annual taxes of 8% of casino win (as defined in the Casino Act), net of a provision for uncollectible accounts of up to 4% of casino win. During the years ended December 31, 1995, 1994 and 1993, the taxes assessed by, and the license and other fees paid by the Sands to the Casino Commission amounted to $25 million, $24.5 million and $23.3 million, respectively.\nThe Casino Act also requires a casino licensee to make certain approved investments (including CRDA bonds) in New Jersey of at least 1.25% of its gross casino revenues (as defined in the Casino Act) or pay an investment alternative tax of 2.5% of its gross casino revenues.\nGBHC has, from time to time, contributed certain amounts held in escrow to the CRDA. In return, the CRDA granted GBHC waivers of certain of its investment obligations in future periods. GBHC made such contributions during the years ended December 31, 1995, 1994 and 1993 totaling $250,000, $2.5 million and $5.7 million, respectively, resulting in waivers granted by the CRDA during 1995 and 1993 totaling $128,000 and $2.9 million, respectively. No such waivers were granted during 1994; however, the contribution has been designated for a project expected to benefit the community and the Sands facility.\nThe Casino Act also imposes certain restrictions upon the ownership of securities issued by a corporation that holds a casino license or is a holding company of a corporate licensee. Among other restrictions, the sale, assignment, transfer, pledge or other disposition of any security issued by a corporate licensee or holding company is subject to the regulation of the Casino Commission. In the case of corporate holding companies whose stock is publicly traded, the Casino Commission may require divestiture of the security held by a disqualified holder such as an officer, director or controlling stockholder who is required to be qualified under the Casino Act.\nNote holders are also subject to the qualification provisions of the Casino Act and may, in the sole discretion of the Casino Commission, be required to make filings, submit to regulatory proceedings and qualify under the Casino Act. If an investor is an \"Institutional Investor\" such as a retirement fund for governmental employees, a registered investment company or adviser, a collective investment trust, or an insurance company, then, in the absence of a prima facie showing to the DGE that the \"Institutional Investor\" may be found unqualified, the Casino Commission shall grant a waiver of this qualification requirement with respect to publicly traded debt or equity securities if the investor will own (i) less than 10% of the common stock of the company in question on a fully diluted basis, (ii) less than 20% of such company's indebtedness or (iii) less than 50% of an outstanding issue of indebtedness of such company; the Casino Commission, upon a showing of good cause, may, in its sole discretion, grant a waiver of qualification to an \"Institutional Investor\" not satisfying the above criteria. An Institutional Investor must also purchase securities for investment and have no intent to influence the management or operations of such company. The Casino Commission may, in its sole discretion, grant a waiver of the qualification requirement to investors not qualifying as \"Institutional Investors\" under the Casino Act if such investor will own less than 5% of the publicly traded common stock of such company on a fully diluted basis or less than 15% of the publicly traded outstanding indebtedness of such company.\nILLINOIS\nThe Riverboat Act authorizes riverboat gaming on navigable streams within or forming a boundary of the State of Illinois except for Lake Michigan and any waterway in Cook County, which includes Chicago. The Riverboat Act strictly regulates the facilities, persons, associations and practices related to gaming operations pursuant to the police powers of the State of Illinois, including comprehensive law enforcement supervision. The Riverboat Act grants the Illinois Gaming Board specific powers and duties, and all other powers necessary and proper to fully and effectively execute the Riverboat Act for the purpose of administering, regulating and enforcing the system of riverboat gaming. The Illinois Gaming Board's jurisdiction extends to every person, association, corporation, partnership and trust involved in riverboat gaming operations in the State of Illinois.\nSupplier's License. PML is required to maintain a supplier's license ------------------ with respect to the management services it provides to the Aurora Casino. PML's initial supplier's license expired in December 1995 and was renewed by the Illinois Gaming Board through December 1996. A supplier's license is eligible for renewal upon payment of the applicable fee and a determination by the Illinois Gaming Board that the licensee continues to meet all of the requirements of the Riverboat Act. The Illinois Gaming Board also requires that officers, directors and employees of suppliers be licensed. Licenses issued by the Illinois Gaming Board may not be transferred to another person or entity. All licensees must maintain their suitability for licensure and have a continuing duty to disclose any material changes in information provided to the Illinois Gaming Board.\nA holder of any license is subject to imposition of penalties and fines, suspension or revocation of such license, or other action for any act or failure to act by such holder or his or her agents or employees, that is injurious to the public health, safety, morals, good order and general welfare of the people of the State of Illinois, or that would discredit or tend to discredit the Illinois gaming industry or the State of Illinois. The Illinois Gaming Board may revoke or suspend licenses, as the Board may see fit and in compliance with applicable laws of Illinois regarding administrative procedures.\nRegulation of Gaming Operations. The Riverboat Act does not limit the ------------------------------- maximum bet or per patron loss and licensees may set any maximum or minimum limits on wagering. Vessels must have the capacity to hold a minimum of 500 persons if operating on the Mississippi River or the Illinois River south of Marshall County, and a minimum of 400 persons on any other waterway. The number of gaming positions is limited to a maximum of 1,200 per license. Gaming sessions are limited to a four hour duration; however, special event extended cruises may be authorized by the Illinois Gaming Board.\nIf a riverboat captain reasonably determines for reason of safety that although seaworthy, the riverboat should not leave the dock or should return immediately thereto, due to inclement weather, river icing, or mechanical or structural difficulties, a gaming excursion may commence or continue while the gangplank or its equivalent is raised and remains raised, in which event the riverboat is not considered docked. Recently, the Illinois Gaming Board proposed amendments to its rules that restrict the circumstances under which dockside gaming will be permitted and require that imposition of a fine for violations of the cruising requirements.\nA $2 per person admission tax is imposed on the owner of a riverboat operation. Additionally, a wagering tax is imposed on the adjusted gross receipts, as defined in the Riverboat Act, of a riverboat operation at the rate of 20%. The licensee is required to wire transfer all such gaming tax payments to the Illinois Gaming Board.\nThe Illinois Gaming Board is authorized to conduct investigations into the conduct of gaming and into alleged violations of the Riverboat Act and to take such disciplinary and enforcement action as it may deem necessary and proper. Employees and agents of the Illinois Gaming Board have access to and may inspect any facilities relating to the riverboat gaming operations at all times.\nAny riverboat operation not conducted in compliance with the Riverboat Act may constitute an illegal gaming place and consequently may be subject to criminal penalties, which penalties include possible seizure, confiscation and destruction of illegal gaming devices and seizure and sale of riverboats and dock facilities to pay any unsatisfied judgment that may be recovered and any unsatisfied fine that may be levied. The Riverboat Act also provides for civil penalties, equal to the amount of gross receipts derived from wagering on the gaming, whether unauthorized or authorized, conducted on the day of any violation.\nThe Illinois Gaming Board may waive any licensing requirement or procedure provided by rule if it determines that such waiver is in the best interests of the public and the gaming industry.\nOTHER OPERATIONS ----------------\nThe financial structure of PHC's San Juan, Puerto Rico hotel operations has been reorganized, and PHC has disposed of most of its non-casino hotel operations. PHC continues to manage and has an ownership interest (but no obligation to fund future losses) in the San Juan, Puerto Rico hotel operations. PHC also currently manages two non-casino hotels and has an ownership interest in one of the hotels. For the year ended December 31, 1995, earnings before interest, taxes, depreciation and amortization attributable to these operations amounted to $1.3 million. As of December 31, 1995, PHC's non-casino hotel related indebtedness totaled $2.2 million.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nTHE SANDS - ---------\nThe Sands is located in Atlantic City, New Jersey on approximately 2.6 acres of land one-half block from the boardwalk at Brighton Park between Indiana Avenue and Dr. Martin Luther King, Jr. Boulevard. The Sands facility currently consists of a casino and simulcasting facility with approximately 75,000 square feet of gaming space containing approximately 2,000 slot machines and approximately 125 table games, a hotel with 532 rooms (including 58 suites), six restaurants, a cocktail lounge, two private lounges for invited guests (the Plaza Club and the Island Club), an 800-seat cabaret theater, an adjacent nine- story executive office building with 77,000 square feet of office space for its executive, financial and administrative personnel, the \"People Mover\" and parking for approximately 1,900 vehicles. In addition, a warehouse near Atlantic City and a building located in Atlantic City that houses a print shop and auto shop, are used to support the operations of the Sands.\nOn February 17, 1994, GB Property Funding issued the 10 7\/8% First Mortgage Notes collateralized by a first mortgage on the Sands. Interest on the notes accrues at the rate of 10 7\/8% per annum, payable semiannually commencing July 15, 1994. Interest only is payable during the first three years. Commencing on July 15, 1997, semiannual principal payments of $2.5 million will become due on each interest payment date. The 10 7\/8% First Mortgage Notes are redeemable at the option of the issuer, in whole or in part, on or after January 15, 1999 at stated redemption prices ranging up to 104.08% of par plus accrued interest.\nThe indenture to the 10 7\/8% First Mortgage Notes contains various provisions which, among other things, restrict the ability of certain subsidiaries of PHC to pay dividends to PHC, to merge, consolidate or sell substantially all of their assets or to incur additional indebtedness beyond certain limitations. In addition, the indenture provides for the maintenance of certain cash balances and, commencing in 1994, requires that a minimum of $7 million be expended for property and fixture renewals, replacements and betterments, subject to increases of five percent each year thereafter. The indenture also contains certain cross-default provisions with the indenture to the senior notes issued simultaneously by PRT Funding as described below.\nOn February 17, 1994, PRT Funding issued the PRT Funding Notes. Interest on the PRT Funding Notes accrues at the rate of 11 5\/8% per annum, payable semiannually commencing October 15, 1994. The PRT Funding Notes are redeemable at the option of the issuer, in whole or in part, on or after April 15, 1999 at stated redemption prices ranging up to 104.36% of par plus accrued interest. The indenture for the PRT Funding Notes contains various provisions which, among other things, restrict the ability of certain subsidiaries of PCC to pay dividends to PHC, to merge, consolidate or sell substantially all of their assets or to incur additional indebtedness beyond certain limitations. The indenture also contains certain cross default provisions with the indenture to the 10 7\/8% First Mortgage Notes described above.\nTHE AURORA CASINO - -----------------\nAlthough it has no ownership interest in the Aurora Casino, PHC, through its subsidiaries, manages the facility under the Aurora Casino Management Contract. For a description of the facility, see \"Business - The Aurora Casino\" above.\nOTHER OPERATIONS - ----------------\nPHC has a 50% partnership interest with an unrelated third party in the Sheraton Plaza, a 496-room hotel located in Orlando, Florida. PHC does not guarantee the underlying mortgage indebtedness; however, it does have an ongoing commitment to fund its proportionate share of operating cash deficits. No such funding was required during 1995. PHC also agreed to contribute up to $3.9 million (including approximately $1.7 million during 1995) as an additional investment in the Sheraton Plaza hotel partnership to refurbish the\nhotel facility. PHC has contributed $2.5 million toward such commitment through 1995. Such contributions are in recognition of PHC's partner having agreed to make $5 million in principal reductions on the underlying mortgage note on the facility of which $4 million have been made through 1995.\nPHC operates the Holiday Inn located at the north entrance of the Dallas\/Fort Worth Airport (\"DFW North\") which is owned by Metroplex Hotel Limited (\"Metroplex\"), a partnership controlled by certain members of the Pratt Family. During 1995, PHC made capital expenditures under the hotel operating agreement totaling approximately $750,000 toward property improvements. PHC is also obligated by the hotel operating agreement to make minimum rental payments equal to Metroplex's principal and interest payments on the underlying indebtedness of this hotel. During February 1994, PHC utilized funds borrowed from HCC to purchase such underlying indebtedness with a principal balance of $13.8 million from third parties at a cost of $6.8 million ($1 million of which was paid during 1993), and subject to third party indebtedness amounting to $2.7 million. The required minimum rental payments (net of debt service receipts since the February 1994 note acquisition date) amounted to $530,000, $678,000 and $1.4 million, respectively, during the years ended December 31, 1995, 1994 and 1993. PHC recorded the note receivable from Metroplex at acquisition cost, which management believes does not exceed the estimated realizable value of the underlying collateral. Payments from Metroplex, including interest at the rate of 9 1\/2% per annum, are due monthly with the remaining principal balance of $13.5 million due May 31, 1996.\nPHC also has a 46% interest in Southmark San Juan, Inc. (\"Southmark San Juan\"), a subsidiary of Southmark Corporation (\"Southmark\") which owns the 420-room Sands Hotel and Casino located in San Juan, Puerto Rico (the \"Sands San Juan\"). A wholly owned subsidiary of PHC operates this facility under a management agreement with Southmark San Juan and earned management fees of $513,000, $488,000 and $481,000 during the years ended December 31, 1995, 1994 and 1993, respectively. The wholly owned subsidiary of PHC which owns the 46% interest has not recognized losses incurred since 1990 as the subsidiary's investment had been eliminated through the recognition of prior years' losses. The subsidiary has not funded any operating cash deficits since 1990 and has no obligation or intention to fund future losses.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nATLANTIC CITY CASINO\/HOTEL SITE - -------------------------------\nCertain subsidiaries of PHC have been engaged in litigation arising out of an agreement entered into with a subsidiary of Penthouse International, Ltd. (\"Penthouse\") by a subsidiary of PHC to acquire and complete a casino\/hotel site in Atlantic City, New Jersey and the purchase on March 19, 1989, by Donald J. Trump (\"Trump\") of the site from the Penthouse subsidiary.\nOn March 20, 1989, Penthouse and its subsidiary filed suit in the Superior Court of New Jersey in Atlantic City, New Jersey against PHC and certain of its subsidiaries. PHC and certain of its subsidiaries subsequently filed a counterclaim against Penthouse and its subsidiary, and a third-party complaint against Robert C. Guccione, Trump and Trump Plaza Associates. PHC and its subsidiaries sought a determination that the contract for the casino\/hotel site was valid and unlawfully breached, compensatory damages, treble damages, punitive damages and other forms of injunctive relief.\nA bifurcated trial on liability issues in the litigation has been completed. On March 25, 1993, the Court rejected the claims pressed by PHC and held in favor of some of Penthouse's claims. However, the Court refused to pierce the corporate veil so as to permit any recovery against PHC, or its subsidiary which owns the Sands. The PHC subsidiaries which pressed these claims and which may be adversely affected by the Court's ruling are the special purpose subsidiaries which were formed to acquire, develop and operate the proposed casino\/hotel project and ancillary parking facilities.\nBecause the Court's action only affects two separate subsidiaries of PHC, there are no adverse effects to the operations of, or will there be damages assessed against, PHC under the Court's ruling. However, as a result of the Court ruling, certain assets which had been capitalized in connection with the attempted acquisition of the casino\/hotel site amounting to $13.1 million were written off during 1992.\nIn January 1991, the PHC subsidiaries began a separate legal proceeding in the United States District Court for the District of New Jersey alleging essentially the same claims against Penthouse and Trump in the various state court actions, and adding claims under the Sherman and Clayton Antitrust Acts not asserted in state court. Penthouse has filed a counterclaim and third- party complaint against the PHC subsidiaries asserting virtually all of the same claims in the state court actions. As a result of the determination reached in the parallel state court proceedings, this action was similarly dismissed.\nPHC and its subsidiaries recently concluded a settlement with Penthouse and its subsidiary in which a PHC subsidiary assigned its interest in a partnership to the Penthouse subsidiary. Related claims in a separate action brought against PHC subsidiaries by a former partner of Penthouse have been settled on a \"walk away\" basis. The appeal from the state court judgment is pending but only with respect to Trump and Trump Plaza Associates.\nOTHER LITIGATION - ----------------\nPHC and its subsidiaries are also parties in various other legal proceedings with respect to the conduct of casino and hotel operations. Although a possible range of loss cannot be estimated, in the opinion of management, based upon the advice of counsel, settlement or resolution of these proceedings should not have a material adverse impact on the consolidated financial position or results of operations of PHC and its subsidiaries.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nDuring the fourth quarter of 1995, no matter was submitted to a vote of security holders through the solicitation of proxies or otherwise.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS\nPHC's common stock is traded on the American Stock Exchange under the symbol PHC. The prices set forth in the following table represent actual transactions.\nAt March 25, 1996, there were approximately 4,200 holders of record of PHC's common stock.\nNo dividends have been paid on PHC's common stock in the past and PHC has no plans to pay dividends in the foreseeable future. See Note 4 of \"Notes to Consolidated Financial Statements\" for a description of certain agreements that impose certain restrictions upon the ability of certain subsidiaries to transfer funds to PHC.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following tables present selected financial data for PHC and are qualified in their entirety by the consolidated financial statements, including the notes thereto, appearing elsewhere herein. The data as of December 31, 1995 and 1994, and for the years ended December 31, 1995, 1994 and 1993, have been derived from the audited consolidated financial statements of PHC contained elsewhere in Item 8.\n- ---------- (1) Fully diluted per share data are not presented for any year because the inclusion of such securities would be antidilutive.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\nGENERAL\nPHC's consolidated net revenues increased to $303.8 million during 1995 from $295.4 million for 1994; however, PHC's income from operations declined slightly to $31.6 million from $32.2 million during the same period due primarily to higher operating costs at the Sands.\nGAMING OPERATIONS\nThe following table sets forth certain unaudited financial and operating data relating to the Sands' operations:\n__________\n(1) Consists of revenues from poker ($3 million for each of the years ended December 31, 1995 and 1994 and $1.7 million for the year ended December 31, 1993) and simulcast horse racing wagering ($1.4 million, $1.3 million and $700,000, respectively, for the years ended December 31, 1995, 1994 and 1993).\n(2) Gross wagering consists of the total value of chips purchased for table games (excluding poker) and keno wagering (collectively, the \"drop\") and coins wagered in slot machines (\"handle\").\n(3) Casino revenues consist of the portion of gross wagering that a casino retains and, as a percentage of gross wagering, is referred to as the \"hold percentage\".\n(4) The Sands' hold percentage with respect to slot machines is reflected on an accrual basis. Comparable data for the Atlantic City gaming industry is not available. The 1994 and 1993 hold percentage calculations for the Sands have been adjusted to exclude the recognition of approximately $1 million and $340,000, respectively, in slot machine revenues resulting from the reversal of certain progressive jackpot liabilities (see \"Revenues\" below).\nTable games drop at the Sands did not change significantly for the year ended December 31, 1995 compared with 1994 and decreased $5 million (.8%) for the year ended December 31, 1994 compared with 1993. The Sands' slight decrease in drop during 1995 compares with an increase of 4.7% in table drop for all other Atlantic City casinos during the same period. As a result, the Sands' table game market share (expressed as a percentage of the Atlantic City industry aggregate table game drop) decreased to 8.5% during 1995 from 8.8% in 1994. The Sands' table game drop decrease is largely attributable to an increase in competitive pressures in the rated table market segment, of which a significant portion is in the \"high end\" and mid-market segments. Such decreases have been partially offset by increases in the unrated table segment. The 1994 decrease in table drop compares with an increase of .3% in table drop for the overall Atlantic City industry during the same period. Consequently, the Sands' 1994 table game market share declined slightly to 8.8% from 8.9% during 1993. As a result of the Grand Opening on July 1, 1994, the number of table games, excluding poker, increased significantly and table games were made more accessible to casino patrons. These changes resulted in table drop for the final six months of 1994 exceeding table drop for the same period of 1993 by $25 million (8%). This improvement could not, however, completely mitigate the $30 million decrease in table game drop experienced prior to July 1. A number of factors adversely affected the 1994 first six months' table games performance including: (i) the relocation of many blackjack tables to a less accessible temporary gaming space during construction and the periodic closing of selected tables on the main casino floor as construction neared completion; (ii) the severe winter weather during the first quarter, particularly on weekend periods which generally affect the Sands to a greater degree than its competitors since the Sands caters to premium table players who concentrate their visits over weekend periods; (iii) the overall trend in the Atlantic City marketplace towards slot machine play and (iv) competitive pressures, particularly in the high-end table patron segment.\nSlot machine handle increased $132 million (7.5%) and $129.3 million (7.9%) for the years ended December 31, 1995 and 1994, respectively, compared with the previous years. The Sands' slot machine handle increases compare with 15.7% and 9.2% increases, respectively, in slot machine handle for all other Atlantic City casinos during the same periods. Although the Sands' increase in the average number of slot machines during 1995 was comparable to the overall Atlantic City industry increase, the Sands' increase in slot machine handle lagged the 15.7% increase in handle for all other Atlantic City casinos. During the second quarter of 1995, the Sands discontinued certain marketing programs and promotions (particularly slot promotions which included cash giveaways) which management deemed to be only marginally profitable. This strategy worked well during the 1995 second quarter; however, entering the peak summer season, many of the Sands' competitors increased such spending programs and the Sands lost market share in the highly profitable mass market segment. The increase in the average number of slot machines at the Sands during 1994 compared with 1993 was 13%, compared to the Atlantic City industry increase of 8.4%. The Sands' 1994 slot handle increase lagged both its own capacity increase and the average industry handle increases due to the construction-related factors mentioned above as well as to a decrease in the number of bus patrons during the first six months of 1994. Marketing efforts implemented for the Grand Opening were continued through the remainder of 1994 and resulted in overall increases in bus patrons of 5.6% (versus a decline of 4.1% for the Atlantic City industry) and in cars parked of 21.9% for the year 1994 compared to 1993. The\nincrease in slot handle during the last six months of 1994 of 13.4% reflects both the expansion of gaming space and the introduction of new slot machines operated at a higher payback percentage, which encourages extended patron play.\nThe Sands' loss of market share in table game drop and slot machine handle during 1995 is also a direct result of significantly increased competition from a number of casinos in Atlantic City which completed significant expansion projects and mounted aggressive marketing campaigns during this period. Similarly, during 1994, the Sands' incurred significant marketing and advertising expenditures associated with the opening of its expanded gaming facility on July 1, 1994. Such expenditures primarily impacted slot machine handle from the infrequent mass market customer and resulted in record levels of gross wagering during the third quarter of 1994, which could not be sustained in 1995.\nREVENUES\nCasino revenues at the Sands, including poker and simulcast horse racing wagering revenues, increased by $7.8 million (3.1%) for the year ended December 31, 1995 compared with 1994. Casino revenues during the second quarter of 1994 included the recognition of approximately $1 million resulting from the reversal of certain progressive jackpot liabilities; the exclusion of such amount from 1994 revenues results in a more comparable 1995 increase in casino revenues of 3.5%. Casino revenues were also negatively impacted by decreases in both the table games and slot machine hold percentages at the Sands during 1995 compared to 1994.\nDuring 1994, casino revenues at the Sands increased by $11.3 million (4.6%) compared with 1993. The 1994 revenue increases result from the expansion of gaming space as demonstrated by the aforementioned increases in slot machine and table games gross wagering during the second half of the year of 13.4% and 8%, respectively. The impact on revenue of such volume increases was enhanced by improved hold percentages on table games, but diminished by a decline in slot machine hold percentages; such a decline is consistent with the competitive trend in Atlantic City towards lower slot hold percentages. Table games benefited from improved table hold percentages and other casino revenues benefited from increases of $1.3 million in poker revenues during 1994 compared to 1993 as a result of a full year of poker operations (poker commenced at the Sands during June 1993), from improved simulcast revenues and from the introduction in 1994 of keno. In addition, the removal of certain progressive jackpots during 1994 and 1993 resulted in the recognition of casino revenues amounting to approximately $1 million and $340,000, respectively.\nRooms revenues did not change significantly for the year ended December 31, 1995 compared with 1994 or for 1994 compared with 1993. Food and beverage revenues increased by $3.3 million (10.6%) and by $3.1 million (11.1%), respectively, for the years ended December 31, 1995 and 1994 compared with the prior years. The 1995 increase was primarily the result of the opening of the Epic Buffet during the third quarter of 1995. The 1994 increase results from the opening of additional dining outlets and increases in casino patronage at the Sands. Other revenues decreased $1.1 million (6.1%) during 1995 compared to 1994 primarily due to decreased revenues from PHC's computer services subsidiary. Such revenues increased by $4.7 million (34.9%) for 1994 compared with 1993 reflecting the inclusion of $10 million of fees earned from the management of the Aurora Casino in 1994 compared with $5.6 million for the partial year of operations in 1993.\nPromotional allowances represent the estimated value of goods and services provided free of charge to casino customers under various marketing programs. As a percentage of rooms, food and beverage and other revenues at the Sands, these allowances have varied from 58.3% in 1995, to 57.5% in 1994 and to 59% in 1993. The 1995 increase is primarily attributable to promotional activity associated with the 1995 opening of the Epic Buffet. As a result of the Sands' expansion in 1994, table drop and slot machine handle attributable to the mass market segment (which generally does not require the same level of complimentaries) have\nincreased at a greater rate than overall wagering. In addition, the Sands reduced utilization of rooms, food and beverage and entertainment complimentaries during the casino construction period.\nDEPARTMENTAL EXPENSES\nCasino expenses at the Sands increased $10.9 million (5.6%) during 1995 and $12 million (6.7%) during 1994 compared with the prior years. Higher operating costs during the first half of 1995 resulted primarily from increased casino patronage at the expanded Sands facility. The increased costs were most apparent during the first quarter of 1995, which saw a $7.7 million increase (18.3%) compared to the first quarter of 1994. Higher operating costs were substantially offset during the remainder of 1995 by decreases in marketing programs as previously discussed and by other cost containment measures implemented by management. The 1994 increase was primarily due to higher operating costs during the second half of the year as a result of increased casino patronage at the expanded Sands facility. In addition, marketing costs preparatory to the Grand Opening, including the implementation of an aggressive mass marketing strategy and direct costs of approximately $1.1 million, contributed to the increase.\nRooms expense increased $237,000 (5.7%) and $150,000 (3.7%) during 1995 and 1994 compared with the prior years reflecting both improved occupancy at non-casino properties as well as increased operating costs at the Sands during the last six months of 1994. Costs associated with patronage increases subsequent to the Grand Opening offset lower costs at the Sands earlier during the year which resulted primarily from inclement weather during the first quarter of 1994.\nFood and beverage expense decreased $563,000 (4.6%) during 1995 compared with 1994 and increased slightly by $142,000 (1.2%) during 1994 compared with 1993. Increased costs associated with the 1995 third quarter opening of the Epic Buffet were offset by increases in food and beverage complimentaries allocated to the casino department. The 1994 increase was a result of increased patronage at the Sands, which is reflected in increased payroll and operating costs, and to increased promotional expenditures incurred in 1994 with respect to the Ambassador buffet.\nOther expenses decreased $1.5 million (24.7%) during 1995 compared with 1994 primarily due to reductions in entertainment costs associated with headliner entertainment at the Sands. Other expenses increased $455,000 (8%) for 1994 compared with 1993 principally because of higher payroll and production costs associated with theater entertainment at the Sands.\nGENERAL AND ADMINISTRATIVE\nGeneral and administrative expenses decreased by $1.1 million (3.8%) during 1995 compared to 1994 primarily due to reductions in legal and professional fees. General and administrative expenses increased $1.7 million (6.3%) during 1994 compared to 1993 primarily due to increases in payroll and general corporate overhead consistent with the additional management and consulting services being provided by PHC to HCC-owned facilities.\nDEPRECIATION AND AMORTIZATION\nDepreciation and amortization expense increased $1 million (5.1%) during 1995 compared to 1994 and decreased $1.3 million (6.2%) during 1994 compared to 1993. Increases in depreciation during 1995 and the second half of 1994 attributable to the expansion of gaming space at the Sands were partially offset by reduced amortization of investment credits on obligatory investments (see \"Liquidity and Capital Resources - Capital Expenditures and Obligatory Investments\") and were more than offset in 1994 by reductions in the monthly amortization of deferred financing costs resulting from the refinancing of PHC's casino-related indebtedness in February 1994.\nINTEREST\nInterest income decreased $704,000 (22.7%) during 1995 compared to 1994 and increased $1.7 million (113.9%) during 1994 compared to 1993. The 1995 decrease results from comparison to an unusually high level of interest income in 1994. The 1994 increase was due primarily to the recognition of interest earned on funds escrowed for the repayment of debt as part of GBHC's 1994 debt refinancing (see \"Liquidity and Capital Resources - Financing Activities\"). In addition, PHC earned interest income during 1994 on the underlying indebtedness of a noncasino hotel which it had previously sold; such indebtedness was repaid during the third quarter of 1994. Interest expense did not change significantly during either 1995 or 1994 from prior years.\nINCOME TAX BENEFIT (PROVISION)\nPHC and its subsidiaries have tax net operating loss carryforwards (\"NOL's\") totaling approximately $61 million (after reduction for approximately $23 million used by HCC in 1994), of which approximately $45 million do not begin to expire until the year 2003. Additionally, PHC and its subsidiaries have various tax credits available totaling approximately $4 million, many of which expire by the year 2002. In the first quarter of 1993, PHC adopted the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\" The new standard requires that the tax benefit of such NOL's and credit carryforwards be recorded as an asset and, to the extent that management can not assess that utilization of such NOL's is more likely than not, a valuation allowance should be recorded. Due to losses sustained for both financial and tax reporting by PHC and its subsidiaries through 1995, management was unable to determine that realization of that asset was more likely than not and, thus, provided valuation allowances for the entire deferred tax asset for all periods presented. As a result, there was no cumulative financial statement effect of adopting the standard as of January 1, 1993.\nEXTRAORDINARY ITEM\nDuring February 1994, PHC and its subsidiaries refinanced virtually all of their casino-related indebtedness. As a result, costs and fees incurred in connection with the early retirement of such indebtedness, including the unamortized portion of transaction costs related to such indebtedness, aggregating $14.8 million, net of the related state tax benefit of $888,000, have been reflected as an extraordinary item in the results of operations for the fourth quarter of 1993.\nINFLATION\nManagement believes that in the near term, modest inflation, together with increasing competition within the gaming industry for qualified and experienced personnel, will continue to cause increases in operating expenses, particularly labor and employee benefits costs.\nSEASONALITY\nHistorically, the Sands' operations have been highly seasonal in nature, with the peak activity occurring from May to September. Consequently, the results of PHC's operations for the first and fourth quarters are traditionally less profitable than the other quarters of the fiscal year. Furthermore, the Aurora Casino has also experienced seasonality, but to a lesser degree than the Sands, and, as a result, the management fees earned have fluctuated with such seasonality. In addition, the Sands' and the Aurora Casino's operations may fluctuate significantly due to a number of factors, including chance. Such seasonality and fluctuations may materially affect PHC's casino revenues and profitability.\nLIQUIDITY AND CAPITAL RESOURCES\nOPERATING ACTIVITIES\nPHC's principal assets and sources of revenues are the Sands and management and consulting contracts with the Aurora Casino and the Tunica Casino. During 1995, PHC's net cash provided by operating activities (after net interest expense and income taxes) amounted to $29.2 million. A PHC subsidiary receives a base management fee equal to 5% of operating revenues (as defined in the management agreement) subject to a maximum of $5.5 million annually, and an incentive fee equal to 10% of gross operating profit (as defined in the management agreement) from the operation of the Aurora Casino. Management fees received during 1995 amounted to $9.6 million. During 1994, a subsidiary of PHC entered into a consulting agreement with HCT with respect to the Tunica Casino which provides for the payment of $1.2 million annually by the Tunica Casino to the subsidiary for consulting services and for reimbursement of direct costs and expenses incurred.\nThe Sands' earnings before depreciation, interest, amortization, taxes and intercompany management fees of more than $42 million during each of the last five years have been sufficient to meet its debt service obligations (other than certain maturities of principal that have been refinanced) and to fund a substantial portion of its capital expenditures. Historically, the Sands has also utilized short-term borrowings to fund seasonal cash needs and for certain capital projects.\nPHC utilized its operating cash flow together with existing cash during 1995 to fund capital additions ($19.9 million), prepay long-term indebtedness to HCC ($5.5 million), make obligatory investments at the Sands ($3 million) and provide funding to an unconsolidated partnership for the refurbishment of a Florida hotel property ($1.7 million).\nIn prior years PHC's hotel operations required substantial infusions of operating funds; however, the disposition of all but three of its hotel properties has greatly reduced the cash required to fund hotel operations. In connection with a certain hotel property which PHC operates pursuant to an operating agreement with an affiliate, PHC is obligated to make minimum rental payments equal to the principal and interest payments on the underlying indebtedness attributable to the property. During February 1994, PHC purchased such underlying indebtedness with a principal balance of $13.8 million from third parties at a cost of $6.8 million, with funds borrowed from HCC, and subject to third party indebtedness amounting to $2.7 million.\nTax allocation payments and the repayment of intercompany loans from the Sands have historically been the primary source of liquidity for PHC's other operations and activities, including the substantial litigation costs associated with the attempted acquisition of a casino\/hotel site in Atlantic City, as well as PHC's debt service obligations; such payments from the Sands to PHC are subject to the prior approval of the New Jersey Casino Control Commission. In addition, certain loan indenture covenants restrict payments to PHC. PHC's other past sources of liquidity and capital resources have been primarily limited to proceeds from asset sales. PHC has substantially reduced its losses from non-casino hotel operations over the past several years through the sale of certain hotel properties and the termination of management contracts on certain managed hotel properties. Additionally, PHC's litigation costs have been substantially eliminated as all material litigation has been resolved. The combination of reduced costs and the introduction of management and consulting fees earned on non-owned gaming facilities have substantially reduced PHC's reliance on intercompany payments as a source of liquidity.\nEffective December 31, 1994, HCC began compensating PHC for the use of PHC's available tax net operating loss carryforwards. For the year ended December 31, 1994, such payment was effected through the assignment to PHC of $6.3 million principal amount of the 14 5\/8% junior subordinated notes issued by HCC to a subsidiary of PHC together with $1.9 million of accrued interest thereon. No such compensation was required during 1995 as a result of losses sustained by HCC with respect to the refinancing of its outstanding indebtedness.\nFINANCING ACTIVITIES\nDuring February 1994, PHC completed the refinancing of virtually all of its casino-related outstanding debt. The refinancing was completed through a public offering of $270 million of debt securities consisting of $185 million of 10 7\/8% First Mortgage Notes due January 15, 2004 and $85 million of 11 5\/8% PRT Funding Notes due April 15, 2004. Proceeds from the debt offerings were used, in part, to refinance outstanding mortgage notes on the Sands and other indebtedness scheduled to mature in 1994, to repay $58.4 million of publicly held PCPI Notes and to provide partial funding for an expansion of gaming space at the Sands. During 1995, PHC repaid long-term indebtedness of $6 million, including the payment of $5.5 million to HCC in connection with a deferred interest note issued by HCC as part of the refinancing. Scheduled maturities of long-term debt during 1996 are $553,000.\nDuring June 1994, GBHC entered into an agreement for a $5 million bank line of credit, which was renewed in April 1995, and all of which was available for working capital purposes at December 31, 1995. GBHC borrowed $3 million on the line of credit during the first quarter of 1996.\nCAPITAL EXPENDITURES AND OTHER INVESTMENTS\nProperty and equipment additions during 1995 totaled $19.9 million, of which capital expenditures at the Sands amounted to approximately $19.2 million. Projects completed during 1995 include the Epic Buffet, the relocation of the Sands' simulcast and poker facilities and reconfiguration of its slot machines. Additional capital expenditures by PHC during 1995 included approximately $750,000 of property improvements at a non-casino hotel property it operates under an agreement with Metroplex Hotel Limited (see Note 7 of Notes to Consolidated Financial Statements). Management anticipates capital expenditures during 1996 will be approximately $14.5 million at the Sands. Projects currently planned during 1996 include substantial upgrades and improvements to all rooms at the Sands, including its higher-end suite product, refurbishment of public areas, additional refinements to the Epic Buffet and the Sands' retail outlet and enhancements to management information systems.\nThe Sands is required by the New Jersey Casino Control Act to make certain investments with the CRDA, a governmental agency which administers the statutorily mandated investments made by casino licensees. Deposit requirements for 1995 totaled $3 million and are anticipated to be approximately $3.4 million during 1996.\nPHC has also agreed to contribute up to $3.9 million, approximately $2.5 million of which has been paid as of December 31, 1995 (including $1.7 million in 1995), as an additional investment in an unconsolidated hotel partnership to refurbish the hotel facility in Orlando, Florida. Anticipated contributions during 1996 toward such commitment are approximately $1.2 million. Such contributions are in recognition of PHC's partner having agreed to make $5 million in principal reductions on the underlying mortgage note on the facility of which $4 million have been made through 1995.\nSUMMARY\nManagement anticipates that PHC's funding requirements for the next twelve months will be satisfied by (i) existing cash, (ii) cash generated by the Sands' operations, (iii) management fees from the Aurora Casino, (iv) consulting fees from the Tunica Casino and (v) management fees from remaining hotel operations.\nITEM 8.","section_7A":"","section_8":"ITEM 8. INDEX TO FINANCIAL STATEMENTS\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ----------------------------------------\nTo Pratt Hotel Corporation:\nWe have audited the accompanying consolidated balance sheets of Pratt Hotel Corporation (a Delaware corporation) and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations, changes in shareholders' deficit and cash flows for each of the three years in the period ended December 31, 1995. 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 consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Pratt Hotel Corporation and subsidiaries as of December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles.\nARTHUR ANDERSEN LLP\nRoseland, New Jersey February 15, 1996\nPRATT HOTEL CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS\nASSETS\nThe accompanying notes to consolidated financial statements are an integral part of these consolidated balance sheets.\nPRATT HOTEL CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS\nLIABILITIES AND SHAREHOLDERS' DEFICIT\nThe accompanying notes to consolidated financial statements are an integral part of these consolidated balance sheets.\nPRATT HOTEL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS\nThe accompanying notes to consolidated financial statements are an integral part of these consolidated statements.\nPRATT HOTEL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' DEFICIT FOR THE THREE YEARS ENDED DECEMBER 31, 1995\nThe accompanying notes to consolidated financial statements are an integral part of these consolidated statements.\nPRATT HOTEL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS\nThe accompanying notes to consolidated financial statements are an integral part of these consolidated statements.\nPRATT HOTEL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(1) ORGANIZATION, BUSINESS AND BASIS OF PRESENTATION\nPratt Hotel Corporation, a Delaware corporation, and its subsidiaries (\"PHC\"), are engaged in the operation or management of casino and hotel properties. PHC's principal assets are the Sands Hotel and Casino located in Atlantic City, New Jersey (the \"Sands\") and management and consulting contracts with gaming facilities located in Aurora, Illinois (the \"Aurora Casino\") and Tunica, Mississippi (the \"Tunica Casino\") (see Note 7). PHC's other operations in the United States and the Caribbean, including various ventures in which PHC has an interest, are managed by PHC or its subsidiaries. Hollywood Casino Corporation (\"HCC\"), a Delaware corporation which is approximately 53% owned by certain general partnerships and trusts controlled by Jack E. Pratt, Edward T. Pratt, Jr. and William D. Pratt and by other family members (collectively, the \"Pratt Family\") owns approximately 80% of the common stock of PHC.\nPHC estimates that a significant amount of the Sands' revenues are derived from patrons living in southeastern Pennsylvania, northern New Jersey and metropolitan New York City. Competition in the Atlantic City gaming market is intense and management believes that this competition will continue in the future.\n(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nThe significant accounting policies followed in the preparation of the accompanying consolidated financial statements are discussed below. 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.\nPRINCIPLES OF CONSOLIDATION -\nThe consolidated financial statements include the accounts of PHC and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated. Investments in unconsolidated affiliates, including joint ventures, that are 20% to 50% owned are accounted for by the equity method.\nCASINO REVENUES, PROMOTIONAL ALLOWANCES AND DEPARTMENTAL EXPENSES -\nThe Sands recognizes the net win from gaming activities (the difference between gaming wins and losses) as casino revenues. Casino revenues are net of accruals for anticipated payouts of progressive and certain other slot machine jackpots and certain progressive table game payouts. Such anticipated jackpots and payouts are reflected as current liabilities in the accompanying consolidated balance sheets. During the years ended December 31, 1994 and 1993, the Sands removed certain progressive jackpots from the gaming floor in accordance with regulations of the New Jersey Casino Control Commission (the \"Casino Commission\") resulting in the reduction of $1,035,000 and $342,000 of progressive jackpot liabilities, respectively, and the corresponding recognition of an equal amount of slot machine revenues.\nThe estimated value of rooms, food and beverage and other items which were provided to customers without charge has been included in revenues and a corresponding amount has been deducted as promotional allowances. The costs of such complimentaries have been included as casino expenses in the accompanying\nPRATT HOTEL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nconsolidated statements of operations. Costs of complimentaries allocated from the rooms, food and beverage and other operating departments to the casino department during the years ended December 31, 1995, 1994 and 1993 are as follows:\nCASH AND CASH EQUIVALENTS -\nCash and cash equivalents are generally comprised of cash and investments with original maturities of three months or less, such as commercial paper, certificates of deposit and fixed repurchase agreements.\nALLOWANCE FOR DOUBTFUL ACCOUNTS -\nThe allowance for doubtful accounts is maintained at a level considered adequate to provide for possible future losses. Provisions for doubtful accounts amounting to $2,988,000, $3,283,000 and $3,603,000 were made during the years ended December 31, 1995, 1994 and 1993, respectively.\nINVENTORIES -\nInventories are stated at the lower of cost (on a first-in, first-out basis) or market.\nPROPERTY AND EQUIPMENT -\nProperty and equipment have been recorded at cost and are being depreciated utilizing the straight-line method over their estimated useful lives as follows:\nBuildings and improvements 10-25 years Operating equipment 3-15 years\nInterest costs related to property and equipment acquisitions were capitalized during the acquisition period and are being amortized over the useful lives of the related assets.\nDEFERRED FINANCING COSTS -\nThe costs of issuing long-term debt, including all underwriting, licensing, legal and accounting fees, have been capitalized and are being amortized over the term of the related debt issue. Amortization of such costs was $1,113,000, $964,000 and $3,144,000 for the years ended December 31, 1995, 1994 and 1993, respectively.\nPRATT HOTEL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nLONG-LIVED ASSETS\nDuring 1995, PHC adopted the provisions of Statement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets\" (\"SFAS 121\"). SFAS 121 requires, among other things, that an entity review its long-lived assets and certain related intangibles for impairment whenever changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable. As a result of its review, PHC does not believe that any material impairment currently exists related to its long-lived assets.\nACCRUED INSURANCE -\nPHC is self insured for a portion of its general liability, certain health care and other liability exposures. Accrued insurance includes estimates of such accrued liabilities based on an evaluation of the merits of individual claims and historical claims experience; accordingly, PHC's ultimate liability may differ from the amounts accrued.\nINCOME TAXES -\nSince May 1992, PHC has been included in HCC's consolidated federal income tax return. Pursuant to agreements between HCC and PHC, PHC's provision for federal income taxes is based on the amount of tax which would be provided if a separate federal income tax return were filed.\nOn January 1, 1993, PHC adopted the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS 109\"), which utilizes the liability method and results in the determination of deferred taxes based on the estimated future tax effects of differences between the financial statement and tax bases of assets and liabilities.\nINTEREST EXPENSE -\nInterest expense includes the accretion of debt discount amounting to $6,666,000, $5,398,000 and $361,000, respectively, during the years ended December 31, 1995, 1994 and 1993.\nNET LOSS PER COMMON SHARE -\nNet loss per common share is based on the weighted average number of shares of common stock and common stock equivalents outstanding. The weighted average number of common stock equivalents outstanding was 5,187,000, 5,183,000 and 5,164,000 during the years ended December 31, 1995, 1994 and 1993, respectively. Shares issuable upon the exercise of stock options were not considered in the computation of net loss per common share as the result would have been antidilutive.\nRECLASSIFICATIONS -\nCertain reclassifications have been made to the prior years' consolidated financial statements to conform to the 1995 consolidated financial statement presentation.\nPRATT HOTEL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(3) SHORT-TERM CREDIT FACILITIES AND BORROWINGS FROM AFFILIATES\nDuring June 1994, a subsidiary of PHC entered into an agreement for a bank line of credit in the amount of $5,000,000. The agreement, which was renewed in April 1995, provides for interest on borrowings at the bank's prime lending rate plus 3\/4% per annum. In addition to the maintenance of certain financial ratios, the line of credit agreement contains numerous restrictive covenants, all of which are also covenants under other debt as described in Note 4. The bank line of credit agreement also contains certain cross-default provisions with other outstanding debt of PHC and its subsidiaries. Borrowings under the line of credit are guaranteed to the extent of $2,000,000 by another subsidiary of PHC. There were no borrowings outstanding under the line of credit at December 31, 1995 or 1994; however, $3,000,000 was borrowed during the first quarter of 1996.\nDuring 1993, a subsidiary of PHC issued $21,000,000 of Series A and Series B 13 1\/2% Guaranteed First Mortgage Notes due in 1994 (the \"Series Notes\"). The Series Notes were not registered under the Securities Act and, since no such registration became effective prior to August 18, 1993, the interest rate increased to 14% per annum effective at that date with additional increases of 1\/4% after each succeeding 90-day period. Refinancing of the Series Notes was completed in February 1994 when a subsidiary of PHC issued $185,000,000 of 10 7\/8% First Mortgage Notes due in 2004 (see Note 4).\nPHC and its subsidiaries had outstanding affiliate borrowings from HCC of $6,000,000 as of both December 31, 1995 and 1994. Of the amounts borrowed, $1,000,000, which is not due until April 1, 1998, is classified as noncurrent in the accompanying consolidated balance sheets at December 31, 1995 and 1994. In addition, $4,750,000 is due in May 1996 and is secured by a pledge of certain notes receivable from a partnership owned by certain numbers of the Pratt Family (see Note 7). The remaining balance of $250,000 is due on demand, or if no demand is made, on April 1, 1998. All such borrowings from HCC bear interest at the rate of 14% per annum, payable semiannually. Under certain conditions, PHC and its subsidiaries may obtain additional loans from HCC under similar terms.\nIn addition, HCC agreed to loan up to $8,000,000 to a subsidiary of PHC, the proceeds of which were loaned to and used by the Sands in connection with an expansion of its gaming space. During 1993, HCC loaned $7,083,000 to the subsidiary for such purpose. The loan accrued interest at the rate of 13 1\/2% per annum payable semiannually, and the outstanding balance of $8,000,000 was repaid during February 1994 in connection with the refinancing of virtually all of PHC's casino-related outstanding debt (see Note 4).\nPRATT HOTEL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(4) LONG-TERM DEBT AND PLEDGE OF ASSETS\nSubstantially all of PHC's assets are pledged in connection with PHC's long-term indebtedness. Additionally, the indentures with respect to the February 1994 refinancing of substantially all of PHC's casino related outstanding debt contain certain cross-default provisions.\n- --------------------\n(a) On February 17, 1994, a subsidiary of PHC issued $185,000,000 of non- recourse first mortgage notes due January 15, 2004 (the \"10 7\/8% First Mortgage Notes\") and collateralized by a first mortgage on the Sands. Interest on the notes accrues at the rate of 10 7\/8% per annum, payable semiannually commencing July 15, 1994. Interest only is payable during the first three years. Commencing on July 15, 1997, semiannual principal payments of $2,500,000 will become due on each interest payment date. The 10 7\/8% First Mortgage Notes are redeemable at the option of the issuer, in whole or in part, on or after January 15, 1999 at stated redemption prices ranging up to 104.08% of par plus accrued interest.\nThe indenture for the 10 7\/8% First Mortgage Notes contains various provisions which, among other things, restrict the ability of certain subsidiaries of PHC to pay dividends to PHC, to merge, consolidate or sell substantially all of their assets or to incur additional indebtedness beyond certain limitations. In addition, the indenture requires the maintenance of certain cash balances and, commencing in 1994, requires that a minimum of $7,000,000 be expended for property and fixture renewals, replacements and betterments at the Sands, subject to increases of five percent per annum thereafter. The indenture also contains certain cross- default provisions with respect to the PRT Funding Notes described in (b) below.\n(b) On February 17, 1994, a subsidiary of PHC issued $85,000,000 of unsecured senior notes due April 15, 2004 (the \"PRT Funding Notes\"). Interest on the PRT Funding Notes accrues at the rate of 11 5\/8% per annum, payable semiannually commencing October 15, 1994. The PRT Funding Notes are redeemable at the option of the issuer, in whole or in part, on or after April 15, 1999 at stated redemption prices ranging up to 104.36% of par plus accrued interest. The indenture for the\nPRATT HOTEL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nPRT Funding Notes contains various provisions which, among other things, restrict the ability of certain subsidiaries of PHC to pay dividends to PHC, to merge, consolidate or sell substantially all of their assets or to incur additional indebtedness beyond certain limitations. The indenture also contains certain cross default provisions with respect to the 10 7\/8% First Mortgage Notes described in (a) above.\n(c) On February 17, 1994, PRT Funding Corp., a subsidiary of PHC, issued $15,000,000 of junior subordinated notes (the \"Junior Subordinated Notes\") to HCC. At December 31, 1994, $6,317,000 principal amount of the Junior Subordinated Notes (subsequently adjusted to $6,262,000 during 1995) together with $1,914,000 of accrued interest were assigned to PHC by HCC in recognition of tax net operating losses of PHC used by HCC (see Notes 5 and 12). The Junior Subordinated Notes are due in February 2005 and bear interest at the rate of 14 5\/8% per annum which, subject to a PHC subsidiary meeting certain financial coverage and other payment restriction tests required by the indenture for the PRT Funding Notes, is payable semiannually commencing August 17, 1994. Because the PHC subsidiary had not met the financial coverage tests, interest was not paid on August 17, 1994 and February 17, 1995. However, based on the PHC subsidiary subsequently meeting such tests, all interest due through the August 17, 1995 interest payment dates has been paid (see Note 7).\n(d) On February 17, 1994, PPI Funding Corp., a newly formed subsidiary of PHC, issued $40,524,000 discounted principal amount of new deferred interest notes (the \"PPI Funding Notes\") to HCC in exchange for the $38,779,000 principal amount of 15 1\/2% unsecured notes held by HCC and issued by PCPI Funding Corp., a subsidiary of PHC (the \"PCPI Notes\"). The increased principal amount of the new notes included a call premium on the exchange ($1,745,000) equal to 4 1\/2% of the principal amount of PCPI Notes exchanged; such premium was paid to all third party holders of $58,364,000 principal amount of PCPI Notes concurrently redeemed. The PPI Funding Notes were discounted to yield interest at the rate of 14 7\/8% per annum and have a face value of $110,636,000. During the second and third quarters of 1995, PPI Funding Corp. repaid $5,500,000 of principal on the PPI Funding Notes, reducing the maturity value of the notes to $98,076,000. Payment of interest is deferred through February 17, 2001 at which time interest will become payable semiannually, with the unpaid principal balance due on February 17, 2006. The PPI Funding Notes are collateralized by a pledge of all of the common stock of a subsidiary of PHC.\nScheduled payments of long-term debt as of December 31, 1995 are set forth below:\nPRATT HOTEL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nInterest paid, net of amounts capitalized, amounted to $32,058,000, $27,253,000 and $38,582,000, respectively, during the years ended December 31, 1995, 1994 and 1993.\n(5) INCOME TAXES\nComponents of PHC's benefit (provision) for income taxes consist of the following:\nPHC is included in HCC's consolidated federal income tax return. Pursuant to agreements between HCC and PHC, PHC's provision for federal income taxes is based on the amount of tax which would be provided if a separate federal income tax return were filed. In addition, HCC compensates PHC for the use by HCC and its subsidiaries (exclusive of PHC and its subsidiaries) of PHC's available tax net operating loss carryforwards (\"NOL's\"). There was no such utilization of PHC's NOL's for the year ended December 31, 1995 or 1993; for the year ended December 31, 1994, such payment was effected through the assignment of principal and interest on the Junior Subordinated Notes (see Note 12). Total state income taxes paid by PHC for the years ended December 31, 1995, 1994 and 1993 amounted to $171,000, $412,000 and $1,735,000, respectively.\nA reconciliation between the calculated tax benefit (provision) based on the statutory rates in effect and the effective tax rates follows:\nPRATT HOTEL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nPHC and its subsidiaries have NOL's totaling approximately $61,000,000 (after reduction for the approximately $23,000,000 used by HCC in 1994), of which approximately $45,000,000 do not begin to expire until the year 2003. Additionally, PHC and its subsidiaries have various tax credits available totaling approximately $4,000,000, most of which expire by the year 2002. In the first quarter of 1993, PHC adopted the provisions of SFAS 109. SFAS 109 requires that the tax benefit of such NOL's and credit carryforwards be recorded as an asset and, to the extent that management can not assess that the utilization of all or a portion of such NOL's is more likely than not, a valuation allowance should be recorded. Due to losses sustained for both financial and tax reporting by PHC and its subsidiaries through 1995, management was unable to determine that realization of such asset was more likely than not and, thus, has provided valuation allowances for the entire deferred tax asset for all periods presented.\nSales or purchases of PHC or HCC common stock by certain five percent stockholders, as defined in the Internal Revenue Code of 1986, as amended (the \"Code\"), can cause a \"change of control\", as defined in Section 382 of the Code, which would limit the ability of PHC to utilize these loss carryforwards in later tax periods. Should such a change of control occur, the amount of annual loss carryforwards available for use would most likely be substantially reduced. Future treasury regulations, administrative rulings or court decisions may also effect PHC's future utilization of its loss carryforwards.\nThe components of the net deferred tax asset were as follows:\nPRATT HOTEL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nReceivables and payables in connection with the aforementioned tax allocation agreements were as follows:\n(6) STOCK OPTIONS AND COMPENSATION PLANS\nINCENTIVE STOCK OPTION PLAN - ---------------------------\nDuring 1990, PHC adopted the 1990 Incentive Stock Option Plan (the \"Plan\"). The 1990 Plan provides for the granting of incentive stock options intended to qualify for special tax treatment under the Internal Revenue Code, as amended (the \"Code\"). The shares offered under the 1990 Plan consist of shares of PHC common stock. Options for no more than 102,092 shares of common stock may be granted under the 1990 Plan.\nThe 1990 Plan is administered by the Board of Directors of PHC through its compensation committee. Options granted under the 1990 Plan are exercisable for a term ending five years from the date of grant and are subject to limitations on the quantity exercised in a calendar year and to certain repurchase provisions. As of December 31, 1995, no options to purchase shares are outstanding; options to purchase 57,772 shares are available for grant.\nThe following table lists the activity of the stock option plan during 1995 and 1994:\nCOMPENSATION PLAN - -----------------\nDuring October 1995, HCC assumed the outstanding unfunded obligations of PHC under existing agreements with certain of PHC's principal shareholders and key executive officers providing for (1) lifetime\nPRATT HOTEL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\npension benefits upon the expiration of existing employment contracts and subsequent consulting agreements and (2) death benefits to be paid for a period of ten years. The obligation assumed by HCC was based on the net present value of the obligation at that date of $4,283,000. PHC issued a non-interest bearing note payable to HCC for a like amount in exchange for the assumption, which is included in noncurrent due to affiliate on the accompanying consolidated balance sheet at December 31, 1995. The obligation accrued under the agreements at December 31, 1994 amounted to $4,035,000 and was included in other noncurrent liabilities in the accompanying consolidated balance sheet. Amounts charged to expense by PHC under the agreements for the years ended December 31, 1995, 1994 and 1993 were approximately $158,000, $109,000 and $15,000, respectively.\n(7) TRANSACTIONS WITH RELATED PARTIES\nPHC operates the Holiday Inn located at the north entrance of the Dallas\/Fort Worth Airport (\"DFW North\") which is owned by Metroplex Hotel Limited (\"Metroplex\"), a partnership controlled by certain members of the Pratt Family. During 1995, PHC made capital expenditures under the hotel operating agreement totaling approximately $750,000 toward property improvements. PHC is also obligated by the hotel operating agreement to make minimum rental payments equal to Metroplex's principal and interest payments on the underlying indebtedness of this hotel. During February 1994, PHC utilized funds borrowed from HCC to purchase such underlying indebtedness with a principal balance of $13,756,000 from third parties at a cost of $6,750,000 ($1,000,000 of which was paid during 1993) and subject to third party indebtedness amounting to $2,706,000. The required minimum rental payments (net of debt service receipts since the February 1994 note acquisition date) amounted to $530,000, $678,000 and $1,396,000, respectively, during the years ended December 31, 1995, 1994 and 1993. PHC recorded the note receivable from Metroplex at acquisition cost, which management believes does not exceed the estimated realizable value of the underlying collateral. The note is included in notes receivable in the accompanying consolidated balance sheets. Payments from Metroplex, including interest at the rate of 9 1\/2% per annum, are due monthly with the remaining principal balance of $13,533,000 due May 31, 1996.\nPHC leased a hotel located in Garland, Texas from a partnership (the \"Garland Partnership\") controlled by certain members of the Pratt Family. The Garland Partnership was the obligor on the related underlying mortgage note which matured in June 1993. PHC was obligated under the terms of its lease agreement to make minimum rental payments equal to the Garland Partnership's debt service, including all required principal and interest payments and any payment due at maturity. For the year ended December 31, 1993, PHC paid the Garland Partnership $164,000. No such payments were made during 1995 and 1994. In 1990, the Garland Partnership sold the hotel and PHC sold its interest in the hotel's furniture, fixtures and equipment. During June 1993, PHC reacquired the hotel and immediately sold the property to a third party. PHC did not recognize a gain or loss in connection with this reacquisition and sale, and PHC has no further obligation with respect to this property. The Pratt Family's guarantee of indebtedness with respect to this property and PHC's related indemnification have been extinguished.\nFrom time to time, certain members of the Pratt Family have advanced monies to PHC for working capital requirements. At December 31, 1993, a loan in the amount of $140,000 was outstanding. This loan, which accrued interest at the prime lending rate, was repaid during 1994. Interest expense and guarantee fees with respect to such advances amounted to $8,000 for each of the years ended December 31, 1994 and 1993.\nPRATT HOTEL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nPratt Management, L.P. (\"PML\"), a limited partnership wholly owned by PHC, earns, pursuant to a management agreement, a base management fee from Hollywood Casino - Aurora, Inc. (\"HCA\"), an HCC subsidiary, equal to 5% of the Aurora Casino's operating revenues (as defined in the agreement) subject to a maximum of $5.5 million annually, and an incentive fee equal to 10% of gross operating profit (as defined in the agreement to generally include all revenues, less expenses other than depreciation, interest, amortization and taxes). Such fees totaled approximately $9,432,000, $10,009,000 and $5,625,000, respectively, during the years ended December 31, 1995, 1994 and 1993. Unpaid fees amounting to $2,177,000, and $2,341,000, respectively, are included in due from affiliates in the accompanying consolidated balance sheets at December 31, 1995 and 1994.\nPursuant to a ten-year consulting agreement with Hollywood Casino - Tunica, Inc. (\"HCT\"), the HCC subsidiary which owns and operates the Tunica Casino, a subsidiary of PHC receives monthly consulting fees of $100,000. Total fees earned for each of the years ended December 31, 1995 and 1994 amounted to $1,200,000.\nHCC is obligated under the terms of an administrative services agreement to pay PHC $50,000 per month during 1995 and 1994 ($20,000 per month during 1993). In addition, PHC and its subsidiaries share certain general and administrative costs with HCC. Net allocated costs and fees charged to HCC by PHC amounted to $153,000, $315,000 and $2,225,000, respectively, during the years ended December 31, 1995, 1994 and 1993. In connection with such allocated costs and fees, a payable in the amount of $53,000 and a receivable in the amount of $77,000 are included in due to affiliates and due from affiliates, respectively, in the accompanying consolidated balance sheets at December 31, 1995 and 1994.\nHCT and Advanced Casino Systems Corporation (\"ACSC\"), a PHC subsidiary, entered into a Computer Services Agreement dated as of January 1, 1994. The agreement has a term of three years and provides, among other things, that ACSC will sell HCT computer hardware and information systems equipment and will license or sublicense to HCT computer software necessary to operate HCT's casino, hotel and related facilities and business operations. HCT pays ACSC for such equipment and licenses such software at amounts and on terms and conditions that ACSC provides to unrelated third parties as well as a fixed license fee of $30,000 a month payable in arrears on the first day of each month commencing September 1, 1994. HCT also reimburses ACSC for its direct costs and expenses incurred under this agreement. Total charges incurred under such agreement amounted to $532,000 and $763,000, respectively, for the years ended December 31, 1995 and 1994. HCA also receives certain computer-related services from PHC subsidiaries including hardware, software, and operator support. HCA reimburses PHC for its direct costs and any expenses incurred. Such costs totaled $602,000, $288,000 and $2,280,000, respectively, during the years ended December 31, 1995, 1994 and 1993.\nGreate Bay Hotel and Casino, Inc. (\"GBHC\"), the PHC subsidiary which owns and operates the Sands, performs certain administrative and marketing services on behalf of HCT and HCA. During the years ended December 31, 1995, 1994 and 1993, fees charged by GBHC for such services totaled $729,000, $211,000 and $272,000, respectively.\nPRATT HOTEL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nHCT and HCA are charged for certain legal, accounting, and other expenses incurred by PHC that relate to their business. For the years ended December 31, 1995, 1994 and 1993, such charges amounted to $423,000, $257,000 and $349,000, respectively.\nInterest expense with respect to borrowings from HCC is set forth below:\nDuring 1994, a newly formed PHC subsidiary issued $40,524,000 discounted principal amount of PPI Funding Notes in exchange for the PCPI Notes held by HCC (see Note 4). Accretion of interest on the PPI Funding Notes is included in the outstanding note payable balance at December 31, 1995 and 1994. Interest due to HCC on the PCPI Funding Notes at December 31, 1993 amounted to $1,503,000 and is included in interest payable on the accompanying consolidated balance sheet.\nInterest accrued on short-term borrowings at both December 31, 1995 and 1994, which amounted to $23,000 is also included in interest payable on the accompanying consolidated balance sheets together with interest on the Junior Subordinated Notes amounting to $476,000 at December 31, 1995. Outstanding interest on the Junior Subordinated Notes at December 31, 1994 was assigned to PHC by HCC in recognition of tax net operating losses of PHC used by HCC (see Note 4).\n(8) NEW JERSEY REGULATIONS AND OBLIGATORY INVESTMENTS\nCertain of PHC's wholly owned subsidiaries conduct gaming operations in Atlantic City, New Jersey and operate a related hotel, several restaurants, and related support facilities. The operation of an Atlantic City casino\/hotel is subject to significant regulatory control. Under the New Jersey Casino Control Act (the \"Casino Act\"), such PHC subsidiaries were required to obtain and are required to periodically renew their operating licenses. A casino license is not transferable and, after the initial licensing and two one-year renewal periods, is issued for a term of up to four years. However, the Casino Commission still has the authority to reopen license hearings at any time. During September 1994, the Casino Commission renewed GBHC's license to operate the Sands and found PHC qualified as a holding company of a casino license through September 30, 1996 and, during 1995, renewed NJMI's license to manage the Sands through September 30, 1996. Management will file for renewal of GBHC's license to operate and NJMI's license to manage the Sands during 1996. Terms of the current license require the Sands to comply with periodic financial reporting requirements as well as obtain prior Casino Commission approval of certain cash transfers and borrowings to and from affiliates. If it were determined that gaming laws were violated by a licensee, the gaming license held by each licensee could be conditioned, suspended or revoked. In addition, the licensees and other persons involved could be subject to substantial fines.\nPRATT HOTEL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nThe Casino Act requires casino licensees to make certain approved investments in New Jersey or to pay an investment alternative tax. Casino licensees may obtain investment credits, which amount to 1.25% of casino revenues, by purchasing bonds at below-market interest rates from the Casino Reinvestment Development Authority (the \"CRDA\") or by making qualified investments approved by the CRDA. This governmental agency administers the statutorily mandated investments made by casino licensees and is required to expend the monies received by it for eligible projects defined in the statute. The investment alternative tax amounts to 2.5% of casino revenues. Payments of the investment obligations must be made quarterly. The Sands has elected to comply with the requirements by obtaining investment credits or by making qualified investments.\nAs of December 31, 1995 and 1994, the Sands had purchased bonds totaling $4,631,000 and $4,368,000, respectively. In addition, the Sands had remaining funds on deposit and held in escrow by the CRDA at December 31, 1995 and 1994 of $4,683,000 and $2,117,000, respectively. The bonds purchased and the amounts on deposit and held in escrow are collectively referred to as \"obligatory investments\" in the accompanying consolidated financial statements.\nObligatory investments at December 31, 1995 and 1994 are net of accumulated valuation allowances of $3,792,000 and $2,458,000, respectively, based upon the estimated realizable values of the investments. Provisions for valuation allowances during the years ended December 31, 1995, 1994 and 1993 amounted to $1,457,000, $617,000 and $340,000, respectively.\nThrough 1995, the Sands has, from time to time, contributed certain amounts held in escrow to the CRDA. In consideration thereof, the CRDA granted the Sands waivers of certain of its investment obligations in future periods. The amount of the obligatory investments contributed during the years ended December 31, 1995, 1994 and 1993 was $250,000, $2,500,000 and $5,694,000, respectively, resulting in waivers granted by the CRDA during 1995 and 1993 totaling $128,000 and $2,904,000, respectively. No such waivers were granted during 1994; however, the contribution has been designated for a project expected to benefit the community and the Sands facility. Accordingly, intangible assets of $1,275,000 have been included in other assets on the accompanying consolidated balance sheets at both December 31, 1995 and 1994 and will be amortized over a period of ten years effective with the completion of the project. Amortization of waivers granted totaled $128,000, $1,727,000 and $2,078,000, respectively, during the years ended December 31, 1995, 1994 and 1993. At December 31, 1995, all waivers were fully amortized.\n(9) ILLINOIS REGULATORY MATTERS\nRiverboat gaming operations in Illinois are subject to regulatory control by the Illinois Gaming Board. Under the provisions of the Illinois gaming regulations, PML is required to maintain its supplier's license, which was most recently renewed in 1995 and expires in December 1996. Management intends to file for renewal of PML's supplier's license and anticipates that such renewal will be approved by the Illinois Gaming Board during 1996. If it were determined that gaming laws were violated by a licensee, the license held could be limited, conditioned, suspended or revoked. In addition, the licensee and other persons involved could be subject to substantial fines.\nPRATT HOTEL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(10) SUMMARIZED COMBINED FINANCIAL INFORMATION OF AND TRANSACTIONS WITH UNCONSOLIDATED AFFILIATES\nCertain summarized combined financial information of PHC's unconsolidated affiliates, which include joint ventures, is presented below.\nIncome and losses of PHC's unconsolidated affiliates have not been reflected in the accompanying consolidated statements of operations for the years ended December 31, 1995, 1994 or 1993 as PHC's investments in such affiliates have previously been eliminated through the recognition of prior years' losses.\nAt December 31, 1995, PHC had an ongoing commitment to fund its proportionate share of operating cash deficits with respect to its 50% ownership interest in the Sheraton Plaza located in Orlando, Florida; PHC was not required to make any such payments during 1995 and 1994 and paid $200,000 during 1993. PHC also agreed to contribute up to $3,900,000 (including approximately $1,200,000 during 1996) as an additional investment in the Sheraton Plaza hotel partnership to refurbish the hotel facility. PHC contributed $1,675,000, $660,000 and $125,000 during 1995, 1994 and 1993, respectively, toward such commitment. Such contributions are in recognition of PHC's partner having agreed to make $5,000,000 in principal reductions on the underlying mortgage note on the facility.\nPHC earns management and project fees from unconsolidated affiliates for the management and project supervision of certain hotel facilities. During the years ended December 31, 1995, 1994 and 1993, such fees amounted to $1,139,000, $977,000 and $930,000, respectively.\nPRATT HOTEL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(11) LITIGATION\nAtlantic City Casino\/Hotel Site -------------------------------\nCertain subsidiaries of PHC have been engaged in litigation arising out of an agreement entered into with a subsidiary of Penthouse International, Ltd. (\"Penthouse\") by a subsidiary of PHC to acquire and complete a casino\/hotel site in Atlantic City, New Jersey and the purchase on March 19, 1989, by Donald J. Trump (\"Trump\") of the site from the Penthouse subsidiary.\nOn March 20, 1989, Penthouse and its subsidiary filed suit in the Superior Court of New Jersey in Atlantic City, New Jersey against PHC and certain of its subsidiaries. PHC and certain of its subsidiaries subsequently filed a counterclaim against Penthouse and its subsidiary, and a third-party complaint against Robert C. Guccione, Trump and Trump Plaza Associates. PHC and its subsidiaries sought a determination that the contract for the casino\/hotel site was valid and unlawfully breached, compensatory damages, treble damages, punitive damages and other forms of injunctive relief.\nA bifurcated trial on liability issues in the litigation has been completed. On March 25, 1993, the Court rejected the claims pressed by PHC and held in favor of some of Penthouse's claims. However, the Court refused to pierce the corporate veil so as to permit any recovery against PHC, or its subsidiary which owns the Sands. The PHC subsidiaries which pressed these claims and which may be adversely affected by the Court's ruling are the special purpose subsidiaries which were formed to acquire, develop and operate the proposed casino\/hotel project and ancillary parking facilities.\nBecause the Court's action only affects two separate subsidiaries of PHC, there are no adverse effects to the operations of, or will there be damages assessed against, PHC under the Court's ruling. However, as a result of the Court ruling, certain assets which had been capitalized in connection with the attempted acquisition of the casino\/hotel site amounting to $13,086,000 were written off during 1992.\nIn January 1991, the PHC subsidiaries began a separate legal proceeding in the United States District Court for the District of New Jersey alleging essentially the same claims against Penthouse and Trump in the various state court actions, and adding claims under the Sherman and Clayton Antitrust Acts not asserted in state court. Penthouse has filed a counterclaim and third- party complaint against the PHC subsidiaries asserting virtually all of the same claims in the state court actions. As a result of the determination reached in the parallel state court proceedings, this action was similarly dismissed.\nPHC and its subsidiaries recently concluded a settlement with Penthouse and its subsidiary in which a PHC subsidiary assigned its interest in a partnership to the Penthouse subsidiary. Related claims in a separate action brought against PHC subsidiaries by a former partner of Penthouse have been settled on a \"walk away\" basis. The appeal from the state court judgement is pending but only with respect to Trump and Trump Plaza Associates.\nPRATT HOTEL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nOther Litigation ----------------\nPHC and its subsidiaries are also parties in various other legal proceedings with respect to the conduct of casino and hotel operations. Although a possible range of loss cannot be estimated, in the opinion of management, based upon the advice of counsel, settlement or resolution of these proceedings should not have a material adverse impact upon the consolidated financial position or results of operations of PHC and its subsidiaries. The accompanying consolidated financial statements do not include any adjustments that might result from the outcome of the uncertainties described above.\n(12) SUPPLEMENTAL CASH FLOW INFORMATION\nAt December 31, 1994, HCC assigned to PHC $6,317,000 principal amount of the Junior Subordinated Notes (see Note 4) together with $1,914,000 of accrued interest thereon in recognition of the utilization by HCC of a portion of PHC's available tax net operating losses to reduce HCC's separate tax liability. The assignment resulted in the recording of $8,231,000 of additional paid-in capital on the accompanying consolidated balance sheet at December 31, 1994. This amount was adjusted by a charge to paid-in capital in the amount of $55,000 during 1995 upon filing the 1994 HCC consolidated federal income tax return.\nDuring 1994, PHC acquired the underlying indebtedness of the DFW North Holiday Inn subject to third party indebtedness totaling $2,706,000 (see Note 7).\n(13) DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:\nCash and cash equivalents - The carrying amounts approximate fair value because of the short maturity of these instruments.\nObligatory investments - The carrying amount of obligatory investments approximates its fair value as a result of an allowance reflecting the below market interest rate associated with such investments.\nNotes receivable - The fair value of notes receivable is estimated based on the discounting of net cash flows at current market rates for notes of similar remaining maturities and collateral.\nInterest payable - The carrying amount of interest payable approximates fair value because of the short maturity of the obligation.\nLong-term debt - The fair value of PHC's long-term debt is estimated based on either the quoted market prices of the issue or on the discounted cash flow of future payments utilizing current rates available to PHC for debt of similar remaining maturities. Debt obligations with a short remaining maturity are valued at the carrying amount.\nPRATT HOTEL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nThe estimated carrying amounts and fair values of PHC's financial instruments are as follows:\n(14) SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nPHC had no disagreements with its independent accountants to report under this item.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nCertain information is set forth below concerning the executive officers, directors and certain key employees of Pratt Hotel Corporation (the \"Company\").\nName Age Position ---- --- --------\nJack E. Pratt............................. 68 Chairman of the Board, Chief Executive Officer and Director\nEdward T. Pratt, Jr....................... 72 Vice Chairman of the Board, Treasurer and Director\nWilliam D. Pratt.......................... 67 Executive Vice President, Acting General Counsel, Secretary and Director\nEdward T. Pratt III....................... 40 President\nAlbert J. Cohen........................... 56 Executive Vice President and Principal Financial Officer\nLawrence C. Cole.......................... 49 Vice President of Management Information Systems\nCharles F. LaFrano III.................... 40 Vice President\nArthur Lewis.............................. 66 Vice President of Corporate Security and Governmental Relations\nLeonard M. DeAngelo....................... 44 President of Greate Bay Hotel and Casino, Inc. (\"GBHC\"), a wholly owned subsidiary of of the Company\nBernard A. Capaldi, CPA................... 53 Director\nEdward D. Muir............................ 85 Director\nBUSINESS EXPERIENCE FOR PAST FIVE YEARS\nMr. Jack E. Pratt has served as Chairman of the Board, a director and Chief Executive Officer of the Company for more than five years. Mr. Pratt has also served as a director of Hollywood Casino Corporation (\"HCC\"), which owns approximately 80% of the Company's outstanding common stock, since its inception in 1990.\nMr. Edward T. Pratt, Jr. has served as Vice Chairman of the Board and a director and executive officer of the Company for more than five years. Mr. Pratt has also served as a director of HCC since its inception in 1990.\nMr. William D. Pratt has served as Executive Vice President, Secretary and a director of the Company for more than five years. He also currently serves as Acting General Counsel and, prior to May 1995, served as General Counsel of the Company for more than five years. Mr. Pratt has also served as a director of HCC since its inception in 1990. Mr. Pratt also served as Vice President and Secretary of Southmark San Juan, Inc. (\"SSJ\"), 46.3% of the stock of which is owned by a subsidiary of the Company, at the time of the filing by SSJ on August 20, 1992 of a voluntary petition for reorganization under Chapter 11 of the Federal Bankruptcy Code in the United States Bankruptcy Court for the Northern District of Texas, Dallas Division. In November 1992, the reorganization plan was confirmed by the Bankruptcy Court.\nMr. Edward T. Pratt III was elected President and Chief Operating Officer of the Company in November 1995. From May 1987 until November 1995, he served the Company as Executive Vice President -- Development and Corporate Affairs. Mr. Pratt has served as a director of HCC since 1992. Mr. Pratt also served as co-chairman and co-chief executive officer of SSJ at the time of the filing of its voluntary petition for reorganization under Chapter 11 of the Federal Bankruptcy Code (see previous paragraph).\nMr. Albert J. Cohen, a certified public accountant, was elected Executive Vice President and Principal Financial Officer of the Company in May 1987.\nMr. Lawrence C. Cole has served as Vice President of Management Information Systems of the Company since December 1987 and of GBHC since January 1983. Mr. Cole also serves as Chief Executive Officer and President of Advanced Casino Systems Corporation (\"ACSC\"), a subsidiary of the Company, which licenses software for automated casino accounting and control systems.\nMr. Charles F. LaFrano III is a certified public accountant and has served as Vice President of the Company since September 1988. He also served as Corporate Controller (Principal Accounting Officer) of the Company from September 1988 until November 1994.\nMr. Arthur Lewis has served as Vice President of Corporate Security and Governmental Relations of the Company since December 1987 and of GBHC since November 1982.\nMr. Leonard M. DeAngelo was named President of GBHC in November 1995. He previously served as Senior Vice President of GBHC from March 1995 to November 1995 and as Vice President of Casino Operations of GBHC from February 1988 to March 1995.\nMr. Bernard A. Capaldi is a certified public accountant and is a principal of Capaldi, Reynolds & Associates, P.A., C.P.A.'s in New Jersey, and has held such position since 1965. He is also the Chairman of the Board of Shore Memorial Hospital's parent holding company.\nMr. Edward D. Muir is currently retired. He is a former Senior Vice President of Rauscher Pierce Refsnes of San Antonio, Texas, an investment banking firm, and was associated with Rauscher Pierce Refsnes in numerous executive capacities for more than five years.\nFAMILY RELATIONSHIPS\nMessrs. Jack E. Pratt, Edward T. Pratt, Jr. and William D. Pratt are brothers (the \"Pratt Brothers\"). Mr. Edward T. Pratt III, President of the Company, is the son of Mr. Edward T. Pratt, Jr. There is no other family relationship between any of the directors and any executive officers of the Company or its subsidiaries or affiliates.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nSUMMARY OF CASH AND CERTAIN OTHER COMPENSATION\nThe following table provides certain summary information concerning compensation paid or accrued by the Company, its subsidiaries and affiliates to or on behalf of (i) the Company's Chief Executive Officer; (ii) each of the four other most highly compensated executive officers of the Company (determined as of the end of the last fiscal year; and (iii) additional individuals who would have qualified as among the four other most highly compensated executive officers of the Company but for the fact that the individual was not serving as an executive officer of the Company at the end of the last fiscal year (hereafter referred to as the named executive officers) for the fiscal years ended December 31, 1995, 1994 and 1993.\n__________\n(1) Represents directors' fees for service as a director to a subsidiary of the Company.\n(2) Includes matching contributions by the Company to The Hollywood Casino Corporation and Subsidiaries Retirement Savings Plan on behalf of the named executive officer. See also \"Employee Retirement Savings Plan\" below. Amounts set forth for Jack E. Pratt and Edward T. Pratt, Jr. also include pension benefit accruals on their behalf. See also \"Employment Contracts\" below.\n(3) Amounts shown for Jack E. Pratt and Edward T. Pratt, Jr. represent payments by the Company and its subsidiaries for services on their behalf. Messrs. Jack Pratt and Edward T. Pratt, Jr. concurrently hold positions as officers of HCC, which reimburses the Company for services provided to HCC pursuant to intercompany allocation agreements ratified by the respective Boards of Directors of the Company and HCC. Additional compensation amounts earned by the Messrs. Pratt for their services provided to HCC and paid by HCC are set forth in the following tabulation:\nNo grants of stock options under the Pratt Hotel Corporation 1990 Incentive Stock Option Plan (the \"Plan\") were made to the named executive officers during the most recent fiscal year.\nOPTION EXERCISES AND HOLDINGS\nThe following table provides information, with respect to the named executive officers, concerning options granted under the Plan during the last fiscal year and unexercised options held as of the end of the fiscal year:\nAGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES\nEMPLOYMENT CONTRACTS\nJack E. Pratt, Chairman of the Board and Chief Executive Officer of the Company, Edward T. Pratt, Jr., Vice Chairman of the Board and Treasurer of the Company, and William D. Pratt, Executive Vice President, Secretary and Acting General Counsel of the Company, have been under employment contracts with the Company and have provided services to HCC pursuant to intercompany allocation agreements ratified by the respective Boards of Directors of the Company and HCC. Their employment contracts were executed during October 1989 and originally expired on December 31, 1994, but were extended by amendment through December 31, 1996. Effective as of January 1, 1996, HCC has assumed the obligations and extended the terms of the contracts to December 31, 1998 with respect to Jack E. Pratt and to December 31, 1997 with respect to Edward T. Pratt, Jr. and William D. Pratt. Services to the Company will continue to be provided pursuant to intercompany allocation agreements. The terms of the contracts may be extended again by mutual agreement of the parties and the extended term, or any further extension thereof, will be followed immediately by a four-year period as consultants to HCC. Upon expirations the consulting term, each of the Pratt Brothers will be entitled to receive a lifetime pension benefit and his designated beneficiary is entitled to receive a death benefit, throughout the term of the employment, consulting and pension benefit periods.\nThe terms of the employment contracts provide for an annual base salary in the first year for Jack E. Pratt, Edward T. Pratt, Jr. and William D. Pratt of $350,000, $223,000 and $191,000, respectively, subject to annual review and increase by the Compensation Committee of the Board of Directors. Compensation under the consulting and pension benefit provisions of the employment contracts of each of the Pratt Brothers will be 75% of the average of his three highest annual salaries during the employment term of the contract. The death benefit is derived by multiplying a Pratt Brother's highest annual salary during his employment term by 50% and such benefit will be paid annually to his designated beneficiary for a period of ten years after his death. The estimated annual pension benefit payable to Jack E. Pratt, Edward T. Pratt, Jr. and William D. Pratt is currently $425,000, $220,000 and $192,000, respectively.\nLeonard M. DeAngelo, President of GBHC, serves under an employment contract, as amended on November 17, 1995, in such capacity continuing through November 16, 1998, unless sooner terminated by one of the respective parties. The terms of Mr. DeAngelo's amended contract provides for a minimum annual base salary of $450,000, subject to annual increases of five percent.\nLawrence C. Cole, Vice President of Management Information Systems of the Company serves under an employment contract, as amended on January 1, 1996, with a wholly owned subsidiary of the Company in such capacity continuing through December 31, 1998 unless sooner terminated by one of the respective parties. The terms of Mr. Cole's amended contract provides for a minimum annual base salary of $275,000 subject to annual increases based on changes in the Consumer Price Index, as defined in the employment contract, together with incentive bonuses based on operating results. Obligations of the subsidiary under the employment contract are guaranteed by GBHC.\nWilliam P. Weidner, formerly President and Chief Operating Officer of the Company, and Bradley H. Stone, formerly Executive Vice President of the Company and President of GBHC, were under employment contracts in such respective capacities continuing through December 31, 1995; both contracts were terminated in November 1995. The terms of Mr. Weidner's and Mr. Stone's contracts provided for minimum annual base salaries of $677,000 and $422,000, respectively, subject to annual increases based on changes in the Consumer Price Index, as defined in the employment contracts.\nINCENTIVE STOCK OPTION PLAN\nThe 1990 Incentive Stock Option Plan. On March 22, 1990, the Company ------------------------------------ adopted the Pratt Hotel Corporation 1990 Incentive Stock Option Plan (the \"PHC Plan\"). The PHC Plan provides for the granting of incentive stock options that are intended to qualify for special tax treatment under the Internal Revenue Code\n(the \"Code\"). The shares to be offered under the PHC Plan consist of shares (whether authorized and unissued or issued and reacquired) of the Common Stock. Options for no more than 102,092 shares of the Common Stock may be granted under the PHC Plan.\nThe PHC Plan is administered by the Compensation Committee of the Board of Directors (the \"Board\") of the Company. Subject to the terms of the PHC Plan, the Compensation Committee may from time to time determine those key employees who shall be granted stock options under the PHC Plan, the number of shares to be subject to such options and interpret and establish and amend rules and regulations relating to the PHC Plan. Only key employees of the Company or any of its subsidiaries are eligible to participate in the PHC Plan. Incentive stock options granted under the PHC Plan are exercisable for a term ending five years from the date of grant.\nThe exercise of options is subject to a $100,000 calendar-year limit for each option holder based on the fair market value of the Common Stock at the time the option was granted. Options not exercised in earlier periods shall be accumulated and available for exercise in later periods. Options may be exercised only as to full shares of Common Stock. Upon termination of an optionee's employment with the Company for any reason, including death or disability, his or her options will immediately expire.\nThe Compensation Committee may provide for the exercise of options immediately or in installments, and upon such other terms, conditions and restrictions as it may determine, including granting the Company the right to repurchase shares issued upon the exercise of options. The PHC Plan provides that if any person or group (other than Pratt Brothers) becomes the beneficial owner of more than 51% of the Common Stock (other than by merger, consolidation or purchase from the Company), the Company's right to repurchase a former employee's shares shall terminate.\nEMPLOYEE RETIREMENT SAVINGS PLAN\nOn January 1, 1989, the Company adopted GBHC's qualified defined contribution plan for the benefit of all of the Company's employees who satisfy certain eligibility requirements. GBHC had adopted this plan for the benefit of its eligible employees in November 1984. Upon adoption by the Company, the former plan changed its name to The Hollywood Casino Corporation and Subsidiaries Retirement Savings Plan (the \"Savings Plan\"). The Savings Plan is qualified under the requirements of section 401(k) of the Code allowing participating employees to benefit from the tax deferral opportunities provided therein. All employees of the Company who have completed one year of service, as defined, and who have attained the age of 21, are eligible to participate in the Savings Plan.\nThe Savings Plan provides for a matching contribution by the Company based upon certain criteria, including levels of participation by the Company's employees. The Company accrued matching contributions totaling approximately $535,000 for the year ended December 31, 1995.\nCOMPENSATION OF DIRECTORS\nNonemployee directors of the Company received an annual fee of $25,000 for service on the Board of Directors and $1,000 for each Board meeting attended during 1995. The Board of Directors of the Company held four regularly scheduled meetings during the year ended December 31, 1995. The Board of Directors of the Company has Audit, Executive and Compensation Committees, but does not have a standing nominating committee. Nonemployee members of the Audit Committee receive an annual fee of $2,500 for service on the committee and $500 for each committee meeting attended. No additional compensation or fees are paid to directors for attending Executive and Compensation Committee meetings.\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\nThe Compensation Committee of the Board of Directors of the Company is comprised of Messrs. Edward D. Muir, Jack E. Pratt and William D. Pratt and, prior to his resignation in November 1995, included Mr. James A. Colquitt. Messrs. Muir and Colquitt are neither former nor current officers or employees of the Company or any of its subsidiaries. Jack E. Pratt and William D. Pratt serve as executive officers and directors of the Company and HCC. They also serve on the Compensation Committee of HCC.\nREPORT OF THE COMPENSATION COMMITTEE\nAs members of the Compensation Committee, it is our duty to administer the Company's various incentive plans, including its incentive stock option plan and to review compensation levels of members of management, to evaluate the performance of management and to consider management succession and related matters. The Compensation Committee reviews with the Board in detail all aspects of compensation for all executive officers.\nThe compensation policy of the Company, which is endorsed by the Compensation Committee, is that the annual compensation of each officer has been established to reward long-term strategic management and the enhancement of shareholder value, as well as to attract and retain key executives critical to the long-term success of the Company. Such compensation relates to and must be contingent upon the contributions, responsibilities and relative position in the Company of each individual officer, as well as the relative performance of the Company. The Compensation Committee has also taken into consideration competition within the rapidly expanding gaming industry for experienced personnel as well as other subjective considerations in its deliberations regarding executive compensation.\nIn 1995 Mr. Jack E. Pratt, Chairman of the Board and Chief Executive Officer of the Company, served the Company under an employment agreement with the Company dated as of September 21, 1989, as amended (the \"Employment Agreement\"), described in the Company's Form 10K for the fiscal year ended December 31, 1995. In addition, Mr. Pratt provided services to HCC through an intercompany overhead allocation arrangement (the \"Overhead Allocation Arrangement\") previously approved by the Boards of Directors of the Company and HCC. In light of previous decisions of the Board of Directors of the Company and its Compensation Committee, the minimum annual base salary of Mr. Pratt under the Employment Agreement has been set at $566,000 effective as of July 1, 1994. There were no adjustments to the annual base salary of Mr. Pratt in the fiscal year 1995.\nEffective as of January 1, 1996, HCC assumed the obligations of the Company under the Employment Agreement and extended the term of such Employment Agreement to December 31, 1998. Mr. Pratt continues to provide services to the Company and HCC which allocate the cost of such services pursuant to the Overhead Allocation Arrangement. In January 1996, the Compensation Committee of the Board of Directors of HCC approved (i) an increase in the annual base salary of Mr. Pratt from $566,000 to $645,000 effective as of January 1, 1996 and (ii) the award of a bonus to Mr. Pratt in the amount of $205,000 for fiscal year 1995 (of which $71,750 has been allocated to the Company based on the Overhead Allocation Arrangement), in recognition of profitable operations at a riverboat gaming facility owned by a subsidiary of HCC and managed by a subsidiary of the Company, profitable operations at a dockside gaming facility owned by a subsidiary of HCC and for which a subsidiary of the Company provides consulting services and the successful refinancing of substantially all of HCC's gaming related debt obligations at more favorable terms.\nDuring 1995, the Compensation Committee also considered stock option grants to each of the senior officers and key employees of the Company. No such grants were issued during 1995.\nThis report and the accompanying stock price performance graph are provided for general informational purposes only pursuant to regulations under the Securities Exchange Act of 1934. No information contained in this report or the accompanying graph shall be deemed to be filed in whole or in part for purposes under the Securities Act of 1933 or the Securities Exchange Act of 1934, or incorporated by reference into any filing made thereunder.\nCompensation Committee\nJack E. Pratt William D. Pratt Edward D. Muir\nSTOCK PRICE PERFORMANCE\nThe graph set forth below compares the stock price performance of the Company with those of the Dow Jones Equity Market Index and the Dow Jones Index for the Casino Industry for the previous five years. The Company has not paid dividends over such period of time; however, the comparative equity market and industry data assumes reinvestment of dividends. The stock price performance shown below may not be indicative of future stock price performance. (Table substituted for graph).\nPratt Hotel Corporation Stock Price Performance (January 1, 1991 = 100)\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nSECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS\nBased on filings with the Securities and Exchange Commission, the only person known to the Company, other than certain directors of the Company, which beneficially owned more than 5% of the outstanding Common Stock is described below:\nSECURITY OWNERSHIP OF MANAGEMENT\nThe following information pertains to the Common Stock beneficially owned by each director, nominee for director, each executive officer and former executive officer named under Item 11 - \"Executive Compensation\" and by all current directors and officers of the Company as a group as of March 26, 1996:\n__________\n* Less than 1%\n(a) Except as otherwise described, each individual has the sole power to vote and dispose of the Common Stock beneficially owned by him.\n(b) By virtue of the following, Jack E. Pratt may be deemed to share beneficial ownership of all of the Common Stock held by HCC: (i) C. A. Pratt Partners, Ltd., a Texas limited partnership of which Mr. Pratt is the General Partner, owns 1,282,123 shares (5.2%) of the outstanding stock of HCC; such shares are subject to a voting agreement giving Mr. Pratt sole voting power on all matters to come before the stockholders of the Company, (ii) J. E. Pratt Co. I, a Texas general partnership of which Mr. Pratt is the Managing General Partner, owns 1,799,387 shares (7.3%) of the outstanding stock of HCC, (iii) the W.D. Pratt Family Trust, for which Mr. Pratt is the managing trustee, owns 1,003,867 shares (4.1%) of the outstanding stock of HCC and (iv) Mr. Pratt is a director of HCC.\n(c) By virtue of the following, Edward T. Pratt, Jr. may be deemed to share beneficial ownership of all of the Common Stock held by HCC: (i) E.T. Pratt Co. I, a Texas general partnership of which Mr. Pratt is the Managing General Partner, owns 926,748 shares (3.7%) of the outstanding stock of HCC and (ii) Mr. Pratt is a director of HCC.\n(d) By virtue of the following, William D. Pratt may be deemed to share beneficial ownership of all the Common Stock held by HCC: (i) W.D. Pratt Co. I, a Texas general partnership of which Mr. Pratt is the Managing General Partner, owns 290,830 shares (1.2%) of the outstanding stock of HCC, (ii) the J.E. Pratt Family Trust, for which Mr. Pratt is the managing trustee, owns 4,588,867 shares (18.5%) of the outstanding stock of HCC and (iii) Mr. Pratt is a director of HCC.\n(e) By virtue of the following, Edward T. Pratt III may be deemed to share beneficial ownership of all the Common Stock held by HCC: (i) E. Pratt Family Trust, of which Mr. Pratt is the Managing Trustee, owns 2,076,013 (8.4%) of the outstanding stock of HCC; (ii) direct ownership of 332,500 (1.3%) of the outstanding stock of HCC; and (iii) Mr. Pratt is a director of HCC. Mr. Pratt also holds options to purchase 130,008 shares of common stock of HCC exercisable within 60 days, which represents less than one percent of the outstanding shares of HCC.\n(f) Former officer or director of the Company. Resigned effective November 1995.\n(g) Mr. Weidner also owns 339,981 shares of HCC Common Stock, which represents 1.4% of the outstanding shares of HCC Common Stock.\n(h) Mr. Stone also owns 191,990 shares of HCC Common Stock, which represents less than one percent of the outstanding shares of HCC Common Stock.\n(i) Includes 10,780 shares held of record by the Betty Fay Muir Survivors Trust of which Mr. Edward D. Muir is the Trustee.\n(j) Mr. Cole also owns 65,004 shares of HCC Common Stock, which represents less than one percent of the outstanding shares of HCC.\n(k) Mr. DeAngelo also owns 65,004 shares of HCC Common Stock, which represents less than one percent of the outstanding shares of HCC.\n(l) Current officers and directors of the Company as a group also beneficially own 12,516,947 shares of HCC Common Stock (50.1% of the HCC shares outstanding) and hold options to purchase 130,008 shares of HCC Common Stock exercisable within 60 days. Such shares subject to options represent less than one percent of the outstanding shares of HCC Common Stock.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nHOLLYWOOD CASINO CORPORATION. During 1990, HCC, a corporation then wholly owned by the Pratt Family, acquired approximately $38.8 million of unsecured notes (the \"PCPI Notes\") issued by PCPI Funding Corp., a subsidiary of the Company. As part of a refinancing in February 1994 of virtually all of the Company's casino-related outstanding debt, a newly formed subsidiary of the Company issued approximately $40.5 million discounted principal amount of new deferred interest notes (the \"PPI Funding Notes\") in exchange for the $38.8 million principal amount of PCPI Notes held by HCC. The increased principal amount of the new notes includes a call premium on the exchange ($1.7 million) equal to 4 1\/2% of the principal amount of PCPI Notes exchanged; such premium was paid to all third parties holding PCPI Notes. Interest expense accreted with respect to the PPI Funding Notes for the year ended December 31, 1995 amounted to $6.6 million. During 1995, the PHC subsidiary repaid $5.5 million of principal on the PPI Funding Notes.\nSince May 1992, the Company and its subsidiaries have borrowed funds from a liquidity fund established by HCC for such purpose. As of December 31, 1995, the outstanding balance on such borrowings was $6 million and, under certain conditions, the Company and its subsidiaries may obtain additional loans from HCC under similar terms. Of the amounts borrowed, $1 million, which is not due until April 1, 1998, is classified as noncurrent. Borrowings of $4.8 million are due on May 31, 1996 and are secured by a pledge of certain notes receivable acquired by the Company during 1994 (see \"DFW North\" below). The remaining $250,000 is due on demand, or if no demand is made, on April 1, 1998. Such borrowings from HCC bear interest at the rate of 14% per annum, payable semiannually.\nIn connection with the February 1994 refinancing of virtually all of the Company's casino-related indebtedness, a newly formed subsidiary of the Company borrowed $15 million from HCC to be used in connection with an expansion of the Sands Hotel and Casino. The debt accrues interest at the rate of 14 5\/8% per annum and is due in February 2005. At December 31, 1994, $6.3 million principal amount of such notes together with $1.9 million of accrued interest were assigned to the Company by HCC in recognition of tax net operating losses of the Company used by HCC.\nInterest expense on borrowings from HCC as described in the preceding two paragraphs amounted to $2.1 million for the year ended December 31, 1995. Interest payable to HCC in connection with such borrowings amounted to $499,000 at December 31, 1995.\nHollywood Casino - Aurora, Inc. (\"HCA\"), a wholly owned subsidiary of HCC, was organized for the purpose of developing and owning a riverboat gaming facility in Aurora, Illinois, (the \"Aurora Casino\") which commenced operations on June 17, 1993. A wholly owned subsidiary of the Company receives, pursuant to a services agreement, a base services fee equal to 5% of operating revenues (as defined in the agreement) subject to a maximum of $5.5 million annually, and an incentive fee equal to 10% of gross operating profit (as defined in the agreement to generally include all revenues, less expenses other than depreciation, interest, amortization and taxes). Such fees totaled approximately $9.6 million during 1995 of which unpaid base services and incentive fees of $2.2 million were owed to the PHC subsidiary at December 31, 1995.\nHWCC - Tunica, Inc. (\"HCT\"), a wholly owned subsidiary of HCC, completed construction of a dockside gaming facility in Tunica County, Mississippi (the \"Tunica Casino\") which commenced operations in August 1994. Pursuant to a ten- year consulting agreement with HCT, a subsidiary of the Company receives monthly consulting fees of $100,000.\nHCC is obligated under the terms of an administrative services agreement to pay the Company $50,000 per month in connection with certain shared administrative costs. In addition, the Company and its subsidiaries share certain general and administrative costs with HCC. Net allocated costs and fees charged to HCC by the Company amounted to $153,000 during the year ended December 31, 1995. A payable in the amount of $53,000 in connection with such allocated costs and fees was due to HCC at December 31, 1995.\nVarious subsidiaries of the Company provide legal, accounting, marketing and other administrative services to casino facilities owned by HCC. The HCC facilities are billed for such services at either the direct or allocated cost of providing the services. Such charges amounted to approximately $1.2 million for the year ended December 31, 1995.\nA subsidiary of the Company also provides computer-related services to the HCC-owned casino facilities. The subsidiary has an agreement with one casino facility which expires on December 31, 1996 and provides for the sale of computer hardware and information systems equipment and the licensing of software necessary to operate the facility. The casino pays prices and fees in amounts and on terms and conditions that the subsidiary provides to unrelated third parties as well as a fixed license and consulting fee of $30,000 per month. The subsidiary is also reimbursed for its direct costs and expenses incurred under this agreement. Total charges under the agreement amounted to $532,000 for the year ended December 31, 1995. The PHC subsidiary also provides similar services and hardware to another HCC-owned casino facility which it charges for direct costs and expenses. Such charges amounted to $602,000 for the year ended December 31, 1995.\nOn October 16, 1995, HCC assumed the employment contracts of each of the Pratt Brothers, including the outstanding obligations of the Company for the pension and death benefit payments to be made to the Pratt Brothers. As consideration for the assumption, the Company has incurred a non-interest bearing payable to HCC in the amount of approximately $4.3 million, representing the net present value of the outstanding obligations as of such date.\nDFW NORTH. The Company operates the Holiday Inn located at the north entrance of the Dallas\/Fort Worth International Airport (\"DFW North\") which is owned by Metroplex Hotel Limited (\"Metroplex\"), a limited partnership owned at December 31, 1995 by Jack E. Pratt and Edward T. Pratt, Jr., each as 30% general and limited partners, William D. Pratt as a 10% general and limited partner and Crystal A. Pratt, the former wife of Jack E. Pratt, as a 30% limited partner. During the year ended December 31, 1995, the Company made capital expenditures under the hotel operating agreement totaling approximately $750,000 toward property improvements. The Company is also obligated by the operating agreement, which expires in 2002, to make minimum payments equal to principal and interest payments on the indebtedness incurred by Metroplex to purchase DFW North.\nDuring February 1994, the Company purchased such underlying indebtedness with a principal balance of approximately $13.8 million from third parties at a cost of $6.8 million ($1 million of which was paid during 1993), with funds borrowed from HCC, and subject to third party indebtedness amounting to $2.7 million. Payments under the hotel operating agreement, net of debt service receipts, amounted to $530,000 during the year ended December 31, 1995. Payments from Metroplex, including interest at the rate of 9 1\/2% per annum, are due monthly with the remaining principal balance of $13.5 million due May 31, 1996.\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 financial statements filed as part of this report are listed on the Index to Financial Statements on page 24.\n2. FINANCIAL STATEMENT SCHEDULES\n-- Report of Independent Public Accountants -- Schedule I; Condensed Financial Information of Registrant, Pratt Hotel Corporation (Parent Company): -- Balance Sheets -- Statements of Operations -- Statements of Cash Flows -- Notes to Parent Company Financial Statements -- 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 therefore have been omitted.\n3. EXHIBITS\n@3.1 -- Certificate of Incorporation of PHC as amended. (Exhibit 3.1) @3.2 -- Amended Bylaws of PHC. (Exhibit 3.2) +4.1 -- Form of Indenture among PCPI Funding Corp., Pratt Casino Properties and PHC and First Interstate Bank of Dallas as Trustee (including form of Security). (Exhibit 10.4) +4.2 -- First Supplemental Indenture, dated as of February 27,1989, among PCPI Funding Corp., First Interstate Bank of Texas, N.A., PHC and Pratt Casino Properties. (Exhibit 10.11)\n**4.3 -- Indenture dated as of February 15, 1994 between GB Property Funding Corp. as Issuer, GB Holdings, Inc. and GBHC as Guarantors, and Shawmut Bank Connecticut, N.A. as Trustee. (Exhibit 10.50) **4.4 -- Mortgage, Fixture Filing and Security Agreement dated February 17, 1994, by GBHC in favor of Shawmut Bank Connecticut, National Association, as Mortgagee. (Exhibit 10.51) **4.5 -- Security Agreement dated February 17, 1994 made by GB Property Funding Corp., GBHC, GB Holdings, Inc., Advanced Casino Systems International, Inc. Computerized Management Systems International, Inc. and any Additional Collateral Grantor to Shawmut Bank Connecticut, National Association, as Trustee. (Exhibit 10.52) **4.6 -- Collateral Assignment of Leases dated as of February 17, 1994, by GBHC, in favor of Shawmut Bank Connecticut, National, Association, as Assignee. (Exhibit 10.53) **4.7 -- Indenture dated as of February 15, 1994 between PRT Funding Corp. as Issuer, Pratt Casino Corporation as Guarantor and Shawmut Bank, N.A. as Trustee. (Exhibit 10.54) ++9.1 -- Voting Trust Agreement dated as of May 31, 1990 by and between Crystal A. Pratt and Jack E. Pratt. (Exhibit 9.1) ++9.2 -- Voting Interest Trust Agreement dated as of November 9, 1987 between the partners of J.E. Pratt Co. I and William D. Pratt. (Exhibit 9.2) +10.1 -- Management Services Agreement dated August 19, 1987, between Pratt Hotel Management, Inc. (\"PHMI\") and GBHC. (Exhibit 10.1) +10.2 -- Overhead Allocation Agreement, effective as of January 1, 1988, between PHC and PHMI. (Exhibit 10.2) +10.3 -- Amended License Agreement by and between Hughes Properties, Inc. and PHC dated May 19, 1987. (Exhibit 10.3) *10.4 -- Amendment and Restatement of Joint Venture Agreement dated August 1, 1984, between PHC and DeBartolo Hotel Associates. (Exhibit 10.13) *10.5 -- Second Amendment of Joint Venture Agreement of Pratt\/DeBartolo Associates of Orlando dated June 30, 1985 between PHC and DeBartolo Hotel Associates. (Exhibit 10.14) +10.6 -- Joint Operating Agreement dated as of May 31, 1992 between Metroplex Hotel Limited and PHC. (Exhibit 10.14) +10.7 -- Management Agreement between Pratt\/DeBartolo Associates of Orlando and PHC dated May 20, 1983, as amended. (Exhibit 10.15) +10.8 -- Management Agreement by and between Southmark San Juan, Inc., owner, and SJPR Inc., operator, dated September 15, 1987, as amended. (Exhibit 10.16) +10.9 -- Tax Allocation Agreement by and among PHC, PPI Corporation, Greate Bay Hotel Corporation, Pratt Casino Properties, Pacsa No. 2, Inc., Pacsa No. 3, Inc., Pratt Hotel Funding, Inc. and Greate Bay Property Funding Corp., effective as of January 1, 1987. (Exhibit 10.17) +10.10 -- Tax Allocation Agreement by and among Pratt Casino Properties, BPHC Acquisition, Inc., PHMI, Greate Bay Casino Corporation, PCPI Funding Corp. and GBHC effective as of January 1, 1987. (Exhibit 10.18) +10.11 -- Indemnification Agreement dated as of December 17, 1987, by and between PHC and the Pratt Brothers. (Exhibit 10.19) @@10.12 -- Fourth Amendment to Employment Agreement dated January 1, 1996, between HCC and Jack E. Pratt. (Exhibit 10.12) @@10.13 -- Fourth Amendment to Employment Agreement dated January 1, 1996, between HCC and Edward T. Pratt, Jr. (Exhibit 10.13)\n@@10.14 -- Fourth Amendment to Employment Agreement dated January 1, 1996, between HCC and William D. Pratt. (Exhibit 10.14) +++10.15 -- Employment Agreement as amended, dated May 14, 1992, between PHC and William P. Weidner. (Exhibit 10.28) +++10.16 -- Employment Agreement dated May 31, 1992, between GBHC and Bradley H. Stone. (Exhibit 10.29) @@10.17 -- Employment Agreement, as amended, dated November 17, 1995 between GBHC and Leonard M. DeAngelo. (Exhibit 10.15) @@10.18 -- Employment Agreement dated January 1, 1996, between ACSC and Lawrence C. Cole. (Exhibit 10.16) *10.19 -- Management Services Agreement dated as of June 21, 1991, between HCA and GBCC (the \"Management Services Agreement\"). (Exhibit 10.34) *10.20 -- First Amendment to the Management Services Agreement dated as of May 14, 1992. (Exhibit 10.35) *10.21 -- Tax Sharing Agreement dated May 13, 1992, by and among HCC, HCA and PHC. (Exhibit 10.36) *10.22 -- Administrative Services Agreement dated as of May 14, 1992, between HCC and PHC. (Exhibit 10.41) *10.23 -- Technical Services Agreement dated February 21, 1992, between HCA and PHC (the \"Technical Services Agreement\"). (Exhibit 10.42) *10.24 -- First Amendment to the Technical Services Agreement dated May 14, 1992. (Exhibit 10.43) **10.25 -- Agreement of Limited Partnership of Pratt Management, L.P. (Exhibit 10.55) ***10.26 -- Consulting Agreement dated as of January 1, 1994 between PCC, as the Consultant, and HWCC - Tunica, Inc. ***10.27 -- Computer Services Agreement dated as of January 1, 1994 between Summit Tunica Partnership and Advanced Casino Systems Corporation. 21.1 -- Subsidiaries of PHC. 23.1 -- Consent of Arthur Andersen LLP 27.1 -- Financial Data Schedule\n__________\n@ Incorporated by reference from the exhibit shown in parenthesis to PHC's Annual Report on Form 10-K for the fiscal year ended December 31, 1992.\n@@ Incorporated by reference from the exhibit shown in parenthesis to Hollywood Casino Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1995.\n+ Incorporated by reference from the exhibit shown in parenthesis to Form S-1 Registration Statement (Registration No. 33-58732) for Hollywood Casino Corporation as filed with the SEC on May 27, 1993.\n++ Incorporated by reference from the exhibit shown in parenthesis filed in PHC's Annual Report on Form 10-K for the fiscal year ended December 31, 1990.\n+++ Incorporated by reference from the exhibit shown in parenthesis filed in HCC's Registration Statement on Form S-1 (Registration No. 33-48887) as filed with the SEC on September 10, 1992.\n* Incorporated by reference from the exhibit shown in parenthesis to that Registration Statement on Form 10 filed with the SEC on May 28, 1992 by PRT Corporation (now known as HCC).\n** Incorporated by reference from the exhibit shown in parenthesis to Form S-1 Registration Statement (Registration No. 33-77502) for Hollywood Casino Corporation as filed with the SEC on April 8, 1994.\n*** Incorporated by reference from the exhibit shown in parenthesis to Form S-1 Registration Statement (Registration No. 33-82182) for HWCC - Tunica, Inc. as filed with the SEC on September 29, 1994.\n(B) REPORTS ON FORM 8-K.\nPHC did not file any reports on Form 8-K during the quarter ended December 31, 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, in the City of Dallas, State of Texas on March 28, 1996.\nPRATT HOTEL CORPORATION\nBy: \/s\/ Jack E. Pratt ----------------------------- Jack E. Pratt Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant in the capacities and on the dates indicated:\nSIGNATURE TITLE DATE --------- ----- ----\n\/s\/ Jack E. Pratt Chairman of the Board, March 28, 1996 - ------------------------- Chief Executive Jack E. Pratt Officer and Director\n\/s\/ Edward T. Pratt, Jr. Vice Chairman of the March 28, 1996 - ------------------------- Board, Treasurer and Edward T. Pratt, Jr. Director\n\/s\/ Edward T. Pratt III President and Chief March 28, 1996 - ------------------------- Operating Officer Edward T. Pratt III\n\/s\/ William D. Pratt Executive Vice March 28, 1996 - ------------------------- President, Acting General William D. Pratt Counsel, Secretary and Director\n\/s\/ Albert J. Cohen Executive Vice March 28, 1996 - ------------------------- President and Principal Albert J. Cohen Financial Officer\n\/s\/ John C. Hull Corporate Controller March 28, 1996 - ------------------------- John C. Hull\n\/s\/ Bernard A. Capaldi Director March 28, 1996 - ------------------------- Bernard A. Capaldi\n\/s\/ Edward D. Muir Director March 28, 1996 - ------------------------- Edward D. Muir\nINDEX TO FINANCIAL STATEMENT SCHEDULES\nPRATT HOTEL CORPORATION AND SUBSIDIARIES\n-- Report of Independent Public Accountants\n-- Schedule I; Condensed Financial Information of Registrant: -- Balance Sheets -- Statements of Operations -- Statements of Cash Flows -- Notes to Parent Company Financial Statements\n-- Schedule II; Valuation and Qualifying Accounts\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ----------------------------------------\nTo Pratt Hotel Corporation:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements of Pratt Hotel Corporation and subsidiaries included in this Form 10-K and have issued our report thereon dated February 15, 1996. 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 to financial statement schedules are the responsibility of the Company's management and are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic financial statements. These schedules have been subjected to the auditing procedures applied in the 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\nRoseland, New Jersey February 15, 1996\nSCHEDULE I PRATT HOTEL CORPORATION AND SUBSIDIARIES\nCONDENSED FINANCIAL INFORMATION OF REGISTRANT PRATT HOTEL CORPORATION (PARENT COMPANY)\nBALANCE SHEETS ASSETS\nThe accompanying notes to consolidated financial statements are an integral part of this schedule.\nSCHEDULE I PRATT HOTEL CORPORATION AND SUBSIDIARIES\nCONDENSED FINANCIAL INFORMATION OF REGISTRANT PRATT HOTEL CORPORATION (PARENT COMPANY)\nSTATEMENTS OF OPERATIONS\nThe accompanying notes to consolidated financial statements are an integral part of this schedule.\nSCHEDULE I PRATT HOTEL CORPORATION AND SUBSIDIARIES\nCONDENSED FINANCIAL INFORMATION OF REGISTRANT PRATT HOTEL CORPORATION (PARENT COMPANY)\nSTATEMENTS OF CASH FLOWS\nThe accompanying notes to consolidated financial statements are an integral part of this schedule.\nSCHEDULE I PRATT HOTEL CORPORATION AND SUBSIDIARIES CONDENSED FINANCIAL INFORMATION OF REGISTRANT PRATT HOTEL CORPORATION (PARENT COMPANY)\nNOTES TO PARENT COMPANY FINANCIAL STATEMENTS\n(1) SCHEDULED PAYMENTS OF LONG-TERM DEBT\nScheduled payments of long-term debt of the Registrant as of December 31, 1995 are set forth below:\nPratt Hotel Corporation paid interest of $6,635,000, $39,255,000 and $3,702,000, respectively, during the years ended December 31, 1995, 1994 and 1993.\n(2) RECLASSIFICATIONS\nCertain reclassifications have been made to the prior years' condensed financial information of the Registrant to conform such information to the 1995 presentation.\nThe accompanying notes to consolidated financial statements are an integral part of this schedule.\nSCHEDULE II\nPRATT HOTEL CORPORATION AND SUBSIDIARIES\nVALUATION AND QUALIFYING ACCOUNTS\n______________________________\n(1) Represents net write-offs of uncollectible accounts.\n(2) Represents write-offs of obligatory investments in connection with the contribution of certain obligatory investments to the Casino Reinvestment Development Authority.\nThe accompanying notes to consolidated financial statements are an integral part of this schedule.\nINDEX TO EXHIBITS\nSEQUENTIALLY EXHIBIT NUMBERED NUMBER PAGE - ------- -------------\n@3.1 -- Certificate of Incorporation of PHC as amended. (Exhibit 3.1) @3.2 -- Amended Bylaws of PHC. (Exhibit 3.2) +4.1 -- Form of Indenture among PCPI Funding Corp., Pratt Casino Properties and PHC and First Interstate Bank of Dallas as Trustee (including form of Security). (Exhibit 10.4) +4.2 -- First Supplemental Indenture, dated as of February 27, 1989, among PCPI Funding Corp., First Interstate Bank of Texas, N.A., PHC and Pratt Casino Properties. (Exhibit 10.11) **4.3 -- Indenture dated as of February 15, 1994 between GB Property Funding Corp. as Issuer, GB Holdings, Inc. and GBHC as Guarantors, and Shawmut Bank Connecticut, N.A. as Trustee. (Exhibit 10.50) **4.4 -- Mortgage, Fixture Filing and Security Agreement dated February 17, 1994, by GBHC in favor of Shawmut Bank Connecticut, National Association, as Mortgagee. (Exhibit 10.51) **4.5 -- Security Agreement dated February 17, 1994 made by GB Property Funding Corp., GBHC, GB Holdings, Inc., Advanced Casino Systems International, Inc. Computerized Management Systems International, Inc. and any Additional Collateral Grantor to Shawmut Bank Connecticut, National Association, as Trustee. (Exhibit 10.52) **4.6 -- Collateral Assignment of Leases dated as of February 17, 1994, by GBHC, in favor of Shawmut Bank Connecticut, National Association, as Assignee. (Exhibit 10.53) **4.7 -- Indenture dated as of February 15, 1994 between PRT Funding Corp. as Issuer, Pratt Casino Corporation as Guarantor and Shawmut Bank, N.A. as Trustee. (Exhibit 10.54) ++9.1 -- Voting Trust Agreement dated as of May 31, 1990 by and between Crystal A. Pratt and Jack E. Pratt. (Exhibit 9.1) ++9.2 -- Voting Interest Trust Agreement dated as of November 9, 1987 between the partners of J.E. Pratt Co. I and William D. Pratt. (Exhibit 9.2) +10.1 -- Management Services Agreement dated August 19, 1987, between Pratt Hotel Management, Inc. (\"PHMI\") and GBHC. (Exhibit 10.1) +10.2 -- Overhead Allocation Agreement, effective as of January 1, 1988, between PHC and PHMI. (Exhibit 10.2) +10.3 -- Amended License Agreement by and between Hughes Properties, Inc. and PHC dated May 19, 1987. (Exhibit 10.3)\nSEQUENTIALLY EXHIBIT NUMBERED NUMBER PAGE - ------- -------------\n*10.4 -- Amendment and Restatement of Joint Venture Agreement dated August 1, 1984, between PHC and DeBartolo Hotel Associates. (Exhibit 10.13) *10.5 -- Second Amendment of Joint Venture Agreement of Pratt\/DeBartolo Associates of Orlando dated June 30, 1985 between PHC and DeBartolo Hotel Associates. (Exhibit 10.14) +10.6 -- Joint Operating Agreement dated as of May 31, 1992 between Metroplex Hotel Limited and PHC. (Exhibit 10.14) +10.7 -- Management Agreement between Pratt\/DeBartolo Associates of Orlando and PHC dated May 20, 1983, as amended. (Exhibit 10.15) +10.8 -- Management Agreement by and between Southmark San Juan, Inc., owner, and SJPR Inc., operator, dated September 15, 1987, as amended. (Exhibit 10.16) +10.9 -- Tax Allocation Agreement by and among PHC, PPI Corporation, Greate Bay Hotel Corporation, Pratt Casino Properties, Pacsa No. 2, Inc., Pacsa No. 3, Inc., Pratt Hotel Funding, Inc. and Greate Bay Property Funding Corp., effective as of January 1, 1987. (Exhibit 10.17) +10.10 -- Tax Allocation Agreement by and among Pratt Casino Properties, BPHC Acquisition, Inc., PHMI, Greate Bay Casino Corporation, PCPI Funding Corp. and GBHC effective as of January 1, 1987. (Exhibit 10.18) +10.11 -- Indemnification Agreement dated as of December 17, 1987, by and between PHC and the Pratt Brothers. (Exhibit 10.19) @@10.12 -- Fourth Amendment to Employment Agreement dated January 1, 1996, between HCC and Jack E. Pratt. (Exhibit 10.12) @@10.13 -- Fourth Amendment to Employment Agreement dated January 1, 1996, between HCC and Edward T. Pratt, Jr. (Exhibit 10.13) @@10.14 -- Fourth Amendment to Employment Agreement dated January 1, 1996, between HCC and William D. Pratt. (Exhibit 10.14) +++10.15 -- Employment Agreement as amended, dated May 14, 1992, between PHC and William P. Weidner. (Exhibit 10.28) +++10.16 -- Employment Agreement dated May 31, 1992, between GBHC and Bradley H. Stone. (Exhibit 10.29) @@10.17 -- Employment Agreement, as amended, dated November 17, 1995 between GBHC and Leonard M. DeAngelo. (Exhibit 10.15) @@10.18 -- Employment Agreement dated January 1, 1996, between ACSC and Lawrence C. Cole. (Exhibit 10.16)\nSEQUENTIALLY EXHIBIT NUMBERED NUMBER PAGE - ------- -------------\n*10.19-- Management Services Agreement dated as of June 21, 1991, between HCA and GBCC (the \"Management Services Agreement\"). (Exhibit 10.34) *10.20-- First Amendment to the Management Services Agreement dated as of May 14, 1992. (Exhibit 10.35) *10.21-- Tax Sharing Agreement dated May 13, 1992, by and among HCC, HCA and PHC. (Exhibit 10.36) *10.22-- Administrative Services Agreement dated as of May 14, 1992, between HCC and PHC. (Exhibit 10.41) *10.23-- Technical Services Agreement dated February 21, 1992, between HCA and PHC (the \"Technical Services Agreement\"). (Exhibit 10.42) *10.24-- First Amendment to the Technical Services Agreement dated May 14, 1992. (Exhibit 10.43) **10.25-- Agreement of Limited Partnership of Pratt Management, L.P. (Exhibit 10.55) ***10.26-- Consulting Agreement dated as of January 1, 1994 between PCC, as the Consultant, and HWCC - Tunica, Inc. ***10.27-- Computer Services Agreement dated as of January 1, 1994 between Summit Tunica Partnership and Advanced Casino Systems Corporation. 21.1 -- Subsidiaries of PHC. 23.1 -- Consent of Arthur Andersen LLP 27.1 -- Financial Data Schedule _______________________\n@ Incorporated by reference from the exhibit shown in parenthesis to PHC's Annual Report on Form 10-K for the fiscal year ended December 31, 1992.\n@@ Incorporated by reference from the exhibit shown in parenthesis to Hollywood Casino Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1995.\n+ Incorporated by reference from the exhibit shown in parenthesis to Form S-1 Registration Statement (Registration No. 33-58732) for Hollywood Casino Corporation as filed with the SEC on May 27, 1993.\n++ Incorporated by reference from the exhibit shown in parenthesis filed in PHC's Annual Report on Form 10-K for the fiscal year ended December 31, 1990.\n+++ Incorporated by reference from the exhibit shown in parenthesis filed in HCC's Registration Statement on Form S-1 (Registration No. 33-48887) as filed with the SEC on September 10, 1992.\nSEQUENTIALLY EXHIBIT NUMBERED NUMBER PAGE - ------- -------------\n* Incorporated by reference from the exhibit shown in parenthesis to that Registration Statement on Form 10 filed with the SEC on May 28, 1992 by PRT Corporation (now known as HCC).\n** Incorporated by reference from the exhibit shown in parenthesis to Form S-1 Registration Statement (Registration No. 33-77502) for Hollywood Casino Corporation as filed with the SEC on April 8, 1994.\n*** Incorporated by reference from the exhibit shown in parenthesis to Form S-1 Registration Statement (Registration No. 33-82182) for HWCC - Tunica, Inc. as filed with the SEC on September 29, 1994.","section_15":""}
{"filename":"87588_1995.txt","cik":"87588","year":"1995","section_1":"Item 1. Business.\nGeneral\nSchultz Sav-O Stores, Inc. (\"Company\") is engaged in distributing food and related products at wholesale and retail. As of December 30, 1995, the Company franchised 66 and owned 19 retail supermarkets under the Piggly Wiggly\/R\/ name in its Eastern Wisconsin and Northeastern Illinois market area. While the Company has a presence in some larger metropolitan areas, it has attempted to develop a niche for serving the food shopping needs of customers in smaller and suburban communities within its market areas.\nThe Company is the primary supplier to its 85 franchised and corporate owned Piggly Wiggly supermarkets. The Company also serves as a wholesaler to a number of small, independently operated retail supermarkets in its market area.\nThe Company supplies a variety of products to its franchised and corporate supermarkets and other wholesale customers primarily from its warehouse and distribution center in Sheboygan, Wisconsin. The Company also provides its franchised and corporate supermarkets and other customers with fresh, frozen and processed meat, eggs and deli products from a third-party distribution facility in Milwaukee, Wisconsin on a contract basis. Additionally, the Company bottles carbonated soft drinks, fruit drinks and drinking and distilled water under its Springtime label and supplies these products to its franchised and corporate supermarkets and other wholesale customers.\nThe Company is a Wisconsin corporation organized in 1912.\nWholesale Operations\nFor several years the Company has been emphasizing its more profitable wholesale distribution business and the associated expansion of its franchise store base, while also effecting changes to its corporate retail operations to improve profitability. As part of implementing this corporate strategy, the Company has sold and converted 11 underperforming corporate retail supermarkets into franchise units and added 12 new replacement or new market franchise supermarkets since 1991. In 1995, there were 7 franchise expansion projects in process, resulting in 6 completed expansions and 1 expansion that will be completed in early 1996. Additionally, in 1995, 3 replacement stores were completed and 3 replacement stores are expected to be completed in 1996. Finally, in 1995, 1 new market franchise unit was completed and 2 new market franchise units are projected to be completed in 1996. These expansion, replacement and new market franchise projects added approximately 98,000 square feet of store space in 1995, and are projected to add approximately 87,000 square feet in 1996 if all scheduled projects are completed.\nThe following table shows the Company's development of, and changes in, its franchised and corporate retail supermarkets for the periods presented:\nDuring 1995, the Company established new earnings records, but sales decreased from the previous year. The increase in earnings was principally the result of continued improvements in the Company's wholesale operations, where the lower gross margins associated with wholesale sales were offset by the decreased operating and administrative expenses associated with previously sold retail operations.\nThe Company believes one of the competitive advantages it provides to its franchised supermarkets is its value-oriented customer merchandising and community-specific marketing support program, pursuant to which franchisees participate with corporate stores in systemwide promotions and other merchandising events. Through a variety of partnering, merchandising and marketing programs, the Company benefits its franchisees through additional sales resulting from heightened consumer name recognition and in-store merchandising programs, combined with special promotional pricing. Additional services include retail accounting, preparation of store payrolls, preparation of print, electronic and outdoor media advertising (including various point-of-sale materials), assistance in the selection and analysis of store locations, lease negotiations, store design, floor layout, merchandising planning, equipment selection, engineering and architectural services, retail technology implementation and support, labor planning and scheduling and product category supervision. Certain of such services are provided as part of the franchise relationship, and other services are provided for a separate fee intended to cover the Company's costs.\nTo maintain and improve its ability to be a low-cost supplier, in 1995 the Company installed a new computer-assisted buying system, implemented a truck routing system and installed on-board truck computers.\nThe Company is the primary supplier to all of its franchised and corporate supermarkets. The Company is also a wholesaler to a number of small, independently operated retail supermarkets in its market area, although less than 3% of the Company's 1995 net sales was derived from such operations. The volume provided by the Company's wholesale operations benefits its retail operations by enhancing the Company's purchasing power and enabling it to improve the efficiency of its distribution system.\nFranchisees pay fees to the Company determined by the retail sales of their supermarkets. The Company does not charge an initial fee to the franchisee for granting a franchise. Consistent with industry practice, in certain situations, the Company provides credit enhancements to certain qualified franchisees by (i) leasing the franchisee's supermarket premises and\/or equipment and, in turn, subleasing the premises and\/or equipment to the franchisee and\/or (ii) guaranteeing a portion of the franchisee's bank borrowings.\nThe Company owns the right to grant Piggly Wiggly franchises in its market areas, which includes designated counties in Eastern Wisconsin, Northeastern Illinois and the Upper Peninsula of Michigan. The Company's right to grant franchises is exclusive in these areas, except that if there are less than 40 supermarkets in the franchise territory operated under the Piggly Wiggly and certain other names, the current franchisor has the right to operate for its own account, or to franchise, supermarkets in the territory under those names. As of December 30, 1995, there were 85 supermarkets operated in the Company's territory that satisfied this requirement. The Company's franchise rights are of unlimited duration and are not subject to any specific termination provision. The Company is not required to pay any additional franchise or other fees to the current franchisor. The only material obligation imposed on the Company is that the supermarkets operated under the Piggly Wiggly and other names must comply with the standards imposed on supermarkets in the Piggly Wiggly system. The Company believes its own franchised and corporate store standards exceed the Piggly Wiggly system standards.\nRetail Operations\nDuring 1995, a number of the Company's corporate retail stores continued not to meet financial performance goals. The Company closed its underperforming Palatine, Illinois corporate supermarket in February 1995. In order to improve the Company's results of operations, the Company continues to evaluate various business alternatives relating to these underperforming operations, including the sale and subsequent conversion of these stores into franchise units, closing the stores or implementing other operational changes.\nThe Company's franchised and corporate supermarkets stock a comprehensive selection of groceries, frozen foods, prepared foods, fresh produce, meat, poultry, eggs and dairy products. The Company's franchised and corporate supermarkets also allocate display space to non-food items, such as health and beauty aids, housewares, periodicals, video cassette rentals, flowers and plants, greeting cards and general merchandise. The Company's franchised and corporate supermarkets carry a broad range of branded merchandise and private label product alternatives to branded merchandise. In general, the private label products carried by the Company's franchised and corporate supermarkets have lower selling prices, but higher gross profit margins, than branded merchandise. Consistent with trends generally within the industry, the Company continues to experience increases in retail customer demand for private label store brands and believes its Topco line of private label products is satisfying this consumer trend. See \"Purchasing and Distribution.\" Pricing differentials between 1995 and 1994 did not materially effect net sales.\nIn 1995, the Company introduced the Piggly Wiggly Preferred Club Card\/R\/, a new customer-friendly card-based marketing program. The Piggly Wiggly Preferred Club Card is intended to reward current customers and attract new customers by offering \"clipless coupons\" on weekly advertised specials and \"automatic\" savings on monthly store specials. The card also doubles as a check-cashing and video rental identification card. Initial test results have been very favorable for the Company's retail stores, and 11 of the Company's corporate and franchise stores are already operating with the program, with 54 additional stores currently planned for installation in 1996. The program was developed by the Company's Marketing and Retail Technology Groups and the Company currently plans to install the program in all of its corporate and franchise stores.\nThe Company's franchised supermarkets range in size from 8,340 square feet to 47,000 square feet, with an average of 23,720 square feet. The Company's corporate supermarkets range in size from 14,900 square feet to 46,250 square feet, with an average of 29,600 square feet. All of the Company's franchised and corporate supermarkets contain several perishable or specialty service departments, such as fresh and processed meat; take- home entrees and snacks; produce; fresh seafood; delicatessen; flowers and plants; and baked goods. A number of supermarkets also contain or provide for one or more of the following: wine and spirit sales; video rentals; TicketMaster\/R\/ ticket centers; in-house banking services; automated teller machines; and on-line debit and credit card check-out services.\nPurchasing and Distribution\nThe Company purchases groceries in sufficient volume to qualify for favorable price brackets for most items. The Company purchases brand name grocery merchandise directly from the manufacturers or processors and purchases substantially all of its private label items through Topco Associates, Inc. (\"Topco\"). The Company purchases produce, meat and seafood from a variety of sources. Topco is a national purchasing cooperative whose member-owners consist of 42 regional supermarket chains who collectively operate approximately 3,500 stores. According to Topco data, its member-owners accounted for approximately 14% of United States grocery store sales volume in 1995. In 1995, purchases through Topco accounted for approximately 14% of the Company's total inventory purchases. The Company also purchases store and warehouse equipment and supplies, primarily bags and packaging material, through Topco. Topco's size and purchasing power enable it to employ large-volume, low-cost purchasing techniques on behalf of its member-owners, including the Company.\nApproximately 77% of the products supplied to the Company's stores in 1995 were supplied from the Company and its direct contract third-party distribution centers. The remainder were supplied by direct store delivery vendors. The Company owns its 364,000 square foot warehouse and distribution center in Sheboygan, Wisconsin. With the exception of fresh, frozen and processed meat, eggs and deli products, all products supplied by the Company are distributed from its Sheboygan facility. While the Company performs the buying function, a third-party contractor in Milwaukee, Wisconsin performs the warehousing and transportation for the Company's meat operations. The Company believes this arrangement has provided it with operating cost efficiencies and has enabled it to expand its wholesale product offerings and better satisfy wholesale customer delivery schedules through improved capacity.\nAs described above under \"Wholesale Operations,\" the Company believes one of its competitive advantages is its community-oriented marketing programs. High visibility outdoor billboard advertising stress the value and customer service provided by the Company's local Piggly Wiggly supermarkets. The Company also sponsors local events and festivals throughout the marketing area to improve its Piggly Wiggly name recognition, such as the Midwest's largest fireworks display at Milwaukee's Summerfest lakefront music festival.\nThe Company operates a leased, full service trucking fleet, which consists of 25 tractors, 40 refrigerated trailers and 6 dry trailers. The Company augments its transportation requirements with temporary leasing arrangements as conditions warrant. On January 1, 1996, the Company formed PW Trucking, Inc., a wholly-owned subsidiary, to provide contract and common carrier services throughout a seven-state Midwest territory for the Company and other companies. Revenues from unrelated parties generated by this business are expected to be nominal in 1996.\nBottling Operations\nThe Company bottles carbonated soft drinks, fruit drinks and drinking and distilled water under its Springtime label. The Company also bottles soft drinks for several regional beverage distributors on a contract basis. The Company supplies these products to its franchised and corporate supermarkets and independent supermarket customers. The Company's bottling facility occupies approximately 5,000 square feet within its Sheboygan warehouse and distribution center. The sale of these products accounted for less than 1% of the Company's 1995 net sales.\nCompetition\nThe wholesale and retail food industry is highly competitive. At the wholesale level, the Company competes with regional and national wholesalers, such as Fleming Companies, Inc., SuperValu Inc., Roundy's, Inc. and Nash Finch Co. In addition to price, product quality and variety, competitive factors include credit support to customers and the provision of various support services, such as advertising; accounting and financial services; merchandising; facilities engineering, design and project management; and retail technology support. The Company believes that the location of its Sheboygan warehouse and distribution facility and the wide range of support and marketing services provided to its franchised and corporate retail supermarkets allow it to provide prompt and efficient low-priced, high-quality products and important supplemental services to its franchised and corporate supermarkets and other customers.\nThe degree of competition at the retail level varies with store location. In most of its franchised and corporate supermarket locations, the Company competes primarily with local retail operators, virtually all of whom are affiliated with competing wholesalers through arrangements similar to the Company's franchisees. In its remaining supermarket locations, the Company competes with national and regional retail chain stores, such as Sentry Food Stores, Pick 'N Save, Cub Foods, Jewel Food Stores, Dominicks Finer Foods, Copp's Supermarkets and Kohl's Food Stores. Other competitors include the general merchandise, wholesale club and supercenter format stores of Wal-Mart Stores, Inc., K Mart Corp. and ShopKo. Principal retail competitive factors include price, product quality and variety, store location and appearance and the extent of a store's perishable product and service departments. The Company believes its supermarkets' emphasis on low-cost, high-quality products, community- based multi-media marketing and merchandising programs and a high degree of in-store customer service and friendliness provide its franchised and corporate supermarkets with a competitive advantage in many of their retail market areas.\nCertain of the Company's competitors at both the wholesale and retail level may have a competitive advantage resulting from utilizing lower-cost, non-union workforces. Certain of the Company's competitors have greater financial resources and marketing budgets than the Company. Also, certain competitors using the general merchandise, wholesale club format or supercenter format may choose to carry and market a less extensive variety of products for which they may choose to sell such items at a lower per unit cost than the Company.\nEmployees\nAs of December 30, 1995, the Company employed approximately 1,600 persons, of whom approximately 1,150 were employed in the operation of the Company's corporate retail supermarkets. A majority of the Company's corporate retail employees are employed on a part-time basis. Of the Company's remaining employees, approximately 225 are engaged in warehousing and trucking activities and the remainder are corporate and administrative personnel. The Company is currently negotiating new collective bargaining agreements covering approximately 75 retail clerks and meat cutters to replace agreements that expired in November 1995. The Company and employees are continuing to operate under the terms of the expired contract while the new contract is negotiated. Four separate collective bargaining agreements covering approximately 120 total retail clerks and meat cutters expire at different times throughout 1996. The Company's collective bargaining agreement covering the approximately 225 warehouse and trucking employees at its Sheboygan distribution facility expires in February 1997. The Company does not currently anticipate any strikes, work stoppages or slowdowns in connection with renewing such agreements.\nItem 1A.","section_1A":"Item 1A. Executive Officers of the Company.\nPositions and Offices with the Name and Age Company\nJames H. Dickelman, 48 . . . . Chairman of the Board, President and Chief Executive Officer\nJohn H. Dahly, 55 . . . . . . . Executive Vice President, Chief Financial Officer, Treasurer and Secretary\nMichael R. Houser, 44 . . . . . Senior Vice President--Marketing and Merchandising\nWilliam K. Jacobson, 45 . . . . Senior Vice President--Retail Operations\nKenneth S. Folberg, 35 . . . . Vice President--Logistics\nLarry D. Hayes, 53 . . . . . . Vice President--Meat, Bakery and Deli Operations\nJohn S. Kwas, 56 . . . . . . . Vice President--Grocery Procurement\nThomas J. Timler, 38 . . . . . Vice President--Business Systems Support Group\nFrank D. Welch, 55 . . . . . . Vice President--Engineering and Assistant Secretary\nMessrs. Dickelman, Dahly, Houser and Jacobson are also members of the Company's Board of Directors.\nExecutive officers are generally elected annually at the annual meeting of the Board of Directors held on the date of the Company's annual meeting of shareholders. Each executive officer holds office until his successor has been elected or until his prior death, resignation or removal.\nAll of the Company's executive officers have served in the positions indicated or in other management positions with the Company for more than the last five years.\nThomas H. Fox, formerly Senior Vice President--Director of Retail Operations and Robert A. Hobart, formerly Vice President--Director of Management Information Services, retired from the Company in March and January 1996, respectively.\nItem 2.","section_1B":"","section_2":"Item 2. Properties.\nAs is customary in the Company's industry, a substantial portion of the Company's capital assets are leased. As of December 30, 1995, the Company leased 17 of its corporate supermarkets and owned 2 supermarkets. The leased supermarkets range in size from 14,900 to 41,200 square feet, with an average of 29,060 square feet.\nThe Company generally leases its supermarkets from nonaffiliated real estate developers under long-term leases. Such leases generally contain initial terms of 15 to 20 years with several five-year renewal options. None of such existing lease arrangements contain Company repurchase options nor is the land underlying any of such supermarkets owned by the Company. No leases are scheduled to expire in 1996. As of December 30, 1995, the Company subleased 47 of its leased supermarkets, and leased 2 owned supermarkets, to independent operators who are wholesale customers of the Company and, except for one, are also franchisees.\nRenovations and expansions continue at 3 franchise retail operations. These renovations involve 1 addition to an existing franchise store, and 2 replacement franchise units. Additionally, two new market franchise retail operations are expected to be completed in 1996. These projects are expected to add approximately 49,000 square feet of store space.\nThe Company owns its warehouse\/distribution center and headquarters complex in Sheboygan, Wisconsin which occupies approximately nine acres of a 16-acre site owned by the Company. The facility provides approximately 30,500 square feet of space for offices and related activities, approximately 364,000 square feet of warehouse space and approximately 5,000 square feet for the Company's bottling facility. The Company also leases approximately 4,500 square feet of office space in Sheboygan under a five-year lease expiring at the end of 1997, which is used for customer support services.\nThe Company owns approximately 22 acres of commercially zoned property in two Wisconsin communities. The Company has entered into brokerage arrangements for the development and sale of these properties.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nThere are no material legal proceedings to which the Company is a party or to which any of its property is subject, other than ordinary routine litigation incidental to the Company's business. No material legal proceedings were terminated during the fourth quarter of 1995.\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 during the fourth quarter of 1995.\nPART II\nItem 5.","section_5":"Item 5. Market for the Company's Common Stock and Related Shareholder Matters.\nPursuant to General Instruction G to Form 10-K (\"Instruction G\"), the information required by this Item is incorporated herein by reference from information included under the caption entitled \"Company Business\" set forth in the Company's 1995 Annual Report to Shareholders (\"Annual Report\").\nItem 6.","section_6":"Item 6. Selected Financial Data.\nPursuant to Instruction G, the information required by this Item is incorporated herein by reference from information included under the caption entitled \"Selected Five-Year Financial Highlights\" set forth in the Annual Report.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nPursuant to Instruction G, the information required by this Item is incorporated herein by reference from information included under the caption entitled \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" set forth in the Annual Report.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nPursuant to Instruction G, the Balance Sheets of the Company as of December 30, 1995 and December 31, 1994, the Statements of Shareholders' Investment, Earnings and Cash Flows for each of the three fiscal years in the period ended December 30, 1995, together with the related Notes to Financial Statements (including supplementary financial data), are incorporated herein by reference from information included under the captions having substantially the same titles as set forth in 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 Company.\nPursuant to Instruction G, the information required by this Item (other than such information regarding executive officers which appears in Item 1A hereof and information required by Item 405 of Regulation S-K, which is inapplicable) is incorporated by reference from information included under the caption entitled \"Election of Directors\" set forth in the Company's definitive Proxy Statement for its 1995 annual meeting of shareholders (\"Proxy Statement\").\nItem 11.","section_11":"Item 11. Executive Compensation.\nPursuant to Instruction G, the information required by this Item is incorporated by reference from information included under the caption entitled \"Executive Compensation\" set forth in the Proxy Statement.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nPursuant to Instruction G, the information required by this Item is incorporated by reference from information included under the captions entitled \"Principal Shareholders\" and \"Election of Directors\" set forth in the Proxy Statement.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nPursuant to Instruction G, the information required by this Item is incorporated by reference from information under the caption entitled \"Compensation and Stock Option Committee Interlocks and Insider Participation\" set forth in the Proxy Statement.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.\n(a) The following documents are filed as a part of this Form 10-K:\nPage Reference Page 1995 Annual Reference Report 1. Financial Statements. Form 10-K to Shareholders\nBalance Sheets as of December 30, 1995 and December 31, 1994 -- 10-11 Statements of Shareholders' Investment, Earnings and Cash Flows for the fiscal years 1995, 1994 and 1993 -- 10-12\nNotes to Financial Statements -- 13-19\nReport of Independent Public Accountants -- 23\nThe additional information referred to under \"Financial Statement Schedules\" below is filed as part of this Form 10-K and should be read in conjunction with the financial statements referred to above.\n2. Financial Statement Schedules.\nReport of Independent Public -- Accountants Schedule VIII - Valuation and -- Qualifying Accounts and Reserves\nAll other schedules have been omitted as not required or not applicable or the information required to be shown thereon is included in the financial statements and related notes.\n3. Exhibits.\n(a) The Exhibits filed or incorporated by reference herewith are as specified in the Exhibit Index included herein.\n(b) No reports on Form 8-K were filed by the Company during the fourth quarter of 1995.\nSIGNATURES\nPursuant to the requirements 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.\nSCHULTZ SAV-O STORES, INC.\nDate: March 22, 1996 By \/s\/ John H. Dahly John H. Dahly 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 on behalf of the Company in the capacities indicated as of the date indicated above.\n\/s\/ James H. Dickelman \/s\/ Bernard S. Kubale James H. Dickelman, Chairman of Bernard S. Kubale, Director Board, President, Chief Executive Officer and Director (Principal Executive Officer)\n\/s\/ John H. Dahly \/s\/ Martin Crneckiy, Jr. John H. Dahly, Executive Vice Martin Crneckiy, Jr., Director President, Chief Financial Officer and Director (Principal Financial and Accounting Officer)\n\/s\/ Howard C. Dickelman \/s\/ R. Bruce Grover Howard C. Dickelman, Director R. Bruce Grover, Director\n\/s\/ William K. Jacobson \/s\/ Michael R. Houser William K. Jacobson, Director Michael R. Houser, Director\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULES\nTO SCHULTZ SAV-O STORES, INC.:\nWe have audited in accordance with generally accepted auditing standards, the financial statements included in Schultz Sav-O Stores, Inc.'s annual report to shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated February 7, 1996. Our audit was made for the purpose of forming an opinion on those statements taken as a whole. The schedule listed in the index to financial statements is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\nARTHUR ANDERSEN LLP\nMilwaukee, Wisconsin February 7, 1996.\nSCHULTZ SAV-O STORES, INC.\nSCHEDULE VIII--VALUATION AND QUALIFYING ACCOUNTS AND RESERVES\nFOR THE FISCAL YEARS 1995, 1994 AND 1993\nAllowance for Doubtful Accounts--\nChanges in the allowance for doubtful accounts are summarized as follows:\n1995 1994 1993\nBalance, beginning of year $1,750,000 $1,750,000 $3,050,000 Provision charged to earnings 2,079,000 526,000 4,143,000 (Writeoffs), net of recoveries (1,264,000) (526,000) (5,443,000) ---------- ---------- ---------\nBalance, end of year $2,565,000 $1,750,000 $1,750,000 ========= ========= ==========\nEXHIBIT INDEX\nSCHULTZ SAV-O STORES, INC. ANNUAL REPORT ON FORM 10-K\nFOR THE FISCAL YEAR ENDED DECEMBER 30, 1995\nExhibit No. Description\n3.1 Restated Articles of Incorporated, as amended. [Incorporated by reference to Exhibit 3.2 to the Company's Annual Report on Form 10-K for the year ended December 31, 1988.]\n3.2 By-Laws, as amended and restated as of January 24, 1991. [Incorporated by reference to Exhibit 3.2 to the Company's Annual Report on Form 10-K for the year ended December 29, 1990.]\n4.1 Restated Articles of Incorporation, as amended (included as Exhibit 3.1). [Incorporated by reference to Exhibit 4.2 to the Company's Annual Report on Form 10-K for the year ended December 31, 1988.]\n4.2 Rights Agreement dated December 20, 1988 between the Company and First Bank (N.A.), Milwaukee, Wisconsin. [Incorporated by reference to Exhibit 4 to the Company's Current Report on Form 8-K dated December 21, 1988.]\n4.3 Amendment to Rights Agreement dated February 2, 1989 between the Company and First Bank (N.A.), Milwaukee, Wisconsin. [Incorporated by reference to Exhibit 2 to the Company's Form 8 dated February 20, 1989.]\n4.4 Letter dated June 30, 1992 constituting appointment of Firstar Trust Company (f\/k\/a First Wisconsin Trust Company) as the successor rights agent under the Rights Agreement dated December 20, 1988, as amended. [Incorporated by reference to Exhibit 4.4 to the Company's Annual Report on Form 10-K dated March 31, 1994.] As summarized in Notes (3) and (8) of the Notes to Financial Statements incorporated by reference from the Company's 1995 Annual Report to Shareholders, as part of Parts II and IV of this Form 10-K, the Company has various outstanding long-term debt and capital lease obligations. None of such obligations individually exceeds 10% of the Company's total assets. The Company hereby agrees to furnish to the Commission, upon its request, a copy of each instrument with respect to such obligations.\n10.1 Master Franchise Agreement, dated April 23, 1982, between Commodores Point Terminal Corporation and Piggly Wiggly Corporation. [Incorporated by reference to Exhibit 10.1 to the Company's Annual Report on Form 10-K for the year ended January 1, 1982.]\n10.2 Agreement, dated August 1, 1982, between the Company and Commodores Point Terminal Corporation. [Incorporated by reference to Exhibit 10.2 to the Company's Annual Report on Form 10-K for the year ended January 1, 1982.]\n10.3 Amendment to Master Franchise Agreement, dated October 15, 1982, between the Company and Piggly Wiggly Corporation. [Incorporated by reference to Exhibit 10.3 to the Company's Annual Report on Form 10-K for the year ended January 1, 1982.]\n10.4 Form of Director\/Officer Indemnity Agreement. [Incorporated by reference to Exhibit 10.4 to the Company's Annual Report on Form 10-K for the year ended January 2, 1988.] This Agreement is required to be filed as an exhibit to this Form 10-K pursuant to Item 14(c) of Form 10-K.\n10.5 Form of Key Executive Employment and Severance Agreement, dated as of October 19, 1990, between the Company and each of James H. Dickelman, John H. Dahly, and Michael R. Houser, and dated as of January 31, 1996, between the Company and William K. Jacobson. [Incorporated by reference to Exhibit 10.5 to the Company's Annual Report on Form 10-K for the year ended December 29, 1990.] This Agreement is required to be filed as an exhibit to this Form 10-K pursuant to Item 14(c) of Form 10-K.\n10.6 Membership and Licensing Agreement dated August 1, 1973 by and between Topco Associates, Inc. (Cooperative) and the Company\n10.7 Articles of Incorporation of Topco Associates, Inc. (Cooperative). [Incorporated by reference to Exhibit 10.12 to the Company's Annual Report on Form 10-K for the year ended December 31, 1988.]\n10.8 Bylaws of Topco Associates, Inc. (Cooperative), as amended through June 7, 1995.\n10.9 1990 Stock Option Plan, as amended as of March 17, 1993. [Incorporated by reference to exhibit 10.10 to the Company's Annual Report on Form 10- K for the year ended January 2, 1993.] This Plan is required to be filed as an exhibit to this Form 10-K pursuant to Item 14(c) of Form 10-K.\n10.10 1995 Equity Incentive Plan. [Incorporated by reference to Exhibit 10.9 to the Company's Annual Report on Form 10-K for the year December 31, 1994.] This Plan is required to be filed as an exhibit to this Form 10-K pursuant to Item 14(c) of Form 10-K.\n10.11 Schultz Sav-O Stores, Inc. Executive Benefit Restoration Plan. [Incorporated by reference to Exhibit 10.10 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994.] This Plan is required to be filed as an exhibit to this Form 10-K pursuant to Item 14(c) of Form 10-K.\n10.12 Schultz Sav-O Stores, Inc. Officer Annual Incentive Plan. [Incorporated by reference to Exhibit 10.11 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994.] This Plan is required to be filed as an exhibit to this Form 10-K pursuant to Item 14(c) of Form 10-K.\n13 Portions of the 1995 Annual Report to Shareholders expressly incorporated by reference into this Form 10-K.\n23 Consent of Independent Public Accountants.\n27 Financial Data Schedule (EDGAR version only).\n99 Definitive Proxy Statement for 1995 Annual Meeting of Shareholders (filed with the Commission under Regulation 14A and incorporated by reference herein to the extent indicated in this Form 10-K).","section_15":""}
{"filename":"814050_1995.txt","cik":"814050","year":"1995","section_1":"ITEM 1. BUSINESS\nINTRODUCTION\nEcogen Inc. (\"Ecogen\" or the \"Company\"), a Delaware corporation incorporated in 1983, is a biotechnology company specializing in the development and marketing of environmentally compatible products for the control of pests in agricultural and related markets. Ecogen's product revenues are generated by sales of biological insecticides derived from the bacterial microorganism Bacillus thuringiensis (\"Bt\") and various pest control and crop pollination products based on pheromone and related technologies. In addition, Ecogen is introducing to the marketplace biofungicide products for the control of powdery mildew and post harvest rot disease. Ecogen also sells into certain niche markets insecticidal nematodes (microscopic roundworms) for the control of insect pests. Ecogen was the first company to sell genetically enhanced biological pesticide products which are registered with the U.S. Environmental Protection Agency (the \"EPA\") for commercial sale. In addition, Ecogen is the only company to have received an EPA approval to sell a Bt insecticide incorporating a recombinant Bt strain.\nOn January 24, 1996 the Company entered into a strategic alliance with Monsanto Company for the joint development of Bt technology. As part of the transaction, Monsanto agreed to purchase a 13% interest in the Company for $10 million, acquired certain rights with respect to Ecogen's Bt technology for $5 million and agreed to fund a four-year $10 million research and development program.\nOn December 28, 1994, the Company changed its fiscal year end from December 31 to October 31 so that its fiscal year would better conform to the agricultural growing season in its primary markets. Unless the context otherwise requires, all references in this document to the year 1995 shall mean fiscal year 1995 beginning on November 1, 1994 and ending on October 31, 1995, and all references to the fiscal 1994 shall mean the ten months beginning on January 1, 1994 and ending on October 31, 1994.\nREVERSE STOCK SPLIT\nOn January 29, 1996, the stockholders of the Company approved an amendment to the Company's Certificate of Incorporation that effected a one-for-five reverse stock split of the Company's outstanding Common Stock (the \"Reverse Split\"). As a result of the Reverse Split, the outstanding shares of Common Stock of the Company were reduced from approximately 30,109,000 to 6,022,000. All references in this document to shares of Common Stock take into account the effect of the Reverse Split unless the context otherwise requires.\nUpon the effectiveness of the Reverse Split, each certificate representing shares of Common Stock outstanding immediately prior to the Reverse Split (the \"Old Shares\") was deemed automatically, to represent one fifth the number of shares of Common Stock (the \"New Shares\"). A stockholder's proportionate ownership interest in the Company remained unchanged by the Reverse Split. The New Shares issued pursuant to the Reverse Split were fully paid and nonassessable. The voting and other rights of the Common Stock were not altered. The authorized number of shares of the Company's Preferred Stock, $.01 par value per share (the \"Preferred Stock\") remained unchanged after the Reverse Stock Split at 7,500,000 shares. The number of issued and outstanding shares of Preferred Stock also remained unchanged.\nTECHNOLOGY\nMany naturally-occurring organisms are either antagonistic to or produce substances toxic to agricultural pests. These include a variety of microorganisms such as bacteria, yeasts, fungi, viruses and protozoans that either directly kill or produce compounds that interfere with certain insects, fungal pathogens or plant disease organisms. In addition, more complex organisms such as insecticidal nematodes (microscopic roundworms) that attack insect pests have been long recognized as a potential source of pest control. Insect pheromones, which are natural odors emitted by insects, are also a recognized source of environmentally compatible, biorational insect pest control. All of these natural agents when isolated and formulated as commercially useful products are commonly called \"biopesticides.\"\nBacillus thuringiensis (\"Bt\")\nBt is a bacterium found in soil. The insecticidal activity of Bt derives from production of spores and specific proteins in the form of crystals found within the Bt bacteria. These insecticidal agents are produced by the bacterial cells during a fermentation production process. They are then formulated into products that are applied to plants by conventional ground and aircraft spray equipment. When susceptible insects feed on plant foliage sprayed with Bt-based products, the crystals are ingested and generate soluble proteins that attack and destroy the insect's intestinal tract. The proteins produced by various strains of Bt are highly active against specific, targeted insect pests. Many insects are also susceptible to bacterial spores. Bt has no adverse activity against non-target insects, fish, birds or mammals (including humans). The genes for the insecticidal proteins reside on specific non-essential DNA molecules termed plasmids. Bt bacteria in nature generally contain several different genes that endow different insecticidal activities. Plasmids can either be removed (\"cured\") from cells that harbor them or they can be transferred between different strains by a natural mating process called conjugal transfer that occurs in nature between Bt strains and that can be replicated in the laboratory.\nEcogen has developed, through genetic modification techniques, novel Bt bioinsecticide products that have higher levels of effectiveness and that can act against a broader array of significant insect pests than Bt products previously in use. Ecogen has developed and characterized approximately 10,000 Bt strains and maintains one of the world's largest collections of Bt strains. The Company uses strains from this collection to screen and test for insecticidal activities. The characterization of the diversity of Bt insecticidal proteins found in Ecogen's strain collection, coupled with the ability to transfer or cure plasmids that contain the genetic code for those proteins, was the basis for Ecogen's early-stage development of new Bt bioinsecticides. Potent insecticidal crystal proteins produced by new Bt strains containing novel and desirable combinations, which are obtained by plasmid curing and conjugal transfer techniques, have been the active ingredients in Ecogen's Bt bioinsecticides.\nThese natural genetic approaches to Bt bioinsecticide development can be applied, however, only to those plasmids that can be transferred or cured. Certain insecticidal proteins are encoded by plasmids that are not transferable, and some plasmid combinations are unstable or yield undesired insecticidal activities. Under these circumstances, the development of genetically manipulated strains of Bt having novel activities against specific insects is greatly facilitated by the application of recombinant DNA technology. Ecogen has developed a proprietary Bt-based cloning vector system, its SSR System(TM), that utilizes recombinant DNA technology to develop new Bt strains having either increased potency or activity on a broader array of insect species. Ecogen believes that the use of Bt (as opposed to other microorganisms) as the host microorganism in which new Bt insecticidal gene combinations are constructed facilitates regulatory review in obtaining field trial permission and subsequent registrations for recombinant-derived products. For example, in July 1992 Ecogen received a generic approval from the United States Environmental Protection Agency to field test recombinant Bt insecticides using this approach. In January, 1995 the Company received EPA\napproval to commercialize Raven(TM) Bioinsecticide, a recombinant Bt product based on a Bt strain into which protein genes from different Bt strains were combined. The Company expects to receive EPA approval in 1996 to commercialize CryMax(TM) Bioinsecticide, a recombinant Bt insecticide for use on vegetable crops. Ecogen's genetically enhanced bioinsecticides contain multiple insecticidal genes and have complex modes of action, and Ecogen therefore believes that pest populations will have difficulty developing resistance to them.\nEcogen has also developed technology to improve the insecticidal capabilities of the Bt proteins through its work on the mechanisms involved in the insecticidal activity. This technology, collectively referred to as Mechanism Assisted Insecticidal Design (\"MAID\"), permits Ecogen to move beyond naturally occurring proteins to identify new and commercially valuable proteins.\nPheromone and Crop Pollination Technology\nInsect pheromones are natural odors emitted by insects that are undetectable to humans. Pheromones and related technologies act as behavior modifying agents that can be used to suppress insect mating by disrupting communications between potential mates, to attract target insects or to stimulate foraging by target insects. Due to their range of agricultural applications, pheromone and related products are a significant component of Ecogen's product strategy.\nPheromones can be used either alone to control insect populations or in conjunction with biological or chemical insecticides in order to reduce the amount of such insecticides required to control insect pests. Pheromone products may be used to disrupt insect mating cycles. These products, which duplicate the mating attractant emitted by female insects, control insect populations by confusing male insects and making it more difficult for them to find females with which to mate. After application of the pheromone product, male insects become confused and are attracted to the pheromone products rather than potential mates. In addition, the mating attractant of the pheromone product camouflages the natural attractant emitted by the female which also works to disrupt the mating cycle and to control insect populations. Pheromones can also be used to attract insects to trap devices for the purpose of monitoring insect populations or to sources of chemical insecticides that are lethal to the target insects.\nCrop pollination technology is designed to attract honey bees to crops to increase plant quality and grower yields through increased pollination. Products incorporating this technology assist honey bees in finding plants, thereby maximizing the number of visitations by such bees to the flowers of various fruit and vegetable crops. Fruit and vegetable quality is increased and grower yields are maximized through such increased pollination. Ecogen's Bee-Scent(TM) Attractant is based on this crop pollination technology.\nBiofungicide Technologies\nBiofungicide technologies are based on naturally occurring organisms such as fungi or yeasts that can control harmful fungi that reduce crop yields or infect crops after harvesting. Ecogen focuses biofungicide research and development efforts on two biofungicide technologies: hyperparasitic fungi which kill other fungi, such as powdery mildews that infect plant leaves, flowers and fruit; and a yeast formulation which protects stored fruit from post-harvest rot pathogens.\nA fungal hyperparasite, Ampelomyces quisqualis, has been identified that infects most, if not all, types of powdery mildews harmful to agricultural products. Ecogen has obtained an exclusive license to this hyperparasite. Powdery mildew is a significant fungal disease affecting many crops. Special structures of the mildew penetrate the plant epidermal cells and feed on cellular tissue, causing dwarfing of the plant and fruit and cosmetic damage which is particularly undesirable on fresh produce. Plants severely infected with these pathogens have reduced yields. Historically, chemical fungicides have been used for the control of these fungal pathogens, but these pathogens typically\ndevelop resistance to these chemical fungicides over a short period of time. In response to this market need, the Company developed its AQ10(TM) Biofungicide, which is based on the fungal hyperparasite Ampelomyces quisqualis, for use in an integrated pest management system with other fungicide products to control powdery mildew. AQ10 was the first biofungicide registered by the U.S. EPA to protect crops from powdery mildew.\nSeveral non-antibiotic producing strains of yeast have been found to control a number of post harvest rot pathogens of citrus, pome fruits, grapes and other fruits and vegetables. The Company has incorporated a selection of these strains into its Aspire(TM) Biofungicide. Aspire, which may be applied by fruit growers, processors and packers in a manner consistent with the method of application of standard chemicals, provides control of post harvest rot pathogens.\nInsecticidal Nematodes\nInsecticidal or entomopathogenic nematodes are microscopic roundworms that attack insect pests in the soil or in plant stems. Insecticidal nematodes are not directly responsible for insect mortality, but rather harbor bacteria that are released into and cause an infection of the insect after nematode entry into the pest. Normally the insect dies within 48 hours after infection. The natural characteristics of insecticidal nematodes give nematode-based insecticides certain advantages over other insecticides. For example, nematodes attack insect pests in the soil where approximately 90% of insect pests spend at least a portion of their life cycle. In addition, insecticides using nematodes, which cause no adverse effects to humans, animals or plants, are currently exempt from EPA pesticide regulations and, unlike other insecticides, including other bioinsecticides, are subject to significantly lower levels of regulation or are exempt from registration by state agencies.\nNematode product development is dependent on the improvement of production technology, particularly to obtain higher yields and to reduce the costs of production. In addition, current shelf life of the insecticidal nematode products being developed by Ecogen is insufficient for widespread commercialization. Ecogen is exploring methods of formulating and preserving the nematodes to further increase shelf life while maintaining the nematodes' insecticidal capabilities, including the development of formulations that would be stable at various temperatures.\nRELATIONSHIP WITH MONSANTO\nOn January 24, 1996, the Company closed a transaction with Monsanto Company (\"Monsanto\") forming a strategic alliance for development of the Company's proprietary Bt technology.\nUnder the terms of the agreement, Monsanto purchased 943,397 shares of Ecogen Common Stock for $10.60 per share (as adjusted for the Reverse Split) for an aggregate purchase price of $10 million. Monsanto is required to maintain its ownership position in Ecogen stock during the term of the four year Research and Development Agreement between Ecogen and Monsanto and Monsanto is prohibited, for three years after closing, from acquiring more than a 25% aggregate equity interest in the Company. These restrictions, however, terminate upon the occurrence of certain defined events relating to a change of control of the Company. Monsanto has certain registration rights with respect to the shares of Company Common Stock. In addition, Monsanto has a right of first refusal to purchase securities from the Company so as to maintain its percentage ownership interest in the Company.\nIn addition, Monsanto acquired for $5 million certain rights to Ecogen's existing Bt strain library and insecticidal crystal protein gene library, and the intellectual property rights associated with such libraries including certain patents and patent applications (the \"Bt Technology\"). Ecogen maintains rights to the Bt Technology for applications other than in-plant uses. Monsanto did not acquire\nany rights to Ecogen's fermentation and formulation technology, Ecogen's insectary technology or Ecogen's technology related to the movement of Bt genes from Bt and back into Bt without foreign DNA.\nMonsanto and Ecogen also entered into a Research and Development Agreement to perform research and development focusing on Bt technology (the \"R & D Program\"). Under the R & D Program, Monsanto will provide Ecogen with a minimum of $10 million over four years, of which $3 million has been received to date. The results of the R & D Program will be owned by Monsanto and licensed to Ecogen for use outside of in-plant applications. Under the terms of the agreements with Monsanto, Ecogen will also share in the commercialization success of transgenic plants incorporating the Bt technology. Monsanto shall pay a commercialization Success Fee based on sales revenue and license fees received by Monsanto from products which incorporate the Bt Technology or the results from the R & D Program.\nRELATIONSHIP WITH ETECH\nBetween November, 1992 and January, 1993, Ecogen Technologies I Incorporated (\"ETech\"), a company incorporated by but not then affiliated with Ecogen, completed a private placement of 300 ETech Units, each unit consisting of four shares of common stock of ETech and 2,000 warrants, each to purchase one share of common stock of Ecogen at a per share purchase price of $43.75 as adjusted for the Reverse Split (the \"Ecogen Warrants\"). The Ecogen Warrants may be exercised at any time prior to January 31, 1998, and the Ecogen Warrants and the underlying shares of Ecogen common stock are freely tradable. In January, 1995 the Company exchanged 822,400 shares of its common stock for 854 shares of the common stock of ETech (approximately 70% of the outstanding common stock of ETech). As a result of this exchange ETech is a majority owned subsidiary of Ecogen and its financial condition and results of operations are included in the Company's consolidated financial statements.\nETech was formed in 1992 to initiate or accelerate research and development of certain products using technology exclusively licensed or sublicensed by Ecogen to subsidiaries of ETech. The licensed rights include the right to develop and commercialize products based on technology for: (i) the control of powdery mildew disease on agricultural crops (including grapes, fruit and nut trees, vegetables and flowering and other ornamental plants); (ii) the control of post harvest rot disease on agricultural crops (including citrus, pome fruits, grapes and a number of other fruits and vegetables); (iii) the control of the European corn borer insect, which affects corn production; (iv) the control of black vine weevil, citrus weevil, wireworm and black cutworm utilizing insecticidal nematodes; (v) the control of corn rootworm; and (vi) the control of certain insects which cause damage to turf.\nPursuant to research and development agreements between Ecogen and the subsidiaries of ETech, Ecogen conducted research, development and testing, on behalf of each ETech subsidiary, on the technology licensed to such subsidiary (the \"ETech R&D Programs\"). The ETech R&D Programs were designed to accelerate the development of products primarily in calendar 1993 and 1994 with reduced budgeted spending levels thereafter. Under each research and development agreement, ETech pays to Ecogen an amount equal to all of the qualifying development costs, unless such amount exceeds a previously agreed-up on development budget, and a management fee equal to 3.89% of such costs. In addition, the Company entered into a services agreement with ETech pursuant to which the Company provides certain financial, legal and administrative services to ETech on a cost reimbursement basis and is paid a management fee equal to 5.75% of the costs of such services. (All references in this document to ETech shall, unless the context otherwise requires, be deemed to include the ETech subsidiaries.)\nIn consideration for issuing the Ecogen Warrants, Ecogen was granted an option by each purchaser of ETech Units (the \"Stock Purchase Option\"), exercisable at any time prior to July, 1996, to purchase all (but not less than all) of the outstanding shares of ETech common stock which form part of the ETech Units (but not the Ecogen Warrants or underlying Ecogen common stock) at a price that has increased to 200% of the cash amounts paid by such purchaser for the ETech Units. Ecogen, in\nits sole discretion, may purchase the ETech shares by payment in cash, in shares of freely tradable Ecogen common stock or in any combination thereof.\nPRODUCTS\nThe following are Ecogen's current principal products:\nCONDOR(R) XL BIOINSECTICIDE -- Condor XL Bioinsecticide is an EPA registered genetically enhanced Bt product developed by Ecogen for the control of caterpillar pests in cotton, soybean, corn and other row crops, tree and nut crops, and forestry applications. Condor is marketed primarily in the southern United States for use on cotton, soybeans and other row crops.\nCONDOR(R) G BIOINSECTICIDE -- Condor G Bioinsecticide, a granular formulation of Ecogen's Condor product, is an EPA registered genetically enhanced Bt product for the control of the European corn borer caterpillar on corn crops. Condor G is marketed in the midwest United States and limited product sales occurred in 1995.\nCUTLASS(R) BIOINSECTICIDE -- Cutlass Bioinsecticide is an EPA registered genetically enhanced Bt product developed by Ecogen for control of caterpillar pests that damage vegetable, tree, nut and vine crops. Cutlass is sold primarily in California and international markets, including Taiwan, Mexico and Italy.\nRAVEN(TM) BIOINSECTICIDE -- Raven Bioinsecticide is the first EPA registered Bt product developed by Ecogen using recombinant DNA techniques. Raven was introduced to the market on a limited basis in 1995 for use in the eastern United States on potatoes, tomatoes and eggplants for control of the Colorado potato beetle.\nNOMATE(R) PHEROMONE PRODUCTS -- Ecogen markets various EPA registered NoMate pheromone products for the control of pink bollworm on cotton and for the control of tomato pinworm. NoMate products are marketed primarily in the southern United States and Mexico.\nBEE-SCENT(TM) ATTRACTANT -- Bee-Scent Attractant directs honey bees to treated blossoms to improve crop pollination, thereby increasing grower yields and crop quality. Bee-Scent is marketed in various regions of the United States including California, the Pacific Northwest and the Great Lakes region.\nAQ10(TM) BIOFUNGICIDE -- AQ10 Biofungicide is the first biofungicide registered by the EPA to protect crops from powdery mildew. In 1995, Ecogen began to introduce AQ10 on a limited basis for use on grapes in California.\nASPIRE(TM) BIOFUNGICIDE -- Aspire Biofungicide is the first biofungicide registered by the EPA to protect crops from post harvest rot pathogens. Ecogen expects to begin to introduce Aspire for use on citrus in the United States in 1996.\nCRUISER(TM) BIOINSECTICIDE -- Cruiser Bioinsecticide contains the Heterorhabditis bacteriophora nematode and has been developed for the control of a variety of insect pests. Ecogen had only limited sales of Cruiser in 1995.\nDuring fiscal 1995, the foregoing products represented substantially all of Ecogen's product sales. Product sales represented approximately 76% of the Company's total revenues in fiscal 1995. Ecogen's Bt products represented approximately 60% of Ecogen's product sales in 1995.\nMARKETING\nAgricultural pesticides and related products are sold in the United States primarily through traditional agricultural chemical distribution channels consisting of large wholesale distributors and dealers which serve extensive farm areas. Ecogen makes use of these traditional channels for the domestic distribution of its current products. To coordinate these distribution activities and generate grower interest in its products, the Company employs a marketing staff including several United States sales representatives who are located in key agricultural chemical distribution locations primarily in the southern and western areas of the United States. Ecogen may enter into one or more distribution agreements to better serve its primary markets or to access specialty or other selected markets. Ecogen's domestic product sales for fiscal 1995, the ten months of fiscal 1994, and for calendar 1993 totaled $8.4 million, $7.7 million, and $5.8 million respectively.\nFor the international distribution of its products, Ecogen has entered into several collaborations with companies that have a significant presence in the markets covered by their respective agreements. In 1991 the Company and Roussel Uclaf (now named \"AgrEvo\") entered into a distribution and product supply agreement that grants to AgrEvo exclusive distribution rights to the Company's Condor, Cutlass and Raven products in Europe (except Germany, which is excluded; and except Spain, Portugal and Italy, where rights are co-exclusive), Africa, the People's Republic of China, Australia, the Middle East and Latin America (except Mexico). As part of the distribution agreement, Ecogen has agreed to supply AgrEvo with the active ingredients necessary to commercialize the licensed products. Ecogen will be entitled to receive additional compensation based upon AgrEvo's product revenues on the licensed products. In addition to its agreement with AgrEvo, Ecogen has distribution agreements for certain of its products with a number of other companies including: UAP (for Mexico), Nissan Chemical (for Japan), Intrachem (International) S.A. (for Italy, Spain and Portugal), ISK Biotech Corporation (for Mexico), Jia Non Enterprises (for Taiwan) and Incitec Ltd. (for Australia, and New Zealand). International product sales totaled $716 thousand for fiscal 1995, $897 thousand for the ten months of fiscal 1994, and $1.3 million for calendar 1993.\nPRODUCTION\nThe manufacturing process for Ecogen's current Bt-based bioinsecticides involves fermentation of the desired microorganism. Upon completion of this fermentation process, the product is recovered using standard techniques, such as centrifugation. The insecticidal agent is then spray-dried into a technical grade powder. Finally, the product is formulated into granular or wettable powder form for sale into the commercial market. Ecogen currently operates fermentation and formulation pilot plants to support some product requirements for field trials and to facilitate the transition of products from laboratory to large-scale manufacturing. A significant portion of Ecogen's research and development activities during 1995 were dedicated to the improvement of fermentation and formulation techniques in order to improve product yield and correspondingly reduce the costs of product manufacturing.\nEcogen is a party to a Supply Agreement with biosys Inc. pursuant to which biosys has agreed to manufacture Ecogen's Bt-based products through December 31, 1999. Biosys has both fermentation and spray-drying capability, and supplies Ecogen with finished goods. Ecogen believes that adequate fermentation, spray-dry and other services will likely continue to be available from contract manufacturers and Ecogen does not currently intend to build its own manufacturing facilities.\nThe Company purchases the active ingredients for its pheromone products from various suppliers and manufactures its pheromone products at its facility in Billings, Montana. In addition, the Company obtains certain manufacturing services from 3M Corporation with respect to the formulation of some of its NoMate products. The Company believes that its Billings, Montana facility has sufficient capacity to meet its current and near-term anticipated pheromone product needs.\nThe manufacturing process for Ecogen's biofungicide products involves fermentation of fungal or yeast-based products and formulation of the fermentation results into a granular form for commercial sale. Ecogen has engaged Zohar Dalia Factory Ltd., located in Israel, to manufacture the active ingredient for AQ10 on a contract manufacturing basis. The manufacture of Aspire was on a pilot plant basis in 1995 and the Company is scaling up to produce Aspire through toll manufacturers in 1996.\nNematode products are now being manufactured on a pilot plant basis by Ecogen at its Langhorne, Pennsylvania facility. Ecogen's current nematode production processes yield products with a shelf life that is insufficient for widespread commercialization of such products. Ecogen is investigating methods of fermentation and storage that will result in increased production yield and insecticidal nematode product shelf life, including the development of formulations that would be stable at various temperatures.\nThe most important raw materials needed by Ecogen to conduct its product manufacturing and research and development activities include both fermentation media components and formulation chemicals, which are readily available from a variety of independent sources, and microbial strains that are either proprietary to Ecogen or are licensed from outside parties. Ecogen does not anticipate any shortages of these or other raw materials that would materially affect product availability or cost.\nRESEARCH AND PRODUCT DEVELOPMENT\nThe Company's operating expenses to date have related to a large extent to the research and development of products for future commercialization. Costs incurred by Ecogen under third-party funded research and development programs, aggregated approximately $1.7 million, for fiscal 1995 $6.0 million for the ten months of fiscal 1994 and $6.8 million for calendar 1993, respectively. Costs incurred under Ecogen-funded research and development programs, aggregated approximately $7.3 million, $3.3 million, and $5.3 million for fiscal 1995 and 1994 and calendar 1993, respectively.\nDuring fiscal 1995, the Company derived approximately 24% of its revenues from research and development contracts and licensing agreements. This contrasts with approximately 54% in 1994 and 61% in 1993. As a result of the Exchange Offer in December 1994, the Company did not record contract revenue in connection with the ETech R&D Programs in fiscal 1995. In 1996, the Company expects to derive contract revenue from its Research and Development Agreement with Monsanto Company.\nBacillus thuringiensis Products\nEcogen's Bt product development activities are focused on improving, through recombinant DNA and other technologies, the efficacy of its bioinsecticides already in the market, adapting such products for application to additional uses particularly in markets outside of North America, and developing new bioinsecticides. In addition, Ecogen is developing improved formulations for its Bt products that are designed, among other things, to improve their handling and ease of application, to enhance their insecticidal activity in the field and to reduce their cost of production. In 1996, Ecogen plans to continue to focus its research and development efforts on a new product for the vegetable market that will incorporate recombinant DNA technologies and is also targeting its research efforts toward a Bt-based product for the control of fall armyworm, an important corn pest.\nPheromone and Related Products\nEcogen is exploring additional formulations of its pheromone products in order to develop alternative application techniques for such products. Tests also are being conducted by the Company in order to expand its pheromone product line for the control of additional pests such as the leafroller, the codling moth and other insect pests.\nYeast, Fungal and Other Products\nThe Company is continuing to develop processes for the commercial production by fermentation of AQ10 and Aspire Biofungicides. The Company is also continuing to develop stable and efficacious formulations for these products. With respect to Aspire Biofungicide, the Company is working to develop formulations that provide Aspire with increased shelf life at room temperatures. In addition, the Company is working on different types of bacteria that may be used for the control of certain plant parasitic nematodes that feed on or enter roots of growing plants causing damage and reduced crop yields. In laboratory tests and greenhouse trials, Ecogen has identified bacterial isolates with nematicidal activity against root knot nematodes which attack a variety of crop plants.\nInsecticidal Nematodes\nThe Company is (i) developing liquid fermentation techniques that are designed to allow the Company to more efficiently produce nematodes and (ii) investigating through its own efforts and the efforts of third parties methods for increasing the shelf life of nematode products (particularly at ambient temperatures). In addition, the Company is working on the development of formulations that are designed to make the Company's products easier to use and to increase product shelf life.\nPATENTS AND TRADE SECRETS\nEcogen pursues a policy of seeking patent protection, both in the United States and abroad, to protect its novel technologies, compositions of matter and processes. In particular, Ecogen has patent rights to the Bt strains utilized as the active ingredients in its Condor, Cutlass and Raven Bioinsecticides. With respect to the Company's two biofungicide products, AQ10 Biofungicide and Aspire Biofungicide, and with respect to certain of its Bt technology, the Company holds an exclusive license to patents covering the base technologies.\nThere can be no assurance that patents or exclusive license rights under patents for all of the Company's products and processes will be obtained, or that issued patents will provide substantial protection or be of commercial benefit to the Company. The issuance of a patent is not conclusive as to its validity or enforceability, nor does it provide the patent holder with freedom to operate without infringing the patent rights of others. A patent could be challenged by litigation and, if the outcome of such litigation were adverse to the patent holder, competitors could be free to use the subject matter covered by the patent or the patent holder could be required to license the technology to others.\nBecause of the uncertainty concerning patent protection, the Company relies, in certain cases, upon trade secret protection and continuing technological innovation to maintain its competitive position. All Ecogen employees and consultants sign confidentiality agreements under which they agree not to use or disclose the Company's confidential information as long as that information remains proprietary or, in other cases, for fixed time periods. There can be no assurance, however, that such proprietary technology will not be independently developed or that secrecy will not be breached. The Company's research, development and commercialization partners, as well as its biopesticide production subcontractors, are provided access to know-how under confidentiality\nagreements. To the extent that such entities use this technological information, disputes may arise as to the proprietary and patent rights to such technological information and related developments.\nThe Company is aware that substantial research efforts in biotechnology are taking place at universities, government laboratories and other corporations around the world and that numerous patent applications have been filed, and that patents have been issued, relating to fundamental technologies and to specific biological pesticide products and processes. The Company may have to obtain licenses under certain of these patents. No assurance can be given concerning the terms on which such licenses would be available, if at all.\nGOVERNMENTAL REGULATION\nRegulation by governmental authorities in the United States and other countries is a significant factor affecting the success of products resulting from biotechnological research.\nThe pesticide industry is heavily regulated in the United States. The EPA regulates pesticide products under the Federal Insecticide, Fungicide and Rodenticide Act (\"FIFRA\"). Pesticides also are regulated by various state agencies. Some states, such as California, have their own extensive registration requirements. To develop and commercialize a pesticide product, detailed and complex procedures must be followed and federal approvals obtained under FIFRA. Small scale field testing usually may be conducted prior to product registration to evaluate product efficacy. To conduct large scale tests, a company must obtain an Experimental Use Permit (\"EUP\"), which generally requires satisfactory completion of certain toxicology and environmental studies. Synthetic chemical pesticides require additional extensive toxicology and environmental testing that typically is not required of biopesticides to substantiate product safety prior to obtaining a product registration. Commercial sale of a pesticide requires a registration for each pest and crop for which the product is used. Registration requirements include submission and EPA approval of the text of a label which must be included on every pesticide product. The United States Congress has mandated that the EPA require that all pesticide products registered prior to November 1984 be re-registered by 1997 using today's stricter testing protocols.\nThe EPA has recognized that biochemical and microbial pesticides are distinguished from standard chemical pesticides, and has established different data requirements as part of its registration regulations. These data requirements are set out in Subdivision M of the EPA's Pesticide Assessment Guidelines. Biopesticides currently are subject to a three-tier toxicology testing procedure, and a four-tier environmental testing procedure. A biopesticide product which satisfactorily completes both the Tier I toxicology and environmental tests is not required to go through the tests specified in subsequent tiers. This has been the case for product registration applications filed by the Company to date. However, should questions arise during any tier of testing, additional tests may be required. For a biopesticide product required to complete only Tier I testing, approximately one year of laboratory testing is required. Subsequent EPA registration generally takes approximately one year. Although the process for obtaining regulatory approval to test and market biopesticides that are genetically modified is designed to be less complex and time-consuming than the regulatory approval process for synthetic chemical pesticides, there can be no assurance that approvals will be granted on a timely basis, if at all.\nCertain of Ecogen's products under development utilize recombinant DNA technology. The Federal government regulates certain recombinant DNA research activity through the National Institute of Health's Guidelines for Research Involving Recombinant DNA Molecules (\"NIH Guidelines\"). The NIH Guidelines, among other things, set laboratory procedures and establish levels of biological and physical containment and other standards for recombinant DNA molecules that must be met for various types of research. Ecogen believes that it is in compliance with the NIH Guidelines. The Company believes that the registration in January 1995 of Raven Bioinsecticide indicates that commercialization of products utilizing recombinant DNA technology will not likely involve greater time\nand expense than it has experienced to date with respect to its nonrecombinant products. In August, 1992 Ecogen received blanket permission from the EPA to conduct small-scale field trials of its recombinant Bt strains without prior notice (generally required for small scale field testing of microbial pesticides).\nPheromone and related products (other than trap and lure products) generally require EPA and state registrations.\nInsecticidal nematodes are currently exempt from registration under EPA pesticide regulations and, unlike other insecticides, including other bioinsecticides, are subject to significantly lower levels of regulation or are exempt from registration by state agencies.\nEcogen's activities, including operation of its laboratories and pilot-scale manufacturing facilities, are, or may be, subject to regulation (i) under various other state and federal laws and regulations, including the Occupational Safety and Health Act, the Toxic Substances Control Act, the Federal Food, Drug and Cosmetic Act, the Solid Waste Disposal Act, the Resource Conservation and Recovery Act, the Emergency Planning and Community Right-to-Know Act, the Clean Air Act, the Clean Water Act, and other state and federal laws regulating environmental quality, and the implementing regulations for all such laws; and (ii) by other state and federal agencies, including the U.S. Department of Agriculture and the U.S. Food and Drug Administration. In addition, the actions of federal agencies in reviewing applications by Ecogen or issuing permits or other authorizations may be subject to the National Environmental Policy Act, and state or local agencies may be required to comply with similar state laws. Historically, the cost of compliance with such laws and regulations have not had a material impact on Ecogen's business.\nFrom time to time, governmental authorities review the need for additional laws and regulations for biotechnology products and for pesticide products that could, if adopted, apply to the business of Ecogen. Ecogen is unable to predict whether any such new regulations will be adopted or whether, if adopted, such regulations will adversely affect its business.\nHistorically, the cost to Ecogen of compliance with federal, state and local provisions enacted for the protection of the environment has not been material. Toxicology testing, field development trials and related costs for EPA registrations incurred to date by Ecogen have averaged under $500,000 for each product registration, while state registration and related costs per product have been nominal. This does not mean that such costs are unlikely to increase in the future, particularly if more restrictive approval requirements are adopted by federal, state or local authorities. Also, delays in obtaining necessary product registrations can have a significant impact upon Ecogen's revenues and competitive position in the way of delayed product sales and lost market opportunities.\nField development and testing, as well as the commercial sale, of Ecogen's biopesticide products outside the United States can be highly regulated. The impact of such regulation upon Ecogen's business cannot be assessed at this time.\nCOMPETITION\nCompetition in the pesticide market is intense. Competition is based principally on price and efficacy, but safety and ease of application are also factors. Competitors of Ecogen include manufacturers and marketers of synthetic chemical pesticides and biopesticides including large chemical companies, such as Abbott Laboratories, Ciba-Geigy Corp., and Sandoz Corporation as well as specialized biotechnology firms. Many of these companies have considerably greater financial and marketing resources than Ecogen. Competitors with respect to research and development activities also include universities and public and private research organizations. In addition, Ecogen's bioinsecticide\nproduct's compete with certain transgenic seed and plant products that purport to have insecticidal capabilities.\nEcogen believes that its ability to compete in the pesticide market may be enhanced by heightened concerns about the effects of chemical pesticides upon the environment and, in some cases, by the increasing resistance of plant pests to synthetic pesticides. However, Ecogen expects competition in the agricultural pesticide industry to intensify as technical advances in the fields of pesticides and pest-resistant plants are made. There can be no assurance that developments by others will not render the Company's products or technology obsolete or noncompetitive.\nSEASONALITY\nThe bulk of the Company's current products are presently marketed for agricultural applications in the northern hemisphere, where the growing season generally runs from spring until fall. Commercial introduction of the Company's new products is contingent on, among other factors, completion of field testing and receipt of required regulatory approvals. Unusual weather conditions during field tests or failure to receive regulatory approvals prior to the growing season may require additional field tests in subsequent growing seasons, with resulting delays in product development and commercialization. In addition, because of the seasonal nature of its business, the Company's product revenues are likely to be concentrated in the fiscal quarters prior to and during a particular growing season and may result in substantial variations in quarter-to-quarter financial results. Product sales from year-to-year are also affected by unusual weather conditions, such as droughts or floods, and the level of insect infestation in grower areas.\nEMPLOYEES\nAs of January 15, 1996 Ecogen and its subsidiaries employed full time 100 persons, of whom 19 hold Ph.D. degrees and 15 hold other advanced degrees. Doctoral degrees held by employees of Ecogen encompass the areas of biochemical engineering, biochemistry, entomology, microbiology, molecular genetics, physiology and plant pathology.\nEmployees of the Company are required to enter into confidentiality agreements with Ecogen. Pursuant to these agreements, the employees have agreed not to disclose Ecogen's proprietary information and to assign to Ecogen all rights to any inventions made during their employment or relating to Ecogen's activities, and not to engage in activities similar to Ecogen's for any other person or entity during the term of their employment and for one year thereafter. Ecogen believes that its relationship with its employees is good.\nEXECUTIVE OFFICERS\nThe executive officers of the Company and their respective ages and positions with the Company are as follows:\nAll executive officers are elected by the Board of Directors. There is no family relationship among any of the officers or directors.\nBUSINESS EXPERIENCE\nMr. Reilly has served as Chairman since November 1, 1995 and as a director of the Company since June 1992. Since January 1994 he has been the Chief Executive Officer of the Company and since June 1992, he has been the Company's President. From June 1992 to January 1994, Mr. Reilly served as Chief Operating Officer of the Company. From 1976 until he joined the Company, Mr. Reilly was employed in various management capacities at Rhone Poulenc, Inc., most recently, from April 1991 to May 1992, as Vice President and General Manager of the Fine Chemicals Division. He received a B.S. in Business Administration from Boston College.\nMr. Deak has served as Vice President, General Counsel of the Company since August 1993 and as Secretary since May, 1995. From January 1993 to July 1993 Mr. Deak served as General Counsel of the Company. From January 1985 until he joined the Company, Mr. Deak was employed by Unisys Corporation in various positions, including Associate General Counsel, Corporate, Acquisitions and Finance. Prior to joining Unisys Corporation, Mr. Deak practiced law with Mann & Ungar and Dechert Price & Rhoads. Mr. Deak received a J.D. from the University of Pennsylvania Law School and a BBA in Accountancy from the University of Notre Dame.\nDr. English has served as Vice President, Research of the Company since October 1995. From March 1986 until October 1995, Dr. English served Ecogen in various positions including Principal Research Scientist and Team Leader. Prior to joining Ecogen, Dr. English was a research assistant at Tufts University School of Medicine. Dr. English received a B.S. in Entomology from Cornell University and a Ph.D in Membrane Biochemistry from North Dakota State University.\nMs. Paetzold has served as Vice President, Chief Financial Officer and Treasurer of the Company since she joined Ecogen in August 1994. Prior to joining the Company, Ms. Paetzold was a partner with KPMG Peat Marwick LLP, certified public accountants, where she worked for over twenty years. Ms. Paetzold received a B.A. in Mathematics from Montclair State University and is a Certified Public Accountant.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nEcogen currently leases approximately 44,000 square feet of space for its administrative offices and research and development operations in two buildings located in the Bucks County Business Park, Langhorne, Pennsylvania. The leases for these facilities expire on March 31, 2000 and Ecogen has renewal options to March 31, 2005. Approximately 32,000 square feet of this space is devoted to research and development facilities, including laboratories, an insectary and two fermentation and formulation pilot plants. In addition, Ecogen currently leases approximately 20,000 square feet of space in Billings, Montana for its pheromone business, under a lease which expires December 31, 1996. The Company believes that its leased space is sufficient for current needs.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nNot Applicable.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNot Applicable.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nA. Market Information\nThe Company's Common Stock trades under the NASDAQ symbol EECN and is included in the National Market System. The high and low prices of the Company's Common Stock during the year ended October 31, 1995 and the ten month period ended October 31, 1994 adjusted retroactively for a one-for-five reverse stock split on January 29, 1996 are as follows:\nA. Holders\nOn December 11, 1995, there were approximately 1,295 stockholders of record.\nB. Dividends\nNo cash dividends have ever been paid on the Company's Common Stock, and the Company does not intend to pay cash dividends in the foreseeable future.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nYear ended October 31, 1995, ten months ended October 31, 1994, and years ended December 31, 1993, 1992 and 1991 (all amounts in thousands, except per share data)\nCONSOLIDATED STATEMENTS OF OPERATIONS DATA:\nCONSOLIDATED BALANCE SHEET DATA\nNo cash dividends have ever been paid on the Company's Common Stock, and the Company does not intend to pay cash dividends in the foreseeable future.\n(1) In December 1994, the Company changed from a calendar year end to a fiscal year ended October 31. Accordingly, results of operations in 1994 represent the ten month period ended October 31, 1994.\n(2) Effective December 31, 1991, the Company acquired Ecogen Israel, specializing in the development of novel biofungicides. In March 1992, the Company acquired a company in Australia involved in the research and development of nematode technology. In September 1992, the Company acquired certain assets of Scentry, a company that markets and develops pheromone products. All acquisitions were accounted for as purchases with the operations of the business acquired included in the consolidated financial statements from the date of acquisition and a special charge to operations in 1991 and 1992 for purchased technology.\n(3) Adjusted retroactively to reflect the effects of a one-for-five reverse split approved by shareholders on January 29, 1996.\n(4) Reflects the Monsanto transaction as if such transaction occurred on October 31, 1995.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION\nEcogen Inc. is an agricultural biotechnology company specializing in the development and marketing of quality biorational products for the control of pests in agricultural and related markets. On December 28, 1994, the Company changed its fiscal year end from December 31 to October 31 so that its fiscal year end would better conform to the agricultural growing season in its primary markets. Accordingly, in the discussion below fiscal 1995 have been compared to a pro forma year ended October 31, 1994 and the ten months ended October 31, 1994 has been compared with a pro forma ten-month period ended October 31, 1993. The unaudited consolidated financial statements for the year ended October 31, 1994 and the ten-month period ended October 31, 1993 are not presented separately herein. Further, on January 29, 1996, the stockholders of the Company approved a one-for-five reverse stock split. All references to common shares and per share amounts have been retroactively adjusted to reflect the reverse stock split.\nOVERVIEW\nIn fiscal 1995, product sales decreased 2% from $9.3 million in the comparable twelve month period in 1994 to $9.1 million in 1995. Gross margins improved from 31% in 1994 to 40% in in fiscal 1995. Net loss before special charges increased from ($6.5) million in the comparable twelve month period in 1994 to ($13.1) million in 1995 as a result of lower research contract revenue offset in part by lower operating expenses and higher gross margins. Contract revenues decreased $10.3 million during the year due principally to lower research contract revenue from ETech. As a result of the acquisition of ETech, the Company no longer records contract revenue from ETech. The 1995 results include special charges of $10.2 million relating to purchased technology from ETech, the shutdown of Ecogen Australia and other severance costs. Net loss in fiscal 1995 was ($23.3) million or ($4.34 per share) compared to ($6.8) million or ($1.84) per share in the same period in 1994.\nThe following is a summary of results as a percentage of sales, as well as the percentage change in dollar amounts compared to the prior period:\nRESULTS OF OPERATIONS - YEAR ENDED OCTOBER 31, 1995 COMPARED TO UNAUDITED PRO FORMA YEAR ENDED OCTOBER 31, 1994.\nREVENUES\nTotal revenues decreased $10.9 million or 48% in fiscal 1995 compared to the same period in 1994 principally due to lower research contract revenue. Product sales in 1995 approximated the same level as the comparable period in 1994. Sales of Bt products increased marginally in 1995 despite adverse weather conditions in the Mississippi Delta, the Company's primary market for its Bt product line. Sales of the Company's pheromone product line decreased 3% primarily due to economic uncertainties in the Mexican market and inventory carryover in the Pacific Northwest. Gross margins on product sales increased to 40% in 1995 from 31% in the same period in 1994 in spite of the fact that pheromone product sales, which have the highest gross margins decreased in 1995. The increase in gross margins in 1995 reflects the continuing impact of improvements made to the Bt manufacturing process.\nOPERATING COSTS\nResearch and development costs decreased $3.0 million or 25.0% in fiscal 1995 compared to the same period in 1994 due principally to scheduled reductions in spending under ETech programs for which research effort had been accelerated in 1993 and 1994 as a result of the ETech financing. Research and development expenses are expected to decrease further in 1996 primarily as a result of the divestiture of Ecogen Europe, the closure of the Company's laboratory in Germany and cost saving measures in the U.S. Selling and marketing expenses increased $.8 million or\n18.5% as a result of costs associated with new product introductions. General and administrative expenses decreased $1.2 million or 17.6% in fiscal 1995 compared to the same period in 1994 as a result of cost containment measures taken in late 1994 and in 1995.\nTotal operating expenses were $29.8 million during fiscal 1995 compared to $23.3 million in the same period in 1994. The increase in operating expenses is due to special charges of $10.2 million in 1995. Operating expenses exclusive of special charges decreased 14% from $22.9 million in fiscal 1994 to $19.6 million in the comparable period in 1995.\nNet loss for fiscal 1995 was ($23.3) million or ($4.34) per share compared to ($6.8) million or ($1.84) per share in the same period in 1994. The net loss exclusive of special charges was ($13.1) million or ($2.45) per share in 1995 compared to ($6.5) million or ($1.75) per share in 1994. The increase in net loss exclusive of special charges is due to the decrease in research contract revenue partially offset by lower operating costs and higher gross margins.\nSPECIAL CHARGES\nThe following represents a summary of special charges:\nRestructuring costs include $.9 million of severance costs of which $.2 million and $.2 million are payable in fiscal 1996 and 1997.\nRESULTS OF OPERATIONS - TEN MONTHS ENDED OCTOBER 31, 1994 COMPARED TO UNAUDITED PRO FORMA TEN MONTHS ENDED OCTOBER 31, 1993\nIn fiscal 1994, the Company attained record revenues of $19.8 million up 19% from $16.6 million in the similar ten-month period ended October 31, 1993. The Company also reduced its net loss by 52% to ($4.6) million from ($9.6) million in the 1993 comparative period. The 1993 period included special charges consisting principally of $1.6 million relating to the value of warrants issued in connection with the ETech financing and $2.0 million for marketing repositioning charges relating to the Company's Bt product line. Net loss per share decreased to ($1.25) per share in fiscal 1994, from ($2.75) per share in the prior year's ten month period ended October 31, 1993.\nREVENUES\nTotal revenues increased 19% in the ten months ended October 31, 1994 compared to the same period in 1993. Net product sales of $8.5 million increased 33% in the ten months ended October 31, 1994 compared to the same period in 1993. The pheromone product line experienced a 58.8% increase in sales while Bt products increased 23.7%. Sales of Bt products increased in spite of the negative effect of adverse weather conditions and unexpectedly low levels of insect pressure resulting in reduced applications of Bt products throughout 1994. Contract revenue increased $815 thousand due primarily to higher revenue earned on the Company's agreements with ETech and 3A. Interest and other income increased 59% to $664 thousand, due to higher rates earned on investments and favorable exchange differences.\nCOSTS AND EXPENSES\nTotal costs and expenses were $24.4 million in fiscal 1994 and $26.2 million in the corresponding period in 1993, a decrease of $1.8 million or 7% on 19% higher revenues. The prior period includes a special charge of $1.6 million relating to the value of the warrants issued in connection with the ETech financing and a marketing charge of $2.0 million in connection with the repositioning of the Bt product line. There were no special charges in 1994. Cost of goods sold increased $757 thousand due primarily to the higher net product sales. Gross margins on product sales were 31% in fiscal 1994 compared to 20% in the corresponding period in 1993. The improvement in gross margins resulted in large part from the Company's efforts initiated in 1994 to reduce product costs. Total research and development expenses of $9.3 million approximated the same levels incurred in 1993. Self-funded R&D expenses decreased $600 thousand due primarily to the shifting of research efforts to funded ETech and 3A projects. Selling, general and administrative expenses increased $1.2 million due primarily to increased marketing and promotional expenses.\nSEASONALITY OF BUSINESS\nThe bulk of the Company's current products are presently marketed for agricultural applications in the northern hemisphere, where the growing season generally runs from spring until fall. Commercial introduction of the Company's new products is contingent on, among other factors, completion of field testing and receipt of required regulatory approvals. Unusual weather conditions during field tests or failure to receive regulatory approvals prior to the growing season may require additional field tests in subsequent growing seasons, with resulting delays in product development and commercialization. In addition, because of the seasonal nature of the Company's business, product revenues are likely to be concentrated in the fiscal quarters prior to and during a particular growing season and may result in substantial variations in quarter-to-quarter financial results. Product sales from year-to-year are also affected by unusual weather conditions, such as droughts, and the level of insect infestation in grower areas.\nINFLATION\nTo date and for the foreseeable future, inflation has not had nor is it anticipated to have a significant impact on revenues or costs and expenses of the Company, except to the extent of normal cost of living adjustments related to personnel costs.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company has financed its working capital needs primarily through private and public offerings of equity securities, research payments and license fees from its research and development contract payments and product sales.\nAt October 31, 1995, the Company had cash and cash equivalents of $1.8 million, a net decrease of $7.0 million from October 31, 1994. During 1995, the Company received approximately $4.0 million from the ETech research and development agreements and $7.8 million from the sale of equity securities and had a net decrease in cash and cash equivalents of $3.3 million due to the disposition of Ecogen Europe. Cash expenditures during the current period were for operations, and purchases of $.9 million of equipment and leasehold improvements.\nSubsequent to October 31, 1995, the Company completed the Monsanto transaction which resulted in an immediate cash infusion to the Company of $18.0 million including $10 million from the sale of 953 thousand shares of the Company's common stock. On a pro forma basis, assuming the Monsanto transaction had closed on October 31, 1995, the Company had $19.3 in cash and cash equivalents. Further, subsequent to October 31, 1995 the Company sold 122,000 shares of Series C preferred stock at $25 per share in a private placement to institutional investors for aggregate net proceeds of $2.8 million. The terms of the preferred stock are disclosed in note 8 of the notes to the consolidated financial statements. In connection with the private placement the Company issued warrants to purchase 77,877 shares of the Company's common stock at $7.30 per share exercisable for five years.\nTo date, the Company has not generated positive cash flow from operations. The Company believes that its existing working capital including funds received from Monsanto in January 1996 should be sufficient to meet its capital and liquidity requirements for the immediate future. However, the Company's working capital and working capital requirements are affected by numerous factors and there is no assurance that such factors will not have a negative impact on the Company's liquidity. Principal among these are the success of its product commercialization and marketing efforts and the efforts of its strategic partners in commercializing and selling products based on the Company's technology, the technological advantages and pricing of the Company's products, economic and environmental considerations which impact agricultural crop production and the agricultural sector generally, competitive conditions in the agricultural pest control market, and access to capital markets that can provide the Company with the resources necessary to fund its strategic priorities.\nAt October 31, 1995 the Company had commitments for capital expenditures of $1.6 million. The Company has obtained a lease facility to finance such equipment subject to a 15% deposit.\nThrough October 31, 1995, the Company had available Federal net operating loss carryforwards of approximately $60.6 million which expire at various times through the year 2010. In addition, the Company had research and experimentation tax credits of approximately $2.4 million, which credits expire at various times through the year 2010.\nAs a result of certain equity transactions, the Company experienced ownership changes as defined by rules enacted with the Tax Reform Act of 1986 (the \"Act\"). Accordingly, the Company's ability to use its net operating loss and research and experimentation credit carryforwards is subject to certain limitations as defined by the Act. The Company believes that such limitations should not have a significant impact in 1996 or 1997 since anticipated taxable profits, if any, will not exceed the amount of the limitation. In addition, to the extent that the Company recognizes gains, if any, on the disposition of assets held on the date of the ownership change, the annual limitation is increased by the amount of the \"built-in\" gains attributable to those assets. The built-in gain on a particular asset is the excess of its fair market value over its cost basis on the date of the ownership change.\nOTHER ASSETS, LIABILITIES AND STOCKHOLDERS' EQUITY\nDeferred contract revenue decreased $5.7 million in fiscal 1995 as a result of $2.0 million research contract revenue earned under the 3A and AgrEvo research contracts during fiscal 1995 and the divestiture of Ecogen Europe.\nOther long-term liabilities increased $2.1 million in 1995 principally as a result of funds received from ETech minority shareholders which are required to be recorded as a deferred liability under generally acceptable accounting principles until such time as the minority interest in ETech is acquired. The Company has no obligation to acquire such minority interest.\nStockholders' equity decreased $4.1 million as a result of 1995 operating losses offset by equity financings in 1995.\nIn March, 1995, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 121, \"Accounting for the Impairment of Long-lived Assets and for Long-lived Assets to be Disposed of\", which is effective for the fiscal years beginning after December 15, 1995. This standard is not expected to have a significant effect on either the results of operations or financial position of the Company.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nSee Item 14 for an Index to Financial Statements and Financial Statement Schedules. 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 EXECUTIVE OFFICERS OF THE REGISTRANT\n1. The section labeled \"Election of Directors\" appearing in the Proxy Statement is hereby incorporated herein by reference.\n2. Information concerning the Company's Executive Officers is set forth in Part I of this Form 10-K.\n3. The section labeled \"Election of Directors\" appearing in the Proxy Statement is hereby incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe section labeled \"Executive Compensation\" appearing in the Proxy Statement is hereby incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe section labeled \"Principal Stockholders\" appearing in the Proxy Statement is hereby incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe section labeled \"Certain Transactions\" appearing in the Proxy Statement 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)(1) AND (2) FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nThe following consolidated financial statements of Ecogen Inc. and Subsidiaries are included in Item 8:\nAll other schedules are omitted for the reasons that they are not applicable or that equivalent information has been included in the consolidated financial statements, and notes thereto, or elsewhere herein.\n(a)(3) Exhibits\n* These items are hereby incorporated by reference from the exhibits of the filing or report inidicated (except where noted, Commission File No. 1-9579, File no. 33-14119 in the case of the Form S-1 Registration Statement and File No. 33-40319 in the case of the Form S-1 Registration Statement filed on May 1, 1991, as amended) and are made part of this Report.\n* These items are hereby incorporated by reference from the exhibits of the filing or report inidicated (except where noted, Commission File No. 1-9579, File no. 33-14119 in the case of the Form S-1 Registration Statement and File No. 33-40319 in the case of the Form S-1 Registration Statement filed on May 1, 1991, as amended) and are made part of this Report.\n* These items are hereby incorporated by reference from the exhibits of the filing or report inidicated (except where noted, Commission File No. 1-9579, File no. 33-14119 in the case of the Form S-1 Registration Statement and File No. 33-40319 in the case of the Form S-1 Registration Statement filed on May 1, 1991, as amended) and are made part of this Report.\n* These items are hereby incorporated by reference from the exhibits of the filing or report inidicated (except where noted, Commission File No. 1-9579, File no. 33-14119 in the case of the Form S-1 Registration Statement and File No. 33-40319 in the case of the Form S-1 Registration Statement filed on May 1, 1991, as amended) and are made part of this Report.\n* These items are hereby incorporated by reference from the exhibits of the filing or report inidicated (except where noted, Commission File No. 1-9579, File no. 33-14119 in the case of the Form S-1 Registration Statement and File No. 33-40319 in the case of the Form S-1 Registration Statement filed on May 1, 1991, as amended) and are made part of this Report.\n(b) Reports on Form 8-K.\nNot applicable.\n* These items are hereby incorporated by reference from the exhibits of the filing or report inidicated (except where noted, Commission File No. 1-9579, File no. 33-14119 in the case of the Form S-1 Registration Statement and File No. 33-40319 in the case of the Form S-1 Registration Statement filed on May 1, 1991, as amended) and are made part of this Report.\nIndependent Auditors' Report\nThe Board of Directors and Stockholders Ecogen Inc.:\nWe have audited the consolidated financial statements of Ecogen Inc. and subsidiaries as listed in the accompanying index in Item 14. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule as listed in the accompanying index in Item 14. 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 Ecogen Inc. and subsidiaries as of October 31, 1995 and 1994, and the results of their operations and their cash flows for the year ended October 31, 1995, the ten months ended October 31, 1994 and the year ended December 31, 1993, in conformity with generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.\nKPMG Peat Marwick LLP\nShort Hills, New Jersey January 24, 1996, except as to note 17, which is as of January 29, 1996 ECOGEN INC. AND SUBSIDIARIES\nConsolidated Balance Sheets\nSee accompanying notes to consolidated financial statements.\nECOGEN INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF OPERATIONS\nSee accompanying notes to consolidated financial statements.\nECOGEN INC AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY YEAR ENDED OCTOBER 31, 1995, TEN MONTHS ENDED OCTOBER 31, 1994 AND YEAR ENDED DECEMBER 31, 1993\nSee accompanying notes to consolidated financial statements\nECOGEN INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\n(Continued)\nECOGEN INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED\nNONCASH INVESTING AND FINANCING ACTIVITIES:\nIn 1995 debt totalling approximately $466,000 was incurred by the Company for the acquisition of production equipment.\nIn 1994, the Company issued 489,706 shares of common stock in connection with the exercise of warrants on a net issuance method in which 389,706 shares of common stock were surrendered.\nIn 1995, 1994 and 1993, the Company issued 5,517, 9,594 and 43,218 shares of common stock, respectively, in connection with a research and development and cross-licensing agreement with CSIRO.\nIn 1994, the Company issued 10,000 shares of common stock in connection with a consulting agreement.\nIn 1994, subscriptions receivable aggregating $422,850 were eliminated against paid-in capital as the underlined shares or retired upon foreclosure.\nIn 1993, the Company issued common stock to satisfy a $997,500 obligation to issue common stock outstanding as of December 31, 1992, in connection with a research and development agreement with 3A.\nIn 1995 and 1993, holders of the Company's Series A convertible preferred stock converted 260,000 and 240,000 shares of preferred stock, respectively, to shares of common stock.\nSee accompanying notes to consolidated financial statements.\nECOGEN INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements October 31, 1995 and 1994 and December 31, 1993\n(1) Summary of Significant Accounting Policies\nOrganization and Business Activities: The consolidated financial statements include the accounts of Ecogen Inc. (\"Ecogen or the Company\") and its wholly-owned and majority-owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation. During fiscal 1995, Ecogen acquired an approximately 70% interest in Ecogen Technologies I, Inc. (ETech) (see note 6).\nThe Company is a biotechnology company specializing in the development and marketing of environmentally compatible products for the control of pests in agricultural and related markets. The Company has not yet achieved profitable operations and there is no assurance that profitable operations, if achieved could be sustained on a continuing basis. Further, the Company's future operations are dependent on the success of the Company's commercialization efforts and market acceptance of the Company's products.\nFiscal year end: In December 1994, the Company changed its year end from a calendar year end to a fiscal year ending October 31. Accordingly, the accompanying consolidated financial statements include a balance sheet at October 31, 1995 and 1994 and statements of operations, cash flows and stockholders' equity for the year ended October 31, 1995, for the ten months ended October 31, 1994 and for the year ended December 31, 1993.\nInventory: Inventory is stated at the lower of cost, as determined by the average cost method, or net realizable value.\nPlant and equipment: Plant and equipment are recorded at cost. Depreciation is computed by utilizing an accelerated method over the estimated useful lives of the related assets which range from three to ten years. Amortization of leasehold improvements is computed using the straight-line method over the lesser of the estimated useful lives of the improvements or the remaining lease term.\nResearch and development: All research and development costs are charged to operations as incurred.\nRevenue recognition: Revenue from research and development contracts is recognized in accordance with the terms of the respective contracts. Revenue from certain contracts is recognized on a pro-rata basis over the life of the contract. Related contract costs are generally incurred ratably over the contract term. Revenue from achievement of milestone events is recognized when all parties concur that the scientific results and\/or milestones stipulated in the agreement have been met. Revenue from time and materials contracts is recognized in the period in which the related services have been rendered and costs incurred by the Company. Revenue recognized in the accompanying consolidated statements of operations is not subject to repayment. Revenue received that is related to future performance under such contracts is deferred and recognized as revenue when earned.\nRevenues from product sales are recognized upon shipment and passage of title to the customer.\nECOGEN INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\n1) Summary of Significant Accounting Policies, cont.\nConcentration of credit risk: The Company's product sales are made primarily to distributors of agricultural products located predominantly in North America. The Company does not generally require collateral or other security to ensure collection of trade receivables, except for certain international sales, where letters of credit are generally obtained.\nIntangible and other assets: Intangible and other assets include purchased proprietary technology, patents, license fees and cost in excess of net assets acquired. Amounts capitalized are amortized over their estimated useful lives which range from 2.5 years to 15 years. Technology acquired that is still in the research and development stage is charged to operations. Amortization expense on intangible assets amounted to $135,631 in 1995, $118,761 in fiscal 1994, and $165,239 in 1993.\nCash and cash equivalents: For purposes of the consolidated statements of cash flows, the Company considers all highly liquid temporary investments purchased with an original maturity of three months or less to be cash equivalents. Cash equivalents consist primarily of U.S. Government obligations, commercial paper and foreign money market accounts and are carried at cost which approximates market value.\nTemporary investments: Temporary investments consist of U.S. Government obligations and commercial paper with original maturities greater than three months and are carried at cost which approximates market value. The Company adopted Statement of Financial Accounting Standards No. 115 (FAS 115), \"Accounting for Certain Investments in Debt and Equity Securities\", as of January 1, 1994. Adoption of FAS 115 had no material impact on the Company's consolidated financial position or results of operations.\nNet loss per common share: Net loss per common share is computed using the weighted average number of shares outstanding during the period. Common stock equivalents are not included in the computation of weighted average shares outstanding since the effect would be anti-dilutive.\nForeign currency translation: Substantially all assets and liabilities of the Company's foreign subsidiaries are translated at year-end exchange rates while related income and expenses are translated at rates which approximate the exchange rates prevailing during the year. The resulting adjustments are accumulated as a separate component of stockholders' equity. Foreign currency transaction gains (losses) are charged to operations as incurred and amounted to ($16,940) in 1995, $33,452 in fiscal 1994, ($56,673) in 1993.\nIncome Taxes: The Company accounts for income taxes under Financial Accounting Standards No. 109 (FAS 109) \"Accounting for Income Taxes\". Under the asset and liability method of FAS 109, deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and the benefits arising from the realization of operating loss and tax credit carryforwards. 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. A valuation allowance is provided when it is more likely than not that some portion or all of the deferred tax assets will not be realized. Under FAS 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 of the tax rate change.\nECOGEN INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\n1) Summary of Significant Accounting Policies, cont.\nReclassification: Certain amounts contained in the 1994 and 1993 consolidated financial statements have been reclassified to conform to the 1995 presentation.\nUse of Estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\n(2) Inventory\nInventory consists of the following components as of October 31, 1995 and 1994:\n(3) Plant and Equipment\nPlant and equipment consist of the following components as of October 31, 1995 and 1994:\n(4) Accounts Payable and Accrued Expenses\nAccounts payable and accrued expenses consist of the following components as of October 31, 1995 and 1994:\nECOGEN INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\n(5) Long-term Debt\nDuring 1995 the Company received approval from the Israeli government to provide financing for 70% of the cost of scale-up of a manufacturing facility in Israel and certain working capital and research and development financing for a three-year period up to a maximum loan balance of $1.6 million. The equipment loan component of $.5 million will be payable over a 7 year period, with the first two years being interest only at a rate of 5.625% (linked to the Israeli CPI index) and the working capital financing of $1.1 million will be payable over five years with the first three years being interest only. The interest rate on the working capital loan is Israeli prime (currently 15%) +3.275%. The program also includes a grant of $.3 million. The Israeli government will guarantee 85% of the amount financed. To date, the Company has borrowed approximately $154,000 on the Israeli line of credit. Principal payments of approximately $78,000 and $76,000 are due in 1999 and 2000 respectively.\nFurther, the Company obtained a $2.0 million line of credit to be used for leasing of production equipment. To date, the Company has borrowed approximately $466,000 under the line of credit. The Company is required to pay interest only until all of the equipment is ready for use at which time the notes will be converted to a capital lease obligation. The Company expects the lease to be in place in early 1996, and the lease facility will require a 15% security deposit.\n(6) Ecogen Technologies I Incorporated\nIn 1992 and 1993, Ecogen Technologies I Incorporated, a corporation organized by, but not at that time affiliated with, the Company, completed a private placement of 300 units for $10,000 per Unit (ETech Units), each consisting of four shares of common stock of ETech and 2,000 warrants expiring June 1998, each to purchase one share of common stock of the Company at a per share purchase price of $43.75. Purchasers of the ETech Units paid 20% of the purchase price for the ETech Units at the time of closing, with the balance of the purchase price payable in three installments over a two-year period. The placement agent for the ETech financing received commissions amounting to $2,322,750 from this private placement and was issued warrants to purchase 60,000 shares of the Company's common stock at $43.75 per share. The fair value, as determined by an independent investment banker, of the warrants issued to ETech investors and the placement agent was charged to operations as part of the special charge for warrants issued for research.\nDuring 1995, the Company acquired approximately 70% of the outstanding stock of ETech pursuant to which the Company issued 822,240 shares of its common stock having a market value of approximately $11.3 million. The acquisition of approximately 70% of ETech was accounted for under the purchase method of accounting and in fiscal 1995 the Company recorded approximately $9.1 million as a special charge to operations for the value of in-process research and development acquired from ETech. Market feasibility and acceptance has not yet been established with respect to the ETech research programs and there is no assurance that the Company will be successful in its commercialization efforts.\nEffective October 1, 1994, the Company discontinued recording contract revenue and management fees under the ETech agreements because it was the Company's intention to initiate an exchange offer for 20% or more of the ETech shares. Subsequent to October 1, 1994, ETech collected from investors participating in the Exchange Offer and remitted to the Company approximately $3.0 million of payments under the ETech Investor Notes. As a result of the acquisition, effective January 1, 1995, ETech's consolidated financial statements are consolidated with those of the Company resulting in the Company recording 100% of the research and development expenses of ETech programs and reflecting any payments from ETech investors, subsequent to the Exchange Offer, as a long-term obligation. At October 31, 1995 approximately $1.6 million had been recorded as a long-term obligation for cash received from ETech investors not electing to exchange their ETech shares for the Company's shares. The Company assumed the obligation to fund the final installment ($1.6 million) for those units participating in the exchange.\nECOGEN INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\n(6) Ecogen Technologies I Incorporated, cont.\nETech was formed to initiate or accelerate research and development of certain products using technology exclusively licensed or sublicensed by the Company to subsidiaries of ETech. Pursuant to research and development agreements between Ecogen and each of the subsidiaries of ETech, Ecogen is conducting research, development and testing on the technology licensed to the subsidiaries of ETech in exchange for receiving reimbursement from ETech equal to Ecogen's development costs, as defined, plus a research management fee equal to 3.89% of such costs. Further, pursuant to a services agreement ETech pays the Company a management fee equal to 5.75% of ETech's program subsidiaries' fully burdened costs. It is anticipated that the work Ecogen is performing will utilize substantially all of the net proceeds from the sale of the ETech Units. During 1993, the Company earned contract revenue and management fees of $8,118,000 and $717,000, respectively from ETech. During fiscal 1994, the Company earned contract revenue and management fees of $6,844,000 and $731,000, respectively.\nThe following unaudited pro forma results of operations for the years ended October 31, 1995 and 1994 give effect to the acquisition of ETech as though it had occurred on November 1, 1993 instead of December 31, 1994, the effective date of the transaction. The unaudited pro forma results include adjustments to eliminate contract revenue and management fees from Etech and to include all operating expenses of Etech as if Etech was a consolidated subsidiary on November 1, 1993. The following unaudited pro forma results of operations do not include the 1995 nonrecurring charge to operations of approximately $9.1 million ($1.85 per share) for the purchased technology.\nThe unaudited pro forma results of operations are not necessarily indicative of the actual results of operations that would have occurred had the acquisition been made on November 1, 1993, or the results which may occur in the future.\n(7) Research, Development and License Agreements\nDuring 1991 and 1992 the Company, through Ecogen Europe S.r.l. (Ecogen Europe), a majority owned subsidiary of Ecogen Inc., entered into two long-term research and development agreements with 3A S.r.l. (3A), an Italian corporation. Ecogen Europe was owned 75% by the Company and 25% by 3A. On October 23, 1995 the Company terminated its European research and development agreements with 3A. As part of the transaction, Ecogen transferred its ownership interest in Ecogen Europe to 3A and Ecogen Europe changed its name to Bio Integrated Technology S.r.l. (BIT).\nAs a result of the deal, Ecogen is released from the obligation to provide $5.6 million of funding to Ecogen Europe. Further, as part of the transaction, the Company received cash of approximately $1.0 million and 683,202 of its common shares that had been held by Ecogen Europe. The Company licensed to BIT the Company's existing nematode technology for use solely in Europe, Africa and the Middle East (\"BIT Territory\") and agreed to provide BIT with improvements to certain of its nematode formulation technology. BIT licensed to the Company nematode technology for use outside of BIT's Territory. The Company also licensed to BIT certain of its existing Bt technology principally 12 non-commercialized strains and process and formulation technology solely for use in BIT's Territory. The Company will also pay BIT until the year 2002 a royalty on net sales in BIT's Territory of certain biofungicide products. The Company recorded a gain of approximately $.2 million on the transaction.\nECOGEN INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\n(7) Research, Development and License Agreements, cont.\nThe following unaudited pro forma results of operations for the years ended October 31, 1995 and 1994 give effect to the acquisition of ETech (note 6) and the disposition of the Company's interest in Ecogen Europe as though it had occurred on November 1, 1993. The unaudited pro forma results include adjustments to eliminate Ecogen Europe's operations including principally contract revenue interest income and research and development expense as if Ecogen Europe was not a consolidated subsidiary on November 1, 1993. The unaudited pro forma results of operations do not include the 1995 non recurring gain of approximately $.2 million ($.04 per share) recorded on the Ecogen Europe transaction and $9.1 million for purchased technology for ETech.\nThe unaudited pro forma results of operations are not necessarily indicative of the actual results of operations that would have occurred had the acquisition\/disposition been made on November 1, 1993, or the results which may occur in the future.\nIn connection with one of the 3A research agreements, the Company had a consulting agreement with a corporation whose president was a director of Ecogen Europe and a former director of the Company. Under this agreement, the Company was obligated to issue 10,000 unregistered shares of common stock as a stock award. The estimated fair value of this stock of $249,375 was recorded as a research agreement expense. Such shares of common stock were issued in 1994. The Company also paid consulting fees to this individual aggregating $75,000 and $100,000 in fiscal 1994 and 1993, respectively.\nFurther, in 1994 the Company paid 3A, $132,000 for management fees and facilities costs in Italy.\n(8) Preferred Stock\nSeries A Convertible Preferred Stock During 1995 and 1993, holders converted 260,000 and 240,000 shares respectively, of the Series A convertible preferred stock to common stock in accordance with its terms.\nSeries B Convertible Preferred Stock In September 1995, the Company raised $.7 million net of expenses from two institutional investors in exchange for 35,000 shares of 8% Series B Convertible Preferred Stock (the \"Series B Preferred Stock\"). Dividends are payable annually in either cash, shares of Series B Preferred Stock or shares of the Company's common stock at the discretion of the Company. Each share of Series B Preferred Stock entitles the holder, to one vote on all matters presented to the Company's stockholders for a vote. At the election of the holder, the Series B Preferred Stock may be converted at various dates to shares of the Company's common stock, subject to adjustments for stock splits and adjustments, at predetermined discounts from the average market price per share over a five day trading period preceding the date of conversion. At any time after September 8, 1996, the Company may elect to convert the shares to common stock. Any time after September 15, 1997, the Company may redeem the Series B Preferred Stock at a predetermined premium to the original issuance price. In the event of liquidation the holders of the Series B Preferred Stock have the right to $20.00 per share plus all accrued and unpaid dividends. Subsequent to October 31, 1995, 17,499 shares of the Company's the Series B Preferred Stock were converted into 68,856 shares of the Company's common stock.\nECOGEN INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\n(8) Preferred Stock, cont.\nSeries C Convertible Preferred Stock In November 1995, the Company raised $2.8 million net of expenses, from institutional investors in exchange for 122,000 shares of 8% Series C Convertible Preferred Stock (the \"Series C Preferred Stock\"). Dividends are payable annually or at the time of redemption or conversion in cash, shares of the Company's common stock or shares of Series C Preferred Stock at the discretion of the Company. The Series C Preferred holders have certain limited voting rights. At the election of the holders, pursuant to a predetermined schedule, the Series C Preferred Stock may be converted to shares of the Company's common stock, subject to adjustments for stock splits and adjustments, at predetermined discounts from the average market price per share on the date of conversion. At any time after June 1, 1997, the Company may elect to convert the shares to common stock. At any time after June 11, 1997, the Company may redeem the Series C Preferred Stock at a predetermined premium to the original issuance price. In the event of liquidation the holders of the Series C Preferred Stock have the right to $25.00 per share plus all accrued and unpaid dividends.\n(9) Common Stock\nDuring 1994, the Company raised an aggregate of $1.8 million net of issuance costs from two institutional investors in exchange for 70,000 shares of the Company's common stock. In connection with the transaction, five year warrants to purchase 7,000 shares of the Company's common stock at $29.00 per share were issued.\nIn 1994, the Company also completed a private placement consisting of 83,640 shares of common stock and 83,640 warrants, each to purchase one share of common stock at an exercise price of $43.75 per share until January 1998. The Company raised an aggregate of $1.8 million net of issuance costs from this private placement. In connection with the private placement, the placement agent was granted unit purchase options to purchase 8,364 shares of common stock at $35 per share, and 8,364 warrants to purchase one share of common stock at $43.75 per share, expiring in 1998.\nDuring 1995, the Company raised an aggregate of $7.1 million, net of issuance costs in private placements to institutional investors in exchange for 723,750 shares of the Company's common stock.\n(10) Warrants and Other Options\nAs of October 31, 1995, the Company had the following warrants and options outstanding and exercisable (excluding stock options issued under the Company's stock option plan - see note 11):\nECOGEN INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\n(10) Warrants and Other Options, cont.\nSubsequent to October 31, 1995, 375,190 warrants at exercise prices from $38.25 to $70.00 expired, and 16,899 unit purchase options at an exercise price of $50.00 expired. Further, subsequent to October 31, 1995, the Company issued 75,077 five year warrants to purchase shares of the Company's common stock at $7.30 per share to the placement agents in connection with the private placement of the Company's securities.\n(11) Stock Option Plan\nThe Company has a stock option plan (Option Plan) under which the number of shares of common stock which may be granted under the Option Plan can not exceed 800,000 shares. The Option Plan permits the granting of both incentive stock options and nonstatutory stock options. The option price of the shares for incentive stock options cannot be less than the fair market value of such stock at the grant date. Options are exercisable over a period determined by the Board of Directors, but not longer than ten years after the grant date.\nThe status of the Option Plan for the year ended October 31, 1995 and the ten months ended October 31, 1994 and the year ended December 31, 1993 is as follows:\nSubsequent to October 31, 1995, 197,360 stock options were granted at an exercise price ranging from $5.94 to $7.19 per share and 19,215 options were canceled at exercise prices ranging from $6.30 to $53.55.\nIn addition, during fiscal 1995, employees were given the right to exchange 290,079 options at exercise prices from $32.30 to $65.88 for new options at an exercise price of $10.94, the fair market value at the grant date for the exchange right. The new options are not exercisable until the later of November 13, 1995 or the exercisable date of the option exchanged. Accordingly, options to purchase 290,079 shares were canceled and an equal number of new options were issued, which is reflected in the table above.\nECOGEN INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\n(12) Geographic Area and Related Information\nThe Company's operations consist primarily of the research, development and marketing of biopesticide and related products, which constitutes one industry segment. Information with respect to the Company's operations by geographic area for fiscal year ended October 31, 1995, ten months ended October 31, 1994 and calendar 1993 is as follows:\nOf the $9,940,018, $15,744,243 and $15,501,472 United States revenue from unaffiliated customers in 1995, 1994 and 1993 respectively, $1,433,084, $2,179,315 and $3,481,787 were export revenue from the following geographic areas:\nECOGEN INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\n(13) Income Taxes\nThe tax effects of temporary differences that give rise to significant portions of deferred tax assets and deferred tax liabilities as of October 31, 1995 and 1994 are presented below:\nAt October 31, 1995, the Company has net operating loss carryforwards for Federal income tax purposes of approximately $60,612,000 which are available to offset future Federal taxable income, if any, through 2010. The Company also has research and experimentation tax credit carryforwards for Federal income tax purposes of approximately $2,414,000 which are available to reduce future Federal income taxes, if any through 2010. The Company's ability to use such net operating loss and research and experimental credit carryforwards is subject to certain limitations due to ownership changes, as defined by rules enacted with the Tax Reform Act of 1986.\n(14) Commitments and Other Matters\nLeases: The Company leases its facilities and certain equipment and automobiles under various noncancellable operating leases. Rental expense charged to operations aggregated approximately $816,000, $721,000 and $639,000, for the year ended October 31, 1995, for the ten months ended October 31, 1994 and for the year ended December 31, 1993, respectively.\nMinimum lease payments under noncancelable leases for the years subsequent to October 31, 1995 are as follows:\nECOGEN INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\n(14) Commitments and Other Matters, cont.\nSpecial Charges: Special charges consist of the following:\nIn 1995 the Company recorded a special charge for purchased technology resulting from the acquisition of a majority interest in ETech. Also in 1995, restructuring costs represent amounts incurred in connection with the shut down of Ecogen Australia and personnel reductions at the Company, including agreements with a former officer and director of the Company, and a former officer and current director. Included in severance costs are $364,500, $174,500 and $174,500 which will be due in 1996, 1997 and 1998, respectively. Such amounts are included in accounts payable and accrued expenses and other long-term obligations on the accompanying consolidated balance sheet at October 31, 1995.\nDuring 1993, the Company incurred a special marketing charge amounting to $2,008,325 in connection with the repositioning of its Bt product line, and recorded a special charge of $1,597,750 for the cost of warrants issued in connection with the ETech research and development agreement.\nOther: Sales derived from one customer aggregated 15% of total revenues in 1995. Sales derived from another customer aggregated 10% of total revenues in 1994. Contract revenues derived from one entity aggregated 35% and 41% of total revenues in 1994 and 1993, respectively. Contract revenues derived from another entity aggregated 11% of total revenues in 1995 and 1993, respectively.\n(15) Profit Sharing 401(k) Plan\nEffective January 1, 1988, the Company established a 401(k) Profit Sharing Plan (the 401(k) Plan) which covers substantially all employees. All eligible employees may elect to contribute a portion of their wages to the 401(k) Plan, subject to certain limitations. The Company contributes 50% of the employees' contributions, subject to a maximum equal to 6% of the employees compensation. The matching Company contribution vests over a five-year period. The Company contributed approximately $126,000, $127,000, and $136,000 to the 401(k) Plan in 1995, fiscal 1994 and 1993, respectively.\n(16) Related Party Transactions\nA Director, elected subsequent to October 31, 1995, is a partner of a law firm that has acted as legal counsel to the Company. The Company paid fees of $668,234, $566,550 and $674,374 to this law firm during fiscal 1995, ten months ended October 31, 1994 and year ended 1993, respectively.\nECOGEN INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\n(16) Related Party Transactions, cont.\nThe Company has engaged an advertising agency, whose principal is the son of the Company's former Chairman and a Company director. Fees to this agency aggregated approximately $932,000, $621,000 and $909,970 in fiscal 1995, the months ended October 31, 1994 and calendar 1993, respectively.\nIn 1994 and 1993, the Company had a consulting agreement with a company that is affiliated with a former director of Ecogen and Ecogen Europe for administration services provided to Ecogen Europe. Fees paid under this agreement aggregated $60,000 in 1994 and 1993.\nManagement believes that all transactions with related parties were conducted on an arm's-length basis.\n(17) Subsequent Events\nMonsanto Transaction On January 24, 1996 the Company entered into an agreement with Monsanto Company (Monsanto) for an equity investment, purchase of technology and joint research and development arrangement relating to the Company's proprietary Bacillus thuringiensis (Bt) technology for in plant applications (collectively, the \"Monsanto Transaction\"). The transaction includes the acquisition by Monsanto of certain rights inthe Company's Bt technology for an aggregate purchase price of $5.0 million in cash which will be recorded as other revenue in the first quarter of 1996, the sale by the Company to Monsanto of 943,396 shares of Common Stock at $10.60 per share for an aggregate purchase price of $10.0 million in cash (the Common Stock Sale), and a four year research and development collaboration arrangement with Monsanto for the further development of the Company's Bt gene library for a minimum of $10.0 million, of which $3.0 million was paid in advance and recorded as deferred contract revenue. Such contract revenue will be recorded as earned under the terms of the agreement.\nUnder the terms of the agreement, Monsanto purchased $10 million of the Company's Common Stock at $10.60 per share of which $7.3 million was received on January 24, 1996 and $2.7 million was received on January 29, 1996. As part of the agreement, Monsanto has agreed to maintain its ownership position during the term of the research and development agreement and Monsanto is prohibited, during the first three years following the closing, from acquiring more than 25% of the Company's voting stock without the Company's consent. Monsanto was granted certain demand and piggyback registration rights with respect to its shares. In addition, Monsanto has a right of first refusal to purchase securities of the Company so as to maintain its ownership percentage in the Company.\nReverse Stock Split On January 29, 1996 the shareholders approved an amendment to the Company's Restated Certificate of Incorporation (the \"Amendment\") which effected a one-for-five reverse split (the \"Reverse Split\") of the Company's outstanding shares of common stock. All references to numbers of shares, weighted averages shares and loss per share amounts except shares authorized, have been retroactively restated to give effect to the stock split.\nECOGEN INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\n(17) Subsequent Events, cont.\nUnaudited Pro Forma Consolidated Balance Sheet The unaudited pro forma consolidated balance sheet presented is based upon the Company's historical consolidated balance sheet at October 31, 1995 after giving effect to the $17.5 million of cash received net of transaction costs, of which $3.0 million is deferred contract revenue. The historical accumulated deficit at October 31, 1995 includes an adjustment of $5.0 million of other income associated with the transaction which will be recorded in the first quarter of 1996. The unaudited pro forma consolidated balance sheet should be read in conjunction with the Company's historical consolidated financial statements and accompanying notes thereto.\nSchedule VIII ECOGEN INC. AND SUBSIDIARIES\nVALUATION AND QUALIFYING ACCOUNTS\nYEAR ENDED OCTOBER 31, 1995, TEN MONTHS ENDED OCTOBER 31, 1994 AND YEAR ENDED DECEMBER 31, 1993\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nECOGEN INC.\nBy: \/s\/ Mary Paetzold Mary Paetzold Vice President and Chief Financial Officer\nDated: January 29, 1996\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints James P. Reilly, Jr. and Mary Paetzold, or any of them, his attorney-in-fact, each with the power of substitution, for him in any and all capacities, to sign any amendments to this Annual Report, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact, or his substitute or substitutes, may do or cause to be done by virtue hereof.\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons in the capacities indicated as of the 29th day of January, 1996.","section_15":""}
{"filename":"791269_1995.txt","cik":"791269","year":"1995","section_1":"ITEM 1. BUSINESS --------\nCHRYSLER CORPORATION --------------------\nGENERAL -------\nChrysler Corporation was incorporated under the laws of the State of Delaware on March 4, 1986, and is the surviving corporation following mergers with a number of its operating subsidiaries, including Chrysler Motors Corporation which was originally incorporated in 1925.\nChrysler Corporation and its consolidated subsidiaries (\"Chrysler\") operate in two principal industry segments: automotive operations and financial services. Automotive operations include the research, design, manufacture, assembly and sale of cars, trucks and related parts and accessories. Financial services include the operations of Chrysler Financial Corporation and its consolidated subsidiaries (\"CFC\"), which are engaged principally in providing consumer and dealer automotive financing for Chrysler's products. Chrysler also participates in short-term vehicle rental activities through certain of its subsidiaries (the \"Car Rental Operations\") and engages in aircraft modification and the manufacture of electronics products and systems through its Chrysler Technologies Corporation subsidiary. Chrysler's principal executive offices are located at Chrysler World Headquarters, 1000 Chrysler Drive, Auburn Hills, Michigan 48326-2766. The telephone number of those offices is (810) 576-5741.\nAUTOMOTIVE OPERATIONS ---------------------\nChrysler manufactures, assembles and sells cars and trucks under the brand names Chrysler, Dodge, Plymouth, Eagle and Jeep(R), and related automotive parts and accessories, primarily in the United States, Canada and Mexico (\"North America\"). Passenger cars are offered in various size classes and models. Chrysler produces trucks in pickup, sport-utility and van\/wagon models, which constitute the largest segments of the truck market. Chrysler also purchases and distributes certain passenger cars manufactured in Japan by Mitsubishi Motors Corporation (\"MMC\"), as well as cars manufactured in the United States by MMC's subsidiary, Mitsubishi Motors Manufacturing of America (\"MMMA\"), formerly Diamond-Star Motors Corporation.\nAlthough Chrysler currently sells most of its vehicles in the United States, Canada and Mexico, Chrysler also participates in other international markets through its subsidiaries, Chrysler Motors de Venezuela, S.A., Chrysler Japan Sales Limited (\"CJSL\"), Chrysler do Brasil Comercial Exportadora Importadora Ltda., and Chrysler Sales & Services (Thailand) Ltd., and indirectly through its minority investments in Beijing Jeep Corporation, Ltd. and Arab American Vehicles Company. Chrysler sells to independent distributors in Europe and other world markets vehicles which are produced in North America by Chrysler and in Austria by Eurostar Automobilwerk Ges.mb.H & Co. KG (\"Eurostar\"), a joint venture between Chrysler and Steyr-Daimler-Puch Fahrzeugtechnik (\"Steyr\") in Graz, Austria.\nChrysler's strategy is to focus on its core automotive business. As part of this strategy, Chrysler has sold certain assets and businesses which are not related to its core automotive business, and is exploring the sale of other such assets and businesses in the near term.\nTHE AUTOMOTIVE INDUSTRY IN NORTH AMERICA - ----------------------------------------\nThe automotive industry in North America is highly competitive with respect to a number of factors, including vehicle quality, price, development and introduction time, appearance, size, special options, distribution organization, warranties, reliability, safety, fuel economy, dealer service and financing terms. As a result, Chrysler's ability to increase vehicle prices and to use retail sales incentives effectively are significantly affected by the pricing actions and sales programs of its principal competitors. Moreover, the introduction of new products by other manufacturers may adversely affect the market shares of competing products made by\nITEM 1. BUSINESS -- CONTINUED PART I -- CONTINUED ---------------------\nAUTOMOTIVE OPERATIONS -- CONTINUED - ----------------------------------\nTHE AUTOMOTIVE INDUSTRY IN NORTH AMERICA -- CONTINUED - -----------------------------------------------------\nChrysler. Recently, Chrysler has been very successful in bringing new products to market, in greatly reduced vehicle development time. However, many of Chrysler's competitors have larger worldwide sales volumes and greater financial resources, which may, over time, place Chrysler at a competitive disadvantage in responding to new competitor offerings, substantial changes in consumer preferences, governmental regulations, or adverse economic conditions in North America.\nChrysler's long-term profitability will depend significantly on its ability to continue its capital expenditure and vehicle development programs and market its products successfully. The success of Chrysler's new vehicles will depend on a number of factors, including general economic conditions, competition, consumer acceptance, product quality, new product development, the effect of governmental regulation and the strength of Chrysler's marketing and dealer networks. As both Chrysler and its competitors plan to introduce new products, Chrysler cannot predict the market shares its new products will achieve. Moreover, Chrysler is substantially committed to its product plans and would be adversely affected by events requiring a major shift in product development.\nChrysler's principal competitors in North America are General Motors Corporation and Ford Motor Company. In addition, a number of foreign automotive companies own and operate manufacturing and\/or assembly facilities in North America (\"transplants\"), and there are a number of other foreign manufacturers that distribute automobiles and light-duty trucks in North America.\nITEM 1. BUSINESS -- CONTINUED PART I -- CONTINUED ---------------------\nAUTOMOTIVE OPERATIONS -- CONTINUED ----------------------------------\nUNITED STATES --------------\nThe tables below set forth comparative market share data for retail sales of cars and trucks in the United States for the major manufacturers (including cars and trucks imported by them) and for foreign-based manufacturers, and unit sales of passenger cars and trucks (including imports) by Chrysler.\n- ------------------------- (1) All U.S. retail sales data are based on publicly available information on manufacturers from the American Automobile Manufacturers Association and data on foreign company imports from Ward's Automotive Reports, a trade publication.\n(2) \"Foreign-Based Manufacturers\" include imports and vehicles assembled and sold in the United States by foreign companies.\n(3) U.S. truck retail market share includes minivans.\nITEM 1. BUSINESS -- CONTINUED PART I -- CONTINUED ---------------------\nAUTOMOTIVE OPERATIONS -- CONTINUED - ----------------------------------\nUNITED STATES -- CONTINUED - --------------------------\nCompetition from foreign car and truck manufacturers, in the form of both exports to the United States and sales by transplants, is substantial. The market share for foreign passenger cars sold in the United States (including transplants) was 36.3 percent in 1995, compared to 35.4 percent in 1994. The market share for foreign trucks sold in the United States (including transplants) was 14.9 percent in 1995, compared to 15.3 percent in 1994. Vehicles assembled in the United States by Japanese manufacturers have significantly contributed to the market share obtained by foreign-based manufacturers. Japanese transplant sales accounted for approximately 18.5 percent of the U.S. passenger car market and 5.3 percent of the U.S. truck market in 1995, compared to 16.1 percent and 5.6 percent, respectively, in 1994.\nCHRYSLER CANADA LTD. - --------------------\nChrysler's consolidated subsidiary, Chrysler Canada Ltd. (\"Chrysler Canada\"), operates manufacturing and assembly facilities and sales and distribution networks in Canada. Chrysler Canada, whose operations are substantially integrated with Chrysler's U.S. operations, manufactures components and assembles minivans, mid-size and large sedans, and full-size vans.\nIn 1995 and 1994, Chrysler Canada shipped 540,493 and 692,615 vehicles, respectively, the majority of which were sold outside of Canada. Chrysler Canada's retail sales totaled 225,122 vehicles in 1995 and 247,752 vehicles in 1994, the majority of which were manufactured outside of Canada. Chrysler Canada's retail unit sales of cars accounted for 14.6 percent and 15.7 percent of the Canadian car market in 1995 and 1994, respectively. In 1995, retail unit sales of trucks accounted for 25.8 percent of the Canadian truck market compared with 25.7 percent in 1994. In 1995, Chrysler Canada ranked third in the Canadian industry in retail unit sales of both cars and trucks.\nCHRYSLER DE MEXICO S.A. - -----------------------\nChrysler's consolidated subsidiary, Chrysler de Mexico S.A. (\"Chrysler Mexico\"), operates assembly and manufacturing facilities in Mexico, producing vehicles and components for both Mexican and export markets. In addition, Chrysler Mexico provides certain major automobile components to Chrysler, including engines and air conditioning condensers.\nChrysler Mexico manufactured 207,004 vehicles in 1995 and 238,888 vehicles in 1994. Of these totals, 26,503 vehicles and 77,832 vehicles were sold in Mexico in 1995 and 1994, respectively. Sales of vehicles exported to Mexico were not significant in 1995 or 1994. The decrease in vehicles manufactured and sold in Mexico was primarily attributable to unfavorable economic conditions in Mexico, commencing with the devaluation of the Mexican peso in December 1994. Chrysler's operating results will continue to be adversely affected to the extent that the unfavorable economic conditions in Mexico continue.\nChrysler Mexico's vehicle sales accounted for 14.6 percent of the Mexican wholesale car market and 16.9 percent of the Mexican wholesale truck market in 1995, compared with 13.1 percent and 19.4 percent, respectively, in 1994. Within the Mexican industry, Chrysler Mexico's wholesale unit sales ranked fourth in both cars and trucks in 1995. In 1995, overall wholesale industry sales in Mexico are estimated to have been approximately 235,500 units, compared with 620,000 units in 1994, a decrease of 62.0 percent. Although Chrysler expects the economic conditions in Mexico to improve slightly in 1996, Chrysler cannot predict when the Mexican automotive industry sales will return to predevaluation levels.\nINTERNATIONAL OPERATIONS - ------------------------\nChrysler's automotive operations in Europe consist primarily of manufacturing operations in Austria, where Jeep Grand Cherokees and Chrysler Voyagers are produced, and the export of finished vehicles and\nITEM 1. BUSINESS -- CONTINUED PART I -- CONTINUED --------------------- AUTOMOTIVE OPERATIONS -- CONTINUED - ---------------------------------- INTERNATIONAL OPERATIONS -- CONTINUED - ------------------------------------- component kits produced in North America to independent foreign distributors and local manufacturers. In addition, Chrysler opened a parts distribution center in 1995 and will open a European Headquarters Office in Brussels, Belgium in 1996.\nChrysler's Latin American operations include an assembly facility in Venezuela. During 1995, Chrysler established wholly owned distribution companies in Brazil and Argentina and announced its intent to establish a manufacturing facility in Argentina to produce vehicles for sale in South America. Production of the Chrysler Neon will begin in Venezuela in 1996 and the Jeep Grand Cherokee will be produced in Argentina beginning in 1997.\nChrysler's automotive operations in Asia consist of both manufacturing and assembly of Jeep vehicles in Beijing, China and assembly of component kits in Malaysia and Indonesia. During 1995, Chrysler expanded its presence in Asia by purchasing a majority interest in its Japanese distributor (CJSL), opening a parts distribution center in Singapore and entering into a joint-venture in Thailand to sell Chrysler products. In addition, Chrysler received a license to build a plant in Vietnam, where assembly of Dakota pickup trucks is anticipated. Chrysler also has an equity interest in a company with manufacturing and assembly facilities in Egypt.\nChrysler expects to continue to focus on growth opportunities in major markets such as Western Europe, Japan and China and will explore developing markets in South America, Eastern Europe and the Asia-Pacific region. New manufacturing and joint venture operations could be established if market conditions, sales levels and profitability opportunities are consistent with Chrysler's corporate objectives.\nChrysler's expansion strategy in international markets includes integrating international and North American product development which enables Chrysler to make European and right-hand-drive versions available overseas shortly after left-hand-drive versions debut in the U.S. During 1995, right-hand-drive and diesel engine options have been added to many product lines to enhance product acceptance and growth opportunities in international markets. By the end of 1996, five right-hand-drive models (Chrysler Neon, Chrysler Voyager and Jeep Cherokee, Grand Cherokee and Wrangler) will be available in certain markets, such as the United Kingdom, Australia, South Africa and Japan.\nChrysler shipped 168,860 vehicles to international markets in 1995, an increase of 23 percent from 1994. Chrysler sold 90,016 units in European markets and 78,844 units in other world markets, primarily Japan, Taiwan and the Middle East. In addition, Chrysler exported 40,892 kits to worldwide affiliates for assembly in 1995, compared to 24,272 kits in 1994. The majority of the kits were Jeep products shipped to China, Indonesia and Venezuela.\nEurostar sold 37,063 minivans in 1995, compared to 38,830 in 1994. The decline in minivan sales was primarily attributable to the launch of Chrysler's all-new minivans at the Graz, Austria assembly plant in the third quarter of 1995. In addition, Chrysler, under an assembly agreement with Steyr, began production of Jeep Grand Cherokees in Austria during the fourth quarter of 1994 for European and other world markets.\nChrysler presently does not have significant risks related to changes in currency exchange rates as Chrysler is primarily a North American automotive company. Chrysler does, however, have international component sourcing and growing international sales. When Chrysler sells vehicles outside the United States or purchases components from suppliers outside the United States, transactions are frequently denominated in currencies other than U.S. dollars. The primary foreign currencies in which Chrysler has activities are the German mark, French franc, Japanese yen, Canadian dollar, Mexican peso, Taiwan dollar, Austrian schilling and British pound. To the extent possible, receipts and disbursements in a specific currency are offset against each other. In addition, Chrysler periodically initiates hedging activities by entering into currency exchange agreements, consisting primarily of currency forward contracts and purchased currency options, to minimize revenue and cost variations which could result from fluctuations in currency exchange rates. Chrysler also\nITEM 1. BUSINESS -- CONTINUED PART I -- CONTINUED --------------------- AUTOMOTIVE OPERATIONS -- CONTINUED - ---------------------------------- INTERNATIONAL OPERATIONS -- CONTINUED - ------------------------------------- utilizes written currency options to effectively close out existing purchased currency options. At December 31, 1995, Chrysler had currency exchange agreements for the German mark, French franc, Japanese yen and British pound. Chrysler's operating results are affected by changes in currency exchange rates during the period in which transactions are executed, to the extent that hedge coverage does not exist. However, the impact of any changes in currency exchange rates on unhedged transactions is not expected to be material to Chrysler's operating results or financial position.\nChrysler does not use derivative financial instruments for trading purposes. Chrysler's hedging activities are based upon purchases and sales which are exposed to foreign currency risk. The currency exchange agreements which provide hedge coverage typically mature within two years of origination, consistent with the underlying purchase or sales commitment. These hedging instruments are periodically modified as existing commitments are fulfilled and new commitments are made. Chrysler's management believes that its hedging activities have been effective in reducing Chrysler's limited risks related to currency exchange fluctuations.\nMITSUBISHI MOTORS CORPORATION - -----------------------------\nUnder the terms of the United States Distribution Agreement (\"USDA\") in effect between Chrysler and MMC, which terminates in March 1998, Chrysler imports and distributes selected models of passenger cars manufactured by MMC in Japan. In 1995, Chrysler sold 14,823 MMC-manufactured vehicles in the United States, representing less than one percent of Chrysler's U.S. retail vehicle sales. In 1994, Chrysler sold 28,849 MMC-manufactured vehicles in the United States, representing slightly more than one percent of Chrysler's U.S. retail vehicle sales. An agreement similar to the USDA is in effect covering the Canadian market. Chrysler's imported vehicles have posted relatively low sales in recent years. As a result, during 1996, Chrysler and MMC plan to consider an early termination of the existing USDA.\nIn addition to passenger cars, Chrysler purchases 2.5-liter and 3.0-liter V-6 engines from MMC for use in the production of certain minivans and other vehicles. Chrysler purchased approximately 372,000 such engines during 1995. MMMA produces small sporty cars in the United States for Chrysler and Mitsubishi Motor Sales of America. Pursuant to a distribution agreement that terminates in July 1999, Chrysler retains the right to purchase vehicles up to a specific maximum allocation that has been agreed to by the parties for each model year.\nIn addition, Chrysler will provide engines and transmissions for use in certain MMMA vehicles. Chrysler's sales of MMMA-manufactured vehicles in 1995 and 1994 represented 3.7 and 1.7 percent, respectively, of Chrysler's U.S. retail vehicle sales volume in each period. Chrysler does not anticipate any major changes to its MMMA distribution agreement during 1996.\nChrysler previously owned an equity interest in both MMC and MMMA. Chrysler sold its 50 percent interest in MMMA to MMC, its partner in the joint venture, in October 1991. Chrysler subsequently sold its equity interest in MMC in 1992 and 1993.\nSEGMENT INFORMATION - -------------------\nIndustry segment and geographic area data for 1995, 1994 and 1993 are summarized in Part II, Item 8, Notes to Consolidated Financial Statements, Note 17.\nSEASONAL NATURE OF BUSINESS - ---------------------------\nReflecting retail sales fluctuations of a seasonal nature, production varies from month to month in the automotive business. In addition, the changeover period related to model year introductions has traditionally\nITEM 1. BUSINESS -- CONTINUED PART I -- CONTINUED --------------------- AUTOMOTIVE OPERATIONS -- CONTINUED - ---------------------------------- SEASONAL NATURE OF BUSINESS -- CONTINUED - ---------------------------------------- occurred in the third quarter of each year. Accordingly, third quarter operating results are generally less favorable than those in the other quarters of the year.\nAUTOMOTIVE PRODUCT PLANS - ------------------------\nChrysler's automotive design and development activities are organized into cross-functional product development groups called \"platform teams.\" The platform team system is designed to improve communications, reduce the design and development time of new vehicles, improve product quality, and reduce the cost of developing new vehicle lines. The platform team concept has contributed significantly to Chrysler's success in recent years.\nChrysler introduced an all-new compact car marketed as the Chrysler Cirrus in the third quarter of 1994. The Cirrus offers newly designed engines, includes driver and passenger airbags, and utilizes Chrysler's \"cab-forward\" design. The Cirrus received the Motor Trend Car of the Year Award in 1995. A Dodge version of the vehicle, the Dodge Stratus, was introduced in the first quarter of 1995. In addition, a Plymouth version of the vehicle, the Plymouth Breeze, was added in the 1996 model year.\nChrysler added the Dodge Avenger in the third quarter of 1994 and introduced the Chrysler Sebring in the first quarter of 1995. These two-door coupes compete in the mid-specialty segment and are built exclusively for Chrysler by MMMA.\nChrysler introduced its all-new minivan in the first quarter of 1995. The new Chrysler Town & Country, Dodge Caravan, and Plymouth Voyager provide many unique product features, including a driver's side sliding door. Despite its classification as a truck, the Dodge Caravan was named the Motor Trend Car of the Year in 1996. Chrysler held 42.1 percent and 43.4 percent of the U.S. minivan segment in 1995 and 1994, respectively. In spite of increased competition in this segment and reduced availability due to model changeover, retail sales of Chrysler minivans in the United States were 493,997 in 1995, compared to 513,163 in 1994.\nThe Chrysler Sebring convertible, which utilizes \"cab-forward\" styling in a convertible model, was added to Chrysler's product lineup in the 1996 model year.\nIn January 1996, Chrysler announced its intent to produce the Plymouth Prowler convertible as a 1997 1\/2 model unique to the Plymouth brand. The Prowler draws on the heritage of \"street rods\" for its retro styling cues, but offers all the technology and customer convenience of a '90s production car. As a small volume niche vehicle, the Prowler will serve as a technology testbed for aluminum body and chassis applications.\nChrysler will begin production of a substantially redesigned Jeep Wrangler in early 1996. It includes an all-new suspension, front and rear, an all-new interior with an integrated instrument panel, and improved front and rear passenger accommodations, while maintaining Wrangler's traditional exterior styling and rugged appearance. Also included are driver and passenger airbags.\nIn March 1996, Chrysler will launch the new Viper GTS, a coupe version of the original Viper roadster which was the first vehicle developed under Chrysler's platform team system. In addition, the Dodge Dakota pickup truck will undergo a major renewal for the 1997 model year.\nAUTOMOTIVE MARKETING - --------------------\nNew passenger cars and trucks are sold at retail by dealers who have sales and service agreements with Chrysler. The dealers purchase cars, trucks, parts and accessories from Chrysler for sale to retail customers. In the United States, Chrysler had 4,652 dealers at December 31, 1995 compared with 4,687 at December 31,\nITEM 1. BUSINESS -- CONTINUED PART I -- CONTINUED ---------------------\nAUTOMOTIVE OPERATIONS -- CONTINUED - ----------------------------------\nAUTOMOTIVE MARKETING -- CONTINUED - ---------------------------------\n1994. Chrysler Canada had 609 dealers at December 31, 1995 compared with 607 dealers at December 31, 1994.\nThe quality and strength of Chrysler's dealer organization will have an important impact on future sales. Chrysler maintains programs to provide dealership operating capital through equity investments where sufficient private capital is not available. The programs anticipate that the dealer receiving such assistance will eventually use its share of the dealership profits to purchase Chrysler's equity investment. Chrysler's equity interest in U.S. and Canadian dealerships totaled $22 million in 51 dealerships as of December 31, 1995, compared with $28 million in 64 dealerships as of December 31, 1994.\nChrysler continues to focus on quality customer service. A redesigned customer satisfaction survey process provides Chrysler and its franchised dealers continuous customer feedback regarding dealer sales, service and parts operations. In addition, the Chrysler Customer Center is designed to promote customer satisfaction and communicate customer concerns to dealers and internally to vehicle platform teams.\nMANUFACTURED AND PURCHASED COMPONENTS AND MATERIALS - ---------------------------------------------------\nChrysler continues to focus on its core automotive business. Chrysler manufactures most of its requirements for engines, transmissions and transaxles, certain body stampings, electronic components, and fabricated glass parts.\nChrysler purchases materials, parts and other components from numerous unaffiliated suppliers. Chrysler used approximately 1,150 suppliers of productive materials in 1995, compared to approximately 1,250 used in 1994. Interruptions in production or delivery of these productive materials could adversely affect Chrysler. Chrysler purchases a larger portion of its productive materials from unaffiliated suppliers than do its principal competitors and expects to continue purchasing its requirements for these items rather than manufacturing them.\nGOVERNMENT REGULATION - ---------------------\nVEHICLE REGULATION - ------------------\nFuel economy, safety and emissions regulations and standards applicable to motor vehicles have been issued from time to time under a number of federal statutes, including the National Traffic and Motor Vehicle Safety Act of 1966 (the \"Safety Act\"), the Clean Air Act, Titles I and V of the Motor Vehicle Information and Cost Savings Act and the Noise Control Act of 1972. In addition, the State of California has promulgated exhaust emission standards, some of which are more stringent than the federal standards. Other states may, under the Clean Air Act, adopt vehicle emission standards identical to those adopted by the State of California. The States of New York, Massachusetts, Connecticut, Maine, and New Jersey have also adopted California standards and several other states are considering similar action. Federal courts have generally upheld New York and Massachusetts' adoption of the California standards.\nVehicle Emissions Standards\nUnder the Clean Air Act, auto manufacturers are required, among other things, to significantly reduce tailpipe emissions of polluting gases from automobiles and light trucks and are obligated to recall vehicles for failure to meet emission standards for a period of ten years or 100,000 miles, whichever occurs first. This Act imposes standards for model years through 2003 that require further significant reductions in motor vehicle emissions and directs the U.S. Environmental Protection Agency (\"EPA\") to study the need for much more stringent emissions standards beginning as early as the 2004 model year. This Act also directs the EPA to\nITEM 1. BUSINESS -- CONTINUED PART I -- CONTINUED ---------------------\nAUTOMOTIVE OPERATIONS -- CONTINUED - ----------------------------------\nGOVERNMENT REGULATION -- CONTINUED - ----------------------------------\nVEHICLE REGULATION -- CONTINUED - -------------------------------\nVehicle Emissions Standards -- Continued\nreview the Federal Test Procedure used to measure vehicle tailpipe emissions. The EPA has issued a Notice of Proposed Rulemaking to impose additional test requirements, potentially increasing the stringency of the test. This Act also may require production of certain vehicles capable of operating on fuels other than gasoline or diesel fuel (alternative fuels) under the Clean Fuel Vehicle Program beginning in the 1998 model year. Chrysler is actively pursuing the development of flexible fuel vehicles capable of operating on both gasoline and either methanol or ethanol blend fuels, as well as the development of vehicles capable of operating on compressed natural gas and liquid petroleum gas.\nThe California Air Resources Board (\"CARB\") has received federal approval, pursuant to the Clean Air Act, for its Low Emission Vehicle Program for a series of passenger car and light truck emission standards that are more stringent than those prescribed by the Clean Air Act for the corresponding periods of time. These California standards are intended to promote the development of various classes of low-emission vehicles. Included in this program is a requirement that a specified percentage of each manufacturer's California light-duty production volume, beginning at two percent in 1998 and increasing to ten percent in 2003, be zero-emission vehicles (\"ZEVs\") that produce no emissions of regulated pollutants. Chrysler has entered into a consortium of vehicle manufacturers, electric utilities and the U.S. Department of Energy to develop new battery technology for use in electric vehicles which would qualify as ZEVs and has built a limited number of experimental prototype electric vehicles using existing advanced battery technology. On December 21, 1995, the CARB directed its staff to finalize a plan to modify the ZEV mandate for model years 1998 - 2002. If adopted, the plan would suspend the ZEV mandate until model year 2003, and the program will be replaced by market-based action along with continued research and development on ZEVs as well as a ZEV demonstration program in California.\nOn December 19, 1994, the Administrator of the EPA responded to a petition filed by the Ozone Transport Commission (\"OTC\"), a group of 12 Northeast states and the District of Columbia. The response held that the states comprising the OTC must either adopt the California vehicle emissions standards or a 49 state program advocated by the American Automobile Manufacturers Association (\"AAMA\") (of which Chrysler is a member) and the Association of International Automobile Manufacturers (\"AIAM\"). The Administrator's decision does not require the states that adopt California's general vehicle emission standards to adopt California's ZEV requirement, but permits the states to adopt the ZEV requirement if they elect to do so. New York, Massachusetts and Maine have adopted the California general standards as well as the California ZEV requirement. Connecticut and New Jersey have adopted the general standards but not the ZEV requirement. The EPA issued a Notice of Proposed Rulemaking on October 10, 1995, detailing a voluntary 49 state National Low Emission Vehicle Program which might form the basis of a 49 state program of the type advocated by AAMA and AIAM.\nThe Clean Air Act also requires full implementation of on-board diagnostic systems (\"OBD\") on 1996 model year light-duty vehicles. California has its own OBD requirements which are more stringent than the federal requirements. These OBD requirements are of concern because they may cause increased warranty costs and additional recalls.\nCAFE\nThe Motor Vehicle Information and Cost Savings Act, as amended by the Energy Policy and Conservation Act, requires vehicle manufacturers to provide vehicles that comply with federally mandated Corporate Average Fuel Economy (\"CAFE\") standards. Under this Act, a manufacturer earns credits for\nITEM 1. BUSINESS -- CONTINUED PART I -- CONTINUED ---------------------\nAUTOMOTIVE OPERATIONS -- CONTINUED - ----------------------------------\nGOVERNMENT REGULATION -- CONTINUED - ----------------------------------\nVEHICLE REGULATION -- CONTINUED - -------------------------------\nCAFE -- Continued\nexceeding the applicable fuel economy standards; however, fuel economy credits earned on cars may not be used for trucks. Failure to meet the average fleet fuel economy standards can result in the imposition of penalties unless a manufacturer has sufficient fuel economy credits from the preceding three years or projects that it will generate sufficient credits over the succeeding three years. Chrysler is in substantial compliance with passenger car CAFE requirements and anticipates continued compliance with such requirements. Chrysler anticipates compliance with light-duty truck CAFE through the use of carryback and carryforward credits. In addition, the Energy Tax Act of 1978 imposes a graduated \"Gas Guzzler\" tax on automobiles with a fuel economy rating below specified levels.\nFrom time to time there have been federal legislative and administrative initiatives that would increase CAFE standards from their current levels. In addition, the National Highway Traffic Safety Administration (\"NHTSA\") has initiated rulemaking to set more stringent light truck CAFE standards for the 1998-2006 model years. A significant increase in those requirements could be costly to Chrysler and could result in significant restrictions on the products Chrysler offers.\nVehicle Safety\nUnder the Safety Act, NHTSA is required to establish federal motor vehicle safety standards that are practicable, meet the need for motor vehicle safety and are stated in objective terms. NHTSA has announced its intention to upgrade certain existing standards and to establish additional standards in the future. Chrysler expects to be able to comply with those standards.\nVehicle Recalls\nUnder the Clean Air Act, the EPA may require manufacturers to recall and repair vehicles that fail to meet emission standards established under that Act. Similarly, the Act authorizes the State of California to require recalls for vehicles that fail to meet its emissions standards.\nThe Safety Act authorizes NHTSA to investigate reported vehicle problems and to order a recall if it determines that a safety-related defect exists. NHTSA conducted an engineering analysis of the rear liftgate latches in Chrysler's 1984-1995 model year minivans (approximately 4 million vehicles) as a result of allegations that some latches open during collisions. On October 25, 1995, NHTSA closed this investigation and announced that it was satisfied with Chrysler's voluntary service action to replace the latches in these minivans. Chrysler began its latch replacement service action in September 1995 and expects to complete it by the end of 1996.\nChrysler's emissions and safety-related recall costs vary widely from year to year, and could be significant in future periods, depending on the corrective action required to remedy a particular condition and the number of vehicles involved.\nSTATIONARY SOURCE REGULATION - ----------------------------\nChrysler's assembly, manufacturing and other operations are subject to substantial environmental regulation under the Clean Air Act, the Clean Water Act, the Resource Conservation and Recovery Act, the Pollution Prevention Act of 1990 and the Toxic Substances Control Act, as well as a substantial volume of state legislation paralleling and, in some cases, imposing more stringent obligations than the federal requirements. These regulations impose severe restrictions on air and water-born discharges of pollution from\nITEM 1. BUSINESS -- CONTINUED PART I -- CONTINUED --------------------- AUTOMOTIVE OPERATIONS -- CONTINUED - ---------------------------------- GOVERNMENT REGULATION -- CONTINUED - ---------------------------------- STATIONARY SOURCE REGULATION -- CONTINUED - -----------------------------------------\nChrysler facilities, the handling of hazardous materials at Chrysler facilities and the disposal of wastes from Chrysler operations. Chrysler is faced with many similar requirements in its operations in Canada and is facing increased governmental regulation and environmental enforcement in Mexico.\nWhile Chrysler is unable to predict the exact level of expenditures that will be required to develop and implement new technology in its North American facilities, since federal and state requirements are not fully defined, Chrysler expects its capital requirements for the period 1996 through 2000 will be approximately $500 million. Of this total, Chrysler estimates that $130 million will be spent in 1996 and $60 million will be spent in 1997. Substantially all of these expenditures are included in Chrysler's planned disbursements for new product development and the acquisition of productive assets over the 1996 to 2000 period. In addition, the extensive federal-state permit program established by the Clean Air Act may reduce operational flexibility and cause delays in upgrading Chrysler's production facilities in the United States.\nClean Air Act\nPursuant to the Clean Air Act, states are required to amend their implementation plans to require more stringent limitations and other controls on the quantity of pollutants which may be emitted into the atmosphere to achieve national ambient air quality standards established by the EPA. In addition, the Clean Air Act requires reduced emissions of substances that are classified as hazardous, toxic or that contribute to acid deposition, imposes comprehensive permit requirements for manufacturing facilities in addition to those required by various states, and expands federal authority to impose severe penalties and criminal sanctions. The Clean Air Act also allows states to adopt standards more stringent than those required by the Clean Air Act. Most recent reports filed with the EPA pursuant to the Superfund Amendments and Reauthorization Act of 1986 indicate that, for calendar year 1994, releases and emissions of chemicals and toxins by Chrysler were reduced by more than 70 percent from comparable 1987 levels, even though vehicle production increased more than 10% during this period.\nEnvironmental Liabilities\nThe EPA and various state agencies have notified Chrysler that it may be a potentially responsible party (\"PRP\") for the cost of cleaning up hazardous waste storage or disposal facilities pursuant to the Comprehensive Environmental Response, Compensation and Liability Act (\"CERCLA\") and other federal and state environmental laws. A number of lawsuits allege that Chrysler violated CERCLA or other environmental laws and seek to recover costs associated with remedial action. In most instances, Chrysler is only one of a number of PRPs who may be found to be jointly and severally liable for remediation costs at the 101 sites involved in the foregoing matters at December 31, 1995. Chrysler may also incur remediation costs at an additional 45 of its active or deactivated facilities. Chrysler's reserves for these environmental matters totalled $271 million as of December 31, 1995. Chrysler periodically evaluates and revises estimates for environmental liabilities based on expenditures against established reserves and the availability of additional information.\nEstimates of future costs of such environmental matters are necessarily imprecise due to numerous uncertainties, including the enactment of new laws and regulations, the development and application of new technologies, the identification of new sites for which Chrysler may have remediation responsibility and the apportionment and collectibility of remediation costs among responsible parties. Chrysler establishes reserves for these environmental matters when the loss is probable and reasonably estimable. It is reasonably possible that final resolution of some of these matters may require Chrysler to make significant expenditures, in excess of established reserves, over an extended period of time and in a range of amounts that cannot be reasonably\nITEM 1. BUSINESS -- CONTINUED PART I -- CONTINUED --------------------- AUTOMOTIVE OPERATIONS -- CONTINUED - ---------------------------------- GOVERNMENT REGULATION -- CONTINUED - ---------------------------------- STATIONARY SOURCE REGULATION -- CONTINUED - -----------------------------------------\nEnvironmental Liabilities -- Continued\nestimated. Although the final resolution of any such matters could have a material effect on Chrysler's consolidated operating results for the particular reporting period in which an adjustment of the estimated liability is recorded, Chrysler believes that any resulting liability should not materially affect its consolidated financial position.\nFINANCIAL SERVICES ------------------\nCFC, Chrysler's wholly owned subsidiary, is a financial services organization that provides retail and lease financing for vehicles, dealer inventory and other financing needs, dealer property and casualty insurance and dealership facility development and management primarily for Chrysler dealers and their customers. CFC, a Michigan corporation, is the continuing corporation resulting from a merger on June 1, 1967 of a financial services subsidiary of Chrysler into a newly acquired, previously unaffiliated finance company incorporated in 1926.\nCFC's portfolio of finance receivables managed includes receivables owned and receivables serviced for others. Receivables serviced for others include securitized automotive receivables and retail leases. At December 31, 1995, receivables serviced for others accounted for 66 percent of CFC's portfolio of receivables managed. Total finance receivables managed at the end of each of the five most recent years were as follows:\nDue to the significant and increasing portion of CFC's business that relates to Chrysler, lower levels of production and sales of Chrysler automotive products would likely result in a reduction in the level of finance operations of CFC.\nAutomotive Financing\nCFC is the major source of wholesale and retail financing for Chrysler vehicles throughout North America. CFC also offers dealers working capital loans, real estate and equipment financing and financing plans for fleet buyers, including daily rental car companies independent of, and affiliated with, Chrysler. The automotive financing operations of CFC are conducted through 95 branches in the United States, Canada (Chrysler Credit Canada Ltd.) and Mexico (Chrysler Comercial S.A. de C.V.).\nDuring 1995, CFC financed or leased approximately 1,031,000 new and used vehicles at retail in the United States, including approximately 594,000 new Chrysler passenger cars and light-duty trucks, representing 27 percent of Chrysler's U.S. retail and fleet deliveries. In 1995, the average monthly payment for new vehicle retail installment sale contracts acquired in the United States was $364. The average new contract balance was $18,934 and the average original term was 52 months. In the U.S., CFC also financed approximately 1,632,000 new Chrysler passenger cars and light-duty trucks at wholesale representing 74 percent of Chrysler's U.S. factory shipments in 1995.\nITEM 1. BUSINESS -- CONTINUED PART I -- CONTINUED --------------------- FINANCIAL SERVICES -- CONTINUED - ------------------------------- Nonautomotive Financing - -----------------------\nCFC conducts its nonautomotive finance business through its subsidiaries, Chrysler Capital Corporation and Chrysler First Inc. At December 31, 1995, the nonautomotive receivables managed throughout the United States consisted of $712 million of commercial loans and leases and $1.7 billion of leveraged leases.\nAutomotive Insurance - --------------------\nChrysler Insurance Company and its subsidiaries (\"Chrysler Insurance\") provide specialized insurance coverages for automotive dealers and their customers in the United States and Canada. Chrysler Insurance's property and casualty business includes physical damage, garage liability, workers' compensation and property and contents coverage provided directly to automotive dealers. Chrysler Insurance also provides vehicle collateral protection and single interest insurance to retail customers and their financing sources.\nAutomobile Dealership Management - --------------------------------\nChrysler Realty Corporation (\"Chrysler Realty\"), is engaged in the ownership, development and management of Chrysler automotive dealership properties in the United States. Chrysler Realty typically purchases, leases or options dealership facilities and then leases or subleases these facilities to Chrysler dealers. At December 31, 1995, Chrysler Realty controlled 840 sites (of which 271 were owned by Chrysler Realty).\nFunding - --------\nReceivable sales are a significant source of funding. Net proceeds from the sale of automotive retail receivables were $6.5 billion during 1995 compared to $6.4 billion in 1994. Securitization of revolving wholesale account balances provided funding which aggregated $6.7 billion and $3.8 billion at December 31, 1995 and 1994, respectively. During 1995, CFC issued $4.3 billion of term debt (primarily medium term notes), repaid term debt of $1.1 billion and reduced the level of commercial paper by $1.9 billion.\nDuring the second quarter of 1995, CFC entered into new revolving credit facilities which replaced its existing U.S. and Canadian revolving credit and receivable sale facilities. The new facilities which total $8.0 billion consist of a $2.4 billion facility expiring in May 1996 and a $5.6 billion facility expiring in May 2000. As of December 31, 1995, no amounts were outstanding under these facilities.\nCFC uses derivative financial instruments to manage funding costs and its exposure arising from changes in interest rates and currency exchange rates. These derivative financial instruments include interest rate swaps, interest rate caps, forward interest rate contracts and currency exchange agreements. CFC does not use derivative financial instruments for trading purposes.\nITEM 1. BUSINESS -- CONTINUED PART I -- CONTINUED --------------------- FINANCIAL SERVICES -- CONTINUED - ------------------------------- Funding -- Continued - --------------------\nCFC's outstanding debt at December 31, in each of the five most recent years was as follows:\nCAR RENTAL OPERATIONS ---------------------\nThrough its Pentastar Transportation Group, Inc. (\"Pentastar\") subsidiary, Chrysler owns Thrifty Rent-A-Car System, Inc. (\"Thrifty\"), and Dollar Systems, Inc. (\"Dollar\", formerly Dollar Rent A Car Systems, Inc.). Both Thrifty and Dollar are engaged in leasing vehicles to independent businesses they have licensed to use their trade names, systems and technologies in the daily rental of cars for business, personal and leisure use. They also maintain and operate a number of their own locations. Snappy Car Rental, Inc., which engages in renting automobiles on a short-term basis, was sold in September 1994.\nRESEARCH AND DEVELOPMENT ------------------------\nFor the years ended December 31, 1995, 1994 and 1993, Chrysler spent $1.4 billion, $1.3 billion, and $1.2 billion, respectively, for company-sponsored research and development activities. These activities relate to the development of new products and services and the improvement of existing products and services, as well as compliance with standards that have been and are being promulgated by the government.\nEMPLOYEES ---------\nAt December 31, 1995, Chrysler had a total of approximately 126,000 employees worldwide. Of this total, approximately 85,000 hourly workers and 29,000 salaried workers were employed in the United States and Canada. In the United States and Canada, approximately 95 percent of Chrysler's hourly employees and 22 percent of its salaried employees are represented by unions. Of these represented employees, 97 percent of hourly and 90 percent of salaried employees are represented by the United Automotive, Aerospace, and Agricultural Implement Workers of America (\"UAW\") or the National Automobile, Aerospace and Agricultural Implement Workers of Canada (\"CAW\"). The existing national agreements with the UAW and CAW will expire in September of 1996. Chrysler cannot predict the outcome of negotiations with the UAW and CAW as to the renewal of these agreements.\nIn 1993, Chrysler negotiated three-year national agreements with the UAW and CAW in the United States and Canada, respectively, without an interruption of production. The UAW contract provides for essentially the same levels of wages and benefits as negotiated by Chrysler's major domestic competitors. The UAW contract retains the job and income security protection program and health care coverage. The job and income security benefit caps were negotiated at the previous contract amount of $612 million with new Supplemental Unemployment Benefits Contingency Accounts of $106 million. The contract also adopted\nITEM 1. BUSINESS -- CONTINUED PART I -- CONTINUED --------------------- EMPLOYEES -- CONTINUED - ---------------------- provisions expected to abate future increases in labor costs including Cost of Living Allowance diversions, lower new hire rates, and a broadened approach to managed health care.\nChrysler's pension plans, group life, and health care benefits for active, inactive, and retired employees generally follow the structure of benefits common to the automotive industry. See Part II, Item 8, Notes to Consolidated Financial Statements, Notes 1, 11 and 12 for further information on postemployment benefits, pension plans, and nonpension postretirement benefits.\nINTELLECTUAL PROPERTY ---------------------\nChrysler has intellectual property rights, including patents, proprietary technology, trademarks, trade dress, service marks, copyrights, and licenses under such rights of others, relating to its businesses, products, and manufacturing equipment and processes. Chrysler grants licenses to others under its intellectual property rights and receives fees and royalties under some of these licenses. While Chrysler does not consider any particular intellectual property right to be essential, it does consider the aggregate of such rights very important to the overall conduct of its businesses.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES ----------\nAUTOMOTIVE OPERATIONS ---------------------\nThe statements concerning ownership of Chrysler's properties are made without regard to taxes or assessment liens, rights of way, contracts, easements or like encumbrances or questions of survey and are based on the records of Chrysler. Chrysler knows of no material defects in title to, or adverse claims against, any of such properties, nor any existing material liens or encumbrances against Chrysler or its properties.\nChrysler's manufacturing plants include a foundry, machining plants, metal stamping plants, engine plants, transmission plants, electronic parts plants, an air conditioning equipment plant, glass fabricating plants and other component parts plants. In addition to Michigan, manufacturing plants in the United States are located in Alabama, Indiana, New York, Ohio, Texas and Wisconsin.\nChrysler's U.S. passenger car assembly plants are located in Sterling Heights and Detroit, Michigan; Belvidere, Illinois and Newark, Delaware. The U.S. truck assembly plants are located in Warren and Detroit, Michigan; Fenton, Missouri; and Toledo, Ohio. Parts depots, warehouses and sales offices are situated in various sections of the United States, while Chrysler's principal engineering and research facilities and its general offices are located in Auburn Hills, Michigan.\nAutomotive properties outside the U.S. are owned or leased principally by Chrysler Canada and Chrysler Mexico. Other manufacturing and assembly plants of subsidiaries outside the U.S. are located in Venezuela and Austria.\nChrysler's technology center in Auburn Hills, Michigan consists of 3.4 million square feet of floor space and includes design, vehicle engineering, manufacturing engineering and pilot build facilities associated with the development of new Chrysler cars and trucks. The technology center was completed and fully occupied in the first half of 1994. The facility was subsequently expanded by approximately 1.0 million square feet of floor space and includes an administrative building, which serves as Chrysler's World Headquarters and principal place of business. The expansion is scheduled for completion in the first half of 1996. In the fourth quarter of 1994, the Board of Directors approved a project to build a new Powertrain Test Center. The Powertrain Test Center will include powertrain test cells, its related support laboratories, emissions development and road test simulators. The building will add approximately 430,000 square feet of floor space to the facility and is scheduled for completion in the year 2000.\nITEM 2. PROPERTIES -- CONTINUED PART I -- CONTINUED - -------------------------------\nAUTOMOTIVE OPERATIONS -- CONTINUED - ----------------------------------\nIn the opinion of management, Chrysler's properties include facilities which are suitable and adequate for the conduct of its present assembly and component plant requirements. The annual productive capacity of Chrysler's worldwide automotive operations was approximately 2.6 million units in 1995, compared to 2.4 million units in 1994. Chrysler's worldwide assembly plants operated at 95 percent of capacity in 1995, compared to 110 percent of capacity in 1994 (with capacity determined based on two eight-hour shifts). Capacity utilization in 1995 was lower than 1994 primarily as a result of the changeover and launch of Chrysler's all-new minivans during 1995. The launch of Chrysler's all-new minivans was substantially complete by the end of 1995.\nFINANCIAL SERVICES ------------------\nAt December 31, 1995, the following facilities were utilized by CFC in conducting its business:\n(a) executive offices of CFC, Chrysler Insurance and certain other domestic subsidiaries of CFC in Southfield, Michigan;\n(b) a total of 83 branches and 3 customer service centers of CFC located throughout the United States;\n(c) headquarters of Chrysler First Inc. in Allentown, Pennsylvania, and a total of 3 offices in the United States;\n(d) headquarters of Chrysler Capital in Stamford, Connecticut;\n(e) headquarters of Chrysler Realty in Auburn Hills, Michigan; and\n(f) a total of 12 offices used as headquarters and branch offices in Canada and Mexico.\nAll of the facilities described above were leased by CFC.\nAt December 31, 1995, a total of 271 automobile dealership properties generally consisting of land and improvements, were owned by Chrysler Realty and leased primarily to Chrysler franchised dealers.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS - -------------------------\nChrysler and its subsidiaries are parties to various legal proceedings, including some purporting to be class actions, and some which demand large monetary damages or other relief which, if granted, would require significant expenditures. Chrysler believes that each of the product and environmental proceedings described below constitutes ordinary routine litigation incidental to the business conducted by Chrysler. See also Note 8 of Notes To Consolidated Financial Statements.\nPRODUCT MATTERS - ---------------\nMany of the legal proceedings seek damages for personal injuries claimed to have resulted from alleged defects in the design or manufacture of products distributed by Chrysler. The complaints filed in those matters specify approximately $1.2 billion in compensatory and $932 million in punitive damages in the aggregate as of December 31, 1995. These amounts represent damages sought by plaintiffs and, therefore, do not necessarily constitute an accurate measure of Chrysler's ultimate cost to resolve those matters. Further, many complaints do not specify a dollar amount of damages or specify only the jurisdictional minimum. These amounts may vary significantly from one period to the next depending on the number of new complaints filed or pending cases resolved in a given period.\nNumerous complaints seek damages for personal injuries sustained in accidents involving alleged rollovers of Jeep CJ vehicles. These complaints represent approximately $302 million of the compensatory and $755 million of the punitive damages specified above. Pursuant to an indemnification agreement with\nITEM 3. LEGAL PROCEEDINGS -- CONTINUED PART I -- CONTINUED - -------------------------------------- PRODUCT MATTERS -- CONTINUED - ---------------------------- Chrysler, Renault has agreed to indemnify Chrysler against a portion of certain costs arising from accidents involving alleged Jeep CJ vehicle rollovers that occurred between April 1, 1985 and March 31, 1994.\nMany of the remaining complaints seek compensatory and punitive damages for personal injuries sustained in accidents involving alleged defects in occupant restraint systems, seats, heater cores, liftgate latches, or various other components in several different vehicle models. Some complaints seek repair of the vehicles or compensation for the alleged reduction in vehicle value.\nFive purported class action lawsuits seeking unspecified economic damages in connection with rear liftgate latches on Chrysler's 1984-1994 model year minivans have been consolidated in Federal District Court in San Francisco. Chrysler previously announced a voluntary owner service action to replace those latches. The parties agreed to a proposed settlement that requires Chrysler to achieve a 60% response rate to its service action by December 31, 1996, or spend $14 million on consumer notices and incentives aimed at increasing the response rate. Chrysler will also be required to pay $5.2 million in attorneys fees and costs. Notices were sent to class members in September 1995 following the Court's preliminary approval of the settlement. On November 30, 1995, the Court approved the consolidated settlement as fair, reasonable and adequate to protect the interests of the class members. Certain parties have objected to the settlement ruling, but no date has been set for a hearing on those objections.\nFour purported class action lawsuits were filed against Chrysler in the second half of 1995 alleging defects in the antilock braking system (ABS) found in some of its 1991-1995 model year vehicles. The lawsuits seek compensatory and punitive damages, restitution, repair, and\/or profits from vehicle sales.\nLitigation is subject to many uncertainties, and the outcome of individual matters is not predictable with assurance. It is reasonably possible that the final resolution of some of these matters may require Chrysler to make expenditures, in excess of established reserves, over an extended period of time and in a range of amounts that cannot be reasonably estimated. Although the final resolution of any such matters could have a material effect on Chrysler's consolidated operating results for the particular reporting period in which an adjustment of the estimated liability is recorded, Chrysler believes that any resulting liability should not materially affect its consolidated financial position.\nENVIRONMENTAL MATTERS - ---------------------\nThe EPA and various state agencies have notified Chrysler that it may be a PRP for the cost of cleaning up hazardous waste storage or disposal facilities pursuant to the CERCLA and other federal and state environmental laws. A number of lawsuits allege that Chrysler violated CERCLA or other environmental laws and seek to recover costs associated with remedial action. In most instances, Chrysler is only one of a number of PRPs who may be found to be jointly and severally liable for remediation costs at the 101 sites involved in the foregoing matters at December 31, 1995. Chrysler may also incur remediation costs at an additional 45 of its active or deactivated facilities. Chrysler's reserves for these environmental matters totalled $271 million as of December 31, 1995. Chrysler periodically evaluates and revises estimates for environmental liabilities based on expenditures against established reserves and the availability of additional information.\nThe Indiana Department of Environmental Management initiated an administrative proceeding in August 1985 alleging improper disposal of waste at a Chrysler facility in Indianapolis. This proceeding, which seeks to require Chrysler to conduct a site assessment and undertake remedial action, may result in the imposition of civil penalties in excess of $100,000.\nThe State of Wisconsin filed a lawsuit in February 1995 against Chrysler Outboard Corporation, a Chrysler subsidiary subsequently merged into Chrysler, alleging improper disposal of hazardous waste in 1969. This lawsuit, which seeks unspecified damages, may result in the imposition of civil penalties in excess of $100,000.\nITEM 3. LEGAL PROCEEDINGS -- CONTINUED PART I -- CONTINUED - -------------------------------------- ENVIRONMENTAL MATTERS -- CONTINUED - ---------------------------------- Estimates of future expenditures in connection with these environmental matters are necessarily imprecise due to numerous uncertainties, including the enactment of new laws and regulations, the development and application of new technologies and the apportionment and collectibility of remediation costs among responsible parties. Chrysler establishes reserves for these environmental matters when the loss is probable and reasonably estimable. It is reasonably possible that final resolution of some of these matters could require Chrysler to make significant expenditures, in excess of established reserves, over an extended period of time and in a range of amounts that cannot be reasonably estimated. Although the final resolution of any such matters could have a material effect on Chrysler's consolidated operating results for the particular reporting period in which an adjustment of the estimated liability is recorded, Chrysler believes that any resulting liability should not materially affect its consolidated financial position.\nOTHER MATTERS - -------------\nIn December 1990 and January 1991, eight class action lawsuits were commenced by separate plaintiffs against Chrysler and certain of its directors in the Court of Chancery of the State of Delaware for New Castle County, Delaware. The Complaints in these suits are very similar and allege that the directors breached their fiduciary duties to stockholders by amending Chrysler's Share Purchase Rights Plan in a manner designed to entrench themselves in office and to impair the right of stockholders to avail themselves of offers to purchase their shares by an acquiror not favored by management. The Complaints ask for (a) certification of the class, (b) rescission of and an injunction against implementation of the Rights Plan amendments, (c) an order that Chrysler cooperate with Kirk Kerkorian, the holder of 9.8% of Chrysler's common stock at the time the complaints were filed, and take steps to enhance its attractiveness as a merger\/acquisition candidate, and (d) damages and costs. On January 9, 1991, the eight suits were consolidated into one. On January 28, 1991, Chrysler filed an Answer and Affirmative Defenses in the consolidated case. On March 7, 1991, the parties agreed to allow an Amended Complaint to be filed which purports to assert a derivative claim brought on behalf of Chrysler, in addition to class action claims as originally filed. In this regard, the Amended Complaint alleges injury to Chrysler as a direct result of violations of fiduciary duties by the individual defendants. On July 25, 1991, Chrysler filed a motion to dismiss the consolidated lawsuit. On July 27, 1992, the Court entered a memorandum opinion dismissing the complaint as to all claims for relief other than rescission. Chrysler later filed a Motion for Reargument which was denied on August 11, 1992. On June 6, 1995, Chrysler entered into a Memorandum of Understanding which contemplates settlement of the litigation. The Memorandum is subject to several conditions, including satisfactory completion of discovery as to the fairness of the proposed settlement, and the settlement itself is subject to Court approval. The Memorandum also contemplates that the settlement, if approved, will consist of Chrysler's action in December 1994 further amending its Rights Plan. A hearing on the settlement has been scheduled by the Court for February 26, 1996.\nIn April 1995, thirty four class action lawsuits were commenced by separate plaintiffs against Chrysler, certain of its current and former directors and, in some cases, Tracinda Corporation, a holding company wholly owned by Kirk Kerkorian and the beneficial owner of more than 13% of the outstanding common stock of Chrysler as of December 31, 1995, and its affiliates, in the Court of Chancery of the State of Delaware for New Castle County, Delaware. The Complaints in these suits fall into two general categories: (a) those which allege that the directors breached their fiduciary duties to stockholders by failing to negotiate with Tracinda regarding its proposal to acquire all of the outstanding stock of Chrysler not then owned by it; and (b) those which allege that the directors breached their fiduciary duties to stockholders by contemplating, planning and\/or effecting Tracinda's proposal at a time when the market price of Chrysler's stock was depressed and did not reflect its true value. The Complaints in the former category ask for, among other things, (a) an injunction or an order obligating the Board of Directors to undertake an evaluation of alternatives, including measures with respect to Chrysler's Rights Plan, designed to maximize shareholder value, (b) a declaration that the defendants have breached their fiduciary duties to the plaintiffs, (c) compensatory damages and interest, and (d) costs and fees. The Complaints in the latter category ask for, among other things, (a) a declaration that the transaction proposed by Tracinda is unfair, unjust and inequitable, (b) an injunction against implementation of the transaction proposed by Tracinda and any improper\nITEM 3. LEGAL PROCEEDINGS -- CONTINUED PART I -- CONTINUED ------------------------------\nOTHER MATTERS -- CONTINUED - --------------------------\ndevice which impedes maximization of shareholder value, (c) damages and interest, (d) costs and fees, and (e) such other relief as may be just and proper. Four of these actions have subsequently been dismissed without prejudice by the plaintiffs.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ---------------------------------------------------- None during the three months ended December 31, 1995.\nEXECUTIVE OFFICERS OF THE REGISTRANT - ------------------------------------ (AS OF JANUARY 19, 1996)\n- ------------------------- (1) The \"Officer Since\" date shown is the date from which the named individual has served continuously as an officer of either Chrysler Corporation or the former Chrysler Motors Corporation which, effective December 31, 1989, was merged with and into Chrysler Corporation. (2) Also a member of the Board of Directors.\nThere are no family relationships, as defined for reporting purposes, between any of the executive officers named above and there is no arrangement or understanding between any of the executive officers named above and any other person pursuant to which he was selected as an officer. All of the executive officers named above, except Messrs. Eaton and Henson have been in the employ of Chrysler Corporation or its subsidiaries for more than five years. During the last five years, and immediately preceding employment by Chrysler Corporation, Messrs. Eaton and Henson were high level executives at General Motors Corporation.\nPART II -------\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND - ----------------------------------------------------- RELATED STOCKHOLDER MATTERS ---------------------------\nChrysler's common stock is listed on the stock exchanges specified on pages 1 and 2 of this Form 10-K under the trading symbol (C). There were approximately 136,000 shareholders of record of Chrysler's common stock at December 31, 1995. The following table sets forth the high and low sale prices of Chrysler's common stock as reported on the composite tape and the quarterly dividends declared for the last two years.\nDividends on the common stock are payable at the discretion of the Chrysler's Board of Directors out of funds legally available therefor. Chrysler's ability to pay dividends in the future will depend upon its financial results, liquidity and financial condition and its ability to continue its capital expenditure and vehicle development programs and market its vehicles successfully. Chrysler's ability to pay dividends is also affected by the provision in its credit agreement that it must maintain a ratio of indebtedness to total capitalization (each as defined) at the end of each quarter at certain specified levels.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA PART II -- CONTINUED -----------------------\nThe table below summarizes recent financial information for Chrysler. For further information, refer to Chrysler's consolidated financial statements and notes thereto presented under Item 8 of this Form 10-K.\n- ------------------------- (1) Earnings for the year ended December 31, 1995 were reduced by a $263 million charge ($162 million after taxes) for costs associated with production changes at Chrysler's Newark assembly plant and a $115 million charge ($71 million after taxes) for a voluntary minivan owner service action. Net earnings in 1995 also include an after-tax charge of $96 million for the cumulative effect of a change in accounting principle related to the consensus reached on Emerging Issues Task Force (\"EITF\") Issue 95-1, \"Revenue Recognition on Sales with a Guaranteed Minimum Resale Value.\"\n(2) Earnings for the year ended December 31, 1994 include favorable adjustments to the provision for income taxes aggregating $132 million. These adjustments related to: (1) the recognition of tax credits related to expenditures in prior years for qualifying research and development activities, in accordance with an Internal Revenue Service settlement which was based on U.S. Department of Treasury income tax regulations issued in 1994, and (2) the reversal of valuation allowances related to tax benefits associated with net operating loss carryforwards.\n(3) Results for the year ended December 31, 1993 include a pretax gain of $205 million ($128 million after taxes) on the sale of Chrysler's remaining 50.3 million shares of MMC stock, a pretax gain of $60 million ($39 million after taxes) on the sale of Chrysler's plastics operations, a $4.7 billion after-tax charge for the adoption of Statement of Financial Accounting Standards (\"SFAS\") No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" and a $283 million after-tax charge for the adoption of SFAS No. 112, \"Employers' Accounting for Postemployment Benefits.\"\n(4) Earnings for the year ended December 31, 1992 include a pretax gain of $142 million ($88 million after taxes) on the sale of 43.6 million shares of MMC stock, a $218 million favorable effect of a change in accounting principle relating to the adoption of SFAS No. 109, \"Accounting for Income Taxes,\" a $101 million pretax charge ($79 million after taxes) relating to the restructuring of Chrysler's short-term vehicle rental subsidiaries, and a $110 million pretax charge ($69 million after taxes) relating to investment losses experienced by Chrysler Canada.\n(5) Results for the year ended December 31, 1991 include a pretax gain of $205 million ($127 million after taxes) on the sale of Chrysler's 50 percent equity interest in Mitsubishi Motors Manufacturing of America, the favorable effect of a $391 million ($242 million after taxes) noncash, nonrecurring credit provision relating to a plant capacity adjustment and a $257 million after-tax charge for the cumulative effect of a change in accounting principle related to the timing of the recognition of the costs of sales incentive programs.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL PART II -- CONTINUED ------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS -----------------------------------\nThe following discussion and analysis should be read in conjunction with the consolidated financial statements and notes thereto.\nFINANCIAL REVIEW ----------------\n1995 COMPARED WITH 1994 - -----------------------\nChrysler reported earnings before income taxes and the cumulative effect of a change in accounting principle of $3.4 billion in 1995, compared with $5.8 billion in 1994. Net earnings for 1995 were $2.0 billion, or $5.11 per fully diluted common share, compared with $3.7 billion, or $9.10 per fully diluted common share in 1994. Earnings in 1994 represented an all-time record for Chrysler. Earnings in 1995 were the third best in Chrysler's history. Earnings in 1995 were reduced by a $263 million charge ($162 million after income taxes) for costs associated with production changes at Chrysler's Newark assembly plant and a $115 million charge ($71 million after income taxes) for a voluntary minivan owner service action. Net earnings in 1995 also include a charge of $96 million, or $0.24 per fully diluted common share, for the cumulative effect of a change in accounting principle related to the consensus reached on Emerging Issues Task Force Issue 95-1, \"Revenue Recognition on Sales with a Guaranteed Minimum Resale Value.\" Net earnings for 1994 included favorable tax adjustments aggregating $132 million.\nChrysler also reported earnings before income taxes of $1,659 million in the fourth quarter of 1995, compared with $1,631 million in the fourth quarter of 1994. Earnings before income taxes for the fourth quarter of 1995 represented an all-time record for Chrysler and earnings before income taxes for the fourth quarter of 1994 were the second best in Chrysler's history. Net earnings for the fourth quarter of 1995 were $1,040 million, or $2.67 per fully diluted common share, compared with $1,168 million, or $2.86 per fully diluted common share in the fourth quarter of 1994. Net earnings for the fourth quarter of 1994 included favorable tax adjustments aggregating $132 million. Net earnings for the fourth quarter of 1994 represented an all-time record for Chrysler and net earnings for the fourth quarter of 1995 were the second best quarter in Chrysler's history. Chrysler's worldwide factory car and truck shipments in the fourth quarter of 1995 were 741,770 units, an increase of 16,824 units or 2 percent from fourth quarter 1994 levels.\nThe lower operating results for full year 1995 compared with 1994 resulted primarily from lower minivan shipments and costs associated with the launch of Chrysler's all-new minivans, higher sales incentives and material costs, a lower mix of higher-margin vehicles, lower factory shipments in Mexico and the costs associated with production changes at the Newark assembly plant.\nChrysler's worldwide factory car and truck shipments in 1995 were 2,673,539 units, a decrease of 88,564 units or 3 percent from 1994 levels. Minivan factory shipments in 1995 were 555,824 units, a decrease of 121,652 units from 1994 levels. The decline in minivan factory shipments was primarily attributable to the launch of Chrysler's all-new minivans at its assembly plants in Fenton, Missouri; Windsor, Ontario; and Graz, Austria. By the end of 1995, the launch of Chrysler's all-new minivans was substantially complete. Minivan factory shipments in the fourth quarter of 1995 were 167,615 units as compared with 167,839 units in the fourth quarter of 1994.\nChrysler's revenues and results of operations are derived principally from the U.S. and Canada automotive marketplaces. Retail sales of new cars and trucks in the U.S. and Canada were 16.3 million units in 1995, compared with 16.7 million units in 1994, a decrease of 2 percent. This decrease was primarily due to a slowdown in economic growth caused primarily by increases in interest rates. As a result, Chrysler increased retail sales incentives and lowered production during 1995.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL PART II -- CONTINUED ------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS -- CONTINUED ------------------------------------------------\nFINANCIAL REVIEW -- CONTINUED - -----------------------------\n1995 COMPARED WITH 1994 -- CONTINUED - ------------------------------------\nChrysler's U.S. and combined U.S. and Canada retail sales and market share data for 1995 and 1994 were as follows:\n- ------------------------- (1) All retail sales and market share data include fleet sales.\nThe decline in Chrysler's U.S. truck market share during 1995 was primarily due to a decrease in retail sales of Chrysler's minivans largely offset by a net increase in retail sales of Chrysler's other truck models. The decrease in minivan retail sales was primarily due to the launch of Chrysler's all-new minivans. With the completion of the minivan launch and the launch of Chrysler's full-size Dodge Ram pickup truck at two additional facilities, Chrysler believes it is well positioned to meet the growing demand for trucks.\nChrysler manufactured 207,004 vehicles and 238,888 vehicles in Mexico in 1995 and 1994, respectively. Of these totals, 26,503 vehicles and 77,832 vehicles were sold in Mexico in 1995 and 1994, respectively. Sales of vehicles exported to Mexico were not significant in 1995 or 1994. The decrease in vehicles manufactured and sold in Mexico was primarily attributable to unfavorable economic conditions in Mexico, commencing with the devaluation of the Mexican peso in December 1994. Chrysler's operating results will continue to be adversely affected to the extent that the unfavorable economic conditions in Mexico continue. Although Chrysler expects economic conditions in Mexico to improve slightly in 1996, Chrysler cannot predict when Mexican automotive industry sales will return to predevaluation levels.\nIn the fourth quarter of 1995, the Emerging Issues Task Force (\"EITF\") of the Financial Accounting Standards Board reached a consensus on EITF Issue 95-1, \"Revenue Recognition on Sales with a Guaranteed Minimum Resale Value.\" The consensus on EITF Issue 95-1 (the \"consensus\") affects Chrysler's accounting treatment for vehicle sales (principally to non-affiliated rental car companies) for which Chrysler conditionally guarantees the minimum resale value of the vehicles. In accordance with the consensus, these vehicle sales are accounted for as operating leases with the related revenues and costs deferred at the time of shipment. A portion of the deferred revenues and costs is recognized over the corresponding guarantee period, with the remainder recognized at the end of the guarantee period. The average guarantee period for these vehicles is approximately nine months. Chrysler changed its accounting treatment in accordance with the consensus effective January 1, 1995 which resulted in the recognition of an after-tax charge of $96 million for the cumulative effect of this change in accounting principle. The ongoing effect of this accounting change was not material to 1995 earnings.\nCFC's earnings before income taxes were $522 million in 1995, compared with $315 million in 1994. CFC's net earnings were $339 million in 1995, compared with $195 million in 1994. The increase in earnings\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL PART II -- CONTINUED ------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS -- CONTINUED ----------------------------------- FINANCIAL REVIEW -- CONTINUED - ----------------------------- 1995 COMPARED WITH 1994 -- CONTINUED - ------------------------------------ in 1995 was primarily attributable to higher levels of automotive financing, lower operating expenses and lower costs of bank facilities.\nFor the past three years, Chrysler has benefitted from several factors, including: (1) favorable economic conditions in the U.S. and Canada, where Chrysler's sales are concentrated, (2) a cost advantage in comparison to vehicles manufactured in Japan (or vehicles containing significant material components manufactured in Japan) as a result of favorable exchange rates between the Japanese yen and the U.S. dollar, and (3) a continuing shift in U.S. and Canada consumer preferences toward trucks, as Chrysler manufactures a higher proportion of trucks to total vehicles than its principal competitors in the U.S. and Canada. A significant deterioration of any of these factors could adversely affect Chrysler's operating results. In addition, Chrysler has benefitted from a strategy of focusing resources on its core automotive business and an aggressive capital expenditure and vehicle development program that has resulted in the replacement of substantially all of its car and truck offerings over the last four years. Chrysler's long-term profitability will depend significantly on its ability to continue its capital expenditure and vehicle development programs and market its vehicles successfully.\n1994 COMPARED WITH 1993\nChrysler reported earnings before income taxes and the cumulative effect of changes in accounting principles of $5.8 billion in 1994, compared with $3.8 billion in 1993. The earnings in 1993 included gains on sales of automotive assets and investments totaling $265 million.\nChrysler reported net earnings for 1994 of $3.7 billion, compared to a net loss for 1993 of $2.6 billion. Net earnings for 1994 included favorable tax adjustments aggregating $132 million. The net loss for 1993 resulted from a charge of $4.7 billion for the cumulative effect of a change in accounting principle related to the adoption of Statement of Financial Accounting Standards (\"SFAS\") No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" Also included in the 1993 results was a charge of $283 million for the cumulative effect of a change in accounting principle relating to the adoption of SFAS No. 112, \"Employers' Accounting for Postemployment Benefits\" and a $72 million favorable adjustment of Chrysler's deferred tax assets and liabilities as a result of the increased U.S. federal income tax rate.\nThe improvement in earnings in 1994 over 1993 was primarily the result of an increase in shipments, a reduction in lower-margin fleet shipments in proportion to total retail sales and reduced sales incentives, partially offset by increased profit-based employee compensation costs. Chrysler's worldwide factory car and truck shipments in 1994 were 2,762,103 units, an increase of 286,365 units or 12 percent from 1993 levels.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL PART II -- CONTINUED ------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS -- CONTINUED ------------------------------------------------ COMPARISON OF SELECTED ELEMENTS OF REVENUES AND EXPENSES --------------------------------------------------------\nChrysler's total revenues were as follows:\nThe increase in sales of manufactured products in 1995 as compared with 1994 primarily reflects an increase in average revenue per unit, net of sales incentives, from $17,663 to $18,305, largely offset by a 3 percent decrease in factory shipments. The increase in average revenue per unit in 1995 as compared with 1994 was primarily due to pricing actions, partially offset by higher sales incentives. The increase in sales of manufactured products in 1994 as compared with 1993 was primarily due to a 12 percent increase in factory shipments and an increase in average revenue per unit, net of sales incentives, from $16,461 to $17,663. The increase in average revenue per unit in 1994 as compared with 1993 was principally due to reduced sales incentives and sales of an increased proportion of trucks to total vehicles.\nThe increase in finance and insurance revenues in 1995 as compared with 1994 was primarily attributable to higher levels of automotive financing volume. The decrease in finance and insurance revenues in 1994 as compared with 1993 was primarily attributable to reduced nonautomotive financing revenue, resulting from sales and liquidations of CFC's nonautomotive receivables, partially offset by increased levels of automotive financing volume. Total automotive financing volume in 1995, 1994 and 1993 was $81.9 billion, $70.4 billion and $59.8 billion, respectively. The increases in automotive financing volume over the last two years reflects higher retail lease penetration and higher levels of dealer financing.\nFinancing support provided in the United States by CFC for new Chrysler vehicle retail deliveries (including fleet) and wholesale vehicle sales to dealers and the number of vehicles financed during the last three years were as follows:\nOther revenues increased in 1995 as compared with 1994 primarily as a result of increased interest income, reflecting Chrysler's higher average cash, cash equivalents and marketable securities balances and higher interest rates as well as the recognition of lease revenue as a result of the accounting change for vehicle sales with guaranteed minimum resale values. Other revenues increased in 1994 as compared with 1993 primarily as a result of increased interest income, reflecting Chrysler's higher average cash, cash equivalents and marketable securities balances and higher interest rates.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL PART II -- CONTINUED ------------------------------------------------------------------------ CONDITION AND RESULTS OF OPERATIONS -- CONTINUED ------------------------------------------------ COMPARISON OF SELECTED ELEMENTS OF REVENUES AND EXPENSES -- CONTINUED - --------------------------------------------------------------------- Chrysler's total expenses were as follows:\nCosts, other than items below increased in 1995 as compared with 1994 primarily as a result of increased product costs, costs associated with the changeover and launch of Chrysler's all-new minivans and costs associated with production changes at the Newark assembly plant, partially offset by the effect of a decrease in factory shipments of 3 percent. The increase in product costs in 1995 resulted primarily from higher material costs (including increased product content) and higher warranty costs. Warranty costs in 1995 included a charge of $115 million related to a voluntary minivan owner service action and the effect of enhanced warranty programs. Costs, other than items below increased in 1994 as compared with 1993 primarily due to a 12 percent increase in factory shipments. Costs, other than items below as a percent of sales of manufactured products were 83 percent, 77 percent and 79 percent in 1995, 1994 and 1993, respectively.\nDepreciation of property and equipment in 1995 increased as compared with 1994 primarily as a result of higher levels of property and equipment in use. Depreciation of property and equipment in 1994 was comparable to 1993 as increases resulting from higher levels of property and equipment in use were largely offset by reductions at CFC resulting from the sales and downsizing of its nonautomotive financing operations. Special tooling amortization increased in 1995 as compared with 1994 primarily as a result of increased tooling costs for Chrysler's new products. Special tooling amortization increased in 1994 as compared with 1993 primarily as a result of the shortening of the remaining service lives of certain special tools in 1994.\nSelling and administrative expenses increased in 1995 as compared with 1994 primarily as a result of advertising costs related to Chrysler's all-new minivans, sedans and coupes. Selling and administrative expenses increased in 1994 as compared with 1993 primarily as a result of increased advertising and profit-based employee compensation costs.\nPension expense decreased in 1995 as compared with 1994 due to improved funding of the pension plans and an increase in the discount rate used to determine 1995 pension expense. Pension expense decreased in 1994 as compared with 1993 due to improved funding of the pension plans, partially offset by increases resulting from a reduction in the discount rate used to determine 1994 pension expense and benefit increases from Chrysler's 1993 national contracts with its principal bargaining units. Chrysler's contributions to the pension fund during 1995, 1994 and 1993 were $838 million, $2.6 billion and $3.5 billion, respectively.\nNonpension postretirement benefit expense decreased in 1995 as compared with 1994 primarily as a result of an increase in the discount rate used to determine 1995 nonpension postretirement benefit expense and favorable health care inflation experience. Nonpension postretirement benefit expense increased slightly in\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL PART II -- CONTINUED ------------------------------------------------------------------------ CONDITION AND RESULTS OF OPERATIONS -- CONTINUED ------------------------------------------------ COMPARISON OF SELECTED ELEMENTS OF REVENUES AND EXPENSES -- CONTINUED - --------------------------------------------------------------------- 1994 as compared with 1993, as increases resulting from a reduction in the discount rate used to determine nonpension postretirement benefit expense in 1994 were partially offset by cost savings associated with the implementation of new managed care initiatives. Nonpension postretirement benefit expense is expected to increase in 1996 primarily as a result of a reduction in the discount rate used to determine this expense.\nInterest expense increased slightly in 1995 as compared with 1994 primarily as a result of higher levels of term debt at CFC largely offset by a decrease in average non-CFC debt levels. The decline in interest expense in 1994 as compared with 1993 was primarily due to reductions in CFC's effective cost of borrowings, resulting from higher levels of commercial paper, which have lower costs than borrowings under CFC's bank facilities. CFC's average effective cost of borrowings was 7.9 percent, 8.0 percent and 8.6 percent in 1995, 1994 and 1993, respectively.\nIn 1995, Chrysler recorded a $263 million provision for costs associated with production changes at its Newark assembly plant. The plant ended production of Chrysler's LeBaron convertibles in July 1995. In addition, Newark production of the Chrysler Concorde and Dodge Intrepid was reduced to one shift in August 1995 and will end prior to the production of a new vehicle in the fall of 1997. The provision includes the recognition of supplemental unemployment benefits, job security benefits and other related employee costs, and the write-down of certain equipment and tooling. The provision is included in Costs, other than items below in the consolidated statement of earnings.\nOperating results for 1993 included gains on sales of automotive assets and investments of $265 million. The 1993 pretax gain was comprised of a $205 million gain on the sales of an aggregate of 50.3 million shares of MMC stock and a $60 million gain on the sale of Chrysler's plastics operations.\nChrysler's effective tax rates in 1995, 1994 and 1993 were 38.5 percent, 36.3 percent and 37.1 percent, respectively. The provision for income taxes in 1994 included favorable adjustments aggregating $132 million, including $100 million for the recognition of tax credits related to expenditures in prior years for qualifying research and development activities. The 1993 provision for income taxes included a favorable adjustment of Chrysler's deferred tax assets and liabilities resulting from an increased U.S. federal tax rate.\nLIQUIDITY AND CAPITAL RESOURCES -------------------------------\nChrysler's combined cash, cash equivalents and marketable securities totaled $8.1 billion at December 31, 1995 (including $1.2 billion held by CFC and Car Rental Operations), compared with $8.4 billion at December 31, 1994 (including $756 million held by CFC and Car Rental Operations). At December 31, 1995, $394 million of CFC's combined cash, cash equivalents and marketable securities were limited for use in its insurance operations in accordance with various statutory requirements. The decrease in Chrysler's consolidated combined cash, cash equivalents and marketable securities in 1995 was the result of capital expenditures, net finance receivables acquired and common stock repurchases, largely offset by cash generated by operating activities and cash provided by an increase in long-term debt. The increase in Chrysler's consolidated combined cash, cash equivalents and marketable securities of $3.3 billion in 1994 was the result of cash generated by operating activities, partially offset by capital expenditures and pension contributions.\nChrysler's long-term profitability will depend significantly on its ability to continue its capital expenditure and vehicle development programs and market its vehicles successfully. Chrysler's expenditures for new product development and the acquisition of productive assets were $14.9 billion for the three-year period ended December 31, 1995. Expenditures for these items during the succeeding three-year period are expected to be at similar or higher levels. At December 31, 1995, Chrysler had commitments for capital expenditures, including commitments for assets currently under construction, totaling approximately $1.2 billion.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL PART II -- CONTINUED ------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS -- CONTINUED ------------------------------------------------\nLIQUIDITY AND CAPITAL RESOURCES -- CONTINUED - --------------------------------------------\nIn December 1994, Chrysler's Board of Directors approved a $1 billion common stock repurchase program commencing in the first quarter of 1995. In September 1995, Chrysler's Board of Directors approved an increase in the program to $2 billion to be completed by the end of 1996, depending on market conditions. During 1995, Chrysler repurchased 23 million shares of its common stock under this program at a cost of $1.1 billion (including $23 million in unsettled repurchases). In addition, holders of the Series A Convertible Preferred Stock converted 1.6 million shares of preferred stock into 44.1 million shares of common stock during 1995.\nIn the second quarter of 1995, Chrysler increased its quarterly dividend from $0.40 to $0.50 per common share. In the fourth quarter of 1995, Chrysler increased its quarterly dividend from $0.50 to $0.60 per common share, the highest dividend rate in Chrysler's history.\nAt December 31, 1995, Chrysler (excluding CFC) had aggregate debt maturities of $469 million through 1998. During 1995, Chrysler redeemed its $300 million 13% Debentures Due 1997 and repaid $185 million of other debt. In December 1995, Thrifty issued $450 million of long-term debt ($190 million of 6.6% notes and $260 million of floating rate notes which at December 31, 1995 had a weighted average interest rate of 6.7%). At December 31, 1995, Chrysler had a $1.7 billion revolving credit agreement which expires in July 1999. None of the commitment was drawn upon at December 31, 1995. Chrysler believes that cash from operations and its cash position will be sufficient to enable it to meet its capital expenditure, debt maturity, common stock repurchase, dividend payment and other funding requirements.\nChrysler's ability to market its products successfully depends significantly on the availability of vehicle financing for its dealers and, to a lesser extent, the availability of financing for retail and fleet customers, both of which are provided by CFC.\nTerm debt, commercial paper and receivable sales are CFC's primary funding sources. CFC increased its term debt outstanding by $3.1 billion and $880 million during 1995 and 1994, respectively. CFC's commercial paper outstanding decreased by $1.9 billion during 1995 and increased by $1.5 billion in 1994. CFC realized $6.5 billion and $6.4 billion of net proceeds from the sales of automotive retail receivables during 1995 and 1994, respectively. In addition, securitization of revolving wholesale account balances provided funding for CFC which aggregated $6.7 billion and $3.8 billion at December 31, 1995 and 1994, respectively.\nAt December 31, 1995, CFC had debt maturities of $4.1 billion in 1996 (including $2.4 billion of short-term notes), $3.0 billion in 1997, and $2.1 billion in 1998. During the second quarter of 1995, CFC entered into new revolving credit facilities which replaced its existing U.S. and Canadian revolving credit and receivable sale facilities. The new facilities, which total $8.0 billion, consist of a $2.4 billion facility expiring in May 1996 and a $5.6 billion facility expiring in May 2000. As of December 31, 1995, no amounts were outstanding under these facilities. CFC believes that cash provided by operations, receivable sales, access to term debt markets and the issuance of commercial paper will provide sufficient liquidity to meet its debt maturity and other funding requirements.\nChrysler's strategy is to focus on its core automotive business. As part of this strategy, Chrysler has sold certain assets and businesses in past years which are not related to its core automotive business, and is exploring the sale of other such assets and businesses in the near term.\nNEW ACCOUNTING STANDARDS ------------------------\nIn March 1995, the Financial Accounting Standards Board (\"FASB\") issued Statement of Financial Accounting Standards (\"SFAS\") No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,\" effective for fiscal years beginning after December 15, 1995. This Statement establishes accounting standards for the impairment of long-lived assets, certain identifiable\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL PART II -- CONTINUED ------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS -- CONTINUED ------------------------------------------------\nNEW ACCOUNTING STANDARDS -- CONTINUED - -------------------------------------\nintangibles, and goodwill related to those assets to be held and used and long-lived assets and certain identifiable intangibles to be disposed of. The Statement requires that long-lived assets and certain identifiable intangibles to be held and used by an entity be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In addition, the Statement requires that certain long-lived assets and identifiable intangibles to be disposed of be reported at the lower of carrying amount or fair value less cost to sell. Chrysler believes that the implementation of this new accounting standard will not have a material impact on its consolidated operating results or financial position. Chrysler will adopt this accounting standard on January 1, 1996, as required.\nIn October 1995, the FASB issued SFAS No. 123, \"Accounting for Stock-Based Compensation,\" effective for fiscal years beginning after December 15, 1995. This Statement encourages entities to use a fair value based method of accounting for stock-based compensation plans. This Statement also requires certain disclosures about stock-based employee compensation arrangements regardless of the method used to account for them. Pro forma disclosures are required for entities that continue to apply the provisions of Accounting Principles Board Opinion No. 25, \"Accounting for Stock Issued to Employees.\" The pro forma amounts will reflect the difference between compensation cost, if any, included in net income and the related cost measured by the fair value based method as defined in this Statement, including tax effects, if any, that would have been recognized in the income statement if the fair value method had been used. Chrysler intends to adopt this Statement on a disclosure only basis. Chrysler will adopt this accounting standard on January 1, 1996, as required.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND PART II -- CONTINUED ------------------------ SUPPLEMENTARY DATA ------------------\nCHRYSLER CORPORATION AND CONSOLIDATED SUBSIDIARIES CONSOLIDATED STATEMENT OF EARNINGS\nSee notes to consolidated financial statements.\nITEM 8. FINANCIAL STATEMENTS AND PART II -- CONTINUED ------------------------ SUPPLEMENTARY DATA -- CONTINUED -------------------------------\nCHRYSLER CORPORATION AND CONSOLIDATED SUBSIDIARIES CONSOLIDATED BALANCE SHEET\n- ------------------------- * Less than $1 million\nSee notes to consolidated financial statements.\nITEM 8. FINANCIAL STATEMENTS AND PART II -- CONTINUED ------------------------ SUPPLEMENTARY DATA -- CONTINUED ------------------------------- CHRYSLER CORPORATION AND CONSOLIDATED SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS\nSee notes to consolidated financial statements.\nITEM 8. FINANCIAL STATEMENTS AND PART II -- CONTINUED ------------------------ SUPPLEMENTARY DATA -- CONTINUED -------------------------------\nCHRYSLER CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - --------------------------------------------------\nCONSOLIDATION AND FINANCIAL STATEMENT PRESENTATION\nThe consolidated financial statements of Chrysler Corporation and its consolidated subsidiaries (\"Chrysler\") include the accounts of all significant majority-owned subsidiaries and entities. Intercompany accounts and transactions have been eliminated in consolidation. Amounts for 1994 and 1993 have been reclassified to conform with current period classifications.\nESTIMATES\nThe preparation of Chrysler's 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 disclosures 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.\nREVENUE RECOGNITION\nIn the fourth quarter of 1995, the Emerging Issues Task Force (\"EITF\") of the Financial Accounting Standards Board (\"FASB\") reached a consensus on EITF Issue 95-1, \"Revenue Recognition on Sales with a Guaranteed Minimum Resale Value.\" The consensus on EITF Issue 95-1 (the \"consensus\") affects Chrysler's accounting treatment for vehicle sales (principally to non-affiliated rental car companies) for which Chrysler conditionally guarantees the minimum resale value of the vehicles. In accordance with the consensus, these vehicle sales are accounted for as operating leases with the related revenues and costs deferred at the time of shipment. A portion of the deferred revenues and costs is recognized over the corresponding guarantee period, with the remainder recognized at the end of the guarantee period. The average guarantee period for these vehicles is approximately nine months. Chrysler changed its accounting treatment in accordance with the consensus effective January 1, 1995 which resulted in the recognition of an after-tax charge of $96 million, or $0.25 per common share, for the cumulative effect of this change in accounting principle. The ongoing effect of this accounting change was not material to 1995 earnings.\nVehicle and parts sales are generally recognized when such products are shipped to dealers, except for sales under which Chrysler conditionally guarantees the minimum resale value of the vehicles. Provisions for sales allowances and incentives are recognized at the time the related sale is recognized and are treated as revenue reductions.\nFinance revenue from finance receivables of Chrysler Financial Corporation (\"CFC\"), a wholly owned subsidiary, is recognized using the interest method. Certain loan and lease origination costs are deferred and amortized to finance revenue over the contractual terms. Recognition of finance revenue is generally suspended when a loan or lease becomes contractually delinquent for periods ranging from 60 to 90 days. Finance revenue recognition is resumed when the loan or lease becomes contractually current, at which time all past due finance revenue is recognized.\nCFC sells significant amounts of automotive retail and wholesale receivables in transactions subject to limited recourse provisions. CFC generally sells its receivables to a trust and remains as servicer, for which it is paid a servicing fee. Normal servicing fees are earned on a level yield basis over the remaining terms of the related sold receivables. In a subordinated capacity, CFC retains excess servicing cash flows, a limited interest in the principal balances of the sold receivables and certain cash deposits provided as credit enhancements for investors. Gains or losses from the sales of retail receivables are recognized in the period in which such sales\nITEM 8. FINANCIAL STATEMENTS AND PART II -- CONTINUED ------------------------ SUPPLEMENTARY DATA -- CONTINUED -------------------------------\nCHRYSLER CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- CONTINUED - ---------------------------------------------------------------\nREVENUE RECOGNITION -- CONTINUED\noccur. 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.\nDEPRECIATION AND TOOL AMORTIZATION\nProperty and equipment are stated at cost less accumulated depreciation. Depreciation is generally provided on a straight-line basis. At December 31, 1995, the weighted average service lives of assets were 34 years for buildings (including improvements and building equipment), 14 years for machinery and equipment and 10 years for furniture and fixtures. Special tooling costs are amortized over the years that a model using that tooling is expected to be produced, and within each year based on the units produced. Amortization is deducted directly from the asset account. During any given model year, special tools will contain tooling with varying useful lives.\nEffective April 1, 1994, Chrysler revised the estimated service lives of certain special tools and property and equipment. These revisions were based on updated assessments of the service lives of the related assets and resulted in the recognition of additional amortization of special tools of $246 million in 1994 and lower depreciation of property and equipment of $45 million in 1994.\nPRODUCT-RELATED COSTS\nExpenditures for advertising, sales promotion and other product-related costs are expensed as incurred. Provisions for product warranty costs are recognized at the time the related sale is recognized. Advertising expense was $1.2 billion, $1.1 billion and $858 million in 1995, 1994 and 1993, respectively. Research and development costs were $1.4 billion, $1.3 billion and $1.2 billion in 1995, 1994 and 1993, respectively.\nCASH AND CASH EQUIVALENTS\nHighly liquid investments with a maturity of three months or less at the date of purchase are classified as cash equivalents.\nMARKETABLE SECURITIES\nEffective January 1, 1994, Chrysler adopted Statement of Financial Accounting Standards (\"SFAS\") No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" Adoption of this accounting standard did not have a material effect on Chrysler's financial statements.\nUnder SFAS No. 115, debt and equity securities with readily determinable fair values are segregated into one of the following categories -- trading, available-for-sale or held-to-maturity. Trading securities and available-for-sale securities are carried at their fair values. Changes in the fair values of trading securities are recorded in the statement of earnings. Changes in the fair values of available-for-sale securities are recognized as a component of shareholders' equity until such securities are sold. Held-to-maturity securities are carried at cost adjusted for amortized premium or discount.\nAt December 31, 1995 and 1994, Chrysler had investments in securities (including cash equivalents) with an aggregate carrying value of $7.3 billion and $7.9 billion, respectively, accounted for in accordance with SFAS No. 115. These securities consisted primarily of commercial paper, federal government agency\nITEM 8. FINANCIAL STATEMENTS AND PART II -- CONTINUED ------------------------ SUPPLEMENTARY DATA -- CONTINUED -------------------------------\nCHRYSLER CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- CONTINUED - --------------------------------------------------------------- MARKETABLE SECURITIES -- CONTINUED securities and corporate debt. At December 31, 1995, securities categorized as available-for-sale and held-to-maturity totaled $6.6 billion and $677 million, respectively. At December 31, 1994, securities categorized as available-for-sale and held-to-maturity totaled $5.5 billion and $2.4 billion, respectively. Substantially all such securities have maturities within one year.\nOn December 29, 1995, CFC transferred all of its securities classified as held-to-maturity to available-for-sale. At the date of transfer, the amortized cost and unrealized gain of the securities transferred totaled $283 million and $9 million, respectively. This transfer resulted from CFC conducting a one-time reassessment of the classification of securities held in accordance with FASB Special Report, \"A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities.\"\nALLOWANCE FOR CREDIT LOSSES\nAn allowance for credit losses is generally established during the period in which receivables or vehicle leases are acquired. The allowance for credit losses is maintained at a level deemed appropriate, based primarily on loss experience. Other factors affecting collectibility are also evaluated and appropriate adjustments are recorded. Retail automotive receivables and vehicle leases not supported by a dealer guaranty are charged to the allowance for credit losses net of the estimated value of repossessed collateral at the time of repossession. Nonautomotive finance receivables are reduced to the estimated fair value of the collateral when such loans are deemed to be impaired.\nINVENTORIES\nInventories are valued at the lower of cost or market. The cost of approximately 42 percent and 51 percent of inventories at December 31, 1995 and 1994, respectively, was determined on a Last-In, First-Out (\"LIFO\") basis. The balance of inventory cost was determined on a First-In, First-Out (\"FIFO\") basis.\nINTANGIBLE ASSETS\nThe purchase price of companies in excess of the value of net identifiable assets acquired (\"goodwill\") is amortized on a straight-line basis over periods of up to 40 years. The amount is reported net of accumulated amortization of $767 million and $723 million at December 31, 1995 and 1994, respectively. Chrysler periodically evaluates the carrying value of goodwill for impairment. Such evaluations are based principally on the projected, undiscounted cash flows of the operations to which the goodwill relates.\nPOSTEMPLOYMENT BENEFITS\nEffective January 1, 1993, Chrysler adopted SFAS No. 112, \"Employers' Accounting for Postemployment Benefits,\" which required the accrual of benefits provided to former or inactive employees after employment but prior to retirement. Prior to 1993, Chrysler accrued for certain of these benefits at the time an employee's active service ended and expensed certain other benefits on the basis of cash expenditures. Adoption of this accounting standard resulted in the recognition of an after-tax charge of $283 million, or $0.82 per common share, for the cumulative effect of this change in accounting principle.\nITEM 8. FINANCIAL STATEMENTS AND PART II -- CONTINUED ------------------------ SUPPLEMENTARY DATA -- CONTINUED -------------------------------\nCHRYSLER CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- CONTINUED - --------------------------------------------------------------- DERIVATIVE FINANCIAL INSTRUMENTS\nChrysler manages risk arising from fluctuations in interest rates and currency exchange rates by using derivative financial instruments. Chrysler does not use derivative financial instruments for trading purposes.\nWhen Chrysler sells vehicles outside the United States or purchases components from suppliers outside the United States, transactions are frequently denominated in currencies other than U.S. dollars. Periodically, Chrysler initiates hedging activities by entering into currency exchange agreements, consisting principally of currency forward contracts and purchased options, to minimize revenue and cost variations which could result from fluctuations in currency exchange rates. These instruments, consistent with the underlying purchase or sale commitments, typically mature within two years of origination. The currency exchange agreements are treated as off-balance sheet financial instruments, with related gains and losses recorded in the settlement of the underlying transactions. In the event of an early termination of a currency exchange agreement designated as a hedge, the gain or loss continues to be deferred and is included in the settlement of the underlying transaction. Chrysler also uses written currency options to effectively close out existing purchased options, both of which are then carried at fair value. Previously unrecognized gains and losses on the purchased options continue to be deferred and are included in the settlement of the underlying transaction.\nCFC utilizes interest rate swaps, interest rate caps, forward interest rate contracts and currency exchange agreements to manage funding costs and exposure arising from changes in interest and currency exchange rates. Interest differentials resulting from interest rate swap agreements used to change the interest rate characteristics of CFC's debt are recorded on an accrual basis as an adjustment to interest expense. Interest rate swaps are either matched with specific term debt obligations or with groups of commercial paper on a layered basis. Forward interest rate contracts are used to manage exposure to fluctuations in funding costs for anticipated securitizations of retail receivables. Unrealized gains or losses on forward interest rate contracts that qualify for hedge accounting treatment are deferred. Unrealized gains or losses on forward interest rate contracts that do not qualify for hedge accounting treatment are included in other revenues. Realized gains or losses for hedge instruments are included in the determination of the gain or loss from the related sales of retail receivables. In the event of an early termination of an interest rate exchange agreement designated as a hedge, the gain or loss is deferred and recorded as an adjustment to interest expense over the remaining term of the underlying debt. In addition, CFC enters into currency exchange agreements to manage its exposure to fluctuations in currency exchange rates related to specific borrowings denominated in currencies other than the local currency of the borrowing entity. As a result, such borrowings are translated in the consolidated balance sheet at the rates of exchange established under the related currency exchange agreement.\nNOTE 2. INVENTORIES AND COST OF SALES - -------------------------------------\nInventories, summarized by major classification, were as follows:\nITEM 8. FINANCIAL STATEMENTS AND PART II -- CONTINUED ------------------------ SUPPLEMENTARY DATA -- CONTINUED -------------------------------\nCHRYSLER CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 2. INVENTORIES AND COST OF SALES -- CONTINUED - --------------------------------------------------\nInventories valued on the LIFO basis would have been $334 million and $328 million higher than reported had they been valued on the FIFO basis at December 31, 1995 and 1994, respectively.\nBeginning in 1995, vehicles held for short-term lease include the carrying value of vehicles for which Chrysler conditionally guarantees the minimum resale value of the vehicles.\nTotal manufacturing cost of sales aggregated $41.7 billion, $39.0 billion and $33.1 billion for 1995, 1994 and 1993, respectively.\nNOTE 3. FINANCE RECEIVABLES AND RETAINED INTERESTS IN SOLD RECEIVABLES - ----------------------------------------------------------------------\nFinance receivables and retained interests in sold receivables were as follows:\nRetained interests in sold receivables are generally restricted and subject to limited recourse provisions. At December 31, 1994, CFC was a party to an interest rate cap agreement related to $134 million of its retained interests. At December 31, 1994, CFC was also party to a forward interest rate contract (notional amount $500 million) to manage its exposure to fluctuations in funding costs.\nContractual maturities of total finance receivables as of December 31, 1995, were (in millions of dollars): 1996 - $4,271; 1997 - $1,703; 1998 - $1,603; 1999 - $1,042; 2000 - $623; and 2001 and thereafter - $1,959. Actual cash flows will vary from contractual maturities due to future sales of finance receivables, prepayments and charge-offs.\nChanges in the allowance for credit losses were as follows:\nITEM 8. FINANCIAL STATEMENTS AND PART II -- CONTINUED ------------------------ SUPPLEMENTARY DATA -- CONTINUED -------------------------------\nCHRYSLER CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 3. FINANCE RECEIVABLES AND RETAINED INTERESTS IN SOLD RECEIVABLES -- CONTINUED - -------------------------------------------------------------------------\nNonearning finance receivables, including receivables sold subject to limited recourse, totaled $333 million and $282 million at December 31, 1995 and 1994, respectively, which represented 1.0 percent and 0.9 percent of such receivables outstanding, respectively.\nNOTE 4. PROPERTY AND EQUIPMENT - ------------------------------\nProperty and equipment, summarized by major classification, were as follows:\nNOTE 5. ACCRUED LIABILITIES AND EXPENSES - ----------------------------------------\nAccrued liabilities and expenses consisted of the following:\nITEM 8. FINANCIAL STATEMENTS AND PART II -- CONTINUED ------------------------ SUPPLEMENTARY DATA -- CONTINUED -------------------------------\nCHRYSLER CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 6. DEBT - ------------\nDebt consisted of the following:\n- ------------------------- (1) The weighted average interest rates include the effects of interest rate exchange agreements.\nAt December 31, 1995, aggregate annual maturities of consolidated debt, including principal payments on capital leases, were as follows (in millions of dollars): 1996-$4,335; 1997-$2,973; 1998-$2,354; 1999-$1,804; and 2000-$925.\nCFC enters into currency exchange agreements to manage its exposure to fluctuations in currency exchange rates related to specific borrowings denominated in currencies other than the local currency of the borrowing entity. As a result, such borrowings are translated in the consolidated balance sheet at the rates of exchange established under the related currency exchange agreement. The reported amount of such borrowings was $330 million. If CFC had not entered into currency exchange agreements, the amount would have been $175 million higher at December 31, 1995.\nTo mitigate risks associated with changing interest rates on certain of its debt, CFC has entered into interest rate exchange agreements. CFC manages exposure to counterparty credit risk by entering into such agreements only with major financial institutions that are expected to fully perform under the terms of such\nITEM 8. FINANCIAL STATEMENTS AND PART II -- CONTINUED ------------------------ SUPPLEMENTARY DATA -- CONTINUED -------------------------------\nCHRYSLER CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 6. DEBT -- CONTINUED - ------------------------- agreements. The notional amounts are used to measure the volume of these agreements and do not represent exposure to credit loss. The impact of interest rate exchange agreements on interest expense was immaterial in 1995, 1994 and 1993.\nThe following table summarizes CFC's interest rate derivatives related to its debt:\nDuring the second quarter of 1995, CFC entered into new revolving credit facilities which replaced its existing U.S. and Canadian revolving credit and receivable sale facilities. The new facilities, which total $8.0 billion, consist of a $2.4 billion facility expiring in May 1996 and a $5.6 billion facility expiring in May 2000. As of December 31, 1995, no amounts were outstanding under these facilities.\nAt December 31, 1995, Chrysler had a $1.7 billion revolving credit agreement which expires in July 1999. None of the commitment was drawn upon at December 31, 1995.\nITEM 8. FINANCIAL STATEMENTS AND PART II -- CONTINUED ------------------------ SUPPLEMENTARY DATA -- CONTINUED -------------------------------\nCHRYSLER CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 7. INCOME TAXES - --------------------\nEarnings before income taxes and the cumulative effect of changes in accounting principles were attributable to the following sources:\nThe provision for income taxes included the following:\nChrysler does not provide for U.S. income taxes or foreign withholding taxes on the undistributed earnings of foreign subsidiaries, as such cumulative earnings of $2.1 billion are intended to be permanently reinvested in those operations. It is not practicable to estimate the amount of unrecognized deferred tax liability for these undistributed foreign earnings.\nITEM 8. FINANCIAL STATEMENTS AND PART II -- CONTINUED ------------------------ SUPPLEMENTARY DATA -- CONTINUED -------------------------------\nCHRYSLER CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 7. INCOME TAXES -- CONTINUED - ---------------------------------\nA reconciliation of income taxes determined using the statutory U.S. rate of 35 percent to actual income taxes provided was as follows:\nThe adjustment to the provision for income taxes for the recognition of prior years' research and development tax credits in 1994 represented the tax benefits related to expenditures in prior years for qualifying research and development activities, in accordance with an Internal Revenue Service settlement which was based on U.S. Department of Treasury income tax regulations issued in 1994.\nThe tax-effected temporary differences and carryforwards which comprised deferred tax assets and liabilities were as follows:\nChrysler's tax credit carryforwards expire at various dates through the year 2009; alternative minimum tax credit carryforwards have no expiration dates. NOL carryforwards totaled $218 million at December 31,\nITEM 8. FINANCIAL STATEMENTS AND PART II -- CONTINUED ------------------------ SUPPLEMENTARY DATA -- CONTINUED -------------------------------\nCHRYSLER CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 7. INCOME TAXES -- CONTINUED - ---------------------------------\n1995, and may be used through the year 2008. The valuation allowance was principally related to a subsidiary's NOL carryforwards. Changes in the valuation allowance were as follows:\nNOTE 8. COMMITMENTS, CONTINGENCIES AND CONCENTRATIONS - -----------------------------------------------------\nLITIGATION - ----------\nVarious claims and legal proceedings have been asserted or instituted against Chrysler, including some purporting to be class actions, and some which demand large monetary damages or other relief which could result in significant expenditures. Litigation is subject to many uncertainties, and the outcome of individual matters is not predictable with assurance. It is reasonably possible that the final resolution of some of these matters may require Chrysler to make expenditures, in excess of established reserves, over an extended period of time and in a range of amounts that cannot be reasonably estimated. The term \"reasonably possible\" is used herein to mean that the chance of a future transaction or event occurring is more than remote but less than likely. Although the final resolution of any such matters could have a material effect on Chrysler's consolidated operating results for the particular reporting period in which an adjustment of the estimated liability is recorded, Chrysler believes that any resulting liability should not materially affect its consolidated financial position.\nENVIRONMENTAL MATTERS\nChrysler is subject to potential liability under government regulations and various claims and legal actions which are pending or may be asserted against Chrysler concerning environmental matters. Estimates of future costs of such environmental matters are necessarily imprecise due to numerous uncertainties, including the enactment of new laws and regulations, the development and application of new technologies, the identification of new sites for which Chrysler may have remediation responsibility and the apportionment and collectibility of remediation costs among responsible parties. Chrysler establishes reserves for these environmental matters when the loss is probable and reasonably estimable. It is reasonably possible that final resolution of some of these matters may require Chrysler to make significant expenditures, in excess of established reserves, over an extended period of time and in a range of amounts that cannot be reasonably estimated. Although the final resolution of any such matters could have a material effect on Chrysler's consolidated operating results for the particular reporting period in which an adjustment of the estimated liability is recorded, Chrysler believes that any resulting liability should not materially affect its consolidated financial position.\nITEM 8. FINANCIAL STATEMENTS AND PART II -- CONTINUED ------------------------ SUPPLEMENTARY DATA -- CONTINUED -------------------------------\nCHRYSLER CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 8. COMMITMENTS, CONTINGENCIES AND CONCENTRATIONS -- CONTINUED - ------------------------------------------------------------------\nPOSSIBLE DISPOSITION OF ASSETS AND BUSINESSES\nChrysler's strategy is to focus on its core automotive business. As part of this strategy, Chrysler has sold certain assets and businesses in past years which are not related to its core automotive business, and is exploring the sale of other such assets and businesses in the near term. Although Chrysler cannot reasonably estimate the gains or losses that may result from the sales of such assets and businesses, if any, such gains or losses could have a material effect on Chrysler's consolidated operating results. However, Chrysler believes that such gains or losses should not materially affect its consolidated financial position.\nCONCENTRATIONS\nAt December 31, 1995, Chrysler had a total of approximately 126,000 employees worldwide. Of this total, approximately 85,000 hourly workers and 29,000 salaried workers were employed in the U.S. and Canada. In the U.S. and Canada, approximately 95 percent of Chrysler's hourly employees and 22 percent of its salaried employees are represented by unions. Of these represented employees, 97 percent of hourly and 90 percent of salaried employees are represented by the United Automotive, Aerospace, and Agricultural Implement Workers of America (\"UAW\") or the National Automobile, Aerospace, and Agricultural Implement Workers of Canada (\"CAW\"). The existing national agreements with the UAW and CAW will expire in September of 1996.\nOTHER MATTERS\nThe majority of Chrysler's lease payments are for operating leases. At December 31, 1995, Chrysler had the following minimum rental commitments under noncancelable operating leases: 1996-$341 million; 1997-$182 million; 1998-$99 million; 1999-$77 million; 2000-$61 million; and 2001 and thereafter-$201 million. Future minimum lease commitments have not been reduced by minimum sublease rentals of $218 million due in the future under noncancelable subleases.\nRental expense for operating leases with original expiration dates beyond one year was $436 million, $407 million and $410 million in 1995, 1994 and 1993, respectively. Sublease rentals of $58 million, $60 million, and $61 million were received in 1995, 1994 and 1993, respectively.\nChrysler had commitments for capital expenditures, including commitments for assets currently under construction, approximating $1.2 billion at December 31, 1995.\nAt December 31, 1995, Chrysler had guaranteed obligations of others in the amount of $301 million, none of which were secured by collateral.\nNOTE 9. STOCK OPTIONS AND PERFORMANCE-BASED COMPENSATION - --------------------------------------------------------\nThe Chrysler Corporation 1991 Stock Compensation Plan (the \"1991 Plan\") provides that Chrysler may grant stock options to officers, key employees and nonemployee directors and also may grant reload stock options (which are options granted when outstanding options are exercised by payment in stock), stock appreciation rights (payable in cash or stock, at the sole discretion of the Stock Option Committee) and limited stock appreciation rights (payable in cash in the event of a change in control). The 1991 Plan also provides for awarding restricted stock units and performance stock units, which reward service for specified periods or attainment of performance objectives. The Chrysler Corporation Stock Option Plan (the \"Plan\"), initially adopted in 1972 and readopted in 1982, was amended to incorporate certain features of the 1991 Plan.\nITEM 8. FINANCIAL STATEMENTS AND PART II -- CONTINUED ------------------------ SUPPLEMENTARY DATA -- CONTINUED -------------------------------\nCHRYSLER CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 9. STOCK OPTIONS AND PERFORMANCE-BASED COMPENSATION -- CONTINUED - ---------------------------------------------------------------------\nUnder the Plan and the 1991 Plan, outstanding options, consisting of ten-year nonqualified stock options, have exercise prices of not less than the market value of Chrysler common stock at the date of grant. Options generally become exercisable on up to 40 percent of the shares after one year from the date of grant, 70 percent after two years and 100 percent after three years. Information with respect to options granted under the Plan and the 1991 Plan, including the conversion of American Motors Corporation (\"AMC\") options outstanding at the date of the AMC acquisition, was as follows:\nShares available for granting options at the end of 1995, 1994 and 1993 were 11.2 million, 15.1 million, and 1.5 million, respectively. At December 31, 1995, 6.2 million options with prices ranging from $43.19 to $57.00 were not yet exercisable under the terms of the Plan and the 1991 Plan.\nIn addition to the Plan and the 1991 Plan, Chrysler has programs under which additional compensation is paid to hourly and salaried employees based upon various measures of Chrysler's performance. Such performance-based compensation programs include incentive compensation and profit sharing paid to certain hourly and salaried employees.\nITEM 8. FINANCIAL STATEMENTS AND PART II -- CONTINUED ------------------------ SUPPLEMENTARY DATA -- CONTINUED -------------------------------\nCHRYSLER CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 10. SHAREHOLDERS' EQUITY - -----------------------------\nInformation with respect to shareholders' equity was as follows (shares in millions):\n- ------------------------- * Less than $1 million\nDuring December 1994, Chrysler's Board of Directors approved a $1 billion common stock repurchase program commencing in the first quarter of 1995. In 1995, Chrysler's Board of Directors approved an increase in the program to $2 billion to be completed by the end of 1996, depending on market conditions. In 1995, Chrysler repurchased 23 million shares of its common stock under this program at a cost of $1,070 million (including $23 million in unsettled repurchases).\nThe annual dividend on the Series A Convertible Preferred Stock (the \"Preferred Stock\") is $46.25 per share. The Preferred Stock is convertible, unless previously redeemed, at a rate (subject to adjustment in\nITEM 8. FINANCIAL STATEMENTS AND PART II -- CONTINUED ------------------------ SUPPLEMENTARY DATA -- CONTINUED -------------------------------\nCHRYSLER CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 10. SHAREHOLDERS' EQUITY -- CONTINUED - ------------------------------------------\ncertain events) of 27.78 shares of common stock for each share of Preferred Stock. The Preferred Stock is not redeemable prior to January 22, 1997. Thereafter, Chrysler may redeem the Preferred Stock, in whole or in part, at $523.13 per share of Preferred Stock for the period ending December 31, 1997 and thereafter declining ratably annually to $500.00 per share after December 31, 2001, plus accrued and unpaid dividends. During 1995, holders of substantially all of the Preferred Stock converted their shares into shares of common stock.\nIn February 1988, the Board of Directors declared and distributed a dividend of one Preferred Share Purchase Right (a \"Right\") for each then outstanding share of Chrysler's common stock and authorized the distribution of one Right with respect to each subsequently issued share of common stock. Each Right, as most recently amended, entitles a shareholder to purchase one one-hundredth of a share of Junior Participating Cumulative Preferred Stock of Chrysler at a price of $120. The Rights are attached to the common stock and are not represented by separate certificates or exercisable until the earliest to occur of (i) 10 days following the time (the \"Stock Acquisition Time\") of a public announcement or communication to Chrysler that a person or group of persons has acquired or obtained the right to acquire 15 percent or more of Chrysler's outstanding common stock, and (ii) 10 business days after a person or group of persons announces or commences a tender offer that would result, if successful, in the bidder owning 15 percent or more of Chrysler's outstanding common stock. If the acquiring person or group acquires 15 percent or more of the common stock (except pursuant to a tender offer made for all of Chrysler's common stock, and determined by Chrysler's independent directors to be fair and in the best interests of Chrysler and its shareholders) each Right (other than those held by the acquiror) will entitle its holder to buy, for $120, a number of shares of Chrysler's common stock having a market value of $240. Similarly, if after the Stock Acquisition Time, Chrysler is acquired in a merger or other business combination and is not the surviving corporation, or 50 percent or more of its assets, cash flow or earning power is sold, each Right (other than those held by the surviving or acquiring company) will entitle its holder to purchase, for $120, shares of the surviving or acquiring company having a market value of $240. Chrysler's directors may redeem the Rights at $0.05 per Right, and may amend the Rights or extend the time during which the Rights may be redeemed, only prior to the Stock Acquisition Time. Additionally, at any time after a person or group acquires 15 percent or more, but less than 50 percent, of Chrysler's common stock, Chrysler's directors may exchange the Rights (other than those held by the acquiror), in whole or in part, at an exchange ratio of one share of common stock (or a fractional share of preferred stock with equivalent voting rights) per Right. The Rights will expire on February 22, 1998.\nOf the 1.0 billion shares of authorized common stock at December 31, 1995, 53 million shares were reserved for issuance under Chrysler's various employee benefit plans and the conversion of the Preferred Stock.\nPrimary earnings (loss) per common share amounts were computed by dividing earnings (loss) after deduction of preferred stock dividends by the average number of common and dilutive equivalent shares outstanding. Fully diluted per-common-share amounts assume conversion of the Preferred Stock, the elimination of the related preferred stock dividend requirement, and the issuance of common stock for all other potentially dilutive equivalents outstanding. Fully diluted per-common-share amounts are not applicable for loss periods.\nNOTE 11. PENSION PLANS - ----------------------\nChrysler's pension plans provide noncontributory and contributory benefits. The noncontributory pension plans cover substantially all of the hourly and salaried employees of Chrysler and certain of its consolidated\nITEM 8. FINANCIAL STATEMENTS AND PART II -- CONTINUED ------------------------ SUPPLEMENTARY DATA -- CONTINUED -------------------------------\nCHRYSLER CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 11. PENSION PLANS -- CONTINUED - ----------------------------------- subsidiaries. Benefits are based on a fixed rate for each year of service. Additionally, contributory benefits are provided to substantially all salaried employees of Chrysler and certain of its consolidated subsidiaries under the Salaried Employees' Retirement Plan. This plan provides benefits based on the employee's cumulative contributions, years of service during which employee contributions were made, and the employee's average salary during the consecutive five years in which salary was highest in the 15 years preceding retirement.\nContributions to the pension trust fund for U.S. plans are in compliance with the Employee Retirement Income Security Act of 1974, as amended. All pension trust fund assets and income accruing thereon are used solely to pay pension benefits and administer the plans. Chrysler made pension fund contributions totaling $838 million in 1995, $2.6 billion in 1994 and $3.5 billion in 1993.\nAt December 31, 1995, plan assets were invested in a diversified portfolio that consisted primarily of debt and equity securities, including 11.9 million shares of Chrysler common stock with a market value of $658 million. During 1995, $29 million of dividends were received on Chrysler common stock.\nThe components of pension expense were as follows:\nDuring 1995, 1994 and 1993, the cost of voluntary early retirement programs, which are periodically offered to certain salaried and hourly employees, was $21 million, $68 million and $40 million, respectively, and is included in pension expense.\nITEM 8. FINANCIAL STATEMENTS AND PART II -- CONTINUED ------------------------ SUPPLEMENTARY DATA -- CONTINUED -------------------------------\nCHRYSLER CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 11. PENSION PLANS -- CONTINUED - -----------------------------------\nPension expense is determined using assumptions at the beginning of the year. The projected benefit obligation (\"PBO\") is determined using the assumptions at the end of the year. Assumptions used to determine pension expense and the PBO were:\nThe decrease in the discount rate for U.S. Plans from 8.63 percent as of December 31, 1994 to 7.00 percent as of December 31, 1995 resulted in a $1.7 billion increase in the PBO at December 31, 1995 and is expected to result in an $89 million increase in 1996 pension expense.\nITEM 8. FINANCIAL STATEMENTS AND PART II -- CONTINUED ------------------------ SUPPLEMENTARY DATA -- CONTINUED -------------------------------\nCHRYSLER CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 11. PENSION PLANS -- CONTINUED - -----------------------------------\nThe following table presents a reconciliation of the funded status of the plans with amounts recognized in the consolidated balance sheet:\nITEM 8. FINANCIAL STATEMENTS AND PART II -- CONTINUED ------------------------ SUPPLEMENTARY DATA -- CONTINUED -------------------------------\nCHRYSLER CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 11. PENSION PLANS -- CONTINUED - ----------------------------------- Included in other assets on the consolidated balance sheet as of December 31, 1995 and 1994 was noncurrent prepaid pension expense of $4.7 billion and $4.1 billion, respectively.\nNOTE 12. NONPENSION POSTRETIREMENT BENEFITS - -------------------------------------------\nChrysler provides health and life insurance benefits to substantially all of its hourly and salaried employees and those of certain of its consolidated subsidiaries. Upon retirement from Chrysler, employees may become eligible for continuation of these benefits. However, benefits and eligibility rules may be modified periodically. Prior to 1993, the expense recognized for these benefits was based primarily on cash expenditures for the period. Effective January 1, 1993, Chrysler adopted SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" which requires the accrual of such benefits during the years employees provide services. The adoption of this accounting standard resulted in an after-tax charge of $4.7 billion, or $13.57 per common share, in 1993. Implementation of SFAS No. 106 did not increase Chrysler's cash expenditures for postretirement benefits.\nComponents of nonpension postretirement benefit expense were as follows:\nThe following table summarizes the components of the nonpension postretirement benefit obligation recognized in the consolidated balance sheet at December 31, 1995 and 1994:\nITEM 8. FINANCIAL STATEMENTS AND PART II -- CONTINUED ------------------------ SUPPLEMENTARY DATA -- CONTINUED -------------------------------\nCHRYSLER CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 12. NONPENSION POSTRETIREMENT BENEFITS -- CONTINUED - -------------------------------------------------------- Nonpension postretirement benefit expense is determined using assumptions at the beginning of the year. The ANPBO is determined using the assumptions at the end of the year. Assumptions at December 31, 1995, 1994 and 1993 were:\n- ------------------------- (1) Rate decreases annually through the year 2002\nThe decrease in the discount rate from 8.6 percent to 7.0 percent as of December 31, 1995 resulted in a $1.6 billion increase in the ANPBO in 1995, and is expected to result in a $124 million increase in nonpension postretirement benefit expense in 1996.\nA one percentage point increase in the assumed health care inflation rate in each year would have increased the ANPBO at December 31, 1995 by $1.2 billion and would have increased the aggregate of the service and interest cost components of nonpension postretirement benefit expense in 1995 by $105 million.\nNOTE 13. SALES OF AUTOMOTIVE ASSETS AND INVESTMENTS - ---------------------------------------------------\nDuring 1994, Chrysler sold its wire harness operations and certain of its soft trim operations, and entered into five-year supply agreements with each of the purchasers. Aggregate net proceeds from the sales and the supply agreements were $315 million. The related pretax gains of $254 million were deferred and are being recognized over the periods of the respective supply agreements.\nIn 1993, Chrysler sold its plastics operations for net proceeds of $132 million. The sale resulted in a pretax gain of $60 million ($39 million after income taxes). Also during 1993, Chrysler sold its remaining 50.3 million shares of Mitsubishi Motors Corporation stock for net proceeds of $329 million, resulting in a pretax gain of $205 million ($128 million after income taxes).\nNOTE 14. SPECIAL PLANT PROVISION - --------------------------------\nDuring 1995, Chrysler recorded a $263 million provision ($162 million after income taxes) for costs associated with production changes at its Newark assembly plant. The plant ended production of Chrysler's LeBaron convertibles in July 1995. In addition, Newark production of the Chrysler Concorde and Dodge Intrepid was reduced to one shift in August 1995 and will end prior to production of a new vehicle in the fall of 1997. The provision includes the recognition of supplemental unemployment benefits, job security benefits and other related employee costs, and the write-down of certain equipment and tooling. The provision is included in Costs, other than items below in the consolidated statement of earnings.\nITEM 8. FINANCIAL STATEMENTS AND PART II -- CONTINUED ------------------------ SUPPLEMENTARY DATA -- CONTINUED -------------------------------\nCHRYSLER CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 15. SUPPLEMENTAL CASH FLOW INFORMATION - -------------------------------------------\nSupplemental disclosures to the consolidated statement of cash flows were as follows:\nCFC acquired $250 million and $300 million of asset-backed securities in non-cash transactions relating to the securitization of retail receivables during 1995 and 1994, respectively.\nNOTE 16. FINANCIAL INSTRUMENTS - ------------------------------\nThe estimated fair values of financial instruments have been determined by Chrysler using available market information and the valuation methodologies described below. However, considerable judgment is required in interpreting market data to develop the estimates of fair value. Accordingly, the estimates presented herein may not be indicative of the amounts that Chrysler could realize in a current market exchange. The use of different assumptions or valuation methodologies may have a material effect on the estimated fair value amounts.\nAmounts related to Chrysler's financial instruments were as follows:\n- ------------------------- (1) The carrying value of finance receivables and retained interests excludes $1,800 million and $1,864 million of direct finance and leveraged leases classified as finance receivables in the consolidated balance sheet at December 31, 1995 and 1994, respectively.\n(2) Currency exchange agreements are recorded on the consolidated balance sheet as a net reduction to the carrying value of debt.\nITEM 8. FINANCIAL STATEMENTS AND PART II -- CONTINUED ------------------------ SUPPLEMENTARY DATA -- CONTINUED -------------------------------\nCHRYSLER CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 16. FINANCIAL INSTRUMENTS -- CONTINUED - -------------------------------------------\n- ------------------------- (1) Includes purchased currency options with a notional amount of $351 million which have been effectively closed out with written currency options also with a notional amount of $351 million.\nThe carrying values of cash and cash equivalents, accounts receivable and accounts payable approximated fair values due to the short-term maturities of these instruments.\nThe methods and assumptions used to estimate the fair values of other financial instruments are summarized as follows:\nMarketable securities - ---------------------\nThe fair values of marketable securities were estimated using quoted market prices.\nFinance receivables and retained interests in sold receivables - --------------------------------------------------------------\nThe carrying value of variable-rate finance receivables was assumed to approximate fair value since they are priced at current market rates. The fair value of fixed-rate finance receivables was estimated by discounting expected cash flows using rates at which loans of similar maturities would be made as of the date of the consolidated balance sheet. The fair values of excess servicing cash flows and other subordinated amounts due CFC arising from receivable sale transactions were estimated by discounting expected cash flows.\nDebt - ----\nThe fair value of public debt was estimated using quoted market prices. The fair value of other long-term debt was estimated by discounting future cash flows using rates currently available for debt with similar terms and remaining maturities.\nITEM 8. FINANCIAL STATEMENTS AND PART II -- CONTINUED ------------------------ SUPPLEMENTARY DATA -- CONTINUED -------------------------------\nCHRYSLER CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 16. FINANCIAL INSTRUMENTS -- CONTINUED - -------------------------------------------\nCurrency exchange agreements - ----------------------------\nThe fair values of currency exchange agreements were estimated by discounting the expected cash flows using market exchange rates and relative market interest rates over the remaining terms of the agreements. Currency exchange agreements are more fully described in Notes 1 and 6.\nInterest rate exchange agreements - ---------------------------------\nThe fair values of interest rate swaps, interest rate caps and forward interest rate contracts were estimated by discounting expected cash flows using quoted market interest rates. Interest rate exchange agreements are more fully described in Notes 1, 3 and 6.\nCurrency forward and option contracts - -------------------------------------\nThe fair values of currency forward and option contracts were estimated based on quoted market prices for contracts of similar terms. Currency forward and option contracts are more fully described in Note 1.\nAlthough not a counterparty to certain derivative financial instruments entered into between securitization trusts and third parties, CFC receives an indirect beneficial interest from such instruments.\nThe fair value estimates presented herein were based on information available as of the date of the consolidated balance sheet. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been revalued since the date of the consolidated balance sheet and, therefore, current estimates of fair value may differ from the amounts presented herein.\nNOTE 17. INDUSTRY SEGMENT AND GEOGRAPHIC AREA DATA - --------------------------------------------------\nINDUSTRY SEGMENT DATA - ---------------------\nChrysler operates in two principal industry segments: Car and Truck and Financial Services. The Car and Truck segment is comprised of the automotive operations of Chrysler, which includes the research, design, manufacture, assembly and sale of cars, trucks and related parts and accessories. Based on assets, revenues and earnings, automotive operations represent the majority of Chrysler's business activities. The Financial Services segment is comprised of CFC, which is engaged principally in retail and lease financing for vehicles, dealer inventory and other financing needs, dealer property and casualty insurance, and dealership facility development and management. Chrysler also participates in short-term vehicle rental activities through its Car Rental Operations and engages in aircraft modification and the manufacture of electronics products and systems through its Chrysler Technologies Corporation subsidiary (\"CTC\"). The Car Rental Operations and CTC, each represent less than 10 percent of revenues, operating profits and identifiable assets, and have been included in the Car and Truck segment. Chrysler's operations are conducted primarily in North America including the United States, Canada and Mexico.\nITEM 8. FINANCIAL STATEMENTS AND PART II -- CONTINUED ------------------------------- SUPPLEMENTARY DATA -- CONTINUED -------------------------------\nCHRYSLER CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 17. INDUSTRY SEGMENT AND GEOGRAPHIC AREA DATA -- CONTINUED - --------------------------------------------------------------- INDUSTRY SEGMENT DATA -- CONTINUED - ---------------------------------- Information concerning operations by industry segment was as follows:\nInterest expense of the Financial Services segment has been netted against operating earnings, which is consistent with industry practice. Certain line items do not add to the consolidated amounts due to the elimination of intersegment transactions.\nITEM 8. FINANCIAL STATEMENTS AND PART II -- CONTINUED ------------------------ SUPPLEMENTARY DATA -- CONTINUED -------------------------------\nCHRYSLER CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 17. INDUSTRY SEGMENT AND GEOGRAPHIC AREA DATA -- CONTINUED - ---------------------------------------------------------------\nGEOGRAPHIC AREA DATA - --------------------\nInformation concerning operations by principal geographic area was as follows:\nTransfers between geographic areas are based on prices negotiated between the buying and selling locations.\nITEM 8. FINANCIAL STATEMENTS AND PART II -- CONTINUED ------------------------ SUPPLEMENTARY DATA -- CONTINUED -------------------------------\nINDEPENDENT AUDITORS' REPORT\nShareholders and Board of Directors Chrysler Corporation Auburn Hills, Michigan\nWe have audited the accompanying consolidated balance sheet of Chrysler Corporation and consolidated subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of earnings and cash flows for each of the three years in the period ended December 31, 1995. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Chrysler Corporation and consolidated subsidiaries at December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\nAs discussed in the notes to the financial statements, in 1995 the Company changed its method of accounting for sales of vehicles for which it has guaranteed a minimum resale value.\nDELOITTE & TOUCHE LLP\nJanuary 18, 1996\nLOGO\nITEM 8. FINANCIAL STATEMENTS AND PART II -- CONTINUED ------------------------ SUPPLEMENTARY DATA -- CONTINUED -------------------------------\nMANAGEMENT REPORT ON RESPONSIBILITY FOR FINANCIAL REPORTING\nChrysler's management is responsible for preparing the financial statements and other financial information in this Annual Report. This responsibility includes maintaining the integrity and objectivity of financial data and the presentation of Chrysler's results of operations and financial position in accordance with generally accepted accounting principles. The financial statements include amounts that are based on management's best estimates and judgments.\nChrysler's financial statements have been audited by Deloitte & Touche LLP, independent auditors. Their audits were conducted in accordance with generally accepted auditing standards and included consideration of the internal control system and tests of transactions as part of planning and performing their audits.\nChrysler maintains a system of internal controls that provides reasonable assurance that its records reflect its transactions in all material respects and that significant misuse or loss of assets will be prevented. Management believes the system of internal controls is adequate to accomplish these objectives on a continuous basis. Chrysler maintains a strong internal auditing program that independently assesses the effectiveness of the internal controls and recommends possible improvements. Management considers the recommendations of the General Auditor and Deloitte & Touche LLP concerning the system of internal controls and takes appropriate actions to respond to these recommendations.\nThe Board of Directors, acting through its Audit Committee composed solely of nonemployee directors, is responsible for determining that management fulfills its responsibilities in the preparation of financial statements and the maintenance of internal controls. In fulfilling its responsibility, the Audit Committee recommends independent auditors to the Board of Directors for appointment by the shareholders. The Audit Committee also reviews the consolidated financial statements and adequacy of internal controls. The Audit Committee meets regularly with management, the General Auditor and the independent auditors. Both the independent auditors and the General Auditor have full and free access to the Audit Committee, without management representatives present, to discuss the scope and results of their audits and their views on the adequacy of internal controls and the quality of financial reporting.\nIt is the business philosophy of Chrysler to obey the law and to require that its employees conduct their activities according to the highest standards of business ethics. Management reinforces this philosophy by numerous actions, including issuing a Code of Ethical Behavior and maintaining a Business Practices Committee and a Business Practices Office to support compliance with Chrysler's policies.\nITEM 8. FINANCIAL STATEMENTS AND PART II -- CONTINUED ------------------------ SUPPLEMENTARY DATA -- CONTINUED -------------------------------\nSUPPLEMENTAL INFORMATION ------------------------\nCHRYSLER CORPORATION AND CONSOLIDATED SUBSIDIARIES SELECTED QUARTERLY FINANCIAL DATA (unaudited)\n- ------------------------- (1) Previously reported results for the first quarter of 1995 have been restated to include a $96 million charge for the cumulative effect of a change in accounting principle related to the consensus reached on Emerging Issues Task Force (\"EITF\") Issue 95-1, \"Revenue Recognition on Sales with a Guaranteed Minimum Resale Value.\" The ongoing effect of this accounting change was not material to Chrysler's 1995 quarterly results. First quarter results also included a $115 million pretax charge for a voluntary minivan owner service action.\n(2) Results for the second quarter of 1995 included a $232 million pretax provision for costs associated with production changes at Chrysler's Newark assembly plant. The provision includes the recognition of supplemental unemployment benefits, job security benefits and other related employee costs, and the write-down of certain equipment and tooling. During the third quarter of 1995, this provision was increased by $31 million to $263 million, primarily reflecting changes in the estimate for job security benefit costs.\n(3) Earnings for the fourth quarter of 1994 included favorable adjustments to the provision for income taxes aggregating $132 million. These adjustments related to: (1) the recognition of tax credits related to expenditures in prior years for qualifying research and development activities, in accordance with an Internal Revenue Service settlement which was based on U.S. Department of Treasury income tax regulations issued in 1994, and (2) the reversal of valuation allowances related to tax benefits associated with net operating loss carryforwards.\nITEM 8. FINANCIAL STATEMENTS AND PART II -- CONTINUED ------------------------ SUPPLEMENTARY DATA -- CONTINUED -------------------------------\nSUPPLEMENTAL INFORMATION ------------------------\nCHRYSLER (WITH CFC AND CAR RENTAL OPERATIONS ON AN EQUITY BASIS) STATEMENT OF EARNINGS (unaudited)\nThis Supplemental Information, \"Chrysler (with CFC and Car Rental Operations on an Equity Basis),\" reflects the results of operations of Chrysler with its investments in Chrysler Financial Corporation (\"CFC\") and its investments in short-term vehicle rental subsidiaries (the \"Car Rental Operations\") accounted for on an equity basis rather than as consolidated subsidiaries. This Supplemental Information does not purport to present results of operations in accordance with generally accepted accounting principles because it does not comply with Statement of Financial Accounting Standards (\"SFAS\") No. 94, \"Consolidation of All Majority-Owned Subsidiaries.\" Because the operations of CFC and the Car Rental Operations are different in nature than Chrysler's manufacturing operations, management believes that this disaggregated financial data enhances an understanding of the consolidated financial statements.\nITEM 8. FINANCIAL STATEMENTS AND PART II -- CONTINUED ------------------------ SUPPLEMENTARY DATA -- CONTINUED -------------------------------\nSUPPLEMENTAL INFORMATION ------------------------\nCHRYSLER (WITH CFC AND CAR RENTAL OPERATIONS ON AN EQUITY BASIS) BALANCE SHEET (unaudited)\n- ------------------------- * Less than $1 million\nThis Supplemental Information, \"Chrysler (with CFC and Car Rental Operations on an Equity Basis),\" reflects the financial position of Chrysler with its investments in CFC and the Car Rental Operations accounted for on an equity basis rather than as consolidated subsidiaries. This Supplemental Information does not purport to present financial position in accordance with generally accepted accounting principles because it does not comply with SFAS No. 94, \"Consolidation of All Majority-Owned Subsidiaries.\" The financial covenant contained in Chrysler's revolving credit facility is based on this Supplemental Information. In addition, because the operations of CFC and the Car Rental Operations are different in nature than Chrysler's manufacturing operations, management believes that this disaggregated financial data enhances an understanding of the consolidated financial statements.\nITEM 8. FINANCIAL STATEMENTS AND PART II -- CONTINUED ------------------------ SUPPLEMENTARY DATA -- CONTINUED -------------------------------\nSUPPLEMENTAL INFORMATION ------------------------\nCHRYSLER (WITH CFC AND CAR RENTAL OPERATIONS ON AN EQUITY BASIS) STATEMENT OF CASH FLOWS (unaudited)\nThis Supplemental Information, \"Chrysler (with CFC and Car Rental Operations on an Equity Basis),\" reflects the cash flows of Chrysler with its investments in CFC and the Car Rental Operations accounted for on an equity basis rather than as consolidated subsidiaries. This Supplemental Information does not purport to present cash flows in accordance with generally accepted accounting principles because it does not comply with SFAS No. 94, \"Consolidation of All Majority-Owned Subsidiaries.\" Because the operations of CFC and the Car Rental Operations are different in nature than Chrysler's manufacturing operations, management believes that this disaggregated financial data enhances an understanding of the consolidated financial statements.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS PART II -- CONTINUED --------------------------------------------- ON ACCOUNTING AND FINANCIAL DISCLOSURE --------------------------------------\nNone.\nPART III --------\nItems 10, 11, 12, and 13\nInformation required by Part III (Items 10, 11, 12, and 13) of this Form 10-K is incorporated by reference from Chrysler Corporation's definitive Proxy Statement for its 1995 Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission, pursuant to Regulation 14A, not later than 120 days after the end of the fiscal year, all of which information is hereby incorporated by reference in, and made part of, this Form 10-K, except that the information required by Item 10","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, ---------------------------------------- AND REPORTS ON FORM 8-K -----------------------\n(a) The following documents are filed as part of this report:\n1. Financial Statements\nFinancial statements filed as part of this Form 10-K are listed under Part II, Item 8.\n2. Financial Statement Schedules\nNo schedules are included because they are not required under the instructions contained in Regulation S-X or because the information called for is shown in the financial statements and notes thereto.\n3. Exhibits:\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, PART IV -- CONTINUED ---------------------------------------- AND REPORTS ON FORM 8-K -- CONTINUED ------------------------------------\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, PART IV -- CONTINUED ---------------------------------------- AND REPORTS ON FORM 8-K -- CONTINUED ------------------------------------\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, PART IV -- CONTINUED ---------------------------------------- AND REPORTS ON FORM 8-K -- CONTINUED ------------------------------------\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, PART IV -- CONTINUED ---------------------------------------- AND REPORTS ON FORM 8-K -- CONTINUED ------------------------------------\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, PART IV -- CONTINUED ---------------------------------------- AND REPORTS ON FORM 8-K -- CONTINUED ------------------------------------\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, PART IV -- CONTINUED ---------------------------------------- AND REPORTS ON FORM 8-K -- CONTINUED ------------------------------------\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, PART IV -- CONTINUED ---------------------------------------- AND REPORTS ON FORM 8-K -- CONTINUED ------------------------------------\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, PART IV -- CONTINUED ---------------------------------------- AND REPORTS ON FORM 8-K -- CONTINUED ------------------------------------\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, PART IV -- CONTINUED ---------------------------------------- AND REPORTS ON FORM 8-K -- CONTINUED ------------------------------------\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, PART IV -- CONTINUED ---------------------------------------- AND REPORTS ON FORM 8-K -- CONTINUED ------------------------------------\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, PART IV -- CONTINUED ---------------------------------------- AND REPORTS ON FORM 8-K -- CONTINUED ------------------------------------\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, PART IV -- CONTINUED ---------------------------------------- AND REPORTS ON FORM 8-K -- CONTINUED ------------------------------------\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, PART IV -- CONTINUED ---------------------------------------- AND REPORTS ON FORM 8-K -- CONTINUED ------------------------------------\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, PART IV -- CONTINUED ---------------------------------------- AND REPORTS ON FORM 8-K -- CONTINUED ------------------------------------\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, PART IV -- CONTINUED ---------------------------------------- AND REPORTS ON FORM 8-K -- CONTINUED ------------------------------------\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, PART IV -- CONTINUED ---------------------------------------- AND REPORTS ON FORM 8-K -- CONTINUED ------------------------------------\n- ------------------------- * Filed herewith\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, PART IV -- CONTINUED ---------------------------------------- AND REPORTS ON FORM 8-K -- CONTINUED ------------------------------------\nIn lieu of filing certain instruments with respect to the long-term debt of the type described in Item 601(b)(4) of Regulation S-K with respect to the long-term debt of Chrysler Corporation and its consolidated subsidiaries, Chrysler Corporation agrees to furnish a copy of such instruments to the Securities and Exchange Commission on request.\n(b) Reports on Form 8-K:\nNo reports on Form 8-K were filed during the three months ended December 31, 1995.\nSIGNATURES ----------\nPursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nCHRYSLER CORPORATION\nBy R. J. EATON ---------------------------------- R. J. EATON Chairman of the Board and Chief Executive Officer January 19, 1996\nPursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nPrincipal executive officers:\n* By R. D. HOUTMAN ---------------------------------- R. D. HOUTMAN Attorney-in-Fact January 19, 1996\nEXHIBIT INDEX\n- ------------------------- * Filed herewith","section_15":""}
{"filename":"79731_1995.txt","cik":"79731","year":"1995","section_1":"ITEM 1. BUSINESS\nAllegheny Power System, Inc. (APS), incorporated in Maryland in 1925, is an electric utility holding company which owns directly and indirectly various regulated subsidiaries (collectively, Allegheny Power), and a nonutility subsidiary, AYP Capital, Inc. (AYP Capital). 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, 1995, Allegheny Power had 5,905 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 347,600 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, 1995, Monongahela had 1,921 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 368,800 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, 1995, Potomac Edison had 1,097 employees. 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 cooperatives, one of which purchases power from 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 660,000 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, 1995, West Penn had 1,981 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).\nAPSC, incorporated in Maryland in 1963, is a wholly owned subsidiary of APS which provides various technical, engineering, accounting, administrative, purchasing, computing, managerial, operational, and legal services to the Subsidiaries and AYP Capital at cost. On December 31, 1995, APSC had 906 employees.\nAYP Capital, incorporated in Delaware in 1994, is a 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. AYP Capital has no employees. However, as of February 1, 1996, 10 APSC employees are dedicated to AYP Capital activities on a full-time basis. Other APSC employees provide services to AYP Capital as required. AYP Capital reimburses APSC for the use of its employees. APS' total investment in AYP Capital was $1.8 million as of December 31, 1995. APS is currently committed to invest up to an additional $10 million in AYP Capital to fund AYP Capital's investment in two limited partnerships. AYP Capital has agreed to purchase a 50% interest (276 MW) in a generating unit for approximately $170 million. AYP Capital has also formed a limited liability company (APS Cogenex) with EUA Cogenex, a nonutility subsidiary of Eastern Utilities Associates. (See ITEM 1. COMPETITION, for a further description of AYP Capital's activities.)\nAllegheny Power has in the past and may in the future 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\nAmendments of 1990 (CAAA), which among other things, require a substantial annual reduction in emissions of sulfur dioxides (SO[2]) and nitrogen oxides (NO[x]).\nAdditional concerns include proposals to restructure and to deregulate portions of the industry and to 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 conservation, market competition, weather, and interruptions in fuel supply because of weather. (See ITEM 1. CAPITAL REQUIREMENTS AND FINANCING, RATE MATTERS, and ENVIRONMENTAL MATTERS for information concerning the effect on the Subsidiaries of the CAAA.)\nCOMPETITION\nCompetitive forces within the electric utility industry continued to increase in 1995 due to a variety of influences including legislative and regulatory proceedings. Difficult questions including stranded investment recovery, responsibility for service and service reliability, the obligation to serve, recovery of environmental and other social costs, tax implications, and the effect of competition on all classes of customers are being debated. Large industrial users of electricity remain the principal nongovernmental advocates of increased competition, including retail wheeling. In response to the competitive environment that has evolved following the passage of the National Energy Policy Act of 1992 (EPACT), Allegheny Power has developed, and is continuing to develop, a number of strategies to retain and continue to serve its existing customers and to expand its customer base.\nIn 1995, Allegheny Power began to restructure its operations in an effort to control costs by making more efficient use of resources and streamlining processes. Although certain initiatives have been completed, the process is continuing. (See ITEM 1. RESTRUCTURING for a description of the Allegheny Power reorganization efforts.) In addition, Allegheny Power established and staffed in 1995 a Major Accounts Program to enhance the working relationship between Allegheny Power and its largest customers. In- depth knowledge from the Major Accounts Program is already providing opportunities for potential business ventures and is enhancing Allegheny Power's reputation as an efficient, low cost provider of energy services.\nVarious states in the Allegheny Power service area have initiated investigations concerning competition, but, except for Maryland, definitive conclusions have not been reached. (See ITEM 1. REGULATION for a discussion of the competitive investigations in Maryland, Ohio, Pennsylvania, and Virginia.)\nTo help meet the challenges of the new competitive environment and the new opportunities presented in EPACT, AYP Capital was formed in 1994. Its purpose is to pursue and develop new opportunities in unregulated markets to strengthen the long-term competitiveness and profitability of APS. During 1995, AYP Capital funded several investments. They include EnviroTech Investment Fund I, L.P. (EnviroTech), a limited partnership formed to invest in emerging electrotechnologies that promote the efficient use of electricity\nand improve the environment. AYP Capital has committed to invest up to $5 million in EnviroTech. AYP Capital has also invested in the Latin American Energy and Electricity Fund I, L.P. (FONDELEC), a limited partnership formed to invest in and develop electric energy opportunities in Latin America. AYP Capital has committed to invest up to $5 million in FONDELEC. Both EnviroTech and FONDELEC may offer AYP Capital opportunities to identify investments in which AYP Capital may coinvest, in excess of its capital commitment in each limited partnership.\nAYP Capital is also developing other energy-related service businesses. AYP Capital offers engineering consulting services and project management for transmission and distribution facilities. AYP Capital has also invested in APS Cogenex, a limited liability company formed jointly with EUA Cogenex, a nonutility subsidiary of Eastern Utilities Associates. APS Cogenex provides energy services to improve the energy efficiency of consumer facilities in the five states in which Allegheny Power provides electric service, plus the District of Columbia. AYP Capital intends to provide financing to consumers that undertake capital improvements necessary to achieve energy efficiency.\nAYP Capital is moving into the wholesale unregulated power generation market with its agreement to purchase Duquesne Light Company's (Duquesne) 50% interest in Unit No. 1 of the Fort Martin Power Station for about $170 million. AYP Capital intends to utilize its share of the unit as an exempt wholesale generator and sell the output at market price. Obtaining the necessary regulatory approvals will likely take several months. AYP Capital expects a closing in 1996. AYP Capital is also pursuing other opportunities.\nIn addition, management continues to explore methods of marketing and pricing its core services - electric energy and the transmission thereof - in new and competitive ways, such as bulk sales of each type of service to nonaffiliates, incentive pricing to traditional utility customers, and repackaging of services in nontraditional ways. It is also attempting to reduce costs, particularly capital expenditures, to position Allegheny Power in a more competitive mode.\nFully meeting challenges in the emerging competitive environment will be difficult unless certain outmoded and anti-competitive laws, specifically the Public Utility Holding Company Act of 1935 (PUHCA) and Section 210 of the Public Utility Regulatory Policies Act of 1978 (PURPA), are repealed or significantly revised.\nAllegheny Power is a member of the PURPA Reform Group, an ad hoc group of utilities seeking repeal or reform of PURPA on the grounds that it is obsolete, anticompetitive and it results in utility customers paying above- market prices for power. This Group supports legislation which has been introduced in both houses of Congress to repeal or reform PURPA. (See ITEM 3. LEGAL PROCEEDINGS for information concerning PURPA-related litigation.)\nAllegheny Power, along with the other registered electric public utility holding companies under PUHCA, advocates repeal of PUHCA. PUHCA prevents or significantly disadvantages regulated holding companies from\ndiversifying into utility-related or nonutility businesses within or outside their service territories, except under limited circumstances. Exempt companies as well as other competitors, on the other hand, can diversify into other types of businesses with generally no greater limitations than any other domestic company. Legislation has been introduced in Congress to repeal PUHCA and grant utility oversight responsibility to the Federal Energy Regulatory Commission (FERC). The Securities and Exchange Commission (SEC) has also recommended repeal of PUHCA. If the problems with PUHCA are not resolved through legislation, restructuring of Allegheny Power to reduce or eliminate the effect of PUHCA is an alternative.\nRESTRUCTURING\nIn the late 1960's and early 1970's, Allegheny Power was one of the first public utility holding company systems to establish a service company, APSC, to increase efficiencies and savings through centralization. APSC was organized into two groups - Bulk Power Supply (BPS) and Central Services. That structure served Allegheny Power and its customers well and is one of the reasons that its electric rates are among the lowest in the region.\nThe competitive environment emerging in the electric utility industry, however, is requiring Allegheny Power to restructure many of its functions to strengthen its competitive position and improve its cost structure.\nThe restructuring process is initiated by core teams consisting of selected employees chosen to evaluate existing processes and recommend changes. The core teams receive guidance from review groups, senior management, and consultants. Recommendations are implemented following acceptance by senior management and, in some cases, the Board of Directors.\nBPS has been reengineered from its functional groups - Planning, Engineering, Construction, and Operating - to Generation, Transmission, and Planning and Compliance Business Units. Reengineering of the Transmission and Planning and Compliance Business Units has been completed, and process redesign and restructuring now under way in the power stations will complete the reengineering of the Generation Business Unit.\nThe Business Unit concept adopted in BPS and planned for other parts of Allegheny Power is designed to improve Allegheny Power's ability to compete and to respond to customers. The Business Unit organization is structured to make extensive use of teams including individuals from other Business Units or from other areas of Allegheny Power.\nThe Generation Business Unit will be responsible for ensuring that adequate generation is available to serve the native load customers of Allegheny Power by employing Allegheny Power generating facilities and third- party generation obtained through its marketing efforts. Its primary responsibilities include ensuring the cost-effective operation and maintenance of Allegheny Power's generating units and providing the most economic mix of generation by available Allegheny Power generating units and off-system purchases and sales.\nThe Transmission Business Unit will be responsible for ensuring that adequate high voltage network facilities are available and on line to convey power produced from the power production operations run by, or procured by, the Generation Business Unit to serve native load and to engage in wholesale transmission sales to nonaffiliates. It will also engage in marketing efforts for sales of bundled and unbundled transmission services to nonaffiliates and will be responsible for accommodating requests for transmission service submitted by nonaffiliates who qualify as customers for that service under federal regulations. Finally, the Transmission Business Unit will be responsible for maintaining the optimal economic balance on a real time basis between native customer load and the output of the generation resources supplied by the Generation Business Unit.\nThe Planning and Compliance Business Unit will provide strategic resource planning and engineering analysis of alternate transmission and generation resource options, environmental and regulatory issues management, environmental compliance oversight, research and development, and emerging technology development for Allegheny Power. Much of the work of this Business Unit will be accomplished through multi-functional, cross-organizational teams yielding a more balanced, multiple perspective solution to strategic problems.\nReorganization in the Operating Subsidiaries began early in 1995 and has resulted in a single management team. There are now 18 operating divisions compared with 23 at the beginning of 1995, and functions such as engineering, construction, construction services, as well as marketing functions have been consolidated. An effort is currently under way to redesign all the processes in the Operating Subsidiaries.\nIn 1995, the Engineering and Construction Departments (E&C) of the Operating Subsidiaries completed a partial reorganization in conjunction with the restructuring of BPS. Some functions in E&C were transferred to the new Business Units, while functions in BPS involving land management, communications, standards, and nonnetwork planning were transferred to E&C. The Construction Services Division of E&C consolidated its General Stores function into two locations and developed a Material Transportation System to serve all locations of the Operating Subsidiaries. Repair and testing of electrical equipment were consolidated. The balance of E&C is undergoing reengineering as part of the core team evaluation of the Operating Subsidiaries.\nCorporate Services, including Accounting, Finance, Information Services, Human Resources, and Legal, as well as other support functions, are being reengineered along with other functions in the internal supply chain for materials and services. The Corporate Services and supply chain restructuring will help to eliminate internal barriers to meeting external competition. As part of the restructuring, Allegheny Power consolidated two data processing centers, which resulted in the closing of one center.\nAs of January 1, 1996, APS and APSC began using the common name, \"Allegheny Power.\" The Operating Subsidiaries will also begin using the \"Allegheny Power\" name by September 1996, to reflect Allegheny Power's unified\nmission and one-company concept. For legal purposes, APS and the Subsidiaries will retain their formal names.\nBy late 1996, the corporate headquarters of Allegheny Power will move from New York City to Washington County, Maryland. The move will situate Allegheny Power's headquarters in the service territory of the Operating Subsidiaries.\nIt is currently anticipated that all of the reengineering now under way will be completed by the end of 1996, although Allegheny Power will continue to identify ways to increase efficiencies.\nDownsizing was not a specific goal of Allegheny Power's reorganization and reengineering efforts, but as a consequence of process redesign and elimination of duplicate positions, approximately 200 employees have been placed in a staffing force thus far. Employees in the staffing force on January 1, 1996 were offered a separation package. Employees who did not elect to accept the separation package and who are not placed in a regular employment position will be laid-off at the end of 12 months.\nIn addition, it is currently estimated that about 130 fewer employees will be required in the power station work force by the end of 1997. Employee reductions are also likely to result from reengineering in the Operating Subsidiaries and support functions.\nSALES\nIn 1995, consolidated kilowatt-hour (kWh) sales to the Operating Subsidiaries' retail customers increased 3.9% from those of 1994 as a result of increases of 3.0%, 4.7%, and 4.2% in residential, commercial, and industrial sales, respectively. The increased kWh sales in 1995 reflect both growth in number of customers and higher use. Consolidated revenues from residential, commercial, and industrial sales increased 7.3%, 7.5%, and 5.8%, respectively, primarily because of rate increases (See ITEM 1. RATE MATTERS) and increased kWh sales.\nConsolidated kWh sales to and revenues from nonaffiliates under buy\/resale agreements increased 36.3% and 16.1%, respectively, due primarily to increased sales of power purchased from nonaffiliated utilities and power brokers, and transmitted through our system to others. Consolidated sales under the Standard Transmission Service Tariff increased from 0.5 billion kWh to 1.5 billion kWh and revenues increased from $3.2 million to $5.6 million.\nAllegheny Power's all-time peak load of 7,500 MW, which was higher than that forecast, occurred on February 5, 1996. The peak load in 1995 and 1994 was 7,280 MW and 7,153 MW, respectively. The average System load (yearly net power supply divided by number of hours in the year) was 4,969 MW and 4,776 MW in 1995 and 1994, respectively. More information concerning sales may be found in the statistical sections. (See also ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.)\nConsolidated electric operating revenues for 1995 were derived as follows: Pennsylvania, 44.6%; West Virginia, 28.3%; Maryland, 20.6%; Virginia, 5.0%; Ohio, 1.5% (residential, 35.0%; commercial, 18.7%; industrial, 29.1%; nonaffiliated utilities, 14.5%; and other, 2.7%). The following percentages of such revenues were derived from these industries: iron and steel, 6.2%; fabricated products, 3.4%; chemicals, 3.3%; aluminum and other nonferrous metals, 3.1%; coal mines, 3.0%; cement, 1.7%; and all other industries, 8.4%. Revenues from each of 19 industrial customers exceeded $5 million, including one coal customer of both Monongahela and West Penn providing total revenues exceeding $23 million, three steel customers providing revenues exceeding $31 million each, and one aluminum customer providing revenues exceeding $67 million.\nDuring 1995, Monongahela's kWh sales to retail customers increased 4.5% as a result of increases of 5.0%, 6.5%, and 3.5% in residential, commercial, and industrial sales, respectively. Revenues from residential, commercial and industrial customers increased 9.5%, 7.1%, and 5.1%, respectively, and revenues from kWh sales to affiliated and nonaffiliated utilities increased 3.9%. Monongahela's all-time peak load of 1,825 MW occurred on August 17, 1995.\nMonongahela's electric operating revenues were derived as follows: West Virginia, 94.6% and Ohio, 5.4% (residential, 28.9%; commercial, 17.2%; industrial, 29.4%; nonaffiliated utilities, 12.6%; and other, 11.9%). Revenues from each of five industrial customers exceeded $11 million, including one steel customer providing revenues exceeding $31 million and one coal customer providing revenues exceeding $20 million.\nDuring 1995, Potomac Edison's kWh sales to retail customers increased 3.3% as a result of increases of 3.9%, 3.6%, and 2.7% in residential, commercial, and industrial sales, respectively. Revenues from such customers increased 7.0%, 6.7%, and 3.0%, respectively, and revenues from kWh sales to affiliated and nonaffiliated utilities increased 17.1%. 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, 66.9%; West Virginia 16.9% and Virginia, 16.2%; (residential, 38.7%; commercial, 17.7%; industrial, 24.5%; nonaffiliated utilities, 15.4%; and other, 3.7%). Revenues from one industrial customer, the Eastalco aluminum reduction plant near Frederick, Maryland, amounted to $67.4 million (8.2% 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 $20.3 million in 1995. This 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 1995, West Penn's kWh sales to retail customers increased 4.0% as a result of increases of 1.4%, 4.4% and 5.8% in residential, commercial, and industrial sales, respectively. Revenues from residential, commercial, and industrial customers increased 6.5%, 8.2%, and 7.9%, respectively, and revenues from kWh sales to affiliated and nonaffiliated utilities increased\n17.6%. West Penn's all-time peak load of 3,242 MW occurred on February 5, 1996.\nWest Penn's electric operating revenues were derived as follows: Pennsylvania, 100% (residential, 32.7%; commercial, 18.3%; industrial, 29.1%; nonaffiliated utilities, 13.7%; and other, 6.2%). Revenues from each of four industrial customers exceeded $11 million, including two steel customers providing revenues exceeding $36 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 very 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, the Operating Subsidiaries face increased competition from utilities with excess generation that may be willing to sell at prices only slightly in excess of variable costs. At the same time, the Operating Subsidiaries are experiencing higher costs due to compliance with the CAAA and purchases from PURPA projects. (See page 12 for a discussion of PURPA projects, and ITEM 3. LEGAL PROCEEDINGS for a description of litigation and regulatory proceedings concerning PURPA capacity.)\nIn 1995, the Operating Subsidiaries provided approximately 15.4 billion kWh of energy to nonaffiliated companies, of which 0.78 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 nonaffiliates. The transaction began in mid-1987 and will continue through 2005, unless terminated earlier.\nSales to nonaffiliated companies vary with the needs of those companies for capacity and\/or economic replacement power; the availability of generating facilities and excess power, fuel, and regional transmission facilities; and the availability and price of competitive sources of power. Although increases occurred in both sales of power purchased from and transmission services with nonaffiliates in 1995, sales of power generated by Allegheny Power decreased relative to 1994 primarily because of stagnant demand, increased Operating Subsidiaries' native load, and increased number of and willingness of other suppliers to make sales at lower prices. Further decreases in sales by Allegheny Power of power generated from rate-based assets to nonaffiliates are expected in 1996 and beyond. For 1995, substantially all of the benefits of power and transmission service sales to nonaffiliates were 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, 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\nmutually determined no less than 34 months prior to each year for which an exchange is to take place. Negotiations are currently under way to reach an agreement on an amount of diversity exchange beyond February 1998. 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 which will continue through February 1999 and may be extended beyond that date, 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 distribution facilities leased from Tarentum under a 30-year lease agreement terminating in 1996. In June 1993, Tarentum, which in that year provided 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 and re-enter the retail electric business. The termination of the lease agreement and resulting transfer and sale by West Penn of electric facilities installed by West Penn will result in Tarentum becoming a municipal customer which will purchase electricity on a wholesale basis from West Penn or another supplier. Tarentum has agreed to purchase wholesale electricity from West Penn until at least March 16, 1999. West Penn's sale of electric facilities and discontinuance of its electric service to customers in Tarentum will require Pennsylvania Public Utility Commission (Pennsylvania PUC) approval.\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. In 1995, the FERC continued to develop new policies and procedures to implement EPACT and requested comments on the following: a Notice of Proposed Rulemaking on open access nondiscriminatory transmission services (Mega-NOPR), a Supplemental Notice of Proposed Rulemaking on recovery of stranded costs, a Request for Comments and subsequent Notice of Proposed Rulemaking on Real-Time Information Networks and Standards of Conduct, and an Inquiry concerning alternative power pooling arrangements. Of particular significance to public utilities, on March 29, 1995, the FERC issued the Mega-NOPR with the stated intent of stimulating wholesale (sale for resale) competition among electric utilities and nonregulated electricity generators. The Mega-NOPR encourages wholesale competition by requiring utilities to allow their transmission facilities to be used by sellers or buyers of wholesale power without undue discrimination, as long as sufficient transmission capacity is available to provide service without impairing reliability. To meet the objective of providing nondiscriminatory or comparable wholesale transmission services, the Mega- NOPR, if adopted as proposed, requires that utilities functionally unbundle. Accordingly, the proposed rule if adopted will require separation of public utility systems' operations and marketing functions and will require that wholesale transmission services purchased by the transmission owner must be taken under its filed open access tariffs. In addition, the Mega-NOPR\nproposes pro forma open access tariffs containing the terms and conditions for these transmission services. The Mega-NOPR also states that electric utilities would be able to collect stranded costs (costs of facilities made uneconomic by wholesale transmission access) and that it is up to the states to decide if retail wheeling should be adopted and, if so, to address retail stranded costs. FERC has received public input to the Mega-NOPR and is currently reviewing that information before issuing a final rule. (See ITEM 1. REGULATION for a further discussion of the Mega-NOPR.)\nIn response to both the Mega-NOPR and the continuing evolution of the wholesale power and transmission service markets, Allegheny Power implemented reorganization of its existing wholesale marketing function into separate transmission and generation marketing functions. (See ITEM 1. RESTRUCTURING for further discussion of the restructuring of Bulk Power Supply.) Through rulings issued in various cases, the FERC 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 Allegheny Power's transmission facilities.)\nThrough 1995, the Operating Subsidiaries provided wholesale transmission services under their FERC-approved Standard Transmission Service Tariff. The tariff stipulated that such service was subordinate in priority to native load and reliability requirements of interconnected systems to avoid adverse effects on regional and Operating Subsidiaries' reliability. Transmission services requiring special arrangements or long-term commitments were provided through specially negotiated, mutually acceptable bilateral agreements that were consistent with and accommodated the Standard Transmission Service Tariff. Effective in 1996 and consistent with the intentions of the FERC under the Mega-NOPR, Allegheny Power submitted a filing to FERC of a set of two new transmission service tariffs which qualify as open access filings pursuant to the Mega-NOPR. As of December 6, 1995, the FERC accepted for filing a Network Transmission Service Tariff and a Point-to-Point Transmission Service Tariff under which the Operating Subsidiaries will sell comparable open access transmission services to eligible wholesale customers. Customers may choose from a range of services that extend from broad use of the transmission network on a firm basis for the life of a customer facility to a fully interruptible energy only service that is available for a one-hour term. The tariffs were accepted subject to modification pending the outcome of the Final Rule in the Mega-NOPR proceeding. The FERC acceptance for filing set the tariffs for hearing during the summer of 1996; in the interim, the Operating Subsidiaries may sell transmission services under the tariffs, subject to refund. With this filing, the need for and applicability of the Standard Transmission Service Tariff was eliminated for new service transactions. Substantially all of the revenues from transmission service sales now arise from transactions with customers located outside the service territory of the Operating Subsidiaries and are passed through to retail customers. As a result, they presently have little effect on net income. In addition, the Operating Subsidiaries have a Standard Generation Service Rate Schedule tariff on file with and accepted by the FERC under which the Operating Subsidiaries make available bundled, nonfirm generation services with associated System transmission services to any customer who executes an\nagreement under such tariff. Revenues from this tariff are also passed through to retail customers.\nIn conjunction with the Mega-NOPR, on December 16, 1995, the FERC issued a notice of proposed rulemaking on Real-Time Information Networks and Standards of Conduct to ensure the separation of service directed by the functional unbundling of wholesale services required by the Mega-NOPR and to assure that all buyers and sellers of transmission services will have equal and timely access to the information needed to transact business. Allegheny Power commented on this proposed rulemaking.\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 consistent with PURPA and ordered by appropriate state commissions. Allegheny Power's total generating capacity includes 299 MW of on-line PURPA capacity. Payments for PURPA capacity and energy in 1995 totaled approximately $129 million at an average cost to Allegheny Power of 5.5 cents\/kWh, as compared to Allegheny Power's own generating cost of about 3 cents\/kWh. Allegheny Power projects an additional 180 MW (Warrior Run) of PURPA capacity to come on-line in 1999. It is expected that the Warrior Run project will result in increased costs for Potomac Edison's customers. Eighty MW (Burgettstown) of PURPA capacity has been removed from Allegheny Power's projections due to a PURPA project that expired when the project failed to meet its financing closing deadline. (See ITEM 3. LEGAL PROCEEDINGS for a description of the Washington Power lawsuit filed by the Burgettstown developer against West Penn and APS concerning this project.) Lapsed purchase agreements totaling 203 MW (Burgettstown, Shannopin, and Milesburg) and other PURPA related complaints totaling 470 MW (MidAtlantic and South River) are the subject of ongoing litigation and are not included in Allegheny Power's current planning strategy. (See ITEM 3. LEGAL PROCEEDINGS concerning an agreement to resovle the Shannopin lawsuit and for a description of litigation and regulatory proceedings in Pennsylvania and West Virginia.)\nELECTRIC FACILITIES\nThe following table shows Allegheny Power's December 31, 1995, generating capacity, based on the maximum monthly normal seasonal operating capacity of each unit. Allegheny Power's 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 Allegheny Power's steam stations shown on the following page, based on generating capacity at December 31, 1995, was about\n25.6 years. In 1995, their average heat rate was 9,970 Btu's\/kWh, and their availability factor was 82.3%.\n(a) Excludes 207 MW of West Penn oil-fired capacity at Springdale Power Station and 77 MW of the total MW at Mitchell Power Station, which were placed on cold reserve status as of June 1, 1983. Current plans call for the reactivation of these units in about five years. On December 31, 1994, 82 MW of the total MW at Mitchell Power Station were reactivated.\n(b) Where more than one year is listed as a commencement date for a particular source, the dates refer to the years in which operations commenced for the different units at that source.\n(c) Capacity entitlement through ownership of AGC, 27%, 28% and 45% by Monongahela, Potomac Edison and West Penn, respectively.\n(d) The FERC issued a new license with a 30-year term for Lake Lynn on December 27, 1994. Certain terms of said license are being appealed but do not affect its validity. Potomac Edison's license for hydroelectric facilities Dam #4 and Dam #5 will expire in 2003. Potomac Edison has received 30-year licenses, effective January 1994, for the Shenandoah, Warren, Luray and Newport projects. The FERC accepted Potomac Edison's surrender of the license for the Harper's Ferry Dam No. 3 and issued an order effective October 1994.\n(e) Nonutility generating capacity available through state utility commission approved arrangements pursuant to PURPA.\n(f) The Warrior Run project of 180 MW has completed its financial closing, is under construction, and is planned to begin providing capacity and energy to Potomac Edison in 1999.\nALLEGHENY POWER MAP\nThe Allegheny Power Map (Map), which has been omitted, provides a broad illustration of the names and approximate locations of Allegheny Power'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 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 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 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 capcity 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, 1995:\n(a) Allegheny Power has a total of 5,831 miles of underground distribution lines.\n(b) The substations have an aggregate transformer capacity of 39,207,919 kilovoltamperes.\n(c) Total Bath County transmission lines, of which AGC owns an undivided 40% interest and Virginia Power owns the remainder.\nAllegheny Power 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 operated near reliability limits because of frequent periods of heavy power flows, predominantly in a west-to-east direction. In 1994 and early 1995, use of the transmission system in aggregate declined and the west- to-east power flows decreased to more comfortable levels. However, in the later months of 1995, west-to-east transfers began to increase, although not to the critical levels commonly seen earlier in the decade. If transfers and customer load continue to increase, along with coincident parallel flows, interregional EHV transmission facilities, including Allegheny Power facilities, will again operate nearer to reliability limits, at which time restrictions on transfers may 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 Allegheny Power's transmission facilities may add to heavy power flows on Allegheny Power's facilities.\nThe Operating Subsidiaries have, to date, provided managed contractual access to Allegheny Power's transmission facilities via the provisions of their Standard Transmission Service Tariff, or the terms and conditions of bilateral contracts. As described earlier, for new agreements starting in 1996, managed access will also be governed by the provisions of the Allegheny Power open access tariffs recently accepted provisionally by FERC.\nRESEARCH AND DEVELOPMENT\nThe Operating Subsidiaries spent $9.0 million, $7.7 million, and $4.6 million in 1995, 1994, and 1993, respectively, for research programs. Of these amounts, $6.2 million, $5.9 million, and $3.2 million were for Electric Power Research Institute (EPRI) dues in 1995, 1994, and 1993, respectively. EPRI is an industry-sponsored research and development institution. The Operating Subsidiaries plan to spend approximately $8.5 million for research in 1996, with EPRI dues representing $5.5 million of that total.\nIndependent research conducted by the 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.\nResearch is also being directed to help address major issues facing Allegheny Power including electric and magnetic field (EMF) assessment of employee exposure within the work environment, waste disposal and discharges, greenhouse gases, client-server information system prospects, Internet, renewable resources, fuel cells, new combustion turbines and cogeneration technologies. In addition, there is continuing evaluation of technical proposals from outside sources and monitoring of developments in industry- related literature, law, litigation, and standards.\nAs Allegheny Power continues in its effort to comply with the NOx control requirements of the CAAA, it has entered into a collaborative effort coordinated by EPRI to gain a greater understanding of the formation of ground level ozone and how measures to control NOx and volatile organic compounds affect ozone formation. The North American Research Strategy for Tropospheric Ozone-Northeast is focused on this effort in the Ozone Transport Region (See page 28). With reference to alleged global climate change, a Participation Accord was entered into on behalf of the Operating Subsidiaries with the Department of Energy (DOE) to participate in the DOE's Climate Challenge Program.\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.\nResearch is being directed into communication systems to develop and demonstrate a high speed advanced power line communication system utilizing existing utility wires to service information needs of the Operating Subsidiaries' customers.\nAllegheny Power, in cooperation with the Pennsylvania Department of Environmental Protection and the West Virginia Division of Environmental Protection, continued to investigate the feasibility and cost-effectiveness of injecting fly ash from Allegheny Power's power stations into abandoned underground mine sites in Pennsylvania and West Virginia to reduce acid mine\ndrainage and mine surface subsidence. The project cost is anticipated to be shared with EPRI as part of a Tailored Collaboration Agreement with EPRI.\nAn additional collaborative effort in which Allegheny Power participated through West Penn in 1995 was the Pennsylvania Electric Energy Research Council (PEERC). PEERC was formed in 1987 as a partnership of Pennsylvania based electric utilities to promote technological advancements related to the electric utility industry.\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.\nCAPITAL REQUIREMENTS AND FINANCING\nConstruction expenditures by the Subsidiaries in 1995 amounted to $318.9 million and for 1996 and 1997 are expected to aggregate $278.6 million and $305.2 million, respectively. In 1995, these expenditures included $36.4 million for compliance with the CAAA. The 1996 and 1997 estimated expenditures include $6.7 million and $19.7 million, respectively, to cover the costs of compliance with the CAAA. Expenditures to cover the costs of compliance with the CAAA were much more significant in prior years and may be again in future years if required for Phase II compliance.\n* Includes allowance for funds used during construction (AFUDC) for 1995, 1996 and 1997 of: Monongahela $1.4, $1.0 and $2.0; Potomac Edison $1.8, $1.9 and $2.5; and West Penn $5.0, $3.0 and $2.9.\nThese construction expenditures include major capital projects at existing generating stations, 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) favorable rulings of state commissions allowing the inclusion of carrying costs of construction in rates in lieu of AFUDC; b) the absence of any major construction problems; and c) financing, material and equipment costs lower than expected.\nOn a collective basis for the Operating Subsidiaries, total expenditures for 1995, 1996, and 1997 include $76 million, $48 million, and $71 million, respectively, for construction of environmental control technology. Outages for construction, CAAA compliance work and other\nenvironmental work is, and will continue to be coordinated with planned outages.\nAllegheny Power continues 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, increasing the efficiency and availability of Allegheny Power generating facilities, reducing internal 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.)\nCurrent forecasts, which reflect demand-side management efforts and other considerations and assume normal weather conditions, project average annual winter and summer peak load growth rates of 1.56% and 1.57%, respectively, in the period 1996-2006. After considering the reactivation of West Penn capacity in cold reserve (see page 15), 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 Allegheny Power 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, medium-term note, subordinated debt, 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. 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\nand 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.\nAYP Capital has agreed to purchase Duquesne's 50% ownership interest (276 MW) in Fort Martin Unit No. 1 for approximately $170 million. Various financing alternatives for this acquisition are being considered.\nIn 1995, the Operating Subsidiaries refunded an aggregate of $493.4 million of securities. The securities issued for the refunding had interest rates ranging from 6.05% to 8.00%. Preferred stock issues totaling $155.5 million were refunded with Quarterly Income Debt Securities (QUIDS). QUIDS are subordinated debt instruments which permit deferral of interest payments under certain circumstances for up to 20 consecutive quarters.\nIn May 1995, the Operating Subsidiaries issued $245 million of first mortgage bonds having interest rates between 7-5\/8% and 7-3\/4% to refund like securities having interest rates from 8-7\/8% to 9-5\/8%. Monongahela sold $70 million of 7-5\/8% 30-year first mortgage bonds to refund a $70 million 8-7\/8% issue due in 2019. Potomac Edison sold $65 million of 7-3\/4% 30-year first mortgage bonds to refund a $65 million 9-1\/4% issue due in 2019 and $80 million of 7-5\/8% 30-year first mortgage bonds to refund an $80 million 9-5\/8% issue due in 2020. West Penn sold $30 million of 7-3\/4% 30-year first mortgage bonds to refund a $30 million 9% issue due in 2019.\nIn June 1995, the Operating Subsidiaries issued $92.9 million of tax- exempt bonds having interest rates from 6.05% to 6.15% to refund like securities having interest rates from 6.95% to 9-3\/8%. Monongahela sold $25 million of 6.15% 20-year tax-exempt bonds to refund a $25 million 7-3\/4% issue. Potomac Edison sold $21 million of 6.15% 20-year tax-exempt bonds to refund a $21 million 7.3% issue. West Penn sold $31.5 million of 6.15% 20- year tax-exempt bonds to refund a $20 million 7% issue and an $11.5 million 6.95% issue. West Penn also sold $15.4 million of 6.05% 19-year tax-exempt bonds to refund a $15.4 million 9-3\/8% issue.\nIn June 1995, the Operating Subsidiaries issued QUIDS to refund an aggregate of $155.5 million of preferred stock. Monongahela sold $40 million of 8% 30-year QUIDS to refund $40 million of preferred stock with rates between 7.36% and 8.8%. Potomac Edison sold $45.5 million of 8% 30-year QUIDS to refund $45.5 million of preferred stock with rates between 7% and 8.32%. West Penn sold $70 million of 8% 30-year QUIDS to refund $70 million of preferred stock with rates between 7% and 8.2%.\nIn 1995, APS sold 1,407,855 shares of its common stock for $34.6 million through its Dividend Reinvestment and Stock Purchase Plan and its Employee Stock Ownership and Savings Plan.\nDuring 1995, 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 4.75%, 4.71%, 4.249% and 4.292%. The rate set at auction on January 12, 1996, was 4.185%.\nAt December 31, 1995, short-term debt was outstanding in the following amounts: APS $78.7 million, Monongahela $29.9 million, Potomac Edison $21.6 million, and West Penn $70.2 million, respectively. At December 31, 1995, AGC had $30.6 million of commercial paper outstanding.\nThe Subsidiaries' ratios of earnings to fixed charges for the year ended December 31, 1995, were as follows: Monongahela, 3.68; Potomac Edison, 3.27; West Penn, 3.58; and AGC, 3.22.\nAllegheny Power's consolidated capitalization ratios as of December 31, 1995, were: common equity, 46.6%; preferred stock, 3.7%; and long-term debt, 49.7%, including QUIDS (3.3%). Allegheny Power's long-term objective is to maintain the common equity portion above 45%.\nDuring 1996, the Operating Subsidiaries currently anticipate meeting their capital requirements through a combination of internally generated funds, cash on hand, and short-term borrowing as necessary. APS plans to continue selling common stock through its Dividend Reinvestment and Stock Purchase Plan and Employee Stock Ownership and Savings Plan.\nFUEL SUPPLY\nAllegheny Power-operated stations burned approximately 15.9 million tons of coal in 1995. Of that amount, 88% was either cleaned (5.2 million tons) or used in stations equipped with scrubbers (8.8 million tons). The use of desulfurization equipment and the cleaning and blending of coal make burning local higher-sulfur coal practical. In 1995 about 97% of the coal received at Allegheny Power-operated 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 11 million tons of coal in 1996. 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 Allegheny Power-operated stations are expected to be met with coal acquired under existing contracts or from known suppliers.\nFor each of the years 1991 through 1994, the average cost per ton of coal burned was $36.74, $36.31, $36.19 and $35.88, respectively. For the year 1995, the cost per ton decreased to $32.68.\nLong-term arrangements, subject to price change, are in effect and will provide for the lime requirements of scrubbers at Allegheny Power's scrubbed stations.\nIn addition to using ash in various power plant applications such as scrubber by-product 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 also ITEM 1. RESEARCH AND DEVELOPMENT.) In 1995, the Operating Subsidiaries received approximately $459,000 for the sale of 206,609 tons of fly ash and 31,014 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 were issued for Monongahela, Potomac Edison and AGC in 1995.\nMonongahela Power\nAs previously reported, on 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 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. On November 9, 1994 the West Virginia PSC affirmed the recommended decision of the Administrative Law Judge (ALJ) which provided for a rate increase of $23.5 million and a 10.85% return on equity (ROE) effective November 16, 1994. This amount was in addition to $6.9 million of CAAA recovery granted effective July 1, 1994, in the Expanded Net Energy Cost (ENEC) recovery proceeding which had been included in Monongahela's $61.3 million request. The West Virginia PSC invited all parties to file petitions for reconsideration which resulted in a second order issued on March 17, 1995. The March 17, 1995 order deferred some of CAAA issues to the 1995 ENEC proceeding. The net result of both the March 17, 1995 base rate order and the ENEC order decreased the previously allowed increase to base rates adopted in the November 9, 1994 order by $1.1 million to $22.4 million and maintained the ROE of 10.85%. The ENEC order permits Monongahela to apply for review of its post-1994 scrubber operation and maintenance expense levels and CAAA investment during the 1996 ENEC proceeding. Monongahela filed a Petition for Appeal with the West Virginia Supreme Court of Appeals challenging the March 17 order. The court declined to hear the appeal.\nOn 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 included 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.\nOn October 20, 1995, a stipulation was submitted by all of the parties to the Ohio PUC. The Ohio PUC approved the stipulation on November 9, 1995 providing for an annual revenue increase of $6.0 million effective November 9, 1995.\nPotomac Edison\nOn January 14, 1994, Potomac Edison filed an application with the West Virginia PSC for a base rate increase of $12.2 million which 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. On November 9, 1994, the West Virginia PSC affirmed the recommended decision of the ALJ providing for a rate increase of $1.5 million and an ROE of 10.85% effective November 11, 1994. This increase was in addition to $1.9 million of CAAA recovery granted effective July 1, 1994, which had been included in Potomac Edison's original request for $12.2 million. The West Virginia PSC invited all parties to file petitions for reconsideration which resulted in a second order issued on March 17, 1995. This order deferred some of the CAAA issues to the 1995 ENEC proceeding. The net result of both the March 17, 1995 base rate order and the ENEC order reduced the original $1.5 million increase in base rates adopted in the November 9, 1994 order by $1.1 million to $.4 million. The ROE was maintained at 10.85%. The order permits Potomac Edison to apply for review of its post- 1994 scrubber operation and maintenance expense levels and CAAA investment during the 1996 ENEC proceeding. Potomac Edison filed a Petition for Appeal with the West Virginia Supreme Court of Appeals challenging the March 17 order. The court declined to hear the appeal.\nOn June 25, 1995, Potomac Edison implemented two FERC-approved settlement agreements covering wholesale rates in effect for its municipal, co-op, and borderline agreement customers subject to the jurisdiction of the FERC. Each agreement 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 first agreement, with all but one of Potomac Edison's FERC customers, provides for a three-year term of service with an increase in annual revenues of $2.12 million. During this period, a moratorium on further rate changes, except for changes based on fuel costs, taxes, and environmental statutes or regulations, is in effect. This agreement also allows Potomac Edison to seek legitimate and verifiable stranded costs from any customer who terminates service under the tariff. The second agreement, with the one remaining Potomac Edison FERC customer not included under the first agreement, provides for service until January 1, 1997, (approximately eighteen months) with an increase in annual rates of $.15 million. A moratorium on rate increases is also in effect for this time period. However, this agreement contains no provision for recovery of stranded costs from the customer should service be terminated.\nAGC\nAGC's rates are set by a formula filed with and previously accepted by FERC. The only component which changes is the ROE. In December 1991, AGC\nfiled for a continuation of the existing ROE of 11.53% and other interested parties filed to reduce the ROE to 10%. Hearings were held and a recommendation was issued by an ALJ on December 21, 1993, for an ROE of 10.83%. Exceptions to this recommendation were filed by all parties for consideration by the FERC. On January 28, 1994, a complaint was filed jointly by several parties 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. A recommendation was issued by an ALJ on December 22, 1994, to dismiss the joint complaint. A settlement agreement for both cases was filed with FERC on January 12, 1995, which would reduce AGC's ROE from 11.53% to 11.13% for the period from March 1, 1992 through December 31, 1994, and increase AGC's ROE to 11.2% for the period from January 1, 1995 through December 31, 1995. This settlement was approved by FERC on March 23, 1995. Refunds were made by AGC of any revenues collected between March 1, 1992 and March 23, 1995 in excess of these levels. A second settlement has been negotiated to address AGC's ROE after 1995. On December 21, 1995, AGC submitted the new settlement to the FERC and action is pending. The interested parties representing less than 2% of AGC's eventual revenues have filed exceptions to the settlement. Under the terms of the settlement, AGC's ROE for 1996 would be 11%. For 1997 and 1998 the ROE would be set by a formula based upon the yields of 10-year constant maturity U.S. Treasury securities. However, the change in ROE from the previous year's value cannot exceed 50 basis points.\nThrough a filing completed on October 31, 1994, AGC sought FERC approval to add a prior tax payment of approximately $12 million to rate base which would produce about $1.4 million in additional annual revenues. The FERC accepted AGC's filing and ordered the increase to become effective June 1, 1995.\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 $199 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\nAllegheny Power currently meets applicable standards as to particulates and opacity at the power stations through 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.\nOn July 17, 1995, the West Virginia Division of Environmental Protection (WVDEP), Office of Air Quality (OAQ), issued a Notice of Violation (NOV) regarding the accidental release of particulate matter that occurred on June 17, 1995, at the Pleasants Power Station. Allegheny Power responded on August 11, 1995, and stated that the accidental release of particulate matter was not due to a failure of any of the pollution control equipment, but was a side effect of testing a further reduction of the sulfur dioxide (SO[2]) emissions from the power station. Subsequently, on November 16, 1995, the WVDEP issued a Cease and Desist Order pertaining to the release. In order to minimize the risk of future releases, the station intends to increase the frequency of scheduled stack washing. Also, a consultant has been retained to determine whether any operational or equipment changes can be implemented to reduce the risk of releases in the future.\nAllegheny Power meets current emission standards as to SO[2] 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 SO[2] and two million tons of nitrogen oxides (NO[x]) from 1980 emission levels, to be completed in two phases, Phase I and Phase II. Five coal-fired Allegheny Power plants are affected in Phase I and the remaining plants and units reactivated in the future will be affected in Phase II. Installation of scrubbers at the Harrison Power Station was the strategy undertaken by Allegheny Power to meet the required SO[2] emission reductions for Phase I (1995-1999). Continuing studies will determine the compliance strategy for Phase II (2000 and beyond). Studies to evaluate cost effective options to comply with Phase II SO[2] limits, including those which may be available from the use of Allegheny Power's banked emission allowances and from the emission allowance trading market, are continuing. It is expected that burner modifications at possibly all Allegheny Power stations will satisfy the NO[x] 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.\nIn an effort to introduce market forces into pollution control, the CAAA created SO[2] emission allowances. An allowance is defined as an authorization to emit one ton of SO[2] into the atmosphere. Subject to regulatory limitations, allowances (including bonus and extension allowances) may be sold or banked for future use or sale. Allegheny Power received, through an industry allowance pooling agreement, a total of approximately 554,000 bonus and extension allowances during Phase I. These allowances are in addition to the CAAA Table A allowances of approximately 356,000 per year during the Phase I years. Ownership of these allowances permits Allegheny Power to operate in compliance with Phase I, as well as to postpone a decision on its compliance strategy for Phase II. As part of its compliance strategy, Allegheny Power continues to study the allowance market to determine whether sales or purchases of allowances or participation in certain derivative or hedging allowance transactions are appropriate.\nIn a case brought by the electric utility industry which disputed the EPA's inclusion of overfire air equipment as well as low NO[x] burners in its definition of \"low NO[x] burner technology,\" the District of Columbia Circuit Court of Appeals on November 29, 1994 vacated and remanded to the EPA the Title IV NO[x] rule. As a result, the January 1, 1995, Phase I NO[x] compliance deadline under Title IV is no longer applicable. On April 13, 1995, the EPA published the revised NO[x] regulation which redefined low NO[x] burner technology as \"burners only\" and changed the Phase I compliance date from January 1, 1995, to January 1, 1996.\nPursuant to an option in the CAAA and in order to avoid the potential for more stringent NO[x] limits in Phase II, Allegheny Power chose to treat seven Phase II Group 1 boilers (tangential- and wall-fired) as Phase I affected units (Substitution Units) as of January 1, 1995. Additionally, the four Phase II, Group 2 boilers (top- and cyclone-fired) were also made Substitution Units for 1995. The status of all Substitution Units will be evaluated on an annual basis to ascertain the financial benefits. As a result of being Phase I affected, these Substitution Units will also be required to comply with the Phase I SO[2] limits for each year that they are accorded substitution status by Allegheny Power. Phase I NO[x] and SO[2] compliance for these units should not require additional capital or operating expenditures.\nTitle I of the CAAA established an ozone transport region (OTR) consisting of the District of Columbia, the northern part of Virginia and 11 northeast states including Maryland and Pennsylvania. On October 11, 1995, Pennsylvania petitioned the EPA to remove western Pennsylvania from the OTR. The EPA has not acted on the request. Sources within the OTR will be required to reduce NO[x] 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 NO[x] burners) at all Pennsylvania and Maryland stations has been completed. This is essentially compatible with Title IV NO[x] reduction requirements.\nThe Ozone Transport Commission (OTC), formed by the states in the OTR and Washington, DC, has determined that Allegheny Power will be required to make additional NO[x] reductions beyond RACT in order for the ozone transport region to meet the ozone NAAQS. Under terms of a Memorandum of Understanding (MOU) among the OTR states, Allegheny Power's power stations located in Maryland and Pennsylvania will be required to reduce NO[x] emissions by 55% from the 1990 baseline emissions, with a compliance date of May 1999. Further reductions of 75% from the 1990 baseline will be required by May 2003, unless the results of modeling studies due to be completed by 1998, indicate otherwise. If Allegheny Power has to make reductions of 75%, it could be very expensive and would depend upon further technological advances. Both Maryland and Pennsylvania must promulgate regulations to implement the terms of the MOU.\nDuring 1995, the Environmental Council of States (ECOS) and the EPA established the Ozone Transport Assessment Group (OTAG) to develop recommendations for the regional control of NO[x] and Volatile Organic Compounds (VOC's) in 31 states east of and bordering the west bank of the\nMississippi River plus Texas. OTAG appears to be similar to the OTC in purpose and organization. OTAG could lead to additional NO[x] controls on certain Allegheny Power generating facilities in West Virginia. There is no assurance that NO[x] control for non-OTR states will be limited to RACT. What occurs in the non-OTR states could also affect whether Allegheny Power generating facilities in Maryland and Pennsylvania would need post-RACT controls. OTAG plans to issue recommendations by the end of 1996.\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 ambient standards for SO[2]. 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 SO[2] 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 the 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 of Allegheny Power's stations and disposal sites are in place. However, NPDES permit renewals for several West Virginia disposal sites contain what Allegheny Power believes are overly stringent discharge limitations. The WVDEP has temporarily stayed the stringent permit limitations while Allegheny Power continues 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 stormwater permitting program required under the 1987 Amendments to the Clean Water Act required implementation in two phases. In Phase I, the EPA and state agencies 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\ncurrent round of permit renewals began in 1993, monitoring requirements have been imposed, with pollution reduction plans and additional control of some discharges anticipated.\nIn April 1995, EPA promulgated the Phase II stormwater rule which establishes a two-tiered application process for discharges composed entirely of stormwater. Under the rule, sources determined to be significant contributors to water quality problems will be required to apply for a discharge permit within 180 days of receiving notice. The remaining sources are required to apply for permits within six years of the rule's effective date or August 2, 2001 under yet-to-be proposed application requirements.\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 Allegheny Power 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, Allegheny Power jointly filed with American Electric Power Company, Inc. (AEP) 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 through EPRI by all participants, including Allegheny Power. While the justification for the variance requests is being developed, Allegheny Power is 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 Protection (PADEP) 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. PADEP 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 Allegheny Power cannot be predicted.\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, Ohio, Pennsylvania, 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.\nAllegheny Power is 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.\nSignificant costs were incurred during 1995 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 Allegheny Power's facilities. Allegheny Power continues 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.\nAllegheny Power continues to actively pursue, with PADEP and WVDEP encouragement, ash utilization projects such as deep mine injection for subsidence and water quality improvement, structural fills for highway and building construction, and soil enhancement for surface mine reclamation.\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.\nThe Operating Subsidiaries are also among a group of potentially responsible parties under the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended (CERCLA), for the Jack's Creek\/Sitkin Smelting Superfund Site in central Pennsylvania. (See ITEM 3. LEGAL PROCEEDINGS for a description of this superfund 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 early 1996. 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 Allegheny Power is unknown at this time.\nReauthorization of the Clean Water Act, CERCLA 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 began 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 by-product disposal areas containing pyrites to that\nof 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 Allegheny Power and which is undergoing intense study, is the health effect, if any, of electric and magnetic fields. The financial impact of this issue on Allegheny Power, if any, cannot be assessed at this time.\nIn connection with President Clinton's Climate Change Action Plan concerning greenhouse gases, Allegheny Power expressed by letter to DOE in August 1993, its 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 Allegheny Power's integrated resource planning process and must not have an adverse effect on its competitive position in terms of costs and rates, or be unacceptable to its 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 established the principles DOE and utilities will operate under to reduce or avoid emission of greenhouse gases. A company-specific agreement was entered into on behalf of the Operating Subsidiaries and DOE in February 1995.\nThe EPA is required by law to regularly review the National Ambient Air Quality Standards for criteria pollutants. Recent court orders due to litigation by the American Lung Association have expedited these reviews. The EPA is currently reviewing the standards for ozone, SO[2], NO[x], and particulate matter. The impact on Allegheny Power of any revision to these standards is unknown at this time.\nREGULATION\nAllegheny Power and AYP Capital are subject to the broad jurisdiction of the SEC under PUHCA. APS, as a Maryland corporation, 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. The Subsidiaries and AYP Capital are regulated by the FERC. In addition, they are subject to numerous other city, county, state, and federal laws, regulations, and rules.\nIn June 1995, the SEC published its report which recommended changes to PUHCA, including a recommendation to Congress to repeal the entire act. A bill has been introduced in Congress to repeal PUHCA. However, Allegheny Power\ncannot predict what changes, if any, will be made to PUHCA as a result of these activities.\nOn March 29, 1995, the FERC issued a Notice of Proposed Rulemaking on open access nondiscriminatory transmission service which came to be known as the \"Mega-NOPR\" due to its size and scope. If adopted by the FERC, the Mega- NOPR will lead to a fundamental restructuring of the business of transmitting wholesale electric power and could potentially influence the future of retail electric sales as well. The FERC's stated objective was to ensure development of a competitive market for wholesale power buyers and sellers while preventing anti-competitive or discriminatory transmission practices. The Mega-NOPR requires all public or investor-owned utilities that own transmission systems and are under FERC's jurisdiction to file nondiscriminatory, open access transmission tariffs available to all wholesale buyers and sellers of electricity and apply these open access tariffs to their own wholesale purchases and sales of electricity. The Mega-NOPR also permits such utilities to recover stranded costs that may result from restructuring of the wholesale electric industry. In a separate notice, FERC proposed the development of a standardized, real-time electronic information network to provide all potential users of a utility's transmission system equal access to information regarding transmission capability and pricing. Allegheny Power has numerous concerns regarding the Mega-NOPR, including the issue of stranded costs, reliability of service and the development of a real-time electronic information network.\nThe requirements of the Mega-NOPR, if adopted by FERC, would force utilities to functionally unbundle their transmission and generation assets to operate independently of one another, in order to promote nondiscriminatory behavior. In response to the Mega-NOPR and in conjunction with Allegheny Power's reengineering of its Bulk Power Supply functions, Allegheny Power has established separate business units to operate and manage its generation and transmission assets. (See ITEM 1. REORGANIZATION for further discussion of the formation of business units.) Allegheny Power cannot predict when FERC will issue final regulations, nor the specifics thereof, regarding nondiscriminatory open access transmission services and related issues.\nAllegheny Power founded and continues to participate in, along with other utilities, an organization (General Agreement on Parallel Paths) whose primary purpose is to develop a mutually acceptable method of resolving the inequities imposed on transmission network owners by parallel power flows.\nSection 111 of EPACT requires 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. In 1994, Maryland, Pennsylvania, Virginia, and West Virginia initiated investigations to determine whether to adopt the federal standards, while Ohio summarily issued a final order. Allegheny Power submitted comments in all proceedings. Maryland, Ohio, Virginia and West Virginia have issued final orders. All four states declined to adopt the federal standards,\nconcluding that existing state regulations adequately address the issues. The outcome in Pennsylvania cannot be predicted.\nOn December 30, 1995, the Pennsylvania PUC issued its regulations regarding future competitive bidding for purchase of capacity and energy. The regulations specify the rules an electric utility must follow to competitively bid the long-term purchase of capacity and energy.\nIn 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. By March 1995, all appeals to the June 1994 order were withdrawn and the order became final.\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 Order.\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 and a number of interested parties, including Monongahela, submitted comments. The Ohio PUC has taken no further action following the filing of comments.\nAs part of its investigation into market competition and regulatory policies, the Maryland PSC has declared that all new capacity needs in the state will be subject to competitive bidding unless a utility can demonstrate why a particular capacity need should not be bid.\nVirginia has not mandated compulsory competitive bidding for capacity additions.\nOn September 20, 1994, the Maryland PSC 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 described the issues on which they requested comment by the utilities and interested persons. Potomac Edison submitted comments. After legislative hearings were held and comments were filed, the Maryland PSC issued an order. In its order dated August 18, 1995 the Commission found that while competition in the electric wholesale market should be encouraged, retail competition is not in the public interest at this time. The Commission also announced in its order that in the future it would be flexible and allow utilities to implement\nspecial rates and contracts including cost-based economic development rates as appropriate.\nBy order dated September 18, 1995, the Virginia State Corporation Commission began an investigation reviewing Commission policy regarding restructuring of and competition in the electric utility industry. The Commission staff has been directed to investigate and file a report on competitive issues by March 29, 1996. Comments by utilities and other interested persons on the staff report are due by May 31.\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. These discussions are being undertaken pursuant to an Ohio Energy Strategy issued in April 1994. The Ohio PUC is pursuing an incremental approach to competition by holding roundtable meetings. As a first step, the meetings have resulted in a set of guidelines on interruptible rates which are now pending before the Ohio PUC.\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 and reply comments have been filed. The Pennsylvania PUC staff issued a report advising against instituting retail wheeling at this time. Thereafter, the Pennsylvania PUC held hearings in December 1995, January 1996, and February 1996. The Pennsylvania PUC has set a target of April 1996 to issue a final report to the Governor and the Pennsylvania Legislature.\nIn August 1994, the Pennsylvania PUC instituted a proposed rulemaking relating to Pennsylvania PUC review of siting and construction of electric transmission lines. 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 1995, the Staff of the Maryland PSC issued draft regulations concerning the construction of generating stations and overhead transmission lines by nonutility generators (NUGS), applications covering modifications of electric generating stations by utilities and by NUGs, and changes to current regulations relating to whether certificates of public convenience and necessity must be obtained prior to modifying existing overhead transmission lines. Potomac Edison commented on the proposed changes in November 1995, and cannot predict what, if any, modifications might be made to current regulations.\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\nPennsylvania 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 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. The Pennsylvania PUC has appealed the case to the Pennsylvania Supreme Court.\nDuring 1995, Potomac Edison continued its participation in the Collaborative Process for demand-side management in Maryland. Potomac Edison's two programs, the Commercial and Industrial Lighting Rebate Program and the Power Saver\/Comfort Home Program for new residential construction continued. Through December 31, 1995, Potomac Edison had approved applications for $15.2 million in rebates related to the commercial lighting program and $2.6 million in rebates related to the residential new construction program. The peak demand reductions from these two programs through the end of 1995 should reduce future generation requirements by about 18.4 and 3.3 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. Potomac Edison filed a request to change the method used to allocate demand-side management costs to customers as part of the surcharge. The requested change was denied by a Hearing Examiner but has been appealed to the full Commission. Potomac Edison is awaiting the Commission's decision on this allocation issue.\nWest Penn implemented a two-year Low Income Payment and Usage Reduction Pilot Program in 1994. This program 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 nonprofit, 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 of the indenture 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\nAGC'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 ALLEGHENY POWER MAP.)\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nOn September 16, 1994, Duquesne Light Company (Duquesne) initiated a proceeding before the FERC by filing a request for an order requiring the Operating Subsidiaries to provide 300 MW of transmission service at parity with native load customers from interconnection points with Allegheny Power to Allegheny Power's points of interconnection with the Pennsylvania-New Jersey- Maryland Interconnection. On May 16, 1995, the FERC issued a preliminary order directing the Operating Subsidiaries to provide 300 MW of transmission service as requested by Duquesne. The order established further procedures for the development of rates, terms, and conditions of service by the parties. The parties have completed the procedural schedule and await a final order from the FERC. On October 6, 1995, the Operating Subsidiaries filed open access tariffs under which they intend to provide comparable wholesale transmission services to all potential customers, including Duquesne. Consequently, on October 23, 1995, the Operating Subsidiaries filed a motion asking FERC to suspend further proceedings in the Duquesne docket and to consolidate it with the open access docket. The FERC has chosen not to consolidate the proceedings for the present time.\nIn 1979, National Steel Corporation (National Steel) filed suit against APS and 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 APS and 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. APS and the Subsidiaries believe the motion is without merit; however, they cannot predict the outcome of this case.\nIn 1987, West Penn entered into separate Electric Energy Purchase Agreements (EEPAs) with developers of three PURPA projects: Milesburg (43 MW), Burgettstown (80 MW), and Shannopin (80 MW). The EEPAs provided for the purchase of each project's power over 30 years or more at rates generally approximating West Penn's estimated avoided cost at the time the EEPAs were\nnegotiated. Each EEPA 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 EEPA. Thereafter the Pennsylvania PUC issued orders that significantly modified the EEPAs. Since that time, all three EEPAs as modified 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 Advanced Materials Company and Allegheny Ludlum Corporation, 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, acting upon a pending petition of Shannopin, entered an order calculating capacity costs to be paid to the project. West Penn and its two largest industrial customers appealed this order to the Pennsylvania Commonwealth Court. On July 20, 1995, the Pennsylvania Commonwealth Court reversed part of the PUC order by reducing the maximum avoided capacity cost rate to be paid to the project from 8.0151 cents per kWh to 5.5933 cents per kWh. On October 23, 1995, West Penn filed a Petition for Allowance of Appeal with the Pennsylvania Supreme Court. A cross petition for Allowance of Appeal was subsequently filed by Shannopin. These appeals are pending.\nWest Penn and the developers of the Shannopin project reached an agreement on January 25, 1996, which provides that West Penn will buy out the Shannopin EEPA and terminate the project and all pending litigation associated with the Shannopin project. The agreement provides for a buy out price of $31 million. The buy out agreement is subject to Pennsylvania PUC approval of West Penn's full pass through of the buy out price to West Penn's customers through the energy cost rate by no later than March 31, 1999. Once the Pennsylvania PUC order is final and no longer subject to appeal, both parties will withdraw their pending Pennsylvania Supreme Court appeals. Because the buy out agreement is conditioned on full pass through of the buy out price to customers, it will not have a material effect on West Penn's net income. However, the buy out will significantly aid West Penn's customers by eliminating a requirement to purchase unneeded, above market cost power for 30 years. The agreement was filed with the Pennsylvania PUC on February 13, 1996, along with a request for expedited approval.\nOn February 27, 1995, the Milesburg developers filed with the Pennsylvania PUC a Petition for Recalculation of capacity cost to be paid to the project in accordance with the July 1990 order of the Commonwealth Court. These matters have since been stayed at the request of Milesburg and West Penn for the purpose of pursuing settlement discussions.\nThe Pennsylvania PUC orders relating to recalculated rates and adjusted milestone dates for Burgettstown became final and no longer subject to appeal 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 rescind its orders regarding these projects because they\nwere not in accord with PURPA and were no longer in the public interest. On December 16, 1994, the Pennsylvania PUC dismissed the complaint. West Penn appealed the order to the Pennsylvania Commonwealth Court. By order entered May 25, 1995, the Pennsylvania Commonwealth Court affirmed the Pennsylvania PUC order.\nIn November 1994, Washington Power (I), Inc. and Air Products and Chemicals, Inc., trading as Washington Power Company, L.P. (Washington Power), the developer of Burgettstown, filed a complaint against West Penn in the Court of Common Pleas of Washington County, Pennsylvania. The complaint requested equitable relief in the form of specific performance, declaratory and injunctive relief, and also sought monetary damages for breach of contract and for tortious interference with Burgettstown's contractual relations with others. The Court set April 3, 1995 as the trial date for the specific performance remedy only. The trial was cancelled at the request of Washington Power. On May 5, 1995, at the request of Washington Power, the Court entered an order discontinuing the case without prejudice.\nOn March 10, 1995, West Penn filed a petition for issuance of a declaratory order with FERC. This petition sought a declaration that the orders of the Pennsylvania PUC requiring West Penn to purchase capacity from Burgettstown at rates and pursuant to the terms in the Pennsylvania PUC Orders violated PURPA and FERC's PURPA regulations and thus West Penn had no obligation to purchase capacity from Burgettstown. On May 8, 1995, FERC denied the petition.\nThe Burgettstown EEPA automatically terminated in accordance with its terms, as the financing closing had not occurred by May 8, 1995, as required by the Pennsylvania PUC orders. Burgettstown did not request an extension.\nOn May 2, 1995, Washington Power filed a complaint against West Penn, APS and APSC in the United States District Court for the Western District of Pennsylvania asserting claims of treble damages for monopolization and attempts to monopolize in violation of the federal antitrust laws, unfair competition, breach of contract, intentional interference with contract and interference with prospective business relations. West Penn, APS and APSC cannot predict the outcome of this litigation.\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 of power 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. On August 2, 1995, these proceedings, with the exception of discovery, were stayed due to South River's appeal to the Commonwealth Court of an order of the Pennsylvania PUC requiring South River to bear the cost associated with providing notice of the proceedings to West Penn's customers. West Penn cannot predict the outcome of this proceeding.\nTwo previously reported complaints had been filed with the West Virginia PSC by developers of PURPA cogeneration projects in Marshall County, West Virginia (MidAtlantic) and Barbour County, West Virginia, seeking to require Monongahela and Potomac Edison to purchase capacity from the projects.\nFollowing a meeting in February, 1994, and an exchange of correspondence in the spring and summer of 1994, no further contact was had with the developers of the Barbour County project until, following a request by the PSC for a status report, Barbour County reported it was ready to go forward and discuss substantial modifications to the project. Potomac Edison and Monongahela responded on May 8, 1995, recommending the West Virginia PSC require evidence that a new project would be a qualifying facility (QF) under PURPA, that Barbour County provide a plan for resolving its QF status, and that any meeting with Staff be open to representatives of all parties. By Order dated June 15, 1995, the West Virginia PSC dismissed the Barbour County complaint on the basis that the project was undefined and contrary to the public interest.\nThe developers of the MidAtlantic project contacted Potomac Edison and Monongahela in September 1994 proposing a new, two-phased gas turbine facility. Following an exchange of letters, on January 10, 1995 MidAtlantic filed with the West Virginia PSC a Motion to Compel Potomac Edison to enter into an agreement, alleging bad faith negotiations. Potomac Edison and Monongahela filed a response on January 30, 1995, denying bad faith and noting numerous problems with MidAtlantic's new proposed project, including its plan to have West Virginia customers pay 100% of costs of the first phase, contrary to an order entered by the West Virginia PSC on March 5, 1993. On March 20, 1995 the West Virginia PSC issued an order rejecting MidAtlantic's plan to charge 100% of its Phase I project to West Virginia customers; directing MidAtlantic to obtain from FERC a resolution of its QF status; and requiring MidAtlantic to advise the West Virginia PSC within 30 days if it intended to pursue its complaint.\nMidAtlantic filed a response to the West Virginia PSC order on April 19, 1995, together with a motion for extension of time to respond to the question whether it would continue with the project, citing withdrawal of its financial partner (Babcock and Wilcox) from the project. Following a grant of an extension of time, on June 26, 1995, MidAtlantic filed a letter informing the West Virginia PSC that it would not pursue its project further, blaming APS for its inability to obtain a financial partner. The West Virginia PSC dismissed the MidAtlantic complaint by order dated June 29, 1995.\nOn September 7, 1995, MidAtlantic sued Monongahela, Potomac Edison, and APS in state court in Marshall County, West Virginia for failure to comply with PURPA regulations in refusing to purchase capacity and energy from the proposed project; interference with MidAtlantic's contract with Babcock and Wilcox; causing and\/or aiding Babcock and Wilcox in breaching a fiduciary duty; defamation; and undermining PURPA in an anti-competitive civil conspiracy with Babcock and Wilcox. The MidAtlantic suit was also filed against Babcock and Wilcox for breach of contract, breach of fiduciary duty, and conspiring with Allegheny Power to undermine PURPA. MidAtlantic seeks compensatory and punitive damages. Monongahela, Potomac Edison and APS filed\nan answer on October 24, 1995, and Babcock and Wilcox filed an answer, counterclaim and motion for summary judgment, alleging that MidAtlantic had released Babcock and Wilcox from all obligations arising from their development agreement. The court heard oral argument on the summary judgment motion on January 19, 1996. Monongahela, Potomac Edison and APS cannot predict the outcome of this litigation.\nOn August 24, 1995, American Bituminous Power Partners, L.P. (ABPP), owner and operator of the Grant Town project, an operating 80 MW waste coal PURPA project located in Marion County, West Virginia (see page 14), filed a Petition to Reopen and for Emergency Interim Relief with the West Virginia PSC against Monongahela. ABPP seeks modifications to the EEPA that will result in an unspecified increase in the cap of the Tracking Account and a retroactive restoration of the price for project energy to 1.9 cents\/kWh. The West Virginia PSC issued an order on November 29, 1995, which set a schedule for briefing of issues. In its brief, ABPP advised for the first time that the modifications it is seeking are only for interim relief and that if such relief is granted, it intends to petition the West Virginia PSC to further amend the EEPA to permanently increase the avoided energy cost. On December 20, 1995, ABPP requested additional briefing to clarify the relief sought. On January 5, 1996, the West Virginia PSC granted ABPP's request and set a schedule for additional briefs which concluded on January 26, 1996. Monongahela cannot predict the outcome of this proceeding.\nAs previously reported, effective March 1, 1989, West Virginia enacted a new method for calculating the Business and Occupation Tax (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 were filed. Effective June 1, 1995, West Virginia enacted a new method of calculating the B & O Tax, assessing the tax on a capacity rather than a generation basis and effective January 31, 1996, included a lower rate for generating units with flue-gas desulfurization systems (scrubbers). As a result of these changes, this litigation ended.\nAs of March 8, 1996, Monongahela has been named as a defendant along with multiple other defendants in a total of 5,564 pending asbestos cases involving one or more plaintiffs. Potomac Edison and West Penn have been named as defendants along with multiple other defendants in a total of 2,749 of those cases. Because these cases are filed in a \"shot-gun\" format whereby multiple plaintiffs file claims against multiple defendants in the same case, it is presently impossible to determine the actual number of cases in which plaintiffs make claims against the Operating Subsidiaries. However, based upon past experience and available data, it is estimated that about one-\nthird of the total number of cases filed 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. With very few exceptions, plaintiffs claiming exposure at stations operated by the Operating Subsidiaries were employed by third-party contractors, not the Operating Subsidiaries. Three plaintiffs are known to be either present or former 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 which 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 there are multiple defendants, the Operating Subsidiaries believe their relative percentage of potential liability is a small percentage of the total amount of the damages sought. A total of 94 cases have been previously settled and\/or dismissed as against Monongahela for an amount substantially less than the anticipated cost of defense. While the Operating Subsidiaries believe that all of the cases are without merit, they cannot predict the outcome nor are they able to determine whether additional cases will be filed.\nOn June 10, 1994, Allegheny Power filed a declaratory judgment action in the Superior Court of New Jersey against its 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. On January 27, 1995, the Court granted the CGL insurers' motion which dismissed the complaint, without prejudice, on procedural grounds. On the same day, Allegheny Power recommenced action in the Court of Common Pleas of Westmoreland County, Pennsylvania where it is currently pending. To date, two insurers have settled. However, the final outcome of this proceeding cannot be predicted.\nOn December 13, 1995, APSC, Monongahela, and Potomac Edison filed a civil complaint in the Court of Common Pleas of Westmoreland County, Pennsylvania against Industrial Risk Insurers (IRI) seeking damages in excess of $5 million for breach of an insurance contract covering physical damage to property at Unit No. 1 of Fort Martin Power Station. IRI previously denied coverage under an all risk insurance policy in effect at the time of the property damage. The outcome of the litigation or the amount of damages, if any, that may be recovered 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 (RI\/FS) prepared by the EPA indicates remedial alternatives which range as high as $113 million, to be shared by all responsible parties. A PRP Group has been formed and has submitted an addendum to the RI\/FS which proposes a substantially less expensive cleanup remedy. The EPA has not yet selected which remedial alternatives it will use,\nnor has it issued a Proposed Plan and Record of Decision. 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 reaching 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\nAPS, Monongahela, West Penn and AGC did not submit any matters to a vote of shareholders during the fourth quarter of 1995.\nThe holder of all the outstanding common stock of Potomac Edison consented in writing on October 23, 1995, to the amendment of the Charter of the Corporation to reclassify shares that had been purchased pursuant to a mandatory sinking fund.\n(a) All officers and directors are elected annually. (b) Retired effective September 1, 1995. (c) Retired effective December 1, 1995. (d) Resigned effective December 1, 1995. (e) Retired effective January 1, 1996.\n(a) All officers and directors are elected annually. (b) Retired effective January 1, 1996.\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, 1995, there were 63,290 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 1, 1996 were $30-1\/2 and $28. The last reported sale on that date was at $30.\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 48 Monongahela 51 Potomac Edison 53 West Penn 55 AGC 57\n[a] To record unbilled revenues, net of income taxes. [b] Reflects a two-for-one common stock split effective November 4, 1993. [c] Excludes the cumulative effect of the accounting change in 1994. [d] Capability available through contractual arrangements with nonutility generators. [e] Preliminary.\n(a) To record unbilled revenues, net of income taxes. (b) Excludes the cumulative effect of the accounting change in 1994.\n*Capability available through contractual arrangements with nonutility generators.\n(a) To record unbilled revenues, net of income taxes. (b) Excludes the cumulative effect of the accounting change in 1994.\n(a) To record unbilled revenues, net of income taxes. (b) Excludes the cumulative effect of the accounting change in 1994.\n(*) Capability available through contractual arrangements with nonutility generators.\n*Reflects a balance sheet reclassification of $12 million from deferred charges to plant for a prior tax payment.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nPage No.\nAPS 59 Monongahela 68 Potomac Edison 77 West Penn 87 AGC 95\nAPS Management Discussion & Analysis of Financial Condition and Results of Operations Review of Utility Operations Earnings\nEarnings in 1995 increased to $240 million ($2.00 per share) compared with $220 million ($1.86 per share) in 1994, excluding in 1994 the cumulative effect of an accounting change to record unbilled revenues. The increase resulted primarily from additional retail revenues due to increased kilowatt-- hour (kWh) sales and previously reported rate increases. These revenue increases were offset in part by restructuring charges and inventory write-offs in 1995 of $14.1 million after tax ($.12 per share) and higher expenses. Earnings in 1994 included a charge of $5.3 million after tax ($.05 per share) related to asset write-offs. Consolidated net income in 1993 was $216 million ($1.88 per share). Consolidated net income in 1994 also reflects higher retail revenues from increased kWh sales and rate increases, offset in part by higher expenses.\nRestructuring activities in 1995 were initiated by the System in response to the competitive environment emerging in the electric utility industry. The subsidiaries are restructuring many of their functions to strengthen their competitive position and improve their cost structure. During 1995, reenginee- ring of the Bulk Power Supply department was substantially completed and process redesign is expected to be substantially completed in 1996 for the remainder of the System. Downsizing was not a specific goal of the restructur- ing efforts but, as a consequence of process redesign and elimination of duplicate positions, approximately 200 employees have been placed in a staffing force pending reassignment or layoff. In addition, about 130 fewer employees will be required in the power station work force by the end of 1997, and employee reductions are also likely to result from reengineering in other areas. The charges recorded in 1995 in connection with restructuring activi- ties reflect estimated liabilities related to staffing force employees' separation costs, inventory write-offs in connection with changes in inventory management objectives, and certain other costs. These costs will be recovered through future cost savings.\nSales and Revenues\nKWh sales to and revenues from residential, commercial, and industrial customers are shown on page 50. Such kWh sales increased 3.9% and 2.8% in 1995 and 1994, respectively. The increases in revenues from sales to residential, commercial, and industrial customers resulted from the following:\nChanges from Prior Year\n(Millions of Dollars) 1995 1994 Increased kWh sales $ 56.2 $ 23.6 Rate changes: Pennsylvania 50.2 22.7 Maryland 17.7 11.9 West Virginia 19.3 9.7 Virginia (1.8) 8.5 Ohio .5 85.9 52.8 Fuel and energy cost adjustment clauses* (2.8) 48.3 Other .6 4.3 $139.9 $129.0\n* Changes in revenues from fuel and energy cost adjustment clauses have little effect on consolidated net income.\nThe increase in kWh sales in 1995 was largely attributable to industrial and commercial sales. Industrial sales increased 4.2% and 4.4% in 1995 and 1994, respectively. The 4.7% increase in commercial sales in 1995 and the 2.2% increase in 1994 reflect growth in the number of customers and in 1995 also reflects increased customer usage. These increases continue to reflect a trend of economic growth in the service territory. In 1995 the subsidiaries implemented a new Major Accounts Program which focuses on enhancing the working relationships with the System's largest customers. The goal of the program is to assure, through superior service, that Allegheny Power remains the energy supplier for these major customers.\nResidential kWh sales increased 3% in 1995 and .9% in 1994. The rate of growth in the number of residential customers has remained constant at 1.2% annually in 1995, 1994, and 1993. However, the impact of weather on customer usage continues to produce fluctuations in residential sales. In 1995, decreased sales due to mild weather in the first and second quarters were more than offset by extremely hot summer weather and cooler than normal winter weather in November and December as compared to 1994. The 1994 residential use was down slightly from 1993 levels reflecting a decrease in both heating and cooling degree days.\nRate case decisions in all jurisdictions, representing revenue increases in excess of $125 million on an annual basis, have been obtained, most of them effective in late 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. Additional base rate increases are not expected to be necessary for the next several years. However, future purchased power expenses related to a qualified facility under the Public Utility Regulatory Policies Act of 1978 (PURPA), to be completed in late 1999, may make it necessary to increase rates at that time.\nKWh sales to and revenues from nonaffiliated utilities are comprised of the following items:\nSales from subsidiaries' generation in 1995 decreased because of growth in kWh sales to retail customers, which reduced the amount available for sale, and because of continuing price competition. The generation tax imposed in West Virginia, which in prior years was a significant factor affecting the subsidiaries' ability to compete in the market for sales to nonaffiliated utilities, was favorably amended effective in June 1995 to change the basis of the tax from generation to generating capacity. Sales of purchased power vary depending on the availability of other utilities' generating equipment, demand for energy, and price competition. In the future, some of these transactions may be made under new transmission tariffs described below. About 95% of the aggregate benefits from sales to nonaffiliated utilities are passed on to retail customers and have little effect on consolidated net income.\nThe increase in other revenues in 1995 and 1994 resulted primarily from increased revenues from wholesale customers (cooperatives and municipalities who own their own distribution systems and who buy all or part of their bulk power needs from the subsidiaries under regulation by the Federal Energy Regulatory Commission). Under the National Energy Policy Act of 1992, these customers obtained the ability to choose the bulk power supplier of their choice by the requirement that transmission-owning utilities must provide transmission service. In 1995, rate cases for wholesale customers were completed with the result that such customers, with revenues representing about 97% of the $46 million in annual wholesale revenues, agreed to negotiat- ed rate increases and signed contracts to remain as System customers for periods ranging from three to seven years. One customer representing the remaining 3% of annual revenues selected an 18-month contract at higher rates. In the event that this customer selects another supplier, the subsidiaries would retain transmission revenues with the result that any reduction in consolidated net income would not be significant.\nOther revenues in 1995 also reflect an increase in standard transmission service revenues. See page 66 under Competition in Core Business for informa- tion about a Notice of Proposed Rulemaking (Mega-NOPR) issued by the Federal Energy Regulatory Commission (FERC) in 1995. Effective in 1996, pursuant to the intentions of the Mega-NOPR, the subsidiaries eliminated their Standard Transmission Service tariff for new service transactions, and began using two new transmission service tariffs which qualify as required open access tariffs - - a Network tariff and a Point-to-Point tariff. The FERC accepted the filing of the new tariffs subject to hearings in the summer of 1996 and modification pending final Mega-NOPR rules. The subsidiaries are using the new tariffs in the interim, subject to refund. In addition, the subsidiaries have a Standard Generation Service tariff accepted by the FERC under which the subsidiaries make available bundled, nonfirm generation services with associated transmis- sion services. Substantially all of the benefits of these sales of transmis- sion and generation services to customers outside the service territory are passed through to retail customers and, as a result, have little effect on consolidated net income. While this procedure will continue to apply to similar sales under the new tariffs, the subsidiaries may petition to revise the procedure in the future.\nOperating Expenses\nThe 7% decrease in fuel expenses in 1995 was primarily the result of renegotiations of long-term fuel contracts which reduced fuel prices effective in January 1995, and the ability to use lower-cost, high-sulfur coal at the Harrison Power Station because of the new scrubbers. 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 purchases from qualified facilities under PURPA, and is comprised of the following items:\nThe amount of power purchased from other utilities for use by subsidiaries and for resale to other utilities depends upon the availability of subsidiar- ies' generating equipment, transmission capacity, and fuel, and their cost of\ngeneration 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 decrease in purchases from PURPA generation in 1995 was due primarily to a contractual reduction in the energy rate effective in June 1995 for the Grant Town PURPA project. American Bituminous Power Partners, L.P., the developer of the Grant Town project, has filed an emergency petition with the Public Service Commission of West Virginia for interim relief to have its former energy rate reinstated. Monongahela Power has filed objections to this petition. The increase in purchases from PURPA generation in 1994 reflects generation from the Grant Town PURPA project beginning in late 1993. As reported under Sales and Revenues, an agreement has been reached with a proposed facility to commence purchasing generation in 1999. This project and others may significantly increase the costs of power purchases passed on to customers. None of the subsidiaries' purchased power contracts is capitalized since there are no minimum payment requirements absent associated kWh generation. Other purchased power continued to increase in 1995 because of increased sales to retail customers and the availability of more economic energy. 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.\nIn January 1996, West Penn and the developers of a proposed Shannopin PURPA project reached agreement to terminate the project and all pending litigation, at a buy out price of $31 million. The agreement is subject to Pennsylvania Public Utility Commission (PUC) approval of recovery of the buy out price by West Penn by no later than March 31, 1999. The agreement was filed with the PUC in February 1996 along with a request for expedited approval.\nThe increase in other operation expense in 1995 resulted primarily from restructuring charges which are described in Note B to the consolidated financial statements on page 112. Additional restructuring charges will be incurred in 1996 as the subsidiaries complete their reengineering process. Other operation expense in 1996 and thereafter is expected to reflect the benefits of savings related to the restructuring activities. The 1994 increase in other operation expense 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 in 1994 due to an increase in aged outstanding receivables caused primarily by Pennsylvania rate regulations which make it difficult if not impossible to curtail service to non-paying customers. It is expected that the allowance for these uncollectible accounts will be increased in the future because of increasing accounts receivables in arrears. The increase in pension expense occurred because the subsidiaries in 1994 discontinued the practice of deferring pension expense in Pennsylvania and West Virginia to reflect rate case decisions in those states. Pension expense in 1994 also includes a charge of $3.1 million for write-off of prior deferrals in West Virginia because recovery of those deferrals was denied.\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, and the amount of work found necessary when the equipment is dismantled. Maintenance expense in 1995 includes a charge of about $7 million for inventory write-offs described in\nNote B to the consolidated financial statements on page 112 and $3 million due to maintenance expense for the Harrison scrubbers which went into service in late 1994. Maintenance expense for the scrubbers is expected to increase since the warranty period has expired.\nDepreciation expense increases resulted primarily from additions to electric plant. The subsidiaries began depreciating the Harrison scrubbers in mid-Nove- mber 1994, amounting to $32 million annually. Future depreciation expense increases for utility operations are expected to be less than historical increases because of reduced levels of proposed capital expenditures.\nThe increase in taxes other than income in 1995 and 1994 was due primarily to increases in gross receipts taxes resulting from higher revenues from retail customers. In 1995 this increase was offset in part by a decrease in West Virginia Business and Occupation (B&O) taxes resulting from an amendment in the B&O tax law effective June 1995, which changed the basis for this tax from generation to generating capacity.\nThe net increase of $24 million in federal and state income taxes in 1995 resulted primarily from an increase in income before taxes ($16 million) and an increase in reversals of prior year depreciation benefits for which deferred taxes were not then provided ($6 million). The net increase in 1994 of $2 million resulted primarily from an increase in income before taxes. Note C to the consolidated financial statements provides a further analysis of income tax expenses.\nThe combined decreases in allowances for funds used during construction in 1995 and 1994 of $11 million and $2 million, respectively, reflect decreases in construction expenditures upon substantial completion of the compliance program for Phase I of the CAAA. The increase in other income, net, of $5 million in 1995 was due primarily to income from demand-side management programs. During 1995, Potomac Edison continued its participation in the collaborative process for demand-side management in Maryland. Program costs, including lost revenues and rebates, are deferred as a regulatory asset and are being recovered through an energy conservation surcharge over a seven-year period. The balance in the regulatory asset for this program is $16 million as of December 31, 1995. Other income, net, in 1994 reflects 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.\nIn 1995 interest on long-term debt increased $14 million due primarily to the new security issues in 1994 and the timing of the refinancing of $245 million of first mortgage bonds and $93 million of pollution control revenue notes in 1995. Dividends on preferred stock decreased $5 million in 1995 due primarily to the redemption of preferred stock issues refinanced with $155.5 million of Quarterly Income Debt Securities. Other interest expense reflects changes in the levels of short-term debt maintained by the companies through- out the year, as well as the associated interest rates.\nEnvironmental and Other Issues\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.\nContingencies and uncertainties related to the CAAA are discussed in Liquidity and Capital Requirements. The CAAA, among other things, require an annual reduction in total utility emissions within the United States of 10 million tons of sulfur dioxide and two million tons of nitrogen oxides (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 and units reactivated in the future will be affected in Phase II. Installation of scrubbers at the Harrison Power Station was the strategy undertaken to meet the required SO[2] emission reductions for Phase I (1995-1999). Continuing\nstudies will determine the compliance strategy for Phase II (2000 and beyond). Studies to evaluate cost effective options to comply with Phase II SO[2] limits, including those which may be available from the use of the subsidiaries' banked emission allowances and from the emission allowance trading market, are continuing. It is expected that burner modifications at possibly all 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.\nThe subsidiaries previously reported that the Environmental Protection Agency had identified them and approximately 875 others as potentially responsible parties in a Superfund site subject to cleanup. The subsidiaries have also been named as defendants along with multiple other defendants in pending asbestos cases involving one or more plaintiffs. The subsidiaries believe that provisions for liabilities and insurance recoveries are such that final resolution of these claims will not have a material effect on their financial position.\nIn March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,\" effective in 1996. SFAS No. 121 establishes standards for the impairment of long-lived assets and certain identifiable intangibles and requires companies to recognize an impairment loss if the expected future undiscounted cash flows are less than the carrying amount of an asset. The Company and its subsidiar- ies do not believe at this time that adoption of this standard will have a materially adverse effect on their financial position.\nFinancial Condition and Requirements Liquidity and Capital Requirements\nTo meet the System companies' need for cash for operating expenses, the payment of interest and dividends, retirement of debt and certain preferred stocks, and for their construction programs, the companies have used internal- ly 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.\nConstruction expenditures of the regulated subsidiaries in 1995 were $319 million and for 1996 and 1997 are estimated at $279 million and $305 million, respectively. In 1995, these expenditures included $36 million for compliance with the CAAA. The 1996 and 1997 estimated expenditures include $7 million and $20 million, respectively, for additional CAAA compliance costs. The Harrison scrubbers, which were constructed for compliance with Phase I of the CAAA, were completed on schedule in late 1994 and the final cost was approximately 24% below the original budget. Expenditures in the future to cover the costs of compliance with Phase II of the CAAA may be significant. Based on current forecasts and considering the reactivation of capacity in cold reserve, peak diversity exchange arrangements, demand-side management and conservation programs, and contracted PURPA capacity, it is not anticipated that the regulated subsidiaries will require new generating capacity until the year 2000 or beyond. The regulated subsidiaries also have additional capital requirements for debt maturities (see Note H to the consolidated financial statements). The Company will have additional capital requirements in the future related to nonutility investments of AYP Capital which are described under Nonutility Business on page 67.\nInternal Cash Flows\nInternal generation of cash, consisting of cash flows from operations reduced by dividends, was $281 million in 1995 compared with $246 million in 1994. Because of the new rate case authorizations effective in late 1994 and 1995 and reduced levels of capital expenditures, the regulated subsidiaries were able to finance approximately 88% of their capital expenditure program through internal cash generation in 1995, as compared to 48% in 1994. This ratio is expected to continue to increase over the next several years for utility investments. See page 67 for a description of future nonutility investments. Dividends paid on common stock in 1995 increased to $1.65 per share compared with $1.64 in 1994. However, the dividend payout ratio decreased from 88%, excluding the cumulative effect of the accounting change in 1994, to 83% in 1995.\nAs capital-intensive electric utilities, the regulated subsidiaries are affected by the rate of inflation. The inflation rate over the past several years has been relatively low and has not materially affected their financial position. However, since utility revenues are based on rate regulation that generally only recognizes historical costs, cash flows based on recovery of historical plant may not be adequate to replace plant in future years.\nFuel inventory provided a source of cash in 1995 ($12 million), primarily related to lower fuel prices attained through renegotiations of fuel contracts effective in January 1995 and the ability to use lower-cost, high-sulfur coal at the Harrison Power Station because of the new scrubbers. In 1994, fuel inventory represented a use of cash ($13 million) as it returned to a higher level after selective mine shutdowns during contract renegotiations in 1993. The decrease in operating and construction inventory in 1995 resulted from the write-off of obsolete and slow-moving inventory. In connection with ongoing restructuring activities and consolidation of facilities, the subsidiaries are reevaluating inventory management objectives to take advantage of centralized storerooms serving several facilities and to improve turnover ratios.\nFinancings\nDuring 1995, the Company issued 1,407,855 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. The subsidiaries refinanced $338 million of debt securities with new debt securities having lower interest rates and refinanced preferred stock issues totaling $155.5 million with Quarterly Income Debt Securities (QUIDS). Under certain circum- stances the interest payments on QUIDS may be deferred for a period of up to 20 consecutive quarters. Debt redemption costs of refinancings are amortized over the life of the associated new securities. Due to the significant number of refinancings which have occurred over the past four years, this balance is now $57 million. Reduced future interest expense will more than offset these expenses. Preferred stock redemption costs of $5.5 million were charged directly to retained earnings.\nShort-term debt is used to meet temporary cash needs until the timing is considered appropriate to issue long-term securities. Short-term debt increased $74 million to $200 million in 1995. At December 31, 1995, unused lines of credit with banks were $173 million. In addition, a multi-year credit program established in 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 1995. During 1996, the subsidiaries anticipate meeting their capital requirements through a combination of internally generated funds, cash on hand, and short-term borrowing as necessary. The Company plans to continue DRISP\/ESOSP common stock sales. The 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. See page 67 for information on financing requirements for proposed nonutility investments.\nChanges in the Electric Utility Industry\nCompetitive forces within the electric utility industry continued to increase in 1995. As in the past, utilities must compete for siting of new industrial and commercial customers and for retaining existing customers in the franchised territory. Electric utilities must also compete with suppliers of other forms of energy. Growing competitive challenges due to legislative, economic, and technological changes, and Allegheny Power's ability to meet these challenges, have been a major focal point in 1995.\nCompetition in Core Business\nCompetition in the wholesale market for electricity was enhanced by the National Energy Policy Act of 1992 (EPACT), which permits wholesale genera- tors, utility-owned and otherwise, and wholesale customers to request from owners of bulk power transmission facilities a commitment to supply transmis- sion services. EPACT is the first legislative action to permit wholesale customers within a utility's franchised service territory to seek alternative providers of energy.\nThe FERC issued a Notice of Proposed Rulemaking (Mega-NOPR) in 1995 which intends to stimulate wholesale competition among electric utilities and unregulated electricity generators. The Mega-NOPR encourages wholesale competition by requiring utilities to allow their transmission facilities to be used by sellers or buyers of wholesale power. The Mega-NOPR provides that electric utilities would be able to recover stranded costs (costs of facili- ties made uneconomic by wholesale transmission access). The FERC has not yet issued a final rulemaking on these issues.\nState regulators in Ohio, Pennsylvania, and Virginia are in various stages of proceedings to evaluate the feasibility of retail competition. The Maryland commission has completed its investigation and issued an order which found that while competition in the electric wholesale market should be encouraged, retail competition is not in the public interest at this time. The regulated subsidiaries have filed responses in these proceedings which emphasize the need to move cautiously toward retail competition in order to protect the reliability of service to retail customers, and to insure that utilities without excess generating capacity, like the regulated subsidiaries, are not placed at a competitive disadvantage by permitting utilities with excess capacity to dump energy at low marginal cost while keeping their own customers captive through high stranded investment fees. Attempts at variations of retail wheeling have been authorized in some states, and various municipali- ties around the country that are not wholesale customers are exploring ways to become wholesale customers to obtain the ability to choose their electric supplier. In 1995, the Department of Defense proposed that it be granted competitive procurement rights for defense facilities.\nEfforts to Maintain and Improve Competitive Position\nThe emerging competitive environment in generation and wholesale markets and the increasing possibility of retail competition have created greater planning uncertainty and risks for the Company. In response, the Company is continuing to develop a number of strategies to retain its existing customers and to expand its retail and wholesale customer base, including:\n1. Restructuring its operations to maintain its relatively low-cost status by controlling costs and operating more efficiently\n2. Implementing new marketing strategies\n3. Increasing customer and energy services\n4. Avoiding future rate increases\n5. Expanding core business into nonutility activities (see below)\nThe Company believes it is taking necessary actions to position itself to meet current and future competitive challenges.\nNonutility Business\nTo help meet the challenges of the competitive environment in the electric utility industry, Allegheny Power is broadening its operations into nonutility businesses. In 1994, AYP Capital was formed to pursue opportunities in unregulated markets in order to strengthen the long-term competitiveness and profitability of the Company. AYP Capital's primary objectives are to develop new energy-related services businesses and to pursue wholesale unregulated power generation. The most significant project is an agreement with Duquesne Light Company to purchase for about $170 million its 50% interest (276 megawatts) in Unit No. 1 of the Fort Martin Power Station. The rest of the station is owned by the Company's regulated subsidiaries. AYP Capital intends to operate its share of the unit as an exempt wholesale generator and sell the output at market rates. After necessary approvals, AYP Capital expects a closing by late 1996. Various financing alternatives for this acquisition are being considered. Upon commencement of operations, AYP Capital will incur depreciation expense and other operating expenses related to Fort Martin.\nAYP Capital has also committed to invest up to $10 million in two limited partnerships. AYP Capital has also invested in APS Cogenex, a joint venture limited liability company which provides services to improve the energy efficiency of consumer facilities in the five states in which Allegheny Power provides electric service plus the District of Columbia. AYP Capital intends to provide financing to consumers that undertake capital improvements necessary to achieve energy efficiency. AYP Capital will continue to evaluate investment opportunities with potentially significant additional capital investments in the future. AYP Capital's total investments as of December 31, 1995, were $1.1 million.\nAlthough nonutility investments offer the potential for earning returns in excess of regulated investments, they generally involve a higher degree of risk. AYP Capital intends to manage these risks by diversifying its invest- ments and by investing where there is an appropriate balance of risk and reward.\nThe ability of AYP Capital to engage and compete in nonutility businesses will be impeded unless the Public Utility Holding Company Act of 1935 (PUHCA) is repealed or revised. PUHCA prevents or significantly disadvantages the Company and other non-exempt holding companies from diversifying into utility-related or nonutility businesses, a disadvantage not imposed on exempt holding companies and other competitors. The Company has been active in seeking repeal or reform of this law.\nMonongahela MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nREVIEW OF OPERATIONS\nNet Income\nNet income in 1995 increased to $66.7 million compared with $59.9 million in 1994, excluding in 1994 the cumulative effect of an accounting change to record unbilled revenues. The increase resulted primarily from additional retail revenues due to increased kilowatt-hour (kWh) sales and previously reported rate increases. These revenue increases were offset in part by restructuring charges and inventory write-offs in 1995 of $3.3 million after tax and higher expenses. Net income in 1993 was $61.7 million. The decrease in 1994 resulted primarily from higher expenses, including taxes, pension expense, and depreciation.\nRestructuring activities in 1995 were initiated by the System in response to the competitive environment emerging in the electric utility industry. The System, including the Company, is restructuring many of its functions to strengthen its competitive position and improve its cost structure. During 1995, reengineering of the Bulk Power Supply department in the affiliated Allegheny Power Service Corporation was substantially completed and process redesign is expected to be substantially completed in 1996 for the remainder of the System. Downsizing was not a specific goal of the restruc- turing efforts, but as a consequence of process redesign and elimination of duplicate positions, approximately 200 System employees have been placed in a staffing force pending reassignment or layoff. In addition, about 130 fewer System employees will be required in the power station work force by the end of 1997, and employee reductions are also likely to result from reengineering in other areas. The charges recorded in 1995 in connection with restructuring activities reflect estimated liabilities related to staffing force employees' separation costs, inventory write-offs in connection with changes in inventory management objectives, and certain other costs. It is expected that these costs will be recovered through future cost savings.\nSales and Revenues\nKWh sales to and revenues from residential, commercial, and industrial customers are shown on pages 51 and 52. Such kWh sales increased 4.5% and 3.2% in 1995 and 1994, respectively. The increases in revenues from sales to residential, commercial, and industrial customers resulted from the following: Changes from Prior Year 1995 1994 (Millions of Dollars) Increased kWh sales.............................. $21.6 $ 3.8 Rate increases: West Virginia.................................. 17.1 7.9 Ohio........................................... .5 17.6 7.9 Fuel and energy cost adjustment clauses*......... (3.1) 13.0 Other............................................ .6 1.0 $36.7 $25.7\n*Changes in revenues from fuel and energy cost adjustment clauses have little effect on net income.\nThe increase in kWh sales in 1995 was largely attributable to commercial and industrial sales. Industrial sales increased 3.5% and 6.1% in 1995 and 1994, respectively. The 6.5% increase in commercial sales in 1995 and the 1.2% increase in 1994 reflect growth in the number of customers and in 1995 also increased customer usage. These increases continue to reflect a trend of economic growth in the service territory. In 1995, the Company implemented a new Major Accounts Program which focuses on enhancing the working relationships with its largest customers. The goal of the program is to assure, through superior service, that the Company remains the energy supplier for these major customers.\nResidential kWh sales increased 5.0% in 1995 and decreased .6% in 1994. The rate of growth in the number of residential customers has remained constant at 1% annually in 1995, 1994, and 1993. However, the impact of weather on customer usage continues to produce fluctuations in residential sales. In 1995, decreased sales due to mild weather in the first and second quarters were more than offset by extremely hot summer weather and cooler than normal winter weather in November and December as compared to 1994. The 1994 residential use was down slightly from 1993 levels reflecting a decrease in both heating and cooling degree days.\nRate case decisions in all jurisdictions, representing revenue increases in excess of $35 million on an annual basis, have been obtained. About $29 million became effective in 1994 and $6 million in Ohio became effective on November 9, 1995. 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. Additional base rate increases are not expected to be necessary for the next several years.\nKWh sales to and revenues from nonaffiliated utilities are comprised of the following items:\n1995 1994 1993 KWh sales (Billions): From Company generation................. .1 .3 .3 From purchased power.................... 3.1 2.1 2.8 3.2 2.4 3.1 Revenues (Millions): From Company generation................. $ 2.7 $ 7.7 $ 8.4 From sales of purchased power................................. 88.2 72.0 77.6 $90.9 $79.7 $86.0\nSales to nonaffiliated companies from the Company's generation in 1995 decreased because of growth in kWh sales to retail customers which reduced the amount available for sale and because of continuing price competition. The generation tax imposed in West Virginia, which in prior years was a signifi- cant factor affecting the Company's ability to compete in the market for sales to nonaffiliated companies, was favorably amended effective in June 1995 to change the basis of the tax from generation to generating capacity. Sales of purchased power vary depending on the availability of other companies'\ngenerating equipment, demand for energy, and price competition. In the future, some of these transactions may be made under new transmission tariffs described below. About 90% of the aggregate benefits from sales to nonaffili- ated companies and to affiliates included in other revenues described below, are passed on to retail customers and have little effect on net income.\nThe decrease in other revenues in 1995 resulted primarily from a decrease in sales of energy and spinning reserve to affiliated companies, offset in part by increased revenues from wholesale customers (cooperatives and municipalities who own their own distribution systems and who buy all or part of their bulk power needs from the Company under regulation by the Federal Energy Regulatory Commission). Under the National Energy Policy Act of 1992, these customers obtained the ability to choose the bulk power supplier of their choice by the requirement that transmission-owning utilities must provide transmission service. In 1994, a rate case for wholesale customers was completed with the result that such customers, representing about $4.5 million in annual wholesale revenues, agreed to negotiated rate increases and signed contracts to remain as the Company's customers for five years. The increase in 1994 resulted from continued increases in sales of capacity, energy, and spinning reserve to affiliated companies because of additional capacity and energy available from qualified facilities under the Public Utility Regulatory Policies Act of 1978 (PURPA).\nOther revenues in 1995 also reflect an increase in standard transmis- sion service revenues. See page 76 under Competition in Core Business for information about a Notice of Proposed Rulemaking (Mega-NOPR) issued by the Federal Energy Regulatory Commission (FERC) in 1995. Effective in 1996, pursuant to the intentions of the Mega-NOPR, the Company eliminated its Standard Transmission Service tariff for new service transactions, and began using two new transmission service tariffs which qualify as required open access tariffs - a Network tariff and a Point-to-Point tariff. The FERC accepted the filing of the new tariffs subject to hearings in the summer of 1996 and modification pending final Mega-NOPR rules. The Company is using the new tariffs in the interim, subject to refund. In addition, the Company has a Standard Generation Service tariff accepted by the FERC under which the Company makes available bundled, nonfirm generation services with associated transmission services. About 90% of the benefits of these sales of transmis- sion and generation services to customers outside the service territory are passed through to retail customers and as a result have little effect on net income. While this procedure will continue to apply to similar sales under the new tariffs, the Company may petition to revise the procedure in the future.\nOperating Expenses\nThe 9% decrease in fuel expenses in 1995 was primarily the result of renegotiations of long-term fuel contracts which reduced fuel prices effective in January 1995, and the ability to use lower-cost, high-sulfur coal at the Harrison Power Station because of the new scrubbers. Fuel expenses increased 4% in 1994 due primarily to an increase 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.\n\"Purchased power and exchanges, net\" represents power purchases from and exchanges with nonaffiliated utilities and purchases from qualified facilities under PURPA, capacity charges paid to Allegheny Generating Company (AGC), an affiliate partially owned by the Company, 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:\n1995 1994 1993 (Millions of Dollars) Nonaffiliated transactions: Purchased power: For resale to other companies........ $ 79.1 $ 63.7 $ 68.6 From PURPA generation................ 64.6 68.3 55.7 Other................................ 11.6 9.4 8.1 Power exchanges, net................... .1 (.2) (.6) Affiliated transactions: AGC capacity charges................... 20.6 20.1 23.3 Energy and spinning reserve charges...................... .4 .5 .5 $176.4 $161.8 $155.6\nThe amount of power purchased from nonaffiliated companies for use by the Company and for resale to nonaffiliated companies 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 companies from which such purchases are made. The primary reason for the fluctuations in purchases for resale to nonaffiliated companies is described under Sales and Revenues above. The decrease in purchases from PURPA generation in 1995 was due primarily to a contractual reduction in the energy rate effective in June 1995 for the Grant Town PURPA project. American Bituminous Power Partners, L.P., the developer of the Grant Town project, has filed an emergency petition with the Public Service Commission of West Virginia for interim relief to have its former energy rate reinstated. The Company has filed objections to this petition. The increase in purchases from PURPA generation in 1994 reflects generation from the Grant Town PURPA project beginning in late 1993. None of the Company's purchased power contracts is capitalized since there are no minimum payment requirements absent associated kWh generation. Other purchased power continued to increase in 1995 because of increased sales to retail customers and the availability of more economic energy. 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 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.\nThe increase in other operation expense in 1995 resulted primarily from restructuring charges which are described in Note B to financial statements on page 125. Additional restructuring charges will be incurred in 1996 as the Company and its affiliates complete their reengineering process. Other operation expense in 1996 and thereafter is expected to reflect the benefits of savings related to the restructuring activities. The 1994 increase in other operation expense 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\nexpense occurred because the Company in 1994 discontinued the practice of deferring pension expense in West Virginia to reflect a rate case decision in that state, and wrote off $2.5 million of prior deferrals in West Virginia because recovery of those deferrals was denied.\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 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, and the amount of work found necessary when the equipment is dismantled. Maintenance expense in 1995 includes a charge of about $1.4 million for inventory write-offs described in Note B to the financial statements on page 125. Maintenance expense for the Harrison scrubbers which went into service in late 1994 is expected to increase since the warranty period has expired.\nThe depreciation expense decrease in 1995 was the net result of a decrease in depreciation rates in West Virginia concurrent with the West Virginia base rate case effective in November 1994, offset by additions to electric plant. The Company began depreciating the Harrison scrubbers in mid- November 1994 amounting to approximately $8 million annually. 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.\nThe decrease in taxes other than income in 1995 was primarily due to a decrease in West Virginia Business and Occupation Taxes (B&O) resulting from an amendment in the B&O tax law effective June 1995, which changed the basis for this tax from generation to generating capacity. The 1994 increase in taxes other than income was primarily due to an increase in B&O taxes resulting from prior period adjustments recorded in 1993.\nThe net increase of $11 million in federal and state income taxes in 1995 resulted from an increase in income before taxes ($7 million) and changes in the provisions for prior years ($4 million). The net decrease in 1994 of $3 million resulted primarily from a decrease in income before taxes. Note C to the financial statements provides a further analysis of income tax expenses.\nThe combined decreases in allowances for borrowed and other than borrowed funds used during construction (AFUDC) in 1995 and 1994 of $2 million and $3 million, respectively, reflect decreases in construction expenditures upon substantial completion of the compliance program for Phase I of the CAAA. The increase in other income, net, of $1 million in 1995 reflects an increase in the deferral of carrying charges on CAAA expenditures in Ohio until the base rate increase became effective in November 1995, proceeds from the sale of timber, and interest income on a tax refund. The changes in other income,\nnet, in 1994 resulted primarily from the Company's share of earnings of AGC (see Note E to the financial statements).\nIn 1995, interest on long-term debt increased $2 million due primarily to the new security issues in 1994 and the timing of the refinancing of $70 million of first mortgage bonds and $25 million of pollution control revenue notes in 1995. The increase also reflects interest on $40 million of Quarterly Income Debt Securities issued in 1995 to refund preferred stock issues. 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.\nEnvironmental and Other Issues\nIn 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.\nContingencies and uncertainties related to the CAAA are discussed in Liquidity and Capital Requirements. The CAAA, among other things, require an annual reduction in total utility emissions within the United States of 10 million tons of sulfur dioxide (SO[2]) and two million tons of nitrogen oxides (NOx) from 1980 emission levels, to be completed in two phases, Phase I and Phase II. Four coal-fired Company plants are affected in Phase I and the remaining plants will be affected in Phase II. Installation of scrubbers at the Harrison Power Station was the strategy undertaken to meet the required SO[2] emission reductions for Phase I (1995-1999). Continuing studies will determine the compliance strategy for Phase II (2000 and beyond). Studies to evaluate cost effective options to comply with Phase II SO[2] limits, including those which may be available from the use of the Company's banked emission allowances and from the emission allowance trading market, are continuing. It is expected that burner modifications at possibly all 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 Pennsylvania (where the Company has ownership in a station) for ozone nonattainment (Title I) reasons. Continuous emission monitoring equipment has been installed on all Phase I and Phase II units.\nThe Company previously reported that the Environmental Protection Agency had identified the Company and its affiliates and approximately 875 others as potentially responsible parties in a Superfund site subject to cleanup. The Company has also been named as a defendant along with multiple other affiliated and nonaffiliated defendants in pending asbestos cases involving one or more plaintiffs. The Company believes that provisions for liabilities and insurance recoveries are such that final resolution of these claims will not have a material effect on its financial position.\nIn March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,\" effective in 1996. SFAS No. 121 establishes standards for the impairment of long-lived assets and certain identifiable intangibles and\nrequires companies to recognize an impairment loss if the expected future undiscounted cash flows are less than the carrying amount of an asset. The Company does not believe at this time that adoption of this standard will have a materially adverse effect on its financial position.\nFINANCIAL CONDITION AND REQUIREMENTS\nLiquidity and Capital Requirements\nTo meet the Company's need for cash for operating expenses, the payment of interest and dividends, retirement of debt and certain preferred stocks, and for its construction program, 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.\nConstruction expenditures in 1995 were $75 million and for 1996 and 1997 are estimated at $66 million and $75 million, respectively. In 1995, these expenditures included $8 million for compliance with the CAAA. The 1996 and 1997 estimated expenditures include $2 million and $7 million, respective- ly, for additional CAAA compliance costs. The Harrison scrubbers, which were constructed for compliance with Phase I of the CAAA, were completed on schedule in late 1994 and the final cost was approximately 24% below the original budget. Expenditures in the future to cover the costs of compliance with Phase II of the CAAA may be significant. Based on current forecasts and considering peak diversity exchange arrangements, demand-side management and conservation programs, a power supply agreement with affiliates, and contract- ed PURPA capacity, it is not anticipated that the Company will require new generating capacity until the year 2000 or beyond. The Company also has additional capital requirements for debt maturities (see Note I to the financial statements).\nInternal Cash Flows\nInternal generation of cash, consisting of cash flows from operations reduced by dividends, was $93 million in 1995 compared with $67 million in 1994. Because of the new rate case authorizations effective in late 1994 and 1995 and reduced levels of capital expenditures, the Company was able to finance 100% of its capital expenditure program through internal cash generation in 1995, as compared to 64% in 1994. This ratio is expected to remain close to 100% over the next several years.\nAs a capital-intensive electric utility, the Company is affected by the rate of inflation. The inflation rate over the past several years has been relatively low and has not materially affected the Company's financial position. However, since utility revenues are based on rate regulation that generally only recognizes historical costs, cash flows based on recovery of historical plant may not be adequate to replace plant in future years.\nFuel inventory provided a source of cash in 1995 ($3 million), primarily related to lower fuel prices attained through renegotiations of fuel contracts effective in January 1995 and the ability to use lower-cost, high- sulfur coal at the Harrison Power Station because of the new scrubbers. In 1994, fuel inventory represented a use of cash ($4 million) as it returned to a higher level after selective mine shutdowns during contract renegotiations in 1993. The decrease in operating and construction inventory in 1995 resulted from the write-off of obsolete and slow-moving inventory. In connection with ongoing restructuring activities and consolidation of facilities, the Company is reevaluating inventory management objectives to take advantage of centralized storerooms serving several facilities and to improve turnover ratios.\nFinancings\nDuring 1995, the Company refinanced $95 million of debt securities with new debt securities having lower interest rates and refinanced preferred stock issues totaling $40 million with Quarterly Income Debt Securities (QUIDS). Under certain circumstances the interest payments on QUIDS may be deferred for a period of up to 20 consecutive quarters. Debt redemption costs of refinancings are amortized over the life of the associated new securities. Due to the significant number of refinancings which have occurred over the past four years, this balance is now $16 million. Reduced future interest expense will more than offset these expenses. Preferred stock redemption costs of $1.4 million were charged directly to retained earnings.\nShort-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 $7 million to $30 million in 1995. At December 31, 1995, the Company had SEC authorization to issue up to $100 million of short-term debt. The Company and its affiliates use 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. In addition, a multi-year credit program established in 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 1995. During 1996, the Company anticipates meeting its capital require- ments through a combination of internally generated funds, cash on hand, and short-term borrowing as necessary. 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.\nCHANGES IN THE ELECTRIC UTILITY INDUSTRY\nCompetitive forces within the electric utility industry continued to increase in 1995. As in the past, utilities must compete for siting of new industrial and commercial customers and for retaining existing customers in the franchised territory. Electric utilities must also compete with suppliers of other forms of energy. Growing competitive challenges due to legislative, economic, and technological changes, and the ability to meet these challenges, have been a major focal point in 1995.\nCompetition in Core Business\nCompetition in the wholesale market for electricity was enhanced by the National Energy Policy Act of 1992 (EPACT), which permits wholesale generators, utility-owned and otherwise, and wholesale customers to request from owners of bulk power transmission facilities a commitment to supply transmission services. EPACT was the first legislative action to permit wholesale customers within a utility's franchised service territory to seek alternative providers of energy.\nThe FERC issued a Notice of Proposed Rulemaking (Mega-NOPR) in 1995 which intends to stimulate wholesale competition among electric utilities and unregulated electricity generators. The Mega-NOPR encourages wholesale competition by requiring utilities to allow their transmission facilities to be used by sellers or buyers of wholesale power. The Mega-NOPR provides that electric utilities will be able to recover stranded costs (costs of facilities made uneconomic by wholesale transmission access). The FERC has not yet issued a final rulemaking on these issues.\nThe Public Utilities Commission of Ohio has initiated proceedings to evaluate the feasibility of retail competition. The Company has filed a response in this proceeding which emphasizes the need to move cautiously towards retail competition in order to protect the reliability of service to retail customers, and to insure that utilities without excess generating capacity, like the Company, are not placed at a competitive disadvantage by permitting utilities with excess capacity to dump energy at low marginal cost while keeping its own customers captive through high stranded investment fees. Attempts at variations of retail wheeling have been authorized in some states, and various municipalities around the country that are not wholesale customers are exploring ways to become wholesale customers to obtain the ability to choose their electric supplier. In 1995, the Department of Defense proposed that it be granted competitive procurement rights for defense facilities.\nEfforts to Maintain and Improve Competitive Position\nThe emerging competitive environment in generation and wholesale markets and the increasing possibility of retail competition have created greater planning uncertainty and risks for the Company. In response, the Company is continuing to develop a number of strategies to retain its existing customers and to expand its retail and wholesale customer base, including:\n1. Restructuring its operations to maintain its relatively low-cost status by controlling costs and operating more efficiently\n2. Implementing new marketing strategies\n3. Increasing customer and energy services\n4. Avoiding future rate increases\nThe Company believes it is taking necessary actions to position itself to meet current and future competitive challenges.\nPotomac Edison MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nREVIEW OF OPERATIONS\nNet Income\nNet income was $78.3 million in 1995 compared with $82.0 million in 1994, excluding in 1994 the cumulative effect of an accounting change to record unbilled revenues. The decrease resulted primarily from restructuring charges and inventory write-offs in 1995 of $4.3 million after tax and higher expenses offset in part by increased kilowatt-hour (kWh) sales and previously reported rate increases. Net income in 1993 was $73.5 million. The increase in 1994 resulted from an increase in kWh sales and revenue increases, offset in part by higher expenses.\nRestructuring activities in 1995 were initiated by the System in response to the competitive environment emerging in the electric utility industry. The System, including the Company, is restructuring many of its functions to strengthen its competitive position and improve its cost structure. During 1995, reengineering of the Bulk Power Supply department in the affiliated Allegheny Power Service Corporation was substantially completed and process redesign is expected to be substantially completed in 1996 for the remainder of the System. Downsizing was not a specific goal of the restruc- turing efforts, but as a consequence of process redesign and elimination of duplicate positions, approximately 200 System employees have been placed in a staffing force pending reassignment or layoff. In addition, about 130 fewer System employees will be required in the power station work force by the end of 1997, and employee reductions are also likely to result from reengineering in other areas. The charges recorded in 1995 in connection with restructuring activities reflect estimated liabilities related to staffing force employees' separation costs, inventory write-offs in connection with changes in inventory management objectives, and certain other costs. It is expected that these costs will be recovered through future cost savings.\nSales and Revenues\nKWh sales to and revenues from residential, commercial, and industrial customers are shown on pages 53 and 54. Such kWh sales increased 3.3% and 2.3% in 1995 and 1994, respectively. The increases in revenues from sales to residential, commercial, and industrial customers resulted from the following: Changes from Prior Year 1995 1994 (Millions of Dollars) Increased kWh sales.............................. $17.3 $10.3 Rate changes: Maryland....................................... 17.7 11.9 Virginia....................................... (1.8) 8.5 West Virginia.................................. 2.2 1.9 18.1 22.3 Fuel and energy cost adjustment clauses*............................ 3.2 18.6 Other............................................ (3.0) 1.0 $35.6 $52.2\n*Changes in revenues from fuel and energy cost adjustment clauses have little effect on net income.\nThe increase in kWh sales in 1995 was in part attributable to industrial and commercial sales. Industrial sales increased 2.7% and 2.8% in 1995 and 1994, respectively. The 3.6% increase in commercial sales in 1995 and the 2.1% increase in 1994 reflect growth in the number of customers and in 1995 also increased customer usage. These increases continue to reflect a trend of economic growth in the service territory. In 1995 the Company implemented a new Major Accounts Program which focuses on enhancing the working relationships with its largest customers. The goal of the program is to assure, through superior service, that the Company remains the energy supplier for these major customers.\nResidential kWh sales increased 3.9% in 1995 and 1.7% in 1994. The rate of growth in the number of residential customers has remained constant at about 2.1% annually in 1995, 1994, and 1993. However, the impact of weather on customer usage continues to produce fluctuations in residential sales. In 1995, decreased sales due to mild weather in the first and second quarters were more than offset by extremely hot summer weather and cooler than normal winter weather in November and December as compared to 1994. The 1994 residential use was down slightly from 1993 levels reflecting a decrease in both heating and cooling degree days.\nRate case decisions in all jurisdictions, representing revenue increases in excess of $35 million on an annual basis, have been obtained, most of them in late 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\nincreasing levels of expenses. Additional base rate increases are not expected to be necessary for the next several years. However, future purchased power expenses related to a qualified facility under the Public Utility Regulatory Policies Act of 1978 (PURPA), to be completed in late 1999, may make it necessary to increase rates at that time.\nKWh sales to and revenues from nonaffiliated utilities are comprised of the following items:\n1995 1994 1993 KWh sales (Billions): From Company generation............... .2 .3 .4 From purchased power.................. 4.2 2.9 3.5 4.4 3.2 3.9 Revenues (Millions): From Company generation............... $ 4.6 $ 8.9 $ 8.6 From sales of purchased power............................... 121.3 98.1 99.5 $125.9 $107.0 $108.1\nSales to nonaffiliated companies from the Company's generation in 1995 decreased because of growth in kWh sales to retail customers which reduced the amount available for sale and because of continuing price competition. The generation tax imposed in West Virginia, which in prior years was a signifi- cant factor affecting the Company's ability to compete in the market for sales to nonaffiliated companies, was favorably amended effective in June 1995 to change the basis of the tax from generation to generating capacity. Sales of purchased power vary depending on the availability of other companies' generating equipment, demand for energy, and price competition. In the future, some of these transactions may be made under new transmission tariffs described below. About 95% of the aggregate benefits from sales to nonaffili- ated companies are passed on to retail customers and have little effect on net income.\nThe increase in other revenues in 1995 resulted primarily from provisions recorded for rate refunds in 1994 and increased revenues from wholesale customers (cooperatives and municipalities who own their own distribution systems and who buy all or part of their bulk power needs from the Company under regulation by the Federal Energy Regulatory Commission). Under the National Energy Policy Act of 1992, these customers obtained the ability to choose the bulk power supplier of their choice by the requirement that transmission-owning utilities must provide transmission service. In June 1995, rate cases for wholesale customers were completed with the result that such customers, with revenues representing about 94% of the $23.4 million in annual wholesale revenues, agreed to negotiated rate increases of about $2.1 million, and signed three-year contracts to remain as Company customers. One customer representing the remaining 6% of annual revenues selected an 18-month contract at higher rates. In the event that this customer was to select another supplier, the Company would retain transmission revenues with the result that any reduction in net income would not be significant. The 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. The refunds were completed in 1995.\nOther revenues in 1995 also reflect an increase in standard transmis- sion service revenues. See page 85 under Competition in Core Business for information about a Notice of Proposed Rulemaking (Mega-NOPR) issued by the Federal Energy Regulatory Commission (FERC) in 1995. Effective in 1996, pursuant to the intentions of the Mega-NOPR, the Company eliminated its Standard Transmission Service tariff for new service transactions, and began using two new transmission service tariffs which qualify as required open access tariffs - a Network tariff and Point-to- Point tariff. The FERC accepted the filing of the new tariffs subject to hearings in the summer of 1996 and modification pending final Mega-NOPR rules. The Company is using the new tariffs in the interim, subject to refund. In addition, the Company has a Standard Generation Service tariff accepted by the FERC under which the Company makes available bundled, nonfirm generation services with associated transmission services. About 95% of the benefits of these sales of transmis- sion and generation services to customers outside the service territory are passed through to retail customers and as a result have little effect on net income. While this procedure will continue to apply to similar sales under the new tariffs, the Company may petition to revise the procedure in the future.\nOperating Expenses\nThe 7% decrease in fuel expenses in 1995 was primarily the result of renegotiations of long-term fuel contracts which reduced fuel prices effective in January 1995, and the ability to use lower-cost, high-sulfur coal at the Harrison Power Station because of the new scrubbers. 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.\n\"Purchased power and exchanges, net\" represents power purchases from and exchanges with nonaffiliated utilities, capacity charges paid to Allegheny Generating Company (AGC), an affiliate partially owned by the Company, 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:\n1995 1994 1993 (Millions of Dollars) Nonaffiliated transactions: Purchased power: For resale to other companies........ $108.5 $ 86.5 $ 87.9 Other................................ 15.4 12.7 10.5 Power exchanges, net................... (.2) (.2) (.8) Affiliated transactions: AGC capacity charges................... 28.1 29.4 28.0 Other affiliated capacity charges...... 45.6 37.6 28.4 Energy and spinning reserve charges...................... 48.2 51.1 51.1 $245.6 $217.1 $205.1\nThe amount of power purchased from nonaffiliated companies for use by the Company and for resale to nonaffiliated companies 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\ncompanies from which such purchases are made. The primary reason for the fluctuations in purchases for resale to nonaffiliated companies is described under Sales and Revenues above. Other purchased power continued to increase in 1995 because of increased sales to retail customers and the availability of more economic energy. The increase in affiliated capacity in 1995 and 1994 was due to growth of kWh sales to retail customers. 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 subject to deferred power cost procedures with the result that changes in such costs have little effect on net income.\nWhile the Company does not currently purchase generation from qualified facilities under PURPA, it will be required to do so in 1999 because of a PURPA facility which is then scheduled to commence operations. This project may significantly increase the cost of power purchases passed on to customers.\nThe increase in other operation expense in 1995 resulted primarily from restructuring charges which are described in Note B to the financial statements on page 140. Additional restructuring charges will be incurred in 1996 as the Company and its affiliates complete their reengineering process. Other operation expense in 1996 and thereafter is expected to reflect the benefits of savings related to the restructuring activities. The 1994 increase in other operation expense 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. The increase in pension expense occurred because the Company in 1994 discontinued the practice of deferring pension expense in West Virginia to reflect a rate case decision in that state, and wrote off $.9 million of prior deferrals in Virginia and West Virginia because recovery of those deferrals was denied.\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 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, and the amount of work found necessary when the equipment is dismantled. Maintenance expense in 1995 includes a charge of about $2 million for inventory write-offs described in Note B to the financial statements on page 140. Maintenance expense for the Harrison scrubbers which went into service in late 1994 is expected to increase since the warranty period has expired.\nDepreciation expense increases resulted primarily from additions to electric plant. The Company began depreciating the Harrison scrubbers in mid- November 1994 amounting to approximately $10 million annually. Future depreciation expense increases for utility operations are expected to be less than historical increases because of reduced levels of proposed capital expenditures.\nThe net increase of $4 million in federal and state income taxes in 1995 resulted primarily from an increase in reversals of prior year deprecia- tion benefits for which deferred taxes were not then provided. The net increase of $3 million in federal and state income taxes in 1994 resulted primarily from an increase in income before taxes. Note C to the financial statements provides a further analysis of income tax expenses.\nThe combined decreases in allowances for borrowed and other than borrowed funds used during construction (AFUDC) in 1995 and 1994 of $4 million and $1 million, respectively, reflect decreases in construction expenditures upon substantial completion of the compliance program for Phase I of the CAAA. The increase in other income, net, of $2 million in 1995 was due primarily to income from demand-side management programs. During 1995, the Company continued its participation in the collaborative process for demand-side management in Maryland. Program costs, including lost revenues and rebates, are deferred as a regulatory asset and are being recovered through an energy conservation surcharge over a seven-year period. The balance in the regulato- ry asset for this program is $16 million as of December 31, 1995. The increase in other income, net, in 1994 resulted primarily from the Company's share of earnings of AGC (see Note E to the financial statements) and income from demand-side management programs.\nIn 1995 interest on long-term debt increased $4 million due primarily to the new security issues in 1994 and the timing of the refinancing of $145 million of first mortgage bonds and $21 million of pollution control revenue notes in 1995. The increase also reflects interest on $45.5 million of Quarterly Income Debt Securities issued in 1995 to refund preferred stock issues. 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.\nEnvironmental and Other Issues\nIn 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.\nContingencies and uncertainties related to the CAAA are discussed in Liquidity and Capital Requirements. The CAAA, among other things, require an annual reduction in total utility emissions within the United States of 10 million tons of sulfur dioxide (SO[2]) and two million tons of nitrogen oxides (NOx) from 1980 emission levels, to be completed in two phases, Phase I and Phase II. Three coal-fired Company plants are affected in Phase I and the remaining plants will be affected in Phase II. Installation of scrubbers at the Harrison Power Station was the strategy undertaken to meet the required SO[2] emission reductions for Phase I (1995-1999). Continuing studies will\ndetermine the compliance strategy for Phase II (2000 and beyond). Studies to evaluate cost effective options to comply with Phase II SO[2] limits, including those which may be available from the use of the Company's banked emission allowances and from the emission allowance trading market, are continuing. It is expected that burner modifications at possibly all 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 (where the Company has ownership in a station) for ozone nonattainment (Title I) reasons. Continuous emission monitoring equipment has been installed on all Phase I and Phase II units.\nThe Company previously reported that the Environmental Protection Agency had identified the Company and its affiliates and approximately 875 others as potentially responsible parties in a Superfund site subject to cleanup. The Company has also been named as a defendant along with multiple other affiliated and nonaffiliated defendants in pending asbestos cases involving one or more plaintiffs. The Company believes that provisions for liabilities and insurance recoveries are such that final resolution of these claims will not have a material effect on its financial position.\nIn March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,\" effective in 1996. SFAS No. 121 establishes standards for the impairment of long-lived assets and certain identifiable intangibles and requires companies to recognize an impairment loss if the expected future undiscounted cash flows are less than the carrying amount of an asset. The Company does not believe at this time that adoption of this standard will have a materially adverse effect on its financial position.\nFINANCIAL CONDITION AND REQUIREMENTS\nLiquidity and Capital Requirements\nTo meet the Company's need for cash for operating expenses, the payment of interest and dividends, retirement of debt and certain preferred stocks, and for its construction program, 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.\nConstruction expenditures in 1995 were $92 million and for 1996 and 1997 are estimated at $87 million and $103 million, respectively. In 1995, these expenditures included $9 million for compliance with the CAAA. The 1996 and 1997 estimated expenditures include $1 million and $2 million, respective- ly, for additional CAAA compliance costs. The Harrison scrubbers, which were\nconstructed for compliance with Phase I of the CAAA, were completed on schedule in late 1994 and the final cost was approximately 24% below the original budget. Expenditures in the future to cover the costs of compliance with Phase II of the CAAA may be significant. Based on current forecasts and considering peak diversity exchange arrangements, demand-side management and conservation programs, a power supply agreement with affiliates, and contract- ed PURPA capacity, it is not anticipated that the Company will require new generating capacity until the year 2000 or beyond. The Company also has additional capital requirements for debt maturities (See Note I to the financial statements).\nInternal Cash Flows\nInternal generation of cash, consisting of cash flows from operations reduced by dividends, was $85 million in 1995 compared with $67 million in 1994. Because of the new rate case authorizations effective in late 1994 and 1995 and reduced levels of capital expenditures, the Company was able to finance approximately 92% of its capital expenditure program through internal cash generation in 1995, as compared to 47% in 1994. This ratio is expected to continue to increase over the next several years.\nAs a capital-intensive electric utility, the Company is affected by the rate of inflation. The inflation rate over the past several years has been relatively low and has not materially affected the Company's financial position. However, since utility revenues are based on rate regulation that generally only recognizes historical costs, cash flows based on recovery of historical plant may not be adequate to replace plant in future years.\nFuel inventory provided a source of cash in 1995 ($3 million), primarily related to lower fuel prices attained through renegotiations of fuel contracts effective in January 1995 and the ability to use lower-cost, high- sulfur coal at the Harrison Power Station because of the new scrubbers. In 1994, fuel inventory represented a use of cash ($4 million) as it returned to a higher level after selective mine shutdowns during contract renegotiations in 1993. The decrease in operating and construction inventory in 1995 resulted from the write-off of obsolete and slow-moving inventory. In connection with ongoing restructuring activities and consolidation of facilities, the Company is reevaluating inventory management objectives to take advantage of centralized storerooms serving several facilities and to improve turnover ratios.\nFinancings\nDuring 1995, the Company refinanced $166 million of debt securities with new debt securities having lower interest rates and refinanced preferred stock issues totaling $45.5 million with Quarterly Income Debt Securities (QUIDS). Under certain circumstances the interest payments on QUIDS may be deferred for a period of up to 20 consecutive quarters. Debt redemption costs of refinancings are amortized over the life of the associated new securities. Due to the significant number of refinancings which have occurred over the past four years, this balance is now $19 million. Reduced future interest expense will more than offset these expenses. Preferred stock redemption costs of $2.0 million were charged directly to retained earnings.\nShort-term debt is used to meet temporary cash needs until the timing is considered appropriate to issue long-term securities. Short-term debt increased to $22 million in 1995. At December 31, 1995, the Company had SEC authorization to issue up to $115 million of short-term debt. The Company and its affiliates use 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. In addition, a multi-year credit program established in 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 1995. During 1996, the Company anticipates meeting its capital require- ments through a combination of internally generated funds, cash on hand, and short-term borrowing as necessary. 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.\nCHANGES IN THE ELECTRIC UTILITY INDUSTRY\nCompetitive forces within the electric utility industry continued to increase in 1995. As in the past, utilities must compete for siting of new industrial and commercial customers and for retaining existing customers in the franchised territory. Electric utilities must also compete with suppliers of other forms of energy. Growing competitive challenges due to legislative, economic, and technological changes, and the ability to meet these challenges, have been a major focal point in 1995.\nCompetition in Core Business\nCompetition in the wholesale market for electricity was enhanced by the National Energy Policy Act of 1992 (EPACT), which permits wholesale generators, utility-owned and otherwise, and wholesale customers to request from owners of bulk power transmission facilities a commitment to supply transmission services. EPACT was the first legislative action to permit wholesale customers within a utility's franchised service territory to seek alternative providers of energy.\nThe FERC issued a Notice of Proposed Rulemaking (Mega-NOPR) in 1995 which intends to stimulate wholesale competition among electric utilities and unregulated electricity generators. The Mega-NOPR encourages wholesale competition by requiring utilities to allow their transmission facilities to be used by sellers or buyers of wholesale power. The Mega-NOPR provides that electric utilities will be able to recover stranded costs (costs of facilities made uneconomic by wholesale transmission access). The FERC has not yet issued a final rulemaking on these issues.\nThe Virginia commission is conducting proceedings to evaluate the feasibility of retail competition. The Maryland commission has completed its investigation and issued an order which found that while competition in the electric wholesale market should be encouraged, retail competition is not in the public interest at this time. The Company has filed responses in these proceedings which emphasize the need to move cautiously toward retail competition in order to protect the reliability of service to retail custom- ers, and to insure that utilities without excess generating capacity, like the\nCompany, are not placed at a competitive disadvantage by permitting utilities with excess capacity to dump energy at low marginal cost while keeping its own customers captive through high stranded investment fees. Attempts at variations of retail wheeling have been authorized in some states, and various municipalities around the country that are not wholesale customers are exploring ways to become wholesale customers to obtain the ability to choose their electric supplier. In 1995, the Department of Defense proposed that it be granted competitive procurement rights for defense facilities.\nEfforts to Maintain and Improve Competitive Position\nThe emerging competitive environment in generation and wholesale markets and the increasing possibility of retail competition have created greater planning uncertainty and risks for the Company. In response, the Company is continuing to develop a number of strategies to retain its existing customers and to expand its retail and wholesale customer base, including:\n1. Restructuring its operations to maintain its relatively low-cost status by controlling costs and operating more efficiently\n2. Implementing new marketing strategies\n3. Increasing customer and energy services\n4. Avoiding future rate increases\nThe Company believes it is taking necessary actions to position itself to meet current and future competitive challenges.\nWest Penn MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nREVIEW OF OPERATIONS\nConsolidated Net Income\nConsolidated net income in 1995 increased to $117.9 million compared with $101.0 in 1994, excluding in 1994 the cumulative effect of an accounting change to record unbilled revenues. The increase resulted primarily from additional retail revenues due to increased kilowatt-hour (kWh) sales and previously reported rate increases. These revenue increases were offset in part by restructuring charges and inventory write-offs in 1995 of $6.5 million after tax and higher expenses. Earnings in 1994 included a charge of $5.2 million after tax related to asset write-offs. Consolidated net income in 1993 was $102.1 million. Consolidated net income in 1994 reflects higher retail revenues from increased kWh sales and rate increases, offset in part by higher expenses.\nRestructuring activities in 1995 were initiated by the System in response to the competitive environment emerging in the electric utility industry. The System, including the Company, is restructuring many of its functions to strengthen its competitive position and improve its cost structure. During 1995, reengineering of the Bulk Power Supply department in the affiliated Allegheny Power Service Corporation was substantially completed and process redesign is expected to be substantially completed in 1996 for the remainder of the System. Downsizing was not a specific goal of the restruc- turing efforts, but as a consequence of process redesign and elimination of duplicate positions, approximately 200 System employees have been placed in a staffing force pending reassignment or layoff. In addition, about 130 fewer System employees will be required in the power station work force by the end of 1997, and employee reductions are also likely to result from reengineering in other areas. The charges recorded in 1995 in connection with restructuring activities reflect estimated liabilities related to staffing force employees' separation costs, inventory write-offs in connection with changes in inventory management objectives, and certain other costs. It is expected that these costs will be recovered through future cost savings.\nSales and Revenues\nKWh sales to and revenues from residential, commercial, and industrial customers are shown on pages 55 and 56. Such kWh sales increased 4.0% and 2.9% in 1995 and 1994, respectively. The increases in revenues from sales to residential, commercial, and industrial customers resulted from the following: Changes from Prior Year 1995 1994 (Millions of Dollars)\nIncreased kWh sales.............................. $17.3 $ 9.4 Rate increases................................... 50.2 22.7 Fuel and energy cost adjustment clauses*......... (2.9) 16.8 Other............................................ 3.0 2.3 $67.6 $51.2\n*Changes in revenues from fuel and energy cost adjustment clauses have little effect on consolidated net income.\nThe increase in kWh sales in 1995 was largely attributable to industrial and commercial sales. Industrial sales increased 5.8% and 4.4% in 1995 and 1994, respectively. The 4.4% increase in commercial sales in 1995 and the 2.9% increase in 1994 reflect growth in the number of customers and increased customer usage. These increases continue to reflect a trend of economic growth in the service territory. In 1995 the Company implemented a new Major Accounts Program which focuses on enhancing the working relation- ships with its largest customers. The goal of the program is to assure, through superior service, that the Company remains the energy supplier for these major customers.\nResidential kWh sales increased 1.4% in 1995 and 1.1% in 1994 due to growth in number of customers and higher usage. The rate of growth in the number of residential customers has remained constant at just under 1% annually in 1995, 1994, and 1993. However, the impact of weather on customer usage continues to produce fluctuations in residential sales. In 1995, decreased sales due to mild weather in the first and second quarters were more than offset by extremely hot summer weather and cooler than normal winter weather in November and December as compared to 1994. Residential usage increased in 1994 despite a decrease in both heating and cooling degree days.\nRate case decisions, representing revenue increases in excess of $57 million on an annual basis, have been obtained effective in late 1994. These included recovery of the remaining carrying charges on investment, deprecia- tion, 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. Additional base rate increases are not expected to be necessary for the next several years.\nKWh sales to and revenues from nonaffiliated utilities are comprised of the following items:\n1995 1994 1993 KWh sales (Billions): From Company generation................. .2 .5 .4 From purchased power.................... 5.7 3.8 5.0 5.9 4.3 5.4 Revenues (Millions): From Company generation................. $ 5.7 $ 12.3 $ 11.5 From sales of purchased power........... 162.5 132.5 141.0 $168.2 $144.8 $152.5\nSales to nonaffiliated companies from the Company's generation in 1995 decreased because of growth in kWh sales to retail customers which reduced the amount available for sale and because of continuing price competition. The generation tax imposed in West Virginia, which in prior years was a signifi- cant factor affecting the Company's ability to compete in the market for sales to nonaffiliated companies, was favorably amended effective in June 1995 to change the basis of the tax from generation to generating capacity. Sales of purchased power vary depending on the availability of other companies' generating equipment, demand for energy, and price competition. In the\nfuture, some of these transactions may be made under new transmission tariffs described below. Most of the aggregate benefits from sales to nonaffiliated companies and sales of energy and spinning reserve to affiliates included in other revenues described below, are passed on to retail customers and have little effect on consolidated net income.\nThe increase in other revenues in 1995 resulted primarily from an increase in sales of capacity, energy, and spinning reserve to other affiliat- ed companies. About $18 million of other revenues in 1995 were derived from wholesale customers (cooperatives and municipalities who own their own distribution systems and who buy all or part of their bulk power needs from the Company under regulation by the Federal Energy Regulatory Commission). Under the National Energy Policy Act of 1992, these customers obtained the ability to choose the bulk power supplier of their choice by the requirement that transmission-owning utilities must provide transmission service. In 1994, a rate case for wholesale customers was completed with the result that such customers agreed to negotiated rate increases and signed seven-year contracts to remain as Company customers.\nOther revenues in 1995 also reflect an increase in standard transmis- sion service revenues. See page 94 under Competition in Core Business for information about a Notice of Proposed Rulemaking (Mega-NOPR) issued by the Federal Energy Regulatory Commission (FERC) in 1995. Effective in 1996, pursuant to the intentions of the Mega-NOPR, the Company eliminated its Standard Transmission Service tariff for new service transactions, and began using two new transmission service tariffs which qualify as required open access tariffs - a Network tariff and a Point-to-Point tariff. The FERC accepted the filing of the new tariffs subject to hearings in the summer of 1996 and modification pending final Mega-NOPR rules. The Company is using the new tariffs in the interim, subject to refund. In addition, the Company has a Standard Generation Service tariff accepted by the FERC under which the Company makes available bundled, nonfirm generation services with associated transmission services. Most of the benefits of these sales of transmission and generation services to customers outside the service territory are passed through to retail customers and as a result have little effect on consolidated net income. While this procedure will continue to apply to similar sales under the new tariffs, the Company may petition to revise the procedure in the future.\nOperating Expenses\nThe 6% decrease in fuel expenses in 1995 was primarily the result of renegotiations of long-term fuel contracts which reduced fuel prices effective in January 1995, and the ability to use lower-cost, high-sulfur coal at the Harrison Power Station because of the new scrubbers. Fuel expenses decreased 2% in 1994 due primarily to a decrease 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 nonaffiliated companies and purchases from qualified facilities under the Public Utility Regulatory Policies Act of 1978 (PURPA), capacity charges paid to Allegheny Generating Company (AGC), an affiliate partially owned by the Company, and other transactions with affiliates made\npursuant 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:\n1995 1994 1993 (Millions of Dollars) Nonaffiliated transactions: Purchased power: For resale to other companies........ $145.4 $116.9 $124.5 From PURPA generation................ 64.7 65.7 49.6 Other................................ 21.6 18.3 15.2 Power exchanges, net................... (.1) (.2) (1.2) Affiliated transactions: AGC capacity charges................... 37.8 37.2 42.3 Energy and spinning reserve charges...................... 4.6 8.6 4.7 Other affiliated capacity charges...... .7 .7 .7 $274.7 $247.2 $235.8\nThe amount of power purchased from nonaffiliated companies for use by the Company and for resale to nonaffiliated companies 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 companies from which such purchases are made. The primary reason for the fluctuations in purchases for resale to nonaffiliated companies is described under Sales and Revenues above. The reduced level of 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. Other purchased power continued to increase in 1995 because of increased sales to retail customers and the availability of more economic energy. The cost of power 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 Pennsylvania Public Utility Commission (PUC), and is primarily subject to deferred power cost procedures with the result that changes in such costs have little effect on consolidated net income.\nIn January 1996, the Company and the developers of a proposed Shannopin PURPA project reached agreement to terminate the project and all pending litigation, at a buy out price of $31 million. The agreement is subject to PUC approval of recovery of the buy out price by the Company by no later than March 31, 1999. The agreement was filed with the PUC in February 1996 along with a request for expedited approval.\nThe increase in other operation expense in 1995 resulted primarily from restructuring charges which are described in Note B to the consolidated financial statements on page 157. Additional restructuring charges will be incurred in 1996 as the Company and its affiliates complete their reengineeri- ng process. Other operation expense in 1996 and thereafter is expected to reflect the benefits of savings related to the restructuring activities. The 1994 increase in other operation expense 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\nprovisions for environmental liabilities ($1 million). Allowances for uncollectible accounts were increased in 1994 due to an increase in aged outstanding receivables caused primarily by Pennsylvania rate regulations which make it difficult if not impossible to curtail service to non-paying customers. It is expected that the allowance for these uncollectible accounts will be increased in the future because of increasing accounts receivable in arrears. The increase in pension expense occurred because the Company in 1994 discontinued the practice of deferring pension expense to reflect a rate case decision.\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 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, and the amount of work found necessary when the equipment is dismantled. Maintenance expense in 1995 includes a charge of about $4 million for inventory write- offs described in Note B to the consolidated financial statements on page 157. Maintenance expense for the Harrison scrubbers which went into service in late 1994 is expected to increase since the warranty period has expired.\nDepreciation expense increases resulted primarily from additions to electric plant and from a change in depreciation rates. The Company began depreciating the Harrison scrubbers in mid-November 1994 amounting to approximately $14 million annually. Future depreciation expense increases are expected to be less than historical increases because of reduced levels of proposed capital expenditures.\nThe increase in taxes other than income in 1995 was due primarily to an increase in gross receipts taxes resulting from higher revenues from retail customers. 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 ($2 million).\nThe net increase of $11 million in federal and state income taxes in 1995 resulted primarily from an increase in income before taxes. The net decrease in 1994 of $1 million resulted primarily from plant removal cost tax deductions for which deferred taxes were not provided. Note C to the consolidated financial statements provides a further analysis of income tax expenses.\nThe combined decrease in allowances for borrowed and other than borrowed funds used during construction (AFUDC) in 1995 of $6 million reflects decreases in construction expenditures upon substantial completion of the compliance program for Phase I of the CAAA. The increase of $2 million in AFUDC in 1994 reflects increased construction expenditures, including those associated with the CAAA, net of CAAA amounts included in rate base and earning a cash return. Other income, net, in 1994 reflects the write-off of $5.2 million net of income taxes of previously accumulated costs related to\nfuture facilities which are no longer considered meaningful in the industry's more competitive environment.\nIn 1995, interest on long-term debt increased $6 million due primarily to the new security issues in 1994 and the timing of the refinancing of $30 million of first mortgage bonds and $47 million of pollution control revenue notes in 1995. The increase also reflects interest on $70 million of Quarterly Income Debt Securities issued in 1995 to refund preferred stock issues. 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.\nEnvironmental and Other Issues\nIn 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.\nContingencies and uncertainties related to the CAAA are discussed in Liquidity and Capital Requirements. The CAAA, among other things, require an annual reduction in total utility emissions within the United States of 10 million tons of sulfur dioxide (SO[2]) and two million tons of nitrogen oxides (NO[x]) from 1980 emission levels, to be completed in two phases, Phase I and Phase II. Four coal-fired Company plants are affected in Phase I and the remaining plants and units reactivated in the future will be affected in Phase II. Installation of scrubbers at the Harrison Power Station was the strategy undertaken to meet the required SO[2] emission reductions for Phase I (1995- 1999). Continuing studies will determine the compliance strategy for Phase II (2000 and beyond). Studies to evaluate cost effective options to comply with Phase II SO[2] limits, including those which may be available from the use of the Company's banked emission allowances and from the emission allowance trading market, are continuing. It is expected that burner modifications at possibly all stations will satisfy the NO[x] emission reduction requirements for the acid rain (Title IV) provisions of the CAAA. Additional post- combustion controls may be mandated in Pennsylvania for ozone nonattainment (Title I) reasons. Continuous emission monitoring equipment has been installed on all Phase I and Phase II units.\nThe Company previously reported that the Environmental Protection Agency had identified the Company and its affiliates and approximately 875 others as potentially responsible parties in a Superfund site subject to cleanup. The Company has also been named as a defendant along with multiple other affiliated and nonaffiliated defendants in pending asbestos cases involving one or more plaintiffs. The Company believes that provisions for liabilities and insurance recoveries are such that final resolution of these claims will not have a material effect on its financial position.\nIn March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,\" effective in 1996. SFAS No. 121 establishes standards for the impairment of long-lived assets and certain identifiable intangibles and requires companies to recognize an impairment loss if the expected future undiscounted\ncash flows are less than the carrying amount of an asset. The Company does not believe at this time that adoption of this standard will have a materially adverse effect on its financial position.\nFINANCIAL CONDITION AND REQUIREMENTS\nLiquidity and Capital Requirements\nTo meet the Company's need for cash for operating expenses, the payment of interest and dividends, retirement of debt and certain preferred stocks, and for its construction program, 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.\nConstruction expenditures in 1995 were $149 million and for 1996 and 1997 are estimated at $125 million and $126 million, respectively. In 1995, these expenditures included $19 million for compliance with the CAAA. The 1996 and 1997 estimated expenditures include $4 million and $10 million, respectively, for additional CAAA compliance costs. The Harrison scrubbers, which were constructed for compliance with Phase I of the CAAA, were completed on schedule in late 1994 and the final cost was approximately 24% below the original budget. Expenditures in the future to cover the costs of compliance with Phase II of the CAAA may be significant. Based on current forecasts and considering the reactivation of capacity in cold reserve, peak diversity exchange arrangements, demand-side management and conservation programs, a power supply agreement with affiliates, and contracted PURPA capacity, it is not anticipated that the Company will require new generating capacity until the year 2000 or beyond. The Company also has additional capital requirements for debt maturities (See Note I to the consolidated financial statements).\nInternal Cash Flows\nInternal generation of cash, consisting of cash flows from operations reduced by dividends, was $110 million in 1995 compared with $109 million in 1994. Because of the new rate case authorizations effective in late 1994 and reduced levels of capital expenditures, the Company was able to finance approximately 74% of its capital expenditure program through internal cash generation in 1995, as compared to 42% in 1994. This ratio is expected to continue to increase over the next several years.\nAs a capital-intensive electric utility, the Company is affected by the rate of inflation. The inflation rate over the past several years has been relatively low and has not materially affected the Company's financial position. However, since utility revenues are based on rate regulation that generally only recognizes historical costs, cash flows based on recovery of historical plant may not be adequate to replace plant in future years.\nFuel inventory provided a source of cash in 1995 ($6 million), primarily related to lower fuel prices attained through renegotiations of fuel\ncontracts effective in January 1995 and the ability to use lower-cost, high- sulfur coal at the Harrison Power Station because of the new scrubbers. In 1994, fuel inventory represented a use of cash ($5 million) as it returned to a higher level after selective mine shutdowns during contract renegotiations in 1993. The decrease in operating and construction inventory in 1995 resulted from the write-off of obsolete and slow-moving inventory. In connection with ongoing restructuring activities and consolidation of facilities, the Company is reevaluating inventory management objectives to take advantage of centralized storerooms serving several facilities and to improve turnover ratios.\nFinancings\nDuring 1995, the Company refinanced $77 million of debt securities with new debt securities having lower interest rates and refinanced preferred stock issues totaling $70 million with Quarterly Income Debt Securities (QUIDS). Under certain circumstances the interest payments on QUIDS may be deferred for a period of up to 20 consecutive quarters. Debt redemption costs of refinancings are amortized over the life of the associated new securities. Due to the significant number of refinancings which have occurred over the past four years, this balance is now $12 million. Reduced future interest expense will more than offset these expenses. Preferred stock redemption costs of $2.2 million were charged directly to retained earnings.\nShort-term debt is used to meet temporary cash needs until the timing is considered appropriate to issue long-term securities. Short-term debt increased to $70 million in 1995. At December 31, 1995, the Company had SEC authorization to issue up to $170 million of short-term debt. The Company and its affiliates use 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. In addition, a multi-year credit program established in 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 1995. During 1996, the Company anticipates meeting its capital require- ments through a combination of internally generated funds, cash on hand, and short-term borrowings as necessary. 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.\nCHANGES IN THE ELECTRIC UTILITY INDUSTRY\nCompetitive forces within the electric utility industry continued to increase in 1995. As in the past, utilities must compete for siting of new industrial and commercial customers and for retaining existing customers in the franchised territory. Electric utilities must also compete with suppliers of other forms of energy. Growing competitive challenges due to legislative, economic, and technological changes, and the ability to meet these challenges, have been a major focal point in 1995.\nCompetition in Core Business\nCompetition in the wholesale market for electricity was enhanced by the National Energy Policy Act of 1992 (EPACT), which permits wholesale generators, utility-owned and otherwise, and wholesale customers to request from owners of bulk power transmission facilities a commitment to supply transmission services. EPACT was the first legislative action to permit wholesale customers within a utility's franchised service territory to seek alternative providers of energy.\nThe FERC issued a Notice of Proposed Rulemaking (Mega-NOPR) in 1995 which intends to stimulate wholesale competition among electric utilities and unregulated electricity generators. The Mega-NOPR encourages wholesale competition by requiring utilities to allow their transmission facilities to be used by sellers or buyers of wholesale power. The Mega-NOPR provides that electric utilities will be able to recover stranded costs (costs of facilities made uneconomic by wholesale transmission access). The FERC has not yet issued a final rulemaking on these issues.\nThe Pennsylvania PUC has begun an investigation into electric power competition. The PUC staff issued a report advising against instituting retail wheeling at this time. The Company has filed a response to this investigation which emphasizes the need to move cautiously toward retail competition in order to protect the reliability of service to retail custom- ers, and to insure that utilities without excess generating capacity, like the Company, are not placed at a competitive disadvantage by permitting utilities with excess capacity to dump energy at low marginal cost while keeping their own customers captive through high stranded investment fees. Attempts at variations of retail wheeling have been authorized in some states, and various municipalities around the country that are not wholesale customers are exploring ways to become wholesale customers to obtain the ability to choose their electric supplier. In 1995, the Department of Defense proposed that it be granted competitive procurement rights for defense facilities.\nEfforts to Maintain and Improve Competitive Position\nThe emerging competitive environment in generation and wholesale markets and the increasing possibility of retail competition have created greater planning uncertainty and risks for the Company. In response, the Company is continuing to develop a number of strategies to retain its existing customers and to expand its retail and wholesale customer base, including:\n1. Restructuring its operations to maintain its relatively low-cost status by controlling costs and operating more efficiently\n2. Implementing new marketing strategies\n3. Increasing customer and energy services\n4. Avoiding future rate increases\nThe Company believes it is taking necessary actions to position itself to meet current and future competitive challenges.\nAGC MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nResults of Operations\nAs described under Liquidity and Capital Requirements, 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 1995 decreased due to a reduction in net investment and reduced operating expenses which are described below. Revenues for 1994 increased primarily because of the return on equity settlement which resulted in an adjustment of prior period provisions for rate refunds.\nThe decrease in operating expenses in 1995 resulted from a decrease in federal income taxes due to a decrease in income before taxes ($1.2 million) combined with a decrease in operation and maintenance expense ($1.0 million). 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).\nThe decrease in interest on long-term debt in 1994 was the combined result of a decrease in the average amount of, and interest rates on, long- term debt outstanding. The increase in other interest in 1995 was due to cash needs for refunds mandated in rate case proceedings (see Liquidity and Capital Requirements), and the increase in 1994 was due to amortization of the premium paid to refund debentures in 1993.\nIn March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,\" effective in 1996. SFAS No. 121 establishes standards for the impairment of long-lived assets and certain identifiable intangibles and requires companies to recognize an impairment loss if the expected future undiscounted cash flows are less than the carrying amount of an asset. The Company does not believe at this time that adoption of this standard will have a materially adverse effect on its financial position.\nLiquidity and Capital Requirements\nThe 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 plans for construction of any other major facilities.\nPursuant 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, deprecia- tion, taxes, and a return on its investment.\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 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 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 was filed with the FERC on January 12, 1995, which would reduce the Company's ROE from 11.53% to 11.13% for the period from March 1, 1992 through December 31, 1994, and increase the Company's ROE to 11.2% for the period from January 1, 1995 through December 31, 1995. This settlement was approved by the FERC on March 23, 1995. Refunds were made by the Company of any revenues collected between March 1, 1992 and March 23, 1995 in excess of these levels. A second settlement has been negotiated to address the Company's ROE after 1995. On December 21, 1995, the Company submitted the new settlement to the FERC and action is pending. Interested parties representing less than 2% of the Company's eventual revenues have filed exceptions to the settlement. Under the terms of the settlement, the Company's ROE for 1996 would be 11%. For 1997 and 1998 the ROE would be set by a formula based upon the yields of 10- year constant maturity U.S. Treasury securities. However, the change in ROE from the previous year's value cannot exceed 50 basis points.\nThrough a filing completed on October 31, 1994, the Company sought FERC approval to add a prior tax payment of approximately $12 million to rate base which will produce about $1.4 million in additional annual revenues. The FERC accepted the Company's filing and ordered the increase to become effective June 1, 1995.\nAn internal money pool accommodates intercompany short-term borrowing needs to the extent that certain of the Company's affiliates have funds available.\nAll other 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\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, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995, 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 audit provides a reasonable basis for the opinion expressed above.\nAs discussed in Note A to the consolidated financial statements, the Company changed its method of accounting for revenue recognition in 1994.\nPRICE WATERHOUSE LLP PRICE WATERHOUSE LLP\nNew York, New York February 1, 1996\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, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, 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 A to the financial statements, the Company changed its method of accounting for revenue recognition in 1994.\nPRICE WATERHOUSE LLP PRICE WATERHOUSE LLP\nNew York, New York February 1, 1996\nREPORT OF INDEPENDENT ACCOUNTANTS\nThe 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, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, 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 A to the financial statements, the Company changed its method of accounting for revenue recognition in 1994.\nPRICE WATERHOUSE LLP PRICE WATERHOUSE LLP\nNew York, New York February 1, 1996\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, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, 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 A to the consolidated financial statements, the Company changed its method of accounting for revenue recognition in 1994.\nPRICE WATERHOUSE LLP PRICE WATERHOUSE LLP\nNew York, New York February 1, 1996\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, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.\nPRICE WATERHOUSE LLP PRICE WATERHOUSE LLP\nNew York, New York February 1, 1996\nAPS Notes to Consolidated Financial Statements (These notes are an integral part of the consolidated financial statements.)\nNote A: Summary of Significant Accounting Policies\nAllegheny Power System, Inc. (the Company) is an electric utility holding company that derives substantially all of its income from the electric utility operations of its regulated subsidiaries, Monongahela Power Company, The Potomac Edison Company, and West Penn Power Company. The principal markets for the System's electric sales are in the states of Pennsylvania, West Virginia, Maryland, Virginia, and Ohio. In 1995, revenues from 50 of its largest electric utility customers provided approximately 20% of the System's retail revenues. The Company also has a wholly-owned nonutility subsidiary, AYP Capital, Inc., formed in 1994, which is involved primarily in energy-related services, development of wholesale unregulated power generation, and other energy-related businesses.\nThe Company and its subsidiaries are subject to regulation by the Securities and Exchange Commission (SEC), including the Public Utility Holding Company Act of 1935. 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:\nThe 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.\nUse of Estimates:\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates that affect the reported amounts of assets, liabilities, revenues, expenses, and disclosures of contingencies during the reporting period, which in the normal course of business are subsequently adjusted to actual results.\nRevenues:\nBeginning 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, revenues were recorded for billings rendered to customers, except for a portion of unbilled revenues in West Virginia.\nDeferred Power Costs, Net:\nThe costs of fuel, purchased power, and certain other costs, and revenues from sales to other utilities, including transmission services, are deferred until they are either recovered from or credited to customers under fuel and energy cost recovery procedures.\nProperty, Plant, and Equipment:\nProperty, 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.\nThe cost of depreciable property units retired, plus removal costs less salvage, are charged to accumulated depreciation.\nAllowance for Funds Used During Construction:\nAFUDC, 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 by the regulated subsidiaries 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 1995, 1994, and 1993 averaged 8.73%, 9.00%, and 9.37%, 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:\nProvisions for depreciation are determined generally on a straight-line method based on estimated service lives of depreciable properties and amounted to approximately 3.5% of average depreciable property in 1995, 3.3% in 1994, and 3.4% in 1993. The cost of maintenance and of certain replacements of property, plant, and equipment is charged principally to operating expenses.\nInvestments:\nThe investment in subsidiaries consolidated represents the excess of acquisi- tion 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.\nBenefit plans' investments represent the estimated cash surrender values of purchased life insurance on the Board of Directors and qualifying management employees under a Directors' pension plan, and an executive life insurance plan and a supplemental executive retirement plan. Payment of future premiums will fully fund these benefits.\nIncome Taxes:\nFinancial 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 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.\nProvisions 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. These balances are being amortized over the estimated service lives of the related properties.\nPostretirement Benefits:\nThe 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 an amount equal to the annual cost, but not more than can be deducted for federal income tax purposes. Funding of these benefits is made primarily into Voluntary Employee Beneficiary Association (VEBA) trust funds in amounts up to that which can be deducted for federal\nincome tax purposes. Medical benefits are self-insured; the life insurance plan is paid through insurance premiums.\nAccounting Changes:\nEffective January 1, 1994, the regulated 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 rate making 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 1994 consolidated income before the cumulative effect of accounting change, as well as 1993 consolidated net income, is not material.\nIn March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,\" effective in 1996. The Company does not believe at this time that the adoption of this standard will have a materially adverse effect on its financial position.\nNote B: Restructuring Charges and Asset Write-Offs\nThe System is undergoing a reorganization and reengineering process (restruc- turing) to simplify its management structure and to increase efficiency. As a consequence of this process, approximately 200 employees, primarily in the Bulk Power Supply department, have been placed in a staffing force. In January 1996, these employees were offered an option to resign immediately under a Voluntary Separation Program (VSP) or to remain employed subject to involuntary separation (layoff) after one year, if during that year they have not found other employment within the System.\nIn 1995, the regulated subsidiaries recorded restructuring charges of $16.0 million ($9.6 million after tax) in other operation expense, for the estimated liabilities related primarily to staffing force employees' involuntary separation costs. Further separation costs for these employees will be recorded in 1996 depending upon those employees who elect early separation under the VSP, which provides enhanced separation benefits. Additional restructuring costs may be required as the restructuring process is completed for other departments.\nIn connection with changes in inventory management objectives, the regulated subsidiaries in 1995 also recorded $7.4 million ($4.5 million after tax) primarily in maintenance expense for the write-off of obsolete and slow-moving materials.\nIn 1994, the regulated subsidiaries wrote off $9.2 million ($5.3 million after tax) in other income (expense), net, 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 was no longer reasonable to assume future recovery of these costs in rates.\nNote C: Income Taxes Details of federal and state income tax provisions are:\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:\nFederal income tax returns through 1991 have been examined and substantially settled.\nAt 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 regulated subsidiaries have recorded regulatory assets of $559 million and $605 million as of December 31, 1995 and 1994, respectively. Regulatory liabilities of $98 million and $105 million as of December 31, 1995 and 1994, respectively, have been recorded 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 D: Dividend Restriction\nSupplemental indentures relating to most outstanding bonds of the regulated subsidiaries contain dividend restrictions under the most restrictive of which $209,729,000 of consolidated retained earnings at December 31, 1995, 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 E: Pension Benefits\nNet pension costs, 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 at December 31 using a measurement date of September 30 were as follows:\nIn determining the actuarial present value of the projected benefit obligation at September 30, 1995, 1994, and 1993, the discount rates used were 7.5%, 7.75%, and 7.25%, and the rates of increase in future compensation levels were 4.5%, 4.75%, and 4.75%, respectively. The expected long-term rate of return on assets was 9% in each of the years 1995, 1994, and 1993.\nNote F: Postretirement Benefits Other Than Pensions The cost of postretirement benefits other than pensions (principally health care and life insurance) for employees and covered dependents in 1995 and 1994, 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 at December 31 using a measurement date of September 30 were as follows:\nIn determining the APBO at September 30, 1995, 1994, and 1993, the discount rates used were 7.5%, 7.75%, and 7.25%, and the rates of increase in future compensation levels were 4.5%, 4.75%, and 4.75%, respectively. The 1995 expected long-term rate of return on assets was 8.25% net of tax. For measurement purposes, a health care trend rate of 8% for 1996, declining 1% each year thereafter to 6.5% 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, 1995, by $12.8 million and the aggregate of the service and interest cost components of net periodic postretirement benefit cost for 1995 by $1.3 million.\nNote G: Fair Value of Financial Instruments\nThe carrying amounts and estimated fair value of financial instruments at December 31 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 long-term debt and QUIDS 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 H: Capitalization Common Stock:\nIn 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:\nIn 1995, the regulated subsidiaries refunded $130 million of preferred stock with dividend rates between 7% and 8.8%, with the proceeds from the issuance of Quarterly Income Debt Securities (QUIDS) described below. 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.\nLong-Term Debt and QUIDS:\nMaturities for long-term debt for the next five years are: 1996, $43,575,000; 1997, $26,900,000; 1998, $185,400,000; 1999, $34,861,000; and 2000, $145,300,000. 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.\nIn 1995, the regulated subsidiaries issued $155.5 million of 8% 30-year QUIDS to refund preferred stock. Under certain circumstances the interest payments may be deferred for a period of up to 20 consecutive quarters.\nCommercial 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 1999. Each bank has the option to discontinue its loans after 1999 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 Company and its regulated subsidiaries, Allegheny Generating Company borrowings are made through an internal money pool as described in Note I.\nNote I: Short-Term Debt\nTo provide interim financing and support for outstanding commercial paper, lines of credit have been established with several banks. The Company and its regulated subsidiaries have fee arrangements on all of their lines of credit and no compensating balance requirements. At December 31, 1995, unused lines of credit with banks were $173,350,000. 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 regulated subsidiaries may borrow up to $300 million on a standby revolving credit basis. Short-term debt outstanding for 1995 and 1994 consisted of:\nNote J: Commitments and Contingencies Construction Program:\nThe regulated subsidiaries have entered into commitments for their construction programs, for which expenditures are estimated to be $279 million for 1996 and $305 million for 1997. Through 1999, annual construction expenditures are not expected to significantly exceed 1996 estimated levels. Construction expenditure levels in 2000 and beyond will depend upon future generation requirements, as well as the strategy eventually selected for complying with Phase II of the Clean Air Act Amendments of 1990.\nNonutility Investments:\nAYP Capital, Inc. has entered into an agreement with Duquesne Light Company, subject to regulatory approvals, to purchase its 50% interest in Unit No. 1 of the Fort Martin Power Station for approximately $170 million. AYP Capital intends to operate the unit as an exempt wholesale generator and sell the output at market rates. Necessary regulatory approvals will likely take several months, and AYP Capital expects a closing by late 1996.\nAYP Capital has committed to invest up to $10 million in two limited partner- ships formed to invest in emerging electrotechnologies that promote the efficient use of electricity and improve the environment, and to invest in and develop electric energy opportunities in Latin America. As of December 31, 1995, AYP Capital's investments totaled $1.1 million.\nEnvironmental Matters and Litigation:\nThe 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. 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.\nThe regulated subsidiaries previously reported that the Environmental Protec- tion Agency (EPA) had identified them and approximately 875 others as potential- ly responsible parties in a Superfund site subject to cleanup. The regulated subsidiaries have also been named as defendants along with multiple other defendants in pending asbestos cases involving one or more plaintiffs. The subsidiaries believe that provisions for liabilities and insurance recoveries are such that final resolution of these claims will not have a material effect on their financial position.\nMonongahela NOTES TO FINANCIAL STATEMENTS (These notes re an integral part of the financial statements)\nNote A - Summary of Significant Accounting Policies:\nThe 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).\nThe 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.\nUSE OF ESTIMATES: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates that affect the reported amounts of assets, liabilities, revenues, expenses, and disclosures of contingencies during the reporting period, which in the normal course of business are subsequently adjusted to actual results.\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 to other companies, including transmission services, 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.\nThe 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 1995, 1994, and 1993 were 7.29%, 8.16%, and 8.69%, 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 3.4%, 3.6%, and 3.8% of average depreciable property in 1995, 1994, and 1993, respectively. 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.\nFinancial 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 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.\nProvisions 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. These balances are being amortized over the 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 an amount equal to the annual cost,\nbut not more than can be deducted for federal income tax purposes. Funding of these benefits is made primarily into Voluntary Employee Beneficiary Association (VEBA) trust funds in amounts up to that which can be deducted for federal income tax purposes. Medical benefits are self- insured; the life insurance plan is paid through insurance premiums.\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 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 1994 income before the cumulative effect of accounting change, as well as 1993 net income, is not material.\nIn March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,\" effective in 1996. The Company does not believe at this time that the adoption of this standard will have a materially adverse effect on its financial position.\nNote B - Restructuring Charges and Asset Write-Offs:\nThe System is undergoing a reorganization and reengineering process (restructuring) to simplify its management structure and to increase efficiency. As a consequence of this process, approximately 200 employees, primarily in the System's Bulk Power Supply department, have been placed in a staffing force. In January 1996, these employees were offered an option to resign immediately under a Voluntary Separation Program (VSP) or to remain employed subject to involuntary separation (layoff) after one year, if during that year they have not found other employment within the System.\nIn 1995, the Company recorded restructuring charges of $4.1 million ($2.5 million after tax) in other operation expense, for its share of the estimated liabilities related primarily to staffing force employees' involuntary separation costs. Further separation costs for these employees will be recorded in 1996 depending upon those employees who elect early separation under the VSP, which provides enhanced separation benefits. Additional restructuring costs may be required as the restructuring process is completed for other departments.\nIn connection with changes in inventory management objectives, the Company in 1995 also recorded $1.4 million ($.8 million after tax) primarily in maintenance expense for the write-off of obsolete and slow-moving materials.\nNote C - Income Taxes:\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:\nFederal income tax returns through 1991 have been examined and substantially settled.\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 $152 million and $174 million as of December 31, 1995 and 1994, respectively. Regulatory liabilities of $20 million as of December 31, 1995 and 1994, respectively, have been recorded 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 D - Dividend Restriction:\nSupplemental indentures relating to most outstanding bonds of the Company contain dividend restrictions under the most restrictive of which $76,384,000 of retained earnings at December 31, 1995, 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 E - Allegheny Generating Company:\nThe 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.\nAGC 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. AGC's rates are set by a formula filed with and previously accepted by the FERC.\nThe only component which changes is the return on equity (ROE). In December 1991, AGC filed for a continuation of the existing ROE of 11.53% and other interested parties filed to reduce the ROE to 10%. A recommendation was issued by an Administrative Law Judge on December 22, 1994, to dismiss the joint complaint. A settlement agreement for both cases was filed with the FERC on January 12, 1995, which would reduce AGC's ROE from 11.53% to 11.13% for the period from March 1, 1992, through December 31, 1994, and increase AGC's ROE to 11.2% for the period from January 1, 1995, through December 31, 1995. This settlement was approved by the FERC on March 23, 1995. Refunds were made by AGC of any revenues collected between March 1, 1992 and March 23, 1995 in excess of these levels. A second settlement has been negotiated to address AGC's ROE after 1995. On December 21, 1995, AGC submitted the new settlement to the FERC. Interested parties representing less than 2% of AGC's eventual revenues have filed exceptions to the settlement. Under the terms of the settlement, AGC's ROE for 1996 would be 11%, and set by formula in 1997 and 1998 based primarily on changes in interest rates.\nFollowing is a summary of financial information for AGC:\nDecember 31 1995 1994 (Thousands of Dollars) Balance sheet information: Property, plant, and equipment............... $677,857 $680,749 Current assets............................... 7,586 5,991 Deferred charges............................. 24,844 27,496 Total assets............................... $710,287 $714,236\nTotal capitalization......................... $463,862 $489,894 Current liabilities.......................... 11,892 6,484 Deferred credits............................. 234,533 217,858 Total capitalization and liabilities....... $710,287 $714,236\nThe Company's share of the equity in earnings above was $7.4 million, $8.0 million, and $7.3 million for 1995, 1994, and 1993, respectively, and is included in other income, net, on the Statement of Income.\nNote F - Pension Benefits:\nThe 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:\n1995 1994 1993 (Thousands of Dollars)\nService cost - benefits earned........ $ 3,340 $ 3,677 $ 3,198 Interest cost on projected benefit obligation.................. 9,375 9,045 8,577 Actual (return) loss on plan assets......................... (27,269) 87 (22,606) Net amortization and deferral......... 15,183 (11,563) 12,048 Pension cost.......................... 629 1,246 1,217 Regulatory reversal (deferral)........ 3,718 (1,179) Net pension cost...................... $ 629 $ 4,964 $ 38\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:\n1995 1994 (Thousands of Dollars) Actuarial present value of accumulated benefit obligation earned to date (including vested benefit of $100,006,000 and $92,823,000)................ $107,672 $ 99,605 Funded status: Actuarial present value of projected benefit obligation......................... $133,485 $123,935 Plan assets at market value, primarily common stocks and fixed income securities.. 156,554 134,166 Plan assets in excess of projected benefit obligation......................... (23,069) (10,231) Add: Unrecognized cumulative net gain from past experience different from that assumed............................. 24,151 13,969 Unamortized transition asset, being amortized over 14 years beginning January 1, 1987.......................... 3,242 3,988 Less unrecognized prior service cost due to plan amendments................ 2,195 2,471 Pension cost liability at September 30....... 2,129 5,255 Fourth quarter contributions................. 1,829 Pension liability at December 31............. $ 2,129 $ 3,426\nThe foregoing includes the Company's portion of amounts applicable to employees at power stations which are owned jointly with affiliates.\nIn determining the actuarial present value of the projected benefit obligation at September 30, 1995, 1994, and 1993, the discount rates used were 7.5%, 7.75%, and 7.25%, and the rates of increase in future\ncompensation levels were 4.5%, 4.75%, and 4.75%, respectively. The expected long-term rate of return on assets was 9% in each of the years 1995, 1994, and 1993.\nNote G - Postretirement Benefits Other Than Pensions:\nThe cost of postretirement benefits other than pensions (principally health care and life insurance) for employees and covered dependents in 1995 and 1994, a portion of which (about 25% to 30%) was charged to plant construction, included the following components:\n1995 1994 (Thousands of Dollars)\nService cost - benefits earned.................. $ 741 $ 764 Interest cost on accumulated postretirement benefit obligation............. 3,939 3,655 Actual (return) loss on plan assets............. (1,702) 38 Amortization of unrecognized transition obligation......................... 1,783 1,783 Other net amortization and deferral............. 1,376 50 Postretirement cost............................. 6,137 6,290 Regulatory reversal (deferral).................. 345 (3,450) Net postretirement cost......................... $ 6,482 $ 2,840\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: 1995 1994 (Thousands of Dollars)\nAccumulated postretirement benefit obligation (APBO): Retirees.................................... $32,249 $33,528 Fully eligible employees.................... 5,221 4,947 Other employees............................. 14,177 14,458 Total obligation.......................... 51,647 52,933 Plan assets at market value, in common stocks, fixed income securities, and short-term investments................................... 10,515 5,338 Accumulated postretirement benefit obligation in excess of plan assets........... 41,132 47,595 Less: Unrecognized cumulative net loss from past experience different from that assumed...... 7,559 12,752 Unrecognized transition obligation, being amortized over 20 years beginning January 1, 1993................... 30,378 32,368 Postretirement benefit liability at September 30............................... 3,195 2,475 Fourth quarter contributions and benefit payments.......................... 2,046 1,437 Postretirement benefit liability at December 31................................ $ 1,149 $ 1,038\nIn determining the APBO at September 30, 1995, 1994, and 1993, the discount rates used were 7.5%, 7.75%, and 7.25% and the rates of increase in future compensation levels were 4.5%, 4.75%, and 4.75%, respectively. The 1995 expected long-term rate of return on assets was 8.25% net of tax. For measurement purposes, a health care trend rate of 8% for 1996, declining 1% each year thereafter to 6.5% 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, 1995, by $3.4 million and the aggregate of the service and interest cost components of net periodic postretirement benefit cost for 1995 by $.3 million.\nNote H - Fair Value of Financial Instruments:\nThe carrying amounts and estimated fair value of financial instruments at December 31 were as follows:\n1995 1994 Carrying Fair Carrying Fair Amount Value Amount Value (Thousands of Dollars)\nLiabilities: Short-term debt..... $ 29,868 $ 29,868 $ 36,570 $ 36,570 Long-term debt and QUIDS............. 513,710 540,387 473,710 458,714\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 and QUIDS 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.\nFor 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 I - Capitalization:\nCOMMON STOCK AND OTHER PAID-IN CAPITAL: Other paid-in capital decreased $76,000 in 1995 as a result of preferred stock transactions and $477,000 in 1994 as a result of underwriting fees and commissions associated with the Company's sale of $50 million of preferred stock.\nPREFERRED STOCK: In 1995, the Company refunded $40 million of preferred stock with dividend rates between 7.36% and 8.80%, with the proceeds from the issuance of Quarterly Income Debt Securities (QUIDS) described below. 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.\nLONG-TERM DEBT AND QUIDS: Maturities for long-term debt for the next five years are: 1996, $18,500,000; 1997, $15,500,000; 1998, $20,100,000; 1999, $1,000,000; and 2000, $66,000,000. 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.\nIn 1995, the Company sold $70 million of 7-5\/8% 30-year first mortgage bonds to refund a $70 million 8-7\/8% issue due in 2019. The Company also issued $25 million of 6.15% 20-year tax-exempt notes to refund a $25 million 7-3\/4% issue.\nIn 1995, the Company issued $40 million of 8% 30-year QUIDS to refund preferred stock. QUIDS may not be redeemed until the year 2000. Under certain circumstances the interest payments may be deferred for a period of up to 20 consecutive quarters.\nNote J - Short-Term Debt:\nTo 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 1995 and 1994 consisted of:\n1995 1994 (Thousands of Dollars) Balance at end of year: Commercial Paper.................. $22,368-6.09% $24,970-6.21% Notes Payable to Banks............ 7,500-6.00% 11,600-6.43% Money Pool........................ 2,900-5.49% Average amount outstanding during the year: Commercial Paper.................. 8,699-5.96% 8,751-3.58% Notes Payable to Banks............ 7,153-5.99% 15,283-3.89% Money Pool........................ 3,116-5.85% 11,363-4.51%\nNote K - Commitments and Contingencies:\nCONSTRUCTION PROGRAM: The Company has entered into commitments for its construction program, for which expenditures are estimated to be $66 million for 1996 and $75 million for 1997. Through 1999, annual construction expenditures are not expected to significantly exceed 1996 estimated levels. Construction expenditure levels in 2000 and beyond will depend upon future generation requirements, as well as the strategy eventually selected for complying with Phase II of the Clean Air Act Amendments of 1990.\nENVIRONMENTAL MATTERS AND LITIGATION:\nSystem 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. 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.\nThe Company previously reported that the Environmental Protection Agency had identified it and its affiliates and approximately 875 others as potentially responsible parties in a Superfund site subject to cleanup. The Company has also been named as a defendant along with multiple other defendants in pending asbestos cases involving one or more plaintiffs. The Company believes that provisions for liabilities and insurance recoveries are such that final resolution of these claims will not have a material effect on their financial position.\nThe Company is guarantor as to 27% of a $50 million revolving credit agreement of AGC, which in 1995 was used by AGC solely as support for its indebtedness for commercial paper outstanding.\nPotomac Edison\nNOTES TO FINANCIAL STATEMENTS (These notes are an integral part of the financial statements.)\nNote A - Summary of Significant Accounting Policies:\nThe 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).\nThe Company is subject to regulation by the Securities and Exchange Commis- sion (SEC), by various state bodies having jurisdiction, and by the Federal Energy Regulatory Commission (FERC). Significant accounting policies of the Company are summarized below.\nUSE OF ESTIMATES: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates that affect the reported amounts of assets, liabilities, revenues, expenses, and disclosures of contingencies during the reporting period, which in the normal course of business are subsequently adjusted to actual results.\nREVENUES: Beginning in 1994, revenues, including amounts resulting from the applica- tion 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, revenues were recorded for billings rendered to customers. Revenues of $67.4 million from one industrial customer, Eastalco Aluminum Company, were 8% of total electric operating revenues in 1995.\nDEFERRED POWER COSTS, NET: The costs of fuel, purchased power, and certain other costs, and revenues from sales to other companies, including transmission services, 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 administra- tion, maintenance, and depreciation of transportation and construction equipment, and pensions, taxes, and other fringe benefits related to employees engaged in construction.\nThe 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 1995, 1994, and 1993 were 9.71%, 9.73%, and 9.97%, 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 3.6%, 3.4%, and 3.6% of average depreciable property in 1995, 1994, and 1993, respectively. 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.\nFinancial 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 substan- tially in accordance with the accounting procedures followed for ratemaking purposes. Deferred tax assets and liabilities 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.\nProvisions for federal income tax were reduced in previous years by invest- ment credits, and amounts equivalent to such credits were charged to income with concurrent credits to a deferred account. These balances are being amortized over the 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 an amount equal to the annual cost, but not more than can be deducted for federal income tax purposes. Funding of these benefits is made primarily into Voluntary Employee Beneficiary Association (VEBA) trust funds in amounts up to that which can be deducted for federal income tax purposes. Medical benefits are self-insured; the life insurance plan is paid through insurance premiums.\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 1994 income before the cumulative effect of accounting change, as well as 1993 net income, is not material.\nIn March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,\" effective in 1996. The Company does not believe at this time that the adoption of this standard will have a materially adverse effect on its financial position.\nNote B - Restructuring Charges and Asset Write-Offs:\nThe System is undergoing a reorganization and reengineering process (re- structuring) to simplify its management structure and to increase efficiency. As a consequence of this process, approximately 200 employees, primarily in the System's Bulk Power Supply department, have been placed in a staffing force. In January 1996, these employees were offered an option to resign immediately under a Voluntary Separation Program (VSP) or to remain employed subject to involuntary separation (layoff) after one year, if during that year they have not found other employment within the System.\nIn 1995, the Company recorded restructuring charges of $4.6 million ($2.9 million after tax) in other operation expense, for its share of the estimated liabilities related primarily to staffing force employees' involuntary separation costs. Further separation costs for these employees will be recorded in 1996 depending upon those employees who elect early separation under the VSP, which provides enhanced separation benefits. Additional restructuring costs may be required as the restructuring process is completed for other departments.\nIn connection with changes in inventory management objectives, the Company in 1995 also recorded $2.2 million ($1.4 million after tax) primarily in maintenance expense for the write-off of obsolete and slow-moving materials.\nNote C - Income Taxes:\nDetails of federal and state income tax provisions are:\n1995 1994 1993 (Thousands of Dollars) Income taxes--current: Federal............................. $25,949 $34,193 $29,758 State............................... (640) (2,849) 3,991 Total............................. 25,309 31,344 33,749 Income taxes--deferred, net of amortization........................ 16,504 14,955 (770) Amortization of deferred investment credit................... (2,225) (2,267) (2,349) Total income taxes................ 39,588 44,032 30,630 Income taxes--charged to other income and deductions............... (2,652) (1,176) (544) Income taxes--charged to accounting change (including state income taxes)................. (9,693) Income taxes--charged to operating income.................... $36,936 $33,163 $30,086\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:\n1995 1994 1993 (Thousands of Dollars) Financial accounting income before cumulative effect of accounting change and income taxes............ $115,201 $115,146 $103,553 Amount so produced................... $ 40,300 $ 40,300 $ 36,200 Increased (decreased) for: Tax deductions for which deferred tax was not provided: Lower tax depreciation......... 4,200 100 2,300 Plant removal costs............ (1,200) (1,700) (2,100) State income tax, net of federal income tax benefit............... 2,200 1,300 1,600 Amortization of deferred investment credit................ (2,225) (2,267) (2,349) Equity in earnings of subsidiaries..................... (2,600) (2,900) (2,600) Other, net......................... (3,739) (1,670) (2,965) Total.......................... $ 36,936 $ 33,163 $ 30,086\nFederal income tax returns through 1991 have been examined and substantially settled.\nAt December 31, the deferred tax assets and liabilities were comprised of the following:\n1995 1994 (Thousands of Dollars) Deferred tax assets: Unamortized investment tax credit............ $ 15,084 $ 16,497 Unbilled revenue............................. 3,492 3,504 Tax interest capitalized..................... 11,221 12,701 Contributions in aid of construction......... 12,614 11,653 State tax loss carryback\/carryforward........ 24 2,721 Advances for construction.................... 1,573 1,338 Other........................................ 5,619 5,800 49,627 54,214 Deferred tax liabilities: Book vs. tax plant basis differences, net.... 189,618 192,862 Other........................................ 15,803 13,367 205,421 206,229 Total net deferred tax liabilities............. 155,794 152,015 Less portion above included in current liabilities.......................... 362 2,716 Total long-term net deferred tax liabilities.............................. $155,432 $149,299\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 $61 million and $76 million as of December 31, 1995 and 1994, respectively. Regulatory liabilities of $15 million and $17 million as of December 31, 1995 and 1994, respectively, have been recorded 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 D - Dividend Restriction:\nSupplemental indentures relating to most outstanding bonds of the Company contain dividend restrictions under the most restrictive of which $94,355,000 of retained earnings at December 31, 1995, 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 E - Allegheny Generating Company:\nThe 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.\nAGC 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. AGC's rates are set by\na formula filed with and previously accepted by the FERC. The only component which changes is the return on equity (ROE). In December 1991, AGC filed for a continuation of the existing ROE of 11.53% and other interested parties filed to reduce the ROE to 10%. A recommendation was issued by an Administra- tive Law Judge on December 22, 1994, to dismiss the joint complaint. A settlement agreement for both cases was filed with the FERC on January 12, 1995, which would reduce AGC's ROE from 11.53% to 11.13% for the period from March 1, 1992, through December 31, 1994, and increase AGC's ROE to 11.2% for the period from January 1, 1995, through December 31, 1995. This settlement was approved by the FERC on March 23, 1995. Refunds were made by AGC of any revenues collected between March 1, 1992 and March 23, 1995 in excess of these levels. A second settlement has been negotiated to address AGC's ROE after 1995. On December 21, 1995, AGC submitted the new settlement to the FERC. Interested parties representing less than 2% of AGC's eventual revenues have filed exceptions to the settlement. Under the terms of the settlement, AGC's ROE for 1996 would be 11%, and set by formula in 1997 and 1998 based primarily on changes in interest rates.\nFollowing is a summary of financial information for AGC:\nDecember 31 1995 1994 (Thousands of Dollars) Balance sheet information: Property, plant, and equipment............... $677,857 $680,749 Current assets............................... 7,586 5,991 Deferred charges............................. 24,844 27,496 Total assets............................... $710,287 $714,236\nTotal capitalization......................... $463,862 $489,894 Current liabilities.......................... 11,892 6,484 Deferred credits............................. 234,533 217,858 Total capitalization and liabilities....... $710,287 $714,236\nYear Ended December 31 1995 1994 1993 (Thousands of Dollars) Income statement information: Electric operating revenues......... $86,970 $91,022 $90,606 Operation and maintenance expense........................... 5,740 6,695 6,609 Depreciation........................ 17,018 16,852 16,899 Taxes other than income taxes...................... 5,091 5,223 5,347 Federal income taxes................ 13,552 14,737 13,262 Interest charges.................... 18,361 17,809 21,635 Other income, net................... (16) (11) (328) Net income.......................... $27,224 $29,717 $27,182\nThe Company's share of the equity in earnings above was $7.6 million, $8.3 million, and $7.6 million for 1995, 1994, and 1993, respectively, and is included in other income, net, on the Statement of Income.\nNote F - Pension Benefits:\nThe 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:\n1995 1994 1993 (Thousands of Dollars)\nService cost--benefits earned......... $ 3,286 $ 3,555 $ 3,225 Interest cost on projected benefit obligation.................. 10,161 9,867 9,612 Actual (return) loss on plan assets......................... (25,718) 304 (22,481) Net amortization and deferral......... 12,631 (12,808) 10,669 Pension cost.......................... 360 918 1,025 Regulatory reversal................... 1,194 537 Net pension cost...................... $ 360 $ 2,112 $ 1,562\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:\n1995 1994 (Thousands of Dollars) Actuarial present value of accumulated benefit obligation earned to date (including vested benefit of $111,538,000 and $103,546,000)............... $119,383 $110,577 Funded status: Actuarial present value of projected benefit obligation......................... $144,800 $135,060 Plan assets at market value, primarily common stocks and fixed income securities.. 169,830 146,211 Plan assets in excess of projected benefit obligation......................... (25,030) (11,151) Add: Unrecognized cumulative net gain from past experience different from that assumed............................. 23,839 13,165 Unamortized transition asset, being amortized over 14 years beginning January 1, 1987.......................... 3,435 4,183 Less unrecognized prior service cost due to plan amendments................ 2,450 2,732 Pension cost liability at September 30....... (206) 3,465 Fourth quarter contributions................. 1,989 Pension (prepayment) liability at December 31............................. $ (206) $ 1,476\nThe foregoing includes the Company's portion of amounts applicable to employees at power stations which are owned jointly with affiliates.\nIn determining the actuarial present value of the projected benefit obliga- tion at September 30, 1995, 1994, and 1993, the discount rates used were 7.5%, 7.75%, and 7.25%, and the rates of increase in future compensation levels were 4.5%, 4.75%, and 4.75%, respectively. The expected long-term rate of return on assets was 9% in each of the years 1995, 1994, and 1993.\nNote G - Postretirement Benefits Other Than Pensions:\nThe cost of postretirement benefits other than pensions (principally health care and life insurance) for employees and covered dependents in 1995 and 1994, a portion of which (about 25% to 30%) was charged to plant construction, included the following components:\n1995 1994 (Thousands of Dollars)\nService cost - benefits earned.................. $ 683 $ 696 Interest cost on accumulated postretirement benefit obligation............. 4,476 4,047 Actual loss (return) on plan assets............. (1,938) 47 Amortization of unrecognized transition obligation......................... 2,011 1,976 Other net amortization and deferral............. 1,570 53 Postretirement cost............................. 6,802 6,819 Regulatory reversal (deferral).................. 11 (457) Net postretirement cost......................... $6,813 $6,362\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:\n1995 1994 (Thousands of Dollars)\nAccumulated postretirement benefit obligation (APBO): Retirees.................................... $35,852 $36,927 Fully eligible employees.................... 8,699 8,152 Other employees............................. 13,805 14,035 Total obligation.......................... 58,356 59,114 Plan assets at market value, in common stocks, fixed income securities, and short-term investments................................... 11,882 5,962 Accumulated postretirement benefit obligation in excess of plan assets........... 46,474 53,152 Less: Unrecognized cumulative net loss from past experience different from that assumed...... 8,578 14,223 Unrecognized transition obligation, being amortized over 20 years beginning January 1, 1993................... 34,125 35,928 Postretirement benefit liability at September 30............................... 3,771 3,001 Fourth quarter contributions and benefit payments.......................... 2,221 1,634 Postretirement benefit liability at December 31................................ $ 1,550 $ 1,367\nIn determining the APBO at September 30, 1995, 1994, and 1993, the discount rates used were 7.5%, 7.75%, and 7.25%, and the rates of increase in future compensation levels were 4.5%, 4.75%, and 4.75%, respectively. The 1995 expected long-term rate of return on assets was 8.25% net of tax. For measurement purposes, a health care trend rate of 8% for 1996, declining 1% each year thereafter to 6.5% 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, 1995, by $3.8 million and the aggregate of the service and interest cost components of net periodic postretirement benefit cost for 1995 by $.4 million.\nNote H - Fair Value of Financial Instruments:\nThe carrying amounts and estimated fair value of financial instruments at December 31 were as follows:\n1995 1994 Carrying Fair Carrying Fair Amount Value Amount Value (Thousands of Dollars) Liabilities: Mandatorily redeemable preferred stock.... $ - $ - $ 26,400 $ 25,542 Short-term debt...... 21,637 21,637 Long-term debt and QUIDS.............. 655,657 689,003 610,200 594,519\nThe fair value of mandatorily redeemable preferred stock was estimated based on quoted market prices. The 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 and QUIDS 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.\nFor 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 I - Capitalization:\nCOMMON STOCK AND OTHER PAID-IN CAPITAL: In October 1993, the Company issued and sold 2,500,000 shares of common stock to its parent at $20 per share. Other paid-in capital decreased $34,000 in 1995 and increased $10,000 in 1994 as a result of preferred stock transac- tions.\nPREFERRED STOCK: In 1995, the Company refunded $45.5 million of preferred stock with dividend rates between 7% and 8.32%, with the proceeds from the issuance of Quarterly Income Debt Securities (QUIDS) described below. All of the preferred stock is entitled on voluntary liquidation to its then current call price and on involuntary liquidation to $100 a share.\nLONG-TERM DEBT AND QUIDS: Maturities for long-term debt for the next five years are: 1996, $18,700, 000; 1997, $800,000; 1998, $1,800,000; 1999, $1,800,000; and 2000, $76,800,000. 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.\nIn 1995, the Company sold $65 million of 7-3\/4% 30-year first mortgage bonds to refund a $65 million 9-1\/4% issue due in 2019 and $80 million of 7-5\/8% 30- year first mortgage bonds to refund an $80 million 9-5\/8% issue due in 2020. The Company also issued $21 million of 6.15% 20-year tax-exempt notes to refund a $21 million 7.3% issue.\nIn 1995, the Company issued $45.5 million of 8% 30-year QUIDS to refund preferred stock. QUIDS may not be redeemed until the year 2000. Under certain circumstances the interest payments may be deferred for a period of up to 20 consecutive quarters.\nNote J - Short-Term Debt:\nTo 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. Short-term debt outstanding for 1995 and 1994 consisted of:\n1995 1994 (Thousands of Dollars) Balance at end of year: Commercial Paper.................... $21,637-6.10% Average amount outstanding during the year: Commercial Paper.................. $ 499-5.94% $1,021-3.96% Notes Payable to Banks............ 995-6.04% 2,499-3.96% Money Pool........................ 179-5.96% 87-4.10%\nNote K - Commitments and Contingencies:\nCONSTRUCTION PROGRAM: The Company has entered into commitments for its construction program, for which expenditures are estimated to be $87 million for 1996 and $103 million for 1997. Through 1999, annual construction expenditures are not expected to significantly exceed 1996 estimated levels. Construction expenditure levels in 2000 and beyond will depend upon future generation requirements, as well as the strategy eventually selected for complying with Phase II of the Clean Air Act Amendments of 1990.\nENVIRONMENTAL MATTERS AND LITIGATION: 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. In the normal course of business, the Company becomes involved in various legal proceedings.\nThe Company does not believe that the ultimate outcome of these proceedings will have a material effect on its financial position.\nThe Company previously reported that the Environmental Protection Agency had identified it and its affiliates and approximately 875 others as potentially responsible parties in a Superfund site subject to cleanup. The Company has also been named as a defendant along with multiple other defendants in pending asbestos cases involving one or more plaintiffs. The Company believes that provisions for liabilities and insurance recoveries are such that final resolution of these claims will not have a material effect on its financial position.\nThe Company is guarantor as to 28% of a $50 million revolving credit agreement of AGC, which in 1995 was used by AGC solely as support for its indebtedness for commercial paper outstanding.\nWest Penn NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (These notes are an integral part of the consolidated financial statements.)\nNote A - Summary of Significant Accounting Policies:\nThe 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).\nThe 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).\nUSE OF ESTIMATES: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates that affect the reported amounts of assets, liabilities, revenues, expenses, and disclosures of contingencies during the reporting period, which in the normal course of business are subsequently adjusted to actual results.\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, 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 to other companies, including transmission services, 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 administra- tion, maintenance, and depreciation of transportation and construction equipment, and pensions, taxes, and other fringe benefits related to employees engaged in construction.\nThe 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 1995, 1994, and 1993 were 8.90%, 8.88%, and 9.40%, 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 3.9%, 3.5%, and 3.4% of average depreciable property in 1995, 1994, and 1993, 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 consoli- dated 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.\nFinancial 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 substan- tially in accordance with the accounting procedures followed for ratemaking purposes. Deferred tax assets and liabilities 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.\nProvisions 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. These balances are being amortized over the 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\ncomprise 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 an amount equal to the annual cost, but not more than can be deducted for federal income tax purposes. Funding of these benefits is made primarily into Voluntary Employee Beneficiary Association (VEBA) trust funds in amounts up to that which can be deducted for federal income tax purposes. Medical benefits are self-insured; the life insurance plan is paid through insurance premiums.\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 1994 consolidated income before the cumulative effect of accounting change, as well as 1993 consolidated net income, is not material.\nIn March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,\" effective in 1996. The Company does not believe at this time that the adoption of this standard will have a materially adverse effect on its financial position.\nNote B - Restructuring Charges and Asset Write-Offs:\nThe System is undergoing a reorganization and reengineering process (restructuring) to simplify its management structure and to increase efficien- cy. As a consequence of this process, approximately 200 employees, primarily in the System's Bulk Power Supply department, have been placed in a staffing force. In January 1996, these employees were offered an option to resign immediately under a Voluntary Separation Program (VSP) or to remain employed subject to involuntary separation (layoff) after one year, if during that year they have not found other employment within the System.\nIn 1995 the Company recorded restructuring charges of $7.3 million ($4.3 million after tax) in other operation expense, for its share of the estimated liabilities related primarily to staffing force employees' involun- tary separation costs. Further separation costs for these employees will be recorded in 1996 depending upon those employees who elect early separation under the VSP, which provides enhanced separation benefits. Additional restructuring costs may be required as the restructuring process is completed for other departments.\nIn connection with changes in inventory management objectives, the Company in 1995 also recorded $3.8 million ($2.3 million after tax) primarily in maintenance expense for the write-off of obsolete and slow-moving materi- als.\nIn 1994, the Company wrote off $8.9 million ($5.2 million after tax) in other income (expense), net, of previously accumulated costs related to a potential future power plant site and a proposed transmission line. In\nthe industry's more competitive environment, it was no longer reasonable to assume future recovery of these costs in rates.\nNote C - Income Taxes:\nDetails of federal and state income tax provisions are:\n1995 1994 1993 (Thousands of Dollars) Income taxes--current: Federal............................. $49,928 $46,964 $47,089 State............................... 9,344 13,282 14,983 Total............................. 59,272 60,246 62,072 Income taxes--deferred, net of amortization................. 4,944 3,277 (7,522) Amortization of deferred investment credit................... (2,580) (2,578) (2,592) Total income taxes................ 61,636 60,945 51,958 Income taxes--credited (charged) to other income and deductions...... 109 3,300 (429) Income taxes--charged to accounting change (including state income taxes)................. (13,860) Income taxes--charged to operating income.................... $61,745 $50,385 $51,529\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:\n1995 1994 1993 (Thousands of Dollars) Financial accounting income before cumulative effect of accounting change and income taxes............ $179,624 $151,400 $153,590 Amount so produced................... $ 62,900 $ 53,000 $ 53,800 Increased (decreased) for: Tax deductions for which deferred tax was not provided: Lower tax depreciation......... 4,300 2,000 100 Plant removal costs............ (900) (1,700) (900) State income tax, net of federal income tax benefit............... 9,300 6,400 9,600 Amortization of deferred investment credit................ (2,580) (2,578) (2,592) Equity in earnings of subsidiaries..................... (4,300) (4,600) (4,300) Other, net......................... (6,975) (2,137) (4,179) Total.......................... $ 61,745 $ 50,385 $ 51,529\nFederal income tax returns through 1991 have been examined and substan- tially settled.\nAt December 31, the deferred tax assets and liabilities were comprised of the following:\n1995 1994 (Thousands of Dollars) Deferred tax assets: Unamortized investment tax credit............ $ 35,043 $ 38,560 Unbilled revenue............................. 8,594 9,539 Tax interest capitalized..................... 19,049 16,165 State tax loss carryback\/carryforward........ 508 5,535 Postretirement benefits other than pensions.. 7,324 3,952 Contributions in aid of construction......... 6,009 4,866 Other........................................ 21,499 14,953 98,026 93,570 Deferred tax liabilities: Book vs. tax plant basis differences, net.... 526,257 536,343 Other........................................ 20,304 16,204 546,561 552,547 Total net deferred tax liabilities............. 448,535 458,977 Add portion above included in current assets............................ 21,024 12,538 Total long-term net deferred tax liabilities.............................. $469,559 $471,515\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 $332 million and $351 million as of December 31, 1995 and 1994, respectively. Regulatory liabilities of $36 million and $39 million as of December 31, 1995 and 1994, respectively, have been recorded 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 D - Dividend Restriction:\nSupplemental indentures relating to most outstanding bonds of the Company contain dividend restrictions under the most restrictive of which $70,576,000 of consolidated retained earnings at December 31, 1995, 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 E - Allegheny Generating Company:\nThe 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.\nAGC 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. AGC's rates are set by a formula filed with and previously accepted by the FERC. The only component which changes is the return on equity (ROE). In December 1991, AGC filed for a continuation of the existing ROE of 11.53% and other interested parties filed to reduce the ROE to 10%. A recommendation was issued by an Adminis- trative Law Judge on December 22, 1994, to dismiss the joint complaint. A settlement agreement for both cases was filed with the FERC on January 12, 1995, which would reduce AGC's ROE from 11.53% to 11.13% for the period from March 1, 1992, through December 31, 1994, and increase AGC's ROE to 11.2% for the period from January 1, 1995, through December 31, 1995. This settlement was approved by the FERC on March 23, 1995. Refunds were made by AGC of any revenues collected between March 1, 1992 and March 23, 1995 in excess of these levels. A second settlement has been negotiated to address AGC's ROE after 1995. On December 21, 1995, AGC submitted the new settlement to the FERC. Interested parties representing less than 2% of AGC's eventual revenues have filed exceptions to the settlement. Under the terms of the settlement, AGC's ROE for 1996 would be 11%, and set by formula in 1997 and 1998 based primarily on changes in interest rates.\nFollowing is a summary of financial information for AGC:\nDecember 31 1995 1994 (Thousands of Dollars) Balance sheet information: Property, plant, and equipment............... $677,857 $680,749 Current assets............................... 7,586 5,991 Deferred charges............................. 24,844 27,496 Total assets............................... $710,287 $714,236\nTotal capitalization......................... $463,862 $489,894 Current liabilities.......................... 11,892 6,484 Deferred credits............................. 234,533 217,858 Total capitalization and liabilities....... $710,287 $714,236\nYear Ended December 31 1995 1994 1993 (Thousands of Dollars) Income statement information: Electric operating revenues......... $86,970 $91,022 $90,606 Operation and maintenance expense........................... 5,740 6,695 6,609 Depreciation........................ 17,018 16,852 16,899 Taxes other than income taxes...................... 5,091 5,223 5,347 Federal income taxes................ 13,552 14,737 13,262 Interest charges.................... 18,361 17,809 21,635 Other income, net................... (16) (11) (328) Net income.......................... $27,224 $29,717 $27,182\nThe Company's share of the equity in earnings above was $12.3 million, $13.4 million, and $12.2 million for 1995, 1994, and 1993, respectively, and is included in other income, net, on the Consolidated Statement of Income.\nNote F - Pension Benefits:\nThe 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:\n1995 1994 1993 (Thousands of Dollars)\nService cost - benefits earned........ $ 4,655 $ 5,124 $ 4,606 Interest cost on projected benefit obligation.................. 14,412 14,051 13,773 Actual (return) loss on plan assets......................... (32,610) 358 (31,224) Net amortization and deferral......... 14,000 (18,210) 14,262 Pension cost.......................... 457 1,323 1,417 Regulatory reversal (deferral)........ 760 - (1,309) Net pension cost...................... $ 1,217 $ 1,323 $ 108\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.\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:\n1995 1994 (Thousands of Dollars) Actuarial present value of accumulated benefit obligation earned to date (including vested benefit of $155,921,000 and $150,168,000)............... $165,162 $158,578 Funded status: Actuarial present value of projected benefit obligation......................... $199,683 $191,787 Plan assets at market value, primarily common stocks and fixed income securities.. 234,200 207,623 Plan assets in excess of projected benefit obligation......................... (34,517) (15,836) Add: Unrecognized cumulative net gain from past experience different from that assumed............................. 29,164 15,103 Unamortized transition asset, being amortized over 14 years beginning January 1, 1987.......................... 7,178 8,427 Less unrecognized prior service cost due to plan amendments................ 4,467 4,999 Pension cost liability at September 30....... (2,642) 2,695 Fourth quarter contributions................. 2,843 Pension prepayment at December 31............ $ (2,642) $ (148)\nThe foregoing includes the Company's portion of amounts applicable to employees at power stations which are owned jointly with affiliates.\nIn determining the actuarial present value of the projected benefit obligation at September 30, 1995, 1994, and 1993, the discount rates used were 7.5%, 7.75%, and 7.25%, and the rates of increase in future compensation levels were 4.5%, 4.75%, and 4.75%, respectively. The expected long-term rate of return on assets was 9% in each of the years 1995, 1994, and 1993.\nNote G - Postretirement Benefits Other Than Pensions:\nThe cost of postretirement benefits other than pensions (principally health care and life insurance) for employees and covered dependents in 1995 and 1994, a portion of which (about 25% to 30%) was charged to plant construc- tion, included the following components:\n1995 1994 (Thousands of Dollars)\nService cost - benefits earned.................. $ 1,055 $ 1,154 Interest cost on accumulated postretirement benefit obligation............. 4,595 4,461 Actual (return) loss on plan assets............. (1,990) 31 Amortization of unrecognized transition obligation......................... 2,830 2,817 Other net amortization and deferral............. 1,610 83 Postretirement cost............................. 8,100 8,546 Regulatory reversal............................. 137 - Net postretirement cost......................... $ 8,237 $ 8,546\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:\n1995 1994 (Thousands of Dollars)\nAccumulated postretirement benefit obligation (APBO): Retirees.................................... $36,041 $35,895 Fully eligible employees.................... 7,802 8,290 Other employees............................. 17,608 17,013 Total obligation.......................... 61,451 61,198 Plan assets at market value in common stocks, fixed income securities, and short-term investments................................... 12,512 6,173 Accumulated postretirement benefit obligation in excess of plan assets........... 48,939 55,025 Less: Unrecognized cumulative net gain from past experience different from that assumed................................ (3,292) (543) Unrecognized transition obligation, being amortized over 20 years beginning January 1, 1993................... 48,099 50,929 Postretirement benefit liability at September 30............................... 4,132 4,639 Fourth quarter contributions and benefit payments.......................... 3,649 2,113 Postretirement benefit liability at December 31................................ $ 483 $ 2,526\nIn determining the APBO at September 30, 1995, 1994, and 1993, the discount rates used were 7.5%, 7.75%, and 7.25%, and the rates of increase in future compensation levels were 4.5%, 4.75%, and 4.75%, respectively. The 1995 expected long-term rate of return on assets was 8.25% net of tax. For measurement purposes, a health care trend rate of 8% for 1996, declining 1% each year thereafter to 6.5% 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, 1995, by $4.0 million and the aggregate of the service and interest cost components of net periodic postretirement benefit cost for 1995 by $.4 million.\nNote H - Fair Value of Financial Instruments:\nThe carrying amounts and estimated fair value of financial instruments at December 31 were as follows:\n1995 1994 Carrying Fair Carrying Fair Amount Value Amount Value (Thousands of Dollars) Assets: Temporary cash investments........ $ 425 $ 425 $ 73 $ 73 Liabilities: Short-term debt...... 70,218 70,218 - - Long-term debt and QUIDS............ 913,985 955,336 870,985 826,003\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 long-term debt and QUIDS 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.\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 I - Capitalization:\nCOMMON 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 1993. Other paid-in capital decreased $212,000 in 1995 as a result of preferred stock transactions and decreased $145,000 in 1993 due to underwriting fees and commissions and miscellaneous expenses associated with the Company's sale of $40 million of preferred stock in 1992.\nPREFERRED STOCK: In 1995, the Company refunded $70 million of preferred stock with dividend rates between 7% and 8.2%, with the proceeds from the issuance of Quarterly Income Debt Securities (QUIDS) described below. 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.\nLONG-TERM DEBT AND QUIDS: Maturities for long-term debt for the next five years are: 1996 and 1997, none; 1998, $103,500,000; 1999, $1,500,000; and 2000, $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.\nIn 1995, the Company sold $30 million of 7-3\/4% 30-year first mortgage bonds to refund a $30 million 9% issue due in 2019. The Company also issued $31.5 million of 6.15% 20-year tax-exempt notes to refund a $20 million 7% issue and an $11.5 million 6.95% issue and issued $15.4 million of 6.05% 19- year tax-exempt notes to refund a $15.4 million 9-3\/8% issue.\nIn 1995, the Company issued $70 million of 8% 30-year QUIDS to refund preferred stock. QUIDS may not be redeemed until the year 2000. Under certain circumstances the interest payments may be deferred for a period of up to 20 consecutive quarters.\nNote J - Short-Term Debt:\nTo 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. Short-term debt outstanding for 1995 and 1994 consisted of:\n1995 1994 (Thousands of Dollars) Balance at end of year: Commercial Paper.................. $36,318-6.09% Notes Payable to Banks............ 33,900-5.90% Average amount outstanding during the year: Commercial Paper.................. $ 5,692-6.00% $2,216-4.38% Notes Payable to Banks............ 5,342-5.96% 2,379-4.37% Money Pool........................ 592-5.79% 521-4.24%\nNote K - Commitments and Contingencies:\nCONSTRUCTION PROGRAM: The Company has entered into commitments for its construction program, for which expenditures are estimated to be $125 million for 1996 and $126 million for 1997. Through 1999, annual construction expenditures are not expected to significantly exceed 1996 estimated levels. Construction expenditure levels in 2000 and beyond will depend upon future generation requirements, as well as the strategy eventually selected for complying with Phase II of the Clean Air Act Amendments of 1990.\nENVIRONMENTAL MATTERS AND LITIGATION: System companies are subject to various laws, regulations, and uncer- tainties 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 opera- tions. 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.\nThe Company previously reported that the Environmental Protection Agency had identified it and its affiliates and approximately 875 others as poten- tially responsible parties in a Superfund site subject to cleanup. The Company has also been named as a defendant along with multiple other defen- dants in pending asbestos cases involving one or more plaintiffs. The Company believes that provisions for liabilities and insurance recoveries are such that final resolution of these claims will not have a material effect on its financial position.\nThe Company is guarantor as to 45% of a $50 million revolving credit agreement of AGC, which in 1995 was used by AGC solely as support for its indebtedness for commercial paper outstanding.\nAGC\nNOTES TO FINANCIAL STATEMENTS (These notes are an integral part of the financial statements.)\nNote A - Summary of Significant Accounting Policies:\nThe 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 regula- tion by the Securities and Exchange Commission (SEC) and by the Federal Energy Regulatory Commission (FERC). Significant accounting policies of the Company are summarized below.\nUSE OF ESTIMATES: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates that affect the reported amounts of assets, liabilities, revenues, expenses, and disclosures of contingencies during the reporting period, which in the normal course of business are subsequently adjusted to actual results.\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 1995, 1994, and 1993. 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 consoli- dated 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.\nFinancial 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 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.\nPrior 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 account. These balances are being amortized over the estimated service lives of the related properties.\nACCOUNTING CHANGE:\nIn March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,\" effective in 1996. The Company does not believe at this time that the adoption of this standard will have a materially adverse effect on its financial position.\nNote B - Income Taxes:\nDetails of federal income tax provisions are:\n1995 1994 1993 (Thousands of Dollars)\nCurrent income taxes payable.......... $ 7,053 $ 5,176 $ 8,112 Deferred income taxes- accelerated depreciation............ 7,818 10,883 6,637 Amortization of deferred investment credit................... (1,310) (1,316) (1,316) Total income taxes................ 13,561 14,743 13,433 Income taxes--charged to other income........................ (9) (6) (171) Income taxes--charged to operating income.................... $13,552 $14,737 $13,262\nIn 1995, the total provision for income taxes ($13,552,000) was less than the amount produced by applying the federal income tax statutory rate to financial accounting income before income taxes ($14,272,000), due primarily to amortization of deferred investment credit ($1,310,000).\nFederal income tax returns through 1991 have been examined and substan- tially settled.\nAt December 31, the deferred tax assets and liabilities were comprised of the following:\n1995 1994 (Thousands of Dollars) Deferred tax assets: Unamortized investment tax credit............ $ 27,455 $ 28,160 Other........................................ 104 27,455 28,264 Deferred tax liabilities: Book vs. tax plant basis differences, net.... 183,546 165,561 Total net deferred tax liabilities............. $156,091 $137,297\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 $14.6 million and $4.4 million as of December 31, 1995 and 1994, respectively. Regulatory liabilities of $27.5 million and $28.3 million as of December 31, 1995 and 1994, respective- ly, have been recorded 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:\nThe carrying amounts and estimated fair value of financial instruments at December 31 were as follows:\n1995 1994 Carrying Fair Carrying Fair Amount Value Amount Value (Thousands of Dollars) Liabilities: Long-term debt: Debentures......... $150,000 $146,279 $150,000 $120,195 Medium term notes.. 76,975 78,075 77,975 73,704 Commercial paper... 30,561 30,561 41,736 41,736\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 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:\nThe Company had long-term debt outstanding as follows:\nInterest December 31 Rate - % 1995 1994 (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.................. 5.82 (1) 30,561 41,736 Medium term notes due 1995-1998... 6.36 (1) 76,975 77,975 Unamortized debt discount......... (1,452) (1,546) Total......................... 256,084 268,165 Less current maturities........... 6,375 1,000 Total......................... $249,709 $267,165\n(1) Weighted average interest rate at December 31, 1995.\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 1999. Each bank has the option to discontinue its loans after 1999 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.\nMaturities for long-term debt for the next five years are: 1996, $6,375,000; 1997, $10,600,000; 1998, $60,000,000; 1999, $30,561,000; and 2000, none.\nITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nFor APS and the Subsidiaries, none. PART III\nITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANTS\nAPS, Monongahela, Potomac Edison, West Penn, and AGC. Reference is made to the Executive Officers of the Registrants in Part I of this report. The names, ages, and the business experience during the past five years of the directors of the System companies are set forth below:\n(1) See Executive Officers of the Registrants in Part I of this report for further details.\n(a) Eleanor Baum. Dean of The Albert Nerken School of Engineering of The Cooper Union for the Advancement of Science and Art. Director of Avnet, Inc. and United States Trust Company. Commissioner of the Engineering Manpower Commission, a fellow of the Institute of Electrical and Electronic Engineers, member of Board of Governors, New York Academy of Sciences and President, American Society of Engineering Education.\n(b) William L. Bennett. Chairman, HealthPlan Services Corporation, a leading managed health care services company. Formerly, Chairman and Chief Executive Officer of Noel Group, Inc. Director of Belding Heminway Company, Inc., Global Natural Resources Inc., Noel Group, Inc. and Sylvan, Inc.\n(c) Wendell F. Holland. Of Counsel, Law Firm of Reed, Smith, Shaw & McClay. Formerly, Partner, Law Firm of LeBoeuf, Lamb, Greene & MacRae, and Commissioner of the Pennsylvania Public Utility Commission.\n(d) Phillip E. Lint. Retired. Formerly, partner, Price Waterhouse.\n(e) Edward H. Malone. Retired. Formerly, Vice President of General Electric Company and Chairman, eneral Electric Investment Corporation. Director of Fidelity Group of Mutual Funds, General Re Corporation, and Mattel, Inc.\n(f) Frank A. Metz, Jr. Retired. Formerly, Senior Vice President, Finance and Planning, and Director, International Business Machines Corporation. Director of Monsanto Company and Norrell Corporation.\n(g) Steven H. Rice. Bank consultant and attorney-at-law. Director and Vice Chairman of the Board of Stamford Federal Savings Bank. Formerly, President and Director of The Seamen's Bank for Savings and Director of Royal Group, Inc.\n(h) Gunnar E. Sarsten. Chairman and Chief Executive Officer of MK International. Formerly, President and Chief Operating Officer of Morrison Knudsen Corporation, President and Chief Executive Officer of United Engineers & Constructors International, Inc. (now Raytheon Engineers & Constructors, Inc.), and Deputy Chairman of the Third District Federal Reserve Bank in Philadelphia.\n(i) Peter L. Shea. Managing director of Hydrocarbon Energy, Inc., a privately owned oil and gas development drilling and production company and an Individual General Partner of Panther Partners, L.P., a closed-end, non-diversified management company. Member and Manager of Temblor Petroleum Company L.L.C., a privately owned oil and gas exploration and production company operating exclusively in California.\n* Stanley I. Garnett, II resigned effective December 1, 1995.\nEmployment Contracts\nIn February 1995, APS entered into employment contracts with certain Allegheny Power 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 if there is a Change in Control, 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 payable to the employee will consist of a cash payment equal to 2.99 times the employee's annualized compensation and APS will maintain 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 1995, 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 attend- ed, except Executive Committee meetings, for which fees 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 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\nIn connection with the relocation of the New York office, Allegheny Power made available to each employee involved in the relocation an interest- free loan of up to 95% of the appraised equity in the employee's current residence for the purchase of a new residence. The loans must be repaid to Allegheny Power upon actual relocation. In addition, interest paid by an employee on a new mortgage will be reimbursed by Allegheny Power until the actual date of relocation. On October 10, 1995, Allegheny Power made an interest-free loan in the amount of $215,000 to Richard J. Gagliardi, a Vice President of APS. On December 7, 1995, Allegheny Power made an interest-free loan in the amount of $75,000 to Thomas K. Henderson, a Vice President of Monongahela, Potomac Edison and West Penn. On January 5, 1996, Allegheny Power made an interest-free loan in the amount of $61,000 to Peter J. Skrgic, a Senior Vice President of APS and a Vice President of Potomac Edison and AGC. Appropriate monthly interest payments as described above also have been and will be paid.\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":"313041_1995.txt","cik":"313041","year":"1995","section_1":"ITEM 1. BUSINESS\nHISTORY\nThe Corporation was incorporated under Texas law on June 5, 1979 to engage generally in the oil and gas business. Its offices and phone number are 414 E. Elm Street, Gainesville, Texas 76240, (817) 668-1271.\nDESCRIPTION OF BUSINESS\nSince its formation, the Corporation has engaged in exploration for and development of oil and gas reserves, primarily onshore in the Northeastern and Southwestern area of the United States. To a lesser extent, the Corporation has also acquired and sold oil and gas properties.\nIn December, 1992, the Board of Directors approved a Private Placement Memorandum, The Loch Exploration, Inc. 1993 A 12% Secured Convertible Debenture, in the maximum amount of $350,000. There were seventy (70) units available for private sale, each unit being comprised of a $5,000 debenture along with 25,000 shares of the Company's Common Stock. The minimum placement was 10 units. At the close of the offering on October 31, 1993, subscriptions for 25.6 Units ($128,000) had been received.\nThe funds raised were used for acquiring producing oil and gas properties through public auctions as well as privately negotiated transactions.\nThe 1993-A 12% Secured Convertible Debentures are payable on or before May 1, 1999. Interest only will be payable during the first three years at 12% per annum of the first on each month, continuing through May 1, 1996, with the unpaid principal balance being payable in 36 equal consecutive monthly installments, plus interest, commencing June 1, 1996 through May 1, 1999. The Units are secured by first mortgage covering the Corporation's interest in the producing oil and gas properties acquired with the net proceeds from this Placement. The debenture holders have the option, exercisable only during May or June of 1996, to convert the unpaid principal balance of their Debentures into their pro rata portion of 75% of the Corporation's interest in the producing oil and gas properties which secure payment of the Debentures. The Debentures are convertible in multiples of $1,000 at holder's option at $.025 per Share in 1st year, $.035 per Share in 2nd year, $.05 per Share in 3rd year and thereafter at greater of $.05 per Share or average of \"bid\/asked\" price during prior 20 day trading period.\nOn November 1, 1994, $63,000 in debentures were converted into Loch Exploration, Inc. common stock at a one-time conversion price of $.02 per share. In addition to lowering the conversion price to $.02 per share, the Board of Directors approved the continuation of the monthly interest payments on these converted Debentures for one year after the conversion date of November 1, 1994.\nOn October 5, 1995, Loch Exploration, Inc. sold sixteen natural gas producing wells along with their respective oil and gas leases, located in Chautauqua and Cattaragus Counties, New York. The properties were sold to a corporation not affiliated with the Registrant for a total price of $124,500, which was paid at closing. The subject properties were acquired from a corporation not affiliated with the Registrant for a total purchase price of $29,668 which was paid at closing on May 31, 1995.\nCOMPETITION\nSignificant competition exists for the acquisition of producing oil and gas properties and undeveloped leases. Many of the Company's competitors have greater financial capabilities and more sophisticated means for in-house evaluation than the Company possesses. The principal means of competition for oil and gas properties is the amount and terms of the consideration offered. The oil and gas exploration and development industry has been highly competitive, particularly with respect to the acquisition of desirable undeveloped oil and gas leases. However, due to the deterioration in prices the demand for oil and gas leases has dropped significantly. Competitors include the major oil companies, independent oil and gas concerns and individual producers and operators, many of which have financial resources, staffs and facilities substantially greater than those of the Company. In time of high drilling activity, exploration for and production of oil and gas may be affected by availability of the equipment and supplies and by competition for drilling rigs. The Company cannot predict the effect these factors will have on its operations. The Company owns no drilling rigs, and all of its drilling is conducted by third parties. The demand for drilling rigs and equipment has declined sharply due to the decline in the number of oil and gas wells being drilled. This has led to a decline in prices being paid to drillers. The principal means of competition in oil and gas exploration and development are product availability and price. The Company may be at a competitive disadvantage in acquiring oil and gas prospects since it must compete with such companies, many of which have greater financial resources and larger technical staffs.\nREGULATION\nThe production and sale of oil and gas is regulated by various state and federal authorities.\nSTATE REGULATION OF OIL AND GAS PRODUCTION. The State of Texas and other states in which the Company conducts oil and gas activities regulate the production and sale of oil and natural gas, including requirements for obtaining drilling permits, the method of developing new fields, the spacing and operation of wells and the prevention of waste of oil and gas resources. In addition, most states, including Texas, regulate the rate of production and may establish maximum daily production allowable from both oil and gas wells on a market demand or conservation basis. As a result of recent domestic crude oil shortages, producers have been permitted to produce 100% of allowable daily production on the basis of market demand since mid-1972; however, production continues to be regulated for conservation purposes.\nENVIRONMENTAL REGULATIONS. The Company's activities are also subject to existing federal and state laws and regulations governing environmental quality and pollution control. The existence of such regulations has had no material effect on the Company's individual operations and the cost of such compliance has not been material to date. It is anticipated that compliance with federal, state and local laws, rules and regulations regulating the discharge of material will not significantly effect upon the capital expenditures, earnings or competitive position of the Company.\nOIL PRICE REGULATION. Historically, regulatory policy affecting crude oil pricing was derived for the Emergency Petroleum Allocation Act of 1973, as amended, which provided for mandatory crude oil price controls until June 1, 1979, and discretionary controls through September 30, 1981. On April 5, 1979, President Carter directed the Department of Energy to complete administrative procedures designed to phase out, commencing June 1, 1979, price controls on all domestically produced crude oil by October 1, 1981. However, on January 28, 1981, President Reagan ordered the elimination of remaining federal controls on domestic oil production, effective immediately. Consequently, oil may currently be sold at unregulated prices.\nGAS PRICE REGULATION. The Natural Gas Act of 1938 (the \"NA\") regulates the interstate transportation and certain sales for resale of natural gas. The Natural Gas Policy Act of 1978 (the\"NGPA\") regulates the maximum selling prices of certain categories of natural gas and provided for graduated deregulation of price controls for first sales of several categories of natural gas. With certain exceptions, all price deregulation contemplated under the NGPA as originally enacted in 1978 has already taken place. Under current market conditions, deregulated gas prices\nunder new contracts tend to be substantially lower than most regulated price sellings prescribed by the NGPA.\nOn July 26, 1989, the Natural Gas Wellhead Decontrol Act of 1989 (\"Decontrol Act\") was ended. The Decontrol Act amends the NGPA to remove as of July 27, 1989 both price and non-price controls from natural gas not subject to a first sale contract in affect on July 26, 1989. The Decontrol Act also provided for the phasing out of all price regulation under the NGPA by January 1, 1993. The FERC is currently considering the promulgation of regulations pertaining to the Decontrol Act but has taken no action to date other than to propose such new rules. The Company is unable to predict the consequences of the Decontrol Act on its operations.\nEMPLOYEES\nThe Registrant presently has one full-time officer. In addition, the Registrant employs consultants from time-to-time to assist it in acquiring and evaluating oil and gas properties. Pursuant to industry practice, the Registrant expects it will pay its consultants a retainer and a cash and\/or overriding bonus on properties which prove productive which were brought to the Registrant's attention by one or more such consultants.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\n(A) PHYSICAL FACILITIES -------------------\nThe Company's executive and administrative offices are located at 414 E. Elm, Gainesville, Texas 76240, telephone 817-668-1271. The Company's offices, consisting of approximately 1,000 square feet are leased on a monthly basis at a rate of $562 per month. It is expected that this office space will serve the Company's needs adequately for the foreseeable future.\n(B) OIL AND GAS DRILLING ACTIVITIES ------------------------------- None\n(C) OIL AND GAS PROPERTIES ----------------------\nThe Following information is provided pursuant to Item 102 of Regulation S-K. All of the Registrant's reserves are located in the United States. The Registrant has no interests in oil and gas applicable to long-term supply or similar agreements with foreign governments or authorities in which the Registrant acts as producer of and share of revenues from the reserves of investors accounted for by the equity method, and hence, no information pertaining to those categories is presented herein.\nAs of December 31, 1995 the Registrant owned an aggregate of 16,718 gross (3,877 net) acres of developed oil and gas leases.\nThe oil and gas properties in which the Registrant owns an interest are held under oil and gas leases negotiated directly with private mineral owners. The leases were generally for a specific primary term, such as five years, and so long thereafter as oil or gas is produced in paying quantities. The leases generally reserve a royalty of 12-1\/2% to the mineral owner and require a payment of up to $1 per acre per year as rentals to retain the lease during the primary term. Some of the leases held by the Registrant were also subject to overriding royalty burdens reserved by various predecessors-in- title and geologists.\nThe Registrant paid $7,688 in rental costs on oil and gas leases for 1995.\nThe estimated net proved and proved developed reserves of oil and gas, together with the estimated future net revenue of those reserves, and present value of estimated future net revenue attributable to those reserves as set forth in the following tables have been estimated as of December 31, 1995, by an in-house petroleum engineer.\nOIL AND GAS RESERVES - -------------------- The following table sets forth the estimated net quantities of proved and proved developed oil and gas reserves as of December 31, 1995, 1994 and 1993.\n(1) For purposes of all tabular information included in Item 2, proved oil and gas reserves are the 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, i.e., prices and costs as of the date the estimate is made. Prices include consideration of changes in existing prices provided only by contractual arrangements, but not on escalations based upon future conditions.\n(2) For purposes of all tabular information included in Item 2, proved developed oil and gas reserves are reserves that can be expected to be recovered through existing wells with existing equipment and operating methods.\n(3) Additional oil and gas expected to be obtained through the application of fluid injection or other improved recovery techniques for supplementing the natural forces and mechanisms of primary recovery are included as \"proved developed reserves\" only after testing by a pilot project or after the operation of an installed program has confirmed through production response that increased recovery will be achieved.\nPRESENT VALUE OF ESTIMATED FUTURE NET REVENUE - --------------------------------------------- The following table sets forth information as to the present value of estimated future net revenues of proved reserves and proved developed reserves attributable to the Registrant as of December 31, 1995, 1994 and 1993. Present Value of future net revenues for the years shown below were computed by applying current contract prices of oil and gas to estimated future production of proved oil and gas revenues after deducting production taxes, direct lease operating expenses and ad valorem taxes, discounted by 10% per year, in accordance with Securities and Exchange Commission rules and regulations.\nThe Registrant has a gas sales contract with U.S. Gypsum Company which expires on 30 days written notice by either party. The Registrant has no long-term oil contracts. The Registrant would not be adversely affected by loss of the U.S. Gypsum Company contract.\nOIL AND GAS RESERVE ESTIMATES FILED - ----------------------------------- No reserve reports pertaining to the Registrant's proved or proved developed reserve estimates were filed by the Registrant with or included in reports to any federal authority or agency since the beginning of the last fiscal year.\nNET QUANTITIES OF OIL AND GAS PRODUCED FOR LAST FISCAL YEAR - ----------------------------------------------------------- The following table sets forth information as to quantities of oil and gas produced, net to the Registrant's interest, for the years ended December 31, 1995, 1994 and 1993.\n(1) Includes production that is owned by the Registrant and produced to its interest, less royalties and production due others.\n(2) Includes only marketable production of a gas on an \"as sold\" basis. Recovered gas-lift gas and reproduced gas may not be included until sold.\nAVERAGE SALES PRICES AND PRODUCTION COSTS - ----------------------------------------- The following table sets forth information as to the average sales price (including transfers) per unit of oil or gas produced and the average production cost (lifting cost) per unit of production for the last fiscal years ended December 31, 1995, 1994 and 1993.\n(1) Production (lifting) costs do not include depreciation, depletion, and amortization of capitalized acquisitions, exploration, and development costs, and indirect management costs.\nGROSS AND NET PRODUCTIVE OIL AND GAS WELLS AND DEVELOPED ACRES - -------------------------------------------------------------- The following table sets forth, as of December 31, 1995, the Registrant's interest in productive oil and gas wells and developed acres:\nDEVELOPED ACRES (4) PRODUCTIVE WELLS (1) ------------------- --------------------- GROSS (2) NET (3) GROSS (2) NET (3) ------------------- --------------------- Oil Gas Oil Gas --- --- --- --- 16,718 3,877 66 53 2.8 19 ------ ----- -- -- --- --\nThe Registrant's interests in oil and gas wells are all operated by third party operators. Information as to multiple completions is not available to the Registrant.\n(1) Includes producing wells and wells capable of production. One or more completions in the same bore hole are counted as one well.\n(2) A gross well or acre is a well or acre in which a working interest is owned.\n(3) A net well or acre is deemed to exist when the sum of fractional ownership working interests in gross wells or acres equals one. The number of net wells or acres is the sum of the fractional working interests owned in gross wells of acres expressed as whole numbers and fractions thereof.\n(4) Includes acres spaced or assignable to productive wells.\nUNDEVELOPED ACREAGE AS OF DECEMBER 31, 1995 - ------------------------------------------- 4632 acres\nPRODUCTIVE AND DRY EXPLORATORY AND DEVELOPMENT WELLS - ---------------------------------------------------- The following table sets forth the number of gross and net productive and dry development wells drilled in which the Registrant had an interest in each fiscal year indicated below:\n(1) Refers to the number of wells (holes) completed any time during the fiscal year regardless of when drilling was initiated.\n(2) A productive well is an exploratory or a development well that is not a dry hole.\n(3) A dry well (hole) is an exploratory or a development well found to be incapable of producing either oil or gas in sufficient quantities to justify completion as an oil or gas well.\n(D) NET OIL AND GAS PRODUCTION -------------------------- Same as (C)\n(E) UNIT SALES PRICE AND PRODUCTION COST ------------------------------------ Same as (C)\n(F) RESERVES -------- Same as (C)\n(G) GAS COMPRESSION EQUIPMENT ------------------------- The Company owns two (2) gas compressors. The compressors are currently servicing wells in Palo Pinto and Parker Counties, Texas which are operated by Spindletop Oil & Gas Co. and are covered by written lease agreements between the Company and Spindletop Oil & Gas Co. The current monthly rental payable to the Company under the terms of the rental agreements is $3,064.00 less maintenance costs. The Company and Spindletop Oil & Gas Co. are brother-sister companies as defined by the Internal Revenue Service Code. Paul E. Cash is a substantial working interest owner in the above described wells and is also the majority shareholder of Spindletop Oil & Gas Co.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Registrant knows of no material pending legal proceedings to the subject and no such proceedings are known to the Registrant to be contemplated by governmental authorities.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS\nNot applicable.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS\nThe Company's Common Stock is traded in the over-the-counter market, and at various times has been listed in the \"OTC Bulletin Board\". The following table sets forth the range of high and low bid quotations as reported by security dealers, do not include retail mark-up, mark-down or commission, and do not necessarily represent actual transactions.\nThe Company has not paid cash dividends on shares of its common stock since its inception and does not anticipate the payment of cash dividends on its Common Stock in the foreseeable future. It is expected that any earnings which may be generated from operations would be used to finance the growth of the Company. Holders of shares of Common Stock are entitled to receive such dividends as may be declared by the Company's Board of Directors.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following table summarizes certain selected historical financial data for the five years ended December 31, 1995 and is qualified in its entirety by the more detailed financial statements included in this report and should be read in conjunction with such financial statements, the notes thereto and with Management's Discussion and Analysis of Financial Condition and Results of Operations included in this report.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company plans to invest funds in capital assets necessary to the growth of its oil and gas exploration and related activities. The funding of these expenditures is planned from equity offerings, cash flow, bank borrowings, debenture sales, joint ventures and limited partnerships and it is the Company's intent to continue the use of all these capital sources in future periods.\nRESULTS OF OPERATIONS\n1995 COMPARED TO 1994 - ---------------------\nTotal revenues for 1995 were $327,075 as compared to $222,723 in 1994, primarily due to the gain on sale of oil and gas properties totaling approximately $95,000. Costs and expenses have increased from $221,049 in 1994 to $284,105 in 1995. This increase was due to general administration and lease operating expenses.\n1994 COMPARED TO 1993 - ---------------------\nTotal revenues for 1994 were $222,723 as compared to $97,808 in 1993, primarily as the result of a full year of revenues generated by production related to reserves acquired during 1993. Costs and expenses have increased from $128,064 in 1993 to $221,049 in 1994. This increase was due to depletion, depreciation, and lease operating expenses.\n1993 COMPARED TO 1992 - ---------------------\nTotal revenues for 1993 were $97,808 as compared to $97,910 in 1992. Costs and expenses have increased from $108,105 in 1992 to $128,064 in 1993. This increase was due to depletion, depreciation, general administration, and lease operating expenses.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA\nThe audited financial statements and schedules are included on pages through.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES\nIn January 1996, the Company's Board of Directors accepted the resignation of Rigler, Hess & Rohmer, P.C., Certified Public Accountants and named Farmer, Fuqua, Hunt & Munselle, P.C., Certified Public Accountants as the Company's new independent auditors.\nThere were no disagreements with Rigler, Hess & Rohmer, P.C. on any matters 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 Directors and executive officers of Loch and certain information concerning each of them are set forth in the following table:\nNAME AGE POSITION - ---- --- --------\nGlenn L. Loch 60 President, Chief Executive Officer, Treasurer and Director Paul E. Cash 63 Vice President, Secretary and Director K. Paul Cash 39 Vice President, Assistant Secretary and Director\nGLENN L. LOCH graduated from the Louisiana State University with a B.S. degree in Petroleum Engineering in 1960. He has served as President of the Company from June 1979 through March 1989 and from January 1, 1990 to present. For more than five years preceding 1979, he served as president of Loch & Tracy Engineering Company, and Vice President of Scientific Petroleum, Inc. He is past Chairman of Texas Chapter, A.P.I. and received the Meritorious Service Award for the A.P.I. in 1968. He is past mayor of Gainesville, Texas, and was a member of the Governor's State Manpower Board.\nPAUL E. CASH is a graduate of The University of Texas (B.B.A. Accounting) and is a Certified Public Accountant. He has been active in the oil and gas industry for over 20 years, during which time he has served as financial officer of two publicly owned companies, Texas Gas Producing Co., and Landa Oil Co., and also served as president of publicly owned Continental American Royalty Co., Aledo Oil & Gas Co., Prairie States Energy Co., Spindletop Oil & Gas Co., and Double River Oil & Gas Co. During the last 10 years, Mr. Cash has also been an officer and part owner of a large number of private oil and gas companies and partnerships, including EnnTex Oil & Gas Co. and Spindletop Oil & Gas Co. He is currently serving as President and a Director of Spindletop Oil & Gas Co., and is an officer and director of Double River Oil & Gas Co. and Loch Exploration, Inc. Mr. Cash was formerly the Mayor of Sunnyvale, Texas.\nK. PAUL CASH is a geologist and received his degree in geology from the University of Texas at Arlington in 1981. He has been serving as Vice President and Director of Spindletop Oil & Gas Co. since 1993. Prior to 1993, he had been a Director and President of Daltex Oil & Gas Co., a privately held company for more than ten years.\nFAMILY RELATIONSHIPS\nK. Paul Cash is the son of Paul E. Cash.\nDIRECTORSHIP\nGlenn Loch, director of the Registrant is not a director of any other company with a class of securities registered pursuant to Section 12 of the Securities Exchange Act of 1934, as amended (\"1934 Act\"). No Director of the Registrant is subject to the requirements of Section 15(d) of the Act or any company registered as an investment company under the Investment Company Act of 1940. Paul E. Cash is a director of other companies with a class of Securities Registered pursuant to Section 12 of the 1934 Act as shown: officer\/director of Spindletop Oil & Gas Co., and officer\/director of Double River Oil & Gas Co.\nPOTENTIAL CONFLICTS OF INTEREST\nBoth Paul E. Cash and K. Paul Cash, officers and directors of the Company are actively involved in the management of other companies, and are owners of rental equipment and personally invest in oil and gas properties. In some instances, business opportunities in the oil and gas industry known to them or developed by them may be offered first to other companies or individuals, and the Registrant may not be able to participate in such ventures.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe Company had no director or officer, nor group of directors and officers whose aggregate renumeration exceeded $60,000 during twelve (12) months ended December 31, 1995.\nThe Company is not a party to any employment contract, nor does it have any pension, profit sharing, bonuses, stock option plan or royalty pools in effect or under consideration. Such plans may be adopted in the future if deemed in the best interest of the Company by its Board of Directors.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following table sets forth the ownership of the Company's Common Stock $.001 par value per share as of February 1, 1996, by (i) each director of the Company, (ii) each person who is known by the Company to own beneficially more than 5% of the outstanding shares of its Common Stock, and (iii) information as to the shares beneficially owned by all directors and officers of the Company as a group.\n(1) Glenn Loch, officer and director of the registrant, owns 50% of Sonel Companies, Inc.\nThe Registrant knows of no contractual arrangements which might at a subsequent date result in a change in control of the Registrant.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nOn February 24, 1994, Mr. Paul E. Cash purchased 35,310,000 shares of Loch Exploration, Inc. common stock from Double River Oil & Gas Co. There was no change of control of the Company since Mr. Cash was the majority owner of Double River Oil & Gas Co., at the time of the exchange.\nThe Company serves as its own stock transfer agent, and charges a fee of $5.00 per new certificate issued for such services. Computer services and records of such shareholder transactions are furnished and maintained by Spindletop Oil & Gas Co. Spindletop charges a fee to the Company for such services, which approximate the $5.00 stock transfer fee. Paul E Cash is president and a director of Spindletop, and owns in excess of 80% of the common stock of Spindletop.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL SCHEDULES, AND REPORTS ON FORM 8-K\nThe following documents are filed as a part of this report.\nFinancial Statements (included herein at Pages through\nReport of Independent Certified Public Accountants.\nBalance Sheets - December 31, 1995 and 1994................\nStatements of Operations for the years ended December 31, 1995, 1994 and 1993..............................................\nStatements of Stockholders' Equity for the years ended December 31, 1995, 1994 and 1993........................................\nStatements of Cash Flows for the years ended December 31, 1995, 1994 and 1993..............................................\nNotes to Financial Statements..............................\nReports on Form 8-K\nA report on Form 8-K was filed on February 24, 1994, a copy of which is attached.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nLOCH EXPLORATION, INC.\nBy Glenn L. Loch ----------------------------------- Glenn L. Loch President\nDated: April 10, 1996\nPursuant to the requirements of the Securities Exchange Act 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.\nNAME TITLE DATE - ---- ----- ----\nGlenn L. Loch President, Chief April 10, 1996 - ----------------------- Executive Officer, Glenn L. Loch Treasurer and Director\nPaul E. Cash Vice President, April 10, 1996 - ----------------------- Secretary and Director Paul E. Cash\nK. Paul Cash Vice President, April 10, 1996 - ----------------------- Assistant Secretary K. Paul Cash and Director\nLOCH EXPLORATION, INC. Index to Financial Statements and Schedules\nPage ---------\nIndependent Auditors' Report\nBalance Sheets - December 31, 1995 and 1994 -\nStatements of Operations for the years ended December 31, 1995, 1994 and 1993\nStatements of Changes in Shareholders' Equity for the years ended December 31, 1995, 1994 and 1993\nStatements of Cash Flows for the years ended December 31, 1995, 1994 and 1993\nNotes to Financial Statements\nAll schedules have been omitted because they are not applicable, not required, or the information has been supplied in the financial statements or notes thereto.\n[FARMER, FUQUA, HUNT & MUNSELLE, P.C. LETTERHEAD APPEARS HERE]\nINDEPENDENT AUDITORS' REPORT ----------------------------\nBoard of Directors Loch Exploration, Inc.\nWe have audited the accompanying balance sheets of Loch Exploration, Inc. (a Texas Corporation) as of December 31, 1995 and 1994, and the related statements of operations, changes in shareholders' equity and cash flows for the years ended December 31, 1995, 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 audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as 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 Loch Exploration, Inc. as of December 31, 1995 and 1994, and the results of its operations and its cash flows for the years ended December 31, 1995, 1994 and 1993, in conformity with generally accepted accounting principles.\nOur audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedules 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.\n\/s\/ Farmer, Fuqua, Hunt & Munselle, P.C.\nDallas, Texas April 3, 1996\nLOCH EXPLORATION, INC. Balance Sheets December 31,\nASSETS\nThe accompanying notes are an integral part of these statements.\nLOCH EXPLORATION, INC. Balance Sheets - (Continued) December 31,\nLIABILITIES AND SHAREHOLDERS' EQUITY\nThe accompanying notes are an integral part of these statements.\nLOCH EXPLORATION, INC. Statements of Operations Years Ended December 31,\nThe accompanying notes are an integral part of these statements.\nLOCH EXPLORATION, INC. Statements of Changes in Shareholders' Equity Years Ended December 31, 1995, 1994, and 1993\nThe accompanying notes are an integral part of these statements.\nLOCH EXPLORATION, INC Statements of Cash Flows Years Ended December 31,\nThe accompanying notes are an integral part of these statements.\nLOCH EXPLORATION, INC NOTES TO FINANCIAL STATEMENTS December 31, 1995, 1994 and 1993\nNOTE 1 - ORGANIZATION AND NATURE OF OPERATIONS\nOrganization - ------------\nLoch Exploration, Inc. (the Company) was originally organized under the laws of the State of Texas, on June 5, 1979.\nThe Company filed for Chapter 11 bankruptcy in April 1989, and was reorganized in connection with its Plan of Reorganization (the Plan), effective November 17, 1989. In connection with the Plan, approximately 3,500,000 shares of the Company's common stock are expected to be issued to the Company's former shareholders, to be exchanged as follows: one share of the Company's $.001 par value common stock for each eight shares of the Company's pre-reorganization common stock. As of December 31, 1995, 1994 and 1993, 3,391,152, 3,390,726, and 3,390,726 and shares, respectively, have been issued to former shareholders in connection with the Plan.\nNature of Operations - --------------------\nThe Company is engaged in the exploration for and development of oil and gas reserves, primarily in the Northeastern and Southwestern United States. To a lesser extent, the Company also acquires and sells oil and gas properties.\nNOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nOil and Gas Properties - ----------------------\nThe Company follows the full cost method of accounting for its oil and gas exploration and development activities. Under this method, the Company capitalizes leasehold acquisition, exploration (including unsuccessful exploration) and development costs into one cost center. If unamortized costs within the cost center exceed the cost center ceiling, as defined, the excess will be charged to expense during the year in which the excess occurs.\nDepreciation and amortization for each cost center are computed on a composite unit-of-production method, based on estimated provided reserves attributable to the respective cost center. All costs associated with oil and gas properties are currently included in the base for computation and amortization. Such costs include all acquisition, exploration and development costs. All of the Company's oil and gas properties are located within the continental United States.\nGains and losses on sales of oil and gas properties are treated as adjustments of capitalized costs. Gains or losses on sales of property and equipment, other than oil and gas properties, are recognized as part of operations. Expenditures for renewals and improvements are capitalized, while expenditures for maintenance and repairs are charged to operations as incurred.\nLOCH EXPLORATION, INC NOTES TO FINANCIAL STATEMENTS - Continued December 31, 1995, 1994 and 1993\nNOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -CONTINUED\nOil and Gas Properties - Continued - ----------------------------------\nCosts of oil and gas properties including leases are periodically evaluated by management and losses are recognized if a property becomes impaired or the net value of the capitalized cost center exceeds the present value of discounted future net cash flows.\nProperty and Equipment - ----------------------\nDepreciation is provided in amounts sufficient to relate to the cost of depreciable assets to operations over their estimated service lives (5 to 15 years). The straight-line method of depreciation is used for financial reporting purposes, while accelerated methods are used for tax purposes.\nStatement of Cash Flows - -----------------------\nThe Company does not consider any of its assets to meet the definition of a cash equivalent.\nIncome Taxes - ------------\nThe Company accounts for income taxes pursuant to Statement of Financial Accounting Standards No. 109 \"Accounting for Income Taxes\", which requires the recognition of deferred tax liabilities and assets 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 tax liabilities and assets are determined based on the difference between the financial statement carrying amounts and tax bases of assets and liabilities, using enacted tax rates in effect in the years in which the differences are expected to reverse. These temporary differences primarily relate to depreciation, depletion and intangible drilling costs.\nUse of Estimates - ----------------\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nNOTE 3 - ACCOUNTS PAYABLE AND ACCRUED LIABILITIES\nLOCH EXPLORATION, INC NOTES TO FINANCIAL STATEMENTS - Continued December 31, 1995, 1994 and 1993\nNOTE 4 - LONG-TERM DEBT\nThe debentures are convertible into shares of the Company's common stock, in multiples of $1,000, at the holder's option, at the rate of $.025 per share in the first year, $.035 per share in the second year, $.05 per share in the third year, and, thereafter, at the greater of $.05 per share or the average of the bid\/asked price of the Company's common stock during the prior 20 day trading period. In 1994, the Company's Board of Directors approved a one-time, lowered conversion price of $.02 per share, and approved the continuation of interest payments on the converted debentures, for one year after the conversion date of November 1, 1994. On November 1, 1994, debentures totaling $56,700, net of the related unamortized discount, were converted into 3,150,000 shares of the Company's common stock, at the lowered conversion price of $.02 per share.\nFuture maturities of long-term debt are as follows:\nLOCH EXPLORATION, INC NOTES TO FINANCIAL STATEMENTS - Continued December 31, 1995, 1994 and 1993\nNOTE 5 - SHAREHOLDERS' EQUITY\nIn connection with a private placement offering (the Offering) of its debentures in May 1993, the Company acquired 640,000 shares of its $.001 par value common stock as treasury stock by donation from two shareholders. The shares were sold in units with the debentures in the Offering, with a minimum unit consisting of $5,000 debentures and 25,000 shares of the Company's $.001 par value common stock. The Company recorded $12,800 as additional paid-in capital in accordance with the private placement memorandum, and a discount of an equal amount was recorded with respect to the debentures. The discount is being amortized over the life of the debentures.\nDuring 1994, two of the Company's shareholders contributed 2,500,000 shares of the Company's common stock back to the Company. This treasury stock was issued by the Company to a third party, in exchange for an oil and gas property, in a transaction recorded at $150,000, based on the estimated fair value of the assets acquired.\nNOTE 6 - INCOME TAXES\nThere was no income tax expense recorded in 1995 or 1994, due to the availability of a nonconventional source fuel credit, which eliminated any federal income taxes. This credit is available to the extent of the current year tax liability, and is not available for carryover to future years.\nDeferred taxes have not been provided because temporary differences between book and taxable income are not significant.\nNOTE 7 - RELATED PARTY TRANSACTIONS\nIn June 1993, the Company entered into an agreement with a wholly-owned subsidiary of Spindletop Oil & Gas Co. (Spindletop), a related party, whereby the parties agreed to combine their talents and resources to evaluate and acquire producing and non-producing oil and gas properties at various auctions. Any properties acquired under the terms of this agreement are to be acquired by initial assignment to Spindletop. Spindletop has agreed to provide the Company with a recordable assignment of its interest, such interest to be determined by the proportionate share of monies expended for the acquisition of said properties. All costs are borne by the Company and Spindletop in the same proportions as their respective ownership interests. Spindletop serves as administrator for the properties acquired in connection with this agreement, and is entitled to an overhead reimbursement for properties for which it serves as operator. This agreement had an initial term of six months, and continues month- to-month, thereafter, until cancelled by either party. No properties were acquired in connection with this agreement during 1995. During 1994 and 1993, the Company acquired interests in approximately seven and 78 properties, respectively, with total costs of approximately $7,000 and $81,000, respectively, in connection with this agreement.\nLOCH EXPLORATION, INC NOTES TO FINANCIAL STATEMENTS - Continued December 31, 1995, 1994 and 1993\nNOTE 7 - RELATED PARTY TRANSACTIONS - CONTINUED\nAt December 31, 1994, the Company had notes payable to Spindletop, totaling $34,800, consisting of a promissory note in the amount of $14,800, and an 8% convertible promissory note in the amount of $20,000. The first promissory note bore interest at 8% per annum, due quarterly, beginning April 1, 1993. The second promissory note had an interest rate of 8% per annum and was due and payable on December 31, 1997. Interest on the second note was due annually, payable in cash or common stock of the Company at the request of either the holder or the Company, at valuation rates detailed in the note. The first such interest payment was due December 31, 1993. The accrued interest on both notes, in the amount of $2,800, that was due and payable on December 31, 1993, was converted to 70,000 shares of the Company's $.001 par value common stock on May 25, 1994. Both notes were repaid in 1995.\nThe Company leases its compressors to Spindletop. During the years ended December 1995, 1994 and 1993, Spindletop paid the Company approximately $35,000, $40,000, and $42,000, respectively, under the lease agreements for the compressors.\nThe Company operates an oil and gas partnership drilling program, Loch Exploration, Inc. 1980A, for which it makes commitments, pays expenses and collects an operating fee.\nNOTE 8 - CASH FLOW INFORMATION\nThe Company paid approximately $17,000, $19,000, and $2,000 for interest in 1995, 1994 and 1993, respectively.\nExcluded from the Statements of Cash Flows were the effects of certain non-cash investing and financing activities, as follows:\nNOTE 9 - EARNINGS PER SHARE\nEarnings per common share is based on the weighted average number of shares outstanding during each year.\nLOCH EXPLORATION, INC NOTES TO FINANCIAL STATEMENTS - Continued December 31, 1995, 1994 and 1993\nNOTE 10 - CONCENTRATIONS OF CREDIT RISK\nAccounts receivable as of December 31, 1995 and 1994 are primarily from oil and gas operators, including Spindletop, related to the Company's interests in oil and gas wells, and its compressor leases.\nNOTE 11 - COMMITMENTS AND CONTINGENCIES\nThe Company leases its office facilities on a month to month basis. Total rent expense incurred was approximately $7,800, $7,100 and $7,600 in 1995, 1994 and 1993, respectively.\nNOTE 12 - ADDITIONAL OPERATIONAL AND BALANCE SHEET INFORMATION\nCertain information about the Company's operations for the years ended December 31, 1995, 1994 and 1993 follows.\nLOCH EXPLORATION, INC NOTES TO FINANCIAL STATEMENTS - Continued December 31, 1995, 1994 and 1993\nNOTE 12 - ADDITIONAL OPERATIONAL AND BALANCE SHEET INFORMATION - CONTINUED\nIn October 1995, the Company sold, for $124,500, its interests in 16 natural gas producing properties. These properties had been acquired in May 1995 for approximately $30,000. The full cost method of accounting requires that sales of oil and gas properties shall be accounted for as adjustments of capitalized costs, unless such adjustments would significantly, alter the relationship between capitalized costs and proved reserves attributable to a cost center. Due to the significance of the effect of this sale on the relationship between capitalized costs and proved reserves, a gain was recognized in the sale in the 1995 statement of operations.\nNOTE 13 - SUPPLEMENTARY INCOME STATEMENT INFORMATION\nNOTE 14 - SUPPLEMENTAL RESERVE INFORMATION (UNAUDITED)\nThe Company's net proved oil and gas reserves as of December 31, 1995, 1994 and 1993 have been estimated by Company personnel in accordance with guidelines established by the Securities and Exchange Commission. Accordingly, the following reserve estimates were based on existing economic and operating conditions. Oil\nLOCH EXPLORATION, INC NOTES TO FINANCIAL STATEMENTS - Continued December 31, 1995, 1994 and 1993\nNOTE 14 - SUPPLEMENTAL RESERVE INFORMATION (UNAUDITED) - CONTINUED\nand gas prices in effect at December 31 of each year were used. Operating costs, production and ad valorem taxes and future development costs were based on current costs with no escalation.\nThere are numerous uncertainties inherent in estimating quantities of proved reserves and in projecting the future rates of production and timing of development expenditures. The following reserve data represents estimates only and should not be construed as being exact. Moreover, the present values should not be construed as the current market value of the Company's oil and gas reserves or the costs that would be incurred to obtain equivalent reserves.\nChanges in Estimated Quantities of Proved Oil and Gas Reserves\nStandardized Measure of Discounted Future Net Cash Flows and Changes Therein Relating to Proved Oil and Gas Reserves (Unaudited)\nThe Standardized Measure of Discounted Future Net Cash Flows and Changes Therein Relating to Proved Oil and Gas Reserves (\"Standardized Measures\") does not purport to present the fair market value of a company's oil and gas properties. An estimate of such value should consider, among other factors, anticipated future prices of oil and gas, the probability of recoveries in excess of existing proved reserves, the value of probable\nLOCH EXPLORATION, INC NOTES TO FINANCIAL STATEMENTS - Continued December 31, 1995, 1994 and 1993\nNOTE 14 - SUPPLEMENTAL RESERVE INFORMATION (UNAUDITED) - CONTINUED\nStandardized Measure of Discounted Future Net Cash Flows and Changes Therein Relating to Proved Oil and Gas Reserves (Unaudited) - Continued\nreserves and acreage prospects, and perhaps different discount rates. It should be noted that estimates of reserve quantities, especially from new discoveries, are inherently imprecise and subject to substantial revision.\nFuture net cash flows were computed using the contract price, which was not escalated. Future production includes operating costs and taxes. No deduction has been made for interest, general corporate overhead, depreciation or amortization. The annual discount of estimated future net cash flows is defined, for use herein, as future cash flows discounted at 10% per year, over the expected period of realization.","section_15":""}
{"filename":"795662_1995.txt","cik":"795662","year":"1995","section_1":"ITEM 1. BUSINESS\nSterling Chemicals, Inc. (\"Company\") was organized as a Delaware corporation in 1986 and has its principal executive offices in Houston, Texas. The Company manufactures seven commodity petrochemicals at its Texas City, Texas plant (\"Texas City Plant\") and manufactures chemicals for use primarily in the pulp and paper industry at four plants in Canada. At its Texas City Plant, the Company produces styrene, acrylonitrile, acetic acid, plasticizers, lactic acid, tertiary butylamine (\"TBA\") and sodium cyanide. The Company generally sells its petrochemical products to customers for use in the manufacture of other chemicals and products, which in turn are used in the production of a wide array of consumer goods and industrial products. Sodium chlorate is produced at the four plants in Canada and sodium chlorite is produced at one of the Canadian locations. The Company licenses, engineers and oversees construction of large-scale chlorine dioxide generators for the pulp and paper industry as part of the pulp chemicals business. These generators convert sodium chlorate into chlorine dioxide at pulp mills.\nHereafter, unless otherwise indicated, the Company and its subsidiaries are collectively referred to as \"the Company\".\nRECENT DEVELOPMENTS\nIn fiscal 1995, the Company initiated a three year capital spending program of approximately $200 million. The program includes modernization of the Company's Texas City petrochemical plant, the construction of a methanol plant at Texas City, a substantial expansion of the Company's acetic acid capacity, the construction of a sodium chlorate plant at Valdosta, Georgia, debottlenecking projects to add incremental capacity at the Company's existing sodium chlorate facilities and various other projects. The plant modernization effort at Texas City includes a significant capital commitment for replacing the older control technology in the styrene, acrylonitrile and acetic acid units with state-of-the-art distributive control systems, which should result in increased efficiencies and stronger operating fundamentals.\nThe Company is constructing a world-scale, 150 million gallon per year methanol plant at Texas City as part of its capital plan. The plant is expected to be operational by June 1996. Capital investment in the plant and production capacity will be shared by the Company and BP Chemicals Inc. Approximately 50% of the methanol production will be used as a raw material in the Company's acetic acid plant, replacing methanol that is currently being purchased, while the remainder will be available for the merchant market and for BP Chemical's worldwide acetic acid business. The plant will be constructed at significantly less than normal replacement cost because available equipment already at the Company's Texas City Plant will be refurbished and used in the project. The plant will use highly efficient state-of-the-art ICI catalyst technology. The lower capital investment coupled with modern operating technology should result in a methanol plant with significant competitive advantages.\nIn a project related to the new methanol plant, Praxair, Inc. (\"Praxair\") will construct a new partial oxidation unit at the Company's Texas City Plant that will supply carbon monoxide and hydrogen to the Company for use in the production of acetic acid and plasticizers. The Company's synthesis gas reformer, which currently is being used to produce carbon monoxide and hydrogen at the Texas City Plant, will then be available for use in the methanol plant. Refurbishing the existing reformer, rather than building a new one, will enable the Company to construct the methanol plant at significantly less than the normal capital cost of a new plant. The partial oxidation unit is expected to begin production in the second quarter of fiscal 1996.\nThe Company and BP Chemicals are expanding acetic acid capacity by nearly 30% or 200 million pounds, to nearly 800 million pounds annually. This expansion is scheduled to be completed early in fiscal 1996. BP Chemicals will continue to market all of the Company's acetic acid production.\nThe Company also is constructing a 110,000 ton per year sodium chlorate plant in Valdosta, Georgia. The new facility, expected to cost approximately $50 million, will increase the Company's total annual sodium chlorate capacity by more than 30% to nearly 460,000 tons. Valdosta, Georgia was selected because of its proximity to existing customers, currently being supplied from the Company's Canadian plants, and to reliable, competitively priced electricity, the most important variable in sodium chlorate production costs. The new facility is intended to meet the growing market demand from the pulp and paper industry in the southeastern U.S. In addition to building the new facility to meet growing demand, debottlenecking is adding incremental capacity at each of the Company's existing sodium chlorate plants.\nOn April 13, 1995, the Company entered into a seven-year credit agreement (the \"Credit Agreement\") with a group of 14 commercial banks that was used to refinance the Company's existing debt except for the revolving debt associated with Sterling Pulp Chemicals, Ltd. (\"Sterling Pulp\"). The Credit Agreement provides for a revolving credit facility of $150 million (the \"Revolver\") and a term loan of $125 million (the \"Term Loan\"). The Credit Agreement will reduce the Company's future interest costs and provide additional financial flexibility and debt capacity. On April 28, 1995, Sterling Pulp entered into a separate agreement for a Cdn. $20 million revolving credit facility with the Bank of Nova Scotia (the \"Canadian Revolver\"). The Canadian Revolver was utilized to refinance the revolving debt associated with Sterling Pulp.\nOn September 28, 1995, Sterling Pulp entered into a seven-year credit agreement to finance the construction of the new sodium chlorate plant (the \"Chlorate Plant Credit Agreement\") with the same bank group that is a party to the Credit Agreement. Sterling Pulp can borrow up to $60 million under the Chlorate Plant Credit Agreement to purchase taxable bonds from the local county development authority that will utilize the bond proceeds to finance the construction of the plant.\nSALES AND MARKETING\nThe Company sells its products primarily pursuant to multi-year contracts and spot transactions in both the domestic and export markets through its commercial organization and sales force. This long-term, high volume focus allows the Company to maintain relatively low selling, general and administrative expenses related to the marketing of its products. The Company competes primarily on the basis of product price, quality and deliverability. Prices for the Company's commodity chemicals are determined by market factors that are largely beyond the Company's control, and, except with respect to a number of its multi-year contracts, the Company generally sells its products at prevailing market prices. The Company emphasizes the importance of delivering products to its customers on time and within specifications. In its effort to insure that its products are of consistently high quality, the Company uses a statistical quality control program.\nDuring fiscal 1995 a significant portion of the Company's production from the Texas City Plant was dedicated to multi-year contracts with Monsanto Company (\"Monsanto\"), subsidiaries of British Petroleum Company plc (\"BP\"), BASF Corporation (\"BASF\"), Mitsubishi International Corporation (\"Mitsubishi\") Flexsys America L.P. (a joint venture between Monsanto and Akzo Nobel N. V.) (\"Flexsys\") and E.I. du Pont de Nemours and Company (\"Dupont\"). These contracts provide for the dedication of 100% of the Company's production of acetic acid, plasticizers, TBA and sodium cyanide, each to one customer, as well as significant portions of the Company's production of styrene monomer and acrylonitrile. Under certain market conditions, the loss of one or more of these customers or a material reduction in the amount of product purchased by one or more of them could have a material adverse effect on the Company. The balance of the Company's products are sold by its direct sales force, which concentrates on the styrene, acrylonitrile, pulp chemical and lactic acid markets. Revenues from BP and Mitsubishi accounted for approximately 16% and 13%, respectively, of the Company's revenue during the year ended September 30, 1995. These sales were primarily petrochemical products. There were no individual customers of the Company's pulp chemical business which accounted for more than 10% of the Company's revenues.\nSome of the Company's multi-year contracts for its petrochemical products are structured as conversion agreements, pursuant to which the customer furnishes raw materials which the Company processes. In exchange, the Company receives a fee typically designed to cover its fixed and variable costs of production and to generally provide an element of profit dependent in amount on the then existing market conditions. These conversion agreements allow the Company to lower working capital requirements and, in some cases, to gain access to certain improvements in manufacturing process technology. The Company believes its conversion agreements help insulate the Company to some extent from the effects of declining markets and changes in raw material prices while allowing it to share in the benefits of favorable market conditions for most of the products sold under these arrangements.\nThe Company's production is geared primarily to the level of incoming orders and to projections of future demand. In general, the Company does not manufacture its products against a backlog of firm orders. The Company has no material contracts with the government of the United States or any state, local or foreign government.\nFor information regarding the Company's export sales and domestic and foreign operations, see Item 8, Note 7 of the \"Notes to Consolidated Financial Statements\" which is hereby incorporated by reference.\nPRODUCTS\nAt its Texas City Plant, the Company manufactures seven commodity petrochemicals which are used in the manufacture of other goods or in other chemical processes. At its four Canadian plants, the Company manufactures chemicals used primarily in the bleaching of kraft pulp for paper manufacturing. The Company also is a supplier of patented and proprietary technology for chlorine dioxide generators used by certain mills in the kraft pulp bleaching process.\nPETROCHEMICALS\nStyrene. The Company manufactures styrene from ethylene and benzene using Monsanto\/Lummus technology. Styrene is principally used in the manufacture of intermediate products such as polystyrene, acrylonitrile butadiene styrene (\"ABS\") resins, synthetic rubbers, SBLatex, unsaturated polyester resins and styrene acrylonitrile resins (\"SAN\"). These intermediate products are used to produce various consumer products, including building products, boat and automotive components, disposable cups and trays, packaging and containers, housewares, tires, audio and video cassettes, luggage, children's toys, paper coating, appliance parts and carpet backing.\nThe Company and Monsanto are currently operating under a conversion agreement and a sales agreement, each effective through December 31, 1995. Under these agreements the Company provides Monsanto, subject to a specified minimum and maximum, a major portion of Monsanto's styrene requirements for its manufacture of styrene-containing polymers. The Company and Monsanto have entered into a new conversion agreement that will begin January 1, 1996 and be effective through December 31, 2000 with terms and conditions similar to the previous agreements. The new agreement permits Monsanto to terminate its obligations upon twelve months' notice to the Company should Monsanto sell its business that uses styrene or to assign the agreement, subject to the Company's consent, to a third party that may purchases the business. Monsanto has recently announced a tentative agreement to sell its ABS and SAN businesses to Bayer AG. However, the Company has not yet received any notice of termination or assignment of the new agreement. During fiscal 1995, the Company delivered approximately 13% of its styrene production to Monsanto pursuant to these agreements.\nEffective April 1, 1994 the Company and BP entered into a sales and purchase agreement. The term of the agreement initially expires in December 1996 but extends on a year-to-year basis thereafter unless terminated by either party by giving the other a written notice of at least twelve months prior to cancellation. During fiscal 1995, the Company delivered approximately 13% of its styrene production to BP pursuant to this agreement.\nThe balance of the Company's styrene production is sold by the Company's sales organization in the export and domestic markets.\nAcrylonitrile. The Company manufactures acrylonitrile by propylene ammoxidation.. Acrylonitrile is used primarily in the manufacture of intermediate products such as acrylic fiber and ABS resins. The principal end uses for acrylonitrile include apparel, furnishings, upholstery, household appliances, carpets and plastics for automotive parts.\nApproximately 80% of the Company's acrylonitrile production in fiscal 1995 was exported, principally to the Far East, either directly or pursuant to arrangements with large international trading companies. Except for the two conversion agreements described below, the Company's acrylonitrile production is sold by its sales force and certain international agents.\nThe Company and Monsanto entered into a multi-year conversion agreement effective January 1, 1994 which superseded a prior agreement that had been in place since 1986 and contains essentially the same terms. This agreement will expire at the end of 1998. The agreement permits Monsanto to terminate all or part of its obligation upon six months' notice to the Company should Monsanto sell its business using acrylonitrile. Monsanto has recently announced a tentative agreement to sell its ABS and SAN businesses to Bayer AG. However, the Company has not yet received any notice of termination or assignment of this agreement. During fiscal 1995, the Company delivered approximately 25% of its acrylonitrile production to Monsanto pursuant to this agreement.\nIn 1988, the Company entered into a long-term conversion agreement with BP, under which BP contributed the majority of the capital expenditures required for starting the third acrylonitrile reactor train at the Texas City Plant and has the option to take up to approximately one-sixth of the Company's total acrylonitrile capacity. BP furnishes the necessary raw materials and pays the Company a conversion fee for the amount of acrylonitrile it takes. During fiscal 1995, the Company delivered approximately 21% of its acrylonitrile production to BP pursuant to this agreement. This agreement has an initial term of ten years, with BP having the option to extend the agreement for two additional five-year terms. One of the Company's three acrylonitrile reactors incorporates certain BP technological improvements under a separate license agreement from BP, and the Company has the right to incorporate these and any future improvements into its other existing acrylonitrile facilities. BP has a first security interest in and lien on the third reactor and related equipment and in the first acrylonitrile produced in the three reactor units and the proceeds generated from the sales thereof to the extent of the acrylonitrile which BP is entitled to purchase under the production agreement. These rights are only to be exercised upon an event of default by the Company.\nAcetic Acid. The Company produces acetic acid from carbon monoxide (produced on-site from carbon dioxide and natural gas) and methanol using a technology owned and licensed to the Company by BP. Acetic acid is primarily used in the manufacture of intermediate products such as vinyl acetate monomer. These intermediate products are used to produce various consumer products, including pharmaceuticals, adhesives, glue, cigarette filters and surface coatings.\nThe Company has had an agreement in effect since August 1986 with BP which, as now amended, gives BP the exclusive right to purchase all of the Company's acetic acid production until August 2016. In exchange for that exclusive right, BP is obligated to make certain unconditional monthly payments to the Company until August 2006. BP provides methanol and reimburses the Company on the basis of a formula designed to provide the Company with full cost recovery. In addition, the Company is entitled to receive annually a portion of the profits earned by BP from the sale of acetic acid produced by the Company. The acetic acid unit is subject to certain security arrangements (taking the form of a sale-leaseback transaction) which provide that, until August 1996, under certain limited circumstances generally under the Company's control, BP can take physical possession of and operate the acetic acid unit. In August 1996, title to the acetic acid unit will revert to the Company.\nPlasticizers. The Company manufactures plasticizers employing a series of processes using alpha-olefins and orthoxylene as the primary raw materials. Major end-uses for plasticizers include flexible plastics such as shower curtains and liners, floor coverings, cable insulation, upholstery and plastic molding.\nThe Company has a product sales agreement with BASF that extends through the end of the decade, pursuant to which the Company sells all of its plasticizer production to BASF. BASF provides certain raw materials to the Company and markets the plasticizers produced by the Company. BASF pays fees to the Company on a formula basis designed to reimburse the Company's direct and allocated costs. In addition, the Company is entitled to a share of profits earned by BASF attributable to the plasticizers supplied by the Company. BASF retains title to and has a security interest in the raw materials furnished by it and in the finished inventory of plasticizers produced by the Company for delivery to BASF.\nLactic Acid. The Company markets synthetic lactic acid, the highest purity lactic acid available, to food processing and pharmaceutical companies in both the domestic and export markets through its sales personnel. The Company uses hydrogen cyanide, a by-product of its acrylonitrile process, acetaldehyde and hydrogen chloride as raw materials. Primary uses for lactic acid are as a food additive and preservative and in pharmaceuticals.\nTBA. The Company manufactures TBA by adding part of the Company's by-product hydrogen cyanide to isobutylene in an acid catalyst reaction. Major end uses for TBA include pesticides, solvents, pharmaceuticals and synthetic rubber. The Company sells all of its TBA production to Flexsys pursuant to a long-term conversion agreement which expires on December 31, 1996, but shall continue thereafter unless terminated by either party with 24 months prior written notification, as of December 31 of any calendar year. The Company has not received any such notice and does not anticipate any such termination in the foreseeable future. The Company's capacity for TBA production is currently 21 million pounds per year.\nSodium Cyanide. The Company operates a sodium cyanide facility owned by Dupont which was constructed in 1989 on land owned by the Company at the Texas City Plant. The Company and Dupont have an agreement whereby the Company receives a fee for operating the facility for up to 30 years. The facility utilizes as a raw material hydrogen cyanide, a by-product of the Company's acrylonitrile process. The Company is compensated by Dupont for the raw material value of the hydrogen cyanide as well as for the Company's allocated and incremental out-of-pocket costs for operating the facility. Either party may terminate this agreement by giving 36 months' written notice. Termination by the Company prior to the 15th anniversary of the agreement (May 2003) would require various remedies to be made by the Company to Dupont, including penalties and cost of removal of the facility from the Company's plant site. Termination by Dupont would require Dupont to pay for the cost of removal of the facility. Assignability of the agreement is limited, and if the Company assigns the agreement under certain circumstances, it must deliver to Dupont a lease for the land on which the facility is situated and permit Dupont to operate the facility. Dupont also may operate the sodium cyanide facility in the event of certain defaults.\nPULP CHEMICALS\nSodium Chlorate. Sodium chlorate is used in the production of chlorine dioxide and is sold primarily to paper manufacturers for use as a bleaching chemical for kraft pulp manufacturing. Kraft pulp is a strong paper or paperboard made from wood chips. Bleached kraft pulp is used to make uncoated paper for commercial printing and for office copiers and printers and coated paper for magazines, catalogues and promotional printed products. Chlorine dioxide also is used to bleach paperboard for packing, tissue and other products and as a raw material to produce sodium chlorite. Other uses for sodium chlorate include a raw material for rocket propellants and as a cotton defoliant. The Company markets sodium chlorate primarily in Canada and the U.S.\nHeightened environmental concerns and new regulations limiting dioxins and furans in bleach plant effluent have resulted in growth in the sodium chlorate industry as pulp mills have accelerated substitution of chlorine dioxide for elemental chlorine. Chlorine dioxide is a powerful and highly selective oxidizing agent suitable for pulp bleaching with the ability to substantially reduce dioxins and furans in bleach plant effluent as well as produce high- brightness pulp with little or no damage to the cellulose fiber.\nThe Company sells sodium chlorate generally under one to five year supply contracts, most of which provide for minimum and maximum volumes at market prices. In addition, most sales contracts contain certain \"meet or release\" pricing clauses and some contain restrictions on the amount of future price increases. Certain contracts are evergreen and require advance notice before termination.\nChlorine Dioxide Generators. Through its ERCO Systems Group (\"ERCO\"), the Company is the largest worldwide supplier of patented technology for the generators which certain pulp mills use to convert sodium chlorate into chlorine dioxide. Each mill that uses chlorine dioxide requires at least one generator. The Company receives revenue when a generator is sold to a mill and also receives royalties from the mill after start-up, generally over the next ten-year period, based on the amount of chlorine dioxide produced by the generator.\nThe research and development group of Sterling Pulp works to develop new and more efficient generators. When pulp mills move to higher levels of substitution of chlorine dioxide for chlorine, they usually upgrade generator capacity which frequently requires new generator technology. Mills may also convert to a newer generator to take advantage of efficiency advances and technological improvements. Each upgrade or conversion results in a licensing agreement which generally provides for payment of an additional ten-year royalty. Selection by a mill of the type of generator is completely independent from the selection of their sodium chlorate supplier.\nThe Company has a small representative office in Beijing, China. This office focuses on the development of opportunities for future sales of sodium chlorate and chlorine dioxide generators as well as for the licensing and construction of sodium chlorate plants in that region. The first generator in China to convert sodium chlorate to chlorine dioxide was sold by ERCO and commenced operation in fiscal 1994. Several more generators are under construction in China by ERCO.\nSodium Chlorite. The Company manufactures sodium chlorite at its Buckingham, Quebec facility. Sodium chlorite is a specialty product used primarily for water treatment and as a disinfectant for fresh produce.\nRAW MATERIALS FOR PRODUCTS AND ENERGY RESOURCES\nFor each of the Company's products, the combined cost of raw materials and utilities is far greater than all other production costs combined. Thus, an adequate supply of these materials at reasonable prices is critical to the success of the Company's business. The Company does not currently produce any of its major raw materials, benzene, ethylene, propylene, ammonia and methanol, at the Texas City Plant, or electricity at its pulp chemical facilities, although a methanol plant is under construction at the Texas City Plant as previously described under \"Recent Developments\". Moreover some of the Company's competitors are integrated and produce their own raw materials. Although management believes that the Company will continue to be able to secure adequate supplies of its raw materials at acceptable prices to meet its requirements, there can be no assurance that it will be able to do so.\nPETROCHEMICALS\nStyrene. Styrene is a clear liquid that the Company manufactures from ethylene and benzene. The Company's conversion agreements require that other parties furnish to the Company the ethylene and\/or benzene necessary to fulfill its conversion obligations. Approximately 30% and 20% of the Company's fiscal 1995 benzene and ethylene requirements, respectively, were furnished by customers pursuant to conversion arrangements. The Company purchases benzene and ethylene for use in the remainder of its production of styrene for sale to others. Benzene and ethylene are both commodity petrochemicals and the price for each can fluctuate widely due to significant changes in the availability of these products, such as major capacity additions or significant plant operating problems, and due to variations in the economy and commodity\nchemical markets in general. The Company has multi-year arrangements with several ethylene suppliers that provide for its estimated requirements for purchased ethylene at generally prevailing and competitive market prices. If the conversion agreement with Monsanto is terminated or reduced upon the sale of Monsanto's ABS and SAN businesses, or if various other customers for whom the Company now manufactures styrene under conversion arrangements were to cease furnishing their own raw materials and seek only to purchase styrene from the Company, the Company's requirements for purchased benzene and ethylene could significantly increase. The Company believes that benzene and ethylene will, for the foreseeable future, remain in adequate supply to meet demand.\nAcrylonitrile. The Company produces acrylonitrile by reacting propylene and ammonia over a solid-fluidized catalyst at low pressure. The Company's conversion agreements require that other parties furnish to the Company the propylene and\/or ammonia necessary to fulfill its conversion obligations. Approximately 45% of the Company's fiscal 1995 propylene and ammonia requirements were furnished by customers pursuant to conversion arrangements. The Company purchases propylene and ammonia for use in the remainder of its production of acrylonitrile for sale to others. Propylene and ammonia are both commodity petrochemicals and the price for each can fluctuate widely due to significant changes in the availability of these products such as major capacity additions or significant plant operating problems, and due to variations in the economy and commodity chemical markets in general. If various customers for whom the Company now manufactures acrylonitrile under conversion arrangements were to cease furnishing their own raw materials and seek only to purchase acrylonitrile from the Company, the Company's requirements for purchased propylene and ammonia could significantly increase. The Company believes that both ammonia and propylene will, for the foreseeable future, remain in adequate supply to meet demand.\nHydrogen cyanide is a by-product of the manufacture of acrylonitrile and is used by the Company as a raw material for the production of lactic acid, TBA and sodium cyanide and is also burned as fuel.\nAcetic Acid. Acetic acid is manufactured by the Company primarily from carbon monoxide and methanol using a technology originally licensed worldwide by Monsanto to the Company and others but now owned by BP. At present, the Company's methanol is supplied by BP under its long-term contract with the Company which expires in August 2016. However, the Company has begun construction of a methanol unit at its Texas City Plant. BP is a participant in the project. Once completed, this unit will supply the methanol needed for production of acetic acid. Carbon monoxide is currently produced on-site from carbon dioxide and natural gas. Carbon dioxide and natural gas are purchased under requirements contracts with major suppliers and are available in adequate supply. In a project related to the new methanol plant, Praxair will construct and own a partial oxidation unit at the Company's Texas City Plant that will supply carbon monoxide to the Company for production of acetic acid. The construction of the partial oxidation unit will allow equipment currently used in the production of carbon monoxide to be used in the new methanol unit, thereby reducing the new capital required for the methanol unit. The partial oxidation and methanol units are expected to begin production in the second and third quarters of fiscal 1996, respectively.\nPlasticizers. The Company manufactures plasticizers using a series of processes. Primary raw materials are alpha-olefins and orthoxylene, which are supplied by BASF under its long-term contract with the Company which expires at the end of 1999. Management believes that adequate supplies of raw materials will be available for the Company's needs in the foreseeable future.\nLactic Acid. Lactic acid is manufactured from the Company's hydrogen cyanide, a by-product of its acrylonitrile process, and two other raw materials, acetaldehyde and hydrogen chloride, which are readily available from commercial suppliers.\nTBA. TBA is produced by the addition of hydrogen cyanide to isobutylene in an acid catalyst reaction. The Company uses a portion of its by-product hydrogen cyanide in this process. Flexsys supplies the isobutylene, sulfuric acid and caustic soda under its long-term conversion agreement with the Company. Management believes that supplies of these raw materials will remain adequate for its needs in the foreseeable future.\nSodium Cyanide. Sodium cyanide is manufactured from the Company's by-product hydrogen cyanide and caustic soda. Dupont supplies the caustic soda under its long-term contract with the Company which expires in May 2018.\nPULP CHEMICALS\nSodium Chlorate. Sodium chlorate is manufactured by passing an electric current through an undivided cell containing a solution of sodium chloride (salt). Electric power costs typically represent approximately 70% of the variable cost of production of sodium chlorate. Electric power is purchased by each of the Company's facilities pursuant to contracts with local electric utilities. Consequently, the rates charged by local electric utilities are an important competitive factor among sodium chlorate producers. On average, the Company's electrical power costs are believed to be competitive with other producers in the areas in which it operates.\nThe Company also purchases sodium chloride for use in the manufacture of sodium chlorate. Sodium chloride is purchased under requirements contracts with major suppliers. The Company believes that sodium chloride will be available for its needs for the foreseeable future.\nTECHNOLOGY AND LICENSING\nPETROCHEMICALS\nMonsanto has assigned to the Company certain third party technology licenses that granted the Company a nonexclusive, irrevocable and perpetual right and license to use Monsanto's technology at the Texas City Plant in effect at the time of the acquisition for the purpose of (i) continuing the production of the chemicals which were then produced at the Texas City Plant and (ii) modifying, operating and maintaining the synthesis gas production unit to produce carbon monoxide, blend gas and hydrogen for internal plant use. During fiscal 1991, BP purchased the license related to the acetic acid unit from Monsanto. Under this license, the Company is not obligated to make any royalty payments to BP. The Company believes that these licenses are material to the operation of the Texas City Plant.\nBP has granted to the Company a perpetual, royalty free license to use BP's acrylonitrile technology at the Company's Texas City Plant as part of the acrylonitrile expansion project. The Company and BP have agreed to cross- license any technology or improvements relating to the manufacture of acrylonitrile in the Company's facility.\nDuring the term of the Company's agreement with Dupont pursuant to which Dupont supplies the caustic soda needed in the Company's manufacture of sodium cyanide, Dupont has the option to provide to the Company any improvements in its sodium cyanide technology without cost to the Company.\nManagement believes that the manufacturing processes that the Company utilizes at the Texas City Plant are cost effective and competitive. Although the Company does not engage in alternative process research with respect to its U.S. operations, it does monitor new technology developments, and when management believes it is appropriate, the Company will seek to obtain licenses for process improvements.\nPULP CHEMICALS\nThere are various technologies available for production of sodium chlorate. The Company's current technology was developed internally, prior to the acquisition of the pulp chemicals business by the Company in 1992, and is metal cell technology utilizing titanium anodes, piping and reactors.\nThe principal business of ERCO is the design, sale and technical service of custom-built patented chlorine dioxide generators. Sterling Pulp's engineering group is involved in the technical support of the Company's sales and marketing group through joint calling efforts and defines the scope of a project and produces technical schedules and cost estimates. The Company performs detailed design of chlorine dioxide generators which are then constructed by customers. Plant and instrumentation testing and generator start-up are handled by a joint engineering\/technical service team of the Company. The Company is involved in a number of patent disputes with Akzo Nobel. See Item 8, Note 6 of the \"Notes to Consolidated Financial Statements\".\nThe Company's pulp chemical research and development activities are carried out at its Toronto, Ontario laboratories. Activities include the development of new or improved chlorine dioxide generation processes and research in new technologies focusing on electrochemical and membrane technology related to chorine dioxide, including municipal water treatment, its by-products and pulp mill effluent.\nCOMPETITION AND INDUSTRY CONDITIONS\nGENERAL\nThe basis for competition in all of the Company's petrochemical products is price, quality and deliverability. The industries in which the Company operates are highly competitive. Many of the Company's competitors are larger and have greater financial resources than the Company. Among the Company's competitors are some of the world's largest chemical companies and major integrated petroleum companies, some of which, unlike the Company, have their own raw material sources.\nThe Company has both domestic and foreign competitors and sells its products in both domestic and foreign markets. The Company sells large percentages of its styrene and acrylonitrile production in the export market, which has historically been more volatile than the domestic market. The Company's export operations subject it to a number of potential risks, including fluctuations in currency, exchange control regulations, changes in foreign tax and economic policies including import and trade restrictions, employment and environmental regulations, governmental instability and other potentially detrimental foreign government practices or policies affecting U.S. companies doing business abroad.\nThe petrochemical industry historically has experienced periods of high demand and high capacity utilization resulting in increasingly high operating margins and profitability. This generally leads to new capacity investment until supply exceeds demand. The overcapacity in turn leads to periods of decreasing capacity utilization and declining operating margins until demand exceeds supply and the cycle is repeated. Changes in capacity, combined with the effects of U.S. and world economic conditions, directly impacts margins and the volume of products sold. There is no assurance that capacity increases in the U.S. and in other parts of the world or other factors, will not adversely affect the industry's supply and demand balance.\nHistorically, petrochemical industry profitability has been affected by vigorous price competition, which may intensify due to, among other things, new domestic and foreign industry capacity. The Company's businesses are subject to changes in the world economy, including changes in currency exchange rates. In general, weak economic conditions either in the United States or in the world tend to reduce demand and put pressure on margins. Operations outside the United States are subject to the economic and political risks inherent in the countries in which they operate. Additionally, the export and domestic markets can be affected significantly by import laws and regulations. During 1995, the Company's export sales were approximately 52% of total revenues. It is not possible to predict accurately how changes in raw material costs, market conditions or other factors will affect petrochemical industry margins in the future.\nPETROCHEMICALS\nStyrene. According to industry publications, the total domestic capacity for styrene is currently 13.8 billion pounds per year. The Company's rated capacity of 1.5 billion pounds per year represents approximately 11% of the domestic capacity. The Company's major domestic competitors in the manufacture of styrene are Dow Chemical Company, Arco Chemical Company, Amoco Chemicals Company, Chevron Chemical Company, COS-MAR (a joint venture of General Electric Company and Fina) and Huntsman Chemical Corporation.\nPrior to 1994, styrene's profitability was depressed because of both overcapacity and recessionary pressures in parts of the world. By the spring of 1994, however, market growth resulting from economic expansion had absorbed much of the excess capacity. As a result, the Company's styrene volumes and margins\nincreased substantially in fiscal 1994 and through most of fiscal 1995. Beginning in the third quarter of fiscal 1995, styrene prices started decreasing as demand weakened as a result of a general economic slowdown in the worldwide economic growth rate, prompting customers to begin utilizing their available inventories and decreasing purchases of additional product. The weakening market conditions were accelerated in the fourth fiscal quarter by significantly decreased purchases of styrene and styrene derivatives by China primarily as a result of changes in China's enforcement of economic and tax policies and monetary constraints that negatively affected its imports. China accounts for a significant portion of global purchases of styrene and styrene derivatives. While the industry cannot predict when China's chemical imports will return to previous levels, the Company believes that demand in the Far East is beginning to improve. The Company anticipates that styrene demand worldwide will improve in fiscal 1996, relative to the fourth quarter of fiscal 1995, although the Company does not anticipate prices and margins returning to 1995 levels.\nAcrylonitrile. According to industry publications, the total domestic capacity for acrylonitrile production is approximately 3.4 billion pounds per year, with the Company's rated capacity of approximately 700 million pounds representing approximately 21% of the total. Approximately 80% of the Company's acrylonitrile production in fiscal 1995 was exported, either directly or pursuant to arrangements with large international trading companies. Other major domestic producers of acrylonitrile are Cytec Industries (formerly American Cyanamid Co.), Dupont, BP and Monsanto.\nAs a result of the Company's very high percentage of export acrylonitrile sales, demand for the Company's acrylonitrile is most significantly influenced by export customers, particularly those that supply acrylic fiber to China. In recent years the acrylic fiber market has been subject to volatility because of the relatively unstable nature of the Chinese market. During most of fiscal 1995, strong demand for acrylic fiber and ABS, particularly in China, increased demand for acrylonitrile. However, the Company believes that acrylonitrile demand began to weaken in the third quarter for the same reasons that caused the significant negative changes in the styrene market. Demand for acrylonitrile from export customers decreased significantly in the fourth quarter of fiscal 1995 as a result of these changes, although export prices and margins did not decrease significantly until the first quarter of fiscal 1996. While the industry cannot predict when China's chemical imports will return to previous levels, the Company believes that demand in the Far East is beginning to improve. The Company anticipates that acrylonitrile demand worldwide will improve in fiscal 1996, relative to the fourth quarter of fiscal 1995, although the Company does not anticipate prices and margins returning to 1995 levels.\nAcetic Acid. According to industry publications, the total domestic capacity for acetic acid production is approximately 4.7 billion pounds per year, with the Company's current rated capacity of approximately 600 million pounds per year representing approximately 13% of the total domestic capacity. The Company has begun an expansion of acetic acid capacity from 600 million pounds to nearly 800 million pounds annually. This expansion is expected to be completed in 1996. The Company's major domestic competitors are Hoechst Celanese Corporation, Eastman Chemical Products, Inc. and Hanson plc (formerly Quantum Chemicals).\nPlasticizers. The Company's capacity for plasticizers is 280 million pounds per year. The Company's major domestic competitors in the production of plasticizers are Exxon Chemical Americas, Aristech Chemicals and Eastman Chemical Products, Inc. The Company has an agreement with BASF pursuant to which the Company sells all of its plasticizer production to BASF through the end of the decade.\nLactic Acid. The Company is the sole domestic producer of synthetic lactic acid, the highest purity lactic acid available. Major competition for the Company in lactic acid is from foreign competitors who manufacture primarily fermentation grade lactic acid. Management believes that the quality of synthetic lactic acid generally is preferred over the quality of fermentation grade lactic acid, particularly in certain time and heat exposure applications.\nTBA. The Company believes that there are currently only three TBA production units in the world: the Company's TBA unit (21 million pounds rated capacity), Nitto Chemical Industries Co., Ltd. (3.3 million pounds rated capacity) and BASF (13 million pounds rated capacity).\nSodium cyanide The Company operates a sodium cyanide plant at its Texas City facility which is owned by Dupont. The capacity of this plant is 100 million pounds per year.\nPULP CHEMICALS\nSodium Chlorate. The Company markets sodium chlorate primarily in Canada and the U.S. The Company is one of the three largest producers of sodium chlorate in North America with its rated capacity of 350,000 tons representing approximately 20% of North American capacity. Upon completion of the Valdosta, Georgia plant, the Company's capacity for sodium chlorate will increase to nearly 460,000 tons. The Company's major North American competitors in the manufacture of sodium chlorate are Akzo Nobel, CXY Chemicals, Ltd. and Kerr- McGee.\nChlorine Dioxide Generators. The Company is the largest worldwide supplier of patented technology for chlorine dioxide generators, and historically has supplied approximately two-thirds of all large scale pulp mill generators worldwide. The Company's major competitor is Akzo Nobel. Outside of North America, Akzo Nobel operates under the name Cell Chem.\nSodium Chlorite. Total North American capacity for sodium chlorite production is approximately 13,000 metric tons per year, with the Company's rated capacity of approximately 3,000 metric tons representing approximately 23% of the total. The only other North American producer of sodium chlorite is Vulcan Chemical.\nFor information regarding capacity utilization and revenues for each of the Company's principal products, see Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" which is hereby incorporated herein by reference.\nENVIRONMENTAL AND SAFETY MATTERS\nThe Company's operations involve the handling, production, transportation and disposal of materials classified as hazardous or toxic and are extensively regulated under environmental and health and safety laws. Operating permits required for the Company's operations are subject to periodic renewal and may be revoked or modified for cause.\nNew laws or permit requirements and conditions may affect the Company's operations, products or waste disposal. Past or future operations may result in claims, regulatory action or liabilities. Expenditures could be required to upgrade wastewater collection, pretreatment, disposal systems or other matters. Some risk of environmental costs and liabilities is inherent in particular operations and products of the Company, as it is with other companies engaged in similar businesses.\nManagement believes that the environmental management programs to maintain compliance with applicable environmental laws are appropriate and adequate. As part of its ongoing environmental oversight efforts, the Company conducts or commissions reviews of its environmental performance and addresses issues identified. The Company routinely conducts inspection and surveillance programs to detect and respond to any leaks or spills of regulated hazardous substances and to correct any identified regulatory deficiency. To reduce the risk of off- site consequences from any unanticipated event, the Company acquired a greenbelt buffer zone adjacent to the Texas City Plant in 1991. The Company also participates in a regional air monitoring network to monitor ambient air quality in the Texas City community. This five-year program is part of the Company's commitment to Responsible Care initiatives of the Chemical Manufacturers Association and Canadian Chemical Producers Association.\nThe Company has recently been recognized as a 33\/50 Environmental Champion by the EPA for surpassing the emission reduction goals of the 33\/50 program at the Texas City Plant faster than the EPA's timetable. The voluntary 33\/50 program targeted 17 high priority chemicals included in the EPA's Toxic Release\nInventory. Six of the 17 chemicals are present at the Company's Texas City Plant. The goal of the program was a 33% reduction in air emissions of these compounds by 1992, compared to 1987 levels, and a 50% reduction by 1995. For the 1994 reporting year, the Company achieved a 74% reduction in the targeted chemicals including a 99% reduction in chromium and nickel compounds, a 96% reduction in hydrogen cyanide emissions by converting this byproduct into sodium cyanide and an 87% reduction in benzene emissions primarily by constructing a major new waste water treatment facility. In addition to these improvements, the Company has voluntarily initiated a complete review of the overall environmental condition at its Texas City Plant and will initiate appropriate actions or preventative projects necessary to insure that the facility continues to operate in a safe and environmentally responsible manner, including appropriate responses to previously identified elevated concentrations of certain chemicals in the soil and groundwater. The Company is presently unable to determine what remediation or other action, if any, may need to be taken regarding these conditions. No assurances can be given that the Company will not incur material environmental expenditures associated with its facilities, operations or products.\nChanging and increasingly strict environmental laws and regulations might affect the manufacture, handling, processing, distribution or use of chemical products and the release, treatment, storage or disposal of wastes by the Company. For example, at both the state and federal level, the trend towards regulation of discharges on a sectoral, geographic or multimedia basis may directly or indirectly affect producers of specific chemicals. Such actions may be expected to exert pressure on companies in the commodity chemical industry to enhance their wastewater recycling and on-site treatment systems to reflect the government's evolving views. Accordingly, the Company could be required from time to time to make expenditures to upgrade its wastewater collection, pretreatment or disposal systems at the Texas City Plant.\nProduction of chemical products involves the use, storage, transportation and disposal of materials that may be classified as hazardous or toxic under applicable laws. Management believes that the Company's procedures for the use, storage, transportation and disposal of these materials are consistent with industry standards and applicable laws and that it takes precautions to protect its employees and others from harmful exposure to such materials. However, there can be no assurance that past or future operations will not result in exposure or injury or to claims of injury by employees or the public due to the use, storage, transportation or disposal of these materials.\nUnder the Assets Purchase Agreement for the Company's acquisition of the Texas City Plant from Monsanto, Monsanto agreed to be liable and to indemnify the Company for (a) any pre-acquisition violations of environmental law; (b) the clean-up of pre-acquisition deposits or emissions, of hazardous substances (defined in the Assets Purchase Agreement as government agency mandated remedial work, including investigative work, monitoring and temporary relocation of assets) with certain limitations for securely-contained deposits; (c) legal liability to third parties as a result of such pre-acquisition deposits or emissions or for exposure to hazardous substances; (d) clean-up, fines, penalties and third party liabilities arising from any improper clean-up undertaken by Monsanto pursuant to the Assets Purchase Agreement; and (e) related legal fees, costs and expenses incurred by the Company. Certain of Monsanto's obligations and agreements under the provisions of the Assets Purchase Agreement described herein (\"Monsanto's Commitments\") expire and are no longer applicable under a variety of circumstances, including an assignment of the Assets Purchase Agreement without Monsanto's consent, or if either Gordon A. Cain, the Company's Chairman, or J. Virgil Waggoner, the Company's President and Chief Executive Officer, cease to have Active Management Responsibility (as defined in the Assets Purchase Agreement) for the Company or cease to own at least 2.5% of the outstanding shares of voting stock of the Company, except due to death or disability. In the event of a death or disability prior to August 1, 1996, the Company has the right to designate, subject to Monsanto's reasonable approval, a replacement for either individual. After that date, however, certain of Monsanto's Commitments expire if, for any reason, including prior or subsequent death or disability and regardless of any previously designated replacement, either of the two named individuals no longer have such Active Management Responsibility or ownership. Certain of Monsanto's Commitments also expire (as to the facility\nas a whole or any operating unit) on the purchase or assumption of operating responsibility by a third party for the entire facility or unit. In addition, certain of Monsanto's Commitments could be terminated as to specific areas of the Texas City Plant if the Company does not satisfy various other conditions contained in the Assets Purchase Agreement. The Company's management is unable to determine the impact, if any, of the potential expiration of Monsanto's Commitments.\nThe Company has entered into negotiations with Monsanto with respect to the scope of Monsanto's obligations to the Company for pre-acquisition environmental conditions at the Company's Texas City Plant under applicable state and federal law and the indemnification provisions of the Assets Purchase Agreement. To date, the negotiations have not produced any change in the parties respective rights and obligations. The results of those negotiations could impact the Company's future environmental expenditures.\nIn connection with the Company's purchase of the pulp chemical business in 1992, the seller, Tenneco Canada, Inc., contractually retained liability for costs, damages, fines, penalties and other losses under claims by third parties (including employees and authorities) arising from the ownership or operation of the facilities and businesses prior to the acquisition. The Company is also indemnified against the breach of Tenneco Canada's environmental remediation covenants. These covenants oblige Tenneco Canada to do specific remedial work (including decommissioning the old section of the Vancouver facility, which is underway) at the facilities within set time periods, and to do any investigation, monitoring or remedial work required by present or future legislation governing environmental conditions predating the acquisition. Tenneco Canada has, in addition, indemnified the Company against losses arising from the remediation of preacquisition environmental conditions or from preacquisition violations of environmental laws. With the exception of any third party claims, the losses against which the Company is indemnified do not include consequential damages or lost profits.\nGroundwater data obtained in the course of the acquisition of the pulp chemical business indicated elevated concentrations of certain chemicals in the soil and groundwater at the four Canadian sites. The Company conducted a focused baseline sampling of groundwater conditions beneath its Canadian facilities in connection with Tenneco Canada's indemnification of the Company for preclosing conditions which confirmed the previous data. Tenneco Canada continues to work with the provincial governments to address these issues. The Company from time to time has encountered elevated concentrations of chemicals in soils or groundwater at its Canadian plants which it has addressed or is addressing.\nDuring the course of the acquisition of the pulp chemical facilities by the Company, air emissions sources were reviewed, and any available dustfall and vegetation stress studies were considered. This review indicated emission excursion episodes at specific locations in the scrubber systems at the Thunder Bay, Buckingham and Vancouver facilities. The conditions at Thunder Bay and Vancouver have been addressed and satisfactorily resolved and the conditions at Buckingham are being addressed. Management believes that the Company is otherwise in compliance in all material respects with permit requirements under applicable provincial law for operating emissions sources.\nThe Company's pulp chemical business is sensitive to potential environmental regulation. In general, environmental regulations support substitution of chlorine dioxide, which is produced from sodium chlorate, for elemental chlorine in the pulp bleaching process. Certain environmental groups are encouraging passage of regulations which restrict the amount of Absorbable Organic Halides (AOX) or chlorine derivatives in bleach plant effluent. Increased substitution of chlorine dioxide for elemental chlorine in the pulp bleaching process significantly reduces the amount of AOX and chlorine derivatives in bleach plant effluent. As long as there is not an outright ban on chlorine containing compounds, regulation restricting AOX or chlorine derivatives in bleach plant effluent should favor the use of chlorine dioxide, thus sodium chlorate. Any significant ban on all chlorine containing compounds could have a material adverse effect on the Company's financial condition and results of operations.\nThere are currently efforts in some jurisdictions to ban all chlorine and chlorine-containing products, including chlorine dioxide, from the pulp bleaching process. British Columbia has a regulation in place that would effectively eliminate the use of chlorine dioxide in the bleaching process by the year 2002. The pulp and paper industry is working to change this regulation and believes that a ban of chlorine dioxide in the bleaching process will yield no measurable environmental or public health benefit. The Company is not aware of any other laws or regulations currently in place which would restrict the use of the product.\nEmissions into the air from the Company's Texas City Plant are subject to certain permit requirements and self-implementing emission limitations and standards under state and federal law. The Company's Texas City Plant is located in an area that is classified by the EPA as not having attained the ambient air quality standards for ozone, which is controlled by direct regulation of volatile organic compounds (\"VOCs\") and nitrogen oxide (\"NOx\"). Additional requirements were issued in fiscal 1992 and modified in fiscal 1994 by the Texas Natural Resource Conservation Commission (\"TNRCC\") in order to achieve ambient air quality standards for ozone. These measures may substantially increase the Company's VOCs and NOx control costs in the future, although the cost and full impact, if any, cannot be determined at this time.\nAdditionally, the Clean Air Act Amendments of 1990 contain new federal permit requirements and provisions governing toxic air emissions. The Company has incurred and will incur additional costs to comply with this law and with requirements issued by the State of Texas to control VOCs and NOx, as will all other similarly situated organic chemical manufacturing facilities.\nManagement believes that the Company's solid and hazardous waste management practices are in compliance in all material respects with permit and other requirements under applicable environmental law. However, there can be no assurance that past practices or future operations will not result in claims or regulatory action.\nEMPLOYEES\nAs of September 30, 1995, just under 1,200 persons were employed by the Company including approximately 300 at its facilities in Canada. Approximately 60% of the employees at the Company's manufacturing facilities are covered by union agreements. The primary union agreement is with the Texas City, Texas Metal Trades Council, AFL-CIO, of Galveston County, Texas and covers all hourly employees except security guards at the Texas City Plant. The union agreements for the security guards are with the Associated Guards of the United States. These agreements were last negotiated in May 1993 and the full contract is again subject to renegotiation in May 1996. Employees at the Buckingham plant are represented the Canadian Communications, Energy and Chemicals Workers Union and the Office and Professional Employees International Union, while employees at the Vancouver plant are represented by the Pulp Paper and Woodworkers Union. The Buckingham agreements were last negotiated in June 1995 and are subject to renegotiation in November 1997. The Vancouver agreement was renegotiated in November 1994 and is subject to renegotiation in November 1997. The Company enjoys a good relationship with its employees.\nINSURANCE\nThe Company currently maintains $500 million of coverage for property damage to its Texas City facility and resulting business interruption. Although the Company carries such insurance, it has only one styrene manufacturing facility and one acrylonitrile manufacturing facility; thus, a significant interruption in the operation of either facility could have a material adverse affect on the Company's financial condition, results of operations or cash flows. The Company maintains $338 million of combined coverage for property damage and resulting business interruption for its pulp chemical operations. The Company also maintains other insurance coverages for various risks associated with its business. There is no assurance that the Company will not incur losses beyond the limits of, or outside the coverage of, its insurance. From time to time various types of insurance for companies in the chemical industry have been very expensive or, in some cases, unavailable. There is no assurance that in the future the Company will be able to maintain its existing coverage or that the premiums will not increase substantially.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe principal executive offices of the Company are located in Houston, Texas and are subleased through Citicorp, N.A.\nThe Company's Texas City Plant is located approximately 45 miles south of Houston in Texas City, Texas, on a 290-acre site on Galveston Bay near many other chemical manufacturing complexes and refineries. The Company has facilities to load its products in drums, containers, trucks, railcars, barges and ocean-going tankers for shipment to customers. The site offers room for future expansion and includes a greenbelt around the northern edge of the plant site.\nThe Company's Texas City Plant comprises seven basic operating units which can be divided into three groups based on the chemistry involved. One group of operating units involves synthesis gas chemistry (carbon monoxide and hydrogen), and its facilities include the synthesis gas complex, the acetic acid unit and three plasticizer units (oxo-alcohol, phthalic anhydride and linear phthalate esters). Carbon monoxide and hydrogen are utilized as feedstocks in the oxo-alcohol manufacturing process, and carbon monoxide is a feedstock to produce acetic acid. As described in Item 1 under the caption \"Recent Developments\", a new partial oxidation unit will be constructed by Praxair at the Texas City Plant to supply carbon monoxide and hydrogen to the Company. The synthesis gas reformer will then be available for use in the new methanol unit also under construction at the Texas City Plant. A second group of operating units involves acrylonitrile and hydrogen cyanide chemistry, and its facilities include the acrylonitrile unit, the lactic acid unit, the TBA unit and the sodium cyanide unit. Ammonia and propylene are used as feedstocks in the acrylonitrile process, and hydrogen cyanide, a by-product of that process, is used as a feedstock for the other units in this second group and is also burned as fuel. The third operating group is based on ethylene and benzene chemistry, and its facilities comprise the ethylbenzene and styrene units. Although the styrene unit is independent of the rest of the facility from a feedstock and by-product standpoint, it is the cornerstone of the Company's energy balance, as it uses large quantities of by-product steam generated by the acrylonitrile and phthalic anhydride units, thus reducing the demands on the Company's steam generating facility. In this way, the Company's utilities system links the three operating groups together in an effort to minimize utility costs. This integration results in cost efficiencies without significantly compromising the operating flexibility of the individual product units.\nThe Company owns or leases all of the real property which comprise its Texas City Plant, and all of the facilities and equipment located there other than the sodium cyanide unit owned by Dupont, a cogeneration facility owned by a joint venture between the Company and Praxair, the new partial oxidation unit currently under construction at the site by Praxair and the acetic acid unit and related facilities which are operated under a ten-year sale leaseback arrangement with BP ending in August 1996. Upon expiration of such ten-year period the Company will reacquire title to the acetic acid unit. The Company also owns storage facilities, approximately 200 rail cars and an acetic acid barge. In addition, the Company subleases approximately 20,000 square feet of office space in Houston, Texas for its corporate headquarters and leases several storage facilities in the U.S. and Asia.\nThe Company's pulp chemical business includes four manufacturing plants in Canada and one under construction in Valdosta, Georgia. The Buckingham, Quebec and Vancouver, British Columbia sites are approximately 20 acres each and are owned by the Company. The Thunder Bay, Ontario and Grande Prairie, Alberta sites are leased by the Company. The new plant is being constructed in conjunction with, and will be leased from, the Valdosta-Lowndes County Industrial Authority. The Company also leases approximately 200 rail cars. Headquarters for the Canadian operations is located in Toronto in an approximately 50,000 square foot single story office building owned by the Company. The building is situated on 6.56 acres owned by the Company and serves as the headquarters for the pulp chemicals business and its respective laboratories.\nManagement believes that these properties and equipment are sufficient to conduct the Company's business.\nSee Item 1. \"Business\" for other information required by this item.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe information set forth under the caption \"Legal Proceedings\" in Note 6 of the \"Notes to Consolidated Financial Statements\" is hereby incorporated herein by this reference. The cause numbers, the styles of the cases, the courts in which the cases are pending and certain other information with respect to the matters described in Note 6 is set forth below.\nHUNTSMAN LAWSUIT: Sterling Chemicals, Inc. v. Huntsman Chemical Corporation, Huntsman Styrene Corporation and Huntsman Corporation; Cause No. 95-005256; In the 61st Judicial District Court of Harris County, Texas.\nALLEMAND LAWSUIT: George Allemand and Willa Allemand v. Sterling Chemicals, Inc., Olin Corporation, Goodyear Tire & Rubber Co., Inc. Marine Fueling Service, Inc.; le Manufacturier de Granford, Triplex Inc. and Shrieve Chemical Company, Cause No. A-152,286; In the 58th Judicial District Court of Jefferson County, Texas.\nAMMONIA RELEASE: 1. Otis Pointer Jr., individually and on behalf of all others similarly situated, v. Sterling Chemicals, Inc., Paul Saunders and an unknown chemical operator; Cause No. 94CV0514; In the 56th Judicial District Court of Galveston County, Texas. 2. Bobbie J. Adams, et al. v. Sterling Chemicals, Inc.; Cause No. 94CV0764; In the 56th Judicial District Court of Galveston County, Texas. 3. Courtney Adomond, et al. v. Sterling Chemicals, Inc.; Cause No. 94CV0947; In the 56th Judicial District Court of Galveston County, Texas. 4. Caroll Allen, et al. v. Sterling Chemicals, Inc.; Cause No. 94CV1147; In the 212th Judicial District Court of Galveston County, Texas. 5. Holly Benefiel, et al. v. Sterling Chemicals, Inc.; Cause No. 95CV0246; In the 56th Judicial District Court of Galveston County, Texas. 6. Richard Gayton, individually and as next friend of Ruben Gayton, et al. v. Sterling Chemicals, Inc., Paul Saunders and an unknown chemical operator; Cause No. 95-43771; In the 55th Judicial District Court of Harris County, Texas. 7. Lilly Gordon, et al. v. Sterling Chemicals, Inc.; Cause No. 95-36592; In the 281st Judicial District Court of Harris County, Texas. 8. Connie Alaniz and Emilio Alaniz, et al. v. Sterling Chemicals, Inc., Paul Saunders and Terry Bellard; Cause No. 95CV1011; In the 10th Judicial District Court of Galveston County, Texas. 9. Anita R. Afriyie, et al. v. Sterling Chemicals, Inc., Paul Saunders and Terry Bellard; Cause No. 95CV0997; In the 122nd Judicial District Court of Galveston County, Texas. 10. Versell Allums, et al. v. Sterling Chemicals, Inc., Paul Saunders and an unknown chemical operator; Cause No. 95CV1017; In the 10th Judicial District Court of Galveston County, Texas. 11. Guadalupe Trevino v. Sterling Chemicals, Inc.; Cause No. 42634; In the Probate and County Court of Galveston County, Texas. 12. Beverly D. Mitchell, et al. v. Sterling Chemicals, Inc., et al.; Cause No. 94CV1312 in the 56th Judicial District Court of Galveston County, Texas. 13. Maurice Benson, et al. v. Sterling Chemicals, Inc.; Cause No. 95CV1265; In the 56th Judicial District Court of Galveston County, Texas. 14. Rodney Curry, et al. v. Sterling Chemicals, Inc.; Cause No. 95CV1263; In the 122nd Judicial District Court of Galveston County, Texas. 15. Jayson Rhodes, et al. v. Sterling Chemicals, Inc.; Cause No. 95CV1266; In the 10th Judicial District Court of Galveston County, Texas. 16. Darrell Vick, et al. v. Sterling Chemicals, Inc.; Cause No. 95CV1262; In the 122nd Judicial District Court of Galveston County, Texas.\nSMITH LAWSUIT: Angela Smith, et al. v. Amoco Chemical Company, et al.; Cause No. 95CV0509; In the 212th Judicial District Court of Galveston County, Texas.\nALLEN LAWSUIT: Moranda Allen, et al. v. Sterling Chemicals, Inc., et al.; Cause No. 91-019786; In the 127th Judicial District Court of Harris County, Texas.\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 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe information on pages 22 and 38 of the Company's 1995 Annual Report to Shareholders is incorporated herein by reference in response to this item.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe information on pages 38 and 39 of the Company's 1995 Annual Report to Shareholders is incorporated herein by reference in response to this item.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe information on pages 18 to 23 of the Company's 1995 Annual Report to Shareholders is incorporated herein by reference in response to this item.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA\nThe information on pages 24 to 39 of the Company's 1995 Annual Report to Shareholders is incorporated herein by reference in response to this item.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nOn October 25, 1995, the Audit Committee of the Board of Directors of the Company recommended and the Board of Directors of the Company approved the engagement of the firm of Arthur Andersen LLP (\"Arthur Andersen\") as its independent auditors for the year ending September 30, 1996, to replace the firm of Coopers & Lybrand L.L.P. (\"Coopers & Lybrand\"). The termination by the Company of the engagement of Coopers & Lybrand was effective upon the completion of the audit for the year ended September 30, 1995, and the filing of this Form 10-K.\nDuring the two most recent fiscal years and the subsequent interim period through the filing of this Form 10-K, there were no disagreements with Coopers & Lybrand on any matter of accounting principles or practices, financial statement disclosure, or audit scope or procedures, which disagreements, if not resolved to their satisfaction, would have caused them to make reference in connection with their report to the subject matter of the disagreement.\nOn October 31, 1995, the Company filed a Current Report on Form 8-K describing the engagement of Arthur Andersen as its independent auditors for the year ending September 30, 1996, to replace Coopers & Lybrand.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information concerning directors of the Company beginning on page 3 and the information beginning on page 16 of the Definitive Proxy Statement for the Company's 1996 Annual Meeting of Shareholders is incorporated herein by reference in response to this item.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information concerning Executive Compensation beginning on page 5 of the Proxy Statement for the Company's 1996 Annual Meeting of Shareholders is incorporated herein by reference in response to this item.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information beginning on page 3 and beginning on page 15 of the Proxy Statement for the Company's 1996 Annual Meeting of Shareholders is incorporated herein by reference in response to this item.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nNone.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, CONSOLIDATED FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(a) Financial Statements, Financial Statement Schedules and Exhibits\n1. Consolidated Financial Statements\n* Incorporated herein by reference to the appropriate portions of the Company's Annual Report to Shareholders for the fiscal year ended September 30, 1995.\n2. All schedules for which provision is made in Regulation S-X of the Securities and Exchange Commission are not required under the related instruction or are inapplicable and, therefore, have been omitted.\n3. Exhibits\nExcept as otherwise noted under \"Description of Exhibit,\" each exhibit not filed herewith is incorporated by reference to the exhibit of the same number filed with the Company's Registration Statement of Form S-1 dated October 12, 1988 (Registration No. 33-24020).\n- -------- ** Filed herewith. + Confidential treatment has been requested with respect to portions of this Exhibit, and such request has been granted. ++ Filed herewith and confidential treatment has been requested with respect to portions of this Exhibit.\n(b) Reports on Form 8-K.\nNo reports on Form 8-K were filed during the quarter ended September 30, 1995. However, on October 31, 1995, the Company filed a Current Report on Form 8-K describing the engagement of the firm of Arthur Andersen LLP as its independent auditors for the year ending September 30, 1996, to replace the firm of Coopers & Lybrand L.L.P.\nSIGNATURES\nPURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.\nSTERLING CHEMICALS, INC. (Registrant)\n\/s\/ J. Virgil Waggoner By __________________________________ (J. Virgil Waggoner) President and ChiefExecutive Officer\nDATE: OCTOBER 25, 1995\nPURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1934, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.","section_15":""}
{"filename":"205402_1995.txt","cik":"205402","year":"1995","section_1":"Item 1. Business - - ------- --------\nGraybar Electric Company, Inc. (the \"Company\") is engaged internationally in the distribution of electrical and communications equipment and supplies primarily to contractors, industrial plants, telephone companies, power utilities, and commercial users. All products sold by the Company are purchased by the Company from others. The Company was incorporated under the laws of the State of New York on December 11, 1925 to take over the wholesale supply department of Western Electric Company, Incorporated. The location and telephone number of the principal executive offices of the Company are 34 North Meramec Avenue, St. Louis, Missouri (314) 512-9200, and the mailing address of the principal executive offices is P.O. Box 7231, St. Louis, Missouri 63177.\nSuppliers - - ---------\nThe Company acts as a distributor of the products of more than 1,000 manufacturers. The relationship of the Company with a number of its principal suppliers goes back many years. It is customarily a nonexclusive national or regional distributorship terminable upon 30 to 90 days notice by either party. During 1995, the Company purchased a significant portion of its products from its three largest suppliers. The termination by any of these companies, within a short period of time, of a significant number of their agreements with the Company might have an immediate material adverse effect on the business of the Company, but the Company believes that within a reasonable period of time it could find alternate sources of supply adequate to alleviate such adverse effect.\nProducts Distributed - - --------------------\nThe Company distributes more than 100,000 different products and, therefore, is able to supply its customers with a wide variety of electrical and communications products. The products distributed by the Company consist primarily of wire, conduit, wiring devices, tools, motor controls, transformers, lamps, lighting fixtures and hardware, power transmission equipment, telephone station apparatus, key systems, PBXs, data products for local area networks or wide area networks, fiber optic products, and CATV products. These products are sold to customers such as contractors (both industrial and residential), industrial plants, telephone companies, private and public utilities, and commercial users. On December 31, 1995 and 1994, the Company had orders on hand which totalled approximately $192,721,000 and $189,349,000, respectively. The Company believes that the increase from 1994 to 1995 reflects the improvements in the market sectors of the economy in which the Company operates. The Company expects that approximately 85% of the orders on hand at December 31, 1995 will be filled within the twelve-month period ending December 31, 1996. Historically, orders on hand for the Company's products have been firm, but customers from time to time request cancellation and the Company has historically allowed such cancellations.\nMarketing - - ---------\nThe Company sells its products through a network of distributing houses located in 14 geographical districts throughout the United States. In each district the Company maintains a main distributing house and a number of branch distributing houses, each of which carries an inventory of supply materials and operates as a wholesale distributor for the territory in which it is located. The main distributing house in each district carries a substantially larger inventory than the branch houses so that the branch houses can call upon the main distributing house for additional items of inventory. In addition, the Company maintains two (2) zone warehouses with special inventories so all locations can call upon them for additional items. The Company also has subsidiary operations with distribution facilities located in Puerto Rico, Mexico, Singapore and Canada.\nWhere the specialized nature or size of a particular shipment warrants, the Company has products shipped directly from its suppliers to the place of use, while in other cases orders are filled from the Company's inventory. On a dollar volume basis, over one-half of the orders are filled from the Company's inventory and the remainder are shipped directly from the supplier to the place of use. The Company generally finances its inventory from internally generated funds and from long and short-term borrowings.\nAt December 31, 1995, the Company employed approximately 2,400 persons in sales capacities. Approximately 1,100 of these sales personnel were sales representatives who work in the field making sales to customers at the work site. The remainder of the sales personnel were sales and marketing managers, and telemarketing, advertising, quotation, counter and clerical personnel.\nCompetition - - -----------\nThe Company believes that it is the largest distributor of electrical products not affiliated with a manufacturing company, and one of the three largest distributors of such products in the United States. The field is highly competitive, and the Company estimates that the three largest distributors of electrical products account for only a small portion of the total market, with the balance of the market being accounted for by independent distributors and manufacturers operating on a local, state-wide or regional basis. The Company believes that its competitive position is primarily a result of its ability to supply its customers through a network of conveniently located distribution facilities with a broad range of electrical and telecommunications materials within a short period of time. Price is also important, particularly where the Company is asked to submit bids to contractors in connection with large construction jobs.\nEmployees - - ---------\nAt December 31, 1995, the Company employed approximately 6,200 persons on a full-time basis. Approximately 160 of these persons were covered by union contracts. The Company has not had a material work stoppage and considers its relations with its employees to be good.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties - - ------- ----------\nAs of December 31, 1995 the Company operated offices and distribution facilities in 239 locations. Of these, 129 were owned by the Company, and the balance were leased. The leases are for varying terms, the majority having a duration of less than five years. The Company's distribution facilities consist primarily of warehouse space. A small portion of the space in each facility is used for offices. Distribution facilities vary in size from approximately 3,000 square feet to 129,000 square feet, the average being approximately 28,000 square feet. As of December 31, 1995, approximately $42.9 million in debt of the Company was secured by mortgages on thirty-two buildings. Twenty of these facilities are subject to a first mortgage securing a 12.25% note, of which approximately $10.3 million in principal amount remains outstanding. Seven of these facilities are subject to a first mortgage securing a 9.23% note, of which $27.3 million in principal amount remains outstanding. A facility in Houston, Texas is subject to a first mortgage securing an 8.53% note, of which $3.7 million in principal remains outstanding. Distribution houses in Pinellas County and Polk County, Florida; Beaumont, Texas and Glendale Heights, Illinois are subject to mortgages securing Industrial Revenue Bonds at variable interest rates with payments totaling $1.6 million due periodically to 2004.\nItem 3.","section_3":"Item 3. Legal Proceedings - - ------- -----------------\nThe Company has been named, together with numerous other companies, as a co-defendant in actions by approximately 2,400 plaintiffs which have been filed in various federal and state courts in Arkansas, California, Maryland, Massachusetts, Mississippi, New Hampshire, New Jersey, New York, Ohio, Pennsylvania and West Virginia. The plaintiffs allege personal injuries due to exposure to asbestos products and seek substantial damages. The majority of the complaints do not identify any products containing asbestos allegedly sold by the Company.\nHowever, since all products sold by the Company have been and are purchased from suppliers, if a plaintiff were to successfully establish an asbestos-related injury claim with respect to a product sold by the Company, the Company believes it would normally have a claim against its supplier. Furthermore, the Company believes it has product liability insurance coverage available to cover these claims. Accordingly, based on information now known to the Company, in the opinion of management the ultimate disposition of the asbestos-related claims against the Company will not have a materially adverse effect on 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 shareholders during the fourth quarter of the fiscal year covered by this Annual Report on Form 10-K.\nPART II -------\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Stock and Related - - ------- ---------------------------------------------------- Shareholder Matters -------------------\nThe Company is wholly owned by its active and retired employees, and there is no public trading market for its Common Stock, par value $1 per share with a stated value of $20 per share. No shareholder may sell, transfer or otherwise dispose of shares of Common Stock without first offering the Company the option to purchase such shares at the price at which they were issued. The Company also has the option to purchase the Common Stock of any shareholder who dies or ceases to be an employee of the Company for any cause other than retirement on a Company pension. In the past all shares issued by the Company have been issued at $20 per share, and the Company has always exercised its repurchase option, and expects to continue to do so. The information as to number of holders of Common Stock and frequency and amount of dividends, required to be included pursuant to this Item 5, is included under the captions \"Capital Stock Data\" and \"Dividend Data\" on page 1 of the Company's Annual Report to Shareholders for the year ended December 31, 1995, (the \"1995 Annual Report\") furnished to the Securities and Exchange Commission (the \"Commission\") pursuant to Rule 14c-3 under the Securities Exchange Act of 1934, as amended (the \"Exchange Act\"), and such information is incorporated herein by reference.\nIn May, 1994, the Company entered into a ten-year note agreement that includes various covenants which limit the Company's ability to make investments, pay dividends, incur debt, dispose of property, and issue equity securities. The Company is also required to maintain certain financial ratios as defined in the agreement.\nItem 6.","section_6":"Item 6. Selected Financial Data - - ------- -----------------------\nThe selected financial data for the Company as of December 31, 1995 and for the five years then ended, which is required to be included pursuant to this Item 6, is included under the caption \"Selected Consolidated Financial Data\" on page 15 of the 1995 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 -------------------------\nManagement's discussion and analysis required to be included pursuant to this Item 7 is included under the caption \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" on pages 16 and 17 of the 1995 Annual Report and is incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data - - ------- -------------------------------------------\nThe financial statements required by this Item 8 are listed in Item 14(a)(1) of this Annual Report on Form 10-K under the caption \"Index to Financial Statements.\" Such financial statements specifically referenced from the 1995 Annual Report in such list are incorporated herein by reference. There is no supplementary financial information required by this item which is applicable to the Company.\nItem 9.","section_9":"Item 9. Disagreements on Accounting and Financial Disclosure - - ------- ----------------------------------------------------\nNone.\nPART III --------\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant - - -------- --------------------------------------------------\nThe information with respect to the directors and executive officers of the Company required to be included pursuant to this Item 10 will be included under the caption \"Directors and Executive Officers -- Nominees for Election as Directors\" in the Company's Information Statement relating to the 1996 Annual Meeting (the \"Information Statement\"), to be filed with the Commission pursuant to Rule 14c-5 under the Exchange Act, and is incorporated herein by reference.\nItem 11.","section_11":"Item 11. Executive Compensation - - -------- ----------------------\nThe information with respect to executive compensation required to be included pursuant to this Item 11 will be included under the captions \"Executive Compensation\" and \"Pension Plan\" in the Information Statement and is incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and - - -------- --------------------------------------------------- Management ----------\nThe information with respect to the security ownership of beneficial owners of more than 5% of the Common Stock, the directors of the Company and all directors and officers of the Company, which is required to be included pursuant to this Item 12, will be included in the introductory language and under the caption \"Directors and Executive Officers -- Nominees for Election as Directors\" in the Information Statement and is incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions - - -------- ----------------------------------------------\nThe information with respect to any reportable transactions, business relationships and 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, required to be included pursuant to this Item 13, will be included under the caption \"Directors and Executive Officers\" in the Information Statement and is incorporated herein by reference.\nPART IV -------\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K - - -------- ----------------------------------------------------------------\n(a) Documents filed as part of this report: --------------------------------------\nThe following financial statements and Report of Independent Accountants are included on the indicated pages in the 1995 Annual Report and are incorporated by reference in this Annual Report on Form 10-K:\n1. Index to Financial Statements -----------------------------\n(i) Consolidated Statements of Income and Retained Earnings for each of the three years ended December 31, 1995 (page 18).\n(ii) Consolidated Balance Sheets, as of December 31, 1995 and December 31, 1994 (page 19).\n(iii) Consolidated Statements of Cash Flows for each of the three years ended December 31, 1995 (page 20).\n(iv) Notes to Consolidated Financial Statements (pages 21 to 24).\n(v) Report of Independent Accountants relating to above mentioned financial statements and notes for each of the three years ended December 31, 1995 (page 25).\n2. Index to Financial Schedules ----------------------------\nThe following schedules for each of the three years ended December 31, 1995, to the Financial Statements and Report of Independent Accountants thereon is included on the indicated pages in this Annual Report on Form 10-K:\n(i) Schedule IX. Reserves (page 15).\n(ii) Report of Independent Accountants on Financial Statement Schedules (page 14).\nAll schedules other than those indicated above are omitted because of the absence of the conditions under which they are required or because the required information is set forth in the financial statements and the accompanying notes thereto.\n3. Exhibits --------\nThe following exhibits required to be filed as part of this Annual Report on Form 10-K have been included:\n(3) Articles of incorporation and by-laws\n(i) Restated Certificate of Incorporation dated March 9, 1984 filed as exhibit 3(i) to the Company's Annual Report on Form 10-K for the year ended December 31, 1984 (Commission File No. 0-255) and incorporated herein by reference.\n(ii) By-laws as amended through August 1, 1991 filed as exhibit 6(a)(19) to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1991 (Commission File No. 0-255) and incorporated herein by reference.\n(4)and(9) Instruments defining the rights of security holders, including indentures and voting trust agreements.\nVoting Trust Agreement dated as of April 15, 1987, attached as Annex A to the Prospectus, dated January 20, 1987, constituting a part of the Registration Statement on Form S-13 (Registration No. 2-57861) and incorporated herein by reference.\nThe Company hereby agrees to furnish to the Commission upon request a copy of each instrument omitted pursuant to Item 601(b)(4)(iii)(A) of Regulation S-K.\n(10) Material contracts.\n(i) Management Incentive Plan, filed as Exhibit 4(a)(1) to the Annual Report on Form 10-K for the year ended December 31, 1972 (Commission File No. 0-255), as amended by the Amendment effective January 1, 1974, filed as Exhibit 13-c to the Registration Statement on Form S-1 (Registration No. 2-51832), the Amendment effective January 1, 1977, filed as Exhibit 13(d) to the Registration Statement on Form S-1 (Registration No. 2-59744), and the Amendment effective January 1, 1980, filed as Exhibit 5(f) to the Registration Statement on Form S-7 (Registration No. 2-68938) and incorporated herein by reference.\n(13) Annual Report to Shareholders for 1995 (except for those portions which are expressly incorporated by reference in this Annual Report on Form 10-K, this exhibit is furnished for the information of the Commission and is not deemed to be filed as part of this Annual Report on Form 10-K).\n(21) List of subsidiaries of the Company.\n(b) Reports on Form 8-K: -------------------\nNo reports on Form 8-K were filed during the last quarter of the Company's fiscal year ended December 31, 1995.\nSIGNATURES ----------\nPursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the Company has duly caused this Annual Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized, as of the 27th day of March, 1996.\nGRAYBAR ELECTRIC COMPANY, INC.\nBy \/S\/ C. L. HALL ------------------------------ (C. L. Hall, President)\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 Company, in the capacities indicated, on March 27, 1996.\nREPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULES\nTo the Board of Directors of Graybar Electric Company, Inc.\nOur audits of the consolidated financial statements referred to in our report dated February 16, 1996 appearing on page 25 of the 1995 Annual Report to Shareholders of Graybar Electric Company, Inc., (which report and consolidated financial statements are incorporated by reference in this Annual Report on Form 10-K) also included an audit of the Financial Statement Schedule listed in Item 14(a) of this Form 10-K. In our opinion, this Financial Statement Schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.\nPRICE WATERHOUSE LLP\nSt. Louis, Missouri February 16, 1996\nINDEX TO EXHIBITS\nINDEX TO EXHIBITS -----------------\nExhibits --------\n(3) Articles of incorporation and by-laws.\n(i) Restated Certificate of Incorporation dated March 9, 1984..................................................\n(ii) By-laws as amended through August 1, 1991.............\n(4)and(9) Instruments defining the rights of security holders, including indentures and voting trust agreements.\nVoting Trust Agreement dated as of April 15, l987, attached as Annex A to the Prospectus, dated January 20, 1987, constituting a part of the Registration Statement on Form S-13 (Registration No. 2- 57861)...............................................\n(10) Material contracts.\n(i) Management Incentive Plan, filed as Exhibit 4(a)(1) to the Annual Report on Form 10-K for the year ended December 31, 1972 (Commission File No. 0-255), as amended by the Amendment effective January 1, 1974, filed as Exhibit 13-c to the Registration Statement on Form S-1 (Registration No. 2- 51832), the Amendment effective January 1, 1977, filed as Exhibit 13(d) to the Registration Statement on Form S-1 (Registration No. 2-59744), and the Amendment effective January 1, 1980, filed as Exhibit 5(f) to the Registration Statement on Form S-7 (Registration No. 2- 68938).................................\n(13) Annual Report to Shareholders for 1995 (except for those portions which are expressly incorporated by reference in this Annual Report on Form 10-K, this exhibit is furnished for the information of the Commission and is not deemed to be filed as part of this Annual Report on Form 10-K)\n(21) List of subsidiaries of the Company\n--------------\n[FN] Incorporated by reference in this Annual Report on Form 10-K.","section_15":""}
{"filename":"5981_1995.txt","cik":"5981","year":"1995","section_1":"ITEM 1 BUSINESS\nAmerican Vanguard Corporation was incorporated under the laws of the State of Delaware in January 1969 and operates as a holding company. Unless the context otherwise requires, references to the \"Company\", the \"Registrant\" or \"AMVAC\" in this Annual Report refer to American Vanguard Corporation and its consolidated subsidiaries. The Company conducts its business through its wholly-owned subsidiaries, Amvac Chemical Corporation (\"CHEMICAL\"), GemChem, Inc. (\"GemChem\"), and 2110 Davie Corporation (\"DAVIE\").\nGEMCHEM, INC.\nOn March 31, 1994, the Company purchased all of the issued and outstanding stock of GemChem, Inc., a national chemical distributor. The purchase was effective January 15, 1994. GemChem, in addition to representing CHEMICAL as its domestic sales force, also sells into the pharmaceutical, cosmetic and nutritional markets. Prior to the acquisition, GemChem acted in the capacity as the domestic sales force for the Company (from September 1991).\nSee also PART III, Item 13 of this Annual Report.\n2110 DAVIE CORPORATION\nEffective September 30, 1989, the Company sold substantially all operating assets of DAVIE.\nIn connection with the sale, DAVIE provided Buyer with a five year covenant not to compete in the business formerly conducted by DAVIE. Herbert A. Kraft, the Chairman and Chief Executive Officer of both the Company and DAVIE, entered into a consulting agreement with the Buyer providing an aggregate consideration of $6,000 per annum for a five year period ended September 1994.\nDAVIE currently invests in real estate for corporate use only. See also PART I, Item 2","section_1A":"","section_1B":"","section_2":"ITEM 2 PROPERTIES\nThe Company's corporate headquarters are located in Newport Beach, California. This facility is leased. See PART IV, Item 14, Note 12 of this report for further information.\nCHEMICAL owns in fee approximately 148,000 square feet of improved land in Commerce, California, on which substantially all of its offices and plant and some of its warehouse facilities are located.\nDAVIE owns in fee approximately 72,000 square feet of warehouse and office space on approximately 118,000 square feet of land in Commerce, California, which is leased to CHEMICAL. The Company occupies offices located with CHEMICAL's office and plant facilities in Commerce, California.\nCHEMICAL's manufacturing facilities are divided into five cost-centers; granular products, small packaging, Metam Sodium manufacturing, PCNB manufacturing, and the production and formulation of all other products. All production areas are designed to run on a continuous twenty-four hour per day basis.\nCHEMICAL regularly adds chemical processing equipment to enhance its production capabilities. CHEMICAL believes its facilities are in good operating condition and are suitable and adequate for CHEMICAL's foreseeable needs, have flexibility to change products, and can produce at greater rates as required. Facilities and equipment are insured against losses from fire and other usual business risks. The Company knows of no material defects in title to, or encumbrances on, any of its properties except that substantially all of the Company's assets are pledged as collateral under the Company's loan agreements with its primary lender. For further information, refer to Note 4 of the Notes to the Consolidated Financial Statements in PART IV, Item 14 of this Annual Report.\nCHEMICAL purchased unimproved land in Texas for possible future expansion.\nGemChem's facilities consist of administration and sales offices which are leased.\nThe Company believes its properties to be suitable and adequate for its current purposes.\nITEM 3","section_3":"ITEM 3 LEGAL PROCEEDINGS\nDBCP LAWSUITS\nA. California Matters\ni) 1995 Settlement of Claims.\nIn 1995 CHEMICAL has brought its participation in twenty-three similar lawsuits filed between January 1990 and December 1994 to an end. The Plaintiffs in each matter were primarily water districts and municipalities that alleged property damage resulting from, among other things, the fact that each plaintiff's water supply had been contaminated by DBCP. The settlement covered all the plaintiff's current and future 1,2 Dibromo-3-Chloropropane (hereinafter referred to as \"DBCP\") a pesticide, ethylene dibromide (hereinafter referred to as \"EDB\") a fumigant, and related claims. On February 15, 1995, the Superior Court of California in San Francisco County approved this settlement as having been made in \"good faith\". The effect of the Superior Court's approval is to bar claims, arising from these pleadings, against CHEMICAL by other defendants (and other tortfeasors) for equitable comparative contribution and\/or partial or comparative indemnity. CHEMICAL's portion of the settlement was $905,000. As to matters independent of indemnity issues, the Company recovered $675,000 from two of its insurers.\nii) Post Settlement Actions.\nSubsequent to the settlements discussed above, two additional suits alleging property damage resulting from DBCP contamination of water supply were filed in the San Francisco Superior Court and served on CHEMICAL: City of Madera v. Shell Oil Co., et. al., and Malaga County Water District v. Shell Oil Co., et. al. The City of Madera action also alleges contamination of the water supply with EDB. CHEMICAL has never marketed EDB. These suits name as defendants Shell Oil Company, the Dow Chemical Company, Occidental Chemical Company, Chevron Chemical Company, Velsicol Chemical Company and in the Madera action Great Lakes Chemical Corporation. Malaga has made a settlement demand of $1,344,000 for one of five wells at issue. As discovery is at the early stages no other settlement demands have been received. Defendants are operating under an open extension of time to file responsive pleadings. CHEMICAL has tendered the defense of these two cases to Columbia Casualty\/CNA. That insurer has thus far accepted the defense under a reservation of rights in the Malaga action, but has yet to respond to the tender of defense for the Madera action.\nB. Texas Matters\ni) The Carcamo Case.\nThe Company was served with a third-party first amended complaint by Dow Chemical Company which sought indemnity and contribution from CHEMICAL, Del Monte tropical Fruit Company, Del Monte Fresh Produce, N.A., Dead Sea Bromine Co. Ltd., Ameribrom Inc., Saint Lucia Banana Growers Association, Saint Vincent Banana Growers Association, Dominica Banana Growers Association, and Program Nacional de Banano, for any liability Dow may have under a complaint filed by Jorge Colindres Carcamo, et al. vs. Shell, Dow, et al. (the \"Carcamo Case\"). The Carcamo Case was tried in the United States District Court for the Southern District of Texas, Houston Division, and is an action originally filed in a Texas state court by a purported class of citizens from Honduras, Costa Rica, Guatemala, Nicaragua, Panama, Philippines, Dominica, and the Ivory Coast. These plaintiffs were banana workers and allege that they were exposed to DBCP while applying the product in their native countries. Approximately 15,000 plaintiffs have been named in this and the other suits hereinafter mentioned.\nIn an October 27, 1996 Court Order the third party action against CHEMICAL was dismissed without prejudice. The Order also dismissed the Plaintiff's consolidated cases concluding that these claims should be litigated in the foreign countries where the alleged injuries occurred subject to a number of conditions. One of the more significant conditions requires the Defendants and third party Defendants consent to the jurisdiction of the courts of each of the foreign countries. Under the Order the Defendants may proceed against CHEMICAL, in a court in the United States, for contribution and indemnity should plaintiffs in the underlying actions obtain a judgement against Defendants in any foreign forum. As of the filing of this report, no actions against CHEMICAL have been filed.\nii) The Rodriguez Case.\nThe Company was served with a third-party complaint on March 15, 1996 by Defendant Standard Fruit Company and Standard Steamship Company seeking indemnity and contribution from any liability it may have under a complaint entitled Ramon Rodriguez et. al. v. Shell Oil Company, et. al. (the \"Rodriguez Case\") filed in the District Court of Jim Hogg County, Texas. Also named as Third Party Defendants are Dead Sea Bromine Co., Ltd. and Bromine Compounds Ltd. The underlying case alleges injuries caused by Plaintiffs' exposure to DBCP when they applied that pesticide at farms located in Central America, Ecuador and the Philippines. The Company has made a demand upon certain insurers for indemnity from and a defense of the Rodriguez Case. No answer has yet been received from said insurers.\nPHOSDRIN(R) LAWSUIT\nOn September 21, 1995, CHEMICAL was served with a complaint filed in the Superior Court of King County, Washington on September 12, 1995 entitled Ricardo Ruiz Guzman, et. al. v. AMVAC Chemical Corporation, et. al.(the \"Guzman Case\"). The Complaint is for unspecified monetary damages based on Plaintiff farm worker's alleged injuries from their exposure to the pesticide Phosdrin(R) while working in several orchards in Central Washington State in 1993. Other Defendants named in the Guzman case include: Wilbur-Ellis Company, Alan Hilliker, and Ellis D. Wilker. The matter is currently pending in the United States District Court for the Eastern District of Washington and Defendant's Hilliker and Wilker have been dismissed from the action. CHEMICAL has made a demand against its insurers for indemnity and defense of the Guzman Case. The insurer Lexington Insurance Company has thus far accepted the defense under a reservations of rights letter. CHEMICAL has a self insured retention limit of $300,000 under its insurance policy.\nTRAIN DERAILMENTS\nA. July 14, 1991; Dunsmuir, California:\nIn August 1992, the Company settled all personal and economic injury claims asserted in a class action lawsuit arising from the July 14, 1991 derailment of a rail tank car leased by CHEMICAL. The derailment, occurring about six miles north of Dunsmuir, California, involved the spill into the Upper Sacramento River of approximately 19,000 gallons of Metam Sodium, a soil fumigant manufactured by CHEMICAL which was being transported by Southern Pacific Transportation Company (\"SP\") along SP's tracks. The court, when finding that such settlement by CHEMICAL was in \"good faith\", also ordered that no other person or entity falling within the definition of the settlement class could proceed with claims against the Company.\nOn March 14, 1995, the federal court approved the Consent Decree which the Company and the federal and state governments entered which settled litigation seeking to hold potentially responsible parties under various federal and state statutes responsible for the costs of studying and remediating the environmental consequences caused by the Sacramento Spill, and for damages to the Natural Resources. On January 5, 1996, the Court dismissed the California Sportfishing Protection Alliance's (\"Alliance\") appeal of a court's order dismissing their intervention. This Order finally resolves the action brought by the Alliance which was the only remaining issue arising from this incident.\nB. February 1, 1996; Devore, California:\nOn March 7, 1996, CHEMICAL was served with a Complaint in an action entitled Alvin Williams, Administrator of the Estate of Kevin Lewis Williams v. Burlington Northern Santa Fe Railway Company, et. al. (the \"Williams Estate Case\"). This case was filed on February 26, 1996 in the Superior Court of Los Angeles County and arose from Kevin Lewis Williams' death in a train derailment which occurred on Burlington Northern Santa Fe Railway Company tracks involving a tank car leased by GATX to Albright & Wilson Americas Corporation (\"A&WA\") which was transporting 158,000 pounds of Trimethyl Phosphite (\"TMP\") from A&WA's Charleston, South Carolina Facility to CHEMICAL's manufacturing facility in Los Angeles, California. The derailment, occurred on February 1, 1996 at approximately 4:14 a.m. about 6 miles north of Devore, California, adjacent to the intersection of Interstate 15 and State Highway 138. The derailment involved the engine and most of the railcars on the train resulting in a chemical fire that consumed all of the TMP in addition to the contents of railcars transporting an assortment of hazardous chemicals and other goods. The Estate alleges pecuniary loss to family members in the amount of $ 20,000,000 and prays for other unspecified monetary relief. Other Defendants presently named in the suit are: Burlington Northern Santa Fe Railway Company, The Atchison, Topeka & Santa Fe Railway Company, UNOCAL, Rohm & Haas, and Westinghouse Corporation. CHEMICAL is named in only one of the Estate's seven causes of action. The Company has made demand upon its insurers for indemnity from and defense of the Williams Estate Case. No answer has yet been received from the Company's insurers.\nRAILROAD SIDING:\nAs a result of inspections and sampling conducted by the California Department of Toxic Substances Control (\"DTSC\") of the railroad located, in part, immediately adjacent to CHEMICAL's Commerce, California facility, CHEMICAL was directed to, and did, conduct sampling during 1993 to evaluate the nature and extent of pesticide contamination detected by DTSC on the railroad siding. Following its review of the sampling report prepared by CHEMICAL's independent consultant, DTSC directed that additional sampling be undertaken and CHEMICAL's independent consultant prepared a sampling plan for submittal to DTSC for prior approval as required. However, before additional sampling could be conducted, the Los Angeles county District Attorney's Office (\"LADA\"), at the request of DTSC, commenced an enforcement action in April 1994, against CHEMICAL, one of its officers, and two employees alleging felony illegal disposal of hazardous waste on the railroad siding. At the same time, DTSC demanded sums of money for alleged violations of certain compliance requirements related to CHEMICAL's management of hazardous waste at its\nCommerce, California facility. Joint settlement negotiations were conducted with the DTSC and the LADA and were concluded with a settlement agreement which was entered with the Los Angeles Municipal Court in a Stipulated Sentencing Memorandum which provided as follows: (i) all felony charges against CHEMICAL and the three individuals were dismissed; (ii) CHEMICAL entered a plea of nolo contendere to one misdemeanor; (iii) CHEMICAL was placed on probation for approximately six (6) months commencing on or about September 23, 1994; (iv) CHEMICAL was ordered to pay, by March 22, 1995, the sum of $135,000 in fines and penalties, and civil restitution in the amount of $325,000; (v) CHEMICAL agreed to enter into a Consent Agreement and Order (the \"First CAO\") with DTSC to correct the alleged hazardous waste management compliance violations and to submit a new plan for closure of ten (10) underground storage tanks (\"USTs\") at the Commerce, California facility and (vi) CHEMICAL agreed to enter into a Consent Agreement and Order (the \"Second CAO\") with DTSC providing for CHEMICAL to further investigate and remediate the railroad siding.\nPursuant to the settlement agreement, CHEMICAL entered into the First CAO effective on January 26, 1995, and on March 22, 1995, with the concurrence of the LADA, CHEMICAL withdrew its plea of nolo contendere to the one misdemeanor, entered a plea of not guilty which was accepted, and the court dismissed the complaint against CHEMICAL. CHEMICAL has substantially fulfilled the requirements of the First CAO and, in accordance therewith, submitted new plans for closure of ten (10) USTs located at the facility. During 1995, in accordance with the UST closure plan, CHEMICAL arranged for the removal and cleaning of residues within the tanks and completed the initial investigation of soils in the area of the tanks and their associated piping. CHEMICAL anticipates that additional UST related soil investigations will be completed by late 1996 and that remedial activities, if any, will commence by late 1996 or early 1997.\nCHEMICAL is currently in discussions with DTSC regarding the specific terms of the Second CAO which will address investigation and remediation of the railroad siding. CHEMICAL is in the process of completing all requirements for addressing investigation and remediation of the railroad siding under a new DTSC program created by California Senate Bill 923 known as the Expedited Remedial Action Program (ERAP). CHEMICAL anticipates that addressing the railroad siding under ERAP will result in a more rapid and cost-effective resolution of environmental conditions in the railroad siding area than could otherwise be expected if the area were addressed under other available DTSC site investigation and remediation programs. The potential future costs associated with the railroad siding investigation and remediation are currently unknown and cannot be reasonably determined until soil investigations will be completed by late 1996 or early 1997.\nThe Company has made claims against its insurance carriers and has expensed all costs incurred which now exceed its $100,000 self-insured retention. There can be no assurance the Company will prevail in its position.\nVarious other legal actions, governmental proceedings, and claims are pending against the Company and its subsidiaries incidental to their businesses.\nITEM 4","section_4":"ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matters were submitted during the fourth quarter of 1995 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 COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Company's $0.10 par value common stock (\"Common Stock\") trades on The NASDAQ Stock Market under the symbol AMGD. The following table sets forth the range of high and low sales prices as reported on NASDAQ's National Market System for the Company's Common Stock for the calendar quarters indicated.\nThe Company's share activity is reported in the Wall Street Journal and is listed as \"Am Vngrd\". The Los Angeles Times reports the share activity as \"A Vang\".\nAs of March 22, 1996, the number of shareholders of the Company's Common Stock was approximately 600, which includes beneficial owners with shares held in brokerage accounts under street name and nominees.\nOn February 5, 1996, the Company announced that the Board of Directors declared a cash dividend of $.06 per share as well as a 10% stock dividend. Both dividends were distributed on March 15, 1996 to shareholders of record at the close of business on February 29, 1996. The cash dividend was paid on the number of shares outstanding prior to the 10% stock dividend. Shareholders entitled to fractional shares resulting from the 10% stock dividend received cash in lieu of such fractional share based on $9.50 per share, the closing price of the Company's stock on February 29, 1996. Prior to the declaration of these dividends, the Company had not declared any dividends since 1989. The resumption of dividends can only be considered if profitable operations continue. Certain loan covenants described in Note 4 to the Notes to Consolidated Financial Statements, limit payments of cash dividends to a maximum of 25% of net income.\nAMERICAN VANGUARD CORPORATION AND SUBSIDIARIES\nITEM 6","section_6":"ITEM 6 SELECTED FINANCIAL DATA (IN THOUSANDS, EXCEPT FOR WEIGHTED AVERAGE NUMBER OF SHARES AND PER SHARE DATA)\nThe selected consolidated financial data set forth above with respect to each of the calendar years in the five-year period ended December 31, 1995, have been derived from the Company's consolidated financial statements and are qualified in their entirety by reference to the more detailed consolidated financial statements and the independent certified public accountants' reports thereon which are included elsewhere in this Report on Form 10-K for the three years ended December 31, 1995. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\n- ---------------------\n(1) All per share amounts have been restated to reflect a 10% stock dividend (see footnote 2 below).\n(2) On February 5, 1996, the Company announced that the Board of Directors declared a cash dividend of $.06 per share as well as a 10% stock dividend. Both dividends were distributed on March 15, 1996 to shareholders of record at the close of business on February 29, 1996. The cash dividend was paid on the number of shares outstanding prior to the 10% stock dividend. Weighted average number of shares have been restated to reflect the 10% stock dividend.\nITEM 7","section_7":"ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION\nRESULTS OF OPERATIONS\n1995 COMPARED WITH 1994:\nThe Company reported net income of $3,124,000 or $1.23 per share in 1995 as compared to net income of $1,202,700 or $.47 per share in 1994. (All per share amounts have been restated to give effect to a 10% stock dividend paid on March 15, 1996 to stockholders of record as of February 29, 1996.) The increase in net income in 1995 is attributable to a 22.8% increase in net sales which is primarily related to increases in volume of products sold and not to increases in prices, while operating expenses increased only 15.7%. Another significant factor is that there were no legal settlement costs incurred during 1995. The positive factors are mitigated to an extent by an increase in the effective income tax rate to 38% in 1995 from 17% in 1994.\nNet sales increased by $10,304,000 to $55,402,100 in 1995 as compared to $45,098,100 in 1994. CHEMICAL's sales increased by approximately $10,632,000 in 1995 as compared to 1994. $8,945,200 of this increase was due to an increase in the sales of Bidrin(R). In December 1994 the appropriate permitting was finally obtained and the Company began manufacturing Bidrin(R). The late start in manufacturing resulted in reduced sales of Bidrin(R) in 1994, however the latent demand was satisfied in the first half of 1995 resulting in strong Bidrin(R) sales in the first and second quarters of 1995. Sales of Bidrin(R) in the fourth quarter 1995 were significantly higher than the fourth quarter 1994. During 1995 CHEMICAL was also able to generate significant sales increases in its PCNB products of $4,187,900 to $12,002,100 as compared to $7,814,200 in 1994 and Naled products of $3,541,600 to $6,393,900 from $2,852,300 in 1994. However, these increases were substantially offset by a decrease in the sales of Phosdrin(R) in the amount of $6,755,900 to $413,000 in 1995 from $7,169,000 in 1994. As a result of agreements reached with the Environmental Protection Agency (\"EPA\") during 1994, the Company agreed to phaseout the domestic distribution, sale and use of Phosdrin(R). Although the effective date of the cessation of Phosdrin(R) use domestically was November 30, 1995, domestic sales of Phosdrin(R) began to drop off significantly beginning in July 1994. Essentially all of the Phosdrin(R) sales in 1995 were export sales. The remaining change in CHEMICAL's sales was attributable to less significant changes in the sales mix of CHEMICAL's products. GemChem's sales (after elimination of intercompany sales) declined from approximately $4,700,000 in 1994 to approximately $4,200,000 in 1995 reflecting competition in GemChem's non-ag markets.\nGross profits increased by $4,928,600 to $24,660,400 in 1995 as compared to $19,731,800. The increase in 1995 is a result of the higher volume of sales in 1995. The gross profit percentage increased to 44.5% in 1995 from 43.8% in 1994. While the phaseout of Phosdrin(R), a very profitable product, had a negative impact on gross profit in 1995, the overall gross profit percentage increased as the sales volume increased proportionately higher than cost of sales.\nOperating expenses increased by $2,533,800 to $18,689,400 in 1995 from $16,155,600 in 1994. The following is a discussion of operating expenses:\nSelling and Regulatory:\nSelling and regulatory expenses increased by $2,190,200 to $6,772,900 in 1995 from $4,582,700 in 1994. The increase in selling and regulatory expenses is primarily attributable to an increase in variable selling costs. Due to the significant increase in Bidrin(R) sales in 1995, related Bidrin(R) rebates and royalties increased by approximately $1,360,000. Rebates and royalties on NAA products increased approximately $943,500 in 1995 primarily as a result of agreements with distributors to promote the Company's products in the market. Expenses of GemChem increased approximately $334,000 in 1995. Product liability insurance, which varies directly with sales levels, also increased approximately $160,000 in 1995 as a result of the increased sales volume. The only significant decrease in selling and regulatory costs was attributable to a $647,000 decline in Phosdrin(R) related rebates which was a result of the phase out of Phosdrin(R).\nResearch and Development:\nResearch and development costs, which include costs incurred to generate scientific data and other activities performed in the department, decreased by $1,365,100 to $4,846,400 in 1995 from $6,211,500 in 1994. Costs incurred to generate scientific data decreased by $1,826,600 to $3,717,400 in 1995 as compared to $5,544,000 in 1994. The largest reduction in scientific data generation was in connection with Phosdrin(R). Due to the phase out of Phosdrin(R) as discussed above, data generation costs with respect to Phosdrin(R) decreased approximately $1,236,000 in 1995 to approximately $54,000. The NAA, DDVP and PCNB product groups also experienced significant declines in scientific data generation of approximately $301,000, $239,000 and $196,000, respectively, in 1995 due to the maturation of the products and of the related research studies being conducted. Bidrin(R), which is a relatively recent addition to CHEMICAL's product line, was the only major product group\nto experience an increase in scientific data generation in 1995. Bidrin(R) scientific data generation costs increased approximately $212,000 in 1995. In 1994 the Company received a benefit of $350,000 as a result of an unrelated chemical company paying the Company for the right to cite and rely upon data developed by the Company. The Company did not receive any benefits of this kind in 1995.\nFreight, Delivery and Warehousing:\nFreight, delivery and warehousing costs increased by $447,600 to $3,008,300 in 1995 from $2,560,700 in 1994. The increase in costs is primarily due to increased freight costs as a result of the higher sales at CHEMICAL and additions to shipping department personnel to handle the additional demand.\nGeneral, Administrative and Corporate:\nGeneral, administrative and corporate costs increased by $1,261,100 to $4,061,800 in 1995 from $2,800,700 in 1994. The increase was primarily attributable to environmental consulting projects and legal fees which accounted for approximately $913,700. Additionally, the Company elected to provide for the remaining expected costs in connection with the phase out of Phosdrin(R) in the amount of $175,000.\nInterest costs were $935,400 in 1995 as compared to $978,200 in 1994. The average level of short-term borrowing decreased by $313,900 to $6,526,200 in 1995 from $6,840,100 in 1994. The average level of long-term debt declined by $1,552,400 to $3,816,600 in 1995 from $5,369,000 in 1994. The reduction in the average debt and the change in effective interest rates accounted for the decrease in interest costs in 1995.\nIncome tax expense increased by $1,657,200 to $1,919,000 in 1995 as compared to $261,800 in 1994. Higher pre-tax income combined with lower tax credits are the reason for the increased income tax expense. See Note 5 to the Consolidated Financial Statements for additional analysis of the changes in income tax expense.\nWeather patterns can have an impact on the Company's operations. Weather conditions influence pest population by impacting gestation cycles for particular pests and the effectiveness of some of the Company's products, among other factors. The Company manufactures and formulates chemicals for crops, human and animal health protection. The end user of some of the Company's products may, because of weather patterns, delay or intermittently disrupt field work during the planting season which may result in a reduction of the use of some of the Company's products.\nBecause of elements inherent to the Company's business, such as differing and unpredictable weather patterns, crop growing cycles, changes in product mix of sales and ordering patterns that may vary in timing, measuring the Company's performance on a quarterly basis, (gross profit margins on a quarterly basis may vary significantly) even when such comparisons are favorable, is not as good an indicator as full-year comparisons.\n1994 COMPARED WITH 1993:\nThe Company reported net income of $1,202,700 or $.47 per share in 1994 as compared to net income of $2,225,100 or $.89 per share in 1993. Significant factors adversely affecting net income in 1994 include provisions for settlements of legal matters in the amount of $1,140,000 (Refer to PART I, Item 3 of this Annual Report), a reduction in gross profits from 1993 of approximately $1,407,000 and an increase in interest expense of approximately $144,000. Partially offsetting these negative factors were a decrease in operating expenses of approximately $823,000 as well as a decrease in income tax expense of approximately $847,000.\nNet sales declined by $379,400 to $45,098,100 in 1994 as compared to $45,477,500. CHEMICAL's sales declined by approximately $5,122,000 in 1994 as compared to 1993. This decline was primarily due to a reduction in the sales of Bidrin(R). In November 1993, CHEMICAL purchased from Du Pont, the rights, title and interest in Bidrin(R), an insecticide for cotton crops. Concurrently with the purchase of the rights to Bidrin(R), CHEMICAL purchased Du Pont's existing inventory at Du Pont's approximate cost and sold that inventory in 1993. CHEMICAL did not begin manufacturing Bidrin(R) until December 1994, when the required permitting was granted. As a result, product delivered in 1994 was significantly less than in 1993. The decline in CHEMICAL's sales was essentially offset by an increase in sales as a result of the Company's acquisition of GemChem in mid January 1994. GemChem's sales (in 1994, after it was acquired by the Company) were approximately $4,700,000. The remaining change in sales was attributable to changes in the sales mix of the Company's products.\nGross profits declined by $1,406,700 to $19,731,800 in 1994 as compared to $21,138,500 in 1993. This represents a decline in the gross profit margin of approximately 2.7%. This decline was primarily due to the impact of GemChem sales on consolidated gross profit. GemChem, in addition to being the exclusive sales agent for the Company, is also a distributor of various pharmaceutical and nutritional supplement products. The gross profit margin for the distribution of GemChem's products was approximately 15% compared to the gross profit margin of approximately 47% for the Company's manufactured products.\nOperating expenses declined by $822,900 to $16,155,600 in 1994 from the $16,978,500 reported in 1993. The following is a discussion of operating expenses:\nSelling and Regulatory:\nSelling and Regulatory expenses decreased by $1,666,000 to $4,582,700 in 1994 from $6,248,700 in 1993. The decrease in selling and regulatory expenses is primarily attributable to a decrease in variable selling costs. Significant reductions in Bidrin(R) rebates and royalties of approximately $724,000 occurred as a result of the lower sales of Bidrin(R) in 1994. Additionally, a royalty contract related to sales of Phosdrin(R) expired at the end of 1993 eliminating royalties of approximately $499,000 incurred in 1993. Other reductions in rebates as a result of changes in the sales mix amounted to approximately $283,000.\nResearch and Development:\nResearch and development costs, which include costs incurred to generate scientific data and other activities performed in the department, increased by $527,800 to $6,211,500 in 1994 from $5,683,700 in 1993. Costs incurred to generate scientific data increased by $826,600 to $5,544,000 in 1994 as compared to $4,715,400 in 1993. The most significant increases in scientific data generation related to the Bidrin(R) and Napthalene Acetic Acid product groups which accounted for an increase in costs of approximately $1,500,000 while a gradual curtailment of costs related to the DDVP product group resulted in a reduction in costs in 1994 of approximately $778,000. The Company did receive a benefit of $350,000 in 1994 as a result of an unrelated chemical company paying the Company for the right to cite and rely upon data developed by the Company.\nFreight, Delivery and Warehousing:\nFreight, delivery and warehousing costs decreased by $132,800 to $2,560,700 in 1994 from $2,693,500 in 1993. These costs decreased primarily as a result of decreased freight costs due to lower sales at CHEMICAL.\nGeneral, Administrative and Corporate:\nGeneral, administrative and corporate costs increased by $464,700 to $2,800,700 in 1994 from $2,336,000 in 1993. The increase was primarily attributable to an increase in legal costs. (Refer to PART I, Item 3 for a discussion of legal proceedings.)\nInterest costs were $978,200 in 1994 as compared to $833,900 in 1993. The average level of short-term borrowing increased by $429,800 to $6,840,100 in 1994 from $6,410,300 in 1993. The average level of long-term debt declined by $819,800 to $5,369,000 in 1994 from $6,188,800 in 1993. The lower average debt for 1994 as compared to 1993, was not sufficient to offset higher effective interest rates which accounted for the increase in interest costs.\nIncome tax expense decreased by $846,500 to $261,800 in 1994 as compared to $1,108,300 in 1993. See Note 5 to the Consolidated Financial Statements for an analysis of the changes in income tax expense.\nLIQUIDITY AND CAPITAL RESOURCES\nWorking capital was $15,694,500 as of December 31, 1995 reflecting an $11,021,800 improvement over working capital of $4,672,700 as of December 31, 1994.\nCurrent assets were $722,300 higher at December 31, 1995 than at December 31, 1994. While trade receivables were $2,505,900 higher at December 31, 1995 due to the greater sales volume at CHEMICAL, the increase was substantially offset by the payment in 1995 of a $2,075,000 legal settlement receivable recorded at December 31, 1994 related to the DBCP settlement (Refer to PART I, Item 3, Legal Proceedings and Note 7 of the Notes to the Consolidated Financial Statements of this annual report for additional information). Also offsetting the increase in trade receivables was a decrease in other receivables of $425,500 which was primarily attributable to the receipt of $350,000 related to the sale of rights to the use of scientific data generated by the Company. Inventories increased $1,051,700 in 1995 over 1994. The higher inventory level is attributable to a planned build-up of certain of the Company's finished products in anticipation of meeting future sales demands. Prepaid expenses decreased $348,700 in 1995 which was primarily due to the expense recognition of royalties paid in advance.\nCurrent liabilities decreased $10,299,500 in 1995 over 1994. The Company paid down the Company's fully-secured line of credit from $8,000,000 at December 31, 1994 to $3,900,000 at December 31, 1995. Additionally, in September 1995, the Company renewed and amended its line of credit agreement with its bank, one of the terms of which was the extension of the expiration date to July 31, 1997. As such, the balance of $3,900,000 under the line of credit agreement at December 31, 1995 has been classified as a long-term liability. The line of credit agreement, which has a borrowing limit of $10,500,000, had $6,600,000 of available credit at December 31, 1995. Another significant reduction in current liabilities as of December 31, 1994 was the payment during 1995 of a legal settlement in the\namount of $3,366,900 related to the DBCP lawsuits (Refer to PART I, Item 3, Legal Proceedings and Note 7 of the Notes to the Consolidated Financial Statements of this annual report for additional information). The effects of the above noted decreases were offset by an increase in income taxes payable of $693,300 and a net increase in accounts payable and other accrued expenses of $313,200.\nThe Company invested $755,000 in capital expenditures in 1995. These expenditures improve and\/or maintain the existing capacity of the Company's manufacturing facility, and address the Company's continual effort to adapt its manufacturing processes to the environmental control standards of its various controlling agencies. The Company also invested $226,500 in deferred charges in 1995, most of which relate to EPA study costs. The capitalized balance of deferred charges as of December 31, 1995 are not material. The Company recognized $3,415,300 of depreciation and amortization expense in 1995. As of December 31, 1995, the Company does not have any material commitments for future capital expenditures.\nAs part of the renewal and amendment of the Company's credit facility, as discussed above, the Company increased its term loan availability to a maximum of $5,250,000 to be paid in monthly installments through December 1, 2000. The Company borrowed an additional $3,702,300 in December 1995 which increased the existing term loan to the maximum amount allowed as of December 31, 1995. The Company made principal payments on its long-term debt of $1,797,800 during 1995.\nThere has been constant public pressure upon the federal and state governments to require FIFRA product registrants to supply new scientific data (such as toxicological and environmental fate tests), which has resulted in government action requiring additional studies and the submission of more data. Based on facts known today, the Company estimates it will spend approximately $3,900,000 in 1996 on these studies. Because scientific analyses are constantly improving, it cannot be determined with certainty whether or not material new or additional tests may be required. Additionally, while FIFRA Good Laboratory Practice standards specify the minimum practices and procedures which must be followed in order to ensure the quality and integrity of data related to these tests submitted to the EPA, there can be no assurance the EPA will not request certain tests\/studies be repeated. For further information, refer to PART I, Item 1, Business, Competition of this Annual Report.\nCHEMICAL is a manufacturer and formulator of chemicals for crops, human and animal health protection. For discussions pertaining to the Company's litigation refer to PART I, Item 3, Legal Proceedings of this Annual Report.\nManagement believes current financial resources (working capital and borrowing arrangements) and anticipated funds from operations will be adequate to meet total financial needs in 1996. Management also continues to believe, to improve its working capital position and maintain flexibility in financing interim needs, it is prudent to explore alternate sources of financing.\nThe Company, as previously disclosed, is required to supply studies and the submission of data to federal and state governmental agencies. Because scientific analyses are constantly improving, it cannot be determined with certainty whether or not additional tests that may be material will be required. Although management does not currently foresee any critical liquidity problems, should material new or additional tests be required during 1996, anticipated funds from operations may not be adequate to meet total financial needs in 1996.\nManagement believes that inflation has not had a significant impact on the Company's costs and prices during the past three years.\nNew Accounting Standards\nStatement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long- Lived Assets to be Disposed of\" (\"SFAS No. 121\") issued by the Financial Accounting Standards Board (\"FASB\") is effective for financial statements for fiscal years beginning after December 15, 1995. The new standard establishes guidelines regarding when impairment losses on long-lived assets, which include plant and equipment, and certain identifiable intangible assets, should be recognized and how impairment losses should be measured. The Company does not expect adoption to have a material effect on its financial position or results of operations.\nStatements of Financial Accounting Standards No. 123, \"Accounting for the Stock-Based Compensation\" (\"SFAS No. 123\") issued by the FASB is effective for specific transactions entered into after December 15, 1995, while the disclosure requirements of SFAS No. 123 are effective for financial statements for fiscal years beginning no later than December 15, 1995. The new standard establishes a fair value method of accounting for stock- based compensation plans and for transactions in which an entity acquires goods or services from non-employees in exchange for equity instruments. The Company does not expect adoption to have a material effect on its financial position or results of operations. At the present time, the Company has not determined if it will change its accounting policy for stock based compensation or only provide the required financial statement disclosures. As such, the impact on the Company's financial position and results of operations is currently unknown.\nITEM 8","section_7A":"","section_8":"ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - ------ -------------------------------------------\nThe Financial Statements and Supplementary Data are listed at PART IV, Item 14, Exhibits, Financial Statement Schedules, and Reports on Form 8-K in 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 following persons are the current Directors and Executive Officers of Registrant:\nHerbert A. Kraft has served as Co-Chairman of the Board since July 1994. Mr. Kraft served as Chairman of the Board and Chief Executive Officer from 1969 to July 1994.\nGlenn A. Wintemute has served as Co-Chairman of the Board since July 1994. Mr. Wintemute served as President of the Company and all operating subsidiaries since 1984 and was elected a director in 1971. He served as President of CHEMICAL from 1963 to July 1994.\nEric G. Wintemute has served as a director since June 1994. Mr. Wintemute has also served as President and Chief Executive Officer since July 1994. He was appointed Executive Vice President and Chief Operating Officer of the Company in January 1994, upon the Company's acquisition of GemChem, Inc. He co-founded GemChem, Inc., a national chemical distributor, in 1991 and served as its President. Mr. Wintemute was previously employed by CHEMICAL from 1977 to 1982. From 1982 to 1991, Mr. Wintemute worked with R. W. Greeff & Co., Inc., a former distributor of certain of CHEMICAL's products. During his tenure with R. W. Greeff & Co., Inc., he served as Vice President and\nDirector. He is the son of the Company's Co-Chairman, Glenn A. Wintemute.\nJames A. Barry has served as a director since June 1994. Mr. Barry was appointed Treasurer in July 1994. He has served as Chief Financial Officer of the Company since 1987, and as Vice President and Assistant Secretary since 1990. From 1990 to July 1994, he also served as Assistant Treasurer.\nGlenn E. Mallory has served as a director of the Company since 1971 and its Secretary since 1976. Mr. Mallory served as Treasurer from 1976 to July 1994. He also served as Vice President of CHEMICAL from 1970 to September 1993.\nHenry L. Scott has served as a director of the Company since 1983. He has been a practicing certified public accountant since 1951. Mr. Scott serves on the board of directors of Royal American Printing Machine Company, Beverly Hills Medical Group and several privately held companies.\nJesse E. Stephenson has served as director of the Company since 1977 (except for a 10-month period following March 1992). He was the General Manager of a wholly-owned subsidiary of the Company, from 1968 to 1978. Mr. Stephenson is retired and is a private investor.\nCompliance with Section 16(a) of the Securities Exchange Act of 1934\nSection 16(a) of the Securities Exchange Act of 1934 requires the Company's executive officers, 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.\nThe Company believes that during 1995 all reports required to be filed under Section 16(a) by its executive officers, directors, and greater than ten percent beneficial owners were timely filed.\nITEM 11","section_11":"ITEM 11 EXECUTIVE COMPENSATION\nThe following table sets forth the aggregate cash and other compensation for services rendered for the years ended December 31, 1995, 1994, and 1993 paid or awarded by the Corporation and its subsidiaries to the Corporation's Chief Executive Officer and each of the four most highly compensated executive officers of the Corporation, whose aggregate remuneration exceeded $100,000 (the \"named executive officers\").\nSUMMARY COMPENSATION TABLE\n- --------\n(1) No executive officer enjoys perquisites that exceed the lesser of $50,000, or 10% of such officer's salary.\n(2) Mr. Eric G. Wintemute joined the Company in January 1994.\n(3) Amounts prior to 1994 were not required to be reported.\n(4) Represents options to purchase Common Stock of the Company issued to Eric Wintemute in connection with the acquisition of GemChem, Inc., by the Company during 1994. The options issued to Mr. Wintemute represent approximately 43% of the total options issued by the Company in 1994. The exercise price of the options is $10.00 per share and the options vest one-fourth on January 15, 1995, 1996, 1997 and 1998 and all options expire on April 15, 1998.\n(5) Represents options to purchase Common Stock of the Company. The options issued to Mr. Barry represent approximately 13% of the total options issued by the Company in 1995.\n(6) These amounts represent the Company's contribution to the Company's Retirement Savings Plan, a qualified plan under Internal Revenue Code Section 401 (k).\n(7) Messrs. Kraft and Wintemute retired from the Company as active employees in July 1994 and subsequently entered into consulting agreements with the Company to provide specified services through July 1999. All other compensation (column (I)) includes $127,164 paid to each individual under his consulting agreement and $4,693 on behalf of each individual as a retirement savings plan contribution as described in (6) above for 1994. Amounts for 1995 represent payments paid to each individual under his consulting agreement.\nCompensation Committee Interlocks and Insider Participation\nThe Compensation Committee of the Board consists of Messrs. Herbert A. Kraft, Jesse E. Stephenson and James A. Barry. The executive compensation philosophy of the Company is aimed at (i) attracting and retaining qualified executives; (ii) motivating performance to achieve specific strategic objectives of the Company; and (iii) aligning the interest of senior management with the long-term interest of the Company's shareholders.\nITEM 12","section_12":"ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS - ------- ----------------------------------------------- AND MANAGEMENT --------------\nTo the knowledge of Registrant, the ownership of Registrant's outstanding Common Stock as of March 22, 1996, by persons who are directors, beneficial owners of 5% or more of the outstanding Common Stock and by all directors and officers as a group is set forth below. Unless otherwise indicated Registrant believes that each of the persons set forth below has the sole power to vote and to dispose of the shares listed opposite his name.\n- ---------------------\n(1) Record and Beneficial.\n(2) This figure includes 22,220 common shares owned by Mr. Wintemute's children for which Mr. Wintemute is a trustee and disclaims beneficial ownership.\n(3) Mr. Kraft owns all of his shares with his spouse in a family trust, except as to 1,430 shares held in an Individual Retirement Account.\n(4) The Company has relied on information reported on a Statement on Schedule 13D dated August 21, 1992, filed by Goldsmith & Harris et al. with the Securities and Exchange Commission, and has adjusted for the 10% stock dividend issued March 15, 1996.\n(5) Mr. Stephenson holds all of his shares in a family trust.\n(6) This figure includes 16,500 shares Common Stock Mr. Wintemute is entitled to acquire pursuant to stock options exercisable within sixty days of March 22, 1996.\n(7) This figure represents shares Common Stock Mr. Barry is entitled to acquire pursuant to stock options exercisable within sixty days of March 22, 1996.\n(8) Under 1% of class.\nITEM 13","section_13":"ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - ------- ----------------------------------------------\nIn September 1991, the Company entered into an agreement with GemChem to represent the Company as its sales representative. No director, officer or significant shareholder of the Company had any direct or indirect relationship with or interest in GemChem; however, Eric G. Wintemute, the son of the Company's then President Glenn A. Wintemute, owned an approximate one-third equity interest in GemChem. The Company purchased approximately $3,600,000 and $3,200,000 in 1993 and 1992, respectively, of raw materials from GemChem. During the years ended December 31, 1993, and 1992, the Company expensed $1,586,400 and $1,386,400, respectively, in commissions earned by GemChem. No commissions were owed GemChem as of December 31, 1993. The Company believes that the commissions paid to GemChem for sales of products were no less favorable to the Company than would have been available from unrelated parties.\nIn March 1994, the Company concluded the purchase of all the issued and outstanding stock of GemChem. The purchase was effective January 15, 1994. The aggregate purchase price consisted of 50,000 unregistered shares of the Company's common stock and approximately $592,000 in two year notes with interest at prime plus .75%. The total purchase price was valued at $1,029,500. See also Note 11 of the Notes to the Consolidated Financial Statements in PART 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) Index to Consolidated Financial Statements and Supplementary Data:\nDESCRIPTION\nAll schedules are omitted because they are not applicable, or not required, or because the required information is included in the consolidated financial statements or notes thereto.\n(3) Exhibits:\nThe exhibits listed on the accompanying Index To Exhibits, page 59, are filed as part of this annual report.\n(b) Reports on Form 8-K were filed during the quarter ended December 31, 1995.\nNone.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, American Vanguard Corporation has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on the 28th day of March, 1996.\nAMERICAN VANGUARD CORPORATION (Registrant)\n\/s\/ Eric G. Wintemute \/s\/ James A. Barry - -------------------------------- -------------------------------- By: ERIC G. WINTEMUTE By: JAMES A. BARRY President, Vice President, Chief Executive Officer Chief Financial Officer, and Director Treasurer 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.\n\/s\/ Herbert A. Kraft \/s\/ Glenn A. Wintemute - -------------------------------- --------------------------- HERBERT A. KRAFT GLENN A. WINTEMUTE Co-Chairman Co-Chairman March 28, 1996 March 28, 1996\n\/s\/ Glenn E. Mallory \/s\/ Henry L. Scott - -------------------------------- --------------------------- GLENN E. MALLORY HENRY L. SCOTT\nCorporate Secretary and Director Director March 28, 1996 March 28, 1996\n\/s\/ Jesse E. Stephenson - -------------------------------- JESSE E. STEPHENSON Director March 28, 1996\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nThe Board of Directors and Stockholders American Vanguard Corporation\nWe have audited the accompanying consolidated balance sheets of American Vanguard Corporation and subsidiaries as of December 31, 1995 and 1994 and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1995. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of American Vanguard Corporation and their subsidiaries at December 31, 1995 and 1994 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\nBDO SEIDMAN, LLP\nLos Angeles, California March 4, 1996\nAMERICAN VANGUARD CORPORATION AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\nDECEMBER 31, 1995 AND 1994\n(CONTINUED)\nAMERICAN VANGUARD CORPORATION AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\nDECEMBER 31, 1995 AND 1994\nSee summary of significant accounting policies and notes to consolidated financial statements.\nAMERICAN VANGUARD CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF INCOME\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSee summary of significant accounting policies and notes to consolidated financial statements.\nAMERICAN VANGUARD CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSee summary of significant accounting policies and notes to consolidated financial statements.\nAMERICAN VANGUARD CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n(Continued)\nAMERICAN VANGUARD CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED\nSUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:\nDuring 1993, capital lease obligations of $216,200 were incurred when the Company entered into leases for new property, plant, and equipment.\nDuring 1994, in connection with the acquisition of GemChem, Inc. (see note 11), as part of the purchase price, the Company issued 50,000 shares of its common stock with a fair value of $437,500.\nSee summary of significant accounting policies and notes to consolidated financial statements.\nAMERICAN VANGUARD CORPORATION AND SUBSIDIARIES\nSUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nDECEMBER 31, 1995 AND 1994\nDescription of Business and Basis of Consolidation\nThe Company is primarily a specialty chemical manufacturer that develops and markets safe and effective products for agricultural and commercial uses. The Company manufacturers and formulates chemicals for crops, human and animal protection. One of the Company's subsidiaries, GemChem, Inc. (see note 11), is the Company's exclusive sales agent and is also a distributor of various pharmaceutical and nutritional supplement products. The consolidated financial statements include the accounts of American Vanguard Corporation (\"Company\") and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.\nBecause of elements inherent to the Company's business, such as differing and unpredictable weather patterns, crop growing cycles, changes in product mix of sales and ordering patterns that may vary in timing, measuring the Company's performance on a quarterly basis, (gross profit margins on a quarterly basis may vary significantly) even when such comparisons are favorable, is not as good an indicator as full-year comparisons.\nInventories\nInventories are stated at the lower of cost or market. Cost is determined using the first-in, first-out method.\nIntangible Assets\nIntangible assets resulting from the business acquisition (see Note 11), consists of cost in excess of net assets (goodwill) acquired. Goodwill is being amortized on a straight-line basis over the period of an expected benefit of 15 years. Management has a policy to review goodwill and other productive assets at each quarterly balance sheet date for possible impairment. This policy includes recognizing write-downs if it is probable that measurable undiscounted future cash flows and\/or the aggregate net cash flows of an asset, as measured by current revenues and costs (exclusive of depreciation) over the asset's remaining depreciable life, are not sufficient to recover the net book value of an asset.\nRevenue Recognition\nSales are recognized upon shipment of products or transfer of title to the customer.\nDepreciation\nDepreciation of property, plant and equipment is calculated on the straight-line method over the estimated useful lives of the assets.\nFair Value of Long-term Debt\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.\nAMERICAN VANGUARD CORPORATION AND SUBSIDIARIES\nIncome Taxes\nIncome taxes have been provided using the asset and liability method in accordance with Financial Accounting Standard No. 109, \"Accounting for Income Taxes\" (\"SFAS 109\").\nSFAS 109 employs an asset and liability approach in accounting for income taxes, the objective of which, is to recognize the amount of current and deferred taxes at the date of the financial statements using the provisions of the tax laws then in effect.\nPer Share Information\nEarnings per share amounts are computed based on the weighted average number of shares of common stock. Common stock equivalents, which consisted of options to purchase the Company's common stock, were anti-dilutive in 1995 and 1994. There were no common stock equivalents outstanding during 1993. Earnings per share have been restated to reflect a 10% common stock dividend payable March 15, 1996 to common stockholders of record as of February 29, 1996.\nAccounting Estimates\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, and expenses at the date that the financial statements are prepared. Actual results could differ from those estimates.\nNew Accounting Pronouncements\nStatement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of\" (\"SFAS No. 121\") issued by the Financial Accounting Standards Board (\"FASB\") is effective for financial statements for fiscal years beginning after December 15, 1995. The new standard establishes guidelines regarding when impairment losses on long-lived assets, which include plant and equipment, and certain identifiable intangible assets, should be recognized and how impairment losses should be measured. The Company does not expect adoption to have a material effect on its financial position or results of operations.\nStatements of Financial Accounting Standards No. 123, \"Accounting for the Stock-Based Compensation\" (\"SFAS No. 123\") issued by the FASB is effective for specific transactions entered into after December 15, 1995, while the disclosure requirements of SFAS No. 123 are effective for financial statements for fiscal years beginning no later than December 15, 1995. The new standard establishes a fair value method of accounting for stock-based compensation plans and for transactions in which an entity acquires goods or services from non-employees in exchange for equity instruments. The Company does not expect adoption to have a material effect on its financial position or results of operations. At the present time, the Company has not determined if it will change its accounting policy for stock based compensation or only provide the required financial statement disclosures. As such, the impact on the Company's financial position and results of operations is currently unknown.\nReclassifications\nCertain prior years' amounts have been reclassified to conform to the current year's presentation.\nAMERICAN VANGUARD CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1995 AND 1994\n(1) PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment at December 31, 1995 and 1994 consists of the following:\n(2) DEFERRED CHARGES\nDuring 1995 and 1994, the Company capitalized $185,000 and $509,000, respectively, in deferred charges relating to certain Environmental Protection Agency study costs for a new product the Company began producing in October 1990. Amortization of these costs began in October 1990, and was provided by the units of production method over a period of five years through September 1995. Total study costs incurred and capitalized through September 1995 for this product approximated $5,812,500.\nAMERICAN VANGUARD CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\n(3) LONG-TERM DEBT\nLong-term debt of the Company at December 31, 1995 and 1994 is summarized as follows (fair values approximate reported carrying amounts):\nApproximate principal payments on long-term debt mature as follows:\n(4) NOTE PAYABLE TO BANK\nUnder a credit agreement with a bank, the Company may borrow up to $10,500,000. The note bears interest at a rate of prime plus .25% (prime was 8.5% at December 31, 1995 and 1994). Additionally, the Company, at its option, may pay a fixed rate offered by the bank for terms not less than 30 nor more than 180 days and provided that any such period of time does not extend beyond the expiration date of the credit agreement. Substantially all of the Company's assets not otherwise\nAMERICAN VANGUARD CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\nspecifically pledged as collateral on existing loans and capital leases are pledged as collateral under the credit agreement. The note payable expires on July 31, 1997. The Company had $6,600,000 available under this credit agreement as of December 31, 1995. The credit agreement, among other financial covenants, limits payments of cash dividends to a maximum of 25% of net income. The Company was in compliance with the financial covenants as of December 31, 1995. The balance outstanding at December 31, 1995 and 1994 was $3,900,000 and $8,000,000. The average amount outstanding during the years ended December 31, 1995 and 1994 was $6,526,200 and $6,840,100. The weighted average interest rate during the years ended December 31, 1995 and 1994 was 9.1% and 7.25%.\n(5) INCOME TAXES\nThe components of income tax expense are:\nTotal income tax expense differed from the amounts computed by applying the U.S. Federal income tax rate of 34% to income before income tax expense as a result of the following:\nAMERICAN VANGUARD CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\nTemporary differences between the financial statement carrying amounts and tax bases of assets and liabilities that give rise to significant portions of the deferred tax liability at December 31, 1995 and 1994 relate to the following:\nThe Company believes it is more likely than not that the deferred tax assets above will be realized in the normal course of business.\n(6) LEASES\nThe Company leases certain manufacturing equipment, and office furniture, fixtures and equipment under long-term capital lease agreements.\nProperty, plant and equipment include the following leased property under capital leases by major classes:\nAMERICAN VANGUARD CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\nThe following is a schedule of future minimum lease payments for capital leases as of December 31, 1995:\nYear ending December 31:\n(7) LITIGATION AND ENVIRONMENTAL\nDBCP LAWSUITS\nA. California Matters\ni) 1995 Settlement of Claims.\nIn 1995 CHEMICAL has brought its participation in twenty-three similar lawsuits filed between January 1990 and December 1994 to an end. The Plaintiffs in each matter were primarily water districts and municipalities that alleged property damage resulting from, among other things, the fact that each plaintiff's water supply had been contaminated by DBCP. The settlement covered all the plaintiff's current and future 1,2 Dibromo-3-Chloropropane (hereinafter referred to as \"DBCP\") a pesticide, ethylene dibromide (hereinafter referred to as \"EDB\") a fumigant, and related claims. On February 15, 1995, the Superior Court of California in San Francisco County approved this settlement as having been made in \"good faith\". The effect of the Superior Court's approval is to bar claims, arising from these pleadings, against CHEMICAL by other defendants (and other tortfeasors) for equitable comparative contribution and\/or partial or comparative indemnity. CHEMICAL's portion of the settlement was $905,000. As to matters independent of indemnity issues, the Company recovered $675,000 from two of its insurers.\nii) Post Settlement Actions.\nSubsequent to the settlements discussed above, two additional suits alleging property damage resulting from DBCP contamination of water supply were filed in the San Francisco Superior Court and served on CHEMICAL: City of Madera v. Shell Oil Co., et. al., and Malaga County Water District v. Shell Oil Co., et. al. The City of Madera action also alleges contamination of the water supply with EDB. CHEMICAL has never marketed EDB. These suits name as defendants Shell Oil Company, the Dow Chemical Company, Occidental Chemical Company, Chevron Chemical Company, Velsicol Chemical Company and in the Madera action Great Lakes Chemical Corporation. Malaga has made a settlement\nAMERICAN VANGUARD CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\ndemand of $1,344,000 for one of five wells at issue. As discovery is at the early stages no other settlement demands have been received. Defendants are operating under an open extension of time to file responsive pleadings. CHEMICAL has tendered the defense of these two cases to Columbia Casualty\/CNA. That insurer has thus far accepted the defense under a reservation of rights in the Malaga action, but has yet to respond to the tender of defense for the Madera action.\nB. Texas Matters\ni) The Carcamo Case.\nThe Company was served with a third-party first amended complaint by Dow Chemical Company which sought indemnity and contribution from CHEMICAL, Del Monte tropical Fruit Company, Del Monte Fresh Produce, N.A., Dead Sea Bromine Co. Ltd., Ameribrom Inc., Saint Lucia Banana Growers Association, Saint Vincent Banana Growers Association, Dominica Banana Growers Association, and Program Nacional de Banano, for any liability Dow may have under a complaint filed by Jorge Colindres Carcamo, et al. vs. Shell, Dow, et al. (the \"Carcamo Case\"). The Carcamo Case was tried in the United States District Court for the Southern District of Texas, Houston Division, and is an action originally filed in a Texas state court by a purported class of citizens from Honduras, Costa Rica, Guatemala, Nicaragua, Panama, Philippines, Dominica, and the Ivory Coast. These plaintiffs were banana workers and allege that they were exposed to DBCP while applying the product in their native countries. Approximately 15,000 plaintiffs have been named in this and the other suits hereinafter mentioned.\nIn an October 27, 1996 Court Order the third party action against CHEMICAL was dismissed without prejudice. The Order also dismissed the Plaintiff's consolidated cases concluding that these claims should be litigated in the foreign countries where the alleged injuries occurred subject to a number of conditions. One of the more significant conditions requires the Defendants and third party Defendants consent to the jurisdiction of the courts of each of the foreign countries. Under the Order the Defendants may proceed against CHEMICAL, in a court in the United States, for contribution and indemnity should plaintiffs in the underlying actions obtain a judgement against Defendants in any foreign forum. As of the filing of this report, no actions against CHEMICAL have been filed.\nii) The Rodriguez Case.\nThe Company was served with a third-party complaint on March 15, 1996 by Defendant Standard Fruit Company and Standard Steamship Company seeking indemnity and contribution from any liability it may have under a complaint entitled Ramon Rodriguez et. al. v. Shell Oil Company, et. al. (the \"Rodriguez Case\") filed in the District Court of Jim Hogg County, Texas. Also named as Third Party Defendants are Dead Sea Bromine Co., Ltd. and Bromine Compounds Ltd. The underlying case alleges injuries caused by Plaintiffs' exposure to DBCP when they applied that pesticide at farms located in Central America, Ecuador and the Philippines. The Company has made a demand upon certain insurers\nAMERICAN VANGUARD CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\nfor indemnity from and a defense of the Rodriguez Case. No answer has yet been received from said insurers.\nPHOSDRIN(R) LAWSUIT\nOn September 21, 1995, CHEMICAL was served with a complaint filed in the Superior Court of King County, Washington on September 12, 1995 entitled Ricardo Ruiz Guzman, et. al. v. AMVAC Chemical Corporation, et. al.(the \"Guzman Case\"). The Complaint is for unspecified monetary damages based on Plaintiff farm worker's alleged injuries from their exposure to the pesticide Phosdrin(R) while working in several orchards in Central Washington State in 1993. Other Defendants named in the Guzman case include: Wilbur-Ellis Company, Alan Hilliker, and Ellis D. Wilker. The matter is currently pending in the United States District Court for the Eastern District of Washington and Defendant's Hilliker and Wilker have been dismissed from the action. CHEMICAL has made a demand against its insurers for indemnity and defense of the Guzman Case. The insurer Lexington Insurance Company has thus far accepted the defense under a reservations of rights letter. CHEMICAL has a self insured retention limit of $300,000 under its insurance policy.\nTRAIN DERAILMENTS\nA. July 14, 1991; Dunsmuir, California:\nIn August 1992, the Company settled all personal and economic injury claims asserted in a class action lawsuit arising from the July 14, 1991 derailment of a rail tank car leased by CHEMICAL. The derailment, occurring about six miles north of Dunsmuir, California, involved the spill into the Upper Sacramento River of approximately 19,000 gallons of Metam Sodium, a soil fumigant manufactured by CHEMICAL which was being transported by Southern Pacific Transportation Company (\"SP\") along SP's tracks. The court, when finding that such settlement by CHEMICAL was in \"good faith\", also ordered that no other person or entity falling within the definition of the settlement class could proceed with claims against the Company.\nOn March 14, 1995, the federal court approved the Consent Decree which the Company and the federal and state governments entered which settled litigation seeking to hold potentially responsible parties under various federal and state statutes responsible for the costs of studying and remediating the environmental consequences caused by the Sacramento Spill, and for damages to the Natural Resources. On January 5, 1996, the Court dismissed the California Sportfishing Protection Alliance's (\"Alliance\") appeal of a court's order dismissing their intervention. This Order finally resolves the action brought by the Alliance which was the only remaining issue arising from this incident.\nB. February 1, 1996; Devore, California:\nOn March 7, 1996, CHEMICAL was served with a Complaint in an action entitled Alvin Williams, Administrator of the Estate of Kevin Lewis Williams v. Burlington Northern Santa Fe Railway Company, et. al.\nAMERICAN VANGUARD CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\n(the \"Williams Estate Case\"). This case was filed on February 26, 1996 in the Superior Court of Los Angeles County and arose from Kevin Lewis Williams' death in a train derailment which occurred on Burlington Northern Santa Fe Railway Company tracks involving a tank car leased by GATX to Albright & Wilson Americas Corporation (\"A&WA\") which was transporting 158,000 pounds of Trimethyl Phosphite (\"TMP\") from A&WA's Charleston, South Carolina Facility to CHEMICAL's manufacturing facility in Los Angeles, California. The derailment, occurred on February 1, 1996 at approximately 4:14 a.m. about 6 miles north of Devore, California, adjacent to the intersection of Interstate 15 and State Highway 138. The derailment involved the engine and most of the railcars on the train resulting in a chemical fire that consumed all of the TMP in addition to the contents of railcars transporting an assortment of hazardous chemicals and other goods. The Estate alleges pecuniary loss to family members in the amount of $ 20,000,000 and prays for other unspecified monetary relief. Other Defendants presently named in the suit are: Burlington Northern Santa Fe Railway Company, The Atchison, Topeka & Santa Fe Railway Company, UNOCAL, Rohm & Haas, and Westinghouse Corporation. CHEMICAL is named in only one of the Estate's seven causes of action. The Company has made demand upon its insurers for indemnity from and defense of the Williams Estate Case. No answer has yet been received from the Company's insurers.\nRAILROAD SIDING:\nAs a result of inspections and sampling conducted by the California Department of Toxic Substances Control (\"DTSC\") of the railroad located, in part, immediately adjacent to CHEMICAL's Commerce, California facility, CHEMICAL was directed to, and did, conduct sampling during 1993 to evaluate the nature and extent of pesticide contamination detected by DTSC on the railroad siding. Following its review of the sampling report prepared by CHEMICAL's independent consultant, DTSC directed that additional sampling be undertaken and CHEMICAL's independent consultant prepared a sampling plan for submittal to DTSC for prior approval as required. However, before additional sampling could be conducted, the Los Angeles county District Attorney's Office (\"LADA\"), at the request of DTSC, commenced an enforcement action in April 1994, against CHEMICAL, one of its officers, and two employees alleging felony illegal disposal of hazardous waste on the railroad siding. At the same time, DTSC demanded sums of money for alleged violations of certain compliance requirements related to CHEMICAL's management of hazardous waste at its Commerce, California facility. Joint settlement negotiations were conducted with the DTSC and the LADA and were concluded with a settlement agreement which was entered with the Los Angeles Municipal Court in a Stipulated Sentencing Memorandum which provided as follows: (i) all felony charges against CHEMICAL and the three individuals were dismissed; (ii) CHEMICAL entered a plea of nolo contendere to one misdemeanor; (iii) CHEMICAL was placed on probation for approximately six (6) months commencing on or about September 23, 1994; (iv) CHEMICAL was ordered to pay, by March 22, 1995, the sum of $135,000 in fines and penalties, and civil restitution in the amount of $325,000; (v) CHEMICAL agreed to enter into a Consent Agreement and Order (the \"First CAO\") with DTSC to correct the alleged hazardous waste management compliance violations and to submit a new plan for closure of ten (10) underground storage tanks (\"USTs\") at the\nAMERICAN VANGUARD CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\nCommerce, California facility and (vi) CHEMICAL agreed to enter into a Consent Agreement and Order (the \"Second CAO\") with DTSC providing for CHEMICAL to further investigate and remediate the railroad siding.\nPursuant to the settlement agreement, CHEMICAL entered into the First CAO effective on January 26, 1995, and on March 22, 1995, with the concurrence of the LADA, CHEMICAL withdrew its plea of nolo contendere to the one misdemeanor, entered a plea of not guilty which was accepted, and the court dismissed the complaint against CHEMICAL. CHEMICAL has substantially fulfilled the requirements of the First CAO and, in accordance therewith, submitted new plans for closure of ten (10) USTs located at the facility. During 1995, in accordance with the UST closure plan, CHEMICAL arranged for the removal and cleaning of residues within the tanks and completed the initial investigation of soils in the area of the tanks and their associated piping. CHEMICAL anticipates that additional UST related soil investigations will be completed by late 1996 and that remedial activities, if any, will commence by late 1996 or early 1997.\nCHEMICAL is currently in discussions with DTSC regarding the specific terms of the Second CAO which will address investigation and remediation of the railroad siding. CHEMICAL is in the process of completing all requirements for addressing investigation and remediation of the railroad siding under a new DTSC program created by California Senate Bill 923 known as the Expedited Remedial Action Program (ERAP). CHEMICAL anticipates that addressing the railroad siding under ERAP will result in a more rapid and cost-effective resolution of environmental conditions in the railroad siding area than could otherwise be expected if the area were addressed under other available DTSC site investigation and remediation programs. The potential future costs associated with the railroad siding investigation and remediation are currently unknown and cannot be reasonably determined until soil investigations will be completed by late 1996 or early 1997.\nThe Company has made claims against its insurance carriers and has expensed all costs incurred which now exceed its $100,000 self-insured retention. There can be no assurance the Company will prevail in its position.\nVarious other legal actions, governmental proceedings, and claims are pending against the Company and its subsidiaries incidental to their businesses.\nWhile the ultimate results of the pending matters described above cannot be determined, management does not expect, based upon the facts known today, that they will have a material adverse effect on the Company's results of operations or financial condition.\nAMERICAN VANGUARD CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\n(8) EMPLOYEE DEFERRED COMPENSATION PLAN\nThe Company maintains a deferred compensation plan (Plan) for all eligible employees. The Plan calls for each eligible employee, at the employee's election, to participate in an income deferral arrangement under Internal Revenue Code Section 401(k) whereby the Company will match the first $5.00 of weekly employee contributions. The Plan also permits employees to contribute an additional 15% of their salaries of which the Company will match 50% of the first 6% of the additional contribution. The Company's contributions to the Plan amounted to approximately $175,100, $154,000 and $118,200 in 1995, 1994 and 1993, respectively.\n(9) MAJOR CUSTOMERS AND EXPORT SALES\nThe Company had sales to four major customers that accounted for 24%, 14%, 11%, and 10% of the Company's sales in 1995. In 1994 there were sales to one major customer that accounted for 27% of the Company's sales. In 1993, there were sales to four major customers that accounted for 25%, 11%, 10%, and 10% of the Company's sales.\nExport sales were $3,374,700, $3,812,500 and $4,714,400 for 1995, 1994, and 1993.\n(10) ROYALTIES\nThe Company has various royalty agreements in place extending through June 2001, some of which relate to the Company's acquisition of certain products. Royalty expenses were $786,800, $91,600 and $1,129,900 for 1995, 1994, and 1993.\n(11) ACQUISITION OF GEMCHEM, INC.\nIn September 1991, the Company entered into an agreement with GemChem, Inc. (\"GemChem\"), a related party, to represent the Company as its sales representative. Eric G. Wintemute, the son of the Company's former President, Glenn A. Wintemute, owned an approximate one-third equity interest in GemChem. The Company purchased approximately $3,600,000 in 1993 of raw materials from GemChem. During the year ended December 31, 1993 the Company expensed $1,586,400 in commissions earned by GemChem. The Company believes that the commissions paid to GemChem for sales of products were no less favorable to the Company than would have been available from unrelated parties.\nEffective January 15, 1994, the Company purchased all of the issued and outstanding stock of GemChem. The results of operations of GemChem have been included in the consolidated results of operations since the effective date of the purchase. The aggregate purchase price consisted of 50,000 unregistered shares of the Company's common stock and approximately $592,000 in two year notes with interest at prime plus .75%. The Company has valued the 50,000 shares at $437,500. All assets acquired were valued at book value, which approximated fair market value, resulting in an allocation to cost in excess of net assets acquired of $437,500 which is being amortized over 15 years. The\nAMERICAN VANGUARD CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\nresults of operations of GemChem are not material in relation to the Company.\n(12) Commitments\nIn July 1994, the Company entered into consulting agreements with two former employees who are the current Co-Chairmen of the Company's Board of Directors. The agreements expire in July 1999 and provide for total remuneration of $1,000,000 over the five year period to be paid to each former employee. As part of the acquisition of GemChem, the Company entered into employment agreements with GemChem's former three officers and shareholders. The employment agreements commenced January 15, 1994 and expire January 14, 1998. The agreements provide for aggregate salaries of $390,000 per year. Annual increases shall be determined by the Board of Directors or its designee but shall not be less than the increase in an agreed upon cost of living index. The employment agreements with the former officers and shareholders of GemChem also provide for the issuance of stock options to purchase an aggregate of 70,000 shares of the Company's common stock. The options are exercisable at the rate of 25% per year commencing January 15, 1995. The exercise price is $10.00 per share. Unexercised options expire on April 15, 1998. All options were anti-dilutive in 1995.\nAmounts to be paid under the aforementioned consulting and employment agreements are summarized as follows:\nIn July 1995, the Company entered into a noncancellable operating sublease for its corporate headquarters expiring in October 1999. The lease contains a provision to pass through to the Company the Company's pro rata share of the building's operating expenses commencing July 1, 1996 in excess of the amount passed through to the sublandlord during the first year of the sublease. Rent expense for the year ended December 31, 1995 was $49,400. There was no rent expense in 1994 and 1993. Future minimum lease payments under the terms of the sublease are as follows:\nAMERICAN VANGUARD CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\n(13) Research and Development\nResearch and development expenses were $3,717,400, $5,544,000 and $4,715,400 for the years ended December 31, 1995, 1994 and 1993, respectively.\n(14) Subsequent Event\nOn February 5, 1996, the Company announced that the Board of Directors declared a cash dividend of $.06 per share as well as a 10% stock dividend. Both dividends were distributed on March 15, 1996 to shareholders of record at the close of business on February 29, 1996. The cash dividend was paid on the number of shares outstanding prior to the 10% stock dividend. Weighted average number of shares have been restated to reflect the 10% stock dividend.\nINDEX TO EXHIBITS\nITEM 14(a)3\n- ----------------------\n(1) Incorporated by reference as an Exhibit to Registrant's Form 10 Registration Statement No. 2-85599 filed June 13, 1972.\n(2) Incorporated by reference as an Exhibit to Registrant's Form 10-K filed June 13, 1972.\n(3) Incorporated by reference as an Exhibit to Registrant's Form 10-K filed March 30, 1993.\n(4) Incorporated by reference to Exhibit 2.1 to the Registrant's Current Report on Form 8-K dated November 23, 1993.\n(5) Incorporated by reference as an Exhibit to Registrant's Form 10-K filed March 30, 1994.\n(6) Incorporated by reference as an Exhibit to Registrant's Form 10-K filed March 30, 1995.\n(7) Incorporated by reference as Appendix A to Registrant's Proxy Material filed June 3, 1995.","section_15":""}
{"filename":"931866_1995.txt","cik":"931866","year":"1995","section_1":"ITEM 1. BUSINESS.\nThe Spiegel Master Trust (the \"Trust\") was formed pursuant to\npooling and servicing agreement among Spiegel Credit Corporation\n(\"SCCIII\"), as seller and originator of the Trust; First\nConsumers National Bank (\"FCNB\"), a national banking association\nengaged in credit card operations and a wholly-owned subsidiary\nof Spiegel,Inc. (\"Spiegel\"), as servicer (referred to in such\ncapacity as the(\"Servicer\"); and a third party bank as trustee\n(the \"Trustee\"). The property of the Trust includes certain FCNB\nPreferred Charge accounts receivable (the \"Receivables\")\ngenerated or to be generated by FCNB in its ordinary course of\nbusiness and arising under designated FCNB Preferred Charge\naccounts used to charge sales of merchandise and services by\nSpiegel and its retailing subsidiaries (the \"Accounts\"), all\nmonies due or to become due in respect of the Receivables, all\nRecoveries, Collections and other proceeds of the Receivables\nand proceeds of credit insurance policies relating to the\nReceivables and all monies on deposit in certain bank accounts\nof the Trust.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nNot applicable.\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.\n- ---------------------------------------------------\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED\nSTOCKHOLDER MATTERS\nThe Series 1995-A Class A Certificates and the Series 1995-A\nClass B Certificates represent undivided interest in the Trust.\nThe property of the Trust includes a portfolio of FCNB\nPreferred Charge accounts receivable. There are two holders of\nrecord for the Series 1995-A Class A Certificates and the Series\n1995-A Class B Certificates. There is a third class of\ncertificates in the Master Trust, the Series 1995-A Class C\nCertificates. These certificates were issued to SCCIII by the\nTrust and are being held by SCCIII.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nNot applicable.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL\nCONDITION AND OF OPERATIONS\nNot applicable.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nNot applicable.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON\nACCOUNTING AND FINANCIAL DISCLOSURE.\nNot applicable.\n- -----------------------------------------------------------\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\nMANAGEMENT.\nNot applicable.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nNone, except the information concerning the servicing fees paid\nto the registrant by the Trust as contained in Exhibit 99.1\nthrough 99.3 hereto, which are hereby incorporated herein by\nreference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES,\nAND REPORTS ON FORM 8-K.\na. The following documents are filed as part of this Report:\n3. Exhibits\nNo. 99.1 Form of Monthly Certificateholders' Statement for\nOctober 1995\nNo. 99.2 Form of Monthly Certificateholders' Statement for\nNovember 1995\nNo. 99.3 Form of Monthly Certificateholders' Statement for\nDecember 1995\nb. Reports on Form 8-K filed with respect to fiscal 1995.\t\nDuring 1995, two Current Reports on Form 8-K were filed with the\nSecurities and Exchange Commission. The first, filed on August\n15, 1995, submitted the monthly certificateholders' statements\nfor April, May, and June required by the Pooling and Servicing\nAgreement. The second, filed on November 14, 1995, submitted the\nmonthly certificateholders' statements for July, August, and\nSeptember required by the Pooling and Servicing Agreement.\n- -------------------------------------------------------------\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the\nSecurities Exchange Act of 1934, Spiegel Credit Corporation III\nhas duly caused this Annual Report on Form 10-K to be signed on\nits behalf by the undersigned, thereunto duly authorized, on\nMarch 29, 1996.\nSpiegel Credit Corporation III on behalf\nof Spiegel Master Trust\nBy: \/s\/ John J. Shea ------------------------ John J. Shea, President (Principal Operating Executive Officer)\nPursuant to the requirements of the Securities Exchange Act of\n1934, this report has been signed below by the following persons\non behalf of the registrant, and in the capacities indicated on\nMarch 29,1996.\n- ------------------------------------------------------\nEXHIBIT INDEX\nExhibit\nNo. Exhibit\n- ----------- ----------------\n99.1 Form of Monthly Certificateholders' Statement\nfor October 1995\n99.2 Form of Monthly Certificateholders' Statement\nfor November 1995\n99.3 Form of Monthly Certificateholders' Statement\nfor December 1995","section_15":""}
{"filename":"50178_1995.txt","cik":"50178","year":"1995","section_1":"Item 1. Business.\nThe Company\nIndiana Bell Telephone Company, Incorporated (the Company), incorporated under the laws of the State of Indiana, has its principal office at 240 North Meridian Street, Indianapolis, Indiana 46204 (telephone number 1-800-257-0902). 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; Michigan Bell Telephone Company; The Ohio Bell Telephone Company and Wisconsin Bell, Inc. (referred to collectively as the \"Ameritech landline communications subsidiaries\"), as well as several other communications businesses, and has its principal executive offices at 30 South Wacker Drive, Chicago, Illinois 60606 (telephone number 1-800-257-0902). The Company is managed by its sole shareowner rather than a Board of Directors as permitted by Indiana law.\nAmeritech operates its business within the framework of customer-specific business units 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 communications industry, overlap the legal entities, including the Company, which form the infrastructure of Ameritech. The products and services of all the companies are marketed under the \"Ameritech\" brand identity, but Ameritech's five landline communications subsidiaries remain responsible within their respective service areas for providing telephone and other communications services, subject to regulation by the Federal Communications Commission (FCC) and the five respective state public service commissions. In 1995, Ameritech further aligned its business unit and legal entity structure into three sectors: communications and information products, consumer and business services and worldwide network systems, to sharpen its strategic focus and to better position the Company to serve customers and meet the competition. The Company offers services and operates under the names \"Ameritech\" and \"Ameritech Indiana\", pursuant to assumed name filings with the state of Indiana.\nOperations Under Line-of-Business Restrictions\nUntil a new telecommunications law came into effect in February 1996, the operations of Ameritech and its subsidiaries were 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 those assets relating to exchange telecommunications, exchange access functions, printed directories and cellular 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 communications subsidiaries, as well as a cellular communications company.\nThe Consent Decree, as originally approved, prohibited the RHCs from providing long distance communications 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 manufacturing 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 produce 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 April 1995, the Court opened the long distance market to the RHCs, allowing them to offer long distance cellular and other wireless services on the condition that they demonstrate measurable competition in their own markets. The ruling allowed the RHCs to resell long distance services provided by long distance carriers and handle all marketing, billing and discounts, but imposed a number of conditions which were recently superseded by the Telecommunications Act of 1996 (the 1996 Act).\nOn February 8, 1996, the first comprehensive overhaul of telecommunications legislation in 62 years was signed into law, removing barriers that had prevented the phone, cable TV and broadcast industries from entering each others businesses. The 1996 Act addresses various aspects of competition within, and regulation of, the communications industry. Among other things, the new law defines the conditions under which the Company may offer long distance service and provides certain mechanisms intended to facilitate local exchange competition. The new law removes the Consent Decree, lifting many prohibitions imposed by the Court, and gives the FCC responsibility for making a host of new rules governing telephone service. One rule-making function of the FCC is to determine when the local exchange carriers (LECs) have met a 14-step competition test that will allow them to offer long distance service to their local customers. For the RHCs, immediate relief under the new law includes permission to provide cellular long distance, in and out of region, out of region long distance and certain other incidental long distance services. The 1996 Act eliminates any barriers to companies wishing to compete against providers of local phone service.\nThe Company furnishes a wide variety of advanced communications services, including local exchange and toll service, network access and communications products, in an operating area comprised of 7 Local Access and Transport Areas (LATAs) in Indiana. 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 communications services. First, it transports communications 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 communications service between LATAs (interLATA, or long distance, service).\nAbout 64% of the population and 28% of the area of Indiana is served by the Company. The remainder of the state is served by nonaffiliated telephone companies. Fort Wayne and Terre Haute are the only cities of over 50,000 population in the State in which local service is provided by another telephone company.\nThe Company 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. The Company also provides billing and collection services for several companies, including billing for long distance services offered by certain long distance carriers, some of which began billing their own customers in 1996. It is not possible for the Company to estimate the impact of this change on future billing and collection revenues due to the uncertainty as to the number of customers affected, the timing of the billing changeovers and the degree of acceptance by customers.\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 had an agreement with Ameritech Publishing, Inc. (API), an Ameritech subsidiary doing business as Ameritech Advertising Services, under which API published and distributed classified directories under a license from the Company and provided services to the Company relating to both classified and alphabetical directories. API paid license fees to the Company under the agreement. That agreement terminated effective December 31, 1995. The Company has entered into a subsequent agreement with API for 1996 under which the Company furnishes to API certain services and data to be used by API in publishing and distributing classified and alphabetical directories. In exchange, the Company will receive compensation for the services and data.\nAmeritech Services, Inc. (ASI) is a company jointly owned by the Company and the other Ameritech landline communications 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 communications subsidiaries and integrated communications and information systems for all the business units.\nIn 1995, about 87% of the total operating revenues of the Company were from communications services and the remainder principally from billing and collection services, rents, directory advertising and other miscellaneous nonregulated operations. About 72% of the revenues from communications services were attributable to intrastate operations.\nLong Distance Services\nWhen Ameritech first unveiled its Customers First plan in 1993, becoming the first company in the U.S. communications industry to voluntarily offer to open its local network to competitors, it sought regionwide freedom to compete in both its existing businesses and long distance services. In exchange, to facilitate competition in the local exchange business, Ameritech would allow other service providers to purchase components of its network and to repackage them with their own services for resale. Ameritech proposed to change the way local communications services are provided and regulated and to furnish a policy framework for advanced universal access to modern communications services -- voice, data and video information. 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. In 1995, Ameritech sought permission to enter the interLATA market on a trial basis only, in order to demonstrate conclusively the substantial customer and economic benefits of full competition.\nMuch of the detailed language of the 1996 Act was based on Ameritech's plan. Under the 1996 Act, the Company must comply with a checklist to ensure competition before it can offer long distance service to its local landline customers. The FCC will determine whether or not a local service provider's entry into the long distance market serves the public interest. An RHC is restricted from providing long distance service until a competitor provides local phone service to its residential and business customers. The FCC will have to give substantial weight to DOJ recommendations in reviewing a company's entry into the market. In preparation, the Company is currently pursuing local network resale agreements with companies planning to offer local exchange service in 1996.\nThe new Act allows Ameritech and the other RHCs to provide long distance service immediately to their cellular customers, regardless of location. Ameritech is currently offering long distance service to its cellular customers in Illinois, northwest Indiana, Ohio, Wisconsin, Michigan and Missouri.\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, plant and equipment 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 companies to originate and terminate interstate and intrastate communications services using the facilities of the Company. Access charges, which recover the Company's costs associated with such facilities, consist primarily of three types: common line, traffic sensitive and trunking.\nCommon line charges are recovered through separate charges applied to end users (monthly subscriber line charges) and long distance carriers. The FCC has authorized subscriber 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. The remaining portion of the interstate common line revenue requirement is recovered by means of usage-based long distance carrier common line charges.\nTraffic sensitive charges are usage-based charges billed to long distance carriers which are associated with central office switching facilities used in the provision of access services and cable and wire facilities that connect customers through common facilities from the Company's end office where switching occurs to the serving wire center where access is provided.\nTrunking 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 through dedicated facilities from the Company's end office where switching occurs to the serving wire center (including the entrance facilities to the long distance carrier) where access is provided. Trunking services associated with special access handle the transmission of interstate private line services using dedicated facilities between any two customer-designated premises or between a customer-dedicated premises and a Company end office where multiplexing, the transmission of two or more signals over a single channel, occurs. Trunking charges are fixed monthly charges per access line which in certain cases involve a distance element associated with the dedicated facilities used to provide the trunking service.\nIn 1994, the FCC initiated its review of interstate price cap regulation initially adopted effective January 1, 1991. The FCC's price cap regulatory scheme sets maximum limits on the prices that LECs, including the Company, can charge for access services. The limits are adjusted each year to reflect inflation, a productivity factor and certain other cost changes. LECs under price caps have increased flexibility to change prices of existing services within the common line, traffic sensitive and trunking access revenue categories, as well as for interexchange (interstate intraLATA) and video dial tone service offerings.\nIn March 1995, the FCC adopted changes to its price cap plan to be effective August 1, 1995. The new rules include changes to the measure of inflation, the introduction of new productivity factor options and changes in the definition of other costs which may be included in the price cap formula. Under the new rules, LECs can annually elect one of three productivity factors: 4.0%, 4.7% or 5.3%. Ameritech's election of the 5.3% productivity factor allowed the Company to retain all of its earnings, whereas election of a lower factor would require earnings to be shared with customers. Concurrently, Ameritech filed a waiver request with the FCC to make an additional downward adjustment of its indices to apply the 5.3% productivity factor retroactively to January 1, 1995.\nRegulatory Environment -- State\nThe Company is also subject to regulation by the Indiana Utility Regulatory Commission (IURC) with respect to certain intrastate rates and services and other matters.\nIn 1994, the IURC approved the Company's Opportunity Indiana plan. Under the plan, market based pricing and flexibility has been instituted for competitive services, including Centrex, dedicated communications services, 800, WATS, operator services and business intraLATA toll service. Monthly rates for basic local residential service will decrease by $2.21 over two years and remain capped until 1998. Charges for Touch-Tone service were eliminated, retroactive to May 1, 1994. IURC oversight of depreciation was suspended for the term of the plan. In addition, the Company will invest up to $120 million in infrastructure over six years to extend advanced communications links to interested schools, hospitals and major government centers and will contribute another $30 million to the Corporation for Educational Communications, an unaffiliated, not-for- profit organization, which will provide grants to public and private schools in the Company's service area for equipment, software and training so the schools can take advantage of advanced network applications. Indiana is already a national leader in the use of distance learning to enhance education.\nOther Matters\nIn addition, the Company is a party to various proceedings pending before the IURC which involve, among other things, local exchange service competition, terms and conditions of services provided by the Company, terms for interconnecting networks, and reciprocal compensation arrangements (compensation to be exchanged with competitive local service providers for terminating other carriers' calls).\nCompetition\nThe communications industry is undergoing significant changes. LECs, long distance service companies, cable TV companies, cellular service companies, computer companies and the entertainment and information services industries are converging, forming alliances and positioning to provide a variety of services.\nMarket convergence, already a reality, intensified in 1995. Regulatory, legislative and judicial decisions, and technological advances, as well as heightened customer interest in advanced communications services, have expanded the types of available communications services and products, as well as the number of companies offering such services.\nThe primary competitors in the Company's business historically have been other access providers, cellular service providers and long distance companies. AT&T, MCI Communications Corp. and other long distance providers are ready to offer local phone service in various parts of Ameritech's five-state region. Companies, such as AT&T and McCaw Cellular Communications, Inc., have allied to form expanded cellular markets, creating the possibility of a wireless network with nationwide presence and brand-name recognition. Cable companies and long distance companies are joining to offer alternative wireless and landline local service. Today, many of the companies planning to provide local telephone service also have directory operations. Various communications groups, including almost all the nation's largest phone and cable companies hold licenses to offer personal communication services throughout the U.S. Increased competition in the local exchange service business, as well as the technological innovations rapidly spawned by that business, will further intensify competition. Much of it will come from companies with substantial capital, technological and marketing resources, many of which do not face the same regulatory constraints as the Company.\nRegulatory reform continues to be one of the most significant issues facing the communications industry today. The Company believes that relief from excessive regulation will benefit customers and ultimately shareowners by enabling the Company to compete effectively and meet customers' expanding needs. The Company is seeking relief before the regulatory agencies from the restraints, laws and regulations that impose restrictions on its current business and curtail its future business offerings.\nThe 1996 Act will radically alter the U.S. communications business and enhance the Ameritech landline communication subsidiaries' ability to compete. Passage of the new law broadly opens up the communications industry to competition and allows cable TV, local phone companies and long distance carriers into each others businesses, removing the formal barriers between businesses and reshaping the information industry.\nThe Company's competitive strategy includes positioning itself to take advantage of future opportunities by streamlining its processes to continue to contribute to Ameritech's standing as the most efficient of the RHCs.\nPatents, Trademarks and Licenses\nThe Company, through its parent, Ameritech, has rights to use various patents, copyrights, trademarks and other intellectual property which are necessary for it to conduct its present business operations. It is not anticipated that any such intellectual property will be subject to expiration or nonrenewal of rights which would materially and adversely affect the Company.\nEmployee Relations\nAs of December 31, 1995, the Company employed 4,188 persons, a decrease from 4,398 at December 31, 1994. By year end 1995, approximately 1,344 nonmanagement employees had resigned or retired in response to an early retirement offer announced in 1994 (approximately 249 employees left in 1995). Under terms of agreements between the Company, 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 left the business during a designated period ending with contract expiration, a period extended during contract negotiations to the end of the third quarter of 1995. Staff additions partially offset these departures. New employees were added to ensure high quality customer service and to meet special skill requirements. In 1996, as a result of a planned consolidation of data centers and other reductions, more employees will leave the Company.\nIn September 1995, members of the CWA and IBEW ratified new three-year contracts with Ameritech. The new contract wage increases were retroactive to the expiration dates of the prior contracts, June 25, 1995 for the IBEW and August 6, 1995 for the CWA. Both contracts address wages, benefits, pensions, employment security, child and family care, training and retraining and other conditions of employment. Base wages were increased approximately 10.9% (compounded at the maximum wage rate) over the next three years. In addition, all eligible employees received a lump sum bonus of $500. The new contracts will expire on June 27, 1998, for the IBEW and August 8, 1998, for the CWA.\nMost of the Company's employees (approximately 85%) are represented by unions.\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, 1995, 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 are 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.\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 $2.8 billion at December 31, 1990, to about $3.1 billion at December 31, 1995, after giving effect to retirements but before deducting accumulated depreciation at either date.\nCapital expenditures are expected to be about $167 million in 1996.\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.\nIn January 1995, Ameritech and the other RHCs agreed to terminate the sharing arrangement among the Bell Companies with respect to pre-divestiture 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 pre-divestiture liabilities and AT&T's share of Bell Company pre-divestiture liabilities.\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.\nINDIANA BELL TELEPHONE COMPANY, INCORPORATED Selected Financial and Operating Data (Dollars in Millions)\n* As discussed in Note E to the financial statements, 1995 operating expenses include a net work force restructuring credit of $36.9, while 1994 operating expenses include a nonmanagement work force restructuring charge of $93.5.\n** The Company had a noncash after-tax extraordinary charge in 1994 of $220.7 as a result of discontinuing the application of FAS 71 (See Note D) and a charge of $14.7 in 1993 (See Note F) due to the early extinguishment of debt. The Company had accounting changes in 1992 for FAS 106 and FAS 112 aggregating $160.2.\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, 1995 and for the year ended December 31, 1994, which is based on the Statements of Income and Reinvested Earnings. Other pertinent data are also given in the Selected Financial and Operating Data.\nResults of Operations\nRevenues\nTotal operating revenues were $1,212.4 for 1995 and $1,168.1 for 1994. The increase of $44.3 or 3.8% consisted of the following:\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 have generally been regulated by the Indiana Utility Regulatory Commission (IURC). Through the Opportunity Indiana proceeding, price regulation of intrastate services was achieved in 1994. In exchange, the Company agreed to certain rate reductions which affected 1995 local service revenues by about $5.2, with additional intrastate network access rate reductions discussed below. All intrastate limits on earnings were removed.\nLocal service revenues increased by $41.4 during 1995 due to higher network usage. Increased volumes were primarily attributed to growth in the number of customer lines increased, which increased 4.9% to 2,018,000 from 1,924,000 the previous year, as well as greater sales of call management services (e.g., Call Forwarding, Caller ID, etc.) and second line additions.\nNetwork access revenues are fees charged to interexchange carriers, such as AT&T Corp. (AT&T) and MCI Communications Corp. (MCI), that use the local telecommunications network to provide long distance services to their customers. In addition, end users pay flat rate access fees to connect to the local network to obtain long distance service. These revenues are generated from both interstate and intrastate services.\nInterstate access revenues decreased as a result of net rate reductions of $11.8 largely offset by volume increases of $10.7 due to growth in customer lines, switched access minutes of use and special access circuits. Also partially offsetting the decrease were increased revenues of $2.3 due to lower National Exchange Carrier Association common line support payments. Minutes of use related to interstate calls increased 6.0% in 1995.\nAs a result of the FCC's approval of the Company's request for price regulation without sharing of earnings, as previously discussed in Part I, the Company was required to reduce its annual access charges to long distance companies for local network connections by $11.8. The impact in 1995 was a reduction in interstate access revenues of $5.0.\nIntrastate access revenues decreased in 1995 primarily due to rate reductions of $22.5, primarily resulting from regulatory proceedings which adopted certain regulatory freedoms as previously discussed. Higher network usage resulted in additional revenues of $8.9 which partially offset these decreases. Minutes of use related to intrastate calls increased 14.2% in 1995. Scheduled rate reductions will affect 1996 revenues by about $13.\nLong distance revenues are derived from customer calls to locations outside of the local calling area but within the same service area. The decrease in long distance service revenues in 1995 was primarily attributable to volume reductions of $3.1 partially offset by rate increases of $1.5.\nOther revenues include revenues derived from directory advertising, billing and collection services, inside wire installation and maintenance services and other miscellaneous services. The increase in other revenues is primarily due to an increase in revenues from customer premises equipment (CPE) sales and nonregulated services, such as voice message and Caller ID, of $15.9, as well as inside wire installation and maintenance services of $6.9, primarily from rate increases. Partially offsetting these increases was a decrease of $3.7 in billing and collection, rents and miscellaneous revenues. As discussed in Part I above, the Company has entered into a new agreement with Ameritech Publishing, Inc.(API), an Ameritech subsidiary, for the publishing and distribution of directories in 1996. As a result of this agreement, 1996 revenues from directory services will decrease by approximately $50.\nThe Company provides billing and collection services for several companies, including billing for long distance services offered by certain long distance carriers, some of which began billing their own customers in 1996. It is not possible for the Company to estimate the impact of this change on future billing and collection revenues due to the uncertainty as to the number of customers affected, the timing of the billing changeovers and the degree of acceptance by customers. Accounts receivable and payable balances will be impacted in 1996 reflecting the reduction in accounts billed on behalf of the long distance carriers and purchased from them.\nOperating Expenses\nTotal operating expenses in 1995 decreased by $151.9 or 16.0% percent to $799.4. The decrease was almost entirely attributable to the 1994 work force restructuring, which resulted in a credit of $36.9 ($23.1 after-tax) in 1995 related primarily to the net settlement gains from lump-sum pension payments to former employees, partially offset by fourth quarter charges for planned work force reductions due to data center consolidations, increased force costs related to the work force restructuring started in 1994 and a charge of $1.0 to write-down certain data processing equipment in connection with information technology restructuring. This compares with the 1994 charge of $93.5 ($58.0 after-tax) for work force restructuring.\nThe decrease in employee-related expenses in 1995 was attributable primarily to the effect of work force reductions over the past year of $20.9, as well as reduced bonus accruals, overtime payments, payroll taxes, other benefits and related employee costs of $16.2. These decreases were partially offset by a decrease in pension credits of $7.5 and wage increases of $3.4.\nDuring September 1995, union agreements were ratified by the Communications Workers of America (CWA) and the International Brotherhood of Electrical Workers (IBEW). The new contracts and wage increases were retroactive to June 25, 1995 for the IBEW and August 6, 1995 for the CWA. The contracts include basic wage increases of 10.9% (compounded at the maximum wage rate) over three years. In addition, the contracts provided for a signing bonus of $500 to eligible employees upon ratification. In addition, union employees will receive their annual bonus in the form of Ameritech stock instead of cash beginning with the bonus for 1995 and continuing for the remaining three years of the labor contracts. Both contracts address wages, benefits, pensions, employment security, training and retraining and other conditions of employment. Most of the Company's nonmanagement work force (about 85 percent of total employees) is represented by the two unions.\nThere were 4,188 employees at December 31, 1995, compared with 4,398 at December 31, 1994. Work force restructuring at the Company resulted in a decrease of 249 employees since December 31, 1994. See also the discussion of restructuring (credits) charges below.\nThe decrease in depreciation and amortization expense in 1995 was primarily due to the cessation of depreciation of analog switches determined to be obsolete in connection with discontinuing the application of Statement of Financial Accounting Standards No. 71 (FAS 71), \"Accounting for the Effects of Certain Types of Regulation,\" in the fourth quarter of 1994. This decrease was partially offset by the increase in depreciation rates as a result of shortening telephone plant lives following the discontinuation of FAS 71. See Note D for further details.\nThe increase in other operating expenses in 1995 was primarily attributable to higher affiliated services expenses of $23.3, resulting from increased project billings from Ameritech Services, Inc. (ASI). Advertising, cost of sales and bad debt expenses increased $11.1 as a result of increased marketing and sales efforts. These increases were offset by a net decrease of $10.3 in expenses for access charges, as a result of renegotiated contracts, switching system software charges, contract and professional services, and other expenses as compared to the prior year.\nThe Company announced in March 1994 that it intended to significantly reduce its nonmanagement work force by the end of 1995. Reduction of the work force resulted from the implementation of technology improvements, consolidations and initiatives to balance the cost structure in the core business with emerging competition. The nonmanagement work force was reduced by 1,344 employees. New employees were added during these periods with different skills to accommodate growth, ensure high quality customer service and meet staffing requirements for new business opportunities. Pretax charges totaling $93.5 ($58.0 after-tax) related to the work force reductions were recorded in 1994. Noncash settlement gains of $32.5 were recorded in 1995, associated primarily with lump-sum pension payments to former employees, and accrual adjustments were made that reduced gross program costs by $7.3, partially offset by $1.9 associated with increased force costs related to the restructuring, as well as a $1.0 charge that was recorded to write down certain data processing equipment to net realizable value.\nThe restructuring program was recorded by quarter as follows:\nActual employee reductions by quarter in 1994 were: 220 in the second quarter, 271 in the third quarter and 604 in the fourth quarter or 1,095 in total. Employee reductions in 1995 aggregated 249 as follows: 46 in the first quarter, 66 in the second quarter and 137 in the third quarter. See also the discussion of employee-related expenses above. Additional employees are expected to leave the Company in 1996 as a result of the consolidation of data centers and additional work force reductions previously discussed. Cash requirements to fund the financial incentives (principally contractual termination payments totaling approximately $26.3) were met as prescribed by the applicable collective bargaining agreements. Certain of these collective bargaining agreements required contractual termination payments to be paid in a manner other than lump-sum, thus requiring cash payments beyond an employee's termination date.\nThe work force restructuring program reduced annual employee-related costs by approximately $50 thousand per departing employee. The projected savings are being partially offset by the hiring of new employees as discussed above.\nThe decrease in taxes other than income taxes is primarily attributable to lower property taxes and gross receipts taxes.\nOther Income and Expenses\nThe increase in interest expense in 1995 resulted from higher interest on borrowings from the Ameritech short-term funding pool resulting from higher interest rates, offset by lower average debt balances. (See Note A).\nOther income, net includes earnings related to the Company's investments, interest income and other nonoperating items. Other income in 1995 decreased primarily because the Company's share of equity earnings from ASI decreased.\nThe increase in income taxes in 1995 was primarily attributable to the previously discussed increases in pretax income.\nExtraordinary Item -- FAS 71\nAs described in Note D to the financial statements, the Company discontinued FAS 71 in the fourth quarter of 1994, after determining 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 $220.7.\nAs a result of the discontinuation of applying FAS 71, 1995 depreciation expense decreased due to the cessation of depreciation on analog switches. Depreciation expense in 1996 and beyond will likely be higher as the effects of shorter lives intensifies at the Company.\nAdditional financial statement impacts occurred as a result of no longer following FAS 71. Specifically, the effective income tax rate increased in 1995 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.\nOther Matters\nCompetition.\nThe communications industry is undergoing significant changes. LECs, such as the Company, and long distance service companies, cable TV companies, cellular service providers, computer companies 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 communications services, have expanded the types of available communications services and products, as well as the number of companies offering such services.\nThe primary competitors of the Company historically have been other access providers, cellular service providers and long distance companies. Today, as the Company prepares to open its local market to competition, AT&T, MCI and other long distance providers are ready to offer local phone service in various parts of Ameritech's five state region, including Chicago. Companies, such as AT&T with its acquisition of McCaw Cellular, have allied to form expanded cellular markets, creating the possibility of a wireless network with nationwide presence and brand-name recognition. Cable companies and long distance companies are joining to offer alternative wireless and landline local service. Today, many of the companies planning to provide local telephone service also have directory operations. Various communications groups, including almost all of the nation's largest phone and cable companies, hold licenses to offer personal communication services throughout the U.S. Increased competition in the local exchange service business, as well as the technological innovations rapidly spawned by that business, will further intensify competition in the directory business.\nRegulatory reform continues to be one of the most significant issues facing the communications industry today. The Company believes that continued relief from regulation will benefit customers and ultimately shareowners by enabling the Company to compete effectively and meet customers' expanding needs. Ameritech is seeking relief before regulatory agencies from the restraints, laws and regulations that impose restrictions on its current business and curtail its future business offerings.\nThe Company's competitive strategy includes positioning itself to take advantage of future opportunities by streamlining its processes to continue its efficiency gains. In 1995, Ameritech realigned its business units into three sectors to sharpen its strategic focus and better serve the needs of its customers.\nOn the national level, the Telecommunications Act of 1996 was signed into law by the President on February 8, 1996. This legislation defines the conditions under which Ameritech will be permitted to offer interLATA long distance service and provides certain mechanisms intended to facilitate local exchange competition. This legislation, in addition to allowing Ameritech to offer interLATA long distance services, will allow competitors into the Company's traditional local exchange markets. Management believes the legislation gives Ameritech an opportunity to expand its revenue base by providing long distance services, while retaining lower-margin access revenues as other local service providers, acting as resellers, continue to use the Company's network facilities.\nAs the communications industry expands and converges, Ameritech is positioned to compete aggressively in new and existing markets, all of which are expanding at rates far in excess of historical levels. Ameritech plans to maintain aggressive revenue growth rates and productivity increases as it faces formidable competition in these markets.\nRegulatory Environment\nOn July 18, 1995, FCC approved Ameritech's request for price regulation without sharing of earnings effective January 1, 1995, resulting in a reduction in prices that the Company charges long distance companies for local connections. These price reductions resulted in a decrease in 1995 interstate access revenues as discussed above. Also see Regulatory Environment--Federal in Part I.\nOpportunity Indiana\nIn June 1994, the IURC approved an alternative regulation proposal -- Opportunity Indiana -- that eliminated rate of return regulation and replaced it with price regulation. See Regulatory Environment -- State in Part I for a more complete discussion.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Shareowner of Indiana Bell Telephone Company, Incorporated\nWe have audited the accompanying balance sheets of Indiana Bell Telephone Company, Incorporated (an Indiana Corporation) as of December 31, 1995 and 1994, and the related statements of income and reinvested earnings and cash flows for each of the three years in the period ended December 31, 1995. 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 Indiana Bell Telephone Company, Incorporated as of December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\nAs discussed in Note D 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.\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\nChicago, Illinois January 17, 1996\nINDIANA BELL TELEPHONE COMPANY, INCORPORATED STATEMENTS OF INCOME AND REINVESTED EARNINGS (Dollars in Millions)\nThe accompanying notes are an integral part of the financial statements.\nINDIANA BELL TELEPHONE COMPANY, INCORPORATED BALANCE SHEETS (Dollars in Millions)\nThe accompanying notes are an integral part of the financial statements.\nINDIANA BELL TELEPHONE COMPANY, INCORPORATED STATEMENTS OF CASH FLOWS (Dollars in Millions)\nThe accompanying notes are an integral part of the financial statements.\nINDIANA BELL TELEPHONE COMPANY, INCORPORATED NOTES TO FINANCIAL STATEMENTS (Dollars in Millions)\nA. Significant Accounting Policies\nNature of Operations -- Indiana Bell Telephone Company, Incorporated (the Company) is a wholly owned subsidiary of Ameritech Corporation (Ameritech). Ameritech is the parent of the Company, Illinois Bell Telephone Company, Michigan Bell Telephone Company, The Ohio Bell Telephone Company, and Wisconsin Bell, Inc. (referred to collectively as the \"Ameritech landline communications subsidiaries\"). The Company provides a wide variety of communications services, including local exchange and toll service, network access and telecommunications products in Indiana.\nSee discussion of Competition in Other Matters in Management's Discussion and Analysis of Results of Operations.\nBasis of Accounting -- The financial statements have been prepared in accordance with generally accepted accounting principles (GAAP). The financial statements include the accounts of the Company. 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 D).\nUse of Estimates -- The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of 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.\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) -- ASI, an Ameritech-controlled affiliate, in which the Company has 10% ownership, provides planning, development, management, procurement and support services to all of the Ameritech landline communications subsidiaries. The Company also provides certain services 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 doing business as Ameritech Advertising Services -- The Company had an agreement with API under which API published and distributed classified directories under a license from the Company and provided services to the Company relating to both classified and alphabetical directories. API paid license fees to the Company under the agreement. That agreement terminated, effective December 31, 1995. The Company has entered into a subsequent agreement with API for 1996 under which the Company furnishes to API certain services and data to be used by API in publishing and distributing classified and alphabetical directories. In exchange, the Company will receive compensation for the services and data.\n4. Ameritech Information Systems, Inc. (AIS), a wholly owned subsidiary of Ameritech -- 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 at original cost. The provision for depreciation is based principally on the straight-line remaining life and the straight-line equal life group methods of depreciation applied to individual categories of property, plant and equipment with similar characteristics. As a result of the discontinuation of applying FAS 71 in the fourth quarter of 1994, the Company recognized shorter, more economically realistic lives and increased its accumulated depreciation balance by $361.2. (See Note D).\nThe following is a summary of average lives (in years) before and after the discontinuation of FAS 71:\nGenerally, when depreciable plant is retired, the amount at which such plant has been carried in property, plant and equipment in service is charged to accumulated depreciation. The cost of maintenance and repairs of plant is charged to expense.\nInvestments -- The Company's investment in ASI (10% ownership and $26.5) is 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 1995 or 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 federal income tax return filed by Ameritech and its subsidiaries. Effective January 1, 1993, the Company adopted FAS 109, \"Accounting for Income Taxes.\" The 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 determined at the end of each period based on differences between the financial statement bases of assets and liabilities and the tax bases of those same assets and liabilities, using the currently enacted statutory tax rates. 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 the investment tax credit whereby credits realized 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. The Company considers all highly liquid, short-term investments with an original maturity of three months or less to be cash equivalents.\nAdvertising Costs -- Advertising costs are charged to operations as incurred.\nRevenue Recognition -- The Company recognizes revenue as earned.\nShort-Term Financing Arrangement -- Ameritech provides short-term financing and cash management services to its subsidiaries, including the Company. Ameritech issues commercial paper and notes and secures bank loans to fund the working capital requirement of its subsidiaries and invests short-term, excess funds on their behalf. (See Note F).\nReclassifications -- In 1994, the Company made certain reclassifications, which were applied retroactively, to its financial statements to correspond to financial reporting for unregulated enterprises.\nTotal income taxes paid were $124.3, $143.9 and $114.2 in 1995, 1994 and 1993, 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 statutory federal income tax rate was increased to 35% in 1993. Deferred income tax balances were adjusted to reflect the enacted tax rate. The result was a reduction in deferred income tax expense of $2.4, primarily from increasing the deferred tax asset associated with the adoption of FAS 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\"\nAs of December 31, 1995 and 1994 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 resulting from vacation pay, bad debts and work force restructuring. The Company had immaterial valuation allowances against certain deferred tax assets as of December 31, 1995 and 1994.\nC. Property, Plant and Equipment\nThe components of property, plant and equipment are as follows:\nDepreciation expense on property, plant and equipment was $187.6, $208.0 and $214.5 in 1995, 1994 and 1993, respectively.\nD. Discontinuation of Regulatory Accounting -- FAS 71\nIn 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.\nAs a result of discontinuing the application of FAS 71, the Company recorded an extraordinary noncash after-tax charge of $220.7 in 1994. The following table is a summary of the extraordinary charge.\nThe adjustment of $361.2 to net property, plant and equipment was necessary because estimated useful lives and depreciation methods historically prescribed by regulators did not keep pace with technological changes and differed significantly from those used by unregulated enterprises. Plant balances were adjusted by increasing the accumulated depreciation balance. The necessary adjustment 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.\nWhen adjusting its net property, plant and equipment, the Company gave effect to shorter, more economically realistic lives, as previously outlined in Note A.\nThe discontinuation of FAS 71 also required the Company to eliminate from its balance sheet 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 certain deferred vacation pay, debt financing costs, and certain deferred assets.\nAdditionally, at the time the Company discontinued the application of FAS 71, the income tax-related regulatory assets and liabilities were eliminated and deferred tax balances adjusted to reflect application of FAS 109 consistent with other unregulated enterprises.\nAs asset lives were shortened, the related unamortized investment tax credits deemed already earned were credited to income.\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.\nE. Employee Benefit Plans\nPension Plans -- Ameritech maintains noncontributory defined benefit pension plans covering substantially all employees and death benefit plans for nonmanagement employees. 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 credits for the Ameritech plans:\nPension credits were determined using the projected unit credit actuarial method. 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 investments and real estate. As of December 31, 1995, the fair value of plan assets available for plan benefits exceeded the projected benefit obligation (calculated using a discount rate of 6.9% and 7.2% as of December 31, 1995 and 1994, respectively). The assumed long-term rate of return on plan assets used in determining pension credits (or income) was 7.25% for 1995, 1994 and 1993. The assumed increase in future compensation, also used in the determination of the projected benefit obligation, was 4.5% in 1995 and 1994.\nPostretirement Benefits Other Than Pensions -- Ameritech sponsors health care and life insurance plans which provide noncontributory postretirement benefits to substantially all of its retirees and their dependents. Ameritech accrues the cost of postretirement benefits granted to employees as expense over the period in which the employee renders service and becomes eligible to receive benefits. The cost of postretirement health care and life insurance benefits for current and future retirees was recognized as determined under the projected unit credit actuarial method. Ameritech allocates its retiree health care costs on a per participant basis, whereas group life insurance is allocated based on compensation levels.\nAmeritech has provided for part of the cost of these plans by making contributions for health care benefits to voluntary employee benefit association trust funds (VEBAs) and maintains retirement funding accounts (RFAs) to provide life insurance benefits. Ameritech intends to continue to fund the nonmanagement VEBA. During 1993 the Ameritech utilized excess pension plan assets to help pay the nonmanagement retiree health care obligation. Funding of the management VEBA was suspended effective in 1994, primarily due to a tax rate increase from 31.0% to 39.6% on its investment income. The nonmanagement VEBA and the RFAs earn income without tax. Plan assets consist principally of corporate securities and bonds.\nCertain disclosures are required 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 plans 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, 1995, 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 6.9% as of December 31, 1995 and 8.5% as of December 31, 1994. The assumed rate of increase in future compensation levels was 4.5% in 1995 and 1994. The expected long-term rate of return on plan assets was 7.25% in 1995, 1994 and 1993 on VEBAs, and 8.0% in 1995, 1994 and 1993 on RFAs. The assumed health care cost trend rate in 1995 was 8.8% and 9.2% in 1994, and is assumed to decrease gradually to 4.0% in 2007 and remain at that level. The assumed health care cost trend rate is 8.4% for 1996. The health care cost trend rate has 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 have increased the 1995 annual expense by approximately 12.8%.\nPostretirement benefit cost under FAS 106 was $25.0 in 1995, $25.0 in 1994 and $23.5 in 1993.\nAs of December 31, 1995, the Company had 5,462 retirees eligible to receive health care and group life insurance benefits.\nWork Force and Other Restructuring -- During March 1994, Ameritech announced a plan to reduce its existing nonmanagement work force. As of December 31, 1995, 1,344 employees have left the Company as a result of this restructuring. See additional discussion in Management's Discussion and Analysis of Results of Operations.\nAs a result of this restructuring, a pretax charge of $93.5, or $58.0 after- tax, was recorded in 1994. In 1995, a credit of $36.9, or $23.1 after-tax, was recorded resulting primarily from settlement gains from lump-sum pension payments to former employees, net of additional restructuring charges of $2.9 recorded in the fourth quarter of 1995. The fourth quarter restructuring charges include $1.9 associated with increased force costs related to the restructuring started in 1994, as well as planned work force reductions due to consolidation of Ameritech's data centers and $1.0 recorded to write down certain data processing equipment to estimated net realizable value. The cumulative gross program cost through December 31, 1995 totaled $132.0, partially offset by settlement gains of $75.4 for an aggregate pretax net program cost of $56.6, or $34.9 after-tax.\nManagement Work Force Reductions -- Effective January 1, 1995, management employees who are asked to leave the Company will receive a severance payment under the Management Separation Benefit Program. The Company accounts for this benefit in accordance with FAS 112, \"Employers' Accounting for Postemployment Benefits,\" accruing the separation cost when incurred. 1995 activity under this program included 20 employees.\nDuring 1994, 81 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 other operating expense of $2.7 in 1995 and $3.8 in 1994. The 1995 credit resulted from settlement gains from lump-sum pension payments to former employees.\nDuring 1993, 305 management employees left the Company through voluntary and involuntary programs. The net cost of these reductions, including termination benefits, settlement and curtailment gains from the pension plan, was a credit to other operating expense of $1.4.\nThe involuntary plans are funded from Company operations and required cash payments of $0.5, $2.8 and $2.7 in 1995, 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 the following as of December 31:\nIn December 1993, the Company called $90.0 of 8% debentures due in 2014 and $130.0 of 8 1\/8% debentures due in 2017 using funds obtained from short-term borrowings. Early extinguishment of debt costs (including call premiums and write-offs of unamortized deferred costs) in 1993 were $23.5 ($14.7 after-tax) and were classified as an extraordinary item on the Statements of income and reinvested earnings.\nDuring 1991, Ameritech consolidated the short-term financing of its subsidiaries at Ameritech Corporate. (See Note A -- Short-Term Financing Arrangement).\nG. Long-Term Debt\nLong-term debt consists principally of debentures issued by the Company.\nThe following table sets forth interest rates, scheduled maturities and other information on long-term debt outstanding at December 31:\nThe Company filed a registration statement with the Securities and Exchange Commission for issuance of up to $225.0 in unsecured debt securities for general corporate purposes. As of January 17, 1996, none of these securities had been issued.\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 $6.9, $26.1 and $26.0 for 1995, 1994 and 1993 respectively. At December 31, 1995, 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, 1995 and 1994:\nThe following methods and assumptions were used to estimate the fair value of financial instruments:\nCash and temporary cash investments -- The carrying value approximates fair value because of the 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 fair value.\nInterest paid, net of amounts capitalized, was $16.2, $22.3 and $29.8 in 1995, 1994 and 1993, respectively.\nRevenues from AT&T, consisting principally of interstate network access and billing and collection services revenues, comprised approximately 10%, 11% and 12% of total revenues in 1995, 1994 and 1993, respectively. No other customer accounted for more than 10% of total revenues.\nK. Other Income, Net\nThe components of other income, net are as follows:\nL. Quarterly Financial Information (Unaudited)\nTotal nonmanagement work force restructuring credits in 1995 were $36.9 or $23.1 after-tax as follows: $36.5 or $22.9 after-tax in the first quarter, $2.7 or $1.7 after-tax in the third quarter and a net charge of $2.3 or $1.5 after- tax in the fourth quarter. The fourth quarter restructuring charge includes costs related to the restructuring started in 1994 and charges relating to consolidation of Ameritech's data centers as discussed more fully in Note E.\nTotal nonmanagement work force restructuring charges in 1994 were $93.5 or $58.0 after-tax as follows: $68.9 or $42.8 after-tax in the first quarter, $36.0 or $22.4 after-tax in the third quarter, and a net credit of $11.4 or $7.2 after-tax in the fourth quarter. The credit in the fourth quarter results from settlement gains. (See Note E above.) The fourth quarter of 1994 also includes a $220.7 noncash after-tax extraordinary charge related to the discontinuance of applying FAS 71, as discussed in Note D above.\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, 1995, 1994, 1993, 1992 and 1991 was 20.59, 8.65, 8.13, 7.13 and 6.29, respectively.\nFor the purpose of calculating this ratio, (i) earnings have been calculated by adding to income before interest expense and extraordinary item, 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 changes in nor 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:\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 parentheses below, on file with the SEC, are incorporated herein by reference as exhibits hereto.\n(b) Reports on Form 8-K:\nNo Form 8-K was filed by the registrant during the quarter 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.\nINDIANA BELL TELEPHONE COMPANY, INCORPORATED\n\/s\/ Laurie L. Streling _______________________________ (Laura L. Streling, Comptroller, State Finance Organization)\nMarch 11, 1996\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\/ Kent A. Lebherz - ---------------------------------------- (Kent A. Lebherz, President)\nPrincipal Financial and Accounting Officer:\n\/s\/ Laurie L. Streling - ---------------------------------------- (Laura L. Streling, Comptroller, State Finance Organization)\nAmeritech Corporation:\n\/s\/ Barry K. Allen - ---------------------------------------- (Barry K. Allen, Senior Vice President, Communications and Information Services)\nThe sole shareowner of the registrant, which has elected under the laws of Indiana to be managed by the shareowner rather than by a board of directors\nMarch 11, 1996\n(a) Excludes direct charges and credits to expense on the statements of income and reinvested earnings related to interexchange carrier receivables.\n(b) Includes principally amounts related to the interexchange carrier receivables which are being billed by the Company and amounts previously written off which were credited directly to this account when recovered.\n(c) Amounts written off as uncollectible.","section_15":""}
{"filename":"729986_1995.txt","cik":"729986","year":"1995","section_1":"Item 1. BUSINESS . . . . . . . . . . . . . . . . . . . . . . . 4\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nThe following discussion satisfies the reporting requirements of Items 1 and 2.\nDESCRIPTION OF UNITED BANKSHARES, INC.\nOrganizational History and Subsidiaries - - ---------------------------------------\nUnited Bankshares, Inc. (\"United\") is a West Virginia corporation registered as a bank holding company pursuant to the Bank Holding Company Act of 1956, as amended. United was incorporated on March 26, 1982 and organized on September 9, 1982. United began conducting business on May 1, 1984 with the acquisition of three wholly-owned subsidiaries. On October 1, 1985, these three subsidiaries were merged and on November 1, 1985, were renamed United National Bank (\"UNB\").\nSince that time UNB has acquired through merger or consolidation the following banks: Heritage Bancorp, Inc. (a holding company); First National Bank of Ripley; Kanawha Banking and Trust Company; Ohio Valley National Bank; Elk National Bank; Montgomery National Bank, the sole subsidiary of Liberty Bancshares Inc., a bank holding company; First Bank of Ceredo, the bank subsidiary of Financial Future Corporation, a bank holding company; CB&T Westover Bank; and the Star City Branch of Community Bank & Trust, N. A.\nOn September 1, 1993, UBC Holding Company, (\"UBC\"), a United subsidiary, was formed to effect the Financial Future Corporation transaction. UBC is a second tier holding company with UNB currently being its only subsidiary.\nOn August 9, 1990, United acquired BankFirst Corporation (\"BankFirst\"), a one bank holding company based in McLean, Virginia. BankFirst was merged with UBF Holding Company, Inc. (\"UBF\"), a United subsidiary formed to effect this acquisition. UBF acquired Bank First, N.A. (\"Bank First\"), the subsidiary of BankFirst.\nOn October 11, 1995, United formed Commercial Interim Bank, Inc. (\"Interim Bank\"), a state member bank located in Arlington, Virginia, to facilitate the acquisition of First Commercial Bank of Arlington, Virginia (\"FCB\"). United then merged Bank First into Interim Bank from its wholly owned subsidiary, UBF. Concurrent with the merger of Bank First into Interim Bank, UBF was merged into United. United acquired FCB on October 31, 1995 and merged it into Interim Bank. United then effected a name change of Interim Bank to First Commercial Bank. On March 18, 1996 First Commercial Bank's name was changed to United Bank.\nUnited National Bank-South (\"UNB-S\"), was formed on November 1, 1992, as a part of United's acquisition of Summit Holding Corporation and their lead bank, Raleigh County National Bank.\nOn January 27, 1996, UNB-S was merged into and became a part of UNB. Offices of UNB-S became branch offices of UNB.\nIn late 1988, United chartered and capitalized United Venture Fund, Inc., a West Virginia corporation which has qualified as a Capital Company under the West Virginia Capital Company Act. This subsidiary makes loans and limited equity investments, consistent with the Bank Holding Company Act, that will result in or contribute to new jobs and\/or industry in West Virginia.\nOffices - - -------\nThe headquarters of United are located in United Center at 500 Virginia Street, East, Charleston, West Virginia.\nThe main office of UNB is located at 514 Market Street, Parkersburg, West Virginia. United's corporate offices and UNB's executive offices are also located in Parkersburg at Fifth and Avery Streets. Currently, all of UNB's offices are located in West Virginia. UNB operates three branches in the Parkersburg area, seven branches in the Charleston area, three branches in the Morgantown area, two branches in Vienna, three branches in the Montgomery area, two branches in Ripley, four branches in the Huntington, area and four branches in the Beckley, area. UNB owns all of these facilities except for two in the Parkersburg area, two in the Charleston area and one in the Beckley area, which are leased under operating leases. UNB also owns and operates six branches throughout West Virginia's northern panhandle. The main facility of UNB's Wheeling office is leased from Ogden Newspapers, Inc. See Part III - ------------ Transactions with Management and Others. UNB also operates five branch facilities in central West Virginia. UNB owns all five of these offices.\nUnited Bank conducts business from an office located at 3801 Wilson Boulevard, Arlington, Virginia with a branch office at 1301 Beverly Road, McLean, Virginia under a lease agreement.\nEmployees - - ---------\nAs of December 31, 1995 United and its subsidiaries had approximately 819 full-time equivalent employees and officers. None of these employees is represented by a collective bargaining unit, and management considers employee relations to be excellent.\nBusiness of United - - ------------------\nAs a bank holding company registered under the Bank Holding Company Act of 1956, as amended, United's present business is the operation of its bank subsidiaries. As of December 31, 1995, United's consolidated assets approximated $1,815,443,000 and total shareholders' equity approximated $201,222,000.\nUnited is permitted to acquire other banks and bank holding companies, as well as thrift institutions. United is also permitted to engage in certain non- banking activities which are closely related to banking under the provisions of the Bank Holding Company Act and the Federal Reserve Board's Regulation Y. Management continues to consider such opportunities as they arise, and in this regard, management from time to time makes inquiries, proposals, offers or expressions of interest as to potential opportunities; although no agreements or understandings to acquire other banks or bank holding companies or nonbanking subsidiaries or to engage in other nonbanking activities, other than those identified herein, presently exist. With regard to pending acquisitions, United has executed a definitive merger agreement with Eagle Bancorp, Charleston, West Virginia, dated as of August 18,\n1995. For further discussion, see Note Q, Notes to Consolidated Financial Statements.\nBusiness of Subsidiary Banks - - ----------------------------\nAll of United's subsidiary banks are full-service commercial banks and, as such, engage in most types of business permitted by law and regulation. Included among the banking services offered are the acceptance of deposits in checking, savings, time and money market accounts; the making and servicing of personal, commercial, floor plan and student loans; and the making of construction and real estate loans. Also offered are individual retirement accounts, safe deposit boxes, wire transfers and other standard banking products and services. As a part of their lending function, UNB and United Bank offer credit card services including accounts issued under the name of certain correspondent banks.\nUNB also maintain trust departments which act as trustees under wills, trust and pension and profit sharing plans, as executors and administrators of estates, and as guardians for estates of minors and incompetents, and in addition perform a variety of investment and security services. UNB trust services are available to customers of affiliate banks. UNB provides services to its correspondent banks such as check clearing, safekeeping and the buying and selling of federal funds.\nUNB is members of a regional network of automated teller machines known as the MAC ATM network while United Bank participates in the MOST network. Through MAC and MOST, all of United's subsidiary banks are participants in a network known as Cirrus which provides banking on a nationwide basis.\nLending Activities - - ------------------\nThe total loan portfolio of United increased $76,928,000, or 5.93%, to $1,374,005,000, in 1995 and is comprised of commercial, real estate and consumer loans including credit card and home equity loans. Commercial and real estate loans increased $10,309,000 or 4.94% and $74,411,000 or 8.66%, respectively, while consumer loans, net of unearned income, decreased $7,792,000 or 3.40%.\nCommercial Loans - - ----------------\nThe commercial loan portfolio consists of loans to corporate borrowers in the small to mid-size industrial and commercial companies, as well as automobile dealers, service, retail and wholesale merchants. Coal mining companies make up an insignificant portion of loans in the portfolio. Collateral securing these loans includes equipment, machinery, inventory, receivables, vehicles and commercial real estate. Commercial loans are considered to contain a higher level of risk than other loan types although care is taken to minimize these risks. Numerous risk factors impact this portfolio including industry specific risks such as economy, new technology, labor rates and cyclicality, as well as customer specific factors, such as cash flow, financial\nstructure, operating controls and asset quality. United diversifies risk within this portfolio by closely monitoring industry concentrations and portfolios to ensure that it does not exceed established lending guidelines. Diversification is intended to limit the risk of loss from any single unexpected economic event or trend. Underwriting standards require a comprehensive review and independent evaluation of virtually all larger balance commercial loans by the loan committee prior to approval with ongoing updates of the loan portfolio.\nReal Estate Loans - - -----------------\nCommercial real estate loans consist of commercial mortgages, which generally are secured by nonresidential and multi-family residential properties. Also included in this portfolio are loans that are secured by owner-occupied real estate, but made for purposes other than the construction or purchase of real estate. Commercial real estate loans carry many of the same customers and industry risks as the commercial loan portfolio. Real estate mortgage loans to consumers are secured primarily by a first lien deed of trust. These loans are traditional one-to-four family residential mortgages. The loans generally do not exceed an 80% loan to value ratio at the loan origination date and most are at a variable rate of interest. These loans are considered to contain normal risk.\nConsumer Loans - - --------------\nConsumer loans are secured by automobiles, boats, recreational vehicles, and other personal property. Personal loans, home equity, student loans and unsecured credit card receivables are also included as consumer loans. United monitors the risk associated with these types of loans by monitoring such factors as portfolio growth, lending policies and economic conditions. Underwriting standards are continually evaluated and modified based upon these factors. Historically, losses on these types of loans have been minimal.\nUnderwriting Standards - - ----------------------\nUnited's loan underwriting guidelines and standards are updated periodically and are presented for approval by each of the respective Boards of Directors of its subsidiary banks. The purpose of the standards and guidelines is to grant loans on a sound and collectible basis; to invest available funds in a safe, profitable manner; to serve the legitimate credit needs of the communities of United's primary market area; and ensure that all loan applicants receive fair and equal treatment in the lending process. It is the intent of the underwriting guidelines and standards: to minimize loan losses by carefully investigating the credit history of each applicant, verifying the source of repayment and the ability of the applicant to repay, collateralizing those loans in which collateral is deemed to be required, exercising care in the documentation of the application, review, approval, and origination process, and administering a comprehensive loan collection program. The above guidelines are adhered to and subject to the experience, background and personal judgement of the loan officer assigned to the loan application. A loan officer may grant and justify\na loan with slight variances from the underwriting guidelines and standards. However, the loan officer may not exceed their respective lending authority without obtaining the prior, proper approval from a superior, a regional supervisor, or the Loan Committee, whichever is deemed appropriate for the nature of the variance.\nLoan Origination and Processing - - -------------------------------\nUnited generally originates loans within the primary market area of its banking subsidiaries. United may from time to time make loans to borrowers and\/or on properties outside of its primary market area as an accommodation to its customers. Processing of all loans is centralized in the Charleston, West Virginia office. United also has a limited number of loans that are processed for other institutions for which United receives a processing fee. As of December 31, 1995, the balance of mortgage loans being processed by United for other institutions was $30,000.\nSecondary Markets - - -----------------\nHistorically, United has not been in the business of selling or purchasing loans and has not originated loans with the intent to sell them in the secondary market. During 1995, United did not purchase or sell any loans in the secondary market.\nInvestment Activities - - ---------------------\nUnited's investment policy stresses the management of the investment securities portfolio, which includes both securities held to maturity and securities available for sale, to maximize return over the long-term in a manner that is consistent with good banking practices and relative safety of principal. United currently does not engage in trading account activity. The Asset\/Liability Committee of United is responsible for the coordination and evaluation of the investment portfolio.\nSources of funds for investment activities include \"core deposits\". Core deposits include certain demand deposits, statement and special savings and NOW accounts. These deposits are relatively stable and they are the lowest cost source of funds available to United. Short-term borrowings have also been a significant source of funds. These include federal funds purchased and securities sold under agreements to repurchase. Repurchase agreements represent funds which are generally obtained as the result of a competitive bidding process.\nUnited's investment portfolio remains comprised largely of U.S. Treasury securities and obligations of U.S. Agencies and Corporations. Obligations of States and Political Subdivisions are comprised of municipal securities with an average quality of not less than an \"A\" rating.\nDuring 1994, United realized net losses from sales in the securities available for sale portfolio. The sales of these securities occurred as United, in response to the substantial rise in interest\nrates during 1994, readjusted the securities available for sale portfolio in order to increase interest income without extending the duration of the portfolio. The proceeds from these sales were reinvested in similar securities yielding a higher rate of return. The net losses from the sales of the securities were fully recovered within the first eight months of 1995 through the repurchase of higher yielding securities. There were no securities sales in 1995.\nAdditionally, United has used an off-balance-sheet instrument known as an interest rate swap, to further aid in interest rate risk management. The use of the interest rate swap is a cost effective means of synthetically altering the repricing structure of certain balance sheet items. The interest rate swap transaction involves the exchange of a floating interest rate payment based on the one month London inter-bank offered rate (LIBOR) for a fixed rate receipt based on the U. S. three year Treasury note. The net pay and receive amount is calculated on an underlying notional amount without the exchange of the underlying principal amount. The interest rate swap subjects United to market risk associated with changes in interest rates, as well as the risk that the counterparty will fail to perform. Performance risk is considered nominal by virtue of the caliber of the parties involved. Only the interest payments are exchanged, and therefor, cash requirements and exposure to credit risk are significantly less than the notional amount.\nThe interest rate swap was entered into early in 1994 in response to tactical asset\/liability management considerations; specifically, in response to declining market interest rates during 1993 and United's net interest margin being compressed due to the asset sensitivity position of the balance sheet. The interest rate swap was to adjust the asset sensitivity to within United's policy of +10% or -10% of earning assets. The interest rate swap was entered into specifically to hedge prime rate indexed loans and swap a variable rate for a fixed rate.\nAt December 31, 1995, the total notional amount of the interest rate swap in effect was only $50 million. The current maturity of the swap portfolio is one year and one month. During 1995, the interest rate swap reduced net interest income by $787,000. This impact was offset by higher net interest revenue generated by the on-balance sheet instruments hedged by the interest rate swap and produced a higher rate of return and net interest margin. At December 31, 1995, the estimated unrealized loss on the swap, which may reduce interest income in future periods, approximated $738,000. A key assumption utilized in computing the unrealized loss is that interest rates will remain at the December 31, 1995 level throughout the term of the agreement. United did not have interest rate swaps prior to 1994. For further details, see Interest Rate Sensitivity and the related Interest Rate Sensitivity Gap in Management's Discussion and Analysis of Financial Condition and Results of Operations and Note L to the Consolidated Financial Statements.\nOperating Subsidiaries - - ----------------------\nUNB is currently in the process of forming two operating subsidiaries, United Brokerage Services, Inc. and United Mortgage Company, Inc. United anticipates that both of these operating subsidiaries of UNB will be chartered and will have obtained all necessary regulatory approvals for operations to begin during the second quarter of 1996.\nUnited Brokerage Services, Inc. will be a fully-disclosed broker\/dealer and a registered Investment Advisor registered with the National Association of Securities Dealers, Inc. and the Securities and Exchange Commission and a member of the Securities Investor Protection Corporation. United Brokerage Services, Inc. will offer a wide range of investment products as well as comprehensive financial planning and asset management services to the general public.\nUnited Mortgage Company, Inc. is being formed in connection with the pending merger of Eagle Bancorp, Inc. (\"Eagle\") with and into United and the related merger of First Empire Federal Savings and Loan Association (\"First Empire\") with and into UNB. In accordance with the merger agreement, UNB will request regulatory approval to form and operate United Mortgage Company, Inc. The business of United Mortgage Company, Inc. will be the origination and acquisition of residential real estate loans for resale, the conducting of mortgage loan servicing activities for certain loans, and generally the activities commonly conducted by a mortgage banking company.\nCompetition - - -----------\nUnited faces a high degree of competition in nearly all of the markets it serves. These markets may generally be defined as Wood, Kanawha, Putnam, Monongalia, Jackson, Cabell, Wayne, Hancock, Brooke, Ohio, Marshall, Gilmer, Braxton, Lewis, Webster, Fayette and Raleigh Counties in West Virginia; Lawrence, Belmont, Jefferson and Washington Counties in Ohio; and Arlington and Fairfax Counties in Virginia, located adjacent to the Washington D.C. area, which is in close proximity to West Virginia's eastern panhandle. United competes in Ohio markets because of the close proximity to the Ohio border of certain subsidiary offices. Included in United's markets are the Parkersburg Metropolitan Statistical Area (MSA), the Charleston MSA, the Huntington MSA, the Wheeling MSA and the Weirton MSA. These represent the five largest West Virginia MSA's. United considers the above counties and MSA's to be the primary market area for the business of its banking subsidiaries.\nWest Virginia banks are permitted unlimited branch banking throughout the state. In addition, interstate acquisitions of and by West Virginia banks and bank holding companies are permissible on a reciprocal basis. West Virginia also allows reciprocal interstate acquisitions by thrift institutions. These conditions serve to intensify competition within United's market.\nAs of December 31, 1995, there were 14 multi-bank holding companies and 33 one-bank holding companies in the State of West Virginia registered with the Federal Reserve System. United presently ranks fourth among these bank holding companies and second among holding companies headquartered in West Virginia based on both asset and deposit size. These holding companies are headquartered in various West Virginia cities and control banks throughout the state, including banks which compete for business as well as for the acquisition of additional banks.\nEconomic Characteristics of Primary Market Area - - -----------------------------------------------\nAlthough the market area of the banking subsidiaries encompass a portion of the coal fields located in southern West Virginia, an area of the state which has been economically depressed, the coal related loans in the loan portfolio of the banking subsidiaries constitute less than 2% of United's total loans outstanding. The state of West Virginia has a more diversified economy than it had during the peak periods of coal production. This diversified economy has contributed to the positive trends in the personal income and unemployment rates in recent years as personal income has increased from $14,315 in 1991 to $17,096 in 1994 and the state's overall unemployment rate has declined from 10.5% in 1991 to 7.8% in 1995, according to available information from the West Virginia Bureau of Employment Programs.\nEleven of the 17 counties within United's primary West Virginia market area rank among the state's top twenty counties in terms of personal income and low unemployment rates. United generally serves the stronger economic areas of the state while maintaining a satisfactory CRA rating.\nRegulation and Supervision - - --------------------------\nUnited, as a bank holding company, is subject to the restrictions of the Bank Holding Company Act of 1956, as amended, and is registered pursuant to its provisions. As such, United is subject to the reporting requirements of and examination by the Board of Governors of the Federal Reserve System (\"Board of Governors\").\nThe Bank Holding Company Act prohibits the acquisition by a bank holding company of direct or indirect ownership of more than five percent of the voting shares of any bank within the United States without prior approval of the Board of Governors. With certain exceptions, a bank holding company also 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, and from engaging directly or indirectly in business unrelated to the business of banking, or managing or controlling banks.\nThe Board of Governors of the Federal Reserve System, in its Regulation Y, permits bank holding companies to engage in non-banking activities closely related to banking or managing or controlling banks. Approval of the Board of Governors is necessary to engage in these activities or to make acquisitions of corporations engaging in these\nactivities. In addition, on a case by case basis, the Board of Governors may approve other non-banking activities.\nAs a bank holding company doing business in West Virginia, United is also subject to regulation and examination by the West Virginia Board of Banking and Financial Institutions (the \"West Virginia Banking Board\") and must submit annual reports to the department. Further, any acquisition application which United must submit to the Board of Governors must also be submitted to the West Virginia Banking Board for approval.\nUnited is also registered under and is subject to the requirements of the Securities Exchange Act of 1934, as amended.\nUNB, as national banking associations, is subject to supervision, examination and regulation by the Office of the Comptroller of the Currency. UNB is also a member of the Federal Reserve System, and as such, is subject to applicable provisions of the Federal Reserve Act and regulations issued thereunder.\nUnited Bank, as a Virginia state member bank, is subject to supervision, examination and regulation by the Federal Reserve System, and as such, is subject to applicable provisions of the Federal Reserve Act and regulations issued thereunder. United Bank is subject to regulation by the Virginia Corporation Commission's Bureau of Financial Institutions.\nThe deposits of United's wholly-owned banking subsidiaries are insured by the Federal Deposit Insurance Corporation (\"FDIC\") to the extent provided by law. Accordingly, these banks are also subject to regulation by the FDIC.\nUNITED BANKSHARES, INC. FORM 10-K, PART I\nItem 3.","section_3":"Item 3. Legal Proceedings\nLitigation - - ----------\nThe reader is directed to Note L - Notes to Consolidated Financial Statements.\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.\nUNITED BANKSHARES, INC.\nFORM 10-K, PART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Stock and Related Shareholder Matters\nStock - - -----\nAs of December 31, 1995, 20,000,000 shares of common stock, par value $2.50 per share, were authorized for United, of which 12,156,571 were issued and outstanding including 140,520 shares held as treasury shares. These shares are held by approximately 4,844 shareholders of record as of December 31, 1995. The unissued portion of United's authorized common stock (subject to registration approval by the SEC) and the treasury shares are available for issuance as the Board of Directors determines advisable. United offers its shareholders the opportunity to invest dividends in shares of United stock through its dividend reinvestment plan. United has also established stock option plans and a stock bonus plan as incentive for certain eligible officers. Additionally, United is presenting an incentive stock option plan to its shareholders for their approval at the 1996 Annual Meeting. See PART III - Succession Management Stock Bonus ------------ Plan and Incentive Stock Option Plans. United offers an employee stock purchase plan for all employees. See PART III - Employee Benefit Plans. While there are ------------ no present plans, understandings, arrangements or agreements, except for the above incentive plans, additional shares could be issued for the purpose of raising capital, in connection with acquisitions of other businesses, or for other appropriate purposes.\nThe Board of Directors believes that the availability of authorized but unissued common stock of United is of considerable value if opportunities should arise for the acquisition of another business through the issuance of United's stock. Shareholders do not have preemptive rights, which allows United to issue additional authorized shares without first offering them to current shareholders.\nUnited has only one class of stock and all voting rights are vested in the holders of United's stock. On all matters subject to a vote of shareholders, the shareholders of United will be entitled to one vote for each share of common stock owned. Shareholders of United have cumulative voting rights with regard to election of directors. At the present time, no senior securities of United are outstanding, nor does the Board of Directors presently contemplate issuing senior securities.\nThere are no preemptive or conversion rights or, redemption or sinking fund provisions with respect to United's Stock. All of the issued and outstanding shares of United's stock are fully paid and non-assessable.\nDividends - - ---------\nThe shareholders of United are entitled to receive dividends when and as declared by its Board of Directors. Dividends are paid quarterly. Aggregate dividends were $1.17 per share in 1995, $1.06 per share in 1994 and $.95 per share in 1993. Dividends are paid from funds legally available; therefore, the payment of dividends is subject to the restrictions set forth in the West Virginia Corporation Act. See \"Market and Stock Prices of United\" for quarterly dividend information.\nPayment of Dividends by United is dependent upon payment of dividends to it by its subsidiary banks. The ability of national banks to pay dividends is subject to certain limitations imposed by the national banking laws. Generally, the most restrictive provision requires approval by the Office of the Comptroller of the Currency (\"OCC\") if dividends declared in any year exceed the year's net income, as defined, plus the retained net profits of the two preceding years. Payment of dividends by United's state member bank is regulated by the Federal Reserve System and generally, the prior approval of the Federal Reserve Board (\"FRB\") is required if the total dividends declared by a state member bank in any calendar year exceeds its net profits, as defined, for that year combined with its retained net profits for the preceding two years. Additionally, prior approval of both the OCC and the FRB is required when a national bank or state member bank has deficit retained earnings but has sufficient current year's net income, as defined, plus the retained net profits of the two preceding years. The OCC and FRB may prohibit dividends if it deems the payment to be an unsafe or unsound banking practice. The OCC has issued guidelines for dividend payments by national banks, emphasizing that proper dividend size depends on the bank's earnings and capital while the FRB has issued similar guidelines pertaining to state member banks. See Note C - Notes to Consolidated Financial Statements.\nMarket and Stock Prices of United - - ---------------------------------\nUnited Bankshares, Inc. stock is traded over the counter on the National Association of Securities Dealers Automated Quotations System (\"NASDAQ\") under the trading symbol UBSI.\nThe following table presents the dividends and high and low prices of United's common stock during the periods set forth below:\n(1) On February 26, 1996, United declared a dividend of $0.30 per share, payable April 1, 1996, to shareholders of record as of March 8, 1996.\nThe high and low prices listed above are based upon information available to United's management from NASDAQ listings. No attempt has been made by United's management to ascertain the prices for every sale of its stock during the periods indicated. However, based on the information available, United's management believes that the prices fairly represent the amounts at which United's stock was traded during the periods indicated.\nUNITED BANKSHARES, INC. FORM 10-K, PART II\nItem 6.","section_6":"Item 6. Selected Financial Data\nUNITED BANKSHARES, INC. AND SUBSIDIARIES\nSELECTED FINANCIAL DATA (In thousands except for per share data)\n(1) Cash dividends are the amounts declared by United and do not include cash dividends of acquired subsidiaries prior to the dates of consummation.\nUNITED BANKSHARES, INC. FORM 10-K, PART II\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nUNITED BANKSHARES, INC. AND SUBSIDIARIES\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe following discussion and analysis presents the significant changes in financial condition and the results of operations of United and its subsidiaries for the periods indicated below. This discussion and analysis should be read in conjunction with the audited financial statements and accompanying notes thereto, which are included elsewhere in this document. All references to United in this discussion and analysis are considered to refer to United and its wholly-owned subsidiaries, unless otherwise indicated.\n1995 COMPARED TO 1994\nThe following Earnings Summary is a broad overview of the financial condition and results of operations and is not intended to replace the more detailed discussion which is presented under specific headings on the following pages.\nEARNINGS SUMMARY\nFor the year ended December 31, 1995, net income increased 12.8% to a record $28,079,000. Net income per share of $2.35 for the year was up 13.0% from $2.08 in 1994. United's return on average assets of 1.58% makes United one of the nation's most profitable regional banking companies. Dividends per share increased 10.4% from $1.06 in 1994 to a record level of $1.17 per share in 1995. This was the twenty-second consecutive year of dividend increases to shareholders. Core earnings, or earnings before taxes, security transactions, cumulative effect of change in accounting principle and the provision for possible loan losses, were strong and increased 11.6% for 1995 compared to 1994. These strong core earnings are indicative of the 5.7% increase in net interest income driven by an increase in average net earning assets with significant growth of 7.3% in average net loans.\nFactors contributing to the 1995 earnings increase include an improved net interest margin, partially resulting from a $27,511,000 increase in average earning assets from 1994 and an overall increase in noninterest income which included fewer losses on the sale of securities. The favorable impact of the above items was partly offset by increased occupancy expenses and increased income taxes as a result of the higher level of pre-tax earnings. United is in the process of realigning its interest rate sensitivity for 1996 to a more interest-rate-neutral position. This investment strategy may reduce current earnings, but should enhance United's future earnings momentum.\nUnited's key performance measures, return on average assets and return on average equity, improved significantly from 1994 and remained very strong in comparison to industry standards. United's return on average assets of 1.58% and return on average shareholders' equity of 14.81% both compare excellently with regional peer grouping ratios of 1.17% and\n12.56% and national peer group ratios of 1.21% and 13.47%, respectively, according to information provided by Wheat, First Securities, Inc. United is one of the nation's most profitable regional banking companies. United has a strong capital position and is well positioned to take advantage of future growth opportunities.\nThe following discussion explains in more detail the results of operations and changes in financial condition by major category.\nNet Interest Income\nNet interest income represents the primary component of United's earnings. It is the difference between interest and fee income related to earning assets and interest expense incurred to fund these earning assets. Net interest income is impacted by changes in the volume and mix of interest-earning assets and interest-bearing liabilities, as well as changes in market interest rates. Such changes, and their impact on net interest income in 1995, are explained below.\nFor the years ended December 31, 1995 and 1994, net interest income approximated $81,690,000 and $77,270,000, respectively. On a tax-equivalent basis the net interest margin was strong at 5.15% in 1995 and 4.97% in 1994. Higher average loan volumes of approximately $89 million resulting primarily from an acquisition contributed to the increase in net interest income. At 5.15%, United's net interest margin remains well above peer group averages.\nTotal interest income of $136,460,000 increased 12.6% in 1995 over 1994 as a result of higher volumes of interest-earning assets. Comparing year-end 1995 to year-end 1994, a moderate decrease occurred in consumer loans of 3.8% while commercial loans and mortgage loans showed increases of 4.9% and 8.7%, respectively.\nTotal interest expense increased $10,883,000 or 24.8% in 1995. This increase can be attributed primarily to United's competitive pricing of interest-bearing deposits in its markets and continued change in the retail deposit mix as customers shift funds into products offering higher yields. United's average interest-bearing deposits increased by 1.9% in 1995, while its average long-term borrowings decreased 23.5% and average short-term borrowings increased 5.50%. United made greater use of short-term funds as the Federal Reserve held short- term rates steady at approximately 6.0% for nearly half of 1995. The average cost of funds, which increased from 3.30% in 1994 to 4.07% in 1995, reflected the general upward trend in market interest rates during 1995.\nProvision for Possible Loan Losses\nUnited evaluates the adequacy of the allowance for loan losses on a quarterly basis and its loan administration policies are focused upon the risk characteristics of the loan portfolio. United's process of evaluating the allowance is a formal company-wide process that focuses on early identification of potential problem credits and procedural discipline in managing and accounting for those credits. See Note F to the Consolidated Financial Statements for a discussion of concentrations of credit risk.\nNonperforming loans were $9,089,000 at December 31, 1995 and $6,036,000 at December 31, 1994, an increase of 50.6%. The level of nonperforming assets increased as a result of delinquencies on certain large balance commercial creditors and nonperforming assets purchased in a recent acquisition. The components of nonperforming loans include nonaccrual loans and loans which are contractually past due 90 days or more as to interest or principal, but have not been put on a nonaccrual basis. United has no significant troubled debt restructurings. Loans past due 90 days or more increased $1,853,000 or 80.5% during 1995; nonaccrual loans increased $1,201,000 or 32.2% since year-end 1994. Much of the increase in nonaccrual loans was the result of the addition of a single large commercial loan to nonaccrual status. United is currently negotiating workout terms with the borrowers and will closely monitor the ongoing status. Nonperforming loans represented 0.50% of total assets at the end of 1995, which is approximately one-half of the national peer levels.\nAt year-end 1995 and 1994 the allowance for possible loan losses was 1.46% and 1.54% of total loans, net of unearned income, respectively. At December 31, 1995 and 1994, the ratio of the allowance for loan losses to nonperforming loans was 220.2% and 331.5%, respectively.\nManagement believes that the allowance for loan losses of $20,017,000 as of December 31, 1995, is adequate to provide for potential losses on existing loans based on information currently available.\nFor the years ended December 31, 1995 and 1994 the provision for loan losses was $2,075,000 and $1,818,000, respectively. The slight increase can be attributed to the higher net charge-offs and the increase in nonperforming loans during 1995. The provision for loan losses charged to operations is based on management's evaluation of individual credits, the past loan loss experience, and other factors which, in management's judgement, deserve recognition in estimating possible loan losses. Such other factors considered by management include growth and composition of the loan portfolio, known deterioration in certain classes of loans or collateral, trends in delinquencies, and current economic conditions.\nTotal net charge-offs were $3,083,000 in 1995 and $825,000 in 1994, which represents 0.23% and 0.07% of average loans for the respective years. United's ratio of net charge-offs to average loans is comparable to its peers' ratio of 0.19% in 1995 and compared very favorably with its peers' ratio of 0.22% in 1994.\nManagement is not aware of any potential problem loans, trends or uncertainties which management reasonably expects will materially impact future operating results, liquidity, or capital resources which have not been disclosed. Additionally, management has disclosed all known material credits which cause management to have serious doubts as to the ability of such borrowers to comply with the loan repayments. Management is not aware of any current recommendations by regulatory authorities which, if implemented, would have a material effect on liquidity, capital resources or operations.\nEffective January 1, 1995, United adopted Financial Accounting Standards Board Statement No. 114, \"Accounting by Creditors for Impairment of a Loan,\"(SFAS No. 114), as amended by SFAS No. 118, \"Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures,\" collectively SFAS 114. As a result of applying the rules prescribed by SFAS No. 114, certain loans are being reported at the present value of their expected future cash flows using 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. At the time of adoption of SFAS No. 114, United had approximately $8,000,000 of loans which were considered impaired in accordance with the guidelines prescribed by SFAS No. 114. The adoption of SFAS No. 114 did not have a material impact on the allowance for loan losses, the provision for possible loan losses, the charge-off policy or the comparability of credit risk.\nImpaired loans are specifically reviewed loans for which it is probable that the creditor will be unable to collect all amounts due according to the original terms of the loan agreement. The specific factors that influence management's judgement in determining when a loan is impaired include the evaluation that the loan is classified as \"substandard\" or worse, also the strength of the borrower and the net realizable value of the collateral. A valuation allowance is required to the extent that the measure of the impaired loans is less than the recorded investment. A specifically reviewed loan is not impaired during a period of \"minimum delay\" in payment, regardless of the amount of shortfall, if the ultimate collectibility of all amounts due is expected. United defines \"minimum delay\" as past due less than 90 days.\nSFAS 114 does not apply to smaller balance, larger groups of homogeneous loans such as consumer installment, bank card and real estate mortgage loans, which are collectively evaluated for impairment. Impaired loans are therefore primarily business loans, which include commercial loans and income property. United applies the measurement methods described above to these loans on a loan- by-loan basis. Smaller balance populations of business loans, loans with a balance of $100,000 or less, which are not specifically reviewed in accordance with United's normal credit review procedures, are also excluded from the application of SFAS 114.\nImpaired loans are charged-off when the impaired loan, or a portion thereof, is considered uncollectible or is transferred to other real estate owned.\nConsistent with United's existing method of income recognition for loans, interest receipts on impaired loans, except those classified also as nonaccrual, are recognized as interest income using the accrual method of income recognition. United's method of income recognition for impaired loans that are classified as nonaccrual is to recognize interest income on the cash method of income recognition or apply the cash receipt to principal when the ultimate collectibility of principal is in doubt. The average recorded investment in impaired loans during the year ended December 31, 1995 was approximately $9,545,000. For the year ended December 31, 1995, United recognized interest income on those\nimpaired loans of approximately $412,000, substantially all of which was recognized using the accrual method of income recognition. The amount of interest income which would have been recorded under the original terms for the above loans was $633,000.\nAt December 31, 1995, the recorded investment in loans that were considered to be impaired under SFAS No. 114 was $8,792,000 (of which $4,934,000 were on a nonaccrual basis). Included in this amount was $4,793,000 of impaired loans for which the related allowance for credit losses was $1,918,000 and $3,999,000 of impaired loans that did not have an allowance for credit losses. The impact of adopting SFAS 114 was immaterial to the financial condition and operations of United as of and for the year ended December 31, 1995, and had no material impact on the comparability of the credit risk as presented herein.\nUnited has commercial real estate loans, including owner occupied, income producing real estate and land development loans, of approximately $328,226,000 and $300,679,000 as of December 31, 1995 and 1994, respectively. The loans are primarily secured by real estate located in West Virginia, Southeastern Ohio, and Virginia. The loans were originated by United's subsidiary banks using underwriting standards as set forth by management. United's loan administration policies are focused on the risk characteristics of the loan portfolio, including commercial real estate loans, in terms of loan approval and credit quality. It is the opinion of management that these loans do not pose any unusual risks and that adequate consideration has been given to the above loans in establishing the allowance for loan losses.\nOther Income\nNoninterest income has been and will continue to be an important factor contributing to United's profitability. Accordingly, management continues to evaluate areas where noninterest income can be enhanced. Other income consists of all revenues which are not included in interest and fee income related to earning assets. In 1995, other income, excluding securities transactions, increased when compared to 1994. The overall increase in noninterest income of $1,394,000 or 12.4% is primarily attributed to the absence of net losses on securities transactions incurred in 1994 and a $541,000 increase in service charges, commissions and fees.\nTrust income increased $43,000 or 1.5% in 1995. This was due to repricing of services and an increased volume of trust business.\nService charges, commissions and fees increased by $541,000 or 6.3% in 1995. This income consists of charges and fees related to various banking services provided by United. The increase was primarily due to a combination of increased fees in bankcard accounts and an increased fee structure for sales of checking related products.\nSecurities transactions resulted in a net loss of $872,000 in 1994. The proceeds from these sales were reinvested in similar securities yielding a higher rate of return. The net losses from the sales of the securities were fully recovered within the first eight months of 1995. There were no securities sales in 1995.\nOn January 1, 1994, United adopted Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" (SFAS No. 115) which was effective for fiscal years beginning after December 15, 1993. The $872,000 of net securities losses for 1994 relates primarily to debt securities losses of approximately $1,024,000 which were classified as available for sale. For further details, see Note D to the Consolidated Financial Statements.\nOn November 15, 1995, the FASB staff issued a Special Report, \"A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities.\" In accordance with the provision of that Special Report, United chose to reclassify securities from held-to-maturity to available-for-sale. At the date of the transfer the amortized cost of those securities was $103,595,000, and the unrealized gain on those securities was $242,000, which is included in shareholders' equity. This enabled United to take advantage of certain interest rate risk management strategies.\nOther Expense\nJust as management continues to evaluate areas where noninterest income can be enhanced, it strives to improve the efficiency of its operations and thus reduce operating costs. United's cost control efforts have been very successful with an efficiency ratio of 50.1%, which is well below the 64.7% reported by peer group averages.\nOther expenses include all items of expense other than interest expense, the provision for possible loan losses, and income taxes. In total, other expenses were flat in 1995, and management was successful in controlling costs. The income statement reflects a 0.4% increase in 1995 as compared to 1994.\nSalaries and employee benefits expense increased $20,000 or 0.1% in 1995. As of December 31, 1995 and 1994, United employed 819 and 834 full-time equivalent employees, respectively.\nNet occupancy expense in 1995 exceeded 1994 levels by $235,000 or 4.8% primarily due to decreased rental income from vacancies and an increase in real property repairs and utilities expense.\nRemaining other expenses decreased $50,000 or 0.2% in 1995 compared to 1994. The decrease in other expenses for the year relates primarily to lower data processing fees and FDIC insurance expense as a result of the Federal Deposit Insurance Corporation's decision to lower deposit insurance premiums from $0.23 to $0.04 per $100 in Bank Insurance Fund (BIF) deposits for well capitalized and well managed banks. The premium change resulted in a refund of approximately $910,000 which was received in September 1995. The overall decrease in FDIC insurance premiums for 1995 when compared to 1994 was $1,542,000. United's two banking subsidiaries are assessed at the lowest FDIC insurance premium rate. The decrease in FDIC insurance premiums and data processing fees was offset by higher advertising, postage, bankcard and nonrecurring legal expenses which included certain merger related expenses for the First\nCommercial acquisition consummated by United during 1995 and the pending Eagle merger to be consummated during 1996.\nIncome Taxes\nFor the year ended December 31, 1995, income taxes approximated $15,271,000 compared to $13,096,000 for 1994. This increase is principally the result of lower levels of tax-exempt income and higher levels of pretax income. United's effective tax rates in these two years were 35.2% and 34.5%, respectively.\nAt December 31, 1995, gross deferred tax assets totaled approximately $11.6 million. The allowance for loan losses and various accrued liabilities represent the most significant temporary differences. Based on management's evaluation at December 31, 1995, no valuation allowance has been allocated to deferred tax assets.\nFourth Quarter Results\nNet income for the fourth quarter of 1995 was $6,953,000, an increase of 13.0% from the $6,156,000 earned in the fourth quarter of 1994. On a per share basis, fourth quarter earnings were $.58 per share in 1995 and $.51 per share in 1994. Net income was higher in 1995 than in 1994 because of the factors previously discussed herein relative to annual results.\nAdditional quarterly financial data for 1995 and 1994 may be found in Note P to the Consolidated Financial Statements.\nThe Effect of Inflation\nUnited's income statements generally reflect the effects of inflation. Since interest rates, loan demand, and deposit levels are related to inflation, the resulting changes in the interest sensitive assets and liabilities are included in net interest income. Similarly, operating expenses such as salaries, rents, and maintenance include changing prices resulting from inflation. One item which would not reflect inflationary changes is depreciation expense. Subsequent to the acquisition of depreciable assets, inflation causes price levels to rise; therefore, historically presented dollar values do not reflect this inflationary condition. With inflation levels at relatively low levels and monetary and fiscal policies being implemented to keep the inflation rate increases within an acceptable range, management expects the impact of inflation would continue be minimal in the near future.\nInterest Rate Sensitivity\nInterest sensitive assets and liabilities are defined as those assets or liabilities that mature or are repriced within a designated time-frame. The principal function of asset and liability management is to maintain an appropriate relationship between those assets and liabilities that are sensitive to changing market interest rates. United closely monitors the sensitivity of its assets and liabilities on an on-going basis and projects the effect of various interest rate changes on its net interest margin.\nThe difference between rate sensitive assets and rate sensitive liabilities for specified periods of time is known as the \"GAP\".\nA primary objective of Asset\/Liability Management is managing interest rate risk. At United, interest rate risk is managed to minimize the impact of fluctuating interest rates on earnings. As shown in the interest rate sensitivity gap table on the following page of this report, United was liability sensitive (excess of liabilities over assets) in the one year horizon. United, however, has not experienced the kind of earnings volatility indicated from the cumulative gap. This is because a significant portion of United's retail deposit base does not reprice on a contractual basis. Management has estimated, based upon historical analyses, that savings deposits are less sensitive to interest rate changes than are other forms of deposits. The GAP table presented herein has been adapted to show the estimated differences in interest rate sensitivity which result when the retail deposit base is assumed to reprice in a manner consistent with historical trends. (See \"Management Adjustments\" in the GAP table). Using these estimates, United was asset sensitive in the one year horizon in the amount of $136,372,000 or 8.10% of the cumulative gap to related earning assets. The primary method of measuring the sensitivity of earnings to changing market interest rates is to simulate expected cash flows using varying assumed interest rates while also adjusting the timing and magnitude of non- contractual deposit repricing to more accurately reflect anticipated pricing behavior. These simulations include adjustments for the lag in prime loan repricing and the spread and volume elasticity of interest-bearing deposit accounts, regular savings and money market deposit accounts. To aid in interest rate management, United's lead bank, UNB, is a member of the Federal Home Loan Bank of Pittsburgh (FHLB). The use of FHLB advances provides United with a low risk means to match maturities of earning assets and interest-bearing funds to achieve a desired interest rate spread over the life of the earning assets.\nUNITED BANKSHARES, INC. AND SUBSIDIARIES\nThe following table shows the interest rate sensitivity GAP as of December 31, 1995:\nInterest Rate Sensitivity Gap\nAdditionally, United is using certain off-balance-sheet instruments known as interest rate swaps, to further aid in interest rate risk management. The use of interest rate swaps is a cost effective means of synthetically altering the repricing structure of balance sheet items. The interest rate swap transaction involves the exchange of a floating rate payment based on the one month London inter-bank offered rate (LIBOR) for a fixed rate receipt based on the U. S. three year treasury note. The net pay and receive amount is calculated on an underlying notional amount without the exchange of the underlying principal amount. The interest rate swap subjects United to market risk associated with changes in interest rates, as well as the risk that the counterparty will fail to perform. Only the interest payments are exchanged, and therefore, cash requirements and exposure to credit risk are significantly less than the notional amount.\nAt December 31, 1995, the total notional amount of United's interest rate swap was $50 million. The current maturity of the swap portfolio is one year and one month. The interest rate swap reduced net interest\nincome by $787,000 and $1,000, in 1995 and 1994, respectively. For further details, see Note L to the Consolidated Financial Statements.\nLiquidity and Capital Resources\nIn the opinion of management, United maintains liquidity which is sufficient to satisfy its depositors' requirements and the credit needs of its customers. Like all banks, United depends upon its ability to renew maturing deposits and other liabilities on a daily basis and to acquire new funds in a variety of markets. A significant source of funds available to United are \"core deposits\". Core deposits include certain demand deposits, statement and special savings and NOW accounts. These deposits are relatively stable and they are the lowest cost source of funds available to United. Short-term borrowings have also been a significant source of funds. These include federal funds purchased and securities sold under agreements to repurchase. Repurchase agreements represent funds which are generally obtained as the result of a competitive bidding process.\nLiquid assets are cash and those items readily convertible to cash. All banks must maintain sufficient balances of cash and near-cash items to meet the day- to-day demands of customers. Other than cash and due from banks, the available for sale securities portfolio and maturing loans are the primary sources of liquidity.\nThe goal of liquidity management is to ensure the ability to access funding which enables United to efficiently satisfy the cash flow requirements of depositors and borrowers and meet United's cash needs. Liquidity is managed by monitoring funds availability from a number of primary sources. Substantial funding is available from cash and cash equivalents, unused short-term borrowings and a geographically dispersed network of subsidiary banks providing access to a diversified and substantial retail deposit market.\nShort-term needs can be met through a wide array of sources such as correspondent and downstream correspondent federal funds and utilization of Federal Home Loan Bank advances.\nOther sources of liquidity available to United to provide long-term as well as short-term funding alternatives, in addition to FHLB advances, are long-term certificates of deposit, lines of credit, and borrowings secured by bank premises or stock of United's subsidiaries. United has no intention at this time of utilizing any long-term funding sources other than FHLB advances and long-term certificates of deposit.\nCash flows from operations in 1995 of $35,666,000 were 3.5% higher than the $34,458,000 in 1994 as a result of approximately $3,200,000 million increase in net income. In 1995, investing activities resulted in a source of cash of $23,280,000 as compared to 1994 in which investing activities resulted in a use of cash of $52,200,000. The primary reason for the decrease in the use of cash for investing activities is that net loan originations decreased by $79,827,000 in 1995 as compared to 1994 while the net excess of proceeds from sales, maturities and calls of securities over security purchases decreased from $67,103,000 in 1994 to\n$63,739,000 in 1995 for a decrease of $3,364,000. Financing activities resulted in a use of cash in 1995 of $62,800,000 primarily due to a $50,072,000 decrease in net borrowings from the FHLB of Pittsburgh, payment of $10,273,000 of cash dividends to shareholders and a net decreases in deposits of $12,206,000. These uses of cash for financing activities were partially offset by a net increase of $10,358,000 in other short-term borrowings. See the Consolidated Statement of Cash Flows in the Consolidated Financial Statements.\nUnited anticipates no problems in its ability to service its obligations over the next 12 months and has no material commitments for capital expenditures. There are no known trends, demands, commitments, or events that will result in or that are reasonably likely to result in United's liquidity increasing or decreasing in any material way. United also has significant lines of credit available to it. See Note I, Notes to Consolidated Financial Statements.\nThe asset and liability committee monitors liquidity to ascertain that a strong liquidity position is maintained. In addition, variable rate loans are a priority. These policies should help to protect net interest income against fluctuations in interest rates.\nUnited also seeks to maintain a proper relationship between capital and total assets in order to support growth and sustain earnings. United's average equity to average asset ratio was 10.65% in 1995 and 10.16% in 1994. United's risk- based capital ratio was 15.91% in 1995 and 15.52% in 1994 which are both significantly higher than the minimum regulatory requirements. United's Tier 1 capital and leverage ratios of 14.66% and 10.27%, respectively, at December 31, 1995, are also strong relative to its peers and are well above regulatory minimums.\nCommitments\nThe following table indicates the outstanding loan commitments of United in the categories stated:\nPast experience has shown that, of the foregoing commitments, approximately 12- 15% can reasonably be expected to be funded within a one year period. For more information, see Note L to the Consolidated Financial Statements.\n1994 COMPARED TO 1993\nThe following Earnings Summary is a broad overview of the financial condition and results of operations and is not intended to replace the more detailed discussion which is presented under specific headings on the following pages.\nEARNINGS SUMMARY\nFor the year ended December 31, 1994, net income increased 14.7% to a record $24,902,000. Net income per share of $2.08 for the year was up 14.3% from $1.82 in 1993. United's return on average assets was 1.42%. Dividends per share increased 11.6% from $.95 in 1993 to $1.06 per share in 1994. Core earnings, or earnings before taxes, security transactions, cumulative effect of change in accounting principle and the provision for possible loan losses, were strong and increased 19.7% for 1994 as compared to 1993. These strong core earnings were indicative of the 8.1% increase in net interest income driven by an increase in average net earning assets with significant growth of 8.6% in average net loans.\nFactors contributing to the 1994 earnings increase included an improved net interest margin, partially resulting from a $39,338,000 increase in average earning assets from 1993, a lower loan loss provision due to improved credit quality and increased earnings from 1993 acquisitions. The favorable impact of the above items was partly offset by increased occupancy expenses, decreased fee income from customer accounts for which a fee is charged and losses from the sale of securities.\nUnited's key performance measures, return on average assets and return on average equity, improved significantly from 1993 and remained very strong in comparison to industry standards. United's return on average assets of 1.42% made United one of the nation's most profitable regional banking companies. In the December 31, 1994, Bank Holding Company Performance Report, which is prepared by the Federal Reserve Board's Division of Banking Supervision and Regulation, United was ranked in the 85th percentile of bank holding companies nationwide in terms of return on average assets for the year ended December 31, 1994.\nThe following discussion explains in more detail the results of operations and changes in financial condition by major category.\nNet Interest Income\nFor the years ended December 31, 1994 and 1993, net interest income approximated $77,270,000 and $71,496,000, respectively. On a tax-equivalent basis the net interest margin was strong at 4.97% in 1994 and 4.75% in 1993. Higher average loan volumes of $98 million contributed to the increase in net interest income. United also experienced modest decreases in its overall cost of funds. At 4.97%, United's net interest margin was well above peer group averages.\nTotal interest income of $121,157,000 increased 4.0% in 1994 over 1993 as a result of higher volumes of interest-earning assets. Comparing\nyear-end 1994 to year-end 1993, a moderate decrease in commercial loans of 4.6% and a slight increase in consumer loans of 1.8%, which resulted from lower commercial and consumer demand, were offset by significant mortgage loan growth of 16.4%.\nTotal interest expense decreased 2.5% in 1994. This decrease was primarily the result of lower rates paid on interest-bearing funds. United's average interest- bearing deposits increased only slightly or 0.5% in 1994, while its average long-term borrowings increased 25.1% as United made greater use of these funds in order to meet the demand for mortgage loan products with matching maturities. The average cost of funds reflected the general downward trend in market interest rates in 1994, falling from 3.44% in 1993 to 3.30% in 1994.\nProvision for Possible Loan Losses\nUnited evaluated the adequacy of the allowance for loan losses on a quarterly basis and its loan administration policies are focused upon the risk characteristics of the loan portfolio.\nNonperforming loans were $6,036,000 at December 31, 1994 and $13,517,000 at December 31, 1993, a decrease of 55.4%. The level of nonperforming assets declined as a result of the recovering of the regional economy and management's continual monitoring of problem loans. The components of nonperforming loans include nonaccrual loans, loans which are contractually past due 90 days or more as to interest or principal, but have not been put on a nonaccrual basis and troubled debt restructurings. Loans past due 90 days or more decreased $173,000 or 7.0% during 1994; while troubled debt restructurings decreased $2,453,000 or 100.0% and nonaccrual loans decreased $4,855,000 or 56.5% since year-end 1993. Nonperforming loans continue to decline and represented less than 0.34% of total assets at the end of 1994.\nAt year-end 1994 and 1993 the allowance for possible loan losses was 1.54% and 1.61% of total loans, net of unearned income, respectively. As of December 31, 1994 and 1993, the ratio of the allowance for loan losses to nonperforming loans was 331.5% and 140.7%, respectively.\nFor the years ended December 31, 1994 and 1993 the provision for loan losses was $1,818,000 and $4,332,000, respectively. The decrease was attributable to the general improvement in all areas of asset quality and the increased coverage ratio of the allowance for loan losses to nonperforming loans. The provision for loan losses charged to operations is based on management's evaluation of individual credits, the past loan loss experience, and other factors which, in management's judgement, deserve recognition in estimating possible loan losses. Such other factors considered by management include growth and composition of the loan portfolio, known deterioration in certain classes of loans or collateral, trends in delinquencies, and current economic conditions.\nTotal net charge-offs were $825,000 in 1994 and $1,773,000 in 1993, which represents .07% and .16% of average loans for the respective years. United's ratio of net charge-offs to average loans compares very favorably with its peers.\nOther Income\nOther income consists of all revenues which are not included in interest and fee income related to earning assets. In 1994, other income, excluding securities transactions, was flat when compared to 1993. The overall decrease in noninterest income of $1,451,000 or 11.4% was primarily attributed to the net losses on securities transactions.\nTrust income increased $229,000 or 8.7% in 1994. This was due to repricing of services and an increased volume of trust business.\nService charges, commissions and fees decreased by $194,000 or 2.2% in 1994. This income consists of charges and fees related to various banking services provided by United. The decrease was primarily due to a combination of decreased activity in customer accounts and a decline in net account analysis fees.\nSecurities transactions resulted in a net loss of $872,000 in 1994 and a net gain of $479,000 in 1993. As evidenced by the Statement of Cash Flows, the volume of securities sold increased significantly in 1994. The primary reason for this increased sales activity was to restructure a portion of the investment portfolio to reflect current market rates in response to the rising interest rate environment in order to enhance United's future earnings momentum.\nOn January 1, 1994, United adopted Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" (SFAS No. 115) which was effective for fiscal years beginning after December 15, 1993. The $872,000 of net securities losses for 1994 relates primarily to debt securities losses of approximately $1,024,000 which were reclassified to available for sale at January 1, 1994.\nOther Expense\nOther expense includes all items of expense other than interest expense, the provision for possible loan losses, and income taxes. In total, other expenses were flat in 1994, and management was successful in controlling costs. The income statement reflects a 2.0% decrease in 1994 as compared to 1993.\nSalaries and employee benefits expense decreased $176,000 or 1.0% in 1994.\nNet occupancy expense in 1994 exceeded 1993 levels by $390,000 or 8.7% primarily due to decreased rental income from vacancies and an increase in real property taxes.\nThe remaining other expense decreased $1,228,000 or 5.4% in 1994 compared to 1993. The decrease in other expenses for the year related primarily to nonrecurring expenses during 1993 which included certain merger expenses for the two acquisitions consummated by United during 1993, a lower provision for other real estate owned and the realization of further economies from recent mergers.\nIncome Taxes\nFor the year ended December 31, 1994, income taxes approximated $13,096,000 compared to $9,770,000 for 1993. This increase is principally the result of lower levels of tax-exempt income and higher levels of pretax income. United's effective tax rates in these two years were 34.5% and 32.4%, respectively.\nAt December 31, 1994, gross deferred tax assets totaled approximately $11.5 million compared to $10.4 million at December 31, 1993. The allowance for loan losses and various accrued liabilities represent the most significant temporary differences. Based on management's evaluation at December 31, 1994 and 1993, no valuation allowance had been allocated to deferred tax assets.\nUNITED BANKSHARES, INC. AND SUBSIDIARIES\nDISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY INTEREST RATES AND INTEREST DIFFERENTIAL:\nThe following table shows the daily average balance of major categories of assets and liabilities for each of the three years ended December 31, 1995, 1994 and 1993 with the interest and rate earned or paid on such amount.\n(1) The interest income and the yields on nontaxable loans and investment securities are presented on a tax-equivalent basis using the statutory federal income tax rate of 35%.\n(2) Nonaccruing loans are included in the daily average loan amounts outstanding.\nUNITED BANKSHARES, INC. AND SUBSIDIARIES\nRATE\/VOLUME ANALYSIS\nThe following table sets forth a summary of the changes in interest earned and interest paid detailing the amounts attributable to (i) changes in volume (change in the average volume times the prior year's average rate), (ii) changes in rate (change in the average rate times the prior year's average volume), and (iii) changes in rate\/volume (change in the average volume times the change in average rate).\n(1) Yields and interest income on tax exempt loans and investment securities are computed on a fully tax-equivalent basis using the statutory federal income tax rate of 35%.\n(2) Nonaccruing loans are included in the daily average loan amounts outstanding.\nUNITED BANKSHARES, INC. AND SUBSIDIARIES\nLOAN PORTFOLIO\nTYPES OF LOANS\nThe following is a summary of loans outstanding at December 31:\nAt December 31, 1995, real estate mortgage loans include $570,635,000 in single family residential real estate loans and $328,226,000 in commercial real estate loans.\nThe following is a summary of loans outstanding as a percent of total loans at December 31:\nREMAINING LOAN MATURITIES\nThe following table shows the maturity of commercial, financial, and agricultural loans and real estate construction outstanding as of December 31, 1995:\nUNITED BANKSHARES, INC. AND SUBSIDIARIES\nAt December 31, 1995, commercial, financial and agricultural loans maturing within one to five years and in more than five years are interest sensitive as follows:\nThere were no real estate construction loans with maturities greater than one year.\nRISK ELEMENTS\nNonperforming Loans\nNonperforming loans include loans on which no interest is currently being accrued, loans which are past due 90 days or more as to principal or interest payments, and loans for which the terms have been modified due to a deterioration in the financial position of the borrower. Management is not aware of any other significant loans, groups of loans, or segments of the loan portfolio not included below where there are serious doubts as to the ability of the borrowers to comply with the present loan repayment terms. The following table summarizes nonperforming loans for the indicated periods.\nLoans are designated as nonaccrual when, in the opinion of management, the collection of principal or interest is doubtful. This generally occurs when a loan becomes 90 days past due as to principal or interest unless the loan is both well secured and in the process of collection. When interest accruals are discontinued, unpaid interest credited to income in the current year is reversed, and unpaid interest accrued in prior years is charged to the allowance for loan losses. See Note F to the consolidated financial statements for additional information regarding nonperforming loans and credit risk concentration.\nUNITED BANKSHARES, INC. AND SUBSIDIARIES\nINVESTMENT PORTFOLIO\nThe following is a summary of the amortized cost of investment securities held to maturity at December 31, 1995 and 1994 and all securities at December 31, 1993:\nThe following is a summary of the amortized cost of available for sale securities at December 31,:\nThe market value of mortgage-backed securities is affected by changes in interest rates and prepayment risk. When interest rates decline, prepayment speeds generally accelerate due to homeowners refinancing their mortgages at lower interest rates. This may result in the proceeds being reinvested at lower interest rates. Rising interest rates may decrease the assumed prepayment speed. Slower prepayment speeds may extend the maturity of the security beyond its assumed prepayment speed. Therefore, investors may not be able to invest at current higher market rates due to the extended expected maturity of the security. United had an unrealized loss of $331,000 on all mortgage-backed securities at December 31, 1995, as compared to a net unrealized loss of $7,805,000 at December 31, 1994. This increase in value from 1994 to 1995 is consistent with the decrease in interest rates during 1995.\nThe following table sets forth the maturities of all securities at December 31, 1995, and the weighted average yields of such securities (calculated on the basis of the cost and the effective yields weighted for the scheduled maturity of each security).\n(1) Tax-equivalent adjustments (using a 35% federal rate) have been made in calculating yields on obligations of states and political subdivisions.\nNOTE: There are no securities with a single issuer whose book value in the aggregate exceeds 10% of total shareholders' equity.\nUNITED BANKSHARES, INC. AND SUBSIDIARIES\nSHORT-TERM BORROWINGS\nThe following table shows the distribution of United's short-term borrowings and the weighted average interest rates thereon at the end of each of the last three years. Also provided are the maximum amount of borrowings and the average amounts of borrowings as well as weighted average interest rates for the last three years.\nAt December 31, 1995, repurchase agreements include $53,846,000 in overnight accounts. The remaining balance principally consists of agreements having maturities ranging from 2-90 days. The rates offered on these funds vary according to movements in the federal funds and short-term investment market rates.\nUNITED BANKSHARES, INC. AND SUBSIDIARIES\nDEPOSITS\nThe average daily amount of deposits and rates paid on such deposits is summarized for the years ended December 31:\nMaturities of time certificates of deposit of $100,000 or more outstanding at December 31, 1995 are summarized as follows:\nRETURN ON EQUITY AND ASSETS\nThe following table shows selected consolidated operating and capital ratios for each of the last three years ended December 31:\n(1) Based on historical results of United before the effects of restatements for pooling of interests business combinations.\nUNITED BANKSHARES, INC. AND SUBSIDIARIES\nSUMMARY OF LOAN LOSS EXPERIENCE\nThe following table summarizes United's loan loss experience for each of the five years ended December 31:\n(1) The amount charged to operations and the related balance in the allowance for possible loan losses is based upon periodic evaluations of the loan portfolio by management. These evaluations consider several factors including, but not limited to, general economic conditions, loan portfolio composition, prior loan loss experience and management's estimation of future potential losses.\nQuarterly reviews of individual loans as well as the loan portfolio as a whole are made by management and the credit department. Management performs extensive procedures in granting and monitoring loans on a continual basis. Further, management believes that the allowance for possible loan losses is adequate to absorb anticipated losses.\nUNITED BANKSHARES, INC. AND SUBSIDIARIES\nSUMMARY OF LOAN LOSS EXPERIENCE--Continued\nThe portion of the allowance for loan losses that is not specifically allocated to individual credits has been apportioned among the separate loan portfolios based on the relative risk of each portfolio.\nUNITED BANKSHARES, INC. FORM 10-K, PART II\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\n(A) - FINANCIAL STATEMENTS REQUIRED BY REGULATION S-X\nYEAR ENDED DECEMBER 31, 1995 UNITED BANKSHARES, INC.\nPage\nReport of Independent Auditors.............................. 47 Consolidated Balance Sheets................................. 48 Consolidated Statements of Income........................... 49 Consolidated Statements of Changes in Shareholders' Equity.. 50 Consolidated Statements of Cash Flows....................... 51 Notes to Consolidated Financial Statements.................. 52\nREPORT OF ERNST & YOUNG LLP INDEPENDENT AUDITORS\nBoard of Directors and Shareholders United Bankshares, Inc. and Subsidiaries\nWe have audited the accompanying consolidated balance sheets of United Bankshares, Inc. and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of income, changes in shareholders' equity and cash flows for each of the three years in the period ended December 31, 1995. 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 United Bankshares, Inc. and subsidiaries at December 31, 1995 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, 1995, in conformity with generally accepted accounting principles.\nAs discussed in Note J to the consolidated financial statements, United Bankshares, Inc. changed its method of accounting for income taxes effective January 1, 1993.\n\/s\/ Ernst & Young LLP\nCharleston, West Virginia February 22, 1996\nCONSOLIDATED BALANCE SHEETS UNITED BANKSHARES, INC. AND SUBSIDIARIES\nSee notes to consolidated financial statements.\nCONSOLIDATED STATEMENTS OF INCOME UNITED BANKSHARES, INC. AND SUBSIDIARIES\nSee notes to consolidated financial statements.\nCONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY\nUNITED BANKSHARES, INC. AND SUBSIDIARIES\nSee notes to consolidated financial statements.\nCONSOLIDATED STATEMENTS OF CASH FLOWS UNITED BANKSHARES, INC. AND SUBSIDIARIES\nSee notes to consolidated financial statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nUNITED BANKSHARES, INC. AND SUBSIDIARIES\nDecember 31, 1995\nNOTE A--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nUnited Bankshares, Inc. is a multi-bank holding company headquartered in Charleston, West Virginia. The principal West Virginia markets of United Bankshares, Inc. and subsidiaries (United) are located in Parkersburg, Charleston, Huntington and Wheeling. United also operates a banking subsidiary in Arlington, Virginia.\nThe accounting and reporting policies of United conform 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 amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. A description of the significant accounting policies is presented below.\nBasis of Presentation: The consolidated financial statements include the - - ---------------------- accounts of United Bankshares, Inc. and its wholly-owned subsidiaries. United considers all of its principal business activities to be bank related. All significant intercompany accounts and transactions have been eliminated in the consolidated financial statements.\nCertain amounts in the prior year's financial statements have been reclassified to conform with the 1995 presentation. The reclassifications had no effect on net income.\nSecurities: Management determines the appropriate classification of securities - - ----------- at the time of purchase. Debt securities that management has the intent and United has the ability to hold to maturity are carried at amortized cost. Securities to be held for indefinite periods of time and all marketable equity securities are classified as available for sale and carried at fair value. Unrealized holding gains and losses on securities classified as available for sale are carried as a separate component of shareholders' equity net of deferred income taxes.\nGains or losses on sales of securities are recognized by the specific identification method and are reported separately in the statements of income.\nLoans: Interest on loans is accrued and credited to operations using methods - - ------ that approximate a level yield on principal amounts outstanding. Loan origination and commitment fees and related direct loan origination costs are deferred and amortized as an adjustment of loan yield over the estimated life of the related loan.\nNOTE A--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - continued\nThe accrual of interest income generally is discontinued when a loan becomes 90 days past due as to principal or interest. When interest accruals are discontinued, unpaid interest recognized in income in the current year is reversed, and interest accrued in prior years is charged to the allowance for loan losses. Management may elect to continue the accrual of interest when the estimated net realizable value of collateral exceeds the principal balance and accrued interest, and the loan is in the process of collection.\nAllowance for Possible Loan Losses: In providing for loan losses, United - - ----------------------------------- considers all significant factors that affect the collectibility of loans including the evaluation of impaired loans under SFAS No. 114. The provision for loan losses charged to operations is based on management's evaluation of individual credits, the past loan loss experience, and other factors which, in management's judgment, deserve recognition in estimating possible loan losses. Such other factors considered by management include growth and composition of the loan portfolio, known deterioration in certain classes of loans or collateral, trends in delinquencies, and current economic conditions.\nBank Premises and Equipment: Bank premises and equipment are stated at cost, - - ---------------------------- less allowances for depreciation and amortization. The provision for depreciation is computed principally by the straight-line method over the estimated useful lives of the respective assets.\nOther Assets: Other real estate owned (OREO), acquired principally through - - ------------- foreclosure on collateral securing loans made by United, is reported at the lower of cost or fair value less costs estimated to sell and is included in other assets. Any write-downs at the date of foreclosure are charged to the allowance for possible loan losses. Expenses incurred in connection with ownership, subsequent declines in estimated net realizable value, and realized gains and losses upon sale of the properties are included in other expenses, or other income, as appropriate.\nUnited maintains an allowance for possible OREO losses. Such allowance is based upon the estimated values of specific properties in consideration of prevailing market conditions.\nIncome Taxes: Deferred income taxes are provided for temporary differences - - ------------- between the financial reporting and tax bases of assets and liabilities at statutory tax rates.\nUnited and its subsidiaries file consolidated federal and state income tax returns. The subsidiaries provide for income taxes on a separate return basis and remit amounts to the parent company deemed to be currently payable.\nStock-Based Compensation: In October 1995, the Financial Accounting Standards - - ------------------------- Board (\"FASB\"), issued Statement No. 123, (SFAS No. 123), \"Accounting for Stock- Based Compensation,\" which is effective for fiscal years beginning after December 15, 1995. SFAS No. 123 defines a fair value based method of accounting for stock-based compensation plans.\nNOTE A--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - continued\nUnder the fair value method, compensation expense is measured based upon the estimated value of the award as of the grant date and is recognized over the service period. SFAS No. 123 provides companies with the option of accounting for stock-based compensation under APB Opinion No. 25, \"Accounting for Stock Issued to Employees,\" or applying the provisions of SFAS No. 123. United has decided to continue to apply the provisions of APB No. 25 to account for stock- based compensation. The disclosure requirements of SFAS No. 123 require entities applying APB Opinion No. 25 to provide pro forma disclosures of net income and earnings per share as if the fair value method of accounting had been applied. United will provide these disclosures beginning in 1996.\nTrust Assets and Income: Assets held in a fiduciary or agency capacity for - - ------------------------ subsidiary bank customers are not included in the balance sheets since such items are not assets of the subsidiary banks. Trust department income is reported on a cash basis. Reporting such income on an accrual basis would not materially affect United's consolidated financial position or its results of operations as reported herein.\nCash Flow Information: For purposes of the statement of cash flows, United - - ---------------------- considers cash and due from banks and federal funds sold as cash and cash equivalents. Interest paid approximated $52,377,000, $43,478,000 and $45,502,000 in 1995, 1994, and 1993, respectively. Income taxes paid approximated $16,769,000, $13,033,000, and $10,363,000 in 1995, 1994, and 1993, respectively. Noncash investing and financing activities were as follows: $103,595,000 of securities were transferred to available for sale from the held to maturity portfolio in 1995; and $6,063,000 of common stock was issued in 1995 in a purchase acquisition.\nInterest Rate Swaps: Interest rate swaps are utilized by United to manage - - -------------------- interest rate exposure. Income or expense derived from these instruments is recognized as an adjustment to interest income of the underlying instrument.\nEarnings Per Common Share: Earnings per common share is computed based on the - - -------------------------- weighted average number of common and common equivalent shares outstanding during the applicable period. Options granted under United's stock option plans are considered common stock equivalents for the purpose of computing earnings per share.\nNOTE B--ACQUISITIONS\nOn October 31, 1995, United merged its Bank First office into Commercial Interim Bank (\"Interim\"), and acquired 100% of the common stock of First Commercial Bank(\"FCB\") of Arlington, Virginia, in a combination cash and common stock exchange accounted for using the purchase method of accounting. United exchanged 202,125 shares of its common stock for all 201,100 of FCB's common stock. United then renamed Interim to First Commercial Bank (\"First Commercial\"). As of the date of acquisition, FCB reported total assets of $76,964,000, total net loans of $41,386,000 and deposits of $50,200,000. The results of operations of FCB, which are not significant, have been included in the consolidated results of operations from the date of acquisition.\nNOTE B--ACQUISITIONS - continued\nThe purchase prices of this acquisition and certain acquisitions made in prior years were allocated to the identifiable tangible and intangible assets acquired based upon their fair values at the acquisition dates. Intangible assets relating to the estimated value of the deposit base of the acquired institutions are being amortized on an accelerated basis over a 7 to 10 year period. The excess of the purchase price over the fair market value of the net assets of the banks acquired (goodwill) is being amortized on a straight-line basis over 15 years. Net intangible assets (deposit base intangibles and goodwill) of approximately $14,998,000 and $10,276,000 at December 31, 1995 and 1994, respectively, are included in other assets. The carrying amount of goodwill is evaluated if facts and circumstances suggest that it may be impaired. If this evaluation indicates that goodwill will not be recoverable, as determined based on the estimated undiscounted cash flows of the entity acquired over the remaining amortization period, the carrying amount of goodwill will be reduced.\nNOTE C--REGULATORY RESTRICTIONS\nThe subsidiary banks are required to maintain average reserve balances with their respective Federal Reserve Bank. The average amount of those reserve balances for the year ended December 31, 1995 was approximately $34,021,000.\nThe primary source of funds for the dividends paid by United Bankshares, Inc. is dividends received from its subsidiary banks. Dividends paid by United's subsidiary national banks are subject to regulatory limitations imposed primarily by the Comptroller of the Currency. Generally, the most restrictive provision requires approval by the Comptroller of the Currency if dividends declared in any year exceed the year's net income, as defined, plus the retained net profits of the two preceding years. Payment of dividends by United's state member bank is regulated by the Federal Reserve System and generally, the prior approval of the Federal Reserve Board is required if the total dividends declared by a state member bank in any calendar year exceeds its net profits, as defined, for that year combined with its retained net profits for the preceding two years. During 1996, the retained net profits available for distribution to United Bankshares, Inc., as dividends without regulatory approval, are approximately $9,814,000, plus net income for the interim periods through the date of declaration.\nUnder Federal Reserve regulation, the banking subsidiaries are also limited as to the amount they may loan to affiliates, including the parent company. Loans from the banking subsidiaries to the parent company are limited to 10% of the banking subsidiaries' capital, and surplus, as defined, or $19,068,000 at December 31, 1995, and must be secured by qualifying collateral.\nNOTE D--SECURITIES AVAILABLE FOR SALE\nEffective January 1, 1994, United adopted FASB Statement 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" (SFAS No. 115). The effect of adopting SFAS No. 115 as of January 1, 1994, was to increase shareholders' equity by $1,284,000 for the net unrealized holding gains on securities classified as available for sale which were previously carried at amortized cost.\nOn November 15, 1995, the FASB staff issued a Special Report, \"A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities.\" In accordance with the provision of that Special Report, United chose to reclassify securities from held to maturity to available for sale. At the date of the transfer the amortized cost of those securities was $103,595,000, and the unrealized gain on those securities was $242,000, which is included in shareholders' equity.\nThe amortized cost and estimated fair value of securities available for sale at December 31, 1995, by contractual maturity are as follows:\nThe table above includes $27,735,000 of mortgage-backed securities at estimated fair value with an amortized cost of $27,766,000. Maturities of mortgage-backed securities are based upon the estimated average life.\nThe amortized cost and estimated fair values of securities available for sale are summarized as follows:\nNOTE D--SECURITIES AVAILABLE FOR SALE - continued\nThe amortized cost and estimated fair values of securities available for sale are summarized as follows:\nGross realized gains and losses from sales of securities available for sale in 1994 were $152,000 and $1,024,000, respectively.\nNOTE E--SECURITIES HELD TO MATURITY\nThe amortized cost and estimated fair values of investment securities are summarized as follows:\nNOTE E--SECURITIES HELD TO MATURITY - continued\nThe amortized cost and estimated fair value of debt securities at December 31, 1995 and 1994 by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because the issuers may have the right to call or prepay obligations with or without call or prepayment penalties.\nThe table above includes $55,389,000 of mortgage-backed securities with an estimated fair value of $55,089,000 at December 31, 1995 and mortgage-backed securities of $97,644,000 with an estimated fair value of $89,839,000 at December 31, 1994. Maturities of the mortgage-backed securities are based upon the estimated average life.\nGross realized gains from sales of securities were $496,000 and gross realized losses were $17,000 in 1993. There were no sales of held to maturity securities during 1994 and 1995.\nThe amortized cost of securities pledged to secure public deposits, securities sold under agreements to repurchase, and for other purposes as required or permitted by law, approximated $176,855,000 and $176,625,000 at December 31, 1995 and 1994, respectively.\nNOTE F--LOANS\nMajor classifications of loans as of December 31 are as follows:\nNOTE F--LOANS - Continued\nAn analysis of the allowance for possible loan losses follows:\nEffective January 1, 1995, United adopted Financial Accounting Standards Board Statement No. 114, \"Accounting by Creditors for Impairment of a Loan,\"(SFAS No. 114), as amended by SFAS No. 118, \"Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures,\" collectively SFAS 114. As a result of applying the new rules prescribed by SFAS No. 114, certain loans are being reported at the present value of their expected future cash flows using 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. At the time of adoption of SFAS No. 114, United had approximately $8,000,000 of loans which were considered impaired in accordance with the guidelines prescribed by SFAS No. 114. The adoption of SFAS No. 114 did not have a material impact on the allowance for loan losses, the provision for possible loan losses or the charge-off policy.\nSFAS 114 does not apply to smaller balance, larger groups of homogeneous loans such as consumer installment, bank card and real estate mortgage loans, which are collectively evaluated for impairment. Impaired loans are therefore primarily business loans, which include commercial loans and income property. Smaller balance populations of business loans, loans with a balance of $100,000 or less, which are not specifically reviewed in accordance with United's normal credit review procedures, are also excluded from the application of SFAS 114.\nConsistent with United's existing method of income recognition for loans, interest receipts on impaired loans, except those classified also as nonaccrual, are recognized as interest income using the accrual method of income recognition. United's method of income recognition for impaired loans that are classified as nonaccrual is to recognize interest income on the cash method of income recognition or apply the cash receipt to principal when the ultimate collectibility of principal is in doubt. The average recorded investment in impaired loans during the year ended December 31, 1995 was approximately $9,545,000. For the year ended December 31, 1995, United recognized interest income on those impaired loans of approximately $412,000, substantially all of which was recognized using the accrual method of income recognition.\nNOTE F--LOANS - Continued\nAt December 31, 1995, the recorded investment in loans that are considered to be impaired under SFAS No. 114 was $8,792,000 (of which $4,934,000 were on a nonaccrual basis). Included in this amount is $4,793,000 of impaired loans for which the related allowance for credit losses is $1,918,000 and $3,999,000 of impaired loans that do not have an allowance for credit losses.\nThe amount of interest income which would have been recorded under the original terms for the above loans was $1,045,000, $346,000 and $793,000 for the years ended December 31, 1995, 1994 and 1993, respectively. Amounts recorded as interest income for these loans totaled $633,000, $1,000 and $183,000 for 1995, 1994 and 1993, respectively.\nUnited has commercial real estate loans, including owner occupied, income producing real estate and land development loans, of approximately $328,226,000 and $300,679,000 as of December 31, 1995 and 1994, respectively. The loans are primarily secured by real estate located in West Virginia, Southeastern Ohio, and Virginia. The loans were originated by United's subsidiary banks using underwriting standards as set forth by management. United's loan administration policies are focused on the risk characteristics of the loan portfolio, including commercial real estate loans, in terms of loan approval and credit quality. It is the opinion of management that these loans do not pose any unusual risks and that adequate consideration has been given to the above loans in establishing the allowance for loan losses.\nUnited's subsidiary banks have made loans, in the normal course of business, to the directors and officers of United and its subsidiaries, and to their associates. Such related party loans were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons and did not involve more than normal risk of collectibility. The aggregate dollar amount of these loans was $55,919,000 and $57,310,000 at December 31, 1995 and 1994, respectively. During 1995, $41,582,000 of new loans were made and repayments totaled $39,615,000.\nNOTE G--BANK PREMISES AND EQUIPMENT AND LEASES\nBank premises and equipment are summarized as follows:\nNOTE G--BANK PREMISES AND EQUIPMENT AND LEASES - continued\nUnited and certain banking subsidiaries have entered into various noncancelable operating leases. These noncancelable operating leases are subject to renewal options under various terms and some leases provide for periodic rate adjustments based on cost-of-living index changes. Rent expense for noncancelable operating leases approximated $1,721,000, $1,746,000 and $1,620,000 for the years ended December 31, 1995, 1994, and 1993, respectively.\nFuture minimum payments, by year and in the aggregate, under noncancelable operating leases with initial or remaining terms of one year or more, for years subsequent to December 31, 1995 consisted of the following:\nUnited owns an office tower facility, known as \"United Square.\" United occupies a portion of this building and leases the remainder under agreements expiring principally in 1998. The principal tenant has an option to renew its lease agreement on a year-to-year basis for an additional period of five years beyond the expiration date. United Square, including the portion under such operating lease, is included in bank premises as follows:\nRental income under such operating leases approximated $892,000, $986,000, and $1,341,000 for the years ended December 31, 1995, 1994, and 1993, respectively. As of December 31, 1995, future minimum lease payments receivable under noncancelable operating leases aggregated $1,426,000, of which $728,000 is due in 1996.\nNOTE H--DEPOSITS\nThe book value of deposits consisted of the following:\nNOTE I--FEDERAL HOME LOAN BANK BORROWINGS\nUnited's lead subsidiary, United National Bank (UNB), is a member of the Federal Home Loan Bank of Pittsburgh, (the FHLB). As of December 31, 1995, UNB owns 57,525 shares of the FHLB stock at par value. Such stock ownership entitles UNB to its pro rata share of the quarterly dividends declared by the FHLB and provides an additional source of short-term and long-term funding, in the form of collateralized advances. Based upon the shares presently held by UNB, as well as its Qualifying Collateral and Mortgage Assets Ratio, as defined in the Master Agreement with the FHLB (the Agreement), at December 31, 1995, UNB is entitled to receive approximately $405,091,000 in collateralized advances from the FHLB at prevailing interest rates, subject to satisfying the Capital Stock Requirement provisions of the Agreement, as defined.\nUNB also has various unused lines of credit available from certain of its correspondent banks in the aggregate amount of $36,000,000. These lines of credit, which bear interest at prevailing market rates, permit UNB to borrow funds in the overnight market, and are renewable annually provided that UNB does not experience a material adverse change in its financial position or results of operations.\nApproximately $33,900,000 of FHLB advances with an interest rate of 5.65% are scheduled to mature in 1996.\nNOTE J--INCOME TAXES\nEffective January 1, 1993, United 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 the change increased net income by $1,329,000 or $0.11 per share.\nThe income tax provisions included in the consolidated statements of income are summarized as follows:\nNOTE J--INCOME TAXES - continued\nThe following is a reconciliation of income tax expense to the amount computed by applying the statutory federal income tax rate to income before income taxes:\nFederal income tax expense (benefit) applicable to securities transactions approximated ($305,000) and $168,000 in 1994 and 1993, respectively. There were no securities transactions in 1995.\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 United's deferred tax assets and liabilities as of December 31, 1995 and 1994 are as follows:\nNOTE K--EMPLOYEE BENEFIT PLANS\nUnited has a defined benefit retirement plan covering substantially all employees. The benefits are based on years of service and the average of the employee's highest five consecutive plan years of basic compensation paid during the ten plan years preceding the date of determination. United's funding policy is to contribute annually the maximum amount that can be deducted for federal income tax purposes. Contributions are intended to provide not only for benefits attributed to service to date, but also for those expected to be earned in the future.\nThe following table sets forth the funded status of United's defined benefit plan and amounts recognized in the respective consolidated balance sheets:\nNet periodic pension cost included the following components:\nNOTE K--EMPLOYEE BENEFIT PLANS - continued\nThe changes in unrecognized net gain, actual (return)\/loss on plan assets and net amortization and deferral are primarily due to differences in the expected return and the actual return or loss on plan assets and a decrease in the weighted average discount rate from 8.5% in 1994 to 7.5% in 1995.\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 approximately 7.5% and 4.5% at December 31, 1995 and 8.5% and 4.5% at December 31, 1994. The weighted average expected long-term rate of return on plan assets was 9.0% for the years ended December 31, 1995, 1994 and 1993.\nThe United Savings and Stock Investment Plan (the Plan) is a deferred compensation plan under Section 401(k) of the Internal Revenue Code. All employees who complete one year of service are eligible to participate in the Plan. Each participant may contribute from 1% to 10% of pre-tax earnings to his\/her account which may be invested in any of four investment options chosen by the employee. United matches 100% of the first 2% of salary deferred and 25% of the next 2% of salary deferred with United common stock. Vesting is 100% for employee deferrals and the United match at the time the employee makes his\/her deferral. United's expense relating to the Plan approximated $297,000, $336,000 and $280,000 in 1995, 1994, and 1993, respectively.\nThe assets of United's defined benefit plan and 401(k) Plan each include investments in United common stock. At December 31, 1995, the combined plan assets included 161,999 shares of United common stock with a market value of approximately $4,738,000.\nUnited has certain deferred compensation plans covering various key employees. Periodic charges are made to operations so that the present value of the liability due each employee is fully recorded as of the date of their retirement. Amounts charged to expense have not been significant in any year.\nDuring 1988, United formed the 1988 Incentive Stock Option Plan for key employees. Stock option grants are awarded at the fair market value of United's common stock on the date of the grant. The options are immediately exercisable and have a maximum duration of 10 years. Options need not be exercised in the order granted. The final 20,000 options under this plan were granted in January 1992 at the then current market price of $13.25.\nDuring 1991, United formed the 1991 Incentive Stock Option Plan for key employees. Five hundred thousand (500,000) shares were allocated to the plan with no more than 100,000 options to be awarded each year. Stock option grants were awarded at the fair market value of United's common stock on the date of the grant. The options may be exercised in accordance with a three year vesting schedule and have a maximum duration of 10 years. Options need not be exercised in the order granted. The final 100,000 options under this plan were granted in November 1995 at the then current market price of $30.00.\nNOTE K--EMPLOYEE BENEFIT PLANS - continued\nThe following is a summary of the 1988 Incentive Stock Option Plan activity:\nThe following is a summary of the 1991 Incentive Stock Option Plan activity:\nUnited provides postemployment and postretirement benefits for certain employees at subsidiaries acquired in prior years. United accounts for such costs as expense when paid. United's analysis indicates that accounting for such costs when paid does not produce results materially different from those which would result if such costs were accrued during the period of employee service. United does not anticipate providing postemployment or postretirement benefits to its currently active employees after employment or retirement except on a fully contributory basis.\nNOTE L--COMMITMENTS AND CONTINGENT LIABILITIES\nUnited 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 alter its own exposure to fluctuations in interest rates. These financial instruments include loan commitments, standby letters of credit and interest rate swap agreements. The instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the financial statements.\nUnited's maximum exposure to credit loss in the event of nonperformance by the counterparty to the financial instrument for the loan commitments and standby letters of credit is represented by the contractual amount of those instruments. United uses the same policies in making commitments and conditional obligations as it does for on-balance sheet instruments.\nNOTE L--COMMITMENTS AND CONTINGENT LIABILITIES - continued\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 the payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if deemed necessary upon the extension of credit, is based on management's credit evaluation of the counterparty. United had approximately $262,836,000 and $244,975,000 of loan commitments outstanding as of December 31, 1995 and 1994, respectively, with substantially all of them expiring within one year.\nStandby letters of credit are agreements used by United's customers as a means of improving their credit standing in their dealings with others. Under these agreements, United guarantees certain financial commitments of its customers. United has issued standby letters of credit of $16,533,000 and $15,022,000 as of December 31, 1995 and 1994, respectively.\nManagement does not anticipate any material losses as a result of these loan commitments, standby letters of credit and interest rate swap agreements.\nIn 1994 United entered into an interest rate swap agreement to manage its interest rate exposure. The interest rate swap transaction involves the exchange of a floating rate payment based on the one month London inter-bank offered rate (LIBOR) for a fixed rate receipt based on the U. S. three year treasury note. The net pay and receive amount is calculated on an underlying notional amount without the exchange of the underlying principal amount. The interest rate swap subjects United to market risk associated with changes in interest rates, as well as the risk that the counterparty will fail to perform. Only the interest payments are exchanged, and therefore, cash requirements and exposure to credit risk are significantly less than the notional amount.\nThe notional amount shown below represents an agreed upon amount on which calculations of amounts to be exchanged are based. It does not represent direct credit exposure. United's credit exposure is limited to the net difference between the calculated pay and receive amounts on the transaction which is netted monthly.\nThe swap, which matures in 1997, is summarized as follows:\nNOTE L--COMMITMENTS AND CONTINGENT LIABILITIES - continued\nDuring 1995 and 1994 the interest rate swap reduced interest income by $787,000 and $1,000, respectively. At December 31, 1995, the estimated unrealized loss on the swap, which may reduce interest income in future periods, approximated $738,000. A key assumption utilized in computing the unrealized loss is that interest rates will remain at the December 31, 1995 level throughout the term of the agreement.\nIn the normal course of business, United and its subsidiaries are currently involved in various legal proceedings. Management is vigorously pursuing all its legal and factual defenses and, after consultation with legal counsel, believes that all such litigation will be resolved with no material effect on its financial position or results of operations.\nNOTE M--OTHER INCOME AND EXPENSE\nThe following items of other income and expense exceeded one percent of total revenue for the periods indicated:\nNOTE N--FAIR VALUES OF FINANCIAL INSTRUMENTS\nThe following methods and assumptions were used by United in estimating its fair value disclosures for financial instruments:\nCash and Cash Equivalents: The carrying amounts reported in the balance sheet - - -------------------------- for cash and cash equivalents approximate those assets' fair values.\nSecurities: The estimated fair values of securities are based on quoted market - - ----------- prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments.\nLoans: The estimated fair values of variable-rate loans that reprice frequently - - ------ with no significant change in credit risk are based on carrying values. The fair values of certain mortgage loans (e.g., one-to-four family residential), credit card loans, and other consumer loans are based on quoted market prices of similar loans sold in conjunction with securitization transactions, adjusted for differences in loan\nNOTE N--FAIR VALUES OF FINANCIAL INSTRUMENTS - continued\ncharacteristics. The fair values of other loans (e.g., commercial real state and rental property mortgage loans, commercial and industrial loans, financial institution loans, and agricultural loans) are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit worthiness.\nOff-Balance-Sheet Instruments: Fair values of United's loan commitments are - - ------------------------------ based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties' credit standing. The estimated fair values of these commitments approximate their carrying values. The fair value of the interest rate swap agreement is calculated with pricing models using current rate assumptions. A key assumption utilized in computing the estimated fair value of the interest rate swap agreement is that interest rates will remain at the December 31, 1995 level throughout the term of the agreement.\nDeposits: The fair values of demand deposits (e.g. interest and non-interest - - --------- checking, regular savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e. their carrying amounts). The carrying amounts of variable-rate, fixed-term money market accounts and certificates of deposit approximate their fair values at the reporting date. Fair values of fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.\nShort-term Borrowings: The carrying amounts of federal funds purchased, - - ---------------------- borrowings under repurchase agreements, and other short-term borrowings approximate their fair values.\nFederal Home Loan Bank Borrowings: The fair values of United's Federal Home - - ---------------------------------- Loan Bank borrowings are estimated using discounted cash flow analyses, based on United's current incremental borrowing rates for similar types of borrowing arrangements. The carrying value of federal Home Loan Bank borrowings approximates their fair value.\nThe estimated fair values of United's financial instruments are summarized below:\nNOTE O - UNITED BANKSHARES, INC. (PARENT COMPANY ONLY) FINANCIAL INFORMATION\nCondensed Balance Sheets\nCondensed Statements of Income\nNOTE O - UNITED BANKSHARES, INC. (PARENT COMPANY ONLY) FINANCIAL INFORMATION - CONTINUED\nCondensed Statements of Cash Flows\nNOTE P - QUARTERLY FINANCIAL DATA (UNAUDITED)\nQuarterly financial data for 1995 and 1994 is summarized below (dollars in thousands except for per share data):\nNOTE Q--PENDING ACQUISITION (UNAUDITED)\nUnited has entered into an agreement with Eagle Bancorp, Inc., Charleston, West Virginia (\"Eagle\") to exchange 1.15 shares of United common stock for each of the 2,729,468 common shares of Eagle. The transaction, valued at approximately $95,000,000 based on recent market prices of United's stock, will be accounted for using the pooling of interests method of accounting. It is anticipated that the proposed acquisition will be consummated during the second quarter of 1996.\nNOTE Q--PENDING ACQUISITION (UNAUDITED) - continued\nThe following represents selected pro forma financial information regarding the effects of the transaction as though United and Eagle had been combined during 1995, 1994 and 1993:\nThe data set forth above is not necessarily indicative of the results of operations or the combined financial position of United that would have resulted had the merger been consummated at the beginning of the applicable periods indicated, nor is it necessarily indicative of the results of operations in future periods or the future financial position of the combined entities.\nUNITED BANKSHARES, INC. FORM 10-K, PART II\nItem 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES\nThis item is omitted since it is not applicable.\nUNITED BANKSHARES, INC. FORM 10-K, PART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe following discussion satisfies the reporting requirements of Items 10 through 13.\nPrincipal Shareholders of United - - --------------------------------\nThe following table lists each shareholder of United who is the beneficial owner of more than 5% of United's common stock, the only class of stock outstanding, as of December 31, 1995.\n(1) UNB is a wholly-owned subsidiary of United and its Trust Department holds in fiduciary or agency capacity 910,895 shares of United's stock. The voting and investment authority for the shares held by the Trust Department is exercised by UNB's Board of Directors.\nBoard of Directors - - ------------------\nThe Bylaws of United provide that its Board of Directors shall consist of not fewer than five nor more than thirty-five persons, as may be determined, from time to time, by resolution adopted by the shareholders or by a majority of the Board of Directors. The twenty-three (23) persons listed below have been elected or appointed to serve as directors of United until the 1996 Annual Meeting of shareholders and until their successors are elected and qualified.\nEach director has served continuously to date as a director beginning in the indicated year.\nDirectors have sole voting and investment authority of directly owned shares. The total of directly owned shares also includes stock options granted to executive officers pursuant to incentive stock option plans. For four of the directors who are executive officers, direct ownership includes options to purchase shares as follows: Richard Adams, 84,714 shares, Douglass H. Adams, 9,066 shares, Thomas A. McPherson, 20,320 shares and I. N. Smith, Jr., 12,506 shares. The options to purchase shares included in the direct ownership of all executive officers as a group total 245,554. For the executive offices held by them, see the section of this document captioned \"Executive Officers.\"\nIndirect shares for each individual director include those owned by spouses and immediate family members, shares held in any trust of which a director is a beneficiary, and shares held by a corporation which the director controls. These shares do not include the Trust Shares referred to in a following footnote.\nRICHARD M. ADAMS, who is Chairman and Chief Executive Officer of both United and UNB, became a director of United in 1984. Mr. Adams is 49 years old. He owns 235,611 shares of United directly and 91,670 shares indirectly, the total of which represents 2.73 percent of the total outstanding shares of United. Of the 90,861 shares indirectly owned by Mr. Adams, 25,590 shares are in the Stevenson Trust over which he exercises voting power, 35,414 shares are owned by the members of his immediate family and 30,666 shares are held in two family trusts over which he exercises voting power but no investment authority. Messrs. Richard M. Adams and Douglass H. Adams are brothers.\nI. N. SMITH, JR., who is President of United, Vice Chairman of UNB, and former President of UNB, became a director in 1986. Mr. Smith is 63 years old. He owns 16,812 shares of United directly and 220,184 shares indirectly, the total of which represents 1.98 percent of the total outstanding shares of United. Of the 220,184 shares indirectly owned beneficially by Mr. Smith, 14,700 shares are owned by members of his immediate family and 4,000 shares are owned by the mother of Mr. Smith over which he has power of attorney. The following shares owned of record by others may be deemed to be owned by Mr. Smith under the rules and regulations of the Securities and Exchange Commission: Kanawha City Company 15,000 shares; Kanawha Company 56,000 shares; Roane Land Company 484 shares; Roxalana Land Company 75,000 shares; and West Virginia Coal Land Company 55,000 shares.\nDOUGLASS H. ADAMS, who is Executive Vice-President of United, became a director in 1988. Mr. Adams is 57 years old. He owns 43,438 shares of United directly and 2,551 shares indirectly, the total of which represents less than one percent of the total outstanding shares of United. Messrs. Richard M. Adams and Douglass H. Adams are brothers.\nROBERT G. ASTORG, who is a CPA and Managing Director of IDS Tax and Business Services, a financial consultant and tax service, became director in 1991. Mr. Astorg is 52 years old. He owns 12,313 shares of United directly and 827 shares indirectly, the total of which represents less than one percent of the total outstanding shares of United. Mr. Astorg is a former Partner of Astorg and Altizer, CPAs.\nTHOMAS J. BLAIR, III, who is President and Chief Executive Officer of Kelley, Gidley, Blair & Wolfe, Inc., former Chairman of the Board of UNB- Central, Heritage and Weston National, became a director in 1988. Mr. Blair is 62 years old. He owns 135,860 shares of United directly and 7,100 shares indirectly, the total of which represents 1.19 percent of the total outstanding shares of United. Mr. Blair is a former president of the McDowell County Water Company.\nHARRY L. BUCH, who is an Attorney at Law, and Partner with Bailey, Riley, Buch & Harman, became a director in 1990. Mr. Buch is 65 years old. He owns 6,063 shares of United directly which represents less than one percent of the total outstanding shares of United. Mr. Buch is a former Partner with Gompers, Buch, McCarthy & McLure.\nR. TERRY BUTCHER, who is an Attorney at Law, and Partner with Butcher & Butcher, became a director in 1988. Mr. Butcher is 48 years old. He owns 23,500 shares of United directly and 500 shares indirectly, the total of which represents less than one percent of the total outstanding shares of United.\nJOHN W. DUDLEY, who is President of J. W. Dudley Sons & Company, a retail business, became a director in 1986. Mr Dudley is 49 years old. He owns 8,703 shares of United directly which represents less than one percent of the total outstanding shares of United.\nH. SMOOT FAHLGREN, who is Chairman and former Chief Executive Officer of Fahlgren, Inc., became a director in 1984. Mr. Fahlgren is 65 years old. He owns 135,974 shares of United directly which represents 1.13 percent of the total outstanding shares of United. Mr. Fahlgren is Mr. Graff's father-in-law.\nTHEODORE J. GEORGELAS, who is Chairman of the Board of First Commercial Bank, and President of Georgelas and Sons, Inc., a commercial real estate development company, became a director in 1990. Mr. Georgelas is 49 years old. He directly owns 49,666 shares of United which represents less than one percent of the total outstanding shares of United.\nC. E. GOODWIN, who is an Attorney at Law and Counsel with Goodwin & Goodwin, became a director in 1985. Mr. Goodwin is 85 years old. He owns 15,620 shares of United directly and 1,272 shares indirectly, the total of which represents less than one percent of the total outstanding shares of United.\nF.T. GRAFF, JR., who is a practicing attorney and partner of Bowles Rice McDavid Graff and Love, became a director of United in 1984. Mr. Graff is 56 years old. He owns 2,000 shares of United directly and 6,000 shares indirectly, the total of which represents less than one percent of the total outstanding shares of United. The indirectly owned shares are held by a bank in a trustee account for Mr. Graff over which he exercises voting and dispositive power. Mr. Graff is Mr. Fahlgren's son-in-law.\nLEONARD A. HARVEY, who is a former Secretary of the West Virginia Department of Commerce, Labor, and Environmental Resources, became a director of United in 1990. Mr. Harvey is 69 years old. He owns 29,659 shares of United directly and 859 shares indirectly, the total of which represents less than one percent of the total outstanding shares of United.\nANDREW J. HOUVOURAS, who is President of A&L Industries, an investment company, became a director of United in 1985. Mr. Houvouras is 76 years old. He owns 439 shares of United directly and 27,745 shares indirectly, the total of which represents less than one percent of the total outstanding shares of United. The indirect shares are owned by a company in which Mr. Houvouras is a partner.\nRUSSELL L. ISAACS, who is the owner of Russell L. Isaacs and Company, a consulting firm, became a director of United in 1984. Mr. Isaacs is 63 years old. He owns 20,958 shares of United directly which represents less than one percent of the total outstanding shares of United.\nROBERT P. MCLEAN, who is the President of Stanaford Acres, Inc. and Vice- President of Sigmund-McLean, Inc. became a director of United in 1992. Mr. McLean is 65 years old. He owns 4,633 shares of United directly and 1,399 shares indirectly, the total of which represents less than one percent of the total outstanding shares of United.\nTHOMAS A. MCPHERSON, who is an Executive Vice President of United and the former President and Chief Executive Officer of UNB-C, became a director of United in 1988. Mr. McPherson is 59 years old. He owns 68,756 shares of United directly which represents less than one percent of the total outstanding shares of United.\nG. OGDEN NUTTING, who is the former Chairman of the Board of UNB-N and President of The Ogden Newspapers, Inc., became a director of United in 1986. Mr. Nutting is 60 years old. He owns 326,328 shares of United indirectly which represents 2.72 percent of the total outstanding shares of United. The voting and investment authority for the indirectly owned shares of Mr. Nutting are as follows: he has beneficial ownership, through shared investment or voting authority of 326,328 shares consisting of 20,952 shares held by Mr. Nutting as co-trustee, and 277,376 shares registered in the name of The Ogden Newspapers, Inc. of which Mr. Nutting is President. He is also a settlor and sole beneficiary of a trust which contains 28,000 shares.\nWILLIAM C. PITT, III, who is a hotel and resort developer, became a director of United in 1987. Mr. Pitt is 51 years old. He owns 5,000 shares of United directly which represents less than one percent of the total outstanding shares of United.\nCHARLES E. STEALEY, who is a private consultant and former Assistant Vice President and Director of Administration of Olsten Corporation, became a director of United in 1986. Mr. Stealey is 55 years old. He owns 30,668 shares of United directly and 48,362 shares indirectly, the total of which represents less than one percent of the total outstanding shares of United. Mr. Stealey's mother holds 7,354 of the indirect shares over which Mr. Stealey has power of attorney and the other 41,008 indirect shares are held in a trustee account for Mr. Stealey over which he exercises voting and investment authority.\nWARREN A. THORNHILL, III, who is an Attorney at Law, former Chairman of the Board of Summit Holding Corporation and Raleigh County National Bank and UNBS, became a director of United in 1992. Mr. Thornhill is 67 years old. He owns 131,997 shares of United directly and 92,730 shares indirectly, the total of which represents 1.87 percent of the total shares outstanding of United. Mr. Thornhill's indirectly owned shares are owned by the members of his immediate family.\nHAROLD L. WILKES, who is President of Little General Stores, Inc., a convenience store chain, became a director of United in 1993. Mr. Wilkes is 55 years old. He directly owns 1,977 shares of United which represents less than one percent of the total outstanding shares of United.\nJAMES W. WORD, JR., who is President of Beckley Loan Company and Vice- President of Beckley Loan and Industrial Corporation became a director of United in 1992. He is 71 years old. He owns 33,680 shares of United directly and 26,337 shares indirectly, the total of which represents less than one percent of the total outstanding shares of United. Mr. Word's indirectly owned shares are owned by the members of his immediate family.\nAll directors and executive officers of United as a group, 28 persons, own 1,182,119 shares of United directly and 1,771,161 shares indirectly, the total of which represents 24.62 percent of the total shares outstanding for United. Included in indirectly owned shares is 910,895 shares of United common stock held by UNB's Trust Department serving in a fiduciary or agency capacity (the \"Trust Shares\"). The voting and investment authority for the Trust Shares held by the Trust Department is exercised by UNB's Board of Directors. The members of UNB's Board of Directors who are also directors or executive officers of United are: Richard M. Adams, I. N. Smith, Jr., and Gary L. Ellis.\nEffective November 29, 1995, Joseph N. Gompers resigned from the Board of Directors with no disagreements with management. Leonard A. Harvey and Thomas A. McPherson have chosen not to stand for re-election for the 1996 Annual Meeting. It is anticipated that Mr. Harvey will be named Director Emeritus.\nMeetings and Committees of the Board of Directors - - -------------------------------------------------\nThe Board of Directors of United met four times during 1995. The Board reviews management reports and general corporate policy. During the calendar year ended December 31, 1995, each director of United attended more than 75% of the total number of meetings of the Board and Board Committees on which he or she served during the period he or she served as a director, except for Harry L. Buch, John W. Dudley, Joseph N. Gompers and Andrew J. Houvouras.\nThe Board has three standing committees--the Executive, Audit and Compensation Committees. The Audit Committee met four times in 1995 to review the quarterly reports of internal audit, all reports of external auditors, and all reports of examination by federal and state bank regulatory authorities. This committee consisted of: Robert G. Astorg, Chairman, R. Terry Butcher, C. E. Goodwin and James W. Word, Jr.\nThe Executive Committee met five times during 1995. The Executive Committee may exercise the power of the Board of Directors between meetings of the full Board of Directors or upon the call of the Chairman, as directed by the Board and consistent with the provisions of West Virginia corporate law and United's articles of incorporation and bylaws. The committee consisted, during 1995, of Richard M. Adams, Chairman, I. N. Smith, Jr., Thomas J. Blair, III, Harry L. Buch, H. Smoot Fahlgren, Theodore J. Georgelas, Leonard A. Harvey, Russell L. Isaacs, G. Ogden Nutting, William C. Pitt, III, Warren A. Thornhill, III and F.T. Graff, Jr., who also serves as secretary for the Executive Committee.\nThe Compensation Committee met one time during 1995. The Compensation Committee makes recommendations regarding officer compensation and budgetary matters to the Board of Directors. The committee consisted of the same members as served on the Executive Committee except for Messrs. R. Adams and Smith. Mr. Isaacs is chairman of the Compensation Committee.\nCompensation Committee Interlocks and Insider Participation - - -----------------------------------------------------------\nF.T. Graff, Jr., a member of the Board of Directors of United and the Board's Compensation Committee, is a partner in the law firm of Bowles Rice McDavid Graff & Love in Charleston, West Virginia. Bowles Rice McDavid Graff & Love rendered legal services to United and UNB during 1995 and it is expected that the firm will continue to render services to both in the future. The fees paid to Bowles Rice McDavid Graff & Love represent less than 5% of that firm's revenues for 1995.\nCompensation of Directors - - -------------------------\nDirectors other than executive officers of United receive a retainer of $550 per month without regard to meeting attendance. In addition, each outside director receives a fee of $550 for each United Board Committee attended except for Mr. Isaacs. Mr. Isaacs, as chairman of the Compensation Committee, receives an additional $550 for each committee meeting attended. Mr. Astorg, as chairman of the Audit Committee, receives an additional retainer payment of $550 per month without regard to meeting attendance.\nSUMMARY COMPENSATION TABLE\nThe following table is a summary of certain information concerning the compensation awarded or paid to, or earned by, the Company's chief executive officer and each of the Company's other four most highly compensated executive officers during the last three fiscal years.\n(1) All reported amounts indicate annual amounts accrued under the Company's 401(K) Plan.\n(2) Included are $9,240 representing the Company's matching contribution to the Company's 401(K) Plan and $26,424 accrued under a supplemental executive retirement plan.\n(3) The aggregate value of all perquisites and other personal benefits did not exceed either $50,000 or 10% of the total annual salary and bonus reported for the named executive officers; therefore, no disclosure has been made.\nSTOCK OPTION GRANTS TABLE\nThe following table sets forth information concerning individual grants of options to purchase the Company's Common Stock made to the named executives in 1995.\n(1) Granted from the 1991 Incentive Stock Option Plan. The option exercise price is the market value of United's stock at the date the option was granted. All options granted under this plan are exercisable in accordance with a three year vesting schedule: 50% after the first year; 75% after the second year and 100% after three years.\nSTOCK OPTION EXERCISES AND YEAR-END VALUE TABLE\nThe following table sets forth certain information regarding individual exercises of stock options during 1995 by each of the named executives.\nExecutive Officers - - ------------------\nSet forth below are the executive officers of United and relations that exist with affiliates and others for the past five years.\nCertain Reports - - ---------------\nSection 16(a) of the Securities and Exchange Act of 1934 requires United's directors and executive officers and persons who beneficially own more than ten percent of United's stock (currently, to the best of United's knowledge, there are no such persons) to file initial forms of beneficial ownership (Form 3), statements of changes in beneficial ownership (Form 4) and annual statements of beneficial ownership (Form 5) with the Securities and Exchange Commission (\"SEC\"). Persons filing such reports are required by SEC regulations to furnish United with copies of all such beneficial ownership statements filed under section 16(a) of the Exchange Act.\nBased solely on a review of such reports and representations from United directors and executive officers, United believes that during 1995 all such reports were filed on a timely basis, with one exception: Director Leonard A. Harvey did not file a Form 4 to report the purchase of 2,000 shares of common stock in November 1995. Mr. Harvey reported the transaction on a subsequent Form 4 in January of 1996.\nUnited's contributions to the Pension Plan, a defined benefit plan, are not and cannot be calculated separately for specific participants by the Pension Plan's actuary. No company contributions to the Pension Plan are included in the amounts shown as aggregate or contingent forms of remuneration. See the section captioned, Employee Benefit Plans, on the pages following.\nAs of December 31, 1995, the persons named in the table above had compiled and credited service under the Pension Plan as follows: R. Adams 27 years; I.N. Smith 36 years; G. Ellis 14 years; T. McPherson 33 years; S. Wilson 24 years.\nExecutive officers above are eligible to participate in the 401(K) Plan, a defined contribution plan. Discretionary contributions made by the individuals are matched in accordance with provisions of the plan as described under the section entitled Employee Benefit Plans. Discretionary contributions, made from the participant's regular pay, are reflected in Cash Compensation above. United's matching contributions are not reflected in Cash Compensation. Both the individual contributions and matching contributions are tax deferred income.\nOfficer Employment Contracts - - ----------------------------\nRichard M. Adams, Chairman and Chief Executive Officer of United and UNB entered into an employment contract with United effective April 11, 1986. This contract was amended in 1989, again in January and November 1991, April 1992 and again in November 1993. This most recent amendment also served to initiate a new five year term. Under the contract Mr. Adams is required to devote his full-time energies to performing his duties as Chairman and CEO on behalf of United and UNB. The contract provides for a base compensation of $300,000 and additional benefits consistent with the office. This base compensation may be increased but not decreased. If the contract is terminated by Adams for change in control, or for any reason other than mutual consent or criminal misconduct, Mr. Adams, or his family or estate, is entitled to his base salary for the remainder of the contract term.\nOn July 27, 1990, United also entered into a Supplemental Retirement Plan with Mr. Adams. This plan provides for an annual supplemental retirement benefit upon his reaching age 65 or upon the later termination of his employment with United. The annual benefit will be equal to seventy percent of the average of Mr. Adams' three highest base salaries during his employment with United, reduced by benefits. The plan also provides for reduced benefits for early retirement after age 62 as well as payments to his spouse in the event of his death.\nUnited and UNB entered into an employment agreement with I. N. Smith, Jr., President of United and Vice-Chairman of UNB, on December 17, 1985. The term of the agreement extends until Mr. Smith reaches the age of 75. Until Smith becomes 65, he will be employed full-time by United as an executive officer and will receive an annual salary of no less than $115,000. Upon reaching the age of 65 and until he reaches the age of 75, Mr. Smith shall render such consulting and advisory services as United may request, and shall receive for such services an annual fee of $36,000 from age 65 until he reaches age 70, and $30,000\nthereafter. The agreement also contains provisions which address the issues of disability, early retirement and the death of Mr. Smith. All of these events carry reduced payment provisions. In addition, until Mr. Smith reaches age 65, he has agreed to serve as, and United has agreed to use its best efforts to nominate and elect him, a director of United and UNB.\nOhio Valley National Bank, (now a part of UNB as a result of its merger with United) entered into a Salary Contribution Agreement with Douglass H. Adams, Executive Vice President of United, on June 13, 1985. This agreement provides at age 65 for an annual supplemental retirement equal to $30,000 for life or fifteen years certain. This future liability is being funded with life insurance. Provision is made for an early retirement benefit beginning at age 60 at a reduced percentage of the normal benefit. The agreement also provides for payment to beneficiaries in the event of his death.\nChange of Control Agreements - - ----------------------------\nIn March of 1994, United entered into agreements with G. Ellis, S. Wilson, T. McPherson, J. Hayhurst and J. Wilson to encourage those executive officers not to terminate their employment with United because of the possibility that United might be acquired by another entity. The Board of Directors determined that such an arrangement was appropriate, especially in view of the recent entry of large regional bank holding companies into West Virginia. The agreements were not undertaken in the belief that a change of control of United was imminent.\nGenerally, the agreements provide severance compensation to those officers if their employment should end under certain specified conditions after a change of control of United. Compensation is paid upon any involuntary termination following a change of control unless the officer is terminated for cause. In addition, compensation will be paid after a change of control if the officer voluntarily terminates employment because of a decrease in the total amount of the officer's base salary below the level in effect on the date of consummation of the change of control, without the officer's consent; a material reduction in the importance of the officer's job responsibilities without the officer's consent; geographical relocation of the officer without consent to an office more than fifty (50) miles from the officer's location at the time of a change of control; failure by United to obtain assumption of the contract by its successor or any termination of employment within thirty-six (36) months after consummation of a change of control which is effected for any reason other than good cause.\nUnder the agreements, a change of control is deemed to occur in the event of a change of ownership of United which must be reported to the Securities and Exchange Commission as a change of control, including but not limited to the acquisition by any \"person\" (as such term is used in Sections 13(d) and 14(d) of the Securities and Exchange Act of 1934\n(the \"Exchange Act\")) of direct or indirect \"beneficial ownership\" (as defined by Rule 13d-3 under the Exchange Act) of twenty-five percent (25%) or more of the combined voting power of United's then outstanding securities, or the failure during any period of two (2) consecutive years of individuals who at the beginning of such period constitute the Board 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 (2\/3) of the directors at the beginning of the period.\nUnder the agreements, severance benefits include: (a) cash payment equal to the officers monthly base salary in effect on either (i) the date of termination; (ii) the date immediately preceding the change of control, whichever is higher, multiplied by the number of full months between the date of termination and the date that is thirty-six (36) months after the date of consummation of the change of control; (b) payment of cash incentive award, if any, under United's Incentive Plan; (c) continuing participation in employee benefit plans and programs such as retirement, disability and medical insurance for a period of thirty-six (36) months following the date of termination.\nSuccession Management Stock Bonus Plan - - --------------------------------------\nIn April 1989, the Executive Committee, which at that time also served as the Compensation Committee, approved a management stock bonus plan. The purpose of the plan is to retain certain key \"junior\" officers. The plan is intended to encourage these individuals to stay with the company and to continue to develop their potential for future management roles. The plan provides for grants of the right to receive up to 500 shares per year, for five years, per officer. The shares granted will be held in trust and the recipients have no ownership rights until the shares are distributed. All granted stock was distributed to the grantees at the beginning of 1994. In certain limited circumstances distribution could have been earlier, such as, in the case of disability or death. Shares have been purchased by United and are held in a trust account for this plan. None of the individuals included in this plan were executive officers of United. No grants have been made since 1990.\nIncentive Stock Option Plan - - ---------------------------\nIn February, 1988, the Board adopted an incentive stock option (\"ISO\") plan which was approved by United's shareholders at the 1988 annual meeting. The ISO plan was conceived by United's Board in order to retain and motivate key management executives of United. The class of eligible employees is executive officers of United and its subsidiaries owning less than 10% of United's issued and outstanding stock. The Executive Committee of United, in its sole discretion, will award stock options to eligible employees, will determine the conditions for exercise, and will administer the ISO plan generally. One hundred\nthousand (100,000) shares were allocated to the plan, with options for no more than 20,000 shares to be awarded each year. The option exercise price was the fair market value of United's stock at the time the option is granted. The last grants under this plan were awarded in 1992. All options granted are vested. Messrs. R. Adams, Smith, S. Wilson, J. Wilson, D. Adams, Sowards and Ellis have exercised options.\nIn April, 1991, the Board adopted an incentive stock option plan (\"1991 Plan\") which was approved by United's shareholders at the 1991 annual meeting. The 1991 Plan was intended to attract and retain qualified and motivated management. The class of eligible employees was officers of United and its subsidiaries owning less than 10% of United's issued and outstanding stock. The Executive Committee of United, in its sole discretion, awarded stock options to eligible employees and administered the 1991 Plan generally. Five hundred thousand (500,000) shares were allocated to the plan, with options for no more than 100,000 shares to be awarded each year. The option exercise prices were the fair market value of United's stock at the time the option was granted. The last grants under this plan were awarded in 1995.\nIn 1995, 100,000 shares were granted as follows: Richard M. Adams-12,714 shares; I. N. Smith, Jr.-3,506 shares; Gary L. Ellis-6,028 shares; Joe L. Wilson-3,506 shares; Steven E. Wilson-6,028 shares; James B. Hayhurst-4,120 shares; Joseph Wm. Sowards-2,366 shares; Douglass H. Adams-2,366 shares and Thomas A. McPherson-4,120 shares. Fifty-two nonexecutive officers received a total of 55,246 shares. These shares were granted at the then current market price of $30.00. The options granted become exercisable in accordance with a three year vesting schedule: 50% year one; 75% year two and 100% year three. Messrs. Ellis, Smith, S. Wilson, D. Adams, McPherson, Sowards and seventeen nonexecutive officers have exercised options.\nIn August, 1995, the Board adopted an incentive stock option plan (\"1996 Plan\") which will be presented to United's shareholders at the 1996 annual meeting to be voted on for their approval. The 1996 Plan is intended to attract and retain qualified and motivated management. The class of eligible employees is officers of United and its subsidiaries owning less than 10% of United's issued and outstanding stock. The Executive Committee of United, in its sole discretion, will award stock options to eligible employees and will administer the 1996 Plan generally. Six hundred thousand (600,000) shares will be allocated to the 1996 Plan. Each Plan year, 120,000 options will be considered for award to eligible employees; however, not all of the 120,000 options are required to be awarded in that year. Any ungranted options from the prior year(s) will be added to the current year's options for the Executive Committee's consideration for granting the options. The total number of options that may be granted in any one year, with the exception of the first year whereby 120,000 will be considered for award, is the current year's allocation plus the cumulative total of all ungranted options of all prior years under the 1996 Plan. The option\nexercise price of each grant will be the fair market value of United's stock at the time the option is granted. The first grants under the 1996 Plan, subject to shareholder approval, will be awarded in November 1996.\nEmployee Benefit Plans - - ----------------------\nNo directors or principal shareholders of United and its subsidiaries, other than those persons who are salaried officers, participate in any type of benefit plan of United.\nUnited's subsidiaries provide, on a substantially non-contributory basis for all full-time employees, life, disability, hospital and dental insurance. Life insurance with value of 250% of base salary is provided to all full-time employees, including executive officers. The premiums paid by the subsidiaries for life insurance on any individual which has a face value greater than $50,000 is properly reported as compensation. These plans do not discriminate, in scope, terms or operation, in favor of the executive officers of United or its subsidiaries and are available generally to all salaried employees of United and its subsidiaries.\nEach employee of United, or its participating subsidiaries, who completes one year of eligible service and is 21 years of age is eligible to participate in the Pension Plan. The plan is noncontribu-tory on the part of the employee. Vesting is attained with five years of participation.\nNormal retirement benefits under the United Plan are equal to:\n1.25% of Average Final Compensation* plus 0.5% of Average Final Compensation in excess of Covered Compensation** multiplied by years of service not to exceed 25.\n*Average Final Compensation = The average of the highest five consecutive plan years of basic compensation paid during the ten plan years preceding the date of determination.\n**Covered Compensation = The average of the last 35 years of the social security wage base prior to Social Security retirement age.\nEach employee of United, or its participating subsidiaries, who completes one year of eligible service is eligible to participate in the United Savings and Stock Investment Plan, a deferred compensation plan under Section 401(k) of the Internal Revenue Code. Each participant may contribute from 1% to 10% of pre-tax earnings to his\/her account which may be invested in one to four investment options chosen by the employee. United matches 100% of the first 2% of salary deferred and 25% of the second 2% of salary deferred with United stock. Vesting is 100% for employee deferrals and the company match at the time the employee makes his\/her deferral.\nUnited employees may participate in an employee stock purchase plan whereby its employees may purchase shares of United's common stock. Purchases made by employees under this plan are coordinated by the Trust Department of UNB, and involve stock purchased at market price for this purpose.\nTransactions with Management and Others - - ---------------------------------------\nUnited's subsidiaries have had, and expect to have in the future, banking transactions with United and with its officers, directors, principal shareholders, or their interests (entities in which they have more than a 10% interest). The transactions were in the ordinary course of business and with respect to loans were made on substantially the same terms, including interest rates, collateral and repayment terms as those prevailing at the time for comparable transactions. United's subsidiary banks are subject to federal statutes and regulations governing loans to officers and directors and extend loans in compliance with such laws and only with the approval of the Board of Directors.\nThe building utilized by UNB to house its Rosemar Circle Branch in North Parkersburg, West Virginia, is owned by Richard M. Adams, Chairman and Chief Executive Officer of United and UNB, his brother, Douglass H. Adams, Executive Vice President of United and their step-mother, Dorothy D. Adams. The Adams' lease the land from UNB at a nominal annual rental and lease the branch facility they constructed to UNB. The leases were entered into prior to UNB's ownership of the branch facility and were assumed by UNB upon its acquisition of the previous lessee, United Bank. Management believes the lease terms are comparable with lease terms for similar property in the market area.\nH. Smoot Fahlgren, a member of the Board of Directors of United, is Chairman of Fahlgren Inc., an advertising agency with its headquarters in Parkersburg, West Virginia. The agency has provided the advertising for United since 1978. United utilizes an aircraft owned by Mr. Fahlgren, a member of United's Board of Directors. During 1995, Mr. Fahlgren received $20,995 in compensation for these services. Payment for the advertising by United to Fahlgren Martin, Inc. was less than 5% of that firm's revenues during the year 1995.\nF.T. Graff, Jr., a member of the Board of Directors of United, is a partner in the law firm of Bowles Rice McDavid Graff & Love in Charleston, West Virginia. Bowles Rice McDavid Graff & Love rendered legal services to United and UNB during 1995 and it is expected that the firm will continue to render certain services to both in the future. The fees paid to Bowles Rice McDavid Graff & Love represent less than 5% of that firm's revenues for 1995.\nR. Terry Butcher, a member of the Board of Directors of United, is a partner in the law firm of Butcher & Butcher of Glenville, West Virginia. Butcher & Butcher has rendered legal services to UNB, a United affiliate, during 1995 and it is expected that the firm will continue to render legal services in the future. The fees paid to Butcher & Butcher represent less than 5% of the firm's revenues for 1995.\nUNB leases its northern region main banking premises from The Ogden Newspapers, Inc. pursuant to a written lease agreement dated August 1, 1979 (the \"Lease\"). The Ogden Newspapers, Inc. is a shareholder of United, and the voting and investment authority for its shares are beneficially owned by its President, G. Ogden Nutting who is a director of United. The Lease is on terms comparable to market terms for similar rental space in Wheeling, West Virginia. The Lease provides for five (5) successive options to renew and extend the terms of the Lease for five (5) years each. United exercised its option to renew the Lease for five (5) years in 1989 and again in 1994. In addition, during the year 1995 subsidiaries of United advertised, at market rates, in newspapers published by The Ogden Newspaper, Inc. The fees paid in such advertising and the rent paid to The Ogden Newspapers, Inc. represent less than 5% of that firm's revenue for the year 1995.\nUNITED BANKSHARES, INC. FORM 10-K, PART IV\nItem 14.","section_14":"Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\nPage\n(a) (1) and (2) Financial Statements and Financial Statement schedules . . . . . . . . . . . . . . . . 46\n(3) Listing of Exhibits - See the Exhibits' Index . . . . . . . . . . . . . . . . . . . . . . . 94\n(b) Reports on Form 8-K filed in the fourth quarter of 1995:\nForm 8-K dated November 30, 1995\nItem 5. Acquisition of First Commercial Bank.\nForm 8-K dated December 13, 1995\nItem 5. Director resignation with no disagreements with management.\n(c) Exhibits . . . . . . . . . . . . . . . . . . . . . . 99\n(d) Consolidated Financial Statement Schedules -- 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 or pertain to items as to which the required disclosures have been made elsewhere in the financial statements and notes thereto, and therefor have been omitted.\nUNITED BANKSHARES, INC.\nFORM 10-K\nINDEX TO EXHIBITS\nItem 14.\nFootnotes - - ---------\n(a) N\/A = Not Applicable\n(b) Incorporated into this filing by reference to Exhibit 10 of the 1985 Form 10-K for Intermountain Bankshares, Inc., File No. 0-12356\n(c) Incorporated into this filing by reference to Exhibit 10 of the 1986 Form 10-K for United Bankshares, Inc., File No. 0-13322\n(d) Incorporated into this filing by reference to Part II of Form S-4 Registration Statement of United Bankshares, Inc., Registration No. 33- 19968 filed February 3, 1988\n(e) Incorporated into this filing by reference to Exhibits to the 1988 10-K for United Bankshares, Inc., File No. 0-13322\n(f) Incorporated into this filing by reference to Exhibits to the 1989 10-K for United Bankshares, Inc., File No. 0-13322\n(g) Incorporated into this filing by reference to Exhibits to the 1990 10-K for United Bankshares, Inc., File No. 0-13322\n(h) Incorporated into this filing by reference to Exhibits to the 1991 10-K for United Bankshares, Inc., File No. 0-13322\n(i) Incorporated into this filing by reference to Exhibits to the 1992 10-K for United Bankshares, Inc., File No. 0-13322\n(j) Incorporated into this filing by reference to Exhibits to the 1993 10-K for United Bankshares, Inc., File No. 0-13322\n(k) Incorporated into this filing by reference to Exhibits to the 1994 10-K as amended by Form 10K\/A filed February 8, 1996, for United Bankshares, Inc., File No. 0-13322\nSIGNATURES\nPursuant to the requirements of Section 13 or 15 (d) of the 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 BANKSHARES, INC. (Registrant)\nBy \/s\/ Richard M. Adams -------------------------------- 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.\nSignatures Title Date\n\/s\/ Richard M. Adams Chairman of the Board, March 22, 1996 - - ------------------------------- Director, Chief Execu- tive Officer\n\/s\/ I. N. Smith President and Director March 22, 1996 - - -------------------------------\n\/s\/ Steven E. Wilson Chief Financial Officer March 22, 1996 - - ------------------------------- Chief Accounting Officer\n\/s\/ Thomas J. Blair, III Director March 22, 1996 - - -------------------------------\n\/s\/ James W. Word, Jr. Director March 22, 1996 - - -------------------------------\n\/s\/ F. T. Graff, Jr. Director March 22, 1996 - - -------------------------------\n\/s\/ H. Smoot Fahlgren Director March 22, 1996 - - -------------------------------\n\/s\/ William C. Pitt, III Director March 22, 1996 - - -------------------------------\n\/s\/ G. Ogden Nutting Director March 22, 1996 - - -------------------------------\n\/s\/ R. Terry Butcher Director March 22, 1996 - - -------------------------------\n\/s\/ Harry L. Buch Director March 22, 1996 - - -------------------------------\n\/s\/ Russell L. Isaacs Director March 22, 1996 - - -------------------------------\n\/s\/ Leonard A. Harvey Director March 22, 1996 - - -------------------------------\n\/s\/ C. E. Goodwin Director March 22, 1996 - - -------------------------------\nSIGNATURES (continued)\nSignatures Title Date\n\/s\/ Charles E. Stealey Director March 22, 1996 - - -------------------------------\n\/s\/ Warren A. Thornhill, III Director March 22, 1996 - - -------------------------------\n\/s\/ Robert P. McLean Director March 22, 1996 - - -------------------------------\n\/s\/ Robert G. Astorg Director March 22, 1996 - - -------------------------------\n\/s\/ Thomas A. McPherson Director March 22, 1996 - - -------------------------------\n\/s\/ Douglass H. Adams Director March 22, 1996 - - -------------------------------","section_15":""}
{"filename":"719184_1995.txt","cik":"719184","year":"1995","section_1":"Item 1. Business\nGeneral\nConsolidated Capital Institutional Properties\/2 (the \"Partnership\") was organized on April 12, 1983, as a limited partnership under the California Uniform Limited Partnership Act. On July 22, 1983, the Partnership registered with the Securities and Exchange Commission (\"SEC\") under the Securities Act of 1933 (File No. 2-83540) and commenced a public offering for sale of Units. The Units represent equity interests in the Partnership and entitle the holders thereof to participate in certain allocations and distributions of the Partnership. The sale of Units terminated on July 21, 1985, with 912,182 units sold at $250 each, or gross proceeds of approximately $227.8 million to the Partnership. The Partnership subsequently filed a Form 8-A Registration Statement with the SEC and registered its Units under the Securities Exchange Act of 1934 (File No. 0-11723). As permitted under its Partnership Agreement (the original partnership agreement of the Partnership with all amendments shall be referred to as the \"Partnership Agreement\"), the Partnership has repurchased and retired a total of 3,028 Units for a total of $611,000. The Partnership may, at its absolute discretion, repurchase Units, but is under no obligation to do so.\nUpon the Partnership's formation in 1983, CCEC, a Colorado corporation, was the corporate general partner. In 1988, through a series of transactions, Southmark Corporation (\"Southmark\") acquired controlling interest in CCEC. In December 1988, CCEC filed for reorganization under Chapter 11 of the United States Bankruptcy Code (\"Chapter 11\"). In 1990, as part of CCEC's reorganization plan, ConCap Equities, Inc. (\"CEI\" or the General Partner) acquired CCEC's general partner interests in the Partnership and 15 other affiliated public limited partnerships (the \"Affiliated Partnerships\") and CEI replaced CCEC as managing general partner in all 16 partnerships. The selection of CEI as the general partner was approved by a majority of the limited partners in the Partnership and in each of the Affiliated Partnerships pursuant to a solicitation of the Limited Partners dated August 10, 1990. As part of this solicitation, the Limited Partners also approved an amendment to the Partnership Agreement to limit changes of control of the Partnership.\nAll of CEI's outstanding stock is owned by GII Realty, Inc. In December 1994, the parent of GII Realty, Inc., entered into a transaction (the \"Insignia Transaction\") in which among other things, MAE-ICC, Inc., a wholly owned subsidiary of Metropolitan Asset Enhancement, L.P. (\"MAE\"), an affiliate of Insignia Financial Group, Inc. (\"Insignia\") acquired an option (exercisable in whole or in part from time to time) to purchase all of the stock of GII Realty, Inc. and, pursuant to a partial exercise of such option, acquired 50.5% of that stock. As a part of the Insignia Transaction, MAE-ICC, Inc. also acquired all of the outstanding stock of Partnership Services, Inc., an asset manager, and a subsidiary of Insignia acquired all of the outstanding stock of Coventry Properties, Inc., a property manager. In addition, confidentiality, non-competition, and standstill arrangements were entered into between certain of the parties. Those arrangements, among other things, prohibit GII Realty's former sole shareholder from purchasing Partnership Units for a period of three years. On October 24, 1995, MAE-ICC, Inc. exercised the remaining portion of its option to purchase all of the remaining outstanding capital stock of GII Realty, Inc. held by Gordon Realty, Inc. Pursuant to the terms of the option, MAE-ICC, Inc. acquired the remaining 49.5% of the outstanding capital stock of GII Realty, Inc.\nThe Partnership's primary business and only industry segment is real estate related operations. The Partnership was formed, for the benefit of its Limited Partners (herein so called and together with the General Partner shall be called the \"Partners\"), to lend funds to Equity Partners\/Two (\"EP\/2\"), a California general partnership in which certain of the partners were former shareholders and former management of CCEC, the former corporate general partner of the Partnership. See \"Status of Master Loan\" for a description of the loan and settlement of EP\/2's bankruptcy.\nThrough December 31, 1995, the Partnership advanced a total of approximately $182.1 million to EP\/2 and its successor under the Master Loan (as defined in \"Status of the Master Loan\"). As of December 31, 1995, the balance of the Master Loan, net of the allowance for possible losses, was approximately $43.4 million. EP\/2 used the proceeds from these loans to acquire eleven (11) apartment buildings and ten (10) office complexes, which collateralized the Master Loan. EP\/2's successor in bankruptcy (as more fully described in \"Status of Master Loan\") currently owns four (4) apartment buildings, and seven (7) office complexes which secure the Master Loan. The Partnership owns directly one (1) office complex which it acquired pursuant to a foreclosure in 1990. For a brief description of the property refer to \"Item 2","section_1A":"","section_1B":"","section_2":"Item 2. Description of Property\nThe following table sets forth the Registrant's investment in real estate as of December 31, 1995:\nDate of Property Purchase Type of Ownership Use\nNorth Park Plaza 07\/13\/90 Fee ownership. Office Bldg. Southfield, Michigan 267,273 sq.ft.\nSchedule of Property: (in thousands)\nSee \"Note A\" of the financial statements included in \"Item 8\" for a description of the Partnership's depreciation policy.\nAverage Annual Rental Rates and Occupancy:\nAverage Annual Average Rental Rates Occupancy\nProperty 1995 1994 1995 1994\nNorth Park Plaza $11.94\/s.f. $11.61\/s.f. 61% 61%\nAs noted under \"Item 1. Business,\" the real estate industry is highly competitive. The property of the Partnership is subject to competition from other commercial buildings in the area. The General Partner believes that the property is adequately insured. No tenant leases 10% or more of the available space.\nThe following is a schedule of the lease expirations at North Park Plaza for the years beginning 1996 through the maturities of current leases:\nNumber of % of Gross Expirations Square Feet Annual Rent Annual Rent\n1996 20 45,065 $520,465 29% 1997 12 27,053 310,605 18% 1998 10 21,322 231,612 13% 1999 17 29,005 329,214 19% 2000 3 11,010 141,717 8% 2001 0 -- -- -- 2002 3 19,736 181,945 10% Thereafter 0 -- -- --\nReal estate taxes and rates in 1995 were (in thousands):\n1995 1995 Billing Rate\nNorth Park Plaza $163 2.86%\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe Partnership is unaware of any pending or outstanding litigation that is not of a routine nature. The General Partner of the Registrant believes that all such pending or outstanding litigation will be resolved without a material adverse effect upon the business, financial condition, results of operations, or liquidity of the Partnership.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nDuring the fourth quarter of the fiscal year ended December 31, 1995, no matter was submitted to a vote of the unit holders through the solicitation of proxies or otherwise.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Units of Limited Partnership and Related Security Holder Matters\nThere is no established market for the Units and it is not anticipated that any will occur in the foreseeable future. As of December 31, 1995, there were 45,809 holders of record owning an aggregate of 909,138 units.\nThe Partnership made a distribution of cash generated from operations of approximately $3,003,000 for the year ended December 31, 1995. No distributions were paid in the year ended December 31, 1994. Future distributions will depend on levels of cash generated from operations, refinancings, property sales, and the availability of cash reserves. Such cash reserves are subject to the requirements of the Partnership Agreement which requires that the Partnership maintain reserves equal to 5% of Net Invested Capital. At this time the General Partner anticipates that cash distributions will be made during fiscal year 1996, but the timing or amount of such distributions cannot be determined at this time.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe following table sets forth a summary of certain financial data for the Partnership. This summary should be read in conjunction with the Partnership's financial statements and notes thereto appearing in \"Item 8 - Financial Statements and Supplementary Data.\"\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nThis item should be read in conjunction with the financial statements and other items contained elsewhere in this report.\nResults of Operations\n1995 Compared with 1994\nThe Partnership's net loss for the year ended December 31, 1995, was approximately $2,616,000 compared to a net loss of approximately $10,736,000 for the year ended December 31, 1994. This decrease in net loss was primarily due to the reduction of the allowance for possible losses of the Master Loan as determined under FASB Statement 114 in 1995 compared to an increase in the allowance in 1994. Contributing to the decrease in net loss was an increase in other income which resulted from an insurance policy refund of approximately $286,000 accrued in the fourth quarter of 1995. Operating expense decreased primarily as a result of decreased advertising costs. This decrease is attributable to fewer rental concessions given to tenants in 1995. Depreciation and amortization expense decreased due to the write-down of the investment property of $3,350,000 and $2,496,000 taken in 1995 and 1994, respectively. Offsetting these decreases in net loss was a decrease in interest income on the Master Loan due to decreased cash flows of the investment properties that secure the loan (income is recorded based on the cash flow of the properties collateralized by the Master Loan). Also, general and administrative expense increased for the year ended December 31, 1995, as a result of higher printing and mailing costs associated with first and second quarter 10-Q's that were sent to investors. Additionally, expenses related to the combined efforts of the Dallas and Greenville offices during the transition period that ended June 30, 1995, also contributed to the increase in general and administrative expense. The increased costs related to the transition efforts were incurred to minimize any disruption in the year-end 1994 reporting function including the financial reporting and K-1 preparation and distribution.\nAs part of the ongoing business plan of the Partnership, the General Partner monitors the rental market environment of its investment property to assess the feasibility of increasing rents, maintaining or increasing occupancy levels and protecting the Partnership from increases in expenses. As part of this plan, the General Partner attempts to protect the Partnership from the burden of inflation-related increases in expenses by increasing rents and maintaining a high overall occupancy level. However, due to changing market conditions, which can result in the use of rental concessions and rental reductions to offset softening market conditions, there is no guarantee that the General Partner will be able to sustain such a plan.\n1994 Compared with 1993\nThe Partnership's net loss for the year ended December 31, 1994, was approximately $10,736,000 compared to a net loss of approximately $3,146,000 for the year ended December 31, 1993. The increase in net loss was due to an increase in the provision for possible losses on the Master Loan in 1994. Rental revenues increased $269,000 as a result of an increase in occupancy at the Partnership's sole property, the North Park Plaza Office complex in 1994. This increase was partially offset by increased property operations expenses of $137,000 primarily due to a refund of 1990 property taxes received in 1993 and a general increase in utilities, service, cleaning, and repair and maintenance expense. General and administrative expenses decreased approximately $178,000 primarily due to decreased administrative overhead costs allocated to the Partnership and other professional fees.\nLiquidity and Capital Resources\nAt December 31, 1995, the Partnership had unrestricted cash of approximately $9,276,000 versus $1,351,000 at December 31, 1994. Net cash provided by operating activities increased primarily due to the decreases in net loss discussed above. Also contributing to the increase in net cash provided by operating activities is a decrease in due from affiliates, which resulted from the payment of the December 31, 1994, accrued interest receivable on the Master Loan which had been recorded as \"due from affiliates\" at December 31, 1994. Net cash provided by investing activities increased due to an increase in proceeds from the sale of securities available for sale which was partially offset by a decrease in purchases of securities available for sale. Net cash used in financing activities increased due to a distribution made during the third quarter of 1995.\nAt December 31, 1994, the Partnership had unrestricted cash of approximately $1,351,000 versus approximately $1,912,000 at December 31, 1993. Net cash provided by operating activities decreased primarily due to the increase in amounts due from affiliates. This is the result of accrued interest receivable on the Master Loan. 1994 net cash used in investing activities and net cash used in financing activities remained consistent with 1993 amounts.\nThe General Partner is currently marketing North Park Plaza for sale. However, the property is still considered an Asset to be Held and Used in Operations as the General Partner will not necessarily sell the property unless certain terms of the potential sale are satisfied. If the property can not be sold at terms deemed acceptable by the General Partner after a period of time, the property will no longer be marketed for sale. At this time, the General Partner has been contacted by a potential purchaser and is negotiating a possible sale. The General Partner has not entered into any agreement to sell the property to the potential purchaser and the General Partner will continue to solicit other purchasers until a sales agreement is signed. Capital improvement projects planned for 1996 include approximately $3 million in deferred maintenance and general upgrades at several of the CCEP\/2 properties which will be funded by additional borrowings under the Master Loan. These upgrades and repairs include exterior and interior improvements, drainage repair, HVAC upgrades, installation of fire and sprinkler systems and upgrades required to comply with ADA requirements.\nThe sufficiency of existing liquid assets to meet future liquidity and capital expenditure requirements is directly related to the level of capital expenditures required at the property to adequately maintain the physical assets and other operating needs of the Partnership. Such assets are currently thought to be sufficient for any near-term needs of the Partnership. See \"CCEP\/2 Property Operations\" for discussion on CCEP\/2's ability to provide future cash flow as Master Loan debt service. In September 1995, the Partnership made a distribution to the limited partners of approximately $2,973,000, or $3.27 per unit. A matching distribution of approximately $30,000 was made to the General Partner. Future cash distributions will depend on the levels of net cash generated from operations, master loan interest income, property sales, and the availability of cash reserves.\nThe Partnership is required by the Partnership Agreement to maintain working capital reserves for contingencies of not less than 5% of Net Invested Capital, as defined by the Partnership Agreement. Reserves, including cash and cash equivalents and securities available for sale (at market), totaling approximately $9.3 million, were greater than the reserve requirement of $7.6 million at December 31, 1995.\nCCEP\/2 Property Operations\nNet loss at CCEP\/2 was approximately $36,270,000 for the year ended December 31, 1995, versus a net loss of approximately $19,922,000 for the year ended December 31, 1994. This increase in net loss was primarily due to the write down of several properties as required by FASB Statement 121. CCEP\/2 recognizes interest expense on the New Master Loan Agreement obligation according to the note terms, although payments to the Partnership are required only to the extent of Excess Cash Flow, as defined therein. During 1995, CCEP\/2's consolidated statement of operations includes total interest expense attributable to the Master Loan of $18.8 million, of which approximately $721,000 represents required payments. CCEP\/2 is expected to continue to generate operating losses as a result of such interest accruals and noncash charges for depreciation. However, CCEP\/2's operations are expected to provide cash flow during 1996 which will be available to be utilized as Master Loan debt service.\nThe Partnership has invested approximately $1.5 million in CCEP\/2 during 1995 as advances under the Master Loan. This money was used by CCEP\/2 for deferred maintenance and capital improvements at its investment properties. Additional advances under the Master Loan are anticipated to be made to CCEP\/2 in 1996 as these properties continue the deferred maintenance and capital improvement programs. During the year ended December 31, 1995, the Partnership received approximately $1.3 million as principal payments on the Master Loan, $1.1 million of which was due to the cash received by CCEP\/2 on certain of its investments. These funds are required to be transferred to the Partnership under the terms of the Master Loan. CCEP\/2 also received proceeds from the partial settlement of an outstanding lawsuit of approximately $.2 million (as discussed below) which were also transferred to the Partnership.\nCCEP\/2 was a general partner in a limited partnership (\"Broad and Locust Associates\") which was managed by an unaffiliated co-general partner and which owned the 230 S. Broad Street Office Complex. Broad and Locust Associates filed for protection under Chapter 11 of the U.S. Bankruptcy Code in 1992, and in 1993 a reorganization plan was confirmed by the bankruptcy court. Pursuant to the reorganization, the 230 S. Broad Street Office Complex was transferred to the first lien holder which held a mortgage loan of approximately $16 million secured by the property. The bankruptcy court determined the first lien was in excess of the property's estimated fair value, therefore, CCEP\/2's general partner interest was unsecured. The disposition of the property did not release CCEP\/2 from its $4.4 million obligation to the Partnership under the Master Loan which had been secured by the general partner interest in Broad and Locust Associates. The Partnership had previously recognized a provision for possible losses for the balance of the Investments in Master Loan secured by the general partner interest in Broad and Locust Associates. In 1994, CCEP\/2 made a demand on certain other partners of Broad & Locust Associates for the amount of the Deficit Restoration Obligation (\"DRO\") as defined in the Broad & Locust Associates Second Amended and Restated Partnership Agreement entered into in July 1984, by CCEP\/2 and certain other partners. In 1995, approximately $204,000 was received by CCEP\/2 on partial settlement of this claim. No assurance can be given that CCEP\/2 will be successful in its attempts to obtain further payment of the DRO amount.\nThe first mortgage note at Richmond Plaza matured March 1995 and has a principal balance of $14,369,000 at December 31, 1995. The Partnership has continued to make principal and interest payments monthly under the terms of the original note, and is currently investigating a refinancing which is expected to close in the second quarter of 1996. No assurance can be given that the General Partner will be successful in its negotiations with the lender.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nCONSOLIDATED CAPITAL INSTITUTIONAL PROPERTIES\/2\nLIST OF FINANCIAL STATEMENTS\nReports of Independent Auditors\nBalance Sheets as of December 31, 1995 and 1994\nStatements of Operations for the Years Ended December 31, 1995, 1994 and 1993\nStatement of Partners' Capital (Deficit) for the Years Ended December 31, 1995, 1994 and 1993\nStatements of Cash Flows for the Years Ended December 31, 1995, 1994 and 1993\nNotes to Financial Statements\nReport of Ernst & Young LLP, Independent Auditors\nThe Partners Consolidated Capital Institutional Properties\/2\nWe have audited the accompanying balance sheet of Consolidated Capital Institutional Properties\/2 as of December 31, 1995, and the related statements of operations, changes in partners' capital (deficit) and cash flows for the period then ended. These financial statements are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements based on our audit.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by the Partnership's 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 Consolidated Capital Institutional Properties\/2 as of December 31, 1995, 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 A to the financial statements, in 1995 the Partnership changed its method of accounting for impairment of long-lived assets and for long-lived assets to be disposed of, and of accounting by creditors for impairment of a loan.\n\/s\/ERNST & YOUNG LLP\nGreenville, South Carolina February 23, 1996\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Partners of Consolidated Capital Institutional Properties\/2:\nWe have audited the accompanying balance sheet of Consolidated Capital Institutional Properties\/2 (a California limited partnership) as of December 31, 1994, and the related statements of operations, partners' capital (deficit) and cash flows for the years ended December 31, 1994 and 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 Consolidated Capital Institutional Properties\/2 as of December 31, 1994, and the results of its operations and its cash flows for the years ended December 31, 1994 and 1993, in conformity with generally accepted accounting principles.\n\/s\/Arthur Andersen, LLP\nDallas, Texas March 23, 1995\nCONSOLIDATED CAPITAL INSTITUTIONAL PROPERTIES\/2\nBALANCE SHEETS (in thousands, except unit data)\nDECEMBER 31, Assets 1995 1994 Cash and cash equivalents: Unrestricted $ 9,276 $ 1,351 Restricted - tenant security deposits 5 -- Securities available for sale 11 9,769 Other assets 818 575 Due from affiliates -- 1,347 Net investment in master loan to affiliate 91,771 91,523 Less: Allowance for impairment loss (48,405) (48,992) 43,366 42,531 Investment property: Land 716 1,247 Buildings and related personal property 5,440 7,578 6,156 8,825 Less: accumulated depreciation (4,138) (3,325) 2,018 5,500 $ 55,494 $ 61,073\nLiabilities and Partners' Capital (Deficit) Liabilities Accounts payable and accrued liabilities $ 136 $ 89 Tenant security deposits 114 106 Distributions payable 141 141 Accrued taxes 58 73 449 409\nPartners' Capital (Deficit) General Partner (554) (498) Limited Partners - (909,138 and 909,145 units outstanding at December 1995 and 1994, respectively.) 55,599 61,162 55,045 60,664 $ 55,494 $ 61,073\nSee Accompanying Notes to Financial Statements\nCONSOLIDATED CAPITAL INSTITUTIONAL PROPERTIES\/2\nSTATEMENTS OF OPERATIONS (in thousands, except per unit data)\nCONSOLIDATED CAPITAL INSTITUTIONAL PROPERTIES\/2\nSTATEMENT OF PARTNERS' CAPITAL (DEFICIT)\nFor the Years Ended December 31, 1995, 1994 and 1993 (in thousands)\nCONSOLIDATED CAPITAL INSTITUTIONAL PROPERTIES\/2\nSTATEMENTS OF CASH FLOWS (in thousands)\nCONSOLIDATED CAPITAL INSTITUTIONAL PROPERTIES\/2\nNOTES TO FINANCIAL STATEMENTS\nNote A - Organization and Summary of Significant Accounting Policies\nOrganization: Consolidated Capital Institutional Properties\/2 (the \"Partnership\"), a California limited partnership, was formed on April 12, 1983, to lend funds through nonrecourse notes with participation interests (the \"Master Loan\"). The loans were made to, and the real properties that secure the Master Loan were purchased and owned by Equity Partners\/Two, (\"EP\/2\"), a California general partnership in which certain of the partners were former shareholders and former management of Consolidated Capital Equities Corporation (\"CCEC\"), the former corporate general partner. Through December 31, 1995, the Partnership had advanced approximately $182.1 million under the Master Loan.\nDuring 1989, EP\/2 defaulted on certain interest payments that were due under the Master Loan. Before the Partnership could exercise its remedies for such defaults, EP\/2 filed for bankruptcy protection under Chapter 11 of the United States Bankruptcy Code (\"Chapter 11\"). On October 18, 1990, the bankruptcy court approved EP\/2's consensual plan of reorganization (the \"Plan\"). In November 1990, EP\/2 and the Partnership consummated a closing under the Plan pursuant to which, among other things, the Partnership and EP\/2 executed an amended and restated loan agreement (the \"New Master Loan Agreement\"), EP\/2 was converted from a California general partnership to a California limited partnership, Consolidated Capital Equity Partners\/Two, L.P. (\"CCEP\/2\"), and CCEP\/2 renewed the deeds of trust and mortgages on all the properties collaterally securing the New Master Loan Agreement. ConCap Holdings, Inc. (\"CHI\"), a Texas corporation and wholly-owned subsidiary of CEI, is the sole general partner of CCEP\/2 and an affiliate of the Partnership. The general partners of EP\/2 became limited partners in CCEP\/2. CHI has full discretion with respect to conducting CCEP\/2's business, including managing CCEP\/2's properties and initiating and approving capital expenditures and asset dispositions and refinancings. See \"Note C\" for further discussion of EP\/2's bankruptcy settlement.\nUpon the Partnership's formation in 1983, CCEC, a Colorado corporation, was the corporate general partner. In December 1988, CCEC filed for reorganization under Chapter 11. In 1990, as part of CCEC's reorganization plan, ConCap Equities, Inc., a Delaware corporation (the \"General Partner\" or \"CEI\") acquired CCEC's general partner interests in the Partnership and in 15 other affiliated public limited partnerships and replaced CCEC as managing general partner in all 16 partnerships.\nAll of CEI's outstanding stock is owned by GII Realty, Inc. In December 1994, the parent of GII Realty, Inc., entered into a transaction (the \"Insignia Transaction\") in which among other things, MAE-ICC, Inc., a wholly owned subsidiary of Metropolitan Asset Enhancement, L.P., an affiliate of Insignia Financial Group, Inc. (\"Insignia\") acquired an option (exercisable in whole or in part from time to time) to purchase all of the stock of GII Realty, Inc. and, pursuant to a partial exercise of such option, acquired 50.5% of that stock. As a part of the Insignia Transaction, MAE-ICC, Inc. also acquired all of the outstanding stock of Partnership Services, Inc., an asset manager, and Insignia acquired all of the outstanding stock of Coventry Properties, Inc., a property manager. In addition, confidentiality, non-competition, and standstill arrangements were entered into between certain of the parties. Those arrangements, among other things, prohibit GII Realty's former sole shareholder from purchasing Partnership Units for a period of three years. On October 24, 1995, MAE-ICC, Inc. exercised the remaining option to purchase all of the remaining outstanding capital stock of GII Realty, Inc. held by Gordon Realty, Inc. Pursuant to the terms of the option, MAE-ICC, Inc. acquired the remaining 49.5% of the outstanding capital stock of GII Realty, Inc.\nThe Partnership owns and operates one commercial property in Michigan. Also, the Partnership is the holder of a note receivable which is collateralized by apartment and commercial properties located throughout the United States.\nUse of Estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. Actual results could differ from those estimates.\nEscrows for Taxes: These funds are held by the Partnership, designated for the payment of real estate taxes and are included in other assets.\nDepreciation: Depreciation is provided by the straight-line method over the estimated life of the commercial property and related personal property. For Federal income tax purposes, the modified accelerated cost recovery method is used. As a result of the Tax Reform Act of 1986, for additions after December 31, 1986, the modified accelerated cost recovery method is used for depreciation of (1) real property additions over 27 1\/2 years and (2) personal property additions over 5 to 15 years.\nCash and Cash Equivalents:\nUnrestricted - Unrestricted cash includes cash on hand and in banks, money market funds and U.S. Treasury Bills with original maturities less than 90 days. U.S. Treasury Bills with original maturities greater than 90 days are considered to be investments. At certain times, the amount of cash deposited at a bank may exceed the limit on insured deposits.\nRestricted cash - tenant security deposits - The Partnership requires security deposits from lessees for the duration of the lease and such deposits are considered restricted cash. Deposits are refunded when the tenant vacates, provided the tenant has not damaged its space and is current on its rental payments.\nAdvertising: The Partnership expenses the costs of advertising as incurred.\nInvestment Properties: Prior to 1995, investment properties were carried at the lower of cost or estimated fair value, which was determined using the higher of the property's non-recourse debt amount, when applicable, or the net operating income of the investment property capitalized at a rate deemed reasonable for the type of property. During 1995, the Partnership adopted FASB Statement No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,\" which requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amount. The impairment loss is measured by comparing the fair value of the asset to its carrying amount. The effect of adoption was not material.\nThe property owned by the Partnership has experienced declines in its estimated net realizable value due to regional economic factors and its deteriorating physical condition. Accordingly, the Partnership recorded approximately $3.3 million, $2.5 million and $2.0 million in expense for the write-down on the real estate in the years ended December 31, 1995, 1994 and 1993, respectively.\nInvestment in Master Loan: Beginning in 1995, the Partnership adopted Financial Accounting Standards Board Statement No. 114, \"Accounting by Creditors for Impairment of a Loan.\" Under the new standard, the 1995 allowance for credit losses related to loans that are identified for evaluation in accordance with Statement 114 is based on discounted cash flows using the loan's initial effective interest rate or the fair value of the collateral for certain collateral dependent loans. Prior to 1995, the allowance for credit losses related to these loans was based on undiscounted cash flows or the fair value of the collateral for collateral dependent loans.\nInvestments: Securities available-for-sale: The General Partner determines the appropriate classification of debt securities at the time of purchase and reevaluates such designation as of each balance sheet date. Presently, all of the Partnership's investments 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 partner's capital. The amortized cost of debt securities in this category is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization is included in investment income. Realized gains and losses and declines in value judged to be other-than-temporary on available-for-sale securities are included in investment income. The cost of securities sold is based on the specific identification method. Interest and dividends on securities classified as available-for-sale are included in investment income.\nLeases: The Partnership leases certain commercial space to tenants under various lease terms. The leases are accounted for as operating leases in accordance with Financial Accounting Standards Board Statement No. 13. Some of the leases contain stated rental increases during their term. For leases with fixed rental increases, rents are recognized on a straight-line basis over the terms of the lease.\nFor all other leases, minimum rents are recognized over the terms of the leases.\nIncome Taxes: No provision has been made in the financial statements for Federal income taxes because, under current law, no Federal income taxes are paid directly by the Partnership. The Unitholders are responsible for their respective shares of Partnership net income or loss. The Partnership reports certain transactions differently for tax than for financial statement purposes.\nNote A - Organization and Summary of Significant Accounting Policies - continued\nThe tax basis of the Partnership's assets and liabilities is approximately $111.4 million greater than the assets and liabilities as reported in the financial statements.\nLease Commissions: Lease commissions are capitalized and amortized using the straight-line method over the life of the applicable lease. At December 31, 1995 and 1994, lease commissions totaled $272,855 and $202,746, respectively, with accumulated amortization of $86,679 and $57,112, respectively. Lease commissions are included in other assets.\nPartners' Capital (Deficit): The Partnership Agreement provides for net income and net losses for both financial and tax reporting purposes to be allocated 99% to the Limited Partners and 1% to the General Partner. \"Distributable Cash from Operations,\" as defined in the Partnership Agreement, are to be allocated 99% to the Limited Partners and 1% to the General Partner. Distributions of surplus funds are to be allocated 100% to the Limited Partners.\nNet Income (Loss) Per Limited Partnership Unit: Net income (loss) per Limited Partnership Unit (\"Unit\") is computed by dividing net income (loss) allocated to the Limited Partners by the number of Units outstanding. Per Unit information has been computed based on 909,138, 909,145, and 909,154 Units outstanding in 1995, 1994, and 1993, respectively.\nFair Value: In 1995, the Partnership implemented Statement of Financial Accounting Standards No. 107, \"Disclosure about Fair Value of Financial Instruments,\" which requires disclosure of fair value information about financial instruments for which it is practicable to estimate that value. The carrying amount of the Partnership's cash and cash equivalents approximates fair value due to short-term maturities. The carrying amount of the Partnership's net investment in the Master Loan approximates fair value due to the fact that it has been valued based on the fair value of the underlying collateral.\nAllowance for Impairment Loss: Allowances to reduce the carrying cost of the Master Loan are provided when it is probable that reasonably estimable net realizable values are less than the recorded carrying cost of such investment. Gains or losses that result from the ongoing periodic evaluation of the net realizable value of the Master Loan are credited or charged, as appropriate, to operations in the period in which they are identified. If a collateral property is sold, CCEP\/2 remains liable for any outstanding debt under the Master Loan Agreement, however, the value of the net investment in Master Loan on the Partnership's books would be written down to the appropriate level.\nReclassifications: Certain reclassifications have been made to the 1994 and 1993 information to conform to the 1995 presentation.\nNote B - Securities Available for Sale\nInvestments, stated at cost, consist of the following at December 31, 1995, (in thousands):\nInterest Face Maturity Rate Amount Cost Date Southmark Corporation Redeemable Series A Preferred Stock N\/A $11 $11 N\/A\nThe Partnership's investments are classified as available for sale. The General Partner believes that the market value of the investment is approximately the same as its cost. Securities available for sale as of December 31, 1994, consist of $9,758,000 in U.S. Treasury Bills and $11,000 in Equity Securities.\nNote C - Net Investment in Master Loan\nAt December 31, 1995, the recorded investment in the Master Loan is considered to be impaired under Statement 114. The Partnership measured the impairment of the loan based upon the fair value of the collateral due to the fact repayment of the loan is expected to be provided solely by the collateral. For the year ended December 31, 1995, the Partnership recorded approximately $587,000 in income based upon an increase in the fair value of the collateral.\nThe principal balance of the Master Loan due to the Partnership totaled approximately $91.8 million and $91.5 million at December 31, 1995 and 1994, respectively. Interest due to the Partnership pursuant to the terms of the Master Loan Agreement, but not recognized in the income statements, totaled approximately $18.8 million, $15.4 million and $13.8 million for the years ended December 31, 1995, 1994 and 1993, respectively. At December 31, 1995 and 1994, such cumulative unrecognized interest totaled approximately $112.7 million and $93.9 million and was not included in the balance of the investment in Master Loan. The allowance for possible losses totaled approximately $48.4 million and $49 million at December 31, 1995 and 1994, respectively.\nDuring 1995, the Partnership advanced $1,500,000 to CCEP\/2 as an advance on the Master Loan. The advance was used by CCEP\/2 to fund deferred maintenance and capital improvement projects on these properties in order to maximize returns during improved market conditions and maintain the condition of the properties securing the Master Loan. CCEP\/2 has approximately $24,284,000 in liens on the collateral that are superior to the Master Loan.\nThe investment in Master Loan consists of the following:\nAS OF DECEMBER 31, 1995 1994 (in thousands)\nMaster Loan funds advanced, at beginning of year $ 91,523 $ 91,838 Advances on Master Loan 1,500 -- Principal receipts on Master Loan (1,252) (315) Master Loan funds advanced, at end of year $ 91,771 $ 91,523\nNote C - Net Investment in Master Loan - continued\nThe allowance for impairment loss on Master Loan to affiliates consists of the following:\nTerms of the New Master Loan Agreement: Under the terms of the New Master Loan Agreement, interest accrues at 10% and payments are due quarterly in an amount equal to Excess Cash Flow, generally defined in the New Master Loan Agreement as net cash flow after third party debt service and capital improvements. If such Excess Cash Flow payments are less than the current accrued interest during the quarterly period, the unpaid interest is added to principal, compounded annually, and is payable at the maturity. If such Excess Cash Flow payments are greater than the current accrued interest, the excess amount is applied to the principal balance of the loan. Any net proceeds from the sale or refinancing of any of CCEP\/2's properties are paid to the Partnership under the terms of the New Master Loan Agreement. The New Master Loan Agreement matures in November 2000.\nEffective January 1, 1993, the Partnership and CCEP\/2 amended the New Master Loan Agreement to stipulate that Excess Cash Flow would be computed net of capital improvements. Such expenditures were formerly funded from advances on the Master Loan from the Partnership to CCEP\/2. This amendment and change in the definition of Excess Cash Flow will have the effect of reducing income on the investment in Master Loan by the amount of CCEP\/2's capital expenditures, since such amounts were previously excluded from Excess Cash Flow.\nEP\/2's Bankruptcy Settlement: In November 1990, pursuant to EP\/2's reorganization plan described in \"Note A,\" the Partnership and EP\/2 consummated a closing pursuant to which: (1) the Partnership and EP\/2 executed the New Master Loan Agreement more fully described below; (2) CCEP\/2 renewed the deeds of trust on all the collateral securing the Master Loan; (3) the Partnership received cash of approximately $2.5 million, including $1.8 million from the general partners of EP\/2 related to their promissory notes; (4) the Partnership accepted assignment of certain partnership interests in affiliated partnerships (the \"Affiliated Partnership Interests\"), which were valued by management of the Partnership at approximately $2.5 million, as additional collateral securing the Master Loan; and (5) all liabilities and claims between the Partnership and EP\/2's general partners were released.\nNote C - Net Investment in Master Loan - continued\nEP\/2 was the holder of a note receivable secured by North Park Plaza which had not been performing according to the note terms since 1989. In the process of negotiating the final bankruptcy settlement discussed above, EP\/2 assigned its interest in the note receivable to the Partnership. The Partnership foreclosed upon and acquired North Park Plaza in July 1990, CCEP\/2 is still obligated for $6.6 million under the Master Loan attributable to North Park Plaza not extinguished in the foreclosure proceeding.\nNote D - Related Party Transactions\nThe Partnership has no employees and is dependent on the General Partner and its affiliates for the management and administration of all Partnership activities. The Partnership paid property management fees based upon collected gross rental revenues for property management services as noted below for the years ended December 31, 1995, 1994 and 1993. For the year ended December 31, 1994, a portion of such property management fees were paid to Coventry Properties, Inc. (\"Coventry\"), an affiliate of the General Partner, for day-to-day property management services and a portion was paid to Partnership Services, Inc. (\"PSI\") for advisory services related to day-to-day property operations. During 1993, property management services were provided by an unaffiliated management company. In July 1993, Coventry assumed day-to- day property management responsibilities. In late December 1994, an affiliate of Insignia Financial Group, Inc. (\"Insignia\") assumed day-to-day property management responsibilities for the Partnership's property. Fees paid to affiliates of Insignia during the year ended December 31, 1995, and fees paid to Coventry and PSI for the years ended December 31, 1994 and 1993, are reflected in the following table:\nThe Partnership Agreement (\"Agreement\") also provides for reimbursement to the General Partner and its affiliates for costs incurred in connection with the administration of Partnership activities. The General Partner and its current and former affiliates, which included Coventry, received reimbursements as reflected in the following table:\nNote D - Related Party Transactions - continued\nOn July 1, 1995, the Partnership began insuring its properties under a master policy through an agency and insurer unaffiliated with the General Partner. An affiliate of the General Partner acquired, in the acquisition of a business, certain financial obligations from an insurance agency which was later acquired by the agent who placed the current year's master policy. The agent assumed the financial obligations to the affiliate of the General Partner, who receives payments on these obligations from the agent. The amount of the partnership's insurance premiums accruing to the benefit of the affiliate of the General Partner by virtue of the agent's obligations is not significant.\nDue from affiliates at December 31, 1994, primarily represents cash flow payments owed by CCEP\/2 to the Partnership under the terms of the New Master Loan and were paid during 1995.\nNote E - Commitment and Contingencies\nThe Partnership is required by the Partnership Agreement to maintain working capital reserves for contingencies of not less than 5% of Net Invested Capital, as defined in the Partnership Agreement. In the event expenditures are made from this reserve, operating revenue shall be allocated to such reserves to the extent necessary to maintain the foregoing levels. Reserves, including cash and cash equivalents and securities available for sale (at market), totaling approximately $9.3 million, were greater than the reserve requirement of $7.6 million at December 31, 1995.\nThe Partnership is unaware of any pending or outstanding litigation that is not of a routine nature. The General Partner believes that all such matters are adequately covered by insurance and will be resolved without a material adverse effect upon the business, financial condition, results of operations, or liquidity of the Partnership.\nNote F - Other Income\nIn 1991, the Partnership (and simultaneously 15 Affiliated Partnerships) entered claims in Southmark Corporation's Chapter 11 bankruptcy proceeding. These claims related to Southmark Corporation's activities while it exercised control (directly, or indirectly through its affiliates) over the Partnership. The Bankruptcy Court set the Partnership's and the affiliated Partnerships' allowed claim at $11 million, in aggregate. In March 1994, the Partnership received 1,468 shares of Southmark Corporation Redeemable Series A Preferred Stock and 10,738 shares of Southmark Corporation New Common Stock with an aggregate market value on the date of receipt of $11,000 and approximately $80,000 in cash representing the Partnership's share of the recovery, based on its pro rata share of the claims filed. Other income for 1995 includes a $286,000 refund from the former master insurance policy.\nNote G - Real Estate and Accumulated Depreciation\n(in thousands)\nInitial Cost To Partnership\nBuildings Cost and Related Written Down Personal Subsequent to Description Land Property Acquisition\nNorth Park Plaza $ 2,281 $ 7,719 $ (3,844) Southfield, MI\nReconciliation of real estate and accumulated depreciation:\nNote G - Real Estate and Accumulated Depreciation - continued\nThe aggregate cost of the real estate for Federal income tax purposes at December 31, 1995 and 1994 is $14,104,103 and $13,422,847. The accumulated depreciation taken for Federal income tax purposes at December 31, 1995 and 1994 is $2,069,998 and $1,687,082.\nNote H - Revenues\nThe Partnership leases its commercial property under operating leases which vary in duration from one to seven years. Rental income is recognized on a straight-line basis over the life of the applicable leases. Minimum future rental income subject to noncancellable operating leases is as follows (in thousands):\nYEAR ENDING DECEMBER 31, 1996 $ 1,533 1997 1,139 1998 866 1999 495 2000 283 Thereafter 231 Total $ 4,547\nThere is no assurance that this rental income will continue at the same level when the current leases expire.\nItem 9.","section_9":"Item 9. Changes In And Disagreements With Accountants On Accounting And Financial Disclosure.\nAs of May 3, 1995, Arthur Andersen LLP, the independent accountant previously engaged as the principal accountant to audit the financial statements of the Registrant, was dismissed. As of the same date, the firm of Ernst & Young LLP was engaged to provide that service for the Registrant.\nThe audit report of Arthur Andersen LLP on the financial statements of the Partnership as of and for the year ended December 31 1994, did not contain any adverse opinion or disclaimer of opinion, nor was it qualified or modified as to uncertainty, audit scope or accounting principles.\nDuring the Partnership's two most recent fiscal years and any subsequent interim period preceding the change, there were no disagreements with the former accountant 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 the former accountant, would have caused it to make reference to the subject matter of the disagreement in connection with its report.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors And Executive Officers Of The General Partner Of The Partnership.\nThe names of the directors and executive officers of ConCap Equities, Inc. (\"CEI\"), the Partnership's Managing General Partner as of December 31, 1995, their ages and the nature of all positions with CEI presently held by them are as follows:\nNAME OF INDIVIDUAL POSITION IN CEI AGE\nCarroll D. Vinson President 55\nWilliam H. Jarrard, Jr. Vice President 49\nJohn K. Lines Vice President\/Secretary 36\nKelley M. Buechler Assistant Secretary 38\nRobert D. Long, Jr. Chief Accounting Officer\/ 28 Controller\nCarroll D. Vinson has been President of CEI since December of 1994 and President of the MAE subsidiaries since August 1994. Prior to that, during 1993 to August 1994, Mr. Vinson was affiliated with Crisp, Hughes & Co. (a regional CPA firm) and engaged in various other investment and consulting activities. Briefly, in early 1993, Mr. Vinson served as President and Chief Executive Officer of Angeles Corporation, a real estate investment firm. From 1991 to 1993, Mr. Vinson was employed by Insignia in various capacities including Managing Director-President during 1991. From 1986 to 1990, Mr. Vinson was President and a Director of U.S. Shelter Corporation, a real estate services company which sold substantially all of its assets to Insignia in December 1990.\nWilliam H. Jarrard, Jr. has been Vice President of CEI since December of 1994, Vice President of the MAE subsidiaries since January 1992 and Managing Director - Partnership Administration of Insignia since January 1991. During the five years prior to joining Insignia in 1991, he served in a similar capacity for U.S. Shelter. Mr. Jarrard is a graduate of the University of South Carolina and a certified public accountant.\nJohn K. Lines has been Vice President and Secretary of CEI since December of 1994, Secretary of the MAE subsidiaries since August 1994, General Counsel of Insignia since June 1994, and General Counsel and Secretary of Insignia since July 1994. From May 1993 until June 1994, Mr. Lines was the Assistant General Counsel and Vice President of Ocwen Financial Corporation in West Palm Beach, Florida. From October 1991 until April 1993, Mr. Lines was a Senior Attorney with Banc One Corporation in Columbus, Ohio. From May 1984 until October 1991, Mr. Lines was employed as an associate with Squire Sanders & Dempsey in Columbus, Ohio.\nRobert D. Long, Jr. has been Controller and Chief Accounting Officer of CEI since December 1994 and Chief Accounting Officer and Controller of the MAE subsidiaries since February 1994. Prior to joining MAE, he was an auditor for the State of Tennessee and was associated with the accounting firm of Harshman Lewis and Associates. He is a graduate of The University of Memphis.\nKelley M. Buechler has been Assistant Secretary of CEI since December 1994, Assistant Secretary of the MAE subsidiaries since January 1992, and Assistant Secretary of Insignia since January 1991. During the five years prior to joining Insignia in 1991, she served in a similar capacity for U.S. Shelter. Ms. Buechler is a graduate of the University of North Carolina.\nItem 11.","section_11":"Item 11. Executive Compensation\nNo remuneration was paid to the General Partner nor any of its directors and officers during the year ended December 31, 1995.\nItem 12.","section_12":"Item 12. Security Ownership Of Certain Beneficial Owners And Management\n(a) Security Ownership of Certain Beneficial Owners\nAs of December 31, 1995, no person was known to CEI to own of record or beneficially more than 5 percent (5%) of the Units of the Partnership.\n(b) Beneficial Owners of Management\nNeither CEI nor any of the directors or officers or associates of CEI own any Units of the Partnership of record or beneficially.\n(c) Changes in Control\nBeneficial Owners of CEI\nAs of December 31, 1995, the following persons were known to CEI to be the beneficial owners of more than 5 percent (5%) of its common stock:\nNUMBER OF PERCENT NAME AND ADDRESS CEI SHARES OF TOTAL\nGII Realty, Inc. 100,000 100% One Insignia Financial Plaza P.O. Box 1089 Greenville, SC 29602\nItem 13.","section_13":"Item 13. Certain Relationships And Related Transactions\nTransactions with Current Management and Others\nThe Registrant has a property management agreement with Insignia Management Group, L.P. pursuant to which Insignia Management Group, L.P., has assumed direct responsibility for day-to-day management of the Partnership's properties. This service includes the supervision of leasing, rent collection, maintenance, budgeting, employment of personnel, payment of operating expenses, etc. Insignia Management Group, L.P. receives a property management fee equal to 5% of revenues. During the fiscal year ended December 31, 1995, Insignia Management Group, L.P. received $95,000 in fees for property management.\nTransactions with Former Related Parties\nIn 1991, the Partnership (and simultaneously 15 Affiliated Partnerships) entered claims in Southmark Corporation's Chapter 11 bankruptcy proceeding. These claims related to Southmark Corporation's activities while it exercised control (directly, or indirectly through its affiliates) over the Partnership. The Bankruptcy Court set the Partnership's and the affiliated Partnership's allowed claim at $11 million, in aggregate. In March 1994, the Partnership received 1,468 shares of Southmark Corporation Redeemable Series A Preferred Stock and 10,738 shares of Southmark Corporation New Common Stock with an aggregate market value on the date of receipt of $11,000 and approximately $80,000 in cash representing the Partnership's share of the recovery, based on its pro rata share of the claims filed.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statements, Schedules And Reports On Form 8-K\n(a) The following documents are filed as part of this report:\n1. Financial Statements\nBalance Sheets as of December 31, 1995 and 1994\nStatements of Operations for the Years Ended December 31, 1995, 1994 and 1993\nStatement of Partners' Capital (Deficit) for the Years Ended December 31, 1995, 1994 and 1993\nStatements of Cash Flows for the Years Ended December 31, 1995, 1994 and 1993\nNotes to Financial Statements\n2. Schedules\nAll other schedules are omitted because they are not required, are not applicable or the financial information is included in the financial statements or notes thereto.\n3. Exhibits\n(b) Reports on Form 8-K filed in the fourth quarter of fiscal year 1995:\nA Form 8-K dated October 24, 1995, was filed reporting the purchase of the remaining capital stock of GII Realty, Inc. by MAE-ICC, Inc.\nCONSOLIDATED CAPITAL INSTITUTIONAL PROPERTIES\/2\nSIGNATURE PAGE\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nCONSOLIDATED CAPITAL INSTITUTIONAL PROPERTIES\/2\nBy: CONCAP EQUITIES, INC. Its General Partner,\nMarch 29, 1996 By: \/s\/ Carroll D. Vinson Date Carroll D. Vinson President\nMarch 29, 1996 By: \/s\/ Robert D. Long, Jr. Date Robert D. Long, Jr. Controller, 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 29, 1996 By: \/s\/ Carroll D. Vinson Date Carroll D. Vinson Director and President\nMarch 29, 1996 By: \/s\/ Robert D. Long, Jr. Date Robert D. Long, Jr. Controller, Principal Accounting Officer","section_15":""}
{"filename":"104174_1995.txt","cik":"104174","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nWalbro Corporation (the \"Company\") is a global leader in the design, development and manufacture of precision fuel systems and products for automotive and small engine markets worldwide. The Company manufactures fuel pumps, fuel modules, fuel level sensors, plastic fuel tanks and fuel rails for sale to Original Equipment Manufacturers (\"OEMs\") of vehicles. On July 27, 1995, the Company, through certain of its wholly-owned subsidiaries, acquired the fuel systems business of Dyno Industrier A.S (\"Dyno\"), Oslo, Norway. See \"Dyno\" below. Products manufactured for the small engine market include carburetors and ignitions for chain saws, outboard marine engines, two-wheeled vehicles, industrial engines and lawn and garden equipment, such as lawn mowers and weed trimmers. From 1990 to 1995, the Company (excluding Dyno) increased net sales at the compound rate of approximately 17% per year. This growth was primarily due to the introduction of new automotive products, penetration of additional automotive platforms and a recovery in the small engine industry. The Company had 1995 net sales of $459.3 million including Dyno sales subsequent to the acquisition.\nThrough its subsidiary, Walbro Automotive Corporation, the Company designs, develops and manufactures fuel storage and delivery products for a broad range of U.S. and foreign manufacturers of passenger automobiles and light trucks (including minivans). The Company holds a strong market position in the U.S. and, through the Dyno Acquisition and the Company's joint ventures in France, Brazil, India, Japan and South Korea, has diversified its business across a number of geographic markets. In 1995, management believes that, in the North American automotive market, the Company manufactured fuel pumps for approximately 38% of Ford's automobiles and light trucks. The Company also manufactured all fuel module requirements for Ford light trucks, and, according to management's estimates, manufactured approximately 25% of Ford's fuel rail needs. In addition, management estimates that the Company supplied Chrysler with approximately 74% of its fuel pump and fuel module requirements, including all requirements for Chrysler's passenger cars and minivans and approximately 50% of its requirements for Chrysler's light trucks. Other automotive customers of the Company, including the Company's joint ventures, include Audi, Daewoo, Fiat, General Motors, Hyundai, Kia, Mercedes-Benz, Nedcar, Peugeot, Renault, Rover, Saab, Volkswagen and Volvo. Management believes that the Company manufactures substantially all of the fuel tank systems for Volvo and Saab and the fuel tank for the Mercedes 190\/C Class, Volkswagen Polo and Renault Twingo. Approximately 76% of the Company's 1995 net sales, including Dyno on a pro forma basis, were generated by its automotive operations.\nThrough its subsidiary, Walbro Engine Management Corporation, the Company designs, develops and manufactures diaphragm carburetors for portable engines (such as those used in chain saws and weed trimmers), float feed carburetors for ground supported engines (such as those used in lawn mowers and marine engines) and ignition systems and other components for a variety of small engine products. The Company believes that it is the world's largest independent manufacturer of small engine carburetors, with an approximate 76% share of the global diaphragm carburetor market including sales to such leading chain saw and weed trimmer manufacturers as Poulan\/Weedeater (a Division of Electrolux, A.B.), Homelite (a Division of Deere & Company), Stihl, Incorporated, McCulloch, Ryobi Ltd. and Kioritz (Echo) Corporation. The Company believes it has an approximate 10% share of the global float feed carburetor market, including sales to Briggs & Stratton Corporation, the world's largest small engine manufacturer, Kohler Company, Tecumseh Products Co., and to Mercury Marine (a Division of Brunswick Corporation), a major manufacturer of outboard marine engines. The Company also manufactures replacement products for both the automotive and small engine aftermarkets, sales of which\nare included within its small engine product business. Approximately 24% of the Company's 1995 net sales, including Dyno on a pro forma basis, were generated by its small engine operations.\nThe Company was incorporated in Michigan in 1950 and reincorporated in Delaware in 1972. Unless the context indicates otherwise, all references to \"the Company\" include Walbro Corporation and its consolidated subsidiaries. The Company's principal executive offices are located at 6242 Garfield Street, Cass City, Michigan 48726-1325, and its telephone number is (517) 872-2131.\nDYNO\nOn July 27, 1995, the Company acquired Dyno for approximately $114 million (the \"Dyno Acquisition\"). Dyno is a leading designer, manufacturer and marketer of plastic mono-layer fuel tank systems and components to many European vehicle manufacturers, including Audi, Mercedes-Benz, Nedcar, Peugeot, Renault, Rover, Saab, Volkswagen and Volvo, and has operations in France, Norway, Germany, Great Britain, Spain and Belgium. Dyno produced approximately 1.75 million plastic fuel tanks in 1995, which management estimates to be approximately 20% of the European plastic fuel tank market.\nIn addition to manufacturing fuel tanks, Dyno manufactures plastic fill pipes, fluid overflow containers, and other automobile blow-molded components for cooling, heating and air conditioning systems. These products, in the aggregate, accounted for approximately 10% of Dyno's 1995 revenues.\nDyno has increased its revenues from $147.1 million in 1994 to $210.5 million in 1995 (based on the average Norwegian Kroner(\"NOK\")\/U.S. Dollar exchange rates for each of 1994 and 1995). Dyno has achieved this growth by capitalizing on the European OEMs' increased use of plastic instead of steel fuel tanks. Plastic blow molding techniques are especially suited for the short automobile production runs common in Europe. In addition, Dyno's results have improved as production in its Spanish, Belgium and German plants has increased and as Dyno has added new platforms.\nThe Dyno Acquisition is a continuation of the Company's efforts to strengthen its position as a key supplier of integrated fuel systems to the global automotive market, and it will create the only integrated provider of plastic fuel tank and fuel pump systems in Europe. The Dyno Acquisition has provided the Company with a number of benefits, including:\n- - Further diversification of the Company's geographic markets and the increased ability to participate in the European automotive market. The Company's international sales, on a pro forma basis for the Dyno Acquisition, would have been 54% of the Company's net sales (excluding joint ventures) in 1995 compared to 27% excluding Dyno.\n- - An increased opportunity for the Company to sell its fuel system products to Dyno's European-based OEM customers and for Dyno to sell its products to the European operations of Chrysler, Ford and General Motors.\n- - The ability to share blow molding process technology, especially with respect to the eventual transfer of the Company's multi-layer blow molding technology to Dyno's European facilities.\nWALBRO AUTOMOTIVE CORPORATION\nAUTOMOTIVE INDUSTRY OVERVIEW\nA number of trends within the global automotive market have had and will continue to have a fundamental impact on the Company's future profitability and growth prospects, including: the shift by OEMs to the purchase of \"systems\" rather than individual components, the globalization of the OEM supplier base, the expansion of OEM supplier responsibilities and increased emissions regulation. These trends have contributed to a consolidation of OEM suppliers which the Company expects will continue.\nPurchase of Integrated Systems. North American automotive OEMs are relying increasingly on suppliers who can provide entire systems rather than a number of different parts. OEMs can reduce their own internal engineering efforts and the number of suppliers by purchasing systems rather than components. Management believes the engineering and technological challenges facing systems suppliers will continue to grow as these systems become more complex. To strengthen the Company's position as a major supplier of automotive fuel systems, the Company is investing in its engineering and testing capabilities and actively pursuing its systems philosophy. The Company believes that the systems approach will also be adopted outside North America and that the acquisition of Dyno will allow the Company to provide systems to the European market in the future.\nGlobalization of the OEM Supplier Base. Several OEMs, including Ford, the Company's largest customer, are introducing automobile models which are designed for the world automotive market (\"World Cars\"). This departure from the historical practice of designing separate models for each regional market will require suppliers to establish international development and manufacturing facilities capable of providing system components with consistent quality on a worldwide basis. Through the Dyno Acquisition and the Company's joint ventures, the Company believes it is well positioned as a major supplier of fuel storage and delivery systems (\"FSDS\") to the world automotive markets.\nExpansion of OEM Supplier Responsibilities. Since the 1980s, Ford, Chrysler and General Motors have been actively reducing their supplier base to those who accept significant responsibility for product management and meet increasingly strict standards for product quality, on time delivery and manufacturing costs. These suppliers are expected to control all aspects of production of system components, including design, development, component sourcing, manufacturing, quality assurance, testing and delivery to the customer's assembly plant. The Company believes that many suppliers do not have the resources to meet these OEM requirements and that the automotive OEM supplier market will be divided among a smaller group of key suppliers. The Company has received a number of quality awards from its OEM customers, including the Ford Q1 Award, Chrysler QE Award and General Motors Supplier of the Year Award and believes that this supplier consolidation provides an opportunity for the Company's increased penetration of the OEM market.\nIncreasing Emissions Regulation. Beginning in the late 1970s, U.S. environmental regulations, including fuel economy regulations and the Clean Air Act and its Amendments, have had a significant impact on fuel systems and the controls placed on mobile source emissions. As a result, U.S. automotive fuel systems have evolved from mechanically controlled carbureted systems to more sophisticated, electronically controlled fuel injection systems. Governmental action in many other parts of the world is forcing a similar transition to engine management systems which produce less emissions. For example, the European Economic Community, which previously had less stringent automotive exhaust regulations, adopted exhaust standards effective January 1, 1993 which are comparable to 1983 U.S. requirements.\nCompliance with these regulations has resulted in efforts to reduce evaporative emissions and the development of new \"flexible\" fuels such as ethanol and methanol blends. In response to these changes, the Company has developed a number of products including electric pumps designed for electronic fuel injection systems, onboard running vapor recovery (\"ORVR\") systems and plastic fuel tanks which reduce hydrocarbon permeation and are corrosion resistant to flexible fuels.\nAUTOMOTIVE BUSINESS STRATEGY\nThe Company intends to capitalize on trends in the automotive industry through the development of its fuel systems technology and expansion of its product line and customer base. The key elements of the Company's strategy include:\nSystems Approach to Product Development. The Company is utilizing its expertise to develop integrated FSDS which reduce evaporative emissions, are compatible with the corrosive nature of flexible fuels and provide customers with the cost savings and convenience of purchasing complete systems rather than numerous individual components. The Company's \"systems\" approach to product development is designed to allow the Company to increase product content on each vehicle in which its products are installed while providing customers with substantial performance and cost benefits. This systems approach has made possible an increase in the value of the Company's products per vehicle from $15 in 1987 to as much as $100 in 1995. The 1995 Ford Windstar with a three-liter engine, for example, is equipped with $54 of the Company's products, whereas a similar Ford model was equipped with only $15 of the Company's products in 1987. The Company's ability to assume responsibility for the development of FSDS allows OEMs to reduce internal engineering efforts and use fewer suppliers through the purchase of systems rather than components.\nGlobal Capabilities. The Company's international manufacturing and market presence will allow the Company to offer its current and future FSDS technology to the global automotive market. The Dyno Acquisition significantly expands the Company's presence in Europe and provides it with additional resources and marketing contacts to supply integrated fuel systems to both European and North American OEMs assembling vehicles in Europe and European OEMs assembling vehicles in the United States. Dyno's plastic tank manufacturing capability will assist the Company in pursuing its systems strategy in Europe and in serving OEM customers as they confront new environmental and regulatory challenges worldwide and introduce World Cars designed for sale to the global automotive market. In addition, the Company has entered into joint ventures with foreign manufacturers in Brazil, France, India, Japan and South Korea which enable the Company to access those foreign markets. In the future, the Company may make additional strategic acquisitions of, or enter into strategic alliances with, fuel systems product manufacturers whose products could be integrated with the Company's existing product lines as part of the Company's focus on systems development and global capability.\nTechnical and Product Development Capabilities. The Company's engineers focus their research and development efforts to respond to the technical challenges facing their customers. The Company has designed its current line of FSDS products in response to U.S. fuel economy and emission regulations and changing consumer demands over the past two decades. Management believes that the Company is well positioned to capitalize on the emergence of more stringent global emission regulations through the development of a new generation of products and systems with greater fuel efficiency, reduced component weight, improved durability, fuel vapor control and flexible fuel compatibility. Examples of these products include the idle air solenoid, which regulates engine idle speed in concert with the engine management system, and ORVR systems, which capture fuel vapors from the fuel system and route them to a carbon canister for storage and use.\nThe Company has made substantial investments in fuel system technology, product design and test capability and technical personnel to advance FSDS technology and respond to customer needs. The Company's new state-of-the-art systems center in Auburn Hills, Michigan provides the Company with the full-service product management capability which OEMs require of key suppliers and provides the Company with a competitive advantage in the development of proprietary fuel systems technology. Similarly, the Company intends to build a new systems center in Europe to provide product design and test capabilities, thereby enabling the Company to be a full-service FSDS supplier to European and North American OEMs manufacturing vehicles in Europe.\nAUTOMOTIVE PRODUCTS\nThe Company's product development engineers design fuel storage and delivery systems in response to customer needs and in anticipation of evolving trends in the market. Today's electronic fuel injection system equipped engines demand an uninterrupted supply of fuel under pressure and some vehicles require complex fuel tank configurations. The Company specializes in technology employed in the FSDS and currently manufactures and sells fuel pumps, fuel modules, fuel level sensors, plastic fuel tanks, bracket assemblies and fuel rails.\nIn response to the environmental and fuel efficiency demands on today's automobiles, the Company has developed, and is continually taking steps to improve, an electric pump designed to deliver fuel under pressure to electronic fuel injection equipped engines. The pump is fastened to a bracket and flange assembly, which allows the pump to be mounted in the fuel tank. The assembly has been increasingly replaced with a single integrated unit, called a fuel module, which performs all of the functions of the assembly described above. The fuel module is a complete, value-added package for specific applications composed of a fuel pump, plastic reservoir, fuel level sensor and related parts. These injection-molded plastic units fit inside the fuel tank, ensuring continuous fuel delivery under low fuel conditions, maximum vehicle driving range and enhanced fuel delivery under high temperature conditions, all at a reduced noise level. Although vehicles were not equipped with fuel modules until 1988, approximately 28% of cars and light trucks currently sold by General Motors, Ford and Chrysler in North America use fuel modules. The Company supplies approximately 70% of all of the fuel modules purchased in North America, principally to Ford and Chrysler.\nApproximately 20% of North American vehicles and 65% of European vehicles produced in 1995 contain plastic fuel tanks. Plastic fuel tanks offer several advantages over conventional steel tanks, including lighter weight, greater corrosion resistance to new, cleaner-burning fuels like methanol and the ability to be produced in unusual shapes to better use available space. In anticipation of customer demand in North America for more sophisticated fuel tanks, the Company built a new facility in Ossian, Indiana in 1993 to produce plastic multi-layer fuel tanks. The Company began production of three-layer plastic fuel tanks during the fourth quarter of 1994 for the 1995 Ford Windstar and during the fourth quarter of 1995 for the Ford Escort. The multi-layer construction of the Company's new, six-layer plastic tank substantially eliminates fuel permeation, making this one of the first plastic tanks which complies with future EPA permeability requirements due to become effective beginning in model year 1996. The first production run of six-layer tanks will begin in 1996 for the 1996 GM T600 Truck.\nThrough Dyno, the Company is currently producing single-layer plastic tanks for Audi, Mercedes-Benz, Nedcar, Peugeot, Renault, Rover, Saab, Volkswagen and Volvo. As Dyno's customers require more sophisticated fuel tanks, the Company will likely supplement a portion of Dyno's single-layer blow molding machines with multi-layer blow-molding machines to provide the Company's OEM customers in Europe with advanced, plastic fuel tank process technology.\nThe Company also produces metal and plastic fuel rails suitable for a variety of engine applications. An extension of the FSDS concept, these under-hood components, located on the engine, deliver fuel to the individual fuel injectors used in electronic multi-point fuel injection systems. The Company has designed a plastic fuel rail which is superior to metal fuel rails in cost, weight and handling of more corrosive flexible fuels. In 1994, Ford began to install this new rail on the three-liter engine in the Windstar. In 1996, Chrysler will begin to install this rail on the V-8 engine for its Dodge Ram and Dakota trucks. Because of the conversion from metal to plastic fuel rails and, therefore, the declining volume of the metal rail business, the Company has decided to sell its steel fuel rail business. The Company intends to concentrate on plastic fuel rails which use more of one of its core competencies - plastic injection molding.\nAn important advantage of the Company's systems philosophy is that it assists customers in responding to developments in safety and environmental standards. For example, current environmental regulations call for a FSDS that minimizes or eliminates the escape of fuel vapors during refueling, storage and operation. In January 1994, the EPA announced regulations governing ORVR systems as mandated by the 1990 Clean Air Act. The regulations require installation of devices which trap hydrocarbon vapors on a phase-in basis for passenger cars beginning in model year 1998 and for light trucks in model year 2001. In anticipation of these regulations, the Company developed a variety of ORVR devices which help prevent fuel vapor loss from fuel delivery systems. These devices are expected to enter production during 1997.\nAUTOMOTIVE MARKETS AND CUSTOMER BASE\nThe Company currently provides a wide variety of products to a diverse customer base in a number of geographic areas.\nNorth America. Net sales to the Company's largest customer, Ford, accounted for 21% of the Company's consolidated net sales in 1995, 30% in 1994 and 30% in 1993. Net sales to Chrysler accounted for 19%, 23% and 21% of the Company's consolidated net sales in 1995, 1994 and 1993, respectively. Including the Dyno Acquisition, on a pro forma basis, net sales to Ford and Chrysler would have accounted for 17% and 15%, respectively, of the Company's consolidated net sales in 1995. Both of these customers have ongoing supply relationships with the Company which are subject to continued satisfactory price, quality and delivery. The Company is the primary outside supplier of fuel pumps, the core of the FSDS, to Ford and Chrysler. In the past, the Company has capitalized on its fuel system components penetration to supply additional fuel system products, such as fuel modules and fuel rails, to Ford and Chrysler, and to assume a key role in the development of new fuel system products, such as ORVR devices. General Motors currently develops and produces substantially all of its fuel storage and delivery systems internally but recently has sourced a significant portion of future plastic fuel tank programs to outside suppliers.\nEurope. In 1991, the Company began operations in Europe with the establishment of its Marwal Systems joint venture in France with Magneti Marelli S.p.A. of Italy. This joint venture has expanded to include ventures in Brazil and Mexico. Marwal's net sales were $113.9 million in 1995 to customers which included Peugeot, Renault, Fiat, Rover, Volvo, Saab and Nissan. Following the Dyno Acquisition, on a pro forma basis, the Company's international sales (excluding joint ventures) have increased from approximately 27% to approximately 54% of the Company's consolidated net sales, and the Company will become the only integrated FSDS company in Europe. Dyno has provided the Company with the immediate opportunity to increase its participation in the European automotive market. In addition, the Company intends to use its relationships in the U.S. to increase Dyno's sales to American manufacturers in Europe. Similarly, the Company intends to take advantage of Dyno's relationships with\nMercedes-Benz, Renault, Volkswagen, Peugeot and other European manufacturers to enhance the Company's marketing efforts with these European manufacturers around the world.\nSouth America. In January 1993, operations began at the Company's Marwal do Brasil joint venture in Brazil, which targets the South American automotive market of approximately two million units per year. In September 1995, the Company established Walbro Automotive do Brazil to manufacture plastic fuel tanks for the Brazilian automotive market.\nAsia. In November 1995, the Company established Mutual Walbro P. Ltd., a joint venture with Mutual Industries Ltd. in India to manufacture plastic fuel tanks for the Indian automotive market. In November 1994, the Company established Korea Automotive Fuel Systems Ltd., a joint venture with Daewoo Precision Industries Ltd. in South Korea, to manufacture and market fuel sending units (which include a fuel pump, bracket and level sensor) for the domestic Korean automotive market (estimated at approximately 1.5 million units per year) and additional export markets established by Korean OEMs. In December 1986, the Company entered into a joint venture in Japan known as Mitsuba-Walbro, Inc. with Mitsuba Electric Manufacturing Company to manufacture fuel pump components.\nAUTOMOTIVE COMPETITION\nThe Company competes with several other manufacturers, including the OEMs themselves, all of which have greater sales and financial resources than the Company. In the fuel pump market, the Company's major competitors include Robert Bosch GmbH, Nippondenso Co., Ltd., VDO (a division of Mannesmann), Electronics and Fuel Handling Division of Ford, and Delphi Automotive Systems (GM's component group). In the fuel rail market, the Company's major competitors include Delphi, Ford, Echlin Inc. and Siemens A.G. The Company has competition in the fuel module market from Delphi and Ford. The Company's largest competitors in the plastic fuel tank market include Kautex Werke Reinold Hagen A.G., Solvay S.A., Plastic Omnium Industries, Inc. and Ford. Steel tanks, manufactured primarily by the OEMs, also compete with the Company's plastic fuel tanks.\nThe Company principally competes for new business both at the beginning of the development of new models and upon the redesign of existing models. New model development generally begins two to three years prior to a product introduction. Once a producer has been designated to supply parts for a new program, an OEM usually will continue to purchase those parts from the designated producer for the life of the program, although not necessarily for a redesign. Competitive factors in the market for fuel storage and delivery products include product quality and reliability, cost and timely delivery, technical expertise and development capability and new product innovation.\nAUTOMOTIVE SALES AND ENGINEERING SUPPORT\nSales of the Company's FSDS products to automotive OEMs are made directly by the Company's sales\/engineering force, who not only sell the products but assist customers with related engineering matters. Because of the automobile design process, the Company is able to determine a few years in advance the models for which it will supply products. The Company's sales force works closely with the Company's engineering departments and systems center in Auburn Hills in the research, design, development and improvement of new products. Upon completion of the Company's systems center in Europe, Dyno and Marwal will also have additional design and research capabilities to provide OEMs in Europe with full-service product management. Because the Company has the capability to provide comprehensive engineering resources with respect to its product line and assume increasing\nresponsibility for the development of FSDS products, the Company has been successful in responding to the decisions by OEMs to consolidate suppliers and reduce internal engineering resources.\nAUTOMOTIVE WARRANTY AND OTHER PRODUCT EXPOSURE\nThe design and manufacture of fuel systems entails an inherent risk that a governmental authority or a customer may require the recall of one of the Company's products or a product in which one of the Company's products has been installed. The Company has taken and intends to continue to take all reasonable precautions to avoid the risk of exposure to an expensive recall campaign which could have a material adverse effect on the business and financial condition of the Company. Dyno through its former parent, Dyno Industrier A.S, carried recall insurance against losses of up to 50 million NOK, or approximately $7 million, which insurance covered certain costs incurred in connection with a recall. The Company is uncertain whether it will insure its European operations against recall losses and does not believe that recall insurance in the United States is cost effective.\nWALBRO ENGINE MANAGEMENT CORPORATION\nSMALL ENGINE INDUSTRY OVERVIEW\nThe small engine industry is facing a number of environmentally driven changes which will require an increased emphasis on fuel systems technology and the development of new fuel systems products. Growth opportunities outside of the U.S. are expected to be driven by growth in the use of two-wheeled vehicles and the increased use of gasoline-powered portable equipment in developing countries.\nEmphasis on Engine Management Systems and New Product Development. Historically, exhaust emissions of gasoline-powered small engines were unregulated. In 1992, the California Air Resources Board promulgated comprehensive air quality regulations limiting small engine emissions, which regulations became effective in August 1995. A more stringent phase is scheduled to become effective in 1999. In addition, the U.S. Environmental Protection Agency (\"EPA\") has implemented similar regulations scheduled to become effective in August 1996, with a more stringent phase expected to be phased in beginning 2002. The products designed to meet these new emission standards in the small engine market will require more sophisticated product research and new production capabilities. The increased technological content and sophistication required to meet emission regulations is expected to result in lower unit sales with greater value added per product and higher unit prices.\nGrowing Demand in Developing Countries. The Company expects significant growth in the demand for float feed carburetors in developing countries as per capita income increases and two-wheeled vehicles become more affordable. Production of two-wheeled vehicles in The People's Republic of China, for example, increased from approximately 49,000 units in 1980 to approximately 3.4 million in 1993, 5.2 million in 1994 and 7.8 million in 1995. In addition, management believes demand for diaphragm carburetors used in gasoline-powered portable tools will grow in these developing countries. The inaccessibility of electrical power distribution and geographic isolation of many projects, such as the clearing of land and highway construction, hinder the use of electric-powered equipment.\nSMALL ENGINE BUSINESS STRATEGY\nTo respond to the promulgation of increasingly strict emission regulations in the small engine industry, the Company is working to develop a small engine management system which will comply with new emission standards. As the leading developer of fuel systems technology for portable engines, the Company is well positioned to draw upon its expertise in carburetor and ignition system design and development, as well as its experience in responding to emissions-driven challenges in the automotive sector. The Company's advanced product design and development facilities in Michigan and Japan,\nwhich are equipped with sophisticated emission measurement instruments, provide the Company with the facilities necessary to develop more sophisticated small engine management systems.\nIn addition to developing new technologies, the Company intends to grow its small engine business through expansion into foreign markets. The Company's presence in developing countries such as The People's Republic of China will allow it to benefit from the growing market for carburetors for two-wheeled vehicles and from infrastructure development which requires portable power tools.\nSMALL ENGINE PRODUCTS\nThe Company was founded as a manufacturer of carburetors for small engine products such as lawn mowers and marine engines, and later expanded its customer base to include manufacturers of chain saws, weed trimmers, snow blowers and two-wheeled vehicles. The Company's carburetor technology has continually evolved, with the Company now manufacturing diaphragm and float feed carburetors, ignition systems and other components for small engine products and aftermarket applications. The Company's diaphragm carburetor, float feed carburetor and ignition system sales accounted for 53%, 23% and 6%, respectively, of the Company's 1995 small engine revenues. The remaining 18% of small engine revenue consisted of aftermarket sales.\nThe diaphragm carburetor uses a diaphragm and a series of interconnected passages to draw and regulate the amount of fuel delivered to the engine from the fuel tank. The Company manufactures several basic models of diaphragm carburetors from which are derived numerous variations. Diaphragm carburetors are used on chain saw and weed trimmer engines because they will operate in any position and minimize vapor lock. The Company believes that it is the world's largest manufacturer of small engine diaphragm carburetors.\nThe float feed carburetor uses a float in a reservoir of fuel to regulate the amount of fuel delivered to the engine. In contrast to the diaphragm carburetor, which operates in all positions, the float feed carburetor operates only in an upright position. The Company manufactures several basic models of float feed carburetors from which are derived numerous variations. The Company's float feed carburetors are used on engines for lawn mowers, garden tractors, two-wheeled vehicles, marine outboard engines, generators and industrial engines.\nThe ignition system uses rotating magnets in a flywheel, which induce an electrical charge in the ignition module. The ignition module releases this charge to the spark plug. The Company's ignition systems are used predominantly in chain saw and weed trimmer applications.\nIn response to California and proposed EPA air quality regulations, the Company has begun to integrate its carburetor and ignition technology to develop an engine management system which will electronically control both fuel delivery and ignition functions to limit exhaust emissions. The Company has successfully refined existing carburetors through the incorporation of extremely close tolerances which provide more accurate control of the fuel\/air mixture to meet the first set of standards in California in 1995 and scheduled to take effect nationwide in 1996. Company engineers are developing new technology to meet the subsequent requirements which will become effective in California in 1999 and nationwide during the period 2002 to 2005. This development effort focuses on complete engine management systems that control air flow, fuel delivery and ignition timing to enhance fuel efficiency and reduce pollution.\nSMALL ENGINE MARKETS AND CUSTOMER BASE\nThe Company sells its small engine products in a global market. Carburetors and small engine ignitions are sold by the Company's sales\/engineering staff directly to engine manufacturers. The Company sells a major portion of its diaphragm carburetors to most of the leading chain saw and weed trimmer manufacturers, including Poulan\/Weedeater (a Division of Electrolux, A.B.), Homelite (a Division of Deere & Company), Stihl, Incorporated, McCulloch, Ryobi Ltd. and Kioritz (Echo) Corporation. The Company sells float feed carburetors to several of the leading manufacturers of small engines, including Briggs & Stratton Corporation, the world's largest small engine manufacturer. Mercury Marine (a Division of Brunswick Corporation), a major outboard engine manufacturer, buys all of its outboard engine carburetors from the Company. Ten of the Company's small engine customers in 1995 collectively accounted for approximately 60% of small engine product sales and approximately 14% of the Company's net sales, including Dyno on a pro forma basis.\nOne of the Company's opportunities for growth in the small engine industry is the Chinese market. In January 1994, the Company acquired a 60% interest, increased to 70% in 1995, in Fujian Hualong Carburetor Co., Ltd. (Fujian) which manufactures and markets carburetors for two-wheeled vehicles in The People's Republic of China. In addition, the Company has built a new manufacturing facility near Beijing to provide additional capacity to take advantage of growth in the two-wheeled vehicle market.\nSMALL ENGINE COMPETITION\nThe Company has several competitors that manufacture diaphragm carburetors for the global small engine market, including Zama Industries, Ltd., Tillotson Commercial Motors Ltd. and Dell' Orto, some of which are divisions of large diversified organizations which have total sales and financial resources exceeding those of the Company. In the market for float feed carburetors, the Company has several competitors, including Briggs & Stratton and Tecumseh, both of which have greater sales and financial resources than the Company. The Company's major competitor in the ignition systems market is R.E. Phelon Company Inc.\nAFTERMARKET PRODUCTS\nThe Company's aftermarket sales of both automotive and small engine products are consolidated within the small engine business. The Company sells automotive aftermarket products for both carbureted vehicle applications and electronic fuel injection vehicle applications through independent distributors, such as Federal Mogul and Standard Motor Products, and jobbers and dealers worldwide. Some automotive products are also sold to national manufacturing and distribution organizations for sale under private brand names or to industrial customers for use in special applications. Aftermarket sales accounted for $25.2 million in 1995 compared to $11.3 million in 1990.\nThe Company sells automotive aftermarket products to support its OEM customers and to benefit from higher margins on aftermarket sales. Management believes that the overall market size for automotive electronic fuel injection systems components sold to the aftermarket will continue to grow as the population of vehicles equipped with electronic fuel injection systems ages.\nThe Company sells its own brand name small engine aftermarket products through independent distributors, jobbers and dealers worldwide. Some of these products are also sold to national manufacturing and distribution organizations for sale under private brand names or to industrial customers for use in special applications.\nMANUFACTURING AND FACILITIES\nThe Company (including Dyno and the Company's joint ventures) conducts operations in approximately 1.75 million square feet of space in a total of 31 locations. The Company believes that substantially all of its property and equipment is in good condition. The Company has not experienced significant limitations on its ability to transfer products between, or sell products in, various countries.\nEach of the Company's manufacturing facilities practices advanced inventory control procedures and has installed statistical process controls to insure high levels of quality. In that regard, some of the Company's factories have received the Ford Q1 Award and the Chrysler QE Award. In connection with its sales to Saab, which is partially owned by General Motors, Dyno's Norway facility has been named a General Motors Supplier of the Year four years in a row beginning in 1991. Various other Company factories have been recognized by Mercury Marine, Stihl and Federal Mogul for excellence in product quality and delivery.\nWhen justified by volume, the Company has invested in labor-saving automated machining, assembly and testing equipment. For example, the operation in Meriden, Connecticut employs computer controlled molding machines to form the Company's plastic in-tank reservoirs. These machines are individually programmable so that variations can be reduced and refined as part of the continuous control process. Another example is the Caro, Michigan manufacturing facility's automated fuel pump assembly line, which is capable of producing 1,000 pumps per hour using only six persons. Over the past several years, the Company has reduced the cost to manufacture its fuel pumps at this facility by reducing both labor and material costs. In Ettlingen, Germany, the Company uses a fully automated assembly line for production of plastic fuel tanks for the Mercedes-Benz 190\/C Class. In addition to these examples of purchased automation, the Company designs and builds major portions of its own machining and assembly equipment. This in-house capability permits close control over the manufacturing process and helps the Company stay competitive in both cost and quality.\nPATENTS, RESEARCH AND PRODUCT DEVELOPMENT\nThe Company owns approximately 150 U.S. patents and 600 international patents in the fuel systems field and has a number of applications pending. These patents include proprietary ownership of designs for control devices for engines and engine systems, fuel pumps, fuel rails, fuel regulators, fuel level sensors, fuel reservoirs and fuel system vapor control devices, carburetors and throttle bodies, as well as ancillary devices for engine and vehicle applications.\nAlthough these patents are significant to the Company, management believes that in many cases the adaptation and use of the technology involved and the proprietary process technology employed to manufacture these products are more important. The Company maintains a systems center in Michigan for the research, design and development of new products. The Company's engineering departments also engage in design, development and testing. In 1995, 1994 and 1993, the Company (excluding Dyno) spent approximately $14.0 million, $12.2 million and $9.5 million, respectively, for engineering and research and product development. After giving effect to the Dyno Acquisition the Company has spent approximately $16.7 million in 1995 for engineering and research and product development.\nCOMPONENTS, MATERIALS AND INVENTORY\nThe Company has a number of sources for the components used in manufacturing its products. The suppliers who manufacture components often utilize tools and dies owned by the Company. If a supplier were to discontinue supplying any component, it could take the Company some time to replace the supplier; however, the Company believes its operations would not be materially adversely affected.\nThe Company's principal customers provide it with estimates of their annual needs and make monthly purchase commitments. As a result, the Company does not experience material backlog. Consequently, the Company manages its manufacturing facilities on a just-in-time supply basis and does not maintain a finished product inventory of any significance. The Company does not believe the Dyno Acquisition has had a material effect on the Company's materials sourcing or inventory management.\nEMPLOYEES\nAs of February 29, 1996, the Company had approximately 4,400 employees. The Company believes that its relations with its employees are satisfactory. All of the Company's approximately 900 European plant employees are unionized. All of the Company's United States plant employees are non-unionized except approximately 450 employees at its Michigan locations. The Company's three-year contract with the bargaining unit for these Michigan plants expires in November 1998.\nREGULATION\nThe Company's operations are subject to increasingly stringent environmental laws and regulations governing air emissions, waste water discharges, the generation, treatment, storage, disposal and remediation of hazardous substances and wastes, and employee health and safety. Certain of these laws can impose joint and several liability for releases or threatened releases of material upon certain statutorily defined parties, including the Company, regardless of fault or the lawfulness of the original activity or disposal.\nThe Company believes it is currently in material compliance with applicable environmental laws and regulations. The Company's compliance with environmental laws and regulations has not materially affected the results of its operations or the conduct of its business; however, the Company cannot predict the future effects of such laws and regulations.\nACQUISITION AND JOINT VENTURE STRATEGY\nAs part of a long-term strategy for growth and expansion into new geographic and product markets, the Company may undertake select acquisitions and strategic alliances in the form of joint ventures. The Company may make select acquisitions of fuel system product manufacturers such as Dyno whose products can be integrated with the Company's traditional products as part of the Company's system development focus. These acquisitions would contribute new product technology and open new markets to the Company. In evaluating these acquisitions, the Company seeks high quality operations which fit with the Company's expertise in markets where the company has an established customer base and a clear vision of opportunities, thus decreasing transition costs and other financial risks associated with corporate acquisitions. Similarly, each of the Company's joint ventures provides the Company with the opportunity to benefit from established customer relationships or a unique technological advancement which the Company could not develop on its own without the risk and expense of establishing marketing and manufacturing organizations alone. In management's opinion, the Company's joint ventures ultimately reduce the cost of penetrating new markets and limit the Company's financial exposure with respect to these operations. At the present time the Company has no specific agreements with respect to any such acquisitions or joint ventures.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company believes that substantially all of its property and equipment is in good condition. In total, the Company owns approximately 915,000 square feet of space and leases an additional approximately 614,000 square feet of space in a total of 27 locations.\nIn addition, through various joint ventures described above, the Company has access to manufacturing facilities of approximately 100,000 square feet in Chalons, France (Marwal Systems), 30,000 square feet in Kiryu City, Japan (Mitsuba-Walbro), 40,000 square feet in Sao Paulo, Brazil (Marwal do Brasil), and 50,000 square feet in Jochi-Won, South Korea (Korea Automotive Fuel Systems Ltd.).\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is not a party to any litigation, and is not aware of any pending or threatened litigation, that would have a material adverse effect on the Company or 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 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nIncorporated by reference to \"Common Stock Price and Dividend Information\" on page 12 of the Company's Annual Report to Stockholders for the fiscal year ended December 31, 1995 (the \"1995 Annual Report\").\nITEM 6.","section_6":"ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA\nIncorporated by reference to \"Selected Financial Data\" on page 12 of the 1995 Annual Report.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nIncorporated by reference to \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" on pages 13 through 18 of the 1995 Annual Report.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nIncorporated by reference herein from the following sections of the 1995 Annual Report. The consolidated statements of income, cash flows and stockholders' equity are for each of the years ended December 31, 1995, 1994 and 1993 and the consolidated balance sheets are as of December 31, 1995, 1994 and 1993:\nReport of Independent Public Accountants, page 19.\nConsolidated Balance Sheets, page 20.\nConsolidated Statements of Income, page 21.\nConsolidated Statements of Stockholders' Equity, page 22.\nConsolidated Statements of Cash Flows, page 23.\nNotes to Consolidated Financial Statements, pages 24 through 39.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nIncorporated by reference to \"Election of Directors\" on pages 2 through 6, \"Identification of Other Executive Officers\" on page 9 and \"Compliance with Section 16(a) of the Exchange Act\" on page 10 of the Company's Notice of Annual Meeting of Stockholders and Proxy Statement for its Annual Meeting of Stockholders to be held on April 17, 1996 (the \"1996 Proxy Statement\").\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nIncorporated by reference to \"Executive Compensation\" on pages 11 through 15 and \"Compensation of the Board of Directors\" on pages 5 and 6 of the 1996 Proxy Statement.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nIncorporated by reference to \"Security Ownership of Management\" on page 8 of the 1996 Proxy Statement.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nIncorporated by reference to \"Indebtedness of Management\" on page 10 of the 1996 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 Form 10-K:\n1. The following consolidated financial statements of the Company and its subsidiaries, together with the applicable report of independent public accountants, included in the 1995 Annual Report, are incorporated by reference in Item 8:\nReport of Independent Public Accountants.\nConsolidated Balance Sheets at December 31, 1995, 1994 and 1993.\nConsolidated Statements of Income for the years ended December 31, 1995, 1994 and 1993.\nConsolidated Statements of Stockholders' Equity for the years ended December 31, 1995, 1994 and 1993.\nConsolidated Statements of Cash Flows for the years ended December 31, 1995, 1994 and 1993.\nNotes to Consolidated Financial Statements.\n2. The following consolidated financial information of the Company and its subsidiaries for the three years ended December 31, 1995 is filed as part of this Form 10-K on pages 22 to 34.\nReport of Independent Public Accountants.\nSupplemental Notes to Consolidated Financial Statements.\n(1) Valuation and Qualifying Accounts.\n(2) Supplemental Guarantor Condensed Consolidating Financial Statements.\nThe information required to be submitted in Schedule II is included in the Supplemental Notes to Consolidated Financial Statements.\n3. The following exhibits are filed with this report or incorporated by reference as set forth below.\nExhibit No.\n3.1 Restated Certificate of Incorporation of the Company, filed as Exhibit 3.1 to the Company's 1989 Annual Report on Form 10-K, incorporated herein by reference.\n3.2 By-laws of the Company, as amended, filed as Exhibit 3.2 to the Company's 1989 Annual Report on Form 10-K, incorporated herein by reference.\n3.3 Amendment to Section 2.9 of the By-laws of the Company, filed as Exhibit 3.3 to the Company's 1994 Annual Report on Form 10-K, incorporated herein by reference.\n4.1 Shareholder Rights Plan, dated December 8, 1988, filed as the Exhibit to the Company's Registration Statement on Form 8-A for Shareholder Stock Purchase Rights filed December 12, 1988, incorporated herein by reference.\n4.2 First Amendment to Rights Agreement, dated February 6, 1991, filed as Exhibit 4.8 to the Company's 1990 Annual Report on Form 10-K, incorporated herein by reference.\n4.3 Loan Agreement between City of Ligonier, Indiana and Sharon Manufacturing Company, dated as of June 1, 1992, filed as Exhibit 4.12 to the Company's 1992 Annual Report on Form 10-K, incorporated herein by reference.\n4.4 Loan Agreement between Walbro Automotive Corporation and the Town of Ossian, Indiana, dated as of December 1, 1993, filed as Exhibit 4.13 to the Company's 1993 Annual Report on Form 10-K, incorporated herein by reference.\n4.5 Note Agreement among the Company and the purchasers named therein, dated as of October 1, 1994, relating to the 7.68% Senior Notes of the Company, filed as Exhibit 4.9 to the Company's 1994 Annual Report on Form 10-K, incorporated herein by reference.\n4.6 Indenture for the Notes, dated as of July 27, 1995, among the Company, Walbro Engine Management Corporation, Sharon Manufacturing Company, Whitehead Engineered Products, Inc., and Bankers Trust Company, as Trustee (including form of Exchange Note), filed as Exhibit 2.3 to the Company's Current Report on Form 8-K, dated July 27, 1995 (the \"Form 8-K\"), incorporated herein by reference.\n4.7 Amended and Restated Credit Agreement dated as of September 22, 1995, among the Company, certain of its subsidiaries, Comerica Bank, as agent, and Harris Bank, as co-agent, filed as Exhibit 4.2 to the Company's Registration Statement on Form S-4, filed September 27, 1995, incorporated herein by reference.\n4.8 First Amendment, dated March 8, 1996, to the Amended and Restated Credit Agreement among the Company, certain of its subsidiaries, Comerica Bank, as agent, and Harris Bank, as co-agent.\n4.9 First Amendment, dated as of July 26, 1995, to the Note Agreement among the Company and the purchasers named therein, relating to the 7.68% Senior Notes of the Company.\n10.1 The Company's 1983 Incentive Stock Option Plan, filed as the Exhibit to the Company's Registration Statement on Form S-8, filed November 15, 1989, incorporated herein by reference.**\n10.2 Joint Venture Agreement between the Company and Mitsuba Electric Manufacturing Company, Ltd., dated December 12, 1986, filed as Exhibit 10.4 to the Company's 1986 Annual Report on Form 10-K, incorporated herein by reference.\n10.3 The Company's Equity Based Long-Term Incentive Plan, filed as Exhibit 4.5 to the Company's Registration Statement on Form S-8, filed June 15, 1992, incorporated herein by reference.**\n10.4 Executive Disability Plan adopted July 8, 1988, filed as Exhibit 10.10 to the Company's 1988 Annual Report on Form 10-K, incorporated herein by reference.**\n10.5 Retirement Income Plan for Directors, dated February 9, 1988, filed as Exhibit 10.11 to the Company's 1988 Annual Report on Form 10-K, incorporated herein by reference.**\n10.6 Equipment Leasing Agreement between the Company and NEMLC Leasing Associates No. 3, without supplements, dated July 1, 1988, filed as Exhibit 10.13 to the Company's 1988 Annual Report on Form 10-K, incorporated herein by reference.\n10.7 The Company's Employee Stock Ownership Plan, dated August 15, 1989, filed as Exhibit 10.14 to the Company's 1989 Annual Report on Form 10-K, incorporated herein by reference.\n10.8 Walbro Engine Management Incentive Compensation Plan, filed as Exhibit 10.21 to the Company's 1990 Annual Report on Form 10-K, incorporated herein by reference.**\n10.9 Joint Venture Agreement, dated June 17, 1991, between the Company and Jaeger S.A, an indirect, majority-controlled subsidiary of Magneti Marelli S.p.A., relating to the Marwal Systems S.A. joint venture, filed as Exhibit 10.23 to the Company's Registration Statement on Form S-2, File No. 33- 41425, incorporated herein by reference.\n10.10 Joint Venture Agreement between the Company and Jaeger S.A., dated as of January 1, 1993, relating to the Marwal do Brasil joint venture, filed as Exhibit 10.10 to the Company's 1992 Annual Report on Form 10-K, incorporated herein by reference.\n10.11 Agreement among AB Svenska Elektromagneter, Opcon AB, Cartona Fastighetsforvaltning K.B., Erling Edmundson, Four Seasons Venture Capital AB, SEM-Walbro Corporation and the Company, effective as of January 2, 1991, filed as Exhibit 10.20 to the Company's 1991 Annual Report on Form 10-K, incorporated herein by reference.\n10.12 The Company's Advantage Plan, filed as the Exhibit to the Company's Registration Statement on Form S-8, filed October 28, 1991, incorporated herein by reference.**\n10.13 Aircraft Lease Agreement between the Company and C.I.T. Leasing Corporation, dated as of October 27, 1992, filed as Exhibit 10.13 to the Company's 1992 Annual Report on Form 10-K, incorporated herein by reference.\n10.14 Joint Venture Contract among Walbro Engine Management Corporation, Fujian Fuding Carburetor Factory and Twin Winner Trading Co., Ltd., dated December 30, 1993, relating to the Fujian Hualong Carburetor Co. Ltd. joint venture, filed as Exhibit 10.14 to the Company's 1994 Annual Report on Form 10-K, incorporated herein by reference.\n10.15 Severance Compensation and Consulting Agreement between the Company and R. H. Whitehead III, dated as of February 26, 1990, filed as Exhibit 10.15 to the Company's 1994 Annual Report on Form 10-K, incorporated herein by reference.**\n10.16 Employment Agreement between the Company and L. E. Althaver, dated August 6, 1993, filed as Exhibit 10.16 to the Company's 1994 Annual Report on Form 10-K, incorporated herein by reference.**\n10.17 Severance Compensation and Consulting Agreement between the Company and L. E. Althaver, dated as of February 26, 1990, filed as Exhibit 10.17 to the Company's 1994 Annual Report on Form 10-K, incorporated herein by reference.**\n10.18 Employment Agreement between the Company and Robert H. Walpole, dated October 1, 1993, filed as Exhibit 10.18 to the Company's 1994 Annual Report on Form 10-K, incorporated herein by reference.**\n10.19 Severance Compensation and Consulting Agreement between the Company and Robert H. Walpole, dated as of February 26, 1990, filed as Exhibit 10.19 to the Company's 1994 Annual Report on Form 10-K, incorporated herein by reference.**\n10.20 Employment Agreement between the Company and Gary L. Vollmar, dated August 6, 1993, filed as Exhibit 10.20 to the Company's 1994 Annual Report on Form 10-K, incorporated herein by reference.**\n10.21 Severance Compensation and Consulting Agreement between the Company and Gary L. Vollmar, dated as of February 26, 1990, filed as Exhibit 10.21 to the Company's 1994 Annual Report on Form 10-K, incorporated herein by reference.**\n10.22 Employment Agreement between the Company and Daniel L. Hittler, dated August 6, 1993, filed as Exhibit 10.22 to the Company's 1994 Annual Report on Form 10-K, incorporated herein by reference.**\n10.23 Severance Compensation and Consulting Agreement between the Company and Daniel L. Hittler, dated as of February 26, 1990, filed as Exhibit 10.23 to the Company's 1994 Annual Report on Form 10-K, incorporated herein by reference.**\n10.24 Agreement among the Company, Walbro Automotive Corporation and Magneti Marelli France S.A., dated February 7, 1995, filed as Exhibit 10.24 to the Company's 1994 Annual Report on Form 10-K, incorporated herein by reference.**\n10.25 Joint Venture Agreement between the Company and Daewoo Precision Industries, Ltd., dated November 30, 1994, filed as Exhibit 10.25 to the Company's 1994 Annual Report on Form 10-K, incorporated herein by reference.**\n10.26 Employment Agreement between the Company and Michael A. Shope, dated December 20, 1993.**\n10.27 Severance Compensation and Consulting Agreement between the Company and Michael A. Shope, dated as of December 20, 1993.**\n10.28 Purchase and Sale Agreement dated as of April 7, 1995 by and between the Company and Dyno, filed as Exhibit 2.1 to the Company's Quarterly Report on Form 10-Q, for the quarter ended March 31, 1995, incorporated herein by reference.\n10.29 Addendum to Purchase and Sale Agreement by and between the Company and Dyno dated as of July 27, 1995, filed as Exhibit 2.2 to the Form 8-K, incorporated herein by reference.\n10.30 Joint Venture Agreement between Walbro Automotive Corporation and Mutual Industries Ltd., dated November 28, 1995, relating to the Mutual Walbro P. Ltd. joint venture.\n10.31 General Partnership Agreement dated August 18, 1995 between Iwaki Diecast U.S.A., Inc. and Walbro Tucson Corp.\n13.1 1995 Annual Report to Stockholders. With the exception of the information incorporated by reference into Items 5, 6, 7, 8 and 14(a)(1) of this Form 10-K, the 1995 Annual Report to Stockholders is not deemed filed as part of this report.\n21.1 Subsidiaries of the Company.\n23.1 Consent of Arthur Andersen LLP, independent public accountants.\n27.1 Financial Data Schedule.\n- -------------- ** Management contract or compensatory plan or arrangement required to be filed as an exhibit to this Form 10-K.\n(b) Reports on Form 8-K:\nThe Company did not file any reports on Form 8-K during the last quarter of the period covered by this Form 10-K.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 21st day of March, 1996.\nWALBRO CORPORATION\nBy: \/s\/ MICHAEL A. SHOPE --------------------------------------- Michael A. Shope, 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 and on the dates indicated.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Board of Directors and Stockholders of Walbro Corporation:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in Walbro Corporation and Subsidiaries' annual report to shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated February 13, 1996. Our audits were made for the purpose of forming an opinion on those statements taken as a whole. The supplemental notes to the consolidated financial statements on pages 23 to 34 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 required part of the basic consolidated financial statements. The information contained in these supplemental notes 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\nDetroit, Michigan, February 13, 1996\nWALBRO CORPORATION AND SUBSIDIARIES SUPPLEMENTAL NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(1) VALUATION AND QUALIFYING ACCOUNTS\nFollowing is a summary of changes in the valuation and qualifying accounts for the three years ended December 31,:\n- ------------------------------------------- (A) Represents costs of discontinuance incurred subsequent to decision date.\nWALBRO CORPORATION AND SUBSIDIARIES\nSUPPLEMENTAL NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(2) SUPPLEMENTAL GUARANTOR CONDENSED CONSOLIDATING FINANCIAL STATEMENTS\nWALBRO CORPORATION AND SUBSIDIARIES\nSUPPLEMENTAL NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(2) SUPPLEMENTAL GUARANTOR CONDENSED CONSOLIDATING FINANCIAL STATEMENTS (CONTINUED)\nWALBRO CORPORATION AND SUBSIDIARIES\nSUPPLEMENTAL NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(2) SUPPLEMENTAL GUARANTOR CONDENSED CONSOLIDATING FINANCIAL STATEMENTS (CONTINUED)\nWALBRO CORPORATION AND SUBSIDIARIES\nSUPPLEMENTAL NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(2) SUPPLEMENTAL GUARANTOR CONDENSED CONSOLIDATING FINANCIAL STATEMENTS (CONTINUED)\nWALBRO CORPORATION AND SUBSIDIARIES\nSUPPLEMENTAL NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(2) SUPPLEMENTAL GUARANTOR CONDENSED CONSOLIDATING FINANCIAL STATEMENTS (CONTINUED)\nWALBRO CORPORATION AND SUBSIDIARIES\nSUPPLEMENTAL NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(2) SUPPLEMENTAL GUARANTOR CONDENSED CONSOLIDATING FINANCIAL STATEMENTS (CONTINUED)\nWALBRO CORPORATION AND SUBSIDIARIES\nSUPPLEMENTAL NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(2) SUPPLEMENTAL GUARANTOR CONDENSED CONSOLIDATING FINANCIAL STATEMENTS (CONTINUED)\nWALBRO CORPORATION AND SUBSIDIARIES\nSUPPLEMENTAL NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(2) SUPPLEMENTAL GUARANTOR CONDENSED CONSOLIDATING FINANCIAL STATEMENTS (CONTINUED)\nWALBRO CORPORATION AND SUBSIDIARIES\nSUPPLEMENTAL NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(2) SUPPLEMENTAL GUARANTOR CONDENSED CONSOLIDATING FINANCIAL STATEMENTS (CONTINUED)\nWALBRO CORPORATION AND SUBSIDIARIES\nSUPPLEMENTAL NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(2) SUPPLEMENTAL GUARANTOR CONDENSED CONSOLIDATING FINANCIAL STATEMENTS (CONTINUED)\nBasis of Presentation -- In connection with the acquisition (the Dyno Acquisition) by the Company of the fuel systems business of Dyno Industrier A.S (Dyno) and the execution of a new $135,000,000 credit facility, the Company issued $110,000,000 in aggregate principal amount of Senior Notes due in 2005 (the Notes). The Notes are guaranteed on a senior unsecured basis, jointly and severally, by each of the Company's principal wholly-owned domestic operating subsidiaries and certain of its indirect wholly-owned subsidiaries (the Guarantors). The Guarantors include Walbro Automotive Corporation, Walbro Engine Management Corporation, Whitehead Engineered Products, Inc. and Sharon Manufacturing Co. The condensed consolidating financial statements of the Guarantors are presented on pages 24 through 32 and should be read in connection with the consolidated financial statements of the Company. Separate financial statements of the Guarantors are not presented because the Guarantors are jointly, severally and unconditionally liable under the guarantees, and the Company believes the condensed consolidating financial statements presented are more meaningful in understanding the financial position of the Guarantors.\nDistributions -- There are no significant restrictions on the ability of the Guarantors to make distributions to Walbro Corporation.\nPostretirement Health Benefits -- The Company provides postretirement health care, dental benefit and prescription drug coverage to a limited number of current retirees. Effective January 1, 1993, the Company changed its method of accounting for the cost of these benefits from a pay-as-you-go (cash) method to an accrual method as required by SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other than Pensions,\" and recognized the unfunded transition obligation of $4,394,000 ($2,900,000 after-tax) as a one-time cumulative effect of change in accounting in 1993. The net periodic postretirement benefit cost amounted to $350,000 in 1995, $413,000 in 1994 and $321,000 in 1993. These amounts are recorded under Parent Corporation in the accompanying Supplemental Guarantor Condensed Consolidating Financial Statements. As these costs relate to existing retirees, they have not been allocated to the Guarantors.\nWALBRO CORPORATION AND SUBSIDIARIES\nSUPPLEMENTAL NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(2) SUPPLEMENTAL GUARANTOR CONDENSED CONSOLIDATING FINANCIAL STATEMENTS (CONTINUED)\nCombined Long-Term Debt of the Parent Corporation and Guarantor Subsidiaries -- Long-term debt of the Issuer and the Guarantors consisted of the following at December 31 (in thousands):\nFor a more detailed description of the above indebtedness, see Note 8 of Notes to Consolidated Financial Statements.\nAggregate minimum principal payment requirements on long-term debt, including capital lease obligations, in each of the five years subsequent to December 31, 1995 are as follows: 1996 - $963,000; 1997 - $1,036,000; 1998 - $7,863,000; 1999 - $7,504,000; 2000 - $57,248,000 and thereafter - $151,619,000.\nINDEX TO EXHIBITS\nSequential Exhibits Description Page No. -------- ----------- ---------- 4.8 First Amendment, dated March 8, 1996, to the Amended and Restated Credit Agreement among the Company, certain of its subsidiaries, Comerica Bank, as agent, and Harris Bank, as co-agent.\n4.9 First Amendment, dated as of July 26, 1995, to the Note Agreement among the Company and the purchasers named therein, relating to the 7.68% Senior Notes of the Company.\n10.26 Employment Agreement between the Company and Michael A. Shope, dated December 20, 1993.\n10.27 Severance Compensation and Consulting Agreement between the Company and Michael A. Shope, dated as of December 20, 1993.\n10.30 Joint Venture Agreement between Walbro Automotive Corporation and Mutual Industries Ltd., dated November 28, 1995, relating to the Mutual Walbro P. Ltd. joint venture.\n10.31 General Partnership Agreement dated August 18, 1995 between Iwaki Diecast U.S.A., Inc. and Walbro Tucson Corp.\n13.1 1995 Annual Report to Stockholders. With the exception of the information incorporated by reference into Items 5, 6, 7, 8 and 14(a)(1) of this Form 10-K, the 1995 Annual Report to Stockholders is not deemed filed as part of this report.\n21.1 Subsidiaries of the Company.\n23.1 Consent of Arthur Andersen LLP, independent public accountants.\n27.1 Financial Data Schedule.","section_15":""}
{"filename":"80816_1995.txt","cik":"80816","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nThe Registrant (\"The Providence Journal Company\") and its consolidated subsidiaries are herein collectively referred to as the \"Company\". The Company's principal executive offices are located at 75 Fountain Street, Providence, Rhode Island, and its telephone number is (401) 277-7000.\nThe Company is a diversified communications company with operations in television broadcasting (\"Broadcasting\"), newspaper publishing (\"Publishing\") and programming and new media ventures (\"Programming and New Media\"). In television broadcasting, the Company owns and operates or provides programming and marketing services for eleven television stations in nine geographically diverse markets, including five stations serving areas that are among the fifty largest domestic television markets. The Company's published newspapers known collectively as the Journal, have the largest circulation in the Rhode Island and Southeastern Massachusetts market. The Company was a founding partner of the Television Food Network, is the key investor in America's Health Network, launched the NorthWest Cable News Channel and Rhode Island Horizons (an electronic on-line information service) in 1995, and is involved in various other programming and new media ventures.\nRecent Developments\nPursuant to the transactions described below, on October 5, 1995, the Company acquired its joint venture partner's 50% interest in five television broadcasting stations owned and operated by King Holding Corp. (\"KHC\") and disposed of all its cable operations.\nPrior to the consummation of the Merger (defined below) on October 5, 1995 and other transactions described below, Broadcasting, Publishing and Programming and New Media were conducted by Old PJC (as defined below), which was also engaged in the ownership and operation of cable television systems (\"PJC Cable Business\"). The Company was incorporated in the State of Delaware on November 15, 1994 and is successor to Providence Journal Company (\"Old PJC\") which reorganized itself and disposed of its cable operations on October 5, 1995 in a series of transactions as described below. Old PJC was incorporated in the State of Rhode Island in 1884.\nOn October 5, 1995, Old PJC completed the acquisition of its joint venture partner's interest in KHC for $265 million, including $5 million in transaction fees (the \"Kelso Buyout\"), completed the transfer of all non-cable operations from Old PJC to the Company in a substantially tax-free reorganization pursuant to which the shares of capital stock of the Registrant were distributed to the shareholders of Old PJC (the \"PJC Spin-Off\"), and, following the PJC Spin-Off, at which point it held only Old PJC's cable television businesses and assets, Old PJC was merged (\"the Merger\") with and into Continental Cablevision, Inc. (\"Continental\"). Immediately prior to the Kelso Buyout, Continental purchased for $405 million all of the stock of King Videocable Company (\"KVC\"), a wholly owned subsidiary of King Broadcasting Company (\"KBC\"), which is wholly owned by KHC. As a result of these transactions, the Company, in substance, became successor to Old PJC, in the same lines of businesses, simultaneously disposing of its cable operations. These transactions are more fully discussed in Note 2 of the Consolidated Financial Statements. Since the Company is in substance the successor to Old PJC, the remainder of this Annual Report on Form 10-K will not distinguish between Old PJC and the Company except when such distinction is necessary for clear disclosure.\nSegment Financial Information\nFinancial information about the Company's segments in addition to that provided in the description of the businesses which immediately follows, is provided in item 7 of this Form 10-K and in Note 18 of the Consolidated Financial Statements of the Company included herein.\nEBITDA\nEarnings before interest, taxes, depreciation, amortization, stock-based compensation and pension expense (\"EBITDA\") is considered by the Company to be a good indicator in evaluating performance and is used throughout this document. EBITDA should not, however, be considered by the reader as an alternative to operating or net income computed in accordance with generally accepted accounting principles (\"GAAP\") as an indicator of performance or as an alternative to cash flows from operating activities (as determined in accordance with GAAP) as a measure of liquidity.\nDESCRIPTION OF BROADCASTING BUSINESS\nTHE STATIONS\nThe Company owns and operates nine network-affiliated television stations (the ''Stations'') in geographically diverse markets, including five in the fifty largest domestic television markets, as measured by the number of television households. The Company also provides programming and marketing services for two television stations (one in Honolulu and one in Tucson) under \"Local Marketing Agreements\" (\"LMA\"), as discussed below. Seven of the television stations extend their reach through satellite stations, low power television stations and translators. For the year ended December 31, 1995, the Company had net revenues from its broadcast operations of $181 million, or 58% of consolidated revenues of the Company. EBITDA for broadcasting was $64.4 million of consolidated EBITDA of $65.2 million.\nThe following table sets forth general information for each of the Stations and the markets they serve, based on the Nielsen Station Index as of November 1995. The Stations are listed in order of the ranking of their Designated Marketing Area (\"DMA\").\nKING-TV-Seattle, WA. KING operates in the Seattle\/Tacoma market, the twelfth largest television market in the United States, with approximately 1.46 million television households and a population of approximately 3.8 million. In 1995, the Seattle\/Tacoma market totaled approximately $258 million in television advertising revenue. There are ten licensed commercial television stations in Seattle\/Tacoma (six VHF stations and four UHF stations) and three public stations. All four network affiliates are VHF (including KING), two independents are VHF and the other four independents are UHF. KING has been an NBC affiliate since 1959, and its current affiliation agreement expires in 2001.\nKGW(TV)-Portland, OR. KGW operates in the Portland market, the twenty-fourth largest television market in the United States, with approximately 933,000 television households and a population of approximately 2.4 million. In 1995, the Portland market totaled approximately $142 million in television advertising revenue. There are eight licensed commercial television stations in the Portland market (four VHF stations and four UHF stations) and one public station. Three network affiliates are VHF (including KGW), the Fox station is UHF, one independent station is VHF and the other three independent stations are UHF. KGW has been an NBC affiliate since 1959, and its current affiliation agreement expires in 2001.\nWCNC-TV-Charlotte, NC. WCNC operates in the Charlotte market, the twenty-eighth largest television market in the United States, with approximately 802,000 television households and a population of approximately 2.1 million. In 1995, the Charlotte market totaled approximately $119 million in television advertising revenue. There are seven licensed commercial television stations in Charlotte (two VHF and five UHF stations) and one public station. Two network affiliates are VHF stations, two network affiliates are UHF stations (including WCNC), and three independent stations are UHF stations. WCNC has been an NBC affiliate since 1978, and its current affiliation agreement expires in 2001.\nKASA-TV-Albuquerque\/Santa Fe, NM. KASA operates in the Albuquerque\/Santa Fe market, the forty-eighth largest television market in the United States, with approximately 553,000 television households and a population of 1.5 million. In 1995, the Albuquerque\/Santa Fe market totaled approximately $71 million in television advertising revenue. There are eight licensed commercial television stations in Albuquerque\/Santa Fe (five VHF stations and three UHF stations) and two public stations. All four networks affiliates are VHF stations (including KASA), one independent is a VHF station and three independents are UHF stations. KASA has been a Fox affiliate since 1986, and its current affiliation agreement expires in 1998. KASA is the Fox affiliate for New Mexico and Southern Colorado.\nWHAS-TV-Louisville, KY. WHAS operates in the Louisville market, the fiftieth largest television market in the United States, with approximately 543,000 television households and a population of approximately 1.4 million. In 1995, the Louisville market totaled approximately $82 million in television advertising revenue. There are seven licensed commercial television stations in Louisville (two VHF and five UHF stations) and one public station. Two network stations are VHF (including WHAS), two network stations are UHF and the three independent stations are UHF. WHAS has been an ABC affiliate since 1990, and its current affiliation agreement expires in 2000.\nKHNL(TV)-Honolulu, HI. KHNL operates in the Honolulu market, the seventieth largest market in the United States, with approximately 381,000 television households and a population of approximately 1.2 million. In 1995, the Honolulu market totaled approximately $58 million in television advertising revenue. There are nine licensed commercial television stations in Honolulu (five VHF stations and four UHF stations) and one public station. All four network stations are VHF (including KHNL). One independent station is VHF (KFVE) and four independent stations are UHF. KHNL became an NBC affiliate on January 1, 1996, and its affiliation agreement with NBC will expire in 2002.\nFor a description of KHNL's local marketing agreement with KFVE, see \"Local Marketing Agreements\".\nKREM-TV-Spokane, WA. KREM operates in the Spokane market, the seventy-fourth largest television market in the United States, with approximately 366,000 television households and a population of approximately 925,000. In 1995, the Spokane market totaled approximately $43 million in television advertising revenue. There are four licensed commercial television stations in Spokane (three VHF stations and one UHF station) and three public stations. Three network affiliates are VHF stations (including KREM) and the Fox affiliate is a UHF station. KREM has been a CBS affiliate since 1977, and its current affiliation agreement expires in 1996 and it is anticipated it will be extended to 2002.\nKMSB-TV-Tucson, AZ. KMSB operates in the Tucson market, the eightieth largest television market in the United States, with approximately 344,000 television households and a population of approximately 860,000. In 1995, the Tucson market totaled approximately $50 million in television advertising revenue. There are six licensed commercial television stations in Tucson (four VHF stations and two UHF stations) and two public stations. All four network affiliates are VHF stations (including KMSB), and two independent stations are UHF stations. KMSB has been a Fox affiliate since 1986, and its current affiliation agreement expires in 1998.\nFor a description of KMSB's local marketing agreement with KTTV, see \"Local Marketing Agreements\".\nKTVB(TV)-Boise, ID. KTVB operates in the Boise market, the one hundred twenty-seventh largest television market in the United States, with approximately 233,000 television households and a population of 475,000. In 1995, the Boise market totaled approximately $26 million in television advertising revenue. There are five licensed commercial television stations in Boise (all VHF stations) and one public station. KTVB has been an NBC affiliate since 1953, and its current affiliation agreement expires in 2001. KTVB's programming is simulcast through its low power television station, KTFT-LP, located in Twin Falls, Idaho. KTVB is the market leader in Boise, with news ratings and audience shares which are nearly double those of its nearest competitor.\nCOMPETITION IN THE TELEVISION INDUSTRY\nCompetition in the television industry is on several levels: competition for audience, competition for programming (including news) and competition for advertisers. Additional factors that are material to a television station's competitive position include signal coverage and assigned frequency. The broadcasting industry is continually faced with technological change and innovation, the possible rise in popularity of competing entertainment and communications media, and governmental restrictions or actions of federal regulatory bodies, including the Federal Communications Commission (\"FCC\") and the Federal Trade Commission, any of which could have a material effect on Broadcasting.\nAUDIENCE. Stations compete for audience on the basis of program popularity, which has a direct effect on advertising rates. A majority of the daily programming on the Stations is supplied by the network with which each Station is affiliated. In those time periods, the Stations are totally dependent upon the performance of the network programs in attracting viewers. There can be no assurance that such programming will achieve or maintain satisfactory viewership levels in the future. Non-network time periods are programmed by the Station with a combination of self-produced news, public affairs and other entertainment programming, including news and syndicated programs purchased for cash, cash and barter, or barter only.\nIndependent stations, whose number has increased significantly over the past decade, have also emerged as viable competitors for television viewership. In addition, each of Warner Brothers and Paramount has launched a new television network. The Company is unable to predict the effect, if any, that either network or future networks will have on the future operating results of Broadcasting.\nIn addition, the development of methods of television transmission of video programming other than over-the-air broadcasting, and in particular the growth of cable television, has significantly altered competition for audience in the television industry. These other transmission methods can increase competition for a broadcasting station by bringing into its market distant broadcasting signals not otherwise available to the station's audience and also by serving as a distribution system for non-broadcast programming originated on the cable system. Through the 1970s, television broadcasting enjoyed virtual dominance in viewership and television advertising revenues because network-affiliated stations competed only with each other in most local markets. Although cable television systems were initially used to retransmit broadcast television programming to paid subscribers in areas with poor broadcast signal reception, significant increases in cable television penetration occurred throughout the 1970s and 1980s in areas that did not have signal reception problems. As the technology of satellite program delivery to cable systems advanced in the late 1970s, development of programming for cable television accelerated dramatically, resulting in the emergence of multiple, national- scale program alternatives and the rapid expansion of cable television and higher subscriber growth rates. Historically, cable operators have not sought to compete with broadcast stations for a share of the local news audience. Recently, however, certain cable operators have elected to compete for such audiences, and the increased competition could have an adverse effect on the advertising revenues of Broadcasting.\nOther sources of competition include home entertainment systems (including VCRs and playback systems, videodisks and television game devices), ''wireless cable'' services, satellite master antenna television systems, low power television stations, television translator stations and low-powered DBS video distribution services, telephone company video systems, computer on-line services, and other entertainment and advertising media. The Stations also face competition from medium and high-powered DBS services, which transmit programming directly to homes equipped with special receiving antennas.\nFurther advances in technology may increase competition for household audiences and advertisers. Video compression techniques, now in use with direct broadcast satellites and in development for cable and \"wireless cable,\" are expected to permit greater numbers of channels to be carried with existing bandwidth. These compression techniques, as well as other technological developments, are applicable to all video delivery systems, including over-the-air broadcasting, and have the potential to provide vastly expanded programming to highly targeted audiences. Reduction in the cost of creating additional channel capacity could lower entry barriers for new channels and encourage the development of increasingly specialized ''niche'' programming. This ability to reach very narrowly defined audiences is expected to alter the competitive dynamics for advertising expenditures. The Company is unable to predict the effect that these or other technological changes will have on the broadcast television industry or the future results of The Company's operations.\nPROGRAMMING. Competition for programming involves negotiating with national program distributors or syndicators which sell first-run and rerun packages of programming. The Stations compete against in-market broadcast station competitors for exclusive access to off-network first-run products (such as Oprah) and reruns (such as Roseanne) in their respective markets. Cable systems generally do not compete with local stations for programming, although various cable networks from time to time have acquired programs that might have otherwise been purchased by local television stations. Competition for exclusive news stories and features is also endemic to the television industry.\nADVERTISING. Advertising rates are based upon the size of the market in which the Station operates, a program's popularity among the viewers that an advertiser wishes to attract, the number of advertisers competing for the available time, the demographic makeup of the market served by the Station, the availability of alternative advertising media in the market area, aggressive and knowledgeable sales forces, and development of projects, features and programs that tie advertiser messages to programming. In addition to competing with other media outlets for audience share, the Stations also compete for advertising revenues, which comprise their primary source of revenues. The Stations compete for such advertising revenues with other television stations in their respective markets, as well as with other advertising media, such as newspapers, radio stations, magazines, outdoor advertising, transit advertising, yellow page directories, direct mail and local cable systems. Competition for advertising dollars in the broadcasting industry occurs primarily within individual markets. The Stations are located in competitive markets.\nLOCAL MARKETING AGREEMENTS\nIndependent stations sometimes do not have the management expertise or operating efficiencies available to the Company as a multiple-station group broadcaster. Accordingly, these stand-alone stations often operate at minimal profit or at a loss. In Tuscon and Honolulu, the Company has entered into LMAs with the owners of such stand-alone stations pursuant to which the Company provides operational and marketing services and programming to such stations for its own account (subject to certain FCC requirements regarding licensee control of the station) and pays the station owner an agreed upon fee.\nThe Company's LMA strategy, in part, is intended to permit stations that otherwise might \"go dark\" or operate marginally to add programming and public affairs coverage and contribute to diversity in their respective markets.\nIn 1991 and 1993 respectively, the Company entered into 10-year LMA's, pursuant to which KMSB-TV provides marketing services and programming to KTTU-TV in Tucson, Arizona and KHNL(TV) provides marketing services and programming to KFVE(TV) in Honolulu, Hawaii. Under its LMA in Tucson, the Company is required to pay a fixed periodic fee and incur programming and operating costs relating to the LMA station, but retains all advertising revenues. Under its LMA in Honolulu, the Company incurs programming and most operating costs and is required to pay a percentage of revenue to KFVE(TV). In consultation with the respective LMA station owners, the Company in 1994 arranged for both KTTU and KFVE to become affiliates of the new United Paramount Network.\nSATELLITE, LOW POWER AND TRANSLATOR STATIONS\nThe Company owns and operates, or is constructing, satellite, low-power or translator stations in seven of its markets. By operating these facilities, a television station is able to achieve coverage of all, or nearly all, of a market that is difficult to cover because of its large size or its terrain features. Low power television stations and translators broadcast at a lower transmitting power and cover a smaller geographic area than a full-power station. A satellite station operates as a full-power television station.\nTranslators or low-power television stations are operated by WCNC-TV, KMSB-TV, KASA-TV, KGW(TV), KREM-TV, KTVB(TV) and KHNL(TV). Additionally, KHNL(TV) operates two satellite stations KHBC-TV, Channel 2, Hilo, Hawaii; and KOGG(TV), Channel 15, Wailuku, Hawaii.\nLICENSING AND REGULATION\nThe following is a brief discussion of certain provisions of the Communications Act and of FCC regulations and policies that affect Broadcasting. Reference should be made to the Communications Act, FCC rules and the public notices and rulings of the FCC, on which this discussion is based, for further information concerning the nature and extent of FCC regulation of television broadcasting stations.\nLICENSE RENEWAL, ASSIGNMENTS AND TRANSFERS. Television broadcasting licenses are granted for a maximum of eight years (five years prior to 1996) and are subject to renewal upon application to the FCC. The FCC prohibits the assignment of a license or the transfer of control of a broadcasting license without prior FCC approval. In determining whether to grant or renew a broadcasting license, the FCC considers a number of factors pertaining to the applicant, including compliance with limitations on alien ownership, common ownership of broadcasting, cable and newspaper properties, and compliance with character and technical standards. The Telecommunications Act of 1996 (\"Telecommunications Act\"), which has been enacted, but not yet fully implemented by the FCC, eliminates the comparative renewal process and simplifies license renewal. During certain limited periods when a renewal application is pending, petitions to deny a license renewal may be filed by interested parties, including members of the public. Such petitions may raise various issues before the FCC. The FCC is required to hold evidentiary, trial-type hearings on renewal applications if a petition to deny renewal raises a \"substantial and material question of fact\" as to whether the grant of the renewal application would be inconsistent with the public interest, convenience and necessity. The FCC is required to renew a broadcast license if the FCC finds that the station has served the public interest, convenience and necessity; there have been no serious violations by the licensee of either the Communications Act or the FCC's rules; and there have been no other violations by the licensee which taken together would constitute a pattern of abuse. If the incumbent licensee fails to meet the renewal standard, and if it does not show other mitigating factors warranting a lesser sanction, the FCC then has the authority to deny the renewal application and consider a competing application.\nFailure to observe FCC rules and policies, including, but not limited to, those discussed herein, can result in the imposition of various sanctions, including monetary forfeitures, the grant of short-term (i.e., less than the full eight-years) license renewals or, for particularly egregious violations, the denial of a license renewal application or revocation of a license.\nThe FCC license for WCNC-TV expires on December 1, 1996. The license for WHAS-TV expires on August 1, 1997. The licenses for KMSB-TV, KASA-TV and KTVB(TV) expire on October 1, 1998. The licenses for KING-TV, KREM-TV, KGW(TV) and KHNL(TV) expire on Feb. 1, 1999.\nMULTIPLE OWNERSHIP RULES AND CROSS OWNERSHIP RESTRICTIONS. The FCC generally applies its ownership limits to ''attributable'' interests held by an individual, corporation, partnership or other association. In the case of corporations holding broadcast licenses, the interests of officers, directors and those who, directly or indirectly, have the right to vote 5% or more of the corporation's stock (or 10% or more of such stock in the case of insurance companies, mutual funds, bank trust departments and certain other passive investors that are holding stock for investment purposes only) are generally deemed to be attributable, as are positions as an officer or director of a corporate parent of a broadcast licensee. On a national level, pursuant to the Telecommunications Act, the FCC has eliminated the restrictions on the number of television stations in which a person or entity may have an attributable interest. The Telecommunications Act establishes a national television audience reach limit of 35%. The Telecommunications Act requires the FCC to conduct a rulemaking proceeding to determine whether the local \"duopoly\" television ownership rules should be retained, modified or eliminated. The present \"duopoly\" rules prohibit attributable interests in two or more television stations with overlapping service areas. The Telecommunications Act grandfathers existing LMAs and permits future LMAs that are in compliance with FCC rules. The FCC may, however, consider the adoption of new restrictions on television LMAs, including the treatment of an LMA as an attributable interest in the future. Further, if the FCC were to find that a licensee of an LMA station failed to maintain control over its operations, the licensee of the LMA station and\/or the operator be subject to sanctions. The Telecommunications Act directs the FCC to extend its liberal waiver policy of the one-to-a-market restrictions (allowing radio-television combinations) to the top 50 markets, consistent with the public interest, convenience and necessity.\nThe statutory prohibition against television station\/cable system cross-ownership is repealed in the Telecommunications Act, but the FCC's parallel cross-ownership rule remains in place. The FCC intends to conduct a proceeding on repeal of this cross-ownership restriction. The television station\/daily newspaper cross-ownership prohibition in the FCC rule was not repealed by the Telecommunications Act. The FCC, however, intends to conduct a rulemaking proceeding on whether to repeal the restriction. The Telecommunications Act requires the FCC to review its ownership rules biennially as part of its regulatory reform obligations.\nThe Company is unable to predict the ultimate outcome of possible changes to these FCC rules and the impact such changes may have on its broadcasting operations.\nALIEN OWNERSHIP. Under the Communications Act, broadcast licenses may not be granted to or held by any corporation having more than one-fifth of its capital stock owned of record or voted by non-U.S. citizens (including a non-U.S. corporation), foreign governments or their representatives (collectively, ''Aliens'') or having an Alien as an officer or director. The Communications Act also prohibits a corporation, without an FCC public interest finding, from holding a broadcast license if that corporation is controlled, directly or indirectly, by another corporation, any officer of which is an Alien, or more than one-fourth of the directors of which are Aliens, or more than one-fourth of the capital stock of which is owned of record or voted by Aliens. The FCC has issued interpretations of existing law under which these restrictions in modified form apply to other forms of business organizations, including general and limited partnerships. As a result of these provisions, and without an FCC public interest finding, the Company, which serves as a holding company for its various television station licensee subsidiaries, cannot have more than 25% of its capital stock owned of record or voted by Aliens, cannot have an officer who is an Alien and cannot have more than one-fourth of the Company's Board of Directors consisting of Aliens.\nPROGRAMMING AND OPERATION. The Communications Act requires broadcasters to serve the ''public interest.'' Since the late 1970s, the FCC gradually relaxed or eliminated many of the more formalized procedures it had developed to promote the broadcast of certain types of programming responsive to the needs of a station's community of license. Broadcast station licensees continued, however, to be required to present programming that is responsive to community problems, needs and interests and to maintain certain records demonstrating such responsiveness. Complaints from viewers concerning a station's programming may be considered by the FCC when it evaluates license renewal applications, although such complaints may be filed, and generally may be considered by the FCC, at any time. Stations also must follow various rules promulgated under the Communications Act that regulate, among other things, children's television programming, political advertising, sponsorship identifications, contest and lottery advertising, obscene and indecent broadcasts, and technical operations, including limits on radio frequency radiation. In addition, broadcast licensees must develop and implement affirmative action programs designed to promote equal employment opportunities, and must submit reports to the FCC with respect to these matters on an annual basis and in connection with a license renewal application.\nSYNDICATED EXCLUSIVITY\/TERRITORIAL EXCLUSIVITY. Effective January 1, 1990, the FCC reimposed syndicated exclusivity rules and expanded the existing network non-duplication rules. The syndicated exclusivity rules allow local broadcast stations to require that cable operators black out certain syndicated, non-network programming carried on ''distant signals'' (i.e., signals of broadcast stations, including so-called superstations, that serve areas substantially removed from the local community).\nPRIME TIME ACCESS RULE. The FCC's prime time access rule (the ''PTAR'') also places programming restrictions on affiliates of ''networks''. The PTAR restricts affiliates of ''networks'' in the 50 largest television markets (as defined by the PTAR) from broadcasting more than three hours of network programming during the four hours of prime time. Five of the Stations are located in the nation's 50 largest television markets. In a Report and Order released on July 31, 1995, the FCC decided to repeal the PTAR effective August 30, 1996. The Company cannot predict the effect any modification or elimination of the PTAR would have on Providence Journal's programming or operations.\nRESTRICTIONS ON BROADCAST ADVERTISING. The advertising of cigarettes on broadcast stations has been banned for many years. The broadcast advertising of smokeless tobacco products has more recently been banned by Congress. Certain Congressional committees have in the past examined legislative proposals to eliminate or severely restrict the advertising of beer and wine. Providence Journal cannot predict whether any or all of such proposals will be enacted into law and, if so, what the final form of such law might be. The elimination of all beer and wine advertising would have an adverse effect on the Stations' revenues and operating income as well as the revenues and operating income of other stations that carry beer and wine advertising.\nOTHER PROGRAMMING RESTRICTIONS. The Telecommunications Act requires that any newly manufactured television set with a picture screen of 13 inches or greater be equipped with a feature designed to enable viewers to block all programs with a certain violence rating (the \"v-chip\"). The FCC, after consulting with the TV manufacturing industry, shall specify the effective date of this requirement, which may not be less than two years after enactment of the law. The FCC is directed to oversee the adoption of standards for this blocking technology. If the television industry has not voluntarily devised a violence rating system within one year, the FCC is directed to prescribe a rating system. Industry efforts to adopt a rating system, similar to the motion picture rating system, are now underway. The Company cannot predict whether the v-chip and a ratings system will have any significant effect on the operations of Broadcasting.\nCABLE \"MUST-CARRY\" OR \"RETRANSMISSION CONSENT\" RIGHTS. The 1992 Cable Act requires television broadcasters to make an election to exercise either certain \"must-carry\" or \"retransmission consent\" rights in connection with carriage by cable television systems of its programming in the station's local market. If a broadcaster chooses to exercise its must-carry rights, it may demand\ncarriage on a specified channel on cable systems within its market. Must-carry rights are not absolute, and their exercise is dependent on variables such as the number of activated channels on and the location and size of the cable system and the amount of duplicative programming on a broadcast station. Under certain circumstances, a cable system may decline to carry a given station. If a broadcaster chooses to exercise its retransmission consent rights, it may prohibit cable systems from carrying its signal, or permit carriage under a negotiated compensation arrangement.\nOn April 8, 1993, a three-judge panel of the United States District Court for the District of Columbia upheld the constitutionality of the must-carry provisions of the 1992 Cable Act. In 1994, the Supreme Court ruled that the must-carry provisions were ''content neutral'' and thus not subject to strict scrutiny and that Congress' stated interests in preserving the benefits of free, over-the- air local broadcast television, promoting the widespread dissemination of information from a multiplicity of sources and promoting fair competition in the market for television programming all qualify as important governmental interests. However, the Court remanded the case to a lower federal court with instructions to hold further proceedings with respect to evidence that lack of the must-carry requirements would harm local broadcasting. In late 1995, on remand, the three-judge panel of the United States District Court for the District of Columbia upheld the constitutionality of the must-carry requirements. The case is now again before the Supreme Court. A decision is likely in the first half of 1997.\nPROPOSED LEGISLATION AND REGULATIONS. The FCC has proposed the adoption of rules for implementing Advanced Television (''ATV'') in the United States. Implementation of ATV will improve the technical quality of over-the-air broadcast television. Under certain circumstances, however, conversion to ATV operations may reduce a station's geographical coverage area. The FCC is considering the implementation of a proposal that would allot a second broadcast channel to each regular commercial television station for ATV operation. Stations would be required to phase in their ATV operations on the second channel, with a three-year period to build necessary ATV facilities and a consecutive three-year period in which to begin operations. Such stations would be required to surrender their non-ATV channel 15 years after the commencement of the first three-year period. Implementation of ATV will impose additional costs on television stations providing the new service due to increased equipment and operating costs. The Company estimates that the adoption of ATV would require average capital expenditures of approximately $8-10 million per Station to provide facilities and equipment necessary to broadcast an ATV signal. The introduction of this new technology will require that consumers purchase new receivers (television sets) for ATV signals or, if available by that time, adapters for their existing receivers. The FCC has also proposed to assign to full-power ATV stations the channels currently occupied by LPTV stations, which could adversely affect the Company's LPTV channels. When the Telecommunications Act was passed, certain leaders in Congress asked the FCC to postpone issuing ATV licenses pending consideration of possible future legislation that might require broadcasters to bid at auction for ATV channels or which might require that the current conventional channels be returned to the government on an expedited schedule. In the course of the debate on the federal budget, some leaders in Congress have proposed various plans that might require the auctioning of the spectrum which broadcasters will need in order to provide ATV. Various plans for raising revenue also include provisions to require the auctioning of radio frequencies in bands which encompass those currently licensed for use by broadcasters, including those channels used for \"auxiliary\" purposes, such as remote pickups in electronic news gathering and studio-to-transmitter links. Hearings on spectrum auctions and usage will be held by Congress beginning in the Spring of 1996. While the Company believes that the FCC will authorize ATV in the United States, the Company cannot predict when such authorization might be given or the effect such authorization might have on Broadcasting. The Company cannot predict whether legislation requiring auctions for ATV spectrum will be enacted or the effect of such legislation.\nIn addition, the FCC is conducting an inquiry to consider proposals to increase broadcasters' obligations under its rules implementing the Children's Television Act of 1990, which requires television stations to present programming specifically directed to the ''educational and informational'' needs of children. Other matters that could affect the Stations include technological innovations affecting the mass communications industry such as technical allocation matters, including assignment by the FCC of channels for additional broadcast stations, low-power television stations and wireless cable systems and their relationship to and competition with full-power television broadcasting service.\nCongress and the FCC also have under consideration, or may in the future consider and adopt, new laws, regulations and policies regarding a wide variety of matters that could, directly or indirectly, affect the operation, ownership and profitability of Broadcasting and the Stations, result in the loss of audience share and advertising revenues of the Stations, and affect the Company's ability to acquire additional broadcast stations or finance such acquisitions. Such matters include, for example, (i) changes to the license renewal process; (ii) imposition of spectrum use or other governmentally imposed fees upon a licensee; (iii) proposals to expand the FCC's equal employment opportunity rules and other matters relating to minority and female involvement in broadcasting; (iv) proposals to increase the benchmarks or thresholds for attributing ownership interest in broadcast media; (v) proposals to change rules or policies relating to political broadcasting; (vi) technical and frequency allocation matters, including those relative to the implementation of ATV; (vii) proposals to restrict or prohibit the advertising\nof beer, wine and other alcoholic beverages on broadcast stations; (viii) changes in the FCC's cross-interest, multiple ownership, alien ownership and cross-ownership policies; (ix) changes to broadcast technical requirements; and (x) proposals to limit the tax deductibility of advertising expenses by advertisers.\nThe Company cannot predict what other matters might be considered in the future, nor can it judge in advance what impact, if any, the implementation of any of these proposals or changes might have on Broadcasting.\nThe foregoing does not purport to be a complete discussion of all of the provisions of the Communications Act or other Congressional Acts or the regulations and policies promulgated by the FCC thereunder. Reference is made to the Communications Act, other Congressional Acts, such regulations, and the public notices promulgated by the FCC, on which the foregoing discussion is based, for further information. There are additional FCC regulations and policies, and regulations and policies of other federal agencies, that govern political broadcasts, public affairs programming, equal employment opportunities and other areas affecting the Station's businesses and operations.\nDESCRIPTION OF PUBLISHING BUSINESS\nGENERAL\nThe Company publishes (i) the Providence Journal-Bulletin, Monday through Saturday, and (ii) The Providence Sunday Journal (collectively the \"Journal\") in Providence, Rhode Island. The Journal is primarily distributed by home delivery throughout Rhode Island and Southeastern Massachusetts. Founded in 1820, the Providence Journal is the oldest continuously published daily newspaper in the United States. The largest newspaper in the Rhode Island and Southeastern Massachusetts market, the Journal maintains its market position through effective reporting, dedication to public service, quality printing and efficient distribution. The Journal has received numerous awards over the years for its coverage of both local and national issues, including a Pulitzer Prize in 1994, its fourth.\nThe Publishing division generated approximately $128 million in revenues in 1995 or 41% of consolidated operating revenues. Publishing was $14.8 million of consolidated EBITDA of $65.2 million.\nOn June 5, 1995, the Company consolidated the morning Providence Journal and The Evening Bulletin as the Providence Journal-Bulletin, a morning newspaper. Approximately $2 million of the $6 million in initial savings was reinvested to improve local news coverage. Annual savings are expected to be $4 million. As a result of the consolidation to a single cycle, daily circulation has dropped 5.0% from an average of approximately 177,500 for the month of July 1995 to approximately 169,000 (as calculated by management) for the two months ended February, 1996 and is expected to continue to fall somewhat in the first half of 1996. However, a recent study conducted by the Company has indicated that both daily and Sunday readership has remained constant over the past three years with daily readership fluctuating between 56% and 58% of the total adults in the market and Sunday readership remaining between 68% to 70% of total adults in the market. In addition, management is making efforts to increase circulation levels through expanded local coverage and continued improvement in content and customer service. There can be no assurances, however, that management will be successful in these efforts. Despite the decline in circulation levels, circulation revenues of $32.2 million in 1995 were 4% ahead of 1994 circulation revenues of $30.9 million as a result of price increases.\nCIRCULATION AND PRICING\nThe following table shows the average net paid daily, Saturday and Sunday circulation of the Journal for the 52 weeks ended on the last Sunday in March in each of the years 1991 through 1994, as reported by the Audit Bureau of Circulation (the ''Audit Bureau''), an independent agency that audits the circulation of most U.S. newspapers and magazines on an annual basis. To coincide with the consolidation discussed in the previous paragraph, the auditing cycle at the \"Audit Bureau\" was changed to July 2, 1995, a 53-week period. The 13 week interim period, March 27, 1994 to June 26, 1994, was audited but is not shown below.\nThe above numbers are before the consolidation of the morning and afternoon newspapers. Circulation levels as calculated by management for the two months ended February 29, 1996 are approximately 169,000 for Daily Circulation and 251,900 for Sunday Circulation.\nThe suggested newsstand price of the Journal is $.50 on Monday through Saturday and $2.00 on Sunday, which was increased from $1.75 on February 4, 1996. The suggested rate charged to subscribers for home delivery of the daily and Sunday newspapers is $4.05 per week, which was increased from $3.80 on February 4, 1996 and from $3.60 in October, 1995. Approximately 76% of the Monday through Saturday circulation and approximately 68% of the Sunday circulation were home-delivered in calendar year 1995.\nADVERTISING\nApproximately three-quarters of the revenue of the Journal is derived from the sale of advertising (historically between 70% and 80% of the Journal's revenues). In recent years, retail advertising has accounted for approximately 60%, classified advertising approximately 30%, and national advertising approximately 10% of the total advertising revenue for the Journal. Reail advertising appears throughout the Journal and is comprised of display advertising from local merchants, such as grocery and departments stores, and national retail advertisers that have local outlets. Classified advetising is comprised for display and agate line advertisements which are listed together in sequence by the nature of the advertisement, such as automobile, employment and real estate and appear in the classified section of the Journal. National advertising is comprised of advertisements from national distributors and manufacturers that appear throughout the Journal. The Journal also contains preprint advertisements which are advertising inserts that are provided to the Journal for distribution both in the Journal and at times through the mail. Preprint advertising revenue is derived primarily from retail and national advertisers and accounted for approximately 20% of the total Journal advertising revenue in calendar year 1995.\nThe Journal increased advertising rates for most major categories of retail and classified advertising by at least 3% in 1993, 1994 and 1995.\nProduction and Raw Materials\nIn 1987, the Company began operations of its newly constructed flexographic printing and distribution plant in Providence, Rhode Island. The use of flexography, a water-based printing process, improves printing quality and prevents newspaper ink from rubbing off onto the reader's hands. The facility is also equipped with computer control-driven systems, which shut down presses within five copies of the specified production number, thereby significantly reducing the number of unusable copies.\nNewprint costs, which are the largest component of direct expenses, have in recent years accounted for between 16% to 24% of the Journal's total operating expenses. In 1995, the Journal incurred total newprint costs of $21.5 million, or 20% of total Journal operating expenses, and used approximately 33,000 metric tons of newsprint. Management reduced the number of newsprint suppliers to five from eight in 1992 and has entered into contracts with these suppliers resulting in favorable pricing and continuity of supply. The Journal currently receives modest discounts off list price for newsprint supplies. Additional cost savings have been achieved by the implementation of quality controls.\nNewsprint expenses are considered variable to the extent that usage varies depending on advertising linage. Newsprint prices move in cycles associated with the capacity of paper mills and newspaper demand. When national advertising linage levels declined beginning in 1988, suppliers began offering substantial discounts of between 10% and 18% from list price, which grew over time to 40% discounts. Newsprint prices then increased significantly because of increased demand and constricted supply. Newsprint prices per ton paid by the Company increased approximately 45% in 1995 over 1994 levels. Recently, the major paper producers withdrew their planned increase of 7% for 1996. The Company believes that newprint prices will decline somewhat as a result of market trends reflected in this withdrawn price increase.\nOTHER PUBLISHING ACTIVITIES\nThe Journal has also developed a number of fax-on-demand services providing material ranging from old Journal newspaper articles to current information on sports, weather and other subjects of general interest. The Journal has also developed and expanded Journal Line, a voice information service; the New England Wire Service, which electronically provides editorial content to area newspapers; and Journal Telemarketing, a telemarketing sales division providing services to a range of customers.\nIn 1990, the Company provided financing to Lowell Sun Publishing Company (the publisher of the Sun, a daily newspaper serving the Lowell, Massachusetts area) and Lowell Sun Realty Company (collectively, the ''Lowell Sun Companies'') in the\namount of approximately $26 million, and agreed to provide a $6.5 million revolving credit facility to the Lowell Sun Companies. These loans are secured by a lien on the assets of Lowell Sun Companies, plus a pledge of a controlling interest in the stock of such companies. In connection with this financing, the Company received a warrant to acquire up to a 41.67% interest in the Lowell Sun Companies which it chose not to exercise. The loan and credit facility which were originally due in March, 1996 are subject to a forebearance until January 2, 1997.\nIn 1993, the Company launched the Town Crier, a weekly newspaper referred to in the industry as a \"shopper\", containing coupons and advertisements directed at consumers, in fourteen communities adjacent to Providence, Rhode Island. In connection with this project, the Company entered into a multi-year management contract with Shopper Enterprises, Inc., a firm based in Minnesota. In 1995, the Company made a decision to discontinue this project and in December, 1995 ceased publication.\nCOMPETITION\nThe Journal has five daily newspaper competitors in the Rhode Island: The Times (Pawtucket, RI), Woonsocket Call, Daily News (Newport, RI), Westerly Sun, and Kent County Daily Times each with net paid circulation levels under 20,000. The Journal also encounters competition in varying degrees from Boston and other Massachusetts newspapers, nationally circulated newspapers, television, radio, magazines, electronic publishing services, and other advertising media, including direct mail advertising and yellow pages. The competition from electronic information services may be increased in the future as a result of the Telecommunications Act which allows the Regional Bell Holding Companies to provide such services, subject to certain safeguards.\nDESCRIPTION OF PROGRAMMING AND NEW MEDIA BUSINESS\nThe Company has interests in a number of developing entertainment and information businesses which are closely related to the Company's traditional media businesses. The Company's strategy in these businesses is to apply its expertise in the production and distribution of content to new media formats as they arise. In particular, the Company has focused on cable television programming services and interactive on-line media.\nCABLE TELEVISION PROGRAMMING\nThe Company continually reviews opportunities to participate in the creation and development of new cable television programming services. The Company seeks to enter into partnerships and other relationships with companies or individuals having specialized expertise with regard to the content of the programming. The Company's practice is to play the leading role in the formation and management of the service and to increase its ownership interest when appropriate.\nTelevision Food Network\nAs of December 31, 1995, the Company controlled a 20% interest in Television Food Network, G.P. (\"TVFN\"). The Partnership was formed specifically to own and operate the Television Food Network channel. TVFN is a 24-hour advertising supported network service that provides television programming related to the preparation, enjoyment and consumption of food, as well as programs focusing on nutrition and topical news areas. TVFN is a general partnership consisting of eight media companies with cable television, broadcast television and programming holdings. TVFN is distributed predominantly through cable television stations to approximately 15.4 million subscribers throughout the United States. The Company is the general partner of the managing partner of TVFN and has invested approximately $12.6 million through December 31, 1995. In addition, the Company is negotiating with three of its partners to purchase interests which, when combined with the Company's current interest, would give the Company majority ownership of TVFN. TVFN is based in New York, NY.\nProgramming. TVFN's programming effectively targets a mostly female audience. TVFN's schedule consists of an eight hour block of programming, approximately 90% of which is original and exclusive programming owned by the network. Generally, each hour of programming is repeated multiple times throughout each week. During its first two years of operations, TVFN has created a library of valuable programming assets of cooking shows, restaurant reviews, nutrition shows, and other food-related programming that can be re-edited and repurposed in multiple ways.\nDistribution. TVFN's full-time equivalent subscriber base grew 57% in 1995 to 15.4 million, from 9.9 million at year end 1994. At present, TVFN has affiliation agreements with 42 of the top 50 multiple system operators and is carried in 26 of the top 50 cable\nsystems in the United States. TVFN has not charged distributors for carriage of its service since its inception. However, as regulatory changes evolve, TVFN will consider license fees as an additional revenue stream opportunity. TVFN originally benefited from the distribution capabilities of its partners through cable carriage and retransmission consent agreements. To date, TVFN partners have contributed 11.8 million subscribers, or 76% of the current subscriber base. TVFN is pursuing distribution agreements with all appropriate cable, telephone, direct broadcast satellite and multi-channel, multi-point distribution systems. Three minutes of local spots are currently made available to the distributor for the sale of advertising time. Approximately 30% of TVFN subscribers are in cable systems which insert advertising locally on the network. The network promotes the advantage of local insertion in order to drive further subscriber penetration.\nViewership. TVFN's programming strategy is to broadcast programming to reach a target audience of women, particularly young and working women, in order to attract advertisers. The network reaches 34% more working women than the average of all other cable networks. Additionally, TVFN viewers are highly interactive with the network. TVFN receives approximately 40,000 letters per month from viewers requesting recipes, critiquing the network, and writing to chefs and hosts.\nMerchandising. A significant part of the network's strategy going forward is to tap into the high interest and involvement of its viewers by creating and marketing merchandise related to the network, its programs and its talent. In 1996, TVFN will introduce several on-air direct merchandising projects which allow the network to share in the revenues from the on-air sale of merchandise. In each of these segments, products will be presented for sale by the network in both short and long form programming formats. This strategy will allow TVFN to play the role of retailer and participate in the retail margin of the product sales effort. Among the product selection will be TVFN branded items, product from third party suppliers and advertiser-related products. As TVFN's merchandising plan develops and as success dictates, a strategic partner with fulfillment, customer service and warehousing capabilities may be desired.\nAmerica's Health Network\nOn April 5, 1995, the Company entered into an agreement to purchase an interest of up to 37% in America's Health Network, Inc. (\"AHN, Inc.\"), a development stage cable programming network service that provides health-related information and products. The channel launched on March 25, 1996 with 750,000 subscribers. In early 1996, AHN, Inc. was reorganized and became America's Health Network, L.L.C. (\"AHN LLC\"), a limited liability corporation which is the general partner in AHN Partners, L.P. (\"AHN Partners\"), a limited partnership formed to carry on the operations of the network. The Company has invested approximately $15.3 million collectively in AHN LLC and AHN Partners as of March 25, 1996, representing a 59% interest, which is considered temporary until the full funding by investors is completed, which is expected to occur in the second quarter of 1996. It is anticipated that the Company's overall interest in this venture at that time will be approximately 50%. Although consolidation is not material to the Company's financial statements, to the extent the Company has control over this investment, it will be consolidated in 1996. AHN is based in Orlando, Florida.\nAmerican's Health Network (\"AHN\") is a basic cable television programming service principally featuring viewer call-in programs designed for health-conscious adults who are active participants in their own health care and the health care of spouses, parents and children. AHN's Ask the Doctor programs are hosted by health care professionals whose responses to viewers' questions are extensively visualized. AHN's programming also includes brief Health Mall segments during which health-related products will be offered for sale to viewers, and Health IQ quizzes which test the viewer's level of health knowledge and Health News Segments which provide daily updates on the areas of health, medicine, wellness and nutrition. In addition, a limited number of commercials from national and local advertisers are shown.\nThe network has assembled a group of strategic partners that management believes significantly enhances its prospects for success. Mayo Foundation for Medical Education and Research (\"Mayo\") and IVI Publishing, Inc., Mayo's electronic publisher and an AHN LLC investor, have entered into a comprehensive and exclusive program content relationship with AHN. National Call Center, Inc., a wholly-owned subsidiary of Home Shopping Network, Inc., provides telemarketing, order processing, warehousing and fulfillment services related to the sale of merchandise on AHN's Health Mall segments and through the network's database marketing programs through an exclusive agreement. Universal Studios Florida (\"USF\"), a joint venture of MCA, Inc., and Rank, P.L.C., has built a 16,500 square foot production facility for AHN's exclusive use immediately adjacent to the USF theme park in Orlando, and USF recruits its theme park visitors to participate in AHN's live productions. AHN also has an exclusive programming agreement with Massachusetts Medical Society and Reuters to provide Health News segments to AHN for airing on the network.\nNorthWest Cable News\nOn December 18, 1995, the Company, through its wholly-owned subsidiary, King News Corporation, launched the NorthWest Cable News Network (\"NWCN\"), a 24-hour regional cable news network serving cable subscribers in the Pacific Northwest. NWCN is based in Seattle and combines advanced digital news-gathering and editing systems with resources of the Company's four television stations in the area: KGW(TV) - Portland, KREM-TV - Spokane, KING-TV - Seattle and KTVB(TV) - Boise. The Company receives monthly payments from contracting cable systems based on the number of subscribers of such cable systems receiving the service, as well as advertising revenues generated by this new programming service. NWCN currently reaches 1.2 million subscribers. NWCN is based in Seattle, Washington.\nNWCN was launched as a strategic business opportunity in order to grow and protect the Company's valuable news franchises in the Pacific Northwest. As part of retransmission consent agreements with local cable operators, the Company agreed to provide a 24- hour news network service focusing on that region of the United States in exchange for an agreement to carry the network and to pay certain subscriber fees. The Company's research indicated that this region of the country felt isolated and removed from the other parts of the country. Moreover, a survey of the region's population indicated that a 24-hour news channel would have a high degree of receptivity.\nINTERACTIVE AND ON-LINE MEDIA\nThe Company continually reviews opportunities to participate in the creation and development of interactive and on-line media ventures. The Company seeks to enhance its current media portfolio with incremental investment in these areas. The Company seeks to enter into partnerships and other relationships with companies or individuals having this specialized expertise. The Company has the following interactive and on-line media investments.\nRhode Island Horizons\nDuring 1994, the Company entered into a two year agreement with Prodigy Services Company providing for the creation of a local on-line service owned by the Company to be offered in conjunction with the national Prodigy service. The local on-line service includes news, features, and advertising for Rhode Island and certain areas in Massachusetts, similar to that appearing in the Journal. The new service, called Rhode Island Horizons, began operations in the second quarter of 1995 and is based in Providence, Rhode Island.\nPeapod, L.P.\nOn July 27, 1995, the Company purchased a 17.1% interest in Peapod, L.P., which currently provides an interactive computer on-line grocery ordering, shopping and delivery service in Chicago and San Francisco. Such services are expected to be expanded to several additional cities, including Boston and Providence, in 1996. Total investments in the partnership during 1995 were $5.3 million. The Company has committed to invest $1.0 million in 1996 as part of a $15 million private placement. No other commitments have been made. Trygve E. Myhren, a member of the Board of Directors of the Company, is on the Board of Peapod, L.P.\nStarSight\nIn 1993, the Company purchased a 4.85% interest for $5.5 million in StarSight Telecast, Inc., (\"StarSight\") a company engaged in developing and marketing an on-screen interactive television program guide designed to facilitate the identification, selection and recording of television programming. Jack C. Clifford, Vice President-Broadcasting, is a member of the Board of Directors of StarSight. In 1995, the Company invested an additional $.4 million, for a total interest of approximately 5% as of February 29, 1996. The Company has no formal commitments to invest additional amounts as of December 31, 1995. StarSight's shares are traded through the National Association of Security Dealers Automated Quotation (\"NASDAQ\") National Market. StarSight is based in Fremont, California.\nTelecommunications Act of 1996\nWhile the effects of the Telecommunications Act of 1996 on the Company's programming and new media operations cannot be fully determined at this time, various provisions of the new law create an environment that is favorable for the development and distribution of new programming services and new interactive services. The Telecommunications Act allows telephone companies to provide cable television service and cable television companies to provide local telephone service. Thus, a regulatory framework is established which encourages expanded competition and new outlets for the distribution of programming and interactive services. Distribution outlets available for programming and interactive services may include current cable systems, telephone company owned video systems, DBS, MMDS, incumbent local telephone networks and the Internet.\nThe changes in cable television rate regulation contained in the Telecommunications Act will facilitate the expansion of channel capacity on cable systems and the addition of new programming services. The new law deregulates the rates for upper tiers of cable television service on March 31, 1999. In the meantime, in addition to the existing tests for \"effective competition,\" under which rates are deregulated, a new test is added. A cable system will be deemed subject to \"effective competition\" and not subject to any rate regulation if a telephone company offers comparable video programming to subscribers by any means, other than DBS, including by means of a cable system, an open video system or MMDS. The law also makes other favorable changes in rate regulation. Cable operators now have certainty as to the end of upper tier rate regulation and, in the interim, there is rate deregulation if competition develops. These provisions will stimulate investment and facilitate rebuilds of cable plant and the transition to digital. This translates\ninto greater channel capacity. Furthermore, rate deregulation eliminates the regulatory constraints on the ability of cable operators to recoup the costs of adding new programming networks which add value to service offerings.\nOTHER INVESTMENTS\nPartner Stations Network, L.P.\nThe Company is a limited partner with four other television group broadcasters in Partners Stations Network, L.P. (\"PSN\"), a limited partnership formed in 1994 to develop and produce television programming for broadcast on their own stations and for potential national distribution to other television broadcast stations. Each limited partner has a 16% interest, and the general partner, Lambert Television Management, Inc., has a 20% interest in PSN. The stations owned by PSN's five limited partners serve markets accounting for approximately 20% of the television households in the United States. Each of PSN's limited partners has a right of first access in its respective television markets to the programs produced by PSN. The Company believes PSN to be a cost-effective testing ground for new programs and a launch vehicle for successful syndicated programming. As of December 31, 1995, the Company's total commitment, consisting of amounts paid to date and current obligations, with respect to PSN, was approximately $1.8 million.\nLinkatel Pacific, L.P.\nIn July 1993, the Company, through its wholly-owned subsidiary Colony\/Linkatel Networks, Inc., invested in Linkatel Pacific, L.P. (a development stage enterprise ), with two other communications companies. The Company has a 45% limited interest in the partnership, which was formed to pursue the development of alternative access networks. Through December 31, 1995, the Company has invested $6.5 million in Linkatel Pacific, L.P. The Company intends to sell this investment because it is no longer related to the Company's core business. Although the Company intends to realize an amount at least equal to the amount invested to date, there can be no assurances in this regard.\nSEASONALITY OF THE BUSINESSES\nThe Company's revenues are generally highest in the fourth quarter of each year. The seasonality is particularly attributable to increased expenditures by advertisers in anticipation of holiday retail spending and an increase in broadcast television viewership during the Fall\/Winter season. Accordingly, accounts receivable balances as of the end of the first three calendar quarterly periods are generally less than the balances at the end of the year. Each of the Stations and the Journal generally produce positive EBITDA on an annual basis. Generally, Stations in larger markets contribute a larger proportionate share of EBITDA.\nEMPLOYEES\nAs of December 31, 1995, the Company employed approximately 2,500 full-time equivalents, of which approximately 1,075 worked in Broadcasting, approximately 1,255 worked in Publishing, and the remainder worked in Corporate headquarters and Programming and New Media. Approximately 340 of the Broadcasting employees are represented by independent, unaffiliated labor unions among the stations. Approximately 50% of Publishing employees are represented by labor unions, mostly under existing collective bargaining agreements. The Providence Newspaper Guild agreement expires December 31, 1996. The Newspaper Printing Pressman's Union is in the fifth year of a ten-year contract. The Communications Workers of America, Local 33, is in the last year of a ten-year contract. The International Brotherhood of Teamsters, Local 64, was elected on February 29, 1996 as the bargaining agent for 172 Distribution Department employees. The Company contributes to and maintains various employee benefit or retirement plans for eligible employees and contributes to some union plans pursuant to its collective bargaining agreements. The Company considers its relations with its employees to be good.\nAs discussed in Note 8 (b) of the Consolidated Financial Statements, management of the Company adopted a plan of reorganization and restructuring of most departments of Publishing. Under the plan, the Company has targeted a reduction in workforce of approximately 100 full-time equivalents, or 7.9% of the Publishing workforce.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company's corporate headquarters and various operating departments and administrative departments of Broadcasting, Publishing, and Programming and New Media are located at 75 Fountain Street, Providence, Rhode Island, an historic building owned by the Company which has 205,635 square feet of working space. In addition the Company has the following materially important physical properties described below as of December 31, 1995. The Company believes that its properties are generally in good condition and adequate and suitable for the operations of Broadcasting, Publishing and Programming and New Media. The Company has not received any notice that it is in default under any of its property leases.\nBROADCASTING BUSINESS PROPERTIES\nEach of the Stations also has facilities consisting of offices, studios, sales offices and transmitter and tower sites. Transmitter and tower sites are located to provide coverage of each Station's market. The Company owns the offices where its Stations are located and owns or leases the property where its towers and primary transmitters are located. The Company leases the remaining properties, consisting primarily of other transmitter sites. While none of the properties owned or leased by the Company are individually material to the operations of Broadcasting, if the Company were required to relocate any of its towers the cost could be significant because the number of sites in any geographic area that permit a tower of reasonable height to provide good coverage of the market is limited, and zoning and other land use restrictions, as well as Federal Aviation Administration regulations, limit the number of alternative sites or increase the cost of acquiring such properties for tower sites.\nPUBLISHING BUSINESS PROPERTIES\nAll of the following are owned facilities located in Providence, Rhode Island.\nThe Journal also leases various regional distribution centers and news and advertising offices.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nOn January 17, 1995, Cable LP I, Inc. (\"Cable LP\") brought a declaratory judgment action against Old PJC, Colony Communications, Inc. (\"Colony\") and Dynamic Cablevision of Florida, Inc. (\"Dynamic\") in the Circuit Court of the Eleventh Judicial Circuit in and for Dade County, Florida. Colony and Dynamic were cable television subsidiaries of Old PJC, which became units of Continental in connection with the Merger. This case relates to a partnership (the \"Dynamic Partnership\"), in which Dynamic is the general partner with an 89.8% interest, and Cable LP is the limited partner with a 10.2% interest. In this action, Cable LP claims that Dynamic was obligated to offer to sell Dynamic's general partnership interest to Cable LP before Old PJC entered into the Merger Agreement with Continental. Cable LP further claims that Dynamic's offer to purchase Cable LP's limited partnership interest for $13.1 million triggered a right of first refusal entitling Cable LP to purchase the general partnership interest for $115 million. Cable LP seeks a declaration by the court that the right of first refusal it is asserting applies.\nOld PJC, Colony and Dynamic made a motion to strike allegations against them of bad faith and breach of fiduciary duty, which motion was granted by the court, and they filed an Answer to the Complaint and a Counterclaim on March 16, 1995. In their counterclaim, Colony and Dynamic seek a declaratory judgment that Cable LP unreasonably refused consent to the transfer of the general partner's interest to Continental and that a purported transfer of Cable LP's interest in the Dynamic Partnership to a partnership to be managed by Adelphia Communications, Inc. violates Dynamic's right of first refusal under the Dynamic Partnership Agreement. The case was tried with testimony given on December 11 through December 13, 1995 with final arguments heard on January 12, 1996. The decision of the Court is expected shortly. The Company's management believes that the claims asserted by Cable LP are without merit and intends to continue to vigorously defend this matter through the appeal process in the event of an unfavorable ruling.\nIn the event that, as a result of such litigation, Dynamic is required to sell its interest in the Dynamic partnership to Cable LP, the Merger Agreement provides that the Company will pay to Continental simultaneously with the closing of such sale an\namount equal to the sum of (i) the amount (if any) by which the consideration received by Dynamic for the sale of such interest is less than $115 million plus (ii) the taxes which would have been payable assuming the purchase price for such interest equaled $115 million.\nThe Company is party to various claims, legal actions and complaints arising in the ordinary course of business. In the opinion of management, all such matters are adequately covered by insurance or, if not so covered, are without merit or are of such kind, or involve such amounts, that unfavorable disposition would not have a material effect on the consolidated 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.\nPART II.\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS.\nNo established public trading market exists for the Common Stock, and accordingly no high and low bid information or quotations are available with respect to the Common Stock. As of February 29, 1996, there were approximately 430 holders of record of Class A Common Stock and 260 holders of record of Class B Common Stock. Since a number of holders own shares of both Class A Common Stock and Class B Common Stock, the total number of stockholders is approximately 471.\nThe annual cash dividend per share paid on all Class A Common Stock and Class B Common Stock in 1994 and 1995 was $114.40. The Company currently intends to pay in 1996 dividends at an annual rate equal to that paid in 1995. However, following such payout it is expected that future dividends will be reduced or eliminated, subject to the exercise by the Board of Directors of its fiduciary obligations and the exercise of the Board's business judgment in connection with, among other things, any and all requirements of Delaware law or other applicable law, and all covenants, restrictions or limitations in connection with any financing, future earnings, capital requirements, financial condition and other factors.\nITEM 7.","section_6":"","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nGeneral\nThe following analysis of the financial condition and results of operations of the Company should be read in conjunction with the Company's audited consolidated financial statements and notes thereto and the unaudited \"Adjusted Combined\" financial data included elsewhere in this Form 10-K.\nThe Company's businesses are concentrated principally in broadcast television, the publication of the Journal, and in programming and new media ventures. The Company's broadcast television revenues are derived principally from local and national advertising and, to a lesser extent, from network compensation for the broadcast of network programming. The Company's publishing revenues are derived principally from advertising and, to a lesser extent, paid circulation. Revenues from the programming and new media ventures are principally derived from subscriptions, service fees and advertising.\nThe Company's revenues are generally highest in the fourth quarter of each year. This seasonality is particularly attributable to increased expenditures by advertisers in anticipation of holiday retail spending and an increase in broadcast television viewership during the Fall\/Winter season. Accordingly, accounts receivable balances as of the end of the first three calendar quarterly periods are generally less than the balances at the end of the year. Each of the Stations and the Journal generally has produced positive EBITDA on an annual basis. Generally, Stations in larger markets contribute a larger proportionate share of EBITDA.\nThe Company's principal costs of operations, in the case of Broadcasting, are employee salaries and commissions, programming, production, promotion, and other expenses (such as maintenance, supplies, insurance, rent, and utilities), and in the case of Publishing are labor and newsprint costs. The Programming and New Media segment consists primarily of investments in operations that are in the early development phase.\nThe Company has experienced operating losses primarily as a result of non-cash charges attributable to amortization of intangibles resulting from acquisitions of its television stations and stock-based compensation expense, and in the case of 1995, costs related to the consolidation of the morning and afternoon newspapers (\"single cycle costs\") and a restructuring charge associated with Publishing (see Note 8 of the Company's consolidated financial statements).\nReorganization\nOn October 5, 1995, Old PJC completed the acquisition of its joint venture partner's interest in KHC through the Kelso Buyout for $265 million, including transaction fees, completed the PJC Spin-Off, and, following the PJC Spin-Off, at which point it held only Old PJC's cable television businesses and assets, Old PJC was merged with and into Continental. Immediately prior to the Kelso Buyout, Continental purchased for $405 million all of the stock of KVC, a wholly owned cable subsidiary of KBC, which is wholly owned by KHC. As a result of these transactions, the Company, in substance, became successor to Old PJC, in the same lines of businesses, simultaneously disposing of its cable operations.\nDisposal of Cable Operations\nGross proceeds from the disposal of the cable operations discussed above consisted of a combination of Continental stock, which was received directly from Continental by Old PJC's shareholders in connection with the Merger, assumption of a portion of Old PJC's debt by Continental and cash. The total combined consideration amounted to approximately $1.4 billion (including $405 million from the sale of KVC). The accounting for this transaction was to treat the disposal of the cable operations as if the Company had spun off its cable operations to shareholders, which management believes more appropriately reflects the substance of the transaction. Accordingly, the excess of the gross proceeds over the net assets of the discontinued cable operations less income taxes is reflected in the consolidated statement of stockholders' equity. This excess amounted to $582.5 million. The receipt by the Old PJC shareholders of the Continental shares, valued at $584.8 million, is recorded as a \"deemed distribution\" in the consolidated statement of stockholders' equity.\nIn connection with the Merger, the Company agreed to indemnify Continental from any and all liabilities arising from the non-cable television businesses, and is responsible for all federal and state income tax liabilities for periods ending on or before the closing date.\nKelso Buyout\nThe Kelso Buyout as discussed above and in Note 3 (a) of the consolidated financial statements, was recorded in the fourth quarter of 1995 as a step acquisition under the purchase method of accounting. As illustrated below , the excess of the purchase price over the net book value of assets acquired, including deferred taxes, was $206.7 million, of which approximately $88.0 million was allocated to identifiable intangibles and the remainder to goodwill together to be amortized over an average life of approximately 30 years.\nThe primary business of KHC is broadcast television, and prior to the sale to Continental of KVC, also included cable television. Prior to the Kelso Buyout, the Company reported its 50% investment in KHC under the equity method of accounting. Audited financial statements of KHC as of December 31, 1994 and for each of the years in the two-year period then ended are presented elsewhere in this Form 10-K.\nCONSOLIDATED RESULTS OF OPERATIONS\nThe following discussion of the results of operations for the years ended December 31, 1995, 1994, and 1993 is divided into three sections in order to assist the reader in analyzing the effects on the Company's operations of the above described reorganization, disposal of cable operations, and Kelso Buyout while at the same time providing the required discussion of the consolidated results of operations presented in the audited financial statements. The sections are as follows:\n- - ADJUSTED COMBINED Results of Operations - presents a discussion of Adjusted Combined results of operations assuming the transactions discussed above occurred on January 1, 1993.\n- - CONSOLIDATED RESULTS OF OPERATIONS - presents a discussion of the historical audited consolidated results of operations.\n- - ANALYSIS BY SEGMENT - presents a discussion of the results of operations for each of the Company's significant segments: Broadcasting, Publishing, and Programming and New Media.\nADJUSTED COMBINED RESULTS OF OPERATIONS\nThe following table presents adjusted combined results of operations for the years ended December 31, 1995, 1994, and 1993 with appropriate adjustments for the effects on amortization expense, interest expense, and income taxes as if the reorganization, disposal of cable operations, and Kelso Buyout occurred on January 1, 1993. This information, which is unaudited, consolidates the historical audited results of the Company and KHC with appropriate elimination entries for all periods presented. Although not required to be shown, this adjusted combined financial information is presented because management believes the information is more meaningful in evaluating the current status of the Company in that it includes KHC operations for all years presented and excludes discontinued operations for all years presented. However, the adjusted combined financial information presented below is not necessarily indicative of what would have actually occurred on January 1, 1993 nor is it indicative of results which may occur in the future.\nAdjusted Combined 1995 to Adjusted Combined 1994\nADJUSTED COMBINED OPERATING REVENUES. Consolidated revenues in 1995 increased by 3.7% over 1994 to $312.5 million from $301.3 million. Broadcasting revenues contributed significantly to the increase in consolidated revenues with an increase of 5.5% in 1995 to $180.5 million from $171.1 million in 1994 due to improved ratings and local market growth. Publishing contributed substantially the same revenue in 1995 as in the prior year with $128.5 million for 1995 compared with $127.9 million in 1994. The operations in the Programming and New Media segment are in the early development phase and contributed $3.5 million in revenue in 1995 compared to $2.3 million in 1994.\nADJUSTED COMBINED OPERATING AND ADMINISTRATIVE EXPENSES. Consolidated operating and administrative expenses increased 4.8% to $248.5 million in 1995 from $237.2 million in 1994, primarily as a result of the increased costs in Publishing. Broadcasting operating and administrative expenses increased 2.4% to $116.1 million in 1995 from $113.4 million in 1994. Publishing operating and administrative expenses increased 5.9% in 1995 to $113.7 million from $107.4 million in 1994. This increase was a result of a 45% increase in the average price per ton of newsprint paid by the Company which caused a $6.5 million increase in newsprint costs in 1995 compared to 1994. Operating expenses for the development stage businesses in the Programming and New Media segment increased from $2.6 million in 1994 to $5.1 million in 1995 primarily due to expenses associated with the launching of the cable network NorthWest Cable News Channel. Such expenses are expected to continue to escalate 30-40% in 1996 as these businesses grow.\nADJUSTED COMBINED EBITDA. Consolidated EBITDA excluding the one-time impact of single cycle costs and restructuring costs was relatively flat at $65.2 million and $64.4 million in 1995 and 1994, respectively. Broadcasting experienced 11.8% EBITDA growth in 1995 to $64.4 million compared to $57.6 million in 1994. The growth in Broadcasting EBITDA was offset by a $5.7 million decline in Publishing EBITDA that was primarily the result of the 45% increase in newsprint prices. Because the Programming and New Media segment is in an early development phase, EBITDA was a loss of $1.7 million in 1995 and $.6 million in 1994.\nSINGLE CYCLE AND RESTRUCTURING COSTS. In 1995, the Company recorded a $7.4 million charge for the costs associated with the consolidation of the morning and afternoon newspapers (\"single cycle\" conversion) and a $6.8 million restructuring charge at year end under a plan of reorganization and restructuring of most Publishing departments to increase efficiencies. To the extent not funded by the Company's pension plan, the Company will pay such costs in 1996. The combined impact of both of these efforts is expected to reduce the number of employees by approximately 160 (net of 20 additional local news\/photo interns) full time equivalents and, when fully implemented, to generate annual cost savings of up to $8 million. Included in the $7.4 million single cycle charge are early retirement benefits accepted by 61 employees and voluntary separation benefits accepted by 19 employees, together totaling approximately $4.9 million. Also included are costs of approximately $2.5 million for promotion, training, and other costs of the conversion. The early retirement benefits will be paid from the Company's retirement plans (in which plan assets exceed plan obligations). As of December 31, 1995 approximately $.7 million remains unpaid under the voluntary separation plans and benefits and is expected to be paid in 1996. Included in the $6.8 million restructuring charge is the cost of salaries and related payroll taxes associated with a targeted reduction in workforce of approximately 100 full time equivalents through a combination of early retirement and voluntary and involuntary separation assistance plans. Of the 100 full time equivalents, approximately 62 are from the news and operations departments with the remainder coming from all other departments. Early retirement and voluntary separation benefits will be paid out of the Company's pension plans (in which plan assets exceed plan obligations). All costs are expected to be paid out in 1996.\nSTOCK-BASED COMPENSATION. Stock-based compensation expense relates to the Company's restricted stock unit, incentive unit compensation (\"IUP\"), and certain stock option plans. Stock-based compensation declined $12.7 million to $2.4 million in 1995 from $15.1 million in 1994 primarily due to the freezing of the IUP plan in 1994. (See also \"Liquidity and Capital Resources\" regarding possible additional payments under these plans).\nADJUSTED COMBINED DEPRECIATION AND AMORTIZATION EXPENSE. Consolidated depreciation and amortization expense decreased $1.6 million from $41.2 million in 1994 to $39.6 million in 1995 reflecting management's continued effort to control capital spending. Included in adjusted combined depreciation and amortization is approximately $7.5 million associated with the step-up in the carrying value of intangible assets (with an average life of 30 years) acquired in the Kelso Buyout.\nADJUSTED COMBINED OTHER INCOME (EXPENSE), NET. Other income (expense), net increased $2.2 million to $22.6 million in 1995 from $20.4 million in 1994. The increase of $2.8 million in equity in losses of affiliates from 1994 is a result of them Programming and New Media segment's investments in start up businesses, America's Health Network (\"AHN\") and Peapod, L.P. (See \"Description of Programming and New Media Business\"). An increase in interest expense of $1.6 million in 1995 was offset by recognition in 1995 of $2.4 million in interest income from a note receivable with the Lowell Sun Companies. Interest income received in 1994 and 1993 had been used to create a reserve against the principal of the note receivable in those years.\nADJUSTED COMBINED LOSS FROM CONTINUING OPERATIONS. Adjusted Combined loss from continuing operations for 1995 was $14.9 million compared with $19.1 million in 1994 reflecting the fluctuations discussed above. Adjusted Combined income tax expense decreased from $6.5 million in 1994 to $.1 million in 1995 primarily due to a $6.0 million additional tax provision recorded in 1994 primarily relating to interest on settlements and contingencies on income tax exposures identified during Internal Revenue Service examinations. The effective tax rate is unfavorably affected by non-deductible amortization of certain intangibles acquired.\nADJUSTED COMBINED 1994 TO ADJUSTED COMBINED 1993\nADJUSTED COMBINED OPERATING REVENUES. Consolidated revenues in 1994 increased by 10.4% over 1993 to $301.3 million from $272.8 million. Broadcasting revenues contributed 15.8% growth in revenues to $171.1 million in 1994 from $147.8 million in 1993, accounting for most of the consolidated revenue increase. Publishing revenues grew slowly at 2.4% to $127.9 million in 1994 from $124.9 million in 1993 reflecting a continuing recession in the local economy. The Programming and New Media segment began developing its operating services in 1994 and generated $2.3 million in revenue.\nADJUSTED COMBINED OPERATING AND ADMINISTRATIVE EXPENSES. Consolidated operating and administrative expenses increased 4.5% to $237.2 million in 1994 from $227.0 in 1993, primarily as a result of the increased costs in Broadcasting. Broadcasting operating and administrative expenses increased 8.2% to $113.4 million in 1994 from $104.8 million in 1993 as a result of program development and increased promotional activities. Publishing operating and administrative expenses increased 3.7% in 1994 to $107.4 million from $103.6 million in 1993 due to development expenses, system conversion costs, and payroll cost increases. Operating expenses for the start up of businesses in the Programming and New Media segment amounted to $2.6 million in 1994.\nADJUSTED COMBINED EBITDA. Consolidated EBITDA grew 37.0% to $64.4 million from $47.0 million primarily due to a 34.0% increase in Broadcasting EBITDA. Broadcasting EBITDA increased to $57.6 million in 1994 compared to $43.0 million in 1993. Publishing EBITDA declined slightly to $20.5 million in 1994 from $21.3 million in 1993. Corporate overhead declined $4.2 million in 1994 to $13.1 million from $17.3 million in 1993 primarily due to consolidation and allocation of shared services.\nSTOCK-BASED COMPENSATION. Stock-based compensation increased $9.4 million to $15.1 million in 1994 from $5.7 million in 1993 primarily due to a 40% increase in the valuation of the Company as determined by an independent appraiser.\nADJUSTED COMBINED DEPRECIATION AND AMORTIZATION EXPENSE. Consolidated depreciation and amortization expense decreased $1.6 million to $41.2 million in 1994 from $42.8 million in 1993 reflecting management's effort to control capital spending. Included in adjusted combined depreciation and amortization is approximately $7.5 million associated with the step-up in carrying values of intangible assets (with an average life of 30 years) acquired in the Kelso Buyout.\nADJUSTED COMBINED OTHER (EXPENSE), NET. Adjusted Combined other income (expense), net remained relatively flat in 1994 at $20.4 million compared with $20.8 million in 1993. Losses in the Company's ancillary garage operations included a valuation adjustment of approximately $3 million in 1993. However, 1994 equity in losses of affiliates increased $3.5 million primarily due to developing operations at TVFN and Partner Stations Network. (See table in Programming and New Media segment).\nADJUSTED COMBINED LOSS FROM CONTINUING OPERATIONS. Including the $6.0 million provision for income tax settlements and contingencies in 1994 discussed earlier, adjusted combined loss from continuing operations was $19.1 million in 1994 compared with $19.8 million in 1993, a $.7 million improvement.\nOPERATING REVENUES. Consolidated revenues increased 69.7%, or $128.3 million to $312.5 million in 1995 from $184.2 million in 1994 primarily due to the acquisition of the KHC stations. Including KHC broadcasting revenues in 1994, consolidated revenues in 1995 increased by 3.7% over 1994 to $312.5 million from $301.3 million. Broadcasting revenues contributed significantly to the increase in consolidated revenues with an increase of 5.5% for the year ended December 31, 1995 as compared to the year ended December 31, 1994. Publishing contributed substantially the same revenue in 1995 as in the prior year with $128.5 million for 1995 compared with $127.9 million in 1994. The operations in the Programming and New Media segment are in the early development phase and contributed $3.5 million in revenue in 1995 compared to $2.3 million in 1994.\nOPERATING AND ADMINISTRATIVE EXPENSES. Consolidated operating and administrative expenses increased $103.3 million primarily due to the acquisition and consolidation of KHC's operations in 1995. Including KHC operations for 1994, consolidated operating and administrative expenses increased 4.8% to $248.5 million in 1995 from $237.2 in 1994 (adjusted combined), primarily as a result of the increased costs in Publishing. Publishing operating and administrative expenses increased 5.9% in 1995 to $113.7 million from $107.4 million in 1994. This increase is a result of a 45% increase in the average price per ton of newsprint which caused a $6.5 million increase in newsprint costs in 1995 as compared to 1994. Operating expenses for the early development phase businesses in the Programming and New Media segment increased from $2.6 million in 1994 to $5.1 million in 1995 primarily due to expenses associated with the launching of the cable network NorthWest Cable News Channel.\nSTOCK-BASED COMPENSATION. See discussion under \"Adjusted Combined 1995 to Adjusted Combined 1994.\"\nSingle Cycle and Restructuring Costs. See discussion under \"Adjusted Combined 1995 to Adjusted Combined 1994\".\nDEPRECIATION AND AMORTIZATION EXPENSE. Consolidated depreciation and amortization expense increased $14.0 million primarily due to the consolidation of KHC's operations in 1995. Additional amortization recorded in 1995 as a result of the step-up in carrying value of intangibles acquired amounted to approximately $1.9 million in 1995.\nOTHER INCOME (EXPENSE), NET. Other income (expense), net increased $4.7 million to $14.4 million in 1995 from $9.7 million in 1994. In addition to the changes discussed in the \"Adjusted Combined 1995 to Adjusted Combined 1994\", the change is also due to consolidation of KHC in 1995 and related effects on equity in loss of affiliates and other income.\nLOSS FROM CONTINUING OPERATIONS. Loss from continuing operations for 1995 was $5.0 million compared with $23.2 million in 1994 reflecting the fluctuations discussed above.\nLOSS FROM DISCONTINUED OPERATIONS. Loss from the discontinued cable business is not reflected in 1995 because loss on disposal of that business, including estimated loss during the 1995 phase-out period, was recognized in the fourth quarter of 1994. The loss from the operations and disposal of discontinued wholly owned cable operations (excluding KHC's discontinued cable operation) in 1994 amounted to $36.6 million of which $34.8 million reflected severance and transaction costs and $1.8 million reflected the loss from cable operations, net of allocated interest of $20.7 million and loss during the phase out period.\nNET LOSS. Net loss for 1995 was $9.6 million including an extraordinary charge of $2.1 million related to the early extinguishment of debt. Net loss including the loss for discontinued operations of $36.6 million was $59.8 million in 1994.\nHistorical 1994 to Historical 1993\nOPERATING REVENUES. Historical consolidated revenues increased 8.1% to $184.2 million in 1994 from $170.4 million in 1993. Broadcasting revenues grew 18.7% to $54.0 million from $45.5 million due to a nationwide improvement in the economy. Publishing revenues grew slowly at 2.4% to $127.9 million in 1994 from $124.9 million in 1993 reflecting a continuing recession in the local economy. The Programming and New Media segment began its early stage development operating services in 1994 and generated $2.3 million in revenue.\nOPERATING AND ADMINISTRATIVE EXPENSES. Operating and administrative expenses increased 2.2% on a consolidated basis from $157.3 million in 1993 to $160.7 million in 1994 primarily due to $2.6 million in start up costs associated with new operations of the Programming and New Media segment.\nSTOCK-BASED COMPENSATION. See discussion under \"Adjusted Combined 1994 to Adjusted Combined 1993\".\nDEPRECIATION AND AMORTIZATION EXPENSES. Depreciation and amortization declined slightly to $20.0 million in 1994 from $20.6 million in 1993 due to management's focus on controlling capital spending.\nOTHER INCOME (EXPENSE), NET. Other income (expense), net remained relatively even in 1994 at $9.7 million compared with $9.2 million in 1993. A valuation adjustment of $3.0 million associated with the Company's ancillary garage operation recorded in 1993 was offset in 1994 by increases in losses from affiliates of $4.6 million primarily associated with the Company's share of KHC's net operations (including discontinued operations) of $7.2 million.\nLOSS FROM CONTINUING OPERATIONS. Including the $6.0 million provision for income tax settlements and contingencies in 1994 discussed earlier, loss from continuing operations declined $6.9 million to $23.2 million in 1994 from $16.3 million in 1993.\nLOSS FROM DISCONTINUED OPERATIONS. As previously discussed, the loss from the operations and disposal of discontinued wholly owned cable operations in 1994 amounted to $36.6 million. The loss in 1993 from discontinued cable operations of $6.4 million includes $19.8 million in allocated interest expense.\nNET LOSS. Net loss for 1994 including the $36.6 million loss for discontinued operations was $59.8 million. Net loss for 1993, including a $1.6 million extraordinary gain associated with the early extinguishment of debt, was $21.1 million.\nBroadcasting revenues have grown 22.1% over 1993 (adjusted combined) levels, with 15.7% growth in 1994 and 5.5% growth in 1995. While national revenues grew 19.1% in 1994 to $88.7 million (adjusted combined) from $74.5 million (adjusted combined) in 1993 reflecting nationwide economic improvement, growth slowed in 1995 to reflect only a modest increase of 2.7% to $91.1 million. This modest increase is a result of a slight downturn in the industry in the fourth quarter of 1995 as well as the unfavorable effects of large advance sales of advertising by the major networks which reduced national advertiser demand for spot advertising at the Company's stations. Local and regional revenues exhibited strong growth in 1995 and 1994 (adjusted combined) of 10.2% and 16.5%, respectively, due to improved ratings and market growth. Contributing to revenue growth in 1994 (adjusted combined) were changes in certain network affiliations, increased market share for the three stations that were Fox affiliates at the time and advertising revenue generated by the 1994 Winter Olympics.\nOperating and administrative expenses increased 2.4% to $116.1 million in 1995 from $113.4 million in 1994 (adjusted combined), a change of $2.7 million. These expenses reflect the incremental costs of a start-up news operation in Honolulu (required by\nKHNL's affiliation switch from Fox to NBC at the end of 1995) and the offsetting impact of cost containment policies at the stations. Operating and administrative expenses increased 8.2% to $113.4 million in 1994 (adjusted combined) from $104.8 million in 1993 (adjusted combined), a change of $8.6 million. This increase is a result of program development and promotional incentive programs to increase market share.\nDepreciation and amortization expense decreased 5.2 % to $27.5 million from $29.0 million in 1994 (adjusted combined), a change of $1.5 million, reflecting management's effort to control capital spending. Included in adjusted combined depreciation and amortization is approximately $7.5 million annually associated with the step-up in carrying value of intangible assets (with an average life of 30 years) resulting from the Kelso Buyout.\nAs a result of revenue growth and cost control, EBITDA for the group increased 11.8% to $64.4 million in 1995 from $57.6 million in 1994 (adjusted combined) and increased 34.0% in 1994 from $43.0 million in 1993 (adjusted combined). Broadcasting cash flow also grew 11.4% to $66.3 million in 1995 from $59.5 million in 1994 (adjusted combined) and increased 39.7% in 1994 from $42.6 million in 1993 (adjusted combined). Operating income improved 29.0% in 1995 (adjusted combined) and 105.4% in 1994 (adjusted combined). Performance was particularly strong at the stations in Seattle, Portland, Louisville, and Albuquerque.\nThe primary difference between \"Historical\" and \"Adjusted Combined\" results of operations for the Broadcasting segment in 1995, 1994, and 1993 is attributable to (1) an adjustment increasing amortization expense $5.6 million in 1995 and $7.5 million in both 1994 and 1993 in connection with the step-up in carrying value of intangible assets resulting from the Kelso Buyout and (2) consolidation of KHC broadcast operations. Historical depreciation and amortization increased $14.0 million in 1995 from $7.9 million in 1994 as a result of the consolidation of KHC and additional amortization expense of $1.9 million associated with the step-up in carrying values from the Kelso Buyout. Historical depreciation and amortization for 1994 decreased from $8.7 million in 1993 due to maintaining control over capital spending.\nHistorical revenue and operating and administrative expenses for the three year period exhibited the same trends as those discussed on an \"Adjusted Combined\" basis.\nPublishing revenues have grown 2.9% over a three year period since 1993. Advertising revenues have remained relatively flat over the three year period primarily due to a lackluster Rhode Island economy. Advertising linage for the three year period was 1,909,600; 2,031,400; and 2,104,900 for 1995, 1994, and 1993, respectively.\nPrior to June 5, 1995, the Company published a Sunday newspaper, The Providence Sunday Journal and both a morning daily newspaper, Providence Journal (Monday through Saturday) and an afternoon daily newspaper The Evening Bulletin (Monday through Friday). As discussed previously, the Company, in response to the changing readership preferences and declining circulation, primarily in The Evening Bulletin, consolidated the afternoon newspaper with the morning newspaper, and now only publishes the morning daily Providence Journal-Bulletin (Monday through Saturday) in addition to The Providence Sunday Journal.\nAs a result of the consolidation to a single cycle, daily circulation has dropped 5.0% from an average of approximately 177,500 for the month of July 1995 to approximately 169,000 (as calculated by management) for the two months ended February, 1996 and is expected to continue to fall somewhat in the first half of 1996. However, a recent study conducted by the Company has indicated that both daily and Sunday readership has remained constant over the past three years with daily readership fluctuating between 56% to 58% of the total adults in the market and Sunday readership remaining between 68% to 70% of total adults in the market. In addition, management is making efforts to increase circulation levels through expanded local coverage and continued improvement in content and customer service. There can be no assurances, however, that management will be successful in these efforts. Despite the decline in circulation levels, circulation revenues of $32.2 million in 1995 were 4% ahead of 1994 circulation revenues of $30.9 million as a result of price increases.\nOperating and administrative expenses increased 5.9% in 1995 to $113.7 million and 3.7% in 1994 to $107.4 million primarily due to newsprint and ink increases of $6.5 million in 1995 and development efforts of $2.0 million in 1994. The average price per ton of newsprint paid by the Company\nincreased 45% in 1995. Publishing has implemented several newsprint conservation programs to offset these price increases, including, among others, increased recycling and reduction of web width. Due to recent market trends in price increase withdrawals, the Company believes that newsprint prices will decline somewhat in 1996.\nIn implementing the conversion to a single cycle, the Company incurred costs of $7.4 million which include early retirement and voluntary separation costs totaling $4.9 million affecting approximately 80 employees and $2.5 million for promotion, training, and other costs of the conversion. Annualized savings from this consolidation are expected to approximate $4 million.\nAs previously discussed, management approved a plan of reorganization and restructuring of most departments of Publishing at the end of 1995 in an effort to improve efficiencies. Under the plan, the Company has targeted a reduction in workforce of approximately 100 full time equivalents through a combination of early retirement and voluntary and involuntary separation assistance plans. Approximately 62% of the reductions are in the news and operations departments. A charge of $6.8 million was recorded in the fourth quarter of 1995 relating to salaries, benefits, and payroll taxes associated with the restructuring. Annual savings from the restructuring are expected to be approximately $4 million. Together with the savings from the single cycle consolidation, total annualized savings are estimated to be approximately $8 million.\nAs a result of the above fluctuations, EBITDA excluding single cycle costs and restructuring costs declined to $14.8 million in 1995 from $20.5 million in 1994. The early retirement and voluntary separation benefits under the restructuring plan as well as the early retirement benefits offered in the single cycle conversion are expected to be paid from the Company's pension plan (in which plan assets exceed plan obligations), thereby minimizing the impact on Publishing's cash flow.\nCash Flows - Investing and Financing Activities.\nThe significant investing and financing activities in 1995 are primarily related to the consummation of the Merger and Kelso Buyout transactions. The cash flows of KHC's operations are included in the above table for 1995 since January 1, 1995, net of the effects of the acquired assets and liabilities of KHC. KHC's operating activities included above have been adjusted for minority interests from January 1, 1995 through the acquisition date.\nIn connection with the Merger and Kelso Buyout transactions, Old PJC, prior to the PJC Spin-Off, incurred indebtedness to a subsidiary of Continental in a principal amount of approximately $408 million (net of $2 million in certain costs shared with Continental) (\"New Cable Indebtedness\"). Prior to the PJC Spin- Off, Old PJC used the proceeds of the New Cable Indebtedness, the $405 million provided by the sale of KVC and the Company Indebtedness (defined below) to (i) consummate the Kelso Buyout (ii) to repay substantially all outstanding indebtedness of Old PJC and KHC in an aggregate amount of approximately $623 million, and (iii) to pay other costs associated with the transactions. Additional indebtedness (the \"Company Indebtedness\") required to meet the foregoing obligations, among others, was incurred by Old PJC and the Company in the principal amount of $105 million. Following the PJC Spin-Off, the Company had no obligations or liabilities with respect to the New Cable Indebtedness, and Continental had no obligations or liabilities with respect to the Company Indebtedness. In connection with the sale of KVC, KBC paid approximately $121 million in taxes, which was funded by the Company Indebtedness in December, 1995.\nCredit Facility\nThe Company Indebtedness was incurred pursuant to a Credit Agreement entered into by the Company on October 5, 1995 (the \"Credit Agreement\"). The Credit Agreement, which consists of a $75 million term loan and a $300 million revolving credit facility, provides the Company with maximum credit availability of $375 million. The amount of credit available as of December 31, 1995 under this facility was approximately $141 million.\nCredit availability under the Credit Agreement decreases quarterly commencing December 31, 1996, with a final maturity on June 30, 2004. The revolving commitment decreases as follows (in thousands): 1996-$4,000; 1997-$10,500; 1998-$14,500; 1999-$21,500; 2000-$53,250; 2001-$65,750; 2002-$67,750; and 2003-$62,750. The indebtedness evidenced by the Credit Agreement is secured by guarantees from all of the material subsidiaries of the Company and a first priority pledge of all such material subsidiaries' capital stock. The Credit Agreement provides for borrowings indexed, as the Company may from time to time elect, to the Eurodollar rate, the certificate of deposit rate, or the \"base\" rate of the agent, plus the \"spread\" over such rates. The \"spread\" will be determined by the ratio of the total debt of the Company to the operating cash flow of the Company (as defined by the Credit Agreement). The Credit Agreement contains customary events of default, financial covenants, covenants restricting the incurrence of debt (other than under the Credit Agreement), investments and encumbrances on assets and covenants limiting mergers and acquisitions. The Credit Agreement provides for the mandatory prepayment of amounts outstanding and a reduction in the commitment under certain circumstances.\nThe Company has hedged against changes in interest rates on its revolving credit and term loan facilities described above through an interest rate swap agreement. The interest rate under the swap agreement is equal to 6.71% plus an applicable margin as defined in the revolving credit and term loan facility which, at December 31, 1995 effectively sets the interest rate at 8.1% on the first $200 million of outstanding debt. The Company recorded additional interest expense during 1995 of approximately $1.1 million which represents the excess of the swap agreement rate over the original contractual rate. The notional amounts under the agreement are as follows: $200 million in 1996, $175 million in 1997 and $150 million in 1998 and 1999.\nStock-based compensation payouts identified above totaling $20.6 million relate to cash paid to participants in the liquidation of 85% of the units in the Company's incentive stock units plan (the \"IUP Plan\"). Amounts paid to participants in the IUP Plan and for the remaining units previously were to be adjusted if, upon the occurrence of a public offering of Continental Class A Common Stock or certain other events, the price of Continental Class A Common Stock is greater or less than the price attributed to such shares at the time 85% of the units were liquidated. A similar adjustment was applicable to certain\nother stock-based compensation plans of the Company. As a result of a planned merger of Continental with and into USWest Media Group (\"USWest\/Continental Merger\"), jointly announced by these entities on February 27, 1996, participants in these plans may now receive the adjustment as additional payments in cash or stock reflecting the increase in the price of Continental Class A Common Stock since the Merger. The final amount of additional consideration is subject to approval by the Compensation Committee of the Company's Board of Directors and the closing of the USWest\/Continental Merger but could approximate $21 million the vested portion of which will be charged to first quarter operations in 1996. It is currently anticipated that following the payout of any additional consideration, the IUP Plan will be fully liquidated and terminated.\nCapital Expenditures\nOf the $15.3 million spent in 1995 on capital expenditures, $8.0 million was spent by the Broadcasting division; $3.2 million was spent by Publishing; and $3.7 million was spent in Programming and New Media. Broadcasting and Programming and New Media capital expenditures consisted primarily of maintenance of existing broadcasting plant and equipment but also consisted of approximately $2.1 million spent on advanced digital editing systems with another $4 million to $5 million planned for such digital editing systems in 1996. Total capital expenditures planned for Broadcasting in 1996 are expected to be approximately $12.5 million. Publishing capital expenditures of $3.2 million are primarily related to information and prepress systems and equipment replacement. Similar amounts for Publishing are planned for 1996.\nInvestments\nIn addition to the Kelso Buyout, the Company made significant investments in Programming and New Media in 1995. Investments in the cable networks AHN and TVFN totaled $10.3 million and $5.2 million, respectively in 1995. Investments in its interactive shopping venture, Peapod, totaled $5.3 million and investments in Partner Stations Network totaled $.9 million. The Company intends to increase its investment in these and other entities in Programming and New Media in 1996 with minimum amounts of $32 million planned for AHN and TVFN. In addition, the Company intends to pursue a proposed transaction to purchase some or all of the cash equity partnership interests held by three partners of TVFN. In 1995, the Company disposed of the Biltmore Hotel in Providence, Rhode Island, for approximately $7 million, which approximated net book value.\nDividends and Treasury Stock\nTotal gross dividends have been fairly constant over the past three years at $9.7 million in 1995 and 1994 and $8.9 million in 1993. It is anticipated that total dividends for 1996 will be equivalent to those paid in 1995. After 1996, it is anticipated that dividends will be reduced to zero subject to change at the discretion of the Board of Directors of the Company.\nThe Company has not repurchased its stock since 1994 and does not currently have plans to do so in 1996. As discussed in note 16 of the consolidated financial statements, additional consideration totaling $7.4 million was paid in 1995 to a former stockholder under the terms of a redemption agreement dated April 15, 1987 in connection with a treasury stock repurchase at that time.\nFuture Funding and Capital Resources\nFuture cash flows from the Company's operations are expected to be sufficient to meet foreseeable working capital, debt service, capital expenditure, and dividend requirements. In addition, the Company expects to use its unused credit facility and cash flow from operations for developing its existing businesses and investing in programming and new media ventures, among other things. In order to enhance corporate flexibility, management is currently exploring other debt or equity capital resource alternatives.\nINFLATION\nCertain of the Company's expenses, such as those for wages and benefits increase with general inflation. However, the Company does not believe that its results of operations have been, or will be, adversely affected by inflation, provided that it is able to increase its advertising rates periodically.\nRECENT ACCOUNTING PRONOUNCEMENTS\nEffective January 1, 1996, the Company will adopt Statement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation\" (\"SFAS No. 123\"). The Statement encourages, but does not require, a fair value based method of accounting for stock- based compensation plans. SFAS No. 123 allows an entity to continue to measure compensation cost for those plans using the intrinsic value based method prescribed by APB Opinion No. 25. For those entities electing to use the intrinsic value based method, SFAS No. 123 requires pro forma disclosures of net income and earnings per share computed as if the fair value based method had been applied. The Company intends to continue to account for stock-based compensation costs under APB Opinion No. 25 and will provide the additional required disclosures relating to 1995 and 1996 stock options in its 1996 Annual Report.\nOn January 1, 1996, the Company adopted SFAS No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.\" This statement requires that long-lived assets and certain identifiable intangibles to be held and used by an entity be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. This statement also requires that long-lived assets and certain identifiable intangibles to be disposed of be reported at the lower of carrying value or fair value less costs to sell. Adoption of this statement is not expected to have any impact on the Company's consolidated financial statements.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nINDEPENDENT AUDITORS' REPORT\nTo the Board of Directors and Shareholders of The Providence Journal Company:\nWe have audited the consolidated financial statements of The Providence Journal Company and Subsidiaries (the Company) as listed in the accompanying index. In connection with our audit 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 consolidated financial statements and financial statement schedule based on our audits. We did not audit the consolidated financial statements of King Holding Corp. (a 50% owned investee company prior to October 5, 1995) as of December 31, 1994 and for each of the years in the two-year period then ended. The Company's investment in King Holding Corp. at December 31, 1994 was $76,829,000 and its equity in losses of King Holding Corp. was $8,325,000 and $7,244,000 for the years ended December 31, 1994 and 1993, respectively. The consolidated financial statements and financial statement schedule of King Holding Corp. were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to the amounts included for King Holding Corp. 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 and the report of the other auditors provide a reasonable basis for our opinion.\nAs discussed more fully in Note 2 to the consolidated financial statements, the Company completed the Merger and related transactions with Continental Cablevision, Inc. and the Kelso Buyout on October 5, 1995 which resulted in the disposal of the Company's cable operations, and the acquisition of the Company's joint venture partner's interest in King Holding Corp.\nIn our opinion, based on our audits and the report of the other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of The Providence Journal Company and Subsidiaries as of December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1995, 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.\n\/s\/ KPMG PEAT MARWICK LLP\nProvidence, Rhode Island February 16, 1996, except for Notes 2 and 13 which are dated March 4, 1996 and February 27, 1996, respectively.\nINDEPENDENT AUDITORS' REPORT\nKing Holding Corp.:\nWe have audited the consolidated financial statements of King Holding Corp. (the Company) as listed in the accompanying index. Our audits also included the financial statement schedule listed in the index at Item 14. These consolidated financial statements and the financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and 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 King Holding Corp. and subsidiaries at December 31, 1994, and the 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. 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\nBoston, Massachusetts February 10, 1995\nSEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nSEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nSEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nTHE PROVIDENCE JOURNAL COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)\nSEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nTHE PROVIDENCE JOURNAL COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1995, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)\nNOTE 1-- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\n(a) Description of Business and Basis of Consolidation\nThe consolidated financial statements present the financial position and results of operations of The Providence Journal Company (\"Registrant\") and its subsidiaries (collectively the \"Company\"). Registrant is the successor to Providence Journal Company (\"Old PJC\") which reorganized itself, acquired all of its joint venture partner's interest in King Holding Corp. (\"KHC\"), and disposed of its cable operations on October 5, 1995 in a series of transactions as described in Note 2. The Company is a diversified communications company with operations and investments in several media and electronic communications businesses. The principal areas of the Company's activities are television broadcasting (\"Broadcasting\"), newspaper publishing (\"Publishing\") and programming and new media ventures (\"Programming and New Media\"). Prior to the consummation of the Merger (defined below) and other transactions described below, these businesses were conducted by Old PJC which was also engaged in the ownership and operation of cable television systems (\"PJC Cable Business\").\nAll significant intercompany balances and transactions have been eliminated and appropriate minority interests have been recorded in consolidation. The results of operations for KHC have been consolidated in the accompanying statement of operations since January 1, 1995 with appropriate adjustments for minority interests for the period from January 1, 1995 to October 5, 1995 the date of the Kelso Buyout, as discussed in Note 3.\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nCertain prior year amounts have been reclassified to conform with the current year presentation.\n(b) Cash\nThe Company has a cash management program whereby outstanding checks in excess of cash in the concentration account are not accounted for as reductions of cash until presented to the bank for payment. At December 31, 1995 and 1994, the Company reclassified $2,162 and $2,805, respectively, of net outstanding checks to accounts payable.\nTHE PROVIDENCE JOURNAL COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1995, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)\n(c) Investments\nInvestments in Affiliates\nInvestments in affiliates in which the Company has significant influence (generally ownership of 20% to 50% of voting stock) and investments in partnerships are accounted for using the equity method. Other investments (generally ownership of less than 20% of voting stock) are carried at the lower of cost or net realizable value. The following investments are accounted for under the equity method as of December 31, 1995:\nTelevision Food Network, G.P. America's Health Network Peapod, L.P. Partner Stations Network, L.P. Linkatel Pacific, L.P.\nInformation about these investments is presented in Note 3.\nInvestments in Marketable Equity Securities\nInvestments in marketable equity securities consist of one common stock investment, StarSight Telecast, Inc., in which the Company owns approximately 5% of the outstanding common stock. This marketable equity security is included in other assets on the accompanying consolidated balance sheets.\nPrior to January 1, 1994, marketable equity securities were stated at cost. Effective January 1, 1994, the Company adopted Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\". Under this standard, the Company's marketable equity securities are considered to be \"held for sale\" and unrealized gains and losses, net of the related tax effect, are recorded as a separate component of stockholders' equity. A decline in the market value of any marketable equity security below cost that is deemed other than temporary results in an adjustment to the cost basis of the security which is charged to the consolidated statement of operations.\nAt December 31, 1995 and 1994, the cost of marketable equity securities totaled $5,949 and $5,552, respectively; fair market value totaled $3,861 and $5,727, respectively.\n(d) Inventories\nInventories, principally comprising raw materials, are stated at the lower of cost or market. Cost is determined principally on the last-in, first-out (LIFO) basis. Replacement cost of inventories was $2,806 and $1,945 at December 31, 1995 and 1994, respectively.\nTHE PROVIDENCE JOURNAL COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1995, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)\n(e) Television Program Rights\nTelevision program rights acquired under license agreements are recorded as assets at the gross value of the related liabilities at the time the programs become available for showing. The rights are amortized using accelerated methods over the term of the applicable contract. Amortized costs are included in operating expenses in the accompanying consolidated statements of operations.\nProgram rights classified as a current asset represent the total amount estimated to be amortized within a year. Related liabilities due to licensers are classified as current or long-term in accordance with the payment terms.\nTelevision program rights are reviewed periodically for impairment and, if necessary, adjusted to estimated net realizable value.\n(f) Property, Plant and Equipment\nWhen the Company determines that certain property, plant and equipment is impaired, a loss for impairment is recorded for the excess of the carrying value over the fair value of the asset. Fair value is determined by independent appraisal, if an active market exists for the related asset. Otherwise, fair value is estimated through forecasts of expected cash flows.\n(g) License Costs, Goodwill and Other Intangible Assets\nLicense costs and other intangible assets are stated at cost. Goodwill represents the excess of purchase price over fair value of net assets acquired. The Company provides for amortization using the straight-line method over periods ranging from 5 to 40 years.\nThe Company periodically reviews its intangible assets to determine whether any impairment has occurred. The Company assesses the recoverability of intangible assets by reviewing the performance of the underlying operations, in particular the operating cash flows (earnings before income taxes, depreciation, and amortization) of the operation.\nTHE PROVIDENCE JOURNAL COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1995, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)\n(h) Income Taxes\nDeferred 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. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period that includes the enactment date.\n(i) Pension and Other Postretirement Benefits\nThe Company has defined benefit pension plans covering substantially all employees of Publishing and certain employees of Broadcasting. The plans are funded in accordance with the requirements of the Employee Retirement Income Security Act.\nThe Company sponsors a defined life insurance and medical plan for its newspaper and one of its broadcast operations, respectively. The plans are accounted for under Statement of Financial Accounting Standards (\"SFAS\") No. 106, \"Employer's Accounting for Postretirement Benefits Other than Pensions\".\n(j) Derivative Financial Instruments\nThe Company has only limited involvement with derivative financial instruments and does not use them for trading purposes. Derivative financial instruments are only used to manage interest rate risks.\nThe Company has entered into an interest rate swap agreement which is accounted for as a hedge of the obligation and, accordingly, the net swap settlement amount is recorded as an adjustment to interest expense in the period incurred (see note 10). Gains and losses upon settlement of a swap agreement are deferred and amortized over the remaining term of the agreement.\n(k) Net Loss Per Share\nNet loss per share is based on the weighted average number of Class A and Class B shares of common stock outstanding. Restricted stock units and stock options are both considered common stock equivalents. Common stock equivalents were anti-dilutive for all periods in which the common stock equivalents were outstanding.\n(l) Stock-Based Compensation\nEffective January 1, 1996, the Company will adopt SFAS No. 123, \"Accounting for Stock-Based Compensation.\" The Statement encourages, but does not require, a fair value based method of accounting for stock-based compensation plans. SFAS No. 123 allows an entity to continue to measure compensation cost for those plans using the intrinsic value based method prescribed by APB Opinion No. 25. For those entities electing to use the intrinsic value based method, SFAS No. 123 requires pro forma disclosures of net income and earnings per share computed as if the fair value based method had been applied. The Company intends to continue to account for stock-based compensation costs under APB Opinion No. 25 and will provide the additional required disclosures relating to 1995 and 1996 stock options in its 1996 Annual Report.\nTHE PROVIDENCE JOURNAL COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1995, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)\nNOTE 2-- REORGANIZATION AND DISCONTINUED CABLE OPERATIONS\n(a) Reorganization\nOn October 5, 1995, Old PJC completed the acquisition of the 50% interest in King Holding Corp. (\"KHC\") held by an unrelated third party for $265 million, including $5 million in transaction fees (the \"Kelso Buyout\"), completed the transfer of all non-cable operations from Old PJC to the Company in a substantially tax-free reorganization pursuant to which the shares of capital stock of the Company were distributed to the shareholders of Old PJC (the \"PJC Spin-Off\"), and, following the PJC Spin-Off, at which point it held only Old PJC's cable television businesses and assets, Old PJC was merged (\"the Merger\") with and into Continental Cablevision, Inc. (\"Continental\"). Immediately prior to the Kelso Buyout, Continental purchased for $405 million all of the stock of King Videocable Company (\"KVC\"), a wholly owned subsidiary of King Broadcasting Company (\"KBC\"), which is wholly owned by KHC. As a result of these transactions, the Company, in substance, became successor to Old PJC, in the same lines of businesses, simultaneously spinning off its cable subsidiaries to its shareholders who then merged them into Continental.\nProceeds from the disposal of the cable operations discussed above consisted of a combination of Continental stock, which was received directly from Continental by Old PJC's shareholders in connection with the Merger, assumption of a portion of the Old PJC's debt by Continental (see Note 10), and cash. The total combined consideration amounted to approximately $1.4 billion (including the $405 million from the sale of KVC). The excess of the proceeds over the net assets of the discontinued cable operations was $582,510 and is reflected in the consolidated statement of stockholders' equity. The receipt by the Old PJC Shareholders of the Continental shares, valued at $584,769, is recorded as a deemed distribution to shareholders in the statement of stockholders' equity.\nThe Merger agreement between Old PJC and Continental provides that the total combined consideration received from the disposal of the Company's cable operations will be adjusted for certain working capital items of the cable operations acquired by Continental. On March 4, 1996, the Company agreed to pay Continental $4,250 in full settlement of this working capital adjustment which was accrued in the accompanying balance sheet as of December 31, 1995 and included in discontinued operations of 1995.\nIn connection with the Merger, the Company agreed to indemnify Continental from any and all liabilities arising from the non-cable television businesses, and is responsible for all federal and state income tax liabilities for periods ending on or before the closing date.\nTHE PROVIDENCE JOURNAL COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1995, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)\nThe net loss for discontinued operations in 1995 was accrued in 1994 as part of the costs to dispose of the cable operations. No amounts were required to be recorded in the loss from operations of discontinued segments in the consolidated statement of operations for 1995.\nLoss from operations of discontinued segments includes allocated interest expense totaling $17,265 (excluding $12,386 allocated to KVC operations), $20,674 and $19,807 in 1995, 1994 and 1993, respectively. Interest allocated to discontinued segments was limited to the associated interest on debt that was repaid in connection with the Merger. The estimated loss on disposal of segments in 1994 of $34,764, which is net of income tax benefits of $8,038, includes severance packages, transaction costs and a provision for loss during the phase-out period.\nIn addition, in 1994 the Company sold its remaining cellular system investment and its paging subsidiary. As a result of these transactions, the Company recorded gains of $1,390 (net of phase-out period operating losses and income taxes).\nIncluded in discontinued operations is a 50% equity investment in Copley\/Colony, Inc. (\"Copley\/Colony\"), a joint venture between Colony Communications, Inc. (\"Colony\") (a subsidiary of Old PJC) and Copley Press Electronics Company (\"Copley\"), engaged in cable television operations. In connection with the Merger agreement with Continental, in May, 1995 Copley sold all of its interests in Copley\/Colony to Colony for a fixed aggregate purchase price of $47,790 in cash. As a result, Colony owned all of the outstanding shares of Copley\/Colony at the time of the Merger with Continental.\nThe net assets of the cable television businesses acquired by Continental are presented in the accompanying consolidated balance sheets as \"net assets of discontinued operations\" prior to the disposal. Discontinued assets acquired consisted primarily of plant and equipment, and intangible assets. Liabilities assumed consisted primarily of accounts payable and accrued expenses.\nTHE PROVIDENCE JOURNAL COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1995, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)\nNOTE 3 -- INVESTMENTS IN AFFILIATED COMPANIES\n(a) King Holding Corp.\nThe Kelso Buyout as discussed in Note 2 (a), was recorded in the fourth quarter of 1995 as a step acquisition under the purchase method of accounting. The excess of the purchase price over the net book value of assets acquired including deferred taxes was $206,740, of which approximately $88,000 was allocated to identifiable intangibles and the remainder to goodwill, together to be amortized over an average life of approximately 30 years.\nPrior to the acquisition of all outstanding interests, the Company received annual governance fees and management fees from KHC totaling $3,525 and $3,781 in 1994 and 1993 respectively, which had been included in management fees from related parties. The Company charged KHC $1,130 and $330 for accounting services in 1994 and 1993, respectively, and was also reimbursed $3,240, and $2,842 by KHC for expenses in its capacity as manager in 1994 and 1993, respectively. In 1995, the annual governance, management, and accounting fees and expenses reimbursed have been eliminated in consolidation.\nTHE PROVIDENCE JOURNAL COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1995, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)\n(b) Television Food Network, G.P.\nAs of December 31, 1995, the Company, controlled a 20% interest in Television Food Network, G.P. (\"TVFN\"). The partnership was formed specifically to own and operate the Television Food Network channel. TVFN is a 24-hour advertising supported network service that provides television programming related to the preparation, enjoyment and consumption of food, as well as programs focusing on nutrition and topical news areas. TVFN is a general partnership consisting of eight media companies with cable television, broadcast television and programming holdings. TVFN is distributed predominantly through cable television stations to aproximately 15.4 million subscribers throughout the United States. The Company is the general partner in the managing partner of TVFN and has invested approximately $12,650 through December 31, 1995. In addition, the Company is negotiating with three of its partners to purchase interests which, when combined with the Company's current interest, would give the Company majority ownership of TVFN. In addition, the Board approved additional investments in TVFN of up to an additional $20,000 to fund operating losses of TVFN through 1997.\nEffective March 1994 the Company entered into a sub-lease agreement with TVFN for use of the Company's C-band primary transponder. The lease is effective through March 1999. The Company recorded $1,090 and $1,700 in rental revenue from TVFN in 1995 and 1994, respectively.\n(c) America's Health Network\nDuring 1995, the Company invested $10,250 in America's Health Network (\"AHN\"), a development stage cable programming network service intending to provide health-related information and products. The channel launched on March 25, 1996 with 750,000 subscribers. The Company's Board of Directors has approved additional investments up to $12,000, expected to made in 1996. In early 1996, AHN, Inc. was reorganized and became America's Health Network, L.L.C. (\"AHN LLC\"), a limited liability corporation which is the general partner in AHN Partners, L.P. (\"AHN Partners\"), a limited partnership formed to carry on the operations of the network. The Company has invested approximately $15,300 collectively in AHN LLC and AHN Partners as of February 29, 1996, representing a 59% interest, which is considered temporary until the full funding by investors is completed, which is expected to occur in the second quarter of 1996. It is anticipated that the Company's overall interest in this venture at that time will be approximately 50%. Although consolidation is not material to the Company's financial statements, to the extent the Company attains control over this investment, it will be consolidated in 1996.\nTHE PROVIDENCE JOURNAL COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1995, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)\nThe Company also entered into a sub-lease agreement with AHN for use of the Company's C-band primary transponder. The lease term is from November 1, 1995 through October 31, 2000. The Company recorded revenue of $410 related to this agreement during 1995.\n(d) Peapod, L.P.\nOn July 27, 1995, the Company purchased a 17.1% interest in Peapod, L.P., which currently provides an interactive computer on-line grocery ordering, shopping and delivery service in Chicago and San Francisco and will expand such services to Boston and Providence in 1996. Total investments in the partnership during 1995 were $5,335. The Company has committed to invest an additional $1,000 in 1996 as part of a $15 million private placement. No additional investments have been committed to.\nSummary Financial Information -- TVFN, AHN, and Peapod, L.P\n(e) Partner Stations Network, L.P.\nThe Company is a limited partner with four other television group broadcasters in Partner Stations Network, L.P. (\"PSN\"). PSN was formed in 1994 to develop and produce television programming for broadcast on their own stations and for potential national distribution to other television broadcast stations. Each of the limited partners has a 16% interest and the general partner, Lambert Television Management, Inc. has a 20% interest. Through December 31, 1995, the Company has invested $1,810.\nTHE PROVIDENCE JOURNAL COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1995, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)\n(f) Linkatel Pacific, L.P.\nIn July 1993, the Company, through its wholly-owned subsidiary Colony\/Linkatel Networks, Inc., invested in Linkatel Pacific, L.P. (a development stage enterprise), with two other communications companies. The Company has a 45% limited interest in the partnership, which was formed to pursue the development of alternative access networks. Through December 31, 1995, the Company has invested $6,531 in Linkatel Pacific, L.P. The Company intends to sell this investment in 1996 for an amount at least equal to the amounts invested to date, although no firm commitments are in place as of December 31, 1995.\nLinkatel Pacific, L.P.'s net loss approximated $2,319 and $1,262 for the years ended December 31, 1995 and 1994. Net assets approximated $9,088 and $7,367 as of December 31, 1995 and 1994.\nNOTE 4 -- NOTES RECEIVABLE\nIn September 1990, the Company advanced the Lowell Sun Publishing Company and Lowell Sun Realty Company (collectively the \"Lowell Sun Companies\") $25,650 and agreed to provide a $6,500 revolving credit facility. The loan and revolving credit facility which were originally due in March 1996 are subject to a forebearance until January 2, 1997. Amounts outstanding bear interest at a floating rate of prime plus 1.25%. The advance is collateralized by all assets of the Lowell Sun Companies and an interest in Lowell Sun Companies stock. The principal balance receivable at December 31, 1995 and 1994 was $23,575 and $23,675, respectively.\nNOTE 5 -- PROPERTY, PLANT AND EQUIPMENT, NET\nDepreciation expense on property, plant and equipment used in continuing operations totaled $22,346, $16,617 and $16,964 in 1995, 1994 and 1993, respectively.\nTHE PROVIDENCE JOURNAL COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1995, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)\nNOTE 6 -- INTANGIBLE ASSETS\nAmortization expense on intangible assets charged to continuing operations totaled $11,623, $3,366 and $3,649 in 1995, 1994, and 1993, respectively. Accumulated amortization on intangible assets totaled $67,025 and $36,002 at December 31, 1995 and 1994, respectively. See also Note 3.\nNOTE 7 -- ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES\nNOTE 8 -- SINGLE CYCLE COSTS AND RESTRUCTURING\n(a) Single Cycle Costs\nIncluded in the 1995 consolidated statement of operations are one-time charges related to the consolidation of the Company's afternoon newspaper (The Evening Bulletin) with the morning newspaper (The Providence Journal). This consolidation was effective June 5, 1995 and resulted in the publishing of Providence Journal-Bulletin, a morning newspaper. This consolidation is referred to as \"Single Cycle\" conversion. In connection with the Single Cycle conversion, the Company offered early retirement benefits and voluntary separation assistance to affected employees. As of December 31, 1995, 61 employees accepted early retirement benefits and 19 employees accepted voluntary separation amounting to a charge to operations of approximately $3,826 and $1,071, respectively, including benefits. In addition, the Company incurred costs of approximately $2,525 for promotion, training, and other costs of the conversion. The early retirement benefits will be paid from the Company's retirement plans. As of December 31, 1995 approximately $700 remains unpaid under the voluntary separation plans. This amount is expected to be paid in 1996.\nTHE PROVIDENCE JOURNAL COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1995, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)\n(b) Publishing Restructuring\nDuring the fourth quarter of 1995, management approved a plan of reorganization and restructuring of most departments of Publishing in an effort to improve efficiencies. Under the plan, the Company has targeted a reduction in workforce of approximately 100 full time equivalents through a combination of early retirement and voluntary and involuntary separation assistance plans. Of the 100 full time equivalents, approximately 62 are from the news and operations departments with the remainder coming from other departments. Salaries and related payroll taxes associated with these reductions amounted to approximately $6,800 and has been included as a restructuring charge in the accompanying consolidated statement of operations for 1995. Early retirement and voluntary separation benefits will be paid out of the Company's pension plans (in which plan assets exceed plan obligations) and all other costs are expected to be paid out in 1996.\nTHE PROVIDENCE JOURNAL COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1995, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)\nDuring 1995, the Company paid $15,023 in additional taxes and interest in final settlement with the Internal Revenue Service (\"IRS\") relating to examinations of its income tax returns for the years 1984 through 1989. In anticipation of the interest on these settlements and in providing for various contingencies on income tax exposures identified during on-going examinations, the Company recorded additional income tax expense of $6,000 in 1994.\nDuring 1994, the Company also agreed to a settlement in connection with the IRS initiative for settlement of intangible asset issues. Consequently, deferred tax liabilities previously recorded for uncertainties related to income taxes in connection with prior purchase business combinations were adjusted to reflect the revised tax basis resulting from the settlement of these intangible asset issues. As a result of these adjustments, deferred tax liabilities and goodwill associated with the purchase business combinations were reduced by approximately $12,500.\nIn assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible, or the recovery of taxes paid in the carryback period. Based upon certain assumptions, such as the scheduled reversal of deferred tax liabilities, available taxes in the carryback period, projected future taxable income, (the realization of which there can be no assurance). Management has determined that it is more likely than not that the deferred tax assets will be realized.\nThe valuation allowance for deferred tax assets as of December 31, 1995 and 1994 was $3,329 and $3,252. The net change in the total valuation allowance was an increase of $77 in 1995, a decrease of $1,283 in 1994, and an increase of $394 in 1993. Changes to the valuation allowance relate principally to deferred tax assets recorded for state net operating loss carryforwards.\nAt December 31, 1995, the Company had net operating loss carryforwards for state income tax purposes of approximately $59,401 which are available to offset future state taxable income, if any, expiring in various years ending in 2007.\nNOTE 10 -- LONG-TERM DEBT\nTHE PROVIDENCE JOURNAL COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1995, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)\nScheduled principal payments on outstanding debt total $244,098 and are due as follows: IRB payments of $100 in each of the years 1996 through 2000. Thereafter scheduled principal payments on the IRB continue at $100 annually until increasing to $200 in 1998 through 2005; to $300 in 2006 through 2010; to $400 in 2011 through 2014; to $500 in 2015 through 2017; to $600 in 2018 through 2019; to $700 in 2020 and 2021, and a final payment of $800 in 2022. Of the revolver and term loan outstanding at December 31, 1995, $75,000 is a term loan with a balloon payment due in 2004. The revolver commitment decreases quarterly on a schedule commencing December 31, 1996 in accordance with the Credit Agreement as described below.\nCosts of obtaining debt financing have been deferred and are being amortized using the straight-line method over the period of the related debt. Deferred financing costs totaled $1,748 and $7,097 at December 31, 1995 and 1994, respectively. Accumulated amortization at December 31, 1995 and 1994 aggregated $50 and $1,876, respectively. On October 5, 1995 the Company refinanced its debt in connection with the transactions described in Note 2. Accordingly, unamortized deferred financing costs of $4,554 associated with the debt refinanced was written off and allocated to discontinued operations in the fourth quarter of 1995.\nOn October 5, 1995, in connection with the transactions discussed in Note 2, Old PJC (net of $2 million in certain costs shared with Continental), prior to the PJC Spin-Off, incurred indebtedness to a subsidiary of Continental in a principal amount of approximately $408 million (\"New Cable Indebtedness\"). Prior to the PJC Spin-Off, Old PJC used the proceeds of the New Cable Indebtedness, the $405 million provided by the sale of KVC and the Registrant Indebtedness (defined below) to (i) consummate the Kelso Buyout (ii) to repay substantially all outstanding indebtedness of Old PJC and KHC in an aggregate amount of approximately $623 million, and (iii) to pay other costs associated with the transactions discussed in Notes 2 and 16. Additional indebtedness (the \"Company Indebtedness\") required to meet the foregoing obligations, among others, was incurred by Old PJC and the Company in the principal amount of $105 million. Following the PJC Spin-Off, the Company had no obligations or liabilities with respect to the New Cable Indebtedness, and Continental had no obligations or liabilities with respect to the NEW Cable Indebtedness, and Continental had no obligations or liabilities with respect to the Company Indebtedness. In connection with the sale of KVC, KBC paid approximately $121 million in taxes.\nThe Company Indebtedness was incurred pursuant to a Credit Agreement entered into by the Company on October 5, 1995 (the \"Credit Agreement\"). The Credit Agreement, consists of a $75,000 term loan and a $300,000 revolving credit facility. The $75,000 Term Loan provided for under the Credit Agreement is due 2004. The revolving credit facility provided for under the Terms of the Credit Agreement decreases by the following amounts in the years indicated: 1996 - $4,000; 1997 - $10,500; 1998 - $14,500; 1999 - $21,500; 2000 - $53,250; 2001 - $65,750; 2002 - $67,750; 2003 - $62,750. The indebtedness evidenced by the Credit Agreement is secured by guarantees from all of the material subsidiaries of the Company and a first priority pledge of all such material subsidiaries capital stock. The Credit Agreement provides for borrowings indexed, as the Company may from time to time elect, to the Eurodollar rate, the certificate of deposit rate, or the \"base\" rate of the agent, plus the \"spread\" over such rates. The \"spread\" will be determined by the ratio of the total debt of the Company to the operating cash flow of the Company (as defined by the Credit Agreement).\nThe Credit Agreement contains customary events of default, financial covenants, covenants restricting the incurrence of debt (other than under the Credit Agreement), investments and encumbrances on assets and covenants limiting mergers and acquisitions. The Credit Agreement provides for the mandatory prepayment of amounts outstanding and a reduction in the commitment under certain circumstances.\nIn July, 1995, the Company retired its 18% note payable for $8,734. The loss on the early retirement of this debt amounted to $2,086 (net of income taxes of $417) and is included as an extraordinary item in the Company's consolidated statement of operations.\nIn January 1993, the Company retired an industrial revenue bond with a face value of $9,500 for $7,150. The gain resulting from this transaction, totaling $1,551 net of tax, has been presented as an extraordinary item in the 1993 statement of operations. These retirements were funded through additional borrowings under the revolving credit and term loan facility.\nTHE PROVIDENCE JOURNAL COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1995, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)\nIn November 1992, the Company entered into an interest rate swap agreement to reduce the impact of changes in interest rates on its revolving credit and term loan facilities described above. The interest rate under the swap agreement is equal to 6.71% plus an applicable margin as defined in the revolving credit and term loan facility which presently sets the fixed interest rate at 8.1% on the first $200,000 of outstanding debt. The Company recorded additional interest expense during 1995, 1994 and 1993 totaling approximately $1,121, $4,880, and $6,883, respectively, which represents the excess of the swap agreement rate over the original contractual rate. In accordance with certain covenants under the Credit Agreement, the Company will maintain its existing interest rate swap arrangements with The First National Bank of Chicago through December 31, 1999.\nThe Company is exposed to credit loss in the event of nonperformance by the other party to the interest rate swap agreement, however, the Company does not anticipate nonperformance under the agreement.\nNOTE 11 -- TELEVISION PROGRAM RIGHTS PAYABLE\nTelevision program rights payable consist of the gross value of cash payments due on the acquisition of program rights as well as amounts due in the amount of approximately $3,805 at December 31, 1995 for programs purchased through barter transactions. Future cash payments total $18,167 and are due in the following years: 1996 -- $12,658; 1997 -- $3,128; 1998 -- $1,814; and 1999 -- $567. The barter obligations are scheduled to be fulfilled in 1996.\nNOTE 12 -- OPERATING LEASES\nThe Company has certain noncancelable operating leases with renewal options for land, buildings, machinery and equipment. Future minimum lease payments under noncancelable operating leases are due in the following years: 1996 -- $6,037; 1997 -- $5,362; 1998 -- $4,711; 1999 -- $4,253; 2000 -- $4,229; and thereafter - -- $15,228. Gross rental expense for the years ended December 31, 1995, 1994 and 1993, was $5,993, $5,167, and $2,173, respectively.\nFuture minimum rental income under noncancelable satellite subleases is as follows: 1996 -- $4,030; 1997 -- $4,030; 1998 -- $3,220; 1999 -- $1,923; and 2000 -- $900. Sublease satellite rental income totaled $3,349 and $2,300 in 1995 and 1994 and is included in Programming and New Media revenue. There was no sublease satellite rental income in 1993.\nTHE PROVIDENCE JOURNAL COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1995, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)\nNOTE 13 -- STOCK-BASED COMPENSATION PLANS\n(a) Incentive Compensation Plans\nThe Company has a deferred incentive compensation plan which is administered by the Compensation Committee of the Board of Directors. The expense under this plan was $773, $12,747, and $5,330 in 1995, 1994 and 1993, respectively. As of December 31, 1995 and 1994, the amounts accrued under this plan equaled $4,806 and $31,266, respectively. On September 29, 1995, the Company liquidated 85% of the units in the Company's deferred incentive compensation units plan (the \"IUP Plan\") which was paid in cash and stock totaling $27,233.\n(b) Restricted Stock Unit Plan\nDuring 1993, the Company established a Restricted Stock Unit Plan for certain key executives. Participants were awarded restricted stock units with each unit being equivalent to one share of Class A Common Stock. Restricted stock units, including additional units accrued as a result of dividends and reinvested dividends, will be 100% vested at the end of three years from the date of the award. Upon vesting, the restricted stock units will be paid out, net of taxes, in actual shares of Class A Common Stock. Participants will be offered an opportunity to defer such payout. Vesting is accelerated for death, total disability, termination other than for cause, and for retirement (pro-rata). In connection with the disposal of its cable operations, the Company fully vested 257 units of which 134 units were paid in cash and stock totaling $1,653 prior to the Merger. In connection with the reorganization and transactions described in Note 2, and as provided under the terms of the plans, the number of units awarded to participants holding units immediately after the closing of the transaction were adjusted upward by a factor of approximately 2.3876 (the \"Conversion Factor\") in order to preserve the economic value of the outstanding units. In connection with the Plan, a total of 1,624 Class A shares (after considering the Conversion Factor) have been reserved. As of December 31, 1995 and 1994, 1,261 (after the Conversion Factor) and 666 units, respectively, were issued and outstanding. Compensation expense, included in continuing operations, totaled $1,173, $2,400, and $405 during 1995, 1994 and 1993, respectively.\n(c) Stock Option Plans\nEffective October 1, 1994, the Board of Directors of the Company adopted the ''1994 Employee Stock Option Plan'' and the ''1994 Non-Employee Director Stock Option Plan'', (The ''Option Plans''). The Option Plans were approved by the stockholders of the Company at its Annual Meeting in 1995. The Option Plans will remain in effect until the earlier of October 1, 1999 or termination of the aforementioned Option Plans by the Board of Directors of the Company.\nUnder the terms of the Option Plans, key employees recommended by the Compensation Committee of the Board of Directors (or by any other committee appointed by the Board consisting of two or more non-employee Directors) and all 12 non-employee directors, are eligible to receive grants of stock options. The maximum number of shares of Class A Common Stock that can be used for purposes of the Option Plans is 4,150. Shares may be awarded from authorized and unissued shares or from treasury shares, as determined by the Compensation Committee.\nOptions granted under the ''1994 Employee Stock Option Plan'' are exercisable in four equal annual installments beginning one year after the grant date. Options under the ''1994 Non-Employee Director Stock Option Plan'' are exercisable on the first anniversary date of the grant. Options granted under both plans have a term of ten years.\nUpon a \"Change of Control\" as defined in the Option Plans, all options granted will become immediately vested and exercisable. In 1994, 637 options were granted, at an exercise price of $7,700. In 1995, an additional 60 options were granted to the non-employee directors, and an additional 776 options were granted to key employees at an exercise price of $5,072. In connection\nTHE PROVIDENCE JOURNAL COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1995, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)\nwith the reorganization and transactions described in Note 2, and as provided under the terms of the plans, the option exercise price on the 637 options issued in 1994 were adjusted to $662 in order to preserve the economic value of the outstanding options. During 1995, 14 options were exercised at an exercise price of $662. As of December 31, 1995, there were 1,459 options outstanding of which 182 are exercisable.\nAmounts paid to participants in the liquidation of 85% of the IUP Plan and the remaining units in the IUP Plan, may be adjusted if, upon the occurrence of a public offering of Continental Class A Common Stock or certain other events, the price of Continental Class A Common Stock is greater or less than the price attributed to such shares at the time 85% of the units were liquidated. A similar adjustment is applicable to certain options and units issued prior to the Merger in the Option Plans and the Restricted Stock Unit Plan. As a result of a planned merger of Continental with and into US West Media Group (the US West\/Continental Merger\"), jointly announced by these entities on February 27, 1996, participants in these plans may receive the adjustment as additional payments in cash or stock reflecting the increase in the price of Continental Class A Common Stock since the Merger. The final amounts of additional consideration is subject to approval by the Compensation Committee of the Company's Board of Directors and the closing of the US West\/Continental Merger but could approximate $21 million. It is currently anticipated that following the payout of any additional consideration, the IUP Plan will be fully liquidated and terminated.\nNOTE 14 -- PENSIONS AND OTHER EMPLOYEE BENEFITS\n(a) Defined Benefit Pension Plans\nThe Company has three noncontributory defined benefit retirement plans (including one funded by KHC acquired in the Kelso Buyout). The Company's funding policy for the defined benefit plans is to contribute such amounts as are deductible for federal income tax purposes. Benefits are based on the employee's years of service and average compensation immediately preceding retirement.\nTHE PROVIDENCE JOURNAL COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1995, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)\nThe effects of the special termination benefits of $3,701 and curtailment gain of $531 associated with the Single Cycle conversion and early retirement program are included in the Single Cycle costs discussed in Note 8 (a).\n(b) Defined Contribution Plan\nThe Company contributes to defined contribution plans based on the amount of each employee's plan contribution, not to exceed a predetermined amount as defined by each plan. The total expense of these plans was $1,312, $1,150 and $1,086 in 1995, 1994 and 1993, respectively.\n(c) Other Postretirement Benefit Plans\nIn addition to the Company's defined benefit pension plans, one of Broadcasting stations provides postretirement medical benefits to its group of employees. The Registrant provides postretirement life insurance benefits to substantially all of its employees. These plans are non-contributory and are not funded.\nTHE PROVIDENCE JOURNAL COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1995, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)\nThe Company's accrued postretirement benefit cost as of December 31, 1995 and 1994 was $3,461 and $3,086, respectively, consisting primarily of accumulated postretirement benefit obligations for retirees. Net periodic postretirement benefit cost for 1995, 1994 and 1993 totaled $204, $300 and $252, respectively, consisting primarily of interest costs.\nFor measurement purposes relating to the medical plan, a medical trend rate of 13.0% was used grading to 6.0% by the year 2002. A 1% change in the medical trend rate does not result in a material impact to the Company's reported postretirement benefits. The discount rate used in determining the accumulated postretirement benefit obligation for the medical and life insurance plans was 7.0% and 7.5% in 1995 and 1994, respectively.\n(d) Supplemental Retirement Plan\nThe Company maintains an unfunded supplemental retirement plan which provides supplemental benefits to a select group of senior management employees. At December 31, 1995 and 1994, the vested benefit obligation was $3,933 and $1,220, respectively, and the accumulated benefit obligation was $4,684 and $3,437, respectively. The projected benefit obligation totaled $6,065 and $5,799, respectively, at December 31, 1995 and 1994.\nThe net periodic pension cost for 1995, 1994, and 1993 was $1,000, $997 and $1,501, respectively, consisting of service and interest costs. An assumed discount rate of 7.0% and 7.5% and compensation level increase rate of 4.5% and 5.0% were used in determining the benefit obligations at December 31, 1995 and 1994, respectively.\n(e) Change in Control Agreements\nIn October, 1993, the Company executed various management agreements which only become effective upon a change-in-control of the Company. The terms of the agreements vary, with the maximum agreement providing a three year term of employment with responsibilities, compensation, and benefits at least commensurate as those during the prior six (6) months. If terminated involuntarily, the individuals are entitled to a maximum of 299% of their highest base pay and average bonus received during the prior three years as a lump sum severance payment. In a supplemental agreement, executed in October 1993, the Company committed to paying the severance stated above in the event an individual was involuntarily terminated as a result of corporate restructuring, even if prior to a change-in-control.\nNOTE 15-- DISCLOSURES ABOUT THE FAIR VALUE OF FINANCIAL INSTRUMENTS\n(a) Current Assets and Liabilities\nThe carrying amount of cash, trade receivables, trade accounts payable and accrued expenses approximates fair value because of the short maturity of these instruments.\n(b) Notes Receivable\nThe fair values of the Company's notes receivable are based on the amount of future cash flows associated with each instrument, discounted using current rates at which similar loans would be made to borrowers with similar credit ratings and for the same maturities.\nTHE PROVIDENCE JOURNAL COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1995, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)\n(c) Long-Term Debt and Obligations for Television Program Rights\nThe fair values of each of the Company's long-term debt instruments are based on the amount of future cash flows associated with each instrument discounted using the Company's current borrowing rate, for similar debt instruments of comparable maturity.\nThe fair value of obligations for television program rights are based on future cash flows, discounted using the Company's current borrowing rate, over the term of the related contract.\n(d) Interest Rate Swaps\nThe fair value of interest rate swaps is the amount at which they could be settled, based on estimates obtained from dealers. The amount of payment required to settle outstanding interest rate swaps at December 31, 1995 approximated $8,000. At December 31, 1994 settlement approximated a $9,400 receivable to the Company.\n(e) Limitations\nFair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.\nNOTE 16-- COMMITMENTS AND CONTINGENCIES\nThe Company has outstanding payment commitments for broadcast television programming totaling $45,511 at December 31, 1995, which under the licensing agreements are not yet available for showing. Such programming becomes available at various times over the years 1996 through 2000, at which point the Company records the asset and related liability.\nThe Company has various talent contract commitments primarily with its newscast employees covering up to three years together totaling $28,743.\nThe Company has insurance programs for workers' compensation, general liability, auto and certain health coverages which comprise a form of self-insurance. The Company's liability for large losses is capped, individually and in the aggregate, through contracts with insurance companies. In addition, the Company is self-insured for environmental hazards. An estimate for claims incurred but not paid is accrued annually.\nTHE PROVIDENCE JOURNAL COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1995, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)\nThe Company has a letter of credit commitment in an amount not to exceed $12,000 in support of industrial revenue bonds of a wholly-owned subsidiary.\nIn 1987, the Company repurchased approximately 8% of its outstanding shares of common stock from an unaffiliated party with a provision that additional consideration be paid to the unaffiliated party in the event of a significant change in ownership of the Company. The Company paid this unaffiliated party approximately $7,353 on October 5, 1995 in full settlement of the redemption agreement, and has recorded the additional consideration in the consolidated statement of stockholders' equity.\nOn August 12, 1994, Department of Insurance regulators seized control of Confederation Life Insurance Company. The Company's Qualified Compensation Deferral Plan has an investment contract with Confederation Life Insurance Company. The contract was entered into in 1991 and was scheduled to mature on January 2, 1996. As a result of the seizure, the value of the contract as of August 11, 1994, has been frozen at $3,840. The Company has agreed to guarantee the difference between the amount eventually paid by the regulators and the contract value on the seizure date. To date this amount cannot be quantified but is not expected to have a material effect on the consolidated financial position or results of operations of the Company.\nOn January 17, 1995, Cable LP I, Inc. (\"Cable LP\") brought a declaratory judgment action against Old PJC, Colony and Dynamic Cablevision of Florida, Inc. (\"Dynamic\") in the Circuit Court of Dade County, Florida. Colony and Dynamic were cable television subsidiaries of Old PJC, which became units of Continental in connection with the Merger. This case relates to a partnership (the \"Dynamic Partnership\"), in which Dynamic is the general partner with an 89.8% interest, and Cable LP is the limited partner with a 10.2% interest. In this action, Cable LP claims that Dynamic was obligated to offer to sell to Cable LP Dynamic's general partnership interest before Old PJC entered into the Merger Agreement with Continental. Cable LP further claims that Dynamic's offer to purchase Cable LP's limited partnership interest for $13.1 million triggered a right of first refusal entitling Cable LP to purchase the general partnership interest for $115 million. Cable LP seeks a declaration by the court that the right of first refusal it is asserting applies.\nOld PJC, Colony and Dynamic made a motion to strike allegations of bad faith and breach of fiduciary duty filed against them, which motion was granted by the court, and they filed an Answer to the Complaint and a Counterclaim on March 16, 1995. In their counterclaim, Colony and Dynamic seek a declaratory judgment that Cable LP unreasonably refused consent to the transfer of the general partner's interest to Continental and that a purported transfer of Cable LP's interest in the Dynamic Partnership to a partnership to be managed by Adelphia Communications, Inc. violates Dynamic's right of first refusal under the Dynamic Partnership Agreement. The case was tried with testimony given on December 11 through December 13, 1995 with final arguments heard on January 12, 1996. The decision of the Court is expected shortly. The Company believes that the claims asserted by Cable LP are without merit and intends to continue to vigorously defend this matter through the appeal process in the event of an unfavorable ruling.\nIn the event that, as a result of such litigation, Dynamic is required to sell its interest in the Dynamic partnership to Cable LP, the Merger Agreement provides that the Registrant will pay to Continental simultaneously with the closing of such sale an amount equal to the sum of (i) the amount (if any) by which the consideration received by Dynamic for the sale of such interest is less than $115 million plus (ii) the taxes which would have been payable assuming the purchase price for such interest equaled $115 million.\nThe Company is party to various claims, legal actions and complaints arising in the ordinary course of business. In the opinion of management, all such matters are adequately covered by insurance or, if not so covered, are without merit or are of such kind, or involve such amounts, that unfavorable disposition would not have a material effect on the consolidated financial position or results of operations of the Company.\nTHE PROVIDENCE JOURNAL COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1995, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)\nNOTE 17-- STOCKHOLDERS' EQUITY\nThe Company has two classes of common stock: Class A and Class B. Each class has the same rights and privileges, except that Class A common stock is entitled to one vote per share, whereas Class B common stock is entitled to four votes per share. In addition, the transfer of Class B common stock is limited to ''Permitted Transferees'' only, otherwise the shares convert to Class A common stock upon sale. In connection with the Merger agreement, trading of all shares is restricted for a period of one year from the date of the closing.\nEffective September 26, 1990, pursuant to a shareholder rights agreement, the Company issued to shareholders one common stock right for each share of Class A or Class B common stock then outstanding. The right entitles the holder to purchase one share of Class A or Class B common stock at a purchase price of $35,000 per share. Upon the occurrence of certain events, as defined in the rights agreement, the Board of Directors may order the exchange of three common shares for each right held. The shareholder rights agreement was terminated in connection with the closing under the Merger Agreement. A substantially similar agreement was entered into by the Company.\nTreasury stock at December 31, 1994, consisted of 641 Class A shares and 320 Class B shares. In connection with the PJC Spin-off, all treasury stock was canceled as of the effective time of the closing.\nNOTE 18-- BUSINESS SEGMENT INFORMATION\nThe Company primarily operates in Broadcasting, Publishing, and Programming and New Media. Broadcasting consists of nine owned network-affiliated television stations and two television stations for which the Company provides programming and marketing services for under local marketing agreements (\"LMA\"s) serving the following markets: Seattle, Portland, Charlotte, Albuquerque, Louisville, Honolulu, Spokane, Tucson, and Boise. Prior to the Kelso Buyout, Broadcasting consisted of five stations (including one station under an LMA). Publishing consists primarily of the publication and sale of the major daily newspaper serving Rhode Island and parts of southeastern Massachusetts. The Programming and New Media segment consists of wholly owned subsidiaries or equity investments in cable television programming networks, electronic and interactive media, programming ventures, and other new media. It currently consists of the Company's investments in AHN and TVFN (cable programming networks); interactive media investments: Peapod and StarSight; its electronic on-line information service: Rhode Island Horizons; its broadcast programming venture: Partner Stations Network; and its recently launched cable news network: NorthWest Cable News Network (\"NWCN\"). NWCN is a 24-hour regional cable news network serving cable subscribers in the Pacific Northwest. It was launched on December 18, 1995 and currently reaches 1.2 million subscribers.\nOperating results and other financial data for the principal business segments of the Company for 1995, 1994 and 1993 are presented in the table which follows. Operating income (loss) by business segment is total revenue less operating expenses. Other income (expense), income taxes and extraordinary items have all been excluded from the computation of operating income (loss) by segment. Identifiable assets by business segment are those assets used in Company operations in each segment. Capital expenditures are reported exclusive of acquisitions.\nINDEPENDENT AUDITORS' REPORT\nKing Holding Corp.:\nWe have audited the consolidated financial statements of King Holding Corp. (the Company) as listed in the accompanying index. Our audits also included the financial statement schedule listed in the index at Item 14. 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, such consolidated financial statements present fairly, in all material respects, the financial position of King Holding Corp. and subsidiaries at December 31, 1994, and the 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. 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.\n\/s\/ DELOITTE & TOUCHE LLP\nBoston, Massachusetts February 10, 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.\nKING HOLDING CORP. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nFOR THE YEARS ENDED DECEMBER 31, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)\n1. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBusiness -- King Holding Corp. (the \"Company\") owns and operates certain television stations and cable television properties throughout the central and western United States and Hawaii. The Company was formed as a joint venture between the Providence Journal Company and subsidiaries (the \"Providence Journal\") and an investment banking organization (the \"Investor Stockholder\"). The Providence Journal and Investor Stockholder each own a 50% interest in the Company. On February 25, 1992, the Company acquired the outstanding capital stock of King Broadcasting Company (\"KBC\"), the parent company of King Videocable Company (\"KVC\"), for a purchase price of approximately $364,000 plus assumed liabilities aggregating $183,000 (the \"Acquisition\"). The Acquisition has been accounted for as a purchase, and accordingly, the accompanying consolidated statements of operations, stockholders' equity, and cash flows include the operations of the Company and its subsidiaries commencing February 25, 1992. The purchase price was funded through the initial capitalization of the Company and proceeds received from debt financing with a syndicate of banks (see Note 5). As part of the initial capitalization of the Company, the Providence Journal was awarded a warrant allowing for the purchase of 2,012 shares of Class B nonvoting common stock at $.10 per share.\nDuring 1994 the Company entered into a plan to dispose of its Cable operations (see Note 2).\nSummary of Significant Accounting Policies\nBasis of Presentation -- The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. The accompanying consolidated financial statements differ from those previously issued by the Company due to the reporting of its discontinued cable operations (see Note 2). All significant transactions between the consolidated entities have been eliminated (see Note 9).\nRevenue Recognition -- Revenues from broadcast activities are recognized as advertisements are broadcast. Revenues from cable activities are recognized as the services are provided.\nInvestment in Nonconsolidated Partnerships -- The Company has made certain investments in media partnerships as a limited and general partner with voting interests of approximately 10% and 50%, respectively. These investments are accounted for using the equity method and are included in net assets of discontinued operations. Income attributable to the Company's proportional share of the partnership earnings is reported within other expense.\nAllowance for Doubtful Accounts -- The allowance for doubtful accounts related to continuing operations at December 31, 1994 aggregated $1,200.\nProperty and Equipment -- Property and equipment are recorded at cost, or in the case of property and equipment acquired as a result of the Acquisition, at appraised fair value at the date of purchase. Cable system betterments, including materials, labor and interest, are recorded at cost. Depreciation and amortization are provided using the straight-line method over the estimated useful lives of the related assets, generally three to twenty years.\nKING HOLDING CORP. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nFOR THE YEARS ENDED DECEMBER 31, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)\nIn 1993, due to provisions of the Cable Television Consumer Protection and Competition Act of 1992 (\"Cable Act\") which effectively transferred ownership of wiring and additional outlets installed in a customer's residence, KVC accelerated the depreciation of these items based upon the estimated customer churn rate and expensed all costs of installation and wiring in the home as incurred effective January 1, 1993. The change recorded in December 1993 related to these items aggregated $4,607 and is reflected in discontinued operations.\nDeferred Financing Costs -- Costs of obtaining debt financing have been deferred and are being amortized using the straight-line method over the amortization period of the related debt (ten years). Included in such costs are $12,000 of fees paid to the Company's stockholders to assist in the arrangement of the financing. Accumulated amortization at December 31, 1994 aggregated $4,201.\nIntangible Assets -- Intangible assets are recorded at their appraised fair value at the date of Acquisition. Amortization is provided using the straight-line method over the estimated useful lives of the related assets, generally fifteen to forty years. The Company evaluates the recoverability of intangible assets by reviewing the performance of the underlying operations, in particular the future undiscounted operating cash flows. The Company also evaluates the amortization periods of the intangible assets to determine whether events or circumstances warrant revised estimates of useful lives.\nFilm and Syndication Rights -- Assets and liabilities related to film and syndication rights are recorded at cost, when the related film or television series is available for broadcast. Film rights assets are amortized using principally accelerated methods, based on the anticipated value of each film showing and the number of anticipated showings. Syndication rights are amortized ratably over the term of the series expected showing.\nCash and Cash Equivalents -- The Company considers all short-term, highly liquid investments purchased with remaining maturities of three months or less to be cash equivalents.\nIncome Taxes -- Deferred income taxes are provided to recognize temporary differences between book and tax bases of the Company's assets and liabilities and the effects of credits and other items not yet recognized for tax purposes.\nInterest Rate Swaps -- The Company has only limited involvement with derivative financial instruments and does not use them for trading purposes. Derivative financial instruments are used only to manage well-defined interest rate risks.\nKING HOLDING CORP. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nFOR THE YEARS ENDED DECEMBER 31, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)\nThe Company has entered into interest rate swap agreements which are accounted for as a hedge of the obligation and accordingly, the net swap settlement amount is recorded as an adjustment to interest expense in the period incurred. Gains and losses upon settlement of a swap agreement are deferred and amortized over the remaining term of the agreement.\nNet Loss Per Common Share -- Net loss per common share is computed using the weighted average number of common shares outstanding during the year.\nReclassifications -- The accompanying statements of cash flows have been reclassified to present cash flows from discontinued operations in investing activities.\n2. DISCONTINUED OPERATIONS (Information Subsequent to February 10, 1995 is unaudited)\nIn November 1994, the Providence Journal entered into an agreement with Continental Cablevision, Inc. (\"Continental\") whereby Continental would acquire all of the Providence Journal's cable operations, both wholly and partly owned. Under the terms of the agreement, as modified in August 1995 (the \"August Modification\"), in an integrated transaction, KBC sold its entire interest in KVC to Continental for proceeds which approximated $405 million. Simultaneously with this transaction, the Providence Journal acquired the remaining 50% interest in the Company held by the Investor Stockholder, thus becoming sole owner of the Company. Immediately thereafter, the remaining cable operations of the Providence Journal were merged into Continental in accordance with the terms of the agreement in a tax-free transaction.\nPrior to the August Modification, the transaction had been structured to qualify as a tax-free exchange effected through a distribution of assets to the shareholders, which would have resulted in no gain or loss for the Company. Accordingly, the Company provided for the anticipated operating losses of KVC through the expected date of its disposal in the Company's 1994 financial statements. The provision for loss during the phase-out period, recorded by the Company during 1994, including allocated interest of $18,258, net of taxes was $12,078. Proceeds of the transaction were used to repay all of the Company's existing long-term debt and to settle the outstanding interest rate swaps.\nThe net assets of KVC have been segregated in the accompanying consolidated balance sheets as ''net assets of discontinued operations''. Net assets to be acquired consist primarily of property and equipment, and intangible assets. Such amounts have been reported net of costs and expenses expected to be incurred through the disposal date.\nThe results of operations of KVC have been reported as discontinued operations in the accompanying consolidated statements of operations. Prior year financial statements have been reclassified to conform to the current year presentation. The condensed statements of operations relating to the discontinued cable operations are presented below:\n3. PROPERTY AND EQUIPMENT\nProperty and equipment of continuing operations consisted of the following at December 31:\nKING HOLDING CORP. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nFOR THE YEARS ENDED DECEMBER 31, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)\n5. FINANCING AGREEMENTS\nThe Company has a credit agreement (the \"Credit Agreement\") with a syndicate of banks which consists of a revolving credit facility, ''swing'' loans (as defined), and a term loan.\nThe revolving credit facility provides for borrowings of up to $50,000 of which $10,800 was outstanding on December 31, 1994. Borrowings outstanding under the facility are payable in full in February 2000. The term loan of $283,249 is payable in 32 quarterly installments commencing in March 1994.\n''Swing'' loans are available to the Company from the lead bank of the syndicate. ''Swing'' loans are available up to a maximum aggregate borrowing level of $5,000 at any one time, and are generally subject to the same repayment terms as the revolving credit facility.\nBorrowings under the Credit Agreement bear interest at either a bank's CD rate plus an applicable margin (as defined), the LIBOR rate plus the applicable margin or an alternate base rate determined as the greater of a bank's prime rate, the Federal Funds rate plus 1\/2% or a secondary market determined rate plus 11\/4% all determined at the Company's option. At December 31, 1994, the interest rate on the revolving credit facility was 7.375%. During 1994, interest rates on the term loan ranged between 4.88% and 7.75%, based on the one and three month LIBOR rates, respectively.\nIn connection with the Credit Agreement, the Company is required to pay an annual fee of 3\/8 of 1% of the average daily unused availability under the revolving credit facility. In addition, the Company is required to pay the lead bank an annual fee of 3\/8 of 1% of the average daily unused ''swing'' loan availability. Such fees aggregated $194 $187 in 1994 and 1993, respectively.\nKING HOLDING CORP. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nFOR THE YEARS ENDED DECEMBER 31, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)\nThe Credit Agreement contains certain limitations on additional indebtedness, capital expenditures, payments to affiliates and disposition of assets and requires the Company to maintain certain leverage and interest coverage ratios, all as defined in the Agreement.\nAt December 31, 1994, long-term debt was due as follows: 1995 - $28,804; 1996 - 38,408; 1997 - $38,408; 1998 - $38,408; 1999 - $28,804; thereafter - $121,217.\nIn March 1992, the Company entered into two interest rate swap agreements to minimize interest rate risk on its revolving and term credit facilities described above and to access lower interest rates in certain markets. The interest rate under the swap agreements is equal to 7.23%, plus an applicable margin as defined in the revolving credit and term loan facility, which effectively sets the interest rate at 8.6%. The agreements expire March 25, 1999 and cover $250,000 of notional principal amount.\nThe 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 under the agreement.\nKVC has been allocated interest (including amortization of deferred financing costs) of $18,224 and $19,054 for the years ended December 31, 1994 and 1993, respectively. Interest expense has been allocated to KVC based upon intercompany financing in connection with the Acquisition. The effective interest rate used in these allocations was 8.36% during these periods. The common stock and assets of the Company are pledged to collateralize all external financing arrangements.\n6. EMPLOYEE BENEFIT PLANS\nIn connection with the Acquisition described in Note 1, the Company assumed a defined benefit pension plan (the Plan). The Plan covers all qualified employees who meet certain employment service and age requirements and are not covered by union pension plans. Net periodic pension cost is comprised of the components listed below, as determined using the actuarial cost aggregate method. The Company's funding policy is to make annual\nKING HOLDING CORP. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nFOR THE YEARS ENDED DECEMBER 31, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)\ncontributions to the Plan in such amounts necessary to fund benefits provided by the Plan on the basis of information provided by the Plan's actuary.\nThe following table sets forth the Plan's funded status and obligations at December 31, 1994 without regard to the effect of the discontinued operations:\nKING HOLDING CORP. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nFOR THE YEARS ENDED DECEMBER 31, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)\nIn 1993, the Company instituted an employee savings plan (401(k) Plan) to provide benefits for substantially all employees of the Company meeting certain eligibility requirements. The Plan requires the Company to match 25% of employee contributions, up to a maximum of 1% of covered compensation. Expense related to the Plan without regard to the effect of the discontinued operations aggregated $252 and $228 for the years ended December 31, 1994 and 1993, respectively.\nPension expense allocated to KVC, pursuant to these plans, aggregated $54 and $60 for 1994 and 1993, respectively. Further, prepaid pension costs with respect to the defined benefit plan of $384 and $457 have been allocated to KVC at December 31, 1994 and 1993, respectively.\nKING HOLDING CORP. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nFOR THE YEARS ENDED DECEMBER 31, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)\nKING HOLDING CORP. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nFOR THE YEARS ENDED DECEMBER 31, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)\nAt December 31, 1994, the Company has net operating loss carryforwards of $75,000 for state income tax purposes which are available to offset future state taxable income, if any, through 2009. Approximately $54,000 of these net operating loss carryforwards were present at Acquisition and, due to uncertainty of eventual realization, a full valuation reserve was provided against these assets at that time. Should these net operating loss carryforwards be realized in the future, the effect would be to reduce the recorded value of certain intangible assets.\nKING HOLDING CORP. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nFOR THE YEARS ENDED DECEMBER 31, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)\nIn addition, the Company has entered into film and syndication rights' agreements covering programs not yet available for broadcast. No asset or liability related to these programs has been reflected in the financial statements. At December 31, 1994, the Company had executed contracts aggregating $36,745 (net of deposits) for programs not yet available for broadcast.\nRent expense under operating leases from continuing operations aggregated $490 and $383 for the years ended December 31, 1994 and 1993, respectively.\nKING HOLDING CORP. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nFOR THE YEARS ENDED DECEMBER 31, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)\n9. RELATED-PARTY TRANSACTIONS\nThe Company has entered into a management agreement (the \"Management Agreement\") with the Providence Journal, under the terms of which the Providence Journal will operate and manage the Company's cable systems and KBC's television stations through February 1997. The Management Agreement provides for a base management fee of $2,525 per year and payment of bonuses based on operating cash flow (as defined in the Management Agreement) at the end of each fiscal year for managing both the Company and KBC. No bonus was earned during 1994 and 1993. In addition, the Management Agreement provides for the awarding of certain warrant bonuses, both on an annual and cumulative basis, based on operating cash flow at the end of defined periods. Through December 31, 1994, the Providence Journal had been awarded warrant bonuses providing for the purchase of 1,552 shares, of the Company's Class B nonvoting common stock at $0.10 per share. Compensation expense recorded related to these warrant issuances aggregated $335 in 1993. Based upon the purchase and sale agreement (See note 2) whereby the Providence Journal will buy out the Investor Stockholder for a fixed price, it is not probable that the Providence Journal will exercise any outstanding warrants and accordingly, the Company has not recorded compensation expense during 1994.\nThe Providence Journal is also entitled to compensation for out-of-pocket costs incurred in its capacity as manager of the cable systems for which the Company reimbursed the Providence Journal $3,844 and $2,842 during 1994, and 1993, respectively.\nThe Company is also obligated to pay the Providence Journal an annual $1,000 governance fee, in advance, on December 20 of each year.\nThe Company entered into a consulting and advisory services agreement (the \"Services Agreement\") with the Investor Stockholder. Under the terms of the Services Agreement, the Company is obligated to pay the Investor Stockholder an annual fee of $1,000, in advance, on January 1 of each year.\nFor the years ended December 31, 1994 and 1993, KVC has been allocated expenses under the terms of the Management Agreement, and other related fees discussed above, aggregating $1,901 and $2,034, respectively.\n10. FAIR VALUE DISCLOSURE\nCurrent Assets and Liabilities -- The carrying amount of cash, trade receivables, trade accounts payable and accrued expenses approximates fair value because of the short maturity of these instruments.\nLong-term Debt -- The fair values of each of the Company's long-term debt instruments are based on the amount of future cash flows associated with each instrument discounted using current borrowing rates for similar debt instruments of comparable maturity. The fair value of long-term debt approximated carrying value at December 31, 1994.\nKING HOLDING CORP. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nFOR THE YEARS ENDED DECEMBER 31, 1994 AND 1993\n(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)\nInterest Rate Swaps -- The fair value of interest rate swaps is the amount at which they could be settled based on estimates obtained from dealers. The amount required to settle outstanding interest rate swaps at December 31, 1994 approximated $3,575 (gain).\n11. COMMITMENTS AND CONTINGENCIES\nThe Company is the defendant in a number of legal actions, the outcome of which management believes, based upon the advice of counsel, will not have a material effect on the Company's financial position or results of operations.\nThe Company has outstanding letter of credit commitments amounting to $756 as of December 31, 1994.\nIn October 1992, the Congress of the United States passed the Cable Act. As a result of the Cable Act, several cable television systems of the Company are subject to regulation by local franchise authorities and\/or the FCC. Regulations imposed by the Cable Act, among other things, allow regulators to limit and reduce the rates that cable operators can charge for certain basic cable television services and equipment rental charges. The Company has been notified by certain franchise authorities that various regulated rates charged to subscribers were in excess of the rates permitted. The Company has reviewed the notifications as well as the disputed rates and has accrued for amounts it believes it may be required to refund. Further rules and regulations are being considered by the FCC, however, these regulations have not yet been finalized. The ultimate impact on the operations of the Company resulting from existing rules and regulations and proposed rules and regulations, if any, cannot be determined.\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.\nPursuant to Instruction G(3) to Form 10-K, the information required in Items 10-13 is incorporated by reference from the Company's definitive proxy statement for the Company's 1995 Annual Meeting of shareholders, which is expected to be filed pursuant to Regulation 14A within 120 days after the end of the company's 1995 fiscal year.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nPursuant to Instruction G(3) to Form 10-K, the information required in Items 10-13 is incorporated by reference from the Company's definitive proxy statement for the Company's 1995 Annual Meeting of shareholders, which is expected to be filed pursuant to Regulation 14A within 120 days after the end of the company's 1995 fiscal year. Such incorporations by reference shall not be deemed to specifically incorporate by reference the information referred to in Item 402(a)(8) of Regulation S-K.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nPursuant to Instruction G(3) to Form 10-K, the information required in Items 10-13 is incorporated by reference from the Company's definitive proxy statement for the Company's 1995 Annual Meeting of shareholders, which is expected to be filed pursuant to Regulation 14A within 120 days after the end of the company's 1995 fiscal year.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nPursuant to Instruction G(3) to Form 10-K, the information required in Items 10-13 is incorporated by reference from the Company's definitive proxy statement for the Company's 1995 Annual Meeting of shareholders, which is expected to be filed pursuant to Regulation 14A within 120 days after the end of the company's 1995 fiscal year.\nPART IV.\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(a) The following documents are filed as part of this Report:\n1 The financial statements listed below are included in item 8 of this Form 10-K. See Index of Financial Statements and Schedules on page 40.\n(i) Consolidated Financial Statements of the Company -- The Providence Journal Company and Subsidiaries.\n(ii) Consolidated Financial Statements of Significant Unconsolidated Affiliate -- King Holding Corp. and Subsidiaries.*\n*King Holding Corp. acquired and consolidated by the Company in 1995.\n2 Financial Statement Schedules. The financial statement schedules listed below are included in item 8 of this Form 10-K. See Index of Financial Statements and Schedules on page 40.\n(i) Financial Statement Schedules of the Company (as required)\nII. Valuation and Qualifying Accounts and Reserves for the Years Ended December 31, 1995, 1994, and 1993\n(ii) Financial Statement Schedules of the Company's Unconsolidated Affiliate -- King Holding Corp.* (as required)\nII. Valuation and Qualifying Account and Reserves for the Years Ended December 31, 1994 and 1993.\n*King Holding Corp. acquired and consolidated by the Company in 1995.\n3 Exhibits required to be filed by Item 601 of Regulation S-K:\n(i) Certificate of Incorporation of the Registrant (incorporated by reference to Exhibit 1 of Registrant's Registration Statement on Form 8-A dated September 29, 1995).\n(ii) By-laws of the Registrant. Filed herewith as Exhibit 3.2.\n4 Credit Agreement dated as of October 5, 1995 among Providence Journal Company, Registrant, Fleet National Bank, as Administrative Agent, The First National Bank of Boston, The Chase Manhattan Bank, N.A., Chemical Bank and The Toronto Dominion Bank, as Managing Agents and the other lenders named therein (incorporated by reference to Exhibit 4 of Registrant's Current Report on Form 8-K dated October 5, 1995).\n10 (i) The Providence Journal Company 1994 Employee Stock Option Plan (incorporated by reference to Exhibit 4(a) of Registrant's Registration Statement on Form S-8 (No. 33-63833) dated November 1, 1995).\n(ii) The Providence Journal Company 1994 Non-Employee Director Stock Option Plan (incorporated by reference to Exhibit 4(b) of Registrant's Registration Statement on Form S-8 (No. 33-63833) dated November 1, 1995).\n(iii) Form of Restricted Stock Unit Grant Agreement (incorporated by reference to Exhibit 10.2 of Registrant's Registration Statement on Form S-4(No. 33-57479) dated August 31, 1995).\n(iv) Form of Change of Control Agreement (incorporated by reference to Exhibit 10.6 of Registrant's Registration Statement on Form S-4 (No. 33-57479) dated August 31, 1995).\n(v) Letter Agreement between Providence Journal Company and James F. Stack dated August 29, 1995. Filed herewith as Exhibit 10.5.\n(vi) Separation Agreement and Release between The Providence Journal Company and Trygve E. Myhren dated February 9, 1996. Filed herewith as Exhibit 10.6.\n21 Subsidiaries of the Registrant. Filed herewith as Exhibit 21.0.\n23 (i) Independent Auditors' consent of KPMG Peat Marwick LLP. Filed herewith as Exhibit 23.1.\n(ii) Independent Auditors' consent of Deloitte & Touche LLP. Filed herewith as Exhibit 23.2.\n27 Financial Data Schedule.\n(b) Reports on Form 8-K.\nReport on Form 8-K, dated October 5, 1995: Item 5 - voluntary disclosure of divestiture of cable operations and completion of Kelso Buyout.\nPursuant to the requirements 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: April 1, 1996\nTHE PROVIDENCE JOURNAL COMPANY\nBy: \/s\/ Stephen Hamblett ----------------------------------------------------- Stephen Hamblett Chairman of the Board and Chief Executive Officer\nBy: \/s\/ Thomas N. Matlack ----------------------------------------------------- Thomas N. Matlack Vice President-Finance (principle financial and accounting officer)\nBy: \/s\/ F. Remington Ballou ----------------------------------------------------- F. Remington Ballou Director\nBy: \/s\/ Henry P. Becton, Jr. ----------------------------------------------------- Henry P. Becton, Jr. Director\nBy: \/s\/ Fanchon M. Burnham ----------------------------------------------------- Fanchon M. Burnham Director\nBy: \/s\/ Kay K. Clarke ----------------------------------------------------- Kay K. Clarke Director\nBy: \/s\/ Peter B. Freeman ----------------------------------------------------- Peter B. Freeman Director\nBy: \/s\/ Benjamin P. Harris, III ----------------------------------------------------- Benjamin P. Harris, III Director\nBy: \/s\/ Paul A. Maeder ----------------------------------------------------- Paul A. Maeder Director\nBy: \/s\/ Trygve E. Myhren ----------------------------------------------------- Trygve E. Myhren Director\nBy: \/s\/ John W. Rosenblum ----------------------------------------------------- John W. Rosenblum Director\nBy: \/s\/ Henry D. Sharpe, Jr. ----------------------------------------------------- Henry D. Sharpe, Jr. Director\nBy: \/s\/ W. Nicholas Thorndike ----------------------------------------------------- W. Nicholas Thorndike Director\nBy: \/s\/ John W. Wall ----------------------------------------------------- John W. Wall Director\nBy: \/s\/ Patrick R. Wilmerding ----------------------------------------------------- Patrick R. Wilmerding Director","section_15":""}
{"filename":"861289_1995.txt","cik":"861289","year":"1995","section_1":"Item 1. Business.\nGeneral\nAdvanced Logic Research, Inc. (\"ALR\" or the \"Company\"), founded in 1984, designs, manufactures, markets and supports a broad line of microcomputer systems (\"PCs\") that offer leading-edge performance and value. The Company's comprehensive portfolio of environmentally friendly, upgradeable products includes sophisticated network servers, high-performance workstations and entry-level PCs. All ALR systems feature advanced designs to enhance performance while supporting the major industry standards. ALR markets its products through a worldwide network of resellers, system integrators, dealers and distributors. It also sells to selected Original Equipment Manufacturer (\"OEM\") customers and direct to end-users through its PrimeLine Direct program.\nProducts\nThe Company's product strategy is focused on becoming a leading provider of computers targeted at the client\/server and high-end\/mid-range desk-top markets. The Company currently offers a number of high-performance server, workstation and personal computer product families based on Intel's Pentium, Pentium Pro and 486 microprocessors (\"CPUs\"). To achieve broad market acceptance for its products, the Company's PCs incorporate either Industry Standard Architecture (\"ISA\") or Extended Industry Standard Architecture (\"EISA\") bus architecture and either Video Electronics Standard Association (\"VESA\") or Peripheral Component Interconnect (\"PCI\") local bus architecture. For compatibility with a broad range of application software, ALR supports the major industry single user and multi-user\/network operating systems: MS DOS, MS Windows, MS Windows 95, MS Windows NT, SCO UNIX, OS\/2, Novell NetWare, Banyan VINES, as well as Intel's MP Spec v1.1 multiprocessing specification.\nALR's SERVER SYSTEMS. The Company's server systems are designed in- house and feature enhanced performance and expandability. This family of computers currently consists of the ALR Revolution Q-SMP and the ALR Revolution MP. ALR also offers a rack-mount version of its ALR Revolution Q- SMP server.\nALR REVOLUTION Q-SMP. The innovative award-winning ALR Revolution Q-SMP is a fully symmetrical multiprocessing server featuring up to four Intel 90-, 100-, or 133-megahertz (\"MHz\") Pentium CPUs. The unique Q-SMP architecture utilizes an advanced 64-bit multiprocessor bus and a symmetrical design to distribute the workload evenly between the different processors. System performance is enhanced by ALR's proprietary Q-SMP architecture supporting 256 kilobytes (\"KB\") (optional 1- or 2-megabytes (\"MB\")) of two-way associative high-speed \"write-back\" memory cache per processor module. This memory cache design nearly doubles cache efficiency compared to earlier architectures. The system comes standard with 16-MB of random access memory (\"RAM\") which is expandable to one gigabyte (\"GB\") and features Memory Error Detection and Correction (\"EDC\") technology to secure data integrity within the system.\nAll ALR Revolution Q-SMP servers come standard with ALR NetTune; the NetWare server management package designed to optimize server performance. The ALR Revolution Q-SMP features a total of 10 expansion slots (six EISA bus slots and four PCI local bus extensions) and thirteen drive bays. The easily accessible chassis makes the drive bays ideal for hot swappable drives, tape backups, multiple CD-ROMs and other removable storage devices. The ALR Revolution Q-SMP has received numerous awards including PC\/Computing Magazine's 'Most Valuable Product' award at COMDEX '94 in Las Vegas and the 'Overall Best Hardware Product for 1995' by UNIX Review in its December 1995 issue.\nThe rack-mountable version of the ALR Revolution Q-SMP is designed to provide maximum flexibility and performance while economizing on space. ALR offers two rack-mount options designed to accommodate either two or four Revolution Q-SMP server units in a single, organized location. The system is designed to offer safeguards against downtime and lost data. An optional DAT drawer provides up to 32-GB of back-up data storage with a redundant hot- swappable power supply for mission critical environments. Additionally, the racks can be configured to house disk array subsystems or uninterruptible power supplies depending on the needs of the user.\nALR REVOLUTION MP. The ALR Revolution MP was the first server to offer both a PCI bus architecture and an upgrade path from 90- or 100-MHz Pentium processing to dual 133-MHz Pentium multiprocessing. In its base configuration the system features 512-KB of high speed \"write-back\" memory cache and 8-MB of RAM which is expandable to 512-MB. Complementing the scaleable processing power of the ALR Revolution MP is its tower chassis which features four PCI slots, six EISA slots and nine drive bays for hard drives, CD-ROM drives or tape back-ups. Designed for mission critical network applications, the REVOLUTION MP is fully compatible with multiprocessing versions of popular multi-user\/network operating systems.\nALR's MINI-TOWER\/HIGH-END DESK-TOP SYSTEMS. The Company's mini- tower\/high-end desk-top systems feature 32-bit local bus technology and superior memory cache\/local bus combinations to optimize CPU performance. This family of computers consists of the ALR EVOLUTION DUAL6, the ALR EVOLUTION V STe and the ALR EVOLUTION X and V ST.\nALR EVOLUTION DUAL6. The ALR EVOLUTION DUAL6 is designed to use up to two 150-MHz Pentium Pro CPUs and is targeted at high-end workstation applications including CAD, graphics design and animation. The systems come standard with 256-KB of memory cache and 8-MB of error checking and correcting RAM expandable to 512-MB. To enhance overall system performance the ALR EVOLUTION DUAL6 incorporates 32-bit PCI local bus technology. This bus provides compatibility with the latest video cards and access to other 32-bit enhancement products.\nALR EVOLUTION V STe. The ALR EVOLUTION V STe is designed to use up to two 90- or 100-MHz Pentium CPUs and is targeted at high-end business users. The systems come standard with 256-KB of synchronous 'burst' cache ensuring the highest performance levels from the Pentium processor. To enhance overall system performance, the ALR EVOLUTION V STe incorporates 32-bit PCI local bus technology providing compatibility with the latest video cards and access to other 32-bit enhancement products including SCSI controllers and network adapters. The systems come standard with 8-MB of RAM expandable to 264-MB.\nALR EVOLUTION X & V ST. These two systems share the same motherboard and offer a selection of processor options including Intel's 75-, 90-, 100-, 120- or 133-MHz Pentium CPUs. To enhance overall performance, the systems incorporate 32-bit PCI local bus technology and fully support the Pentium's \"write-back\" mode ensuring the highest performance levels by utilizing a unique 256-KB \"burst\" memory cache architecture for the 100-, 120- or 133-MHz Pentium CPU models and asynchronous \"write-back\" cache for the 75- and 90-MHz Pentium CPU models. The ALR EVOLUTION V ST is packaged in a sport-tower chassis whereas the EVOLUTION X comes in a desk-top chassis.\nALR's MID-RANGE AND ENTRY-LEVEL DESK-TOP SYSTEMS. The Company's mid- range desk-top PCs optimize performance through advanced technology. The systems incorporate local bus technology and consist of the ALR OPTIMA, the ALR OPTIMA SL and the EXPRESS XP\/2.\nALR OPTIMA. The ALR Optima system is designed for high-end desk-top requirements and features PCI local bus technology. The Optima offers a selection of processor options including Intel's 75-, 90-, 120- or 133-MHz Pentium CPUs. The system comes standard with 256-KB of memory cache which can be doubled to 512-KB for more demanding applications. The system features 8- MB of RAM which is expandable to 128-MB on the system board. The system features PCI and ISA \"Plug 'n' Play\" technology allowing for easy set-up and installation of peripheral cards.\nALR OPTIMA SL. The ALR Optima SL combines performance with ease of use by featuring \"Plug 'n' Play\" technology. The system offers a selection of processor options including Intel's 75-, 90- or 100-MHz Pentium CPUs. For enhanced performance the system incorporates PCI local bus technology with accelerated Super VGA graphics integrated onto the motherboard. The system comes standard with 8-MB of RAM expandable to 128-MB on the system board. The Optima SL is packaged in a slimline chassis providing room for two storage bays and three enhancement cards.\nALR EXPRESS XP\/2. The Company's entry-level desk-top system is based on Intel's 66-MHz 486DX2 CPU and is designed to meet the personal requirements of individuals and to serve as a node on networks. This PC features advanced 32- bit PCI local bus technology with an integrated local bus video controller and a built-in PCI IDE interface. It comes standard with 4-MB of RAM which is expandable to 128-MB on the motherboard.\nOther Hardware Options. ALR offers a number of hardware options, including the ALR DataStation for data storage in networking and multi-user environments, VESA and PCI local bus video adapters and hard drive controllers. For certain systems, ALR offers a Multimedia Upgrade kit which includes an IDE CD-ROM drive and various titles, a 16-bit sound card, external speakers and a microphone. The Company also offers systems and memory boards, hard disk drives, CD-ROM drives, tape backup systems, fax modems, keyboards, monitors and other related peripherals. In September 1995, the Company announced its Pentium CPU based ALR Sequel 586, a system board upgrade designed specifically for the Compaq Prolinea desktop, minitower and Deskpro 386 and 486 PCs.\nResearch and Product Development\nThe Company believes that being early-to-market with high-performance systems is critical to its success. ALR follows the early introduction of its high-end products with the introduction of mid-range products based on the same core technologies. As a result, the Company's research and product development activities have been focused on developing methods for designing products efficiently. To achieve these efficiencies, the Company uses technology modules which can be transported effectively and used in its other computer systems with minimal modification, as \"building blocks\" for concurrent and future product development efforts. Examples of these building blocks include the Company's memory management technology and custom chip sets. The Company believes this approach better enables it to control its engineering, research and development expenditures while increasing the speed with which it can bring new products to market.\nThe Company's research and product development staff consists of 36 hardware and systems engineers located in the U.S. The Company's engineers are divided into two groups involved in the design of new products as well as the continued development of existing products. The Company's hardware engineers focus on the design of the Company's CPU platforms, while its systems engineers are responsible for enclosure design, software\/system compatibility and integration of input\/output peripherals to the system.\nDuring the fiscal years ended September 30, 1995, 1994 and 1993, the Company's engineering, research and development expenses were $4.8 million, $4.4 million, and $3.9 million, respectively.\nSales, Marketing and Support\nALR and its subsidiaries sell the Company's products worldwide through an extensive network of value added resellers (\"VARs\"), system integrators, dealers, distributors, and selected OEM customers. In the U.S., the Company also sells directly to end-users through its PrimeLine Direct program.\nSince 1992, the PC industry has experienced a significant increase in price competition. See \"Competition\". The Company has responded to this new environment by focusing its product strategy towards providing computers aimed at the high-performance, multi-processing server and desk-top markets. The Company has also attempted to optimize the pricing structure offered to its different distribution channels and the marketing programs provided to its reseller channels.\nThe Company has focused on providing its reseller channel (VARs, system integrators and dealers) with some of the most competitive programs in the PC industry. The Company's reseller programs include free shipping, cooperative advertising, lead referral, toll-free technical support, warranty reimbursement and the facilitation of product purchases through flooring companies offering up to 60 days free financing. The Company has implemented a \"Channel Build\" strategy for its resellers and distributors allowing them to purchase base models and determine their own margins by customizing these products for resale. The Company further enhanced this strategy by adopting a \"Cost Plus\" pricing strategy for its reseller channel where the \"Cost\" is the price paid by its distributors. Sales to the Company's reseller channel accounted for 65%, 69% and 68% of net sales for fiscal 1995, 1994 and 1993, respectively.\nThe Company currently markets its products through four major distributors, Gates\/Arrow, GBC\/Vitek, Merisel, and Tech Data. This channel provides broad market penetration for the Company's products. Distributors represented approximately 5%, 8% and 8% of the Company's net sales in fiscal 1995, 1994 and 1993, respectively. During fiscal 1993, ALR experienced significant changes in its distributor and national retail organization (\"NRO\") channel due to a reorientation of its sales channel focus in North America. As a result, product purchase agreements with Ingram Micro, Inc., Intelligent Electronics and ComputerLand were terminated. However, ALR continues to sell its products directly to the franchisees of Intelligent Electronics and ComputerLand through its reseller program.\nThe Company's PrimeLine Direct channel, established in fiscal 1993, serves the requirements of customers who choose to purchase directly from the Company. Since 1993, ALR's PrimeLine Direct sales force has evolved into three cohesive groups focused on serving the disparate needs of the small business customer and the large corporate and government end-users. The government sales group negotiated a contract with the federal government (GSA contract) allowing federal agencies to procure product directly from ALR at pre-negotiated prices. Additionally, qualified resellers can sell products to government end-users based on the pre-negotiated prices in ALR's GSA contract and receive a pass-through commission from ALR. PrimeLine Direct sales represented 20%, 16% and 9% of the Company's net sales for fiscal 1995, 1994 and 1993, respectively.\nIn October 1994, ALR expanded its OEM relationships by entering into an OEM agreement with Unisys Corporation for ALR's high-end servers. This new agreement added to the Company's existing OEM relationships with Siemens Nixdorf in the U.S. and Germany. OEM sales represented 9%, 4% and 5% of the Company's net sales for fiscal 1995, 1994 and 1993, respectively.\nThe Company's resellers, distributors and OEM customers are not contractually committed to future purchases of the Company's products and, therefore, could discontinue carrying the Company's products at any time. Additionally, consistent with industry practice, the Company provides certain of its large distributors with stock balancing and price protection rights, which permit these customers to return products to the Company for credit and to receive price adjustments for inventories of the Company's products if ALR lowers the prices of these products.\nALR serves its markets worldwide through export sales from the U.S. and a network of subsidiaries and branches. ALR's sales subsidiaries include ALR International (Pte) Ltd. (\"ALR International\"), Advanced Logic Research Inc. (U.K.) Limited and Advanced Logic Research (Deutschland) GmbH which are located in Singapore, London and Frankfurt, respectively. ALR International maintains branch sales and support offices in Hong Kong and Malaysia. International sales represented 43%, 46% and 50% of the Company's net sales for fiscal years 1995, 1994 and 1993, respectively. For further geographic information, see Note 12 of Notes to Consolidated Financial Statements.\nA portion of the sales made by the Company in international markets are priced in local currency and are subject to currency exchange fluctuations. At September 30, 1995, the Company had no forward contracts outstanding. International sales are subject to the risk of compliance with laws of various countries and the risk of import\/export restrictions and tariff regulations. ALR has not experienced any difficulty in obtaining export licenses from the United States Department of Commerce for international sales.\nALR maintains a sales and service staff at each of its locations worldwide to support the Company's end-users, authorized resellers and distributors. Reseller and distributor sales and service training classes are conducted at most of the Company's major worldwide locations. See \"Customer Service and Product Warranty.\"\nThe Company's corporate marketing communications group has primary responsibility for launching and maintaining product exposure including advertising, promotion and public relations. This group also develops sales materials such as brochures, merchandising kits and point-of-purchase displays.\nBacklog\nThe Company's customers generally order products on an as-needed basis. Therefore, a significant portion of product shipments in a given fiscal quarter result from orders received in that quarter. Consequently, order backlog represents a small percentage of the product sales anticipated by the Company in a given fiscal quarter and is not indicative of the Company's actual sales for any future fiscal period. Manufacturing plans and expenditure levels are based primarily on sales forecasts. The absence of scheduled backlog could lead to unanticipated fluctuations in operating results in any quarter in which anticipated sales and shipments do not occur as expected.\nManufacturing and Quality Control\nThe Company's manufacturing operations are located at its Irvine facilities in the United States. They include procurement and testing of parts, components and subassemblies and final assembly of its systems. In order to reduce capital investment requirements, the Company subcontracts a substantial portion of its printed circuit board assembly to several vendors in the United States and Taiwan, including affiliates of Wearnes Technology (Private) Limited (\"Wearnes\", Wearnes holds approximately 41% of the outstanding common stock of ALR). All subcontracted components are tested either by the Company or the subcontractor before undergoing final assembly. Once assembled, all systems undergo a fully operational test cycle including stress testing. Quality control also includes ongoing production reliability audits for early identification of production problems.\nThe Company has focused on improving its inventory controls and enhancing its management information systems. The inability of the Company to continue to improve its inventory controls and other management information systems, or to successfully produce, test and deliver sufficient products in time to meet demand, would adversely affect the Company's operating results.\nThe Company generally utilizes industry standard parts and components available from multiple vendors. However, the Company and the microcomputer industry, from time to time, have experienced shortages of key components including memory chips and standard integrated circuits. Prices for these and other key components have periodically increased and the Company could be put on allocation by its suppliers. On occasion, this has resulted in production delays for some of the Company's products.\nCertain parts and components used in the Company's systems are available only from a single source. Components for which the Company does not have multiple manufacturers include Intel's Pentium and Pentium Pro CPUs. These CPUs are either generally available through distribution or available from Intel in quantities that the Company believes are adequate to meet its current requirements. If, contrary to its expectations, the Company is unable to obtain sufficient quantities of any of these parts and components, the Company will experience delays in product shipments.\nThe Company is currently sourcing motherboards for its EXPRESS XP\/2 and Optima SL systems from Acer and is purchasing the Optima system from Intel on an OEM basis. In the future, the Company may choose to source additional products from these and other vendors. If, contrary to its expectations, the Company is unable to obtain sufficient quantities of these motherboards or systems, the Company could experience delays in product shipments.\nThe various proprietary chip sets based on ALR designs are currently supplied by single sources: VLSI Technology, LSI Logic or Matra Semiconductor. A disruption in the manufacture of these chip sets could result in additional expense, as well as delays in product shipment.\nSupply shortages of any of the foregoing or other components may cause an increase in material cost that could result in a decline in the Company's operating results. In certain circumstances, supply shortages could result in production delays that could also adversely affect the Company's operating results.\nCustomer Service and Product Warranty\nALR maintains a customer support hotline at its Irvine headquarters to answer questions from its customers relating to ALR systems and other products. The Company also offers a variety of customer support and repair services which are made available on a fixed-fee or time and materials basis after the product warranty period has expired. Internationally, the Company provides service to end-users through selected resellers trained by ALR, as well as through the Company's own technical support personnel.\nThe Company has strengthened its service and technical support to end- users through a relationship with Unisys Corporation and Decision One to provide on-site field service and warranty support in the U.S. The Company's in-house technical support department in the U.S. has benefited from advanced telephone tracking technology that streamlines the routing, processing and tracking of calls. The Company also offers on-line support service 24 hours a day through its facsimile question and response system. This service supplements the Company's 24-hour bulletin board service which allows customers to confer with ALR technicians, download software and receive support updates and technical bulletins. These services are now also available through the ALR CompuServe forum.\nIn November 1994, ALR enhanced its product warranty policy to offer a 5- year\/36-month warranty (five years system warranty and 36 months warranty on factory installed peripherals) compared to a 5-year\/15-month warranty policy. For fiscal 1995, technical support expenses, which include warranty and non- warranty repairs, were approximately $4.3 million. Except for stock-balancing agreements with its distributors, the Company does not customarily allow returns of its products for reasons other than malfunction or failure.\nFCC Approvals\nThe Federal Communications Commission (the \"FCC\") has adopted regulations setting radio frequency emission standards for computing equipment. All of the Company's current products meet the FCC's Class A requirements and certain of the Company's products qualify for the more stringent Class B approval. From time to time, however, the Company has experienced delays in securing FCC Class B approvals. To the extent the Company's present and future products may be required to meet the more stringent Class B requirements, there can be no assurance that similar delays will not occur in the future.\nCompetition\nThe principal elements of competition among PC manufacturers are pricing, performance, product quality and reliability, compatibility, marketing and distribution capability, service and support, reputation and the capability to deliver products in large volumes. ALR competes with a large number of manufacturers, including Apple Computer, AST Research, Compaq Computer, Dell Computer, Digital Equipment Corporation, Gateway 2000, Hewlett Packard, IBM Corporation (\"IBM\"), NCR and NEC Information Systems, as well as private label products manufactured by companies such as Intel. Most of these companies have significantly greater financial, marketing and technological resources than ALR and may be able to command better terms with their suppliers due to higher purchasing volumes.\nThe Company has entered into OEM agreements with two large computer manufacturers who are competitors of ALR. While selecting its OEM customers, the Company tries to ensure that there is a minimum amount of overlap between the markets and end-users targeted by ALR and its OEM customers. However, changes in the marketing strategy of its OEM customers may adversely affect ALR's future revenue mix and gross margin rate. See \"Sales, Marketing and Support.\"\nSince 1992, the PC industry has experienced a significant increase in price competition from the top tier PC manufacturers like Compaq and IBM. This has resulted in a rapid decline in PC prices and an increase in marketshare for the top tier manufacturers. ALR has responded to this new environment by focusing its product strategy towards providing computers aimed at the high-performance multi-processing server and desk-top markets. ALR's long-term success will depend primarily on the continued market acceptance of its existing products, its ability to develop and introduce similarly acceptable new products, its ability to continue to reduce costs through product design and operating efficiencies and its ability to expand its channels of distribution and the number of customers within these channels.\nPatents, Trademarks and Licenses\nThe Company believes that its continued success will depend primarily upon the technical expertise, creative skills and management abilities of its directors, officers and key employees rather than on patent ownership. The Company has been issued patents covering certain aspects of its upgrade technology in the United States and Taiwan, which expire in 2111 and 2005, respectively. The Company has also applied for patents covering its upgrade module technology in Europe, Canada and Australia, although there can be no assurance that these patents will be granted or that these patents will provide adequate protection, if granted. The Company currently relies on trade secrets and confidentiality agreements to protect its proprietary information, although there can be no assurance that the confidentiality agreements on which ALR relies to protect its trade secrets will be adequate or that the Company's competitors will not independently develop or patent substantially equivalent or superior technologies.\nThe Company has obtained federal trademark registration on the following trademarks: Advanced Logic Research, Inc., ALR, the ALR logo, PowerFlex, Business Veisa, PowerVeisa, BusinessServer, PowerFlex Flyer, Business Station and Evolution and has applied for federal trademark registration on certain other product names and logos. The Company has also trademarked the ALR logo in various countries including Singapore, Germany and the United Kingdom and has applied for registration of its logo in certain other foreign countries in which it anticipates expanding its international business.\nALR currently licenses from IBM the right to use certain technology covered under patents issued to IBM. The licensing agreement permits the Company to develop, manufacture and sell personal computers without liability for infringement on IBM's existing patents. The Company pays, and expects to pay in the future, royalties to IBM on sales of a substantial number of the Company's existing and future personal computer products. IBM's policy is to offer lower royalty rates to licensees that possess patent rights of interest to IBM if these licensees provide IBM with a cross-license. To the extent that ALR's competitors avoid the payment of royalties or obtain more favorable royalty payment terms from IBM, ALR could be at a disadvantage.\nIn the past, the Company has licensed certain of its designs to a large computer manufacturer. In the future, the Company may choose to license its designs to other computer manufacturers which may permit these manufacturers to compete directly with the Company. See \"Sales, Marketing and Support.\"\nFrom time to time, companies have asserted exclusive patent, copyright and other intellectual property rights to technologies that are important to the microcomputer industry. The Company evaluates each claim and, if appropriate, seeks a license to use the protected technology. There can be no assurance that the Company would be able to obtain licenses to use such technology or obtain such licenses on terms that would not have a material adverse effect on the Company. If the Company or its suppliers are unable to license protected technology used in ALR's products, ALR could be prohibited from marketing such products. The Company could also incur substantial costs to redesign its products or to defend any legal action taken against it. If the Company's products should be found to infringe protected technology, ALR could be required to pay damages to the infringed party and to stop using such protected technology.\nEmployees\nAs of September 30, 1995, ALR had 475 full-time employees, of whom 39 were engaged in engineering, research and development, 88 in sales and marketing, 53 in customer support and service, 248 in manufacturing and 47 in administrative activities. No employee of the Company is represented by a labor union or is subject to a collective bargaining agreement.\nThe Company believes its ability to attract and retain skilled technical and management personnel has been and will continue to be critical to its success. Accordingly, the Company has adopted stock option plans and other benefit plans to assist in attracting and retaining qualified employees at all levels.\nForeign and Domestic Operations\nA substantial portion of the Company's sales are made outside the United States. See Note 12 of Notes to Consolidated Financial Statements, which is incorporated by reference.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nThe Company leases approximately 75,000 square feet of space for its corporate headquarters in Irvine under a lease which expires in June 1999. The Company leases an additional 40,000 square feet of space at a nearby facility for manufacturing and warehousing operations under a lease which expires in June 1997. ALR International leases approximately 22,000 square feet of space in Singapore for sales, support and warehousing needs under a lease that expires in 1997. In addition, the Company leases space for sales and support offices in London, Frankfurt, Hong Kong and Malaysia. The information in Note 13 of Notes to Consolidated Financial Statements is incorporated by reference.\nALR believes that its manufacturing facilities will be sufficient to meet its reasonably foreseeable needs. The Company believes that space will be available at commercially reasonable rates when and as needed to accommodate either a move or an expansion of the Company's operations.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nThe Company is a party to litigation matters and claims which are normal in the course of its operations, and while the results of litigation and claims cannot be predicted with certainty, the Company believes that the final outcome of such matters will not have a materially adverse effect on the Company's consolidated financial position or results of operations.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nNone.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Stock and Related Stockholder Matters.\nMarket Information (Unaudited)\nAdvanced Logic Research, Inc.'s common stock is traded on The Nasdaq Stock Market under the symbol AALR. The following table sets forth the range of high and low closing sale prices for the Company's common stock for the fiscal quarters indicated.\nYear ended September 30, High Low\n1995: First fiscal quarter $ 4.88 $ 3.75 Second fiscal quarter 5.38 4.00 Third fiscal quarter 6.75 4.50 Fourth fiscal quarter $ 9.38 $ 5.75\n1994: First fiscal quarter $ 3.63 $ 2.88 Second fiscal quarter 7.25 3.38 Third fiscal quarter 6.50 4.50 Fourth fiscal quarter $ 4.50 $ 3.63\nAt December 15, 1995, the closing sale price of the Company's common stock as reported on The Nasdaq Stock Market was $6.75.\nHolders of Record\nAt September 30, 1995, ALR had approximately 277 stockholders of record of the Company's common stock.\nDividends\nThe Company has never paid dividends on its capital stock. The Company presently intends to retain earnings for use in its business and, therefore, does not anticipate paying any cash dividends in the foreseeable future. In addition, the terms of the Company's current loan agreement restrict the ability of the Company to pay cash dividends.\nItem 7. Management's Discussion and Analysis of Results of Operations and Financial Condition.\nNET SALES Change Change FY95 From FY94 FY94 From FY93 FY93 (In thousands) Net Sales $192,425 5% $183,387 8% $169,254\nNet sales increased to $192.4 million for fiscal 1995 from $183.4 million for fiscal 1994 and $169.3 million for fiscal 1993. The consecutive years of sales growth was principally due to the reorientation of the Company's product and marketing focus to network servers and high-end desk-top systems. During the three years, sales of servers and high-end desk-top systems grew from $22.3 million for fiscal 1993 to $56.3 million and $98.9 million for fiscal 1994 and 1995, respectively. A major contributor to this growth in sales was the ALR Revolution Q-SMP. From its introduction in the latter half of fiscal 1994, sales of this product have grown to represent 13% of net sales for fiscal 1995. Consequently, as a result of the shift in product mix to servers and high-end desk-top systems, the average system selling price for fiscal 1995 increased to $1,960 from $1,676 and $1,357 for fiscal 1994 and 1993, respectively, despite the existence of industry-wide competitive pricing pressures.\nIn fiscal 1995, the Company's principal channel of distribution continued to be resellers which comprised 65% of net sales. However, due to the growth in sales made directly to small businesses, government, corporate and individual end-users, and OEM customers, this represented a decline from fiscal 1994 and 1993 in which sales to resellers represented 69% and 68% of net sales, respectively.\nFrom fiscal 1993 through fiscal 1995, direct sales to small businesses, government, corporate and individual end-users grew to become the Company's second major channel of distribution. Direct sales increased from $15.7 million for fiscal 1993 to $28.5 million and $38.8 million for fiscal 1994 and 1995, respectively. The growth in sales through this channel during fiscal 1995 was predominately due to the negotiation of a GSA contract with the federal government allowing federal agencies to procure product directly from ALR.\nIn October 1994, the Company entered into an OEM agreement with Unisys Corporation for certain high-end products which complemented the Company's existing OEM relationships with Siemens Nixdorf in the U.S. and Germany. The addition of Unisys accounted for the 169% increase in OEM sales during fiscal 1995 from fiscal 1994. For fiscal 1995, OEM sales totaled $17.5 million and represented approximately 9% of net sales compared to 4% and 5% for fiscal 1994 and 1993, respectively.\nSales to distributors and NROs for fiscal 1995 declined to 5% of net sales compared to 9% and 14% for fiscal 1994 and 1993, respectively. This decline in sales over the three years was due to the reorientation of the Company's sales channel. Product purchase agreements with Ingram Micro, Inc., Intelligent Electronics and ComputerLand were terminated during fiscal 1993.\nDuring fiscal 1995, principally due to the growth in sales through the direct and OEM channels, U.S. sales grew by 11% to represent 57% of net sales compared to 54% and 50% for fiscal 1994 and 1993, respectively. Consequently, international sales declined to represent 43% of net sales for fiscal 1995 compared to 46% and 50% for fiscal 1994 and 1993, respectively. The decline in international sales during fiscal 1995 was principally due to lower sales to Asia-Pacific region and Canadian customers. Partially offsetting this decline was an 18% increase in sales to customers in Europe and Latin America during fiscal 1995.\nGROSS PROFIT Change Change FY95 From FY94 FY94 From FY93 FY93 (In thousands) Gross Profit 35,960 30% 27,735 44% 19,280 Percentage of Net Sales 18.7% 15.1% 11.4%\nGross profit margins for fiscal 1995 increased to 18.7% from 15.1% for fiscal 1994 and from 11.4% for fiscal 1993. The shift in sales to servers and high- end desk-top systems favorably impacted gross profit margins since these systems typically generate greater gross profit margins than the Company's entry-level and mid-range systems. Design changes, chiefly to product chassis and motherboards, coupled with lower vendor component costs, particularly on CPUs and disk drives, lowered material costs and contributed to improving gross profit margins. Also contributing was the growth in sales volume which allowed manufacturing and technical support costs to be absorbed over a greater revenue base.\nThe Company anticipates that competitive pricing pressures will continue throughout the personal computer industry. Although vendor component costs generally decreased during the three year period, a change in market conditions brought about by increased demand for these components could result in price increases which would adversely affect the Company's gross profit margins and profitability.\nOPERATING EXPENSES SELLING, GENERAL AND ADMINISTRATIVE Change Change FY95 From FY94 FY94 From FY93 FY93 (In thousands) Selling, General and Administrative Expenses $21,915 14% $19,308 (16%) $22,898 Percentage of Net Sales 11.4% 10.5% 13.5%\nSelling, general and administrative expenses increased by 14% to $21.9 million for fiscal 1995 compared to $19.3 million for fiscal 1994. Expanded product advertising and increased dealer cooperative promotional activities principally accounted for the increase in expenses during fiscal 1995. As a percentage of net sales, advertising and promotional expenses increased to 4.3% of net sales for fiscal 1995 compared to 3.5% of net sales for fiscal 1994. Also contributing to the increase was a reduction in bad debt reserves during fiscal 1994. In fiscal 1994, $.8 million in bad debt expense was reversed against the allowance for doubtful accounts.\nFor fiscal 1994, selling, general and administrative expenses declined by 16% to $19.3 million compared to $22.9 million for fiscal 1993. This decline was principally the result of lower bad debt expense, lower expenditures on cooperative advertising, trade shows and media advertising and lower personnel related expenses. As previously discussed the decline in bad debt expense was due to the reversal of $.6 million in bad debt expense against the allowance for doubtful accounts. The decrease in advertising expense related to fewer cooperative advertising and promotional programs while the decline in personnel related expenses was associated with a streamlining of worldwide operations in the first quarter of fiscal 1994. This resulted in part from the closure of the Company's Canadian sales branch and a significant reduction in the Company's operations in Singapore.\nENGINEERING, RESEARCH AND DEVELOPMENT Change Change FY95 From FY94 FY94 From FY93 FY93 (In thousands) Engineering, Research and Development Expenses $4,762 8% $4,409 12% $3,935 Percentage of Net Sales 2.5% 2.4% 2.3%\nEngineering, research and development expenses increased during the three year period to $4.8 million for fiscal 1995 compared to $4.4 million and $3.9 million for fiscal 1994 and 1993, respectively. Increases in payroll and payroll-related costs associated with increased headcount and higher engineering material expense from ongoing product development principally accounted for the increase in fiscal 1995 compared to fiscal 1994. The increase in fiscal 1994 compared to fiscal 1993 was principally due to higher outside professional service fees associated with product design and testing and higher engineering material expenses related to product development.\nROYALTY EXPENSE, NET Change Change FY95 From FY94 FY94 From FY93 FY93 (In thousands) Royalty Expense, Net $5,289 (10%) $5,867 13% $5,183 Percentage of Net Sales 2.7% 3.2% 3.1%\nThe decline in net royalty expense for fiscal 1995 to 2.7% of sales from 3.2% for fiscal 1994 resulted because certain of the Company's products are exempt from royalties. For fiscal 1994, net royalty expense increased to 3.2% of net sales from 3.1% of net sales for fiscal 1993 due to the provisions of the Company's agreement with IBM.\nEffective January 1, 1996, the royalty rate related to the sale of certain of the Company's products will increase an additional 1% to its maximum applicable rate according to the terms of the Company's agreement with IBM.\nINTEREST INCOME, NET Change Change FY95 From FY94 FY94 From FY93 FY93 (In thousands) Interest Income, Net $2,502 85% $1,355 249% $388\nThe increase in net interest income since fiscal 1993 was due to the steady growth in cash and cash equivalents balances, increased rates of return on short-term investments and the repayment of outstanding bank debt in January 1994.\nINCOME TAXES FY95 FY94 FY93 (In thousands) Income Tax Expense (Benefit) $1,624 $(148) $(2,640) Effective Tax Rate 25.0% 30.0% 21.4%\nFor fiscal 1995, 1994 and 1993, the Company recorded effective income tax rates of 25.0%, 30.0% and 21.4%, respectively. The changes in the effective tax rates were principally attributable to changes in the earnings mix among the Company's subsidiaries located in various taxing jurisdictions and utilization of certain net operating loss carryforwards.\nDuring fiscal 1993, the Company adopted Financial Accounting Standards Board Statement No. 109 (\"SFAS No. 109\"), \"Accounting for Income Taxes\". The cumulative effect of adopting SFAS No. 109 increased the net loss by $919,000, or $0.08 per share. See Notes 1 and 9 of the Notes to Consolidated Financial Statements for additional information regarding SFAS No. 109 and income taxes.\nLIQUIDITY AND CAPITAL RESOURCES Sept. 30, 1995 Sept. 30, 1994 (In thousands) Cash and cash equivalents $46,580 $40,836 Working capital 79,771 72,967 Current ratio 4.3 4.5 Debt --- --- Stockholders' equity 83,249 76,861\nThe Company's cash and cash equivalents increased to $46.6 million at September 30, 1995 compared to $40.8 million at September 30, 1994. The $5.8 million increase in cash and cash equivalents during the fiscal year was due to positive cash flow from operating activities partially offset by capital expenditures.\nAccounts receivable increased to $26.5 million at September 30, 1995, from $24.5 million at September 30, 1994. For the quarter ended September 30, 1995, accounts receivable days outstanding were 45 days compared to 46 days for the quarter ended September 30, 1994. Inventories increased to $27.1 million at September 30, 1995, from $22.6 million at September 30, 1994. Inventory turns declined to 6.4 for the quarter ended September 30, 1995 compared to 7.1 for the quarter ended September 30, 1994. The Company's higher level of inventory at September 30, 1995 was principally due to increased purchases of key components during fiscal 1995 which are in limited supply or have a long delivery lead time.\nALR International continues to have available an uncommitted revolving credit line with an availability of approximately $4.2 million which is used to supplement its working capital requirements. At September 30, 1995, the Company had not borrowed against this line of credit.\nThe Company's primary credit facility continues to be a $15.0 million revolving line with Heller Financial, Inc. The line is secured by the Company's assets and availability is subject to a borrowing base requirement. In October 1995, the Company signed an amendment to this credit agreement extending the expiration to August 1998 and reducing the borrowing rate to Prime, based on the Prime rate charged by Bank of America, from Prime rate plus 1%. A commitment fee of .75% per annum is paid on the unused portion of the revolving line of credit. The facility contains certain net worth, profitability, financial ratio and other covenants with which the Company was in compliance during fiscal 1995 and 1994. During fiscal 1995 and 1994, the Company had no outstanding borrowings against this line of credit.\nThe Company believes that its existing cash resources, combined with anticipated cash flows from future operating activities, supplemented as necessary with funds expected to be available under the Company's various credit agreements, will provide it with sufficient resources to meet present and reasonably foreseeable working capital requirements and other cash needs.\nItem 8. Financial Statements, Financial Statement Schedule and Supplementary Data.\nIndex to Financial Statements and Financial Statement Schedule\nConsolidated Financial Statements:\nReport of Independent Auditors................................19\nConsolidated Balance Sheets as of September 30, 1995 and 1994.20\nConsolidated Statements of Operations for the years ended September 30, 1995, 1994 and 1993............................21\nConsolidated Statements of Stockholders' Equity for the years ended September 30, 1995, 1994, and 1993...............22\nConsolidated Statements of Cash Flows for the years ended September 30, 1995, 1994, and 1993.....................23\nNotes to Consolidated Financial Statements....................24\nFinancial Statement Schedule: (For the three years ended September 30, 1995)\nSchedule II - Valuation and Qualifying Accounts.........................32\nAll other schedules and financial statements are omitted because they are not applicable or the required information is shown in the consolidated financial statements or notes thereto.\nItem 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure.\nNone.\nREPORT OF INDEPENDENT AUDITORS\nTo the Board of Directors Advanced Logic Research, Inc.:\nWe have audited the accompanying consolidated financial statements of Advanced Logic Research, Inc. and subsidiaries as listed in the accompanying index. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule as listed in the accompanying index. These consolidated financial statements and 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 Advanced Logic Research, Inc. and subsidiaries at September 30, 1995 and 1994, and the results of their operations and their cash flows for each of the years in the three-year period ended September 30, 1995 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\nOrange County, California November 2, 1995\nCONSOLIDATED BALANCE SHEETS (In thousands, except share data)\nSeptember 30, 1995 1994 Assets (note 8)\nCurrent assets: Cash and cash equivalents $46,580 $40,836 Trade accounts receivable, less allowance of $1,999 and $1,870 at September 30, 1995 and 1994, respectively 26,524 24,507 Inventories (note 2) 27,088 22,555 Prepaid expenses and other assets 1,692 4,540 Deferred income taxes (note 9) 1,858 1,597 Total current assets 103,742 94,035 Equipment, furniture and fixtures, net (note 3) 2,764 3,316 Other assets 714 578 $107,220 $97,929\nLiabilities and Stockholders' Equity (notes 7 and 8)\nCurrent liabilities: Accounts payable $11,607 $ 9,024 Payable to affiliates (note 4) 330 2,619 Accrued expenses (note 5) 10,528 9,425 Income taxes (note 9) 1,506 --- Total current liabilities 23,971 21,068\nCommitments and contingencies (notes 10 and 13)\nStockholders' Equity (note 6) Preferred stock, $.01 par value; 2,500,000 shares authorized; none issued --- --- Common stock, $.01 par value; 25,000,000 shares authorized; 11,668,871 and 11,478,347 shares issued and outstanding at September 30, 1995 and 1994, respectively 117 115 Additional paid-in capital 54,675 53,842 Retained earnings 26,803 21,931 Adjustments for foreign currency translation 1,654 973 Total stockholders' equity 83,249 76,861 $107,220 $ 97,929\nSee accompanying notes to consolidated financial statements\nCONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share data)\nYear ended September 30, 1995 1994 1993\nNet sales (note 12) $192,425 $183,387 $169,254 Cost of sales (notes 4 and 10) 156,465 155,652 149,974 Gross profit 35,960 27,735 19,280\nOperating expenses: Selling, general and administrative (note 10) 21,915 19,308 22,898 Engineering, research and development 4,762 4,409 3,935 Royalty expense, net (note 10) 5,289 5,867 5,183 Total operating expenses 31,966 29,584 32,016\nOperating income (loss) 3,994 (1,849) (12,736)\nInterest income 2,513 1,435 944 Interest expense (11) (80) (556)\nIncome (loss) before income taxes and cumulative effect of change in accounting principle 6,496 (494) (12,348)\nIncome tax expense (benefit) (note 9) 1,624 (148) (2,640)\nIncome (loss) before cumulative effect of change in accounting principle 4,872 (346) (9,708)\nCumulative effect of change in accounting for income taxes (note 9) --- --- (919)\nNet income (loss) $4,872 $ (346) $(10,627)\nNet income (loss) before cumulative effect of change in accounting principle per common and common equivalent share $ 0.41 $(0.03) $(0.86)\nCumulative effect of change in accounting principle --- --- (0.08)\nNet income (loss) per common and common equivalent share $ 0.41 $(0.03) $(0.94)\nCommon and common equivalent shares used in per share calculation 11,750 11,434 11,336\nSee accompanying notes to consolidated financial statements\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (In thousands, except share data)\nAdjustment Additional for Foreign Total Common Stock Paid-in Retained Currency Stockholders' Shares Amount Capital Earnings Translation Equity Balance, September 30, 1992 11,244,295 $ 112 $53,300 $32,904 $ 1,109 $ 87,425 Exercise of stock options 136,348 2 183 --- --- 185 Foreign currency translation --- --- --- --- (1,066) (1,066) Net loss --- --- (10,627) -- (10,627) Balance, September 30, 1993 11,380,643 114 53,483 22,277 43 75,917 Exercise of stock options 97,704 1 359 --- --- 360 Foreign currency translation --- --- --- --- 930 930 Net loss --- --- (346) --- (346) Balance, September 30, 1994 11,478,347 115 53,842 21,931 973 76,861 Exercise of stock options 190,524 2 833 --- --- 835 Foreign currency translation --- --- --- --- 681 681 Net income --- --- --- 4,872 --- 4,872 Balance, September 30, 1995 11,668,871 $ 117 $54,675 $26,803 $1,654 $83,249\nSee accompanying notes to consolidated financial statements\nCONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)\nYear ended September 30, 1995 1994 1993\nCash flows from operating activities: Net income (loss) $4,872 $ (346) $(10,627) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization 1,840 2,358 2,472 (Gain) loss on disposal of equipment (79) 203 137 Provisions for losses on accounts receivable 310 (752) 897 Deferred income tax provision (benefit) (261) 4,208 (494)\nChanges in assets and liabilities: Trade accounts receivable (1,761) (1,215) 11,535 Inventories (4,135) 14,554 6,557 Prepaid expenses and other assets 2,615 (889) (863) Accounts payable 2,389 (5,878) 5,155 Payable to affiliates (2,289) 891 (1,367) Accrued expenses 991 278 (237) Income taxes 1,506 (735) 738 Net cash provided by operating activities 5,998 12,677 13,903\nCash flows from investing activities - Purchase of equipment, furniture and fixtures (1,164) (967) (1,417)\nCash flows from financing activities: Net repayments to banks --- (316) (1,824) Repayments under notes payable --- (6,000) (6,827) Issuance of stock under stock option plan 835 360 185 Net cash provided by (used in) financing activities 835 (5,956) (8,466)\nEffect of exchange rate changes on cash 75 635 789\nNet increase in cash and cash equivalents 5,744 6,389 4,809\nCash and cash equivalents at beginning of year 40,836 34,447 29,638 Cash and cash equivalents at end of year $46,580 $40,836 $34,447\nSupplemental disclosure of cash flow information: Cash paid (refunded) during the year for: Interest $ 2 $ 119 $ 470 Income taxes $(2,070) $(4,294) $ (936)\nSee accompanying notes to consolidated financial statements\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYears ended September 30, 1995, 1994, 1993\n(1) Summary of Significant Accounting Policies\nORGANIZATION Advanced Logic Research, Inc., together with its wholly-owned subsidiaries, Advanced Logic Research International, Inc., ALR International (Pte) Ltd. (\"ALR International\"), Advanced Logic Research Inc. (U.K.) Limited and Advanced Logic Research (Deutschland) GmbH, herein referred to collectively as the \"Company\", designs, manufactures, markets and supports a broad line of microcomputer systems based on Intel's Pentium, Pentium Pro and 486 microprocessors. These operations comprise the Company's only business segment.\nWearnes Technology (Private) Limited (\"Wearnes\") holds approximately forty-one percent of the Company's outstanding common stock.\nPRINCIPLES OF CONSOLIDATION The accompanying consolidated financial statements include the accounts of Advanced Logic Research, Inc. and its subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.\nINVENTORIES Inventories are valued at the lower of cost (first-in, first-out) or market (net realizable value).\nDEPRECIATION Depreciation of equipment, furniture and fixtures and the amortization of leasehold improvements is provided over the estimated useful lives of the assets using the straight-line method. The useful lives range from three to five years for equipment, furniture and fixtures, and the shorter of the useful lives or the terms of the leases for leasehold improvements.\nREVENUE RECOGNITION AND WARRANTY POLICY Revenue is recognized upon product shipment, except for sales to the U.S. government, which are recognized when product is delivered. The Company grants certain distributors limited rights to exchange product and price protection on unsold merchandise. The Company also has financing agreements with credit corporations that provide alternative financing to pre-approved dealers. These financing agreements generally require the Company to repurchase inventory that has been repossessed by the credit corporations from these dealers. The Company establishes estimated allowances based on experience for future product returns and price adjustments by charges to current operations. The Company provides, by a current charge to income, an amount it estimates will be needed to cover future warranty obligations for products sold during the year.\nFOREIGN CURRENCY TRANSLATION The Company uses the local currency as the functional currency for its international operations. Accordingly, assets and liabilities outside the United States are translated into dollars at the rate of exchange in effect at the balance sheet date. Income and expense items are translated at the weighted average exchange rates prevailing during the year. The cumulative translation gain or loss is shown as an adjustment to stockholders' equity. During fiscal 1995, 1994 and 1993, the Company recorded foreign currency transaction gains of $30,000 and foreign exchange losses of $154,000 and $559,000, respectively.\nForward contracts are used by the Company to hedge certain portions of its foreign currency exposure resulting from exchange rate fluctuations and are not used to engage in speculation. At September 30, 1995, the Company had no forward contracts outstanding.\nINCOME TAXES During fiscal 1993, the Company elected early adoption of Statement of Financial Accounting Standards No. 109, (\"SFAS No. 109\"), \"Accounting for Income Taxes\" and has reported the cumulative effect of that change in the fiscal 1993 Consolidated Statement of Operations. 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 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.\nNET INCOME (LOSS) PER SHARE Net income (loss) per share is computed using the weighted average number of common shares and dilutive common stock options outstanding, at the average market price for the period, which are considered common stock equivalents. Fully diluted income (loss) per share amounts are not presented because they approximate primary net income (loss) per share or are anti-dilutive.\nCASH EQUIVALENTS Cash equivalents are highly liquid investments with an original maturity of three months or less, consisting primarily of commercial paper, variable-rate demand notes, short-term government obligations and other money market instruments.\n(2) Inventories A summary of the components of inventories follows (in thousands): September 30, 1995 1994 Raw materials and component parts $10,944 $ 7,782 Work in process 3,647 3,244 Finished goods 12,497 11,529 $27,088 $22,555\n(3) Equipment, Furniture and Fixtures Equipment, furniture and fixtures, at cost, consist of the following (in thousands): September 30, 1995 1994 Machinery and equipment $ 8,211 $ 9,376 Vehicles 248 632 Furniture and fixtures 958 967 Leasehold improvements 1,101 1,087 10,518 12,062 Less accumulated depreciation and amortization (7,754) (8,746) $ 2,764 $ 3,316\n(4) Transactions with Related Parties A summary of the payable to Wearnes' subsidiaries follows (in thousands): September 30, 1995 1994 Wearnes Thakral $ --- $ 1,528 Wearnes Automation --- 875 Other Wearnes' subsidiaries 330 216 $ 330 $ 2,619\nThe balance payable to Wearnes' subsidiaries is due and payable 30 days from the shipment date. Total inventory purchases from Wearnes' subsidiaries during fiscal 1995, 1994 and 1993 were $7,426,000, $14,350,000 and $6,487,000, respectively.\n(5) Accrued Expenses A summary of accrued expenses follows (in thousands): September 30, 1995 1994 Accrued royalty $ 2,903 $ 2,769 Accrued warranty 2,148 2,311 Other 5,477 4,345 $10,528 $ 9,425\n(6) Stockholders' Equity During 1986, the Board of Directors authorized the granting of up to 714,000 shares of common stock for issuance to key individuals or the directors under an informal stock option program (\"1986 Plan\"). The options become exercisable at varying periods relative to the date of employment or the grant of the option. The options generally expire at the earlier of termination of employment or January 31, 1996.\nThe following is a summary of transactions under the 1986 Plan: Number Price of shares per share Options outstanding at September 30, 1992 245,083 $ .07 - 1.68 Exercised (136,348) .07 - .42 Options outstanding at September 30, 1993 108,735 .07 - 1.68 Exercised (60,053) .07 - 1.68 Options outstanding at September 30, 1994 48,682 .10 - .42 Exercised (45,542) .10 - .42 Options outstanding at September 30, 1995 3,140 $ .42\nAs of September 30, 1995, all outstanding options are exercisable.\nDuring 1990, the Board of Directors of the Company adopted the Flexible Stock Incentive Plan (the \"Plan\") authorizing the granting of common stock to key individuals of which 2,500,000 shares have been registered with the Securities and Exchange Commission. The Plan contains three components: a stock option component, a stock bonus\/stock purchase component and a stock appreciation rights component. The purpose of the plan is to provide incentives to selected individuals whose services contribute to the financial success and growth of the Company and its affiliates.\nThe Plan provides for the granting of stock options, stock bonuses, stock appreciation rights or rights to purchase stock for up to an aggregate of not more than the greater of (i) 10% of the authorized shares of the Company's common stock or (ii) 15% of the shares of common stock outstanding as of the close of business on the last day of the Company's prior fiscal year. Awards under the Plan can be granted to officers, employees and other individuals as determined by the committee of the Board of Directors which administers the Plan (the \"Committee\").\nOptions granted under the Plan may be either \"incentive\" stock options or options that do not qualify as Incentive Options (\"Nonqualified Options\"). The exercise price of shares of common stock covered by each Incentive Option cannot be less than the per share fair market value of the Company's common stock on the date the option is granted. The exercise price in the case of Nonqualified Options granted under the Plan is set by the Committee with a minimum exercise price of at least 85% of the fair market value of the Company's common stock on the date the option is granted.\nThe following is a summary of transactions under the Plan: Number Price of shares per share Options outstanding at September 30, 1992 427,844 $ 6.25 - 12.50 Granted 428,000 4.25 - 4.50 Canceled (48,791) 4.25 - 11.00 Options outstanding at September 30, 1993 807,053 4.25 - 12.50 Granted 351,000 3.38 - 3.625 Exercised (37,651) 4.25 - 6.25 Canceled (57,598) 3.38 - 12.50 Options outstanding at September 30, 1994 1,062,804 3.38 - 11.00 Granted 600,000 4.50 Exercised (137,482) 3.38 - 6.25 Canceled (34,483) 3.38 - 6.25 Options outstanding at September 30, 1995 1,490,839 $ 3.38 - 11.00\nAll options granted under the Plan are Nonqualified Options which were granted at an exercise price that approximated fair market value. As of September 30, 1995, 727,591 of the outstanding options are exercisable.\nOn August 13, 1990, the Board of Directors of the Company adopted the Director's Nonqualified Stock Option Plan (\"Director's Plan\") authorizing the registration of 60,000 shares of common stock for issuance to directors at an exercise price equal to the fair market value on the date the option is granted. The purpose of the Director's Plan is to provide incentives to participants for increased efforts and successful achievements on behalf of or in the interest of the Company while serving on the Company's Board of Directors. In each of fiscal 1995, 1994 and 1993, 10,000 shares were granted to the non-employee directors of ALR under the Director's Plan. During fiscal 1995, 7,500 options were exercised while during 1994 and 1993 no options were exercised. As of September 30, 1995, the number of options outstanding and exercisable under this Director's Plan were 52,500 at a price per share of $3.44 to $8.75. During fiscal 1995, 1994 or 1993 no options were canceled.\n(7) Notes Payable to Banks ALR International currently has a line of credit totaling approximately $4,212,000. The line of credit bears interest at the lending bank's prime rate. At September 30, 1995 and 1994, ALR International had no outstanding borrowings against this line of credit. The maximum and average amounts outstanding during fiscal 1995 were $718,900 and $59,900, respectively, with a weighted average interest rate of 6.13%. The maximum and average amounts outstanding during fiscal 1994 were $635,200 and $66,000, respectively, with a weighted average interest rate of 5.33%.\n(8) Long-Term Debt During June 1993, the Company entered into a three-year agreement with Heller Financial, Inc. providing the Company with a $15,000,000 revolving line of credit. The line is secured by the Company's assets and availability is subject to a borrowing base requirement. In October 1995, the Company signed an amendment to this existing credit agreement extending the expiration to August 1998 and reducing the borrowing rate to Prime, based on the Prime rate charged by Bank of America, from Prime rate plus 1%. A commitment fee of .75% per annum is paid on the unused portion of the revolving line of credit. The facility contains certain net worth, profitability, financial ratio and other covenants with which the Company was in compliance at September 30, 1995 and 1994. During fiscal 1995 and 1994, the Company had no outstanding borrowings against this line of credit.\n(9) Income Taxes The components of income (loss) before income taxes and cumulative effect of change in accounting principle are as follows (in thousands):\nYear ended September 30, 1995 1994 1993 U.S. $4,005 $(1,908) $ (9,821) Foreign 2,491 1,414 (2,527) $6,496 $ (494) $(12,348)\nIncome tax expense (benefit) consists of the following (in thousands):\nYear ended September 30, 1995 1994 1993 Current: Federal $1,856 $(4,357) $(2,766) State 29 1 26 Foreign --- --- 594 $1,885 $(4,356) $(2,146) Deferred: Federal $ (261) $ 4,208 $ (494) State --- --- --- (261) 4,208 (494) $ 1,624 $ (148) $(2,640)\nIncome tax expense for the year ended September 30, 1995 includes a benefit of $1,118,000 resulting from the utilization of certain state and foreign net operating loss carryforwards.\nAs discussed in Note 1, the Company adopted SFAS No. 109 in fiscal 1993. The cumulative effect of this change in accounting for income taxes resulted in an increase to the net loss of $919,000, or $0.08 per share, and is reported separately in the Consolidated Statement of Operations for the year ended September 30, 1993.\nTotal income tax expense (benefit) differs from the amount computed by applying the federal corporate income tax rate of 34% to income (loss) before taxes and cumulative effect of change in accounting principle as follows (in thousands):\nYear ended September 30, 1995 1994 1993 Computed expected income taxes (benefit) $ 2,209 $ (168) $(4,198) State income taxes, net of federal income tax benefit 27 1 14 Effect of foreign operations (486) (278) 1,727 Tax exempt foreign sales corporation income (132) (99) (70) Tax exempt interest income (91) (64) (103) Changes in valuation allowance 102 469 --- Other (5) (9) (10) $ 1,624 $ (148) $(2,640)\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 as of September 30, 1995 are as follows (in thousands):\nYear ended September 30, 1995 1994 Deferred tax liabilities: Prepaid expenses $ 333 $ 296\nDeferred tax assets: Net operating loss carryforwards 1,703 2,821 Inventories 1,379 1,629 Warranty provisions 773 687 Allowance for doubtful accounts 601 618 Promotional and sales allowances 510 376 Other 633 424 5,599 6,555 Valuation allowance (3,408) (4,662) Net deferred tax assets 2,191 1,893 $1,858 $1,597\nThe Company has recorded a valuation allowance in the amount set forth in the above table for certain deductible temporary differences for which it is not certain whether the Company will receive future tax benefit. The net decrease in the total valuation allowance for the year ended September 30, 1995 was $1,254,000. The change in the valuation allowance for the year ended September 30, 1995, resulted primarily from the recognition of available state and foreign net operating loss carryforwards. The Company believes that the remaining deferred tax assets will more likely than not be realizable due to availability of the net operating loss carryback potential.\nThe Company has approximately $6,769,000 of net operating loss carryforwards in various state and foreign tax jurisdictions which can be utilized to offset the Company's future taxable earnings. Approximately $1,198,000 of the carryforwards expire in fiscal 1999. The remaining $5,571,000 have no expiration date.\n(10) Operating Expenses Selling expenses include advertising costs of $8,304,000, $6,394,000 and $6,682,000 for fiscal 1995, 1994 and 1993, respectively. These costs include expenses related to print media advertising, cooperative advertising with customers, promotional activities, trade shows, merchandising kits, point-of- purchase displays and brochures.\nIn 1988, the Company entered into a nonexclusive licensing agreement with IBM Corporation (\"IBM\") which enables the Company to make, use, lease, sell, manufacture or have manufactured certain products under patent with IBM. Under this agreement, the Company will pay a royalty to IBM for products sold that utilize IBM technology. Royalty expense under this agreement for fiscal 1995, 1994 and 1993 was $5,289,000, $5,867,000 and $5,189,000, respectively.\nIn April 1991, the Company entered into a non-exclusive distribution agreement with Microsoft Corporation (\"Microsoft\") whereby the Company was granted the right to distribute specific Microsoft products. Royalty expense under this agreement for fiscal 1995, 1994 and 1993 was $2,174,000, $1,971,000 and $1,694,000, respectively, which is included in cost of sales in the accompanying Consolidated Statements of Operations.\n(11) Profit Sharing Plan In September 1988, the Company established a pretax savings and profit sharing plan under Section 401(k) of the Internal Revenue Code. Under the plan, eligible employees are able to contribute from 3% to 15% of their compensation. The Company makes a matching contribution of 50% of the first 5% contributed by the employee and may, at its discretion, make additional contributions to the plan, up to a maximum of 15% of the employee's compensation. The Company's contribution to the Plan was approximately $234,000, $195,000 and $177,000 for fiscal 1995, 1994 and 1993, respectively.\nThe Financial Accounting Standards Board has issued Statement of Financial Accounting Standards No. 112 (\"SFAS No. 112\"), \"Employers Accounting for Postemployment Benefits\" requiring accrual basis accounting for post employment benefits. The Company does not offer post employment benefits subject to guidelines established by SFAS No. 112. Accordingly, no provisions have been reflected in the Company's consolidated financial statements at September 30, 1995.\n(12) International Operations The following table reflects information with respect to the Company's domestic and foreign operations (in thousands):\nNorth America Asia Europe Elimination Total Year ended September 30, 1995 Sales to unaffiliated customers $128,858 $32,945 $30,576 $ --- $192,379 Intercompany sales 22,408 --- --- (22,408) --- Sales to affiliated customers 28 18 --- --- 46 Net sales $151,294 $32,963 $30,576 $(22,408) $192,425 Net income (loss) $ 2,781 $ 1,041 $ 1,450 $ (400) $ 4,872 Identifiable assets $ 90,022 $14,569 $14,317 $(11,688) $107,220\nYear ended September 30, 1994 Sales to unaffiliated customers $116,403 $40,348 $25,997 $ --- $182,748 Intercompany sales 21,244 --- --- (21,244) --- Sales to affiliated customers 163 476 --- --- 639 Net sales $137,810 $40,824 $25,997 $(21,244) $183,387 Net income (loss) $ (1,840) $ (79) $ 1,493 $ 80 $ (346) Identifiable assets $ 83,701 $14,087 $11,430 $(11,289) $ 97,929\nYear ended September 30, 1993 Sales to unaffiliated customers $105,535 $36,028 $26,287 $ --- $167,850 Intercompany sales 31,389 --- --- (31,389) --- Sales to affiliated customers 1,345 59 --- --- 1,404 Net sales $138,269 $36,087 $26,287 $(31,389) $169,254 Net income (loss) $ (8,358) $(2,297) $ (824) $ 852 $(10,627) Identifiable assets $ 85,615 $19,295 $14,545 $(11,360) $108,095\nThe U.S. Company had export sales to unaffiliated customers of $20,002,000, $18,075,000 and $15,893,000 for fiscal 1995, 1994 and 1993, respectively.\nDuring fiscal 1995, 1994 and 1993, no customer accounted for more than 10% of net sales.\n(13) Commitments and Contingencies The Company leases its U.S. manufacturing and office facilities under noncancelable operating leases which expire in 1997 and 1999. Additionally, office facility leases for the U.K. subsidiary expire in 2010, for the German subsidiary in 2002 and for the Singapore subsidiary in 1997. Rental expense for fiscal 1995, 1994 and 1993 amounted to $1,685,000, $1,931,000 and $2,487,000, respectively.\nAt September 30, 1995, future minimum rental payments under all noncancelable operating leases with terms in excess of one year are as follows (in thousands):\nYear ending September 30, 1996 $1,405 1997 1,259 1998 701 1999 579 2000 256 Thereafter 700 $4,900\nThe Company has been notified that certain of its products may require licenses under patents held by others. The Company evaluates these licensing proposals on a case-by-case basis to determine whether licenses are necessary. In the opinion of Company management, the liability, if any, resulting from such claims would not have a material adverse affect on the Company's consolidated financial statements.\nThe Company is involved with certain legal proceedings and other claims arising in the normal course of business. In the opinion of Company management, the liability, if any, resulting from such litigation would not have a material adverse affect on the Company's consolidated financial position or results of operations.\n(14) Selected Quarterly Financial Data (unaudited) The tables below set forth selected quarterly financial information for the years ended September 30, 1995 and 1994 (in thousands, except per share data):\nFirst Second Third Fourth Quarter Quarter Quarter Quarter Year Net sales $45,718 $47,359 $45,951 $53,397 $192,425 Gross profit 8,053 8,429 9,159 10,319 35,960 Net income 649 1,058 1,177 1,988 4,872 Net income per share $ 0.06 $ 0.09 $ 0.10 $ 0.17 $ 0.41\nNet sales $49,617 $48,257 $37,774 $47,739 $183,387 Gross profit 8,184 7,038 4,878 7,635 27,735 Net income (loss) (1) 521 293 (1,525) 365 (346) Net income (loss) per share $ 0.05 $ 0.03 $ (0.13) $ 0.03 $ (0.03)\nThe sum of quarterly income per share will not necessarily equal the annual amount since the calculations are based on the weighted average number of shares outstanding during each period.\n(1) Included in the fiscal 1994 fourth quarter net income is a $.6 million reversal of bad debt expense against the allowance for doubtful accounts.\nADVANCED LOGIC RESEARCH, INC. AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS (Amounts in thousands)\nYear ended September 30, 1995 1994 1993\nAllowance for doubtful accounts Balance, beginning of year $ 1,870 $ 3,158 $ 3,293 Additions (reductions) charged (credited) to expense 310 (752) 897 Reductions (181) (536) (1,032) Balance, end of year $ 1,999 $ 1,870 $ 3,158\nAllowance for sales returns Balance, beginning of year $ 2,050 $ 2,150 $ 3,566 Net additions (reductions) charged (credited) to sales 750 (100) (1,416) Balance, end of year $ 2,800 $ 2,050 $ 2,150\nAllowance for price protection Balance, beginning of year $ 225 $ --- $ 317 Net additions (reductions) charged (credited) to sales 99 225 (317) Balance, end of year $ 324 $ 225 $ ---\nPART III\nCertain information required by Part III is omitted from this report in that the Registrant will file a definitive proxy statement within 120 days after the end of its fiscal year pursuant to Regulation 14A (the \"Proxy Statement\") for its Annual Meeting of Stockholders to be held February 21, 1996 and the information included therein is incorporated herein by reference.\nItem 10. Directors and Executive Officers of the Registrant.\nInformation with respect to directors of ALR is incorporated by reference from the information under the caption \"Election of Directors- - -Nominees\" in the Company's Proxy Statement. Information with respect to executive officers of ALR is incorporated by reference from the information under the caption \"Executive Officers\" in the Company's Proxy Statement.\nItem 11. Executive Compensation.\nThe information under the caption \"Executive Compensation and Other Information\" in the Company's Proxy Statement is incorporated by reference.\nItem 12. Security Ownership of Certain Beneficial Owners and Management.\nThe information under the caption \"Stock Ownership of Management and Principal Stockholder\" in the Company's Proxy Statement is incorporated by reference.\nItem 13. Certain Relationships and Related Transactions.\nThe information under the caption \"Certain Transactions\" in the Company's Proxy Statement is incorporated by reference.\nPART IV\nItem 14. Exhibits, Financial Statement Schedule and Reports on Form 8-K.\n(a) The following documents are filed as a part of this report:\nFinancial Statements and Financial Statement Schedule -- See Index to Consolidated Financial Statements on page 18.\n(3) Exhibits included herein (numbered in accordance with Item 601 of the Regulation S-K):\nExhibit Number Description of Exhibits\n3.1 Articles of Incorporation (California) (1)\n3.2 Restated Certificate of Incorporation (following the reincorporation of registrant in Delaware) (l)\n3.3 Bylaws of Registrant (California) (1)\n3.4 Bylaws of Registrant (following the reincorporation of Registrant in Delaware) (1)\n3.5 Amended and Restated Bylaws of Registrant (2)\n10.1 Agreement (relating to term loan facility of U.S. $15,000,000 dated January 26, 1989) among Registrant, The Mitsui Trust & Banking Co., Ltd., The Tokai Bank, Limited and Singapore International Merchant Bankers Limited and Amendments (1)\n10.4 Right of Participation Agreement dated March 1, 1990 between Registrant and Wearnes Technology (Private) Limited (1)\n10.7 Stock Option Letter dated January 5, 1987 between Registrant and David Kirkey and Amendments (1)\n10.9 Stock Option Letter dated November 28, 1989 between Registrant and Vic Sangveraphunsiri (1)\n10.11 Registrant's Flexible Stock Incentive Plan and related forms of Agreement (1)\n10.12 Form of Indemnification Agreement (1)\n10.13 Manufacturing Agreement dated as of October 22, 1985 between Registrant and Wearnes Technology (Private) Limited (1)\n10.14 Agreement dated September 14, 1989 between Registrant and Wearnes Technology (Private) Limited (1)\n10.16 Brand Name Distributor Reseller Purchase Agreement dated April 24, 1989 between Registrant and Gates\/FA Distributing (1) (3)\n10.17 Agreement dated October 1, 1988 between Registrant and International Business Machines Corporation (1) (3)\n10.18 Computer Technology License Agreement dated December 12, 1988 between Registrant and Phoenix Technologies Ltd. (1) (3)\n10.19 Amendment to Computer License Agreement dated as of May 5, 1989 between Registrant and Phoenix Technologies Ltd. (1) (3)\n10.20 Amendment to Computer Technology License Agreement dated as of November 9, 1989 between Registrant and Phoenix Technologies Ltd. (1) (3)\n10.21 OEM Distribution Agreement dated October 27, 1987 between Registrant and The Santa Cruz Operation, Inc. (1)\n10.22 Amendment to OEM Distribution Agreement dated October 27, 1987 between Registrant and The Santa Cruz Operation, Inc. (1)\n10.23 Amendment to OEM Distribution Agreement dated October 27, 1987 between Registrant and The Santa Cruz Operation, Inc. (1)\n10.24 Standard Form Lease dated April 27, 1988 between Registrant and Alton Technical Center, Ltd. (1)\n10.25 First Amendment to Standard Form Lease dated August 15, 1988 between Registrant and Alton Technical Center, Ltd. (1)\n10.26 Second Amendment to Standard Form Lease dated June 23, 1989 between Registrant and Alton Technical Center Holding Company, Ltd. (1)\n10.27 Standard Form Lease (Single Tenant) dated August 21, 1989 between Registrant and The Irvine Company (1)\n10.28 Registrant's Directors' Non-Qualified Stock Option Plan (2)\n10.33 ALR Reseller Terms and Agreement dated February 4, 1991 between Registrant and JWP Information Systems and Addendum thereto (4) (5)\n10.35 Loan and Security Agreement dated June 16, 1993, between Registrant and Heller Financial, Inc. (6)\n10.36 Third Amendment to Standard Form Lease dated March 31, 1994 between Registrant and Alton Technical Center Holding Company, Ltd. (8)\n10.37 First and Second Amendments to Standard Form Lease (Single Tenant) dated August 17, 1993 and April 15, 1994, respectively, between Registrant and The Irvine Company (8)\n10.38 First Amendment to Loan and Security Agreement dated August 7, 1995, between Registrant and Heller Financial, Inc. (9)\n11. Statement Regarding the Computation of Per Share Earnings.\n22.1 Subsidiaries of Registrant (7)\n23.1 Consent of KPMG Peat Marwick LLP\n24.1 Power of Attorney (Included on page 37.)\n(b) Reports on Form 8-K: None\n(1) Incorporated by reference to identically numbered exhibits filed in response to Item-16(a), \"Exhibits\", of Registrant's Registration Statement on Form S-1 (file No. 33-33907), which became effective on April 11, 1990.\n(2) Incorporated by reference to identically numbered exhibits filed in response to Item 14 of the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 1990 filed with the Securities and Exchange Commission on December 31, 1990.\n(3) Confidential treatment of certain portions of this agreement granted August 9, 1990.\n(4) Incorporated by reference to identically numbered exhibits filed in response to Item 14 of the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 1991 filed with the Securities and Exchange Commission on December 27, 1991.\n(5) Confidential treatment of certain portions of this agreement granted April 22, 1992.\n(6) Incorporated by reference to identically numbered exhibit filed in response to Item 6","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":"316770_1995.txt","cik":"316770","year":"1995","section_1":"ITEM 1. BUSINESS\nProvident Bancorp, Inc.\nProvident Bancorp, Inc. (\"Bancorp\") is a Cincinnati-based bank holding company formed in 1980, which operates throughout Ohio, northern Kentucky and southeastern Indiana. At December 31, 1995, Bancorp had total assets of $6.2 billion and total shareholders' equity of $433 million. Its lead bank, chartered in 1902, is The Provident Bank (\"Provident\"), a full-service commercial bank that operates primarily in the greater Cincinnati area.\nBancorp has expanded its business in recent years through acquisitions. In September 1995, Bancorp purchased Mathematical Investment Management, Inc., a mutual fund advisor, with $60 million in managed funds. In December 1993, Bancorp acquired Heritage Savings Bank (\"Heritage\"), an Ohio-chartered savings bank, located in the greater Cincinnati area, with total assets of $54 million. Heritage's deposits and branches were subsequently sold in August 1995. In 1992, Bancorp acquired, through conversion merger transactions, four mutual savings and loan associations (\"Mutuals\"), with combined total assets of $340 million. Two were located in Cincinnati while the other two were located in northern Kentucky. In 1991, Bancorp increased its market share in the Cincinnati area and entered the greater Dayton, Ohio market through the acquisition of Hunter Savings Association (\"Hunter\"), a Cincinnati-based savings association with $900 million in assets. Hunter was indirectly owned by American Financial Group (\"AFG\"), formerly known as American Financial Corporation. AFG and Bancorp are controlled by Carl H. Lindner and various members of his family and certain entities controlled by and\/or established for the benefit of such family members. Hunter was merged with Provident upon its acquisition. In 1990, Bancorp acquired its other banking subsidiary, The Provident Bank of Kentucky (\"Provident Kentucky\") through its acquisition of Northern Kentucky Trustcorp, Inc. (\"NKTI\").\nBancorp's banking subsidiaries have 71 branch offices: 56 in the greater Cincinnati area (which includes 9 in northern Kentucky), 12 in the greater Dayton area, 1 branch in Columbus, Ohio and 2 branches in Cleveland, Ohio. Bancorp's executive offices are located at One East Fourth Street, Cincinnati, Ohio 45202 and its telephone number is (513) 579-2000.\nBancorp offers a full range of financial services to its commercial and consumer customers. Focusing on customers in the local markets, served by its branch network, allows management to better monitor and control risk, target and develop new relationships, and expand existing relationships by providing additional services. During 1994 and continuing through the present, Bancorp also attracted new deposit customers located outside of its local market area to supplement its in-market retail deposit activity.\nAt December 31, 1995, approximately 63% of Bancorp's total loan portfolio was represented by commercial loans and 37% by consumer loans. Bancorp does not have a material exposure to foreign, energy or agricultural loans. At December 31, 1995, Bancorp maintained $60.2\nmillion in reserves for loan losses. Such reserves equaled 143% of its nonperforming loans and 1.23% of its total loan portfolio at that date.\nApproximately 9.9% of Bancorp's total loan portfolio at December 31, 1995, consisted of residential first mortgage loans, compared to approximately 4% prior to 1991. Bancorp intends to continue its traditional emphasis on commercial and consumer loans and, accordingly, expects that over time the percentage of its assets invested in residential mortgage loans will continue to decrease toward levels existing prior to its acquisition of Heritage, the Mutuals and Hunter.\nCommercial Banking. Central to Bancorp's long-term strategy is the concept of relationship banking with commercial customers that emphasizes attracting new small and middle market customers and cross- selling additional services to established customers. These services include cash management, loan, letter of credit, trade financing and corporate trust activities. Bancorp implements this strategy by attracting and retaining experienced banking officers and rewarding them for originating loans and cross-selling additional services. In addition, Bancorp's Corporate Finance Group specializes in the origination of regional and national corporate loan transactions that are consistent with the overall relationship lending strategy of Bancorp. Bancorp originates these transactions directly, or participates in transactions with other financial institutions. At December 31, 1995, the Corporate Finance Group's loan portfolio was $420 million. Bancorp and Provident Commercial Group, Inc. (\"Commercial Group\"), Provident's equipment finance group, originate equipment collateralized loans and equipment leases to corporate customers on a national basis. These transactions are sourced both directly and through intermediaries. At December 31, 1995, Bancorp's commercial lease and loan portfolio was approximately $285 million.\nConsumer Banking. Bancorp offers a full range of financial services to its consumer banking customers. The goal is to establish a full banking relationship with each customer. This is accomplished through Bancorp's variety of relationship accounts, deposit accounts providing pricing incentives and various levels of services and benefits depending on the needs of and balances maintained by the customer. These deposit accounts allow Bancorp to more effectively offer additional banking services such as credit cards, consumer and mortgage loans, home equity loans, auto loans and leases, retirement accounts and investment accounts. During 1994, Commercial Group initiated an automobile leasing program directed primarily at consumers. At December 31, 1995, the consumer automobile lease portfolio was approximately $334 million.\nOther Operations. Bancorp provides a variety of financial services, including a full range of trust, custodial, asset management, securities brokerage and mutual fund administration to its customers.\nAt December 31, 1995, Bancorp and its subsidiaries employed approximately 1,800 employees. This is comparable to approximately 1,700 full-time-equivalent employees.\nThe Provident Bank\nProvident, an Ohio banking corporation, had $5.9 billion in assets and approximately $4.1 billion in deposits at December 31, 1995. Ranked by total assets, Provident is currently the third largest bank based in Cincinnati. Provident is a member of the Federal Reserve System (\"Federal Reserve\") and its deposits are insured by the Federal Deposit Insurance Corporation (\"FDIC\").\nThe Provident Bank of Kentucky\nBancorp entered the northern Kentucky sector of the greater Cincinnati market in 1990 with the acquisition of Provident Kentucky. Provident Kentucky is a Kentucky chartered state bank with total assets of approximately $244 million and total deposits of $194 million at December 31, 1995. Provident Kentucky is a member of the Federal Reserve and its deposits are insured by the FDIC. Provident Kentucky has nine offices in Kentucky, five in Campbell County, two in Kenton County and two in Boone County.\nCompetition\nThe banking business is highly competitive. The banking subsidiaries of Bancorp compete actively with national and state banks, savings and loan associations, securities dealers, mortgage bankers, finance companies and other financial service entities.\nSupervision and Regulation\nBancorp is registered as a bank holding company, and is subject to the regulations of the Board of Governors of the Federal Reserve under the Bank Holding Company Act of 1956, as amended (\"BHCA\"). Bank holding companies are required to file periodic reports with and are subject to examinations by the Federal Reserve. Bancorp is prohibited by the BHCA from acquiring direct or indirect control of more than 5% of the outstanding shares of any class of voting stock, or substantially all of the assets of any bank or merging or consolidating with another bank holding company, without prior approval of the Federal Reserve. The BHCA, as amended, authorizes interstate bank acquisitions anywhere in the country, effective September 29, 1995 and interstate branching by acquisition and consolidation, effective June 1, 1997 in those states that have not opted out by that date. As of December 31, 1995, Ohio, Kentucky and Indiana have not opted out of interstate branching.\nAdditionally, Bancorp is prohibited by the BHCA from engaging in nonbanking activities, unless such activities are determined by the Federal Reserve to be closely related to banking. The BHCA does not place territorial restrictions on the activities of such nonbanking- related activities.\nThere are various legal and regulatory limits on the extent to which Bancorp's subsidiary banks may pay dividends or otherwise supply funds to Bancorp. In addition, federal and state regulatory agencies also have the authority to prevent a bank or bank holding company from paying a dividend or engaging in any other activity that, in the opinion of the agency, would constitute an unsafe or unsound practice. See ITEM 7 \"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Liquidity\" and Note O included in \"Notes to Consolidated Financial Statements\".\nVarious requirements and restrictions under federal and state laws regulate the operations of Bancorp's banking affiliates, requiring the maintenance of reserves against deposits, limiting the nature of loans and interest that may be charged thereon, restricting investments and other activities, and subjecting the banking affiliates to regulation and examination by the Federal Reserve or state banking authorities and the FDIC.\nThe Financial Institutions Reform, Recovery and Enforcement Act of 1989 (\"FIRREA\") provides that a holding company's controlled insured depository institutions can be held liable for any loss incurred by, or reasonably expected to be incurred by, the FDIC in connection with the default of an affiliated insured bank or savings association.\nThe Federal Deposit Insurance Corporation Improvement Act of 1991 (\"FDICIA\") covers a wide range of banking regulatory issues including: (i) the recapitalization of the Bank Insurance Fund; (ii) deposit insurance reform, including requiring the FDIC to establish a risk- based premium assessment system; (iii) substantial new examination, audit and reporting requirements on insured depository institutions and (iv) a number of other regulatory and supervisory matters. FDICIA requires federal bank regulatory authorities to take \"prompt corrective action\" with respect to bank organizations that do not meet minimum capital requirements. \"Undercapitalized\" bank organizations are subject to growth limitations and are required to submit a capital restoration plan. Additionally, under FDICIA, a bank holding company is required to guarantee the compliance of any insured depository institution subsidiary that may become \"undercapitalized\" (as defined in the statute).\nUnder FDICIA, a bank organization 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. Bancorp's subsidiary banks are not prohibited from accepting brokered deposits or offering interest rates on deposits higher than the prevailing rate in their markets. As of December 31, 1995, Bancorp's subsidiary banks had brokered deposits (as defined) of $752.3 million compared to $693.6 million as of December 31, 1994.\nThe monetary policies of regulatory authorities, including the Federal Reserve, have a significant effect on the operating results of banks and bank holding companies. The nature of future monetary policies and the effect of such policies on the future business and earnings of Bancorp and its subsidiaries cannot be predicted.\nProvident Securities and Investment Company, a Provident subsidiary, is licensed as a retail securities broker and is subject to regulation\nby the Securities and Exchange Commission (\"SEC\"), state securities authorities and the National Association of Securities Dealers, Inc. Provident Investment Advisors, Inc., a Bancorp subsidiary, is a registered investment advisor, subject to regulation by the SEC and state securities authorities.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nBancorp and certain of its subsidiaries lease their executive offices at One East Fourth Street, Cincinnati, Ohio and additional space at Three East Fourth Street, Cincinnati, Ohio under leases expiring in 2010 from a trust, for the benefit of a subsidiary of AFG. Provident also leases approximately 5,000 square feet of office space from Great American Insurance Company, a subsidiary of AFG. In addition, Provident rents approximately 81,000 square feet of office space in downtown Cincinnati. Provident owns five buildings in the Queensgate area of Cincinnati that contain approximately 192,000 square feet of which three buildings are used for offices, data processing and warehouse facilities and two buildings are leased to other parties. Provident owns twenty-five of its branch locations and leases thirty- seven. Bancorp owns a 3,000 square foot building in which Provident Kentucky's main office is located in Alexandria, Kentucky. Bancorp also owns the 9,000 square foot building in Cold Spring, Kentucky in which one of Provident Kentucky's branches is located. In addition to the two branches leased from Bancorp, Provident Kentucky owns two of its branch locations and leases five. For information concerning rental obligations see Note F included in \"Notes to Consolidated Financial Statements\" that are included in this report in Part II, Item 8.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nBancorp and its subsidiaries are not parties to any pending legal proceedings other than routine litigation incidental to their business, the results of which will not be material to Bancorp or its financial condition.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone in the fourth quarter.\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 National Market under the symbol \"PRBK\". The following table sets forth the high and low bid prices per share of Common Stock on the NASDAQ National Market for the periods shown. These bids represent quotations between dealers and do not include retail markups, markdowns or commissions and do not necessarily reflect actual transactions.\nAt February 29, 1996, there were approximately 4,000 holders of record of Bancorp's Common Stock.\nIn 1995 and 1994 Bancorp paid dividends on its Common Stock of $16.4 million and $14.7 million and on its Preferred Stock of $2.4 million and $3.0 million, respectively. Bancorp has indicated its intention to pay annual dividends of approximately 30% of recurring net earnings. Recurring net earnings is defined as net earnings excluding the net after-tax effect of certain amounts related to acquisitions, security gains or losses and changes in accounting principles. It is expected that in the next several years, Bancorp's revenues will consist principally of dividends paid to it by its subsidiaries and interest generated from lending and investing activities. A discussion of limitations and restrictions on the payment of dividends by subsidiaries to Bancorp is contained under ITEM 7 \"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Liquidity\" and Note O included in \"Notes to Consolidated Financial Statements\".\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following is a summary of selected financial data for Bancorp and subsidiaries for the five years ended December 31, 1995. The summary should be read in conjunction with the Financial Statements and Notes to Consolidated Financial Statements included under Item 8 \"FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\".\nAdditional financial data and a discussion of major variances in financial operations between the current reporting period and the previous two periods is included in Item 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThis discussion is presented in conjunction with and should be read with the audited consolidated financial statements. Average balances reported are based on daily calculations.\nGENERAL\nBancorp reported net earnings for 1995 of $71.9 million, an increase of $14.2 million (25%) over 1994 net earnings. Net interest income increased $20.7 million (11%) while the provision for loan losses increased $2.0 million (17%). Other income increased $20.5 million (56%) primarily due to increases in gains from the sales of loans, mortgage loan servicing rights and Heritage's deposits and branches. Other expense increased $19.5 million (16%) because of increases in compensation and other.\nAverage net loans increased by $723.5 million (20%) in 1995 compared to 1994. This increase consisted principally of growth in commercial and financial loans of $379.9 million (23%),consumer lease financing of $191.5 million (331%) and instalment loans of $83.1 million (10%). Asset quality was not as strong during 1995 as during 1994. The ratio of nonperforming assets to total assets was .77% and .20% as of December 31, 1995 and 1994, respectively. This compares to .76% for the average of the past five years. Net loan charge-offs as a percentage of average net loans was .13% in 1995 in contrast to .02% for 1994. For the past five years, the average has been .36%. The lower ratios experienced in 1995 and 1994 resulted primarily from the\nrecovery of approximately $12 million, which was recognized equally during 1995 and 1994, relating to one borrower which had been charged off in 1991.\nBancorp reported net earnings for 1994 of $57.7 million, which represented an increase of $6.4 million (12%) over 1993 net earnings. Net interest income increased $19.1 million (12%) while the provision for loan losses was unchanged. Other income decreased $2.2 million (6%) primarily due to the decline in gain on sale of loans. Other expenses increased $8.7 million (8%) primarily due to the increase in salary expense.\nAverage net loans in 1994 increased by $617.3 million (20%) over the prior year. The increase in commercial and financial loans of $289.7 million (21%), combined with a $188.9 million (28%) increase in instalment loans and a $57.9 million increase in consumer lease financing, were the primary reasons for the increase in average net loans. Asset quality improved in 1994, with nonperforming assets decreasing to .20% of total assets compared to .58% in 1993. Net loan charge-offs as a percentage of average net loans declined to .02% in 1994 compared to .24% in 1993.\nNET INTEREST INCOME\nNet interest income equals the difference between interest earned on loans and investments and interest incurred on deposits and other borrowed funds. Net interest income is affected by changes in both interest rates and the amounts of interest earning assets and interest bearing liabilities outstanding.\nNet interest income represents the principal source of income for Bancorp. In 1995, 1994 and 1993, net interest income on a taxable equivalent basis was $203.1 million, $182.3 million and $163.3 million, respectively, which represented approximately 78%, 83% and 81%, respectively, of the net revenues (net interest income plus other income) of Bancorp.\nNet interest margin represents net interest income as a percentage of total interest earning assets. For 1995, the net interest margin, on a fully taxable equivalent basis, was 3.86%, compared to 4.14% in 1994 and 4.41% in 1993. The decrease in net interest margin from 1994 to 1995 reflects the average rate paid on interest bearing liabilities, which increased 132 basis points, more than offsetting the increase on interest earning assets, which increased 93 basis points. The increase in the overall cost of interest bearing liabilities was primarily due to an increase in the average balance of time deposits along with higher interest rates paid on time deposits. The increase on interest earning assets was principally due to an increase in the average balance of commercial and financial loans along with higher rates received on commercial and financial loans and instalment loans. Bancorp enters into interest rate swap transactions to manage the impact of interest rate moves and interest rate risk. During 1995, interest rate swaps decreased the net interest margin by 11 basis points.\nThe decline in the net interest margin from 1993 to 1994 reflects the increase in the average rate paid on interest bearing liabilities, which increased 41 basis points, more than offsetting the increase of 12 basis points in the average rate earned on interest earning assets. Increases in the amount of time deposits and long-term debt was the primary reason for the increase in Bancorp's overall cost of interest bearing liabilities. Increases in the amount of commercial and financial and instalment loans combined with repricing of commercial and financial loans were the primary reasons for the increase in the average rate earned on interest earning assets. As interest rates increased during 1994, interest bearing liabilities reacted more quickly than interest earning assets, causing the net interest margin to decrease. During 1994, interest rate swaps increased the net interest margin by 14 basis points.\nTable 1 provides an analysis of net interest income and illustrates the interest income earned and interest expense charged for each major component of interest earning assets and interest bearing liabilities. The net interest spread is the difference between the average yield earned on assets and the average rate incurred on liabilities. For comparative purposes, the table has been adjusted to reflect tax- exempt income on a fully taxable equivalent basis assuming an income tax rate of 35%.\nTABLE 1: Net Interest Income, Average Balances and Rates\nInterest free funds (interest earning assets less interest bearing liabilities) increased $60.7 million (12%) in 1995 and increased $61.9 million (14%) in 1994. Such funds, consisting primarily of demand deposits and shareholders' equity, supported 11% of total interest earning assets in 1995, 11% in 1994 and 12% in 1993. In preparing the net interest margin table, nonaccrual loan balances are included in the average balances for loans. Loan fees are included in loan income as follows: 1995 - $18.2 million, 1994 - $15.4 million and 1993 - $16.5 million.\nTable 2 shows the changes in net interest income on a tax equivalent basis resulting from changes in volume and changes in rates. Changes not solely due to volume or rate have been allocated proportionately.\nTABLE 2: Net Interest Income Changes Due to Volume and Rates\nPROVISION FOR POSSIBLE LOAN LOSSES\nThe provision for possible loan losses was $14.0 million, $12.0 million, and $12.0 million in 1995, 1994 and 1993, respectively. The increase of $2.0 million (17%) in 1995 over 1994 is due to increases in total loans of $691.5 million (16%) and nonperfoming loans of $35.0 million. The provision for loan losses did not change from 1993 to 1994 despite an increase in total loans of $814.7 million (24%) due to the small amount of net charge-offs reducing the reserve for loan losses and the small number of nonperforming assets in 1994. The ratio of the loan loss reserve as a percentage of total loans has remained consistent. The ratio was 1.23% at year end 1995 compared to 1.24% at year end 1994 and 1.20% at year end 1993.\nOTHER INCOME\nTable 3 details the components of other income and their change since 1993:\nTABLE 3: Other Income\nOther income increased $20.5 million (56%) in 1995 compared to 1994. Service charges on deposit accounts increased due to higher rates on corporate deposit accounts, nonsufficient funds, and ATM fees. Other service charges and fees increased primarily due to a gain on the sale of mortgage loan servicing rights. The sale of equipment leases was the principal reason for the increase in gain on sale of loans. Other increased chiefly due to a gain from the sale of Heritage's deposits and branches.\nOther income decreased $2.2 million (6%) in 1994 primarily due to the decreases in gain on sale of loans and security gains. Service charges on deposit accounts increased primarily due to increased service charge income on corporate accounts and items returned due to insufficient funds. Other service charges and fees increased primarily due to increased credit card fee income. The decrease in gain on sale of loans was primarily due to a decrease in the amount of loans sold combined with the increase in interest rates in the residential mortgage markets. The increase in other was primarily due to an increase in miscellaneous income, more than offsetting the decline in trading account income.\nOTHER EXPENSES\nTable 4 details the components of other expenses and their change since 1993:\nTABLE 4: Other Expenses\nOther expenses increased $19.5 million (16%) for 1995 compared to 1994. Compensation increased as a result of merit and promotion increases, expenses related to the sale of Heritage's branches, and increased personnel in lending, telebanking and electronic delivery systems. Occupancy expense increased primarily due to increased rent expense from additional supermarket branches, ATMs and space for telebanking. Increased professional fees resulted from the Heritage transaction. The increase in equipment expense was primarily due to increased depreciation expense relating to Bancorp's data processing operations. Charges and fees increased due to costs associated with obtaining credit card applications. Increases in marketing, recruiting and insurance expense were the primary reasons for the increase in other.\nOther expenses increased $8.7 million (8%) for 1994 compared to 1993. Salaries increased as a result of merit and promotion increases, increases in incentives and increased personnel in the retail banking area. Occupancy expense increased primarily due to increased rent expense caused by an increase in the number of branch offices. Professional services increased due to an increase in management consulting fees. Increases in marketing expense and data processing expenses were the primary reasons for the increase in other.\nINCOME TAXES\nThe effective tax rates for 1995, 1994 and 1993 were approximately 32.9%, 34.1% and 35.4%, respectively. The decrease in the effective rate for 1995 reflects the reversal of tax-exempt negative goodwill associated with the sale of Heritage's deposits and branches and the increase in the level of tax-exempt interest income.\nCUMULATIVE EFFECT OF CHANGES IN ACCOUNTING PRINCIPLES\nBancorp adopted Statement of Financial Accounting Standards (\"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\", on January 1, 1995. Bancorp considers a nonperforming loan, except consumer loans, to be an impaired loan where it is probable that all amounts due will not be collected according to the contractual terms of the loan agreement. Bancorp measures the value of an impaired loan based on the present value of expected future cash flows discounted at the loan's effective interest rate or, if more practical, at the loan's observable market price, or the fair value of the collateral, if the loan is collateral dependent. The adoption of SFAS No. 114 and 118 had no material impact on Bancorp's financial condition or results of operations.\nDuring 1994, Bancorp changed its method of accounting for: (a) postemployment benefits, as prescribed in SFAS No. 112, \"Employers' Accounting for Postemployment Benefits\" and (b) securities, as prescribed in SFAS No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\".\nOn January 1, 1994, Bancorp adopted SFAS No. 112, which requires employers to recognize any obligation to provide postemployment benefits (salary continuation, severance benefits, outplacement services, etc.) by accruing the estimated liability through a charge\nto expense. The effect of this change in accounting principle had no material impact on Bancorp's consolidated financial position or results of operations.\nIn addition, as of January 1, 1994, Bancorp adopted SFAS No. 115 which addresses accounting and reporting for (1) investments in equity securities that have readily determinable fair values and (2) all investments in debt securities. It requires that these securities be classified in three categories as follows: Held to Maturity, Trading and Available for Sale. The only change in accounting treatment for these three categories is in regard to the Available for Sale securities where, under SFAS No. 115, these securities would be reported at their fair value, with unrealized holding gains and losses reported as a separate component of shareholders' equity.\nINVESTMENT SECURITIES AND SHORT-TERM INVESTMENTS\nAverage federal funds sold and reverse repurchase agreements decreased $24.7 million during 1995 and $24.0 million during 1994, as funds were shifted to asset categories with higher yields. The amount of federal funds sold changes daily as cash is managed to meet reserve requirements and customer needs. After funds have been allocated to meet lending and investment requirements, the remainder is placed in overnight federal funds.\nInvestment securities represented approximately 16% of average earning assets in 1995, 1994 and 1993. The amortized cost and market value of investment securities at the dates indicated are summarized in Table 5:\nTABLE 5: Investment Securities\nEffective January 1, 1994, Bancorp adopted SFAS No. 115. Securities classified as held to maturity are those securities that Bancorp has the intent and ability to hold to maturity, subject to continued credit worthiness of the issuer. Debt securities classified as available for sale are intended to be held for indefinite periods of time and include those securities that Bancorp may employ as part of its asset\/liability management strategy, or that may be sold in response to changes in interest rates, prepayments, regulatory capital requirements or similar factors.\nDuring the last 45 days of 1995, the Financial Accounting Standards Board, in conjunction with the adoption of a new implementation guide, allowed companies to transfer securities which had been previously classified as held to maturity to available for sale without forcing the company to revalue all securities in its held to maturity category. During this time period, Bancorp reclassified all of its\nheld to maturity securities to available for sale. Amortized cost of $247.4 million was transferred which resulted in an unrealized gain of $375,000.\nTable 6 shows the December 31, 1995, maturities and weighted average yields for investments in debt securities. A 35% tax rate was used in computing the tax equivalent yield adjustment. The yields shown are calculated based on original cost and effective yields weighted for the scheduled maturity of each security. Mortgage-backed securities are assigned to maturity categories based on their estimated average lives.\nTABLE 6: Investments in Debt Securities Yields and Maturities\nBancorp executes interest rate swaps to convert floating rate investment securities to a fixed rate. At December 31, 1995, Bancorp had $410 million in fixed receive swaps of which $60 million are callable by the counterparty. The interest rate swaps did not materially change the average weighted yield on the securities.\nLOANS\nAverage net loans were approximately 84% and 83% of total average earning assets in 1995 and 1994, respectively. Average net loans increased $723.5 million (20%) in 1995 over 1994. Increases in commercial and financial loans of $379.9 million (23%), consumer lease financing of $191.5 million (331%) and instalment loans of $83.1 million (10%) were the primary reasons for the increase in loans. The increase in average loan balances is a result of a continuing emphasis on lending activity. Bancorp did not offer consumer lease financing prior to 1994. Bancorp does not have a material exposure to foreign loans, energy loans or agricultural loans. Table 7 shows loans outstanding at period end by type of loan:\nTABLE 7: Loan Portfolio Composition\nTable 8 shows the composition of the commercial and financial loan category by industry type at December 31, 1995:\nTABLE 8: Commercial and Financial Loans\nTable 9 shows the composition of commercial mortgage and construction loans by loan and property type at December 31, 1995:\nTABLE 9: Commercial Mortgage and Construction Loans\nAt December 31, 1995 and 1994, the amount of first mortgage residential loans that were considered available for sale was immaterial.\nLoans outstanding at December 31, 1995, are presented in Table 10 by maturity, based on remaining scheduled repayments of principal:\nTABLE 10: Loan Maturities\nCREDIT RISK MANAGEMENT\nBancorp maintains a reserve for loan losses to absorb potential losses in its portfolio. Management's determination of the adequacy of the reserve is based on reviews of specific loans, loan loss experience, general economic conditions and other pertinent factors. If, as a result of charge-offs or increases in the risk characteristics of the loan portfolio, the reserve is below the level considered by management to be adequate to absorb possible future loan losses, the provision for loan losses is increased. Loans deemed uncollectible are charged off and deducted from the reserve and recoveries on loans previously charged off are added to the reserve.\nTable 11 shows selected information relating to Bancorp's loans and reserves for loan losses:\nTABLE 11: Reserve For Loan Losses\nNet charge-offs over the years have varied since loans are written off against the reserve when they are determined to be uncollectible. The increase in net charge-offs in 1995 is primarily due to increases in charge-offs of $2.7 million and $2.1 million in instalment and commercial and financial loans, respectively. The decrease in net charge-offs in 1994 is primarily due to a $6.6 million increase in commercial and financial loan recoveries. The high level of recoveries in 1995 and 1994 resulted from recoveries of $5.8 million and $5.9 million, respectively, of a commercial loan that was charged off in 1991.\nIn 1993, Provident and a commercial customer entered into an agreement in which Provident granted certain concessions on its loans and agreed not to exercise certain rights available to it under the loan documents. In return, the customer issued to Provident 346,718 shares of its common stock, representing 5% of its issued and outstanding common stock, and 74,659 shares of Series B non-voting convertible preferred stock that is convertible into 746,590 shares of its common\nstock. Although these shares were not registered under the Securities Act of 1933, Provident could require the registration by the customer. In 1995, Provident and the commercial customer amended the agreement whereby certain loan maturity dates were extended and additional funds were made available for future borrowing. In consideration, the customer removed certain restrictions from the selling of these shares and issued a stock warrant for the purchase of an additional 200,000 shares of common stock at the quoted market price as of the date the warrant was issued. As of the end of 1995, Provident had sold 225,000 shares of the common stock resulting in $3.5 million in proceeds of which $3.1 million were recorded as loan loss recoveries and $392,000 as interest income. The unsold common and preferred stock, along with the stock warrant is recorded at a nominal amount.\nTable 12 shows the dollar amount of the reserve for loan losses using management's estimate by principal loan category:\nTABLE 12: Allocation of Reserve For Loan Losses\nManagement considers the present allowance to be appropriate and adequate to cover losses inherent in the loan portfolio based on the current economic environment. However, future economic changes cannot be predicted at this time. Deterioration in economic conditions could result in an increase in the risk characteristics of the loan portfolio and an increase in the provision for possible loan losses.\nTable 13 presents a summary of various indicators of credit quality:\nTABLE 13: Credit Quality\nNonperforming assets increased $37.3 million during 1995. Nonaccrual loans increased $31.2 million during 1995, primarily due to four commercial and financial loans being placed on nonaccrual status. Renegotiated loans increased principally due to one commercial and financial loan being restructured. Other real estate and equipment owned increased primarily due to property on an operating lease being reclassified due to the bankruptcy of the lessee. Net losses of $80,000 were recorded from the sale of other real estate and equipment during 1995. As of the end of 1995, nonperforming assets as a percentage of total assets are at a level that is consistent with historical averages.\nNonperforming assets decreased $16.4 million during 1994. Nonaccrual loans decreased $11.5 million during 1994, primarily due to the decrease in nonaccrual commercial and financial loans. Nonaccrual commercial and financial loans decreased primarily due to two loans\nbeing brought current and removed from nonaccrual status. The decrease in other real estate owned was due primarily to the sale of commercial and residential properties. Approximately $7.5 million in sales of properties held as other real estate owned occurred during 1994, with approximately $120,000 of net gains recorded with regard to these property sales.\nWhen a loan is placed on nonaccrual status or is renegotiated, the recognition of interest income differs from what would have been recognized had the loan retained its original terms. The gross amount of interest income recognized during 1995 with respect to these loans was $540,000 compared to $2,640,000 that would have been recognized had the loans remained current in accordance with their original terms.\nOf the $37.5 million in nonaccrual loans at December 31, 1995, management estimates approximately $11.8 million of potential loss. The loss estimate is based, in part, upon information from Provident's credit watch and impaired loan lists (\"lists\"), and loss exposure reports. The lists are prepared quarterly following detailed discussions between lending officers, the credit and loan review departments and senior management. The lists include nonperforming loans along with loans that were classified by bank examiners. The lists also include loans where potential borrower problems may raise concern about the ability of the borrower to comply with the present loan repayment terms. These loans, while not nonperforming or necessarily expected to result in losses, are considered in need of closer monitoring. The loss exposure report is prepared monthly and updates loan balance information and loss estimates from the previous lists. The loss exposure report also includes other real estate owned balances and any possible loss exposure involving other real estate.\nLoans 90 days past due still accruing increased $21.9 million during 1995. One customer accounted for $16.9 million of this increase. Loans from this customer were not placed on nonaccrual due to being well secured and in the process of collection.\nThe year-end 1995 lists and loss exposure reports included approximately $27.9 million of loans that were current, but which due to the possible credit problems of such borrowers that were known by management or other factors, were considered to be in need of closer monitoring. Through an ongoing monitoring process, the value of the collateral securing these loans is analyzed each quarter to determine loss potential. A review of pertinent loan information, including borrower financial statements and collateral appraisals, determined that loans with an aggregate principal amount of approximately $17.9 million had some loss potential. The loss potential was estimated to be approximately $4.3 million. In determining this estimate, collateral values are carefully examined on an ongoing basis. Management considers the present reserve for loan losses of $60.2 million to be appropriate and adequate to cover the estimated losses in the loan portfolio.\nDEPOSITS\nAverage total interest bearing deposits increased 18% during 1995 to $3.6 billion after increasing 15% during 1994 to $3.0 billion. Increases in brokered deposits and other deposits raised through our telebanking program were the primary reasons for the increase in interest bearing deposits. For 1995 and 1994, average total interest\nbearing deposits represented 77% and 78%, respectively, of average interest bearing liabilities. Bancorp has no foreign deposits. Table 14 presents a summary of period end deposit balances:\nTABLE 14: Deposits\nAt December 31, 1995, the maturities of deposits of $100,000 or more are as follows (In Millions):\nIncluded in Certificates of Deposit (\"CD's\") of $100,000 or more at December 31, 1995, 1994 and 1993 are brokered deposits of $752 million, $694 million and $55 million, respectively.\nIn 1995, Bancorp began issuing brokered CD's with embedded call options combined with interest rate swaps with matching call dates as part of its CD program. Bancorp has the right to redeem the CD's on specific dates prior to their stated maturity while the interest rate swaps are callable at the option of the swap counterparty, rather than Bancorp. The terms and conditions of the call options embedded in the interest rate swaps match those of the CD's, offsetting any option risk exposure to Bancorp. At December 31, 1995, Bancorp had $221 million of callable CD's.\nBORROWED FUNDS\nBorrowed funds are an important source of funds to support earning assets. In 1995, average short-term debt increased $186.0 million (42%), while average long-term debt increased $58.1 million (15%). The increased use of federal funds purchased and repurchase agreements was the primary reason for the increase in average short-term debt in 1995. The increase in long-term debt is attributable to borrowings on Medium-Term Bank Notes of $312.5 million and advances from the Federal Home Loan Bank (\"FHLB\") of $150 million. The medium-term borrowings have stated fixed rates, however, they have been converted to variable one-month London Interbank Offered Rate (\"LIBOR\") funds through the use of interest rate swaps. The FHLB advances have a variable rate based on the one-month LIBOR rate. The proceeds from the additional debt became part of Provident's general funds for use in its business.\nIn 1994, average short-term debt decreased $34.4 million (7%), while average long-term debt increased $267.9 million (203%). The decrease in average balance for federal funds purchased and repurchase agreements, which more than offset the increase in commercial paper, was the primary reason for the decrease in average short-term debt in 1994. The issuance of subordinated notes and borrowings from the Federal Home Loan Bank were the primary reasons for the increase in average long-term debt in 1994. In January, 1994, Provident issued $100 million of 6.375% subordinated notes due in 2004. The proceeds from this debt issue became part of Provident's general funds.\nCAPITAL RESOURCES\nBank holding companies are required to comply with the Federal Reserve risk-based capital guidelines. At the end of 1995, the required minimum ratio of total risk-based capital to risk-weighted assets (including certain off-balance sheet activities, such as standby letters of credit) was 8%. At least half of the total capital is required to be Tier 1 capital. In addition to risk-based capital guidelines, the Federal Reserve requires a bank holding company to comply with a so-called \"Tier 1 Leverage Ratio\", under which the bank holding company must maintain a minimum level of Tier 1 capital to average total consolidated assets of at least 3%. All but the strongest companies and companies contemplating significant growth or expansion are expected to maintain a ratio of at least 1% to 2% above the stated minimum.\nTABLE 15: Capital Adequacy\nPursuant to the terms of its Series B Preferred Stock (\"B Preferred\"), Bancorp elected in the fourth quarter of 1994 to change the dividend rate to a rate equivalent to that paid on its Common Stock. Based on the actual common stock dividend rate, annual dividends paid on the Preferred Stock decreased by approximately $534,000 in 1995. In the third quarter of 1994 and 1995, Bancorp announced an increase in the quarterly common dividend from $.22 to $.25 per share and from $.25 to $.275 per share, respectively. In the third quarter of 1995, Bancorp exchanged all of the shares of its B Preferred for an identical number of shares of its Series C Convertible Preferred Stock (\"C Preferred\"). In the fourth quarter of 1995, Bancorp exchanged all of the shares of its C Preferred for an identical number of shares of its Series D Convertible Preferred Stock (\"D Preferred\"). The terms of the D Preferred are substantially identical to the B Preferred and C Preferred except that the terms of the D Preferred permit AFG, its subsidiaries or affiliates to convert the D Preferred into Bancorp common stock regardless of their percentage of ownership of Bancorp's voting equity securities. In December 1995, 301,146 shares of D Preferred were converted into 1,882,162 shares of Common Stock. As of\nDecember 31, 1995, 70,272 shares of D Preferred remains outstanding which is convertible into 439,200 shares of Common Stock.\nBancorp's capital expenditure program in recent years has included renovations to Bancorp's main office, improvements to the data processing center and additions to Provident's branch banking network. Capital expenditures for 1996 are estimated to be approximately $16 million and include improvements for Provident and Provident Kentucky in data processing capabilities and improvement of the branch banking network, with emphasis being placed on enhancing the branches located in local supermarkets and placement of additional ATMs. Bancorp also intends to expand and improve its telephone banking operations. Management believes that currently available funds and funds provided by normal operations will be sufficient to meet capital requirements.\nLIQUIDITY\nAdequate liquidity is necessary to meet the borrowing needs and deposit withdrawal requirements of customers as well as to satisfy liabilities, fund operations and support asset growth. Bancorp has a number of sources to provide for liquidity needs. First, liquidity needs can be met by the liquid assets on its balance sheet such as cash and deposits due from banks. Another source for providing liquidity is the generation of new deposits. Total deposits increased by 3% during 1995 to $4.2 billion. Bancorp may borrow both short-term and long-term funds. Bancorp obtained $462.2 million in long-term borrowings during 1995 and has an additional $137.5 million available for borrowing under a medium-term bank note program. Approximately $55.1 million of long-term debt is due to be repaid during 1996. Additional sources of liquidity include the sale of investment securities classified as available for sale and the sale of commercial and consumer loans.\nAlthough no significant capital expenditures are expected for Bancorp on a parent-only basis during 1995, Bancorp still has liquidity needs. Bancorp's primary liquidity need will be the payment of dividends to its preferred and common shareholders. The major source of liquidity for Bancorp is dividends paid to it by its subsidiaries. Bancorp received dividends of $23 million in 1995, $26 million in 1994 and $45.3 million in 1993 from its subsidiaries. The maximum amount available for dividends that may be paid in 1996 to its parent by Provident without approval is approximately $71.9 million, plus 1996 net earnings. Dividends of approximately $3.1 million plus 1996 net earnings may be paid in 1996 by Provident Kentucky. Management believes that amounts available from the banking subsidiaries will be sufficient to meet Bancorp's liquidity requirements in 1996. Under the Federal Deposit Insurance Corp. Improvement Act of 1991 (\"FDICIA\"), an insured depository institution, such as Bancorp's banking subsidiaries, would be prohibited from making capital distributions, including the payment of dividends, if, after making such distribution, the institution would become \"undercapitalized\" (as such term is defined in the statute). A discussion of restrictions on transfer of funds from subsidiaries to Bancorp is presented in Note O, included in \"Notes to Consolidated Financial Statements\".\nAdditional sources of liquidity to the parent include loan payments and sales of investment securities. At December 31, 1995, Bancorp had $130 million and $30 million in lines of credit with unaffiliated\nbanks to support commercial paper borrowings of $145 million and other general obligations, respectively. As of January 18, 1996, these lines had not been used.\nOFF-BALANCE SHEET FINANCIAL AGREEMENTS\nBancorp employs derivatives, such as interest rate swaps, interest rate caps, financial futures and forward contracts primarily to manage the interest rate risk inherent in Bancorp's core businesses.\nBancorp uses interest rate swaps as its primary off-balance sheet financial instrument. At December 31, 1995, approximately $1.8 billion in interest rate swaps held by Bancorp essentially convert a fixed rate of interest into a shorter repricing frequency. Approximately $1.36 billion are receive fixed pay variable swaps used to convert the interest rate sensitivity of long-term fixed rate deposit and debt liabilities to a floating interest rate based on LIBOR. Bancorp also employs $410 million of this type of swap in association with floating rate collateralized mortgage obligations (\"CMO's\") and asset backed securities to create a synthetic fixed rate investment portfolio with a reduced prepayment risk profile.\nInterest rate swaps in which Bancorp pays a fixed rate of interest in exchange for receiving a floating interest rate of LIBOR or prime rate are used to manage the interest rate risk associated with long-term fixed rate commercial and residential real estate mortgage loans. Bancorp had $33 million of pay fixed receive variable rate swaps at December 31, 1995.\nBancorp manages the credit risk in these transactions through its counterparty credit policy, which limits transacting business only with counterparties classified as investment grade by the rating agencies of Moody's and Standard & Poor's. Bancorp has in place in certain cases, but does not require, bilateral collateral agreements as a technique to reduce credit risk. These bilateral collateral agreements have threshold credit limits above which investment securities must be pledged as collateral for the mark-to-market. At December 31, 1995, Bancorp pledged investment securities with a carrying value of $21.4 million as collateral to two of its counterparties to cover the mark-to-market. As a second credit risk measure, Bancorp utilizes bilateral netting of interest payments. The frequency and timing of the interest payments are matched between counterparties, thereby reducing the credit exposure.\nGenerally, interest rate swaps are not amortizing in nature. At December 31, 1995, there were no past due amounts on any interest rate swap. Bancorp has never experienced a credit loss related to an off- balance sheet position, and does not reserve for credit losses on these transactions.\nThe following table shows the composition of interest rate swap agreements as of December 31, 1995:\nTABLE 16: Interest Rate Swap Agreement Maturities\nThe changes in interest rate swap agreements for the years ended December 31 were as follows:\nBancorp uses financial futures contracts and forward contracts to manage interest rate risk in a manner similar to interest rate swap agreements. At December 31, 1995, Bancorp had no outstanding positions in financial futures contracts or forward contracts.\nBancorp maintains a portfolio of interest rate caps sold to corporate customers at their request to manage the interest rate risk associated with their borrowings. Bancorp offsets the interest rate risk of customer cap transactions by purchasing an offsetting position in interest rate caps of matching terms. Bancorp executes these transactions as a customer convenience and does not consider itself to be a dealer in these financial instruments. At December 31, 1995, Bancorp's positions in matched customer interest rate caps was $57.5 million in notional principal amount.\nInterest rate swaps decreased the net interest margin by 11 basis points in 1995 and increased the net interest margin by 14 basis points and 40 basis points for 1994 and 1993, respectively.\nINTEREST RATE SENSITIVITY\nRecognizing that interest rate risk is inherent in its core business activities and understanding that fluctuating interest rates may cause volatility in its net interest income, Bancorp actively engages in the interest rate risk management process. At December 31, 1995, Bancorp's interest rate sensitivity position was within established guidelines.\nBancorp develops forecasts and assumptions as to deposit growth and mix, loan growth and mix, deposit and loan pricing spreads, early\nrepayment of assets and early redemption of liabilities. The resulting impact on net interest income is then evaluated, given potential changes in interest rate risk.\nBancorp actively manages and makes modifications to its balance sheet through product structuring, product pricing, and promotional offerings to achieve its targeted interest rate risk management objectives. If management believes additional modifications to Bancorp's sensitivities are warranted, off-balance sheet financial agreements such as interest rate swaps, interest rate caps and futures contracts are employed. At December 31, 1995, Bancorp had positions in interest rate swaps and interest rate caps and had no positions in futures contracts. A summary of the interest rate swap positions may be found in Note L in the \"Notes to Consolidated Financial Statements\".\nBancorp employs several analytical techniques in the assessment of interest rate risk, including gap analysis, simulation analysis, duration analysis, and market value of portfolio equity analysis. Bancorp relies most heavily on simulation analysis as it's primary analytical technique.\nBancorp simulates net interest income over a variety of interest rate scenarios including \"shock\" analysis of +\/- 100 basis points and +\/- 200 basis points. These shock scenarios assume an instantaneous and permanent change in the pricing of all interest rate sensitive assets and liabilities and do not give consideration to any management of the shock by Bancorp. As a result, these shock scenarios are considered worst case scenarios through which Bancorp can quantify its maximum exposures. Bancorp also simulates net interest income through a market driven forecast using forward yield curves implied by the financial futures markets. Bancorp develops most of its strategies and tactics using the forward yield curve as the base interest rate scenario.\nTable 17 provides a summary of Bancorp's gap analysis, which measures the difference between interest sensitive assets and liabilities repricing in the same time period. For this analysis, cash flow of assets and liabilities are segregated by their stated or forecasted repricing intervals. The forecasted repricing includes assumptions of early loan repayments, specifically in the areas of instalment and residential mortgage loan receivables. These prepayment assumptions are based on industry average prepayment rates for these loan products. Similarly, assumptions are made to the anticipated repricing and maturity characteristics of liability products with managed interest rates such as NOW and money market accounts. Adjustments are then made for the impact of off-balance sheet derivatives. Bancorp manages its gap through a targeted 12 month cumulative time horizon. At December 31, 1995, management assessed its gap position as a liability sensitivity of approximately 11% through the 12 month cumulative period. A liability sensitivity implies potential margin compression in a rising rate environment, and potential margin expansion in a falling rate environment.\nTABLE 17: Interest Rate Sensitivity\nIMPACT OF INFLATION AND CHANGING PRICES\nThe majority of assets and liabilities of a financial institution are monetary in nature and therefore differ greatly from capital intensive companies that have a significant investment in fixed assets or inventories. However, inflation does have an important impact in the banking industry. During periods of inflation, monetary assets lose value, while monetary liabilities gain value. This results in the need to increase equity capital at higher than normal rates in order to maintain an appropriate equity to assets ratio. Inflation can also have a significant effect on other expenses, which tend to rise during periods of general inflation. Inflation has not had a material effect on Bancorp in the recent past.\nBancorp's ability to react to changes in interest rates has a significant impact on financial results. As discussed previously, management attempts to increase or decrease interest rate sensitivity in order to protect against wide interest rate fluctuations.\nNEW ACCOUNTING STANDARDS\nBancorp will adopt SFAS No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of\" on January 1, 1996. This statement requires that long-lived assets be segregated into two categories, those to be held and used and those to be disposed of. Long-lived assets to be held and used are reviewed for impairment whenever circumstances indicate that the carrying value may not be recoverable. An impairment loss is recorded when the sum of the expected future cash flows is less than the carrying amount of the assets. In this situation, an impairment loss is recorded in the\namount of the difference between the carrying amount and the fair value of the asset. Assets to be disposed of that are subject to the reporting requirements of Accounting Principles Board (\"APB\") 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\" are to be measured at the lower of carrying amount or net realizable value. Long-lived assets to be disposed of that are not subject to APB Opinion No. 30 requirements are to be accounted for at the lower of carrying amount or fair value less cost to sell.\nSFAS No. 122, \"Accounting for Mortgage Servicing Rights\" will also be adopted by Bancorp on January 1, 1996. Under this statement, when mortgage loans are originated or purchased by an institution and subsequently sold or securitized with servicing retained, the cost of the loan shall be allocated between the loan (without servicing) and the fair value of the servicing. Prior to this statement, no costs of the loan were allocated to the servicing. Additionally, the statement specifies how mortgage servicing rights and excess servicing rights should be evaluated for impairment.\nManagement currently believes that neither the adoption of SFAS No. 121 nor SFAS No. 122 will have a material impact on Bancorp's consolidated financial position or results of operations.\nSFAS No. 123, \"Accounting for Stock-Based Compensation\" was issued in October, 1995. The statement defines a fair value-based method of accounting for stock-based employee compensation plans. It encourages all companies to adopt this method of accounting and measure compensation cost for stock-based awards, based on their estimated fair value on the date of grant, and recognize such cost over the service period. However, it also allows a company to continue to measure compensation costs for its plans as prescribed by APB Opinion No. 25, \"Accounting for Stock Issued to Employees.\" Companies electing to continue following present accounting rules under APB Opinion No. 25 will be required to provide pro-forma disclosures of what net earnings and earnings per share would have been had the new fair value method been used. At this time, management expects to continue its accounting in accordance with APB Opinion No. 25. The disclosure requirements of SFAS No. 123 will be adopted as required for financial statements beginning in 1996.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nReport of Ernst & Young LLP, Independent Auditors 32\nFinancial Statements:\nProvident Bancorp, Inc. and Subsidiaries Consolidated Balance Sheets 33 Consolidated Statements of Earnings 34 Consolidated Statements of Changes in Shareholders' Equity 35 Consolidated Statements of Cash Flows 36 Notes to Consolidated Financial Statements 37\nSupplementary Data:\nQuarterly Consolidated Results of Operations (unaudited) 57\nREPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS\nBoard of Directors Provident Bancorp, Inc.\nWe have audited the accompanying consolidated balance sheets of Provident Bancorp, Inc. and subsidiaries as of December 31, 1995, and 1994, and the related consolidated statements of earnings, changes in shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1995. These financial statements are the responsibility of the management of Provident Bancorp, Inc. 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 Provident Bancorp, Inc. and subsidiaries at December 31, 1995 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, 1995, in conformity with generally accepted accounting principles.\nAs discussed in Note B to the consolidated financial statements, Provident Bancorp, Inc. changed its method of accounting for certain investments in debt and equity securities in 1994.\nERNST & YOUNG LLP\nCincinnati, Ohio January 18, 1996\nSee notes to consolidated financial statements.\nSee notes to consolidated financial statements.\nSee notes to consolidated financial statements.\nSee notes to consolidated financial statements.\nPROVIDENT BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nA. ORGANIZATION Provident Bancorp, Inc (\"Bancorp\") was incorporated in February, 1980 for the purpose of acquiring and holding the common stock of The Provident Bank (\"Provident\") owned by American Financial Group (\"AFG\"), formerly known as American Financial Corporation. The acquisition of Provident in October, 1980 was accounted for as a pooling-of-interests.\nBancorp is Cincinnati-based and operates primarily throughout Ohio, northern Kentucky and southeastern Indiana. It owns two banking subsidiaries that provide financial services to it customers.\nB. ACCOUNTING POLICIES The following is a summary of significant accounting policies:\nBASIS OF PRESENTATION The consolidated financial statements include the accounts of Bancorp and its subsidiaries, all of which are wholly owned. Bancorp's investments in partnerships (included in \"Other Assets\") are carried at the lower of cost or net realizable value and are adjusted for changes in equity. Certain estimates are required to be made by management in the preparation of the consolidated financial statements. All significant intercompany balances and transactions have been eliminated. Certain reclassifications have been made to conform to the current year presentation.\nSTATEMENT OF CASH FLOWS For cash flow purposes, cash equivalents include amounts due from banks and federal funds sold and reverse repurchase agreements. Generally, federal funds sold and reverse repurchase agreements are purchased and sold for one-day periods.\nINVESTMENT SECURITIES Bancorp adopted Statement of Financial Accounting Standards (\"SFAS\") No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\", effective January 1, 1994. Securities classified as held to maturity are those securities that Bancorp has the intent and ability to hold to maturity, subject to continued credit worthiness of the issuer. Accordingly, these securities are stated at amortized cost.\nSecurities classified as available for sale are intended to be held for indefinite periods of time and include those securities that Bancorp may employ as part of asset\/liability management strategy or that may be sold in response to changes in interest rates, prepayments, regulatory capital requirements or similar factors. Certain interest rate swaps have been entered into that relate to securities classified as available for sale. These securities and interest rate swaps are stated at fair value with unrealized gains and losses excluded from earnings and reported as a separate component of shareholders' equity, net of taxes.\nSecurities purchased with the intention of recognizing short-term profits are placed in the trading account and are carried at market value. The specific identification method is the method used for determining gains and losses from securities transactions.\nLOANS Interest on loans is computed on the outstanding principal balance. The portion of loan fees which exceeds the direct costs to originate the loan is deferred and recognized as interest income over the actual lives of the related loans using the interest method. Any premium or discount applicable to specific loans purchased is amortized over the remaining lives of such loans using the interest method. Loans are generally placed on nonaccrual status when the payment of principal and\/or interest is past due 90 days or more. However, instalment loans are not placed on nonaccrual status because they are charged off when 120 days to 150 days past due. In addition, loans that are well secured and in the process of collection are not placed on nonaccrual status. When a loan is placed on nonaccrual status, any interest income previously recognized that has not been received is reversed. Future interest income is recorded only when a payment is received. Bancorp generally recognizes income on impaired loans on a cash basis.\nLOAN LOSS RESERVE The reserve for loan losses is maintained to absorb potential losses in the loan portfolio. Management's determination of the adequacy of the reserve is based on reviews of specific loans, loan loss experience, general economic conditions and other pertinent factors. The reserve is increased by charges to earnings, as provisions for possible loan losses. Loans deemed uncollectible are charged off and deducted from the reserve and recoveries on loans previously charged off are added to the reserve.\nBancorp adopted 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\", effective January 1, 1995. Bancorp considers a nonperforming loan, except consumer loans, to be an impaired loan where it is probable that all amounts due will not be collected according to the contractual terms of the loan agreement. Bancorp measures the value of an impaired loan based on the present value of expected future cash flows discounted at the loan's effective interest rate or, if more practical, at the loan's observable market price, or the fair value of the collateral if the loan is collateral dependent. The adoption of this statement had no material impact on Bancorp's consolidated financial condition or results of operations.\nLOAN SALES Bancorp classifies loans that are intended to be sold within a short period of time as available for sale. Such loans available for sale are carried at the lower of aggregate cost or market value. In 1995, Bancorp sold its rights to service residential loans for others. Prior to 1995, Bancorp generally retained the right to service residential loans that it sold. Gains and losses on loan sales are included in \"Other Income\". Such gains and losses are determined by the difference between the sale proceeds and the carrying value of loans sold. These gains and losses are adjusted, where appropriate, by the present value of the difference between estimated future net servicing revenues and normal servicing revenues and by any other item as provided for in the sales agreement. The resulting excess servicing fees are deferred and amortized as an adjustment to service fee income over the estimated life of the related loans using the interest method.\nLEASE OPERATIONS Unearned income on direct financing leases is amortized over the terms of the leases resulting in an approximate level rate of return on the net investment in the leases. Income from leveraged lease transactions is recognized using a method which yields a level rate of return in relation to Bancorp's net investment in the lease. The investment includes the sum of the aggregate rentals receivable and the estimated residual value of leased equipment less unearned income and third party debt on leveraged leases. Income from leases is included in \"Interest and Fees on Loans\".\nPREMISES AND EQUIPMENT Premises and equipment are stated at cost less depreciation and amortization that are computed principally on the straight-line method over the estimated useful lives of the assets.\nOTHER REAL ESTATE OWNED Real estate owned is recorded at the lower of cost or fair value and is included in \"Other Assets\". Bancorp's policy is to include in the cost of real estate owned the unpaid balance of applicable loans, costs of foreclosure, unpaid taxes and subsequent major repairs. However, in no case is the carrying value of real estate owned greater than net realizable value. Real estate taxes are capitalized on real estate held for development. Other costs are expensed as incurred.\nRESERVE FOR RETIREMENT OF CAPITAL SECURITIES The Capital Notes of Provident included in \"Long-Term Debt\" are designated as \"Capital Securities\" under Ohio law. In accordance with the terms of the Notes, Provident has classified a portion of its retained earnings as \"Reserve for Retirement of Capital Securities\" in amounts designed to replace the Notes with capital at the time those Notes are repaid.\nBENEFIT PLANS On January 1, 1994, Bancorp adopted SFAS No. 112, which requires employers to recognize any obligation to provide postemployment benefits (salary continuation, severance benefits, outplacement services, etc.) by accruing the estimated liability through a charge to expense. The effect of this change in accounting principle had no material impact on Bancorp's consolidated financial position or results of operations.\nBancorp has a Retirement Plan for the benefit of its employees. Included under this plan is an Employee Stock Ownership Plan (\"ESOP\"), an Employee Profit Sharing Plan (\"EPSP\") and a Personal Investment Election Plan (\"PIE Plan\"). Bancorp also maintains a Life and Health Plan for Retired Employees (\"LH Plan\"), an Employee Stock Purchase Plan (\"ESPP\"), stock option plans and a Deferred Compensation Plan.\nThe ESOP covers all employees who are qualified as to age and length of service. It is a trusteed plan with the entire cost borne by Bancorp. Bancorp's contributions are discretionary by the directors of Bancorp. The contributions made by Bancorp are charged against earnings in the year for which they are declared. Qualified employees having vested rights in the plan are entitled to benefit payments at age 60.\nThe PIE Plan, a tax deferred retirement plan, covers all employees who are qualified as to age and length of service. Employees who wish to participate in the PIE Plan may contribute from 1% to 8% of their pre- tax salaries (to a maximum prescribed by the Internal Revenue Service) to the plan as voluntary contributions. Bancorp will make a matching contribution equal to 25% of the pre-tax voluntary contributions made by the employees during the plan year. The contribution made by Bancorp is charged against earnings as the employees' contributions are made. Upon the effective date of participation the employee becomes 100% vested. Vested benefits will normally be distributed to the employee or his beneficiary upon death, retirement or termination.\nBancorp's LH Plan provides medical coverage as well as life insurance benefits to eligible retirees. The LH Plan is contributory until the retiree reaches age 62 after which time Bancorp pays the entire cost, however, Bancorp's responsibility for the payment of premiums is limited to a maximum of two times the monthly premium costs as of the effective date of the LH Plan. Monthly premiums exceeding the maximum amount payable by Bancorp shall be the responsibility of the retiree. Bancorp may amend or terminate the LH Plan at any time, without the consent of the retirees.\nThe ESPP provides eligible employees with an opportunity to purchase Bancorp's common stock through payroll deduction in an amount up to 10% of their compensation, at a price equal to eighty-five percent of the fair market price on either the first or the last business day of each calendar month, whichever is lower.\nIn 1994, shareholders approved increasing the total number of options available for grant under the 1988 Employee Stock Option Plan to 1,737,500 options. Bancorp's stock option plan authorizes the issuance of options to purchase common stock to officers and key employees. The options are to be granted, with exercise prices from 95% to 110% of market value, at date of grant. Options become exercisable beginning one year from date of grant generally at the rate of 20% per year. During 1992, the Advisory Directors' Stock Option Plan and Outside Directors' Stock Option Plan were approved. These plans authorized the issuance of 165,000 and 75,000 options, respectively. The terms of these options are comparable to the terms of the 1988 Stock Option Plan.\nIn 1993, shareholders approved the Deferred Compensation Plan (\"DCP\"). This plan permits participants to defer compensation in a manner that aligns their interests with those of Bancorp shareholders through the investment of deferred compensation in Bancorp common stock. The participants of this plan are selected by the Compensation Committee of the Board of Directors. The DCP allows participants to postpone the receipt of from 5% to 50% of compensation until retirement. Amounts deferred are invested in a Provident Stock Account or a Self-Directed Account. Bancorp will credit the Provident Stock Account with a percentage, dependent upon Bancorp's return on equity, of Bancorp's pre-tax earnings per share for each share of Bancorp Common Stock in the account during the first four years. Computation of the credit is made by dividing the pre-tax earnings by the average number of fully diluted shares outstanding for the year, adjusted by a return on equity multiplier which results in a credit of from 0% to 200% of the\npre-tax earnings per share, where a 15% return on equity is equal to a 100% multiplier. The calculated credit is charged against earnings by Bancorp annually. The participant may withdraw or transfer to a Self- Directed Account his account balance after a specifically stated period of time. Distributions are also made at the time of termination of employment and in the event of hardship. In addition to the amounts deferred by a participant in a Self-Directed Account, Bancorp will also contribute to the Self-Directed Account the amounts by which deferral of compensation under the DCP results in a reduction in the participant's share of contributions under Bancorp's Retirement Plan. Distributions are permitted prior to termination of employment in the event of hardship. When the participant retires or otherwise terminates employment with Bancorp, amounts deferred are distributed.\nINCOME TAXES Bancorp files a consolidated federal income tax return that includes all of its subsidiaries. Subsidiaries provide for income taxes on a separate-return basis and remit to Bancorp amounts determined to be currently payable.\nOFF-BALANCE SHEET FINANCIAL AGREEMENTS Bancorp employs derivatives such as interest rate swaps, interest rate caps, financial futures and forward contracts to manage the interest sensitivity of certain on- balance sheet assets and liabilities. The net interest income or expense on interest rate swaps is accrued and recognized as an adjustment to the interest income or expense of the associated on- balance sheet asset or liability. Realized gains and losses on interest rate swap transactions used to manage interest rate risk that are terminated prior to maturity are deferred and amortized as a yield adjustment over the remaining original life of the agreement. Deferred gains and losses are recorded in \"Other Assets\" and \"Other Liabilities\", as applicable. At December 31, 1995, these unamortized amounts were immaterial. Futures and forwards are also used to manage exposure to changes in interest rates. Realized gains and losses on futures and forward contracts used for risk management are deferred. These deferred items are either amortized to interest income or expensed over the life of the assets and liabilities they are associated with, or are recognized as a component of income in the period of disposition of the assets and liabilities.\nEARNINGS PER COMMON SHARE Net earnings per common share are computed by dividing net earnings, less the dividend requirement on preferred stock, by the weighted average number of common stock equivalents outstanding during the year. Fully diluted net earnings per common share are computed by dividing net earnings by the weighted average number of common stock equivalents, including the additional common stock outstanding as a result of the assumed conversion of the Series B and D Preferred Stock as of the first day of the year for which earnings per share data is shown.\nC. INVESTMENT SECURITIES The amortized cost and estimated market values of securities at December 31 were as follows:\nInvestment securities with a carrying value of approximately $562.9 million and $533.3 million at December 31, 1995, and 1994, respectively, were pledged as collateral to secure public and trust deposits, repurchase agreements, Federal Home Loan Bank (\"FHLB\") advances, interest rate swap agreements and for other purposes.\nIn 1995, 1994 and 1993 gross gains of $18,000, $- and $1,028,000 and gross losses of $104,000, $- and $94,000, respectively, were realized on the sale of securities Available for Sale. In 1995, FHLB stock, classified as Held to Maturity, was sold. Bancorp was no longer required to hold the stock due to the sale of Heritage's deposits. The stock was sold at its cost basis of $416,000 resulting in no gain or loss. No other sales of securities classified as Held to Maturity occurred in 1995, 1994 or 1993.\nDuring December, 1995, Bancorp reallocated securities that had been identified as Held to Maturity to the classification Available for Sale. The Financial Accounting Standards Board, in its special report,\nA Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities, which was issued on November 15, 1995, permitted this one time reallocation. On the date of transfer, these securities had an amortized cost of $247.4 million and an unrealized gain of $375,000. The transfer was made to allow for greater flexibility in the future use of these securities. No other transfers were made among the security categories of Held to Maturity, Available for Sale and Trading categories during 1995, 1994 and 1993.\nThe amortized cost and estimated market value of securities at December 31, 1995, are shown below by contractual maturity. 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.\nD. LEASE FINANCING In 1994, Bancorp initiated a consumer automobile leasing program. Prior to this, the leasing operations consisted principally of the leasing of various types of aircraft, transportation containers and locomotives, and miscellaneous equipment. Except for six aircraft leases and one coal conveyor lease which were classified as leveraged leases, almost all of the leases are classified as direct financing leases, with expiration dates over the next 1 to 8 years. Rentals receivable at December 31, 1995 and 1994 include $12.6 million and $9.1 million, respectively, for leveraged leases which is net of principal and interest on the nonrecourse debt. The residual values on the leveraged leases that were entered into are estimated to be approximately $37.8 million and $23.9 million in total at December 31, 1995 and 1994, respectively. The components of the net investment in lease financing at December 31 were as follows:\nThe following is a schedule by year of future minimum lease payments to be received for the next five years as of December 31, 1995:\nE. RESERVE FOR LOAN LOSSES The changes in the loan loss reserve for the years ended December 31 were as follows:\nAt December 31, 1995 impaired loans totaled $36.8 million. Of that amount, $33.1 million of impaired loans had related reserves of $12.8 million. An additional $3.7 million of impaired loans were determined to be carried at or below fair value of the underlying collateral and, accordingly, had no reserves. The valuation allowance recorded on impaired loans is included in the reserve for loan losses. During 1995, the average balance of impaired loans was $7.8 million which resulted in an immaterial amount of related interest income.\nLoans on nonaccrual status at December 31, 1995, 1994 and 1993 were $37.5 million, $6.3 million and $17.8 million, respectively. Loans renegotiated to provide a reduction or deferral of interest or principal were $4.8 million, $961,000 and $408,000 at December 31, 1995, 1994 and 1993, respectively.\nF. PREMISES AND EQUIPMENT Following is a summary of premises and equipment at December 31:\nThe future gross minimum rentals under noncancelable leases for the rental of premises and equipment for 1996 and subsequent years are as follows:\nRent expense for all bank premises and equipment leases was $5,692,000, $4,329,000 and $3,507,000 in 1995, 1994 and 1993, respectively.\nG. SHORT-TERM DEBT Short-term debt was as follows at December 31:\nAt December 31, 1995, Bancorp had $130 million in lines of credit with unaffiliated banks to support commercial paper borrowings. As of January 18, 1996, these lines had not been used.\nH. LONG-TERM DEBT Long-term debt consisted of the following at December 31:\nProvident has a $500 million Medium-Term Bank Notes program. These notes can be issued with either fixed or floating rates, are unsecured and are unsubordinated general obligations of Provident. These notes do not qualify as Tier 2 capital and are not insured by the FDIC. Provident borrowed $312.5 million (less underwriting discount) and $10 million during 1995 and 1994, respectively. At December 31, 1995, $137.5 million was available under this program.\nOf the $312.5 million issued under the Medium-Term Bank Notes program, Bancorp issued $12.5 million with a callable debt structure. The notes have a final maturity of 2005, but have a call option exercisable by Bancorp in 2000. These notes are hedged with an interest rate swap with a call option, exercisable by the swap counterparty, which matches that of the notes, which was executed to reduce Bancorp's overall funding cost and to modify the interest rate sensitivity of the notes. Under the terms of this transaction, if the swap counterparty exercises the call option on the interest rate swap in 2000, Bancorp may, at its discretion, exercise its call option to redeem the notes at the same time, or if the market offers a similarly\nattractive funding cost, Bancorp may execute another interest rate swap to hedge the notes for the remaining five years to maturity. Because the terms of the call options are matching, any options risk to Bancorp has been neutralized.\nThe notes payable to the FHLB are collateralized under a blanket agreement by investment securities and residential loans receivable with a book value of $360.2 million. They are subordinated to the claims of depositors and other creditors of Provident and are not insured by the FDIC.\nThe 6.38% Subordinated Notes, which qualify as Tier 2 capital, were issued through an underwritten offering in January, 1994 by Provident. They are subordinated to the claims of depositors and other creditors of Provident and are not insured by the FDIC. The 7.13% Subordinated Notes, which also qualify as Tier 2 capital, were issued in March 1993 by Provident. The 9% Fixed Rate Capital Notes are designated as \"Capital Securities\" under Ohio law and, in accordance with the terms of the Notes, Provident classifies a portion of its undivided profits as \"Reserve for Retirement of Capital Securities\".\nAs of December 31, 1995, scheduled principal payments on long-term debt for the following five years were as follows:\nI. INCOME TAXES Following is a reconciliation of income taxes at the statutory rate of 35% as shown in the Consolidated Statements of Earnings:\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 Bancorp's deferred tax liabilities and assets as of December 31 are as follows:\nAt December 31, 1995, approximately $11.5 million of excess bad debt reserve associated with prior acquisitions of savings and loans remains to be amortized to taxable income. Approximately $7.9 million will be added to taxable income in 1996.\nJ. BENEFIT PLANS In 1995, 1994 and 1993 Bancorp contributed $3,274,000, $2,825,000, and $3,194,000, respectively, to the ESOP.\nUnder the three stock option plans, stock options issued to date are generally exercisable at a rate of 20% per year. The following table summarizes option activity for the three years ended December 31, 1995:\nUnder the DCP Bancorp makes an annual contribution to the plan relating to the earnings credit. In 1995 and 1994, Bancorp expensed approximately $995,000 and $400,000, respectively.\nK. PREFERRED STOCK In 1991, Bancorp issued 371,418 shares of series B Non-Voting Convertible Preferred Stock (\"B Preferred) to AFG as partial consideration for the acquisition of Hunter Savings Association. Pursuant to the terms of the B Preferred, Bancorp, during the fourth quarter of 1994, elected to change the dividend rate from $8.00 per share to a rate equivalent to that paid on its Common Stock.\nIn 1995, Bancorp exchanged the B Preferred for an identical number of Series C Preferred Stock (\"C Preferred\") and later exchanged the C Preferred for the same number of Series D Preferred Stock (\"D Preferred\"). The terms of the D Preferred are substantially identical to the B Preferred except that the terms of the D Preferred permit AFG, its subsidiaries or affiliates to convert the D Preferred into Bancorp Common Stock regardless of their percentage of ownership of Bancorp's voting equity securities. In December 1995, 301,146 shares of the D Preferred were converted into 1,882,162 shares of Common Stock. As of December 31, 1995, 70,272 shares of D Preferred remain outstanding. These shares have a stated value and liquidation value of $100 per share and a conversion ratio of 6.25 shares of Bancorp's Common Stock for each share of convertible preferred stock.\nL. OFF-BALANCE SHEET FINANCIAL AGREEMENTS Bancorp uses financial instruments with off-balance sheet risk to manage its interest rate risk and to meet the financing needs of its customers. These financial instruments include derivatives such as interest rate swaps and caps along with commitments to extend credit and standby letters of credit. These instruments may involve credit and interest rate risk in excess of the amount recognized in the consolidated balance sheet.\nInterest rate swap agreements involve the exchange of interest payment obligations without the exchange of the underlying principal amounts. Such interest rate swap transactions, which are a part of Bancorp's asset\/liability management program, are structured to modify interest rate risk of specified assets and\/or liabilities resulting from interest rate fluctuations. Interest rate swap agreements have a credit risk component based on the ability of a counterparty to meet the obligations to Bancorp under the terms of the interest rate swap agreement. Notional principal amounts express the volume of the transactions, but Bancorp's potential exposure to credit risk is limited only to the flow of interest payments. Bancorp manages its credit risk in these transactions through counterparty credit policies. At December 31, 1995, Bancorp had bilateral collateral agreements in place with certain of its counterparties, against which Bancorp has pledged investment securities with a carrying value of $21.4 million as collateral.\nSummary information with respect to the interest rate swap portfolio used to manage Bancorp's interest rate sensitivity follows:\nThe expected notional maturities of Bancorp's interest rate swap portfolio at December 31, 1995 are as follows:\nSince many of the commitments to extend credit are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Bancorp evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained if deemed necessary by Bancorp upon extension of credit is based on management's credit evaluation of the counter- party. Collateral held varies but may include accounts receivable, inventory, property, plant, and equipment, and income-producing commercial properties.\nStandby letters of credit are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing, and similar transactions. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Collateral is obtained based on management's credit assessment of the customer.\nBancorp's commitments to extend credit which are not reflected in the balance sheet at December 31 are as follows:\nM. TRANSACTIONS WITH AFFILIATES AFG and Bancorp are controlled by Carl H. Lindner and various members of his family. Mr. Lindner and his family and trusts for the benefit of his family own approximately 46% of the Common Stock of Bancorp. In addition, subsidiaries of AFG own approximately 14% of the Common Stock of Bancorp and 100% of Bancorp's Series D Convertible Preferred Stock. Bancorp leases its home office space and other office space from a trust, for the benefit of a subsidiary of AFG. During 1995, the lease agreements were rewritten and extended to the year 2010, with Bancorp receiving $1.2 million which represented the net present value of the difference between payments of the old and current lease agreements. Bancorp is amortizing the amount received against rent expense until September 1997, which was the expiration of the old lease agreements. Bancorp also leased one of its branch locations and seventy ATM locations from principal shareholders and their affiliates. Rentals paid to AFG and affiliates for the years ended December 31, 1995, 1994 and 1993 amounted to $1,397,000, $1,233,000 and $1,133,000, respectively. Rentals of $306,000 were paid to principal shareholders and their affiliates during 1995 for branch and ATM locations.\nIn the fourth quarter of 1992, Bancorp began to offer shares of The Riverfront Funds, Inc. (\"Riverfront\"), a proprietary family of mutual funds, to customers. Riverfront is a registered investment company with five portfolios, each having a different investment objective. Provident manages the portfolios and performs other related services, such as shareholder services and acting as transfer agent and custodian. Riverfront is offered to customers of Provident, including personal trust, employee benefit, agency and custodial clients, as well as individual investors. At December 31, 1995, Riverfront had\ntotal assets of $316.5 million. Approximately $34.9 million of the amount was held by Bancorp and $136.9 million was held by Provident's trust department. During 1995, 1994 and 1993, Bancorp recorded approximately $1,020,000, $500,000 and $180,000 of income, respectively, from management fees of Riverfront. Bancorp also absorbed approximately $73,000, $103,000 and $304,000 of expense associated with managing the portfolios during 1995, 1994 and 1993, respectively.\nBancorp has had certain transactions with various executive officers, directors and principal holders of equity securities of Bancorp and its subsidiaries and entities in which these individuals are principal owners. Various loans and auto leases have been made as well as the sale of commercial paper and repurchase agreements to these persons. Such loans to these persons aggregated approximately $28.8 million and $27.2 million at December 31, 1995, and 1994, respectively. None of these loans were held by the parent company. During 1995, new loans aggregating $18.0 million were made to such parties and loans aggregating $16.4 million were repaid. All of the loans were made at market interest rates and, in the opinion of management, all amounts are fully collectible. At December 31, 1995, and 1994, Bancorp's commercial paper amounting to $6.0 million and $3.7 million, respectively, was held by these persons. Additionally, repurchase agreements in the amount of $6.5 million and $6.6 million had been sold to these persons at December 31, 1995, and 1994, respectively. All of these transactions were at market interest rates.\nN. FAIR VALUE OF FINANCIAL INSTRUMENTS Carrying values and estimated fair values for certain financial instruments as of December 31 are shown in the following table. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Because no secondary market exists for many of Bancorp's assets and liabilities, the derived fair values are calculated estimates, and the fair values provided herein do not necessarily represent the actual values which may be realized in the disposition of these instruments. The aggregate fair value amounts presented do not represent the underlying value of Bancorp. What is presented below is a point-in-time valuation which is affected, in part, by unrealized gains and losses resulting from management's implementation of its program to manage overall interest rate risk. It is not management's intention to immediately dispose of a significant portion of its financial instruments. As a result, the following fair value information should not be interpreted as a forecast of future earnings and cash flows.\nThe following methods and assumptions were used by Bancorp in estimating its fair value disclosures for financial instruments:\nCash and cash equivalents: The carrying amounts reported in the balance sheet for cash and short-term instruments approximate those assets' fair values.\nInvestment securities (including mortgage-backed securities): Fair values for investment securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments.\nTrading account assets: Fair values for Bancorp's trading account assets, which also are the amounts recognized in the balance sheet, are based on quoted market prices where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments.\nLoans receivable: For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. The fair values for certain residential mortgage loans and other consumer loans are based on quoted market prices of similar loans sold in conjunction with securitization transactions, adjusted for differences in loan characteristics. The fair values for other loans (e.g., commercial real estate, commercial and financial loans, construction loans, and other business\nloans) are estimated using discounted cash flow analyses, using interest rates currently being offered for loans, with similar terms to borrowers of similar credit quality.\nOff-balance sheet financial instruments: The amounts shown under carrying value represent fees receivable arising from the related unrecognized financial instruments. Fair values for Bancorp's lending commitments and standby letters of credit are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties' credit standing. Fair value for interest rate swaps is based upon current market quotes.\nDeposit liabilities: The fair values disclosed for demand deposits (e.g., interest and noninterest checking, passbook savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). The carrying amounts for variable-rate, fixed-term money market accounts and certificates of deposit approximate their fair values at the reporting date. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.\nShort-term debt: The carrying amounts of federal funds purchased, borrowings under repurchase agreements, and other short-term borrowings approximate their fair values.\nLong-term debt: The fair values of Bancorp's long-term borrowings that are traded in the markets are calculated using their market prices. The fair values of Bancorp's other long-term borrowings (other than deposits) are estimated using discounted cash flow analyses, based on Bancorp's current incremental borrowing rates for similar types of borrowing arrangements.\nO. ADDITIONAL INFORMATION\nRESTRICTIONS ON CASH AND NONINTEREST BEARING DEPOSITS Federal Reserve Board regulations require that Provident and Provident Kentucky maintain certain minimum reserve balances. The average amount of those reserve balances for the year ended December 31, 1995, was approximately $49.6 million.\nINVESTMENT IN PARTNERSHIPS Bancorp's share of partnerships was carried at approximately $12.6 million and $11.0 million at December 31, 1995, and 1994, respectively, which includes equity in net earnings (losses) of $601,000, $(344,000) and $106,000 in the years 1995, 1994 and 1993, respectively.\nOTHER REAL ESTATE OWNED At December 31, 1995, and 1994, the carrying value of other real estate and equipment owned was $5.6 million and $3.3 million, respectively.\nPARENT COMPANY FINANCIAL INFORMATION Parent Company only condensed financial information for Provident Bancorp, Inc. is as follows:\nRESTRICTIONS ON TRANSFER OF FUNDS FROM SUBSIDIARIES TO PARENT The transfer of funds by the banking subsidiaries to the parent as dividends, loans or advances is subject to various laws and regulations that limit the amount of such transfers that can be made without regulatory approval. The maximum amount available for dividend distribution that may be paid in 1996 by Provident to its parent without approval is approximately $71.9 million, plus 1996 net earnings. Dividends of approximately $3.1 million plus 1996 net earnings may be paid in 1996 by Provident Kentucky to its parent. Pursuant to Federal Reserve and State regulations, the maximum amount available to be loaned to affiliates (as defined), including their Parent, by the banking subsidiaries, was approximately $43.8 million to any single affiliate, and $89.3 million to all affiliates combined of which $28.1 million was loaned at December 31, 1995.\nSUPPLEMENTARY DATA\nQuarterly Consolidated Results of Operations - (Unaudited)\nThe following are quarterly consolidated results of operations for the two years ended December 31, 1995.\nQuarterly earnings per share numbers do not add to the year-to-date amount due to rounding.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone\nPART III\nThe following items are incorporated by reference to Bancorp's definitive proxy statement to be filed with the Commission pursuant to Regulation 14A within 120 days after the close of Bancorp's fiscal year ending December 31, 1995:\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\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORT ON FORM 8-K\n(a) 1. See Index to Financial Statements on page 31 for a list of all financial statements filed as a part of this report.\n2. Schedules to the consolidated financial statements required by Article 9 of Regulation S-X have been omitted as they are not required, not applicable or the information required thereby is set forth in the related financial statements.\n3. Exhibits:\nNumber Exhibit Description Filing Status\n3.1 Articles of Incorporation Incorporation by reference to Form 10-Q, Quarterly Report of Provident Bancorp, Inc. for the quarter ended September 30, 1995.\n3.2 Amendment to Articles of Filed herewith. Incorporation relating to the Series D, Non-Voting Convertible Preferred Stock\n3.3 Amended Code of Regulations Incorporated by reference to Annex I to Provident Bancorp, Inc.'s Proxy Statement for the 1994 Annual Meeting of Shareholders.\nNumber Exhibit Description Filing Status\n4.1 Instruments defining the Bancorp has no outstanding rights of security holders issue of indebtedness exceeding 10% of the assets of Bancorp and Consolidated Subsidiaries. A copy of the instruments defining the rights of security holders will be furnished to the Commission upon request.\n4.2 Plan of Reorganization Filed herewith. relating to Series D, Non-Voting Convertible Preferred Stock\n10.1 Restated Agreement and Plan Incorporated by reference to of Reorganization, as Form S-2 (File No. 33-44641). amended through May 8, 1992, between Provident Bancorp, Inc. and Merit Savings Association\n10.2 Restated Agreement and Plan Incorporated by reference to of Reorganization, as Form S-2 (File No. 33-44641). amended through May 11, 1992, between Provident Bancorp, Inc. and Peoples Federal Savings Association of Bellevue\n10.3 Third Restated Agreement Incorporated by reference to and Plan of Reorganization, Form S-2 (File No. 33-44641). as amended through April 30, 1992, between Provident Bancorp, Inc. and Suburban Federal Savings and Loan Association of Covington\n10.4 Agreement and Plan of Incorporated by reference to Reorganization between Form S-3 (File No. 33-69666). Provident Bancorp, Inc. and Heritage Savings Bank\n10.5 Second Restated Agreement Incorporated by reference to and Plan of Reorganization, Form S-2 (File No. 33-44641). as amended through May 6, 1992, between Provident Bancorp, Inc. and Thrift Savings and Loan Company\nNumber Exhibit Description Filing Status\nManagement Compensatory Agreements\n10.6 Provident Bancorp, Inc. Incorporated by reference to 1990 Employee Stock Post-Effective Amendment No. Purchase Plan 1 to Form S-8 (File No. 33-34904).\n10.7 Provident Bancorp, Inc. Incorporated by reference to Retirement Plan (As amended) Form S-8 (File No. 33-90792).\n10.8 Provident Bancorp, Inc. Incorporated by reference to 1988 Stock Option Plan (As Form S-8 (File No. 33-34906), amended) Form S-8 (File No. 33-43102) and Form S-8 (File No. 33-84094).\n10.9 Provident Bancorp, Inc. Incorporated by reference to 1992 Advisory Directors' Form 8-K filed October 22, Stock Option Plan (As 1992, and Form S-8 (File No. amended) 33-62707).\n10.10 Provident Bancorp, Inc. Incorporated by reference to 1992 Outside Directors' Form S-8 (File No. 33-51230). Stock Option Plan\n10.11 Provident Bancorp, Inc. Incorporated by reference to Restricted Stock Plan Form S-2 (File No. 33-44641).\n10.12 Provident Bancorp, Inc. Incorporated by reference to Deferred Compensation Plan Form S-8 (File No. 33-61576) and Form 8-K filed March 28, 1995.\n21 Subsidiaries of Provident Filed herewith. Bancorp, Inc.\n23 Consent of Independent Filed herewith. Auditors\n27 Financial Data Schedule Filed herewith.\n(b) Reports on Form 8-K:\nNo reports on Form 8-K were filed by Bancorp during the fourth quarter of 1995.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, Provident Bancorp, Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nProvident Bancorp, Inc.\n\/s\/Allen L. Davis\nAllen L. Davis President March 25, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of Provident Bancorp, Inc. and in the capacities and on the dates indicated.\nSignature Capacity Date\n\/s\/Allen L. Davis Director and President March 25, 1996 Allen L. Davis (Principal Executive Officer)\n\/s\/Philip R. Myers Director March 25, 1996 Philip R. Myers\n\/s\/Sidney A. Peerless Director March 25, 1996 Sidney A. Peerless\n\/s\/Joseph A. Pedoto Director March 25, 1996 Joseph A. Pedoto\n\/s\/John R. Farrenkopf Vice President and March 25, 1996 John R. Farrenkopf Chief Financial and Accounting Officer (Principal Financial Officer and Principal Accounting Officer)","section_15":""}
{"filename":"711425_1995.txt","cik":"711425","year":"1995","section_1":"Item 1. BUSINESS --------\nGeneral -------\nGalileo Electro-Optics Corporation (the \"Company\") was incorporated in Delaware in 1973 as the successor to a business which was founded in 1959.\nSince its formation in 1973, the Company has been engaged in developing, manufacturing and marketing fiberoptic and electro-optic components which transmit, sense or intensify light or images and a variety of components for office copiers. In fiscal year 1995, the Company's products were sold primarily to original equipment manufacturers (OEMs) for use in electronic imaging, scientific, analytical, office products and medical applications (approximately 95% of sales) and in military night vision devices (approximately 5% of sales). The Company's capabilities in the formulation of specialty glass and experience in fiberoptic and electro-optic technology are fundamental to the development and manufacture of its products. Although the Company purchases a large quantity of its glass requirements, it also owns and operates a specialty glass manufacturing plant which enables it to develop experimental glass formulations and respond quickly to unique customer requirements.\nThe Company operates in a single industry segment. Prior to fiscal year 1995, the Company had segregated its operations into five product lines for marketing and manufacturing purposes. As a result of the sale of a substantial portion of the Fused Fiberoptic Products business in fiscal year 1994 as described further in the Management's Discussion and Analysis of Financial Condition and Results of Operations under Item 7 of this report, the Electro-Optic Components business was eliminated and the Company's businesses were classified into the following four product lines in fiscal year 1995.\nOffice Products ---------------\nSales of Office Products accounted for 54%, 49% and 40% of the Company's net sales for fiscal years 1995, 1994 and 1993, respectively. These products are used in a variety of applications to improve the reliability and performance of high-volume, high-speed copiers and laser printers as well as high-performance desk-top copiers and ion deposition printers. Xerox Corporation is the principal customer for these products.\nThe Company's highest volume product is the dicorotron, for which it is currently the sole source of supply to Xerox. The dicorotron, which utilizes the Company's proprietary glass-coated wire technology, generates ions which charge a copier's photoreceptor during the image transfer process. The quality, cost-effectiveness, reliability and extended product life of the dicorotron have been key to the success of the product. The Company also supplies other electromechanical assemblies to Xerox which are used in a variety of copiers. The majority of the Office Products sold by the Company to Xerox are used as replacement units in existing copiers.\nGALILEO ELECTRO-OPTICS CORPORATION - --------------------------------------------------------------------------------\nScientific Detector Products ----------------------------\nSales of Scientific Detector Products accounted for 34%, 35% and 34% of the Company's net sales for fiscal years 1995, 1994 and 1993, respectively. The principal products within Scientific Detector Products are the following:\nSINGLE CHANNEL DETECTORS are small glass tubes with semiconducting inner surfaces which emit electrons when struck by sub-atomic particles, photons or other electrons. This electron emission process is repeated many times along the length of the tube in a multiplying sequence, whereby one electron, ion or photon entering at one end of the tube generates a pulse containing millions of electrons at the other end of the tube, which pulse can easily be measured as it emerges. The major application of this product is as the detecting element in a mass spectrometer. Mass spectrometers identify the atoms of unknown elements by determining atomic mass through the measurement of velocity or path of movement and are used in such industries as biotechnology and pharmaceutical as well as in drug screening applications. A detector recognizes the time or the place at which an atom exits from the vacuum chamber of the spectrometer and thereby permits the identification of the unknown atom.\nThe Company's Channeltron[REGISTERED TRADEMARK] and Spiraltron[TRADEMARK] Single Channel Detectors have replaced the complex multi-electrode structure of older detectors and require only a single two-terminal power supply. The simplicity of the Company's Detectors, their mechanical ruggedness and their resistance to contamination in service have led to their adoption as the preferred detector in mass spectrometers, ultraviolet spectrometers and in a growing range of surface-scanning instruments. The Company's Detectors are used by all major mass spectrometer manufacturers, and, in many cases, the Company is the single source.\nDETECTOR ASSEMBLIES AND SYSTEMS consist of multichannel electron multipliers, which multiply electrons that enter the channels of the device, mated with fiberoptic, mechanical and electronic components. These value-added devices are used as ion, X-ray or particle detectors in scientific instrumentation. The Company provides these detector assemblies primarily to the major manufacturers of analytical instrumentation and to the research community.\nMICROCHANNEL PLATES (MCPs) are multichannel electron multipliers. The initial manufacturing process of MCPs is similar to that of a Fused Fiberoptic Product in that a small wafer-thin fused fiberoptic disc is produced. However, MCPs are further processed by etching out the core of each fiber to produce hollow channels, approximately 10 microns in diameter, the surfaces of which are semiconducting. Each channel serves as a microscopic single channel electron multiplier, multiplying the electrons that enter the channel in order to intensify faint electron images.\nThe Company manufactures an improved, long-life MCP with enhanced gain stability, resulting in improved brightness and a significantly longer life expectancy than other MCPs available in the marketplace. The Company's MCPs are used primarily in military night vision devices as an integral part of the image intensification process. MCPs are also employed in electron and field-ion microscopes and in high-speed oscilloscopes.\nGALILEO ELECTRO-OPTICS CORPORATION - --------------------------------------------------------------------------------\nRemote Sensor Products ----------------------\nSales of Remote Sensor Products accounted for 3%, 2% and 3% of the Company's net sales for fiscal years 1995, 1994 and 1993, respectively. Remote Sensor Products provide technically advanced, cost-effective solutions for industrial process monitoring with on-line, remote, infrared spectroscopy systems. Applications are found in markets where cost controls and manufacturing yields are critical to profitability, including the chemical, food, beverage, petrochemical, semiconductor, environmental, textile and pharmaceutical industries.\nThe Company's infrared transmitting fiberoptic cables are integrated with on-line sensors which identify a material's chemical signature and transmit that data to a spectrometer for analysis. Applications for this technology include raw materials screening, moisture content and octane measurements, and the monitoring of a variety of manufacturing processes. The Company's IR Link[TRADEMARK] Systems, a family of integrated sensors and accessories, are valuable for monitoring quality and also reduce costs by moving process analysis from the laboratory directly to the manufacturing line. IR Link Multi-Channel Systems allow up to seven sensing points to be monitored using just one analytical instrument, resulting in process analysis systems which provide the lowest cost-per-measurement.\nThe Company also manufactures several different probes, sensors or cells, depending upon the specific application. High-pressure liquid and gas cells are designed to monitor heated and pressurized liquid and gas side-streams. Web sensors monitor materials, such as films, plastics and polymers, while immersible transmission probes can be installed on-line or dipped into liquid samples or liquid streams, and diffuse reflectance systems analyze samples such as powders, slurries and textiles. These accessories help provide immediate, analytical feedback which enables customers to make instantaneous adjustments to their processes and allows them to reduce costs, improve quality and raise productivity.\nMedical Products ----------------\nSales of Medical Products accounted for 9%, 14% and 23% of the Company's net sales for fiscal years 1995, 1994 and 1993, respectively. The principal products within Medical Products are the following:\nENDOSCOPES are used for minimally invasive surgery and use a combination of glass rods and plastic lenses resulting in a high-quality, low-cost device in single-use or limited reuse applications for arthroscopic surgery. Other endoscopes in prototype development use the Company's patented Fractal Fiberoptics[TRADEMARK] architecture and Integral Contrast Enhancement, ICE[TRADEMARK], technology to create fiberoptics that are defect-free, producing clear, sharp images for the surgeon.\nAs a result of improvements in the manufacturing process, the Company has developed the Galaxy endoscope which incorporates improvements to the Company's original disposable endoscope. These improvements facilitate the use of this product in the limited reuse and reusable endoscope markets. The Company currently has permission from the FDA to market several of its endoscopes -- creating the opportunity to offer products directly to end-users and speed time-to-market for its OEM partners.\nGALILEO ELECTRO-OPTICS CORPORATION - --------------------------------------------------------------------------------\nFUSED FIBEROPTIC PRODUCTS are formed by fusing large numbers of optical fibers together to form a rigid structure containing several million fibers per square inch. These products have the unique characteristic of transferring an image on one surface to the opposite surface with minimal loss of resolution. The most common form of these products is known as a fiberoptic faceplate, a circular or rectangular optical plate made in varying sizes and thicknesses and finished to optical specifications. Fiberoptic faceplates are frequently used in electron tubes, particularly in military night vision image intensifier tubes, to preserve the detail of optical images transmitted through them. In specialty camera applications, fiberoptic faceplates are used to extend the focal plane of a camera to accommodate different films and Polaroid film attachments.\nSince the sale of a substantial portion of the Fused Fiberoptic Products business in fiscal year 1994, the Company has been phasing down this product line and expects to stop manufacturing Fused Fiberoptic Products early in fiscal year 1996.\nFLEXIBLE FIBEROPTIC PRODUCTS are used to transmit light (\"lightguides\") or images (\"imagescopes\") in a flexible format and employ much longer fibers than do Fused Fiberoptic Products. Lightguides are used to supply remote illumination in flexible probes in a variety of lengths and formats depending upon customer requirements. Lightguides can also be used as sensors to detect signals, position, dimensions, images and many other physical phenomena. The applications for lightguides and sensors range from counting, positioning and dimensional measurements to laser delivery systems and remote spectroscopy. A remote spectroscopy system makes it possible to take a measurement of chemical constituents of a sample on-line and on a real-time basis using fiberoptic cables to transfer the information to the spectrometer. Outside the visible light spectrum, lightguides fabricated from ultraviolet transmitting glasses are used for the curing of resins. Imagescopes are image transfer devices capable of monitoring remote events and inspecting otherwise inaccessible or hazardous areas. Imagescopes are used in a variety of applications such as tank sights, periscopes and industrial endoscopes.\nResearch and New Product Development ------------------------------------\nThe Company's scientists and engineers conduct research and development in glass, fiberoptic and electro-optic technologies to develop new products and to enhance and expand applications for existing products. The Company's expenditures for research and development were approximately $3,054,000, $3,685,000 and $4,764,000 in fiscal years 1995, 1994 and 1993, respectively.\nGALILEO ELECTRO-OPTICS CORPORATION - --------------------------------------------------------------------------------\nCurrent projects include the following: fibers usable as lasers and optical amplifiers, fiberoptic devices for medical imaging and laser power delivery, systems and devices for infrared fiber-based process remote spectroscopy, improved Channeltrons[REGISTERED TRADEMARK], MCP-based devices for medical imaging and astrophysics research and advanced detectors for scientific instruments. In addition, programs are continuing to improve the manufacturing efficiency as well as the quality of all of the Company's products.\nMarketing ---------\nThe Company's strategy is to supply technologically advanced fiberoptic and electro-optic components and electromechanical assemblies. Customers include large OEMs and end-users of products produced by such OEMs. The Company is continuing to broaden and solidify its technical relationship with its customers. Marketing and sales activities are focused on technical support of existing products, development of future products and technologies, and on providing cost-effective solutions to complex problems.\nCustomers ---------\nSales to Xerox Corporation were 51.9% of net sales in fiscal year 1995. In total, the Company's top twenty customers accounted for 80.5% of sales.\nExport Sales ------------\nExport sales to foreign customers amounted to approximately $6,284,000, $5,060,000 and $5,857,000 in fiscal years 1995, 1994 and 1993, respectively, principally in Europe and Japan. In addition, sales to domestic affiliates of foreign customers and to domestic customers, both for export by the purchaser, amounted to approximately $325,000, $837,000 and $710,000 in fiscal years 1995, 1994 and 1993, respectively.\nRaw Materials and Supplies --------------------------\nThe principal raw materials and supplies used by the Company in the manufacture of its products are glass tubing and glass core bars, chemicals for glass manufacture, and purchased parts for commercial assemblies. The Company has not experienced any shortages in the past and does not anticipate any future shortages or unavailability of these items. Most of these items are available from alternative sources. In order to maintain a competitive advantage in quality and price, the Company has determined that it is economically attractive to purchase high quality optical glass from a major domestic source and is purchasing the majority of its glass from this supplier. The Company has maintained its own in-house capability to produce these glasses and other lower volume compositions and to facilitate research and development of new glasses.\nGALILEO ELECTRO-OPTICS CORPORATION - --------------------------------------------------------------------------------\nPatents -------\nWhile the Company possesses many patents which relate to its technology, it does not believe that the protection offered by these patents is of material importance to the success of its business. The Company believes that its success depends primarily on its development, manufacturing and marketing skills.\nBacklog -------\nAt September 30, 1995, the sales backlog was $8,552,000, all of which is scheduled for shipment during fiscal year 1996.\nCompetition -----------\nThe Company's competitive position depends primarily upon the technological development of its products, as well as service, quality and price. Some of the Company's competitors are divisions of major corporations, including Schott Glaswerke and Litton Industries, Inc., which have greater financial resources than the Company.\nEmployees ---------\nAs of September 30, 1995, the Company had 204 full-time employees, none of whom is a party to a collective bargaining agreement with the Company. Of these employees, 166 were engaged in direct manufacturing, maintenance, engineering, quality assurance and related manufacturing support functions, 14 in sales and marketing and 24 in administration and finance. The Company believes that it has good relations with its employees.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES ----------\nThe Company's corporate headquarters are located in Sturbridge, Massachusetts, where the Company owns three buildings, with a total of 197,000 square feet on a 56 acre tract. Two of these buildings house a glass plant, draw towers, clean rooms, furnaces and ovens, extruding, etching, grinding and polishing equipment, and assembly, research, test and inspection equipment principally for manufacturing Office Products, Medical Products and Remote Sensor Products. The third building is used primarily for manufacturing Scientific Detector Products.\nIn Forest, Virginia, the Company owns a 61,000 square foot manufacturing facility on 51 acres of land which it purchased in fiscal year 1988. During the fourth quarter of fiscal year 1993, the Company decided to consolidate its manufacturing operations in Sturbridge, Massachusetts. This consolidation was completed in the first half of fiscal year 1994, and the Forest, Virginia, facility has been for sale since that time. The Company is in the process of finalizing negotiations for the sale of the facility, and it expects the sale to be completed early in fiscal year 1996.\nGALILEO ELECTRO-OPTICS CORPORATION - --------------------------------------------------------------------------------\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS ----------------- There are no material pending legal proceedings outside the ordinary course of business to which the Company is a party or to which any of its property is subject.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ---------------------------------------------------\nThere were no matters submitted during the fourth quarter of fiscal year 1995 to a vote of the Company's security holders, through the solicitation of proxies or otherwise.\nEXECUTIVE OFFICERS OF THE REGISTRANT - ------------------------------------\nThe following table indicates the names and ages of all executive officers of the Company and the offices held by each:\nEach officer serves for a term extending until the meeting of directors following the next annual meeting of shareholders and until a successor is elected and qualified or until earlier resignation or removal.\nMr. Hanley holds a B.S. degree in Glass Science from Alfred University and an A.S. degree from Corning Community College. He joined Galileo in 1982 as Vice President of Manufacturing, was subsequently appointed Executive Vice President and Chief Operating Officer prior to being appointed President, Chief Executive Officer and Director in 1984. Prior experience includes positions as Manufacturing Manager, Fiber Optics for Times Fiber Communications, Inc., a manufacturer of fiberoptic products, and key managerial positions with Corning Incorporated, a specialty glass manufacturer.\nMr. Rokus holds an M.B.A. in Finance from The Tuck School, Dartmouth College and an M.S. and B.S. in Electrical Engineering from the University of Illinois. Mr. Rokus joined Galileo as Vice President, Manufacturing in 1984, was appointed Vice President, Corporate Development in 1986 and Vice President, Finance in 1988. He was named Chief Financial Officer in 1990 and Corporate Secretary in 1993. Prior experience includes management and controller positions with Corning Incorporated, a specialty glass manufacturer.\nGALILEO ELECTRO-OPTICS CORPORATION - --------------------------------------------------------------------------------\nMr. Skiles holds a B.S. in Chemistry from Frostburg State College. Prior to joining Galileo in 1992, Mr. Skiles was Director of Sales for the MilliGen Division of Millipore Corp., a manufacturer of biotechnology products from 1988 to 1991, and prior to that he was Vice President, Marketing, ESA, Inc., a manufacturer of analytical and clinical instruments and supplies, and National Sales Manager for Waters Associates, Inc., a manufacturer of chromotography instruments and supplies.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Stockholder ----------------------------------------------------------------- Matters -------\nThe Company's Common Stock is traded in the over the counter market, and prices are quoted on the Nasdaq National Market System under the symbol GAEO. The following table sets forth, for the periods indicated, the high and low sale prices for the Common Stock as reported by Nasdaq.\nThe Company had 508 shareholders of record as of December 15, 1995.\nDividend Policy ---------------\nThe Company has not paid any dividends since 1979. The Company's policy is to retain earnings to provide funds for the operation and expansion of its business, and it does not anticipate paying cash dividends in the foreseeable future.\nGALILEO ELECTRO-OPTICS CORPORATION - --------------------------------------------------------------------------------\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA -----------------------\nGALILEO ELECTRO-OPTICS CORPORATION - --------------------------------------------------------------------------------\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND --------------------------------------------------------------- RESULTS OF OPERATIONS ---------------------\nAs an aid to understanding the Company's operating results, the following table summarizes the percentage relationships to net sales of income and expense items included in the Consolidated Statements of Operations for 1995, 1994 and 1993 and the changes in those items from the respective prior years.\nRESULTS OF OPERATIONS\nFiscal Year 1995 Compared to Fiscal Year 1994 - ---------------------------------------------\nNet sales in fiscal year 1995 of $34,043,000 increased 13% from sales of $30,241,000 in fiscal year 1994 with sales volume increasing in three of the Company's four businesses. Commercial sales increased 18% from fiscal year 1994 and set a new record of $32,337,000, while military sales declined 37%. Military sales represented 5% of total sales in 1995 versus 9% of total sales in 1994. Operating profit for 1995 amounted to $836,000 versus an operating loss of $1,296,000 in 1994 with a net profit of $1,110,000, or $.17 per share, as compared to a net loss of $1,121,000, or $.17 per share, in 1994.\nGALILEO ELECTRO-OPTICS CORPORATION - --------------------------------------------------------------------------------\nThe improvement in profitability was the result of higher sales volume in most of the Company's businesses, a favorable sales mix, selective price increases, the elimination of certain unprofitable product lines and the reduction of fixed costs, primarily due to the consolidation of the Company's manufacturing operations in fiscal year 1994.\nIn the Office Products business, sales increased 24% from the previous year and reached a new high of $18,226,000. These products include dicorotron glass-coated wire assemblies, which utilize the Company's proprietary technology to generate ions which charge the photoreceptor in office copiers, as well as a variety of other components for copiers and laser and ion deposition printers. Most Office Products sales are for the replacement market. Xerox Corporation is the largest customer for these products as well as the Company's largest customer accounting for 52% of the Company's total revenues in 1995. Although the Company is currently the sole-source supplier of dicorotrons to Xerox Corporation, there is no long-term commitment by Xerox to purchase these components from the Company and no assurance that Xerox will not develop alternative sources of supply in the future. Demand for these products continued to be strong in fiscal year 1995 as they were designed into new products and the installed base of office machines continued to grow. In addition, moderate price increases were implemented for selective products, and several products were phased out because they did not meet the Company's profitability criteria. In fiscal year 1995, the Company established three new customers for its Office Products and started to explore new applications for its glass-coated wire technology.\nSales of Scientific Detector Products also increased from fiscal year 1994, being up $1,155,000 or 11%. This business includes Channeltron single-channel detectors, used primarily in mass spectrometers, microchannel plates and microchannel plate-based detectors and assemblies. Shipments of Channeltrons and microchannel plates were up 15% and 14%, respectively, from the previous year while sales of microchannel plate assemblies were essentially flat. Channeltron shipments increased due in part to strong demand for detectors by the semiconductor industry and the success of a new mass spectrometer detector. Also, billings for engineering services were up 10% as the Company completed its two-year, $1.9 million contract it was awarded in 1993 by the National Institute of Standards and Technology to develop new fabrication methods for microchannel plates. The product mix for this business was favorable due to higher sales of Channeltrons and microchannel plates and the above average incremental profitability associated with these products.\nSales of Remote Sensor Products were up $410,000 or 65% in fiscal year 1995 versus 1994. This business includes fiberoptic cables, sensors and systems for a variety of industrial process and telecommunications applications. Several new products were introduced to the market place this year which contributed to the higher sales, with the Hand-Held Diffuse Reflectance Probe, which is designed to perform incoming inspection of raw materials, being particularly well received. Good progress was also made in fiscal year 1995 in the development of the Fluorolase technology for use as fiber amplifiers in telecommunications applications. This business, which is currently the smallest of the Company's four businesses, is a developing business and was unprofitable at the operating profit level.\nThe Medical business includes fused products, flexible fiberoptic products and medical endoscopes. In fiscal year 1994, fused products and flexible products were part of the Electro-Optic Components business which was merged into the Company's present four businesses. In fiscal year 1995, sales of fused products declined 53% from the previous year due to the sale of a substantial portion of that business in fiscal year 1994 while shipments of flexible fiberoptics increased 40% from 1994.\nGALILEO ELECTRO-OPTICS CORPORATION - --------------------------------------------------------------------------------\nSales of medical endoscopes for minimally invasive surgery applications were essentially unchanged from the 1994 level. The Company continued to improve its existing products and has been developing several low-cost, high-quality, single-use and limited re-use medical endoscopes which have successfully undergone clinical trials and are now being actively marketed through medical instrument distributors in the United States as well as abroad. Significant progress was made in the development of the Company's Fractal Fiberoptics imaging conduit which is being designed into small diameter, low-cost endoscopes. Sales of medical endoscopes constituted a small percentage of the Company's sales in fiscal year 1995, but the Company expects these sales to grow in fiscal year 1996 and beyond. The Company's medical endoscopes business is a developing business and is not yet profitable at the operating profit level.\nThe consolidation of manufacturing operations, which involved the relocation of the Medical, Office and Flexible Fiberoptic products from Forest, Virginia to Sturbridge, Massachusetts and which was completed in fiscal year 1994, impacted fiscal year 1995 favorably due to the reduction of fixed costs and better utilization of capacity. The consolidation was also largely responsible for achieving a record level of productivity, as measured by sales per employee, which averaged $162,000 for the entire year and reached $191,000 for the fourth quarter. The reserves related to the consolidation, which were established at the end of 1993, have been adequate since the expenditures have been consistent with management's expectations. In fiscal year 1995, these expenditures consisted primarily of maintenance costs for the Forest, Virginia facility which has been actively marketed and is expected to be sold in the early part of fiscal year 1996. At the end of fiscal year 1995, the reserve balance was $290,000 which is expected to be adequate for the anticipated ongoing expenses of that facility for a portion of fiscal year 1996. The Company believes that the facility is properly valued on the Company's books at an estimate of its net realizable value.\nFiscal Year 1994 Compared to Fiscal Year 1993 - ---------------------------------------------\nNet sales in fiscal year 1994 of $30,241,000 declined 12% from sales of $34,307,000 in fiscal year 1993. This drop in revenue occurred primarily in Medical Products which accounted for $3,120,000 of the decline. The Company incurred an operating loss of $1,296,000 in fiscal year 1994 versus an operating loss of $10,512,000 the previous year. The net loss in fiscal year 1994 amounted to $1,121,000, or $.17 per share, as compared to a net loss of $10,262,000, or $1.60 per share, in fiscal year 1993.\nThe Company's results for fiscal year 1993 were significantly affected by a restructuring charge of $6,144,000 resulting from a decision to shut down its Forest, Virginia facility and consolidate all manufacturing operations in Sturbridge, Massachusetts. This restructuring charge also included a write-off of unused equipment specific to the Fused Fiberoptics business. Without the restructuring charge, the operating loss in fiscal year 1993 would have been $4,368,000. In addition, the 1993 results were affected by the adoption of Financial Accounting Standards Board Statement No. 106, Employers Accounting for Postretirement Benefits Other Than Pensions, which resulted in a one-time after tax charge of $430,000, or $.07 per share.\nGALILEO ELECTRO-OPTICS CORPORATION - --------------------------------------------------------------------------------\nThe consolidation of manufacturing operations, which involved the relocation of production lines for Medical, Office and Flexible Fiberoptic Products from Forest, Virginia to Sturbridge, Massachusetts was completed by the end of the second quarter of fiscal year 1994, slightly ahead of schedule with no negative impact on deliveries or quality. The Company added some warehousing space and reconfigured some of its manufacturing space in Sturbridge to accommodate the transferred operations. Because very few of the Forest, Virginia employees were relocated, the Company realized a reduction in fixed costs related to staffing as well as in other areas. The reserves related to the consolidation which were established at the end of 1993 were adequate since the expenditures related to this project were consistent with management's expectations. These reserves were reduced during fiscal year 1994 primarily as a result of cash expenditures for the purposes intended when the reserves were established. At the end of fiscal year 1994, the reserve balance was $528,000. The Company had previously estimated that the annualized cost reduction effect of the restructuring would be approximately $3,000,000 with some of the savings benefiting selling, engineering and administrative expenses and the balance reducing fixed costs included in the cost of sales.\nThe reduction in fixed costs which resulted from the consolidation of manufacturing operations was primarily responsible for the improvement of profitability in the second half of fiscal year 1994. Gross profit for fiscal year 1994 of $7,548,000 increased $407,000 despite a decrease in sales from the previous year. Selling, engineering and administrative expenses declined in fiscal year 1994 by $2,665,000, primarily as a result of cost reductions resulting from the consolidation. At the operating profit level, the Office Products and Scientific Detector Products businesses were profitable.\nAt the end of the second quarter of fiscal year 1994, the Company completed the sale of a substantial portion of its Fused Fiberoptics business. The purchaser acquired exclusive license rights to certain technologies of the Company related to that business. However, the Company retained rights to its patented Fractal Fiberoptics technology, which it continues to use in support of the Medical Products and Scientific Detector Products businesses. The purchase price of the assets involved in the sale was $1,400,000. Of this amount, $1,271,000 was paid to the Company by the end of fiscal year 1994. There was no gain or loss to the Company on the transaction.\nSales of components for military applications declined $664,000 in fiscal year 1994 to $2,725,000 or 9% of total sales, a decrease of 20% from 1993. Commercial sales, which amounted to $27,516,000, or 91% of total sales, were down 11% from the previous year.\nSales of Office Products, consisting of dicorotron glass-coated wire assemblies and other components for a variety of copiers, increased to $14,690,000 and set a new record. During fiscal year 1994, the Company started to manufacture several new products at rates higher than originally anticipated in support of a new series of office machines launched by Xerox Corporation, the Company's largest customer. Approximately 60% of the Company's sales to Xerox were for the replacement market.\nGALILEO ELECTRO-OPTICS CORPORATION - --------------------------------------------------------------------------------\nShipments of Medical Products were down $3,120,000 versus the previous year as sales of endoscopes for minimally invasive surgery declined. This decline started in the fourth quarter of 1993 when the sole customer for this product notified the Company that its requirements would be significantly less than anticipated. Under a renegotiated supply agreement with this customer, the Company has a nonexclusive license to use the endoscope technologies to develop medical imaging devices for other customers. The Company improved its existing products and developed a broad line of low-cost, high-quality single-use and limited re-use endoscopes for medical applications as well as its Microvision borescope for non-medical uses. Approvals were received from the FDA for two products in fiscal year 1994, and two additional approvals were received shortly after the end of fiscal year 1994.\nIn the Electro-Optic Components business, sales of fused fiberoptics, flexible fiberoptics and microchannel plates each declined approximately 10% with the drop of military sales being the principal reason of this change. Sales of Fused Fiberoptics Products, which include some components for military applications, were down also as a result of the sale of that business. Sales of engineering services, however, were up slightly due to billings related to the two-year, $1.9 million contract the Company was awarded in 1993 by the National Institute of Standards and Technology to develop new fabrication methods for microchannel plates. This program made good progress.\nSales of Scientific Detector Products were down 10% versus the previous year, as shipments of Channeltron single-channel detectors and microchannel plate-based detectors and assemblies declined. Shipments of Channeltrons were lower primarily because of a decline in sales to Hewlett-Packard. However, the Company introduced a new detector in mid-1994 in an effort to regain this lost revenue. Finally, Remote Sensor Products sales declined 18% compared to fiscal year 1993. Several more new products were scheduled for introduction in the near future in both Scientific Detector and Remote Sensor Products.\nLIQUIDITY, CAPITAL RESOURCES AND CHANGES IN FINANCIAL POSITION\nWorking capital at September 30, 1995 was $18,744,000, an increase of $5,775,000 from the working capital balance of $12,969,000 at September 30, 1994. Cash and short-term investments were $8,274,000 at the end of fiscal year 1995 as compared to $6,185,000 at the end of the previous fiscal year, for an increase of $2,089,000. The increase in working capital was primarily due to the increase in cash, an increase in accounts receivable of $1,771,000 which was principally attributable to strong sales at the end of the fiscal year and the reclassification of the book value of the Company's Forest, Virginia facility as a current asset. The major factors which affected the increase in cash were an increase in working capital provided by operations partially offset by an increase in accounts receivable.\nCapital expenditures amounted to $988,000 versus expenditures of $1,352,000 in fiscal year 1994. The Company expects that its need for capital in 1996 will be comparable to that in fiscal year 1995. The Company has no long-term debt other than capitalized lease obligations. The nature of the Company's business is such that its sales are not subject to extended payment terms or return privileges, except for defective goods. The Company does not anticipate a need for external financing to support its currently planned operations.\nGALILEO ELECTRO-OPTICS CORPORATION - --------------------------------------------------------------------------------\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA -------------------------------------------\nSee Consolidated Financial Statements and Consolidated Financial Statement Schedules at pages 18 through 36 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 --------------------------------------------------\nSee \"Executive Officers of the Registrant\" at the end of Part I of this report and the information contained in the Company's Proxy Statement dated December 11, 1995 relating to the 1996 Annual Meeting of Shareholders (the \"Proxy Statement\") under the captions \"Election of Directors\" and \"Share Ownership,\" which information is incorporated herein by reference.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION ----------------------\nSee the information contained in the Proxy Statement under the captions \"Election of Directors - Director Compensation,\" \"Executive Compensation\" and \"Compensation Committee Interlocks and Insider Participation,\" which information is incorporated herein by reference.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT --------------------------------------------------------------\nSee the information contained in the Proxy Statement under the heading \"Share Ownership,\" which information is incorporated herein by reference.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ----------------------------------------------\nNot applicable.\nGALILEO ELECTRO-OPTICS CORPORATION - --------------------------------------------------------------------------------\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 Form 10-K -------------------------------------------\n1. Financial Statements.\nThe Financial Statements filed as a part of this Form 10-K are listed on the Index to Consolidated Financial Statements and Consolidated Financial Statement Schedules on page 18.\n2. Financial Statement Schedules.\nThe Financial Statement Schedule filed as a part of this Form 10-K is listed on the Index to Consolidated Financial Statements and Consolidated Financial Statement Schedules on page 18.\n3. Exhibits.\nThe Exhibits filed as a part of this Form 10-K are listed on the Exhibit Index on page 39.\n(b) No reports on Form 8-K were filed by the Registrant during the last quarter of the period covered by this Form 10-K.\nGALILEO ELECTRO-OPTICS CORPORATION - --------------------------------------------------------------------------------\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND CONSOLIDATED FINANCIAL STATEMENT SCHEDULES ITEM 14(a)\nFinancial Statements: - --------------------\nReport of Independent Auditors 19\nConsolidated Balance Sheets at September 30, 1995 and 1994 20\nConsolidated Statements of Operations for the fiscal years ended September 30, 1995, 1994 and 1993 22\nConsolidated Statements of Changes in Shareholders' Equity for the fiscal years ended September 30, 1995, 1994 and 1993 23\nConsolidated Statements of Cash Flows for the fiscal years ended September 30, 1995, 1994 and 1993 24\nNotes to Consolidated Financial Statements 25\nSupplementary Information: - -------------------------\nUnaudited Quarterly Financial Information 35\nSchedules: - ---------\nII. Valuation and qualifying accounts for the fiscal years ended September 30, 1995, 1994 and 1993 36\nSchedules Omitted: - -----------------\nAll other schedules are omitted as they are not applicable or the information is shown in the financial statements or notes thereto.\nGALILEO ELECTRO-OPTICS CORPORATION - --------------------------------------------------------------------------------\nREPORT OF INDEPENDENT AUDITORS\nERNST & YOUNG LLP\nThe Board of Directors Galileo Electro-Optics Corporation\nWe have audited the accompanying consolidated balance sheets of Galileo Electro-Optics Corporation as of September 30, 1995 and 1994, and the related consolidated statements of operations, changes in shareholders' equity and cash flows for each of the three years in the period ended September 30, 1995. 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 based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as 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 Galileo Electro-Optics Corporation at September 30, 1995 and 1994, and the consolidated results of its operations and its cash flows for each of the three years in the period ended September 30, 1995 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 3 to the financial statements, in 1993 the Company changed its method of accounting for postretirement benefits other than pensions.\nProvidence, Rhode Island October 20, 1995 ERNST & YOUNG LLP\nGALILEO ELECTRO-OPTICS CORPORATION - --------------------------------------------------------------------------------\nCONSOLIDATED BALANCE SHEETS ---------------------------\nGALILEO ELECTRO-OPTICS CORPORATION - --------------------------------------------------------------------------------\nCONSOLIDATED BALANCE SHEETS ---------------------------\nGALILEO ELECTRO-OPTICS CORPORATION - --------------------------------------------------------------------------------\nCONSOLIDATED STATEMENTS OF OPERATIONS -------------------------------------\nGALILEO ELECTRO-OPTICS CORPORATION - --------------------------------------------------------------------------------\nCONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY ----------------------------------------------------------\nGALILEO ELECTRO-OPTICS CORPORATION - --------------------------------------------------------------------------------\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - --------------------------------------------------------------------------------\n1. ACCOUNTING POLICIES -------------------\nORGANIZATION - The Company develops, manufactures and markets fiberoptic and electro-optic components, assemblies and systems which transmit, sense or intensify light or images. The Company's products are sold primarily to original equipment manufacturers for applications in electronic imaging, analytical instrumentation, office equipment, medical instrumentation and process analysis. The majority of the Company's customers are located in North America with most international customers in Europe and the Far East.\nCONSOLIDATION - The consolidated balance sheets at September 30, 1995 and 1994 and the related consolidated statements of operations, changes in shareholders' equity and cash flows for each of the three years in the period ended September 30, 1995, include the accounts of Galileo Electro-Optics Corporation and its wholly-owned subsidiary. Intercompany transactions have been eliminated in consolidation.\nCASH FLOWS - For purposes of the 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.\nIn 1995, the capital leases pertaining to computer equipment then in effect were replaced with a new capital lease obligation of $180,000 for new computer equipment.\nINVENTORIES - Inventories are valued at the lower of cost (first in, first out) or market.\nENGINEERING EXPENSE - Engineering expense includes research and development, engineering support of manufacturing operations relating to problem solving and process improvement, the preparation of bids and proposals and sales support of customers. The amounts charged to income for research and development were approximately $3,054,000, $3,685,000 and $4,764,000 for fiscal years 1995, 1994 and 1993, respectively.\nNET INCOME PER COMMON AND COMMON EQUIVALENT SHARE - Net income per common and common equivalent share is computed using the weighted average number of common and common equivalent shares outstanding. The exercise of stock options has not been assumed for fiscal years 1993 and 1994 because the effect was antidilutive.\nGALILEO ELECTRO-OPTICS CORPORATION - --------------------------------------------------------------------------------\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - --------------------------------------------------------------------------------\nGOODWILL - Goodwill, which is included in other assets, is being amortized on a straight-line basis over a period of forty years.\nREVENUE RECOGNITION - The Company records a sale and recognizes revenue when title passes to the customer or when services are performed in accordance with contracts.\nUSE OF ESTIMATES - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.\nCURRENT ACCOUNTING DEVELOPMENTS - In March and October of 1995, the Financial Accounting Standards Board issued two new statements: Statement 121, Accounting for the Impairment of Long-lived Assets and for Long-lived Assets to be Disposed Of and Statement 123, Accounting for Stock Based Compensation. Statement 121 principally requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amount. Statement 123 encourages the expensing of the fair value of employee stock options but allows the continuance of current practice with disclosure of the pro forma effect on net income had the fair value of the options been expensed. The Company will adopt Statement 121 in the first quarter of fiscal year 1997 and is expecting to adopt Statement 123 in fiscal year 1996. Based on current circumstances, the Company does not believe the effects of adopting either of these statements will be material.\n2. RESTRUCTURING -------------\nIn 1993, the Company's operating loss included a charge of approximately $6,144,000 related to a decision to consolidate its manufacturing operations in its Sturbridge, Massachusetts, facility. As part of this consolidation, all manufacturing operations in Forest, Virginia, were relocated, and the Forest facility was shut down in fiscal year 1994 and is currently for sale. The Company expects that this facility will be sold in the early part of fiscal year 1996. The charge also included a write-off specific to the Company's Fused Fiberoptics product line, which related principally to production equipment no longer used in manufacturing.\nGALILEO ELECTRO-OPTICS CORPORATION - --------------------------------------------------------------------------------\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - --------------------------------------------------------------------------------\n3. RETIREMENT PLANS ---------------- PENSION PLAN - The Company has a noncontributory pension plan covering substantially all employees who joined the Company prior to January 1, 1995. The Plan provides pension benefits based upon years of service and average compensation during the five years preceding retirement. The Company's policy is to fund the maximum amount that can be deducted for federal income tax purposes.\nIn 1993, the Company reduced its work force and as a result, recognized a curtailment gain of approximately $556,000.\nThe assumptions used in calculating pension expense included discount rates of 8% and expected long-term rates of return on Plan assets of 9%. In addition, the rate of increase in compensation levels was assumed to be 5% for 1995 and 5.5% for 1994 and 1993.\nGALILEO ELECTRO-OPTICS CORPORATION - --------------------------------------------------------------------------------\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - --------------------------------------------------------------------------------\nTAX DEFERRED SAVINGS PLAN - The Company has a tax deferred savings plan under Section 401(k) of the Internal Revenue Code under which, subject to certain limitations, each eligible employee may contribute up to 15% of gross wages per year. The Company matches 50% of the first 6% of employee contributions. Company contributions to the Plan were approximately $139,000, $126,000 and $147,000 in fiscal years 1995, 1994 and 1993, respectively.\nOTHER RETIREMENT PLANS - In addition to the Company's defined benefit pension plan, the Company sponsors a defined benefit postretirement medical and life insurance plan that covers substantially all of its full-time employees. Employees who retire from the Company and who have attained age 65 with 15 years of service (10 years of service for employees hired before October 1, 1989) and who were hired prior to October 1, 1993 are eligible. Employees who retired prior to October 1, 1989 are not required to contribute; employees who retired after October 1, 1989 contribute a portion of the cost beyond a Company subsidy. The plan is not funded.\nGALILEO ELECTRO-OPTICS CORPORATION - --------------------------------------------------------------------------------\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - --------------------------------------------------------------------------------\nIn 1993, the Company adopted Financial Accounting Standards Board Statement No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions. The Company elected to immediately recognize the accumulated liability, measured as of October 1, 1992. This resulted in a one-time, after tax charge of $430,000 or $.07 per share. The tax benefit of adoption was approximately $138,000. Aside from the one-time effect of this adjustment, adoption of Statement 106 was not material to 1993 financial results. Previously reported first quarter 1993 results have been restated to reflect the accumulated postretirement benefit obligation recognition. Postretirement benefit costs for years prior to 1993, which were recorded on a cash basis, have not been restated.\nFor measurement purposes, a 10% annual rate of increase in the per capita cost of covered health care benefits was assumed for fiscal year 1995. The rate was assumed to decrease gradually down to 6% for fiscal year 2003 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 rate one percentage point in each year would increase the accumulated postretirement benefit obligation as of September 30, 1995 by $35,000 (or by 6%) and the aggregate of the service and interest cost components of the net periodic postretirement benefit cost for fiscal year 1995 by $3,600 (or by 6.5%).\nThe weighted average discount rate used in determining the accumulated postretirement benefit obligation was 8%. As the plan is unfunded, no assumption was needed as to the long-term rate of return on assets.\nGALILEO ELECTRO-OPTICS CORPORATION - --------------------------------------------------------------------------------\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - --------------------------------------------------------------------------------\n4. LEASE COMMITMENTS -----------------\nMinimum rental commitments under all noncancelable operating leases, primarily machinery and equipment, in effect at September 30, 1995 are $78,000, $45,000, $43,000, $33,000 and $14,000 in fiscal years 1996, 1997, 1998, 1999 and 2000, respectively.\nTotal rental expense for all operating leases was approximately $145,000, $149,000 and $184,000 in fiscal years 1995, 1994 and 1993, respectively.\n5. COMMON STOCK\nEmployee Stock Option Plan - Under the Company's 1991 Stock Option Plan, which succeeded the 1981 Stock Option Plan, the Plan Administrative Committee of the Board of Directors may grant options to purchase common stock to officers and key employees of the Company and its subsidiary. The stock options are exercisable at a price not less than the fair market value of the common stock on the date of grant. The Plan also provides that the Committee may issue stock appreciation rights. The exercise price of the stock appreciation rights may not be less than the fair market value of the common stock on the date of grant or if issued with a stock option, the exercise price of the related option. Stock appreciation rights provide for the issuance of common stock, or the payment of cash, or a combination of both equal to the difference between the exercise price of the stock appreciation right and the fair market value of the common stock on the date of exercise.\nGALILEO ELECTRO-OPTICS CORPORATION - --------------------------------------------------------------------------------\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - --------------------------------------------------------------------------------\nAs of September 30, 1995, 214,000 option shares were available for grant under the 1991 Plan, and 137,597 options were exercisable at prices ranging from $3.00 to $7.50, aggregating approximately $672,239 under the 1981 and 1991 Plans. The remainder of the outstanding options become exercisable on various dates through 1999.\nDIRECTOR STOCK OPTION PLAN - Under the Company's 1989 Director Stock Option Plan, each non-employee director as of March 15, 1989 was granted nonstatutory options to purchase 10,000 shares of the Company's common stock, 5,000 of which became exercisable immediately and 1,250 of which became exercisable on each of the next four anniversaries of the date of grant. Options to purchase 5,000 shares of common stock are granted automatically to each new non-employee director on the date of the director's first election, with 25 percent of the shares becoming exercisable on each of the next four anniversaries of the date of grant. A director may be granted options only once. The option exercise price is the fair market value of the common stock on the date of grant.\nUnder the Director Stock Option Plan as of September 30, 1995, 20,000 shares were exercisable at prices ranging from $4.875 to $9.00 per share, aggregating $157,813. Options covering 70,000 shares remain available for grant under the Director Stock Option Plan. No options under the Plan have been exercised.\nGALILEO ELECTRO-OPTICS CORPORATION - --------------------------------------------------------------------------------\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - --------------------------------------------------------------------------------\nNo accounting recognition is given to stock options until they are exercised, at which time the proceeds are credited to the capital accounts. The Company recognizes a tax benefit upon exercise of nonstatutory options in an amount equal to the difference between the option price and the fair market value of the common stock. With respect to incentive stock options, tax benefits arising from disqualifying dispositions are recognized at the time of disposition. Tax benefits related to stock options are credited to additional paid-in capital.\nEMPLOYEE STOCK PURCHASE PLAN - The Company has an Employee Stock Purchase Plan under which it contributes up to 37.5% of amounts contributed by participating employees to a combined maximum of $1,375 per calendar year. All contributions are made to a trust for investment in the Company's common stock. Shares are purchased in the open market. The Plan held 26,357 and 26,091 shares at September 30, 1995 and 1994, respectively.\n6. MAJOR CUSTOMERS AND EXPORT SALES --------------------------------\nSales were made to certain customers in amounts exceeding 10% of consolidated revenues in fiscal years 1995, 1994 and 1993, respectively. Sales to these customers were as follows:\nExport sales to various foreign customers amounted to approximately $6,284,000, $5,060,000 and $5,857,000 in fiscal years 1995, 1994 and 1993, respectively. In addition, sales to domestic affiliates of foreign customers and to domestic customers, both for export by the purchaser, amounted to approximately $325,000, $837,000 and $710,000 in fiscal years 1995, 1994 and 1993, respectively.\nAt September 30, 1995 and 1994, accounts receivable from Customer A, a Fortune 100 office products manufacturer, represented approximately 51% and 38%, respectively, of total accounts receivable. The Company extends credit based on evaluating individual customers' financial condition, and collateral is generally not required. Credit losses are provided for in the financial statements and have historically been within management's expectations.\nGALILEO ELECTRO-OPTICS CORPORATION - -------------------------------------------------------------------------------\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------\n7. Income Taxes ------------\nThe net change in the total valuation allowance for the fiscal years ended September 30, 1995 and 1994 amounted to increases of $197,000 and $398,000, respectively.\nGALILEO ELECTRO-OPTICS CORPORATION - -------------------------------------------------------------------------------\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------\nAt September 30, 1995, the Company had net operating loss carryforwards of $12,487,000 for income tax purposes that expire in years 2006 through 2010.\nGALILEO ELECTRO-OPTICS CORPORATION - -------------------------------------------------------------------------------\nGALILEO ELECTRO-OPTICS CORPORATION - --------------------------------------------------------------------------------\nGALILEO ELECTRO-OPTICS CORPORATION - -------------------------------------------------------------------------------\nSIGNATURES ----------\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nGalileo Electro-Optics Corporation\nDated: December 15, 1995\n\/s\/ William T. Hanley -------------------------------- William T. Hanley, President and Chief Executive Officer\nGALILEO ELECTRO-OPTICS CORPORATION - -------------------------------------------------------------------------------\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities indicated on December 15, 1995.\n\/s\/ William T. Hanley ------------------------------------------------- William T. Hanley, President and Chief Executive Officer and Director (Principal Executive Officer)\n\/s\/ Josef W. Rokus ------------------------------------------------- Josef W. Rokus, Vice President, Finance (Principal Financial and Accounting Officer)\n\/s\/ William T. Burgin ------------------------------------------------- William T. Burgin Director\n\/s\/ Allen E. Busching ------------------------------------------------- Allen E. Busching Director\n\/s\/ Kenneth W. Draeger ------------------------------------------------- Kenneth W. Draeger Director\n\/s\/ Robert D. Happ ------------------------------------------------- Robert D. Happ Director\nGALILEO ELECTRO-OPTICS CORPORATION - -------------------------------------------------------------------------------\nINDEX TO EXHIBITS\nGALILEO ELECTRO-OPTICS CORPORATION - -------------------------------------------------------------------------------\nINDEX TO EXHIBITS (Continued)\nExecutive Compensation Plans and Arrangements - ---------------------------------------------\nExhibits 10.3, 10.4 and 10.5 are management contracts or compensatory plans or arrangements in which the executive officers or directors of the Company participate.","section_15":""}
{"filename":"748580_1995.txt","cik":"748580","year":"1995","section_1":"ITEM 1: BUSINESS - -----------------\nNooney Realty Trust, Inc. (the \"Registrant\") is a corporation formed under The General and Business Corporation Law of Missouri on June 14, 1984, to make equity investments in income-producing real properties, primarily commercial and light industrial properties. The Registrant has invested in three real property investments as set forth in Item 2","section_1A":"","section_1B":"","section_2":"ITEM 2: PROPERTIES - -------------------\nOn March 28, 1985, the Registrant purchased The Atrium at Alpha Business Center (\"The Atrium\"), an office building located at 2626 East 82nd Street in Bloomington, Minnesota, a suburb of Minneapolis. The Atrium contains approximately 89,000 net rentable square feet and is located, along with a parking lot that will accommodate 336 cars, on a 4.2 acre site. The purchase price of The Atrium was $8,393,716. The Atrium was 99% leased by 27 tenants at year-end.\nOn January 22, 1986, the Registrant purchased the Applied Communications, Inc. Building (the \"ACI Building\"), an office building located at 330 South 108th Avenue in Omaha, Nebraska. The ACI Building contains approximately 70,000 net rentable square feet and is located on a 7.59 acre site which provides paved parking for 400 cars. The building is 100% leased by a single tenant, Applied Communications, Inc. The purchase price of the ACI Building was $6,401,008.\nOn December 16, 1986, the Registrant purchased the Franklin Park Distribution Center (\"Franklin Park\"), a warehouse and distribution facility located at 3431 N. Powell Avenue in Franklin Park, Illinois, a suburb west of Chicago. Franklin Park contains approximately 162,000 net rentable square feet and is located on a 5 acre site which provides parking for 100 cars. The purchase price of Franklin Park was $4,301,494. Franklin Park was 100% leased by 2 tenants at year-end.\nReference is made to Note 3 of Notes to Financial Statements incorporated by reference to the Registrant's 1995 Annual Report to Shareholders under the heading \"Financial Statements and Notes\" for a description of the mortgage indebtedness secured by the Registrant's real property investments. Reference is also made to Note 6 of Notes to Financial Statements for a discussion of revenues derived from major tenants.\nThe following table sets forth certain information as of December 31, 1995, relating to the properties owned by the Registrant.\nITEM 3:","section_3":"ITEM 3: LEGAL PROCEEDINGS - --------------------------\nThe Registrant 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 - ------------------------------------------------------------\nThere were no matters submitted to a vote of Shareholders during the fourth quarter of fiscal 1995.\nEXECUTIVE OFFICERS OF THE REGISTRANT - ------------------------------------\nThe following table sets forth certain information with respect to the executive officers of the Registrant. These officers have been elected to terms which expire on May 13, 1996:\nHas served as Name Position Age officer since - -------------------------- ------------------------------- --- -------------\nGregory J. Nooney, Jr. (1) Chairman of the Board 65 1984 and Chief Executive Officer\nPatricia A. Nooney (1) President, Secretary and 39 1990 Treasurer\nDale W. Brouk Chief Financial Officer 33 1995\n- ---------------\n(1) Patricia A. Nooney is the daughter of Gregory J. Nooney, Jr.\nGregory J. Nooney, Jr. has served as Chairman of the Board and Chief Executive Officer of Nooney Company since May 1983. Mr. Nooney joined Nooney Company in 1954 and served as President from 1969 to May 1983. Nooney Company, which was founded in 1945, is a diversified real estate investment management company.\nDuring 1993 Lindbergh Boulevard Partners, L.P. filed a voluntary petition under Chapter 11 of the United States Bankruptcy Code. Gregory J. Nooney is the general partner of Nooney Ltd. II, L.P, which in turn is the general partner of Nooney Development Partners, L.P., which in turn is the general partner of Nooney-Hazelwood Associates, L.P. which is the general partner of Lindbergh Boulevard Partners, L.P. Lindbergh Boulevard Partners, L.P. emerged from bankruptcy on May 17, 1994, when its Plan of Reorganization was confirmed.\nPatricia A. Nooney is Senior Vice President and Chief Financial Officer of Nooney Krombach Company, a wholly-owned subsidiary of Nooney Company. Ms. Nooney joined Nooney Company in 1981 and has served as an officer since 1985.\nDale W. Brouk is Controller of Nooney Krombach Company, a wholly-owned subsidiary of Nooney Company. Mr. Brouk joined Nooney Krombach Company as Controller in 1995. Mr. Brouk is a certified public accountant, and prior to joining Nooney Krombach Company, Mr. Brouk was employed by The Forsyth Group, a real estate management and development company, since May 1990.\nPART II -------\nITEM 5:","section_5":"ITEM 5: MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS - --------------------------------------------------------------------------\nThe information required by Item 201 of Regulation S-K is incorporated by reference to the Registrant's 1995 Annual Report to Shareholders under the headings \"Market Information\" and \"Dividends\".\nITEM 6:","section_6":"ITEM 6: SELECTED FINANCIAL DATA - --------------------------------\nThe information required by Item 301 of Regulation S-K is incorporated by reference to the Registrant's 1995 Annual Report to Shareholders under the heading \"Financial Highlights\".\nITEM 7:","section_7":"ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - ------------------------------------------------------------------------\nThe information required by Item 303 of Regulation S-K is incorporated by reference to the Registrant's 1995 Annual Report to Shareholders under the heading \"Management's Discussion and Analysis of Financial Condition and Results of Operations\".\nITEM 8:","section_7A":"","section_8":"ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - ----------------------------------------------------\nThe financial statements of the Registrant are incorporated by reference to the Registrant's 1995 Annual Report to Shareholders. Financial Statement Schedules are filed herewith as Exhibit 99.1 and are incorporated herein by reference. The supplementary financial information specified by Item 302 of Regulation S-K is not applicable.\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 401 and Item 405 of Regulation S-K regarding nominees and directors is incorporated by reference to the Registrant's 1996 Notice of Annual Meeting of Shareholders and Proxy Statement (the \"1996 Proxy Statement\") under the heading \"Election of Directors\". Information regarding executive officers is set forth in Part I of this report.\nITEM 11:","section_11":"ITEM 11: EXECUTIVE COMPENSATION - -----------------------------------\nThe information required by Item 402 of Regulation S-K is incorporated by reference to the Registrant's 1996 Proxy Statement under the heading \"Executive Compensation\".\nITEM 12:","section_12":"ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - ------------------------------------------------------------------------\nThe information required by Item 403 of Regulation S-K is incorporated by reference to the Registrant's 1996 Proxy Statement under the heading \"Security Ownership of Certain Beneficial Owners and Management\".\nITEM 13:","section_13":"ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - --------------------------------------------------------\nThe information required by Item 404 of Regulation S-K is incorporated by reference to the Registrant's 1996 Proxy Statement under the heading \"Certain Business Relationships\".\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 financial statements of the Registrant are incorporated by reference to the Registrant's 1995 Annual Report to Shareholders.\n2. Financial Statement Schedules (filed herewith as Exhibit 99.1):\nIndependent Auditors' Report on Financial Statement Schedule Schedule III - Real Estate and Accumulated Depreciation\nAll other schedules are omitted because they are inapplicable or not required under the instructions.\n3. Exhibits:\nSee Exhibit Index on Page 10.\n(b) Reports on Form 8-K:\nDuring the last quarter of the period covered by this report, the Registrant filed no reports on Form 8-K.\n(c) Exhibits:\nSee Exhibit Index on Page 10.\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.\nNOONEY REALTY TRUST, INC.\nDate: March 30, 1996 By: \/s\/ Gregory J. Nooney, Jr. ------------------------------------- Gregory J. Nooney, Jr. Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on March 30, 1996, by the following persons on behalf of the Registrant and in the capacities indicated.\n\/s\/ Gregory J. Nooney, Jr. ----------------------------------------- Gregory J. Nooney, Jr. Chief Executive Officer and Director\n\/s\/ Patricia A. Nooney ----------------------------------------- Patricia A. Nooney President, Secretary, Treasurer and Director\n\/s\/ Dale W. Brouk ----------------------------------------- Dale W. Brouk Principal Financial & Accounting Officer\n\/s\/ Gene K. Beare ----------------------------------------- Gene K. Beare Director\n\/s\/ Bruce P. Hayden ----------------------------------------- Bruce P. Hayden Director\n\/s\/ James P. Ingram ----------------------------------------- James P. Ingram Director\n\/s\/ Robert E. Kresko ----------------------------------------- Robert E. Kresko Director\n\/s\/ R. Michael O'Brien, Jr. ----------------------------------------- R. Michael O'Brien, Jr. Director\nEXHIBIT INDEX -------------\nExhibit Number Description - -------------- --------------------------------------------------------------\n3.1 Articles of Incorporation dated June 12, 1984, are incorporated by reference to Exhibit 3(a) to the Registration Statement on Form S-11 under the Securities Act of 1933 (File No. 2-91851).\n3.2 Bylaws of the Registrant, as amended, are incorporated by reference to Exhibit 3.2 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1987, as filed pursuant to Rule 13a-1 under The Securities Exchange Act of 1934 (File no. 0-13754).\n10.1 Advisory Agreement between Nooney Advisors Ltd., L.P. and the Registrant is incorporated by reference to Exhibit 10(a) to Amendment No. 2 to the Registration Statement on Form S-11 under the Securities Act of 1933 (File No. 2-91851).\n10.2 Dividend Reinvestment Agreement between Boatmen's Trust Company and the Registrant is incorporated by reference to Exhibit 10(d) to Amendment No. 1 to the Registration Statement on Form S-11 under the Securities Act of 1933 (File No. 2-91851).\n10.3 Dividend Reinvestment Plan is incorporated by reference to pages A-1 - A-3 of the Prospectus of the Registrant dated September 25, 1984, as supplemented and filed pursuant to Rule 424(c) under the Securities Act of 1933 (File No. 2-91851).\n10.4 Management Contract between the Registrant and Nooney Management Company (now Nooney Krombach Company) dated March 28, 1985, is incorporated by reference to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1985, as filed pursuant to Rule 13a-1 under the Securities Exchange Act of 1934 (File No. 0-13754).\n13 1995 Annual Report to Shareholders. Except for those portions expressly incorporated by reference in this Form 10-K, the 1995 Annual Report to Shareholders is furnished for the information of the Commission and is not to be deemed \"filed\" as part of this Form 10-K.\n27 Financial Data Schedule (provided for the information of the Securities and Exchange Commission only)\n99.1 Financial Statement Schedules.","section_15":""}
{"filename":"746481_1995.txt","cik":"746481","year":"1995","section_1":"Item 1 - Business - -----------------\na. General Development of Business -------------------------------\nUNB Corp. (Registrant) was incorporated under the laws of the State of Ohio during 1983. Its principal business is to act as a bank holding company for the United National Bank & Trust Company (Bank). Effective October 1, 1984, in a transaction accounted for as an internal reorganization, the Registrant acquired all of the outstanding stock of the United National Bank & Trust Company. The Corporation exchanged two shares of common stock for each previously outstanding share of the United National Bank & Trust Company. The Registrant did not have any operations prior to the business combination. UNB Corp. is registered under the Bank Holding Company Act of 1956, as amended. A substantial portion of UNB Corp.'s revenue is derived from cash dividends paid by the Bank.\nb. Financial Information About Industry Segments ---------------------------------------------\nThe Registrant and its subsidiary bank are engaged in commercial and retail banking. Reference is hereby made to Item 1(e), \"Statistical Disclosure\", and Item 8 of this Form 10-K for financial information pertaining to the Registrant's banking business.\nc. Description of UNB Corp.'s Business -----------------------------------\nThe Bank is a full-service bank offering a wide range of commercial and personal banking services primarily to customers in northern Stark and southern Summit Counties of Ohio. These services include a broad range of loan, deposit and trust products and various miscellaneous services. Loan products include commercial and commercial real estate loans, a variety of mortgage and construction loan products, installment loans, home equity lines of credit, MasterCard lines of credit, accounts receivable and lease financing. Deposit products include interest and non-interest bearing checking accounts, various savings accounts, certificates of deposit, and IRAs. The Trust Department provides services in the areas of employee benefits and personal trusts. Miscellaneous services include safe deposit boxes, night depository, United States savings bonds, traveler's checks, money orders and cashier checks, bank-by-mail service, money transfers, wire services, utility bill payments and collections, notary public services, discount brokerage services and alternative investments. In addition, the Bank has correspondent relationships with major banks in New York, Pittsburgh and Detroit pursuant to which the Bank receives various financial services. The Bank accounts for substantially all (98%) of UNB Corp.'s consolidated assets at December 31, 1995.\nThe Bank's primary lending area consists of Stark County, Ohio, and its contiguous counties. Loans outside the primary lending area are considered for creditworthy applicants. Lending decisions are made in accordance with written loan policies designed to maintain loan quality.\nRetail lending products are comprised of credit card loans, overdraft lines, personal lines of credit and installment loans. Credit cards are unsecured credit accounts, on which the credit limits are determined by analysis of two criteria, the borrowers debt service and gross income. Overdraft lines of credit are lines attached to checking accounts to cover overdrafts and\/or allow customers to write themselves a loan. Credit limits are based on a percentage of gross income and average deposits. Personal lines of credit\ninclude lines secured by junior mortgages (home equity) and Private Banking lines which are generally secured by junior mortgages but may be unsecured or secured by other collateral. The lines have a five year draw period and may then be renewed or amortized over ten years. Credit limits are determined by comparing three criteria, appraised value, debt service and gross income. Criteria for determining credit limits on private banking products also consider the applicant's annual income, net worth and average deposits. Installment loans include both direct and indirect loans. The term can range from three to 180 months, depending upon the collateral which includes new and used automobiles, boats and recreational vehicles as well as junior mortgages and unsecured personal loans. Retail lending underwriting guidelines include evaluating the entire credit using the Five C's of Credit, character, capacity, capital, condition and collateral. Credit scoring, analysis of credit bureau ratings and debt to income ratios are the major tools used by the lender in the underwriting process.\nThe Bank offers a variety of mortgage loan programs, including a variety of fixed and adjustable rate mortgages ranging from 120 to 360 months. The Bank also offers some specialty products such as jumbo mortgages, Mortgage Assistance Programs for low income individuals, construction and bridge loans. The underwriting guidelines include those for consumer loans and those necessary to meet secondary market guidelines. The Bank may sell loans to the secondary market when it deems it profitable and desirable to do so. Residential real estate decisions focus on loan to value limits, debt to income ratio, housing to income ratio, credit history, and in some cases, whether private mortgage insurance is obtained.\nBusiness credit products include commercial loans and commercial real estate loans, Business Manager and leases. Commercial loans include lines and letters of credit, fixed, and adjustable rate term loans, demand and time notes. Commercial real estate loans include fixed, and adjustable mortgages. Loans are generally to owner occupied businesses. The portfolio also includes loans to churches, residential rental property, shopping plazas and residential development loans. Loans to businesses often entail greater risk because the primary source of repayment is typically dependent upon adequate cash flow. Cash flow of a business can be subject to adverse conditions in the economy or a specific industry. Should cash flow fail, the lender looks to the assets of the business and\/or the ability of the comakers to support the debt. Commercial lenders consider the Five C's of Credit, character, capacity, capital, condition and collateral in making commercial credit decisions. Business Manager is a system which the Bank uses to assist creditworthy businesses with accounts receivable management. It is a hybrid program combining funding and billing with cash management, monitoring and reporting functions. The Bank purchases creditworthy receivables at full recourse with a flexible reserve. The Bank may earn a discount, interest and\/or fees. The Bank has provided both direct and indirect leasing on a limited basis. The direct leases are for specific equipment and may be open-end or closed-end. Indirect leases are established by granting a lease line to a dealer, while the Bank holds title and files a UCC lien for an assignment of the lease. Each vehicle has its own amortization.\nIn addition to the underwriting guidelines followed for specific loan types, the Bank has underwriting guidelines common to all loan types. With regard to collateral, the Bank follows supervisory limits set forth in Regulation H for transactions secured by real estate. Loans in excess of these guidelines are reported to the Board of Directors on a monthly basis. Loans not secured by real estate are analyzed on a loan by loan basis, based on collateral type guidelines set forth in the loan policy. Appraisal policies follow and comply with provisions outlined under Title XI of FIRREA. All appraisals are done by\noutside independent appraisers approved by the Board of Directors. The Bank, as a general rule, gets an appraisal on all real estate transactions even when not required by Title XI. The Bank may occasionally rely on a tax appraisal. Senior Loan Committee has the option of requiring equipment appraisals. Approval procedures include loan authorities approved by the Board of Directors for individual lenders and loan committees. Retail and residential loans are centrally underwritten by their respective departments. Business credits can be approved by the individual commercial lender or taken to Loan Committee if it exceeds individual approval limits. Senior Loan Committee approves aggregate loan commitments in excess of the lender's authority up to $1 million. Executive Loan Committee approves aggregate loan commitments in excess of $1 million up to the Bank's legal lending limit. Loans to Directors and Executive Officers are approved by the Board of Directors. Business loans within a lender's authority are reported in the Senior Loan Committee minutes. Retail and residential real estate loan transactions are also reported to Senior Loan Committee at certain dollar limits. Exceptions and\/or overrides are tracked and reported to Senior Loan Committee.\nThe Loan Quality Review Committee meets on a monthly basis. The Committee reviews Bank lending trends, the Past Due Report, the Watch List and various other reports in order to monitor and maintain credit quality. The Committee also reviews on a relationship basis, customers on the Bank's Watch List and credits with aggregate commitments in excess of $1 million.\nRevenues from loans accounted for 75%, 73%, and 71% of consolidated revenues in 1995, 1994, and 1993, respectively. Revenues from interest and dividends on investment and mortgage-backed securities accounted for 14%, 13%, and 14%, of consolidated revenues in 1995, 1994, and 1993, respectively.\nThe Registrant formed the United Credit Life Insurance Company (United Credit Life) to engage in the underwriting of credit life and credit accident and health insurance directly related to the extension of credit by the Bank to its customers. United Credit Life commenced business in May, 1986. The insurance is currently written by Union Fidelity Life Insurance Company; however, United Credit Life has entered into reinsurance treaties with Union Fidelity Life Insurance Company whereby United Credit Life assumes up to $25,000 of liability on each life policy.\nIn September, 1994, the Bank purchased four branch offices of the former TransOhio Federal Savings Bank headquartered in Cleveland, Ohio, from the Resolution Trust Corporation (RTC). Included in this purchase were $70.4 million in deposits and other liabilities assumed and $0.6 million in cash, premises and equipment, and other assets. The intangible assets acquired in the transaction amounted to $6.6 million.\nThe business of the Registrant is not seasonal to any material degree, nor is it dependent upon a single or small group of customers whose loss would result in a material adverse effect on the Registrant or its subsidiaries.\nRegulation and Supervision --------------------------\nUNB Corp. is a bank holding company under the Bank Holding Company Act of 1956, as amended, which restricts the activities of the Corporation and the acquisition by the Corporation of voting stock or assets of any bank, savings association or other company. The Corporation is also subject to the reporting requirements of, and examination and regulation by, the Board of Governors of the Federal Reserve system (Federal Reserve Board). Subsidiary banks of a bank holding company are subject to certain restrictions imposed by the Federal Reserve Act on transactions with affiliates, including any loans\nor extensions of credit to the bank holding company or any of its subsidiaries, investments in the stock or other securities thereof and the taking of such stock or securities as collateral for loans to any borrower; the issuance of guarantees, acceptances or letters of credit on behalf of the bank holding company and its subsidiaries; purchases or sales of securities or other assets; and the payment of money or furnishing of services to the bank holding company and other subsidiaries. Banks and bank holding companies are prohibited from engaging in certain tie-in arrangements in connection with extensions of credit or provision of property or services.\nBank holding companies are prohibited from acquiring direct or indirect control of more than 5% of any class of voting stock or substantially all of the assets of any bank holding company without the prior approval of the Federal Reserve. In addition, acquisitions across state lines are limited to acquiring banks in those states specifically authorizing such interstate acquisitions. However, in September 1995, federal law permitted interstate acquisitions of banks, if the acquired bank retains its separate charter.\nAs a national bank, United National Bank & Trust Co. is supervised and regulated by the Comptroller of the Currency (Comptroller). The deposits of the Bank are insured by the Bank Insurance Fund (BIF) and the deposits assumed from savings and loans in 1994 and 1991 are insured by the Savings Association Insurance Fund (SAIF) of the Federal Deposit Insurance Corporation (FDIC). The Bank is subject to the applicable provisions of the Federal Deposit Insurance Act. Various requirements and restrictions under the laws of the United States and the State of Ohio affect the operations of the Bank, including requirements to maintain reserves against deposits, restrictions on the nature and amount of loans which may be made and the interest which may be charged thereon, restrictions relating to investments and other activities, limitations on credit exposure to correspondent banks, limitations on activities based on capital and surplus, limitations on payment of dividends, and limitations on branching. Under current laws, the Bank may establish branch offices throughout the State of Ohio. Pursuant to recent federal legislation, the Bank may branch across state lines, if permitted by the law of the other state. In addition, effective June 1997, such interstate branching by the Bank will be authorized, unless the law of the other state specifically prohibits the interstate branching authority granted by federal law.\nThe Federal Reserve Board has adopted risk-based capital guidelines for bank holding companies. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-based assets by assigning assets and off-balance sheet items to broad risk categories. The required minimum ratio of capital to risk-weighted assets (including certain off-balance sheet items, such as standby letters of credit) was 10.00% at December 31, 1995 as disclosed in Note 14 of UNB Corp.'s 1995 Annual Report (See Exhibit 13). At least half of the total regulatory capital is to be comprised of common stockholders' equity, including retained earnings, noncumulative perpetual preferred stock, a limited amount of cumulative perpetual preferred stock, and minority interests in equity accounts of consolidated subsidiaries less goodwill (Tier 1 capital). The remainder (Tier 2 capital) may consist of, among other things, mandatory convertible debt securities, a limited amount of subordinated debt, other preferred stock and a limited amount of allowance for loan and lease losses. The Federal Reserve Board has also imposed a minimum leverage ratio (Tier 1 capital to total assets) of 4% for bank holding companies that meet certain specified conditions, including no operational, financial or supervisory deficiencies, and including those having the highest regulatory (CAMEL) rating. The minimum leverage ratio is 1.0-2.0% higher for other holding companies based on their\nparticular circumstances and risk profiles and those experiencing or anticipating significant growth. National banks are subject to similar capital requirements adopted by the Comptroller.\nUNB Corp. and its subsidiaries currently satisfy all regulatory capital requirements. Failure to meet the capital guidelines could subject a banking institution to a variety of enforcement remedies available to federal regulatory authorities, including dividend restrictions and the termination of deposit insurance by the FDIC.\nUnder an outstanding proposal of the Comptroller and the FDIC, the Bank may be required to have additional capital if its interest rate risk exposure exceeds acceptable levels provided for in the regulation. In addition, those regulators have established regulations governing prompt corrective action to resolve capital deficient banks. Under these regulations, banks which become undercapitalized become subject to mandatory regulatory scrutiny and limitations, which increase as capital continues to decrease. Such banks are also required to file capital plans with their primary federal regulator, and their holding companies must guarantee the capital shortfall up to 5% of the assets of the capital deficient bank at the time it becomes undercapitalized.\nThe ability of UNB Corp. to obtain funds for the payment of dividends and for other cash requirements is largely dependent on the amount of dividends which may be declared by the Bank. However, the Federal Reserve expects UNB Corp. to serve as a source of strength to its subsidiaries, which may require it to retain capital for further investment in the subsidiaries, rather than for dividends for shareholders of the Corporation. Generally, United National Bank & Trust Co. must have the approval of its regulatory authority if a dividend in any year would cause the total dividends for that year to exceed the sum of current year's net profits and retained net profits for the preceding two years, less required transfers to surplus. A national bank may not pay a dividend in an amount greater than its net profits then on hand after deducting its losses and bad debts or, if less than 1\/10 of net profits for the preceding six months, for a quarterly or semiannual dividend, or the preceding year for an annual dividend, was transferred to surplus. The Bank may not pay dividends to the Corporation if, after such payment, it would fail to meet the required minimum levels under the risk-based capital guidelines and the minimum leverage ratio requirements. Payment of dividends by the Bank may be restricted at any time at the discretion of the regulatory authorities, if they deem such dividends to constitute an unsafe and\/or unsound banking practice or if necessary to maintain adequate capital for the bank. These provisions could have the effect of limiting the Corporation's ability to pay dividends on its outstanding common shares.\nManagement is not aware of any recommendations by regulatory authorities which, if they were to be implemented, would have a material effect on the Registrant.\nGovernment Monetary Policies ----------------------------\nThe earnings and growth of UNB Corp. are affected not only by general economic conditions, but also by the fiscal and monetary policies of the federal government and its agencies and regulatory authorities, particularly the Federal Reserve Board. Its policies influence the growth and mix of bank loans, investments and deposits and the interest rates earned and paid thereon, and thus have an effect on earnings of the Corporation.\nDue to the changing conditions in the economy and the activities of monetary and fiscal authorities, no predictions can be made regarding future changes in interest rates, credit availability or deposit levels.\nCompetition -----------\nThe Bank competes with nine state and national banks located in Stark and Summit Counties as well as an additional four in Summit County alone. The Bank also competes with a large number of other financial institutions, such as savings and loan associations, savings banks, insurance companies, consumer finance companies, credit unions, mortgage banking companies, and commercial finance and leasing companies, for deposits, loans and financial services business. Money market mutual funds, brokerage houses, and similar organizations provide many of the financial services offered by the Bank. Many competitors have substantially greater resources than the Bank. In the opinion of management, the principal methods of competition are the rates of interest charged for loans, the rates of interest paid for deposits and borrowing, the fees charged for services, the availability and quality of services provided and the convenience of its branch locations.\nEffects of Compliance with Environmental Regulations ----------------------------------------------------\nCompliance with Federal, State and local provisions regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment has not had a material effect upon the capital expenditures, earnings or competitive position of the Registrant or its subsidiaries. The Registrant anticipates, based on the nature of its business, that it will have no material capital expenditures for the purpose of protecting the environment in the foreseeable future. From time to time the Bank may be required to make capital expenditures for environmental control facilities related to properties acquired through foreclosure proceedings. Currently the Bank owns such a parcel of OREO property in the northwest quadrant of Stark County. The Bank continues to negotiate with a large national petroleum company, owner of the facility at the date it was taken out of service and also the party responsible for the cleanup according to the State of Ohio's Bureau of Underground Storage Tanks (BUSTER) regulations. Environmental assessments by the Bank and the petroleum company have been filed with the State agency, which has requested further validation of the Bank's assessment. Upon completion of the second assessment report, the Bank will ask for another ruling by the State. The outcome will determine whether the Bank can proceed with the marketing of the property for sale and\/or any legal action against the national oil company to remediate the contamination of the property. The estimated costs, should they become the responsibility of the Bank, are not material to the business or financial condition of the Registrant and have been set up as an allowance against the property's value on the Registrant's Consolidated Balance Sheet.\nEmployees ---------\nAs of December 31, 1995, UNB Corp. and its subsidiaries had 263 full-time employees and 65 part-time employees. UNB Corp. and its subsidiaries are not a party to any collective bargaining agreement and management considers its relationship with its employees to be good.\nd. Financial Information About Foreign and Domestic Operations and Export ---------------------------------------------------------------------- Sales -----\nThe Registrant and its subsidiaries do not have any offices located in foreign countries and they have no foreign assets, liabilities, or related income and expense for the years presented.\ne. Statistical Disclosure ----------------------\nThe following section contains certain financial disclosures related to the Registrant as required under the Securities and Exchange Commission's Industry Guide 3, \"Statistical Disclosures by Bank Holding Companies\", or a specific reference as to the location of the required disclosures in the Registrant's 1995 Annual Report to Shareholders, portions of which are incorporated in this Form 10-K by reference.\nUNB CORP.'S STATISTICAL INFORMATION -----------------------------------\nI. DISTRIBUTION OF ASSETS, LIABILITIES, AND SHAREHOLDERS' EQUITY; INTEREST ----------------------------------------------------------------------- RATES AND INTEREST DIFFERENTIAL -------------------------------\nA. & B. The average balance sheet information and the related analysis of net interest earnings for the years ending December 31, 1995, 1994, and 1993 are included in Table 4 - \"Average Balance Sheet and Related Yields\", within Management's Discussion and Analysis of Financial Condition and Results of Operations found on page 31 of the Registrant's 1995 Annual Report to Shareholders and is incorporated into this Item I by reference.\nAll interest is reported on a fully taxable equivalent basis using a marginal tax rate of 35%. Nonaccruing loans, for the purpose of the computations, are included in the daily average loan amounts outstanding. Loan fees in the amount of $2,901,438 are included in interest on loans.\nC. Tables setting forth the effect of volume and rate changes on interest income and expense for the years ended December 31, 1995 and 1994 are included in Table 2 - \"Changes in Net Interest Differential - Rate\/Volume Analysis\", within Management's Discussion and Analysis of Financial Condition and Results of Operations found on Page 29 of the Registrant's 1995 Annual Report to Shareholders and is incorporated into this Item I by reference. For purposes of these tables, changes in interest due to volume and rate were determined as follows:\nVolume Variance - change in volume multiplied by the previous year's rate.\nRate Variance - change in rate multiplied by the previous year's volume.\nRate\/Volume Variance - change in volume multiplied by the change in rate.\nThe rate\/volume variance was allocated to volume variance and rate variance in proportion to the relationship of the absolute dollar amount of the change in each.\nII. INVESTMENT PORTFOLIO --------------------\nA. Investment Securities\nThe carrying value of investment and mortgage-backed securities at the dates indicated are summarized below:\nB. The carrying value and weighted average interest yield for each investment category listed in Part A at December 31, 1995 which are due (1) in one year or less, (2) after one year through five years, (3) after five years through ten years, and (4) after ten years are presented in Note 3 - Securities, found on page 18 in the Notes to Consolidated Financial Statements in the Registrant's 1995 Annual Report to Shareholders and is incorporated herein by reference. The weighted average yields have been computed by dividing the total interest income adjusted for amortization of premiums or accretion of discount over the life of the security by the par value of the securities outstanding. The weighted average yields of tax exempt obligations are presented on an after tax basis.\nC. Excluding those holdings of the investment portfolio in U.S. Treasury Securities and other agencies and corporations of the U.S. Government, there were no investments in securities of any one issuer which exceeded 10% of the consolidated shareholder's equity of the Registrant at December 31, 1995.\nIII. LOAN PORTFOLIO --------------\nA. Types of Loans - Total loans on the balance sheet are comprised of the following classifications at December 31,\nThe dollar amounts of loans contained in the Commercial real estate category are not available for the years ending December 31, 1992 and 1991. Balances for this category of loans are included in the Commercial and Residential real estate loan categories for those years.\nB. Maturities and Sensitivities of Loans to Changes in Interest Rates - The following is a schedule of contractual maturities and repayments excluding residential real estate mortgage and installment loans, as of December 31, 1995:\nThe following is a schedule of fixed rate and variable rate commercial and commercial real estate loans due after one year (variable rate loans are those loans with floating or adjustable interest rates):\nC. Risk Elements\n1. Nonaccrual, Past Due and Restructured Loans - The following schedule summarizes nonaccrual, past due, and restructured loans:\nFor the year ended December 31, 1995, $17,799 of interest income would have been earned under the original terms of those loans classified as nonaccrual. The policy for placing loans on nonaccrual status is to cease accruing interest on loans when management believes that the collection of interest is doubtful, or when loans are past due as to principal or interest ninety days or more. The loans must be brought current and kept current for six consecutive months before being removed from nonaccrual status. When loans are charged-off, any accrued interest recorded in the current fiscal year is charged against interest income. The remaining balance is treated as a loan charge-off.\nThe Corporation adopted SFAS No. 114 and SFAS No. 118 effective January 1, 1995. At December 31, 1995, loans totaling $566 thousand were classified as impaired. All loans classified as impaired at December 31, 1995 were also classified as nonaccrual loans, and therefore the adoption of SFAS No. 114 and SFAS NO. 118 had no effect on the comparability of non-performing assets at December 31, 1995 to prior periods.\n2. Potential Problem Loans - As shown in the table above, at December 31, 1995, there are approximately $1.1 million of loans not otherwise identified which are included on management's watch list. Management's watch list includes both loans which management has some doubt as to the borrowers' ability to comply with the present repayment terms and loans which management is actively monitoring due to changes in the borrowers financial condition. These loans and their potential loss exposure have been considered in management's analysis of the adequacy of the allowance for loan losses.\n3. Foreign Outstandings - There were no foreign outstandings at December 31, 1995, 1994, or 1993.\n4. Loan Concentrations - As of December 31, 1995, indirect installment loans comprise 33.4% of loans. The dealer network from which the indirect loans are generated included 162 active relationships at December 31, 1995, the largest of which was responsible for 7% of total indirect volume for 1995. There are no additional concentrations of loans greater than 10% of total loans which are not otherwise disclosed as a category of loans pursuant to Item III. A. above. Also refer to the Note 1, Concentrations of Credit Risk, found on Page 16 of the 1995 Annual Report incorporated herein by reference.\n5. No material amount of loans that have been classified by regulatory examiners as loss, substandard, doubtful, or special mention have been excluded from the amounts disclosed as nonaccrual, past due 90 days or more, restructured, or potential problem loans.\nD. Other Interest Bearing Assets - As of December 31, 1995, there are no other interest bearing assets that would be required to be disclosed under Item III C.1 or 2 if such assets were loans. The Registrant had Other Real Estate Owned at December 31, 1995, in the amount of $325,000.\nIV. SUMMARY OF LOAN LOSS EXPERIENCE -------------------------------\nA. The following schedule presents an analysis of the allowance for loan losses, average loan data, and related ratios for the years ended December 31,\nThe allowance for loan losses balance and the provision charged to expense are judgmentally determined by management based upon the periodic review of the loan portfolio, an analysis of impaired loans, past loan loss experience, economic conditions, anticipated loan portfolio growth, and various other circumstances which are subject to change over time. In making this judgment, management reviews selected large loans as well as delinquent loans, nonaccrual loans, problem loans, and loans to industries experiencing economic difficulties. The collectability of these loans is evaluated after considering the current financial position of the borrower, the estimated market value of the collateral, guarantees, and the Company's collateral position versus other creditors. Judgments, which are necessarily subjective, as to the probability of loss and the amount of such loss, are formed on these loans, as well as other loans in the aggregate.\nB. The following schedule is a breakdown of the allowance for loan losses allocated by type of loan and related ratios:\nA comparison of allocations of the allowance for loan losses between December 31, 1995 and prior year ends shows a significant shift in the dollars allocated to each of the four loan categories. During the third quarter of 1995, a change in the methodology used to determine the allocation of the allowance for loan losses among the various loan categories was approved by the Executive Committee of the Board of Directors and instituted by management. Management will continue to use the same three methodologies it has historically used to determine the allocation of the allowance, however, it will select the single methodology that results in the highest aggregate calculation for allocation of the allowance among the various loan categories, and not the highest specific allocation for each loan category from among the three methodologies. Management believes this change reflects a more reliable analysis of the Bank's risk of loan loss.\nAt December 31, 1995, $188 thousand was specifically allocated to commercial loans in connection with the adoption of SFAS No. 114. Because management's analysis of problem loans would have provided a similar allocation prior to\nadopting SFAS No. 114, the adoption of SFAS No. 114 had no impact on the comparability of the December 31, 1995 allowance for loan loss allocation to prior periods.\nWhile management's periodic analysis of the adequacy of the allowance for loan loss may allocate portions of the allowance for specific problem loan situations, the entire allowance is available for any loan charge-offs that occur.\nV. DEPOSITS -------- The following is a schedule of average deposit amounts and average rates paid on each category for the periods included:\nThe following table summarizes time deposits issued in amounts of $100,000 or more as of December 31, 1995 by time remaining until maturity:\nVI. RETURN ON EQUITY AND ASSETS ---------------------------\nInformation required by this section is incorporated by reference to the information appearing in the table under the caption \"Five-Year Summary of Selected Data\" located on Page 38 of the Registrant's 1995 Annual Report to Shareholders.\nVII. SHORT-TERM BORROWING --------------------\nInformation required by this section is incorporated by reference to Note 8 - \"Short-term Borrowing\" on Page 20 of the 1995 Annual Report to Shareholders incorporated herein by reference.\nItem 2","section_1A":"","section_1B":"","section_2":"Item 2 - Properties -------------------\nThe Bank's main office in the United Bank Building at 220 Market Avenue South, Canton, Ohio, housing its executive offices and the Corporation's executive offices, is leased through 2003 with five three-year options extending through 2018. The properties occupied by fourteen of the Bank's branches are owned by the Bank, while properties occupied by its remaining six branches are leased with various expiration dates running through 2002 with renewal options. Property has been purchased to consolidate the two branch offices in Hartville, Ohio, into a new facility with construction to begin the first quarter of 1996.\nThe Bank's Operations Center, at 624 Market Avenue North, Canton, Ohio, is owned by the Bank which leases approximately 13,000 square feet of this facility to a law firm. There is no mortgage debt owing on any of the above property owned by the Bank. A listing of all branch offices is located under the caption \"Banking Centers\" found on page 8 of the Registrant's 1995 Annual Report to Shareholders, and is incorporated herein by reference. With the new Hartville facility and scheduled renovations and enhancements to the Bank's Belden Village, Wales Square and Beach City offices as well as its Operations Center, management considers its properties to be satisfactory for its current operations.\nItem 3","section_3":"Item 3 - Legal Proceedings - --------------------------\nThe Company is subject to various pending and threatened lawsuits in which claims for monetary damages are asserted in the ordinary course of business. While any litigation involves an element of uncertainty, in the opinion of management, liabilities, if any, arising from such litigation or threat thereof will not have a material 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 December 31, 1995, there were no matters submitted to a vote of security holders.\nPART II\nItem 5","section_5":"Item 5 - Market Price of and Dividends on the Common Equity and Related - ----------------------------------------------------------------------- Shareholder Matters -------------------\nThe information required under this item is incorporated by reference to the information appearing under the caption \"Market Price Ranges for Common Stock\" located on Page 37 of the Registrant's 1995 Annual Report to Shareholders. In addition, attention is directed to the caption \"Capital Resources\" within Management's Discussion and Analysis located on page 33 of the Registrant's 1995 Annual Report to Shareholders and to Note 14 \"Commitments and Contingencies\" located on page 23 therein. Such information is incorporated herein by reference.\nItem 6","section_6":"Item 6 - Selected Financial Data - --------------------------------\nThe information required under this item is incorporated by reference to the information appearing under the caption \"Five Year Summary of Selected Data\"\nlocated on page 38 of the 1995 Annual Report to Shareholders. See Note 1 under the caption \"Allowance for Loan Losses\" on page 15 and Note 4 - Loans on page 19 of the 1995 Annual Report to Shareholders, incorporated herein by reference for a discussion of the impact of the adoption on January 1, 1995 of SFAS No. 114 and No. 118, \"Accounting by Creditors for Impairment of a Loan\". See Note 2 on page 17 of the 1995 Annual Report to Shareholders for a discussion of the impact on the Registrant of the acquisition of certain assets and assumption of certain deposits and other liabilities of the former TransOhio Federal Savings Bank from the Resolution Trust Company in 1994. See Note 1 under the caption \"Federal Income Taxes\" on page 16 of the Annual Report to Shareholders for a discussion of the impact of adopting SFAS No. 109, \"Accounting for Income Taxes\", on the Registrant's Consolidated Statement of Income in 1993.\nItem 7","section_7":"Item 7 - Management's Discussion and Analysis of Financial Condition and - ------------------------------------------------------------------------ Results of Operations ---------------------\n\"Management's Discussion and Analysis of Financial Condition and Results of Operations\" appears on pages 27 through 36 of the Registrant's 1995 Annual Report to Shareholders and is incorporated herein by reference.\nItem 8","section_7A":"","section_8":"Item 8 - Financial Statements and Supplementary Financial Data - --------------------------------------------------------------\nThe Registrant's Report of Independent Auditors and Consolidated Financial Statements are listed below and are incorporated herein by reference to UNB Corp.'s 1995 Annual Report to Shareholders (Exhibit 13), pages 10 through 26. The supplementary financial information specified by Item 302 of Regulation S-K, selected quarterly financial data, is included in Note 17 to the consolidated financial statements found on page 26.\nReport of Independent Auditors\nConsolidated Balance Sheets December 31, 1995 and 1994\nConsolidated Statements of Income For the three years ended December 31, 1995\nConsolidated Statements of Changes in Shareholders' Equity For the three years ended December 31, 1995\nConsolidated Statements of Cash Flows For the three years ended December 31, 1995\nNotes to Consolidated Financial Statements\nItem 9","section_9":"Item 9 - Changes in and Disagreements with Accountants on Accounting and - ------------------------------------------------------------------------ Financial Disclosure --------------------\nCrowe, Chizek and Company LLP, Certified Public Accountants, served as independent public accountants for the purpose of auditing the Corporation's Annual Consolidated Financial Statements and for the preparation of consolidated tax returns for the fiscal years ending December 31, 1995, 1994, and 1993. The appointment of independent public accountants is approved annually by the Board of Directors. For the year 1996, the Board of Directors has again authorized the engagement of Crowe, Chizek and Company LLP as independent auditors.\nPART III\nInformation relating to the following items is included in the Registrant's definitive proxy statement for the annual meeting of shareholders to be held Tuesday, April 16, 1996, (\"1995 Proxy Statement\") filed with the Commission pursuant to Section 14(A) of the Securities Exchange Act of 1934 and is incorporated by reference into this Form 10-K Annual Report (Exhibit 22).\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 - --------------------------------------------------------\nPART IV\nItem 14","section_14":"Item 14 - Exhibits, Financial Statement Schedules and Reports on Form 8-K - --------------------------------------------------------------------------\nA. Financial Statement Schedules -----------------------------\n1. Financial Statements --------------------\nThe following consolidated financial statements of the Registrant appear in the 1995 Annual Report to Shareholders (Exhibit 13) on the pages referenced and are specifically incorporated by reference under Item 8 of this Form 10-K:\n2. Financial Statement Schedules -----------------------------\nFinancial statement schedules are omitted as they are not required or are not applicable, or the required information is included in the financial statements found in the Registant's 1995 Annual Report to Shareholders.\n3. Exhibits -------- Reference is made to the Exhibit Index which is found on Page 22 of this Form 10-K.\nB. Reports on Form 8-K -------------------\nNo reports on Form 8-K were filed during the last quarter of the year ending December 31, 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.\nUNB Corp.\nBy \/s\/ Robert L. Mang ---------------------------------- Robert L. Mang, President and CEO\nDate March 25, 1996 -----------------\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nSIGNATURES (continued) UNB Corp.\nEXHIBIT INDEX --------------","section_15":""}
{"filename":"78716_1995.txt","cik":"78716","year":"1995","section_1":"ITEM 1. BUSINESS\nThe description of business contained in the Annual Report to Shareholders for the year ended August 31, 1995 is incorporated herein by reference.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe description of properties contained in the Annual Report to Shareholders for the year ended August 31, 1995 is incorporated herein by reference.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nNo material legal proceedings\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nMarket information for the Registrant's Common Stock contained in the Annual Report to Shareholders for the year ended August 31, 1995 is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nSelected financial data contained in the Annual Report to Shareholders for the year ended August 31, 1995 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 contained in the Annual Report to Shareholders for the year ended August 31, 1995 is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe consolidated financial statements of the Registrant, together with the report thereon of KPMG Peat Marwick LLP contained in the Annual Report to Shareholders for the year ended August 31, 1995 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\nReference is made to registrant's definitive proxy statement to be filed with the Commission pursuant to Regulation 14(a) not later than December 29, 1995; and the information responsive to the item is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nReference is made to registrant's definitive proxy statement to be filed with the Commission pursuant to Regulation 14(a) not later than December 29, 1995; and the information responsive to the item is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nReference is made to registrant's definitive proxy statement to be filed with the Commission pursuant to Regulation 14(a) not later than December 29, 1995; and the information responsive to the item is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nReference is made to registrant's definitive proxy statement to be filed with the Commission pursuant to Regulation 14(a) not later than December 29, 1995; and the information responsive to the item is incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) 1. Financial Statements\nThe consolidated financial statements of Pioneer Hi-Bred International, Inc. and subsidiaries filed are listed on page 4.\n(a) 2. Financial Statement Schedules\nThe financial statement schedules of Pioneer Hi-Bred International, Inc. and subsidiaries filed are listed on page 4.\n(a) 3. Exhibits\nThe exhibits to the Annual Report of Pioneer Hi-Bred International, Inc. filed are listed on page 7.\n(b) Reports on Form 8-K\nNo report on Form 8-K was filed during the fourth quarter of the year ended August 31, 1995.\nFINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES OF PIONEER HI-BRED INTERNATIONAL, INC. FOR THE FISCAL YEAR ENDED AUGUST 31, 1995\nINDEX\nFinancial Statements\nThe following consolidated financial statements of Pioneer Hi-Bred International, Inc. and subsidiaries are incorporated by reference in Part II, Item 8:\nIndependent Auditors' Report Consolidated Balance Sheets - August 31, 1995 and 1994 Consolidated Statements of Income - years ended August 31, 1995, 1994 and 1993 Consolidated Statements of Shareholders' Equity - years ended August 31, 1995, 1994 and 1993 Consolidated Statements of Cash Flows - years ended August 31, 1995, 1994 and Notes to Consolidated Financial Statements\nPage\nFinancial Statement Schedules\nThe following financial statement schedules of Pioneer Hi-Bred International, Inc. and subsidiaries are submitted in response to Part IV, Item 14:\nIndependent Auditors' Report 5\nSchedule II - Valuation and Qualifying Accounts 6\nExhibits to the Annual Report 7\nAll other financial statement schedules have been omitted as not required, not applicable, or because all the data are included in the financial statements.\nIndependent Auditors' Report\nTO THE SHAREHOLDERS PIONEER HI-BRED INTERNATIONAL, INC. DES MOINES, IOWA\nUnder date of October 13, 1995, we reported on the consolidated balance sheets of Pioneer Hi-Bred International, Inc. and subsidiaries as of August 31, 1995 and 1994, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the years in the three-year period ended August 31, 1995, as contained in the 1995 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 1995. In connection with our audits of the aforementioned consolidated financial statements, we also have audited the related 1995, 1994 and 1993 financial statement schedule II. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement schedule based on our audits.\nIn our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.\nKPMG Peat Marwick LLP\nDes Moines, Iowa October 13, 1995\nPIONEER HI-BRED INTERNATIONAL, INC.\nSCHEDULE II-VALUATION AND QUALIFYING ACCOUNTS (In millions)\nINDEX\nExhibits to Annual Report on Form 10-K Year Ended August 31, 1995 PIONEER HI-BRED INTERNATIONAL, INC.\nPage\nExhibit 3--Articles of incorporation and by-laws 8-29\nExhibit 4--Rights Agreement, incorporated herein by reference to Exhibit 1 of the Company's Form 8-A\/A-1 filed March 14, 1995\nExhibit 10--Material Contracts Supplemental Executive Retirement Plan, incorporated herein by reference to Exhibit 10 of the Company's 1986 Annual Report on Form 10-K (file #0-7908) Restricted Stock Plan* Deferred Compensation Plan* Annual Deferred Compensation Plan* Consulting Agreement with a Director 30\nExhibit 11--Statement re: Computation of earnings per share 31\nExhibit 13--Annual Report to Shareholders for the fiscal year ended August 31, 1995\nDescription of the Company's business incorporated by reference 32-34\nConsolidated net sales and operating income (loss) by product statement incorporated by reference 35\nResearch and product development incorporated by reference 36\nDescription of properties incorporated by reference 37-38\nMarket for the Registrant's common stock incorporated by reference 39\nSelected financial data incorporated by reference 40\nManagement's discussion and analysis of financial condition and results of operations incorporated by reference 41-52\nConsolidated financial statements of the Registrant, together with the report thereon incorporated by reference 53-70\nExhibit 21--Subsidiaries of Registrant 71-74\nExhibit 27--Financial data schedule 78\n* Incorporated herein by reference to Exhibit 10 of the Company's 1993 Annual Report on Form 10-K\nEXHIBIT 3\nSECOND RESTATED AND AMENDED ARTICLES OF INCORPORATION OF PIONEER HI-BRED INTERNATIONAL, INC.\nTO THE SECRETARY OF STATE OF THE STATE OF IOWA:\nPursuant to the provisions of Section 490.1007 of the Iowa Business Corporation Act, Chapter 490, Code of Iowa, the undersigned Corporation adopts the following Second Restated and Amended Articles of Incorporation\nARTICLE I\nThe name of the corporation shall be PIONEER HI-BRED INTERNATIONAL, INC., and its principal place of business shall be in the City of Des Moines, Polk County, Iowa.\nARTICLE II\nThe duration of the Corporation's existence hereunder is perpetual.\nARTICLE III\nThe purpose or purposes for which the Corporation is organized are: This Corporation shall have unlimited power to engage in and to do any lawful act concerning any or all lawful businesses for which corporations may be organized under Chapter 490 of the Code of Iowa.\nARTICLE IV\nA. The aggregate amount of authorized capital stock of this Corporation shall be $l50,000,000 divided into (i) 150,000,000 shares, consisting of one class designated as common and having a par value of One Dollar ($1.00) per share, and (ii) 10,000,000 shares, consisting of one class designated as serial preferred without par value.\nB. 1. Each outstanding share of common stock shall entitle the holder thereof to five votes on each matter properly submitted to the holders of shares of common stock for their vote, consent, waiver, release or other action; except that no holder shall be entitled to exercise more than one vote on any such matter in respect of any share of common stock with respect to which there has been a change in beneficial ownership during the thirty-six (36) months immediately preceding the date on which a determination is made of the shareholders who are entitled to take any such action.\n2. A change in beneficial ownership of an outstanding share of common stock shall be deemed to have occurred whenever a change occurs in any person or group of persons who, directly or indirectly, through any contract, arrangement, understanding, relationship or otherwise has or shares (i) voting power, which includes the power to vote, or to direct the voting of such share; (ii) investment power, which includes the power to direct the sale or other disposition of such share; (iii) the right to receive or retain the proceeds of any sale or other disposition of such share; or (iv) the right to receive any distributions, including cash dividends, in respect of such share.\na. In the absence of proof to the contrary provided in accordance with the procedures referred to in subparagraph (4) of this paragraph B, a change in beneficial ownership shall be deemed to have occurred whenever a share of common stock is transferred of record into the name of any other person.\nb. In the case of a share of common stock held of record in the name of a corporation, general partnership, limited partnership, voting trustee, bank, trust company, broker, nominee or clearing agency, or in any other name except a natural person, if it has not been established pursuant to such procedures that there has been no change in the person or persons who direct the exercise of the rights referred to in clauses 2(i) through 2(iv) of this paragraph with respect to such share of common stock during the period of thirty-six months immediately preceding the date on which a determination is made of the shareholders who are entitled to take any action (or since November 14, 1985 for any period ending on or before November 14, 1988), then a change in beneficial ownership shall be deemed to have occurred during such period.\nc. In the case of a share of common stock held of record in the name of any person as trustee, agent, guardian or custodian under the Uniform Gifts to Minors Act as in effect in any state, a change in beneficial ownership shall be deemed to have occurred whenever there is a change in the beneficiary of such trust, the principal of such agent, the ward of such guardian or the minor for whom such custodian is acting or in such trustee, agent, guardian or custodian.\n3. Notwithstanding anything in this paragraph B to the contrary, no change in beneficial ownership shall be deemed to have occurred solely as a result of:\na. any event that occurred prior to November 14, 1985 or pursuant to the terms of any contract (other than a contract for the purchase and sale of shares of common stock contemplating prompt settlement), including contracts providing for options, rights of first refusal and similar arrangements in existence on such date to which any holder of shares of common stock is a party;\nb. any transfer of any interest in shares of common stock pursuant to a bequest or inheritance, by operation of law upon the death of any individual, or by any other transfer without valuable consideration, including a gift that is made in good faith and not for the purpose of circumventing this Article IV;\nc. any change in the beneficiary of any trust, or any distribution of a share of common stock from trust, by reason of the birth, death, marriage or divorce of any natural person, the adoption of any natural person prior to age 18 or the passage of a given period of time or the attainment by any natural person of a specific age, or the creation or termination of any guardianship or custodial arrangement;\nd. any appointment of a successor trustee, agent, guardian or custodian with respect to a share of common stock if neither such successor has nor its predecessor had the power to vote or to dispose of such share of common stock without further instructions from others, whose identities remain unchanged;\ne. any change in the person to whom dividends or other distributions in respect to a share of common stock are to be paid pursuant to the issuance or modification of a revocable dividend payment order; or\nf. except as provided in subparagraph (5) of this paragraph B, any issuance of a share of common stock by the Corporation or any transfer by the Corporation of a share of common stock held in treasury, (i.e., the person acquiring the share shall be deemed on the date of issuance or transfer by the Corporation to have continuously beneficially owned such share for thirty-six (36) months), unless otherwise determined by the Board of Directors at the time of authorizing such issuance or transfer.\n4. For purposes of this paragraph B, all determinations concerning changes in beneficial ownership, or the absence of any such change, shall be made by the Corporation. Written procedures designed to facilitate such determinations shall be established by the Corporation and refined from time to time. Such procedures shall provide, among other things, the manner of proof of facts that will be accepted and the frequency with which such proof may be required to be renewed. The Corporation and any transfer agent shall be entitled to rely on all information concerning beneficial ownership of the common stock coming to their attention from any source and in any manner reasonably deemed by them to be reliable, but neither the Corporation nor any transfer agent shall be charged with any other knowledge concerning the beneficial ownership of the common stock.\n5. In the event of any stock split or stock dividend with respect to the common stock, each share of common stock acquired by reason of such split or dividend shall be deemed to have been beneficially owned by the same person continuously from the same date as that on which beneficial ownership of the share of common stock, with respect to which such share of common stock was distributed, was acquired.\n6. Each share of common stock, whether at any particular time the holder thereof is entitled to exercise five votes for one, shall be identical to all other shares of common stock in all other respects, and together all of the common shares shall constitute a single class of shares of the Corporation.\n7. Notwithstanding any provision in this paragraph B to the contrary, if at any time the common stock will be ineligible for inclusion on the National Market System of the National Association of Securities Dealers, Inc. Automated Quotation System (or such other similar automated quotation system as may exist at the time) so long as some but not all shares of common stock have five votes per share, then, upon a determination by the Board of Directors that the provisions of this paragraph B no longer are in the best interests of the shareholders, and without any shareholder action, each outstanding share of common stock shall entitle the holder thereof to one vote on each matter properly submitted thereafter to the holders of common stock for their vote, consent, waiver, release or other action.\nC. The preferences, voting rights, if any, limitations and relative rights of the serial preferred stock are as follows:\n1. The holders of the preferred stock shall be entitled to receive dividends when and as declared by the Board of Directors at such rate as shall be fixed by resolution of the Board of Directors as hereafter provided, which dividends shall be cumulative, before any dividends shall be paid or set apart for payment on the common stock. The holders of the preferred stock shall have no rights to share in any dividend or distribution of profits or assets of the Corporation, whether in the form of cash, stock dividend or otherwise, except to the extent specifically provided herein or in said resolutions of the Board of Directors.\n2. In the event of any liquidation, dissolution or winding up of the Corporation, the holders of the preferred stock shall be entitled to be paid such amounts as shall be fixed by resolution of the Board of Directors, as hereafter provided, before any amount shall be paid on the common stock. After the payment to the holders of the preferred stock of all such amounts to which they are entitled pursuant to said resolutions of the Board of Directors, the remaining assets and funds of the Corporation shall be divided and paid to the holders of common stock. Neither the consolidation nor the merger of the Corporation with or into any other corporation or corporations, nor a reorganization of the Corporation alone, nor the sale or transfer by the Corporation of all or any part of its assets, shall be deemed to be a liquidation, dissolution or winding up of the Corporation for the purpose of this subparagraph (2).\n3. The preferred stock shall be subject to redemption in whole or in part at such price and at such time and place and in such manner as the Board of Directors shall determine.\n4. Each share of preferred stock shall be entitled to such privileges of conversion, if any, as are provided and declared by the Board of Directors at such time as the issue of which it is a part is established by the Board of Directors.\nThe preferred stock may be issued from time to time in series. Authority is hereby expressly granted to the Board of Directors to authorize one or more series of preferred stock and to fix the number of shares to constitute such series and distinctive designations thereof and, with respect to each series of preferred stock, to fix by resolution or resolutions providing for the issuance of such series such variations in respect thereof as may be determined by the Board of Directors. All shares of every series of preferred stock shall be alike in every particular, and all series of preferred stock hereafter created shall rank equally and be identical in all respects, except as to the following rights and preferences which may constitute variations as between different series of preferred stock:\na. The rate of the dividend on the shares of such series;\nb. The price at, and the terms and conditions upon which shares may be redeemed;\nc. The amount payable upon shares in the event of involuntary liquidation;\nd. The amount payable upon shares in the event of voluntary liquidation;\ne. Sinking fund provisions for the redemption or purchase of shares;\nf. The terms and conditions on which shares may be converted, if the shares of any series are issued with the privilege of conversion; and\ng. Voting rights, if any.\nD. The holder of any share of such common or serial preferred stock shal have no preemptive rights to acquire any additional shares of the Corporation or to acquire any treasury stock of the Corporation.\nARTICLE V\nThe address of the registered office of the Corporation is 700 Capital Square, 400 Locust St., Des Moines, Polk County, Iowa, and the name of its registered agent at such address is John D. Hintze.\nARTICLE VI\nA. The number of directors of the Corporation shall be not less than twelve (12) and not greater than sixteen (16), and, effective as of the annual meeting of shareholders in 1982, the Board of Directors shall be divided into three classes, designated Class I, Class II and Class III. Such classes shall be as nearly equal in number as possible. The term of directors of one class shall extend to each annual meeting of shareholders and in all cases as to each director, until his successor shall be elected and shall qualify, or until his earlier resignation, removal from office, death or incapacity. Additional directorships resulting from an increase in number of directors shall be apportioned among the classes as equally as possible. The initial term of office of directors of Class I shall extend to the annual meeting of shareholders in 1983, that of Class II shall extend to the annual meeting in 1984, and that of Class III shall extend to the annual meeting in 1985, and in all cases as to each director until his successor shall be elected and shall qualify or until his earlier resignation, removal from office, death or incapacity. At each annual meeting of shareholders, the number of directors equal to the number of directors of the class whose term extends to the time of such meeting shall be elected to hold office until the third succeeding annual meeting of shareholders after their election. The Board of Directors may, upon a majority vote of its members, increase or decrease the number of directors within the limits set forth above. Vacancies in the Board of Directors or new directorships created by an increase in the number of directors shall be filled by majority vote of the remaining members of the Board and the person filling such vacancy or newly-created directorship shall serve out the remainder of the term for the vacated directorship or, in the case of a new directorship, the term designated for the class of directors of which that directorship is a part.\nB. The shareholders may at any time at a meeting expressly called for that purpose remove any or all of the directors, for cause, by a vote of two-thirds of the shares then entitled to vote at an election of directors. For purposes of this Article, removal \"for cause\" shall mean that the director to be removed has been convicted of a felony by a court of competent jurisdiction and such conviction is no longer subject to direct appeal, or that the director to be removed has been adjudged to be liable for negligence or misconduct in the performance of his duty to the Corporation by a court of competent jurisdiction and such adjudication is no longer subject to direct appeal.\nC. This Article VI may not be amended, altered or repealed without the approval of two-thirds of the shares entitled to vote at the time such amendment, alteration or repeal is proposed.\nARTICLE VII\nEach director and officer and each former director and officer of this Corporation and each person who may serve at its request as a director or officer of another corporation in which this Corporation or a subsidiary of this Corporation owns shares of capital stock, or of which it is a creditor, shall be indemnified by this Corporation against all costs and expenses reasonably incurred by him in connection with any action, suit or proceeding in which he is or may be involved by reason of his being, or having been, a director or officer of this Corporation or of such other corporation (whether or not he is a director or officer at the time of incurring such costs and expenses), except with respect to matters as to which he shall be adjudged in any such action, suit or proceeding to be liable by reason of his negligence, fraud or other civil or criminal misconduct in the performance of his duties. In the case of the settlement of any such action, suit or proceeding, he shall be indemnified by this Corporation against the costs and expenses (including any amount paid in settlement to this Corporation or to such other corporation or otherwise) reasonably incurred by him in connection with such action, suit or proceeding (whether or not he is a director or officer at the time of incurring such costs and expenses) if, and only if, the holders of a majority of capital stock of the Corporation represented at any annual meeting or special meeting of such shareholders shall vote to approve such settlement and the reimbursement of such director or officer of such costs or expenses.\nThe foregoing rights of indemnification shall apply to the heirs, executors and administrators of any such director or officer, or former director or officer or person and shall not be exclusive of other rights to which any such director or officer or former director or officer or persons (or his heirs, executors or administrators) may be entitled as a matter of law.\nARTICLE VIII\nThe Board of Directors of this Corporation shall have the power to adopt a corporate seal which shall be the corporate seal of this Corporation.\nARTICLE IX\nThe private property of the shareholders of this Corporation shall at all times be exempt from liability of corporate debts of any kind and this Article shall not be amended or repealed.\nARTICLE X\nIn the event that any shareholder shall become indebted to the Corporation, the Corporation shall have a lien upon any shares of stock in this Corporation owned by such shareholder for the full amount of such indebtedness.\nARTICLE XI\nStock in this Corporation shall be transferred only by assignment upon the books of the Corporation, subject to and in accordance with such restrictions as may be provided in the by-laws of this Corporation.\nARTICLE XII\nTo the fullest extent permitted by the Iowa Business Corporation Act as the same now exists or may hereafter be amended, a director of the Corporation shall not be liable to the Corporation or its stock-holders for monetary damages for breach of fiduciary duty as a director. Any repeal or modification of this ARTICLE XII by the stockholders of the Corporation only shall be applied prospectively, to the extent that such repeal or modification would, if applied retrospectively, adversely affect any limitation on the personal liability of a director of the Corporation existing immediately prior to such repeal or modification.\nThe above Second Restated and Amended Articles of Incorporation do not contain an amendment requiring the approval of the Corporation's shareholders, and were unanimously adopted by the Corporation's Board of Directors on December 11, 1990.\nDated December 11, 1990\nPIONEER HI-BRED INTERNATIONAL, INC.\nBy: \/s\/ Jerry L. Chicoine Jerry L. Chicoine Title: Senior Vice President, CFO and Secretary\nSTATE OF IOWA) ss: COUNTY OF POLK)\nOn this 11th day of December, 1990, before me, a notary public in and for the State of Iowa, personally appeared Jerry L. Chicoine, to me personally known, who being by me duly sworn do say that he is the Senior Vice President, CFO and Secretary, respectively of said corporation, that the corporate seal has been affixed to this document and that said Second Restated and Amended Articles of Incorporation were signed on behalf of said corporation by authority of its Board of Directors and the said Jerry L. Chicoine acknowledges the execution of said instrument to be the voluntary act and deed of said corporation by it voluntarily executed.\nBy: \/s\/ Jane B. Forbes Jane B. Forbes Notary Public in and for the State of Iowa\nSeptember 12, 1995\nRESTATED AND AMENDED BYLAWS\nOF\nPIONEER HI-BRED INTERNATIONAL, INC.\nARTICLE I.\nPRINCIPAL OFFICE\nThe principal office of the Corporation shall be located at 700 Capital Square, 400 Locust Street in the City of Des Moines, in the County of Polk, State of Iowa.\nARTICLE II.\nMEETINGS OF SHAREHOLDERS\nSECTION 1. Annual Meeting. The annual meeting of the shareholders shall be held on the fourth Tuesday of February of each year, beginning with the year 1988 at the hour of 2:00 P.M. for the purpose of electing directors and for the transaction of such other business as may come before the meeting; PROVIDED, HOWEVER, that the President may in any year designate an earlier date as the day of the annual meeting that year. If the day fixed for the annual meeting as herein provided shall be a legal holiday, and a different day is not designated by the President, such meeting shall be held on the next succeeding business day. If the election of directors shall not be held on the day designated herein for any annual meeting or any adjournment thereof, the Board of Directors shall cause the election to be held at a meeting of the shareholders as soon thereafter as conveniently may be held.\nSECTION 2. Special Meetings. Special meetings of the shareholders, for any purpose or purposes, unless otherwise prescribed by statute or by the Articles of Incorporation, may be called by the President and shall be called by the President or Secretary at the request in writing of a majority of the Board of Directors, or at the request in writing of shareholders owning not less than one-tenth in amount of the entire capital stock of the Corporation issued and outstanding and entitled to vote. Such request shall state the purpose or purposes of the proposed meeting. Business transacted at any special meeting of the shareholders shall be limited to the purposes stated in the notice.\nSECTION 3. Place of Meeting. The Board of Directors or the President may designate any place, either within or without the State of Iowa, as the place of meeting for any annual meeting or for any special meeting called by the Board of Directors. A waiver of notice signed by all shareholders may designate any place, either within or without the State of Iowa, as the place for the holding of such meeting. If no designation is made, or if a special meeting be otherwise called, the place of meeting shall be the registered office of the Corporation in the State of Iowa.\nSECTION 4. Notice of Meetings. Written or printed notice stating the place, day and hour of the meeting, and in the case of a special meeting, the purpose or purposes for which the meeting is called, shall be delivered not less than ten (10) or more than sixty (60) days before the date of the meeting, either personally or by mail, by or at the direction of the President, or the Secretary, or the officer or persons calling the meeting, to each shareholder of record entitled to vote at such meeting. If mailed, such notice shall be deemed to be delivered when deposited in the United States mail, addressed to the shareholder at his address as it appears on the records of the Corporation, with postage thereon prepaid.\nSECTION 5. Closing of Transfer Books or Fixing of Record Date. For the purpose of determining shareholders entitled to notice of or to vote at any meeting of shareholders, or shareholders entitled to receive payment of any dividend, or in order to make a determination of shareholders for any other proper purpose, the Board of Directors of the Corporation may provide that the stock transfer books shall be closed for a stated period, but not to exceed, in any case, seventy (70) days. If the stock transfer books shall be closed for the purpose of determining shareholders entitled to notice of or to vote at a meeting of shareholders, such books shall be closed for at least ten (10) days immediately preceding such meeting. In lieu of closing the stock transfer books, the Board of Directors may fix in advance a date as the record date for any such determination of shareholders, such date in any case to be not more than seventy (70) days and, for a meeting of shareholders, not less than ten (10) days, prior to the date on which the particular action, requiring such determination of shareholders, is to be taken. If the transfer books are not closed and no record date is fixed for the determination of shareholders entitled to notice of or to vote at a meeting of shareholders, or shareholders entitled to receive payment of a dividend, the date on which notice of the meeting is mailed or the date on which the resolution of the Board of Directors declaring such dividend is adopted, as the case may be, shall be the record date for such determination of shareholders. When a determination of shareholders entitled to vote at any meeting of shareholders has been made as provided in this section, such determination shall apply to any adjournment thereof.\nSECTION 6. Voting Lists. The officer or agent having charge of the transfer books for shares of the Corporation shall make, at least ten (10) days before each meeting of shareholders, a complete list of the shareholders entitled to vote at such meeting, arranged in alphabetical order, with the address of and the number of shares held by each, which list, for a period of ten (10) days prior to such meeting, shall be subject to inspection by any shareholder at any time during usual business hours. Such list shall also be produced and kept open at the time and place of the meeting and shall be subject to the inspection of any shareholder during the whole time of the meeting. The original share ledger or transfer book, or a duplicate thereof kept in this State, shall be prima facie evidence as to who are the shareholders entitled to examine such list or share ledger or transfer book or to vote at any meeting of shareholders.\nSECTION 7. Quorum. The holders of a majority of the stock issued and outstanding and entitled to vote thereat, present in person or represented by proxy, shall constitute a quorum at all meetings of the shareholders for the transaction of business as otherwise provided by statute or by the Articles of Incorporation. If, however, such quorum shall not be present or represented at any meeting of the shareholders, a majority of the shareholders entitled to vote thereat, present in person or represented by proxy, shall have power to adjourn the meeting from time to time, without notice other than announcement at the meeting, until a quorum shall be present or represented. At such adjourned meeting, at which a quorum shall be present or represented, any business may be transacted which might have been transacted at the meeting as originally noticed. When a quorum is present at any meeting, the vote of the holders of a majority of the stock having voting power present in person or represented by proxy shall decide any question brought before such meeting, unless the question is one upon which by express provision of the statutes or of the Articles of Incorporation a different vote is required, in which case, such express provision shall govern and control the decision of such question.\nSECTION 8. Proxies. Each shareholder shall at every meeting of the shareholders be entitled to that number of votes as is determined by the Corporation in accordance with Article IV of the Articles of Incorporation of the Corporation, as presently in effect or as may be amended hereafter, upon each matter submitted to vote of the shareholders to be voted in person or by proxy executed in writing by said shareholder or by his duly authorized attorney-in-fact, for each share of the capital stock having voting power held by such shareholder. Such proxy shall be filed with the Secretary of the Corporation before or at the time of the meeting. No proxy shall be valid after eleven (11) months from the date of its execution, unless otherwise provided in the proxy.\nSECTION 9. Voting of Shares by Certain Holders. Shares standing in the name of another Corporation, domestic or foreign, may be voted by such officer, agent, or proxy as the Bylaws of such Corporation may prescribe, or, in the absence of such provision, as the Board of Directors of such Corporation may determine.\nShares standing in the name of a deceased person, a minor, ward or an incompetent person, may be voted by his administrator, executor, court appointed guardian or conservator, either in person or by proxy without a transfer of such shares into the name of such administrator, executor, court appointed guardian or conservator. Shares standing in the name of a trustee may be voted by him either in person or by proxy.\nShares standing in the name of the receiver may be voted by such receiver, and shares held by or under the control of a receiver may be voted by such receiver without the transfer thereof into his name if authority to do so be contained in an appropriate order of the court by which such receiver was appointed.\nA shareholder whose shares are pledged shall be entitled to vote such shares until the shares have been transferred into the name of the pledgee, and thereafter the pledgee shall be entitled to vote the shares so transferred.\nShares of its own stock belonging to this Corporation shall not be voted, directly or indirectly, at any meeting and shall not be counted in determining the total number of outstanding shares at any time, but shares of its own stock held by it in a fiduciary capacity may be voted and shall be counted in determining the total number of outstanding shares at any given time.\nSECTION 10. Inspectors. At any meeting of shareholders, the chairman of the meeting may, or upon the request of any shareholder, shall appoint one or more persons as inspectors for such meeting. Such inspectors shall ascertain and report the number of shares represented at the meeting, based upon their determination of the validity and effect of proxies; count all votes and report the results; and do such other acts as are proper to conduct the election and voting with impartiality and fairness to all the shareholders. Each report of an inspector shall be in writing and signed by him or by a majority of them if there be more than one inspector acting at such meeting. If there is more than one inspector, the report of the majority shall be the report of the inspectors. The report of the inspector or inspectors on the number of shares represented at the meeting and the results of the voting shall be prima facie evidence thereof.\nSECTION 11. Informal Action by Shareholders. Any action required to be taken at a meeting of the shareholders, or any other action which may be taken at a meeting of the shareholders, may be taken without a meeting if a consent in writing, setting forth the action so taken, shall be signed by all the shareholders entitled to vote with respect to the subject matter thereof.\nSECTION 12. Voting by Ballot. Voting on any question or in any election may be viva voce unless the presiding officer shall order or any shareholder shall demand that voting be by ballot.\nSECTION 13. Shareholder Business Proposals. At any annual meeting of the Corporation's shareholders, only such business shall be conducted as shall have been properly brought before the meeting. To be properly brought before an annual meeting, business must be (a) specified in the notice of meeting (or any supplement thereto) given by or at the direction of the Board of Directors, (b) otherwise properly brought before the meeting by or at the direction of the Board of Directors, or (c) otherwise properly brought before the meeting by a shareholder. Business may be properly brought before an annual meeting by a shareholder only if written notice of the shareholder's intent to propose such business has been given, either by personal delivery or by United States mail, first class postage prepaid, to the Secretary of the Corporation no later than ninety days in advance of such annual meeting, provided that in the event that less than ninety days' notice or prior public disclosure of the date of such annual meeting is given or made to shareholders, the shareholder's submission shall be timely if received by the Secretary of the Corporation not later than the close of business on the tenth day following the day on which such notice of the date of the meeting was mailed or such public disclosure was made (whichever first occurs). Each notice of new business must set forth: (i) the name and address of the shareholder who intends to raise the new business;\n(ii) the business desired to be brought forth at the meeting and the reasons for conducting such business at the meeting; (iii) a representation that the shareholder is a holder of record of stock of the Corporation entitled to vote with respect to such business and intends to appear in person or by proxy at the meeting to move the consideration of such business; (iv) such shareholder's beneficial ownership of the Corporation's voting stock; and (v) such shareholder's interest in such business. The chairman of the meeting may refuse to acknowledge a motion to consider any business that he determines was not made in compliance with the foregoing procedures.\nAn adjourned meeting, if notice of the adjourned meeting is not required to be given to shareholders, shall be regarded as a continuation of the original meeting, and any notice of new business must meet the foregoing requirements based upon the date on which notice or public disclosure of the date of the original meeting was given or made. In the event of an adjourned meeting where notice of the adjourned meeting is required to be given to shareholders, any notice of new business made by a shareholder with respect to the adjourned meeting must meet the foregoing requirements based upon the date on which notice or public disclosure of the date of the adjourned meeting was given or made.\nNo action may be taken by the Board of Directors (whether through amendment of the Bylaws or otherwise) to amend, alter, change or repeal, directly or indirectly, the provisions of this Article II, Section 13 of the Bylaws, unless two-thirds of the directors (based on the number of directors then authorized, regardless of whether there are any vacancies) shall concur in such action.\nARTICLE III.\nBOARD OF DIRECTORS\nSECTION 1. General Powers. The business and affairs of the Corporation shall be managed by its Board of Directors which may exercise all such powers of the Corporation and do all such lawful acts and things as are not by statute or by the Articles of Incorporation or by these Bylaws directed or required to be exercised or done by the shareholders.\nSECTION 2. Number, Tenure and Qualifications. The number of directors which shall constitute the whole Board shall be such number, not less than twelve (12) nor more than sixteen (16), as may be determined from time to time by vote of a majority of the entire Board of Directors. The directors shall be divided into three (3) classes each of which shall be as nearly equal in number as possible except as provided in Section 3 of this Article. The directors shall be elected at an annual meeting of the shareholders, and shall hold an office for a term of the lesser of (a) three (3) years or (b) until the end of the term for the Class of Directors to which such Director has been elected and until his successor is elected and qualified. A Director need not be a shareholder of this Corporation.\nSECTION 3. Vacancies. Any vacancy occurring in the Board of Directors and any directorship to be filled by reason of an increase in the number of directors, may be filled by the affirmative vote of a majority of the remaining directors though less than a quorum of the Board of Directors. Any director elected to fill a vacancy created other than by reason of an increase in the number of directors shall be elected for the unexpired term of his or her predecessor in office. Any director elected to fill a vacancy by reason of an increase in the number of directors may continue in office only until the next election of directors by the shareholders.\nNo action may be taken by the Board of Directors (whether through amendment of the Bylaws or otherwise) to amend, alter, change or repeal, directly or indirectly, the provisions of this Article III, Section 3 of the Bylaws, unless two-thirds of the directors (based on the number of directors then authorized, regardless of whether there are any vacancies) shall concur in such action.\nSECTION 4. Regular Meetings. A regular meeting of the Board of Directors shall be held without other notice than this Bylaw, immediately after, and at the same place as, the annual meeting of shareholders. The Board of Directors may provide, by resolution, the time and place, either within or without the State of Iowa, for the holding of additional regular meetings without other notice than such resolution.\nSECTION 5. Special Meetings. Special Meetings of the Board of Directors may be called by or at the request of the President or any two directors. The person or persons authorized to call special meetings of the Board of Directors may fix any place, either within or without the State of Iowa, as the place for the holding of such meeting.\nSECTION 6. Notice. Notice shall be given at least 24 hours in advance of the time set for such meeting and may be given by telephone or telegram. If notice be given by telegram, such notice shall deem to be delivered when delivered to the telegraph company. Any director may waive notice of a meeting by written waiver, executed either before or after the time stated in the notice. Attendance at a meeting shall constitute a waiver of notice of such meeting, except where a director attends such meeting for the express purpose of objecting to the transaction of any business because the meeting is not lawfully called or convened.\nSECTION 7. Quorum. A majority of the number of directors currently in office shall constitute a quorum for transaction of business at any meeting of the Board of Directors, provided, that if less than a majority of such number of directors are present at said meeting, a majority of the directors present may adjourn the meeting from time to time without further notice.\nSECTION 8. Manner of Acting. The act of the majority of the directors present at a meeting at which a quorum is present shall be the act of the Board of Directors, except as may be otherwise specifically provided by statute, the Articles of Incorporation or these Bylaws. Members of the Board of Directors or any committee designated by such board, may participate in a meeting of such board or committee by conference telephone or similar communications equipment by means of which all persons participating in the meeting can hear each other, and participation in a meeting pursuant to this provision shall constitute presence in person at such meeting.\nSECTION 9. Informal Action. Unless specifically prohibited by statute, the Articles of Incorporation or these Bylaws, any action required to be taken at a meeting of the Board of Directors, or any other action which may be taken at a meeting of the Board of Directors or of any committee thereof, may be taken without a meeting if a consent in writing, setting forth the action so taken, shall be signed by all the directors entitled to vote with respect to the subject matter thereof, or by all the members of such committee and filed with the minutes of proceedings of the Board or committee as the case may be. Any such consent signed by all the Directors or all the members of such committee shall have the same effect as a unanimous vote, and may be stated as such in any document filed with the Secretary of State, or issued for any other reason.\nSECTION 10. Compensation. The Directors may be paid for their expenses, if any, of attendance at such meeting of the Board of Directors, and may be paid a fixed sum for attendance at each meeting of the Board of Directors, or a stated salary or fee as such director. No such payment shall preclude any director from serving the Corporation in any other capacity and receiving compensation therefor. Members of special or standing committees may be allowed like compensation for attending committee meetings.\nSECTION 11. Presumption of Assent. A Director of the Corporation who is present at a meeting of the Board of Directors at which action on any corporate matter is taken shall be presumed to have assented to the action taken unless his dissent shall be entered in the minutes of the meeting or unless he shall file his written dissent to such action with the person acting as the Secretary of the meeting before the adjournment thereof or shall forward such dissent by registered mail to the Secretary of the Corporation immediately after the adjournment of the meeting. Such right to dissent shall not apply to directors who voted in favor of such action.\nSECTION 12. Removal of Directors. The shareholders may at any time at a meeting expressly called for that purpose remove any or all of the directors, for cause, by a vote of two-thirds of the shares then entitled to vote at an election of directors. For the purposes of this Section 12, removal \"for cause\" shall mean that the director to be removed has been convicted of a felony by a court of competent jurisdiction and such conviction is no longer subject to direct appeal, or that the director to be removed has been adjudged to be liable for negligence or misconduct in the performance of his duty to the Corporation by a court of competent jurisdiction and such adjudication is no longer subject to direct appeal. Any vacancy in the Board of Directors resulting from the removal of a director shall be filled by majority vote of the remaining members of the Board of Directors.\nSECTION 13. Committees of Directors. The Board of Directors may, by resolution passed by a majority of the whole board, designate an executive committee and\/or one or more other committees, each committee to consist of two or more of the Directors of the Corporation, which, to the extent provided in the resolution, shall have and may exercise the powers of the Board of Directors in the management of the business and affairs of the Corporation and may authorize the seal of the Corporation to be affixed to all papers which may require it. Such committee or committees shall have such name or names as may be determined from time to time by resolution adopted by the Board of Directors.\nThe Compensation Committee shall consist of no less than three and no more than eight directors who are not at the time of their election employees of the Corporation or otherwise entitled to participate in any compensation or incentive plan administered by the Committee, except to the extent otherwise determined by a majority of the directors who are not members of the Compensation Committee. The Compensation Committee shall be responsible for all executive compensation programs of the Corporation, including, without limitation, stock incentive plans and shall evaluate and recommend to the Board of Directors compensation for executive officers. It shall review summaries of current compensation paid all other officers, and shall periodically report changes in the compensation plans for all officers and employees to the Board of Directors. It shall receive and review such reports of compensation and benefit plan administration from the Corporation's management as it may require. The Compensation Committee shall also review, and make recommendations concerning, management structure and succession planning, management retirement policy, and officer supervision and training to assure the full development of management potential and an orderly succession of management.\nThe Nominating Committee shall consist of not less than three nor more than nine directors and shall be responsible for establishing criteria for the election of directors, reviewing management's evaluation of any officers proposed for nomination to the Board of Directors, and reviewing the qualifications of, and when appropriate interviewing, candidates who may be proposed for nomination to the Board of Directors, including those nominees recommended by shareholders. The Committee shall be responsible for recommending to the Board of Directors, not less than 120 days prior to each annual meeting of the shareholders, a slate of directors to be elected for the following year. The Committee shall also perform such other duties in connection with the search for qualified directors and the selection, election, or termination of directors as the Board of Directors may request.\nThe Audit Committee shall consist of not less than three nor more than nine directors, a majority of whom shall be independent directors. The Committee shall have general oversight responsibility with respect to the Corporation's financial reporting. In performing its oversight responsibility, the Committee shall make recommendations to the Board of Directors as to the selection, retention, or change in the independent accountants of the Corporation, review with the independent accountants the scope of their examination and other matters (relating to both audit and non-audit activities), and review generally the internal auditing procedures of the Corporation. In addition, the Committee shall review corporate policies relating to compliance with laws and regulations, ethics, and conflicts, and (consistent with the NASDAQ listing requirement) it shall conduct a review of all material related party transactions on an ongoing basis. In undertaking the foregoing responsibilities, the Audit Committee shall have unrestricted access, if necessary, to company personnel and documents and shall be provided with the resources and assistance necessary to discharge its responsibilities, including periodic reports from management assessing the impact of regulation, accounting, and reporting or other significant matters that may affect the Corporation. The Committee shall have authority to appoint and dismiss the Corporation's director of internal audit. The duties and responsibilities of the Audit Committee shall be set forth in further detail in a charter developed by the Committee, provided that the duties and responsibilities set forth therein shall be consistent with this Section 13 and any resolution passed by a majority of the Directors relating to the responsibilities of the Committee.\nIn addition, the Board of Directors may, by resolution passed by a majority of the Directors, designate an executive committee and\/or one or more other committees, each committee to consist of two or more of the Directors of the Corporation, which, to the extent provided in the resolution, shall have and may exercise the powers of the Board of Directors in the management of the business and affairs of the Corporation. Such committee or committees shall have such name or names as may be determined from time to time by resolution adopted by the Board of Directors.\nSECTION 14. Committee Minutes. Each committee shall keep regular minutes of its meetings and report the same to the Board of Directors when required.\nSECTION 15. Shareholder Nomination of Director Candidates. Subject to the rights of holders of any class or series of stock having a preference over the Common Stock as to dividends or upon liquidation, nominations for the election of directors may be made by the Board of Directors or a committee appointed by the Board of Directors or by any shareholder entitled to vote in the election of directors generally. However, any shareholder entitled to vote in the election of directors generally may nominate one or more persons for election as directors at a meeting only if written notice of such shareholder's intent to make such nomination or nominations has been given, either by personal delivery or by United States mail, postage prepaid, to the Secretary of the Corporation not later than (i) with respect to an election to be held at an annual meeting of shareholders, ninety days prior to the anniversary date of the records date set for the immediately preceding annual meeting of shareholders, and (ii) with respect to an election to be held at a special meeting of shareholders for the election of directors, the close of business on the tenth day following the date on which notice of such meeting is first given to shareholders. Each such notice shall set forth: (a) the name and address of the shareholder who intends to make the nomination and of the person or persons to be nominated; (b) a representation that the shareholder is a holder of record of stock of the Corporation entitled to vote at such meeting and intends to appear in person or by proxy at the meeting to nominate the person or persons specified in the notice; (c) a description of all arrangements or understandings between the shareholder and each nominee and any other person or persons (naming such person or persons) pursuant to which the nomination or nominations are to be made by the shareholder; (d) such other information regarding each nominee proposed by such shareholder as would be required to be included in a proxy statement filed pursuant to the proxy rules of the Securities and Exchange Commission, had the nominee been nominated, or intended to be nominated, by the Board of Directors; and (e) the consent of each nominee to serve as a director of the Corporation if so elected. The presiding officer at the meeting may refuse to acknowledge the nomination of any person not made in compliance with the foregoing procedures.\nNo action may be taken by the Board of Directors (whether through amendment of the Bylaws or otherwise) to amend, alter, change or repeal, directly or indirectly, the provisions of this Article III, Section 15 of the Bylaws, unless two-thirds of the directors (based on the number of directors then authorized, regardless of whether there are any vacancies) shall concur in such action.\nARTICLE IV.\nOFFICERS\nSECTION 1. Number. The officers of the Corporation shall be a President, Vice President, Secretary and a Treasurer. The Board of Directors may also choose additional Vice Presidents and one or more Assistant Secretaries and Assistant Treasurers. Any two or more offices may be held by the same person, except that the offices of President and Secretary shall not be held by the same person.\nSECTION 2. Election and Term of Office. The officers of the Corporation shall be elected annually by the Board of Directors at the first meeting of the Board of Directors held after each annual meeting of shareholders. If the election of officers shall not be held at such meeting, such election shall be held as soon thereafter as conveniently may be. Each officer shall hold office until his successor shall have been duly elected or until his death or until he shall resign or shall have been removed in the manner herein provided. Election or appointment of an officer or agent shall not of itself create contract rights.\nSECTION 3. Other Officers. The Board of Directors may appoint such other officers and agents, as it shall deem necessary, who shall hold their offices for such terms and shall exercise such powers and perform such duties as shall be determined from time to time by the Board.\nSECTION 4. Removal. Any officer or agent elected or appointed by the Board of Directors may be removed from office by the affirmative vote of a majority of the Board of Directors at any meeting whenever in its judgment the best interests of the Corporation would be served thereby, but such removal shall be without prejudice to the contract rights, if any, of the person so removed.\nSECTION 5. Vacancies. A vacancy in any office because of death, resignation, removal, disqualification or otherwise, and new offices may be filled by the Board of Directors, at any meeting thereof for the unexpired portion of the term.\nSECTION 6. President. The President shall be the principal executive officer of the Corporation and shall, in general, supervise and control all of the business and affairs of the Corporation. Unless otherwise provided by the Board, he shall preside at all meetings of the shareholders and the Board of Directors. He may sign, with the Secretary or any other proper officer of the Corporation thereunto authorized by the Board of Directors, certificates for shares of the Corporation, any deeds, mortgages, bonds, contracts, or other instruments which the Board of Directors has authorized to be executed, except in cases where the signing and execution thereof shall be expressly delegated by the Board of Directors or by these Bylaws to some other officer or agent of the Corporation, or shall be required by law to be otherwise signed or executed; and in general shall perform all duties incident to the office of President and such other duties as may be prescribed by the Board of Directors from time to time.\nSECTION 7. Vice President. In the absence of the President, or in the event of his inability or refusal to act, the Vice President, or if there shall be more than one, the Vice Presidents, in the order determined by the Board of Directors, shall perform the duties of the President, and when so acting, shall have all powers of and be subject to all restrictions upon the President. Any Vice President may sign, with the Secretary or an Assistant Secretary, certificates for shares of the Corporation; and shall perform such other duties as from time to time may be assigned to him by the President or by the Board of Directors.\nSECTION 8. Secretary. The Secretary shall: (1) attend all meetings of the Board of Directors and all meetings of the shareholders and record all the proceedings of the meetings of the Corporation and of the Board of Directors in a book to be kept for that purpose and shall perform like duties for the standing committees when required; (2) see that all notices are duly given in accordance with the provisions of these Bylaws or as required by law; (3) keep a register of the post office address of each shareholder which shall be furnished to the Secretary by such holder; (4) have general charge of the stock transfer books of the Corporation; (5) perform all duties incident to the office of Secretary and such other duties as from time to time may be assigned to him by the President or by the Board of Directors; and (6) have custody of the corporate seal of the Corporation and have authority to affix the same to any instrument requiring it and when so affixed, it may be attested by his signature. The Board of Directors may give general authority to any other officer to affix the seal of the Corporation and to attest the affixing by his signature.\nSECTION 9. Assistant Secretary. The Assistant Secretary, or, if there be more than one, the Assistant Secretaries, in the order determined by the Board of Directors, shall, in the absence or disability of the Secretary, perform the duties and exercise the powers of the Secretary and shall perform such other duties and have such other powers as the Board of Directors may from time to time prescribe.\nSECTION 10. Treasurer. The Treasurer shall: (1) have charge and custody of and be responsible for all funds and securities of the Corporation; (2) receive and give receipts for monies due and payable to the Corporation from any source whatsoever, and deposit all moneys and other valuable effects in the name and to the credit of the Corporation in such banks, trust companies or other depositories as shall be designated by the Board of Directors; (3) disburse the funds of the Corporation as may be ordered by the Board of Directors, taking proper vouchers for such disbursements; (4) keep full and accurate accounts of receipts and disbursements in books belonging to the Corporation; (5) render to the President and the Board of Directors, at its regular meetings, or when the Board of Directors so requires, an account of all his transactions as Treasurer and of the financial condition of the Corporation; and (6) perform all the duties incident to the office of Treasurer and such other duties as from time to time may be assigned to him by the President or by the Board of Directors. If required by the Board of Directors, give a bond in such sum and with such surety or sureties as the Board of Directors may determine for the faithful performance of the duties of his office and for the restoration to the Corporation, in case of his death, resignation, retirement or removal from office, of all books, papers, vouchers, money and other property of whatever kind in his possession or under his control belonging to the Corporation.\nSECTION 11. Assistant Treasurer. The Assistant Treasurer, or if there shall be more than one, the Assistant Treasurers, in the order determined by the Board of Directors, shall, in the absence or disability of the Treasurer, perform the duties and exercise the powers of the Treasurer and shall perform such other duties and have such other powers as the Board of Directors may from time to time prescribe.\nSECTION 12. Salaries. The salaries of the officers shall be fixed from time to time by the Board of Directors and no officer shall be prevented from receiving such salary by reason of the fact that he is also a director of the Corporation.\nARTICLE V.\nCONTRACTS, LOANS AND CHECKS\nSECTION 1. Contracts. The Board of Directors may authorize any officer or officers, agent or agents, to enter into any contract or execute and deliver any instrument in the name of and on behalf of the Corporation, and such authority may be general or confined to specific instances.\nSECTION 2. Loans. No loans shall be contracted on behalf of the Corporation and no evidences of indebtedness shall be issued in its name unless authorized by a resolution of the Board of Directors. Such authority may be general or confined to specific instances.\nSECTION 3. Checks, Drafts, Etc. All checks, drafts or other orders for payment of money, notes or other evidences of indebtedness issued in the name of the Corporation, shall be signed by such officer or officers, agent or agents, of the Corporation and in such manner as shall from time to time be determined by resolution of the Board of Directors.\nARTICLE VI.\nINDEMNIFICATION\nSECTION 1. Claims in General. The Corporation shall indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative (other than an action by or in the right of the Corporation) by reason of the fact that he is or was a director, officer, employee or agent of the Corporation, or is or was serving at the request of the Corporation, partnership, joint venture, trust or other enterprise, against expenses (including attorney's fees), judgments, fines and amounts paid in settlement actually and reasonably incurred by him in connection with such action, suit or proceeding if he acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the Corporation and, with respect to any criminal action or proceedings, had no reasonable cause to believe that his conduct was unlawful. The termination of any action, suit or proceeding by judgment, order, settlement, conviction, or upon a plea of nolo contendere or its equivalent, shall not, of itself, create a presumption that the person did not act in good faith and in a manner which he reasonably believed to be in or not opposed to the best interests of the Corporation, and, with respect to any criminal action or proceeding, had reasonable cause to believe that his conduct was unlawful.\nSECTION 2. Claim by Corporation. The Corporation shall indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action or suit by or in the right of the Corporation to procure a judgment in its favor by reason of the fact that he is or was a director, officer, employee or agent of the Corporation, or is or was serving at the request of the Corporation as a director, officer, employee or agent of another Corporation, partnership, joint venture, trust or other enterprise against expense (including attorney's fees) actually and reasonably incurred by him in connection with the defense or settlement of such action or suit if he acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the Corporation and except that no indemnification shall be made in respect of any claim, issue or matter as to which such person shall have been adjudged to be liable for negligence or misconduct in the performance of his duty to the Corporation unless and only to the extent that the court in which such action or suit was brought shall determine upon application that, despite that adjudication of liability but in view of all the circumstances of the case, such person is fairly and reasonably entitled to indemnity for such expense which such court shall deem proper.\nSECTION 3. Expense Indemnification. Notwithstanding the other provisions of this Article, to the extent that a director, officer, employee, or agent of a Corporation has been successful on the merits or otherwise in defense of any action, suit or proceeding referred to in Section 1 or 2 of this Article, or in defense of any claim, issue or matter therein, he shall be indemnified against expenses (including attorney's fees) actually and reasonably incurred by him in connection therewith).\nSECTION 4. Authorization of Indemnification. Any indemnification under Sections 1 and 2 (unless ordered by court) shall be made by the Corporation only as authorized in the specific case upon a determination that the indemnification of the director, officer, employee or agent is proper in the circumstances because he has met the applicable standard of conduct set forth in Sections 1 and 2. Such determination shall be made (1) by the Board of Directors by a majority vote of a quorum consisting of directors who were not parties to such action, suit, or proceeding, or (2) if such a quorum is not obtainable, or even if obtainable, a quorum of disinterested directors so directs, by independent legal counsel in a written opinion, or (3) by the shareholders.\nSECTION 5. Advancement of Expense. Expenses incurred in defending a civil or criminal action, suit or proceeding may be paid by the Corporation in advance of the final disposition of such action, suit or proceeding as authorized in the manner provided in Section 4 of this Article upon receipt of an undertaking by or on behalf of the director, officer, employee or agent to repay such amount unless it shall ultimately be determined that he is entitled to be indemnified by the Corporation as authorized in this Article.\nSECTION 6. Other Rights. The indemnification provided by this Article shall not be deemed exclusive of any other rights to which those seeking indemnification may be entitled under any bylaw, agreement, vote of shareholders or disinterested directors or otherwise, both as to action in his official capacity and as to action in another capacity while holding such office, and shall continue as to a person who has ceased to be a director, officer, employee or agent and shall inure to the benefit of the heirs, executors, and administrators of such a person.\nSECTION 7. Insurance. Upon resolution passed by the Board of Directors, the Corporation may purchase and maintain insurance on behalf of any person who is or was a director, officer, employee or agent of the Corporation or is or was serving at the request of the Corporation as a director, officer, employee or agent of another Corporation, partnership, joint venture, trust or other enterprise against any liability asserted against him and incurred by him in any such capacity, or arising out of his status as such, whether or not the Corporation would have the power to indemnify him against such liability under the provisions of this Article.\nARTICLE VII.\nCERTIFICATES FOR SHARES AND THEIR TRANSFER\nSECTION 1. Certificates for Shares. Every holder of shares in the Corporation shall be entitled to have a certificate in such form as may be determined by the Board of Directors. Such certificates shall be signed by the President or Vice President and by the Secretary or Assistant Secretary and shall be sealed with the seal of the Corporation or a facsimile thereof. The signatures of the President or Vice President and the Secretary or Assistant Secretary or other persons signing for the Corporation upon a certificate may be facsimiles. If the certificate is countersigned by a transfer agent or registered by a registrar, the signatures of the person signing for such transfer agent or registrar also may be facsimiles. In case any officer or other authorized person who has signed or whose facsimile signature has been place upon such certificate for the Corporation, shall have ceased to be such officer or employee or agent before such certificate is issued, it may be issued by the Corporation with the same effect as if he were such officer or employee or agent at the date of its issue. All certificates for shares shall be consecutively numbered or otherwise identified. The name of the person to whom the shares represented thereby are issued, with the number of shares and date of issue, shall be entered on the books of the Corporation. All certificates surrendered to the Corporation for transfer shall be canceled and no new certificate shall be issued until the former certificate for a like number of shares shall have been surrendered and canceled, except that in case of a lost, destroyed or mutilated certificate a new one may be issued therefor upon such terms and indemnity to the Corporation as the Board of Directors may prescribe.\nSECTION 2. Transfer of Shares. Transfers of shares of the Corporation shall be made only on the books of the Corporation by the holder of record thereof or by his legal representative, who shall furnish proper evidence of authority to transfer, or by his attorney thereunto authorized by power of attorney duly executed and filed with the Secretary of the Corporation, and on surrender for cancellation of the certificate for such shares. The person in whose name shares stand on the books of the Corporation shall be deemed the owner thereof for all purposes as regards the Corporation.\nSECTION 3. Registered Shareholder. The Corporation shall be entitled to recognize the exclusive right of a person registered on its books as the owner of shares to receive dividends, and to vote as such owner, and shall not be bound to recognize any equitable or other claim to, or interest in, such shares on the part of any other person, whether or not it shall have express or other notice thereof, except as otherwise provided by law.\nARTICLE VIII.\nFISCAL YEAR\nSECTION 1. Fiscal Year. This Corporation shall operate on a fiscal year basis beginning September 1 of each year and ending August 31 of the following year.\nARTICLE IX.\nDIVIDENDS\nSECTION 1. Dividends. The Board of Directors, from time to time, may declare, and the Corporation may pay, dividends on its outstanding shares in the manner and upon the terms and conditions provided by law and its Articles of Incorporation.\nARTICLE X.\nWAIVER OF NOTICE\nSECTION 1. Waiver of Notice. Whenever any notice is required to be given under the provisions of the statutes or of the Articles of Incorporation or of these Bylaws, a waiver thereof in writing, signed by the person or persons entitled to said notice, whether before or after the time stated therein, shall be deemed equivalent thereto.\nARTICLE XI.\nAMENDMENTS\nSECTION 1. Amendments. Except where otherwise specifically noted, these Bylaws may be altered, amended or repealed and new Bylaws may be adopted at any meeting of the Board of Directors of the Corporation by a majority vote of the directors present at the meeting.\nEXHIBIT 10\nCONSULTING AGREEMENT WITH A DIRECTOR\nDr. Ray Goldberg has a three year consulting agreement with the Company beginning in July, 1995. Dr. Goldberg is paid $25,000 a year under this arrangement. He is a director of the Company.\nEXHIBIT 11\nPIONEER HI-BRED INTERNATIONAL, INC.\nCOMPUTATION OF EARNINGS PER SHARE (In thousands, except per share amounts)\nEXHIBIT 13\nTHE COMPANY'S BUSINESS\nPioneer Hi-Bred's business is the broad application of the science of genetics. Pioneer was founded in 1926 to apply newly discovered genetic techniques to hybridize corn. Today, the Company develops, produces, and markets hybrids of corn, sorghum, sunflower, and vegetables, and varieties of soybean, alfalfa, wheat, and canola.\nHybrids, crosses of two or more unrelated inbred lines, can be reproduced only by crossing the original parent lines. Thus, a grower must purchase new seed each year to obtain the original hybrid.\nVarietal crops, such as soybeans and wheat, will reproduce themselves with little or no genetic variation. Growers can save grain from the previous crop for planting. Growers are becoming increasingly aware of the advantages of purchasing \"new\" seed every year, although in times of cash-flow crisis, they may tend to forgo those advantages.\nPioneer maintains the ownership of and controls the use of inbreds and varieties through patents and the Plant Variety Protection Act. Within the United States, this essentially prohibits other parties from selling seed made from those inbreds and varieties until such protection expires, usually well after the useful life of the seed. Outside of the United States, the level of protection afforded varies from country to country according to local law and international agreement. The Company believes it is vital that products developed by its research programs remain proprietary. They must remain so in order to provide the economic return necessary to support continued research and product development and to generate an adequate return to the Company's shareholders.\nPioneer also applies the science of genetics to the development of microorganisms useful in crop and livestock production. The Company has established a business group to aid in the development and sales of Pioneer products with improved characteristics for end-use markets. A business group also has been established to develop and market a range of products and services designed to enhance the value of its core products.\nThe Company's principal products are hybrid seed corn and soybean seed which have accounted for approximately 89 percent of total net sales and substantially 100 percent of operating profits over the last five years. These products are expected to continue to play a dominant role in the Company's results of operations for the foreseeable future.\nThe Company also develops and produces various other products which provide the sales organization with a full line of products. The contribution margin on sales of these products covers fixed costs which would not disappear if the product lines were eliminated.\nApproximately 68 percent of total 1995 sales were made within the United States and Canada (the North America region) and 24 percent in Europe. Our goal within developing nations is to aid the development of the existing seed markets and establish businesses that can grow and prosper.\nTwo significant factors that determine the volume of seed sold and the related profit are government policies and weather. Government policies affect, among other things, crop acreage and performance, the Company's seed field yields, and planting decisions hybrid seed are more heavily dependent on commodity prices and the competition from farmer-saved seed. As a result, the margins are narrower and contributions are subject to year-to-year fluctuations.\nIn North America, the majority of Pioneer(R) brand seed is marketed through independent sales representatives, most of whom are also farmers. In areas outside of the traditional Corn Belt, seed products are often marketed through dealers and distributors who handle other agricultural supplies.\nPioneer products are marketed outside North America through a network of subsidiaries, joint ventures, and independent producer-distributors.\nThe hybrid seed industry is characterized by intense competition. In 1995, Pioneer seed corn held an estimated market share of 45 percent in North America. The next six competitors held an estimated combined market share of 25.5 percent with the closest competitor holding approximately ten percent. The remainder of the market is divided among more than 300 companies selling regionally. The Company's 1995 purchased soybean seed market share is estimated at 17.5 percent, placing it above the closest competitor's estimated ten percent market share.\nPioneer is the leading brand of hybrid seed corn in many European countries. In France, the largest Western European market for seed corn, Pioneer holds about a 22 percent market share. In Germany, Hungary, Italy, and Austria, Pioneer has market shares of approximately 12, 35, 61, and 48 percent, respectively. In addition, Pioneer has seed corn market shares of approximately 40 percent in Mexico and 11 percent in Brazil.\nCompetition in the seed industry is based primarily on price and product performance. The Company's objective is to produce products which consistently out-perform the competition and so command a premium price. The Company has been successful competing on that basis and expects to continue to do so through its on-going investment in research and product development. The future success of the Company depends heavily on the results of these research activities. Continued improvement in the performance of the Company's products is necessary to maintain profit margins and market share.\nThe Company's research and product development activities are directed at products with significant market potentials. Pioneer believes it possesses the largest single proprietary pool of germplasm in the world from which to develop new hybrid and varietal seed products. The majority of the Company's seed research is done through classical plant breeding techniques. However, the use of biotechnology is expected to have a significant impact on future results, both for Pioneer and the seed industry at large.\nIn the production of its commercial seed, the Company generally provides the parent seed stock, detasseling and roguing labor, and certain other production inputs. The balance of the labor, equipment, and inputs are supplied by independent growers. The Company believes the availability of growers, parent stock, and other inputs necessary to produce its commercial seed is adequate for planned production levels.\nPioneer(R) brand microbial products include inoculants for high-moisture corn silage, hay, and other forages, and direct-fed microbial products for livestock. This product line is focused on the research and development of products containing naturally-occurring microorganisms. Microbial-based products are expected to continue to have an important role in the Company's business as their use in agriculture expands.\nThe Nutrition and Industry Markets (NIM) group is the worldwide focal point for addressing opportunities driven by the \"end-use\" markets. The primary mission of NIM is to ensure that Pioneer dominates seed sales growth in this end-use market segment.\nAt August 31, 1995, the Company employed approximately 4,900 people worldwide.\nBecause the seed business is highly seasonal, the Company's interim results will not necessarily indicate the results for the full year. Substantially all seed sales are made from late second quarter through the end of the third quarter (February 1 through May 31) of the fiscal year. Typically, the Company operates at a loss during the first and fourth quarters. Varying climatic conditions can change the earnings pattern between quarters. These conditions affect the delivery of seed and can cause a shift in sales between quarters.\nEXHIBIT 13\nConsolidated Net Sales and Operating Income (Loss) by Product\nRESEARCH AND PRODUCT DEVELOPMENT\nAt August 31, 1995, the Company employed a total of 987 people directly and indirectly engaged in research and product development activities. Of these, 347 scientists performed research in the agricultural seed area and eight in microbial cultures. Of the 347 people performing research in agricultural seeds, 76 are employed outside of North America and 125 are scientists whose efforts are focused on biotechnology research. Total research expenditures for 1995 were $130 million. During the three fiscal years ended August 31, 1995, the Company expended the following amounts on research and product development:\nYears Ended August 31, 1995 1994 1993 - ------------------------------------------------------------------------ (In millions) Seed corn $ 87 $ 75 $ 70 Soybean seed 10 9 9 Other products 33 30 26 Total $ 130 $ 114 $ 105\nPlanned growth in field testing and winter nursery costs and additional costs related to technology acquisitions make up most of the increase over 1994. The investment in research has increased yearly since 1973, supporting the Company's commitment to improving products through research and product development.\nEXHIBIT 13\nPROPERTIES\nPioneer owns 23 commercial seed corn conditioning plants in North America. These plants are located in Florida (1), Illinois (4), Indiana (4), Iowa (8), Michigan (1), Nebraska (2), Texas (1), and Ontario, Canada (2).\nSeed corn, unlike commercial corn, must be harvested and dried before freezing temperatures can limit germination potential. Because of this, seed drying capacity is a critical factor. The dryers at the North American plants have a total capacity of two million bushels and, depending on factors such as seed moisture content, can be filled 11 times before fall weather presents a significant freeze risk.\nAt normal capacity, the husking and sorting units at the North American plants can handle 55,700 bushels of ear corn per hour. In total, these plants have the capacity to condition 14,400 units per hour. In a normal year, seed conditioning is completed by early February. These plants have the facilities to store ten million bushels of bulk seed and 15.8 million units of bagged seed corn, including cold storage for 7.6 million units.\nIn North America, conditioning of other commercial Pioneer(R) brand seed is performed at a total of 17 plants, six of which also condition corn. Pioneer also owns interests in 25 commercial production plants in 21 countries outside North America. Parent seed is conditioned at nine locations in North America and at eight locations outside North America. Four of these facilities also condition commercial Pioneer brand seed.\nThe Company's plant breeders conduct research at 55 stations in the U.S. and Canada. There are 31 stations which conduct research on corn, six of those conduct research on more than one crop. There are 24 stations which conduct research on other seeds. Two of these stations conduct research on more than one crop. In addition to these research efforts, Pioneer conducts seed research at 55 locations throughout the rest of the world.\nIn addition to the research stations, approximately 261,000 square feet of laboratory, greenhouse, and office space located in Johnston, Iowa are also devoted to plant breeding, biotechnology, and microbial product research.\nAdditional research and production facilities for microbial products are located at Company-owned properties in Durant, Iowa and Buxtehude, Germany. A livestock nutrition center is located in Sheldahl, Iowa.\nPioneer also owns 6,000 acres of agricultural land in the United States used primarily for research activities. Of this, 1,000 acres located in Johnston, Iowa are under commercial and residential development. As properties are developed, they are either sold or retained as equity projects.\nCompany properties, substantially all of which are owned, were subject to aggregate encumbrances of $1 million on August 31, 1995. The Company believes that all properties, including machinery, equipment, and vehicles, are well maintained and suitable for their intended uses and are adequately insured.\nEXHIBIT 13\nMARKET FOR THE COMPANY'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS\nOn November 7, 1995, the Company's stock began trading on the New York Stock Exchange. Prior to that date, the Company's stock was traded in the National Association of Securities Dealers National Market System. The range of closing prices for these shares for the past two fiscal years, as reported by the National Association of Securities Dealers, follows below:\nOn August 31, 1995, there were approximately 3,800 accounts representing approximately 17,000 shareholders of the Company's 83,486,829 outstanding shares.\nThe stock of the Company became publicly traded in 1973 and quarterly dividends have been paid continuously since that time. It is anticipated that dividends will continue to be paid in the future. The Company's stock is included in the Standard & Poors Composite Stock Price Index.\nEXHIBIT 13\nSELECTED FINANCIAL DATA\nConsolidated Ten-Year Financial History\nEXHIBIT 13\nManagement's Discussion and Analysis of Financial Condition and Results of Operations\nSales by Region - 1995 (millions)\nCorn Soybeans Other Total\nNorth America $ 808 $ 141 $ 90 $1,039 Europe $ 304 $ 3 $ 55 $ 362 Other Regions $ 114 $ 0 $ 17 $ 131\nFiscal 1995 Available Domestic Lines of Credit (millions)\n1st Qtr 2nd Qtr 3rd Qtr 4th Qtr\nRevolving $ 100 $ 100 $ 50 $ 250 Seasonal 24 48 - - ----- ----- ----- ----- Total $ 124 $ 148 $ 50 $ 250 ===== ===== ===== =====\nFiscal 1996 Available Domestic Lines of Credit (millions)\n1st Qtr 2nd Qtr 3rd Qtr 4th Qtr\nRevolving $ 200 $ 200 $ 200 $ 200 Seasonal 100 100 - - ----- ----- ----- ----- Total $ 300 $ 300 $ 200 $ 200 ===== ===== ===== =====\nNet Income (millions)\n1990 1991 1992 1993 1995 ---- ---- ---- ---- ----\n$ 104 $ 152 $ 120 $ 213 $ 183\nAnnual Dividends (millions)\n1990 1991 1992 1993 1995 ---- ---- ---- ---- ----\n$ 35 $ 36 $ 45 $ 52 $ 60\nResearch and Product Development Expenditures (millions)\n1990 1991 1992 1993 1995 ---- ---- ---- ---- ----\n$ 79 $ 92 $ 105 $ 114 $ 130\nRESULTS OF OPERATIONS\nYear Ended August 31, 1995, Compared to the Year Ended August 31, 1994\nDespite significant challenges, the Company achieved solid financial results in 1995. ROE was at the Company's targeted level of 20 percent. After-tax earnings were $183 million on sales of $1.532 billion, compared to 1994 earnings of $213 million on sales of $1.479 billion. On a per-share basis, 1995 earnings were $2.16, compared to $2.40 in 1994.\nEarnings in 1994 were positively affected by the settlement of a lawsuit involving Holden Foundation Seeds, Inc. The net effect of this and other unusual events was to increase pre-tax earnings $45 million, or $.29 per share after tax. Without the net benefit of these items, 1994 earnings per share were $2.11. On an apples-to-apples basis, 1995 per share results reflect record performance.\nSales and operating income levels for 1995 reflect an estimated 9.5 percent decrease in market size for seed corn in North America from 1994 levels. Within North America, unit sales decreased approximately eight percent, a direct relationship to fewer acres planted. The acreage reduction was the result of an increase in the United States farm program set-aside requirement, poor corn planting conditions, and record cotton prices. However, higher seed corn yields from the 1994 crop and excellent winter production activities in Argentina and Chile improved variable costs. The lower cost per unit, combined with a higher average per unit sales price, partially offset the impact of fewer seed corn unit sales. Increased soybean sales over a year ago also positively impacted the current year.\nIn Europe, the weakening of the U.S. dollar compared to European currencies improved operating income $11 million over 1994 levels. However, lower operating results in several countries offset some of this improvement. In addition, European financial results showed both higher sales and higher expenses because the Company took sole ownership of the entity in France that distributes and markets Pioneer(R) brand products there.\nIn Mexico, a reduction in corn subsidies and tighter water restrictions reduced corn acreage resulting in reduced corn unit sales of approximately 25 percent. Lower sales, in conjunction with a devaluation of the Mexican peso, reduced operating income in Mexico 68 percent from that reported in 1994. Operating income in Asia improved over 1994 due to increased unit sales.\nFinancial results in 1995 were positively impacted by a two percent decrease in the Company's worldwide effective tax rate. In addition, 1995's per share earnings reflect a lower number of shares outstanding due to the repurchase of Pioneer stock.\nManagement is optimistic about 1996. North American corn acreage is expected to rebound significantly. Reduced U.S. production and strong demand has reduced carryover corn stocks to the lowest levels in decades. As a result, the government program set-aside requirement is expected to be reduced, potentially to zero. That is expected to positively impact 1996 seed corn unit sales. The Company expects North American per unit seed corn margins to be level with 1995. The average sales price is expected to increase due to a higher priced sales mix. However, this gain is expected to be offset by higher cost of sales.\nWhile results in regions outside North America are more difficult to predict, management believes that growth can be attained in those regions as well.\nHybrid Seed Corn\nNorth America\nThe three primary drivers affecting seed corn sales are planted corn acreage, market share, and seed price. Planted corn acreage in North America had the biggest impact on current year operating income. Acreage planted to corn decreased approximately 9.5 percent from 1994. A major factor contributing to the acreage decrease was the U.S. government set-aside program which required farmers participating in the 1995 feed grain program to keep their planted corn acres at 92.5 percent or less of their historical corn acreage base, down from 100 percent in 1994.\nIn addition, high cotton prices caused some farmers in the South to switch acreage to cotton while wet conditions in the Midwest forced affected farmers to switch acreage from corn to other crops such as soybeans. Others were never able to plant a crop. As a result, the Company sold approximately 910,000 fewer units in 1995, assuming 1994 market share levels and that an 80,000-kernel unit of seed corn plants 3.1 acres. This had the effect of decreasing operating income $44 million from 1994 levels.\nSeed corn pricing was also a major factor in 1995 financial results, contributing $27 million to seed corn operating income. The average per-unit sales price increased 3.4 percent due to an increase in the list price of key hybrids and a higher priced sales mix. The higher priced sales mix occurred as customers shifted their purchases to higher-priced better-performing hybrids which are more profitable to growers and to Pioneer.\nManagement estimates the Company's seed corn market share at 45 percent -- comparable to 1994. Maintaining market share was a challenge in a year when high levels of seed inventory throughout the industry led to aggressive competition. The ability to hold market share can be attributed to a world-class sales and supply management group. They were able to use the flexibility of our product line-up to respond to the changing needs of customers, providing them with appropriate products when and where they were needed as growing conditions changed.\nHigher seed corn yields from the 1994 crop also provided positive results, reducing 1995's average per unit cost of seed corn by $.80, or $9 million. Higher operational fixed costs and provisions for inventory reserves offset $7 million of the improvements gained in production costs. Provisions for inventory reserves totaled $14 million in 1995 compared to $11 million in 1994.\nPlanned growth in winter nursery costs and expansion of biotechnology projects were the main factors in an $11 million, or 18 percent, increase in research expenses for corn. This commitment to research continues to provide the Company with a steady line of new and improved products each year. For 1995, 18 new seed corn products were released. These new releases will add to the Company's ability to provide higher yielding and more valuable products to customers.\nSales of hybrid 3394 totaled 2.3 million units in 1995, 21 percent of the Company's total North American seed corn unit sales. In 1994, unit sales were 2.7 million, 23 percent of the North American total.\nFixed selling and general and administrative expenses for seed corn in North America decreased $4 million, or five percent, from 1994 levels. The major component of this decrease was lower performance incentive costs. That was partially offset by planned increases in advertising expenses. Variable selling costs (commissions and shipping costs) as a percentage of sales increased from a year ago because of additional expenses incurred shipping product to customers who switched seeds due to weather related planting delays.\nEurope\nThe Company's European region includes the countries in West and Central Europe, plus CIS (the former USSR), Turkey, Morocco, Australia, and Japan. This combined region showed a $6 million increase in operating income from a year earlier.\nApproximately $11 million of this change was the result of a weaker U.S. dollar against certain European currencies. On a constant dollar basis, European operations provided a slight decrease in operating income from a year ago. Operations in Italy improved from 1994 levels to contribute substantial improvement to the region. However, that was more than offset by lower operating results in France, Hungary, and Germany.\nItalian operations posted gains in operating income totaling $7 million over 1994 results. Most of the improvement was due to lower product costs and fewer inventory writedowns. An increase in the average unit sales price, an increase in market size, and market share gain over 1994 also contributed to the improvement.\nIn 1994, the Company acquired the remaining 60 percent interest in the French entity which handled distribution and marketing of Pioneer(R) brand products. Increased sales and expenses were reported as the subsidiary was reflected in the 1995 financials on a consolidated basis for the first time. Overall, consolidated country operating income for France decreased $6 million due to fewer unit sales.\nOperating income in Hungary decreased $3 million as unit sales declined. New competitors entered the market at significantly lower prices, reducing unit sales and operating income. Higher inventory reserves also impacted current year operations.\nLower sales volume and higher costs reduced operating income in Germany. Unit sales were lower than 1994 levels due to decreased market share. Higher sales commissions, product costs, and inventory writedowns also contributed to a $3 million decrease in operating income for Germany from 1994.\nOther Regions\nMexico's operating income decreased $13 million, or 68 percent, to $6 million. The devaluation of the Mexican peso was the major factor contributing to lower operating results. Also, nearly 35 percent fewer acres were planted to seed corn in Northeast and Northwest regions because of drought, subsidy reductions, and NAFTA quotas. These factors reduced unit sales 25 percent.\nOperating income in Brazil decreased $3 million as a result of fewer unit sales. A change in government subsidized farm programs reduced the amount of reasonably priced credit available to customers. This lack of financing directly affected unit sales because many Brazilian customers rely on credit for seed purchases.\nArgentina's operating income increased $3 million from 1994 results. Increased unit sales, higher average sales price, and lower unit costs were the main factors for this improvement.\nOperations in Asia account for most of the remaining change from 1994 in other regions seed corn operating income. Increased market size and market share in the Philippines, increased market size in Indonesia, and cost savings contributed to a $3 million operating income improvement in the region.\nSoybean Seed\nSoybean seed represents the Company's second largest product in terms of revenue and operating income. In 1995, North American operations accounted for virtually all of the worldwide soybean seed operating income.\nNorth American unit sales increased 16.7 percent from 1994, a result of market share gains and increased acreage. A continued recognition of the value associated with Pioneer(R) brand soybeans provided for market share gains, as customers understood that planting Pioneer brand soybean seed, much like Pioneer brand seed corn, provides them economic value.\nNorth American soybean acreage increased as poor weather conditions forced customers who planned to plant corn to switch to soybeans. Higher overall acreage and increased market share contributed $6 million more to operating income than in 1994.\nThe average sales price of soybean seed decreased approximately three percent from 1994 levels, the result of bulk sales and early payment discounts. However, contribution per unit remained the same because of lower cost of sales, the result of lower commodity costs.\nIncreased investments in research and additional fixed selling and general and administrative expenses reduced operating income $4 million from 1994.\nOther Products\nOther products contribution for 1995 improved $8 million from results recorded a year ago. The Company manages these products at the contribution level because all fixed costs allocated to them could not be eliminated in the event these products were discontinued.\nAlthough in terms of operating income these products as a whole are not profitable, they provide a value beyond the financial bottom line. The presence of these products in the Company's line-up provide the sales organization a full line of seed products, significantly aiding the sale of higher margin products like hybrid seed corn. In addition, the Company's investment in research for these products, which totaled $33 million in 1995, is expected to provide Pioneer future growth opportunities.\nCorporate Items\nIndirect general and administrative expenses increased $5 million in 1995, a seven percent increase over 1994. The major components of this increase were personnel costs and increased charitable contributions.\nNet interest income for 1995 increased $2 million compared to a year ago because of higher interest rates earned on current year investments and decreased interest expense on lower levels of external borrowing. Net exchange gain increased $6 million from 1994 levels. The strengthening of certain European currencies against the U.S. dollar and translation gains in Mexico accounted for a majority of the improvement.\nA reduction in taxes on foreign earnings reduced the 1995 effective tax rat to 36.5 percent compared to 38.5 percent in 1994.\nYear Ended August 31, 1994, Compared to the Year Ended August 31, 1993\nHYBRID SEED CORN\nNorth America\nOperations in North America (U.S. and Canada) accounted for most of the 1994 improvement in annual worldwide seed corn operating results. All of the primary factors affecting seed corn sales -- planted corn acreage, market share, and seed price -- positively affected 1994 operating income.\nUnits delivered reached record levels in 1994. The 14 percent increase in delivered units in North America was the result of increased acreage and market share gains.\nA change in the U.S. farm program for 1994 spurred an 7.6 percent increase in acres planted to corn in North America. The Company's ability to capitalize on this increase in acres provided additional operating income of approximately $35 million over prior year results, based on approximately 750,000 additional units sold.\nMarket share gains also impacted 1994 unit sales, which translated into approximately 550,000 additional unit sales over 1993. The Company posted a market share gain of two percentage points in 1994 -- the result of hard-working, dedicated sales representatives, and employees producing and selling a high-quality lineup of products and services. The increase in market share accounted for approximately $26 million of seed corn operating income improvement.\nThe average sales price of Pioneer(R) brand seed corn within North America increased one percent over 1993. This improvement was the result of an increase in the list price of the Company's top-performing hybrids and a shift by customers to higher-priced, higher-performing hybrids. That improved 1994 operating results $7 million.\nHigher per-unit cost of sales reduced 1994 operating income $17 million. Below average seed field yields, resulting from poor weather in the spring and summer of 1993, and higher commodity costs increased the per-unit cost of the 1993 crop. Lower provisions for inventory reserves partially offset the impact of higher seed costs. Provisions for inventory reserves decreased $8 million from $19 million in 1993.\nResearch expenses for corn increased $3 million, or seven percent from 1993 levels. Planned growth in field testing and winter nursery costs and additional costs related to technology acquisitions accounted for most of the increase.\nFixed selling and general and administrative expenses for seed corn in North America increased $13 million from 1993. The major components of this increase were higher compensation costs due to merit increases and additional sales personnel to support the growth in the business, along with additional employee related costs and increased marketing efforts. Variable selling costs for seed corn as a percentage of sales were comparable to 1993 levels.\nEurope\nEuropean operating income in 1994 decreased $12 million from a year earlier. Operations in the CIS (the former USSR) represent most of the decrease from 1993. CIS operations in 1993 included unusual sales of seed and the benefit of collections on previously written-off accounts receivable. Excluding the CIS, operating income for the region was essentially unchanged from 1993 levels.\nIn Turkey, a 25 percent decline in market size combined with price decreases reduced corn operating income by $2 million from prior year results.\nOperating income in Italy decreased $4 million from 1993 primarily due to a weaker lira and a smaller seed corn market. The devaluation of the lira reduced operating results $3 million. An estimated five percent decrease in market size contributed to the remaining $1 million decrease.\nIn France, operating income decreased approximately $3 million from 1993. Common Agricultural Policy programs and a decline in market share combined to significantly reduce 1994 sales.\nOperating income in Germany decreased approximately $2 million from the prior year principally due to a decline in sales price. Prices were reduced in response to lower-priced seed being sold into Germany from other European countries.\nHungary's operating income improved approximately $8 million from 1993 levels. The improvement was largely attributable to lower inventory reserves and costs incurred in 1993 to terminate old distribution arrangements. Unit price increases and market share gains also positively impacted 1994 results.\nIn 1994, operations in Spain rebounded after several years of drought to post a $4 million improvement in operating income. Better weather conditions directly resulted in increased corn acreage and higher unit sales. Lower inventory reserves also contributed to the improvement in 1994 operating income.\nOther Regions\nMexico's seed corn operating income was down slightly from 1993. Unit sales increased on reduced acreage. However, higher provisions for inventory reserves and increased selling costs offset the margins on these sales.\nIn South America, operating income increased as a result of higher selling prices and market share gains in Brazil and Argentina, combined with a market share gain in Chile. Operating income in Brazil rose approximately $5 million, operating income in Argentina improved nearly $3 million, and Chile operations improved approximately $1 million. In addition, Chile and Argentina continued to significantly benefit the North American business through off-season seed corn production. Off-season production supplied 796,000 corn units to the Northern Hemisphere at a cost lower than previous years. This improved margins while supplying our customers with our products in the highest demand.\nSoybean Seed\nOperations in North America accounted for all of the worldwide soybean seed operating income in 1994. In North America, an increase in the average sales price per unit improved operating results $5 million. Increased unit sales contributed another $1 million to operating results over 1993. However, higher commodity prices increased the cost of seed produced in 1993 reducing 1994 operating results $5 million. Fixed selling and general and administrative expenses for soybean seed in North America increased $1 million, accounting for most the remaining change in operating income from 1993.\nOther Products\nOther products sales continued to show improvement in 1994. While these products generate positive contributions, they did not cover all of the allocated costs. However, all these costs would not be eliminated in the event these products were discontinued.\nCorporate Items\nIn 1994, indirect general and administrative expenses grew $9 million, or 15 percent from the previous year. Compensation, information management costs, and other employee related costs account for most of the increase.\nNet financial income totaled $3 million in 1994 compared to net financial expense of $6 million in 1993. Higher cash receipts on sales allowed the Company to increase investment income and reduce interest expense. Interest expense was lowered by internal funding of international operations.\nThe worldwide effective tax rate for 1994 was 38.5 percent compared to 39.1 percent in 1993. The effective rate in 1994 decreased primarily due to the effect of taxes on foreign earnings.\nRestructuring and Settlements\nOn July 13, 1994, the U.S. Circuit Court of Appeals affirmed a prior court's decision in the Company's lawsuit against Holden Foundation Seeds, Inc., awarding Pioneer damages for lost profits from the misappropriation of germplasm. In August, the Company received the settlement plus interest totaling $52 million. The Company also incurred $7 million of additional restructuring charges. The charges reflect $4 million of costs incurred in 1994 to complete the divestment of the Egyptian Edible Oil business and $3 million for other operations. We believe all expenses related to these restructurings have been incurred and remaining reserves are not material.\nIn 1993, the Company incurred $54 million in restructuring charges from closing and redefining most of its operations in Africa and the Middle East.\nLiquidity and Capital Resources\nDue to the seasonal nature of the agricultural seed business, the Company generates most of its cash from operations during the second and third quarters of the fiscal year. Cash generated during this time is used to pay the commercial paper and accounts payable which are the Company's primary sources of credit during the first and fourth quarters of the fiscal year. Any excess funds available are invested, primarily in short-term commercial paper.\nHistorically, the Company has financed growth through earnings. Cash provided by operating activities was $140 million in 1995, compared to $331 million and $176 million in 1994 and 1993, respectively. Higher inventory levels and a decrease in accounts payable and accruals contributed to the decrease in current year cash provided by operating activities. In addition, cash flow in 1994 was favorably impacted by the settlement and collection of damages on the Holden suit. Collections on increased sales were largely responsible for the high levels of cash provided by operating activities for 1994. Cash provided by operating activities is expected to increase in 1996 based on increased seed sales and lower inventory levels.\nMost of the Company's financing is done through the issuance of commercial paper in the U.S., backed by revolving and seasonal lines of credit. In addition, foreign lines of credit and direct borrowing agreements are relied upon to support overseas financing needs. Short-term debt at August 31, 1995, totaled $58 million, a $44 million increase from 1994 and $6 million lower than 1993. The collection of damages on the Holden suit during August of 1994 allowed for lower levels of borrowing at year end. In 1995, short-term borrowings peaked at $217 million compared to $164 million and $255 million in 1994 and 1993, respectively.\nIn 1995, short-term domestic investments peaked at $257 million compared to $326 million and $212 million in 1994 and 1993, respectively. Short-term investments are made through a limited number of reputable institutions after evaluation of investment procedures and credit quality. Pioneer invests in only high-quality short-term securities, primarily commercial paper. Individual securities must meet credit quality standards, and the portfolios are monitored to ensure diversification among issuers.\nThe Company believes the domestic lines of credit available in 1996 are sufficient to meet domestic borrowing needs. The revolving line of credit agreements expire August, 2000. The Company also has a seasonal revolving credit facility to meet peak borrowing needs which expires August, 1996.\nThe Company also has a $100 million private medium-term note program of which $50 million was available at August 31, 1995. The medium-term note matures in February, 1996 and is expected to result in increased levels of short-term debt. At year end, cash and cash equivalents totaled $84 million, down from $135 million at August 31, 1994. It is the Company's policy to repatriate excess funds not required for operating capital or to fund asset purchases.\nCapital expenditures, including business and technology acquisitions, were $86 million in 1995 compared to $79 million in 1994 and $107 million in 1993. In 1993, total expenditures were higher principally due to expanded production capacity, additional research facilities, and technology acquisitions. Capital expenditures for 1996 are expected to be approximately $120 million, and will be funded through earnings. In addition, the Company expects to invest approximately $51 million in 1996 as part of a proposed research collaboration with Mycogen Corporation.\nDividends paid in July of 1995 increased to $.20 per share, up 18 percent from the $.17 per share dividend paid the prior three quarters. The Company's dividend policy is to annually pay out 40 percent of a four-year rolling average of earnings.\nDuring 1995, 2.8 million shares of the Company's stock were repurchased under a Board authorized repurchase plan at a total cost of $100 million. At August 31, 1995, authorized shares remaining to be purchased under the plan totaled 700,000. On September 12, 1995, the Board of Directors authorized the repurchase of an additional three million shares of the Company's stock.\nEffects of Inflation\nInflation typically is not a major factor in the Company's operations. The cost of seed products is largely influenced by seed field yields and commodity prices which are not impacted by inflation. Costs normally impacted by inflation -- wages, transportation, and energy -- are a relatively small part of the total operations.\nEXHIBIT 13\nINDEPENDENT AUDITORS' REPORT\nTo the Shareholders Pioneer Hi-Bred International, Inc. Des Moines, Iowa\nWe have audited the accompanying consolidated balance sheets of Pioneer Hi-Bred International, Inc. and subsidiaries as of August 31, 1995 and 1994, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the years in the three-year period ended August 31, 1995. 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 Pioneer Hi-Bred International, Inc. and subsidiaries as of August 31, 1995 and 1994, and the results of their operations and their cash flows for each of the years in the three-year period ended August 31, 1995, in conformity with generally accepted accounting principles.\nAs discussed in Note 1 to the consolidated financial statements, the Company changed its method of accounting for other postretirement benefits in 1993.\nKPMG Peat Marwick LLP\nDes Moines, Iowa October 13, 1995\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNote 1. Nature of Business and Significant Accounting Policies\nNature of business:\nThe Company's business is the broad application of the science of genetics. Pioneer was founded in 1926 to apply newly-discovered genetic techniques to hybridize corn. Today, the Company develops, produces, and markets hybrids of corn, sorghum, sunflower, and vegetables; varieties of soybean, alfalfa, wheat, and canola; and microorganisms useful in crop and livestock production.\nConsolidation policy:\nThe consolidated financial statements include the accounts of the Company and all of its subsidiaries. All material intercompany balances and transactions have been eliminated in consolidation.\nCash equivalents:\nThe Company considers all liquid investments with a maturity at purchase of three months or less to be cash equivalents.\nReceivables:\nReceivables are stated net of an allowance for doubtful accounts of $19 million and $21 million at August 31, 1995 and 1994, respectively.\nInventories\nInventories are valued at the lower of cost (first-in, first-out method) or market. Gains or losses on commodity hedging transactions are included as a component of inventory.\nProperty and equipment:\nProperty and equipment is recorded at cost, net of an allowance for loss on plant closings of $9 million and $5 million at August 31, 1995 and 1994, respectively. Depreciation is computed primarily by the straight-line method over estimated service lives of two to 40 years.\nIntangibles:\nIntangible assets are stated at amortized cost and are being amortized by the straight-line method over one- to twenty-year periods, with the weighted-average amortization period approximating 7.6 years for the year ended August 31, 1995. Accumulated amortization of $32 million and $26 million at August 31, 1995 and 1994, respectively, have been netted against these assets.\nBasis of accounting:\nSubsidiary and asset acquisitions are accounted for by the purchase method.\nTranslation of foreign currencies and foreign exchange hedging:\nAll assets and liabilities in the balance sheets of foreign subsidiaries whose functional currency is other than the U.S. dollar are translated at year-end exchange rates. Translation gains and losses are not included in determining net income but are accumulated as a separate component of shareholders' equity. However, for subsidiaries considered to be operating in highly inflationary countries and for certain other subsidiaries, the U.S. dollar is the functional currency, and translation gains and losses are included in determining net income. Foreign currency transaction gains and losses are included in determining net income.\nThe Company uses a combination of forward foreign exchange contracts and foreign currency option contracts to hedge open foreign denominated payables and receivables and also to hedge firm sales and purchase commitments with its foreign subsidiaries. Unrealized gains and losses on hedges of existing foreign denominated payables or receivables are included in other assets or liabilities and are recognized in net exchange gain (loss) in conjunction with the revaluation of the foreign currency denominated transaction. Unrealized gains and losses related to qualifying hedges of firm sales and purchase commitments are deferred and recognized in income when the future sales or purchases are recognized or immediately if the commitment is canceled. Option premiums paid are amortized to income over the life of the contract.\nIncome taxes:\nIncome taxes are computed in accordance with SFAS No. 109. Deferred income taxes have been provided on temporary differences in the financial statement and income tax bases of certain assets and liabilities.\nDeferred income taxes have not been provided on the undistributed earnings or the cumulative translation adjustment of the foreign subsidiaries to the extent the Company intends to reinvest such undistributed earnings indefinitely or to repatriate them only to the extent that no additional income tax liability is created. The cumulative amount of the undistributed net income and translation adjustment of such subsidiaries is approximately $169 million at August 31, 1995. The Company files consolidated U.S. Federal income tax returns with its domestic subsidiaries; therefore, no deferred income taxes have been provided on the undistributed earnings of those subsidiaries.\nPension plans:\nThe Company's domestic and Canadian operations have defined benefit pension plans covering substantially all their employees. The plans provide benefits that are based on average monthly earnings of the employees. The funding policy is to contribute annually an amount to fund pension cost as actuarially determined by an independent pension consulting firm.\nOther postretirement benefits:\nThe Company sponsors a health care plan and a life insurance plan which provide benefits to eligible retirees. The Company's contribution is based on age and years of service at retirement. The health insurance plan contains the cost-sharing features of coinsurance and\/or deductibles. The life plan is paid for by the Company. Benefits under both plans are based on eligibility status for pension and length of service. Substantially all of the Company's U.S. and Canadian full-time employees may become eligible for these benefits upon reaching age 55 and having worked for the Company at least five years.\nDuring the second quarter of fiscal 1993, the Company adopted Financial Accounting Standards Board Statement No. 106 \"Employers' Accounting for Postretirement Benefits Other than Pensions.\" The Company recorded the transition obligation as the cumulative effect of an accounting change.\nDeferred executive compensation and supplemental retirement benefit plans:\nThe estimated liability for the deferred executive compensation and supplemental retirement benefit plans is being accrued over the expected remaining years of active employment.\nRestricted stock plans:\nThe Company amortizes as compensation expense the cost of stock acquired for the restricted stock plans by the straight-line method over the five-year restriction period.\nNote 2. Inventories\nUnfinished seed represents the Company's cost of parent seed, detasseling and roguing labor, and certain other production costs incurred by the Company to produce its seed supply. Much of the balance of the labor, equipment, and production costs associated with planting, growing, and harvesting the seed is supplied by independent growers who contract specific acreage for the production of seed for the Company. The compensation of the independent growers is determined based upon yield, contracted acreage, and commodity prices. The commitment for grower compensation is accrued as seed is delivered to the Company. Accrued grower compensation was $6 million and $19 million at August 31, 1995 and 1994, respectively.\nThe Company uses commodity futures and options to hedge grower compensation costs. At August 31, 1995 and 1994, the Company had futures contracts with brokers on notional quantities amounting to seven million bushels and 17 million bushels, respectively for corn, and five million bushels and two million bushels, respectively for soybeans. At August 31, 1995, unrealized gains on these contracts were $2 million.\nNote 3. Current Borrowings, Lines of Credit, Long-Term Debt, and Guarantees\nAt August 31, 1995, the Company had domestic lines of credit totaling $250 million available to be used as support for the issuance of the Company's commercial paper. Commercial paper outstanding at August 31, 1995, totaling $43 million, bears interest at an average rate of 5.85 percent. There was no commercial paper outstanding at August 31, 1994.\nIn addition, the Company's foreign subsidiaries have lines of credit and direct borrowing agreements totaling $48 million, substantially all of which are unsecured. At August 31, 1995, short-term borrowings of $15 million were outstanding under these lines of credit at a weighted average interest rate of 17.8 percent. At August 31, 1994, short-term borrowings of $14 million were outstanding under foreign subsidiary lines of credit at a weighted average interest rate of 14.4 percent.\nThe Company has in place a $100 million private medium-term note program of which $50 million is outstanding at August 31, 1995. The note is unsecured and bears interest at 8.5 percent with payment due in 1996.\nThe remaining long-term debt at August 31, 1995, bears interest at varying rates and requires annual principal payments through fiscal 2001. The maturities of long-term debt for the next five fiscal years, in millions, are as follows: $53; $8; $3; $1; and $0.2.\nThe Company has guaranteed the repayment of principal and interest on certain obligations of Village Court Associates, an affiliated real estate venture. At August 31, 1995, such guarantees totaled approximately $23 million.\nNote 4. Income Taxes\nThe provision for income taxes is based on income before income taxes as follows:\nThe provision for income taxes is composed of the following components:\nThe tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at August 31, 1995 and 1994, are presented below:\nThe net operating loss carryforwards result from various international subsidiaries. The expiration of these net operating losses range from 1996 to indefinite. Utilization of these losses is dependent upon earnings generated in the respective subsidiaries. A valuation allowance for the losses has been set up where appropriate.\nThere was no change in the total valuation allowance for the year ended August 31, 1995. The net change in the total valuation allowance for the year ended August 31, 1994, was a decrease of $3 million.\nFollowing is a reconciliation of the statutory U.S. Federal income tax rate to the Company's actual worldwide effective income tax rate.\nNote 5. Pension Plans and Other Postretirement Benefits\nQualified pension plans: The components of pension cost expensed under qualified defined benefit pension plans for the years ended August 31, 1995, 1994, and 1993, consisted of the following:\nThe following table sets forth the plans' funded status as of June 30, 1995 and 1994, respectively:\nPlan assets include common stock of the Company of $11 million and $8 million at June 30, 1995 and 1994, respectively.\nIn determining the present value of benefit obligations, a discount rate of eight percent was used in 1995 and 1994. The expected long-term rate of return on plan assets used was nine percent and the assumed rate of increase in compensation levels used was 6.5 percent in both years.\nNon-qualified pension plans: The components of pension cost expensed under non-qualified pension plans for the years ended August 31, 1995, 1994, and 1993, consisted of the following:\nThe following table sets forth the plans' funded status as of August 31, 1995 and 1994, respectively:\nIn determining the present value of benefit obligations, a discount rate of eight percent was used in 1995 and 1994. The assumed rate of increase in compensation levels used was eight percent in both years.\nOther postretirement benefit plans: The components of postretirement benefits cost expensed for the years ended August 31, 1995, 1994, and 1993, consist of the following components:\nThe following table sets forth the plans' funded status as of August 31, 1995 and 1994, respectively:\nFor 1995 and 1994, the discount rate used in determining the accumulated postretirement benefit obligation was eight percent. An 11 percent annual rate of increase in the per capita cost of covered health care benefits was assumed for 1994. This rate was assumed to decrease gradually to six percent in the year 2004 and remain at that level thereafter. A one-percentage-point increase in the assumed health care cost trend rates would increase the accumulated postretirement benefit obligation as of August 31, 1995, by approximately $5 million and the total of the service and interest cost components of net postretirement health care cost for the year then ended, by approximately $1 million.\nNote 6. Financial Instruments\nForeign exchange:\nThe Company uses foreign currency hedge instruments to reduce the effect of exchange rate fluctuations on the U.S. dollar value of cash flows of foreign operations and reported earnings. The main financial instruments used are foreign exchange forward contracts, purchased foreign currency options, and cross currency swaps. In some countries, foreign currency hedge instruments are not available or are cost prohibitive. The exposures in these countries are addressed through managing net asset positions and borrowing in local currency or investing in U.S. dollars.\nWhile the hedge instruments are subject to risk of loss from exchange rate movement, these losses would generally be offset by expected gains in the U.S. dollar value of foreign sales and\/or cash flows. The Company does not trade these instruments with the objective of earning financial gains on the exchange rate price fluctuations alone, nor does it trade in currencies for which there are no underlying exposures.\nThe notional amounts for contracts in place at August 31, 1995 and 1994, are shown in the following table in U.S. dollars. These contracts generally mature in less than one year.\nAt August 31, 1995, deferred unrealized gains from hedging firm purchase and sale commitments, based on broker quoted prices, were $1 million and deferred unrealized losses were $3 million.\nCredit risk: The Company's financial instruments subject to credit risk are primarily trade accounts receivable, cash and cash equivalents, and foreign currency exchange contracts. The Company is exposed to credit risk of non-performance by counterparties. Generally, the Company does not require collateral or other security to support customer receivables or foreign currency exchange contracts. The counterparties to the Company's hedge instruments are major financial institutions. The Company evaluates the credit worthiness of the counterparties to hedge instruments and has never experienced, nor does it anticipate, nonperformance by any of its counterparties.\nThe Company had the following significant concentrations of trade accounts receivables and cash and cash equivalents subject to credit risk:\nWithin the United States, the majority of the Company's business is conducted with individual farm operators located throughout the country. The majority of the Company's business in Italy is transacted with distributors and cooperatives. In Central Europe and the Commonwealth of Independent States (CIS), the Company conducts business primarily with government-sponsored companies and agencies.\nFair value:\nThe Company estimated the fair value of its financial instruments by discounting the expected future cash flows using the current interest rates which would apply to each class of financial instruments, except for foreign currency contractsfor which quotes from brokers were used.\nThe fair value of cash equivalents, receivables, short-term borrowings, and foreign currency contracts approximates carrying value. The fair value of long-term debt at August 31, 1995, is approximately $65 million compared to its carrying value of $71 million.\nNote 7. Restructuring And Settlements\nOn July 13, 1994, the U.S. Circuit Court of Appeals affirmed a prior court's decision in its suit against Holden Foundation Seeds, Inc., awarding Pioneer damages for lost profits from the misappropriation of germplasm. In August 1994, the Company received the settlement plus interest totaling approximately $52 million. During 1994, the Company also incurred $7 million of additional restructuring charges. The charges reflect $4 million of costs incurred in 1994 to complete the divestment of the Egyptian Edible Oil business and $3 million for other operations.\nOperating results in 1993 include $54 million in provisions for costs associated with restructuring operations in Africa and the Middle East. The Company recorded reserves on accounts receivable, inventory, and long-term assets and provided for the estimated costs of closing and redefining most of the operations in this region. These charges included writing off 100 percent of the Company's investment in its Egyptian Edible Oil business.\nWe believe all expenses related to the restructuring of operations have been incurred and remaining reserves are not material.\nNote 8. Capital Stock\nStock plans:\nThe Company has restricted stock plans under which 879,596 shares of the Company's common stock are held by the Company for key employees. Such stock is subject to an agreement requiring forfeiture by the employee in the event of termination of employment within five years of the date of grant other than as a result of retirement, death, or disability. The maximum number of shares authorized for grant under these plans is 5,250,000 shares of which 2,063,745 had been granted as of August 31, 1995.\nOn September 12, 1995, the Board of Directors approved a stock option plan subject to shareholder approval. The plan authorizes options covering three million shares to be granted to officers of the Company.\nVoting rights:\nGenerally, each share of common stock is entitled to five votes per share if the share has been beneficially owned continuously by the same person for a period of 36 consecutive months preceding the record date for the relevant shareholders' meeting; and, all other shares are entitled to one vote per share.\nShare repurchase:\nAt August 31, 1995, shares remaining to be purchased under a Board authorized repurchase plan totaled 700,000. On September 12, 1995, the Board of Directors authorized the repurchase of an additional three million shares of the Company's stock.\nNote 9. Geographic Data Certain financial information concerning the Company's domestic and foreign operations is as follows:\nNote 10. Unaudited Quarterly Financial Data\nSummarized unaudited quarterly financial data for 1995 is as follows:\nSummarized unaudited quarterly financial data for 1994 is as follows:\nNote 11. SUPPLEMENTAL CASH FLOW INFORMATION\nCertain financial information concerning the Consolidated Statements of Cash Flows is as follows:\nNote 12. Subsequent Events\nOn September 18, 1995, the Company and Mycogen Corporation announced they had signed a Memorandum of Understanding to pursue an agreement in which Pioneer would make an investment in Mycogen and the two companies would create a research collaboration.\nThe proposed investment by Pioneer would total $51 million, of which, $30 million would be for the purchase of three million shares of Mycogen common stock and the remainder would be funding for the research collaboration.\nEXHIBIT 21\nPIONEER HI-BRED INTERNATIONAL, INC. SUBSIDIARIES OF THE REGISTRANT\nThe following are all of the subsidiaries of the Registrant, and are included in its audited consolidated financial statements filed with its Annual Report on Form 10-K for the fiscal year ended August 31, 1995. Each subsidiary listed is wholly-owned by the Registrant or one of the Registrant's wholly owned subsidiaries, except as otherwise indicated.\nSubsidiary Place of Incorporation\nSubsidiaries of the Registrant: The Advantage Corp U.S.A. Green Meadows, Ltd. U.S.A. PHI Communications Company, Inc. U.S.A. PHI Financial Services, Inc. U.S.A. PHI Insurance Co. U.S.A. PHI Insurance Services, Inc. U.S.A. PHI Mexico, SA de CV (99%) Mexico PHI Specialty Products U.S.A. Pioneer Hi-Bred Australia, Pty. Ltd. Australia Pioneer Hi-Bred FSC Ltd. (0.45%) Jamaica Pioneer Hi-Bred Limited Canada Pioneer Hi-Bred Production, Ltd. Canada Pioneer Hi-Bred Puerto Rico, Inc. U.S.A. Pioneer Maghreb S.A. (99.9%) Morocco Pioneer Overseas Corporation U.S.A. Pioneer Sementes Ltda. (74.39%) Brazil Pioneer Vegetable Genetics, Inc. U.S.A. Pioneer Vegetable Genetics, Ltd Israel Semillas Pioneer Chile Ltda. (99.74%) Chile Semillas Pioneer Colombia S.A. (1.5%) Colombia Semillas Pioneer, S.A. Spain\nEXHIBIT 21\nSUBSIDIARIES OF THE REGISTRANT\nSubsidiary Place of Incorporation\nSubsidiaries of Pioneer Overseas Corporation, a wholly owned subsidiary of the Registrant: Agri-Genetic Realty, Inc. (30%) Philippines Ethiopian Pioneer Hi-Bred Seeds, Inc. JV (76.91%) Ethiopia Grainfield Co., Ltd. (35%) Thailand Hibridos Pioneer de Mexicanos S.A. de C.V. Mexico MISR Pioneer Seeds Company S.A.E. (80.39%) Egypt P. T. Pioneer Hibrida Indonesia (80%) Indonesia Part Agri SARL (50%) France PHI Genetics (Proprietary) Limited South Africa PHI Hi-Bred (Proprietary) Limited South Africa PHI Seeds Proprietary Ltd. (99.99%) Botswana Pioneer Argentina, S.A. Argentina Pioneer France Mais S.A. (99.44%) France Pioneer Genetique S.A.R.L. (99%) France Pioneer Hi-Bred Agricultural Technologies, Inc.(80%) Philippines Pioneer Hi-Bred Benelux B.V. Netherlands Pioneer Hi-Bred Europe, Inc. U.S.A. Pioneer Hi-Bred FSC Ltd. (99.55%) Jamaica Pioneer Hi-Bred Italia S.p.A. (90%) Italy Pioneer Hi-Bred Japan Co., Ltd. (52%) Japan Pioneer Hi-Bred Korea, Inc. U.S.A. Pioneer Hi-Bred Magyarorszag Kft. (90%) Hungary Pioneer Hi-Bred S.A.R.L. (99.8%) France Pioneer Hi-Bred Seeds Agro S.R.L. Romania Pioneer Hi-Bred Sementes de Portugal, S.A. (99.96%) Portugal Pioneer Hi-Bred Thailand Co., Ltd. (94.5%) Thailand Pioneer Holding Company Ltd. Turks & Caicos Pioneer Overseas Corporation (Thailand) Ltd.(99.96%) Thailand Pioneer Overseas Research Corporation U.S.A. Pioneer Pakistan Seed Limited (24%) Pakistan Pioneer Saaten GmbH Austria Pioneer Saaten GmbH Germany Pioneer Seed Company (Zimbabwe) (Pvt.) Ltd. (95%) Zimbabwe Pioneer Seed Holding Nederland B.V. Netherlands Pioneer Seeds, Inc. U.S.A. Pioneer Semena Holding GmbH (99%) Austria Pioneer Sementes Ltda. (25.61%) Brazil Pioneer Sjeme D.O.O. (10%) Croatia Pioneer Tohumculuk A.S. (99.96%) Turkey Pioneer Trading Ltd. (51%) Turks & Caicos Semillas Hibridas Pioneer S.A. (75%) Colombia Semillas Pioneer Chile Ltda. (.26%) Chile Semillas Pioneer Colombia, S.A. (94%) Colombia Semillas Pioneer de Venezuela C.A. Venezuela SPIC PHI Seeds Inc. (40%) India Swazi-American (PHI) Seeds, Ltd. (70%) Swaziland Ukranian-American Russian Zorya-Nassinya (33.33%) CIS\nEXHIBIT 21\nSUBSIDIARIES OF THE REGISTRANT\nSubsidiary Place of Incorporation\nSubsidiaries of Green Meadows, Ltd., a wholly owned subsidiary of the Registrant: Green Meadows Development Board U.S.A. Iowa India Investments Company Ltd. U.S.A. PHI Mexico, SA de CV (1%) Mexico Pioneer France Mais S.A. (.08%) France Semillas Pioneer Colombia, S.A. (1.5%) Colombia Village Court, Inc. U.S.A. Subsidiary of PHI Insurance Co., a wholly owned subsidiary of the Registrant: Semillas Pioneer Colombia, S.A. (1.5%) Colombia Subsidiary of PHI Insurance Services, Inc., a wholly owned subsidiary of the Registrant: Pioneer Insurance Services, Inc. - An Insurance Agency U.S.A. Subsidiary of Pioneer Genetique S.A.R.L., a wholly owned subsidiary of Pioneer Overseas Corporation and Pioneer Hi-Bred Limited: Pioneer France Mais S.A. (.08%) France Subsidiaries of Pioneer Hi-Bred Europe, Inc., a wholly owned subsidiary of Pioneer Overseas Corporation PHI Seeds Proprietary Ltd. (.01%) Botswana Pioneer Hi-Bred (U.K.) Limited (99.99%) United Kingdom Pioneer Hi-Bred Magyarorszag Kft. (10%) Hungary Pioneer Hi-Bred Sementes de Portugal S.A. (.01%) Portugal Pioneer Tohumculuk A.S. (.01%) Turkey Subsidiary of Pioneer Hi-Bred Korea, Inc., a wholly owned subsidiary of Pioneer Overseas Corporation: Pioneer Hi-Bred Sementes de Portugal S.A. (.01%) Portugal Subsidiaries of Pioneer Hi-Bred Limited, a wholly owned subsidiary of the Registrant: Pioneer France Mais S.A. (.08%) France Pioneer Genetique S.A.R.L. (1%) France Pioneer Hi-Bred S.A.R.L. (.2%) France Subsidiary of Pioneer Holding Company Ltd., a wholly owned subsidiary of Pioneer Overseas Corporation: Pioneer Pakistan Seed Limited (56%) Pakistan Subsididary of Pioneer Overseas Research Corporation, a wholly owned subsidiary of Pioneer Overseas Corporation: Pioneer Hi-Bred Sementes de Portugal S.A. (.01%) Portugal Subsidiaries of Pioneer Seed Holding Nederland B.V., a wholly owned subsidiary of Pioneer Overseas Corporation: Hellaseed S.A. (51%) Greece Pioneer France Mais S.A. (.08%) France Pioneer Hi-Bred Slovakia S.R.O. Slovakia\nEXHIBIT 21\nSUBSIDIARIES OF THE REGISTRANT\nSubsidiary Place of Incorporation\nSubsidiaries of Pioneer Seeds, Inc., a wholly owned subsidiary of Pioneer Overseas Corporation: Pioneer France Mais S.A. (.08%) France Pioneer Hi-Bred (U.K.) Limited (0.01%) United Kingdom Pioneer Hi-Bred Italia S.p.A. (10%) Italy Pioneer Hi-Bred Sementes de Portugal S.A. (.01%) Portugal Pioneer Maghreb S.A. (.10%) Morocco Pioneer Semena Holding GmbH (1%) Austria Pioneer Sjeme D.O.O. (90%) Croatia Pioneer Tohumculuk A.S. (.01%) Turkey Semillas Pioneer Colombia, S.A. (1.5%) Colombia Subsidiary of Pioneer Sementes Ltda., a wholly owned subsidiary of the Registrant and Pioneer Overseas Corporation: Empreendimentos Agricolas Pioneer Ltda. (40%) Brazil\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report or amendment thereto to be signed on its behalf by the undersigned, thereunto duly authorized.\n(REGISTRANT) PIONEER HI-BRED INTERNATIONAL, INC.\n(NAME AND TITLE) Charles S. Johnson, President and Chief Executive Officer and Director DATE November 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.\n(NAME AND TITLE) Charles S. Johnson, President and Chief Executive Officer and Director DATE November 28, 1995\n(NAME AND TITLE) Thomas N. Urban, Chairman of the Board of Directors DATE November 28, 1995\n(NAME AND TITLE) Jerry L. Chicoine, Senior Vice President, Chief Financial Officer and Corporate Secretary to the Board DATE November 28, 1995\n(NAME AND TITLE) Dwight G. Dollison, Vice President and Treasurer DATE November 28, 1995\n(NAME AND TITLE) Brian G. Hart, Vice President and Corporate Controller DATE November 28, 1995\n(NAME AND TITLE) C. Robert Brenton, Director DATE November 28, 1995\n(NAME AND TITLE) Dr. Pedro Cuatrecasas, Director DATE November 28, 1995\n(NAME AND TITLE) Dr. Ray A. Goldberg, Director DATE November 28, 1995\n(NAME AND TITLE) Fred S. Hubbell, Director DATE November 28, 1995\n(NAME AND TITLE) Dr. F. Warren McFarlan, Director DATE November 28, 1995\n(NAME AND TITLE) Dr. Owen J. Newlin, Director DATE November 28, 1995\n(NAME AND TITLE) Dr. Virginia Walbot, Director DATE November 28, 1995\n(NAME AND TITLE) H. Scott Wallace, Director DATE November 28, 1995\n(NAME AND TITLE) Fred W. Weitz, Director DATE November 28, 1995\n(NAME AND TITLE) Herman H.F. Wijffels, Director DATE November 28, 1995\n(NAME AND TITLE) Nancy Y. Bekavac, Director DATE November 28, 1995\n(NAME AND TITLE) Luiz Kaufmann, Director DATE November 28, 1995\nAPPENDIX TO MANAGEMENT'S DISCUSSION AND ANALYSIS\nThe table titled \"Sales by Region - 1995\" appears in The Company's Business of the Annual Report to Shareholders in the form of a bar graph.\nThe table titled \"Fiscal 1995 Available Domestic Lines of Credit\" appears in the Management Discussion and Analysis of the Annual Report to Shareholders in the form of a bar graph.\nThe table titled \"Fiscal 1996 Available Domestic Lines of Credit\" appears in the Management Discussion and Analysis of the Annual Report to Shareholders in the form of a bar graph.\nThe table titled \"Net Income\" appears in the Management Discussion and Analysis of the Annual Report to Shareholders in the form of a bar graph.\nThe table titled \"Annual Dividends\" appears in the Management Discussion and Analysis of the Annual Report to Shareholders in the form of a bar graph.\nThe table titled \"Research and Product Development Expenditures\" appears in the Management Discussion and Analysis of the Annual Report to Shareholders in the form of a bar graph.","section_15":""}
{"filename":"764478_1995.txt","cik":"764478","year":"1995","section_1":"Item 1. BUSINESS\nGeneral\nBest Buy Co., Inc. (the \"Company\" or \"Best Buy\"), is one of the nation's fastest growing specialty retailers. The Company offers a wide selection of name brand consumer electronics, home office equipment, entertainment software and appliances. The Company commenced business in 1966 as an audio component systems retailer, and in the early 1980s, with the introduction of the video cassette recorder, expanded into video products. In 1983, the Company changed its marketing strategy to use mass merchandising techniques for a wider variety of products, and began to operate its stores with a \"superstore\" format. In 1989, Best Buy dramatically changed its method of retailing by introducing its \"Concept II\" store format, a self-service, non-commissioned, discount style sales environment designed to give the customer more control over the purchasing process. The Company determined that an increasing number of customers had become knowledgeable enough to select products without the assistance of a commissioned salesperson and preferred to make purchases in a more convenient and customer friendly manner. With its innovative retail format, the Company has moved into a leading position nationally in all of its principal product categories except appliances.\nDuring the past year, the Company developed a strategy to further enhance its store format. The strategy, known as \"Concept III\", features a larger, redesigned store format created to produce a more informative and exciting shopping experience for the customer. Through focus group interviews and other research, the Company determined that customers wanted more product information and a larger product selection. In order to meet these evolving consumer preferences, the Company developed interactive Answer Centers featuring touch screen monitors from which customers and sales personnel can immediately access product information. Additionally, the enhanced store format features more hands-on demonstrations allowing customers to, among other things, experience audio and video products such as \"surround sound\" systems and sample featured compact discs at approximately 100 private listening stations. Finally, these larger stores, generally 45,000 square feet with some as large as 58,000 square feet, accommodate a larger product selection intended to be as good as or better than the largest selection offered by most of Best Buy's competitors in each of its principal product categories. Management continues to evaluate and refine the content and features of these Concept III stores to maximize the revenue and operating profit while providing customers with the most desirable shopping experience. The stores to be opened in fiscal 1996 will incorporate many of the Concept III features when opened and are designed to accommodate all features. The Company will continue to refine the touch screen Answer Center kiosks in the coming year.\nIn the last three fiscal years the Company has nearly tripled the number of stores it operates and, as of February 25, 1995, was operating 204 stores from coast to coast. The Company anticipates opening a total of 47 stores in fiscal 1996, including seven stores in the Miami market. By the end of fiscal 1996, the Company expects to operate 251 stores.\nBusiness Strategy\nThe Company's business strategy is to offer consumers an enjoyable and convenient shopping experience while maximizing the Company's profitability. Best Buy believes it offers consumers meaningful advantages in store environment, product value, selection and service. An objective of this strategy has been to achieve a dominant share of the markets Best Buy serves. The Company currently holds a leading, and in some cases dominant, share in its markets. The Company's recently introduced Concept III store format uses interactive technology to enhance the customer's shopping experience. As part of its overall strategy, the Company:\n* Offers a self-service, discount style store format, featuring easy to locate product groupings, emphasizing customer choice and product information and providing assistance from non-commissioned product specialists and, in Concept III stores, interactive product displays and information.\n* Provides a large selection of brand name products comparable to retailers that specialize in the Company's principal product categories and seeks to ensure a high level of product availability for customers.\n* Seeks to provide customers with the best product value available in the market area through active comparison shopping programs, daily price changes, lowest price guarantees and special promotions, including interest-free financing, extended warranties generally priced below the competitors and home delivery.\n* Provides a variety of services not offered by certain competitors, including convenient financing programs, product delivery and installation, computer training and post-sale services including repair and warranty services and computer upgrades.\n* Locates stores at sites that are easily accessible from major highways and thoroughfares and seeks to create sufficient concentrations of stores in major markets to maximize the leverage on fixed costs including advertising and operations management.\n* Controls costs and enhances operating efficiency by centrally controlling all buying, merchandising and distribution, and vertically integrating certain support functions such as advertising.\nBest Buy's store format is a key component of its business strategy. The Company believes that because customers are familiar with most of the products the Company sells and are accustomed to discount shopping formats, they increasingly resist efforts to direct their choice of product and appreciate controlling the purchase decision.\nBest Buy continuously evaluates the retail environment and regularly uses focus groups to assess customer preferences. Through these processes, Best Buy concluded that customers want access to more product information in order to be more confident about their purchase decisions. As a result, Best Buy's new Concept III store format features interactive product displays and information including, in selected locations, Answer Centers enabling customers to immediately access product information from touch screen monitors that display informative and entertaining full motion videos. All Concept III stores contain a demonstration area for television \"surround sound\" systems so that customers can see for themselves how different configurations of audio components enhance sound quality; a simulated, life-size car display that demonstrates differences in car stereo sound resulting from different speaker configurations; a speaker room with a 100 disc CD changer allowing customers to compare speaker quality while listening to their choice of music; approximately 100 private listening posts where customers can sample featured music software; and a \"Fun & Games\" area where customers and their children can try the latest video games. Best Buy believes that these features further differentiate it from competing retailers and should also provide an advantage for the Company relative to potential future competitors such as catalog and on-line services and television shopping networks.\nThe Company's stores are in large, open buildings with high ceilings. Most of Best Buy's existing stores contain approximately 36,000 to 45,000 square feet. The Concept III stores feature specialty areas such as larger viewing rooms for large screen and projection televisions, larger speaker rooms, a separate department for movie videos, a working kitchen for appliance demonstrations and a larger, consolidated accessories department. To accommodate an expanding product selection, as well as these specialty features, approximately half of the stores which the Company plans to open in fiscal 1996 will have approximately 45,000 square feet, with the remaining stores having approximately 58,000 square feet.\nBest Buy's merchandising strategy differs from most other retailers selling comparable merchandise. Best Buy's merchandise is displayed at eye level next to signs identifying the products' major features, with the boxed products available above or below\nthe display model. The Company's salaried product specialists, who are knowledgeable about the operation and features of the merchandise on display, are dedicated to a particular product area for customers who desire assistance. This convenient, self service format allows the customer to carry merchandise directly to the check-out lanes, pay for it and leave the store thus avoiding the time-consuming process used at traditional superstores and catalog showrooms. Certain of the Company's competitors with the traditional superstore format use commissioned sales staffs and have only display models on the selling floor with boxed merchandise stored in a back room. This traditional superstore design allows sales personnel to direct the customer to products selected by the salesperson. At these stores, a salesperson typically will promote products yielding the greatest sales commissions. In addition, unlike Best Buy, these traditional superstores generally stress the sale of extended service plans and have trained their sales staffs to maximize the sale of these plans. The Company offers extended service plans, generally at lower prices than its competitors.\nThe Company believes that its advertising strategy has greatly contributed to its overall success. Best Buy spends approximately 3% of store sales on advertising, including the distribution of about 18 million newspaper inserts weekly. The Company has vertically integrated advertising and promotion capabilities and operates its own in-house advertising agency. This capability allows the Company to respond rapidly to competitors in a cost effective manner. In many of its markets, the Company is able to secure and deliver merchandise to its stores and to create, produce and run an advertisement all within a period of less than one week.\nPrint advertising consists of four-color weekly inserts of up to 20 pages that emphasize a variety of product categories and feature extensive name brand selection and price range. The Company also produces all of its television and radio commercials, each with a specific marketing message. Television commercials and radio spots account for approximately 35% of total advertising expenditures. The Company is reimbursed by vendors for a substantial portion of advertising expenditures through cooperative advertising arrangements.\nProduct service and repair are important aspects of Best Buy's marketing strategy, providing the opportunity to differentiate itself from warehouse clubs and other discount stores which generally provide no such services. Virtually all products sold by the Company carry manufacturers' warranties. The Company offers to service and repair almost all of the products it sells, except major appliances in certain markets, and has been designated by most of its suppliers as an authorized service center. The Company contracts with outside factory service organizations to service and repair major appliances and is expanding its own in-home appliance repair service. In addition, the Company\nconducts computer software training classes at selected stores and makes its technical support staff available to assist customers with the custom configuration of personal computers and peripheral products. The Company also delivers and installs major appliances and large electronics products and installs car stereos, cellular phones and car security systems.\nProduct Selection and Merchandising\nBest Buy provides a broad selection of name brand models within each product line in order to provide customers with greater choice. The Company currently offers approximately 4,000 products, exclusive of entertainment software titles and accessories, in its four principal product categories. In addition, the Company continues to expand its selection of accessories, which typically yield a higher margin than most of the Company's other products. The Company believes that this expanded assortment of accessories will build customer traffic for its other products. The Company also aggressively promotes and displays a large selection of lower priced, high volume items, such as blank audio and video tapes, portable audio equipment and photographic equipment.\nThe home office category, Best Buy's largest product category, includes personal computers and related peripheral equipment, telephones, cellular phones, answering machines, fax machines, copiers and calculators. The Company was among the first consumer electronics retailers to carry an extensive assortment of personal computer products and related software. The Company believes that it is well positioned to withstand increased competition in the retail market for personal computer products, traditionally low margin items, due to its early entry and experience in the market, its broad product lines, including those that generate higher profit margins, and its relatively low cost structure. In addition, the Company believes that the related services it offers, such as computer training, configuration, maintenance and upgrade, are distinct advantages compared to other discount and mail order computer retailers. The Company also believes that changing technology will continue to be the primary factor in the growth in sales of personal computers and related products in the future. The Company's home office products category includes brand names such as Acer, Apple, AT&T, Canon, Compaq, Epson, Hewlett Packard, IBM, Motorola, NEC, Packard Bell, Panasonic, Sharp and Toshiba.\nBest Buy's second largest product category is consumer electronics, consisting of video and audio equipment. Video products include televisions, video cassette recorders, camcorders and the new satellite dishes that receive direct broadcast satellite television. Audio products include audio components, audio systems, portable audio equipment, car stereos and security systems. The Company has recently expanded its product selection in consumer electronics by offering higher end products and components that have greater appeal to audio and video enthusiasts.\nFurther, the Company anticipates that with the availability of better picture and sound quality through direct broadcast satellite, it will have more opportunities to sell higher end equipment such as home theaters, \"surround sound\" systems and in-wall components. The Company sells consumer electronics with brand names such as Aiwa, Bose, Cambridge Soundworks, General Electric, Infinity, JBL, JVC, Magnavox, Panasonic, Pioneer, RCA, Sanyo, Samsung, Sharp, Sony, Technics and Toshiba.\nBest Buy's entertainment software category includes compact discs, pre-recorded audio and video cassettes and computer software. The Company is one of the few large consumer electronics retailers that sells a broad selection of entertainment software in all of its stores. The Company offers from 25,000 to 60,000 titles in its stores with as many as 80,000 titles in its largest Concept III stores. In addition, Best Buy customizes a portion of the music software assortment for a particular store. The Company believes that it has substantially increased customer traffic by offering this wide and customized assortment of entertainment software.\nThe major appliance category includes microwave ovens, washing machines, dryers, air conditioners, dishwashers, refrigerators, freezers, ranges and vacuum cleaners. Products in this category include brand names such as Eureka, Frigidaire, Hoover, Maytag, Roper, Sharp, and White-Westinghouse.\nThe Company also sells cameras and other photographic equipment, easy to assemble furniture designed for use with computer and audio\/video equipment and a broad selection of accessories. The Company continues to evaluate compatible products to maximize the profit from the available space in the larger stores.\nThe following table sets forth the approximate percentages of store sales from each of Best Buy's principal product lines.\nFiscal Years Ended ------------------------------------------------------- February 27, 1993 February 26, 1994 February 25, 1995 ----------------- ----------------- ----------------- Home Office 27% 35% 37% Consumer Electronics: Video 26 22 20 Audio 20 16 14 Entertainment Software 9 12 14 Major Appliances 11 9 8 Other (1) 7 6 7 ---- ---- ---- Total 100% 100% 100% ---- ---- ---- ---- ---- ----\n(1) Includes photographic equipment, blank audio and video tapes, video games, furniture and accessories and extended service plans.\nStore Locations and Expansion\nThe Company's expansion strategy generally has been to enter major metropolitan areas with the simultaneous opening of several stores and then to expand into contiguous non-metropolitan markets. Currently, approximately half of the Company's stores are in non-metropolitan markets. The entry into a new market is preceded by a detailed market analysis which includes a review of competitors, demographics and economic data. Best Buy's store location strategy enables it to increase the effectiveness of advertising expenditures and to create a high level of consumer awareness. In addition, the clustering of stores allows the Company to maintain more effective management control, enhance asset utilization, and utilize its distribution facilities more efficiently.\nWhen entering a major metropolitan market, the Company establishes a district office, service center and major appliance warehouse. Each new store requires approximately $3.0 to $3.6 million of working capital, depending on the size of the store, for merchandise inventory (net of vendor financing), leasehold improvements, fixtures and equipment. Pre-opening costs of approximately $200,000 per store are incurred in hiring and training new employees and in advertising and are expensed in the year the store is opened.\nBest Buy is continuing its national market expansion. The Company believes it has the necessary distribution and management information systems as well as management experience and depth to support its expansion plans. During fiscal 1995, the Company opened 53 stores, a 35% increase in its store base. The Company also expanded or relocated 30 stores to larger facilities. The Company expects to open 47 new stores in fiscal 1996 including entry into Miami with seven stores. The Company also expects to continue developing the new markets entered in fiscal 1995 with the planned addition of ten to twelve stores in the Los Angeles market and additional stores in the Baltimore\/Washington D.C. market. To further implement the Concept III store format, the Company also plans to reposition another 20 stores in fiscal 1996.\nThe following table presents the number and location of stores operated by the Company at the end of each of the last three fiscal years and the number of stores the Company expects to open during the current fiscal year.\nNumber of Stores Expected Expected Number of At Fiscal Year End Store Openings Stores at End ------------------ 1993 1994 1995 Fiscal 1996 Of Fiscal 1996 ---- ---- ---- ----------- -------------- Texas 26 28 32 2 34 Illinois 20 30 31 1 32 California -- -- 7 12 19 Ohio -- 2 12 6 18 Michigan -- 10 14 2 16 Minnesota 14 15 15 - 15 Florida -- -- 3 9 12 Wisconsin 11 11 11 - 11 Georgia -- 7 9 1 10 Missouri 10 10 10 - 10 Indiana 7 7 8 - 8 Maryland -- -- 4 4 8 Arizona -- 6 7 - 7 Colorado 6 6 6 1 7 North Carolina -- -- 3 4 7 Virginia -- -- 5 1 6 Iowa 5 5 5 - 5 Kansas 3 4 5 - 5 South Carolina -- -- 3 1 4 Arkansas 1 2 3 -- 3 Nebraska 3 3 3 -- 3 Oklahoma 3 3 3 - 3 Kentucky -- -- 1 - 1 Nevada -- -- 1 - 1 New Mexico 1 1 1 - 1 North Dakota -- -- 1 - 1 South Dakota 1 1 1 - 1 To be determinted - - - 3 3 -- -- -- -- -- Total 111 151 204 47 251 --- --- --- -- --- --- --- --- -- ---\nSuppliers, Purchasing and Distribution\nThe Company's marketing strategy depends, in part, upon its ability to offer a wide selection of name brand products to its customers and is, therefore, dependent upon satisfactory and stable supplier relationships. In fiscal 1995, Best Buy's 25 largest suppliers accounted for approximately 70% of the merchandise purchased by the Company, with five suppliers, Acer, Hewlett-Packard, Packard Bell, Phillips Consumer Electronics, and Sony, accounting for approximately 31% of the Company's total purchases. The loss of or disruption of supply, including disruptions in supply due to manufacturers' product quality issues, from any one of these major suppliers could have a material adverse effect on the Company's sales. Certain suppliers have, at times, limited or discontinued their supply of products to the Company. While Whirlpool and Dell Computer changed their channels of distribution during the past year and the Company no longer carries these brand names, the Company's operations have not been materially adversely impacted by the loss of supply from these or any other supplier. Best Buy has no long term written contracts with its major suppliers but has not received any indication that any other suppliers will discontinue selling merchandise to the Company. The\nCompany has not experienced difficulty in maintaining satisfactory sources of supply, and management expects that adequate sources of supply will continue to exist for the types of merchandise sold in its stores.\nBest Buy's centralized buying staff purchases substantially all of the Company's merchandise. The buying staff is responsible for overall inventory management, including promotion planning, pricing and replenishment of store inventory. Generally, with the exception of certain entertainment software, there are no agreements with suppliers for the return of unsold inventory. Merchandise remaining at the time of new product introduction is generally sold on a close-out basis. Revenues from the sale of close-out merchandise have been insignificant.\nThe Company has made product availability a high priority and has made significant investments in facilities, personnel and systems to assure that its in-stock position will be among the highest in the industry. The Company utilizes an automatic replenishment system for restocking its stores and is able to deliver products to its stores as required. Replenishment of store inventories is based on inventory levels, historical and projected sales trends, promotions and seasonality. The Company utilizes an extensive merchandise planning and daily inventory monitoring system to manage inventory turns.\nThe majority of the Company's merchandise, except for major appliances, is shipped directly from manufacturers to the Company's distribution centers in California, Minnesota, Oklahoma and Virginia. During the last twelve months, the Company increased its permanent distribution space from approximately 500,000 square feet to over 1,800,000 square feet. In addition, the Company recently opened a dedicated distribution center for entertainment software in Minnesota and installed a state-of-the-art sortation system for music software. The Company is currently constructing a fifth distribution center in Findlay, Ohio. This facility will be approximately 780,000 square feet and is expected to open in August 1995. Major appliances are shipped to satellite warehouses in each of the Company's major markets. In order to respond to the need to meet release dates for certain computer products and entertainment software titles, the Company has increased the volume of merchandise shipped directly to the stores from manufacturers and distributors. The Company is, however, still dependent upon the distribution centers for inventory storage and shipment of most merchandise to stores. The Company primarily uses contract carriers to ship merchandise from its distribution centers to its stores. The Company believes that its distribution centers can most effectively service stores within a 600 to 700 mile radius and that its six distribution centers will accommodate the Company's expansion plans for the next year. The Company plans to continue investing in new systems and purchasing material handling equipment to reduce labor costs, improve accuracy in filling orders and enhance space utilization.\nManagement Information Systems\nBest Buy has invested significant resources to develop proprietary software that provides daily information on sales, gross margins and inventory levels by store and by stockkeeping unit. These systems allow the Company to compare current performance against historical performance and the current year's budget. The systems have been designed to integrate all major aspects of the Company's business including sales, warehousing, distribution, purchasing, inventory control, merchandise planning and replenishment, as well as various financial systems. Best Buy uses point-of-sale bar code scanning from which sales information is polled at the end of each day. The Company's MIS group, in conjunction with the advertising department, has also developed the proprietary technology to be used in the touch screen Answer Centers. The Company uses EDI (Electronic Data Interchange) with selected suppliers for the more efficient transmittal of purchase orders, shipping notices and invoices. The Company believes that the systems it has developed have the ability to continue to improve customer service, operational efficiency, and management's ability to monitor critical performance factors. The systems have been designed to support the growth and expansion of the Company for the foreseeable future. Best Buy is continuing to make investments in designing new systems, modifying existing systems and increasing processing capacity, particularly with respect to distribution, inventory management and store operations.\nStore Operations\nBest Buy has developed a standardized and detailed system for operating its stores. The system includes procedures for inventory management, transaction processing, customer relations, store administration and merchandise display. The Company's store operations are organized into three regions. Each region is divided into districts and is under the supervision of a senior vice president who oversees the operation through several regional managers, each of whom has responsibility for a number of districts within the region. District managers monitor store operations closely and meet regularly with store managers to discuss merchandising and new product introductions, sales promotions, customer feedback and requests, store operating performance and other matters. Similar meetings are conducted at the corporate level with regional management. Each district also has a loss prevention manager, with product security controllers employed at each store to control inventory shrinkage. Advertising, pricing and inventory policies are controlled at corporate headquarters. The Company's training, consumer affairs, human resources and store merchandising functions are also centralized at corporate headquarters.\nThe Company's stores are open seven days and six evenings a week. A store is typically staffed by one manager, two or three assistant managers, and an average staff ranging from 70 to 140\npersons depending on store size. Approximately 60% of a store's staff, which includes product specialists and a support staff of cashiers and customer service and stock handling employees, is employed on a part-time basis. Store managers are paid a salary and have the opportunity to earn bonuses if their stores exceed sales and gross margin quotas, meet certain budget criteria in controlling expenses, and achieve certain administrative goals.\nThe Company has an extensive in-house education program to train new employees, keep current employees informed of changes and modifications to its operating procedures and demonstrate new products. The training program includes classes for employees and the use of detailed store manuals and training video tapes produced in-house. Best Buy also provides its store personnel with in-store training in the demonstration and operation of the Company's merchandise, which is enhanced using tests that are administered through the Company's mainframe computer system. The Company also conducts a six-week course of classroom instruction combined with on-the-job training for future management candidates. In fiscal 1996, the Company will introduce a new training program known as Career Path 2000. This program is designed to provide clearly defined steps to improve employee product and store operation knowledge and will enable employees to improve their overall performance and customer service and to plan a career path with the Company. The Company's policy is to staff store management positions with personnel promoted from within each store and to staff new stores from its pool of trained managers. However, as Best Buy expands into new markets, it also recruits local management personnel who have valuable knowledge about the new market.\nCredit Policy\nApproximately 35% of store revenues are paid for in cash, with the remaining 65% paid for by either major credit cards or the Best Buy private label credit card. The Company has significantly expanded the use of special financing offers and considers them an important part of its marketing strategy. Generally, the special financing offers allow customers to defer all payments interest-free for 90 days or six months, depending on the price of the product, or to defer interest payments for one year on the purchase of selected products. The special financing offers are provided to customers who qualify for Best Buy's private label credit card. The private label credit card allows these customers to obtain financing on purchases of merchandise at Best Buy stores through arrangements between the Company and independent banks and consumer credit programs. The Company is generally able to qualify a new customer for credit on the spot, typically in less than five minutes. Receivables from private label credit card sales are sold, without recourse to the Company, to unaffiliated third party institutions. The Company receives payment from these institutions within 2 to 3 days following the sale.\nCompetition\nRetailing in each of the Company's product categories is highly competitive. While overall consumer electronics sales have grown relatively slowly in recent years, the concentration of sales among the top retailers in the industry has increased significantly. The industry's consolidation has been evidenced in the previous two years by the liquidation of Highland Superstores, the closing of 97 Silo stores in many of the markets where the Company competes and the closing of 110 McDuff\/Video Concepts (owned by Tandy Corp.) stores in states such as Texas, Colorado and Missouri. The relatively slow industry sales growth is due to market saturation for many consumer electronics products and the general absence of new products in that market. Growth of sales nationally in the home office product category has increased significantly and the Company now competes with an increasing number of retailers and alternative channels of distribution. In addition, the Company believes that consumers have become more knowledgeable and value conscious, thereby putting pressure on profit margins. Management believes that its store format distinguishes the Company from most of its competitors by offering customers a friendlier and less pressured shopping experience. In addition, the Company competes by aggressively advertising and emphasizing product selection, low prices and service.\nBest Buy competes in most of its markets against Sears and Montgomery Ward and in an increasing number of markets against Circuit City and Incredible Universe (owned by Tandy Corp.). It also competes against computer superstores such as Computer City (owned by Tandy Corp.) and CompUSA and entertainment software superstores operated by Musicland, Tower Records and Blockbuster Entertainment. Certain of these competitors have significantly greater financial resources than the Company. The Company also competes against independent dealers, discount stores, wholesale clubs, office products superstores and mass merchandisers. As of February 25, 1995, approximately 60% of the Company's stores compete with Circuit City.\nEmployees\nAs of February 25, 1995, the Company employed approximately 25,300 persons, of whom 13,500 were part-time employees. The Company has never experienced a strike or work stoppage, and management believes that its employee relations are good. There are currently no collective bargaining agreements covering any of the Company's employees.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nThe Company's stores, most of which are leased, include sales space, inventory storage, management offices and employee areas. All of the leases provide for a fixed minimum rent with scheduled escalation dates and amounts. Leases for 11 of the stores have a percentage rent provision equal to from .75% to 4% of gross sales at each location in excess of certain specified sales amounts. Currently, percentage rent is paid for only eight stores. The initial terms of the leases range from 5 to 25 years and generally allow the Company to renew for up to three additional five-year terms. The terms of a majority of the leases, including renewal options, extend beyond the year 2020.\nThe Company leases a 425,000 square foot distribution center in Bloomington, Minnesota, and a 440,000 square foot distribution center in Ardmore, Oklahoma. During fiscal 1995, the Company added a 700,000 square feet distribution center in Staunton, Virginia, a 310,000 square feet distribution center in Ontario, California, and a 240,000 square feet software distribution center in Edina, Minnesota. The Company is constructing a 780,000 square feet distribution facility in Findlay, Ohio, that is expected to open in August 1995. The Company also operates leased satellite warehouses for major appliances in all of its major markets and uses a satellite warehouse operated by a third party in Kansas City. The Company's corporate offices are located in a 260,000 square foot facility it owns in Eden Prairie, Minnesota.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nThe Company is a named defendant in a lawsuit against the Company and certain officers filed in the United States District Court for the District of Minnesota. The plaintiffs purport to represent a class consisting of all persons who purchased Best Buy Common Stock during the period from September 20, 1994 through December 1, 1994. The complaint alleges various violations of federal securities laws and seeks damages in an unspecified amount. The matter is in the early stages of discovery. The Company believes that the complaint is without merit, intends to pursue a vigorous defense of the action and believes that the ultimate resolution of the case will not have a material effect on its business or financial position.\nTHE EXECUTIVE OFFICERS OF THE REGISTRANT ARE AS FOLLOWS:\nRICHARD M. SCHULZE is a founder of the Company. He has served as an officer and director of the Company from its inception in 1966 and currently serves as its Chairman and Chief Executive Officer.\nBRADBURY H. ANDERSON has been the Company's President and Chief Operating Officer since April 1991, having served as Executive Vice President - Marketing of the Company from February 1986. He has been employed in various other capacities with the Company since 1973, including retail salesperson, store manager and sales manager. Mr. Anderson has been a Director of the Company since 1986.\nALLEN U. LENZMEIER was promoted to his present position in April 1991 after having served as Senior Vice President - Finance and Operations and Treasurer of the Company from 1986. Mr. Lenzmeier joined the Company in 1984 and has also served as Vice President - Finance and Operations and Treasurer.\nWADE R. FENN was promoted to his present position in April 1991, having served as Regional Vice President of the Company from 1987. Mr. Fenn joined the Company in 1980 as a salesperson and has also been employed by the Company as a store and district manager.\nGEORGE S. FOUTS was promoted to his present position in April 1991, having served as Regional Vice President of the Company from 1987. Mr. Fouts joined the Company in 1986 as a sales manager after being employed by RCA Corporation for nineteen years, most recently as Vice President of RCA Sales Corporation.\nKENNETH R. WELLER joined the Company in May 1993. Since 1986, he was Vice President of Sales of The Good Guys!, a San Francisco-based consumer electronics retailer where he had worked since 1982.\nSTEVEN R. ANDERSON was promoted to his present position in April 1994, after having served as Vice President-MIS since July 1990. Mr. Anderson joined the Company in 1986 as Director of Management Information Systems.\nJULIE M. ENGEL was promoted to her present position in April 1995. Ms. Engel joined the Company in July 1981 as Advertising Manager, was promoted to Advertising Director in 1984 and became Vice-President - Advertising in April 1987.\nROBERT C. FOX was promoted to his present position in April 1994, after having served as Vice President-Accounting since 1987 and Treasurer since 1993. Mr. Fox joined the Company in 1985 as Controller.\nJAMES P. MIXON joined Best Buy in April 1994 as Senior Vice President-Transportation and Distribution. Prior to joining the Company, Mr. Mixon held various distribution management positions with several national retailers, most recently with Marshalls Stores, Inc.\nLEE H. SCHOENFELD was promoted to his present position in July 1993. Mr. Schoenfeld joined the Company in 1978 as a salesperson and has served most recently as Vice President - Marketing.\nRANDALL K. ZANATTA joined the Company in March 1980 and was promoted to his present position in April 1994. Mr. Zanatta initially joined the Company as a salesperson and was promoted to store manager, joined the Company's Marketing Department, becoming a Vice President-Marketing in 1986.\nPART II\nITEM 5.","section_4":"","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe information set forth under the caption \"Common Stock Prices\" on page 10 of the Annual Report is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe information set forth under the caption \"Selected Consolidated Financial and Operating Data\" on page 5 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 information set forth under the caption \"Management's Discussion & Analysis of Financial Condition and Results of Operations\" on pages 6 through 9 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 required by this Item, listed below, are contained in the Annual Report on the pages thereof indicated, and are expressly incorporated herein by this reference.\nPage No. --------\nConsolidated balance sheets as of February 25, 1995 and February 26, 1994 11 For the fiscal years ended February 25, 1995, February 26, 1994, and February 27, 1993 Consolidated statements of earnings 12 Consolidated statements of cash flows 13 Consolidated statements of shareholders' equity 14 Notes to consolidated financial statements 15-19\nREPORT OF INDEPENDENT AUDITORS - ERNST & YOUNG LLP\nShareholders and Board of Directors Best Buy Co., Inc.\nWe have audited the accompanying consolidated balance sheet of Best Buy Co., Inc. and subsidiaries as of February 25, 1995, and the related consolidated statements of earnings, shareholders' equity and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.\nWe have 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 1995 financial statements referred to above present fairly, in all material respects, the consolidated financial position of Best Buy Co., Inc. and subsidiaries at February 25, 1995, and the consolidated results of their operations and their cash flows for the year then ended, in conformity with generally accepted accounting principles.\nERNST & YOUNG LLP Minneapolis, Minnesota April 19, 1995\nREPORT OF INDEPENDENT AUDITORS - DELOITTE & TOUCHE LLP\nWe have audited the accompanying balance sheets of Best Buy Co., Inc. (the Company) as of February 26, 1994 and the related statements of earnings, shareholders' equity, and cash flows for the years ended February 26, 1994 and February 27, 1993. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, such financial statements present fairly, in all material respects, the financial position of Best Buy Co., Inc., as of February 26, 1994 and the results of its operations and its cash flows for the years ended February 26, 1994 and February 27, 1993, in conformity with generally accepted accounting principles.\nAs discussed in Note 8 to the financial statements, the Company changed its method of accounting for income taxes during the year ended February 26, 1994.\nDELOITTE & TOUCHE LLP Minneapolis, Minnesota April 13, 1994\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nOn August 16, 1994, the Company dismissed Deloitte & Touche LLP as its independent auditors and retained Ernst & Young LLP. The Audit Committee of the Board of Directors approved the decision to change auditors. The reports of Deloitte & Touche LLP for each of the previous two fiscal years contained no adverse opinion or disclaimer of opinion and were not qualified or modified with respect to uncertainty, audit scope or accounting principle. During the past two fiscal years and through the date of dismissal, there were no disagreements with Deloitte & Touche LLP on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure. During the same time period there were no \"reportable events\" as defined by the Rules and Regulations of the Securities and Exchange Commission.\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 \"Security Ownership of Certain Beneficial Owners\" and \"Nominees and Directors\" on pages 3 through 6 of the Proxy Statement is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information set forth under the caption \"Executive Compensation\" on pages 7 through 13 of the Proxy Statement is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information set forth under the caption \"Security Ownership of Beneficial Owners and Management\" on pages 3 through 5 of 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 captions \"Nominees and Directors\" and \"Certain Transactions\" on pages 5 through 7 of the Proxy Statement is incorporated herein by reference.\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.\nAll financial statements of the Registrant as set forth under Item 8 of this Report.\n2. Financial Statement Schedules:\nNo schedules have been included since they are either not applicable or the information is included elsewhere herein.\n3. Exhibits: Method of Number Description filing ------ ----------- ------\n3.1 Amended and Restated Articles of (2) Incorporation, as amended, of Best Buy\n3.2 Certificate of Designation with respect (1) to Best Buy Series A Cumulative Convertible Preferred Stock, filed November 1, 1994\n3.3 Amended and Restated By-Laws, as (1,3,4) amended, of Best Buy\n4.1 Form of Indenture between Best Buy and (5) First Trust Company, Inc., relating to $30,000,000 Subordinated Extendible Notes due 1997, dated as of July 1, 1987\n4.2 Note Purchase Agreement with Principal (6) Mutual Life Insurance Company, dated as of July 30, 1992\n4.3 Credit Agreement dated July 29, 1994 (7) between Best Buy and First Bank National Association\n4.4 First Amendment to the Credit Agreement (1) between Best Buy and First Bank National Association, dated October 5, 1994\n4.5 Second Amendment to the Credit Agreement (1) between Best Buy and First Bank National Association, dated October 26, 1994\n4.6 Indenture between Best Buy and (2) Mercantile Bank of St. Louis N.A. relating to $150,000,000 8-5\/8% Senior Subordinated Notes due 2000, dated as of October 12, 1993\n4.7 Amended and Restated Agreement of (1) Limited Partnership of Best Buy Capital, L.P., dated as of November 3,\n4.8 Indenture between Best Buy, Best Buy (1) Capital, L.P., and Harris Trust and Savings Bank relating to $288,227,848 6-1\/2% Convertible Subordinated Debentures due 2024, dated as of November 3, 1994\n4.9 Guarantee Agreement related to 6-1\/2% (1) Convertible Monthly Income Preferred Securities of Best Buy Capital, L.P., dated November 3, 1994\n4.10 Deposit Agreement with respect to Best (1) Buy Series A Cumulative Convertible Preferred Stock, dated November 3, 1994\n10.1 1987 Employee Non-Qualified Stock Option (2) Plan, as amended\n10.2 Amended 1987 Directors' Non-Qualified (1) Stock Option Plan, as amended\n10.3 1994 Full-Time Employee Non-Qualified (2) Option Stock Plan\n10.4 Resolutions of the Board of Directors (1) dated April 10, 1995 implementing the fiscal 1996 bonus program for senior officers\n11.1 Computation of Earnings Per Share (1)\n13.1 1995 Annual Report to Shareholders (1)\n21.1 Subsidiaries of the Registrant (1)\n23.1 Consent of Ernst & Young LLP (1)\n23.2 Consent of Deloitte & Touche LLP (1)\n27.1 Financial Data Schedule (1)\n(1) Document is filed herewith.\n(2) Exhibits so marked were filed with the Securities and Exchange Commission on May 20, 1994 as exhibits to the Form 10-K of Best Buy Co., Inc. and are incorporated herein by reference and made a part hereof.\n(3) Exhibit so marked was filed with the Securities and Exchange Commission on November 12, 1991, as an exhibit to the Registration Statement on Form S-3 (Registration No. 33-43065) of Best Buy Co., Inc., and is incorporated herein by reference and made a part of hereof.\n(4) Exhibit so marked was filed with the Securities and Exchange Commission on January 13, 1992, as an exhibit to Form 10-Q of Best Buy Co., Inc., and is incorporated herein by reference and made a part hereof.\n(5) Exhibit so marked was filed with the Securities and Exchange Commission on June 19, 1987, as an exhibit to the registration statement on form S-1 (Registration No. 33-15201) of Best Buy Co., Inc., and are incorporated herein by reference and made a part hereof.\n(6) Exhibits so marked were filed with the Securities and Exchange Commission on October 12, 1992, as exhibits to Form 10-Q of Best Buy Co., Inc., and are incorporated herein by reference and made a part hereof.\n(7) Exhibit so marked was filed with the Securities and Exchange Commission on September 30, 1994, as an exhibit to Form 10-Q of Best Buy Co., Inc. and is incorporated herein by reference and made a part hereof.\nPursuant to Item 601(b)(4)(iii) of Regulation S-K under the Securities Act of 1933, the Registrant has not filed as exhibits to the Form 10-K certain instruments with respect to long-term debt under which the amount of securities authorized does not exceed 10 percent of the total assets of the Registrant. The Registrant hereby agrees to furnish copies of all such instruments to the Commission upon request.\n(b) Reports on Form 8-K\nA Current Report on Form 8-K was filed on December 7, 1994, reporting the lawsuit against the Company alleging various federal securities law violations.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nBEST BUY CO., INC. (Registrant)\nBy: \/s\/ RICHARD M. SCHULZE ---------------------- Richard M. Schulze Chief Executive Officer Dated: May 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 indicated on May 23, 1995.\n\/s\/ Richard M. Schulze Chairman, Chief Executive Officer ------------------------------ and Director (principal executive Richard M. Schulze officer)\n\/s\/ Bradbury H. Anderson President, Chief Operating Officer ------------------------------ and Director Bradbury H. Anderson\n\/s\/ Allen U. Lenzmeier Executive Vice President and Chief ------------------------------ Financial Officer (principal Allen U. Lenzmeier financial officer)\n\/s\/ Robert C. Fox Sr. Vice President - Finance and ------------------------------ Treasurer (principal accounting Robert C. Fox officer)\n\/s\/ Elliot S. Kaplan ------------------------------ Director Elliot S. Kaplan\n\/s\/ Frank D. Trestman ------------------------------ Director Frank D. Trestman\n------------------------------ Director Culver Davis, Jr.\n------------------------------ Director David Stanley\n------------------------------ Director James C. Wetherbe","section_15":""}
{"filename":"843387_1995.txt","cik":"843387","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Retirement Fund does not own or lease any physical properties.\nItem 3.","section_3":"Item 3. Legal Proceedings\nOn February 3, 1992 and February 5, 1992, respectively, one Limited Partner from Fund II and one Limited Partner from the Retirement Fund each commenced class actions in the US District Court for the District of Delaware, purportedly on behalf of all persons who purchased limited partnership interests in the Funds between November 10, 1989 and January 5, 1990, against the Funds, the Managing General Partner, the Individual General Partners, the Investment Adviser to the Funds and certain named affiliates of such persons. These actions, alleging that the defendants in the action made material misrepresentations or omitted material information in the offering materials for the Funds concerning the investment purposes of the Funds, were consolidated by the court on March 31, 1992, and a consolidated complaint was filed by the plaintiffs on May 14, 1992. In April 1993, plaintiffs filed an amended complaint, adding claims that certain transactions by the Funds were prohibited by the federal securities laws applicable to the Funds and their affiliates under the Investment Company Act of 1940, as amended. The amended complaint also named the Funds' counsel as a defendant. Defendants moved to dismiss the amended complaint, and, by Opinion and Order dated March 31, 1994, the court granted in part and denied in part the motions to dismiss.\nAdditionally, by its March 31, 1994 Opinion and Order, the Court certified the case as a class action, and ordered plaintiffs to replead by filing a new complaint reflecting the Court's rulings. On April 15, 1994, plaintiffs served and filed a new complaint, which defendants moved to strike for not conforming to the Court's ruling. On August 3, 1994, the Court granted defendants' motion to strike the new complaint. Plaintiffs thereafter filed a revised second amended complaint dated September 26, 1994. Factual discovery in this litigation has concluded. Expert discovery is currently set to conclude in early 1996. The defendants in this action believe that the remaining claims are without merit, although whether or not the plaintiffs prevail, the Funds may be obligated to indemnify and advance litigation expenses to certain of the defendants under the terms and conditions of various indemnity provisions in the Funds' Partnership Agreements and separate indemnification agreements, and the amount of such indemnification and expenses could be material. The Retirement Fund has advanced amounts to the indemnified parties based upon amounts which are deemed reimbursable in accordance with the indemnification provisions and has included these amounts in professional fees. The outcome of this case is not determinable at this time.\nOn August 9, 1994, the same two Limited Partners noted in the preceding paragraphs commenced another putative class action in the US District Court for the District of Delaware, purportedly on behalf of all persons who owned limited partnership interests in the Funds on November 4, 1993, against the Funds, the Managing General Partners, the Individual General Partners, the Investment Adviser to the Funds and certain named affiliates of such persons. Plaintiffs allege that the defendants violated certain provisions of the Investment Company Act of 1940 and the common law in connection with the sale by certain of the defendants of shares of common stock of Snapple Beverage Corp. in a November 1993 secondary offering and seek actual and punitive damages and an accounting in connection therewith. The defendants have filed papers in opposition to the motion for partial summary judgment on January 10, 1995. On August 4, 1995, plaintiffs filed an amended complaint alleging additional violations of the Investment Company Act of 1940 and common law arising out of the secondary offering. The plaintiffs moved for summary judgment on certain of these claims. On October 13, 1995, the defendants in this litigation each filed briefs in opposition to plaintiffs' motions. Because the defendants in this action believe that the claims are without merit, each defendant also filed a separate motion to dismiss, although whether or not the plaintiffs prevail, the Funds may be obligated to indemnify and advance litigation expenses to certain of the defendants under the terms and conditions of various indemnity provisions in the Funds' Partnership Agreements and separate indemnification agreements. The outcome of this case is not determinable at this time.\nOn November 2, 3 and 4, 1994, stockholders of Snapple Beverage Corp. commenced approximately twenty putative class actions in the Delaware Chancery Court, purportedly on behalf of all public stockholders of Snapple, against Snapple, the Funds, Thomas H. Lee Equity Partners, L.P., and some or all of Snapple's directors. Since then, the plaintiffs have filed a Consolidated Amended Complaint against Snapple, the Funds, Thomas H. Lee Equity Partners, L.P., some or all of Snapple's directors and Quaker Oats. The complaint alleges that the sale of Snapple to Quaker Oats was at an unfair price and in violation of the defendants' fiduciary duties to public stockholders. The plaintiffs sought an injunction against the merger transaction, an accounting for any damages suffered by the public stockholders, and attorneys' fees and related expenses. The Court on November 15, 1994 denied plaintiffs application to take expedited discovery and request to schedule a preliminary injunction hearing. The defendants in these actions believe that the claims are without merit, although whether or not the plaintiffs prevail, the Funds may be obligated to indemnify and advance litigation expenses to certain of the defendants under the terms and conditions of various indemnity provisions in the Funds' Partnership Agreements and separate indemnification agreements. The outcome of this case is not determinable at this time.\nOn November 27, 1995, one Limited Partner from Fund II and one Limited partner from the Retirement Fund filed a putative class action in the United States District Court for the District of Delaware, purportedly on behalf on behalf of all persons or entities who owned units in the Funds between April 5, 1991 and November 27, 1995, against the Funds, the Managing General Partner, the Individual General Partners, the Investment Adviser to the Funds, and certain named affiliates of such persons. The complaint contends that the Funds improperly advanced legal fees and litigation costs to the defendants in connection with three previously filed lawsuits. The plaintiffs are seeking an accounting, rescissory or actual damages, punitive damages, plaintiffs' litigation costs and attorneys fees, pre-judgment and post-judgment interest, and an injunction barring the defendants from further indemnifying themselves. The defendants in this action believe that the claims are without merit and have moved to dismiss the case. Although the defendants believe the advancement of legal fees and litigation costs was properly made pursuant to indemnification agreements signed by the defendants, the outcome of this case is not determinable 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 the Limited Partners of the Retirement Fund during the fourth quarter of the year ended December 31, 1995.\nPart II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters\nThere is no established trading market for the Units. The Partnership Agreement contains restrictions that are intended to prevent the development of a public market. Accordingly, accurate information as to the market values of Units at any given date is not available.\nThe approximate number of holders of Units as of March 15, 1996 is 20,542. The Managing General Partner and Thomas H. Lee as an Individual General Partner also hold general partner interests.\nEffective November 9, 1992, MLPF&S introduced a new limited partnership secondary service through Merrill Lynch's Limited Partnership Secondary Transaction Department (\"LPSTD\"). This service assists Merrill Lynch clients wishing to buy or sell limited partnership interests, but does not represent an established trading market for the Units.\nBeginning with December 1994 client account statements, MLPF&S implemented new guidelines for valuing and reporting limited partnership investments on client account statements. As a result, the Managing General Partner's estimate is no longer reported on these statements, although the Managing General Partner may continue to provide its estimate of net asset value in reports to Unit holders. Pursuant to such MLPF&S guidelines, estimated values for limited partnership interests originally sold by MLPF&S (such as Units in the Retirement Fund) are provided to MLPF&S by independent valuation services. Commencing this year, such estimated values will be updated two times per year. The estimated values will be based on financial and other information available to the independent services on the prior August 15th for reporting on December year-end client account statements, and on information available to the services on March 31st for reporting on June month-end MLPF&S client account statements. The Managing General Partner's estimate of net asset value as set forth in the Fund's year-end financial statements reflects the value of the Fund's underlying assets remaining at fiscal year end, whereas the value provided by the independent services reflects the estimated value of the Units themselves based on information that was available on the prior August 15th. MLPF&S clients may contact their Merrill Lynch Financial Consultants or telephone the number provided to them on their account statements to obtain a general description of the methodology used by the independent valuation services to determine their estimated values, provided the independent services are not market values and Unit holders may not be able to sell their Units or realize the amounts shown on their MLPF&S statements upon a sale. In addition, Unit holders may not realize the amount shown on their account statements upon the liquidation of the Retirement Fund over its remaining life.\nThe Retirement Fund distributes Distributable Cash from Investments and Distributable Capital Proceeds in accordance with the terms of the Partnership Agreement.\nPursuant to the Partnership Agreement, transfers of Units are recognized on the first day of the fiscal quarter after which the Managing General Partner has been duly notified of a transfer pursuant to the Partnership Agreement. Until a transfer is recognized, the limited partner of record (i.e. the transferor) will continue to receive all the benefits and burdens of ownership of Units (including allocations of profit and loss and distributions), and any transferee will have no rights to distributions of sale proceeds generated at any time prior to the recognition of the transfer and assignment.\nAccordingly, distributable cash from investments for a quarter and distributable sale proceeds from sales after transfer or assignment have been entered into, but before such transferred and assignment is recognized by the Managing General Partner, will be payable to the transferor and not the transferee.\nCash Distributions\nThe Retirement Fund has made quarterly distributions including both Distributable Cash from Investments and Distributable Capital Proceeds. The Retirement Fund's ability to make future cash distributions is restricted in part by the factors as set forth in Item 7.","section_6":"","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nLiquidity & Capital Resources\nAs of December 31, 1995, capital contributions from the Limited Partners and the General Partners totaled $178,065,000 in the public offering of ML-Lee Acquisition Fund (Retirement Accounts) II, L.P. (the \"Retirement Fund\"), the final closing for which was held on December 20, 1989. Net proceeds available for investment by the Retirement Fund as of December 31, 1995 were $116,434,836, after adjusting for returns of capital distributed to partners, volume discounts, sales commissions and organizational, offering, sales and marketing expenses.\nAt December 31, 1995, the Retirement Fund had outstanding a total of $88,353,161 invested in Mezzanine Investments representing $63,434,624 Managed and $24,918,537 Non-Managed portfolio investments. The remaining proceeds were invested in Temporary Investments primarily comprised of commercial paper with maturities of less than two months.\nThe Retirement Fund invested substantially all of its net proceeds in Mezzanine Investments consisting of high-yield subordinated debt and\/or preferred stock linked with an equity participation, of middle market companies in connection with friendly leveraged acquisitions, recapitalizations and other leveraged financings. The Retirement Fund's Mezzanine Investments typically were issued in private placement transactions which are generally subject to certain restrictions on sales thereby limiting their liquidity. The Retirement Fund was fully invested as of December 20, 1992, which was within 36 months from the date of the final closing (after including the reserve for follow-on investments and exclusive of amounts available for reinvestment). The reinvestment period for various amounts of capital proceeds received during the last twelve months of the Retirement Fund's investment period terminated at various times through December 18, 1993.\nUpon the consummation of the sale of Snapple Common Stock, the Retirement Fund received gross proceeds of approximately $78 million on December 8, 1994. As provided by the Partnership Agreement, the Managing General Partner of the Retirement Fund received incentive fees from this transaction to the extent certain returns of capital and priority returns were achieved. The Managing General Partner was entitled to an incentive MGP distribution of approximately $21 million, approximately $6.7 million of which was deferred in payment (the \"Deferred Distribution Amount\") to the Managing General Partner in accordance with the Partnership Agreement. This Deferred Distribution Amount is distributed to the Partners pro-rata in accordance with their capital contributions, and certain amounts otherwise later payable to Limited Partners from distributable cash from operations instead are payable to the Managing General Partner until the Deferred Distribution Amount is paid in full. The Limited Partners received approximately $63.8 million or $359.24 per Unit from the Snapple proceeds. As of February 14, 1996, the Deferred Distribution Amount owed to the Managing General Partner was $5,211,680.\nOn August 6, 1991, the Independent General Partners approved a reserve for follow-on investments of $20.0 million for the Retirement Fund. As of December 31, 1995, the reserve balance was reduced to $8.2 million due to follow-on investments of $153 in Petco Animal Supplies, $1.6 million in Fitz and Floyd\/Silvestri, Corporation, $128,270 in Fine Clothing, Inc., $2.5 million in Hills and $1.9 million in Ghirardelli. Additionally, $5.7 million of the reserve has been returned to the partners during 1995. The level of the reserve was based upon an analysis of potential Follow-On Investments in specific portfolio companies that may become necessary to protect or enhance the Retirement Fund's existing investment. As of March 6, 1996, the Independent General Partners have approved retention of the reserve at its current level.\nAll net proceeds from the sale of Mezzanine Investments received by the Retirement Fund in the future will be distributed to its partners unless applied to or set aside for expenses or follow-on investments.\nThe proportion of distributions provided by net investment income has dropped significantly from prior years and due primarily to increased sales and redemptions of Mezzanine Investments, a resulting decrease in investment income as those holdings cease to generate interest income. Pursuant to the terms of the Partnership Agreement, all net investment income from Mezzanine Investments will be distributed to the Managing General Partner until the Managing General Partner receives an amount equal to any outstanding Deferred Distribution Amount. Given these circumstances, it is expected that the majority of future cash distributions to Limited Partners for the next few years will almost entirely be derived from gains and recovered capital from asset sales, which are subject to market conditions and are inherently unpredictable as to timing. Assuming there are no asset sales in a particular quarter, Limited Partners are expected to receive only small amounts of net distributable cash from Temporary Investments, which are estimated to be less than one dollar per Limited Partnership Unit each quarter for the next few years. Distributions therefore are expected to vary significantly in amount and may not be made in every quarter.\nInvestment in High-Yield Securities\nThe Retirement Fund invests primarily in subordinated debt and preferred stock securities (\"High-Yield Securities\"), generally linked with an equity participation, issued in conjunction with the mezzanine financing of privately structured, friendly leveraged acquisitions, recapitalizations and other leveraged financings. High-Yield Securities are debt and preferred equity securities that are unrated or are rated by Standard & Poor's Corporation as BB or lower and by Moody's Investor Services, Inc. as Ba or lower. Risk of loss upon default by the issuer is significantly greater with High-Yield Securities than with investment grade securities because High-Yield Securities are generally unsecured and are often subordinated to other creditors of the issuer. Also, these issuers usually have high levels of indebtedness and are more sensitive to adverse economic conditions, such as recession or increasing interest rates, than investment grade issuers. Most of these securities are subject to resale restrictions and generally there is no quoted market for such securities.\nAlthough the Retirement Fund cannot eliminate the risks associated with its investments in High-Yield Securities, it has established risk management policies. The Retirement Fund subjected each prospective investment to rigorous analysis and made only those investments that were recommended by the Investment Adviser and that met the Retirement Fund's investment guidelines or that had otherwise been approved by the Managing General Partner and the Independent General Partners. The Retirement Fund's investments were measured against specified Retirement Fund investment and performance guidelines. To limit the exposure of the Retirement Fund's capital in any single issuer, the Retirement Fund limited the amount of its investment in a particular issuer. The Retirement Fund's Investment Adviser also continually monitors portfolio companies in order to minimize the risks associated with its investments in High-Yield Securities.\nCertain issuers of Securities held by the Retirement Fund (First Alert, Hills, Petco, Playtex and Stanley Furniture) have registered their equity securities in public offerings. Although the equity securities of the same class presently held by the Retirement Fund (other than Hills and Stanley Furniture) were not registered in these offerings, the Retirement Fund has the ability under Rule 144 under the Securities Act of 1933 to sell publicly traded equity securities held by it for at least two years on the open market, subject to the volume restrictions set forth in that rule. The Rule 144 volume restrictions generally are not applicable to equity securities of non-affiliated companies held by the Retirement Fund for at least three years. In certain cases, the Retirement Fund has agreed not to make any sales of equity securities for a specified hold-back period following a public offering.\nThe Investment Adviser reviews each portfolio company's financial statements quarterly. In addition, the Investment Adviser routinely reviews and discusses financial and operating results with the company's management and where appropriate, attends board of director meetings. In some cases, representatives of the Investment Adviser, acting on behalf of the Funds (and affiliated investors where applicable), serve as one or more of the directors on the boards of portfolio companies. The Retirement Fund may, from time to time, make follow-on investments to the extent necessary to protect or enhance its existing investments.\nResults of Operations\nInvestment Income and Expenses\nThe investment income from operations for the period consists primarily of interest and discount income earned on the investment of proceeds from partners' contributions in Mezzanine Investments and short-term money market instruments.\nFor the year ended December 31, 1995, the Retirement Fund had investment income of $6,433,071, as compared to $9,485,887 for the same period in 1994 and $9,784,746 for the same period in 1993. This decrease in 1995 investment income from 1994 is due primarily to the decline in short-term interest income stemming from the decrease in short term interest rates and in the amount of Temporary Investments held by the Retirement Fund after distributions of return of capital to partners. Also contributing to this decrease is the sale of Mezzanine Investments during 1995. The decrease in 1994 investment income from 1993 is due primarily to the sales and redemption of Mezzanine Investments.\nMajor expenses for the period consisted of Legal and Professional Fees, Investment Advisory Fees, Fund Administration Fees and Administrative Expenses.\nLegal and Professional Fees were primarily incurred in connection with the litigation proceedings as described in Note 11 to the Financial Statements. Professional fees for the years ended December 31, 1995, 1994 and 1993 were $1,389,303, $1,659,263, and $2,419,228, respectively. These expenses are attributable to legal fees incurred and advanced on behalf of indemnified defendants as well as fees incurred directly by the Retirement Fund in connection with the aforementioned litigation proceedings.\nThe Investment Adviser and Fund Administrator both receive their compensation on a quarterly basis. The total Investment Advisory Fees paid to the Investment Adviser for the years ended December 31, 1995, 1994 and 1993 were $1,063,604, $1,202,216, and $1,411,755, respectively, and were calculated at an annual rate of 1.0% of assets under management (net offering proceeds reduced by cumulative capital reductions), with a minimum annual amount of $1,200,000 for the Retirement Fund and Fund II on a combined basis. These decreases in Investment Advisory Fees are a direct result of the sales of investments, returns of capital to Partners and realized losses on investments.\nThe Fund Administration Fees paid to the Fund Administrator for the years ended December 31, 1995, 1994 and 1993 were $602,002, $633,558, and $715,816, respectively, and were calculated at an annual rate of 0.45% of the excess of net offering proceeds, less 50% of capital reductions. These decreases in Fund Administration Fees are a direct result of sales of investments, returns of capital distributed to partners and realized losses on investments.\nPursuant to the administrative services agreement between the Retirement Fund and the Fund Administrator, effective November 10, 1993, a portion of the actual out-of-pocket expenses incurred in connection with the administration of the Retirement Fund is reimbursable to the Fund Administrator. Actual out-of-pocket expenses (\"reimbursable expenses\") primarily consist of printing, audits, tax preparation and custodian fees.\nFor the year ended December 31, 1995, the Retirement Fund had net investment income of $3,071,361, as compared to $5,571,207 for the same period in 1994 and $4,904,017 for the same period in 1993. This decrease in 1995 as compared to 1994 is primarily attributable to a decrease in interest income from Mezzanine Investments and Temporary Investments partially offset by lower Investment Advisory Fees, Fund Administration Fees, and Expenses and Legal and Professional Fees. The increase in 1994 net investment income as compared to 1993 can be attributed to the lower Investment Advisory Fees, Fund Administration Fees and Legal and Professional Fees in 1994, offset by Petco Animal Supplies' March 17, 1994 initial public offering and the recognition of thirty-eight and one half months of interest, discount and dividend income recorded in the first quarter of 1994.\nNet Assets\nThe Retirement Fund's net assets decreased by $45,115,400 during the year ended December 31, 1995, due to the payment of cash distributions to partners of $29,053,844 ($15,645,654 of the cash distributions paid was return of capital from the sales of portfolio investments) and net unrealized depreciation of $28,395,532, partially offset by net investment income of $3,071,361 and realized gains of $9,262,616 from the sale of Mezzanine Investments.\nThe Retirement Fund's net assets decreased by $144,859,649 during the year ended December 31, 1994, due to the payment of cash distributions to partners of $110,407,812 ($17,985,052 of cash distributions paid was return of capital from the sales of portfolio investments) and net unrealized depreciation of $114,349,601, partially offset by net investment income of $5,571,207 and realized gains of $74,326,557. The 1994 decrease in net assets over the year is considerably larger than the increase recorded in the comparable 1993 period. This is primarily attributed to the appreciation recorded in 1993 compared with the depreciation recorded in 1994 and the increase in the cash distributions paid during 1994 from the sale of the Snapple common stock.\nUnrealized Appreciation and Depreciation on Investments\nFor the year ended December 31, 1995, the Retirement Fund recorded net unrealized depreciation of $28.4 million of which $23.3 million was related to net depreciation in market value of publicly traded securities. This decrease can be attributed primarily to the decrease in value of the Retirement Fund's investment in First Alert, Inc. and Hills Stores Company at December 31, 1995, as well as the reversal of appreciation on the investment in EquiCredit upon the sale of EquiCredit Securities. This compares to a net unrealized depreciation of $114.3 million for the same period in 1994 of which $111.1 million was related to net depreciation in market value of publicly traded securities. The Retirement Fund's cumulative net unrealized depreciation on investments as of December 31, 1995 totaled $8.5 million.\nFor the year ended December 31, 1993, the Retirement Fund recorded net unrealized appreciation of $94,671,310 of which $83,500,000 was related to net appreciation in market value of publicly traded securities. The increase can be attributed primarily to the increase in valuation on Snapple Beverage Corp.\nThe Retirement Fund's valuation of the common stock of First Alert, Hills, Petco, Playtex and Stanley Furniture reflect their closing market prices at December 31, 1995.\nThe Managing General Partner and the Investment Adviser review the valuation of the Retirement Fund's portfolio investments that do not have a readily ascertainable market value on a quarterly basis with final approval from the Individual General Partners. Portfolio investments are valued at original cost plus accrued value in the case of original issue discount or deferred pay securities. Such investments will be revalued if there is an objective basis for doing so at a different price. Investments will be written down in value if the Managing General Partner and Investment Advisor believe adverse credit developments of a significant nature require a write-down of such securities. Investments will be written up in value only if there has been an arms'-length third party transaction to justify the increased valuation.\nA substantial number of the Retirement Fund's assets (at cost) are invested in private placement securities for which there are no ascertainable market values. Although the Managing General Partner and Investment Adviser use their best judgment in estimating the fair value of these investments, there are inherent limitations in any estimation technique. Therefore, the fair value estimates presented herein are not necessarily indicative of the amount which the Retirement Fund could realize in a current transaction.\nThe First Alert, Petco, Hills, Playtex and Stanley Furniture securities held by the Retirement Fund are restricted securities under the SEC's Rule 144 and can only be sold under that rule, in a registered public offering, or pursuant to an exemption from the registration requirement. In addition, resale in some cases is restricted by lockup or other agreements. The Retirement Fund may be considered an affiliate of First Alert and Stanley Furniture under the SEC's Rule 144, and therefore any resale of securities of those companies, under Rule 144, is limited by the volume limitations in that rule. Accordingly, the values referred to in the financial statements for the remaining First Alert, Hills, Petco, Playtex and Stanley Furniture securities held by the Retirement Fund do not necessarily represent the prices at which these securities could currently be sold.\nThe information presented herein is based on pertinent information available to the Managing General Partner and Investment Adviser as of December 31, 1995. Although the Managing General Partner and Investment Adviser are not aware of any factors not disclosed herein that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued since that time, and the current estimated fair value of these investments may have changed significantly since that point in time.\nFor additional information, please refer to Supplemental Schedule of Unrealized Appreciation and Depreciation (Schedule 2 - page 41).\nRealized Gains and Losses\nFor the year ended December 31, 1995, the Retirement Fund had net realized gains from investments of $9.3 million as compared to $74.3 million and $16 million for the same periods in 1994 and 1993, respectively.\nFor additional information, please refer to Supplemental Schedule of Realized Gains and Losses (Schedule 1 - page 40).\nCash Distributions\nOn February 8, 1996, the Individual General Partners approved the fourth quarter 1995 cash distribution totalling $19,587 which represents net investment income of $159,555 from Temporary Investments offset by a net investment loss from Mezzanine Investments of $139,968. The total amount distributed to Limited Partners was $19,527 or $.11 per Unit, which was paid on February 14, 1996. The Managing General Partner received a total of $55, with respect to its interest in the Retirement Fund. Thomas H. Lee, as an Individual General Partner, received $5 with respect to his interest in the Retirement Fund.\n(a) Distributions are paid no later than 45 days after the end of each quarter.\n(b) For periods prior to the Third Quarter 1991, the amount shown is for the 1st closing participants only. The second closing amounts as to such periods will vary.\n(c) Incentive distribution to the Managing General Partner for exceeding the cumulative Priority Return of 10% on Mezzanine Investments to Limited Partners.\n(d) Includes $97.16 per Unit return of capital from the sale of EquiCredit and Playtex securities.\n(e) Includes $3.49 per Unit return of capital from the sale of EquiCredit securities.\n(f) Includes $1.89 per Unit return of capital from the sale of EquiCredit and Snapple securities.\n(g) Includes $72.50 per Unit return of capital from the redemption of BRK Electronics and Petco Notes.\n(h) Includes $10.00 per Unit return of uninvested proceeds.\n(i) Includes $2.79 per Unit return of uninvested proceeds.\n(j) Includes $13.81 per Unit return of capital from the sale of Snapple Common Stock.\n(k) Includes $3.82 per Unit return of capital from the sale of EquiCredit Common Stock.\n(l) Includes $0.38 per Unit return of capital from the sale of Petco Common Stock.\n(m) Includes $51.57 per Unit return of capital from the sale of Sun Pharmaceuticals.\n(n) As of February 14, 1996, there is a Deferred Distribution Amount outstanding of $5,211,680 that is payable to the Managing General Partner. This amounts equates to $29.36 per Limited Partner Unit and will be paid out of Net Mezzanine Income, after the priority return has been reached, before this source of income can be distributed to the Limited Partners.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nML-LEE ACQUISITION FUND (RETIREMENT ACCOUNTS) II, L.P.\nReports of Independent Accountants\nStatements of Assets, Liabilities and Partners' Capital As of December 31, 1995 and December 31, 1994\nStatements of Operations For the Years Ended December 31, 1995, December 31, 1994 and December 31, 1993\nStatements of Changes in Net Assets For the Years Ended December 31, 1995, December 31, 1994 and December 31, 1993\nStatements of Cash Flows For the Years Ended December 31, 1995, December 31, 1994 and December 31, 1993\nStatements of Changes in Partners' Capital For the Years Ended December 31,1995, December 31, 1994 and December 31, 1993\nSchedule of Portfolio Investments - December 31, 1995\nNotes to Financial Statements\nSupplementary Schedule of Realized Gains and Losses (Schedule 1)\nSupplementary Schedule of Unrealized Appreciation and Depreciation (Schedule 2)\nReport of Independent Accountants\nMarch 15, 1996, except as to Note 14 which is as of March 22, 1996.\nTo the General and Limited Partners of ML-Lee Acquisition Fund (Retirement Accounts) II, L.P.\nIn our opinion, the accompanying statements of assets, liabilities and partners' capital, including the schedule of portfolio investments, and the related statements of operations, of changes in net assets, of cash flows, and of changes in partners' capital present fairly, in all material respects, the financial position of ML-Lee Acquisition Fund (Retirement Accounts) II, L.P. (the \"Fund\") at December 31, 1995 and 1994, and the results of its operations, the changes in its net assets, its cash flows, and the changes in its partners' capital for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles. 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. We conducted our audits of these financial 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, which included confirmation of securities at December 31, 1995 by correspondence with the custodian and brokers and the application of alternative auditing procedures where confirmations were not received, provide a reasonable basis for the opinion expressed above.\nThe financial statements include securities, valued at $79,513,706 at December 31, 1995 (89.9% of net assets), whose values have been estimated by the Managing General Partner and the Investment Adviser (with the approval of the Independent General Partners) in the absence of readily ascertainable market values, as further described in Note 2. We have reviewed the procedures used by the Managing General Partner and the Investment Adviser in arriving at their estimate of value and have inspected underlying documentation, and, in the circumstances, we believe the procedures are reasonable and the documentation appropriate. However, 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 to the financial statements.\nOur audits were conducted for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule of realized gains and losses (Schedule 1) and the schedule of unrealized appreciation and depreciation (Schedule 2) are presented for the purpose of additional analysis and are not a required part of the basic financial statements. These schedules are the responsibility of the Fund's management. Such schedules have been subjected to the auditing procedures applied in our audits of the basic financial statements and, in our opinion, are fairly stated in all material respects when considered in relation to the basic financial statements taken as a whole.\nPRICE WATERHOUSE LLP New York, New York\nSee the Accompanying Notes to Financial Statements.\nSee the Accompanying Notes to Financial Statements.\nSee the Accompanying Notes to Financial Statements.\nSee the Accompanying Notes to Financial Statements.\nSee the Accompanying Notes to Financial Statements.\nSee the Accompanying Notes to Financial Statements.\nSee the Accompanying Notes to Financial Statements.\nSee the Accompanying Notes to Financial Statements.\nSee the Accompanying Notes to Financial Statements.\nSee the Accompanying Notes to Financial Statements.\nML-LEE ACQUISITION FUND (RETIREMENT ACCOUNTS) II, L.P. NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995\n1. Organization and Purpose\nML-Lee Acquisition Fund (Retirement Accounts) II, L.P. (the \"Retirement Fund\") (formerly T.H. Lee Acquisition Fund (Retirement Accounts) II, L.P.) was formed along with ML-Lee Acquisition Fund II, L.P. (\"Fund II\"; collectively referred to as the \"Funds\") and the Certificates of Limited Partnership were filed under the Delaware Revised Uniform Limited Partnership Act on September 23, 1988. The Funds' operations commenced on November 10, 1989.\nMezzanine Investments II, L.P. (the \"Managing General Partner\"), subject to the supervision of the Individual General Partners, is responsible for overseeing and monitoring the Retirement Fund's investments. The Managing General Partner is a Delaware limited partnership in which ML Mezzanine II Inc. is the general partner and Thomas H. Lee Advisors II, L.P., the Investment Adviser to the Funds, is the limited partner. The Individual General Partners are Vernon R. Alden, Joseph L. Bower and Stanley H. Feldberg (the \"Independent General Partners\") and Thomas H. Lee.\nThe Retirement Fund has elected to operate as a business development company under the Investment Company Act of 1940. The Retirement Fund's primary investment objective is to provide current income and capital appreciation potential by investing in privately-structured, friendly leveraged buyouts and other leveraged transactions. The Retirement Fund pursues this objective by investing primarily in subordinated debt and related equity securities issued in conjunction with the \"mezzanine financing\" of friendly leveraged buyout transactions, leveraged acquisitions and leveraged recapitalizations. The Retirement Fund may also invest in \"bridge investments\" if it is believed that such investments would facilitate the consummation of a mezzanine financing.\nAs stated in the Prospectus, the Retirement Fund will terminate no later than December 20, 1999, subject to the right of the Individual General Partners to extend the term for up to one additional two-year period and one additional one-year period if it is in the best interest of the Retirement Fund. The Retirement Fund will then have five additional years to liquidate its remaining investments.\n2. Significant Accounting Policies\nBasis of Accounting\nFor financial reporting purposes, the records of the Retirement Fund are maintained using the accrual method of accounting. For federal income tax reporting purposes, the results of operations are adjusted to reflect statutory requirements arising from book to tax differences. The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts and disclosures in the financial statements. Actual reported results could vary from these estimates.\nValuation of Investments\nSecurities for which market quotations are readily available are valued by reference to such market quotation using the last trade price (if reported) or the last bid price for the period. For securities without a readily ascertainable market value (including securities restricted as to resale for which a corresponding publicly traded class exists), fair value is determined, on a quarterly basis, in good faith by the Managing General Partner and the Investment Adviser with final approval from the Individual General Partners of the Retirement Fund. For privately issued securities in which the Retirement Fund typically invests, the fair value of an investment is its original cost plus accrued value in the case of original issue discount or deferred pay securities. Such investments will be revalued if there is an objective basis for doing so at a different price. Investments will be written down in value if the Managing General Partner and Investment Adviser believe adverse credit developments of a significant nature require a write-down of such securities. Investments will be written up in value only if there has been an arms'-length third party transaction to justify the increased valuation. Although the Managing General Partner and Investment Adviser use their best judgment in estimating the fair value of these investments, there are inherent limitations in any estimation technique. Therefore, the fair value estimates presented herein are not necessarily indicative of the amount which the Retirement Fund could realize in a current transaction. Future confirming events will also affect the estimates of fair value and the effect of such events on the estimates of fair value could be material.\nTemporary Investments with maturities of less than 60 days are stated at amortized cost, which approximates market.\nThe information presented herein is based on pertinent information available to the Managing General Partner and Investment Adviser as of December 31, 1995. Although the Managing General Partner and Investment Adviser are not aware of any factors not disclosed herein that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued since that time, and because investments of companies whose equity is publicly traded are valued at the last price at December 31, 1995, the current estimated fair value of these investments may have changed significantly since that point in time.\nInterest Receivable on Investments\nInvestments generally will be placed on non-accrual status in the event of a default (after the applicable grace period expires) or if the Investment Adviser and the Managing General Partner determine that there is no reasonable assurance of collecting interest.\nPayment-In-Kind Securities\nAll payment-in-kind securities received in lieu of cash interest payments by the Retirement Fund's portfolio companies are recorded at face value (which approximates accrued interest), unless the Investment Adviser and the Managing General Partner determine that there is no reasonable assurance of collecting the full principal amounts of such securities. As of December 31, 1995 and December 31, 1994, the Retirement Fund has in its portfolio of investments $739,601 and $235,451, respectively, of payment-in-kind notes which excludes $4,298,447 and $1,723,465, respectively, of payment-in-kind notes received from notes placed on non-accrual status. As of December 31, 1995 and December 31, 1994, the Retirement Fund has in its portfolio of investments $1,224,548 and $1,239,188 respectively of payment-in-kind equity.\nDeferred Organization Expenses\nOrganization costs of $233,859 for the Retirement Fund were fully amortized on November 10, 1994.\nInvestment Transactions\nThe Retirement Fund records investment transactions on the date on which it obtains an enforceable right to demand the securities or payment therefor. The Retirement Fund records Temporary Investment transactions on the trade date.\nRealized gains and losses on investments are determined on the basis of specific identification for accounting and tax purposes.\nSales and Marketing Expenses, Offering Expenses and Sales Commissions\nSales commissions and selling discounts were allocated to the specific Partners' accounts in which they were applied. Sales and marketing expenses and offering expenses were allocated between the Funds in proportion to the number of Units issued by each Fund and to the Partners in proportion to their capital contributions.\nDeferred Interest Income\nAll fees received by the Retirement Fund upon the funding of Mezzanine or Bridge Investments are treated as deferred interest income and amortized over the maturity of such investments.\nPartners' Capital\nPartners' Capital represents the Retirement Fund's equity divided in proportion to the Partners' Capital Contributions and does not represent the Partners' Capital Accounts. Profits and losses, when realized, are allocated in accordance with the provisions of the Partnership Agreement summarized in Note 3.\n3. Allocations of Profits and Losses\nPursuant to the Partnership Agreement, all profits from Temporary Investments generally will be allocated 99.69% to the Limited Partners, 0.28% to the Managing General Partner and 0.03% to the Individual General Partner. Profits from Mezzanine Investments will, in general, be allocated as follows:\nfirst, if the capital accounts of any partners have negative balances, to such partners in proportion to the negative balances in their capital accounts until the balances of all such capital accounts equal zero,\nsecond, 99.69% to the Limited Partners, 0.28% to the Managing General Partner and 0.03% to the Individual General Partner until the sum allocated to the Limited Partners equals any previous losses allocated together with a cumulative Priority Return of 10% on the average daily amount in Mezzanine Investments, and any outstanding Compensatory Payments,\nthird, 69.69% to the Limited Partners, 30.281% to the Managing General Partner and .029% to the Individual General Partner until the Managing General Partner has received 20.281% of the total profits allocated,\nthereafter, 79.69% to the Limited Partners, 20.281% to the Managing General Partner and 0.029% to the Individual General Partner.\nLosses will be allocated in reverse order of profits previously allocated and thereafter 99.69% to the Limited Partners, 0.28% to the Managing General Partner and 0.03% to the Individual General Partner.\n4. Investment Transactions\nOn January 27, 1995, the Retirement Fund sold 259,474 shares of EquiCredit Common Stock, realizing a gain of $7,623,346 on an original investment of $679,822.\nOn April 27, 1995, Petco Animal Supplies, Inc. (\"Petco\") completed a public offering of approximately 3.6 million shares of Common Stock (the \"Petco Offering\") at a net price of $19.71 per share. Of the shares sold, approximately 2.4 million shares were offered by Petco and approximately 1.2 million were offered by certain existing shareholders, including the Retirement Fund. As part of the Petco Offering, the Retirement Fund sold 64,151 shares (including shares sold as a result of the exercise of the underwriters' overallotment option) representing 51% of its Petco holdings. The Retirement Fund received proceeds of $1,264,577 and realized a gain of $212,949 on the sale of the equity.\nOn May 12, 1995, the Retirement Fund made a follow-on investment in Ghirardelli Holdings Corp. for a total of $1,864,800. The Retirement Fund received 15,984 shares of Series A Preferred Stock for $1,598,400 and 84,039 additional shares of Common Stock for $266,400.\nEffective June 29, 1995, Soretox structured a management led buyout of the company. As a result, the Stablex Canada, Inc. $7,060,925, 14% Subordinated Note and the 209,829 shares of 176347 Canada, Inc. Common Stock Purchase Warrants held by the Retirement Fund were exchanged for a Stablex Canada Inc. $3,996,750 principal amount 10% Subordinated Note, a $3,568,325 principal amount 11% Junior Subordinated Note and 2,286 shares of Seaway TLC, Inc. Common Stock Purchase Warrants. No gain or loss was recorded on the transaction.\nOn August 21, 1995, the Retirement Fund entered into a stock purchase and exchange agreement with Hills Stores Company and exchanged the 116,994 Common Stock Rights held by the Retirement Fund for 33,427 shares of Hills Stores Common Stock. No gain or loss was recognized on the transaction. The common shares were registered with the Securities and Exchange Commission in the fourth quarter of 1995.\nOn October 17, 1995 Playtex Products, Inc. and Banana Boat Holding Corp. entered an Agreement and Plan of Merger (the \"Agreement\") pursuant to which Playtex agreed to acquire all of the outstanding equity of Banana Boat that it did not already own. In accordance with the Agreement, the 12.5% Subordinated Note held by the Retirement Fund, plus all accrued interest, was paid in full by Playtex upon consummation of the merger. Additionally, the Retirement Fund received net proceeds of $173.55 per share for each of the 8,218.5 Common Stock Purchase Warrants that were exercised pursuant to the Agreement. As a result, on October 31, 1995, the Retirement Fund received total proceeds of $10.7 million which resulted in a gain of $1.4 million.\nOn August 6, 1991, the Independent General Partners approved a reserve for follow-on investments of $20.0 million for the Retirement Fund. As of December 31, 1995, the reserve balance was reduced to $8.2 million due to follow-on investments of $153 in Petco Animal Supplies, $1.6 million in Fitz and Floyd, Inc., $128,270 in Fine Clothing, Inc., $2.5 million in Hills Stores and $1.9 million in Ghirardelli Holdings. Additionally, $5.7 million of the reserve has been returned to the partners during 1995. The level of the reserve was based upon an analysis of potential follow-on investments in specific portfolio companies that may become necessary to protect or enhance the Retirement Fund's existing investment. As of March 6, 1996, the Independent General Partners have approved retention of the reserve at its current level.\nBecause the Retirement Fund primarily invests in high-yield private placement securities, the risk of loss upon default by an issuer is greater than with investment grade securities because high-yield securities are generally unsecured and are often subordinated to other creditors of the issuer. Also, high-yield issuers usually have higher levels of indebtedness and are more sensitive to adverse economic conditions.\nAlthough the Retirement Fund cannot eliminate the risks associated with its investments in high-yield securities, it has procedures in place to continually monitor the risks associated with its investments under a variety of market conditions. Any potential Retirement Fund loss would generally be limited to its investment in the portfolio company as reflected in the portfolio of investments.\nShould bankruptcy proceedings commence, either voluntarily or by action of the court against a portfolio company, the ability of the Retirement Fund to liquidate the position or collect proceeds from the action may be delayed or limited.\n5. Unrealized Appreciation and Depreciation of Investments\nFor the year ended December 31, 1995, the Retirement Fund recorded net unrealized depreciation of $28.4 million of which $23.3 million was related to net depreciation in market value of publicly traded securities. The unrealized depreciation can be attributed primarily to the decrease in value of First Alert and Hills Stores Company at December 31, 1995, as well as the reversal of unrealized appreciation of EquiCredit from the sale of the EquiCredit securities held by the Retirement Fund. This compares to a net unrealized depreciation of $114.3 million of which $111.1 million was related to net depreciation in market value of publicly traded securities for the same period in 1994. The Retirement Fund's cumulative net unrealized depreciation on investments as of December 31, 1995 totaled $8.5 million.\nFor the year ended December 31, 1993, the Retirement Fund recorded net unrealized appreciation of $94,671,310 of which $83,500,000 was related to net appreciation in market value of publicly traded securities. The increase can be attributed primarily to the increase in valuation on Snapple Beverage Corp.\nThe Retirement Fund's valuation of the Common Stock of First Alert, Hills, Petco, Playtex and Stanley Furniture reflects their closing market prices at December 31, 1995.\nFor additional information, please refer to the Supplemental Schedule of Unrealized Appreciation and Depreciation (Schedule 2 - page 41).\n6. Non-Accrual of Investments\nIn accordance with the Retirement Fund's Accounting Policy, the following securities have been on non-accrual status since the date indicated:\n- CST Office Products, Inc. on October 1, 1992 (See Note 14). - Fitz and Floyd\/Silvestri Corporation, on January 1, 1994. - FLA Orthopedics, Inc. on January 1, 1995. - Stablex Canada, Inc. on June 29, 1995.\n7. Investment Advisory Fee\nThe Investment Adviser provides the identification, management and liquidation of portfolio investments for the Funds. As compensation for services rendered to the Funds, the Investment Adviser receives a quarterly fee at the annual rate of 1% of assets under management (net offering proceeds reduced by cumulative capital reductions), with a minimum annual fee of $1.2 million for the Retirement Fund and Fund II on a combined basis. The Investment Advisory Fee is calculated and paid quarterly in advance. In addition, the Investment Adviser receives 95% of the benefit of any MGP Distributions paid to the Managing General Partner (see Note 10). For the years ended December 31, 1995, 1994 and 1993, the Retirement Fund paid $1,063,604, $1,202,216, and $1,411,755, respectively, in Investment Advisory Fees to Thomas H. Lee Advisors II, L.P.\n8. Fund Administration Fees and Expenses\nAs compensation for its services, ML Fund Administrators Inc. (the \"Fund Administrator\"; an affiliate of the Managing General Partner), is entitled to receive from the Funds an annual amount of the greater of $500,000 or 0.45% of the excess of net offering proceeds less 50% of capital reductions. In addition, ML Mezzanine II Inc., an affiliate of the Fund Administrator and of Merrill Lynch & Co. Inc., receives 5% of the benefit of any MGP Distributions paid to the Managing General Partner (see Note 10). The Fund Administration Fee is calculated and paid quarterly, in advance, by each fund in proportion with the net offering proceeds. For the years ended December 31, 1995, 1994 and 1993, the Retirement Fund paid $602,002, $633,558, and $715,816, respectively, in Fund Administration Fees.\nPursuant to the administrative services agreement between the Retirement Fund and the Fund Administrator, effective November 10, 1993, a portion of the actual out-of-pocket expenses incurred in connection with the administration of the Retirement Fund is being reimbursed to the Fund Administrator. Actual out-of-pocket expenses (\"reimbursable expenses\") primarily consist of printing, audits, tax preparation and custodian fees. For the years ended December 31, 1995 and 1994, the Retirement Fund incurred $100,721 and $220,205, respectively, in reimbursable expenses.\n9. Independent General Partners' Fees and Expenses\nAs compensation for their services, each Independent General Partner will receive a combined annual fee of $40,000 (payable quarterly) from the Funds in addition to a $1,000 fee for each meeting attended ($500 if a meeting is held on the same day as a committee meeting of the General Partners) plus reimbursement for any out-of-pocket expenses incurred. Fees and expenses are allocated between the Funds in proportion to the number of Units issued by each fund. Compensation for each of the Independent General Partners is reviewed annually. For the years ended December 31, 1995, 1994 and 1993, the Retirement Fund incurred $201,406, $153,909, and $281,709, respectively, in Independent General Partners' Fees and Expenses.\n10. Related Party Transactions\nThe Retirement Fund's investments generally are made as co-investments with Fund II. In addition, certain of the Mezzanine Investments and Bridge Investments which were made by the Retirement Fund involve co-investments with entities affiliated with the Investment Adviser. Such co-investments are generally prohibited absent exemptive relief from the Securities and Exchange Commission (the \"Commission\"). As a result of these affiliations and the Retirement Fund's expectation of engaging in such co-investments, the Funds together with ML-Lee Acquisition Fund, L.P., sought an exemptive order from the Commission allowing such co-investments, which was received on September 1, 1989. The Retirement Fund's co-investments in Managed Companies, and in certain cases its co-investments in Non-Managed Companies, typically involve the entry by the Funds and other equity security holders into stockholders' agreements. While the provisions of such stockholders' agreements vary, such agreements may include provisions as to corporate governance, registration rights, rights of first offer or first refusal, rights to participate in sales of securities to third parties, rights of majority stockholders to compel minority stockholders to participate in sales of securities to third parties, transfer restrictions, and preemptive rights.\nThomas H. Lee Company, a sole proprietorship owned by Thomas H. Lee, an Individual General Partner of the Retirement Fund and an affiliate of the Investment Adviser, typically performs certain management services for Managed Companies and receives management fees in connection therewith, usually pursuant to written agreements with such companies. In addition, certain of the portfolio companies have contractual or other relationships pursuant to which they do business with one another.\nMerrill Lynch, Pierce, Fenner & Smith Incorporated (\"MLPF&S\") is an affiliate of the Managing General Partner. MLPF&S and certain of its affiliates, in the ordinary course of their business, perform various financial services for various portfolio companies of the Funds, which may include investment banking services, broker\/dealer services and economic forecasting, and receive in consideration therewith various fees, commissions and reimbursements. Furthermore, MLPF&S and its affiliates or investment companies advised by affiliates of MLPF&S may, from time to time, purchase or sell securities issued by portfolio companies of the Funds in connection with its ordinary investment operations.\nFor the year ended December 31, 1995, the Retirement Fund paid $125,246 to the Fund Administrator for reimbursable out-of-pocket expenses (please refer to Note 8 for further information).\nDuring 1995, the Retirement Fund paid Managing General Partner distributions totalling $4,472,911 (which includes $4,397,592 of incentive fees and $75,319 with respect to its interest in the Retirement Fund). Of this incentive fee amount, 95% or $4,177,712 was paid to the Investment Adviser and the remaining 5% totalling $219,880 was paid to ML Mezzanine Inc. As of December 31, 1995, the Managing General Partner has earned $24,110,084 in Incentive Fees of which $5,211,680 was deferred in payment to the Managing General Partner as a Deferred Distribution Amount in accordance with the Partnership Agreement. This Deferred Distribution Amount was distributed to the Partners pro-rata in accordance with their capital contributions, and certain amounts otherwise later payable to Limited Partners from distributable cash from operations would instead be payable to the Managing General Partner until the Deferred Distribution Amount is paid in full.\n11. Litigation\nOn February 3, 1992 and February 5, 1992, respectively, one Limited Partner from Fund II and one Limited Partner from the Retirement Fund each commenced class actions in the US District Court for the District of Delaware, purportedly on behalf of all persons who purchased limited partnership interests in the Funds between November 10, 1989 and January 5, 1990, against the Funds, the Managing General Partner, the Individual General Partners, the Investment Adviser to the Funds and certain named affiliates of such persons. These actions, alleging that the defendants in the action made material misrepresentations or omitted material information in the offering materials for the Funds concerning the investment purposes of the Funds, were consolidated by the court on March 31, 1992, and a consolidated complaint was filed by the plaintiffs on May 14, 1992. In April 1993, plaintiffs filed an amended complaint, adding claims that certain transactions by the Funds were prohibited by the federal securities laws applicable to the Funds and their affiliates under the Investment Company Act of 1940, as amended. The amended complaint also named the Funds' counsel as a defendant. Defendants moved to dismiss the amended complaint, and, by Opinion and Order dated March 31, 1994, the court granted in part and denied in part the motions to dismiss.\nAdditionally, by its March 31, 1994 Opinion and Order, the Court certified the case as a class action, and ordered plaintiffs to replead by filing a new complaint reflecting the Court's rulings. On April 15, 1994, plaintiffs served and filed a new complaint, which defendants moved to strike for not conforming to the Court's ruling. On August 3, 1994, the Court granted defendants' motion to strike the new complaint. Plaintiffs thereafter filed a revised second amended complaint dated September 26, 1994. Factual discovery in this litigation has concluded. Expert discovery is currently set to conclude in early 1996. The defendants in this action believe that the remaining claims are without merit, although whether or not the plaintiffs prevail, the Funds may be obligated to indemnify and advance litigation expenses to certain of the defendants under the terms and conditions of various indemnity provisions in the Funds' Partnership Agreements and separate indemnification agreements, and the amount of such indemnification and expenses could be material. The Retirement Fund has advanced amounts to the indemnified parties based upon amounts which are deemed reimbursable in accordance with the indemnification provisions and has included these amounts in professional fees. The outcome of this case is not determinable at this time.\nOn August 9, 1994, the same two Limited Partners as noted in the preceding paragraphs commenced another putative class action in the US District Court for the District of Delaware, purportedly on behalf of all persons who owned limited partnership interests in the Funds on November 4, 1993, against the Funds, the Managing General Partners, the Individual General Partners, the Investment Adviser to the Funds and certain named affiliates of such persons. Plaintiffs allege that the defendants violated certain provisions of the Investment Company Act of 1940 and the common law in connection with the sale by certain of the defendants of shares of common stock of Snapple Beverage Corp. in a November 1993 secondary offering and seek actual and punitive damages and an accounting in connection therewith. The defendants have filed papers in opposition to the motion for partial summary judgment on January 10, 1995. On August 4, 1995, plaintiffs filed an amended complaint alleging additional violations of the Investment Company Act of 1940 and common law arising out of the secondary offering. The plaintiffs moved for summary judgment on certain of these claims. On October 13, 1995, the defendants in this litigation each filed briefs in opposition to plaintiffs' motions. Because the defendants in this action believe that the claims are without merit, each defendant also filed a separate motion to dismiss, although whether or not the plaintiffs prevail, the Funds may be obligated to indemnify and advance litigation expenses to certain of the defendants under the terms and conditions of various indemnity provisions in the Funds' Partnership Agreements and separate indemnification agreements. The outcome of this case is not determinable at this time.\nOn November 2, 3 and 4, 1994, stockholders of Snapple Beverage Corp. commenced approximately twenty putative class actions in the Delaware Chancery Court, purportedly on behalf of all public stockholders of Snapple, against Snapple, the Funds, Thomas H. Lee Equity Partners, L.P., and some or all of Snapple's directors. Since then, the plaintiffs have filed a Consolidated Amended Complaint against Snapple, the Funds, Thomas H. Lee Equity Partners, L.P., some or all of Snapple's directors and Quaker Oats. The complaint alleges that the sale of Snapple to Quaker Oats was at an unfair price and in violation of the defendants' fiduciary duties to public stockholders. The plaintiffs sought an injunction against the merger transaction, an accounting for any damages suffered by the public stockholders, and attorneys' fees and related expenses. The Court on November 15, 1994 denied plaintiffs application to take expedited discovery and request to schedule a preliminary injunction hearing. The defendants in these actions believe that the claims are without merit, although whether or not the plaintiffs prevail, the Funds may be obligated to indemnify and advance litigation expenses to certain of the defendants under the terms and conditions of various indemnity provisions in the Funds' Partnership Agreements and separate indemnification agreements. The outcome of this case is not determinable at this time.\nOn November 27, 1995, one Limited Partner from Fund II and one Limited Partner from the Retirement Fund filed a putative class action in the United States District Court for the District of Delaware, purportedly on behalf of all persons or entities who owned Units in the Funds between April 5, 1991 and November 27, 1995, against the Funds, the Managing General Partner, the Individual General Partners, the Investment Adviser to the Funds, and certain named affiliates of such persons. The complaint contends that the Funds improperly advanced legal fees and litigation costs to the defendants in connection with three previously filed lawsuits. The plaintiffs are seeking an accounting, rescissory or actual damages, punitive damages, plaintiffs' litigation costs and attorneys fees, pre-judgment and post-judgment interest, and an injunction barring the defendants from further indemnifying themselves. The defendants in this action believe that the claims are without merit and have moved to dismiss the case. Although the defendants believe the advancement of legal fees and litigation costs was properly made pursuant to indemnification agreements signed by the defendants, the outcome of this case is not determinable at this time.\n12. Commitments\nOn August 18, 1993, the Retirement Fund established a letter of credit from Banque Nationale de Paris in favor of FLA. Orthopedics, a Non-Managed portfolio company. The Retirement Fund posted as collateral a $394,800 Banque Nationale de Paris certificate of deposit which pays an annual interest rate of 3.875%. If the commitment is drawn upon, the Retirement Fund will receive additional subordinated notes and equity of FLA. Orthopedics. The letter of credit will expire on May 1, 1996.\n13. Income Taxes (Statement of Financial Accounting Standards No. 109)\nNo provision for income taxes has been made because all income and losses are allocated to the Retirement Fund's partners for inclusion in their respective tax returns.\nPursuant to the Statement of Financial Accounting Standards No. 109 Accounting for Income Taxes, the Retirement Fund is required to disclose any difference in the tax basis of the Retirement Fund's assets and liabilities versus the amounts reported in the financial statements. Generally, the tax basis of the Retirement Fund's assets approximate the amortized cost amounts reported in the financial statements. This amount is computed annually and as of December 31, 1995, the tax basis of the Retirement Fund's assets are less than the amounts reported in the financial statements by $9,598,909. This difference is primarily attributable to unrealized depreciation and appreciation on investments which has not been recognized for tax purposes.\n14. Subsequent Events\nOn February 8, 1996, the Individual General Partners approved the fourth quarter 1995 cash distribution totalling $19,587 which represents net investment income of $159,555 from Temporary Investments offset by a net investment loss from Mezzanine Investments of $139,968. The total amount distributed to Limited Partners was $19,527 or $.11 per Unit, which was paid on February 14, 1996. The Managing General Partner received a total of $55, with respect to its interest in the Retirement Fund. Thomas H. Lee, as an Individual General Partner, received $5 with respect to his interest in the Retirement Fund.\nOn February 14, 1996, Ghirardelli Holdings Corporation (\"Ghirardelli\"), Ghirardelli Chocolate Company, and all of the equityholders of Ghirardelli, including the Funds and certain Lee Affiliates, executed a Stock Purchase Agreement pursuant to which (i) the equityholders agreed to sell all of their shares and options to Ghirardelli and (ii) HMTF\/CH Acquisition Company (the \"Buyer\") agreed to purchase new shares of Ghirardelli. The closing is scheduled for the later to occur of (x) the 10th day after the first closing of the Buyer's parent's equity fund, and (y)the date upon which the last of any approvals and consents necessary to the transaction are obtained. The price per share for the stock of Ghirardelli is $5.88854; provided that if the closing occurs after March 31, 1996, the purchase price shall bear interest at an annual rate of 9% for the period April 1, 1996 through the closing. If the transaction occurs, the Retirement Fund will sell 616,839 shares for proceeds of approximately $3.6 million. In addition, the Buyer will (i) repay all of Ghirardelli's Subordinated Notes held by the Funds, including all interest and all prepayment penalties thereon and (ii) pay the redemption price, including the redemption premium, on all outstanding Series A Preferred Stock of Ghirardelli held by the Retirement Fund. As part of the transaction, each stockholder is required to allocate approximately 3.5% of the proceeds received on account from the sale of the equity of Ghirardelli to an escrow account to be held for a period of one year from the closing. As such, the Retirement Fund will escrow $130,839 of the proceeds.\nOn March 22, 1996 by means of merger of Lee-CST Holding Corp. with an unaffilated third party, the Retirement Fund sold its entire investment in CST Office Products (\"CST\") for total proceeds of $14.2 million. The Retirement Fund received $11.3 million for the $3,395,000 principal amount 12% senior subordinated note, the $3,395,000 principal amount 18% junior subordinated note, appoximately $4 milliion in principal amount of 15% payment in kind subordinated notes issued with respect thereto, plus all outstanding accrued interest on these notes. Additionally, the Retirement Fund received $1.4 million, or $16 per share, for its common stock and $1.5 million, or $15.99 per share, for its common stock purchase warrants. The Retirement Fund realized a gain of $2.3 million, and additional interest income of $3.9 million for the payment in kind subordinated notes that were previously classified as non-accrual.\n* Restricted Security.\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 Retirement Fund\nThe five General Partners of the Retirement Fund are responsible for the management and administration of the Retirement Fund and have the same positions and responsibilities with respect to Fund II. The General Partners of the Retirement Fund and Fund II consist of four Individual General Partners: Vernon R. Alden, Joseph L. Bower, Stanley H. Feldberg (the \"Independent General Partners\"), Thomas H. Lee and Mezzanine Investments II, L.P., the Managing General Partner. Pursuant to exemptive orders issued by the Securities and Exchange Commission, each Independent General Partner is not an \"interested person\" of the Retirement Fund as such term is defined in the Investment Company Act.\nIndividual General Partners\nThe Individual General Partners provide overall guidance and supervision with respect to the operations of the Retirement Fund and perform the various duties imposed on the directors of business development companies by the Investment Company Act of 1940. The Individual General Partners supervise the Managing General Partner and must, with respect to any Mezzanine Investment transactions, either certify that it meets the Retirement Fund investment guidelines or specifically approve it as a non-Guideline Investment or Bridge Investment. In addition, if a Portfolio Company is in default of performance of a material provision of a lending agreement or has a ratio of operating cash flow to current cash fixed charges for its four most recent fiscal quarters of less than or equal to 1.1 to 1, the Independent General Partners are required to approve any material changes in the terms of investment in such Portfolio Company.\nMessrs. Alden, Bower, Feldberg and Lee have served as Individual General Partners of the Retirement Fund and Fund II since 1989. Each Individual General Partner shall hold office until his removal or withdrawal pursuant to the provisions of the Retirement Fund's Partnership Agreement.\nMr. Alden, age 73, is a director of Augat Inc., Colgate - Palmolive Company, Digital Equipment Corporation, Intermet Corporation, and Sonesta International Hotels Corporation. Mr. Alden also serves as Chairman of the Japan Society of Boston, Trustee Emeritus of the Boston Symphony Orchestra and the Boston Museum of Science and Honorary Counsel General of the Royal Kingdom of Thailand. Mr. Alden also serves as an Individual General Partner of ML-Lee Acquisition Fund, L.P. (\"Fund I\") since its inception in 1987.\nMr. Bower, age 57, is the Donald Kirk David Professor of Business Administration, Chairman of the Doctoral Programs and Director of Research at the Harvard University Graduate School of Business Administration. He has served as a faculty member of the University since 1963. Mr. Bower is also a director of Anika Research, Inc., Brown Group, Inc., New America High Income Fund, Sonesta International Hotels Corporation and The Lincoln Foundation. Mr. Bower serves as trustee of the DeCordova & Dana Museum and Park and the New England Conservatory of Music. Mr. Bower also serves as an Individual General Partner of Fund I since its inception in 1987.\nMr. Feldberg, age 71, is director of The TJX Companies, Inc., and Waban Inc. He also serves as a Trustee of Brandeis University. Mr. Feldberg also serves as an Individual General Partner of Fund I since its inception in 1987.\nMr. Lee, age 52, founded the Thomas H. Lee Company in 1974 and since that time has served as its Chief Executive Officer. Mr. Lee also is Chairman and a Trustee of Thomas H. Lee Advisors I and Thomas H. Lee Advisors II, L.P., the respective investment advisers to Fund I and the Funds, and is Individual General Partner of THL Equity Advisors Limited Partnership, the investment adviser to Thomas H. Lee Equity Partners, L.P. which participates in equity or equity-related investments of certain companies acquired by the respective funds. In addition, Mr. Lee serves as an Individual General Partner of Fund I since its inception in 1987.\nFrom 1966 through 1974, Mr. Lee was with First National Bank of Boston where he directed the bank's high technology lending group from 1968 to 1974 and became a Vice President in 1973. Prior to 1966, Mr. Lee was a Securities Analyst in the institutional research department of L.F. Rothschild in New York. Mr. Lee serves as a director of Autotote Corporation, J. Baker, Inc., Finlay Fine Jewelry Corporation, General Nutrition Companies, Inc., Health o meter Products, Inc., Playtex Products Inc. and Snapple Beverage Corp. Mr. Lee was Chairman of Hills Department Stores, Inc. and Hills Stores Company from 1990 to 1993. In February 1991, Hills Department Stores, Inc. and Hills Stores Company filed for protection under Chapter 11 of the Federal Bankruptcy Code.\nMr. Lee is a trustee of Brandeis University (Vice Chairman), Museum of Arts (Boston), the Wang Center for the Performing Arts and Boston's Beth Israel Hospital (Vice Chairman). Mr. Lee is also an overseer of Boston Symphony Orchestra and New England Conservatory of Music, a member of the Dean's Council and an Executive Committee Member of the Committee on University Resources at Harvard University and a member of the Corporation of Belmont Hill School.\nThe Investment Adviser\nThe Investment Adviser, pursuant to an investment management agreement among the Investment Adviser, the Thomas H. Lee Company and the Retirement Fund dated November 10, 1989, is responsible for the identification, management and liquidation of Mezzanine Investments and Bridge Investments for the Retirement Fund. The Investment Adviser received an Investment Advisory Fee in compensation for these services outlined in Note 7 to the Financial Statements.\nCertain officers of the Lee Company have been designated as trustees and executive officers of T. H. Lee Mezzanine II, the administrative general partner of the Investment Adviser.\nTitle\nThomas H. Lee Chairman, Trustee\nJohn W. Childs President, Trustee\nThomas R. Shepherd Executive Vice President\nDavid V. Harkins Senior Vice President, Trustee\nC. Hunter Boll Vice President\nScott A. Schoen Vice President\nWendy L. Masler Treasurer, Clerk\nInformation concerning Mr. Lee is set forth above.\nJohn W. Childs, age 54, is the founder of J.W. Childs Associated, L.P., Mr. Childs was a Senior Managing Director of the Thomas H. Lee Company (\"Lee Company\"), from 1987 to 1995. For the 17 years prior to joining the company, Mr. Childs was with the Prudential Insurance Company of America where he was most recently Senior Managing Director in charge of the Capital Markets Group. In that position he was responsible for Prudential's approximately $77 billion fixed income portfolio, including all of the Capital Markets Group's investments in leveraged acquisitions. Mr. Child's past positions at Prudential include, from 1982 to 1984, Senior Vice President of PruCaptial, Inc., a Prudential subsidiary; from 1981 to 1982, Vice President, responsible for private placements of the Capital Markets Group; and from 1980 to 1981, Vice President in Corporate Finance of the Capital Markets Group. Mr. Childs serves as President and Trustee of Thomas H. Lee Advisors I (\"Advisors I\"), the investment advisor to Fund I. Mr. Childs is a director of General Nutrition Companies, Inc., Health o meter, Inc., and Snapple Beverage Corp. Mr. Childs also serves as Chairman of the Jane Coffin Childs Fund for medical research.\nMr. Shepherd, age 66, has been engaged as a consultant to the Thomas H. Lee Company since 1986 and is currently a Managing Director. Mr. Shepherd is currently a director of General Nutrition Companies, Inc., Health o meter, Inc. and Playtex Products, Inc. He is Executive Vice President of Thomas H. Lee Advisors I and T.H. Lee Mezzanine II. Previously, Mr. Shepherd was Chairman of Amerace Corporation from 1986 to 1988 and President of GTE (Sylvania) Lighting Products Group from 1983 to 1986. Mr. Shepherd served as President of North American Philips Commercial Electronics Corporation from 1981 to 1983 and from 1979 to 1981, he served as Senior Vice President and general manager of GTE Entertainment Products Group.\nMr. Harkins, age 56, has been a Managing Director of the Lee Company since 1986 and the Chairman of National Dentex Corporation since 1983. He served as President of Massachusetts Capital Corporation and Masscap Investment Company, Inc. from 1976 to 1983, and as President of First American Investment Company, Inc. from 1982 to 1983. Mr. Harkins is a Senior Vice President and Trustee of Advisor I. He also is a director of EquiCredit Corporation, Kevlin Microwave Corp., National Dentex Corporation and Stanley Furniture Corp.\nMr. Boll, age 40, has served as a Managing Director of the Lee Company since 1991. From 1986 to 1991 he served as a Vice President of the Lee Company. Prior to joining the Lee Company, he worked as a consultant with The Boston Consulting Group from 1984 to 1986, and was Assistant Vice President of the Energy and Minerals Division of Chemical Bank from 1977 to 1982. Mr. Boll is a Vice President of Advisors I and a director of Snapple Beverage Corp., Stanley Furniture Corp. and Big V Supermarkets, Inc.\nMr. Schoen, age 37, has served as a Managing Director of the Lee Company since 1991. From 1986 to 1990 he served as a Vice President of the Lee Company. Prior to joining the Lee Company he was an Associate in the Private Finance Department of Goldman, Sachs & Co. from 1984 to 1986. Mr. Schoen is a Vice President of Advisors I. Mr. Schoen is also a director of First Alert, Inc., Health o meter Products, Inc. and LaSalle Reinsurance Limited.\nMs. Masler, age 42, has been Treasurer of the Lee Company since 1984. From 1981 to 1984 she was employed by Paine Webber Properties Incorporated and prior to that she was a Senior Auditor with Touche Ross & Co. Ms. Masler is also Treasurer and Clerk of Advisors I.\nThe Managing General Partner\nThe Managing General Partner is a limited partnership in which ML Mezzanine II Inc. is the sole general partner and the Investment Adviser is the limited partner. The Managing General Partner is responsible for the supervision of the Retirement Fund's investments.\nThe executive officers of ML Mezzanine II Inc. are as follows:\nTitle\nKevin K. Albert Chairman and President\nRobert Aufenanger Executive Vice President, Director\nJames V. Caruso Executive Vice President, Director\nRosalie Y. Goldberg Vice President, Director\nAudrey L. Bommer Vice President, Treasurer\nRoger F. Castoral, Jr. Assistant Treasurer\nKevin Albert, age 43, a Vice President and a Managing Director of Merrill Lynch Investment Banking Group (\"ML Investment Banking\") joined Merrill Lynch in 1981. Mr. Albert is the manager of the Equity Private Placement Group of ML Investment Banking and is involved in structuring, marketing and closing a diversified array of private equity financings including common stock, preferred stock, limited partnership interests and other equity-related securities. Mr. Albert has a B.A. and an M.B.A. from the University of California, Los Angeles. Mr. Albert is also a director of ML Media Management Inc. (\"ML Media\"), an affiliate of the Managing General Partner and a joint venture of Media Management Partners, the general partner of ML Media Partners, L.P.; a director of ML Film Entertainment Inc. (\"ML Film\"), an affiliate of the Managing General Partner and the managing general partner of the general partners of Delphi Film Associates, Delphi Film Associates III, IV, V and ML Delphi Premier Partners, L.P.; a director of ML Opportunity Management Inc. (\"ML Opportunity\"), an affiliate of the General Partner and a joint venture in Media Opportunity Management Partners, the general partner of ML Media Opportunity Partners, L.P.; a director of MLL Antiquities Inc. (\"MLL Antiquities\"), an affiliate of the Managing General Partner and the administrative general partner of The Athena Fund II, L.P.; ML Mezzanine Inc. (\"ML Mezzanine\"), an affiliate of the General Partner and the sole general partner of the managing general partner of ML-Lee Acquisition Fund, L.P.; a director of Merrill Lynch Venture Capital Inc. (\"ML Venture\"), an affiliate of the Managing General Partner and the general partner of the managing general partner of ML Venture Partners I, L.P. (\"Venture I\"), ML Venture Partners II, L.P. (\"Venture II\"), and ML Oklahoma Venture Partners Limited Partnership; a director of Merrill Lynch R&D Management Inc. (\"ML R&D\"), an affiliate of the general partner and the general partner of the General Partner of ML Technology Ventures, L.P.; and a director of MLL Collectibles Inc. (\"MLL Collectibles\"), an affiliate of the General Partner and the administrative general partner of The NFA World Coin Fund, L.P. Mr. Albert also serves as an independent general partner of Venture I and Venture II.\nRobert Aufenanger, age 42, a Vice President of Merrill Lynch & Co. Corporate Strategy Credit and Research and a Director of the Partnership Management Department, joined Merrill Lynch in 1980. Mr. Aufenanger is responsible for the ongoing management of the operations of the equipment and project related limited partnerships for which subsidiaries of ML Leasing Equipment Corp., an affiliate of Merrill Lynch, are general partners. Mr. Aufenanger is also a director of, ML Media, ML Film, ML Opportunity, MLL Antiquities, ML Mezzanine, ML Venture, ML R&D and MLL Collectibles. Mr. Aufenanger is an executive officer of Mid-Miami Diagnostics Inc. (\"Mid-Miami Inc.\"). On October 28, 1994, both Mid-Miami Inc. and Mid-Miami Diagnostics, L.P., a limited partnership of which Mid Miami, Inc. is the general partner, filed voluntary petitions for protection form creditors under Chapter 7 of the United States Bankruptcy Code in the United States Bankruptcy Court for the Southern District of New York.\nJames V. Caruso, age 44, a Director in the Investment Banking Group of Merrill Lynch, Pierce, Fenner & Smith Incorporated (\"Merrill Lynch\"), joined Merrill Lynch in 1975. Since June 1992, Mr. Caruso has served as Manager of Merrill Lynch's Partnership Analysis & Management Department, which is responsible for accounting and the ongoing administration and operations of more than 150 investment limited partnership as well as the Merrill Lynch affiliated entities that manage or administer such partnerships. He serves as a director of ML Mezzanine Inc., ML Eneregy Investments, Inc. and KECALP Inc. an affiliate of the MGP and general partner.\nRosalie Y. Goldberg, age 58, serves as Vice President of Merrill Lynch Private Client, Manager of the Special Investments Group, Vice President and Director of ML Mezzanine Inc. and Director of MLL Antiquities and MLL Collectibles. Ms. Goldberg joined Merrill Lynch & Co. in 1975.\nAudrey L. Bommer, age 29, joined ML Investment Banking in 1994 and serves as treasurer and controller to the Funds. Ms. Bommer manages all accounting, financial reporting and administrative functions in the Merrill Lynch Partnership Analysis and Management Department. She also serves as Vice President and Treasurer of ML Mezzanine II, Inc.\nRoger F. Castoral, Jr., age 28, joined Merrill Lynch Investment Banking in 1995 and serves as Assistant Treasurer and controller to the funds. Mr. Castoral is responsible for financial reporting and fund accounting in the Merrill Lynch Partnership Analysis and Management Department and serves as Assistant Treasurer of ML-Mezzanine II, Inc.\nThe Fund Administrator\nML Fund Administrators Inc., a Delaware corporation and a subsidiary of Merrill Lynch & Co., Inc., is responsible for the provision of administrative services necessary for the operation of the Funds. The Fund Administrator receives Fund Administration Fees in compensation an reimbursement for a portion of administrative expenses paid on behalf of the Fund for services as outlined in Note 8 to the Financial Statements.\nThe Fund Administrator is responsible for the day-to-day administrative affairs of the Funds and for the management of the accounts of Limited Partners. The Fund Administrator also provides the Funds, at the Fund Administrator's expense, with office space, facilities, equipment and personnel necessary to carry out its obligations under the Administrative Services Agreement.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe information with respect to compensation of the Individual General Partners set forth under the caption \"Management Arrangements - the Individual General Partners\" in the Prospectus pages 73 - 74 is incorporated herein by reference. The Retirement Fund paid Independent General Partners, Mr. Alden, Mr. Bower and Mr. Feldberg each $27,789, for their services as Independent General Partners in 1995.\nThe information with respect to the allocation and distribution of the Retirement Fund's profits and losses to the Managing General Partner set forth under the caption \"Distributions and Allocations - Allocations of Profits and Losses\" in the Prospectus pages 86 - 87 is incorporated herein by reference. The Managing General Partner received distributions of $4,472,080 with respect to 1995, including Incentive Fees of $4,396,764 that it distributed, $4,176,926 to the Investment Adviser and $219,838 to ML Mezzanine II Inc.\nThe information with respect to the Management Fee payable to the Investment Adviser (and distributions from the Managing General Partner) set forth under the caption \"Management Arrangements - Description of the Advisory Agreement\" in the Prospectus pages 74 - 75 is incorporated herein by reference. Pursuant to the Investment Advisory Agreement, the Retirement Fund paid the Investment Adviser $1,063,604 with respect to 1995.\nThe information with respect to the Fund Administration Fees and Expenses payable to the Fund Administrator set forth under the caption \"Management Arrangements - The Fund Administrator\" in the Prospectus pages 72 - 73 is incorporated herein by reference. Pursuant to the Administration Service Agreement, the Retirement Fund paid the Fund Administrator a total of $727,248 in 1995.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nAs of March 15, 1996, Common Fund is the only entity known to the management of the Retirement Fund which may be deemed to be a beneficial owner of more than five percent of the outstanding units of the Retirement Fund. As of March 15, 1996, the Common Fund owns 21,448 Units of the outstanding Units of limited partnership interest or 12.08% of the Retirement Fund. The Common Fund is located at 363 Reef Road, P.O. Box 940, Fairfield, CT 06430. Mr. Bower owns 11 units of the Retirement Fund.\nThere exists no arrangement known to the Retirement Fund, the execution of which may at a subsequent date result in a change of control of the Retirement Fund.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThe Retirement Fund's investments generally are made as co-investments with Fund II. In addition, certain of the Mezzanine Investments and Bridge Investments which were made by the Retirement Fund may involve co-investments with entities affiliated with the Investment Adviser. Such co-investments are generally prohibited absent exemptive relief from the Securities and Exchange Commission (the \"Commission\"). As a result of these affiliations and the Retirement Fund's expectation of engaging in such co-investments, the Retirement Fund together with Fund II and Fund I, sought an exemptive order from the Commission allowing such co-investments, which was received on September 1, 1989. The Retirement Fund's co-investments in Managed Companies, and in certain cases its co-investments in Non-Managed Companies, typically involve the entry by the Funds and other equity security holders into stockholders' agreements. While the provisions of such stockholders' agreements vary, such agreements may include provisions as to corporate governance, registration rights, rights of first offer or first refusal, rights to participate in sales of securities to third parties, rights of majority stockholders to compel minority stockholders to participate in sales of securities to third parties, transfer restrictions, and preemptive rights.\nThomas H. Lee Company, a sole proprietorship owned by Thomas H. Lee, an Individual General Partner of the Retirement Fund and an affiliate of the Investment Adviser, typically performs certain management services for Managed Companies and receives management fees in connection therewith usually pursuant to written agreements with such companies. Of the total of eleven Managed Companies of the Funds, eight paid management fees to Thomas H. Lee Company ranging from $120,000 to $270,000 for the fiscal year ended December 31, 1995. In addition, certain of the Managed Companies have contractual or other relationships pursuant to which they do business with one another.\nMerrill Lynch, Pierce, Fenner & Smith Incorporated (\"MLPF&S\") is an affiliate of the Managing General Partner. MLPF&S and certain of its affiliates, in the ordinary course of their business, perform various financial services for various portfolio companies of the Funds, which may include investment banking services, broker\/dealer services and economic forecasting, and pension plan services and receives in consideration therewith various fees, commissions and reimbursements. The aggregate revenue received by MLPF&S and its affiliates during 1995 for providing such services to Managed Companies in which the Funds have a material interest (other than those specifically set forth below) was not in excess of $100,000. Furthermore, MLPF&S and its affiliates or investment companies advised by affiliates of MLPF&S may, from time to time, purchase or sell securities issued by portfolio companies of the Funds in connection with their ordinary investment operations.\nDuring 1995, the Retirement Fund paid Managing General Partner distributions totalling $4,472,080 (which includes $4,396,764 of incentive fees and $75,316 with respect to its interest in the Retirement Fund). Of this incentive fee amount, 95% or $4,176,926 was paid to the Investment Advisor and the remaining 5% totalling $219,838 was paid to ML Mezzanine Inc. As of December 31, 1995, the Managing General Partner has earned $24,110,044 in Incentive Fees of which $5,211,680 was deferred in payment to the Managing General Partner as a Deferred Distribution Amount in accordance with the Partnership Agreement. To the extent not payable to the Managing General Partner, this Deferred Distribution Amount was distributed to the Partners pro-rata in accordance with their capital contributions, and certain amounts otherwise later payable to Limited Partners from distributable cash from operations would instead be payable to the Managing General Partner until the Deferred Distribution Amount is paid in full.\nCST Office Products, Inc.\nOn March 22, 1996 the Retirement Fund sold its entire investment in CST Office Products, Inc. See Note 14 to the Financial Statements for further information.\nAs of December 31, 1995 the Retirement Fund, Fund II and the Lee Affiliates owned 11.9%, 22.3% and 65.9%, respectively, of the common equity of CST on a fully diluted basis.\nEquiCredit\nOn January 27, 1995, the Retirement Fund sold its entire investment in Equicredit, consisting of 259,474 shares of Common Stock, realizing a gain of $7,623,346 on an original investment of $679,822.\nPrior the sale of the EquiCredit Investment, the Retirement Fund, Fund II and the Affiliates held 2.4%, 2.2% and 10.7%, respectively, of the common equity of EquiCredit on a fully diluted basis.\nFirst Alert\nAs of December 31, 1995, the Retirement Fund, Fund II and the Lee Affiliates hold 2,058,474, 2,281,524 and 10,102,268 shares, respectively, of First Alert common stock, representing 8.1%, 8.9%, and 39.6%, respectively, of its common equity on a fully-diluted basis.\nDavid V. Harkins, Scott A. Schoen and Anthony J. DiNovi, officers of the Investment Adviser to the Funds, serve as directors of First Alert.\nGhirardelli\nOn May 12, 1995, the Retirement Fund made a follow-on investment in Ghirardelli Holdings Corp. for a total of $1,864,800. The Retirement Fund received 15,984 shares of Series A Preferred Stock for $1,598,400 and 84,039 additional shares of Common Stock for $266,400.\nAs of December 31, 1995 the Retirement Fund and Fund II and the Lee Affiliates hold 540,892 and 616,839 and 3,476,250 shares, respectively, of Ghirardelli's common shares which represents 10.6%, 9.3% and 59.8% of equity on a fully diluted basis.\nOn February 14, 1996, Ghirardelli Holdings Corporation (\"Ghirardelli\"), Ghirardelli Chocolate Company, and all of the equityholders of Ghirardelli, including the Funds and certain Lee Affiliates, executed a Stock Purchase Agreement. Please see Note 14 to the Financial Statements for further information.\nPetco Animal Supplies, Inc.\nOn April 27, 1995, Petco completed a public offering of approximately $3.6 million shares of common stock (the \"Petco Offering\") at a net price of $19.71 per share. As part of the Petco Offering the Retirement Fund sold 64,151 (including shares sold as a result of the exercise of the underwriters' overallotment option) representing 51% of its Petco holdings. The Retirement Fund received proceeds of $1.3 million and realized a gain of $212,949 on the sale of the equity.\nAs of December 31, 1995, the Retirement Fund and Fund II, hold 62,379 shares and 116,825 shares of Petco common stock, respectively. In addition, Fund I holds 981,748 shares of Petco common stock, and the Lee Affiliates, in the aggregate, hold 10,764 shares of Petco common stock. As of such date, Fund I, Fund II, the Retirement Fund and the Lee Affiliates, respectively, hold 11.0%, 1.3%, .7% and .1% of the common equity of Petco.\nC. Hunter Boll, an officer of the Investment Adviser to Fund I, Fund II and the Retirement Fund, serves as a director of Petco.\nPlaytex Products Inc.\nOn October 17, 1995 Playtex Products, Inc. and Banana Boat Holding Corp. entered an Agreement and Plan of Merger (the \"Agreement\") pursuant to which Playtex agreed to acquire all of the outstanding equity of Banana Boat that it did not already own. In accordance with the Agreement, the 12.5% Subordinated Note held by the Retirement Fund, plus all accrued interest, was paid in full by Playtex upon consummation of the merger. Additionally, the Retirement Fund received net proceeds of $173.55 per share for each of the 8,218.5 Common Stock Purchase Warrants that were exercised pursuant to the Agreement. As a result, on October 31, 1995, the Retirement Fund received total proceeds of $10.7 million which resulted in a gain of $1.4 million.\nOn June 6, 1995, Playtex sold 20,000,000 of newly issued Common Stock, or approximately 40% of its outstanding equity, to an investment group led by Hass Wheat Harrison Inc. for $9.00 per share, or $180 million (the \"Haas Investment\"). None of Playtex's existing shareholders, including the Retirement Fund or the Lee Affiliates, sold any of their stock in connection with the Haas Investment. An affiliate of Merrill Lynch & Co., Inc. has approximately a 4% capital interest as a limited partner in the limited partnership that made the Haas Investment.\nAs of December 31, 1995, the Retirement Fund holds 183,560 shares of the common stock of Playtex and Fund II holds 343,726 shares of Playtex common stock. In addition, Fund I holds 1,406,204 shares of Playtex common stock and the other Lee Affiliates hold 2,249,288 shares. The Retirement Fund, Fund II, Fund I and the other Lee Affiliates own, respectively, .3%, .6%, 2.6%, and 4.2% of the fully diluted common equity of Playtex.\nThomas H. Lee, who is an Individual General Partner of the Funds and the Chairman and an officer of the Investment Adviser, serves as director of Playtex.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.\n(a) Financial Statements, Financial Statement Schedules and Exhibits\nFinancial Statements and Financial Statement Schedules\nSee Item 8. \"Financial Statements and Supplementary Data Table of Contents\"\nExhibits\n3.1 Amended and Restated Certificate Incorporated by reference of Limited Partnership, dated as to Exhibit 3.1 to of August 25, 1989 registrant's Registration Statement on Form N-2 number 33-25816.\n3.2 Amended and Restated Agreement of Incorporated by reference Limited Partnership, dated to Exhibit 3.2. to November 10, 1989 Amendment No. 1, registrant's Annual Report dated January 30, 1990. of Form 10-K for the year ending December 31, 1989.\n10.1 Investment Advisory Agreement, Incorporated by reference dated November 10, 1989 by and to Exhibit 10.1 to between Registrant, Thomas H. Lee registrant's Annual Report Advisors II, L.P. and Thomas H. of Form 10-K for the year Lee Company. ended December 31, 1991.\n10.2 Custodian Agreement, dated Incorporated by reference November 10, 1989, by and between to Exhibit 10.2 to Registrant and State Street Bank registrant's Annual Report and Trust Company. of Form 10-K for the year ended December 31, 1991.\n10.3 Administrative Services Agreement, Incorporated by reference dated November 10, 1989 by and to Exhibit 10.3 to between Registrant and ML Fund registrant's Annual Report Administrators Inc. of Form 10-K for the year ended December 31, 1991.\n27 Financial Data Schedule for the Filed Herewith. year ended December 31, 1995\n28 Pages 21-91 of the Prospectus Incorporated by reference dated September 6,1989, filed to Exhibit 28 to pursuant to Rule 497(b) under the registrant's Annual Report Securities Act of 1933. of Form 10-K for the year ended December 31, 1991.\n(b) 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 on the 29th day of March, 1996.\nML-LEE ACQUISITION FUND (RETIREMENT ACCOUNTS) II, L.P.\nBy: Mezzanine Investments II, L.P. Managing General Partner\nBy: ML Mezzanine II, Inc., its General Partner\n\/s\/ Kevin K. Albert Dated: March 29, 1996 Kevin K. Albert President, ML Mezzanine II Inc., a General Partner of Mezzanine Investments II, L.P., the Managing 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 in the capacities indicated on the 29th day of March, 1996.\nSignature Title\n\/s\/ Kevin K. Albert ML Mezzanine II, Inc. Kevin K. Albert President and Director (Principal Executive Officer of Registrant)\n\/s\/ Vernon R. Alden Individual General Partner Vernon R. Alden ML-Lee Acquisition Fund (Retirement Accounts) II, L.P.\n\/s\/ Audrey Bommer ML Mezzanine II, Inc. Audrey Bommer Vice President and Treasurer (Principal Financial Officer of Registrant)\n\/s\/ Joseph L. Bower Individual General Partner Joseph L. Bower ML-Lee Acquisition Fund (Retirement Accounts) II, L.P.\n\/s\/ Roger F. Castoral, Jr. ML Mezzanine II, Inc. Roger F. Castoral, Jr. Assistant Treasurer (Principal Accounting Officer of Registrant)\n\/s\/ Stanley H. Feldberg Individual General Partner Stanley H. Feldberg ML-Lee Acquisition Fund (Retirement Accounts) II, L.P.\n\/s\/ Thomas H. Lee Individual General Partner Thomas H. Lee ML-Lee Acquisition Fund (Retirement Accounts) II, L.P.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nML-LEE ACQUISITION FUND (RETIREMENT ACCOUNTS) II, L.P.\nBy: Mezzanine Investments II, L.P. Managing General Partner\nBy: ML Mezzanine II, Inc., its General Partner\nDated: March 29, 1996 Kevin K. Albert President, ML Mezzanine II Inc., a General Partner of Mezzanine Investments II, L.P., the Managing 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 in the capacities indicated on the 29th day of March, 1996.\nSignature Title\n_____________________ ML Mezzanine II, Inc. Kevin K. Albert President and Director (Principal Executive Officer of Registrant)\n_____________________ Individual General Partner Vernon R. Alden ML-Lee Acquisition Fund (Retirement Accounts) II, L.P.\n_____________________ ML Mezzanine II Inc. Audrey Bommer Vice President and Treasurer (Principal Financial Officer of Registrant)\n______________________ Individual General Partner Joseph L. Bower ML-Lee Acquisition Fund (Retirement Accounts) II, L.P.\n_____________________ ML Mezzanine II Inc. Roger F. Castoral, Jr. Assistant Treasurer (Principal Accounting Officer of Registrant)\n_____________________ Individual General Partner Stanley H. Feldberg ML-Lee Acquisition Fund (Retirement Accounts) II, L.P.\n_____________________ Individual General Partner Thomas H. Lee ML-Lee Acquisition Fund (Retirement Accounts) II, L.P.","section_15":""}
{"filename":"64247_1995.txt","cik":"64247","year":"1995","section_1":"ITEM 1. BUSINESS.\nThe Registrant has owned and managed businesses in a variety of industries. With the sale of its S.K. Wellman business on June 30, 1995, the Registrant no longer has recurring revenues or operating subsidiaries and is engaged in the active search for acquisition opportunities which meet its financial acquisition criteria. These criteria generally focus the Company's search on mid-sized entities which are involved in manufacturing, distribution or assembly of non-consumer products and which offer continuing management.\nReference is made to the information set forth in Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations,\" elsewhere in this Form 10-K for a discussion of the development of the business since January 1, 1995.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nNo response under this item is required.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThe Registrant is unaware of any litigation that is expected to have a material effect on the results of operations or financial condition of the Registrant.\nITEM 4.","section_4":"ITEM 4. SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNo matter was submitted to a vote of security holders during the three months ended December 31, 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS.\nReference is made to the information set forth in \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" under \"Market, Share Ownership and Dividend Information\" in Section 7 of this report, which information is incorporated into this Item 5 by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe following selected financial data should be read in conjunction with the Consolidated Financial Statements and notes thereto included elsewhere herein.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nRESULT OF OPERATIONS\nBASIS OF PRESENTATION: On June 30, 1995 the Company completed the sale of all the common stock of its subsidiary, S.K. Wellman Limited, Inc., following the approval of such divestiture by the Company's shareholders at the 1995 Annual Meeting. The accompanying financial statements report the financial condition and results of operations of the Wellman business as a discontinued operation and, accordingly, the results of operations of Wellman for all the periods presented are excluded from earnings\/loss from continuing operations. The gain on the disposal of the Wellman subsidiary is reported as a gain from the disposal of a discontinued business.\nThe discussion below addresses the operations and financial condition of the Registrant only.\nOPERATIONS: After the disposal of S.K. Wellman, the Registrant has no recurring revenues or operating subsidiaries. The general and administrative expenses of the Registrant are incurred for acquisition search, compensation, occupancy, shareholders costs (such as printing, distribution and stock transfer fees) and legal and professional matters. The sale of the Wellman business is not expected to materially alter the level of such expenses incurred by the Registrant.\nIn the short-term, the Company intends to invest the proceeds of the Wellman transaction in short-term repurchase instruments managed by selected commercial banks. At December 31, 1995 the Company's average rate of return on these investments was approximately 5.17%. As these investments account for all of the Company's income subsequent to the sale of Wellman, the Company's future financial results will be impacted by changes in the short-term interest rates available to the Company. Since the divestiture of S.K. Wellman, the Company has been actively engaged in pursuing the acquisition of new businesses where purchase valuations are attractive. No agreements have been entered into with respect to any acquisition opportunity.\nThe Company believes that it will not meet the definition of an investment company under the Investment Company Act of 1940 at least through June 30, 1996, which is the first anniversary of the sale of Wellman. However, the inability of the Company to control the timing of any acquisition of an operating business after such anniversary makes it possible that it will then be deemed to be an investment company. In such case, it would be required to register under and be subject to the various regulations contained under the Investment Company Act of 1940, which could add significant expenses to the operations of the Company and fundamentally alter the presentation of the Company's financial statements.\n1995 VERSUS 1994: On June 30, 1995 the Registrant completed the sale of the Wellman business. The proceeds of this transaction amounted to $60.0 million, which included certain amounts related to the repayment or assumption of debt and capital leases by the purchaser. After purchase price adjustments and expenses, the transaction resulted in a gain to MLX of $31.4 million. The gain was reduced by $3.3 million for estimated income taxes due and payable as well as by $10.0 million for a charge in lieu of federal income taxes which are not due or payable resulting in a net gain to the Company of $18.1 million. No such sale or gain occurred in 1994. General and administrative expenses in 1995 were approximately $1.0 million versus a 1994 level of approximately $800,000, an increase of 23%. Principal components of this increase were higher expenses associated with employee compensation, insurance charges, shareholder costs and legal and professional matters.\nInterest income in 1995 amounted to $1.1 million compared to a nominal amount in 1994 as a result of the investment of the proceeds of the Wellman transaction. Correspondingly, interest expense of the Company dropped from $200,000 in 1994 to $100,000 in 1995 since the debt obligations of MLX were repaid following the divestiture of the Wellman business.\nA portion of the proceeds of the Wellman transaction was used to repay the Registrant's Zero Coupon Bonds and Variable Rate Subordinated Notes. These repayments resulted in a pre-tax extraordinary gain on the early retirement of debt of $412,000. No such gain occurred in 1994.\nDividends and accretion on the Registrant's Series A Preferred Stock amounted to $700,000 in 1995 versus $1.1 million in 1994. This decrease resulted from the redemption of such Preferred Stock at the time of the Wellman transaction.\nIn 1995, the Company had net earnings of $20.8 million (or $7.53 per share net of obligations on the Series A Preferred Stock) compared to $2.7 million in 1994 (or $0.65 per share). In 1995, the gain on disposal of Wellman amounted to $6.76 per share and the extraordinary gain amounted to $0.10 per share.\n1994 VERSUS 1993: General and administrative expenses amounted to $800,000 in 1994 compared to $1.3 million in 1993. This decrease resulted from lower expenses for incentive compensation, shareholder costs (principally distribution and printing) and legal and professional matters. A one-for-ten reverse stock split executed on June 25, 1993 served to reduce the administrative charges for printing and distribution of shareholder communication material.\nInterest expense at MLX dropped by $164,000 year over year due to the repayments of the minority interest purchase note in February and December 1993.\nIncluded in the results for 1993 is an extraordinary gain from early retirement of debt resulting from an exchange of Series A Preferred Stock for certain debt obligations described in Note 3 to the financial statements. No such exchange or gain occurred in 1994.\nDividends and accretion applicable to Series A Preferred Stock increased to $1.1 million in 1994 versus $900,000 in 1993 due to increases in the prime rate component in the dividend rate structure.\nIn 1994, the Company had net earnings of $2.7 million (or $0.65 per share net of obligations on the Series A Preferred Stock) compared to earnings before extraordinary item in 1993 of $2.0 million (or $0.45 per share net of obligations on the Series A Preferred Stock). The extraordinary gain in 1993 amounted to $1.38 per common share.\n[BOXED COPY] The Company is able to offset substantially all of its federal taxable income with its pre- reorganization tax loss carryforwards and therefore has a federal tax liability only for Alternative Minimum Tax amounts. Accordingly, the charge in lieu of federal income taxes included in the statements of income is not accruable or payable. These pro forma charges in 1995, 1994 and 1993 were $11.3 million, $1.3 million and $3.1 million, respectively. The following table illustrates the effect of this pro forma charge on the Company's earnings and earnings per share.\n1995 1994 1993 (in thousands, except per share data) Net earnings $20,810 $2,747 $5,666 Less dividends and accretion on preferred stock (652) (1,058) (873) Plus pro forma federal tax charge not due or payable 11,325 1,314 3,112 Total earnings $31,483 $3,003 $7,905 Total earnings per common share $ 11.76 $ 1.15 $ 3.02 [END BOX COPY]\nFINANCIAL POSITION AND LIQUIDITY\nConsolidated working capital at December 31, 1995 was $36.4 million compared to a nominal amount at the end of 1994. Working capital at December 31, 1995 consisted principally of cash and short-term investments of $32.9 million and estimated short-term obligations of $700,000 for income taxes, transaction expenses and compensation. This increase resulted from the receipt of the proceeds from the Wellman divestiture.\nThe Company invests its available funds in short-term repurchase agreements managed by five selected commercial banks and collateralized by U.S. Treasury and federal agency obligations. The Company has issued instructions to each such bank providing guidelines on investments and restrictions on any disbursement of the Registrant's funds.\nIn connection with the sale of Wellman, the Company funded an escrow fund with a cash payment of $4 million to partially collateralize the indemnification obligations of the Registrant in the purchase and sale agreement. The Company's maximum liability under such indemnity provisions is $5 million and any amount remaining in the escrow fund after September 30, 1996, net of allowed and asserted claims, will be disbursed to MLX. An additional escrow fund amounting to $1,250,000 was established at June 30, 1995 (adjusted to $1,347,000 in August 1995) relating to certain estimated income tax obligations arising from the sale.\nThe Registrant's Zero Coupon Bonds were originally issued in 1990 and amended in 1992. The proceeds of the Wellman transaction were used to repay all outstanding obligations under these Bonds.\nThe 1993 Variable Rate Subordinated Notes were issued in April 1993 in exchange for certain of the Zero Coupon Bonds. All obligations under such Notes were repaid with proceeds from the Wellman divestiture.\nThe Series A Preferred Stock was issued as of December 31, 1992 and April 22, 1993 and included an escalating dividend rate feature and provision for redemption solely at the option of the Registrant. In connection with the Wellman transaction, all such Preferred Stock was redeemed.\nOTHER DATA\nCAPITAL EXPENDITURES: There were no material commitments for capital expenditures outstanding at December 31, 1995.\nEMPLOYEES: Subsequent to the sale of S.K. Wellman, and as of December 31, 1995, the Registrant's business is conducted by two full-time and four part-time employees. The services of the part-time employees are obtained through a facilities and service sharing arrangement with Pameco Corp. At December 31, 1994 the Company had 559 employees including 247 which were covered by collective bargaining agreements.\nMARKET, SHARE OWNERSHIP AND DIVIDEND INFORMATION: As of December 31, 1995 (and commencing on April 28, 1994) the Company's common shares were traded on the NASDAQ National Market under the trading symbol \"MLXR\". From August 30, 1993 until April 28, 1994, the Company's shares were traded on the NASDAQ Small Cap Market. From January 26, 1993 until August 30, 1993, the Company's shares were traded on the Domestic OTC Electronic Bulletin Board regulated by NASD.\nThe Company was advised by NASDAQ on February 5, 1996 that it failed to comply with Section 3(a)3 of Schedule D of the NASD By-Laws by not having an operating business activity. A temporary exception was granted on that date permitting the Registrant's common shares to remain listed on the NASDAQ National Market until June 30, 1996. At that time if an additional exception is not granted or if compliance is not achieved, the Registrant's shares will be delisted and traded on the Domestic OTC Electronic Bulletin Board.\nAs of December 31, 1995 the Company estimated there were approximately 6,600 shareholders of record of its common stock. In addition, the Company believes that there are approximately 2,400 shareholders whose shares are registered in names of nominees.\nMLX's current policy is to retain earnings to finance future growth and acquisition opportunities and, accordingly, does not currently expect to pay any cash dividends on its common stock in the foreseeable future.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nReference is made to the consolidated financial statements of MLX Corp., consisting of the Report of Independent Auditors, the Consolidated Balance Sheets as of December 31, 1995 and 1994, the related Consolidated Statements of Income, Consolidated Statements of Cash Flows, and Consolidated Statements of Shareholders' Equity for each of the three years in the period ended December 31, 1995, together with the Notes to Consolidated Financial Statements. See Section F of this report, which information is incorporated into this Item 8 by reference.\nReference is made to the information set forth under \"Quarterly Data\" in Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations,\" elsewhere in this Form 10-K, which information is incorporated into 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.\nThe Registrant incorporates by reference herein information appearing under the caption \"Remuneration of Directors and Executive Officers\" contained in the Registrant's definitive Proxy Statement for the fiscal year ended December 31, 1995 in connection with the Registrant's 1996 Annual Meeting of Shareholders.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe Registrant incorporates by reference herein information appearing under the caption \"Remuneration of Directors and Executive Officers\" contained in the Registrant's definitive Proxy Statement for the fiscal year ended December 31, 1995 in connection with the Registrant's 1996 Annual Meeting of Shareholders.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe Registrant incorporates by reference herein information appearing under the caption \"Security Ownership of Certain Beneficial Owners and Management\" contained in the Registrant's definitive Proxy Statement for the fiscal year ended December 31, 1995 in connection with the Registrant's 1996 Annual Meeting of Shareholders.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe Registrant incorporates by reference herein information appearing under the caption \"Employment Agreements with Executive Officers,\" and \"Compensation Committee Interlocks and Related Transactions\" contained in the Registrant's definitive Proxy Statement for the fiscal year ended December 31, 1995 in connection with the Registrant's 1996 Annual Meeting of Shareholders. PART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(a) (1) Financial Statements The following consolidated financial statements of the Registrant are incorporated by reference in Item 8:\nReport of Independent Auditors\nConsolidated Balance Sheets at December 31, 1995 and 1994.\nConsolidated Statements of Income for the years ended December 31, 1995, 1994 and 1993.\nConsolidated Statements of Cash Flows for the years ended December 31, 1995, 1994 and 1993.\nConsolidated Statements of Shareholders' Equity for the years ended December 31, 1995, 1994 and 1993.\nNotes to Consolidated Financial Statements - December 31, 1995.\n(2) Schedules\nAll schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted.\n(3) Listing of Exhibits\nExhibit 3.1 & 4.1 -- Articles of Incorporation of the Registrant, as amended (incorporated herein by reference to Exhibit 3.1 to the Registrant's Report on Form 10-Q for the quarter ended June 30, 1993). Exhibit 3.2 & 4.2 -- By-Laws of the Registrant (incorporated herein by reference to Exhibit 3.2 to the Registrant's Report on Form 10-Q for the quarter ended June 30, 1993). Exhibit 4.3 & 9.1 -- Voting Trust Agreement dated December 11, (incorporated herein by reference to Exhibit 4.3 to the Registrant's Report on Form 10-K for the fiscal year ended December 31, 1991).\nExhibit 4.4 & 9.2 -- Amendment No. 1, dated October 26, 1987, to the Voting Trust Agreement dated December 11, 1984 (incorporated herein by reference to Exhibit 4.3 to the Registrant's Report on Form 10-K for the fiscal year ended December 31, 1991). Exhibit 4.5 & 9.3 -- Amendment No. 2, dated April 2, 1991, to the Voting Trust Agreement dated December 11, (incorporated herein by reference to Exhibit 4.3 to the Registrant's Report on Form 10-K for the fiscal year ended December 31, 1991). Exhibit 4.6 -- Restricted Transfer Trust Agreement dated October 10, 1986 (incorporated herein by reference to Exhibit 4.3 to the Registrant's Report on Form 10-K for the fiscal year ended December 31, 1991). Exhibit 4.7 -- Amendment No. 1, dated October 26, 1987, to the Restricted Transfer Trust Agreement dated October 10, 1986 (incorporated herein by reference to Exhibit 4.3 to the Registrant's Report on Form 10-K for the fiscal year ended December 31, 1991). Exhibit 4.8 -- Amendment No. 2 dated June 4, 1991 to the 1990 Restricted Transfer Trust Agreement dated October 10, 1986 (incorporated herein by reference to Exhibit 4.3 to the Registrant's Report on Form 10-K for the fiscal year ended December 31, 1991). Exhibit 4.9 -- MLX Exchange Agreement dated as of April 13, 1990, as amended and restated as of March 19, 1992, as amended and restated as of April 21, 1993, among the Registrant, the Lenders listed therein, and Morgan Guaranty Trust Company of New York, as Bond Agent. Exhibit 4.10 -- MLX Limited Guarantee, dated as of March 19, (incorporated herein by reference to Exhibit 2.17 to the Registrant's Current Report on Form 8-K, dated April 10, 1992). Exhibit 4.11 -- Management Services Agreement, dated as of March 19, 1992, between the Registrant and Pameco Holdings, Inc. (incorporated herein by reference to Exhibit 2.16 of the Registrant's Current Report on Form 8-K, dated April 10, 1992). Exhibit 4.12 -- Amendment to Management Services Agreement, dated as of November 30, 1992, between the Registrant and Pameco Holdings, Inc. (incorporated herein by reference to Exhibit 4.12 of Registrant's Report on Form 10-K for the year ended December 31, 1992). Exhibit 4.13 -- Nomination Agreement, dated as of December 15, 1992, among the Registrant and the Investors listed therein (incorporated herein by reference to Exhibit 4.13 of Registrant's Report on Form 10-K for the year ended December 31, 1992). Exhibit 4.14 -- Exchange Agreement, dated as of January 15, 1993, among MLX Corp. and the Investors listed therein (incorporated herein by reference to Exhibit 4.14 of Registrant's Report on Form 10-K for the year ended December 31, 1992). Exhibit 4.15 -- Loan and Security Agreement, dated as of January 15, 1993, between S.K. Wellman Limited, Inc. and Barclays Business Credit, Inc. (incorporated herein by reference to Exhibit 4.15 of Registrant's Report on Form 10-K for the year ended December 31, 1992). Exhibit 4.16 -- First Amendment to Loan and Security Agreement, dated as of February 19,1993, between S.K. Wellman Limited, Inc. and Barclays Business Credit, Inc. (incorporated herein by reference to Exhibit 4.16 of Registrant's Report on Form 10-K for the year ended December 31, 1992). Exhibit 4.17 -- Second Amendment to Loan and Security Agreement, dated as of March 15,1993, between S.K. Wellman Limited, Inc. and Barclays Business Credit, Inc. (incorporated herein by reference to Exhibit 4.17 of Registrant's Report on Form 10-k for the year ended December 31, 1992). Exhibit 4.18 - - Stock Pledge Agreement (S.K. Wellman S.p.A.), dated as of January 15, 1993, between The S.K. Wellman Corp. and Barclays Business Credit, Inc. (incorporated herein by reference to Exhibit 4.18 of Registrant's Report on Form 10-K for the year ended December 31, 1992). Exhibit 4.19 -- Stock Pledge Agreement (S.K. Wellman S.p.A.), dated as of January 15, 1993, between S.K. Wellman Limited, Inc. and Barclays Business Credit, Inc. (incorporated herein by reference to Exhibit 4.19 of Registrant's Report on Form 10-K for the year ended December 31, 1992). Exhibit 4.20 -- Stock Pledge Agreement (The S.K. Wellman Company of Canada Limited), dated as of January 15, 1993, between The S.K. Wellman Corp. and Barclays Business Credit, Inc. (incorporated herein by reference to Exhibit 4.20 of Registrant's Report on Form 10-K for the year ended December 31, 1992). Exhibit 4.21 -- Patent Collateral Assignment and Security Agreement, dated as of January 15, 1993, between The S.K. Wellman Corp. and Barclays Business Credit, Inc. (incorporated herein by reference to Exhibit 4.21 of Registrant's Report on Form 10-K for the year ended December 31, 1992). Exhibit 4.22 -- Trademark Security Agreement, dated as of January 15, 1993, between The S.K. Wellman Corp. and Barclays Business Credit, Inc. (incorporated herein by reference to Exhibit 4.22 of Registrant's Report on Form 10-K for the year ended December 31, 1992). Exhibit 4.23 -- Exchange Agreement, dated as of April 2, 1993, among MLX Corp. and the Bondholders Listed Herein. - -18-\nExhibit 4.24 -- First Consolidated Amendment to Loan and Security Agreement, dated as of November 16, 1994, between S.K. Wellman Limited, Inc. and Barclays Business Credit, Inc. (incorporated herein by reference to Exhibit 4.24 of Registrant's Report on Form 10-K for the year ended December 31, 1994.) Exhibit 10.1# -- Employment Agreement, dated February 10, 1991, between the Registrant and Brian R. Esher (incorporated herein by reference to Exhibit 10.1 to the Registrant's Report on Form 10-K for the fiscal year ended December 31, 1990). Exhibit 10.1a# -- First Amendment to Employment Agreement, dated as of March 19, 1992, between the Registrant and Brian Esher. Exhibit 10.1b# -- Second Amendment to Employment Agreement, dated as of January 1, 1994, between Registrant and Brian Esher. Exhibit 10.1c# -- Third Amendment to Employment Agreement, dated as of January 1, 1995, between the Registrant and Brian Esher. Exhibit 10.1d*# -- Fourth Amendment to Employment Agreement, dated as of January 1, 1996, between the Registrant and Brian Esher. Exhibit 10.3 -- Severance\/ Consulting Agreement, dated January 14, 1991, between the Registrant and William P. Panny (incorporated herein by reference to Exhibit 10.3 to the Registrant's Report on Form 10-K for the fiscal year ended December 31, 1990). Exhibit 10.4 -- Purchase Agreement, dated as of March 19, 1992,among the Registrant, Pameco Holdings, Inc., and Pameco Corporation (incorporated herein by reference to Exhibit 21 of Registrant's Current Report on Form 8-K dated April 10, 1992). Exhibit 10.5# -- MLX Corp. Stock Option Plan, dated as of December 29, (incorporated herein by reference to Exhibit 10.5 of Registrant's Report on Form 10-K for the year ended December 31, 1992). - -19-\nExhibit 10.6# -- Senior Management Discretionary Bonus Plan, dated as of January 21, (incorporated herein by reference to Exhibit 10.6 of Registrant's Report on Form 10-K for the year ended December 31, 1992). Exhibit 10.8# -- MLX 1995 Stock Option and Incentive Award Plan (incorporated herein by reference to Exhibit C of Registrant's definitive Proxy Statement for the fiscal year ended December 31, 1994 in connection with the Registrant's 1995 Annual Meeting of Shareholders). Exhibit 10.9 -- Wellman Sale Agreement (incorporated herein by reference to Exhibit B of Registrant's definitive Proxy Statement for the fiscal year ended December 31, 1994 in connection with the Registrant's 1995 Annual Meeting of Shareholders). Exhibit 23* -- Consent of Independent Auditors. Exhibit 27* -- Financial Data Schedule.\n- -----------\n*Filed with this Report on Form 10-K #Management compensatory plan or arrangement\n(b) Reports on Form 8-K\nNo reports on Form 8-K were filed by the Registrant during the quarter ended December 31, 1995. - -20-\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nMLX Corp.\nDated: March 13, 1996 By:\/S\/ THOMAS C. WAGGONER President & Chief Financial Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on March 13, 1996.\nSignature Title\n\/s\/ Brian R. Esher Chairman of the Board & Chief Executive Officer and Director (Principal Executive Officer)\n\/s\/ Thomas C. Waggoner President & Chief Financial Officer(Principal Financial and Accounting Officer)\n\/s\/ Willem F.P. de Vogel Director\n\/s\/ Alfred R. Glancy III Director\n\/s\/ S. Sterling McMillan, III Director\n\/s\/ J. William Uhrig Director\n\/s\/ W. John Roberts Director\n\/s\/ H. Whitney Wagner Director\n- -21-\nMLX CORP. ANNUAL REPORT ON FORM 10-K YEAR ENDED DECEMBER 31, 1995 ITEM 8 REPORT OF INDEPENDENT AUDITORS FINANCIAL STATEMENTS\nSECTION F - -22-\nREPORT OF INDEPENDENT AUDITORS\nBOARD OF DIRECTORS MLX CORP.\nWe have audited the accompanying consolidated balance sheets of MLX Corp. as of December 31, 1995 and 1994, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1995. 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 MLX Corp. at December 31, 1995 and 1994, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles.\nErnst & Young LLP\nMarch 7, 1996 Atlanta, Georgia - -F1-\nSee accompanying notes - -F2-\n- -F-3-\n- -F-4-\n- -F-5-\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nORGANIZATION AND BASIS OF PRESENTATION\nMLX Corp. (MLX or the Company) is a publicly traded company which has invested in operating subsidiaries in a variety of industries.\nDuring 1995 the Company sold its sole remaining operating subsidiary, S.K. Wellman Limited, Inc. (Wellman). Accordingly, the accompanying financial statements and notes have been restated to report the financial condition and operating results of Wellman as a discontinued operation.\nPRINCIPLES OF CONSOLIDATION\nThe financial statements include the accounts of MLX and, prior to their sale, its wholly owned subsidiaries. The wholly owned subsidiaries include S.K. Wellman Limited, Inc. and each of its wholly owned subsidiaries - comprising the Wellman business. Upon consolidation, all significant intercompany accounts and transactions were eliminated.\nUSE OF ESTIMATES\nThe preparation of the consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results may differ from those estimates.\nCASH EQUIVALENTS\nCash equivalents consist of investments in short-term asset management accounts with five banking institutions, none of which holds greater than $8 million of these assets. All investments are stated at cost plus accrued interest which approximates market value. At December 31, 1995 the Company's average rate of return on these investments was approximately 5.17%. As these investments account for all of the Company's income subsequent to the sale of Wellman, the Company's future financial results will be impacted by changes in the short-term interest rates available to the Company. For purposes of the accompanying Consolidated Statements of Cash Flows, the Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents.\nFEDERAL INCOME TAXES\nAny tax benefits resulting from the utilization of the Company's federal net operating loss or other carryforwards existing at December 11, 1984, the date of confirmation of the Plan of Reorganization (Confirmation Date), are excluded from operations and credited to capital in excess of par value in the year such tax benefits are realized. - -F-6-\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)\nSTOCK OPTIONS\nProceeds from the sale of stock under options are credited to common stock at par value and the excess of the option price over par value is credited to capital in excess of par value.\nThe Company grants stock options for a fixed number of shares to employees with an exercise price equal to the fair value of the shares at the date of grant. The Company accounts for stock option grants in accordance with APB Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, and intends to continue to do so.\nEARNINGS PER COMMON SHARE\nPrimary earnings per common share is based on the weighted average number of shares outstanding during each year and dilutive common stock equivalents. Earnings applicable to common stock is determined by adjusting net earnings for dividends and accretion on preferred stock.\nRELATIONSHIP WITH PAMECO CORPORATION\nMLX has an arrangement with Pameco Corporation (Pameco) pursuant to which MLX shares certain management, operational and administrative functions. The costs for such services are also shared. MLX paid $60,000 to Pameco Corporation under this agreement in 1995 and in 1994. MLX received $81,500 (net of amounts paid) in 1993. Such amounts are included as a component of general and administrative expenses in the accompanying Consolidated Statements of Income.\n2. SALE OF S.K. WELLMAN SUBSIDIARY\nOn April 10, 1995 the Company entered into a stock purchase agreement (the Agreement) with a third party for the sale of all the common stock of Wellman for $60 million, which includes certain amounts related to the repayment or assumption of debt and capital leases by the purchaser. Such sale was approved by the common shareholders of MLX Corp. at the 1995 annual meeting of shareholders and was completed on June 30, 1995. The cash proceeds received by the Company pursuant to the transaction, less purchase price adjustments and estimated expenses, amounted to $48.9 million.\nIn connection with the sale of the Wellman subsidiary, the Company repaid its principal and interest obligations under the Variable Rate Subordinated Notes and Zero Coupon Bonds and redeemed its Series A Preferred Stock along with unpaid dividends. The net proceeds to the Company from the transaction after such repayments were $38.5 million.\nA portion of these proceeds was used by the Company to fund an escrow account of $4 million to partially collateralize its indemnification obligations in the purchase and sale agreement. This escrow fund is expected to exist for a period of 15 months from the date of the sale and accordingly has been classified as a current asset at December 31, 1995. The Company's maximum liability under the indemnification provisions in the Agreement is $5 million. An additional escrow - -F-7-\n2. SALE OF S.K. WELLMAN SUBSIDIARY (CONTINUED)\nfund amounting to $1,250,000 was established at June 30, 1995 (and adjusted to $1,347,000 in August 1995) relating to certain estimated income tax obligations arising from the sale. This escrow fund has been classified as long-term in the Consolidated Balance Sheet. Other Long-Term Liabilities include taxes related to this escrow fund which are estimated to be payable after one year.\nThe transaction resulted in a gain of $31.4 million. Income taxes were provided for this gain as follows (in thousands):\nFederal and state income taxes due and payable $ 3,291 Pro-forma charge in lieu of federal income taxes 10,020 -------- $13,311\nThe accompanying consolidated financial statements reflect the operating results, balance sheet and cash flows of the discontinued operations separately from continuing operations for all years presented.\nThe operating results of the discontinued operations were as follows (the 1995 results include operations through the date of the sale):\nNet assets of the discontinued operations at December 31, 1994 were as follows:\nCash and cash equivalents.................. $ 447 Accounts receivable........................ 9,638 Inventories................................ 9,681 Prepaid expenses and other current assets.. 958 Property, plant and equipment, net......... 13,361 Intangible assets, net..................... 2,288 Other assets............................... 509 Accounts payable and accrued expenses...... (9,464) Debt and capital leases.................... (11,807) Other accrued liabilities.................. (2,379) --------- $ 13,232\n- -F-8-\n2. SALE OF S.K. WELLMAN SUBSIDIARY (CONTINUED)\nThe following table provides supplemental information pertaining to the discontinued operations in the Consolidated Statements of Cash Flows (the 1995 cash flows include operations through the date of the sale):\n3. GAIN ON EARLY RETIREMENT OF DEBT\nIn connection with the sale of Wellman (see Note 2), the Company retired Zero Coupon Bonds and Variable Rate Subordinated Notes with a carrying value of $2.5 million with cash payments totaling $2.1 million. The resulting net gain on early retirement of debt (net of a pro-forma charge in lieu of federal income taxes of $140,000) has been reported as an extraordinary item.\nAlso on June 30, 1995, the Company redeemed all its outstanding shares of Series A Preferred Stock for cash payments totaling $7.9 million, the contractual redemption value. The difference between this redemption amount and the carrying value of $7.4 million was charged to Capital in Excess of Par Value. - -F-9-\n3. GAIN ON EARLY RETIREMENT OF DEBT (CONTINUED)\nDuring the quarter ended June 30, 1993, the Company exchanged shares of its Series A Preferred Stock (see Note 5) with an approximate fair value of $1.6 million (face value of $1.9 million) and 1993 Variable Rate Subordinated Notes with an approximate fair value of $1.4 million for Zero Coupon Bonds with a carrying value of $8.5 million. The resulting net gain on early retirement of debt of $3.6 million was reported in the quarter ended June 30, 1993 as an extraordinary item.\n4. LONG-TERM DEBT\nThe components of long-term debt are as follows (in thousands):\n1995 1994 ---- ------ Zero coupon bonds net of unamortized discount of $130 in 1994. . . . . . . . . . . . . . $ -- $1,022 Variable rate subordinated notes. . . . . . . -- 1,441\n$ -- $2,463\nAt December 31, 1994, the Company had outstanding Zero Coupon Bonds with a maturity date of March 2002. Such bonds were redeemed during 1995 in connection with the sale of Wellman.\nIn April 1993 MLX issued variable rate subordinated notes to certain holders of its Zero Coupon Bonds. The notes were initially recorded at their estimated fair value and were being increased to the redemption value of $1,444,000 during the period from date of issuance until March 19, 2002 (date of maturity). The notes were due in 2002 or, on a pro rata basis, whenever shares of the Series A preferred stock are repurchased. All such notes were redeemed during 1995 in connection with the sale of Wellman.\nInterest paid was $127,000 in 1995, $197,000 in 1994, and $122,000 in 1993.\n5. SHAREHOLDERS' EQUITY AND STOCK OPTIONS\nThe assets and liabilities of foreign operations of the discontinued operations were translated into U.S. dollars at current exchange rates with the resulting cumulative translation adjustment, $(1,018,000) at December 31, 1994 and $(1,127,000) at December 31, 1993, recorded as a separate component of shareholders' equity. In connection with the sale of Wellman, the cumulative translation adjustment at June 30, 1995 was included in the calculation of the gain on the sale.\nThe Company has two stock option plans. Under the MLX Corp. Stock Option Plan, adopted in 1985, the Company granted stock options to certain officers, directors and key employees at prices not less than the market value on the date the option was granted. At December 31, 1995 30,200 options were outstanding under this Plan (excluding 190,400 options issued to the Company's Chief Executive Officer - see below) with exercise periods extending through December 1999. No new options may be granted under this Plan. - -F-10-\n5. SHAREHOLDERS' EQUITY AND STOCK OPTIONS (CONTINUED)\nUnder the MLX Corp. Stock Option and Incentive Award Plan (the \"1995 Plan\"), adopted in 1995, stock-based awards may be issued to key employees (including directors who are also employees) and certain others in a variety of forms. Such awards may include incentive stock options, non-qualified stock options, restricted stock and outright stock awards. A total of 125,000 shares of MLX common stock are reserved under the 1995 Plan and no option granted under the 1995 Plan can have an exercise date greater than ten years from the date of the grant. The 1995 Plan terminates in June 2005.\nA summary of transactions under both plans is as follows:\nOn February 11, 1991, MLX issued options to its Chief Executive Officer (CEO) to acquire 190,400 shares of the Company's common stock at $5.00 per share (the market value at date of grant), which are not reflected in the table above. At December 31, 1995, all such options are exercisable and will expire in February 1998. The options contain a clause that in the event that any new or existing shareholders increase their percentage ownership interest of the Company's common stock by 5% or more, the options are immediately converted to Stock Appreciation Rights (SAR). The options also provide for anti-dilution adjustments in certain events, including a stock dividend, merger, consolidation or other recapitalization.\nThe Company is authorized to issue up to 500,000 shares designated as Series A Preferred Stock with a par value and liquidation preference of $30 per share. The Series A Preferred Stock is non-voting. Dividends on shares of Series A Preferred Stock outstanding during 1995, 1994 and 1993 were payable in cash on the basis of an increasing rate formula (12.5% at June 30, 1995 and 11% at December 31, 1994). All outstanding shares of Series A Preferred Stock were redeemed by the Company with the proceeds from the sale of Wellman. - -F-11-\n5. SHAREHOLDERS' EQUITY AND STOCK OPTIONS (CONTINUED)\nAn aggregate of 264,000 shares of Series A Preferred Stock was issued to certain holders of Zero Coupon Bonds as of December 1992 and April 1993. The Series A Preferred Stock was initially recorded at its estimated fair value and was being increased to the redemption price of $30 per share during the period from date of issuance until January 1, 1999 (commencement of maximum annual dividend rate). This annual accretion, based on the interest method, was charged to retained earnings and amounted to $117,000 in 1995, $284,000 in 1994 and $235,000 in 1993.\n6. INCOME TAXES\nThe Company accounts for income taxes in accordance with the liability method as required by FASB Statement No. 109, \"Accounting for Income Taxes.\"\nAt December 31, 1995, MLX has net operating loss carryforwards, existing as of the Confirmation Date, of approximately $240 million which are available to offset future taxable income for federal income tax purposes. Such carryforwards expire as of December 31 in each of the years as follows: $20.6 million in 1996, $144.3 million in 1997, $1.2 million in 1998 and $73.8 million in 1999. Any tax benefit derived from the utilization of these net operating loss carryforwards is excluded from operations and credited to capital in excess of par value in the year such tax benefits are utilized.\nSubsequent to the Confirmation Date, the Company has available (for federal income tax purposes), net operating loss carryforwards of approximately $59.2 million, which expire as of December 31 in each of the years as follows: $2.7 million in 2000, $2.2 million in 2002, $5.0 million in 2005, $2.0 million in 2006 and $47.3 million in 2007.\nThe cumulative net operating loss for financial reporting purposes approximates the tax amount as shown above. The components of the income tax provision are as follows (in thousands):\nIncome tax expense associated with discontinued operations is set forth in Note 2. - -F-12-\n6. INCOME TAXES (CONTINUED)\nThe charge in lieu of federal income taxes (federal income tax benefit) approximates the statutory rate applied to earnings before income taxes.\nDeferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax assets are as follows (in thousands):\n1995 1994\nFederal net operating loss carryforward...... $102,000 $114,000 State net operating loss carryforward........ 3,000 3,000 Reserves and other........................... 1,000 1,000 Total.................................... 106,000 118,000 Valuation allowance for deferred tax assets.. (106,000) (118,000) Net deferred tax assets...................... $ -- $ --\nThe valuation allowance for deferred tax assets decreased $2 million during 1994. - -F-13-\n[IBC}Corporate Data\nExecutive Office Legal Counsel 1000 Center Place Kilpatrick & Cody Norcross, Georgia 30093 Atlanta, Georgia\nIndependent Auditors Stock Transfer Agent & Registrar Ernst & Young LLP American Stock Transfer & Trust Atlanta, Georgia Company New York, New York\nMLX Corp. common stock is traded on the NASDAQ National Market under the symbol \"MLXR\".\nFor more information about the Company contact the Investors Relations Department at (770) 798-0677 or write to MLX Corp., 1000 Center Place, Norcross, Georgia 30093.\nThe annual meeting of shareholders of MLX Corp. will be held on May 1, 1996 at 11:00 a.m. at the offices of Kilpatrick & Cody, 1100 Peachtree Street, Suite 2700, Atlanta, Georgia.\n[recycle logo] Printed on Recycled paper\nDesigned and produced by Phoenix Communications, Inc. \/ Atlanta, Georgia\n[BC] MLX LOGO MLX Corp. Headquarters 1000 Center Place Norcross, Georgia 30093 (770) 798-0677 FAX (770) 798-0633","section_15":""}
{"filename":"731012_1995.txt","cik":"731012","year":"1995","section_1":"Item 1. Business\n(a) General\nHealthcare Services Group, Inc. (the \"Company\") provides housekeeping, laundry and linen services to long-term care facilities, including nursing homes and retirement complexes. The Company believes that it is the largest provider of contractual housekeeping and laundry services to the long-term care industry in the United States, rendering such services to in excess of 800 facilities in 41 states and Canada.\n(b) Not Applicable\n(c) Description of Services\nThe Company provides management, administrative and operating expertise and services to the housekeeping, laundry and linen departments of a single industry segment (long-term care). The Company's labor force is also interchangeable with respect to each of these services. The Company believes that each service it performs offers similar opportunity for growth. Accordingly, the Company does not deem it meaningful to identify the percentage of revenues derived from the several services which it performs.\nHousekeeping and laundry services. Housekeeping and laundry services is the largest service sector of the Company. It involves cleaning, disinfecting and sanitizing resident areas in the facilities as well as laundering and processing the residents' personal clothing. In providing services to any given client facility, the Company typically hires and trains the hourly employees who were employed by such facility prior to the engagement of the Company. The Company normally assigns two on-site managers to each facility to supervise and train hourly housekeeping and laundry personnel and to coordinate housekeeping and laundry with other facility support functions. Such management also oversees the execution of a variety of quality and cost-control procedures, including continuous training and employee evaluation as well as on-site testing for infection control. The on-site management team also assists the facility in complying with Federal, state and local regulations.\nLinen services. Linen services is the other significant service sector of the Company. It involves providing and laundering the sheets, pillow cases, blankets, towels, uniforms and assorted linen items used by the facilities. At most of the facilities that utilize the Company's linen services, the equipment is acquired and installed by the Company. On many occasions the Company purchases the existing laundry installations from nursing homes with which it concurrently enters into service agreements to provide laundry and linen services. Each such installation generally requires initial capital outlays by the Company of from $50,000 to $250,000 depending on the size of the facility and the amount of equipment required. The Company could incur relocation or other costs in the event of the cancellation of a linen agreement where there was a corresponding laundry installation. From January 1, 1989 through December 31, 1995, the Company's services were cancelled by forty-one facilities with respect to which the Company had previously invested in a laundry installation.\nDuring each year, except for certain agreements cancelled in 1995 and 1993, the laundry installations were sold to the Company's clients for an amount in excess of the net amount recorded on the Company's balance sheets. The laundry installations relating to agreements cancelled in 1995 and 1993 resulted in the Company receiving approximately $15,000 and $17,000, respectively, less than the net amount at which these assets have been recorded on its balance sheet. Linen supplies are, in most instances also owned by the Company, and the Company maintains a sufficient inventory of these items in order to ensure their availability. The Company provides linen services to approximately 46% of the facilities to which it provides housekeeping and laundry services.\nFacility maintenance, materials acquisition and consulting services. Facility maintenance services consist of the repair and maintenance of laundry equipment, plumbing and electrical systems, as well as carpentry and painting. In many instances, materials, equipment and supplies utilized by the Company in the performance of maintenance services, as well as housekeeping, laundry and linen services, are provided by the Company through its Huntingdon Supply division. The Company also provides consulting services to facilities to assist them in updating their housekeeping, laundry and linen operations.\nLaundry installation sales. The Company (as distributor of laundry equipment) sells laundry installations to its clients which generally represent the construction and installation of a turn-key operation. With regard to laundry installation sales, the Company generally offers payment terms, ranging from 36 to 60 months. In 1995, two facilities that purchased laundry installations from the Company canceled the Company's services. The Company received approximately $18,000 less than the net amount recorded on its balance sheet as of the dates of such cancellations. In 1993, one facility that purchased a laundry installation from the Company cancelled the Company's services. The Company received approximately $9,000 less than the net amount recorded on its balance sheet as of the date of cancellation. During 1992, five facilities that had purchased laundry installations from the Company cancelled the Company's services. In the aggregate, the Company received approximately $10,000 less than the net amount recorded on its balance sheet as of the date of the latest of such cancellations. Although the Company has incurred only minor losses related to amounts not collected as result of these laundry installation sales, there can be no assurance that any such losses will not occur in the future. Although the Company has sold laundry installations since 1981, they were not significant to the Company's operations prior to 1991 (see Note 1 of Notes to Financial Statements). During the years 1993 through 1995, laundry installation sales were not material as the Company prefers to own such laundry installations in connection with performance of its service agreements.\nOperational-Management Structure\nBy applying its professional management techniques, the Company is able to contain certain housekeeping and laundry costs on a continuing basis. The Company provides its services through a network of management personnel, as illustrated below.\n----------------------------------------------------- Vice President - Operations -----------------------------------------------------\n-------------------------------------------------- Divisional Vice President (4 Divisions) --------------------------------------------------\n------------------------------------------------- Regional Vice President\/Manager (15 Regions) -------------------------------------------------\n---------------------------------- District Manager (83 Districts) ----------------------------------\n---------------------------------- Training Manager ----------------------------------\n------------------------------------- Facility Manager and Assistant Facility Manager -------------------------------------\nEach facility is managed by an on-site Facility Manager, an Assistant Facility Manager, and, if necessary, additional supervisory personnel. Districts, typically consisting of from eight to twelve facilities, are supported by a District Manager and a Training Manager. District Managers bear overall responsibility for the facilities within their districts. They are generally based within close proximity to each facility. These managers provide active support to clients in addition to the support provided by the Company's on-site management. Training Managers are responsible for the recruitment, training and development of Facility Managers. At December 31, 1995, the Company maintained fifteen regions within four divisions. A division consists of two to six regions within a specific geographical area. A Divisional Vice President manages each division. Additionally, each division has a Divisional Vice President-Sales who supports the Divisional Vice President by managing the marketing efforts of the divisions's Regional Sales Managers. Regions are geographically structured to include three to eight districts and are each headed by a Regional Vice President\/Manager and a Regional Sales Director who assumes primary responsibility for marketing the Company's services. Regional managers report to Divisional Vice Presidents who in turn report to the Vice President of Operations. The Company believes that its regional and district organizational structure facilitates its expansion into new geographic areas.\nMarket and Services\nThe market for the Company's services consists of a large number of facilities involved in various aspects of the long-term care field, including nursing homes, retirement complexes and rehabilitation centers. Such facilities may be specialized or general, privately owned or public, profit or not-for-profit and may serve patients on a long-term or short-term basis. The market for the Company's services is expected to continue to grow as the elderly increase as a percentage of the United States population and as government reimbursement policies require increased cost control or containment by long-term care facilities.\nAccording to estimates of the Department of Health and Human Services, the long-term care market in the United States consists of approximately 23,000 facilities, which range in size from small private facilities with 65 beds to facilities with over 500 beds. The Company markets its services primarily to facilities with 100 or more beds. The Company believes that less than five percent of long-term facilities currently use outside providers of housekeeping and laundry services such as the Company.\nMarketing and Sales\nThe Company's services are marketed at four levels of the Company's organization: at the corporate level by the Chief Executive Officer, President and the Vice President of Operations; at the divisional level by Divisional Vice Presidents and Divisional Sales Directors; at the regional level by the Regional Vice Presidents\/Managers; and at the district level by District Managers. The Company provides incentive compensation to its operational personnel based on achieving budgeted earnings and to its Divisional Sales Directors and Regional Sales Directors based on new business revenues.\nThe Company's services are marketed primarily through referrals and in-person solicitation of target facilities. The Company also utilizes direct mail campaigns and participates in industry trade shows, healthcare trade associations and healthcare support service seminars that are offered in conjunction with state or local health authorities in most of the states in which the Company conducts its business. The Company's programs have been approved for continuing education credits by state nursing home licensing boards in certain states, and are typically attended by facility owners, administrators and supervisory personnel, thus presenting a marketing opportunity for the Company. Indications of interest in the Company's services arising from initial marketing efforts are followed up with a presentation regarding the Company's services and survey of the service requirements of the facility. Thereafter, a formal proposal, including operational recommendations and recommendations for proposed savings, is submitted to the prospective client. Once the prospective client accepts the proposal and signs the service agreement, the Company can set up its operations on-site within days.\nService Agreements\nThe Company offers two kinds of service agreements, a full service agreement or a management agreement. In a full service agreement, the Company assumes both management and payroll responsibility for the hourly housekeeping and laundry employees.\nThe Company typically adopts and follows the client's employee wage structure, including its policy of wage rate increases, and passes through to the client any labor cost increases associated with wage rate adjustments. Some full service agreements also include linen services. Under a management agreement, the Company provides management and supervisory services while the client facility retains payroll responsibility for its hourly employees. Substantially all of the Company's agreements are full service agreements. These agreements typically provide for a one year term, cancelable by either party upon 30 days' notice after the initial 90-day period. As of December 31, 1995, the Company had approximately 2,075 service agreements with in excess of 800 client facilities.\nAlthough the service agreements are cancelable on short notice, the Company has historically had a very favorable client retention rate and expects to be able to continue to maintain a good relationship with its clients. The risks associated with short-term service agreements have not affected either the Company's linen services, which generally require a capital investment or laundry installation sales, which require the Company to finance the sales price. Such risks are often mitigated by certain provisions set forth in the agreements which are entered into by the Company. Many of the linen service agreements, where the Company has first purchased the laundry installation from its clients, require that in the event the Company's services are terminated, the client becomes obligated to purchase the laundry installation from the Company at a price no less then the value recorded on the Company's financial statements at the time of termination. The laundry installation sales agreements obligate the purchaser to pay for such installation upon terms independent of the services rendered by the Company.\nThe Company encounters difficulty in collecting amounts due from certain of its clients, including those in bankruptcy, those who have terminated service agreements and slow payers experiencing financial difficulties. In order to provide for these collection problems and the general risk associated with the granting of credit terms, the Company has increased its bad debt provisions (Allowance for Doubtful Accounts) by $1,672,594, $1,423,338 and $567,754 in 1995, 1994 and 1993, respectively. In making its evaluation, in addition to analyzing and anticipating, where possible, the specific cases described above, management considers the general collection risk associated with trends in the long-term care industry.\nCompetition\nThe Company competes primarily with the in-house support service departments of its potential clients. Most healthcare facilities perform their own support service functions without relying upon outside management firms such as the Company. In addition, a number of local firms compete with the Company in the regional markets in which the Company conducts business. Several national service firms are larger and have greater financial and marketing resources than the Company, although historically, such firms have concentrated their\nmarketing efforts on hospitals rather than the long-term care facilities typically serviced by the Company. Although the competition to service long-term care facilities is strong, the Company believes that it competes effectively for new agreements, as well as renewals of existing agreements based upon the quality and dependability of its services and the cost savings it can effect for the client.\nEmployees\nAt December 31, 1995, the Company employed 1,614 management and supervisory personnel. Of these employees, 168 held executive, management and office support positions, and 1,446 of these salaried employees were on-site management personnel. On such date, the Company employed approximately 10,911 hourly employees. Many of the Company's hourly employees are previous support employees of the Company's clients. In addition, the Company manages hourly employees who remain employed by certain of its clients.\nApproximately 11% of the Company's hourly employees are unionized. These employees are subject to collective bargaining agreements that are negotiated by individual client facilities and are assented to by the Company so as to bind the Company as an \"employer\" under the contract. The Company may be adversely affected by relations between its client facilities and the employee unions. The Company is a party to a negotiated collective bargaining agreement with respect to approximately 20 employees at three facilities located in New York. The Company believes its employee relations are satisfactory.\n(d) Financial Information About Foreign and Domestic Operations and Export Sales\nNot Applicable.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company leases its corporate offices, located at 2643 Huntingdon Pike, Huntingdon Valley, Pennsylvania 19006, which consists of 6,600 square feet. The term of the lease expires on March 31, 2001. The Company also leases office space at other locations in Pennsylvania, Massachusetts, Florida, Illinois, California, Colorado, Georgia, Missouri and Texas. These locations serve as divisional or regional offices. In addition, the Company leases warehouse space in Pennsylvania, Illinois and Florida for the Huntingdon Supply division. Each office consists of approximately 1,000 square feet, and each warehouse consists of approximately 5,000 square feet. None of these leases is for more than a five-year term.\nThe Company is provided with office and storage space at each of its client facilities. Management does not foresee any difficulties with regard to the continued utilization of such premises.\nThe Company presently owns laundry equipment, office furniture and equipment, housekeeping equipment and automobiles and trucks. Management believes that all of such equipment is sufficient for the conduct of the Company's current operations.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe Securities and Exchange Commission (SEC) has been conducting a non-public investigation since 1990 with respect to certain matters, including the Company's financial statements, financial condition and results of operations. The Company has cooperated fully with such inquiry on a voluntary basis. On March 21, 1996, the Staff of the SEC informed the Company that the SEC had accepted a settlement which had been offered by the Company and recommended by the Staff, pertaining to certain allegations of violations of the Federal securities laws by the Company and certain of its officers with respect to periods ended on or before March 31, 1992. The settlement is subject to mutual agreement on the final form of the Complaint and Consent to be filed in the United States District Court. Under the settlement, upon the filing of the complaint and the entry of a final judgment upon consent, and without admitting or denying any of the allegations of the complaint, the Company, two officers and a former officer, will be permanently enjoined from violating certain provisions of the Federal securities laws, and the Company and these individuals will be required to pay civil penalties aggregating approximately $825,000. Upon entry of a final judgement, the Company will file a Report with the SEC containing the final Judgement, the Consent and the SEC Complaint. The estimated monetary impact of this settlement plus related legal costs have been reflected in the accompanying financial statements (see Note 10 of Notes to Financial Statements).\nIn addition, the United States Attorney for the Eastern District of Pennsylvania is investigating matters relating to certain payments (approximately $84,000 in 1988, $54,000 in 1989, $110,000 in 1990, $125,000 in 1991 and $34,000 in 1992) made by the Company between June 1988 and January 1992 to certain vendors that were not in accordance with Company policy. This matter was previously investigated and reported upon by the Company in its Form 10-K for the year ended December 31, 1991. Information regarding this matter was voluntarily furnished to the U.S. Attorney's office in New Jersey in May and November 1992 and such payments were recovered by the Company in November 1992. The Company is cooperating with the U.S. Attorney's office in an attempt to resolve any issues or claims arising out of these payments.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNot applicable.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Stock and Related Security Holder Matters\n(a) Market Information\nThe Company's common stock, $.01 par value (the \"Common Stock\") is traded on the NASDAQ National Market System. On December 31, 1995, there were 8,143,063 shares of Common Stock outstanding.\nPrice quotations during the two years ended December 31, 1995, ranged as follows:\n1995 High 1995 Low ---------- -------- 1st Qtr. 15 5\/8 10 3\/4 2nd Qtr. 12 1\/4 10 1\/4 3rd Qtr. 12 1\/8 10 3\/16 4th Qtr. 10 3\/8 8 1\/4\n1994 High 1994 Low --------- -------- 1st Qtr. 11 3\/4 9 1\/8 2nd Qtr. 13 3\/8 9 7\/16 3rd Qtr. 12 3\/4 11 1\/8 4th Qtr. 13 1\/2 11 1\/4\n(b) Holders\nAs of March 22, 1996, there were approximately 460 holders of record of the common stock, including stock held in nominee name by brokers or other nominees. It is estimated that there are approximately 3,200 beneficial holders.\n(c) Dividends\nThe Company has not paid any dividends on its Common Stock during the last two years. Currently, it intends to continue this policy of retaining all of its earnings, if any, to finance the development and expansion of its business.\nSELECTED FINANCIAL DATA\nThe selected financial data presented below should be read in conjunction with, and is qualified in its entirety by reference to, the Financial Statements and Notes thereto.\nSee Notes 2, 9 and 10 of Notes to Financial Statements regarding uncertainties with respect to litigation and other contingencies.\n(1) Adjusted to reflect the 3 for 2 Stock Split paid in the form of a 50% Stock Dividend on November 15, 1991.\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe following discussion and analysis should be read in conjunction with the financial statements and notes thereto.\nRESULTS OF OPERATIONS\nFrom 1991 through 1995, the Company's revenues grew at a compound annual rate of 12%. This growth was achieved through obtaining new clients in both existing and newly developed market areas, as well as providing additional services to existing clients. Although there can be no assurance thereof, the Company anticipates future growth, although its compound growth rates will likely decrease as growth is measured against the Company's increasing revenue base.\nThe following table sets forth for the years indicated the percentage which certain items bear to revenues:\n1995 COMPARED WITH 1994\nRevenues increased 9% to $148,746,773 in 1995 from $136,414,172 in 1994. The following factors contributed to the increase in revenues: service agreements with new clients in existing geographic areas increased revenues 19.3%; geographic expansion increased revenues 2.7%; and cancellations and other minor changes decreased revenues 13.0%.\nCosts of services provided as a percentage of revenues increased to 85.6% in 1995 from 84.4% in 1994. The primary factors affecting the\nvariations and their impact on the 1.2% change in cost of services provided as a percentage of revenue are as follows: increase in labor costs of 1.1%; increase of .7% in amortization of service agreements and costs associated with service agreements cancelled (See Note 1 -- Intangible Assets of Notes to Financial Statements); offsetting these increases were decreases of .4% and .3% in regional and district costs and depreciation expense, respectively.\nSelling, general and administrative expenses as a percentage of revenue increased slightly to 8.2% in 1995 from 8.1% in 1994 primarily as a result of additional costs associated with expanding the divisional and regional staffs in order to better position the Company to achieve its performance objectives in the future.\nRECOVERY FROM COLLECTING $300,000 OF PROMISSORY NOTES SOLD THAT WAS RESERVED FOR IN 1991\nA client paid; $150,000 in the first quarter of 1995, $50,000 in the second quarter of 1995, and $100,000 in the third quarter of 1995 (or an aggregate of $300,000). These payments represent the pay-off of the remaining balance on a note. As a result, the Company recorded the recovery as income in its Statements of Income for the year ended December 31, 1994 (see Note 6 of Notes to Financial Statements).\n1994 COMPARED WITH 1993\nRevenues increased 19% to $136,414,172 in 1994 from $114,275,458 in 1993. The following factors contributed to the increase in revenues: service agreements with new clients in existing geographic areas increased revenues 21.1%; geographic expansion increased revenues 2.8%; and cancellations and other minor changes decreased revenues 4.7%.\nCosts of services provided as a percentage of revenues decreased to 84.4% in 1994 from 84.7% in 1993. The primary factors affecting the variations and their impact on the net .3% change in cost of services provided as a percentage of revenue are as follows: decrease in workers' compensation, general liability and other insurance of 1%; decrease in depreciation expense of .3%; offsetting these decreases was an increase of .5% in allowance for doubtful accounts.\nSelling, general and administrative expenses as a percentage of revenue increased slightly to 8.1% in 1994 from 7.9% in 1993 primarily as a result of additional costs associated with expanding the divisional and regional staffs in order to better position the Company to achieve its performance objectives in the future.\nRECOVERY FROM COLLECTING $300,000 OF PROMISSORY NOTES SOLD THAT WAS RESERVED FOR IN 1991\nA client paid; $50,000 in the first quarter of 1994, $75,000 in each of the second and third quarters of 1994, and $100,000 in the fourth quarter of 1994 (or an aggregate of $300,000) as partial payment on a note. As a result, the Company recorded the recovery as income in its Statements of Income for the year ended December 31, 1994 (see Note 6 of Notes to Financial Statements).\nLIQUIDITY AND CAPITAL RESOURCES\nAt December 31, 1995, the Company had working capital of $51,067,973 which represents a 11% increase over $46,146,376 at December 31, 1994. Working capital continues to grow, reflected principally in increased cash and cash equivalents and higher accounts receivable. The increase in cash and cash equivalents is a result of the improvement in the collection of receivables, as well as the timing of payments to vendors. Higher accounts receivable are primarily attributable to the Company's 9% increase in revenues. The Company's current ratio at December 31, 1995 was 6.3 to 1 compared to 6.5 to 1 and 6.2 to 1 in 1994 and 1993, respectively.\nThe net cash provided by the Company's operating activities was $5,940,040 for the year ended December 31, 1995. The components of working capital that required the largest amount of cash were: increases in accounts receivable and long term trade notes receivable of $1,362,583 and $1,712,922, respectively and a $1,466,184 increase in prepaid income taxes. The increase in accounts receivable and long term trade notes receivable resulted primarily from the continued growth in the Company's revenues, which increased 9%. The increased use of cash associated with prepaid income taxes resulted primarily from the timing of estimated income tax liability payments. Although accounts receivable have increased in 1995, the number of days revenue (based on fourth quarter revenues) in the accounts receivable balance at December 31, 1995 was reduced to 79 days from 81 days at December 31, 1994.\nAt December 31, 1994, the Company had working capital of $46,146,376 which represents a 16% increase over December 31, 1993. Working capital continues to grow, reflected principally in increased cash and cash equivalents and higher accounts receivable. The increase in cash and cash equivalants is a result of the improvement in the collection of receivables, as well as the timing of payments to vendors. Higher accounts receivable is primarily attributable to the Company's 19% increase in revenues. The Company's current ratio at December 31, 1994 was 6.5 to 1 compared to 6.2 to 1 and 6.6 to 1 in 1993 and 1992, respectively.\nThe net cash provided by the Company's operating activities was $3,934,184 for the year ended December 31, 1994. The component of working capital that required the largest amount of cash was accounts receivable, which increased by $3,394,706. The increase resulted primarily from the continued growth in the Company's revenues, which increased 19%. Although accounts receivable have increased in 1994, the number of days revenue (based on fourth quarter revenues) in the accounts receivable balance at December 31, 1994 was reduced to 81 days from 90 days at December 31, 1993.\nThe net cash provided by the Company's operating activities was $2,992,440 for the year ended December 31, 1993. The component of working capital that required the largest amount of cash was accounts receivable, which increased by $4,712,412. The increase resulted primarily from the continued growth in the Company's revenues, which increased 15%. Although accounts receivable have increased in 1993, the number of days revenue (based on fourth quarter revenues) in the accounts receivable balance at December 31, 1993 was reduced to 90 days from 91 days at December 31, 1992.\nThe Company expends considerable effort to collect the amounts due for its services on the terms agreed upon with its clients. Many of the Company's clients participate in programs funded by federal and state governmental agencies which historically have encountered delays in making payments to its program participants. Whenever possible, when a client falls behind in making agreed-upon payments, the Company converts the unpaid accounts receivable to interest bearing promissory notes receivable. The promissory notes receivable provide a means by which to further evidence the amounts owed, provide a definitive repayment plan and therefore may enhance the ultimate collectibility of the amounts due. In some instances the Company obtains a security interest in certain of the debtors' assets.\nThe Company encounters difficulty in collecting amounts due from certain of its clients, including those in bankruptcy, those which have terminated service agreements and slow payers experiencing financial difficulties. In order to provide for these collection problems and the general risk associated with the granting of credit terms, the Company has increased its bad debt provisions (allowance for doubtful accounts) by $1,672,594, $1,423,338 and $567,754 in 1995, 1994 and 1993, respectively. In making its evaluation, in addition to the analyzing, and anticipating, where possible, the specific cases described above, management considers the general collection risk associated with trends in the long-term care industry.\nThe Company has a $13,000,000 bank line of credit on which it may draw to meet short-term liquidity requirements in excess of internally generated cash flow, that expires on June 30, 1996. Amounts drawn under the line are payable on demand. At December 31, 1995, there were no borrowings under the line. However, at such date, the amount available under the line had been reduced by approximately $8,200,000 as a result of contingent liabilities of the Company to the lender relating to letters of credit issued for the Company.\nAt December 31, 1995, the Company had $16,335,886 of cash and cash equivalents, which it views as its principal measure of liquidity.\nIn the fourth quarter of 1993, the Company and its insurer reached an agreement in principle to settle the consolidated class action complaints filed against it in Federal District Court. The Order approving the settlement was approved by the court on September 8, 1994 and became effective on October 10, 1994. The settlement provided for the payment of $2,625,000 by the Company's insurer and common stock having a value of $2,125,000 to be issued by the Company (see Note 8 of Notes to Financial Statements). On August 1, 1995, the Company issued 180,851 shares of its common stock representing its payment obligation under the 1993 settlement of the consolidated class action complaints. Accordingly, the December 31, 1995 Balance Sheet reflects the payment of the previously recorded Litigation Liability of $2,125,000 by increasing stockholders' equity in the same amount.\nThe Company has no specific material commitments for capital expenditures and believes that its cash from operations, existing balances and available\ncredit line will be adequate for the foreseeable future to satisfy the needs of its operations and to fund its continued growth. However, if the need arose, the Company would seek to obtain capital from such sources as long-term debt or equity financing.\nEFFECTS OF INFLATION\nAll of the Company's service agreements allow it to pass through to its clients increases in the cost of labor resulting from new wage agreements. The Company believes that it will be able to recover increases in costs attributable to inflation by continuing to pass through cost increases to its clients.\nOTHER DEVELOPEMENTS\/ACCOUNTING PRONOUNCEMENTS NOT YET ADOPTED\nIn 1993, the Company adopted the provisions of Statement of Financial Accounting Standards No. 109 (SFAS No. 109) \"Accounting for Income Taxes\", which requires a change from the deferred method to the asset and liability method of accounting for income taxes for temporary differences between the financial reporting basis and tax basis of the Company's assets and liabilities. The statement also requires that deferred tax liabilities or assets be adjusted for the future effects of any changes in tax laws or rates. The effect of adopting SFAS No. 109 as of January 1, 1993 required the recognition of a deferred tax asset of $103,853 (see Note 4 to Notes to Financial Statements).\nSFAS No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,\" is required to be implemented in 1996. SFAS No. 121 requires that long-lived assets and certain identifiable intangibles held and used by the entity be reviewed for impairment whenever events or changes in circumstances indicates that the carrying amount of an asset may not be recoverable. If the sum of the expected future cash flows (undiscounted and without interest) is less than the carrying amount of the asset, an impairment loss is recognized. Measurement of that loss would be based on the fair value of the asset. The Company believes that implementation of this statement will not have any material effect on its financial position.\nSFAS No. 123, \"Accounting for Stock-Based Compensation,\" is also required to be implemented in 1996 and introduces a choice of the method of accounting used for stock-based compensation. Entities may use the \"intrinsic value\" method currently based on APB No. 25 or the new \"fair value\" method contained in SFAS No. 123. The Company intends to implement SFAS No. 123 in 1996 by continuing to account for stock-based compensation under APB No. 25. As required by SFAS No. 123, the pro forma effects on net income and earnings per share will be determined as if the fair value based method had been applied and disclosed in the notes to the financial statements.\nBALANCE SHEETS\nASSETS\nSee accompanying notes.\nINCOME STATEMENTS\nHEALTHCARE SERVICES GROUP, INC.\nSee accompanying notes.\nSTATEMENTS OF CASH FLOWS\nSUPPLEMENTAL DISCLOSURE OF NONCASH FINANCING ACTIVITY:\nOn August 1, 1995, the Company issued 180,851 shares of its common stock representing its payment obligation under the 1993 settlement of the lawsuits relating to the consolidated class action complaints filed against it in 1991 and 1992. Accordingly, the December 31, 1995 Balance Sheet reflects the payment of the previously recorded Litigation Liability of $2,125,000 by increasing stockholders' equity in the same amount.\nSee accompanying notes.\nStatements of Stockholders' Equity\nYears Ended December 31, 1995, 1994, and 1993\nSee accompanying notes.\nNOTES TO FINANCIAL STATEMENTS\nNote 1 -- Summary of SignificanT Accounting Policies\nGeneral The Company provides housekeeping, laundry and linen services to long-term care facilities, including nursing homes and retirement complexes.\nCash and cash equivalents Cash and cash equivalents consist of short-term, highly liquid investments with a maturity of three months or less at time of purchase.\nInventories and supplies Inventories and supplies include housekeeping and laundry supplies which are valued at the lower of cost or market. Cost is determined on a first-in, first-out (FIFO) basis. Linen supplies are included in inventory and are amortized over a 24 month period.\nProperty and equipment Property and equipment are stated at cost. Additions, renewals and improvements are capitalized, while maintenance and repair costs are expensed. When assets are retired or otherwise disposed of, the cost and related accumulated depreciation are removed from the respective accounts and any resulting gain or loss is included in income. Depreciation is provided by the straight-line method over the following estimated useful lives: laundry and linen equipment -- 3 to 7 years; housekeeping equipment and office furniture -- 3 to 7 years; autos and trucks -- 3 years.\nRevenue recognition Revenues from service agreements are recognized as services are performed. The Company (as a distributor of laundry equipment since 1981) occasionally makes sales of laundry installations to certain of its clients. The sales in\nmost cases represent the construction and installation of a turn-key operation and are for payment terms ranging from 36 to 60 months. The Company's accounting policy for these sales is to recognize the gross profit over the life of the original payment terms associated with the financing of the transactions by the Company. During 1995, 1994 and 1993, laundry installation sales were not material.\nIncome taxes Deferred income taxes result from temporary differences between tax and financial statement recognition of revenue and expense. These temporary differences arise primarily from differing methods used for financial and tax purposes to calculate insurance expense, certain receivable reserves, other provisions which are not currently deductible for tax purposes, and revenue recognized on laundry installation sales.\nDuring the first quarter of 1993 the Company adopted the provisions of Statement of Financial Accounting Standards No. 109 (SFAS No. 109) \"Accounting for Income Taxes\" (see Note 4).\nIncome taxes paid were approximately $3,391,000, $3,356,000 and $2,310,000 during 1995, 1994 and 1993, respectively.\nIntangible assets Intangible assets at December 31, 1994 arose from the 1988 acquisition of American Services Company (subsequently renamed HEalthcare Services Company and merged into the Company). They consisted principally of commenced service agreements of $1,454,996 (prior to accumulated amortization) at December 31, 1994. The amounts reflect an adjustment to the original purchase price, as well as certain service agreement cancellations. The commenced service\nagreements were being amortized on a straight-line basis over twenty-six years up to December 1994. In December 1994, as a result of a change in control of the nursing homes, the long term service agreements with the Company were cancelled. However, many of the nursing homes continued to utilize the services of the Company under standard 30 day cancellable service agreements. As a result, the Company reevaluated the remaining life of the related intangible assets and commenced amortization of the remaining balance over a three year period beginning in January 1995. During 1995, the remaining service agreements were cancelled and the unamortized balance was charged to operations. There was no significant effect on operations in 1994 as a result of this change in estimated remaining lives.\nAmortization charged to earnings was $954,000 for the year ended December 31, 1995 and $55,960 per year for the years ended December 31, 1994 and 1993.\nCosts in excess of fair value of net assets acquired Costs in excess of the fair value of net assets of businesses acquired are amortized on a straight-line basis over periods not exceeding forty years. All of the carrying value at December 31, 1995 resulted from a 1985 acquisition which is being amortized over a thirty-one year period. Amortization charged to earnings was $108,958 in 1995 and $111,625 per year in 1994 and 1993.\nOn an ongoing basis, management reviews the valuation and amortization of costs in excess of fair value of net assets acquired. As part of this review, the Company estimates the value and future benefits of the net income generated by the related service agreements to determine that no impairment has occurred.\nOther noncurrent assets Other noncurrent assets consist of:\n1995 1994 ------------ ------------ Long-term note receivables $9,471,036 $7,758,114 Other 268,155 405,020 ------------ ------------ $9,739,191 $8,163,134 ============ ============\nLong-term notes receivable primarily represent trade receivables that were converted to notes to enhance collection efforts. Interest income is only recognized as cash payments are received. Amounts shown are net of allowance of $549,400 and $965,900 in 1995 and 1994, respectively.\nReclassification Certain reclassifications to 1994 reported amounts have been made in the financial statements to conform to 1995 presentation.\nConcentration of credit risk Statement of Financial Accounting Standards No. 105 (\"SFAS no. 105\") requires the disclosure of significant concentrations of credit risk, regardless of the degree of such risk. Financial instruments, as defined by SFAS No. 105, which potentially subject the Company to concentrations of credit risk, consist principally of cash and cash equivalents and trade accounts receivable. At December 31, 1995 and 1994, substantially, all of the company's cash and cash equivalents were invested with one financial institution.\nThe Company's clients are concentrated in one industry, providers of long-term care. The clients are generally individual long-term care facilities with a wide geographical dispersion. However, recent industry trends indicate consolidation of nursing home ownership into chains, which can lead to a customer concentration. At DECEMBER 31, 1995, no single client or nursing home chain accounted for more than 10% of total revenue.\nFair value of Financial Instruments The carrying value of financial instruments (principally consisting of cash and cash equivalents, accounts and notes receivable and accounts payable) approximate fair value.\nUse of Estimates in Financial Statements In preparing financial statements in conformity with generally accepted accounting principles, management makes estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nAccounting Pronouncements Not Yet Adopted SFAS No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,\" Is required to be implemented in 1996. SFAS No. 121 requires that long-lived assets and certain identifiable intangibles held and used by the entity be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If the sum of the expected future cash flows (undiscounted and without interest) is less than the carrying amount of the asset, an impairment loss is recognized. Measurement of that loss would be based on the fair value of the asset. The Company believes that implementation of this statement will not have any material effect on its financial position.\nSFAS NO. 123, \"Accounting for Stock-Based Compensation,\" is also required to be implemented in 1996 and introduces a choice of the method of accounting used\nfor stock-based compensation. Entities may use the \"intrinsic value\" method currently based on APB No. 25 or the new \"fair value\" method contained in SFAS No. 123. The Company intends to implement SFAS No. 123 in 1996 by continuing to account for stock-based compensation under APB No. 25. As required by SFAS No. 123, the pro forma effects on net income and earnings per share will be determined as if the fair value based method had been applied and disclosed in the notes to the financial statements.\nNote 2 -- Lease Commitments The Company leases office facilities and autos under operating leases expiring on various dates through 2002 (see Note 5).\nThe following is a schedule, by calendar years, of future minimum lease payments under operating leases having remaining terms in excess of one year as of December 31, 1995: Operating Year Leases - ---- ---------- 1996 $ 394,564 1997 225,579 1998 148,470 1999 133,231 2000 108,324 Thereafter 32,746 ----------- Total minimum lease payments $1,042,914 ===========\nTotal expense for all operating leases was $644,302, $792,570 and $725,222 for the years ended December 31, 1995, 1994 and 1993, respectively.\nNote 3 -- Stockholders' Equity On May 23, 1995, the Stockholders approved an increase in authorized shares of common stock from 10,000,000 to 15,000,000 authorized shares, $.01 par value.\nAs of December 31, 1995, 1,062,388 shares of common stock were reserved under various Incentive Stock Option Plans, including one approved by stockholders on May 23, 1995 (the \"1995 Plan\"). Of such amount, 550,515 shares which were\navailable for future grant. On December 1, 1995, 90,039 incentive stock options were granted under the 1995 Plan. These options are exercisable commencing June 1, 1996. The Stock Option Committee is responsible for determining the individuals who will be granted options, the number of options each individual will receive, the option price per share, and the exercise period of each option. The incentive stock option price will not be less than the fair market value of the common stock on the date the option is Granted. No option will have a term in excess of ten years. As to any stockholder who owns 10% or more of the common stock, the option price per share will be no less than 110% of the fair market value of the common stock on the date the options are granted and such options shall not have a term in excess of ten years.\nA summary of incentive stock option activity is as follows:\nThe Company has granted non-qualified stock options to directors and outside consultants under the Company's Non-qualified Stock Option Plan, which was adopted on March 8, 1995 and approved by stockholders on May 23, 1995. The non-qualified options were granted at an option price which was not less than the fair market value of the common stock on the date the option was granted. The options are exercisable over a five year period, commencing six months from the option date.\nOn November 5, 1993, December 6, 1994 and December 1, 1995 certain directors were granted nonqualified options to purchase 42,000, 58,217 and 53,236 shares respectively. The 1993 options were granted at an exercise price of $8.25 per share, the 1994 options were granted at an average exercise price of $11.61 and the 1995 options were granted at an average exercise price of $8.95. The 1995 options are exercisable commencing June 1, 1996.\nA summary of non-qualified stock option activity is as follows:\nNOTE 4 -- INCOME TAXES\nThe provision for income taxes consists of:\nYear Ended December 31, ------------------------------------------- 1995 1994 1993 ------------ ------------ ------------ Current: Federal $1,695,400 $2,692,000 $2,193,400 State 564,600 878,000 793,600 ------------ ------------ ------------ 2,260,000 3,570,000 2,987,000 ------------ ------------ ------------ Deferred: Federal 805,000 677,600 463,500 State 284,000 221,400 168,500 ------------ ------------ ------------ 1,089,000 899,000 632,000 ------------ ------------ ------------ Income tax provision before tax benefit of extraordinary item 3,349,000 4,469,000 3,619,000 Tax (benefit) of extraordianry item Deferred (844,000) ------------ ------------ ------------ Tax Provision $3,349,000 $4,469,000 $2,775,000 ============ ============ ============\nUnder FAS 109, 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 amount used for income tax purposes. Significant components of the Company's federal and state deferred tax assets and liabilities are as follows:\nYear Ended December 31, ----------------------------- 1995 1994 ------------- ------------ Net current deferred tax assets: Allowance for doubtful accounts $ 1,814,008 $1,827,000 Accrued insurance claims-current 387,682 550,936 Expensing of housekeeping supplies (1,097,340) (942,586) ------------- ------------ $ 1,104,350 $1,435,350 ============= ============ Net noncurrent deferred tax assets: Deferred profit on laundry installation sales $ 235,140 $ 341,444 Non-deductible reserves 1,046,393 1,611,933 Depreciation of property and equipment (786,056) (916,879) Accrued insurance claims-noncurrent 904,590 1,170,738 Other 49,169 ------------- ------------ $ 1,449,236 $2,207,236 ============= ============\nDeferred tax expense (benefit) results from temporary differences in the recognition of revenue and expense for tax and financial statement purposes. The sources of these differences and the tax effect of each were as follows:\nYear Ended December 31, ------------------------------------------ 1995 1994 1993 ------------ ---------- ------------- Accrued insurance claims liability not currently deductible $ 429,400 $259,000 $ 560,800 Deferred profit recognition on laundry installation sales 106,300 144,200 219,100 Reserves recorded on the books not currently deductible for tax purposes 539,400 325,600 (1,183,000) Use of direct write-off method for bad debts for tax purposes 13,000 (14,200) (68,000) Housekeeping supplies expensed for tax purposes prior to financial purposes 154,800 146,100 207,200 Depreciation computed under the accelerated cost recovery system for tax purposes and the straight-line method for financial accounting (130,800) (26,100) 70,000 Other (23,100) 64,400 (18,100) ------------ ---------- ------------- $1,089,000 $899,000 $ (212,000) ============ ========== =============\nA reconciliation of the provision for income taxes and the amount computed by applying the statutory federal income tax rate (34%) to income before income taxes is as follows:\nYear Ended December 31, ------------------------------------------- 1995 1994 1993 ------------ ------------ ------------ Computed \"expected\" tax expense $2,478,500 $3,695,600 $2,335,500 Increases (decreases) in taxes resulting from: State income taxes, net of federal tax benefit 560,100 734,200 486,500 Tax exempt interest (111,000) (54,000) (10,600) Reserves recorded on the books not deductible for tax purposes 408,000 -- -- Amortization of costs in excess of fair value of net assets acquired 37,000 38,000 38,000 Other, net (23,600) 55,200 (74,400) ------------ ------------ ------------ $3,349,000 $4,469,000 $2,775,000 ============ ============ ============\nSFAS No. 109\nEffective January 1, 1993, the Company adopted the provisions of Statement of Financial Accounting Standards No. 109 (SFAS 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 diferences are expected to reverse.\nThe effect of adopting SFAS No. 109 as of January 1, 1993 required the recording of a deferred tax asset of $103,853. Such amount has been reflected in the statement of income for the year ended December 31, 1993 as the cumulative effect of an accounting change. SFAS No. 109 did not have a material impact on the results of 1993 operations.\nNote 5 -- Related Party Transactions\nThe Company leases its corporate offices from a partnership in which the chief executive officer of the Company is a general partner. The rental payments made during the year ended December 31, 1995 was $88,617 and $74,900 per year for the years ended December 31, 1994 and 1993. The Company made no leasehold improvements in either 1994 or 1993, although in 1995 the Company made leasehold improvements of approximately $23,150. A director of the Company has an ownership interest in several client facilities which have entered into service agreements with the Company. In addition, an officer of the Company has minority ownership interests in a client facility of the Company. During the years ended December 31, 1995, 1994 and 1993 all of these agreements collectively resulted in revenues of approximately $3,010,000, $3,203,000, and $2,991,000 respectively.\nNote 6 -- Sale of Promissory Notes Receivable and Provision for Contingent Losses on Promissory Notes Sold\nIn 1991 and 1990, the Company sold to its bank, with recourse, promissorY notes receivable at face value of approximately $3,800,000 and $2,500,000, respectively. As of December 31, 1995 the 1991 and 1990 promissory notes sold have been paid in full. As of December 31, 1994 approximately $300,000 and $800,000, respectively, of the aggregate amount of such promissory notes sold in each year remained out standing. On July 15, 1992, a client paid in full\nto the Company's bank one of the promissory notes in the amount of $910,000. In addition, the client paid $400,000 in 1993 and $300,000 in both 1994 and 1995 as partial payment on another note (see discussion below regarding these promissory notes). Therefore, the Company reversed the provision recorded as of December 31, 1991 and recognized the $910,000, $400,000, $300,000 and $300,000 payments as income in 1992, 1993, 1994 and 1995, respectively. All of the promissory notes sold during 1990 and all but one of the promissory notes sold during 1991 represent accounts receivable due to the Company for services rendered. These accounts receivable had been converted to promissory notes prior to their sale to the bank. The Company converted the accounts receivable to interest bearing promissory notes receivable in order to further evidence the amounts owed and to enhance its collection efforts. All of the promissory notes (except the one mentioned in the following paragraph) provided for monthly payments of principal and interest and some were secured by certain assets of the issuers. Pursuant to agreements with its bank, the Company would have been required to post substitute collateral if its line of credit from its bank expired or was terminated prior to the promissory notes being paid in full.\nIn 1991, the Company made arrangements with its bank to provide financing of $1,000,000 to one of its clients for which the Company agreed to guarantee payment. In order for the Company to negotiate maximum security for its guarantee, the Company made the loan directly to the client and simultaneously sold the promissory note receivable to the bank. In addition, among the notes sold during 1991, is a promissory note in the amount of $910,000 which was\nissued in 1990 by an entity related to this client and subsequently paid in full to the bank on July 15, 1992. On April 22, 1992 a director of the Company, who is not an officer, agreed to purchase these promissory notes (for the full principal amount thereof plus accrued interest) without recourse to the Company, upon a request by the bank that the Company post substitute collateral. Any such purchase would include the assignment of the collateral pledged as security. The Company entered into this agreement (which was approved by the Board of Directors) with the director in order to protect its interests with respect to these promissory notes. The director is engaged in the operation of nursing homes. Although the Company believed that it would not have incurred any financial loss as a result of these promissory notes, it had, as of December 31, 1994 established a reserve for contingent losses in the amount of $300,000. The borrower of the $1,000,000 financing used the proceeds to fully fund the purchase price for its acquisition of the client. The equity method of accounting had been used to value the collateral held as security for these promissory notes, which, as a consequence of losses incurred by the client after the closing date of the transaction, had resulted in the Company providing a reserve for the total unpaid amount of the promissory notes as of December 31, 1994. During 1995, the balance of the promissory note was paid in full.\nNote 7 -- Laundry Installation Purchases\nDuring 1993, 1994 and 1995 the Company purchased certain existing laundry installations from nursing homes with which it concurrently entered into service agreements to provide laundry and linen services. The Company entered\ninto the following laundry installation purchase transactions; in 1993 with ten nursing homes for approximately $545,000, in 1994 with six nursing homes for approximately $306,000 and in 1995 with seven nursing homes for approximately $100,125. the agreements governing these purchase transactions provide that if the service agreements are terminated at any time, the nursing home is obligated to buy the laundry installations at a purchase price based on the Company's original cost together with any additional equipment, improvements or expansion required in order to improve or increase the productivity of operation (after depreciation on a straight line basis over the original term of the service agreement which is generally three to seven years). THe Company has recorded these transactions as purchases of property and equipment and they are reported as such in the accompanying balance sheets net of accumulated depreciation. The equipment is generally being depreciated over a three to five year period.\nNote 8 -- Extraordinary Item -- Settlement of Class Action Litigation\nIn the fourth quarter of 1993 the Company and its insurer consummated an agreement to settle the consolidated class action complaints filed against it in Federal District Court in 1991 and 1992. The settlement was approved by court order dated September 8, 1994 and became effective on October 10, 1994. The settlement provided for the payment of $2,625,000 by the Company's insurer and the issuance of common shares by the Company having a value of $2,125,000. The settlement and related estimated legal costs have been recorded as an extraordinary item in 1993. Such extraordinary item reduced 1993 net income by approximately $1,437,000, net of income tax benefit of $844,000. On August 1, 1995, the Company issued 180,851 shares of its common stock representing its payment obligation under the 1993 settlement relating to the consolidated class action complaints. Accordingly, the effect of issuing these shares is reflected in the per share amounts reported for the years ended December 31, 1995 and 1994. The December 31, 1995 Balance Sheet also reflects the payment of the previously recorded Litigation Liability of $2,125,000 by increasing stockholders' equity in the same amount.\nNote 9 -- Other Contingencies\nIn 1988, the Company acquired a 19.5% interest in T.L.C. St Petersburg, Inc. (\"TLC\"), a corporation which owned and operated a long-term care facility in Florida and which was a client of the Company. The Company had guaranteed $1,500,000 of working capital loans of TLC at both December 31, 1994 and December 31, 1993 and has pledged equal amounts of\ncertificates of deposit as collateral for the guarantees (which is listed as Certificates of Deposit Pledged for Loan Guarantees in the accompanying balance sheets at December 31, 1994. In addition, the Company had guaranteed notes payable of approximately $1,700,000. TLC made all required principal and interest payments due under the terms of these loans through December 31, 1994. Total guarantees for TLC aggregate $3,200,000 at December 31, 1994.\nDuring 1993, one of the Company's clients, which owns and operates a significant number of long-term care facilities throughout the country, purchased from a third party the balance of the issued and outstanding shares of TLC and that client now holds 90.1% of the issued and outstanding shares of TLC. During the fourth quarter of 1993, TLC entered into an agreement to sell substantially all of its assets to an unrelated third party. The sale closed on March 28, 1995 and all loans guaranteed by the Company have been paid in full and the Certificates of Deposit pledged for the Loan Guarantees have been released to the Company.\nAs of January 1, 1994, TLC entered into a twenty year agreement to lease the operations of the facility to an entity controlled by TLC's majority shareholder. The purchaser of TLC's assets assumed such operating lease.\nBy reason of TLC's uncertain financial condition, the Company, until the time TLC entered into an agreement to sell its assets, fully reserved advances to and receivables from TLC which amounted to approximately $2,000,000 at both December 31, 1994 and 1993 and $1,200,000 at December 31, 1992. Subsequent to the sales agreement, the Company advanced approximately $2,900,000 to TLC. The obligations\nare being repaid in accordance with the terms of a promissory note issued to the Company.\nThe Company has a $13,000,000 bank line of credit on which it may draw to meet short-term liquidity requirements or for other purposes, that expires on June 30, 1996. Amounts drawn under the line are payable upon demand. At both December 31, 1995 and 1994, there were no borrowings under the line. However during 1991 and 1990, the Company sold promissory notes receivable of approximately $3,800,000 and $2,500,000, respectively, to its bank with recourse. As of December 31, 1995 the 1991 and 1990 promissory notes receivable have been paid in full. At December 31, 1994, the unpaid balance of the promissory notes receivable sold was approximately $1,100,000 (see Note 7). At both December 31, 1995 and 1994, the Company had outstanding approximately $8,200,000 of irrevocable standby letters of credit, which primarily relate to payment obligations under the Company's insurance program. As a result of the promissory notes receivable sold and letters of credit issued, the amount available under the line was reduced by approximately $8,200,000 at December 31, 1995 and $9,300,000 at December 31, 1994.\nNote 10 -- Provision for Estimated Cost Related to SEC Inquiry and Other Matters\nThe Securities and Exchange Commission (SEC) has been conducting a non-public investigation since 1990 with respect to certain matters, including the Company's financial statements, financial condition and results of operations. The Company has cooperated fully with such inquiry on a voluntary basis. On March 21, 1996 the Staff of the SEC informed the Company that the SEC had accepted a settlement which had been offered by the Company and\nrecommended by the staff pertaining to certain allegations of violations of the Federal securities laws by the Company and certain of its officers with respect to periods ended on or before March 31, 1992. The settlement is subject to mutual agreement on the final form of the Complaint and Consent to be filed in the United States District Court. Under the settlement, upon filing of the Complaint and the entry of a final judgment upon Consent, and without admitting or denying any of the allegations of the Complaint, the Company, two officers and a former officer, will be permanently enjoined from violating certain provisions of the Federal securities laws, and the Company and these individuals will be required to pay civil penalties aggregating approximately $825,000. The estimated monetary impact of this settlement plus related legal costs have been reflected in the accompanying financial statements.\nIn addition, the United States Attorney for the Eastern District of Pennsylvania is investigating matters relating to certain payments (approximately $84,000 in 1988, $54,000 in 1989, $110,000 in 1990, $125,000 in 1991 and $34,000 in 1992) made by the Company between June 1988 and January 1992 to certain vendors that were not in accordance with Company policy. This matter was previously investigated and reported upon by the Company in its Form 10-K for the year ended December 31, 1991. Information regarding this matter was voluntarily furnished to the U.S. Attorney's office in New Jersey in May and November 1992 and such payments were recovered by the Company in November 1992. The Company is cooperating with the United States Attorney's office in an attempt to resolve any issues or claims arising out of these payments.\nThe Company anticipates that it will incur a significant amount of legal and related costs in connection with these matters. During 1995, the Company incurred approximately $950,000 of costs and estimates that the additional costs which may be incurred in connection with these matters will be in a range of approximately $2,150,000 to $3,500,000 and accordingly has accrued as of December 31, 1995 the estimated low range of this liability. The result of this $3,100,000 provision was to reduce 1995 net income by approximately $2,321,000 or $.28 per common share.\nNote 11 -- Accrued Insurance Claims\nFor years 1993 through 1995, the Company has a PAid Loss Retrospective Insurance plan for general liability and workers' compensation insurance. In addition, for years 1993 and 1994, the Company also had a Paid Loss Retrospective Insurance Plan for its automobiles. Under these plans, predetermined loss limits are arranged with an insurance company to limit both The Company's per occurence cash outlay and annual insurance plan cost.\nFor workers' compensation and automobile insurance, the Company records a reserve based on the present value of future payments that are developed as a result of a review of the Company's historical data and actuarial analysis done by an independent company. The accrued insurance claims were reduced by approximately $1,360,000, $1,247,000 and $895,000 at December 31, 1995, 1994 and 1993, respectively in order to record the estimated present value at the end of each year using an 8% interest factor for 1995 and 1994 and a 5% interest factor for 1993. During 1995, the Company amended its Insurance Plan from a 66 month to a 126 month claim payout. This amendment decreased the 1995\nestimated insurance cost by approximately $1,360,000. During the fourth quarter of 1994, the Company changed the present value discount factor which it applies to estimated accrued workers' compensation insurance claims liability from 5.0% to 8.0% to reflect a more current rate. This change in discount factor decreased the 1994 estimated insurance cost by approximately $400,000. In the fourth quarter of 1993, the Company changed the present value discount factor from 7.5% to 5.0% which had the effect of increasing the 1993 estimated insurance cost by approximately $375,000. It was actuarially estimated that the accrued workers' compensation insurance claims will principally be paid to the claimants within six years from the date of the incident.\nFor general liability insurance, the Company records a reserve for the estimated ultimate amounts to be paid for known claims.\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nThe Stockholders and Board of Directors Healthcare Services Group, Inc.\nWe have audited the accompanying balance sheets of Healthcare Services Group, Inc. as of December 31, 1995 and 1994, and the related statements of income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1995. 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 Healthcare Services Group, Inc. at December 31, 1995 and 1994 and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\n\/s\/ GRANT THORNTON LLP\nParsippany, New Jersey February 26, 1996 (except for Note 10, as to which the date is March 21, 1996)\nItem 9.","section_6":"","section_7":"","section_7A":"","section_8":"","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures\nNot Applicable.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nThe information regarding Directors and executive officers is incorporated herein by reference to the Company's definitive proxy statement to be mailed to its shareholders in connection with its 1996 Annual Shareholders' Meeting and to be filed within 120 days of the close of the year ended December 31, 1995.\nItem ll. Executive Compensation\nThe information regarding executive compensation is incorporated herein by reference to the Company's proxy statement to be mailed to shareholders in connection with its 1996 Annual Meeting and to be filed within 120 days of the close of the fiscal year ended December 31, 1995.\nItem 12.","section_11":"","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThe information regarding security ownership of certain beneficial owners and management is incorporated herein by reference to the Company's proxy statement to be mailed to shareholders in connection with its 1996 Annual Meeting and to be filed within 120 days of the close of the fiscal year ending December 31, 1995.\nDirectors holding approximately 12% of the outstanding voting stock of the registrant have been deemed to be \"affiliates\" solely for the purpose of computing the aggregate market value of the voting stock held by non-affiliates set forth on the cover page of this Report.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThe information regarding certain relationship and related transactions is incorporated herein by reference to the Company's proxy statement mailed to shareholders in connection with its 1996 Annual Meeting and to be filed within 120 days of the close of the fiscal year ended December 31, 1995.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statements Schedules and Reports on Form 8-K\n(a) 1. Financial Statements\nReport of Independent Certified Public Accountants Balance Sheets as of December 31, 1995 and 1994 Statements of Income for the three years ended December 31, 1995, 1994 and 1993 Statements of Stockholders Equity for the three years ended December 31, 1995, 1994 and 1993 Statements of Cash Flows for the three years ended December 31, 1995, 1994 and 1993 Notes to Financial Statements\n2. Financial Statement Schedules\nIncluded in Part IV of this report:\nConsent of Independent Certified Public Accountants Report of Independent Certified Public Accountants on Schedule VII - Valuation and Qualifying Accounts for the three years ended December 31, 1995, 1994 and 1993 Financial Data Schedule\nAll other schedules are omitted since they are not required, not applicable or the information has been included in the Financial Statements or notes thereto.\n3. Exhibits\nThe following Exhibits are filed as part of this Report (references are to Reg. S-K Exhibit Numbers):\nPOWER OF ATTORNEY\nHealthcare Services Group, Inc. and each of the undersigned do hereby appoint Daniel P. McCartney and Thomas A. Cook and each of them severally, its or his true and lawful attorneys to execute on behalf of Healthcare Services Group, Inc. and the undersigned any and all amendments to this Report and to file the same with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission. Each of such attorneys shall have the power to act hereunder with or without the others.\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.\nDated: HEALTHCARE SERVICES GROUP, INC. (Registrant)\nBy: \/s\/ Daniel P. McCartney ------------------------- Daniel P. McCartney, Chief Executive Officer and Chairman\nPursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed below by the following persons and in the capacities and on the dated indicated:\nHEALTHCARE SERVICES GROUP, INC. Schedule VII - VALUATION AND QUALIFYING ACCOUNTS Years Ended December 31, 1995, 1994, 1993","section_15":""}
{"filename":"38074_1995.txt","cik":"38074","year":"1995","section_1":"ITEM 1. BUSINESS - ------- -------- GENERAL\nForest Laboratories, Inc. and its subsidiaries (collectively, \"Forest\" or the \"Company\") develop, manufacture and sell both branded and generic forms of ethical drug products which require a physician's prescription, as well as non-prescription pharmaceutical products sold over-the-counter. Forest's most important United States products consist of branded ethical drug specialties marketed directly, or \"detailed,\" to physicians by the Company's salesforce and its controlled release line of generic products sold to wholesalers, chain drug stores and generic distributors. In recent years the Company has emphasized increased detailing to physicians of those branded ethical drugs it believes have the most potential for growth, and the introduction of new products acquired from other companies or developed by the Company.\nForest's products include those developed by Forest and those acquired from other pharmaceutical companies and integrated into Forest's marketing and distribution systems. See \"Recent Developments.\"\nForest is a Delaware corporation organized in 1956, and its principal executive offices are located at 909 Third Avenue, New York, New York 10022 (telephone number (212-421-7850).\nRECENT DEVELOPMENTS\nCERVIDIL: On March 30, 1995, the United States Food and Drug Administration (\"FDA\") approved a New Drug Application (\"NDA\") for Forest's Cervidil-TM-, a pessary infused with the hormone Prostaglandin E2. The product is used for the initiation or continuation of cervical ripening where there is a medical or obstetrical indication for the induction of labor. Forest launched the product commercially in May, 1995.\nFLUMADINE: In September 1993, Forest received the approval of the FDA to market rimantadine, an antiviral agent used for the treatment and prophylaxis of Influenza A. The Company markets this product under the trademark Flumadine-R-.\nMONUROL: In November 1991, the Company entered into a licensing agreement with the Zambon Group of Italy for the marketing by the Company in the United States of the antibiotic fosfomycin trometamol sold under the tradename Monurol-R-.\nFosfomycin trometamol is currently approved for marketing in eleven countries, including the United Kingdom, Germany, Italy and Spain. The product is a single dose antibiotic used for the treatment of uncomplicated urinary tract infections. There are currently no single dose antibiotics approved for this indication in the United States. Forest filed an NDA for this product in September, 1994.\nINFASURF: In June 1991, the Company entered into a licensing agreement with ONY, Inc. for the marketing by the Company in the United States, the United Kingdom and Canada of the product Infasurf-R- for the treatment of respiratory distress syndrome in premature infants. Such licensing arrangements were expanded in May 1992 to include worldwide rights to the product. The Company is conducting early stage clinical trials of Infasurf in order to evaluate its possible use in adult respiratory distress syndrome. An NDA for Infasurf was filed in March 1995. In May 1995 the Company was notified by the FDA that it refused to accept the NDA for filing because it determined that Infasurf is the \"same drug\" as Survanta-R- under the Orphan Drug Regulations and is, therefore, not approvable until seven years after Survanta's approval, which was granted in 1991. Management believes that there are significant chemical and clinical differences between Infasurf and Survanta and intends to pursue the FDA review procedure. In addition, the Company has been notified by Abbott Laboratories, the owner of the Survanta patents, that it considers that Infasurf infringes its Survanta patents. The Company believes, following consultation with its patent counsel, that such claim is without merit.\nSYNAPTON: The Company is conducting multi-center clinical trials to study the safety and efficacy of Synapton-TM- for the treatment of Alzheimer's Disease. Synapton contains physostigmine, a cholinesterase inhibitor. Cholinesterase is an enzyme which metabolizes or breaks down acetylcholine, which is the neurotransmitter in the brain most associated with memory. It is believed that in Alzheimer's patients, the cells that produce acetylcholine progressively die, and the reduced availability of this important neurotransmitter is believed to contribute to the patient's mental deterioration. Synapton is formulated to partially inhibit cholinesterase activity so that the acetylcholine produced by the body is available for a longer period of time. It is recognized that cholinesterase inhibitors generally are not a cure for Alzheimer's Disease but are expected to have an ameliorative effect for certain patients.\nSynapton is a controlled release formulation of physostigmine. Synapton makes use of Forest's patented Synchron-R- technology which provides for the continuous release of medication into the bloodstream and, in the case of Synapton, permits twice-a-day administration. The Company has concluded\none Phase III clinical study which demonstrates Synapton's effectiveness. The Company hopes to complete a second successful Phase III study which would enable an NDA to be filed.\nMICTURIN: In August 1989, Forest completed and submitted a full NDA to the FDA covering Micturin-R-, which is licensed to Forest in the United States by the Swedish pharmaceutical manufacturer Pharmacia AB (\"Pharmacia\"). The product had been marketed outside the United States by Pharmacia since 1986 and by 1991 was approved and marketed in 20 countries, with over 400 million doses having been sold. In mid-1991, some cases of a rare but serious cardiac side effect, polymorphic ventricular tachycardia, were reported principally in the United Kingdom among patients taking Micturin. In all but a few of those cases, the patients appeared to have identifiable predisposing risk factors. As a result of those reports, the United Kingdom Committee on the Safety of Medicines (the \"CSM\") sent a letter to physicians and pharmacists advising them of those reported cases and contraindicating the drug for patients with the predisposing risk factors. In September 1991, following the CSM action and after regulatory action in other markets, including withdrawals of the product in Germany and Austria, Pharmacia withdrew Micturin from all markets worldwide. Following the worldwide withdrawal of Micturin, the FDA requested that Forest discontinue its ongoing studies of Micturin in the United States until the FDA could review the possible relationship between the use of Micturin and the reported cardiac side effect. Forest is analyzing data from a recently conducted clinical study to further assess Micturin's safety and the prospects for marketing the drug in the United States.\nPRINCIPAL PRODUCTS\nThe Company actively promotes in the United States those of its branded products which the Company's management believes have the most potential for growth and which enable its salesforce to concentrate on specialty groups of physicians who are high prescribers of its products. Such products include the respiratory products Aerobid-R-, Aerochamber-R- and Tessalon-R- , the thyroid product Levothroid-R-, the ESGIC-R- and Lorcet-R- lines of analgesics and Flumadine (See \"Recent Developments\").\nAerobid is a metered dose inhaled steroid used in the treatment of asthma. Sales of Aerobid accounted for 24.2% of Forest's sales for the fiscal year ended March 31, 1995 as compared to 21.3% and 17.7% for the fiscal years ended March 31, 1994 and 1993, respectively. Aerochamber is a spacer device used to improve the delivery of aerosol administered products, including Aerobid.\nESGIC and ESGIC Plus are combination analgesic\/sedatives for the relief of tension headaches, while Lorcet is a line of potent analgesics. Lorcet sales accounted for 17.0% of sales for the fiscal year ended March 31, 1995, as compared to 11.2% and 7.8% of sales for the fiscal years ended March 31, 1994 and 1993, respectively. Tessalon is a solid dose non-narcotic cough suppressant. Sales of Tessalon (including sales of a generic formulation) accounted for 4.8% of sales for the fiscal year ended March 31, 1995, as compared to 6.0% and 10.9% for the fiscal years ended March 31, 1994 and 1993, respectively.\nForest's generic line emphasizes the Company's capability to produce difficult to formulate controlled release products which are sold in the United States by Forest's Inwood Laboratories, Inc. subsidiary. Inwood's most important products include Propranolol E.R., a controlled release beta blocker used in the treatment of hypertension, Indomethacin E.R., a controlled release non-steroidal anti-inflammatory drug used in the treatment of arthritis, and Theochron-TM- , a controlled release theophylline tablet used in treatment of asthma. Sales of Propranolol accounted for 16.0% of Forest's sales for the fiscal year ended March 31, 1995, as compared to 14.3% and 14.1% for the fiscal years ended March 31, 1994 and 1993, respectively. American Home Products, the marketer of the original branded version of Propranolol E.R., recently introduced its own generic version of the drug which will compete against Inwood's product.\nThe Company's United Kingdom and Ireland subsidiaries sell both ethical products requiring a doctor's prescription and over-the-counter preparations. Their most important products include Sudocrem, a topical preparation for the treatment of diaper rash, Colomycin, an antibiotic used in the treatment of Cystic Fibrosis and Suscard and Sustac, sustained action nitroglycerin tablets in both buccal and oral form used in the treatment of angina pectoris, an ailment characterized by insufficient oxygenation of the heart muscle.\nMARKETING\nIn the United States, Forest directly markets its products through its domestic salesforce, currently numbering 456 persons, which details products directly to physicians, pharmacies and managed care organizations. The expansion of Forest's direct sales efforts and related promotional activities has significantly increased sales of Forest's branded ethical pharmaceutical products, including certain of those acquired or licensed by Forest. See \"Principal Products\". In the United Kingdom, the Company's Pharmax subsidiary's salesforce, currently 54 persons, markets its products directly. Forest's products are sold elsewhere through independent distributors.\nIn December 1994 and April 1995, the Company entered into two co-promotion agreements with Bock Pharmacal Company pursuant to which the salesforce of Bock Pharmacal Company will promote the products Flumadine and Lorcet 10\/650. In February 1995, the Company entered into a co-promotion agreement with Muro Pharmaceutical, Inc. pursuant to which the salesforce of Muro Pharmaceutical, Inc. will market Aerobid, and the Company's salesforce will promote Volmax-R-, an extended release formulation of albuterol marketed by Muro.\nCOMPETITION\nThe pharmaceutical industry is highly competitive as to the sale of products, research for new or improved products and the development and application of competitive controlled release technologies. There are numerous companies in the United States and abroad engaged in the manufacture and sale of both proprietary and generic drugs of the kind sold by Forest and drugs utilizing controlled release technologies. Many of these companies have substantially greater financial resources than Forest. In addition, the marketing of pharmaceutical products is increasingly affected by the growing role of managed care organizations in the provision of health services. Such organizations negotiate with pharmaceutical manufacturers for highly competitive prices for pharmaceutical products in equivalent therapeutic categories, including certain of the Company's principal promoted products.\nGOVERNMENT REGULATION\nThe pharmaceutical industry is subject to comprehensive government regulation which substantially increases the difficulty and cost incurred in obtaining the approval to market newly proposed drug products and maintaining the approval to market existing drugs. In the United States, products developed, manufactured or sold by Forest are subject to regulation by the FDA, principally under the Federal Food, Drug and Cosmetic Act, as well as by other federal and state agencies. The FDA regulates all aspects of the testing, manufacture, safety, labeling, storage, record keeping, advertising and promotion of new and old drugs, including the monitoring of compliance with good manufacturing practice regulations. Non-compliance with applicable requirements can result in fines and other sanctions, including the initiation of product seizures, injunction actions and criminal prosecutions based on practices that violate statutory requirements. In addition, administrative remedies can involve voluntary recall of products as well as the withdrawal of approval of products in accordance with due process procedures. Similar regulations exist in most foreign countries in which Forest's products are manufactured or sold. In many foreign countries, such as the United Kingdom, reimbursement under\nnational health insurance programs frequently require that manufacturers and sellers of pharmaceutical products obtain governmental approval of initial prices and increases if the ultimate consumer is to be eligible for reimbursement for the cost of such products.\nDuring the past several years the FDA, in accordance with its standard practice, has conducted a number of inspections of the Company's manufacturing facilities. Following these inspections the FDA called the Company's attention to certain \"Good Manufacturing Practices\" compliance and record keeping deficiencies, including warning letters issued April 22, 1994 with respect to Forest's manufacture of Indomethacin. The Company believes it has satisfactorily remedied these deficiencies.\nThe cost of human health care products continues to be a subject of investigation and action by governmental agencies, legislative bodies, and private organizations in the United States and other countries. In the United States, most states have enacted generic substitution legislation requiring or permitting a dispensing pharmacist to substitute a different manufacturer's version of a drug for the one prescribed. Federal and state governments continue to press efforts to reduce costs of Medicare and Medicaid programs, including restrictions on amounts agencies will reimburse for the use of products. Under the Omnibus Budget Reconciliation Act of 1990 (OBRA), manufacturers must pay certain statutorily-prescribed rebates on Medicaid purchases for reimbursement on prescription drugs under state Medicaid plans. Federal Medicaid reimbursement for drug products of original NDA-holders is denied if less expensive generic versions are available from other manufacturers. In addition, the Federal government follows a diagnosis related group (DRG) payment system for certain institutional services provided under Medicare or Medicaid. The DRG system entitles a health care facility to a fixed reimbursement based on discharge diagnoses rather than actual costs incurred in patient treatment, thereby increasing the incentive for the facility to limit or control expenditures for many health care products.\nUnder the Prescription Drug User Fee Act of 1992, the FDA has imposed fees on various aspects of the approval, manufacture and sale of prescription drugs. In 1993, the Clinton Administration presented to Congress a proposal for reforming the United States healthcare system. Other healthcare reform proposals were also introduced in Congress. These proposals were highly regulatory and contain provisions which would affect the marketing of prescription drug products. None of these proposals were enacted in 1994. The debate as to reform of the health care system is expected to be protracted and the Company cannot\npredict the outcome or effect on the marketing of prescription drug products of the legislative process.\nPRINCIPAL CUSTOMERS\nMcKesson Drug Company, a national drug wholesaler, accounted for 11% of Forest's consolidated net sales for the year ended March 31, 1995. No customer accounted for more than 10% of Forest's consolidated net sales in the fiscal years ended March 31, 1994 and March 31, 1993.\nENVIRONMENTAL STANDARDS\nForest anticipates that the effects of compliance with federal, state and local laws and regulations relating to the discharge of materials into the environment will not have any material effect on capital expenditures, earnings or the competitive position of Forest.\nRAW MATERIALS\nThe principal raw materials used by Forest for its various products are purchased in the open market. Most of these materials are obtainable and available from several sources in the United States and elsewhere in the world, although certain of Forest's products contain patented or other exclusively manufactured materials available from only a single source. Forest has not experienced any significant shortages in supplies of such raw materials.\nPRODUCT LIABILITY INSURANCE\nForest currently maintains $100 million of product liability coverage per \"occurrence\" and in the aggregate. Although in the past there have been claims asserted against Forest, none for which Forest has been found liable, there can be no assurance that all potential claims which may be asserted against Forest in the future would be covered by Forest's present insurance.\nRESEARCH AND DEVELOPMENT\nDuring the year ended March 31, 1995, Forest spent $32,010,000 for research and development, as compared to $27,998,000 and $22,054,000 in the fiscal years ended March 31, 1994 and 1993, respectively. Forest's research and development activities during the past year consisted primarily of the conduct of clinical studies required to obtain approval of new products and the development of additional products some of which utilize the Company's controlled release technologies.\nEMPLOYEES\nAt March 31, 1995, Forest had a total of 1,319 employees.\nPATENTS AND TRADEMARKS\nForest owns or licenses certain U.S. and foreign patents on many of its branded products and products in development, including, but not limited to, Aerobid, Cervidil, Monurol, Synapton, Flumadine and Methoxatone (an anti-inflammatory compound being evaluated for use in head trauma and for other uses), which patents expire through 2010. Forest believes these patents are or may become of significant benefit to its business. Additionally, Forest owns and licenses certain U.S. patents, and has pending U.S. and foreign patent applications, relating to various aspects of its Synchron technology and to other controlled release technology, which patents expire through 2008. Forest believes that these patents are useful in its business, however, there are numerous patents and unpatented technologies owned by others covering other controlled release processes.\nForest owns various trademarks and trade names which it believes are of significant benefit to its business.\nBACKLOG -- SEASONALITY\nBacklog of orders is not considered material to Forest's business prospects. Forest's business is not seasonal in nature.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES - ------- ---------- Forest owns six buildings and leases two buildings in and around Inwood, Long Island, New York, containing a total of approximately 133,000 square feet. The buildings are used for manufacturing, research and development, warehousing and administration. In 1993, Forest acquired a 150,000 square foot building on 28 acres in Commack, New York. The building and land are being used for packaging, warehousing and administration.\nForest Pharmaceuticals, Inc. (\"FPI\"), a wholly owned subsidiary of the Company, owns two facilities in Cincinnati, Ohio aggregating approximately 140,000 square feet. In St. Louis, Missouri, FPI owns facilities of 22,000 square feet and 87,000 square feet. These facilities are used for manufacturing, warehousing and administration. The Company sold a facility of approximately 35,000 square feet in St. Louis during 1994.\nPharmax owns an approximately 95,000 square foot complex in the London suburb of Bexley, England, which houses its plant and administrative and central marketing offices. Approximately 15,000 square feet of such space is leased by Pharmax to other tenants.\nForest leases two buildings of 39,250 and 34,400 square feet located in Rio Piedras, Puerto Rico, under leases which expire in 1998 subject to one five-year renewal option. The space is used by Sein-Mendez, Forest Laboratories Caribe, Inc. and Forest Pharmaceuticals, Inc., wholly-owned subsidiaries of Forest, for manufacturing, warehousing and administration.\nForest's Tosara subsidiary owns an 18,000 square foot manufacturing and distribution facility located in an industrial park in Dublin, Ireland. Forest Ireland, a newly-formed subsidiary of Forest, has recently completed the development, together with the Development Authority of the Republic of Ireland, of an approximately 86,000 square foot manufacturing and distribution facility located in Dublin, Ireland. The facility, will be used principally for the manufacture and distribution of products in Europe.\nForest's UAD division owns an 18,000 square foot facility located in Jackson, Mississippi which is presently being used for sales training.\nForest presently leases approximately 75,000 square feet of executive office space at 909 Third Avenue, New York, New York. The lease is for a sixteen (16) year term, subject to 2 five year renewal options.\nManagement believes that the above-described properties are sufficient for Forest's present and anticipated needs.\nNet rentals for leased space for the fiscal year ended March 31, 1995 aggregated approximately $2,220,000 and for the fiscal year ended March 31, 1994 aggregated approximately $1,821,000.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS - ------- ----------------- The Company and certain of its officers are currently defendants in WILSON, ET AL. V. FOREST LABORATORIES, INC., ET AL., 91 Civ. 5815 (S.D.N.Y.) (the \"Federal Action\"), a putative class action that seeks to assert claims based on alleged violations of the Securities Exchange Act of 1934 and common law negligent misrepresentation arising out of certain statements allegedly made by the defendants concerning Micturin.\nThe Company is the nominal defendant in WEISBERG ET ANO V. CANDEE, ET AL., (Sup. Ct. New York Cty.), a putative derivative action against the directors of the Company seeking to void certain options granted to the director defendants and require the director defendants to indemnify the Company for any liability resulting from statements concerning Micturin.\nThe Company believes the claims in both cases are without merit and intends to vigorously defend the actions.\nThe Company is a defendant in actions filed in various federal district courts alleging certain violations of the Federal anti-trust laws in the marketing of pharmaceutical products. In each case, the actions were filed against many pharmaceutical manufacturers and suppliers and allege price discrimination and conspiracy to fix prices in the sale of pharmaceutical products. The actions were brought by various pharmacies (both individually and, with respect to certain claims, as a class action) and seek injunctive relief and monetary damages. The Judicial Panel on Multi-District Litigation has ordered these actions coordinated (and, with respect to those actions brought as class actions, consolidated) in the Federal District Court for the Northern District of Illinois (Chicago) under the caption \"In re Brand Name Prescription Drugs Antitrust Litigation.\" Similar actions alleging price discrimination claims under state law are pending against many pharmaceutical manufacturers, including the Company, in state courts in California, Alabama, Washington, Wisconsin and Minnesota. The Company believes these actions are without merit and intends to defend them vigorously.\nThe Company is not subject to any other material pending legal proceedings, other than ordinary routine claims incidental to its business.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE - ------- OF SECURITY HOLDERS ------------------------------- Not Applicable.\nPAGE\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 by reference to page 28 of the Annual Report.\nForest has never paid cash dividends on its Common Stock and does not expect to pay such dividends in the foreseeable future. Management presently intends to retain all available funds for the development of its business and for use as working capital. Future dividend policy will depend upon Forest's earnings, capital requirements, financial condition and other relevant factors.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA - ------- ----------------------- The information required by this item is incorporated by reference to page 15 of the Annual Report.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND - ------- --------------------------- ANALYSIS OF FINANCIAL CONDITION ------------------------------- AND RESULTS OF OPERATIONS ------------------------- The information required by this item is incorporated by reference to pages 13 and 14 of the Annual Report.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND - ------- ------------------------ SUPPLEMENTARY DATA ------------------ The information required by this item is incorporated by reference to pages 16 through 28 of the Annual Report.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS - ------- ---------------------------- WITH ACCOUNTANTS ON ACCOUNTING ------------------------------ AND FINANCIAL DISCLOSURE ------------------------ Not Applicable.\nPAGE\nPART III --------\nIn accordance with General Instruction G(3), the information called for by Part III (Items 10 through 13) is incorporated by reference from Forest's definitive proxy statement to be filed pursuant to Regulation 14A promulgated under the Securities Exchange Act of 1934 in connection with Forest's 1995 Annual Meeting of Stockholders.\nPAGE\nPART IV ------- ITEM 14.","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES -------- --------------------------------------- AND REPORTS ON FORM 8-K -----------------------\n(a) 1. Financial statements. The following consolidated financial statements of Forest Laboratories, Inc. and subsidiaries included in the Annual Report are incorporated by reference herein in Item 8:\nReport of Independent Certified Public Accountants\nConsolidated balance sheets - March 31, 1995 and 1994\nConsolidated statements of income - years ended March 31, 1995, 1994 and 1993\nConsolidated statements of shareholders' equity - years ended March 31, 1995, 1994 and 1993\nConsolidated statements of cash flows - years ended March 31, 1995, 1994 and 1993\nNotes to consolidated financial statements\n2. Financial statement schedules. The following consolidated financial statement schedules of Forest Laboratories, Inc. and Subsidiaries are included herein:\nReport of Independent Certified Public Accountants S-1\nSchedule II Valuation and qualifying accounts S-2\n-\nAll other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted.\n3. Exhibits:\n(3)(a) Articles of Incorporation of Forest, as amended. Incorporated by reference from the Current Report on Form 8-K dated March 9, 1981 filed by Forest,\nfrom Registration Statement on Form S-1 (Registration No. 2-97792) filed by Forest on May 16, 1985, from Forest's definitive proxy statement filed pursuant to Regulation 14A with respect to Forest's 1987, 1988 and 1993 Annual Meetings of Shareholders and from the Current Report on Form 8-K dated March 15, 1988.\n(3)(b) By-laws of Forest. Incorporated by reference to Forest's Current Report on Form 8-K dated October 11, 1994.\n(10) Material Contracts ------------------ 10.1 Option Agreement and Registration Rights Agreement dated February 18, 1988 between Forest and Howard Solomon. Incorporated by reference to Forest's Annual Report on Form 10-K for the fiscal year ended March 31, 1988 (the \"1988 10-K\").\n10.2 Option Agreement and Registration Rights Agreement dated February 18, 1988 between Forest and Phillip M. Satow. Incorporated by reference to the 1988 10-K.\n10.3 Benefit Continuation Agreement dated as of December 1, 1989 between Forest and Howard Solomon. Incorporated by reference to Forest's Annual Report on Form 10-K for the fiscal year ended March 31, 1990 (the \"1990 l0-K\").\n10.4 Benefit Continuation Agreement dated as of December 1, 1989 between Forest and Joseph M. Schor. Incorporated by reference to the 1990 10-K.\n10.5 Benefit Continuation Agreement dated as of May 27, 1990 between Forest and Kenneth E. Goodman. Incorporated by reference to the 1990 10-K.\n10.6 Benefit Continuation Agreement dated as of April 1, 1995 between Forest and Phillip M. Satow.\n10.7 Option Agreement dated December 10, 1990 between Forest and Howard Solomon. Incorporated by reference to Forest's\nAnnual Report on Form 10-K for the fiscal year ended March 31, 1991 (the \"1991 10-K\").\n10.8 Option Agreement dated December 10, 1990 between Forest and Kenneth E. Goodman. Incorporated by reference to the 1991 10-K.\n10.9 Option Agreement dated December 10, 1990 between Forest and Phillip M. Satow. Incorporated by reference to the 1991 10-K.\n10.10 Split Dollar Life Insurance Agreement dated March 29, 1994 between Forest and Howard Solomon. Incorporated by reference to Forest's Annual Report on Form 10-K for the fiscal year ended March 31, 1994 (the \"1994 10-K\").\n10.11 Split Dollar Life Insurance Agreement dated March 29, 1994 between Forest and Joseph M. Schor. Incorporated by reference to the 1994 10-K.\n10.12 Split Dollar Life Insurance Agreement dated March 29, 1994 between Forest and Phillip M. Satow. Incorporated by reference to the 1994 10-K.\n10.13 Split Dollar Life Insurance Agreement dated March 29, 1994 between Forest and Kenneth E. Goodman. Incorporated by reference to the 1994 10-K.\n10.14 Employment Agreement dated as of January 16, 1995 by and between Forest and Howard Solomon.\n10.15 Employment Agreement dated as of January 16, 1995 by and between Forest and Philip M. Satow.\n10.16 Employment Agreement dated as of January 16, 1995 by and between Forest and Kenneth E. Goodman.\n13 Portions of the Registrant's Annual Report to Stockholders.\n22 List of Subsidiaries. Incorporated by reference to Exhibit 22 to the 1988 10-K.\n23 Consent of BDO Seidman.\n27 Financial Data Schedule.\nPAGE\nSIGNATURES ----------\nPursuant to the requirements of Section 13 and 15(d) of the Securities Exchange Act of 1934, Forest has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nDated: June 27, 1995 FOREST LABORATORIES, INC. -------------------------\nBy: \/s\/Howard Solomon ---------------------------- Howard Solomon, President, Chief Executive Officer and Director\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of Forest and in the capacities and on the dates indicated.\nPRINCIPAL EXECUTIVE - ------------------- OFFICER: - -------\n\/s\/ Howard Solomon President, Chief June 27, 1995 - ---------------------------- Executive Officer Howard Solomon and Director\nPRINCIPAL FINANCIAL - ------------------- AND ACCOUNTING OFFICER: - ----------------------\n\/s\/ Kenneth E. Goodman Vice President, June 27, 1995 - ---------------------------- Finance Kenneth E. Goodman\nDIRECTORS ---------\n\/s\/ George S. Cohan Director June 27, 1995 - ---------------------------- George S. Cohan\n\/s\/William J. Candee, III Director June 27, 1995 - ---------------------------- William J. Candee, III\n\/s\/ Dan L. Goldwasser Director June 27, 1995 - ---------------------------- Dan L. Goldwasser\n\/s\/Joseph M. Schor Director June 27, 1995 - ---------------------------- Joseph Martin Schor\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS - --------------------------------------------------\nBoard of Directors and Shareholders Forest Laboratories, Inc.\nThe audits referred to in our report dated April 28, 1995 relating to the consolidated financial statements of Forest Laboratories, Inc. and Subsidiaries, which is referred to in Item 8 of this Form 10-K, included the audits of the accompanying financial statement schedule. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion of this financial statement schedule based upon our audits.\nIn our opinion, such financial statement schedule presents fairly, in all material respects, the information set forth therein.\nBDO Seidman\nNew York, New York April 28, 1995\nS-1\nSCHEDULE II\nS-2\nEXHIBIT 10.6\nBENEFITS CONTINUATION AGREEMENT ------------------------------- AGREEMENT dated as of April 1, 1995 by and between\nForest Laboratories, Inc., a Delaware corporation, having its\nprincipal executive offices at 909 Third Avenue, New York, New\nYork 10022 (the \"Company\") and Philip M. Satow an individual\nresiding at 1075 Park Avenue, New York, New York 10120 (the\n\"Executive\").\nR E C I T A L S: _ _ _ _ _ _ _ _ A. Executive has served as Executive Vice President-\nMarketing of the Company for more than the past ten years.\nB. The Company recognizes the substantial\ncontributions made by Executive to the development and growth of\nthe Company's business and expects such contributions to\ncontinue. Pursuant to a resolution duly adopted by the Company's\nBoard of Directors, the Company desires to provide certain life-\ntime benefits to Executive and his wife following the termination\nof Executive's employment with the Company.\nC. The parties hereto wish to set forth the terms and\nconditions upon which the Company shall provide such benefits to\nExecutive and his wife.\nNOW, THEREFORE, in consideration of the premises and of\nthe mutual promises herein contained, the parties hereto agree as\nfollows:\n1. In consideration of Executive's services to the\nCompany during the past 10 years and in order to induce the\nExecutive to continue such services as a valuable member of the\nCompany's senior management (subject to the Company's and\nExecutive's continuing right to terminate such services), the\nCompany agrees that from and after the date that Executive's\nemployment with the Company terminates (the \"Termination Date\"),\nwhether by the retirement of Executive or otherwise, the Company\nshall provide to Executive and his wife during his and her\nlifetime, at the sole cost and expense of the Company, the same\nbenefits they enjoy under all health insurance programs (major\nmedical, hospitalization, and dental) of the Company existing on\nthe Termination Date or the date hereof, whichever is more\nbeneficial to Executive or his wife, as the case may be.\n2. The Company may discharge its obligations under\nparagraph 1 above, in whole or in part, by permitting the\nExecutive and his wife to participate in health care insurance\nprograms of the Company or by acquiring other third party health\ncare insurance coverage for the benefit of Executive and his\nwife, all at the sole cost and expense of the Company. Executive\nagrees to cooperate with the Company to the extent necessary for\nExecutive and his wife to participate in such insurance programs\nor for the Company to obtain such other insurance coverage,\nincluding without limitation (i) supplying such information about\nExecutive and his wife as may be reasonably requested by a third\nparty insurer, and (ii) undergoing and causing his wife to\nundergo medical examinations, but not more frequently than once a\nyear. Nothing contained in this paragraph 2 shall be deemed to\nlimit the extent of the benefits required to be provided by the\nCompany under paragraph 1 above. Without limiting the generality\nof the preceding sentence, the failure by the Executive or his\n- 2 -\nwife to meet the medical condition requirement of any third party\ninsurer shall not relieve the Company of its obligations under\nparagraph 1.\n3. Notwithstanding anything to the contrary contained\nin this Agreement, the amount of the benefits required to be\nprovided by the Company at any time shall be reduced to the\nextent comparable health care benefits, if any, are being\nprovided after the Termination Date by a new employer of\nExecutive or any other third party and are then in effect,\nwhether under a health insurance program or otherwise.\n4. Nothing contained herein shall be construed to be\na contract of employment for any term of years, nor as conferring\nupon Executive the right to continue in the employ of the Company\nin any capacity. It is expressly understood by the parties\nhereto that this Agreement relates exclusively to additional\ncompensation for Executive's services, payable after termination\nof his employment with the Company, and is not intended to be an\nemployment contract. 5. The Executive acknowledges that customer lists,\nprocesses, formulae, know-how, technical information and other\nproprietary data and information (the \"Confidential Information\")\npossessed by the Company constitutes a valuable and unique asset\nof the Company. In consideration for the benefits granted to the\nExecutive herein, the Executive agrees that, except (i) as may be\nnecessary or appropriate in connection with the performance of\nhis duties on behalf of the Company or any of its subsidiaries,\n(ii) as may be required by applicable law or regulation or (iii)\n- 3 -\nas may be consented to by the Company, the Executive shall not,\nduring the term of or following his employment by the Company,\ndisclose such Confidential Information to any other person, firm\nor corporation. The term \"Confidential Information\" shall not be\ndeemed to include information which is or becomes generally\navailable or known to the public or the pharmaceutical industry\nother than as a result of the disclosure by the Executive and\nshall not include information the disclosure of which would not\nreasonably be likely to have a demonstrable, material adverse\neffect upon the Company or its business.\n6. Neither Executive nor his wife shall have any\npower or right to transfer, assign, hypothecate or otherwise\nencumber any part or all of the benefits payable hereunder. Any\nsuch attempted assignment or transfer shall be void.\n7. Any decision by the Company denying a claim by the\nEmployee under this Agreement shall be stated in writing and\ndelivered or mailed to Executive. Such decision shall set forth\nthe specific reasons for the denial. In addition, the Company\nshall afford a reasonable opportunity to Executive for a full and\nfair review of the decision denying such claim.\n8. This Agreement may not be amended, altered or\nmodified, except by a written instrument signed by the parties\nhereto, or their respective successors or assigns, and may not be\notherwise terminated except as provided herein. This Agreement\nsupersedes in its entirety that certain agreement dated as of\nDecember 1, 1989 by and between the Company and Executive\nrelating to the subject matter hereof.\n- 4 -\n9. This Agreement shall be binding upon and inure to\nthe benefit of the Company and its successors and assigns, and\nExecutive and his wife and their heirs, executors, administrators\nand beneficiaries.\n10. Any notice, consent or demand required or\npermitted to be given under the provisions of this Agreement\nshall be in writing, and shall be signed by the party giving or\nmaking the same. If such notice, consent or demand is mailed to\na party hereto, it shall be sent by United States certified mail,\npostage prepaid, addressed to such party's last known address as\nshown on records of the Company. The date of such mailing shall\nbe deemed the date of notice, consent or demand.\n11. Any dispute or controversy arising out of or\nrelating to this Agreement or any breach of this Agreement shall\nbe settled by arbitration to be held in the City of New York in\naccordance with the rules then in effect of the American\nArbitration Association (the \"AAA\") or any successor thereto.\nThe arbitration shall be held before a single arbitrator chosen\nby mutual agreement of the parties; provided that if no such\narbitrator is so chosen within 10 days following a demand for\narbitration hereunder, such arbitrator shall be chosen by the AAA\nin accordance with its rules. The decision of the arbitrator\nshall be final, conclusive, and binding on the parties to the\narbitration. Judgment may be entered on the arbitrator's\ndecision in any court having jurisdiction, and the parties\nirrevocably consent to the jurisdiction of the New York State\ncourts for this purpose. The Company shall pay all the costs and\n- 5 -\nexpenses of such arbitration and all the attorneys' fees and\nexpenses of the other parties thereto unless the arbitration\naward evidences a finding that there was no reasonable basis for\nthe position taken by Executive in such proceeding.\n12. If any provision of this Agreement is invalid,\nillegal, or unenforceable, the balance of this Agreement shall\nremain in effect, and if any provision is inapplicable to any\nperson or circumstance, it shall nevertheless remain applicable\nto all other persons and circumstances.\n13. This Agreement, and the rights of the parties\nhereunder, shall be governed by and construed in accordance with\nthe laws of the State of New York.\nIN WITNESS WHEREOF, the parties hereto have executed\nthis Agreement, in duplicate, as of the day and year first above\nwritten.\nFOREST LABORATORIES, INC.\nBy: \/s\/ KENNETH E. GOODMAN _____________________________ KENNETH E. GOODMAN\n\/s\/ PHILIP M. SATOW ----------------------------- PHILIP M. SATOW\nEXHIBIT 10.14\nEMPLOYMENT AGREEMENT --------------------\nAGREEMENT by and between FOREST LABORATORIES, INC. Company, a Delaware corporation (the \"Company\") and HOWARD SOLOMON (the \"Executive\"), dated as of the 16th day of January 1995.\nThe Board of Directors of the Company (the \"Board\") has determined that it is in the best interests of the Company and its shareholders to assure that the Company will have the continued dedication of the Executive, notwithstanding the possibility, threat or occurrence of a Change of Control (as defined below) of the Company. The Board believes it is imperative to diminish the inevitable distraction of the Executive by virtue of the personal uncertainties and risks created by a pending or threatened Change of Control and to encourage the Executive's full attention and dedication to the Company currently and in the event of any threatened or pending Change of Control, and to provide the Executive with compensation and benefits arrangements upon a Change of Control which ensure that the compensation and benefits expectations of the Executive will be satisfied and which are competitive with those of other corporations. Therefore, in order to accomplish these objectives, the Board has caused the Company to enter into this Agreement.\nNOW, THEREFORE, IT IS HEREBY AGREED AS FOLLOWS:\n1. Certain Definitions. ------------------- (a) The \"Effective Date\" shall mean the first date during the Change of Control Period (as defined in Section 1(b)) on which a Change of Control (as defined in Section 2) occurs. Anything in this Agreement to the contrary notwithstanding, if a Change of Control occurs and if the Executives employment with the Company is terminated prior to the date on which the Change of Control occurs, and if it is reasonably demonstrated by the Executive that such termination of employment (i) was at the request of a third party who has taken steps reasonably calculated to effect a Change of Control or (ii) otherwise arose in connection with or anticipation of a Change of Control, then for all purposes of this Agreement the \"Effective Date\" shall mean the date immediately prior to the date of such termination of employment.\n(b) The \"Change of Control Period\" shall mean the period commencing on the date hereof and ending on the third anniversary of the date hereof; provided, however, that commencing on the date one year after the date hereof, and on each annual anniversary of such date (such date and each annual anniversary thereof shall be hereinafter referred to as the \"Renewal Date\"), unless previously terminated, the Change of Control Period shall be automatically extended so as to terminate three years from such Renewal Date, unless at least\n60 days prior to the Renewal Date the Company shall give notice to the Executive that the Change of Control Period shall not be so extended.\n2. Change of Control. For the purpose of this Agreement, a \"Change of ----------------- Control\" shall mean:\n(a) The acquisition by any individual, entity or group (within the meaning of Section 13(d)(3) or 14(d)(2) of the Securities Exchange Act of 1934, as amended (the \"Exchange Act\")) (a \"Person\") of beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Exchange Act) of 20% or more of either (i) the then outstanding shares of common stock of the Company (the \"Outstanding Company Common Stock\") or (ii) the combined voting power of the then outstanding voting securities of the Company entitled to vote generally in the election of directors (the \"Outstanding Company Voting Securities\"); provided, however, that for purposes of this subsection (a), the following acquisitions shall not constitute a Change of Control: (i) any acquisition directly from the Company, (ii) any acquisition by the Company, (iii) any acquisition by any employee benefit plan (or related trust) sponsored or maintained by the Company or any corporation controlled by the Company or (iv) any acquisition by any corporation pursuant to a transaction which complies with clauses (i), (ii) and (iii) of subsection (c) of this Section 2; or\n(b) Individuals who, as of the date hereof, constitute the Board (the \"Incumbent Board\") cease for any reason to constitute at least a majority of the Board; provided, however, that any individual becoming a director subsequent to the date hereof whose election, or nomination for election by the Company's shareholders, was approved by a vote of at least a majority of the directors then comprising the Incumbent Board shall be considered as though such individual were a member of the Incumbent Board, but excluding, for this purpose, any such individual whose initial assumption of office occurs as a result of an actual or threatened election contest with respect to the election or removal of directors or other actual or threatened solicitation of proxies or consents by or on behalf of a Person other than the Board; or\n(c) Consummation of a reorganization, merger or consolidation or sale or other disposition of all or substantially all of the assets of the Company (a \"Business Combination\"), in each case, unless, following such Business Combination, (i) all or substantially all of the individuals and entities who were the beneficial owners, respectively, of the Outstanding Company Common Stock and Outstanding Company Voting Securities immediately prior to such\n- 2 -\nBusiness Combination beneficially own, directly or indirectly, more than 50% of, respectively, the then outstanding shares of common stock and the combined voting power of the then outstanding voting securities entitled to vote generally in the election of directors, as the case may be, of the corporation resulting from such Business Combination (including, without limitation, a corporation which as a result of such transaction owns the Company or all or substantially all of the Company's assets either directly or through one or more subsidiaries) in substantially the same proportions as their ownership, immediately prior to such Business Combination of the Outstanding Company Common Stock and Outstanding Company Voting Securities, as the case may be, (ii) no Person (excluding any corporation resulting from such Business Combination or any employee benefit plan (or related trust) of the Company or such corporation resulting from such Business Combination) beneficially owns, directly or indirectly, 20% or more of, respectively, the then outstanding shares of common stock of the corporation resulting from such Business Combination or the combined voting power of the then outstanding voting securities of such corporation except to the extent that such ownership existed prior to the Business Combination and (iii) at least a majority of the members of the board of directors of the corporation resulting from such Business Combination were members of the Incumbent Board at the time of the execution of the initial agreement, or of the action of the Board, providing for such Business Combination; or\n(d) Approval by the shareholders of the Company of a complete liquidation or dissolution of the Company.\n3. Employment Period. The Company hereby agrees to continue the Executive ----------------- in its employ, and the Executive hereby agrees to remain in the employ of the Company subject to the terms and conditions of this Agreement, for the period commencing on the Effective Date and ending on the third anniversary of such date (the \"Employment Period\").\n4. Terms of Employment. ------------------- (a) Position and Duties. ------------------- (i) During the Employment Period, (A) the Executive's position (including status, offices, titles and reporting requirements), authority, duties and responsibilities shall be at least commensurate in all material respects with the most significant of those held, exercised and assigned at any time during the 120-day period immediately preceding the Effective Date and (B) the Executive's services shall be performed at the location where the Executive was employed immediately preceding the Effective Date or any office or location less than 35 miles from such location.\n(ii) During the Employment Period, and excluding any periods of vacation and sick leave to which the Executive is entitled, the Executive agrees to devote reasonable attention and time during normal business hours to the business and affairs of\n- 3 -\nthe Company and, to the extent necessary to discharge the responsibilities assigned to the Executive hereunder, to use the Executive's reasonable best efforts to perform faithfully and efficiently such responsibilities. During the Employment Period it shall not be a violation of this Agreement for the Executive to (A) serve on corporate, civic or charitable boards or committees, (B) deliver lectures, fulfill speaking engagements or teach at educational institutions and (C) manage personal investments, so long as such activities do not significantly interfere with the performance of the Executives responsibilities as an employee of the Company in accordance with this Agreement. It is expressly understood and agreed that to the extent that any such activities have been conducted by the Executive prior to the Effective Date, the continued conduct of such activities (or the conduct of activities similar in nature and scope thereto) subsequent to the Effective Date shall not thereafter be deemed to interfere with the performance of the Executives responsibilities to the Company.\n(b) Compensation. ------------ (i) Base Salary. During the Employment Period, the Executive shall ----------- receive an annual base salary (\"Annual Base Salary\"), which shall be paid at a monthly rate, at least equal to twelve times the highest monthly base salary paid or payable, including any base salary which has been earned but deferred, to the Executive by the Company and its affiliated companies in respect of the twelve-month period immediately preceding the month in which the Effective Date occurs. During the Employment Period, the Annual Base Salary shall be reviewed no more than 12 months after the last salary increase awarded to the Executive prior to the Effective Date and thereafter at least annually. Any increase in Annual Base Salary shall not serve to limit or reduce any other obligation to the Executive under this Agreement. Annual Base Salary shall not be reduced after any such increase and the term Annual Base Salary as utilized in this Agreement shall refer to Annual Base Salary as so increased. As used in this Agreement, the term \"affiliated companies\" shall include any company controlled by, controlling or under common control with the Company.\n(ii) Annual Bonus. In addition to Annual Base Salary, the ------------ Executive shall be awarded, for each fiscal year ending during the Employment Period, an annual bonus (the \"Annual Bonus\") in cash at least equal to the highest aggregate amount awarded to the Executive under all annual bonus, incentive and other similar plans of the Company with respect to any of the last three full fiscal years prior to the Effective Date (annualized in the event that the Executive was not employed by the Company for the whole of such fiscal\n- 4 -\nyear) (the \"Recent Annual Bonus\"). Each such Annual Bonus shall be paid no later than the end of the third month of the fiscal year next following the fiscal year for which the Annual Bonus is awarded, unless the Executive shall elect to defer the receipt of such Annual Bonus.\n(iii) Incentive, Savings and Retirement Plans. During the --------------------------------------- Employment Period, the Executive shall be entitled to participate in all incentive, savings and retirement plans, practices, policies and programs applicable generally to other peer executives of the Company and its affiliated companies, but in no event shall such plans, practices, policies and programs provide the Executive with incentive opportunities (measured with respect to both regular and special incentive opportunities, to the extent, if any, that such distinction is applicable), savings opportunities and retirement benefit opportunities, in each case, less favorable, in the aggregate, than the most favorable of those provided by the Company and its affiliated companies for the Executive under such plans, practices, policies and programs as in effect at any time during the 120-day period immediately preceding the Effective Date or if more favorable to the Executive, those provided generally at any time after the Effective Date to other peer executives of the Company and its affiliated companies.\n(iv) Welfare Benefit Plans. During the Employment Period, the --------------------- Executive and\/or the Executive's family, as the case may be, shall be eligible for participation in and shall receive all benefits under welfare benefit plans, practices, policies and programs provided by the Company and its affiliated companies (including, without limitation, medical, prescription, dental, disability, employee life, group life, accidental death and travel accident insurance plans and programs) to the extent applicable generally to other peer executives of the Company and its affiliated companies, but in no event shall such plans, practices, policies and programs provide the Executive with benefits which are less favorable in the aggregate, than the most favorable of such plans, practices, policies and programs in effect for the Executive at any time during the 120-day period immediately preceding the Effective Date or, if more favorable to the Executive, those provided generally at any time after the Effective Date to other peer executives of the Company and its affiliated companies.\n(v) Expenses. During the Employment Period, the Executive shall -------- be entitled to receive prompt reimbursement for all reasonable expenses incurred by the Executive in accordance with the most favorable policies, practices and procedures of the Company and its affiliated companies in effect for the Executive at any time during the 120-day period immediately preceding the Effective Date or, if more favorable to the Executive, as in effect generally at\n- 5 -\nany time thereafter with respect to other peer executives of the Company and its affiliated companies.\n(vi) Fringe Benefits. During the Employment Period, the --------------- Executive shall be entitled to fringe benefits, including, without limitation, tax and financial planning services, payment of club dues, and, if applicable, use of an automobile and payment of related expenses, in accordance with the most favorable plans, practices, programs and policies of the Company and its affiliated companies in effect for the Executive at any time during the 120- day period immediately preceding the Effective Date or, if more favorable to the Executive, as in effect generally at any time thereafter with respect to other peer executives of the Company and its affiliated companies.\n(vii) Office and Support Staff. During the Employment Period, the ------------------------ Executive shall be entitled to an office or offices of a size and with furnishings and other appointments, and to exclusive personal secretarial and other assistance, at least equal to the most favorable of the foregoing provided to the Executive by the Company and its affiliated companies at any time during the 120-day period immediately preceding the Effective Date or, if more favorable to the Executive, as provided generally at any time thereafter with respect to other peer executives of the Company and its affiliated companies.\n(viii) Vacation. During the Employment Period, the Executive -------- shall be entitled to paid vacation in accordance with the most favorable plans, policies, programs and practices of the Company and its affiliated companies as in effect for the Executive at any time during the 120-day period immediately preceding the Effective Date or, if more favorable to the Executive, as in effect generally at any time thereafter with respect to other peer executives of the Company and its affiliated companies.\n5. Termination of Employment. ------------------------- (a) Death or Disability. The Executives employment shall terminate ------------------- automatically upon the Executive's death during the Employment Period. If the Company determines in good faith that the Disability of the Executive has occurred during the Employment Period (pursuant to the definition of Disability set forth below), it may give to the Executive written notice in accordance with Section 12(b) of this Agreement of its intention to terminate the Executives employment. In such event, the Executives employment with the Company shall terminate effective on the 30th day after receipt of such notice by the Executive (the \"Disability Effective\n- 6 -\nDate\"), provided that, within the 30 days after such receipt, the Executive shall not have returned to full-time performance of the Executives duties. For purposes of this Agreement, \"Disability\" shall mean the absence of the Executive from the Executives duties with the Company on a full-time basis for 180 consecutive business days as a result of incapacity due to mental or physical illness which is determined to be total and permanent by a physician selected by the Company or its insurers and acceptable to the Executive or the Executives legal representative.\n(b) Cause. The Company may terminate the Executive's employment ----- during the Employment Period for Cause. For purposes of this Agreement, \"Cause\" shall mean:\n(i) the willful and continued failure of the Executive to perform substantially the Executives duties with the Company or one of its affiliates (other than any such failure resulting from incapacity due to physical or mental illness), after a written demand for substantial performance is delivered to the Executive by the Board or the Chief Executive Officer of the Company which specifically identifies the manner in which the Board or Chief Executive Officer believes that the Executive has not substantially performed the Executives duties, or\n(ii) the willful engaging by the Executive in illegal conduct or gross misconduct which is materially and demonstrably injurious to the Company.\nFor purposes of this provision, no act or failure to act, on the part of the Executive, shall be considered \"willful,, unless it is done, or omitted to be done, by the Executive in bad faith or without reasonable belief that the Executive's action or omission was in the best interests of the Company. Any act, or failure to act, based upon authority given pursuant to a resolution duly adopted by the Board or upon the instructions of the Chief Executive Officer or a senior officer of the Company or based upon the advice of counsel for the Company shall be conclusively presumed to be done, or omitted to be done, by the Executive in good faith and in the best interests of the Company. The cessation of employment of the Executive shall not be deemed to be for Cause unless and until there shall have been delivered to the Executive a copy of a resolution duly adopted by the affirmative vote of not less than three-quarters of the entire membership of the Board at a meeting of the Board called and held for such purpose (after reasonable notice is provided to the Executive and the Executive is given an opportunity, together with counsel, to be heard before the Board), finding that, in the good faith opinion of the Board, the Executive is guilty of the conduct described in subparagraph (i) or (ii) above, and specifying the particulars thereof in detail.\n(c) Good Reason. The Executives employment may be terminated by the ----------- Executive for Good Reason. For purposes of this Agreement, \"Good\n- 7 -\nReason\" shall mean:\n(i) the assignment to the Executive of any duties inconsistent in any respect with the Executives position (including status, offices, titles and reporting requirements), authority, duties or responsibilities as contemplated by Section 4(a) of this Agreement, or any other action by the Company which results in a diminution in such position, authority, duties or responsibilities, excluding for this purpose an isolated, insubstantial and inadvertent action not taken in bad faith and which is remedied by the Company promptly after receipt of notice thereof given by the Executive;\n(ii) any failure by the Company to comply with any of the provisions of Section 4(b) of this Agreement, other than an isolated, insubstantial and inadvertent failure not occurring in bad faith and which is remedied by the Company promptly after receipt of notice thereof given by the Executive;\n(iii) the Company's requiring the Executive to be based at any office or location other than as provided in Section 4(a)(i) (B) hereof or the Company's requiring the Executive to travel on Company business to a substantially greater extent than required immediately prior to the Effective Date;\n(iv) any purported termination by the Company of the Executives employment otherwise than as expressly permitted by this Agreement; or\n(v) any failure by the Company to comply with and satisfy Section 11(c) of this Agreement.\nFor purposes of this Section 5(c), any good faith determination of \"Good Reason\" made by the Executive shall be conclusive. Anything in this Agreement to the contrary notwithstanding, a termination by the Executive for any reason during the 30-day period immediately following the first anniversary of the Effective Date shall be deemed to be a termination for Good Reason for all purposes of this Agreement.\n(d) Notice of Termination. Any termination by the Company for Cause, or --------------------- by the Executive for Good Reason, shall be communicated by Notice of Termination to the other party hereto given in accordance with Section 12(b) of this Agreement. For purposes of this Agreement, a \"Notice of Termination\" means a written notice which (i) indicates the specific termination provision in this Agreement relied upon, (ii) to the extent applicable, sets forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of the Executive's employment under the provision so indicated and (iii) if the Date of Termination (as defined below) is other than the date of receipt of such notice, specifies the termination date (which date shall be not more than thirty days after the giving of such notice). The failure by the Executive or the Company to set forth in the Notice of Termination any fact or circumstance which contributes to a showing of Good Reason or\n- 8 -\nCause shall not waive any right of the Executive or the Company, respectively, hereunder or preclude the Executive or the Company, respectively, from asserting such fact or circumstance in enforcing the Executive's or the Company's rights hereunder.\n(e) Date of Termination. \"Date of Termination\" means (i) if the ------------------- Executive's employment is terminated by the Company for Cause, or by the Executive for Good Reason, the date of receipt of the Notice of Termination or any later date specified therein, as the case may be, (ii) if the Executive's employment is terminated by the Company other than for Cause or Disability, the Date of Termination shall be the date on which the Company notifies the Executive of such termination and (iii) if the Executive's employment is terminated by reason of death or Disability, the Date of Termination shall be the date of death of the Executive or the Disability Effective Date, as the case may be.\n6. Obligations of the Company upon Termination. ------------------------------------------- (a) Good Reason; Other Than for Cause, Death or Disability. If, ------------------------------------------------------ during the Employment Period, the Company shall terminate the Executive's employment other than for Cause or Disability or the Executive shall terminate employment for Good Reason:\n(i) the Company shall pay to the Executive in a lump sum in cash within 30 days after the Date of Termination the aggregate of the following amounts:\nA. the sum of (1) the Executive's Annual Base Salary through the Date of Termination to the extent not theretofore paid, (2) the product of (x) the higher of (I) the Recent Annual Bonus and (II) the Annual Bonus paid or payable, including any bonus or portion thereof which has been earned but deferred (and annualized for any fiscal year consisting of less than twelve full months or during which the Executive was employed for less than twelve full months), for the most recently completed fiscal year during the Employment Period, if any (such higher amount being referred to as the \"Highest Annual Bonus\") and (y) a fraction, the numerator of which is the number of days in the current fiscal year through the Date of Termination, and the denominator of which is 365 and (3) any compensation previously deferred by the Executive (together with any accrued interest or earnings thereon) and any accrued vacation pay, in each case to the extent not theretofore paid (the sum of the amounts described in clauses (1), (2), and (3)shall be hereinafter referred to as the \"Accrued Obligations,,); and\nB. the amount equal to the product of (1) three and (2) the sum of (x) the Executives Annual Base Salary and (y)\n- 9 -\nthe Highest Annual Bonus; and\nC. an amount equal to the excess of (a) the actuarial equivalent of the benefit under the Company's qualified defined benefit retirement plan (the \"Retirement Plan\") (utilizing actuarial assumptions no less favorable to the Executive than those in effect under the Company's Retirement Plan immediately prior to the Effective Date), and any excess or supplemental retirement plan in which the Executive participates (together, the \"SERP\") which the Executive would receive if the Executive's employment continued for three years after the Date of Termination assuming for this purpose that all accrued benefits are fully vested, and, assuming that the Executive's compensation in each of the three years is that required by Section 4(b)(i) and Section 4(b)(ii), over (b) the actuarial equivalent of the Executive's actual benefit (paid or payable), if any, under the Retirement Plan and the SERP as of the Date of Termination;\n(ii) for three years after the Executive's Date of Termination, or such longer period as may be provided by the terms of the appropriate plan, program, practice or policy, the Company shall continue benefits to the Executive and\/or the Executive's family at least equal to those which would have been provided to them in accordance with the plans, programs, practices and policies described in Section 4(b)(iv) of this Agreement if the Executive's employment had not been terminated or, if more favorable to the Executive, as in effect generally at any time thereafter with respect to other peer executives of the Company and its affiliated companies and their families, provided, however, that if the Executive becomes reemployed with another employer and is eligible to receive medical or other welfare benefits under another employer provided plan, the medical and other welfare benefits described herein shall be secondary to those provided under such other plan during such applicable period of eligibility. For purposes of determining eligibility (but not the time of commencement of benefits) of the Executive for retiree benefits pursuant to such plans, practices, programs and policies, the Executive shall be considered to have remained employed until three years after the Date of Termination and to have retired on the last day of such period;\n(iii) the Company shall, at its sole expense as incurred, provide the Executive with outplacement services the scope and provider of which shall be selected by the Executive in his sole discretion; and\n(iv) to the extent not theretofore paid or provided, the Company shall timely pay or provide to the Executive any other amounts or benefits required to be paid or provided or which the Executive is eligible to receive under any plan, program, policy or practice or contract or agreement of the Company and its affiliated companies (such other amounts and benefits shall be here-inafter referred to as the \"Other Benefits\").\n- 10 -\n(b) Death. If the Executive's employment is terminated by reason of the ----- Executive's death during the Employment Period, this Agreement shall terminate without further obligations to the Executive's legal representatives under this Agreement, other than for payment of Accrued Obligations and the timely payment or provision of Other Benefits. Accrued Obligations shall be paid to the Executive's estate or beneficiary, as applicable, in a lump sum in cash within 30 days of the Date of Termination. With respect to the provision of Other Benefits, the term Other Benefits as utilized in this Section 6(b) shall include, without limitation, and the Executive's estate and\/or beneficiaries shall be entitled to receive, benefits at least equal to the most favorable benefits provided by the Company and affiliated companies to the estates and beneficiaries of peer executives of the Company and such affiliated companies under such plans, programs, practices and policies relating to death benefits, if any, as in effect with respect to other peer executives and their beneficiaries at any time during the 120-day period immediately preceding the Effective Date or, if more favorable to the Executive's estate and\/or the Executive's beneficiaries, as in effect on the date of the Executive's death with respect to other peer executives of the Company and its affiliated companies and their beneficiaries.\n(c) Disability. If the Executive's employment is terminated by ---------- reason of the Executive's Disability during the Employment Period, this Agreement shall terminate without further obligations to the Executive, other than for payment of Accrued Obligations and the timely payment or provision of Other Benefits. Accrued Obligations shall be paid to the Executive in a lump sum in cash within 30 days of the Date of Termination. With respect to the provision of other Benefits, the term Other Benefits as utilized in this Section 6(c) shall include, and the Executive shall be entitled after the Disability Effective Date to receive, disability and other benefits at least equal to the most favorable of those generally provided by the Company and its affiliated companies to disabled executives and\/or their families in accordance with such plans, programs, practices and policies relating to disability, if any, as in effect generally with respect to other peer executives and their families at any time during the 120-day period immediately preceding the Effective Date or, if more favorable to the Executive and\/or the Executive's family, as in effect at any time thereafter generally with respect to other peer executives of the Company and its affiliated companies and their families.\n(d) Cause; Other than for Good Reason. If the Executive's employment --------------------------------- shall be terminated for Cause during the Employment Period, this Agreement shall terminate without further obligations to the Executive other than the obligation to pay to the Executive (x) his Annual Base Salary through the Date of Termination, (y) the amount of any compensation previously deferred by the\n- 11 -\nExecutive, and (z) Other Benefits, in each case to the extent theretofore unpaid. If the Executive voluntarily terminates employment during the Employment Period, excluding a termination for Good Reason, this Agreement shall terminate without further obligations to the Executive, other than for Accrued Obligations and the timely payment or provision of Other Benefits. In such case, all Accrued Obligations shall be paid to the Executive in a lump sum in cash within 30 days of the Date of Termination.\n7. Non-exclusivity of Rights. Nothing in this Agreement shall prevent ------------------------- or limit the Executive's continuing or future participation in any plan, program, policy or practice provided by the Company or any of its affiliated companies and for which the Executive may qualify, nor, subject to Section 12(f), shall anything herein limit or otherwise affect such rights as the Executive may have under any contract or agreement with the Company or any of its affiliated companies. Amounts which are vested benefits or which the Executive is otherwise entitled to receive under any plan, policy, practice or program of or any contract or agreement with the Company or any of its affiliated companies at or subsequent to the Date of Termination shall be payable in accordance with such plan, policy, practice or program or contract or agreement except as explicitly modified by this Agreement.\n8. Full Settlement. The Company's obligation to make the payments --------------- provided for in this Agreement and otherwise to perform its obligations hereunder shall not be affected by any set-off, counterclaim, recoupment, defense or other claim, right or action which the Company may have against the Executive or others. In no event shall the Executive be obligated to seek other employment or take any other action by way of mitigation of the amounts payable to the Executive under any of the provisions of this Agreement and such amounts shall not be reduced whether or not the Executive obtains other employment. The Company agrees to pay as incurred, to the full extent permitted by law, all legal fees and expenses which the Executive may reasonably incur as a result of any contest (regardless of the outcome thereof) by the Company, the Executive or others of the validity or enforceability of, or liability under, any provision of this Agreement or any guarantee of performance thereof (including as a result of any contest by the Executive about the amount of any payment pursuant to this Agreement), plus in each case interest on any delayed payment at the applicable Federal rate provided for in Section 7872(f)(2)(A) of the Internal Revenue Code of 1986, as amended (the \"Code\").\n9. Certain Reductions of Payments ------------------------------ (a) Anything in this Agreement to the contrary not-withstanding, in the event it shall be determined that any payment or distribution by the Company to or for the benefit of the Executive (whether paid or payable or distributed or distributable pursuant to the terms of\n- 12 -\nthis Agreement or otherwise) (a \"Payment\") would be nondeductible by the Company for Federal income tax purposes because of Section 28OG of the Code, then the aggregate present value of amounts payable or distributable to or for the benefit of the Executive pursuant to this Agreement (such payments or distributions pursuant to this Agreement are hereinafter referred to as \"Agreement Payments\") shall be reduced (but not below zero) to the Reduced Amount. The \"Reduced Amount\" shall be an amount expressed in present value which maximizes the aggregate present value of Agreement Payments without causing any Payment to be nondeductible by the Company because of Section 28OG of the Code. For purposes of this Section 9 present value shall be determined in accordance with Section 28OG(d)(4) of the Code.\n(b) All determinations required to be made under this Section 9 shall be made by BDO Seidman (the \"Accounting Firm\") which shall provide detailed supporting calculations both to the Company and the Executive within 15 business days of the Date of Termination or such earlier time as is requested by the Company. Any such determination by the Accounting Firm shall be binding upon the Company and the Executive. The Executive shall determine which and how much of the Agreement Payments (or, at the election of the Executive, other payments) shall be eliminated or reduced consistent with the requirements of this Section 9, provided that, if the Executive does not make such determination within ten business days of the receipt of the calculations made by the Accounting Firm, the Company shall elect which and how much of the Agreement Payments shall be eliminated or reduced consistent with the requirements of this Section 9 and shall notify the Executive promptly of such election. Within five business days thereafter, the Company shall pay to or distribute to or for the benefit of the Executive such amounts as are then due to the Executive under this Agreement.\n(c) As a result of the uncertainty in the application of Section 28OG of the Code at the time of the initial determination by the Accounting Firm hereunder, it is possible that Agreement Payments will have been made by the Company which should not have been made (\"Overpayment\") or that additional Agreement Payments which will have not been made by the Company could have been made (\"Underpayment\"), in each case, consistent with the calculations required to be made hereunder. In the event that the Accounting Firm determines that an Overpayment has been made, any such Overpayment shall be treated for all purposes as a loan to the Executive which the Executive shall repay to the Company together with interest at the applicable Federal rate provided for in Section 7872(f)(2) of the Code; provided, however, that no amount shall be payable by the Executive to the Company (or if paid by the Executive to the Company shall be returned to the Executive) if and to the extent such payment would not reduce the amount which is subject to taxation under Section 4999 of the Code. In the event that the Accounting Firm determines that an Underpayment has occurred, any such Underpayment shall be promptly paid by the Company to or for the benefit of the Executive together with interest at the applicable Federal rate provided for in Section 7872(f)(2) of the Code.\n- 13 -\n10. Confidential Information. The Executive shall hold in a fiduciary ------------------------ capacity for the benefit of the Company all secret or confidential information, knowledge or data relating to the Company or any of its affiliated companies, and their respective businesses, which shall have been obtained by the Executive during the Executive's employment by the Company or any of its affiliated companies and which shall not be or become public knowledge (other than by acts by the Executive or representatives of the Executive in violation of this Agreement). After termination of the Executive's employment with the Company, the Executive shall not, without the prior written consent of the Company or as may otherwise be required by law or legal process, communicate or divulge any such information, knowledge or data to anyone other than the Company and those designated by it. In no event shall an asserted violation of the provisions of this Section 10 constitute a basis for deferring or withholding any amounts otherwise payable to the Executive under this Agreement.\n11. Successors. ---------- (a) This Agreement is personal to the Executive and without the prior written consent of the Company shall not be assignable by the Executive otherwise than by will or the laws of descent and distribution. This Agreement shall inure to the benefit of and be enforceable by the Executive's legal representatives.\n(b) This Agreement shall inure to the benefit of and be binding upon the Company and its successors and assigns.\n(c) The Company will require any successor (whether direct or indirect, by purchase,merger, consolidation or otherwise) to all or substantially all of the business and\/or assets of the Company to assume expressly and agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform it if no such succession had taken place. As used in this Agreement, \"Company\" shall mean the-Company as hereinbefore defined and any successor to its business and\/or assets as aforesaid which assumes and agrees to perform this Agreement by operation of law, or otherwise.\n12. Miscellaneous. ------------- (a) This Agreement shall be governed by and construed in accordance with the laws of the State of New York, without reference to principles of conflict of laws. The captions of this Agreement are not part of the provisions hereof and shall have no force or effect. This Agreement may not be amended or modified otherwise than by a written agreement executed by the parties hereto or their respective successors and legal representatives.\n- 14 -\n(b) All notices and other communications hereunder shall be in writing and shall be given by hand delivery to the other party or by registered or certified mail, return receipt requested, postage prepaid, addressed as follows:\nIf to the Executive: ------------------- Howard Solomon 160 East 72nd Street New York, NY 10021\nIf to the Company: ----------------- Forest Laboratories, Inc. Attention: President 909 Third Avenue New York, New York 10022\nor to such other address as either party shall have furnished to the other in writing in accordance herewith. Notice and communications shall be effective when actually received by the addressee.\n(c) The invalidity or unenforceability of any provision of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement.\n(d) The Company may withhold from any amounts payable under this Agreement such Federal, state, local or foreign taxes as shall be required to be withheld pursuant to any applicable law or regulation.\n(e) The Executive's or the Company's failure to insist upon strict compliance with any provision of this Agreement or the failure to assert any right the Executive or the Company may have hereunder, including, without limitation, the right of the Executive to terminate employment for Good Reason pursuant to Section 5(c)(i)-(v) of this Agreement, shall not be deemed to be a waiver of such provision or right or any other provision or right of this Agreement.\n(f) The Executive and the Company acknowledge that, except as may otherwise be provided under any other written agreement between the Executive and the Company, the employment of the Executive by the Company is \"at will\" and, subject to Section i(a) hereof, prior to the Effective Date, the Executive's employment and\/or this Agreement may be terminated by either the Executive or the Company at any time prior to the Effective Date, in which case the Executive shall have no further rights under this Agreement. From and after the Effective Date this Agreement shall supersede any other agreement between the parties with respect to the subject matter hereof.\nIN WITNESS WHEREOF, the Executive has hereunto set the Executive's hand and, - ------------------ pursuant to the authorization from its Board of Directors, the Company has caused these presents to be executed in its name on its behalf, all as of the day and year first above written.\n\/s\/HOWARD SOLOMON ----------------------------------- HOWARD SOLOMON\nFOREST LABORATORIES, INC. By:\n\/s\/KENNETH E. GOODMAN ------------------------------------- KENNETH E. GOODMAN Vice President-Finance\nEXHIBIT 10.15\nEMPLOYMENT AGREEMENT --------------------\nAGREEMENT by and between FOREST LABORATORIES, INC. Company, a Delaware corporation (the \"Company\") and PHILLIP M. SATOW (the \"Executive\"), dated as of the 16th day of January 1995.\nThe Board of Directors of the Company (the \"Board\") has determined that it is in the best interests of the Company and its shareholders to assure that the Company will have the continued dedication of the Executive, notwithstanding the possibility, threat or occurrence of a Change of Control (as defined below) of the Company. The Board believes it is imperative to diminish the inevitable distraction of the Executive by virtue of the personal uncertainties and risks created by a pending or threatened Change of Control and to encourage the Executive's full attention and dedication to the Company currently and in the event of any threatened or pending Change of Control, and to provide the Executive with compensation and benefits arrangements upon a Change of Control which ensure that the compensation and benefits expectations of the Executive will be satisfied and which are competitive with those of other corporations. Therefore, in order to accomplish these objectives, the Board has caused the Company to enter into this Agreement.\nNOW, THEREFORE, IT IS HEREBY AGREED AS FOLLOWS:\n1. Certain Definitions. ------------------- (a) The \"Effective Date\" shall mean the first date during the Change of Control Period (as defined in Section 1(b)) on which a Change of Control (as defined in Section 2) occurs. Anything in this Agreement to the contrary notwithstanding, if a Change of Control occurs and if the Executives employment with the Company is terminated prior to the date on which the Change of Control occurs, and if it is reasonably demonstrated by the Executive that such termination of employment (i) was at the request of a third party who has taken steps reasonably calculated to effect a Change of Control or (ii) otherwise arose in connection with or anticipation of a Change of Control, then for all purposes of this Agreement the \"Effective Date\" shall mean the date immediately prior to the date of such termination of employment.\n(b) The \"Change of Control Period\" shall mean the period commencing on the date hereof and ending on the third anniversary of the date hereof; provided, however, that commencing on the date one year after the date hereof, and on each annual anniversary of such date (such date and each annual anniversary thereof shall be hereinafter referred to as the \"Renewal Date\"), unless previously terminated, the Change of Control Period shall be automatically extended so as to terminate three years from such Renewal Date, unless at least\n60 days prior to the Renewal Date the Company shall give notice to the Executive that the Change of Control Period shall not be so extended.\n2. Change of Control. For the purpose of this Agreement, a \"Change of ----------------- Control\" shall mean:\n(a) The acquisition by any individual, entity or group (within the meaning of Section 13(d)(3) or 14(d)(2) of the Securities Exchange Act of 1934, as amended (the \"Exchange Act\")) (a \"Person\") of beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Exchange Act) of 20% or more of either (i) the then outstanding shares of common stock of the Company (the \"Outstanding Company Common Stock\") or (ii) the combined voting power of the then outstanding voting securities of the Company entitled to vote generally in the election of directors (the \"Outstanding Company Voting Securities\"); provided, however, that for purposes of this subsection (a), the following acquisitions shall not constitute a Change of Control: (i) any acquisition directly from the Company, (ii) any acquisition by the Company, (iii) any acquisition by any employee benefit plan (or related trust) sponsored or maintained by the Company or any corporation controlled by the Company or (iv) any acquisition by any corporation pursuant to a transaction which complies with clauses (i), (ii) and (iii) of subsection (c) of this Section 2; or\n(b) Individuals who, as of the date hereof, constitute the Board (the \"Incumbent Board\") cease for any reason to constitute at least a majority of the Board; provided, however, that any individual becoming a director subsequent to the date hereof whose election, or nomination for election by the Company's shareholders, was approved by a vote of at least a majority of the directors then comprising the Incumbent Board shall be considered as though such individual were a member of the Incumbent Board, but excluding, for this purpose, any such individual whose initial assumption of office occurs as a result of an actual or threatened election contest with respect to the election or removal of directors or other actual or threatened solicitation of proxies or consents by or on behalf of a Person other than the Board; or\n(c) Consummation of a reorganization, merger or consolidation or sale or other disposition of all or substantially all of the assets of the Company (a \"Business Combination\"), in each case, unless, following such Business Combination, (i) all or substantially all of the individuals and entities who were the beneficial owners, respectively, of the Outstanding Company Common Stock and Outstanding Company Voting Securities immediately prior to such\n- 2 -\nBusiness Combination beneficially own, directly or indirectly, more than 50% of, respectively, the then outstanding shares of common stock and the combined voting power of the then outstanding voting securities entitled to vote generally in the election of directors, as the case may be, of the corporation resulting from such Business Combination (including, without limitation, a corporation which as a result of such transaction owns the Company or all or substantially all of the Company's assets either directly or through one or more subsidiaries) in substantially the same proportions as their ownership, immediately prior to such Business Combination of the Outstanding Company Common Stock and Outstanding Company Voting Securities, as the case may be, (ii) no Person (excluding any corporation resulting from such Business Combination or any employee benefit plan (or related trust) of the Company or such corporation resulting from such Business Combination) beneficially owns, directly or indirectly, 20% or more of, respectively, the then outstanding shares of common stock of the corporation resulting from such Business Combination or the combined voting power of the then outstanding voting securities of such corporation except to the extent that such ownership existed prior to the Business Combination and (iii) at least a majority of the members of the board of directors of the corporation resulting from such Business Combination were members of the Incumbent Board at the time of the execution of the initial agreement, or of the action of the Board, providing for such Business Combination; or\n(d) Approval by the shareholders of the Company of a complete liquidation or dissolution of the Company.\n3. Employment Period. The Company hereby agrees to continue the Executive ----------------- in its employ, and the Executive hereby agrees to remain in the employ of the Company subject to the terms and conditions of this Agreement, for the period commencing on the Effective Date and ending on the third anniversary of such date (the \"Employment Period\").\n4. Terms of Employment. ------------------- (a) Position and Duties. ------------------- (i) During the Employment Period, (A) the Executive's position (including status, offices, titles and reporting requirements), authority, duties and responsibilities shall be at least commensurate in all material respects with the most significant of those held, exercised and assigned at any time during the 120-day period immediately preceding the Effective Date and (B) the Executive's services shall be performed at the location where the Executive was employed immediately preceding the Effective Date or any office or location less than 35 miles from such location.\n(ii) During the Employment Period, and excluding any periods of vacation and sick leave to which the Executive is entitled, the Executive agrees to devote reasonable attention and time during normal business hours to the business and affairs of\n- 3 -\nthe Company and, to the extent necessary to discharge the responsibilities assigned to the Executive hereunder, to use the Executive's reasonable best efforts to perform faithfully and efficiently such responsibilities. During the Employment Period it shall not be a violation of this Agreement for the Executive to (A) serve on corporate, civic or charitable boards or committees, (B) deliver lectures, fulfill speaking engagements or teach at educational institutions and (C) manage personal investments, so long as such activities do not significantly interfere with the performance of the Executives responsibilities as an employee of the Company in accordance with this Agreement. It is expressly understood and agreed that to the extent that any such activities have been conducted by the Executive prior to the Effective Date, the continued conduct of such activities (or the conduct of activities similar in nature and scope thereto) subsequent to the Effective Date shall not thereafter be deemed to interfere with the performance of the Executives responsibilities to the Company.\n(b) Compensation. ------------ (i) Base Salary. During the Employment Period, the Executive shall ----------- receive an annual base salary (\"Annual Base Salary\"), which shall be paid at a monthly rate, at least equal to twelve times the highest monthly base salary paid or payable, including any base salary which has been earned but deferred, to the Executive by the Company and its affiliated companies in respect of the twelve-month period immediately preceding the month in which the Effective Date occurs. During the Employment Period, the Annual Base Salary shall be reviewed no more than 12 months after the last salary increase awarded to the Executive prior to the Effective Date and thereafter at least annually. Any increase in Annual Base Salary shall not serve to limit or reduce any other obligation to the Executive under this Agreement. Annual Base Salary shall not be reduced after any such increase and the term Annual Base Salary as utilized in this Agreement shall refer to Annual Base Salary as so increased. As used in this Agreement, the term \"affiliated companies\" shall include any company controlled by, controlling or under common control with the Company.\n(ii) Annual Bonus. In addition to Annual Base Salary, the ------------ Executive shall be awarded, for each fiscal year ending during the Employment Period, an annual bonus (the \"Annual Bonus\") in cash at least equal to the highest aggregate amount awarded to the Executive under all annual bonus, incentive and other similar plans of the Company with respect to any of the last three full fiscal years prior to the Effective Date (annualized in the event that the Executive was not employed by the Company for the whole of such fiscal\n- 4 -\nyear) (the \"Recent Annual Bonus\"). Each such Annual Bonus shall be paid no later than the end of the third month of the fiscal year next following the fiscal year for which the Annual Bonus is awarded, unless the Executive shall elect to defer the receipt of such Annual Bonus.\n(iii) Incentive, Savings and Retirement Plans. During the --------------------------------------- Employment Period, the Executive shall be entitled to participate in all incentive, savings and retirement plans, practices, policies and programs applicable generally to other peer executives of the Company and its affiliated companies, but in no event shall such plans, practices, policies and programs provide the Executive with incentive opportunities (measured with respect to both regular and special incentive opportunities, to the extent, if any, that such distinction is applicable), savings opportunities and retirement benefit opportunities, in each case, less favorable, in the aggregate, than the most favorable of those provided by the Company and its affiliated companies for the Executive under such plans, practices, policies and programs as in effect at any time during the 120-day period immediately preceding the Effective Date or if more favorable to the Executive, those provided generally at any time after the Effective Date to other peer executives of the Company and its affiliated companies.\n(iv) Welfare Benefit Plans. During the Employment Period, the --------------------- Executive and\/or the Executive's family, as the case may be, shall be eligible for participation in and shall receive all benefits under welfare benefit plans, practices, policies and programs provided by the Company and its affiliated companies (including, without limitation, medical, prescription, dental, disability, employee life, group life, accidental death and travel accident insurance plans and programs) to the extent applicable generally to other peer executives of the Company and its affiliated companies, but in no event shall such plans, practices, policies and programs provide the Executive with benefits which are less favorable in the aggregate, than the most favorable of such plans, practices, policies and programs in effect for the Executive at any time during the 120-day period immediately preceding the Effective Date or, if more favorable to the Executive, those provided generally at any time after the Effective Date to other peer executives of the Company and its affiliated companies.\n(v) Expenses. During the Employment Period, the Executive shall be entitled to receive prompt reimbursement for all reasonable expenses incurred by the Executive in accordance with the most favorable policies, practices and procedures of the Company and its affiliated companies in effect for the Executive at any time during the 120-day period immediately preceding the Effective Date or, if more favorable to the Executive, as in effect generally at\n- 5 -\nany time thereafter with respect to other peer executives of the Company and its affiliated companies.\n(vi) Fringe Benefits. During the Employment Period, the --------------- Executive shall be entitled to fringe benefits, including, without limitation, tax and financial planning services, payment of club dues, and, if applicable, use of an automobile and payment of related expenses, in accordance with the most favorable plans, practices, programs and policies of the Company and its affiliated companies in effect for the Executive at any time during the 120- day period immediately preceding the Effective Date or, if more favorable to the Executive, as in effect generally at any time thereafter with respect to other peer executives of the Company and its affiliated companies.\n(vii) Office and Support Staff. During the Employment Period, the Executive shall be entitled to an office or offices of a size and with furnishings and other appointments, and to exclusive personal secretarial and other assistance, at least equal to the most favorable of the foregoing provided to the Executive by the Company and its affiliated companies at any time during the 120-day period immediately preceding the Effective Date or, if more favorable to the Executive, as provided generally at any time thereafter with respect to other peer executives of the Company and its affiliated companies.\n(viii) Vacation. During the Employment Period, the Executive -------- shall be entitled to paid vacation in accordance with the most favorable plans, policies, programs and practices of the Company and its affiliated companies as in effect for the Executive at any time during the 120-day period immediately preceding the Effective Date or, if more favorable to the Executive, as in effect generally at any time thereafter with respect to other peer executives of the Company and its affiliated companies.\n5. Termination of Employment. ------------------------- (a) Death or Disability. The Executives employment shall terminate automatically upon the Executive's death during the Employment Period. If the Company determines in good faith that the Disability of the Executive has occurred during the Employment Period (pursuant to the definition of Disability set forth below), it may give to the Executive written notice in accordance with Section 12(b) of this Agreement of its intention to terminate the Executives employment. In such event, the Executives employment with the Company shall terminate effective on the 30th day after receipt of such notice by the Executive (the \"Disability Effective\n- 6 -\nDate\"), provided that, within the 30 days after such receipt, the Executive shall not have returned to full-time performance of the Executives duties. For purposes of this Agreement, \"Disability\" shall mean the absence of the Executive from the Executives duties with the Company on a full-time basis for 180 consecutive business days as a result of incapacity due to mental or physical illness which is determined to be total and permanent by a physician selected by the Company or its insurers and acceptable to the Executive or the Executives legal representative.\n(b) Cause. The Company may terminate the Executive's employment\nduring the Employment Period for Cause. For purposes of this Agreement, \"Cause\" shall mean:\n(i) the willful and continued failure of the Executive to perform substantially the Executives duties with the Company or one of its affiliates (other than any such failure resulting from incapacity due to physical or mental illness), after a written demand for substantial performance is delivered to the Executive by the Board or the Chief Executive Officer of the Company which specifically identifies the manner in which the Board or Chief Executive Officer believes that the Executive has not substantially performed the Executives duties, or\n(ii) the willful engaging by the Executive in illegal conduct or gross misconduct which is materially and demonstrably injurious to the Company.\nFor purposes of this provision, no act or failure to act, on the part of the Executive, shall be considered \"willful,, unless it is done, or omitted to be done, by the Executive in bad faith or without reasonable belief that the Executive's action or omission was in the best interests of the Company. Any act, or failure to act, based upon authority given pursuant to a resolution duly adopted by the Board or upon the instructions of the Chief Executive Officer or a senior officer of the Company or based upon the advice of counsel for the Company shall be conclusively presumed to be done, or omitted to be done, by the Executive in good faith and in the best interests of the Company. The cessation of employment of the Executive shall not be deemed to be for Cause unless and until there shall have been delivered to the Executive a copy of a resolution duly adopted by the affirmative vote of not less than three-quarters of the entire membership of the Board at a meeting of the Board called and held for such purpose (after reasonable notice is provided to the Executive and the Executive is given an opportunity, together with counsel, to be heard before the Board), finding that, in the good faith opinion of the Board, the Executive is guilty of the conduct described in subparagraph (i) or (ii) above, and specifying the particulars thereof in detail.\n(c) Good Reason. The Executives employment may be terminated by the ----------- Executive for Good Reason. For purposes of this Agreement, \"Good\n- 7 -\nReason\" shall mean:\n(i) the assignment to the Executive of any duties inconsistent in any respect with the Executives position (including status, offices, titles and reporting requirements), authority, duties or responsibilities as contemplated by Section 4(a) of this Agreement, or any other action by the Company which results in a diminution in such position, authority, duties or responsibilities, excluding for this purpose an isolated, insubstantial and inadvertent action not taken in bad faith and which is remedied by the Company promptly after receipt of notice thereof given by the Executive;\n(ii) any failure by the Company to comply with any of the provisions of Section 4(b) of this Agreement, other than an isolated, insubstantial and inadvertent failure not occurring in bad faith and which is remedied by the Company promptly after receipt of notice thereof given by the Executive;\n(iii) the Company's requiring the Executive to be based at any office or location other than as provided in Section 4(a)(i) (B) hereof or the Company's requiring the Executive to travel on Company business to a substantially greater extent than required immediately prior to the Effective Date;\n(iv) any purported termination by the Company of the Executives employment otherwise than as expressly permitted by this Agreement; or\n(v) any failure by the Company to comply with and satisfy Section 11(c) of this Agreement.\nFor purposes of this Section 5(c), any good faith determination of \"Good Reason\" made by the Executive shall be conclusive. Anything in this Agreement to the contrary notwithstanding, a termination by the Executive for any reason during the 30-day period immediately following the first anniversary of the Effective Date shall be deemed to be a termination for Good Reason for all purposes of this Agreement.\n(d) Notice of Termination. Any termination by the Company for Cause, or --------------------- by the Executive for Good Reason, shall be communicated by Notice of Termination to the other party hereto given in accordance with Section 12(b) of this Agreement. For purposes of this Agreement, a \"Notice of Termination\" means a written notice which (i) indicates the specific termination provision in this Agreement relied upon, (ii) to the extent applicable, sets forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of the Executive's employment under the provision so indicated and (iii) if the Date of Termination (as defined below) is other than the date of receipt of such notice, specifies the termination date (which date shall be not more than thirty days after the giving of such notice). The failure by the Executive or the Company to set forth in the Notice of Termination any fact or circumstance which contributes to a showing of Good Reason or\n- 8 -\nCause shall not waive any right of the Executive or the Company, respectively, hereunder or preclude the Executive or the Company, respectively, from asserting such fact or circumstance in enforcing the Executive's or the Company's rights hereunder.\n(e) Date of Termination. \"Date of Termination\" means (i) if the ------------------- Executive's employment is terminated by the Company for Cause, or by the Executive for Good Reason, the date of receipt of the Notice of Termination or any later date specified therein, as the case may be, (ii) if the Executive's employment is terminated by the Company other than for Cause or Disability, the Date of Termination shall be the date on which the Company notifies the Executive of such termination and (iii) if the Executive's employment is terminated by reason of death or Disability, the Date of Termination shall be the date of death of the Executive or the Disability Effective Date, as the case may be.\n6. Obligations of the Company upon Termination. ------------------------------------------- (a) Good Reason; Other Than for Cause, Death or Disability. If, ------------------------------------------------------ during the Employment Period, the Company shall terminate the Executive's employment other than for Cause or Disability or the Executive shall terminate employment for Good Reason:\n(i) the Company shall pay to the Executive in a lump sum in cash within 30 days after the Date of Termination the aggregate of the following amounts:\nA. the sum of (1) the Executive's Annual Base Salary through the Date of Termination to the extent not theretofore paid, (2) the product of (x) the higher of (I) the Recent Annual Bonus and (II) the Annual Bonus paid or payable, including any bonus or portion thereof which has been earned but deferred (and annualized for any fiscal year consisting of less than twelve full months or during which the Executive was employed for less than twelve full months), for the most recently completed fiscal year during the Employment Period, if any (such higher amount being referred to as the \"Highest Annual Bonus\") and (y) a fraction, the numerator of which is the number of days in the current fiscal year through the Date of Termination, and the denominator of which is 365 and (3) any compensation previously deferred by the Executive (together with any accrued interest or earnings thereon) and any accrued vacation pay, in each case to the extent not theretofore paid (the sum of the amounts described in clauses (1), (2), and (3)shall be hereinafter referred to as the \"Accrued Obligations,,); and\nB. the amount equal to the product of (1) three and (2) the sum of (x) the Executives Annual Base Salary and (y)\n- 9 -\nthe Highest Annual Bonus; and\nC. an amount equal to the excess of (a) the actuarial equivalent of the benefit under the Company's qualified defined benefit retirement plan (the \"Retirement Plan\") (utilizing actuarial assumptions no less favorable to the Executive than those in effect under the Company's Retirement Plan immediately prior to the Effective Date), and any excess or supplemental retirement plan in which the Executive participates (together, the \"SERP\") which the Executive would receive if the Executive's employment continued for three years after the Date of Termination assuming for this purpose that all accrued benefits are fully vested, and, assuming that the Executive's compensation in each of the three years is that required by Section 4(b)(i) and Section 4(b)(ii), over (b) the actuarial equivalent of the Executive's actual benefit (paid or payable), if any, under the Retirement Plan and the SERP as of the Date of Termination;\n(ii) for three years after the Executive's Date of Termination, or such longer period as may be provided by the terms of the appropriate plan, program, practice or policy, the Company shall continue benefits to the Executive and\/or the Executive's family at least equal to those which would have been provided to them in accordance with the plans, programs, practices and policies described in Section 4(b)(iv) of this Agreement if the Executive's employment had not been terminated or, if more favorable to the Executive, as in effect generally at any time thereafter with respect to other peer executives of the Company and its affiliated companies and their families, provided, however, that if the Executive becomes reemployed with another employer and is eligible to receive medical or other welfare benefits under another employer provided plan, the medical and other welfare benefits described herein shall be secondary to those provided under such other plan during such applicable period of eligibility. For purposes of determining eligibility (but not the time of commencement of benefits) of the Executive for retiree benefits pursuant to such plans, practices, programs and policies, the Executive shall be considered to have remained employed until three years after the Date of Termination and to have retired on the last day of such period;\n(iii) the Company shall, at its sole expense as incurred, provide the Executive with outplacement services the scope and provider of which shall be selected by the Executive in his sole discretion; and\n(iv) to the extent not theretofore paid or provided, the Company shall timely pay or provide to the Executive any other amounts or benefits required to be paid or provided or which the Executive is eligible to receive under any plan, program, policy or practice or contract or agreement of the Company and its affiliated companies (such other amounts and benefits shall be here-inafter referred to as the \"Other Benefits\").\n- 10 -\n(b) Death. If the Executive's employment is terminated by reason of the Executive's death during the Employment Period, this Agreement shall terminate without further obligations to the Executive's legal representatives under this Agreement, other than for payment of Accrued Obligations and the timely payment or provision of Other Benefits. Accrued Obligations shall be paid to the Executive's estate or beneficiary, as applicable, in a lump sum in cash within 30 days of the Date of Termination. With respect to the provision of Other Benefits, the term Other Benefits as utilized in this Section 6(b) shall include, without limitation, and the Executive's estate and\/or beneficiaries shall be entitled to receive, benefits at least equal to the most favorable benefits provided by the Company and affiliated companies to the estates and beneficiaries of peer executives of the Company and such affiliated companies under such plans, programs, practices and policies relating to death benefits, if any, as in effect with respect to other peer executives and their beneficiaries at any time during the 120-day period immediately preceding the Effective Date or, if more favorable to the Executive's estate and\/or the Executive's beneficiaries, as in effect on the date of the Executive's death with respect to other peer executives of the Company and its affiliated companies and their beneficiaries.\n(c) Disability. If the Executive's employment is terminated by reason of the Executive's Disability during the Employment Period, this Agreement shall terminate without further obligations to the Executive, other than for payment of Accrued Obligations and the timely payment or provision of Other Benefits. Accrued Obligations shall be paid to the Executive in a lump sum in cash within 30 days of the Date of Termination. With respect to the provision of other Benefits, the term Other Benefits as utilized in this Section 6(c) shall include, and the Executive shall be entitled after the Disability Effective Date to receive, disability and other benefits at least equal to the most favorable of those generally provided by the Company and its affiliated companies to disabled executives and\/or their families in accordance with such plans, programs, practices and policies relating to disability, if any, as in effect generally with respect to other peer executives and their families at any time during the 120-day period immediately preceding the Effective Date or, if more favorable to the Executive and\/or the Executive's family, as in effect at any time thereafter generally with respect to other peer executives of the Company and its affiliated companies and their families.\n(d) Cause; Other than for Good Reason. If the Executive's employment --------------------------------- shall be terminated for Cause during the Employment Period, this Agreement shall terminate without further obligations to the Executive other than the obligation to pay to the Executive (x) his Annual Base Salary through the Date of Termination, (y) the amount of any compensation previously deferred by the\n- 11 -\nExecutive, and (z) Other Benefits, in each case to the extent theretofore unpaid. If the Executive voluntarily terminates employment during the Employment Period, excluding a termination for Good Reason, this Agreement shall terminate without further obligations to the Executive, other than for Accrued Obligations and the timely payment or provision of Other Benefits. In such case, all Accrued Obligations shall be paid to the Executive in a lump sum in cash within 30 days of the Date of Termination.\n7. Non-exclusivity of Rights. Nothing in this Agreement shall prevent or limit the Executive's continuing or future participation in any plan, program, policy or practice provided by the Company or any of its affiliated companies and for which the Executive may qualify, nor, subject to Section 12(f), shall anything herein limit or otherwise affect such rights as the Executive may have under any contract or agreement with the Company or any of its affiliated companies. Amounts which are vested benefits or which the Executive is otherwise entitled to receive under any plan, policy, practice or program of or any contract or agreement with the Company or any of its affiliated companies at or subsequent to the Date of Termination shall be payable in accordance with such plan, policy, practice or program or contract or agreement except as explicitly modified by this Agreement.\n8. Full Settlement. The Company's obligation to make the payments provided for in this Agreement and otherwise to perform its obligations hereunder shall not be affected by any set-off, counterclaim, recoupment, defense or other claim, right or action which the Company may have against the Executive or others. In no event shall the Executive be obligated to seek other employment or take any other action by way of mitigation of the amounts payable to the Executive under any of the provisions of this Agreement and such amounts shall not be reduced whether or not the Executive obtains other employment. The Company agrees to pay as incurred, to the full extent permitted by law, all legal fees and expenses which the Executive may reasonably incur as a result of any contest (regardless of the outcome thereof) by the Company, the Executive or others of the validity or enforceability of, or liability under, any provision of this Agreement or any guarantee of performance thereof (including as a result of any contest by the Executive about the amount of any payment pursuant to this Agreement), plus in each case interest on any delayed payment at the applicable Federal rate provided for in Section 7872(f)(2)(A) of the Internal Revenue Code of 1986, as amended (the \"Code\").\n9. Certain Reductions of Payments ------------------------------ (a) Anything in this Agreement to the contrary not-withstanding, in the event it shall be determined that any payment or distribution by the Company to or for the benefit of the Executive (whether paid or payable or distributed or distributable pursuant to the terms of\n- 12 -\nthis Agreement or otherwise) (a \"Payment\") would be nondeductible by the Company for Federal income tax purposes because of Section 28OG of the Code, then the aggregate present value of amounts payable or distributable to or for the benefit of the Executive pursuant to this Agreement (such payments or distributions pursuant to this Agreement are hereinafter referred to as \"Agreement Payments\") shall be reduced (but not below zero) to the Reduced Amount. The \"Reduced Amount\" shall be an amount expressed in present value which maximizes the aggregate present value of Agreement Payments without causing any Payment to be nondeductible by the Company because of Section 28OG of the Code. For purposes of this Section 9 present value shall be determined in accordance with Section 28OG(d)(4) of the Code.\n(b) All determinations required to be made under this Section 9 shall be made by BDO Seidman (the \"Accounting Firm\") which shall provide detailed supporting calculations both to the Company and the Executive within 15 business days of the Date of Termination or such earlier time as is requested by the Company. Any such determination by the Accounting Firm shall be binding upon the Company and the Executive. The Executive shall determine which and how much of the Agreement Payments (or, at the election of the Executive, other payments) shall be eliminated or reduced consistent with the requirements of this Section 9, provided that, if the Executive does not make such determination within ten business days of the receipt of the calculations made by the Accounting Firm, the Company shall elect which and how much of the Agreement Payments shall be eliminated or reduced consistent with the requirements of this Section 9 and shall notify the Executive promptly of such election. Within five business days thereafter, the Company shall pay to or distribute to or for the benefit of the Executive such amounts as are then due to the Executive under this Agreement.\n(c) As a result of the uncertainty in the application of Section 28OG of the Code at the time of the initial determination by the Accounting Firm hereunder, it is possible that Agreement Payments will have been made by the Company which should not have been made (\"Overpayment\") or that additional Agreement Payments which will have not been made by the Company could have been made (\"Underpayment\"), in each case, consistent with the calculations required to be made hereunder. In the event that the Accounting Firm determines that an Overpayment has been made, any such Overpayment shall be treated for all purposes as a loan to the Executive which the Executive shall repay to the Company together with interest at the applicable Federal rate provided for in Section 7872(f)(2) of the Code; provided, however, that no amount shall be payable by the Executive to the Company (or if paid by the Executive to the Company shall be returned to the Executive) if and to the extent such payment would not reduce the amount which is subject to taxation under Section 4999 of the Code. In the event that the Accounting Firm determines that an Underpayment has occurred, any such Underpayment shall be promptly paid by the Company to or for the benefit of the Executive together with interest at the applicable Federal rate provided for in Section 7872(f)(2) of the Code.\n- 13 -\n10. Confidential Information. The Executive shall hold in a fiduciary ------------------------ capacity for the benefit of the Company all secret or confidential information, knowledge or data relating to the Company or any of its affiliated companies, and their respective businesses, which shall have been obtained by the Executive during the Executive's employment by the Company or any of its affiliated companies and which shall not be or become public knowledge (other than by acts by the Executive or representatives of the Executive in violation of this Agreement). After termination of the Executive's employment with the Company, the Executive shall not, without the prior written consent of the Company or as may otherwise be required by law or legal process, communicate or divulge any such information, knowledge or data to anyone other than the Company and those designated by it. In no event shall an asserted violation of the provisions of this Section 10 constitute a basis for deferring or withholding any amounts otherwise payable to the Executive under this Agreement.\n11. Successors. ---------- (a) This Agreement is personal to the Executive and without the prior written consent of the Company shall not be assignable by the Executive otherwise than by will or the laws of descent and distribution. This Agreement shall inure to the benefit of and be enforceable by the Executive's legal representatives.\n(b) This Agreement shall inure to the benefit of and be binding upon the Company and its successors and assigns.\n(c) The Company will require any successor (whether direct or indirect, by purchase,merger, consolidation or otherwise) to all or substantially all of the business and\/or assets of the Company to assume expressly and agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform it if no such succession had taken place. As used in this Agreement, \"Company\" shall mean the-Company as hereinbefore defined and any successor to its business and\/or assets as aforesaid which assumes and agrees to perform this Agreement by operation of law, or otherwise.\n12. Miscellaneous. ------------- (a) This Agreement shall be governed by and construed in accordance with the laws of the State of New York, without reference to principles of conflict of laws. The captions of this Agreement are not part of the provisions hereof and shall have no force or effect. This Agreement may not be amended or modified otherwise than by a written agreement executed by the parties hereto or their respective successors and legal representatives.\n- 14 -\n(b) All notices and other communications hereunder shall be in writing and shall be given by hand delivery to the other party or by registered or certified mail, return receipt requested, postage prepaid, addressed as follows:\nIf to the Executive: ------------------- Phillip M. Satow 1075 Park Avenue New York, NY 10128\nIf to the Company: ----------------- Forest Laboratories, Inc. Attention: President 909 Third Avenue New York, New York 10022\nor to such other address as either party shall have furnished to the other in writing in accordance herewith. Notice and communications shall be effective when actually received by the addressee.\n(c) The invalidity or unenforceability of any provision of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement.\n(d) The Company may withhold from any amounts payable under this Agreement such Federal, state, local or foreign taxes as shall be required to be withheld pursuant to any applicable law or regulation.\n(e) The Executive's or the Company's failure to insist upon strict compliance with any provision of this Agreement or the failure to assert any right the Executive or the Company may have hereunder, including, without limitation, the right of the Executive to terminate employment for Good Reason pursuant to Section 5(c)(i)-(v) of this Agreement, shall not be deemed to be a waiver of such provision or right or any other provision or right of this Agreement.\n(f) The Executive and the Company acknowledge that, except as may otherwise be provided under any other written agreement between the Executive and the Company, the employment of the Executive by the Company is \"at will\" and, subject to Section i(a) hereof, prior to the Effective Date, the Executive's employment and\/or this Agreement may be terminated by either the Executive or the Company at any time prior to the Effective Date, in which case the Executive shall have no further rights under this Agreement. From and after the Effective Date this Agreement shall supersede any other agreement between the parties with respect to the subject matter hereof.\nIN WITNESS WHEREOF, the Executive has hereunto set the Executive's hand and, - ------------------ pursuant to the authorization from its Board of Directors, the Company has caused these presents to be executed in its name on its behalf, all as of the day and year first above written.\n\/s\/PHILLIP M. SATOW ----------------------------------- PHILLIP M. SATOW\nFOREST LABORATORIES, INC. By:\n\/s\/KENNETH E. GOODMAN ------------------------------------- KENNETH E. GOODMAN Vice President-Finance\nEXHIBIT 10.16\nEMPLOYMENT AGREEMENT --------------------\nAGREEMENT by and between FOREST LABORATORIES, INC. Company, a Delaware corporation (the \"Company\") and KENNETH E. GOODMAN (the \"Executive\"), dated as of the 16th day of January 1995.\nThe Board of Directors of the Company (the \"Board\") has determined that it is in the best interests of the Company and its shareholders to assure that the Company will have the continued dedication of the Executive, notwithstanding the possibility, threat or occurrence of a Change of Control (as defined below) of the Company. The Board believes it is imperative to diminish the inevitable distraction of the Executive by virtue of the personal uncertainties and risks created by a pending or threatened Change of Control and to encourage the Executive's full attention and dedication to the Company currently and in the event of any threatened or pending Change of Control, and to provide the Executive with compensation and benefits arrangements upon a Change of Control which ensure that the compensation and benefits expectations of the Executive will be satisfied and which are competitive with those of other corporations. Therefore, in order to accomplish these objectives, the Board has caused the Company to enter into this Agreement.\nNOW, THEREFORE, IT IS HEREBY AGREED AS FOLLOWS:\n1. Certain Definitions. ------------------- (a) The \"Effective Date\" shall mean the first date during the Change of Control Period (as defined in Section 1(b)) on which a Change of Control (as defined in Section 2) occurs. Anything in this Agreement to the contrary notwithstanding, if a Change of Control occurs and if the Executives employment with the Company is terminated prior to the date on which the Change of Control occurs, and if it is reasonably demonstrated by the Executive that such termination of employment (i) was at the request of a third party who has taken steps reasonably calculated to effect a Change of Control or (ii) otherwise arose in connection with or anticipation of a Change of Control, then for all purposes of this Agreement the \"Effective Date\" shall mean the date immediately prior to the date of such termination of employment.\n(b) The \"Change of Control Period\" shall mean the period commencing on the date hereof and ending on the third anniversary of the date hereof; provided, however, that commencing on the date one year after the date hereof, and on each annual anniversary of such date (such date and each annual anniversary thereof shall be hereinafter referred to as the \"Renewal Date\"), unless previously terminated, the Change of Control Period shall be automatically extended so as to terminate three years from such Renewal Date, unless at least\n60 days prior to the Renewal Date the Company shall give notice to the Executive that the Change of Control Period shall not be so extended.\n2. Change of Control. For the purpose of this Agreement, a \"Change of ----------------- Control\" shall mean:\n(a) The acquisition by any individual, entity or group (within the meaning of Section 13(d)(3) or 14(d)(2) of the Securities Exchange Act of 1934, as amended (the \"Exchange Act\")) (a \"Person\") of beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Exchange Act) of 20% or more of either (i) the then outstanding shares of common stock of the Company (the \"Outstanding Company Common Stock\") or (ii) the combined voting power of the then outstanding voting securities of the Company entitled to vote generally in the election of directors (the \"Outstanding Company Voting Securities\"); provided, however, that for purposes of this subsection (a), the following acquisitions shall not constitute a Change of Control: (i) any acquisition directly from the Company, (ii) any acquisition by the Company, (iii) any acquisition by any employee benefit plan (or related trust) sponsored or maintained by the Company or any corporation controlled by the Company or (iv) any acquisition by any corporation pursuant to a transaction which complies with clauses (i), (ii) and (iii) of subsection (c) of this Section 2; or\n(b) Individuals who, as of the date hereof, constitute the Board (the \"Incumbent Board\") cease for any reason to constitute at least a majority of the Board; provided, however, that any individual becoming a director subsequent to the date hereof whose election, or nomination for election by the Company's shareholders, was approved by a vote of at least a majority of the directors then comprising the Incumbent Board shall be considered as though such individual were a member of the Incumbent Board, but excluding, for this purpose, any such individual whose initial assumption of office occurs as a result of an actual or threatened election contest with respect to the election or removal of directors or other actual or threatened solicitation of proxies or consents by or on behalf of a Person other than the Board; or\n(c) Consummation of a reorganization, merger or consolidation or sale or other disposition of all or substantially all of the assets of the Company (a \"Business Combination\"), in each case, unless, following such Business Combination, (i) all or substantially all of the individuals and entities who were the beneficial owners, respectively, of the Outstanding Company Common Stock and Outstanding Company Voting Securities immediately prior to such\n- 2 -\nBusiness Combination beneficially own, directly or indirectly, more than 50% of, respectively, the then outstanding shares of common stock and the combined voting power of the then outstanding voting securities entitled to vote generally in the election of directors, as the case may be, of the corporation resulting from such Business Combination (including, without limitation, a corporation which as a result of such transaction owns the Company or all or substantially all of the Company's assets either directly or through one or more subsidiaries) in substantially the same proportions as their ownership, immediately prior to such Business Combination of the Outstanding Company Common Stock and Outstanding Company Voting Securities, as the case may be, (ii) no Person (excluding any corporation resulting from such Business Combination or any employee benefit plan (or related trust) of the Company or such corporation resulting from such Business Combination) beneficially owns, directly or indirectly, 20% or more of, respectively, the then outstanding shares of common stock of the corporation resulting from such Business Combination or the combined voting power of the then outstanding voting securities of such corporation except to the extent that such ownership existed prior to the Business Combination and (iii) at least a majority of the members of the board of directors of the corporation resulting from such Business Combination were members of the Incumbent Board at the time of the execution of the initial agreement, or of the action of the Board, providing for such Business Combination; or\n(d) Approval by the shareholders of the Company of a complete liquidation or dissolution of the Company.\n3. Employment Period. The Company hereby agrees to continue the Executive ----------------- in its employ, and the Executive hereby agrees to remain in the employ of the Company subject to the terms and conditions of this Agreement, for the period commencing on the Effective Date and ending on the third anniversary of such date (the \"Employment Period\").\n4. Terms of Employment. ------------------- (a) Position and Duties. ------------------- (i) During the Employment Period, (A) the Executive's position (including status, offices, titles and reporting requirements), authority, duties and responsibilities shall be at least commensurate in all material respects with the most significant of those held, exercised and assigned at any time during the 120-day period immediately preceding the Effective Date and (B) the Executive's services shall be performed at the location where the Executive was employed immediately preceding the Effective Date or any office or location less than 35 miles from such location.\n(ii) During the Employment Period, and excluding any periods of vacation and sick leave to which the Executive is entitled, the Executive agrees to devote reasonable attention and time during normal business hours to the business and affairs of\n- 3 -\nthe Company and, to the extent necessary to discharge the responsibilities assigned to the Executive hereunder, to use the Executive's reasonable best efforts to perform faithfully and efficiently such responsibilities. During the Employment Period it shall not be a violation of this Agreement for the Executive to (A) serve on corporate, civic or charitable boards or committees, (B) deliver lectures, fulfill speaking engagements or teach at educational institutions and (C) manage personal investments, so long as such activities do not significantly interfere with the performance of the Executives responsibilities as an employee of the Company in accordance with this Agreement. It is expressly understood and agreed that to the extent that any such activities have been conducted by the Executive prior to the Effective Date, the continued conduct of such activities (or the conduct of activities similar in nature and scope thereto) subsequent to the Effective Date shall not thereafter be deemed to interfere with the performance of the Executives responsibilities to the Company.\n(b) Compensation. ------------ (i) Base Salary. During the Employment Period, the Executive shall ----------- receive an annual base salary (\"Annual Base Salary\"), which shall be paid at a monthly rate, at least equal to twelve times the highest monthly base salary paid or payable, including any base salary which has been earned but deferred, to the Executive by the Company and its affiliated companies in respect of the twelve-month period immediately preceding the month in which the Effective Date occurs. During the Employment Period, the Annual Base Salary shall be reviewed no more than 12 months after the last salary increase awarded to the Executive prior to the Effective Date and thereafter at least annually. Any increase in Annual Base Salary shall not serve to limit or reduce any other obligation to the Executive under this Agreement. Annual Base Salary shall not be reduced after any such increase and the term Annual Base Salary as utilized in this Agreement shall refer to Annual Base Salary as so increased. As used in this Agreement, the term \"affiliated companies\" shall include any company controlled by, controlling or under common control with the Company.\n(ii) Annual Bonus. In addition to Annual Base Salary, the ------------ Executive shall be awarded, for each fiscal year ending during the Employment Period, an annual bonus (the \"Annual Bonus\") in cash at least equal to the highest aggregate amount awarded to the Executive under all annual bonus, incentive and other similar plans of the Company with respect to any of the last three full fiscal years prior to the Effective Date (annualized in the event that the Executive was not employed by the Company for the whole of such fiscal\n- 4 -\nyear) (the \"Recent Annual Bonus\"). Each such Annual Bonus shall be paid no later than the end of the third month of the fiscal year next following the fiscal year for which the Annual Bonus is awarded, unless the Executive shall elect to defer the receipt of such Annual Bonus.\n(iii) Incentive, Savings and Retirement Plans. During the --------------------------------------- Employment Period, the Executive shall be entitled to participate in all incentive, savings and retirement plans, practices, policies and programs applicable generally to other peer executives of the Company and its affiliated companies, but in no event shall such plans, practices, policies and programs provide the Executive with incentive opportunities (measured with respect to both regular and special incentive opportunities, to the extent, if any, that such distinction is applicable), savings opportunities and retirement benefit opportunities, in each case, less favorable, in the aggregate, than the most favorable of those provided by the Company and its affiliated companies for the Executive under such plans, practices, policies and programs as in effect at any time during the 120-day period immediately preceding the Effective Date or if more favorable to the Executive, those provided generally at any time after the Effective Date to other peer executives of the Company and its affiliated companies.\n(iv) Welfare Benefit Plans. During the Employment Period, the --------------------- Executive and\/or the Executive's family, as the case may be, shall be eligible for participation in and shall receive all benefits under welfare benefit plans, practices, policies and programs provided by the Company and its affiliated companies (including, without limitation, medical, prescription, dental, disability, employee life, group life, accidental death and travel accident insurance plans and programs) to the extent applicable generally to other peer executives of the Company and its affiliated companies, but in no event shall such plans, practices, policies and programs provide the Executive with benefits which are less favorable in the aggregate, than the most favorable of such plans, practices, policies and programs in effect for the Executive at any time during the 120-day period immediately preceding the Effective Date or, if more favorable to the Executive, those provided generally at any time after the Effective Date to other peer executives of the Company and its affiliated companies.\n(v) Expenses. During the Employment Period, the Executive shall be entitled to receive prompt reimbursement for all reasonable expenses incurred by the Executive in accordance with the most favorable policies, practices and procedures of the Company and its affiliated companies in effect for the Executive at any time during the 120-day period immediately preceding the Effective Date or, if more favorable to the Executive, as in effect generally at\n- 5 -\nany time thereafter with respect to other peer executives of the Company and its affiliated companies.\n(vi) Fringe Benefits. During the Employment Period, the --------------- Executive shall be entitled to fringe benefits, including, without limitation, tax and financial planning services, payment of club dues, and, if applicable, use of an automobile and payment of related expenses, in accordance with the most favorable plans, practices, programs and policies of the Company and its affiliated companies in effect for the Executive at any time during the 120- day period immediately preceding the Effective Date or, if more favorable to the Executive, as in effect generally at any time thereafter with respect to other peer executives of the Company and its affiliated companies.\n(vii) Office and Support Staff. During the Employment Period, the Executive shall be entitled to an office or offices of a size and with furnishings and other appointments, and to exclusive personal secretarial and other assistance, at least equal to the most favorable of the foregoing provided to the Executive by the Company and its affiliated companies at any time during the 120-day period immediately preceding the Effective Date or, if more favorable to the Executive, as provided generally at any time thereafter with respect to other peer executives of the Company and its affiliated companies.\n(viii) Vacation. During the Employment Period, the Executive -------- shall be entitled to paid vacation in accordance with the most favorable plans, policies, programs and practices of the Company and its affiliated companies as in effect for the Executive at any time during the 120-day period immediately preceding the Effective Date or, if more favorable to the Executive, as in effect generally at any time thereafter with respect to other peer executives of the Company and its affiliated companies.\n5. Termination of Employment. ------------------------- (a) Death or Disability. The Executives employment shall terminate automatically upon the Executive's death during the Employment Period. If the Company determines in good faith that the Disability of the Executive has occurred during the Employment Period (pursuant to the definition of Disability set forth below), it may give to the Executive written notice in accordance with Section 12(b) of this Agreement of its intention to terminate the Executives employment. In such event, the Executives employment with the Company shall terminate effective on the 30th day after receipt of such notice by the Executive (the \"Disability Effective\n- 6 -\nDate\"), provided that, within the 30 days after such receipt, the Executive shall not have returned to full-time performance of the Executives duties. For purposes of this Agreement, \"Disability\" shall mean the absence of the Executive from the Executives duties with the Company on a full-time basis for 180 consecutive business days as a result of incapacity due to mental or physical illness which is determined to be total and permanent by a physician selected by the Company or its insurers and acceptable to the Executive or the Executives legal representative.\n(b) Cause. The Company may terminate the Executive's employment\nduring the Employment Period for Cause. For purposes of this Agreement, \"Cause\" shall mean:\n(i) the willful and continued failure of the Executive to perform substantially the Executives duties with the Company or one of its affiliates (other than any such failure resulting from incapacity due to physical or mental illness), after a written demand for substantial performance is delivered to the Executive by the Board or the Chief Executive Officer of the Company which specifically identifies the manner in which the Board or Chief Executive Officer believes that the Executive has not substantially performed the Executives duties, or\n(ii) the willful engaging by the Executive in illegal conduct or gross misconduct which is materially and demonstrably injurious to the Company.\nFor purposes of this provision, no act or failure to act, on the part of the Executive, shall be considered \"willful,, unless it is done, or omitted to be done, by the Executive in bad faith or without reasonable belief that the Executive's action or omission was in the best interests of the Company. Any act, or failure to act, based upon authority given pursuant to a resolution duly adopted by the Board or upon the instructions of the Chief Executive Officer or a senior officer of the Company or based upon the advice of counsel for the Company shall be conclusively presumed to be done, or omitted to be done, by the Executive in good faith and in the best interests of the Company. The cessation of employment of the Executive shall not be deemed to be for Cause unless and until there shall have been delivered to the Executive a copy of a resolution duly adopted by the affirmative vote of not less than three-quarters of the entire membership of the Board at a meeting of the Board called and held for such purpose (after reasonable notice is provided to the Executive and the Executive is given an opportunity, together with counsel, to be heard before the Board), finding that, in the good faith opinion of the Board, the Executive is guilty of the conduct described in subparagraph (i) or (ii) above, and specifying the particulars thereof in detail.\n(c) Good Reason. The Executives employment may be terminated by the ----------- Executive for Good Reason. For purposes of this Agreement, \"Good\n- 7 -\nReason\" shall mean:\n(i) the assignment to the Executive of any duties inconsistent in any respect with the Executives position (including status, offices, titles and reporting requirements), authority, duties or responsibilities as contemplated by Section 4(a) of this Agreement, or any other action by the Company which results in a diminution in such position, authority, duties or responsibilities, excluding for this purpose an isolated, insubstantial and inadvertent action not taken in bad faith and which is remedied by the Company promptly after receipt of notice thereof given by the Executive;\n(ii) any failure by the Company to comply with any of the provisions of Section 4(b) of this Agreement, other than an isolated, insubstantial and inadvertent failure not occurring in bad faith and which is remedied by the Company promptly after receipt of notice thereof given by the Executive;\n(iii) the Company's requiring the Executive to be based at any office or location other than as provided in Section 4(a)(i) (B) hereof or the Company's requiring the Executive to travel on Company business to a substantially greater extent than required immediately prior to the Effective Date;\n(iv) any purported termination by the Company of the Executives employment otherwise than as expressly permitted by this Agreement; or\n(v) any failure by the Company to comply with and satisfy Section 11(c) of this Agreement.\nFor purposes of this Section 5(c), any good faith determination of \"Good Reason\" made by the Executive shall be conclusive. Anything in this Agreement to the contrary notwithstanding, a termination by the Executive for any reason during the 30-day period immediately following the first anniversary of the Effective Date shall be deemed to be a termination for Good Reason for all purposes of this Agreement.\n(d) Notice of Termination. Any termination by the Company for Cause, or --------------------- by the Executive for Good Reason, shall be communicated by Notice of Termination to the other party hereto given in accordance with Section 12(b) of this Agreement. For purposes of this Agreement, a \"Notice of Termination\" means a written notice which (i) indicates the specific termination provision in this Agreement relied upon, (ii) to the extent applicable, sets forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of the Executive's employment under the provision so indicated and (iii) if the Date of Termination (as defined below) is other than the date of receipt of such notice, specifies the termination date (which date shall be not more than thirty days after the giving of such notice). The failure by the Executive or the Company to set forth in the Notice of Termination any fact or circumstance which contributes to a showing of Good Reason or\n- 8 -\nCause shall not waive any right of the Executive or the Company, respectively, hereunder or preclude the Executive or the Company, respectively, from asserting such fact or circumstance in enforcing the Executive's or the Company's rights hereunder.\n(e) Date of Termination. \"Date of Termination\" means (i) if the ------------------- Executive's employment is terminated by the Company for Cause, or by the Executive for Good Reason, the date of receipt of the Notice of Termination or any later date specified therein, as the case may be, (ii) if the Executive's employment is terminated by the Company other than for Cause or Disability, the Date of Termination shall be the date on which the Company notifies the Executive of such termination and (iii) if the Executive's employment is terminated by reason of death or Disability, the Date of Termination shall be the date of death of the Executive or the Disability Effective Date, as the case may be.\n6. Obligations of the Company upon Termination. ------------------------------------------- (a) Good Reason; Other Than for Cause, Death or Disability. If, ------------------------------------------------------ during the Employment Period, the Company shall terminate the Executive's employment other than for Cause or Disability or the Executive shall terminate employment for Good Reason:\n(i) the Company shall pay to the Executive in a lump sum in cash within 30 days after the Date of Termination the aggregate of the following amounts:\nA. the sum of (1) the Executive's Annual Base Salary through the Date of Termination to the extent not theretofore paid, (2) the product of (x) the higher of (I) the Recent Annual Bonus and (II) the Annual Bonus paid or payable, including any bonus or portion thereof which has been earned but deferred (and annualized for any fiscal year consisting of less than twelve full months or during which the Executive was employed for less than twelve full months), for the most recently completed fiscal year during the Employment Period, if any (such higher amount being referred to as the \"Highest Annual Bonus\") and (y) a fraction, the numerator of which is the number of days in the current fiscal year through the Date of Termination, and the denominator of which is 365 and (3) any compensation previously deferred by the Executive (together with any accrued interest or earnings thereon) and any accrued vacation pay, in each case to the extent not theretofore paid (the sum of the amounts described in clauses (1), (2), and (3)shall be hereinafter referred to as the \"Accrued Obligations,,); and\nB. the amount equal to the product of (1) three and (2) the sum of (x) the Executives Annual Base Salary and (y)\n- 9 -\nthe Highest Annual Bonus; and\nC. an amount equal to the excess of (a) the actuarial equivalent of the benefit under the Company's qualified defined benefit retirement plan (the \"Retirement Plan\") (utilizing actuarial assumptions no less favorable to the Executive than those in effect under the Company's Retirement Plan immediately prior to the Effective Date), and any excess or supplemental retirement plan in which the Executive participates (together, the \"SERP\") which the Executive would receive if the Executive's employment continued for three years after the Date of Termination assuming for this purpose that all accrued benefits are fully vested, and, assuming that the Executive's compensation in each of the three years is that required by Section 4(b)(i) and Section 4(b)(ii), over (b) the actuarial equivalent of the Executive's actual benefit (paid or payable), if any, under the Retirement Plan and the SERP as of the Date of Termination;\n(ii) for three years after the Executive's Date of Termination, or such longer period as may be provided by the terms of the appropriate plan, program, practice or policy, the Company shall continue benefits to the Executive and\/or the Executive's family at least equal to those which would have been provided to them in accordance with the plans, programs, practices and policies described in Section 4(b)(iv) of this Agreement if the Executive's employment had not been terminated or, if more favorable to the Executive, as in effect generally at any time thereafter with respect to other peer executives of the Company and its affiliated companies and their families, provided, however, that if the Executive becomes reemployed with another employer and is eligible to receive medical or other welfare benefits under another employer provided plan, the medical and other welfare benefits described herein shall be secondary to those provided under such other plan during such applicable period of eligibility. For purposes of determining eligibility (but not the time of commencement of benefits) of the Executive for retiree benefits pursuant to such plans, practices, programs and policies, the Executive shall be considered to have remained employed until three years after the Date of Termination and to have retired on the last day of such period;\n(iii) the Company shall, at its sole expense as incurred, provide the Executive with outplacement services the scope and provider of which shall be selected by the Executive in his sole discretion; and\n(iv) to the extent not theretofore paid or provided, the Company shall timely pay or provide to the Executive any other amounts or benefits required to be paid or provided or which the Executive is eligible to receive under any plan, program, policy or practice or contract or agreement of the Company and its affiliated companies (such other amounts and benefits shall be here-inafter referred to as the \"Other Benefits\").\n- 10 -\n(b) Death. If the Executive's employment is terminated by reason of the Executive's death during the Employment Period, this Agreement shall terminate without further obligations to the Executive's legal representatives under this Agreement, other than for payment of Accrued Obligations and the timely payment or provision of Other Benefits. Accrued Obligations shall be paid to the Executive's estate or beneficiary, as applicable, in a lump sum in cash within 30 days of the Date of Termination. With respect to the provision of Other Benefits, the term Other Benefits as utilized in this Section 6(b) shall include, without limitation, and the Executive's estate and\/or beneficiaries shall be entitled to receive, benefits at least equal to the most favorable benefits provided by the Company and affiliated companies to the estates and beneficiaries of peer executives of the Company and such affiliated companies under such plans, programs, practices and policies relating to death benefits, if any, as in effect with respect to other peer executives and their beneficiaries at any time during the 120-day period immediately preceding the Effective Date or, if more favorable to the Executive's estate and\/or the Executive's beneficiaries, as in effect on the date of the Executive's death with respect to other peer executives of the Company and its affiliated companies and their beneficiaries.\n(c) Disability. If the Executive's employment is terminated by reason of the Executive's Disability during the Employment Period, this Agreement shall terminate without further obligations to the Executive, other than for payment of Accrued Obligations and the timely payment or provision of Other Benefits. Accrued Obligations shall be paid to the Executive in a lump sum in cash within 30 days of the Date of Termination. With respect to the provision of other Benefits, the term Other Benefits as utilized in this Section 6(c) shall include, and the Executive shall be entitled after the Disability Effective Date to receive, disability and other benefits at least equal to the most favorable of those generally provided by the Company and its affiliated companies to disabled executives and\/or their families in accordance with such plans, programs, practices and policies relating to disability, if any, as in effect generally with respect to other peer executives and their families at any time during the 120-day period immediately preceding the Effective Date or, if more favorable to the Executive and\/or the Executive's family, as in effect at any time thereafter generally with respect to other peer executives of the Company and its affiliated companies and their families.\n(d) Cause; Other than for Good Reason. If the Executive's employment --------------------------------- shall be terminated for Cause during the Employment Period, this Agreement shall terminate without further obligations to the Executive other than the obligation to pay to the Executive (x) his Annual Base Salary through the Date of Termination, (y) the amount of any compensation previously deferred by the\n- 11 -\nExecutive, and (z) Other Benefits, in each case to the extent theretofore unpaid. If the Executive voluntarily terminates employment during the Employment Period, excluding a termination for Good Reason, this Agreement shall terminate without further obligations to the Executive, other than for Accrued Obligations and the timely payment or provision of Other Benefits. In such case, all Accrued Obligations shall be paid to the Executive in a lump sum in cash within 30 days of the Date of Termination.\n7. Non-exclusivity of Rights. Nothing in this Agreement shall prevent or limit the Executive's continuing or future participation in any plan, program, policy or practice provided by the Company or any of its affiliated companies and for which the Executive may qualify, nor, subject to Section 12(f), shall anything herein limit or otherwise affect such rights as the Executive may have under any contract or agreement with the Company or any of its affiliated companies. Amounts which are vested benefits or which the Executive is otherwise entitled to receive under any plan, policy, practice or program of or any contract or agreement with the Company or any of its affiliated companies at or subsequent to the Date of Termination shall be payable in accordance with such plan, policy, practice or program or contract or agreement except as explicitly modified by this Agreement.\n8. Full Settlement. The Company's obligation to make the payments provided for in this Agreement and otherwise to perform its obligations hereunder shall not be affected by any set-off, counterclaim, recoupment, defense or other claim, right or action which the Company may have against the Executive or others. In no event shall the Executive be obligated to seek other employment or take any other action by way of mitigation of the amounts payable to the Executive under any of the provisions of this Agreement and such amounts shall not be reduced whether or not the Executive obtains other employment. The Company agrees to pay as incurred, to the full extent permitted by law, all legal fees and expenses which the Executive may reasonably incur as a result of any contest (regardless of the outcome thereof) by the Company, the Executive or others of the validity or enforceability of, or liability under, any provision of this Agreement or any guarantee of performance thereof (including as a result of any contest by the Executive about the amount of any payment pursuant to this Agreement), plus in each case interest on any delayed payment at the applicable Federal rate provided for in Section 7872(f)(2)(A) of the Internal Revenue Code of 1986, as amended (the \"Code\").\n9. Certain Reductions of Payments ------------------------------ (a) Anything in this Agreement to the contrary not-withstanding, in the event it shall be determined that any payment or distribution by the Company to or for the benefit of the Executive (whether paid or payable or distributed or distributable pursuant to the terms of\n- 12 -\nthis Agreement or otherwise) (a \"Payment\") would be nondeductible by the Company for Federal income tax purposes because of Section 28OG of the Code, then the aggregate present value of amounts payable or distributable to or for the benefit of the Executive pursuant to this Agreement (such payments or distributions pursuant to this Agreement are hereinafter referred to as \"Agreement Payments\") shall be reduced (but not below zero) to the Reduced Amount. The \"Reduced Amount\" shall be an amount expressed in present value which maximizes the aggregate present value of Agreement Payments without causing any Payment to be nondeductible by the Company because of Section 28OG of the Code. For purposes of this Section 9 present value shall be determined in accordance with Section 28OG(d)(4) of the Code.\n(b) All determinations required to be made under this Section 9 shall be made by BDO Seidman (the \"Accounting Firm\") which shall provide detailed supporting calculations both to the Company and the Executive within 15 business days of the Date of Termination or such earlier time as is requested by the Company. Any such determination by the Accounting Firm shall be binding upon the Company and the Executive. The Executive shall determine which and how much of the Agreement Payments (or, at the election of the Executive, other payments) shall be eliminated or reduced consistent with the requirements of this Section 9, provided that, if the Executive does not make such determination within ten business days of the receipt of the calculations made by the Accounting Firm, the Company shall elect which and how much of the Agreement Payments shall be eliminated or reduced consistent with the requirements of this Section 9 and shall notify the Executive promptly of such election. Within five business days thereafter, the Company shall pay to or distribute to or for the benefit of the Executive such amounts as are then due to the Executive under this Agreement.\n(c) As a result of the uncertainty in the application of Section 28OG of the Code at the time of the initial determination by the Accounting Firm hereunder, it is possible that Agreement Payments will have been made by the Company which should not have been made (\"Overpayment\") or that additional Agreement Payments which will have not been made by the Company could have been made (\"Underpayment\"), in each case, consistent with the calculations required to be made hereunder. In the event that the Accounting Firm determines that an Overpayment has been made, any such Overpayment shall be treated for all purposes as a loan to the Executive which the Executive shall repay to the Company together with interest at the applicable Federal rate provided for in Section 7872(f)(2) of the Code; provided, however, that no amount shall be payable by the Executive to the Company (or if paid by the Executive to the Company shall be returned to the Executive) if and to the extent such payment would not reduce the amount which is subject to taxation under Section 4999 of the Code. In the event that the Accounting Firm determines that an Underpayment has occurred, any such Underpayment shall be promptly paid by the Company to or for the benefit of the Executive together with interest at the applicable Federal rate provided for in Section 7872(f)(2) of the Code.\n- 13 -\n10. Confidential Information. The Executive shall hold in a fiduciary ------------------------ capacity for the benefit of the Company all secret or confidential information, knowledge or data relating to the Company or any of its affiliated companies, and their respective businesses, which shall have been obtained by the Executive during the Executive's employment by the Company or any of its affiliated companies and which shall not be or become public knowledge (other than by acts by the Executive or representatives of the Executive in violation of this Agreement). After termination of the Executive's employment with the Company, the Executive shall not, without the prior written consent of the Company or as may otherwise be required by law or legal process, communicate or divulge any such information, knowledge or data to anyone other than the Company and those designated by it. In no event shall an asserted violation of the provisions of this Section 10 constitute a basis for deferring or withholding any amounts otherwise payable to the Executive under this Agreement.\n11. Successors. ---------- (a) This Agreement is personal to the Executive and without the prior written consent of the Company shall not be assignable by the Executive otherwise than by will or the laws of descent and distribution. This Agreement shall inure to the benefit of and be enforceable by the Executive's legal representatives.\n(b) This Agreement shall inure to the benefit of and be binding upon the Company and its successors and assigns.\n(c) The Company will require any successor (whether direct or indirect, by purchase,merger, consolidation or otherwise) to all or substantially all of the business and\/or assets of the Company to assume expressly and agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform it if no such succession had taken place. As used in this Agreement, \"Company\" shall mean the-Company as hereinbefore defined and any successor to its business and\/or assets as aforesaid which assumes and agrees to perform this Agreement by operation of law, or otherwise.\n12. Miscellaneous. ------------- (a) This Agreement shall be governed by and construed in accordance with the laws of the State of New York, without reference to principles of conflict of laws. The captions of this Agreement are not part of the provisions hereof and shall have no force or effect. This Agreement may not be amended or modified otherwise than by a written agreement executed by the parties hereto or their respective successors and legal representatives.\n- 14 -\n(b) All notices and other communications hereunder shall be in writing and shall be given by hand delivery to the other party or by registered or certified mail, return receipt requested, postage prepaid, addressed as follows:\nIf to the Executive: ------------------- Kenneth E. Goodman 7 Iris Lane Chappaqua, NY 10514\nIf to the Company: ----------------- Forest Laboratories, Inc. Attention: President 909 Third Avenue New York, New York 10022\nor to such other address as either party shall have furnished to the other in writing in accordance herewith. Notice and communications shall be effective when actually received by the addressee.\n(c) The invalidity or unenforceability of any provision of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement.\n(d) The Company may withhold from any amounts payable under this Agreement such Federal, state, local or foreign taxes as shall be required to be withheld pursuant to any applicable law or regulation.\n(e) The Executive's or the Company's failure to insist upon strict compliance with any provision of this Agreement or the failure to assert any right the Executive or the Company may have hereunder, including, without limitation, the right of the Executive to terminate employment for Good Reason pursuant to Section 5(c)(i)-(v) of this Agreement, shall not be deemed to be a waiver of such provision or right or any other provision or right of this Agreement.\n(f) The Executive and the Company acknowledge that, except as may otherwise be provided under any other written agreement between the Executive and the Company, the employment of the Executive by the Company is \"at will\" and, subject to Section i(a) hereof, prior to the Effective Date, the Executive's employment and\/or this Agreement may be terminated by either the Executive or the Company at any time prior to the Effective Date, in which case the Executive shall have no further rights under this Agreement. From and after the Effective Date this Agreement shall supersede any other agreement between the parties with respect to the subject matter hereof.\nIN WITNESS WHEREOF, the Executive has hereunto set the Executive's hand and, - ------------------ pursuant to the authorization from its Board of Directors, the Company has caused these presents to be executed in its name on its behalf, all as of the day and year first above written.\n\/s\/KENNETH E. GOODMAN ----------------------------------- KENNETH E. GOODMAN\nFOREST LABORATORIES, INC. By:\n\/s\/HOWARD SOLOMON ------------------------------------- HOWARD SOLOMON President\nEXHIBIT 13\nQUARTERLY STOCK MARKET PRICES High Low - ----------------------------------------------------------------------\nApril-June 1993 38 1\/2 31 1\/2 - ---------------------------------------------------------------------- July-September 1993 37 7\/8 28 1\/4 - ---------------------------------------------------------------------- October-December 1993 47 7\/8 37 3\/8 - ---------------------------------------------------------------------- January-March 1994 52 1\/2 41 1\/2 - ---------------------------------------------------------------------- April-June 1994 49 40 - ---------------------------------------------------------------------- July-September 1994 50 40 1\/2 - ---------------------------------------------------------------------- October-December 1994 49 1\/2 44 7\/8 - ---------------------------------------------------------------------- January-March 1995 52 1\/4 43 1\/8 - ----------------------------------------------------------------------\nAs of June 5, 1995, there were 3,064 stockholders of record of the Company's common stock.\nNo dividends were paid on common shares during the period.\nSELECTED FINANCIAL DATA - -----------------------\nA. Net income per share was computed by dividing net income by the weighted average number of common and common equivalent shares during each year. All amounts give effect to the February 1991 100% stock dividend. Common equivalent shares consist of unissued shares under options and warrants, and are included to the extent that they have a dilutive effect. Fully dilutd net income per share is presented because of an increase in the dilutive effect of stock options (using the treasury stock method) which resulted from the higher price of the Company's stock at the end of the year as compared with the average price during the year. The weighted average number of common and common equivalent shares outstanding for 1995 was computed as follows:\nFOREST LABORATORIES, INC. AND SUBSIDIARIES ------------------------------------------ MANAGEMENT DISCUSSION AND ANALYSIS OF ------------------------------------- FINANCIAL CONDITION AND RESULTS OF OPERATIONS ---------------------------------------------\nFINANCIAL CONDITION AND LIQUIDITY Net current assets decreased by $2,386,000 in - --------------------------------- fiscal 1995 principally due to the Company investing a portion of its cash in long-term marketable securities maturing over a period of one to two years. Compared to the short-term marketable securities which they replaced, these long-term marketable securities have, and are expected to continue to increase the Company's yield on investments. Company operations have historically provided a strong, positive cash flow and management believes that on-going operations, when combined with the Company's strong cash position, will continue to provide adequate liquidity to facilitate potential acquisitions of products or companies and capital investments. Accounts receivable and accounts payable increased principally as a result of the continued growth of the Company's principal promoted and specialty controlled release generic products and an increase in the overall level of the Company's operations. Property, plant and equipment increased as a result of the Company's facilities expansion in the United States and Ireland. This expansion, when complete, should for the time being meet the Company's needs for the manufacturing, warehousing and distribution of its existing and presently anticipated future products. The increase in license agreements, product rights and intangible assets resulted from the Company acquiring certain product rights from Prutech Research and Development Partnership (Prutech), which previously entitled Prutech to royalties on controlled release generic propranolol and indomethacin. Deferred income taxes non-current increased due to the recording of state and local tax benefit carryforwards which resulted from the exercise of employee stock options. The change in cumulative foreign currency translation adjustments is attributed to a significant increase in the UK pound and Irish punt to US dollar rates of exchange.\nRESULTS OF OPERATIONS Net sales increased in 1995 by $41,718,000 as a result of the continued growth of the Company's branded promoted products, particularly Aerobid and Lorcet, and specialty controlled release generic products. These increases were partially offset by lower sales of Flumadine due to the relatively mild flu season and high inventory levels remaining from the prior year's initial launch. Net volume growth of these products amounted to $57,014,000. Excluding Flumadine sales, net sales growth of the Company's principal promoted and specialty release generic products totaled $76,669,000. Sales decreases of certain of the Company's unpromoted product lines resulted in a net volume decline of $4,574,000. The remainder of the net sales change was primarily the result of increased sales to managed care customers at lower net realized prices. Net sales for fiscal 1994 increased by $66,277,000 as compared to fiscal 1993. Volume growth of the Company's principal promoted and generic product lines accounted for $46,103,000 of the increase. Flumadine sales amounted to $21,660,000 in fiscal 1994. Sales volume of the Company's older unpromoted product lines increased by $2,384,000, while foreign exchange translation rate declines reduced net sales by $5,936,000. The remainder of the net sales increase was attributed to price increases.\nOther income increased $1,790,000 during fiscal 1995. An increase in funds available for investment, combined with higher yields received by investing in longer term marketable securities with up to two year maturities, resulted in an increase in interest income as compared with last year. The decrease in other income in fiscal 1994 as compared to 1993 was primarily the result of lower commission income resulting from the termination of the Company's joint marketing agreement for the product DDAVP.\nFOREST LABORATORIES, INC. AND SUBSIDIARIES ------------------------------------------ MANAGEMENT DISCUSSION AND ANALYSIS OF ------------------------------------- FINANCIAL CONDITION AND RESULTS OF OPERATIONS ---------------------------------------------\nCost of sales as a percentage of sales increased to 19% in fiscal 1995 from 18% in fiscal 1994 due mostly to increases in overhead costs related to the Company's facilities expansion and lower net prices received on certain products. During fiscal 1994 as compared to 1993, cost of sales as a percentage of sales decreased to 18% from 19% as result of changes in product mix and volume and price increases.\nSelling, general and administrative expense decreased by $2,816,000 during fiscal 1995. The decrease was primarily due to a reduction in royalty expense resulting from the acquisition from Prutech of the product rights to controlled release generic propranolol and indomethacin and the absence of the substantial launch costs for the product Flumadine which were incurred during 1994. Offsetting this decrease were costs associated with the consolidation of the Company's Jackson, Mississippi and St Louis, Missouri facilities in St Louis, which will result in future savings. As a percentage of sales, selling, general and administrative expense decreased in 1995 as compared to 1994. The increase in selling, general and administrative expense in 1994 as compared to 1993 resulted from continued growth of the Company's salesforce activities and the launch costs for Flumadine.\nInterest expense of $1,957,000 in fiscal 1993 was the result of the debt incurred in connection with the purchase of a line of thyroid products. The debt was repaid during fiscal 1993.\nResearch and development expense increased by $4,012,000 during fiscal 1995 and $5,944,000 in 1994 principally as a result of the cost of conducting clinical trials in order to obtain approval of new products and the cost of developing products using the Company's controlled release technology. During fiscal 1995, there was particular emphasis on Synapton, Methoxatone and AF102B. Synapton is the Company's controlled release formulation of physostigmine being tested for the treatment of Alzheimer's Disease. One Phase III clinical study has been successfully concluded. Two additional Phase III clinical studies are currently in progress, and if successfully completed, will enable the Company to seek approval for marketing from the FDA. Methoxatone is being developed for the treatment of brain trauma and AF102B is an M1 agonist for the treatment of Alzheimer's Disease. Phase II\/III clinical trials are currently in progress for AF102B. Also during 1995, the Company completed studies and filed new drug applications for the products Monurol, a single dose antibiotic used for the treatment of uncomplicated urinary tract infections and Infasurf, a lung surfactant for the treatment of respiratory distress syndrome in preterm infants. The Company anticipates a continued increase in research and development expense as these and other potential products are developed and tested.\nInflation has not had a material effect on the Company's operations for the periods presented.\nFOREST LABORATORIES, INC. AND SUBSIDIARIES ------------------------------------------ CONSOLIDATED FINANCIAL STATEMENTS --------------------------------- YEARS ENDED MARCH 31, 1995, 1994 AND 1993 -----------------------------------------\nPAGE\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS - --------------------------------------------------\nBoard of Directors and Shareholders Forest Laboratories, Inc. New York, New York\nWe have audited the accompanying consolidated balance sheets of Forest Laboratories, Inc. and Subsidiaries as of March 31, 1995 and 1994, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended March 31, 1995. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Forest Laboratories, Inc. and Subsidiaries as of March 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended March 31, 1995 in conformity with generally accepted accounting principles.\nBDO SEIDMAN\nNew York, New York April 28, 1995\nPAGE\nSEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.\nSEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.\nPAGE\nSEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.\nSEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.\nPAGE\nFOREST LABORATORIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:\nBASIS OF CONSOLIDATION: The consolidated financial statements include the accounts of Forest Laboratories, Inc. (the \"Company\") and its subsidiaries, all of which are wholly owned. All significant intercompany accounts and transactions have been eliminated.\nCASH EQUIVALENTS: Cash equivalents consist of short-term, highly liquid investments (primarily municipal bonds with interest rates that are re-set weekly) which are readily convertible into cash at par value (cost).\nINVENTORIES: Inventories are stated at the lower of cost or market, with cost determined on the first-in, first-out basis.\nMARKETABLE SECURITIES: Effective April 1, 1994, the Company adopted Statement of Financial Accounting Standards No. 115 \"Accounting for Certain Investments in Debt and Equity Securities\". At March 31, 1995, the Company's investments in debt securities have been categorized as held to maturity and are stated at amortized cost. Marketable securities consist of investments in municipal bonds maturing through 1997 and bonds of the Commonwealth of Puerto Rico maturing through 2000. In prior years, the Company's investments in debt securities were accounted for using substantially the same method.\nPROPERTY, PLANT AND EQUIPMENT AND DEPRECIATION: Property, plant and equipment are stated at cost. Depreciation is provided over the estimated useful lives of the assets primarily by the straight-line method.\nINTANGIBLE ASSETS: The excess of cost of investment over the fair value of net assets of subsidiaries at the time of acquisition is being amortized over 35 to 40 years. The costs of obtaining license agreements, product rights and other intangible assets are being amortized over the estimated lives of the assets, 10 to 40 years.\nREVENUE RECOGNITION: Sales are recorded in the period the merchandise is shipped.\nRESEARCH AND DEVELOPMENT: Expenditures for research and development are charged to expense as incurred.\nSAVINGS AND PROFIT SHARING PLAN: Effective April 1, 1994, the Company's domestic and Puerto Rican subsidiaries savings and profit sharing plans were merged into one plan. Under the plan, substantially all non-bargaining unit employees may participate in the plan after becoming eligible (as defined). The profit sharing plan contributions are primarily at the discretion of the Company. The savings plan contributions include a matching contribution made by the Company. Savings and profit sharing contributions amounted to $3,320,000, $2,818,000 and $1,959,000 for 1995, 1994 and 1993, respectively.\nFOREST LABORATORIES, INC. AND SUBSIDIARIES ------------------------------------------ NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) ------------------------------------------\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)\nEARNINGS PER SHARE: Earnings per share are based on the weighted average number of common and common equivalent shares outstanding during each year. Common equivalent shares consist of the dilutive effect of unissued shares under options and warrants, computed using the treasury stock method (using the average stock prices for primary basis and the higher of average or period end stock prices for fully diluted basis). At March 31, 1995, 1994 and 1993, the primary and fully diluted common equivalent shares amounted to 2,206,000 and 2,287,000, 2,672,000 and 3,329,000, 3,346,000 and 3,678,000, respectively.\nINCOME TAXES: The Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\", for the year ended March 31, 1993 and, accordingly, has accounted for income taxes on the liability method. Under the liability method, deferred income taxes are provided on the differences in bases of assets and liabilities between financial reporting and tax returns using enacted tax rates. Previously, the Company utilized the deferred method when accounting for income taxes. The effect of this accounting change had an immaterial impact on the consolidated results of operations for the year ended March 31, 1993 and no cumulative effect adjustment was required as of April 1, 1992.\nRECLASSIFICATIONS: Certain amounts as previously reported have been reclassified to conform to current year classifications.\n2. BUSINESS OPERATIONS:\nThe Company and its subsidiaries, which are located in the United States, Puerto Rico, the United Kingdom and Ireland, manufacture and market ethical and other pharmaceutical products. Information about the Company's sales and profitability by different geographic areas for the years ended March 31, 1995, 1994 and 1993 follows:\nFOREST LABORATORIES, INC. AND SUBSIDIARIES ------------------------------------------ NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) ------------------------------------------\n2. BUSINESS OPERATIONS: (CONTINUED)\nThe Company sells primarily in the United States and European markets. Operating profit is net sales less operating expenses, and does not include other income, unallocated expenses or income taxes.\nOne customer accounted for 11% of the Company's consolidated net sales for the year ended March 31, 1995. No customer accounted for more than 10% of the Company's consolidated net sales in the fiscal years ended March 31, 1994 and March 31, 1993.\nPAGE\nFOREST LABORATORIES, INC. AND SUBSIDIARIES ------------------------------------------ NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) ------------------------------------------\n3. INVENTORIES:\nInventories consist of the following:\n4. MARKETABLE SECURITIES:\nThe contractual maturities of debt securities held to maturity at March 31, 1995, regardless of their balance sheet classification, consist of the following:\n5. OTHER ASSETS:\nLicense agreements, product rights and other intangible assets consist of the following:\n6. ACCRUED EXPENSES:\nAccrued expenses consist of the following:\nFOREST LABORATORIES, INC. AND SUBSIDIARIES ------------------------------------------ NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) ------------------------------------------\n7. COMMITMENTS:\nLeases: The Company leases manufacturing, office and warehouse facilities, equipment and automobiles under operating leases expiring through 2010. Rent expense approximated $4,869,000 for 1995, $4,215,000 for 1994 and $3,213,000 for 1993. Aggregate minimum rentals under noncancellable leases are as follows:\nYEAR ENDING MARCH 31, (IN THOUSANDS) 1996 $ 4,255 1997 4,121 1998 2,976 1999 2,424 2000 2,214 Thereafter 26,435 ------- $42,425 =======\nROYALTY OBLIGATIONS: In 1984 and 1986, the Company entered into agreements for research and development (the \"1984 Prutech Agreement\" and \"1986 Prutech Agreement\") with Prutech Research and Development Partnership (\"Prutech\"). In accordance with the provisions of these agreements, the Company granted Prutech nonexclusive licenses to certain of the Company's controlled release technologies for the purpose of developing certain products. Prutech contracted with the Company to perform research necessary to develop the products. In addition, Prutech granted the Company options (some of which were exercised) to acquire exclusive manufacturing and marketing rights to the products if they are successfully developed. Under the 1984 Prutech Agreement, the Company was paying to Prutech royalties of 12% on the sales of certain of the products which amounted to $7,732,000 and $6,273,000 in 1994 and 1993, respectively. Effective April 1, 1994, the Company purchased the product rights of certain products for $17,700,000 and eliminated the royalty. The product rights are being amortized over a period of 14 years representing the estimated useful life of this asset. Under the 1986 Prutech Agreement, the Company will pay to Prutech an initial royalty on sales of the products of 7%, decreasing to 2%, through December 31, 1999. No royalties have been incurred under this agreement.\nFOREST LABORATORIES, INC. AND SUBSIDIARIES ------------------------------------------ NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) ------------------------------------------\n8. SHAREHOLDERS' EQUITY:\nPREFERRED STOCK PURCHASE RIGHTS: On September 30, 1994, the Company's Board of Directors redeemed the then outstanding preferred stock purchase rights distributed onFebruary 18, 1988 at the redemption price of $.001 per right. Additonally, on September 30, 1994, the Company's Board of Directors declared a dividend of one preferred share purchase right (a \"Right\") for each outstanding share of the Company's common stock, par value $.10 per share. Each Right will entitle the holder to buy one one-hundredth of a share of authorized Series A Junior Participating Preferred Stock, par value $1.00 per share (\"Series A Preferred Stock\") at an exercise price of $250 per Right, subject to adjustment. Prior to becoming exercisable, the Rights are evidenced by the certificates representing the common stock and may not be traded apart from the common stock. The Rights become exercisable on the tenth day after public announcements that a person or group has acquired, or obtained the right to acquire, 20% or more of the Company's outstanding common stock, or an announcement of a tender offer that would result in a beneficial ownership by a person or group of 20% or more of the Company's common stock.\nIf, after the Rights become exercisable, the Company is a party to certain merger or business combination transactions, or transfers 50% or more of its assets or earning power, or if an acquirer engages in certain self-dealing transactions, each Right (except for those held by the acquirer) will entitle its holder to buy a number of shares of the Company's Series A Preferred Stock or, in certain circumstances, a number of shares of the acquiring company's common stock, in either case having a value equal to two-and-one-half times the exercise price of the Right. The Rights may be redeemed by the Company at any time up to ten days after a person or group acquires 20% or more of the Company's common stock at a redemption price of $.001 per Right. The Rights will expire on September 30, 2004.\nThe Company has reserved 500,000 shares of Series A Preferred Stock for the exercise of the Rights.\nSTOCK OPTIONS: The Company has various Employee Stock Option Plans whereby options to purchase an aggregate of 7,500,000 shares of common stock have been or remain to be issued to employees of the Company and its subsidiaries at prices not less than the fair market value of the common stock at the date of grant.\nPAGE\nFOREST LABORATORIES, INC. AND SUBSIDIARIES ------------------------------------------ NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) ------------------------------------------\n8. SHAREHOLDER'S EQUITY: (CONTINUED)\nTransactions under the stock option plans and individual non-qualified options not under the plans are summarized as follows:\nAt March 31, 1995 and 1994, 2,259,373 and 348,373 shares, respectively, were available for grant.\nIn connection with the acquisition of product rights, the Company issued 280,000 warrants, which expire on July 7, 2004, at an exercise price equal to the then fair market value of the Company's common stock.\nFOREST LABORATORIES, INC. ------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) ------------------------------------------\n9. CONTINGENCIES:\nThe Company is subject to product liability and other claims which management does not believe will have a material effect on the Company.\nThe Company and certain of its officers are defendants in a putative class action alleging certain misrepresentations in disclosures related to Micturin. The Company is a nominal defendant in a putative derivative action against the Company's directors arising from such disclosures and challenging the validity of certain options granted to the director defendants. Management believes the claims are without merit and intends to vigorously defend the actions.\nThe Company is a defendant in actions filed in various federal district courts alleging certain violations of the Federal anti-trust laws in the marketing of pharmaceutical products. In each case, the actions were filed against many pharmaceutical manufacturers and suppliers and allege price discrimination and conspiracy to fix prices in the sale of pharmaceutical products. The actions were brought by various pharmacies (both individually and, with respect to certain claims, as a class action) and seek injunctive relief and monetary damages. The Judicial Panel on Multi-District Litigation has ordered these actions coordinated (and, with respect to those actions brought as class actions, consolidated) in the Federal District Court for the Northern District of Illinois (Chicago) under the caption \"In re Brand Name Prescription Drugs Antitrust Litigation.\" Similar actions alleging price discrimination claims under state law are pending against many pharmaceutical manufacturers, including the Company, in state courts in California, Alabama, Washington, Wisconsin and Minnesota The Company believes these actions are without merit and intends to defend them vigorously.\n10. OTHER INCOME:\nOther income consists of the following:\n11. INCOME TAXES:\nThe Company and its mainland U.S. subsidiaries file a consolidated federal income tax return.\nIncome before income taxes includes income from foreign operations of $7,238,000, $7,615,000 and $8,163,000 for the years ended March 31, 1995, 1994 and 1993, respectively.\nThe Company has tax holidays in Puerto Rico and Ireland which expire primarily in 1997 and 2010, respectively. The net impact of these tax holidays was to increase net income and net income per share (primary) by approximately $2,794,000 and $.06 in 1995, $1,938,000 and $.04 in 1994 and $2,571,000 and $.06 in 1993.\nFOREST LABORATORIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n11. INCOME TAXES: (CONTINUED)\nThe provision for income taxes consists of the following:\nNo provision has been made for income taxes on the undistributed earnings of the Company's foreign subsidiaries of approximately $40,858,000 at March 31, 1995, as the Company intends to indefinitely reinvest such earnings.\nThe reasons for the difference between the provision for income taxes and expected federal income taxes at statutory rates are as follows:\nFOREST LABORATORIES, INC. AND SUBSIDIARIES ------------------------------------------ NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) ------------------------------------------\n11. INCOME TAXES (CONTINUED)\nNet deferred income taxes consist of the following:\n12. QUARTERLY FINANCIAL DATA (unaudited): (IN THOUSANDS, EXCEPT PER SHARE DATA)\nFully diluted earnings per share are not presented, as the results obtained are substantially the same as primary earnings per share.\nPAGE\nEXHIBIT 23\nCONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS - ---------------------------------------------------\nForest Laboratories Inc. New York, New York\nWe hereby consent to the incorporation by reference in the Registration Statements of Forest Laboratories, Inc. on Form S-8, filed with the Securities and Exchange Commission on November 13, 1990 and October 28, 1994 and on Forms S-3, filed with the Securities and Exchange Commission on November 30, 1993 and August 8, 1994, of our reports dated April 28, 1995, on the consolidated financial statements and schedule of Forest Laboratories Inc. and Subsidiaries, included or incorporated by reference in the Forest Laboratories, Inc. Annual Report on Form 10-K for the year ended March 31, 1995.\nBDO Seidman\nNew York, New York June 26, 1995","section_15":""}
{"filename":"355787_1995.txt","cik":"355787","year":"1995","section_1":"Item 1. Business.\nGENERAL\nThe Company has historically been a nationwide communications company. Until consummation of their sale in March and February 1996, the Company owned an ABC affiliate, WHTM-TV (which was acquired by the Company during 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 (see \"Recent Developments\"), respectively. Prior to 1995 the Company owned a number of television, radio, newspaper and other media and related properties which were disposed of pursuant to the Company's long-standing policy of buying and selling media properties at times deemed advantageous by the Company's Board of Directors. The Company intends to continue to investigate and pursue potential media and other acquisitions such as 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 of properties since the beginning of 1995. 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\nOn March 1, 1996, the Company sold substantially all of the assets, except cash but including accounts receivable together with certain liabilities of its ABC affiliate serving the Harrisburg-York-Lebanon-Lancaster, Pennsylvania television market for approximately $115 million in cash to Allbritton Communications Company. The Company expects to recognize a pre-tax gain of approximately $65 million from this transaction.\nI-1\nOn February 2, 1996, the Company sold substantially all of the assets, except cash and accounts receivable, together with certain liabilities, of its three NBC affiliates, KJAC-TV, Beaumont\/Port Arthur, Texas; KFDX-TV, Wichita Falls, Texas\/Lawton, Oklahoma and KSNF-TV, Joplin, Missouri\/Pittsburg, Kansas for approximately $41 million in cash. The stations were sold to US Broadcast Group, a newly organized acquirer of television properties. The Company expects to recognize a pre-tax gain of approximately $30 million from this transaction.\nPrior to 1995, 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. During 1994, the Company entered into a settlement agreement with the various parties to the Fairmont bankruptcy proceedings although the exact amount was uncertain until 1995. The Company received during 1995 cash payments totaling approximately $7.9 million in respect of sales of properties by Fairmont.\nAfter giving effect to the sale of its television properties, the Company has significant liquid assets on hand to invest in communications properties and possibly in other companies in the form of debt or equity that its Board of Directors decides to be in the best interests of its shareholders. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.\" In that connection, during December, 1995, the Company invested approximately $8.4 million in warrants to acquire approximately 1.2 million shares of Class B Common Stock of PriCellular Corporation (\"PriCellular\"), a publicly held cellular telephone company of which Mr. Price is President.\nDuring February 1996, the Company purchased 600,000 shares of PriCellular Class A Common Stock for approximately $6.3 million. The Company's Board of Directors will continue to investigate investments for the Company that it believes provide opportunities for significant returns to shareholders, including possible additional investments in PriCellular.\nDue to the developments described above, the Company's historical results of operation 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 stations contributed 100 percent of the Company's net revenue for 1995. 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. During 1994, the Company disposed of all of its radio properties. For the year ended December 31, 1993, the Company's television, radio, and other segments contributed 52 percent, 45 percent and 3 percent, respectively, of the Company's net revenue.\nI-2\nACQUISITION STRATEGY\nAfter giving effect to the consummation of the sale by the Company of WHTM-TV, KSNF-TV, KJAC-TV and KFDX-TV, the Company has significant funds available for acquisition and investment purposes. See \"Business - Recent Developments.\" The Company continues to actively review potential acquisitions and investments. Among the possible acquisitions or investments which may be considered by the Company are: (i) subject to the availability of such properties at prices deemed prudent by the Company, making acquisitions of radio and television properties; (ii) exploring related media activities, such as newspapers, outdoor advertising companies and publishing enterprises; (iii) investing funds in media and media related securities; (iv) returning to the Company's historic investment in PriCellular Corporation either through the purchase of PriCellular securities or a business combination with PriCellular; and (v) other acquisition and investment opportunities which may present themselves from time to time.\nTo finance its acquisitions and to provide funds for other purposes, the Company may consider using a variety of sources in addition to its cash on hand, 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. 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 level.\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 sometime 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 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\nI-3\nnational \"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 P.M. to 11 P.M. E.S.T. Sundays and 8 P.M. to 11 P.M. E.S.T. other days) generally earns the highest rates. In addition, a network often allocates portions of advertising time during network broadcasts for direct sale by the local station to advertisers.\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 network-affiliated 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 have also acquired 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.\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 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.\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\"). On February 8, 1996, President Clinton signed into law the Telecommunications Act of 1996 (the \"New Act\"), which amends substantially the 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. Because many provisions of the New Act require regulatory actions by the FCC that have not yet occurred, the Company cannot predict the effect of any such new legislation or amendments on the Company. The businesses in which the Company may engage in the future may be subject to a greater or lesser degree of government regulation depending on the nature of such businesses.\nI-4\nEMPLOYEES\nAs of December 31, 1995, the Company employed approximately 220 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 studio and production facilities and own or lease space for other offices, antenna sites and certain equipment for their station. (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.)\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.\nI-5\nPART 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 as adjusted to reflect its April, 1995 5 for 4 stock split, and rounded to the nearest eighth for each of the four quarters of 1995 and 1994, as reported by the AMEX was:\nThe high and low last sale prices for the Company's Common Stock on the AMEX for March 1, 1996 as reported by the AMEX were $7 and $7, 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 March 1, 1996, there were approximately 430 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\nII-1\nrespect to the Company for each of the five years in the period ended December 31, 1995, 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-organization 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.\nCONSOLIDATED OPERATING STATEMENT ITEMS (in thousands)\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 3 and 4 to Consolidated Financial Statements.\n(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.\n(3) See Note 2 of Notes to Consolidated Financial Statements.\n(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. All per share amounts prior to 1995 have been restated to reflect the April, 1995 5 for 4 stock split. See Note 14 to Consolidated Financial Statements.\nII-2\nCONSOLIDATED BALANCE SHEET ITEMS (in thousands, including notes)\n(1) Net of unamortized original issue discount of $5,124 as of December 31, 1991.\n(2) Includes $28,000 of a note payable to Bank of Montreal which was repaid upon the sale of three television stations on February 2, 1996. See \"Business - Recent Developments.\"\n(3) Net of unamortized original issue discount of $8,705 as of December 31, 1992.\nITEM 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 consolidated 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-organization 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 - General\" and \"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 compatibility of results for future periods will be affected by the acquisition and dispositions during 1994, and thereafter (see Notes 3 and 4 of Notes to Consolidated Financial Statements) and by the nature and timing of any future acquisitions or dispositions. The Company currently has disposed of all of its operating properties. Consequently, the Company will have no operating revenues following such dispositions, and the Company's future revenues will be derived from the investment of its funds and\nII-3\nfrom operating businesses which may be acquired by the Company. 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.\n1995 COMPARED TO 1994\nThe Company's net revenue, operating expenses, depreciation and amortization, and interest expense for the year ended December 31, 1995 are not comparable to the year ended December 31, 1994 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 3 and 4 of Notes to Consolidated Financial Statements). During 1995, net revenue increased by approximately 21% to $29.2 million from $24.0 million. This increase was primarily due to the acquisition of WHTM-TV the results of which were included in the Company's results for a full year as opposed to only three months in 1994. Operating expenses of the Company increased overall to $16.7 million in 1995 from $15.0 million in 1994 due to the acquisition of WHTM-TV which was owned for the full year. Depreciation and amortization expense rose to $3.5 million in 1995 from $3.3 million in 1994 primarily as a result of the amortization of intangibles associated with the acquisition of WHTM-TV, offset by a reduction in the expense due to properties sold in 1994.\nThe Company recognized net income of approximately $11.1 million in 1995, as compared to $14.4 million in 1994 primarily as a result of the recovery on the Fairmont Notes of approximately $7.9 million in 1995. Net income in 1994 was $14.4 million primarily due to the net gains on the sale of its radio properties of $17.2 million. Additionally, interest expense was $2.1 million in 1995 as opposed to $.8 million in 1994 as a result of the acquisition of WHTM-TV in September 1994 and the related borrowings under the Amended Line of Credit.\nThe Company had net income per share of $1.06 in 1995, as opposed to $1.15 in 1994.\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 3 and 4 of Notes to Consolidated Financial Statements). During 1994, net revenue increased by approximately 5% to $24.0million from $22.8 million in 1993. This increase was due to the acquisition of WHTM-TV during September 1994 which resulted in an increase in television segment revenues of approximately 42.7% to $16.8 million from $11.7 million during 1993. This increase was\nII-4\npartially offset by a decline in net revenue from radio and other segments to $7.3 million from $11.0 million. Television revenues during 1994 were impacted by a large influx of political advertising revenues which contributed to increases in the Company's revenues. Operating expenses of the Company decreased overall to $15.0 million in 1994 from $16.3 million in 1993 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 in 1994 from $2.3 million in 1993 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 4 of Notes to Consolidated Financial Statements) and amortization of intangibles associated with the acquisition of WHTM-TV.\nThe Company had 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 of $1.15 in 1994, as opposed to a net loss per share of $.11 in 1993. During 1993, net loss includes an extraordinary gain of $.14 per share due to the early extinguishment of debt. No such extraordinary item existed during 1994.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company had approximately $1.2 million in cash and cash equivalents and negative net working capital at December 31, 1995 due to the classification of $28 million of long-term debt as current. Such debt was repaid by the Company during February 1996 upon the sale of three of its television stations. See Note 4.\nIf the Company's acquisition strategy (see \"Business - Acquisition Strategy\") is successful the Company may require substantial capital to finance it. After giving effect to\nII-5\nthe sale of its remaining television property, the Company has significant liquid assets on hand (estimated at $100 million) for acquisition purposes. Additionally, the Company may use a variety of sources including the proceeds of debt sold to the public, additional borrowings from banks and other institutional leaders, 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 1996 prior to the sale of its stations. Capital expenditures for 1995 were approximately $1.5 million.\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.\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 negotiated transactions. During the year ended December 31, 1995, the Company repurchased approximately 1.7 million shares pursuant to that authorization.\nII-6\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 SUBSIDIARY\nCONSOLIDATED FINANCIAL STATEMENTS\nAuditors' Reports II-9-1\nConsolidated Balance Sheets at December 31, 1995 and 1994 II-9-4\nConsolidated Statements of Operations for Years ended December 31, 1995, 1994 and 1993 II-9-5\nConsolidated Statements of Cash Flows for Years ended December 31, 1995, 1994 and 1993 II-9-6\nConsolidated Statements of Shareholders' Equity for Years ended December 31, 1995, 1994 and 1993 II-9-7\nNotes to Consolidated Financial Statements II-9-8\nITEM 9.","section_9":"ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNot applicable.\nII-7\n[ARTHUR ANDERSEN LLP LETTERHEAD]\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Board of Directors and Shareholders of Price Communications Corporation:\nWe have audited the accompanying consolidated balance sheet of Price Communications Corporation and subsidiaries (a New York corporation) as of December 31, 1995, and the related consolidated statements of operations, shareholders' equity and cash flows for the year then ended. These consolidated financial statements and the schedules referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and schedules based on our audit.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Price Communications Corporation and subsidiaries as of December 31, 1995, and the results of its operations and its cash flows for the year then ended in conformity with generally accepted accounting principles.\nOur audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. Schedules I and II are presented for purposes of additional analysis and are not a required part of the basic consolidated financial statements. This information has been subjected to the auditing procedures applied in our audit of the basic consolidated financial statements and, in our opinion, is fairly stated in all material respects in relation to the basic consolidated financial statements taken as a whole.\n\/s\/ Arthur Andersen LLP\nNew York, New York February 16, 1996\nII-9-1\nKPMG Peat Marwick LLP\n345 Park Avenue New York, NY 10154\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, cash flows, and shareholders' equity for the year then ended. 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 our 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 year ended December 31, 1994 in conformity with generally accepted accounting principles. Also in our opinion, the relaxed 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\nNew York, New York January 20, 1995\nII-9-2\nREPORT OF INDEPENDENT AUDITORS\nThe Board of Directors and Shareholders Price Communications Corporation\nWe have audited the accompanying consolidated statements of operations, shareholders' equity and cash flows of Price Communications Corporation and Subsidiaries (the \"Company\") for the year ended December 31, 1993. Our audit also included the financial statement schedules listed at item 14(a) for the year ended December 31, 1993. These consolidated financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audit.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated results of operations and cash flows of Price Communications Corporation and Subsidiaries for the year ended December 31, 1993 in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nErnst & Young LLP\nNew York, New York March 8, 1994\nII-9-3\nPRICE COMMUNICATIONS CORPORATION AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\nDECEMBER 31, 1995 AND 1994\nThe accompanying notes are an integral part of these balance sheets.\nII-9-4\nPRICE COMMUNICATIONS CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF OPERATIONS\nFOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nThe accompanying notes are an integral part of these statements.\nII-9-5\nPRICE COMMUNICATIONS CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nThe accompanying notes are an integral part of these statements.\nII-9-6\nPRICE COMMUNICATIONS CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY\nFOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nThe accompanying notes are an integral part of these statements.\nII-9-7\nPRICE COMMUNICATIONS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1995, 1994 AND 1993\n1. OPERATIONS\nPrice Communications Corporation (\"Price\" or the \"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, 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. In 1996, the Company sold all of its operating assets in two separate transactions. Reference is made to Note 17, \"subsequent events,\" for a discussion of these transactions.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBasis of Presentation\nThe consolidated financial statements include the accounts of Price and its subsidiaries. All significant intercompany balances and transactions have been eliminated in the consolidated financial statements. All presentations of shares outstanding and amounts for years prior to 1995 have been restated to reflect a five-for-four common stock split in April, 1995 (Note 14).\nEstimates\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. Actual results could differ from these estimates.\nCash and Cash Equivalents\nThe 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.\nII-9-8\nShort-Term Investments\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. At December 31, 1995, the Company's short-term investments were in marketable equity securities, which are classified as trading securities under the provisions of SFAS No. 115. Accordingly, net unrealized holding gains and losses for trading securities were included in net earnings for 1995.\nShort-Term investments at December 31, 1995, are carried at fair value, which is based on quoted market prices for these investments. The adoption of SFAS No. 115 did not have a material impact on the Company's results of operations or financial condition.\nProperty and Equipment\nProperty and equipment are recorded at cost. Depreciation and amortization are computed using the straight-line method over 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\nBroadcast Licenses and Other Intangibles\nExcess 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. The Company amortizes such assets over a 40-year life commencing from the original date of acquisition.\nDeferred expenses associated with debt instruments were amortized under the straight-line method over their respective life of such debt instruments. Debt discounts were amortized using the effective interest method.\nIn 1992, the Company reorganized and emerged from Chapter 11 bankruptcy proceedings 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 Bankruptcy Code.\" 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.\nII-9-9\nFilm Broadcast Rights\nThe cost of film broadcast rights is stated at the lower of cost or estimated net realizable value. The total cost of the rights is recorded as an asset and a liability when the program becomes available for broadcast. The cost of film broadcast rights is charged to operations on the basis of the estimated number of showings or, if unlimited showings are permitted, over the term of the broadcast license agreements. The current portion of film broadcast rights represent those rights that will be amortized in the succeeding year. Amortization of film broadcast rights included in operating expenses amounted to approximately $1,831,000, $1,077,000 and $800,000 for the years ended December 31, 1995, 1994, and 1993, respectively.\nRevenue Recognition\nAdvertising revenue is recognized as income when the advertisements are broadcast.\nRevenue 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.\nCredit Risk\nThe Company provides an allowance for doubtful accounts based on reviews of its customers' accounts. Included in operating expense is bad debt expense of approximately $84,000, $319,000, and $264,000 for the years ended December 31, 1995, 1994, and 1993, respectively.\nPer Share Data\nIncome (loss) per share is based on net income (loss) for the period divided by the weighted average number of shares of common stock and common stock equivalents outstanding, which were approximately 10.4 million shares, 12.4 and 14.9 million shares for 1995, 1994, and 1993, respectively.\nIncome Taxes\nThe Company accounts for income taxes in accordance with the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS No. 109\"). 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. 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.\nReclassifications\nCertain reclassifications have been made to prior year amounts to conform with current year presentation.\nII-9-10\n3. 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. Funds for the acquisition were provided by cash on hand and a credit facility from the Bank of Montreal (\"BMO\") of $45 million (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 (Note 4). The acquisition resulted in intangible assets, primarily broadcast licenses of approximately $44.2 million and goodwill of approximately $18.6 million, both of which are being amortized over a forty year period.\n4. DISPOSITIONS\nIn February 1994, the Company sold its outdoor advertising business for a total of $875,000 in cash and notes receivable (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 (Note 5). The Company's pretax gain on the transaction was deminimis.\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 (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 deminimis 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.\nII-9-11\n5. NOTES RECEIVABLE\nInvestments in notes receivable include the following:\nIn May 1995, the Company received a $655,000 payment on a note receivable originating from the sale of its outdoor advertising business in 1994 from the buyer, Midwest Media, Inc. During 1994, the Company set up a reserve of $337,500 against this note receivable. Since this note receivable has been collected in full, the previously established reserve has been reversed and treated as income included in other (income) expense, net on the Company's consolidated statement of operations.\nDuring 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 (Note 4), 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.\nIn 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, 1995 and 1994.\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. In 1995, the Company received net cash payments totaling approximately $7.5 million from the proceeds of the liquidation of Fairmont. This amount has been treated as income and included in other (income) expense, net on the Company's consolidated statement of operations.\n6. INVESTMENT IN PARTIALLY OWNED COMPANIES\nOn October 1, 1993, the Company sold its 74% interest in PriCellular Corporation (\"PriCellular\"), an affiliate of the Company, 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. During 1993, the Company recognized a charge of\nII-9-12\napproximately $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.\nOn December 21, 1995, the Company acquired warrants for $8,350,000 to purchase 1,220,550 shares of PriCellular's, Class B Common Stock. The exercise price is $7.46, per share of Class B Common Stock, and escalates over the next four years to $9.84.\n7. PROPERTY AND EQUIPMENT\nProperty and equipment consists of the following:\n8. ACCOUNTS PAYABLE AND ACCRUED EXPENSES\nAccounts payable and accrued expenses consist of the following:\nII-9-13\n9. OTHER LIABILITIES\nOther liabilities consist of:\n10. LONG-TERM DEBT\nLong-term debt consists of the following notes payable by wholly-owned subsidiaries of the Company at December 31, 1995 and 1994 as follows:\n(A) On December 12, 1995, the Company entered into an amended line of credit agreement (\"Credit Agreement\") with The Bank of Montreal (\"BMO\"). The Credit Agreement created a line of credit for $28 million. Borrowings under the Credit Agreement are subject to base interest at the BMO base rate, as defined, plus a maximum of .75% and are secured by the assets of the subsidiaries. Additionally, there is a commitment fee of .5% on the unused portion, if any, of the Credit Agreement. On December 31, 1995, the effective interest rate was 8.5%. The terms of the Credit Agreement require the Company to maintain certain financial ratios, restrict the declaration of dividends and to apply the proceeds from future asset sales to the outstanding balance due.\nOn February 2, 1996, the Company sold its three NBC affiliates and used a portion of the proceeds to pay $28 million plus interest to BMO to terminate the Credit Agreement.\nII-9-14\n(B) 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 (Note 4) and reduced further quarterly, in varying amounts through the year 2001 as follows:\nBorrowings under the Amended Line of Credit bore interest at the BMO Base Rate, as defined, plus up to a maximum of .75%, and were secured by the assets of the subsidiaries, had a book value of approximately $81.3 million as of December 31, 1994. There was 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%. These borrowings were repaid and this agreement was superceded by the amended agreement as discussed in (A) above.\n(C) In connection with the plan of reorganization, 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 (Note 2). 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.\n11. INCOME TAXES\n(Benefit) provision for income taxes is approximately:\nII-9-15\nFor the year ended December 31, 1995, the Company was unable to utilize the tax benefit of capital and net operating losses, and accordingly, no amounts were provided therefor. For the years ended December 31, 1995 and 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:\nThe Company had, as of December 31, 1995 and 1994, deferred tax assets which were subject to a valuation allowance of approximately $31,925,000 and $39,529,000, respectively. The allowance has been recognized to offset the related 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 $65.9 million are available for federal income tax purposes at December 31, 1995. These carryforwards expire in the years 2002 through 2010. The Company also has available investment tax credit carryforwards of approximately $100,000 expiring in the year 2000 and capital loss carryforwards of approximately $31.4 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.\nII-9-16\n12. OTHER (INCOME) EXPENSE, NET\nOther (income) expense, net, consists of:\n13. SEGMENT DATA\nThe Company's business operations were previously classified into two segments: Television and Radio Broadcasting and Other. The Company sold its radio stations and outdoor advertising business during 1994 and accordingly operated in only one segment in 1995. The segment data for prior years follows:\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.\nII-9-17\n14. SHAREHOLDERS' EQUITY\nOn 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. 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. 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 (income) expense for 1993 in the accompanying statement of operations (Note 12), and the common stock purchased from Huff has been treated as constructively retired in the accompanying balance sheet at December 31, 1993.\nIn 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.\nIn October 1994, the Company's Board of Directors enacted a Stockholders' Rights Plan (the \"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.\nII-9-18\nOn February 10, 1994, the Company's Board of Directors authorized the repurchase by the Company of up to 2,500,000 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 when 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 1,245,000 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.\nOn February 1, 1995, Price purchased 1,077,875 shares of its common stock from S.A.C. Capital Management, L.P. for approximately $6.6 million. The Company paid a premium over the daily quoted market price of approximately $1.2 million that is recorded as other (income) expense on the Company's statement of operations.\nIn March 1995, at the Company's Annual Meeting, the shareholders authorized the creation of 20 million shares of undesignated Preferred Stock for acquisitions and other purposes. No preferred stock had been issued as of December 31, 1995.\nOn April 8, 1995, the Company's Board of Directors approved a five-for-four stock split of the Company's Common Stock to shareholders of record as of the close of business on March 27, 1995. The Company issued approximately 2 million shares of Common Stock. The stated par value of each share was not changed from $.01. All presentations of shares outstanding and amounts per share in years prior to 1995 have been restated to reflect the 1995 stock split.\nIn March 1995, the Company's Board of Directors authorized the purchase of Common Stock in the open market or in privately negotiated transactions when it is legally permissible to do so or believed to be in the best interest of Price's shareholders, in addition to previous authorizations. Approximately 1.7 million shares were purchased in 1995 under this new authorization and previous authorizations. Repurchased Common Stock of the Company has been treated as constructively retired in the accompanying consolidated balance sheet as of December 31, 1995.\n15. STOCK OPTION PLAN\nThe Company has a long-term incentive plan, (the \"1992 Long Term Incentive 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 1,250,000. 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.\nII-9-19\nThe following table sets forth information with respect to the Company's stock options for the years ended December 31, 1995 and 1994:\nThe above has been restated to reflect the April, 1995 five-for-four common stock split.\n16. COMMITMENTS AND CONTINGENCIES\nThe Company is involved in various claims and litigation 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 extendible 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 1995 and in the aggregate:\nII-9-20\nRental expense for operating leases was approximately $187,250, $312,000 and $312,000 for the years ended December 31, 1995, 1994, and 1993, respectively.\nAt December 31, 1995, the Company is committed to the purchase of film broadcast rights of various syndicated programming aggregating approximately $2,956,704, $2,116,675, $777,437, $97,069 and $-0- for the years 1996, 1997, 1998, 1999 and 2000, respectively.\n17. SUBSEQUENT EVENTS\nOn February 2, 1996, the Company sold substantially all of the assets, except cash and accounts receivable, together with certain liabilities, of its three NBC affiliates, KJAC-TV, Beaumont\/Port Arthur, TX; KFDX-TV, Wichita Falls, TX\/Lawton, OK and KSNF-TV, Joplin, MO\/Pittsburgh, KS for approximately $41 million in cash. The stations were sold to USA Broadcasting Group L.L.C., a newly organized acquirer of television properties. The Company expects to recognize a pre-tax gain of approximately $30 million from this transaction during 1996.\nOn March 1, 1996, the Company sold substantially all of the assets, together with certain liabilities of WHTM, its ABC affiliate serving the Harrisburg-York-Lebanon-Lancaster, PA television market, for $113 million in cash to Allbritton Communications Company. The Company expects to recognize a pre-tax gain of approximately $65 million from this transaction.\nIn January 1996, the Company purchased 600,000 shares of PriCellular's, an affiliate, Class A Common Stock for approximately $6.3 million.\nAlso in January 1996, the Company repurchased 129,000 shares of its Common Stock in the open market for approximately $1.0 million.\n18. SUPPLEMENTAL CASH FLOW INFORMATION\nThe following is supplemental disclosure cash flow information for the years ended December 31, 1995, 1994, and 1993:\nII-9-21\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 1996 Meeting of Shareholders.\nItem Incorporated from ---- -----------------\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. Directors and Executive \"Directors and Executive Officers of the Company Officers\"\nITEM 11.","section_11":"ITEM 11. Executive Compensation \"Executive Compensation\" and \"Certain Relationships and Related Transactions\"\nITEM 12.","section_12":"ITEM 12. Security Ownership of \"Principal Shareholders\" Certain Beneficial and Security Ownership of Owners and Management Management\"\nITEM 13.","section_13":"ITEM 13. Certain Relationships \"Executive Compensation and Related Transactions and \"Certain Relationships and Related Transactions\"\nIII-1\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:\nIndependent Auditors' Reports\nConsolidated Balance Sheets at December 31, 1995 and 1994\nConsolidated Statements of Operations for Years ended December 31, 1995, 1994 and 1993\nConsolidated Statements of Shareholders' Equity for Years ended December 31, 1995, 1994 and 1993\nConsolidated Statements of Cash Flows for the Years ended December 31, 1995, 1994 and 1993\nNotes to Consolidated Financial Statements\nI. Condensed Financial Information of Registrant II. 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.\nNone.\nIV-1\nPRICE COMMUNICATIONS CORPORATION AND SUBSIDIARIES SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT BALANCE SHEETS DECEMBER 31, 1995 AND 1994\n* Eliminated in consolidation PRICE COMMUNICATIONS CORPORATION AND SUBSIDIARIES SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT STATEMENTS OF OPERATIONS\nPRICE COMMUNICATIONS CORPORATION AND SUBSIDIARIES SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT STATEMENTS OF CASH FLOWS\n* Eliminated in consolidation PRICE COMMUNICATIONS CORPORATION AND SUBSIDIARIES\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS\nDECEMBER 1995, 1994 AND 1993\n(a) Amounts written off as uncollectible and payments. (b) Includes adjustments for the disposition of properties and the acquisition of WHTM-TV.\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: March 11, 1996\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: March 11, 1996 By \/s\/ Robert Price ----------------------------------------- Robert Price, Director and President (Principal Executive Officer, Financial Officer and Accounting Officer)\nDated: March 11, 1996 By \/s\/ George H. Cadgene ----------------------------------------- George H. Cadgene, Director\nDated: March 11, 1996 By \/s\/ Robert F. Ellsworth ----------------------------------------- Robert F. Ellsworth, Director\nDated: March 11, 1996 By \/s\/ Robert Paul ----------------------------------------- Robert Paul, Director\nDated: March 11, 1996 By \/s\/ Kim I. Pressman ----------------------------------------- Kim I. Pressman, Director\nDated: March 11, 1996 By \/s\/ Steven Price ----------------------------------------- Steven Price, Director\nEXHIBIT INDEX ITEM 14(a)(3)\nPRICE COMMUNICATIONS CORPORATION\nAnnual Report on Form 10-K for the year ended December 31, 1995\nPage ---- (3)(a)(1) 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(2) Certificate of Amendment of the Certificate of Incorporation of the Registrant as filed with the Secretary of State of New York on March 17, 1995.\n(3) Certificate of Amendment of the Certificate of Incorporation of the Registrant as filed with the Secretary of State of New York on January 2, 1996.\n(b) Restated By-laws of the Registrant.\n(10)(a) The Registrant's 1992 Long Term Incentive Plan, incorporated by reference to Exhibit 10(a) to Registrant's Form 10-K for the year ended December 31, 1992.\n(b) 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(c) 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(d) Stock Purchase Agreement, dated as of\nE-1 Page ---- 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(e) 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(f) 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(g) 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(h) Employment Agreement, dated as of October 6, 1994, between the Registrant and Robert Price, incorporated by reference to Exhibit 10(aa) to the Registrant's Form 10-K for the year ended December 31, 1994.\n(i) Employment Agreement, dated as of January 5, 1995, between the Registrant and Kim Pressman, incorporated by reference to Exhibit 10(bb) to the Registrant's Form 10-K for the year ended December 31, 1994.\nE-2 Page ---- (j) Stock Option Agreement, dated as of February 10, 1994, between the Registrant and Robert Price, incorporated by reference to Exhibit 10(cc) to the Registrant's Form 10-K for the year ended December 31, 1994.\n(k) 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(l) 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 Registrant's Form 8-K filed to report an event on January 12, 1995.\n(m) 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(n) Asset purchase agreement dated as of August 8, 1995 by and between USA Broadcast Group L.L.C. and Price Communications Corporation, Texoma Broadcasting Corp., Southeast Texas Broadcasting Corp. and Tri-State Broadcasting Corp., incorporated by reference to Exhibit 10(gg) to the Registrant's Form 10-Q for the Quarter ended September 30, 1995.\n(o) Asset purchase agreement dated as of October 18, 1995 by and between WHTM-TV, Inc. and Allbritton Communications Company, incorporated by reference to Exhibit 10(hh) to the Registrant's Form 10-Q for the Quarter ended September 30, 1995.\nE-3 Page ---- (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. - None.\n(24) The powers of attorney to sign amendments to this Report appear on the signature page.\n(27) Financial Data Schedule.\nE-4","section_15":""}
{"filename":"63276_1995.txt","cik":"63276","year":"1995","section_1":"ITEM 1. BUSINESS - ------- --------\nMattel is the leading worldwide designer, manufacturer and marketer of toys. The Company's four principal core brands are BARBIE fashion dolls and doll clothing and accessories; FISHER-PRICE toys and juvenile products, including the POWER WHEELS line of battery-powered, ride-on vehicles; the Company's Disney-licensed toys; and die cast HOT WHEELS vehicles and playsets, each of which has broad worldwide appeal. Additional core product lines consist of large dolls, including CABBAGE PATCH KIDS; preschool toys, including SEE 'N SAY talking toys; the UNO and SKIP-BO card games; and the SCRABBLE game, which the Company owns in markets outside of the United States and Canada. Revenues for 1995 of $3.6 billion were a record level for the Company.\nAs used herein, unless the context requires otherwise, \"Mattel\" or the \"Company\" refers to Mattel, Inc., and its subsidiaries, and \"Fisher-Price\" refers to Fisher-Price, Inc., a Delaware corporation and wholly-owned subsidiary of Mattel.\nMattel was incorporated in California in 1948 and reincorporated in Delaware in 1968. Its executive offices are located at 333 Continental Boulevard, El Segundo, California 90245-5012, telephone (310) 252-2000.\nCOMPETITION AND INDUSTRY BACKGROUND - -----------------------------------\nCompetition in the toy industry is based primarily on price, quality and play value. In recent years, the toy industry has experienced rapid consolidation driven, in part, by the desire of industry competitors to offer a range of products across a broader variety of categories. In the United States, the Company competes with several large toy companies, including Hasbro, Inc. and Tyco Toys, Inc., as well as a number of smaller toy companies. The larger toy companies have pursued a strategy of focusing on core product lines. Core product lines are those lines which are expected to be marketed for an extended period of time, and which historically have provided relatively consistent growth in sales and profitability. By focusing on core product lines, toy manufacturers have been able to reduce their reliance on new product introductions and the associated risk and volatility. The juvenile products market, in which Fisher-Price is one of the leading companies, is more fragmented. The more significant competitors in this area include: Gerry Baby Products Company; Century Products Company; Graco Children's Products, Inc.; Cosco, Inc.; and Evenflo Juvenile Furniture Company, Inc.\nThe toy industry is also experiencing a shift toward greater consolidation of retail distribution channels, such as large specialty toy stores and discount retailers, including Toys R Us, Wal-Mart, Kmart and Target, which have increased their overall share of the retail market. This consolidation has resulted in an increased reliance among retailers on the large toy companies because of their financial stability and ability to support products through advertising and promotion and to distribute products on a national basis. These retailers' growing acceptance of electronic data interchange has provided toy manufacturers with an ability to more closely monitor consumers' acceptance of a particular product or product line.\nOver the last ten years, toy companies based in the United States have expanded their international marketing and manufacturing operations. The Company believes a strong international distribution system can add significantly to the sales volume of core product lines and extend the life cycles of newly-developed products.\nSEASONALITY - -----------\nSales of toy products at retail are seasonal, with a majority of retail sales occurring during the period from September through December. Consequently, shipments of toy products to retailers are greater in the third and fourth quarters than in each of the first and second quarters combined. As the large toy retailers become more efficient in their control of inventory levels, this seasonality is increasing.\nIn anticipation of this seasonal increase in retail sales, the Company significantly increases its production in advance of the peak selling period, resulting in a corresponding build-up of inventory levels in the first three quarters of the year. In addition, the Company and others in the industry develop sales programs, including offering extended payment terms, to encourage retailers to purchase merchandise earlier in the year. These sales programs, coupled with seasonal shipping patterns, result in significant peaks in the third and fourth quarters in the respective levels of inventories and accounts receivable, which contribute to a seasonal working capital financing requirement. See \"Seasonal Financing.\"\nPRODUCTS - --------\nThe Company has achieved consistent sales and earnings growth by focusing on a number of core product lines supplemented by various new product introductions. The Company's four strongest core product lines are BARBIE fashion dolls and doll clothing and accessories; FISHER-PRICE toys and juvenile products, including the POWER WHEELS line of battery-powered, ride-on vehicles; the Company's Disney-licensed toys; and die-cast HOT WHEELS vehicles and playsets, each of which has broad worldwide appeal. Additional core product lines consist of large dolls, including CABBAGE PATCH KIDS; preschool toys, including SEE 'N SAY talking toys; the UNO and SKIP-BO games; and the SCRABBLE game, which the Company owns in markets outside of the United States and Canada. Core product lines are expected to be marketed for an extended period of time and historically have provided relatively consistent growth in sales and profitability. For the year ended December 31, 1995, core products accounted for approximately 87% of sales. In order to provide greater flexibility in the manufacture and delivery of products, and as part of a continuing effort to reduce manufacturing costs, the Company has concentrated production of most of its core products in Company-owned facilities and generally uses independent contractors for the production of non-core products.\nWith respect to new product introductions, the Company's strategy is to begin production on a limited basis until a product's initial success has been proven in the marketplace. The production schedule is then modified to meet anticipated demand. The Company further limits its risk by generally having independent contractors manufacture new product lines in order to minimize capital expenditures associated with new product introductions. This strategy has reduced inventory risk and significantly limited the potential loss associated with new product introductions.\nNew product introductions in 1995 included BUTTERFLY PRINCESS BARBIE doll, STROLLIN' FUN BARBIE and KELLY dolls, Teacher BARBIE doll, BARBIE all occasion cards that come with a fashion, CABBAGE PATCH KIDS dolls, the addition of a series of fashion dolls based on the animated feature \"Pocahontas\" to the Company's Disney line, the addition of SMUD to the Company's Nickelodeon line, STREET SHARKS action figures and FISHER-PRICE outdoor play equipment.\nNew product introductions in 1996 will include Olympic Gymnast BARBIE doll, Songbird BARBIE doll, SHOPPIN' FUN BARBIE and KELLY dolls, JEWEL HAIR MERMAID BARBIE doll, TWIRLING BALLERINA BARBIE doll, BARBIE DREAM HOUSE, a Victorian-style fold-up house, the addition of a series of fashion dolls and action figures based on the animated feature \"Hunchback of Notre Dame\" to the Company's Disney line, COMPUTER CARS computer disks to the HOT WHEELS line, CONSTRUX building sets, BARBIE FASHION DESIGNER CD-ROM, FISHER-PRICE WONDER TOOLS and FISHER-PRICE CREATIVE EFFECTS INSTANT CAMERA and picture packs.\nINTERNATIONAL OPERATIONS - ------------------------\nRevenues from the Company's international operations represented approximately 40%, 41% and 40% of total consolidated revenues in 1995, 1994 and 1993, respectively. Products which are developed and marketed successfully in the United States typically generate incremental sales and profitability when marketed through the Company's international distribution network. Generally, products marketed internationally are the same as those marketed domestically, although some are developed or adapted for particular international markets. The Company sells its products directly through its marketing operations in Argentina, Australia, Austria, the Benelux countries, Canada, Chile, Colombia, France, Germany, Greece, Italy, Japan, Mexico, New Zealand, Portugal, Scandinavia, Spain, Switzerland, the United Kingdom, Venezuela, and in certain areas of Eastern Europe and Asia. In addition to direct sales, the Company sells principally through distributors in certain parts of Latin America, the Middle East, South Africa and Southeast Asia. It also licenses some of its products to other toy companies for sale in various other countries. See \"Licenses and Distribution Agreements.\"\nThe strength of the US dollar relative to other currencies can significantly affect the revenues and profitability of the Company's international operations. The Company hedges a majority of its intercompany purchases and sales of inventory in order to protect local cash flows and profitability from currency fluctuations. See \"Financial Instruments.\" For financial information by geographic area, see Note 8 to the Consolidated Financial Statements in the Annual Report to Shareholders, incorporated herein by reference.\nPRODUCT DESIGN AND DEVELOPMENT - ------------------------------\nThrough its product design and development group, the Company regularly refreshes, redesigns and extends existing product lines and develops innovative new product lines. The Company's success is dependent on its ability to continue this activity. Product design and development are principally conducted by a group of professional designers and engineers employed by the Company.\nLicense agreements with third parties permit the Company to utilize the trademark, character or product of the licensor in its product line. A principal licensor is The Walt Disney Company, which licenses many of its characters for use on the Company's products. The Company also has entered into license agreements with, among others, the following: Viacom International Inc. relating to its Nickelodeon properties; Bluebird Toys (UK) Ltd.; and Original Appalachian Artworks, Inc. A number of these licenses relate to product lines that are significant to the Company.\nIndependent toy designers and developers bring products to the Company and are generally paid a royalty on the net selling price of products licensed by the Company. These independent toy designers may also create different products for other toy companies.\nThe Company devotes substantial resources to product design and development. During the years ended December 31, 1995, 1994 and 1993, the Company expended approximately $111 million, $93 million and $75 million, respectively, in connection with the design and development of products, exclusive of royalty payments. See Note 10 to the Consolidated Financial Statements in the Annual Report to Shareholders, incorporated herein by reference.\nADVERTISING AND PROMOTION - -------------------------\nThe Company supports its product lines with extensive advertising and consumer promotions. Advertising continues at varying levels throughout the year and peaks during the Christmas season. Advertising includes television and radio commercials and magazine and newspaper ads. Promotions include in-store displays, coupons, merchandising materials and major events focusing on products and tie-ins with various consumer product companies. To further promote the Company and its products, the Company participates in the attractions \"It's A Small World\" at Disneyland and Walt Disney World and \"Autopia\" and \"Storybook Land\" at Disneyland Paris under a ten-year agreement with The Walt Disney Company. The Company also participates in toy stores in Disneyland, near Disneyland Paris and in the Disney Village Market Place near Walt Disney World. Separately, a total of twenty BARBIE Boutiques are located in F.A.O. Schwarz toy stores, including the \"BARBIE on Madison\" boutique at the F.A.O. Schwarz flagship store in New York City.\nDuring the years ended December 31, 1995, 1994 and 1993, Mattel spent approximately $584 million (16% of net sales), $516 million (16% of net sales) and $427 million (16% of net sales), respectively, on worldwide advertising and promotion.\nMARKETING AND SALES - -------------------\nThe Company's toy products are sold throughout the world. In the United States, the Company's products are distributed directly to large retailers, including discount and free-standing toy stores, chain stores and department stores, and other retail outlets and, to a limited extent, to wholesalers. Discount and free-standing toy stores continue to increase their market share. During the year ended December 31, 1995, Toys R Us and Wal-Mart accounted for approximately 23% and 12%, respectively, of worldwide consolidated net sales and were the only customers accounting for 10% or more of consolidated net sales.\nIn general, the Company's major domestic and international customers review its product lines and product concepts for the upcoming year at showings beginning in late summer. The Company also participates in the domestic and international toy industry trade fairs in the first quarter of the year. A majority of the full-year orders are received by May 1. As is traditional in the toy industry, these orders may be canceled at any time before they are shipped. Historically, the greater proportion of shipments of products to retailers occurs during the third and fourth quarters of the year. See \"Seasonality.\"\nThrough its marketing research departments, the Company conducts basic consumer research and product testing and monitors demographic factors and trends. This information assists the Company in evaluating consumer acceptance of products, including an analysis of increasing or decreasing demand for its products.\nThe Company bases its production schedules on customer orders, modified by historical trends, results of market research and current market information. The actual shipments of products ordered and the order cancellation rate are affected by consumer acceptance of the product line, the strength of competing products, marketing strategies of retailers and overall economic conditions. Unexpected changes in these factors can result in a lack of product availability or excess inventory in a particular product line.\nMANUFACTURING - -------------\nThe Company's products are manufactured in Company-owned facilities and by independent contractors. Products are also purchased from unrelated entities that design, develop and manufacture the products. In order to provide greater flexibility in the manufacture and delivery of products, and as part of a continuing effort to reduce manufacturing costs, the Company has concentrated production of most of its core products in the Company's facilities and generally uses independent contractors for the production of non-core products.\nMattel's manufacturing facilities are located in the states of California, Indiana, Kentucky, Georgia, and New York, and in the United Kingdom, Mexico, the Far East (China, Indonesia and Malaysia) and Italy. In 1995, the Company opened new factories in Ontario, California and Augusta, Georgia to manufacture FISHER-PRICE outdoor play equipment. The Company also utilizes independent contractors to manufacture products in the United States, Mexico, the Far East and Australia. To protect the stability of its product supply, the Company produces many of its key products in more than one facility.\nAll foreign countries in which the Company's products are manufactured (principally China, Indonesia, Malaysia and Mexico) currently enjoy \"most favored nation\" (\"MFN\") status under US tariff laws, which provides a favorable category of US import duties. As a result of continuing concerns in the United States Congress regarding China's human rights policies, and disputes regarding Chinese trade policies, including the country's inadequate protection of US intellectual property rights, there has been, and may be in the future, opposition to the extension of MFN status for China.\nThe loss of MFN status for China would result in a substantial increase in the import duty for toys manufactured in China and imported into the United States and would result in increased costs for the Company and others in the toy industry. The impact of such an event on the Company would be significantly mitigated by the Company's ability to source product for the US market from countries other than China and ship product manufactured in China to markets outside the US. Toward that end, the Company has expanded its production capacity in other countries. A number of other factors, including the Company's ability to pass along the added costs through price increases and the pricing policies of vendors in China, could further mitigate the impact of a loss of China's MFN status.\nOn February 8, 1994, the European Union (\"EU\") adopted quotas on the importation of certain classes of toys (as well as other products) manufactured in China. The impact of these quotas on the Company's business has been significantly mitigated by shifts in demand in favor of toy categories not subject to the quotas, and by the ability of the Company to source product for the EU from countries other than China and ship product manufactured in China elsewhere.\nWith the implementation of the Uruguay Round agreement effective January 1, 1995, all US duties on dolls and traditional toys were completely eliminated. Canada also eliminated its tariffs on dolls and most toy categories in 1995, with the exception of certain toy sets and board games which will have their duties eliminated over ten years. Meanwhile, both the EU and Japan began implementing Uruguay Round tariff reductions that, by 1999, will lower the tariffs on dolls by over 40% in the EU and by 15% in Japan. The EU and Japan are fully eliminating tariffs on several other toy categories over a period of ten years.\nCOMMITMENTS - -----------\nIn the normal course of business, the Company enters into contractual arrangements for future purchases of goods and services to ensure availability and timely delivery, and to obtain and protect the right to create and market certain toys. Such arrangements include commitments for future inventory purchases and royalty payments pursuant to license agreements. Certain of these purchase agreements and licenses contain provisions for guaranteed or minimum payments during the terms of the contracts and licenses. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations--Commitments\" and Note 6 to the Consolidated Financial Statements in the Annual Report to Shareholders, incorporated herein by reference.\nLICENSES AND DISTRIBUTION AGREEMENTS - ------------------------------------\nThe Company's level of licensing activity has expanded in recent years. Royalty expense during the years ended December 31, 1995, 1994 and 1993 was approximately $104 million, $84 million and $69 million, respectively. See Note 6 to the Consolidated Financial Statements in the Annual Report to Shareholders, incorporated herein by reference.\nThe Company also distributes products which are independently designed and manufactured.\nFINANCIAL INSTRUMENTS - ---------------------\nFrom time to time, the Company enters into foreign currency forward exchange contracts and swap agreements as hedges for payment of inventory purchases, collection of sales and various other intercompany transactions. The contracts are intended to fix a portion of the Company's product cost and intercompany cash flows, and thereby moderate the impact of foreign currency fluctuations. The Company does not speculate in foreign currencies.\nFor additional information regarding foreign currency contracts, see Note 6 to the Consolidated Financial Statements in the Annual Report to Shareholders, incorporated herein by reference.\nSEASONAL FINANCING - ------------------\nThe Company's financing of seasonal working capital typically grows throughout the first half of the year and peaks in the third or fourth quarter, when accounts receivable are at their highest due to increased sales volume and Company sales programs, and when inventories are at their highest in anticipation of expected second half sales volume. See \"Seasonality.\" Domestic borrowings for seasonal financing under the Company's revolving credit agreement are generally repaid in full by year-end from cash flows generated in the fourth quarter from sales and collection of accounts receivable.\nThe Company maintains and periodically amends or replaces a revolving credit agreement with a commercial bank group that is utilized to finance the working capital requirements of its domestic and certain international operations. The agreement in effect during 1995, which was recently amended (see below), was renegotiated in the first quarter of 1995 to increase the total facility to $650.0 million from $500.0 million. Within the facility, up to $400.0 million was a standard revolving credit line available for advances and backup for commercial paper issuances (a three- year facility). Interest was charged at various rates selected by the Company not greater than the base rate charged by the agent bank, plus a commitment fee of up to .095% of the unused line available for advances. The remaining $250.0 million (a three-year facility) was available for nonrecourse purchases of certain trade accounts receivable of the Company by the commercial bank group providing the credit line. Outstanding receivables sold are reduced by collections and cannot exceed the $250.0 million at any time. The agreement required the Company to comply with certain financial covenants for consolidated debt-to-capital, interest coverage and tangible net worth levels.\nEffective in August 1995, the Company entered into an agreement providing for up to $100.0 million, at each specified purchase date, of nonrecourse purchases of certain trade accounts receivable of the Company by a commercial bank.\nEffective in March 1996, the Company amended its revolving credit agreement. The new agreement consists of unsecured facilities providing a total of $800.0 million in seasonal financing from substantially the same group of commercial banks. The facilities provide for up to $400.0 million in advances and backup for commercial paper issuances (a five-year facility), and up to an additional $400.0 million (a five-year facility) for nonrecourse purchases of certain trade accounts receivable by the bank group. In connection with the agreement, the Company is to comply with certain financial covenants for consolidated debt-to-capital, interest coverage and tangible net worth levels.\nThe Company believes the amounts available to it under its revolving credit agreement and foreign credit lines will be adequate to meet its seasonal financing requirements.\nRAW MATERIALS - -------------\nPackaging materials, most plastics and zinc, which are essential to the production and marketing of toy products, are currently in adequate supply. These and other raw materials are generally available from a number of suppliers.\nPrices for resin and packaging were highly volatile in 1995. Resin and packaging prices generally rose during the first three quarters of 1995, but decreased dramatically by the close of the fourth quarter of 1995. While management believes that resin and packaging prices have temporarily stabilized, there can be no assurance that the volatility experienced in 1995 will not continue, resulting in a material impact on the Company's gross margins and earnings.\nTRADEMARKS, COPYRIGHTS, AND PATENTS - -----------------------------------\nMost of the Company's products are sold under trademarks, trade names and copyrights and a number of those products incorporate patented devices or designs. Trade names and trademarks are significant assets to the Company in that they provide product recognition and acceptance worldwide.\nThe Company customarily seeks patent, trademark or copyright protection covering its products, and it owns or has applications pending for United States and foreign patents covering many of its products. A number of these trademarks and copyrights relate to product lines that are significant to the Company, and the Company believes its rights to these properties are adequately protected.\nThe Company also licenses various of its trademarks, characters and other property rights to others for use in connection with the sale by others of non-toy and other products which do not compete with the Company's products.\nGOVERNMENT REGULATIONS - ----------------------\nThe Company's toys are subject to the provisions of the Consumer Product Safety Act, the Federal Hazardous Substances Act and the Flammable Fabrics Act, and the regulations promulgated thereunder. The Consumer Product Safety Act and the Federal Hazardous Substances Act enable the Consumer Product Safety Commission (the \"CPSC\") to exclude from the market consumer products that fail to comply with applicable product safety regulations or otherwise create a substantial risk of injury, and articles that contain excessive amounts of a banned hazardous substance. The Flammable Fabrics Act enables the CPSC to regulate and enforce flammability standards for fabrics used in consumer products. The CPSC may also require the repurchase by the manufacturer of articles which are banned. Similar laws exist in some states and cities and in various international markets.\nFisher-Price's car seats are subject to the provisions of the National Highway Transportation Safety Act, which enables the National Highway Traffic Safety Administration (\"NHTSA\") to promulgate performance standards for child restraint systems. Fisher-Price conducts periodic tests to ensure that its child restraint systems meet applicable standards. A Canadian agency, Transport Canada, also regulates child restraint systems sold for use in Canada. As with the CPSC, NHTSA and Transport Canada can require the recall and repurchase or repair of products which do not meet their respective standards.\nThe Company maintains a quality control program to ensure product safety compliance with the various federal, state and international requirements.\nEFFECTS OF INFLATION - --------------------\nInflation rates in the US and major foreign countries in which the Company operates have not had a significant impact on operating results for the three years ended December 31, 1995. The US Consumer Price Index increased 2.5% in 1995, and 2.7% in both 1994 and 1993. The Company is afforded some protection from the impact of inflation as a result of high turnover of inventories and benefited from inflation on the repayment of fixed-rate liabilities during these periods.\nEMPLOYEES - ---------\nThe total number of persons employed by the Company and its subsidiaries at any one time varies because of the seasonal nature of its manufacturing operations. At December 31, 1995, the Company's total number of employees, including its international operations, was approximately 25,000.\nEXECUTIVE OFFICERS OF THE REGISTRANT - ------------------------------------\nThe executive officers of the Company, all of whom are appointed annually by the Board of Directors and serve at the pleasure of the Board, are as follows:\nMr. Amerman has been Chairman of the Board & Chief Executive Officer since February 1987 and a member of the Board of Directors since November 1985. Prior to that he served as President of Mattel International.\nMs. Barad has been President & Chief Operating Officer since August 1992 and a member of the Board of Directors since November 1991. From December 1989 until August 1992, she was President, Mattel USA. Prior to that she served in various executive positions in the Marketing, Product Design and Product Development areas.\nMr. Eskridge has been a member of the Board of Directors since February 1993 and Group President, Mattel, Worldwide since April 1995. Prior to that he was President of Fisher-Price, Inc. and Executive Vice President & Chief Financial Officer of Mattel, Inc.\nMr. Mansour has been President, Mattel-USA & Secretary since February 1996. From April 1995 to February 1996, he was Executive Vice President, Chief Administrative Officer, General Counsel & Secretary. From February 1993 until April 1995, he was Senior Vice President, General Counsel & Secretary. From May 1992 until February 1993, he was Senior Vice President & General Counsel and from April 1991 until May 1992, he was Vice President & Associate General Counsel. Prior to that he was Vice President & Assistant General Counsel.\nMr. Davis has been President, Fisher-Price, Inc. since April 1995. From March 1993 to April 1995, he served as President - Toys, Fisher-Price. Prior to that, he served as Senior Vice President - Sales of Fisher-Price from June 1991 to March 1993.\nMr. Gandolfo has been President, Mattel Operations, since April 1990.\nMr. Quinlan has been President, ARCOTOYS since January 1992. From October 1985 to January 1992, he served as Chief Financial Officer, ARCOTOYS.\nMs. Luzuriaga has been Executive Vice President & Chief Financial Officer since December 1995. From March 1989 until December 1995, she served in several senior managerial positions at Mattel, including Controller, Treasurer and Executive Vice President, Finance.\nMr. McKay has been Senior Vice President, Human Resources since November 1993. From December 1991 until November 1993, he was Vice President, Human Resources. He was Senior Director Human Resources from March 1991 to December 1991. Prior to that he was Vice President Human Resources- Administration of Mileage Plus, Inc.\nMr. Phippen has been Senior Vice President & Chief Information Officer since June 1993. From February 1991 to June 1993, he served as Senior Vice President - Information Systems.\nMr. Rolfes has been Senior Vice President & Controller since November 1993. From June 1993 to November 1993, he was Vice President & Controller. Prior to that he held various executive positions within the finance department.\nMr. Stavro has been Senior Vice President & Treasurer since May 1995. From November 1993 to May 1995, he was Vice President & Treasurer. From March 1992 to November 1993, he was Vice President & Assistant Treasurer. Prior to that he was Assistant Treasurer for more than five years.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES - ------- ----------\nMattel owns its corporate headquarters consisting of approximately 335,000 square feet in El Segundo, California, which is subject to a $45.0 million mortgage. Mattel also leases buildings in El Segundo consisting of approximately 300,000 square feet, which are primarily used for its design and development and audio visual departments. Fisher-Price owns its headquarters facilities in East Aurora, New York, consisting of approximately 290,000 square feet.\nThe Company maintains sales offices in California, Illinois, New York and Texas, and warehouse and distribution facilities in California, Georgia, Indiana, Kentucky, Tennessee and Texas. The Company owns a computer facility in Phoenix, Arizona. Internationally, the Company has offices and\/or warehouse space in Argentina, Australia, Belgium, Canada, Colombia, Chile, Denmark, France, Germany, Greece, Hong Kong and in certain other areas of Asia, Italy, Japan, Mexico, The Netherlands, New Zealand, Spain, Switzerland, the United Kingdom and Venezuela. The Company's principal manufacturing facilities are located in China, Indonesia, Italy, Malaysia, Mexico, the United Kingdom and the United States. See \"Manufacturing.\"\nMost of the Company's facilities are occupied under long-term leases and, for the most part, are fully utilized, although excess manufacturing capacity exists from time to time based on product mix and demand. With respect to leases which are scheduled to expire during the next twelve months, the Company may negotiate new lease agreements, renew leases or utilize alternative facilities.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS - ------- -----------------\nThe Company's Fisher-Price subsidiary has executed a consent order with the State of New York involving a remedial action\/feasibility study for voluntary cleanup of contamination at one of its manufacturing plants. The ultimate liability associated with this cleanup presently is estimated to be less than $1,425,000, approximately $794,000 of which has been incurred through December 31, 1995.\nThe Company is involved in various litigation and other legal matters which are being defended and handled in the ordinary course of business. None of these matters is expected to result in outcomes having a material adverse effect on the Company's liquidity, operating results or consolidated financial position.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - ------- ---------------------------------------------------\nNone\nPART II -------\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED - ------- STOCKHOLDER MATTERS -----------------------------------------------------\nFor information regarding the markets in which the Company's common stock is traded, see the cover page hereof, and for information regarding the high and low sales prices of the Company's common stock for the last two calendar years, see Note 9 to the Consolidated Financial Statements in the Annual Report to Shareholders, incorporated herein by reference.\nAs of March 1, 1996, the Company had approximately 37,000 holders of record of its common stock.\nIn January of 1994, the Company paid dividends of $0.031 per share, and in April, July and October 1994 and January 1995, the Company paid dividends of $0.038 per share. The Company paid per share dividends of $0.048 in April, July and October 1995. The dividends have been adjusted to reflect five-for-four stock splits which the Company declared on its common stock to holders of record on December 17, 1993, January 6, 1995 and February 16, 1996.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA - ------- -----------------------\nThe information under the caption \"Five-Year Financial Summary\" on page 27 in 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 ---------------------------------------------------------------\nThe information under the caption \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" on pages 28 through 31 in the Annual Report to Shareholders is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - ------- -------------------------------------------\nThe consolidated financial statements of Mattel, Inc. and Subsidiaries, together with the report of Price Waterhouse LLP dated February 6, 1996, included on pages 32 through 51 in the 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 - -------- --------------------------------------------------\nInformation required under this Item relating to members of the Board of Directors is incorporated by reference herein from the Company's 1996 Notice of Annual Meeting of Stockholders and Proxy Statement. The information with respect to executive officers of the Company appears under the heading \"Executive Officers of the Registrant\" in Part I herein.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION - -------- ----------------------\nThe information required under this Item is incorporated by reference herein from the Company's 1996 Notice of Annual Meeting of Stockholders and Proxy Statement.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - -------- --------------------------------------------------------------\nThe information required under this Item is incorporated by reference herein from the Company's 1996 Notice of Annual Meeting of Stockholders and Proxy Statement.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - -------- ----------------------------------------------\nThe information required under this Item is incorporated by reference herein from the Company's 1996 Notice of Annual Meeting of Stockholders and Proxy Statement.\nPART IV -------\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, AND REPORTS ON FORM 8-K - -------- -------------------------------------------------------\n(a) The following documents are filed as part of this report:\nAnnual Report Page Number(1) ------------- (1) Financial Statements\nConsolidated Balance Sheets as of 32-33 December 31, 1995 and 1994\nConsolidated Statements of Income for 34 the years ended December 31, 1995, 1994 and 1993\nConsolidated Statements of Cash Flows for 35 the years ended December 31, 1995, 1994 and 1993\nConsolidated Statements of Shareholders' 36 Equity for the years ended December 31, 1995, 1994 and 1993\nNotes to Consolidated Financial Statements 37-50\nReport of Price Waterhouse LLP, Independent 51 Accountants to the Company\nIncorporated by reference from the indicated pages of the Annual Report to Shareholders for the year ended December 31, 1995. With the exception of the information incorporated by reference in Items 1, 5, 6, 7, 8 and 14 of this report, the Annual Report to Shareholders is not deemed filed as part of this report.\n(2) Financial Statement Schedule for the years ended December 31, 1995, 1994 and 1993 (1)\nSchedule II - Valuation and Qualifying Accounts and Allowances\n(3) Exhibits (Listed by numbers corresponding to Item 601 of Regulation S-K)\n3.0 Restated Certificate of Incorporation of the Company (incorporated by reference to Exhibit 3.0 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993)\n3.1 By-laws of the Company, as amended to date (incorporated by reference to Exhibit 3.1 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992)\n4.0 Rights Agreement, dated as of February 7, 1992, between the Company and The First National Bank of Boston, as Rights Agent (incorporated by reference to Exhibit 1 to the Company's Registration Statement on Form 8-A, dated February 12, 1992)\n(The Company has not filed certain long-term debt instruments under which the principal amount of securities authorized to be issued does not exceed 10% of the total assets of the Company. Copies of such agreements will be provided to the Securities and Exchange Commission upon request.)\n10.0 Credit Agreement dated as of March 10, 1995 among the Company, the Banks named therein and Bank of America National Trust and Savings Association, as Agent (incorporated by reference to Exhibit 99.5 to the Company's Current Report on Form 8-K dated March 21, 1995)\n10.1* First Amendment to Credit Agreement dated as of March 11, 1996 among the Company, the Banks named therein and Bank of America National Trust and Savings Association, as Agent\n10.2 Second Amended and Restated Transfer and Administration Agreement dated as of March 10, 1995 among the Company, Mattel Sales Corp., Fisher-Price, Inc., the Banks named therein and NationsBank of Texas, N.A., as Agent (incorporated by reference to Exhibit 99.6 to the Company's Current Report on Form 8-K dated March 21, 1995)\n10.3 First Amendment to Second Amended and Restated Transfer and Administration Agreement dated as of March 10, 1995 among the Company, Mattel Sales Corp., Fisher-Price, Inc., the Banks named therein and NationsBank of Texas, N.A., as Agent (incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1995)\n- ------------------- All other schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto.\n10.4* Second Amendment to Second Amended and Restated Transfer and Administration Agreement dated as of March 11, 1996 among the Company, Mattel Sales Corp., Fisher-Price, Inc., the Banks named therein and NationsBank of Texas, N.A., as Agent.\n10.5 Receivables Purchase Agreement dated as of August 29, 1995 among the Company, Mattel Sales Corp., Fisher-Price, Inc., and Bank of America N.T.S.A. (incorporated by reference to Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1995)\n10.6 Stock Purchase Agreement dated as of October 20, 1995 by and between Mattel, Inc. and Marine Midland Bank, as sub-trustee of the International Games, Inc. Employee Stock Ownership Trust (incorporated by reference to Exhibit 10.3 to the Company's quarterly Report on Form 10-Q for the quarter ended September 30, 1995)\n10.7 Underwriting Agreement dated May 19, 1993 between the Company, Morgan Stanley & Co. Incorporated and Kidder, Peabody & Co. Incorporated (incorporated by reference to Exhibit 10.3 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993)\n10.8 Stock Subscription Warrant dated as of June 28, 1991 between Fisher-Price, Inc. and certain investors (incorporated by reference to Exhibit 4(c) to Fisher-Price's Report on Form 10-K for the transition period from July 1, 1991 to December 29, 1991)\n10.9 Underwriting Agreement dated July 31, 1992 between the Company, Morgan Stanley & Co. Incorporated and Kidder, Peabody & Co. Incorporated (incorporated by reference to Exhibit 10.5 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992)\n10.10 Distribution Agreement dated September 19, 1994 among the Company, Morgan Stanley & Co. Incorporated and CS First Boston Corporation (incorporated by reference to Exhibit 99.0 to the Company's Current Report on Form 8-K dated September 20, 1994)\nExecutive Compensation Plans and Arrangements of the Company - ------------------------------------------------------------\n10.11 Form of Indemnity Agreement between Mattel and its directors and certain of its executive officers (incorporated by reference to Exhibit B to Notice of Annual Meeting of Stockholders of the Company dated March 24, 1987)\n10.12 Form of Employment Agreement between the Company and certain executive officers (incorporated by reference to Exhibit 10.6 of Amendment No. 1 of the Company's Annual Report on Form 10-K for the fiscal year ended December 26, 1987)\n10.13 Form of Employment Agreement between the Company and certain executive officers (incorporated by reference to Exhibit 10.8 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992)\n10.14 Form of Amended & Restated Employment Agreement between the Company and certain executive officers (incorporated by reference to Exhibit 10.13 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993)\n10.15* Mattel, Inc. Management Incentive Plan\n10.16* Mattel, Inc. Long-Term Incentive Plan\n10.17 Mattel, Inc. Financial Security Program Agreement for certain officers (incorporated by reference to Exhibit 10.7 of the Company's Registration Statement No. 2-95161 on Form S-1, filed January 7, 1985)\n10.18 Form of Deferred Compensation Plan for Directors (incorporated by reference to Exhibit No. 10.11 of Amendment No. 1 of the Company's Annual Report on Form 10-K for the fiscal year ended December 26, 1987)\n10.19 Mattel, Inc. 1990 Stock Option Plan (incorporated by reference to Exhibit A to the Notice of Annual Meeting of Stockholders and Proxy Statement of the Company dated March 15, 1990)\n10.20 Amendment No. 1 to the Mattel, Inc. 1990 Stock Option Plan (incorporated by reference to the information under the heading \"Amendment to Mattel 1990 Stock Option Plan\" on page of the Joint Proxy Statement\/Prospectus of the Company and Fisher- Price included in the Company's Registration Statement on Form S-4, Registration Statement No. 33-50749)\n10.21 Amendment No. 2 to the Mattel 1990 Stock Option Plan (incorporated by reference to Exhibit A to the Company's Proxy Statement dated March 22, 1995)\n10.22 Form of Award Agreement evidencing award of stock appreciation rights granted pursuant to the Company's 1990 Stock Option Plan to certain executive officers of the Company (\"Award Agreement\") (incorporated by reference to Exhibit 10.12 to the Company's Annual Report on Form 10-K for the year ended December 31, 1991)\n10.23 Form of First Amendment to Award Agreement (incorporated by reference to Exhibit 10.21 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993)\n10.24 Notice of Grant of Stock Options and Grant Agreement (incorporated by reference to Exhibit 99.0 to the Company's Current Report on Form 8-K dated May 31, 1994)\n10.25 Grant Agreement for a Non-Qualified Stock Option (incorporated by reference to Exhibit 99.1 to the Company's Current Report on Form 8-K dated May 31, 1994)\n10.26 Award Cancellation Agreement (incorporated by reference to Exhibit 99.2 to the Company's Current Report on Form 8-K dated May 31, 1994)\n10.27 Form of Restricted Stock Award Agreement under the Mattel 1990 Stock Option Plan (incorporated by reference to Exhibit 10.22 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993)\n10.28 Mattel, Inc. Supplemental Executive Retirement Plan effective as of October 7, 1990 (incorporated by reference to Exhibit 10.10 of the Company's Annual Report on Form 10-K for the fiscal year ended December 29, 1990)\n10.29 Mattel, Inc. Supplemental Executive Retirement Plan effective as of April 1, 1994 (incorporated by reference to Exhibit 99.7 to the Company's Current Report on Form 8-K dated March 21, 1995)\n10.30 Description of the Mattel, Inc. Deferred Compensation Plan for Officers (incorporated by reference to Exhibit 10.16 to the Mattel, Inc. Annual Report on Form 10-K for the year ended December 31, 1991)\n10.31 Fisher-Price, Inc. Matching Savings Plan, 1994 Restatement (incorporated by reference to Exhibit 99.8 to the Company's Current Report on Form 8-K dated March 21, 1995)\n10.32 The Fisher-Price, Inc. Pension Plan (1989 Restatement) (incorporated by reference to Exhibit 10(l) to Fisher-Price's Registration Statement on Form 10 dated June 28, 1991)\n10.33 Mattel, Inc. Personal Investment Plan, 1993 Restatement (incorporated by reference to Exhibit 99.9 to the Company's Current Report on Form 8-K dated March 21, 1995)\n10.34 First Amendment to the Mattel, Inc. Personal Investment Plan, 1993 Restatement (incorporated by reference to Exhibit 99.10 to the Company's Current Report on Form 8-K dated March 21, 1995)\n10.35 Second Amendment to the Mattel, Inc. Personal Investment Plan (incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1995)\n10.36 Third Amendment to the Mattel, Inc. Personal Investment Plan (incorporated by reference to Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1995)\n10.37 Fourth Amendment to the Mattel, Inc. Personal Investment Plan (incorporated by reference to Exhibit 10.4 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1995)\n10.38 Mattel, Inc. Hourly Personal Investment Plan (incorporated by reference to Exhibit 10.1 to the Company's Registration Statement on Form S-8 dated February 20, 1996)\n11.0* Computation of Income per Common and Common Equivalent Share\n13.0* Pages 26 through 53 of the Mattel, Inc. Annual Report to Shareholders for the year ended December 31, 1995\n21.0* Subsidiaries of the Registrant\n23.0* Consent of Price Waterhouse LLP\n24.0* Power of Attorney (on page 23 of Form 10-K)\n27.0* Financial Data Schedule (EDGAR filing only)\n(b) Reports on Form 8-K\nMattel, Inc. filed the following Current Report on Form 8-K during the quarterly period ended December 31, 1995:\nFinancial Date of Report Items Reported Statements Filed ------------------ -------------- ---------------- October 17, 1995 5, 7 None\n(c) Exhibits Required by Item 601 of Regulation S-K\nSee Item (3) above\n(d) Financial Statement Schedule\nSchedule II - Valuation and Qualifying Accounts and Allowances\nCopies of Form 10-K (which includes Exhibit 24.0), Exhibits 11.0, 13.0, 21.0 and 23.0 and the Annual Report to Shareholders are available to stockholders of the Company without charge. Copies of other Exhibits can be obtained by stockholders of the Company upon payment of twelve cents per page for such Exhibits. Written requests should be sent to Secretary, Mattel, Inc., 333 Continental Boulevard, El Segundo, California 90245-5012.\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.\nMATTEL, INC. Registrant\nBy: \/s\/ Gary P. Rolfes ------------------------- GARY P. ROLFES Senior Vice President and Date: As of March 22, 1996 Controller --------------------\nPOWER OF ATTORNEY -----------------\nWe, the undersigned directors and officers of Mattel, Inc. do hereby severally constitute and appoint John W. Amerman, Ned Mansour, Leland P. Smith and John L. Vogelstein, and each of them, our true and lawful attorneys and agents, to do any and all acts and things in our name and behalf in our capacities as directors and officers and to execute any and all instruments for us and in our names in the capacities indicated below, which said attorneys and agents, or any of them, may deem necessary or advisable to enable said Corporation to comply with the Securities Exchange Act of 1934, as amended, and any rules, regulations and requirements of the Securities and Exchange Commission, in connection with this Annual Report on Form 10-K, including specifically, but without limitation, power and authority to sign for us or any of us, in our names in the capacities indicated below, any and all amendments hereto; and we do each hereby ratify and confirm all that said attorneys and agents, or any one of them, shall 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.\nREPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE ---------------------------------\nTo the Board of Directors of Mattel, Inc.\nOur audits of the consolidated financial statements referred to in our report dated February 6, 1996 appearing on page 51 of the December 31, 1995 Annual Report to Shareholders of Mattel, Inc. (which report and consolidated financial statements are incorporated by reference in this Annual Report on Form 10-K) also included an audit of the Financial Statement Schedule listed in Item 14(a)(2) of this Form 10-K. In our opinion, based on our audits, 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 - ------------------------ Los Angeles, California February 6, 1996\nMATTEL, INC. AND SUBSIDIARIES SCHEDULE II\nVALUATION AND QUALIFYING ACCOUNTS AND ALLOWANCES\n(In thousands)","section_15":""}
{"filename":"809697_1995.txt","cik":"809697","year":"1995","section_1":"Item 1. Business.\nUnited Parcel Service of America, Inc., through its subsidiaries, provides specialized transportation and logistics services, primarily through the pickup and delivery of packages and documents. Service is offered throughout the United States and over 200 other countries and territories around the globe. UPS is the largest package distribution company in the world, with revenues of over $21 billion in 1995 generated by the delivery of more than three billion packages. UPS provides a daily pickup service for approximately 1.4 million customers.\nWith minor exceptions, UPS Common Stock, $.10 par value per share (the \"Common Stock\") is owned by or held for the benefit of its active employees and their families, former employees and their estates or heirs, charitable foundations established by UPS founders and their family members or by other charitable organizations that acquired their stock by donations from shareowners. UPS Common Stock is not listed on a national securities exchange or traded in the organized over-the-counter markets. When used herein, the terms \"UPS\" and the \"Company\" refer to United Parcel Service of America, Inc., a Delaware corporation and its subsidiaries.\nDelivery Service in the United States\nGround Services\nFor most of its history, UPS has been engaged primarily in the delivery of packages traveling by means of ground transportation. This service was expanded gradually and today it is available for interstate and intrastate destinations, serving every address in the 48 contiguous states and between those states and Alaska and Hawaii. In Hawaii, an intra-island service is provided between addresses on Oahu and an inter-island air service is offered between all islands of the state. In Alaska, an intrastate package delivery service is available.\nService is restricted to packages that weigh no more than 150 pounds and are no larger than 108 inches in length and 130 inches in length and girth combined.\nIn addition to its standard ground delivery product, UPS provides a variety of ground shipment options. UPS Hundredweight Service(R) offers discounted contract rates to customers sending multiple package shipments having a combined weight of 200 pounds or more, addressed to one consignee at one address, with delivery on the same day. Customers can realize significant savings on these shipments compared to regular ground service rates. UPS Hundredweight Service was expanded to reach all 48 contiguous states on January 1, 1995\nand is also available for air shipments. Approximately 140,000 UPS customers have contracts for UPS Hundredweight Service. By mid-1996, UPS plans to introduce Common Carrier Hundredweight service that will allow all UPS customers to take advantage of the discounted pricing available with UPS Hundredweight Service, but without a contract. UPS Hundredweight Service revenue increased in 1995 by 12.1% over 1994.\nUPS GroundSaver(R) is another contract service which offers special rates and services for business-to-business shipments to specified ZIP Codes. UPS GroundSaver revenue for 1995 increased 10% from 1994.\nUPS's domestic ground revenue increased in 1995 by 2.0% over 1994, primarily as a result of favorable changes in rates.\nDomestic Air Services\nUPS provides domestic air delivery throughout the United States and Puerto Rico. The Company's premium express service is UPS Next Day Air(R), which offers guaranteed overnight or next business day delivery by 10:30 a.m. to more than 76% of the United States population, and delivery by noon to areas covering an additional 13%. Saturday delivery is offered for UPS Next Day Air shipments to most areas of the country for an additional fee.\nEarly A.M. Service(SM) was introduced in 1994. This service provides guaranteed next day delivery of packages and documents by 8:00 a.m. from most metropolitan areas. In addition, 8:30 a.m. delivery is available from virtually all overnight shipping locations coast to coast to approximately 1,100 destination cities in 41 states.\nUPS offers two options for customers who desire less expensive guaranteed delivery services. UPS 2nd Day Air(R) provides guaranteed delivery of letters and packages in two business days and 3 Day Select(R) provides guaranteed delivery in three business days. Developed primarily for longer distance customers who need time-definite delivery and higher levels of information, 3 Day Select is priced between traditional ground and air express services.\nThe Company's newest air express product is UPS SonicAir Service(R), which offers same-day or \"next flight out\" delivery service to virtually any location in the continental United States from delivery pickup locations in the United States, as well as from many international business centers. Same day and logistics services, including critical parts warehousing, are available through UPS SonicAir Service 24 hours a day, 365 days a year.\nUPS provides on-line tracking for all domestic time definite services except UPS SonicAir Service through its cellular tracking system, TotalTrack(R).\nCustomer demand for UPS's domestic air services continued to increase in 1995, with volume and revenue growing by 14% and 11%, respectively.\nTo support this growth and to address future needs, UPS continued to invest in new equipment, primarily in the form of additional aircraft, and facility expansions, in 1995. During 1995, UPS took delivery of eight Boeing 757-200 freighter aircraft, and in October 1995, UPS became the launch customer for the world's first Boeing 767-300 ER freighter aircraft. Working in tandem with Boeing, UPS engineers helped design this latest addition to the Company's fleet, which will ultimately replace certain of its DC-8 aircraft. Five Boeing 767-300 ER freighter aircraft were delivered to UPS in 1995.\nThroughout the year, UPS worked on improving its domestic air service through better utilization of its regional air hub network. These efforts proved particularly effective in December when heavy snows and freezing temperatures shut down most of the air traffic in the Northeast and Midwest.\nThe Company's domestic regional air hubs are located in Philadelphia, Pennsylvania, Dallas, Texas, Rockford, Illinois, and Ontario, California. Louisville, Kentucky is the site of the Company's all-points international air hub, where most of the Company's air volume is processed. A sixth regional air hub in Columbia, South Carolina is currently under construction and is expected to commence operations in August 1996. This new facility will include Next Day Air and 2nd Day Air sort operations, and it will process much of UPS's air volume originating in the southeastern United States.\nUnited States domestic business accounted for approximately 86.7%, 88.4% and 89.0% of the Company's consolidated revenue in 1995, 1994 and 1993, respectively. For additional financial information relating to domestic and foreign operations, see Note 10 to the Consolidated Financial Statements filed herewith.\nInternational Delivery Service\nUPS offers guaranteed overnight delivery to more of the world's key business centers than any other carrier, as well as other express products for less urgent shipments. Throughout 1995, UPS continued to develop its global delivery and logistics network.\nExpansion has been focused on improving communication and the transfer of information. The Company's rapid international expansion has been accomplished in part through a multi-billion dollar technology upgrade program that includes a computerized customs clearance system with a unique pre-alert procedure to expedite delivery upon arrival in the destination country and a global telecommunications network that links approximately 1,000 distribution sites.\nThrough the strategic acquisition of existing delivery services and service partner agreements, UPS has established a worldwide distribution network. This includes the first pan-European, integrated ground and air distribution network similar to its operations in the United States.\nAir service is offered throughout Canada, Germany, Italy and Spain. Ground service is provided throughout Austria, Belgium, Canada, Denmark, France, Germany, Ireland, Italy, the Netherlands, Norway, Spain, Sweden, Switzerland and the United Kingdom. Service in Mexico is offered between Mexico City, Guadalajara and Monterrey.\nUPS Worldwide Express is the equivalent of the Company's domestic air express products, providing delivery of urgent packages, documents and letters to more than 200 countries and territories. Worldwide Express shipments are generally delivered within two business days. In 1995, UPS launched Worldwide Express Plus, becoming the first carrier to offer guaranteed overnight delivery by 8:00 a.m. from major business centers in Europe, Asia, Canada, Mexico and Puerto Rico to 100 cities in the United States. Destinations not covered by the 8:00 a.m. delivery guarantee receive delivery by 8:30 a.m. Shippers using the new service receive automatic notification of any time-in-transit delays, as well as automatic delivery confirmation, at no additional charge.\nUPS also offers Worldwide Expedited Package Service for less urgent multi-package shipments. Transit times are slightly longer than for UPS Worldwide Express service, but rates are up to 40% less.\nThe Company's transborder air and ground services within Europe are enhanced by UPS EuroExpress and UPS EuroExpedited(R) services. EuroExpress is a time-definite next day delivery service for shipments between major European cities. EuroExpedited is used for less urgent shipments traveling by ground transportation between 15 countries, with shipments tracked electronically. A reduction in border restrictions has contributed greatly to more direct and efficient transborder services.\nIn October 1995, UPS discontinued a significant portion of its ground services from the United States into Mexico, due primarily to customs delays at the border and little control over delivery times. Transborder service between the U.S. and Canada, however, has continued with three levels of service: Express, for delivery in one business day; Expedited, for delivery within three days; and Standard, for basic ground service.\nAlthough UPS continued to experience pre-tax losses in its international business, the Company reduced its losses by over $115 million or 35.2% in 1995.\nForeign domestic and export business accounted for approximately 13.3%, 11.6% and 11.0% of consolidated revenues in 1995, 1994 and 1993, respectively. For additional financial information relating to domestic and foreign operations, see Note 10 to the Consolidated Financial Statements filed herewith.\nOther Services\nUPS offers customized services for certain types of customers or even a single customer, such as Consignee Billing and Delivery Confirmation. Consignee Billing was designed for customers who receive large amounts of merchandise from a number of vendors. UPS bills these consignee customers directly for the shipping charges, enabling the customer to obtain tighter control over inbound transportation costs. The Company's Consignee Billing service volume increased 14% in 1995. Electronic tracking of all Consignee Billing packages is offered, as well as on-demand pick up service for return shipments. Delivery Confirmation provides automatic confirmation and weekly reports of deliveries. Immediate confirmation is provided upon request. This service is available throughout the United States and Puerto Rico.\nUPS GroundTrac(SM) service electronically tracks ground packages so that UPS's customers can receive immediate information about the status of their packages while in transit. UPS TotalTrack(SM) is an enhanced tracking system. With the introduction of in-vehicle data transmission capabilities, this service enables customers in the United States as well as Canada and Germany to receive verification of deliveries within minutes after they are completed. Shippers can access tracking information 24 hours a day, seven days a week, by telephone or through the UPS MaxiTrac(R) software system, which enables customers to track and trace their own packages via telecommunications links with the Company's electronic data systems. As of December 31, 1995, UPS had distributed MaxiTrac software to approximately 300,000 customers. The UPS MaxiShip System(R) is a hardware-software system that assists customers in managing their shipping operations by automating a customer's shipping room with features such as automatic zoning, rating and printing of address labels, pickup records and shipping reports. As of December 31, 1995, approximately 42,000 customers were using the MaxiShip System.\nRates\nDuring the first quarter of 1995, published rates for domestic ground services for commercial and residential deliveries were increased by 3.9%. Additionally, the published rates for Next Day Air and 2nd Day Air packages were each increased by 3.9% and the published rates for Next Day Air and 2nd Day Air letters increased by 4.7% and 4.3%, respectively.\nDuring the first quarter of 1996, the Company implemented distance-based pricing for its air express services. This new pricing structure is based on both weight and distance of packages shipped. Under the revised structure, air express rates are geographically defined by ZIP code. The continental United States is divided into the same seven zones used for UPS standard ground services. Previously, express shipments were priced by weight only, the standard method in the industry. The new structure means that prices for UPS Next Day Air have been dropped by as much as 40% in short-distance zones, while prices in longer zones have increased up to 28%.\nIn addition, rates for standard ground shipments were increased an average of 2.9% for commercial deliveries and 3.9% for residential deliveries. Rates for the newly-zoned UPS Next Day Air and UPS 2nd Day Air services increased approximately 4.9%. Rates for UPS 3-Day Select, already zoned, increased approximately 3.9%. All increases were limited to deliveries within the continental United States.\nRates for international shipments originating in the United States were increased 4.9% for UPS Worldwide Express, 6.9% for UPS Worldwide Expedited and 3.9% for UPS Standard Service to Canada. The rate increases did not affect shipments originating outside the United States.\nCompetition\nUPS is the largest package distribution company in the world, in terms of both revenue and volume. UPS also offers the broadest array of services in the package delivery industry, and therefore competes with many companies and services on a local, regional, national and international basis. These include the postal services of the United States and other nations, various motor carriers, express companies, freight forwarders, air couriers and others.\nCompetition is increasing based on the ability of carriers to offer highly reliable, customized delivery solutions, rich with information, at competitive prices. UPS also endeavors to attract customers by offering value-added services such as delivery guarantees, tracking and performance reports. In recent years, the company has directed a larger portion of its resources to compete for higher revenue, \"premium\" service packages and documents (such as UPS Next Day Air, UPS 2nd Day Air, 3 Day Select and Worldwide Express) as well as for commercial, or \"business-to-business\" packages. However, UPS still values and competes intensely for residential delivery volume.\nRegulation\nUnder the Federal Aviation Act of 1958, as amended, both the Department of Transportation (\"DOT\") and the Federal Aviation Administration (\"FAA\") regulate air transportation services.\nThe DOT's authority relates primarily to economic aspects of air transportation, such as discriminatory pricing, non-competitive practices, interlocking relations or cooperative agreements. The DOT also regulates, subject to the authority of the President, international routes, fares, rates and practices and is authorized to investigate and take action against discriminatory treatment of United States air carriers abroad.\nFAA authority relates primarily to safety aspects of air transportation, including aircraft standards and maintenance, personnel and ground facilities. UPS was granted an operating certificate by the FAA in 1988 which remains in effect so long as UPS meets the operational requirements of the Federal Aviation Regulations.\nThe FAA has issued rules mandating repairs on all Boeing Company and McDonnell Douglas Corporation aircraft which have completed a specified number of flights and has also issued rules requiring a corrosion control program for Boeing Company aircraft. Total expenditures under these programs for 1995 were approximately $17 million. Each of these programs requires that UPS make periodic inspections of its aircraft. These inspections may result in a determination that additional repairs are required under these programs. Hence, the future cost of such repairs pursuant to the programs may fluctuate.\nUntil January 1, 1995, ground transportation of packages by UPS in the United States was subject to regulation by the Interstate Commerce Commission (\"ICC\") and by various state regulatory agencies when such trans- portation was pursuant to common carrier certificates and contract carrier permits issued by the ICC and state agencies. After January 1, 1995, all state regulation of rates, routes and services was declared preempted by federal legislation, for both integrated intermodal carriers and motor carriers. UPS remains subject to the jurisdiction of the Department of Transportation, the department into which the ICC was merged in January 1996, with respect to the regulation of rates, routes and services, while the states maintain regulation over such areas as safety, insurance and hazardous materials. UPS is subject to similar regulation in many foreign jurisdictions.\nPostal Rate Proceedings\nThe Postal Reorganization Act of 1970 (the \"Act\") created the Postal Service as an independent establishment of the executive branch of the federal government and vested the power to recommend domestic postal rates in a regulatory body, the Postal Rate Commission\n(the \"Commission\"). UPS believes that the Postal Service consistently attempts to set rates for its monopoly services, particularly First Class letter mail, above the cost of providing such services and to use the excess revenues to subsidize its expedited, parcel, international, and other competitive services. Therefore, UPS participates in the postal rate proceedings before the Commission in an attempt to secure fair postal rates for the competitive services.\nUPS anticipates that the Postal Service will file for reclassification of certain competitive classes of mail during 1996. If this occurs, UPS expects to intervene in the proceedings.\nRecently, Congressional hearings have been held seeking input from the Postal Service and its users and competitors with respect to postal reform. At this time, it is too early to determine what the outcome of this process may be.\nOther Operations\nSeveral of the Company's other operations have been grouped together under a new company, UPS Logistics Group, Inc. (\"Logistics Group\"), which was formed in early 1996. Logistics Group is the parent company for six subsidiaries that encompass the core of these operations.\nUPS Worldwide Logistics, Inc. (\"Worldwide Logistics\") offers a consultative service to develop customized solutions for a shipper's distribution needs. UPS Inventory Express(SM) service offered by Worldwide Logistics provides for the storage of inventory, processing of orders and shipment of customers' products through a warehouse located near UPS's national air hub in Louisville, Kentucky. Worldwide Logistics maintains its second Inventory Express facility near the Company's European air hub in Cologne, Germany. Worldwide Logistics also has a distribution interest in the Netherlands and recently opened a facility in Singapore featuring state-of- the-art inventory management systems.\nWorldwide Logistics recently introduced a new service called \"Reverse Logistics and Repair\" which uses UPS Authorized Return Services to pick up components in need of servicing, fly them to one of its repair operations at a Worldwide Logistics facility, and return them - often overnight - - through a neighboring UPS air hub.\nUPS Truck Leasing, Inc. (\"UPS Truck Leasing\"), rents and leases trucks and tractors to commercial users under full-service rental agreements. Through programs established with Worldwide Logistics, UPS Truck Leasing is capitalizing on a business trend toward increased outsourcing of trucking needs. As of December 31, 1995, UPS Truck Leasing had 45 facilities and a fleet of 4,547 vehicles. UPS Truck Leasing's revenues increased by 13.7% in 1995.\nThe other companies in the new Logistics Group include: Roadnet Technologies, a route scheduling software developer; Martrac, which transports produce and other commodities in temperature-controlled trailers over railroads; SonicAir, which provides same day and next-flight-out delivery services and critical parts warehousing; and Worldwide Dedicated Services, which provides dedicated contract carriage services.\nEnvironmental Regulation\nIn 1989, regulations were adopted pursuant to the Resource Conservation and Recovery Act, which required owners and operators of underground storage tanks (\"USTs\") to test, upgrade and\/or replace their USTs on a rolling schedule of deadlines through 1998. UPS substantially completed this project ahead of the mandated Environmental Protection Agency (\"EPA\") schedule. As of January 1996, UPS has replaced approximately 3,000 USTs at a cost in excess of $100 million.\nThe Clean Air Act Amendments of 1990 require a ten-year phase in of alternative fuel vehicles by fleets in the urban areas with the worst air quality problems. UPS began a project in 1989 using compressed natural gas (\"CNG\") as a fuel in the package cars. By the end of 1995, 398 package cars were running on CNG in various cities.\nThe EPA's final rules under the Clean Air Act Amendments established regulations governing the exemption of clean fuel fleet vehicles from certain transportation control measures (\"TCMs\"). The regulations exempt clean fuel vehicles, such as UPS's CNG vehicles, from urban TCMs, such as truck bans and time-of-day restrictions. The regulations also permit the CNG vehicles to travel in high occupancy vehicle lanes, provided they meet certain emission criteria.\nOver 100 of the aircraft owned by UPS meet Stage III federal noise regulations. For additional information regarding compliance with such regulations, see Item 2, \"Properties - Aircraft.\"\nEmployees\nAs of February 29, 1996, UPS had approximately 332,000 employees, a 4.8% increase over 1995. Most hourly employees are represented by unions, principally by locals of the International Brotherhood of Teamsters.\nExecutive Officers\nListed below is certain information relating to the executive officers and management of UPS.\nEach officer of UPS has been elected to serve until the next organizational meeting of the directors of UPS following the annual meeting of shareowners of UPS.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nOperating Facilities\nUPS moved into its newly constructed headquarters, located in Atlanta, Georgia in August, 1994. The corporate offices consist of approximately 735,000 square feet.\nThe Company's principal operating facilities are those located in Dallas, Texas, Jacksonville, Florida, Denver, Colorado, Earth City, Missouri, Grand Rapids, Michigan, Philadelphia, Pennsylvania and Palatine, Illinois. These operating facilities, having floor spaces which range from 350,000 to 1,000,000 square feet, have central sorting facilities, operating hubs and service centers for local operations. In addition, UPS has constructed a 1,900,000 square foot hub facility near Chicago, Illinois, which is expected to be fully operational in late 1996.\nUPS also owns approximately 700 and leases approximately 1,000 other operating facilities throughout the territories it serves. The smaller of these facilities have vehicles and drivers stationed for the pickup of packages and facilities for the sorting, transfer and delivery of packages. The larger of these facilities have additional facilities for servicing UPS vehicles and equipment and employ specialized mechanical installations for the sorting and handling of packages.\nThe Company's aircraft are operated in a hub and spokes pattern in the United States. The Company's principal air hub in the United States is located in Louisville, Kentucky, with regional air hubs in Philadelphia, Pennsylvania, Ontario, California, Dallas, Texas, and Rockford, Illinois. These hubs house facilities for the sorting, transfer and delivery of packages. The Louisville, Kentucky hub handles the largest volume of packages for air delivery in the United States. A sixth regional air hub in Columbia, South Carolina is currently under construction and is expected to commence operations in August 1996. The Company's European air hub is located in Cologne, Germany. In March 1996, the Company announced that it has signed an agreement to establish its main Asia-Pacific air hub in Taiwan.\nUPS's computer operations are consolidated in a 400,000 square foot leased facility located on a 39 acre site in Mahwah, New Jersey. The construction of a 27,000 square foot addition to the facility was completed in 1995. The addition will accommodate further expansions of up to 54,000 square feet. UPS has leased this facility for an initial term ending in 2019 for use as a data processing, telecommunications and operations facility. In 1995, UPS also completed construction of a 160,000 square foot facility located on a 25 acre site in the Atlanta, Georgia area, which serves as a backup to the main computer operations facility in\nNew Jersey. The new facility provides certain production functions and backup capacity in case a power outage or other disaster incapacitates the main data center. It will also help meet future communication needs.\nAircraft\nUPS currently operates, either directly or by charter, a fleet of 467 aircraft. UPS's fleet at December 31, 1995 consisted of the following aircraft:\nAn inventory of spare engines and parts is maintained for each aircraft.\nAll of UPS's DC-8-71's, DC-8-73's, Boeing 747-100's, Boeing 757-200's and Boeing 767-300's meet Stage III federal noise regulations. UPS is replacing the three engines on all B727-100 aircraft with new, quieter engines. These re-engined Boeing 727-100's will meet Stage III federal noise regulations and will allow UPS to operate into airports with aircraft noise restrictions. UPS recently completed engine modifications for each of its eight Boeing 727-200 aircraft to achieve Stage III noise compliance. The current noise regulations do not impact the valuation of these aircraft as their depreciable lives all end before the final phase-in date for Stage III compliance in 1999. All of the other aircraft models operated by UPS are not subject to Stage III noise regulations.\nIn 1994, UPS completed a cockpit modernization program of all but seven aircraft in the Boeing 727-100 fleet. This modernization program consisted of replacing many of the original cockpit instruments with modern cathode ray tube (CRT) instrumentation. In addition, the layout and positioning of instruments in these Boeing 727-100 cockpits has been standardized to a common configuration. A similar cockpit modernization program is also\nunderway for all the DC8-71 and DC8-73 aircraft. At this time, UPS has not committed seven B727-100's purchased in 1994 to either the re-engining program or the cockpit modernization program.\nDuring 1995, UPS took delivery of eight Boeing 757-200 and five Boeing 767-300 aircraft. UPS is currently scheduled to take delivery of five Boeing 757-200 and ten Boeing 767-300 aircraft in 1996.\nIn addition, UPS has firm commitments to purchase five Boeing 757-200 and 15 Boeing 767-300 aircraft for delivery between 1997 and 2000. If additional aircraft are required, UPS has options for the purchase of 31 Boeing 757-200 and 30 Boeing 767-300 aircraft for delivery between 1997 and 2008.\nVehicles\nUPS owns and operates a fleet of approximately 150,000 vehicles and leases 2,900 vehicles, ranging in size from panel delivery cars to large tractors and trailers, including 1,430 temperature-controlled trailers owned by Martrac and 4,547 vehicles owned by UPS Truck Leasing. During 1995, approximately 17,000 package cars, tractors and trailers were purchased and approximately 1,700 older vehicles were retired.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nUPS desires to take advantage of the new \"safe harbor\" provisions of the Private Securities Litigation Reform Act of 1995 and is including the following description of its dispute with the United States Internal Revenue Service (the \"IRS\") and certain forward-looking statements with respect to the potential financial impact of such dispute on the Company in this Annual Report on Form 10-K in order to do so.\nUPS is a defendant in various lawsuits that arise in the normal course of business. In the opinion of management, none of these cases are expected to have a material effect on the financial condition of UPS.\nDuring the second quarter of 1995, the Company received a Notice of Deficiency from the United States Internal Revenue Service (\"IRS\") asserting that it is liable for additional tax for the 1983 and 1984 tax years. The Notice of Deficiency is based in large part on the theory that UPS is liable for tax on income of Overseas Partners Ltd., a Bermuda Company, which reinsures excess value package insurance purchased by UPS's customers from unrelated insurers. The deficiency sought by the IRS relating to package insurance is based on a number of inconsistent theories and ranges from $8 million to $35 million of tax, plus penalties and interest for 1984.\nAgents for the IRS have also asserted in reports that UPS is liable for additional tax for the 1985 through 1987 tax years. The additional tax sought by the agents relating to package insurance for this period ranges from $89 million to $148 million, plus penalties and interest, and is based on the same theories as the above-described Notice of Deficiency.\nIn addition, the IRS and its agents have raised a number of other issues relating to the timing of deductions, the characterization of expenses as capital rather than ordinary, and the Company's entitlement to the Investment Tax Credit in the 1983 through 1987 tax years. These issues total $32 million in tax for the 1983 and 1984 tax years and $95 million in tax for the 1985 through 1987 tax years. Penalties and interest are in addition to these amounts. The majority of these adjustments would reverse in future years.\nIn August 1995, the Company filed a petition in Tax Court in opposition to the Notice of Deficiency related to the 1983 and 1984 tax years. After consultation with tax legal experts, management believes there is no merit to any material issues raised by the IRS and that the eventual resolution of these matters will not have a material impact on the Company. The actual cost to UPS of this litigation, however, will depend upon the financial and managerial resources required to resolve the dispute and the amounts, if any, determined by the Tax Court to be due to the IRS. The Company has appealed with the IRS all issues related to the 1985 through 1987 tax years. The IRS may take positions similar to those in the reports described above for the periods after 1987.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nNone.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity And Related Stockholder Matters.\nUPS is authorized to issue 900,000,000 shares of common stock, $.10 par value per share, of which 570,000,000 shares were issued (including those shares held by UPS for distribution in connection with its stock plans) as of February 29, 1996. UPS is also authorized to issue 200,000,000 shares of preferred stock, without par value. No shares of preferred stock have been issued or are outstanding.\nEach share of UPS Common Stock is entitled to one vote in the election of directors and other matters, except that, generally, any shareowner, or shareowners acting as a group, who beneficially own more than 10% of the voting stock are entitled to only one one-hundredth of a vote with respect to each vote in excess of 10% of the voting power of the then outstanding shares of voting stock. Holders have no preemptive or other right to subscribe to additional shares. In the event of liquidation or dissolution, they are entitled to share ratably in the assets available after payment of all obligations. The shares are not redeemable by UPS except through the Company's exercise of the preferential right of purchase mentioned below and, in the case of stock subject to the UPS Managers Stock Trust, as amended, and the UPS Employees Stock Trust, the Company's right of purchase in the circumstances described therein.\nShareowners are entitled to such dividends as are declared by the Board of Directors. The policy of the UPS Board is to declare dividends each year out of current earnings. However, the declaration of future dividends is subject to the discretion of the Board of Directors in light of all relevant facts, including the Company's earnings, general business conditions and capital requirements.\nUPS Common Stock is not listed on a national securities exchange or traded in the organized over-the-counter market. The UPS Certificate of Incorporation provides that no outstanding shares of UPS capital stock entitled to vote generally in the election of directors may be transferred to any other person, except by bona fide gift or inheritance, unless the shares shall have first been offered, by written notice, for sale to UPS at the same price and on the same terms upon which they are to be offered to the proposed transferee.\nUPS has the right, within 30 days after receipt of the notice, to purchase all or a part of the shares at the price and on the terms offered. If it fails to exercise or waives the right, the shareowner may, within a period of 20 days thereafter, sell to the proposed transferee all, but not part, of the shares that UPS elected not to purchase, for the price and on the terms described in the offer. All transferees of shares hold their shares subject to the same restriction. Shares previously offered but not transferred within the 20 day period remain subject to the\ninitial restrictions. Shares may be pledged or otherwise used for security purposes, but no transfer may be made upon a foreclosure of the pledge until the shares have been offered to UPS at the price and on the terms and conditions bid by the purchaser at the foreclosure.\nUPS, from time to time, has waived and may in the future waive its right of first refusal to purchase its shares in order to permit eligible employees to purchase shares at the same price as UPS was willing to pay. The grant of waivers has been and will continue to be affected by the Company's needs for purposes of the UPS Managers Incentive Plan, the UPS 1986 Stock Option Plan (the \"1986 Plan\"), the UPS 1991 Stock Option Plan (the \"1991 Plan\") and, if approved by the shareowners at the 1996 Annual Meeting of Shareowners, the UPS 1996 Stock Option Plan (the \"1996 Plan\" and, together with the 1986 Plan and the 1991 Plan, the \"Plans\") and other corporate purposes. Persons who purchase shares in this manner are required to deposit them in the UPS Managers Stock Trust or the UPS Employees Stock Trust.\nUPS notifies its shareowners periodically of its willingness to purchase shares at specified prices determined by the Board of Directors, in the event that shareowners wish to sell their shares. During 1995, UPS purchased 31,610,129 shares at an aggregate purchase price of approximately $768 million.\nIn determining the prices at which UPS is willing to purchase shares, the Board considers a variety of factors, including past and current earnings, earnings estimates, the ratio of UPS Common Stock to debt of UPS, other factors affecting the business and outlook of UPS and general economic conditions, as well as opinions furnished from time to time by two firms of investment counselors, each acting independently, as to the value of UPS shares. The Board has not followed any predetermined formula. It has considered a number of formulas commonly used in the evaluation of securities of closely held and of publicly held companies, but its decisions have been based primarily on the judgment of the Board of Directors as to the long-range prospects of UPS rather than what the Board considers to be the short-term trends relating to UPS or the values of securities generally. Thus, for example, the Board has not given substantial weight to short-term variations in average price-earnings ratios of publicly traded securities which at times have been considerably higher, and at other times, considerably lower, than those for the Company's securities. However, the Board's decision as to prices does take into account factors affecting generally the market prices of publicly traded securities, and prolonged changes in those prices could have an effect on the prices offered by UPS.\nOne factor in determining the prices at which securities trade in the organized markets is that of supply and demand. When demand is high in relation to the shares which investors seek to sell, prices tend to increase, while prices tend to decrease when demand is low in relation to the shares being sold. To date, the UPS Board of Directors has not given significant weight to considerations of supply and demand in determining the price to be paid by UPS for its shares. UPS has had a need for many of its shares for purposes of awards under the Plans, and eligible employees have purchased many other available shares. When the\nnumber of shares acquired by UPS exceeds the number needed for these purposes within a reasonable period, the excess shares are constructively retired and treated as authorized and unissued shares by UPS.\nUPS intends to continue its policy of purchasing a limited number of shares when offered by shareowners. However, there can be no assurance of continuation of that policy. The feasibility of purchases by UPS and the prices at which shares may be purchased are both subject to the continued maintenance by UPS of satisfactory earnings and financial condition. Hence, both the salability of UPS shares and the prices at which they may be sold would be adversely affected by a continuous decline of UPS's earnings or by unfavorable changes in its financial position and might be adversely affected by decisions of shareowners to sell substantially more shares than the Board considers necessary for the ultimate purpose of making awards under the Plans.\nThe prices at which UPS has published notices of its willingness to purchase shares of Common Stock since January 1994 have been as follows:\nOn February 15, 1996, UPS expressed its willingness to purchase shares at $27.00 per share, which is still the price at the date of this report.\nIn January 1996, UPS distributed an aggregate of 6,301,427 shares of UPS Common Stock, subject to the UPS Managers Stock Trust, under the UPS Managers Incentive Plan to a total of 27,223 employees at a managerial or supervisory level. In February 1995, it distributed an aggregate of 6,487,408 shares of UPS Common Stock under that Plan to a total\nof 29,462 managerial or supervisory employees. The UPS Managers Stock Trust and the Managers Incentive Plan have been previously described in the UPS Registration Statement on Form 10 and in the UPS Prospectus, dated February 1, 1995, relating to the UPS Managers Incentive Plan awards. Such distributions do not represent \"sales\" as defined under the Securities Act of 1933, as amended (the \"1933 Act\"). However, the shares awarded were registered under the 1933 Act to permit resales of the shares consistent with the interpretations of the Securities and Exchange Commission under Rule 144 adopted under the 1933 Act.\nDuring 1995, 1,251,933 shares of UPS Common Stock were distributed to 2,058 employees upon the exercise of stock options granted to them by UPS under the 1986 Plan. In addition, a total of 12,476,607 shares of UPS Common Stock were sold pursuant to stock offerings by UPS to 22,233 UPS managers, supervisors and other employees. Approximately 18,409 UPS managers and supervisors purchased shares with a value of approximately $6.9 million and approximately 3,824 other employees purchased shares with a value of approximately $856,400. The offering to UPS managers and supervisors has been previously described in the UPS Registration Statement on Form S-3 (No. 33-54297), as amended, which became effective in August 1994 and the offering to non-management employees has been previously described in the UPS Registration Statement on Form S-8 (No. 33-62169), which became effective on August 28, 1995. The shares issued upon exercise of the options and the shares purchased pursuant to the offering are subject to the UPS Managers Stock Trust, as amended and restated, or the UPS Employees Stock Trust.\nShares of UPS Common Stock issued to employees under the Plans and most other shares of UPS Common Stock owned by UPS employees are held subject to the UPS Managers Stock Trust, as amended and restated, or the UPS Employees Stock Trust (the \"Trusts\"). First Fidelity Bank, N.A., now First Union National Bank (\"First Union\"), serves as trustee under the Trusts. The Trust agreements give UPS the right to purchase the shares of UPS Common Stock of members deposited in the Trusts at their fair market value, as defined, when the member retires, dies or ceases to be an employee of UPS, or when the member requests the withdrawal of shares from a Trust. Fair market value is defined as the fair market value of the shares at the time of the sale, or in the event of differences of opinion as to value, the average price per share of all shares of UPS Common Stock sold during the 12 months preceding the sale involved. If at the time a member ceases to be an employee of UPS, 1,000 or more shares are held for the benefit of such member and his or her transferees under the Trusts, UPS may, beginning in June of the calendar year next succeeding the year of termination of employment, purchase at any time and from time to time a cumulative annual amount of up to 10% of the 1,000 or more shares held for the benefit of the member and his or her transferees, unless the member requests withdrawal of the shares from the Trust, whereupon UPS may elect whether or not to purchase the shares within 60 days of the request. If less than 1,000 shares are held for the benefit of a member and his or her transferees under the Trusts, UPS may purchase all or part of the shares beneficially owned at any time, subject to the member's right to request withdrawal of the shares from the Trust, whereupon UPS may\nelect whether or not to purchase the shares within 60 days of the request. UPS is also entitled to purchase shares of UPS Common Stock held under the Trusts after receipt of a request from the member to release the shares from the Trust and upon occurrence of several other enumerated events. In the event UPS fails to elect to purchase the shares and to deliver the purchase price therefor within the prescribed periods, the member would become entitled, upon request, to the delivery of the shares of UPS Common Stock free and clear of the Trusts, unless the purchase period has been extended by agreement of UPS and such member. UPS has consistently exercised its purchase rights.\nMembers of the Trusts are entitled to the dividends on shares of UPS Common Stock held for their accounts (except that stock dividends are added to the shares held by the Trustee for the benefit of the individual members), to direct the Trustee as to how the shares held for their benefit are to be voted and to request proxies from the Trustee to vote shares held for their accounts.\nIn January 1996, UPS paid a cash dividend of $.32 a share. During the fiscal year ended December 31, 1995, UPS paid cash dividends of $.30 a share in January 1995 and $0.32 in June 1995. During the fiscal year ended December 31, 1994, UPS paid a cash dividend of $.25 a share in January 1994 and $.25 in June 1994.\nUPS intends to continue its policy of paying dividends to its shareowners. However, the declaration of future dividends is subject to the discretion of the Board of Directors in light of all relevant facts, including earnings, general business conditions and working capital requirements. Loan agreements, to which UPS is a party, limit the amount which UPS may declare as dividends and use for the repurchase of its Common Stock. The most restrictive of these agreements limits the declaration of dividends, other than stock dividends, and payments for the purchase of Common Stock to the extent that such declarations and payments, together with all other payments made subsequent to January 1, 1985 would exceed, in the aggregate, (i) $250,000,000, (ii) 66-2\/3% of net income, as defined in the agreement, and (iii) the net proceeds from the issuance, sale or disposition of any shares of stock of UPS or any warrants or other rights to purchase such stock subsequent to January 1, 1985. As of December 31, 1995 UPS had approximately $1.0 billion not subject to these restrictions. These limits do not materially restrict the declaration of dividends.\nSet forth below is the approximate number of record holders of equity securities of UPS as of February 29, 1996.\n________________________________ 1\/ Refers to beneficial owners. The record holder of the shares of Common Stock subject to the Trusts is Saul & Co., as nominee for First Union, as Trustee.\nItem 6","section_6":"Item 6 - Selected Financial Data.\n(1) All per share amounts have been restated to reflect the four for one split in 1991.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nOperations\n1995 Compared to 1994\nRevenue increased $1.469 billion, or 7.5%, during 1995 compared to 1994. For 1995, domestic revenue totaled $18.243 billion, an increase of $945 million, or 5.5%, over 1994 and international revenue totaled $2.802 billion, an increase of $524 million, or 23.0%, over 1994.\nDomestic revenue increased as a result of higher volume which was up 1.8%, favorable changes in rates and a continuing shift toward higher yielding packages. The volume increase was mainly a result of lower volume during the first quarter of 1994, which was affected by severe weather conditions which disrupted both air and ground operations and a one day strike in February 1994. During the first quarter of 1995, published rates for domestic ground services for commercial and residential deliveries were increased by 3.9%. Additionally, the published rates for Next Day Air and 2nd Day Air packages each increased by 3.9% and the published rates for Next Day Air and 2nd Day Air letters increased by 4.7% and 4.3%, respectively.\nThe increase in international revenue was primarily attributable to higher volume, which was up 11.8% and the effect of stronger foreign currencies. The majority of the increased volume related to higher yielding, export packages.\nOperating expenses increased by $1.231 billion, or 6.8%. Included in this increase is a one time charge of $372 million for a voluntary early retirement and severance program for certain, primarily management, employees which concluded August 15, 1995 (\"restructuring charge\"). Excluding this restructuring charge, operating expenses increased only 4.8% resulting in an improvement in the operating ratio, from 92.1 during 1994 to 89.7 during 1995. The improvement in the operating ratio, excluding the restructuring charge, is a function of cost control efforts during 1995 and adverse factors affecting results for the first quarter of 1994, as discussed above. These factors not only affected first quarter 1994 volume, but increased first quarter 1994 operating costs as well. The effect of cost control efforts should be further enhanced as a result of the restructuring.\nOperating profit for 1995 increased by $238 million, or 15.3%, as a result of higher revenue and the improved operating ratio offset by the restructuring charge of $372 million.\nIncome before income taxes (\"pre-tax income\") increased by $133 million, or 8.4%. Domestic pre-tax income amounted to $1.92 billion, an increase of $18 million, or 0.9%, over 1994. Results for the period were reduced by the restructuring charge of $372 million.\nIgnoring the effect of this one-time charge, domestic pre-tax income would have been up $390 million, or 20.5%, primarily due to higher operating profits. In 1994, domestic pre-tax income included a non-recurring $46 million gain from the sale of an investment property. The international pre-tax loss decreased by $115 million, or 35.2%, to $212 million for 1995.\nThe international pre-tax loss attributable to the foreign domestic operations decreased by $76 million, or 32.7%. The pre-tax loss associated with export operations decreased by $39 million, or 41.4%. The improvement noted in both foreign domestic and export operations is primarily a result of higher volume and improved operating margins. Export volume increased by 34.5% and 17.8% for international and U.S. origin, export shipments, respectively. UPS expects the cost of operating its international business will continue to exceed revenue in the near future.\nNet income increased by $100 million, or 10.6%. This increase resulted primarily from improved operating profit.\n1994 Compared to 1993\nRevenue increased $1.794 billion, or 10.1%, during 1994 compared to 1993. For 1994, domestic revenue totaled $17.298 billion, an increase of $1.476 billion, or 9.3%, over 1993 and international revenue totaled $2.278 billion, an increase of $318 million, or 16.2%, over 1993.\nDomestic revenue increased as a result of higher volume which was up 2.3%, favorable changes in rates and a continuing shift toward higher yielding packages. During the first quarter of 1994, published rates for domestic ground services for commercial and residential deliveries were increased by 3.8% and 4.3%, respectively. Additionally, the published rates for Next Day Air and 2nd Day Air packages each increased by 3.9% and the published rates for Next Day Air and 2nd Day Air letters increased by 2.4% and 4.5%, respectively.\nThe increase in international revenue was primarily attributable to higher volume, which was up 8.0%. The majority of the increased volume related to higher yielding, export packages.\nOperating expenses increased by $1.696 billion, or 10.4%, which was commensurate with the increase in revenues. Higher wages and employee benefits accounted for the majority of the increase. Other operating expenses were up in a variety of categories with the largest increases relating to depreciation and purchased transportation.\nOperating profit for 1994 increased by $98 million, or 6.7%. This increase resulted primarily from higher revenue discussed above.\nIncome before income taxes (\"pre-tax income\") increased by $143 million, or 10.0%. Domestic pre-tax income amounted to $1.902 billion, an increase of $204 million, or 12.0%, over 1993. This increase was a result of higher operating profit and the sale of an investment property in January at a gain of approximately $46 million. The international pre-tax loss increased by $61 million, or 22.9%, bringing the total international pre-tax loss to $327 million for 1994.\nThe international pre-tax loss attributable to the foreign domestic operations increased by $56 million, or 31.8%, primarily as a result of competitive factors. The pre-tax loss associated with export operations increased by $5 million, or 4.8%. Export volume increased by 48.0% and 16.3% for international and U.S. origin, export shipments, respectively.\nNet income increased by $133 million, or 16.4%. This increase resulted primarily from the higher operating profit, a gain on a long-term investment property described above and a deferred tax adjustment recorded in 1993 to reflect the effect of the increase in the maximum U.S. federal income tax rate for corporations from 34% to 35%.\nLiquidity and Capital Resources\nUPS believes that its internally generated funds, revolving credit facilities and commercial paper program will provide adequate sources of liquidity and capital resources to meet its expected future short-term and long-term needs for the operation of its business, including anticipated capital expenditures of $2.3 billion for land, buildings, equipment and aircraft in 1996, as well as commitments for aircraft purchases through 2000.\nFrom time to time, the Company may take advantage of attractive borrowing costs in longer term debt markets. In January 1996, UPS issued $200 million of 5.5% Eurobond notes which are due January 1999. In March, 1996, UPS obtained a commitment for issue in April, 1996, of $166 million of 3.25% Swiss franc notes which are due in October 1999.\nDuring the second quarter of 1995, the Company received a Notice of Deficiency from the United States Internal Revenue Service (\"IRS\") asserting that it is liable for additional tax for the 1983 and 1984 tax years. The Notice of Deficiency is based in large part on the theory that UPS is liable for tax on income of Overseas Partners Ltd., a Bermuda company, which has reinsured excess value package insurance purchased by UPS's customers from unrelated insurers. The deficiency sought by the IRS relating to package insurance is based on a number of inconsistent theories and ranges from $8 million to $35 million of tax, plus penalties and interest for 1984.\nAgents for the IRS have also asserted in reports that UPS is liable for additional tax for the 1985 through 1987 tax years. The additional tax sought by the agents relating to package insurance for this period ranges from $89 million to $148 million, plus penalties and interest, and are based on the same theories included in the above described Notice of Deficiency.\nIn addition, the IRS and its agents have raised a number of other issues relating to the timing of deductions; the characterization of expenses as capital rather than ordinary; and UPS's entitlement to the Investment Tax Credit in the 1983 through 1987 tax years. These issues total $32 million in tax for the 1983 and 1984 tax years and $95 million in tax for the 1985 through 1987 tax years. Penalties and interest are in addition to these amounts. The majority of these adjustments would reverse in future years.\nIn August, 1995, the Company filed a petition in Tax Court in opposition to the Notice of Deficiency related to the 1983 and 1984 tax years. After consultation with tax legal experts, management believes there is no merit to any material issues raised by the IRS and that the eventual resolution of these matters will not have a material impact on the Company. The Company has appealed with the IRS all issues related to the 1985 through 1987 tax years. The IRS may take positions similar to those in the reports described above for periods after 1987.\nFuture Accounting Changes\nIn October, 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123 \"Accounting for Stock-Based Compensation\" (\"FAS 123\"). UPS intends to continue to account for its option awards under APB Opinion No. 25 as allowed by FAS 123. Accordingly, management does not anticipate that adoption of this standard will have an effect on net income or shareowners' equity.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nFinancial Statements\nThe Financial Statements of UPS are filed together with this Report. See the Index to Financial Statements on page for a list of the Financial Statements filed herewith.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.\nNot applicable.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant.\nInformation regarding the Directors of UPS is presented under the caption \"Election of Directors\" in UPS's definitive Proxy Statement for the Annual Meeting of Shareowners to be held on May 9, 1996, which will be filed with the Securities and Exchange Commission (the \"SEC\") on or about March 31, 1996, and is incorporated herein by reference.\nInformation concerning the Company's executive officers can be found in Part I, Item 1, of this Form 10-K under the caption \"Executive Officers\" in accordance with Instruction 3 of Item 401(b) of Regulation S-K and General Instruction G(3) of Form 10-K.\nItem 11.","section_11":"Item 11. Executive Compensation.\nInformation in answer to this Item 11 is presented under the caption \"Compensation of Executive Officers and Other Information\" excluding the information under the captions \"Report of the Officer Compensation Committee on Executive Compensation\" and \"Shareowner Return Performance Graph\" in the Company's definitive Proxy Statement for the Annual Meeting of Shareowners to be held on May 9, 1996, which will be filed with the SEC on or about March 31, 1996, and is incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nInformation in answer to this Item 12 is presented under the caption \"Stock Ownership\" in the Company's definitive Proxy Statement for the Annual Meeting of Shareowners to be held on May 9, 1996, which will be filed with the SEC on or about March 31, 1996, and is incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nInformation in answer to this Item 13 is presented under the captions \"Certain Business Relationships\" and \"Common Relationships with Overseas Partners Ltd.\" in the Company's definitive Proxy Statement for the Annual Meeting of Shareowners to be held on May 9, 1996, which will be filed with the SEC on or about March 31, 1996, 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. See the Index to Financial Statements and Financial Statement Schedules on page for a list of the Financial Statements filed herewith.\n2. Financial Statement Schedules. Not Applicable.\n3. List of Exhibits. See the Exhibit Index on page E-1 for a list of the Exhibits incorporated by reference herein or filed herewith.\n(b) Reports on Form 8-K. The Company filed one Current Report on Form 8-K (Date of Earliest Event Reported: December 19, 1995) on December 21, 1995 reporting amendments to Article II, Sections 3 and 10, and Article III, Section 14, of the Company's By-laws.\n(c) Exhibits required by Item 601 of Regulation S-K. See the Exhibit Index beginning on page E-1 for a list of the Exhibits incorporated by reference herein or filed herewith.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, United Parcel Service of America, Inc. has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nUNITED PARCEL SERVICE OF AMERICA, INC. (Registrant)\nDate: March 31, 1996 By: \/s\/ Kent C. Nelson ---------------------------------- Kent C. Nelson Chairman of the Board\nPursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nUnited Parcel Service of America, Inc., and Subsidiaries\nConsolidated Financial Statements and Independent Auditors' Report\nThree Years Ended December 31, 1995\nUNITED PARCEL SERVICE OF AMERICA, INC. AND SUBSIDIARIES INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nItems 14(a)(2) - Financial Statement Schedules\nAll schedules are omitted because they are not applicable, or not required, or because the required information is included in the consolidated financial statements or notes thereto.\nINDEPENDENT AUDITORS' REPORT\nBoard of Directors and Shareowners United Parcel Service of America, Inc. Atlanta, Georgia\nWe have audited the accompanying consolidated balance sheets of United Parcel Service of America, Inc., and its subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of income, shareowners' equity, and cash flows for each of the three years in the period ended December 31, 1995. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of United Parcel Service of America, Inc., and its subsidiaries at December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles.\nDELOITTE & TOUCHE LLP\nAtlanta, Georgia February 7, 1996\nUNITED PARCEL SERVICE OF AMERICA, INC., AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS December 31, 1995 and 1994 (In millions except share amounts)\nSee notes to consolidated financial statements.\nUNITED PARCEL SERVICE OF AMERICA, INC., AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS December 31, 1995 and 1994 (In millions except share amounts)\nSee notes to consolidated financial statements.\nUNITED PARCEL SERVICE OF AMERICA, INC., AND SUBSIDIARIES STATEMENTS OF CONSOLIDATED INCOME Years Ended December 31, 1995, 1994, and 1993 (In millions except per share amounts)\nSee notes to consolidated financial statements.\nUNITED PARCEL SERVICE OF AMERICA, INC., AND SUBSIDIARIES STATEMENTS OF CONSOLIDATED SHAREOWNERS' EQUITY Years Ended December 31, 1995, 1994 and 1993 (In millions except per share amounts)\nSee notes to consolidated financial statements.\nUNITED PARCEL SERVICE OF AMERICA, INC., AND SUBSIDIARIES STATEMENTS OF CONSOLIDATED CASH FLOWS Years Ended December 31, 1995, 1994 and 1993 (In millions)\nSee notes to consolidated financial statements.\nUNITED PARCEL SERVICE OF AMERICA, INC., AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years Ended December 31, 1995, 1994 and 1993\n1. SUMMARY OF ACCOUNTING POLICIES\nBasis of Financial Statements and Business Activities\nThe accompanying consolidated financial statements include the accounts of United Parcel Service of America, Inc., and all of its subsidiaries (collectively \"UPS\"). All material intercompany balances and transactions have been eliminated.\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nUPS concentrates its operations in the field of transportation services, primarily domestic and international package delivery. Revenue is recognized upon delivery of a package.\nCash Equivalents\nCash equivalents (short-term investments) consist of highly liquid investments which are readily convertible into cash. The carrying amount approximates fair value because of the short-term maturity of these instruments.\nCommon Stock Held for Stock Plans\nUPS accounts for its common stock held for awards and distributions under various UPS stock and benefit plans as a current asset. Common stock held in excess of current requirements is accounted for as a reduction in Shareowners' Equity.\nProperty, Plant and Equipment\nProperty, plant and equipment are carried at cost. Depreciation (including amortization) is provided by the straight-line method over the estimated useful lives of the assets, which are as follows: Vehicles - 9 years; Aircraft - 12 to 20 years; Buildings - 10 to 40 years; Leasehold Improvements - lives of leases; Plant Equipment - 5 to 8 1\/3 years.\nCosts in Excess of Net Assets Acquired\nCosts in excess of net assets acquired are amortized over a 10-year period using the straight-line method.\nUNITED PARCEL SERVICE OF AMERICA, INC., AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years Ended December 31, 1995, 1994 and 1993\nIncome Taxes\nEffective January 1, 1993, UPS adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"FAS 109\"). FAS 109 is an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Company's financial statements or tax returns. In estimating future tax consequences, FAS 109 generally considers all expected future events other than enactments of changes in the tax law or rates. Previously, the Company used the FAS 96 asset and liability approach that gave no recognition to future events other than the recovery of assets and settlement of liabilities at their carrying amounts. The benefit of investment tax credits is amortized over seven years except investment tax credits from the investment in leveraged leases, which is amortized over the life of the lease.\nCapitalized Interest\nInterest incurred during the construction period of certain property, plant and equipment is capitalized until the underlying assets are placed in service, at which time amortization of the capitalized interest begins, straight-line, over the estimated useful lives of the related assets. Capitalized interest was $49, $45 and $28 million for 1995, 1994 and 1993, respectively.\nDerivative Instruments\nUPS has entered into interest rate swap agreements to lower the effective interest rate on its debentures. These agreements have an average remaining life of less than one year. The periodic settlement payments are accrued monthly, as either a charge or credit to expense, and are not material to net income. Based on estimates provided by third party investment bankers, the fair value of the Company's interest rate swap agreements is not material to the Company's financial statements.\nThe Company also purchases options to reduce the impact of changes in foreign currency rates on its foreign currency purchases and to moderate the impact of major increases in the cost of crude oil on fuel expense. The options are adjusted to fair value at period end based on market quotes and are not material to the Company's financial statements.\nUPS is exposed to credit loss in the event of nonperformance by the other parties to the interest rate swap agreements. However, UPS does not anticipate nonperformance by the counterparties. UPS is exposed to market risk based upon changes in interest rates, foreign currency exchange rates, and crude oil prices.\nUNITED PARCEL SERVICE OF AMERICA, INC., AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years Ended December 31, 1995, 1994 and 1993\n2. LONG-TERM DEBT\nLong-term debt, as of December 31, consists of the following (in millions):\nThe debentures are not subject to redemption prior to maturity and are not subject to sinking fund requirements. Interest is payable semi-annually on the first of April and October. The weighted average interest rate on the commercial paper outstanding as of December 31, 1995 and 1994, was 5.7% and 6.0%, respectively. The commercial paper has been classified as long-term debt in accordance with the Company's intention and ability to refinance such obligations on a long-term basis. However, the amount of commercial paper outstanding in 1996 is expected to fluctuate. UPS is authorized to borrow up to $1 billion under this commercial paper program as of December 31, 1995. The industrial development bonds bear interest at either a daily, variable, or fixed rate. The average interest rates for 1995 and 1994 were 3.7% and 2.7%, respectively. The installment notes, mortgages and bonds bear interest at rates of 6.0% to 11.5%.\nThe aggregate annual principal payments for the next five years, excluding commercial paper, are (in millions): 1996- $1; 1997- $5; 1998- $5; 1999- $5; and 2000- $3.\nUNITED PARCEL SERVICE OF AMERICA, INC., AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years Ended December 31, 1995, 1994 and 1993\nBased on the borrowing rates currently available to the Company for long-term debt with similar terms and maturities, the fair value of long-term debt is approximately $1.893 billion as of December 31, 1995.\nUPS maintains two credit agreements with a consortium of banks which provide revolving credit facilities of $1.25 billion each, with one expiring June 10, 1996 and the other June 12, 2000. At December 31, 1995, there were no outstanding borrowings under these facilities.\nIn January, 1996, UPS issued $200 million of 5.5% Eurobond notes which are due in January 1999.\n3. COMMON STOCK PER SHARE DATA\nPer share amounts related to income are based on 570,000,000 shares in 1995 and 580,000,000 shares in 1994 and 1993 and include Common Stock Held for Stock Plans.\n4. LEGAL PROCEEDINGS AND COMMITMENTS\nUPS is a defendant in various lawsuits which arose in the normal course of business. In the opinion of management, none of these cases are expected to have a material effect on the financial condition of UPS.\nDuring the second quarter of 1995, the Company received a Notice of Deficiency from the United States Internal Revenue Service (\"IRS\") asserting that it is liable for additional tax for the 1983 and 1984 tax years. The Notice of Deficiency is based in large part on the theory that UPS is liable for tax on income of Overseas Partners Ltd., a Bermuda company, which has reinsured excess value package insurance purchased by UPS's customers from unrelated insurers. The deficiency sought by the IRS relating to package insurance is based on a number of inconsistent theories and ranges from $8 million to $35 million of tax, plus penalties and interest for 1984.\nAgents for the IRS have also asserted in reports that UPS is liable for additional tax for the 1985 through 1987 tax years. The additional tax sought by the agents relating to package insurance for this period ranges from $89 million to $148 million, plus penalties and interest, and are based on the same theories included in the above described Notice of Deficiency.\nUNITED PARCEL SERVICE OF AMERICA, INC., AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years Ended December 31, 1995, 1994 and 1993\nIn addition, the IRS and its agents have raised a number of other issues relating to the timing of deductions; the characterization of expenses as capital rather than ordinary; and UPS's entitlement to the Investment Tax Credit in the 1983 through 1987 tax years. These issues total $32 million in tax for the 1983 and 1984 tax years and $95 million in tax for the 1985 through 1987 tax years. Penalties and interest are in addition to these amounts. The majority of these adjustments would reverse in future years.\nIn August, 1995, the Company filed a petition in Tax Court in opposition to the Notice of Deficiency related to the 1983 and 1984 tax years. After consultation with tax legal experts, management believes there is no merit to any material issues raised by the IRS and that the eventual resolution of these matters will not have a material impact on the Company. The Company has appealed with the IRS all issues related to the 1985 through 1987 tax years. The IRS may take positions similar to those in the reports described above for periods after 1987.\nUPS leases certain operating facilities and aircraft, the majority of which are from related parties. These leases expire at various dates through 2030. Total aggregate minimum lease commitments are as follows (in millions):\nAs of December 31, 1995, UPS has outstanding letters of credit totaling approximately $908 million issued in connection with routine business requirements.\nAt December 31, 1995, UPS had commitments outstanding for capital expenditures under purchase orders and contracts of approximately $2.7 billion, of which approximately $1.2 billion is expected to be spent in 1996.\nUNITED PARCEL SERVICE OF AMERICA, INC., AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years Ended December 31, 1995, 1994 and 1993\n5. EMPLOYEE BENEFIT PLANS\nUPS maintains the UPS Retirement Plan (the \"Plan\"). The Plan is a defined benefit plan which provides employees annual defined retirement benefits. The Plan is noncontributory and all employees who meet certain minimum age and years of service are eligible, except those covered by certain multi-employer plans provided for under collective bargaining agreements.\nThe Plan provides for retirement benefits based on average compensation levels earned by employees during certain years of service preceding retirement. The Plan's assets consist primarily of publicly traded stocks and bonds. In addition, the Plan's assets include 8,052,840 shares of UPS common stock at both December 31, 1995 and 1994. The actual earnings on the Plan's assets were $363, $89, and $224 million in 1995, 1994 and 1993, respectively. UPS's funding policy is consistent with relevant federal tax regulations. Accordingly, UPS contributes amounts deductible for federal income tax purposes.\nPension expense, consisting of various component parts, and certain assumptions used during the years ended December 31, are as follows (in millions):\nUNITED PARCEL SERVICE OF AMERICA, INC., AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years Ended December 31, 1995, 1994 and 1993\nThe following schedule reconciles the funded status of the Plan with certain amounts included in the balance sheet as of December 31 (in millions):\nUPS also contributes to several multi-employer pension plans for which the above information is not determinable. Amounts charged to operations for contributions to pension plans other than the Plan described above were $574, $506, and $456 million during 1995, 1994 and 1993, respectively.\nUPS sponsors defined benefit postretirement medical plans that provide health care benefits to its retirees who meet certain eligibility requirements and who are not covered by multi-employer retirement plans. Generally, this includes employees with at least 10 years of service who have reached age 55 and will be receiving benefits from one of the Company's retirement plans. The Company has the right to modify or terminate certain of these plans. Historically, these benefits have been provided to retirees on a noncontributory basis; however, effective January 1, 1992, the Company made modifications which will likely result in cost sharing in the future for certain of its retirees.\nUNITED PARCEL SERVICE OF AMERICA, INC., AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years Ended December 31, 1995, 1994 and 1993\nThe accumulated postretirement benefit obligation at December 31, is detailed as follows (in millions):\nNet periodic postretirement benefit cost for the years ended December 31, included the following components (in millions):\nUNITED PARCEL SERVICE OF AMERICA, INC., AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years Ended December 31, 1995, 1994 and 1993\nThe significant assumptions used in determining postretirement benefit cost and the accumulated postretirement benefit obligation were as follows:\nFuture benefit costs were forecasted assuming an initial annual increase of 8.5% for pre-65 medical costs and an increase of 7.5% for post-65 medical costs, decreasing to 6% for pre-65 and 5% for post-65 by the year 2000 and with consistent annual increases at those ultimate levels thereafter. A one percentage point increase in the annual trend rate would have increased the total accumulated postretirement benefit obligation at December 31, 1995, by $95 million and the aggregate of the service and interest components of the net periodic postretirement benefit costs for 1995 by $12 million.\nPlan assets consist primarily of publicly traded stocks and bonds. The Trust holding the Plan assets is not subject to income taxes. UPS's funding policy is consistent with relevant federal tax regulations. Accordingly, UPS contributes amounts deductible for federal income tax purposes.\nUPS also contributes to several multi-employer health and welfare plans which cover both active and retired employees for which the above information is not determinable. Amounts charged to operations for contributions to health and welfare plans other than the Plan described above were $395, $356, and $306 million during 1995, 1994 and 1993, respectively.\nAs part of UPS' overall effort to lower operating expense, the Company implemented a program of voluntary early retirement and severance for certain, primarily management, employees which concluded August 15, 1995. As a result, UPS recognized net additional pension and postretirement costs of $223 million and $115 million, respectively. These costs resulted from the net increase in UPS' obligation for pension and postretirement benefits for certain employees participating in the program. Other costs associated with the program totaled $34 million. The total cost for the program of $372 million was recorded as a one-time restructuring charge against 1995 operations.\nUNITED PARCEL SERVICE OF AMERICA, INC., AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years Ended December 31, 1995, 1994 and 1993\n6. MANAGEMENT INCENTIVE PLANS\nUPS maintains the UPS Managers Incentive Plan. Persons earning the right to receive awards are determined annually by either the Officer Compensation Committee or the Salary Committee of the UPS Board of Directors. Awards consist primarily of UPS common stock and cash equivalent to the tax withholdings on such awards. The total of all such awards is limited to 15% of consolidated income before federal income taxes for the 12-month period ending each September 30, exclusive of gains and losses from the sale of real estate and stock of subsidiaries and the effect of certain other non-recurring transactions or accounting changes. Amounts charged to operations were $277, $255, and $218 million during 1995, 1994 and 1993, respectively.\nUPS maintains stock option plans under which options are granted to purchase shares of UPS common stock at the current price of UPS shares as determined by the Board of Directors on the date of option grant. Except in the case of death, disability, or retirement, options are exercisable only during a limited period after the expiration of five years from the date of grant but are subject to earlier cancellation or exercise under certain conditions. Persons earning the right to receive stock options under the 1991 plan are determined each year by either the Officer Compensation Committee or Salary Committee of the UPS Board of Directors. Options covering a total of 30,000,000 common shares may be granted during the five-year period ending in 1996.\nFollowing is an analysis of options for shares of common stock issued and outstanding:\nUNITED PARCEL SERVICE OF AMERICA, INC., AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years Ended December 31, 1995, 1994 and 1993\n7. INCOME TAXES\nThe provision for income taxes for the years ended December 31, consists of the following (in millions):\nIncome before income taxes includes losses of foreign subsidiaries of $98, $172, and $170 million for 1995, 1994 and 1993, respectively.\nA reconciliation of the statutory federal income tax rate to the effective income tax rate for the years ended December 31, consists of the following:\nUNITED PARCEL SERVICE OF AMERICA, INC., AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years Ended December 31, 1995, 1994 and 1993\nDeferred tax liabilities and assets are comprised of the following at December 31 (in millions):\nThe valuation allowance increased approximately $60 and $64 million during the years ended December 31, 1995 and 1994, respectively.\nUPS has international loss carryforwards of approximately $704 million as of December 31, 1995. Of this amount, $401 million expires in varying amounts through 2003. The remaining $303 million may be carried forward indefinitely. These international loss carryforwards have been fully reserved in the deferred tax assets valuation allowance due to the uncertainty resulting from a lack of previous international taxable income. In addition, a portion of these losses have been deducted on the U.S. tax return, which could affect the amount of any future benefit.\nUNITED PARCEL SERVICE OF AMERICA, INC., AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years Ended December 31, 1995, 1994 and 1993\n8. DEFERRED TAXES, CREDITS AND OTHER LIABILITIES\nDeferred taxes, credits and other liabilities, as of December 31, consist of the following (in millions):\n9. OTHER OPERATING EXPENSES\nThe major components of other operating expenses for the years ended December 31, are as follows (in millions):\nUNITED PARCEL SERVICE OF AMERICA, INC., AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years Ended December 31, 1995, 1994 and 1993\n10. SEGMENT AND GEOGRAPHIC INFORMATION\nUPS operates primarily in one industry segment, transportation services, which is comprised principally of domestic and international package delivery. Information about operations in different geographic segments for the years ended December 31, is shown below (in millions):\nForeign operations include shipments which either originate in or are destined to foreign (non-U.S.) locations. Foreign revenues attributable to shipments which originated in the U.S. totaled $616, $496, and $391 million in 1995, 1994 and 1993, respectively.\n================================================================================\nSECURITIES AND EXCHANGE COMMISSION\nWashington, D.C. 20549\n-----------------------\nEXHIBITS\nTO\nFORM 10-K\nANNUAL REPORT\nFOR THE FISCAL YEAR ENDED DECEMBER 31, 1995\n-----------------------\nUNITED PARCEL SERVICE OF AMERICA, INC.\n================================================================================ EXHIBIT INDEX\nE-1\nE-2\nE-3\nE-4\nE-5\nE-6\nE-7\nE-8\nE-9\nE-10\nE-11\nE-12","section_15":""}
{"filename":"723594_1995.txt","cik":"723594","year":"1995","section_1":"ITEM 1. BUSINESS\nPOCAHONTAS BANKSHARES CORPORATION\nPocahontas Bankshares Corporation (\"Corporation\" or \"Registrant\") was organized under the laws of West Virginia in 1983 at the direction of the Board of Directors of The First National Bank of Bluefield (\"Bluefield\"). On March 1, 1984, the effective date of the corporate reorganization, the shareholders of Bluefield became the shareholders of the Corporation, and Bluefield became a wholly-owned subsidiary of the Corporation. On March 11, 1988, the Registrant acquired control of the Bank of Oceana, Oceana, WV (\"Oceana\"). On May 24, 1991, the Registrant formed First Century Bank, Roanoke, Virginia. During 1993, the main office of First Century Bank was redesignated to Wytheville, Virginia. Effective November 28, 1994, the merger of Bank of Oceana into The First National Bank of Bluefield was completed and the name of the resulting entity was changed to First Century Bank, National Association, with its main office in Bluefield, West Virginia. Substantially, all of the operations of the Corporation are carried on through its Bluefield subsidiary which serves as the Registrant's lead bank. The officers and directors of the Corporation, who are also officers and directors of the subsidiaries, receive their entire compensation from the subsidiaries. The Corporation's executive offices are located at 500 Federal Street, Bluefield, West Virginia.\nThe Registrant's principal business and major source of revenue is, and is expected to remain, commercial banking. The Registrant currently derives substantially all its revenues from dividends paid by the subsidiary banks. Dividend payments by these subsidiaries are influenced by the earnings, asset growth and current capital position of the individual subsidiary. In addition, various regulatory agencies control the payment of dividends. For additional information regarding the payment of dividends, see Note 11 of the Notes to the Consolidated Financial Statements in the Registrant's 1995 Annual Report to the Stockholders attached as Exhibit 13 to this report.\nFIRST CENTURY BANK, N.A.\nFirst Century Bank, N.A., a national banking association, was organized and chartered in 1891 as The First National Bank of Bluefield, under the laws of the State of West Virginia and the National Bank Act. Bluefield offers customary banking services, including commercial, real estate, installment, and other loans; interest-bearing and non-interest bearing transaction accounts, savings and time deposit accounts including certificates and other deposit accounts, featuring various maturities and market rates; Individual Retirement Accounts; Visa and MasterCard services under an arrangement with a correspondent bank; safe deposit facilities; personal and corporate trust services; and various cash management services. In addition to the main office, Bluefield currently operates five additional branches in Mercer and Wyoming counties in southern West Virginia.\nAs of December 31, 1995, Bluefield had 120 full-time employees and 9 part-time employees. Bluefield is not a party to any collective bargaining agreements, and, in the opinion of management, enjoys satisfactory re lations with its employees.\nFIRST CENTURY BANK\nFirst Century Bank, Wytheville, Virginia (\"Wytheville\"), is a state chartered bank organized under the laws of the Commonwealth of Virginia. Wytheville offers customary banking services, including commercial, real estate, installment, and other loans; interest-bearing and non-interest bearing transaction accounts, savings and time deposit accounts including certificates and other deposit accounts, featuring various maturities and market rates; Individual Retirement Accounts; Visa and MasterCard services under an arrangement with a correspondent bank; safe deposit facilities; personal and corporate trust services; and various cash management services. In addition to the main office, Wytheville currently operates one additional branch.\nAs of December 31, 1995, Wytheville had 14 full-time employees and 2 part-time employees. Wytheville is not a party to any collective bargaining agreements, and, in the opinion of management, enjoys satisfactory relations with its employees.\nCOMPETITION\nVigorous and intense competition exists in all areas where the Registrant and its subsidiaries are engaged in business, generally from other banks located in southern West Virginia and southwestern Virginia. However, this competition is not only limited to other commercial banks. The subsidiary banks also compete for certain lines of business with savings and loan associations, mortgage companies, credit unions, consumer finance companies, leasing companies, insurance companies, mutual funds and brokerage firms. Significant competition also exists from state-wide multi-bank holding companies located in West Virginia and Virginia, which have offices in the communities the Registrant serves. These institutions are larger in terms of capital, resources and personnel. This requires that the Registrant place a high emphasis on quality service, with a significant amount of personal attention, in order to effectively compete with these larger institutions. Management feels that this competition is likely to intensify in the future, as the so called \"super-regionals\" (such as NationsBank and Banc One) continue to enter the markets in which the Registrant currently operates.\nFUTURE ACQUISITIONS AND EXPANSION\nThe Registrant may from time to time consider expansion of its banking operations through acquisition of or formation of other banks and\/or bank related businesses.\nSUPERVISION AND REGULATION\nThe Corporation is under the jurisdiction of the United States Securities and Exchange Commission and the State of West Virginia's Secretary of State with respect to matters relating to the offer and sale of its securities and matters relating to reporting to such commissions and to its shareholders.\nThe Corporation is a registered holding company under the Bank Holding Company Act of 1956, as amended, and is regulated by the Federal Reserve. As a bank holding company, the Corporation is required to file with the Federal Reserve an Annual Report and such additional information as the Federal Reserve may require pursuant to the Bank Holding Company Act. The Federal Reserve may also conduct examinations of the Corporation and each subsidiary. The Bank Holding Company Act requires every bank holding company to obtain prior approval from the Federal Reserve before acquiring direct or indirect ownership or control of more than five percent of the voting shares of any bank which is not already majority owned or controlled by that bank holding company. The Federal Reserve is prohibited, however, from approving the acquisition by the Corporation of the voting shares of, or substantially all of the assets of, any bank located outside West Virginia, unless such acquisition is specifically authorized by the laws of the state in which the bank is located. Under West Virginia law, the Corporation is authorized to acquire ownership or control of additional banks in the state of West Virginia, provided, this does not result in control of more than twenty percent (20%) of the total deposits of all depository institutions in the state of West Virginia. Acquisition of such additional banks would require ap proval from the Federal Reserve and the Commissioner of Banking of the State of West Virginia.\nThe Bank Holding Company Act further provides that the Federal Reserve will not approve any acquisition, merger or consolidation (a) which would result in a monopoly, (b) which would be in furtherance of any combination or conspiracy to monopolize or attempt to monopolize the business of banking at any part of the United States, (c) the effect of which may be to substantially lessen competition or to tend to create a monopoly in any section of the country or (d) which in any other manner would be in restraint of trade, unless the anti-competitive effects of the proposed transaction are clearly outweighed by the public interest in the probable effect of the transaction meeting the convenience and needs of the community to be served.\nIn addition to having the right to acquire ownership and control of other banks, the Corporation is authorized to acquire ownership and control of non-banking companies, provided the activities of such companies are so closely related to banking or managing or controlling banks that the Federal Reserve considers such activities to be proper to the operation and control of banks. Regulation Y, promulgated by the Federal Reserve, sets forth those activities which are regarded as closely related to banking or managing or controlling banks and thus are permissible activities for bank holding companies, subject to the approval by the Federal Reserve in individual cases.\nSubsidiary banks of a bank holding company are subject to certain restrictions imposed by the Bank Holding Company Act on any extension of credit to the bank holding company or any of its subsidiaries, on investment in the stock or other securities thereof, and on the taking of such stock or securities for loans to any borrower. Further, under Section 106 of the 1970 amendments to the Bank Holding Company Act and the regulations of the Federal Reserve, a bank holding company through its banking subsidiaries is prohibited from engaging in certain tie-in arrangements in connection with any extension\nof credit or provision of any property or services. The Federal Reserve possesses cease and desist powers over bank holding companies and their non-bank subsidiaries if their actions are unsafe or unsound practices or violations of law.\nBluefield operates as a national banking association subject to examination by the Office of the Comptroller of the Currency (the \"Comptroller\"). The Comptroller regulates all areas of a national bank's operations, both commercial and trust, including loans, deposits, mergers, branches, interest rates, and payments of dividends.\nBluefield, by means of its national charter, is also a member of the Federal Reserve System, and as such, is affected by the monetary policies of the Federal Reserve System which regulates the national money supply in order to mitigate recessionary and inflationary pressures. The instruments of monetary policy employed by the Federal Reserve include open market operations in U. S. Government securities, changes in the reserve requirement for member banks, and changes in the discount rate for member bank borrowings.\nIn view of the changing conditions in the national economy and the money markets, as well as, the effect of actions by monetary and fiscal authorities, including the Federal Reserve, no prediction can be made as to possible future changes in interest rates, deposit levels, loan demand of the business and earnings of the Corporation or its subsidiaries.\nWytheville operates as an insured state non-member bank subject to examination by the Bureau of Financial Institutions of the State Corporation Commission of the Commonwealth of Virginia. The Bureau of Financial Institutions regulates all areas of a state bank's operation, both commercial and trust, including loans, deposits, mergers, branches, interest rates and payment of dividends.\nBoth of the subsidiary banks are also insured and regulated by the Federal Deposit Insurance Corporation (the \"FDIC\"). The major function of the FDIC with respect to insured member banks is to pay depositors to the extent provided by law in the event an insured bank is closed without adequately providing for payment of the claims of the depositors.\nSTATISTICAL DISCLOSURE\nThe statistical and other financial data disclosures required pursuant to Guide 3 of the Preparation and Filing of Reports and Registration Statements under the Securities Exchange Act of 1934 are contained within Management's Discussion and Analysis of Financial Condition and Results of Operations appearing on pages 3 through 15 of the accompanying 1995 Annual Report to Stockholders, incorporated herein by reference in this Form 10-K annual report as Exhibit 13.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe offices of the Registrant are located at 500 Federal Street, Bluefield, West Virginia. Principal properties owned or leased by the subsidiary banks consist of modern single purpose facilities that house all the amenities to comfortably conduct the full range of financial services provided by the Registrant and its subsidiaries.\nBluefield holds title to seven pieces of real estate, including the property and building at 500 Federal Street, the property and building at 516 Federal Street, formerly known as the \"Ammar Building.\" These two buildings, which are adjacent to each other, comprise a total of approximately 45,000 square feet of space. The third property is located at 501 Federal Street, which comprises approximately 4,300 square feet of interior space and approximately 10,200 square feet of real estate. The fourth property is located at 519 Federal Street, and consists of approximately 5,000 of interior space. These four properties accommodate the main offices of both Bluefield and the Registrant.\nBluefield also holds title to three pieces of real estate in Wyoming County, West Virginia. (1) The property and building that houses the office in Oceana, located on State Route 10, Cook Parkway, Oceana, West Virginia. This property consists of approximately 22,000 square feet, of which approximately 6,500 square feet is interior space. (2) The property and building that houses the Pineville office located on State Route 10, Pineville, West Virginia. This property consists of approximately 18,000 square feet, of which approximately 3,000 square feet is interior space. (3) Lots Number 22 and 23 Hedrick Addition which is currently used as an employee parking lot for the Oceana main office. This property consists of approximately 14,000 square feet, of which 5,500 square feet is paved.\nIn addition, Bluefield leases approximately 8,000 square feet at 200 Princeton Avenue, Bluefield, WV, in accordance with a renewable lease which provides for an annual rent of $5,000. Bluefield also leases ap proximately 21,750 square feet\nfeet of space at 2020 College Avenue, Bluefield, WV, under a renewable lease which currently requires a rental rate of $600 per month. Bluefield also leases approximately 27,225 square feet of space at 1215-A Stafford Drive, Princeton, WV. The current renewable lease provides for rent to be paid at the rate of $14,000 per year with adjustments allowed at the end of each five year period of the term. In addition, Bluefield also leases approximately 10,000 square feet at 525 Federal Street, Bluefield, WV, under a lease which has an annual rent of $19,200.\nWytheville holds title to two pieces of real estate. The property and building located at 200 Peppers Ferry Road in Wytheville, Virginia houses the main office and is comprised of approximately two acres of real estate and approximately 6,200 square feet of interior space. Wytheville also owns the property and building located on State Route 52 in Max Meadows, Virginia, which is comprised of approximately one acre of real estate and approximately 2,000 square feet of interior space and houses the Fort Chiswell branch.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nNeither the Registrant nor any of its subsidiaries are presently involved in any material legal proceedings other than ordinary routine litigation incidental to its business.\nAs a result of efforts to collect a delinquent loan, Bluefield filed suit in the Circuit Court of Mercer County, Civil Action 85-C-847-B, against Andrew L. Clark and William J. Sheppard involving their alleged failure to pay equity into a townhouse project which was the subject of a loan agreement with Mercer County, West Virginia, covering the issuance of an industrial revenue bond in the principal sum of $1,000,000. Still pending are certain counts of a counterclaim filed by Clark and Sheppard in relation to the underlying case which was decided in Bluefield's favor. Management and legal counsel feel strongly that the remaining counts of the counterclaim filed by Clark and Sheppard are without merit.\nAs a result of efforts to collect delinquent loans, Oceana filed suit in the Circuit Court of Wyoming County, Civil Action 90-C-152, against Michael C. Crouch, d\/b\/a K&M Auto Sales. Crouch has filed a counterclaim seeking $3,000,000 in damages against Oceana. The counterclaim purports fraudulent acts and other wrong-doings relative to the payment and collection of these loans. Management feels that this counterclaim is without merit and is vigorously contesting this action.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThere were no matters submitted to security holders for a vote during the fourth quarter ended December 31, 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nNo established public market presently exists for the common stock of the Registrant. Management does not expect that a more active trading market will develop in the near future for the common stock of the Registrant.\nPage 13 of the 1995 Annual Report to Stockholders (incorporated herein by reference) describes further the information for market, stockholders, and dividends. The payment of dividends is subject to the restrictions described in Note 11 of the Notes to Consolidated Financial Statements. The Board of Directors evaluates the dividend payment on the Registrant's common stock after the conclusion of each calendar quarter.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe selected financial data required by this item is set forth in Management's Discussion and Analysis of Financial Condition and Results of Operations on page 15 of the Registrant's 1995 Annual Report to Stockholders (Exhibit 13), 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 appearing on pages 3 through 15 of the accompanying 1995 Annual Report to Stockholders is incorporated by reference in this Form 10-K annual report as Exhibit 13. Management's discussion and analysis should be read in conjunction with the related financial statements and notes thereto.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe following financial statements, management report of financial responsibility, and report of independent accountants for the years ended December 31, 1995, 1994, and 1993, which are included in the Corporation's 1995 Annual Report to Stockholders (Exhibit 13), are incorporated herein by reference:\nThe report of independent accountants on page 35 of the Registrant's 1995 Annual Report to Stockholders reflects an unqualified opinion on the 1995 and 1994 consolidated statements of financial condition 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, 1995, issued by Coopers & Lybrand, Charlotte, North Carolina, the Registrant's independent accountant for those years.\nThe supplementary financial information required by this item is set forth in Note 14 of \"Notes to Consolidated Financial Statements\" on Page 32 of the Corporation's 1995 Annual Report to Stockholders (Exhibit 13), incorporated herein by reference.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThere have been no disagreements with the independent accountants on 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 concerning the directors and executive officers of the Registrant has been omitted in accordance with General Instruction G since Registrant has filed its definitive proxy statement with the Com mission on or about March 29, 1996 (which is not later than 120 days after December 31, 1995, the close of the fiscal year of Registrant): and such information is incorporated herein by reference to such proxy statement.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nManagement remuneration has been omitted in accordance with General Instruction G since Registrant has filed its definitive proxy statement with the Commission on or about March 29, 1996, (which is not later than 120 days after December 31, 1995, the close of the fiscal year of Registrant): and such information is incorporated herein by reference to such proxy statement.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nSecurity ownership of certain beneficial owners and management has been omitted in accordance with General Instruction G since Registrant has filed its definitive proxy statement with the Commission on or about March 29, 1996, (which is not later than 120 days after December 31, 1995, the close of the fiscal year of Registrant): and such information is incorporated herein by reference to such proxy statement.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nCertain relationships and related transactions has been omitted in accordance with General Instruction G since Registrant has filed its definitive proxy statement with the commission on or about March 29, 1996, (which is not later than 120 days after December 31, 1995, the close of the fiscal year of Registrant): and is incorporated herein by reference to such 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. See Item 8 on Page 6 of this document for a listing of all Financial Statements, Accountants' Report, and Supplementary Data.\n2. Financial Statement Schedules. All schedules are omitted, as the required information is inapplicable or the information is presented in the Consolidated Financial Statements or related notes.\n(b) Reports on Form 8-K. No Reports on Form 8-K were filed during the fourth quarter of 1995.\n(c) Exhibits\n3. Articles of incorporation and bylaws.\nArticles of amendment to articles of incorporation and restated articles of incorporation were filed with and are incorporated herein by reference to the 1994 Form 10-K. (Bylaws were previously filed in a Registration Statement on Form S-14, Registration No. 2-85126, and are incorporated herein by reference.)\n10. Material Contracts a. Sample agreement pertaining to a split-dollar life insurance arrangement between Bluefield and Messrs. Wilkinson, Satterfield, Kennett and Albert.\n11. Statement regarding computation of per share earnings. (These statements are included in the notes to the consolidated financial statements which are incorporated herein by reference.)\n13. Annual report to security holders.\n22. Subsidiaries of the registrant. (This disclosure is included in the notes to the consolidated financial statements which are incorporated herein by reference.)\n27. Financial Data Schedule\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\n(Registrant) Pocahontas Bankshares Corporation\nBY: \/s\/ J. Ronald Hypes ----------------------------------------- J. Ronald Hypes, Treasurer (Principal Accounting & Financial Officer)\nDATE: March 20, 1996 ------------------------------------------\nPursuant to the requirements of the Securities Exchange Act of 1934, 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\/ B. L. Jackson Date: March 12, 1996 ------------------------------- -------------- B. L. Jackson, Jr., Chairman of the Board and Director\nBY: \/s\/ R. W. Wilkinson Date: March 20, 1996 ------------------------------- -------------- R. W. Wilkinson, President & Chief Executive Officer & Director (Principal Executive Officer)\nBY: \/s\/ Charles A. Peters Date: March 19, 1996 ------------------------------- -------------- Charles A. Peters, Secretary and Director\nBY: Date: ------------------------------- -------------- Stelio J. Corte, Director\nBY: \/s\/ Eustace Frederick Date: March 19, 1996 ------------------------------- -------------- Eustace Frederick, Director\nBY: Date: ------------------------------- -------------- P. Stanley Hodges, C.P.A., Director\nBY: \/s\/ Robert M. Jones, Jr. Date: March 19, 1996 ------------------------------- -------------- Robert M. Jones, Jr., M.D., Director\nBY: Date: ------------------------------- -------------- Harold L. Miller, Jr., Director\nBY: Date: ------------------------------- -------------- C. E. Richner, Director\nBY: \/s\/ B. K. Satterfield Date: March 20, 1996 ------------------------------- -------------- Byron K. Satterfield, Director\nBY: Date: ------------------------------- -------------- John C. Shott, Director\nBY: \/s\/ Scott H. Shott Date: March 19, 1996 ------------------------------- -------------- Scott H. Shott, Director\nBY: \/s\/ Walter L. Sowers Date: March 19, 1996 ------------------------------- -------------- Walter L. Sowers, Director\nBY: \/s\/ J. Brookins Taylor Date: March 19, 1996 ------------------------------- -------------- J. Brookins Taylor, M. D., Director\nBY: \/s\/ James P. Thomas Date: March 19, 1996 ------------------------------- -------------- James P. Thomas, M. D., Director","section_15":""}
{"filename":"56701_1995.txt","cik":"56701","year":"1995","section_1":"Item 1. BUSINESS.\nAs used herein, the term \"Company\" means Koss Corporation and its consolidated subsidiaries, unless the context otherwise requires.\nThe Company operates in the audio\/video industry segment of the home entertainment industry through its design, manufacture and sale of stereo headphones, audio\/video loudspeakers, and related accessory products.\nThe Company's principal product is the design, manufacture, and sale of stereophones and related accessories. The percentage of total revenues related to the product line over the past three years was:\nThe Company's products are sold through audio specialty stores, catalog showrooms, regional department store chains, military exchanges and national retailers under the \"Koss\" name and dual label. The Company has more than 1,600 domestic dealers and its products are carried in more than 11,000 domestic retail outlets. International markets are served by a foreign sales subsidiary in Canada and a sales office in Switzerland which utilizes independent distributors in several foreign countries.\nManagement believes that it has sources of raw materials that are adequate for its needs.\nThe Company regularly applies for registration of its trademarks and has numerous patents. Certain of its trademarks are of material value and importance to the conduct of its business. Although the Company considers protection of its proprietary developments important, the Company's business is not, in the opinion of management, materially dependent upon any single patent.\nAlthough retail sales of consumer electronics are predictably higher during the holiday season, management of the Company is of the opinion that its business and industry segment are not seasonal as evidenced by the fact that 54% of sales occurred in the first six months of the fiscal year and 46% of sales occurred in the latter six months of the fiscal year.\nThe Company's working capital needs do not differ substantially from those of its competitors in the industry and generally reflect the need to carry significant amounts of inventory to meet delivery requirements of its customers. The Company provides extended payment terms for product sales to certain customers. Based on historical trends, management does not expect these practices to have any material effect on net sales or revenues. The Company's current backlog of orders is not material in relation to annual net sales.\nThe Company markets its products to approximately 2,000 customers worldwide. During 1995 the Company's sales to its largest single customer, Tandy Corporation, were 18% of total sales. Management believes that any loss of this customer's revenues would be partially offset by a corresponding decrease, on a percentage basis, in expenses thereby dampening the impact on the Company's operating income. Although perhaps initially material, management believes this impact would be offset in future years by expanded sales to both existing and new customers. The five largest customers of the Company accounted for approximately 33% of total sales in 1995.\nAlthough competition in the stereophone market has increased this past year, the Company has maintained its competitive position as a leading marketer and producer of high fidelity stereophones in the United States. In the stereophone market, the Company competes directly with approximately five major competitors, several of which are large and diversified and have greater total assets and resources than the Company.\nThe amount spent on engineering and research activities relating to the development of new products or the improvement of existing products was $306,000 during fiscal 1995 as compared with $310,000 during fiscal 1994 and $316,000 during fiscal 1993. These activities were conducted by both Company personnel and outside consultants. The Company relies upon its unique sound, quality workmanship, brand identification, engineering skills and customer service to maintain its competitive position.\nAs of June 30, 1995, the Company employed 148 people. The Company also utilizes temporary personnel to meet seasonal production demands.\nForeign Sales.\nThe Company services the Canadian market through its wholly-owned subsidiary Koss Ltd., a Canadian corporation. Other international markets are serviced through manufacturers representatives or independent distributors with product produced in the United States. In the opinion of management, the Company's competitive position and risks attendant to the conduct of its business in such markets are comparable to the domestic market. For further information, see Note 8 to consolidated financial statements accompanying this Form 10-K.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES.\nThe Company leases its main plant and offices in Milwaukee, Wisconsin from its Chairman, John C. Koss. On June 25, 1993, the lease was renewed for a period of ten years, and is being accounted for as an operating lease. The new lease extension increases the rent from $280,000 per year (plus Consumer Price Index increase in 1994) to a fixed rate of $350,000 per year for three years and $380,000 for the seven years thereafter. The lease is on terms no less favorable to the Company than those that could be obtained from an independent party. The Company is responsible for all property maintenance, insurance, taxes and other normal expenses related to ownership. The Company leases approximately 6,500 square feet of office, service and warehouse space in Canada.\nAll facilities are in good repair and, in the opinion of management, are suitable for the Company's purposes.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS.\nNeither Koss nor its subsidiaries are subject to any material legal proceedings.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNo matters were submitted to a vote of stockholders during the fourth quarter of the fiscal year ended June 30, 1995.\nPART II\nItem 5.","section_5":"Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nMARKET INFORMATION ON COMMON STOCK\nThe Company's common stock is traded on The Nasdaq Stock Market under the trading symbol \"KOSS\". There were approximately 1,240 holders of the Company's common stock as of September 15, 1995. The Company's previous lending agreement prohibited the payment of cash dividends on the common stock. No cash dividends have been paid for the years ended June 30, 1995, 1994, and 1993. (See note 2 to the financial statements accompanying this report.) The quarterly high and low sale prices of the Company's common stock for the last two fiscal years are shown below.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA.\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nFINANCIAL CONDITION AND LIQUIDITY\nDuring 1995, cash provided by operations was $1,751,464. Working capital was $15,462,600 at June 30, 1995. The increase of $964,954 from the balance at June 30, 1994 represents primarily the net effect of an increase of $1,558,596 in inventory, an increase of $132,521 in prepaid expenses, an increase of $160,181 in other assets, an increase in accounts payable of $460,158, an increase in accrued liabilities of $196,584 and a decrease of $154,040 in accounts receivable. The increase in inventory is primarily due to an unexpected decline in computer speaker sales. Volume is expected to be sufficient in fiscal year 1996 to profitably decrease the current level of computer speakers.\nCapital expenditures for new property and equipment including production tooling were $806,551, $370,839, and $699,235 in 1995, 1994, and 1993, respectively. Depreciation charges aggregated $691,492, $638,125, and $728,156 for the same fiscal years. Budgeted capital expenditures for fiscal year 1996 are $1,600,000. The Company expects to generate sufficient funds through operations to fulfill these expenditures.\nStockholders' investment increased to $15,341,426 at June 30, 1995 from $12,658,628 at June 30, 1994. The increase reflects primarily net income and the exercise of stock options for the year. No cash dividends have been paid since the first quarter of fiscal 1984.\nThe Company has an unsecured working capital credit facility with a bank which runs through March 15, 1997. This credit facility provides for borrowings up to a maximum of $8 million. Borrowings under this credit facility bear interest at the bank's prime rate or LIBOR plus 2.25%. This credit facility includes certain covenants that require the Company to maintain a minimum tangible net worth and specified current, interest coverage and leverage ratios. Utilization of this credit facility as of June 30, 1995 totaled $682,808, consisting of $570,000 in borrowings and $112,808 in commitments for foreign letters of credit. In addition, the Company recently negotiated a $2 million credit facility which can be used by the Company in the event the Company desires to purchase shares of its own stock. In April, 1995 the Board of Directors authorized the Company's purchase from time to time of its Common Stock utilizing the aforementioned $2 million line of credit. If the Company decides to make any such purchases, it may do so from time to time as conditions warrant either in open-market transactions or privately-negotiated purchases.\nThe Company's Canadian subsidiary has a line of credit of $550,000. Borrowings under this credit facility bear interest at the bank's prime rate plus 1.25%. This credit facility is subject to the availability of qualifying receivables and inventories which serve as security for the borrowings. As of June 30, 1995, $550,000 was available, of which none was being utilized. The due date for the line is October 31, 1995 and the Company expects the line will be renewed on substantially the same terms.\n1995 RESULTS COMPARED WITH 1994\nNet sales for 1995 were $33,432,344 compared with $35,561,322 in 1994, a decrease of $2,128,978 or 6%. This decrease was the result of a decline in computer speaker sales as compared to the previous year and an increase in sales returns by dealers for repairs and credit. Sources indicate that credit returns were common throughout the retail industry and not limited to the Company.\nGross profit was $10,622,307 or 31.8% in 1995 compared with $11,874,351 or 33.4% in 1994. The decrease relates to higher than expected labor costs related to newer customized items and a less profitable mix of products in the last two quarters of the fiscal year.\nSelling, general and administrative expenses increased from $8,191,504 in 1994 to $8,376,204 in 1995. This increase is mainly attributed to higher professional fees including the cost related to maintaining the company's worldwide patents and trademarks.\nIncome from operations was $2,246,103 in 1995 compared with $3,682,847 in 1994, a decrease of 39%. Interest expense for 1995 was $317,922 compared with $246,911 in 1994. The increase is primarily due to increased levels of borrowings during the fiscal year.\nThe Company has a license agreement with Trabelco N.V., a subsidiary of Hagemeyer, N.V. Hagemeyer, N.V., a diverse international trading company based in the Netherlands, has business interests in food, appliances, electromechanical and automobile distribution as well as a solid base of consumer electronic distribution business in Asia, Europe and North America. Royalty income earned in connection with the license agreement in 1995 was $1,412,723 as compared to $1,108,458 in 1994. This increase in royalty income is a result of Trabelco N.V. experiencing higher sales volumes on products under the license agreement. The license agreement expires December 31, 1997, however, can be renewed for additional three year periods at the option of Trabelco N.V.\n1994 RESULTS COMPARED WITH 1993\nNet sales for 1994 were $35,561,322 compared with $32,137,448 in 1993, an increase of $3,423,874 or 11%. This increase was the result of higher sales of current products as well as the introduction of new products.\nGross profit was $11,874,351 or 33.4% of net sales in 1994 compared with $11,351,328 or 35.3% in 1993. Increased customer demand during this fiscal year for some product lines resulted in the company spending more on air freight than anticipated. This in turn directly affected the decrease in gross profit for the year.\nSelling, general and administrative expenses increased from $7,177,946 in 1993 to $8,191,504 in 1994. This increase is directly attributed to higher promotional activities related to new products and trade show activities in the computer market.\nIncome from operations was $3,682,847 in 1994 compared with $4,173,382 in 1993, a decrease of 12%. Interest expense for 1994 was $246,911 compared with $312,501 in 1993. The decrease is due to lower levels of borrowing throughout the fiscal year.\nThe Company has a license agreement with Trabelco N.V., a subsidiary of Hagemeyer, N.V. Hagemeyer N.V., a diverse international trading company based in the Netherlands, has business interests in food, appliances, electromechanical and automobile distribution as well as a solid base of consumer electronic distribution business in Asia, Europe and North America. Royalty income earned in connection with the license agreement in 1994 was $1,108,458 as compared to $610,795 in 1993. This increase in royalty income is a result of Trabelco N.V. experiencing higher sales volumes on products under the license agreement.\nMANAGEMENT'S REPORT\nThe consolidated financial statements and related financial information included in this report are the responsibility of management as to preparation, presentation and reliability. Management believes that the financial statements have been prepared in conformity with generally accepted accounting principles appropriate in the circumstances and necessarily include amounts that are based on best estimates and judgments.\nThe Company maintains a system of internal accounting controls to provide reasonable assurance that assets are safeguarded and that the books and records reflect the authorized transactions of the Company.\nThe Board of Directors, acting through the Audit Committee, is responsible for the selection and appointment of the independent auditors and reviews the scope of their audit and the findings. The independent auditors have direct access to the Audit Committee, with or without the presence of management representatives, to discuss the scope and the results of their audit work. The Audit Committee is comprised solely of non-employee directors.\nThe independent auditors provide an objective assessment of the degree to which management meets its responsibility for fairness of financial reporting. They evaluate the system of internal accounting controls in connection with their audit and perform such tests and procedures as they deem necessary to reach and express an opinion on the fairness of the financial statements.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nConsolidated financial statements of the Company at June 30, 1995 and 1994 and for each of the three years in the period ended June 30, 1995 and the notes thereto, and the report of independent accountants thereon are set forth on pages 14 to 25.\nSelected unaudited quarterly financial data is as follows:\nItem 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH AUDITORS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNone.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nInformation relating to the directors of Koss Corporation is incorporated herein by reference from the \"ELECTION OF DIRECTORS -- Information As To Nominees\" section of the Koss Corporation Proxy Statement for its 1995 Annual Meeting of Stockholders (the \"1995 Proxy Statement\"), which 1995 Proxy Statement is to be filed within 120 days of the end of the fiscal year covered by this Report pursuant to General Instruction G(3) of Form 10-K.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION.\nInformation relating to executive compensation is incorporated herein by reference from the \"ELECTION OF DIRECTORS -- Executive Compensation And Related Matters\" section of the 1995 Proxy Statement.\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 incorporated herein by reference from the \"ELECTION OF DIRECTORS - -- Information As To Nominees\" and \"ELECTION OF DIRECTORS -- Beneficial Ownership Of Company Securities\" sections of the 1995 Proxy Statement.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nInformation relating to related transactions is incorporated herein by reference from the \"ELECTION OF DIRECTORS -- Executive Compensation And Related Matters\" and \"ELECTION OF DIRECTORS -- Related Transactions\" sections of the 1995 Proxy Statement.\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:\n1. Financial Statements The following consolidated financial statements of Koss Corporation are set forth on pages 14 to 25:\n2. Financial Statement Schedules All schedules have been omitted because the information is not applicable or is not material or because the information required is included in the financial statements or the notes thereto.\n3. Exhibits Filed\n3.5 Articles of Koss Corporation, as amended and in effect on February 6, 1987.\n3.7 By-Laws of Koss Corporation, as amended and in effect on February 6, 1987.\n4.1 Articles of Incorporation of Koss Corporation. (see Exhibit 3.5)\n4.2 By-Laws of Koss Corporation. (see Exhibit 3.7)\n10.1 Officer Loan Policy.\n10.2 Directors' Stock Purchase Plan.\n10.3 Supplemental Medical Care Reimbursement Plan.\n10.4 Death Benefit Agreement with John C. Koss.\n10.5 Stock Repurchase Agreement with John C. Koss.\n10.6 Salary Continuation Resolution for John C. Koss.\n10.7 1983 Incentive Stock Option Plan.\n10.8 Assignment of Lease to John C. Koss.\n10.9 Addendum to Lease.\n10.10 1990 Flexible Incentive Stock Plan.\n10.12 Loan Agreement, effective as of February 17, 1995.\n10.13 Amendment dated June 15, 1995 to Loan Agreement effective as of February 17, 1995.\n22. List of Subsidiaries of Koss Corporation.\n27. Financial Data Schedule.\nb. No reports on Form 8-K were filed by the Company during the last quarter of the period covered by this report.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTO THE BOARD OF DIRECTORS AND STOCKHOLDERS OF KOSS CORPORATION\nIn our opinion, the consolidated financial statements listed in the index appearing under Item 14(a)(1) on page 12 present fairly, in all material respects, the financial position of Koss Corporation and its subsidiaries at June 30, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 1995, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.\nPRICE WATERHOUSE LLP Milwaukee, Wisconsin July 20, 1995\nCONSOLIDATED STATEMENTS OF INCOME\nSee accompanying notes.\nCONSOLIDATED BALANCE SHEETS\nSee accompanying notes.\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nSee accompanying notes.\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' INVESTMENT\nSee accompanying notes.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. ACCOUNTING POLICIES\nCONCENTRATION OF CREDIT RISK--The Company operates in the audio\/video industry segment of the home entertainment industry through its design, manufacture and sale of stereo headphones, audio\/video loudspeakers and related accessory products. The Company's products are sold through audio specialty stores, catalog showrooms, regional department store chains, military exchanges and national retailers under the \"Koss\" name and dual label. The Company has more than 1,600 domestic dealers and its products are carried in more than 11,000 domestic retail outlets. International markets are served by a foreign sales subsidiary in Canada and a sales office in Switzerland, which utilizes independent distributors in several foreign countries. The Company grants credit to its domestic and Canadian customers. Collection is dependent on the retailing industry economy. International customers outside of Canada are sold on a cash against documents or letter of credit basis. Approximately 25% and 23% of the Company's accounts receivable at June 30, 1995 and 1994, respectively, were foreign receivables.\nBASIS 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.\nROYALTY INCOME--The Company recognizes royalty income when earned under terms of a license agreement. The agreement expires December 31, 1997, however, contains renewal options for additional three year periods.\nINVENTORIES--At June 30, 1995 and 1994, approximately 88% and 80%, respectively, of the Company's inventories were 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. If the FIFO method of inventory accounting had been used by the Company for inventories valued at LIFO, inventories would have been $685,679, and $578,314 higher than reported at June 30, 1995 and 1994, respectively.\nThe components of inventories at June 30, is as follows:\nPROPERTY AND EQUIPMENT--Depreciation is provided on a straight-line basis over the estimated useful life of the asset as follows:\nLeasehold Improvements 15 years Machinery, Equipment, Furniture and Fixtures 3-10 years Tools, Dies, Molds and Patterns 4-5 years\nRESEARCH AND DEVELOPMENT--Research and development expenditures charged to operations amounted to approximately $306,000 in 1995, $310,000 in 1994 and $316,000 in 1993.\nEARNINGS PER SHARE--Earnings per share are computed based on the average number of common and common share equivalents outstanding. When dilutive, stock options are included as share equivalents using the Treasury stock method.\nRECLASSIFICATION--Certain reclassifications have been made to the 1994 financial statements to conform with current presentation, including the reclassification of $1,490,000 from Stockholders' Investment to Contingently Redeemable Equity Interest in the June 30, 1995 and 1994 balance sheets. The amount reclassified reflects the estimated net obligation in the event of execution of the stock repurchase agreement between the Company and its Chairman (see Note 3).\n2. NOTES PAYABLE AND LONG TERM DEBT\nThe Company has an unsecured credit facility with a bank providing up to a maximum of $8 million through March 15, 1997. Borrowings under the credit facility bear interest at the bank's prime rate or LIBOR plus 2.25%. Interest is payable monthly. The credit facility includes certain covenants that require the Company to maintain a minimum tangible net worth and specified current, interest coverage and leverage ratios. Utilization of the available line as of June 30, 1995 totaled $682,808, consisting of $570,000 in borrowings and $112,808 in commitments for foreign letters of credit. Subsequent to June 30, 1995, the credit facility was amended to provide an additional $2 million of available borrowings. Terms of the credit facility were not amended.\nThe Company's Canadian subsidiary has a line of credit of $550,000. The due date for the loan is October 31, 1995 and it is renewable annually. The interest rate is the prime rate plus one and one half percent. The credit facility is subject to the availability of qualifying receivables and inventories which serve as security for the borrowings. Loan advances against the line were $0 at June 30, 1995 and 1994.\nLong term debt at June 30, 1995 and 1994 is as follows:\nMaturities of long term debt in subsequent fiscal years are as follows: 1997 - $570,000.\n3. STOCK OPTIONS AND STOCK PURCHASE AGREEMENTS\nAs of June 30, 1995, there were stock options outstanding granted pursuant to the Company's 1983 Incentive Stock Option Plan (the \"1983 Plan\"). The 1983 Plan provides for the granting of options to certain officers and key employees to purchase up to 200,000 shares of the Company's common stock at a price not less than the market value of the stock on the date of grant. The options are exercisable at varying times and expire no later than ten years after the date of grant. All of the authorized shares available for grant pursuant to the 1983 Plan have been granted.\nIn 1990, pursuant to the recommendation of the Board of Directors, the stockholders ratified the creation of the Company's 1990 Flexible Incentive Stock Plan (the \"1990 Plan\"). The 1990 Plan is administered by a committee of the Board of Directors and provides for the granting of various stock-based awards including stock options to eligible participants, primarily officers and certain key employees. A total of 225,000 shares of common stock were available in the first year of the Plan's existence. Each year thereafter additional shares equal to .25% of the shares outstanding as of the first day of the applicable fiscal year were reserved for issuance pursuant to the 1990 Plan. On July 22, 1992, the Board of Directors authorized the reservation of an additional 250,000 shares to the 1990 Plan, which was approved by the stockholders.\nOn April 3, 1995 and May 19, 1993, the Board of Directors authorized the grant of 52,500 and 375,000 incentive stock options, respectively, under the 1990 Plan.\nOn April 12, 1995, the Company's Chairman exercised an option for the purchase of 250,000 shares of the Company's common stock at a price of $1.00 per share.\nThe following table identifies options granted, exercised, cancelled or available for exercise pursuant to the above mentioned Plans:\nThe Company has an agreement with its Chairman to repurchase stock from his estate in the event of his death. The repurchase price is 95% of the fair market value of the common stock on the date that notice to repurchase is provided to the Company. The total number of shares to be repurchased shall be sufficient to provide proceeds which are the lesser of $2,500,000 or the amount of estate taxes and administrative expenses incurred by his estate. The Company is obligated to pay in cash 25% of the total amount due and to execute a promissory note at a prime rate of interest for the balance. The Company maintains a $1,150,000 life insurance policy to fund a substantial portion of this obligation.\n4. INCOME TAXES\nEffective July 1, 1993, the Company adopted Statement of Financial Accounting Standard (\"SFAS\") No. 109, \"Accounting for Income Taxes.\" SFAS No. 109 requires the use of the liability method of accounting for income taxes. The liability method measures the expected tax impact of future taxable income and deductions implicit in the consolidated balance sheet. The adoption of this statement did not have a significant effect on the Company's financial position or results of operations.\nThe Company provision for income taxes in 1995, 1994, and 1993 consists of the following:\nThe 1995, 1994 and 1993 tax provision results in an effective rate different than the federal statutory rate due to the following:\nIncome (loss) before taxes for United States operations was $4,042,437 in 1995, $4,700,339 in 1994, and $4,366,374 in 1993. Such amounts for foreign operations were $(603,443), $(99,484), and $149,385 for the respective years.\nTemporary differences which give rise to deferred tax assets and liabilities at June 30 include:\nThe net deferred tax asset at June 30, 1995 is comprised of a current asset, prepaid income taxes of $378,946 and a long term liability, deferred income taxes of $6,862. The net deferred tax asset at June 30, 1994 is comprised of a current asset, prepaid income taxes of $268,486 and a long term liability, deferred income taxes of $87,202.\n5. ACCRUED LIABILITIES\nAccrued liabilities at June 30 consist of the following:\n6. ADDITIONAL CASH FLOW INFORMATION\nThe net changes in cash as a result of changes in operating assets and liabilities, other than cash and indebtedness, consist of the following:\n7. EMPLOYEE BENEFIT PLANS\nSubstantially all domestic employees are participants in the Company's Employee Stock Ownership Plan and Trust (KESOT) under which an annual contribution in either cash or common stock may be made at the discretion of the Board of Directors. The expense recorded for such contributions amounted to $205,000 in 1995 and $0 in 1994 and 1993.\nThe Company maintains a retirement savings plan under Section 401(k) of the Internal Revenue Code. This plan covers all employees of the Company who have completed six months of service. Matching contributions can be made at the discretion of the Company's Board of Directors. For calendar years 1995, 1994, and 1993, the matching contribution was 100% of employee contributions to the plan, not to exceed 10% of the employee's annual compensation. Vesting of Company contributions occurs immediately. Contributions for the years ended June 30, 1995, 1994, and 1993 were $144,000, $141,700, and $120,501, respectively.\n8. INDUSTRY SEGMENT INFORMATION, FOREIGN OPERATIONS AND SIGNIFICANT CUSTOMERS\nThe Company has one line of business--the design, manufacture and sale of stereophones and related accessories. The table below summarizes certain information regarding the Company's United States and Canadian operations for the years ended June 30, 1995, 1994, and 1993.\nThe Company ships directly to independent distributors from its domestic plant. The Company's export sales to customers in foreign countries amounted to $2,231,509 during 1995, $1,951,212 during 1994, and $1,675,517 during 1993.\nSales to one customer, Tandy Corporation, were approximately 18%, 16%, and 16% of total sales for 1995, 1994, and 1993, respectively.\n9. COMMITMENTS AND CONTINGENCIES\nThe Company leases its main plant and offices in Milwaukee, Wisconsin from its Chairman, John C. Koss. On June 25, 1993, the lease was renewed for a period of ten years, and is being accounted for as an operating lease. The new lease extension increases the rent from $280,000 per year (plus Consumer Price Index increase in 1994) to a fixed rate of $350,000 per year for three years and $380,000 for the seven years thereafter. The lease is on terms no less favorable to the Company than those that could be obtained from an independent party. The Company is responsible for all property maintenance, insurance, taxes and other normal expenses related to ownership. The Company also leases approximately 6,500 square feet of office, service and warehouse space in Canada of which a significant portion is subleased to a third party. In addition, the Company leases certain property which requires payments of $84,000 in 1996.\nIn 1980, the Company entered into an agreement with John C. Koss that if he dies prior to attaining 70 years of age, the Company will pay to his spouse or other designated beneficiary the sum of $50,000 every six months until the total benefits paid equal $700,000. The agreement is null and void if he reaches age 70.\nIn 1991, the Board of Directors agreed to continue John C. Koss' current base salary in the event he becomes disabled prior to age 70. After age 70, Mr. Koss shall receive his current base salary for the remainder of his life, whether he becomes disabled or not. The Company is currently recognizing an annual expense of $115,080 in connection with this agreement, which represents the present value of the anticipated future payments. At June 30, 1995 and 1994, respectively, the related liabilities in the amounts of $421,140 and $306,060 have been included in deferred compensation in the accompanying balance sheets.\n10. SUPPLEMENTARY INFORMATION\nChanges in the allowance for doubtful accounts for the years ended June 30, 1995, 1994, and 1993 are summarized as follows:\n*Represents charges against the allowance, net of recoveries.\nThe amounts included for advertising in selling, general and administrative expenses on the accompanying statements of income were $630,181 in 1995, $756,956 in 1994, and $503,285 in 1993.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nKOSS CORPORATION\nBy: \/s\/ Michael J. Koss Dated: 9\/25\/95 --------------------------- ------- Michael J. Koss, President, Chief Executive Officer Chief Operating Officer and Chief Financial Officer\nBy: \/s\/ Sujata Sachdeva Dated: 9\/25\/95 --------------------------- ------- Sujata Sachdeva, Vice President - Finance 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:\n\/s\/ Michael J. Koss ------------------------- --------------------------- John C. Koss, Director Michael J. Koss, Director Dated: Dated: 9\/25\/95 ------- -------\n\/s\/ Martin F. Stein \/s\/ Victor L. Hunter ------------------------- --------------------------- Martin F. Stein, Director Victor L. Hunter, Director Dated: 9\/25\/95 Dated: 9\/25\/95 ------- -------\n\/s\/ John J. Stollenwerk \/s\/ Lawrence S. Mattson ------------------------- --------------------------- John J. Stollenwerk, Director Lawrence S. Mattson, Director Dated: 9\/25\/95 Dated: 9\/25\/95 ------- -------\n------------------------- Thomas L. Doerr, Director Dated: -------\nThe signatures of the above directors constitute a majority of the Board of Directors of Koss Corporation.\nOFFICERS AND DIRECTORS SENIOR MANAGEMENT\nJohn C. Koss John C. Koss Chairman of the Board Chairman of the Board Koss Corporation Michael J. Koss President Thomas L. Doerr Chief Executive Officer President Chief Operating Officer Doerr Corporation Chief Financial Officer Victor L. Hunter John C. Koss, Jr. President Vice President--Sales Hunter Business Direct\nDaniel Esposito Michael J. Koss Vice President--Corporate Systems President, C.E.O., C.O.O., C.F.O. Sujata Sachdeva Vice President--Finance Lawrence S. Mattson Retired President Richard W. Silverthorn Oster Company Secretary General Counsel Martin F. Stein Chairman Declan Hanley Eyecare One Inc. Vice President--International Sales John J. Stollenwerk President ANNUAL MEETING Allen-Edmonds Shoe Corporation\nOctober 19, 1995 Performance Center Koss Corporation 4129 N. Port Washington Avenue Milwaukee, WI 53212\nTRANSFER AGENT INDEPENDENT ACCOUNTANTS\nQuestions regarding change of address, Price Waterhouse LLP stock transfer, lost certificate, or Milwaukee, Wisconsin information on a particular account should be directed in writing to: LEGAL COUNSEL Firstar Trust Company Box 2077 Whyte Hirschboeck Dudek S.C. Milwaukee, WI 53201 Attn: Mr. Eugene R. Lee\nEXHIBIT INDEX\n(1) Incorporated by reference from Form 10-K for year ended June 30, 1986.\n(2) Incorporated by reference from Exhibits 3.1 - 3.7 of Form 10-K for year ended June 30, 1989.\n(3) Incorporated by reference from Form 10-K for year ended June 30, 1988.\n(4) Incorporated by reference from Form 10-K for year ended June 30, 1990.\n(5) Incorporated by reference from Form 10-Q for quarter ended March 31, 1995.","section_15":""}
{"filename":"95504_1995.txt","cik":"95504","year":"1995","section_1":"ITEM 1. BUSINESS.\nGeneral Development of Business _______________________________\nSuper Food Services, Inc., was incorporated on April 29, 1957, under the laws of the State of Delaware. Super Food Services, Inc., and its principal subsidiary, Kentucky Food Stores, Inc., d\/b\/a Affiliated Foods, a Kentucky corporation, (hereinafter sometimes collectively referred to as the \"Company\" or the \"Registrant\") are engaged in the wholesale grocery distribution business. The Company holds IGA (Independent Grocers' Alliance Distributing Company) franchises for each of its warehouse locations except for Lexington, Kentucky. IGA is an alliance of 20 wholesale grocers whose almost 4,000 associated IGA retail food stores located principally in the United States did an annual retail volume of approximately $16.5 billion in the year ended December 31, 1994.\nFinancial Information About Industry Segments _____________________________________________\nThe Company is engaged in a single line of business, the wholesale grocery distribution business.\nDescription of Business _______________________\nThe Company distributes a wide variety of food products, health and beauty aids, general merchandise and related non-food items to approximately 270 independently owned IGA retail food stores and to approximately 580 other retail food stores, including independently owned stores not licensed as IGA stores, several major chains and convenience stores, located primarily in the states of Michigan, Ohio, Indiana, Kentucky, Tennessee and West Virginia. In addition, the Company also provides merchandising, advertising, sales promotion and administrative programs and supervision for the retail stores that desire to utilize these services.\nThe Company does not engage in the retail food store business to any significant extent. Incidental to its primary wholesale grocery function, the Company may from time to time own and operate retail food stores which provide training for the Company's personnel in retail grocery operations or the Company may take over supermarkets formerly operated by its affiliated retailers.\nThe Company also operates a print shop which prints some of the advertising materials, catalogs and other material used by the Company and its independent retail food store customers.\nThe business of the Company is not seasonal to any significant extent.\nDistribution and Cost of Services _________________________________\nThe Company distributes and sells goods and merchandise to retail food stores principally from the five distribution centers consisting of three in Ohio, one in Michigan and one in Kentucky. All of the Company's warehouses are equipped with modern inventory handling equipment for receiving, storing and shipping goods and merchandise. Each warehouse serves as a central source of supply for affiliated retailers within its operating area by handling a full line of products ranging from 10,000 to 15,000 items. Complete inventories are maintained consisting of national brand grocery products along with a number of private label items. In addition, most centers provide full lines of perishables including fresh meats and poultry, dairy and delicatessen products, and frozen foods. Retailers order their inventory requirements at regular intervals through direct linkage with the distribution center computer. Immediate product availability and efficient warehousing methods often make it possible for orders to be selected, loaded and shipped within 24 hours of receipt of the order. In addition, some products are delivered by suppliers directly to the retail stores through drop-ship programs established between suppliers and the Company. Deliveries are made by the Company's delivery fleet on a daily, semi-weekly or weekly basis as orders are received. The Company operates approximately 140 tractors, 195 refrigerated trailers and 205 dry trailers. Most of this equipment is owned by the Company.\nThe Company sells goods and merchandise to retail stores on a cost-plus-fee basis, with a weekly fee based on the type of commodity and quantity purchased. Selling prices are changed daily based on the latest cost information. In some geographic areas, delivery costs are also charged based on mileage and the quantity of goods purchased. Credit is extended generally on a weekly basis.\nService to Retailers ____________________\nIn general, the operations of the Company include (1) the procurement and arrangement for the procurement of food products and other allied items generally sold in retail food stores, (2) the development and administration of promotional, advertising and merchandising programs, (3) the establishment and supervision of retail accounting and payroll systems, (4) the installation of computerized inventory control and ordering systems, (5) store development services, (6) personnel management assistance and employee training and (7) insurance programs. The Company has a staff of retail management specialists who counsel with each store periodically with regard to store operations. The cost of many of these services is included in the fees charged by the Company in connection with the sale of goods and merchandise to the retail stores served. Separate charges are made for certain services such as retail accounting, insurance, employee training and certain store development services.\nThe activities of the store development departments in each operating division provide a means of continued growth for the Company through the development of new retail store locations and the enlargement and remodeling of existing retail stores. The services provided include site selection, market studies, building design, store layout and equipment planning and procurement.\nThe Company also may provide financial assistance to its affiliated independent retailers. Secured loans, generally repayable over a period not exceeding five years, are made for inventories and store fixtures, equipment, and leasehold improvements. Loans are secured by liens on inventory and\/or equipment, by personal guarantees and by other types of security. The Company lends its credit strength by guaranteeing leases for its retail customers or by entering into leases for retail store locations and subleasing the same to affiliated independent retailers at rentals which generally are five to ten percent higher than the rent paid by the Company. As of August 26, 1995, the Company was obligated on a total of 77 leases which are subleased to affiliated independent retailers. As of August 26, 1995, Kentucky Food Stores, Inc., has guaranteed the payment of leases for certain retail customers with future minimum rentals aggregating approximately $4,636,000.\nProducts Supplied _________________\nThe Company primarily distributes and sells nationally advertised brand products purchased directly from various manufacturers, processors and suppliers or through manufacturers' representatives and brokers. Many of the major suppliers of the Company are large publicly-held companies. Adequate alternative sources of supply are available in most cases. The Company also distributes and sells IGA, BETTER VALU and SAVER'S CHOICE brand products and various products using the Company's own registered trademarks FAME, TABLE TREAT, TABLE KING, KINGSAVER and GARD. A wide variety of canned fruits and vegetables, frozen foods, paper products and other packaged products are sold under these labels. Private brand products are purchased from selected canners, packers and processors who apply the Company's private label brands. The FAME line of private label products now includes approximately 1,640 items. Approximately 12% of the total sales of the Company for the fiscal year ended August 26, 1995 were from the Company's own private label brand products and IGA and BETTER VALU brand products.\nRetail Stores Served ____________________\nThe retail food stores served by the Company are mostly conventional self-service supermarkets which carry a wide variety of grocery products, health and beauty aids, general merchandise and other non-food items. Many stores also have one or more specialty departments such as delicatessens, in-store bakeries, lunch counters and flower shops. The stores served by the Company range in size from the small convenience stores to large supermarkets containing 35,000 or more square feet.\nFranchises __________\nUnder the IGA franchises held by the Company, independently owned retail food stores are licensed by the Company to operate under the IGA merchandising, advertising and promotional programs, to use the name IGA in connection with the retail food stores, and to sell IGA merchandise. For these franchises and the merchandising, advertising, sales promotion programs, systems and consultation, the Company pays IGA a monthly membership fee based on the number of affiliated IGA retail stores. The Company in turn receives a fee for similar services from each affiliated IGA retail store it licenses. The IGA stores are privately owned and are otherwise operated independently of IGA and the Company. The franchises which the Company holds from IGA may be terminated by the Company at any time but may be terminated by IGA only if the Company (a) ceases to operate a wholesale grocery business, (b) fails to fulfill its obligations under the franchise, or (c) becomes bankrupt, insolvent or goes into receivership. The licenses granted by the Company to affiliated IGA retail stores may be terminated by either party at any time upon thirty days prior written notice.\nThe Company also licenses independent retailers to do business under the trade names SUPERAMA, SHOPWISE, KING$AVER and $UPER $AVER($).\nCompetition ___________\nThe wholesale food distribution business is highly competitive. The Company is in competition with independent, voluntary and cooperative wholesale grocery businesses in all of the areas in which it operates. In addition, the retail food stores serviced by the Company are in competition with national, regional and local corporate food chains, voluntary cooperative food stores and independent food stores. On the basis of current sales volume, the Company is one of the largest wholesale grocery companies in the United States.\nEmployee Relations and Benefits _______________________________\nThe Company and its subsidiaries currently employ about 1,670 full time employees. Of these, approximately 1,015 are warehouse employees, drivers, and certain other personnel who are members of various labor unions, principally various locals of the International Brotherhood of Teamsters, Chauffeurs, Warehousemen and Helpers of America, under collective bargaining contracts expiring on various dates. During the fiscal year ended August 26, 1995, four contracts covering 465 employees were settled. One contract expired in 1993 which is still being negotiated. During the current fiscal year ending August 31, 1996, two contracts covering approximately 320 employees will expire. The labor relations of the Company are currently considered satisfactory and the Company has experienced no work stoppages since the beginning of last fiscal year.\nMiscellaneous _____________\nThe Company is a substantial user of fuel and energy in its operations. In the last fiscal year, fuel and energy costs generally increased resulting in higher operating costs; however, the supply of fuel and energy was adequate. The Company is unable to predict what effect future cost increases or shortages of fuel and energy would have on its operations.\nThe Company is not involved in any type of business which may be subject to renegotiation of profits or termination of contracts or subcontracts at the election of the government.\nDuring the fiscal year ended August 26, 1995, the Company did not engage in material research and development activities relating to the development of new products or services or the improvement of existing products or services in connec- tion with its business.\nThe Company does not engage in any foreign operations and export sales are not significant.\nCompliance by the Company with Federal, State and local environmental protection laws during the fiscal year ended August 26, 1995, had no material effect upon capital expenditures, earnings or competitive position of the Company.\nDuring the last fiscal year, the Company prepaid the balance of the 9.65% Senior Notes to Teachers Insurance Annuity Association of America in the original principal amount of $13,000,000. The principal amount of the Notes prepaid was $5,571,428 together with accrued interest and a premium of $119,473 applicable to such prepayment.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company's executive offices are located in a 27,800 square foot building located in Miamisburg, Ohio, a southern suburb of Dayton, Ohio, on an 8-acre site owned by the Company.\nThe following table lists the locations, approximate size, lease expiration dates and renewal options available with regard to the principal warehouse properties operated by the Company as of August 26, 1995.\nApproximate Size Lease Renewal Location (Square Feet) Expiration Options\nBellefontaine, Ohio (1) 580,995 - - Cincinnati, Ohio (1) 370,732 - - Cincinnati, Ohio (1) 42,358 - - Bridgeport, Michigan(2)(3) 590,749 2010 4\/5 year Lexington, Kentucky 298,750 1999 -\n(1) This property is owned in fee by the Company.\n(2) The lease for this property has been capitalized for financial statement purposes.\n(3) A 186,000 square foot dry grocery addition and a 56,000 square foot perishable addition were completed in fiscal 1995.\nThe Company also leases 91 retail store locations, the majority of which are subleased to affiliated independent retailers. The leases for these locations expire on various dates, the latest being in 2013. Further information regard- ing lease commitments is contained in Note 8 on pages 20 and 21 of the 1995 Annual Report.\nThe Company also owns two supermarket buildings which it leases to affiliated independent retailers.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThe Company has no material legal proceedings pending other than ordinary routine litigation incidental to its business. Management is of the opinion that any liability, to the extent not provided for through insurance or otherwise, would not be material.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nThere were no matters submitted to a vote of the security holders, through the solicitation of proxies or otherwise, during the fourth quarter of the fiscal year ended August 26, 1995.\n(1) Member of the Executive Committee of the Board of Directors.\n(2) Director of the Registrant.\nThere is no family relationship between any of the executive officers listed above. All executive officers hold office from one annual meeting of the Board of Directors until the next annual meeting of the Board of Directors or until their successors are elected.\nThere are no arrangements or understandings between any of the executive officers of the Registrant and any other person (not an officer or director of the Registrant acting as such) pursuant to which any of the executive officers were selected as an executive officer of the Registrant.\nEach of the executive officers of the Company listed above has been employed by the Registrant for more than five years.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON SHARES AND RELATED SHAREHOLDER MATTERS.\nThe Registrant's Common Shares have been listed on the New York Stock Exchange since December 14, 1989 and trade under the symbol \"SFS\". Prior to that time, the Company's Common Shares were traded on the American Stock Exchange. On October 26, 1995, there were approximately 1,813 holders of record of the Registrant's Common Shares.\nThe information called for by Item 5 as to the Registrant's stock price ranges and quarterly dividends for the last two fiscal years is contained on page 24 of the 1995 Annual Report and is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe information called for by Item 6 is incorporated herein by reference to page 25 of the 1995 Annual Report.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nThe information called for by Item 7 is incorporated herein by reference to pages 6 through 8 of the 1995 Annual Report.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe information called for by Item 8 is incorporated herein by reference to pages 9 through 23 of the 1995 Annual Report.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNone\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nThe information called for by Item 10 as to the Directors of the Registrant and compliance with Section 16(a) of the Securities Exchange Act of 1934 is incorporated by reference to pages 4 through 7 of the Registrant's definitive Proxy Statement dated November 6, 1995 in connection with the Registrant's 1995 Annual Meeting of Shareholders. Certain information regarding executive officers of the Registrant is included in Part 1 above.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe information called for by Item 11 is incorporated by reference to pages 7 through 9 of the Registrant's definitive Proxy Statement dated November 6, 1995 in connection with the Registrant's 1995 Annual Meeting of Shareholders; provided, however, that the information contained in said Proxy Statement under the headings \"Report on Executive Compensation\" is not incorporated herein.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGE- MENT.\nThe information called for by Item 12 with respect to security ownership of certain beneficial owners and by each director of the Registrant and all executive officers and directors of the Registrant as a group is incorporated by reference to Registrant's definitive Proxy Statement dated November 6, 1995 in connection with Registrant's 1995 Annual Meeting of Shareholders on pages 2 through 4.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe information called for by Item 13 is incorporated by reference to page 6 of Registrant's definitive Proxy Statement dated November 6, 1995 in connection with the Registrant's 1995 Annual Meeting of Shareholders.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, CONSOLIDATED FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n1995 Annual (a) 1. Financial Statements Report Page(s)\nThe following are contained in the 1995 Annual Report and are incorporated herein by reference:\nConsolidated Statements of Income for the Fiscal Years Ended August 26, 1995, August 27, 1994 and August 28, 1993 9\nConsolidated Balance Sheets as of August 26, 1995 and August 27, 1994 10-11\nConsolidated Statements of Cash Flows for the Fiscal Years Ended August 26, 1995, August 27, 1994 and August 28, 1993 12\nConsolidated Statements of Shareholders' Equity for the Fiscal Years Ended August 26, 1995, August 27, 1994 and August 28, 1993 13\nNotes to Consolidated Financial Statements 14-22\nReport of Independent Public Accountants 23\n(a) 2. Consolidated Financial Statement Schedule 10-K page\nFor Fiscal Years Ended August 26, 1995, August 27, 1994 and August 28, 1993\nReport of Independent Public Accountants on Consolidated Schedule 18\nSchedule II - Valuation and Qualifying Accounts 19\nAll other schedules are omitted because they are not applicable or not required, or because the required information is included in the consolidated financial statements or notes thereto.\n(a) 3. The following exhibits are filed herewith or incorporated by reference as indicated. Exhibits are listed by numbers corresponding to Item 601 in Regulation S-K.\nExhibit No. Reference\n3(a) Restated Certificate of Filed as Exhibit 4(a) of Incorporation. to Registration Statement No. 2-84640\n3(b) Certificate of Amendment Incorporated by of Restated Certificate reference to of Incorporation. definitive Proxy Statement dated November 1, 1983\n3(c) Certificate of Amendment Incorporated by of Restated Certificate reference to of Incorporation. definitive Proxy Statement dated October 31, 1986\n3(d) By-Laws, as amended. Filed as Exhibit 1 to Form 10-K for the year ended August 30, 1986\n4(a) $10,000,000 Revolving Filed as Exhibit 1 Credit Loan Agreement to Form 8-K dated dated as of September 17, September 17, 1987 1987 between Registrant and PNC Bank, Ohio.\n4(b) Amendment to Loan Filed as Exhibit 1 Agreement dated April 11, to Form 8-K dated 1991 between Registrant April 9, 1991 and PNC Bank, Ohio.\n4(c) $10,000,000 Revolving Filed as Exhibit 1 Credit Loan Agreement to Form 8-K dated dated April 9, 1991 April 9, 1991 between Registrant and Society Bank, N.A.\n4(d) $25,000,000 Note Filed as Exhibit 1 Agreement dated as of to Form 8-K dated November 1, 1989 February 5, 1990 between Registrant and Nationwide Life Insurance Company.\n4(e) $10,000,000 Revolving Filed as Exhibit 1 Credit Agreement dated to Form 8-K dated as of August 30, 1991 August 30, 1991 between Registrant and The First National Bank of Chicago.\n4(f) Rights Agreement dated Filed as Exhibit 4(f) as of January 27, 1989 to Form 8-K dated between Registrant and January 27, 1989 and Chase Manhattan Bank, as Exhibits 1 and 2 N.A. as Rights Agent. to Form 8-A dated January 27, 1989\n4(g) Agreement to furnish Pursuant to Item copies of long-term 601(b)(4)(iii) of debt instruments. Regulation S-K, copies of certain instruments defining the rights of holders of certain long-term debt of the Registrant and its subsidaries are not filed and, in lieu thereof, the Registrant agrees to furnish copies thereof to the Securities and Exchange Commission upon request\n10 Material Contracts\n(a) Employment Agreement Filed as Exhibit 4 to dated December 8, 1976 Form 10-K for the year between Registrant and ended August 29, 1981 Jack Twyman, as amended March 3, 1981.\n(b) Employment Agreement Filed as Exhibit 5 to dated March 3, 1981 Form 10-K for the year between Registrant and ended August 29, 1981 John Demos.\n(c) First Amendment to Filed as Exhibit 10 to Employment Agreement Form 8-K dated dated October 26, 1995 October 26, 1995 between Registrant and John Demos.\n(d) 1986 Stock Option Plan. Filed as Appendix C to definitive Proxy Statement dated October 31, 1986\n(e) Incentive Compensation Filed as Exhibit 7 to Plan. Form 10-K for the year ended August 29, 1981\n(f) 1989 Restricted Stock Filed as Exhibit 4(g) Plan. to Form 8-K dated January 27, 1989\n(g) 401(k) Plan. Description in Form 8-K dated January 27, 1989\n(h) Excess Benefit Plan, Filed as Exhibit 1 to as amended. Form 10-K for the year ended August 26, 1989\n(i) Supplemental Executive Filed as Exhibit 1 to Retirement Plan, as Form 10-K for fiscal amended and restated year ended August 27, as of May 18, 1994 1994 (formerly known as the Excess Benefit Plan).\n(j) Supplemental Executive Filed as Exhibit 2 to Retirement Trust Form 10-K for fiscal Agreement between the year ended August 27, Registrant and Society 1994 National Bank.\n11 Statement Re: Filed as Exhibit 11 Computation of Net herewith Income Per Share.\n13 Annual Report to Filed as Exhibit 1 Shareholders for the herewith fiscal year ended August 26, 1995. (Only those portions of the Annual Report which are specifically designated in this Form 10-K as being incorporated by reference are being electronically filed pursuant to the Securities Exchange Act of 1934.)\n18(a) Letter dated November 23, Filed as Exhibit 9 to 1981 from Registrant's Form 10-K for the year independent public ended August 29, 1981 accountants re change in accounting principles.\n18(b) Letter dated November 22, Filed as Exhibit 2 to 1985 from Registrant's to Form 10-K for the independent public year ended August 31, accountants re change in 1985 accounting principles.\n21 Subsidiaries of the Filed as Exhibit 2 Registrant. herewith\n23 Consent of Arthur Filed as Exhibit 3 Andersen LLP. herewith\n24 Power of Attorney Filed as Exhibit 4 authorizing John Demos, herewith Vice Chairman, Secretary and General Counsel to sign the Annual Report on Form 10-K on behalf of said Directors.\n27 Financial Data Schedule\n(b) Reports on Form 8-K:\nThe Registrant filed a Form 8-K with the Securities and Exchange Commission dated October 26, 1995 reporting the extension of the term of the Employment Agreement between the Registrant and John Demos to March 2, 1998.\nFORM S-8 UNDERTAKING\nPursuant to the requirements of Item 512(h) of Regulation S-K and Part II of Form S-8 under the Securities Act of 1933, the undersigned registrant hereby undertakes as follows, which undertaking shall be incorporated by reference into the following Registration Statements of the registrant on Form S-8: Registration Statement Nos. 2-66358, 2-60616, 2-88433, 33-20892 and 33-21069.\nInsofar as indemnification for liabilities arising under the Securities Act of 1993 may be permitted to directors, officers and controlling persons of the registrant pursuant to the foregoing provisions, or otherwise, the registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act of 1933 and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on the 22nd day of November, 1995.\nSUPER FOOD SERVICES, INC. (Registrant)\nBy\/s\/ Jack Twyman __________________________________ Jack Twyman 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 22nd day of November, 1995.\n\/s\/ Jack Twyman \/s\/ Robert F. Koogler _________________________________ _________________________________ Jack Twyman Robert F. Koogler Director and Senior Vice President-Finance, Chairman of the Board Treasurer and Assistant Secretary (Principal Executive Officer) (Principal Accounting and Financial Officer)\n\/s\/ John Demos \/s\/ Samuel L. Robinson _________________________________ _________________________________ John Demos Samuel L. Robinson Director and Vice Chairman of the Director and President and Board, Secretary and General Chief Operating Officer Counsel\n*\/s\/ John W. Berry *\/s\/ Dr. Thomas S. Haggai ________________________________ ________________________________ John W. Berry Dr. Thomas S. Haggai Director Director\n*\/s\/ Dr. Edward H. Jennings *\/s\/ C. E. Shaffer ________________________________ ________________________________ Dr. Edward H. Jennings C. E. Shaffer Director Director\n* The undersigned, by signing his 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.\n*By\/s\/ John Demos _________________________________ John Demos Attorney-in-Fact November 22, 1995\nSUPER FOOD SERVICES, INC.\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES\nThe following items included in the 1995 Annual Report of the Registrant to its shareholders are incorporated herein by reference:\nConsolidated Statements of Income for the Fiscal Years Ended August 26, 1995, August 27, 1994 and August 28, 1993.\nConsolidated Balance Sheets as of August 26, 1995 and August 27, 1994.\nConsolidated Statements of Cash Flows for the Fiscal Years Ended August 26, 1995, August 27, 1994 and August 28, 1993.\nConsolidated Statements of Shareholders' Equity for the Fiscal Years Ended August 26, 1995, August 27, 1994 and August 28, 1993.\nNotes to Consolidated Financial Statements.\nReport of Independent Public Accountants on the Consolidated Financial Statements as of August 26, 1995 and August 27, 1994 and for each of the three fiscal years in the period ended August 26, 1995.\nWith the exception of the aforementioned information and the information incorporated in Items 5, 6, 7 and 8, the 1995 Annual Report to Shareholders is not to be deemed filed as part of this report.\nThe following information for the fiscal years 1995, 1994 and 1993 is submitted herewith:\nConsent of Independent Public Accountants.\nReport of Independent Public Accountants on Consolidated Schedule.\nConsolidated Financial Statement Schedule -\nSchedule\nValuation and Qualifying Accounts II\nAll schedules except that listed above are omitted as not applicable or not required, or the required information is included in the consoli- dated financial statements or in the notes thereto.\nSeparate financial statements of the Registrant have been omitted since it is primarily an operating company and the minority interest in subsidiaries and long-term debt of the subsidiaries held by other than the Registrant is less than 5% of consolidated total assets.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Shareholders and Board of Directors of Super Food Services, Inc.:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in Super Food Services, Inc. and subsidiaries Annual Report to Shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated October 19, 1995. Our audit was made for the purpose of forming an opinion on those statements taken as a whole. The schedule listed in Part IV, Item 14(a)2 is the responsibility of the Company's management and is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic consolidated financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic consolidated financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic consolidated financial statements taken as a whole.\nArthur Andersen LLP\nDayton, Ohio, October 19, 1995","section_15":""}
{"filename":"47129_1995.txt","cik":"47129","year":"1995","section_1":"ITEM 1. BUSINESS.\nGeneral\nThe Hertz Corporation and its subsidiaries (\"Hertz\"), affiliates and independent licensees are engaged principally in the business of renting automobiles and renting and leasing trucks, without drivers, in the United States and in approximately 150 foreign countries. Collectively, they operate what the registrant believes is the largest rent a car business in the world and one of the largest one-way truck rental businesses in the United States. In addition, through its wholly-owned subsidiary, Hertz Equipment Rental Corporation, Hertz operates what it believes to be the largest rental, lease and sale of construction and materials handling equipment business in the United States. Other activities of Hertz include the sale of its used vehicles, the leasing of automobiles in Australia and New Zealand and in Europe through an affiliate; and providing claim management and telecommunication services in the United States.\nThe registrant, which was incorporated in Delaware in 1967, is a successor to corporations which were engaged in the automobile and truck leasing and rental business since 1924. UAL Corporation (\"UAL\") (formerly Allegis Corporation) purchased all of the registrant's outstanding capital stock from RCA Corporation (\"RCA\") on August 30, 1985. Park Ridge Corporation (\"Park Ridge\") purchased all of the registrant's outstanding capital stock from UAL on December 30, 1987. On July 19, 1993, Park Ridge (which had no material assets other than the registrant) was merged with and into the registrant, with the prior stockholders of Park Ridge becoming the stockholders of the registrant. In March 1994, Ford Motor Company (\"Ford\") acquired the registrant's common stock owned by Commerzbank Aktiengesellschaft. On April 29, 1994, Ford purchased all of the common stock of the registrant owned by Park Ridge Limited Partnership. The registrant then redeemed the preferred and common stock of the registrant owned by AB Volvo, borrowing the funds to pay for the redemption. In addition, a subordinated promissory note of the registrant held by Ford Motor Credit Company was exchanged for an equivalent amount of preferred stock of the registrant. See Notes 1, 5, 7 and 14 of the Notes to Consolidated Financial Statements included in this Report.\nFor information with respect to business segments of Hertz, reference should be made to Note 10 of the Notes to Consolidated Financial Statements included in this Report.\nRent A Car\nHertz provides rent a car service throughout the United States, including virtually all major U.S. cities, and in major foreign countries. Rent a car service is also provided through independent licensees (see Business - Licensees). A wide variety of makes and models of automobiles are used for daily rental purposes, nearly all of which are current year or the previous year's models. Car rentals are made on a daily, weekly or monthly basis, the rental charge being computed on a limited or unlimited mileage rate, or on a time rate plus a mileage charge. Services provided to customers include public liability and property damage protection. In addition to vehicle rentals and licensee fees, revenues are generated from providing customers with ancillary products such as loss or collision damage waiver, theft protection, liability insurance supplement, personal accident insurance and personal effects coverage. Rent a car operations are subject to seasonal factors with the greatest activity occurring in the second and third calendar quarters (see Note 12 of the Notes to Consolidated Financial Statements included in this Report).\nITEM 1. BUSINESS (continued).\nHertz and certain licensees, under the Hertz \"Rent it Here-Leave it There\" program, offer customers in most parts of the world the convenience of leaving a rented car at a Hertz or licensee location in a city other than the one in which it was rented. Depending upon rental location and distance driven, a drop off charge or a special intercity rate may be imposed if the vehicle is not returned to the same location from which it is rented.\nA centralized reservations service is also offered within the continental United States by use of a toll free telephone number. In addition, through \"The Hertz #1 Club\", Hertz maintains a computerized data retrieval system on participating customers' preferences as to type of car and other information typically needed prior to the rental of a car, so that, when #1 Club members make a reservation using their membership number, the renting location is able to have a rental agreement prepared prior to the time of their arrival. A similar service is available to Hertz' customers in certain foreign countries under the name \"Hertz No. 1 Club\". In addition, a Hertz charge card is offered for use by Hertz customers in connection with car rental services.\nAt most major airport locations within the United States, Canada, Europe and Australia, Hertz offers \"Hertz #1 Club Gold,\" which is an expedited rental service designed for the frequent traveler. Hertz #1 Club Gold encompasses two services, canopied and counter service. When using #1 Club Gold canopy service, which is available at a number of major airport locations within the United States and the United Kingdom, the counter rental transaction is eliminated and members are taken by the Hertz courtesy bus to a separate canopied rental area, where an electronic sign board directs them to their assigned car, which is ready to go. Usually, there is nothing to sign. After presenting their driver's license and rental record at the gate, they are on their way.\nHertz also participates in packaged tour plans in conjunction with airlines, tour operators and hotels under which a certain period of rent a car usage is included with air fare, and often hotel accommodations, at a combined quoted price.\nRent a car facilities are operated at virtually all major airports and at downtown locations in major cities in the United States. Hertz estimates that airport revenues accounted for approximately 90% of its rent a car revenues in the United States in 1995. Arrangements are also in effect at hotels, motels and railroad terminals to facilitate car rentals at such locations.\nThe foreign rent a car operations of Hertz that generated the highest volumes of business during 1995 are those conducted in France, Germany, the United Kingdom, Italy, Canada, Spain, Australia and Switzerland. These operations are conducted by wholly-owned subsidiaries of Hertz. In general, Hertz' foreign rent a car operations are conducted along lines similar to those of rent a car operations of Hertz in the United States. Hertz believes there are no unusual risks associated with its foreign operations.\nHertz' ability to withdraw earnings or investments from foreign countries is, in some cases, subject to exchange controls and the utilization of foreign tax credits. It may also be affected by fluctuations in exchange rates for foreign currencies and by revaluation of such currencies in relation to the U.S. dollar by the governments involved. Foreign operations have been financed to a substantial extent through\nITEM 1. BUSINESS (continued).\nloans from local lending sources in the currency of the countries in which such operations are conducted. Rent a car operations in foreign countries are, from time to time, subject to governmental regulations imposing varying degrees of restrictions. Hertz does not believe currency restrictions or other regulations have had any material impact on its operations as a whole.\nIn 1995, the registrant through its subsidiary, H.I.R.E. Corp., started offering vehicle renting services principally in the insurance and auto repair replacement market, and is presently operating this business in two states.\nEquipment Rental and Sales\nHertz also rents, leases and sells a wide range of construction and materials handling equipment to construction, industrial and governmental users through its subsidiaries, Hertz Equipment Rental Corporation (\"HERC\") in the United States, a subsidiary of Hertz Equipment Rental International, Ltd. in Spain, and a subsidiary in France owned 51% by Hertz International, Ltd. and 49% by Equipment Rental Services Netherlands B.V., which operates under a license from HERC.\nRentals are made on a daily, weekly or monthly basis. Rates vary at different locations depending on local market and competitive factors.\nHERC believes it operates the largest rental, lease and sale of construction and materials handling equipment business in the United States and has become so through providing superior equipment, operations and services.\nHERC operations are subject to seasonal factors with the greatest activity occurring in the second and third calendar quarters and its operations have been profitable.\nTruck Leasing and Rental and Car Leasing\nIn 1988, the registrant entered into a license agreement with Hertz Penske Truck Leasing, Inc., which has been succeeded by Penske Truck Leasing Co., L.P., (\"Penske\"), under which Penske has the right, as a Hertz System licensee, to conduct a one-way truck rental business (including trailers) for a 10 year period. The license agreement covers the entire United States, with certain exclusions for those cities and towns that were licensed to other Hertz System licensees, but under certain conditions, Penske may also operate in the localities of other Hertz System licensees.\nEffective January 1, 1995, the registrant sold its European car leasing and car dealership operations to Hertz Leasing International, Inc. (\"HLI\"), at an amount equal to its book value of approximately $61 million. HLI is wholly owned by Ford. In addition, except for Australia and New Zealand, Ford has received the worldwide rights (subject to certain existing license rights) to use and sublicense others to use the \"Hertz\" name in the conduct of motor vehicle leasing businesses, and has agreed to pay the registrant a license fee payable over five years. The registrant believes that this transaction will not have a material effect on its financial position or future operations.\nITEM 1. BUSINESS (continued).\nOther Operations\nThrough its subsidiary HCM Claim Management Corporation (\"HCM\"), Hertz provides a claim administration service to numerous customers, which includes investigating, evaluating, negotiating and disposing of a wide variety of claims including third-party, first-party, bodily injury, property damage, general liability, product liability and workers' compensation claims, but does not include underwriting of risks. In 1992, HCM became the claims administrator for workers' compensation claims of the registrant, which are underwritten by an outside insurance carrier, and also became the administrator for the registrant's medical, dental and other employee health related benefit plans. HCM provides these services throughout the United States and its operations have been profitable.\nIn 1991, Hertz began providing telecommunication services through its subsidiary Hertz Technologies, Inc. (\"HTI\"). HTI markets custom designed voice and data telecommunication packages of rates and services and makes available to customers throughout the United States the opportunity to take advantage of Hertz' negotiated rates with its underlying carriers providing, among other things, discounted long-distance services. HTI provides these services from Oklahoma City and its operations have been profitable.\nInsurance\nFor its domestic operations, the registrant is a qualified self-insurer against liability resulting from accidents under certificates of self-insurance for financial responsibility in all states wherein its motor vehicles are registered. The registrant also self-insures general public liability and property damage for all domestic operations. For its foreign operations, Hertz generally does not act as a self-insurer. Instead, Hertz purchases insurance to comply with local legal requirements from unaffiliated carriers. Effective January 1, 1993, motor vehicle liability insurance for claims arising on or after January 1, 1993, purchased locally from unaffiliated carriers by Hertz owned operations in Europe, has been reinsured by Hertz International RE Limited, a reinsurer in Dublin, Ireland. Hertz also maintains insurance coverage with unaffiliated carriers, or with unaffiliated carriers through Ford, for such amounts in excess of those retained and borne by Hertz, as it determines to be necessary.\nProvisions for public liability and property damage on self-insured domestic claims and reinsured foreign claims are made by charges to expense based upon evaluations of estimated ultimate liabilities on reported and unreported claims. At December 31, 1995, this liability was estimated at $312 million for combined domestic and foreign operations.\nHERC generally requires its customers to provide their own liability insurance on rented equipment with HERC held harmless under various agreements.\nOther types of insurance usually carried by business organizations, such as workers' compensation, property (including boiler and machinery and business interruption), commercial crime and fidelity and performance bonds, are purchased from various insurance companies, or through unaffiliated carriers with Ford, in amounts deemed adequate by Hertz for the respective hazards.\nITEM 1. BUSINESS (continued).\nVehicle Acquisition and Disposition\nHertz believes it is the largest single private purchaser of new vehicles in the United States. The acquisition and disposition of vehicles are, thus, important activities for Hertz and have a significant impact on profitability. Hertz obtains, subject to availability, a majority of its cars pursuant to various fleet programs established by original equipment manufacturers (\"OEMs\"). Such vehicles are deemed \"nonrisk\" because Hertz is able to return these vehicles to the OEMs at pre-established prices and time frames. In 1995, in Hertz' domestic and foreign operations, approximately 90% of the vehicles in the fleet were \"nonrisk\". Hertz disposes of \"at risk\" vehicles, whereby Hertz bears the economic risk of their eventual disposal, through wholesalers and miscellaneous other channels such as auctions. Over the years, the dynamics of the new and used car markets have had a negative impact on Hertz' sales efforts and Hertz has responded by purchasing fewer risk vehicles and by refining the vehicle mix of its fleet. Upon the sale of a vehicle, the difference between the net proceeds from sale and the remaining book value is recorded as an adjustment to depreciation in the period when sold (see Note 7 of the Notes to Consolidated Financial Statements included in this Report.)\nThe purchases of vehicles are financed through funds provided from operations and by an active and ongoing global borrowing program. Domestic short-term requirements are funded primarily in the commercial paper market, while medium and long-term funds are obtained from the U.S. bond market or the Euro-markets.\nLicensees\nThe Hertz Corporation's wholly-owned subsidiaries, Hertz System, Inc. (\"System\") and Hertz International, Ltd. (\"International\"), respectively, issue licenses under franchise arrangements to independent licensees who are engaged in the vehicle renting business in the United States and many foreign countries. These licensees generally pay fees based on the number of vehicles they operate and\/or on revenues. Licensees also share in the cost of the Hertz advertising program, reservations system, and certain other services. In return, licensees are provided with the use of the \"Hertz\" name, management and administrative assistance, training, the availability of Hertz charge cards, #1 Club, reservations service, the \"Rent it Here-Leave it There\" program and other services. System, which owns the Hertz service and trademarks and certain proprietary knowhow used by licensees, establishes the uniform standards and procedures under which all such licensees operate. The Hertz name has significant value. It is well known domestically and in all major international markets.\nITEM 1. BUSINESS (continued).\nThe establishment and operations of all licensees are financed independently by the licensee with Hertz having no investment interest in the licensee (except for two foreign licensees) or in the licensee's fleet. Licenses outside the United States are granted by International, with the consent of System. Initial license fees or the price for the sale to a licensee of a corporate location may be payable over a term of several years. New licenses continue to be issued and in some cases licensee businesses are purchased by Hertz.\nLicensees are of importance since they enable Hertz to offer expanded national and international service and a broader \"Rent it Here-Leave it There\" program. License fees and other payments made by licensees do not contribute materially to Hertz' income.\nEmployees\nOn December 31, 1995, Hertz employed approximately 19,500 persons in its domestic and foreign operations. Labor contracts covering the terms of employment of approximately 4,500 employees in the United States are presently in effect with 96 local unions, affiliated primarily with the International Brotherhood of Teamsters and the International Association of Machinists (AFL-CIO). Labor contracts which cover approximately 1,500 of these employees will expire during 1996. Employee benefits in effect include group life insurance, hospitalization and surgical insurance, pension plans, and an income savings plan. Overseas employees are covered by a wide variety of union contracts and governmental regulations affecting, among other things, compensation, job retention rights and pensions. Hertz has had no work stoppage as a result of labor problems during the last 10 years that has materially affected its operations. Hertz believes its labor relations to be good.\nCompetition\nHertz believes that its rent a car business, collectively with its affiliates and independent licensees, is the largest in the world; that its licensed one-way truck rental business is one of the largest in the United States; and believes that its construction and materials handling equipment rental, lease and sales business is the largest in the United States. Hertz has substantial competitors with large resources in its rent a car and truck rental activities who compete with Hertz in all principal aspects of these activities, including price and service. Hertz is also faced with substantial competition from a growing number of smaller operators. At substantially all of its airport locations, it is faced with competition from one or more competitors on and off the airport. Competition in all of Hertz' areas of business is now, and is expected to continue to be, active and intense.\nITEM 1. BUSINESS (continued).\nGovernmental Regulation\nThroughout the world, Hertz is subject to numerous types of governmental controls, including those relating to price regulation and advertising, currency controls, labor matters, charge card operations, environmental protection, used vehicle sales and franchising.\nThe use of automobiles and other vehicles is subject to various governmental controls designed to limit environmental damage, including that caused by emissions and noise. Generally, these controls are met by the manufacturer, except in the case of occasional equipment failure requiring repair by Hertz. To comply with environmental regulations, measures are being taken at certain locations to reduce the loss of vapor during the fueling process and to maintain and replace underground fuel storage tanks. Hertz is also incurring and providing for expenses for the cleanup of fuel discharges and other alleged violations of environmental laws arising from the disposition of waste products. Hertz does not believe that it will be required to make any material capital expenditures for environmental control facilities or to make any other material expenditures to meet the requirements of governmental authorities in this area.\nHertz' operations, as well as those of its competitors, could be affected by any limitation in the fuel supply or by any imposition of mandatory allocation or rationing regulations. In the event of a severe disruption of fuel supplies, the operations of all vehicle renting and leasing companies could be adversely affected.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nHertz' operations are carried on at rental and sales offices and service facilities located at airports and in downtown and suburban areas. Most of such premises are leased. Substantially all airport locations are leased from governmental authorities charged with the operation of such airports under arrangements generally providing for payment of rents and a percentage of revenues with a guaranteed annual minimum (see Note 9 of the Notes to Consolidated Financial Statements included in this Report).\nHertz has facilities in the vicinity of Oklahoma City at which reservations for its worldwide car rental operations are processed and major domestic accounting functions are performed. Hertz maintains its executive offices in a facility in Park Ridge, New Jersey.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nVarious legal actions, governmental investigations and proceedings, and claims are pending or may be instituted or asserted in the future against the registrant and its subsidiaries. Litigation is subject to many uncertainties, and the outcome of the individual litigated matters is not predictable with assurance. It is reasonably possible that certain of the actions, investigations or proceedings could be decided unfavorably to the registrant or the subsidiary involved. Although the amount of liability at December 31, 1995 with respect to these matters cannot be ascertained, such liability could approximate up to $1 million (net of income tax benefits), and the registrant believes that any resulting liability should not materially affect the consolidated financial position, results of operations or cash flows of the registrant.\nOn January 9, 1995, Newark International Airport, in Newark, N.J., suffered an electrical outage that caused significant operational problems for one day due to a construction accident that occurred on the registrant's property. A subcontractor of the registrant was involved in this accident. The registrant believes that it has adequate defenses, indemnities and insurance coverage against existing and anticipated litigation.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nOmitted.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nThere is no market for the registrant's common stock. The registrant is a wholly-owned subsidiary of Ford.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nOmitted.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION.\n1995 vs. 1994\nRevenues in 1995 of $3,401 million increased by $106 million as compared to 1994. This increase was primarily attributable to gains in the car rental operations resulting from a greater number of transactions, rate increases and changes in foreign exchange rates; and improvements in construction equipment rental and sales due to increased volume resulting from the opening of new locations and increased activity in construction and industrial related markets. These increases were partly offset by lower revenues in car leasing and car dealerships resulting from the sale of these operations in Europe effective January 1, 1995.\nTotal expenses increased $97 million to $3,228 million in 1995 as compared to $3,131 million in 1994. Direct operating expense decreased in amount and as a percent of revenues principally due to lower expenses relating to the sales of the European car leasing and car dealership operations in 1995 and lower costs in the domestic car rental operations for public liability and property damage claims, partly offset by higher costs relating to the increase in the volume of business. Depreciation of revenue earning equipment increased primarily due to an increase in vehicles and equipment operated, higher prices for automobiles, and lower net proceeds received on disposal of revenue earning equipment in excess of book value due to a softness in the domestic vehicle resale markets; these increases were partly offset by lower depreciation relating to the sale of the European car leasing operation in 1995, and a reduction in depreciation of $12.0 million in 1995 due to changes made effective July 1, 1994 increasing certain lives being used to compute the provision for depreciation to reflect changes in the estimated residual values to be realized when the equipment is sold. Selling, general and administrative expense increased primarily due to higher advertising and sales promotion costs and changes in foreign exchange rates. The increase in interest expense was primarily due to higher debt levels and interest rates in 1995, partly offset by higher interest income in 1995 and $8.6 million included in 1994 relating to interest receivable from Park Ridge Limited Partnership which was not collected.\nThe tax provision of $67 million in 1995 was lower than the tax provision of $72 million in 1994, primarily due to a lower effective tax rate in 1995. See Notes 1 and 8 of the Notes to Consolidated Financial Statements included in this Report.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION (continued).\n1994 vs. 1993\nRevenues in 1994 of $3,294 million increased by $440 million as compared to 1993. This increase was primarily attributable to increases in the car rental operations resulting from a greater number of transactions due to increased travel, an increase in market share, and changes in foreign exchange rates; improvements in construction equipment rental and sales in the United States due to increased volume resulting from improvements in the economy and increased volume from industrial related markets; and higher revenues in car leasing due to an acquisition made in July 1994 in Europe and changes in foreign exchange rates. These increases were partly offset by lower revenues in claim administration and telecommunication services due to decreases in volume.\nTotal expenses increased $379 million to $3,131 million in 1994 as compared to $2,752 million in 1993. Direct operating expense increased principally due to the higher volume of business and changes in foreign exchange rates, but was lower in 1994 as a percent of revenues due to more efficient fixed cost coverage. Depreciation of revenue earning equipment increased in 1994 primarily due to an increase in vehicles and equipment operated, higher prices for automobiles, and credits recorded in 1993 resulting from valuing certain pre-acquisition assets on a net of tax basis; these increases were partly offset by a reduction in depreciation of $9.6 million due to changes made effective July 1, 1994 increasing certain lives being used to compute the provision for depreciation to reflect changes in the estimated residual values to be realized when the equipment is sold. Selling, general and administrative expense increased primarily due to higher advertising costs and changes in foreign exchange rates. The increase in interest expense was primarily due to higher debt levels and lower interest income in 1994 and an $8.6 million write-off of interest receivable from Park Ridge Limited Partnership, partly offset by lower interest rates in 1994 in the foreign operations.\nThe tax provision of $72 million in 1994 was higher than the tax provision of $49 million in 1993, primarily due to the increase in income before income taxes in 1994 and changes in effective tax rates. See Notes 1 and 8 of the Notes to Consolidated Financial Statements included in this Report.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe Consolidated Balance Sheet of the registrant at December 31, 1995 and 1994, and the related Consolidated Statement of Income and Reinvested Earnings and Consolidated Statement of Cash Flows for the years ended December 31, 1995, 1994 and 1993, and other financial statement schedules are set forth under Item 14 hereof.\nSelected quarterly data for each quarter of the years 1995 and 1994 is set forth in Note 12 of the Notes to Consolidated Financial Statements included in 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.\nOmitted.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nOmitted.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nOmitted.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nOmitted.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.\n3. Exhibits:\n(3) Articles of Incorporation and By-Laws.\n(i) Restated Certificate of Incorporation of The Hertz Corporation -- incorporated herein by reference to Exhibit (3)(i) to the registrant's report on Form 8-K dated July 20, 1993 (File No. 1-7541).\n(ii) Certificate of Amendment of Restated Certificate of Incorporation of The Hertz Corporation filed with the Secretary of State of Delaware on April 28, 1994 -- incorporated by reference to Exhibit (3)(ii) to the registrant's report on Form 10-K dated March 13, 1995 (File No. 1-7541).\n(iii) Certificate of Amendment of Restated Certificate of Incorporation of The Hertz Corporation filed with the Secretary of State of Delaware on December 18, 1995.\n(iv) By-Laws of The Hertz Corporation adopted by its Board of Directors on July 19, 1993 -- incorporated by reference to Exhibit (3)(ii) to the registrant's report on Form 8-K dated July 20, 1993 (File No. 1-7541).\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (continued).\n3. Exhibits (continued):\n(4) Instruments defining the rights of security holders, including indentures.\n(iii) At December 31, 1995, Hertz had various obligations which could be considered as long-term debt, none of which exceeded 10% of the total assets of Hertz on a consolidated basis. Hertz agrees to furnish to the Commission upon request a copy of any such instrument defining the rights of the holders of such long-term debt.\n(10) Material Contracts.\n(i) (a) Agreement dated December 30, 1985 between The Hertz Corporation and Allegis Corporation incorporated herein by reference to Exhibit (10)(i)(a) to the registrant's report on Form 10-K for the year ended December 31, 1985 (File No. 1-7541).\n(b) Use Agreement dated December 30, 1985 between The Hertz Corporation and Allegis Corporation incorporated herein by reference to Exhibit (10)(i)(b) to the registrant's report on Form 10-K for the year ended December 31, 1985 (File No. 1-7541).\n(ii)(B)(a) Agreement dated January 1, 1988 between The Hertz Corporation and Ford Motor Company (portions of this Exhibit have been omitted and granted confidential treatment under Rule 24b-2) incorporated herein by reference to Exhibit (10)(ii)(B)(a) to the registrant's report on Form 10-K for the year ended December 31, 1987 (File No. 1-7541).\n(b) Agreement dated January 1, 1988 between Hertz System, Inc. and Ford Motor Company (portions of this Exhibit have been omitted and granted confidential treatment under Rule 24b-2) incorporated by reference to Exhibit (10)(ii)(B)(b) to the registrant's report on Form 10-K for the year ended December 31, 1987 (File No. 1-7541).\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (continued).\n3. Exhibits (continued):\n(10) Material Contracts (continued):\n(ii)(B) (c) Agreement dated September 25, 1992 between Hertz System, Inc. and Ford Motor Company. (Portions of this Exhibit have been omitted and granted confidential treatment under Rule 24b-2) incorporated by reference to Exhibit (10)(ii)(B)(c) to the registrant's report on Form 10-Q for the quarterly period ended September 30, 1992 (File No. 1-7541).\n(iii)(A) (a) Employment contract with Frank A. Olson dated April 16, 1987, as amended December 30, 1987, incorporated by reference to Exhibit (10)(iii)(A)(a) to the registrant's report on Form 10-K for the year ended December 31, 1987 (File No. 1-7541).\n(b) Employment contract with Craig R. Koch dated April 16, 1987, as amended December 30, 1987, incorporated by reference to Exhibit (10)(iii)(A)(b) to the registrant's report on Form 10-K for the year ended December 31, 1987 (File No. 1-7541).\n(c) Employment contract with William Sider dated July 1, 1992, incorporated by reference to Exhibit (10)(iii)(A)(c) to the registrant's report on Form 10-K for the year ended December 31, 1992 (File No. 1-7541).\n(d) Employment contract with Brian J. Kennedy dated July 1, 1992, incorporated by reference to Exhibit (10)(iii)(A)(d) to the registrant's report on Form 10-K for the year ended December 31, 1992 (File No. 1-7541).\n(e) Employment agreement with Daniel I. Kaplan dated February 17, 1995, incorporated by reference to Exhibit (10)(iii) (A)(e) to the registrant's report on Form 10-K dated March 13, 1995 (File No. 1-7541).\n(f) Employment contract with Antoine E. Cau dated January 1, 1990, as amended April 4, 1990, December 13, 1990 and December 18, 1990 (portions of this Exhibit have been omitted and granted confidential treatment under Rule 24b-2) incorporated by reference to Exhibit (10)(iii)(A)(f) to the registrant's report on Form 10-K for the year ended December 31, 1990 (File No. 1-7541).\n(g) Executive Incentive Compensation Plan, incorporated by reference to Exhibit (10)(iii)(A)(g) to the registrant's report on Form 10-K dated March 13, 1995 (File No. 1-7541).\n(h) Long Term Incentive Plan, incorporated by reference to Exhibit (10)(iii)(A)(h) to the registrant's report on Form 10-K for the year ended December 31, 1991 (File No. 1-7541).\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (continued).\n3. Exhibits (continued):\n(12) Computation of Consolidated Ratio of Earnings to Fixed Charges for each of the five years in the period ended December 31, 1995.\n(21) Subsidiaries of the registrant. Listing of subsidiaries of the registrant at December 31, 1995.\n(23) Consents of experts and counsel. Consent to the incorporation by reference of report of independent public accountants in previously filed registration statements under the Securities Act of 1933.\n(27) Consolidated Financial Data Schedule for the year ended December 31, 1995.\n(b) Reports on Form 8-K:\nThe registrant did not file any reports on Form 8-K during the quarter ended December 31, 1995.\nSchedules and exhibits not included above have been omitted because the information required has been included in the financial statements or notes thereto or are not applicable or not required.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nTHE HERTZ CORPORATION (Registrant)\nBy: \/s\/ William Sider --------------------------------- William Sider Executive Vice President and Chief Financial Officer March 13, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the indicated capacities, on March 13, 1996.\n\/s\/ Frank A. Olson \/s\/ Craig R. Koch - --------------------------------- -------------------------------------- Frank A. Olson Craig R. Koch Chairman of the Board, Chief President, Chief Operating Officer and Executive Officer and Director Director (Principal Executive Officer)\n\/s\/ William Sider \/s\/ Leo A. Massad, Jr. - --------------------------------- -------------------------------------- William Sider Leo A. Massad, Jr. Executive Vice President, Chief Staff Vice President and Controller Financial Officer and Director (Principal Accounting Officer) (Principal Financial Officer)\n\/s\/ Malcolm S. Macdonald \/s\/ David N. McCammon - --------------------------------- -------------------------------------- Malcolm S. Macdonald David N. McCammon Assistant Treasurer and Director Director\n\/s\/ Peter J. Pestillo - --------------------------------- Peter J. Pestillo Director\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo The Hertz Corporation:\nWe have audited the accompanying consolidated balance sheet of The Hertz Corporation (a Delaware corporation and wholly-owned subsidiary of Ford Motor Company) and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of income and reinvested earnings and cash flows and the financial statement schedule listed in Item 14(a)2(i) for each of the two years ended December 31, 1995. 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 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 Hertz Corporation and subsidiaries as of December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the two years ended December 31, 1995, 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.\nParsippany, New Jersey January 26, 1996\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo The Hertz Corporation:\nWe have audited the accompanying consolidated statements of income and reinvested earnings and cash flows of The Hertz Corporation (a Delaware corporation) and subsidiaries for the year ended December 31, 1993. These consolidated 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 consolidated 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 results of operations of The Hertz Corporation and subsidiaries and their cash flows for the year ended December 31, 1993, in conformity with generally accepted accounting principles.\nOur audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. The financial statement schedule listed in Item 14(a)2(i) for the year ended December 31, 1993, 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\nNew York, New York February 7, 1994\nTHE HERTZ CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET (IN THOUSANDS OF DOLLARS)\nASSETS\nThe accompanying notes are an integral part of this statement.\nTHE HERTZ CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET (IN THOUSANDS OF DOLLARS)\nLIABILITIES AND SHAREHOLDERS' EQUITY\nThe accompanying notes are an integral part of this statement.\nTHE HERTZ CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF INCOME AND REINVESTED EARNINGS (IN THOUSANDS OF DOLLARS)\nThe accompanying notes are an integral part of this statement.\nTHE HERTZ CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS (IN THOUSANDS OF DOLLARS)\nThe accompanying notes are an integral part of this statement.\nTHE HERTZ CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS (IN THOUSANDS OF DOLLARS)\nIn connection with acquisitions made during the years 1994 and 1993, liabilities assumed were $27 million and $2.1 million, respectively.\nThe accompanying notes are an integral part of this statement.\nTHE HERTZ CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNote 1 - Summary of Significant Accounting Policies\nMerger, Change in Ownership and Capitalization -- the registrant, which was incorporated in Delaware in 1967, is a successor to corporations which were engaged in the automobile and truck leasing and rental business since 1924. UAL Corporation (\"UAL\") (formerly Allegis Corporation) purchased all of the registrant's outstanding capital stock from RCA Corporation (\"RCA\") on August 30, 1985. Park Ridge Corporation (\"Park Ridge\") purchased all of the registrant's outstanding capital stock from UAL on December 30, 1987. On July 19, 1993, Park Ridge (which had no material assets other than the registrant) was merged with and into the registrant, with the prior stockholders of Park Ridge becoming the stockholders of the registrant. The merger has been recorded as a \"pooling of interests\". Under this method of accounting, when the entities before and after a merger are under common control with the same management, the operations are combined at historical cost. Consequently, the consolidated financial statements of the registrant included herein have been restated for all periods prior to the effective date of the merger, and are identical to the audited consolidated financial statements of Park Ridge for such periods. On the date of the merger, the registrant refinanced $334.3 million promissory notes of Park Ridge through the public issuance of $400 million aggregate principal amount of junior subordinated debt securities of the registrant; and a $150 million loan to Park Ridge from Ford Motor Credit Company (\"FMCC\") in the form of subordinated debt was assumed by the registrant (the \"FMCC Note\"). The FMCC Note, which had a scheduled maturity date of May 17, 2000, was subordinated in right of payment to all \"Superior Indebtedness\" (as defined for purposes of the FMCC Note) of the registrant including the junior subordinated debt securities referred to above.\nIn March 1994, Ford Motor Company (\"Ford\") acquired the registrant's common stock owned by Commerzbank Aktiengesellschaft. On April 29, 1994, the registrant redeemed its preferred and common stock owned by AB Volvo for $145 million, borrowing the funds from Ford to pay for the redemption, and Ford purchased all of the common stock of the registrant owned by Park Ridge Limited Partnership (\"Partnership\"). This resulted in the registrant becoming a wholly-owned subsidiary of Ford. In addition, the $150 million subordinated promissory note of the registrant held by FMCC, was exchanged for $150 million of Series B Preferred Stock of the registrant, and a promissory note in the amount of $18.5 million, owed by the Partnership to the registrant was assumed by Ford (\"Ford Note\"). In connection with these transactions, notes payable were increased by $145 million, Series A Preferred Stock was reduced by $104 million, and additional capital paid-in was reduced by $41 million; interest expense was increased by $8.6 million and provision for taxes was decreased by $3.0 million; and subordinated promissory notes were reduced by $150 million and Series B Preferred Stock was increased by $150 million. The Ford Note is payable on demand, with interest payable quarterly on the outstanding principal balance at a fluctuating rate per annum equal to LIBOR (London Interbank Offered Rate). At December 31, 1995, the registrant's receivable relating to the Ford Note was $18.7 million and is included in Due From Affiliates in the consolidated balance sheet, and will be repaid in 1996.\nTHE HERTZ CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNote 1 - Summary of Significant Accounting Policies (continued)\nAs of December 31, 1995, 100% of the Common Stock of the registrant was owned by Ford and 100% of the outstanding Preferred Stock was owned by FMCC.\nThe capital stock of the registrant authorized and issued as of December 31, 1995, 1994 and 1993 and the additional capital paid-in for the years ended December 31, 1994 and 1995 are set forth below. There were no changes to the capital stock and additional capital paid-in during 1993.\nTHE HERTZ CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNote 1 - Summary of Significant Accounting Policies (continued)\nThe holders of the Series A Preferred Stock (\"Series A Stock\") and the Series B Preferred Stock (\"Series B Stock\") are entitled, when, as and if declared by the Board of Directors of the registrant, to cumulative annual dividends, but payable only out of funds legally available therefor, compounded annually (if in arrears). The annual dividend rate through December 31, 1998 is 10% for the Series A Stock and at various rates which average 4.5% for the Series B Stock. Commencing January 1, 1999 the annual dividend rate for the Series A Stock and Series B Stock are subject to adjustment and are reset on an annual basis. The Series A Stock and the Series B Stock are redeemable by their terms at the option of the registrant at any time, and do not have any voting rights, except that the holders of the Series A Stock shall have the right to elect two directors in the event of default, and the holders of the Series B Stock will be granted voting rights in the event of significant and continuing net operating losses.\nThe holders of the Class A Common Stock and Class B Common Stock have one vote per share and no special preferences. The holders of the Class C Common Stock have one vote per share and have the right to designate three directors, until such time as fewer than 40 shares thereof (adjusted for stock splits and the like) shall be outstanding, provided, however, that the Class C Common Stock shall in any event have 40% of the general voting power and the right to elect not less than 40% of the members of such Board of Directors, until such time as fewer than 40 shares thereof (as so adjusted) shall be outstanding. The Class C Common Stock is convertible into Class B Common Stock on a share for share basis at any time at the holder's option.\nPrinciples of Consolidation -- the consolidated financial statements include the accounts of The Hertz Corporation and its domestic and foreign subsidiaries. All significant intercompany transactions are eliminated.\nConsolidated Statement of Cash Flows -- for purposes of this statement, the registrant considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents. See page 25 for Noncash Investing and Financing Activities.\nTHE HERTZ CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNote 1 - Summary of Significant Accounting Policies (continued)\nDepreciable Assets -- the provisions for depreciation and amortization are computed on a straight-line basis over the estimated useful lives of the respective assets, as follows:\nHertz follows the practice of charging maintenance and repairs, including the cost of minor replacements, to maintenance expense accounts. Costs of major replacements of units of property are charged to property and equipment accounts and depreciated on the basis indicated above. Gains and losses on dispositions of property and equipment are included in income as realized. Upon disposal of revenue earning equipment, depreciation expense is adjusted for the difference between the net proceeds from sale and the remaining book value.\nEnvironmental Conservation -- the use of automobiles and other vehicles is subject to various governmental controls designed to limit environmental damage, including that caused by emissions and noise. Generally, these controls are met by the manufacturer, except in the case of occasional equipment failure requiring repair by Hertz. To comply with environmental regulations, measures are being taken at certain locations to reduce the loss of vapor during the fueling process and to maintain and replace underground fuel storage tanks. Hertz is also incurring and providing for expenses for the cleanup of fuel discharges and other alleged violations of environmental laws arising from the disposition of waste products. Hertz does not believe that it will be required to make any material capital expenditures for environmental control facilities or to make any other material expenditures to meet the requirements of governmental authorities in this area. Liabilities for these expenditures are recorded when it is probable that obligations have been incurred and the amounts can be reasonably estimated.\nPublic Liability and Property Damage -- provisions for public liability and property damage on self-insured domestic claims and reinsured foreign claims are made by charges to expense based upon evaluations of estimated ultimate liabilities on reported and unreported claims. For its domestic operations, the registrant is a qualified self-insurer against liability resulting from accidents under certificates of self-insurance for financial responsibility in all states wherein its motor vehicles are registered. The registrant also self-insures general public liability and property damage for all domestic operations. Effective July 1, 1987, all claims are retained and borne by the registrant up to a limit of $5,000,000 for each accident. Self-insurance retention borne by the registrant for each accident prior to July 1, 1987 was as follows: $10,000,000 from September 1, 1986 to June 30, 1987; $1,000,000 and 50% of claims for amounts exceeding $1,000,000 up to $6,000,000 from February 17, 1985 to August 31, 1986; and $1,000,000 prior to February 17, 1985. For its foreign operations, Hertz generally does not act as a self-insurer. Instead, Hertz purchases insurance to comply with local legal requirements from unaffiliated carriers. Effective January 1, 1993, motor vehicle liability insurance for claims arising on or after January 1, 1993, purchased locally from unaffiliated carriers by\nTHE HERTZ CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNote 1 - Summary of Significant Accounting Policies (continued)\nHertz owned operations in Europe, has been reinsured by Hertz International RE Limited (\"HIRE\"), a reinsurer in Dublin, Ireland. HIRE effectively responds to the first $1,500,000 of motor vehicle liability for each accident. Excess liability insurance coverage is maintained by Hertz with unaffiliated carriers, or through unaffiliated carriers with Ford.\nEffective January 1, 1993, the registrant adopted the provisions of Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (\"FAS No. 109\"), which requires the recognition of deferred tax assets, net of applicable reserves, related to net operating loss carryforwards and certain temporary differences. The changes made in FAS No. 109, as they relate to the registrant, did not have a material effect on the registrant's consolidated financial position, results of operations or cash flows.\nEffective April 30, 1994, the registrant and its domestic subsidiaries are filing consolidated Federal income tax returns with Ford. The registrant and its domestic subsidiaries filed consolidated Federal income tax returns after December 31, 1987; prior to that, from September 1, 1985 to December 31, 1987 they were included in the consolidated Federal income tax return of UAL, and prior thereto in the consolidated Federal income tax return of RCA. Pursuant to arrangements with Ford, UAL and RCA, the registrant provides for current and deferred taxes as if it filed a separate consolidated tax return with its domestic subsidiaries, except that if any items are subject to limitations in the registrant's consolidated return calculations, such as foreign tax credits, investment tax credits, capital losses and net operating losses, such limitations are determined on the basis of the entire Ford, UAL or RCA consolidated group, as appropriate. To the extent that items which would be subject to limitation at the registrant's consolidated return level are not limited in the Ford, UAL and RCA consolidated return, the registrant and its domestic subsidiaries receive credit for such items. The registrant and its subsidiaries account for investment tax credits under the flow-through method. As of December 31, 1995, U.S. income taxes have not been provided on $274 million in undistributed earnings of subsidiaries that have been or are intended to be permanently reinvested outside the United States or are expected to be remitted free of taxes.\nHertz is a party to a cooperative advertising agreement with Ford pursuant to which Ford participates in some of the cost of certain of Hertz' advertising programs in the United States and abroad which feature the Ford name or products. The amounts contributed by Ford for the years ended December 31, 1995, 1994 and 1993 were (in millions) $44.1, $42.0 and $40.3, respectively. This program will continue in the future.\nTHE HERTZ CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNote 1 - Summary of Significant Accounting Policies (continued)\nPension and Income Saving Plans -- substantially all domestic employees, after completion of specified periods of service, are eligible to participate in the Retirement Plan for the Employees of The Hertz Corporation (\"Hertz Retirement Plan\") and in the Income Savings Plan of The Hertz Corporation (\"Hertz Income Savings Plan\") as of August 30, 1985, and prior thereto in the Retirement Plan and in the Income Savings Plan of RCA. Payments are made to pension plans of others pursuant to various collective bargaining agreements. Under the Hertz Retirement Plan, through June 30, 1987 employees contributed a part of the cost of current-service benefits while Hertz contributed the remainder and all other costs under the projected unit credit cost method. Effective July 1, 1987, the Hertz Retirement Plan was revised to an \"Account Balance Pension Plan\" under which Hertz pays the entire cost and employees are no longer required to contribute. The normal retirement benefits are based on years of credited service and the five highest amounts of annual compensation during the employee's last ten years of credited service up to July 1, 1987. Effective July 1, 1987, the normal retirement benefit will be the value of their cash balance account accrued after July 1, 1987. Hertz' funding policy is to contribute at least the minimum amount required by the Employee Retirement Income Security Act of 1974. Under the Hertz Income Savings Plan, as explained below, Hertz contributes a fixed percentage of eligible employees' base salary. Employees may also elect to have Hertz contribute on their behalf, subject to a percentage limitation, any whole percentage of their base salary to the Plan, in lieu of being paid such salary in cash under a qualified cash or deferred arrangement described in Section 401(k) of the Internal Revenue Code. Prior to July 1, 1987, employees could also make their own contributions of their base salary, subject to a percentage limitation. Effective July 1, 1987, the Hertz Income Savings Plan was amended whereby Hertz contributes a percentage of eligible employees' salary only if the employee elects to contribute a portion of his\/her base salary. Hertz' contribution was 66% of the first 6% of the employee's contribution for a maximum Hertz match of 4% of the employee's base salary. Employee after tax contributions were eliminated. Effective January 1, 1988, the Plan was further amended to change Hertz' contribution from 66% to 50% of the first 6% of the employee's contribution for a maximum Hertz match of 3% of the employee's base salary. Effective July 1, 1991, Hertz' contribution was suspended and was resumed on January 1, 1992.\nMost of the registrant's foreign subsidiaries have defined benefit retirement plans or are required to participate in government plans. These plans are all funded, except in Germany, where an unfunded liability is recorded. In certain countries, when the subsidiaries make the required funding payments, they have no further obligations under such plans.\nThe American Institute of Certified Public Accountants issued in December 1993 Statement of Position No. 93-7, which requires, effective for financial statements for years beginning after June 15, 1994, that advertising costs be expensed in the periods in which those costs are incurred, or the first time the advertising takes place. Implementation of this statement did not have a material effect on Hertz' consolidated financial position, results of operations or cash flows.\nUse of estimates and assumptions as determined by management is required in the preparation of consolidated financial statements in conformity with generally accepted accounting principles. Actual results could differ from those estimates and assumptions. Certain amounts for prior periods have been reclassified to conform with 1995 presentations.\nTHE HERTZ CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNote 2 - Debt\nDebt of the registrant and its subsidiaries (in thousands of dollars) consists of the following:\nTHE HERTZ CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNote 2 - Debt (continued)\nThe aggregate amounts of maturities of debt, in millions, are as follows: 1996, $2,013.1 (including $1,783.4 of commercial paper, demand and other short-term borrowings); 1997, $214.9; 1998, $371.6; 1999, $349.7; 2000, $249.7; after 2000, $1,098.5.\nDuring the year ended December 31, 1995, short-term borrowings, in millions, were as follows: maximum amounts outstanding $1,853.8 commercial paper, $1,083.5 banks and $193.5 other; monthly average amounts outstanding $1,292.6 commercial paper (weighted average interest rate 6.1%), $828.2 banks (weighted average interest rate 6.4%) and $108.6 other (weighted average interest rate 4.3%).\nDuring the year ended December 31, 1994, short-term borrowings, in millions, were as follows: maximum amounts outstanding $1,021.3 commercial paper, $1,247.6 banks and $194.1 other; monthly average amounts outstanding $659.9 commercial paper (weighted average interest rate 4.9%), $975.5 banks (weighted average interest rate 5.8%) and $95.5 other (weighted average interest rate 5.3%).\nDuring the year ended December 31, 1993, short-term borrowings, in millions, were as follows: maximum amounts outstanding $769.7 commercial paper, $940.1 banks and $48.0 other; monthly average amounts outstanding $287.5 commercial paper (weighted average interest rate 3.3%), $722.4 banks (weighted average interest rate 6.9%) and $25.2 other (weighted average interest rate 7.8%).\nThe net amortized discount charged to interest expense for the years ended December 31, 1995, 1994 and 1993 relating to debt and other liabilities was $.9 million, $1.3 million and $1.8 million, respectively. In addition, interest expense for the years 1995, 1994 and 1993 was reduced by $1.3 million, $1.6 million and $8.2 million, respectively, of interest income, relating to refunds of prior years' state, local and federal income taxes.\nIn 1994, the registrant entered into the following two committed bank facilities with a group of twenty-nine commercial banks, which will be utilized to support commercial paper and other short-term borrowings in the aggregate amount of $1.75 billion: (i) five year credit agreement for $1 billion is committed until June 30, 2000. The termination date is automatically extended for an additional one-year period each June 30, unless the bank gives notice to the contrary. A commitment fee of .125% per annum is payable on the unused available credit; and (ii) 364-day credit agreement for $751 million, renewed in June 1995, is committed until June 27, 1996. A commitment fee of .065% per annum is payable on the unused available credit.\nThe registrant also entered into a revolving loan agreement with Ford on June 8, 1994 under which the registrant may borrow from Ford from time to time up to $250 million outstanding at any one time. Obligations of the registrant under this agreement would rank pari passu with the registrant's senior debt securities. This agreement by its terms expires on June 30, 1999, on which date any amounts then outstanding thereunder are required to be repaid. A commitment fee of .125% per annum is payable on the unused available credit. In addition, at December 31, 1995, the registrant and a subsidiary had $268.9 million of outstanding loans from Ford.\nTHE HERTZ CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNote 2 - Debt (continued)\nHertz had consolidated unused lines of credit subject to customary terms and conditions, which includes unused amounts under the three facilities indicated above, of approximately $2.8 billion at December 31, 1995.\nThe terms of the registrant's loan agreements limit the payment of cash dividends. At December 31, 1995, approximately $158 million of consolidated shareholders' equity was free of such limitations.\nNote 3 - Foreign Currency\nForeign currency exchange gains and losses included in net income were net gains of $2.0 million, $1.2 million and $1.4 million for the years ended December 31, 1995, 1994 and 1993, respectively. The cumulative translation charge adjustment at December 31, 1992 was $12.5 million. The net translation credit adjustments were $19.8 million and $23.5 million for the years ended December 31, 1995 and 1994, respectively. The net translation charge adjustment was $16.3 million for the year ended December 31, 1993.\nNote 4 - Available-for-Sale Securities\nEffective January 1, 1994, the registrant adopted the provisions of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\", which requires a more detailed disclosure of debt and equity securities held for investment, the methods to be used in determining fair value, and when to record unrealized holding gains and losses in earnings or in a separate component of shareholders' equity.\nAs of December 31, 1995, Prepaid Expenses and Other Assets in the consolidated balance sheet include available-for-sale securities at fair value of $5.8 million (cost $5.7 million). The fair value is calculated using information provided by outside quotation services. These securities include various governmental and corporate debt obligations, with the following maturity dates (in millions): fair value $.3 (cost $.3) in 1996; fair value $5.3 (cost $5.2) 1997 through 2001; fair value $.2 (cost $.2) 2002 through 2014. For the year ended December 31, 1995, proceeds of $6.6 million from the sale of available-for-sale securities were received, and a gross realized gain of $161,555 and gross realized loss of $56,647 were included in earnings. Actual cost was used in computing the realized gain and loss on the sale. For the year ended December 31, 1995, unrealized holding losses and unrealized holding gains, net of taxes, included in Shareholders' Equity were $26,000 and $126,000, respectively.\nTHE HERTZ CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNote 5 - Acquisitions\nIn 1992, the registrant entered into a lease agreement with a third party lessor, Hertz Funding Corp. (\"HFC\"), providing for the lease of vehicles purchased by HFC under a repurchase program offered by Ford. Under the lease, which was accounted for as an operating lease, the registrant made payments equal to the monthly depreciation and all expenses (including interest) of the third party lessor and was responsible for the remaining net cost on any vehicles that became ineligible under the repurchase program. At October 31, 1994, the net cost of the vehicles leased under this agreement was approximately $300 million. On November 1, 1994, the registrant acquired all of the issued and outstanding shares of HFC from PAZ ABS Corp. (an entity unaffiliated with the registrant or any of its subsidiaries) for the purpose of winding-down the activities of HFC. Commencing in November 1994, the accounts of HFC have been included in the consolidated financial statements of the registrant, which did not have a material effect on the registrant's consolidated financial position or results of operations.\nOn July 31, 1994, Axus, S.A., a car leasing company of the registrant which operates in various countries in Europe, acquired an additional interest in Locaplan S.A., a car leasing operation in France, increasing its ownership from 50% to 100%. The cost relating to this acquisition approximated $2.3 million, which exceeded the net assets acquired by approximately $2.2 million. Commencing in August 1994, the accounts of this operation have been included in the consolidated financial statements of the registrant, which did not have a material effect on the registrant's consolidated financial position or results of operations. These operations were sold by the registrant effective January 1, 1995 (see Note 14).\nIn connection with the acquisition of the registrant by Park Ridge in December 1987 and UAL in August 1985, the excess of the purchase price over the consolidated equity of the registrant at the time of these purchases was $658.3 million. These costs are being amortized by the registrant over 40 years. The unamortized amount of such costs at December 31, 1995 was $517.8 million.\nTHE HERTZ CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNote 6 - Pension and Income Savings Plans and Postretirement Benefit Plans\nThe following tables set forth the funded status and the net periodic pension cost of the Hertz Retirement Plan covering its domestic (\"U.S.\") employees and the retirement plans for foreign operations (\"Non-U.S.\") and amounts included in the consolidated balance sheet and statement of income (in millions of dollars):\nSignificant assumptions used for the U.S. plan were as follows: weighted average discount rate of 7.0% at December 31, 1995, 8.25% during 1995 (7% during 1994 and 7-3\/4% during 1993); 5.1% rate of increase in future compensation levels (5.5% for 1994 and 6.4% for 1993); and expected long-term rate of return on assets of 9%. Assumptions used for the Non-U.S. plans vary by country and are made in accordance with local conditions, but do not vary materially from those used in the U.S. plan. Plan assets consist principally of investments in stocks, government bonds and other fixed income securities.\nTHE HERTZ CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNote 6 - Pension and Income Savings Plans and Postretirement Benefit Plans (continued)\nThe provisions charged to income for the years ended December 31, 1995, 1994 and 1993 for all other pension plans were approximately (in millions) $6.1, $6.0 and $5.6, respectively.\nThe provisions charged to income for the years ended December 31, 1995, 1994 and 1993 for the Hertz Income Savings Plan were approximately (in millions) $3.4, $3.0 and $2.6, respectively.\nThe estimated cost for postretirement health care and life insurance benefits is accrued on an actuarially determined basis. The following sets forth the plans' status, reconciled with the amounts included in the consolidated balance sheet and statement of income (in millions):\nThe significant assumptions used for the postretirement benefit plans were as follows: weighted average discount rate of 7.25% at December 31, 1995, 8.75% during 1995 (7.5% in 1994 and 7.0% in 1993), 5.3% rate of increase in future compensation levels (5.5% in 1994 and 6.4% in 1993), 8.3% weighted average health care cost trend rate through 2000 (9% in 1994 and 10% in 1993), and 7.5% weighted average trend rate in ten years (8% in 1994 and 8.6% in 1993). Changing the assumed health care cost trend rates by one percentage point in each year would change the accumulated postretirement benefit obligation as of December 31, 1995 by approximately $550,000, and the aggregate service and interest cost components of net periodic postretirement benefit cost for 1995 by approximately $70,000.\nTHE HERTZ CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNote 7 - Revenue Earning Equipment\nRevenue earning equipment is used in the rental of vehicles and construction equipment and the leasing of vehicles under closed-end leases where the disposition of the vehicles upon termination of the lease is for the account of Hertz. Revenue is recorded when it becomes receivable and expenses are recorded as incurred. Hertz' domestic revenue earning vehicles include approximately 65% Ford products, which are acquired from dealers who are independent from Ford. The percentage of Ford products acquired by Hertz is expected to continue at approximately this level in the future, pursuant to a long-term supply contract between the registrant and Ford. Hertz purchases the vehicles from Ford dealers at competitive prices.\nUnder operating leases, aggregate minimum future rentals for vehicles leased at December 31, 1995 are receivable approximately as follows (in millions): $29 in 1996, $18 in 1997, $7 in 1998, and $1 in 1999. Vehicles under lease at December 31, 1995 which are owned by Hertz amounted to $80 million, net of accumulated depreciation of $22 million.\nThe average holding periods of vehicles and other revenue earning equipment are as follows: car rental vehicles 5 to 8 months, car leasing vehicles 36 months, and other equipment 18 to 60 months. At December 31, 1995, the average ages of owned vehicles and other revenue earning equipment are as follows: car rental vehicles 5-1\/2 months, car leasing vehicles 18 months, and other equipment 21 months. At December 31, 1995, approximately 15% of owned vehicles and all other revenue earning equipment were \"at risk.\"\nDepreciation of revenue earning equipment includes the following (in thousands of dollars):\nTHE HERTZ CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNote 7 - Revenue Earning Equipment (continued)\nEffective July 1, 1994, certain lives being used to compute the provision for depreciation of revenue earning equipment were increased to reflect changes in the estimated residual values to be realized when the equipment is sold. As a result of this change, depreciation of revenue earning equipment for the years 1995 and 1994 were decreased by $12.0 million and $9.6 million, respectively.\nThe adjustment of depreciation upon disposal of revenue earning equipment for the years ended December 31, 1995, 1994, and 1993 included (in millions) net gains of $13.8, $13.2 and $16.1, respectively, on the sale of equipment in the construction equipment rental operations in the United States; net losses of $7.5 and net gains of $9.8, and $7.9, respectively, in the car rental and car leasing operations; and in 1993, credits of $4.1 resulting from valuing pre-acquisition assets on a net of tax basis.\nAs of December 31, 1995 and 1994, Ford owed Hertz $358.6 million and $352.9 million, respectively, in connection with various vehicle repurchase and warranty programs. As of December 31, 1995 and 1994, Hertz owed Ford $9.4 million and $41.4 million, respectively, (included under Accounts Payable in the consolidated balance sheet) in connection with vehicles purchased. These transactions were made and are being paid in the ordinary course of business.\nDuring the year ended December 31, 1995, the registrant purchased Ford vehicles at a cost of approximately $4.1 billion, and sold Ford vehicles to Ford or its affiliates under various repurchase programs for approximately $3.1 billion.\nTHE HERTZ CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNote 8 - Taxes on Income\nThe provision for taxes on income consists of the following (in thousands of dollars):\nTHE HERTZ CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNote 8 - Taxes on Income (continued)\nThe principal items in the deferred tax liability at December 31, 1995 and 1994 are as follows (in thousands of dollars):\nThe tax operating loss carryforwards at December 31, 1995 of $5.4 million relate to certain foreign operations and have no expiration dates. It is anticipated that such operations will become profitable in the future and the carryforwards will be fully utilized.\nAs of December 31, 1995, the alternative minimum tax credit carryforwards of $41.6 million (which has no expiration date) will be utilized upon reversal of timing differences and against future taxable income.\nAs of December 31, 1995, the foreign tax credit carryforwards of $11.3 million ($.3 million will expire in 1999 and $11.0 million in 2000) is anticipated to be utilized through the consolidated Federal income tax returns filed with Ford.\nTHE HERTZ CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNote 8 - Taxes on Income (continued)\nThe principal items accounting for the difference in taxes on income computed at the U.S. statutory rate of 35% and as recorded are as follows (in thousands of dollars):\nTHE HERTZ CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNote 9 - Lease and Concession Agreements\nHertz has various concession agreements which provide for payment of rents and a percentage of revenue with a guaranteed minimum and real estate leases under which the following amounts were expensed (in thousands of dollars):\nAs of December 31, 1995 minimum obligations under existing agreements referred to above are approximately as follows (in thousands of dollars):\nIn addition to the above, Hertz has various leases on vehicles and office and computer equipment under which the following amounts were expensed (in thousands of dollars):\nAs of December 31, 1995, minimum obligations under existing agreements referred to above that have a maturity of more than one year are as follows (in thousands): office and computer equipment 1996, $5,771; 1997, $2,944; 1998, $498; 1999, $63; 2000, $27.\nTHE HERTZ CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNote 10 - Segment Information\nHertz' business consists of two significant segments: Rental and leasing of automobiles and certain other activities (\"car rental\"); and rental, leasing, and sales of construction and materials handling equipment (\"construction equipment rental and sales\"). The contributions of these segments to revenues are indicated in the Consolidated Statement of Income. The contribution of these segments to other financial data (in millions of dollars) are as follows:\nTHE HERTZ CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNote 10 - Segment Information (continued)\nHertz operates in the United States and in foreign countries. The operations within major geographic areas are summarized as follows (in millions of dollars):\nNote 11 - Litigation\nVarious legal actions, governmental investigations and proceedings, and claims are pending or may be instituted or asserted in the future against the registrant and its subsidiaries. Litigation is subject to many uncertainties, and the outcome of individual litigated matters is not predictable with assurance. It is reasonably possible that certain of the actions, investigations or proceedings could be decided unfavorably to the registrant or the subsidiary involved. Although the amount of liability at December 31, 1995 with respect to these matters cannot be ascertained, such liability could approximate up to $1 million (net of income tax benefits), and the registrant believes that any resulting liability should not materially affect the consolidated financial position, results of operations or cash flows of the registrant.\nOn January 9, 1995, Newark International Airport, in Newark, N.J., suffered an electrical outage that caused significant operational problems for one day due to a construction accident that occurred on the registrant's property. A subcontractor of the registrant was involved in this accident. The registrant believes that it has adequate defenses, indemnities and insurance coverage against existing and anticipated litigation.\nTHE HERTZ CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNote 12 - Quarterly Financial Information (Unaudited)\nA summary of the quarterly operating results during 1995 and 1994 were as follows (in thousands):\nEffective July 1, 1994, certain lives being used to compute the provision for depreciation of revenue earning equipment were increased to reflect changes in the estimated residual values to be realized when the equipment is sold. As a result of this change, pretax income before interest includes credit adjustments of $10.8 million in the first quarter of 1995 and $1.2 million in the second quarter of 1995 as a result of decreasing depreciation of revenue earning equipment.\nThe tax provision in the fourth quarter of 1995 includes $6.5 million credits relating to foreign taxes paid which is anticipated to be offset against U.S. income tax liabilities.\nThe tax provision in the fourth quarter of 1994 includes a $1.5 million credit resulting from adjustments made to tax accruals in connection with tax audit evaluations and the effects of prior years' tax sharing arrangements between the registrant and its former parent company, RCA.\nTHE HERTZ CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNote 13 - Financial Instruments and Commitments\nFinancial instruments which potentially subject the registrant to concentrations of credit risk consist principally of cash equivalents and trade receivables. The registrant places its cash equivalents with financial institutions and limits the amount of credit exposure to any one financial institution. Concentrations of credit risk with respect to trade receivables are limited due to the large number of customers comprising the registrant's customer base, and their dispersion across different businesses and geographic areas. As of December 31, 1995, the registrant had no significant concentration of credit risk.\nCash and equivalents -- fair value approximates cost indicated on the balance sheet at December 31, 1995, because of the short-term maturity of these instruments.\nDebt -- fair value is estimated based on quoted market rates as well as borrowing rates currently available to the registrant for loans with similar terms and average maturities. Carrying value was used as fair value for borrowings with an initial maturity of 92 days or less. The fair value of all debt at December 31, 1995 approximated $4.4 billion compared to carrying value of $4.3 billion.\nPublic Liability and Property Damage -- provisions for public liability and property damage on self-insured domestic claims and reinsured foreign claims are made by charges to expense based upon evaluations of estimated ultimate liabilities on reported and unreported claims. These liabilities are anticipated to be paid in the future which range between one and five years. The present (fair) value of these liabilities at December 31, 1995 approximates $284 million compared to carrying value of $312 million.\nThe registrant and its subsidiaries have entered into arrangements to manage exposure to fluctuations in interest rates. These arrangements consist of interest-rate swap agreements (\"swaps\") and forward rate agreements (\"FRAs\"). The differential paid or received on these agreements is recognized as an adjustment to interest expense. These agreements are not entered into for trading purposes. The effect of these agreements is to make the registrant less susceptible to changes in interest rates by effectively converting certain variable rate debt to fixed rate debt. Because of the relationship of current market rates to historical fixed rates, the effect at December 31, 1995 of the swap and FRA agreements is to give the registrant an overall effective weighted-average rate on debt of 6.94%, with 31% of debt effectively subject to variable interest rates, compared to a weighted-average interest rate on debt of 6.89%, with 42% of debt subject to variable interest rates when not considering the swap and FRA agreements. At December 31, 1995, these agreements expressed in notional amounts aggregated (in millions) $420.3 swaps, and FRAs in the amount of $31.7 which were settled in 1995. Notional amounts are not reflective of the registrant's obligations under these agreements because the registrant is only obligated to pay the net amount of interest rate differential between the fixed and variable rates specified in the contracts. The registrant's exposure to any credit loss in the event of non-performance by the counterparties is further\nTHE HERTZ CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNote 13 - Financial Instruments and Commitments (continued)\nmitigated by the fact that all of these financial instruments are with significant financial institutions that are rated \"A\" or better by the major credit rating agencies. At December 31, 1995, the fair value of all outstanding contracts, which is representative of the registrant's obligations under these contracts, assuming the contracts were terminated at that date, was approximately a net payable of $4.8 million on the swaps. This relates to notional principal (in millions) of $420.3 swaps maturing $156.6, $233.8, $19.8 and $10.1 in 1996, 1997, 1998 and 1999, respectively; and of notional principal scheduled to start after December 31, 1995 of $13.4 swaps maturing $1.2, $.6, $.4 and $11.2 in 1996, 1997, 1998 and 1999, respectively.\nNote 14 - Sale of European Car Leasing and Car Dealership Operations\nEffective January 1, 1995, the registrant sold its European car leasing and car dealership operations to Hertz Leasing International, Inc. (\"HLI\"), at an amount equal to its book value of approximately $61 million. HLI is wholly owned by Ford. In addition, except for Australia and New Zealand, Ford has received the worldwide rights (subject to certain existing license rights) to use and sublicense others to use the \"Hertz\" name in the conduct of motor vehicle leasing businesses, and has agreed to pay the registrant a license fee payable over five years -- $9.3 million was received for the year 1995. The unaudited total assets as of December 31, 1994 and unaudited total revenues and net income for the year ended December 31, 1994 of the registrant's European car leasing and car dealership operations were (in millions) $482, $295 and $6, respectively. The registrant believes that this transaction will not have a material effect on its financial position or future operations.\nAt December 31, 1995, a foreign subsidiary of the registrant had $30.1 million loan receivables and related interest from foreign subsidiaries of HLI, which will be repaid in 1996 and 1997.\nNote 15 - Impairment of Long-Lived Assets and Certain Identifiable Intangibles\nThe registrant evaluates the carrying value of goodwill for potential impairment on an ongoing basis. Such evaluations compare operating income before amortization of goodwill to the amortization recorded for the operations to which the goodwill relates. The registrant also considers projected future operating results, trends and other circumstances in making such estimates and evaluations.\nStatement of Financial Accounting Standards No. 121 (\"FAS 121\"), \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,\" was issued in March 1995. FAS 121 requires that, effective January 1, 1996, long-lived assets and certain identifiable intangibles to be held and used by an entity be reviewed for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. It also requires that long-lived assets and certain identifiable intangibles to be disposed of be reported at the lower of carrying amount or fair value less cost to sell. The effect of adopting FAS 121 is not expected to have a material effect on the registrant's consolidated financial position, results of operations or cash flows.\nSCHEDULE II\nTHE HERTZ CORPORATION AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (IN THOUSANDS OF DOLLARS)\n(a) Amounts written off, net of recoveries. The year 1995 includes $2 million, which represents the balance at December 31, 1994 relating to the European Car Leasing and Car Dealership operations sold by the registrant effective January 1, 1995.\n(b) Payments of claims and expenses.\nINDEX TO EXHIBITS -----------------","section_15":""}
{"filename":"785860_1995.txt","cik":"785860","year":"1995","section_1":"Item 1. Business.\nAetna Real Estate Associates, L.P. (the \"Registrant\") is a limited partnership organized under the laws of the State of Delaware on September 11, 1986. The general partners of the Registrant (the \"General Partners\") are Aetna\/AREA Corporation (\"Aetna\/AREA\"), a Connecticut corporation that is an affiliate of Aetna Life and Casualty Company (\"Aetna\"), and AREA GP Corporation (\"AREA GP\"), a Delaware corporation that is an affiliate of Lehman Brothers Inc. (\"Lehman\").\nFrom March 1986 through December 31, 1990, the Registrant offered up to $300,000,000 of units which represent the economic rights attributable to limited partnership interests in the Registrant (\"Units\") through an ongoing public offering (the \"Primary Offering\") and an additional $30,000,000 of Units pursuant to the Registrant's Distribution Reinvestment Plan (the \"DRIP\"). In addition, in conjunction with the Primary Offering, certain holders of Units (the \"Selling Unitholders\") offered up to $30,000,000 of Units (the \"Remarketing Opportunity\"). Since January 1, 1991, the Registrant has not offered Units for sale in the Primary Offering, the Remarketing Opportunity, or the DRIP. The Registrant received an aggregate of $265,521,423 of capital contributions from the sale of 12,724,547 Units. The Registrant does not anticipate raising additional capital through the sale of Units.\nThe Registrant is engaged in the business of investing in income-producing apartment complexes, office buildings, shopping centers and other commercial real estate offered by non-affiliated sellers (\"Properties\"). All investments in Properties that the Registrant has made are referred to herein collectively as \"Investments in Properties\". The Registrant acquired its interests in Investments in Properties either directly or through joint ventures or other partnerships that own Properties. The Registrant has acquired all of its interests in Properties entirely with cash.\nAs of December 31, 1995, the Registrant held 13 Investments in Properties at a total cost of approximately $239.9 million. (See Item 2","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nAs of December 31, 1995, the Registrant held 13 Investments in Properties.\n(in thousands) Historical Property Cost (1)\nCross Pointe Centre $ 22,261 Lincoln Square Apartments 13,458 Gateway Square 7,346 Summit Village 37,183 Village Square Shopping Center 8,109 Marina Bay Industrial Park 10,880 Town Center Business Park 41,865 Oakland Pointe Shopping Center 22,643 115 & 117 Flanders Road 12,267 Three Riverside Drive 10,122 Windmont Apartments 7,834 Powell Street Plaza 31,829 Westgate Distribution Center 14,146 Total $239,943\n(1) Historical cost is before accumulated depreciation and may not equal cash invested because of certain adjustments based on the application of generally accepted accounting principles. For historical cost purposes, properties are recorded at the lower of cost net of impairment write-down or estimated fair value. At December 31, 1995, an impairment loss was recorded for approximately $4,408,000. (See Footnote 3 to the consolidated financial statements.)\nThe Registrant determines the current value of each of its Investments in Properties quarterly based on independent appraisals of the underlying real estate using generally accepted valuation techniques. These appraisals are used to determine Net Asset Value per Unit on a quarterly basis and to prepare the Registrant's current value financial statements.\nEach appraisal is based on numerous assumptions, limiting conditions and valuation techniques utilized by the independent appraisers retained by the Registrant. Two of the many assumptions utilized by the appraisers are the terminal capitalization rate and the discount rate. The terminal capitalization rate is used to estimate the reversionary proceeds to be received from the assumed sale of an investment at the end of a typical holding period. The discount rate is used to determine the net present value of the estimated annual cash flows of an investment, including the residual proceeds, over the holding period. Terminal capitalization rates utilized in the appraisals of the Investments in Properties at December 31, 1995 ranged from 9.00% to 10.00%. Discount rates utilized in the appraisals of the Investments in Properties at December 31, 1995 ranged from 11.50% to 13.00%.\nCurrent Properties A brief description of all Investments in Properties is set forth below. Neither the Registrant, if it owns a Property directly, nor any joint venture or partnership in which the Registrant has invested, have incurred any debt to acquire or maintain any of the Properties.\nCross Pointe Centre\nThe Registrant owns Cross Pointe Centre, a community shopping center with approximately 211,345 square feet of net rentable space, located on a 25.8-acre site in Centerville, Ohio. As of December 31, 1995, the shopping center was 90% leased and 85% occupied.\nLincoln Square Apartments\nOn November 14, 1986, the Registrant acquired a controlling general partnership interest in a limited partnership which owns the Lincoln Square Apartments, a 240-unit apartment project on a 12.7-acre site located in Arlington Heights, Illinois. Effective December 1, 1993 the Registrant acquired its partner's interest in Lincoln Square Apartments and now owns 100% of the property. As of December 31, 1995, the project was 97% leased and 95% occupied.\nGateway Square\nThe Registrant owns Gateway Square, a specialty retail center located in Hinsdale, Illinois. The center contains approximately 40,366 square feet of rentable space on a 3.7-acre site. As of December 31, 1995, the retail center was 98% leased and occupied.\nSummit Village\nThe Registrant owns Summit Village, a 366-unit apartment complex built in two phases on a 6.2-acre site in the Rosslyn area of Arlington County, Virginia. Historical leasing and occupancy information with respect to Summit Village for the five most recent years is as follows:\nLeased Occupied 12\/31\/91 94% 92% 12\/31\/92 99% 96% 12\/31\/93 96% 94% 12\/31\/94 99% 98% 12\/31\/95 99% 99%\nThe current leases generally have terms of seven or twelve months at monthly rental rates ranging from $945 to $1,349 per unit.\nThere are plans to construct a second phase to Meridian Courthouse, an indirect competitor, which is located less than one mile from Summit Village. The proposed midrise will include 316 additional apartment units. Construction has begun and completion is scheduled for the end of 1996. Rents will be the same as the existing tower at Meridian, which are significantly higher than Summit Village. Leasing is anticipated to begin in late spring 1996.\nMarina Bay Industrial Park\nThe Registrant owns a controlling general partnership interest in a limited partnership that owns the Marina Bay Industrial Park, a 165,780 square foot industrial park located in Richmond, California on an 8.6-acre site. The Marina Bay Industrial Park is a four-building complex that includes a rehabilitated industrial distribution building (approximately 103,680 square feet) and three newer research\/development\/light industrial buildings (approximately 62,100 square feet). As of December 31, 1995, the complex was 98% leased and occupied.\nVillage Square Shopping Center\nThe Registrant owns Village Square Shopping Center, a community shopping center in Hazelwood, Missouri containing approximately 207,304 square feet of net rentable area on approximately 20 acres of land. As of December 31, 1995, the shopping center was 63% leased and 35% occupied.\nA tenant with a lease totaling 22,282 square feet, included in the leased percentage above, vacated the property during 1992 but continues to pay rent until 1997 when the lease expires. Another tenant, who occupied approximately 36,000 square feet vacated its space during 1995. At this time, the General Partner is considering options for the future strategy of this property. Part of this strategy includes a change in the property management firm, effective in April 1996.\nTown Center Business Park\nThe Registrant owns a controlling interest in a general partnership which owns and operates the Town Center Business Park, totaling approximately 456,700 square feet of net rentable area on approximately 28 acres in Santa Fe Springs, California. Town Center Business Park was developed in two phases. Phase I consists of a three-story office building and six industrial buildings totaling approximately 322,700 rentable square feet. Phase II, which opened in February 1990, consists of a two-story office\/service building and two industrial buildings containing approximately 134,000 square feet.\nDuring 1996, ten leases covering 10% of the space in Town Center Business Park are scheduled to expire. Contact has been made with all tenants and renewal discussions are currently underway with five of them. The Registrant anticipates that tenants holding leases for 6% of the space will renew their leases and 4% will vacate the property. Also the Registrant is currently negotiating a lease with a current tenant in the park to expand into approximately 1% of space in Town Center Business Park.\nTown Center Business Park has no single tenant which occupies 10% or more of the rentable square footage. During 1997 and 1998, twelve and eight leases, respectively, are scheduled to expire covering 18% and 6%, respectively, of the space in Town Center Business Park.\nHistorical leasing and occupancy information with respect to Town Center Business Park for the five most recent years is as follows:\nLeased Occupied 12\/31\/91 81% 71% 12\/31\/92 87% 66% 12\/31\/93 67% 62% 12\/31\/94 76% 74% 12\/31\/95 84% 72%\nAverage annualized rental rates for December 1995 were $10.87 per square foot as compared to $10.75 per square foot in December 1994 and $10.62 per square foot for December 1993.\nOakland Pointe Shopping Center\nThe Registrant owns a portion of the Oakland Pointe Shopping Center, a shopping center containing approximately 434,150 square feet located on 49.8 acres in Pontiac, Michigan. The portion owned by the Registrant (the \"Oakland Project\") contains approximately 213,350 square feet of rentable area on approximately 32.1 acres. As of December 31, 1995, the Oakland Project was approximately 89% leased and occupied.\nDuring 1996, three leases covering 4% of the space in Oakland Pointe Shopping Center are scheduled to expire. Contact has been made with each of the tenants. One is expected to terminate, one has executed a renewal and final negotiations are underway with the last tenant. The Registrant is also negotiating a lease with one new tenant to occupy approximately 1% of the space in Oakland Pointe Shopping Center.\nDuring 1997 and 1998 three and eleven leases, respectively, are scheduled to expire covering 9% and 33% of the space, respectively.\nOakland Pointe Shopping Center has two tenants which occupy 10% or more of the rentable square footage. A lease for 27,001 square feet expires in 1998 and provides annual base rent of $189,007 (10% of total base rent) in 1996. Another lease for 27,060 square feet expires in 2004 and provides annual base rent of $216,480 (11% of total base rent) in 1996.\nHistorical leasing and occupancy information with respect to Oakland Pointe Shopping Center for the five most recent years is as follows:\nLeased Occupied 12\/31\/91 83% 81% 12\/31\/92 84% 84% 12\/31\/93 74% 74% 12\/31\/94 90% 90% 12\/31\/95 89% 88%\nAverage annualized rental rates for December 1995 were $13.45 per square foot.\n115 and 117 Flanders Road\nThe Registrant owns 115 and 117 Flanders Road, two buildings containing approximately 115,175 square feet of net rentable area and located on approximately 26.6 acres in Westborough, Massachusetts. Each building has a two-story office\/research and development section and a one-story office\/warehouse section. As of December 31, 1995, 115 Flanders was 100% leased and occupied, while 117 Flanders was 30% leased and occupied. The low occupancy at 117 Flanders Road is attributable to the early termination of a lease for a major tenant occupying 70% of the property. As a result, a lease termination fee of approximately $115,000 was received in November 1995. The space is currently being marketed to potential replacement tenants however, no lease negotiations have commenced as of March 15, 1996.\nThree Riverside Drive\nThe Registrant owns Three Riverside Drive, an office\/research and development building containing approximately 91,350 square feet of rentable area located on approximately 8.8 acres in Andover, Massachusetts. As of December 31, 1995, the building was 79% leased and occupied. The change in occupancy from 95% as of December 31, 1994 to the current 79% is attributable to the early termination of a lease for a tenant. As a result, a lease termination fee of approximately $171,000 was received in September 1995. The space is currently being marketed to potential replacement tenants however, no lease negotiations have commenced as of March 15, 1996.\nWindmont Apartments\nThe Registrant owns Windmont Apartments, a 178-unit apartment complex which is located on 6.8 acres in DeKalb County, Georgia. As of December 31, 1995, the complex was approximately 99% leased and 97% occupied.\nPowell Street Plaza\nThe Registrant owns Powell Street Plaza, a shopping center with approximately 169,551 square feet of rentable space, located on approximately 12.9 acres in Emeryville, California.\nCertain governmental agencies in California, led by the Alameda County Healthcare Services Agency, delivered a letter (the \"Request Letter\") to the Registrant on June 4, 1993 requiring that it remediate certain soil and ground water contamination by petroleum hydrocarbons existing on the Powell Street property. The contamination is the result of a use of the property prior to its acquisition by the Registrant in 1990. Pursuant to the agreement under which the Registrant acquired Powell Street Plaza, the Registrant has made a demand on the former owner from which it acquired the property (the \"Former Owner\") to remediate the contamination. The Former Owner has agreed to respond to the governmental agencies. The Former Owner prepared a site characterization and submitted a remediation plan to the Alameda County Healthcare Services Agency, which have been approved. The Registrant is monitoring the process and anticipates that all costs of complying with the Request Letter will be borne by the Former Owner. The Registrant has hired their own consultant to analyze the extent of the pollution and the most likely method to perform the cleanup. The consultant's analysis will be used as a benchmark for gauging future progress by the Former Owner.\nIn each of the years 1996 and 1997 there is one lease scheduled to expire covering 1.4% and .1%, respectively, of the space in Powell Street Plaza. Six leases expire in 1998 covering 13% of the space in Powell Street Plaza. Additionally, subsequent to December 31, 1995, one tenant, occupying 3.7% of the space, terminated its lease. Negotiations have commenced with potential replacement tenants for this space, including potential expansion by existing tenants.\nPowell Street Plaza has two tenants with leases covering 10% or more of the rentable square footage of the property. The first lease, for 27,275 square feet, expires in 2009 and provides annual base rent of $358,666 (13% of total rent) in 1996. The lease contains two consecutive five-year options to renew. The second lease, for 25,025 square feet, expires in 2003 and provides annual base rent of $287,788 (11% of total rent) in 1996. The lease contains four consecutive five-year options to renew.\nHistorical leasing and occupancy information with respect to Powell Street Plaza for the five most recent years is as follows:\nLeased Occupied 12\/31\/91 100% 95% 12\/31\/92 100% 100% 12\/31\/93 100% 86% 12\/31\/94 100% 100% 12\/31\/95 100% 100%\nAverage annualized rental rates for December 1995 were $15.67 per square foot as compared to $15.28 per square foot for December 1994 and $14.20 per square foot for December 1993.\nThe trade area gained a major new development at the East Bay Bridge site, a 450,000 square foot power center about one mile from Powell Street. The property opened with a Home Depot, Sportmart and Toys R Us. The only direct competition is with Powell Street Plaza's Copeland Sports.\nOn December 21, 1995 approximately 12,100 square feet of land at Powell Street Plaza was condemned, for purposes of road construction, by the State of California Department of Transportation. Net proceeds to the Registrant were approximately $271,000, after paydown of a portion of the City's special assessment. Loss on the sale included in the consolidated financial statements was approximately $23,000 for the year ended December 31, 1995.\nWestgate Distribution Center\nThe Registrant owns Westgate Distribution Center, which consists of three warehouse\/distribution buildings totaling approximately 430,300 rentable square feet on 20.6 acres in Corona, California. Westgate Distribution Center was developed in two phases. Phase One consists of two buildings containing approximately 226,200 rentable square feet. Phase Two consisted of two parcels, one containing a 98,000 square foot building constructed during 1994 and the other containing a 96,400 square foot building constructed in December 1992, and sold to its tenant in October 1994. The three remaining buildings were 100% leased and occupied as of December 31, 1995.\nProperties Sold During 1995\nOn December 21, 1995 approximately 12,100 square feet of land at Powell Street Plaza was condemned, for the purpose of road construction, by the State of California Department of Transportation. Net proceeds to the Partnership were approximately $271,000, after paydown of a portion of the City's special assessment. Loss on the sale included in the consolidated financial statements was approximately $23,000 for the year ended December 31, 1995.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nNeither the Registrant nor any of the Registrant's Investments in Properties are 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 fiscal year ended December 31, 1995, 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 Common Equity and Related Stockholder Matters.\nThe Units represent the economic rights attributable to limited partnership interests in the Registrant. There is no established public trading market for the Units. The Registrant's Units are listed on certain matching services (the \"Matching Programs\") currently maintained by various broker-dealers. These Matching Programs are computerized listing systems that put individuals who wish to sell listed securities in contact with persons who wish to buy such securities. Neither the broker-dealers nor the General Partners are required to list the Registrant's Units on the Matching Program. There can be no assurance that any Units listed on the Matching Program will be sold.\nAs of March 1, 1996, the number of Unitholders was approximately 19,657.\nThe Revised Limited Partnership Agreement dated December 1, 1988 by and among Aetna\/AREA Corporation, AREA GP Corporation and AREA Depositary Corporation (the \"Partnership Agreement\") provides for distributions of net cash from operations, if any, to be paid quarterly to Unitholders. Net cash from operations, according to the Partnership Agreement, is equal to net income, before depreciation, less any amounts set aside to increase or create reserves. In the last two years, quarterly cash distributions of $.18 per Unit have been paid to Unitholders. In addition the Registrant made special cash distributions of $.19 per Unit on December 29, 1994, of which $.16 represents a return of capital, from proceeds from the sale of the building at Westgate Distribution Center.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nThe following selected financial data of the Registrant have been selected by the General Partners and derived from the consolidated financial statements for the indicated periods, which have been audited by Coopers & Lybrand L.L.P., independent certified public accountants, whose report thereon is included elsewhere herein. The information set forth below should be read in conjunction with the Registrant's consolidated financial statements and notes thereto and \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" also included elsewhere herein.\n(Dollars in thousands, except per Unit data) Years Ended December 31,\n1995 1994 1993 1992 1991\nRevenue . . . . . . . . . $ 28,438 $ 26,454 $ 26,389 $ 29,507 $ 30,948 Operating Income before impairment of investment in real estate . . . . . . . 5,002 4,144 4,492 4,457 4,258 Impairment of investment in real estate . . . . . . 4,408 -- -- -- -- Operating Income . . . 594 4,144 4,492 4,457 4,258 Gain (Loss) on Sale of Property . . . . . . . . . (23) 355 2,358 4,111 -- Cash and Cash Equivalents . . . . . 8,971 9,373 13,234 13,299 9,258 Total Assets (Historical Cost Basis) . . . . . . 209,334 217,854 225,248 244,264 254,299 Total Assets (Current Value Basis) . . . . . 199,709 195,916 190,237 214,807 255,452 Rental Income . . . . . 27,455 25,831 25,782 28,681 30,174 Interest Income . . . . 367 301 339 372 336 Earnings per Weighted Average Unit . . . . .04 .35 .54 .67 .33 Cash Distributions per Unit . . . . . . . . . . . . .72 .91 1.92 1.31 .50 Net Asset Value per Unit . . . . . . . . . . . . 15.24 14.96 14.50 16.32 19.39\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nLiquidity and Capital Resources\nOn December 21, 1995 approximately 12,100 square feet of land at Powell Street Plaza was condemned, for purposes of road construction, by the State of California Department of Transportation. Net proceeds to the Partnership were approximately $271,000, after paydown of a portion of the City's special assessment.\nThe Registrant has current Reserves of $4.5 million, including approximately $3.8 million retained from cash generated from operations in 1995 and $.3 million from the proceeds for the land condemned at Powell Street Plaza. During the year ended December 31, 1995, the Partnership expended approximately $4.5 million for capital improvements. At December 31, 1995, the Registrant had approximately $.9 million of outstanding commitments for capital improvements and approximately $4.8 million of projected capital improvements (collectively \"Capital Costs\") related to existing Investments in Properties. The projected capital improvements consist primarily of estimated tenant improvements and leasing commissions for speculative leasing activity at certain properties, which, based on activity in the marketplace, may or may not materialize. The Registrant expects to fund Capital Costs throughout 1996 from existing Reserves and the retention of a portion of cash generated from operations. The General Partners will continue to review the Reserves quarterly to determine whether cash distributions should be adjusted.\nIf sufficient capital is not available at the time of a funding of Capital Costs, the General Partners will review such Capital Costs and take such steps as they consider appropriate, including decreasing future cash distributions from operations, negotiating a delay or other restructuring of the capital funding requirements related to an Investment in Properties or borrowing money, as provided in the Partnership Agreement, on a short-term basis to pay Capital Costs.\nResults of Operations\n1995 versus 1994 Operating income for the year ended December 31, 1995 decreased approximately $3,550,000 from 1994 resulting primarily from an impairment loss of approximately $4,408,000 reflected in the 1995 Statement of Income. Revenue increased approximately $1,984,000 from 1994, resulting primarily from an increase in rental revenue at the majority of the properties. The most significant increases in rental revenue occurred at Oakland Pointe and Marina Bay Industrial Park, as a result of increased occupancy, and at Summit Village, as a result of an increase in rental rates. The increase in other income of approximately $294,000 for the year ended December 1995 is attributable to receipt of lease termination fees at Three Riverside Drive and 117 Flanders Road.\nProperty operating expenses for the year ended December 31, 1995 decreased approximately $200,000 in comparison to 1994, primarily as a result of decreases in operating expenses at certain retail and office and industrial properties. The majority of the decrease is due to decreased operating expenses at Town Center Business Park and Oakland Pointe. The increase in depreciation and amortization expense is primarily a result of the write-off of the unamortized cost of the tenant improvements and leasing commissions associated with a tenant that vacated Village Square Shopping Center. The investment portfolio fee increased slightly due to an increase in net assets at current value as discussed below. Based on an analysis performed on each property, it was necessary to increase the allowance for doubtful accounts at certain properties, including approximately $319,000 related to the tenant that vacated Village Square and approximately $140,000 related to Town Center Business Park.\nCash generated from operations per Unit, excluding the proceeds from the sale of the building at Westgate Distribution Center, for 1995 and 1994 was $1.02 and $.90, respectively. The Registrant made cash distributions of $.72 and $.91 per Unit to Unitholders for the years ended December 31, 1995 and 1994, respectively, including the $.19 per Unit special distribution made in December 1994 from the proceeds from the sale of the building at Westgate Distribution Center.\nNet Asset Value per Unit increased to $15.24 at December 31, 1995 from $14.96 at December 31, 1994. The increase in Net Asset Value per Unit is attributable to the increases in the appraised values of certain of the Registrant's properties, primarily Cross Pointe Centre and Powell Street Plaza. The increase in value in Cross Pointe Centre is a result of an increase in leased percentage, from 82% to approximately 90%, in conjunction with a stronger tenant mix, including an expansion of a proven anchor tenant and a reduced vacancy allowance. Powell Street Plaza's increase in value is primarily due to an increase in percentage rent with stable cash flow and modest lease expirations projected over the next few years. These value increases were partially offset by decreases in the appraised value of Village Square Shopping Center and Oakland Pointe Shopping Center. The decrease in appraised value of Village Square Shopping Center is a result of a significant decrease in its occupancy rate. The General Partners are currently considering options for the future strategy of this property. Part of this strategy includes a change in the property management firm, effective in April 1996. The majority of the decrease in appraised value of Oakland Pointe Shopping Center is a result of a change in renewal assumptions associated with a major tenant and an increase in the vacancy assumptions.\n1994 versus 1993\nOperating income for the year ended December 31, 1994 decreased approximately $348,000 from 1993, resulting primarily from the increased amortization expense due to the write-off of the unamortized cost of certain tenant improvements and leasing commissions for certain retail properties. Rental revenue increased slightly for the year ended 1994. Increases in revenues at certain residential and retail properties, in particular Powell Street and Village Square, were partially offset by reduced revenues at certain of the office\/industrial properties, primarily Town Center and Marina Bay. The effect of the loss of income at Westgate Distribution Center due to the sale of the building was more than offset by the increase in operating income from 1993, partially attributable to the completion of the third building in Phase II. Other income increased approximately $54,000 for the year ended December 1994 due mainly to increases at the residential properties partially offset by a decrease in other income due to the sale of Lincoln Harbour in January 1993.\nProperty operating expenses for the year ended December 31, 1994 remained stable in comparison to 1993; increases in operating expenses at certain residential and office\/industrial properties were offset by decreases at most of the retail properties and, to a lesser extent, a decrease due to the sale of Lincoln Harbour in January 1993.\nCash generated from operations per Unit, excluding the proceeds from the sales of the building at Westgate Distribution Center and Lincoln Harbour, for 1994 and 1993 was $.90 and $.89, respectively. The Registrant made cash distributions of $.91 and $1.92 per Unit to Unitholders for the years ended December 31, 1994 and 1993, respectively, including the $.19 per Unit special distribution made in December 1994 and the $1.20 per Unit special distribution made in February 1993 from the proceeds from the sales of the building at Westgate Distribution Center and Lincoln Harbour, respectively.\nThe net asset value of the Registrant's Units, based upon quarterly independent appraisals, increased to $14.96 at December 31, 1994 from $14.50 at December 31, 1993. The increase in Net Asset Value per Unit is attributable to the increases in the appraised values of certain of the Registrant's properties, primarily Oakland Pointe and Powell Street. The increase in appraised value in Oakland Pointe is a result of improved occupancy, from 74% to 90%, capital costs incurred, a reduced vacancy allowance and a reduction in operating expenses, primarily real estate taxes, for future years. Powell Street's increase in appraised value is primarily due to an increase in percentage rent with stable cash flow and modest lease expirations over the next few years. These increases were partially offset by a decrease in Net Asset Value per Unit attributable to the special distribution of a portion of the sale proceeds related to the sale of a building at Westgate Distribution Center in December 1994. Although there was no significant impact on net asset value, Town Center's occupancy continues to be low. Town Center saw some improvement in occupancy, from 62% to 74%, however market rents were adjusted, resulting in lower effective rents and a slight decrease in appraised value. While efforts to secure tenants for the property are ongoing, the weak economic conditions in Southern California have made it difficult to attract qualified lessees.\nItem 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.\nNone.\nPART III\nItem 10. Directors and Executive Officers of the Registrant.\nThe Registrant has no officers or directors. Aetna\/AREA and AREA GP, the General Partners of the Registrant, jointly manage and control the affairs of the Registrant and have general responsibility and authority in all matters affecting its business.\nCertain officers and directors of AREA GP are now serving (or in the past have served) as officers or directors of entities which act as general partners of a number of real estate limited partnerships, unrelated to the Registrant, which have sought protection under the provisions of the Federal Bankruptcy Code. The partnerships which have filed bankruptcy petitions own real estate which has been adversely affected by the economic conditions in the markets in which the real estate is located and, consequently, the partnerships sought protection of the bankruptcy laws to protect the partnerships' assets from loss through foreclosure. As compared to the Registrant, many of these partnerships had different investment objectives, including the use of leverage.\nCertain Matters Involving Affiliates of AREA GP Corporation\nOn July 31, 1993 Shearson Lehman Brothers Inc. (\"Shearson\") sold certain of its domestic retail brokerage and asset management businesses to Smith Barney, Harris Upham & Co. Incorporated (\"Smith Barney\"). Subsequent to this sale Shearson changed its name to Lehman Brothers, Inc. The transaction did not affect the ownership of AREA GP. However as a result of this transaction, the general partner changed its name from Hutton\/AREA Corporation to AREA GP Corporation.\nItem 11. Executive Compensation.\nNo compensation was paid by the Registrant to the officers or directors of either 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 Registrant.\nItem 12. Security Ownership of Certain Beneficial Owners and Management.\nAs of March 15, 1996, no person was known by the Registrant to be the beneficial owner of more than five percent of the Units of the Registrant. The Registrant has no directors or officers, and as of March 15, 1996, neither of the General Partners of the Registrant owns any Units, though together they own a 1% general partnership interest in the Registrant. As of March 15, 1996, no directors or officers of AREA GP owned or beneficially owned any Units. As of March 15, 1996, no directors of Aetna\/AREA owned any Units, and as of such date, officers of Aetna\/AREA as a group beneficially owned approximately 340 Units, which constituted less than 1% of the outstanding Units. The Registrant knows of no arrangements, the operation or the terms of which may at a subsequent date result in a change in control of the Registrant.\nItem 13. Certain Relationships and Related Transactions.\nThe General Partners and their Affiliates have received or will receive certain types of compensation, fees, or other distributions in connection with the operations of the Registrant. The arrangements for payment of compensation and fees were not determined in arms-length negotiations with the Registrant. The General Partners are entitled to receive an investment portfolio fee based on the net asset value of the Registrant's investments. The fee is payable quarterly from available cash flow and may not exceed 2.5% per annum of net asset value. For the year ended December 31, 1995, Aetna\/AREA and AREA GP were entitled to fees of $1,925,626 and $2,888,439, respectively, totaling $4,814,066.\nDuring the year ended December 31, 1995, $403,479 was paid to Aetna Life Insurance Company, an affiliate of Aetna\/AREA, primarily as reimbursement for insurance expense previously paid on behalf of the Registrant by Aetna Life Insurance Company to persons not affiliated with the Registrant.\nAs required by the Registrant's Revised Limited Partnership Agreement, the General Partners' distributions aggregating $92,542 which pertain to operations for the quarters ended September 30, 1995, June 30, 1995, March 31, 1995 and December 31, 1994, were withheld by the Registrant since funds of equal amount would have to be contributed to the Registrant at the end of the year.\nPART IV\nItem 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.\nThe following documents are filed as part of this report:\n(a) 1. Financial Statements: See List of Financial Statements and Financial Statement Schedule in Item 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nAETNA REAL ESTATE ASSOCIATES, L.P. (a Delaware limited partnership)\nList of Financial Statements and Financial Statement Schedule Page\nReport of Independent Accountants\nReport of Landauer Associates, Inc.\nConsolidated Balance Sheets (Historical Cost and Current Value) December 31, 1995 and 1994\nConsolidated Statements of Income (Historical Cost) for the years ended December 31, 1995, 1994 and 1993\nConsolidated Statements of Partners' Capital (Deficiency) (Historical Cost) for the years ended December 31, 1995, 1994 and 1993\nConsolidated Statements of Partners' Capital (Deficiency) (Current Value) for the years ended December 31, 1995, 1994 and 1993\nConsolidated Statements of Cash Flows (Historical Cost) for the years ended December 31, 1995, 1994 and 1993\nConsolidated Current Value Basis Statements of Changes in Excess (Deficiency) of Current Value over Historical Cost for the years ended December 31, 1995, 1994 and 1993\nNotes to Consolidated Financial Statements -\nReport of Independent Accountants- Supplementary Information\nThe following financial statement schedule of Aetna Real Estate Associates, L.P. required by Item 14","section_9":"","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"","section_15":""}
{"filename":"278194_1995.txt","cik":"278194","year":"1995","section_1":"Item 1. Business\nThe Registrant is a separate account established under the Iowa insurance laws and regulations as Principal Mutual Life Insurance Company Separate Account C on April 12, 1971, pursuant to a resolution of the Executive Committee of the Board of Directors of Principal Mutual Life Insurance Company. Principal Mutual Life Insurance Company, formerly known as Bankers Life Company, adopted its new name effective July 1, 1986. The account was formed to receive payments under Principal Mutual Life Insurance Company Contracts designed for use in connection with pension or profit sharing plans which qualify under the Self-Employed Individuals Tax Retirement Act of 1962, as amended (\"HR-10\"). Principal Mutual Life Insurance Company is a mutual life insurance company, incorporated under the laws of Iowa, offering life, disability, health and annuity contracts written on an individual and group basis.\nPursuant to the Amendments enacted in 1970 to the Investment Company Act of 1940, the Account is not an investment company for purposes of the Act.\nThe objective of these Contracts is to provide for the accumulation of retirement funds and to provide for payments, usually commencing at retirement, which tend to reflect changes in the cost of living both during the years prior to and the years following the commencement of annuity payments. With Bankers Flexible Annuity Contracts (Registration No. 2-39957), Principal Mutual Life Insurance Company, as a depositor for the Account, seeks to accomplish this objective by investing the payments made under the Contracts in shares of Principal Capital Accumulation Fund, Inc. which invests principally in common stocks. Similarly, with Pension Builder Contracts (Registration No. 33-58028), it seeks to accomplish this objective by investing payments made under the Contract in three Divisions. One is a \"Common Stock Division\" where payments are invested in shares of Principal Capital Accumulation Fund, Inc. Another is a \"Money Market Division\" where payments are invested in Principal Money Market Fund, Inc. which invests in short-term money market instruments. The third Division is a \"Government Securities Division\" where payments are invested in Principal Government Securities Fund, Inc., which invests in obligations issued or guaranteed by the United States Government or its agencies. There may be a combination of investments in the three Divisions, as directed by Participants.\nExcept for those Contracts described above with payments credited to the Registrant (Principal Mutual Life Insurance Company Separate Account C) and Variable Annuity Contracts and Variable Life Insurance Contracts with payments credited to Principal Mutual Life Insurance Company Separate Account B and Variable Life Separate Account, respectively, the Company distributes its own products as permitted under the laws of the various jurisdictions in which the Company is authorized to do business, namely the fifty states of the United States, the District of Columbia, the Commonwealth of Puerto Rico and the Canadian provinces of Alberta, British Columbia, Manitoba, Ontario and Quebec. Such distribution is through a field agency system of approximately 1,320 full-time agents, a group insurance sales organization of approximately 207 individuals and through a large number of independent insurance brokers.\nThe Contracts described above with payments credited to the Registrant and other Variable Annuity Contracts and Variable Life Insurance Contracts are distributed through Princor Financial Services Corporation, an affiliated broker-dealer offering open-end management investment company shares, variable annuities, variable life insurance, interests in limited partnerships and general securities to the public. Such Contracts are sold primarily by registered representatives of the broker-dealer who are also insurance agents of or brokers for Principal Mutual Life Insurance Company and authorized by applicable law to sell life and other forms of personal insurance and who are similarly authorized to sell variable annuities. Such Contracts may also be sold through other selected broker-dealers.\nThe Registration Statement filed by the Registrant was made effective September 13, 1971, and the first sale of Bankers Flexible Annuity Contracts occurred on October 8, 1971. Effective January 4, 1989, sales of Bankers Flexible Annuity Contracts were discontinued.\nIn 1982 the Registrant filed a Registration Statement in File No. 2-78747, to register a new class of securities (called \"Pension Builder\") for the same HR-10 plan market utilizing the contingent deferred sales charge concept. The registration for Pension Builder contracts first became effective on May 5, 1983 and the first sale under the Pension Builder Contract was made on September 19, 1983.\nIn 1989 the Registrant filed a new Registration Statement in File No. 33-27256 for the contracts in view of the fact that aggregate sales under the prior registration statement approached the amount of contracts registered thereunder. The contracts offered by the new registration statement are identical to contracts previously registered under the 1933 Act in File No. 2-78747.\nIn 1993 the Registrant filed a new Registration Statement in File No. 33-58028 for the contracts in view of the fact that aggregate sales under the prior registration statement approached the amount of contracts registered thereunder. The contracts offered by the new registration statement are identical to contracts previously registered under the 1933 Act in File No. 33-27256.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Registrant owns no physical properties. The principal properties of the Depositor, Principal Mutual Life Insurance Company, are its home office complex at The Principal Financial Group in Des Moines, Iowa.\nItem 3.","section_3":"Item 3. Legal Proceedings\nNone.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nInapplicable.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters\na. The Registrant does not issue common stock. The Contracts described in Item 1. are distributed through Princor Financial Services Corporation, an affiliated broker-dealer offering open-end management investment company shares, variable annuities, variable life insurance, interests in limited partnerships and general securities to the public. Such Contracts are sold primarily by registered representatives of the broker-dealer who are also insurance agents of or brokers for Principal Mutual Life Insurance Company and authorized by applicable law to sell life and other forms of personal insurance and who are similarly authorized to sell variable annuities. Such Contracts may also be sold through other selected broker-dealers.\nFor Bankers Flexible Annuity Contracts (Registration No. 2-39957) the high and low unit values for each quarterly period during 1994 and 1995 are:\nLowest Unit Value Highest Unit Value\nFirst Quarter 1994 12.2152743 13.2415309 Second \" 1994 11.9810112 12.8083427 Third \" 1994 12.3525626 13.4490710 Fourth \" 1994 12.3430553 13.2803101 First \" 1995 12.7340882 13.7592135 Second \" 1995 13.6942657 14.6657898 Third \" 1995 14.5577805 15.6800495 Fourth \" 1995 15.4730197 16.8388145\nFor Pension Builder Contracts (Registration No. 33-58028) units were first valued at $1.00 on September 19, 1983 for the Common Stock Division, September 22, 1983 for the Money Market Division and March 30, 1987 for the Government Securities Division. Listed below are the low and high unit values for each quarterly period during 1994 and 1995.\nCommon Stock Money Market GovernmentSecurities Division Division Division ------------------- ------------------- ------------------- Quarter Lowest Highest Lowest Highest Lowest Highest ------- --------- --------- --------- --------- --------- ---------\nFirst Quarter 1994 2.5336599 2.7511198 1.6590204 1.6646759 1.5972143 1.6893543 Second \" 1994 2.4838926 2.6513633 1.6647445 1.6722637 1.5463356 1.6102243 Third \" 1994 2.5554476 2.7768113 1.6726689 1.6827300 1.5626396 1.6049044 Fourth \" 1994 2.5425031 2.7393757 1.6828512 1.6962881 1.5410519 1.5766511 First \" 1995 2.6211587 2.8254152 1.6964652 1.7132417 1.5645192 1.6662837 Second \" 1995 2.8104369 3.0045562 1.7134358 1.7307405 1.6591219 1.7619418 Third \" 1995 2.9813502 3.2043269 1.7311185 1.7474271 1.7282744 1.7774597 Fourth \" 1995 3.1588549 3.4337785 1.7476067 1.7641630 1.7744906 1.8412779\nb. The approximate number of holders of record of each group contract and the number of the participants therein as of December 31, 1995, are as follows:\n(1) (2) Number of Group Number of Contract Holders Participants ---------------- ------------ Bankers Flexible Annuity 80 45 Pension Builder 219 258\nc. No dividends have been declared on units held by participants. Any changes in net investment income, net realized gains and net realized appreciation are included in the daily valuation of the units of the Registrant.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe information contained in the \"Statement of Net Assets, Statement of Operations and Statements of Changes in Net Assets for Principal Mutual Life Insurance Company Separate Account C\", filed as Item 8. should be read in conjunction with this item.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation\nAll payments made to the Registrant on behalf of a Participant under a contract (less any authorized deductions) are used to purchase shares of Principal Capital Accumulation Fund, Inc., Principal Money Market Fund, Inc., or Principal Government Securities Fund, Inc., as appropriate, at net asset value. In addition, any distributions made by the Fund with respect to shares held by the Registrant are reinvested by the Fund at net asset value. Values under the contract increase or decrease to reflect the investment performance of the underlying investments.\nPrincipal Capital Accumulation Fund, Inc. is an open-end diversified management investment company, sponsored by Principal Mutual Life Insurance Company. The principal objective of the Fund is long-term capital appreciation and growth of future investment income. It is intended that the assets of the Fund will consist primarily of a portfolio of common stocks. The value of the investments held by the Fund fluctuates daily. It is subject to the risks of changing economic conditions as well as the risks inherent in the ability of the management of the Fund to anticipate changes in such investments necessary to meet changes in economic conditions.\nPrincipal Money Market Fund, Inc. is an open-end diversified management investment company, sponsored by Principal Mutual Life Insurance Company. The principal objective of the Fund is to seek as high a level of income available from short-term securities as is considered consistent with preservation of principal and maintenance of liquidity by investing all of its assets in a portfolio of money market instruments.\nPrincipal Government Securities Fund, Inc. is an open-end diversified management investment company, sponsored by Principal Mutual Life Insurance Company. The principal objective of the Fund is to seek a high level of current income, liquidity and safety of principal through the purchase of obligations issued or guaranteed by the United States Government or its agencies, with emphasis on Government National Mortgage Association Certificates (\"GNMA Certificates\").\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nPrincipal Mutual Life Insurance Company Separate Account C\nNotes to Financial Statements\nDecember 31, 1995\n1. Investment and Accounting Policies\nPrincipal Mutual Life Insurance Company Separate Account C was organized by Principal Mutual Life Insurance Company (Principal Mutual) in accordance with the provisions of the Iowa Insurance Laws and is a part of the total operations of Principal Mutual. The assets and liabilities of Separate Account C are clearly identified and distinguished from the other assets and liabilities of Principal Mutual, with the remaining aggregate value of units registered with the Securities and Exchange Commission under the current registration statement (but not the authorized number of units) limited to $11.1 million. As directed by eligible contractholders, Separate Account C invests solely in shares of Principal Capital Accumulation Fund, Inc., Principal Government Securities Fund, Inc. and Principal Money Market Fund, Inc., diversified open-end management investment companies organized by Principal Mutual. Investments are stated at the closing net asset values per share on December 31, 1995.\nThe average cost method is used to determine realized gains and losses on investments. Dividends are taken into income on an accrual basis as of the ex-dividend date.\nAfter September 30, 1995, Principal Mutual no longer accepted contributions for Pension Builder Plus contracts. Contractholders were given the options of withdrawing their funds or transferring to another contract. Contingent sales charges were waived for contracts transferred prior to November 30, 1995. Contributions for Bankers Flexible Annuity contracts were previously discontinued.\n2. Expenses\nPrincipal Mutual is compensated for the following expenses:\nBankers Flexible Annuity Contracts - Mortality and expense risks assumed by Principal Mutual are compensated for by a charge equivalent to an annual rate of 0.48% of the asset value of each contract. An annual administration charge of $7 for each participant's account is deducted as compensation for administrative expenses. The mortality and expense risk and annual administration charges amounted to $9,346 and $224, respectively, during the year 1995. A sales charge of up to 7% was deducted from each contribution made on behalf of each participant. The sales charge was deducted from the contributions by Principal Mutual prior to their transfer to Separate Account C.\nPrincipal Mutual Life Insurance Company Separate Account C\nNotes to Financial Statements (continued)\n2. Expenses (continued)\nPension Builder Plus Contracts - Mortality and expense risks assumed by Principal Mutual are compensated for by a charge equivalent to an annual rate of 1.4965% of the asset value of each contract. A contingent sales charge of up to 7% may be deducted from withdrawals made during the first 10 years of a contract, except for death or permanent disability. An annual administration charge will be deducted ranging from a minimum of $25 to a maximum of $275 depending upon a participant's investment account values and the number of participants under the retirement plan and their participant investment account value. The charges for mortality and expense risks, contingent sales and annual administration amounted to $119,725, $2,714, and $25,927, respectively, during the year 1995.\n3. Federal Income Taxes\nOperations of Separate Account C are a part of the operations of Principal Mutual. Under current practice, no federal income taxes are allocated by Principal Mutual to the operations of Principal Mutual Life Insurance Company Separate Account C.\n4. Purchases and Sales of Investment Securities\nPurchases include reinvested dividends and capital gains.\nMoney Market purchases include transactions where investment allocations are not known at the time of the deposit. Redemptions reflect subsequent allocations to directed investment divisions.\n5. Net Assets\nReport of Independent Auditors\nBoard of Directors and Participants Principal Mutual Life Insurance Company\nWe have audited the accompanying statement of net assets of Principal Mutual Life Insurance Company Separate Account C (comprising, respectively, the Common Stock, Government Securities, and Money Market Divisions) as of December 31, 1995, and the related statements of operations for the year then ended, and changes in net assets for each of the two years in the period 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. Our procedures included confirmation of securities owned as of December 31, 1995, by correspondence with the transfer agent. An audit also includes assessing the accounting principles used and significant estimates made by management, as 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 Principal Mutual Life Insurance Company Separate Account C at December 31, 1995, and the results of its operations for the year then ended, and the changes in its net assets for each of the two years in the period then ended, in conformity with generally accepted accounting principles.\nERNST & YOUNG LLP Des Moines, Iowa\nFebruary 7, 1996\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\nInapplicable, the Registrant does not have any directors or executive officers.\nItem 11.","section_11":"Item 11. Executive Compensation\nInapplicable, the Registrant does not have any directors or executive officers.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nNo person owns beneficially or of record the assets held by the Depositor, Principal Mutual Life Insurance Company, in the Separate Account. As contractholders of the variable contracts each contractholder has one vote in the election of the Board of Directors at annual meetings and upon other Principal Mutual Life Insurance Company matters, if any, where a policyholder's vote is taken. The contractholders have the same voting privilege as do all other policyholders of Principal Mutual Life Insurance Company. An individual participant (certificateholder) does not have a vote. There are no policyholders that are entitled to cast more than 5% of the votes to be cast.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nInapplicable.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(a) Documents filed as part of this report:\n1. The following financial statements are submitted herewith:\nStatement of Net Assets -- December 31, 1995\nStatement of Operations -- Year ended December 31, 1995\nStatements of Changes in Net Assets -- Years ended December 31, 1995 and 1994.\nNotes to Financial Statements\n2. Schedules - 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.\n3. Exhibits:\n(20) Subsidiaries of the Registrant\nSubsidiaries of the Registrant\nThe Registrant is a separate account of Principal Mutual Life Insurance Company. It has no subsidiary. Principal Mutual Life Insurance Company, as the Depositor of the Account, owns or controls, as of December 31, 1995, subsidiaries as follows:\nI. Principal Holding Company\nA. Organized in Iowa.\nB. Depositor owns 100% of outstanding stock.\nC. Subsidiaries of Principal Holding Company as of December 31, 1995, are as follows:\n1. Princor Financial Services Corporation (a registered broker-dealer)\na. Organized in Iowa.\nb. Principal Holding Company owns 100% of outstanding stock.\nc. Subsidiaries of Princor Financial Services Corporation as of December 31, 1995 are as follows:\n(1) Princor Management Corporation (a registered investment adviser)\n(a) Organized in Iowa.\n(b) Princor Financial Services Corporation owns 100% of outstanding stock.\n(2) Principal Investors Corporation (broker-dealer of securities and registered investments)\n(a) Organized in New Jersey.\n(b) Princor Financial Services Corporation owns 100% of outstanding stock.\n2. Petula Associates, Ltd. (a real estate development company)\na. Organized in Iowa.\nb. Principal Holding Company owns 100% of outstanding stock.\n3. Patrician Associates, Inc. (a real estate development company)\na. Organized in California.\nb. Principal Holding Company owns 100% of outstanding stock.\n4. Principal Development Associates, Inc. (a real estate development company)\na. Organized in California.\nb. Principal Holding Company owns 100% of outstanding stock.\n5. Principal Spectrum Associates, Inc. (a real estate development company)\na. Organized in California.\nb. Principal Holding Company owns 100% of outstanding stock.\n6. Equity FC, Ltd. (a general business corporation that engages in investment transactions including limited partnership and limited liability companies)\na. Organized in Iowa.\nb. Principal Holding Company owns 100% of outstanding stock.\n7. Principal Commerical Advisors, Inc. (purchasing, managing and selling commercial real estate assets)\na. Organized in Iowa.\nb. Principal Holding Company owns 100% of outstanding stock.\n8. Principal FC, Ltd. (limited purpose investment corporation)\na. Organized in Iowa.\nb. Principal Holding Company owns 100% of outstanding stock.\n9. Invista Capital Management, Inc. (a registered investment advisor)\na. Organized in Iowa.\nb. Principal Holding Company owns 100% of outstanding stock.\n10. Delaware Charter Guarantee & Trust Company (nondepository trust company)\na. Organized in Delaware.\nb. Principal Holding Company currently owns 100% of outstanding stock.\n11. Principal Securities Holding Corporation, formerly known as The Principal\/EGT Financial Corporation.\na. Organized in Delaware.\nb. Principal Holding Company owns 100% of outstanding stock.\nc. Subsidiary of Principal Securities Holding Corporation as of December 31, 1995 is as follows:\n(1) Principal Financial Securities, Inc., formerly known as The Principal\/Eppler, Guerin & Turner, Inc., (investment banking and securities brokerage firm)\n(a) Organized in Delaware.\n(b) Principal Securities Holding Corporation owns 100% of outstanding stock.\n12. The Principal Financial Group, Inc. (general business corporation established in connection with corporate identity - not currently active)\na. Organized in Delaware.\nb. Principal Holding Company owns 100% of outstanding stock.\n13. Principal Marketing Services, Inc. (insurance broker)\na. Organized in Delaware.\nb. Principal Holding Company owns 100% of outstanding stock.\n14. Principal Health Care, Inc. (a developer and administrator of managed care systems)\na. Organized in Iowa.\nb. Principal Holding Company owns 100% of outstanding stock.\nc. Subsidiaries of Principal Health Care, Inc. as of December 31, 1995 are as follows:\n(1) Principal Health Care of Delaware, Inc. (a health maintenance organization)\n(a) Organized in Delaware.\n(b) Principal Health Care, Inc. owns 100% of outstanding stock.\n(c) Subsidiary of Principal Health Care of Delaware, Inc. as of December 31, 1995.\n1) Principal Health Care of The Mid-Atlantic, Inc. (a health maintenance organization)\na) Organized in Virginia.\nb) Principal Health Care of Delaware owns 100% of outstanding stock.\n(2) Americas Health Plan, Inc.(a developer of discount provider networks)\n(a) Organized in Maryland.\n(b) Principal Health Care, Inc. owns 100% of outstanding stock.\n(3) PHC Merging Company (a Florida Corporation - not currently active)\n(a) Organized in Florida.\n(b) Principal Health Care, Inc. owns 100% of outstanding stock.\n(4) Principal Health Care of Florida, Inc. (a health maintenance organization)\n(a) Organized in Florida.\n(b) Principal Health Care, Inc. owns 100% of outstanding stock.\n(5) Principal Health Care of Illinois, Inc. (A health maintenance organization)\n(a) Organized in Illinois.\n(b) Principal Health Care, Inc. owns 100% of outstanding stock.\n(6) Principal Health Care of Kansas City, Inc. (a health maintenance organization)\n(a) Organized in Missouri.\n(b) Principal Health Care, Inc. owns 100% of outstanding stock.\n(7) Principal Health Care of Louisiana, Inc. (a health maintenance organization)\n(a) Organized in Louisiana.\n(b) Principal Health Care, Inc. owns 100% of outstanding stock.\n(8) Principal Health Care of Nebraska, Inc. (a health maintenance organization)\n(a) Organized in Nebraska.\n(b) Principal Health Care, Inc. owns 100% of outstanding stock.\n(9) Principal Health Care of Georgia, Inc.(a health maintenance organization)\n(a) Organized in Georgia.\n(b) Principal Health Care, Inc. owns 100% of outstanding stock.\n(10) Principal Health Care of Indiana, Inc.(a health maintenance organization)\n(a) Organized in Delaware.\n(b) Principal Health Care, Inc. owns 100% of outstanding stock.\n(11) Principal Health Care of Iowa, Inc.(a health maintenance organization)\n(a) Organized in Iowa.\n(b) Principal Health Care, Inc. owns 100% of outstanding stock.\n(12) United Healthcare Services of Iowa, Inc.(a health maintenance organization)\n(a) Organized in Iowa.\n(b) Principal Health Care, Inc. owns 100% of outstanding stock.\n(13) Principal Behavioral Health Care, Inc.(a corporation doing business as a mental and nervous\/substance abuse preferred provider organization)\n(a) Organized in Iowa.\n(b) Principal Health Care, Inc. owns 100% of outstanding stock.\n(14) Principal Health Care of the Carolinas, Inc. (a health maintenance organization operating in North Carolina and South Carolina)\n(a) Organized in North Carolina.\n(b) Principal Health Care, Inc. owns 100% of outstanding stock.\n(15) Principal Health Care of Pennsylvania, Inc. (a health maintenance organization operating in Pennsylvania - not currently active)\n(a) Organized in Pennsylvania.\n(b) Principal Health Care, Inc. owns 100% of outstanding stock.\n(16) Principal Health Care of South Carolina, Inc. (a health maintenance organization)\n(a) Organized in South Carolina.\n(b) Principal Health Care, Inc. owns 100% of outstanding stock.\n(17) Principal Health Care of Tennessee, Inc. (a health maintenance organization)\n(a) Organized in Tennessee.\n(b) Principal Health Care, Inc. owns 100% of outstanding stock.\n(18) Principal Health Care of Texas, Inc.(a health maintenance organization)\n(a) Organized in Texas.\n(b) Principal Health Care, Inc. owns 100% of outstanding stock.\n15. Principal Asset Markets, Inc. (a residential mortgage loan broker)\na. Organized in Iowa.\nb. Principal Holding Company owns 100% of outstanding stock.\n16. Principal Financial Advisors, Inc. (a registered investment advisor)\na. Organized in Iowa.\nb. Principal Holding Company owns 100% of outstanding stock.\n17. Principal Residential Mortgage, Inc. (a residential mortgage loan broker)\na. Organized in Iowa.\nb. Principal Holding Company owns 100% of outstanding stock.\n18. Principal Portfolio Services, Inc. (a residential mortgage loan due diligence company)\na. Organized in Iowa.\nb. Principal Holding Company owns 100% of outstanding stock.\n19. Principal International, Inc. (company formed for the purpose of international business development)\na. Organized in Iowa.\nb. Principal Holding Company owns 100% of outstanding stock.\nc. Subsidiaries of Principal International, Inc. as of December 31, 1995 are as follows:\n(1) Principal International, S.A. Compania de Seguros (a Mexican corporation)\n(a) Organized in Mexico.\n(b) Principal International, Inc. owns 80% of outstanding stock, Principal Holding Company owns 10% of outstanding stock and Principal Marketing services, Inc. owns 10% of outstanding stock.\n(2) Grupo Financiero Principal, S.A. de Seguros de Vida (a Spanish insurance company)\n(a) Organized in Spain.\n(b) Principal International, Inc. owns 99.99993333% of outstanding stock and Principal Holding Company owns .00006667% of outstanding stock.\n(c) Subsidiary of Grupo Financiero Principal S.A. de Seguros de Vida as of December 31, 1995 is as follows:\n(1) Agencia de Seguros, SA (insurance agency that is currently dormant).\n(a) Organized in Spain.\n(b) Grupo Financiero Principal, S.A. de Seguros de Vida owns 99.99% of outstanding stock and Principal International, Inc. owns .01% of outstanding stock.\n(3) Principal International Argentina, S.A. (an Argentina corporation)\n(a) Organized in Argentina.\n(b) Principal International, Inc. owns 97.06% of outstanding Stock.\n(c) Subsidiaries of International Argentina, S.A. as of December 31, 1995 are as follows:\n(1) Ethika S.A. Administradoras de Fondo de Jubilaciones y Pensiones (an Argentina corporation).\n(a) Organized in Argentina.\n(b) Principal International Argentina, S.A. owns 99.9% of outstanding stock and Principal International, Inc. owns .1% of outstanding stock.\n(2) Princor Compania de Seguros de Retiro, S.A. (an Argentina corporation)\n(a) Organized in Argentina.\n(b) International Argentina, S.A. owns 99% of outstanding stock.\n(3) Prinlife Compania de Seguros de Vida, S.A. (an Argentina corporation)\n(a) Organized in Argentina.\n(b) International Argentina, S.A. owns 99.9% of outstanding stock and Principal International, Inc. owns .1% of outstanding stock.\n(4) Jacaranda Administradora de Fondos de Jubilaciones y Pensiones, S.A. (an Argentina Corporation)\n(a) Organized in Argentina.\n(b) Principal International Argentina, S.A. owns 62.95% of outstanding stock and Principal International, Inc. owns 7.05% of outstanding stock.\n(4) Principal International Asia Limited, formerly known as Goldchin Champ Limited (a Hong Kong corporation)\n(a) Organized in Hong Kong.\n(b) Principal International, Inc. owns 50% of outstanding stock and Principal Holding Company owns 50% of outstanding stock.\n(5) Principal International de Chile,S.A.\n(a) Organized in Chile.\n(b) Principal International, Inc. owns 99% outstanding stock and Principal Holding Company owns 1% of outstanding stock.\n(c) Subsidiary of Principal International de Chile, S.A. as of December 31, 1995 is as follows:\n(1) Ban Renta Compania de Seguros de Vida Banmedica, S.A.\n(a) Organizede in Chile.\n(b) Principal International de Chile, S.A. owns 50% of outstanding stock.\n20. America's Health Plan, Inc. (a developer of discount provider networks)\na. Organized in Maryland.\nb. Principal Holding Company owns 100% of outstanding stock.\nII. Principal Life Insurance Company (a general life and annuity company)\nA. Organized in Iowa.\nB. Depositor owns 100% of the outstanding stock (except that of the 100,007 shares outstanding on 12-31-95 each of the 7 members of the Board of Directors owned one qualifying share).\nIII. Principal National Life Insurance Company (a general life and annuity company)\nA. Organized in Iowa.\nB. Depositor owns 100% of the outstanding stock (except that of the 210,000 shares outstanding on 12-31-95 each of the 8 members of the Board of Directors owned one qualifying share).\nIV. PT Asuransi Jiwa Principal Egalita Indonesia (an Indonesia corporation)\nA. Organized in Indonsesia.\nB. Depositor owns 75% of the outstanding stock.\nC. Subsidiary of PT Asuransi Jiwa Principal Egalita Indonesia as of December 31, 1995 is as follows:\n1. Dana Pensiun Lembaga Keuangan Principal Egalita Indonesia.\n(a) Organized in Indonesia.\n(b) Dana Pensiun Lembaga Keuangan Principal Egalita Indonesia owns 100% of outstanding stock.\nThe Depositor's investment in its subsidiaries, which in turn includes the subsidiary's investment in its subsidiaries, is included in the financial statements of the Depositor.\nSIGNATURES\nPursuant to the requirements of Section 15(d) of the Securities Exchange Act of 1934, Principal Mutual Life Insurance Company has duly caused this report to be signed on behalf of Principal Mutual Life Insurance Company Separate Account C by the undersigned thereto duly authorized\nPRINCIPAL MUTUAL LIFE INSURANCE COMPANY SEPARATE ACCOUNT C\nBy PRINCIPAL MUTUAL LIFE INSURANCE COMPANY\nD. J. DRURY By --------------------------------------------------- D. J. Drury, Chairman and Chief Executive Officer\nMarch 15, 1996 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 in the capacities with Principal Mutual Life Insurance Company and on the dates indicated.\nSignature Title Date\nD. J. DRURY Chairman and March 15, 1996 - - --------------------- Chief Executive Officer D. J. Drury\nD. C. CUNNINGHAM Vice President and March 15, 1996 - - ---------------------- Controller (Principal D. C. Cunningham Accounting Officer)\nC. E. ROHM Executive Vice March 15, 1996 - - ---------------------- President (Principal C. E. Rohm Financial Officer)\n(M. V. Andringa)* Director March 15, 1996 - - ---------------------- M. V. Andringa\n(R. M. Davis)* Director March 15, 1996 - - ---------------------- R. M. Davis\n(C. D. Gelatt)* Director March 15, 1996 - - ---------------------- C. D. Gelatt\n(G. D. Hurd)* Director March 15, 1996 - - ---------------------- G. D. Hurd\n(T. M. Hutchison)* Director March 15, 1996 - - ---------------------- T. M. Hutchison\n(C. S. Johnson)* Director March 15, 1996 - - ---------------------- C. S. Johnson\n(W. T. Kerr)* Director March 15, 1996 - - ---------------------- W. T. Kerr\n(L. Liu)* Director March 15, 1996 - - ---------------------- L. Liu\n(V. H. Loewenstein)* Director March 15, 1996 - - ---------------------- V. H. Loewenstein\n(J. R. Price, Jr.)* Director March 14, 1996 J. R. Price, Jr.\n(B. A. Rice)* Director March 15, 1996 - - ---------------------- B. A. Rice\n(J-P. C. Rosso)* Director March 15, 1996 - - ---------------------- J-P. C. Rosso\n(D. M. Stewart)* Director March 15, 1996 - - ---------------------- D. M. Stewart\n(E. E. Tallett)* Director March 15, 1996 - - ---------------------- E. E. Tallett\n(D. D. Thornton)* Director March 15, 1996 - - ---------------------- D. D. Thornton\n(F. W. Weitz)* Director March 15, 1996 - - ---------------------- F. W. Weitz\nDAVID J. DRURY *By ------------------------------------- David J. Drury Chairman and Chief Executive Officer\nMarch 15, 1996 ------------------------------------- Pursuant to Powers of Attorney Previously Filed or Included Herein\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned director of Principal Mutual Life Insurance Company, an Iowa corporation (the \"Company\"), hereby constitutes and appoints D. J. Drury, G. D. Hurd, T. M. Hutchison and F. W. Weitz, and each of them (with full power to each of them to act alone), the undersigned's true and lawful attorney-in-fact and agent, with full power of substitution to each, for and on behalf and in the name, place and stead of the undersigned, to execute and file any of the documents referred to below relating to registration under the Securities Act of 1933 with respect to variable annuity contracts, with premiums received in connection with such contracts held in the Principal Mutual Life Insurance Company Separate Account C on Form N-4 or other forms under the Securities Act of 1933,and any and all amendments thereto and reports thereunder with all exhibits and all instruments necessary or appropriate in connection therewith, each of said attorneys-in-fact and agents and his or their substitutes being empowered to act with or without the others or other, and to have full power and authority to do or cause to be done in the name and on behalf of the undersigned each and every act and thing requisite and necessary or appropriate with respect thereto to be done in and about the premises in order to effectuate the same, as fully to all intents and purposes as the undersigned might or could do in person; hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, may do or cause to be done by virtue hereof.\nIN WITNESS WHEREOF, the undersigned director has hereunto set his hand this 15th day of March, 1996. M. Vermeer Andringa _____________________________________________\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned director of Principal Mutual Life Insurance Company, an Iowa corporation (the \"Company\"), hereby constitutes and appoints D. J. Drury, G. D. Hurd, T. M. Hutchison and F. W. Weitz, and each of them (with full power to each of them to act alone), the undersigned's true and lawful attorney-in-fact and agent, with full power of substitution to each, for and on behalf and in the name, place and stead of the undersigned, to execute and file any of the documents referred to below relating to registration under the Securities Act of 1933 with respect to variable annuity contracts, with premiums received in connection with such contracts held in the Principal Mutual Life Insurance Company Separate Account C on Form N-4 or other forms under the Securities Act of 1933,and any and all amendments thereto and reports thereunder with all exhibits and all instruments necessary or appropriate in connection therewith, each of said attorneys-in-fact and agents and his or their substitutes being empowered to act with or without the others or other, and to have full power and authority to do or cause to be done in the name and on behalf of the undersigned each and every act and thing requisite and necessary or appropriate with respect thereto to be done in and about the premises in order to effectuate the same, as fully to all intents and purposes as the undersigned might or could do in person; hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, may do or cause to be done by virtue hereof.\nIN WITNESS WHEREOF, the undersigned director has hereunto set his hand this 15th day of March, 1996. R. M. Davis _____________________________________________\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned director of Principal Mutual Life Insurance Company, an Iowa corporation (the \"Company\"), hereby constitutes and appoints D. J. Drury, G. D. Hurd, T. M. Hutchison and F. W. Weitz, and each of them (with full power to each of them to act alone), the undersigned's true and lawful attorney-in-fact and agent, with full power of substitution to each, for and on behalf and in the name, place and stead of the undersigned, to execute and file any of the documents referred to below relating to registration under the Securities Act of 1933 with respect to variable annuity contracts, with premiums received in connection with such contracts held in the Principal Mutual Life Insurance Company Separate Account C on Form N-4 or other forms under the Securities Act of 1933,and any and all amendments thereto and reports thereunder with all exhibits and all instruments necessary or appropriate in connection therewith, each of said attorneys-in-fact and agents and his or their substitutes being empowered to act with or without the others or other, and to have full power and authority to do or cause to be done in the name and on behalf of the undersigned each and every act and thing requisite and necessary or appropriate with respect thereto to be done in and about the premises in order to effectuate the same, as fully to all intents and purposes as the undersigned might or could do in person; hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, may do or cause to be done by virtue hereof.\nIN WITNESS WHEREOF, the undersigned director has hereunto set his hand this 15th day of March, 1996. C. D. Gelatt, Jr. _____________________________________________\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned director of Principal Mutual Life Insurance Company, an Iowa corporation (the \"Company\"), hereby constitutes and appoints D. J. Drury, G. D. Hurd, T. M. Hutchison and F. W. Weitz, and each of them (with full power to each of them to act alone), the undersigned's true and lawful attorney-in-fact and agent, with full power of substitution to each, for and on behalf and in the name, place and stead of the undersigned, to execute and file any of the documents referred to below relating to registration under the Securities Act of 1933 with respect to variable annuity contracts, with premiums received in connection with such contracts held in the Principal Mutual Life Insurance Company Separate Account C on Form N-4 or other forms under the Securities Act of 1933,and any and all amendments thereto and reports thereunder with all exhibits and all instruments necessary or appropriate in connection therewith, each of said attorneys-in-fact and agents and his or their substitutes being empowered to act with or without the others or other, and to have full power and authority to do or cause to be done in the name and on behalf of the undersigned each and every act and thing requisite and necessary or appropriate with respect thereto to be done in and about the premises in order to effectuate the same, as fully to all intents and purposes as the undersigned might or could do in person; hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, may do or cause to be done by virtue hereof.\nIN WITNESS WHEREOF, the undersigned director has hereunto set his hand this 15th day of March, 1996. G. D. Hurd _____________________________________________\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned director of Principal Mutual Life Insurance Company, an Iowa corporation (the \"Company\"), hereby constitutes and appoints D. J. Drury, G. D. Hurd, T. M. Hutchison and F. W. Weitz, and each of them (with full power to each of them to act alone), the undersigned's true and lawful attorney-in-fact and agent, with full power of substitution to each, for and on behalf and in the name, place and stead of the undersigned, to execute and file any of the documents referred to below relating to registration under the Securities Act of 1933 with respect to variable annuity contracts, with premiums received in connection with such contracts held in the Principal Mutual Life Insurance Company Separate Account C on Form N-4 or other forms under the Securities Act of 1933,and any and all amendments thereto and reports thereunder with all exhibits and all instruments necessary or appropriate in connection therewith, each of said attorneys-in-fact and agents and his or their substitutes being empowered to act with or without the others or other, and to have full power and authority to do or cause to be done in the name and on behalf of the undersigned each and every act and thing requisite and necessary or appropriate with respect thereto to be done in and about the premises in order to effectuate the same, as fully to all intents and purposes as the undersigned might or could do in person; hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, may do or cause to be done by virtue hereof.\nIN WITNESS WHEREOF, the undersigned director has hereunto set his hand this 15th day of March, 1996. T. M. Hutchison _____________________________________________\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned director of Principal Mutual Life Insurance Company, an Iowa corporation (the \"Company\"), hereby constitutes and appoints D. J. Drury, G. D. Hurd, T. M. Hutchison and F. W. Weitz, and each of them (with full power to each of them to act alone), the undersigned's true and lawful attorney-in-fact and agent, with full power of substitution to each, for and on behalf and in the name, place and stead of the undersigned, to execute and file any of the documents referred to below relating to registration under the Securities Act of 1933 with respect to variable annuity contracts, with premiums received in connection with such contracts held in the Principal Mutual Life Insurance Company Separate Account C on Form N-4 or other forms under the Securities Act of 1933,and any and all amendments thereto and reports thereunder with all exhibits and all instruments necessary or appropriate in connection therewith, each of said attorneys-in-fact and agents and his or their substitutes being empowered to act with or without the others or other, and to have full power and authority to do or cause to be done in the name and on behalf of the undersigned each and every act and thing requisite and necessary or appropriate with respect thereto to be done in and about the premises in order to effectuate the same, as fully to all intents and purposes as the undersigned might or could do in person; hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, may do or cause to be done by virtue hereof.\nIN WITNESS WHEREOF, the undersigned director has hereunto set his hand this 15th day of March, 1996. C. S. Johnson _____________________________________________\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned director of Principal Mutual Life Insurance Company, an Iowa corporation (the \"Company\"), hereby constitutes and appoints D. J. Drury, G. D. Hurd, T. M. Hutchison and F. W. Weitz, and each of them (with full power to each of them to act alone), the undersigned's true and lawful attorney-in-fact and agent, with full power of substitution to each, for and on behalf and in the name, place and stead of the undersigned, to execute and file any of the documents referred to below relating to registration under the Securities Act of 1933 with respect to variable annuity contracts, with premiums received in connection with such contracts held in the Principal Mutual Life Insurance Company Separate Account C on Form N-4 or other forms under the Securities Act of 1933,and any and all amendments thereto and reports thereunder with all exhibits and all instruments necessary or appropriate in connection therewith, each of said attorneys-in-fact and agents and his or their substitutes being empowered to act with or without the others or other, and to have full power and authority to do or cause to be done in the name and on behalf of the undersigned each and every act and thing requisite and necessary or appropriate with respect thereto to be done in and about the premises in order to effectuate the same, as fully to all intents and purposes as the undersigned might or could do in person; hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, may do or cause to be done by virtue hereof.\nIN WITNESS WHEREOF, the undersigned director has hereunto set his hand this 15th day of March, 1996. W. T. Kerr _____________________________________________\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned director of Principal Mutual Life Insurance Company, an Iowa corporation (the \"Company\"), hereby constitutes and appoints D. J. Drury, G. D. Hurd, T. M. Hutchison and F. W. Weitz, and each of them (with full power to each of them to act alone), the undersigned's true and lawful attorney-in-fact and agent, with full power of substitution to each, for and on behalf and in the name, place and stead of the undersigned, to execute and file any of the documents referred to below relating to registration under the Securities Act of 1933 with respect to variable annuity contracts, with premiums received in connection with such contracts held in the Principal Mutual Life Insurance Company Separate Account C on Form N-4 or other forms under the Securities Act of 1933,and any and all amendments thereto and reports thereunder with all exhibits and all instruments necessary or appropriate in connection therewith, each of said attorneys-in-fact and agents and his or their substitutes being empowered to act with or without the others or other, and to have full power and authority to do or cause to be done in the name and on behalf of the undersigned each and every act and thing requisite and necessary or appropriate with respect thereto to be done in and about the premises in order to effectuate the same, as fully to all intents and purposes as the undersigned might or could do in person; hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, may do or cause to be done by virtue hereof.\nIN WITNESS WHEREOF, the undersigned director has hereunto set his hand this 15th day of March, 1996. L. Liu _____________________________________________\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned director of Principal Mutual Life Insurance Company, an Iowa corporation (the \"Company\"), hereby constitutes and appoints D. J. Drury, G. D. Hurd, T. M. Hutchison and F. W. Weitz, and each of them (with full power to each of them to act alone), the undersigned's true and lawful attorney-in-fact and agent, with full power of substitution to each, for and on behalf and in the name, place and stead of the undersigned, to execute and file any of the documents referred to below relating to registration under the Securities Act of 1933 with respect to variable annuity contracts, with premiums received in connection with such contracts held in the Principal Mutual Life Insurance Company Separate Account C on Form N-4 or other forms under the Securities Act of 1933,and any and all amendments thereto and reports thereunder with all exhibits and all instruments necessary or appropriate in connection therewith, each of said attorneys-in-fact and agents and his or their substitutes being empowered to act with or without the others or other, and to have full power and authority to do or cause to be done in the name and on behalf of the undersigned each and every act and thing requisite and necessary or appropriate with respect thereto to be done in and about the premises in order to effectuate the same, as fully to all intents and purposes as the undersigned might or could do in person; hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, may do or cause to be done by virtue hereof.\nIN WITNESS WHEREOF, the undersigned director has hereunto set his hand this 15th day of March, 1996. V. H. Loewestein _____________________________________________\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned director of Principal Mutual Life Insurance Company, an Iowa corporation (the \"Company\"), hereby constitutes and appoints D. J. Drury, G. D. Hurd, T. M. Hutchison and F. W. Weitz, and each of them (with full power to each of them to act alone), the undersigned's true and lawful attorney-in-fact and agent, with full power of substitution to each, for and on behalf and in the name, place and stead of the undersigned, to execute and file any of the documents referred to below relating to registration under the Securities Act of 1933 with respect to variable annuity contracts, with premiums received in connection with such contracts held in the Principal Mutual Life Insurance Company Separate Account C on Form N-4 or other forms under the Securities Act of 1933,and any and all amendments thereto and reports thereunder with all exhibits and all instruments necessary or appropriate in connection therewith, each of said attorneys-in-fact and agents and his or their substitutes being empowered to act with or without the others or other, and to have full power and authority to do or cause to be done in the name and on behalf of the undersigned each and every act and thing requisite and necessary or appropriate with respect thereto to be done in and about the premises in order to effectuate the same, as fully to all intents and purposes as the undersigned might or could do in person; hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, may do or cause to be done by virtue hereof.\nIN WITNESS WHEREOF, the undersigned director has hereunto set his hand this 15th day of March, 1996. J. R. Price, Jr. _____________________________________________\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned director of Principal Mutual Life Insurance Company, an Iowa corporation (the \"Company\"), hereby constitutes and appoints D. J. Drury, G. D. Hurd, T. M. Hutchison and F. W. Weitz, and each of them (with full power to each of them to act alone), the undersigned's true and lawful attorney-in-fact and agent, with full power of substitution to each, for and on behalf and in the name, place and stead of the undersigned, to execute and file any of the documents referred to below relating to registration under the Securities Act of 1933 with respect to variable annuity contracts, with premiums received in connection with such contracts held in the Principal Mutual Life Insurance Company Separate Account C on Form N-4 or other forms under the Securities Act of 1933,and any and all amendments thereto and reports thereunder with all exhibits and all instruments necessary or appropriate in connection therewith, each of said attorneys-in-fact and agents and his or their substitutes being empowered to act with or without the others or other, and to have full power and authority to do or cause to be done in the name and on behalf of the undersigned each and every act and thing requisite and necessary or appropriate with respect thereto to be done in and about the premises in order to effectuate the same, as fully to all intents and purposes as the undersigned might or could do in person; hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, may do or cause to be done by virtue hereof.\nIN WITNESS WHEREOF, the undersigned director has hereunto set his hand this 15th day of March, 1996. B. A. Rice _____________________________________________\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned director of Principal Mutual Life Insurance Company, an Iowa corporation (the \"Company\"), hereby constitutes and appoints D. J. Drury, G. D. Hurd, T. M. Hutchison and F. W. Weitz, and each of them (with full power to each of them to act alone), the undersigned's true and lawful attorney-in-fact and agent, with full power of substitution to each, for and on behalf and in the name, place and stead of the undersigned, to execute and file any of the documents referred to below relating to registration under the Securities Act of 1933 with respect to variable annuity contracts, with premiums received in connection with such contracts held in the Principal Mutual Life Insurance Company Separate Account C on Form N-4 or other forms under the Securities Act of 1933,and any and all amendments thereto and reports thereunder with all exhibits and all instruments necessary or appropriate in connection therewith, each of said attorneys-in-fact and agents and his or their substitutes being empowered to act with or without the others or other, and to have full power and authority to do or cause to be done in the name and on behalf of the undersigned each and every act and thing requisite and necessary or appropriate with respect thereto to be done in and about the premises in order to effectuate the same, as fully to all intents and purposes as the undersigned might or could do in person; hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, may do or cause to be done by virtue hereof.\nIN WITNESS WHEREOF, the undersigned director has hereunto set his hand this 15th day of March, 1996. J-P. C. Rosso _____________________________________________\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned director of Principal Mutual Life Insurance Company, an Iowa corporation (the \"Company\"), hereby constitutes and appoints D. J. Drury, G. D. Hurd, T. M. Hutchison and F. W. Weitz, and each of them (with full power to each of them to act alone), the undersigned's true and lawful attorney-in-fact and agent, with full power of substitution to each, for and on behalf and in the name, place and stead of the undersigned, to execute and file any of the documents referred to below relating to registration under the Securities Act of 1933 with respect to variable annuity contracts, with premiums received in connection with such contracts held in the Principal Mutual Life Insurance Company Separate Account C on Form N-4 or other forms under the Securities Act of 1933,and any and all amendments thereto and reports thereunder with all exhibits and all instruments necessary or appropriate in connection therewith, each of said attorneys-in-fact and agents and his or their substitutes being empowered to act with or without the others or other, and to have full power and authority to do or cause to be done in the name and on behalf of the undersigned each and every act and thing requisite and necessary or appropriate with respect thereto to be done in and about the premises in order to effectuate the same, as fully to all intents and purposes as the undersigned might or could do in person; hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, may do or cause to be done by virtue hereof.\nIN WITNESS WHEREOF, the undersigned director has hereunto set his hand this 15th day of March, 1996. D. M. Stewart _____________________________________________\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned director of Principal Mutual Life Insurance Company, an Iowa corporation (the \"Company\"), hereby constitutes and appoints D. J. Drury, G. D. Hurd, T. M. Hutchison and F. W. Weitz, and each of them (with full power to each of them to act alone), the undersigned's true and lawful attorney-in-fact and agent, with full power of substitution to each, for and on behalf and in the name, place and stead of the undersigned, to execute and file any of the documents referred to below relating to registration under the Securities Act of 1933 with respect to variable annuity contracts, with premiums received in connection with such contracts held in the Principal Mutual Life Insurance Company Separate Account C on Form N-4 or other forms under the Securities Act of 1933,and any and all amendments thereto and reports thereunder with all exhibits and all instruments necessary or appropriate in connection therewith, each of said attorneys-in-fact and agents and his or their substitutes being empowered to act with or without the others or other, and to have full power and authority to do or cause to be done in the name and on behalf of the undersigned each and every act and thing requisite and necessary or appropriate with respect thereto to be done in and about the premises in order to effectuate the same, as fully to all intents and purposes as the undersigned might or could do in person; hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, may do or cause to be done by virtue hereof.\nIN WITNESS WHEREOF, the undersigned director has hereunto set his hand this 15th day of March, 1996. E. E. Tallett _____________________________________________\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned director of Principal Mutual Life Insurance Company, an Iowa corporation (the \"Company\"), hereby constitutes and appoints D. J. Drury, G. D. Hurd, T. M. Hutchison and F. W. Weitz, and each of them (with full power to each of them to act alone), the undersigned's true and lawful attorney-in-fact and agent, with full power of substitution to each, for and on behalf and in the name, place and stead of the undersigned, to execute and file any of the documents referred to below relating to registration under the Securities Act of 1933 with respect to variable annuity contracts, with premiums received in connection with such contracts held in the Principal Mutual Life Insurance Company Separate Account C on Form N-4 or other forms under the Securities Act of 1933,and any and all amendments thereto and reports thereunder with all exhibits and all instruments necessary or appropriate in connection therewith, each of said attorneys-in-fact and agents and his or their substitutes being empowered to act with or without the others or other, and to have full power and authority to do or cause to be done in the name and on behalf of the undersigned each and every act and thing requisite and necessary or appropriate with respect thereto to be done in and about the premises in order to effectuate the same, as fully to all intents and purposes as the undersigned might or could do in person; hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, may do or cause to be done by virtue hereof.\nIN WITNESS WHEREOF, the undersigned director has hereunto set his hand this 15th day of March, 1996. D. D. Thornton _____________________________________________\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned director of Principal Mutual Life Insurance Company, an Iowa corporation (the \"Company\"), hereby constitutes and appoints D. J. Drury, G. D. Hurd, T. M. Hutchison and F. W. Weitz, and each of them (with full power to each of them to act alone), the undersigned's true and lawful attorney-in-fact and agent, with full power of substitution to each, for and on behalf and in the name, place and stead of the undersigned, to execute and file any of the documents referred to below relating to registration under the Securities Act of 1933 with respect to variable annuity contracts, with premiums received in connection with such contracts held in the Principal Mutual Life Insurance Company Separate Account C on Form N-4 or other forms under the Securities Act of 1933,and any and all amendments thereto and reports thereunder with all exhibits and all instruments necessary or appropriate in connection therewith, each of said attorneys-in-fact and agents and his or their substitutes being empowered to act with or without the others or other, and to have full power and authority to do or cause to be done in the name and on behalf of the undersigned each and every act and thing requisite and necessary or appropriate with respect thereto to be done in and about the premises in order to effectuate the same, as fully to all intents and purposes as the undersigned might or could do in person; hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, may do or cause to be done by virtue hereof.\nIN WITNESS WHEREOF, the undersigned director has hereunto set his hand this 15th day of March, 1996. F. W. Weitz _____________________________________________","section_15":""}
{"filename":"22606_1995.txt","cik":"22606","year":"1995","section_1":"ITEM 1. BUSINESS.\nGENERAL\nUnicom was organized in the state of Illinois on January 28, 1994. On September 1, 1994, a corporate restructuring took place in which Unicom became the parent holding company of ComEd and Unicom Enterprises, an unregulated subsidiary engaged, through a subsidiary, in energy service activities. The purpose of the restructuring was, in part, to permit Unicom Enterprises to engage in energy service activities without the prior approval of, or being regulated by, the ICC, in part to permit timely responses to competitive activities which could adversely affect ComEd's utility business and in part to permit Unicom to take advantage of unregulated business opportunities. Unicom's principal executive offices are located at 10 South Dearborn Street, Post Office Box A-3005, Chicago, Illinois 60690-3005, and its telephone number is 312\/394-7399.\nComEd continues to represent substantially all of the assets, revenues and net income of Unicom; and Unicom's resources and results of operations are largely dependent on, and reflect, those of ComEd. Unicom's unregulated subsidiaries are not expected to make material contributions to Unicom's revenues or results of operations in the near future. Consequently, the following discussion focuses on ComEd's utility operations although information is also provided about Unicom's unregulated operations.\nUtility Operations\nComEd is engaged principally in the production, purchase, transmission, distribution and sale of electricity to a diverse base of residential, commercial and industrial customers. ComEd was organized in the state of Illinois on October 17, 1913 as a result of the merger of Cosmopolitan Electric Company into the original corporation named Commonwealth Edison Company. The latter had been incorporated on September 17, 1907. ComEd's electric service territory has an area of approximately 11,540 square miles and an estimated population of approximately eight million as of December 31, 1994 and 1995. It includes the city of Chicago, an area of about 225 square miles with an estimated population of approximately three million from which ComEd derived approximately one-third of its ultimate consumer revenues in 1995. ComEd had approximately 3.4 million electric customers at December 31, 1995. ComEd's principal executive offices are located at 10 South Dearborn Street, Post Office Box 767, Chicago, Illinois 60690-0767, and its telephone number is 312\/394-4321.\nComEd's financial condition will continue to depend on its ability to generate revenues to cover its costs and to maintain adequate debt and preferred and preference stock coverages and common stock equity earnings. ComEd has no significant revenues other than from the sale of electricity. In December 1995, ComEd announced a cap on base electric rates at current levels. Consequently, ComEd's financial condition will be affected by, and ComEd's management is addressing, actions to maintain and increase sales, to control operating and capital expenditures, and to anticipate competitive activities. See \"Rate Proceedings\" and \"Business and Competition\" below.\nDuring the past several years, ComEd has instituted cost reduction plans including various workforce reductions. Such efforts included an offer of voluntary early retirement which was made to ComEd and the Indiana Company management, non-union and union employees eligible to retire or who became eligible to retire after December 31, 1993 and before April 1, 1995. Such program resulted in a charge to income of approximately $20.5 million (after reflecting income tax effects), substantially all of which was recorded during 1994. ComEd is continuing to examine methods of\nreducing the size of its workforce, including special severance offers. On October 30, 1995, ComEd declared an impasse in the collective bargaining agreement negotiations with its principal union and implemented virtually all of the terms of its last offered proposal prior to the impasse. Those terms include, among other things, a wage increase retroactive to April 1, 1995 and a voluntary separation offer for employees who accepted and left ComEd's employ by year-end 1995. The voluntary separation offer, combined with separation plans offered to selected groups of non-union employees, resulted in a charge to income of approximately $59 million (after reflecting income tax effects) or $0.27 per common share for the year 1995. This charge to income occurred primarily in the fourth quarter of 1995 when most of the acceptances of the offers occurred. ComEd expects to recover the costs of these plans within two years as a result of reduced personnel. On February 20, 1996, ComEd announced that it had reached agreement with Local 15 of the IBEW with respect to the terms of a new collective bargaining agreement. See \"Employees\" below and Notes 13, 14 and 15 of Notes to Financial Statements in Unicom's Current Report on Form 8-K dated January 26, 1996 and ComEd's Current Report on Form 8-K dated January 26, 1996 (the \"January 26, 1996 Form 8-K Reports\").\nComEd has also examined, and is continuing to examine, the possibility of disposing of one or more of its fossil generating stations to a third party or parties and entering into a long-term power purchase arrangement. In connection with such examination, ComEd has solicited and received binding proposals with respect to such a transaction involving its State Line and Kincaid generating stations; and it is negotiating with possible purchasers with respect to such transactions. As presently structured, such transactions would involve a sale of the generating station assets at a price approximating their book value and a fifteen-year power purchase arrangement. Any such transactions would be subject to the negotiation of definitive agreements and regulatory approvals and are not expected to have a material impact on ComEd's consolidated financial position or results of operations.\nSee \"Fuel Supply,\" \"Regulation\" and \"Item 3. Legal Proceedings\" herein for information concerning administrative and legal proceedings and certain other matters involving ComEd, the Indiana Company and Cotter. The outcome of certain of the proceedings or matters described or referred to therein, if not favorable to ComEd and the Indiana Company, could have a material adverse effect on the future business and operating results of Unicom, ComEd and the Indiana Company.\nUnregulated Operations\nUnicom Enterprises is engaged, through its subsidiaries, in energy service activities which are not subject to utility regulation by state or federal agencies. Its principal subsidiary, Unicom Thermal, currently provides district cooling services to office and other buildings from a central location in the city of Chicago. District cooling involves, in essence, the production of chilled water at a central location(s) and its circulation to customers' buildings through a closed circuit of supply and return piping. Such water is circulated through customers' premises primarily for air conditioning. This process is used in lieu of self-generated cooling. As a result of the Clean Air Amendments, the manufacture of CFCs has been curtailed, commencing in January 1996, thereby creating an excellent marketing opportunity for non-CFC based systems, such as Unicom Thermal's district cooling. Unicom Thermal and the city of Chicago have entered into a non-exclusive franchise agreement. Unicom Thermal's first plant began service in May 1995, and sufficient contracts have been secured to utilize the full capacity of the plant. In January 1996, Unicom Thermal Technologies Boston, Inc., a subsidiary of Unicom Thermal, became a minority participant with Boston Edison Technologies Group, Inc. in a venture to provide district cooling services to office and other buildings in the city of Boston.\nNET ELECTRIC GENERATING CAPABILITY\nComEd and the Indiana Company consider their owned (non-summer) generating capability to be 22,522,000 kilowatts. After deducting summer limitations of 557,000 kilowatts, ComEd and the\nIndiana Company consider their net summer generating capability to be 21,965,000 kilowatts. The net generating capability available for operation at any time may be less due to regulatory restrictions, fuel restrictions, efficiency of cooling facilities and generating units being temporarily out of service for inspection, maintenance, refueling, repairs or modifications required by regulatory authorities. See \"Item 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nComEd's electric properties are located in Illinois and the Indiana Company's electric facilities are located in Indiana. In management's opinion, ComEd and the Indiana Company's operating properties are adequately maintained and are substantially in good operating condition. The electric generating, transmission, distribution and general facilities of ComEd and the Indiana Company represent approximately 68%, 9%, 20% and 3%, respectively, of their gross investment in electric plant and equipment in service.\nThe electric generating stations, substations and a portion of the transmission rights of way of ComEd and the Indiana Company are owned in fee. A significant portion of the electric transmission and distribution facilities is located over or under highways, streets, other public places or property owned by others, for which permits, grants, easements or licenses (deemed satisfactory by ComEd, but without examination of underlying land titles) have been obtained. The principal plants and properties of ComEd are subject to the lien of ComEd's Mortgage dated July 1, 1923, as amended and supplemented, under which ComEd's first mortgage bonds are issued.\nThe net generating capability of ComEd and the Indiana Company is derived from the following electric generating facilities:\n- -------- (1) Excludes the 25% undivided interest of MidAmerican Energy Company (formerly Iowa-Illinois Gas and Electric Company) in the Quad-Cities station. (2) Generating units normally designed for use only during the maximum load period of a designated time interval. Such units are capable of starting and coming on-line quickly.\nMajor electric transmission lines owned and in service are as follows:\nComEd's electric distribution system includes 37,790 pole line miles of overhead lines and 31,750 cable miles of underground lines. A total of approximately 1,318,020 poles are included in ComEd's distribution system, of which about 589,530 poles are owned jointly with telephone companies.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nDuring 1989 and 1991, actions were brought in federal and state courts in Colorado against ComEd and Cotter seeking unspecified damages and injunctive relief based on allegations that Cotter has permitted radioactive and other hazardous material to be released from its mill into areas owned or occupied by the plaintiffs resulting in property damage and potential adverse health effects. In February 1994, a federal jury returned nominal dollar verdicts on eight bellwether plaintiffs' claims in these cases, which verdicts were upheld on appeal. The remaining claims in the 1989 actions are the subject of a settlement agreement entered into by counsel for the plaintiffs and Cotter. If the settlement agreement is implemented, the 1989 actions will be dismissed. Although the remaining cases will necessarily involve the resolution of numerous contested issues of fact and law, Unicom and ComEd's determination is that these actions will not have a material impact on their financial position or results of operations.\nIn 1990, ComEd filed a complaint in the Circuit Court against Westinghouse and certain of its employees. The complaint alleges that the defendants knowingly concealed information regarding the durability of the metal used in the steam generators (a major component of the nuclear steam supply systems) at ComEd's Zion, Byron and Braidwood stations. The complaint further alleges that the defects in the steam generators will prevent the plants from maintaining their full power output through their forty-year design life without costly remanufacture or replacement of the steam generators. Damages, including punitive damages, in an unspecified amount are claimed. Westinghouse has filed a counterclaim against ComEd which seeks recovery of Westinghouse's costs of defense and damages of approximately $13 million.\nShareholder derivative lawsuits were filed in 1992 and 1993 in the Circuit Court against current and former directors of ComEd alleging that they breached their fiduciary duty and duty of care to ComEd in connection with the management of the activities associated with the construction of ComEd's four most recently completed nuclear generating units. The lawsuits sought restitution to ComEd by the defendants for unquantified and undefined losses and costs alleged to have been incurred by ComEd. Both lawsuits were dismissed by the Circuit Court and that dismissal was affirmed by the Illinois Appellate Court. The Illinois Supreme Court declined to review that decision.\nA number of complaints have been filed by former employees with the EEOC, and several lawsuits have been filed by former employees in the U.S. District Court, alleging that the employees' terminations (which occurred as part of ComEd's management workforce reductions that were implemented in 1992) involved discrimination on the basis of age, race, sex, national origin and\/or disabilities, in violation of applicable law. The complainants in these various cases are seeking, among other things, awards of back pay and lost benefits, reinstatement, pecuniary damages, and costs and attorneys' fees. Most of these claims were resolved by settlement in 1995. ComEd does not view the remaining cases as having a material impact on its financial position or results of operations.\nIn July 1995, the Chicago area experienced several consecutive days of unusually high temperatures coupled with high humidity. Between July 12 and 14, 1995, ComEd experienced record demand for electricity. On July 14, 1995, a fire in a substation caused a power outage to approximately 40,000 customers. Other equipment failures in the same general area caused certain of these customers to be without power for up to 48 hours. In the wake of these power outages, three class action lawsuits were filed against ComEd seeking recovery of damages for property losses allegedly suffered. One suit seeks at least $10 million in damages; the others seek unspecified damages. One individual suit was also filed seeking damages less than $100,000 for property losses.\nSee \"Item 1. Business,\" subcaptions \"Rate Proceedings,\" \"Fuel Supply--Fuel Adjustment Clause\" and \"Regulation\" above for information concerning other legal proceedings.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNone.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nComEd's securities and other securities guaranteed by ComEd are currently rated by three principal securities rating agencies as follows:\nAs of March 1996, Standard & Poor's rating outlook on ComEd remained stable. As of October 1995, Moody's rating outlook on ComEd also remained stable. In August 1995, Duff & Phelps upgraded its rating of ComEd's preferred and preference stock from BB+ to BBB- and reaffirmed that its rating outlook on ComEd remained stable.\nThe above ratings reflect only the views of such rating agencies and each rating should be evaluated independently of any other rating. Generally, rating agencies base their ratings on information furnished to them by the issuing company and on investigations, studies and assumptions by the rating agencies. There is no assurance that any particular rating will continue for any given period of time or that it will not be changed or withdrawn entirely if in the judgment of the rating agency circumstances so warrant. Such ratings are not a recommendation to buy, sell or hold securities.\nThe following is a brief summary of the meanings of the above ratings and the relative rank of the above ratings within each rating agency's classification system.\nMoody's top four long-term debt ratings (Aaa, Aa, A and Baa) are generally considered \"investment grade.\" Obligations rated Baa are considered as medium grade obligations, neither highly protected nor poorly secured. Such obligations lack outstanding investment characteristics and in fact have speculative characteristics. (A numerical modifier in Moody's system shows relative standing within the principal rating category, with 1 indicating the high end of that category, 2 the mid-range and 3 the low end.) Standard & Poor's top four bond ratings (AAA, AA, A and BBB) are generally considered to describe obligations in which investment characteristics predominate. Obligations rated BBB are regarded as having an adequate capacity to pay interest and repay principal. Such obligations normally exhibit adequate protection parameters, but adverse economic conditions or changing circumstances are more likely to lead to weakened capacity to pay. (A plus or minus sign in Standard & Poor's system shows relative standing within the major rating categories.)\nBoth Moody's and Standard & Poor's preferred stock ratings represent relative security of dividends. Moody's top four preferred stock ratings (aaa, aa, a and baa) are generally considered \"investment grade.\" Moody's baa rating describes a medium grade preferred stock, neither highly protected nor poorly secured. Standard & Poor's top four preferred stock ratings (AAA, AA, A and BBB) are generally considered \"investment grade.\" Standard & Poor's BBB rating applies to medium grade preferred stock which is below A (\"sound\") and above BB (\"lower grade\").\nDuff & Phelps' credit rating scale has 17 alphabetical categories, of which ratings AAA through BBB (with AAA being the highest rating) represent investment grade securities. Ratings of BBB+,\nBBB and BBB- represent the lowest category of \"investment grade\" rating. This category describes securities with below average protection factors but which are considered sufficient for institutional investment. Considerable variability in risk occurs during economic cycles. Ratings of BB+, BB and BB- describe below investment grade securities which are deemed likely to meet obligations when due. Present or prospective financial protection factors of these securities fluctuate according to industry conditions or company fortunes.\nMoody's P-2 rating of commercial paper is the second highest of three possible ratings; P-2 describes a strong capacity for repayment of short-term promissory obligations. Standard & Poor's rates commercial paper in four basic categories with A-2 being the second highest category. Duff & Phelps rates commercial paper in three basic categories, with D-2 indicating the middle category.\nFurther explanations of the significance of ratings may be obtained from the rating agencies.\nAdditional information required by Item 5 is incorporated herein by reference to the \"Price Range and Cash Dividends Paid Per Share of Common Stock\" on page 3 of Unicom's January 26, 1996 Form 8-K Report.\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.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe information required by Items 6, 7 and 8 is incorporated herein by reference to the \"Summary of Selected Consolidated Financial Data\" on page 3, \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" on pages 4 through 15, and the audited consolidated financial statements and notes thereto on pages 16 through 44 of Unicom's January 26, 1996 Form 8-K Report and to Unicom's Form 8-K\/A-1 Current Report dated March 14, 1996. Reference is also made to \"Item 1. Business,\" subcaptions \"Construction Program,\" \"Regulation\" and \"Business and Competition\" for additional 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 information required by Item 10 relating to directors and nominees for election as directors at ComEd's Annual Meeting of shareholders to be held on May 22, 1996 is incorporated herein by reference to information under the heading \"Security Ownership of Certain Beneficial Owners and Management\" in ComEd's definitive Information Statement (1996 Information Statement) to be filed with the SEC prior to April 29, 1996 pursuant to Regulation 14C under the Securities Exchange Act of 1934. The information required by Item 10 relating to executive officers is set forth in Part I of ComEd's Annual Report on Form 10-K under \"Item 1. Business,\" subcaption \"Executive Officers of the Registrant\" and under the heading \"Security Ownership of Certain Beneficial Owners and Management\" in ComEd's 1996 Information Statement, which are incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe information required by Item 11 is incorporated herein by reference to the paragraph labelled \"Compensation of Directors\" and the paragraphs under the heading \"Executive Compensation\" (other than the paragraphs under the heading \"Corporate Governance and Compensation Committee Report on Executive Compensation\") of ComEd's 1996 Information Statement.\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 stock ownership information under the heading \"Security Ownership of Certain Beneficial Owners and Management\" of ComEd's 1996 Information Statement.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nNone.\nANNUAL REPORTS ON FORM 10-K FOR UNICOM CORPORATION AND COMMONWEALTH EDISON COMPANY\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:\nThe following schedules are omitted as not applicable or not required under rules of Regulation S-X: I, III, IV and V.\nThe individual financial statements and schedules of ComEd's nonconsolidated wholly-owned subsidiaries have been omitted from Unicom's and ComEd's Annual Report on Form 10-K because the investments are not material in relation to ComEd's financial position or results of operations. As of December 31, 1995, the assets of the nonconsolidated subsidiaries in the aggregate approximated 1% of ComEd's consolidated assets and for the year 1995 annual revenues of the nonconsolidated subsidiaries in the aggregate were less than 1% of ComEd's consolidated annual revenues.\nThe following exhibits are filed with the indicated Annual Report on Form 10-K or incorporated therein by reference. Documents indicated by an asterisk (*) are incorporated by reference to the File No. indicated. Documents indicated by a plus sign (+) identify management contracts or compensatory plans or arrangements.\nPursuant to Item 601(b)(4)(iii) of Regulation S-K, Unicom and ComEd hereby agree to furnish to the SEC, upon request, any instrument defining the rights of holders of long-term debt of ComEd not filed as an exhibit herein. No such instrument authorizes securities in excess of 10% of the total assets of ComEd.\n(B) REPORTS ON FORM 8-K:\nA Current Report on Form 8-K dated December 11, 1995 was filed by Unicom and ComEd to describe ComEd's announcement of a series of customer initiatives.\nA Current Report on Form 8-K dated December 13, 1995 was filed by Unicom and ComEd to describe ComEd's announcement of a proposal to amend certain provisions of the Illinois Public Utilities Act.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SUPPLEMENTAL SCHEDULE\nTo Unicom Corporation:\nWe have audited, in accordance with generally accepted auditing standards, the consolidated financial statements of Unicom Corporation and subsidiary companies incorporated by reference in this Annual Report on Form 10-K, and have issued our report thereon dated January 26, 1996.\nOur audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule listed on page 29, Item 14.(a), 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 January 26, 1996\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SUPPLEMENTAL SCHEDULE\nTo Commonwealth Edison Company:\nWe have audited, in accordance with generally accepted auditing standards, the consolidated financial statements of Commonwealth Edison Company and subsidiary companies incorporated by reference in this Annual Report on Form 10-K, and have issued our report thereon dated January 26, 1996.\nOur audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule listed on page 29, Item 14.(a), 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 January 26, 1996\nSCHEDULE II\nUNICOM CORPORATION AND SUBSIDIARY COMPANIES\nSCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS (THOUSANDS OF DOLLARS) - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------\nNotes: (a) Bad debt losses, net of recoveries, and provisions for uncollectible accounts were charged to operating expense and amounted to $28,867,000, $25,287,000 and $26,278,000 in 1993, 1994 and 1995, respectively.\n(b) Expenditures for site investigation and cleanup costs.\n(c) Payments of claims and related costs.\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, IN THE CITY OF CHICAGO AND STATE OF ILLINOIS ON THE 28TH DAY OF MARCH 1996. UNICOM CORPORATION\nBy James J. O'Connor ----------------------------- James J. O'Connor, 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 INDICATED ON THE 28TH DAY OF MARCH 1996. SIGNATURE TITLE - ---------------------------- ---------------------\nJames J. O'Connor Chairman and Chief - ---------------------------- Executive Officer and James J. O'Connor Director (principal executive officer) John C. Bukovski - ---------------------------- Vice President (principal John C. Bukovski financial officer)\nRoger F. Kovack Comptroller (principal - ---------------------------- accounting officer) Roger F. Kovack Jean Allard Director Edward A. Brennan* Director James W. Compton* Director Sue L. Gin* Director Donald P. Jacobs Director Edgar D. Jannotta* Director George E. Johnson* Director Edward A. Mason* Director Leo F. Mullin* Vice Chairman and Director Frank A. Olson Director Samuel K. Skinner* President and Director David A. Scholz *By ---------------------------- David A. Scholz, Attorney-in- fact\n[Signature page to Unicom Corporation Annual Report on Form 10-K]\nUNICOM CORPORATION COMMONWEALTH EDISON COMPANY FILE NO.'S 1-11375 AND 1-1839\nEXHIBIT INDEX\nThe following exhibits are filed with the indicated Annual Report on Form 10- K or incorporated therein by reference. Documents indicated by an asterisk (*) are incorporated by reference to the File No. indicated. Documents indicated by a plus sign (+) identify management contracts or compensatory plans or arrangements.\nPursuant to Item 601(b)(4)(iii) of Regulation S-K, Unicom and ComEd hereby agree to furnish to the SEC, upon request, any instrument defining the rights of holders of long-term debt of ComEd not filed as an exhibit herein. No such instrument authorizes securities in excess of 10% of the total assets of ComEd.","section_15":""}
{"filename":"28452_1995.txt","cik":"28452","year":"1995","section_1":"Item 1. Business.\nGeneral\nDevcon International Corp. (the \"Company\") is the largest producer and distributor of ready-mix concrete and quarry products in the United States Virgin Islands, Antigua and Barbuda, West Indies (\"Antigua\"), St. Maarten, Netherlands Antilles (\"St. Maarten\"), St. Martin, French West Indies (\"St. Martin\") Saba, Netherlands Antilles (\"Saba\"), Dominica, West Indies (\"Dominica\") and Tortola, British Virgin Islands (\"Tortola\") and is a land development contractor in the Caribbean.\nIn the Caribbean, the Company produces and distributes ready-mix concrete, crushed stone, concrete block and asphalt and distributes bulk and bagged cement. The Company's facilities have enabled the Company to establish a significant market share in most of the locations in which it operates and afford the Company resources, production capacity, a local presence and a cost structure that the Company believes would be difficult for competitors to duplicate. As a result, the Company has less competition and, therefore, produces a substantial percentage of the concrete and related products used in these islands.\nThe Company currently performs earthmoving, excavating and filling operations and builds golf courses, roads, utility infrastructures, dredges waterways and constructs deep water piers and marinas in the Caribbean. The Company has historically provided land devel- opment contracting services to both private enterprises and govern- ments in Florida and the Caribbean. Since early 1993, the Company has not been seeking new contracts in the United States. The Com- pany's project managers have substantial experience working in the land development contracting business, and the Company has equip- ment that is well-suited for the Caribbean markets. The Company has equipment and personnel in the Caribbean that the Company believes, in some instances, allow the Company to start work more quickly and less expensively than other contractors and, therefore, to bid competitively for and complete cost-effectively land development contracts. The Company believes its relationships with customers in the Caribbean give it a significant competitive advan- tage.\nThe Company also owns and operates a marina in the United States Virgin Islands and has a majority interest in a partnership that manufactures and sells specialty ceiling tiles. The ceiling tile business was discontinued for financial statement purposes as of December 31, 1995.\nThe following table sets forth certain financial information concerning the Company's concrete and related products, land development contracting and other businesses:\n1995 1994 1993 (in thousands) Revenues*: Concrete and related products $37,716 $39,342 $38,300 Contracting 16,068 22,942 16,926 Other 2,367 2,965 638 Total $56,151 $65,249 $55,864\nOperating income (loss)*:\nConcrete and related products 1,252 2,841 (321) Contracting (569) 1,747 (6,943) Other 409 321 128 Unallocated corporate overhead (818) (424) (1,019)\nTotal $ 274 $ 4,485 $(8,155)\n* Information is presented net of intersegment sales. See Note 12 of Notes to Consolidated Financial Statements for addi- tional financial information with respect to the Company's business segments. See Summary of Significant Accounting Policies in Notes to Consolidated Financial Statements.\nThe Company's principal executive offices are located at 1350 East Newport Center Drive, Suite 201, Deerfield Beach, Florida 33442 and its telephone number is (954)429-1500. Unless the context otherwise requires, the terms the \"Company\" and \"Devcon\" as used herein refer to Devcon International Corp. and its subsidiaries.\nBusiness Development\nThe Company expanded its operations in the Caribbean by acquiring a company in St. Martin in August 1995 which sells and distributes ready mix concrete and operates a quarry. The Company opened ready- mix concrete plants on the islands of Saba and St. Kitts during the second quarter of 1993 and in 1992 completed the installation of a bulk cement facility and cement bagging plant in Dominica. In 1991, the Company opened a ready mix concrete plant on the island of Dominica and in October 1990 acquired the assets of a company engaged in the ready mix concrete and quarry business on the island of Tortola. The Company acquired an affiliated group of companies operating a ready mix concrete operation, block plant, cement plant and quarry in St. Maarten in April 1990. The Company is planning to open a quarry in Puerto Rico in early 1996 and is presently investigating the possibility of expanding its operations to other areas of the Caribbean where the Company does not presently do business. Such expansion can take place in the form of joint ventures, acquisitions or other business arrangements. The Company periodically reviews its strategic alternatives and is in the process of such review now, with the assistance of a financial advisor. The Company does not have any definitive agreements regarding any particular strategic alternative, joint venture, acquisition or business arrangement at this time and there can be no assurance that the Company will be able to consummate any such transactions on satisfactory terms.\nRisks of Foreign Operations\nVarious portions of the Company's operations are conducted in foreign areas, primarily Antigua, St. Maarten, St. Martin, Dominica, Saba, St. Kitts and Tortola, all of which are in the Caribbean. In 1995, 53.1 percent of the Company's revenues were derived from foreign operations. Overseas contract work performed by the parent company (a United States corporation) is not considered foreign source revenue for purposes of the foregoing calculation. The majority of contract work is performed by the parent company. For a summary of the Company's revenues and earnings from foreign operations, see Note 10 of Notes to Consolidated Financial Statements. The potential risks of doing business in foreign areas include potential adverse changes in the diplomatic relations of foreign countries with the United States, changes in the relative purchasing power of the United States dollar, hostility from local populations, adverse effects of exchange controls, restrictions on the withdrawal of foreign investment and earnings, government policies against businesses owned by non-nationals, expropriations of property, the instability of foreign governments and the risk of insurrection that could result in losses against which the Company is not insured. The Company was not subject to these risks in Florida and is not subject to them in the United States Virgin Islands (a United States territory that uses the United States dollar as its currency). The Company also is subject under certain circumstances to United States Federal income tax upon the distribution of certain offshore earnings. See Note 8 of Notes to Consolidated Financial Statements. Although the Company has not encountered significant difficulties in its foreign operations in the past, there can be no assurance that the Company will not encounter difficulties in the future.\nConcrete and Related Products\nGeneral The Company manufactures and distributes ready-mix concrete and crushed aggregate (both coarse and fine) on St. Thomas and St. Croix, United States Virgin Islands, Antigua, St. Maarten, St. Martin, Dominica, Saba, St. Kitts and Tortola (although crushed aggregate is not manufactured on Dominica, St. Kitts and St. Maarten). The Company's customers on St. Kitts are limited, at this time, to those organizations or individuals engaged in duty free contracting or development activities. The Company also distributes bulk and bagged cement to customers on each of the foregoing islands. In addition, the Company manufactures concrete block on St. Thomas, Antigua and St. Maarten.\nThe Company's concrete and related products business employs assets such as quarries, rock crushing plants, bulk cement terminals, concrete block plants, concrete batch plants, a fleet of concrete mixer trucks, cement bagging facilities and asphalt plants, in various locations in the United States Virgin Islands, Antigua, St. Maarten, St. Martin, Dominica, St. Kitts, Saba and Tortola. The Company also has an oceangoing bulk cement ship that affords the Company ready access to reliable and more economical sources of cement. As a result, the Company has become the largest supplier of concrete and related products in the United States Virgin Islands, Antigua, St. Maarten, St. Martin, Dominica, Saba and Tortola. The Company is presently investigating the possibility of expanding its cement distribution and concrete and aggregate busi- ness to other areas in the Caribbean. See \"Business - Business Development.\"\nReady-Mix Concrete and Concrete Block The Company's concrete batch plants mix cement, sand, crushed stone, water and certain chemical additives to produce ready-mix concrete for use in local construc- tion. The Company's fleet of concrete mixer trucks deliver the concrete to the customer's job site. At the Company's concrete block plants, a low moisture concrete mixture is machine formed, then dried and stored for later sale. The Company's ready-mix concrete operations are significantly larger than those of any other competitor on St. Croix, Antigua, St. Maarten, St. Martin, Dominica, Tortola, Saba and St. Thomas. The Company has the only concrete block plant on St. Thomas, and in Antigua and St. Maarten, the Company's block plant is the area's largest.\nQuarry Operations and Crushed Stone The Company owns or leases quarry sites on which it blasts rock from exposed mineral forma- tions. At the quarries, this rock is crushed and screened to varying sizes of aggregate from 3 1\/2-inch stones down to manufac- tured sand, and the aggregate is then sorted, cleaned and stored. The resulting aggregate is sold to customers and used in the Company's operations to make concrete products. The Company's quarries are the largest on St. Thomas, St. Croix, Antigua, St. Martin, Saba and Tortola. It is significantly less expensive to manufacture crushed rock at the Company's quarries than to import aggregate from off-island sources.\nBulk and Bagged Cement The Company has an oceangoing bulk cement ship with a 6,000 metric ton capacity. The ship delivers cement in bulk to the Company's cement terminals on St. Thomas, St. Croix, Antigua, Dominica and St. Maarten. From silos at these terminals, the cement is transferred for use in the Company's concrete batch plants, sold in bulk or bagged and then sold. Bulk cement is readily available from a number of manufacturers located throughout the Caribbean basin. As a result of the Company's bulk cement ship, the Company is able to assure itself of reliable and relatively economical sources of cement. See \"Business - Equipment.\"\nSupplies The Company presently obtains all of the crushed rock and a majority of the sand necessary for the production of ready-mix concrete in the United States Virgin Islands, Antigua, St. Martin, St. Maarten, Saba and Tortola by quarrying its own rock and crushing it at its own locations. The Company's ability to produce its own sand gives it a competitive advantage because of the substantial investment required to produce sand, the difficulty in obtaining the necessary environmental permits to establish quarries and the moratorium on mining beach sand imposed by most Caribbean countries. The sand the Company produces is blended with sand obtained from various offshore sources unaffiliated with the Company and, occasionally, from Company construction or dredging sites. The Company's oceangoing bulk cement ship described above allows it to satisfy its bulk cement requirements.\nCustomers The Company's primary customers are building contractors, governments, asphalt pavers and individual homeowners.\nCustomers generally pick up quarry products, concrete block and bagged cement at the Company's facilities, and the Company gen- erally delivers ready-mix concrete and bulk cement to the customer's job sites.\nCompetition The Company has few competitors in the concrete and related products business in the locations where it conducts business. The Company encounters competition from the producers of asphalt, which is an alternative material to concrete for road construction. The Company's concrete and related products facil- ities and the Company's oceangoing bulk cement ship have enabled the Company to establish a significant market share in the United States Virgin Islands, Antigua, St. Maarten, St. Martin, Dominica, Saba and Tortola and afford the Company resources, a production capacity, a local presence and a cost structure that the Company believes would be difficult for competitors to duplicate. As a result, the Company believes that it presently has a competitive advantage in the United States Virgin Islands, Antigua, St. Maarten, St. Martin, Dominica, Saba and Tortola.\nLand Development Contracting\nGeneral The Company has completed a wide variety of land development construction projects since its inception, including interstate highways, airport sites and runways, deep-water piers and marinas, hydraulic dredging projects, golf courses, industrial site development and residential and commercial site development. The Company generally attempts to pursue the most profitable types of land development contracting work available, rather than attempting to maintain a high level of volume. In prior years, the Company has been engaged in residential and commercial site development (including golf courses) for real estate developers in Florida and the Caribbean, and marine construction (dredging of deep-water harbors and construction of deep-water piers and marinas) in the Caribbean. Since early 1993, the Company has not been seeking new contracts in the United States.\nThe nature of the work performed by the Company's land development contracting division is such that the work is accomplished and revenue generated on a contract-by-contract basis. The majority of the Company's land development contracts are less than one year in duration, although it does obtain multi-year contracts from time to time. A majority of the Company's contracts are fixed-price contracts. These contracts are bid or negotiated at an established price that does not vary except for changes in the scope of the work requested by the owner during the term of the contract. The majority of the Company's work is performed using its own labor and equipment and is not subcontracted. The Company also enters into unit-price contracts pursuant to which the Company's fee is based upon the quantity of work performed. The Company historically has contracted to provide land development contracting services to both private enterprises and governments. The Company believes that, on occasion, it is able to obtain more desirable margins on some private and public contracts in the United States Virgin Islands and Antigua because the Company has equipment and personnel in those markets that, in some instances, allow the Company to start work more quickly and less expensively than other contractors. As a result, the Company believes that it is able to bid competitively for and complete cost-effectively land development contracts in the Company's Caribbean markets.\nOperations The Company's first step in any project is deciding whether to submit a bid on, or to negotiate to undertake, a particular project. The Company obtains leads for new projects from a variety of sources, including past or existing customers of the Company, referrals from past or existing customers and referrals from engineering firms with which the Company has estab- lished business relationships. At the appropriate time, a proposal is submitted that the Company believes will best meet a customer's objectives. In some instances in the past, the Company has provided long-term or short-term financing to facilitate early com- mencement or efficient continuation of a project. The Company believes that providing such financing enhances its ability to obtain more profitable construction contracts. The continuation of such financing is contingent upon the financial position and operating results of the Company. All project proposals and bids are reviewed by the Company's Vice President of Construction Operations and\/or the Company's President, depending upon the size of the contract. After a proposal has been accepted, a formal contract is negotiated with the customer. The Company is normally the prime contractor on any work it undertakes. The Company assigns a project manager and a field superintendent to maintain close contact with the customer and its engineers, to supervise personnel and the relocation, purchase, lease and maintenance of equipment and to schedule and monitor the Company's operations. The Company currently employs 5 job superintendents.\nBacklog The Company's backlog of unfilled portions of land development contracts at December 31, 1995 was $11.4 million involving 25 projects, as compared to $6.8 million involving 23 projects at December 31, 1994. Since December 31, 1995 the Company has entered into new land development contracts in the Caribbean amounting to $432,000. As a result of the Company's current backlog, new contracts must be obtained as 1996 progresses, in order to achieve the contract revenue levels obtained in 1995. The Company reasonably expects that all of the backlog, including the 1996 contracts, will be completed during the year ending December 31, 1996. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Revenues.\"\nBonding In order to bid on some private construction contracts and substantially all government contracts, the Company must obtain a bond for the performance of the contract. The Company's bonding capacity is sufficient to enable the Company to perform some government and major private contracts.\nCompetition The land development contracting business is extremely competitive, regardless of the general level of activity within the construction industry. The Company believes that the primary fac- tors of competition are price, prior experience and relationships, the amount of machinery and heavy equipment available to complete a given job, the speed with which a company can complete a specific contract, the availability of an engineering staff to assist an owner in planning its projects so as to minimize costs, the ability to innovate and, where applicable, the ability to obtain bonding for large contracts in order to guarantee completion. Management believes that the Company competes effectively on the basis of the foregoing factors and that the Company's relative competitive position in its Caribbean markets is favorable.\nOther Operations\nMarina Two subsidiaries of the Company own a Virgin Islands general partnership formed in 1988 to construct and operate a marina on a 4.92 acre parcel of land leased by the partnership from the United States Virgin Islands government. The lease is for a term of 20 years commencing in 1991 and contains a renewal option for an additional 10 years. The Company originally owned fifty percent of the marina partnership. It acquired management control of the marina in 1991 and acquired its partners fifty percent interest in 1992. The marina facility contains retail and office space, a fuel farm and 96 slips for boats ranging in size from 15 to 200 feet in length.\nDiscontinued Operations\nIn September 1989, a subsidiary of the Company obtained a minority interest in a partnership engaged in the manufacture, sale and distribution of acoustical ceiling tiles. The subsidiary invested approximately $1.2 million in the partnership for a 29 percent interest and two of the Company's directors obtained an 11 percent interest for which they paid $450,000. In January 1994 an Antiguan subsidiary of the Company became the new general partner and the Company's ownership interest in the partnership was increased to 57.98 percent. The directors' ownership interest was reduced to 6.47 percent. In November 1995 the Company elected to dispose of this operation because of its poor operating results and uncertain prospects for improvement. Accordingly, at December 31, 1995, the intended disposal has been accounted for as a discontinued operation. The financial statements for all prior periods presented have been restated to reflect the ceiling tile partnership as a discontinued operation. The Company's investment in the partnership was written down $800,000, to its estimated net realizable value of approximately $749,000, which consists of property, equipment and inventory with a net book value of approximately $1.4 million, along with debt of approximately $621,000. The Company provided no reserve for anticipated losses during the phaseout period and expects to recognize no income tax benefit on the loss from discontinued operations. The Company is currently negotiating the sale of a major portion of the partnership's net assets, however, no definitive sales agreement has been concluded at this time.\nIn 1991 the marina, discussed in \"Other Operations\", was classified as a discontinued operation for financial statement presentation purposes. The marina assets were written down $2.2 million dollars, to their estimated net realizable value, and a reserve of $1.3 million dollars was established for marina losses for the period from January 1, 1992 to the expected disposal date. The Company elected to reconsolidate the marina operation into its financial statements as of September 30, 1993, primarily because the Company believed it would take a significant amount of time to dispose of the marina in the current real estate market. Approximately $600,000 of the original $1.3 million reserve was reflected as a gain on discontinued operations subsequently retained.\nTax Exemptions and Benefits\nThe Company for a number of years has benefitted from having a substantial part of the earnings of its offshore operations taxed at rates lower than United States statutory Federal income tax rates due to tax exemptions and lower prevailing tax rates offshore. The United States Virgin Islands Industrial Development Commission (\"IDC\") and the Government of Antigua have granted the Company certain tax exemptions that exempt a larger portion of the earnings of the Company's offshore operations from tax in the United States Virgin Islands and Antigua through 2003 and 1996, as more fully described below.\nIn April 1988, the IDC granted a subsidiary of the Company a 10- year tax exemption expiring in 1998, pursuant to which, and subject to certain conditions and exceptions, the Company's (i) production and sale of ready-mix concrete; (ii) production and sale of concrete block on St. Thomas and St. Johns and outside of the Virgin Islands; (iii) production and sale of sand and aggregate; and (iv) bagging of cement from imported bulk cement, are 100 percent exempt from all United States Virgin Islands real property, gross receipts (currently set at 4 percent) and excise taxes, 90 percent exempt from United States Virgin Islands income taxes, and approximately 83 percent exempt from United States Virgin Islands custom duties. The IDC granted the Company the tax exemption in return for the Company's commitment to (i) make capital expendi- tures of at least $4.6 million for new or replacement equipment over a 10-year period, which the Company has satisfied; (ii) employ a minimum of 142 United States Virgin Islands residents as full- time personnel; (iii) spend at least $75,000 annually for a youth training program; (iv) not increase the price of its concrete and related products except as the result of certain direct cost increases incurred by the Company over which it has no control; and (v) make an annual scholarship fund contribution of $150,000.\nIn January 1994, the Company received a five year extension, through April 2003, of its previously granted benefits. This extension was granted in return for the Company agreeing to (i) continue to employ a minimum of 160 United States Virgin Islands residents as full time personnel, (ii) make additional capital expenditures of $1.7 million and (iii) continue to make a combined youth training\/scholarship contribution of $225,000 per annum during the extension period.\nIn partial consideration for the Company's work on a major contract, the Government of Antigua granted two subsidiaries of the Company a 10-year tax holiday effective January 1, 1987 and expiring on December 31, 1996 from all taxes due (i) in connection with the Company's construction contract with Antigua to, among other things, dredge St. John's harbor, (ii) as a result of the Company's participation in a joint venture to develop 230 acres of vacant land as well as 20,000 square feet of commercial property in Antigua; and (iii) in connection with the Company's sale of concrete and related products in Antigua. The tax holiday also exempted the Company from certain accrued tax liabilities. In 1989, in connection with and in consideration for additional work done by the Company with respect to the foregoing contract, the Government of Antigua granted an additional tax exemption to the Company. The tax exemption exempts the Company from taxes that would otherwise result from the Company's income relating to a construction contract in Jolly Harbor, Antigua.\nFurthermore, as a result of certain United States tax laws, earnings from the Company's offshore operations are not taxable for United States Federal income tax purposes and most post-April 1988 concrete and related product earnings in the United States Virgin Islands can be distributed to the Company in the United States free of statutory United States Federal income tax. However, the distribution to the Company's United States operations of (i) earn- ings from the Company's United States Virgin Islands operations accumulated prior to April 1, 1988 or (ii) earnings from the Company's Antigua, St. Martin, St. Maarten, Dominica, Saba, St. Kitts and Tortola operations, would in each case subject the Company to United States Federal income tax on any amounts so distributed, less applicable tax credits for taxes previously paid in such jurisdictions. At December 31, 1995, $41.0 million of such accumulated earnings from the Company's United States Virgin Islands, Antigua, St. Martin, St. Maarten, Dominica, Saba, St. Kitts and Tortola operations had not been distributed to the Company's United States operations. The Company has not provided for Federal income tax on the undistributed earnings of foreign subsidiaries because the Company intends to permanently reinvest those earnings in regions offshore of the United States.\nThe aforementioned tax exemptions, along with the Company's ability to receive most of the current earnings from its United States Virgin Islands operations without being subjected to United States Federal income taxes thereon, result in a significant reduction in the tax expense (including Federal income taxes) incurred by the Company with respect to its earnings from Caribbean operations. For further information on both tax exemptions and income taxes in general, see Note 8 of Notes to Consolidated Financial Statements.\nEquipment\nThe concrete and related products and the land development contracting businesses require the Company to purchase and maintain many items of equipment. As of December 31, 1995, the Company's equipment included an ocean going bulk cement vessel, draglines, cranes, bulldozers, road graders, rollers, backhoes, earthmovers, hydraulic dredges, barges, traxcavators, rock crushers for use at the Company's rock crushing plants, equipment at the Company's bulk cement terminals and concrete block and batch plants, concrete mixer trucks, asphalt processing and paving equipment and other miscellaneous items. A portion of this equipment is encumbered by chattel mortgages. See Notes 7 and 11 of Notes to Consolidated Financial Statements.\nEmployees\nAt December 31, 1995, the Company employed 99 persons in the land development contracting business in the Caribbean, of whom 31 United States Virgin Islands and Antigua employees are members of a union. The Company employed 403 persons in its concrete and related products division, of whom 128 employees in the Caribbean are members of a union. The Company will also utilize personnel in one division or another as its needs warrant. In addition, the Company employs 40 managerial, supervisory and administrative personnel in the overall administration and management of all divi- sions of the Company. Employee relations in the Company are considered satisfactory and the Company has never been subjected to a work stoppage.\nMiscellaneous Investments and Joint Ventures\nThe Company has invested or participated in several joint ventures in connection with the activities of its land development contracting division and concrete and related products division, which are more particularly described below.\nIn connection with a land development contract with the Government of Antigua and as partial consideration therefor, the Company obtained a 75 percent interest in a corporation formed to own and develop approximately 230 acres of real property in Antigua (the \"Corbkinnon Property\"), and a 1 percent interest in another corporation (the \"Newport Project\") formed to develop approximately 20,000 square feet of commercial property located in downtown St. Johns, Antigua. In 1990, the Company sold a portion of its 75 percent interest in the Corbkinnon Property for $500,000 and the buyer's commitment to provide 50 percent of the financing required to develop the project. The Company agreed to provide the first $500,000 of financing and provide a guarantee for 50 percent of all additional financing required. As a result of the transaction, the Company's remaining interest in the Corbkinnon Property is 34 percent. The Company did not record earnings or losses for the Newport Project in 1995 because the amounts are not material. The Company wrote down its investment in the Corbkinnon Property by $200,000 in 1993. For additional information, see Notes 4 and 10 of Notes to Consolidated Financial Statements.\nThe Company is a 43 percent shareholder in a Tortolan corporation formed to construct condominium housing units in Antigua. The Company has advanced $200,000 in capital contributions to the Tortolan corporation. In 1995, the Company recorded no earnings or loss related to its investment in this corporation, which investment is being accounted for under the equity method. For additional information, see Note 4 of Notes to Consolidated Financial Statements.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Property\nGeneral\nSubstantially all of the real property that the Company owns or leases is utilized by its concrete and related products division. The Company has quarries, rock crushing plants and concrete batch plants on St. Thomas, St. Croix, Antigua, St. Martin, Saba and Tortola, concrete batch plants on Dominica, St. Maarten and St. Kitts, and bulk cement terminals and cement bagging facilities on St. Croix, St. Thomas, St. Maarten, Dominica and Antigua. In addition, the Company has asphalt plants on St. Croix and Antigua and concrete block plants on St. Thomas, Antigua and St. Maarten.\nOther Property\nThe Company also has a 34 percent interest in 230 acres of real property and a 1 percent interest in a commercial property development, both in Antigua (see \"Business - Miscellaneous Investments and Joint Ventures\"), and the Company owns undeveloped parcels of land in Collier County, Florida, and St. Johns, United States Virgin Islands. The Company has no current plans to develop or sell the parcels located in the United States and United States Virgin Islands.\nThe following table sets forth certain information concerning the property and facilities that are owned or leased by the Company for use in its operations.\n[CAPTION]\n(1) Underlying land is leased, however, any equipment or machinery on the land is owned by the Company.\n(2) Leased from Donald L. Smith, Jr., the Company's Chairman, President, and Chief Executive Officer. See \"Certain Relationships and Related Transactions.\"\n(3) Acreage is estimated.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe Company is from time to time involved in routine litigation arising in the ordinary course of its business, primarily related to its contracting activities. No litigation in which the Company is presently involved is material to its financial position or results of operations.\nThe Company is subject to certain Federal, state and local en- vironmental laws and regulations. Management believes that the Company is in compliance with all such laws and regulations. Compliance with environmental protection laws has not had a material adverse impact on the Company's financial condition or results of operations in the past and is not expected to have a material adverse impact in the foreseeable future.\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 1995.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stock- holder Matters.\nMARKET INFORMATION\nThe Company's Common Stock is traded in the over-the-counter market and quoted in the NASDAQ National Market System under the symbol DEVC. The following table sets forth the high and low sales prices for the Company's Common Stock for each quarter for the last two fiscal years as quoted in the NASDAQ National Market System.\n1995 High Low\nFirst Quarter $8.75 $8.00 Second Quarter 8.38 6.75 Third Quarter 9.88 5.50 Fourth Quarter 8.88 6.87\n1994 High Low\nFirst Quarter $7.50 $6.37 Second Quarter 9.50 6.75 Third Quarter 9.75 7.75 Fourth Quarter 8.75 7.75\nAs of March 25, 1996, there were 247 holders of record of the 4,464,510 outstanding shares of Common Stock. The closing sales price for the Common Stock on March 25, 1996 was $9.13. The Company paid no dividends in 1995 or 1994. The payment of cash dividends will depend upon the earnings, financial position and cash requirements of the Company, its compliance with loan agreements and other relevant factors existing from time to time. The Company does not presently intend to pay dividends.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe following selected financial data of the Company and its consolidated subsidiaries are qualified in their entirety by, and should be read in conjunction with, the Consolidated Financial Statements and the notes thereto and \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\" The data for each of the 5 years in the period ended December 31, 1995, are derived from the Consolidated Financial Statements of the Company audited by KPMG Peat Marwick LLP, independent certified public accountants. The Consolidated Financial Statements of the Company as of December 31, 1995 and 1994 and for each of the years in the three year period ended December 31, 1995, and the report thereon appear elsewhere herein.\n[CAPTION]\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nAll dollar amounts of $1.0 million or more are rounded to the nearest one tenth of a million; all other dollar amounts are rounded to the nearest one thousand and all percentages are stated to the nearest one tenth of one percent.\nResults of Operations\nGeneral\nThe following tables set forth, for the periods indicated, certain financial information.\n[CAPTION]\n[CAPTION]\n* Information is presented net of intersegment sales and before discontinued operations. See Note 12 of Notes to Consolidated Financial Statements. See Summary of Significant Accounting Policies in Notes to Consolidated Financial Statements.\nComparison of Year Ended December 31, 1995 with Year Ended December 31, 1994\nRevenues\nThe Company's revenues in 1995 were $56.2 million as compared to $65.2 million in 1994. This 13.9 percent decrease was primarily due to decreases in the Company's land development contracting revenues, and to a lesser extent decreases in concrete and related products division revenues.\nThe Company's concrete and related products division revenues decreased 4.1 percent to $37.7 million in 1995 from $39.3 million in 1994. This decrease was primarily due to decreased demand for this division's products on two Caribbean Islands, offset by increased demand on certain other islands. Hurricanes Luis and Marilyn, which struck the Caribbean in September 1995, disrupted business operations significantly in the short term, however, sales volumes in all locations except two have returned to or exceeded pre-storm levels.\nRevenues from the Company's land development contracting division decreased by 30.0 percent to $16.1 million in 1995 from $22.9 million in 1994. This decrease was primarily attributable to the recognition of revenues in 1994 on several construction contracts obtained during the latter part of 1993. The Company's contracting operations were not significantly affected by the hurricanes, although it did acquire a number of hurricane-related repair and rebuilding projects. The Company needs to obtain additional new contracts throughout 1996 in order to maintain the revenue levels obtained in 1995.\nRevenues from the Company's other operation (a marina in the U. S. Virgin Islands) were $2.4 million in 1995 and $3.0 million in 1994.\nThis decline is primarily due to a decline in revenues resulting from the disruption in business caused by the hurricane which struck St. Thomas.\nCost of Concrete and Related Products\nCost of concrete and related products as a percentage of concrete and related products revenues increased to 77.1 percent in 1995 from 74.2 percent in 1994. This increase was primarily attributable to changes in the mix of products sold and the decline in revenues actually recognized.\nCost of Contracting\nCost of contracting as a percentage of land development contracting revenues increased to 87.8 percent in 1995 from 83.9 percent in 1994. This increase is attributable to the decline in revenues actually recognized, contract losses recognized on several contracts and the significant levels of cost involved in owning and operating heavy construction equipment, some of which, because of the Company's current level of construction volume, is not heavily used. In addition, the Company's gross margins are also affected by the varying profitability levels of individual contracts and the stage of completion of such contracts.\nCost of Other\nCost of other as a percentage of other revenues decreased to 72.7 percent in 1995 from 80.5 percent in 1994. This was due primarily to the decrease in revenues recognized, offset by decreases in costs actually incurred.\nSelling, General and Administrative Expenses\nSelling, general and administrative expenses (\"SG&A expense\") increased by 10.7 percent to $11.0 million in 1995 from $9.9 million in 1994. This increase was primarily attributable to the opening of a new operation on St. Martin in 1995, and increases in insurance and other operating costs, offset by decreases in cost resulting from various personnel reductions. SG&A expense as a percentage of revenue increased to 19.6 percent in 1995 from 15.2 percent in 1994. This percentage increase was primarily attributable to the decrease in revenues recognized and the increase in expenses actually incurred.\nDivisional Operating Income\nOperating income decreased to $274,000 in 1995 from $4.5 million in 1994. The Company's concrete and related products division operating income decreased to $1.3 million in 1995 from $2.8 million in 1994. This decrease is primarily attributable to decreases in sales revenues and increases in cost of sales.\nThe Company's land development contracting division operating income decreased to a loss of $569,000 in 1995 from income of $1.7 million in 1994. This decrease is primarily attributable to declines in contract revenues recognized and losses taken on certain contracts.\nThe Company's other division operating income increased to $409,000 in 1995 from $321,000 in 1994. The increase was due to lower than expected costs and insurance recoveries.\nIncome Taxes\nIncome taxes increased to $145,000 in 1995 from $50,000 in 1994. The Company's tax rate varies depending on the level of the Company's earnings in the various tax jurisdictions in which it operates and the level of operating loss carryforwards and tax exemptions available to the Company.\nNet Earnings (Loss)\nThe Company's net loss was $2.7 million in 1995 as compared to income of $2.1 million in 1994. This net loss was primarily attributable to losses recognized in the Company's land development contracting division, declines in the concrete and related products division profits and the writedown of the Company's investment in its ceiling tile business.\nComparison of Year Ended December 31, 1994 with Year Ended December 31, 1993\nRevenues\nThe Company's revenues in 1994 were $65.2 million as compared to $55.9 million in 1993. This 16.8 percent increase was primarily due to increases in the Company's land development contracting revenues, other division revenues and, to a lesser extent, increases in concrete and related products division revenues.\nThe Company's concrete and related products division revenues increased 2.7 percent to $39.3 million in 1994 from $38.3 million in 1993. This increase was primarily due to increased demand for this division's products on certain Caribbean Islands, which was generated by a modest increase in the overall level of construction activity in certain locations in which the Company operates its business, offset by a decrease on one island.\nRevenues from the Company's land development contracting division increased by 35.5 percent to $22.9 million in 1994 from $16.9 million in 1993. This increase was primarily attributable to the recognition of revenues in 1994 on several construction contracts obtained during the latter part of 1993. The Company is currently seeking new contract work in the Caribbean only.\nRevenues from the Company's other operation (a marina in the U. S. Virgin Islands) were $3.0 million in 1994 and $638,000 in 1993. The marina operation was only consolidated for the fourth quarter of 1993.\nCost of Concrete and Related Products\nCost of concrete and related products as a percentage of concrete and related products revenues decreased to 74.2 percent in 1994 from 83.1 percent in 1993. This decrease was primarily attributable to the mix of products sold, the locations in which sales were made during the year and the slight increase in revenues. During 1993, the Company also reduced, by $1.5 million, the valuations of sand and parts inventories located at two island operations and recorded additional depreciation expense on assets which had been earlier removed from service and subsequently returned to the fixed asset accounts.\nCost of Contracting\nCost of contracting as a percentage of land development contracting revenues decreased to 83.9 percent in 1994 from 116.4 percent in 1993. This decrease is attributable to the higher profit margins obtained on several contracts, partially offset by the significant levels of cost involved in owning and operating heavy construction equipment, some of which, because of the Company's current level of construction volume, is not heavily used. In addition, the Company's gross margins are also affected by the varying profitability levels of individual contracts and the stage of completion of such contracts. The Company believes it is entitled to additional compensation on a Florida construction project and will continue to pursue a claim of approximately $3.2 million against the owner of the property. While the Company believes it has a meritorious claim, there is no assurance that the claim will be settled on a basis favorable to the Company.\nCost of Other\nCost of other as a percentage of other revenues decreased to 80.5 percent in 1994 from 82.9 percent in 1993. This was due primarily to the increase in revenues recognized, offset to some extent by the increase in costs actually incurred.\nSelling, General and Administrative Expenses\nSelling, general and administrative expenses (\"SG&A expense\") decreased by 17.1 percent to $9.9 million in 1994 from $12.0 million in 1993. This decrease was primarily attributable to reductions in insurance, professional fees and personnel costs resulting from the phaseout of the United States construction operations, offset by additional SG&A costs of the marina, which, except for the fourth quarter, was not consolidated into the Company's financial statements in 1993. SG&A expense as a percentage of revenue decreased to 15.2 percent in 1994 from 21.4 percent in 1993. This percentage decrease was primarily attributable to the increase in revenues recognized and the decrease in expenses actually incurred.\nDivisional Operating Income\nOperating income increased to income of $4.5 million in 1994 from a loss of $8.2 million in 1993. The Company's concrete and related products division operating income increased to $2.8 million in 1994 from a loss of $321,000 in 1993. This increase is primarily attributable to decreases in cost of sales and a slight increase in revenues for this division.\nThe Company's land development contracting division operating income increased to income of $1.7 million in 1994 from a loss of $6.9 million in 1993. This increase is primarily attributable to profits recognized on new Caribbean construction contracts, the losses taken in 1993 on two United States construction projects and the elimination of a significant portion of the United States contracting overhead.\nInterest Expense\nInterest expense increased to $2.7 million in 1994 from $2.2 million in 1993. This increase was primarily due to the reconsolidation into the financial statements of the marina operation and its related debt, along with increases in interest rate levels during 1994.\nIncome Taxes\nIncome taxes decreased to $50,000 in 1994 from $108,000 in 1993. The Company's tax rate varies depending on the level of the Company's earnings in the various tax jurisdictions in which it operates, the level of operating loss carryforwards and tax exemptions available to the Company.\nNet Earnings (Loss)\nThe Company's net earnings increased to income of $2.1 million in 1994 from a net loss of $9.1 million in 1993. This increase in net earnings was primarily attributable to profits recognized in the Company's land development contracting division, improvements in the concrete and related products division profits and reductions of selling, general and administrative expenses.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company generally funds its working capital needs from operations and bank borrowings. In the land development contracting business, the Company must expend considerable amounts of funds for equipment, labor and supplies to meet the needs of particular projects. The Company's capital needs are greatest at the start of any new contract, since the Company generally must complete 45 to 60 days of work before receiving the first progress payment. In addition, as a project continues, a portion of the progress billing is usually withheld as retainage until all work is complete, further increasing the need for capital. On occasion the Company has provided long-term financing to certain customers who have utilized its land development contracting services. The Company has also provided financing for other business ventures from time to time. With respect to the Company's concrete and related products division, accounts receivable are typically outstanding for a minimum of 60 days and in some cases much longer. The nature of the Company's business requires a continuing investment in plant and equipment along with the related maintenance and upkeep costs of such equipment.\nThe Company has funded many of these expenditures out of its current working capital. However, notwithstanding the foregoing and after factoring in the Company's obligations as set forth below, management believes that the Company's cash flow from operations, existing working capital (approximately $4.8 million at December 31, 1995) and funds available from lines of credit will be adequate to meet the Company's anticipated needs for operations during the next twelve months.\nAt December 31, 1995, the Company had a revolving secured line of credit in the amount of $2.0 million and three secured lines of credit in the amount of $1.0 million, $400,000 and $400,000 from commercial banks in South Florida and the Caribbean. The Company had $2.0 million of borrowings outstanding under the $2.0 million line of credit, $517,000 of borrowings outstanding under the $1.0 million line of credit and $800,000 of borrowings outstanding under the two $400,000 lines of credit. The $2.0 million line expires in May 1996, the $1.0 million line expires in June 1996 and the two $400,000 lines have no expiration date. The interest rates on all such indebtedness outstanding at December 31, 1995 was 9.3 percent.\nThe Company has a $500,000 unsecured overdraft facility from a commercial bank in the Caribbean. The facility expires on September 30, 1996 and bears interest at 14.0 percent per annum. At December 31, 1995 the Company had borrowings of $512,000 outstanding under this line.\nThe Company has a $500,000 secured line of credit from a commercial bank in the United States. The line expires in October 1996 and bears interest at the prime interest rate plus one half of one percent. At December 31, 1995, the Company had borrowings of $170,000 outstanding under this line.\nThe Company has entered into three term loans with a Caribbean bank, repayable in varying monthly installments through December 2001. The interest rate on indebtedness outstanding at December 31, 1995 ranged from 9.0 percent to 10.3 percent and the Company had $5.0 million of borrowings outstanding. The loans are secured by individual leasehold mortgages on a block manufacturing plant, a cement distribution facility and a marina in the U.S. Virgin Islands.\nIn September 1993, the Company entered into a $4.0 million secured term loan. Borrowings outstanding bear interest at the prime interest rate plus three fourths of one percent. The interest rate on indebtedness outstanding at December 31 1995 was 9.5 percent and the Company has $2.0 million of borrowings outstanding. This loan is being repaid in quarterly installments which commenced in November 1993 and all remaining unpaid amounts are due in full on June 30, 1996. The loan is secured by the Company's notes receivable from the Government of Antigua and Barbuda.\nThe Company has borrowed $4.7 million from a Company officer. One note has an outstanding balance of $4.5 million, is unsecured, bears interest at the prime interest rate and is due in full on January 1, 1997. The other note has a balance of $140,000, is secured by equipment, bears interest at 8.0 percent per annum and is due in monthly principal installments of $10,000, plus interest, through February 1997.\nThe Company is seeking a commitment from a bank in the Caribbean for a new $8.2 million credit facility which would be structured as a seven year term loan of $7.2 million with a $1.0 million revolving line of credit tied to the same facility. The bank reacted favorably to the Company's proposal although there is no assurance that the loan will be granted on terms acceptable to the Company or even granted at all. The loan proceeds of $7.2 million would be used to repay and retire a $2.0 million revolving line of credit which expires in May 1996, two term loans totalling $1.3 million, an equipment loan with a balance of $375,000, a term loan with a balance of $2.0 million which is due in June 1996, a line of credit with a balance of $517,000 which expires in June 1996, another line of credit with a balance of $400,000 which expires in May 1996 and various other notes amounting to approximately $318,000. The balance of $300,000 would be used to provide additional working capital for the Company. The loan would be collateralized by various parcels of real property located in the United States Virgin Islands. If the new credit facility is not obtained, the Company will seek alternative financing or extensions of its existing facilities expiring in 1996.\nThe Company purchases equipment from time to time as needed for its ongoing business operations. At present, management believes that the Company's inventory of equipment is adequate for its current contractual commitments and operating activities, however, the acquisition of significant new construction contracts, depending on the nature of the contract, the job location and job duration, may require the Company to make significant investments in heavy construction equipment. During 1995, the Company sold equipment with an original cost basis of approximately $2.4 million and net book value of $534,000.\nAccordingly, except for the circumstances previously discussed, and normal equipment replacements and additions, management does not anticipate having to make a substantial investment in new equipment during the current year. The Company believes it has available or can obtain sufficient financing for all of its contemplated equipment replacements and additions. Historically, the Company has used a number of lenders to finance machinery and equipment purchases, including its ocean going bulk cement vessel, on an individual asset basis. At December 31, 1995 amounts outstanding to these lenders totalled $7.1 million. These loans are typically repaid over a three to six year term in monthly principal and interest installments.\nThe Company is in violation of certain loan covenants in several of its loan agreements with two lenders. One of its lenders has provided the Company a waiver of the violations and the Company believes it can obtain a waiver from the other lender.\nA significant portion of the Company's outstanding debt bears interest at variable rates. The Company could be negatively impacted by a substantial increase in interest rates.\nThe Company has contingent obligations and has made certain guarantees in connection with acquisitions, its participation in certain joint ventures, certain employee and construction bonding matters and its receipt of a tax exemption. As part of the 1995 acquisition of Societe des Carrieres de Grand Case (SCGC), a French company operating a ready-mix concrete plant and quarry in St. Martin, the Company agreed to pay the quarry owners (who were also the owners of SCGC), a royalty payment of $550,000 per year through August 2000, which at the Company's option, may be renewed for two successive five year periods and requires annual payments of $550,000 per year. At the end of the fifteen year royalty period, the Company has the option to purchase a fifty hectare parcel of property for $4,400,000. In connection with the 1990 St. Maarten acquisition, the Company agreed to pay the seller annually an amount per unit of certain concrete and stone products sold by the Company in St. Maarten from April 1, 1990 to March 31, 1998, but in no event less than $500,000 per year. The Company has certain offsets available against this payment which has reduced the minimum annual payment to $350,000 per year.\nNotes receivable and accrued interest at December 31, 1995 include $16.2 million, net due the Company pursuant to certain promissory notes delivered to the Company in connection with two construction contracts with the Government of Antigua, $2.5 million of which is classified as a current receivable. Scheduled payments call for both quarterly and monthly principal and interest payments until maturity in 1997. The Government of Antigua has routinely made the required quarterly payments aggregating $2.0 million per year but has made only some of the required monthly payments. The Company does not presently anticipate material increases in or accelerations of payments by the Government of Antigua. The Company expects that the notes will not be satisfied at maturity but the Antiguan government has advised the Company that the current payment stream will continue until the obligation is satisfied. A portion of the payment received from Antigua is derived from the lease proceeds the Antiguan government receives from the United States Department of Defense for the rental of two military bases. In January 1995, the Antiguan government was notified by the United States government that one of the bases would be closed in late 1995. The Antiguan government has advised the Company that it will make up any shortfall in the payments to the Company from the military base rents from its general treasury.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe financial information and the supplementary data required in response to this Item are as follows:\n[CAPTION]\nIndependent Auditors' Report\nThe Board of Directors and Stockholders Devcon International Corp.:\nWe have audited the consolidated financial statements of Devcon International Corp. and subsidiaries as listed in the accompanying index. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedules as listed in the accompanying index. These consolidated financial statements and this financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and this 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 Devcon International Corp. and subsidiaries at December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1995 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 note 1(j) 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,\" in 1993.\nKPMG PEAT MARWICK LLP\nFort Lauderdale, Florida March 27, 1996\nDEVCON INTERNATIONAL CORP. AND SUBSIDIARIES Consolidated Balance Sheets December 31, 1995 and 1994\n[CAPTION]\nDEVCON INTERNATIONAL CORP. AND SUBSIDIARIES\nConsolidated Statements of Operations\nFor Each of the Years in the Three Year Period Ended December 31,\n[CAPTION]\nDEVCON INTERNATIONAL CORP. AND SUBSIDIARIES\nConsolidated Statements of Operations (Continued)\n[CAPTION]\nDEVCON INTERNATIONAL CORP. AND SUBSIDIARIES\nConsolidated Statements of Stockholders' Equity\nFor Each of the Years in the Three Year Period Ended December 31,\n[CAPTION]\nDEVCON INTERNATIONAL CORP. AND SUBSIDIARIES\nConsolidated Statements of Cash Flows\nFor Each of the Years in the Three Year Period Ended December 31,\n[CAPTION]\nSupplemental non-cash items:\nDuring 1995, the Company issued 33,333 shares of common stock to acquire an additional partnership interest in a Mexican manufacturing partnership.\nDuring 1993 the Company reclassified approximately $3,900,000 from assets held for sale to property, plant and equipment.\nDuring 1993, the Company reduced by $1.5 million the valuations of sand and parts inventory at two island operations.\nDuring 1993, the company wrote down a concrete block manufacturing facility by $250,000. This operation was sold in 1993.\nDuring 1993, a $628,000 note receivable from the sale of the block operation was offset against existing debt owed to the same party.\nDuring 1993, the Company recorded a writedown of $200,000 on the investment in Corbkinnons and recognized a loss of $775,000 on the Mexican manufacturing company.\nDuring 1993, the Company issued 62,500 shares of stock to the former owner of a purchased subsidiary as partial payment for amounts due related to the purchase of the subsidiary by the Company.\nDEVCON INTERNATIONAL CORP. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\nYears ended December 31, 1995, 1994 and 1993\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\n(a) PRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the accounts of Devcon International Corp. and its majority owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.\nThe Company's investments in unconsolidated joint ventures and affiliates are accounted for by the equity method. Under the equity method, original investments are recorded at cost and adjusted by the Company's share of undistributed earnings or losses of these companies.\n(b) REVENUE RECOGNITION\nCONCRETE AND RELATED PRODUCTS Revenue is recognized when the products are delivered.\nCONTRACTING\nThe Company uses the percentage of completion method of accounting for financial statement preparation and tax reporting purposes. Revenues earned and related costs are recorded based on the Company's estimates of the percentage of completion of each project using the cost to cost method. Anticipated losses on contracts are charged to earnings when probable and estimable. Changes in estimated profits on contracts are recorded in the period of change. Selling, general and administrative expenses are not allocated to contract costs. Monthly billings are based on the percentage of work completed in accordance with a specific contract. Contracts are generally completed within one year of the commencement date, although the Company has had contracts that extended past one year.\nOTHER\nOther revenue consists of revenue from a marina owned by the Company. Revenue is recognized when products or services are delivered.\n(c) CASH AND CASH EQUIVALENTS\nThe Company considers certificates of deposits, commercial paper and repurchase agreements with an original maturity or restriction of three months or less at time of purchase to be cash equivalents.\n(d) INVENTORIES\nThe cost of sand, stone, cement and concrete block inventories is determined using average costs approximating the first-in, first-out (FIFO) method and is not in excess of market. All other inventories are stated at the lower of average cost or market.\n(e) PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment are stated at cost. Depreciation on property, plant and equipment is calculated on the straight-line method over the estimated useful lives of the assets. Property, plant and equipment held under capital leases and leasehold improvements are amortized using the straight-line method over the shorter of the lease term or the estimated useful life of the asset.\nUseful lives and\/or lease terms for each asset type are summarized below:\nBuildings 15 - 40 years Leasehold interests 3 - 55 years Equipment 3 - 20 years Furniture and fixtures 3 - 10 years\nDuring 1995, the Company changed the estimated useful lives of certain equipment of assets used by the concrete and related products and land development contracting divisions in order to more closely match the useful lives to the actual service life of the assets. This change in useful lives was made prospectively and reduced annual depreciation expense by approximately $900,000.\n(f) FOREIGN CURRENCY TRANSLATION\nThe Company owns subsidiaries whose functional currency is the Eastern Caribbean Dollar. The assets and liabilities of these subsidiaries have been translated into U.S. dollars at year end exchange rates. Income statement accounts are translated into U.S. dollars at average exchange rates during the period. Resulting translation adjustments were not significant.\n(g) INTANGIBLE ASSETS\nThe excess of cost over the fair value of net assets of subsidiaries acquired is amortized over five to ten year periods on a straight-line basis. The Company periodically reevaluates the recoverability of its intangible assets as well as their amortization periods to determine whether an adjustment to the carrying value or a revision to the estimated useful lives is appropriate. The primary indicators of recoverability are the current and forecasted operating cash flows, which pertain to that particular asset. An entity that has a deficit in its cash flow from operations for a full fiscal year, in light of the surrounding economic environment, is viewed by the Company as a situation which could indicate an impairment of value. Taking into account the above factors, the Company determines that an impairment loss has been triggered when the future projected undiscounted cash flows associated with the intangible asset does not exceed its current carrying amount and the amount of the impairment loss to be recorded is the difference between the current carrying amount and the future projected undiscounted cash flows. Based on the Company's policy, management believes that there is no impairment of value related to the intangible assets as of December 31, 1995.\nAccumulated amortization on intangible assets amounted to $206,582 in 1995 and $109,120 in 1994.\n(h) EARNINGS (LOSS) PER SHARE\nPrimary earnings (loss) per share is computed by dividing the weighted average number of shares outstanding during each year, increased by common equivalent shares (stock options) using the treasury stock method. Fully diluted earnings per share did not differ significantly from primary earnings per share in any of the years presented.\n(i) FOREIGN OPERATIONS\nSignificant portions of the Company's operations are conducted in foreign areas, primarily Antigua, St. Maarten, St. Martin, Dominica, Saba, St. Kitts and Tortola, all of which are in the Caribbean. Operations are also conducted in Mexico.\n(j) INCOME TAXES\nThe Company and certain of its domestic subsidiaries file consolidated Federal and state income tax returns. Subsidiaries located in U.S. possessions and foreign countries file individual income tax returns. Deferred income taxes are recognized for income and expense items that are reported in different years of financial reporting and income tax purposes.\nU.S. income taxes are not provided on undistributed earnings which are expected to be permanently reinvested by the foreign subsidiaries located in Antigua, the Netherlands Antilles, the French West Indies, the British Virgin Islands, Dominica, Grand Cayman, the Bahamas and certain subsidiaries located in U.S. possessions.\nThe Company accounts for income taxes under the provisions of 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 estimated future tax consequence 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 in effect for the year 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 for the period that includes the enactment date.\nEffective January 1, 1993, the Company adopted Statement 109 and has reported the cumulative effect of that change in the method of accounting for income taxes in the 1993 consolidated statement of earnings.\n(k) USE OF ESTIMATES\nManagement of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare these consolidated financial statements in conformity with generally accepted accounting principles.\n(l) RECLASSIFICATIONS\nCertain amounts in the 1994 and 1993 consolidated financial statements have been reclassified to conform with the 1995 presentation.\n(m) NEW ACCOUNTING PRONOUNCEMENTS\nIn March 1995, the Financial Accounting Standards Board issued Statement No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long Lived Assets to be Disposed Of.\" The statement requires that long-lived assets and certain identifiable intangibles to be held and used by an entity be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The impairment of value is based on estimated future cash- flows expected to result from the use of the asset and its eventual disposition. The provisions of this statement must be adopted for fiscal years beginning after December 15, 1995. The Company has not determined the effect of the adoption of this pronouncement.\nIn October 1995, the Financial Accounting Standards Board issued Statement No. 123, \"Accounting for Stock-Based Compensation.\" The statement permits a company to choose either a new fair value based method or the current APB Opinion 25 intrinsic value based method of accounting for its stock-based employee compensation plans in which an employer grants shares of its stock or other equity instruments to employees. The statement requires pro forma disclosures of net income and earnings per share computed as if the fair value based method had been applied in financial statements of companies that elect to follow current practice in accounting for such arrangements under Opinion 25. The Company has not determined the effect of the adoption of this pronouncement.\n(2) RECEIVABLES\nReceivables consist of the following:\n[CAPTION]\nReceivables are classified in the consolidated balance sheets as follows:\n[CAPTION]\nRetainage will be due upon completion of construction contracts and acceptance by the customer. The Company expects retainage will be collected during 1996.\nIncluded in notes and other receivables are unsecured notes due from the Government of Antigua and Barbuda amounting to $16,218,549 and $18,055,066 in 1995 and 1994, respectively, and having maturity dates through 1997. See note 10. The Company believes payments of approximately $2,500,000 will be received in 1996. The current payment schedule calls for both quarterly and monthly payments until note maturity. The Government of Antigua has routinely made the required quarterly payments totalling $2.0 million per year but has only made some of the required monthly payments. The Company does not presently anticipate material increases or decreases in the level of payments by the Government of Antigua. The Company expects that the notes will not be satisfied at maturity but the Antigua government has advised the Company that the current payment stream will continue until the obligation is satisfied. A portion of the payment received from Antigua is derived from the lease proceeds the Antiguan government receives from the United States Department of Defense for the rental of two military bases. In January 1995, the Antiguan government was notified by the United States government that one of the bases would be closed in late 1995. The Antiguan government has advised the Company that it will make up any shortfall in payments to the Company from the military base rents from its general treasury.\nNotes receivable, from an Antiguan government agency, amounting to $855,803 in 1995 and 1994 are included in the total due from the government of Antigua, along with Antigua-Barbuda Government Development Bonds 1994-1997 series amounting to $200,297 in 1995 and 1994.\nThe Company also has trade receivables from various Antiguan government agencies of $717,554 and $112,020 in 1995 and 1994, respectively. Several of the Company's customers perform services for the Antiguan government and depend on payments from the government to satisfy their obligations to the Company.\nTrade notes receivable - other consist of the following:\n[CAPTION]\n(3) INVENTORIES\nInventories consist of the following:\n[CAPTION]\n(4) INVESTMENTS IN AND ADVANCES TO UNCONSOLIDATED JOINT VENTURES AND AFFILIATES\nAt December 31, 1995, the Company has equity interests in two real estate ventures, a 43 percent equity interest in a foreign construction company and a 1 percent equity interest in a commercial property development in Antigua. One real estate joint venture was formed primarily to acquire and develop land for sale in Antigua, West Indies. The other real estate venture was formed to develop property in Florida and has insignificant assets and operations. No income or loss was recognized in 1995 and 1994 on any of these ventures because the amounts were not material.\n[CAPTION]\n(5) ACQUISITIONS\nOn August 16, 1995, the Company acquired for $1,000,000 cash, the stock of Societe des Carrieres de Grand Case (SCGC), a French company engaged in the ready mix concrete and quarry business on the French island of St. Martin. The transaction was accounted for as a purchase. As a result of the transaction, the Company recorded costs in excess of the fair value of the net assets purchased in the amount of $615,000.\n(6) Fair Value of Financial Instruments\nThe carrying amount of financial instruments including cash, cash equivalents, receivables, net, other current assets, accounts payable trade and other, accrued expenses and other liabilities, notes payable to banks, and current installments of long-term debt approximated fair value at December 31, 1995 because of the short maturity of these instruments. The carrying value of debt and notes receivable approximated fair value at December 31, 1995 based upon the present value of estimated future cash flows.\n(7) LONG-TERM DEBT\nLong-term debt consists of the following:\n[CAPTION]\n[CAPTION]\nShown in the consolidated balance sheet under the following captions:\n[CAPTION]\nThe total maturities of long-term debt subsequent to December 31, 1995 are as follows:\n[CAPTION]\nAt December 31, 1995 the Company is in violation of various financial covenants contained in certain loan agreements it has with two banks. One bank has granted a waiver of the violations and the Company believes it can obtain a waiver from the other lender. The amounts due from the bank which did not grant a waiver are classified as current liabilities.\nThe Company is currently seeking a new credit facility to replace several of the loans which mature in 1996. The Company believes that it can obtain a new credit facility or obtain extensions of the maturing loans.\n(8) INCOME TAXES\nIncome tax expense (benefit) consists of:\n[CAPTION]\nThe significant components of deferred income tax benefit attributable to loss from continuing operations for the year ended December 31, 1995 are as follows:\nDeferred tax expense (exclusive of component listed below) $2,342,000 Decrease in valuation allowance for deferred tax assets (3,119,021) $ (777,021)\nThe actual expense differs from the \"expected\" tax expense computed by applying the U.S. Federal corporate income tax rate to earnings before income taxes as follows:\n[CAPTION]\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) net operating loss carryforwards.\nThe tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 1995 are presented below:\n[CAPTION]\nThe valuation allowance for deferred tax assets as of December 31, 1995 was $4,134,979. The valuation allowance was established at approximately 69 percent of the potential deferred tax benefit as the Company believes it can utilize net operating losses via partial repatriation of foreign subsidiary earnings.\nIn April 1988, the Virgin Islands Industrial Development Commission (IDC) granted a subsidiary of the Company a 10-year tax exemption expiring in 1998, pursuant to which, and subject to certain conditions and exceptions, the Company's (i) production and sale of ready-mix concrete; (ii) production and sale of concrete block on St. Thomas and St. Johns and outside of the Virgin Islands; (iii) production and sale of sand and aggregate; and (iv) bagging of cement from imported bulk cement, are 100 percent exempt from all United States Virgin Islands real property, gross receipts (currently set at 4 percent) and excise taxes, 90 percent exempt from United States Virgin Islands income taxes, and approximately 83 percent exempt from United States Virgin Islands custom duties. The IDC granted the Company the tax exemption in return for the Company's commitment to (i) make capital expenditures of at least $4.6 million for new or replacement equipment over a 10-year period, which the Company has satisfied (ii) employ a minimum of 142 United States Virgin Islands residents as full-time personnel; (iii) spend at least $75,000 annually for a youth training program; (iv) not increase the price of its concrete and related products except as the result of certain direct cost increases incurred by the Company over which it has no control; and (v) make an annual scholarship fund contribution of $150,000.\nIn January 1994, the Company received a five year extension, through April 2003, of its previously granted benefits. This extension was granted in return for the Company agreeing to (i) continue to employ a minimum of 160 United States Virgin Islands residents as full time personnel; (ii) make additional capital expenditures of $1.7 million and (iii) continue to make a combined job training\/scholarship contribution of $225,000 per annum during the extension period.\nThe Company believes it is in compliance with all of the requirements of this program.\nThe Company has received exemptions relating to income and excise taxes and customers duties for operations of certain foreign subsidiaries and unconsolidated joint ventures See note 10.\nAt December 31, 1995, approximately $34.2 million of foreign subsidiaries earnings have not been distributed and no U.S. income taxes have been provided thereon as these earnings are considered permanently reinvested in the subsidiaries' operations and in the year earned, were not of the nature which would require current income tax recognition under United States income tax laws. Current assets include approximately $619,000 of cash and cash equivalents that the Company currently intends to use only to fund foreign operations and U.S. possession operations, respectively, due to U.S. income tax restrictions. Should the foreign subsidiaries distribute these earnings to the parent company or provide the parent company access to these earnings through other means, taxes at the U.S. Federal tax rate net of foreign tax credits may be incurred.\nAt December 31, 1995, the Company had accumulated net operating loss carryforwards available to offset future taxable income in their Caribbean and United States operations of approximately $17.1 million which expire in varying periods through the year ended December 31, 2004.\n(9) DISCONTINUED OPERATIONS\nIn September 1989, a subsidiary of the Company obtained a minority interest in a partnership engaged in the manufacture, sale and distribution of acoustical ceiling tiles. The subsidiary invested approximately $1.2 million in the partnership for a 29 percent interest and two of the Company's directors obtained an 11 percent interest for which they paid $450,000. In January 1994 an Antiguan subsidiary of the Company became the new general partner and the Company's ownership interest in the partnership was increased to 57.98 percent. The directors' ownership interest was reduced to 6.47 percent. In November 1995, the Company elected to dispose of this operation because of its poor operating results and uncertain prospects for improvement. Accordingly, at December 31, 1995, the intended disposal has been accounted for as a discontinued operation. The financial statements for all prior periods presented have been restated to reflect the ceiling tile partnership as a discontinued operation. The Company's investment in the partnership was written down $800,000 to its estimated net realizable value of approximately $749,000, which consists principally of property, equipment and inventory with a net book value of approximately $1.4 million, along with debt of approximately $621,000. The Company provided no reserve for anticipated losses during the phaseout period and expects to recognize no income tax benefit on the loss from discontinued operations. These represent management's best estimates of the amounts expected to be realized on the sale of its ceiling tile business. The amounts the Company will ultimately realize could differ materially in the near term from the amounts assumed in arriving at a the loss on disposal of the discontinued operations. The Company is currently negotiating the sale of a major portion of the partnership's assets, however, no definitive sales agreement has been concluded at this time.\nTwo subsidiaries of the Company own a 100 percent interest in a Virgin Islands general partnership formed in 1988 to construct and operate a marina on a 4.92 acre parcel of land leased by the joint venture from the United States Virgin Islands government.\nIn 1991 the marina operation was classified as a discontinued operation for financial statement presentation purposes. The marina assets were written down $2.2 million dollars, to their estimated net realizable value, and a reserve of $1.3 million dollars was established for marina losses for the period from January 1, 1992 to the expected disposal date. The Company elected to reconsolidate the marina operation into its financial statements as of September 30, 1993, primarily because the Company believed it would take a significant amount of time to dispose of the marina in the current real estate market. Approximately $600,000 of the original $1.3 million reserve was reflected as a gain on discontinued operations subsequently retained.\n(10) FOREIGN SUBSIDIARIES\nSummary combined financial information for the Company's foreign subsidiaries, located in the Caribbean, except for those located in the U.S. Virgin Islands, follows:\n[CAPTION]\nThe expenses for 1993 included a writedown of $250,000 related to an operation the Company disposed of during 1993. The above foreign subsidiaries are included in the consolidated financial statements.\nIn 1987, the Company entered into a construction contract with the government of Antigua and Barbuda (Antigua). The original contract provided for payment of $13,479,600 in cash and notes bearing interest at 10 percent, a ten year income tax exemption for the project and the Company's concrete and related products subsidiary in Antigua commencing January 1, 1987 and an ownership interest in Corbkinnons Limited (Corbkinnons), a corporation formed with Antigua to own and develop 230 acres of real property in Antigua. Corbkinnons and its shareholders received an exemption from income and excise taxes and custom duties for a minimum of 12 years with respect to the earnings and operations of Corbkinnons. Since 1987, amendments to the original contract totaling $20,864,867 have been executed. One amendment provides for a tax exemption on a project accounted for by one of the Company's Antigua contracting subsidiaries.\n(11) LEASE COMMITMENTS\nThe Company leases real property, buildings and equipment under operating leases that expire over one to fifty-five years. Future minimum lease payments under noncancellable operating leases as of December 31, 1995 are as follows:\n[CAPTION]\nTotal rent expense for operating leases was $1,147,041 in 1995, $950,908 in 1994 and $961,175 in 1993. Some operating leases have provisions for contingent rentals or royalties based on related sales and production; and such contingent expense amounted to $63,575 in 1995, $131,041 in 1994 and $109,289 in 1993.\n(12) LINES OF BUSINESS\nThe Company operates primarily in two principal lines of business. Information about the Company's operations in these different industries are as follows:\n[CAPTION]\nRevenues by line of business include only sales to unaffiliated customers, as reported in the Company's consolidated statement of operations.\nOperating income (loss) is revenues less operating expenses. In computing operating income (loss), the following items have not been added or deducted: interest expense, income tax expense, equity in earnings from unconsolidated joint ventures and affiliates, interest and other income, minority interest and gain or loss on sales of equipment.\n(13) RELATED PARTY TRANSACTIONS\nA director and shareholder of the Company has a 2 percent interest in an ocean going bulk cement ship in which the Company has a 98 percent interest.\nThe Company leases a 4.4 acre parcel of real property from the Company's President, pursuant to which he received $46,512 in annual rent in 1995.\nThe Company has borrowed approximately $4.7 million from a Company officer. One note has an outstanding balance of approximately $4.5 million, is unsecured, bears interest at the prime interest rate and is due in full on January 1, 1997. The other note has a balance of $140,000 is secured by equipment, bears interest at 8 percent per annum and is due in monthly principal installments of $10,000, plus interest, through February 1997. See note 7.\nContract losses totalling $147,341 were recognized during 1993 on contracts with related parties.\nA subsidiary of the Company paid approximately $12,800 per year in rent to a company in which a director was a principal.\n(14) STOCK OPTION PLANS\n(a) 1986 Stock Option Plan\nThe Company adopted a stock option plan in 1986 (the \"1986 Plan\"), which terminates in 1996. Until 1996, options to acquire up to 300,000 shares of common stock may be granted to officers and employees of the Company at no less than the fair market value on the date of grant.\nThe exercise terms and conditions for each option granted are established by the Compensation Committee of the Board of Directors.\nAt December 31, 1995 the Company had the following options granted under the 1986 Plan outstanding:\n[CAPTION]\n(b) 1992 STOCK OPTION PLAN\nThe Company adopted a stock option plan in 1992 (the \"1992 Plan\"), which terminates in 2002. Until 2002, options to acquire up to 350,000 shares of common stock may be granted to officers and employees at no less than the fair market value on the date of grant.\nThe exercise terms and conditions for each option granted are established by the Compensation Committee of the Board of Directors.\nAt December 31, 1995, the Company had the following options granted under the 1992 Plan outstanding:\n[CAPTION]\n(c) 1992 DIRECTORS STOCK OPTION PLAN\nThe Company adopted a stock option plan in 1992 (the \"1992 Directors Plan\") which terminates in 2002. Until 2002, options to acquire up to 50,000 shares of common stock may be granted to nonemployee Directors at no less than the fair market value on the date of grant. The 1992 Directors Plan provides that each Director shall receive an initial grant of 8,000 shares and be granted an additional 1,000 shares annually immediately subsequent to their reelection as a director of the Company.\nAt December 31, 1995, the Company had the following options granted under the 1992 Directors Plan outstanding:\n[CAPTION]\n(15) EMPLOYEE BENEFIT PLANS\nThe Company sponsors a 401K plan for all employees over the age of 21 with 1,000 hours of service in the previous 12 months of employment. Employee contributions are matched by the Company up to 3 percent of an employee's salary. The Company's contributions totaled $129,518 in 1995, $134,146 in 1994 and $147,879 in 1993.\n(16) COSTS AND ESTIMATED EARNINGS ON CONTRACTS\n[CAPTION]\nIncluded in the accompanying balance sheet under the following captions:\n[CAPTION]\n(17) COMMITMENTS AND CONTINGENCIES\nThe Company believes it is entitled to additional compensation on a Florida construction project and is pursuing a claim of approximately $3.2 million against the owner of the property. In addition to its claim, the Company has an account receivable of approximately $500,000 from the owner of the project. Costs in excess of billings and estimated earnings amount to approximately $1.0 million. This amount is included in the Company's claim of $3.2 million. While the Company believes it has a meritorious claim, there is no assurance the claim will be settled on a basis favorable to the Company. The Company recorded a loss of approximately $2.3 million on this contract in 1993. No income or loss was recorded in 1995 or 1994.\nIn 1989, the Company entered into a new Life Insurance and Salary Continuation Agreement with the President of the Company.\nThe agreement provides that should the President cease to be employed by the Company as a result of disablement or death, the Company shall pay an amount equal to his salary and bonus for a period of five years to the President or his designated beneficiary. The Company has not accrued for the salary continuation over the expected remaining period of the President's active employment as the agreement does not provide for payment upon retirement; therefore, based on present facts and circumstances, future payments, if any, are not determinable at this date.\nIn June 1995, an employee of a subsidiary of the Company filed a lawsuit against the Company for personal injuries resulting from an accident in which the employee alleges to have operated an improperly maintained piece of heavy equipment. The claim of approximately $1.5 million is currently being defended by the Company's insurance carrier, subject to a reservation of rights.\nManagement believes the claim is without merit and intends to vigorously defend its position. While the final outcome of this lawsuit cannot be determined with certainty, Company management believes that the final outcome will not have a material adverse effect on the Company's consolidated financial position.\nThe Company is involved in other litigation and claims arising in the normal course of business. The Company believes that such litigation and claims will be resolved without a material effect on its financial condition or results of operations.\nThe Company is subject to certain Federal, state and local environmental laws and regulations. Management believes that the Company is in compliance with all such laws and regulations.\nCompliance with environmental protection laws has not had a material adverse impact on the Company's financial condition or results of operations in the past and is not expected to have a material adverse impact in the foreseeable future.\nThe Company is contingently liable to the Government of Antigua and Barbuda in respect to obligations assumed by the purchaser of a portion of the Company's interest in a joint venture.\n(18) BUSINESS AND CREDIT CONCENTRATIONS\nThe Company's customers are concentrated in the Caribbean and are primarily involved in the contracting industry. Credit risk may be affected by the economic and political conditions in the various countries in which the Company operates. Financial instruments which potentially expose the Company to concentrations of credit risk consist primarily of receivables and costs in excess of billings and estimated earnings. No single customer accounted for a significant amount of the Company's sales in 1995, 1994 or 1993 and there are no significant receivables from a single customer as of December 31, 1995 or 1994, other than the notes receivable due from the Government of Antigua and Barbuda. Although receivables are generally not collateralized, the Company may place liens or their equivalent in certain jurisdictions in the event of non- payment. The Company estimates an allowance for doubtful accounts based on the creditworthiness of customers as well as the general economic conditions of the countries in which it operates. Consequently, an adverse change in these factors would affect the Company's estimate of its bad debts.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Account- ing and Financial Disclosure.\nThe Company has had no changes in or disagreements with its independent certified public accountants on accounting and financial disclosure.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant.\nThe information with respect to the directors and executive officers of the Company is incorporated by reference to the Company's Proxy Statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this report.\nItem 11.","section_11":"Item 11. Executive Compensation.\nThe information required in response to this item is incorporated by reference to the Company's Proxy Statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this report. The information included in the proxy statement pursuant to Rule 402(i), (k) and (l) is not incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nThe information required in response to this item is incorporated by reference to the Company's Proxy Statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this report.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nThe information required in response to this item is incorporated by reference to the Company's Proxy Statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this report.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statements, Schedules and Reports on Form 8-K.\n(a) The following documents are filed as part of this report:\n(1) Financial Statements.\nAn index to financial statements for the year ended December 31, 1995 appears on pages 22 and 51.\n(2) Financial Statement Schedule.\nThe following financial statement schedules for each of the years in the three year period ended December 31, 1995 are submitted herewith:\nForm 10-K (Page Number(s)\nItem\nReport of Independent Auditors Financial Statement Schedule Schedule II - Valuation and Qualifying Accounts\nAll other financial schedules are omitted because they are not required, inapplicable, or the information is otherwise shown in the financial statements or notes thereto.\n(3) Exhibits.\nExhibit Description\n3.1 Registrant's Restated Articles of Incorporation (1)(3.1) 3.2 Registrant's Bylaws(2)(3.2) 10.1 Registrant's 1986 Non-Qualified Stock Option Plan (3)(10.1) 10.2 Dredging, Filling and Other Land Improvements Agreement by and between Jolly Harbour Ltd. (Vaduz, Liechtenstein), Antigua Development and Construction, Limited, and the Registrant(4)(10.1) 10.3 Registrant's 401(k) Retirement and Savings Plan (5)(10.3) 10.4 Life Insurance and Salary Continuation Agreement dated as of March 29, 1989, between the Registrant and Donald L. Smith, Jr.(5)(10.13) 10.5 Form of Indemnification Agreement between the Registrant, and its directors and certain of its officers(6)(A) 10.6 St. John's Dredging and Deep Water Pier Construction Agreement dated as of April 3, 1987, by and between Antigua and Barbuda and Antigua Masonry Products, Limited (the \"St. Johns Agreement\") (6)(10.1) 10.7 Amendment No. 1 to the St. John's Agreement dated June 15, 1988(7)(10.2) 10.8 Mortgage Note dated June 12, 1989 of Crown Bay Marina Joint Venture-I to Banco Popular de Puerto Rico for $5,000,000 (7)(10.5) 10.9 Guarantee dated June 12, 1989, from the Registrant to Banco Popular de Puerto Rico(7)(10.6) 10.10 Lease dated October 31, 1989, between William G. Clarenbach and Pricilla E. Clarenbach, as lessors, and Controlled Concrete Products, Inc., as lessee (1)(10.26) 10.11 Lease dated April, 18, 1988, between Jeanne Pacquette, Jennifer Pacquette, and Siewdath Sookram, as lessors, and the Registrant, as lessee(1)(10.27) 10.12 Lease dated April 13, 1981, between Mariano Lima and Genevieve Lima, as lessors, and the Registrant, as lessee(1)(10.28) 10.13 Lease dated May 23, 1983, between the Government of the Virgin Islands, as lessor, and Controlled Concrete Products, Inc. as lessee(1)(10.29) 10.14 Lease dated February 24, 1989, between Felix Pitterson, as lessor, and V.I. Cement and Building Products, Inc., as lessee(1)(10.30) 10.15 Lease dated September 1, 1989, between Donald L. Smith, Jr., as lessor, and the Registrant, as lessee(1)(10.31) 10.16 Lease dated September 12, 1966, between His Honour Hugh Burrowes, a Commander of the British Empire of Government House in the Island of Antigua, as lessor, and The Antigua Sand and Aggregate Limited, as lessee(1)(10.32) 10.17 Stock Purchase Agreement, dated April 18, 1990, by and between B.B.W. Holding Corporation Limited (\"BBW Holding\") and Proar Construction Materials Company N.V. (\"Proar Construction\") (9)(2.1) 10.18 Incentive Agreement, dated April 18, 1990, by and among BBW Holding, Proar Construction, Bouwbedrijf Boven Winden N.V., Cramer Construction N.V. and Caribbean Heavy Construction Company Limited (9)(28.1) 10.19 Agreement, dated April 18, 1990, by and between Mr. Richard Lawrence, Sr. and the Registrant (9)(28.2) 10.20 Agreement, dated October 31, 1990, by and between Tortola Concrete Products, Limited \"Tortola\"), and Devcon Masonry Products (BVI) Limited (\"Devcon Masonry (BVI)\") (10) (10.37) 10.21 Consulting Agreement, dated October 31, 1990, by and between Tortola and Devcon Masonry (BVI)(10)(10.38) 10.22 Amendment No. 2 to the St. John's Agreement dated December 7, 1988 (11) (10.34) 10.23 Amendment No. 3 to the St. John's Agreement dated January 23, 1989 (11) (10.35) 10.24 Amendment No. 4 to the St. John's Agreement dated April 5, 1989 (11) (10.36) 10.25 Amendment No. 5 to the St. John's Agreement dated January 29, 1991 (11) (10.37) 10.26 Loan Agreement dated November 19, 1991 between V.I. Cement and Building Products, Inc. (\"VI Cement\"), the Registrant, Mark 21 Industries, Inc. (\"Mark 21\"), Masonry Products V.I. Corporation (\"Masonry Products\") and Corestates First Pennsylvania Bank (\"Corestates\") (11) (10.39) 10.27 Promissory Note, dated November 19, 1991 of V.I. Cement to Corestates for $2,000,000 (11) (10.40) 10.28 Guaranty dated November 19, 1991 of the Registrant, Mark 21 and Masonry Products to Corestates (11) (10.41) 10.29 Registrant's 1992 Stock Option Plan (12)(A) 10.30 Registrant's 1992 Directors' Stock Option Plan (12)(B) 10.31 Notes receivable from Red Pond Estates, N.V. in the principal sums of $242,516, $139,478 and $167,740, respectively (13) (10.41) 10.32 Amendment No. 6 to the St. Johns Agreement dated November 30, 1993 (14) (10.39) 10.33 Loan agreement, dated November 1, 1993, between Caribbean Cement Carriers, Ltd. and First National Bank of Maryland (14) (10.43) 10.34 Loan agreement, dated June 30, 1993, between the Registrant and Barnett Bank of South Florida (14) (10.44) 10.35 Loan agreement, dated September 15, 1993, between Antigua Masonry Products, Ltd. and Barnett Bank of South Florida (14) (10.45) 10.36 Loan agreement, dated January 15, 1993, between V. I. Cement and Building Products, Inc. and CoreStates First Pennsylvania Bank (14) (10.48) 10.37 Second Amended and Restated Partnership Agreement of International Perlite partners, S.C. (15) (10.38) 10.38 Limited Partnership Agreement of International Perlite Partners, L.P. (15) (10.39) 10.39 Second Amendment to Loan Agreement and Amendment to Promissory Note between the Registrant and Barnett Bank of Broward County, N.A. (15) (10.40) 10.40 Second Amendment to Loan Agreement and Amendment to Promissory Note between the Registrant, Antigua Masonry Products, Ltd. and Barnett Bank of Broward County, N.A. (15) (10.41) 10.41 Material Purchase Agreement, dated August 17, 1995, between Bouwbedrijf Boven Winden, N.V. and Hubert Petit, Francois Petit and Michel Petit (16) 10.42 Stock Purchase Agreement, dated August 17, 1995, between the Registrant and Hubert Petit, Francois Petit and Michel Petit (16) 22.1 Registrant's Subsidiaries (16) 24.1 Consent of KPMG Peat Marwick (16)\n(1) Incorporated by reference to the exhibit shown in parenthesis and filed with the Registrant's Registration statement on Form S-2 (No. 33-31107). (2) Incorporated by reference to the exhibit shown in the parenthesis and filed with the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1989. (3) Incorporated by reference to the exhibit shown in the parenthesis and filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1987 (the \"1987 10-K\"). (4) Incorporated by reference to the exhibit shown in the parenthesis and filed with the Registrant's Form 8 dated July 14, 1988 to the 1987 10-K. (5) Incorporated by reference to the exhibit shown in the parenthesis and filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1988 (the \"1988 10-K\"). (6) Incorporated by reference to the exhibit shown in paren- thesis and filed with the Registrant's Proxy Statement dated May 30, 1989. (7) Incorporated by reference to the exhibit shown in parenthesis and filed with the Registrant's Form 8 dated August 17, 1989 to the 1988 10-K. (8) Incorporated by reference to the exhibit showing in parenthesis and filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1989. (9) Incorporated by reference to the exhibit shown in parenthesis and filed with Registrant's Current Report on Form 8-K dated May 2, 1990. (10) Incorporated by reference to the exhibit showing in parenthesis and filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1990. (11) Incorporated by reference to the exhibit showing in parenthesis and filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1991. (12) Incorporated by reference to the exhibit showing in parenthesis and filed with the Registrant's Proxy Statement dated May 6, 1992. (13) Incorporated by reference to the exhibit showing in parenthesis and filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1992. (14) Incorporated by reference to the exhibit showing in parenthesis and filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993. (15) Incorporated by reference to the exhibit showing in parenthesis and filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994. (16) Filed herewith.\nManagement employee contracts, compensatory plans and other arrangements included as part of the exhibits referred to above are as follows:\n10.1 Registrant's 1986 Non Qualified Stock Option Plan (3) 10.3 Registrant's 401(k) Retirement and Savings Plan (5) (10.3) 10.4 Life Insurance and Salary Continuation Agreement dated as of March 29, 1989, between the Registrant and Donald L. Smith, Jr.(5)(10.13) 10.29 Registrant's 1992 Stock Option Plan (12) (A) 10.30 Registrant's 1992 Directors' Stock Option Plan (12) (B)\n(b) Reports on Form 8-K.\nNo Reports on Form 8-K were filed by the Registrant during the last quarter of the period covered by this report.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, there- unto duly authorized.\nMarch 27, 1996 DEVCON INTERNATIONAL CORP.\nBy:\/s\/Donald L. Smith, Jr. Donald L. Smith, Jr. Chairman, President and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nDEVCON INTERNATIONAL CORP.\nMarch 27, 1996 By:\/s\/Donald L. Smith, Jr. Donald L. Smith, Jr. Chairman, President and Chief Executive Officer\nMarch 27, 1996 By:\/s\/Richard L. Hornsby Richard L. Hornsby Executive Vice President and Director\nMarch 27, 1996 By:\/s\/Walter B. Barrett Walter B. Barrett Vice President of Finance, Chief Financial Officer and Treasurer\nMarch 27, 1996 By:\/s\/Robert A. Steele Robert A. Steele Director\nMarch 27, 1996 By: \/s\/Robert L. Kester Robert L. Kester Director\nDEVCON INTERNATIONAL CORP. AND SUBSIDIARIES\nSchedule II\nValuation and Qualifying Accounts\n[CAPTION]\nACCOUNTANT'S CONSENT\nThe Board of Directors Devcon International Corp. and Subsidiaries\nWe consent to incorporation by reference in the registration statements (No. 33-32968 and No. 33-59557) on Form S-8 and (No. 33- 65235) on Form S-3 of Devcon International Corp. and subsidiaries of our report dated March 27, 1996, relating to the consolidated balance sheets of Devcon International Corp. and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the years in the three year period ended December 31, 1995, and the related schedule, which report appears in the December 31, 1995 annual report on Form 10-K of Devcon International Corp. and Subsidiaries. As discussed in note 1(j) 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,\" in 1993.\nKPMG PEAT MARWICK LLP\nFort Lauderdale, Florida March 27, 1996\nEXHIBIT 10.41\nPROTOCOL\nBETWEEN:\n- - Hubert Petit, residing at Marigot 97150 - Saint-Martin F.W.I. - - Francois Petit, his son, residing at Simpson Bay Sint- Maarten - - Michel Petit, his son, residing at Sandy-Ground at Anguilla\nhereinafter collectively, the PETIT,\nas party of the first part,\nAND:\nBOUWVEDRIJF BOVEN WINDEN, N.V. (BBW) with registered office at P.O. Box 2050 Juliana Airport - Sint Maarten duly represented hereof by Mr. Kevin M. Smith according to a power of attorney granted to him by BBW's Management Committee,\nthe said power of attorney authorizing him to engage BBW and if not, appointing him as having usurped said powers,\nas a party of the second part\nWHEREAS:\n- - The PETIT are the owners of a property located at Esperance - Carata and Hope Hill, French part of Saint Martin (F.W.I.) surveyed and registered as section AR and BD;\n- - This property contains materials (stone and sand) in its soil as both parties, the PETIT and BBW, have verified and recognize.\nAFTER HAVING RECALLED THIS, IT IS NOW HEREBY AGREED:\n1) The PETIT sell to BBW, or to any other individual or entity elected by BBW, a quantity of 12,850,000 tons of materials, in situ, said materials being stones, sand and direct materials.\nAt the request of BBW for stone extraction, the Petit undertake to furnish to BBW, or to any other individual or entity elected by BBW, the adequate authorizations necessary for BBW to request the authorizations to extract.\n2) This sale will occur during a period of 15 years starting as of the execution hereof.\nBBW will take care of the use of the materials without being entitled to engage the Petit's liability in this respect.\n3) If, for administrative reasons, BBW could not be provided with the agreed quantity for 12,850,000 tons during the period provided for in article 2, said period of 15 years would be extended for a duration equivalent to the duration of the stoppage.\nDuring the stoppage, the performance of this agreement will be suspended as well as the payments set forth in article 4 and BBW shall be entitled to terminate this agreement.\nHowever, the duration as provided for under article 2 hereof could not exceed 20 years starting as of the execution hereof.\n4) The parties agree that BBW will pay to the PETIT the amount of US 12,850,000 for the 12,850,000 tons of material (sand and stones) extracted from the property hereabove described.\nThe payment will occur according to the following time schedule:\nFebruary 1, 1996. . . . . . . . . . . . . . . . $ 287,500 May 1, 1996 . . . . . . . . . . . . . . . . . . $ 287,500 August 1, 1996. . . . . . . . . . . . . . . . . $ 575,000\nFebruary 1, 1997. . . . . . . . . . . . . . . . $ 137,500 May 1, 1997 . . . . . . . . . . . . . . . . . . $ 137,500 August 1, 1997. . . . . . . . . . . . . . . . . $ 137,500 November 1, 1997. . . . . . . . . . . . . . . . $ 137,500\nQuarterly installments. . . . . . . . . . . . . $7,150,000 ($137,500 on the first day of February, May, August and November for 13 years from 1998 until 2010). The last installment will occur at the end of the 15th year . . . . . . . . . . . . . . . . . $4,000,000\nTOTAL . . . . . . $12,850,000\n5) The present agreement will be terminated:\n- either, where BBW would not satisfy one of these installments within 30 days, after the due date; However, if BBW wishes to extend such 30 day period, it shall obtain a written agreement for the PETIT before the 30 day has elapsed.\n- of after 5 years as of the execution hereof if BBW so wishes.\n6) At the end of the 15-year period, provided under article 2 hereof or at the end of this period extended by the periods provided for under article 3, BBW or any other individual or entity elected by BBW is granted a purchase option on the property hereabove mentioned for a price of USD 400,000.\nThis option will have to be exercised by BBW within 6 months as of the expiration of the hereabove period and after all conditions of the agreement of sale of materials have been complied with.\n7) During the duration hereof, the PETIT undertake not to directly or indirectly carry on a competing professional activity or an activity which could harm BBW's professional interests in Saint Martin or Saint Maarten.\n8) As a warranty, the PETIT represent subject to annulment hereof:\n- that they have all powers and authority to establish and warrant the present agreement:\n- that they are the owners of the 50 hectares property hereabove mentioned and they prove it;\n- that no third party has any right or authorization for any professional or commercial activity on this property;\n- that no individual or legal entity other than BBW has any right or authorization for being entitled to the 12,850,000 tons of materials extracted from the property.\n9) Indemnification\nBBW agrees to indemnify and hold the Petit harmless from any damages that they will suffer from BBW's violation of the agreement hereof.\nThe PETIT agree to indemnify and hold BBW harmless from any and all losses or damages including, without limitation, taxes, interest indemnification, penalties, reasonable fees and other related expenses of BBW as a result of or arising from, any breach or inaccuracy or omission of any represen- tation, warranty or covenant of the PETIT in this agreement or in any document, certificate or other instrument related thereto.\n10) BBW is entitled to appoint, in its place and stead, any individual or entity of its choice in order to proceed with the performance hereof in all respects, subject to it remaining liable as co-debtor jointly in respect of all the commitments provided herein.\nAll rights and obligations stipulated herein shall inure to be and be binding actively and passively on the heirs, successors and assigns of each of the parties of the first part, whether minors or subject to any other incapacity, jointly and indivisibly, among themselves and with the other parties of the first part.\nThe validity, construction and enforceability of this agreement shall be governed by the laws of the Republic of France.\nThis agreement may not be amended, except by an instrument in writing signed by each of the parties hereto.\nThe present agreement may be filed on the record of a notary of BBW's choice, (\"depot au rang des minutes\") if BBW so wishes.\n11) A sample of the plan of the property is attached hereto.\n12) The expenses and fees for the drafting of this agreement shall be borne by the Petit. The expenses in connection with the registration shall be borne by BBW and said registration will be achieved by SCP F. HERMANTIN F. KACY-BAMBUCK.\n13) In case of dispute, the parties elect the Tribunal de Grande Instance of Basse Terre.\n14) The agreement hereof is drafted in three counterparts, one of which for registration.\nDone at Saint Martin, on July 31, 1995\nBBW\nBy:\nH. Petit Kevin M. Smith, gerant\nF. Petit\nM. Petit\nEXHIBIT 10.42\nSTOCK PURCHASE AGREEMENT\nBETWEEN THE UNDERSIGNED:\nMr. Hubert Petit, a French citizen, born in Saint Martin on September 4, 1926, unremarried widow of Mrs. Claudine Genevieve Leroy, living at Saint Martin Marigot;\nMr. Francois Petit, a French citizen, born in Montfermeil (Seine et Oise) on November 7, 1953, single, living at Saint Martin Marigot;\nMr. Michel Petit, a French citizen, born in Paris on February 9, 1950, divorced in a first marriage and unremarried from Mrs. Edwina Brooke, living at Saint Martin Marigot;\n(Messrs. Hubert Petit, Francois Petit and Michel Petit are hereinafter collectively referred to as the \"Sellers\" acting jointly and severally for the purposes hereof);\nAND\nThe company Devcon International Corp., company of the State of Florida of the United States of America, with registered office located at 1350 E. Newport Center Drive, Suite 201, Deerfield Beach, Florida 33442, duly represented by Richard Hornsby who is duly empowered for the purposes hereof (hereinafter, the \"Purchaser\").\nWHEREAS:\nWhereas, the Sellers own all of the issued and outstanding shares of the capital stock of a French company, Societe des Carrieres de Grand-Case, S.A.R.L. (\"Societe\"). Societe is a company with limited liability with a registered share capital of FF 700,000, and headquarters located at Route du Fort Saint Louis Marigot, 97 150 Saint-Martin (France), registered with the registry of commerce and companies of Basse-Terre, under the number B 319 179 248.\nWhereas, Societe engages in the following businesses: the mining, manufacture and sale of ready-mix concrete, concrete block and aggregate (hereinafter, the \"Businesses\").\nWhereas the Sellers, owners of land being used as a quarry, have and must enter into before the date of fulfillment of the conditions precedent with Societe, two lease agreements with a right to extract, one concerning an area of 2 hectares for which no prefectoral authorization has been granted, the other concerning an area of 1 hectare for which a quarry exploitation authorization has been granted by the Prefecture of Guadeloupe on May 30, 1988 for a duration to expire on May 30, 1998.\nWhereas the Sellers desire to sell and Purchaser desires to purchase all of the shares of the capital stock of Societe, all of which are owned by the Sellers (the \"Shares\"), upon the modalities, terms and conditions herein set forth.\nNOW THEREFORE THE PARTIES HERETO HEREBY AGREE AS FOLLOWS:\n1. SALE OF SHARES\n1.1 SALE OF SHARES\nUpon the terms and conditions of this agreement and in accordance with the present agreement and pursuant to the conditions of article 3 herebelow, the Sellers sell to the Purchaser, and the Purchaser agrees to purchase all of the Shares. The number of Shares being sold by each Seller are set forth on SCHEDULE 1.1 hereto.\n1.2 PURCHASE PRICE\nThe sale hereof is agreed upon and accepted in consideration of a purchase price for all the Share One Million Dollars ($1,000,000) (the \"Purchase Price\") payable at the date of fulfillment of conditions precedent (as defined in Section 2 herebelow).\n1.3 FINANCING SITUATION OF SOCIETE AT THE DATE OF FULFILLMENT OF THE CONDITIONS PRECEDENT\nThe accounts of Societe at the date of fulfillment of the conditions precedent will reflect claims which amount will be at least equivalent to the whole amount of the Societe due liabilities.\nSellers shall remit to Purchaser, within ten days following the date of fulfillment of the conditions precedent, a balance sheet and an income statement of Societe at the date of fulfillment of the conditions precedent reflecting strictly the financial situation hereabove described. The balance sheet and income statement shall be certified exact and sincere by the account firm . In the case where the Financial Statements at the date of fulfillment of the conditions precedent would show some due liabilities which amount would not be covered by the amount of the claims, the Sellers undertake to repay forthwith these liabilities to Societe or to Purchaser.\n2. DATE OF FULFILLMENT OF THE CONDITIONS PRECEDENT\nThe instrument stating the fulfillment of the conditions precedent shall be established by the most diligent party at the notarial office of Eugene and Michel Desgranges located at Baie-Mahault, Jarry Houelbourg (Guadeloupe) on August 1995 subject to the provisions of the second phrase of article 3.1 hereunder, or at such other place, date and time as Purchaser and the Representative of Sellers may mutually agree.\n3. CONDITIONS PRECEDENT TO CLOSING AND COMMITMENTS ESSENTIAL TO THE OBLIGATIONS OF THE PARTIES\n3.1 CONDITIONS PRECEDENT\nThis sale hereof shall be subject to the fulfillment of the following condition precedent, at the latest on , 1995.\nNo negative reply from the French Treasury Department to the prior application of acquisition that shall have been sent to it by the Purchaser pursuant to the regulations relating to foreign investments in France, shall have been notified to the Purchaser within 15 days of the receipt by the said Treasury Department of such prior applications; or Societe shall have received explicit and unconditional approval without any reserve from the French Treasury Department within 90 days of the date hereof, in the event that within 15 days of receipt of the prior application of acquisition by the French Treasury Department, said Treasury Department shall have issued an adjournment decision. In this latter case, the parties shall use their best efforts to obtain the said approval and each party shall consult the other prior to taking any action with a view to obtaining such approval and whenever possible, shall associate the other party in such action.\nIn the event that the above condition precedent is not fulfilled within the time limits provided for its fulfillment or such other time limit accepted by joint agreement of the parties, each of the parties shall recover its entire freedom without any obligation as regards the other and without any obligation to give indemnity to the other.\n3.2 COMMITMENTS ESSENTIAL TO OBLIGATIONS OF PURCHASER\nThe following commitments and obligations of the Sellers are essential to the Purchaser's consent to its obligations and commitments under this Agreement and, consequently, are conditions to the validity of this Agreement. Should any of these commitments and obligations not be achieved, the present agreement would not be perfected.\n(a) REPRESENTATIONS AND WARRANTIES TRUE\nThe representations and warranties of Sellers contained in Article 5 below are correct in all respects and will so be on the date of fulfillment of the conditions precedent, with the same effect as though such representations and warranties had been made on and as of such date.\n(b) ABSENCE OF CERTAIN CHANGES OR EVENTS\nThere shall have been no material adverse change in, or fact or event likely to have such an adverse material effect on, the financial condition, results or operations, business or prospects of Societe since December 31, 1994.\n(c) COVENANTS PERFORMED\nThe covenants of Sellers to be performed on or before the date of fulfillment of the conditions precedent pursuant to the terms of this Agreement shall have been duly performed, in particular, those taken in connection with the restructuring set forth under article 1.3 hereinabove.\n(d) RESIGNATIONS\nPurchaser shall have received, at the latest on the date of fulfillment of the conditions precedent, resignations of the managing director of Societe.\n(e) LEASE\nSociete and Sellers shall have modified by covenant a form of which is attached hereto as SCHEDULE 3.2, the current lease including a right to extract dated October 15, 1980 and concluded a lease including a right to extract on the area of 1 hectare which has been granted a quarry exploitation authorization delivered by the Prefecture of Guadeloupe on May 30, 1988.\n3.3 COMMITMENTS ESSENTIAL TO OBLIGATIONS OF SELLERS\nThe following commitments and obligations of the Purchaser are essential to the Seller's consent to their obligations and commitments under this Agreement and, consequently, are conditions to the validity of this Agreement. Should any of these commitments and obligations not be achieved, the present agreement would not be perfected:\n(a) REPRESENTATIONS AND WARRANTIES TRUE\nThe representations and warranties of Purchaser contained in article 6 below are correct in all respects and will so be as of the date of the fulfillment of the conditions precedent, with the same effect as though such representations and warranties had been made on and as of such date.\n(b) COVENANTS PERFORMED\nThe eventual covenants of Purchaser to be performed on or before the date of the fulfillment of the conditions precedent pursuant to the terms of this Agreement shall have been duly performed.\n4. DOCUMENTS DELIVERED [DELIVERIES AT CLOSING]\na) Sellers or their counsel have delivered the following to Purchaser which acknowledges the same:\ni) a copy of k.bis excerpt and Societe's by-laws, both of which are to be certified by Societe's manager (\"gerant\") as conforming with the original and being updated, at the date of fulfillment of the conditions precedent;\nii) a resignation letter, subject to the condition that the present sale is perfected, of Societe's Manager (\"gerant\") which shall be without indemnity;\niii) a certified copy of the resolution of Societe's partners' general meeting approving, in accordance with article 45 of the French company Law dated July 24, 1966, the present sale of shares as well as the Purchaser as transferee of the Shares;\nb) At the signature of the instrument stating the fulfillment of the conditions precedent, the Purchaser shall remit the Purchase Price as agreed under article 1.2 hereabove to the Sellers. The Purchase Price shall be paid by bank cashier's check or by transmission of funds by bank wire transfer to the specified bank account designated by the Representative of the Sellers;\n5. REPRESENTATIONS AND WARRANTIES OF SELLERS\nSellers represent and warrant that each of the following representations and warranties is accurate, complete and precise, without any reserve or exception other than those mentioned in this article, and determining in Purchaser's consent to enter into the agreement hereof;\n5.1 CORPORATION ORGANIZATION\nSociete is a corporation duly constituted. Societe has the corporate power and all authority to own or lease all of its properties and assets. Societe's by-laws, of which a certified copy conforming to the original is attached hereto as SCHEDULE 5.1, as well as the functioning of Societe's corporate bodies, comply with the regulations in effect. The Businesses are not conducted by any other persons or entities other than Societe. Furthermore, as of the date hereof and in the past, no receiver has been appointed to administer all or part of the assets of Societe. No request, petition or declaration has been made with a view to an amicable arrangement, a bankruptcy proceeding or judicial liquidation of Societe or with a view to any equivalent procedure. Societe has not ceased making payments to its creditors and is not insolvent or incapable of paying its debts. No as-yet unenforced judgment can be invoked against Societe.\n5.2. CAPITALIZATION; SHARE OWNERSHIP\nThe share capital of Societe consist of 700 shares, par value FF 1,000 per share. All the Shares are owned as of the date hereof by the Sellers as set forth on Schedule 1.1 hereto and at the date of fulfillment of the conditions precedent, Sellers shall own all right, title and interest in, and have full authority to sell and transfer good title to, the Shares. At the date of fulfillment of the conditions precedent, the Purchaser shall receive good title to the Shares, free and clear of any and all liens, claims, security interests, charges or encumbrances, of any kind or value whatsoever. All Shares have been legally issued, duly authorized and are fully paid and are not subject to and will not be subject to the preemptive or similar rights of any person. All taxes due with respect to the issuance and the possible subsequent transfer of such Shares have been paid.\nThere is no agreement or commitment in effect which has been signed with a view to allocate to, issue to the benefit of, or grant to any person whatsoever the right to an allocation or an issuance of shares or to exercising the voting rights of the Shares.\n5.3. AUTHORITY AND POWER\nEach of the Sellers has full power and authority to enter into and perform this agreement which constitutes the valid and binding obligations of each of them.\nAll rights and obligations stipulated herein will bind actively and passive the heirs, successors or beneficiaries of the Sellers, whether the persons are minors or incapable, jointly and severally with the other Sellers and between themselves.\n5.4. NO VIOLATION\nThe conclusion and performance of this Agreement by the Sellers are not contrary to i) any of the stipulations of the Societe's by-laws, ii) any laws, customs, regulations or judicial decision whatsoever applicable to any of the Sellers and\/or Societe or any of their assets. The conclusion and performance of this Agreement by the Sellers are not contrary to any of their and\/or Societe's commitments and will not result in unfavorable consequences to Societe and\/or Purchaser such as the anticipated payability of sums of money or the modification, termination or cancellation of any agreement entered into by Societe.\n5.5 FINANCIAL STATEMENTS\nSCHEDULE 5.5 hereto set forth the financial statements (balance sheet, income statement and Annex) of Societe as of December 31, 1992, 1993 and 1994 (collectively the \"Financial Statements\"). The Financial Statements have been prepared in accordance with the applicable regulations, are straight and sincere and given a true and fair view of the financial situation and results of Societe and comply with the principles and standards customarily adopted in France, in particular the 1982 General Chart of Accounts. The accounting books and other records of Societe have been, and are being, maintained and updated in all material respects in accordance with applicable rules and are in its possession. Such books and records contain accurate and in all respects significant data according to principles generally accepted. They relate to all of the operations to which Societe was or is a party to.\nAll acts, corporate records and other documents evidencing Societe's ownership of assets and all copies duly executed of all the agreements in effect entered into by Societe are effectively held by it.\n5.6. ABSENT OF CERTAIN CHANGES OR EVENTS\nSince December 31, 1994, which is the date of the last Financial Statements, there has not been:\n- any change affecting or liable to affect the business, operations, assets, liabilities, financial condition, prospects of Societe from that described in the Financial Statements;\n- no damage, destruction or loss (whether or not covered by insurance) affecting or liable to affect any of the foregoing;\n- no disposition of Societe's assets except in the ordinary course of business;\n- no change in the accounting methods and practices;\n- no social disorder, strike or other circumstances relating to Societe's social climate.\nExcept as set forth on SCHEDULE 5.6, each of the Sellers and Societe have complied since December 14, 1994 with the covenants applicable in the first phrase of Section 7.1.\n5.7. LEGAL AND OTHER PROCEEDINGS\nExcept as set forth on SCHEDULE 5.7, Societe is not currently a party to, whether as claimant or defendant, any legal, administrative (of a jurisdictional nature or otherwise), arbitration or other proceedings. No employee or manager of Societe is sued criminally for acts relating to Societe's activities. There is no current claim, civil, administrative (of a jurisdictional nature or otherwise) or criminal proceedings against or envisioned against Societe, and there is no reasonable basis for any of the foregoing. Neither any of the Sellers nor Societe is a party to any order, judgment or decree which will or is likely to affect the business, operations, properties, assets or financial condition of Societe. Except as set forth on SCHEDULE 5.7; neither any of the Sellers nor Societe is a party or subject to any action that would or could prevent the performance in any material respect of this Agreement. Except as set forth on SCHEDULE 5.7, Societe is not a party to or subject to any enforcement action whether judicial, administrative or of whatever nature, or to any agreement or memorandum of understanding or similar document with any judicial, governmental or other authority restricting its operations or requiring that actions be taken and; no such action, memorandum order is likely to occur. Neither any of the Sellers nor Societe has received any injunction, report or notice from any judicial, governmental or other authority which requires that Societe address any material problem or take any material action which has not already been addressed or taken in a manner satisfactory to such judicial, governmental or other authority.\n5.8. UNDISCLOSED LIABILITIES\nAs of the date of fulfillment of the conditions precedent, Societe will have no indebtedness, obligation, liability or commitment (contingent or otherwise) except those reflected in the Financial Statements at the date of fulfillment of the conditions precedent nor does there exist any event or circumstance resulting in particular from transactions effected or actions occurring prior to the date of fulfillment of the conditions precedent that could reasonably be expected to result in any indebtedness, obligations, liabilities or commitments of Societe.\n5.9. TAX MATTERS\nSociete has duly and within the legal period of time, effected all and provided to any relevant authorities any information requested by virtue of the tax regulations. Such returns are accurate and complete in all respects. Societe has duly paid all taxes, assessments, fees, penalties, interest and other governmental charges whatsoever owed by it. There are no tax liens of any kind or nature upon the properties or assets of Societe and there is no pending tax authorities's audit, request of information whatsoever or pending litigation. All prior audits have been concluded and resolved definitely and Societe has not requested any extension of statutory period of limitation applicable to any tax or para-tax return. No tax authorities audit or request for information whatsoever would disclose incomes which would not have been properly declared by Societe.\nAll social security contributions payable or due by Societe have been paid at the proper time (or reserves have been made therefor) and all returns required under the regulations have been filed on time and are sincere and true. Societe has provided all information required. No social authorities audit is in progress, no request for information has been made and, to the knowledge of the Sellers, no such claim is likely to be made.\nAll instruments granting any rights whatsoever to Societe subject to stamp duty or registration tax have been properly stamped or registered in accordance with applicable tax regulations.\n5.10. PROPERTY - TITLE AND LEASES\nSCHEDULE 5.10 contains a complete and accurate list of all real property and personal property owned or leased by Societe specifying for each item its exact nature and if it is owned, leased or otherwise held. All of the lease agreements, commercial lease or leasing are listed in SCHEDULE 5.10. Except as set forth on SCHEDULE 5.10, Societe has good, valid and marketable title, free and clear of any and all liens, easements, security interests, claims, encumbrances, charges or other limitations, including any restriction to the right of disposal. All buildings, equipment and other property held under leases or subleases by Societe are held under valid instruments enforceable in accordance with their terms and Societe has complied with all obligations thereunder. All operating facilities, buildings, furniture, equipment and other tangible property owned or used by Societe are in a good condition. Such properties and all fixtures and improvements and the use thereof, conform in all respects with all regulations which are applicable to them, in particular the applicable building, zoning, environmental and other rules, and do not materially encroach in any respect on property of others.\nThere exists no covenant, restriction or stipulation, agreed to by Societe which would conflict with the use or affect the value of the real property. All required administrative authorizations have been obtained for the occupancy and use of the buildings and for all work carried out in the real property; they are effective and in full effect; valid and final certificates of compliance have been issued in respect of such work undertaken in the buildings; there exists no notice currently in force against Societe served by any competent authority and instancing any breach of any provision under the Town Planning Code or Building and Housing Code or under any other laws, regulations (including local or municipal regulations) or ordinances concerning real property or the use thereof.\nNo action, claim or demand in connection with the real property is pending and no notice of any such action, claim or demand has been or is likely to be given or received.\n5.11. CONTRACTS\nSCHEDULE 5.11 sets forth a list of all agreements and other commitments to which Societe is a party or by which Societe is bound including contracts or purchase order to sell ready-mix concrete, concrete block, paving stones and aggregate. No commitment entered into by Societe exists whose conditions would be abnormal. As of the date hereof, except for this Agreement and agreements described in SCHEDULE 5.11, Societe is not a party to or bound by any agreement or commitment. Societe is not in default in any respect under its by-laws or, to the best of any of the Sellers' knowledge, under any contract, agreement or commitment or other instrument to which it is a party or by which any of its assets, business or operations may be bound or affected and, in particular, the contract relating to the excavator Liebherr 962. To the knowledge of the Sellers, no event or omission has occurred entitling a third party to demand accelerated payment or to proceed with early termination of any contract to which Societe is a party. Societe has not provided services which were not, or are not satisfactory or which breached any stipulated representation or warranty or condition. The Sellers are not aware of any event capable of leading to an action for damages for breach of any contract or obligation whatsoever. Societe has not received notice or special information leading it to understand that prior to the date of execution hereof any major customer or supplier of Societe intended to cease or materially reduce its operations. The transfer of the Shares to the Purchaser is snot liable to affect Societe's relations with third parties.\nThe Purchaser has been informed that the following inventory remains on the site and does not belong any longer to Societe and shall be loaded on trucks:\n-25,000 CM of material belonging to SEMSAMAR; -400 CM of stone belonging to SDL.\n5.12. COMPLIANCE WITH APPLICABLE LAW\nNeither Societe nor any oft the Sellers has received any notice of non compliance with the necessary authorizations to exercise its activities. The authorizations and permits of Societe are enforceable vis-a-vis third parties and are not likely to be challenged and have been performed pursuant to their terms.\n5.13. EMPLOYEES AND EMPLOYEE BENEFIT PLANS\nExcept as set forth on SCHEDULE 5.13, Societe is not a party to any employment agreement containing stock option, stock purchase, deferred compensation, bonus, percentage compensation, profit sharing, service award, severance payment higher than those computed by application of the Collective Bargaining Agreement or any other arrangement, whether verbal or written. All contributions payable and due to Societe in respect of the benefits referred to in SCHEDULE 5.13 have been duly paid.\nThe employment contracts listed in SCHEDULE 5.13 BIS do not contain any provision which would be contrary to French Labor Law and\/or rules other than those resulting from the Collective Bargaining Agreement and Company Agreements listed in SCHEDULE 5.13BIS. No amount is owed to any person presently or formerly employed by Societe by virtue of his employment contract, other than remuneration rights accumulated but not yet payable or reimbursement of business expenses duly evidenced. Societe has not effected or agreed to effect any payments whatsoever to one of its employees, presently or formerly employed by it, which would not be tax deductible.\nExcept where a provision would have been entered ins the Financial Statements in this respect, Societe has not incurred any liabilities in respect of breach of any contract or in respect of, in particular, severance indemnities with the exception, however, of a pending litigation before the labor courts of which Sellers expressly undertake to personally and jointly assume the consequences, and in the case of condemnation of Societe, pay all accessory indemnities and related expenses. Societe has not entered into any contract still in force providing for any ex gratia payment to be made in the event of dismissal or suspension or variance of the terms of the employment contract of any current or former employee. Societe has at all times observed all applicable enactments in the field of labor law, social security law, hygiene and safety regulations and all other regulations concerning staff employment.\n5.14. INSURANCE\nSociete is properly and validly insured and the insurance policies set forth adequate coverage and complete coverage of the risks of liability. SCHEDULE 5.14 contains a complete and correct list of all insurance policies maintained in effect on the date hereof by Societe. All premiums due on such policies have been paid and all such policies are enforceable and in full force and effect, none are cancelable for non-disclosure of the insured party of an act, omission or absence of disclosure. Societe has not received any notice of premium increases.\n5.15. INTANGIBLE PERSONAL PROPERTY\nSCHEDULE 5.15 contains a true, correct and complete list of all franchises, patents, trademarks, trade or corporate names and licenses (collectively, \"Intangible Rights\") which are owned or used by Societe. The Intangible Rights have been duly registered, filed and, as the case may be, renewed within the required legal period of time; none are subject to abandonment. Except as set forth in SCHEDULE 5.15, Societe is the sole and exclusive owner of, and has the unrestricted right to use, each of the copyrights and industrial rights set forth on SCHEDULE 5.15. No claims or demands whatsoever have been asserted against Societe with respect to any of the Intangible Rights and no proceedings have been instituted, are pending or, to the knowledge of Sellers, are likely to be threatened which challenge the rights of Societe with respect thereto.\nNone of the processes utilized by Societe infringes any third party intellectual property or requires the use of any third party confidential information.\n5.16. AFFILIATE TRANSACTIONS\nSociete has no obligations or commitments existing on the date hereof to or from any partner, manager or employee of Societe or any member of their respective families or to or from any other legal entity of which one of the persons hereabove mentioned has control or is associated.\n5.17. NO MISREPRESENTATIONS\nTo the best of each Seller's knowledge, all of the information contained in the representations and warranties set forth in this Agreement its Schedules, or in any of the documents or certificates which would have been delivered to the Purchaser are true and sincere.\nThe Sellers are not aware of any fact or circumstance, not known to the public or not having been disclosed by writing to the Purchaser, rendering the said information false, inaccurate or misleading.\n6. REPRESENTATIONS AND WARRANTIES OF PURCHASER\nPurchaser represents and warrants that each of the following representations and warranties is accurate, complete and precise, without any reserve or exceptions other than those mentioned in this article, and acknowledge that they are determinant in Sellers' consent to enter into the agreement hereof.\n6.1. CORPORATE ORGANIZATION\nThe Purchaser is a corporation duly constituted; its functioning conforms to the regulations in effect. The Purchaser has the corporate power and all authority to own or lease all of its properties and assets and to carry on it business as it is now being conducted.\n6.2. AUTHORITY AND POWER\nThe Purchaser has full corporate power and authority to enter into and perform this agreement which constitutes the valid and binding obligations of it. All rights and obligations stipulated herein will actively and passively bind the heirs, successors or beneficiaries of the Purchaser, whether these persons are minors or incapable, jointly and severally with the Purchaser and between themselves.\n6.3. NO VIOLATION\nThe conclusion, performance, execution and delivery of this Agreement by Purchaser will not (i) violate any provision of Purchaser's by-laws or (ii) violate any law, use, regulation, judicial decision whatsoever applicable to the Purchaser or to any of its assets. The conclusion and performance of this agreement by the Purchaser will not violate any of the Purchaser's undertakings or result in unfavorable consequences for the Sellers.\n7. CERTAIN AGREEMENTS AND COVENANTS OF THE PARTIES\n7.1. Between the date hereof and the date of fulfillment of the conditions precedent, Societe will not undertake any act other than in the ordinary course of business and shall preserve intact its assets, its activity and its going concern.\nEach of the parties represents and warrants that the statements in articles 5 and 6 shall remain correct and true at the date of fulfillment of the conditions precedent.\nBetween the date hereof and the date of fulfillment of the conditions precedent, the parties undertake to cooperate with a view to perfecting this agreement, in particular, by spontaneously providing all information susceptible to be reasonably requested by the authorities or the other party.\n7.2. In the case where the extraction activities of Societe would be stopped by any administrative or jurisdictional authority because of a withdrawal or a non-renewal and more generally because of the loss of the current authorizations, the parties undertake to perform the following commitments:\na) For a period not to exceed 12 months and during which it is prevented from exercising its extraction activity, Societe shall idle its mining and crushing equipment and shall make its best efforts to obtain from the competent authorities the authorization to resume its extraction activity.\nb) If after the 12 months period hereabove described, Societe has not obtained the authorization to resume its extraction activity, the Sellers undertake, upon simple request of Purchaser, to:\ni) purchase the mining and crushing equipment of Societe at a price appraised by a third party expert.\nThe third party expert shall be elected by mutual agreement of the parties within 15 days following the end of the 12 month period hereabove described. In the event where the parties would not agree on the election of the third party expert, such expert shall be appointed by ordinance of the President of the Tribunal de Grande Instance of Basse- Terre, at the request of the most diligent party.\nThe mission of the third party expert shall be to determine the price of the extraction equipment of Societe within the conditions of articles 1591 and seq. of the French Civil Code. The third party expert shall remit, via certified mail with return receipt requested, to the parties its appraisal report within 30 days of its appointment. The conclusions of the third party expert shall bind the parties who waive the possibility of discussing such conclusions for whatever reason.\nOne-half of the fee of the third party expert shall be paid by Sellers and the other half by Purchaser, and\nii) sell Societe, in the framework of their mining operation, all extracted materials at the herebelow defined prices:\nCrushed Stone $12.50\/CM Manufactured Sand $12.50\/CM Washed Sand $ 7.00\/CM Crusher Run $ 9.00\/CM Boulders $ 9.00\/CM\nThe prices indicated above have been computed on the basis of the average selling price of concrete at $140\/CM. These prices shall be revised in proportion to any variation of the average concrete selling price.\nIn the event where the Sellers cannot furnish Societe with 96,000 CM per year of crushed stone and\/or manufactured sand, they agree to pay $5,500 for each 1% of quantity of material not furnished to Societe in comparison with the 96,000 CM commitment. For example, if the Sellers have produced 80,000 CM of stone instead of 96,000 CM for a given year, the quantity of material not furnished is equivalent to 16.7% (80,000\/96,0000); consequently, the Sellers shall pay to Societe the sum of $91,850 ($5,500 x 16.7%), and\nc) At such time, Societe is again allowed to mine and it will then repurchase the assets sold to the Societe for a price appraised by a third party expert intervening within the conditions defined under b)ii) hereabove.\n8. INDEMNIFICATION\n8.1. OBLIGATIONS OF THE PURCHASER\nThe Purchaser agrees to indemnify and hold harmless the Sellers from any and all losses or damages including, without limitation, taxes, interest, indemnification, penalties, reasonable fees and other related expenses asserted against, imposed upon or paid, incurred or suffered by the Sellers as a result of or arising from, any breach or inaccuracy or omission of any representation, warranty, covenant or agreement of the Purchaser in this Agreement or in any document, certificate or other instrument related thereof.\n8.2. OBLIGATIONS OF THE SELLERS\nThe Sellers hereby agree to indemnify and hold harmless the Purchaser from i) any and all losses or damages, including without limitation, taxes, interest, indemnification, penalties, reasonable fees and other related expenses asserted against, imposed upon or paid, incurred or suffered by the Purchaser as a result of or arising from any breach or inaccuracy or omission of any representation, warranty, covenant or agreement of the Sellers in this Agreement, or in any document, certificate or other instrument related thereto, and\/or any increase of Societe's liabilities or decrease of Societe's assets which would occur during the duration of Sellers warranty and which would have been originated prior to the date of fulfillment of the conditions precedent, and ii) any violation of any applicable regulations, in particular, those relating to permits or authorizations necessary for carrying on Societe's activities or any violation of the said permits or authorizations, the consequences of which would occur after the date of fulfillment of the conditions precedent, during the duration of the applicable statute of limitation, and that would have been originated before the date of fulfillment of the conditions precedent.\nAs a consequence, the Sellers agree to pay, at the election of the Purchaser, either to Societe or to the Purchaser, an amount corresponding to any loss or damage including, in particular, taxes, interests, indemnities and other related expenses of any nature whatsoever borne or incurred by Societe as a result of any tax or social security adjustment or of any claim from the Customs Service or from any other competent authority relating to a period prior to the date of fulfillment of the conditions precedent that may be, or have been, made or accepted or that may be, or have been, the subject matter of a settlement agreement.\nGenerally, the Sellers hereby agree to be responsible for any social security or other contribution and\/or any debt or contribution, tax or charge, whether direct or indirect, including but not limited to customs charges, payable by Societe, that may not appear in the Financial Statements or for which allowance may not have been made in such Financial Statements, or of which the origin may be prior to the date of fulfillment of the conditions precedent.\n8.3. INDEMNIFICATION PROCEDURE\nThe party claiming indemnification hereunder is referred to as the \"Indemnified Party.\" The other party is called the \"Indemnifying Party.\" The Indemnified Party shall give as soon as possible by mail with return receipt requested to the Indemnifying Party of any event, situation, notice or claim from any authority which might give rise to a claim for indemnity under this Agreement. As to any claim, action or proceeding by a third party, the Indemnified Party shall keep control of the proceedings and the Indemnifying Party shall be entitled, together with the Indemnified Party, to participate in the defense by presenting its allegations and to be associated to the discussions with a view to compromise or settle any such matter at the Indemnifying Party's own expense; each of the Indemnifying and the Indemnified Party shall provide such cooperation and such reasonable access to its books, records and properties as the other party shall reasonably request with respect to any such matter, and the parties agree to cooperate with each other in order to ensure the proper and adequate defense thereof. The payment of any amount due by the Sellers under this warranty agreement may be made, at Purchaser's election, either by means of set- off against any amount that may be due by Purchaser, or any other company of its group, to the Sellers or some of them, or by actual payment by Sellers to Societe or to Purchaser, as appropriate, no later than thirty (30) calendar days after the payment demand was made. Interest at the rate of 12% per annum shall automatically accrue for the benefit of Purchaser or Societe on any amounts not paid within the aforesaid period, without prior formal notice being required and without this provision implying any respite of payment.\nThe Indemnifying Party shall not make any settlement of any claims without the prior written consent of the Indemnified Party, which consent shall not be unreasonably withheld.\n8.4. TERM\nThe indemnification obligations of the parties set forth in this Section 8 are given for a period expiring on December 31, 1999 with respect to the situation of Societe and the general representations and warranties given hereof, and at the latest thirty (30) days after the time period of limitation of administrations and competent authorities, in particular, fore tax, para- tax, social and custom matters, have elapsed.\n9. MISCELLANEOUS\n9.1. ENTIRE AGREEMENT\nThis Agreement constitutes the entire agreement between the parties hereto with respect to the matter hereof. It supersedes all prior agreements, both oral and written, which could have existed between the parties hereto and\/or companies to which they are affiliated with, with respect to such subject matter.\n9.2. NOTICES\nAny notice by either party shall be in writing and hand-delivered or mailed by certified mail with return receipt requested or telecopied (with confirmation by certified mail with return receipt requested sent the same day) to the following addresses and number:\nIf to Purchaser, to:\nc\/o Devcon International Corp. 1350 E. Newport Center Drive, Suite 201 Deerfield Beach, Florida 33442\nAttention: Richard Hornsby\nIf to Sellers:\nFernand Hubert Petit Marigot 97150 Saint Martin (France)\n9.3. SEVERABILITY\nThe nullity of any provision hereof shall not cause the rest of this agreement to be null and void and neither party hereto shall be entitled to claim damages by reason of any such nullity.\n9.4. JURISDICTION\nThe commercial court of Basse-Terre shall be competent for all disputes arising from or related to the construction, validity, performance or non performance of the agreement hereof.\n9.5. HEADINGS AND CAPTIONS FOR REFERENCE ONLY\nThe titles preceding the text of each section and subsection of this Agreement have been inserted solely for convenient reference and neither constitute a part of this Agreement or affect is meaning, interpretation or effect.\n9.6. SUCCESSORS AND ASSIGNS\nAll rights and obligations stipulated herein shall insure to and be binding on the heirs, successors and assigns of each of the Sellers, whether minors or subject of any other incapacity, jointly and indivisibly, among themselves and with the other Sellers.\n9.7. GOVERNING LAW:\nThe validity, construction, interpretation and enforceability of this Agreement shall be governed by the laws of the Republic of France. All of the parties to this Agreement have participated fully in the negotiation and preparation hereof, and, accordingly, this Agreement shall not be more strictly construed against any one of the parties hereto.\n9.8. INTERMEDIARIES\nEach of the Sellers and Purchaser represent and warrant to the others that it has not employed or dealt with any broker, agent or finder in respect of the transactions provided for herein.\n9.9. EXPENSES\nEach of the parties hereto agrees to pay all of the respective expenses incurred by it in connection with the negotiation, preparation, execution and performance of this Agreement, in particular, for Devcon the 4.8% tax to be levied on the Purchase Price (at the exchange rate of the dollar at the date of the drafting of the instrument stating the fulfillment of the conditions precedent) as well as the instrument stating the fulfillment of the conditions precedent.\nAs expressly agreed, Devcon shall pay to the notary, holder of the agreement, in application of article 4 of the notary fee regulation, the sum of FF 100,000 as agreed by letter of June 13, 1995.\n9.10. UNITED STATES DOLLARS\nExcept where otherwise specifically stated, all references to \"dollars\" contained herein shall refer to United States Dollars.\n9.11. AMENDMENTS\nThis agreement may not be amended, except by an instrument in writing signed by each of the parties hereto.\n9.12. REGISTRATION OF TRANSFER; RECORDATION\nThe transfer of the Shares shall be registered with the relevant French Tax Authorities and thereafter notified to Societe either (i) under article 1690 of the Civil Code, by way of notification by a \"huissier de justice\" (bailiff) or by way of an acceptation by the Gerant of Societe in an authenticated deed or, (ii) by deposit to the Societe registered office, of an original copy of the present Stock Purchase Agreement against remittance by the manager of Societe of a statement of deposit (\"Certificat de depot\").\nIn addition, two original copies of the Stock Purchase Agreement shall be filed with the relevant commercial court within the jurisdiction of which Societe is recorded.\nDone at\nOn , 1995.\nIn counterparts.\nSELLERS; PURCHASER: BBW\nMr. Fernand Hubert Petit By: Mr. Richard Hornsby\nMr. Francois Petit\nMr. Michel Petit\nEXHIBIT 22.1\nAntigua Cement, Ltd. Antigua Development and Construction, Ltd. Antigua Heavy Constructors, Ltd. Antigua Masonry Products, Ltd. Bahamas Construction and Development, Ltd. Bouwbedrifj Boven Winden, N.V. Bouwbedrifj Boven Winden (Saba), N.V. Bouwbedrifj Boven Winden (St. Eustatius), N.V. Caribbean Cement Carriers, Ltd. Caribbean Construction and Development, Ltd. Caribbean Heavy Construction, Ltd. Caribbean Masonry Products, Ltd. Cramer Construction, N.V. Crown Bay Marina Joint Venture I Devcon Caribbean Purchasing Corp. Devcon Crown Bay II Corp. Devcon Crown Bay Corp. Devcon Masonry Products (BVI), Ltd. Eurostone, Inc. Industrias de Productos Pelita de Mexico, S.A. de C.V. International Perlite Partners, L.P. International Perlite Partners, S.C. Marco, Inc. M21 Industries, Inc. Proar Construction Materials Company, N.V. Seaward Shipping & Dredging Co., Ltd. Societe des Carriers de Grand Case, S.A.R.L. St. Martin Block, S.A.R.L. V.I. Cement and Building Products, Inc.","section_15":""}
{"filename":"711417_1995.txt","cik":"711417","year":"1995","section_1":"Item 1. Business. --------\nNew England Life Pension Properties; A Real Estate Limited Partnership (the \"Partnership\") was organized under the Uniform Limited Partnership Act of the Commonwealth of Massachusetts on December 17, 1982, to invest primarily in newly-constructed and existing income-producing real properties.\nThe Partnership was initially capitalized with contributions of $2,000 from Copley Properties Company, Inc. (the \"General Partner\") and $10,000 from NELRECO Troy, Inc. (the \"Initial Limited Partner\"). On December 23, 1982 the Partnership filed a Registration Statement on Form S-11 (the \"Registration Statement\") with the Securities and Exchange Commission with respect to the public offering of 20,000 units of limited partnership interest at a purchase price of $1,000 per unit (the \"Units\") with an option to sell up to an additional 10,000 Units (an aggregate of $30,000,000). The Registration Statement was declared effective on March 22, 1983. On June 29, 1983 the Partnership sold all 30,000 Units, and the Partnership admitted 3,193 investors as limited partners (the \"Limited Partners\"), with $29,652,760 being contributed to the capital of the Partnership. At the same time, the Initial Limited Partner withdrew its contribution from the Partnership.\nThe Partnership does not have any employees. Services are performed for the Partnership by the General Partner and by affiliates of the General Partner.\nAt December 31, 1995 the Partnership had the three real estate investments described below. In 1985 a joint venture in which the Partnership was a partner sold its interest in a fourth real estate investment. In May, 1991, the Partnership sold a fifth real estate investment that resulted in a capital distribution of $50.00 per Unit. In June 1994, a sixth investment, an industrial building in Ontario, California, was sold, resulting in a capital distribution of $193.34 per unit.\nThe Partnership and its affiliate, New England Life Pension Properties II have provided the ground lessee of one of the Partnership's properties, the Willows Shopping Center in Concord, California, with a $2.5 million leasehold mortgage loan for the purpose of completing the renovation of the Center. New England Life Pension Properties I will fund $625,000, with the balance funded by New England Life Pension Properties II. The Partnership has no other current plan to renovate, improve or further develop any of its real property.\nIn the opinion of the General Partner of the Partnership, the properties are adequately covered by insurance.\nA. Research and Development Facility in Columbia, Maryland. ---------------------------------------------------------\nIn 1984 the Partnership consummated a land purchase-leaseback and leasehold mortgage loan investment totaling $5,100,000 in a 75,500 square foot research and development facility located in Rivers Corporate Park, Columbia, Maryland. The ground lease provides that the Partnership will receive an annual rental of $126,500 plus 50% of the ground lessee's gross revenues from the building in excess of a base amount. The mortgage loan bears interest at the rate of 11.5% per annum and is paid currently. The Partnership is negotiating an extension to the loan which matured on March 31, 1994. The tenant occupying the building has a right of first offer during the period which began in September, 1992 and continues through November, 2004.\nB. Office Building in Decatur, Georgia. -------------------------------------\nIn 1985 the Partnership acquired a 3.28 acre parcel of land in Decatur, Georgia, for $1,675,000 and leased it back to the seller. Situated on the land is a four-story, 79,855 square foot office building. The ground lease provides that the Partnership will receive an annual rental of $201,000 plus 60% of the ground lessee's gross revenues from the building in excess of a base amount.\nThe Partnership has fully funded its $5,825,000 non-recourse mortgage loan commitment to the ground lessee. The loan is secured by a first mortgage of the building and the leasehold interest in the land. Through February 1993, interest only was payable monthly at the rate of 12% per annum. Interest was paid at a 7% rate from October, 1991 through April, 1992, with the remainder being deferred. The Partnership agreed effective March 1993, that (1) the interest rate be reduced to 8.5%, (2) monthly payments be made in a sum necessary to amortize, using a 25-year amortization schedule, the outstanding principal balance of the loan through maturity in February 1995; and (3) an additional monthly payment of $7,005.38 be made for twenty-four months to retire the outstanding accrued interest.\nThe Partnership has also made an additional loan of $633,076 to fund tenant improvements. Interest accrues monthly at the rate of 12% per annum. This loan is secured by a second mortgage of the building and the leasehold interest in the land.\nEffective February 19, 1995, the ground lease and the first mortgage loan were amended to provide that ground rent and interest will be payable only to the extent that net cash flow from the property is available therefor. To the extent net cash flow is not sufficient to pay the ground rent and interest payments, such amounts will accrue. The Partnership also obtained the sole right to cause a sale of the property beginning on or after January 1, 1996, and the maturity date was extended to December 31, 1996.\nC. Shopping Center in Concord, California. ----------------------------------------\nOn July 30, 1984, the Partnership and an affiliate of the Partnership (the \"Affiliate\") jointly made land purchase-leaseback and leasehold mortgage loan investments aggregating $15,719,317 in a 24.8 acre shopping center located in Concord, California, known as the Willows Shopping Center. The Partnership's share of the investments aggregated $3,929,829, giving the Partnership a 25% interest in each component of the investment held in common with the Affiliate. The investments entitled the Partnership and the Affiliate jointly to receive an annual interest return of 13% on the $10,719,317 ten-year mortgage, together with an annual fixed rental under the ground lease equal to a 12.2% return on the $5,000,000 land purchase price plus an annual percentage rental equal to 50% of the ground tenant's annual gross revenues in excess of specified base amounts.\nOn August 15, 1985, the Partnership and the Affiliate consented to a sale by the ground tenant, Willows Concord Venture (\"Willows Concord\"), of the ground tenant's ownership interest in the buildings and leasehold interest in the land to an affiliate of VMS Realty, Inc., an Illinois corporation. In conjunction with the sale, the ground lease was amended to provide that the Partnership and the Affiliate would no longer participate in excess rental revenues from the Shopping Center or in net appreciation from the sale of the property. The mortgage loan was also amended to increase the principal amount by $3,880,683 to $14,600,000, to extend the maturity date one year to August, 1995, and to lower the interest rate from 13% per annum to a stepped rate beginning at 9% per annum and increasing to 12% over six years. Under the terms of the original ground lease, the joint ground lessors were entitled to 50% of the net proceeds from a sale. The Partnership received cash of $1,071,875 and an interest in the incremental mortgage loan amount equal to $970,171, 50% of which was payable to the former ground lessee upon full\npayment of the loan principal by the new mortgagor. The joint mortgagees also entered into a Collection and Disbursement Agreement pursuant to which Concord Willows was entitled to share in 50% of interest paid under the new note in excess of the interest that would have been payable under the original note.\nThe Partnership and the Affiliate had not received interest payments currently on the mortgage loan since the payment due in March, 1990, and as a result, the Partnership and the Affiliate began foreclosure proceedings to take possession of the property. On October 4, 1990, Pacific First Bank, the second leasehold mortgagee, filed an involuntary bankruptcy petition in the United States Bankruptcy Court for the Northern District of California against the ground lessee\/debtor, to which filing the ground lessee\/debtor subsequently consented. The ground lessee\/debtor later consented to relief from stay of foreclosure proceedings. The Partnership and its Affiliate sold their interest in the leasehold mortgage loan to Willows Concord on June 14, 1991. In return, the Partnership and the Affiliate took back a note in the amount of $14,863,206.\nOn June 18, 1991, Willows Concord foreclosed on the leasehold mortgage. The Partnership, the Affiliate and Willows Concord entered into a replacement promissory note in the principal amount of $14,863,206, effective June 18, 1991. The new loan is secured by the leasehold interest, bears interest at the rate of 9.323% per annum and provides for a reduction in principal if the note is paid prior to maturity. The Partnership, the Affiliate and Willows Concord also entered into a new ground lease which provides for annual rent in the amount of $550,000 plus an annual percentage rent equal to 70% of the ground lessee's annual gross revenues in excess of a specified amount. The Partnership has a 25% share of such rent. To the extent that operating cash flow from the shopping center is not sufficient to pay the ground rent, such rent may accrue until June 1996, at which time Willows Concord is obligated to pay all unpaid accrued rent and to pay all future ground rent on a current basis.\nOn January 1, 1995 the Partnership and the Affiliate provided a $2.5 million construction loan to the ground lessee in order to fund the completion of the renovation of the Center, the Partnership has committed to fund $625,000 of this amount. The loan bears interest at 11% per annum, provides for amortization on a 15-year schedule, and matures on December 31, 1997. In addition, the ground lease was amended to provide the Partnership and the Affiliate with the sole right to cause a sale on or after January 1, 1996.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties. -----------\nThe following table sets forth the annual realty taxes for the Partnership's properties and information regarding tenants who occupy 10% or more of gross leasable area (GLA) in the Partnership's properties:\nThe following table sets forth for each of the last five years the gross leasable area, occupancy rates, rental revenue and net effective rent for the Partnership's properties:\n* Net effective rent calculation is based on average occupancy during the respective years.\nFollowing is a schedule of lease expirations for each of the next ten years for the Partnership's properties based on the annual contract rent in effect at December 31, 1995:\n(1) Remaining leases do not expire within 10 years.\n* Does not include expenses paid by tenants.\nFollowing is information regarding the competitive market conditions for each of the Partnership's properties. This information has been gathered from sources deemed reliable. However, the Partnership has not independently verified the information and, as such, cannot guarantee its accuracy or completeness.\nA. R&D in Columbia, MD. -------------------\nThe Howard County R&D market contains approximately 3.2 million square feet and exhibited a vacancy rate of 10% as of December 31, 1995. The 10% vacancy rate is a strong improvement from the 1990 to 1993 period when the vacancy rate hovered in the 22%-to-24% range.\nB. Office building in Decatur, GA. ------------------------------\nThe metropolitan Atlanta class \"A\" office market comprises eight sub-markets that total 47 million square feet, of which approximately 16 million square feet is located in the Central Business District area. The overall office vacancy rate stands at 9.5%, which is a significant decline from 14.7% in 1993.\nThe Decatur office building is located in the Northlake sub-market, one of the smallest markets with just 1.3 million square feet of space. This sub-market has a reported vacancy of 5% which is down significantly from 10.9% in 1993.\nC. Shopping Center in Concord, CA. ------------------------------\nThis neighborhood shopping center lies within the Central Contra Costa County market in which there is approximately 8.1 million square feet of retail inventory. This market incorporates the cities along the I-680 corridor and includes Walnut Creek, Concord, Pleasant Hill and Martinez. An average vacancy rate of 5% was reported within the neighborhood centers, with retail strip properties posting a slightly higher average vacancy of 7%. Since 1992, no new retail projects have come on-line within the property's immediate neighborhood. New construction is expected to be limited due to the lack of available land and the still cautious attitude among the lending community.\nItem 3.","section_3":"Item 3. Legal Proceedings. -----------------\nThe Partnership is not a party to, nor are any of its properties subject 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 security holders during the fourth quarter of the fiscal year covered by this Annual Report on Form 10-K.\nPART II -------\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder ------------------------------------------------------------- Matters. ---------\nThere is no active market for the Units. Trading in the Units is sporadic and occurs solely through private transactions.\nAs of December 31, 1995, there were 3,387 holders of Units.\nThe Partnership's Amended and Restated Agreement of Limited Partnership dated June 29, 1983, as amended (the \"Partnership Agreement\"), requires that any Distributable Cash (as defined therein) be distributed quarterly to the Partners in specified proportions and priorities. There are no restrictions on the Partnership's present or future ability to make distributions of Distributable Cash. For the year ended December 31, 1995 cash distributions paid in 1995 or distributed after year end with respect to 1995 to the Limited Partners as a group totaled $984,000. For the year ended December 31, 1994, cash distributions paid in 1994 or distributed after year end with respect to 1994 to the Limited Partners as a group totaled $7,096,200 which included $5,800,200 of capital distributions.\nCash distributions were less than net income and less than cash provided by operating activities in 1995; therefore, partners' capital increased. Reference is made to the Partnership's Statement of Changes in Partners' Capital and Statement of Cash Flows in Item 8 hereof.\nItem 6.","section_6":"Item 6. Selected Financial Data. -----------------------\n(1) The Partnership consummated a sale in 1991 which increased Net Income by $32,402 ($1.07 per Unit) and cash distributions by $1,500,000 ($50 per Unit).\n(2) The Partnership recorded a provision of $2,800,000 ($92.40 per Unit) for impaired mortgage loans during 1993.\n(3) The Partnership consummated a sale in 1994 which increased Net Income by $1,385,562 ($45.72 per Unit) and capital distributions by $5,800,200 ($193.34 per Unit).\nThe Partnership also recorded a credit of $200,000 ($6.60 per Unit) related to impaired mortgage loans during 1994.\n(4) The Partnership recorded a credit of $260,000 ($8.58 per Unit) related to impaired mortgage loans during 1995.\nITEM NO. 7 - ----------\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF - -------------------------------------------------------------------------- OPERATIONS - ----------\nLIQUIDITY AND CAPITAL RESOURCES - -------------------------------\nThe Partnership completed its offering of units of limited partnership interest in June 1983. A total of 30,000 units were sold. The Partnership received proceeds of $27,253,251, net of selling commissions and other offering costs, which were invested in real estate, used to pay related acquisition costs, or retained as working capital reserves. The Partnership made the real estate investments described in Item 1 hereof. One investment was sold in each of 1985 and 1991; a third investment was sold in 1994. As a result of these sales and similar transactions, capital of $13,600,200 has been returned to the limited partners through December 31, 1995. One of the Partnership's mortgage loan investments had a maturity date in 1994. Renewal discussions are ongoing; however, the Partnership intends to extend the maturity until the underlying property can be sold, at terms which are in the best interest of the limited partners. Two other mortgage loans matured in February 1995 but were subsequently extended to December 31, 1996.\nOn June 17, 1994, the Partnership sold its Ontario Distribution Center investment and received net proceeds of $6,414,737. The resulting capital distribution to limited partners of $5,800,200 on July 28, 1994 ($193.34 per limited partnership) reduced the adjusted capital contribution to $546.66 per unit.\nAt December 31, 1995, the Partnership had $1,204,043 in cash and cash equivalents which was partially used for cash distributions of $248,485 to partners on January 25, 1996; the remainder is expected to be used to fund the renovation of the Willows Shopping Center or retained as working capital reserves. The source of future liquidity and cash distributions to partners is expected to be cash generated by the Partnership's real estate investments and proceeds from the sale of such investments. Distributions of cash from operations for the four quarters of 1995 were made at the annualized rate of 6% on the adjusted capital contribution. Distributions of cash from operations for 1994 were made at the annualized rate of 7% for the first and second quarters and 6% for the third and fourth quarters. The reduction in the cash distribution rate is due to the absence of cash flow from the Ontario Distribution Center.\nThe carrying value of the real estate investments in the financial statements at December 31, 1995, other than impaired mortgage loans (Decatur TownCenter), is at depreciated cost or if the investment's carrying value is determined not to be recoverable through expected undiscounted future cash flows, the carrying value is reduced to estimated fair market value. The fair market value of such investments is further reduced by the estimated cost of sale for properties held for sale. Carrying value may be greater or less than current appraised value. At December 31, 1995, the carrying value of Willows Shopping Center exceeded its appraised value by approximately $390,000. The appraised value of the remaining investments at December 31, 1995 exceeded their related carrying values by an aggregate of $46,000. The current appraised value of real estate investments has been estimated by the general partner and is generally based on a combination of traditional appraisal approaches performed by the Partnership's advisor and independent appraisers. Because of the subjectivity inherent in the valuation process, the estimated current appraised value may differ significantly from that which could be realized if the real estate were actually offered for sale in the marketplace.\nRESULTS OF OPERATIONS - ---------------------\nFORM OF REAL ESTATE INVESTMENTS\nThe Willows Shopping Center is structured as a ground lease\/mortgage loan investment. However, for financial reporting purposes it is accounted for as a jointly-owned property. The remainder of the Partnership's investments are structured and accounted for as ground lease\/ mortgage loan investments.\nOPERATING FACTORS\nAt December 31, 1995, the Willows Shopping Center was 91% leased, compared to approximately 91% and 78% at the end of 1994 and 1993, respectively. The ground lessee\/borrower has commenced the full rehabilitation of this property including the complete renovation and reconfiguration of the center to a mini power center. The general partner determined that it is in the best interest of the Partnership to provide funding for the rehabilitation costs in the form of a construction loan, together with its affiliate which owns a share of the center. The Partnership's share of the remaining estimated cost is approximately $525,000 at December 31, 1995.\nDecatur TownCenter's occupancy rate remained stable at 90% throughout 1995. Occupancy was 90% and 82% at the end of 1994 and 1993, respectively.\nINVESTMENT RESULTS\nThe Partnership determined that the mortgage loans to the Decatur TownCenter were impaired and had recognized a provision for impaired mortgage loans of $2,800,000 which was charged to operations in 1993. During 1994 and 1995, the estimated market value of the loan collateral increased and, accordingly, the valuation allowance was reduced by $200,000 and $260,000, respectively, through a credit to operating results.\nThe sale of the Ontario Distribution Center in June 1994 resulted in the recognition of a gain of $1,385,562.\n1995 COMPARED TO 1994\nExclusive of the credit related to the allowance for impaired mortgage loans and revenue from the Ontario Distribution Center, real estate operating results for 1995 were $1,391,034, a slight increase compared to $1,359,953 in 1994. The increase primarily stemmed from results at Willows Shopping Center which increased by $40,000, partially offset by a decrease in operating income generated by Decatur TownCenter.\nInterest income on short-term investments and cash equivalents increased during 1995 due to an increase in interest rates.\nOperating cash flow, exclusive of Ontario Distribution Center, decreased approximately $57,000 between 1994 and 1995. This change differs from the change in operating results primarily due to an increase in non-cash working capital items.\n1994 COMPARED TO 1993\nExclusive of the credit related to the allowance for impaired mortgage loans and revenue from the Ontario Distribution Center, real estate operating results for 1994 were $1,359,953, a slight decrease compared to $1,365,612 in 1993. Real estate operating results in 1993 included two significant transactions; a lease termination fee of $80,000 from Rivers Corporate Parks and $90,000 from the settlement of past due rents at Willows Shopping Center in connection with an anchor tenant's lease revision. Excluding that settlement, operating income at Willows Shopping Center increased by $60,000. In addition, operating income generated by Decatur TownCenter increased by approximately $100,000 due to a higher average occupancy rate in 1994.\nInterest income on short-term investments and cash equivalents increased during 1994 due to an increase in interest rates and to an increase in the average investment balance resulting from the temporary investment of sales proceeds from the Ontario Distribution Center.\nOperating cash flow, exclusive of Ontario Distribution Center, decreased approximately $277,000 between 1993 and 1994. This decline is primarily due to the realization in 1993 of previously accrued revenue from Decatur TownCenter and Willows Shopping Center.\nPORTFOLIO EXPENSES\nThe Partnership management fee is 9% of distributable cash flow from operations after any increase or decrease in working capital reserves as determined by the general partner. General and administrative expenses primarily consist of real estate appraisal, printing, legal, accounting and investor servicing fees.\n1995 COMPARED TO 1994\nThe Partnership management fee decreased approximately $31,000 due to the decrease in distributable cash flow. General and administrative expenses increased 2% due to an increase in legal fees, partially offset by a decrease in printing and accounting fees.\n1994 COMPARED TO 1993\nThe Partnership management fee decreased due to a decrease in distributable cash flow. General and administrative expenses decreased 3% primarily due to a decrease in printing and appraisal costs.\nINFLATION - ---------\nBy their nature, real estate investments tend not to be adversely affected by inflation. Inflation may result in appreciation in the value of the Partnership's real estate investments over time, if rental rates and replacement costs increase. Declines in real property values, during the period of Partnership operations, due to market and economic conditions, have overshadowed the positive effect inflation may have on the value of the Partnership's investments.\nItem 8.","section_7":"","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data. -------------------------------------------\nSee the Financial Statements of the Partnership included 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. --------------------\nThe Partnership has had no disagreements with its accountants on any matters of accounting principles or practices or financial statement disclosure.\nPART III --------\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant. --------------------------------------------------\n(a) and (b) Identification of Directors and Executive Officers. --------------------------------------------------\nThe following table sets forth the names of the directors and executive officers of the General Partner and the age and position held by each of them as of December 31, 1995.\nMr. O'Connor and Mr. Coughlin have served in an executive capacity since the organization of the General Partner on December 16, 1982. Mr. Gardiner and Mr. Twining have served in their capacities since June 1994, and Mr. Mackowiak has served in his capacity as of January 1, 1996. All of these individuals will continue to serve in such capacities until their successors are elected and qualify.\n(c) Identification of Certain Significant Employees. -----------------------------------------------\nNone.\n(d) Family Relationships. --------------------\nNone.\n(e) Business Experience. -------------------\nThe General Partner was incorporated in Massachusetts on December 16, 1982. The background and experience of the executive officers and directors of the General Partner are as follows:\nJoseph W. O'Connor has been President, Chief Executive Officer and a Director of Copley Real Estate Advisors, Inc. (\"Copley\") since January, 1982. He was a Principal of Copley from 1985 to 1987 and has been a Managing Director of Copley since January 1, 1988. He has been active in real estate for 27 years. From June, 1967, until December, 1981, he was employed by New England Mutual Life Insurance Company (\"The New England\"), most recently as a Vice President in which position he was responsible for The New England's real estate portfolio. He received a B.A. from Holy Cross College and an M.B.A. from Harvard Business School.\nDaniel J. Coughlin was a Principal of Copley from 1985 to 1987 and has been a Managing Director of Copley since January 1, 1988 and a Director of Copley since July 1994. Mr. Coughlin has been active in financial management and control for 21 years. From June, 1974 to December, 1981, he was Real Estate Administration Officer in the Investment Real Estate Department at The New England. Since January, 1982, he has been in charge of the asset management division of Copley. Mr. Coughlin is a Certified Property Manager and a licensed real estate broker. He received a B.A. from Stonehill College and an M.B.A. from Boston University.\nPeter P. Twining is a Managing Director and General Counsel of Copley. As such, he is responsible for general legal oversight and policy with respect to Copley and its investment portfolios. Before being promoted to this position in January 1994, he was a Vice President\/Principal and senior lawyer responsible for assisting in the oversight and management of Copley's legal operations. Before joining Copley in 1987, he was a senior member of the Law Department at The New England and was associated with the Boston law firm, Ropes and Gray. Mr. Twining is a graduate of Harvard College and received his J.D. in 1979 from Northeastern University.\nWesley M. Gardiner, Jr. joined Copley in 1990 and has been a Vice President at Copley since January, 1994. From 1982 to 1990, he was employed by Metric Realty, a nationally-known real estate investment advisor and syndication firm, as a portfolio manager responsible for several public and private limited partnerships. His career at Copley has included asset management responsibility for the company's Georgia and Texas holdings. Presently, as a Vice President and Team Leader, Mr. Gardiner has overall responsibility for all the partnerships advised by Copley whose securities are registered under the Securities and Exchange Act of 1934. He received a B.A. in Economics from the University of California at San Diego.\nDaniel C. Mackowiak has been a Vice President of Copley since January 1989 and has been a Vice President and the Principal Financial and Accounting Officer of the Managing General Partner since January 1996. Mr. Mackowiak previously held the offices of Chief Accounting Officer of Copley from January 1989 through April 1994 and Vice President and Principal Financial and Accounting Officer of the Managing General Partner between January 1989 and May 1994. From 1975 until joining Copley, he was employed by the public accounting firm of Price Waterhouse, most recently as a Senior Audit Manager. He is a certified public accountant and has been active in the field of accounting his entire business career. He received a B.S. from Nichols College and an M.B.A. from Cornell University.\nMr. O'Connor is a director of Copley Properties, Inc., a Delaware corporation organized as a real estate investment trust which is listed for trading on the American Stock Exchange. None of the other directors of the General Partner is a director of a company with a class of securities registered pursuant to Section 12 of the Securities Exchange Act of 1934. All of the directors and officers of the General Partner also serve as directors and officers of one or more corporations which serve as general partners of publicly-traded real estate limited partnerships which are affiliated with the General Partner.\n(f) Involvement in Certain Legal Proceedings. ----------------------------------------\nNone.\nItem 11.","section_11":"Item 11. Executive Compensation. ----------------------\nUnder the Partnership Agreement, the General Partner and its affiliates are entitled to receive various fees, commissions, cash distributions, allocations of taxable income or loss and expense reimbursements from the Partnership. See Notes 1, 2 and 6 of Notes to Financial Statements.\nThe following table sets forth the amounts of the fees and cash distributions and reimbursements for out-of-pocket expenses which the Partnership paid to or accrued for the account of the General Partner and its affiliates for the year ended December 31, 1995. Cash distributions to the General Partner include amounts distributed after year end with respect to 1995.\nFor the year ended December 31, 1995, the Partnership allocated $19,973 of taxable income to the General Partner.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management. --------------------------------------------------------------\n(a) Security Ownership of Certain Beneficial Owners. -----------------------------------------------\nNo person or group is known by the Partnership to be the beneficial owner of more than 5% of the outstanding Units at December 31, 1995. Under the Partnership Agreement, the voting rights of the Limited Partners are limited and, in some circumstances, are subject to the prior receipt of certain opinions of counsel or judicial decisions.\nExcept as expressly provided in the Partnership Agreement, the right to manage the business of the Partnership is vested exclusively in the General Partner.\n(b) Security Ownership of Management. --------------------------------\nAn affiliate of the General Partner of the Partnership owned 1,094 Units at December 31, 1995.\n(c) Changes in Control. ------------------\nThere exists no arrangement known to the Partnership the operation of which may at a subsequent date result in a change in control of the Partnership.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions. ----------------------------------------------\nThe Partnership has no relationships or transactions to report other than as reported in Item 11, above.\nPART IV -------\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K. ---------------------------------------------------------------\n(a) The following documents are filed as part of this report:\n(1) Financial Statements--The Financial Statements listed on the accompanying Index to Financial Statements and Schedules, Financial Statements Index No. 2 and Financial Statements Index No. 3 are filed as part of this Annual Report. The opinion of independent accountants on the 1995 financial statements of the Decatur ground lessee\/ mortgagor refers to the uncertainty as to the ability of that entity to continue to operate as a going concern. This condition has no effect on the Partnership's carrying value of, or revenue recognition from, the Decatur investment, since both are based on the economic attributes of the underlying property to which the Partnership has priority entitlements.\n(2) Financial Statement Schedules--The Financial Statement Schedules listed on the accompanying Index to Financial Statements and Schedules are filed as part of this Annual Report.\n(3) Exhibits--The Exhibits listed in the accompanying Exhibit Index are filed as a part of this Annual Report and incorporated in this Annual Report as set forth in said Index.\n(b) Reports on Form 8-K. No Current Reports on Form 8-K were filed during the fourth quarter of 1995.\nNEW ENGLAND LIFE PENSION PROPERTIES; A REAL ESTATE LIMITED PARTNERSHIP\nFinancial Statements\n* * * * * * *\nDecember 31, 1995\nNEW ENGLAND LIFE PENSION PROPERTIES; ------------------------------------ A REAL ESTATE LIMITED PARTNERSHIP ---------------------------------\nINDEX TO FINANCIAL STATEMENTS AND SCHEDULES -------------------------------------------\nAll other schedules have been omitted because they are either not applicable or the required information is shown in the financial statements or notes thereto.\nREPORT OF INDEPENDENT ACCOUNTANTS ---------------------------------\nTo the Partners\nNEW ENGLAND LIFE PENSION PROPERTIES; A REAL ESTATE LIMITED PARTNERSHIP\nIn our opinion, the financial statements listed in the accompanying index present fairly, in all material respects, the financial position of New England Life Pension Properties; A Real Estate Limited Partnership (the \"Partnership\") at December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles. These financial statements are the responsibility of Copley Properties Company, Inc., the General Partner of the Partnership; 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 the General Partner, and evaluating the overall financial statement presentation. We believe our audits provide a reasonable basis for the opinion expressed above.\n\/s\/ Price Waterhouse LLP - ------------------------ Price Waterhouse LLP\nBoston, Massachusetts March 15, 1996\nNEW ENGLAND LIFE PENSION PROPERTIES; A REAL ESTATE LIMITED PARTNERSHIP\nBALANCE SHEET\n(See accompanying notes to financial statements)\nNEW ENGLAND LIFE PENSION PROPERTIES; A REAL ESTATE LIMITED PARTNERSHIP\nSTATEMENT OF OPERATIONS\n(See accompanying notes to financial statements)\nNEW ENGLAND LIFE PENSION PROPERTIES; A REAL ESTATE LIMITED PARTNERSHIP\nSTATEMENT OF CHANGES IN PARTNERS' CAPITAL\n(See accompanying notes to financial statements)\nNEW ENGLAND LIFE PENSION PROPERTIES; A REAL ESTATE LIMITED PARTNERSHIP\nSTATEMENT OF CASH FLOWS\n(See accompanying notes to financial statements)\nNEW ENGLAND LIFE PENSION PROPERTIES; A REAL ESTATE LIMITED PARTNERSHIP\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1 - ORGANIZATION AND BUSINESS - ----------------------------------\nGeneral\nNew England Life Pension Properties; A Real Estate Limited Partnership (the \"Partnership\") is a Massachusetts limited partnership organized for the purpose of investing primarily in newly constructed and existing income producing real properties. It primarily serves as an investment for qualified pension and profit sharing plans and other entities intended to be exempt from federal income tax. The Partnership commenced operations in June 1983, and acquired several real estate investments through 1985. It intends to dispose of its investments within twelve years of their acquisition, and then liquidate; however, the general partner could extend the investment period if it is in the best interest of the limited partners.\nThe general partner of the Partnership is Copley Properties Company, Inc., a wholly-owned subsidiary of Copley Real Estate Advisors, Inc. (\"Copley\"). The associate general partner is CCOP Associates Limited Partnership, a Massachusetts limited partnership, the general partners of which, are managing directors of Copley and\/or officers of the managing general partner. Subject to the general partner's overall authority, the business of the Partnership is managed by Copley pursuant to an advisory contract. Copley is an indirect wholly-owned subsidiary of New England Investment Companies, L.P. (\"NEIC\"), a publicly traded limited partnership. New England Mutual Life Insurance Company (\"The New England\") the parent of NEIC's predecessor, is NEIC's principal unitholder. In August 1995, The New England announced an agreement to merge (the \"Merger\") with Metropolitan Life Insurance Company (\"Metropolitan Life\"), with Metropolitan Life to be the surviving entity. This merger, which is subject to various policyholder and regulatory approvals, is expected to take place in the first half of 1996. Metropolitan Life is the second largest life insurance company in the United States in terms of total assets, having assets of over $130 billion (and adjusted capital of over $8 billion) as of June 30, 1995.\nAt December 31, 1995 an affiliate of the general partner owned 1,094 units of limited partnership interest and at December 31, 1994 the general partner owned 1,069 units of limited partnership interest, which were repurchased from certain qualified plans, within specified annual limitations provided for in the Partnership Agreement.\nManagement\nCopley, as advisor, is entitled to receive stipulated fees from the Partnership in consideration of services performed in connection with the management of the Partnership and the acquisition and disposition of Partnership investments in real property. Partnership management fees are 9% of distributable cash flow from operations, as defined, before deducting such fees. Acquisition fees were paid in an amount equal to 2% of the gross proceeds from the offering available for investment. Disposition fees are generally 3% of the selling price of the property, but are subject to the prior receipt by the limited partners of their capital contributions plus a stipulated return thereon.\nNew England Securities Corporation, an indirect subsidiary of The New England, is engaged by the Partnership to act as its unit holder servicing agent. Fees and out-of-pocket expenses for such services totaled $4,719, $6,985 and $7,066 in 1995, 1994 and 1993, respectively.\nNOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - ---------------------------------------------------\nAccounting Estimates\nThe preparation of financial statements in conformity with generally accepted accounting principles requires the general partner to make estimates affecting the reported amounts of assets and liabilities, and of revenues and expenses. In the Partnership's business, certain estimates require an assessment of factors not within management's control, such as the ability of tenants to perform under long-term leases and the ability of the properties to sustain their occupancies in changing markets. Actual results, therefore, could differ from those estimates.\nGround Leases and Mortgage Loans\nWhile the related land and loan investments are legally separable, the terms thereof have been negotiated jointly and the general partner evaluates investment performance on a combined basis. They are, therefore, presented together in the accompanying balance sheet and statement of operations.\nInvestments in land subject to ground leases are stated at cost, plus accrued revenue. Investments in mortgage loans to the related ground lessees are originally stated at cost, plus accrued interest. If the investment is subject to ownership accounting (see below), cost is adjusted for the accumulated cost recovery allowance. If the mortgage loan is impaired (see \"Impaired Mortgage Loans\" below), the carrying amount is adjusted to the estimated market value of the underlying collateral less anticipated costs of sale.\nAccrual of contractual ground rent and loan interest is discontinued if the total of the Partnership's invested cash and such accrual approximates the appraised value of the investment. Under this condition, the Partnership applies ownership accounting whereby revenue is recognized only to the extent of net operating income generated by the underlying property, before depreciation, to which the Partnership is entitled. In addition, the cost of the investment related to depreciable property is subject to a recovery allowance similar to depreciation, which is computed using the straight-line method based on estimated useful lives. The Partnership, however, retains a priority claim to all unrecognized contractual revenue. If a mortgage loan is determined to be impaired, the Partnership recognizes revenue only to the extent of operating cash flow generated by the collateral underlying the loan and no longer recognizes a cost recovery allowance.\nImpaired Mortgage Loans\nThe Partnership considers a loan to be impaired when it is probable that it will be unable to collect all amounts due under the contractual terms of the loan agreement. Factors that the Partnership considers in determining whether a loan is impaired include its past due status, fair value of the underlying collateral and economic prospects of the borrower. When a loan is impaired, its carrying value is periodically adjusted, through a valuation allowance, to its estimated market value which is based on the appraised value of the underlying collateral less anticipated costs of sale. Changes in the valuation allowance are reported in the Statement of Operations.\nProperty\nThe Partnership and an affiliate share common ownership of an investment. The form of the investment is a combination ground lease and mortgage loan, as described above; however, in this case (Willows Shopping Center), substantial economic risks of property ownership rest with the Partnership and its affiliate. Accordingly, the investment is accounted for as owned property, although the Partnership and its affiliate have a priority claim to all unrecognized contractual revenue. The Partnership's financial statements include its proportionate ownership share (25%) of the individual assets, liabilities, revenue and expenses related to the property. Land and buildings and improvements (net of accumulated depreciation) are classified as property in the balance sheet.\nLeases provide for rental increases over the respective lease terms. Rental revenue is being recognized on a straight-line basis over the lease terms.\nCapitalized Costs\nMaintenance and repair costs are expensed as incurred. Significant improvements and renewals are capitalized. Depreciation is computed using the straight-line method based on estimated useful lives of the buildings and improvements. Leasing costs are also capitalized and amortized over the related lease terms.\nAcquisition fees have been capitalized as part of the cost of real estate investments. Amounts not related to land are being amortized using the straight-line method over the terms of the mortgage loans or the estimated useful lives of the property.\nRealizability of Real Estate Investments\nThe Partnership considers a real estate investment, other than a mortgage loan, to be impaired when it determines the carrying value of the investment is not recoverable through undiscounted cash flows generated from the operations and disposition of the property. Effective January 1, 1995, with its adoption of Statement of Financial Accounting Standards No.121 (SFAS 121) entitled, \" Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of,\" the Partnership measures the impairment loss based on the excess of the investment's carrying value over its estimated fair market value. For investments being held for sale, impairment loss is measured based on the excess of the investment's carrying value over\nits estimated fair market less estimated costs of sale. Property held for sale is not depreciated during the holding period.\nThe carrying value of an investment may be more or less than its current appraised value. At December 31, 1995, the carrying value of Willows Shopping Center exceeded its appraised value by approximately $390,000, while at December 31, 1994 the carrying value exceeded its appraised value by approximately $270,000. The appraised value of the remaining investments at December 31, 1995 and 1994 exceeded their related carrying values by an aggregate of $46,000 for both years.\nThe current appraised value of real estate investments has been estimated by the general partner and is generally based on a correlation of traditional appraisal approaches performed by Copley and independent appraisers. Because of the subjectivity inherent in the valuation process, the estimated current appraised value may differ significantly from that which could be realized if the real estate were actually offered for sale in the marketplace.\nCash Equivalents and Short-Term Investments\nCash equivalents are stated at cost, plus accrued interest. The Partnership considers all highly liquid debt instruments purchased with a maturity of ninety days or less to be cash equivalents; otherwise, they are classified as short-term investments.\nThe Partnership has the positive intent and ability to hold all short-term investments to maturity; therefore, short-term investments are carried at cost plus accrued interest, which approximates market value. At December 31, 1995 all investments are in commercial paper with less than six months remaining to maturity. At December 31, 1994, the Partnership did not hold any short-term investments.\nDeferred Disposition Fees\nDisposition fees due to Copley related to sales or restructuring of investments are included in the determination of gains or losses resulting from such transactions. According to the terms of the advisory contract, payment of such fees has been deferred until the limited partners first receive their capital contributions, plus stipulated returns thereon.\nIncome Taxes\nA partnership is not liable for income taxes and, therefore, no provision for income taxes is made in the financial statements of the Partnership. A proportionate share of the Partnership's income is reportable on each partner's tax return.\nPer Unit Computations\nPer unit computations are based on the number of units of limited partnership interest outstanding during the year. The actual per unit amount will vary by partner depending on the date of admission to, or withdrawal from, the Partnership.\nNOTE 3 - INVESTMENTS IN GROUND LEASES AND MORTGAGE LOANS - --------------------------------------------------------\nThe following is a summary of the Partnership's investments in ground leases and mortgage loans:\n(L) Ground lease (M) Mortgage loan\nGround leases have terms of fifty to sixty years and provide for additional rent equal to a percentage, ranging from 50% to 60%, of gross revenues in excess of a base amount from the rental of the buildings situated on the land. Percentage rent totaled $7,413, $22,643 and $187,269 in 1995, 1994 and 1993, respectively. The Partnership is also entitled to that same percentage of the net proceeds from the sale of the entire property after it has recovered its cash investment in the land and mortgage loan and, for Decatur TownCenter, after payment to the ground lessee of an amount equal to its cost of any capital improvements made during the lease term. The lease agreements require the lessee to pay all operating expenses related to the subject land. The tenant occupying Rivers Corporate Park has the right of first refusal to purchase the building and a right to request the purchase of the land through November 2004 at fair market value.\nGenerally, interest on the mortgage loans is payable monthly, except for interest on the second mortgage loan on Decatur TownCenter which is payable upon maturity. The loans are secured by first mortgages on the buildings, as well as a second mortgage on Decatur TownCenter, and by the ground leasehold interests. The mortgage loan on Rivers Corporate Park matured on March 31, 1994. Renewal discussions are ongoing. The first and second mortgage loans on Decatur TownCenter matured on February 19, 1995. On August 15, 1995, the ground lease\/mortgage loan agreements were amended to extend the maturity dates until December 31, 1996 and to provide the Partnership the sole right to cause a sale of the property on or after January 1, 1996.\nSale of Ontario Distribution Center\nThe Ontario Distribution Center in Ontario, California was sold on June 17, 1994. The net sale proceeds received by the Partnership fully repaid its ground lease and mortgage loan investment and resulted in a gain of $1,385,562 ($45.72 per limited partnership unit), net of the disposition fee of $192,442 payable to the advisor. On July 28, 1994, the Partnership made a capital distribution to the limited partners in the aggregate amount of $5,800,200 ($193.34 per limited partnership unit) with the proceeds from this sale.\nDecatur TownCenter\nThe payment terms for the ground lease and mortgage loans on Decatur TownCenter have been modified. Effective March 1, 1993, the rate on the first mortgage loan was reduced to 8.5%, principal amortization commenced on a 25-year schedule; and previously accrued interest was to be paid over a twenty-four month period. The 1995 amendment to the first mortgage loan and ground lease provides for interest and ground rent payments only to the extent of cash flow from operations of the property. The Partnership, however, retains its claim to all unpaid amounts.\nWith the determination that the loan was impaired as of January 1, 1993, the Partnership has recognized income to the extent of operating cash flow generated by the collateral underlying the loans ($602,256, $638,472 and $535,192 in 1995, 1994 and 1993, respectively). In addition, a valuation allowance has been established to adjust the carrying value of the loans to estimated fair market value less anticipated costs of sale. The activity in the valuation allowance during\n1994 and 1995, together with the related recorded and carrying value of the impaired mortgage loans at the beginning and end of each year, are summarized as follows:\nThe average recorded value of the impaired mortgage loans did not differ materially from the balances at the end of the period.\nNOTE 4 - INVESTMENTS IN PROPERTY - --------------------------------\nThe Willows Shopping Center investment (the \"Willows\"), acquired in 1984, is owned jointly with an affiliate of the Partnership (the \"Affiliate\"); the Partnership has a 25% ownership share. The ground lessee\/mortgagor stopped paying interest on the mortgage loan as of March 1990. As a result, the Partnership and its Affiliate began foreclosure proceedings to take possession of the property. A protracted series of legal interactions ensued, including the filing of an involuntary bankruptcy petition by the second leasehold mortgagee. In June 1991, the Partnership and its Affiliate sold the mortgage note to the original owner of the Willows, who in turn undertook and completed the foreclosure action. The Partnership and its Affiliate received a new mortgage note; the principal related to the Partnership's share is $3,715,802. The note bears interest at 9.323% per annum, payable monthly; however, it may accrue with interest compounded at 11%. The loan matures on June 18, 2001. The original owner also assumed the ground lease. The ground lease provides for annual rental payments to the Partnership of $137,500. Rental payments may accrue through June 1996, with interest compounding at 11%. The ground lease also provides for participation rentals at 70% of gross revenues in excess of a base amount to the Partnership and its Affiliate. Under this investment arrangement, however, the Partnership and its Affiliate are bearing substantial economic risks of ownership; accordingly, the investment is being accounted for as a jointly owned property.\nIn connection with a major renovation of the property, on January 1, 1995, the Partnership and its Affiliate committed to make a construction loan to the ground lessee in the amount of $2,500,000. The Partnership's share is $625,000 of which $100,621 has been funded as of December 31, 1995. Interest accrues at 11% compounded monthly; debt service payments begin on January 1, 1996, including principal payments based upon a 15-year amortization schedule. The note matures on December 31, 1997. In addition, the ground lease was amended, whereby after January 1, 1996, the Partnership and the Affiliate may, at their sole discretion, offer the entire property for sale.\nAt December 31, 1995 and 1994, the Partnership's proportionate share of the carrying value of the property was comprised of land of $1,250,000 and building and improvements of $3,867,318 and $3,636,582, respectively (net of accumulated depreciation of $766,954 and $581,911, respectively). The buildings are being depreciated on a straight-line basis with an estimated useful life ranging from 21 to 25 years.\nThe Partnership's proportionate share of future minimum rentals under non-cancelable operating leases are: $583,750 in 1996; $591,250 in 1997; $581,750 in 1998; $537,250 in 1999; $413,000 in 2000; and $1,446,500 thereafter.\nNOTE 5 - INCOME TAXES - ---------------------\nThe Partnership's income for federal income tax purposes differs from that reported in the accompanying statement of operations as follows:\n(1) Represents additional contractual revenue recognized for tax purposes related to the Willows Shopping Center in 1993.\nNOTE 6 - PARTNERS' CAPITAL - --------------------------\nAllocations of net income (losses) from operations and distributions of distributable cash from operations, as defined, are in the ratio of 99% to the limited partners and 1% to the general partner. Cash distributions are made quarterly.\nNet sales proceeds and financing proceeds are allocated first to limited partners to the extent of their contributed capital plus a stipulated return thereon, as defined, second to pay disposition fees, and then 85% to the limited partners and 15% to the general partner. The adjusted capital contribution per limited partnership unit was reduced from $1,000 to $790 during 1985, from $790 to $740 during 1991, and from $740 to $546.66 during 1994 as a result of such transactions. Income from a sale is allocated in proportion to the distribution of related proceeds, provided that the general partner is allocated at least 1%. Income or losses from a sale, if there\nare no residual proceeds after the repayment of the related debt, will be allocated 99% to the limited partners and 1% to the general partner.\nNOTE 7 - SUBSEQUENT EVENT - -------------------------\nDistributions of cash from operations relating to the quarter ended December 31, 1995 were made on January 25, 1996 in the aggregate amount of $248,485 ($8.20 per limited partnership unit).\nNEW ENGLAND LIFE PENSION PROPERTIES; A REAL ESTATE LIMITED PARTNERSHIP\nSCHEDULE III\nREAL ESTATE AND ACCUMULATED DEPRECIATION AT DECEMBER 31, 1995\nNotes: (L) Land (A) All senior mortgages on the properties are (B) Buildings & Improvements held by New England Life Pension Properties.\nNEW ENGLAND LIFE PENSION PROPERTIES; A REAL ESTATE LIMITED PARTNERSHIP\nSCHEDULE IV\nMORTGAGE LOANS ON REAL ESTATE AT DECEMBER 31, 1995\nDECATUR TOWNCENTER ASSOCIATES, LTD.\nFINANCIAL STATEMENTS\nDECEMBER 31, 1995, 1994, AND 1993\nFINANCIAL STATEMENTS INDEX NO. 2\nAUDITOR'S REPORT AND FINANCIAL STATEMENTS\nOF DECATUR TOWNCENTER ASSOCIATES, LTD.\n[LETTERHEAD OF DUGGAN & MASSEY, P.C.]\nINDEPENDENT AUDITOR'S REPORT ----------------------------\nTo The Partners Decatur TownCenter Associates, Ltd.\nWe have audited the accompanying balance sheets of Decatur TownCenter Associates, Ltd. as of December 31, 1995 and 1994 and the related statements of income, partners' capital and cash flows for each of the three years in the period ended December 31, 1995. 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 Decatur TownCenter Associates, Ltd. as of December 31, 1995 and 1994 and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\nThe accompanying financial statements have been prepared assuming that the Partnership will continue as a going concern. The Partnership's significant cash deficits and operating losses raise substantial doubt about its ability to continue as a going concern. The Partnership's ability to continue as a going concern is dependent on attaining future positive cash flow and\/or additional financing. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.\n\/s\/ Duggan & Massey, PC\nJanuary 15, 1996\nDECATUR TOWNCENTER ASSOCIATES, LTD. BALANCE SHEETS\nASSETS ------\nLIABILITIES AND PARTNERS' CAPITAL ---------------------------------\nSee accompanying notes and accountant's report.\nDECATUR TOWNCENTER ASSOCIATES LTD. STATEMENTS OF INCOME\nSee accompanying notes and accountant's report.\nDECATUR TOWNCENTER ASSOCIATES LTD. STATEMENTS OF PARTNERS' CAPITAL\nSee accompanying notes and accountant's report.\nDECATUR TOWNCENTER ASSOCIATES LTD. STATEMENTS OF CASH FLOWS\nSee accompanying notes and accountant's report.\nDECATUR TOWNCENTER ASSOCIATES, LTD. NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nDescription of Operations ------------------------- Decatur TownCenter Associates, Ltd. was formed on March 8, 1984 as a partnership between A.J. Land, Jr., Daniel B. Pattillo and Lawrence P. Kelly. A.J. Land, Jr. is the general partner of the project. The partnership was established to construct, manage, and lease an office building in Decatur, Georgia.\nBuilding and Improvements ------------------------- Building and improvements are carried at cost. Depreciation on the building is computed using the straight-line method over a thirty year period. Tenant improvements are being depreciated using the straight-line method over the lives of the related tenant leases. Expenditures for maintenance, repairs, renewals and improvements which do not materially extend the useful lives of the assets are charged to current earnings.\nIntangible Assets ----------------- Loan costs are being amortized using the straight-line method over a ten year period.\nCommissions and procurement fees are being amortized using the straight- line method over the lives of the related leases.\nIncome Taxes ------------ These financial statements do not reflect a provision or expense for income taxes. Each partner's pro rata share of income or loss is reported on their individual income tax return.\nReclassifications ----------------- Certain amounts in the prior year financial statements have been reclassified for comparative purposes to conform with the presentation in the current year financial statements.\nCash and Cash Equivalents ------------------------- For purposes of the statements of cash flows, the Partnership considers all highly liquid debt instruments purchased with a maturity of twelve months or less together with accrued interest to be cash equivalents.\nDECATUR TOWNCENTER ASSOCIATES, LTD. NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995\n2. BUILDING AND IMPROVEMENTS\nThe investment in building and improvements consists of the following:\n3. FIRST MORTGAGE PAYABLE\nNew England Life Pension Properties holds a first mortgage secured by all of the real property and improvements of the partnership. The total proceeds were $5,825,000. Monthly payments of interest only began April 1, 1985 and continue until maturity. On February 19, 1995, the maturity date of the note was changed from February 19, 1995 to December 31, 1996. On the maturity date, the loan shall be due and payable in full, including any unpaid interest. Annual interest expense amounted to $495,125 for the year ended December 31, 1995, $495,125 for the year ended December 31, 1994, and $529,100 for the year ended December 31, 1993. Interest in the amount of $84,498, $15,369 and $98,072 was accrued but unpaid at December 31, 1995, 1994 and 1993, respectively. There are no binding agreements to refinance on or after the maturity date. The promissory note was amended March 1, 1993 to reduce the interest rate from 12% to 8.5% per annum.\n4. SECOND MORTGAGE PAYABLE\nNew England Life Pension Properties ($633,076) and Decatur TownCenter Associates, Ltd. partners ($422,040) hold a second leasehold mortgage secured by all of the real property and improvements of the Partnership. The total proceeds were $1,055,116. The loan bears interest at twelve percent per year, beginning March 10, 1986 until maturity. On February 19, 1995, the maturity date of the note was changed from February 19, 1995 to December 31, 1996. On the maturity date, the loan shall be due and payable including accrued interest. There are no binding agreements to refinance on or after the maturity date. Annual interest expense amounted to $126,614 for each of the years ended December 31, 1995, 1994, and 1993. Interest in the amount of $1,105,779, $979,165 and $852,551 was accrued but unpaid at December 31, 1995, 1994 and 1993, respectively.\nDECATUR TOWNCENTER ASSOCIATES, LTD. NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995\n5. RELATED PARTY TRANSACTIONS\nThe Partnership has contracted with related parties for the performance of various management, leasing and construction services. The Decatur TownCenter Associates, Ltd. partners have common ownership and management control with Land Realty Services, Land & Property In-Town, Pope and Land Enterprises, and Decatur TownCenter II Associates.\nAmounts involving related parties are summarized as follows:\nOther related party items include a portion of the second mortgage funded by partners in the amount of $422,040 (See Note 4) and the accrued interest due to the partners on the second mortgage for the years ended December 31, 1995, 1994 and 1993 of $442,311, $391,665 and $341,020, respectively.\n6. LEASE COMMITMENTS\nLand - Building Site -------------------- The Partnership sold to and leased back from New England Life Pension Properties the land on which the building is located. The Partnership is committed to a sixty-year lease beginning February 20, 1985. The lease covers property of approximately one acre under the building. Annual ground lease expense amounted to $201,000 for each of the years ended December 31, 1995, 1994 and 1993. At December 31, 1995, 1994 and 1993, a total of $1,189,250, $988,250 and $787,250 was accrued but unpaid.\nDECATUR TOWNCENTER ASSOCIATES, LTD. NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995\nThe lease amount is comprised of a fixed annual rental and a participation rental. The fixed annual rental is $16,750 per month. The participation rental is a sum equal to sixty percent (60%) of gross receipts (as defined in the lease agreement) in excess of the base amount attributable to the current lease year. Gross receipts did not exceed the stated base amounts for the years ended December 31, 1995, 1994 and 1993; therefore, no participation rental was owed.\nMinimum future rental payments are as follows:\nThe Partnership has an option to repurchase the land on the date the first mortgage is repaid.\nLand - Parking Lot ------------------ The Partnership owns approximately one and one-half acres on which the parking lot is located; however, in conjunction with the sale-leaseback described above, this land was leased to and subleased back from New England Life Pension Properties. The primary lease is for a term of ninety-nine years, beginning February 20, 1985. The annual rent income amount is $1. The terms of the sublease are identical to those of the primary lease, with the annual rent expense amount being $1.\n7. INVESTMENT IN DECATUR TOWNCENTER II ASSOCIATES\nDecatur Town Center Associates, Ltd. entered into a joint venture on December 31, 1987 with New England Life Pension Properties IV to build an office building on the Leasehold Tract - Clairmont Road Property. The joint venture will lease and manage the property until December 31, 2047 unless sooner dissolved or terminated. No losses from the joint venture have been allocated to Decatur TownCenter Associates, Ltd. since operating deficiencies are funded by New England Life Pension Properties IV.\nDECATUR TOWNCENTER ASSOCIATES, LTD. NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995\n8. RENTALS UNDER OPERATING LEASES\nMinimum future rental income on noncancellable operating leases as of December 31, 1995 is:\n9. CONTINGENCY\nThe Partnership is negotiating with New England Life Pension Properties to purchase the land and retire the debt in Decatur TownCenter Associates, Ltd. If these negotiations are unsuccessful, New England Life Pension Properties has the option to offer the property for sale at its sole discretion as granted in the amended ground lease dated February 19, 1995.\nM.O.R. XVIII ASSOCIATES LIMITED PARTNERSHIP\nFINANCIAL REPORT\nDECEMBER 31, 1995\nFINANCIAL STATEMENTS INDEX NO. 3\nAUDITOR'S REPORT AND FINANCIAL STATEMENTS\nOF M.O.R. XVIII ASSOCIATES LIMITED PARTNERSHIP\n[LETTERHEAD OF WOLPOFF & COMPANY, LLP]\nTo the Partners M.O.R. XVIII Associates Limited Partnership Columbia, Maryland\nWe have reviewed the balance sheet of M.O.R. XVIII Associates Limited Partnership as of December 31, 1995 and 1994, and the related statements of income, partners' capital and cash flows for the three years ended December 31, 1995, 1994 and 1993, in accordance with Statements on Standards for Accounting and Review Services issued by the American Institute of Certified Public Accountants. All information included in these financial statements is the representation of the management of M.O.R. XVIII Associates Limited Partnership.\nA review consists principally of inquiries of Partnership personnel and analytical procedures applied to financial data. It is substantially less in scope than an audit in accordance with generally accepted auditing standards, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.\nBased on our review, we are not aware of any material modifications that should be made to the accompanying financial statements in order for them to be in conformity with generally accepted accounting principles.\nThe accompanying financial statements have been prepared assuming that the Partnership will continue as a going concern. The Partnership has a mortgage which was due in March 1994. The Partnership's plans regarding this matter are described in Note 7. The financial statements do not include any adjustments that might result from this uncertainty.\n\/s\/ Wolpoff & Company, LLP WOLPOFF & COMPANY, LLP\nBaltimore, Maryland February 15, 1996\nM.O.R. XVIII ASSOCIATES LIMITED PARTNERSHIP -------------------------------------------\nBALANCE SHEET -------------\nASSETS ------\n__________\nSee Accountant's Review Report. The notes to financial statements are an integral part of this statement.\nM.O.R. XVIII ASSOCIATES LIMITED PARTNERSHIP -------------------------------------------\nBALANCE SHEET -------------\nLIABILITIES AND PARTNERS' CAPITAL ---------------------------------\n__________\nSee Accountant's Review Report. The notes to financial statements are an integral part of this statement.\nM.O.R. XVIII ASSOCIATES LIMITED PARTNERSHIP -------------------------------------------\nSTATEMENT OF INCOME -------------------\n__________\nSee Accountant's Review Report. The notes to financial statements are an integral part of this statement.\nM.O.R. XVIII ASSOCIATES LIMITED PARTNERSHIP -------------------------------------------\nSTATEMENT OF PARTNERS' CAPITAL ------------------------------\n__________\nSee Accountant's Review Report. The notes to financial statements are an integral part of this statement.\nM.O.R. XVIII ASSOCIATES LIMITED PARTNERSHIP -------------------------------------------\nSTATEMENT OF CASH FLOWS -----------------------\n(Continued)\n__________\nSee Accountant's Review Report. The notes to financial statements are an integral part of this statement.\nM.O.R. XVIII ASSOCIATES LIMITED PARTNERSHIP -------------------------------------------\nSTATEMENT OF CASH FLOWS -----------------------\n__________\nSee Accountant's Review Report. The notes to financial statements are an integral part of this statement.\nM.O.R. XVIII ASSOCIATES LIMITED PARTNERSHIP -------------------------------------------\nNOTES TO FINANCIAL STATEMENTS -----------------------------\nDECEMBER 31, 1995 -----------------\nNote 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nOrganization ------------ M.O.R. XVIII Associates Limited Partnership was formed in 1982 pursuant to an agreement under the Maryland Uniform Limited Partnership Act.\nProperty -------- The Partnership owns a leasehold interest in a 75,000-square-foot office\/warehouse building in Columbia (Howard County), Maryland. See Note 5 regarding the related land lease. The development of the property, which is 100% leased to Crop Genetics International Corporation (see Note 4), was completed and operations commenced in February 1984. The Partnership also owns 5.3 acres of unimproved land adjacent to the property.\nExpenses Pertaining to Unimproved Land -------------------------------------- Carrying costs and expenses incurred when land is being prepared for construction are capitalized and included in land costs. This was the case in 1989 and 1990. In all other years, no substantial activity occurred and carrying costs were expensed as incurred.\nDepreciation ------------ Building and improvement costs are being depreciated using the straight-line method over the estimated useful life of 50 years.\nAmortization ------------ Various deferred costs are being amortized as follows:\n*Fully amortized.\nRental Income ------------- Rental income is recognized on a straight-line basis over the term of the lease. The excess of resulting rental income over the rent stipulated in the lease is reflected as deferred rent receivable.\nCash and Cash Equivalents ------------------------- The Partnership considers all highly liquid debt instruments purchased with a maturity of 3 months or less to be cash equivalents.\nIncome Taxes ------------ Partnerships, as such, are not subject to income taxes. The partners are required to report their respective shares of partnership income or loss on their respective income tax returns (see Note 6).\nM.O.R. XVIII ASSOCIATES LIMITED PARTNERSHIP -------------------------------------------\nNOTES TO FINANCIAL STATEMENTS - CONTINUED -----------------------------------------\nDECEMBER 31, 1995 -----------------\nNote 2 - DEBT SERVICE\nPermanent Financing ------------------- On March 28, 1984, the Partnership obtained permanent financing on the leasehold interest from New England Life Pension Properties in the amount of $4,000,000. Pertinent terms of the mortgage are as follows:\n*The mortgage principal of $4,000,000 was due on March 28, 1994 (see Note 7).\nLand Mortgage and Related Debt Reserve Fund ------------------------------------------- The Partnership obtained a land loan of $1,400,000 from the First National Bank of Maryland in December 1983. The Partnership established a debt service reserve account as collateral. The balance of this account at December 31, 1995, was $106,553. On August 1, 1994, the loan, which had an outstanding balance of $1,075,140, was assumed by MRU Limited Partnership, a limited partner, and MRU's capital account was increased accordingly. The undeveloped land remains as collateral for the loan.\nNote 3 - RELATED PARTY TRANSACTIONS\nManagement Fees --------------- The Partnership has entered into an agreement with Manekin Corporation, an affiliated entity, to act as management agent for the property. The management agreement provides for management fees equal to 1% of rent and tenant expense billings collected. The management fee increased to 3% in 1995. Management fees totaled $19,232, $5,266 and $4,316 in 1995, 1994 and 1993, respectively.\nPayable, Affiliates ------------------- The Partnership participates in a central disbursing cash account with various entities affiliated with the Partnership. As of December 31, 1995 and 1994, funds used by the Partnership in excess of the Partnership's cash balance amounted to $360,261 and $379,608, respectively, and is reflected as payable, affiliates. The funds bear interest at the applicable federal rate.\nReceivable, Partner ------------------- As of December 31, 1995 and 1994, the Partnership had a $150,000 loan receivable from MRU Limited Partnership, a limited partner. The loan is noninterest bearing and is due upon demand.\nM.O.R. XVIII ASSOCIATES LIMITED PARTNERSHIP -------------------------------------------\nNOTES TO FINANCIAL STATEMENTS - CONTINUED -----------------------------------------\nDECEMBER 31, 1995 -----------------\nNote 3 - Receivable, Affiliates ---------------------- (Cont.) As of December 31, 1995 and 1994, the Partnership had amounts due from various affiliated entities totaling $40,512.\nNote 4 - LEASE\nCrop Genetics International Corporation entered into a lease agreement with the Partnership in September 1992 and moved into the space on December 1, 1992. Real property taxes, insurance and most operating expenses are paid directly by the tenant. The lease is for a twelve- year, three-month term and provided for six months of free rent. The average annual rent is $653,076.\nThe following is a schedule of future minimum lease payments to be received:\nNote 5 - LAND SALE AND LEASEBACK\nOn March 28, 1984, the Partnership entered into a sale-leaseback agreement with New England Life Pension Properties (a real estate limited partnership). Pursuant to this agreement, the Partnership sold 11 acres of land for $1,100,000 in exchange for a 60-year net leasehold interest in the land. The annual rent is $126,500 plus 50% of all increases in gross revenues in excess of $597,000. For this purpose, gross revenues do not include expense reimbursements paid by the tenant. Additional ground rent of $28,038 was incurred for 1995. No additional ground rent was incurred in 1994 and 1993.\nNote 6 - TAX ACCOUNTING\nThe taxable loss of the Partnership differs from financial reporting as follows:\nM.O.R. XVIII ASSOCIATES LIMITED PARTNERSHIP -------------------------------------------\nNOTES TO FINANCIAL STATEMENTS - CONTINUED -----------------------------------------\nDECEMBER 31, 1995 -----------------\nNote 7 - CONTINGENCY\nThe Partnership has not secured new financing or an extension of the mortgage that matured on March 28, 1994. They have continued making monthly interest payments on the mortgage and are pursuing new financing. The Partnership's continuation as a going concern is dependent upon their ability to obtain debt or equity financing.\nTo the Partners M.O.R. XVIII Associates Limited Partnership Columbia, Maryland\nACCOUNTANT'S REPORT ON SUPPLEMENTARY INFORMATION ------------------------------------------------\nThe accompanying supplementary information contained on page 13 is presented for purposes of additional analysis. Such information has not been subjected to the same inquiries and analytical procedures applied in the review of the basic financial statements, but has been compiled from information that is the representation of the management of M.O.R. XVIII Associates Limited Partnership, without audit or review. Accordingly, we do not express an opinion or any other form of assurance on such supplementary information.\n\/s\/ Wolpoff & Company, LLP WOLPOFF & COMPANY, LLP\nBaltimore, Maryland February 15, 1996\nM.O.R. XVIII ASSOCIATES LIMITED PARTNERSHIP -------------------------------------------\nSCHEDULE OF CHANGES IN PARTNERS' CAPITAL - INCOME TAX BASIS -----------------------------------------------------------\nYEAR ENDED DECEMBER 31, 1995 ----------------------------\n_________\nSee Accountant's Report on Supplementary Information.\nSIGNATURES ----------\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nNEW ENGLAND LIFE PENSION PROPERTIES; A REAL ESTATE LIMITED PARTNERSHIP\nDate: March 15 , 1996 By: \/s\/ Joseph W. O'Connor ------ ---------------------- Joseph W. O'Connor President of the 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.\nEXHIBIT INDEX -------------\n_________________________________________________ * Previously filed and incorporated herein by reference.\nEXHIBIT INDEX -------------\n____________________________________________________ * Previously filed and incorporated herein by reference.\nEXHIBIT INDEX -------------\n________________________________________________ * Previously filed and incorporated herein by reference.\nEXHIBIT INDEX -------------\nEXHIBIT INDEX -------------\n__________________________________________________ * Previously filed and incorporated herein by reference.","section_15":""}
{"filename":"70530_1995.txt","cik":"70530","year":"1995","section_1":"ITEM 1. BUSINESS\nGeneral National Semiconductor Corporation, including its subsidiaries, (\"National\" or the \"Company\") designs, develops, manufactures and markets a broad line of analog intensive, mixed signal and other integrated circuits for applications in the communications, personal systems and industrial market place. National was incorporated under the laws of the state of Delaware in 1959.\nDuring fiscal years 1995 and 1994, the Company substantially completed its manufacturing consolidation and reduction in cost structure in accordance with the restructuring plan announced in fiscal 1992. In the past two years, these actions included the closure of a wafer fabrication module in its Salt Lake City, Utah facility, closure of a wafer fabrication line in Santa Clara, California, consolidation of its Dynacraft, Inc. (\"DCI\") business which resulted in the elimination of a manufacturing facility in Milpitas, California and other reductions in personnel and related infrastructure at its Santa Clara facility. The Company has initiated significant recapitalization of facilities, machinery and equipment over the past three years. Capital investments over the past three years, inclusive of fiscal year 1995, total $984.6 million. These investments, in conjunction with sizable research and development investments, are required for the introduction of leading edge products into the Company's chosen markets.\nDuring fiscal 1995, the Company acquired Comlinear, Inc., a producer of analog products based in Fort Collins, Colorado. While the results of the acquisition are immaterial to the Company's overall financial position and results of operations, the acquisition adds to the Company's analog products portfolio and brings new design core competencies into the Company. Also during fiscal 1995, the Company entered into a joint venture with a partner in Shanghai, Peoples' Republic of China (\"PRC\"). The joint venture, which is majority owned by National, will produce integrated circuit boards using various National products for consumption by telecommunications and other enterprises within the PRC. The joint venture is not material to the Company's overall financial position and results of operations. The Company operates in one industry segment. The information with respect to sales and identifiable assets for National's geographic segments appearing on page 44-45 of the Company's 1995 Annual Report to Shareholders under the caption \"Industry and Geographic Segment Information\" is incorporated herein by reference.\nProducts Semiconductors are integrated circuits (in which a number of transistors and other elements are combined to form a more complicated circuit) or discrete devices (such as individual transistors). In an integrated circuit, various elements are fabricated in a small area or \"chip\" of silicon, which is then encapsulated in plastic, ceramic or other advanced forms of packaging and connected to a circuit board or substrate. National manufactures a broad variety of analog intensive, mixed signal and digital products. National's products are used in numerous commercial applications, including personal systems, telecommunications and communications products, data processing, automotive, local and wide area networking and other industrial applications as well as some consumer applications.\nThe Company is a leading supplier of analog and mixed signal products, serving both broad based markets such as the industrial and consumer market, and more narrowly defined markets such as Ethernet Local Area Networks (\"LAN\") and automotive. While no precise industry standard for analog and mixed signal exists, the Company considers products which process analog information, converts analog to digital or converts digital to analog as analog and mixed signal. Analog and mixed signal products include amplifiers and regulators, power monitors and line drivers, products optimized for audio, video, automotive or display applications, data acquisition and mass storage products. Other Company products with significant digital to analog or analog to digital capacity include Local Area Network, wireless networking and wireless communications, and personal systems and personal communications products such as its office automation and Super I\/O offerings. Analog and mixed signal business units accounted for 56% of Company revenue in 1995 and their revenues have been increasing over the past few years as a percentage of total Company revenue. The Company also sells bipolar and complimentary metal oxide silicon (\"CMOS\") logic and memory products. These products are largely older, more mature offerings serving broad markets in data processing, switching equipment and personal computing. The Company's bipolar and CMOS products include many of the mature logic families such as Advanced Schottky (\"AS\") and Advanced Low Power Schottky (\"ALS\"), High Performance CMOS (\"HCMOS\") as well as lower density Electronically Erasable Programmable Read Only Memory (\"EEPROM\") and Erasable Read Only Memory (\"EPROM\") products. The Company is limiting its investment in mature products to opportunities which complement its analog and mixed signal product focus. Bipolar and CMOS products accounted for 22% of 1995 revenues, down from the previous year and declining as a percentage of total Company revenue over the past several years. The Company's other product offerings include discretes, its 100% owned DCI plating and stamping operation, and various other products such as low density microcontrollers and customized integrated circuits. These products accounted for 22% of sales in 1995 and revenues have been essentially flat as a percentage of total revenue for several years. Corporate Structure and Organization. For the last three fiscal years, the Company's operating divisions were divided into two groups: the Standards Products Group (\"SPG\") and the Communications and Computing Group (\"CCG\"). SPG served primarily horizontal markets and CCG served primarily vertical markets. At the start of fiscal 1996, the Company was further decentralized by eliminating the group structure, leaving seven main operating divisions, described as follows: Analog and Mixed Signal Divisions. National continues to be a leader in analog products and technology, which has been one of the Company's core competencies since its inception. Analog devices control continuously variable functions (such as light, color, sound, and power) and are used in automotive, telecommunications, audio\/video and many industrial applications. The Company's analog products include high performance operational amplifiers, power management circuits, data acquisition circuits and voltage regulators. National provides a variety of analog products including standard products, application specific products and full custom products, as well as advanced mixed analog digital solutions. The Company's mixed signal products include circuits for video monitors and consumer audio products, real time clocks, automotive, custom linear ASIC (\"CLASIC\"), and peripheral drivers. The Company's discrete products are comprised primarily of transistors and diodes which are used as control and actuating devices in a broad range of electronic systems. Data Management Division. This Division's products incorporate bipolar, CMOS and BiCMOS technologies for high-performance applications\nsuch as switching and data manipulation. These applications are used in a variety of communications applications and computationally intensive applications such as workstations and computers, where the Company's FACT, FAST, BCT and 100K ECL product families are industry standards. Embedded Technologies Division. The Company's Embedded Technology Division consists of 4-, 8-, 16-, and 32-bit microcontrollers and memory products in the form of electronically programmable read only memories (\"EPROM\") and electronically erasable read only memories (\"EEPROM\"). The division addresses markets which combine basic computational or logic algorithms with specific memory storage on chips. National's higher end, more complex microcontrollers have been optimized for laser printers, high speed facsimile machines, scanners, and other imaging applications. Memory configurations of varying densities are also sold into markets for temporary or permanent data storage such as personal computers and workstations. Local Area Networks Division. The worldwide market for Ethernet LAN products has experienced significant growth in the last several years. LANs enable individual computer users within close proximity to share data as a work group. National is one of the world's leading suppliers of LAN Ethernet controller chip sets, which are currently the dominant protocol for LANs. National's LAN family includes a number of sophisticated control functions for networking over standard twisted- pair telephone wiring such as the Systems Oriented Network Interface Controller (\"SONIC-T\"), the AT\/LANTIC single chip network controller for personal computers, and the Repeater Interface Controller (\"RIC\") for use with hubs. Through an alliance with Novell, Inc., the Company also markets its own line of Ethernet adapter cards under its Info Mover trademark. The LAN Division is also developing products in wireless networking which operate independent of twisted-pair or coaxial cabling. Wide Area Networks Division. The Wide Area Networks (\"WAN\") Division offers products which allow customers to transmit large amounts of data at high speed from one location to another anywhere in the world. The WAN Division also includes wireless communication products and high performance Application Specific Integrated Circuit (\"ASIC\") products. The Company currently supplies numerous solutions that enable existing telecommunications equipment as well as next generation SONET\/ATM transmission equipment. Personal Systems Division. The Personal Systems Division develops products for the personal computer and workstation market. The Company does not attempt to compete with the host microprocessor, but instead designs and develops peripheral products which work in tandem with the host microprocessor in either the personal computer or workstation. For example, National offers a family of input\/output devices which consolidate many dependent functions on the motherboard. The Division also markets mass storage products found in high performance disk drives such as read write amplifiers, pulse detectors, data synchronizers, encoder\/decoder circuits and a family of motor speed and head positioning control devices. In addition to the seven product line divisions, National's wholly owned subsidiary, DCI, produces semiconductor packaging materials such as low and high pincount leadframes, advanced packaging materials and tools for both internal consumption and for sale to other semiconductor manufacturers throughout the world. Aside from the operating divisions, the Company's corporate structure also includes the International Business Group (\"IBG\") and the Corporate Technology Group (\"CTG\"), both providing corporate functions in support of the Company's global customers and technology strategies. The IBG is organized around the four major regions of the world in which the Company operates: the Americas, Europe, Japan and Asia and is comprised of the Company's worldwide sales and marketing organization.\nCTG is the central research arm of the Company, providing pure research, process development and initial product prototyping necessary for many of the Company's core production processes and leading edge products. The CTG also leads in the selection and implementation of integrated Computer Aided Design (\"CAD\") tools which design, layout, simulate and test the logical and physical representation of new products before they are actually produced.\nMarketing and Sales The Company markets its products throughout the world to original equipment manufacturers (\"OEMs\") and distributors. Major OEMs include IBM, Hewlett Packard, Compaq, Ford, and General Motors as well as NEC, Fujitsu, Goldstar, Siemens, L.M. Ericsson and others. In addition to its direct sales force, National uses distributors in all four of its business regions and has recently initiated a manufacturers representation (\"rep\") program in the United States. The Company has established cross regional marketing groups responsible for customers operating in multiple regions. In addition, the Company's focus on analog intensive and mixed signal markets has led to the introduction of strategic market segment teams who identify emerging trends and opportunities in these two broad categories, as well as others. Customer support is handled by comprehensive, state of the art central facilities in the United States and Europe. These Customer Support Centers (\"CSC\") provide rapid turnaround on product pricing and availability, technical support for customers questions, order entry and scheduling. A third CSC is planned for Singapore in early fiscal 1996 to support the Asia region. National augments its sales effort with application engineers based in the field. These engineers are specialists in National's complex product portfolio and work with customers to design National parts for their systems. These engineers also help identify emerging markets for new products and are supported by Company design centers in the field or at manufacturing sites. In line with industry practices, National generally credits distributors for the effect of price reductions on their inventory of National products, and under specific conditions repurchases products that are unsold, slow moving or have been discontinued by the Company.\nCustomers National is not dependent upon any single customer, the loss of which would have a material effect on the Company. In addition, no one customer or distributor accounted for 10 percent or more of total net sales in fiscal 1995.\nBacklog Semiconductor backlog quantities and shipment schedules under outstanding purchase orders are frequently revised to reflect changes in customer needs. Binding agreements calling for the sale of specific quantities at specific prices which are contractually subject to price or quantity revisions are, as a matter of industry practice, rarely formally enforced. For these reasons, National does not believe that the amount of backlog at any particular date is meaningful.\nSeasonality Generally, National is affected by the seasonal trends of the semiconductor and related industries. As a result of these trends, the Company typically experiences lower revenue in the third fiscal quarter, primarily due to customer holiday demand adjustments. Revenue usually has a seasonal peak in the Company's fourth quarter.\nManufacturing The design of semiconductor products is based upon customer requirements and general market trends and needs. These designs are compiled and digitized by state of the art design equipment and then transferred to silicon wafers in a series of complex precision processes which include oxidation, lithography, chemical etching, diffusion, deposition, implantation and metalization. Production of integrated circuits continues with wafer sort, where the wafers are tested and separated into individual circuit devices; assembly, where tiny wires are used to connect the electronic circuits on the device to the stronger metal leads or \"prongs\" of the package in which the device is encapsulated for protection; and final test, where the devices are subjected to a series of vigorous tests using computerized circuit testers and for certain applications, environmental testers such as burn in ovens, centrifuges, temperature cycle testers, moisture resistance testers, salt atmosphere testers and thermal shock testers. The Company's product design and development activities are conducted predominantly in the United States. Wafer fabrication is concentrated in four facilities in the United States and in a facility in Scotland. Nearly all product assembly and final test operations are performed in facilities in Southeast Asia. For capacity utilization and other economic reasons, National employs subcontractors to perform certain manufacturing functions in the United States, Southeast Asia and Japan. National also utilizes manufacturing capacity of a minority owned joint venture which operates the Company's former facility in Israel, and the Company recently established a small, majority owned joint venture in Shanghai, PRC, for the manufacture of boards using National produced integrated circuits. National's wafer manufacturing processes span Bipolar, Metal Oxide Silicon (\"MOS\"), Complementary Metal Oxide Silicon (\"CMOS\") and Bipolar Complementary Metal Oxide Silicon (\"BiCMOS\") technologies. As products decrease in size and increase in functionality, National's wafer fabrication facilities are now required in many cases to be able to manufacture integrated circuits with sub-micron circuit pattern widths. Precision manufacturing in wafer fabrication has carried over to assembly and test where advanced packaging technology and comprehensive test operations are required for more and more powerful integrated circuits. Wafer fabrication processes have been adapted for mixed signal applications. National also has optimized its CMOS process for nonvolatile memories, both ultraviolet and electrically erasable. There are a number of Bipolar processes supporting the Company's standard products. Of particular importance are several groups of processes that are optimal for manufacturing the Company's analog products.\nRaw Materials National's manufacturing processes make use of certain key raw materials critical to its products. These include silicon wafers, certain chemicals and gases, ceramic and plastic packaging materials and various precious metals. The Company also is increasingly relying on subcontractors to supply finished or semi-finished products which the Company markets through its sales channels. Both raw materials and semi-finished or finished products are obtained from various sources, although the number of sources for any particular material or product is relatively limited. Although the Company feels its current supply of essential materials is adequate, shortages from time to time have occurred and could occur again. Significant increases in demand, rapid product mix changes or natural disaster all could affect the Company's ability to procure materials or goods.\nResearch and Development National's research and development (\"R&D\") consists of pure research in metallurgical, electro-mechanical and solid state sciences, manufacturing process development and product design. At the corporate level, CTG performs pure research functions. Much of the process development is also defined and developed by CTG. The Company envisions that its process capability will be prototyped in corporate R&D facilities but more and more of the actual process development and product design will be done by the operating divisions. R&D expenses were $283.1 million in 1995 and $257.8 million in 1994, with both years experiencing increases in R&D in the Company's core Analog and Mixed Signal products.\nPatents National owns numerous United States and non-U.S. patents and has many patent applications pending. It considers the development of patents and the maintenance of an active patent program advantageous to the conduct of its business but believes that continued success will depend more on engineering, production, marketing, financial and managerial skills than on its patent program. The Company licenses certain of its patents to other manufacturers and participates in a number of cross licensing arrangements with other parties. In addition, the Company is currently involved in a program to further capitalize on its intellectual property assets through licensing of its intellectual property; the amount of income from the licensing program has varied in the past and the amount and timing of future income from this program cannot be forecast with certainty.\nEmployees At May 28, 1995, National employed approximately 22,400 people of whom approximately 7,900 were employed in the United States, 2,500 in Europe, 11,500 in Southeast Asia and 500 in other areas. The Company believes that its future success depends fundamentally on its ability to recruit and retain skilled technical and professional personnel. National's employees in the United States are not covered by collective bargaining agreements. The Company considers its employee relations worldwide to be favorable.\nCompetition and Risks\nThe Semiconductor Industry The semiconductor industry is characterized by rapid technological change and frequent introduction of new technology leading to more complex and powerful products. The result is a cyclical economic environment generally characterized by short product life cycles, rapid selling price erosion and high sensitivity to the overall business cycle. In addition, substantial capital and R&D investment is required for development and manufacture of products and processes. The Company may experience periodic fluctuations in its operating results because of industry wide conditions. National competes with a number of major companies in the high-volume segment of the industry. These include several companies whose semiconductor business may be only part of their overall operations, such as Motorola, Inc., Philips Electronics, NV, and Texas Instruments Incorporated. National also competes with a large number of companies that target particular markets such as Linear Technology Corporation, Analog Devices, Inc., Advanced Micro Devices, Inc., SGS-Thompson Microelectronics SA and Cirrus Logic, Inc. Competition is based on design and quality of the products, product\nperformance, price and service, with the relative importance of such factors varying among products and markets.\nInternational Operations National conducts a substantial portion of its operations outside the United States and its business is subject to risks associated with many factors beyond its control. These factors include fluctuations in foreign currency rates, instability of foreign economy or its emerging infrastructure to support demanding manufacturing requirements, government changes, and U.S. and foreign laws and policies affecting trade and investment. Although the Company has not experienced any materially adverse effects with respect to its foreign operations arising from such factors, the Company has been impacted in the past by one or more of these factors and could be impacted in the future by such factors. In addition, although the Company seeks to hedge its exposure to currency exchange rate fluctuations, the Company's competitive position relative to non-U.S. suppliers can be affected by the exchange rate of the U.S. dollar against other currencies, particularly the Japanese yen.\nEnvironmental Regulations National believes that compliance with federal, state and local laws or regulations which have been enacted or adopted to regulate the environment has not had, nor will have, a material effect upon the Company's capital expenditures, earnings, competitive or financial position. (Also see Item 3, Legal Proceedings.)\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nNational's principal administrative and research facilities are located in Santa Clara, California. Several other sites in the United States have major concentrations of wafer fabrication and research and development capability, including the Company's plants in Salt Lake City, Utah, South Portland, Maine, and Arlington, Texas. The Company also operates smaller facilities in Murrysville, Pennsylvania and Fort Collins, Colorado, among others. The Company conducts significant manufacturing offshore. One of National's largest wafer fabrication facility exists in Greenock, Scotland. Assembly and test functions are performed primarily in Southeast Asia. These facilities are located in Penang and Malacca, Malaysia, Cebu, the Philippines, and Singapore. A small manufacturing facility, majority owned by National, was established in January 1995, in Shanghai, Peoples' Republic of China. The regional headquarters for National's International Business Group are located in Santa Clara, California, Munich, Germany, Tokyo, Japan and Kowloon, Hong Kong. National maintains local sales offices in various locations and countries throughout its four business regions. In general, the Company owns its manufacturing facilities and leases most of its sales and administrative offices. During fiscal 1995, the Company repurchased its manufacturing facility in Arlington, Texas and its research and development facility in Santa Clara, California, which were part of sales and subsequent operating leaseback transactions entered into prior to 1990. The Company continues to increase its property and plant expenditures in addition to the aforementioned purchases. Wafer fabrication capacity utilization approached 90% for most of 1995 and the Company continues to invest substantial sums in modernization and expansion of its facilities. The Company feels its current plant, property and leased facilities are well maintained.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIn July 1983, the United States Internal Revenue Service (\"IRS\") issued an examination report for the fiscal years ended 1978 and 1979. The Company filed a protest with the appeals office of the IRS in September 1983. The IRS issued a Notice of Deficiency for these years in December 1988 seeking additional taxes of approximately $24 million (exclusive of interest). The issues giving rise to the proposed adjustments related primarily to intercompany product transfer prices and the application of Subpart F provisions of the United States Internal Revenue Code. The Company filed a petition with the United States Tax Court contesting the Notice of Deficiency in March 1989. The IRS' subsequent examination of the Company's United States tax returns for fiscal years 1980 through 1982 resulted in a Notice of Deficiency issued in January 1990 seeking additional taxes of approximately $52 million (exclusive of interest) for the fiscal years ended 1976, 1977, 1980, 1981 and 1982. The issues giving rise to the proposed adjustments for the earlier years related primarily to reductions in the available net operating loss carrybacks and, for the later years, to intercompany product transfer prices, full absorption inventory costing, deductibility of certain reserves and spare parts depreciation. The Company filed a petition with the United States Tax Court contesting this Notice of Deficiency in April 1990. By order dated August 8, 1991, the Tax Court granted the Company's and the IRS' motion to consolidate the two cases for trial. Prior to trial, which was held during February 1993, the Company and the IRS reached a settlement on all disputed issues except for the issue of intercompany product transfer prices; this settlement reduced the total of the additional taxes being sought\nto approximately $52 million (exclusive of interest). An opinion was issued by the Tax Court on May 2, 1994. The opinion found that adjustments to income of $40.6 million were due, which the Company estimates, after giving effect to loss and credit carrybacks, will result in a tax deficiency of approximately $5 million plus associated interest of between $35 million and $45 million. The IRS filed a motion for reconsideration of the opinion on June 3, 1994, seeking an additional $31 million in income adjustments. The motion was denied by the Court on June 10, 1994. The Company and the IRS have reached agreement on the allocation of the additional income, and this agreement was then presented to the Court. A final decision implementing the opinion was entered by the Tax Court on June 6, 1995 and is subject to appeal within 90 days by either the Company or the IRS. It is not known if an appeal will follow at this time. With respect to the IRS' examination of tax returns for other fiscal years, the Company and the IRS settled in January 1994 all issues for fiscal years 1983 through 1985, including issues relating to intercompany product transfer pricing, without the payment of additional federal tax. This result is affected by certain net operating loss carryovers and credits, which will not be determined until the Tax Court litigation is completed. In April 1995, the IRS issued a Notice of Deficiency for fiscal years 1986 through 1989 seeking additional taxes of approximately $11 million (exclusive of interest). The issues giving rise to this set of proposed adjustments relate primarily to the Company's former Israeli operation and the purchase price paid for Fairchild Semiconductor Corporation. The Company intends to file a protest with the appeals office of the IRS contesting the Notice of Deficiency. The Company expects the IRS to begin examination of the Company's tax returns for fiscal years 1990 through 1993 shortly. The Company believes that adequate tax payments have been made or accrued for all years and that the Tax Court opinion will not have a material adverse effect on the Company's financial position. On April 22, 1988, the District Director of the United States Customs Service, San Francisco, issued a Notice of Proposed Action and a Pre-penalty Notice to the Company alleging underpayment of duties of approximately $19.5 million on merchandise imported from the Company's foreign subsidiaries during the period from June 1, 1979 to March 1, 1985. The Company filed an administrative appeal in September 1988. On May 23, 1991, the District Director revised his action and issued a Notice of Penalty Claim and Demand for Restoration of Duties, reducing the alleged underpayment of duties for the same period to approximately $6.9 million; the alleged underpayment was subsequently reduced on April 22, 1994 to approximately $3.6 million. The revised alleged underpayment could be subject to penalties that may be computed as a multiple of the underpayment. The Company is continuing to contest the Penalty Notice in proceedings at the administrative agency level. The Company believes that resolution of this matter will not have a material impact on the Company's financial position. A sales tax examination conducted by the California State Board of Equalization for the tax years 1984 to 1988 resulted in a proposed assessment of approximately $12 million (exclusive of interest and penalty) in October 1991, which assessment has been subsequently reduced to $2.1 million. The Company is waiting for the State Board of Equalization to approve the assessment. The Company believes adequate provisions have been recorded and that its potential liability, if any, in excess of amounts already accrued will not have a material adverse effect upon its financial position. On December 2, 1992, Hughes Aircraft Company (\"Hughes\") filed an action in the U.S. District Court for the Eastern Division of the Northern District of Illinois alleging the Company had infringed U.S.\nPatents Nos. 3,472,712; 3,507,709; and 3,615,934 and seeking unspecified amounts of damages and costs. The Company was served with the suit on January 7, 1993. The Company countersued Hughes' parent company, General Motors (\"GM\") and Hughes in the same action alleging infringement of U.S. Patents Nos. 3,901,735; 4,325,984; and 4,599,634. The case was transferred to the U.S. District Court for the Northern District of California. The Company also filed an action in California State Court seeking declaratory relief and alleging breach of contract by Hughes and GM in connection with a prior patent cross license agreement entered into between GM and Fairchild Camera and Instruments Corporation (subsequently renamed Fairchild Semiconductor Corporation and purchased by the Company in October 1987). In September 1994, the parties agreed to resolve the dispute in its entirety in a binding minitrial procedure structured to handle the primary disputed issue; as part of the agreement, the Company dismissed with prejudice the related California State Court action. In December 1994, the minitrial was conducted before a judge selected by the parties on the single issue of whether claim 2 of the U.S. Patent No. 3,472,712 owned by Hughes was infringed by one of the Company's semiconductor fabrication processes. For purposes of the minitrial, the patent was presumed valid and the parties agreed in advance to the amounts of damages that would be paid by the Company which amount was not disclosed to the judge until after the judge had issued his findings. The judge found for Hughes on the single issue presented in the minitrial and pursuant to prior agreement of the parties, the Company paid to Hughes the sum of $10 million and the Federal Court action was dismissed with prejudice. The dismissal constituted a full settlement and release of all claims for past infringement of the patents in issue. In addition, the Company granted Hughes and GM licenses under its patents at issue; no such license was granted by Hughes back to the Company because the Hughes patents at issue had expired. By letter dated January 6, 1994, the Company was notified by the California Department of Toxic Substances Control (\"DTSC\") of a Report of Violation (\"ROV\") listing 39 violations arising out of inspections of certain facilities and operations of the Company and its wholly owned subsidiary, Dynacraft, Inc. (\"DCI\") located in Santa Clara, California and the DTSC's further review of information obtained during the inspections. The deficiencies cited can be described as violations of various provisions of the California Health and Safety Code and the California Code of Regulations relating to the record keeping for and the handling, treatment, storage, and disposal of hazardous products and wastes. The Company worked with DTSC to correct the deficiencies noted in the ROV and signed a Stipulation and Order with the DTSC on June 16, 1995 whereby the Company agreed to pay a fine of $490,000. The Company believes adequate provisions have been recorded and that its potential liability, if any, in excess of amounts already accrued will not have a material adverse effect upon its financial position. On June 18, 1991, the U.S. Environmental Protection Agency (\"EPA\") issued a Finding of Violation and Order to the Company and DCI relating to the alleged failure of the Company and DCI to comply with the federal categorical pretreatment standards arising from the city of San Jose, California's pretreatment program. The Order requires the Company and DCI to comply with all Federal categorical pretreatment standards and to take further actions to maintain permanent compliance. Since 1992, the Company and DCI have worked with the U.S. Department of Justice (\"DOJ\") and the EPA to settle this matter. A Consent Decree was entered by the U.S. District Court, Northern District of California on March 30, 1995. Under the terms of the Consent Decree, National and DCI agreed to pay a civil penalty in the amount of $50,000 and perform three Supplemental Environmental Projects (\"SEPs\"), the costs of which are estimated at\n$445,000. The $50,000 civil penalty has been paid. In the event the Company and DCI do not perform any or all of the SEPs within two years of March 30, 1995, stipulated penalties in the amounts of $62,517, $55,303, and\/or $96,180 (the respective amounts for each of the SEPs) must be paid to the EPA. The Company has been named to the National Priorities List (\"Superfund\") for its Santa Clara, California site and has completed a Remedial Investigation\/Feasibility Study with the Regional Water Quality Control Board (\"RWQCB\"), acting as agent for the EPA. The Company has agreed in principle with the RWQCB to a site remediation plan. In addition to the Santa Clara site, the Company has been designated as a potentially responsible party by federal and state agencies with respect to certain waste sites with which the Company may have had direct or indirect involvement. Such designations are made regardless of the extent of the Company's involvement. These claims are in various stages of administrative or judicial proceedings and include demands for recovery of past governmental costs and for future investigations and remedial actions. In many cases, the dollar amounts of the claims have not been specified and have been asserted against a number of other entities for the same cost recovery or other relief as was asserted against the Company. The Company accrues costs associated with such matters when they become probable and reasonably estimable. The amount of all environmental charges to earnings, including charges relating to the Santa Clara site remediation, which did not include potential reimbursements from insurance coverage, have not been material during the last three fiscal years. The Company believes that the potential liability, if any, in excess of amounts already accrued will not have a material effect on the Company's financial position.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS\nNo matters were submitted to a vote of security holders, through the solicitation of proxies or otherwise, during the fourth quarter of the fiscal year covered by this report.\nEXECUTIVE OFFICERS OF THE REGISTRANT *\nName Current Title Age * - ---- ------------- -----\nGilbert F. Amelio (1) Chairman of the Board, President and Chief Executive Officer 52\nRichard M. Beyer (2) Executive Vice President and Chief Operating Officer 46\nPatrick J. Brockett (3) President, International Business Group 47\nCharles P. Carinalli (4)Senior Vice President and 47 Chief Technical Officer\nJohn M. Clark III (5) Senior Vice President, General Counsel 45 and Secretary\nDonald Macleod (6) Executive Vice President, Finance and 46 Chief Financial Officer\nKirk P. Pond (7) Executive Vice President and 50 Chief Operating Officer\nGeorge M. Scalise (8) Executive Vice President and 61 Chief Administrative Officer\n* as of July 1, 1995\nBusiness Experience During Last Five Years - ------------------------------------------\n(1) Mr. Amelio has been President, Chief Executive Officer, and a Director of the Company since joining the Company in February 1991. He was named Chairman of the Board in July 1995. Prior to joining the Company, Mr. Amelio was President of Rockwell Communications Systems and had previously served as President of Rockwell International Corporation's Semiconductor Products Division.\n(2) Mr. Beyer joined the Company in February 1993 and served as President of the Communications and Computing Group until being named Executive Vice President and Chief Operating Officer in June 1995. Prior to joining the Company, Mr. Beyer was Vice President and General Manager of the Switching Systems Division of Rockwell International Corporation.\n(3) Mr. Brockett joined the Company in September 1979. Prior to becoming President, International Business Group in February 1993, he had held positions as Corporate Vice President, International Business Group; Vice President, North America Business Center; Vice President and Managing Director, European Operations; and Vice President and Director of European Sales.\n(4) Mr. Carinalli joined the Company in June 1970. Prior to becoming Senior Vice President and Chief Technical Officer in February 1993, he was Executive Vice President, Communications and Computing Group and Chief Technical Officer. Prior to that, he had held positions\nas Vice President, Integrated Systems Group; Group Director, Integrated Systems Group; and Director of Technology, Advanced Digital Products.\n(5) Mr. Clark joined the Company in May 1978. Prior to becoming Senior Vice President, General Counsel and Secretary in April 1992, he had held positions as Associate General Counsel, Vice President and Assistant Secretary.\n(6) Mr. Macleod joined the Company in February 1978. Prior to becoming Executive Vice President, Finance and Chief Financial Officer in June 1995, he had held positions as Senior Vice President, Finance and Chief Financial Officer; Vice President, Finance and Chief Financial Officer; Vice President, Financial Projects; Vice President and General Manager, Volume Products - Europe; and Director of Finance and Management Services - Europe.\n(7) Mr. Pond joined the Company as an employee of Fairchild Semiconductor Corporation (\"Fairchild\") when Fairchild was acquired by the Company in October 1987. Prior to becoming Executive Vice President and Chief Operating Officer in June 1994, he held positions as Co- President, Standard Products Group and Vice President, Digital Logic Division.\n(8) Mr. Scalise joined the Company in August 1991. Prior to becoming Executive Vice President and Chief Administrative Officer in June 1995, he held the positions as Senior Vice President and Chief Administrative Officer and Senior Vice President, Planning and Development. Prior to joining the Company, Mr. Scalise served as Senior Vice President of Advanced Micro Devices, Inc. until July 1987 and as President and Chief Executive Officer of Maxtor Corporation from July 1987 to January 1991. From January 1991 until August 1991, Mr. Scalise was a private investor, and Chairman and Chief Executive Officer of Advantage Production Technology Corporation.\nExecutive officers serve at the pleasure of the Company's Board of Directors. There is no family relationship among any of the Company's directors and executive officers.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nSee information appearing on pages 37-38, 40-41, 46, and 51 under the captions \"Debt Financing\", \"Shareholders' Equity\", \"Financial Information by Quarter (Unaudited)\" and \"Common Stock Data\" of the registrant's 1995 Annual Report to Shareholders which is incorporated herein by reference. Market price range data are based on the New York Stock Exchange Composite Tape. Market price per share at the close of business on July 14, 1995 was $30.375. At July 14, 1995, the number of record holders of the Company's common stock was 12,986.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nSee \"Five-Year Selected Financial Data\" on page 23 of the registrant's 1995 Annual Report to Shareholders which is incorporated herein by reference.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION\nSee \"Management's Discussion and Analysis of Results of Operations and Financial Condition\" on pages 24 through 27 of the registrant's 1995 Annual Report to Shareholders which is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe financial statements described in Item 14(a)1 of Part IV of this report are incorporated herein by reference. The \"Financial Information by Quarter (Unaudited),\" appearing on page 46 of the registrant's 1995 Annual Report to Shareholders, 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 with respect to directors, appearing under the caption \"Election of Directors\" including subcaptions thereof, in the registrant's Proxy Statement for the 1995 annual meeting of shareholders to be held on or about September 29, 1995 and which will be filed in definitive form pursuant to Regulation 14a on or about August 20, 1995 (hereinafter \"1995 Proxy Statement\"), is incorporated herein by reference. Information concerning executive officers is set forth in Part I hereof under the caption \"Executive Officers of the Registrant.\"\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information appearing under the caption \"Director Compensation\", \"Compensation Committee Interlocks and Insider Participation\", and \"Executive Compensation\" (including all related sub captions thereof) 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 concerning the only known ownership of more than 5 percent of the Company's outstanding Common Stock \"Outstanding Capital Stock, Quorum and Voting\" in the 1995 Proxy Statement, is incorporated herein by reference. The information concerning the ownership of the Company's equity securities by directors, certain executive officers and directors and officers as a group, appearing under the caption \"Security Ownership of Management\" in the 1995 Proxy Statement is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information appearing under the caption \"Compensation Committee Interlocks and Insider Participation\" and \"Certain Transactions and Relations\" 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. Financial Statements - --------------------------- The following items appearing in the 1995 Annual Report to Shareholders are incorporated by reference into Part II of this report:\nPages in 1995 Annual Report to Shareholders ----------------------\nConsolidated Balance Sheets at May 28, 1995 28 and May 29, 1994.\nConsolidated Statements of Operations for each 29 of the years in the three-year period ended May 28, 1995.\nConsolidated Statements of Shareholders' Equity 30 for each of the years in the three-year period ended May 28, 1995.\nConsolidated Statements of Cash Flows for each 31 of the years in the three-year period ended May 28, 1995.\nNotes to Consolidated Financial Statements. 32-46\nIndependent Auditors' Report. 47\nPages in (a)2. Financial Statement Schedule this document - ------------------------------------ -------------\nFor the three years ended May 28, 1995:\nIndependent Auditors' Report 17 Schedule II -- Valuation and Qualifying Accounts 18\nAll other schedules are omitted since the required information is inapplicable or the information is presented in the consolidated financial statements or notes thereto. Separate financial statements of the registrant are omitted because the registrant is primarily an operating company and all subsidiaries included in the consolidated financial statements being filed, in the aggregate, do not have minority equity interest or indebtedness to any person other than the registrant in an amount which exceeds five percent of the total assets as shown by the most recent year end consolidated balance sheet filed herein.\n(a)3. Exhibits - --------------- The exhibits listed in the accompanying Index to Exhibits on pages 20 and 21 of this report are filed or incorporated by reference as part of this report.\n(b) Reports on Form 8-K - ------------------------ No reports on Form 8-K were filed during the fiscal quarter ended May 28, 1995.\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Shareholders National Semiconductor Corporation:\nUnder date of June 7, 1995, we reported on the consolidated balance sheets of National Semiconductor Corporation and subsidiaries as of May 28, 1995, and May 29, 1994, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the years in the three-year period ended May 28, 1995, as contained in the 1995 Annual Report to Shareholders. These consolidated financial statements and our report thereon are incorporated by reference in the May 28, 1995 annual report on Form 10-K of National Semiconductor Corporation. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related consolidated financial statement schedule as listed under item 14(a)2. The 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, the financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.\nKPMG PEAT MARWICK LLP\nSan Jose, California June 7, 1995\nNATIONAL SEMICONDUCTOR CORPORATION\nSCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS\nYears Ended May 30, 1993, May 29, 1994, and May 28,1995 (in millions)\nDeducted from receivables in the consolidated balance sheets\nDoubtful Returns and Description Accounts Allowances Total - ----------- -------- ----------- ----- Year ended May 30, 1993 - ----------------------- Balance at beginning of period $ 3.5 $ 35.7 $ 39.2 Additions charged against revenue - 222.9 222.9 Additions charged to costs and expenses 0.1 - 0.1 Deductions (0.1)(1) (229.1) (229.2) -------- -------- -------- Balance at end of period $ 3.5 $ 29.5 $ 33.0 ======== ======== ========\nYear ended May 29, 1994 - ----------------------- Balance at beginning of period $ 3.5 $ 29.5 $ 33.0 Additions charged against revenue - 193.2 193.2 Deductions (0.5)(1) (191.9) (192.4) ------- ------- -------- Balance at end of period $ 3.0 $ 30.8 $ 33.8 ======= ======= ========\nYear ended May 28, 1995 - ----------------------- Balance at beginning of period $ 3.0 $ 30.8 $ 33.8 Additions charged against revenue - 214.1 214.1 Deductions (0.6)(1) (213.6) (214.2) ------- --------- -------- Balance at end of period $ 2.4 $ 31.3 $ 33.7 ======== ========= ========\n________________________________________________\n(1) Doubtful accounts written off, less 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.\nNATIONAL SEMICONDUCTOR CORPORATION\nDate: July 27, 1995 By: \/S\/ GILBERT F. AMELIO ---------------------- Gilbert F. Amelio Chairman of the Board, President and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities stated and on the 27th day of July 1995.\nSignature Title\n\/S\/ GILBERT F. AMELIO Chairman of the Board, President Gilbert F. Amelio and Chief Executive Officer (Principal Executive Officer)\n\/S\/ DONALD MACLEOD* Executive Vice President, Finance Donald Macleod and Chief Financial Officer (Principal Financial Officer)\n\/S\/ ROBERT B. MAHONEY* Vice President and Controller Robert B. Mahoney (Principal Accounting Officer)\n\/S\/ GARY P. ARNOLD* Director Gary P. Arnold\n\/S\/ ROBERT BESHAR* Director Robert Beshar\n\/S\/ MODESTO A. MAIDIQUE* Director Modesto A. Maidique\nDirector Edward R. McCracken\n\/S\/ J. TRACY O'ROURKE* Director J. Tracy O'Rourke\n\/S\/ CHARLES E. SPORCK* Director Charles E. Sporck\n\/S\/ DONALD E. WEEDEN* Director Donald E. Weeden\n*By \/S\/ GILBERT F. AMELIO Gilbert F. Amelio, Attorney-in-fact\nCONSENT OF INDEPENDENT AUDITORS\nThe Board of Directors and Shareholders National Semiconductor Corporation:\nWe consent to incorporation by reference in the Registration Statements No. 33-48943, 33-48941, 33-54931, 33-55699, 33-55703, and 33- 55715 on Form S-8 of National Semiconductor Corporation and subsidiaries of our report dated June 7, 1995, relating to the consolidated balance sheets of National Semiconductor Corporation and subsidiaries as of May 28, 1995, and May 29, 1994, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the years in the three-year period ended May 28, 1995, which report appears on page 47 of the 1995 National Semiconductor Corporation Annual Report to Shareholders (\"National Annual Report\") and is incorporated by reference in the May 28, 1995 annual report on Form 10-K of National Semiconductor Corporation and our report dated June 7, 1995, on the related financial statement schedule which appears on page 21 of the May 28, 1995 annual report on Form 10-K. Our report which appears in the National Annual Report refers to a change in accounting for certain costs in inventory.\nKPMG PEAT MARWICK LLP\nSan Jose, California July 27, 1995\nINDEX TO EXHIBITS Item 14(a) (3) The following documents are filed as part of this report: 1. Financial Statements: reference is made to the Financial Statements described under Part IV, Item 14(a) (1). 2. Other Exhibits:\nDesignation Description of Exhibit - ----------- ---------------------- 3.1 Second Restated Certificate of Incorporation of the Company, as amended (incorporated by reference from the Exhibits to the Company's Registration Statement on Form S-3 Registration No. 33-52775, which became effective March 22, 1994); Certificate of Powers, Designations, Preferences and Rights designating the $32.50 Convertible Preferred Stock (incorporated by reference from the Exhibits to the Company's Registration Statement on Form S-3 Registration No. 33-52775, which became effective March 22, 1994). Certificate of Amendment of Certificate of Incorporation dated September 30, 1994.\n3.2 By-Laws of the Company\n4.1 Form of Common Stock Certificate (incorporated by reference from the Exhibits to the Company's Registration Statement on Form S-3 Registration No. 33-48935, which became effective October 5, 1992).\n4.2 Rights Agreement (incorporated by reference from the Exhibits to the Company's Registration Statement on Form 8-A filed August 10, 1988).\n4.3 Deposit Agreement and Form of Depositary Receipt (incorporated by reference from the Exhibits to the Company's Registration Statement on Form S-3 Registration No. 33-52775, which became effective March 22, 1994).\n10.1 Management Contract or Compensatory Plan or Arrangement: License Agreement with Wave Systems Corporation (incorporated by reference from the Exhibits to the Company's 10-Q filed March 18,1994).\n10.2 Management Contract or Compensatory Plan or Arrangement: Key Employee Incentive Plan (incorporated by reference from the Exhibits to the Company's 10-K filed July 28, 1994). 1995 Key Employee Incentive Plan Agreement (incorporated by reference from the Exhibits to the Company's 10-K filed July 28, 1994). 1995 Key Employee Incentive Plan Agreement as amended through January 12, 1995 (incorporated by reference from the Exhibits to the Company's 10-Q filed March 17, 1995.)\n10.3 Management Contract or Compensatory Plan or Arrangement: Executive Officer Incentive Plan (incorporated by reference from the Exhibits to the Company's definitive Proxy Statement for the Annual Meeting of Stockholders held September 30, 1994 filed on August 10, 1994). 1995 Executive Officer Incentive Plan Agreement (incorporated by reference from the Exhibits to the Company's 10-K filed July 28, 1994). 1996 Executive Officer Incentive Plan Agreement.\n10.4 Management Contract or Compensatory Plan or Arrangement: Stock Option Plan, as amended through January 19, 1995 (incorporated by reference from the Exhibits to the Company's 10-Q filed March 17, 1995).\n10.5 Management Contract or Compensatory Plan or Arrangement: Benefit Restoration Plan (incorporated by reference from the Exhibits to the Company's 10-Q filed December 14, 1994).\n10.6 Management Contract or Compensatory Plan or Arrangement: Promissory Note and Agreement with Peter J. Sprague (incorporated by reference from the Exhibits to the Company's Form 10-K filed August 22, 1991). Amendment Letter dated November 30, 1993 (incorporated by reference from the Exhibits to the Company's 10-K filed July 28, 1994). Agreement with Peter J. Sprague dated May 17, 1995. Non Qualified Stock Option Agreement with Peter J. Sprague dated May 18, 1995.\n10.7 Management Contract or Compensatory Plan or Arrangement: Airplane Use Letter Agreement with Gilbert F. Amelio doing business as Aero Ventures (incorporated by reference from the Exhibits to the Company's Form 10-K filed August 22, 1991). 1992 Extension of Airplane Use Letter Agreement with Gilbert F. Amelio doing business as Aero Ventures (incorporated by reference from the Exhibits to the Company's 10-K filed August 24, 1992). 1993 Extension of Airplane Use Letter Agreement with Gilbert F. Amelio doing business as Aero Ventures (incorporated by reference from the Exhibits to the Company's 10-K filed August 9, 1993). Airplane Use Agreement with Gilbert F. Amelio doing business as Aero Ventures (incorporated by reference from the Exhibits to the Company's 10-Q filed March 18, 1994). Amendment No. 1 to Airplane Use Agreement with Gilbert F. Amelio doing business as Aero Ventures (incorporated by reference from the Exhibits to the Company's 10-Q filed December 14, 1994).\n10.8 Management Contract or Compensatory Plan or Arrangement: Loan Agreement with Gilbert F. Amelio (incorporated by reference from the Exhibits to the Company's 10-K filed August 24, 1992).\n10.9 Management Contract or Compensatory Plan or Arrangement: Director Stock Plan (incorporated by reference from the Exhibits to the Company's Registration Statement on Form S-8 Registration No. 33-54931 which became effective August 5, 1994).\n10.10 Management Contract or Compensatory Plan or Arrangement: Performance Award Plan (incorporated by reference from the Exhibits to the Company's Registration Statement on form S-8 Registration No. 33- 55699 which became effective September 30,1994).\n10.11 Management Contract or Compensatory Plan or Arrangement: Consulting Agreement with Harry H. Wetzel (incorporated by reference from the Exhibits to the Company's 10-K filed July 28, 1994).\n10.12 Management Contract or Compensatory Plan or Arrangement: Preferred Life Insurance Program (incorporated by reference from the Exhibits to the Company's 10-K filed July 28, 1994).\n10.13 Management Contract or Compensatory Plan or Arrangement: Retired Officers and Directors Health Plan.\n11.0 Computation of Earnings (Loss) per share assuming full dilution.\n13.0 Portions of the Annual Report to Shareholders for the fiscal year ended May 28, 1995 (to be deemed filed only to the extent required by the instructions to Exhibits for reports on Form 10-K).\n21.0 List of Subsidiaries.\n23.0 Consent of Independent Auditors (included in Part IV).\n24.0 Power of Attorney.","section_15":""}
{"filename":"2852_1995.txt","cik":"2852","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"ITEM 3. LEGAL PROCEEDINGS (THOUSANDS OF DOLLARS)\nThe Company and its subsidiaries are not involved in any material pending legal proceedings other than ordinary routine litigation incidental to the business except the following:\nIn March 1987, Benjamin Farber filed a third party complaint in the U.S. District Court, District of New Jersey, against certain parties formerly connected with an industrial site in South Kearny, New Jersey. The United States of America, on behalf of the Environmental Protection Agency (EPA), filed a complaint under the federal Comprehensive Environmental Response, Compensation and Liability Act (CERCLA) against Mr. Farber seeking reimbursement for engineering studies, clean up costs, and future remedial work in connection with alleged contamination of the South Kearny property. Mr. Farber's action against Agway and others seeks contribution from Agway and others. Agway, a former owner of the South Kearny property, sold its remaining interest in 1966. Agway has executed a consent decree with the EPA which should resolve Mr. Farber's claims against Agway and potential claims by the EPA against Agway. According to the consent decree, Agway's contribution to the contamination of the South Kearny property, if any, was de minimis and Agway agreed to pay the EPA a $300 settlement. The consent decree should be entered by the Court in the near future. The New Jersey Department of Environmental Protection (NJDEP) has also demanded the clean up of the site. Agway believes the pending lawsuit and the claim by the NJDEP will be satisfactorily resolved and any adjustments will not be material in relation to the consolidated financial position of Agway.\nIn June 1990, the State of New York (NYS) commenced a lawsuit in the New York State Supreme Court for Albany County against Agway Petroleum Corporation (APC), Speedsville Volunteer Fire Department, and other defendants alleging they are strictly and jointly and severally liable for $158 in cleanup and removal costs incurred by the New York Environmental Protection and Spill Compensation Fund and $200 in statutory penalties pursuant to the New York State Navigation Law. NYS alleges that a gasoline storage system located on property of the Speedsville Volunteer Fire Department discharged gasoline which was detected in a nearby residential well. NYS also alleges that the owners of the gasoline storage system included APC and Speedsville Volunteer Fire Department. Because APC believes that at no time did it own the gasoline storage system and its gasoline did not contribute to the contamination, APC denies NYS's allegations and believes the relief sought by NYS against APC is unjustified. Therefore, APC intends to contest the allegations in the lawsuit and believes adjustments, if any, will not be material in relation to the consolidated financial position of Agway.\nIn November 1991, APC notified the EPA that APC had recently discovered that certain forms that APC's facilities are required to file under the Emergency Planning and Community Rights-To-Know Act (EPCRA) may not have been filed on time. In August 1994, the EPA filed an Administrative Complaint against APC for violations of EPCRA alleging penalties. A settlement of this matter has been negotiated in which APC and EPA executed a consent agreement under which APC will pay the EPA $100 in cash and agree to undertake certain environmentally beneficial expenditures with a value of $500.\nOn May 29, 1992, the Commissioner of Environmental Protection of the State of Connecticut (CDEP) commenced a civil action against Hood alleging violations of state statutes and regulations relating to pollution of the waters of the state in connection with Hood's Suffield, Connecticut, facility. In connection with these allegations, the CDEP has made a demand of $2,400. Settlement of this matter is being negotiated in which Hood and the CDEP will agree to a stipulated Judgment under which Hood will pay CDEP $325 and agree to construct on-site wastewater pretreatment facilities and conduct a study of the Suffield facility's level of fat, oil and grease discharge. Hood believes that this matter will be satisfactorily resolved and any adjustments will not be material in relation to the consolidated financial position of Agway.\nITEM 3. LEGAL PROCEEDINGS - CONTINUED (THOUSANDS OF DOLLARS)\nIn August 1994, the EPA notified Motor Transportation Services, Inc. (MTS), an inactive wholly owned subsidiary of AHI, that the EPA has reason to believe that MTS is a potentially responsible party (PRP) under the federal CERCLA at the Rosen Site, Cortland, New York. The EPA requested that MTS and other PRPs participate in the ongoing Remedial Investigation\/Feasibility Study (RI\/FS) for the Rosen Site. MTS believes that its involvement at the Rosen Site, if any, is minimal and responded appropriately to the EPA's request. In a related matter, other PRPs at the Rosen Site, Cooper Industries, Inc., et al., filed a complaint under CERCLA against the Company, MTS and other alleged PRPs at the Rosen Site in the U. S. District Court, Northern District of New York in June 1992 seeking reimbursement for the cost of the ongoing RI\/FS. The Company and MTS believe the relief sought by Cooper Industries, Inc., et al. is unjustified and are contesting the allegations in the lawsuit. Adjustments, if any, will not be material in relation to the consolidated financial position of Agway.\nIn December 1985, it was asserted by the Massachusetts Department of Environmental Protection (MDEP) that certain real property located in West Concord, Massachusetts previously owned by Agway is contaminated and that Agway and the current owner of the property are responsible for the cost of investigating and cleaning up environmental contamination at the property. In September 1993, Agway entered into an Administrative Consent Order with the MDEP pursuant to which Agway performed a phase II comprehensive site assessment. In March 1995, Agway and the current owner entered into a settlement agreement whereby Agway agreed, at Agway's expense, to complete any additional assessment, containment, removal or remediation actions at the property. The current owner agreed to cooperate with Agway in achieving a permanent solution satisfactory to the MDEP and in compliance with the MDEP's requirements. Agway is preparing a risk assessment scope of work in cooperation with the MDEP. The Company currently has accrued its best estimate relative to the cost of any additional assessment, containment, removal or remediation actions regarding the property. However, it is reasonably possible that the results of ongoing and\/or future environmental studies or other factors could alter this estimate and require the recording of additional liabilities. The extent or amount of such events cannot be estimated at this time. However, Agway believes that its past experience provides a reasonable basis for its estimates recorded for this matter.\nIn August 1995, the EPA notified Agway that the EPA has reason to believe that Agway is a PRP under CERCLA at the Tri-Cities Barrel Site, Port Crane, New York. The EPA requested that Agway and other PRPs participate in the ongoing RI\/FS for the Tri-Cities Barrel Site. Agway believes that its involvement at the Tri-Cities Barrel Site is minimal, and Agway is in the process of gathering information concerning the cost of participating in the ongoing RI\/FS and any subsequent remedial work prior to responding to the EPA's request.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThere were no items submitted to a vote of security holders for the three months ended June 30, 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\n(a) Principal Market\nThere is no market for the equity securities of the Company other than through its current practice of repurchasing outstanding securities at par ($25) whenever registered holders thereof elect to tender them for redemption.\n(b) Approximate Numbers of Holders of Common Stock\nThe number of holders of record of the Company's Common Stock, as of September 15, 1995, is 108,496, of which 22,286 shares have been called for those holders no longer meeting the membership eligibility requirements as identified in Section 2.1(a) in the By-Laws of Agway Inc.\n(c) Dividends Paid\nAn annual 6% dividend, or $1.50 per share, was paid on the Company's Common Stock in fiscal 1995 and fiscal 1994.\n(d) Limitations on Ownership and Availability of Net Margin to Membership Common Stockholders Refer to Items 1 and 2, \"Business and Properties\" sections on \"Stockholder Membership and Control of Agway\" and \"Patronage Refunds.\"\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following \"Selected Financial Data\" of the Company and Consolidated Subsidiaries has been derived from consolidated financial statements audited by Coopers & Lybrand L.L.P., whose reports for the periods ended June 30, 1995, 1994 and 1993 are included elsewhere in the 10-K, and should be read in conjunction with the full financial statements of the Company and Notes thereto included under Item 8.\n(1) Certain amounts reported in fiscal years ended June 30, 1991-1994 have been reclassified to conform to current year presentation of Hood being re-introduced as a continuing operation.\n(2) 1995 and 1994 data reflects the adoption of Statement of Financial Accounting Standards No. 106, \"Accounting for Postretirement Benefits Other Than Pensions.\" See Note 13 to the financial statements included in Item 8.\n(3) 1992 data reflects a $75,000 charge before taxes for business restructuring; 1994 data reflects a $6,065 credit before taxes from business restructuring; 1995 data reflects a $16,724 loss before taxes on investment value and divestiture expenses related to Hood, an after-tax gain on the sale of Curtice Burns of $4,430 and a credit before taxes from business restructuring of $3,248. See Note 3 and 17 to the financial statements included in Item 8.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (THOUSANDS OF DOLLARS)\nRESULTS OF OPERATIONS\n1995 COMPARED WITH 1994\nCONSOLIDATED RESULTS\nConsolidated net sales and revenues of $2,082,900 decreased $104,300 (4.8%) in fiscal 1995 compared to 1994. The decrease was due to declines in Agriculture & Consumer, Energy and Dairy. The Agriculture & Consumer decline of $55,300 (5.2%) was attributed to a softer demand for feed products as corn and soybean harvests were strong and plentiful which substantially reduced the tons of feed sold during fiscal 1995. Additionally, the mild winter conditions in 1995 negatively impacted the retail and wholesale bird food, small animal food and bagged feed sales. The Energy decrease of $45,300 (8.1%) was primarily due to 1995 being the third warmest winter on record which negatively impacted the volume of heating oil sales. Dairy experienced a $10,400 (2.1%) decrease in net sales and revenues primarily in its dairy division due to the loss of private label volume. This decline was partially offset by improvements to its manufactured products group (MPG) sales from continued growth of the group's extended shelf-life business.\nConsolidated operating costs and expenses were $2,069,000 in 1995 as compared to $2,163,800 in 1994. The $94,800 (4.4%) decrease was the result of a decrease in product and plant operation costs of $107,700 and was offset by increases in selling, general and administrative costs of $5,300, leasing operating costs of $4,400 and a $2,800 decrease in restructuring credits in 1995. The decrease in product and plant costs was a result of the various location divestitures in the Agriculture & Consumer and Energy businesses that occurred as a part of the Company's restructuring efforts over the past three years. The increase in selling, general and administrative costs was mainly the result of additional costs from severance and increased bad debt expense. Total operating costs, before restructuring credits, as a percent of total net sales and revenues were 99.5% and 99.2% in fiscal 1995 and 1994, respectively.\nInterest expense, net of interest income, totaled $36,200 in 1995 as compared to $33,600 in 1994, representing a $2,600 (7.7%) increase. The increase was attributable to higher interest rates on slightly higher average balances of debt.\nOther income in fiscal 1995 totaled $12,300 as compared to other income of $5,600 in 1994. The increase of $6,700 in 1995 was mainly the result of larger patronage refunds received and a Hood pension curtailment gain.\nAs previously discussed, in keeping with Agway's interest to divest of its 99.9% interest in Hood, the Company recognized a cost of $16,700 in pre-tax loss in value in its investment in Hood and expenses incurred in its efforts to sell Hood from March 23, 1993 to June 30, 1995. These costs include a $15,884 loss before taxes for transaction costs incurred in connection with past sales efforts and an impairment allowance with respect to the ultimate sale of its investment in Hood.\nPre-tax margin (loss) from continuing operations was $(26,700) in 1995 compared to $(4,600) in 1994. As described earlier and in more detail in subsequent segment discussion, the increased loss was primarily a result of the above costs related to Hood, the negative impact in the Energy segment from the mild winter conditions and severance incurred from the Company's decentralization. These were offset by improved operational results in Agriculture & Consumer and the Hood pension plan curtailment gain.\nIncome tax expense (benefit) was $(3,800) and $1,100 in fiscal 1995 and 1994, respectively, for an effective rate of (14.1%) and 24.7%. The statutory rate was beneficially impacted in 1995 and 1994 by the current recognition of an anticipated tax benefit with respect to the future sale of Hood and was adversely impacted by state income taxes as the Company is unable to recognize the benefit of operating losses from certain subsidiaries to offset state tax on income from other operations.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (THOUSANDS OF DOLLARS)\nRESULTS OF OPERATIONS (CONTINUED)\nAGRICULTURE & CONSUMER\nTotal sales and revenues of $1,015,800 in 1995 represented a decline of $55,300 (5.2%) from 1994. The Agway Agricultural Products (AAP) component experienced a $14,400 (2.8%) decrease that was substantially due to softer demand for feed products as corn and soybean harvests were strong and plentiful. The crops sales were relatively level compared to 1994. Agriculture & Related Services (ARS) sales and revenues dropped $36,300 (11.9%) compared to 1994. The retail decrease was due to the warm winter with less than average snowfall negatively impacting seasonal items such as bird food, small animal food and bagged feed sales. The retail product sales decrease was partially offset by an increase in wholesale sales. Wholesale volume increases were the result of higher power equipment, nursery and soil conditioner volumes to franchised dealers in 1995. Country Products Group (CPG) sales declined $4,600 (1.8%) compared to 1994. The majority of the decline occurred in commodity processing, produce repack and tablestock and seed potatoes and was offset by improvements in field and garden seed operations and turf operations. Commodity product declines were in sunflower. The warm winter reduced the demand for sunflower bird food unit volume by 17.5% which was partially offset by 11.8% unit volume increases in human edible sunflower seeds. The produce and Maine operations declines resulted from a net loss of volume, as well as a poor quality of crop in Maine due to a blight that affected the harvest.\nThe Agriculture & Consumer operating results improved in 1995 by $4,400 (62%) due to a loss of $2,700 as compared to a loss of $7,100 in 1994. A 1995 operating result improvement of $10,300 was offset by $3,600 of severance incurred to effect the reorganization initiated and implemented in 1995 and a $2,300 lower credit from restructuring ($2,400 in 1995 compared to $4,700 in 1994). All three components of Agriculture & Consumer successfully reduced expenses from limiting overtime worked, reducing selling and advertising costs and through the elimination of positions.\nENERGY\nTotal net sales and revenues for fiscal 1995 of $510,800 decreased $45,200 (8.1%) as compared to fiscal 1994, primarily due to lower heating oil volume from 1995 being the third warmest winter on record. Heating oil sales decreased $38,300 due to a volume decrease of 35.7 million gallons (15.0%) in 1995 as compared to 1994. Power fuels sales (gasoline and diesel fuel) decreased $6,800 or 11.3 million gallons (4.4%) and is a direct result of underground tank removal necessitated by federal regulations. In total, sales unit volume was down 49.1 million gallons (8.3%). This equates to a $42,100 (7.1%) sales decline due to volume. The average price per unit was down .7 cents per gallon (.8%), which decreased revenues by approximately $3,100 in 1995.\nDue to the unit volume and selling price declines in 1995, Energy realized a decline in operating margins of $11,600 as compared to the previous fiscal year. Operating margins in 1995 were an additional $14,800 lower than 1994 due to a restructuring charge of $1,300 in 1995 compared to a restructuring credit of $13,500 in 1994. Operating margins, after restructuring, as a percentage of net sales and revenues decreased to 2.9% in fiscal 1995 as compared to 4.7% in the prior fiscal year as the result of the above declines.\nDAIRY\nDairy consists of Hood, of which 99.9% is owned by AHI.\nHood net sales and revenues declined $10,400 (2.1%) to $483,600 in 1995. The dairy and ice cream operations experienced decreases of $25,200 (8.4%) and $1,100 (1.5%) in net sales and revenues, while manufactured products group (MPG) had an increase of $15,900 (13.5%) compared to 1994. The dairy division operations decrease was the result of volume reductions of private-label products and the sale of the Mid-Hudson business in February 1995. The ice cream decrease was also volume-related. MPG experienced continued growth in its lactaid and license business which was reflected in increased volume in 1995.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (THOUSANDS OF DOLLARS)\nRESULTS OF OPERATIONS (CONTINUED)\nDAIRY (CONTINUED)\nNet operating results of a $1,400 loss in 1995 showed improvement from a $3,400 loss in 1994. The 1995 gross margin as a percent of net sales improved slightly from 20.7% in 1994 to 21.4% in 1995. Operating expenses as a percent of net sales were consistent between 1995 and 1994 at 19.7% and 19.3%, respectively. The improvement in net operating results substantially came from increased gross margin of $1,600 and a gain of $2,100 in February 1995 when the dairy division sold its Mid-Hudson business to Crowley Foods. These improvements were offset by a May 1995 decision to move the fluid milk operation from Boston to Agawam. As a result, costs of $1,700 were incurred which included $1,300 for severance related to the reduction in work force and $400 for the write-down of certain fixed assets.\nFINANCIAL SERVICES\nFinancial Services consists of Telmark, a leasing subsidiary; Agway Insurance, a property and casualty insurance subsidiary; and Agway General Agency, a subsidiary which markets accident and health insurance products and administers health insurance programs.\nTotal sales and revenues for fiscal 1995 totaled $71,500 and is made up of $41,900 at Telmark and $29,600 at the insurance operations. These results reflect a $6,800 (19.4%) increase in Telmark revenues offset by a $1,100 (3.6%) decrease in revenues from the insurance operations in 1995 as compared to the prior year. Telmark's increase is the result of a 20% increase in its net lease revenues primarily from expanding its territory, thus generating the additional revenues. The insurance operations overall had a stable operating performance and the slight decline in revenue was not inconsistent with prior year variations.\nOperating profit for Financial Services was $10,500 for both 1995 and 1994. Telmark experienced an $800 increase which was fully offset by a decline in the insurance operating profit.\nCORPORATE\nThe Corporate operating loss of $10,300 in 1995 improved over a 1994 loss of $10,900. The $600 improvement resulted from lower miscellaneous net expenses. However, during 1995, many large offsetting items did occur. In 1995, Corporate reported $2,200 of restructuring credits compared to a $13,000 expense in 1994 and Hood curtailed its defined benefit plan which resulted in a $5,700 gain. The $20,900 improvement from these two items was fully offset by Hood loss on investment value and divestiture expenses in 1995 of $16,700, approximately $2,100 of deferred costs written off due to certain planned technological improvements in the Company's restructuring efforts being terminated and $2,100 of severance incurred in connection with 1995 decentralization initiatives.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (THOUSANDS OF DOLLARS)\nRESULTS OF OPERATIONS\n1994 COMPARED WITH 1993\nCONSOLIDATED RESULTS\nConsolidated net sales and revenues of $2,187,200 decreased $91,600 (4.0%) in fiscal 1994 compared to 1993. The decrease in fiscal 1994 was principally due to decreased revenues in Energy and Dairy offset, in part, by increases in Agriculture & Consumer. Energy revenue decreases in 1994 of $82,100 were primarily associated with divestitures of retail locations and gas and diesel sales to low-margin, high-volume commercial customers. The $60,800 sales increase in fiscal 1994 from Agriculture & Consumer primarily reflects $46,900 from the full-year operation of the store corporations under ARS, which were acquired primarily in the fourth quarter of 1993 and the first quarter of fiscal 1994.\nConsolidated operating costs and expenses in fiscal 1994 were $2,163,800 as compared to $2,234,500 in 1993, representing a decrease over the prior year of $70,700 (3.2%). Operating costs and expenses were favorably impacted by a restructuring credit of $6,100 in fiscal 1994. Total operating costs, before restructuring credit, as a percent of total net sales and revenues were 99.2% and 98.1%, respectively, in fiscal 1994 and 1993. In fiscal 1994, selling, general and administrative costs increased by $14,600 (8.1%) to $194,600 as Agriculture & Consumer incurred increased costs to administer the newly acquired store corporations and additional costs in connection with the marketing, selling and operating practices of the newly segregated agriculture and consumer retail operations.\nInterest expense, net of interest income, in fiscal 1994 and 1993 was $33,600 and $35,700, respectively, representing a $2,100 (5.9%) decrease. The decrease was the result of increased average borrowings being more than fully offset by lower interest rates in fiscal 1994 compared to 1993.\nOther income in fiscal 1994 was $5,600 as compared to $1,800 in 1993. In fiscal 1993, other income was adversely impacted by a loss on disposal of property and equipment of $4,200 and settlement costs associated with a former subsidiary.\nPre-tax (loss) margin from continuing operations was $(4,600) and $10,300 in fiscal 1994 and 1993, respectively. The decrease in pre-tax margins in fiscal 1994 resulted primarily from increased operating losses incurred by Agriculture & Consumer offset, in part, by improved operating results from Energy as further explained in the following segment discussions.\nIncome tax expense (benefit) was $1,100 and $(13,900) in fiscal 1994 and 1993, respectively, for an effective rate of 24.7% and (134.2%). The effective rate was beneficially impacted each year by the current recognition of an anticipated tax benefit with respect to the future sale of Hood. In fiscal 1994 and 1993, the effective rate was adversely impacted by state income taxes as the Company was unable to recognize the benefit of operating losses from certain subsidiaries to offset state tax on income from other operations. The 1993 benefit was principally the result of an adjustment of a prior year tax accrual no longer deemed necessary and the net reversal of a $6,000 deferred tax asset valuation allowance established in 1992.\nAGRICULTURE & CONSUMER\nTotal net sales and revenues for Agriculture & Consumer were $1,070,800 and $1,010,200 for fiscal years 1994 and 1993, respectively. Net sales and revenues increased $60,600 (6.0%) in fiscal 1994 due to the acquisition of 53 store corporations, primarily in the fourth quarter of fiscal 1993, which incrementally increased sales, gross margins and expenses over the preceding year; and to volume and price increases in the CPG business unit. Total net sales and revenues for AAP remained relatively constant with the prior year. Gross margins for AAP declined slightly in fiscal 1994 due to competitive market conditions in the northeast service area.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (THOUSANDS OF DOLLARS)\nRESULTS OF OPERATIONS (CONTINUED)\nAGRICULTURE & CONSUMER (CONTINUED)\nAgriculture & Consumer incurred an operating loss of $7,100 in fiscal 1994 ($11,800, excluding a restructuring credit of $4,700) as compared to an operating profit of $13,300 in fiscal 1993. The change in operating results from 1993 to 1994 reflects the decline in gross margin, increases in costs due to inflationary increases, plus increases incurred on transferring the marketing, sales, and related operating assets of agricultural products, previously conducted through retail operations, to agricultural hubs and dedicated service centers. These changes to improve customer service increased the costs of operations during the course of implementation.\nAs part of the Company's overall restructuring efforts previously discussed, restructuring initiatives for Agriculture & Consumer during fiscal 1994 and 1993 were primarily focused on transferring the marketing, sales and related operating assets of agricultural products, previously conducted through retail operations, to agricultural hubs and dedicated customer service centers. This transition was completed in fiscal 1993 in New England and Pennsylvania and was completed in New York in the first half of fiscal 1994. An additional initiative focused on merging 53 local store cooperatives into Agway, which was substantially completed in the fourth quarter of fiscal 1993, which increased sales, gross margins and expenses for ARS. In addition to completing the New York transition, the fiscal 1994 initiatives for the segment centered around designing and, to some degree, implementing the streamlining of operating and administrative processes through reviews of supply chain management, product category management, and warehousing systems; closing, consolidating, or converting facilities to focus assets and capital in selected markets and eliminate duplication; and sales enhancement through customer service and quality reviews.\nENERGY\nIn fiscal 1993, divestitures of 19 locations were completed, and during fiscal 1994, divestitures of four retail locations were completed by Energy as part of the Company's restructuring strategy to focus assets and capital in selected markets. In addition, refocusing of sales to commercial accounts away from price-oriented accounts to service-oriented businesses continued to occur. As expected, this continued to decrease sales volume but had a favorable impact on per unit gross margins realized.\nTotal net sales and revenues for fiscal 1994 of $556,000 decreased $82,100 (12.9%) as compared to fiscal 1993, primarily due to planned plant divestitures ($40,700) and reduced gas and diesel sales to low-margin, high-volume commercial customers. Heating oil and propane sales decreased $5,800 due to a volume increase of 1.2%, offset by a selling price decrease of 3.1%. In total, sales unit volume was down 29,800 gallons (4.8%) primarily for gas and diesel fuels, after accounting for divestitures. The average price per unit was down 5.5 cents per gallon (7.9%) in 1994 compared to 1993, which decreased revenues including heating oil and propane sales by approximately $41,400.\nDespite the unit volume and selling price declines, Energy realized an improvement in operating margins of $17,100 ($3,600, excluding a restructuring credit of $13,500) in the 1994 fiscal year as compared to the previous fiscal year. Operating margins as a percentage of net sales and revenues increased by 3.6% in fiscal 1994 as compared to the prior fiscal year, and total costs and expenses for Energy declined in fiscal 1994 as a result of the above changes.\nDAIRY\nTotal sales and revenues of $493,900 decreased $66,400 (11.8%) during 1994 as compared to 1993. The dairy division operations declined 8.1% while manufactured products group (MPG) and ice cream had increases of 13.5% and 2.2%, respectively. The dairy sales decline resulted from the sale of the Central New York business in January 1993 and the sale of Hood's cheese manufacturing operations. The MPG increase was the result of several new branded products while the ice cream increase was from the introduction of new Hood products.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (THOUSANDS OF DOLLARS)\nRESULTS OF OPERATIONS (CONTINUED)\nDAIRY (CONTINUED)\nNet operating results of a $3,400 loss in 1994 deteriorated from a $2,900 margin in 1993. The 1994 gross margin and operating expenses as a percent of net sales were consistent with 1993 at 20.7% and 19.3% versus 21.8% and 18.8%, respectively. The $6,300 decline in operating results was primarily due to product costs increasing at a faster rate than sales ($9,900, or 3.1%, compared to $4,500, or .9%, for sales).\nFINANCIAL SERVICES\nTotal net sales and revenues for fiscal 1994 decreased $4,300 (6.2%) to $65,800 as compared to fiscal 1993. The decrease, primarily attributed to the Agway Insurance Company and the Agway General Agency, is generated by the termination of reinsurance assumed contracts of $1,400, increased reinsurance ceded treaties of $400, a decline of $1,000 in investment earnings, and a decline in administrative fees of $500 due to a declining base of participants in the Agway member group health insurance plan. In addition, Telmark revenues declined $500 as compared to fiscal 1993 due to the effect of portfolio sales in 1994 and 1993 and the effect of lower lease rates charged on new business in fiscal 1994.\nIn fiscal 1994, operating margins for Financial Services declined $500 (4.9%) as compared to fiscal 1993. The decrease is primarily attributed to Telmark due to a lower gain on portfolio sale in 1994 of $500 versus a 1993 gain of $1,200. The Agway Insurance Company revenue decline from the reinsurance termination was offset by an equal reduction in costs and expenses with no impact on operating margin.\nCORPORATE\nThe net loss from Corporate was $10,800 and $3,900 in 1994 and 1993, respectively. The most significant factors affecting these results were a $13,000 restructuring expense in 1994 with no such charge in 1993 offset by a $3,800 increase in consolidated other income in 1994.\nLIQUIDITY AND CAPITAL RESOURCES\nCASH FLOWS\nCash generated from operations and external borrowings continues to be the Company's major source of funds to finance capital improvements and shareholder dividends.\nCash provided from operating activities totaled $45,700 in 1995, $25,700 in 1994 and $48,700 in 1993. The increase in cash provided in 1995 was due primarily to decreases in receivables and inventory. The decrease in cash provided between 1993 and 1994 was primarily the result of a decline in net margin from continuing operations and increases in accounts payable.\nInvesting activities have used cash of $41,800 in 1995, $85,700 in 1994 and $15,000 in 1993. Capital expenditures totaled $42,100, $40,600 and $34,700, respectively, for the same three-year period. In existing agreements with its lenders, 1996 capital expenditures are limited to annual depreciation amounts and will reflect routine capital and technology improvements. The Company anticipates it will have adequate flexibility to meet its capital expenditure requirements.\nProceeds from the disposal of businesses and property, plant and equipment have declined $30,300 over the past three years and reflect the wind-down of the Company's restructuring efforts, which included divestitures of certain operating assets. Telmark has continued to grow its portfolio as leases originated, net of lease repayments\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (THOUSANDS OF DOLLARS)\nLIQUIDITY AND CAPITAL RESOURCES (CONTINUED)\nCASH FLOWS (CONTINUED)\nand leases sold, have increased $121,200 since 1993 and have represented cash used in investing activities. In 1995, the Company sold its interest in Curtice Burns which generated $55,800 in cash proceeds and was used to pay down debt.\nAt June 30, 1994, the Company had anticipated spending $22,000 over two years to design and implement new processes and information systems. During 1995, it was determined that the expected benefit associated with this spending would be less than anticipated. As a result, this program was terminated.\nDEBT\nThe Company finances its operations and the operations of all its continuing businesses and subsidiaries, except Telmark, Agway Insurance Company and Hood, through Agway Financial Corporation (AFC). Telmark, Agway Insurance Company and Hood finance themselves through operations or direct borrowing arrangements.\nThe Company uses cash from external sources obtained through revolving credit lines, letters of credit and commercial paper programs to meet the Company's short-term capital requirements. Sources of longer-term financing include borrowings from banks and insurance companies as well as through issuances of subordinated debentures and capital leases. In addition, Telmark has occasionally sold blocks of its lease portfolio. Short-term borrowings, including notes payable and current portions of long-term debt and subordinated debt, totaled $178,000 in 1995 and $194,300 in 1994.\nIn fiscal 1995, AFC renegotiated and renewed certain of its bank loan agreements through October 31, 1995. Adequate lines of credit of $122,000 were available to the Company through AFC, Telmark and Hood as of June 30, 1995. In addition, the Company retained a commercial paper facility of $60,000. The AFC short-term lines of credit and $6,000 of AFC long-term debt are collateralized by the Company's accounts receivable and non-petroleum inventories. Amounts which can be drawn under the AFC short-term agreements are limited to a specific calculation based upon the total of these certain accounts receivable and non-petroleum inventories (\"collateral\"). Adequate collateral has existed throughout the fiscal year to meet the ongoing needs of the Company and is expected to continue to do so. In addition, the agreements include certain covenants, the most restrictive of which requires to Company to maintain specific monthly levels of tangible net worth and quarterly levels of interest coverage. In September 1995, waivers were obtained effective as of June 30, 1995 and covering through August 1995, and amendments were obtained for September and October 1995, for specific covenant violations within AFC's ongoing short-term credit facilities. Negotiations of the renewal of AFC short-term lines of credit are in process and are expected to continue through October 1995. It is management's expectation that appropriate credit facilities will be in place to meet the ongoing needs of the Company. Additionally, the covenant violations do not have a material impact on Agway's interest rates for new short-term or long-term debt. These credit facilities continue to be available to the Company.\nIn October 1995, $31,200 of subordinated debt issued by AFC matures. The Company expects to either refinance this debt through a new issue of subordinated debt, fund it through short-term bank borrowings, or a combination of both. Other current maturities of long-term debt, which relate principally to leasing operations, will be funded through a combination of cash from operations, bank or insurance company borrowings, or the issuance of public debentures. The Company does not anticipate the events noted in the preceding paragraph will have an impact on these plans.\nOn October 31, 1994, Telmark's registration of its second offering to the public of $30,000 of debentures, due March 31, 2000, with the Securities & Exchange Commission became effective. The debentures are unsecured, subordinated to all senior debt at Telmark, and are not guaranteed by Agway nor any of Agway's other subsidiaries.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (THOUSANDS OF DOLLARS)\nLIQUIDITY AND CAPITAL RESOURCES (CONTINUED)\nDEBT (CONTINUED)\nThe offering of the debentures is not underwritten, and there can be no guarantee as to the amount of debentures to be sold. This offer of debentures is continuing and the proceeds of the offering will be used to provide financing for Telmark's leasing activities. As of June 30, 1995, approximately $3,500 of debentures were sold. Telmark's first registration of debentures due December 31, 1997 was effective February 1, 1994 and approximately $4,700 of that $25,000 offering were sold and are outstanding at June 30, 1995. No other debentures will be sold pursuant to this offering. It is Telmark's expectation that appropriate credit facilities will be in place to meet ongoing needs of Telmark.\nThe Hood short-term credit facility is used to supply letters of credit as well as short-term financing. Letters of credit of $16,300 were outstanding at June 30, 1995. This facility was scheduled to expire on July 31, 1995. Hood negotiated an extension of this facility until such time as it could be restructured.\nEffective August 7, 1995, Hood restructured its line of credit facility with its bank. Per the amended agreement, the bank has made available to Hood a $28,000 facility through March 31, 1996 with an increase to $33,000 commencing on April 1, 1996. Borrowings under the line of credit facility are limited to the total of 80% of the receivables less than sixty days old plus the balance of inventories (not to exceed $5,000) to the extent that such equation does not exceed $28,000 and $33,000, respectively. Borrowings under the line of credit facility are to be repaid on demand. All outstanding cash advances are due on or before July 1, 1996. Letter of credit accommodations may be comprised of up to $18,000 of the total facility and may be advanced through June 30, 1996. Outstanding letter of credit accommodations as of June 30, 1996 are not renewable upon expiration. Hood's expectation is that appropriate credit facilities will be in place to meet ongoing needs of Hood.\nOTHER MATTERS\nPOSTRETIREMENT BENEFITS OTHER THAN PENSIONS\nThe Company provides postretirement health care and life insurance benefits, and Hood provides postretirement health care benefits, to eligible retirees and their dependents. Eligibility for benefits depends upon age and years of service.\nEffective July 1, 1993, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" which requires employers to accrue the cost of providing postretirement benefits other than pensions during the period employees are expected to earn the benefit. The Company and Hood elected to amortize the transition obligation of $40,800 and $4,600, respectively, over 20 years for both plans. As a result of the adoption of SFAS No. 106, pre-tax income in fiscal 1994 was reduced by approximately $3,900. The change had no impact on cash flow.\nIn October 1994, the Company elected to amend the existing Company program for providing postretirement health care benefits (OPEB) effective January 1, 1995. The plan amendment establishes a separate and distinct insured medical program for retirees aged 65 or over, caps the Company's contributions to retirees aged 65 or over and modifies coverage for active employees and retirees under age 65.\nThese amendments have resulted in reduction to the Company's net periodic expense and accumulated postretirement benefit obligation for the year ended June 30, 1995 of $2,000 and $15,000, respectively.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (THOUSANDS OF DOLLARS)\nOTHER MATTERS (CONTINUED)\nHOOD CURTAILMENT GAIN\nThe Hood pension plan (the \"Plan\") covers substantially all its employees and provides defined benefits based on years of credited service, average compensation (as defined) and social security benefits. The administrative committee of Hood approved, effective December 31, 1994, to freeze the benefit accruals under the Plan. As a result, Hood recognized a curtailment gain of $5,677 as of December 31, 1994. This amount is included in other income.\nIMPAIRMENT OF LONG-LIVED ASSETS\nIn March 1995, the Financial Accounting Standards Board issued SFAS No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.\" This statement requires the recognition of both economic and permanent impairment losses on long-lived assets. The statement is effective for fiscal years beginning after December 15, 1995 (the Company's fiscal 1997). The adoption effect of this statement cannot be reasonably estimated at this time.\nENVIRONMENTAL ISSUES\nThe Company is subject to a number of governmental regulations concerning environmental matters, either directly, or as a result of the operations of its subsidiaries. Agway expects that it will be required to expend funds to remediate certain sites, including certain Superfund sites and sites with underground fuel storage tanks. In addition, Agway expects that it will incur other expenses associated with environmental compliance.\nThe Company continually monitors its operations with respect to potential environmental issues, including changes in legally mandated standards and remediation technologies. Agway's recorded liability reflects those specific issues where remediation activities are currently deemed to be probable and where the cost of remediation is estimable. Estimates of the extent of the Company's degree of responsibility of a particular site and the method and ultimate cost of remediation require a number of assumptions for which the ultimate outcome may differ from current estimates; however, the Company believes that its past experience provides a reasonable basis for estimating its liability. As additional information becomes available, estimates are adjusted as necessary. While the Company does not anticipate that any such adjustment would be material to its financial statements, it is reasonably possible that the result of ongoing and\/or future environmental studies or other factors could alter this expectation and require the recording of additional liabilities. The extent or amount of such events, if any, cannot be estimated at this time. Although settlement of the reserves will cause future cash outlays based upon current estimates, it is not expected that such outlays will materially impact the Company's liquidity position.\nAs part of its long-term environmental protection program, the Company spent approximately $4,000 in fiscal 1995 on capital projects. The Company estimates that during fiscal 1996 and 1997 approximately $4,000 per year will be spent on additional capital projects for environmental protection. These estimates recognize the additional capital required to comply with EPA Underground Storage Tank (UST) regulations which become effective in December 1998. Presently, the total cost to comply with the EPA UST regulations is estimated to be approximately $5,000. The total capital requirements may change due to the actual number of USTs actively in use on the effective date.\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\nThis item is inapplicable.\nAGWAY INC.'S REPORT ON FINANCIAL STATEMENTS\nThe accompanying consolidated financial statements have been prepared in conformity with generally accepted accounting principles by the Company. The integrity and objectivity of the data in these financial statements, including estimates and judgments, are the responsibility of Agway, as is all other information included in this annual report.\nThe consolidated financial statements of Agway Inc. and Consolidated Subsidiaries have been audited by Coopers & Lybrand L.L.P., independent auditors, who relied on the opinions of Price Waterhouse, independent auditors, as it relates to Curtice Burns Foods, Inc. and H. P. Hood Inc. Their reports follow. Agway has made available to Coopers & Lybrand L.L.P. all of the Company's financial records and related data, as well as the minutes of Directors' meetings. Furthermore, Agway believes that all representations made to Coopers & Lybrand L.L.P. during its audit were valid and appropriate.\nAgway maintains a system of internal accounting controls intended to provide reasonable assurance, given the inherent limitations of all internal control systems, at appropriate costs, that transactions are executed in accordance with Company authorization, are properly recorded and reported in the financial statements, and that assets are adequately safeguarded.\nThe Budget & Audit Committee of the Board of Directors, which consists of six directors who are not employees, meets periodically with management and the independent auditor to review the manner in which they are performing their responsibilities and to discuss auditing, internal accounting controls, and financial reporting matters. The independent auditor has free access to the Budget & Audit Committee.\nAGWAY INC.\nBY DONALD P. CARDARELLI President, CEO and General Manager September 15, 1995\nBY PETER J. O'NEILL Senior Vice President, Treasurer and Controller September 15, 1995\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors of Agway Inc.:\nWe have audited the consolidated balance sheets of Agway Inc. and Consolidated Subsidiaries as of June 30, 1995 and 1994, and the related consolidated statements of operations, changes in shareholders' equity and cash flows for the years ended June 30, 1995, 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. We did not audit the financial statements of H. P. Hood Inc. for the years ended June 30, 1995, 1994 and 1993 nor did we audit the financial statements of Curtice Burns Foods, Inc. for the years ended June 30, 1994 and 1993. Such statements of H. P. Hood Inc.(not presented separately herein) reflect total assets amounting to $146,886,000 and $164,276,000 at June 30, 1995 and 1994, respectively, and total revenues amounting to $482,738,000, $493,003,000 and $504,028,000 for the years ended June 30, 1995, 1994 and 1993, respectively. Such statements of Curtice Burns Foods, Inc. (not presented separately herein) reflect total assets amounting to $446,938,000 at June 30,1994 and total revenues amounting to $829,116,000 and $878,627,000 for the years ended June 30, 1994 and 1993, respectively. Those statements were audited by other auditors whose reports have been furnished to us, and our opinion, insofar as it relates to the amounts included for these subsidiaries prior to any adjustment to reflect Curtice Burns Foods, Inc. as a discontinued operation, 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 and the reports of the other auditors provide a reasonable basis for our opinion.\nIn our opinion, based on our audits and the reports of the other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Agway Inc. and Consolidated Subsidiaries, as of June 30, 1995 and 1994 and the results of their operations and their cash flows for the years ended June 30, 1995, 1994 and 1993 in conformity with generally accepted accounting principles.\nAs discussed in Note 13 to the financial statements, the Company changed its method of accounting for postretirement benefits in fiscal 1994 by adopting Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\"\nCOOPERS & LYBRAND L.L.P.\nSyracuse, New York September 15, 1995\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Stockholders of H. P. Hood Inc.\nIn our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations and retained deficit and of cash flows present fairly, in all material respects, the financial position of H. P. Hood Inc. and its subsidiaries (the \"Company\") at June 24, 1995 and June 25, 1994, and the results of their operations and their cash flows for each of the three years in the period ended June 24, 1995, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.\nPRICE WATERHOUSE LLP\nBoston, Massachusetts August 11, 1995\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Shareholders and Board of Directors of Curtice Burns Foods, Inc.\nIn our opinion, the consolidated balance sheets and the related consolidated statements of income and retained earnings and cash flows (not presented separately herein) present fairly, in all material respects, the financial position of Curtice Burns Foods, Inc. and its subsidiaries at June 25, 1994 and June 26, 1993, and the results of their operations and their cash flows for each of the two fiscal years in the period ended June 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.\nPRICE WATERHOUSE LLP\nRochester, New York August 16, 1995\nAGWAY INC. AND CONSOLIDATED SUBSIDIARIES CONSOLIDATED BALANCE SHEETS JUNE 30, 1995 AND 1994 (THOUSANDS OF DOLLARS)\nThe accompanying notes are an integral part of the financial statements.\nAGWAY INC. AND CONSOLIDATED SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS FISCAL YEARS ENDED JUNE 30, 1995, 1994 AND 1993 (THOUSANDS OF DOLLARS)\nThe accompanying notes are an integral part of the financial statements.\nAGWAY INC. AND CONSOLIDATED SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY FISCAL YEARS ENDED JUNE 30, 1995, 1994 AND 1993 (THOUSANDS OF DOLLARS)\nAuthorized shares of common stock is 300,000 shares.\nCommon shares, purchased at par value, held in treasury at June 30 were: 1995 - 61,734; 1994 - 59,639; 1993 - 58,260; 1992 - 56,768. A common stock dividend per share of $1.50 was declared for fiscal 1995, 1994 and 1993. Dividend payments are restricted to a maximum of 8% of par value, as governed by the Farm Credit Administration.\nThe accompanying notes are an integral part of the financial statements.\nAGWAY INC. AND CONSOLIDATED SUBSIDIARIES CONSOLIDATED CASH FLOW STATEMENTS FISCAL YEARS ENDED JUNE 30, 1995, 1994 AND 1993 (THOUSANDS OF DOLLARS)\nThe accompanying notes are an integral part of the financial statements.\nAGWAY INC. AND CONSOLIDATED SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS (THOUSANDS OF DOLLARS)\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nOrganization\nAgway Inc. (the \"Company\" or \"Agway\"), incorporated under the Delaware General Corporation Law in 1964 and headquartered in DeWitt, New York, functions as an agricultural cooperative directly engaged in manufacturing, processing, distribution and marketing of products and services for its farmer-members and other customers in the states of Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New Jersey, New York, Ohio, Pennsylvania, Rhode Island, and Vermont. The Company, through certain of its subsidiaries, is involved in retail and wholesale sales of farm supplies; yard and garden products; pet food and pet supplies; the distribution of petroleum products; repackaging and marketing of vegetables; underwriting and sale of certain types of property and casualty insurance; sale of health insurance; and lease financing.\nFiscal Year\nThe Company's fiscal year-end is on the last Saturday in June. Fiscal years ending June 30, 1995, 1994 and 1993 were each comprised of 52 weeks.\nBasis of Consolidation\nThe consolidated financial statements include the accounts of all wholly owned subsidiaries and the Company's majority-owned subsidiary, H. P. Hood Inc. (Hood), which is 99.9% owned. Curtice Burns Foods, Inc. (Curtice Burns), which was 34% owned through November 3, 1994, is presented as a discontinued operation. All significant intercompany transactions and balances have been eliminated in consolidation.\nCash and Equivalents\nThe Company considers all investments with a maturity of three months or less when purchased to be cash equivalents. The carrying amount reported in the balance sheet approximates fair value.\nLeases Receivable\nThe Company's leasing operation (Telmark Inc.) finances buildings and equipment for Agway members and others. Leases are made on a precomputation basis (finance charges included in the face amounts of the notes). Finance charges are realized as income, utilizing the interest method over the terms of the leases, which for most commercial and agricultural leases is 60 months or less and a maximum of 180 months for buildings. Income recognition is suspended on all leases and loans which become past due greater than 120 days. Gains on lease sales are reduced for estimated future servicing fees and estimated losses under the recourse provisions of the sale (limited to 7.5% of the sale proceeds). Servicing amounts are amortized over the life of the sold leases.\nOrigination Fees and Costs\nFees received and direct costs incurred for the origination of leases and notes are deferred and amortized to interest income over the contractual lives of the instruments using the interest method, adjusted for estimated prepayment experience.\nInventories\nFeed, crops, non-liquid petroleum products and retail inventories (including inventories in regional distribution centers as well as consumer stores) are stated at the lower of cost or market. Cost is determined using average unit cost or first-in, first-out methods. Liquid petroleum inventories are stated at the lower of cost or market using the last-in, first-out method of costing. Grain inventories are stated at market, as adjusted for unrealized gains and losses on open futures contracts and open purchase and sales contracts.\nFinancial Instruments\nThe Company enters into futures contracts to the extent considered practicable to hedge exposure to commodity price fluctuations for grains used in the manufacturing of dairy, beef, swine and poultry feeds. All net gains and losses realized from hedging activities, which were immaterial for the years ended June 30, 1995, 1994 and 1993,\nAGWAY INC. AND CONSOLIDATED SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS (CONTINUED) (THOUSANDS OF DOLLARS)\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)\nFinancial Instruments (continued)\nare included in cost of sales. Contracts and hedges typically expire within one year and included with inventories are marked to market at the date of closing.\nMarketable Securities\nIn 1995, the Company adopted SFAS No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" Under the new rules, all of the Company's marketable debt and equity securities, which relate entirely to the company's insurance operations, are classified as available-for-sale and carried at fair value. Unrealized gains and losses, net of tax, are reported in a separate component of shareholders' equity. At June 30, 1995, the effects of adopting this statement resulted in a reduction in shareholders' equity, net of tax, of approximately $300.\nOther Security Investments\nOther security investments consists of capital stock of a cooperative bank and other cooperative suppliers acquired at par or stated value. This bank stock is not traded and is historically redeemed on a periodic basis by the bank at cost. By its nature, this stock is held to redemption and is reported at cost. Patronage refunds received from the cooperative bank in the form of additional bank stock and cash are recorded as a reduction of interest expense and totaled approximately $1,200, $1,600 and $2,000 for the years ended 1995, 1994 and 1993, respectively. Patronage refunds received on the stock of other cooperatives are reflected in other income.\nProperties and Equipment\nProperty and equipment is recorded at cost. Depreciation and amortization are charged to operations, principally on a straight-line basis, over the estimated useful lives of the properties and equipment, and over the term of the lease for capital leases. Ordinary maintenance and repairs are charged to operations as incurred. Gains and losses on disposition or retirement of assets are reflected in income as incurred.\nOther Assets\nOther assets include approximately $16,000 and $19,400 at June 30, 1995 and 1994, respectively, of costs in excess of the fair value of net tangible assets acquired in purchase transactions (goodwill) as well as acquired non-compete agreements and trademarks. Goodwill and other intangible assets are amortized on a straight-line basis over periods ranging from 1 to 40 years. Amortization included in continuing operations totaled approximately $7,800, $8,600, and $10,200 for fiscal years ending June 30, 1995, 1994 and 1993, respectively.\nImpairment of Long-Lived Assets\nIn March 1995, the Financial Accounting Standards Board issued SFAS No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.\" This statement requires the recognition of both economic and permanent impairment losses on long-lived assets. The statement is effective for fiscal years beginning after December 15, 1995 (the Company's fiscal 1997). The adoption effect of this statement cannot be reasonably estimated at this time.\nEnvironmental Remediation Costs\nThe Company accrues for losses associated with environmental remediation obligations when such losses are probable and reasonably estimable. Accruals for estimated losses from environmental remediation obligations generally are recognized no later than completion of the remedial feasibility study. Such accruals are adjusted as further information develops or circumstances change. Costs of future expenditures for environmental remediation obligations are not discounted to their present value. Recoveries of environmental remediation costs from other parties are recorded as assets when their receipt is deemed probable.\nAGWAY INC. AND CONSOLIDATED SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS (CONTINUED) (THOUSANDS OF DOLLARS)\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)\nResearch and Development\nThe Company expenses research and development costs as they are incurred. Net research and development costs were approximately $2,100, $2,600 and $2,100 for the years ended June 30, 1995, 1994 and 1993, respectively.\nAdvertising Costs\nThe Company generally expenses advertising costs as incurred or shown. Prepaid advertising costs at June 30, 1995 and 1994 are immaterial. Advertising expense for the years ended June 30, 1995, 1994 and 1993 was approximately $39,300, $42,300 and $40,200, respectively.\nIncome Taxes\nThe Company provides for income taxes in accordance with the provisions of SFAS No. 109, \"Accounting for Income Taxes.\" Under the liability method specified by SFAS No. 109, deferred tax assets and liabilities are based on the difference between the financial statement and tax basis of assets and liabilities as measured by the enacted tax rates which are anticipated to be in effect when these differences reverse. The deferred tax provision is the result of the net change in the assets and liabilities for deferred tax. A valuation allowance is established when it is necessary to reduce deferred tax assets to amounts expected to be realized.\nReclassifications\nCertain reclassifications have been made to conform prior year financial statements with the current year presentation.\nAGWAY INC. AND CONSOLIDATED SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS (CONTINUED) (THOUSANDS OF DOLLARS)\n2. AGWAY FINANCIAL CORPORATION\nAgway Financial Corporation (AFC) is a wholly owned subsidiary of Agway whose principal business activity is securing financing through bank borrowings and issuance of corporate debt instruments to provide funds for its sole stockholder, Agway, and AFC's sole wholly owned subsidiary, Agway Holdings Inc. (AHI), and its subsidiaries, for general corporate purposes. The payment of principal and interest on this debt is absolutely and unconditionally guaranteed by Agway. In an exemptive order granted by the Securities and Exchange Commission, AFC, as a separate company, is not required to file periodic reports with respect to these debt securities provided the 1934 Act reports of Agway contain summarized financial information concerning AFC. Accordingly, summarized financial information for AFC and Consolidated Subsidiaries is as follows:\nOn July 1, 1994, certain subsidiaries of AFC were transferred to Agway Inc., and certain operating divisions of Agway Inc. were transferred to AFC. The above summarized financial information for the fiscal years ended June 30, 1994 and 1993 have been restated to reflect these changes.\n3. RESTRUCTURING RESERVES\nIn June 1992, the Company established a $75,000 reserve for the estimated net cost to complete a significant restructuring of the Company (the Project) planned at that time. As initiatives within the restructuring project have been completed and the Project has drawn closer to an end, the Company has been constantly monitoring the estimates of cost to complete. The estimated total project cost as of June 30, 1995 is $65,687 ($75,000 less credits to date of $9,313) and includes a net $6,152 in reserves left to be used. The remaining estimated cost to complete of $6,152 is comprised of $3,597 of environmental-related cost, which will be managed over time in coordination with the Company's overall environmental management activities, and $2,555 of remaining initiatives expected to be completed in fiscal 1996. The $9,313 reduction in cost from the $75,000 original estimate to the current estimate was recognized in income, $6,065 in fiscal 1994 and $3,248 in fiscal 1995.\nAGWAY INC. AND CONSOLIDATED SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS (CONTINUED) (THOUSANDS OF DOLLARS)\n3. RESTRUCTURING RESERVES (CONTINUED)\nDuring the three years ended June 30, 1995, the Company has implemented a substantial portion of its original restructuring plans with modifications, revisions and refinement as determined to be appropriate during this detail implementation period. The more significant revisions made at June 30, 1995 and 1994 related to retention of certain locations originally targeted for divestiture, and severance and other costs in connection with personnel reductions which reduced estimated disposal costs. These reductions were partially offset by additional corporate costs, principally contract buyouts and other costs and outside consulting fees. In 1995, the Company released restructuring reserves to income totaling a net $1,279 in the third quarter and $1,969 in the fourth quarter.\nAGWAY INC. AND CONSOLIDATED SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS (CONTINUED) (THOUSANDS OF DOLLARS)\n3. RESTRUCTURING RESERVES (CONTINUED)\nFor the Year Ended June 30, 1993\n(1) Includes demolition, asset transfer costs, and commissions on real estate transactions. (2) Includes amounts of relocation, debt restructuring costs, legal fees, and other costs.\nAGWAY INC. AND CONSOLIDATED SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS (CONTINUED) (THOUSANDS OF DOLLARS)\n3. RESTRUCTURING RESERVES (CONTINUED)\n(A) During the quarter ended March 31, 1995, the Company completed a review of the planned technological improvement for data warehouse, customer management and supply chain management and concluded that the anticipated future cost of these improvements was excessive for the benefits expected to be achieved. As a result, the employee reductions and related severance originally expected from implementation of this technology will not be realized, and the corresponding restructuring reserve was eliminated.\n(B) Represents certain assets identified for disposition as part of the original restructuring plan which have yet to be sold or closed. Efforts to sell the assets and complete the shutdowns are ongoing. Ultimate disposition will depend upon successful negotiations with willing buyers for remaining properties. During the third and fourth quarters of 1995, it was determined by management that certain anticipated proceeds from the sale of fixed assets would be less than originally estimated and certain assets originally scheduled for disposal will be retained for use in the business. Therefore, the reserve estimates for these items have been revised to reflect these facts. The Company anticipates that the remaining planned activities will be completed in fiscal 1996.\n(C) Cost of divestitures includes shutdown costs in connection with the closing and sale of remaining locations. Ultimate disposition will depend upon successful negotiations with willing buyers for remaining properties. As operational shutdowns are completed, additional costs are expected to be incurred in excess of the original estimations. As a result, an increase to this component of the restructuring reserve was required during 1995. The Company anticipates these efforts will be completed in fiscal 1996.\n(D) Included in the costs related to business divestitures are environmental remediation costs, identified during the process of asset sales, that primarily relate to real estate assets retained on energy business sold. These anticipated environmental costs are reviewed periodically by the Company's environmental engineers and adjusted for changes in circumstances. These anticipated cash outlays are part of the ongoing programs regarding environmental remediation and are expected to be incurred over the next four years. The revision to this component reflects larger anticipated costs associated with the environmental remediation.\n(E) As a result of the termination of certain planned technological improvements noted under Item (A), future consulting costs have been eliminated. Additionally, contract buyouts and other costs have been concluded.\nAGWAY INC. AND CONSOLIDATED SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS (CONTINUED) (THOUSANDS OF DOLLARS)\n4. LEASES RECEIVABLE AND ALLOWANCE FOR CREDIT LOSSES\nNet investments in leases at June 30 were as follows:\n1995 1994 --------- --------- Leases (minimum payments): Commercial and agricultural .................. $ 448,873 $ 366,589 Retail ....................................... 2,461 2,034 --------- --------- Total leases .............................. 451,334 368,623 Unearned interest and finance charges .......... (110,322) (84,984) Net deferred origination costs ................. 6,904 5,236 --------- --------- Net investment ............................ 347,916 288,875 Allowance for credit losses .................... (15,331) (12,434) --------- --------- Net leases receivable ..................... $ 332,585 $ 276,441 ========= =========\nIncluded within the above are unguaranteed estimated residual values of leased property approximating $49,900 and $43,800 at June 30, 1995 and 1994, respectively. Additionally, as of June 30, 1995, 1994 and 1993, the recognition of interest income was suspended on approximately $3,800, $7,700 and $11,800, respectively, of net leases.\nContractual maturities of leases (minimum payments) over the next five years and thereafter were as follows at June 30, 1995: $142,730 in 1996, $110,505 in 1997, $78,801 in 1998, $49,407 in 1999, $26,183 in 2000 and $43,708 thereafter.\n5. INVENTORIES\nInventories at June 30 consist of the following:\n1995 1994 -------- -------- Raw materials ................................ $ 21,221 $ 23,292 Finished goods ............................... 139,791 158,639 Goods in transit and supplies ................ 16,984 15,857 -------- -------- Total inventories ........................ $177,996 $197,788 ======== ========\nInventories valued at the lower of LIFO (last-in, first-out) cost or market include refined products of Agway Petroleum Corporation. At June 30, 1995 and 1994, current costs exceeded LIFO costs by approximately $700 and $400, respectively. The total of such inventories was approximately $13,000 at June 30, 1995 and $9,000 at June 30, 1994.\nAGWAY INC. AND CONSOLIDATED SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS (CONTINUED) (THOUSANDS OF DOLLARS)\n6. MARKETABLE SECURITIES\nThe cost of securities sold is based on the specific identification method. Realized gains and losses, declines in value judged to be other-than-temporary and interest and dividends are included in income. Prior to July 1, 1994, debt securities were stated at amortized cost while preferred and common stocks were stated at fair value.\nProceeds from the sale of debt and equity securities totaled approximately $774, $21,708 and $30,752 in 1995, 1994 and 1993, respectively. Gross gains of approximately $400 and $1,300 were realized on those sales in 1994 and 1993, respectively. There were no gains realized in 1995. Gross losses realized on those sales in 1995, 1994 and 1993 were immaterial.\nAt June 30, 1995, the Company did not hold any debt or equity securities from a single issuer that exceeded 10 percent of the Company's shareholders' equity.\nThe amortized cost and fair value of available-for-sale debt securities at June 30, 1995, 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.\nAmortized Fair Cost Value ------- ------- Due in one year or less $ 2,998 $ 2,444 Due after one year through five years 5,655 5,237 Due after five years through ten years 4,143 3,868 Due after ten years 20,756 21,455 ------- ------- $33,552 $33,004 ======= =======\nAGWAY INC. AND CONSOLIDATED SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS (CONTINUED) (THOUSANDS OF DOLLARS)\n7. PROPERTIES AND EQUIPMENT\nProperties and equipment, at cost, including capital leases, consist of the following at:\nJune 30, 1995 Owned Leased Combined ------------- -------- -------- --------\nLand and land improvements ................. $ 41,623 $ 1,071 $ 42,694 Buildings and leasehold improvements ....... 166,249 8,991 175,240 Machinery and equipment .................... 268,900 10,499 279,399 Office equipment ........................... 40,773 169 40,942 Automotive equipment ....................... 85,535 85,535 Capital projects in progress ............... 17,911 17,911 -------- -------- -------- 620,991 20,730 641,721 Less: accumulated depreciation and amortization ....................... 313,872 16,536 330,408 -------- -------- -------- Properties and equipment, net .............. $307,119 $ 4,194 $311,313 ======== ======== ========\nJune 30, 1994 Owned Leased Combined ------------- -------- -------- --------\nLand and land improvements ................. $ 41,432 $ 1,070 $ 42,502 Buildings and leasehold improvements ....... 165,947 9,375 175,322 Machinery and equipment .................... 253,289 10,645 263,934 Office equipment ........................... 33,572 193 33,765 Automotive equipment ....................... 81,781 243 82,024 Capital projects in progress ............... 13,192 13,192 -------- -------- -------- 589,213 21,526 610,739 Less: accumulated depreciation and amortization ....................... 275,362 17,018 292,380 -------- -------- -------- Properties and equipment, net .............. $313,851 $ 4,508 $318,359 ======== ======== ========\nDepreciation and amortization expense relating to properties and equipment amounted to approximately $39,792, $40,085 and $41,683 in 1995, 1994 and 1993, respectively.\nAGWAY INC. AND CONSOLIDATED SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS (CONTINUED) (THOUSANDS OF DOLLARS)\n8. INCOME TAXES\nThe provision (benefit) for income taxes as of June 30 consists of the following:\n1995 1994 1993 -------- -------- -------- Continuing operations: Current: Federal $ 3,100 $ 1,568 $ (7,763) State 1,466 4,015 6,604 Deferred (9,304) (7,559) (6,659) Increase (decrease) in valuation allowance 960 3,102 (6,060) -------- -------- -------- $ (3,778) $ 1,126 $(13,878) ======== ======== ======== Discontinued operations: Current: Federal $ 9,626 153 $ 8,833 State 1,438 (368) 287 Deferred 405 3,301 (1,689) -------- -------- -------- $ 11,469 $ 3,086 $ 7,431 ======== ======== ========\nThe Company's effective income tax rate on (loss) margin from continuing operations before income taxes differs from the federal statutory regular tax rate as of June 30 as follows:\n(1) For state income tax purposes, the Company does not file combined income tax returns and is therefore unable to recognize the benefit of certain net operating losses incurred by subsidiaries.\nAGWAY INC. AND CONSOLIDATED SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS (CONTINUED) (THOUSANDS OF DOLLARS)\n8. INCOME TAXES (CONTINUED)\nThe components of the deferred tax assets and liabilities as of June 30 were as follows:\nThe Company's net deferred tax asset at June 30, 1995 and 1994 of $20,840 and $12,397, respectively, consists of a net current asset of $35,888 and $36,859 included in prepaid expenses and a net long-term liability of $15,048 and $24,462 included in other liabilities as of June 30, 1995 and 1994, respectively. The total gross deferred tax assets are partially offset by a valuation allowance of $4,961 and $4,001 at June 30, 1995 and 1994, respectively. The allowance is related primarily to the Company's subsidiary, Hood, and its limitations on net operating loss carryforwards and future tax deductions for which no benefit can be realized. Based on the Company's history of taxable earnings and its expectations for the future, management has determined that operating income will more likely than not be sufficient to recognize its deferred tax assets.\nAt June 30, 1995, the Company's federal AMT credit can be carried forward indefinitely, and the net operating loss (NOL) carryforwards expire in 2010.\nAGWAY INC. AND CONSOLIDATED SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS (CONTINUED) (THOUSANDS OF DOLLARS)\n9. SHORT-TERM NOTES PAYABLE\nAs of June 30, 1995, the Company had available lines of credit with various banking institutions whereby lenders have agreed to provide funds up to $122,000 to separately financed units of the Company as follows: Agway Financial Corporation (AFC) - $65,000; Telmark - $24,000; Hood - $33,000. In addition, AFC may issue up to $60,000 of commercial paper under the terms of a separate agreement, backed by a letter of credit.\nBorrowings under these credit facilities were as follows:\nThe credit available to the Company, through its existing lines of credit with banking institutions and its commercial paper program, is sufficient to meet the Company's immediate needs. The carrying amount of the Company's short-term borrowings approximates their fair value.\nInterest rates charged by the banks on cash drawdowns of the Company's lines of credit approximate prevailing short-term borrowing rates ranging between 6.89% and 10.85% at June 30, 1995 and 6.50% and 8.50% at June 30, 1994. Interest rates on commercial paper outstanding range from 5.97% to 6.10% at June 30, 1995 and 4.35% to 4.42% at June 30, 1994.\nAt June 30, 1995, letters of credit of approximately $28,000 and $25,000, which are primarily used to back commercial paper and general liability claims, are available to AFC and Hood, respectively. Letters of credit outstanding at June 30, 1995 were approximately $25,000 and $16,300 for AFC and Hood, respectively.\nThe AFC agreements, as amended in December 1994, cover the period through October 31, 1995 and are in process of renegotiation. These AFC agreements, including $6,000 in long-term debt, are collateralized by the Company's accounts receivable and non-petroleum inventories. Amounts which can be drawn under these agreements are limited to a specific calculation based upon the total of these certain accounts receivable and non-petroleum inventories (\"collateral\"). Adequate collateral has existed throughout the fiscal year to meet the ongoing needs of the Company. In addition, the agreements include certain covenants, the most restrictive of which requires the Company to maintain specific monthly levels of interest coverage and quarterly levels of tangible net worth.\nAs a result of specific covenant violations within AFC's credit facilities at June 30, 1995, waivers were obtained effective as of June 30, 1995 and covering through August 1995, and amendments were obtained for September and October 1995 from AFC's banking institutions. Negotiations are expected to continue through October 1995, and it is management's expectation that appropriate credit facilities will continue to be in place to meet the ongoing needs of the Company.\nAGWAY INC. AND CONSOLIDATED SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS (CONTINUED) (THOUSANDS OF DOLLARS)\n9. SHORT-TERM NOTES PAYABLE (CONTINUED)\nThe Hood short-term credit facility is used to supply letters of credit as well as short-term financing. Letters of credit of $16,300 were outstanding at June 30, 1995. This facility was scheduled to expire on July 31, 1995. Hood negotiated an extension of this facility until such time as it could be restructured.\nEffective August 7, 1995, Hood restructured its line of credit facility with its bank. Per the amended agreement, the bank has made available to Hood a $28,000 facility through March 31, 1996 with an increase to $33,000 commencing on April 1, 1996. Borrowings under the line of credit facility are limited to the total of 80% of the receivables less than sixty days old plus the balance of inventories (not to exceed $5,000) to the extent that such equation does not exceed $28,000 and $33,000, respectively. Borrowings under the line of credit facility are to be repaid on demand. All outstanding cash advances are due on or before July 1, 1996. Letter of credit accommodations may be comprised of up to $18,000 of the total facility and may be advanced through June 30, 1996. Outstanding letter of credit accommodations as of June 30, 1996 are not renewable upon expiration.\n10. DEBT\nLong-Term Debt:\nLong-term debt consists of the following at June 30, 1995:\n(a) Under loan agreements, principal of $122,463 bears interest at fixed rates ranging from 5.4% to 11.50%, payments commencing July 1995 with final installments due in 1999. The notes are collateralized by the Company's investment in the bank having a book value of $22,333 at June 30, 1995.\nThe Agway and AFC debt agreements contain a number of restrictive financial covenants, the most restrictive of which requires the Company to maintain specific monthly levels of interest coverage and quarterly levels of tangible net worth. The $6,000 AFC credit facility loan covenants are integrated with the short-term facilities. As a result of specific covenant violations with the Company's short-term notes, waivers and amendments were obtained (see Note 9).\n(b) Under Telmark loan agreements with various insurance companies, principal of $151,467 bears interest at fixed rates ranging from 5.90% to 9.17%, payments commencing September 1995 with final installment due in 2000.\nAGWAY INC. AND CONSOLIDATED SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS (CONTINUED) (THOUSANDS OF DOLLARS)\n10. DEBT (CONTINUED)\nSome of the Company's subordinated debt is redeemable in whole or in part at the principal amount plus accrued interest, prior to maturity dates, at the option of the Company. The foregoing debt bears interest payable semi-annually on January 1 and July 1 of each year; the debentures at the rates quoted and the money market certificates at the greater of the quoted rate or a rate based upon the discount rate for U.S. Government Treasury Bills, with maturities of 26 weeks.\nMaturities:\nAggregate annual maturities on long-term debt during the next five years and thereafter are as follows:\nAGWAY INC. AND CONSOLIDATED SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS (CONTINUED) (THOUSANDS OF DOLLARS)\n11. COMMITMENTS AND CONTINGENCIES\nEnvironmental\nThe Company is subject to a number of governmental regulations concerning environmental matters, either directly, or as a result of the operations of its subsidiaries. Agway expects that it will be required to expend funds to participate in the remediation of certain sites, including certain Superfund sites and sites with underground fuel storage tanks. In addition, Agway expects that it will incur other expenses associated with environmental compliance.\nThe Company continually monitors its operations with respect to potential environmental issues, including changes in legally mandated standards and remediation technologies. Agway's recorded liability reflects those specific issues where remediation activities are currently deemed to be probable and where the cost of remediation is estimable. Estimates of the extent of the Company's degree of responsibility of a particular site and the method and ultimate cost of remediation require a number of assumptions for which the ultimate outcome may differ from current estimates; however, the Company believes that its past experience provides a reasonable basis for estimating its liability. As additional information becomes available, estimates are adjusted as necessary. While the Company does not anticipate that any such adjustment would be material to its financial statements, it is reasonably possible that the result of ongoing and\/or future environmental studies or other factors could alter this expectation and require the recording of additional liabilities. The extent or amount of such events, if any, cannot be estimated at this time.\nAs part of its long-term environmental protection program, the Company spent approximately $4,000 in fiscal 1995 on capital projects. The Company estimates that during fiscal 1996 and 1997 approximately $4,000 per year will be spent on additional capital projects for environmental protection. These estimates recognize the additional capital required to comply with EPA Underground Storage Tank (UST) regulations which become effective in December 1998. Presently, the total cost to comply with the EPA UST regulations is estimated to be approximately $5,000. The total capital requirements may change due to the actual number of USTs actively in use on the effective date.\nOther\nThe Company is also subject to various investigations, claims, and legal proceedings covering a wide range of matters that arise in the ordinary course of its business activities. Each of these matters is subject to various uncertainties, and it is possible that some of these matters may be resolved unfavorably to the Company. The Company has established accruals for matters for which payment is probable and amounts reasonably estimable. Management believes any liability that may ultimately result from the resolution of these matters in excess of amounts provided will not have a material adverse effect on the financial position or results of operations of the Company.\nCommitments to extend credit at the Company's leasing subsidiary, Telmark, 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. Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Outstanding commitments to extend lease financing at June 30, 1995 approximated $27,600.\nDuring fiscal 1994 and prior, the Company entered into lease sale contracts which contain limited recourse provisions which are limited to 7.5% of the sale proceeds. At June 30, 1995, the Company was contingently liable for approximately $2,600 under the limited recourse provisions.\nRent expense for the fiscal years 1995, 1994 and 1993 approximated $20,800, $14,700 and $17,200, respectively. Future minimum payments under noncancelable operating leases approximate $12,100, $9,700, $8,300, $11,500, and $4,600 for the fiscal years 1996 through 2000, respectively, and approximately $500 thereafter.\nAGWAY INC. AND CONSOLIDATED SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS (CONTINUED) (THOUSANDS OF DOLLARS)\n12. PREFERRED STOCK\nDollar values are whole dollars except where noted as (000).\nDividend payments are restricted to a maximum of 8% of par value, as governed by the Farm Credit Administration. There are 10,000 shares of authorized preferred stock undesignated as to series, rate, and other attributes. The Series A preferred stock has priority with respect to the payment of dividends. The Company maintains the practice of providing a market by repurchasing, at par, preferred stock as the holders elect to tender the securities for repurchase, subject to Board of Directors' approval. The Company practice of repurchasing preferred stock specifically does not apply to approximately 166,600 shares of 6% Series A preferred stock issued in fiscal 1994 in connection with the acquisition of local cooperative affiliates. As a condition of this transaction, the Company's repurchase practice for this preferred stock was specifically suspended for a minimum of four years through July 1997.\nAGWAY INC. AND CONSOLIDATED SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS (CONTINUED) (THOUSANDS OF DOLLARS)\n13. RETIREMENT BENEFITS\nPension Plan\nThe Company and Hood each have non-contributory defined benefit pension plans covering substantially all employees of Agway Inc. and Hood. The pension plans' benefit formulae generally base payments to retired employees upon years of credited service and a percentage of qualifying compensation during the final years of employment. Generally, pension costs are funded annually at no less than the amount required by law nor more than the maximum allowed by federal income tax guidelines. The vested benefit obligation is based on the actuarial present value of the benefits which the employee would be entitled to at the expected retirement date.\nThe majority of the plans' investments consist of U. S. government and agency securities, U. S. corporate bonds, U. S. and foreign equities, equity funds and temporary investments (short-term investments in demand notes and money market funds). At June 30, 1995 and 1994, the Company's plan assets included Company debt securities and preferred stock with estimated fair values of $4,300 and $5,500, respectively.\nAt December 31, 1994, Hood amended its pension plan so that additional benefits to be earned by employees for future service were suspended. In accordance with SFAS No. 88, \"Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits,\" a gain of approximately $5,700 was recognized in the statement of operations for fiscal 1995. The gain is the net of a decrease in the projected benefit obligation of approximately $6,800 and the recognition of previously unrecognized prior service costs of $1,100.\nThe Employees' Retirement Plan of Agway, Inc. and the H. P. Hood Inc. Pension Plan have assets that exceed accumulated benefit obligations. The following table sets forth the plans' funded status and amounts recognized in the Company's consolidated financial statements at June 30:\nAGWAY INC. AND CONSOLIDATED SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS (CONTINUED) (THOUSANDS OF DOLLARS)\n13. RETIREMENT BENEFITS (CONTINUED)\nPension Plan (continued)\nNet pension income included the following income\/(expense) components for the year ended June 30:\nIn determining the actuarial present values of the projected benefit obligations as of June 30, the following assumptions were used:\nThe effect of the changes in the weighted average discount rate was to increase the projected benefit obligation by approximately $18,100 and $1,200 and increase the accumulated benefit obligation by approximately $14,000 and $1,200 for the Company and Hood, respectively. Assumed future salary increases are age-related and range from 10.5% for lower ages to 4.8% for higher ages.\nPostretirement Benefits\nIn addition to providing pension benefits, the Company provides postretirement health care and life insurance benefits, and Hood provides postretirement health care benefits, to eligible retirees and their dependents. Eligibility for benefits depends upon age and years of service.\nPrior to July 1, 1993, the Company and Hood accounted for the expense of providing these benefits as claims were paid and through accruals based on experience. Funding of costs was made as payments were due. Effective July 1, 1993, the Company and Hood adopted SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" This standard requires companies to accrue postretirement benefits during the years employees are working and earning benefits for retirement. In connection with the adoption of this statement, the Company and Hood elected to amortize the transition obligation of approximately $40,800 and $4,600, respectively, as of July 1, 1993 over 20 years. Total net periodic benefit cost under SFAS No. 106 was approximately $6,500 and $8,400 for fiscal years 1995 and 1994, respectively, compared with the costs based on cash payments and accruals for retiree health and life insurance benefits of approximately $4,500 in 1993.\nEffective January 1, 1994, the Hood plan changed its eligibility requirements to age 62 with 25 years of service. For employees who became eligible after January 1, 1994, Hood also limited its employee subsidy.\nEffective January 1, 1995, the Company amended its postretirement health care benefits by establishing a separate and distinct insured medical program for retirees aged 65 or over, limiting the Company's subsidy to a per month\/per retiree basis for retirees aged 65 or over and modifying health care coverage for active employees and retirees under age 65. These amendments have resulted in reduction to the Company's net periodic expense and accumulated postretirement benefit obligation for the year ended June 30, 1995 of $2,000 and $15,000, respectively.\nAGWAY INC. AND CONSOLIDATED SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS (CONTINUED) (THOUSANDS OF DOLLARS)\n13. RETIREMENT BENEFITS (CONTINUED)\nPostretirement Benefits (continued)\nThe following tables set forth the plans' funded status and net periodic postretirement benefit cost recognized in the Company's consolidated financial statements at June 30:\nIn determining the accumulated postretirement benefit obligation, the weighted average discount rate used was 7.5% and 8% at June 30, 1995 and 1994, respectively. This change increased the accumulated postretirement benefit obligation by approximately $1,500.\nFor measurement purposes, the assumed health care cost trend rate used to measure the Company's accumulated benefit obligation was, for persons under age 65, 7.7% and 8% for June 30, 1995 and 1994, respectively. For persons over age 65, a 9% rate was used for June 30, 1994, and due to the plan amendment discussed previously, there was no such assumption at June 30, 1995. The health care cost trend rate assumption for fiscal 1996 and forward at June 30, 1995 and 1994 decreases gradually until the year 2002 where the ultimate trend rate is then fixed at 5.5% (6% at June 30, 1994). A one percentage point increase in the assumed health care cost trend rate at June 30, 1995 would increase the aggregate service and interest cost components of net periodic expense by $300, and the accumulated postretirement benefit obligation by $1,100.\nAGWAY INC. AND CONSOLIDATED SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS (CONTINUED) (THOUSANDS OF DOLLARS)\n13. RETIREMENT BENEFITS (CONTINUED)\nPostretirement Benefits (continued)\nFor fiscal 1995, Hood assumed a 12.5% annual rate of increase in the per capita cost of covered health care benefits decreasing gradually down to 7.5% for fiscal 2005 and remaining level thereafter. An increase in the assumed health care cost trend rate one percentage point each year would not have a material effect on the accumulated postretirement benefit obligation as of June 24, 1995 and the aggregate of the service and interest cost components of the net periodic postretirement benefit cost for fiscal 1995.\nVoluntary Employees' Beneficiary Association\nThe Company has established a Voluntary Employees' Beneficiary Association (\"VEBA\") trust to fund the employer's portion of employee and retiree health and welfare benefits. Contributions to the VEBA trust are tax deductible, subject to limitations contained in the Internal Revenue Code and regulations. Trust assets of approximately $20,500 and $21,400 are included in prepaid expenses in the accompanying balance sheets as of June 30, 1995 and 1994, respectively. The Company's current policy is to invest these trust assets primarily in government securities. Additionally, an actuarially-determined medical benefit obligation for incurred but not reported claims for active employees and retirees under 65 of approximately $4,000 and $4,900 is reflected in other current liabilities at June 30, 1995 and 1994, respectively.\nEmployees' Thrift Investment Plan\nThe Agway Inc. Employees' Thrift Investment Plan is a defined contribution plan covering substantially all employees of Agway and its subsidiaries (excluding Hood). Under the plan, each participant may invest up to 15% of his or her salary, of which a maximum of 6% qualifies for Company matching. Participant contributions are invested at the option of the participant in any combination of four funds. As of June 30, 1995, there were 4,864 employees participating in this plan. The number of employees under each investment fund at June 30, 1995 is as follows:\nCompany Security Fund 4,789 Cash Fund 286 Stock Fund 3,460 Bond Fund 471\nThe Company will contribute an amount of at least 10%, but not more than 50%, of each participant's regular contributions, as defined, up to 6% of his or her salary on an annual basis. Company contributions to this plan for fiscal years ended June 30, 1995, 1994 and 1993 were approximately $500, $1,400 and $500, respectively.\nHood maintains a separate retirement savings plan offering participating employees a program of regular savings and investment funded by their own contributions and those of Hood. The amount of contributions for fiscal 1995, 1994 and 1993 totaled approximately $1,000, $500 and $600, respectively.\nBenefit Equalization Plan\nThe Company also maintains a non-qualified, unfunded benefit equalization plan designed to provide pension and thrift benefits for employees whose normal benefits are reduced by limitations under the Employee Retirement Income Security Act (ERISA) and the Internal Revenue Code. Accrued pension costs under this plan were approximately $3,400 and $3,200 for 1995 and 1994, respectively. Net benefit expense, including the Company matching contributions in the thrift component of the plan, for 1995, 1994 and 1993 totaled approximately $400, $500 and $400, respectively. In determining the actuarial present values of the projected benefit obligations of the pension component of this plan, the same assumptions were used as those for the Company's defined benefit pension plan.\nAGWAY INC. AND CONSOLIDATED SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS (CONTINUED) (THOUSANDS OF DOLLARS)\n14. FINANCIAL INFORMATION CONCERNING SEGMENT REPORTING\nThe company operates principally in four business segments: (1) Agriculture & Consumer engages in the manufacturing and processing of various farm animal feeds, crop inputs, fertilizers, crop protectants and farm supplies under Agway Agricultural Products (AAP). Agriculture & Related Services (ARS) engages in the wholesale purchase, warehousing and distribution of agricultural supplies and materials, yard and garden items and pet food and pet supplies. It also provides marketing, purchasing, technical and strategic support for AAP, the Agway retail store outlets and the wholesale supply of certain product categories to Agway franchised representatives and other businesses. Finally, Country Products Group (CPG), engages in the manufacturing, processing and repacking of a variety of agricultural products which are marketed directly to consumer, retailers, wholesalers and processors as well as to AAP and ARS; (2) Energy markets petroleum products including gasolines, kerosene, fuel oil, propane, lubricating oils and greases, antifreeze, as well as oil and gas heating and air conditioning equipment and other related items; (3) Dairy engages in the processing and distribution of branded and private label dairy and other foods with concentration in three product classes - fluid milk, ice cream and manufactured products. Total revenue of each industry segment includes the sale of products and services to unaffiliated customers, as reported in the Company's consolidated statements of operations, as well as sales to other segments of the Company which are accounted for on a cost plus markup basis; and (4) Financial Services is engaged in the lease financing of buildings, equipment, and vehicles and markets accident and health insurance and long-term care products.\nOperating profit (loss) consists of total revenues less operating expenses. Certain expenses, including personnel, legal, tax reporting, and corporate management, are allocated based on a formula which considers assets, revenues and payroll. In prior years, expenses for rent, data processing, insurance, corporate treasury, and office services were also allocated to the segments. However, in 1995 these costs were decentralized and captured in each segment's operating profit (loss). Prior year amounts have been reclassified to conform to the results of this decentralization. In computing operating profit (loss), none of the following items have been added to or deducted from segment results: corporate expenses; interest expense, net of interest income; other income generated from assets not allocable to segments; member refunds; income taxes; and income or (loss) from discontinued operations.\nIdentifiable assets in the segments of the Company are those assets used by each segment in its operations. General management assets consist principally of cash, various prepaid expenses, fixed assets and net assets of discontinued operations. Contracts with various federal, state, and local government agencies are immaterial.\nAGWAY INC. AND CONSOLIDATED SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS (CONTINUED) (THOUSANDS OF DOLLARS)\n14. FINANCIAL INFORMATION CONCERNING SEGMENT REPORTING (CONTINUED)\nAGWAY INC. AND CONSOLIDATED SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS (CONTINUED) (THOUSANDS OF DOLLARS)\n14. FINANCIAL INFORMATION CONCERNING SEGMENT REPORTING (CONTINUED)\n15. OTHER INCOME (EXPENSE)\nThe components of other income (net) for the year ended June 30 are summarized below:\n1995 1994 1993 -------- -------- -------- Gain on Hood pension curtailment ............ $ 5,677 Rent & storage revenue ...................... 3,313 $ 3,791 $ 2,987 Patronage refund income ..................... 2,904 409 1,567 Gain\/(loss) on sale of properties & equipment 597 584 (4,189) Sale of scrap ............................... 519 446 395 Gain (loss) on sale of investments .......... -- 11 (335) Texas City Refining settlements, net ........ -- -- (1,339) Other, net .................................. (705) 357 2,703 -------- -------- -------- $ 12,305 $ 5,598 $ 1,789 ======== ======== ========\nAGWAY INC. AND CONSOLIDATED SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS (CONTINUED) (THOUSANDS OF DOLLARS)\n16. SUPPLEMENTAL DISCLOSURES ABOUT CASH FLOWS\n1993 and 1994 - During the fiscal year ended June 30, 1993, 46 local cooperative affiliates were either merged into Agway or acquired for a total purchase price of $20,395 plus certain liabilities assumed of $13,779. In fiscal 1994, six additional cooperatives were merged into Agway for a total purchase price of $1,309 plus current liabilities assumed of $2,089. In 1993, of the $20,395 purchase price, $16,316 was paid in Agway restricted preferred stock and, accordingly, was classified as other non-current liabilities with the remaining $4,079 classified as other current liabilities at June 30, 1993. The total purchase price for the 52 affiliates of $21,705 plus certain liabilities assumed of $15,868 was settled in fiscal 1994 in the form of cash ($5,044) and restricted preferred stock-- 6%, $100 par value ($16,661).\n17. DISCONTINUED OPERATIONS\nOn March 23, 1993, the Company's Board of Directors authorized management to sell its 34% interest in Curtice Burns and 99.9% interest in Hood, the major investments in what was Agway's food group segment. Management and the Board had specific plans for the divestiture of these operations and expected to divest of both investments in fiscal 1994; however, due to unanticipated occurrences, neither transaction was consummated by the end of fiscal 1994. Plans for the divestiture continued into 1995.\nCurtice Burns\nCurtice Burns accepted an offer from Pro-Fac Cooperative Inc. (Pro-Fac) to acquire all outstanding shares of Curtice Burns for $19 per share in cash, and entered into a definitive merger agreement with Pro-Fac. This agreement closed on November 3, 1994, and at that time, the Company sold its interest in Curtice Burns to Pro-Fac and received cash proceeds of $55,786 and recorded a profit, net of income taxes of $19,700, of $4,430.\nThe net sales and revenues from discontinued operations (Curtice Burns) was approximately $829,100 in 1994 and $878,600 in 1993.\nA summary of net assets of discontinued operations at June 30, 1994 is as follows:\n--------- Accounts receivable $ 66,337 Inventory 155,259 Property, plant & equipment, net 167,516 Other, net 25,352 Accounts payable and accrued expenses (128,760) Long-term debt (237,280) --------- Net assets of discontinued operations $ 48,424 =========\nAGWAY INC. AND CONSOLIDATED SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS (CONTINUED) (THOUSANDS OF DOLLARS)\n17. DISCONTINUED OPERATIONS (CONTINUED)\nHood\nAs of November 1994, the sale of Hood was anticipated to close shortly in a sale to a Hood management led buyout group, the terms of which had been generally agreed to by Agway and the management buyout group in a transaction which included a complex financing structure. A delay ensued. Based on changed business conditions and financial markets during this prolonged negotiation, on January 24, 1995, Agway and the management buyout group mutually concluded to cease the pursuit of this sale transaction.\nAgway is actively pursuing alternative buyers for Hood. Under these circumstances, while Agway is still actively interested in the sale of Hood and while such a sale could be consummated in the near future, Agway is no longer able to estimate with reasonable certainty whether a sale will occur within the next year and, accordingly, has reclassified Hood to continuing operations for financial reporting purposes.\nA reconciliation to margin (loss) from continuing operations as previously reported follows:\nA reconciliation to margin (loss) from discontinued operations as previously reported follows:\nThe net loss relating to Hood from July 1992 to March 23, 1993 was $6,510 and was reflected in the $5,977 net loss from discontinued operations through the measurement date as previously reported for the year ended June 30, 1994. This included $5,454 of losses related to the operations and sale of the cheese manufacturing division of Hood business offset by a $1,799 gain on the sale of a segment of Hood's fluid milk business.\nAGWAY INC. AND CONSOLIDATED SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS (CONTINUED) (THOUSANDS OF DOLLARS)\n17. DISCONTINUED OPERATIONS (CONTINUED)\nHood (continued)\nThe net (loss) margin and deferred expenses relating to Hood were $(6,378) and $(1,509) for the years ended June 30, 1994 and 1993, respectively. This incurred margin (loss) in relation to Hood includes deferred interest expense, actual Hood losses and a tax benefit representing the book\/tax difference in the basis of Hood. Additionally, at June 30, 1995, the loss on investment value and divestiture expenses related to Hood of $16,724 includes a $15,884 pre-tax loss for transaction costs incurred in connection with these past sales efforts and for pre-tax impairment allowance with respect to the ultimate sale of its investment in Hood.\nTotal assets and total liabilities of Hood previously reported in discontinued operations were $164,726 and $128,601 at June 30, 1994. Net sales and revenues previously reported in discontinued operations were approximately $493,000 and $504,000 in 1994 and 1993, respectively.\n18. FINANCIAL INSTRUMENTS\nThe table below presents the carrying amounts and estimated fair values of the Company's significant financial instruments held for purposes other than trading at June 30, 1995 and 1994 and derivatives at June 30, 1995. Estimated fair value amounts have been determined by the Company 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 instruments in a current market exchange. Carrying amounts of trade notes and accounts receivable, other security investments, financial instruments included in other assets and other liabilities, notes payable and accounts payable approximate their fair values because of the short-term maturities of these instruments. The fair value of the Company's long-term debt and subordinated debentures is estimated based on discounted cash computations using estimated borrowing rates available to the Company ranging from 6.75% to 8.38% in 1995 and 6.66% to 9.55% in 1994. Estimated fair values of derivatives are based on average trade prices.\nIn the normal course of business, the Company has letters of credit, performance contracts 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 instruments.\nThe Company's leasing subsidiary, Telmark, is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its leasing customers. These financial instruments consist of commitments to extend credit not recognized in the balance sheet. In the event of nonperformance by the other party to the financial instrument, the Company's credit risk is limited to the contractual amount of Telmark's commitment to extend credit.\nAGWAY INC. AND CONSOLIDATED SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS (CONTINUED) (THOUSANDS OF DOLLARS)\n18. FINANCIAL INSTRUMENTS (CONTINUED)\nCredit and Market Risk\nMost financial instruments expose the holder to credit risk for non-performance and to market risk for changes in interest and currency rates. The Company, operating as an agricultural cooperative in the Northeast, has a concentration of accounts and lease receivables due from farmer\/members throughout the region. This concentration of agricultural customers may affect the Company's overall credit risk in that the repayment of farmer\/member receivables may be affected by inherent risks associated with (1) the overall economic environment of the region and (2) the impact of adverse regional weather conditions on crops. The Company mitigates this credit risk by analyzing farmer\/member credit positions prior to extending credit and requiring collateral (in the form of crop liens) on long-term arrangements.\nEnergy extends unsecured credit to petroleum wholesalers and residential fuel-oil customers. The Consumer business extends working capital lines of credit, secured by inventory and accounts receivable, to its representatives. The credit function within the Energy and Consumer businesses manage credit risk associated with these trade receivables by routinely assessing the financial strength of its customers.\nThe Company manages market risk primarily by investing in short-term, highly liquid investments and, in the case of derivatives, by limiting the use of derivatives to hedging activities or by limiting potential exposure to amounts that are not material to result of operation or cash flow. The Company does not enter into derivative financial instruments to speculate. The use of derivative instruments has been limited to hedging exposure to price fluctuations on grain and, to a limited extent, petroleum purchases.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nDIRECTORS\nThe Directors of the Company determine Company policy and are nominated on a district representation basis by committees representing members within each district. Each of the following directors is a full-time farmer and has been engaged in full-time farming during the past five years:\nRalph H. Heffner, Chairman of the Board of Directors, was paid $50,200 and Robert L. Marshman, Vice Chairman of the Board of Directors, was paid $13,014 for their services for the fiscal year ended June 30, 1995. All other directors were paid an annual retainer fee of $6,000 and an amount of $200 for each day that they were involved in business for the Company. The Company has a program in which all directors have an option to either receive or defer amounts earned as directors. Expenses of Board members incurred in connection with Company business are reimbursed by the Company.\nEffective July 1, 1993, a retirement benefit plan was instituted for existing and future Board members. The terms of this plan require annual payments to retired or permanently disabled directors who serve a minimum of six full years. The benefit is computed at $250 for each full year of service and is paid to the director or surviving spouse for a period equal to the years served on the Board.\n(1) All correspondence in relation to operational matters should be addressed to D. P. Cardarelli, President, Chief Executive Officer and General Manager, Agway Inc., P.O. Box 4933, Syracuse, New York 13221.\n(2) On May 18, 1995, Mr. Chapman and Mildred E. Chapman, doing business as Chapman Farms and Chapman Country Store, filed a petition under Chapter 12 of the Federal Bankruptcy Code in U. S. Bankruptcy Court, Utica, New York. Agway was listed as an unsecured creditor in the sum of $34,000.\n(3) Director of Long Island Lighting Company.\nITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - CONTINUED\nEXECUTIVE OFFICERS\nThe executive officers of the Company provide operating control to carry out the policies established by the Board of Directors and serve at the discretion of the Board with no guarantee of employment. There are no full-time executive officers of the Company who are members of the Board of Directors. The principal occupation of all executive officers of the Company for the past five years, except for Mr. Schalk, has been as an officer or employee of the Company. The following is a listing of these officers as of July 1, 1995, except as noted below:\nMr. Cardarelli served as Executive Vice President for Agway Insurance Company from July 1988 through August 1991, as Treasurer of the Company from August 1991 through May 1992 and as Vice President, Treasurer of the Company from May 1992 to August 1994, as Executive Vice President and Chief Operating Officer from August 1994 to January 1995 and as General Manager and CEO from January 1995 and President from February 1995 to July 1, 1995.\nMr. Burnett served as Director, Corporate Personnel from August 1988 through November 1990, as Vice President, Financial Services Group from November 1990 through July 1992, as Vice President, Country Foods from July 1992 to September 1992 and as Group Vice President, Energy from October 1992 to July 1, 1995.\nMr. Fischer has served as President, Milford Fertilizer Company since June 1970 and as Vice President, Agway Agricultural Products from September 1994 to July 1, 1995.\nMr. Fuess served as Director of Risk & Environmental Quality from January 1988 through June 1994 and as Vice President, Risk & Environmental Quality from June 1994 to July 1, 1995.\nMr. Hoefer served as Director of Public Affairs\/Government Relations from July 1984 through June 1992, as Director of Government Affairs\/Corporate Transportation Services from June 1992 through June 1994 and as Vice President, Public Affairs from June 1994 to July 1, 1995.\nMr. LaHood served as President, ADS from October 1987 to August 1992, as Director, Computer and Communication Services from August 1992 to October 1992, as Director, Country Foods from October 1992 to October 1994, as Executive Director, Country Foods and Seed Operations from October 1994 to February 1995, and as Vice President, Country Products Group from February 1995 to July 1, 1995.\nITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - CONTINUED\nEXECUTIVE OFFICERS (CONTINUED)\nMs. Luttinger served as Personnel Manager, Crop Services from March 1985 to October 1990, as Employment Services Supervisor from October 1990 to August 1992, as Director Human Resources, Corporate Groups from August 1992 to September 1994 and as Vice President, Human Resources from September 1994 to July 1, 1995.\nMr. Parker served as Vice President, Systems for Agway Insurance from July 1985 to January 1993, as Director of New Project Management from January 1993 to September 1994 and as Vice President, Information Services from September 1994 to July 1, 1995.\nMr. Schalk served as Vice President, Agriculture & Related Services from November 1994 to July 1, 1995 and as Director of Marketing-Agriculture from January 1990 to July 1993. For the period July 1993 to November 1994, Mr. Schalk was a region manager of Harris Moran Seed Co.\nMr. Sears served as Director of Business Development of Country Foods from June 1990 through June 1992, as Director of Member Relations from June 1992 through June 1994 and as Vice President, Membership from June 1994 to July 1, 1995.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe following table sets forth information regarding annual and long-term compensation for services in all capacities to the Company for the fiscal years ended June 1995, 1994 and 1993 of those persons who served as (i) the chief executive officer (CEO) at any time during the prior fiscal year, and (ii) the other four most highly compensated executive officers of the Company (other than the CEO) who were serving in such capacity at June 30, 1995.\n(1) Salary is used in determining the average annual compensation pursuant to the Company's retirement plan. This amount includes all deferred amounts under the Company's 40l(k) Plan and Benefits Equalization Plan.\n(2) Bonuses are payable in cash or executives may elect to defer their awards for payments at a later date, subject to certain contingencies. Members of the General Manager Staff and Division Management Group and other executives designated by the Company's principal executive officer are eligible for participation in the Agway Inc. Management Incentive Plan (the \"Plan\"). Contingent upon each individual's performance, the Company's net margin, and other performance factors, each eligible executive may be paid a bonus. Bonuses are reflected in the fiscal year earned regardless of payment date.\n(3) Amounts shown for certain officers include contributions made by the Company to the Agway Inc. Employees' Thrift Investment Plan, the Agway Inc. Employees' Benefit Equalization Plan, the Agway Inc. Employees' Deferred Compensation Program, non-compete payments and any other payments not appropriately characterized as salary or bonus.\nITEM 11. EXECUTIVE COMPENSATION - CONTINUED\n(4) On August 29, 1994, the board of directors elected Mr. Cardarelli to the position of executive vice president and chief operating officer with full responsibility for management of the Company. Mr. Cardarelli was named chief executive officer and general manager of Agway Inc., January 10, 1995. He assumed the additional title of president upon the retirement of Mr. Saul on February 1, 1995.\n(5) On August 29, 1994, Mr. Saul, then president, chief executive officer and general manager of Agway Inc., announced that he would retire on February 1, 1995. Until that date, Saul retained the title of president and represented Agway in a number of agricultural industry and ag-cooperative related projects. In connection with his retirement, he received other compensation totaling $249,246.\nLONG-TERM INCENTIVE PLAN\nThe Company had a Long-Term Incentive Plan (the \"Incentive Plan\") effective July 1, 1992 to provide an incentive to the former president, CEO and general manager, Mr. Saul, to achieve specified levels of equity. Awards under the Incentive Plan had a maturity date of June 30, 1995. No amounts were earned pursuant to this plan and no other long-term incentive plans existed as of June 30, 1995.\nEMPLOYEES' RETIREMENT PLAN\nThe Employees' Retirement Plan of Agway Inc. (the \"Retirement Plan\") is a non-contributory defined benefit plan covering substantially all employees. The Retirement Plan provides for retirement benefits, at a normal retirement age of 65, based upon average annual compensation received during the highest 60 consecutive months in the last 10 years of service and credited years of service. Optional earlier retirement and other benefits are also provided. The Retirement Plan pays a monthly retirement benefit based on the greater amount calculated under two formulas. The benefit amount under one formula is subject to an offset for Social Security benefits.\nThe following table shows estimated annual benefits payable upon retirement based on certain 5-year average remuneration levels and years-of-service classifications. The table was developed assuming a normal retirement at age 65.\n*Amount under the Retirement Plan may be subject to reduction because of the limitations imposed under the Internal Revenue Code; however, the extent of any reduction will vary in individual cases according to circumstances existing at the time pension payments commence. The Company's Employees' Benefit Equalization Plan of Agway Inc. has been established to provide for the amount of any such reduction in annual pension benefits under the Retirement Plan.\nITEM 11. EXECUTIVE COMPENSATION - CONTINUED\nEMPLOYEES' RETIREMENT PLAN (CONTINUED)\nThe benefits shown are computed on a straight life basis and do not reflect an offset for up to 50% of the Social Security benefits, subject to certain minimum benefits. Also, the benefits are based on continuing the Plan's benefit formulas as in effect on June 30, 1995. As of June 30, 1995, the officers and their respective number of credited years of service under the Retirement Plan were as follows: Messrs. Cardarelli, 10; Saul, 41; O'Neill, 6; Burnett, 25; and Hayes, 22. Mr. Fischer does not participate in the retirement plan nor any other long-term incentive programs of the Company. However, he participates in the profit sharing plan of Milford Fertilizer. \"Compensation\" is defined as the regular salary or wages, as reported in the \"Salary\" column of the Summary Compensation Table, which is paid to an employee for services rendered to Agway Inc., including overtime and vacation pay but excluding bonuses or special pay.\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDE PARTICIPATION\nThere are no reportable items under this caption.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThere are no reportable items under this caption.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nAgway's members, including its Directors, are customers of the Company or its subsidiaries. They purchase product from the Company in the normal course of operating their farm businesses and may sell certain agricultural product to the Company at market prices. The prices, terms and conditions of any purchase or sale transaction is on the same basis for all of the Company's members.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\nSchedules other than these listed above have been omitted as they are not required, inapplicable, or the required information is included in the consolidated financial statements or notes thereto.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors of Agway Inc.:\nOur report on the consolidated financial statements of Agway Inc. and Consolidated Subsidiaries has been included in this Form 10-K of Agway Inc. and Consolidated Subsidiaries. In connection with our audits of such financial statements, we have also audited the related financial statement schedules listed in Item 14(a)(2)(ii) of Part IV of this Annual Report on 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.\nSyracuse, New York September 15, 1995\nITEM 14(A)(2). FINANCIAL STATEMENT SCHEDULES\nAGWAY INC. AND CONSOLIDATED SUBSIDIARIES SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT ----------------------------------------------------------\nAGWAY INC. CONDENSED BALANCE SHEETS JUNE 30, 1995 AND 1994 (THOUSANDS OF DOLLARS)\nITEM 14(A)(2). FINANCIAL STATEMENT SCHEDULES - CONTINUED\nAGWAY INC. AND CONSOLIDATED SUBSIDIARIES SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT ----------------------------------------------------------\nAGWAY INC. CONDENSED STATEMENTS OF OPERATIONS AND RETAINED MARGIN FISCAL YEARS ENDED JUNE 30, 1995, 1994 AND 1993 (THOUSANDS OF DOLLARS)\nITEM 14(A)(2). FINANCIAL STATEMENT SCHEDULES - CONTINUED\nAGWAY INC. AND CONSOLIDATED SUBSIDIARIES SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT ----------------------------------------------------------\nAGWAY INC. CONDENSED CASH FLOW STATEMENTS FISCAL YEARS ENDED JUNE 30, 1995, 1994 AND 1993 (THOUSANDS OF DOLLARS)\nITEM 14(A)(2). FINANCIAL STATEMENT SCHEDULES - CONTINUED\nAGWAY INC. AND CONSOLIDATED SUBSIDIARIES SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT ----------------------------------------------------------\nAGWAY INC. ADDITIONAL DISCLOSURES FISCAL YEARS ENDED JUNE 30, 1995, 1994 AND 1993 (THOUSANDS OF DOLLARS)\nBASIS OF PRESENTATION\nIn the preceding condensed financial statements, which represent the parent company only, the Company's investment in subsidiaries is stated at cost plus equity in undistributed earnings of subsidiaries since the date of acquisition. These financial statements should be read in conjunction with the Company's consolidated financial statements.\nINVENTORIES\nInventories at June 30 consist of the following:\n1995 1994 ------- ------- Raw materials ............... $14,989 $14,479 Finished goods .............. 36,902 45,214 Goods in transit and supplies 3,567 2,877 ------- ------- $55,458 $62,570 ======= =======\nDEBT\nDebt capital for Agway is supplied by its wholly owned subsidiary, AFC, which provides financing through issuance of debt securities and bank borrowings. The payment of principal and interest on such debt is absolutely and unconditionally guaranteed by Agway. The total debt of AFC guaranteed by Agway is disclosed in Note 10.\nRELATED PARTY TRANSACTIONS\nTransactions between Agway Inc. and its unconsolidated subsidiaries are as follows:\nFISCAL YEARS ENDED JUNE 30, -------------------------------- 1995 1994 1993 -------- -------- -------- Net sales and revenues ..................... $ 42,291 $ 64,025 $181,489 Product and plant operation expenses ....... 11,523 7,201 1,821 Selling, general and administrative expenses ............................. 15,618 15,348 10,890 Other income, net .......................... 15,618 15,345 10,885 Interest expense, net ...................... 4,710 10,679 5,072\nITEM 14(A)(2). FINANCIAL STATEMENT SCHEDULES - CONTINUED\nAGWAY INC. AND CONSOLIDATED SUBSIDIARIES SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS (THOUSANDS OF DOLLARS)\n------------------------------------------------------------------------------- (a) Accounts charged off, net of recoveries. (b) Difference between cost and market of applicable inventories. (c) Reversal due to change in circumstance attributable to future taxable income from sale of discontinued subsidiary investments.\nITEM 14(B). REPORTS ON FORM 8-K\nNo reports on Form 8-K for the three months ended June 30, 1995, have been filed.\nITEM 14(C)(1). EXHIBITS REQUIRED BY SECURITIES AND EXCHANGE COMMISSION REGULATION S-K\n(i) The following required exhibits are hereby incorporated by reference to previously filed Registration Statements on Forms S-1, S-2 or S-3, filed on the dates as specified:\nARTICLES OF INCORPORATION AND BY-LAWS\n3(a) - Certificate creating series of preferred stock of Agway Inc. dated July 5, 1977, filed by reference to Exhibit 3(a)(5) of Registration Statement on Form S-1, File No. 2-59896, dated September 16, 1977.\n3(b) - Certificate creating series of Honorary Member Preferred Stock of Agway Inc. dated June 15, 1981, filed by reference to Exhibit 1(c) of the Registration Statement on Form S-1, File No. 2-73928, dated September 3, 1981.\nINSTRUMENT DEFINING THE RIGHTS OF SECURITY HOLDERS, INCLUDING INDENTURES\n4(a) - The Indenture dated as of August 25, 1982, between Agway and Key Bank of Central New York of Syracuse, New York, Trustee, including forms of Subordinated Money Market Certificates (Minimum 9% per annum) due October 31, 1997, and Subordinated Money Market Certificates (minimum 9 1\/2% per annum) due October 31, 1997, filed by reference to Exhibit 4 of the Registration Statement (Form S-1), file No. 2-79047, dated August 27, 1982.\n4(b) - The Indenture dated as of September 1, 1985, between Agway and Key Bank of Central New York of Syracuse, New York, Trustee, including forms of Subordinated Money Market Certificates (Minimum 7 1\/2% per annum) due October 31, 2005, and Subordinated Member Money Market Certificates (Minimum 8% per annum) due October 31, 1995, filed by reference to Exhibit 4 of the Registration Statement (Form S-2), File No. 2-99905, dated August 27, 1985.\n4(c) - The Indenture dated as of September 2, 1985, between Agway and Key Bank of Central New York of Syracuse, New York, Trustee, including forms of Subordinated Money Market Certificates (Minimum 8% per annum) due October 31, 1995, and Subordinated Member Money Market Certificates (Minimum 8 1\/2% per annum) due October 31, 1995, filed by reference to Exhibit 4 of the Registration Statement (Form S-2), File No. 2-99905, dated August 27, 1985.\n4(d) - The Indenture dated as of September 1, 1986 between AFC and Key Bank of Central New York of Syracuse, New York, Trustee, including forms of Subordinated Member Money Market Certificates (Minimum 6 1\/2% per annum) due October 31, 1996, Subordinated Member Money Market Certificates (Minimum 6% per annum) due October 31, 2006, Subordinated Money Market Certificates (Minimum 6% per annum) due October 31, 1996, and Subordinated Money Market Certificates (Minimum 5 1\/2% per annum) due October 31, 2006, filed by reference to Exhibit 4 of the Registration Statement (Form S-3), File No. 33-8676, dated September 11, 1986.\n4(e) - The Supplemental Indenture dated as of October 1, 1986 among AFC, Agway Inc. and Key Bank of Central New York of Syracuse, New York, Trustee, including forms of subordinated debt securities filed by reference to Exhibit 4 of Registration Statement on Form S-3, File No. 33-8676, dated September 11, 1986.\nITEM 14(C)(1). EXHIBITS REQUIRED BY SECURITIES AND EXCHANGE COMMISSION REGULATION S-K - CONTINUED\n4(f) - The Indenture dated as of August 24, 1987 between AFC and Key Bank of Central New York of Syracuse, New York, Trustee, including forms of Subordinated Member Money Market Certificates (Minimum 7% per annum) due October 31, 1998, and Subordinated Member Money Market Certificates (Minimum 6 1\/2% per annum) due October 31, 2008, and Subordinated Money Market Certificates (Minimum 6 1\/2% per annum) due October 31, 1998, and Subordinated Money Market Certificates (Minimum 6% per annum) due October 31, 2008, filed by reference to Exhibit 4 of Registration Statement on Form S-3, File No. 33-16734, dated August 31, 1987.\n4(g) - The Indenture dated as of August 23, 1988 between AFC and Key Bank of Central New York of Syracuse, New York, Trustee, including forms of Subordinated Member Money Market Certificates (Minimum 9 1\/2% per annum) due October 31, 2000, and Subordinated Member Money Market Certificates (Minimum 9% per annum) due October 31, 2008, and Subordinated Money Market Certificates (Minimum 9% per annum) due October 31, 2000, and Subordinated Money Market Certificates (Minimum 8 1\/2% per annum) due October 31, 2000, filed by reference to Exhibit 4 of Registration Statement on Form S-3, File No. 33-24093, dated August 31, 1988.\n4(h) - The Supplemental Indenture dated as of October 14, 1988 among AFC, Agway Inc. and Key Bank of Central New York, National Association, Trustee, amending the Indentures dated as of August 23, 1988 and August 24, 1988 filed on October 18, 1988.\n4(i) - The Indenture dated as of August 23, 1989, among AFC, Agway Inc. and Key Bank of Central New York of Syracuse, New York, Trustee, including forms of Subordinated Money Market Certificates and Subordinated Members Money Market Certificates, filed by reference to Exhibit 4 of Registration Statement on Form S-3, File No. 33-30808, dated August 30, 1989.\n4(j) - AFC Board of Directors resolutions authorizing the issuance of Money Market Certificates under Indentures dated as of August 23, 1989.\n4(k) - Agway Board of Directors resolutions authorizing the issuance of Honorary Member Preferred Stock, Series HM and Membership Common Stock and authorizing AFC to issue Money Market Certificates under Indentures dated as of August 23, 1989.\nITEM 14(C)(1). EXHIBITS REQUIRED BY SECURITIES AND EXCHANGE COMMISSION REGULATION S-K - CONTINUED\n4(l) - The Supplemental Indenture dated as of August 24, 1992 among AFC, Agway Inc. and Key Bank of New York, Trustee, amending the Indenture dated as of August 23, 1989.\n(ii)The following exhibits are filed as a separate section of this report:\n3 - AGWAY, INC. BY-LAWS AS AMENDED MARCH 20, 1995\n12 - STATEMENTS RE COMPUTATION OF RATIOS\n13 - ANNUAL REPORT TO SECURITY HOLDERS, FORM 10-Q OR QUARTERLY REPORT TO SECURITY HOLDERS\n21 - SUBSIDIARIES OF THE REGISTRANT - 23 - CONSENTS OF EXPERTS AND COUNSEL\n27 - FINANCIAL DATA SCHEDULE\n99 - ADDITIONAL EXHIBITS The Annual Report on Form 11-K for fiscal year ended June 30, 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.\nAGWAY INC. (Registrant)\nBy \/s\/ Donald P. Cardarelli DONALD P. CARDARELLI PRESIDENT, CEO AND GENERAL MANAGER (PRINCIPAL EXECUTIVE OFFICER)\nDate September 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.\nSUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT TO SECTION 15(D) OF THE ACT BY REGISTRANTS WHICH HAVE NOT REGISTERED SECURITIES PURSUANT TO SECTION 12 OF THE ACT.\nAs of the date of this filing on Form 10-K, the Registrant has not had available to be sent to security holders the annual report for fiscal year ended June 30, 1995. Subsequent to the filing of the annual report on Form 10-K, the Registrant shall furnish security holders with annual reports.\nAGWAY INC. FORM 10-K JUNE 30, 1995 EXHIBIT INDEX\nExhibit Number Title ------- -----\n( 3) Articles of incorporation and by-laws\n(12) Statements re computation of ratios\n(13) Annual report to security holders, Form 10-Q or quarterly report to security holders\n(21) Subsidiaries of registrant\n(23) Consent of experts and counsel\n(27) Financial data schedule*\n(99) Additional exhibits Annual report on Form 11-K for the year ended June 30, 1995 of The Agway Inc.Employees' Thrift Investment Plan\n*Included with electronic filing only.","section_15":""}
{"filename":"7973_1995.txt","cik":"7973","year":"1995","section_1":"ITEM 1. BUSINESS\nAssociates Corporation of North America (\"Associates\" or the \"Company\"), a Delaware corporation, is a wholly-owned subsidiary and principal operating unit of Associates First Capital Corporation (\"AFCC\"), which in turn is an indirect subsidiary of Ford Motor Company (\"Ford\"). All the outstanding stock of Associates is owned directly or indirectly by AFCC. Unless the context otherwise requires, reference to Associates or to the Company includes Associates and all its subsidiaries.\nOn February 9, 1996, AFCC announced that it filed a registration statement with the Securities and Exchange Commission for a potential initial public offering (the \"Offering\") of up to a 19.8% interest in AFCC's common stock. Immediately following the Offering, Ford will continue to own a controlling interest in the common stock of AFCC. No assurance can be made with respect to future capital contributions by AFCC to the Company after the Offering.\nThe Company is a leading, diversified consumer and commercial finance organization which provides finance, leasing and related services to individual consumers and businesses in the United States. At or for the year ended December 31, 1995, the Company had aggregate net finance receivables of $36.4 billion, total assets of $37.0 billion, net earnings of $708.1 million and stockholders' equity of $4.4 billion. The Company believes that it is the second largest independent finance company in the United States based on aggregate net finance receivables outstanding. The Company's finance receivables are geographically dispersed across the United States. At December 31, 1995, 12% of such receivables were in California, 7% in Florida, 6% in Texas, and no other individual state had more than 4%.\nThe Company divides its diverse activities into consumer finance and commercial finance. The Company's consumer finance operations consist of a variety of specialized consumer financing products and services, including home equity lending, personal lending, retail sales financing and purchasing participations in credit card receivables originated by an affiliate, Associates National Bank (Delaware) (\"ANB\"). The Company's commercial finance operations primarily provide retail financing, leasing and wholesale financing for heavy-duty and medium-duty trucks and truck trailers, construction, material handling and other industrial equipment and manufactured housing. Although financial and statistical information relating to manufactured housing financing presented herein is included with consumer finance information, the Company manages its manufactured housing financing as part of its commercial finance operations. Accordingly, manufactured housing financing operations are described under \"-- Commercial Finance\" below.\nAs part of its consumer finance and commercial finance activities, the Company makes available to its customers credit-related and other insurance products. See NOTE 17 to the consolidated financial statements for financial information by business segment.\nAlthough the Company's finance operations are confined to the United States, certain affiliates of the Company operate outside the United States, including in Japan, the United Kingdom, Canada, Puerto Rico and Mexico. The Company provides certain management and other services relating to these foreign operations. See NOTE 14 to the consolidated financial statements. The results of such foreign operations are not included in the financial or statistical information of the Company presented herein.\nAt December 31, 1995, Associates had 1,543 branch offices geographically dispersed throughout the United States and employed approximately 14,500 persons. Corporate headquarters are located in Irving, Texas.\nCertain prior year ratios presented herein have been restated to conform to current year methodology.\nCONSUMER FINANCE\nGENERAL\nThe Company's consumer finance business consists of a variety of consumer financing services, including home equity lending, personal lending, retail sales financing and purchasing participations in credit card\nreceivables originated by an affiliate, ANB. The Company, through certain subsidiaries and others, also makes available various credit-related and non-credit-related insurance products to its consumer finance customers, including credit life, credit accident and health, accidental death and dismemberment, involuntary unemployment and personal property insurance. See \"-- Related Insurance.\"\nThe following table shows net finance receivables outstanding attributable to the various types of consumer financing products (dollars in millions):\nCONSUMER NET FINANCE RECEIVABLES OUTSTANDING\n- ---------------\n(1) Information concerning manufactured housing is set forth below under \"-- Commercial Finance\". The Company considers its manufactured housing activities to be a commercial business principally because the predominant portion of its financing receivables is obtained from its relationships with manufacturers and dealers, notwithstanding that the credit and related risks typically are that of the consumer purchaser of the housing.\nAt December 31, 1995, the finance charge yield on all types of consumer net finance receivables averaged approximately 16% per annum. Variable rates were charged on approximately 32% of the consumer net finance receivables outstanding at such date. State laws often establish maximum allowable finance charges for certain consumer loans; approximately 92% of the outstanding consumer net 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. See \"-- Regulation\".\nAlthough acquisitions have represented less than 16% of consumer finance growth in 1994 and 1995, acquisitions accounted for an important part of net receivables growth in certain prior years. See NOTE 3 to the consolidated financial statements for certain acquisitions of finance businesses over the past three years.\nHOME EQUITY LENDING\nAt December 31, 1995, home equity loans accounted for the largest share (54%) of the Company's consumer finance portfolio. The Company's home equity lending activities consist of originating and servicing fixed and variable rate mortgage loans that are primarily secured by single family residential properties. Such loans are made to borrowers primarily for the purpose of debt consolidation, including the refinancing of existing mortgage loans, home improvements and a variety of other purposes. Relatively few of the Company's originations of home equity loans are mortgages used for the acquisition of homes.\nThe following table shows certain information with respect to the Company's home equity lending receivables:\nHOME EQUITY LENDING\nThe Company's home equity loans typically have maturities of up to 180 months. Approximately 32% of the Company's home equity loans are variable rate loans. While home equity loans may be secured by either first or second mortgages, at December 31, 1995, approximately 77% of the aggregate net outstanding balance of home equity lending receivables was secured by first mortgages.\nPERSONAL LOANS\/RETAIL SALES FINANCE\nThe Company's personal lending business consists of direct origination and servicing of secured and unsecured personal loans to individuals. Personal loans are direct consumer loans that are generally not secured by real estate. Such loans may be secured by existing personal property (the realizable value of which may be less than the amount of the loan secured), including automobiles, as well as consumer durables and\/or guarantees by third parties. Personal loans generally involve disbursements at the inception of the loan with installment payments leading to full amortization by maturity, which ranges up to 60 months. In general, personal loans are made for debt consolidation, home improvement, education, vacation, taxes and major purchases of appliances and other durable goods. The Company sources personal loan customers through solicitation of existing retail sales finance customers, direct mail, advertising and referrals.\nRetail sales finance contracts are generally for the purchase of items such as household electronic appliances, furniture and home improvements. The Company generally purchases retail finance sales contracts from retailers of such items. These activities provide an important source of new loan customers, since, following the purchase of a retail sales finance contract, the Company has a direct relationship with the borrower. The newly-established relationship often leads to other types of financing for the customer based on the individual's credit needs. As with personal loans, the terms of retail sales finance contracts differ based on the amount financed and the credit quality of the customer. Generally, retail sales finance contracts have terms ranging from 24 to 36 months.\nStatistical information for average personal loan and average retail sales finance contract receivables is generally similar. For example, at December 31, 1995, the average balance of the Company's outstanding personal loans was $2,269, and the average balance of the Company's outstanding retail sales finance contracts was $1,827.\nThe following table shows certain information with respect to the Company's aggregate personal lending and retail sales finance contract receivables:\nPERSONAL LENDING\/RETAIL SALES FINANCE\nCREDIT CARDS\nThe Company purchases participations in credit card receivables originated by Associates National Bank (Delaware) (\"ANB\"), an affiliate of the Company. ANB's credit card business consists primarily of VISA(R) and MasterCard(R) bankcards and private label credit cards to consumers directly to the public and through co-marketing programs. ANB issues its credit cards across a wide spectrum with interest rates based on customer credit profiles.\nThe private label credit card business of ANB principally consists of a customized private label revolving charge program for customers of Amoco Oil Company (\"Amoco\"), who utilize the cards to purchase gasoline and other automotive products at Amoco gasoline stations nationwide.\nThe following table shows certain information regarding the Company's participations in credit card receivables:\nCREDIT CARD\n- ---------------\n(1) In 1994, ANB acquired Amoco's private label gasoline credit card program, which added 3.2 million accounts. These accounts generally carried smaller balances than ANB's bankcard accounts, which had the effect of decreasing the average balance for the Company's credit card receivables in 1994 and 1995.\nThe Company's revenues from its participations are derived from finance charges on revolving accounts, the interchange fees derived from merchant discounts, annual membership and other account fees and fees earned from the sale of insurance and other fee-based products. ANB's credit card receivables typically bear variable interest rates.\nCOMMERCIAL FINANCE\nGENERAL\nThe Company's commercial finance business provides a variety of retail and wholesale financing and leasing products and services for heavy-duty (Class 8) and medium-duty (Classes 3 through 7) trucks and truck trailers, construction and material handling equipment and other industrial equipment. The Company believes that it is the leading independent source of financing for heavy-duty trucks, truck trailers and heavy construction equipment in the United States based on units financed. The Company also engages in a number of other commercial activities, including auto fleet leasing and management, Small Business Administration lending, relocation services and auto club and roadside assistance services. The Company also makes available various credit-related and non-credit-related insurance products to its commercial finance customers, including commercial auto and dealers' open lot physical damage, credit life, motor truck cargo and extended coverage insurance. See \"-- Related Insurance.\"\nThe following table shows net finance receivables outstanding attributable to the various types of commercial financing products (dollars in millions):\nCOMMERCIAL NET FINANCE RECEIVABLES OUTSTANDING\n- ---------------\n(1) Includes auto fleet leasing, Small Business Administration lending and fee-based businesses.\n(2) Except as otherwise indicated, the dollar amount of manufactured housing receivables is included in the dollar amount of total consumer net finance receivables throughout this document, because the credit and related risks of the manufactured housing business are similar to those of the Company's consumer finance business. Manufactured housing receivables are included with consumer net finance receivables in determining the percentage of total net finance receivables which are consumer net finance receivables. However, manufactured housing operations are described below under \"-- Commercial Finance -- Manufactured Housing\" as part of the Company's commercial activities because the marketing and management of manufactured housing products are more closely related to commercial finance products.\nAt December 31, 1995, the interest rates charged on approximately 17% of the commercial net finance receivables were variable rates. 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. See \"-- Regulation\". At December 31, 1995, the finance charge yield on all types of commercial finance receivables averaged approximately 10% per annum, and original maturities of such receivables averaged 52 months.\nExcept for lease or rental transactions in which the Company owns the equipment, liens on the equipment financed secure the receivables. Generally, the dealer and\/or manufacturer provides some form of loss protection to the Company.\nTRUCK AND TRUCK TRAILER FINANCING AND LEASING\nThe Company provides retail financing and leasing for purchasers and users of medium-duty through heavy-duty trucks and truck trailers, as well as wholesale financing, accounts receivable financing and working capital loans to dealers and trucking companies. The Company also provides financing and leasing for truck and truck trailer purchases by truck leasing and rental companies.\nThe following table shows certain information regarding the Company's truck and truck trailer financing and leasing receivables:\nTRUCK AND TRUCK TRAILER\nThe Company provides retail financing of new and used medium-duty through heavy-duty trucks and truck trailers primarily on an indirect basis through truck and truck trailer dealers. Under an installment sales contract, the dealer and purchaser enter into a financing arrangement for the installment purchase of a truck or truck trailer. Subject to credit approval by the Company, the dealer assigns the installment contract to the Company. The Company funds the transaction by a payment to the dealer for the net amount financed in the contract. The Company also sources retail truck and truck trailer financing on a direct basis with the truck or truck trailer purchaser.\nGenerally, retail financing transactions provide for terms up to 60 months for trucks and up to 84 months for truck trailers at fixed rates of interest. The interest rate varies depending on, among other things, the credit quality of the purchaser, the transaction size, the term and down payment, and whether the collateral is new or used.\nThe Company also provides fleet leasing for users of medium-duty through heavy-duty trucks and truck trailers. Most of the Company's truck and truck trailer leases are non-maintenance, net open-end leases. Under such leases, the customer is responsible for the maintenance and residual value of the vehicle and the Company retains the depreciation benefit.\nThe Company also provides new and used vehicle wholesale financing to truck and truck trailer dealers throughout the United States and provides wholesale financing for truck and truck trailer manufacturers' dealer organizations. Generally, wholesale loans are short-term loans with variable rates (prime rate based) and are secured by inventory.\nEQUIPMENT FINANCING AND LEASING\nThe Company is a leading independent source of financing and leasing of new and used construction, mining, forestry, industrial, machine tool, material handling, communications and turf maintenance equipment and golf cars in the United States. The Company offers wholesale and rental fleet financing to dealers (who may either sell or rent the equipment to end-users) and retail financing and leasing to end-users of equipment in niche markets.\nThe following table shows certain information regarding the Company's equipment financing and leasing receivables:\nEQUIPMENT\nThe Company provides retail financing for the purchase of new and used equipment through installment sales contracts purchased from dealers and distributors, and through direct loans to purchasers. Generally, retail financing transactions for equipment provide for maturities of up to 60 months at fixed rates of interest. The interest rate varies depending on, among other things, the credit quality of the purchaser, transaction size, term, down payment and whether the collateral is new or used.\nThe Company also provides leasing for end-users of equipment, either directly to the customer or through dealers. As part of residual risk management, finance leases typically include an option for the lessee to acquire the equipment at a set time before the termination of the lease for a specified price (designed to offer the lessee an incentive to purchase) and typically include an option for the lessee to acquire the equipment at the end of the lease term for the fair market value.\nThe Company also provides wholesale and rental fleet financing for selected dealers. Generally, wholesale loans are short-term loans with variable rates (prime rate based) and are secured by inventory.\nMANUFACTURED HOUSING\nThe Company provides financing both to dealers and purchasers of manufactured housing. The Company purchases manufactured housing retail installment contracts originated by retail dealers, originates and services direct loans to purchasers, and provides wholesale financing to approved manufactured housing dealers. The Company also offers commercial business loans to selected dealers to provide capital to build new retail sales centers, update existing facilities or expand into community park sales.\nThe following table sets forth certain information regarding the Company's manufactured housing receivables:\nMANUFACTURED HOUSING\nRetail finance products provided by the Company include (i) the purchase of a retail installment contract or a direct loan for the purchase of a manufactured home only, (ii) a retail installment contract or loan on a manufactured home and added amenities such as furnishings, air conditioning, skirting, appliances and patios and (iii) loans covering both a manufactured home and the related real estate. Additionally, the Company purchases retail loans from captive finance companies of manufacturers which normally carry some form of loss protection. Retail financing products are generally secured by a lien on the home and have varying maturities, down payments and interest rates. Original loan terms range up to 25 years. Rates offered include fixed, variable and graduated rate programs.\nThe Company also provides revolving lines of credit to approved manufactured housing retailers in connection with their inventory purchases of manufactured homes from pre-approved manufacturers. Generally, wholesale loans are short-term loans with variable rates (prime rate based) and are secured by inventory.\nOTHER COMMERCIAL ACTIVITIES\nThe Company's other commercial activities include: (i) providing leasing and management services for corporations and municipalities that generally have auto and light truck fleets of 100 or more vehicles; (ii) extending the credit that is partially guaranteed by the federal government under the Small Business Administration loan program; (iii) providing corporations and certain agencies of the federal government with assistance in employee relocation, origination of mortgages and management and disposal of residential real estate; and (iv) offering various emergency roadside assistance and related auto club services to consumers through major corporations, primarily automobile manufacturers, including Ford (the largest client of the Company's auto club).\nRELATED INSURANCE\nThe Company, through certain subsidiaries, makes available various credit and non-credit insurance products to its finance customers. Insurance products offered to the Company's consumer finance customers include credit life, credit accident and health, accidental death and dismemberment, involuntary unemployment and personal property insurance. Insurance products offered to the Company's commercial finance customers include commercial auto and dealers' open lot physical damage, credit life, motor truck cargo and extended coverage insurance. In addition to insurance underwriting, the Company also receives compensation for certain insurance programs underwritten by other companies. The Company does not underwrite liability insurance.\nThe purchase of insurance by a finance customer is optional with the exception of physical damage insurance on loan collateral, which is required. The customer can purchase such insurance either from the Company or an alternative carrier. Premiums for insurance coverage are generally financed as part of the insured's finance obligation.\nThe following table sets forth certain information relating to the Company's insurance operations (in millions):\nINSURANCE STATISTICAL DATA(1)\n- ---------------\n(1) This table does not reflect any direct or indirect expenses that may be associated with the Company's insurance operations. The Company markets its insurance products through its consumer and commercial distribution systems and, accordingly, does not allocate overhead and related expenses to its insurance operations. (2) Includes compensation for insurance proceeds underwritten by other companies.\nALLOWANCE FOR LOSSES, CREDIT LOSSES AND CONTRACTUAL DELINQUENCY\nThe Company maintains an allowance for losses on finance receivables at an amount which it believes is sufficient to provide adequate protection against anticipated 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 underlying 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 contained in NOTE 4 to the consolidated financial statements.\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. 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 contractually delinquent for one year. A delinquent account is one on which the customer has not made payments as contractually agreed. Recoveries on losses previously charged to the allowance are credited to the allowance at the time recovery is collected.\nAlthough the allowance for losses on finance receivables reflected in the Company's consolidated balance sheet at December 31, 1995 is considered adequate by the Company's management, there can be no assurance that this allowance will prove to be adequate over time to cover ultimate losses in connection with the Company's finance receivables. This allowance may prove to be inadequate due to unanticipated adverse changes in the economy or discrete events adversely affecting specific customers or industries. The Company's results of operations and financial condition could be materially adversely affected to the extent that the Company's allowance is insufficient to cover such changes or events.\nThe following table sets forth information as of the dates shown concerning net credit losses, allowance for losses and contractual delinquency. This information should be read in conjunction with the discussion of the Company's financial condition under the caption \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Financial Condition\".\nNET CREDIT LOSSES, ALLOWANCE FOR LOSSES TO NET FINANCE RECEIVABLES AND 60 + DAYS CONTRACTUAL DELINQUENCY\nThe Company's ten largest accounts at December 31, 1995 (all of which were current at December 31, 1995) represented 0.8% of the Company's total gross finance receivables outstanding. All ten of such accounts are commercial finance accounts and are secured.\nCOMPETITION\nThe markets in which the Company operates are highly competitive. Many of the competitors of the Company in different segments and regions are large companies that have substantial capital, technological and marketing resources, and some of these competitors are larger than the Company and may have access to capital at a lower cost than the Company. The Company believes that the finance charge rate is one of the primary competitive factors in many of its markets. From time to time, competitors of the Company may seek to compete aggressively on the basis of pricing, and the Company may lose market share to the extent it is not willing to match competitor pricing, in order to maintain interest margins.\nTraditional competitors in the consumer finance business include captive and independent finance companies, commercial banks and thrift institutions, credit unions, industrial banks, credit card issuers, leasing companies, manufacturers and vendors. On a local level, community banks and smaller independent finance and\/or mortgage companies are a competitive force. Additionally, substantial national financial services networks have been formed by major brokerage firms, insurance companies and bank holding companies. Some competitors have substantial local market positions; others are part of large, diversified organizations. Because of their longstanding insured deposit base, many banks that compete with the Company are able to offer financial services on very competitive terms.\nIn its commercial finance business, the Company competes with captive and independent finance companies, commercial banks, thrift and other financial institutions, leasing companies, lease brokers, manufacturers, vendors and others who extend or arrange credit for the acquisition of trucks and truck trailers and equipment.\nREGULATION\nThe Company's operations are subject to extensive state and Federal regulations including, but not limited to, the following Federal statutes and regulations: the Consumer Credit Protection Act of 1968, as amended (including certain provisions thereof, commonly known as the \"Truth-in-Lending Act\" or \"TILA\"), the Equal Credit Opportunity Act of 1974, as amended (the \"ECOA\"), the Fair Credit Reporting Act of 1970, as amended (the \"FCRA\") and the Real Estate Settlement Procedures Act (the \"RESPA\"). In addition, the Company is subject to state laws and regulations with respect to the amount of interest and other charges which lenders can collect on loans.\nIn the judgment of the Company, existing statutes and regulations have not had a materially adverse effect on the operations of the Company. However, it is not possible to forecast the nature of future legislation, regulations, judicial decisions, orders or regulatory interpretations with respect to the foregoing or their impact on the future business, financial condition or prospects of the Company.\nConsumer Finance. The Company's consumer finance business, including its participations in credit card receivables, is subject to detailed supervision by Federal and state authorities under legislation and regulations which generally require licensing of the lender, limitations on the amount, duration and charges for various categories of loans, adequate disclosure of certain contract terms and limitations on certain collection practices and creditor remedies. Licenses are renewable, and may be subject to revocation for violations of such laws and regulations. In addition, most states have usury laws which limit interest rates. Federal legislation preempts state interest rate ceilings on first mortgage loans and state laws which restrict various types of alternative home equity receivables, except in those states which have specifically opted out of such preemption.\nThe Company is required to comply with TILA and Regulation Z promulgated thereunder. TILA requires, among other things, disclosure of pertinent elements of consumer credit transactions, including the finance charges and the comparative costs of credit expressed in terms of an annual percentage rate. The TILA disclosure requirements are designed to provide consumers with uniform, understandable information with respect to the terms and conditions of loans and credit transactions in order to enable them to compare credit terms. TILA also guarantees consumers a three-day right to cancel certain credit transactions, including refinanced mortgages and junior mortgage loans on a consumer's primary residence. Section 32 of Regulation Z mandates that applicants for real estate loans which contain certain rate and fee amounts be provided an additional three days waiting period prior to signing loan documents.\nIn addition, the Company is required to comply with the ECOA which, in part, prohibits credit discrimination on the basis of race, color, religion, sex, marital status, national origin and age. Regulation B promulgated under ECOA restricts the type of information that may be obtained by creditors in connection with a credit application. It also requires certain disclosures by the lender regarding consumer rights and requires lenders to advise applicants who are denied credit of the reasons therefor. In instances where a loan application is denied or the rate or charge on a loan is increased as a result of information obtained from a consumer credit agency, the FCRA requires the lender to supply the applicant with the name and address of the reporting agency.\nRESPA has been extended to cover real estate secured loans that are subordinated to other mortgage loans. RESPA and Regulation X thereunder require disclosure of certain information to customers within prescribed time frames and regulate the receipt or payment of fees or charges for services performed.\nAssociates Investment Corporation, a Utah industrial loan company (\"Associates Investment\"), is regulated by the Federal Deposit Insurance Corporation and the Utah Department of Financial Institutions in regard to capital adequacy, leverage, loans, deposits, consumer protection, community reinvestment, the payment of dividends, transactions with affiliates and other aspects of operations.\nThe right of federally insured depositary institutions, including Associates Investment, to export certain charges to consumers, such as late fees, overlimit fees and returned check fees, is not settled in some states under existing law. The restrictions imposed by such laws and regulations could limit the operations of Associates Investment.\nFederal and state legislation seeking to regulate the maximum interest rate and\/or other charges on consumer finance receivables has been introduced in the past, and may from time to time be introduced in the future. However, it is not possible to predict the nature of future legislation with respect to the foregoing or its impact on the future business, financial condition or prospects of the Company.\nCommercial Finance. Although most states do not regulate commercial finance, certain states do require licensing of lenders and financers, limitations on interest rates and other charges, adequate disclosure of certain contract terms and limitations on certain collection practices and creditor remedies. The Company is also required to comply with certain provisions of the ECOA which are applicable to commercial loans.\nSmall Business Administration loans made by the Company are governed by the Small Business Act and the Small Business Investment Act of 1958, as amended, and may be subject to the same regulations by certain states as are other commercial finance operations. The federal statutes and regulations specify the types of loans and loan amounts which are eligible for the Small Business Administration's guaranty as well as the servicing requirements imposed on the lender to maintain Small Business Administration guarantees.\nInsurance. The insurance operations of the Company are subject to detailed regulation and supervision in each state or other jurisdiction in which they conduct business. The laws of the various jurisdictions establish supervisory and regulatory agencies with broad administrative powers. Generally, such laws cover, among other things, types of insurance that may be sold, policy forms, reserve requirements, permissible investments, premiums charged, trade practices, limitations on the amount of dividends payable by any insurance company and guidelines and standards with respect to dealings between insurance companies and affiliates.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe furniture, equipment and other physical property owned by Associates and its subsidiaries represent less than 1% of total assets at December 31, 1995 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.\nThe Company is a defendant in various lawsuits arising in the ordinary course of its business. While, in the opinion of management, the resolution of any of these matters is not expected to have a material adverse effect on the Company's financial condition or results of operations, there can be no assurance that an adverse decision in one or more of such lawsuits will not have such a material adverse effect. The outcome of various individual lawsuits, however, may affect the manner in which the Company conducts its business, as further described below.\nThe Company is a defendant in a relatively higher concentration of lawsuits in the State of Alabama than in the remainder of the United States. Management believes that the aggregate number of lawsuits instituted in Alabama represents additional exposure to the Company because of the recent history of juries in Alabama awarding significant damages, both compensatory and punitive, in civil cases. For example, in 1994, a jury in Alabama awarded damages in excess of $30,000,000 against the Company in one case relating to a $25,000 real estate-secured loan. The Company's post-trial motion in that case was granted, and the jury verdict overturned. The case was subsequently settled. At February 28, 1996, there were approximately 100 lawsuits pending against the Company in Alabama. In addition, a recent Alabama Supreme Court decision, McCullar v. Universal Underwriters Life Ins. Co., et al. (a case in which the Company was not a party), has cast doubt on the method many lenders, including the Company, have used to calculate coverage amounts and premiums with respect to credit insurance. A motion for reconsideration is currently pending in that case. Although the impact of this decision on the Company's past activities and pending litigation is not clear, as a result of this ruling the Company has changed its practices in this area to conform to the Court's opinion as it currently stands. At February 28, 1996, the Company was a defendant in approximately 10 class action lawsuits in Alabama involving similar claims related to the sale of credit insurance.\nIn various states consumers have filed lawsuits against credit card issuers that claim the issuer does not have the authority to export fees and charges that exceed the numerical interest rate authorized by the law of the state where the issuer is domiciled. For example, the California and Colorado State Supreme Courts have upheld the ability of an out-of-state bank to export all fees and charges, while the New Jersey State Supreme Court and a Pennsylvania state appeals court have ruled that only the numerical interest rate can be exported. In a similar case against ANB, an affiliate of the Company, Szydlik v. Associates National Bank (Delaware), ANB was sued in a Pennsylvania class action that alleged ANB's late fees, overlimit fees and returned check fees were in excess of those allowed by Pennsylvania law. The trial court in Szydlik dismissed the case, and the United States Court of Appeals for the Third Circuit has held that such fees constitute interest and may be exported by a national bank from its state of domicile. With respect to certain issues relating to fees allowed under California law relating to a predecessor bank, the case was remanded to federal district court for further proceedings. An adverse ultimate judgment in Szydlik or an adverse United States Supreme Court ruling in a similar case could affect ANB's future ability to export fees and charges, which could adversely impact ANB's results of operations and, accordingly, the Company's participations in ANB's credit card receivables. The United States Supreme Court has recently agreed to hear arguments in one such case.\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 Associates is owned by AFCC and all of the Class B Common Stock is owned by Associates World Capital Corporation, a directly wholly-owned subsidiary of AFCC. There is no market for Associates stock.\nDividends on the Common Stock and Class B Common Stock are paid when declared by the Board of Directors. Dividends of $14.20 per share per annum on the Class B Common Stock outstanding must be paid each year before any dividends may be paid on the Common Stock. Dividends of $14.2 million were paid on Class B Common Stock during each of the years ended December 31, 1995 and 1994. Annual Common Stock dividends of $265.8 million and $255.8 million were paid during the years ended December 31, 1995 and 1994, respectively.\nAssociates is subject to various limitations under the provisions of its outstanding debt and revolving credit agreements, including limitations on the payment of dividends. A restriction contained in one series of public debt securities, maturing March 15, 1999, generally limits payments of cash dividends on the Company's Common Stock during any fiscal year, beginning with the fiscal year ending December 31, 1996, to not more than 50% of 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 any fiscal year and not so paid, may be paid in any one or more of the five subsequent fiscal years. 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, 1995, Associates tangible net worth was $4.1 billion.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\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, 1995. The information should be read in conjunction with Item 7","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nGENERAL\nThe Company is in the consumer and commercial finance business, providing finance, leasing and related insurance products as well as other services. The Company's revenues principally consist of income through finance charges and, to a lesser extent, insurance premiums and investment income. The Company's primary expenses are interest expense for the funding of its finance business, provision for loan losses and operating expenses. A principal factor determining the profitability of the Company is the Company's finance charge revenue less interest expense (\"net interest margin\").\nThe following discussion and analysis provides information that management believes to be relevant to understanding the Company's consolidated financial condition and results of operations. This discussion should be read in conjunction with the consolidated financial statements of the Company and the related notes thereto included herein.\nRESULTS OF OPERATIONS\nSummary of Results of Operations\nThe following table summarizes the Company's net earnings and related data (dollars in millions):\nNET EARNINGS AND RELATED DATA\nThe primary factors influencing the changes in net earnings are finance charge revenue and interest expense, operating expenses and loan losses, all of which are described below.\nFinance Charge Revenue and Interest Expense\nThe Company's net interest margin was as follows (dollars in millions):\nNET INTEREST MARGIN\n- ---------------\n(1) Finance charge revenue and net interest margin are expressed as a percent of average net finance receivables outstanding for the indicated period; interest expense is expressed as a percent of average debt outstanding for the indicated period.\nFinance charge revenue increased in each of the years presented. The increase principally resulted from growth in net finance receivables in each of the periods which caused corresponding increases in the average net finance receivables outstanding (\"ANR\"). To a lesser extent, an increase in the composite finance charge yield (finance charges as a percent of ANR) contributed to the increase in 1995 and 1994. However, in 1993, a decrease in the composite finance charge yield partially offset the increase in finance charge revenue due to growth in ANR. The components of the change in finance charge revenue attributable to net receivable growth and changes in finance charge yields are set forth in the following table (in millions):\nCOMPONENTS OF CHANGES IN FINANCE CHARGE REVENUE\nFor further discussion regarding growth in the Company's net finance receivables, see \"-- Financial Condition\". The finance charge yields to ANR for each of the Company's business segments were as follows:\nFINANCE CHARGE YIELDS TO ANR\nThe principal factors which influence finance charge yields are (i) the interest rate environment, (ii) the level of business competition and (iii) the varying composition of the finance receivable portfolios (i.e., \"product mix\"). The consumer segment composite finance charge yield is principally influenced by shifts in product mix between higher yielding unsecured finance products and lower yielding secured finance products. Change in product mix was the principal cause of the movements in finance charge yield from 1993 to 1995. The commercial segment composite finance charge yield is principally influenced by the level of business competition and the interest rate environment and not by the mix of secured and unsecured products since substantially all commercial finance receivables are secured. The commercial segment experienced increased competition from other lenders entering the commercial markets during the period from 1992 to 1995, which caused the finance charge yields to decrease as a result of competitive pricing. Changes in the prime lending rate over this period introduced additional sensitivity in the composite finance charge yields because commercial business pricing is substantially tied to the prime lending rate. However, the Company's initiatives to increase pricing more than offset the changes due to competition and the interest rate environment in 1995.\nTotal interest expense increased from 1993 through 1995. The increases were principally due to higher average outstanding debt, primarily resulting from the Company's growth in net finance receivables (see \"-- Financial Condition\") and, to a lesser extent, an overall increase in the Company's borrowing rate (interest expense divided by average outstanding debt). Interest expense and average borrowing rates were as follows (dollars in millions):\nINTEREST EXPENSE AND AVERAGE BORROWING RATES\n- ---------------\n(1) Includes the current portion of long-term debt.\nThe increases in the short-term average borrowing rate from 1993 to 1995, which principally relate to commercial paper issued by the Company, generally reflect the overall market increases in short-term interest rates over the three-year period. The changes in the long-term average borrowing rates are the result of changes in long-term market rates and the refinancing of maturing debt at the prevailing rates. The Company seeks to match fund its total finance receivables through the issuance of debt with maturity and interest rate characteristics that reasonably match the characteristics of its composite portfolio.\nFor purposes of measuring business segment profitability, the Company generally allocates the interest expense incurred to the business segments based on ANR. Management believes that analysis of the principal components of changes in interest expense is only meaningful on a total Company basis. The change in interest expense attributable to growth in average outstanding debt and changes in average borrowing rates are set forth in the following table (in millions):\nCOMPONENTS OF CHANGES IN INTEREST EXPENSE\nAs a result of the forgoing changes in finance charge revenue and interest expense, the Company's net interest margin increased in each of the three years ended December 31, 1995, 1994 and 1993, respectively.\nInsurance Premium Revenue\nInsurance premium revenue was $325.1 million, $293.5 million and $242.2 million for the years ended December 31, 1995, 1994 and 1993, respectively. Insurance premium revenue, which is earned over the coverage term, increased $31.6 million (10.8%) in 1995, $51.3 million (21.2%) in 1994, and $32.3 million (15.4%) in 1993. The insurance operation is engaged in underwriting credit-related and other specialized insurance products for customers of the consumer and commercial finance businesses. Therefore, insurance sales, and resulting revenue, are largely dependent on the business activities and volumes of the consumer and commercial finance businesses. The increase in insurance revenue in each of the years was principally caused by increased sales of insurance products associated with the increase in net finance receivables outstanding.\nInvestment and Other Revenue\nInvestment and other revenue for the years ended December 31, 1995, 1994 and 1993 was $254.0 million, $227.7 million and $196.7 million, respectively. Investment income is derived from investments in marketable securities which are principally owned by the Company's insurance operation. Other revenue is primarily derived from the Company's fee-based financial services (i.e., relocation services and auto club and roadside assistance services). In each of the years 1995, 1994 and 1993, the year-over-year increase in investment and other revenue principally resulted from increases in the Company's investments in marketable securities and related returns and, to a lesser extent, an increase in other revenue related to the growth in the fee-based businesses.\nOperating Expenses\nOperating expenses, which do not include interest expense, were as follows (dollars in millions):\nOPERATING EXPENSES\nTotal operating expenses increased from 1993 to 1995, principally due to higher levels of business volume and outstanding receivables in each of the years. The increases in salaries and benefits in total dollars is primarily due to increases in the number of employees to support the higher business volume and outstanding receivables. As a percentage of ANR, salaries and benefits decreased in each of the years. This decrease reflects continued reductions in the proportion of employee labor required to support the higher business volumes and outstanding net receivables and results from improved operating efficiency. The Company has achieved improved operating efficiency through focused initiatives it has undertaken over the last three years, such as electronic credit applications, centralized payment processing and automated loan documentation. The principal cause for the increases in occupancy, data processing and other expenses in total dollars was growth in the number of business locations, the aforementioned increase in employees and the cost to implement its efficiency improvement initiatives. The increases in the percentage of these expenses to ANR were primarily due to the Company's investments in certain start-up expenses to expand the number of locations, fund and implement its efficiency initiatives, and support its increased number of employees, which are in part incurred in advance of generating expected incremental finance receivables outstanding.\nAllowance for Losses, Losses and Asset Quality\nThe Company maintains an allowance for losses on finance receivables at an amount which it believes is sufficient to provide adequate protection against losses in its 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 underlying finance receivables. For purposes of measuring business segment profitability, each business segment establishes an allowance for loan loss when a loan is made with a corresponding charge to the provision for losses. The Company manages its allowance for losses on finance receivables on a Company-wide basis taking into account actual and expected losses in each business segment and the relationship of the allowance to net finance receivables and total net credit losses; the resulting charge is included in the provision for losses.\nThe components of the changes in the aggregate allowance for losses on finance receivables during the periods indicated were as follows (dollars in millions):\nCOMPONENTS OF CHANGES IN THE ALLOWANCE FOR LOSSES\nThe provision for losses is principally influenced by growth in net finance receivables and, to a lesser extent, net credit loss experience. Additions to the allowance are charged to the provision for losses. Losses are charged to the allowance as incurred and recoveries on losses previously charged to the allowance are credited to the allowance at the time the recovery is collected. The provision for losses increased in each of the years 1995, 1994 and 1993 as a result of growth in finance receivables. The components of the changes in the provision for losses in each of the years ended 1995, 1994 and 1993 are as follows (in millions):\nCOMPONENTS OF CHANGES IN PROVISION FOR LOSSES\nFor further discussion regarding growth in net finance receivables, see \"-- Financial Condition\". Net loss experience improved year-over-year in 1994 and 1993, with the improved loss experience in 1993 more than offsetting the increase in the provision resulting from growth. Loss experience increased moderately in 1995 in substantially all of the Company's portfolios as reflected in the following table (dollars in millions):\nCONTRACTUAL DELINQUENCY AND NET CREDIT LOSSES\nContractual delinquency and net credit losses generally improved, on a ratio basis, across all portfolios from 1992, approaching historical lows in 1994, reflecting similar trends in overall economic conditions. These trends reversed across all portfolios in 1995, principally as a result of generally less favorable trends in economic conditions, including decreased manufacturing capacity utilization and rising consumer debt levels. The relationship of the allowance for losses to net finance receivables at December 31, 1995 increased from 1994, reflecting management's opinion that delinquency and net credit losses will continue to increase in 1996. Management believes the allowance for losses at December 31, 1995 is sufficient to provide adequate protection against losses in its portfolios.\nInsurance Benefits Paid or Provided\nInsurance benefits paid or provided were $135.7 million in 1995, $144.1 million in 1994 and $114.9 million in 1993. Benefits paid or provided are influenced by the amount of insurance in force, underwriting standards, loss experience, term of coverage and product mix. Benefits paid or provided increased in 1994 compared to 1993 primarily as a result of more insurance in force. For 1995, benefits paid or provided decreased when compared to 1994 primarily as a result of favorable loss experience.\nProvision for Income Taxes\nThe Company's provision for income taxes and effective tax rates were as follows (dollars in millions):\nPROVISION FOR INCOME TAXES\nThe state income tax provision, and impact on the Company's effective tax rate, increased from 1993 to 1994 due to changes in the Company's state tax-sharing arrangement with Ford, which generally had the effect of increasing the amount of taxable income in certain states in which the Company does business. The provision and resulting impact on effective tax rate decreased from 1994 to 1995 principally due to a one-time benefit provided to the Company by Ford under its state tax-sharing agreement. Had the Company not received such benefit, the 1995 provision and resulting impact on the effective rate would have been substantially the same as that in 1994.\nFINANCIAL CONDITION\nGrowth in Net Finance Receivables\nThe Company experienced growth in its consumer and commercial finance receivable portfolios in 1995 and 1994 as follows (dollars in millions):\nGROWTH IN NET FINANCE RECEIVABLES\nThe growth in net finance receivables, in both the consumer and commercial finance segments, during 1994 and 1995, was principally due to expansion through the addition of 95 branches in 1994 and 71 branches in 1995, as well as increased penetration of existing markets through expanded lines of business, new products, acquisitions and other activities.\nDebt\nTotal outstanding debt was $31.7 billion, $27.2 billion, and $23.3 billion at December 31, 1995, 1994, and 1993, respectively. Such amounts of debt reflect net increases of $4.5 billion (16.8%) in 1995 and $3.9 billion (16.9%) in 1994. In both years, the increase was primarily a result of the growth in net finance receivables. Debt is the primary source of funding to support the Company's growth in net finance receivables. At December 31, 1995 and 1994, short-term debt, including the current portion of long-term debt, as a percent of total debt was 50% and 52%, respectively. The current portion of long-term debt at December 31, 1995 and 1994 was $2.6 billion and $2.0 billion, respectively.\nStockholders' Equity\nStockholders' equity increased to $4.4 billion in 1995 from $3.8 billion in 1994. The primary cause for this increase was the amount of net earnings from the Company's operations in the amount of $708.1 million in 1995 and $603.5 million in 1994. In 1995 and 1994, the Company paid dividends to AFCC of $280.0 million and $270.0 million, respectively. The Company received capital contributions from Ford, through AFCC, in 1995 and 1994 of $200.0 million in each year.\nLIQUIDITY AND CAPITAL RESOURCES\nThrough its asset and liability management function, the Company maintains a disciplined approach to the management of liquidity, capital, interest rate risk and foreign exchange risk. The Company has a formal process for managing its liquidity to ensure that funds are available at all times to meet the Company's commitments.\nThe Company's principal sources of cash are proceeds from the issuance of short-term and long-term debt and cash provided from the Company's operations. While AFCC has made periodic capital contributions to the Company in the past, no assurance can be made with respect to future capital contributions by AFCC to the Company after the Offering. See Item 1 \"Business\" above. Nevertheless, the Company believes that it has available sufficient liquidity, from a combination of cash provided from operations and external borrowings, to support its operations.\nA principal strength of the Company is its ability to access the global debt markets in a cost-efficient manner. Continued access to the public and private debt markets is critical to the Company's ability to continue to fund its operations. The Company seeks to maintain a conservative liquidity position and actively manage its liability and capital levels, debt maturities, diversification of funding sources and asset liquidity to ensure that the Company is able to meet its obligations. The Company's operations are principally funded through domestic borrowings made by the Company.\nAt December 31, 1995, the Company had short-term debt outstanding of $13.4 billion. Short-term debt principally consists of commercial paper issued by the Company and represents the Company's primary source of short-term liquidity. Commercial paper is issued with maturities ranging from 1 to 270 days. The average interest rate on short-term debt in 1995 and 1994 was 5.93% and 4.32%, respectively. The change in average rates was principally due to the overall changes in market rates during such years.\nAt December 31, 1995, the Company had long-term debt outstanding of $18.3 billion. Long-term debt principally consists of unsecured long-term debt issued publicly and privately by the Company in the United States and abroad. During the years ended 1995 and 1994, the Company raised debt aggregating $5.2 billion and $3.9 billion, respectively, through public and private offerings at weighted average effective interest rates and weighted average terms of 6.87% and 6.0 years and 7.13% and 4.9 years, respectively. The change in effective average interest rates was primarily caused by overall changes in market rates during such years. A portion of the long-term debt raised was used to retire outstanding indebtedness. For the years ended 1995 and 1994, the Company replaced maturing long-term debt in the amount of $2.0 billion in each year.\nManagement believes that the Company has limited exposure to exchange rate risk related to certain transactions with its foreign affiliates. At December 31, 1995, the Company had $55.7 million of outstanding hedged borrowings with its affiliates. The Company has entered into various support agreements on behalf of certain non-U.S. affiliates. Under these support agreements, the Company has either guaranteed specific issues of such affiliates' debt denominated in foreign currency or agreed to supervise operations in a responsible manner and to provide additional support on a lender's reasonable request. See NOTES 6, 7 and 15 to the consolidated financial statements for a further description of the Company's borrowings and currency hedging activities.\nSubstantial additional liquidity is available to the Company's operations through established credit facilities in support of its net short-term borrowings. Such credit facilities provide a means of refinancing its maturing short-term obligations as needed. At December 31, 1995, short-term bank lines, revolving credit facilities and receivable purchase facilities totaled $10.3 billion, none of which was in use at that date. These facilities represented 77% of net short-term indebtedness outstanding at December 31, 1995.\nAdditionally, the Company believes it has access to other sources of liquidity, which to date it has not accessed, including, among others, the securitization or sale of its assets and issuance of alternative forms of capital, including preferred stock.\nRECENT ACCOUNTING PRONOUNCEMENTS\nThe Financial Accounting Standards Board has issued Statement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation\", (\"SFAS No. 123\") effective in 1996. The Company has not determined whether it will adopt the fair value-based method prescribed by SFAS No. 123 or use the accounting prescribed by APB No. 25, \"Accounting for Stock Issued to Employees\". In any event, the effect is not expected to be significant to the Company's results of operations or financial condition.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA\nREPORT OF INDEPENDENT ACCOUNTANTS\nBoard of Directors Associates Corporation of North America\nWe have audited the accompanying consolidated balance sheets of Associates Corporation of North America (a wholly owned subsidiary of Associates First Capital Corporation) as of December 31, 1995 and 1994, and the related consolidated statements of earnings, changes in stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1995. 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 Corporation of North America as of December 31, 1995 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, 1995, in conformity with generally accepted accounting principles.\nCOOPERS & LYBRAND L.L.P.\nDallas, Texas January 26, 1996\nASSOCIATES CORPORATION OF NORTH AMERICA\nCONSOLIDATED STATEMENT OF EARNINGS (IN MILLIONS)\nSee notes to consolidated financial statements.\nASSOCIATES CORPORATION OF NORTH AMERICA\nCONSOLIDATED BALANCE SHEET (IN MILLIONS)\nASSETS\nSee notes to consolidated financial statements.\nASSOCIATES CORPORATION OF NORTH AMERICA\nCONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (IN MILLIONS)\nSee notes to consolidated financial statements.\nASSOCIATES CORPORATION OF NORTH AMERICA\nCONSOLIDATED STATEMENT OF CASH FLOWS (IN MILLIONS)\nSee notes to consolidated financial statements.\nASSOCIATES CORPORATION OF NORTH AMERICA\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1 -- THE COMPANY\nAssociates Corporation of North America (\"Associates\" or the \"Company\"), a Delaware corporation, is a wholly-owned subsidiary and principal operating unit of Associates First Capital Corporation (\"AFCC\"), which in turn is an indirect subsidiary of Ford Motor Company (\"Ford\"). All the outstanding Common Stock of Associates is owned by AFCC. All shares of Class B Common Stock are owned by Associates World Capital Corporation, a wholly-owned subsidiary of AFCC. Class B Common Stock is redeemable only at the option of the issuer.\nNOTE 2 -- SIGNIFICANT ACCOUNTING POLICIES\nThe following is a summary of significant accounting policies:\nBasis of Consolidation\nThe accompanying consolidated financial statements consolidate Associates and its subsidiaries. Amounts of goodwill relating to acquisitions are being amortized by the straight-line method over periods not exceeding forty years. The carrying value of goodwill is reviewed if the facts and circumstances suggest that it may be impaired. If the review indicates that goodwill will not be recoverable, as determined based on undiscounted cash flows, the carrying value of the goodwill is reduced by the estimated short-fall of discounted cash flows.\nAll 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.\nThe preparation of these consolidated financial statements in conformity with generally accepted accounting principles requires the use of management's estimates. These estimates are subjective in nature and involves matters of judgment. Actual results could differ from these estimates.\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 suspended on accounts when they become 60 days contractually delinquent. The accrual is resumed when the loan becomes contractually current. At December 31, 1995 and 1994, net finance receivables on which revenue was not accrued approximated $625.5 million and $418.2 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 stockholders' 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 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 underlying finance\nASSOCIATES CORPORATION OF NORTH AMERICA\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nreceivables. The allowance is managed on an aggregate basis considering the relationship of the allowance to net finance receivables and net credit losses. 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 provides for charge-off of various types of accounts on a contractual basis described as follows: 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 contractually delinquent for one year. 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 each class of insurance. 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.\nIncome Taxes\nAssociates and its subsidiaries are included in the consolidated Federal income tax return of Ford. The provision for income taxes is computed on a separate-return basis. Deferred tax assets and liabilities 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.\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.\nASSOCIATES CORPORATION OF NORTH AMERICA\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\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-assets to certain foreign affiliates denominated in British Sterling. Gains and losses on qualifying hedges are deferred and are recognized in income or as adjustments of carrying amounts when the hedged transaction occurs. See NOTE 15 to the consolidated financial statements for additional information related to currency swap transactions.\nNOTE 3 -- NET FINANCE RECEIVABLES\nComposition of Net Finance Receivables\nAt December 31, 1995 and 1994, net finance receivables consisted of the following (in millions):\nAt December 31, 1995, contractual maturities of net finance receivables were as follows (in millions):\nIt is the Company's experience that a substantial portion of the consumer loan portfolio generally is renewed or repaid prior to contractual maturity dates. The above maturity schedule should not be regarded as a forecast of future cash collections.\nASSOCIATES CORPORATION OF NORTH AMERICA\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nIncluded in commercial finance receivables are direct financing leases as follows (in millions):\nFuture net minimum lease rentals on direct financing leases for each of the years succeeding December 31, 1995 are as follows (in millions): 1996 -- $839.4; 1997 -- $713.0; 1998 -- $567.5; 1999 -- $374.7; 2000 -- $157.4 and 2001 and thereafter -- $68.3.\nEstimated Fair Value of Net Finance Receivables\nThe estimated fair value of net finance receivables at December 31, 1995 and 1994 was $39.4 billion and $33.2 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. The Company's total receivables were dispersed across the United States at December 31, 1995 as follows: 12% were in California, 7% in Florida, 6% in Texas, and no other individual state had more than 4%.\nAcquisitions of Finance Businesses\nDuring the years ended December 31, 1995, 1994 and 1993, the Company made acquisitions of finance businesses accounted for as purchases, the most significant of which were as follows:\nOn January 1, 1995, Associates acquired $116 million of net home equity receivables and certain other assets from Ford Motor Credit Company, an affiliate. The transaction was recorded at historical cost, which approximated market.\nIn October 1995, Associates acquired the assets of LCA Corporation, principally consisting of leasing receivables. The fair market value of total assets acquired and liabilities assumed was $253 million and $225 million, respectively.\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 $405 million.\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.\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 home equity and\nASSOCIATES CORPORATION OF NORTH AMERICA\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\npersonal lending and sales finance receivables. The fair market value of total assets acquired and liabilities assumed was $197 million and $112 million, respectively.\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.\nThe pro forma effect of the above acquisitions, when taken in aggregate for each reporting period, was not significant.\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):\nNOTE 5 -- CREDIT FACILITIES\nAt December 31, 1995, available credit facilities were as follows (in millions):\n- ---------------\n* Included in Associates Lines of Credit and Revolving Lines are $90.0 million and $1,080.0 million of Lines of Credit and Revolving Lines, respectively, that are available either to AFCC or to the Company. The Company would not be responsible for any borrowing by AFCC thereunder.\nLines of Credit, Revolving Lines and Receivables Purchase Facilities may be withdrawn only under certain standard conditions, including failure to pay principal or interest when due, breach of representations, warranties or covenants, default on other debt, or bankruptcy or other insolvency-type proceedings. Associates pays fees for the availability of its credit facilities. Bank fees incurred during 1995, 1994 and 1993 were $11.5 million, $11.0 million and $9.6 million, respectively, and are .07 to .25 of 1% per annum of the amount of the facilities.\nASSOCIATES CORPORATION OF NORTH AMERICA\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\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 are all 4 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):\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):\nThe weighted average interest rate for total long-term debt was 7.08% at December 31, 1995 and 7.26% at December 31, 1994.\nThe estimated fair value of long-term debt at December 31, 1995 and 1994 was $19.2 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: 1996, $2,611.4 million; 1997, $3,080.5 million; 1998, $3,266.3 million; 1999, $2,132.3 million; 2000, $2,368.2 million and 2001 and thereafter, $4,852.8 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, 1995, 3,509 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.\nASSOCIATES CORPORATION OF NORTH AMERICA\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 8 -- INCOME TAXES\nThe following table sets forth the components of the provision for income taxes and deferred income tax (benefit) for the periods indicated (in millions):\nAt December 31, 1995 and 1994, the components of the Company's net deferred tax asset were as follows (in millions):\nASSOCIATES CORPORATION OF NORTH AMERICA\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nDue to the Company's earnings level, no valuation allowance related to the deferred tax asset has been recorded.\nThe effective tax rate differed from the statutory U.S. Federal income tax rate as follows:\nNOTE 9 -- DEBT RESTRICTIONS\nAssociates is subject to various limitations under the provisions of its outstanding debt and credit facilities. 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 the Company's Common Stock in any year to not more than 50% of 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, 1995, $727.6 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, 1995, Associates tangible net worth was $4.1 billion.\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, 1995, 1994 and 1993 was $67.0 million, $53.1 million, and $50.9 million, respectively. Minimum rental commitments as of December 31, 1995 for all noncancelable leases (primarily office leases) for the years ending December 31, 1996, 1997, 1998, 1999 and 2000 are $59.1 million, $46.9 million, $36.6 million, $23.9 million and $11.4 million, respectively, and $2.4 million thereafter.\nNOTE 11 -- EMPLOYEE BENEFITS\nDefined Benefit Plans\nThe Company participates in various qualified and nonqualified pension plans (the \"Plan\" or \"Plans\") sponsored by AFCC, which together cover substantially all permanent employees who meet certain eligibility requirements.\nASSOCIATES CORPORATION OF NORTH AMERICA\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNet periodic pension cost for the years indicated includes the following components (in millions):\nThe funded status of the Plan is as follows (in millions):\n- ---------------\nAmounts in the previous two tables are presented using AFCC data as all calculations are made at the AFCC level. The corresponding amounts for the Company are not significantly different.\nRetirement Savings and Profit Sharing Plan\nThe Company participates in a defined contribution plan sponsored by AFCC 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. For the years ended December 31, 1995, 1994 and 1993, the Company's pretax contributions to the plan were $16.6 million, $15.0 million and $13.1 million, respectively.\nASSOCIATES CORPORATION OF NORTH AMERICA\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nEmployers' Accounting for Postretirement Benefits Other Than Pensions\nThe Company provides certain postretirement benefits through unfunded plans sponsored by AFCC. These benefits are currently provided to substantially all permanent employees who meet certain eligibility requirements. The benefits of the plan can be modified or terminated at the discretion of the Company. The amount paid for postretirement benefits for the years ended December 31, 1995, 1994 and 1993 was approximately $2.0 million, $1.8 million and $1.5 million, respectively.\nNet periodic postretirement benefit cost for 1995, 1994 and 1993 includes the following components (in millions):\nAccrued postretirement benefit cost at December 31, 1995 and 1994 is composed of the following (in millions):\n- ---------------\nAmounts in the previous two tables are presented using AFCC data as all calculations are made at the AFCC level. The corresponding amounts for the Company are not significantly different.\nFor measurement purposes, a 13.00% and 12.10% weighted average annual rate of increase in per capita cost of covered health care benefits was assumed for 1995 and 1994, respectively, decreasing gradually to 5.50% by the year 2010. Increasing the assumed health care cost trend rate by one percentage point each year would increase the APBO as of December 31, 1995 and 1994 by $8.6 million and $6.0 million, respectively, and the aggregate of the service and interest cost components of the net periodic postretirement benefit cost by $1.0 million and $0.9 million, respectively.\nINCENTIVE COMPENSATION PROGRAMS\nThe Company sponsors compensation plans covering certain officers and employees.\nASSOCIATES CORPORATION OF NORTH AMERICA\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nCorporate Annual Performance Plan and Long-Term Performance Plan\nThe Corporate Annual Performance Plan (\"CAPP\") is an annual bonus plan. CAPP bonuses are determined based on the performance of the Company, the business unit in which a participant is employed, and the participant, personally. The Long-Term Performance Plan (\"LTPP\") is a long-term cash incentive plan. LTPP awards are determined for a performance period based on the success of the Company in achieving a target level of profits established for each year of the performance period, with such annual performance then averaged for the performance period. Amounts charged to expense under CAPP and LTPP amounted to $16.1 million, $16.2 million and $14.8 million during the years ended December 31, 1995, 1994 and 1993, respectively.\nPhantom Stock Appreciation Right Plan\nThe Company participates in a long-term cash plan, the Phantom Stock Appreciation Right Plan (the \"PSAR Plan\"). AFCC terminated the PSAR Plan as of December 1995 and intends to cash out all outstanding phantom stock appreciation rights (\"PSARs\"). A PSAR granted under the PSAR Plan entitled the holder thereof to receive from the Company, upon exercise of such PSAR, a specified amount of cash. A PSAR had a term of five years and vested 100% on the first anniversary of the date of grant. Amounts charged to expense by the Company under the PSAR Plan amounted to $30.1 million, $4.1 million and $36.1 million during the years ended December 31, 1995, 1994 and 1993, respectively. AFCC also amended the PSAR Plan to provide that certain officers of the Company (all of whom were granted PSARs in 1995) are required to defer one-half of the amount payable in satisfaction of their respective PSARs granted in 1995. The amounts so deferred will be administered by the Company in accordance with the terms of the Associates First Capital Corporation Equity Deferral Plan.\nLong-Term Equity Compensation Plan\nThe Long-Term Equity Compensation Plan (\"ECP\") is a stock-based incentive plan sponsored by AFCC in which the Company will participate and which will be adopted in 1996. The ECP provides for the grant of incentive and nonqualified stock options, stock appreciation rights, restricted stock, performance shares and performance units of First Capital. Awards granted under the ECP are based on shares of Class A Common Stock of First Capital.\nNOTE 12 -- COMMITMENTS, CONTINGENCIES AND LEGAL PROCEEDINGS\nThe Company is a defendant in various lawsuits arising in the ordinary course of its business. The Company aggressively manages its litigation and assesses appropriate responses to its lawsuits in light of a number of factors, including potential impact of the actions on the conduct of the Company's operations. In the opinion of management, the resolution of any of these matters is not expected to have a material adverse effect on the Company's financial condition or results of operations.\nNOTE 13 -- OTHER ASSETS\nThe components of Other Assets at December 31, 1995 and 1994 were as follows (in millions):\nASSOCIATES CORPORATION OF NORTH AMERICA\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 14 -- TRANSACTIONS AND BALANCES WITH RELATED PARTIES\nAssociates provides debt financing or advances to certain of its former foreign subsidiaries. At December 31, 1995 and 1994, amounts due from foreign affiliates totaled $70.7 million and $68.7 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 $7.9 million, $14.4 million and $21.3 million for the years ended December 31, 1995, 1994 and 1993, respectively. The estimated fair value of these receivables was $72.2 million and $70.4 million at December 31, 1995 and 1994, respectively.\nAssociates, from time to time, invests a portion of its working capital funds in variable rate demand notes of AFCC. The balances of its investment at December 31, 1995 and 1994 were $3.7 million and $195.5 million, respectively, and were included in Other Assets. Income from such investments totaled $14.3 million, $16.4 million and $10.7 million for the years ended December 31, 1995, 1994, and 1993, respectively.\nAssociates occasionally makes advances to Associates National Bank (Delaware) (\"ANB\"), a wholly-owned subsidiary of AFCC. The balances of such advances at December 31, 1995 and 1994 were $181.9 million and $124.1 million, respectively, and were included in Other Assets. Income from such advances totaled $6.9 million, $4.2 million and $2.9 million for the years ended December 31, 1995, 1994 and 1993, respectively.\nAt December 31, 1995 and 1994, the net consumer finance receivables included participations in credit card receivables owned or originated by ANB, an affiliate of Associates. The balances of these receivables were $4.6 billion and $3.8 billion at December 31, 1995 and 1994, respectively, and were included in Finance Receivables.\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, 1995, 1994 and 1993 were $68.4 million, $53.7 million, and $40.1 million, respectively.\nThe Company provides certain auto club and relocation services to Ford. Revenues related to these services were $29.7 million, $19.4 million and $12.1 million for the years ended December 31, 1995, 1994 and 1993, respectively.\nAt December 31, 1995 and 1994, the Company was a guarantor on debt and related accrued interest of its foreign affiliates in Canada and Puerto Rico amounting to $487.2 million and $339.9 million, respectively.\nAssociates receives a fee for services it provides to AFCC. During each of the years ended December 31, 1995, 1994 and 1993, Associates received $6.0 million in fees for these services.\nAt December 31, 1995 and 1994, Associates current income taxes (receivable)\/payable to AFCC amounted to $(9.0) million and $11.1 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.\nASSOCIATES CORPORATION OF NORTH AMERICA\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nAs explained in NOTE 2 to the consolidated financial statements, the 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 assets to certain subsidiaries denominated in British Sterling. One interest rate swap transaction for $40.0 million, assumed in 1993 as part of a business acquisition, matured in April 1995 and is no longer outstanding. The Company is a buyer in each transaction.\nThe Company's currency swap transactions are not material to its consolidated balance sheet and do not represent a material exposure to its consolidated net earnings. Amounts under currency and interest rate swap contracts at December 31, 1995 and 1994 were $55.7 million and $95.7 million, respectively. At December 31, 1995, the Company was at market risk for any currency differential should a counterparty to these contracts fail to meet the terms of the contracts. The contracts expire in October 1996. At December 31, 1995, the Company's estimated exposure to loss resulting from currency differentials, in the event of nonperformance by certain counterparties, was $1.1 million; the Company estimates its benefit resulting from currency differentials, in the event of nonperformance by certain counterparties, was $0.2 million. The estimated fair value of amounts under contract approximated $0.9 million and $0.7 million at December 31, 1995 and 1994, respectively. 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 public 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. The Company does not employ other methods to assess credit risk, because swap transactions are not a significant part of its operating activities and because the Company does not enter into complex derivative transactions.\nThe consumer finance business grants revolving lines of credit to certain of its customers. At December 31, 1995 and 1994, the unused portion of these lines aggregated $661.1 million and $455.2 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 finance business grants lines of credit to certain dealers of truck, construction equipment and manufactured housing. At December 31, 1995 and 1994, the unused portion of these lines aggregated $1.2 billion and $849.7 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 DEBT AND EQUITY SECURITIES\nDebt Securities\nThe Company invests in debt securities, principally bonds and notes held by the Company's insurance subsidiaries, 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 in 1994, 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. During 1995, gross realized gains on sales amounted to $0.2 million. Gross realized gains and losses on sales during 1994 amounted to $2.1 million and $0.3 million, respectively. Unrealized gains or losses are reported as a component of stockholders' equity, net of tax. The following tables set forth, by type of\nASSOCIATES CORPORATION OF NORTH AMERICA\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nsecurity issuer, the amortized cost, gross unrealized holding gains, gross unrealized holding losses, and estimated market value at December 31, 1995 and 1994 (in millions):\nThe amortized cost and estimated market value of debt securities at December 31, 1995 and 1994, by contractual maturity, are shown below (in millions):\nEquity Securities\nEquity security investments are recorded at market value. Concurrent with the adoption of SFAS No. 115 in 1994, 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 stockholders' equity, net of tax. The estimated market value at December 31, 1995 and 1994 was $12.6 million and $41.9 million, respectively. Historical cost at December 31, 1995 and 1994 was $8.5 million and $38.9 million, respectively.\nEstimated market values of debt and equity securities are based on quoted market prices.\nNOTE 17 -- BUSINESS SEGMENT INFORMATION\nAssociates primary business activities are consumer finance and commercial finance. The consumer finance operation is engaged in making and investing in home equity, personal lending and sales finance\nASSOCIATES CORPORATION OF NORTH AMERICA\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nreceivables, purchasing participations in credit card receivables, and providing sales financing for manufactured housing. The commercial finance operation is principally engaged in financing sales of transportation and industrial equipment and leasing, and sales of other financial services, including auto fleet leasing and management, relocation services and auto club and roadside assistance services. The Company has an insurance operation which 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. Such insurance activity is conducted by the Company's licensed insurance agents and managed as a separate activity. Insurance sales are dependent on the business activities and volumes of the consumer and commercial business. Accordingly, insurance revenues and related claims are included in the consumer and commercial business to which they relate.\nThe following table sets forth information by business segment (in millions):\n- ---------------\n(a) Includes information pertaining to the financing of manufactured housing purchases which are managed by the commercial operation.\n(b) Includes operating income pertaining to the Company's non-operating subsidiaries.\nCapital expenditures and depreciation and amortization expense are not significant.\nASSOCIATES CORPORATION OF NORTH AMERICA\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 18 -- UNAUDITED QUARTERLY FINANCIAL DATA\nThe following table sets forth the unaudited quarterly results of operations (in millions):\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNot Applicable.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\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\n(b) Reports on Form 8-K\nDuring the quarter ended December 31, 1995, Associates filed Current Reports on Form 8-K dated October 27, 1995, November 17, 1995 and December 5, 1995, related to issuances of debt securities pursuant to Rule 415, and dated October 17, 1995, related to the announcement of a potential partial sale of AFCC by Ford.\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.\nASSOCIATES CORPORATION OF NORTH AMERICA\nBy \/s\/ ROY A. GUTHRIE ---------------------------------------- Executive Vice President and Comptroller March 29, 1996\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 date indicated.\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","section_15":""}
{"filename":"710983_1995.txt","cik":"710983","year":"1995","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 36618, (334) 633-4300.\nProducts(1) - ----------- The 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(TM) 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.\n(1) The following trademarks and registered trademarks of the Registrant are used herein: QFORM(TM), CrownImage(TM), CrownNet(TM), CrownAdmin(TM), QMS(R), magicolor(R), Crown(R), ColorScript(R) and MAGNUM(R). PostScript(TM) and UltraScript(TM) are trademarks of Adobe Systems Incorporated, which may be registered in certain jurisdictions, and PCL(R) is a registered trademark of Hewlett Packard Company. IBM(R) is a registered trademark of International Business Machines Corporation. Xerox(R) is a registered trademark of Xerox Corporation. MacIntosh(R) is a registered trademark of Apple Computer, Inc.\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 1995 were based on the Registrant's Crown(R) 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 1995, 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(R) OS\/2 marketplace and significantly enhances its support in the Novell Netware(R) arena. It also provides superior performance to several other network options.\nDuring fiscal 1995, the Registrant enhanced its product line by releasing a number of enabling products consisting of, but not limited to: QFORM(TM), a software package that allows QMS laser printers to replace line printers in classic IS forms-based operations; AFP and UDK host software emulations, which allow QMS laser printers to replace IBM and Xerox(R) legacy printers; and Crown Administration, a software tool allowing management of networked QMS printers from a central point and a high performance PostScript Level II printer driver for both PC and MacIntosh(R) compatibility.\nThe Registrant also released a color copier option for the magicolor(R) LX printers. This option allows scanning and printing of color documents. The magicolor CX, a native 600 dpi (dots per inch) next generation color printer, was also introduced. A 1200x1200 dpi monochrome printer, based on the already released QMS 1660, was also introduced.\nThe CrownImage(TM) software released in fiscal 1995 enables QMS printers to scan, store, change, retrieve and print documents utilizing an icon-driven, user-friendly graphical interface. The scanners, printers, faxes and file servers that are controlled by CrownImage on a networked basis allow each to be physically located in non-contiguous areas.\nMost of the Registrant's products provide high-resolution (600x600, 1200x600 and 1200x1200 dpi), large format laser printing (monochrome and\/or color), advanced document-handling features, optional network connectivity or a combination of these features.\nSALES AND MARKETING - ------------------- The 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 29, 1995, the Registrant operated direct sales offices in 28 cities in 20 states.\nDuring fiscal 1995, wholly owned subsidiaries of the Registrant operated 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. Subsequent to the end of fiscal 1995, the Registrant sold its subsidiaries in Europe and Australia, and also sold the assets of its subsidiary in Japan. The Registrant signed master distributor agreements with the purchasers so that the Registrant's products will continue to be marketed in these countries.\nThe Registrant's 10 largest customers accounted for an aggregate of approximately 26% of total net sales during fiscal 1995. During fiscal 1995, 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 - ------------------------ In fiscal 1993, 1994 and 1995, international sales totaled $128,782,000, $135,532,000 and $132,130,000, respectively, representing approximately 43%, 46% and 51%, 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. For financial information regarding the Registrant's foreign and domestic operations and export sales, see Notes 1 and 14 of Notes to the Registrant's Consolidated Financial Statements under Item 8 (Financial Statements and Supplementary Data).\nSERVICE, SUPPORT AND WARRANTY - ----------------------------- The 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 32 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. In fiscal 1995, the Registrant provides international 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. (See Sales and Marketing regarding the sale of the Registrant's subsidiaries in Europe, Australia and Japan.)\nThe Registrant warrants its products for a period of 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 - ----------- Competition 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, Inc., NEC Technologies, Inc., Seiko Epson Corp., Tektronix, Inc. and Xerox Corporation. Many of these competitors are larger companies with greater financial resources than those of the Registrant.\nMANUFACTURING AND QUALITY CONTROL - --------------------------------- The 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 1995, the Registrant performed manufacturing and assembly operations in Mobile, Alabama; Utrecht, the Netherlands; and Utsunomiya, Japan. (See Sales and Marketing regarding the sale of the Registrant's subsidiaries in Europe, Australia and 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. The Registrant is currently seeking to sell this subsidiary; however, no agreement with any potential buyer has been reached.\nIn addition to in-house manufacturing, the Registrant routinely contracts with certain vendors to manufacture high-volume, standard products.\nORDER BACKLOG - ------------- Only 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 September 30, 1994 and September 29, 1995, backlog consisted of orders to purchase $8,577,000 and $7,129,000, 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 29, 1995 backlog during fiscal 1996.\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. The Registrant does not believe that sales of its products are subject to significant seasonal fluctuations.\nPRINT ENGINES - ------------- The 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. The Registrant also purchases print engines from other vendors, including Ricoh Company, Ltd., Hitachi America, Ltd., Fujitsu America, Inc., 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 1996 will be adequately met under the terms of existing arrangements and those expected to be entered into in fiscal 1996. 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 Hitachi America, Ltd. and Minolta Co., Ltd. Consequently, disruption of the Registrant's contracts with these suppliers 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 - ------------------------ The 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 29, 1995, approximately 13.6% of the Registrant's employees were employed in its research and development department. During fiscal 1993, 1994 and 1995, the Registrant spent approximately $17,810,000, $15,960,000 and $16,932,000, respectively, for research and development and software costs and received no customer-sponsored funding for research and development. In fiscal years 1993, 1994 and 1995, approximately $8,803,000, $7,056,000 and $7,096,000, respectively, of the software costs for those fiscal years were capitalized in accordance with Financial Accounting Standards (FAS) Statement No. 86.\nPATENTS AND TRADEMARKS - ---------------------- The 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 applications pending on others, in the United States and other countries.\nENVIRONMENTAL MATTERS - --------------------- Management 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 - --------- As of September 29, 1995, the Registrant employed 980 permanent employees in the United States. During fiscal 1995, the Registrant had four foreign operating subsidiaries employing an aggregate of 214 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 99 permanent employees; QMS Canada, Inc., with sales and support organizations in Calgary, Montreal, Ottawa, Quebec City, Toronto and Vancouver, employing a total of 60 permanent employees; QMS Australia, with sales and support organizations in Melbourne and Sydney, employing a total of 16 permanent employees; and QMS Japan, Inc., with sales and support organizations in Tokyo and Utsunomiya, employing a total of 39 permanent employees. (See Sales and Marketing regarding the sale of the Registrant's subsidiaries in Europe, Australia and Japan.)\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. - ------------------- The 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 4,060 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. During fiscal 1995, the Registrant and its other subsidiaries leased additional space in United States cities in which the Registrant operated sales and\/or service offices, as well as in France, the Netherlands, Sweden, Germany, the United Kingdom, Canada, Australia and Japan. In San Jose, California, the Registrant conducts sales, service and engineering operations in a 13,295 square foot leased facility. (See Sales and Marketing regarding the sale of the Registrant's subsidiaries in Europe, Australia and Japan.)\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. - -------------------------- The Registrant 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.\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 STOCKHOLDER MATTERS. - ------------------------------------------------------------------------------\nMARKET PRICE 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 29, 1995 and September 30, 1994. 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. The new credit facility contains provisions which may restrict the payment of dividends. There were 1,693 holders of record of the Company's common stock at November 27, 1995.\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 -------------\nFiscal Years 1995, 1994 and 1993 Compared - -----------------------------------------\nGENERAL\nThe Company expected a level of operating improvement in fiscal 1995; instead, the year resulted in the largest loss in the Company's history. The losses put the Company under extreme cash flow pressure because the need for cash increased and the Company's borrowing capacity was constrained. During the year, the Company recorded special and restructuring charges in both the second and the fourth quarters. The elements and impact of the charges are discussed below. Additionally, many changes in the Company's structure were effected in order to generate cash and to put the Company in a position to return to profitability.\nOn August 23, 1995, the Company announced its intention to sell or liquidate operational assets in Europe and Japan as part of its business strategy for fiscal 1996. In this regard, the Company reached agreement with Jalak Investments BV for the purchase of all of the common shares of QMS Europe BV and QMS Australia Pty Ltd. Jalak Investments BV was formed by Peter van Schaick, who previously was co-managing director for QMS Europe BV. The sale was consummated on October 17, 1995, and will result in net proceeds to the Company of over $10 million. As part of the same transaction, the Company signed an exclusive master distributor agreement with QMS Europe BV (now owned by Jalak Investments BV) to continue marketing QMS products under the QMS name throughout Europe, the Middle East, India, Africa, Australia and New Zealand. The agreement with the new QMS Europe BV calls for commission payments to the Company on all sales of QMS products by QMS Europe BV.\nOn September 25, 1995, the Company sold a portion of its consumables business to International Imaging Materials, Inc. (also known as IIMAK), resulting in net proceeds of over $5 million. Under the agreement, IIMAK has the right to sell color thermal printer ribbons, paper and transparencies to QMS customers in North and South America. These consumables are used with the discontinued QMS ColorScript(R) line of printers. QMS retains all of its other consumables business relating to its monochrome and color laser printer models.\nOn December 8, 1995, the Company sold the majority of the assets of its wholly owned subsidiary to a new company that will also be known as QMS Japan KK. The new company purchased most of the assets of the former subsidiary of QMS, assumed most of the liabilities and will continue to market QMS products under an exclusive master distributor agreement. The new QMS Japan KK was formed by Yoji Kawai, formerly the president and general manager of the QMS subsidiary in Japan. QMS Japan KK will pay commissions to the Company based on all sales of QMS products into a defined exclusive territory, which includes Japan, South Korea, China, Hong Kong, Singapore and other Asian countries.\nWith these cash generation transactions accomplished or agreed to in principle, the Company was able to enter into a new credit facility with Foothill Capital Corporation on November 7, 1995. Proceeds from the new credit facility were used to repay in full all amounts owed by the Company to its bank lending group and to repay portions of other long-term debt that existed at the end of fiscal 1995. The new credit facility also provides the Company with new working capital borrowing capacity and is more fully described in Note 7 to the Company's Consolidated Financial Statements and below.\nGoing forward, the Company will seek to leverage a reduced operating expense structure to profitability through focus on technologies, products, channels and services that produce sustainable, improved gross margins. The Company's strategic plan is to focus on high-margin networkable laser print systems, color laser printers, consumables and service.\nNET SALES\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 1995, the U.S. direct sales operations resulted in a net sales decrease of 14.9%, after having increased by 30% in fiscal 1994. The Company has identified this change in revenue from U.S. direct sales as the single most important cause of the Company's poor financial performance in fiscal 1995. Instability in marketing and sales management led to inconsistent strategies and focus. The Company considers success in this area of its business to be of utmost importance, and accordingly has restructured the Company to focus on delivering high-end, departmental and shared resource networking products to the market through this channel. The U.S. service business experienced a net sales gain in fiscal 1995 of 11%, after a 2.4% increase in fiscal 1994. Revenues from U.S. service are dependent to a great degree on an increasing installed base of printers sold by the U.S. direct sales channel. Additionally, the Company's U.S. service organization has begun to service products that were sold by other manufacturers, taking advantage of printer engine knowledge and geographic dispersion.\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 decline in net sales of printer products in fiscal 1995 of nearly 54.6%, after a net sales decrease of 48% in fiscal 1994. During fiscal 1995 and fiscal 1994, the U.S. reseller channel product mix was under extreme competitive pressure which resulted in lower sales volume and continued price erosion. Additionally, instability in sales and marketing management led to inconsistent strategies. The performance in the U.S. reseller channel improved during the fourth quarter of fiscal 1995 as sales of the QMS magicolor LX improved. On September 25, 1995, the Company introduced the QMS magicolor CX color laser print system. This product offers several new features, including new color screening technology, improved color management tools and microfine toner. These features result in higher image quality and should improve revenue generated in the U.S. reseller channel in fiscal 1996. This product fits well with the Company's sales and marketing strategies for 1996 because a significant consumables business follows the printer sales.\nQMS Europe BV and QMS Australia Pty Ltd were sold to Jalak Investments BV subsequent to the end of the fiscal year (as described previously). During fiscal 1995, QMS Europe BV experienced a net sales increase of 4.3% and QMS Australia had a sales decline of nearly 13%. In fiscal 1996, the Company will continue to sell component parts and controller boards to QMS Europe under a master distributor agreement and the Company will also receive a commission from QMS Europe on all sales of QMS-branded products. The result will be a significant decrease in the sales revenue recognized by the Company, but the arrangement will also eliminate the entire operating expense structure of QMS Europe BV.\nQMS Japan KK was sold subsequent to the end of fiscal 1995 (as described previously). During 1995, QMS Japan sold 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 1995, QMS Japan experienced a small revenue decline after having increased net sales by 74% in fiscal 1994. New competition forced sales price erosion for low-end monochrome products. In fiscal 1996, the Company will continue to sell component parts and controller boards to QMS Japan KK under a master distributor agreement, and the Company will also receive a commission from QMS Japan KK on all sales that they make of QMS-branded products. The result will be a significant decrease in the sales revenue recognized by the Company, but the arrangement will also eliminate the entire operating expense structure of QMS Japan KK.\nQMS Canada, Inc., a wholly owned subsidiary headquartered in Montreal, sells the entire line of Company products, including service and accessories, directly to end users and also through resellers. Net sales for QMS Canada declined by 29% in 1995 and by 4% in 1994. The primary reason for the decline in 1995 was competitive pressure, which resulted in lower sales volume and price erosion.\nQMS 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 1995, 1994 and 1993, the Company also sold Magnum(R) controller boards, controller-level products to original equipment manufacturers and printer products into Latin America.\nGROSS PROFIT\nThe significant decline in gross profit dollars in fiscal 1995, a total of $46.4 million, has three main components. 1) Special charges of $18.1 million related to inventory obsolescence and the write-off of certain software costs incurred in connection with the implementation of the Company's strategic plan (as described under General above). These special charges relate primarily to low-end products that are not a part of the Company's primary focus going forward. 2) The significant volume declines in the U.S. direct and U.S. reseller channels (as described under Net Sales above), as well as price erosion, resulted in lower gross profit in fiscal 1995 of approximately $18 million. 3) The volume decreases in Japan and Canada described above resulted in less gross profit in fiscal 1995 of $5.4 million. Gross 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 in fiscal 1994 where the higher end of the Company's product offering is sold directly to end users. Going forward, the Company's new strategic focus and the method of doing business in Europe and Japan are intended to result in higher gross margin percentages of sales than were experienced in fiscal 1995.\nOPERATING EXPENSES\nOperating expenses, excluding restructuring charges, totaled $86.2 million in fiscal 1995, approximately 3% less than the fiscal 1994 operating expense level; however, due to the reduction in sales, these operating expenses were 33.2% of sales, up from 30.4% in fiscal 1994. The Company implemented workforce reductions in both the second and the fourth quarters of fiscal 1995 that resulted in headcount reductions totaling 175 people. The Company's total headcount after the reductions and after the change in corporate structure from the divestiture of its businesses in Europe, Australia and Japan is 942, down from 1,194 at fiscal 1995 year end. As part of the Company's operating plan for 1996, management performed an exhaustive review of operating expenses throughout the Company and made reductions in every functional area, including a reduction in executive and senior management salaries and perquisites, reductions in the costs of employee benefits, the sale of the Company aircraft and many other items. Management will continue to emphasize cost containment. During fiscal 1994, operating expenses were contained at $88.9 million, a decrease of $8.1 million compared to fiscal 1993. Fiscal 1993 operating expenses included a 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 this charge, operating expenses were $94 million in fiscal 1993.\nResearch and development expenses increased by 10.4% in fiscal 1995 and were essentially the same in fiscal 1994 as they were in fiscal 1993. Capitalized software costs amounted to $7.1 million, $7.1 million and $8.8 million for fiscal 1995, 1994 and 1993, respectively. Management continues to believe that 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.\nRESTRUCTURING CHARGES\nDuring fiscal 1995, restructuring charges, as part of the Company's cost reduction effort, totaling approximately $8.4 million were recorded to recognize costs associated with salary continuation and outplacement services ($3.7 million), the write-off of certain fixed assets and facility lease obligations ($2.4 million), and the write-down of the Company's investment in QMS Japan ($2.3 million). The subsequent sale of QMS Japan in early December 1995 did not result in additional losses.\nOTHER INCOME (EXPENSE)\nInterest expense increased by 27% in fiscal 1995 and was approximately the same amount in fiscal 1994 and fiscal 1993. In fiscal 1995, the Company's borrowing needs grew because of the operating losses. The net gain on divestitures of businesses (see Note 18 to the Company's Consolidated Financial Statements) includes a loss on the sale of the Europe and Australia entities (approximately $2 million) and a gain on the sale of a portion of the Company's consumables business (approximately $5.7 million). Miscellaneous income (expense) includes a gain on the sale of the Company aircraft (approximately $517,000) and a net gain on foreign currency transactions (approximately $400,000).\nThe Company did not enter into any material foreign exchange contracts in fiscal 1995 or in fiscal 1994. In fiscal 1993, 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 under these contracts were $343,362.\nINCOME TAX\nFor fiscal 1995, no benefit or provision for income taxes was recognized. A provision of 26.7% of pretax income was recognized for fiscal 1994, and a benefit of 31% of pretax loss was recognized for fiscal 1993. 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\nThe Company's products include components, primarily microprocessors and dynamic random-access memory devices, which from time to time are sensitive to market conditions that result in limited availability and\/or extreme price fluctuations. An interruption in the supply of 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 $7.4 million at September 29, 1995, compared to $5 million and $3.6 million at the end of the two previous years. The cash flow from operations was $12.4 million for fiscal 1995, compared to $23.2 million in fiscal 1994 and $3.1 million in fiscal 1993. The Company's financing for fiscal 1995 and 1994 came principally from cash flows from operations, capital leases and a secured revolving credit agreement. In addition, during fiscal 1995, cash flows of $5.7 million came from the sale of the ink roll consumables business and $7.8 million from short-term bank borrowings. During fiscal 1993, the Company's financing came principally from borrowings under a secured revolving credit agreement.\nThe Company's working capital was $35.5 million at September 29, 1995, down from $79.4 million at the end of fiscal 1994 and $78.4 million at the end of fiscal 1993. The reduction of $43.9 million during fiscal 1995 is principally due to reducing net inventories by $22.3 million, net trade accounts receivable by $13.7 million and acquiring new short-term bank borrowings of $7.8 million. During fiscal 1995, the Company reduced its total long-term debt levels to $24.5 million, down from $34.3 million in fiscal 1994. Bank borrowings under the Company's secured revolving credit agreements were reduced to $17.8 million at the end of fiscal 1995, compared to $23.2 million at the end of fiscal 1994. Senior secured notes payable were reduced from $15.1 million at the end of fiscal 1994 to $10.9 million at the end of fiscal 1995. These reductions were directly related to the Company's efforts to refinance its short- and long-term indebtedness, as discussed more fully below.\nAt September 29, 1995, the Company was not in compliance with certain covenants in its credit agreements. As members of the bank group had expressed a desire to exit the credit facility, management entered into negotiations to establish a new credit agreement. On November 7, 1995, the Company entered into a new loan arrangement with Foothill Capital Corporation. Proceeds from the new loan arrangement were used to repay in full all amounts owed by the Company to its bank lending group and to repay portions of other long-term debt that existed at the end of fiscal 1995. The new loan arrangement also provides the Company with additional working capital borrowing capacity and is more fully described in Note 7 to the Company's Consolidated Financial Statements.\nManagement believes that the Company's fiscal 1996 working capital and capital expenditure needs, as well as funding for research and development, will be met by cash flow from operations and by the new financing arrangement.\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. - ---------------------------------------------------\nSee Notes to Consolidated Financial Statements.\nCONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY\n- -------- See Notes to Consolidated Financial Statements.\nCONSOLIDATED BALANCE SHEETS\nSee Notes to Consolidated Financial Statements.\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nSee Notes to Consolidated Financial Statements.\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 1995, 1994 and 1993 included 52 weeks.\nCASH EQUIVALENTS - The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents.\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 of printers and supplies are recorded upon shipments of products to customers provided that no significant vendor obligations remain and collectibility of the resulting receivables is probable. Service revenue is recognized at the time the services are provided or upon completion of certain obligations under deferred service contracts.\nWARRANTY POLICY - The Company warrants its products for a period of 90 days to 2 years from the date of shipment, depending on the product.\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 up 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. Amortization adjustments are made to reflect net realizable value.\nCapitalized software costs for fiscal 1995, 1994 and 1993 totaled $7,096,000, $7,056,000 and $8,803,000, respectively. For fiscal 1995, 1994 and 1993, $13,853,000, $7,345,000 and $6,835,000, respectively, were charged as amortization expense on completed projects, and were included in cost of goods sold. For fiscal 1995 and 1993, amortization included net realizable value adjustments of $4,639,000 and $86,850, respectively. The amortization for fiscal 1994 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 13.)\nEARNINGS (LOSSES) PER COMMON SHARE - Earnings (losses) 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 stockholders' equity except for QMS Japan, for which a gain of approximately $2.3 million was included in restructuring charges in fiscal 1995 as a component of the write- down of the Company's investment in QMS Japan. (See Note 17.) Foreign currency transaction gains (losses) are included as a component of miscellaneous income (expense). (See Note 14.)\nRECLASSIFICATIONS - Certain reclassifications have been made to fiscal 1994 and 1993 amounts to conform to the fiscal 1995 presentation.\nNOTE 2 INVENTORIES\nInventories at September 29, 1995 and September 30, 1994 are summarized as follows (in thousands):\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. The increase in reserve is due to special charges against inventory (approximately $6.4 million) taken in the fourth quarter of fiscal 1995 due to the change in the Company's strategic focus, as described in \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nNOTE 3 OTHER ASSETS\nOther assets at September 29, 1995 and September 30, 1994 are summarized as follows (in thousands):\nAccumulated amortization of capitalized software costs amounted to $30,002,000 and $16,509,000 at September 29, 1995 and September 30, 1994, respectively. Accumulated amortization of deferred software costs amounted to $3,143,000 and $1,987,000 at September 29, 1995 and September 30, 1994, respectively.\nNOTE 4 PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment at September 29, 1995 and September 30, 1994 are summarized as follows (in thousands):\nNOTE 5 SHORT-TERM BANK BORROWINGS\nShort-term bank borrowings at September 29, 1995 and September 30, 1994 were as follows (in thousands):\nProceeds from the above loans were used for working capital. Subsequent to year end, these loans were repaid as part of the divestiture of the Company's European and Japanese subsidiary operations.\nNOTE 6 OTHER CURRENT LIABILITIES\nOther current liabilities at September 29, 1995 and September 30, 1994 are summarized as follows (in thousands):\nNOTE 7 LONG-TERM DEBT\nLong-term debt at September 29, 1995 and September 30, 1994 is summarized as follows (in thousands):\nThe 6.15% senior secured notes are secured by a first priority lien on portions of the Company's land and buildings located in Mobile, Alabama.\nOn November 7, 1995, the Company entered into an agreement with Foothill Capital Corporation (\"Foothill\") which allowed the Company to retire the existing secured revolving credit agreement and the 10.13% senior secured notes payable. The new credit facility provides for a three-year revolving line of credit with maximum availability of $30 million, secured by the Company's domestic accounts receivable, inventory and machinery and equipment. The stated rate of interest for any borrowings under the new agreement is one and one-half percent over prime. Additional provisions of the new credit facility provide for a term loan of $1.2 million secured by machinery and equipment and the availability of a second term loan of $5 million. The $1.2 million term loan requires minimum annual principal payments of approximately $300,000.\nAlthough the Company was not in compliance with certain covenants contained in the credit agreements existing at year end and has not obtained waivers of non- compliance from the lenders, the new long-term credit facility with Foothill provided the Company with the capacity to pay off these debts individually and collectively and, therefore, they have been classified as long-term debt in the financial statements.\nThe new credit facility with Foothill includes requirements for a minimum current ratio, a maximum total liabilities to equity ratio and minimum levels of tangible net worth and working capital.\nIn connection with the new financing arrangements, Foothill was granted a warrant to purchase 100,000 shares of the Company's common stock, at a price of $5 a share, which is exercisable through October 30, 1999. Following 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 29, 1995 and of September 30, 1994, has been estimated as follows (in thousands):\nNOTE 8 LEASES\nThe Company has capital leases that expire through fiscal 2000. 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 29, 1995 were as follows (in thousands):\nRent expense under operating leases for fiscal 1995, 1994 and 1993 was $6,120,000, $7,233,000 and $7,120,000, respectively.\nAssets recorded under capital leases (included in property, plant and equipment in the accompanying consolidated balance sheets) at September 29, 1995 and September 30, 1994 are summarized as follows (in thousands):\nNOTE 9 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 may match employee contributions at varying rates up to a maximum of 3.5% of annual salary, and Company contributions are made on an annual basis. The plan is a calendar year plan. Employees at the end of the plan year are fully vested in applicable Company contributions. In fiscal 1995, 1994 and 1993, the Company contributed $1,010,244, $1,046,137 and $1,029,391 to the plan, respectively.\nNOTE 10 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 1,872,688 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 be paid 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 upon exercise of the option.\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 29, 1995, the Company had reserved 355,138 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. The 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 1995, the Company repriced certain stock option grants under the 1987 Stock Option Plan. Stock option grants of 158,360 shares that were previously issued at option prices greater than the current fair market value were forfeited and replaced with stock option grants for 79,180 shares (a rate of one new share for two previous shares) at the fair market value on the date of grant. The grant of these repriced options was restricted to non-executive officer employees.\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. Compensation expense under this plan for fiscal 1995 and 1994 was $77,244 and $39,750, respectively.\nA summary of stock option activity is as follows:\nNOTE 11 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 1995, 1994 and 1993, the Company expensed $366,396, $291,806 and $441,938, respectively, related to these benefits. In fiscal 1995, the Company paid benefits of $27,831 under these agreements.\nNOTE 12 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 13 INCOME TAXES\nThe components of income (loss) before income taxes and the provision (benefit) for income taxes (both domestic and foreign), for fiscal 1995, 1994 and 1993 are summarized as follows (in thousands):\nAt September 29, 1995, the Company had domestic operating loss carryovers of approximately $36 million which will expire in fiscal 2010, and general business credit carryovers of approximately $1.7 million which will expire during fiscal 2002 through 2007. Foreign tax credit carryforwards of approximately $1.7 million existed at September 29, 1995 and will expire in fiscal 1996 through 1998.\nThere were no undistributed earnings in the Company's Canadian subsidiary at fiscal 1995 year end. Undistributed earnings of the Company's other foreign subsidiaries which were divested will not result in any material taxes payable by the Company.\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 1995, 1994 and 1993 is as follows (in thousands):\nDeferred tax assets and liabilities that arise as a result of temporary differences at September 29, 1995 and September 30, 1994 are summarized as follows (in thousands):\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 1995 and 1993, 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 increased by approximately $16.5 million during fiscal 1995. The Company did not recognize tax benefits for fiscal 1995 losses due to restrictions on the carryback of the losses and there is no assurance that the benefits may be realized in the future.\nNOTE 14 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 1995, 1994 and 1993 are summarized as follows (in thousands):\nAll transfers between geographic areas are sales from the U.S. parent to its foreign subsidiaries.\nA summary of operating income by geographic areas is as follows (in thousands):\n*Miscellaneous expense includes foreign currency transaction gains (losses) as follows (in thousands):\nIdentifiable assets by geographical area are as follows (in thousands):\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 1995, 1994 and 1993 is as follows (in thousands):\nU.S. export sales included in the above summary for fiscal 1995, 1994 and 1993 were $2,171,260, $2,802,489 and $1,298,769, respectively.\nNo customer accounted for 10% or more of consolidated net sales for fiscal 1995, 1994 and 1993.\nNOTE 15 SUPPLEMENTAL CASH FLOW INFORMATION\nCash paid for interest and income taxes for fiscal 1995, 1994 and 1993 is as follows (in thousands):\nAdditions to capital lease assets and related obligations were $823,000, $1,705,000 and $41,000 in fiscal 1995, 1994 and 1993, respectively, as a result of the Company entering into equipment leases.\nNOTE 16 COMMITMENTS AND CONTINGENCIES\nAt September 29, 1995, the Company had a commitment of approximately $13.2 million under contracts to purchase print engines.\nThe Company was contingently liable for approximately $1.2 million as of September 29, 1995, 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.\nNOTE 17 RESTRUCTURING CHARGES\nDuring fiscal 1995, the Company recognized restructuring charges totaling approximately $8.4 million. These costs included $3.7 million associated with salary continuation and outplacement services for a group of 175 employees from all levels and functional areas of the Company, $2.4 million related to the write-off of certain fixed assets and facility lease obligations and $2.3 million for the write-down of the Company's investment in QMS Japan. The subsequent sale of QMS Japan in early December 1995 did not result in additional losses.\nNOTE 18 DIVESTITURES OF BUSINESSES\nOn September 25, 1995, the Company completed a cash sale of a portion of its color thermal ink roll consumables business to International Imaging Materials, Inc., resulting in a gain of $5.7 million.\nOn October 17, 1995, the Company sold all of the common shares of QMS Europe BV and QMS Australia Pty Ltd. This transaction resulted in a loss of approximately $2 million. The proceeds from this transaction were received in the form of cash of $6.3 million, short-term receivables of $1.6 million and a $4 million note receivable, payable in quarterly installments of $1 million each with interest at 6.5%.\nOn December 8, 1995, the Company sold the majority of the assets of QMS Japan with the purchaser acquiring most of the assets and assuming most of the liabilities. This transaction resulted in a loss of approximately $2.3 million. The proceeds from this transaction were received in the form of cash of $500,000 to be paid December 20, 1995, short-term receivables of $500,000 and a $3.0 million note receivable, payable over 54 months with interest at 8%.\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 fairly the financial position, results of operations and cash flows of the Company.\n\/s\/James L. Busby President and Chief Executive Officer\n\/s\/James K. Doan Executive Vice President, Finance and Administration, and Chief Financial Officer\nQUARTERLY DATA\n(a) Includes special charges of $6.8 million principally associated with inventory revaluation charged to cost of sales and $2.7 million for restructuring charges.\n(b) Includes special charges of $11.3 million related to inventory revaluations and the write-down of certain software development costs charged to cost of sales and $5.7 million for restructuring charges.\n(c) The net loss amounts in the second, third and fourth quarters of fiscal 1995 do not include the recognition of any income tax benefits.\nINDEPENDENT AUDITORS' REPORT\nWe have audited the accompanying consolidated balance sheets of QMS, Inc. and subsidiaries as of September 29, 1995 and September 30, 1994, 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 29, 1995. 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 as of September 29, 1995 and September 30, 1994, and the results of their operations and their cash flows for each of the three fiscal years in the period ended September 29, 1995 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\nBirmingham, Alabama November 7, 1995, except for Note 18 as to which the date is December 8, 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 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 Proxy Statement and \"Executive Officers\" on pages 4-5 of the Proxy Statement.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION. - --------------------------------- The information required by this item is incorporated by reference to information under the captions \"Proposal 1 - Election of Directors - Director Compensation\" on pages 3-4, \"Executive Compensation Tables\" on pages 6-9, \"Stock Performance Graph\" on page 10, \"Executive Agreements\" on pages 10-11 and \"Report of the Compensation Committee of the Board of Directors of QMS, Inc.\" on pages 11-13 of the Proxy Statement.\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 information under the caption \"Beneficial Ownership of Common Stock\" on pages 5- 6 of the Proxy Statement.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. - --------------------------------------------------------- The information required by this item is incorporated by reference to information under the caption \"Compensation Committee Interlocks and Insider Participation\" on page 13 of the Proxy Statement.\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:\n1. Financial Statements\nThe following financial statements are included in Item 8 of Part II:\n. Consolidated Statements of Operations for the Fiscal Years Ended September 29, 1995, September 30, 1994 and October 1, 1993.\n. Consolidated Statements of Changes in Stockholders' Equity for the Fiscal Years Ended September 29, 1995, September 30, 1994 and October 1, 1993.\n. Consolidated Balance Sheets at September 29, 1995 and September 30, 1994.\n. Consolidated Statements of Cash Flows for the Fiscal Years September 29, 1995, September 30, 1994 and October 1, 1993.\n. Notes to Consolidated Financial Statements for the Fiscal Years September 29, 1995, September 30, 1994 and October 1, 1993.\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 29, 1995.\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:\n* Indicates a management contract or compensatory plan or arrangement.\n1\/ 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).\n2\/ 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).\n3\/ 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).\n4\/ 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).\n5\/ 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).\n6\/ 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).\n7\/ 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).\n8\/ 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).\n9\/ 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).\n10\/ 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).\n11\/ 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).\n12\/ 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).\n13\/ 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, 1994 (Commission File No. 1-9348).\n14\/ Incorporated herein by reference to exhibits in Registrant's Form 8-K filed on October 16, 1995 (Commission File No. 1-9348).\n15\/ Incorporated herein by reference to exhibits in Registrant's Form 8-K filed on November 21, 1995 (Commission File No. 1-9348).\n(b) Reports on Forms 8-K:\nThe following reports were filed on Forms 8-K during the most recent fiscal quarter:\n. Form 8-K dated October 16, 1995 reporting the sale of QMS Europe B.V. and QMS Australia PTY Ltd. . Form 8-K dated November 21, 1995 reporting the new credit agreement with Foothill Capital Corporation.\nSIGNATURES ----------\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nSCHEDULE VIII QMS, INC. AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS AND RESERVES FOR THE THREE FISCAL YEARS ENDED SEPTEMBER 29, 1995\nINDEX\n3. Exhibits:\n* Indicates a management contract or compensatory plan or arrangement.\n1\/ 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).\n2\/ 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).\n3\/ 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).\n4\/ 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).\n5\/ 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).\n6\/ 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).\n7\/ 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).\n8\/ 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).\n9\/ 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).\n10\/ 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).\n11\/ 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).\n12\/ 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).\n13\/ 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, 1994 (Commission File No. 1-9348).\n14\/ Incorporated herein by reference to exhibits in Registrant's Form 8-K filed on October 16, 1995 (Commission File No. 1-9348).\n15\/ Incorporated herein by reference to exhibits in Registrant's Form 8-K filed on November 21, 1995 (Commission File No. 1-9348).\n(b) Reports on Forms 8-K:\nThe following reports were filed on Forms 8-K during the most recent fiscal quarter:\n. Form 8-K dated October 16, 1995 reporting the sale of QMS Europe B.V. and QMS Australia PTY Ltd. . Form 8-K dated November 21, 1995 reporting the new credit agreement with Foothill Capital Corporation.","section_15":""}
{"filename":"19161_1995.txt","cik":"19161","year":"1995","section_1":"Item 1. BUSINESS\n\tUnless the context indicates otherwise, the term \"Company\" as used herein means Champion Parts, Inc. and its subsidiaries.\nPRODUCTS\n\tThe Company remanufactures a broad line of functional replacement parts for automobiles, trucks and farm and industrial equipment.\n\tThe Company's general product line includes carburetors, water pumps, clutches, starters, alternators, generators, starter drives and solenoids, and constant velocity drive shaft assemblies for substantially all makes and models of domestic and foreign automobiles and trucks, and many makes and models of farm and industrial equipment. In selected markets, the Company sells disc brake calipers, master cylinders, power steering pumps, windshield wiper motors, and distributors. The Company's product line also includes diesel fuel injection systems primarily for light duty vehicles and for some domestic automobiles and heavy duty trucks.\n\t\n\tDuring the fiscal years ended January 1, 1995, January 2, 1994 and January 3, 1993, the Company's sales of parts for automobiles (including light duty trucks) accounted for approximately 92%, 89% and 87%, respectively, of the Company's net sales, and sales of parts for heavy duty trucks and farm equipment accounted for approximately 8%, 11% and 13%, respectively, of such net sales.\nMARKETING AND DISTRIBUTION\n\tThe Company's products are marketed throughout the continental United States and in Canada. The Company sells to automotive warehouse distributors, which in turn sell to jobber stores and through them to service stations, automobile repair shops and individual motorists. In addition, the Company sells to aftermarket retail chains who distribute products through their stores. Other customers of the Company include manufacturers of automobiles, trucks and farm equipment, which purchase the Company's products for resale through their dealers, independent fleet specialists who distribute replacement parts for these vehicles and large volume automotive retailers. Of the Company's net sales in the year ended January 1, 1995, approximately 54% were to automotive warehouse distributors; approximately 13% were to manufacturers of automobiles, trucks and farm equipment and heavy duty fleet specialists; and approximately 33% were to retailers and other customers.\n\tThe Company exhibits its products at trade shows and advertises in nationally and regionally distributed automotive trade magazines. The Company also prepares and publishes catalogs of its products, including a guide with information as to the various vehicle models for which the Company's products may be used and a pictorial product identification guide to assist customers in the return of used units. The Company's salespersons and sales agents call on selected customers of warehouse distributors which carry the Company's products to familiarize these customers with the Company's products and the applications of its products to varied automotive equipment.\n\tDuring the fiscal year ended January 1, 1995, the three largest customers of the Company accounted for approximately 20% (Northern Automotive Corporation), 15% (APS, Inc.) and 13% (Genuine Parts Company), respectively, of net sales, and no other customer accounted for more than 6% of net sales.\n\tMost of the Company's products are distributed from each of the Company's plants. Heavy duty products are stocked at and delivered from the same facilities as automotive products.\n\tThe Company makes available to its customers the MEMA Transnet(TM) computerized order entry system which is administered by the Motor Equipment Manufacturers Association. The MEMA Transnet(TM) system enables a customer in any area of the United States to place orders into the Company's central computer, which transmits the orders to the Company's plant servicing that customer's geographic area.\n\tAs of February 1, 1995, sales were made by a total of 27 sales personnel. Of these, 23 were salaried salespersons, and 4 were employed by the Company as support staff. The Company also utilizes 11 sales agencies to supplement the direct sales force.\n\tApproximately 45% of the Company's net sales during the fiscal year ended January 1, 1995 were under trade names of the Company, and the balance was sold under private labels of certain customers such as vehicle manufacturers, warehouse distributor groups and retailers.\n\tThe Company does not consider its business to be highly seasonal. Typically, fourth quarter sales are lower than those in prior quarters due to customer ordering patterns.\nMATERIALS\n\tIn its remanufacturing operations, the Company obtains used units, commonly known as \"cores\". A majority of the units remanufactured by the Company are purchased back from customers as trade-ins, which are encouraged by the Company in the sale of remanufactured units.\n\tThe price of a finished product is comprised of a separately invoiced amount for the core included in the product (\"core value\") and an amount for remanufacturing. Upon receipt of a core as a trade-in, credit is given to the customer for the then current core value of the part returned. The Company limits trade-ins to cores for units included in its sales catalogs and in rebuildable condition, and credit for cores is allowed only against purchases by a customer of similar remanufactured products within a specified time period. A customer's total allowable credit for core trade-ins is further limited by the dollar volume of the customer's purchases of similar products within such time period. In addition to allowing core returns, the Company permits warranty and stock adjustment returns (generally referred to as \"product returns\") pursuant to established policies. The Company's core return policies are consistent with industry practice, whereby remanufacturers accept product returns from current customers regardless of whether the remanufacturer actually sold the product. The Company has no obligation to accept product returns from customers that no longer purchase from the Company.\n\tOther materials and component parts used in remanufacturing, and some cores, are purchased in the open market. When cores are not available in sufficient supply for late models of automobiles, trucks and farm equipment or for foreign model automobiles, new units sometimes are purchased and sold as remanufactured units. To market a full line of products, the Company also purchases certain remanufactured and new automotive parts which it does not produce.\nPATENTS, TRADEMARKS, ETC.\n\tThe Company has no material patents, trademarks, licenses, franchises or concessions.\nBACKLOG\n\tThe Company did not have a significant order backlog at any time during the fiscal years 1993 or 1994.\nCOMPETITION\n\tThe Company believes it is one of the largest remanufacturers of functional automotive replacement parts in the United States, although reliable information indicating its comparative position in the industry is not available. Certain of the Company's competitors are divisions or subsidiaries of organizations also engaged in other businesses which have substantially greater financial resources than the Company. The remanufactured automotive parts industry is highly competitive as the Company competes with a number of other companies (including certain original equipment manufacturers) which sell remanufactured automotive parts. The Company competes with several large regional remanufacturers and with remanufacturers which are franchised by certain original equipment manufacturers to remanufacture their products for regional distribution. The Company also competes with numerous remanufacturers which serve comparatively local areas. In addition, sales of remanufactured parts compete with sales of similar new replacement parts. Manufacturers of kits used by mechanics to rebuild carburetors may also be deemed to be competitors of the Company.\n\tThe Company competes in a number of ways, including price, quality, product performance, prompt order fill, service and warranties. The Company believes its ability to offer and distribute a full line of products on a national level has been an important factor in enabling the Company to compete effectively.\nENGINEERING\n\tThe Engineering Department participates in product planning, product line structuring, cataloging and engineering of the Company's products and in developing manufacturing processes. The primary activities of the Department are improving the quality of existing products, formulating specifications and procedures for adapting particular remanufactured products for use on makes and models of vehicles in addition to those for which originally designed, converting cores from earlier makes and models for use on later makes and models and developing specifications, supplies and procedures for remanufacturing additional products. The Department also conducts periodic quality audits of the Company's plants under its quality improvement program to test product quality and compliance with specifications.\n\tThe Company believes such activities improve the Company's ability to serve the needs of its customers. The Department also designs and builds new tools, machines and testing equipment for use in all the Company's plants, and develops specifications for certain components manufactured by the Company for use in its remanufacturing operations. The Department designs and tests new methods of reassembling components and cleaning parts and cores. During the fiscal years 1994, 1993 and 1992, the Company expended approximately $944,000, $940,000 and $1,224,000, respectively, in these engineering activities.\nENVIRONMENTAL MATTERS\n\tThe Company is subject to various Federal, state and local environmental laws and regulations incidental to its business. The Company continues to modify, on an ongoing basis, processes that may have an environmental impact. Management believes that the effects of compliance with environmental laws that have been enacted or adopted will not have a material effect on capital expenditures, earnings or competitive position.\nEMPLOYEES\n\tAs of January 31, 1995, the Company employed approximately 1,470 persons, including 205 salaried employees at corporate headquarters and plant locations; and approximately 1,265 production, warehouse and maintenance employees and truck drivers, 720 of whom were subject to union collective bargaining agreements. In addition, the Company utilizes temporary workers provided by employment agencies.\n\tThe Collective Bargaining Agreement between the Company and the United Auto Workers at the Company's Hope, Arkansas facility expired on April 26, 1991. At the expiration of the contract, the Company implemented its final offer with respect to workers at the facility. The union went on strike effective September 4, 1991. Since the commencement of the strike, the plant has been operating with employees who opted to continue working, as well as with permanent replacements. There have been no significant interruptions in production as a result of the strike, and management anticipates no significant interruptions in the future as a result of the strike.\n\tThe Collective Bargaining Agreement between the Company and the International Brotherhood of Electrical Workers at the Company's Pennsylvania facilities was renewed for a three year term beginning September 1, 1993.\nRECENT DEVELOPMENTS\n\tOn March 23, 1995, the Company entered into a Preferred Stock Purchase Agreement (the \"Agreement\") with RGP Holding, Inc. (\"RGP\"), an affiliate of Mr. Raymond G. Perelman, a director, the Chairman of the Board of Directors and the beneficial owner of 18.1% of the outstanding Common Shares of the Company, pursuant to which Agreement RGP agreed, subject to the terms and conditions of the agreement, to purchase 1,666,667 shares of the Company's newly authorized Series A Redeemable Cumulative Convertible Voting 9% Preferred Shares (the \"Preferred Shares\") at a purchase price of $3.00 per share, or an aggregate purchase price of $5,000,001, subject to the terms and conditions of the agreement.\n\tOn April 17, 1995 RGP notified the Company that it had determined, not to consummate the purchase. RGP stated that the Company failed to satisfy certain conditions for closing.\n\tThe Company's Current Report on Form 8-K filed March 23, 1995, which form describes the proposed purchase, is incorporated herein by reference.\n\t\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\n\tThe Company's corporate headquarters are located at 2525 22nd Street, Oak Brook, Illinois, a one-story building which has approximately 91,500 square feet of space, and is leased under a sublease which expires in 1996. The facility houses the Company's corporate office functions, including administration, accounting, data processing, marketing, and limited engineering and product development. Approximately one-third of the facility is used for office space and the remainder is used for storage and a limited distribution facility.\n\tThe following table sets forth certain information with respect to each of the Company's remanufacturing, warehousing and service facilities other than the corporate headquarters:\n\t\t\t Warehouse Remanufacturing \t\t\t\t Area Area Location (sq. ft.) (sq. ft.)\nOWNED:\nFresno, California 50,000 110,000\nLock Haven, Pennsylvania --- 50,000\nBeech Creek, Pennsylvania 40,000 160,000\n\t\t\t\t\nHELD UNDER INDUSTRIAL REVENUE FINANCING ARRANGEMENTS:\nLock Haven, Pennsylvania --- 55,000\n\t\t\t\t Hope, Arkansas 55,000 221,000\n\t\t\t\t\nLEASED:\nMaple, Ontario, Canada 30,000 16,000\nHope, Arkansas 35,000 ---\n\tThe Company's plants are well maintained and are in good condition and repair. A substantial portion of the machinery and equipment has been designed by the Company for its particular purposes and, in many instances, has been built by it.\n\tIn connection with the Company's plant consolidation plan announced in March, 1994, the facilities in Lock Haven, Pennsylvania are currently idle. It is the Company's present intention to dispose of these properties.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nSpectron\/Galaxy Site\n\tThe Company was notified in 1989 by the United States Environmental Protection Agency (\"EPA\") that it was a \"potentially responsible party\" (\"PRP\") with respect to the removal of hazardous substances from the Spectron, Inc. site in Elkton, Maryland (the \"Spectron Site\"). The Company has admitted to sending 93,868 gallons of liquid substances to the Spectron Site.\n\tA PRP Group known as the Spectron Steering Committee (\"SSC\") was formed and in August, 1989, an Administrative Order by Consent (\"Phase I Order\"), authorizing the SSC to conduct the surface removal, and a Consent Agreement under which the PRPs became obligated to reimburse the EPA for its past costs in connection with the site, were entered into by the EPA and approximately ten PRPs, including several major industrial corporations.\n\tThe Company has been informed that the costs incurred to date with respect to the removal phase of the Spectron Site are approximately $8.0 to $8.5 million, but that although the removal project has been completed, there has not yet been a final accounting for that phase of the activity because the EPA has not yet demanded payment of its past or oversight costs.\n\tThe Company entered into an agreement with the Company's waste transporter, which selected the Spectron Site, pursuant to which the transporter paid one-half of the cost attributed to surface removal for the Company's waste sent to the Spectron Site. The Company has paid approximately $17,000 for its portion of the removal.\n\tIn 1990, the Company received notices that the EPA has determined that ground water seepages from the Spectron Site pose an imminent endangerment to nearby residents and the environment. A number of additional PRPs who had not been notified of potential liability for the surface removal were contacted by the EPA in preparation for the second phase of activity at the site (\"Phase II\"). Most of the newly noticed parties had used the site during its earlier years of operation, prior to 1979, when it was known as Galaxy Chemicals.\n\tThe Company has been informed by the waste transporter that the Spectron Contributors reached agreement with the Galaxy Contributors with respect to Phase II to the effect that the Galaxy Contributors will contribute approximately $3.5 million to Phase II, and that up to an additional approximate $4 million of clean-up costs will be allocated between the two groups on a formula basis based on gallons contributed. The Company is informed that the Galaxy Contributors have spent approximately $1 million to date and are focusing efforts on a plan to contain seepage from the site into an adjacent creek. The Company's waste transporter has informed the Company that preliminary estimates of the cost of the containment plan range up to $15 million, of which the Galaxy Contributors would pay $2.5 million (the unpaid balance of the $3.5 million), with the remainder of the cost expected to be shared by the Galaxy Contributors and the Spectron Contributors on a formula based on gallons contributed. Under such an arrangement the Company's liability is estimated to be approximately $35,000.\n\tThe Company is informed that the Galaxy Contributors contributed approximately 10,200,000 gallons and the Spectron Contributors contributed approximately 19,200,000 gallons to the site. The Company is not a Galaxy Contributor.\n\tThe Company cannot estimate at this time the cost of any further cleanup activities for the site nor its portion of any liability, if any. The Company is not an active participant in the proceedings.\nFort Smith, Arkansas\n\tUntil 1984 the Company operated a leased facility in Fort Smith, Arkansas. The lessor was a trust for the benefit of, among others, members of the Gross family, including two present directors of the Company. In 1989, the Company, along with the owner of the property, retained a consultant to perform a limited environmental investigation. The preliminary investigation revealed the possibility of soil contamination, consisting of petroleum hydrocarbons and heavy metals. The results of this limited investigation warrant further investigation. The Company may have liability for environmental conditions at the property. Until a more extensive investigation is conducted, the Company cannot evaluate the extent of the contamination or the appropriate remedial response, if any, or the ultimate cost of responding to the contamination.\nDouble Eagle Site, Oklahoma City\n\tIn 1991, the Company received a 104(e) information request from the EPA under CERCLA with respect to the Double Eagle site to which it responded. Information available to the Company indicates that the facility recycled used oil into finished lubricating oil, and began operating as early as 1929. The Double Eagle site has been identified as a wetland, and the EPA has placed the site on the National Priorities List.\n\tThe Company has not yet received any general or special notice letters indicating that the EPA views it as a potentially responsible party at this site. In 1992 conversations with the Assistant Regional Counsel of the EPA, it was indicated that the EPA did not view the Company as a major contributor of waste to the site and that most of the contamination at the site had occurred prior to 1985. The Company's records indicate that it began shipping waste mineral spirits and blend oil to Double Eagle in 1985 and continued shipments until 1988.\n\tAt this time no formal proceedings have been initiated by the EPA against the Company, and the Company has not paid, nor has it been billed for, any amount. The Company cannot estimate the liability, if any, which might result with respect to the Double Eagle Site, and believes that it may qualify for treatment as a de minimis party.\nCity of Industry, California\n\tIn June, 1992, the Company was notified that contamination was discovered in soil at a site at 825 Lawson Street, City of Industry, California at which the Company conducted operations from about 1969 to 1981. Solvents of the type used by the Company in its operations had impacted the soil and shallow groundwater at the site. These same solvents are found in the soil and groundwater at numerous other sites in the City of Industry and surrounding Puente Valley. To date, the Company's response to the matter has been one of cooperation with the authorities and other potentially responsible parties.\n\tThe potentially responsible parties with respect to the 825 Lawson Street property are the Company, the current landowner, another prior operator at the site, and a prior landowner. The Company, the other prior operator and the prior landowner have conducted a subsurface investigation of the site at the request of the California Regional Water Quality Control Board (the \"Water Board\"), a state agency to which the EPA has delegated CERCLA enforcement authority for any soil contamination at this site. The site assessment, completed in July, 1994, revealed volatile organic compounds in the soil and shallow groundwater beneath the Lawson Street property. The Site Assessment Report has been submitted to the Water Board.\n\tThe Water Board has not yet responded to the Site Assessment Report, but the Company believes that the Water Board will require cleanup of the property. It is too early to predict the cleanup methodology to be required by the Water Board, or the cost of the cleanup. The Company has interviewed consultants who have proposed cleanup approaches, however, which would cost in the range of $500,000 to $750,000. Under the present Cost Sharing Agreement with the other two parties who funded the Site Assessment Report, the Company would be responsible for paying one-third of the cost of the cleanup of the Lawson Street property. The Company and the other parties to this Agreement are also considering pursuit of the current property owner for its share of these costs.\n\tOn a related matter, in April, 1993, the Company was named by the EPA as one of 57 potentially responsible parties from whom the EPA would solicit an offer to investigate and clean up groundwater contamination in the Puente Valley operable unit of the San Gabriel Valley, where the City of Industry is located. The other three 825 Lawson parties referred to above also received this \"special notice\" letter. The Company, the other prior operator and the prior land owner have joined the Puente Valley Steering Committee (\"PVSC\"), which includes approximately 43 of the special notice recipients. The group's members include several large industrial corporations.\n\tOn September 30, 1993, this group of potentially responsible parties entered into an administrative Consent Order (the \"Consent Decree\") with EPA, pursuant to which the participants would perform a remedial investigation and feasibility study (RI\/FS) for the Puente Valley operable unit. The current estimates for the total cost of the RI\/FS range from $2.8 million to $4.2 million. The participants also executed an allocation agreement covering the payments required by the Consent Decree, under which the 825 Lawson Street property was assigned approximately 3.75 percent of the cost. The Company has agreed to pay one-third of this amount. Assuming the cost to be $2.8 million, the Company's liability would be approximately $34,700. The Company has already paid approximately $15,000 of this amount.\n\tThe cost of any remedial groundwater action, if any, in the Puente Valley is unknown at this time, and the participants have not begun to negotiate an allocation to pay for any such cost. If such work was required, it would not begin until the RI\/FS is finished, and the remediation would likely take several years to complete.\nBeech Creek, Pennsylvania TCE Contamination\n\tIn May, 1991 the Pennsylvania Department of Environmental Resources (PADER) notified the Company that there was evidence of trichloroethylene and trichloroethane in the soil, and possibly the groundwater under the Company's Beech Creek facility. PADER requested that the Company conduct an investigation to determine the source and extent of the contamination, and perform any required cleanup.\n\tThe Company retained a qualified environmental consultant to prepare a site investigation plan. In June of 1992, PADER approved the investigation plan. The plan included extensive soil testing and ground water monitoring. The consultant has now completed the investigation and reported the findings to PADER. Cleanup has now commenced at the Beech Creek plant. Cleanup consists of the venting of volatile organic gases from soil, and the pumping and treating of groundwater. While it is too early to predict the total cost of the remediation, the Company's consultant has predicted cleanup costs will be approximately $90,000 during 1995, and approximately another $6,000 per month of operation thereafter. While its prediction is preliminary and tentative, the consultant anticipates that the cleanup system will need to operate for approximately 18 to 24 months.\nInsurance Coverage Litigation\n\tThe Company has filed a complaint in Illinois State Court, in DuPage County, against its insurance carriers for a declaration that the insurance carriers are liable for all the Company's defense, investigation and cleanup costs at the Beech Creek and City of Industry sites.\n\tThe Company has reached a cost sharing agreement with certain carriers regarding payment of past defense costs through January, 1995 and certain future defense costs through November, 1995 with respect to the Beech Creek and City of Industry sites. The payment for past defense costs is expected to be approximately $300,000. The Company has agreed to temporarily stay future litigation against the insurers on indemnification costs pending additional developments at the sites.\nSummary\n\tAlthough the ultimate outcome is not determinable, management believes that the resolution of these matters will not have a material impact on the Company's financial condition or operating results.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF SHAREHOLDERS\n\tDuring the fourth quarter of the fiscal year ended January 1, 1995 the Company did not submit any matter to a vote of shareholders, through the solicitation of proxies or otherwise.\nPART II\nItem 5.","section_5":"Item 5. MARKET FOR THE COMPANY'S COMMON SHARES AND RELATED \t\tSHAREHOLDER MATTERS\n\tThe Company's Common Shares are traded on The NASDAQ Stock Market under the symbol \"CREB\". As of April 11, 1995, there were 830 holders of record of the Company's Common Shares. This number does not include beneficial owners of Common Shares whose shares are held in the name of banks, brokers, nominees or other fiduciaries.\n\tThe information appearing in the following table on the range of high and low trade prices for the Company's Common Shares was obtained from NASDAQ quotations in the NASD's Monthly Statistical Reports.\n\t\t\t Fiscal Fiscal \t\t\t Year Ended Year Ended \t\t\t January 1, 1995 January 2, 1994\n\t\t\t Low High Low High\nQuarter Ended Price Price Price Price\nMarch 31 3-3\/4 4-5\/8 2-7\/8 3-7\/8\nJune 30 2-7\/8 4-1\/2 3-1\/4 6-5\/8\nSeptember 30 4 5 4-7\/8 7-1\/4\nDecember 31 3 4-5\/8 4-1\/8 6-5\/8\n\tUnder the Company's amended and restated credit agreement, the Company is not permitted to pay dividends.\n\tOnly for purposes of the calculation of aggregate market value of the Common Shares held by non-affiliates of the Company as set forth on the cover page of this report, the Common Shares held by Echlin Inc., RGP Holding, Inc., the Company's Employee Stock Ownership Plan and Profit Sharing and Thrift Plan, and shares held by members of the families of the children of Elizabeth Gross, the mother of two of the Company's directors, were included in the shares held by affiliates. Certain of such persons and entities may not be affiliates.\nItem 6.","section_6":"Item 6.\nSelected Financial Data (Note 1)\n(Reported in thousands, except per share data)\n\t\t\n\t\t\t 1994 1993 1992 1991 1990\nNET SALES $95,337 $100,040 $96,743 $111,741 $122,288\nCOSTS AND EXPENSES:\nOperating Costs (Note 2) 99,050 95,769 103,923 108,501 115,697 Interest - net 2,423 2,282 2,248 3,397 4,617 \t\t\t ------- ------ ------- ------- ------- \t\t\t 101,473 98,051 106,171 111,898 120,314 \t\t\t ------- ------ ------- ------- ------- \t\t\t\t\t\t\t\t\t\t\t\t\t\t EARNINGS (LOSS) BEFORE INCOME TAXES, EXTRAORDINARY ITEM AND CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE (6,136) 1,989 (9,428) (157) 1,974\nINCOME TAXES (BENEFIT) (297) 176 (1,644) 77 849 \t\t\t ------- ------ ------- ------- ------- EARNINGS (LOSS) BEFORE EXTRA- ORDINARY ITEM AND CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE (5,839) 1,813 (7,784) (234) 1,125\nEXTRAORDINARY ITEM (net of income taxes) (Note 4) (419) \t\t\t ------- ------ ------- ------- -------\nNET EARNINGS (LOSS) $ (5,839) $ 1,813 $(7,784) $ (653) $ 1,125 \t\t\t ======= ====== ======= ======= ======= \t\t\t\t\t\t\t\t\t\t\t\t\t\t\nAVERAGE COMMON SHARES OUT- STANDING AND COMMON SHARE EQUIVALENTS 3,655 3,655 3,655 3,655 3,653\nEARNINGS (LOSS) PER COMMON SHARE: \t\t\t\t\t\t\t\t\nPrimary and fully diluted: Earnings (loss) before extraordinary item $ (1.60) $ .50 $ (2.13) $ ( .06) $ .31 \t\t\t Extraordinary item, net of income taxes ( .12) \t\t\t ------- ------ ------ ------- ------- NET EARNINGS (LOSS) $ (1.60) $ .50 $ (2.13) $ ( .18) $ .31 \t\t\t ======= ====== ====== ======= =======\nAT YEAR-END Total assets (Note 3) $ 53,312 $ 56,147 $59,895 $ 68,902 $ 72,649 Long-term obligations (Note 3) $ 1,451 $ 19,281 $24,802 $ 29,332 $ 26,889\nNote 1: Results for 1992 reflect the reclassification of a \t foreign joint venture.\nNote 2: Restructuring charges of $3,400,000 in 1994, $3,223,000 \t in 1992 and $1,034,000 in 1991, are included in operating costs.\nNote 3: Total Assets and Long-Term Obligations in 1991 and 1990 \thave been restated. See Note 1 to the Company's Consolidated \tFinancial Statements. In 1994, long term obligations reflect \tacceleration of amounts due on the bank credit agreement and \tother maturities due to default of credit agreement. See Note 3 \tto the Company's Consolidated Financial Statements.\nNote 4: In November, 1991, the Company redeemed $12,160,000 of \tits subordinated debt resulting in an extra-ordinary charge, \tnet of income taxes, of $419,000 for unamortized discount and \tbond issuance costs. \t\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL \t\t\tCONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\n\t1994 Compared to 1993\n\tNet sales for the year ended January 1, 1995 (referred to as \"1994\") were $95.3 million or $4.7 million (4.7%) less than net sales for the year ended January 2, 1994 (referred to as \"1993\") of $100 million. In the fourth quarter of 1993, the Company experienced a significant decrease in sales volume compared with prior quarters. This lower volume continued throughout 1994. The decreased sales resulted primarily from lower sales to existing automotive and one heavy duty customers.\n\tThe Company's ability to maintain its current market position is dependent upon meeting customer expectations and market competition in product offering, price, quality and delivery. The Company has initiated various programs in an effort to improve its operating performance. There are no assurances the Company's efforts will succeed.\n\tThe Company's carburetor sales volume in 1994 was higher than that in 1993. Sales of the Company's automotive and heavy duty electrical products (starters, alternators and generators) and mechanical products (water pumps and clutches) were lower in 1994 than in 1993. The Company's sales of front wheel drive constant velocity joints increased significantly during the year, primarily as a result of volume from initial stocking orders for new customers. However, in February 1995 one of the Company's primary constant velocity joint customers informed the Company that it would be switching to a competitor. The Company is making efforts to replace this business with new customers. The Company anticipates continued overall market volume growth in the constant velocity joint product line as the number of front wheel drive vehicles entering the prime repair age increases. However, there can be no assurance the Company will be able to replace the lost constant velocity joint business or overall sales volume.\n\tProduct and core returns, reflected as reduction in net sales, were 38% in 1994 and 40% in 1993.\n\tCarburetors, which have a higher gross margin than the Company's product line as a whole, continue to be a significant part of the Company's sales and are expected to remain so for several years. Since the mid-1980's, carburetors have been installed in fewer new vehicles sold in the United States and Canada due to the increased use of fuel injection systems. However, the Company continues to sell replacement units for older vehicles, many of which use carburetors. Net carburetor sales were $23.9 million in 1994 versus $21.9 million in 1993. Carburetor sales represented approximately 25% of net sales for 1994 compared to 22% in 1993. The increase in carburetor sales in 1994 was due to the Company increasing its market share as the number of competitors in the carburetor market decreased. The Company expects that carburetor sales will decline in future years. In addition, carburetor margins may be negatively impacted in the future as customers seek to return product during periods of declining demand. The Company has a customer product return policy and has established inventory reserves to help mitigate this effect.\n\t \tCosts of products sold were 84.4% of net sales in 1994 compared to 79.1% in 1993. 1994 results were significantly impacted by a $2.2 million fourth quarter provision to revalue the Company's inventory. Of this incremental provision, approximately $1 million related to an adjustment to the Company's constant velocity joint inventory to reflect current estimated values. Because of improved inventory management systems initiated in the second half of the year, the Company was able to more definitively evaluate this inventory in the fourth quarter. The remainder of the inventory provision was recorded to reflect a change in the Company's management of component and core inventories which should result in carrying lower quantities than it historically has.\n\t\n\tOverall margins were negatively impacted during the year due to the lower sales volume and related lower absorption of manufacturing overhead costs. Management believes 1994 results do not fully reflect the benefits from the Company's plant consolidation plan which it expects to fully complete in 1995. The Company believes that its total plant overhead spending, which trended downward in the fourth quarter, will continue to reflect the plant consolidation savings in future quarters. Modestly favorable labor costs in the fourth quarter, attributed to the efficiencies gained from the plant consolidation, somewhat offset increases in material costs during the year which resulted from procuring higher cost components to satisfy demand for late model applications.\n\tAlso negatively impacting the Company's margins during the year was a significant decrease in sales to a customer in the high margin heavy duty product line. These losses were only partially offset by an increase in carburetor and late model sales.\n\t\n\tSelling, distribution and administrative expenses decreased $1.4 million (8.4%) to $15.2 million in 1994 from $16.6 million in 1993. Lower distribution and selling costs resulting from lower sales volume and reductions in discretionary spending were the primary items affecting the decrease.\n\tIn the first quarter of 1994, the Company recorded a pretax special charge of $3.4 million to reflect a plan to consolidate manufacturing capacity. Of the total charge, $2.5 million related to reserves for personnel and plant closure costs and $0.9 million related to write-downs of property, plant and equipment. The Company charged approximately $1.8 million to reserves for actual personnel and plant closure related costs during 1994. The Company expects to incur substantially all remaining accrued costs in 1995.\n\tInterest expense was $2.4 million in 1994 compared to $2.3 million in 1993. The increase reflected higher average borrowings and increases in variable interest rates.\n\tThe Company's effective tax rate was a 5% benefit in 1994 versus a 9% provision in 1993. The Company was not able to benefit from the 1994 losses due to limited tax carryback availability. In 1993 the effective tax rate was lowered due to utilization of net operating loss carryforwards and recognition of deferred tax assets not previously recognized.\n1993 Compared to 1992\n\tNet sales for the year ended January 2, 1994 (referred to as \"1993\") were $100 million or $3.3 million (3.4%) greater than the year ended January 3, 1993 (referred to as \"1992\") net sales of $96.7 million. The increase was due to higher sales volume in the Company's higher priced carburetors and constant velocity joint (CV) product lines and modest growth in automotive electrical products (starters, alternators and generators). These increases were partially offset by lower heavy duty sales and continued competitive pricing pressures in the water pump product line.\n\tProduct and core returns, reflected as reductions in net sales, were 40% of sales in 1993 and 1992.\n\tNet carburetor sales were $21.9 million in 1993 versus $19.5 million in 1992. Carburetor sales represented approximately 22% of net sales for 1993, compared to 20% in 1992. The increase in carburetor sales in 1993 was due to the Company increasing its market share.\n\tCosts of products sold were 79.1% of net sales in 1993 compared to 84.8% in 1992. The decrease was due primarily to inventory write downs in 1992, including provisions for excess and obsolete inventory, and workers compensation expense, resulting in $3.5 million of incremental cost over 1993. The Company has improved procedures to set core values in 1993 as a means to better control inventory value. The Company experienced a modest increase in material costs in 1993 as a result of procuring higher cost components for late model applications.\n\tSelling, distribution and administrative expenses decreased $2.1 million (11.2%) to $16.6 million in 1993 from $18.7 million in 1992. The major factors contributing to the decrease were lower payroll expense due to headcount reductions early in 1993, lower variable selling and distribution expenses and a decrease in administrative costs.\n\tInterest expense was $2.3 million in 1993 and 1992. The Company's effective tax rate was 9% in 1993 versus 17% in 1992. The decrease was due to utilization of net operating loss carryforwards and recognizing deferred tax assets not previously recognized.\nFactors Which May Affect Future Results\n\tThe Company expects the existing over-capacity in the automotive aftermarket and consolidation within the distribution channels to cause continued selling price pressure for the foreseeable future. The present competitive environment is causing change in traditional aftermarket distribution channels resulting in retailers gaining additional market presence at the expense of traditional wholesalers. In response, the Company has diversified its customer base and currently serves all major segments, including automotive warehouse distributors and jobbers, original equipment manufacturers of automotive equipment and large volume automotive retailers. The anticipated decline in sales from the profitable carburetor product line over the longer term and continued part number proliferation, which requires shorter production runs, will impact future results. The Company will seek to offset these impacts through improvements in its manufacturing processes and cost containment with a strong focus on capacity utilization.\n\t\n\tThe Company has three customers which accounted for an aggregate of 48% of the Company's total sales in 1994. The Company sells to various distribution locations within these customers' groups and has recently been receiving increased pressure to modify its pricing structure and provide additional services. The loss of some or all of the sales to any one of these three customers would have a material adverse impact on the Company's results given the Company's current manufacturing cost structure, recent operating results and financial condition. In the first quarter of 1995, the Company continued to experience soft sales primarily due to lower overall market demand for automotive electrical products. In February 1995 one of the Company's primary constant velocity joint customers informed the Company that it would be changing suppliers. If the Company cannot replace the lost sales volume, it could have a material adverse impact on the Company.\n\tWhile the Company has established reserves for potential environmental liabilities that it believes to be adequate, there can be no assurance that the reserves will be adequate to cover actual costs incurred or that the Company will not incur additional environmental liabilities in the future. See \"Legal Proceedings\" for additional information.\nLIQUIDITY AND CAPITAL RESOURCES\nWorking Capital\n\tWorking capital at January 1, 1995, was $5.6 million, down from $27.8 million at the end of 1993. This decrease was primarily attributable to the Company classifying outstanding loans under its bank credit agreement and a long term capitalized lease obligation as current due to the Company's default of its Bank Credit Agreement. (See the following section on Debt for further discussion.) In addition, a decrease in inventory and increase in accounts payable and accrued expenses, offset by an increase in accounts receivable, contributed to the overall decrease.\n\tAccounts receivable at the end of 1994 were $10.8 million, up $3.8 million, or 53%, from the previous year-end balance of $7.0 million. An increase in accounts receivable days outstanding to more normal levels at the end of 1994 as compared to 1993 and slightly higher sales in the current year fourth quarter accounted for the increase.\n\tInventory at the end of 1994 decreased to $26.9 million, from $31.5 million at the end of the prior year. Consolidation of finished goods inventory due to the plant consolidation and an increase in reserves against inventory caused the decrease. Cores represented approximately 52% of total inventory value at January 1, 1995.\n\tAccounts payable and interest and other accrued expenses increased $2.8 million as a result of the Company extending terms with its suppliers and due to remaining reserves related to the Company's first quarter decision to consolidate manufacturing capacity.\nDebt\n\tIn March 1994, the Company amended its bank credit agreement to extend its maturity until April 1, 1995; removed one of the participating banks; reduced the commitment level to $23 million; reset certain prospective financial covenants in anticipation of a 1994 special charge for a proposed plan to realign the Company's manufacturing capacity; and allowed the Company additional borrowing capability against accounts receivable and inventories.\n\tAt January 1, 1995, the Company had available $18.1 million under the Company's credit agreement of which $17.9 million was borrowed.\n\tThe Company was not in compliance with certain financial covenants of its bank credit agreement during the fourth quarter and in subsequent months. The Company's current credit agreement expired April 1, 1995. It had negotiated with its lenders waivers for the noncompliance and an extension of the credit agreement to July 1, 1995 conditioned upon the $5 million sale of Preferred Stock to RGP by April 17, 1995. (See Part 1, Item 1, \"Recent Developments\" for a description of the equity infusion transaction.) On April 17, 1995 RGP notified the Company pursuant to and in accordance with the Preferred Stock Purchase Agreement, that it would not consummate the sale, which caused the Company to be in default of the credit agreement. Discussions are underway with the Company's lending banks to reach agreement on a credit facility which would allow for continued funding of operations. Two of the three banks party to the credit agreement had indicated to the Company that they did not intend to extend long term financing to the Company. There can be no assurances that the banks will agree to a new facility.\n\tThe Company is also in default of a $1.1 million standby letter of credit and a $1.5 million capitalized lease obligation under cross default provisions.\n\tDiscussions with other financial institutions, including one of the Company's current banks, are also underway to secure a new long term facility through 1995. The discussions contemplated the Preferred Stock sale. The Company is unable to predict whether these institutions would enter into a credit facility in light of the failure to close the Preferred Stock sale.\n\tAs a result, the Company has reflected outstanding amounts under the credit agreement and the capitalized lease obligation as current in its financial statements.\n\tWithout an extension of the current credit agreement or a replacement facility, the Company would not have sufficient funds to pay its debts should the lenders demand payment. The Company's financial statements have been prepared on a going concern basis and do not contain adjustments which may be necessary should the Company be forced to liquidate assets or take other actions to satisfy debt payments.\n\tIn the first quarter of 1992, Echlin Inc. exercised its limited market value protection right received under the Stock Purchase Agreement entered into when Echlin purchased 600,000 common shares of the Company in 1987. Under the terms of this agreement, the Company delivered to Echlin a promissory note for $2.4 million, payable in quarterly installments of $0.2 million. The note carries an interest rate of 1% above the prime rate. The Company reduced its paid-in capital by $2.4 million as a result of this transaction. In March 1992, the Company amended its revolving credit agreement to permit the execution of the note and the issuance of a $1.2 million letter of credit to partially secure the note. At year end, the Company had a remaining balance of $0.4 million on the note and $0.2 million outstanding on the letter of credit. The Company has not paid the final installment of $200,000 due April 8, 1995. Echlin has notified the Company that it is in default on the note.\n\tThe Company has guaranteed a loan secured by an Employee Stock Ownership Plan trust to acquire shares of the Company's stock. The Company intends to provide the funds to the trust needed to satisfy principal and interest payments. The final principal payment of $514,000 was made in April, 1995.\n\tThe Company has a direct guarantee of Canadian $500,000 of the bank debt of a joint venture and is joint and several guarantor of Canadian $1,500,000 with its venture partner. As part of the 1992 restructuring charge, the Company provided a reserve for a contingent liability to the venture's bank. The venture was not in default of its debt facility at January 1, 1995.\nCash Flow\n\tThe Company increased its debt, net of cash, by $0.7 million in 1994. The Company continued to make scheduled payments of $1.2 million on long term debt obligations. These payments and the cash required to fund operations resulted in an increase in the Company's borrowings under its bank credit facility of $2.7 million in 1994. The following summarizes significant items affecting the change in total debt (amounts in thousands).\n\t\t\t\t\tJanuary 1, January 2, \t\t\t\t\t 1995 1994\nNet income (loss), changes in working capital, other $ (4,878) $ 3,325\nSpecial Charge 3,400 ---\nDepreciation and Amortization 1,587 1,793\nCapital Expenditures (831) (916) \t\t\t\t\t-------- -------- (Increase) Decrease in total debt, net of cash $ (722) $ 4,202 \t\t\t\t\t======== ========\n\tThe Company has generally financed major capital additions through medium and long-term borrowing, including the use of industrial revenue bond financing. Working capital requirements have generally been financed by internally generated funds and bank borrowings. The Company had an interest rate swap agreement which fixed the effective interest rate on $12,000,000 of borrowings at 8.3%. This agreement expired in October 1994.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\n\tThe financial statements and supplementary data called for by this item are listed in the accompanying table of contents for consolidated financial statements and financial statement schedule and are filed herewith.\nItem 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS AND ACCOUNTING AND \t\tFINANCIAL DISCLOSURE\n\tReport on Form 8-K dated October 28, 1993, reporting a change in Certifying Accountant is hereby incorporated by reference.\nPART III\nITEM 10:","section_9A":"","section_9B":"","section_10":"ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\n\t(a) Directors and Executive Officers of Registrant\n\tPersons elected as directors of the Company hold office until the next annual meeting of shareholders at which directors are elected.\n\tThe by-laws of the Company provide that officers shall be elected by the board of directors at its first meeting after each annual meeting of shareholders, to hold office until their successors have been elected and have qualified.\n\t\t\t Principal Occupation Served as a \t\t\t and Positions with Director Name (Age) the Company Since\nThomas W. Blashill (35) Director, Executive Vice President, 1993 \t\t\t Secretary and Treasurer of the Company\nCalvin A. Campbell, Jr. (60) President and Chief Executive Officer, 1993 \t\t\t Goodman Equipment Corporation, \t\t\t Bedford Park, Illinois\nJohn R. Gross (63) Owner, Chaney Auto Parts, Inc., 1966 \t\t\t Crest Hill, Illinois\nRaymond F. Gross (56) Vice President, Erecta Shelters, Inc., 1968 \t\t\t Ft. Smith, Arkansas; consultant to \t\t\t the Company\nGary S. Hopmayer (55) Director, Original American Scones, Inc., 1987 \t\t\t Chicago, Illinois\nBarry L. Katz (43) President and General Counsel, 1993 \t\t\t RGP Holding, Inc.\nEdward R. Kipling (63) Retired 1987\n\t\t\t\t Raymond G. Perelman (77) Chairman of the Board of the Company; 1988 \t\t\t Chairman of the Board and Chief Executive \t\t\t Officer, RGP Holding, Inc., Philadelphia, \t\t\t Pennsylvania and General Refractories \t\t\t Company, Bala Cynwyd, Pennsylvania\nDonald G. Santucci (58) President and Chief Executive Officer of 1975 \t\t\t the Company\nRoger L. Wilson (48) Vice President, Sales and Marketing\nMr. Blashill joined the Company in August, 1992 as Director of Financial Operations. He has held the position of Executive Vice President, Secretary and Treasurer since March 1993. He was Vice President and Treasurer of Washington Steel Corporation from 1991 to 1992. He was Director of Finance of Washington Steel Corporation from 1988 to 1991.\nMr. Campbell has been President and Chief Executive Officer of Goodman Equipment Corporation, a designer and manufacturer of underground mining equipment, since 1971 and a designer and manufacturer of blow molding machinery since 1979. He has been Chairman of The Dratt-Campbell Company, a consulting firm, since its founding in 1991. From 1985 to 1994 Mr. Campbell also served as a director of Cyprus Amax Minerals Company, Inc. (\"Cyprus\"), a publicly held mineral resource company listed on the New York Stock Exchange. Mr. Campbell was Chairman of Cyprus from May 1991 until May 1992, and President and Chief Executive Officer of Cyprus from February 1992 until May 1992. Mr. Campbell is also a director of Eastman Chemical Company, a publicly held company listed on the New York Stock Exchange, and Mine Safety Appliances Company, Inc. listed on NASDAQ. Mr. Campbell has informed the Company that he will not be a nominee for reelection as a director at the 1995 Annual Meeting of Shareholders.\nMr. John R. Gross is currently the owner of Chaney Auto Parts, Inc., a retailer of auto parts. John R. Gross is the brother of Raymond F. Gross.\nMr. Raymond F. Gross has been the Vice President of Erecta Shelters Inc., a manufacturer and distributor of metal buildings, since 1985. He has also been a consultant to the Company since June, 1984. Prior to June, 1984 he was a Vice President of the Company. Raymond F. Gross is the brother of John R. Gross.\nMr. Hopmayer was President of Original American Scones, Inc., a privately owned specialty baker, from 1987 to 1993. He is currently a Director of Original American Scones, Inc. Prior to that time he was President of Mega International, Inc. a manufacturer and distributor of automotive electrical parts. Mega International, Inc., founded by Mr. Hopmayer, was sold to Echlin Inc. in October, 1986.\nMr. Katz has served as a director of the Company since December 1993. From December 16, 1992 to January 19, 1993 he held the position of Senior Vice President of the Company. Since 1993 Mr. Katz has been President and General Counsel for RGP Holding, Inc., and its operating subsidiaries, and was its Senior Vice President and General Counsel since May 1992. From March 1990 to 1994, he served as Senior Vice President and General Counsel for General Refractories Company, and since that time has been its President.\nMr. Kipling was Vice President and General Manager of the Rayloc Division of Genuine Parts Company, a remanufacturer of automotive parts, for more than five years prior to January, 1987, and has since been retired.\nMr. Perelman has served as Chairman of the Board since December 16, 1992 and was President and Chief Executive Officer from December 16, 1992 to January 19, 1993. He has been Chairman of the Board of RGP Holding, Inc., a privately-held holding company with subsidiaries operating in manufacturing businesses, since May 1992. Since 1985, he was the Chairman of the Board and Chief Executive Officer of General Refractories Company.\nMr. Donald G. Santucci was elected as the Company's President and Chief Executive Officer in March 1993. He has been a director of the Company since 1975. He has served as President and CEO of DEK, Inc., a closely held manufacturer of engineered plastic products that was founded by Mr. Santucci. Mr. Santucci has also served as a consultant to American Hospital Supply, was a member of the board of directors of Marmion Military Academy, and recently completed a three-year directorship with the Fox Valley Industrial Association.\nMr. Wilson joined the Company in September, 1993 as Vice President of Sales and Marketing. Prior to joining the Company he served as Vice President of Sales of Maremont Exhaust (owned by Arvin Industries, Inc.) in 1992. He was Vice President of Field Sales for Arvin Aftermarket in 1991. From 1987 to 1990 he served in various management positions for Maremont Corporation which was acquired by Arvin Industries, Inc. in 1987.\n\t(b) Arrangements Concerning the Board of Directors\nExcept for directors who are officers of the Company, and except as indicated below, each director received a fee of $10,000 for service as a director during the Company's fiscal year ended January 1, 1995. In addition, directors are reimbursed for their reasonable travel expenses incurred in attending meetings and in connection with Company business.\nThe Company has an indemnification agreement with each director of the Company that provides that the Company shall indemnify the director against certain claims that may be asserted against him by reason of serving on the Board of Directors.\nThe Company and Raymond F. Gross, a director of the Company, are parties to an agreement providing for his engagement as a consultant to the Company for a period ending December 31, 1995. The agreement provides for annual compensation of $10,000 through December 31, 1995 plus certain insurance and other benefits. Mr. Gross received $5,000 in directors' fees in 1994.\nMessrs. Hopmayer and Kipling serve as directors pursuant to a Stock Purchase Agreement dated March 18, 1987 between the Company and Echlin Inc. Under that Agreement, the Company agreed to nominate not fewer than two persons designated by Echlin Inc. for director, provided that if Echlin Inc. disposes of Common Shares of the Company, the Company and Echlin Inc. shall modify the number of persons designated by Echlin Inc. to be nominated by the Company. See \"Ownership of Voting Securities\" below for additional information concerning Echlin Inc. and transactions between the Company and Echlin Inc.\nMessrs. Calvin A. Campbell, Jr., John Gross, Raymond Gross, Gary Hopmayer and Edward Kipling serve on a Special Committee of the Board which was formed in January 1995 to, among other things, evaluate an offer by Mr. Perelman to infuse equity into the Company. For their services, they received $500 compensation for each meeting of the Special Committee. There were eight meetings held through April 17, 1995. In addition, Mr. Campbell received $5,000 to serve as Chairman of the Committee.\nMr. Katz serves as a director at the request of Mr. Perelman; and pursuant to an agreement between Mr. Perelman, RGP Holdings, Inc. and the Company. (See Item 12, Note 2 regarding this agreement.)\nITEM 11:","section_11":"ITEM 11: EXECUTIVE COMPENSATION\n\t(a) Executive Officer Compensation and Arrangements\nExecutive Compensation\nThe following table sets forth information with respect to all cash compensation paid to the Company's chief executive officer at the end of the Company's 1994 fiscal year, and the two other executive officers of the Company, whose annual compensation in the Company's 1994 fiscal year exceeded $100,000 for services rendered in all capacities to the Company, during the fiscal years indicated.\n\t\t\t\t Annual Compensation\n\t (a) (b) (c) (d) (e)\nName and Principal Position Year Salary Bonus Other Annual \t\t\t\t\t\t\t Compensation (1) \t\t\t # ($) ($) ($)\nDonald G. Santucci 1994 $133,300 0 --- President and Chief Executive Officer (3) 1993 $115,000 $70,000 ---\n\t\t\t 1992 NA NA NA\n\t\t\nThomas W. Blashill 1994 $128,173 0 --- Executive Vice President, Secretary and Treasurer (4) 1993 $108,321 $50,000 ---\n\t\t\t 1992 NA NA NA\n\t\t\nRoger L. Wilson 1994 $105,000 $10,500 --- Vice President Sales and Marketing (5) 1993 $ 22,430 0 ---\n\t\t\t 1992 NA NA NA\n\t\t \t\t\t\t ----- Long Term Compensation ----- \t\t\t\t -------- Awards -------- Payouts\n\t (a) (b) (f) (g) (h) (i)\n\t\t\t\t Restricted Securities All Other \t\t\t\t Stock Underlying LTIP Compensa- Name and Principal Position Year Award(s) Options\/SAR's Payouts tion (2) \t\t\t\t# ($) (#) ($) ($)\nDonald G. Santucci 1994 0 0 0 $ 300 President and Chief Executive Officer (3) 1993 0 0 0 0\n\t\t\t 1992 NA NA NA NA\nThomas W. Blashill 1994 0 0 0 $ 3,000 Executive Vice President, Secretary and Treasurer (4) 1993 0 0 0 0\n\t\t\t 1992 NA NA NA NA\nRoger L. Wilson 1994 0 0 0 0 Vice President Sales and Marketing (5) 1993 0 0 0 0\n\t\t\t 1992 NA NA NA NA\n\t(1) The amounts for Messrs. Santucci, Blashill and \t\tWilson are below threshold reporting requirements.\n\t(2) The amounts reported are allocations under its Employee \t\tStock Ownership Plan.\n\t(3) Mr. Santucci was elected President of the Company in March 1993.\n\t(4) Mr. Blashill was elected Executive Vice President in March 1993.\n\t(5) Mr. Wilson joined the Company in September 1993 as Vice \t\tPresident, Sales & Marketing.\n\tMessrs. Santucci, Blashill and Wilson have severance compensation agreements with the Company that provide for severance pay equal to six months salary following their termination from the Company under certain circumstances following a change in control of the Company.\nThe by-laws of the Company provide that officers shall be elected annually by the board of directors at its first meeting after each annual meeting of shareholders, to hold office until their successors have been elected and have qualified.\nThe Company also has an indemnification agreement with each officer of the Company that provides that the Company shall indemnify the officer against certain claims which may be asserted against him by reason of serving as a officer of the Company.\nOptions Outstanding\nAs of January 1, 1995, the Company had options to purchase 4,500 Common Shares outstanding under its qualified and non-qualified option plans. None of the Company's executive officers hold options.\nDuring the fiscal year ended January 1, 1995, the Company did not grant any stock options.\nCompensation Committee Interlocks and Insider Participation\nOn December 9, 1993 the Board elected Messrs. Perelman, Kipling and Campbell as members of the Compensation Committee. None of these members was an officer or employee of the Company, a former officer of the Company, or a party to any relationship requiring disclosure under Item 404 of SEC Regulation S-K during 1994, except for Mr. Perelman, who served as President and CEO of the Company from December 16, 1992 to January 19, 1993 and is presently Chairman of the Board and who entered into a Preferred Stock Purchase Agreement with the Company (See Part I, Item 1, \"Recent Developments\" for a description of the transaction.).\n\t(b) Director Compensation Arrangements\n\t\tInformation regarding director compensation is set forth under Item 10(b) above.\nItem 12:","section_12":"Item 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS\n\t\tAND MANAGEMENT\nThe following tabulation shows, as of April 17, 1995, (a) the name, address and Common Share ownership for each person known by the Company to be the beneficial owner of more than five percent of the Company's outstanding Common Shares, (b) the Common Share ownership of each director (c) the Common Share ownership for each executive officer named in the compensation table, and (3) the Common Share ownership for all directors and executive officers as a group.\n\t\t\t\t Number of Common \t\t\t\t Shares Beneficially Percent of Common Beneficial Owner Owned (1) Shares Outstanding\n\t\t\t\t\nRGP Holding, Inc. 225 City Line Avenue Bala Cynwyd, Pennsylvania 19004 661,600 (2) 18.1% (2)\nEchlin Inc. 100 Double Beach Road Branford, Connecticut 06405 600,000 (3) 16.4% (3)\n\t\t\t\t Champion Parts, Inc. Employee Stock Ownership Plan c\/o Champion Parts, Inc. 2525 22nd Street Oak Brook, Illinois 60521 246,965 (4) 6.8% (4)\n\t\t\t\t Dimensional Fund Advisors, Inc. 1299 Ocean Avenue, 11th Floor Santa Monica, California 90401 197,700 (5) 5.4% (5)\n\t\t\t\t Calvin A. Campbell, Jr., Director 1,000 *\n\t\t\t\t\nJohn R. Gross, Director (8) 110,212 3.0%\n\t\t\t Raymond F. Gross, Director (8) 29,164 *\n\t\t\t\t\nGary S. Hopmayer, Director (3) ---- ----\n\t\t\t\t\nBarry L. Katz, Director (2) 5,000 *\n\t\t\t\t\nEdward R. Kipling, Director (3) 2,000 *\nRaymond G. Perelman, Director, Chairman of the Board 661,600 (2) 18.1% (2)\n\t\t\t\t\nDonald G. Santucci, Director, President and Chief Executive Officer 5,747 (6) *\n\t\t\t\t\nThomas W. Blashill, Director, Executive Vice President, Secretary and Treasurer (7) 4,014 (6) *\n\t\t\t\t\nRoger L. Wilson Vice President, Sales & Marketing ---- *\n\t\t\t\t\nAll directors and executive officers as a group (10 persons) (7) 821,237 22.5%\n\t\t\t\t\n* Not greater than 1%.\n\t\t\t\t ___________\n(1) Information with respect to beneficial ownership is based on information furnished to the Company or contained in filings made with the Securities and Exchange Commission.\n(2) RGP Holding, Inc. is indirectly controlled by Mr. Perelman. Pursuant to an agreement between the Company, Mr. Raymond G. Perelman and RGP Holding, Inc. dated September 20, 1993 Mr. Perelman and RGP granted to the proxy holders appointed by the Board of Directors of the Company the proxy to vote all shares beneficially owned by them, including shares held by any affiliates (the \"Perelman Shares\"), for the election of certain nominees. Mr. Perelman and RGP have also agreed, among other things, not to solicit proxies in opposition to such nominees. The Company and the Board have agreed that if shareholders of the Company vote shares in person or by proxy for nominees other than such nominees, the proxy holders appointed by the Company will cumulate their votes in such manner as to attempt to elect Mr. Katz prior to the election of Mr. Campbell, and Mr. Campbell prior to the election of Mr. Blashill.\n(3) All shares owned by Echlin Inc. (\"Echlin\") are subject to a Stock Purchase Agreement dated March 18, 1987 between the Company and Echlin. Under the Stock Purchase Agreement, Echlin may vote its shares in its discretion. At the time the Company entered into the Stock Purchase Agreement, the Company entered into a Supply Agreement with Echlin whereby the Company agreed to purchase certain automotive parts manufactured by Echlin as required by the Company, provided that Echlin is able to meet the Company's delivery requirements and competitive prices. During the fiscal year ended January 1, 1995, the Company purchased approximately $2.6 million of components used in the remanufacture of automotive parts from Echlin. On March 9, 1992, Echlin notified the Company that it was exercising its limited market protection rights under the Stock Purchase Agreement. Accordingly, the Company issued a $2,400,000 promissory note to Echlin which has been and is to continue to be paid to Echlin in quarterly installments of $200,000. The note carries an interest rate of 1% above prime and one-half the current outstanding balance is secured by a letter of credit. See Part II, Item 7 for a discussion of the Company's default of this note.\n\tMessrs. Hopmayer and Kipling serve as directors pursuant to the Stock Purchase Agreement.\n(4) Shares held by this plan are voted by Messrs. Santucci, Blashill and Mark Smetana, Director of Finance and Corporate Controller, as trustees. Employees participating in the Stock Ownership Plan are entitled to direct the trustees as to the voting of shares allocated to their accounts. The other Stock Ownership Plan shares will be voted in the same manner, proportionately, as the allocated Stock Ownership Plan shares for which voting instructions are received from employees. For more information concerning the ownership and voting of shares held by the Stock Ownership Plan and the trustees, see note (7) below.\n(5) According to a Schedule 13G filed with the Securities and Exchange Commission on January 30, 1995, which reported ownership of (1) 197,700 shares as to which the reporting entity has sole power to dispose of or direct the disposition of and (b) 92,600 shares as to which the reporting entity has sole power to vote or direct the vote.\n(6) Includes 122 and 1,014 shares allocated to Messrs. Santucci's and Blashill's accounts, respectively, under the Employee Stock Ownership Plan.\n\t\n(7) Includes a total of 1,136 shares allocated to the accounts of executive officers under the Employee Stock Ownership Plan (the \"Stock Ownership Plan\"). Does not include 245,951 shares allocated to the accounts of employees other than executive officers. Each of the participants in the Stock Ownership Plan (approximately 160 employees) is entitled to direct the trustees as to the voting of shares allocated to his or her account.\n(8) As of March 31, 1995 Elizabeth Gross, her children and members of their immediate families beneficially owned 199,794 Common Shares, or approximately 5.5% of the Common Shares outstanding. John R. Gross and Raymond F. Gross, children of Elizabeth Gross, are directors of the Company.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\n\tInformation required under this Item 13 is set forth above under Part I, Item 1, \"Recent Developments\" and Part III, Item 12, Notes (2) and (3).\nPART IV\nItem 14.","section_14":"Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n\t(a) Consolidated Financial Statements and Schedule and Exhibits:\n\t(1. and 2.) The consolidated financial statements and schedule listed in the accompanying table of contents for consolidated financial statements are filed herewith.\n\t(3.) The exhibits required by Item 601 of Regulation S-K and filed herewith are listed in the exhibit index which follows the consolidated financial statements and financial statement schedule and immediately precedes the exhibits filed. Pursuant to Regulation S-K, Item 601(b)(4)(iii), the Company has not filed with Exhibit (4) any instrument with respect to long-term debt (including individual bank lines of credit, mortgages and instruments relating to industrial revenue bond financing) where the total amount of securities authorized thereunder does not exceed 10% of the total assets of the Registrant and its subsidiaries on a consolidated basis. The Company agrees to furnish a copy of each such instrument to the Securities and Exchange Commission on request.\n\t(b) Reports on Form 8-K:\n\tThe Company filed a Report on Form 8-K on January 17, 1995. The Form 8-K reported a proposal by Mr. Raymond G. Perelman to infuse equity into the Company.\n\tThe Company filed a Report on Form 8-K on February 21, 1995. The Form 8-K reported a Letter of Intent signed between the Company and Raymond G. Perelman.\n\tThe Company filed a Report on Form 8-K on March 23, 1995. The Form 8-K reported a Preferred Stock Purchase Agreement between the Company and RGP Holdings, Inc.\n\tThe Company filed a Report on Form 8-K on April 18, 1995. The Form 8-K reported RGP Holdings, Inc.'s decision not to consummate the Preferred Stock Purchase Agreement; the Company's default of its bank credit agreement; and notification of its auditors' going concern qualification on its 1994 financial statements.\nSIGNATURES\n\tPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\n\t\t\t\t\t\t CHAMPION PARTS, INC.\nDate: April 21, 1995 By: \/s\/ Donald G. Santucci \t\t\t\t\t\t Donald G. Santucci \t\t\t\t\t\t President\n\t\t\t\t\t\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on March 31, 1995.\nBy: \/s\/ Donald G. Santucci By: \/s\/ Gary S. Hopmayer\nDonald G. Santucci, Gary S. Hopmayer, President and Director Director\n\t By: \/s\/ Thomas W. Blashill By: \/s\/ Edward R. Kipling\nThomas W. Blashill, Edward R. Kipling Executive Vice President, Director Secretary and Treasurer (Principal Financial and Accounting Officer) and Director\nBy: \/s\/ Calvin A. Campbell, Jr. By: \/s\/ Raymond F. Gross\nCalvin A. Campbell, Jr., Raymond F. Gross, Director Director\nBy: \/s\/ Raymond G. Perelman By: \/s\/ John R. Gross\nRaymond G. Perelman, Director John R. Gross, Director\nBy: \/s\/ Barry L. Katz\nBarry L. Katz, Director\n\tCHAMPION PARTS, INC. AND SUBSIDIARIES\n\tConsolidated Financial Statements and Financial Statement Schedule comprising Item 8 and Items 14(a)(1) and (2) for the Years Ended January 1, 1995, January 2, 1994, and January 3, 1993, and Reports of Independent Public Accountants.\nCHAMPION PARTS, INC. AND SUBSIDIARIES\n\t\t\t\t\n\t\t\t\t\t\t\t\t \t\t\t\t\t\t\t\t \t\t\t\t\t\t\t\t\t Page\nReport of Independent Public Accountants 32\nIndependent Auditors' Report 33\nConsolidated Financial Statements (Item 14(a)(1)):\nThe following consolidated financial statements of\nChampion Parts, Inc. and subsidiaries are included in\nPart II, Item 8:\nConsolidated balance sheets - January 1, 1995 and\nJanuary 2, 1994 34-35\nConsolidated statements of operations - years ended\nJanuary 1, 1995, January 2, 1994 and January 3, 1993 36\nConsolidated statements of stockholders' equity - years\nended January 1, 1995, January 2, 1994 and January 3, 1993 37\nConsolidated statements of cash flows - years ended\nJanuary 1, 1995, January 2, 1994 and January 3, 1993 38\nNotes to consolidated financial statements 39-53\nConsolidated Financial Statement Schedule (Item 14(a)(2)):\nSchedule VIII - Valuation and qualifying accounts 54\nAll other schedules are omitted because they are not applicable, not required, or because the required information is included in the consolidated financial statements or notes thereto.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Stockholders and the Board of Directors of\nChampion Parts, Inc.\nWe have audited the accompanying consolidated balance sheets of Champion Parts, Inc. (an Illinois corporation) and subsidiaries as of January 1, 1995, and January 2, 1994, and the related consolidated statements of operations, stockholders' equity, and cash flows for the two years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Champion Parts, Inc. and subsidiaries as of January 1, 1995 and January 2, 1994, and the results of its operations and its cash flows for the years then ended in conformity with generally accepted accounting principles.\nOur audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule listed in the Table of Contents of the consolidated financial statements 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.\nThe accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 3 to the financial statements, the Company is in violation of certain covenants of its loan agreements that give the lenders the right to accelerate the due date of their loans, which 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 3. The financial statements do not include any adjustments relating to the recoverability and classification of asset carrying amounts or the amount and classification of liabilities that might result should the Company be unable to continue as a going concern.\n\/s\/ Arthur Andersen LLP\nFebruary 21, 1995 (Except for Notes 3 and 16 which are dated April 17, 1995.)\nChicago, Illinois\nINDEPENDENT AUDITORS' REPORT\nStockholders and Board of Directors\nChampion Parts, Inc.\nOak Brook, Illinois\nWe have audited the accompanying consolidated statements of operations, stockholders' equity and cash flows of Champion Parts, Inc. and subsidiaries (the \"Company\") for the year ended January 3, 1993. Our audit also included the financial statement schedule for the year ended January 3, 1993 listed in the Index at Item 14. 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 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 Champion Parts, Inc. and subsidiaries for the year ended January 3, 1993 in conformity with generally accepted accounting principles. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.\n\/s\/ DELOITTE & TOUCHE LLP\nChicago, Illinois\nFebruary 26, 1993\n(November 23, 1993 as to the\nsecond paragraph of Note 5)\n\t\t\t\t\nCHAMPION PARTS, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\n\t\t\t\t\n\t\t\t\t\t January 1, January 2,\n\t\t\t\t\t\t 1995 1994\n\t\t\t\t\t\nASSETS\n\t\t\t\t\t\t\nCURRENT ASSETS:\nCash $ 346,000 $ 78,000\nAccounts receivable, less allowance for uncollectible accounts of $465,000 and $406,000 in 1994 and 1993, respectively 10,864,000 6,993,000\nInventories 26,866,000 31,536,000\nPrepaid expenses and other assets 740,000 1,070,000\nDeferred income tax asset 1,907,000 2,270,000 \t\t\t\t\t ---------- ---------- \t\t\t\t\t\t\nTotal current assets 40,723,000 41,947,000\n\t\t\t\t\t\t\nPROPERTY, PLANT AND EQUIPMENT:\nLand 475,000 475,000\nBuildings 13,067,000 13,015,000\nMachinery and equipment 17,265,000 16,707,000\nLeasehold improvements 746,000 760,000 \t\t\t\t\t ---------- ---------- \t\t\t\t\t\t\n\t\t\t\t\t 31,553,000 30,957,000\nLess: Accumulated depreciation 20,059,000 18,190,000 \t\t\t\t\t ---------- ---------- \t\t\t\t\t 11,494,000 12,767,000\n\t\t\t\t\t\t\nOTHER ASSETS 1,095,000 1,433,000\n\t\t\t\t\n\t\t\t\t\t $ 53,312,000 $ 56,147,000 \t\t\t\t\t ========== ==========\nThe accompanying notes are an integral part of these statements.\n_______________________________________________________________________________\n\t\t\t\t\t January 1, January 2, \t\t\t\t\t\t 1995 1994\nLIABILITIES AND STOCKHOLDERS' EQUITY\n\t\t\t\t\t\nCURRENT LIABILITIES:\n\t\t\t\t\t\t\nAccounts payable $ 6,167,000 $ 3,652,000\nAccrued expenses:\nSalaries, wages and employee benefits 1,871,000 2,167,000\nInterest and other expenses 6,808,000 6,551,000\nTaxes other than income 232,000 62,000\nIncome taxes payable 0 481,000\nCurrent maturities on long-term debt 20,026,000 1,206,000 \t\t\t\t\t ---------- ---------- \t\t\t\t\t\t\nTotal current liabilities 35,104,000 14,119,000\n\t\t\t\t\t\t\nDEFERRED INCOME TAXES 1,393,000 1,550,000\nLONG-TERM DEBT - Less current maturities 1,451,000 19,281,000\nSTOCKHOLDERS' EQUITY:\nPreferred stock - No par value; authorized, 10,000,000 shares: issued and outstanding, none --- ---\nCommon stock - $.10 par value; authorized, 50,000,000 shares: issued and outstanding, 3,655,266 366,000 366,000\nAdditional paid-in capital 15,578,000 15,578,000\nRetained earnings 579,000 6,418,000\nCumulative translation adjustment (645,000) (136,000)\nGuarantee of Employee Stock Ownership Plan borrowings (514,000) (1,029,000) \t\t\t\t\t ---------- ---------- \t\t\t\t\t \t\t\t\t\t 15,364,000 21,197,000 \t\t\t\t\t ---------- ---------- \t\t\t\t\t \t\t\t\t\t $ 53,312,000 $ 56,147,000 \t\t\t\t\t ========== ==========\nCHAMPION PARTS, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF OPERATIONS\nYEARS ENDED _______________________________________________________________________________\n\t\t\t January 1, January 2, January 3, \t\t\t\t 1995 1994 1993\nNET SALES $ 95,337,000 $100,040,000 $ 96,743,000\n\t\t\t\t\t\t\t\t\t\nCOST AND EXPENSES: \t\t\nCost of products sold 80,424,000 79,133,000 82,022,000\nSelling, distribution and administration 15,226,000 16,636,000 18,678,000\nSpecial charge 3,400,000 --- 3,223,000 \t\t\t ----------- ----------- ----------- \t\t\t\t\t\t\t\t\t\n\t\t\t $ 99,050,000 $ 95,769,000 $103,923,000 \t\t\t ----------- ----------- -----------\nEARNINGS (LOSS) BEFORE INTEREST, AND INCOME TAXES (3,713,000) 4,271,000 (7,180,000)\nINTEREST EXPENSE - Net 2,423,000 2,282,000 2,248,000 \t\t\t ----------- ----------- ----------- \t\t\t\t\t\t\t\t\t\nEARNINGS (LOSS) BEFORE INCOME TAXES (6,136,000) 1,989,000 (9,428,000)\n\t\t\t\t\t\t\t\t\t INCOME TAXES (BENEFIT) (297,000) 176,000 (1,644,000) \t\t\t ----------- ----------- ----------- \t\t\t\t\t\t\t\t\t\nNET EARNINGS (LOSS) $ (5,839,000) $ 1,813,000 $ (7,784,000) \t\t\t ============ =========== ============ \t\t\t\t\t\t\t\t\t\nAVERAGE COMMON SHARES OUTSTANDING AND COMMON STOCK EQUIVALENTS 3,655,266 3,655,266 3,655,266 \t\t\t =========== =========== =========== \t\t\t\t\t\t\t\t\t\nEARNINGS (LOSS) PER SHARE OF COMMON STOCK $ (1.60) $ .50 $ (2.13) \t\t\t =========== =========== ===========\nThe accompanying notes are an integral part of these statements.\nCHAMPION PARTS, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED JANUARY 1, 1995, JANUARY 2, 1994, AND JANUARY 3, 1993 _______________________________________________________________________________\n\t\t\t\t Additional Cumulative Guarantee \t\t\t Common Paid-in Retained Translation of ESOP Reported in Thousands Stock Capital Earnings Adjustment Borrowings\n\t\t\t\t\t\t\t\t\t\t\t\t\t\t \t\t\t\t\t\t\t BALANCE, DECEMBER 29, 1991 366 17,978 12,389 176 (2,007) \t\t\t ----- ------ ------ ----- ----- Net loss (7,784)\nExercise of market price protection (2,400)\nExchange rate changes (113)\nContribution to ESOP to fund ESOP debt 464 \t\t\t ----- ------ ----- ----- ----- BALANCE, JANUARY 3, 1993 366 15,578 4,605 63 (1,543) \t\t\t ----- ------ ----- ----- ----- Net earnings 1,813\nExchange rate changes (199)\nContribution to ESOP to fund ESOP debt 514\n\t\t\t\t\t\t\t\t\t\t\t\t\t \t\t\t ----- ------ ----- ----- ----- BALANCE, JANUARY 2, 1994 366 15,578 6,418 (136) (1,029) \t\t\t ----- ------ ----- ----- ----- Net loss (5,839) \t\t\t\t Exchange rate changes (509)\nContribution to ESOP to fund ESOP debt 515\nBALANCE, JANUARY 1, 1995 366 15,578 579 (645) (514) \t\t\t ===== ====== ===== ===== =====\nThe accompanying notes are an integral part of these statements.\nCHAMPION PARTS, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nYEARS ENDED _______________________________________________________________________________\n\t\t\t\t January 1, January 2, January 3, \t\t\t\t\t 1995 1994 1993\nCASH FLOWS FROM OPERATING ACTIVITIES: \t\t\t\t\t Net earnings (loss) $(5,839,000) $ 1,813,000 $(7,784,000)\nAdjustments to reconcile net earnings loss) to net cash provided (used) by operating activities: \t\t\t Depreciation and amortization 1,587,000 1,793,000 1,734,000\nProvision for losses on accounts receivable 80,000 3,000 622,000\nRestructuring charge 3,400,000 3,223,000\nDeferred income taxes (448,000) (195,000) (972,000)\nChanges in assets and liabilities: \t\t\t\nAccounts receivable (3,975,000) 4,450,000 4,190,000\nInventories 4,307,000 (2,352,000) 3,254,000\nAccounts payable 2,176,000 658,000 462,000\nAccrued expenses and other 1,863,000 (1,676,000) 1,400,000\nNet cash used by operating --------- --------- --------- \t activities (575,000) 4,494,000 6,129,000 \t\t\t\t --------- --------- ---------\nCASH FLOW FROM INVESTING ACTIVITIES: \t\t\t\nCapital expenditures (831,000) (916,000) (790,000)\nProceeds from sale of property, plant and equipment 184,000 116,000 ---\nNet cash used by investing --------- --------- --------- activities (647,000) (800,000) (790,000) \t\t\t\t --------- --------- ---------\nCASH FLOWS FROM FINANCING ACTIVITIES: \t\t\t\nNet borrowings (payments) under line of credit agreement 2,700,000 (3,800,000) (4,800,000)\nPrincipal payments on long-term debt obligations (1,195,000) (1,222,000) (975,000)\nProceeds from issuance of long-term debt --- --- 187,000\nNet cash provided (used) by --------- --------- --------- \t financing activities 1,505,000 (5,022,000) (5,588,000) \t\t\t\t --------- --------- ---------\nEFFECTS OF EXCHANGE RATE CHANGES ON CASH (15,000) (6,000) (21,000) \t\t\t\t --------- --------- ---------\nNET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 268,000 (1,334,000) (270,000) \t\t\t\t\t\t\nCASH AND CASH EQUIVALENTS - Beginning of year 78,000 1,412,000 1,682,000 \t\t\t\t --------- --------- ---------\nCASH AND CASH EQUIVALENTS - End of year $ 346,000 $ 78,000 $ 1,412,000 \t\t\t\t ========= ========= ========= \t\t\t\t\t\t\t\t\nThe accompanying notes are an integral part of these statements.\nCHAMPION PARTS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED JANUARY 1, 1995, JANUARY 2, 1994 AND\nJANUARY 3, 1993\n\t1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nConsolidation Policy - The consolidated financial statements include the accounts of Champion Parts, Inc. and its subsidiaries (the \"Company\"). In the fourth quarter of 1992, the Company decided to exit from its joint venture in a previously consolidated engine remanufacturing business (Note 6). Accordingly, the Company's investment in the venture is included in the accompanying consolidated balance sheets using the equity method of accounting. The consolidated statements of operations for 1992 have been reclassified to show the results of this operation by the equity method. All significant intercompany transactions and balances have been eliminated in consolidation.\nAccounts Receivable - From time to time the Company's customers may be in a net credit balance position due to the timing of sales and core returns. At January 1, 1995 customers in a net credit balance position totaled approximately $2,000,000.\nInventories - Inventories are stated at the lower of cost (first-in, first-out method) or market. Inventory consists of material, labor and overhead costs.\nProperty, Plant and Equipment - Property, plant and equipment are carried at cost, less accumulated depreciation. The assets are being depreciated over their estimated useful lives, principally by the straight-line method. The range of useful lives of the various classes of assets is 10-40 years for buildings and 4-10 years for machinery and equipment. Leasehold improvements are amortized over the terms of the lease or their useful lives, whichever is shorter.\nWhen properties are retired or otherwise disposed of, their cost and accumulated depreciation are removed from the accounts and any gain or loss is included in operations. Expenditures for maintenance and repairs are charged to operations; major expenditures for renewals and betterments are capitalized and depreciated over their estimated useful lives.\nExcess of Purchase Price Over Net Assets Acquired - The Company is amortizing the excess of purchase price over net assets acquired over a 25-year period. The unamortized amount of goodwill was $152,000 and $174,000 in 1994 and 1993, respectively. The accumulated amortization was $300,000 in 1994 and $278,000 in 1993.\nDeferred Charges - Expenses on long-term debt are deferred and amortized over the terms of the related issues.\nLine of Business - The Company rebuilds parts principally for the automotive aftermarket industry, which is considered to be a single line of business.\nRevenue Recognition - The Company recognizes sales when products are shipped. Net sales reflect deductions for cores returned for credit and other customary returns and allowances. Such deductions and returns and allowances are recorded currently based upon continuing customer relationships and other criteria. The Company's customers are encouraged to trade-in rebuildable cores for products which are included in the Company's current product line.\nCredits for cores are allowed only against purchases of similar remanufactured products. Total available credits are further limited by the dollar volume of purchases. Product and core returns, reflected as reductions in net sales, were $61,234,000 (1994), $67,209,000 (1993) and $67,499,000 (1992).\n2. INVENTORIES\nInventories consist of the following:\n\t\t\t January 1, January 2,\n\t\t\t\t1995 1994\n\t\t\t\t\t\nRaw materials $ 10,870,000 $ 11,634,000\nWork in process 5,028,000 4,641,000\nFinished goods 10,968,000 15,261,000 \t\t\t ---------- ---------- \t\t\t\t\t\t\t \t\t\t $ 26,866,000 $ 31,536,000 \t\t\t ========== ==========\nIncluded in inventory were cores of $14,139,000 (1994) and $14,584,000 (1993).\nThe Company recorded $2,200,000 of provisions in the fourth quarter of 1994 to revalue the Company's inventory. Approximately $1,000,000 of the amount related to write-downs of the Company's constant velocity joint inventory to reflect current values. The remaining amount was recorded to reflect changes in the Company's inventory policies.\n3. DEBT\nThe Company entered into a Credit Agreement on August 8, 1990 with four banks. In March 1994, the Company amended its bank credit agreement to extend its maturity until April 1, 1995; removed one of the participating banks; reduced the commitment level to $23 million; reset certain prospective financial covenants, and allowed the Company additional borrowing capability against accounts receivable and inventories. The Company gave a security interest to the participating banks in its accounts receivable, inventories and other assets. The Company agreed to pay interest on outstanding borrowings at the Prime Rate plus 1-1\/2% and an annual commitment fee of 1\/2% of the facility.\nAt January 1, 1995, the Company had available $18.1 million under the Company's credit agreement of which $17.9 million was borrowed.\nThe terms of the Company's credit agreement require maintenance of minimum working capital and tangible net worth levels and prohibits the payment of dividends. The Company was not in compliance with certain financial covenants of its bank credit agreement throughout the fourth quarter and in subsequent months. It had negotiated with its lenders waivers for the noncompliance and an extension of the credit agreement to July 1, 1995, conditioned upon the sale of Preferred Stock by April 17, 1995 (See Note 16). On April 17, 1995 RGP notified the Company that it would not consummate the sale which caused the Company to be in default of the credit agreement. Discussions are underway with the Company's lending banks to reach agreement on a credit facility which would allow for continued funding of operations. Two of the three banks party to the credit agreement had indicated to the Company that they did not intend to extend long term financing to the Company. There can be no assurances that the banks will agree to a new facility.\nThe Company is also in default of a $1,100,000 standby letter of credit and a $1,500,000 capitalized lease obligation under cross default provisions.\nDiscussions with other financial institutions, including one of the Company's current banks, are also underway to secure a new long term facility through 1995. The discussions contemplated the Preferred Stock sale. The Company is unable to predict whether these institutions would enter into a credit facility in light of the failure to close the Preferred Stock sale.\nAs a result, the Company has reflected outstanding amounts under the credit agreement and $1,500,000 capitalized lease obligation as current in its financial statements. Without an extension of the current credit agreement or a replacement facility, the Company would not have sufficient funds to pay its debts should the lenders demand payment.\nThrough the first quarter of 1995, the Company continued to experience soft sales primarily due to lower market demand for automotive electrical products. In addition, the Company was notified by one of its customers that it would be switching part of its business to another supplier in the first quarter of 1995. This business accounted for approximately 3% of the Company's 1994 net sales.\nThe Company's financial statements have been prepared on a going concern basis and do not contain adjustments which may be necessary should the Company be forced to liquidate assets or take other actions to satisfy debt payments.\nThe Company did not make the final installment of $200,000 on a scheduled payment to Echlin Inc. due April 8, 1995 pursuant to a promissory note agreement. Echlin Inc. has notified the Company that it is in default on the note.\nThe Company had an interest rate swap agreement, which fixed the effective interest rate at 8.3% on $12,000,000 of its bank borrowings through October 15, 1994.\nThe Company had an interest rate protection agreement on $10,000,000 with a bank. Under this agreement, the Company was protected against the average LIBOR rate exceeding the agreement cap rate of 8-1\/2% for any consecutive three month period through August, 1993.\nLong-term debt consists of the following:\n\t\t\t\t\t January 1, January 2, \t\t\t\t\t\t1995 1994\nBank loan, revolving credit agreement at prime plus 1-1\/2% due July 1 , 1995 secured by receivables, inventory and certain other assets $ 17,900,000 $ 15,200,000\n\t\t\t\t\t\t\nNote payable, due in quarterly installments of $200,000. Interest at prime plus 1%. (See Note 11) 400,000 1,200,000\n\t\t\t\t\t\t\nESOP loan guarantee, 8-1\/2% due in varying semiannual installments to 1995 514,000 1,029,000\n\t\t\t\t\t\t\nMortgage, 12%, due in monthly installments of $21,803 (including interest) to 2001 (secured by property having a book value of $2,497,578 at January 1, 1995) 851,000 1,001,000\n\t\t\t\t\t\t\nCapitalized lease obligations under Industrial Revenue Bonds, at approximately 60% of prime rate, due in 2001, varying annual sinking fund payments commencing in 1998 1,500,000 1,500,000\n\t\t\t\t\t\t\nCapitalized building lease obligations under Industrial Revenue Bonds, 7%, due in 1995 7,000 194,000\n\t\t\t\t\t\t\nOther 305,000 363,000 \t\t\t\t\t ---------- ---------- \t\t\t\t\t\t\n\t\t\t\t\t 21,477,000 20,487,000 \t\t\t\t\t ---------- ----------\nLess portion due within one year 20,026,000 1,206,000 \t\t\t\t\t ---------- ---------- \t\t\t\t\t\t\t\t\t \t\t\t\t\t $ 1,451,000 $ 19,281,000 \t\t\t\t\t ========== ==========\nLong-term debt maturities (including obligations under capital leases) are $233,000 (1996), $258,000 (1997), $288,000 (1998), and $77,000 (1999).\nIn February 1988, the Employee Stock Ownership Plan (\"ESOP\"), established by the Company in 1986 (Note 8), borrowed $3,600,000 from a bank and used a contribution of $100,000 from the Company to purchase 400,000 shares of the Company's common stock at the market price of $9.25 per share. The Company has guaranteed the repayment of the 8-1\/2% bank loan. The loan was paid in April 1995.\n4. INCOME TAXES\nAs of the first quarter of fiscal year 1992, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes\". SFAS 109 uses an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Company's financial statements or tax returns.\nThe income tax provision (benefit) consists of the following:\nCURRENT 1994 1993 1992\n\t\t\t\t\t\t\t\t\t\nFederal $ (181,000) $ 660,000 $ (715,000)\nForeign (27,000) (75,000) 37,000\nState and local (33,000) 171,000 6,000 \t\t --------- --------- --------- \t\t\t\t\t\t\t\t\t \t\t $ (241,000) $ 756,000 $ (672,000) \t\t --------- --------- --------- \t\t\t\t\t\t\t\t\t\n\t\t\t\t\t\t\t\t\t\nDEFERRED\n\t\t\t\t\t\t\t\t\t\nFederal $ (67,000) $ (640,000) $ (559,500)\nForeign 11,000 75,000 (310,000)\nState and local --- (15,000) (102,500) \t\t --------- --------- --------- \t\t\t (56,000) (580,000) (972,000) \t\t --------- --------- --------- \t\t \t\t $ (297,000) $ 176,000 $ (1,644,000) \t\t ========= ========= =========\nThe Company has provided a valuation reserve to write-down deferred tax assets due to limited ability to carryback tax losses.\nAt January 1, 1995, the Company had approximately $623,000 of tax credits which can be carried forward indefinitely.\nThe effective tax rate differs from the U.S. statutory federal income tax rate of 34% as described below:\n\t\t\t\t 1994 1993 1992 \t\t\t\nIncome tax (benefit) at statutory rate $ (2,086,000) $ 676,000 $ (3,205,000)\nUtilization of net operating loss (NOL) carryforward --- (566,000) ---\nFederal valuation allowance, other than NOL 1,884,000 (45,000) 1,723,000\nState income taxes net of federal income tax (22,000) 25,000 (96,500)\nEffect of foreign operations (55,000) 66,000 (129,500)\nOther (18,000) 20,000 64,000 \t\t\t\t--------- --------- --------- \t\t\t\t\t\t\t\t\t\n\t\t\t $ (297,000) $ 176,000 $ 1,644,000 \t\t\t\t========= ========= =========\nNo provisions have been made for possible international and U.S. income taxes payable on the distribution of approximately $210,000 of undistributed earnings of its foreign subsidiary and affiliate which have been or will be reinvested abroad or, in the opinion of management, are expected to be returned to the United States with no material United States income tax effect. It is not practicable to determine the hypothetical U.S. federal income tax liability if all such earnings were remitted.\nDeferred tax assets and liabilities are comprised of the following at January 1, 1995 and January 2, 1994.\n\t\t\t--------- 1994 -------- --------- 1993 --------\n\t\t\t Assets Liabilities Assets Liabilities\nInventory Reserves $ 1,470,000 $ --- $ --- $ ---\nAccrued vacation 427,000 --- 466,000 ---\nFringe benefits 1,093,000 --- 1,248,000 ---\nDepreciation $ 1,350,000 --- $ 1,510,000\nBad debts 531,000 --- 646,000 ---\nWrite-off foreign subsidiary 215,000 --- 248,000 ---\nRestructuring Reserves 565,000 --- --- ---\nNet operating loss carryforward --- --- 18,000 ---\nTax credit carryforward 623,000 --- 232,000 ---\nValuation allowance (3,180,000) --- (1,353,000) ---\nOther 163,000 43,000 765,000 40,000 \t\t\t --------- --------- --------- ---------\n\t\t\t$ 1,907,000 $ 1,393,000 $ 2,270,000 $ 1,550,000 \t\t\t ========= ========= ========= =========\n5. DEFERRED COMPENSATION\nIn 1984, the Company entered into a deferred compensation agreement with a former officer which is to be funded with the benefits from whole-life insurance policies. Under the agreement, the Company's obligation for future payments could be reduced if the Company did not receive benefits expected from the policies.\nIn November 1993 the Company and the former officer entered into a Settlement Agreement which, in part, provided for the guaranteed payment of one-half of the deferred compensation benefit irrespective of the proceeds from the life insurance policies. The remaining deferred compensation benefit is payable subject to available policy proceeds. The Company agreed to keep two of the policies in force to fund the obligation and is entitled to reimbursement for annual policy payments and its annual guaranteed deferred compensation payment from policy proceeds if they are sufficient. The Company provided $250,000 in 1994 and $195,000 in 1993 to record the present value of the Company's anticipated obligation to this former officer.\nThe Company holds ten life insurance policies on one current employee and two former officers. Two of the policies are held to fund the deferred compensation benefits described above. In 1991, the insurance company which issued the policies was placed into conservatorship. In September 1993 a rehabilitation\/liquidation plan became effective. The Company's policies were restructured, permanently adjusting the account values. As of January 1, 1995, the Company has recorded an investment of estimated net cash surrender values in such policies of $805,000 and has unrealized death benefits of approximately $3.4 million.\n6. SPECIAL CHARGES\nIn the first quarter of 1994 the Company provided a one-time pretax special charge of $3.4 million to reflect a plan to reduce excess manufacturing capacity in an effort to increase operating efficiencies and reduce costs. Of the total provision, $2.5 million related to accruals for personnel and plant closure costs. The remaining $0.9 million was recorded to reflect write-downs of fixed assets affected by the plan to net realizable value.\nAt January 1, 1995, approximately $1.4 million of reserves remain to cover remaining personnel and plant closure costs ($0.7 million) and asset write-downs ($0.7 million). The Company expects to fully complete the plan in 1995.\nIn the fourth quarter of 1992, the Company provided a pre-tax restructuring charge of $3,223,000 for the exit from a joint venture in an engine remanufacturer, the additional write-down of inventory for products no longer remanufactured and severance pay for a reduction in its salaried workforce.\n7. EMPLOYEE STOCK OPTION AND AWARD PLANS\n1994 Stock Option Plan - The Company's Board of Directors adopted a 1994 Stock Option Plan. This plan is subject to shareholder ratification. Participants in the plan shall be those employees selected by the Compensation Committee of the Board of Directors.\nOptions shall be granted at the greater of (a) the fair market value of the Company's Common Stock at the date of grant or (b) $5 per share. No option may be exercised until six months after the grant date or after 10 years after the grant date. The options vest ratably over a period not to exceed five years.\n1982 Incentive Stock Option Plan - During 1982, the stockholders approved the 1982 Incentive Stock Option Plan. The plan provides that options to purchase 93,750 shares at prices equivalent to the fair market value at the date of grant may be granted to officers and other key employees.\nOptions became exercisable, in whole or part, one year from the date of the grant.\nThe options are considered not to involve compensation. As options are exercised, the par value of the shares issued is credited to the common stock account and the excess of the option price over such par value is credited to additional paid-in capital.\nInformation with respect to stock options outstanding is as follows:\n\t\t\t\t\t\t\t Average \t\t\t\t\t\tNumber Option \t\t\t\t\t\t of Price \t\t\t\t\t\tShares Per Share \t\t Changes in shares:\nBalance, December 29, 1991 42,750 $6.314\nCanceled (24,000) $6.865\nExpired (250) $4.500 \t\t\t\t\t ------- \t\t\t\t\nBalance, January 3, 1993 18,500 $5.625\nCanceled (11,000) $5.625 \t\t\t\t\t ------- \t\t\t\t\nBalance, January 2, 1994 7,500 $5.625\nCanceled (3,000) $5.625 \t\t\t\t\t ------- \t\t\t\t\nBalance, January 1, 1995 4,500 \t\t\t\t\t ======= \t\t\t\t\t\t\t\tExercise \t\t\t\t\t\t\t\t Price\nOptions exercisable: \t\t\t\t\t\t\t January 1, 1995 4,500 $5.625\nNo further options may be granted under the 1982 I.S.O. Plan and all outstanding options must be exercised by November 1997.\n1984 Stock Bonus Plan - In 1984, the Company adopted a stock bonus plan under which officers and other key employees are eligible for stock and cash awards. Unless otherwise determined at the time of award, a stock award becomes 20% vested at the time it is made and vests at the rate of an additional 20% on each anniversary of the award date. The Company reserved 125,000 shares of common stock for issuance under this plan.\nNo awards have been outstanding since 1990. As of January 1, 1995, 1,402 Common Shares were reserved for future issuance under this plan.\nThe vested shares issued are recorded as compensation and the par value of the shares issued is credited to the common stock account, and the excess of the market value at date of issuance over such par value is credited to additional paid-in capital.\n8. EMPLOYEE RETIREMENT AND SAVINGS PLANS\nSalaried employees with one or more years of service are eligible to participate in an Employee Stock Ownership Plan (\"ESOP\"), which was established in 1986. The plan provides for graduated vesting of participants' interests with full vesting upon completion of the fifth year of service. The aggregate expense of the ESOP charged to operations was $573,000, $622,000 and $561,000 for 1994, 1993 and 1992, respectively.\nSalaried employees with one year of service are eligible to participate in a 401(k) plan (\"Thrift Program\"). Under this program, contributions are 100% vested. Expense of the 401(k) plan charged to operations was $20,000 in 1992.\nHourly employees of three facilities are covered under the Company's noncontributory pension plans or under a union-sponsored plan to which the Company contributes. The benefits are based upon years of service of the employee. The Company's contribution consists of an amount to annually fund current service costs and to fund past service costs over 30 years. The Company's funding policy for these plans is to meet, at a minimum, the annual contributions required by applicable regulations.\nIn connection with the Company's 1994 plan to consolidate plant manufacturing capacity (See Note 6), a curtailment loss of $220,000 was provided for in the special charge.\nThe following table sets forth the plans' funded status and amounts recognized in the Company's balance sheets for its pension plans:\n\t\t\t -----January 1, 1995----- ----January 2, 1994----\n\t\t\t\t\t\t\t\t\t\t\t \t\t\t\tAssets Assets \t\t\t\tExceed Accumulated Exceed Accumulated \t\t\t Accumulated Benefits Accumulated Benefits \t\t\t Benefits Exceed Assets Benefits Exceed Assets\n\t\t\t\t\t\t\t\t\t\t\t\nActuarial present value of benefit obligations:\nVested benefit obligation $1,819,000 $3,013,000 $ --- $5,325,000\nNonvested benefit obligation 41,000 25,000 --- 100,000 \t\t\t\t --------- --------- --------- \t\t\t\t\t\t\t\t\t\t\t\nAccumulated benefit obligation $1,860,000 $3,038,000 $ --- $5,425,000\n\t\t\t\t\t\t\t\t\t\t\t\nPlan assets at fair value, primarily equity funds 1,995,000 2,483,000 --- 4,398,000 \t\t\t\t --------- --------- --------- \t\t\t\t\t\t\t\t\t\t\t Projected benefit obligation in excess of plan assets 135,000 (555,000) --- (1,027,000)\n\t\t\t\t\t\t\t\t\t\t\t\nUnrecognized net (gain) from past experience different from that assumed and effects of changes in assumptions (433,000) (255,000) --- (8,000)\nUnrecognized prior service cost 82,000 61,000 --- 200,000\nUnrecognized net obligation at January 1, 1988 being recognized over 18 to 26 years (61,000) 60,000 --- 149,000\nAdjustment to recognized minimum liability 0 (59,000) --- (411,000) \t\t\t\t --------- --------- --------- \t\t\t\t Accrued pension cost included in accrued expenses $ (277,000) $ (748,000) $ --- $(1,097,000) \t\t\t\t ========= ========= =========\nThe weighted average discount rates used in determining the actuarial present value of the projected benefit obligation at January 1, 1995, and January 2, 1994, were 8-3\/4% and 7-1\/2% respectively. The expected rate of return on assets was 8%. No projected wage increases are included in the calculation of the projected benefit obligation as the pension plan benefits are not based upon wage levels.\nPension cost for 1994, 1993 and 1992 consists of the following:\n\t\t\t\t 1994 1993 1992 \t\nService cost - benefits earned during the period $ 236,000 $ 253,000 $ 226,000\nInterest cost on projected benefit obligation 401,000 359,000 331,000\nActual return on plan assets (19,000) (524,000) (230,000)\nNet amortization and deferral (331,000) 262,000 (85,000) \t\t\t --------- --------- --------- \t\t\t\t\t\t\t\t \t\t\t $ 287,000 $ 350,000 $ 242,000 \t\t\t ========= ========= =========\n9. LEASES\nThe Company leases certain plants and offices, trucks and trailers, automobiles and computer equipment. Certain of the real estate leases, constituting non-financing leases, have provisions for renewal. These lease renewals are primarily for five years. Obligations under capital leases are included as a part of long-term debt.\nTotal rental expense charged to operations was as follows:\n\t\t\t\t 1994 1993 1992\n\t\t\t\t\t\t\t\t Plants and offices $ 250,000 $ 263,000 $ 292,000\nTrucks and trailers 1,147,000 1,300,000 1,422,000\nData processing equipment 273,000 480,000 630,000\nOther 257,000 264,000 442,000 \t\t\t --------- --------- ---------\n\t\t\t $1,927,000 $2,307,000 $2,786,000 \t\t\t ========= ========= =========\nThe lease cost for trucks and trailers is comprised of a fixed amount plus a usage charge based on mileage. Operating costs including licenses, use taxes, maintenance and fuel are primarily borne by the lessor. Minimum commitments under all noncancelable operating leases at January 1, 1995, are as follows:\n\t\t\t\t\t\t\t\t DATA \t\t\t\t\tPLANTS & TRUCKS & PROCESSING \t\t\t TOTAL OFFICES TRAILERS AND OTHER\n1995 $ 721,000 $ 147,000 $ 479,000 $ 95,000\n1996 559,000 24,000 441,000 94,000\n1997 480,000 --- 401,000 79,000\n1998 417,000 --- 362,000 55,000\n1999 322,000 --- 322,000 ---\n2000 & AFTER -0- --- --- ---\n10. SALES TO MAJOR CUSTOMERS\nIn 1994, sales to the Company's three largest customers were approximately 20%, 15% and 13% of net sales. In 1993 sales to the Company's three largest customers were approximately 23%, 13% and 12% of net sales. In 1992 sales to the three largest customers were approximately 20%, 12% and 10%, respectively.\n11. RELATED PARTY TRANSACTIONS\nIn March, 1987, the Company sold 600,000 common shares and a noncallable warrant to purchase 300,000 common shares, at $9.20 per share, to one of its suppliers, Echlin Inc. (\"Echlin\"). The warrant expired on February 28, 1992.\nThe total purchase price was $5,400,000. The stock purchase agreement restricted future stock purchases and limited sales by Echlin until March 1, 1994, and provided Echlin limited protection against declines in market value. Echlin has not indicated any intention to acquire additional shares or sell held shares. On March 9, 1992, Echlin exercised its market value rights under the stock purchase agreement. The Company reduced its Additional Paid-In Capital by $2,400,000 and recorded a note payable of the same amount which is being paid to Echlin in quarterly installments of $200,000. The note carries an interest rate of 1% above prime. See Note 3 regarding a discussion of the status of the Echlin note payments.\nTotal purchases from Echlin approximated $2,606,000, $3,686,000 and $3,783,000 in 1994, 1993 and 1992, respectively, of which $450,000, $308,000 and $304,000 were unpaid at year end 1994, 1993 and 1992, respectively.\n12. ENVIRONMENTAL MATTERS\nThe Company is subject to various Federal, state and local environmental laws and regulations incidental to its business. The Company continues to modify, on an ongoing basis, processes that may have an environmental impact.\nThe Company has been named, along with a number of other companies, as a Potentially Responsible Party in several Federal and state sites where the Company had operations or where byproducts from the Company's manufacturing processes were disposed. Three of the sites are currently active, and the others have been settled or are dormant. The Company also has undertaken voluntary actions at its current plant sites ranging from periodic testing to modest amounts of soil and water remediation and storage tank removal.\nThe Company has provided for anticipated net future costs of pending environmental matters at January 1, 1995. Such costs include the Company's estimated allocated share of remedial investigation\/feasibility studies and clean-up and disposal costs. No recoveries from insurance policy coverage has been recorded. The Company's ultimate costs are subject to further development of existing studies and possible readjustment of the Company's pro rata share of total costs.\nAlthough the ultimate outcome is not determinable, management believes that the resolution of these matters will not have a material impact on the Company's financial condition or operating results.\n13. INVESTMENTS\nThe Company has a 50% equity investment in a foreign joint venture. Prior to 1992 the venture was consolidated into the Company's results (Note 1). The Company has a direct guarantee of Canadian $500,000 of the venture's bank debt and is joint and several guarantor on Canadian $1,500,000 with its venture partner. In 1992, the Company wrote off its investment in the venture and provided a reserve for a contingent liability to exit this venture. The Company accounts for this venture using the equity method. Given the venture's current financial situation and the pending guarantees from the Company, the Company continued to record its investment at a zero estimated net realizable value and maintain a reserve for additional contingent financial exposure.\nApproximately $400,000 in charges were recorded against the reserve in 1994 to reflect the costs to exit the Company's distribution operation which was exclusively supplied by the joint venture.\n14. ACCRUED INTEREST AND OTHER EXPENSES.\nAccrued interest and other expenses consists of the following:\n\t\t\t\t January 1, January 2, \t\t\t\t\t1995 1994\n\t\t\t\t\t\t\nInterest $ 224,000 $ 182,000\nWorkers' compensation 1,278,000 1,565,000\nAccrued pension fund (See Note 8) 1,025,000 1,097,000\nMedical insurance reserve 536,000 880,000\nDeferred Compensation 444,000 193,000\nAccrued Rebate Expense 785,000 246,000\nEPA Reserve 434,000 487,000\nSpecial Charge Reserve 667,000 0\nJoint Venture Reserve 802,000 1,225,000\nOther items 613,000 676,000 \t\t\t\t --------- --------- \t\t\t\t\t\t\t\t \t\t\t\t $ 6,808,000 $ 6,551,000 \t\t\t\t ========= =========\n15. SUPPLEMENTAL CASH FLOW INFORMATION\nCash paid during the year for interest and income taxes was as follows:\n\t\t\t1994 1993 1992\n\t\t\t\t\t\t\nInterest $2,363,000 $2,377,000 $2,150,000\nIncome taxes 330,000 294,000 465,000\nSupplemental schedule of non-cash investing and financing activities:\nIn March 1992 the Company reduced its Additional Paid-In Capital by $2,400,000 and recorded a note payable in the same amount (See Note 11).\n16. SUBSEQUENT EVENT\nOn March 23, 1995, the Company entered into a Preferred Stock Purchase Agreement (the \"Agreement\") with RGP Holdings, Inc. (\"RGP\"), an affiliate of Mr. Raymond G. Perelman, a director, the Chairman of the Board of Directors and the beneficial owner of 18.1% of the outstanding Common Shares of the Company, pursuant to which Agreement RGP agreed to purchase 1,666,667 shares of the Company's newly authorized Series A Redeemable Cumulative Convertible Voting 9% Preferred Shares (the \"Preferred Shares\") at a price of $3.00 per share, or an aggregate purchase price of $5 million.\nOn April 17, 1995 RGP notified the Company that, pursuant to and in accordance with the terms of the Agreement, it had determined not to consummate the sale. RGP stated that the Company failed to satisfy certain conditions for closing.\n17. SELECTED QUARTER FINANCIAL DATA (UNAUDITED)\n(Reported in thousands, except per share data)\n\t\t\t\t\t\t\t\t Net \t\t\t\t\t\t Net earnings \t\t Net Gross earnings (loss) \t\t sales margin (loss) per share\n\t\t\t\t\t\t\t\t\t - ------------------------------------------------------------------------ 1994 $ 95,337 $ 14,913 $ (5,839) $(1.60) - ------------------------------------------------------------------------\nQuarters: \t\t\t\t\t\nFourth (2) 22,165 1,220 (3,434) ( .94)\nThird 24,917 3,981 62 .02\nSecond 24,131 5,274 377 .10\nFirst (1) 24,124 4,438 (2,844) ( .78)\n\t\t\t\t\t\t\t\t\t\t - ------------------------------------------------------------------------- 1993 $ 100,040 $ 20,907 $ 1,813 $ .50 - ------------------------------------------------------------------------- \t\t\t\t\t\t\t\t\t\t\nQuarters: \t\t\t\nFourth 21,611 3,603 (434) ( .12)\nThird 27,472 6,105 975 .27\nSecond 25,036 5,402 618 .17\nFirst 25,921 5,797 654 .18\n\t(1) The first quarter reflects a special, one-time pretax charge of \t $3,400,000 related to the consolidation of production facilities.\n\t(2) The fourth quarter includes a $2,200,000 write-down of inventory \t (See Note 2).\nCHAMPION PARTS, INC. AND SUBSIDIARIES\nSCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS \t\n\t\t Balance at Charged Deductions Balance \t\t Beginning to From at End \t\t of Period Operations Reserves of Period\nALLOWANCE FOR UNCOLLECTIBLE ACCOUNTS: \t\t\t\t\t\t\t\nYear Ended January 3, 1993 $ 426,000 $ 622,000 $ 594,000 $ 454,000 \t\t ======== ======== ======== ======== \t\t\t\t\t\t\t\t\t\t\t\t\nYear Ended January 2, 1994 $ 454,000 $ 3,000 $ 51,000 $ 406,000 \t\t ======== ======== ======== ======== \t\t\t\t\t\t\t\t\t\t\t\t\nYear Ended January 1, 1995 $ 406,000 $ 80,000 $ 21,000 $ 465,000 \t\t ======== ======== ======== ========\nCHAMPION PARTS, INC.\nEXHIBIT INDEX\n__________\n\t\t(Pursuant to Item 601 of Regulation S-K)\n\t\t\t\t\t\t\t\t \t\t\t\t\t\t\t\t \t\t\t\t\t\t\t\t\t Total \t\t\t\t\t\t\t\t\t Pages\nNO. DESCRIPTION AND PAGE OR INCORPORATION REFERENCE\n\t\tArticles of Incorporation and By-Laws\n(3)(a) Articles of Incorporation (incorporated by reference to \t\tRegistrant's Quarterly Report on Form 10-Q for the quarter \t\tended June 30, 1988)\n(3)(b) By-Laws (incorporated by reference to Registrant's Annual \t\tReport on Form 10-K for the year ended January 2, 1994).\n\t\t\t\t\t\t\t\t \t\t\t\t\t\t\t\t\t \t\tInstruments Defining the Rights of Security\n\t\tHolders, Including Indentures\n(4)(a) Stock Purchase Agreement dated March 18, 1987 between the \t\tRegistrant and Echlin Inc. (incorporated by reference to \t\tRegistrant's Annual Report on Form 10-K for the fiscal \t\tyear ended December 31, 1986)\n(4)(b) Agreed Final Judgment Order dated January 5, 1988 entered \t\tby the United States District Court for the Northern \t\tDistrict of Illinois, Case No. 86 C 8906 (incorporated by \t\treference to Registrant's Current Report on Form 8-K dated \t\tDecember 29, 1987)\n(4)(c) Agreement dated December 29, 1987 by and among the Company, \t\tNicole M. Cormier, Claude A. Cormier and Daniel O. Cormier \t\t(incorporated by reference to Registrant's Current Report on \t\tForm 8-K dated December 29, 1987)\n(4)(d) Agreement dated April 28, 1987 between the Registrant and \t\tScott Hodes (incorporated by reference to Registrant's Annual \t\tReport on Form 10-K for the fiscal year ended December 31, \t\t1987)\n(4)(e) Specimen of Common Share Certificate (incorporated by \t\treference to Registrant's Annual Report on Form 10-K for \t\tthe fiscal year ended December 31, 1988)\n(4)(f) Articles of Incorporation (see Exhibit (3)(a) above)\n(4)(g) By-Laws (see Exhibit (3)(b) above).\n\t\t(With respect to long-term debt instruments, see \t\t\"Item 14. Exhibits, Financial Statement Schedules, \t\tand Reports on Form 8-K\".)\n(4)(h) Term of Series A Redeemable Cumulative Convertible \t\tVoting 9% Preferred Shares (Incorporated by reference \t\tto Registrant's Form 8-K filing dated March 23, 1995.)\n\t\t\t\t\t\t\t\t\n\t\tMaterial Contracts\n(10)(a) Continuing Unconditional Guaranty dated February 12, 1988 \t\tby the Company of indebtedness of Charles P. Schwartz, Jr. \t\tand Leonard D. O'Brien (now Kevin J. O'Connor), as trustees \t\tof the Champion Parts, Inc. Employee Stock Ownership Trust, \t\tto the Exchange National Bank of Chicago (now LaSalle \t\tNational Bank) (incorporated by reference to Registrant's \t\tAnnual Report on Form 10-K for the fiscal year ended \t\tDecember 31, 1987)\n(10)(b) Amended and Restated Indemnification Agreement dated as of \t\tAugust 17, 1989 between the Registrant and Charles P. \t\tSchwartz, Jr. (incorporated by reference to Registrant's \t\tAnnual Report on Form 10-K for the fiscal year ended \t\tDecember 31, 1989) (1)\n(10)(c) Agreement dated as of December 28, 1983 between Registrant \t\tand Raymond F. Gross (incorporated by reference to \t\tRegistrant's Annual Report on Form 10-K for the fiscal \t\tyear ended December 31, 1983) (1)\n(10)(d) 1984 Stock Bonus Plan, amended as of October 20, 1988 \t\t(incorporated by reference to Registrant's Annual Report on \t\tForm 10-K for the fiscal year ended December 31, 1988) (1)\n(10)(e) 1982 Incentive Stock Option Plan, as amended November 19, \t\t1987 (incorporated by reference to Registrant's Current \t\tReport on Form 8-K dated November 19, 1987) (1)\n(10)(f) Form of Incentive Stock Option Agreement and Schedule of \t\tIncentive Stock Option Agreements executed by executive \t\tofficers of the Registrant (incorporated by reference to \t\tRegistrant's Annual Report on Form 10-K for the fiscal year \t\tended December 31, 1988) (1)\n(10)(g) Amended and Restated Employment and Deferred Compensation \t\tAgreement dated as of June 7, 1989, between Registrant and \t\tCharles P. Schwartz, Jr. (incorporated by reference to \t\tRegistrant's Annual Report on Form 10-K for the fiscal year \t\tended December 29, 1991) (1)\n(10)(h) Agreement dated as of June 7, 1989 between the Registrant \t\tand Robert C. Mikolashek (incorporated by reference to \t\tRegistrant's Annual Report on Form 10-K for the fiscal year \t\tended December 29, 1991) (1)\n(10)(i) Agreement dated December 16, 1992 between the Registrant \t\tand Charles P. Schwartz, Jr. (incorporated by reference to \t\tRegistrant's Current Report on Form 8-K dated December 16, \t\t1992) (1)\n(10)(j) Amended and Restated Credit Agreement dated as of March 31, \t\t1993 among the Registrant, LaSalle National Bank (the successor \t\tto Exchange National Bank of Chicago), NBD Bank, N.A., American \t\tNational Bank and Trust Company of Chicago, and Harris Trust \t\tand Savings Bank (assignee of The Northern Trust Company) \t\t(Incorporated by reference to Registrant's Annual Report on \t\tForm 10-K for the fiscal year ended January 3, 1993.)\n(10)(k) Security Agreement dated as of March 31, 1993 by and between \t\tthe Registrant and LaSalle National Bank acting as collateral \t\tagent for NBD Bank, N.A., American National Bank and Trust \t\tCompany of Chicago, and Harris Trust and Savings Bank \t\t(Incorporated by reference to Registrant's Annual Report on \t\tForm 10-K for the fiscal year ended January 3, 1993.)\n\t\t\t\t\t\t\t\t \t\t\t\t\t\t\t\t \t\t\t\t\t\t\t\t (10)(l) Settlement Agreement dated November 23, 1993 between Registrant \t\tand Charles P. Schwartz, Jr. (Incorporated by reference to \t\tRegistrant's current report on Form 8-K dated November 23, \t\t1993). (1)\n(10)(m) Form of Letter from Registrant to LaSalle National Bank (the \t\tsuccessor of Exchange National Bank of Chicago), NBD Bank, \t\tN.A., and Harris Trust and Savings Bank (assignee of The \t\tNorthern Trust Company) dated March 14, 1994 (incorporated \t\tby reference to Registrant's Annual Report on Form 10-K for \t\tthe year ended January 2, 1994).\n(10)(n) First Amendment to Amended and Restated Credit Agreement \t\tdated March 30, 1994 among Registrant, LaSalle National Bank \t\t(the successor of Exchange National Bank of Chicago), NBD \t\tBank, N.A., and Harris Trust and Savings Bank (assignee of \t\tThe Northern Trust Company). (Incorporated by reference \t\tto Registrant's Annual Report on Form 10-K for the year \t\tended January 2, 1994).\n(10)(o) Indemnification Agreement dated as of March 8, 1994 between \t\tthe Registrant and Donald G. Santucci and Schedule of \t\tIndemnification Agreements executed by directors and executive \t\tofficers of the Registrant. (Incorporated by reference to \t\tRegistrant's Annual Report on Form 10-K for the year ended \t\tJanuary 2, 1994).\n\t\t\n(10)(p) Agreement, as amended, between Registrant and Raymond G. \t\tPerelman dated September 20, 1993 (incorporated by reference \t\tto Registrant's current Report on Form 8-K dated March 7, \t\t1994.)\n\t\t (10)(q) Supply Agreement dated March 18, 1987 between the Registrant \t\tand Echlin Inc. (incorporated by reference to the Registrant's \t\tAnnual Report on Form 10-K for the fiscal year ended December \t\t31, 1988)\n(10)(s) Settlement Agreement between Registrant and Charles P. \t\tSchwartz, Jr. (Incorporated by reference to the Registrant's \t\tCurrent Report on Form 8-K dated November 23, 1993.)\n\t\t\n(10)(t) Agreement between Registrant and Raymond G. Perelman \t\tdated September 20, 1993. (Incorporated by reference to the \t\tRegistrant's Current Report on Form 8-K dated March 7, 1994.)\n(10)(u) 1994 Stock Option Plan as of September 22, 1994. (Included \t\therein on page 62.) 8\n(10)(v) Second Amendment to Amended and Restated Credit Agreement \t\tdated March 31, 1995 among Registrant, LaSalle National \t\tBank (the successor of Exchange National Bank of Chicago), \t\tNBD Bank, N.A., and Harris Trust and Savings Bank (assignee \t\tof The Northern Trust Company). (Included herein on \t\tpage 70.) 11\n(10)(w) Letter Agreement between the Registrant and Mr. Raymond G. \t\tPerelman dated February 21, 1995 (incorporated by reference \t\tto the Registrant's Current Report on Form 8-K filed February \t\t21, 1995).\n(10)(x) Preferred Stock Purchase Agreement between the Registrant \t\tand Mr. Raymond G. Perelman dated March 23, 1995 (incorporated \t\tby reference to the Registrant's Current Report on Form 8-K \t\tdated March 23, 1995).\n\t\tSubsidiaries\n(21) List of Subsidiaries of Registrant (incorporated by reference \t\tto Registrant's Annual Report on Form 10-K for the fiscal \t\tyear ended December 29, 1991)\n\t\tConsents of Experts and Counsel\n(23)(a) Consent of Arthur Andersen LLP (included herein on page \t\t81) 1\n(23)(b) Consent of DELOITTE & TOUCHE LLP (included herein on \t\tpage 82) 1\n\t\tAdditional Exhibits\n(27) Financial Data Schedules\nNote:\n\t(1) Denotes management contract or compensatory plan or \t arrangement required to be filed as an Exhibit to this \t report pursuant to item 601 of Regulation S-K.\n\t\t\t\t ________\n\t Champion Parts, Inc. will furnish any of the above exhibits for which total number of pages is indicated above, to requesting security holders upon payment of a photocopying charge of $.10 per page, and a postage charge of $.32 for the first seven pages or fewer and $.23 for each additional seven pages or fewer, subject to adjustment for changes in postal rates.\n\"EXHIBIT (23)(A)\"\nCONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS\nAs independent public accountants, we hereby consent to the incorporation by reference in the Registration Statement No. 33-16020 of Champion Parts, Inc. and subsidiaries on Form S-8 of our report dated February 21, 1995 (except for Notes 3 and 16 which are dated April 17, 1995) in Champion Parts, Inc. and subsidiaries' Form 10-K for the year ended January 1, 1995.\n\t\t\t\t\t\t\t\nARTHUR ANDERSEN LLP\nChicago, Illinois\nApril 17, 1995\n\"EXHIBIT 23(B)\"\nINDEPENDENT AUDITORS' CONSENT\nWe consent to the incorporation by reference in Registration Statement No. 33-16020 of Champion Parts, Inc. and Subsidiaries on Form S-8 of our report dated February 26, 1993 appearing in this annual Report on Form 10-K of Champion Parts, Inc. and Subsidiaries for the year ended January 1, 1995.\nDELOITTE & TOUCHE LLP\nChicago, Illinois\nApril 17, 1995\n\"EXHIBIT 10(u)\"\nCHAMPION PARTS, INC.\n1994 LONG-TERM STOCK INCENTIVE PLAN\nSECTION 1\nOBJECTIVE\n\tThe objective of the Champion Parts, Inc. 1994 Long-Term Stock Incentive Plan (the \"Plan\") is to attract and retain the best available directors, executive personnel and key employees to be responsible for the management, growth and success of the business, and to provide an incentive for such individuals to exert their best efforts on behalf of the Company and its shareholders.\nSECTION 2\nDEFINITIONS\n\t2.1 General Definitions. The following words and phrases, when used herein, shall have the following meanings:\n\t(a) \"Agreement\" - The written document which evidences the grant of any Award under the Plan and which sets forth the terms, conditions, and limitations relating to such Award. No Award shall be valid until so evidenced.\n\t(b) \"Award\" - The grant of any Option, Stock Appreciation Right, share of Restricted Stock, share of Phantom Stock, Other Stock Based Award, or any combination thereof.\n\t(c) \"Board\" - The Board of Directors of Champion Parts, Inc.\n\t(d) \"Code\" - The Internal Revenue Code of 1986, as amended, and including the regulations promulgated pursuant thereto.\n\t(e) \"Committee\" - The ___________ Committee of the Board of Directors of the Company, which shall consist solely of two or more \"outside directors\" within the meaning of Code section 162(m)(4)(C)(i).\n\t(f) \"Common Stock\" - The present Common Shares of the Company, and any shares into which such shares are converted, changed or reclassified.\n\t(g) \"Company\" - Champion Parts, Inc., a Illinois corporation, and its groups, divisions, and subsidiaries.\n\t(h) \"Employee\" - Any person employed by the Company as an employee or any director of the Company, regardless of whether the director is an employee of the Company.\n\t(i) \"Fair Market Value\" - The fair market value of Common Stock on a particular day shall be the closing price of the Common Stock on the NASDAQ National Market System or any national stock exchange on which the Common Stock is traded, on the last preceding trading day on which such Common Stock was traded.\n\t(j) \"Option\" - A right granted under Section 6 hereof to purchase Common Stock of the Company at a stated price for a specified period of time.\n\t(k) \"Other Stock Based Award\" - An award granted under Section 9 hereof that is valued in whole or in part by reference to, or is otherwise based on, the Company's Common Stock.\n\t(l) \"Participant\" - Any Employee designated by the Committee to participate in the Plan.\n\t(m) \"Phantom Stock\" - A right granted under Section 8 hereof to receive payment from the Company in cash, stock, or in combination thereof, in an amount determined by the Fair Market Value.\n\t(n) \"Period of Restriction\" - The period during which Shares of Restricted Stock or Phantom Stock rights are subject to forfeiture or restrictions on transfer pursuant to Section 8 of the Plan.\n\t(o) \"Restricted Stock\" - Shares granted to a Participant which are subject to restrictions on transferability pursuant to Section 8 of the Plan.\n\t(p) \"Shares\" - Shares of Common Stock.\n\t(q) \"Stock Appreciation Right\" or \"SAR\" - The right granted under Section 7 hereof to receive a payment from the Company in cash, Common Stock, or in combination thereof, equal to the excess of the Fair Market Value of a share of Common Stock on the date of exercise over a specified price fixed by the Committee, but subject to such maximum amounts as the Committee may impose.\n\t2.2 Other Definitions. In addition to the above definitions, certain words and phrases used in the Plan and any Agreement may be defined elsewhere in the Plan or in such Agreement.\nSECTION 3\nCOMMON STOCK\n\t3.1 Number of Shares. Subject to the provisions of Section 3.3, the number of Shares which may be issued or sold or for which Options or Stock Appreciation Rights may be granted under the Plan may not exceed ________________ Shares.\n\t3.2 Re-usage. If an Option or SAR expires or is terminated, surrendered, or canceled without having been fully exercised, if Restricted Stock is forfeited, or if any other grant results in any Shares not being issued, the Shares covered by such Option, SAR, grant of Restricted Stock or other grant, as the case may be, shall again be immediately available for Awards under the Plan.\n\t3.3 Adjustments. In the event of any change in the outstanding Common Stock by reason of a stock split, stock dividend, combination, reclassification or exchange of Shares, recapitalization, merger, consolidation or other similar event, the number of SARs and the number of Shares available for Options, grants of Restricted Stock, and Other Stock Based Awards and the number of Shares subject to outstanding Options, SARs, grants of Restricted Stock, and Other Stock Based Awards, and the price thereof, and the Fair Market Value, as applicable, shall be appropriately adjusted by the Committee in its sole discretion and any such adjustment shall be binding and conclusive on all parties. Any fractional Shares resulting from any such adjustment shall be disregarded.\nSECTION 4\nELIGIBILITY AND PARTICIPATION\n\tParticipants in the Plan shall be those individuals selected by the Committee to participate in the Plan who hold positions of responsibility and whose participation in the Plan the Committee determines to be in the best interests of the Company. No Participant may be granted in any calendar year Awards with respect to which more than ____ Shares may be issued or sold or for which Options or Stock Appreciation Rights may be granted. No Participant may be granted during the Participant's lifetime Awards with respect to which more than ____ Shares may be issued or sold or for which Options or Stock Appreciation Rights may be granted.\nSECTION 5\nADMINISTRATION\n\t5.1 Committee. The Plan shall be administered by the ___________ Committee of the Company, which shall consist solely of two or more \"outside directors\" within the meaning of Code section 162(m)(4)(C)(i). The members of the Committee shall be appointed by and shall serve at the pleasure of the Board, which may from time to time change the Committee's membership.\n\t5.2 Authority. The Committee shall have the sole and complete authority to:\n\t(a) determine the individuals to whom awards are granted, the type and amounts of awards to be granted and the time of all such grants;\n\t(b) determine the terms, conditions and provisions of, and restrictions relating to, each Award granted;\n\t(c) interpret and construe the Plan and all Agreements;\n\t(d) prescribe, amend and rescind rules and regulations relating to the Plan;\n\t(e) determine the content and form of all Agreements;\n\t(f) determine all questions relating to Awards under the Plan, including whether any conditions relating to an Award have been met;\n\t(g) maintain accounts, records and ledgers relating to Awards;\n\t(h) maintain records concerning its decisions and proceedings;\n\t(i) employ agents, attorneys, accountants or other persons for such purposes as the Committee considers necessary or desirable; and\n\t(j) do and perform all acts which it may deem necessary or appropriate for the administration of the Plan and to carry out the objectives of the Plan.\n\t5.3 Determinations. All determinations, interpretations, or other actions made or taken by the Committee pursuant to the provisions of the Plan shall be final, binding, and conclusive for all purposes and upon all persons.\n\t5.4 Delegation. The Committee may delegate to appropriate senior officers of the Company its duties under the Plan pursuant to such conditions and limitations as the Committee may establish.\nSECTION 6\nSTOCK OPTIONS\n\t6.1 Type of Option. Each Option granted under this Plan shall be of one of two types: (i) an \"incentive stock option\" within the meaning of section 422 of the Code (or any successor provision), or (ii) a non-qualified stock option.\n\t6.2 Grant of Option. An Option may be granted to Participants at such time or times as shall be determined by the Committee. Each Option shall be evidenced by a written Agreement that shall specify the exercise price, the duration of the Option, the number of Shares to which the Option applies, and such other terms and conditions not inconsistent with the Plan as the Committee shall determine. No incentive stock options may be awarded after the tenth anniversary of the date this Plan is adopted by the Board.\n\t6.3 Option Price. The per share option price shall be not less than 100 percent of the Fair Market Value at the time the Option is granted (110 percent in the case of an incentive stock option granted to a Participant who at the time the Option is granted owns stock possessing more than 10 percent of the total combined voting power of all classes of stock of the Company or of its parent).\n\t6.4. Exercise of Options. Options awarded under the Plan shall be exercisable at such times and shall be subject to such restrictions and conditions, including the performance of a minimum period of service after the grant, as the Committee may impose, which need not be uniform for all participants; provided, however, that no Option shall be exercisable for more than 10 years after the date on which it is granted (5 years in the case of an incentive stock option granted to a Participant who at the time the Option is granted owns stock possessing more than 10 percent of the total combined voting power of all classes of stock of the Company or of its parent). No Option may be exercised until the Committee certifies that all conditions on the exercise of the Option have been met.\n\t6.5 Payment. The Committee shall determine the procedures governing the exercise of Options, and shall require that the per share option price be paid in full at the time of exercise. The Committee may, in its discretion, permit a Participant to make payment in cash, or in Shares already owned by the Participant, valued at the Fair Market Value thereof, as partial or full payment of the exercise price. As soon as practical after full payment of the exercise price, the Company shall deliver to the Participant a certificate or certificates representing the acquired Shares.\n\t6.6 Rights as a Shareholder. Until the exercise of an Option and the issuance of the Shares in respect thereof, a Participant shall have no rights as a Shareholder with respect to the Shares covered by such Option.\nSECTION 7\nSTOCK APPRECIATION RIGHTS\n\t7.1 Grant of Stock Appreciation Rights. Stock Appreciation Rights may be granted to Participants at such time or times as shall be determined by the Committee and shall be subject to such terms and conditions as the Committee may decide. A grant of an SAR shall be made pursuant to a written Agreement containing such provisions not inconsistent with the Plan as the Committee shall approve.\n\t7.2 Exercise of SARs. SARs may be exercised at such times and subject to such conditions, including the performance of a minimum period of service, as the Committee shall impose. Any SAR related to a non-qualified stock option may be granted at the same time such Option is granted or at any time thereafter before exercise or expiration of such Option. Any SAR related to an incentive stock option shall be granted at the same time such Option is granted. SARs which are granted in tandem with an Option may only be exercised upon the surrender of the right to exercise an equivalent number of Shares under the related Option and may be exercised only with respect to the Shares for which the related Option is then exercisable. Notwithstanding any other provision of the Plan, the Committee may impose conditions on the exercise of an SAR, including, without limitation, the right of the Committee to limit the time of exercise to specified periods, as may be required to satisfy the applicable provisions of Rule 16b-3 as promulgated under The Securities Exchange Act of 1934, as amended, or any successor rule. No SAR may be exercised until the Committee certifies that all conditions on the exercise of the SAR have been met.\n\t7.3 Payment of SAR Amount. Upon exercise of an SAR, the Participant shall be entitled to receive payment of an amount determined by multiplying:\n\t(a) any increase in the Fair Market Value of a Share at the date of exercise over the Fair Market Value of a Share at the date of grant, by\n\t(b) the number of Shares with respect to which the SAR is exercised; provided, however, that at the time of grant, the Committee may establish, in its sole discretion, a maximum amount per Share which will be payable upon exercise of an SAR.\n\t7.4 Method of Payment. Subject to the discretion of the Committee, which may be exercised at the time of grant, the time of payment, or any other time, payment of an SAR may be made in cash, Shares or any combination thereof.\nSECTION 8\nRESTRICTED STOCK OR PHANTOM STOCK\n\t8.1 Grant of Restricted Stock or Phantom Stock. The Committee may grant Shares of Restricted Stock or Phantom Stock rights to such Participants at such times and in such amounts, and subject to such other terms and conditions not inconsistent with the Plan as it shall determine. Each grant of Restricted Stock or Phantom Stock rights shall be evidenced by a written Agreement setting forth the terms of such Award.\n\t8.2 Restrictions on Transferability and Exercise. Restricted Stock or Phantom Stock rights may not be sold, transferred, pledged, assigned, or otherwise alienated until the Committee certifies that any conditions imposed upon the Restricted Stock or Phantom Stock, (including without limitation, the satisfaction of performance goals or the occurrence of such events as shall be determined by the Committee), have been met. Upon such certification, any Restricted Stock will be transferred to the Participant free of all restrictions and any Phantom Stock may be transferred to the Company in exchange for cash, Shares or a combination of cash and Shares.\n\t8.3 Rights as a Shareholder. Unless otherwise determined by the Committee at the time of grant, Participants holding Restricted Stock granted hereunder may exercise full voting rights and other rights as a Shareholder with respect to those Shares during the period of restriction. Holders of Phantom Stock rights shall not be deemed Shareholders and, except to the extent provided in accordance with the Plan, shall have no rights related to any Shares.\n\t8.4 Dividends and Other Distributions. Unless otherwise determined by the Committee at the time of grant, Participants holding Restricted Stock shall be entitled to receive all dividends and other distributions paid with respect to those Shares, provided that if any such dividends or distributions are paid in shares of stock, such shares shall be subject to the same forfeiture restrictions and restrictions on transferability as apply to the Restricted Stock with respect to which they were paid. Unless otherwise determined by the Committee at the time of grant, Participants holding Phantom Stock rights shall not be entitled to receive cash payments equal to any cash dividends and other distributions paid with respect to a corresponding number of Shares.\n\t8.5 Payment of Phantom Stock Rights. The Committee may, at the time of grant, provide for payment in respect of Phantom Stock rights in cash, Shares, partially in cash and partially in Shares, or in any other manner not inconsistent with this Plan.\nSECTION 9\nOTHER STOCK BASED AWARDS AND OTHER BENEFITS\n\t9.1 Other Stock Based Awards. The Committee shall have the right to grant Other Stock Based Awards which may include, without limitation, the grant of Shares based on certain conditions, the payment of cash based on the performance of the Common Stock, and the payment of Shares in lieu of cash under other Company incentive bonus programs. A grant of an Other Stock Based Award shall be made pursuant to a written Agreement containing such provisions not inconsistent with the Plan as the Committee shall approve. Payment under or settlement of any such Awards shall be made in such manner and at such times as the Committee may determine.\n\t9.2 Other Benefits. The Committee shall have the right to provide types of Awards under the Plan in addition to those specifically listed utilizing shares of stock or cash, or a combination thereof, if the Committee believes that such Awards would further the purposes for which the Plan was established. Payment under or settlement of any such Awards shall be made in such manner and at such times as the Committee may determine; provided, that no such Other Stock Based Award may be exercised until the Committee certifies that all conditions on the exercise of the Other Stock Based Award have been met.\nSECTION 10\nAMENDMENT, MODIFICATION, AND TERMINATION OF PLAN\n\tThe Board of Directors at any time may terminate or suspend the Plan, and from time to time may amend or modify the Plan. No amendment, modification, or termination of the Plan shall in any manner adversely affect any Award theretofore granted under the Plan without the consent of the Participant.\nSECTION 11\nTERMINATION OF EMPLOYMENT\n\t11.1 Termination of Employment Due to Retirement. Unless otherwise determined by the Committee at the time of grant, in the event a Participant's employment with the Company terminates by reason of retirement after age 65, any Option or SAR granted to such Participant which is then outstanding may be exercised at any time prior to the expiration of the term of the Option or SAR or within three (3) years following the Participant's termination of employment, whichever period is shorter, and any Restricted Stock, Phantom Stock rights, or other Award then outstanding for which any restriction has not lapsed prior to the effective date of retirement shall be forfeited.\n\t11.2 Termination of Employment Due to Death or Disability. Unless otherwise determined by the Committee at the time of grant, in the event a Participant's employment with the Company is terminated by reason of death or disability, any Option or SAR granted to such Participant which is then outstanding may be exercised by the Participant or the Participant's legal representative at any time prior to the expiration date of the term of the Option or SAR or within three (3) years following the Participant's termination of employment, whichever period is shorter, and any Restricted Stock, Phantom Stock rights, or other Award then outstanding shall become nonforfeitable and shall become transferable or payable, as the case may be, as though any restriction had expired.\n\t11.3 Termination of Employment for Any Other Reason. Unless otherwise determined by the Committee at the time of grant, in the event the employment of the Participant with the Company shall terminate for any reason other than misconduct or one described in Section 11.1 or 11.2, any Option or SAR granted to such Participant which is then outstanding may be exercised by the Participant at any time prior to the expiration date of the term of the Option or SAR or within three (3) months following the Participant's termination of employment, whichever period is shorter; any Restricted Stock, Phantom Stock rights, or other Award then outstanding for which any restriction has not lapsed prior to the date of termination of employment shall be forfeited upon termination of employment. If the employment of a Participant is terminated by the Company by reason of the Participant's misconduct, any outstanding Option or SAR shall cease to be exercisable on the date of the Participant's termination of employment; any Restricted Stock, Phantom Stock rights, or other Award then outstanding for which any restriction has not lapsed prior to the date of termination of employment shall be forfeited upon termination of employment. As used herein, \"misconduct\" means (i) one or more demonstrable and material acts of dishonesty, disloyalty, insubordination or willful misconduct or (ii) the continued failure, in the judgment of the Chief Executive Officer of the Company or the Board by the Participant to substantially perform his duties (other than any such failure resulting from his death or disability). The Committee shall determine whether a Participant's employment is terminated by reason of misconduct.\n\t11.4 Accrual of Right at Date of Termination. The Participant shall have the right to exercise an Option or SAR as indicated in Sections 11.1, 11.2, and 11.3 only to the extent the Participant's right to exercise such Option or SAR had accrued at the date of termination of employment pursuant to the terms of the applicable Agreement and had not previously been exercised.\nSECTION 12\nMISCELLANEOUS PROVISIONS\n\t12.1 Non-transferability of Awards. Unless otherwise determined by the Committee at the time of grant, and except as provided in Section 11, no Awards granted under the Plan shall be assignable, transferable, or payable to or exercisable by anyone other than the Participant to whom it was granted.\n\t12.2 No Guarantee of Employment or Participation. Nothing in the Plan shall interfere with or limit in any way the right of the Company to terminate any Participant's employment at any time, nor confer upon any Participant any right to continue in the employment of the Company. No employee shall have a right to be selected as a Participant, or, having been so selected, to receive any future awards.\n\t12.3 Tax Withholding. The Company shall have the authority to withhold, or require a Participant to remit to the Company, an amount sufficient to satisfy federal, state, and local withholding tax requirements on any Award under the Plan, and the Company may defer payment of cash or issuance of Shares until such requirements are satisfied. The Committee may, in its discretion, permit a Participant to elect, subject to such conditions as the Committee shall require, to have Shares otherwise issuable under the Plan withheld by the Company and having a Fair Market Value sufficient to satisfy all or part of the Participant's estimated total federal, state, and local tax obligation associated with the transaction.\n\t12.4 Governing Law. The Plan and all determinations made and actions taken pursuant hereto, to the extent not otherwise governed by the Code or Act, shall be governed by the law of the State of Delaware and construed in accordance therewith.\n\t12.5 Effective Date. The Plan shall be effective immediately upon such approval by the Shareholders of the Company, provided, however, that no Award requiring the issuance of Shares shall be exercised or paid out unless at the time of such exercise or payout (i) such Shares are covered by a currently effective registration statement filed under The Securities Act of 1933, as amended, if one is then required, or in the sole opinion of the Company and its counsel such issuance of Shares is otherwise exempt from the registration requirements of such act, and (ii) such Shares are listed on any securities exchange upon which the Common Stock of the Company is listed.\n\t12.7 Unfunded Plan. Insofar as the Plan provides for Awards of cash, Shares, rights or a combination thereof, the Plan shall be unfunded. The Company may maintain bookkeeping accounts with respect to Participants who are entitled to Awards under the Plan, but such accounts shall be used merely for bookkeeping convenience. The Company shall not be required to segregate any assets that may at any time be represented by interests in Awards nor shall the Plan be construed as providing for any such segregation. None of the Committee, the Company or its Board of Directors shall be deemed to be a trustee of any cash, Shares or rights to Awards granted under the Plan. Any liability of the Company to any Participant with respect to an Award or any rights thereunder shall be based solely upon any contractual obligations that may be created by the Plan and any Agreement, and no obligation of the Company under the Plan shall be deemed to be secured by any pledge or other encumbrance on any property of the Company.\n\t12.8. Provisions Relating to Section 16 Persons. Notwithstanding any other provision herein, any Option or similar right (including an SAR) granted hereunder to a Participant who is then subject to Section 16 of The Securities Exchange Act of 1934 shall not be transferable other than by will or the laws of descent and distribution and shall be exercisable during the Participant's lifetime only by him.\nEXHIBIT 10(v)\nSECOND AMENDMENT TO\nAMENDED AND RESTATED CREDIT AGREEMENT\n\tThis Second Amendment to Amended and Restated Credit Agreement (this \"Second Amendment\") is made and entered into as of March __, 1995, by and among Champion Parts, Inc., an Illinois corporation (the \"Company\"), LaSalle National Bank, a national banking association (\"LaSalle\"), as successor to both Exchange National Bank of Chicago and American National Bank and Trust Company of Chicago, NBD Bank (\"NBD\"), and Harris Trust and Savings Bank, an Illinois banking corporation (\"Harris\") [LaSalle, NBD and Harris are each a \"Bank\" and collectively, together with their respective successors and permitted assigns, the \"Banks\"], and LaSalle in its capacity as both Agent and Collateral Agent for the Banks.\nW I T N E S S E T H:\n\tWHEREAS, the Banks have provided certain extensions of credit, loans and other financial accommodations to the Company pursuant to that certain Amended and Restated Credit Agreement dated as of March 31, 1993, as amended by that certain First Amendment to Amended and Restated Credit Agreement dated as of March 30, 1994 (the \"First Amendment\")[collectively the \"Credit Agreement\"], and the other agreements, documents and instruments referenced therein or executed and delivered pursuant thereto;\n\tWHEREAS, the Company has requested, among other things, that the Banks, the Agent and the Collateral Agent waive certain defaults pursuant to the Credit Agreement, extend the maturity date from April 1, 1995, to July 1, 1995 thereunder, and amend certain other provisions contained in the Credit Agreement; and\n\tWHEREAS, the Banks, the Agent and the Collateral Agent are willing to waive certain defaults pursuant to the Credit Agreement, extend the maturity date from April 1, 1995, to July 1, 1995 thereunder, and amend certain other provisions contained in the Credit Agreement, but solely on the terms and subject to the conditions set forth in this Second Amendment.\n\tNOW, THEREFORE, in consideration of the foregoing, the mutual promises and understandings of the parties hereto set forth herein, and other good and valuable consideration, the receipt and sufficiency of which consideration is hereby acknowledged, the parties hereto hereby agree as set forth in this Second Amendment.\n\t1. Terms. All terms which have an initial capital letter in this Second Amendment where not required by the rules of grammar, and are not defined herein, are defined in the Credit Agreement.\n\t2. Termination Date. The definition of \"Termination Date\" in Section 1.1 of the Credit Agreement is hereby amended by deleting the definition of \"Termination Date\" in its entirety and substituting therefor the following:\n\t\t\"\"Termination Date\" shall mean July 1, 1995, provided that the \"Initial Equity Infusion\" (hereinafter defined), has been completed on or before April 17, 1995. If the Commitment is terminated prior to such date in accordance with Sections 3.5 or 9.2 hereof, then the Termination Date shall be such earlier date on which the Commitment terminates.\"\n\t3. Tangible Net Worth. Section 6.13 of the Credit Agreement is hereby amended by deleting the Applicable Minimum TNW for the Time Period commencing upon the earlier to occur of (A) the Initial Equity Infusion, or (B) April 17, 1995, and at all times thereafter, and substituting therefor the following:\n\t \"Time Period Applicable Minimum TNW\nUpon the earlier to occur of (i) 95% of the actual Tangible Net Worth of the Initial Equity Infusion, or the Company and its subsidiaries as of (ii) April 17, 1995, and at all times March 31, 1995, plus (i) the aggregate thereafter amount of the Equity Infusion, from time \t\t\t\t\tto time, excluding the reasonable costs \t\t\t\t\tand expenses incurred in connection \t\t\t\t\ttherewith, and (ii) 90% of the aggregate \t\t\t\t\tnet income, to the extent that it is a \t\t\t\t\tpositive number, for all fiscal months \t\t\t\t\tthereafter\"\n\t4. Current Ratio. Section 6.15 of the Credit Agreement is hereby amended by deleting Section 6.15 in its entirety and substituting therefor the following:\n\t\t\"6.15 Current Ratio. Not permit the ratio of current assets (less deferred taxes) to current liabilities, including income taxes currently payable (less deferred taxes) to be less than (a) at any time from March 30, 1994, through and including December 31, 1994, 1.15:1, (b) from January 1, 1995, through and including the earlier to occur of (i) the date immediately preceding the Initial Equity Infusion, or (ii) April 16, 1995, 1.10:1, and (c) from the earlier to occur of (i) the date of the Initial Equity Infusion, or (ii) April 17, 1995, through the Termination Date, 1:25:1.\"\n\t5. Inventory Cap. Section 6.27(a)(x)(A) of the Credit Agreement is hereby amended by deleting the phrase in Section 6.27(a)(x)(A) \"shall in no event exceed $13,000,000.00\" in its entirety and substituting therefor \"shall not at any time on and after the earlier to occur of (i) the Initial Equity Infusion, or (ii) April 17, 1995, exceed $9,000,000.00\".\n\t6. Applicable Eligible Inventory Percentage. Section 6.27(b) of the Credit Agreement is hereby amended by deleting Section (z) from the definition of \"Applicable Eligible Inventory Percentage\" in Section 6.27(b) of the Credit Agreement and substituting therefor the following:\n\t\t\"(z) from and after January 1, 1995, through and including the earlier to occur of (i) the date immediately preceding the Initial Equity Infusion, or (ii) April 16, 1995, thirty-five percent (35%), and (aa) from the earlier to occur of (i) the date of the Initial Equity Infusion, or (ii) April 17, 1995, through the Termination Date, twenty-five percent (25%).\"\n\t7. Eligible Accounts. The definition of \"Eligible Accounts\" in Section 6.27(b) of the Credit Agreement is hereby amended by deleting the reference in Section (f)(ii) to \"360\" in its entirety from the definition of \"Eligible Accounts\" and substituting therefor \"120\".\n\t8. Applicable Leverage Percentage. Section 6.29 of the Credit Agreement is hereby amended by deleting the Applicable Leverage Percentage for the Time Period commencing upon the earlier to occur of (A) the Initial Equity Infusion, or (B) April 17, 1995, and at all times thereafter, and substituting therefor the following:\n\t\"Time Period Applicable Leverage Percentage\n\tUpon the earlier to occur of (i) 190%\" \tthe Initial Equity Infusion, or \t(ii) April 17, 1995, and at all times \tthereafter\n\t9. Event of Default. Section 9.1 of the Credit Agreement is hereby amended by adding a Section 9.1(n) as follows:\n\t\t\"(n) \tthe Initial Equity Infusion has not been completed on or before April 17, 1995.\"\n\t10. Default.\n\t\tA. The Company has informed the Banks, the Agent and the Collateral Agent that (1) for the fiscal year ending January 1, 1995, the Company was in default of the financial covenants set forth in Sections 6.13, 6.14 and 6.29 of the Credit Agreement, and for the period January 29, 1995, through and including April 1, 1995, the Company is and will continue to be in default of the financial covenants set forth in Sections 6.13, 6.14, 6.15 and 6.29 of the Credit Agreement (collectively the \"Financial Covenant Defaults\"), and (2) pursuant to that certain Preferred Stock Purchase Agreement dated as of March 23, 1995, by and between the Company and RGP Holdings, Inc. (\"RGP\")[the \"Stock Agreement\"], RGP desires to contribute to the capital of the Company on or before April 17, 1995, the amount of Five Million One and no\/100 Dollars ($5,000,001.00), in exchange for the issuance of 9% Redeemable Cumulative Convertible Voting Preferred Stock of the Company (\"Initial Equity Infusion\"), and the Company may also offer to issue additional common shares to its existing shareholders for cash pursuant to Section 6.5 of the Stock Agreement (the \"Additional Equity Infusion\"; the Initial Equity Infusion, together with the Additional Equity Infusion is collectively the \"Equity Infusion\").\n\t\tB. The Company desires the Banks, the Agent and the Collateral Agent to, and the Banks, the Agent and the Collateral Agent hereby waive the Company's Financial Covenant Defaults. The Company further desires the Banks, the Agent and the Collateral Agent to, and the Banks, the Agent and the Collateral Agent hereby consent to the Equity Infusion pursuant to the terms of the Stock Agreement. The Company represents and warrants to the Banks, the Agent and the Collateral Agent that, upon the occurrence of the Equity Infusion, the Company will also be in default of Section 9.1(i) of the Credit Agreement (\"Change of Control Default\"). Accordingly, the Company desires the Banks, the Agent and the Collateral Agent to, and the Banks, the Agent and the Collateral Agent hereby waive the Change in Control Default resulting pursuant to the terms of the Stock Agreement. The Banks, the Agent and the Collateral Agent consent to the execution by the Company of the Stock Agreement and performance of its obligations thereunder; provided, however, nothing contained herein shall be deemed a waiver by the Banks, the Agent or the Collateral Agent of any of their rights or remedies pursuant to the Credit Agreement or the other agreements, documents and instruments referenced therein or executed and delivered pursuant thereto or a consent to the redemption of any common or preferred stock of the Company pursuant to the Stock Agreement or any of the agreements or documents contemplated thereby, except as provided in Section 6.5(b) of the Stock Agreement.\n\t\tC. The waiver set forth in Section 10B of this Second Amendment shall not be or be deemed (i) an amendment or modification of any terms or conditions of the Credit Agreement or any of the agreements, instruments or documents referenced in the Credit Agreement or executed and delivered pursuant thereto, (ii) a waiver by the Banks, the Agent or the Collateral Agent of any \"Event of Default\" or \"Unmatured Event of Default\" as defined in the Credit Agreement, other than the Financial Covenant Defaults and the Change of Control Default as described in Section 10B of this Second Amendment, (iii) a waiver of any continuation or reoccurrence of the Company's Financial Covenant Defaults or the Change of Control Default described in Section 10B of this Second Amendment, or (iv) except for the waiver set forth in Section 10B, to affect or waive any of the Banks', the Agent's or the Collateral Agent's rights or remedies pursuant to the Credit Agreement, any of the agreements, instruments or documents referenced in the Credit Agreement or executed and delivered pursuant thereto, at law, in equity or otherwise.\n\t\tD. The Company represents, warrants and covenants unto the Banks, the Agent and the Collateral Agent that (1) none of the Company's common stock or the preferred stock whether issued to RGP or any other person or entity pursuant to the Stock Agreement or otherwise will be redeemed by the Company for cash, except as provided in Section 6.5(b) of the Stock Agreement, and (2) the Company will not declare or make any cash distributions, dividends or other payments in connection with the Company's common or preferred stock, whether issued pursuant to the Stock Agreement or otherwise, or set aside any funds for such purpose.\n\t11. Authority. The Company represents and warrants to the Banks, the Agent and the Collateral Agent that (a) it has obtained all necessary consents to enter into, execute, deliver and perform this Second Amendment, including, but not limited to, resolutions of the Executive Committee of the Board of Directors' of the Company, (b) the Company has the right, power and capacity and is duly authorized and empowered to enter into, execute, deliver and perform this Second Amendment, and (c) the execution and delivery of this Second Amendment shall not breach any agreement, instrument or document to which the Company is a party or by which it is bound.\n\t\n\t12. Fees. Contemporaneously with the execution and delivery of this Second Amendment, the Company shall:\n\t\n\t\t(a) in addition to any other costs, fees and expenses which may be due and owing to the Banks pursuant to the Credit Agreement, pay to LaSalle an extension fee in the amount of Ten Thousand and no\/100 Dollars ($10,000.00) [the \"Extension Fee\"]. LaSalle shall remit the Extension Fee to each Bank in accordance with each Bank's Percentage Share;\n\t\t(b) in addition to any other costs, fees and expenses which may be due and owing to the Agent and the Collateral Agent pursuant to the Credit Agreement, pay to LaSalle, in its capacity as Agent and Collateral Agent, a fee in the amount of Six Thousand Two Hundred Fifty and no\/100 Dollars ($6,250.00) for LaSalle to retain; and\n\t\t(c) execute and deliver a Secretary's Certificate as to Officers and Directors and Directors' Resolutions in the form attached hereto as Exhibit \"A\" authorizing the execution and delivery by the Company of this Second Amendment and the transactions evidenced herein, together with a certified copy of the resolution establishing the Executive Committee and setting forth its powers and certifying that such resolution has not been modified, amended or rescinded in any way and is in full force and effect.\n\t13. Exhibit. The Exhibit described in this Second Amendment is attached hereto, made a part hereof and incorporated herein by this reference thereto.\n\t14. Commitment. The amount of each Bank's Commitment and Percentage Share appearing on page 8 of the Credit Agreement, as amended by the First Amendment, are hereby amended by deleting such amounts and percentages in their entirety and substituting therefor the amounts and percentages set forth next to the signature lines appearing on this Second Amendment.\n\t15. Conflict of Terms. If, and to the extent, the terms and provisions of this Second Amendment contradict or conflict with the terms and provisions of the Credit Agreement, the terms and provisions of this Second Amendment will govern and control; provided, however, to the extent that the terms and provisions of this Second Amendment do not contradict or conflict with the terms and provisions of the Credit Agreement, the Credit Agreement, as amended by this Second Amendment, shall remain in and have its intended full force and effect, and the parties hereto hereby affirm, confirm and ratify the same.\nIN WITNESS WHEREOF, the parties have caused this Second Amendment to be executed and delivered by their duly authorized officers as of the date first set forth above.\n\t\t\t\t\t\t CHAMPION PARTS, INC., an \t\t\t\t\t\t Illinois corporation\n\t\t\t\t\t\t\t\t\t\t\t\n\t\t\t\t\t\t By: _________________\n\t\t\t\t\t\t Title: _________________\nAmount of Percentage LA SALLE NATIONAL BANK, Commitment Share individually, as Agent \t\t\t\t\t\t\tand as Collateral Agent\n\t\t\t\t\t\t\t\t\t\t\n$11,870,967.69, 51.612903% By: _________________\nless an amount equal Title: _________________ to the product of (i) the aggregate amount of the Equity Infusion from time to time, multiplied by (ii) each Bank's Percentage Share of the amount of the Equity Infusion\nAmount of Percentage NBD BANK Commitment Share\n$6,677,419.34, 29.032258% By: _________________\nless an amount equal Title: _________________ to the product of (i) the aggregate amount of the Equity Infusion from time to time, multiplied by (ii) each Bank's Percentage Share of the amount of the Equity Infusion\nAmount of Percentage HARRIS TRUST AND Commitment Share SAVINGS BANK, an \t\t\t\t\t\t Illinois corporation\n\t\t\t\t\t\t\t\t\n$4,451,612.97, 19.354839% By: _________________\nless an amount equal Title: _________________ to the product of (i) the aggregate amount of the Equity Infusion from time to time, multiplied by (ii) each Bank's Percentage Share of the amount of the Equity Infusion\n\t\t\t\t\t\t\nTotal Commitments\n$23,000,000.00,\nless an amount equal to the product of (i) the aggregate amount of the Equity Infusion from time to time, multiplied by (ii) each Bank's Percentage Share of the amount of the Equity Infusion\nEXHIBIT \"A\"\nSECRETARY'S CERTIFICATE AS TO OFFICERS AND\nDIRECTORS AND DIRECTORS' RESOLUTIONS\n\tI, Thomas W. Blashill, do hereby certify that:\n\t1. I am the duly elected, qualified and acting Secretary of Champion Parts, Inc., a corporation duly organized, existing and in good standing under the laws of the State of Illinois (the \"Company\").\n\t2. I am the keeper of the corporate records of the Company.\n\t3. The following named persons are present officers and directors of the Company, each duly elected, qualified and acting as such:\n\t\tDonald G. Santucci President\n\t\tThomas W. Blashill Executive Vice President\n\t\tRoger Wilson Vice President\n\t\tThomas W. Blashill Secretary\n\t\tThomas W. Blashill Treasurer\n\t\tDonald G. Santucci Director*\n\t\tThomas W. Blashill Director\n\t\tCalvin A. Campbell, Jr. Director\n\t\tJohn R. Gross Director\n\t\tRaymond F. Gross Director*\n\t\tGary S. Hopmayer Director\n\t\tBarry L. Katz Director\n\t\tEdward R. Kipling Director*\n\t\tRaymond G. Perelman Director*\n\t\t* Member of Executive Committee\n\t4. The following is a full, true and correct copy of resolutions, unanimously adopted pursuant to the written consent of the Executive Committee of the Board of Directors, executed in accordance with the Company's Articles of Incorporation, By-Laws and all other applicable laws, and which resolutions have not in any way been modified, amended or rescinded, but are in full force and effect as of the date hereof:\n\t\tRESOLVED, that the President or the Executive Vice President, or any other person from time to time designated by either of them in writing (collectively the \"Designated Persons\") are hereby authorized, directed and empowered now and from time to time hereafter to make, execute and deliver for, by, on behalf of and in the name of the Company to LaSalle National Bank, a national banking association (\"LaSalle\"), as successor to both Exchange National Bank of Chicago (\"Exchange\") and American National Bank and Trust Company of Chicago (\"ANB\"), NBD Bank (\"NBD\"), and Harris Trust and Savings Bank, an Illinois banking corporation (\"Harris\")[LaSalle, NBD and Harris are each a \"Bank\" and collectively, together with their respective successors and permitted assigns, the \"Banks\"], and LaSalle, in its capacity as both Collateral Agent and Agent, such documents, instruments and agreements, including, but not limited to, that certain Second Amendment to Amended and Restated Secured Credit Agreement and any other documents, instruments and agreements executed and delivered pursuant thereto, including any amendments, renewals, substitutions, extensions or modifications thereto (collectively the \"Loan Documents\"), as they may in their sole discretion deem advisable, necessary, expedient, convenient or proper, providing for and evidencing various loans, extensions of credit and other financial accommodations by the Banks to the Company.\n\t\tRESOLVED, that the Loan Documents may contain such provisions, terms, conditions, covenants, representations and warranties as such Designated Persons may, in their sole discretion, deem advisable, necessary, expedient, convenient or proper.\n\t\tRESOLVED, that the Designated Persons are authorized, in the name and on behalf of the Company, to do all other acts and execute and deliver such other agreements as the Designated Persons, in their sole discretion, determine to be necessary or required in order to consummate fully, carry out and perform the transactions contemplated under the Loan Documents, these resolutions and any other document, instrument or agreement executed and delivered pursuant thereto or in connection with the Loan Documents.\n\t\tRESOLVED, that the Designated Persons, in their sole discretion, are authorized, directed and empowered to make, execute and deliver, in the name and on behalf of the Company, from time to time, amendments, renewals, substitutions, extensions or modifications of any or all documents delivered to the Banks and LaSalle, in its capacity as both Collateral Agent and Agent.\n\t\tRESOLVED, that the acts of any person or Designated Persons on behalf of the Company, with respect to the Loan Documents, these resolutions and all documents, instruments and agreements, written or oral, of any and every kind, nature or description whatsoever, heretofore executed and delivered by the Company to the Banks and LaSalle, in its capacity as both Collateral Agent and Agent, are hereby fully ratified, approved, adopted, confirmed and declared to be and represent binding obligations of the Company in accordance with the respective terms and provisions thereof.\n\t\tRESOLVED, that the authorizations herein set forth shall remain in full force and effect until written notice of their modification or discontinuance shall be given by certified mail, return receipt requested, and received by the Banks and LaSalle, in its capacity as both Collateral Agent and Agent, at 120 South LaSalle Street, Chicago, Illinois 60604, Attention: Mr. Thomas J. Bieke, but no such modification or discontinuance shall affect the validity of the acts of any Designated Persons or any other person authorized to so act by these resolutions which have been performed prior to the receipt of such notice by the Banks.\n\t\tRESOLVED, that the Secretary of the Company is hereby authorized to furnish the Banks and LaSalle, in its capacity as both Collateral Agent and Agent, a copy of these resolutions and to certify their authenticity.\nI further certify that there is no provision in the Articles of Incorporation or By-Laws of the Company limiting the power of the Executive Committee to pass the foregoing resolutions, that the same are in conformity with the provisions of said Articles of Incorporation and By-Laws, and that no shareholder consent is required to permit the actions taken in such resolutions.\n\tIN WITNESS WHEREOF, I have hereunto subscribed my name as the Secretary of the Company as of March __, 1995.\n\t\t\t\t\t\t\t\t\n(CORPORATE SEAL) _____________________________\n\t\t\t\t\t Thomas W. Blashill, Secretary","section_15":""}
{"filename":"789864_1995.txt","cik":"789864","year":"1995","section_1":"Item 1. Business\n(a) General development of business\nThe Futures Dimension Fund (the \"Partnership\") is a limited partnership organized on January 31, 1986, pursuant to a Limited Partnership Agreement (the \"Limited Partnership Agreement\") and under the Uniform Limited Partnership Act of the State of Illinois, and funded through an offering of Limited Partnership Assignee Units (the \"Units\"). On July 31, 1987, the Partnership elected to be governed under the Illinois Revised Uniform Limited Partnership Act. Each Unit represents the assignment of one unit of limited partnership interest in the Partnership. Limited Partners and holders of Limited Partnership Assignee Units are collectively referred to herein as \"Unitholders.\" The Partnership engages in speculative trading of futures and forward contracts under the direction of multiple trading advisors.\nThe public offering resulted in the sale of 1,001,410 Units and trading began on June 18, 1986. The offering was registered under the Securities Act of 1933, as amended, and Merrill Lynch, Pierce, Fenner & Smith Incorporated (the \"Selling Agent\") acted as the selling agent.\nHeinold Asset Management, Inc., a Delaware corporation, is the General Partner of the Partnership (the \"General Partner\") and performs various administrative services for the Partnership. The General Partner was organized in 1982 to serve as the general partner and pool operator for public and private commodity pools sponsored by Heinold Commodities, Inc. The General Partner is a wholly owned subsidiary of Geldermann, Inc., an Illinois corporation (\"Geldermann\"). Until December 12, 1994, Geldermann was an independent operating subsidiary of ConAgra, Inc., a Delaware corporation with headquarters in Omaha, Nebraska. On that date, Geldermann was acquired by E. D. & F. Man International Inc. (formerly known as E. D. & F. Man International Futures Inc.), a New York corporation with headquarters in New York, New York.\nUntil June 1, 1995, Geldermann acted as the Partnership's futures commission merchant or commodity broker. On that date, E.D. & F. Man International, Inc. (the \"Commodity Broker\") replaced Geldermann as the Partnership's commodity broker. The General Partner and the Commodity Broker perform various services related to the Partnership's Limited Partnership Agreement and customer agreement with the Commodity Broker. References to the \"Commodity Broker\" refer to Geldermann, Inc. for the period prior to June 1, 1995 and to E.D. & F. Man International Inc. for the period on and after June 1, 1995.\nThe General Partner invested $987,000 in the Partnership at the outset of trading; after reflecting redemptions of $500,159, $271,597, $71,116, $330,991 and $83,490 on September 1, 1987, July 1, 1988, October 1, 1988, September 1, 1991 and September 30, 1994, respectively, this investment was worth $99,770 as of December 31, 1995.\nUnder the terms of the Customer Agreement, the Partnership will not pay brokerage commissions on the basis of the number of trades made on its behalf, but will instead pay the Commodity Broker a monthly brokerage fee of 0.8333% of the Partnership's month-end Net Assets, as defined, (a 10% annual rate).\nFrom inception until March 1, 1994, the Partnership's trading manager was Commodities Corporation (U.S.A.) N.V. (the \"Initial Trading Manager\"), a corporation formed under the laws of the Netherlands Antilles in June 1983, and a wholly-owned subsidiary of Commodities Corporation, originally a Delaware corporation formed in 1969 and reincorporated under the laws of the Cayman Islands in 1980. Neither Commodities Corporation nor the Initial Trading Manager is affiliated with the General Partner, the Commodity Broker or the Selling Agent. The Initial Trading Manager provided futures and forward trading advice to the Partnership pursuant to a management contract which was terminated, upon the resignation of the Initial Trading Manager, effective March 1, 1994.\nPursuant to a trading manager agreement with the Partnership (the \"Management Agreement\"), the General Partner assumed the duties of the trading manager of the Partnership effective March 1, 1994 (the \"Trading Manager\"). Under the terms of the Management Agreement, the Trading Manager's duties include, among other things, selecting, hiring, monitoring and replacing trading advisors, allocating and reallocating assets among the trading advisors and terminating and engaging additional or replacement trading advisors.\nThe Partnership's assets were initially allocated among nine different Trading Advisors (the \"Initial Trading Advisors\"), selected by the General Partner on the recommendation of the Initial Trading Manager. One of the Initial Trading Advisors, I.C.S.C., Inc., ceased trading on behalf of the Partnership during 1987 and the Partnership added a new trading advisor, Tiverton Trading Incorporated, on November 1, 1987. Until March 1, 1994, five trading advisors traded on behalf of the Partnership: Blenheim Investments, Inc.; Knightsbridge Capital Management; Mark J. Walsh & Co.; Princeton Paris Research Corporation; and Reynwood Trading Corporation. The Initial Trading Manager terminated the Advisory Agreements with the above-referenced trading advisors effective February 28, 1994.\nHeinold Asset Management, Inc., the Trading Manager, retained ARA Portfolio Management Company (\"ARA\"), LaSalle Portfolio Management, Inc.(\"LaSalle\"), Sunrise Capital Management Inc. (\"Sunrise\") and Welton Investment Systems Corporation (\"Welton\"), effective March 7, 1994, March 8, 1994, March 7, 1994 and March 1, 1994, respectively, to act as the trading advisors for the Partnership. On June 6, 1994, Parthenon Futures Management, Inc. (\"Parthenon\") and Michael Tym, Jr. (\"Tym\") were retained as trading advisors for the Partnership. The Advisory Agreement with Welton was terminated on September 15, 1994 and Lawless Commodities, Inc. (\"Lawless\") was retained as a trading advisor effective January 24, 1995.\nOn February 28, 1995, the Trading Manager terminated the Advisory Agreements with ARA, LaSalle, Sunrise, Parthenon and Lawless. On March 10, 1995, the Trading Manager retained Sabre Fund Management Limited (\"Sabre\"), Telesis Management, Inc. (\"Telesis\"), Gandon Fund Management, Ltd. (\"Gandon\") and First October Trading Company, Inc. (\"First October\") to trade on behalf of the Partnership. The Advisory Agreements with Sabre and First October were terminated on July 31, 1995 and September 30, 1995, respectively. The Advisory Agreements with Telesis, Tym and Gandon were terminated on October 31, 1995.\nOn November 1, 1995, the Trading Manager entered into Management Contracts with Hyman, Beck & Company, Inc., Marathon Capital Growth Partners, L.L.C., RXR, Inc. and Willowbridge Associates, Inc. These four trading advisors are collectively referred to herein as the \"Trading Advisors.\"\nThe Initial Trading Manager, which itself did not direct any trading on behalf of the Partnership, advised the General Partner on the selection of the Initial Trading Advisors and, among other things, monitored the performance of the trading advisors and consulted with the General Partner in reviewing certain aspects of the Trading Advisors' performance through February 28, 1994. The Initial Trading Manager was responsible for providing satisfactory replacement trading advisors throughout the term of the management contract, should a replacement be required. The Trading Advisors are each allocated a percentage of the Partnership's assets for trading. The General Partner intends at all times to retain multiple trading advisors for the Partnership that, collectively, will trade a diverse group of futures and forward contracts pursuant to a mixture of systematic and discretionary trading approaches and technical and fundamental analyses.\nThe Initial Trading Manager purchased 500 Units prior to the time the Partnership commenced trading, which it agreed not to redeem so long as it acted as the Initial Trading Manager. These Units, valued at $84,720, were redeemed on March 1, 1994.\nPrior to March 1, 1994, the Partnership paid the Initial Trading Manager: (i) a monthly management fee of 1\/2 of 1% of the month-end Net Assets (as defined in the Limited Partnership Agreement, subject to certain adjustments) of the Partnership; and (ii) a quarterly incentive fee of 20% of New Appreciation, as defined in the management contract, as of the end of each calendar quarter. The Partnership paid no fees to the trading advisors, who were compensated solely by the Initial Trading Manager.\nEffective March 1, 1994, each Trading Advisor is paid a management and incentive fee by the Partnership at the rates negotiated at arm's-length on behalf of the Partnership by the Trading Manager. At December 31, 1995, each Trading Advisor receives: (i) a monthly management fee equal to 0.167 of 1% (a 2% annual rate) of the month-end Net Assets of the Partnership allocated to the management of the trading advisors; and (ii) a quarterly incentive fee equal to 20% of any new trading profit, as defined in the Advisory Agreement with each of the Trading Advisors, recognized with respect to the assets of the Partnership allocated to each of the\nTrading Advisors. The Trading Manager will receive no compensation for its services to the Partnership.\nRegulation\nUnder the Commodity Exchange Act, as amended (the \"Act\"), futures exchanges and futures trading are subject to regulation by the Commodity Futures Trading Commission (the \"CFTC\"). The National Futures Association (\"NFA\"), a \"registered futures association\" under the Act, is the only non-exchange self-regulatory organization for futures industry professionals. The CFTC has delegated to the NFA responsibility for the registration of \"commodity trading advisors,\" \"commodity pool operators,\" \"futures commission merchants,\" \"introducing brokers\" and their respective associated persons and \"floor brokers.\" The Act requires \"commodity pool operators,\" such as the General Partner, \"commodity trading advisors,\" such as the Trading Advisors, and commodity brokers or a \"futures commission merchant,\" such as the Commodity Broker, to be registered and to comply with various reporting and record keeping requirements. The General Partner, the Trading Advisors and the Commodity Broker are all members of NFA. The CFTC may suspend a commodity pool operator's or commodity trading advisor's registration if it finds that its trading practices tend to disrupt orderly market conditions or in certain other situations. In the event that the registration of the General Partner as a commodity pool operator or any of the Trading Advisors' registration as commodity trading advisors were terminated or suspended, the General Partner and any of the Trading Advisors, respectively, would be unable to continue to manage the business of the Partnership. Should the General Partner's registration be suspended, termination of the Partnership might result.\nAs members of NFA, the General Partner, the Trading Advisors and the Commodity Broker are subject to NFA standards relating to fair trade practices, financial condition and customer protection. As the self-regulatory body of the futures industry, the NFA promulgates rules governing the conduct of futures industry professionals and disciplines those professionals which do not comply with such standards.\nIn addition to such registration requirements, the CFTC and certain futures exchanges have established limits on the maximum net long or net short position which any person may hold or control in particular commodities. The CFTC has adopted a rule requiring all domestic futures exchanges to submit for approval speculative position limits for all futures contracts traded on such exchanges. Many exchanges also limit the changes in futures contract prices that may occur during a single trading day. The Partnership may trade on foreign commodity exchanges which are not subject to regulation by any United States government agency.\n(b) Financial information about industry segments\nThe Partnership's business constitutes only one segment, speculative trading of futures and forward contracts, for financial reporting purposes. The Partnership does not engage in sales of goods and services. The Partnership's revenue, operating results and total assets for each of the five fiscal years in the period ended December 31, 1995 are set forth under \"Item 6. Selected Financial Data.\"\n(c) Narrative description of business\n(1) See Items 1(a) and (b) above.\n(i) through (xii) - not applicable.\n(xiii) - the Partnership has no employees.\n(d) Financial information about foreign and domestic operations and export sales\nThe Partnership does not engage in sales of goods or services. See \"Item 1(b). Business - Financial information about industry segments.\"\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Partnership does not own any properties. Under the terms of the Limited Partnership Agreement, the General Partner performs the following services for the Partnership:\n(1) Manages the business of the Partnership. Pursuant to this authority, the General Partner, as Trading Manager, has entered into a Management Agreement with the Partnership (under which the Trading Advisors have complete discretion with respect to determination of the Partnership's trading decisions pursuant to the Advisory Agreement between each Trading Advisor and the Partnership) and a Customer Agreement with the Commodity Broker (pursuant to which the Commodity Broker executes all trades on behalf of the Partnership based on the instructions of the Partnership's Trading Advisors).\n(2) Maintains the Partnership's books and records, which Unitholders or their duly authorized representatives may inspect during normal business hours for any proper purpose upon reasonable written notice to the General Partner.\n(3) Furnishes each Unitholder with a monthly statement describing the performance of the Partnership, which sets forth aggregate management fees, incentive fees, brokerage commissions and other expenses incurred or accrued by the Partnership during the month.\n(4) Forwards annual audited financial statements (including a statement of financial condition and statement of operations) to each Unitholder.\n(5) Provides to each Unitholder tax information necessary for the preparation of his annual federal income tax return and such other information as the CFTC may by regulation require.\n(6) Performs secretarial and other clerical responsibilities and furnishes office space, equipment and supplies as may be necessary for supervising the affairs of the Partnership.\n(7) Administers the redemption of Units.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe General Partner is not aware of any pending legal proceedings to which the Partnership is a party or to which any of its property is subject. In addition, there are no pending legal proceedings involving the General Partner or the Commodity Broker.\nIn the ordinary course of its business, Geldermann is involved in numerous legal actions, some of which seek substantial damages. In view of the number and diversity of the claims, the number of jurisdictions involved, and the inherent difficulty of predicting the outcome of litigation, Geldermann cannot state what the eventual outcome of these pending claims will be. As a matter of policy, Geldermann vigorously defends civil litigation, reparations or arbitration proceedings pending against it, and in all proceedings currently so pending believes it has defenses which are factually and legally sound. Geldermann is contesting the allegations of each complaint and believes that there are meritorious defenses in most of the lawsuits.\nAlthough the CFTC's staff's interpretation that any matter filed by the CFTC against a registrant is, on its face (even though it has not been litigated), material litigation which has to be disclosed, Geldermann takes exception to this. Notwithstanding the preceding, Geldermann herewith discloses a CFTC Enforcement Action titled In the Matter of Thomas Collins, et al., CFTC Docket No. 94-13.\nThe Complaint in this case alleges that Geldermann, in 1986, carried and cleared accounts in joint tenancy for a Mid-America local floor trader and\/or ten individuals with whom the floor trader maintained a separate joint account with each of the ten individuals. None of the afore-mentioned persons were ever employees of Geldermann. Geldermann's function was only that of clearing broker. Over a period of approximately four years, at the direction of the account holder(s), Geldermann transferred certain positions amongst and between the accounts. It is those transfers that the CFTC is alleging are non-competitive, fictitious transactions. The CFTC's complaint also alleges that Geldermann failed to properly supervise the employees who accepted the transfer instructions from the account holder(s). Geldermann takes exception to the CFTC's allegation and is vigorously defending 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 Registrant's Common Equity and Related Stockholder Matters\n(a) Market Information\nThere is no trading market for the Units, and none is likely to develop. They are transferable only after written notice has been given to and approved by the General Partner. Units may be redeemed as of the first day of any month after the Partnership commences trading, upon ten days' written notice at their Net Asset Value (as defined in the Limited Partnership Agreement) as of the end of the immediately preceding month, without redemption charge or penalty, as provided in the Limited Partnership Agreement. In the event that all Units for which redemption is requested cannot be redeemed as of any redemption date, Units of limited partners will be redeemed in the order that requests for redemption have been received by the General Partner.\n(b) Holders\nAs of January 1, 1996, there were 365 holders of Units.\n(c) Dividends\nNo distributions or dividends have been made on the Units, and the General Partner has no present intention to make any.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe following is a summary of operations and total assets of the Partnership for each of the five fiscal years in the period ended December 31, 1995.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nReference is made to \"Item 6. Selected Financial Data\" and \"Item 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nFinancial statements are listed on page F-l of this report.\nThe supplementary financial information specified by Item 302 of Regulation S-K 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 Partnership has no directors or executive officers. The Partnership is managed by its General Partner. There are no \"significant employees\" of the Partnership. Trading decisions for the Partnership are made by the Trading Advisors and monitored by the Trading Manager.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe Partnership has no directors or officers. The General Partner performs the services described in \"Item 2. Properties\" herein. The Commodity Broker acts as the Partnership's commodity broker pursuant to the Customer Agreement described in \"Item l(a). Business - General development of business.\"\nThe General Partner will participate in any appreciation in the net assets of the Partnership in proportion to its investment in it.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\n(a) Security ownership of certain beneficial owners\nThe Partnership knows of no person who owns beneficially more than 5% of the Units.\n(b) Security ownership of management\nUnder the terms of the Limited Partnership Agreement, the Partnership's affairs are managed by the General Partner and the Trading Advisors have discretionary authority over the Partnership's futures and forward trading, which is monitored by the General Partner as Trading Manager. The General Partner owned 611 Unit-equivalents valued at $99,770 as of December 31, 1996, 1.8% of the Partnership's total equity.\n(c) Changes in control\nNone.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nSee \"Item 11. Executive Compensation\" and \"Item 12. Security Ownership of Certain Beneficial Owners and Management.\"\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\n(a)(1) Financial Statements\nSee Index to Financial Statements, infra.\n(a)(2) Financial Statement Schedules\nAll Schedules are omitted for the reason that they are not required, are not applicable, or because equivalent information has been included in the financial statements or the notes thereto.\n(a)(3) Exhibits as required by Item 601 of Regulation S-K\n(3) Articles of Incorporation and By-laws\na. Limited Partnership Agreement dated as of January 31, 1986, and amended as of April 1, 1986.\nb. Certificate of Limited Partnership of the Partnership as filed with the Cook County Recorder of Deeds on January 31, 1986.\nThe above exhibits are incorporated herein by reference from the Partnership's Registration Statement on Form S-1, file no. 33-3514.\n(10) Material Contracts\na. Customer Agreement between the Partnership and Geldermann.\nb. Management Contract between the Partnership, Commodities Corporation (U.S.A.) N.V. and the Trading Advisors.\nc. Assignment Agreement among the Partnership, the General Partner, Heinold Asset Management Service Corporation and each Unitholder.\nd. Guarantor and Net Worth undertaking of Commodities Corporation.\nThe above exhibits are incorporated herein by reference from the Partnership's Registration Statement on Form S-1, file no. 33-3514.\n(e) Trading Manager Agreement dated March 1, 1994 between Heinold Asset Management, Inc. and the Partnership.\n(f) Advisory Agreement dated March 7, 1994 between ARA Portfolio Management Company, the Trading Manager and the Partnership.\n(g) Advisory Agreement dated March 8, 1994 between LaSalle Portfolio Management, Inc., the Trading Manager and the Partnership.\n(h) Advisory Agreement dated March 7, 1994 between Sunrise Capital Management Inc., the Trading Manager and the Partnership.\n(i) Advisory Agreement dated February 22, 1994 between Welton Investment Systems Corporation, the Trading Manager and the Partnership.\nThe above exhibits are incorporated herein by reference from the Partnership's report on Form 10-K filed on March 30, 1994.\n(j) Advisory Agreement dated June 6, 1994 between Parthenon Futures Management, Inc., the Trading Manager and the Partnership.\n(k) Advisory Agreement dated June 6, 1994 between Michael Tym, Jr., the Trading Manager and the Partnership.\n(l) Advisory Agreement dated January 24, 1995 between Lawless Commodities, Inc., the Trading Manager and the Partnership.\nThe above exhibits are incorporated herein by reference from the Partnership's report on Form 10-K filed on March 30, 1995.\n(m) Advisory Agreement dated March 10, 1995 between the Partnership and First October Trading Company, Inc.\n(n) Advisory Agreement dated March 10, 1995 between the Partnership and Gandon Fund Management, Ltd.\n(o) Advisory Agreement dated March 10, 1995 between the Partnership and Telesis Management, Inc.\n(p) Advisory Agreement dated March 10, 1995 between the Partnership and Michael Tym, Jr.\n(q) Management Contract dated November 1, 1995 between the Partnership and Hyman, Beck & Company, Inc.\n(r) Management Contract dated November 1, 1995 between the Partnership and Marathon Capital Growth Partners, L.L.C.\n(s) Management Contract dated November 1, 1995 between the Partnership and RXR, Inc.\n(t) Management Contract dated November 1, 1995 between the Partnership and Willowbridge Associates Inc.\n(27) Financial Data Schedule\nThe above exhibits are filed herewith.\n(b) Reports on Form 8-K\nThe Partnership did not file a report on Form 8-K during the quarter ended December 31, 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, in the City of Chicago and State of Illinois on the 28th day of March, 1996.\nTHE FUTURES DIMENSION FUND\nBy HEINOLD ASSET MANAGEMENT, INC. General Partner\nBy \/s\/ Daniel E. Ragen -------------------------- Daniel E. Ragen 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 General Partner of the Registrant in the capacities and on the date indicated.\n(Being the principal executive officer, the principal financial and accounting officer, and a majority of the directors of Heinold Asset Management, Inc.)\nBy \/s\/ Daniel E. Ragen - ---------------------- Daniel E. Ragen President\nTHE FUTURES DIMENSION FUND (AN ILLINOIS LIMITED PARTNERSHIP) FINANCIAL STATEMENTS AS OF DECEMBER 31, 1995 AND 1994 AND FOR THE THREE YEARS ENDED DECEMBER 31, 1995 AND INDEPENDENT AUDITORS' REPORT\nTHE FUTURES DIMENSION FUND (AN ILLINOIS LIMITED PARTNERSHIP) PAGE\nINDEPENDENT AUDITORS' REPORT\nFINANCIAL STATEMENTS:\nStatements of Financial Condition as of December 31, 1995 and 1994\nStatements of Operations for the Years Ended December 31, 1995, 1994 and 1993\nStatements of Partners' Capital for the Years Ended December 31, 1995, 1994 and 1993\nStatements of Cash Flows for the Years Ended December 31, 1995, 1994 and 1993\nNotes to Financial Statements -\n[DELOITTE & TOUCHE LLP LETTERHEAD]\nINDEPENDENT AUDITORS' REPORT\nTo the General Partner and Limited Partners of The Futures Dimension Fund:\nWe have audited the accompanying statements of financial condition of The Futures Dimension Fund (an Illinois Limited Partnership, the \"Partnership\") as of December 31, 1995 and 1994, and the related statements of operations, partners' capital and cash flows for each of the three years in the period ended December 31, 1995. These financial statements are the responsibility of the Partnership's General Partner. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, 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 Futures Dimension Fund as of December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\n\/s\/ Deloitte & Touche LLP\nFebruary 9, 1996\nTHE FUTURES DIMENSION FUND (AN ILLINOIS LIMITED PARTNERSHIP)\nSTATEMENTS OF FINANCIAL CONDITION DECEMBER 31, 1995 AND 1994\nSee notes to financial statements.\nTHE FUTURES DIMENSION FUND (aN ILLINOIS LIMITED PARTNERSHIP)\nSTATEMENTS OF OPERATIONS YEARS ENDED DECEMBER 31, 1995, 1994, AND 1993\nSee notes to financial statements.\nTHE FUTURES DIMENSION FUND (aN ILLINOIS LIMITED PARTNERSHIP)\nSTATEMENTS OF PARTNERS' CAPITAL YEARS ENDED DECEMBER 31, 1995, 1994, AND 1993\nSee notes to financial statements.\nTHE FUTURES DIMENSION FUND (aN ILLINOIS LIMITED PARTNERSHIP)\nSTATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1995, 1994, AND 1993\nSee notes to financial statements.\nTHE FUTURES DIMENSION FUND (AN ILLINOIS LIMITED PARTNERSHIP)\nNOTES TO FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1995, 1994, AND 1993\n1. ORGANIZATION OF THE PARTNERSHIP\nThe Futures Dimension Fund (the \"Partnership\") was organized in January 1986, under the Illinois Uniform Limited Partnership Act (the \"Act\"), for purposes of engaging in speculative trading of primarily futures and forward contracts. Heinold Asset Management, Inc. (\"HAMI\"), a wholly owned subsidiary of Geldermann, Inc. (\"Geldermann\"), is the General Partner of the Partnership. On December 12, 1994, the parent of Geldermann, ConAgra, Inc., sold all of the common stock of Geldermann to E.D.& F. Man, International (\"Man\"). As a result, Geldermann and HAMI are wholly owned by Man.\nThe Partnership's funds held at Man, previously Geldermann, are in segregated accounts as required by the Commodity Exchange Act, as amended. These funds are used to meet minimum margin requirements for all of the Partnership's open positions, as set by the exchange upon which each futures contract is traded. These requirements are adjusted, as needed, due to daily fluctuations in the values of the underlying positions. If necessary, certain positions may be liquidated to satisfy resulting changes in margin requirements.\nThe Partnership has a brokerage contract with Man, previously Geldermann, which provides that the Partnership will pay a monthly brokerage fee of 0.8333% (10% annually) of the Partnership's month-end net asset value, plus NFA fees.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nREVENUE RECOGNITION - Futures and forward contracts are recorded on trade date and are reflected in the accompanying statements of financial condition at market value on the last business day of the reporting period. The difference between the original contract amount and the market value of the futures and forward contracts is reflected as the change in net unrealized appreciation. Market values of futures contracts are based upon exchange settlement prices. Market values of forward contracts are based upon quoted rates provided by major financial institutions.\nOPERATING EXPENSES - The Partnership bears all expenses incurred in connection with its activities. These include brokerage commissions, trading manager's management and incentive fees, and periodic legal, auditing, tax return preparation and filing fees. The General Partner bears all other operating expenses.\nINCOME TAXES - No provision for federal income taxes has been made in the accompanying financial statements since the net income (loss) of the Partnership is not taxable as such but is includable in the income tax returns of the individual partners.\nSTATEMENTS OF CASH FLOWS - For purposes of reporting cash flows for each of the three years ended December 31, 1995, cash includes only cash on deposit at financial institutions.\n3. FAIR VALUE AND OFF-BALANCE SHEET RISK\nThe Partnership trades both cash and derivative financial instruments. The Company's principal source of revenues by reporting category is as follows:\nThe Partnership was organized to engage in speculative trading of a diversified portfolio of futures and forward contracts and commodity options. SFAS 119, \"Disclosure About Derivative Financial Instruments and Fair Value of Financial Instruments,\" defines a derivative as a future, forward, swap or option contract, or other financial instruments with similar characteristics such as caps, floors and collars. Generally, these financial instruments represent future commitments to exchange interest payment streams or currencies or to purchase or to sell other financial instruments at specific terms at specified future dates. Option contracts provide the holder with the right, but not the obligation, to purchase or sell a financial instrument at a specific price before or on an established date. These financial instruments may have market and\/or credit risk in excess of amounts recorded in the Statements of Financial Condition.\nMARKET RISK - Derivative financial instruments involve varying degrees of off-balance sheet market risk whereby changes in the level or volatility of interest rates, foreign currency exchange rates or market values of the underlying financial instruments or commodities may result in changes in the value of the financial instrument in excess of the amounts currently reflected in the Statements of Financial Condition. The Partnership's exposure to market risk is influenced by a number of factors, including the relationships among financial instruments with off-balance sheet risk and between financial instruments with off-balance sheet risk and the Partnership's proprietary commodities, as well as the volatility and liquidity in the markets in which the financial instruments are traded.\nFAIR VALUE - The derivative instruments used in the Partnership's trading activities are marked to market daily with the resulting unrealized gains or losses recorded in the Statements of Financial Condition and the related income or loss reflected in revenues derived from these transactions. The fair value of derivative financial instruments held or issued for trading purposes as of December 31, 1995 and the average monthly fair value of the instruments for the fiscal year ended December 31, 1995 are as follows:\n4. LIMITED PARTNERSHIP AGREEMENT\nThe Limited Partnership Agreement (the \"Agreement\") provides for the following:\nALLOCATION OF PROFIT AND LOSS FOR PARTNERSHIP ACCOUNTING PURPOSES - The Limited Partners and the General Partner share in the profits and losses of the Partnership in proportion to the number of units or unit equivalents held by each. However, no Limited Partners are liable for obligations of the Partnership in excess of their capital contribution and profits, if any, and such other amounts for which they may be liable pursuant to the Act.\nDISTRIBUTIONS - Distributions (other than redemption of units) are made on a prorata basis at the sole discretion of the General Partner in accordance with the respective capital accounts of the partners. The General Partner has made no distributions from the Partnership to date.\nREDEMPTIONS - Limited Partners (or any assignee thereof) may cause any or all of their units to be redeemed as of the first of any month following 10 days' written request for redemption, subject to certain other conditions, as described in the Agreement. Redemption is at net asset value as of month-end.\nDISSOLUTION - The Partnership will be dissolved on December 31, 2006 unless preceded by a decline in the Partnership's aggregate net assets to less than $1,000,000 or upon the occurrence of certain future events, as specified in the Agreement.\n5. MANAGEMENT AGREEMENT\nThe Partnership enters into various advisory agreements (the \"Advisory Agreements\"). As of December 31, 1995, the Partnership's trading advisors are Hyman Beck & Co., Inc., RXR, Inc., Willowbridge Associates, Inc., and Marathon Capital Growth Partners.\nUnder the terms of the Advisory Agreements, the trading advisors have sole responsibility for determining futures trades for the Partnership. As compensation for these services, each trading advisor receives a monthly management fee equal to .166% (2% annually) of the Partnership's net asset value, as defined, as of the last day of each month and quarterly incentive fees of 20% of \"new trading profits,\" as defined, on their respective share of the Partnership's net asset value. Incentive fees are retained by the trading advisors even when \"trading losses,\" as defined, occur in subsequent quarters; however, no further incentive fees are payable until any such trading losses (other than those attributable to redeemed units) are recouped by the trading advisors.\n******\nTo the best of my knowledge and belief, the information in this statement is accurate and complete.\nHeinold Asset Management, Inc. (Pool Operator)\n\/s\/ Robert Ledvora - ---------------------------------------------------- Robert Ledvora Executive Vice-President and Chief Financial Officer\nTHE FUTURES DIMENSION FUND EXHIBIT INDEX\nExhibits Included Herein - --------------------------\n10(m) Advisory Agreement dated March 10, 1995 between the Partnership and First October Trading Company, Inc.\n10(n) Advisory Agreement dated March 10, 1995 between the Partnership and Gandon Fund Management, Ltd.\n10(o) Advisory Agreement dated March 10, 1995 between the Partnership and Telesis Management, Inc.\n10(p) Advisory Agreement dated March 10, 1995 between the Partnership and Michael Tym, Jr.\n10(q) Management Contract dated November 1, 1995 between the Partnership and Hyman, Beck & Company, Inc.\n10(r) Management Contract dated Nobember 1, 1995 between the Partnership and Marathon Capital Growth Partners, L.L.C.\n10(s) Management Contract dated November 1, 1995 between the Partnership and RXR Inc.\n10(t) Management Contract dated November 1, 1995 between the Partnership and Willowbridge Associates, Inc.\n27 Financial Data Schedule\nExhibits Incorporated Reference - --------------------------------\nSee pages 13-14 for a list of exhibits incorporated by reference.","section_15":""}
{"filename":"829282_1995.txt","cik":"829282","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is not involved in any material legal proceedings other than routine legal proceedings undertaken in the ordinary course of business. In the opinion of management, after consultation with counsel, the aggregate amount involved in such proceedings is not material to 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\nDuring the fourth quarter of 1995, there were no matters submitted to a vote of the shareholders of Center Banks.\nPART II.\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS\nThe information contained on the inside back cover of the Company's Annual Report to Shareholders for the year ended December 31, 1995 (the \"Annual Report\") and page 1 of the definitive Proxy Statement are incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nOther required information contained in the table on page 6 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 information contained in the section captioned \"Management's Discussion and Analysis of Financial Condition and Results of Operation\" in the Annual Report is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe consolidated financial statements contained in the 1995 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\nSection 16 of the Securities Exchange Act of 1934 (the \"Exchange Act\") requires the reporting to the Securities and Exchange Commission (the \"Commission\") within required time frames of transactions in Company common stock by insiders. All filings required under Section 16 of the Exchange Act during 1995 were filed on a timely basis, except for a Form 4 for J. David Hammond, Executive Vice President, which was filed late due to an oversight. In making these statements, the Company has relied on written representations of its incumbent executive officers and directors.\nAdditional information regarding directors of the Company is incorporated by reference from pages 2 to 5 of the definitive Proxy Statement.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required herein is incorporated by reference from pages 6 to 7 of the definitive Proxy Statement.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required herein is incorporated by reference from pages 2 to 4 of the definitive Proxy Statement.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nNone.\nPART IV.\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a)(1) The following financial statements are incorporated herein by reference:\nIndependent Auditors' Report\nConsolidated Balance Sheets as of December 31, 1995 and 1994\nConsolidated Statements of Income for the Years Ended December 31, 1995, 1994 and 1993.\nConsolidated Statements of Stockholders' Equity for the Years Ended December 31, 1995, 1994 and 1993.\nConsolidated Statements of Cash Flows for the Years Ended December 31, 1995, 1994 and 1993.\nNotes to Consolidated Financial Statements\n(a)(2) There are no financial statement schedules which are required to be filed as a part of this form since they are not applicable.\n(a)(3) See (c) below for all exhibits filed herewith.\n(b) During the three-month period ended December 31, 1995, the Registrant filed a Form 8-K announcing the election of Anne E. O' Connor to the Company's Board of Directors. No financial statements were filed with this report.\n(c) Exhibits. The following exhibits are either filed as part of this annual report on Form 10-K, or are incorporated herein by reference:\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nCenter Banks Incorporated - ------------------------- Registrant","section_15":""}
{"filename":"89261_1995.txt","cik":"89261","year":"1995","section_1":"Item 1. Business. - -----------------\nEXX INC (\"EXX\") is the holding Company resulting from the Reorganization of SFM Corporation (\"SFM\") as approved by its shareholders at a special meeting on October 18, 1994 and effective on October 21, 1994. The purpose of adopting a holding company structure was to enhance the Company's ability to obtain new financing by enabling potential investors to clearly focus on the strengths and diversity of EXX's businesses and to protect each of EXX's businesses to the extent possible from the business risks which arise out of its other businesses.\nAs part of the reorganization each outstanding share of SFM Common stock was converted into three shares of EXX Class A Common Stock and one share of EXX Class B Common Stock. The new stock is substantially identical to the old stock in rights and privileges except that holders of outstanding shares of Class B Common Stock have the right to elect two-thirds or the next rounded number of directors in excess of two-thirds if the number of Directors is not divisible by three, and the holders of outstanding shares of the Class A Common Stock have the right to elect the remaining directors of the Company.\nUnder the Reorganization SFM became a wholly-owned subsidiary of EXX and each of SFM's wholly-owned subsidiaries became wholly-owned subsidiaries of EXX with each subsidiary retaining its assets and liabilities and continuing its business. In order to effect the transactions, SFM distributed as a dividend to EXX all the outstanding stock of each of its subsidiaries as well as SFM's cash, cash equivalents and certain promissory notes.\nEXX through its subsidiaries, is engaged in the design, production and sale of consumer goods in the form of \"impulse toys\", watches and kites. In addition, it is engaged in the design, production and sale of electric motors geared toward the (OEM) original equipment market, and the design, production and sale of cable pressurization equipment sold to the telecommunications industry. It formerly manufactured machine tools and machine tool replacement parts. It continues to receive royalty income from machine tools and replacement parts as part payment for its sale of a subsidiary's assets. Continuing operations are conducted through five wholly-owned subsidiaries.\nHenry Gordy International, Inc. (\"Gordy\") was formed during the third ------------------------------- quarter of 1987 to conduct the business associated with certain assets purchased from Henry Gordy, Inc. and Gordy International, Inc.\nGordy markets a line of \"impulse\" toys and watches through a national network of commissioned sales representatives together with its own sales staff. Its products are distributed directly or through wholesalers to a wide range of retail outlets including, but not limited to, toy stores, department stores, discount chains, drug stores and supermarkets.\nThe majority of the merchandise is manufactured in the Far East to Gordy's specifications and shipped as required. No difficulties have been encountered in sourcing for the products, nor are any expected for the current year.\nInventories are maintained against anticipated orders. Gordy believes that its practices relating to all working capital items, including its inventory practices, do not materially differ from those used by other companies in similar endeavors and comparable in size to Gordy.\nGordy operates in a highly competitive market. It competes with many other companies, some of which have substantially greater resources and assets than Gordy.\nIn February, 1994, Hi-Flier Inc., a newly formed subsidiary of SFM, purchased the assets of Hi-Flier Manufacturing Co., a leader in the kite business for more than seventy years. It is anticipated that this acquisition will strengthen the toy segment by providing product lines that compliment those of the Henry Gordy International Inc. subsidiary.\nThe Howell Electric Motors Division (\"Howell\") is engaged in the ----------------------------------- manufacture and sale of alternating current, fractional and small integral motors ranging from 1\/4 to 10 horsepower. Howell's product line consists of such specialty items as blower motors designed for use in air conditioning systems, flat-type motors used in floor scrubbing and polishing machines, and motor pump assemblies used in food machinery products and a variety of other applications. In recent years, a substantial portion of Howell's sales have been to the floor care service industry and the food machinery industry, and have been effected through Howell's own marketing personnel and several independent sales representatives working on a commission basis.\nThe principal raw materials used by Howell are steel, copper, aluminum and grey-iron or aluminum casting, all of which are purchased from various suppliers on a competitive basis. During the period covered by this report, Howell experienced no significant difficulty in obtaining these raw materials, and, barring some presently unforeseen event, Howell does not expect to encounter any difficulties in obtaining such supplies during the current year.\nRaw material inventories for Howell are maintained largely against known requirements, i.e., they are held against firm orders, or, in the case of certain items with a variety of applications to Howell's products, are held against anticipated orders. Inventories of finished goods consist predominately of products ready for shipment. Howell believes that its practices relating to all working capital items, including its inventory practices, do not materially differ from those used by other companies in similar endeavors and comparable in size to Howell.\nHowell is in a highly competitive business, and believes that it is not a very significant factor. It competes with many other companies which have significantly greater assets and resources.\nIn April, 1994, TX Systems Inc., a newly formed subsidiary of SFM, acquired the operating assets and businesses of TX Technologies, Inc. and TX Software, Inc. These companies were engaged in the Cable Pressurization and Monitoring Systems business. The TX Systems Inc. acquisition together with the activities of another newly formed subsidiary - TX Technology Corp. - broadened our operations in the capital goods segment, allowing us entry to the dynamic and rapidly growing telecommunications industry. The TX Companies operate the cable pressurization and monitoring system business.\nEffective May 1, 1993 the Company's wholly owned subsidiary Waterbury Headers Inc. (\"WH\") sold substantially all of its operating assets to Waterbury Headers Corp. (\"WHC\"), a corporation formed by a prior officer of the Company, in exchange for a promissory note of $275,000 with interest at 10% plus a right to receive a royalty on future sales. In addition SFM Corporation in exchange for an agreement not to compete with WHC obtained a promissory note of $250,000 with interest at 10%. Interest on both notes accrues as of May 1, 1993, with payments of accrued interest and principal commencing in April, 1998. Further information with respect to the transactions may be obtained by examining the Company's Form 8-K dated May 18, 1993 filed with the Securities and Exchange Commission, herein incorporated by reference.\nMaterial Customers. ------------------\nThe registrant's business is not dependent to a material extent on any single customer or group of customers.\nEmployees. ---------\nThe registrant employs approximately 145 full-time employees, of whom approximately 63 are employed by Howell, 15 by TX Technology Corp., 65 by Gordy, and 2 for all other activities of the registrant combined.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties. - -------------------\nSFM Corp., the registrant's wholly owned subsidiary, owns a brick and masonry building in Plainfield, New Jersey containing approximately 120,000 square feet of manufacturing area and 10,000 square feet of office space, where the operations of Howell and Gordy are located. This facility is held by the registrant subject to a mortgage securing the registrant's line of credit. (See Note 8 to the Consolidated Financial Statements page).\nThe registrant through subsidiaries currently leases 11,000 square feet of warehousing and office space in Randolph, New Jersey for its telecommunication operations. In addition the registrant leases office and\/or showroom space in New York City, Dallas, Texas and Las Vegas, Nevada.\nOn May 1, 1993 SFM sold substantially all the assets of its Waterbury Subsidiary. Waterbury leased a cement and cinderblock building located in Waterbury, Connecticut, which contained approximately 15,000 square feet of office and warehouse space.\nThe registrant considers its facilities and the equipment contained therein adequate and suitable to meet its current and foreseeable requirements.\nItem 3.","section_3":"Item 3. Legal Proceedings. - --------------------------\nNone other than in the normal course of business\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders. - ------------------------------------------------------------\nNot applicable.\nPart II -------\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Stock and Related Security Holder - ----------------------------------------------------------------------------- Matters. - -------\nPrincipal Market: American Stock Exchange ------------------------------------------\nQuarterly Price Information ---------------------------\nStockholders: As of March 15, 1996, there were approximately 1,100 ------------ ----- stockholders of record of Class A shares and 500 stockholders of record of Class --- B shares.\nDividend Information: No dividends were paid in 1995 or 1994. --------------------\nThe registrant's current ability to pay dividends is governed by provisions in a loan agreement with its principal bank. No cash dividend may be paid unless the registrant has had net income aggregating at least $400,000 during the four calendar quarters immediately preceding the date of payment, and the aggregate dividends paid over any four calendar quarters may not exceed 40% of the net income for that period. In addition, no dividend may be paid which would have the effect of reducing the Company's net worth below $4,000,000. While the restrictions do not currently prohibit the payment of a dividend, there is no present intention to make any dividend payments.\nItem 6.","section_6":"Item 6. Selected Financial Data. - --------------------------------\n(A) 1991 does not reflect the results of the Seneca Falls Subsidiary sold in February, 1991 as of January 1, 1991.\n(B) As adjusted for a four for one stock split effective October 21, 1994, Class A and Class B shares retroactively shown.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results - -------------------------------------------------------------------------------- of Operations. - --------------\n1995 Compared to 1994 - ---------------------\nNet sales in 1995 were $30,522,000 compared to $45,490,000 which was a decrease of $14,968,000. This year's sales represents 67% of the prior year sales. The Toy Segment's sales were $21,373,000 compared to $37,188,000 in 1994, a decrease of $15,815,000. The current year's sales represent 57% of the prior year sales. The Mechanical Equipment Group had total sales of $9,149,000 in 1995, compared to $8,302,000 in 1994, an increase of $847,000. The current year sales represent 110% of the prior year sales.\nGross profits were $11,471,000 compared to last year's $16,982,000. The Toy Segment accounted for a $ 6,756,000 decrease in gross profit while the Mechanical Equipment Group accounted for the counterbalancing increase. Improved operating results in the Mechanical Equipment Group accounted for this difference.\nSelling and G&A expenses were $ 8,281,000, a decrease of $4,437,000 from $12,718,000 in 1994. The decrease in expenses directly relates to the substantial decreased sales volume in the Toy Segment.\nOperating profits of $3,190,000 were $1,074,000 less than the prior year's $4,264,000. The Toy Segment's operating profits decreased to $2,831,000 from $5,280,000 while the Mechanical Equipment Group sustained an operating profit of $943,000, an increase of $ 1,027,000 from 1994. Corporate and other operating expenses decreased to $584,000 from $932,000 last year.\nInterest expense increased slightly to $84,000 from $18,000 in the prior year. The amount of company borrowing was minimal during the year.\nThe Company generated net income of $2,330,000 or $.86 per A & B share compared to net income of $2,682,000 or $.99 per share A & B share in 1994 as adjusted for a four for one split.\nThe Company reported a deferred tax asset totaling $824,000 at December 31, 1995. Management believes this asset will be realized by taxable earnings in the future.\nAccrued expenses decreased substantially over the prior year. Royalties payable were $728,000 at year end compared to $1,490,000 at December 31, 1994 and commissions payable were $245,000 at year end compared to $468,000 at the end of the prior year. The large decrease in both of the categories relates to the large decrease in sales in the Toy Segment and the payments of the prior amounts payable during the year. The decrease in the accrual in payroll and related costs to $301,000 at December 31, 1995 from $955,000 in the prior year is due to salaries and bonuses disbursed or reclassified during the year.\nThe Toy Segment's reduction in sales was attributable to reduced sales of licensed goods most particularly the Mighty Morphin Power Ranger line of products which during the year had reached a level of market maturity. The prior year's sales reflected an increase specifically due to a positive market condition, the continuation of which was not predictable. Management continues to review and add to its licensing structure based on new items in the market. The new management people added during the year have demonstrated an ability to positively impact on future operations. Management can make no prediction regarding the availabilty on new licenses or their acceptance in the market place.\nAs described last year, for various reasons, namely the nature of the product sold, the economic climate and industry practices, management conservatively provided for returns or allowances relating to the products sold and delivered. During the year a portion of the provision was utilized. Management continues to reevaluate this situation in adequately reserving for possible occurrences of this nature.\nThe Mechanical Equipment Group's results reflect the first full year of operations of the TX Technology business. Increases in sales volume and operating profit occurred in both the Howell and TX segments of the business. Management anticipates that the TX business will continue its growth in 1996 and Howell will sustain operations in 1996.\n1994 Compared to 1993 - ---------------------\nNet sales in 1994 were $45,490,000 compared to $18,037,000 which was an increase of $27,453,000. Last year's sales represented 252% of the prior year sales. The Toy Segment's sales were $37,188,000 compared to $10,762,000 in 1993, an increase of $26,426,000. Last year's sales represent 346% of the prior year sales. The Mechanical Equipment Group had total sales of $8,302,000 in 1994, compared to $7,275,000 in 1993, an increase of $1,027,000. The last year's sales represented 114% of the prior year sales.\nGross profits were $16,982,000 compared to the prior year's $5,114,000. The Toy Segment accounted for a $12,322,000 increase in gross profit while the Mechanical Equipment Group accounted for the counterbalancing decrease. Start up costs for the new acquisition accounted for this difference.\nSelling and G&A expenses were $12,718,000, an increase of $8,513,000 from $4,205,000 in 1993. The increase in expenses directly related to the substantial increased sales volume in the Toy Segment.\nOperating profits of $4,264,000 were $3,355,000 greater than the prior year's $909,000. The Toy Segment's operating profits increased to $5,280,000 from $528,000 while the Mechanical Equipment Group sustained an operating loss of $84,000, a decrease of $1,079,000 from 1993. Corporate and other operating expenses increased to $932,000 from $614,000 last year.\nInterest expense increased slightly to $18,000 from $17,000 in the prior year. The amount of company borrowing was minimal during the year.\nThe Company generated net income of $2,682,000 or $.99 per A & B share compared to net income of $611,000 or $.23 per share in 1993 adjusted for a four for one split.\nThe Company reported a deferred tax asset totaling $1,477,000 at December 31, 1994. Management believes this asset will be realized by taxable earnings in the future.\nAccrued expenses increased substantially over the prior year. Royalties payable were $1,490,000 at year end compared to $34,000 at December 31, 1993 and commissions payable were $468,000 at year end compared to $38,000 at the end of the prior year. The large increase in both of the categories relates to the large increase in sales in the Toy Segment and the related royalties and commissions payable on the sales. The increase in the accrual in payroll and related costs to $955,000 at December 31, 1994 from $300,000 in the prior year is due to salaries and bonuses not disbursed at year end.\nThe Toy Segment's substantial sales increase was caused by various factors which included licenses well received by consumers. The addition of watches and bendable figures to its impulse line benefited operations. Also, the addition of new management people enhanced the overall operation. The Kite acquisition in February, 1994 has provided an additional customer base for all Toy Segment business as well as the existing kite business. Management is continually reviewing its license structure with the view to update and adjust same in light of continuing competition and the availability of new license properties. Management can make no prediction regarding the availability of future licenses or their acceptance by the consumer.\nIn light of the substantial growth referred to in the Toy Segment, the nature of the products sold, the economic climate, and industry practices, Management has conservatively provided for returns or allowances relating to the products sold and delivered. As indicated, it is Management's intention to adequately reserve for possible occurrences of this nature.\nThe Mechanical Equipment Group's results reflect the addition of the TX Technology business as of the end of April, 1994 with its related start up costs. While the Howell Electric Motors Division sales volume reduced slightly, the TX subsidiary more than compensated for the decline. Management anticipates that the TX business will surpass the 1994 levels and that Howell will sustain operations in 1995.\nLiquidity and Sources of Capital. --------------------------------\nDuring 1995 the Company utilized $2,720,000 of cash flows from operating activities compared to generating $7,773,000 in 1994 due in part to decreased income, payment of income taxes, accounts payable and a reduction of accounts receivable and other related assets.\nAt the end of 1995 the Company had working capital of approximately $9,219,000 and a current ratio of 3.1:1. In addition, as described in the Notes to Consolidated Financial Statements, at year-end the Company had a Credit Agreement (the \"Agreement\") with a bank, pursuant to which the bank will provide a line of credit and letters of credit aggregating $5,000,000. The Company gave the bank a security interest in substantially all of its accounts receivable, inventories, machinery and equipment, land and building (See Note 8 to the Consolidated Financial Statements Page). In February 1996, the bank extended the loan agreement until August, 1996. Management currently intends to negotiate a new credit agreement prior to August 31, 1996. The current rate of interest charged by the bank is 3\/4 of 1% over the prime rate. While at year end there was no borrowing on the credit facility there may be borrowings from time to time. In the event that there was a borrowing balance and the Company's bank demanded repayment in full of its revolving credit loan due August 31, 1996, which is considered unlikely, the Company would have options to seek to borrow elsewhere against its receivables or other assets, arrange to collect its receivables early or reach a loan work-out agreement with the Bank. At year- end, unused credit under this line amounted to the facility line of $5,000,000. The Company considers this line to be more than adequate to handle its current operating capital needs.\nThe Company has no present plans that will require material capital expenditures for any of the Company's businesses. Capital expenditures are expected to be in the ordinary course of business and financed by cash generated from operations or borrowing under the credit line.\nThe Company believes the effects of inflation will not have a material effect on its future operations.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements. - -----------------------------\nThe financial statements required by this item may be found beginning with the index page on page immediately following the signature page.\nItem 9.","section_9":"Item 9. Changes in and Disagreements With Accountants on Accounting and - ------------------------------------------------------------------------ Financial Disclosure. --------------------\nNone\nPart III --------\nIn accordance with General Instruction G to Form 10-K, Items 10 through 13, identified below, have been omitted form this report. The information required in those sections, to the extent applicable, has been included in the registrant's Proxy Statement for the current year, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 1995. The Proxy Statement is herein incorporated by reference.\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. - --------------------------------------------------------\nPart IV -------\nItem 14.","section_14":"Item 14. Exhibits, Schedules to Financial Statements and Reports - ----------------------------------------------------------------- on Form 8-K. -----------\n(a) Schedules to Financial Statements ---------------------------------\nSee Schedules to Financial Statements immediately following conclusion of the Notes to Consolidated Financial Statements.\n(b) Reports on Form 8-K -------------------\nNot applicable.\nSIGNATURES ----------\n\/s\/ JERRY FISHMAN EXX INC - ------------------------------- Jerry Fishman, Director\n\/s\/ NORMAN H. PERLMUTTER \/s\/ DAVID A SEGAL - ------------------------------- --------------------- Norman H. Perlmutter, Director David A. Segal Chairman of the Board Chief Executive Officer \/s\/ FREDERIC REMINGTON - ------------------------------- Frederic Remington, Director\n\/s\/ DAVID A. SEGAL - ------------------------------- David A. Segal, Director\nDated: March 28, 1996\nEXX INC AND SUBSIDIARIES\nINDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES (ITEMS 8 AND 14(a))\n================================================================================\nPage No.\n(1) Financial Statements\nIndependent Auditors' Report - 3\nConsolidated Financial Statements Balance Sheets December 31, 1995 and 1994\nStatements of Income Years Ended December 31, 1995, 1994 and 1993\nStatements of Changes in Stockholders' Equity Years Ended December 31, 1995, 1994 and 1993\nStatements of Cash Flows Years Ended December 31, 1995, 1994 and 1993 - 8\nNotes to Consolidated Financial Statements - 23\n(2) Financial Statement Schedules VIII - Valuation and Qualifying Accounts and Reserves S-1\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.\nINDEPENDENT AUDITORS' REPORT\nTo the Board of Directors and Stockholders of EXX INC\nWe have audited the accompanying consolidated balance sheets of EXX INC and Subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of income, changes in stockholders' equity and cash flows for the years then ended, and the supporting schedules listed in the index at Item 14(a)(1) and (2). These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of EXX INC and Subsidiaries as of December 31, 1995 and 1994, and the results of their operations and their cash flows for the years then ended, and the supporting schedules present fairly the information required to be set forth therein, in conformity with generally accepted accounting principles.\nROTHSTEIN, KASS & COMPANY, P.C.\nRoseland, New Jersey February 28, 1996\nINDEPENDENT AUDITORS' REPORT\nTo the Board of Directors and Stockholders of EXX Inc (Formerly SFM Corporation)\nWe have audited the accompanying consolidated statements of operations, stockholders' equity and cash flows of SFM Corporation and subsidiaries for the year ended December 31, 1993. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the results of operations and cash flows of SFM Corporation and subsidiaries for the year ended December 31, 1993, in conformity with generally accepted accounting principles.\nAs discussed in Note 1 to the consolidated financial statements, in 1993 the Company changed its method of accounting for income taxes to conform with Statement of Financial Accounting Standards No. 109.\nWEBER, LIPSHIE & CO.\nRoseland, New Jersey February 22, 1994\nEXX INC AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\nSee accompanying notes to cosolidated financial statements. - ----------------------------------------------------------\nEXX INC AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF INCOME\nSee accompanying notes to consolidated financial statements. - -----------------------------------------------------------\nEXX INC AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY\n================================================================================ Years Ended December 31, 1995, 1994, and 1993 - --------------------------------------------------------------------------------\nSee accompanying notes to consolidated financial statements. - -----------------------------------------------------------\nEXX INC AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nSee accompanying notes to consolidated financial statements. - -----------------------------------------------------------\nEXX INC AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)\nSee accompanying notes to consolidated financial statements. - -----------------------------------------------------------\nEXX INC AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n================================================================================\n1. Business and organization Line of Business ---------------- EXX Inc and Subsidiaries (collectively the Company) operate primarily in the toy and electro mechanical industries. Operations in the toy industry involve the design, production and distribution of consumer goods in the form of impulse toys, watches and kites, which are primarily imported from the Far East. Operations in the electro mechanical equipment industry primarily involve the design, production and sale of capital goods, such as electric motors and cable pressurization equipment, for the telecommunications industry. The Company's electro mechanical products are incorporated into customers' products or are used to maintain customers' equipment.\n2. Summary of significant accounting policies Reorganization -------------- In October 1994, the stockholders of SFM Corporation (SFM) approved a plan of reorganization, whereby SFM was merged, on a tax- free basis, into a subsidiary of EXX Inc. Simultaneous with this merger, each share of common stock of SFM was converted into three shares of EXX Inc Class A common stock and one share of EXX Inc Class B common stock. The EXX Inc stock was substantially identical to the former SFM stock in rights and privileges, except that holders of Class B common stock have the right to elect two-thirds or the next higher rounded number of directors and the holders of the Class A common stock have the right to elect the remaining directors of the Company. This merger has been accounted for in a manner similar to a pooling of interests.\nPrinciples of Consolidation --------------------------- The consolidated financial statements include the accounts of EXX Inc and its wholly owned subsidiaries. All material intercompany accounts and transactions have been eliminated in consolidation.\nEXX INC AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n================================================================================\n2. Summary of significant accounting policies (continued) Cash and Cash Equivalents ------------------------- The Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents. As of December 31, 1995, balances of cash at financial institutions exceeded the federally insured limit of $100,000. These balances fluctuate greatly and often exceed $100,000 during the year. Management regularly monitors the financial condition of the financial institution, along with their balances in cash and cash equivalents, and attempts to keep this potential risk to a minimum.\nShort-Term Investments ---------------------- Short-term investments have maturities of less than one year. These investments are readily convertible into cash and are stated at cost plus accrued interest, which approximates market value.\nFair Value of Financial Instruments ----------------------------------- The fair value of the Company's assets and liabilities which qualify as financial instruments under Statement of Financial Accounting Standards No. 107 approximate the carrying amounts presented in the balance sheets.\nInventories ----------- Certain inventories are valued at the lower of cost, on the last-in, first-out (\"LIFO\") method, or market. The remainder of the inventories are valued at the lower of cost, on the first-in, first out (\"FIFO\") method, or market.\nImpairment of Long-Lived Assets ------------------------------- The Company periodically assesses the recoverability of the carrying amounts of long- lived assets, including intangible assets. A loss is recognized when expected undiscounted future cash flows are less than the carrying amount of the asset. The impairment loss is the difference by which the carrying amount of the asset exceeds its fair value.\nEXX INC AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n================================================================================\n2. Summary of significant accounting policies (continued) Property and Equipment ----------------------\nProperty and equipment are stated at cost and are depreciated on the straight-line method over the estimated useful lives of the assets as follows:\nBuilding and improvements 10 - 50 years Machinery and equipment 3 - 20 years\nMaintenance and repairs are charged to operations, while betterments and improvements are capitalized. The cost of property sold or otherwise disposed of, and the accumulated depreciation thereon, are eliminated from the property and the related accumulated depreciation accounts and any resulting gain or loss is credited or charged to income.\nIncome Taxes ------------\nThe Company complies with Statement of Financial Accounting Standards No. 109 (SFAS 109), \"Accounting for Income Taxes\", which requires an asset and liability approach to financial reporting for income taxes. Deferred income tax assets and liabilities are computed annually for differences between financial statement and tax bases of assets and liabilities that will result in future taxable or deductible amounts, and based on enacted tax laws and rates applicable to the periods in which the differences are expected to effect taxable income. Valuation allowances are established when necessary to reduce deferred income tax assets to the amount expected to be realized. The cumulative effect of adopting this change in accounting principle is reflected in the 1993 statement of income.\nOther Assets ------------\nOther assets include intangible assets which are being amortized over their estimated useful lives of seven years on the straight-line method.\nIncome Per Common Share -----------------------\nIncome per common share is based on the weighted average number of common shares outstanding during each year, after giving effect to the reorganization.\nEXX INC AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n================================================================================\n2. Summary of significant accounting policies (continued) Use of Estimates ---------------- The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Estimates are used when accounting for allowance for doubtful accounts, allowance for sales returns, inventory obsolescence, depreciation and amortization, taxes and contingencies.\nReclassifications -----------------\nCertain reclassifications have been made to prior years financial statements in order to conform to current year presentation.\n3. Acquisitions In February 1994, the Company purchased certain assets of, and began operating, the kite manufacturing and distribution business of Hi- Flier Manufacturing Co.\nIn April 1994, the Company purchased the business and certain assets of TX Technologies, Inc., a manufacturer and distributor of cable pressurizers and monitors, for $900,000.\nThese acquisitions were accounted for as purchases and the purchase price of the assets acquired was allocated on the basis of the relative fair market value of the net assets acquired.\nEXX INC AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS\n================================================================================ 3. Acquisitions (continued) The following unaudited pro forma combined statement of income for 1994 gives effect to the acquisition of TX Technologies, Inc. (the Hi-Flier transaction was not deemed to be material) as if it had occurred on January 1, 1994:\n4. Inventories Inventories consist of the following at December 31, 1995 and 1994:\nInventories stated on the LIFO method amounted to $339,000, $396,000, and $464,000 at December 31, 1995, 1994 and 1993, respectively, which amounts are below replacement cost by approximately $336,000, $300,000 and $292,000, respectively.\nEXX INC AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS\n================================================================================\n4. Inventories (continued) During 1995, 1994 and 1993, net income was not materially effected as a result of using the LIFO method.\n5. Property and equipment Property and equipment consists of the following at December 31, 1995 and 1994:\n6. Other assets Other assets consist of the following at December 31, 1995 and 1994:\nEXX INC AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n================================================================================\n7. Accounts payable and other current liabilities Accounts payable and other current liabilities consist of the following at December 31, 1995 and 1994:\n8. Line of credit Under the terms of a revolving credit agreement, as amended, a bank provides the Company with a line of credit and a letter of credit facility aggregating $5,000,000. Loans under the agreement bear interest at 3\/4% per annum in excess of the bank's base lending rate. The agreement matures in August 1996 and is collateralized by substantially all of the Company's trade accounts receivable, inventories, and property and equipment. At December 31, 1995 and 1994, there were no balances due.\nThe loan agreement imposes various financial covenants on the Company, including the maintenance of minimum net worth of $4,000,000, and limitations on capital expenditures, loans and advances, future borrowings, and the purchase of common stock for the treasury. In addition, no cash dividends may be paid unless the Company has had net income aggregating at least $400,000 during the four calendar quarters immediately preceding the date of payment, and the aggregate dividends paid over any four calendar quarters may not exceed 40% of the net income for that period.\nEXX INC AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n================================================================================\n9. Income taxes The provision for income taxes includes the following:\nSubsequent to the corporate reorganization in 1994, substantially all of the Company's taxable income is generated in states with no state and local income taxes.\nThe difference between the applicable federal statutory income tax rate and the effective income tax rate is reconciled as follows:\nThe tax effect of principal temporary differences at December 31, 1995 and 1994 are shown in the following table:\nEXX INC AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n================================================================================ 9. Income taxes (continued) Amounts for deferred income tax assets and liabilities at December 31, 1995 and 1994 are as follows:\n10. Pension plans The Company participates in two pension plans. One plan covers hourly employees under union contracts and provides for defined contributions based on annual hours worked. Pension expense for these plans was $72,000 in 1995, $57,000 in 1994 and $29,000 in 1993.\nThe Company-sponsored plan is a noncontributory defined benefit pension plan. Benefits are based on years of service and the employees' highest five year average earnings. The Company's funding policy is to contribute annually at least the minimum amount required by the Employee Retirement Income Security Act of 1974. Effective January 1, 1988, the plan was curtailed through an amendment to freeze benefits and future participation.\nNet pension expense for the Company-sponsored plan is as follows:\nEXX INC AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n================================================================================ 10. Pension plans (continued) The following table sets forth the funded status of the Company-sponsored plan and the amounts recognized by the Company in the consolidated balance sheets as of December 31, 1995 and 1994.\nThe discount rate and rate of increase in future compensation assumed in determining the actuarial present value of the projected benefit obligation is 8%. The expected long-term rate of return on assets is 10%.\n11. Stock option plan During 1994, the Company's Board of Directors adopted, and the stockholders approved, the 1994 stock option plan (the Plan) pursuant to which 1,000,000 shares of Class A common stock were reserved for issuance upon the exercise of options granted to officers, directors, employees and consultants of the Company. Options under the Plan may be incentive stock options, unqualified stock options, or any combination thereof, and the Board of Directors (Committee) may grant options at an exercise price which is not less than the fair market value on the date such options are granted. The Plan further provides that the maximum period in which stock options may be exercised will be determined by the Committee, except that they may not be exercisable after ten years from the date of grant. Unless previously terminated, the Plan shall terminate in October 2004. At December 31, 1995, 1,000 options have been granted under the Plan, which are exercisable at $14.50 per share. These options expire in January 1998.\nEXX INC AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n================================================================================\n12. Commitments and contingencies Leases ------\nThe Company leases showroom and office facilities under noncancellable operating leases. The following is the aggregate future minimum rental payments, as of December 31, 1995, under these noncancelable operating leases:\nRent expense for 1995, 1994 and 1993 amounted to $122,000, $129,000 and $106,000, respectively. Rent expense, attributable to a lease with a related party, on a month to month basis, amounted to $15,000 in 1993.\nRoyalty Agreements ------------------\nThe Company has licensing agreements relating to the sale of certain products, which expire through December 31, 1998. Under the terms of the agreements, the Company is required to pay royalties of 6% to 20% on the net sales of the related products. In addition, certain agreements require minimum guaranteed advance payments or payments over the life of the agreement. At December 31, 1995, minimum guaranteed royalty payments aggregate approximately $730,000 and prepaid royalties at December 31, 1995, which expire through December 31, 1998, aggregate $433,000.\nEmployment and Stock Repurchase Agreement -----------------------------------------\nThe Company has an employment agreement with an officer, who is a principal stockholder, requiring the payment of a minimum annual salary of approximately $300,000, adjusted annually for increases in the consumer price index, plus a bonus based on earnings. Amounts earned under this contract from September 1993 through December 31, 1995 have been deferred in the form of a note payable to the officer. The note bears interest at 9% per annum and is due on February 22, 1996. The agreement expires in the year 2004 and is renewable for an additional five years unless written notice of non-renewal is given by either party within 90 days prior to its expiration.\nEXX INC AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n================================================================================\n12. Commitments and contingencies (continued) In addition, the agreement provides that the principal stockholder can require the Company to purchase all of his common stock in the Company on the date his employment terminates, at the greater of fair market value or $10 per share (see Note 8 as to limitations on the repurchase of common stock). At December 31, 1995, the stockholder beneficially owned 1,256,712 shares having an approximate fair market value of $6,542,000.\nConsulting Agreement --------------------\nIn 1993, the Company entered into a three year consulting agreement with a former officer of a subsidiary, for an annual fee of $50,000.\n13. Dependence upon key relationships Approximately 27% and 51% of the Company's revenues for the years ended December 31, 1995 and 1994 were attributable to agreements with a certain licensor. The agreements with this licensor expire through December 31, 1996.\n14. Description of business and industry segments Selected segment and related information is presented in the table below. Operating income is total revenues less operating expenses. In computing operating income, general corporate expenses, interest expense, certain other income and income taxes have been excluded. The LIFO method of valuing inventories of certain electro mechanical equipment decreased operating income for that segment by $22,000, $8,000 and $10,000 in 1995, 1994 and 1993, respectively. Identifiable assets by industry are those assets that are used in the Company's operations in each industry.\nEXX INC AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n================================================================================\n14. Description of business and industry segments (continued) Export revenues for the three years ended December 31, 1995, 1994 and 1993 were approximately $1,549,000, $1,276,000 and $811,000, respectively.\nIndustry segment information for 1995, 1994 and 1993 is summarized as follows:\nEXX INC AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n================================================================================\n14. Description of business and industry segments (continued)\n[A] Excludes corporate assets of $6,207,000, $9,069,000 and $1,610,000 at December 31, 1995, 1994 and 1993, respectively.\nEXX INC AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n================================================================================\n(a) Reflects the reorganization of SFM Corporation into EXX Inc and the four for one stock split effective October 21, 1994.\n(b) Includes the effect of a reclassification of approximately $3,900,000 of royalties to general and administrative expenses.\nEXX INC AND SUBSIDIARIES\nSCHEDULE VIII VALUATION AND QUALIFYING ACCOUNTS AND RESERVES\n================================================================================\nS-1","section_15":""}
{"filename":"19719_1995.txt","cik":"19719","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nBell Atlantic - Washington, D.C., Inc. (the \"Company\") is incorporated under the laws of the State of New York and has its principal offices at 1710 H Street, N.W., Washington, D.C. 20006 (telephone number 202-392-9900). The Company is a wholly owned subsidiary of Bell Atlantic Corporation (\"Bell Atlantic\"), which is one of the seven regional holding companies (\"RHCs\") formed in connection with the court-approved divestiture (the \"Divestiture\"), effective January 1, 1984, of those assets of American Telephone and Telegraph Company (\"AT&T\") related to exchange telecommunications, exchange access functions, printed directories and cellular mobile communications.\nThe Company presently serves a territory consisting of a single Local Access and Transport Area (\"LATA\"). A LATA is generally centered on a city or based on some other identifiable common geography and, with certain limited exceptions, a LATA marks the boundary within which the Company has historically been permitted to provide telephone service.\nThe Company currently provides two basic types of telecommunications services. First, the Company transports telecommunications traffic between subscribers located within the same LATA (\"intraLATA service\"), including both local and toll services. Local service includes the provision of local exchange (\"dial tone\"), local private line and public telephone services (including dial tone service for pay telephones owned by the Company and other pay telephone providers). Among other local services provided are Centrex (telephone company central office-based switched telephone service enabling the subscriber to make both intercom and outside calls) and a variety of special and custom calling services. Toll service includes message toll service (calling service beyond the local calling area) within LATA boundaries, and intraLATA Wide Area Toll Service (WATS)\/800 services (volume discount offerings for customers with highly concentrated demand). Second, the Company provides exchange access service, which links a subscriber's telephone or other equipment to the transmission facilities of interexchange carriers which, in turn, provide telecommunications service between LATAs (\"interLATA service\") to their customers.\nLINE OF BUSINESS RESTRICTIONS AND THE TELECOMMUNICATIONS ACT OF 1996\nThe consent decree entitled \"Modification of Final Judgment\" (\"MFJ\") approved by the United States District Court for the District of Columbia (the \"D.C. District Court\") which, together with the Plan of Reorganization (\"Plan\") approved by the D.C. District Court, set forth the terms of Divestiture also established certain restrictions on the post-Divestiture activities of the RHCs, including Bell Atlantic and its subsidiaries. The MFJ's principal restrictions on post-Divestiture RHC activities included prohibitions on (i) providing interexchange telecommunications, and (ii) engaging in the manufacture of telecommunications equipment and customer premises equipment (\"CPE\").\nThe Telecommunications Act of 1996 (the \"Act\") became effective on February 8, 1996 and replaces the MFJ. In general, the Act includes provisions that would open the Company's local exchange markets to competition and would permit local exchange carriers, such as the Company, to provide interLATA services (long distance) and video programming and to engage in manufacturing. However, the ability of the Company to engage in businesses previously prohibited by the MFJ is largely dependent on satisfying certain conditions contained in the Act and regulations to be promulgated thereunder. For a brief discussion of certain provisions of the Act, see \"Management's Discussion and Analysis of Results of Operations - Factors That May Impact Future Results, Federal Legislation\" on page 14.\nOPERATIONS\nDuring 1993, Bell Atlantic reorganized certain functions formerly performed by each of the seven Bell System operating companies (\"BOCs\") transferred to it pursuant to the Divestiture, including the Company (collectively, the \"Network Services Companies\"), into lines of business (\"LOBs\") organized across the Network Services Companies around specific market segments. The Network Services Companies, however, remain responsible within their respective service areas for the provision of telephone services, financial performance and regulatory matters. The LOBs are:\nBell Atlantic - Washington, D.C., Inc.\nThe Consumer Services LOB markets communications services to residential ----------------- customers within the service territories of the Network Services Companies, including the service territory of the Company.\nThe Carrier Services LOB markets (i) switched and special access to the ---------------- Company's local exchange network, and (ii) billing and collection services, including recording, rating, bill processing and bill rendering. The principal customers of this LOB are interexchange carriers; AT&T is the largest single customer. Other customers include business customers and government agencies with their own special access network connections, wireless companies and other local exchange carriers (\"LECs\") which resell network connections to their own customers.\nThe Small Business Services LOB markets communications and information ----------------------- services to small businesses (customers having up to 20 access lines).\nThe Large Business Services LOB markets communications and information ----------------------- services to large businesses (customers having more than 20 access lines). These services include voice switching\/processing services (e.g., dedicated private lines, custom Centrex, call management and voice messaging), end-user networking (e.g., credit and debit card transactions, and personal computer- based conferencing, including data and video), internetworking (establishing links between the geographically disparate networks of two or more companies or within the same company), network integration (integrating multiple geographically disparate networks into one system), network optimization (disaster avoidance, 911, intelligent vehicle highway systems), video services (distance learning, telemedicine, videoconferencing) and interactive multi-media applications services.\nThe Directory Services LOB manages the provision of (i) advertising and ------------------ marketing services to advertisers, and (ii) listing information (e.g., White Pages and Yellow Pages). These services are currently provided primarily through print media, but the Company expects that use of electronic formats will increase in the future. In addition, the Directory Services LOB manages the provision of photocomposition, database management and other related products and services to publishers.\nThe Public and Operator Services LOB markets pay telephone and operator ---------------------------- services in the service territories of the Network Services Companies to meet consumer needs for accessing public networks, locating and identifying network subscribers, providing calling assistance and arranging billing alternatives (e.g., calling card, collect and third party calls).\nThe Federal Systems LOB markets communications and information technology and --------------- services to departments, agencies and offices of the executive, judicial and legislative branches of the federal government.\nThe Network LOB manages the technologies, services and systems platforms ------- required by the other LOBs and the Network Services Companies, including the Company, to meet the needs of their respective customers, including switching, feature development and on-premises installation and maintenance services.\nFCC REGULATION AND INTERSTATE RATES\nThe Company is subject to the jurisdiction of the Federal Communications Commission (\"FCC\") with respect to interstate services and certain related matters. The FCC prescribes a uniform system of accounts for telephone companies, interstate depreciation rates and the principles and standard procedures used to separate plant investment, expenses, taxes and reserves between those applicable to interstate services under the jurisdiction of the FCC and those applicable to intrastate services under the jurisdiction of the respective state regulatory authorities (\"separations procedures\"). The FCC also prescribes procedures for allocating costs and revenues between regulated and unregulated activities.\nThe FCC has prescribed structures for exchange access tariffs to specify the charges (\"access charges\") for use and availability of the Company's facilities for the origination and termination of interstate interLATA service. In general, the tariff structures prescribed by the FCC provide that interstate costs which do not vary based on usage (\"non-traffic sensitive costs\") are recovered from subscribers through flat monthly charges (\"subscriber line charges\"), and from interexchange carriers through usage-sensitive Carrier Common Line (\"CCL\") charges. Traffic-sensitive interstate costs are recovered from carriers through variable access charges based on several factors, primarily usage.\nBell Atlantic - Washington, D.C., Inc.\nPrice Caps\nThe price cap system, which became effective in 1991, (the \"Prior Price Cap Plan\") placed a cap on overall LEC prices for interstate access services which was modified annually, in inflation-adjusted terms, by a fixed percentage which was intended to reflect increases in productivity. The price cap level could also be adjusted to reflect \"exogenous\" changes, such as changes in FCC separations procedures or accounting rules. Under the Prior Price Cap Plan, the Company was required to share with customers in the form of prospective rate reductions a portion of its earnings above a certain authorized rate of return.\nIn March 1995, the FCC approved an Interim Price Cap Plan (\"Interim Plan\") for interstate access charges, which became effective on August 1, 1995, and replaced the Prior Price Cap Plan.\nUnder the Interim Plan, the Company's price cap index must be adjusted by an inflation index (GDP-PI), less a fixed percentage, either 4.0%, 4.7% or 5.3%, which is intended to reflect increases in productivity (\"Productivity Factor\"). Companies selecting the 4.0% or 4.7% Productivity Factor are required to reduce future prices and share a portion of their interstate return in excess of 12.25%. Companies selecting the 5.3% Productivity Factor are also required to reduce prices but are not required to share a portion of their future interstate earnings. The Interim Plan also provided for a reduction in the price cap index of 2.8% to adjust for what the FCC believes was an underestimate in its calculation of the Productivity Factor in prior years. The Interim Plan also eliminated the recovery of certain \"exogenous\" cost changes, including changes in accounting costs that the FCC believes have no economic consequences.\nIn May 1995, Bell Atlantic selected the 5.3% Productivity Factor for the August 1995 to June 1996 tariff period. The rates included in the May 1995 filing resulted in price decreases totaling approximately $14,600,000 on an annual basis. These price decreases included the scheduled expiration of a temporary rate increase of approximately $4,700,000 on an annualized basis that was in effect from March 17, 1995 through July 31, 1995 to recover prior years \"exogenous\" postemployment benefit costs. Approximately 80% of the remaining $9,900,000 reduction resulted from compliance with the Interim Plan. The remaining 20% represented reductions that the Company was required to make under the Prior Price Cap Plan.\nBell Atlantic appealed the Interim Price Cap Order to the Court of Appeals for the D.C. Circuit, and that case is currently pending.\nFCC Cost Allocation and Affiliate Transaction Rules\nFCC rules govern: (i) the allocation of costs between the regulated and unregulated activities of a communications common carrier and (ii) transactions between the regulated and unregulated affiliates of a communications common carrier.\nThe cost allocation rules apply to certain unregulated activities: activities that have never been regulated as communications common carrier offerings and activities that have been preemptively deregulated by the FCC. The costs of these activities are removed prior to the separations procedures process and are assigned to unregulated activities in the aggregate, not to specific services, for pricing purposes. Other activities must be accounted for as regulated activities, and their costs are subject to separations procedures.\nThe affiliate transaction rules govern the pricing of assets transferred to and services provided by affiliates. These rules generally require that assets be transferred between affiliates at \"market price\", if such price can be established through a tariff or a prevailing price actually charged to third parties. In the absence of a tariff or prevailing price, \"market price\" cannot be established, in which case (i) asset transfers from a regulated to an unregulated affiliate must be valued at the higher of cost or fair market value, and (ii) asset transfers from an unregulated to a regulated affiliate must be valued at the lower of cost or fair market value.\nThe FCC has not attempted to make its cost allocation or affiliate transaction rules preemptive. State regulatory authorities are free to use different cost allocation methods and affiliate transaction rules for intrastate ratemaking and to require carriers to keep separate allocation records.\nBell Atlantic - Washington, D.C., Inc.\nSTATE REGULATION AND COMPETITIVE ENVIRONMENT\nThe communications services of the Company are subject to regulation by the District of Columbia Public Service Commission (the \"PSC\") with respect to intrastate rates and services and certain other matters.\nIn January 1993, the PSC adopted a regulatory reform plan (\"D.C. Reform Plan\") for the intra-Washington, D.C. services of the Company, for a three-year trial period. The D.C. Reform Plan provides a banded rate of return of 100 basis points over or under the authorized return on equity (which was set at 11.45% in December 1993). The Company is permitted to seek a rate increase if its return on equity falls below 10.45% and is required to share, through refunds, 50% of any earnings in excess of a return on equity of 12.45%.\nIn January 1995, the Company filed a petition with the PSC seeking approval of a proposed price cap plan to become effective upon the expiration of the D.C. Reform Plan in 1996. In February 1996, the Company signed a settlement agreement with the Office of People's Counsel to implement a four-year price cap plan to replace the D.C. Reform Plan. The settlement agreement, if approved, would: (1) introduce a four-year price cap plan effective 1\/1\/96 through 12\/31\/99; (2) divide services into three categories, basic, discretionary and competitive; (3) cap certain basic residence rates for the term of the plan and allow other basic rates to change with the rate of inflation minus 3%; (4) allow discretionary services rates to increase by 15% annually; (5) eliminate pricing regulation of competitive services; (6) reduce residential rates by $3.1 million in 1996; business rates by $2.2 million in 1997 and $3.2 million in 1998; and (7) establish a trust fund to wire public schools and libraries with Bell Atlantic integrated services digital network (\"ISDN\") lines. The agreement is pending approval by the PSC.\nCOMPETITION\nGeneral\nRegulatory changes, as well as new technology, are continuing to expand the types of available communications services and equipment and the number of competitors offering such services. An increasing amount of this competition is from large companies which have substantial capital, technological and marketing resources. For a discussion of competition in the local exchange market, see \"Management's Discussion and Analysis of Results of Operations - Factors That May Impact Future Results\" on page 14.\nAlternative Access\nA substantial portion of the Company's revenues from business and government customers is derived from a relatively small number of large, multiple-line subscribers.\nThe Company faces competition from alternative communications systems, constructed by large end users, interexchange carriers and alternative access vendors, which are capable of originating and\/or terminating calls without the use of the Company's plant. In the Washington, D.C., metropolitan area, Institutional Communications Company, in which MFS-Intelenet of Washington, D.C., a subsidiary of MFS Communications Company, Inc. (\"MFS\"), has acquired a controlling interest, has deployed an optical fiber network to compete with the Company in the provision of switched and special access services and local services.\nThe ability of such alternative access providers to compete with the Company has been enhanced by the FCC's orders requiring the Company to offer virtual collocated interconnection for special and switched access services.\nOther potential sources of competition are cable television systems, shared tenant services and other non-carrier systems which are capable of bypassing the Company's local plant, either partially or completely, through substitution of special access for switched access or through concentration of telecommunications traffic on fewer of the Company's lines.\nPersonal Communications Services\nRadio-based personal communications services (\"PCS\") also constitute potential sources of competition to the Company. PCS consists of wireless portable telephone services which would allow customers to make and receive telephone calls from any location using small handsets, and which could also be used for data transmission.\nBell Atlantic - Washington, D.C., Inc.\nDirectories\nThe Company continues to face significant competition from other providers of directories, as well as competition from other advertising media. In particular, the former sales representative of several of the Network Services Companies publishes directories in competition with those published by the Company in its service territory.\nPublic Telephone Services\nThe Company faces increasing competition in the provision of pay telephone services from other pay telephone service providers. In addition, the growth of wireless communications negatively impacts usage of public telephones.\nOperator Services\nAlternative operator services providers have entered into competition with the Company's operator services product line.\nCERTAIN CONTRACTS AND RELATIONSHIPS\nCertain planning, marketing, procurement, financial, legal, accounting, technical support and other management services are provided on behalf of the Company on a centralized basis by Bell Atlantic's wholly owned subsidiary, Bell Atlantic Network Services, Inc. (\"NSI\"). Bell Atlantic Network Funding Corporation provides short-term financing and cash management services to the Company.\nThe seven RHCs each own (directly or through subsidiaries) a one-seventh interest in Bell Communications Research, Inc. (\"Bellcore\"). Pursuant to the Plan, Bellcore furnishes the RHCs and their BOC subsidiaries with technical assistance such as network planning, engineering and software development, as well as various other consulting services that can be provided more effectively on a centralized basis. Bellcore is the central point of contact for coordinating the efforts of the RHCs in meeting the national security and emergency preparedness requirements of the federal government. It also helps to mobilize the combined resources of the RHCs in times of natural disasters.\nEMPLOYEES\nAs of December 31, 1995, the Company had approximately 1,900 employees. This workforce is augmented by employees of the centralized staff of NSI, who perform services for the Company on a contract basis.\nBell Atlantic - Washington, D.C., Inc.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nGENERAL\nThe principal properties of the Company do not lend themselves to simple description by character and location. The Company's investment in plant, property and equipment consisted of the following at December 31:\n\"Central office equipment\" consists of switching equipment, transmission equipment and related facilities. \"Cable, wiring and conduit\" consists primarily of aerial cable, underground cable, conduit and wiring. \"Land and buildings\" consists of land owned in fee and improvements thereto, principally central office buildings. \"Other equipment\" consists of public telephone terminal equipment and other terminal equipment, poles, furniture, office equipment, and vehicles and other work equipment. \"Other\" property consists primarily of plant under construction, capital leases and leasehold improvements.\nThe Company's customers are served by electronic switching systems that provide a wide variety of services. The Company's network is in a transition from an analog to a digital network, which provides the capabilities to furnish advanced data transmission and information management services. At December 31, 1995, approximately 79% of the access lines were served by digital capability.\nCAPITAL EXPENDITURES\nThe Company has been making and expects to continue to make significant capital expenditures to meet the demand for communications services and to further improve such services. Capital expenditures were approximately $106 million in 1993, $123 million in 1994 and $205 million in 1995. The total investment in plant, property and equipment was approximately $1.31 billion at December 31, 1993, $1.35 billion at December 31, 1994, and $1.45 billion at December 31, 1995, in each case after giving effect to retirements, but before deducting accumulated depreciation at such date.\nBell Atlantic - Washington, D.C., Inc.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nPre-Divestiture Contingent Liabilities and Litigation\nThe Plan provides for the recognition and payment by AT&T and the former BOCs (including the Company) of liabilities that are attributable to pre-Divestiture events but do not become certain until after Divestiture. These contingent liabilities relate principally to litigation and other claims with respect to the former Bell System's rates, taxes, contracts and torts (including business torts, such as alleged violations of the antitrust laws). Except to the extent that affected parties otherwise agree, contingent liabilities that are attributable to pre-Divestiture events are shared by AT&T and the BOCs in accordance with formulas prescribed by the Plan, whether or not an entity was a party to the proceeding and regardless of whether an entity was dismissed from the proceeding by virtue of settlement or otherwise. Each company's allocable share of liability under these formulas depends on several factors, including the type of contingent liability involved and each company's relative net investment as of the effective date of Divestiture. Under the formula generally applicable to most of the categories of these contingent liabilities, the Company's aggregate allocable share of liability is approximately 0.5%.\nAT&T and various of its subsidiaries and the BOCs (including, in some cases, the Company) have been and are parties to various types of litigation relating to pre-Divestiture events, including actions and proceedings involving environmental claims and allegations of violations of equal employment laws. Damages, if any, ultimately awarded in the remaining actions relating to pre- Divestiture events could have a financial impact on the Company whether or not the Company is a defendant since such damages will be treated as contingent liabilities and allocated in accordance with the allocation rules established by the Plan.\nEffective in 1994, the Company and the other Regional Holding Companies 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.\nWhile complete assurance cannot be given as to the outcome of any contingent liabilities or litigation, in the opinion of the Company's management, any monetary liability or financial impact to which the Company would be subject after final adjudication of all of the remaining potential or actual pre- Divestiture claims would not be material in amount to the financial position of the Company.\nBell Atlantic - Washington, D.C., Inc.\nPART I\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\n(Omitted pursuant to General Instruction J(2).)\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\n(Inapplicable.)\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\n(Omitted pursuant to General Instruction J(2).)\nBell Atlantic - Washington, D.C., Inc.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS (Abbreviated pursuant to General Instruction J(2).)\nThis discussion should be read in conjunction with the Financial Statements and Notes to Financial Statements included in the index set forth on page.\nRESULTS OF OPERATIONS - ---------------------\nThe Company reported net income of $31,497,000 in 1995, compared to a loss of $34,682,000 in 1994.\nIn 1994, the Company recorded a pretax charge of $7,959,000, in accordance with Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits\" (Statement No. 112), to recognize the Company's proportionate share of benefit costs for the separation of employees who are entitled to benefits under preexisting Bell Atlantic separation pay plans. Results for 1994 also included a noncash, after-tax extraordinary charge of $74,647,000 in connection with the Company's decision to discontinue application of regulatory accounting principles required by Statement of Financial Accounting Standards No. 71, \"Accounting for the Effects of Certain Types of Regulation\" (see Note 2 to the Financial Statements).\nThese and other items affecting the comparison of operating results between 1995 and 1994 are discussed in the following sections.\nOPERATING REVENUES - ------------------\nTRANSPORT SERVICES OPERATING STATISTICS - ---------------------------------------\nBell Atlantic - Washington, D.C., Inc.\nLOCAL SERVICE REVENUES\nDOLLARS IN THOUSANDS (DECREASE) - -------------------------------------------------------------------------------- 1995 - 1994 $(1,938) (.8)% - --------------------------------------------------------------------------------\nLocal service revenues are earned by the Company from the provision of local exchange, local private line and public telephone services.\nLocal service revenues decreased due to a reduction in the Subscriber Plant Factor Surcharge applied to basic local services, effective May 1994, and lower public telephone and directory assistance revenues. These revenue decreases were substantially offset by volume-related growth for basic local services as reflected by a 1.9% increase in network access lines in service.\nNETWORK ACCESS REVENUES\nDOLLARS IN THOUSANDS INCREASE - -------------------------------------------------------------------------------- 1995 - 1994 $5,231 4.6% - --------------------------------------------------------------------------------\nNetwork access revenues are received from interexchange carriers (IXCs) for their use of the Company's local exchange facilities in providing long distance services to IXCs' customers and from end-user subscribers. Switched access service revenues are derived from usage-based charges paid by IXCs for access to the Company's network. Special access revenues arise from access charges paid by IXCs and end-users who have private networks. End-user access revenues are earned from local exchange carrier customers who pay for access to the network.\nNetwork access revenues increased principally due to higher customer demand for access services as reflected by growth of 2.9% in access minutes of use. Lower obligations to affiliated companies pursuant to an interstate revenue sharing agreement also contributed to the growth in network access revenues in 1995. Revenues in 1995 were positively impacted by a temporary rate increase that was in effect from March 17, 1995 through July 31, 1995 to recover prior years \"exogenous\" postemployment benefit costs.\nRevenue growth from volume increases was partially offset by the effect of price reductions under the Federal Communications Commission's (FCC) Price Cap Plans.\nIn March 1995, the FCC adopted an order approving an Interim Price Cap Plan for interstate access charges, which replaced the prior Price Cap Plan. As required by the FCC's order, Bell Atlantic filed its Transmittal of Interstate Rates, which resulted in price decreases for the Company totaling approximately $14,600,000 on an annual basis, effective August 1, 1995. These price decreases included the scheduled expiration of a temporary rate increase of approximately $4,700,000 on an annualized basis that was in effect from March 17, 1995 through July 31, 1995 to recover prior years \"exogenous\" postemployment benefit costs. Also as part of the filing, Bell Atlantic selected a 5.3% Productivity Factor, which eliminates the requirement to share a portion of interstate overearnings related to the August 1995 to June 1996 tariff period.\nTOLL SERVICE REVENUES\nDOLLARS IN THOUSANDS (DECREASE) - -------------------------------------------------------------------------------- 1995 - 1994 $(604) (13.3)% - --------------------------------------------------------------------------------\nToll service revenues are earned from calls made outside a customer's local calling area, but within the same service area boundaries of the Company, commonly referred to as Local Access and Transport Areas (LATAs). Other toll services include 800 services and Wide Area Telephone Service (WATS).\nThe reduction in toll service revenues was caused by a decline of 4.0% in toll message volumes and a settlement with an independent carrier in the third quarter of 1995.\nBell Atlantic - Washington, D.C., Inc.\nDIRECTORY PUBLISHING REVENUES\nDOLLARS IN THOUSANDS INCREASE - -------------------------------------------------------------------------------- 1995 - 1994 $1,052 3.3% - --------------------------------------------------------------------------------\nDirectory publishing revenues are earned primarily from local advertising and marketing services provided to businesses in White and Yellow Pages directories. Other directory publishing services include database and foreign directory marketing.\nGrowth in directory publishing revenues was primarily due to higher rates charged for these services. Changes in billing procedures and lower customer claims and disconnects further boosted directory publishing revenues in 1995.\nOTHER ANCILLARY SERVICES REVENUES\nDOLLARS IN THOUSANDS INCREASE - -------------------------------------------------------------------------------- 1995 - 1994 $11,062 17.6% - --------------------------------------------------------------------------------\nOther ancillary services include billing and collection services provided to IXCs and facilities rental services provided to affiliates and non-affiliates.\nOther ancillary services revenues increased due to higher facilities rental revenues from affiliates in 1995. The increase was offset, in part, by a reduction in billing and collection services revenues as a result of the elimination of certain services from a contract with an IXC.\nVALUE-ADDED SERVICES REVENUES\nDOLLARS IN THOUSANDS INCREASE - -------------------------------------------------------------------------------- 1995 - 1994 $1,290 1.4% - --------------------------------------------------------------------------------\nValue-added services represent a family of services which expand the utilization of the network. These services include recent products such as voice messaging services, Caller ID and Return Call as well as more mature products such as Centrex, Touch-Tone, and customer premises wiring and maintenance services.\nContinued growth in the network customer base (access lines) and higher demand by customers for certain value-added central office and voice messaging services offered by the Company increased value-added services revenues in 1995. Higher demand for customer premises services by government customers also contributed to the growth in value-added services revenues in 1995. These increases were partially offset by a reduction in contract billing for certain advanced premises services for large business customers. Such premises services, which were primarily performed by the Company until May 1994, are now contracted with another affiliate of Bell Atlantic.\nBell Atlantic - Washington, D.C., Inc.\nOPERATING EXPENSES - ------------------\nEMPLOYEE COSTS\nDOLLARS IN THOUSANDS (DECREASE) - -------------------------------------------------------------------------------- 1995 - 1994 $(17,216) (11.1)% - --------------------------------------------------------------------------------\nEmployee costs consist of salaries, wages and other employee compensation, employee benefits and payroll taxes paid directly by the Company. Similar costs incurred by employees of Bell Atlantic Network Services, Inc. (NSI), who provide centralized services on a contract basis, are allocated to the Company and are included in other operating expenses.\nThe decrease in employee costs was due to the effect of lower workforce levels, decreased overtime pay, and a reduction in pension and postretirement benefit costs in 1995. The effect of a third quarter 1994 charge of $6,010,000 to recognize benefit costs, in accordance with Statement No. 112, for the separation of employees who are entitled to benefits under preexisting Bell Atlantic separation pay plans also contributed to the decrease in employee costs in 1995. Benefit costs associated with the separation of employees of NSI were allocated to the Company and included in other operating expenses. These cost reductions were partially offset by annual salary and wage increases and the recognition of certain contract labor and separation pay costs in 1995 associated with the contract settlement with the Communications Workers of America (CWA).\nThe Company's contract with the CWA, representing approximately 1,800 employees, expired on August 5, 1995. In January 1996, a tentative three-year labor agreement was reached, which was subsequently ratified in February 1996. The agreement includes a 10.6% wage increase over the three-year contract period, a ratification bonus, improved pensions and benefits, and certain employment security provisions.\nDEPRECIATION AND AMORTIZATION\nDOLLARS IN THOUSANDS INCREASE - -------------------------------------------------------------------------------- 1995 - 1994 $7,273 6.8% - --------------------------------------------------------------------------------\nDepreciation and amortization increased principally due to growth in depreciable telephone plant and higher depreciation rates. The composite depreciation rates were 8.5% in 1995 and 8.3% in 1994.\nOTHER OPERATING EXPENSES\nDOLLARS IN THOUSANDS INCREASE - -------------------------------------------------------------------------------- 1995 - 1994 $27,365 13.0% - --------------------------------------------------------------------------------\nOther operating expenses consist primarily of contract services including centralized services expenses allocated from NSI, rent, network software costs, operating taxes other than income, provision for uncollectible accounts receivable and other costs.\nThe increase in other operating expenses was attributable to higher centralized services costs allocated from NSI, primarily as a result of additional costs incurred in that organization to enhance systems, consolidate work activities and\nBell Atlantic - Washington, D.C., Inc.\nmarket value-added services at Bell Atlantic's network services subsidiaries. Higher contracted services and network software costs, and an increase in the provision for uncollectible accounts receivable also contributed to the increase in other operating expenses in 1995. These increases were partially offset by the effect of a third quarter 1994 charge for the Company's allocated share of separation benefit costs associated with the employees of NSI.\nOTHER INCOME AND (EXPENSE), NET\nDOLLARS IN THOUSANDS (DECREASE) - -------------------------------------------------------------------------------- 1995 - 1994 $(9,883) - --------------------------------------------------------------------------------\nThe change in other income and (expense), net was largely attributable to the effect of a gain on the sale of land recorded in 1994 and the elimination of the allowance for funds used during construction.\nUpon the discontinued application of regulatory accounting principles, effective August 1, 1994, the Company began recognizing capitalized interest costs as a reduction of interest expense. Previously, the Company recorded an allowance for funds used during construction as an item of other income.\nINTEREST EXPENSE\nDOLLARS IN THOUSANDS INCREASE - -------------------------------------------------------------------------------- 1995 - 1994 $1,118 6.3% - --------------------------------------------------------------------------------\nInterest expense increased principally due to higher levels of average short- term debt during 1995. This increase was partially offset by the recognition of increased capitalized interest costs, subsequent to the discontinued application of regulatory accounting principles, effective August 1, 1994.\nPROVISION FOR INCOME TAXES\nDOLLARS IN THOUSANDS (DECREASE) - -------------------------------------------------------------------------------- 1995 - 1994 $(3,862) (14.8)% - --------------------------------------------------------------------------------\nEFFECTIVE INCOME TAX RATES\nFOR THE YEARS ENDED DECEMBER 31 - -------------------------------------------------------------------------------- 1995 41.3% - -------------------------------------------------------------------------------- 1994 39.5% - --------------------------------------------------------------------------------\nThe Company's effective income tax rate was higher in 1995 principally due to the reduction in the amortization of investment tax credits and the elimination of the benefit of the income tax rate differential applied to reversing timing differences, both as a result of the discontinued application of regulatory accounting principles in August 1994.\nA reconciliation of the statutory federal income tax rate to the effective income tax rate for each period is provided in Note 9 to the Financial Statements.\nBell Atlantic - Washington, D.C., Inc.\nFACTORS THAT MAY IMPACT FUTURE RESULTS - --------------------------------------\nFEDERAL LEGISLATION\nThe Telecommunications Act of 1996 (the Act), which became effective on February 8, 1996, is the most comprehensive revision of the federal communications laws in over 60 years. In general, the Act includes provisions that would open the Company's local exchange markets to competition and would permit local exchange carriers, such as the Company, upon meeting certain conditions, to provide interLATA services (long distance) and video programming and to engage in manufacturing.\nWith regard to the rules governing competition in the interLATA market, the Act takes a two-fold approach. Effective February 8, 1996, Bell Atlantic is permitted to apply for approval to offer interLATA services outside of the geographic region in which it currently operates as a local exchange carrier. Bell Atlantic has announced its plans to offer such services in several states.\nSecondly, within Bell Atlantic's geographic region, each of the telephone subsidiaries, including the Company, must demonstrate to the FCC that it has satisfied certain requirements in order to be permitted to offer interLATA services within its jurisdiction. Among the requirements with which the Company must comply is a 14-point \"competitive checklist\" which is aimed at ensuring that competitors have the ability to connect to the Company's network. The Company must also demonstrate to the FCC that its entry into the interLATA market would be in the public interest.\nThe Act also imposes specific requirements on the Company that are intended to promote competition in the local exchange markets. These requirements include the duty to: (i) provide interconnection to any other carrier for the transmission and routing of telephone exchange service and exchange access at any technically feasible point; (ii) provide unbundled access to network elements at any technically feasible point; (iii) provide retail services for resale at wholesale prices; (iv) establish reciprocal compensation arrangements for the origination and termination of telecommunications and (v) provide physical collocation.\nNo definitive prediction can be made as to the specific impact of the Act on the business or financial condition of the Company. The financial impact on the Company will be dependent on several factors, including the timing, extent and success of competition in the Company's market and the timing, extent and success of the Company's pursuit of new business opportunities resulting from the Act.\nCOMPETITION\nLocal Exchange Services\nThe ability to offer local exchange services has historically been subject to regulation by the District of Columbia Public Service Commission (PSC). An application to provide local exchange services filed by MFS - Intelenet of Washington, D.C., a subsidiary of MFS Communications Company, Inc., is currently pending. The Act is expected to significantly increase the level of competition in the Company's local exchange market. However, increased competition in the local exchange market will facilitate FCC approval of the Company's entry into the interLATA markets.\nOther\nSee Item 1 - Description of Business, Competition on pages 4 and 5 for additional information on the Company's competitive environment.\nBell Atlantic - Washington, D.C., Inc.\nOTHER STATE REGULATORY MATTERS\nThe communications services of the Company are subject to regulation by the PSC with respect to intrastate rates and certain other matters.\nIn January 1993, the PSC adopted a regulatory reform plan (D.C. Reform Plan) for the intra-Washington, D.C. services of the Company, for a three-year trial period. The D.C. Reform Plan provides a banded rate of return of 100 basis points over or under the authorized return on equity (which was set at 11.45% in December 1993). The Company is permitted to seek a rate increase if its return on equity falls below 10.45% and is required to share, through refunds, 50% of any earnings in excess of a return on equity of 12.45%.\nIn January 1995, the Company filed a petition with the PSC seeking approval of a proposed price cap plan to become effective upon the expiration of the D.C. Reform Plan in 1996. In February 1996, the Company signed a settlement agreement with the Office of People's Counsel to implement a four-year price cap plan to replace the D.C. Reform Plan. The settlement agreement, if approved, would: (1) introduce a four-year price cap plan effective 1\/1\/96 through 12\/31\/99; (2) divide services into three categories: basic, discretionary and competitive; (3) cap certain basic residence rates for the term of the plan and allow other basic rates to change with the rate of inflation minus 3%; (4) allow discretionary services rates to increase by 15% annually; (5) eliminate pricing regulation of competitive services; (6) reduce residential rates by $3.1 million in 1996; business rates by $2.2 million in 1997 and $3.2 million in 1998; and (7) establish a trust fund to wire public schools and libraries with Bell Atlantic integrated services digital network (ISDN) lines. The agreement is pending approval by the PSC.\nOTHER MATTERS - -------------\nENVIRONMENTAL ISSUES\nThe Company is subject to a number of environmental proceedings as a result of its operations and the shared liability provisions in the Plan of Reorganization related to the Modification of Final Judgment. The Company is also responsible for the remediation of sites with underground fuel storage tanks and other expenses associated with environmental compliance.\nThe Company continually monitors its operations with respect to potential environmental issues, including changes in legally mandated standards and remediation technologies. The Company's recorded liabilities reflect those specific situations where remediation activities are currently deemed to be probable and where the cost of remediation is estimable. Management believes that the aggregate amount of any additional potential liability would not have a material effect on the Company's results of operations or financial condition.\nFINANCIAL CONDITION - -------------------\nManagement believes that the Company has adequate internal and external resources available to meet ongoing operating requirements, including network expansion and modernization. Management expects that presently foreseeable capital requirements will be financed primarily through internally generated funds. Additional long-term debt may be needed to fund development activities and to maintain the Company's capital structure within management's guidelines.\nAs of December 31, 1995, the Company had $50,549,000 of an unused line of credit with an affiliate, Bell Atlantic Network Funding Corporation. In addition, the Company has $60,000,000 remaining under a shelf registration statement filed with the Securities and Exchange Commission for the issuance of unsecured debt securities.\nThe Company's debt ratio was 59.1% at December 31, 1995, compared to 55.0% at December 31, 1994\nBell Atlantic - Washington, D.C., Inc.\nPART II\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe information required by this Item is set forth on pages through .\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\n(Omitted pursuant to General Instruction J(2).)\nItem 11.","section_11":"Item 11. Executive Compensation\n(Omitted pursuant to General Instruction J(2).)\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\n(Omitted pursuant to General Instruction J(2).)\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\n(Omitted pursuant to General Instruction J(2).)\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(a) The following documents are filed as part of this report:\n(1) Financial Statements\nSee Index to Financial Statements and Financial Statement Schedule appearing on Page.\n(2) Financial Statement Schedule\nSee Index to Financial Statements and Financial Statement Schedule appearing on Page.\nBell Atlantic - Washington, D.C., Inc.\nPART IV\nItem 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (Continued)\n(3) Exhibits Exhibits identified in parentheses below, on file with the Securities and Exchange Commission (SEC), are incorporated herein by reference as exhibits hereto.\nExhibit Number (Referenced to Item 601 of Regulation S-K) ---------------------------------------------------------\n3a Restated Certificate of Incorporation of the registrant, as amended September 14, 1990. (Exhibit 3a to the registrant's Annual Report on Form 10-K for the year ended December 31, 1990, File No. 1-7368.)\n3a(i) Certificate of Amendment of the registrant's Certificate of Incorporation, dated January 12, 1994 and filed January 13, 1994. (Exhibit 3a(i) to the registrant's Annual Report on Form 10-K for the year ended December 31, 1993, File No. 1-7368.)\n3b By-Laws of the registrant, as amended December 15, 1995.\n3b(i) Consent of Sole Stockholder of Bell Atlantic - Washington, D.C., Inc., dated December 15, 1995.\n4 No instrument which defines the rights of holders of long and intermediate term debt of the registrant is filed herewith pursuant to Regulation S-K, Item 601(b)(4)(iii)(A). Pursuant to this regulation, the registrant hereby agrees to furnish a copy of any such instrument to the SEC upon request.\n10a Agreement Concerning Contingent Liabilities, Tax Matters and Termination of Certain Agreements among AT&T, Bell Atlantic Corporation, and the Bell Atlantic Corporation telephone subsidiaries, and certain other parties, dated as of November 1, 1983. (Exhibit 10a to Bell Atlantic Corporation Annual Report on Form 10-K for the year ended December 31, 1993, File No. 1-8606.)\n10b Agreement among Bell Atlantic Network Services, Inc. and the Bell Atlantic Corporation telephone subsidiaries, dated November 7, 1983. (Exhibit 10b to Bell Atlantic Corporation Annual Report on Form 10-K for the year ended December 31, 1993, File No. 1-8606.)\n23 Consent of Independent Accountants.\n24 Powers of Attorney.\n27 Financial Data Schedule.\n(b) Reports on Form 8-K\nThere were no Current Reports on Form 8-K filed during the quarter ended December 31, 1995.\nBell Atlantic - Washington, D.C., Inc.\nSIGNATURES\nPURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.\nBell Atlantic - Washington, D.C., Inc.\nBy \/s\/ Sheila D. Shears ----------------------------- Sheila D. Shears Controller and Treasurer\nMarch 27, 1996\nPURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES AND ON THE DATE INDICATED.\nPrincipal Executive Officer:\nWilliam M. Freeman President and Chief Executive Officer\nPrincipal Financial Officer:\nSheila D. Shears Controller and Treasurer\nDirectors: By \/s\/ Sheila D. Shears ------------------------------- Sherry F. Bellamy Sheila D. Shears Barbara L. Connor (individually and as William M. Freeman attorney-in-fact) Diane B. Gongaware March 27, 1996 Marie C. Johns Glen N. Jones Sheila D. Shears\nBell Atlantic - Washington, D.C., Inc.\nINDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE\nFinancial statement schedules other than that listed above have been omitted because such schedules are not required or applicable.\nBell Atlantic - Washington, D.C., Inc.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareowner of Bell Atlantic - Washington, D.C., Inc.\nWe have audited the financial statements and financial statement schedule of Bell Atlantic - Washington, D.C., Inc. as listed in the index on page of this Form 10-K. The financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Bell Atlantic - Washington, D.C., Inc. as of December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles. In addition, in our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information required to be included therein.\nAs discussed in Notes 1 and 2 to the financial statements, the Company discontinued accounting for its operations in accordance with Statement of Financial Accounting Standards No. 71, \"Accounting for the Effects of Certain Types of Regulation,\" effective August 1, 1994. Also, as discussed in Notes 1, 8 and 9 to the financial statements, the Company changed its method of accounting for income taxes and postemployment benefits in 1993.\n\/s\/ COOPERS & LYBRAND L.L.P.\n2400 Eleven Penn Center Philadelphia, Pennsylvania February 5, 1996\nBell Atlantic - Washington, D.C., Inc.\nSTATEMENTS OF OPERATIONS AND REINVESTED EARNINGS (ACCUMULATED DEFICIT) FOR THE YEARS ENDED DECEMBER 31 (DOLLARS IN THOUSANDS)\nSee Notes to Financial Statements.\nBell Atlantic - Washington, D.C., Inc.\nBALANCE SHEETS (DOLLARS IN THOUSANDS)\nASSETS ------\nSee Notes to Financial Statements.\nBell Atlantic - Washington, D.C., Inc.\nBALANCE SHEETS (DOLLARS IN THOUSANDS)\nLIABILITIES AND SHAREOWNER'S INVESTMENT ---------------------------------------\nSee Notes to Financial Statements.\nBell Atlantic - Washington, D.C., Inc.\nSTATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31 (DOLLARS IN THOUSANDS)\nSee Notes to Financial Statements.\nBell Atlantic - Washington, D.C., Inc.\nNOTES TO FINANCIAL STATEMENTS\n1. DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nDescription of Business\nBell Atlantic - Washington, D.C., Inc. (the Company) is a wholly owned subsidiary of Bell Atlantic Corporation (Bell Atlantic). The Company provides two basic types of telecommunications services in a territory consisting of a single Local Access and Transport Area (LATA) in Washington, D.C. First, the Company transports telecommunications traffic between subscribers located within the same LATA (intraLATA service), including both local and toll services. Local service includes the provision of local exchange, local private line and public telephone services. Toll service includes message toll services and intraLATA Wide Area Toll Service\/800 services. Second, the Company provides exchange access service, which links a subscriber's telephone equipment to the facilities of an interexchange carrier (IXC) which, in turn, provides telecommunications service between LATAs (interLATA service) to their customers. Other services provided by the Company include directory publishing, customer premises wiring and maintenance, and billing and collection services.\nThe Telecommunications Act of 1996 is the most comprehensive revision of the federal communications laws in over 60 years. In general, the Telecommunications Act includes provisions that would open the Company's local exchange markets to competition and would permit local exchange carriers, such as the Company, upon meeting certain conditions, to provide interLATA services (long distance) and video programming and to engage in manufacturing.\nBASIS OF PRESENTATION\nEffective August 1, 1994, the Company discontinued accounting for its operations under the provisions of Statement of Financial Accounting Standards No. 71, \"Accounting for the Effects of Certain Types of Regulation\" (Statement No. 71) (see Note 2).\nUSE OF ESTIMATES\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of revenues, expenses, assets, and liabilities and disclosure of contingencies. Actual results could differ from those estimates.\nREVENUE RECOGNITION\nRevenues are recognized as earned on the accrual basis, which is generally when services are rendered based on the usage of the Company's local exchange network and facilities.\nCASH AND CASH EQUIVALENTS\nThe Company considers all highly liquid investments with a maturity of 90 days or less when purchased to be cash equivalents. Cash equivalents are stated at cost, which approximates market value.\nSHORT-TERM INVESTMENTS\nShort-term investments consist of investments that mature 91 days to 12 months from the date of purchase. Short-term investments are stated at cost, which approximates market value.\nMATERIAL AND SUPPLIES\nNew and reusable materials are carried in inventory, principally at average original cost, except that specific costs are used in the case of large individual items.\nBell Atlantic - Washington, D.C., Inc.\nPREPAID DIRECTORY\nCosts of directory production and advertising sales are principally deferred until the directory is published. Such costs are amortized to expense and the related advertising revenues are recognized over the average life of the directory, which is generally 12 months.\nPLANT AND DEPRECIATION\nThe Company's provision for depreciation is based principally on the composite group remaining life method of depreciation and straight-line composite rates. This method provides for the recovery of the remaining net investment in telephone plant, less anticipated net salvage value, over the remaining asset lives. The composite group method requires periodic revisions to depreciation rates based on a number of variables, including retirement estimates, survivor curves, salvage, and cost of removal.\nIn connection with the discontinued application of Statement No. 71, effective August 1, 1994, for financial reporting purposes, the Company began using estimated asset lives for certain categories of plant and equipment that were shorter than those approved by regulators prior to the discontinuance of Statement No. 71. The shorter lives result principally from the Company's expectation as to the revenue-producing lives of the assets.\nThe following asset lives were used in 1994 and 1995:\nWhen depreciable plant is replaced or retired, the amounts at which such plant has been carried in plant, property and equipment are removed from the respective accounts and charged to accumulated depreciation, and any gains or losses on disposition are amortized over the remaining asset lives of the remaining net investment in telephone plant.\nMAINTENANCE AND REPAIRS\nThe cost of maintenance and repairs, including the cost of replacing minor items not constituting substantial betterments, is charged to operating expense.\nCAPITALIZED INTEREST COST\nUpon the discontinued application of Statement No. 71, effective August 1, 1994, the Company began reporting capitalized interest as a cost of telephone plant and equipment and a reduction in interest expense, in accordance with the provisions of Statement of Financial Accounting Standards No. 34, \"Capitalization of Interest Cost.\"\nPrior to the discontinued application of Statement No. 71, the Company recorded an allowance for funds used during construction, which included both interest and equity return components, as a cost of plant and as an item of other income.\nEMPLOYEE BENEFITS\nPensions, Postretirement Benefits Other Than Pensions, and Postemployment Benefits\nSubstantially all employees of the Company are covered under multi-employer noncontributory defined benefit pension plans and postretirement health and life insurance benefit plans sponsored by Bell Atlantic and certain of its subsidiaries, including the Company.\nBell Atlantic - Washington, D.C., Inc.\nAmounts contributed to the Company's pension plans are actuarially determined, principally under the aggregate cost actuarial method, and are subject to applicable federal income tax regulations. Amounts contributed to 501(c)(9) trusts and 401(h) accounts under applicable federal income tax regulations to pay certain postretirement benefits are actuarially determined, principally under the aggregate cost actuarial method.\nThe Company also provides employees with postemployment benefits such as disability benefits, workers' compensation, and severance pay. Effective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits.\"\nINCOME TAXES\nBell Atlantic and its domestic subsidiaries, including the Company, file a consolidated federal income tax return.\nEffective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (Statement No. 109).\nThe consolidated amount of current and deferred tax expense is allocated by applying the provisions of Statement No. 109 to each subsidiary as if it were a separate taxpayer.\nThe Tax Reform Act of 1986 repealed the investment tax credit (ITC) as of January 1, 1986, subject to certain transitional rules. ITCs were deferred and are being amortized as a reduction to income tax expense over the estimated service lives of the related assets.\nRECLASSIFICATIONS\nCertain reclassifications of prior years' data have been made to conform to 1995 classifications.\n2. DISCONTINUATION OF REGULATORY ACCOUNTING PRINCIPLES\nIn the third quarter of 1994, the Company determined that it was no longer eligible for continued application of the accounting required by Statement of Financial Accounting Standards No. 71, \"Accounting for the Effects of Certain Types of Regulation\" (Statement No. 71). In connection with the decision to discontinue regulatory accounting principles under Statement No. 71, the Company recorded a noncash, extraordinary charge of $74,647,000, which is net of an income tax benefit of $74,423,000.\nThe Company's determination that it was no longer eligible for continued application of the accounting required by Statement No. 71 was based on the belief that the convergence of competition, technological change, actual and potential regulatory, legislative and judicial actions, and other factors were creating fully open and competitive markets. In such markets, the Company does not believe it can be assured that prices can be maintained at levels that will recover the net carrying amount of existing telephone plant and equipment, which has been depreciated over relatively long regulator-prescribed lives. In addition, changes from cost-based regulation to a form of incentive regulation contributed to the determination that the continued application of Statement No. 71 was inappropriate.\nA summary of the components of the after-tax charge recognized as a result of the discontinued application of Statement No. 71 follows:\nBell Atlantic - Washington, D.C., Inc.\nThe increase in the accumulated depreciation reserve was supported by both an impairment analysis, which identified estimated amounts not recoverable from future discounted cash flows, and a depreciation study, which identified inadequate depreciation reserve levels which the Company believes resulted principally from the cumulative underdepreciation of plant as a result of the regulatory process. Investment tax credit amortization was accelerated as a result of the reduction in remaining asset lives of the associated telephone plant and equipment.\nTax-related regulatory assets of $14,206,000 and tax-related regulatory liabilities of $22,217,000, which were established upon the adoption of Statement No. 109 and amortized as the related deferred taxes were recognized in the ratemaking process, were eliminated (See Note 9). The elimination of other regulatory assets and liabilities relates principally to deferred debt refinancing and vacation pay costs, which were being amortized as they were recognized in the ratemaking process.\n3. PLANT, PROPERTY AND EQUIPMENT\nPlant, property and equipment, which is stated at cost, is summarized as follows at December 31:\nCertain prior year amounts previously included in Construction-in-progress have been reclassified to Other to conform to 1995 classifications.\n4. LEASES\nThe Company leases certain facilities and equipment for use in its operations under both capital and operating leases. Plant, property and equipment included capital leases of $11,318,000 and $11,369,000, and related accumulated amortization of $7,245,000 and $6,245,000 at December 31, 1995 and 1994, respectively. The Company incurred no initial capital lease obligations in 1995 and 1994, as compared to $4,346,000 in 1993.\nTotal rent expense amounted to $10,786,000 in 1995, $9,254,000 in 1994 and $11,062,000 in 1993. Of these amounts, $8,756,000, $7,406,000 and $7,558,000 in 1995, 1994 and 1993, respectively, were lease payments to affiliated companies.\nBell Atlantic - Washington, D.C., Inc.\nAt December 31, 1995, the aggregate minimum rental commitments under noncancelable leases for the periods shown are as follows:\n5. DEBT\nDEBT MATURING WITHIN ONE YEAR\nDebt maturing within one year consists of the following at December 31:\nThe Company has a contractual agreement with an affiliated company, Bell Atlantic Network Funding Corporation (BANFC), for the provision of short-term financing and cash management services. BANFC issues commercial paper and secures bank loans to fund the working capital requirements of Bell Atlantic's network services subsidiaries, including the Company, and invests funds in temporary investments on their behalf. At December 31, 1995, the Company had $50,549,000 of an unused line of credit with BANFC.\nBell Atlantic - Washington, D.C., Inc.\nLONG-TERM DEBT\nLong-term debt consists principally of debentures issued by the Company. Interest rates and maturities of the amounts outstanding are as follows at December 31:\nLong-term debt outstanding at December 31, 1995 includes $155,000,000 that is callable by the Company. The call prices range from 102.5% to 100.0% of face value, depending upon the remaining term to maturity of the issue.\nIn 1993, the Company recorded an extraordinary charge associated with the early extinguishment of debentures called by the Company of $4,494,000, net of an income tax benefit of $3,082,000.\nAt December 31, 1995, the Company had $60,000,000 remaining under a shelf registration statement filed with the Securities and Exchange Commission.\n6. FINANCIAL INSTRUMENTS\nCONCENTRATIONS OF CREDIT RISK\nFinancial instruments that subject the Company to concentrations of credit risk consist primarily of trade receivables.\nConcentrations of credit risk with respect to trade receivables other than those from AT&T are limited due to the large number of customers in the Company's customer base. For the years ended December 31, 1995, 1994 and 1993, revenues generated from services provided to AT&T, primarily network access and billing and collection, were $36,550,000, $37,072,000 and $42,983,000, respectively. At December 31, 1995 and 1994, Accounts receivable, net, included $11,287,000 and $13,622,000, respectively, from AT&T.\nBell Atlantic - Washington, D.C., Inc.\nFAIR VALUE OF FINANCIAL INSTRUMENTS\nThe following methods and assumptions were used to estimate the fair value of each class of financial instruments.\nNote Payable to Affiliate (BANFC)\nThe carrying amount approximates fair value.\nDebt\nFair value is estimated based on the quoted market prices for the same or similar issues or on the net present value of the expected future cash flows using current interest rates.\nThe estimated fair values of the Company's financial instruments are as follows at December 31:\n* Debt includes Long-term debt and Debt maturing within one year, but excludes capital lease obligations and unamortized discount and premium.\n7. SHAREOWNER'S INVESTMENT\nOn October 31, 1994, the Board of Directors of the Company approved a transfer in the amount of $58,000,000 from stated capital, as represented by the Company's one issued share of common stock without par value, to capital surplus.\nBell Atlantic - Washington, D.C., Inc.\n8. EMPLOYEE BENEFITS\nPENSION PLANS\nSubstantially all of the Company's management and associate employees are covered under multi-employer noncontributory defined benefit pension plans sponsored by Bell Atlantic and certain of its subsidiaries, including the Company. The pension benefit formula is based on a flat dollar amount per year of service according to job classification under the associate plan. The pension benefit formula for plans covering management employees in 1995 and prior years is based on a stated percentage of adjusted career average earnings. The Company's objective in funding these plans is to accumulate funds at a relatively stable level over participants' working lives so that benefits are fully funded at retirement. Plan assets consist principally of investments in domestic and foreign corporate equity securities, U.S. and foreign government and corporate debt securities, and real estate.\nEffective January 1, 1996, the plan covering management employees was converted to a cash balance plan. Under the cash balance plan, pension benefits are determined by a combination of compensation credits based on age and service and individual account-based interest credits. Each management employee's opening account balance is based on accrued pension benefits as of December 31, 1995, and converted to a lump-sum amount determined under the prior plan's provisions. The lump-sum value is multiplied by a transition factor, based on age and service, to arrive at the opening balance.\nPension cost was $1,615,000, $5,117,000 and $5,343,000 for the years ended December 31, 1995, 1994 and 1993, respectively. The reduction in 1995 pension cost is principally due to an increase in the discount rate from 7.25% at December 31, 1993 to 8.25% at December 31, 1994, and plan changes.\nStatement of Financial Accounting Standards No. 87, \"Employers' Accounting for Pensions\" (Statement No. 87) requires a comparison of the actuarial present value of projected benefit obligations with the fair value of plan assets, the disclosure of the components of net periodic pension costs and a reconciliation of the funded status of the plans with amounts recorded on the balance sheets. The Company participates in multi-employer plans and therefore, such disclosures are not presented for the Company because the structure of the plans does not allow for the determination of this information on an individual participating company basis.\nThe significant assumptions used for the pension measurements were as follows at December 31:\nThe expected long-term rate of return on plan assets was 8.25% for 1995, 1994 and 1993.\nPension benefits for associate employees are subject to collective bargaining. Modifications in pension benefits have been bargained from time to time. Additionally, the Company has amended the benefit formula under pension plans maintained for its management employees. Substantive commitments for future amendments to the Company's pension plans have been reflected in determining the Company's pension cost. The actuarial assumptions used to determine pension cost are based on financial market interest rates, past experience, and management's best estimate of future benefit changes and economic conditions. Changes in these assumptions may impact future pension cost levels and benefit obligations.\nPOSTRETIREMENT BENEFITS OTHER THAN PENSIONS\nSubstantially all of the Company's management and associate employees are covered under postretirement health and life insurance benefit plans sponsored by Bell Atlantic and certain of its subsidiaries, including the Company. The determination of benefit cost for postretirement health benefit plans is based on comprehensive medical and dental benefit plan provisions. The postretirement life insurance benefit formula used in the determination of postretirement benefit cost is primarily based on annual basic pay at retirement. The Company funds the postretirement health and life insurance benefits of current and future retirees. Plan assets consist principally of investments in domestic and foreign corporate equity securities, and U.S. Government and corporate debt securities.\nBell Atlantic - Washington, D.C., Inc.\nPostretirement benefit cost was $8,658,000, $12,251,000 and $13,694,000 for the years ended December 31, 1995, 1994 and 1993, respectively. Postretirement benefit cost decreased in 1995 principally as a result of an increase in the discount rate from 7.25% at December 31, 1993 to 8.25% at December 31, 1994, and the effect of favorable plan experience.\nStatement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" (Statement No. 106) requires a comparison of the actuarial present value of projected postretirement benefit obligations with the fair value of plan assets, the disclosure of the components of net periodic postretirement benefit costs, a reconciliation of the funded status of the plan with amounts recorded on the balance sheets and the effect of a one-percentage-point increase in the assumed health care cost trend rates for each future year on net periodic postretirement benefit cost and the accumulated postretirement benefit obligation. The Company participates in multi-employer plans and therefore, such disclosures are not presented for the Company because the structure of the plans does not provide for the determination of this information on an individual participating company basis.\nAssumptions used in the actuarial computations for postretirement benefits are as follows at December 31:\nThe expected long-term rate of return on plan assets was 8.25% for 1995, 1994 and 1993.\nPostretirement benefits other than pensions for associate employees are subject to collective bargaining agreements and have been modified from time to time. The Company has also periodically modified benefits under plans maintained for its management employees. Substantive commitments for future amendments to the Company's postretirement benefit plans have been reflected in determining the Company's postretirement benefit cost. The actuarial assumptions used to determine postretirement benefit cost are based on financial market interest rates, past experience, and management's best estimate of future benefit changes and economic conditions. Changes in these assumptions may impact future postretirement benefit cost levels and benefit obligations.\nPOSTEMPLOYMENT BENEFITS\nEffective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits\" (Statement No. 112). The cumulative effect at January 1, 1993 of adopting Statement No. 112 reduced net income by $4,221,000, net of a deferred income tax benefit of $2,891,000.\nIn the third quarter of 1994, the Company recorded a pretax charge of $7,959,000 to recognize the Company's proportionate share of benefit costs for the separation of employees who are entitled to benefits under preexisting Bell Atlantic separation pay plans. The charge, which was actuarially determined, represents benefits earned through July 1, 1994 for employees who are expected to receive separation payments in the future.\nBell Atlantic - Washington, D.C., Inc.\nSAVINGS PLANS AND EMPLOYEE STOCK OWNERSHIP PLANS\nSubstantially all of the Company's employees are eligible to participate in savings plans established by Bell Atlantic to provide opportunities for eligible employees to save for retirement on a tax-deferred basis and encourage employees to acquire and maintain an equity interest in Bell Atlantic. Under these plans, a certain percentage of eligible employee contributions are matched with shares of Bell Atlantic common stock. Bell Atlantic funds the matching contribution through two leveraged employee stock ownership plans (ESOPs). Bell Atlantic accounts for its ESOPs in accordance with the accounting rules applicable to companies with ESOP trusts that held securities prior to December 15, 1989. The Company recognizes its proportionate share of total ESOP cost based on the Company's matching obligation attributable to participating Company employees. The Company recorded total ESOP cost of $2,304,000, $2,383,000 and $2,279,000, in 1995, 1994 and 1993, respectively.\n9. INCOME TAXES\nEffective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (Statement No. 109).\nAs of January 1, 1993, the Company recorded a charge to income of $381,000, representing the cumulative effect of adopting Statement No. 109, which has been reflected in the Provision for Income Taxes in the Statement of Operations and Reinvested Earnings (Accumulated Deficit).\nUpon adoption of Statement No. 109, the effects of required adjustments to deferred tax balances of the Company, which would be recognized in the future for regulatory purposes, were deferred on the balance sheet as regulatory assets and liabilities in accordance with Statement No. 71. At January 1, 1993, the Company recorded income tax-related regulatory assets totaling $19,245,000 in Other Assets and income tax-related regulatory liabilities totaling $40,199,000 in Deferred Credits and Other Liabilities - Other. During 1993, these regulatory assets were increased by $722,000 and regulatory liabilities were reduced by $4,319,000 for the effect of the federal income tax rate increase from 34% to 35%, effective January 1, 1993.\nThe income tax-related regulatory assets and liabilities were eliminated as a result of the discontinued application of Statement No. 71, effective August 1, 1994 (see Note 2).\nThe components of income tax expense are as follows:\nIn 1994, state income tax rate changes resulted in an increase to deferred tax expense of $705,000. As a result of the increase in the federal corporate income tax rate from 34% to 35%, effective January 1, 1993, the Company recorded a net benefit to the tax provision of $131,000 in 1993.\nBell Atlantic - Washington, D.C., Inc.\nThe provision for income taxes varies from the amount computed by applying the statutory federal income tax rate to income before provision for income taxes. The difference is attributable to the following factors:\nSignificant components of deferred tax liabilities (assets) were as follows at December 31:\nTotal deferred tax assets include approximately $65,000,000 and $63,000,000 at December 31, 1995 and 1994, respectively, related to postretirement benefit costs recognized in accordance with Statement No. 106. This deferred tax asset will gradually be realized over the estimated lives of current retirees and employees.\nBell Atlantic - Washington, D.C., Inc.\n10. ADDITIONAL FINANCIAL INFORMATION\nInterest paid during the year includes $2,101,000 in 1995, $81,000 in 1994 and $124,000 in 1993 related to short-term financing services provided by Bell Atlantic Network Funding Corporation (see Note 5).\nAt December 31, 1995 and 1994, $8,240,000 and $14,517,000, respectively, of negative cash was classified as accounts payable.\nTotal advertising expense amounted to $4,792,000 in 1995, $3,239,000 in 1994 and $3,175,000 in 1993. Of these amounts, $3,440,000, $2,395,000 and $2,145,000 in 1995, 1994 and 1993, respectively, were advertising expenses allocated to the company by Bell Atlantic Network Services, Inc. (NSI).\n11. TRANSACTIONS WITH AFFILIATES\nThe financial statements include transactions with NSI, Bell Atlantic Network Funding Corporation (BANFC), Bell Atlantic, and various other affiliates.\nThe Company has contractual arrangements with NSI for the provision of various centralized corporate, administrative, planning, financial and other services. These arrangements serve to fulfill the common needs of Bell Atlantic's operating telephone subsidiaries on a centralized basis. The Company's allocated share of NSI costs include costs billed by Bell Communications Research, Inc. (Bellcore), another affiliated company owned jointly by the seven regional holding companies.\nThe Company recognizes interest expense and income in connection with contractual arrangements with BANFC to provide short-term financing, investing and cash management services to the Company (see Note 5).\nBell Atlantic - Washington, D.C., Inc.\nOperating revenues include obligations to affiliates in connection with an interstate revenue sharing arrangement with Bell Atlantic's operating telephone subsidiaries. Operating revenues and expenses also include miscellaneous items of income and expense resulting from transactions with other affiliates, primarily rental of facilities and equipment. The Company also paid cash dividends and made distributions of capital surplus to its parent, Bell Atlantic.\nTransactions with affiliates are summarized as follows:\nOutstanding balances with affiliates are reported on the Balance Sheets at December 31, 1995 and 1994 as Accounts receivable - affiliates, Note payable to affiliate, and Accounts payable and accrued liabilities - affiliates.\nIn 1994, NSI operating expenses included $1,949,000 representing the Company's proportionate share of separation benefit costs for employees of NSI. Bellcore expenses in 1994 included reimbursements of $2,486,000 from other Bellcore owners in connection with their decision to participate in the Advanced Intelligent Network project. This project previously had been supported entirely by Bell Atlantic's operating telephone subsidiaries, including the Company.\nIn 1993, the Company's reported charge for the cumulative effect of the change in accounting for postemployment benefits included $555,000, net of a deferred income tax benefit of $380,000, representing the Company's proportionate share of NSI's accrued cost of postemployment benefits at January 1, 1993.\nBell Atlantic - Washington, D.C., Inc.\n12. QUARTERLY FINANCIAL INFORMATION (unaudited)\n* The loss for the third quarter of 1994 includes an extraordinary charge of $74,647,000, net of an income tax benefit of $74,423,000, related to the discontinuation of regulatory accounting principles (see Note 2).\nBell Atlantic - Washington, D.C., Inc.\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (DOLLARS IN THOUSANDS)\n- ------------------------------------------\n(a) (i) Amounts previously written off which were credited directly to this account when recovered; and (ii) accruals charged to accounts payable for anticipated uncollectible charges on purchases of accounts receivable from others which were billed by the Company.\n(b) Amounts written off as uncollectible.\nEXHIBITS\nFILED WITH ANNUAL REPORT FORM 10-K\nUNDER THE SECURITIES EXCHANGE ACT OF 1934\nFOR THE FISCAL YEAR ENDED DECEMBER 31, 1995\nBell Atlantic - Washington, D.C., Inc.\nCOMMISSION FILE NUMBER 1-7368\nForm 10-K for 1995 File No. 1-7368 Page 1 of 1\nEXHIBIT INDEX\nExhibits identified in parentheses below, on file with the Securities and Exchange Commission (SEC), are incorporated herein by reference as exhibits hereto.\nExhibit Number (Referenced to Item 601 of Regulation S-K) - ---------------------------------------------------------\n3a Restated Certificate of Incorporation of the registrant, as amended September 14, 1990. (Exhibit 3a to the registrant's Annual Report on Form 10-K for the year ended December 31, 1990, File No. 1-7368.)\n3a(i) Certificate of Amendment of the registrant's Certificate of Incorporation, dated January 12, 1994 and filed January 13, 1994. (Exhibit 3a(i) to the registrant's Annual Report on Form 10-K for the year ended December 31, 1993, File No. 1-7368.)\n3b By-Laws of the registrant, as amended December 15, 1995.\n3b(i) Consent of the Sole Stockholder of Bell Atlantic - Washington, D.C., Inc., dated December 15, 1995.\n4 No instrument which defines the rights of holders of long and intermediate term debt of the registrant is filed herewith pursuant to Regulation S-K, Item 601(b)(4)(iii)(A). Pursuant to this regulation, the registrant hereby agrees to furnish a copy of any such instrument to the SEC upon request.\n10a Agreement Concerning Contingent Liabilities, Tax Matters and Termination of Certain Agreements among AT&T, Bell Atlantic Corporation, and the Bell Atlantic Corporation telephone subsidiaries, and certain other parties, dated as of November 1, 1983. (Exhibit 10a to Bell Atlantic Corporation Annual Report on Form 10-K for the year ended December 31, 1993, File No. 1-8606.)\n10b Agreement among Bell Atlantic Network Services, Inc. and the Bell Atlantic Corporation telephone subsidiaries, dated November 7, 1983. (Exhibit 10b to Bell Atlantic Corporation Annual Report on Form 10-K for the year ended December 31, 1993, File No. 1-8606.)\n23 Consent of Independent Accountants.\n24 Powers of Attorney.\n27 Financial Data Schedule.","section_15":""}
{"filename":"818155_1995.txt","cik":"818155","year":"1995","section_1":"ITEM 1: BUSINESS\nGeneral\nWalshire Assurance Company ( Company ) is an insurance holding company headquartered in York, Pennsylvania. Through its wholly owned subsidiary, Lincoln General Insurance Company ( Lincoln General ), the Company primarily provides a specialized line of property and casualty insurance principally in Pennsylvania, and to a lesser extent, in Missouri, Georgia, Maryland, Alabama and in certain other states located in the mid-Atlantic, South, Southeastern and Midwest regions of the country. The Company recently organized Comp America Insurance Company ( Comp ) as an insurance company in Pennsylvania. Through 1995, no business has been written by Comp.\nThe Company principally offers commercial automobile physical damage and liability coverages for trucks, tractors, trailers, buses and other commercial vehicles as well as workers compensation coverages for trucking employees. To a lesser extent, the Company offers certain commercial coverages for cargo in transit and other property, commonly called inland marine coverage, as well as personal automobile physical damage, surety and fidelity coverages. The Company also provides adjusting services for claims covered by the Company and certain third parties, and financing for insurance premiums payable by customers of the Company and others. See Business Written and Claims .\nSince 1991, the Company has offered commercial automobile physical damage and commercial automobile liability coverages as well as surety bonds. In 1992, the Company began to offer personal automobile physical damage insurance, and in 1994, the Company began to offer workers compensation coverages. The following table sets forth the direct premiums written by the Company for the years ended December 31, 1995, 1994 and 1993 by line of business. (in thousands) Years Ended December 31,__ __1995_ 1994_ 1993__ Auto Liability ............ $24,004 $18,666 $14,860 Auto Physical Damage ...... 18,977 16,740 14,762 Workers Compensation ..... 5,329 1,864 - Inland Marine ............. 2,656 2,154 1,385 Other ..................... 1,054 680 497\n$52,020 $40,104 $31,504\nFor the past several years, the Company s principal strategy has been to position itself within its geographical markets as a consistent and reliable provider of commercial automobile coverages for the transportation industry. The Company believes that it has been able to operate successfully in the commercial automobile market due to five principal factors: (i) the Company s comprehensive knowledge of the transportation industry and the geographical markets in which the Company operates, which enables the Company to be more selective of the risks it underwrites and to settle claims within reasonable amounts, (ii) the Company s nineteen-year record of operations, which evidences the Company s willingness and ability to provide a consistent market for\ncommercial automobile coverages, (iii) the Company s strong agency force, which the Company has been able to build through careful selection, (See Business-Marketing), (iv) the Company s reputation for service, which the Company has been able to build through an agency force that is knowledgeable of the trucking industry and a claims department and adjusters which settle claims relatively quickly, and (v) the Company s degree of automation, which management believes is unusual for a company of its size and which permits prompt and efficient service to policyholders and agents.\nThe Company is a Pennsylvania corporation organized in December, 1976. The Company s principal executive offices are located at 3350 Whiteford Road, P. O. Box 3849, York, Pennsylvania 17402-0138, telephone (717) 757-0000. Unless the context otherwise requires, the Company refers to Walshire Assurance Company and its consolidated subsidiaries.\nRisk Factors\nIn analyzing whether to make or to continue an investment in the Company, investors should consider carefully all the information contained or incorporated by reference in this Annual Report on Form 10-K and, in particular, the following:\nImportance of Key Individual. The continued participation of Kenneth R. Taylor, its President and Chief Executive Officer is important to the Company s business. The Company has entered into an employment agreement with Mr. Taylor, expiring in 1997, which contains, among other things, a covenant not to compete during the term of the agreement and for one year thereafter. Although Mr. Taylor may voluntarily terminate his employment under this agreement, he has no present intention to do so. Mr. Taylor devotes such time to the Company as he believes is appropriate, although his employment agreement provides that he is not required to devote his entire business time to the Company. The loss of the services of Mr. Taylor could adversely affect the Company s business. The Company does not maintain key-man life insurance on Mr. Taylor. See - Item 10: Directors and Executive Officers of the Registrant and Item 11: Executive Compensation .\nImportance of Key Agent. During 1995, 1994 and 1993, one of the Company s agents accounted for 23%, 24% and 30%, respectively, of the total premiums written by the Company. The loss of this agent could adversely affect the Company s business. See Item 1: BUSINESS - Marketing .\nRestrictions on Dividends and Other Distributions from Insurance Subsidiaries. One of the Company s sources of cash with which to pay dividends on its outstanding securities is dividends from Lincoln General and Comp ( Insurance Subsidiaries ). The Insurance Subsidiaries are subject to state laws which restrict the amount of dividends and other distributions they may pay. As of December 31, 1995, the Insurance Subsidiaries had $3,238,000 available for the payment of dividends to the Company, without the prior approval of insurance regulatory authorities. The Insurance Subsidiaries are also subject to risk-based capital requirements which may further restrict their ability to pay dividends. See Item 1: BUSINESS - Regulation and Note 11 of the Notes to Consolidated Financial Statements, incorporated by reference.\nRegulation. Insurance companies are subject to the supervision, laws and regulations of the states in which they transact business. These laws and regulations cover many aspects of their business, including licensure, the payment of dividends, the establishment of premium rates, the settlement of claims, the transfer of control and the requirement to participate in assigned risk pools. Certain changes in such laws and regulations could have a material adverse effect on the operations of insurance companies, including the Company. Specific regulatory developments which could have a material adverse effect on the operations of the insurance industry include, but are not limited to, the potential repeal of the McCarran-Ferguson Act (which exempts insurance companies from a variety of federal regulatory requirements) and possible rate rollback legislation. In addition, the administration of such regulations is vested in state agencies which have broad powers and are concerned primarily with the protection of policyholders. Under the Pennsylvania Insurance Company Law, subject to certain exceptions, no person may make an offer to acquire control (as defined by statute) or acquire control of the Company without the prior approval of the Pennsylvania Insurance Department. Control is presumed to exist if any person, directly or indirectly, owns, controls, holds with the power to vote, or holds proxies representing 10% or more of the voting securities of the Company. See Item 1: BUSINESS - Regulation .\nCompetition: The property and casualty insurance industry is highly competitive on the basis of both price and service. There are numerous companies competing for business in the geographic markets in which the Company operates, and no single company dominates. See Item 1: BUSINESS - Competition .\nReinsurance. The Company relies upon reinsurance agreements to limit its maximum net loss from large single risks or risks in concentrated areas, and to increase its capacity to write insurance. Reinsurance does not relieve the primary insurer from liability to its policyholders. To the extent that a reinsurer may be unable to pay losses for which it is liable under the terms of a reinsurance agreement, the Company is exposed to the risk of continued liability for such losses. However, the Company requires all of its reinsurers to have a Best s rating of A (Excellent ) or better. Additional premiums incurred under certain reinsurance arrangements as a result of catastrophic events could adversely affect the profitability of the Company. See Item 1: BUSINESS - Reinsurance .\nCertain Provisions of the Company s Articles of Incorporation and Bylaws. The Company s Articles of Incorporation and Bylaws provide, among other things, that (i) the Board of Directors may, without further action of the shareholders of the Company, issue up to 2,000,000 shares of preferred Stock with such terms as may be determined by the Board of Directors, subject to certain limitations; (ii) directors are to be elected to staggered three-year terms; (iii) directors may only be removed by a vote of shareholders entitled to cast at least 75% of the votes that all shareholders are entitled to cast thereon and, in certain cases only for cause; (iv) there is no cumulative voting for the election of directors; and (v) any proposed amendment to the Company s Articles of Incorporation or Bylaws, which is not approved by the Board of Directors, must be approved by the vote of shareholders entitled to cast at least 75% of the votes that all shareholders are entitled to cast thereon. Pursuant to these provisions, the Company issued 141,700 shares of 6 1\/2% Cumulative Convertible Preferred Stock with certain\npreferred and special rights. These provisions could adversely affect the rights of the holders of 6 1\/2% Cumulative Convertible Preferred Stock and Common Stock and may have the effect of discouraging offers to acquire the Company. In addition, as a result of the super-majority voting provisions relating to an amendment of the Company s Articles of Incorporation and Bylaws and the percentage of the outstanding shares of the Company s Common Stock that certain directors and\/or officers of the Company beneficially own, such directors and\/or officers will be able to defeat any amendment to such Articles or Bylaws not approved by them. No dividends may be declared or paid with respect to the Common Stock until all accrued dividends on the 6 1\/2% Cumulative Convertible Preferred Stock have been paid or set apart for payment. Copies of the Company s Articles of Incorporation and Bylaws are on file with the Securities Exchange Commission.\nBusiness Written\nInsurance underwriting opportunities are evaluated, and the decision to write a particular risk is made, by the underwriting department of the Company or by the Company s agents, subject in the latter case to final approval by the underwriting department. The decision to write a particular risk is based on a number of factors, including the experience and past claims of the insured, the value and type of property to be insured and the type and location of the operation conducted by the insured.\nThe following table sets forth direct premiums written, net premiums earned and the combined ratio of the Company for the last three fiscal years. The combined ratio is a traditional measure of underwriting profitability. The ratio is the sum of (i) the ratio of incurred losses and associated expenses to net premiums earned ( loss ratio ) and (ii) the ratio of expenses incurred for commissions, premium taxes, administrative and other underwriting expenses to net premiums written ( expense ratio ). When the combined ratio is under 100%, underwriting results are generally considered profitable. Conversely, when the combined ratio is over 100%, underwriting results are generally considered unprofitable. The combined ratio does not reflect investment income, federal income taxes or other non-operating income or expenses.\n(in thousands, except percentages) Years Ended December 31,___ 1995_ 1994_ 1993_\nGross premiums written ............. $52,138 $40,199 $31,583 Net premiums earned ................ 36,191 28,848 22,511 Combined ratio (1) ................. 87% 89% 90%\nIn February 1995, the Company received its current rating A+ (Superior) from A. M. Best Company. Best s ratings are based upon factors relevant to policyholders and are not necessarily directed toward the protection of investors.\nMarketing\nThe Company s insurance services are marketed through approximately 360 independent insurance agents. The Company selects agents based on _________________________ (1) Combined ratios have been calculated in accordance with accounting principles prescribed or permitted by state regulatory agencies. their comprehensive knowledge of the industries to which the Company provides insurance coverages and the Company s product markets, including in particular the transportation industry, and of the geographic market in which the agents operate. During 1995, one of the Company s agents accounted for 23% of the total premiums written by the Company and another agent accounted for 6% of the total premiums written by the Company. See Item 13: Certain Relationships and Related Transactions .\nThe Company continually monitors and evaluates each agent s performance in terms of premiums written and loss experience. The Company maintains a contingent commission program for its agents. Under this program, certain agents, who underwrite specific amounts of insurance, are entitled to receive additional commissions based upon the profitability to the Company of the business placed by the particular agent. For 1995, aggregate contingent commissions represented 7% of all commissions for such year. The Company believes this program helps it to retain quality agents and encourages those agents to generate profitable business for the Company.\nReinsurance\nThe Company reinsures a portion of its exposure by paying to reinsurers a portion of the premiums received on all policies. Insurance is ceded primarily to reduce the net liability on individual risks and to protect against catastrophic losses. Although reinsurance does not legally discharge an insurer from its primary liability for the full amount of the coverage, it does make the assuming reinsurer liable to the insurer to the extent of the losses reinsured.\nThe Company maintains excess catastrophe reinsurance covering commercial automobile physical damage and inland marine losses and excess loss reinsurance covering commercial automobile physical damage and inland marine losses occurring at a terminal.\nPursuant to another reinsurance treaty, the Company maintains excess of loss reinsurance covering commercial automobile liability losses. Under this treaty, the Company s maximum loss exposure on any one loss occurrence (at a maximum coverage of $1,000,000) is $250,000. The Company also maintains contingency excess of loss reinsurance covering commercial automobile liability losses in excess of $1,000,000 (to a maximum of $3,000,000).\nThe Company also maintains excess of loss reinsurance covering non- trucking automobile liability losses. Under this treaty, the Company s maximum loss exposure on any one risk (at a maximum coverage of $1,000,000) is $250,000. Also the Company maintains excess of loss reinsurance covering extraordinary medical benefit losses. Under this excess of loss reinsurance treaty, the Company s maximum loss exposure on any one risk (at a maximum coverage of $1,000,000) is $250,000. The Company reinsures all loss exposures in excess of the maximum loss exposure under each of these liability loss reinsurance treaties.\nPursuant to another reinsurance treaty, the Company maintains excess of loss reinsurance covering workers compensation losses. Under this treaty, the Company retains $250,000 of each occurrence. Losses in excess of $250,000 to a limit of $5,000,000 are reinsured. Any loss in excess of $5,000,000 is the obligation of the Company. The Company s policy is to maintain reinsurance only with insurance companies with a Best s rating A (Excellent) or better. The Company generally has experienced little difficulty in obtaining reinsurance or in receiving timely payment from its reinsurers. The Company does not believe allowances for potentially uncollectible reinsurance are needed.\nFor further information relating to the Company s reinsurance arrangement, see Note 2 of the Notes to Consolidated Financial Statements.\nRates\nThe Company develops its rate structure from various sources. For some of the Company s products, rates are derived from rating bureaus such as the Insurance Services Office ( ISO ), the National Council on Compensation Insurance ( NCCI ), the American Association of Insurance Services ( AAIS ) and the Surety Association of America ( SAA ). When developing rates utilizing material provided by these organizations, the Company will use the rates promulgated by the bureau or it will apply its own expense and profit factors to the specific organization-generated loss costs. For other products, the Company has developed its own rate structure independent of any rating bureau. All necessary rate changes requiring approval are submitted to the appropriate regulatory authorities for review and approval prior to use.\nClaims\nAll claims operations, including review of initial reports of claims and the determination of liability amounts, are conducted by the Company s claims department. The Company employs a staff of attorneys and adjusters specializing in the transportation industry for the purpose of adjusting claims covered by the Company and certain third parties. The Company believes that by using attorneys and adjusters with an expertise in the transportation industry, it is able to settle claims within a relatively short period of time and within reasonable amounts. When appropriate, the Company also uses outside attorneys and adjusters.\nLiabilities for Unpaid Claims and Claim Settlement Expenses\nThe Company maintains liabilities for future payments of claims and claim settlement expenses. Claim liabilities are estimates of the ultimate amount that will be required to be paid for claims and consist of reported claims and incurred but not reported claims. Claim settlement expense liabilities are intended to cover the estimated costs of settling all claims, including investigation and litigation costs, and are determined on the basis of historical experience.\nThe amount of claim liabilities for reported claims is based upon an evaluation of the type of risk involved, knowledge of the specific circumstances surrounding each claim and the policy provisions relating to the type of claim. Claim liabilities for incurred but not reported claims are calculated based upon historical experience and current conditions. Liabilities for unpaid claims are closely monitored and are recomputed periodically by the Company using updated information on reported claims.\nPrior to 1994, the majority of the insurance written by the Company was on property risks. Property claims tend to be reported quickly and generally are settled within a relatively short period of time compared to other lines of business. As a result of this short tail , the Company was not required to monitor and recompute liabilities for unpaid claims over an extended period of time on these coverages. Moreover, because of the relatively short period of time within which these claims are settled, the effect of inflation on loss development was not significant. In 1992, the Company began to write more liability coverages, and in 1994, the majority of the business written by the Company was liability coverages. As a result, the Company is required to monitor liabilities for unpaid claims over a longer period of time than was the case when the Company principally wrote property coverages. To date, the Company has not had to make significant recomputations for unpaid claims and the effect of inflation has not been significant.\nThe following table sets forth the unpaid claims, claim settlement expenses and claims drafts outstanding as of December 31, 1995, 1994 and 1993, and the age of such claims based upon the date the claim occurred.\n(in thousands) Years Ended December 31,___ 1995 1994 1993 Unpaid claims, claim settlement expenses and claims drafts outstanding at end of period.. $20,153 $14,292 $11,764\nAge of unpaid claims, claim settlement expenses and claims drafts outstanding at end of period:\nZero to three months ......... $ 4,836 $ 3,314 $ 4,650 Three to six months .......... 2,579 1,297 3,247 Six months to one year ....... 3,639 2,980 1,698 Over one year ................ 9,099 6,701 2,169\nInvestments\nThe following table sets forth the classification of the Company s investment portfolio as of December 31, 1995, 1994, and 1993. As of December 31, 1995, less than 4% of the debt securities in the Company s investment portfolio were considered below investment grade, principally because such securities were not rated.\n(in thousands, except percentages) December 31,_______________ 1995_____ 1994_____ 1993_____ Amount Percent Amount Percent Amount Percent\nHeld to Maturity: Fixed Maturities: U.S. Treasury securi- ties and obligations of U.S. government corporations and agencies ........... $ 4,141 7% $ 1,629 3% $ - -%\nObligations of states and political subdivisions ....... 11,076 19 14,879 30 13,283 33\nTotal held to maturity (1) ....... 15,217 26 16,508 33 13,283 33\nAvailable for sale: Fixed Maturities: U.S. Treasury securi- ties and obligations of U.S. government corporations and agencies ............. 4,594 8 4,988 10 3,446 9 Obligations of states and political subdi- visions .............. 20,981 36 14,939 30 11,039 27 Debt securities issued by foreign govern- ments ................ 35 - 35 - 35 - Corporate securities .. 1,605 3 1,702 3 1,105 3\nTotal fixed maturities (2) ...... 27,215 47 21,664 43 15,625 39\nEquity securities (3) .. 8,720 15 7,611 15 6,076 15\nTotal available for sale ............ 35,935 62 29,275 58 21,701 54 Mortgage loans .......... 116 - 124 - 132 -\nOther investments ....... 1,751 3 744 1 770 2\nShort term investments (4) ........ 5,191 _ 9 3,889 _ 8 4,438 _11\nTotal investments ... $58,210 100% $50,540 100% $40,324 100%\n_________________________ (1) Securities held to maturity are valued at cost, which has been adjusted for amortization of discount or premium. Total fair value of securities held to maturity was $15,712 at December 31, 1995, $16,140 at December 31, 1994 and $13,922 at December 31, 1993. (2) Beginning in 1994, fixed maturities available for sale are valued at fair value. Prior to 1994, fixed maturities available for sale were valued at the lower of aggregate amortized cost or fair value. Total amortized cost of fixed maturities available for sale was $27,007 at December 31, 1995 and $22,588 at December 31, 1994. Total fair value of fixed maturities available for sale was $15,885 at December 31, 1993. (3) Equity securities are valued at fair value. Total costs of equity securities were $8,189 at December 31, 1995, $8,263 at December 31, 1994 and $5,164 at December 31, 1993. (4) Short-term investments are valued at cost, which approximates fair value.\nThe following table sets forth the maturities of the Company s investment portfolio of fixed maturities as of December 31, 1995.\n(in thousands except percentages) December 31, 1995_ Amount Percent\nDue in one year or less ................... $ 1,534 4%\nDue after one year through five years ..... 14,367 34\nDue after five years through ten years .... 14,017 33\nDue after ten years ....................... 12,514 29\nTotals $42,432 100%\nMercantile Safe Deposit & Trust Company, Baltimore, Maryland, acts as investment adviser to the Company in connection with its fixed income investment portfolio.\nCompetition\nThe property and casualty insurance industry is highly competitive on the basis of both price and service. There are numerous companies competing for business in the geographic markets in which the Company operates, and no single company dominates. Some of the Company s competitors are national in scope and some have substantially greater financial resources than those of the Company. The Company believes it has been able to compete successfully by providing a consistent market for commercial automobile coverages and by providing quality service through agents and a staff who are knowledgeable of the transportation industry.\nRegulation\nInsurance companies are subject to supervision and regulation in the states in which they transact business. Such supervision and regulation relates to numerous aspects of an insurance company s business and financial condition. The primary purpose of such regulation is the protection of policyholders. The extent of such regulation varies, but generally derives from state statutes which delegate regulatory, supervisory and administrative authority to state insurance departments. The authority of state insurance departments includes licensing of insurers and agents, approval of policy forms, establishment of standards of solvency for insurers, adoption of rules governing investments and premium rates for property and casualty insurance, and adoption of rules governing provisions for current losses and future liabilities and deposits of securities for the benefit of policyholders. State insurance departments also conduct periodic examinations of the affairs of insurance companies and require the filing of annual and other reports relating to the financial condition of insurance companies.\nThe majority of the states in which the Company does business and proposes to do business have guaranty fund laws under which insurers\ndoing business in such states can be assessed on the basis of premiums written by the insurer in those states in order to fund policyholder liabilities of insolvent companies. In general, under these laws, an insurer is subject to assessment, depending upon its market share of a given line of business, to assist in the payment of certain policyholders claims against insolvent insurers. The Company has made accruals for its portion of assessments related to such insolvencies based upon the most current information furnished by the guaranty associations. During the year ended December 31, 1995, the amount of such insolvency assessments paid by the Company was not material.\nThe property and casualty insurance industry continues to receive a considerable amount of publicity. New regulations and legislation are being proposed to roll back premium rates, to limit damage awards, to control plaintiffs counsel fees, to bring the industry under regulation by the federal government and to control premiums, policy terminations and other policy terms. It is not possible to predict whether, in what form or in which jurisdictions these proposals might be adopted or the effect, if any, on the Company.\nUnder Pennsylvania law, the Company, as the insurance holding company for the Insurance Subsidiaries, is subject to various registration and periodic reporting requirements. In addition, the Insurance Subsidiaries are subject to various restrictions on the amount of dividends they may pay to the Company. Under Pennsylvania law, the Insurance Subsidiaries are permitted to pay, without the prior approval of the Pennsylvania Insurance Commissioner, cash or property dividends to the Company within any twelve month period in an amount up to the greater of (i) 10% of the Insurance Subsidiaries surplus as shown in its most recent annual statement on file with the Pennsylvania Insurance Department, or (ii) the net investment income earned, excluding net realized capital gains or losses, shown in such statement. The Pennsylvania Insurance Company Law also provides that the Insurance Subsidiaries may pay dividends to the Company only from its profits as determined by statute.\nEffective December 31, 1994, the National Association of Insurance Companies (NAIC) required insurance companies to calculate and report information under a risk-based capital formula. Risk-based capital requirements are intended to allow insurance regulators to identify inadequately capitalized insurance companies based upon the type and mixture of risks inherent in the company s operations. The formula includes components for asset risk, liability risk, and other factors. As of December 31, 1995, the Insurance Subsidiaries are above required capital levels.\nUnder the Pennsylvania Insurance Company Law, without the prior approval of the Pennsylvania Insurance Department, subject to certain exceptions, no person (other than the Company) may: (i) make a tender offer for or a request or invitation for tenders of, or enter into any agreement to exchange securities or seek to acquire or acquire in the open market or otherwise, any voting security of the Company if, after the consummation thereof, such person would directly or indirectly, or by conversion or by exercise of any right to acquire, be in control of the Company, or (ii) enter into an agreement to merge with or otherwise to acquire control of the Company. Control is defined as the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through\nthe ownership of voting securities, by contract (other than a commercial contract for goods or non-management services) or otherwise, unless the power is the result of an official position with or corporate office held by the person. Control is presumed to exist if any person, directly or indirectly, owns, controls, holds with the power to vote or holds proxies representing 10% or more of the voting securities of the Company. Such presumption may be rebutted upon a showing that control does not exist. The term voting security includes any security convertible into or evidencing a right to acquire a voting security. As a condition to approval, the Pennsylvania Insurance Department may require that such offer remain open a specified minimum length of time, permit certain withdrawals of shares deposited in connection with such offer and require pro rata acceptance of any shares deposited pursuant to the offer.\nEmployees\nAs of December 31, 1995 the Company had approximately 110 employees. None of the employees of the Company is covered by a collective bargaining contract. The Company believes that its employee relations are excellent.\nITEM 2:","section_1A":"","section_1B":"","section_2":"ITEM 2: PROPERTIES\nThe Company s headquarters are located in a 25,000 square foot building in York, Pennsylvania, which is owned by the Company.\nITEM 3:","section_3":"ITEM 3: LEGAL PROCEEDINGS\nThe Company currently is a party to certain lawsuits arising in the ordinary course of its business. The Company believes that none of its current legal proceedings would, if adversely determined, have a material effect on its business or financial condition.\nITEM 4:","section_4":"ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone\nITEM 4.1: EXECUTIVE OFFICERS OF THE REGISTRANT\nSet forth below is certain information concerning the executive officers of the Company who are not also directors.\nName Age Position with the Company\nGary J. Orndorff 38 Vice President-Treasurer and Chief Financial Officer of the Company and Lincoln General\nRichard S. Kahlbaugh 35 General Counsel of the Company and Secretary of Lincoln General\nGlenn E. Sell, Jr. 52 Vice President-Underwriting of Lincoln General\nMr. Orndorff was elected Vice President-Treasurer and Chief Financial Officer of the Company and of Lincoln General in May, 1989. Mr. Orndorff joined the Company in August, 1986.\nMr. Kahlbaugh was elected Secretary of Lincoln General in February, 1996. Mr. Kahlbaugh joined the Company in July, 1992. Prior thereto, Mr. Kahlbaugh was an attorney with Ford New Holland, Inc.\nMr. Sell was elected Vice President-Underwriting of Lincoln General in June, 1987. Mr. Sell joined the Company in January, 1987.\nPART II\nITEM 5:","section_5":"ITEM 5: MARKET FOR THE REGISTRANT S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nIncorporated by reference from the section entitled Quarterly Common Stock Prices and Cash Dividends Per Share in the Company s Annual Report to Shareholders for the year ended December 31, 1995.\nITEM 6:","section_6":"ITEM 6: SELECTED FINANCIAL DATA\nIncorporated by reference from the section entitled Financials at a Glance in the Company s Annual Report to Shareholders for the year ended December 31, 1995.\nITEM 7:","section_7":"ITEM 7: MANAGEMENT S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nIncorporated by reference from the section entitled Management s Discussion and Analysis of Financial Condition and Results of Operations in the Company s Annual Report to Shareholders for the year ended December 31, 1995.\nITEM 8:","section_7A":"","section_8":"ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nIncorporated by reference from the Company s Financial Statements, the notes thereto, and the independent auditors report included in the Company s Annual Report to Shareholders for the year ended December 31, 1995.\nITEM 9:","section_9":"ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone\nPART III\nITEM 10:","section_9A":"","section_9B":"","section_10":"ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nIncorporated by reference from the Company s 1996 proxy statement to be filed pursuant to General Instruction G(3) to the Form 10-K,except information concerning certain Executive Officers of the Company which is set forth in Item 4.1 hereof.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nIncorporated by reference from the Company s 1996 proxy statement to be filed pursuant to General Instruction G(3) to the Form 10-K.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nIncorporated by reference from the Company s 1996 proxy statement to be filed pursuant to General Instruction G(3) to the Form 10-K.\nITEM 13:","section_13":"ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nIncorporated by reference from the Company s 1996 proxy statement to be filed pursuant to General Instruction G(3) to the Form 10-K.\nPART IV\nITEM 14:","section_14":"ITEM 14: EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\nI. Documents filed as part of this report:\nA. Financial Statements. The following consolidated financial statements and the notes thereto of Walshire Assurance Company, which are included in the Company s Annual Report to Shareholders for the year ended December 31, 1995, have been incorporated by reference into Item 8 of this Report on Form 10-K. The Independent Auditors Report, which covers the Company s financial statement schedules, appears on page A-1 of this Report on Form 10-K.\nConsolidated Balance Sheets - December 31, 1995 and 1994.\nConsolidated Statements of Income - Years ended December 31, 1995, 1994 and 1993.\nConsolidated Statements of Shareholders Equity - Years ended December 31, 1995, 1994 and 1993.\nConsolidated Statements of Cash Flows - Years ended December 31, 1995, 1994 and 1993.\nNotes to Consolidated Financial Statements\nB. Schedules.\nIndependent Auditors Report on Schedules A-1\nI. Summary of Investments Other Than Investments in Related Parties - December 31, 1995. A-2\nII. Condensed Financial Information of Registrant - December 31, 1995 and 1994 and Years ended December 31, 1995, 1994 and 1993 A-3\nIII. Supplementary Insurance Information - Years Ended December 31, 1995, 1994 and 1993 A-6\nIV. Reinsurance - Years Ended December 31, 1995, 1994 and 1993 A-7\nV. Valuation and Qualifying Accounts - Years Ended December 31, 1995, 1994 and 1993. A-8\nAll other schedules not listed have been omitted since the required information is included in the financial statements or the notes thereto, or is not applicable or required.\nC. Exhibits filed pursuant to Item 601 of Regulation S-K. (Management contracts and compensation plans or arrangements are indicated by (*)).\n(1) 3.1 Amended and Restated Articles of Incorporation of the Company.\n(1) 3.2 Bylaws of the Company.\n(5) 3.3 Statement with Respect to 6 1\/2% Cumulative Convertible Preferred Stock.\n(1) 4.1 Specimen Common Stock Certificate of the Company.\n(5) 4.2 Specimen Preferred Stock Certificate of the Company.\n(*) (1) 10.1 The Company s 1987 Stock Option Plan.\n(*) (1) 10.2 The Company s Employee Stock Purchase Plan.\n(*) (5) 10.4 Second Amended and Restated Employment Agreement, dated June 22, 1992, between the Company and Kenneth R. Taylor\n(*) (2) 10.6 The Company s 1990 Stock Option Plan for Non-Employee Directors.\n(3) 10.7 Mortgage and Note, dated July 10, 1989, between Walshire Assurance Company and Gary J. Orndorff\n(*) (3) 10.8 Walshire Assurance Company Master 401(k) Plan and Trust\n(6) 10.10 Term Loan Agreement, dated January 25, 1995, between the Company and Mercantile Pennsylvania Corporation.\n(5) 10.11 Lincoln General Insurance Company Quota Share Fire-Burglary\/Theft Reinsurance Contract\n(4) 10.19 Lincoln General Insurance Company Bond Quota Share Reinsurance Agreement\n(*) (1) 10.22 Form of Director s Stock Option Agreement.\n(7) 11.1 Computation of Per Share Earnings\n(7) 13.1 Annual Report to Shareholders for the year ended December 31, 1995 (such report, except for those portions expressly incorporated by reference in this Report on Form 10-K, is furnished for the information\nof the Commission and is not to be deemed filed as part of this Report on Form 10-K).\n(5) 21.1 Subsidiaries of the Company.\n(7) 23.1 Consent of KPMG Peat Marwick LLP\n_________________________ (1) Incorporated by reference from the Company s Registration Statement on Form S-1, and all amendments thereto, (Registration No. 33-15549), which was declared effective on September 3, 1987.\n(2) Incorporated by reference from the Company s Form 10-K (Commission File No. 0-16267), dated March 28, 1990.\n(3) Incorporated by reference from the Company s Form 10-K (Commission File No. 0-16267), dated March 28, 1991.\n(4) Incorporated by reference from the Company s Form 10-K (Commission File No. 0-16267), dated March 26, 1992.\n(5) Incorporated by reference from the Company s Form 10-K (Commission File No. 0-16267), dated March 28, 1994.\n(6) Incorporated by reference from the Company s Form 10-K (Commission File No. 0-16267), dated March 27, 1995.\n(7) Filed herewith.\nII. Reports on Form 8-K.\nNo reports on Form 8-K were filed during the quarter ended December 31, 1995.\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.\nWALSHIRE ASSURANCE COMPANY\nDate: March 25, 1996 BY: \/s\/ KENNETH R. TAYLOR_ _____ KENNETH R. TAYLOR, President and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on March 25, 1996.\nSIGNATURES TITLE\n\/s\/ CHARLES W. HASH, SR.____ CHARLES W. HASH, SR. Chairman of the Board of Directors\n\/s\/ KENNETH R. TAYLOR_______ KENNETH R. TAYLOR President & Chief Executive Officer (Principal Executive Officer)\n\/s\/ GARY J. ORNDORFF________ GARY J. ORNDORFF Vice President\/Treasurer (Principal Financial and Accounting Officer)\n\/s\/ PETER D. BENNETT________ PETER D. BENNETT Director\n\/s\/ JOHN J. BUCHAN, JR._____ JOHN J. BUCHAN, JR. Director\n\/s\/ CHARLES W. HASH, JR.____ CHARLES W. HASH, JR. Director\n\/s\/ L. EDWARD SAUSMAN, JR.__ L. EDWARD SAUSMAN, JR. Director\n\/s\/ WILLIAM R. TIERNEY, JR._ WILLIAM R. TIERNEY, JR. Director\nIndependent Auditors Report\nThe Board of Directors and Shareholders Walshire Assurance Company:\nUnder date of February 29, 1996, we reported on the consolidated balance sheets of Walshire Assurance Company and subsidiaries as of December 31, 1995 and 1994, 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, 1995, as contained in the 1995 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 1995. In connection with our audits of the aforementioned consolidated financial statements, we also have audited the related financial statements schedules as listed at Item 14B. These financial statement schedules are the responsibility of the Company s management. Our responsibility is to express an opinion on these financial statements 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\nFebruary 29, 1996\nA-1\nSchedule I WALSHIRE ASSURANCE COMPANY AND SUBSIDIARIES\nSummary of Investments Other Than Investments in Related Parties\nDecember 31, 1995 (in thousands)\nAmount at which Fair shown in the Type of Investment Cost__ Value_ balance sheet_ Held to Maturity: Fixed maturities: U. S. Government and Agencies. $ 4,141 $ 4,246 $ 4,141 States and political subdivisions ................ 11,076 11,466 11,076\nTotal held to maturity ...... 15,217 15,712 15,217\nAvailable for sale: Fixed maturities: U. S. Government and Agencies. 4,499 4,594 4,594 States and political subdivisions ................ 20,783 20,981 20,981 Foreign governments .......... 35 35 35 Corporate securities ......... 1,690 1,605 1,605\nTotal fixed maturities ...... 27,007 27,215 27,215 Equity securities: Common Stocks: Public Utilities ............ 97 168 168 Banks, trusts and insurance companies .................. 2,629 3,341 3,341 Industries, miscellaneous and all other .............. 4,331 4,095 4,095 Non-redeemable preferred stock........................ 1,132 1,116 1,116\nTotal equity securities ..... 8,189 8,720 8,720\nTotal available for sale .... 35,196 35,935 35,935\nShort-term investments ......... 5,191 5,191 5,191\nOther investments .............. 1,867 1,867 1,867\n$57,471 $58,705 $58,210\nA-2\nSchedule II\nWALSHIRE ASSURANCE COMPANY AND SUBSIDIARIES\nCondensed Financial Information of Registrant\nWalshire Assurance Company\nBalance Sheets (Parent Company)\nDecember 31\n(in thousands, except per share data)\n1995 1994 Assets: Investments: Available for sale: Fixed maturates . . . . . . . . . . . . $ 1,430 $ 1,155\nEquity securities . . . . . . . . . . . 4,034 3,788 Short-term investments. . . . . . . . . . 368 188 Other investments . . . . . . . . . . . . 1,857 858 Total investments . . . . . . . . . . . 7,689 5,989 Cash. . . . . . . . . . . . . . . . . . . . 45 83 Receivable from subsidiaries. . . . . . . . 897 2,293 Investment in subsidiaries. . . . . . . . . 40,344 33,827 Property and equipment, net . . . . . . . . 786 272 Other assets. . . . . . . . . . . . . . . . 369 103 Total assets. . . . . . . . . . . . . . $50,130 $42,567\nLiabilities Notes payable . . . . . . . . . . . . . . . $ 3,731 $ 2,401 Other liabilities . . . . . . . . . . . . . 385 152 Total liabilities . . . . . . . . . . . 4,116 2,553 Shareholders equity: Preferred stock, par value $.01 per share; 2,000 shares authorized; 142 shares issued; 138 and 142 shares outstanding . . . . . . . . . . . 1 1 Common stock, par value $.01 per share; 10,000 shares authorized; 4,064 and 3,638 shares issued and outstanding . . . . . . . . . . . . . . . 41 36 Additional paid-in capital. . . . . . . . . 31,918 25,751 Unrealized gain (loss) on investments available for sale of parent and subsidiaries (net of deferred taxes of $181 and $(534). .. . . . . . . . . . . . 558 ( 1,042) Retained earnings . . . . . . . . . . . . . 13,496 15,268 Shareholders equity. . . . . . . . . . 46,014 40,014 Total liabilities and shareholders equity. . . . . . . . . $50,130 $42,567\nSee notes to consolidated financial statements.\nA-3 Schedule II (continued)\nWALSHIRE ASSURANCE COMPANY AND SUBSIDIARIES\nCondensed Financial Information of Registrant\nWalshire Assurance Company\nStatements of Income (Parent Company)\nYears Ended December 31\n(in thousands) 1995 1994 1993 Revenues: Net investment income . . . . . . $ 949 $ 479 $ 1,352 Net realized gains on investments . . . . . . . . . . 160 539 459 Management fees: Subsidiaries. . . . . . . . . . 247 216 173 Other . . . . . . . . . . . . . - - 32 Other . . . . . . . . . . . . . . 9 - -\nTotal revenues. . . . . . . . 1,365 1,234 2,016\nExpenses: General and administrative. . . . 1,109 1,004 794 Interest. . . . . . . . . . . . . 247 193 332\nTotal expenses. . . . . . . . 1,356 1,197 1,126\nIncome before (recovery of) income taxes and equity in net income of subsidiaries. . . . 9 37 890 (Recovery of) income taxes. . . . . ( 176) ( 74) 3\nIncome before equity in net income of subsidiaries. . . . . . 185 111 887 Equity in net income of subsidiaries, including $61,000 in 1993 from the cumulative effect of the change in accounting for income taxes. . . . . . . . . . . 5,298 3,677 1,732\nNet income. . . . . . . . . . . . . $ 5,483 $ 3,788 $ 2,619\nSee notes to consolidated financial statements.\nA-4\nSchedule II (continued)\nWALSHIRE ASSURANCE COMPANY AND SUBSIDIARIES\nCondensed Financial Information of Registrant\nWalshire Assurance Company\nStatement of Cash Flow (Parent Company)\nYears ended December 31\n(in thousands) 1995 1994 1993\nCash flows from operating activities: Net income . . . . . . . . . . . . . . . $ 5,483 $ 3,788 $ 2,619 Equity in net income of subsidiaries . . (5,298) ( 3,677) (1,732) Receivable from subsidiaries . . . . . . 1,396 1,553 ( 640) Other. . . . . . . . . . . . . . . . . . ( 76) ( 661) ( 177)\nNet cash provided by operating activities. 1,505 1,003 70\nCash flows from investing activities: Purchase of investments. . . . . . . . . (5,314) (15,630) (8,994) Sale or maturity of investments. . . . . 4,275 13,575 9,306 Decrease (increase) in investment in subsidiaries . . . . . . . . . . . . . (1,218) 968 ( 181) Capital contribution to subsidiaries . . - ( 4,725) - Other, net . . . . . . . . . . . . . . . 470 ( 717) ( 10)\nNet cash provided by (used in) investing activities . . . . . . . . . . . . . . . (1,787) ( 6,529) 121\nCash flows from financing activities: Cash dividends paid. . . . . . . . . . . (1,416) ( 1,104) ( 779) Issuance of treasury stock . . . . . . . - - 12 Issuance of common stock . . . . . . . . 330 284 528 Issuance of preferred stock. . . . . . . - 6,777 - Proceeds from notes payable. . . . . . . 1,770 - 323 Payment of bonds and notes payable . . . ( 440) ( 355) ( 325)\nNet cash provided by (used in) financing activities . . . . . . . . . . . . . . . 244 5,602 ( 241)\nNet increase (decrease) in cash. . . . . . ( 38) 76 ( 50) Cash at beginning of the year. . . . . . . 83 7 57\nCash at the end of the year. . . . . . . . $ 45 $ 83 $ 7\nSee notes to consolidated financial statements.\nA-5\nA-6\nA-7\nA-8\nSECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549\n___________________________________\nExhibits to Annual Report on Form 10-K Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934\n______________________________________\nWalshire Assurance Company\nINDEX\nExhibits to Annual Report on 10-K Sequential Number Title of Document Page No.\n(1) 3.1 Amended and Restated Articles of Incorporation of the Company.\n(1) 3.2 Bylaws of the Company.\n(5) 3.3 Statement with Respect to 6 1\/2% Cumulative Convertible Preferred Stock.\n(1) 4.1 Specimen Common Stock Certificate of the Company.\n(5) 4.2 Specimen Preferred Stock Certificate of the Company.\n(*) (1) 10.1 The Company s 1987 Stock Option Plan.\n(*) (1) 10.2 The Company s Employee Stock Purchase Plan.\n(*) (5) 10.4 Second Amended and Restated Employment Agreement, dated June 22, 1992, between the Company and Kenneth R. Taylor.\n(*) (2) 10.6 The Company s 1990 Stock Option Plan for Non-Employee Directors.\n(3) 10.7 Mortgage and Note, dated July 10, 1989, between Walshire Assurance Company and Gary J. Orndorff.\n(*) (3) 10.8 Walshire Assurance Company Master 401(k) Plan and Trust.\n(6) 10.10 Term Loan Agreement, dated January 25, 1995 between the Company and Mercantile Pennsylvania Corporation.\n(5) 10.11 Lincoln General Insurance Company Quota Share Fire-Burglary\/Theft Reinsurance Contract.\n(4) 10.19 Lincoln General Insurance Company Bond Quota Share Reinsurance Agreement.\n(*) (1) 10.22 Form of Director s Stock Option Agreement.\n(7) 11.1 Computation of Per Share Earnings\n(7) 13.1 Annual Report to Shareholders for the year ended December 31, 1995 (such report, except those portions expressly incorporated by reference in this Report on Form 10-K, is furnished for the information of the Commission and is not to be deemed filed as part of this Report on Form 10-K).\nINDEX (continued)\nExhibits to Annual Report on 10-K Sequential Number Title of Document Page No.\n(5) 21.1 Subsidiaries of the Company.\n(7) 23.1 Consent of KPMG Peat Marwick LLP\n__________________________ (1) Incorporated by reference from the Company s Registration Statement on Form S-1, and all amendments thereto, (Registration No. 33-15549), which was declared effective on September 3, 1987.\n(2) Incorporated by reference from the Company s Form 10-K (Commission File No. 0-16267), dated March 28, 1990.\n(3) Incorporated by reference from the Company s Form 10-K (Commission File No. 0-16267), dated March 28, 1991.\n(4) Incorporated by reference from the Company s Form 10-K (Commission File No. 0-16267), dated March 26, 1992.\n(5) Incorporated by reference from the Company s Form 10-K (Commission File No. 0-16267), dated March 28, 1994.\n(6) Incorporated by reference from the Company s Form 10-K (Commission File No. 0-16267), dated March 27, 1995.\n(7) Filed herewith.\nEXHIBIT 11.1\nEXHIBIT 11.1\nCOMPUTATION OF PER SHARE EARNINGS\n1995 1994 1993\nPrimary Earnings Per Share\nEarnings Per Share Based on Average Shares Outstanding $ 1.25 $ .86 $ .71\nImpact of Stock Options Utilizing Treasury Stock Method ( .06) ( .03) ( .04)\nEarnings Per Share Before Cumulative Effect of the Change in Accounting for Income Taxes 1.19 .83 .67\nCumulative Effect of the Change in Accounting for Income Taxes -__ - .01\nPrimary Earnings Per Share $ 1.19 $ .83 $ .68\nFully Diluted Earnings Per Share\nEarnings Per Share Based on Average Shares Outstanding $ 1.25 $ .86 $ .71\nImpact of Stock Options Utilizing Treasury Stock Method ( .08) ( .03) ( .04)\nImpact of Conversion of 6 1\/2% Convertible Preferred Stock ( .04) - -\nImpact of Conversion of 10% Convertible Subordinated Debentures - - ( .01)\nEarnings Per Share Before Cumulative Effect of the Change in Accounting for Income Taxes 1.13 .83 .66\nCumulative Effect of the Change in Accounting for Income Taxes - - .01\nFully Diluted Earnings Per Share $ 1.13 $ .83 $ .67\nEXHIBIT 13.1\nCorporate Profile\nWalshire Assurance Company is an insurance holding company with headquarters in York, Pennsylvania. Through its subsidiaries, Walshire conducts business in three insurance-related areas: property and casualty insurance (Lincoln General Insurance Company and Comp America Insurance Company), insurance premium finance (Agents Budget Corporation Consumer Discount Company, Inc. and Yorktowne Premium Finance Company) and claims adjustment services (King American Ltd.).\nFinancials at a Glance 1 Letter from the President 2 Expanding the Company's Product Line Overview 4 Liability Coverages 6 Property Coverages 8 Other Services 10 Ahead in 1996 11 Management's Discussion and Analysis 12 Management Report 14 Independent Auditors' Report 14 Financial Statements 15 Quarterly Common Stock Prices and Cash Dividends Per Share 28 Board of Directors, Officers, Subsidiaries and Corporate Information Inside Back Cover\nAbout The Cover Walshire is a provider of insurance products to niche markets. Primarily operating within the trucking industry, the Company provides the insurance coverages as shown, and further defined within the text of this report.\nFinancials at a Glance Book Value Per Common Share (1) (In thousands, except per share data and ratios) Year Ended December 31,1995 1994 1993 1992 1991 Total Revenues$39,927$32,607$25,920$19,933$19,001 Net Income5,4833,7882,6192,5633,216 Primary Net Income Per Share (1)1.19.83.68.931.23 Fully-Diluted Net Income Per Share (1)1.13.83.67.78.95 Dividends Paid on Common Stock955846779503417 Dividends Per Common Share (1).236.212.208.184.165 Gross Premiums Written52,13840,19931,58324,25218,449 Loss Ratio (2)59 59 55 47 42 Combined Ratio (2)87 89 90 82 81\nDecember 31,1995 1994 1993 1992 1991 Total Investments$58,210$50,540$40,324$32,074$26,877 Total Assets101,62783,06866,34554,27943,238 Long-Term Debt1,4811,921165,20811,160 Shareholders' Equity46,01440,01432,04124,82918,370 Book Value Per Common Share (1)9.708.308.097.737.19 Common Shares Outstanding (1)4,0644,0023,9633,2122,557\n(1)These amounts reflect the following events: (i) in August, 1992, the Company declared a 5 stock dividend, (ii) in October and November, 1992, the Company converted $4,522 of its 10 Convertible Subordinated Debentures into 549 shares of common stock, (iii) in January and May, 1993, the Company converted $4,709 of its 10 Convertible Subordinated Debentures into 572 shares of common stock, (iv) in November, 1994, the Company declared a 5 stock dividend, (v) in October, 1995 the Company converted 4 shares of its 6%1\/2 Convertible Preferred Stock into 15 shares of common stock, and (vi) in December, 1995 the Company declared a 10 stock dividend. Included in earnings per share were extraordinary expenses of $112, or $.04 per share ($.03 per share fully-diluted), relating to the redemption of $1,333 of the 10 Convertible Subordinated Debentures. Included in 1993 earnings per share was additional income of $61, or $.01 per share, resulting from the change in accounting for income taxes. Included in 1994 book value per common share was an additional $.07 per share, resulting from the change in accounting for debt and equity securities.\n(2)Loss ratios and combined ratios have been calculated in accordance with accounting principles prescribed or permitted by state regulatory agencies.\nManagement Report The Company's management is responsible for the integrity and accuracy of the financial information contained in this annual report. Management believes that the financial statements have been prepared in conformity with generally accepted accounting principles appropriate in the circumstances and that the other information in this annual report is consistent with those statements. In preparing the financial statements, management makes informed judgments and estimates where necessary to reflect the expected effects of pending events and transactions.\nThe Company maintains a system of internal controls which provides reasonable assurance that assets are safeguarded and that financial records reflect the transactions of the Company. Management conducts periodic reviews of this system to assure the adequacy of the controls in place.\nThe Company's independent auditors, KPMG Peat Marwick LLP, were engaged to perform an audit of the consolidated financial statements. Their audit provides an objective outside review of management's responsibilities to report operating results and financial condition.\nThe Audit Committee of the Board of Directors is comprised of directors who are neither officers nor employees of the Company. The Committee meets periodically with management and the independent auditors to review the adequacy of the internal controls and financial reporting. The independent auditors have unrestricted access to the Committee with and without the presence of management.\nKenneth R. Taylor Gary J. Orndorff President and Vice President\/Treasurer and Chief Executive Officer Chief Financial Officer\nIndependent Auditors' Report The Board of Directors and Shareholders Walshire Assurance Company:\nWe have audited the accompanying consolidated balance sheets of Walshire Assurance Company and subsidiaries as of December 31, 1995 and 1994, 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, 1995. 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 Walshire Assurance Company and subsidiaries at December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1995, in conformity with generally accepted accounting principles.\nHarrisburg, PennsylvaniaKPMG Peat Marwick LLP February 29, 1996\nWalshire Assurance Company and Subsidiaries Consolidated Balance Sheets December 31 (in thousands, except per share data) 1995 1994 Assets Investments: Held to maturity: Fixed maturities (fair value $15,712 and $16,140) .$15,217$16,508 Available for sale: Fixed maturities (cost $27,007 and $22,588) .27,21521,664 Equity securities (cost $8,189 and $8,263) .8,7207,611 Short-term investments .5,1913,889 Other investments .1,867868 Total investments .58,21050,540 Cash .99184 Accrued investment income receivable .864895 Amounts receivable from reinsurers .3,3152,644 Amounts receivable from reinsured company .5951,325 Agents' balances (net of allowance for doubtful accounts of $100) .5,5013,627 Installment premiums receivable .5,9653,633 Agents' balances and installment premiums receivable from related parties .3,6942,258 Premium finance receivables (net of unearned finance charges and allowance for credit losses of $135 and $123) .6,5344,678 einsurance receivable .8,6156,355 Deferred acquisition costs .4,8313,791 Property and equipment (net of accumulated depreciation of $1,284 and $1,054) .3,2702,656 Other assets .134482 Total assets .$101,627$83,068\nLiabilities and Shareholders' Equity Liabilities: Unpaid claims, claim settlement expenses and claims drafts .$20,153$14,292 Unearned premiums .27,55521,065 Short-term notes payable .2,2503,435 Long-term notes payable .1,4811,921 Deposits by insureds .1,488747 Commissions payable to agents .1,049571 Commissons payable to related parties .473214 Other liabilities .1,164809 Total liabilities .55,61343,054 Shareholders' equity: Preferred stock, par value $.01 per share; 2,000 shares authorized; 142 shares issued; 138 and 142 shares outstanding .11 Common stock, par value $.01 per share; 10,000 shares authorized; 4,064 and 3,638 shares issued and outstanding .4136 Additional paid-in capital .31,91825,751 Unrealized gain (loss) on investments available for sale (net of deferred taxes of $181 and $(534)) .558( 1,042) Retained earnings .13,49615,268 Shareholders' equity .46,01440,014 Total liabilities and shareholders' equity .$101,627$83,068 See accompanying notes to consolidated financial statements.\nWalshire Assurance Company and Subsidiaries Consolidated Statements of Income (in thousands, except per share data) Years ended December 31, 1995 1994 1993 Revenues: Premiums earned .$45,648$35,778$28,480 Premiums ceded .( 9,457)( 6,930)( 5,969) Net premiums earned .36,19128,84822,511 Net investment income .2,7212,3101,999 Net realized gains on investments .316743768 Other .699706642 Total revenues .39,92732,60725,920\nExpenses: Claims and claim settlement expenses .23,04518,25414,259 Reinsurance recoveries .( 2,668)( 1,819)( 2,290) Net claims and claim settlement expenses .20,37716,43511,969 Amortization of deferred acquisition costs .5,4475,2664,666 Underwriting, general and administrative expenses .6,9305,7595,263 Interest .290264376 Reorganization of King American Ltd. .-- -- 289 Total expenses .33,04427,72422,563 Income before income taxes and cumulative effect of the change in accounting for income taxes .6,8834,8833,357 Provision for income taxes .1,4001,095799 Income before cumulative effect of the change in accounting for income taxes .5,4833,7882,558 Cumulative effect of the change in accounting for income taxes .-- -- 61 Net income .5,4833,7882,619 Less dividends on convertible preferred stock .458374-- Net income available for common stock .$ 5,025$ 3,414$ 2,619 Net income per common share and common equivalent share: Primary: Income before cumulative effect of the change in accounting for income taxes .$ 1.19$ .83$ .67 Cumulative effect of the change in accounting for income taxes .-- -- .01 Net income .$ 1.19$ .83$ .68 Weighted average shares outstanding .4,2264,0973,829 Fully diluted: Income before cumulative effect of the change in accounting for income taxes .$ 1.13$ .83$ .66 Cumulative effect of the change in accounting for income taxes .-- -- .01 Net income .$ 1.13$ .83$ .67 Weighted average shares outstanding .4,8624,0974,075\nSee accompanying notes to consolidated financial statements.\nWalshire Assurance Company and Subsidiaries Consolidated Statements of Cash Flows (in thousands) Years ended December 31,1995 1994 1993 Cash flows from operating activities: Net income .$ 5,483$ 3,788$ 2,619 Adjustments to reconcile net income to net cash provided by operating activities Net realized gains on investments .( 316)( 743)( 768) Decrease (increase) in assets: Accrued investment income receivable .31( 109)( 112) Amounts receivable from reinsurers .( 671)( 1,708)531 Amounts receivable from reinsured company .730( 10)1,125 Agents' balances and installment premiums receivable .( 4,206)( 2,844)( 2,123) Agents' balances and installment premiums receivable from related parties .( 1,436)65181 Premium finance receivables .( 1,856)( 586)( 1,097) Reinsurance receivable .( 2,260)( 513)( 2,727) Deferred acquisition costs .( 1,040)( 576)( 667) Deposits by insureds .74148390 Other, net .809196505 (Decrease) increase in liabilities: Unpaid claims, claim settlement expenses and claim drafts outstanding .5,8612,5285,951 Unearned premiums .6,4904,4213,102 Other liabilities .347( 267)424 Other, net .737185( 83) Net cash provided by operating activities .9,4443,8757,251\nCash flows from investing activities: Purchase of investments: Held to maturity .( 3,805)( 5,078)( 8,725) Available for sale .( 10,539)( 19,227)( 13,534) Sale of investments: Available for sale .9,2349,65414,072 Maturity of investments .1,9101,9252,332 Net (purchase) sale of short term and other investments .( 2,212)583( 1,199) Purchase of property and equipment .( 1,210)( 426)( 432) Sale of property and equipment .13584273 Other, net .( 335)1,085( 41) Net cash used in investing activities .( 6,822)( 11,400)( 7,254)\nCash flows from financing activities: Cash dividends paid .( 1,412)( 1,104)( 779) Issuance of treasury stock .-- -- 12 Issuance of common stock .330284528 Issuance of preferred stock .-- 6,777-- Proceeds from notes payable .1,7702,145638 Payment of notes payable .( 3,395)( 449)( 470) Net cash provided by (used in) financing activities .( 2,707)7,653( 71) Net increase (decrease) in cash .( 85)128( 74) Cash at beginning of the year .18456130 Cash at end of the year .$ 99$ 184$ 56\nSee accompanying notes to consolidated financial statements.\nWalshire Assurance Company and Subsidiaries Consolidated Statements of Shareholders' Equity (in thousands, except per share data) Years ended December 31,1995 1994 1993 Preferred Stock Shares outstanding Balance at beginning of year .142-- -- Shares issued pursuant to private placement offering .-- 142-- Shares converted to common stock .( 4)-- -- Balance at end of year .138142-- Preferred Stock (par value $.01) Balance at beginning of year .$ 1$ -- $ -- Shares issued pursuant to private placement offering .-- 1-- Balance at end of year .$ 1$ 1$ -- Common Stock Shares Outstanding Balance at beginning of year .3,6383,4312,884 Conversion of bonds .-- -- 470 Conversion of preferred stock .15-- -- Stock dividend .369173-- Exercise of stock options .363077 Employee stock purchase plan .64-- Balance at end of year .4,0643,6383,431 Common Stock (par value $.01) Balance at beginning of year .$ 36$ 34$ 29 Conversion of bonds .-- -- 4 Stock dividend .42-- Exercise of stock options .1-- 1 Balance at end of year .413634 Additional Paid-In Capital Balance at beginning of year .25,75116,83112,600 Conversion of bonds .-- -- 3,702 Stock dividend .5,8381,860-- Dividend reinvestment .4-- -- Exercise of stock options .258239529 Employee stock purchase plan .6745-- Issuance of preferred stock .-- 6,776-- Balance at end of year .31,91825,75116,831 Unrealized gains (losses) on investments available for sale Balance at beginning of year .( 1,042)613228 Unrealized gains on equity securities .-- -- 385 Unrealized gains (losses) on investments available for sale .1,600( 1,827)-- Effect of change in accounting for investments available for sale .-- 172-- Balance at end of year .558( 1,042)613 Retained Earnings Balance at beginning of year .15,26814,56212,722 Net income .5,4833,7882,619 Cash dividends -- common stock (per share $.236; $.212; $.207) .( 955)( 846)( 779) -- preferred stock (per share $3.25; $2.64; $0) .( 458)( 374)-- Stock dividends on common stock .( 5,842)( 1,862)-- Balance at end of year .13,49615,26814,562 Treasury Stock Balance at beginning of year .-- -- ( 750) Conversion of bonds .-- -- 740 Exercise of options .-- -- 10 Balance at end of year .-- -- -- Shareholders' Equity .$46,014$40,014$32,040\nSee accompanying notes to consolidated financial statements.\nFILE #2\nWalshire Assurance Company and Subsidiaries Notes to Consolidated Financial Statements December 31, 1995, 1994 and 1993 (1)Summary of Significant Accounting Policies (a)Organization and Business\nThe Company was organized as a regional insurance holding company and operates in 20 eastern and southern states. Through its wholly owned subsidiaries, it provides products primarily to the trucking industry in three insurance-related areas: property and casualty insurance, Lincoln General Insurance Company (Lincoln) and Comp America Insurance Company (Comp); insurance premium finance, Agents Budget Corporation Consumer Discount Company, Inc. (ABCO) and Yorktowne Premium Finance Company (Yorktowne); and claims adjustment services, King American Ltd. (King). The Company's major lines of business in 1995 and their percentages of total net earned premiums were Automobile Physical Damage (48%), Automobile Liability (40%), Workers' Compensation (6%) and Inland Marine (6%). Lincoln and Comp are subject to regulation by insurance departments in those states in which they operate and undergo periodic examination by these departments. Lincoln and Comp are also subject to competition from other insurance carriers in their operating areas.\n(b)Principles of Consolidation and Basis of Presentation\nThe consolidated financial statements include Walshire Assurance Company (Walshire) and its subsidiaries, ABCO, Ashford Reinsurance Intermediaries Corporation (Ashford), Comp, King, Lincoln, and Yorktowne, collectively referred to herein as the ``Company.'' Significant inter-company balances and transactions have been eliminated in consolidation.\nThe accounts of Lincoln and Comp have been included in the accompanying consolidated financial statements on the basis of generally accepted accounting principles (GAAP), which differ in some respects from the statutory accounting practices employed by Lincoln and Comp in the preparation of their financial reports to the Insurance Department of the Commonwealth of Pennsylvania. See note 11. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. Actual results could differ significantly from those estimates.\nMaterial estimates that are particularly susceptible to significant change in the near term relate to the determination of the liabilities for unpaid claims and claim settlement expenses. While management uses available information to provide for such liabilities, future additions to these liabilities may be necessary based on changes in trends in claim frequency and severity. In addition, various insurance departments, as an integral part of their examination process, periodically review the Company's liabilities for unpaid claims and claim settlement expenses. Such departments may require the Company to recognize additions to the liabilities based on their judgments about information available to them at the time of their examination. Management believes that such liabilities are adequate.\nCertain reclassifications have been made to the prior years' financial statements to correspond to the current year presentation.\n(c)Investments Fixed maturities, which include bonds and redeemable preferred stocks, are purchased to support the investment strategies of the Company, which are developed based on many factors including rate of return, maturity, credit risk, tax considerations and regulatory requirements. Equity securities include common stocks and non-redeemable preferred stocks.\nIn 1994, the Company adopted Financial Accounting Standards Board Statement No. 115, ``Accounting for Certain Investments in Debt and Equity Securities,'' (SFAS 115). SFAS 115 addresses the accounting and reporting for investments in equity securities that have readily determinable fair values (other than those accounted for under the equity method or as investments in consolidated subsidairies) and all investments in debt securities. SFAS 115 provides that a company use its current intent at the time of adoption in classifying investments.\nThese investments are classified into three categories as follows:\nHeld-to-Maturity Securities -- Debt securities that the company has the positive intent and ability to hold to maturity; reported at amortized cost.\nTrading Securities -- Debt and equity securities that are bought and held principally for the purpose of selling them in the near term; reported at fair value, with unrealized gains and losses included in earnings.\nAvailable-for-Sale Securities -- Debt and equity securities not classified as either held-to-maturity securities or trading securities; reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of shareholders' equity (net of tax effects).\nShort term investments, which have an original maturity of one year or less, are carried at amortized cost which approximates fair value.\nRealized gains and losses on the sale of investments are determined on the basis of the cost of the specific investments sold and are credited or charged to income. Unrealized gains or losses on investments available for sale, net of applicable deferred income tax, are excluded from income and credited or charged directly to a separate component of shareholders' equity.\n(d)Deferred Acquisition Costs\nAcquisition costs, consisting of commissions, premium taxes, and certain underwriting expenses related to the production of property and casualty business, are deferred to the extent recoverable and are amortized ratably over the period in which the related premiums are earned. Anticipated claims and claim settlement expenses, expenses for maintenance of policies in force and anticipated investment income are considered in the determination of the recoverability of deferred acquisition costs.\n(e)Property and Equipment Property and equipment are included in the financial statements at cost. Depreciation of property has been provided by the straight-line method with an estimated useful life of 20 to 40 years. Depreciation of equipment has been provided by the straight-line method with estimated useful lives of three to ten years.\n(f)Unpaid Claims and Claim Settlement Expenses\nUnpaid claims and claim settlement expenses are based on individual case estimates for reported claims and estimates, based on experience and industry averages, for unreported claims and claim settlement expenses. The provision for unpaid claims and claim settlement expenses, net of estimated salvage recoverable, has been established to cover the estimated net cost of insured claims. The amounts are necessarily based on estimates and while they are believed to be adequate, the ultimate liability may exceed such estimates. Any change in such estimates will be recorded in the year the change occurs.\nThe provision for unpaid claims and claim settlement expenses for surety business have been established using management's best estimates of the cost of claims. The Company also holds funds as collateral which can be used to offset claims should a default occur. Because the Company has no interest in these funds unless a default occurs, these amounts have not been reflected in the financial statements.\nThe Company has no material exposures to environmental risks.\n(g)Fair Values of Financial Instruments Pursuant to Statement of Financial Accounting Standards No. 107, ``Disclosures about Fair Value of Financial Instruments'' (SFAS 107), the Company has used the following methods and assumptions in estimating its fair value disclosures:\nInvestments and Cash -- Fair values for fixed maturity securities are based on quoted market prices, when available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments or values obtained from independent pricing services through a bank trustee. The fair values for equity securities are based on quoted market prices. The carrying amounts reported in the balance sheets for cash, short-term and other investments approximate their fair values.\nNotes Payable -- The carrying amounts reported in the balance sheets for these instruments approximate their fair values.\n(h)Premium Revenue\nPremium revenue is recognized as earned on the semi-monthly pro-rata basis over the terms of the policies.\n(i)einsurance In the normal course of business, the Company seeks to reduce the loss that may arise from catastrophes or other events that cause unfavorable underwriting results by reinsuring certain levels of risk in various areas of exposure with other insurance enterprises or reinsurers.\nAmounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policy. The Company reports reinsurance receivables (including amounts related to claims incurred but not yet reported) and prepaid reinsurance premiums as assets.\n(j)Income Taxes The Company follows the asset and liability method of SFAS 109, ``Accounting for Income Taxes,'' under which 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.\n(k)Net Income Per Share Net income per share is computed after recognition of preferred stock dividend requirements and is based on the weighted average number of shares of common stock and common stock equivalents outstanding. Fully diluted net income per share is computed after recognition of preferred stock dividend requirements and is based on the weighted average number of shares of common stock and common stock equivalents outstanding for the period and assume conversion of the 10%p convertible subordinated debentures into common stock. The computation assumes the addition to income of the after-tax interest expense applicable to such bonds.\n(l)Fiduciary Funds In its capacity as a reinsurance intermediary, the Company collects premiums from reinsured companies and, after deducting its commission, remits the premiums to the respective reinsuring companies; the Company also collects claims or refunds from the reinsuring companies. Until remittance, these funds are held in a fiduciary capacity.\nNet uncollected premiums due from reinsured companies and payable to reinsuring companies amounting to $1,719,000 as of December 31, 1995 and 1994, are not included in the accompanying Consolidated Balance Sheets.\n(2)einsurance Lincoln assumes reinsurance from and cedes insurance to other insurers and reinsurers under various contracts which cover individual risks or entire classes of business. These reinsurance arrangements provide greater diversification of business and minimize Lincoln's losses arising from large risks or from hazards of an unusual nature. The ceding of insurance does not discharge the original insurer from its primary liability to its policyholders.\nLincoln has catastrophic and excess per risk reinsurance contracts for which it pays premiums based upon its gross earned premiums derived from covered business. The reinsured amounts included in developing the liability for claims and claim settlement expenses were $7,004,000 and $5,291,000 at December 31, 1995 and 1994, respectively.\nAt December 31, 1995, reinsurance receivables with a carrying value of $5,130,000 were associated with a single reinsurer.\nThe effect of reinsurance on premiums written is as follows: (in thousands) Years Ended December 31, 1995 1994 1993 Direct $52,020$40,104$31,504 Assumed 1189579 Ceded ( 9,569)( 7,052)( 6,055) Net premiums written $42,569$33,147$25,528\nThe effect of reinsurance on premiums earned is as follows: (in thousands) Years Ended December 31, 1995 1994 1993 Direct $45,527$35,700$26,921 Assumed 121781,559 Ceded ( 9,457)( 6,930)( 5,969) Net premiums earned $36,191$28,848$22,511\n(3)elated Party Transactions Lincoln pays agency commissions for business placed with it to five corporations with which directors of Walshire are affiliated.\nFor these related parties, the following is a summary of their transactions and balances after deducting the reinsurance portion, where applicable. (in thousands) Years Ended December 31, 51995 1994 1993 Premiums on policies written $11,415$9,467$8,997 Commissions 2,0501,9872,031\n(in thousands) December 31, 1995 1994 Agents' balances receivable $1,609$1,274 Installment premiums receivable 2,085984 Commissions payable 473214\n(4)Major Agencies During 1995, 1994 and 1993, one of the Company's agents with which a director of Walshire is affiliated, accounted for 23%, 24% and 30%, respectively, of the total premiums written. Agents' balances and installment premiums receivable from this agency were $3,116,000 and $1,587,000 as of December 31, 1995 and 1994, respectively. See Note 3. Another agent accounted for 6% of the total premiums written during 1995, while three agents accounted for 21% of the total premiums written during 1994 and one agent accounted for 6% of the total premiums written during 1993. Agents' balances and installment premiums receivable from these agents were $321,000 and $3,479,000 as of December 31, 1995 and 1994, respectively.\n(5)Investments Net investment income, comprised primarily of interest and dividends, is derived from the following sources:\n(in thousands) Years Ended December 31, 1995 1994 1993 Fixed maturities $2,311$1,833$1,653 Equity securities 300322176 Short-term investments 253314160 Other 13( 16)133 Investment expenses ( 156)( 143)( 123) Net investment income $2,721$2,310$1,999\nThe changes in net unrealized gains, less applicable federal income taxes, is as follows: (in thousands) Years Ended December 31, 1995 1994 1993 Increase (decrease) during period in difference between fair value and cost of investments available for sale: Fixed maturities $1,132$(924)$ -- Equity securities 1,183(1,564)576 ,315(2,488)576 Deferred income taxes ( 715)833(191) Increase (decrease) in net unrealized gains of investments available for sale $1,600$(1,655)$ 385\nGross unrealized gains and losses on equity securities were $1,260,000 and $729,000 respectively, as of December 31, 1995.\nDuring December 1995, as permitted by the Financial Accounting Standards Board one-time ``window'', the Company transferred $4,131,000 of investments from its held to maturity portfolio to its available for sale portfolio. The fair value of such investments was $4,208,000. The transfer of securities was made to provide the Company with increased flexibility in managing its liquidity position.\nThe amortized cost and fair values of investments in fixed maturities as of December 31, 1995 are as follows:\nAmortized Unrealized Unrealized Estimated (in thousands) GrossGross AmortizedUnrealizedUnrealizedFair CostGainsLossesValue Held to maturity U.S. Treasury securities and obligations of U.S. government corporations and agencies $4,141$105$--$4,246 Obligations of states and political subdivisions . 11,0764637311,466 Total held to maturity .15,2175687315,712 Available for sale U.S. Treasury securities and obligations of U.S. government corporations and agencies .4,49995--4,594 Obligations of states and political subdivisions .20,78339619820,981 Debt securities issued by foreign governments .35-- -- 35 Corporate securities .1,690621471,605 Total available for sale .27,00755334527,215 Total fixed maturities .$42,224$1,121$418$42,927\nThe amortized cost and fair value of fixed maturities at December 31, 1995, 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.\nAmortized Estimated (in thousands) AmortizedFair CostValue Due in one year or less . $1,560 $1,569 Due after one year through five years .14,23514,513 Due after five years through ten years .14,02814,222 Due after ten years .12,40112,623 Totals .$42,224$42,927\nThe amortized cost and fair values of investments in fixed maturities as of December 31, 1994 are as follows:\nAmoritzed Unrealized Unrealized Estimated (in thousands) GrossGross AmortizedUnrealizedUnrealizedFair CostGainsLossesValue Held to maturity U.S. Treasury securities and obligations of U.S. government corporations and agencies . $1,629 $-- $72 $1,556 Obligations of states and political subdivisions 14,8798337914,584 Total held to maturity 16,5088345116,140 Available for sale U.S. Treasury securities and obligations of U.S. government corporations and agencies 5,074-- 1584,988 Obligations of states and political subdivisions 15,7131201,18914,939 Debt securities issued by foreign governments 35----35 Corporate securities 1,766581221,702 Total available for sale 22,5881781,46921,664 Total fixed maturities .$39,096$261$1,920$37,804\nProceeds from sales of fixed maturities and the gross gains and gross losses realized on those sales were as follows: (in thousands) Years Ended December 31, 1995 1994 1993 Proceeds from sales $5,957$4,799$9,596 Gross gains 11468207 Gross losses 2560118\nAs of December 31, 1995, fixed maturities with an amortized cost totaling $4,513,000 were held by regulatory agencies, as required by law.\n(6)Deferred Acquisition Costs Changes in deferred acquisition costs are as follows: (in thousands) Years Ended December 31, 1995 1994 1993 Balance, January 1 $3,791$3,215$2,548 Acquisition costs deferred 6,4875,8425,333 Amortization charged to earnings ( 5,447)( 5,266)( 4,666) Balance, December 31 $4,831$3,791$3,215\n(7)Federal Income Taxes Walshire and its wholly-owned subsidiaries file a consolidated tax return and are taxed essentially the same as other corporations. The provision for income taxes is comprised of the following components:\nFILE #3\n(in thousands) Years Ended December 31, 1995 1994 1993 Current: Federal $1,741 $1,302 $ 944 State ( 2) 8 7 Deferred ( 339) ( 215) ( 152) $1,400 $1,095 $ 799\nDifferences between the federal income tax rate and effective tax rates as reflected in the financial statements on income before income taxes are as follows:\n(in thousands) Years Ended December 31, 1995 1994 1993 Computed at statutory federal rate (34%) $2,340 $1,660 $1,142 Tax exempt interest and dividend received deduction ( 679) ( 637) ( 423) Reduction of prior year tax provisions ( 277) -- -- Miscellaneous items 16 72 80 $1,400 $1,095 $ 799\nIn accordance with SFAS 109, the tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are presented below:\n(in thousands) December 31, 1995 1994 Deferred tax assets: Unearned premiums . $1,838 $1,404 Unrealized loss on investments available for sale . -- 534 Unpaid claims and claim settlement expenses . 613 425 Allowance for doubtful accounts . 57 50 $2,508 $2,413\nDeferred tax liabilities: Deferred acquisition costs . $1,643 $1,289 Unrealized gain on investments available for sale . 181 -- Other . 15 79 $1,839 $1,368\nManagement has determined that it is not required to establish a valuation allowance for the deferred tax asset since it is likely that the deferred tax asset will be realized through carrybacks, future reversals of existing temporary differences, future taxable income and tax planning strategies. The net deferred tax asset is a component of other liabilities in 1995 and other assets in 1994.\nIn 1995, 1994 and 1993, the Company made cash payments of $1,748,000, $938,000 and $1,005,000 respectively, for income taxes.\n(8) Unpaid Claims, Claims Settlement Expenses and Claims Drafts Activity in the unpaid claims, claims settlement expenses and claims drafts is summarized as follows:\n(in thousands) December 31, 1995 1994 Balance, January 1 . $14,292 $11,764 Less reinsurance recoverables . 5,291 5,321 Net balance, January 1 . 9,001 6,443 Incurred related to: Current year . 20,062 16,311 Prior years . 315 124 Total incurred . 20,377 16,435 Paid related to: Current year . 11,259 10,547 Prior years . 4,970 3,330 Total paid . 16,229 13,877 Net balance, December 31 . 13,149 9,001 Plus reinsurance recoverables . 7,004 5,291 Balance, December 31 . $20,153 $14,292\n(9) Bonds and Notes Payable Bonds and notes payable consisted of the following:\n(in thousands) December 31, 1995 1994 Note payable (prime interest rate), monthly payments of $40 plus interest, due December, 1999 . $1,961 $2,401 Line of credit (prime interest rate), due July, 1995 . -- 2,955 Line of credit (prime interest rate), due on demand . 1,770 -- 3,731 5,356 Current portion . ( 2,250) ( 3,435) Long-term notes payable . $1,481 $1,921\nThe estimated fair value of notes payable approximates the carrying value based on the Company's current ability to obtain loans at similar rates of interest.\nIn 1995, 1994 and 1993, the Company made cash payments of $298,000, $246,000 and $451,000 respectively, for interest expense.\nWalshire and its subsidiaries have a combined line of credit of $5,000,000 at December 31, 1995, $3,230,000 of which is available. The line of credit requires Walshire to maintain a net worth in excess of $40,000,000 and is subject to reaffirmation in November, 1996.\n(10) 401(k) Plan Walshire and its subsidiaries contribute to a qualified 401(k) Plan. All full time employees who meet certain eligibility requirements may elect to participate in the Plan. Participants can contribute no more than 20% of their base compensation. The Company matches 100% of employee contributions, not to exceed 5% of an employee's annual compensation. The Company expense for 401(k) Plan benefits were $109,000, $73,000 and $62,000 in 1995, 1994 and 1993, respectively.\nThe Company currently does not provide any post-retirement or post- employment benefits.\n(11) Shareholders' Equity Lincoln and Comp are restricted by law as to the amount of dividends they may pay to Walshire without the prior approval of the insurance regulatory authorities. These authorities only recognize statutory accounting practices for determining the ability of an insurer to pay dividends to its shareholders. At December 31, 1995, $2,863,000 and $375,000 was available for the payment of dividends from Lincoln and Comp, respectively, to Walshire without the prior approval of the insurance regulatory authorities.\nDividends paid by Lincoln to Walshire for the years ended December 31, 1995 and 1993 were $700,000 and $900,000, respectively. No dividends were paid by Lincoln to Walshire in 1994. Comp has paid no dividends. In addition, Walshire declared 10% and 5% stock dividends in 1995 and 1994, respectively.\nIn March of 1994, 141,700 shares of 61\/2% Convertible Preferred Stock were issued at $50 per share. The Preferred Stock is convertible at any time, unless previously redeemed, into shares of the Common Stock of Walshire Assurance Company at a conversion price of $12.12 per share, subject to adjustment under certain circumstances. During 1995, 4,000 shares were converted into 16,500 shares of common stock.\nA reconciliation of the insurance subsidiaries statutory net income to consolidated GAAP net income is as follows:\n(in thousands) Years Ended December 31, 1995 1994 1993 Statutory net income for insurance subsidiaries . $4,223 $2,822 $2,062 Deferred acquisition costs . 1,040 576 667 Salvage and subrogation . 500 98 ( 10) Deferred income taxes . 310 219 182 Write down of securities . ( 29) 10 ( 10) Insurance deductible . -- 20 -- GAAP net income for insurance subsidiaries . 6,044 3,745 2,891 Net income (loss) of Walshire and other non-insurance subsidiaries . ( 561) 43 ( 272) Consolidated GAAP net income . $5,483 $3,788 $2,619\nA reconciliation of statutory capital and surplus for the insurance subsidiaries to consolidated GAAP equity is as follows:\n(in thousands) Years Ended December 31, 1995 1994 Statutory capital and surplus for insurance subsidiaries $32,377 $28,562 Deferred acquisition costs 4,831 3,791 Salvage and subrogation 1,388 888 Non-admitted assets 1,082 848 Statutory reserves 124 -- Deferred income taxes 535 825 Adjustment for market value of investments available for sale 319 ( 820) Insurance deductible 20 20 GAAP equity for insurance subsidiaries 40,676 34,114 Equity of Walshire and other non-insurance subsidiaries 5,338 5,900 Consolidated GAAP equity $46,014 $40,014\nEffective December 31, 1994, the National Association of Insurance Companies (NAIC) required insurance companies to calculate and report information under a","section_15":""}
{"filename":"78311_1995.txt","cik":"78311","year":"1995","section_1":"ITEM 1. BUSINESS\n(a) General Development of Business.\nPhoto Control Corporation (the \"Registrant\" or the \"Company\") was organized as a Minnesota corporation in 1959. The Registrant acquired all of the outstanding stock of Norman Enterprises, Inc. (\"Norman\"), a California corporation, in 1973. In June, 1983 the Registrant acquired all of the outstanding stock of Nord Photo Engineering, Inc. (\"Nord\"), a Minnesota corporation. In October, 1986 the Registrant acquired all of the outstanding stock of Bardwell & McAlister, Inc. (\"Bardwell\"), a California corporation. As of December 31, 1987, Bardwell was liquidated and its assets and liabilities were transferred to Norman. Norman discontinued the manufacture and sale of the Bardwell product line during 1994.\nThe Registrant designs, manufactures, and markets professional cameras, long-roll film magazines, photographic accessories, Norman electronic flash equipment, and Nord photographic package printers. All references to the \"Registrant\" or the \"Company\" also include \"Norman\" and \"Nord\" unless indicated otherwise.\n(b) Financial Information About Industry Segments.\nDuring the years ended December 31, 1995, 1994, and 1993, the Registrant was engaged in one industry which consisted of designing, manufacturing, and marketing professional photographic equipment.\n(c) Narrative Description of Business.\n(c) (l)(i) Principal Products, Services and Markets. The Registrant designs, manufactures and markets professional cameras, long-roll film magazines, photographic accessories, Norman electronic flash, cine and video lighting equipment, and Nord photographic package printers.\nThe principal market for the Registrant's long-roll camera equipment is the sub-segment of the professional photography market requiring high-volume equipment, such as elementary and secondary school photographers. The market with respect to the Norman electronic flash equipment is broader, extending to all professional photographers and to experienced amateur photographers. The market for Nord photographic package printers is photographic processing labs which specialize in producing photographic color print packages such as those often produced for weddings and school photography. The geographic market in which the Registrant competes with respect to long-roll camera equipment, flash equipment, printers, and cine and video lights consists of the entire United States and, to a lesser extent, some foreign countries.\nThe Registrant markets most of its cameras, film magazines, and photographic accessories through its two employee salesmen and one independent sales representative and part-time use of a service employee. Such equipment is marketed primarily under the tradename, \"Camerz\". Norman markets its electronic flash and lighting equipment through three full-time employee salesmen, and ten independent sales representatives. Nord markets its printers through five employee salesmen, one independent sales representative, and by part-time use of three service employees. The Camerz division and Nord utilize the same independent sales representative to sell both product lines. It is expected that the sales force will remain at the current level during 1996.\n(c)(1)(ii) New Products and Services. The Camerz division introduced two tripods, the Auto-Mate which features a gas charged, counter-balanced center column cylinder for holding cameras from twelve to thirty-five pounds and the Adjusto-Mate which has a gear driven column with precision rack and pinion movement to hold up to fifty pounds. Also the Camerz ZII Digital Preview System was placed in four beta sites. The system main components are a ZII Camera with EIS (electronic identification system) an Electronic Camera mounted on the ZII with synchronized zooming, a customized PC with a camera synchronizing board, and a Camerz frame-grabber board, a camera monitor and an optional point-of-sale computer system and monitor. The Camerz software allows up to sixteen frames to be viewed on the screen at one time, and selection can be made by process of elimination with each frame identified on the screen by a Camerz EIS sequential frame number which matches a number exposed on the film. Delivery of the system started in January 1996.\nNord acquired the Bespro product line which features a low cost multi-lens printer. The daylight printer handles all professional color and black and white film sizes, and prints on either eleven, ten or eight inch paper. Nord enhanced its additive lamphouse by making it compatible with Accudata(TM), a printer controller used on a wide variety of photographic printers.\nNorman improved its line of battery-portable flash units by introducing the new \"Super Battery\" and \"Delta V Charger.\" This nickel-cadmium battery provides 25% more flashes per charge with no memory effect and the charger utilizes a micro processor control circuit that substantially increases battery life. These improvements have dramatically revitalized sales of Norman's portables. Also, Norman introduced the new high-power 40\/40 power supply. Sales in 1995 were to a single high-volume user, with introduction to the dealers in January 1996.\n(c)(1)(iii) Sources and Availability of Raw Materials. Materials required for the Registrant's photographic equipment consist primarily of fabricated parts, lenses, electronic components, and lights, most of which are readily available from numerous sources.\n(c)(1)(iv) Patents, Trademarks, Licenses, Franchises and Concessions. The Registrant, on February 16, 1982, obtained United States patent number 4,319,819 for a reflex shutter, which is used in conjunction with a zoom lens. The Registrant has incorporated the shutter into a zoom lens camera which was first introduced in fiscal 1980.\nThe Registrant on June 7, 1988, obtained a United States Patent number 4,750,012 for a reflex shutter for SLR cameras. The shutter is incorporated into the \"Z35\" camera which was first introduced in 1987.\nIn 1991, the Registrant was granted United States Patent number 5,055,863 for a multiple image transfer camera system for the simultaneous transfer of light rays from an object to a pair of separate, discrete mediums to provide for substantially exact image reproduction and capture thereof at either or both of two media.\nThe Registrant received U.S. Patent No. 5,294,950 on March 15, 1994 for an identification system for automated film and order processing including machine and human readable code.\nOn July 12, 1994, the U.S. Patent and Trademark Office granted the Registrant patent number 5,329,325 for the Registrant's synchronized zoom electronic camera system.\nNord holds two patents. Patent number 4,213,689 granted July 22, 1980 relates to a camera shutter which is electromagnetically activated and is not currently in production. The Additive Color Lamphouse patent, granted in 1991, United States Patent number 5,032,866, covers a closed loop light intensity feedback control system for regulating the light sources within the lamphouse.\nThe Registrant believes that it is the owner of two unregistered trademarks, \"Camerz\" and the logo-type used in connection with the sale of photographic equipment under the name Camerz. Also, the Registrant owns one registered trademark called \"Smart System\".\nNord is the owner of four registered trademarks; \"Portrait Express,\" \"Nord\", \"ESP\", and a logo-type design referred to as the \"Micrometer.\"\nAlthough the Registrant's patents and trademarks are valuable, they are not considered to be essential to the Company's success. Innovative application of existing technology along with providing efficient and quality products are of primary importance.\nThe Registrant has entered into agreements with employees which agreements grant the Registrant a exclusive right to use, make and sell inventions conceived by employees during their employment with the Registrant. The Registrant believes that the right to use, make and sell such inventions adequately protects the Registrant against any employee who might claim an exclusive proprietary right in an invention developed while the employee was employed by the Registrant.\n(c)(1)(v) Seasonal Fluctuations. The photographic equipment business, including that of Norman and Nord, is somewhat seasonal. There is a larger volume of sales from March through October.\n(c)(1)(vi) Working Capital Practices. The Registrant believes that its working capital needs are typical to the industry. The nature of the Registrant's business does not require that it maintain a high volume of finished goods inventory or provide extended payment terms to customers. The Registrant maintains an inventory of raw material and finished products and permits customers to return only defective merchandise.\n(c)(1)(vii) Single Customer. During the years ended December 31, 1995, 1994 and 1993, the company derived 20.2%, 24.2% and 17.4%, respectively, of its sales from one unaffiliated customer, Lifetouch Inc. and its affiliates.\n(c)(1)(viii) Backlog. The dollar amount of backlog believed by the Registrant to be firm as of December 31, is as follows:\n1995 1994 1993\nCompany $1,397,000 $4,994,000 $7,967,000 Nord 426,000 1,109,000 486,000 Norman 1,035,000 83,000 6,000 ---------- ---------- ---------- Total $2,858,000 $6,186,000 $8,459,000 ========== ========== ==========\nThe Registrant anticipates that it and its subsidiaries will be able to fill all current backlog orders during the fiscal year ending December 31, 1996.\n(c)(1)(ix) Government Contracts. No material portion of the Registrant's or its subsidiaries' business is subject to renegotiation of profits or termination of any contract or subcontract at the election of the Government.\n(c)(1)(x) Competition. Primary methods of competition for the Company's products are product performance, reliability, service, and delivery. The Registrant's two primary competitors with respect to such equipment are Lucht Engineering, Inc., which sells photographic printers, and Beattie Systems, Inc., which sells long-roll cameras. Because of varying product lines, the Registrant is unable to state accurately its competitive position in relation to such competitors. In the somewhat broader market in which Norman competes in the sale of professional studio electronic flash equipment, there are approximately fourteen significant competitors, several of which are well established. The Registrant is unable to state accurately Norman's overall competitive position in relation to such competitors. Norman's dominant competitors are Broncolor, Dynalite, White Lighting, Photogenic, and Speed-O-Tron.\n(c)(1)(xi) Research and Development. The Registrant spent the following amounts on research activities relating to the development of new products, services, and production engineering:\nYEAR ENDED DECEMBER 31 ---------------------------------------- 1995 1994 1993 ---- ---- ----\nCamerz Division $ 408,000 407,000 396,000 Nord 520,000 730,000 561,000 Norman 382,000 403,000 329,000 ---------- ---------- ---------- Total $1,310,000 $1,540,000 $1,286,000 ========== ========== ==========\nThe Company intends to maintain its level of spending on research and development.\n(c)(1)(xii) Environmental Regulation. Federal, state and local laws and regulations with respect to the environment have had no material effect on the Registrant's or its subsidiaries' capital expenditures, earnings, or respective competitive positions.\n(c)(1)(xiii) Employees. As of December 31, 1995, the Registrant had the following employees:\nFULL-TIME PART TIME --------- --------- Camerz Division 44 1 Nord 33 1 Norman 62 3 --- --- Total 139 5 === ===\nThe Registrant utilizes subcontract personnel on a temporary basis to supplement its regular work force which totaled 46 people as of December 31, 1995.\n(d) Financial Information About Foreign and Domestic Operations and Export Sales. The Registrant has no operations based outside of the United States. During each of the last three years ended December 31, 1995, slightly more than 5% of the Registrant's consolidated sales were derived from export sales.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Registrant's principal property is located at 4800 Quebec Avenue North, Minneapolis, Minnesota. The building at that location consists of 60,000 square feet and is located on 3 1\/2 acres of land. The building was constructed in 1971 and was purchased in 1980. Extensive remodeling has been done to meet the specific needs of the Company. The Registrant first occupied the building during the fall of 1980, and uses the building for camera production, Nord printer manufacturing, and as corporate offices.\nNord owns a 5,000 square foot building in Hinckley, Minnesota, on one acre of land, which houses optical production and was built in 1981. In February 1996, the production was moved to Minneapolis and the building listed for sale.\nNorman occupies a 32,000 square foot building in Burbank, California which was constructed in 1977 and expanded in 1984. The facility is located on 50,000 square feet of land and houses all of Norman's operations. The land and building are financed through the issuance of an industrial development bond by the Industrial Development Authority of the County of Los Angeles and are owned by Norman subject to a mortgage in favor of the note holder.\nThe Registrant believes its present facilities are adequate for its current level of operation and provide for a reasonable increase in production activities.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nNeither the Registrant nor any of its subsidiaries is a party to, and none of their property is the subject of, 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 the Registrant's shareholders during the Registrant's quarter ending December 31, 1995.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe term of office for each executive officer is from one annual meeting of directors until the next annual meeting or until a successor is elected. There are no arrangements or understandings between any of the executive officers and any other person (other than arrangements or understandings with directors or officers acting as such) pursuant to which any of the executive officers were selected as an officer of the Registrant.\nThere are no family relationships between any of the Registrant's directors or executive officers.\nPART II\nThe information required by Items 5, 6, 7 and 8 of Part II is incorporated herein by reference to the sections labeled \"Stock Market Information,\" \"Selected Financial Data\" and \"Management's Discussion and Analysis of Financial Condition and Results of Operations,\" the Consolidated Financial Statements and Notes and the Independent Auditor's Report which appear in the Registrant's Annual Report to Shareholders for the year ended December 31, 1995. With respect to Item 9, no change of accountants or disagreements on any matter of accounting principles or practices or financial statement disclosure has occurred.\nPART III\nItems 10, 11, 12 and 13 of Part III, except for certain information relating to Executive Officers included in Part I, are omitted inasmuch as the Company intends to file with the Securities and Exchange Commission within 120 days of the close of the year ended December 31, 1995, a definitive proxy statement containing information pursuant to Regulation l4A of the Securities Exchange Act of 1934 and such information shall be deemed to be incorporated herein by reference from the date of filing such document.\nPART IV\nITEM 14.","section_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":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) Documents filed as Part of this Report.\n(a)(l) Consolidated Financial Statements. Page\nIndependent Auditor's Report......................................... *\nConsolidated Statements of Opera- tions for the years ended December 31, 1995, 1994 and 1993..................................... *\nConsolidated Statements of Changes in Stockholders' Equity for the years ended December 31, 1995, 1994 and 1993, ........................................................... *\nConsolidated Balance Sheets at December 31, 1995 and 1994.................................................... *\nConsolidated Statements of Cash Flows for the years ended December 31, 1995, 1994 and 1993.................................................. *\nNotes to Consolidated Financial Statements .......................................................... *\n- -------------------------------\n*Incorporated by reference to the Registrant's Annual Report to Shareholders for the year ended December 31, 1995 a copy of which is included in this Form 10-K as Exhibit 13\nPage\n(a)(2) Consolidated Financial Statement Schedules.\nAuditor's Consent and Report on Schedules............................ 10\nSchedule VIII - Valuation and Qualifying Accounts for the years ended December 31, 1995, 1994 and 1993............................................ 11\nAll other schedules have been omitted because they are not applicable or are not required, or because the required information has been given in the Consolidated Financial Statements or notes thereto.\n(a)(3) Exhibits. See \"Exhibit Index\" on page following signatures.\n(b) Reports on Form 8-K. No reports on Form 8-K were filed during the last fiscal quarter of the Registrant's 1995 fiscal year.\n(c) Exhibits. Reference made to item 14 (A)(3)\n(d) Schedules. Reference made to item 14 (A)(2)\n- --------------------------------\n*Incorporated by reference to the Registrant's Annual Report to Shareholders for the year ended December 31, 1995, a copy of which is included in this Form 10-K as Exhibit 13\nAUDITOR'S CONSENT AND REPORT ON SCHEDULES\nBoard of Directors and Stockholders Photo Control Corporation\nWe hereby consent to the incorporation by reference in this Annual Report on Form 10-K of Photo Control Corporation for the year ended December 31, 1995 of our report, dated January 30, 1996, appearing in the Company's 1995 Annual Report to Shareholders. We also consent to the incorporation by reference of such report in the registration statements on Form S-8 for the Photo Control Stock Option Plan.\nIn the course of our audit of the financial statements referred to in our report, dated January 30, 1996, included in the Company's 1994 Annual Report to Shareholders, we also audited the supporting schedule listed in Item 14(a)(2) of this Annual Report on Form 10-K. In our opinion, the 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.\nVIRCHOW KRAUSE, & COMPANY, LLP\nJanuary 30, 1996 Minneapolis, Minnesota\nPHOTO CONTROL CORPORATION SCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES\n(a) Recoveries of amounts written off in prior years.\n(b) Uncollectible 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.\nPHOTO CONTROL CORPORATION\nDate: March 15, 1996 By \/s\/ Leslie A. Willig Leslie A. Willig, Chairman of the Board of Directors, 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.\nDate: March 15, 1996 \/s\/ Leslie A. Willig Leslie A. Willig, Chief Executive Officer, President and Director (principal executive officer)\nDate: March 15, 1996 \/s\/ Curtis R. Jackels Curtis R. Jackels, Vice President and Treasurer (principal financial and principal accounting officer)\nDate: March 15, 1996 \/s\/ George A. Kiproff George A. Kiproff, Director\nDate: March 15, 1996 \/s\/ James R. Loomis James R. Loomis, Director\nDate: March 15, 1996 \/s\/ William L. Norman William L. Norman, Director\nDate: March 17, 1996 \/s\/ Thomas J. Cassady Thomas J. Cassady, Director\nDate: March 17, 1996 \/s\/ Joe M. Kilgore Joe M. Kilgore, director\nSECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------------------------------------------------------\nPHOTO CONTROL CORPORATION\nCOMMISSION FILE NO.: 0-7475 ------------------------------------------------------------------------\nEXHIBIT INDEX FOR FORM 10-K FOR YEAR ENDED DECEMBER 31, 1995\nPage Number in Sequential Numbering of all Form 10-K and Exhibit Pages EXHIBIT\n3.1 Registrant's Restated Articles of Incorporation, as amended-incorporated by reference to Exhibit 3.1 to the Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 1988 *\n3.2 Registrant's bylaws as amended-incorporated by reference to Exhibit 3.2 to the Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 1989 *\n4.1 Loan Agreement between City of New Hope, Minnesota, and the Registrant, dated May 16, 1980-incorporated by reference to Exhibit 4.1 to the Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 1989 *\n4.2 Mortgage and Security Agreement between the Registrant, Mortgagor, and Washington National Insurance Company, Mortgagee, dated May 16, 1980-incorporated by reference to Exhibit 4.2 to the Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 1989 *\n4.3 Loan Agreement between Industrial Development Authority of the County of Los Angeles and Norman Enterprises, Inc., dated as of December 1, 1983-incorporated by reference to Exhibit 4.3 to the Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 1989 *\n4.4 Trust Deed among Industrial Development Authority of the County of Los Angeles, Norman Enterprises, Inc. and First National Bank of Minneapolis, dated as of December 1, 1983-incorporated by reference to Exhibit 4.4 to the Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 1989 *\n4.5 Guaranty Agreement from Photo Control Corporation as Guarantor to First National Bank of Minneapolis, dated December 1, 1983-incorporated by reference to Exhibit 4.5 to the Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 1989 *\n4.6 Supplemental Agreement between Photo Control Corporation and First National Bank of Minneapolis, dated as of December 29, 1983-incorporated by reference to Exhibit 4.6 to the Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 1989 *\n10.1 Executive Salary Continuation Plan adopted August 9, 1985 together with Exhibits - incorporated by reference to Exhibit 10.4 to the Registrant's Annual Report on Form 10-K * for the year ended June 30, 1986 **\n10.2 The Registrant's 1983 Stock Option Plan - incorporated by reference to Exhibit 10.4 to the Registrant's Annual Report on Form 10-K for the fiscal year * ended June 30, 1989 **\n10.3 Form of Stock Option Agreement under the Registrant's 1983 Stock Option Plan - incorporated by reference to Exhibit 5 to the Registrant's Registration Statement on * Form S-8, Reg. No. 2-85849 **\n10.4 Cash bonus plan for officers - incorporated by reference to the description of such plan contained in the Registrant's definitive Proxy Statement for its 1995 Annual Meeting of * Shareholders **\n10.5 Amendment to Stock Option Plan August 29, 1994 - incorporated by reference to Exhibit 10.5 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 *\n10.6 Amendment to Stock Option Plan, February 23, 1996 **\n11 Statement re computation of per share earnings\n13 Report to Shareholders for the year ended December 31, 1995\n21 Subsidiaries of the Registrant\n23 Consent of Independent Auditors\n25 Power of Attorney from Messrs. Willig, Jackels, Kiproff, Loomis, Norman and Cassady\n- ---------------------------- *Incorporated by reference\n** Indicates management contracts or compensation plans or arrangements required to be filed as exhibs.","section_15":""}
{"filename":"8109_1995.txt","cik":"8109","year":"1995","section_1":"Item 1. Business\nGeneral Development of Business. Athey Products Corporation (\"Registrant\") was incorporated in the State of Illinois on September 29, 1922. In May, 1988, the Registrant's corporate domicile was changed from Illinois to Delaware by reincorporating the Registrant in the latter state. The Registrant is a manufacturer of heavy duty equipment and parts. Its principal products include street sweepers, conveyors, and force feed loaders. The Registrant also manufactures other equipment and replacement parts for its products. The principal users of the Registrant's products are municipalities, contractors, other governmental bodies or agencies, miners and others who have need of heavy duty, large capacity equipment.\nThe following is brief description of the principal products manufactured by the Registrant.\nMobil Street Sweepers. The Mobil street sweepers are of the four-wheel mechanical bottom dump and high-lift type and of the three-wheel mechanical high-lift type which offers flexibility in the street cleaning operation. The four-wheel type may be gasoline, diesel, or compressed natural gas powered with an automatic transmission. The three-wheel type is diesel powered with hydrostatic drive. All units have variable speed, hydraulically driven brooms and elevators for cleaner pickup of hard-to-sweep material.\nConveyors & Systems. The Registrant manufactures a broad range of different types and sizes of conveyors, vibrating screens and pug mill mixing plants. Types of conveyors include portable belt loader conveyors, stationary and portable conveyors, folding stacker conveyors, wash plants and rotary stacking conveyors for use in mining, quarries and material processing plants.\nForce-feed loaders. Force-feed loaders combine the continuous flow capabilities of a belt conveyor with wheel loader mobility, and are produced with either gasoline or diesel engines. They are used to pick up or load dirt, snow or any flowable material from windrow or roadside and drop it into a trailing truck.\nForce-feed loaders can also be used for loading sand, coal, salt, top soil and gravel from stockpiles; assisting in cleanup jobs or paving projects; picking up windrows on road shoulders and ditch trimming; or clearing snow-choked roads. The newest model includes a swivel discharge conveyor and right angle side discharge to either side.\nOther Products\n(a) Trailers. The trailers manufactured by the Registrant, also called \"wagons\", are generally pneumatic tired, and are for large volume, off-highway use. The trailers, which are themselves pulled by tractors manufactured by others, are used for the hauling of earth, sand, stone, coal or any other bulk material. Trailers are manufactured to\nhandle capacities of from 33 to 100 tons and are classified by the manner in which they discharge materials; for example, rear dump, bottom dump and side dump trailers. Trailers are typically used on projects such as the construction of large dams, road building, mining, land fill, and other specialized uses where the large volume capacities of the trailers are needed. During 1995, the Company phased-out the manufacture of this product in connection with its organizational restructuring.\n(b) Graders. This unit, called the \"Maintenance Master, Model 600\", is a small, maneuverable maintenance machine designed to handle jobs where larger, less efficient equipment is not required. This unit can be used for site preparation on small jobs such as parking lots and driveways. Graders are produced with diesel engines, hydrostatic transmission and a wide range of attachments.\n(c) Track Assemblies. Track assemblies are used for the hauling of trailers or other heavy duty equipment, as distinguished from drive track which is used on powered equipment. Track assemblies can haul any load that a track type tractor can pull, and can be especially useful in refuse operations, oil fields, quarries, pipelines and various construction industry functions where the land condition makes use of wheeled vehicles impracticable. During 1995, the Company phased-out the manufacture of this product in connection with its organizational restructuring.\n(d) Refuse Collection Products. The Registrant also manufactures refuse collection truck bodies of front and side loading design for manual, semiautomatic and automated collection. The side loader can also be configured as a leaf loader for high compaction pick up of leaves. During 1995, the Company phased-out the manufacture of this product in connection with its organizational restructuring.\n(e) Replacement Parts. The Registrant also manufactures and distributes replacement parts for its product lines.\nThe Registrant's products are distributed through an equipment dealer network that covers the entire United States and certain foreign countries. Its agreements with its dealers are terminable, by either party, upon 30 days written notice. As is common in the industry, almost all such dealers also sell complementary products produced by other manufacturers, and all of them operate as independent contractors.\nSet forth below, for each of the Registrant's last three years, is the percentage of total sales contributed by each class of similar products which contributed 10% or more of total sales during any of the last three years:\nYear Ended December, 31 Class of Product 1995 1994 1993 -------------------------- ---- ---- ----\nMobil Street Sweepers 84% 89% 85%\nRaw Materials and Component Parts. The principal materials and components used by the Registrant in its manufacturing operations are steel, paint, castings, axles, tires, hydraulic parts, engines, transmissions, small parts and welding supplies. These materials and components are available from and are purchased from many suppliers, none of whom the\nRegistrant is substantially dependent upon and none of whom receive a disproportionate amount of the Registrant's business. In the experience of the Registrant, it has been generally able to receive its supplies as required, though delays in deliveries have occurred.\nPatents, Trademarks, Licenses. Although the Registrant owns certain patents, trademarks and licenses, none is of material importance to its business, with the exception of the trademark \"Mobil Sweeper\" owned by the Registrant and used in connection with its mobile street sweepers.\nSeasonality. With respect to conveyors, it has been the experience of the Registrant that its heavy shipping period begins in the spring of the year and continues through the late fall of the year. Sales of other products manufactured by the Registrant are not significantly seasonal.\nWorking Capital. The Registrant generates working capital from operations and borrowings under a bank line of credit. Because the Registrant does not generally provide extended payment terms to its customers and because its business, as a whole, is not generally subject to seasonal variations in demand, working capital requirements are not subject to material fluctuation.\nCustomers. In 1995, the Company's largest customer, a dealer selling to a local government entity, accounted for approximately 25% of the Company's net sales. No other customer accounted for more than 10% of the Company's net sales.\nThe Company believes that the loss of any customer that accounts for 10% or more of the Company's net sales would have a material adverse effect on its business. As is customary in the industry, the Company does not have a significant amount of long term sales agreements with its customers. However, it believes that it enjoys excellent relationships with its customers. The Company follows customary industry practices regarding terms of sale and does not provide extended payment terms to any significant extent.\nBacklog. The dollar amount of the backlog of orders believed to be firm as of December 31, 1995 and December 31, 1994 was approximately $7,452,000 and $8,860,000, respectively. Mobil street sweepers accounted for 100% and 89%, respectively, of the backlogs as of such dates. The Registrant expects to complete all orders related to the December 31, 1995 backlog during the current year.\nGovernment Contracts. The Registrant has no material contracts with the Federal Government; however, the Company has a contract with a dealer for sales to the city of Los Angeles, California, which the Company expects to complete during 1996.\nCompetition. The Registrant competes in the street sweeper, conveyor, trailer, grader and refuse collection truck markets with a number of other companies which are larger and have greater financial resources than the Registrant.\nTo the knowledge of the Registrant, it is one of the largest manufacturers of four-wheel sweepers; however, there is substantial competition from other manufacturers in the functional sweeper market, which includes three-wheel and vacuum type sweepers.\nConveyors manufactured by the Registrant are priced similarly to machinery of competitors, with competition being primarily on the basis of quality and service. To the knowledge of the Registrant, no one manufacturer, or small group of manufacturers, has a dominant share of the market.\nTo the knowledge of the Registrant, it is one of the primary manufacturers of force-feed loaders. However, front-end loaders, which are manufactured by many other companies, provide substantial functional competition.\nThe Registrant is not a significant manufacturer of trailers and graders. Trailers face functional competition from heavy duty trucks.\nThe Registrant commenced the manufacture and sale of refuse collection truck bodies in 1981, and competes with several other established manufacturers in such market.\nThe Registrant is a manufacturer of track assemblies for hauling purposes. This product also faces functional competition from improved heavy duty rubber tires.\nResearch and Development. The Registrant spent approximately $418,000 in 1995, $485,000 in 1994, and $286,000 in 1993, to improve existing products and to consider new product lines.\nEnvironment. Compliance with federal, state and local provisions which have been enacted or adopted regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, have had no material effects upon the capital expenditures, results of operations, and competitive position of the Registrant and its subsidiaries. Due to the nature of its business, the Registrant does not anticipate any material capital expenditures for environmental control facilities for the remainder of its current fiscal year or for the succeeding fiscal year.\nEmployees. As of December 31, 1995, the Registrant employed 258 persons, of which 157 employees are subject to a collective bargaining agreement. The Registrant considers its relationship with its employees to be excellent.\nExport Sales. Sales to customers in foreign countries approximated $984,500 in 1995, $1,393,800 in 1994 and $1,725,400 in 1993. During 1995, such customers were located in North America, the Middle East and the Pacific Rim.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nThe Registrant owns two manufacturing plants, both of which, in the Registrant's opinion, are suitable and adequate for the manufacture of its products.\nThe Registrant's Raleigh Division (where all of the Registrant's products, except its force-feed loader, grader and conveyor lines, are produced) operates from its plant located in Wake Forest (outside of Raleigh), North Carolina (the \"Raleigh Plant\"). The Raleigh Plant, which was completed in 1965, is situated on approximately 39 acres, and is of prestressed concrete construction with steel crane ways and supports. The Raleigh Plant\nis believed to be one of the finest heavy duty plants of its type in the southeastern part of the United States. During the fourth quarter of 1985, the Company completed an addition of approximately 29,000 square feet to the assembly area of the Raleigh Plant. During 1989, the Company completed an additional building as its new paint shop. This paint shop is 4,800 square feet, and is designed to be environmentally state-of-the-art. It uses filtered air both in and out of the paint room, and substantially reduces the possibility of contaminants in the painting process. During the first quarter of 1995, the Company added a 1,755 square foot Inspection Building. Of the approximately 206,935 square feet in the Raleigh Plant, approximately 186,415 square feet is devoted to manufacturing and assembly facilities, and to stockroom, shipping, and receiving facilities; approximately 16,360 square feet is used for general and executive offices; and approximately 4,160 square feet is an engineering department balcony area.\nThe equipment in the Raleigh Plant includes various boring, drilling and milling machines, lathes, grinders, punches, shears, press brakes and other presses, hydraulic testing equipment, saws, machine shop equipment, layout equipment, heavy duty metal working and robotic welding equipment and appropriately large material handling cranes.\nThe Registrant's Kolman\/Athey Division (where the Registrant's graders, force-feed loader and conveyor product lines are produced) operates from seven separate buildings, of an aggregate of approximately 68,000 square feet, located on approximately 9.6 acres in Sioux Falls, South Dakota (the \"Kolman Plant\"). The largest of such buildings contains approximately 57,100 square feet, is of cement block construction, and is a single story structure. Approximately 52,700 square feet of this building is used for manufacturing functions, and approximately 4,400 square feet is used for general offices. The Kolman plant was sold subsequent to year-end, in February, 1996, as part of the Company's organizational restructuring.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nThe Company is involved in litigation regarding several product liability claims. The Company believes that it has substantial meritorious defenses available and intends to defend the cases vigorously. The Company also believes that the ultimate resolution of these proceedings is not likely to have a materially adverse impact on its financial position, as the Company has insurance coverage it deems adequate.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nNo matters were submitted to a vote of shareholders, through the solicitation of proxies or otherwise, during the fourth quarter of the year ended December 31, 1995.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Shareholder Matters.\nThe stock price and trading data on page 7 of the Registrant's 1995 Annual Report to Shareholders are hereby incorporated by reference as Item 5 of this report. No cash dividends have been paid to shareholders during the last five years.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nThe selected financial data for the years 1991 through 1995 on page 6 of the Registrant's 1995 Annual Report to Shareholders is hereby incorporated by reference as Item 6 of this report.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nManagement's discussion and analysis on pages 5 through 7 of the Registrant's 1995 Annual Report to Shareholders is hereby incorporated by reference as Item 7 of this report.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nThe Financial Statements and Supplementary Data on pages 8 through 13 and the Independent Auditor's Report on page 16 of the Registrant's 1995 Annual Report to Shareholders are hereby incorporated by reference as Item 8 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 or financial disclosures matters.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant.\n(a) Information concerning the directors and persons to be nominated for election as directors of the Registrant will be set forth in the Registrant's Proxy Statement in connection with its Annual Meeting to be held May 16, 1996, which Proxy Statement will be filed with the Commission within 120 days after the end of the Registrant's last fiscal year, and is hereby incorporated herein by reference.\n(b) Set forth below are the names and ages of all of the executive officers of the Registrant, none of whom has any family relationship with any other executive officer or any director of the Registrant, and all positions and offices with the Registrant presently held by such persons, together with a brief account of business experience during the past 5 years of each person: Positions, Offices Held and Business Experience for the Name Age Past 5 Years\nJames H. Stumpo 57 In May, 1995, Mr. Stumpo was elected President and Chief Executive Officer and Director of the Company. From May, 1992 to May, 1995 he was Vice President Finance with Benton Harbor Engineering, Benton Harbor, Michigan. From May, 1987 to May, 1992, Mr. Stumpo served as Chief Financial Officer for Koehring Cranes & Excavators, Waverly, Iowa, a Division of Terex Corporation.\nFranz M. Ahting 48 In May, 1995, Mr. Ahting was elected Vice President Finance, Chief Financial Officer and Director of the Company. In May, 1994, Mr. Ahting became Treasurer of the Company. From November, 1993 to May, 1995, Mr. Ahting served as Controller and Assistant Secretary. Mr. Ahting was Assistant Treasurer of Carolina Steel Corporation from 1988 to 1990 and practiced public accounting from 1991 to November, 1993.\nOfficers are elected annually by the Registrant's Board of Directors at the first meeting of the Board of Directors held after each Annual Meeting of Shareholders. The terms of all of the foregoing officers are from May 18, 1995 to May 16, 1996.\nItem 11.","section_11":"Item 11. Executive Compensation.\nInformation concerning executive compensation will be set forth in the Registrant's Proxy Statement in connection with its Annual Meeting to be held May 16, 1996, which Proxy Statement will be filed with the Commission within 120 after the end of the Registrants last fiscal year, and is hereby incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\n(a)-(b) Information concerning security ownership of certain beneficial owners and management will be set forth in the Registrant's Proxy Statement in connection with its Annual Meeting to be held May 16, 1996, which Proxy Statement will be filed with the Commission within 120 days after the end of the last fiscal year, and is hereby incorporated herein by reference.\n(c) The Registrant knows of no 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 concerning certain relationships and related transactions will be set forth in the Registrant's Proxy Statement in connection with its Annual Meeting to be held May 16, 1996 which Proxy Statement will be filed within 120 days after the end of the last fiscal year, and is hereby incorporated herein by reference.\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 the Registrant are included in its Annual Report to Shareholders for the year ended December 31, 1995, which statements are incorporated herein by reference:\nIndependent Auditor's Report\nBalance Sheets - December 31, 1995 and 1994\nStatements of Operations - years ended December 31, 1995, 1994, and 1993\nStatements of Shareholders' Equity - years ended December 31, 1995, 1994, and 1993\nStatements of Cash Flows - years ended December 31, 1995, 1994, and 1993\nNotes to Financial Statements\n2. FINANCIAL STATEMENT SCHEDULES\nThe following schedules are included in Part IV of this Report:\nIndependent Auditors' Reports, located at sequential pages 13 and 14 of this report.\nSchedule II - Valuation and qualifying accounts located at sequential page 16 of this report.\nSchedules not listed above have been omitted because they are either not applicable or the required information has been included in the financial statements or the notes thereto.\n(b) REPORTS ON FORM 8-K.\nOn October 9, 1995, the Registrant announced that it would close its Kolman plant located at Sioux Falls, South Dakota.\n(c) EXHIBITS.\nExhibit Number: 13.1 1995 Annual Report to Shareholders of Athey Products Corporation. 21.1 Subsidiaries of the Registrant, attached at end of this Report. 27.1 Financial Data Schedule.\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.\nATHEY PRODUCTS CORPORATION (Registrant)\nBy: \/s\/ James H. Stumpo James H. Stumpo President and Chief Executive Officer\nBy: \/s\/ Franz M. Ahting Franz M. Ahting Vice President Finance and Chief Financial Officer\nDate: March 28, 1996.\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.\n\/s\/ John F. McCullough \/s\/ Martin W. McCullough John F. McCullough, Chairman Martin W. McCullough, Director of the Board of Directors March 28, 1996 March 28, 1996\n\/s\/ Henry W. Gron, Jr. \/s\/Richard A.Rosenthal Henry W. Gron, Jr., Director Richard A. Rosenthal, Director March 28, 1996 March 28, 1996\n\/s\/ James H. Stumpo \/s\/ Franz M. Ahting James H. Stumpo, Director Franz M. Ahting , Director March 28, 1996 March 28, 1996\n(McGladrey & Pullen, LLP logo appears here)\nINDEPENDENT AUDITORS' REPORT ON FINANCIAL STATEMENT SCHEDULES\nBoard of Directors Athey Products Corporation\nOur audits were made for the purpose of forming an opinion on the basic 1995 and 1994 financial statements taken as a whole. Supplemental Schedule II - Valuation and Qualifying Accounts, is presented for purposes of complying with the Securities and Exchange Commission's rules and is not a part of the basic financial statements. This schedule for 1995 and 1994 have been subjected to the auditing procedures applied in our audit of the basic 1995 and 1994 financial statements and, in our opinion, is fairly stated in all material respects in relation to the basic 1995 and 1994 financial statements taken as a whole.\n\/s\/ McGladrey & Pullen, LLP\nRaleigh, North Carolina February 23, 1996\nDeloitte & Touche LLP Suite 1800 Telephone: (919) 546-8000 Logo First Union Capitol Center Telex: 4995716 appears 150 Fayetteville Street Mall Facsimile: (919)833-3276 here) P.O. Box 2778 Raleigh, North Carolina 27602-2778\nINDEPENDENT AUDITORS' REPORT\nBoard of Directors and Shareholders Athey Products Corporation Raleigh, North Carolina\nWe have audited the balance sheet of Athey Products Corporation (the \"Company\") as of December 31, 1993, and the related statments of operations, shareholders' equity and cash flows for the year then ended; such statements of operations, stockholders' equity and cash flows are included in your 1995 Annual Report to Shareholders and are incorporated herein by reference. Our audit also included the 1993 financial statement schedule listed in 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 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 misstate- ment. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, such financial statements present fairly, in all material respects, the financial position of Athey Products Corporation as of December 31, 1993, and the results of its operations and its cash flows for the year then ended in conformity with generally accepted accounting principles. Also, in our opinion, such 1993 financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects the information set forth therein.\n\/s\/ Deloitte & Touche LLP\nRaleigh, North Carolina March 8, 1994\nDeloitte Touche Tohmatsu International\nATHEY PRODUCTS CORPORATION\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS\n(a) Deductions for obsolete inventory scrapped and obsolete inventory sold at reduced selling price. (b) Warranty expenses incurred","section_15":""}
{"filename":"789460_1995.txt","cik":"789460","year":"1995","section_1":"ITEM 1. BUSINESS\nGeneral\nInternational Recovery Corp. (the \"Company\"), is involved in three principal businesses. The Company markets aviation and marine fuel and recycles used oil.\nIn its aviation fueling business, the Company extends credit and provides single-supplier convenience, 24 hour service, and competitively-priced aviation fuel to cargo and passenger airlines, and to charter, corporate, and private aircraft. The Company sells aviation fuel to its customers at more than 1,100 airports located throughout the world.\nIn its marine fueling business, the Company markets marine fuel to a broad base of customers covering all market segments, including major international container and tanker fleets, time charter operators, as well as military vessels. Fueling services include credit terms and are available 24 hours a day in over 1,000 ports, and in over 135 countries.\nIn its oil recycling business, the Company collects used oil throughout the Southern and Mid-Atlantic United States from generators which include service stations, quick lube shops, automobile dealerships, and industrial, governmental, marine and utility generators. The Company recycles used oil into various fuel products and sells the recycled oil to industrial and commercial customers.\nFinancial information with respect to the Company's business segments and foreign operations is provided in Note 8 in the accompanying financial statements.\nHistory\nThe Company was incorporated in Florida in July 1984. Its executive offices are located at 700 South Royal Poinciana Boulevard, Suite 800, Miami Springs, Florida 33166, and its telephone number at this address is (305) 884-2001. The Company presently conducts its aviation fueling business through four subsidiaries with principal offices in Florida, England, and Singapore; the Company conducts its marine fueling business through three subsidiaries with principal offices in New York, California, England and Singapore, and its oil recycling business is conducted through six subsidiaries with offices in Florida, Louisiana, Georgia, Maryland, and Delaware. See \"Item 2","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe following page sets forth by segment and subsidiary the principal properties owned or leased by the Company as of May 15, 1995. The Company considers its properties and facilities to be suitable and adequate for its present needs.\nThe Company generally enters into non-cancelable equipment leases and installment notes to finance the replacement, upgrade or expansion of its vehicles and equipment. For additional information with respect to obligations under the Company's leases and installment notes, see Notes 3 and 6 to the financial statements appearing elsewhere in this report.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIn January 1993, Hillsborough County, Florida sued International Petroleum Corporation, the Company's Florida subsidiary, along with 170 other defendants (or potentially responsible persons), in the U.S. District Court of the Middle District of Florida. The complaint seeks to recover response or cleanup costs for the Sydney Mine Waste Disposal Site under the Comprehensive Environmental Response, Compensation, and Liability Act, 42 U.S.C. section 9601 et. seq. (CERCLA or Superfund) and under Florida Statutes. The Company intends to vigorously defend this action.\nThere can be no assurance the Company will prevail in the foregoing legal proceeding, and management cannot estimate at this time the exposure of the Company if it does not prevail in this proceeding. Except for the foregoing, there are no material legal proceedings to which the Company or any of its subsidiaries is a party.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matter was submitted to a vote of shareholders, through the solicitation of proxies or otherwise, during the fourth quarter of fiscal year 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Company's common stock is currently traded on the New York Stock Exchange and the Pacific Stock Exchange under the symbol INT. The following table sets forth, for each quarter within the fiscal years ended March 31, 1995 and 1994, the sale prices of the Company's common stock as reported by the New York Stock Exchange.\nPRICES --------------------- HIGH LOW ---- --- Year ended March 31, 1995 First quarter.................... $ 14 5\/8 $ 11 5\/8 Second quarter................... 16 3\/8 12 3\/4 Third quarter.................... 16 3\/8 14 Fourth quarter................... 17 3\/8 14 5\/8\nYear ended March 31, 1994 First quarter.................... $ 12 1\/2 $ 10 1\/2 Second quarter................... 15 3\/8 11 Third quarter.................... 16 12 1\/2 Fourth quarter................... 16 1\/8 12 1\/2\nAs of May 25, 1995, there were 478 holders of record of the Company's common stock. During fiscal year 1995, the Board of Directors approved the payment of the following cash dividends:\nDeclaration Date Per Share Record Date Payment Date - ---------------- --------- ----------- ------------ May 9, 1994 .05 cents June 22, 1994 July 15, 1994 September 9, 1994 .05 cents September 22, 1994 October 14, 1994 December 9, 1994 .05 cents December 22, 1994 January 12, 1995 January 19, 1995 .05 cents March 22, 1995 April 13, 1995 February 22, 1995 .10 cents March 22, 1995 April 13, 1995\nThe Company's loan agreement with NationsBank restricts the payment of cash dividends to a maximum of 25% of net income for the preceding four quarters. The Company's payment of the above dividends is in compliance with the NationsBank loan agreement.\nOn April 12, 1993, the Board of Directors authorized the repurchase from time to time of up to 400,000 shares of the Company's common stock. The timing and quantity of shares to be repurchased will depend upon a number of factors, including market price. As of March 31, 1995, a total of 5,000 shares had been purchased in the open market for approximately $57,000 pursuant to the repurchase program.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following selected financial data has been summarized from the Company's consolidated financial statements set forth in Item 8 of this report. The selected financial data should be read in conjunction with the consolidated financial statements and the related notes thereto, and with \"Item 7","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe following discussion should be read in conjunction with \"Item 6 - Selected Financial Data,\" and with the consolidated financial statements and related notes thereto appearing elsewhere in this report.\nResults of Operations\nIn January 1995, the Company entered the marine fuel business through the acquisition of the Trans-Tec group of companies. The Company acquired substantially all of the assets and assumed certain liabilities of Trans-Tec Services, Inc., a New York corporation, and Trans-Tec Servicios, S.A., a Costa Rica corporation, and acquired all of the outstanding stock of Trans- Tec Services (UK), Ltd., a United Kingdom corporation (\"UK\"). The UK company owns Trans-Tec Services (Singapore) PTE., Ltd. Accordingly, the consolidated statement of income for the fiscal year ended March 31, 1995, includes the results of operations of the Trans-Tec group of companies from the acquisition date.\nThe aggregate purchase price was approximately $14,832,000, including $321,000 in acquisition costs. At closing, the Company paid approximately $3,927,000 in cash, $6,000,000 in the form of 9.0% promissory notes and $4,584,000 in the form of 387,000 shares of newly issued common stock, which were valued at $11.84 per share. The purchase price was determined as a result of the Company's arms-length negotiations with Trans-Tec, and its former shareholders.\nProfit from the Company's aviation fuel business is directly related to the volume and the margins achieved on sales, as well as the extent to which the Company is required to provision for potential bad debts.\nProfit from the Company's marine fuel business is determined primarily by the volume of brokering business generated and by the volume and margins achieved on marine fuel trades.\nThe Company's profit from oil recycling is principally determined by the spread between the selling price of recycled oil and the cost of collecting and processing waste oil.\nFiscal Year Ended March 31, 1995 Compared to the Fiscal Year Ended March 31, 1994.\nThe Company's revenues for the fiscal year ended March 31, 1995 were $361,891,000, an increase of $111,364,000, or 44.5%, as compared to revenues of $250,527,000 for the prior year. The Company's revenues during these periods were attributable to the following segments:\nFiscal Year Ended March 31, Percent 1995 1994 Increase -------------------------------------- Aviation Fueling $288,728,000 $233,982,000 23.4% Marine Fueling 54,578,000 - * Oil Recycling 18,591,000 16,554,000 12.3 Intersegment Eliminations (6,000) (9,000) * ------------ ------------ ---- Total Revenue $361,891,000 $250,527,000 44.5% ============ ============ ===== * Percent not meaningful\nThe aviation fueling segment sold 456,502,000 gallons of fuel and contributed $288,728,000 of revenue for the fiscal year ended March 31, 1995. This represented an increase in revenue of $54,746,000, or 23.4%, as compared to the prior year when the Company sold 321,154,000 gallons of fuel. This increase in revenue was due to an increase in volume, primarily the result of increased bulk sales, partially offset by a price related revenue shortfall which reflects general market conditions. Also offsetting was $4,688,000 in lower fuel terminaling revenue. The Company's fuel terminaling business, conducted solely at Miami International Airport pursuant to a month-to-month contract, was awarded to another company effective June 30, 1994.\nThe marine fueling segment traded 465,000 metric tons of bunker fuel and brokered 1,091,000 metric tons, contributing $53,298,000 and $824,000 in revenues, respectively. The Company also sold 104,000 gallons in lubricants totalling $456,000 in revenues.\nThe oil recycling segment sold 35,015,000 gallons of recycled oil products and contributed $18,591,000 of revenue for the fiscal year ended March 31, 1995. This was an increase in revenue of $2,037,000, or 12.3%, as compared to last year when the Company sold 32,756,000 gallons of recycled oil products. The revenue increase reflects higher used oil and waste water collection revenues, higher product volume sold, and a price related increase on recycled product.\nThe Company's gross profit of $27,757,000 increased by $806,000, or 3.0%, as compared to last year. The Company's gross margin decreased from 10.8% for the fiscal year ended March 31, 1994 to 7.7% for the fiscal year ended March 31, 1995.\nThe Company's aviation fueling segment achieved a 6.9% gross margin for the fiscal year ended March 31, 1995, as compared to 9.8% achieved for the prior fiscal year. The decline in the gross margin was attributed to a narrower average gross profit per gallon, as well as a decline in fuel terminaling gross profit. The decline in the average gross profit per gallon was due to increased bulk sales.\nThe Company's marine fueling segment achieved a 3.9% gross margin for the fiscal year ended March 31, 1995. The Company's gross margin on trading activities was 2.5%.\nThe gross margin in the Company's oil recycling segment increased from 24.8% for fiscal year 1994 to 30.9% for fiscal year 1995. This resulted from the combined effects of a higher average sales price of recycled oil, and a lower average cost of collection and processing used oil, and blending recycled oil. This decrease was primarily attributed to the higher volume processed by the Company and the lower cost of operating a batch process in Louisiana.\nTotal operating expenses for the fiscal year ended March 31, 1995 were $16,508,000, a decrease of $673,000, or 3.9%, as compared to the same period a year ago. This decrease resulted from a $3,001,000 decrease in the provision for bad debts due to a year over year improvement in the quality of accounts receivable, as well as a $255,000 decline in operating expenses of the Company's used oil segment. Partially offsetting were the operating expenses of the marine segment acquired in January 1995, which totalled $1,912,000, and an $877,000 increase in corporate overhead costs, discussed below. In relation to revenue, total operating expenses decreased from 6.9% to 4.6%.\nThe Company's income from operations for the fiscal year ended March 31, 1995 was $11,249,000, an increase of $1,479,000, or 15.1%, as compared to income from operations of $9,770,000 for the fiscal year ended March 31, 1994. Income from operations during these periods was attributable to the following segments:\nFiscal Year Ended March 31, Percent 1995 1994 Increase ----------- ----------- -------- Aviation Fueling $12,304,000 $12,066,000 2.0% Marine Fueling 220,000 - * Oil Recycling 2,973,000 1,075,000 176.6 Corporate Overhead (4,248,000) (3,371,000) 26.0 ----------- ----------- Total Income From Operations $11,249,000 $ 9,770,000 15.1% =========== =========== =====\nIncome from operations of the aviation fueling segment increased $238,000, or 2.0%, for the fiscal year ended March 31, 1995, as compared to the fiscal year ended March 31, 1994. This increase resulted from higher product volume sold, and a decrease in operating expenses due to a lower provision for bad debts. Partially offsetting were narrower margin fuel sales due to bulk transactions, and lower operating income from the Company's fuel terminaling activities.\nThe marine fueling segment earned $220,000 in income from operations for fiscal year 1995. The gross profit for this segment was $2,132,000, reduced by $1,912,000 in operating expenses.\nIncome from operations of the oil recycling segment increased by $1,898,000, or 176.6%, for the fiscal year ended March 31, 1995, as compared to last year. This increase resulted primarily from higher product volume sold, higher margins on recycled oil and lower operating expenses.\nCorporate overhead costs not charged to the business segments totalled $4,248,000 for the fiscal year ended March 31, 1995, an increase of $877,000, or 26.0%, as compared to last year. The increase was due to higher salaries and payroll related costs. In relation to sales, total corporate overhead decreased to 1.2% for the fiscal year ended March 31, 1995, as compared to 1.3% for the prior year.\nIn the fiscal year ended March 31, 1995, the Company had $1,774,000 in other income, net, an increase of $3,107,000 as compared to $1,333,000 in other expense, net for the same period a year ago. In fiscal year 1994, the Company incurred a $1,300,000 expense related to the settlement of a shareholders class action, originally filed in June 1992. In fiscal year 1995, when compared to the previous fiscal year, the Company earned $737,000 in foreign currency transaction gains, $544,000 in equity earnings of a joint venture, and $502,000 in net interest income which is the result of the Company's improved liquidity.\nNet income for the fiscal year ended March 31, 1995 was $8,088,000, an increase of $2,893,000, as compared to net income for the fiscal year ended March 31, 1994. Earnings per share of $1.65 for the fiscal year ended March 31, 1995 exhibited a $0.55 increase over the $1.10 achieved during the same period last year.\nFiscal Year Ended March 31, 1994 Compared to the Fiscal Year Ended March 31, 1993.\nThe Company's revenues for the fiscal year ended March 31, 1994 were $250,527,000, a decrease of $4,240,000, or 1.7%, as compared to revenues of $254,767,000 for the prior year. The Company's revenues during these periods were attributable to the following segments:\nPercent Fiscal Year Ended March 31, Increase 1994 1993 (Decrease) ------------ ------------ ---------- Aviation Fueling $233,982,000 $241,055,000 (2.9%) Oil Recycling 16,554,000 14,014,000 18.1 Intersegment Eliminations (9,000) (302,000) * ------------ ------------ Total Revenue $250,527,000 $254,767,000 (1.7%) ============ ============ ===== * Percent not meaningful.\nThe aviation fueling segment sold 321,154,000 gallons of fuel and contributed $233,982,000 of revenue for the fiscal year ended March 31, 1994. This represented a decrease in revenue of $7,073,000, or 2.9%, as compared to the prior year when the Company sold 312,485,000 gallons of fuel. This decrease in revenue was due to a price related revenue shortfall which reflects general market conditions as well as competitive pressures. Partially offsetting was an increase in volume, attributed to market expansion (both domestic and international), and $1,363,000 in higher revenue contributed by the fuel terminaling operation.\nThe oil recycling segment sold 32,756,000 gallons of recycled oil products and contributed $16,554,000 of revenue for the fiscal year ended March 31, 1994. This was an increase in revenue of $2,540,000, or 18.1%, as compared to the prior year when the Company sold 25,484,000 gallons of recycled oil products. This reflects additional revenues provided by the Company's used oil and waste water collection activities and an improvement related to higher product volume sold. These increases reflect the opening of the Wilmington, Delaware operation. Partially offsetting was a price related decline on recycled product which resulted from an overall decline in fuel prices.\nThe Company's gross profit of $26,951,000 increased by $3,031,000, or 12.7%, as compared to the prior year. The Company's gross margin increased from 9.4% for the fiscal year ended March 31, 1993 to 10.8% for the fiscal year ended March 31, 1994. The gross margin improvement in the Company's aviation segment offset the decline in the oil recycling segment gross margin, as explained below.\nThe Company's aviation fuel business achieved a 9.8% gross margin for the fiscal year ended March 31, 1994, as compared to 8.0% achieved for the same period during the prior fiscal year. Excluding the fuel terminaling operations, the aviation fueling business achieved a gross margin of 8.2% in fiscal year 1994, as compared to 6.8% in fiscal year 1993. The improvement in the gross margin was attributed to the decline in the average sales price per gallon while the gross profit per gallon improved.\nThe gross margin in the Company's oil recycling operations decreased from 34.2% for the fiscal year ended March 31, 1993 to 24.8% for the fiscal year ended March 31, 1994. This resulted from the combined effects of a lower average sales price of recycled oil and a higher average cost of collecting and processing used oil, and blending recycled oil. These costs increased primarily because of the under-utilization of the Company's facilities.\nTotal operating expenses for the fiscal year ended March 31, 1994 were $17,181,000, an increase of $1,327,000, or 8.4%, as compared to the fiscal year ended March 31, 1993. Of this increase, $626,000 was due to increased charges to the provision for bad debts. For the fiscal year ended March 31, 1994, the Company charged $5,063,000 to the provision for bad debts, primarily to replenish the allowance for bad debts for charge-offs. The charge-offs and increases to the provision for bad debts are due primarily to collection problems encountered by the Company in its aviation segment. During fiscal year 1994, the Company has seen improvement in the quality of its accounts receivable with a substantial reduction in accounts with balances over 90 days old. Also contributing to the increase in total operating expenses was $398,000 related to the opening of the Wilmington, Delaware plant and $500,000 in legal fees, an increase related primarily to the collection of past due accounts receivable.\nThe Company's income from operations for the fiscal year ended March 31, 1994 was $9,770,000, an increase of $1,704,000, or 21.1%, as compared to income from operations of $8,066,000 for the same period last year. Income from operations during these periods was attributable to the following segments:\nPercent Fiscal Year Ended March 31, Increase 1994 1993 (Decrease) ----------- ----------- ---------- Aviation Fueling $12,066,000 $ 8,911,000 35.4% Oil Recycling 1,075,000 2,333,000 (53.9) Corporate Overhead (3,371,000) (3,001,000) 12.3 Intersegment Eliminations - (177,000) * ----------- ----------- Total Income From Operations $ 9,770,000 $ 8,066,000 21.1% =========== =========== ====== * Percent not meaningful.\nIncome from operations of the aviation fueling segment increased $3,155,000, or 35.4%, for the fiscal year ended March 31, 1994, as compared to the prior year. This increase resulted from higher product volume sold, improved margins on fuel sales, and higher operating income from the Company's fuel terminaling activities. Partially offsetting was an increase in operating expenses, which included higher charges to the provision for bad debts and higher legal fees related to the collection of past due accounts receivables. The increase in operating expenses was partly offset by a reduction in salaries mostly associated with the December 31, 1992, expiration of certain employment and non-compete agreements. Also offsetting the increase in operating expenses was a decrease in administrative expenses.\nThe fuel terminaling business was conducted solely at Miami International Airport, pursuant to a month-to-month contract, and accounted for 34.3% of the aviation segment's operating income during the fiscal year. This contract was awarded to another company effective June 30, 1994.\nIncome from operations of the oil recycling segment decreased by $1,258,000, or 53.9%, for the fiscal year ended March 31, 1994, as compared to the prior year. This decrease in income from operations was in part due to a decline in gross profit which resulted from the low utilization of the Company's two main recycling plants. The Florida plant was impacted by a slowdown in sales to phosphate mining customers and the Delaware plant was a start-up operation. Although used oil collection revenues were up, sales of recycled products were lower during fiscal year 1994, when compared to the prior year. The balance of the decline in income from operations was due to an increase in operating expenses which primarily related to the Delaware operation.\nCorporate overhead costs not charged to the business segments totalled $3,371,000 for the fiscal year ended March 31, 1994, an increase of $370,000, or 12.3%, as compared to the prior year. The increase was due to higher salaries and payroll related costs. In relation to sales, total corporate overhead increased from 1.2% in fiscal year 1993 to 1.3% in fiscal year 1994.\nDuring the fiscal year ended March 31, 1993, the Company had other income, net of $180,000, reflecting the capitalization of interest during construction of the Delaware plant. In fiscal year 1994, the Company had other expense, net of $1,333,000, which included a non-recurring charge in the fourth quarter of fiscal year 1994 for the settlement of the shareholders class action which was filed on June 23, 1992.\nThe Company's net income from continuing operations for the fiscal year ended March 31, 1994 was $5,195,000, a decrease of $67,000, or 1.3%, as compared to net income from continuing operations of $5,262,000 for the prior year. Earnings per share from continuing operations was $1.10 for the fiscal year ended March 31, 1994, and decreased 0.9%, as compared to the $1.11 earnings per share achieved during fiscal year 1993.\nNet income for the fiscal year ended March 31, 1994, was $5,195,000, an increase of $3,648,000, as compared to net income for fiscal year 1993. Last year's net income included a $3,715,000 after-tax loss from the Company's discontinued environmental services segment operations. Earnings per share of $1.10 for the fiscal year ended March 31, 1994, exhibited a $.77 increase over the $.33 achieved during the prior year.\nLiquidity and Capital Resources\nIn the Company's aviation and marine fuel businesses, the primary use of capital is to finance accounts receivable. The Company maintains aviation fuel inventories in the United States for competitive reasons. On average, inventory levels represent less than a three week demand. The Company's aviation and marine fuel businesses do not require significant capital investment in fixed assets as the Company subcontracts fueling services and maintains inventory at third party storage facilities.\nIn relation to the Company's aviation and marine fueling segments, the oil recycling segment is capital intensive. The Company normally utilizes internally generated cash to fund capital expenditures, and secondarily the Company will utilize its available line of credit or enter into leasing or installment note arrangements to match-fund the useful life of certain long-term assets with the related debt. The Company's oil recycling operations also require working capital to purchase and carry an inventory of used oil, as well as the costs of operating the plant until the proceeds from the re-refined oil sales are received.\nCash and cash equivalents amounted to $10,907,000 at March 31, 1995, as compared to $7,699,000 at March 31, 1994. The principal sources of cash during the fiscal year ended March 31, 1995 were $9,299,000 in net cash provided by operating activities, $768,000 from collections on notes receivable, and $918,000 from the issuance of common stock in connection with the exercise of warrants and options. Partially offsetting the increase in cash and cash equivalents was $3,184,000 used for the purpose of acquiring the Trans-Tec group of companies, $2,194,000 used for the purchase and construction of plant, equipment and other capital expenditures, net of proceeds from sales of assets, $717,000 in dividends paid on common stock, and $338,000 in advances to a joint venture. Other components of changes in cash and cash equivalents are detailed in the Consolidated Statements of Cash Flows.\nWorking capital as of March 31, 1995 was $27,520,000, exhibiting a $6,979,000 increase from working capital as of March 31, 1994. As of March 31, 1995, the Company's accounts receivable, excluding the allowance for bad debts, amounted to $43,366,000, an increase of $21,025,000 as compared to the March 31, 1994 balance. This increase was due primarily to the acquisition of the marine segment which added $18,347,000 in accounts receivable. The allowance for doubtful accounts as of March 31, 1995 amounted to $4,566,000, an increase of $2,102,000, when compared to the March 31, 1994 balance. During the fiscal year ended March 31, 1995, the Company charged $2,062,000 to the provision for bad debts and had charge-offs in excess of recoveries of $271,000.\nInventories at March 31, 1995 were $933,000 higher as compared to March 31, 1994. This consisted of a $427,000 increase in inventories in the oil recycling segment, and a $506,000 increase in the aviation fueling segment.\nCapital expenditures for the fiscal year ended March 31, 1995 consisted primarily of $474,000 in construction costs related to the Company's Louisiana plant, $958,000 to acquire trucks utilized in the collection of used oil and petroleum contaminated water, and delivery of recycled products, as well as $298,000 in office equipment and furniture. During fiscal year 1996, the Company anticipates spending approximately $1,000,000 to upgrade plant, machinery and equipment. The Company also anticipates spending an additional estimated $1,000,000 over the next several years to clean up contamination which was present at one of the Company's sites when it was acquired by the Company. Clean up will be capitalized as part of the cost of the site, up to the fair market value of the site.\nCurrent maturities of long-term debt amounted to $2,128,000 as of March 31, 1995, an increase of $1,842,000. This increase resulted from the issuance of promissory notes, of which $1,830,000 is current, related to the acquisition of the Trans-Tec group of companies.\nIn the aggregate, accounts payable, accrued expenses and customer deposits increased $14,885,000. This increase was largely due to the acquisition of the Trans-Tec group of companies which added $12,316,000 in accounts payable, accrued expenses and customer deposits. Accrued salaries and wages increased $461,000, principally as the result of accrued sales and management performance bonuses pursuant to employment agreements.\nLong-term liabilities as of March 31, 1995, were $6,984,000, exhibiting a $6,409,000 increase as compared to March 31, 1994. This increase resulted from the issuance of promissory notes, of which $4,170,000 is long-term, related to the acquisition of the Trans-Tec group of companies. The balance of the increase is the result of the reclassification of the $1,300,000 accrued litigation settlement expense from current liabilities to a long-term liability and the assumption of obligations under the Trans-Tec deferred compensation plan which amounted to $1,237,000. For additional information, see the accompanying financial statements.\nStockholders' equity amounted to $52,066,000, or $10.01 per share, at March 31, 1995 compared to $39,971,000, or $8.44 per share, at March 31, 1994. This increase of $12,095,000 was due to $8,088,000 in earnings for the period, $4,584,000 resulting from the issuance of common stock in connection with the acquisition of the Trans-Tec group of companies, and $455,000 and $463,000 due to the issuance of common stock pursuant to the exercise of stock options and warrants, respectively. Partially offsetting was $1,509,000 in cash dividends declared.\nThe Company's working capital requirements for fiscal year 1996 will increase as a result of acquiring the Trans-Tec group of companies. The Company expects to meet its working capital requirements for fiscal year 1996 from existing cash, operations and additional borrowings, as necessary, under its existing line of credit.\nThe Company's business has not been significantly affected by inflation during the periods discussed in this report.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nAttached hereto and filed as a part of this Form 10-K are the financial statements required by Regulation S-X and the supplementary data required by Regulation S-K.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE No disagreements with accountants on any matter of accounting principles or practices or financial statement disclosure have been reported on a Form 8-K within the twenty-four months prior to the date of the most recent financial statement.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information concerning the directors and executive officers of the Company set forth under the captions \"Election of Directors\" and \"Information Concerning Executive Officers\", respectively in the definitive Proxy Statement of the Company for its 1995 Annual Meeting of Shareholders (the \"1995 Proxy Statement\") is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information set forth in the 1995 Proxy Statement under the caption \"Compensation of Officers\" and \"Board of Directors - Compensation of Directors\" is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information set forth under the caption \"Principal Stockholders and Security Ownership of Management\" in the 1995 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 Management and Others\" 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\nSequential Page Number ==========\n(a)(1) The following Financial Statements are filed as a part of this report:\n(i) Report of Independent Certified Public Accountants 31\n(ii) Consolidated Balance Sheets as of March 31, 1995 and 1994 32\n(iii) Consolidated Statements of Income for the Years Ended March 31, 1995, 1994 and 1993 34\n(iv) Consolidated Statements of Stock- holders' Equity for the Years Ended March 31, 1995, 1994 and 1993 36\n(v) Consolidated Statements of Cash Flows for the Years Ended March 31, 1995, 1994 and 1993 37\n(vi) Notes to Consolidated Financial Statements 40\n(a)(2) The following Financial Statement Schedule is filed as a part of this report:\n(i) Schedule II - Valuation and Qualifying Accounts. 57\nSchedules not set forth herein have been omitted either because the required information is set forth in the Consolidated Financial Statements or Notes thereto, or the information called for is not required.\n(a)(3) The Exhibits set forth in the following index of Exhibits are filed as a part of this report:\nEXHIBIT NO. DESCRIPTION ----------- ----------- (2) Plan of acquisition, reorganization, arrangement, liquidation or succession:\n(a) Acquisition Agreement dated December 9, 1994 among International Recovery Corp., Trans-Tec Services, Inc., Trans-Tec Servicios, S.A., Theofilos A. Vatis, Michael J. Kasbar, Paul H. Stebbins, and Stacey A. Polites is incorporated by reference to the Company's Form 8-K filed January 18, 1995.\n(3) Articles of Incorporation and By-laws:\n(a) Articles of Incorporation are incorporated by reference to the Company's Registration Statement on Form S-18 filed February 3, 1986.\n(b) By-laws are incorporated by reference to the Company's Registration Statement on Form S-18 filed February 3, 1986.\n(4) Instruments defining rights of security holders:\n(a) Employee Stock Option Plan is incorporated by reference to the Company's Registration Statement on Form S-18 filed February 3, 1986.\n(b) 1993 Non-Employee Directors Stock Option Plan is incorporated by reference to the Company's Schedule 14A filed June 28, 1994.\n(10) Material Contracts\n(a) Material Contracts incorporated by reference to the Company's Report on Form 10-K filed June 17, 1991:\n(i) Revolving Loan Agreement and Credit Facility, dated March 1, 1991, among The Citizens & Southern National Bank (now known as NationsBank of Florida, N.A.), International Recovery and its subsidiaries.\n(ii) Promissory Note, dated March 1, 1991, executed by International Recovery Corp. and its subsidiaries in favor of The Citizens & Southern National Bank (now known as NationsBank of Florida, N.A.)\n(b) Material Contract incorporated by reference to the Company's Report on Form 10-K filed May 24, 1993.\n(i) Amended and Restated Employment Agreement with Phillip S. Bradley, dated November 10, 1992, amending and restating his employment and non-competition agreements.\n(c) Material contracts incorporated by reference to the Company's Report on Form 10-K filed May 9, 1994.\n(i) Consolidated Amendment No. 2 dated January 21, 1994 among NationsBank of Florida, N.A., International Recovery Corp. and its subsidiaries.\n(ii) Promissory Note, dated January 21, 1994, executed by International Recovery Corp. and its subsidiaries in favor of NationsBank of Florida, N.A.\n(d) Material contracts filed with this Form 10-K.\n(i) Amended and Restated Employment Agreement with Jerrold Blair, dated February 15, 1995.\n(ii) Amended and Restated Employment Agreement with Ralph Weiser, dated February 15, 1995.\n(iii) Consolidated Amendment Agreement dated May 5, 1995, No. 3 among NationsBank of Florida, N.A., International Recovery Corp. and its subsidiaries.\n(iv) Promissory Note dated January 3, 1995, executed by International Recovery Corp. in favor of Theofilos A. Vatis.\n(v) Promissory Note dated January 3, 1995, executed by International Recovery Corp. in favor of Michael J. Kasbar.\n(vi) Promissory Note dated January 3, 1995, executed by International Recovery Corp. in favor of Paul H. Stebbins.\n(vii) Promissory Note dated January 3, 1995, executed by International Recovery Corp. in favor of Stacey A. Polites.\n(21) Subsidiaries of the Registrant\n(23) Consent of Independent Certified Public Accountants\n(27) Financial Data Schedule\n(b) A Form 8-K was filed during the Company's fiscal year ended March 31, 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.\nINTERNATIONAL RECOVERY CORP.\nDated: May 22, 1995 By: \/S\/ Jerrold Blair ------------------------ Jerrold Blair, President\nDated: May 22, 1995 By: \/S\/ Carlos A. Abaunza ------------------------ Carlos A. Abaunza, 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.\nDated: May 22, 1995 By: \/S\/ Ralph R. Weiser ------------------------- Ralph R. Weiser, Director\nDated: May 22, 1995 By: \/S\/ Jerrold Blair ------------------------- Jerrold Blair, Director\nDated: May 22, 1995 By: \/S\/ Phillip S. Bradley ------------------------- Phillip S. Bradley, Director\nDated: May 22, 1995 By: \/S\/ Ralph Feuerring ------------------------- Ralph Feuerring, Director\nDated: May 22, 1995 By: \/S\/ John R. Benbow ------------------------- John R. Benbow, Director\nDated: May 22, 1995 By: \/S\/ Celestin Durand III ------------------------- Celestin Durand III, Director\nDated: May 22, 1995 By: \/S\/ Myles Klein ------------------------- Myles Klein, Director\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nTo the Board of Directors and Stockholders of International Recovery Corp.:\nWe have audited the accompanying consolidated balance sheets of International Recovery Corp. (a Florida corporation) and subsidiaries as of March 31, 1995 and 1994, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended March 31, 1995. These consolidated 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 consolidated 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 International Recovery Corp. and subsidiaries as of March 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended March 31, 1995 in conformity with generally accepted accounting principles.\nOur audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule listed in Item 14 (a)(2) is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\nARTHUR ANDERSEN LLP\nMiami, Florida, May 19, 1995.\nINTERNATIONAL RECOVERY CORP. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\nASSETS\nMARCH 31, --------------------------- 1995 1994 =========== =========== CURRENT ASSETS: Cash and cash equivalents $10,907,000 $ 7,699,000 Accounts receivable, net of allowance for bad debts of $4,566,000 and $2,464,000 at March 31,1995 and 1994, respectively 38,800,000 19,877,000 Inventories 3,714,000 2,781,000 Prepaid expenses and other current assets 4,585,000 3,325,000 ----------- ----------- Total current assets 58,006,000 33,682,000 ----------- -----------\nPROPERTY, PLANT AND EQUIPMENT, at cost: Land 705,000 705,000 Buildings and improvements 2,929,000 3,272,000 Office equipment and furniture 2,394,000 1,549,000 Plant, machinery and equipment 15,052,000 12,751,000 Construction in progress 184,000 1,089,000 ----------- ----------- 21,264,000 19,366,000\nLess accumulated depreciation and amortization 5,680,000 4,950,000 ----------- ----------- 15,584,000 14,416,000 ----------- ----------- OTHER ASSETS: Unamortized cost in excess of net assets of acquired companies, net of accumulated amortization 12,391,000 1,847,000 Other 3,555,000 3,742,000 ----------- ----------- $89,536,000 $53,687,000 =========== ===========\n(Continued)\nINTERNATIONAL RECOVERY CORP. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\n(Continued)\nLIABILITIES AND STOCKHOLDERS' EQUITY\nMARCH 31, ---------------------------- 1995 1994 =========== =========== CURRENT LIABILITIES: Current maturities of long-term debt $ 2,128,000 $ 286,000 Accounts payable and accrued expenses 24,334,000 9,908,000 Customer deposits 1,559,000 1,100,000 Accrued salaries and wages 747,000 286,000 Accrued litigation settlement expense - 1,300,000 Income taxes payable 1,718,000 261,000 ----------- ----------- Total current liabilities 30,486,000 13,141,000 ----------- -----------\nLONG-TERM LIABILITIES: Long-term debt, net of current maturities 4,447,000 575,000 Accrued litigation settlement expense 1,300,000 - Deferred compensation 1,237,000 - ----------- ----------- 6,984,000 575,000 ----------- ----------- COMMITMENTS AND CONTINGENCIES (Notes 2, 3, 5, 6, and 7)\nSTOCKHOLDERS' EQUITY: Preferred stock, $1.00 par value; 100,000 shares authorized, none issued - - Common stock, $.01 par value; 10,000,000 shares authorized, 5,203,000 and 4,738,000 shares issued and outstanding at March 31, 1995 and 1994, respectively 52,000 47,000 Capital in excess of par value 20,440,000 14,929,000 Retained earnings 31,631,000 25,052,000 Less treasury stock, at cost 57,000 57,000 ----------- ----------- 52,066,000 39,971,000 ----------- ----------- $89,536,000 $53,687,000 =========== ===========\nThe accompanying notes to the consolidated financial statements are an integral part of these consolidated balance sheets.\nINTERNATIONAL RECOVERY CORP. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF INCOME\nFor the Year Ended March 31, ------------------------------------------ 1995 1994 1993 ============ ============ ============\nRevenue $361,891,000 $250,527,000 $254,767,000\nCost of sales 334,134,000 223,576,000 230,847,000 ------------ ------------ ------------ Gross profit 27,757,000 26,951,000 23,920,000 ------------ ------------ ------------ Operating expenses: Salaries and wages 8,117,000 6,558,000 6,039,000 Provision for bad debts 2,062,000 5,063,000 4,437,000 Other 6,329,000 5,560,000 5,378,000 ------------ ----------- ------------ 16,508,000 17,181,000 15,854,000 ------------ ----------- ------------ Income from operations 11,249,000 9,770,000 8,066,000 ------------ ----------- ------------ Other income (expense): Litigation settlement - (1,300,000) - Other, net 1,774,000 (33,000) 180,000 ------------ ----------- ------------ 1,774,000 (1,333,000) 180,000 ------------ ----------- ------------ Income from continuing operations before income taxes 13,023,000 8,437,000 8,246,000\nProvision for income taxes 4,935,000 3,242,000 2,984,000 ------------ ----------- ------------ Net income from continuing operations 8,088,000 5,195,000 5,262,000 ------------ ----------- ------------\n(Continued)\nINTERNATIONAL RECOVERY CORP. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF INCOME\n(Continued)\nFor the Year Ended March 31, ---------------------------------------- 1995 1994 1993 ========== ============ ==========\nDiscontinued operations: Loss from operations of discontinued environmental services segment (net of applicable income tax benefit of $1,033,000) - - (1,793,000)\nLoss on disposal of environmental services segment including a provision of $1,350,000 for operating losses during the phase-out period (net of applicable income tax benefit of $993,000) - - (1,922,000) ---------- ------------ ------------ Net loss from discontinued operations - - (3,715,000) ---------- ------------ ------------ Net income $8,088,000 $ 5,195,000 $ 1,547,000 ========== ============ ============\nEarnings (losses) per common and common equivalent share:\nIncome from continuing operations $ 1.65 $ 1.10 $ 1.11\nLoss from discontinued operations - - (.78) ---------- ------------ ------------ Net income $ 1.65 $ 1.10 $ .33 ========== ============ ============\nWeighted average shares outstanding 4,906,000 4,734,000 4,749,000 ========== ============ ============\nThe accompanying notes to the consolidated financial statements are an integral part of these consolidated statements.\nINTERNATIONAL RECOVERY CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY\nCommon Stock Capital in ------------------- Excess of Retained Treasury Shares Amount Par Value Earnings Stock ========= ======== =========== =========== ========= Balance at March 31, 1992 4,689,000 $ 47,000 $14,332,000 $18,310,000 $ -\nExercise of warrants 15,000 - 105,000 - -\nNet income - - - 1,547,000 -\nOther - - 29,000 - - ---------- -------- ----------- ----------- --------- Balance at March 31, 1993 4,704,000 47,000 14,466,000 19,857,000 -\nExercise of warrants 39,000 - 463,000 - -\nRepurchase of common stock (5,000) - - - (57,000)\nNet income - - - 5,195,000 - ---------- -------- ----------- ----------- --------- Balance at March 31, 1994 4,738,000 47,000 14,929,000 25,052,000 (57,000)\nExercise of warrants 38,000 - 463,000 - -\nExercise of options 40,000 - 455,000 - -\nIssuance of shares for acquisition 387,000 5,000 4,579,000 - -\nCash dividends declared - - - (1,509,000) -\nNet income - - - 8,088,000 -\nOther - - 14,000 - - --------- -------- ----------- ----------- --------- Balance at March 31, 1995 5,203,000 $ 52,000 $20,440,000 $31,631,000 $ (57,000) ========= ======== =========== =========== =========\nThe accompanying notes to the consolidated financial statements are an integral part of these consolidated statements.\nINTERNATIONAL RECOVERY CORP. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nFor the Year Ended March 31, ------------------------------------ 1995 1994 1993 =========== =========== ===========\nCash flows from operating activities: Net income $ 8,088,000 $ 5,195,000 $ 1,547,000 ----------- ----------- ----------- Adjustments to reconcile net income to net cash provided by (used in) operating activities- Estimated loss on disposal of discontinued operations - - 1,233,000 Depreciation and amortization 1,373,000 1,502,000 1,473,000 Provision for bad debts 2,062,000 5,063,000 4,437,000 Litigation settlement - 1,300,000 - Deferred income tax (benefit) provision 181,000 (176,000) (441,000) Equity in earnings of joint venture (544,000) - - Deferred compensation expense - - 29,000 Other non-cash operating charges (credits) 35,000 (4,000) 19,000\nChanges in assets and liabilities, net of assets acquired and liabilities assumed: (Increase) decrease in- Accounts receivable 1,959,000 223,000 (6,921,000) Inventories (933,000) 165,000 (278,000) Prepaid expenses and other current assets (72,000) (1,347,000) (36,000) Net cash provided by discontinued operations - 2,431,000 1,033,000 Other assets (15,000) 332,000 (29,000)\nIncrease (decrease) in- Accounts payable, accrued expenses, customer deposits and deferred compensation (4,148,000) (1,751,000) (3,957,000) Accrued salaries and wages 461,000 (299,000) 79,000 Income taxes payable 852,000 (1,510,000) 1,703,000 ----------- ----------- ---------- Total adjustments 1,211,000 5,929,000 (1,656,000) ----------- ----------- ---------- Net cash provided by (used in) operating activities 9,299,000 11,124,000 (109,000) ----------- ----------- ---------- (Continued)\nINTERNATIONAL RECOVERY CORP. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\n(Continued)\nFor the Year Ended March 31, ------------------------------------ 1995 1994 1993 =========== =========== ==========\nCash flows from investing activities: Additions to property, plant and equipment (2,194,000) (3,114,000) (3,885,000) Proceeds from sales of assets 585,000 77,000 93,000 Payment for acquisition of business, net of cash acquired (3,184,000) - - Purchase of short-term investments (3,500,000) - - Proceeds from short-term investments 3,500,000 - - Proceeds from notes receivable 768,000 - - Advances to joint venture (338,000) - - ---------- ---------- ---------- Net cash used in investing activities (4,363,000) (3,037,000) (3,792,000) ---------- ---------- ----------\nCash flows from financing activities: Net (repayments) borrowings under the revolving line of credit - (4,000,000) 3,000,000 Repayment of long-term debt (286,000) (489,000) (511,000) Proceeds from issuance of notes payable - - 750,000 Repayment of notes payable (1,643,000) - (839,000) Proceeds from issuance of common stock 918,000 463,000 105,000 Repurchase of common stock - (57,000) - Dividends paid on common stock (717,000) - - ---------- ---------- ---------- Net cash (used in) provided by financing activities (1,728,000) (4,083,000) 2,505,000 ---------- ---------- ----------\nNet increase (decrease) in cash and cash equivalents 3,208,000 4,004,000 (1,396,000)\nCash and cash equivalents, at beginning of year 7,699,000 3,695,000 5,091,000 ----------- ----------- ---------- Cash and cash equivalents, at end of year $10,907,000 $ 7,699,000 $3,695,000 =========== =========== ==========\n(Continued)\nINTERNATIONAL RECOVERY CORP. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\n(Continued)\nFor the Year Ended March 31, ------------------------------------ 1995 1994 1993 ========== ========== ========== SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION, including discontinued operations: Cash paid during the year for: Interest, net of capitalized interest $ 129,000 $ 149,000 $ 67,000 ========== ========== ==========\nIncome taxes $3,714,000 $3,219,000 $1,912,000 ========== ========== ==========\nSUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES:\nIn April 1995, the Company paid $1,300,000, representing its share of the stockholders class action settlement, by issuing 78,550 of the Company's common stock at an agreed upon price of $16.55 per share. Accordingly, as of March 31, 1995, the Company reclassified from current liabilities to long-term liabilities the accrued litigation settlement expense.\nIn connection with the acquisition of the Trans-Tec group of companies, the Company also issued 387,000 of its common stock valued at $4,584,000, and $6,000,000 in notes payable. See Note 1 for additional information.\nCash dividends declared, but not yet paid totaling $792,000, are included in accounts payable and accrued expenses as of March 31, 1995.\nIn connection with the sale of certain land and buildings, the Company received $1,317,000 in notes receivable during fiscal year 1994.\nNet assets totaling $419,000 were transferred from the Company's discontinued operations to continuing operations during fiscal year 1994. Equipment totaling $185,000 was transferred from the Company's discontinued operations to continuing operations during fiscal year 1993.\nBorrowings totaling $220,000 were incurred during fiscal year 1994 in connection with the acquisition of equipment.\nAccounts receivable totaling $1,500,000 as of March 31, 1993, were converted to long-term notes receivable during fiscal year 1994.\nThe accompanying notes to the consolidated financial statements are an integral part of these consolidated statements.\nINTERNATIONAL RECOVERY CORP. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nInternational Recovery Corp. (the \"Company\") was incorporated on July 20, 1984. The Company is involved in three principal businesses. The Company markets aviation and marine fuel and recycles used oil.\nOrganization and Nature of Acquisitions and Divestitures\nIn December 1986, the Company entered the aviation fueling business with the acquisition of Advance Petroleum, Inc. (\"Advance\"). In October 1989, the Company expanded its aviation fueling capabilities by acquiring JCo Energy Partners, Ltd. and shortly thereafter renamed these operations World Fuel Services, Inc.\nThe Company formed a subsidiary, Air-Terminaling, Inc. (\"ATI\") which began operations in December 1991. ATI managed the fuel storage facilities owned by the Metropolitan Dade County, Florida Aviation Department Authority which are used to distribute aviation fuel at Miami International Airport. On May 3, 1994, the Metropolitan Dade County Board of Commissioners voted to award the fuel management contract to another company effective June 30, 1994.\nThe Company formed a subsidiary, International Petroleum Corp. of Delaware which began operations in April 1993, upon the completion of its used oil and water recycling plant in Wilmington, Delaware.\nIn August 1994, the Company began aviation fueling operations in Ecuador through a joint venture which enables the Company to provide point-to-point aviation fuel sales within Ecuador. See Note 7 for additional information.\nOn January 3, 1995, the Company entered the marine fueling business by purchasing the assets and assuming certain liabilities of Trans-Tec Services, Inc. and Trans-Tec Servicios, S.A. The Company also purchased the stock of Trans-Tec Services (UK) Ltd., which owns Trans-Tec Services, (Singapore) Pte., Ltd. The acquisition of Trans-Tec by the Company has been accounted for as a purchase. The aggregate purchase price, including acquisition costs of approximately $321,000, was $14,832,000. The Company paid approximately $3,927,000 in cash, $6,000,000 in the form of 9% promissory notes, payable over three years, of which $1,830,000 is due within one year, and $4,584,000 ($11.84 per share, or approximately 78% of the quoted market price) in the Company's restricted common stock. In accordance with the related acquisition agreement, the Company can recover a portion of the purchase price (by direct offset to the promissory notes issued to certain of the sellers) in the event that certain representations and warranties related to the collectability of accounts receivables are not met. The newly issued shares of the Company's common stock issued in connection with the acquisition were valued by the Company's Board of Directors. This valuation was made based upon the volume of shares issued in relation to total shares outstanding and the restricted nature of the newly issued shares. The difference between the purchase price and the $4,158,000 fair value of the net assets of the acquired companies, which amounted to $10,674,000, has been allocated to goodwill, and is being amortized over a period of 35 years. The Company determined that no other identifiable intangible assets existed.\nThe following unaudited pro-forma results of operations for the fiscal years ended March 31, 1995 and 1994 assume that the Company acquired the Trans-Tec companies, as of April 1, 1993.\nFor the Year Ended March 31, ------------------------------ 1995 1994 ============ ============\nRevenue $524,893,000 $388,094,000 ============ ============ Net income $ 8,585,000 $ 6,117,000 ============ ============ Net income per share $ 1.65 $ 1.19 ============ ============\nIn December 1992, the Board of Directors approved the Company's exit from the environmental services sector. The Company substantially completed its plan of discontinuance in fiscal year 1994. See Note 2 for additional discussion.\nBasis 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.\nCash and Cash Equivalents\nThe Company classifies as cash equivalents all highly liquid investments with a maturity of three months or less from the date of purchase. The Company's investments at March 31, 1995 and 1994, amounted to $8,863,000 and $7,712,000 respectively, and consisted principally of bank repurchase agreements collaterized by United States Government Securities. Investment maturities do not exceed 30 days and are not rated lower than A1-P1 by Standard & Poor's Corporation - Moody's Investors Services, Inc. Interest income, which is included in other, net, in the accompanying statements of income, totalled $765,000, $182,000 and $83,000 for the years ended March 31, 1995, 1994 and 1993, respectively. Effective April 1, 1994, the Company adopted FASB No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" as required. The adoption of this pronouncement did not have a material effect on the Company's financial position or results of operations.\nInventories\nInventories are stated at the lower of cost (principally, first-in, first- out) or market. Components of inventory cost include oil and fuel purchase cost, direct materials, direct and indirect labor and factory overhead.\nProperty, Plant and Equipment\nProperty, plant and equipment are carried at cost less accumulated depreciation and amortization. Depreciation and amortization are calculated on a straight-line basis over the estimated useful lives of the assets as follows: YEARS =========================\nBuildings and improvements 10-40 Leasehold improvements Minimum term of the lease Office equipment and furniture 3-8 Plant, machinery and equipment 3-40\nThe Company leases premises in New Orleans, Louisiana and Plant City, Florida. The leases expire in August 1996. The Company has an option to purchase the properties at current market value at any time during the lease term. The Company intends to exercise the purchase options and, accordingly, is depreciating the improvements to the premises over their estimated economic lives. See Note 6 for additional information.\nCosts of major additions and improvements are capitalized and expenditures for maintenance and repairs which do not extend the lives of the assets are expensed. Upon sale or disposition of property, plant and equipment, the cost and related accumulated depreciation are eliminated from the accounts and any resultant gain or loss is credited or charged to income.\nUnamortized Cost in Excess of Net Assets of Acquired Companies\nUnamortized cost in excess of net assets of acquired companies is being amortized over 35-40 years using the straight-line method. Accumulated amortization amounted to $413,000 and $284,000, as of March 31, 1995 and 1994, respectively. Subsequent to its acquisition, the Company continually evaluates whether later events and circumstances have occurred that indicate the remaining estimated useful life of this asset may warrant revision or that the remaining balance of this asset may not be recoverable.\nRevenue Recognition\nRevenue is generally recorded in the period when the sale is made or as the services are performed. In the Company's aviation and marine fueling segments, the Company contracts third parties to provide the fuel and\/or intoplane services. This may cause delays in receiving the necessary information for invoicing. Accordingly, revenue may be recognized in a period subsequent to when the delivery of fuel took place. Costs not yet billed are classified as current assets and are included under \"Inventories\".\nIncome Taxes\nThe Company and its United States subsidiaries file consolidated income tax returns. During the first quarter of fiscal year 1994, the Company adopted the liability method of accounting for income taxes pursuant to the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\". See Note 4 for additional information.\nForeign Currency Translation\nThe Company's primary functional currency is the U.S. Dollar which also serves as its reporting currency. Most foreign entities translate monetary assets and liabilities at fiscal year-end exchange rates while non-monetary items are translated at historical rates. Income and expense accounts are translated at the average rates in effect during the year, except for depreciation which is translated at historical rates. The Company's joint venture uses the Company's reporting currency as the functional currency (as it operates in a highly inflationary economy) and translates net assets at fiscal year-end rates while income and expense accounts are translated at average exchange rates. Gains or losses from changes in exchange rates are recognized in consolidated income in the year of occurrence.\nThe Company's purchases from certain aviation fuel suppliers are denominated in local currency. Foreign currency exchange gains and losses resulting from payments to aviation fuel suppliers are included in Other, net, in the period incurred, and amounted to net gains of $737,000 for the fiscal year ended March 31, 1995. There were no significant foreign currency gains or losses in fiscal years 1994 and 1993.\nEarnings Per Share\nEarnings (losses) per common and common equivalent share have been computed by dividing net income (loss) by the weighted average number of shares of common stock and common stock equivalents outstanding. Common stock equivalents include all potentially dilutive outstanding stock options and warrants applying the treasury stock method. Primary and fully diluted earnings per share are not materially different.\n(2) DISCONTINUED OPERATIONS\nOn December 10, 1992, the Company's Board of Directors authorized the sale of the Company's environmental services segment. Accordingly, as of December 31, 1992, the Company reported its environmental services segment as a discontinued operation.\nAs of March 31, 1995, assets included in the accompanying consolidated balance sheet related to entities which were discontinued, consist primarily of $1,288,000 in notes receivable, net of an allowance for bad debts.\nOn April 17, 1995 the Company obtained certified closure of its soil storage permit from the Florida Department of Environmental Protection for the Part-B facility. This enabled the Company to transfer the building ownership under a previously agreed arrangement and to request permit closure from the Environmental Protection Agency. At this time, the Company is unable to determine the period of time or cost required to complete the Environmental Protection Agency permit closure.\nDuring fiscal year 1995, the Company was undergoing the completion of certain environmental projects under state reimbursement programs. However, in March 1995, the State of Florida amended its environmental remediation program. This resulted in the suspension of reimbursement for work performed effective March 27, 1995 on all of the sites at which the Company was contracted to perform work. Pursuant to the enacted changes, the Company believes that it no longer has contractual liability to complete these projects, and accordingly has notified the project owners that pursuant to the legislation all work has ceased, effective March 27, 1995.\nThe Company periodically reevaluates the adequacy of its accruals related to its discontinued operations, including the amounts which may be realized from the reimbursement for remediation work performed under the state reimbursement programs. Any changes in those estimates have been included in discontinued operations in the accompanying financial statements. As of March 31, 1995, the Company had $50,000 in estimated accrued expenses related to its discontinued operations.\nRevenues applicable to the discontinued operations were $36,000, $49,000 and $7,835,000 for the fiscal years 1995, 1994 and 1993, respectively.\n(3) LONG-TERM DEBT\nLong-term debt consists of the following at March 31:\n1995 1994 =========== ========== Promissory notes issued in $ 6,000,000 $ - connection with the acquisition of the Trans-tec group of companies, payable annually through January 1998, bearing interest at 9%, unsecured Capitalized lease obligations, payable through August 1996, interest at rates ranging from 10.19% to 10.70% (secured by property with a net book value of $263,000 and $416,000 at March 31, 1995 and 1994, respectively) 251,000 479,000 Equipment notes, payable monthly through May 1998, interest rates ranging from 6.76% to 7.00%, secured by equipment 147,000 188,000 Mortgage note, bearing interest at 12.0%, payable monthly through July 2001, secured by land, plant and equipment 177,000 194,000 ---------- ---------- 6,575,000 861,000\nLess current maturities 2,128,000 286,000 ---------- ---------- $4,447,000 $ 575,000 ========== ==========\nThe Company has an unsecured credit facility providing a $25,000,000 revolving line of credit with sublimits of $8,000,000 and $6,000,000 for standby letters of credit and documentary letters of credit, respectively. The amendment was effective March 31, 1995. Approximately $2,554,000 in standby letters of credit were outstanding as of March 31, 1995 under the credit facility. The Company also has $1,635,000 outstanding in standby letters of credit from other financing institutions and has pledged $1,635,000 of cash as collateral on these letters of credit.\nThe revolving line of credit bears interest, at the Company's option, at the Prime rate (9.0% at March 31, 1995), or LIBOR plus 1.45%. Interest is payable quarterly in arrears. As of March 31, 1995 and 1994, there were no amounts outstanding under the revolving line of credit. The outstanding principal and interest will mature on March 31, 1998. The revolving line of credit, in addition to other restrictions, requires the maintenance of certain financial ratios and account balances, limits cash outlays for capital expenditures, places certain restrictions on additional borrowings outside of NationsBank of Florida, NA and restricts the payment of dividends, except for the Company's quarterly dividend which complies with the NationsBank facility. See Note 5 for additional discussion. As of March 31, 1995, the Company was in compliance with its debt covenants.\nAggregate annual maturities of long-term debt as of March 31, 1995, are as follows:\n1996 $2,128,000 1997 2,080,000 1998 2,249,000 1999 37,000 2000 32,000 Thereafter 49,000 ---------- $6,575,000 ==========\nInterest expense, which is included in other, net, in the accompanying statements of income, is as follows for the year ended March 31:\n1995 1994 1993 ======== ======== ======== Interest cost $263,000 $175,000 $272,000\nCapitalized interest - 32,000 272,000 -------- -------- -------- Interest expense $263,000 $143,000 $ - ======== ======== ========\n(4) INCOME TAXES\nDuring fiscal year 1995, the U.S. Federal Income Tax Returns for the Company's fiscal years ended March 31, 1992 and 1993, were audited by the Internal Revenue Service. The adjustments for the years under audit and the anticipated effect of amending fiscal year 1994, resulted in a tax benefit which was recognized in fiscal year 1995 for financial reporting purposes.\nThe provision for income taxes consists of the following components for the year ended March 31:\n1995 1994 1993 ========== ========== ========== Continuing operations $4,935,000 $3,242,000 $2,984,000 Discontinued operations - - (2,026,000) ---------- ---------- ---------- $4,935,000 $3,242,000 $ 958,000 ========== ========== ========== Current: Federal $3,764,000 $2,648,000 $1,629,000 State 990,000 412,000 241,000 ---------- ---------- ---------- 4,754,000 3,060,000 1,870,000 ---------- ---------- ---------- Deferred: Federal 142,000 158,000 (800,000) State 39,000 24,000 (112,000) ---------- ---------- ---------- 181,000 182,000 (912,000) ---------- ---------- ---------- Total $4,935,000 $3,242,000 $ 958,000 ========== ========== ==========\nEffective April 1, 1993, the Company adopted the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\" This new statement supersedes Statement No. 96, previously implemented by the Company, and also requires the liability method in accounting for income taxes. The adoption of this new pronouncement did not have a material effect on the Company's consolidated financial position or results of operations.\nThe difference between the reported tax provision and the provision computed by applying the statutory Federal income tax rate currently in effect to income before income taxes for each of the three years ended March 31, 1995, is primarily due to state income taxes.\nThe temporary differences which comprise the Company's net deferred tax assets are as follows:\nMarch 31, -------------------------------- 1995 1994 =========== ============ Excess of provision for bad debts over charge-offs $ 1,340,000 $ 888,000\nExcess of tax over financial reporting depreciation and amortization (1,284,000) (900,000)\nAccrued litigation settlement expense recognized for financial reporting purposes, not currently deductible 481,000 481,000\nExcess of tax over financial reporting amortization of identifiable intangibles (248,000) -\nOther, net (24,000) (111,000) ----------- ----------- $ 265,000 $ 358,000 =========== ===========\nThe net deferred tax assets as of March 31, 1995 and 1994, are included in other assets in the accompanying consolidated balance sheets.\n(5) STOCKHOLDERS' EQUITY\nCommon Stock Activity\nOn January 3, 1995, the Company issued 387,000 shares of the Company's common stock pursuant to the Trans-Tec Services acquisition. See Note 1 for additional information.\nIn June 1994, the United States District Court for the Southern District of Florida approved the settlement of the shareholders class action pending against the Company. The settlement had a total value of approximately $2,600,000, of which the Company's insurance company paid $1,300,000 in cash and the Company paid the balance in April 1995, by issuing 78,550 shares of the Company's common stock at an agreed upon price of $16.55 per share.\nStock Options Activity\nIn January 1986, the stockholders approved a stock option plan under the terms of which the Board of Directors is authorized to grant options to full-time employees of the Company and its subsidiaries. The plan permits the issuance of options to purchase up to an aggregate of 300,000 shares of the Company's common stock. The minimum price at which any option may be exercised will be the fair market value of the stock on the date of grant; provided, however, that with respect to an option granted to an individual owning more than 10% of the Company's outstanding common stock, the minimum exercise price will be 110% of the fair market value of the common stock on the date of grant. All options granted pursuant to the plan must be exercised within ten years after the date of grant, except that options granted to individuals owning more than 10% of the Company's outstanding common stock must be exercised within five years after the date of grant.\nThe following summarizes the status of the plan as of, and for the year ended March 31: 1995 1994 1993 ================ ============= =============\nGranted 46,206 None 81,500 Per Share $14.875 - $15.50 $14.00\nExpired 20,000 None None\nExercised None None None\nOutstanding 171,427 145,221 145,221 Per Share $3.00 - $15.50 $3.00 - $14.75 $3.00 - $14.75\nAvailable for future grant 37,294 63,500 63,500\nExercisable 125,221 63,721 63,721 Per Share $3.00 - $14.75 $3.00 - $14.75 $3.00 - $14.75\nDuring fiscal year 1995, the Board of Directors granted options to several employees for the purchase of 46,206 shares of the Company's common stock under the stock option plan. The exercise prices range from $14.875 to $15.50 per share. On May 10, 1995, the Board of Directors granted options to certain executive officers to purchase 25,894 shares of the Company's common stock at an exercise price of $18.875 per share.\nDuring fiscal year 1995, previously granted options to purchase 20,000 shares of the Company's common stock under the stock option plan expired. Accordingly, as of March 31, 1995, options to purchase 171,427 shares of the Company's common stock remain outstanding and 37,294 additional shares are available for future grant.\nOn June 3, 1994, the Company extended through December 31, 1995, Mr. Phillip Bradley's (an executive officer and director of the Company) non- qualified option to purchase 25,000 shares of the Company's common stock. The exercise price remained unchanged at $10.00 per share. The difference between the fair market value on the extension date of $12.13, and the option price, is being amortized over 1995 as compensation expense. On January 3, 1995, the Board of Directors granted a non- qualified option to two employees to each purchase 5,647 shares of the Company's common stock at an exercise price of $15.50 per share. On May 10, 1995, the Board of Directors granted a non-qualified option to an executive officer to purchase 9,106 shares of the Company's common stock at an exercise price of $18.875 per share. As of March 31, 1995, non- qualified options to purchase a total of 55,036 shares of the Company's common stock at exercise prices ranging from $10.00 to $16.50 per share, remain outstanding.\nNon-Employee Directors Stock Option Plan\nOn August 8, 1994, at the annual meeting of the shareholders of the Company, the 1993 Non-Employee Directors Stock Option Plan (\"Plan\") was adopted. An aggregate of 50,000 shares of the Company's common stock have been reserved for issuance under the Plan.\nUnder the Plan, members of the Board of Directors who are not employees of the Company or any of its subsidiaries or affiliates will receive annual stock options to purchase common stock in the Company pursuant to the following formula. Each non-employee director will receive a non- qualified option to purchase 2,500 shares when such person is first elected to the Board of Directors (or when the Plan was adopted, for those individuals already members of the Board), and will receive a non- qualified option to purchase 2,500 shares each year, starting in August 1995, that the individual is re-elected. On the date the Plan was adopted there were three individuals who qualified and each received an option to purchase 2,500 shares of the Company's common stock at an exercise price of $15.125. This price reflects the fair market value of the Company's common stock on December 31, 1993, the date of grant. As of March 31, 1995, options to purchase 7,500 shares of the Company's common stock remain outstanding under the plan and 42,500 shares are available for future grant.\nThe exercise price for options granted under the Plan may not be less than the fair market value of the common stock, which is defined as the closing bid quotation for the common stock at the end of the day preceding the grant. Options granted under the Plan become fully exercisable one year after the date of grant. All options expire five years after the date of grant. The exercise price must be paid in cash or in common stock, subject to certain restrictions.\nStock Warrants Activity\nIn April 1994, warrants to purchase a total of 38,625 shares of the Company's common stock at $12.00 per share were exercised. No additional warrants were issued or exercised during fiscal year 1995 and subsequent to the April 1994 exercise, no additional warrants remain outstanding.\nStock Repurchase\nOn April 12, 1993, the Board of Directors authorized the repurchase from time to time of up to 400,000 shares of the Company's common stock. The timing and quantity of shares to be repurchased will depend upon a number of factors, including market price. As of March 31, 1995, a total of 5,000 shares had been purchased in the open market for approximately $57,000 pursuant to the repurchase program.\nDividend Declarations\nThe Board of Directors approved the payment of the following cash dividends:\nDeclaration Date Per Share Record Date Payment Date ---------------- --------- ----------- ------------ May 9, 1994 .05 cents June 22, 1994 July 15, 1994 September 9, 1994 .05 cents September 22, 1994 October 14, 1994 December 9, 1994 .05 cents December 22, 1994 January 12, 1995 January 19, 1995 .05 cents March 22, 1995 April 13, 1995 February 22, 1995 .10 cents March 22, 1995 April 13, 1995\n(6) COMMITMENTS AND CONTINGENCIES\nLease Commitments\nThe Company leases premises in New Orleans, Louisiana and Plant City, Florida from a trust managed by the President of the Company under two operating leases with rent aggregating $86,000 per year. The leases expire in August 1996. The Company has an option to purchase the properties at current market value at any time during the lease term. The Company intends to exercise the purchase options on both leases.\nThe Company also leases additional office space and railroad tank cars from unrelated third parties.\nThe future minimum lease payments under capital leases and operating leases with an initial noncancellable term in excess of one year, as of March 31, 1995 are as follows: Capital Operating Leases Leases ========= ========== 1996 $ 248,000 $ 596,000 1997 17,000 438,000 1998 - 324,000 1999 - 61,000 --------- ---------- Total minimum lease payments 265,000 $1,419,000 ========== Less amounts representing interest 14,000 --------- Present value of minimum lease payments $ 251,000 =========\nRental expense under operating leases with an initial noncancellable term in excess of one year was $535,000, $461,000, and $514,000 for the years ended March 31, 1995, 1994 and 1993, respectively.\nCapital Expenditures\nDuring fiscal year 1995, the Company completed the construction of a water and used oil treatment plant in Louisiana at a total cost of $1,550,000. During fiscal year 1996, the Company anticipates spending approximately $1,000,000 to upgrade plant, machinery and equipment. The Company intends to spend an estimated $1,000,000 over the next several years to clean up contamination which was present at one of the Company's sites when it was acquired by the Company. Clean up will be capitalized as part of the cost of the site, up to the fair market value of the site.\nSurety Bonds\nIn the normal course of business the Company is required to post bid, performance and garnishment bonds. The majority of the bonds issued relate to the Company's aviation fueling business. As of March 31, 1995, the Company had $2,675,000 in outstanding bonds.\nPurchase Commitments and Off-Balance Sheet Transaction\nThe Company may from time to time enter into short term fuel purchase commitments. In order to fix the profit on the end market sale of the purchase commitment, the Company may enter into a hedge transaction in the financial futures market. As of March 31, 1995, the Company did not have any outstanding purchase commitments or hedges.\nConcentration of Credit Risk\nFinancial instruments which potentially subject the Company to credit risk consist primarily of trade accounts receivable. The Company extends credit on an unsecured basis to many of its aviation and marine customers, some of which have a line of credit in excess of $1,000,000. The Company's management recognizes that extending credit and setting appropriate reserves for receivables is largely a subjective decision, based on knowledge of the customer. Active management of this risk is essential to the Company's success. A strong capital position and liquidity provide the financial flexibility necessary to respond to customer needs. The Company's management meets regularly to evaluate credit exposure in the aggregate, and by individual credit. This group is also responsible for setting and maintaining credit standards and ensuring the overall quality of the credit portfolio.\nPotential Liability and Insurance\nThe Company, through the use of subcontractors and its own operations, transports, stores, or processes flammable aviation, marine and residual fuel subjecting it to possible claims by employees, customers, regulators, and others who may be injured. In addition, the Company may be held liable for the clean-up costs of spills or releases of materials from its facilities or vehicles, or for damages to natural resources arising out of such events. The Company follows what it believes to be prudent procedures to protect its employees and customers and to prevent spills or releases of these materials.\nThe Company's activities subject it to the risks of significant potential liability under Federal and state statutes, common law, and contractual indemnification agreements. The Company has general and automobile liability insurance coverage, including the statutory Motor Carrier Act\/MCS 90 endorsement for sudden and accidental pollution.\nIn the aviation and marine fuel segments, the Company utilizes subcontractors which provide various services to customers, including intoplane fueling at airports, fueling of vessels in port and at sea, and transportation and storage of fuel and fuel products. Although the Company generally requires its subcontractors to carry liability insurance, not all subcontractors carry adequate insurance. The Company's liability insurance policy does not cover the acts or omissions of its subcontractors. If the Company is held responsible for any liability caused by its subcontractors, and such liability is not adequately covered by the subcontractor's insurance, the Company will be adversely affected.\nThe Company has exited several environmental businesses which handled hazardous wastes. These wastes were transported to various disposal facilities and\/or treated by the Company. The Company may be held liable as a potentially responsible party for the clean-up of such disposal facilities in certain cases pursuant to current Federal and state laws and regulations. Due to the cost of insurance relative to potential exposure, tail coverages were not purchased for businesses exited. The Company is currently responsible to Federal and state environmental agencies for clean-up costs at a site formerly operated by its subsidiary, Resource Recovery of America, which has been sold by the Company.\nThe Company continuously reviews the adequacy of its insurance coverages. However, the Company lacks coverage for various risks. A claim arising out of the Company's activities, if successful and of sufficient magnitude, could have a material adverse effect on the Company's financial position or results of operations.\nLegal Matters\nIn January 1993, Hillsborough County sued the Company's International Petroleum Corporation of Florida subsidiary (\"IPC\"), along with 170 other defendants (or potentially responsible persons), in the U.S. District Court of the Middle District of Florida. The complaint seeks to recover response or cleanup costs for the Sydney Mine Waste Disposal Site under the Comprehensive Environmental Response, Compensation, and Liability Act, 42 U.S.C. section 9601 et. seq. (CERCLA or Superfund) and under Florida Statutes. The Company intends to vigorously defend this action.\nThere can be no assurance the Company will prevail in the foregoing legal proceeding, and management cannot estimate at this time the exposure of the Company if it does not prevail in this proceeding.\nThe Company is involved in other litigation and administrative proceedings primarily arising in the normal course of its business. In the opinion of management, the Company's liability, if any, under any other pending litigation or administrative proceedings, would not materially affect its financial condition or operations.\nEmployment Agreements\nThe Company amended and restated its employment agreements with the Chairman of the Board and the President which expire on March 31, 2000. Each agreement provides for a salary and an annual bonus equal to 5% of the Company's income before income taxes in excess of $2,000,000. The agreements also provide that if the Company terminates the employment of the executive for reasons other than death, disability, or cause, or, if the executive terminates employment with the Company for good reason, including under certain circumstances, a change in control of the Company, the Company will pay the executive compensation of up to three times his average salary and bonus during the five year period preceding his termination.\nThe Company and its subsidiaries have also entered into employment, consulting and non-competition agreements with certain of their executive officers and previous and current employees. The agreements provide for minimum salary levels, as well as bonuses which are payable if specified management goals are attained.\nDuring the years ended March 31, 1995, 1994 and 1993, approximately $3,963,000, $3,124,000 and $2,795,000, respectively, was expensed under the terms of the above described agreements.\nThe future minimum commitments under employment agreements, excluding bonuses, as of March 31, 1995 are as follows:\n1996 $2,709,000 1997 1,844,000 1998 1,425,000 1999 574,000 2000 662,000 ---------- $7,214,000 ==========\nDeferred Compensation Plan\nThe Company has an incentive compensation plan which provides incentive compensation to certain key personnel whose performance contributes to the profitability and growth of the existing Trans-Tec group of companies. The plan is unfunded and is not a qualified plan under the Internal Revenue Code. Under the plan, participants will be awarded units equal to 20% of the Trans- Tec group's net income, excluding the incentive compensation expense, and earn interest on their deferred amounts. The plan allows for distributions of vested amounts over a five year period, subject to certain requirements, during and after employment with the Company. Participants become fully vested over a five year period, fully vested participants must wait two years from the year of contribution to be eligible for the distribution of deferred account balances. The plan is administered by a plan committee appointed by the Board of Directors of Trans-Tec Services, Inc. The plan committee has the authority to suspend or terminate the plan, as well as the responsibility to allocate the amount of incentive compensation among participants, during each plan year. The plan's fiscal year corresponds to the Company's fiscal year.\n(7) JOINT VENTURE\nIn August 1994, the Company, through its wholly-owned subsidiary World Fuel Services, Inc., began operation of a joint venture with Petrosur, an Ecuador corporation. The Company's ownership interest in the joint venture is 42%. The joint venture was organized under the name PetroSur-World Fuel to distribute jet fuel in Ecuador pursuant to a contract with the nationally owned oil company. The contract with the government may be terminated at any time. The Company has management oversight of the business activities of the joint venture. The joint venture arrangement has a term of five years and will automatically renew for a similar term unless one of the partners objects at least ninety days prior to the end of the term.\nDuring fiscal year 1995, the Company has recorded in the accompanying consolidated statement of income its proportionate share of the net earnings of the joint venture which amounted to $544,000, included as part of Other, net. The amount of the investment in the joint venture totalled $544,000, and advances to the joint venture amounted to $338,000 as of March 31, 1995, and are included in other assets and prepaid expenses and other current assets, respectively, in the accompanying consolidated balance sheet.\n(8) BUSINESS SEGMENTS, FOREIGN OPERATIONS AND MAJOR CUSTOMERS\nBusiness Segments\nThe Company operates in three business segments: aviation fueling, marine fueling and oil recycling. Information concerning the Company's operations by business segment is as follows:\nFOR THE YEAR ENDED MARCH 31, ------------------------------------------- 1995 1994 1993 ============ ============ ============ REVENUE: Aviation fueling $288,728,000 $233,982,000 $241,055,000 Marine fueling (1) 54,578,000 - - Oil recycling 18,591,000 16,554,000 14,014,000 Intersegment eliminations (6,000) (9,000) (302,000) ------------ ------------ ------------ Consolidated revenues $361,891,000 $250,527,000 $254,767,000 ============ ============ ============ INCOME FROM OPERATIONS: Aviation fueling $ 12,304,000 $ 12,066,000 $ 8,911,000 Marine fueling (1) 220,000 - - Oil recycling 2,973,000 1,075,000 2,333,000 Corporate (4,248,000) (3,371,000) (3,001,000) Intersegment eliminations - - (177,000) ------------ ------------ ------------ Consolidated income from operations $ 11,249,000 $ 9,770,000 $ 8,066,000 ============ ============ ============ IDENTIFIABLE ASSETS: Aviation fueling $ 27,920,000 $ 26,535,000 $ 32,039,000 Marine fueling 34,313,000 - - Oil recycling 17,557,000 16,548,000 14,005,000 Corporate 9,746,000 10,604,000 4,506,000 Discontinued operations - - 4,167,000 ------------ ------------ ------------ Consolidated identifiable assets $ 89,536,000 $ 53,687,000 $ 54,717,000 ============ ============ ============ CAPITAL EXPENDITURES: Aviation fueling $ 27,000 $ 101,000 $ 58,000 Marine fueling (1) 104,000 - - Oil recycling 1,901,000 3,078,000 3,755,000 Corporate 162,000 155,000 72,000 ------------ ------------ ------------ Consolidated capital expenditures $ 2,194,000 $ 3,334,000 $ 3,885,000 ============ ============ ============ DEPRECIATION AND AMORTIZATION: Aviation fueling $ 236,000 $ 194,000 $ 222,000 Marine fueling (1) 140,000 - - Oil recycling 824,000 1,150,000 1,071,000 Corporate 173,000 158,000 180,000 ------------ ------------ ------------ Consolidated depreciation and amortization $ 1,373,000 $ 1,502,000 $ 1,473,000 ============ ============ ============\n(1) The marine fueling segment reflects activity from January 1, 1995 to March 31, 1995.\nNet assets of the discontinued operations, as described in Note 2, were transferred to continuing operations as of March 31, 1994.\nForeign Operations\nA summary of financial data for foreign operations is shown below as of, and for the fiscal years ended March 31, 1995, 1994 and 1993. Non-U.S. operations of the Company and its subsidiaries are conducted primarily in the United Kingdom. Income from operations is before the allocation of corporate general and administrative expenses and income taxes.\n1995 1994 1993 =========== =========== =========== Revenue $47,045,000 $28,382,000 $23,760,000 =========== =========== =========== Income from operations $ 1,572,000 $ 190,000 $ 240,000 =========== =========== =========== Identifiable assets $11,770,000 $ 1,872,000 $ 3,367,000 =========== =========== ===========\nMajor Customers\nNo customer accounted for more than 10% of total consolidated revenue for the years ended March 31, 1995, 1994 and 1993.\n(9) QUARTERLY INFORMATION (UNAUDITED)\nFOR THE THREE MONTHS ENDED, ------------------------------------------------------- June 30, September 30, December 31, March 31, 1994 1994 1994 1995 =========== =========== =========== ============ Revenue $72,524,000 $76,660,000 $78,103,000 $134,604,000 =========== =========== =========== ============ Gross profit $ 7,242,000 $ 5,731,000 $ 5,802,000 $ 8,982,000 =========== =========== =========== ============ Net income $ 1,944,000 $ 1,760,000 $ 2,054,000 $ 2,330,000 =========== =========== =========== ============ Earnings per common and common equivalent share $ 0.41 $ 0.37 $ 0.43 $ 0.45 =========== =========== =========== ============\nFOR THE THREE MONTHS ENDED, -------------------------------------------------------- June 30, September 30, December 31, March 31, 1993 1993 1993 1994 =========== =========== =========== ============ Revenue $61,403,000 $63,128,000 $62,529,000 $ 63,467,000 =========== =========== =========== ============ Gross profit $ 6,464,000 $ 6,958,000 $ 5,847,000 $ 7,682,000 =========== =========== =========== ============ Net income $ 1,446,000 $ 1,555,000 $ 1,259,000 $ 935,000 =========== =========== =========== ============ Earnings per common and common equivalent share $ 0.31 $ 0.33 $ 0.27 $ 0.19 =========== =========== =========== ============\nSCHEDULE II\nINTERNATIONAL RECOVERY CORP. AND SUBSIDIARIES\nVALUATION AND QUALIFYING ACCOUNTS","section_15":""}
{"filename":"56978_1995.txt","cik":"56978","year":"1995","section_1":"ITEM 1. BUSINESS\nKulicke and Soffa Industries, Inc. (the \"Company\" or \"K&S\") was founded in 1951 to design equipment for industrial use. During the 1970s, the Company began to focus its efforts on the semiconductor assembly equipment market. Today, K&S is the world's largest supplier of semiconductor assembly equipment, according to VLSI Research, Inc. (\"VLSI\"). Through its American Fine Wire (\"AFW\") and Micro- Swiss subsidiaries, the Company also supplies expendable tools and materials used in the semiconductor assembly process. The Company's primary assembly equipment products include wire bonders, dicing saws and die, TAB and flip-chip bonders, while its expendable tools and materials offerings include bonding wire, die collets, capillaries and wedges. The Company's customers consist of leading semiconductor manufacturers and subcontract assemblers of semiconductors, including Advanced Micro Devices, Advanced Semiconductor Engineering, Anam Electronics, Hyundai, IBM, Intel, Matsushita Electronics, Motorola, Philips, Samsung, Swire Technologies and Texas Instruments.\nINDUSTRY BACKGROUND\nThe worldwide market for semiconductors has experienced significant growth in recent years. This growth reflects the increasing demand for a wide variety of electronic devices, such as personal computers, cellular telephones, multimedia systems and other electronic devices for business and consumer use, as well as the increasing semiconductor content within these electronic devices and other products, such as automobiles, consumer appliances and factory automation and control systems. This demand has been driven in large part by continuing increases in semiconductor performance as measured by functionality, speed and memory density at declining costs per function.\nIn response to the growing demand for semiconductor devices, semiconductor manufacturers are increasing capacity by expanding and upgrading existing facilities and constructing new semiconductor fabrication facilities. As new fabrication facilities come on line and existing facilities are expanded and upgraded, the Company anticipates that the semiconductor industry will need to add capacity to assemble the increased output of processed wafers.\nSEMICONDUCTOR ASSEMBLY MARKET\nThe market for semiconductor assembly equipment is expected to continue to be driven by the demand for IC's, as well as the proliferation of different device types and technological advances in IC packages. Different types of devices such as microprocessors, logic devices and memory devices require different assembly and packaging solutions. In addition, current-generation semiconductors are more complex, more densely fabricated and more highly integrated than those of prior generations. To package these newer devices, assembly equipment must be able to handle smaller, more complex packages with higher pin counts. In addition, device manufacturers and assemblers continue to demand equipment with faster throughput, greater reliability, more automated manufacturing support and lower cost of ownership. The market for the expendable tools and materials used in the semiconductor assembly process is similarly driven by IC unit volume, cost and increased technological demands. These demands typically include package size reduction and greater consistency or uniformity of materials.\nSEMICONDUCTOR MANUFACTURING PROCESS\nThe manufacture of semiconductor devices (\"semiconductors\" or \"IC's\") requires complex and precise steps which can be broadly grouped into wafer fabrication, assembly and test. Wafer fabrication, the first step in the semiconductor manufacturing process, starts with raw silicon wafers and ends with finished devices in the form of die on wafers. After fabricated wafers are tested, they typically are shipped to assembly facilities located primarily in the Asia\/Pacific region.\nSemiconductor devices are small and fragile and must be packaged to protect them and facilitate their connection to electronic systems. \"Assembly\" refers to those process steps required to package semiconductor devices.\nThe packages are typically based on a stamped metal leadframe, which is subsequently molded with plastic, or on ceramic, depending on the device and the application in which it will be used.\nThe semiconductor assembly process begins with the mounting of a finished, tested wafer onto a carrier, after which a dicing saw cuts the wafer into individual die. The cut wafer is then moved to a die bonder which picks each good die off the wafer and bonds it to a package. Next, the device is wire bonded. Very fine gold or aluminum wire (typically 0.001 inches in diameter) is bonded between specific locations called bond pads on the die and corresponding leads on the package in order to create the electrical connections necessary for the device to function. After wire bonding, the package is encapsulated. For leadframe-based packages, plastic is molded around the package and the leads are then trimmed and formed. For ceramic packages, encapsulation is accomplished by mounting a lid over the die. After encapsulation, devices are re-tested and are then marked and prepared for shipment.\nACQUISITION OF AFW\nOn October 2, 1995, after completion of the Company's 1995 fiscal year, the Company acquired AFW (the \"AFW Acquisition\") through the merger of a subsidiary of the Company into Circle \"S\" Industries, Inc., the parent corporation of AFW (\"Circle S\"). AFW is a manufacturer of fine gold and aluminum wire for use in the wire bonding process and has facilities in Selma, Alabama, Singapore and Zurich, Switzerland.\nThe preliminary purchase price for the AFW Acquisition totaled approximately $53.6 million, subject to possible upward or downward adjustment based upon completion and audit of the closing balance sheet. The Company does not anticipate that any such adjustment to the purchase price will be material. Of the $53.6 million, approximately $34.4 million was paid by delivery of promissory notes to certain former Circle \"S\" stockholders (the \"AFW Notes\"), approximately $12.9 million was paid in cash, approximately $4.3 million was placed in escrow against certain types of possible liabilities and $2.0 million was withheld in a closing reserve pending completion and audit of the closing balance sheet, in accordance with terms of the acquisition agreements. The Company financed the cash portion of the purchase price with borrowings under a new bank credit facility with Midlantic Bank N.A. (the \"Bank Credit Facility\"). Letters of credit securing the AFW Notes also were issued under this facility. The AFW Notes become due and payable on January 5, 1996; bear interest at the rate of 6.4375% per year, less costs (1% per year) of the letters of credit; are not prepayable without the consent of the holders.\nThe AFW acquisition agreements provide for the indemnification of the Company by certain former stockholders of Circle \"S\" (including Larry D. Striplin, Jr., formerly the Chairman and largest stockholder of Circle \"S\") against breaches of or inaccuracies in various representations and warranties and covenants of Circle \"S\" in the acquisition agreements and against certain types of possible liabilities, including those relating to environmental matters, taxes, possible violations of laws and similar matters. The indemnification obligations of the former Circle \"S\" stockholders generally (i) only apply to the extent that the aggregate covered claims exceed $375,000, (ii) are subject to an aggregate maximum limit of $4.26 million, and (iii) terminate either 15 months or three years after the date of the AFW Acquisition, although certain indemnification claims are not subject to any minimum and certain other claims (including those relating to environmental matters and taxes) are subject to higher maximum limits and extend for longer periods of time. There can be no assurance that such liabilities will not arise or that, if they do arise, the indemnification provisions of the AFW Acquisition agreements will adequately protect the Company.\nIn connection with the AFW Acquisition, the Company appointed R. Kelly Payne, the President of AFW, as a Vice President of the Company, and on December 12, 1995, elected Larry D. Striplin, Jr. as a director of the Company. Pursuant to the AFW Acquisition, the Company assumed a 1990 employment and non-competition agreement between Circle \"S\" and Mr. Striplin providing for payments to him or his estate of $200,000 per year for five years following the date of the AFW Acquisition. Mr. Striplin's employment by Circle \"S\" and AFW terminated at the time of such acquisition. In connection with the AFW Acquisition, the Company also entered into an employment agreement with R. Kelly Payne.\nAFW had sales of approximately $68.8 million and $55.2 million for the year ended December 31, 1994 and the nine months ended September 30, 1995, respectively. Income (loss) from continuing operations totaled $2.6\nmillion and ($130,000), for the periods ended December 31, 1994 and September 30, 1995, respectively. Net income (loss) for the periods ended December 31, 1994 and September 30, 1995 was $2.6 million and ($2.9) million, respectively, which included for the 1995 nine-month period a $2.6 million extraordinary loss from early extinguishment of debt. The consolidated financial statements of Circle \"S\" for the periods ended December 31, 1994 and June 30, 1995 were filed with the Company's Form 8-K dated September 14, 1995 (as amended by a Form 8-K\/A filed October 27, 1995). See also Note 2 to the Company's fiscal 1995 consolidated financial statements included herein.\nThe Company will account for the AFW Acquisition using the purchase method. The excess of the purchase price, including transaction related costs, over the estimated fair value of the net assets acquired is expected to approximate $42 million, consisting primarily of goodwill, and will be amortized over twenty years.\nPRODUCTS\nK&S offers a broad range of semiconductor assembly equipment, expendable tools and materials and complementary services and spare parts used in the semiconductor assembly process. Set forth below is a table listing the approximate percentage of the Company's net sales by principal product areas for its fiscal year ended September 30, 1995 and on a pro forma basis for the same period giving effect to the AFW Acquisition.\nWIRE BONDERS\nThe Company's principal product line is its family of wire bonders, which are used to connect extremely fine wires, typically made of gold or aluminum, between the bonding pads on the die and the leads on the package to which the die has been bonded. The Company offers both ball and wedge bonders in automatic and manual configurations. Ball bonders are typically used for plastic packages (i.e., leadframe-based packages) while wedge bonders are typically used for ceramic packages.\nThe Company's principal wire bonders are its Model 1488 Turbo ball bonder and Model 1474fp wedge bonder. The Company believes that its wire bonders offer competitive advantages based on high throughput and superior process control enabling fine pitch bonding and long, low wire loops, which are needed to assemble advanced IC packages.\nThe selling prices for the Company's automatic wire bonders range from $60,000 to over $150,000 and from $8,000 to $35,000 for manual wire bonders, in each case depending upon system configuration and purchase volume.\nThe Company is in the process of developing a new generation of wire bonder, the 8000 family, which will be based on an entirely new platform has required the development of new software and many subassemblies not part of the Company's current wire bonders. The Company experienced delays in the development of the Model 1488 Turbo wire bonder and has experienced delays in the development of the first product in the 8000 family, the Model 8020. The delays in the development of the Model 8020 have been due to a variety of reasons typical in the development of new technological products, including hardware and software related issues and changes in functional specifications based on input from customers. While development and technical risks exist which have the potential to further affect the introduction of the Model 8020, the Company currently expects that the product will be released in the second half of calendar 1996. However, no assurance can be\ngiven that its scheduled introduction in the second half of 1996 will not be delayed, due to technical or other difficulties, or that the Model 8020 will not experience quality or reliability problems after shipment. The Company's inability to complete the development of and introduce the Model 8020 or other new products, or its inability to manufacture and ship these products in volume and on a timely basis, could adversely affect the Company's competitive position. The Company also may incur substantial costs early in a new product's life cycle to ensure the functionality and reliability of such product.\nFurthermore, the Company's planned transition to the Model 8020 platform involves numerous risks, including the possibility that customers will defer purchases of Model 1488 Turbo wire bonders in anticipation of the availability of the Model 8020 or that the Model 8020 will fail to meet customer needs or achieve market acceptance. To the extent that the Company fails to forecast demand in volume and configuration for both its current and next-generation wire bonders and generally to manage product transitions successfully, it could experience reduced orders, delays in product shipments, increased risk of inventory obsolescence and delays in collecting accounts receivable. There can be no assurance that the Company will successfully develop and manufacture new products, including the Model 8020, that new products introduced by the Company will be accepted in the marketplace or that the Company will manage its product transitions successfully. The Company's failure to do any of the foregoing could materially adversely affect the Company's business, financial condition and operating results.\nADDITIONAL SEMICONDUCTOR ASSEMBLY EQUIPMENT\nIn addition to wire bonders, the Company produces other types of semiconductor assembly equipment, including dicing saws, die bonders, TAB bonders and flip- chip bonders, which allows the Company to leverage its significant investment in customer relationships by offering its customers a broad range of assembly equipment. Principal products offered by the Company consist of the following:\nDicing Saws. After precise automatic positioning of the wafer, a dicing saw is used to cut it into individual die using diamond-embedded saw blades. The Company's primary dicing product is its Model 918 fully automated dicing saw. Dicing saws range in price from $60,000 to more than $185,000. On October 1, 1995, the Company entered into a Manufacturing License and Supply Agreement with Tokyo Seimitsu Co. Ltd. for the right to manufacture, use and distribute certain products. In connection with the signing of this agreement, the Company is discontinuing the manufacture of the 918 saw in its Israeli manufacturing facility.\nDie Bonders. Die bonders are used to attach a semiconductor die to a leadframe or other package before wire bonding. Through its July 1994 acquisition of Assembly Technologies, the Company added Models 4206 and 5408 Automatic Die Attach machines to its die bonder product line. In addition, in March 1995, the Company shipped its first Model 6900, an automatic multi-process assembly system which can be configured to support either conventional die bonding applications or alternate semiconductor assembly technologies. Die bonders range in price from $60,000 to more than $250,000.\nTape Automated Bonding (TAB). TAB is an alternate assembly method which uses a thin, flexible film of laminated copper and polyamide in place of a conventional package. In a TAB assembled device, the die is bonded directly to copper leads, thereby eliminating the need for wire bonding. The Company's principal TAB bonder is the Model SP2100. TAB bonders range in price from $375,000 to approximately $500,000.\nFlip-Chip Assembly Systems. Flip-chip is an alternate assembly technique in which the die is mounted face down in a package or other electronic system using conductive bumps, thereby eliminating the need for either conventional die or wire bonding. The Company's Model 6900 is an automatic multi-process assembly system which can be configured to support flip-chip applications. The Company shipped the first Model 6900, which was configured as a flip-chip bonder, in March 1995. Selling prices for flip-chip assembly systems are expected to exceed $300,000, depending upon configuration.\nThe Company also offers different configurations of certain of its products for non-semiconductor applications, including the Company's Model 980 saw for use in cutting and grinding hard and brittle materials, such as ceramic, glass and ferrite, for applications such as the fabrication of chip capacitors or disk drive heads. A variant of the Model 2100 TAB bonder is used to assemble ink jet printer cartridges.\nEXPENDABLE TOOLS AND MATERIALS\nThe Company currently offers a range of expendable tools and materials to semiconductor device assemblers which it sells under the brand names \"American Fine Wire\" and \"Micro-Swiss.\" The Company intends to expand this business in an effort to increase its revenues related to the manufacture of IC's as opposed to the expansion of IC manufacturing capacity. The Company sells its expendable tools and materials for use with competitors' assembly equipment as well as its own equipment. The following constitute the principal expendable tools and materials products offered by the Company:\nBonding Wire. AFW is a manufacturer of very fine (typically 0.001 inches in diameter) gold and aluminum wire used in the wire bonding process. AFW produces wire to a wide range of specifications, which can satisfy most wire bonding applications. Gold bonding wire is generally priced based on a fabrication charge per 1,000 feet of wire, plus the value of the gold. The fabrication charge varies based on a number of factors, such as total volume, wire diameter and wire length per spool, and typically ranges from $7 to $10 per 1,000 feet of wire, depending upon specifications. To minimize AFW's financial exposure to gold price fluctuations, AFW leases gold for fabrication pursuant to a contract with its gold supplier, Rothschild Australia Limited (\"RAL\"), and only purchases the gold upon shipment and sale of the finished product to the customer. Accordingly, fluctuations in the price of gold are generally absorbed by RAL or passed on to AFW's customers.\nExpendable Tools. The Micro-Swiss family of expendable tools includes die collets, capillaries and wedges. Die collets are used to pick up, place and bond die to packages. Capillaries and wedges are used to feed out, attach and cut the wires used in wire bonding. Die collets sell for up to $150, capillaries sell for $6 to $15 and wedges sell for $17 to $45, in each case depending upon specifications.\nSERVICES AND SPARE PARTS\nThe Company believes that its knowledge and experience have positioned it to deliver innovative, customer-specific services that reduce the cost of ownership associated with the Company's equipment. Historically, the Company's offerings in this area were limited to spare parts, customer training and extended warranty contracts. In response to customer trends in outsourcing equipment- related services, the Company now also focuses on providing repair and maintenance services, a variety of equipment upgrades and training capabilities. These services are generally priced on a time and materials basis.\nCUSTOMERS\nThe Company's customers include large semiconductor manufacturers and subcontract assemblers worldwide, among which are the following:\nSales to a relatively small number of customers account for a significant percentage of the Company's net sales. During fiscal 1995, sales to Intel and Anam accounted for approximately 19.8% and 16.3%, respectively, of the Company's net sales. In fiscal 1994, sales to Anam, Intel and Motorola accounted for 14.2%, 11.5% and 10.8%, respectively, of the Company's net sales.\nThe Company believes that developing long-term relationships with its customers is critical to its success. By establishing these relationships with semiconductor manufacturers and subcontract assemblers, the Company gains insight to its customers' future IC packaging strategies. This information assists the Company in its efforts to develop process and equipment solutions that address its customers' future assembly requirements. The Company expects that sales of its products to a limited number of customers will continue to account for a high percentage of net sales for the foreseeable future. The loss of or reduction of orders from a significant customer, including losses or reductions due to manufacturing, reliability or other difficulties associated with the Company's products, changes in customer buying patterns, market, economic or competitive conditions in the semiconductor or subcontract assembly industries, could adversely affect the Company's business, financial condition and operating results.\nSALES AND CUSTOMER SUPPORT\nThe Company markets its semiconductor assembly equipment and its expendable tools and materials through separate sales organizations. With respect to semiconductor assembly equipment, the Company's direct sales force, consisting of approximately 60 individuals at September 30, 1995, is principally responsible for sales of major product lines to customers in the United States, Japan and the rest of the Asia\/Pacific region. Lower volume product lines, as well as all equipment sales to customers in Europe, are sold through a network of manufacturer's representatives. The Company sells its AFW and Micro-Swiss product lines through an independent sales force supporting customers primarily in the Asia\/Pacific region and through manufacturers' representatives supporting customers throughout the rest of the world.\nThe Company sells its products to semiconductor device manufacturers and contract manufacturers, who are primarily located or have operations in the Asia\/Pacific region. Approximately 74% of the Company's fiscal 1994 and 78% of fiscal 1995 net sales were attributable to sales to customers for delivery outside of the United States.\nThe Company believes that providing comprehensive worldwide sales, service and customer support are important competitive factors in the semiconductor equipment industry. In order to support its U.S. and foreign customers whose semiconductor assembly operations are located in the Asia\/Pacific region, the Company maintains a significant presence in the region with sales facilities in Hong Kong, Japan and Singapore, and a technology center in Japan. In addition, the Company supports its assembly equipment customers with over 160 customer service and support personnel at September 30, 1995, located in Hong Kong, Japan, Korea, Malaysia, the Philippines, Singapore, Taiwan, Thailand and the United States. The Company's local presence in these Asia\/Pacific countries enables it to provide more timely customer service and support as service representatives and spare parts are positioned near customer facilities, and affords customers the ability to place orders locally and to deal with service and support personnel who speak the same language and are familiar with local country practices.\nBACKLOG\nAt September 30, 1995, the Company's backlog was approximately $84.7 million compared to approximately $46.8 million at September 30, 1994. The Company's backlog consists of product orders for which confirmed purchase orders have been received and which are scheduled for shipment within 12 months. In addition, the Company may allocate production capacity to customers for anticipated purchases for which a confirmed purchase order has not yet been received. Virtually all orders are subject to cancellation, deferral or rescheduling by the customer with limited or no penalties. Because of the possibility of customer changes in delivery schedules or cancellations and potential delays in product shipments, the Company's backlog as of any particular date may not be indicative of revenues for any succeeding period.\nMANUFACTURING\nThe Company's assembly equipment manufacturing activities consist primarily of integrating components and subassemblies to create finished systems configured to customer specifications. The Company utilizes an outsourcing strategy for the manufacture of many of its major subassemblies and performs system design, assembly and testing in-house. K&S believes that outsourcing enables it to minimize its fixed costs and capital\nexpenditures and allows the Company to focus on product differentiation through system design and quality control. The Company's just-in-time inventory management strategy has reduced manufacturing cycle times and has limited on- hand inventory. The Company recently obtained ISO 9001 registration for most operations in its Willow Grove, Pennsylvania facility and for both of its Israeli manufacturing facilities.\nThe Company manufactures its Micro-Swiss expendable tools and materials from raw materials at facilities in Israel and its gold and aluminum bonding wire at facilities in Alabama, Singapore and Switzerland. The Company currently is constructing a new facility in Israel for its Micro-Swiss operations and intends to establish a new facility in Singapore for its AFW operations.\nParts, materials and supplies for components used in the Company's products are, for the most part, readily available from a number of sources at acceptable costs. Certain of the Company's products, however, require components or assemblies of an exceptionally high degree of reliability, accuracy and performance. Currently there are a number of such items for which there are only a single or limited number of suppliers which have been accepted by the Company as a qualified supplier. The Company generally does not maintain long- term contracts with its subcontractors and suppliers, and the Company does not believe that the Company's business is substantially dependent on any contract or arrangement with any of its subcontractors or suppliers. However, the Company's reliance on subcontractors and single source suppliers involves a number of significant risks, including the loss of control over the manufacturing process, the potential absence of adequate capacity and the reduced control over delivery schedules, manufacturing yields, quality and costs. Further, certain of the Company's subcontractors and suppliers are relatively small operations and have limited finances and manufacturing resources. In the event that any significant subcontractor or single source supplier were to become unable or unwilling to continue to manufacture or sell subassemblies, components or parts to the Company in required volumes and of acceptable quality, the Company would have to identify and qualify acceptable replacements. The process of qualifying subcontractors and suppliers could be lengthy, and no assurance can be given that any additional sources would be available to the Company on a timely basis.\nThe Company has experienced and continues to experience reliability and quality problems with certain key subassemblies provided by single source suppliers. The Company also has experienced delays in the delivery of subassemblies from these and other subcontractors in the past, which caused delays in Company shipments. If supplies of such items were not available from any such source and a relationship with an alternative supplier could not be developed, shipments of the Company's products could be interrupted and re-engineering of the affected product could be required. In addition, from time to time, the Company has experienced manufacturing difficulties and problems in its own operation, which have caused delays and have required remedial measures. Such delays, interruption and re-engineering could damage the Company's relationships with its customers and have a material adverse effect on the Company's business, financial condition and operating results.\nRESEARCH AND PRODUCT DEVELOPMENT\nBecause technological change occurs rapidly in the semiconductor industry, the Company devotes substantial resources to its research and development programs to maintain competitiveness. The Company employed more than 290 individuals in research and development at September 30, 1995. The Company pursues the continuous improvement and enhancement of existing products while simultaneously developing next generation products. For example, while the performance of current generations of gold ball wire bonders is being enhanced in accordance with a specific continuous improvement plan, the Company is simultaneously developing the series 8000 family of next generation wire bonders, the first models of which are expected to be introduced in the second half of 1996. Most of the next generation equipment presently being developed by the Company is expected to be based on modular, interchangeable subsystems, including the 8000 control platform, which management believes will promote more efficient and cost-effective manufacturing operations, lower inventory levels, improved field service capabilities and shorter product development cycles, which will allow the Company to introduce new products more quickly.\nThe Company's net expenditures for research and development totaled approximately $15.9 million, $21.3 million and $30.9 million during the fiscal years ended September 30, 1993, 1994 and 1995, respectively. The Company receives funding from certain customers and government agencies pursuant to contracts or other arrangements for the performance of specified research and development activities. Such amounts are recognized as a reduction of research and development expense when specified activities have been performed.\nDuring the fiscal years ended September 30, 1993, 1994 and 1995, such funding totaled approximately $1.0 million, $2.0 million and $2.8 million, respectively.\nCOMPETITION\nThe semiconductor equipment and semiconductor materials industries are intensely competitive. Significant competitive factors in the semiconductor equipment market include process capability and repeatability, quality and flexibility, and cost of ownership, including throughput, reliability and automation, customer support and price. The Company's major equipment competitors include Shinkawa and Kaijo in wire bonders; ESEC, Nichiden, ASM Pacific Technology and Alphasem in die bonders; and Disco Corporation in dicing saws. Competitive factors in the semiconductor expendable tools and materials industry include price, delivery and quality. Significant competitors in the expendable tools line include Gaiser Tool Co. and Small Precision Tools, Inc. In the bonding wire market, significant competitors include Tanaka Electronic Industries and Sumitomo Metal Mining.\nIn each of the markets it serves, the Company faces competition and the threat of competition from established competitors and potential new entrants, some of which may have greater financial, engineering, manufacturing and marketing resources than the Company. Some of these competitors are Japanese companies that have had and may continue to have an advantage over the Company in supplying products to Japan-based companies due to their preferences to purchase equipment from Japanese suppliers. The Company expects its competitors to continue to improve the performance of their current products and to introduce new products with improved price and performance characteristics. New product introductions by the Company's competitors or by new market entrants could cause a decline in sales or loss of market acceptance of the Company's existing products. If a particular semiconductor manufacturer or subcontract assembler selects a competitor's product for a particular assembly operation, the Company may experience difficulty in selling a product to that company for a significant period of time. Increased competitive pressure could also lead to intensified price-based competition, resulting in lower prices which could adversely affect the Company's business, financial condition and operating results. The Company believes that to remain competitive it must invest significant financial resources in new product development and expand its customer service and support worldwide. There can be no assurance that the Company will be able to compete successfully in the future.\nINTELLECTUAL PROPERTY\nWhere circumstances warrant, the Company seeks to obtain patents on inventions governing new products and processes developed as part of its ongoing research, engineering and manufacturing activities. The Company currently holds a number of United States patents some of which have foreign counterparts. The Company believes that the duration of its patents generally exceeds the life cycles of the technologies disclosed and claimed therein. Although the patents it holds and may obtain in the future may be of value, the Company believes that its success will depend primarily on its engineering, manufacturing, marketing and service skills.\nThe Company also believes that much of its important technology resides in its proprietary software and trade secrets. Insofar as the Company relies on trade secrets and unpatented knowledge, including software, to maintain its competitive position, there is no assurance that others may not independently develop similar technologies. In addition, although the Company executes non- disclosure and non-competition agreements with certain of its employees, customers, consultants, selected vendors and others, there is no assurance that such secrecy obligations will not be breached.\nCertain of the Company's customers have received notices of infringement from two separate parties, Harold S. Hemstreet and Jerome H. Lemelson, alleging that equipment supplied by the Company, and processes performed by such equipment, infringe on patents held by them. The Company's product warranties generally provide customers with indemnification for damages sustained by a customer as a consequence of patent infringement claims arising out of use of the Company's products and obligate the Company to defend such claims. As a consequence, the Company could be required to reimburse its customers for certain damages resulting from these matters and to defend its customers in patent infringement suits. However, the Company generally does not accept responsibility for any compromise or settlement made without its written consent. To the Company's knowledge, no actions have been initiated or threatened directly against the Company in\nconnection with these matters, although certain customers have requested that the Company defend them and indemnify them against possible claims based on their use of equipment supplied by the Company. A number of the Company's customers have actually been sued, and the Company understands that certain of them have settled such suits but have not sought any contribution from the Company. The Company believes that no equipment marketed by the Company, and no process performed by such equipment, infringe on the patents in question and does not believe that such matters will have a material adverse effect on its financial condition or operating results. However, the ultimate outcome of any infringement claim affecting the Company is uncertain and there can be no assurances that the resolution of these matters will not have a material adverse effect on the Company's business, financial condition or operating results.\nEMPLOYEES\nAt September 30, 1995, K&S had 1,695 permanent employees, 55 temporary employees and 126 contract employees worldwide. In addition, at September 30, 1995, AFW had 295 employees. The only Company employees represented by a labor union are AFW's employees in Singapore. K&S considers its employee relations to be good.\nEXECUTIVE OFFICERS OF THE COMPANY\nThe following table sets forth information regarding the executive officers of the Company.\nC. Scott Kulicke has been Chief Executive Officer since 1979 and Chairman of the Board since 1984. Prior to that he held a number of executive positions with the Company. Mr. Kulicke is the son of Frederick W. Kulicke, Jr., a member of the Board of Directors.\nMorton K. Perchick joined the Company in 1980 and has served in various executive positions, most recently as Senior Vice President, prior to his being appointed Executive Vice President in July 1995.\nClifford G. Sprague joined the Company in March 1989 as Vice President and Chief Financial Officer and was promoted to Senior Vice President in 1990. Prior to joining the Company, he served for more than five years as Vice President and Controller of the Oilfield Equipment Group of NL Industries, Inc., an oilfield equipment and service company.\nMoshe Jacobi has served as the Company's Senior Vice President, Expendable Tools and Materials since July 1995. Prior to that, he had served as Vice President of the Company and Managing Director of Micro-Swiss\nLtd., a wholly-owned subsidiary of the Company since November 1992. He was Division Director and General Manager of the Micro-Swiss Division from July to November 1992, and, from August 1986 to July 1992, he was Deputy Managing Director of Kulicke and Soffa (Israel) Ltd., a wholly-owned subsidiary of the Company.\nAsuri Raghavan was promoted to Senior Vice President, Marketing in July 1995, having served as Vice President of the Wire Bonder Business since December 1993. Prior to that, he served as Vice President, Strategic Development from June 1991 to 1993, and in various other management capacities since joining the Company in 1980, except for the period from December 1985 until November 1987 when he was Director, Research and Technology of American Optical.\nCary H. Baskin joined the Company in 1992 and since February 1995 he has served as Vice President, Die Bonder Business. Prior to such time, Mr. Baskin served as director of corporate marketing and, before that, director of product marketing for the Company's ball bonding and TAB business. Formerly, Mr. Baskin held senior marketing positions with Mars Electronics and Checkpoint Systems.\nMark H. Heeter was appointed Vice President, Human Resources in July 1995. Prior to that, he was Vice President of Human Resources of The Dispatch Printing Company from 1993 to 1994. From 1987 to 1993, Mr. Heeter was Director of Human Resources of Checkers, Simon and Rosner, a public accounting and business services firm.\nShlomo Oren joined the Company in 1980 and has served as a Vice President of the Company since 1991 and has been Managing Director of Kulicke and Soffa (Israel), Ltd. since January 1993. Prior to January 1993, he served as Vice President of Marketing of the Company, Director, Microelectronic Business Division of the Company, and Deputy Managing Director, Marketing, Kulicke and Soffa (Israel).\nR. Kelly Payne was elected a Vice President of the Company in October 1995 following the Company's acquisition of Circle \"S\" and AFW. Prior to joining the Company, he had served since 1989 in various executive capacities with AFW and American Fine Wire, Ltd., its Singapore-based subsidiary. He became President and Chief Executive Officer of AFW in January 1994.\nCharles Salmons joined the Company in 1978 and became Vice President, Operations in September 1994. Prior to that, he served as Vice President of Manufacturing, Director of Operations, Director of Production and Manager of Production.\nTeruhiko Sawachi joined the Company in December 1991 as Vice President of the Company and President of Kulicke & Soffa (Japan) Ltd. Prior to that, he was Representative Director of Senco Japan Ltd., a division of Senco Products, Inc., from November 1987 to December 1991.\nWalter Von Seggern joined the Company in September 1992 as Vice President of Engineering and Technology. From April 1988 to April 1992, he worked for M\/A- Com, Inc. He was General Manager of M\/A-Com's ANZAC, RGH and Eurotec Divisions from 1990 to 1992 and from 1988 to 1990, he was General Manager of M\/A-Com's Radar Products Division.\nMichael A. Wolf was appointed Vice President, Sales in February 1995, having served as Director of Sales since 1993. He came to K&S from Proconics International, Inc., Boston, Massachusetts, where he served as vice president of sales and marketing, and has more than 25 years of experience within the semiconductor manufacturing industry in various marketing, sales and sales management positions.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's major facilities are described in the table below:\n(1) Owned. (2) Leased. (3) Part owned and part leased. (4) Cancelable semi-annually upon six months' notice.\nThe Company is planning to expand its Willow Grove, Pennsylvania facilities and is constructing a manufacturing facility in Yokneam, Israel for its Micro-Swiss operations. Construction of this latter facility is expected to be completed in the fall of 1996. Upon completion, the lease of Micro-Swiss' manufacturing facility in Haifa will be terminated. The Company is also planning to relocate AFW's Singapore facilities. In addition, the Company rents space for sales and service offices in Santa Clara, California; Mesa, Arizona; Zug, Switzerland; Korea; Taiwan; and Singapore. The Company believes that its facilities are generally in good condition.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is not aware of any material pending legal matters involving the Company. See the discussion of certain legal contingencies in Note 12 to the Company's fiscal 1995 consolidated financial statements included herein.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nThe Company's Common Stock trades on the Nasdaq National Market under the symbol KLIC. The following table sets forth for the periods indicated the high and low sale prices for the Common Stock as reported on the Nasdaq National Market, which prices have been adjusted to reflect the Company's July 1995 two-for-one stock split.\nOn December 1, 1995, there were 731 holders of record of the shares of outstanding Common Stock.\nThe Company currently does not pay cash dividends on its Common Stock. The Company presently intends to retain any future earnings for use in its business and does not anticipate paying any cash dividends on the Common Stock in the foreseeable future.\nThe amended Gold Supply Agreement dated October 2, 1995 between AFW and its subsidiaries (collectively, the \"AFW Companies\") and their gold supplier contains certain financial covenants and prohibits the AFW Companies from paying any dividends or making any distributions without the consent of the supplier if following any such dividend or distribution the net worth of the AFW Companies would be less than $7.0 million.\nITEM 6.","section_6":"ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA\nThe selected consolidated financial data presented below should be read in conjunction with the Company's Consolidated Financial Statements and notes thereto, which are included elsewhere herein.\n- ------------------------ (a) In fiscal 1989, the Company began a program of selectively repurchasing its 8% Convertible Subordinated Debentures at such times as market prices were favorable. The effect of such repurchases has been to reduce interest expense. During fiscal 1995, all of the Company's remaining 8% Convertible Subordinated Debentures were converted into Common Stock or redeemed. See Note 6 to the Company's Consolidated Financial Statements included elsewhere herein. (b) In fiscal 1993, the Company incurred $1.1 million in costs associated with a failed acquisition. (c) All share and per share data have been restated to give effect to the July 1995 two-for-one stock split.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nINTRODUCTION\nThe Company's operating results depend primarily upon the capital expenditures of semiconductor manufacturers and subcontract assemblers worldwide, which in turn depend on the current and anticipated market demand for semiconductors and products utilizing semiconductors. The semiconductor industry has historically been highly volatile and experienced periodic downturns and slowdowns, which have had a severe negative effect on the semiconductor industry's demand for semiconductor capital equipment, including assembly equipment manufactured and marketed by the Company and, to a lesser extent, expendable tools and materials such as those sold by the Company. In the past, these downturns and slowdowns have also adversely affected the Company's operating results. While the Company does not consider its business to be seasonal in nature, historically there have been substantial fluctuations in the amounts which semiconductor manufacturers and subcontract assemblers have invested in capital equipment. Furthermore, the Company's sales consist primarily of a relatively small number of machines, most with selling prices ranging from approximately $60,000 to over $500,000. A delay in shipment of a limited number of machines, either due to manufacturing delays or to rescheduling or cancelation of customer orders, could have a material adverse effect on results of operations for any particular quarter. The Company believes that such volatility will continue to characterize the industry and the Company's operations in the future.\nRESULTS OF OPERATIONS\nFISCAL YEARS ENDED SEPTEMBER 30, 1995 AND SEPTEMBER 30, 1994\nThe Company recorded bookings totaling $342.4 million during the fiscal year ended September 30, 1995 compared to $178.0 million during fiscal 1994. The continued strength in customer orders is primarily attributable to the following factors. First, growing end-user demand for semiconductor devices has resulted in industry-wide expansion both in wafer fabrication capacity and semiconductor assembly capacity. In addition, certain semiconductor manufacturers are replacing older assembly capital equipment with newer, higher throughput machines capable of handling more complex semiconductor devices for a wider variety of applications. Finally, enhanced versions of the Company's gold ball wire bonder (Model 1488 Turbo -introduced in late fiscal 1994) and aluminum wedge bonder (Model 1474fp - introduced in the second quarter of fiscal 1995) offer significant performance advantages compared to the Company's earlier models, including greater throughput, finer pitch capabilities and improved programmability to handle a wider variety of applications. Favorable customer acceptance of these enhanced models contributed to the Company's increased volume of orders during fiscal 1995.\nAt September 30, 1995, the backlog of customer orders totaled approximately $84.7 million compared to $46.8 million at September 30, 1994. Since the timing of deliveries may vary and orders generally are subject to cancellation, the Company's backlog as of any date may not be indicative of sales for any succeeding period.\nNet sales for the fiscal year ended September 30, 1995 increased 76% to $304.5 million compared to $173.3 million during fiscal 1994. Approximately $123.6 million of this increase was due to higher unit volume, primarily of the Company's Model 1488 Turbo gold ball wire bonders and 1474fp aluminum wedge bonders, and, to a lesser extent, to increased sales of consumable tools and spare parts. Higher selling prices for the Model 1488 Turbo ball bonder and Model 1474fp wedge bonder contributed approximately $7.6 million to net sales in fiscal 1995, over the amounts reported in fiscal 1994. In addition, approximately $6.1 million of the volume increase was attributable to sales of products added from the July 1994 acquisition of Assembly Technologies (\"AT\"). By geographic region, increases in net sales in fiscal 1995 as compared to fiscal 1994 were primarily attributable to customers located in the Asia\/Pacific region, and, to a lesser extent, to customers located in the United States. Sales to customers in the Asia\/Pacific region and the United States accounted for more than 90% of the Company's net sales in fiscal 1995.\nGross profit as a percentage of net sales increased to 45.0% for fiscal 1995 compared to 41.5% for fiscal 1994. The increase in the gross profit percentage resulted principally from improved manufacturing overhead absorption associated with higher sales volumes, the improved gross profit margin on the gold ball and wedge bonder products largely due to the higher selling prices realized on the new, enhanced models, and to a shift in sales mix toward higher margin wedge bonders. During fiscal 1994, the wedge bonder product line comprised 14% of net revenues; in fiscal 1995, wedge bonder products accounted for 20% of net revenues. Partially offsetting the above factors were additional inventory reserves established for slower moving products during\nfiscal 1995.\nSelling, general and administrative expenses (\"SG&A\") totaled $50.7 million during fiscal 1995, compared to $36.8 million during fiscal 1994. This increase was primarily attributable to higher employment levels required to support the higher volume of business, increased sales incentives and commissions resulting from the higher sales levels, increased management incentives associated with improved earnings and higher outside contractor costs associated with ongoing internal management information systems development efforts. Of the total increase in SG&A costs, $1.5 million was related to the incremental costs incurred by the Company to market and support die bonder products added through the July 1994 acquisition of AT.\nNet research and development (\"R&D\") costs increased to $30.9 million for the fiscal year ended September 30, 1995, compared to $21.3 million for the same period last year. Of the $9.6 million increase in fiscal 1995, $2.0 million resulted from incremental expenditures related to development of the Company's next generation of die bonders and enhancements to die bonder products added through the AT acquisition. The remainder consisted primarily of personnel related costs, outside contractor costs and prototype materials related to new product development. Gross R&D expenses were partially offset by funding received from customers and governmental subsidies totaling $2.8 million in fiscal 1995 and $2.0 million in fiscal 1994.\nThe Company continues to invest heavily in the development of the 8000 Series wire bonders and in enhancements of existing products, including the Model 1488 turbo ball bonder and Model 1474fp wedge bonder to enable them to handle higher lead-count devices with finer pitch requirements at faster bonding speeds than the earlier Models. In addition, the Company continues to invest in new technologies which may eventually lead to improved or alternate semiconductor assembly technologies.\nOperating income totaled $55.4 million for fiscal 1995 compared to $13.9 million for the same period in fiscal 1994. This improvement resulted principally from the higher revenue levels and improved gross profit margins, offset in part by the increased SG&A and R&D expenses noted above. The majority of the increase in operating profit was realized in the United States, where the Company maintains its principal manufacturing operations, and in Hong Kong where the Company's Asia\/Pacific sales activities are centered.\nDuring fiscal 1995, all of the Company's remaining 8% Convertible Subordinated Debentures were converted into Common Stock or redeemed. As a result, interest expense during fiscal 1995 was lower than the amount reported in fiscal 1994. In connection with the October 2, 1995 AFW acquisition, the Company borrowed $15.0 million under its Bank Credit facility and $34.4 million pursuant to promissory notes issued to certain former Circle \"S\" shareholders. During fiscal 1996, the Company will incur interest expense associated with these borrowings until they are repaid.\nThe increase in the effective tax rate to 23% in fiscal 1995 compared to the fiscal 1994 rate of 20% was due primarily to utilization of remaining net operating loss carryforwards in fiscal 1994, utilization in the United States of R&D tax credits not previously used due to the effects of net operating losses, and to the amount and geographic distribution of taxable income in fiscal 1995. The Company expects that its overall effective tax rate will be higher in the future, as most available tax credits were utilized by the end of fiscal 1995.\nThe Company is in the process of developing a new generation of wire bonder, the 8000 family, which will be based on an entirely new platform and will require the development of new software and many subassemblies not part of the Company's current wire bonders. While development and technical risks exist which have the potential to delay the introduction of the Model 8020, the Company currently expects that the product will be released in the second half of calendar 1996. However, no assurance can be given that its scheduled introduction in the second half of 1996 will not be delayed, due to technical or other difficulties, or that the Model 8020 will not experience quality or reliability problems after shipment. The Company's inability to complete the development of and introduce the Model 8020 or other new products, or its inability to manufacture and ship these products in volume and on a timely basis, could adversely affect the Company's competitive position. The Company also may incur substantial costs early in a new product's life cycle to ensure the functionality and reliability of such product. Furthermore, the Company's planned transition to the Model 8020 platform involves numerous risks, including the possibility that customers will defer purchases of Model 1488 Turbo wire bonders in anticipation of the availability of the Model 8020 or that the Model 8020 will fail to meet customer needs or achieve market acceptance. To the extent that the Company fails to forecast\ndemand in volume and configuration for both its current and next-generation wire bonders and generally to manage product transitions successfully, it could experience reduced orders, delays in product shipments, increased risk of inventory obsolescence and delays in collecting accounts receivable. There can be no assurance that the Company will successfully develop and manufacture new products, including the Model 8020, that new products introduced by the Company will be accepted in the marketplace or that the Company will manage its product transitions successfully. The Company's failure to do any of the foregoing would materially adversely affect the Company's business, financial condition and operating results.\nIn October 1995, Statement of Financial Accounting Standards No. 123, \"Accounting for Stock-based Compensation\" (\"SFAS 123\"), was issued. This statement requires the fair value of stock options and other stock-based compensation issued to employees to either be included as compensation expense in the income statement, or the pro forma effect on net income and earnings per share of such compensation expense to be disclosed in the footnotes to the Company's financial statements commencing with the Company's 1997 fiscal year. The Company expects to adopt SFAS 123 on a disclosure basis only. As such, implementation of SFAS 123 is not expected to impact the Company's consolidated balance sheet or income statement.\nACQUISITION OF AFW\nOn October 2, 1995, the Company acquired AFW, a manufacturer of gold and aluminum bonding wire primarily used in the semiconductor assembly industry. Following the AFW acquisition, the Company's consolidated operating results will include the sales, costs and expenses of AFW. During the 12 month period ended September 30, 1995, AFW's revenues totaled $72.4 million. Revenues of AFW include a fabrication charge per thousand feet of wire and the value of precious metals (primarily gold) which is sold to the customer. . AFW has historically reported a lower gross profit margin than the Company. As such, the Company expects its future consolidated gross profit percentage to be lower than historically reported.\nThe Company's future operating costs will include the operating costs of the AFW business, amortization of intangible assets, including goodwill, arising from the AFW Acquisition and interest expense associated with the acquisition financing. The amortization of intangible assets arising from the AFW Acquisition is not expected to be tax deductible, and as such, will adversely affect the Company's overall effective tax rate in the future. See Note 2 to the Company's fiscal 1995 consolidated financial statements include herein.\nAs a result of the AFW acquisition, the portion of the Company's operations attributable to the expendable tools and materials will exceed 10% of total revenues. These products have different manufacturing processes, distribution channels and a less volatile revenue pattern than the Company's capital equipment business. Accordingly, in the future, the Company intends to report its operations in two business segments, its equipment business (sales of capital equipment, related spare parts and services) and its expendable tools and materials business (which will include the Micro-Swiss and AFW operations).\nFISCAL YEARS ENDED SEPTEMBER 30, 1994 AND SEPTEMBER 30, 1993\nThe Company achieved record sales and bookings of customer orders during fiscal 1994. This growth was driven by the continued expansion of the semiconductor industry and increased investment in semiconductor assembly equipment. Driven largely by growing demand for the Company's Model 1484LXQ gold ball wire bonders and Model 1472 aluminum wedge bonders, bookings increased 11% in fiscal 1994 to $178.0 million. Backlog rose from $42.0 million at September 30, 1993 to $46.8 million at September 30, 1994.\nNet sales increased 23% in fiscal 1994 to $173.3 million compared to $140.9 million in 1993. Increased unit volume, primarily of the Company's Model 1484LXQ gold ball wire bonders, Model 1472 aluminum wedge bonders and expendable tools, generated approximately $38.7 million of incremental net sales in fiscal 1994 over fiscal 1993. The acquisition of the AT business contributed an additional $1.9 million to fiscal 1994 net sales. By geographic region, increases in net sales in 1994 as compared with 1993 were primarily attributable to customers located in the Asia Pacific region and, to a lesser extent, to customers located in the United States. Sales to customers in Asia Pacific and the United States accounted for more than 90% of the Company's net sales in fiscal 1994.\nIncreases in net sales from the higher unit volume were partially offset by lower average selling prices of certain machines due to the continuing competitive pricing environment in the Asian market and to discounts given for certain large volume orders booked early in fiscal 1994. In July 1994, the Company introduced the Model 1488 Turbo gold ball wire bonder, which offers significantly improved throughput compared to the Model 1484LXQ ball bonders. The higher productivity offered by this model led to higher average selling prices.\nCost of goods sold increased to $101.3 million for fiscal 1994 from $79.2 million during fiscal 1993, largely as a result of increased unit volume in fiscal 1994. Gross profit as a percentage of net sales decreased from 43.8% during fiscal 1993 to 41.5% for fiscal 1994. This change resulted primarily from the lower average selling prices realized on Model 1484LXQ gold ball wire bonders and, to a lesser extent, from a shift in sales mix. In fiscal 1994, sales of gold ball wire bonders, which have lower than average gross margins, increased to 51% of net sales compared to 46% of total net sales in fiscal 1993. Conversely, sales of higher margin spare parts declined from 14% of net sales in 1993 to 11% in 1994.\nSG&A expenses increased 17% to $36.8 million in fiscal 1994 from the $31.5 million reported in fiscal 1993. These higher expenses were primarily attributable to increased sales and customer support activities associated with increased unit volume and the larger installed base of machines, increased costs to enhance the Company's worldwide management information systems and incremental costs to market and support the additional products offered by the Company following the acquisition of AT, including a new sales and service office in Singapore.\nNet R&D increased to $21.3 million during fiscal 1994 from $15.9 million in fiscal 1993. Personnel related costs rose as the Company expanded its overall level of R&D activities in fiscal 1994. In addition, the Company incurred higher outside service and prototype materials costs in fiscal 1994 as R&D activities on new products progressed from the design to the development and testing stage. Gross R&D expenses were partially offset by funding received from customers and governmental subsidies totaling $2.0 million in fiscal 1994 and $1.0 million in fiscal 1993. Major R&D projects during fiscal 1994 included development of the improved productivity Model 1488 Turbo gold ball wire bonder, continued efforts toward the next generation 8000 series automatic wire bonders, development of the Model 6900 automatic die attach machine and continuous improvements to enhance the capabilities or extend the lives of the Company's existing products.\nIncome from operations totaled $13.9 million in fiscal 1994 compared to $14.3 million in fiscal 1993. Although gross profit increased $10.3 million from fiscal 1993 to fiscal 1994, gross profit margin as a percentage of sales decreased from 43.8% in fiscal 1993 to 41.5% in fiscal 1994. This decline resulted primarily from the lower average selling prices for 1484LXQ gold ball wire bonders and, to a lesser extent, an unfavorable shift in the sales mix. As discussed previously, SG&A and R&D expenses increased $10.7 million resulting in lower operating income (primarily in the United States) in fiscal 1994 compared to fiscal 1993.\nChanges in interest income and expense were not significant. In fiscal 1993, the Company charged $1.1 million to expense in connection with a failed acquisition attempt; there was no comparable charge in fiscal 1994. The Company's effective tax rate increased to 20% in fiscal 1994 compared to 10.4% in fiscal 1993. The increase primarily resulted from a shift in the amount and geographic distribution of taxable income during fiscal 1994 and from higher utilization of net operating loss carryforwards in the United States and Israel during fiscal 1993.\nLIQUIDITY AND CAPITAL RESOURCES\nDuring the past three fiscal years, the Company has financed its operations principally through cash flows from operations. Cash flows from operating activities and the overall increase in cash and total investments in fiscal 1995 compared to fiscal 1994 generally reflect improved profitability in fiscal 1995. Cash generated by operating activities totaled $22.0 million during fiscal 1995 compared to $12.8 million during fiscal 1994. Cash and total investments increased to $40.9 million at September 30, 1995 from the $27.0 million reported at September 30, 1994.\nAt September 30, 1995, working capital increased to $103.8 million compared to $61.5 million at September 30, 1994. The accounts receivable balance at September 30, 1995 increased by $37.2 million compared to the\nSeptember 30, 1994 balance due largely to increased sales volume in the fiscal 1995 fourth quarter. The $13.6 million increase in inventory at September 30, 1995 primarily reflects growth in raw materials and work in process inventories as the Company continues to increase manufacturing activities to satisfy increased customer demand for its products.\nTrade accounts payable and accrued expenses increased by approximately $20.9 million at September 30, 1995 compared to their September 30, 1994 balances. The increase in trade payables is directly attributable to increased inventory purchases during the fourth quarter of fiscal 1995. The increase in accrued expenses primarily resulted from higher sales and management incentives due to improved fiscal 1995 sales and profits and to increased accruals associated with higher employment levels compared to fiscal 1994.\nDuring fiscal 1995, the Company invested approximately $10.8 million in property and equipment, primarily to upgrade equipment used in the Company's manufacturing and R&D activities and for tooling used in the manufacturing of new machines. The Company presently expects fiscal 1996 capital spending to approximate $30 million. The principal capital projects planned for fiscal 1996 include expansion of facilities (including Singapore and Israel), the purchase of equipment necessary to expand capacity, and a new world-wide management information system. Relocation of AFW's facility in Singapore and the Micro- Swiss facility in Israel is not expected to have a material adverse effect on the Company's results of operation, cash flow or liquidity.\nThe Company has signed a memorandum of understanding and is currently in discussions with one party which would involve the formation of a joint venture to pursue flip-chip bonding technology development and subcontract services to semiconductor manufacturers. Such joint venture, if consummated on the terms currently being discussed, would require a minimum initial investment of approximately $11.0 million to fund the start up of operations.\nCash proceeds to the Company from stock option exercises and sales of shares of Common Stock to employees pursuant to the Company's Employee Stock Purchase Plan generated approximately $1.5 million in cash during fiscal 1995.\nThe Company maintains a $10.0 million unsecured revolving bank credit facility, subject to interest at 0.25% below the lender's prime rate. Borrowings under this credit line are subject to the Company's compliance with certain financial and other covenants. There were no borrowings under this credit line during fiscal 1995. This credit line will expire on March 29, 1996, unless renewed. The Company expects to renew this credit line.\nAs described more fully in Note 6 to the Company's fiscal 1995 consolidated financial statements, the Company borrowed $15.0 million under its new term credit facility and $34.4 million pursuant to certain promissory notes, to finance the AFW acquisition. The promissory notes are due January 5, 1996. The Company may borrow additional amounts under the term credit facility to repay the AFW Notes when due. Amounts borrowed under the term credit facility will automatically convert into a five-year term loan payable in equal monthly installments if not repaid by March 29, 1996.\nA significant portion of the Company's cash and investments are attributable to undistributed earnings of its foreign subsidiaries. Deferred income taxes have not been provided on that portion of such undistributed earnings which is considered indefinitely reinvested in the foreign operations. If such funds were required to be repatriated to fund the Company's operations or other financial obligations, additional income tax expenses could be required to be recognized. The amended Gold Supply Agreement dated October 2, 1995 between AFW and its subsidiaries (collectively, the \"AFW Companies\") and their gold supplier contains certain financial covenants and prohibits the AFW Companies from paying any dividends or making any distributions without the consent of the supplier if, following any such dividend or distribution, the net worth of the AFW Companies would be less than $7.0 million.\nThe Company believes that anticipated cash flows from operations, its working capital and amounts available under its revolving credit facility will be sufficient to meet the Company's liquidity and capital requirements for at least the next 12 months, including debt service requirements under its bank credit facility. The Company may, however, seek equity or debt financing to provide capital for corporate purposes and\/or to fund strategic\nbusiness opportunities, including possible acquisitions, joint ventures, alliances or other business arrangements which could require substantial capital outlays. The timing and amount of such capital requirements cannot be precisely determined at this time and will depend on a number of factors, including demand for the Company's products, semiconductor and semiconductor capital equipment industry conditions and competitive factors and the nature and size of strategic business opportunities which the Company may elect to pursue.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA\nThe consolidated Financial Statements of Kulicke and Soffa Industries, Inc. and its subsidiaries, listed in the index appearing under Item 14 (a) (1) and (2) are filed as part of the Annual Report on Form 10-K.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholders Kulicke and Soffa Industries, Inc.\nIn our opinion, based upon our audits and the report of other auditors, the consolidated financial statements listed in the index appearing under Item 14(a)(1) and (2) on page 22 of this Annual Report on Form 10-K present fairly, in all material respects, the financial position of Kulicke and Soffa Industries, Inc. and its subsidiaries at September 30, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended September 30, 1995, 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 did not audit the consolidated financial statements of Kulicke and Soffa (Israel) Ltd., a wholly-owned subsidiary, as of September 30, 1994 and for the years ended September 30, 1994 and 1993 which consolidated statements reflect, before adjustments to eliminate intercompany activity, total assets of $17,906,000 at September 30, 1994 and net sales of $27,864,000 and $23,629,000 for the years ended September 30, 1994 and 1993, 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 Kulicke and Soffa (Israel) Ltd., 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.\n\/s\/ PRICE WATERHOUSE LLP\nPhiladelphia, Pennsylvania November 14, 1995\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Directors and Shareholders of Kulicke and Soffa (Israel) Ltd.\nWe have audited the consolidated balance sheets of Kulicke and Soffa (Israel) Ltd. and subsidiary as of September 30, 1994, and the related consolidated statements of operations and retained earnings and cash flows for each of the two years in the period ended September 30, 1994, all expressed in U.S. dollars. 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 in Israel and the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements (not separately presented herein) expressed in U.S. dollars, present fairly, in all material respects, the consolidated financial position of Kulicke and Soffa (Israel) Ltd. and subsidiary as of September 30, 1994, and the consolidated results of their operations and retained earnings and their cash flows for each of the two years in the period ended September 30, 1994, in conformity with generally accepted accounting principles in the United States.\n\/s\/ LUBOSHITZ, KASIERER & CO.\nCertified Public Accountants (Israel) Haifa, Israel\nNovember 3, 1994\nKULICKE AND SOFFA INDUSTRIES, INC. CONSOLIDATED BALANCE SHEET (IN THOUSANDS)\nThe accompanying notes are an integral part of these consolidated financial statements.\nKULICKE AND SOFFA INDUSTRIES, INC. CONSOLIDATED INCOME STATEMENT (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\nThe accompanying notes are an integral part of these consolidated financial statements.\nKULICKE AND SOFFA INDUSTRIES, INC. CONSOLIDATED STATEMENT OF CASH FLOWS (IN THOUSANDS)\nSee Note 6 for disclosure of non-cash financing activities.\nThe accompanying notes are an integral part of these consolidated financial statements.\nKULICKE AND SOFFA INDUSTRIES, INC. CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (IN THOUSANDS)\nThe accompanying notes are an integral part of these consolidated financial statements.\nKULICKE AND SOFFA INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)\nNOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nThese consolidated financial statements include the accounts of Kulicke and Soffa Industries, Inc. and its subsidiaries (the \"Company\"), with appropriate elimination of intercompany balances and transactions.\nCash Equivalents - The Company considers all highly liquid investments with original maturities of three months or less when purchased to be cash equivalents.\nInvestments - At September 30, 1994, the Company adopted Statement of Financial Accounting Standards No. 115 (\"SFAS 115\"), \"Accounting for Certain Investments in Debt and Equity Securities.\" In accordance with SFAS 115, the Company's investments other than cash equivalents are classified as \"trading,\" \"available- for-sale\" or \"held-to-maturity,\" depending upon the nature of the investment, its ultimate maturity date in the case of debt securities, and management's intentions with respect to holding the securities. Investments classified as available-for-sale are reported at fair market value, with net unrealized gains or losses reflected as a separate component of shareholders' equity. Investments classified as held-to-maturity are reported at amortized cost. Realized gains and losses are determined on the basis of specific identification of the securities sold.\nConcentration of Credit Risks - Financial instruments which may subject the Company to concentration of credit risk at September 30, 1995 and 1994 consist primarily of investments and trade receivables. The Company manages credit risk associated with investments by investing its excess cash in investment grade debt instruments of the U.S. Government, financial institutions and corporations. The Company has established investment guidelines relative to diversification and maturities designed to maintain safety and liquidity. These guidelines are periodically reviewed and modified to take advantage of trends in yields and interest rates. The Company's trade receivables result primarily from the sale of semiconductor equipment and related accessories and replacement parts to a relatively small number of large manufacturers in a highly concentrated industry. The Company continually assesses the financial strength of its customers to reduce the risk of loss. Accounts receivable at September 30, 1995 and 1994 include notes receivable of $15,164 and $204, respectively. The majority of the notes receivable represent an unsecured note from one customer due in 270 days from the date of shipment, with interest commencing after 90 days from the date of issuance at the prime rate plus .25%.\nInventories - Inventories are stated at the lower of cost (determined on the basis of first-in, first-out for certain inventories and average cost for others) or market. The Company generally provides reserves for inventory considered to be in excess of 18 months of forecasted future demand.\nProperty, Plant and Equipment - Property, plant and equipment are carried at cost. The cost of additions and those improvements which increase the capacity or lengthen the useful lives of assets are capitalized while repair and maintenance costs are expensed as incurred. Depreciation and amortization are provided on a straight-line basis over the following estimated useful lives: buildings - 25 to 40 years; machinery and equipment - 3 to 8 years; leasehold improvements - life of lease or life of asset. Purchased computer software costs related to business and financial systems are included in other assets and are amortized over a five year period on a straight-line basis.\nIntangible Assets - Goodwill resulting from acquisitions accounted for using the purchase method is amortized on a straight-line basis over the estimated period to be benefited by the acquisition ranging from fifteen to twenty years (see Notes 2 and 10). The Company has adopted SFAS No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,\" effective October 1, 1994. The carrying value of long-lived assets, including goodwill, is evaluated whenever changes in circumstances indicate the carrying amount of such assets may not be recoverable. In performing such review for recoverability, the Company compares the expected future cash flows to the carrying value of long-lived assets and identifiable intangibles. If the anticipated discounted future cash flows are less than the carrying amount of such assets, the Company recognizes an impairment loss for the difference between the carrying amount of the assets and their estimated fair value. If an asset being tested for recoverability was acquired in a\nbusiness combination accounted for using the purchase method, the excess of cost over fair value of net assets that arose in that transaction is allocated to the assets being tested for recoverability on a pro rata basis using the relative fair values of the long-lived assets and identifiable intangibles acquired at the acquisition date.\nPost-Employment Benefits - In fiscal 1995, the Company adopted SFAS No. 112, \"Employers' Accounting for Postemployment Benefits.\" This Statement requires that these benefits be accrued over the employees' periods of service if such benefits vest ratably, or upon termination in certain instances. Adoption of this new statement did not materially impact the Company's financial position or results of operations.\nForeign Currency Translation - The U.S. dollar is the functional currency for all subsidiaries except Kulicke and Soffa (Japan) Ltd., whose functional currency is the Japanese yen. Unrealized translation gains and losses resulting from the translation of Kulicke and Soffa (Japan) Ltd. functional currency financial statement amounts into U.S. dollars in accordance with SFAS No. 52 are not included in determining net income but are accumulated in the Cumulative Translation Adjustment account as a separate component of shareholders' equity. Gains and losses resulting from foreign currency transactions are included in the determination of net income.\nRevenue Recognition - Sales are recorded upon shipment of products or performance of services. Expenses for estimated product returns and warranty costs are accrued in the period of sale recognition.\nResearch and Development Arrangements - The Company receives funding from certain customers and government agencies pursuant to contracts or other arrangements for the performance of specified research and development activities. Such amounts are recognized as a reduction of research and development expense when specified activities have been performed. During fiscal 1995, 1994 and 1993, reductions to research and development expense related to such funding totaled $2,843, $2,022 and $1,005, respectively.\nIncome Taxes - On October 1, 1993, the Company adopted SFAS No. 109, \"Accounting for Income Taxes,\" on a prospective basis. Until September 30, 1993 the Company's provision for income taxes was based upon SFAS No. 96. Implementation of SFAS No. 109 did not have a material effect on the Company's financial statements. Deferred income taxes are not provided for undistributed earnings of consolidated subsidiaries when such earnings are determined to be invested indefinitely.\nEarnings Per Share - Primary earnings per share are computed using the weighted average number of common shares outstanding. Recognition is given to the assumed exercise of stock options, if dilutive. Fully diluted earnings per share are computed based on the weighted average number of shares outstanding plus those shares assumed to be issued upon the exercise of stock options and, in fiscal 1995, the conversion of the subordinated debentures, after giving effect to the elimination of interest expense, net of income taxes, applicable to the debentures. For fiscal 1994 and 1993, no recognition was given to the assumed conversion of debentures since such conversion would either be anti- dilutive or dilution would be less than 3%.\nAccounting for Stock-based Compensation - In October 1995, Statement of Financial Accounting Standards No. 123, \"Accounting for Stock-based Compensation\" (\"SFAS 123\"), was issued. This statement requires the fair value of stock options and other stock-based compensation issued to employees to either be included as compensation expense in the income statement, or the pro forma effect on net income and earnings per share of such compensation expense to be disclosed in the footnotes to the Company's financial statements commencing with the Company's 1997 fiscal year. The Company expects to adopt SFAS 123 on a disclosure basis only. As such, implementation of SFAS 123 is not expected to impact the Company's consolidated balance sheet or income statement.\nNOTE 2: SUBSEQUENT EVENT - ACQUISITION OF AMERICAN FINE WIRE CORPORATION\nOn October 2, 1995, the Company acquired American Fine Wire Corporation (\"AFW\") through the acquisition of all of the common stock of Circle \"S\" Industries, Inc., the parent corporation of AFW (\"Circle S\"). AFW is a manufacturer of fine gold and aluminum wire used in the wire bonding process, and has manufacturing facilities in Singapore; Selma, Alabama; and Zurich, Switzerland.\nThe preliminary purchase price, before transaction related costs, approximated $53.6 million, subject to possible upward or downward adjustment upon completion of the audit of the closing balance sheet. The Company does not anticipate\nany material adjustment to the preliminary purchase price. The purchase price was initially financed by borrowings under a new bank term credit facility and seller promissory notes (see Note 6). The excess of the total purchase price over the estimated fair value of acquired tangible net assets is expected to approximate $42 million, consisting primarily of goodwill and a favorable operating lease, both of which will be amortized over a twenty-year period.\nThis acquisition will be accounted for in fiscal 1996 using the purchase method. Accordingly, AFW's operating results will be included in the Company's historical financial statements commencing October 2, 1995.\nRevenues of AFW include a fabrication charge per thousand feet of wire and the value of precious metals (primarily gold) which is sold to the customer. Gross revenues could vary significantly based on market fluctuations in the value of gold. To minimize the Company's financial exposure to gold price fluctuations, the Company obtains gold from its gold supplier on a consignment basis during the fabrication process and purchases the gold upon shipment and sale of the finished product to the customer.\nUnaudited pro forma balance sheet and income statement data reflecting the combined balance sheet at September 30, 1995 and combined operating results of the Company and AFW as if the acquisition had occurred on October 1, 1994, after giving effect to certain pro forma adjustments, are as follows:\nThe foregoing unaudited pro forma results of operations reflect one year's amortization of the estimated amount of intangible assets, including goodwill, resulting from the acquisition of AFW.\nNOTE 3: INVESTMENTS\nThe Company adopted SFAS 115 effective September 30, 1994. Adoption of SFAS 115 had no impact on fiscal 1994 results of operations. At September 30, 1995 and 1994, no short-term investments were classified as trading. Investments, excluding cash equivalents, consisted of the following at September 30, 1995 and 1994:\nThe Company has obligations under various operating leases, primarily for manufacturing and office facilities, which expire periodically through 2107. In addition, in connection with the October 2, 1995 acquisition of AFW, the Company assumed certain leases associated with AFW's facilities. Minimum rental commitments under these leases including the AFW leases (excluding taxes, insurance, maintenance and repairs, which are also paid by the Company), are as follows: $1,515 in 1996; $1,191 in 1997; $696 in 1998; $528 in 1999; and $6,347 thereafter.\nRent expense for fiscal 1995, 1994 and 1993 was $2,355, $1,663 and $1,585, respectively.\nThe 8% convertible subordinated debentures (the \"Debentures\") were due March 1, 2008, and required minimum annual sinking fund payments of $1,750. The Debentures were convertible at any time prior to maturity into shares of common stock at a conversion rate of $10.66 per share. In 1995, the Company called for redemption the remaining outstanding Debentures at a redemption price of 101.60% of the principal amount of the Debentures, plus accrued interest thereon. All but $11 of such Debentures were converted into the Company's common stock by July 10, 1995. The remaining $11 in Debentures were redeemed. During fiscal 1994, $174 of Debentures were converted into 16,324 shares of the Company's Common Stock. During fiscal 1993, $9 of Debentures were converted into 842 shares of Common Stock.\nThe term loan of the Asian subsidiary is payable in equal monthly installments of $5, which include interest, to 1999. Interest is calculated at the Hong Kong prime rate plus 1\/2% (9.5% at September 30, 1995 and 8.25% at September 30, 1994).\nDuring fiscal 1995, the Company had a $10,000 unsecured revolving loan facility with interest at prime less 1\/4%, and an unused commitment fee equal to 1\/4 of 1% of the daily average unused amount of the revolving loan. Borrowings under this facility were subject to certain financial and other covenants, all of which were met as of September 30, 1995. There were no borrowings under this revolving loan facility during fiscal 1995.\nIn connection with the AFW acquisition, on September 14, 1995, the Company entered into a Restated Loan Agreement which extended its existing $10,000 revolving loan facility to March 29, 1996 (unless renewed) and established a new\nterm credit facility for borrowings of up to $50,000 to finance the AFW acquisition. Borrowings under the $50,000 term credit facility during the first 180 days bear interest at the LIBOR rate plus 50 basis points (6.4375% on October 2, 1995). If amounts borrowed under the term credit facility are not repaid by March 29, 1996, the loan automatically will be converted into a five- year term loan payable in equal monthly installments, plus accrued interest. If converted into a five-year term loan, the term credit facility would bear interest, at the Company's option, at 115 basis points over the five-year U.S. Treasury Securities rate or 100 basis points over LIBOR. The Restated Loan Agreement is unsecured and contains certain financial and other covenants including maintenance of tangible net worth not less than $55.0 million, working capital of not less than $35.0 million, a current ratio of not less than 1.25 to 1.0, a leverage ratio of not more than 1.75 to 1.0 and a fixed charge coverage ratio of not less than 2.0 to 1.0.\nOn October 2, 1995, the Company borrowed $15,033 under the term credit facility to fund the cash portion of the AFW purchase price. In addition, the Company issued promissory notes to certain selling shareholders of Circle \"S\" totaling $34,395, which are due on January 5, 1996, bear interest at the rate of 6.4375% per year, less costs (1% per year) of the letters of credit securing such notes, and are not prepayable without the consent of the holders.\nMaturities of long-term debt subsequent to September 30, 1995, (exclusive of the $49,428 borrowed in connection with the October 2, 1995 acquisition of AFW) are $60 in 1996, $60 in 1997, $60 in 1998 and $36 in 1999.\nInterest paid on the Company's debt obligations was $1,407, $2,171 and $2,202 in fiscal 1995, 1994, and 1993, respectively.\nNOTE 7: SHAREHOLDERS' EQUITY\nCommon Stock\nOn June 1, 1995, the Company declared a two-for-one split of its common stock which was distributed on July 28, 1995 to holders of record on July 17, 1995. All share and per share data in the accompanying consolidated financial statements have been adjusted to give effect to this stock split.\nStock Option Plans\nThe Company has three employee stock option plans for officers and key employees (the \"Employee Plans\") pursuant to which options may be granted at 100% of the market price of the Company's Common Stock on the date of grant. Options may no longer be granted under two of the plans. Options granted under the Employee Plans are exercisable at such dates as are determined in connection with their issuance, but not later than ten years after the date of grant.\nThe following summarizes all employee stock option activity for the three years ended September 30, 1995:\nThe Company also maintains a stock option plan for non-officer directors (the \"Director Plan\") pursuant to which options to purchase 5,000 shares of the Company's Common Stock at an exercise price of 100% of the market price on the date of grant are issued to each non-officer director each year. Options to purchase 103,000 shares at an average exercise price of $7.19 were outstanding at September 30, 1995. Options to purchase 16,000 shares are currently exercisable. Options to purchase 88,000 shares granted under the Director Plan were exercised during 1995.\nAt September 30, 1995, 2,818,000 shares of the Company's Common Stock were reserved for issuance in connection with the stock option plans.\nEmployee Stock Purchase Plan\nThrough March 31, 1995, the Company maintained an Employee Stock Purchase Plan which allowed employees to purchase the Company's Common Stock at 85% of the market value on the first or last day of the offering period, whichever was lower. On March 31, 1995, 119,016 shares were sold to employees at a price of $4.675 per share, pursuant to this plan. Effective April 1, 1995 this Plan was discontinued.\nNOTE 8: EMPLOYEE BENEFIT PLANS\nThe Company has a non-contributory defined benefit pension plan covering substantially all U.S. employees. The benefits for this plan are based on the employees' years of service and the employees' compensation during the three years before retirement. The Company's funding policy is consistent with the funding requirements of Federal law and regulations. Net pension cost for the U.S. plan comprises the following:\nThe Company's foreign subsidiaries have retirement plans that are integrated with and supplement the benefits provided by laws of the various countries. They are not required to report nor do they determine the actuarial present value of accumulated benefits or net assets available for plan benefits. The Company believes that these plans are substantially fully funded as to vested benefits.\nOn a consolidated basis, pension expense was $618, $465 and $284 in fiscal 1995, 1994 and 1993, respectively.\nThe Company has a 401(k) Employee Incentive Savings Plan. This plan allows for employee contributions and matching Company contributions in varying percentages not to exceed 15% of the employees's contribution. The Company's contributions under this plan were $118, $112 and $91 in fiscal 1995, 1994 and 1993, respectively.\nNOTE 9: INCOME TAXES\nThe provision for income taxes includes the following:\nUndistributed earnings of certain foreign subsidiaries for which taxes have not been provided approximate $46,192 at September 30, 1995. Such undistributed earnings are intended to be indefinitely reinvested in foreign operations.\nThe Company's Japanese subsidiary has $844 in net operating loss carryforwards expiring through fiscal 1997, which may be used to offset future taxable income in Japan.\nThe provision for income taxes differs from the amount computed by applying the statutory federal income tax rate as follows:\nDeferred taxes are determined based on the differences between the financial reporting and tax bases of assets and liabilities as measured by the current tax rates. The net deferred tax liability balance is attributable to the following cumulative temporary differences:\nThe remaining valuation allowance at September 30, 1995 is related to foreign net operating loss carryforwards scheduled to expire through the 1997 fiscal year. The net deferred tax asset at September 30, 1995 is included in other non-current assets.\nThe Company paid income taxes of $8,109, $1,019 and $74 in fiscal 1995, 1994 and 1993, respectively.\nNOTE 10: OTHER FINANCIAL DATA\nOn October 1, 1995, the Company entered into a Manufacturing License and Supply Agreement with Tokyo Seimitsu Co. Ltd. for the right to manufacture, use and distribute certain products. In connection with the signing of this agreement, the Company is discontinuing the manufacture of a similar product in its Israeli manufacturing facility.\nOn July 13, 1994, the Company acquired the business and certain assets of Assembly Technologies, an operating division of General Signal Corporation (\"AT\"), for a cash purchase price approximating $3,296, including transaction- related costs. AT manufactured and sold semiconductor assembly equipment, including automatic die attach machines, automatic dicing saws and related spare parts. The transaction was accounted for as a purchase. Accordingly, the acquired assets and results of operations of the AT business are included in the Company's consolidated financial statements from the date of the acquisition. The excess of the purchase price and transaction-related costs over the fair value of net assets acquired of $1,287 was charged to goodwill, is being amortized over a fifteen year period, and is included in other assets at September 30, 1995 and 1994, net of accumulated amortization.\nDuring fiscal 1993, the Company incurred approximately $1,125 in connection with a proposed acquisition. In September 1993, the Company announced that acquisition negotiations had been terminated and charged all costs associated with this failed transaction to other expense.\nAccrued expenses at September 30, 1995 and 1994 include $7,242 and $3,964, respectively, for accrued wages, incentives and vacations.\nMaintenance and repairs expense totaled $3,737, $3,027 and $2,503 for fiscal 1995, 1994 and 1993, respectively. Warranty and retrofit expense was $5,085, $1,354 and $661 for fiscal 1995, 1994 and 1993, respectively.\nNOTE 11 - OPERATIONS BY GEOGRAPHIC AREA\nPrior to its October 2, 1995 acquisition of AFW, the Company operated primarily in one industry segment, the manufacture and sale of production equipment to the semiconductor industry. As a result of the AFW acquisition, the portion of the Company's operations attributable to the expendable tools and materials products will exceed 10% of total revenues. The expendable tools and materials products have different manufacturing processes, distribution channels and a less volatile revenue pattern than the Company's capital equipment business. As such, prospectively, the Company will report its operations in two business segments, its equipment business (sales of capital equipment, related spare parts and services) and its expendable tools and materials business (which will include the Micro-Swiss and AFW operations).\nThe Company's market for its products is worldwide. Export sales (sales from U.S. based operations directly to foreign based customers and sales to foreign locations of U.S. based customers) totaled $78,435, $48,082 and $40,364 for the fiscal years ended September 30, 1995, 1994 and 1993, respectively. Of these amounts, approximately $68,072, $39,506 and $36,313 in fiscal 1995, 1994 and 1993, respectively, were shipped to customers in the Asia\/Pacific region (primarily Korea and the Philippines). The remainder of the Company's exports were shipped to customers in the European region.\nIn addition, a substantial portion of the Company's products are sold to the Company's foreign subsidiaries which, in turn, sell to foreign based customers. Total shipments of the Company's products with ultimate foreign destinations (including export sales) accounted for 78%, 74% and 78% of net revenues during the fiscal years ended September 30, 1995, 1994 and 1993.\nAdditional information by geographic area for fiscal years ended September 30, 1995, 1994 and 1993 is as follows:\nTransfers between geographic areas are primarily sales of finished products and spare parts and generally are priced at end customer selling price, with intercompany commissions paid to the selling subsidiary in the case of machines, and at a discount off list price in the case of spare parts. Such sales were primarily from the United States to the Company's sales and service operations in Hong Kong, Japan and Europe, and from Israel to the United States. Operating income (loss) by geographic area does not include an allocation of general corporate expenses. Identifiable assets are those that can be directly associated with a particular geographic area. Corporate assets consist principally of cash and investments.\nCustomers for the Company's equipment and systems include major merchant semiconductor manufacturers. Sales to one such customer represented 11% and 16% of the Company's net sales in fiscal 1994 and 1993, respectively Sales to another such customer represented 20% of net sales in fiscal 1995 and 11% of net sales in each of fiscal 1994 and 1993. In addition, customers for the Company's equipment include firms that perform contract assembly of semiconductors, and electronic systems suppliers that assemble semiconductors for use in their own products and for sales to other companies. Sales to one such customer accounted for approximately 16% and 14% of the Company's net sales in fiscal 1995 and 1994, respectively. Sales to another such customer accounted for 11% of net sales in fiscal 1993.\nNet exchange and transaction gains (losses) were ($281), $267 and $138 for the years ended September 30, 1995, 1994 and 1993, respectively.\nNOTE 12: CONTINGENCIES\nCertain of the Company's customers have received notices of infringement from two separate parties, each alleging that equipment supplied by the Company, and processes performed by such equipment, infringe on patents held by them. The Company's product warranties generally provide customers with indemnification for damages sustained by a customer as a consequence of patent infringement claims arising out of use of the Company's products and obligate the Company to defend such claims. As a consequence, the Company could be required to reimburse its customers for certain damages resulting from these matters and to defend customers in patent infringement suits. As of the date of these financial statements, no actions have been initiated or threatened directly against the Company in connection with these matters, although certain customers have requested that the Company defend and indemnify them against any damages that they may be required to pay on the basis of their use of equipment supplied by the Company and two of the Company's customers have actually been sued. The Company believes, based in part on opinions from the Company's outside patent counsel, that no equipment marketed by the Company, and no process performed by such equipment, infringe on the patents in question.\nIn addition, In August 1995, a third-party complaint was filed against the Company with respect to the clean up of alleged contaminated soil and ground water beneath a facility located in Fort Washington, Pennsylvania, which the Company partially occupied from 1962 to 1972. On the basis of the complaint and information currently available to it, the Company is unable to quantify the potential financial impact of this matter, but believes the allegations set forth in the complaint are without merit and intends to vigorously defend itself in this matter.\nThe Company does not believe that the ultimate resolution of the matters described above will have a material adverse effect on its financial condition, operating results or liquidity.\nNOTE 13: SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)\nFinancial information pertaining to quarterly results of operations follows:\n* Represents net sales less costs and expenses but before net interest expense and other expense.\nNOTE 14: SUBSEQUENT EVENT (UNAUDITED)\nEffective December 31, 1995, the benefits under the Company's pension plan were frozen. As a consequence, accrued benefits will no longer change as a result of an employee's length of service or compensation. In addition, commencing January 1, 1996, the Company will increase the employer's matching contribution percentage to the 401(k) Employee Incentive Savings Plan to varying rates, depending on employee age and years of service, ranging from 30% to 175% of the employees' contributions.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nOn March 30, 1995, the Company dismissed Luboshitz, Kasierer & Co., certifying accountant for the Company's wholly-owned subsidiary, Kulicke and Soffa Industries (Israel) Ltd. (\"KSL\"). On the same date, the Company appointed Price Waterhouse LLP's Israeli affiliate, Somekh Chaikin, as the certifying accountant for KSL. This change in certifying accountants was made solely in order to consolidate all audit and tax services with one worldwide accounting firm. This event was reported as Item 4 on a Form 8-K dated March 30, 1995, and filed with the Securities and Exchange Commission on April 5, 1995.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nInformation required hereunder with respect to the directors appears under the heading \"ELECTION OF DIRECTORS\" in the Company's Proxy Statement for the 1996 Annual Meeting, which information is incorporated herein by reference.\nThe information required by Item 401(b) of Regulation S-K appears in Part I hereof under the heading \"Executive Officers of the Company.\"\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required hereunder appears under the heading \"ADDITIONAL INFORMATION\" in the Company's Proxy Statement for the 1996 Annual Meeting, which information is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required hereunder appears on page one and under the heading \"ELECTION OF DIRECTORS\" in the Company's Proxy Statement for the 1996 Annual Meeting, which information is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required hereunder appears under the heading \"ADDITIONAL INFORMATION\" in the Company's Proxy Statement for the 1996 Annual Meeting, which information is incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) The following documents are filed as part of 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 Number Item - ------ ---------------------------------------------------------------- Item [S] [C] 3(i) The Company's Restated Articles of Incorporation, filed as Exhibit 2.1 to the Company's Form 8-A12G dated September 8, 1995, is incorporated herein by reference.\n3(ii) The Company's By-Laws, as amended through June 26, 1990, filed as Exhibit 2.2 to the Company's Form 8-A12G dated September 8, 1995, is incorporated herein by reference.\n10(i) Form of Officer's Loan Agreement, Note and Stock Pledge Agreement, filed as Exhibit 13(a) to Registration Statement No. 65612 filed September 28, 1979, is incorporated herein by reference.\n10(ii) Form of Termination of Employment Agreement between the Company and certain of its officers, filed as Exhibit 10(ii) to the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 1994, is incorporated herein by reference.*\n10(iii) Agreement between the Company and Frederick W. Kulicke, Jr., filed as Exhibit 10(iii) to Company's Annual Report on Form 10-K for the year ended September 30, 1989, is incorporated herein by reference.*\n10(iv) The Company's 1980 Employee Incentive Stock Option Plan, filed as Exhibit 10(iv) to the Company's Annual Report on Form 10-K for the year ended September 30, 1989, is incorporated herein by reference.*\n10(v) The Company's 1983 Employee Incentive Stock Option Plan, filed as Exhibit 10(v) to the Company's Annual Report on Form 10-K for the year ended September 30, 1989, is incorporated herein by reference.*\n10(vi) The Company's 1988 Incentive and Non-Qualified Employee Stock Option Plan, filed as Exhibit 10(xi) to the\nCompany's Annual Report on Form 10-K for the year ended September 30, 1988, is incorporated herein by reference.*\n10(vii) The Company's 1988 Non-Qualified Stock Option Plan for Non-Officer Directors, as amended, filed as Exhibit 10(vii) to the Company's Annual Report on Form 10-K for the year ended September 30, 1989, is incorporated herein by reference.*\n10(viii)The Company's 1994 Employee Stock Option Plan, filed as Exhibit 10(viii) to the Company's Annual Report on Form 10-K for the year ended September 30, 1994, is incorporated by reference.*\n10(ix) The Company's 1995 Executive Incentive Compensation Plan, filed as Exhibit 10(ix) to the Company's Annual Report on Form 10-K for the year ended September 30, 1994, is incorporated by reference.*\n10(x) Restated Loan Agreement between the Company and Midlantic Bank, N.A. dated September 14, 1995, filed as Exhibit 10.1 to the Company's Form 8- K dated September 14, 1994, is incorporated by reference.\n10(xi) Letter agreement between the Company and Midlantic Bank N.A. dated November 27, 1995.\n10(xii) Gold Supply Agreement, as amended October 2, 1995 between American Fine Wire Corporation, et al, and Rothschild Australia Limited, filed as Exhibit 10.1 to the Company's From 8-K dated September 14, 1995 as amended by Form 8-K\/A on October 26, 1995, is incorporated by reference.\n10(xiii)Agreement of Employment between Circle \"S\" Industries, Inc and Larry D. Striplin, Jr. dated January 2, 1990.*\n10(xiv) Amendment No. 1 to Agreement of Employment between Circle \"S\" Industries, Inc. and Larry D. Striplin, Jr dated May 1, 1995.*\n10(xv) Agreement between Circle \"S\" Industries, Inc. and Larry D. Striplin, Jr. dated September 30, 1995.*\n10(xvi) Form of Employment Agreement between Circle \"S\" Industries, Inc. and R. Kelly Payne dated October 2, 1995.*\n21 Subsidiaries of the Company.\n23(i) Consent of Price Waterhouse LLP (Independent Accountants).\n23(ii) Consent of Luboshitz, Kasierer & Co. (Independent Accountants).\n27 Financial Data Schedule. - -------------------- * Indicates a management contract or compensatory plan. (b) Reports on Form 8-K\nA Form 8-K was filed on September 14, 1995 reporting the signing of the AFW Acquisition agreements.\nREPORT OF INDEPENDENT ACCOUNTANTS ---------------------------------\nOur audits of the consolidated financial statements of Kulicke and Soffa (Israel) Ltd. and its subsidiary referred to in our report dated November 3, 1994 appearing on Page of this Annual Report on Form 10-K also included an audit of Financial Statement Schedules of Kulicke and Soffa (Israel) Ltd. and its subsidiary (not presented separately herein). In our opinion, these Financial Statement Schedules of Kulicke and Soffa (Israel) Ltd. and its subsidiary present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.\n\/s\/ LUBOSHITZ, KASIERER & CO.\nCertified Public Accountants (Israel) Haifa, Israel\nNovember 3, 1994 (9393-24)\nKULICKE AND SOFFA INDUSTRIES, INC. Schedule VIII-Valuation and Qualifying Accounts (in thousands)\n(1) Bad debts written off. (2) Amount includes $677 provision for excess and obsolete inventory. The remainder primarily reflects revaluation of inventory pursuant to changed standard costs. (3) Disposal of excess and obsolete equipment and sales of demonstration and evaluation inventory. (4) Net change in valuation allowance for deferred tax assets during fiscal 1994 and 1995. (5) Amount includes $2,758 provision for excess and obsolete inventory. The remainder primarily reflects revaluation of inventory pursuant to changed standard costs.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nKULICKE and SOFFA INDUSTRIES, INC.\nBy: \/s\/ C. Scott Kulicke --------------------------- C. Scott Kulicke Chairman of the Board and Chief Executive Officer\nDated: December 21, 1995\nPursuant to the requirements of Section 13 or 15(d) 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.\nNOTICE\nItem 14(a)3 lists and describes the Exhibits filed as a part of the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 1995. The Company will provide to any shareholder copies of any such Exhibits upon payment of a fee of $.50 per page. Requests for copies of such Exhibits should be made to: Director of Corporate Communications, Kulicke and Soffa Industries, Inc., 2101 Blair Mill Road, Willow Grove, PA 19090.","section_15":""}
{"filename":"107889_1995.txt","cik":"107889","year":"1995","section_1":"ITEM 1 -- BUSINESS\n(A) GENERAL DEVELOPMENT OF BUSINESS\nThe Company is a global manufacturer and marketer of specialty chemical and petroleum products for use in a wide variety of industrial and consumer applications. Most of the Company's products are sold to industrial customers for use as additives and intermediates which impart particular characteristics to such customers' end products. Established in 1920, at December 31, 1995, the Company had 8,053 employees worldwide.\nThe Company's operations are divided between three business segments: Chemical, OSi Specialties and Petroleum which are described in Section (c) below.\nIn 1992, the Company completed the acquisition of the Industrial Chemicals and Natural Substances divisions of Schering AG Berlin (the 'Schering Acquisition'). As a result of the acquisition, the Company's international presence expanded with the addition of a large chemical manufacturing base in Germany and operations in Spain, the United Kingdom, France and Italy.\nOn October 19, 1995, Witco completed the acquisition of OSi Specialties Holding Company ('OSi Specialties' or 'OSi'), an entity engaged in the manufacture of silicone surfactants, amine catalysts, organofunctional silanes and specialty fluids and the operation of manufacturing and blending facilities in West Virginia, Europe, South America and Asia.\nIn 1995, the Company completed the disposition of its Battery Parts and Carbon Black operations. These dispositions completed the Company's previously announced plan to dispose of all of the businesses of the Company's Diversified Products segment.\nIn September 1995, the Company announced its intention to dispose of all of the businesses in the Lubricants portion of its Petroleum segment. The Company anticipates completing this disposition by mid-1996.\nWitco Corporation was incorporated in 1958 under the laws of Delaware as Witco Chemical Company, Inc., at which time it succeeded by merger to the business of Witco Chemical Company, an Illinois corporation formed in 1920. Its executive offices are located at One American Lane, Greenwich, Connecticut 06831-2559, telephone (203) 552-2000.\n(B) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS\nReference is made to Note 15 of Notes to Financial Statements. See Item 8 -- Financial Statements and Supplementary Data following Part IV of this report.\n(C) NARRATIVE DESCRIPTION OF BUSINESS\nThe Company's operations are divided between three business segments: Chemical, OSi Specialties and Petroleum Products.\nChemical Products\nOleochemicals\/Surfactants\nWitco offers one of the broadest lines of surfactants and oleochemicals in the chemical industry, providing 'one-stop shopping' for its customers on a global basis. These products are sold to a range of industries, including cosmetics and pharmaceuticals; personal care, soap and detergent; agricultural; rubber; food; paint and protective coatings; and textile. Surfactants change the surface tension of liquids. They include agricultural emulsifiers, which are used to break up pesticides into small particles, thereby increasing dispersion and improving penetration, and food emulsifiers, which impart particular characteristics (such as consistency) to certain foods. In addition, surfactants are used in personal care products, fabric softeners, and detergents to improve penetration and cleaning capability. These products complement those offered by the Petroleum Specialties Group of the Company's Petroleum\nProducts segment in this area. Oleochemicals are derived from natural fats and oils, and include fatty acids, fatty amines, esters and glycerines. Oleochemicals modify surfaces either as direct lubricants, or as components of ingredients that modify surfaces. Examples of their diverse applications include acting as lubricants in plastics; imparting mold release features for the rubber industry; and acting as curing systems for rubber. The Company is a worldwide producer of cationic and amphoteric surfactant products. These materials are major ingredients in fabric softener, hair conditioner and other personal care products.\nPolymer Additives\nWitco is a worldwide supplier of additives and catalysts for the polymer industry. It manufactures stabilizers, lubricants, plasticizers, and peroxide catalysts used in the manufacture of polyvinyl chloride (PVC) resin for such applications as pipes, fittings, siding and packaging materials. The Company is also a supplier of lubricants, antioxidants, and peroxide catalysts to polyolefin\/polystyrene manufacturers. These resins are used extensively in a broad spectrum of applications ranging from packaging film to small appliance housings. The Company is a European producer of aluminum alkyls, used as co- catalysts in the production of polyolefins (including polyethylene and polypropylene, which are among the world's largest volume plastics used in packaging, cars, furniture, and appliances) and produces organotin compounds for the production of PVC stabilizers and biocides for marine paints.\nResins\nThe Resins Group, based in Germany, serves Witco's diverse global customer base for polyurethane intermediates, coatings, and epoxy resins and hardeners. It encompasses Witco's U.S.-based polyurethane intermediates businesses and epoxy resins, hardeners and polyurethanes manufacturing and marketing operations in the U.K., France, Germany, Italy, and Denmark.\nWitco has been developing water-based polyurethanes to replace higher volatile organic compound solvent-based systems. This has increased the number of new products and Witco's market share among multi-product customers. Witco is conducting an effort to develop technical applications for these products in new markets. Examples include new water-based textile coatings and a patented dimethyl pyrazol (DMP) polyurethane for anti-corrosive coatings developed in the U.K., polyurethane systems for footwear developed in France for manufacturers in Asia and South America, low-fogging polyesters for the European and Asian markets, water-based epoxy resins and hardeners and polyurethane dispersions worldwide.\nWorldwide, footwear, adhesives, and coatings are believed to offer significant new business potential for customers with both epoxy resin and polyurethane needs. To meet these needs, Witco is investing in capacity expansions at plants worldwide.\nCustomers\nThe Company markets its specialty chemical products directly through its own sales force and through an organized distribution program to more than 6,000 customers in the United States and more than 80 foreign countries operating in a broad range of industries. Its chemical business is not dependent upon any single customer or a few customers. During the year ended December 31, 1995, no customer accounted for more than 4 1\/2% of Chemical Segment sales, and sales to the ten largest customers accounted for approximately 15% of Chemical Segment sales.\nCompetition\nCompetition in the Company's specialty chemicals business is based primarily on product consistency, quality and performance, customer service, and the technological resources necessary to develop and deliver new products that meet customer needs. Several factors constitute barriers to entry for new participants in many of the Company's markets: the need to make significant capital and research and development expenditures; the need for an extensive distribution network; the high level of expertise needed to solve technical problems for customers; manufacturing and product formulation\nknowledge; the lengthy product development process and customers' general aversion to contracting with unproven suppliers of specialty chemical products. Competition is fragmented, with no one competitor offering products across all of the Company's chemical product lines.\nOSi Specialties\nOSi Specialties, a wholly-owned subsidiary of the Company acquired in October 1995, manufactures and sells over 500 silicone-based chemical intermediate products to manufacturers of fiberglass, reinforced plastics, polyurethane foam, textiles, coatings, automotives, adhesives, rubber, pharmaceuticals, thermoplastics, sealants and agricultural, electrical and personal care products throughout the world. In 1958, OSi invented the use of silicone surfactants in the manufacture of urethane foam. This fundamental technological advance facilitated a lower-cost, continuous manufacturing method, resulting in accelerated growth in the urethane foam industry. OSi was also a pioneer in the silanes industry, and was instrumental in developing key technology for the reinforcement of plastics.\nRegardless of form, most silicones share a combination of properties, including electrical resistance, ability to maintain performance across a broad range of temperatures, resistance to aging, water repellence, lubricating characteristics and relative chemical and physiological inertness. The versatility of silicone-based intermediates has led to a wide variety of applications across a broad spectrum of industries in all major countries. Examples of OSi's products include catalysts, surfactants, coupling agents, process aids and other silicone-based specialty chemicals. Catalysts promote the process of urethane foam and polymer formation. Surfactants promote the mixing of reactants, control cell size and stabilize urethane foam. Surfactants also serve as wetting agents in a broad spectrum of applications and are used in personal care products (hair conditioning) and coatings (for flow control and leveling). Coupling agents bond inorganic and organic materials and enhance the physical, mechanical and adhesion properties of a variety of products, including fiberglass, sealants, rubber and coatings. Process aides include foam control agents, which inhibit foam formation or reduce foam in such diverse applications as antacid tablets, fountain soda and pulp and paper processing.\nRaw Materials\nThe principal raw materials for the OSi Specialties Segment's products are trichlorosilane, polyether fluids and dimethyl siloxane hydrolyzate. The Segment purchases, in the aggregate, more than 50% of its raw materials from Dow Corning Corporation and Union Carbide Corporation under various long-term agreements expiring from 1998 to 2000. The Segment purchases other raw materials from a variety of domestic and international suppliers, and these products are readily available from other suppliers.\nCustomers\nThe Company markets its OSi Specialties products through direct distribution using a trained sales force, and through distributor sales in the United States and foreign locations. Since the acquisition, no customer accounted for more than 14.2% of OSi Specialties Segment sales, and sales to the ten largest customers accounted for approximately 38.8% of OSi Specialties Segment sales.\nCompetition\nThe OSi Specialties Segment faces relatively few direct silicone competitors. Competition is based primarily on product consistency, quality and performance, customer service and the technological resources necessary to develop and deliver new products that meet customer needs. Several factors constitute barriers to entry in many of the OSi Specialties Segment's markets: the need to make significant capital and research and development expenditures; the need for an extensive distribution network; the high level of expertise needed to solve technical problems for customers; manufacturing and product formulation knowledge; and the lengthy product development process and customers' general aversion to contracting with unproven suppliers of specialty chemical products.\nPetroleum Products\nPetroleum Specialties\nWitco is an important manufacturer and marketer of white mineral oils, petrolatums, refrigeration oils and telecommunication cable filling compounds, as well as natural and synthetic petroleum sulfonates. White mineral oils and petrolatums are extensively refined, high purity petroleum products suitable for food grade, pharmaceutical and cosmetic applications. They are inert and non-reactive, and impart emolliency, moisture resistance, lubrication and insulation properties. These products are marketed in coordination with the Oleochemicals\/Surfactants Group of the Company's Chemical Segment. In addition to personal care and food applications, white mineral oils and petrolatums are used in plastics, agriculture, textiles and chemical processing. Petroleum sulfonates are oil soluble, surface active agents derived from both synthetic and natural petroleum feedstocks. They provide properties of emulsification, dispersion, wetting of solids, and rust and corrosion inhibition, and are used in lubricant additives and metalworking fluids. The Company is also a supplier of fully refined, FDA-quality microcrystalline waxes, which are primarily used in paper lamination and packaging applications including cheese coatings.\nLubricants\nThe Company produces motor oils and lubricants which it sells under the Kendall and Amalie brand names. Kendall and Amalie brand products are sold worldwide through a network of over 300 warehouse distributors. Kendall and Amalie brand products are also sold directly to large national accounts domestically. In addition, Witco is the largest domestic private label grease manufacturer and markets Lubrimatic brand products and lubricating equipment directly to its customers. Witco is also a supplier of specialty naphthenic oils, which are marketed to the rubber, plastics, ink and agricultural industries, and asphalt and specialty road and surface treatment products, which are sold primarily for highway construction and maintenance. In September 1995, Witco announced its intention to divest its Lubricants Group. Results of its Lubricants Group are currently reported as discontinued operations.\nCustomers\nThe Company's petroleum products are marketed directly through its own sales force and through distributors and agents. During the year ended December 31, 1995, no customer accounted for more than 7% of continuing Petroleum Segment sales, and sales to the ten largest customers accounted for approximately 27% of continuing Petroleum Segment sales.\nCompetition\nMany of the specialty petroleum products produced by Witco, like its specialty chemical products, are characterized by a need for a high degree of manufacturing competence and technical service. The petroleum products market is highly competitive with the Company's products competing primarily on the basis of pricing, quality and service. The Company believes its technical expertise, reputation for quality products, and, in the case of consumer products, brand name recognition, give it advantages in the marketplace.\nInternational Operations\nSales of Witco's continuing non-U.S. operations were $787.6 million, or 40% of total sales for continuing operations, for the year ended December 31, 1995. Witco's manufacturing and producing operations outside the United States are in Belgium, Brazil, Canada, Denmark, England, France, Germany, Hong Kong, Indonesia, Israel, Italy, Korea, Malaysia, Mexico, the Netherlands, Spain and Thailand.\nPatents and Trademarks\nThe Company owns and controls patents, trade secrets, trademarks, trade names, copyrights and confidential information, which in the aggregate are of material importance to its business. However, the Company is not materially dependent upon any single patent or trademark. The Company's trademarks are registered in the United States and in a number of foreign countries, with terms of registration expiring generally between 1996 and 2006. The Company also has approximately 1,400 patents and applications worldwide related to its continuing operations. The Company intends to renew and maintain in a timely manner those trademarks and patents that are renewable and maintainable and are deemed important to its business.\nBacklog\nThe nature of the Company's business is such that customer orders are usually filled within 30 days. Accordingly, backlog is not significant to the Company's business.\nResearch and Development\nThe Company is actively engaged in research and development programs designed to develop new products, manufacturing processes, systems and technologies to enhance existing products and processes. The Company believes its investments in research and development have been an important factor in establishing and maintaining its competitive position. Witco expended approximately $52.9 million in 1995, $40.7 million in 1994 and $40.3 million in 1993 on research and development of new products and services for its continuing operations, and for improvements and new applications of existing products and services for its continuing operations.\nEnvironmental Matters\nThe industries in which Witco operates have experienced increased operating costs and capital investments due to statutes and regulations at the federal, state and local levels for the protection of the environment and the health and safety of employees and others. Witco believes that expenditures for compliance with these statutes and regulations will continue to have a significant impact upon the conduct of its business. The trend for greater environmental awareness and more stringent environmental regulations is likely to continue and while Witco cannot accurately predict how this trend will affect future operations and earnings, Witco does not believe its costs will vary significantly from those of its competitors in the chemical and petroleum industries.\nThe Company evaluates and reviews environmental reserves for future remediation and other costs on a quarterly basis to determine appropriate reserve amounts. Inherent in this process are considerable uncertainties which affect the Company's ability to estimate the ultimate costs of remediation efforts. Such uncertainties include the nature and extent of contamination at each site, evolving governmental standards regarding remediation requirements, the number and financial condition of other potentially responsible parties at multi-party sites, innovations in remediation and restoration technology, and the identification of additional environmental sites.\nEnvironmental reserves related to continuing operations at December 31, 1995 amounted to $83.6 million, which reflects management's assessment of future remediation costs in light of currently available information. Remediation expenditures charged to those reserves were $13.7 million in 1995 and include expenditures currently mandated as well as those not required by any regulatory authority or third party. The Company anticipates 1996 expenditures to approximate $24.0 million.\nCapital expenditures related to continuing operations for air, water and solid waste control equipment and facilities related to continuing operations amounted to $8.9 million in 1995. The Company estimates that approximately $20.0 million will be expended on similar capital projects in 1996.\nThe Company is continuing its efforts to reduce hazardous waste and emissions generated by its operations. Through improved operating efficiencies, installation of additional environmental control equipment and utilization of the latest innovations in waste treatment technology, management believes\nthat direct recurring operating costs associated with managing hazardous substances and pollution can be controlled. Such costs related to continuing operations amounted to $28.2 million in 1995.\n(D) FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND EXPORT SALES\nWitco's foreign subsidiaries generally manufacture products similar to the principal products manufactured domestically. Subsidiaries in the Netherlands and Canada manufacture petroleum specialty products; subsidiaries in Belgium, Brazil, Canada, Denmark, England, France, Germany, Israel, Italy, Mexico and Spain manufacture chemical products. In early 1996, the Company acquired a resins manufacturing plant in Singapore.\nIn accord with normal market conditions, sales made outside the United States are generally made on longer terms of payment than would be normal within the United States. Foreign operations are subject to certain risks inherent in carrying on international business, including currency devaluations and controls, export and import restrictions, inflationary factors, product supply, economic controls, nationalization and expropriation. The likelihood of such occurrences varies from country to country and is not predictable. However, the Company's primary foreign operations are based in Western Europe, Canada, and other stable areas, and, therefore, the Company does not believe these risks will have a significant impact upon the Company.\nReference is made to Note 15 of Notes to Financial Statements. See Item 8 -- Financial Statements and Supplementary Data following Part IV of this report.\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2 -- PROPERTIES\nWitco currently conducts its manufacturing operations for its continuing businesses in 51 manufacturing plants and other producing facilities, owned in fee or occupied under lease, of which 21 are in the United States and 30 in other countries. Of these facilities, 33 are utilized for Chemical product manufacturing; 10 are utilized for OSi Specialties product manufacturing; and 8 are utilized for Petroleum product manufacturing. All of the facilities are in good operating condition.\nPRINCIPAL MANUFACTURING PLANTS AND OTHER IMPORTANT PHYSICAL PROPERTIES RELATED TO CONTINUING OPERATIONS -- LOCATIONS BY INDUSTRY SEGMENT (OWNED IN FEE EXCEPT WHERE PARENTHETICAL DATES REFER TO LEASE EXPIRATION)\nCHEMICAL SEGMENT FACILITIES United States Santa Fe Springs, California* Blue Island, Illinois Chicago, Illinois Mapleton, Illinois -- 2 Plants Harahan, Louisiana Taft, Louisiana Brainards, New Jersey* Newark, New Jersey* Perth Amboy, New Jersey Brooklyn, New York Memphis, Tennessee Fort Worth, Texas Houston, Texas LaPorte, Texas Marshall, Texas Janesville, Wisconsin International Brantford, Canada Montreal, Canada Oakville, Canada Soro, Denmark (2005) Accrington, England Droitwich, England Flimby, England Elbeuf, France St. Amour, France Bergkamen, Germany (2091) Steinau, Germany Haifa, Israel Gambolo, Italy Cuatitlan, Mexico Singapore Granollers, Spain\nOSI SPECIALTIES SEGMENT FACILITIES\nUnited States Sistersville, West Virginia\nInternational\nZwijndrecht, Belgium Itatiba, Brazil Termoli, Italy\nPETROLEUM SEGMENT FACILITIES\nUnited States Gretna, Louisiana Petrolia, Pennsylvania Trainer, Pennsylvania International Scarborough, Canada (1996) West Hill, Canada Amsterdam, the Netherlands Haarlem, the Netherlands Koog Aan De Zaan, the Netherlands\n- ------------\n* Manufacturing plants to be closed in 1996 and 1997 as a part of the Company's plant consolidation program.\nOTHER FACILITIES\nUnited States Greenwich, Connecticut (2014) Los Angeles, California (2001) Tarrytown, New York (1997) Oakland, New Jersey Dublin, Ohio Houston, Texas (1996) S. Charleston, West Virginia (1997) Danbury, Connecticut (2000)\nWorld Headquarters -- Principal Executive, Administrative and Sales Office\nAdministrative and Sales Office Research Research Research Administrative and Research Administrative and Research Administrative Office International Paris, France (1999) Frankfurt, Germany (1997) Singapore (1999) Meyrin, Switzerland (2007) Administrative and Sales Office Principal European Executive and Administrative Office Administrative and Research Administrative and Research\nIn addition, OSi Specialties operates producing and other facilities in Mexico, Korea, Hong Kong, Malaysia, Thailand and Indonesia.\nITEM 3","section_3":"ITEM 3 -- LEGAL PROCEEDINGS\nThe Company has been notified that it is a potentially responsible party ('PRP') or a defendant in a number of governmental (federal, state, and local) and private actions associated with the release, or suspected release, of contaminants into the environment. As a PRP, the Company may be liable for costs associated with the investigation and remediation of environmental contamination, as well as various penalties, and damages to persons, property and natural resources. As of December 31, 1995, the Company was a PRP, or a defendant, in connection with 67 sites at which it is likely to incur costs associated with environmental investigation or remedial actions which have been or will be executed pursuant to the Comprehensive Environmental Response Compensation and Liability Act ('CERCLA'), the Resource Conservation and Recovery Act ('RCRA'), or similar state or local laws. With 22 exceptions, all of these sites involve one or more PRPs, and in most cases, there are numerous other PRPs in addition to the Company. CERCLA, RCRA, and the state counterparts to these federal laws, authorize governments to investigate and remediate actual or suspected damage to the environment caused by the release or suspected release of hazardous substances into the environment, or to order the responsible parties to investigate and\/or remediate such environmental damage.\nThe Company evaluates and reviews environmental reserves for future remediation and other costs on a quarterly basis to determine appropriate reserve amounts. Inherent in this process are considerable uncertainties which affect the Company's ability to estimate the ultimate costs of remediation efforts. Such uncertainties include the nature and extent of contamination at each site, evolving governmental standards regarding remediation requirements, changes in environmental regulations, widely varying costs of alternative cleanup methods, the number and financial condition of other potentially responsible parties at multi-party sites, innovations in remediation and restoration technology, and the identification of additional environmental sites.\nThe Company has numerous insurance policies which it believes provide coverage at various levels for environmental liabilities. The Company is currently in litigation with certain of its insurers concerning the applicability and amount of insurance coverage for environmental costs under certain of these policies. Except for amounts reflected in executed settlement agreements, no provision for recovery under any of these policies is included in the Company's financial statements.\nThe Company is a party to a Consent Decree with the United States Environmental Protection Agency ('EPA') and the United States Department of Justice ('DOJ') filed with the District Court,\nEastern District of California, on June 7, 1995. The Consent Decree settles certain litigation related to the Company's Oildale, California refinery operated by its Lubricants Group. Pursuant to the Consent Decree, the Company must construct a new wastewater recycling system at the refinery, which system must be operational by June 30, 1998, must operate for 10 years, and must recycle at least 75% of the total annualized process and storm water in the first year of operation, at least 78% in the second year and at least 82% in the third year and thereafter. The Company must also close the deep injection wells at the refinery by June 30, 1998, although the Company may keep one deep injection well operational past this date (but in no event beyond June 30, 2002) under certain circumstances specified in the Consent Decree. The Consent Decree also requires the Company to perform certain groundwater monitoring and site characterization work at the refinery (including some work off-site at the Chevron property adjacent to the refinery) and to submit to EPA Region IX the Company's recommendations for future site characterization and remediation, if any, deemed necessary as a result of the initial site characterization efforts. The Consent Decree also requires the Company to take certain additional actions at the refinery, some of which have previously been completed, and to report semi-annually to EPA and DOJ its progress with respect to design, construction and operation of the wastewater recycling system.\nThe Company is a defendant in three similar actions pending in California state courts, which arise out of the Company's involvement in the polybutylene resin manufacturing business in the 1970's: East Bay Municipal Utility District v. Mobil Oil Co., et al., filed in November 1993, and pending in Superior Court for the County of San Mateo; City of Santa Maria v. Shell Oil Co., et al.; filed in May 1994, and pending in Superior Court for the County of San Luis Obispo; and Nipomo Community Services District v. Shell Oil Co., et al.; filed in May 1995, and pending in Superior Court for the County of San Luis Obispo. The actions generally allege that the Company and several other defendants negligently misrepresented the performance of polybutylene pipe and fittings installed in water distribution systems. Other allegations include breach of warranty, fraud, strict liability and breach of the California Unfair Practices Act.\nOn November 3, 1995, the United States filed suit against the Company in United States District Court for the Central District of Illinois seeking up to $4.5 million in civil penalties for the alleged discharge of pollutants in violation of the Clean Water Act. In this action, the United States alleges that, at various times from 1990 to 1993, the Company discharged pollutants into the Illinois River from its Mapleton, Illinois facility without first obtaining a National Pollutant Discharge Elimination System Permit.\nThe Company is not a party to any legal proceedings, including environmental matters, which it believes will have a material adverse effect on its consolidated financial position. However, depending on the amount and timing of an unfavorable resolution of these contingencies, it is possible that the Company's future results of operations could be materially affected in a particular period.\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 ended December 31, 1995.\nEXECUTIVE OFFICERS OF THE COMPANY\nThe following sets forth information regarding executive officers of the Company as of February 29, 1996, and is included in Part I in accordance with Instruction 3 of Item 401(b) of Regulation S-K.\n(table continued on next page)\n(table continued from previous page)\nPART II\nITEM 5","section_5":"ITEM 5 -- MARKET FOR THE COMPANY'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS\nWitco's Common Stock is listed on the New York Stock Exchange. The following table reflects the high and low sales prices, as reported on such exchange for each quarterly period during the past two years:\nThe approximate number of holders of record of the Company's Common Stock as of February 29, 1996, was .\nDividends on the Common Stock have been declared quarterly during the past two years as follows:\nITEM 6","section_6":"ITEM 6 -- SELECTED FINANCIAL DATA\nThe data for this item are submitted as a separate section following Part IV of this report.\nITEM 7","section_7":"ITEM 7 -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe data for this item are submitted as a separate section following Part IV of this report.\nITEM 8","section_7A":"","section_8":"ITEM 8 -- FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe consolidated financial statements and supplementary data of the Company and its subsidiaries are included in a separate section following Part IV 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\nDIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS\n(a) Identification of Directors\nReference is made to pages 3 through 6 of the Proxy Statement to be filed pursuant to Regulation 14A no later than March 31, 1996.\n(b) Identification of Executive Officers\nReference is made to Part I of this Form 10-K.\n(c) Business Experience\nReference is made to pages 3 through 6 of the Proxy Statement to be filed pursuant to Regulation 14A no later than March 31, 1996 and Part I of this Form 10-K.\nCOMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT\nReference is made to page 6 of the Proxy Statement to be filed pursuant to Regulation 14A no later than March 31, 1996.\nITEM 11","section_11":"ITEM 11 -- EXECUTIVE COMPENSATION\nReference is made to the information set forth under the captions 'Compensation of Directors' and 'Executive Compensation' on pages 10 through 15 of the Proxy Statement to be filed pursuant to Regulation 14A no later than March 31, 1996.\nITEM 12","section_12":"ITEM 12 -- SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nFor information with respect to beneficial ownership of the Company's voting securities, and rights thereto, reference is made to the information set forth under the captions 'Ownership of Securities by Directors and Officers' and 'Security Ownership of Certain Beneficial Owners' on pages 7 and 8 of the Proxy Statement to be filed pursuant to Regulation 14A no later than March 31, 1996.\nITEM 13","section_13":"ITEM 13 -- CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\n(a) Transactions with Management and Others\nReference is made to the information set forth under the caption 'Compensation of Directors' on page 10 of the Proxy Statement to be filed pursuant to Regulation 14A no later than March 31, 1996.\n(b) Certain Business Relationships\nReference is made to the information set forth under the captions 'Other Transactions' on page 9 and 'Compensation Committee Interlocks and Insider Participation' on page 15 of the Proxy Statement to be filed pursuant to Regulation 14A no later than March 31, 1996.\nPART IV\nITEM 14","section_14":"ITEM 14 -- EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) 1 and 2 -- The response to this portion of Item 14 is submitted as a separate section of this report.\n(a) 3 -- Exhibits:\n(b) Reports on Form 8-K.\n(i) A report on Form 8-K dated October 31, 1995, as amended by a report on Form 8-K\/A dated December 20, 1995, was filed during the quarter ended December 31, 1995, responding to Items 2 and 5 in connection with the Company's completion of the acquisition of OSi Specialties Holding Company.\n(ii) A report on Form 8-K dated December 20, 1995, was filed during the quarter ended December 31, 1995, responding to Item 7 filing the historical and pro forma financial statements required by that Item as a result of the Company's acquisition of OSi Specialties Holding Company.\n(c) The Exhibits filed with this report are listed in response to Item 14(a)3.\n(d) The response to this portion of Item 14 is submitted as a separate section of this report.\n- ------------\n(1) This Exhibit was included as an exhibit to the quarterly report on Form 10-Q for the quarter ended March 31, 1994, and such Exhibit is hereby incorporated by reference.\n(footnotes continued on next page)\n(footnotes continued from previous page)\n(2) This Exhibit was included as an exhibit to the Registration Statement on Form 8A filed with the Securities and Exchange Commission on March 3, 1995, and such Exhibit is hereby incorporated by reference.\n(3) This Exhibit was included as Exhibit 2(a) to Form 8-K filed with the Securities and Exchange Commission on September 25, 1995, and such Exhibit is hereby incorporated by reference.\n(4) This Exhibit was included as Exhibit 2(c) to Form 8-K filed with the Securities and Exchange Commission on October 31, 1995, and such Exhibit is hereby incorporated by reference.\n(5) The 1986 Stock Option Plan, as amended, was filed as an Exhibit to the Registration Statement on Form S-8, registration number 33-10715, Post-Effective Amendment No. 1 to Form S-8 effective October 3, 1988, and Post-Effective Amendment No. 2 to Form S-8 effective June 23, 1992. Such Exhibit is incorporated herein by reference.\n(6) The 1989 Stock Option Plan was filed as an Exhibit to the Registration Statement on Form S-8, registration number 33-30995 effective October 2, 1989, and Post-Effective Amendment No. 1 to Form S-8 effective June 23, 1992, and such Exhibit is hereby incorporated by reference.\n(7) The 1992 Stock Option Plan was filed as an Exhibit to the Registration Statement on Form S-8, registration number 33-48806, effective June 23, 1992, and such Exhibit is hereby incorporated by reference.\n(8) This Exhibit was included as an exhibit to the annual report on Form 10-K for the fiscal year ended December 31, 1992, and such Exhibit is hereby incorporated by reference.\n(9) This Exhibit was included as an exhibit to the annual report on Form 10-K for the fiscal year ended December 31, 1994, and such Exhibit is hereby incorporated by reference.\n(10) The Power of Attorney appears on the Signature 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 on the 20th day of March, 1996.\nWITCO CORPORATION\nBy \/s\/ WILLIAM R. TOLLER ................................... WILLIAM R. TOLLER CHAIRMAN OF THE BOARD AND CHIEF EXECUTIVE OFFICER\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints WILLIAM R. TOLLER, WILLIAM E. MAHONEY, MICHAEL D. FULLWOOD, OR DUSTAN E. MCCOY, acting severally, 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 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, or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nSCHEDULE II\nWITCO CORPORATION AND SUBSIDIARY COMPANIES VALUATION AND QUALIFYING ACCOUNTS (THOUSANDS OF DOLLARS)\n- ------------\nNotes:\n(a) Amount principally consists of the allowance for doubtful accounts of $2.2 million from the Lubricants Group, which is reflected on the balance sheet as net assets of discontinued operations.\n(b) Uncollectible receivables charged against the allowance provided.\nS-1","section_15":""}
{"filename":"770506_1995.txt","cik":"770506","year":"1995","section_1":"ITEM 1. DESCRIPTION OF BUSINESS. -----------------------\nGeneral - -------\nHealthplex, Inc. (the \"Company\" or \"Healthplex\") is a Delaware corporation and the successor by merger of Dentshield, Inc., a New York corporation organized on March 26, 1981. The Company's address is Nassau West Corporate Center I, 60 Charles Lindbergh Boulevard, Uniondale, New York 11553 and its telephone number there is (516) 794-3000.\nThe Company renders marketing, claims processing, electronic data processing, printing and related services to Dentcare Delivery Systems, Inc. (\"Dentcare\"), a dental health company, and operates a second plan through a wholly-owned subsidiary, International Healthcare Services, Inc. (\"IHS\" and together with Dentcare, the \"Plans\"). The Company also provides administrative services to certain unaffiliated dental plans on an \"administrative services only\" basis.\nThe Company's wholly-owned subsidiary, OASYS. Corporation, develops document imaging systems, including hardware and software components, and markets these systems to hospitals, insurance companies and small businesses. O.A.SYS. derives revenues from consulting fees, software development fees and from dealer margins resulting from resales of imaging hardware equipment manufactured by third-party vendors.\nA significant portion of the Company's revenues are derived from its service arrangement with Dentcare and from the Company's operation of IHS. The Company renders consulting, data systems, claims processing, marketing, printing and other services to the Plans pursuant to Service Agreements between the Company and each of the Plans. The Company's Service Agreement with Dentcare provides for compensation to the Company based upon various fee components designed to allocate reasonably the various costs of providing services. The fee may not exceed that permitted by applicable law. See \"Government-Regulation - General.\" Service fee income is generally determined as a percentage of premium income of the related Plan. The Company is responsible for collection of bills and accounts receivable, establishing and maintaining records and books of accounts, processing and payment of claims, marketing, preparation of annual budgets (including setting forth major operating objectives, anticipated revenues, expenses, cash flow and capital expenditures), management of all purchases and leases of equipment (with delegated authority to commit for purchases or leases of up to $5,000), obtaining general liability insurance, review of employee benefit plans, design and implementation of utilization programs and cost control measures, professionalism and quality control systems,\nbanking, contract negotiations and overall responsibility for administrative functions.\nEach Service Agreement is for a term of three years and is automatically renewable for additional one-year periods upon notice given two years in advance. Dentcare may terminate the Service Agreement by furnishing written notice thereof to the Company on or before the anniversary date of the Service Agreement. Such termination would be effective two years after the applicable anniversary date. The Service Agreements may be terminated by either party, among other reasons, for cause upon 60 days prior written notice.\nThe Service Agreement with Dentcare ends automatically if Dentcare's authority to operate a dental health service program is terminated and ends on 15 days' written notice if the parties determine that their best interests cannot be served by modifications to the Service Agreement required by the applicable State Insurance Department.\nThe Company also derives premium revenues from the pre-paid dental plan operations of its wholly-owned subsidiary, IHS.\nThe Company also provides administrative services, primarily claims processing and related electronic data processing services, to unaffiliated dental plans. The administrative services only business enables the Company to utilize the excess capacity of its electronic data processing capabilities. The Company typically charges a per claim handling fee for processing these claims. The administrative services only business is attractive since the Company is not subject to the same risks which exist in those instances where the Company's affiliates undertake an underwriting risk in providing fee-for-service or capitation programs.\nELECTRONIC DATA PROCESSING SERVICES\nAs an integral part of its services, the Company renders information and image processing services to its Plans and to unaffiliated businesses. The Company's EDP functions are provided in-house with a Data General 6240 Series Computer with 128 megabytes of memory and over 16 billion bytes of disk space. The Company has developed its own software using an SQL Fourth Generation Language and an Oracle Database. Over 60 terminals are in use with unlimited expansion capabilities. The Company also utilizes an Oasys document imaging system with PC workstations and a Hewlett-Packard 144 disk optical autochanger.\nMARKETING\nThe Company markets its services through its own employees and through marketing arrangements with third parties. The Company's marketing efforts traditionally have entailed convincing groups to switch from existing dental plans to those\nof the Plans or convincing groups to join a dental plan. This marketing effort involves a two-tier process in which the Company must first convince a group to contract with a Plan to make plan participation available to the members of the group and, if this external marketing is achieved, the Company must then convince potential subscribers and enrollees to participate in the Plan. These marketing efforts typically involve significant marketing costs incurred over a period of several months prior to realization of revenues derived from such efforts.\nTHE PLANS - GENERAL\nDentcare is a New York not-for-profit corporation. Pursuant to its charter and by-laws, Dentcare has no stockholders or members as such. IHS is a New Jersey for profit business corporation and is wholly-owned by Healthplex.\nDentcare is authorized to furnish health expense indemnity under Article 43 of the New York Insurance Law, and provides prepaid dental insurance programs and fee-for-service programs to groups and to individuals in New York State. Under a prepaid plan, the dentist is compensated on the basis of the number of enrolled patients, regardless of the extent of services performed. Under a fee-for-service, or indemnity program, the dentist is paid fees for the performance of various dental procedures. Dentcare's primary service area consists of New York City and surrounding counties.\nIHS is authorized by the New Jersey Department of Insurance to act as a \"dental plan organization\" in the State of New Jersey. IHS provides prepaid dental plans to groups and individuals and is a wholly-owned subsidiary of the Company. As such, the financial statements of the Company contained elsewhere herein include the consolidated statements of IHS.\nAt March 15, 1996, Dentcare and IHS had 83,445 and 24,197 members, respectively, and the Company serviced 85,320 members on an administrative service only basis.\nPREPAID PLANS\nUnder the prepaid dental plans of both Dentcare and IHS, monthly premiums are collected on behalf of Dentcare and IHS from the groups and are paid to participating dentists, or providers, after deduction of expenses paid by Dentcare or IHS or charged by the Company in accordance with its Service Agreement. Such payments to the provider are commonly referred to as capitation fees. Under the Company's capitation fee program, the capitation fee is a fixed monthly fee based only on the number of subscribers enrolled with a particular provider without regard to the number of patient visits or types of work performed. The Company believes that the capitation fee concept provides significant incentive for providers to practice preventive dentistry. If the provider actively improves the dental health\nof his patients, the provider's work load decreases, thereby improving the provider's profitability and margins.\nSpecialized dental services, such as orthodontics, endodontics, periodontics and oral surgery are provided through specialists with whom the Company contracts on behalf of the Plan.\nDentcare and IHS offer several different plans for subscribers, principally groups such as unions, associations, school systems, law enforcement agencies, municipalities and pension benefit organizations. As of March 15, 1996, Dentcare had 1,274 subscribing groups and IHS had 949 subscribing groups for prepaid dental plan programs.\nUnder the prepaid plans of Dentcare and IHS there is no pre- enrollment examination of the enrollee. The plans accept the existing condition of each of the subscribers and their dependents. There are no deductible amounts prior to coverage under the plan, maximum limitations on coverage(s) provided under the plan contract or pre-authorizations as commonly required by indemnity insurance carriers for treatment. In addition, neither the provider, group nor subscriber is burdened with submitting insurance claim forms.\nThe Dentcare and IHS form of group dental agreements do not cover fixed and removable prosthetic devices and orthodontic services. However, Dentcare and IHS offer prosthetic and orthodontic service options to groups through providers and specialists with whom the applicable plan contracts, up to dollar amounts specified in the individual plan. The standard arrangement generally requires subscribers to share in the cost of such services.\nFEE-FOR-SERVICE PLAN\nDentcare is authorized to provide fee-for-service dental plans in New York.\nUnder the fee-for-service dental plan operating in New York, enrollees are entitled to reimbursement for certain dental procedures performed based upon a specified schedule of fees for services. Enrollees are entitled to select dentists of their choice and are not restricted to providers participating in Company managed plans.\nUnder its fee-for-service plans, Dentcare reimburses for all types of dental services based upon specified schedules of fees for services and the Company provides claims processing services to facilitate reimbursement for services performed. Fee schedules are provided to each subscriber with the subscriber's plan contract. The schedules are filed with the New York Insurance Department. Such schedules are subject to change at such time as a subscriber's contract is renewed. The Company undertakes all responsibility for claims processing and professional review of claims presented for payment on behalf of Dentcare and Garden State.\nPROVIDERS\nNeither the Company, Dentcare nor IHS engages in the practice of dentistry, providing of professional dental services or the operation of dental offices or facilities. Dental services are provided by practicing dentists, providers, who enter into participating dentist agreements with Dentcare or IHS. Under the standard participation agreement, the participating dentist represents that he or she is a duly licensed dentist, has professional malpractice liability insurance, agrees to provide necessary dental services to enrollees and agrees not to differentiate or discriminate in treatment of patients by reason of their status as enrollees. The providers are compensated on a monthly basis by payment of a capitation fee per enrollee equal to proceeds of dental premiums less administrative expenses and costs for specialty dental services.\nThe providers furnish dental services to enrollees at their own dental facilities and may continue to treat their own patients on a fee-for-service basis. The providers are regulated by the Boards of Dental Examiners of their respective states of practice.\nQUALITY ASSURANCE PROCEDURES\nDentcare and IHS each has a Professional Standards Committee (\"Standards Committee\"), which is responsible for reviewing the quality, appropriateness and costs of dental care delivered by the providers to the enrollees. Each Standards Committee is composed of several participating providers. The Committee reviews the adequacy of the physical facilities, staffing and equipment of each provider office. Prior to entering into a contractual relationship with any provider, the Company determines whether the potential provider has adequate education, appropriate board certification by the applicable Board of Dental Examiners and proper licensing. See \"Government Regulation.\" The Plans do not accept providers who have had their licenses suspended or revoked. The Committee also inspects the potential provider facility to determine whether the facility, staffing and equipment comply with minimum standards. A random sample of the provider's dental records are reviewed to assure that records are comprehensive and complete. The Committee performs periodic dental audits and surveys of selected providers to determine the quality and dollar value of care rendered by the provider to the enrollees. The audits are based on review of patient dental records and utilization and service reports. The results of the dental audits are furnished to the provider in reports that describe the scope of the review, problems and deficiencies, suggestions for corrective actions and notification of reaudits to determine the effectiveness of corrective actions which are to be implemented by the Plan and\/or the provider.\nThe Committee reviews the utilization of certain services by the subscriber in relationship to the premium fees in order to\nevaluate the adequacy of the capitation fees paid to the provider and whether the services provided are being rendered in an efficient and cost effective manner. The providers are required to maintain utilization statistics of services rendered to the Plans' enrollees which reports are collected on a monthly basis.\nRules and regulations under the applicable New York and New Jersey statutes require internal review of dental care delivered to the consumer. The procedures described above are believed by Management to be adequate to insure the quality and control of dental services. Management also believes that the quality assurance procedures which are set forth hereinabove are in compliance with the statutes, rules and regulations which will govern the prepaid fee-for-service dental plans which are intended to be affiliated with and organized by the Company in the future.\nGOVERNMENT REGULATION\nPrepaid dental plans and fee-for-service dental plans are subject to statutes, rules and regulations in each state in which a plan operates.\nThe applicable rules and regulations of New York and New Jersey provide specific limitations on the dollar amount of expenditures which the Company may charge its Plans for service and other fees. The balance of premiums must be remitted to the provider, as capitation fees or fees for specific procedures.\nUnder Article 43 of the New York Insurance Law, a dental expense indemnity corporation such as Dentcare may not disburse for all expenses other than benefit payments more than 20% for the first $1,000,000 of annual premiums, declining by 1% for each additional $5,000,000 or fraction thereof of additional premiums to 15%.\nUnder the New Jersey Dental Plan Organization Act, IHS may expend up to 20% of its income for general expenses, acquisition expenses and miscellaneous taxes, licenses and fees.\nThe marketing, management, advertising, legal, accounting and general administrative expenses charged by Healthplex to its Plans will be included in the various expense limitations described above.\nIn addition to regulation of the Company's business and proposed operations by statutes regulating prepaid dental plans and fee-for-service dental plans, the practice of dentistry in the United States is regulated by state statutes, rules and regulations of state dental boards and voluntary associations. In New York and New Jersey, respective Boards of Dental Examiners regulate all dentists licensed to practice dentistry. Complaints lodged against dentists regarding fitness to practice dentistry\nare subject to review by the Board of Dental Examiners. These Boards are authorized to withdraw a dentist's license if it deems such action to be appropriate. Guidelines are also established for dentists in connection with the manner in which they must operate and advertise dental facilities.\nApplicable regulations provide that a dentist can be denied the right to act as a provider of dental services if the dentist fails to meet the requisite standards pursuant to applicable regulations and rules.\nINSURANCE COVERAGE\nProviders who contract with a Plan are required to maintain malpractice insurance which provides coverage per individual claim in an amount not less than $100,000 per person and $300,000 per year. In Management's opinion this insurance coverage will be sufficient to cover potential claims in light of the nature of the services performed. Directors and officers of the Company are covered by directors' and officers' indemnification insurance. The Company also maintains customary casualty and liability insurance.\nCOMPETITION\nManagement believes that its largest competitors are traditional insurance carriers, including Aetna Life Insurance and Annuity Company, Metropolitan Life Insurance Co., The Prudential Insurance Company of America, The Guardian and Connecticut General Insurance Company Corp.\nManagement believes that most dental insurance coverage in New York and New Jersey, as well as in the rest of the United States, is provided through indemnity insurance. To date, such dental insurance coverage has obtained substantially greater market penetration than prepaid dental plans and is sponsored by major insurance companies which have greater financial and other resources than the Company. The Company believes that its prepaid dental plans provide several advantages over traditional indemnity or fee-for-service insurance programs.\nManagement believes that dental patients generally pay less through prepaid dental plans than through indemnity insurance companies since fee-for-service insurance, as customarily provided by insurance carriers, generally has monetary limits on its coverage and deductible amounts prior to coverage. In addition, Management believes that private dentists' charges are generally higher than the co-payments charged by plan providers.\nThe Plans may also compete with health maintenance organizations (\"HMOs\") which include dental plans. In the New York and New Jersey areas, U.S. Healthcare, Oxford and PruCare are currently offering prepaid dental plans. There is no assurance that the prepaid and fee-for-service dental plans of\nthe Plans will obtain general market acceptance with consumers, or that prepaid and fee-for-service dental plans will be able successfully to compete against large commercial insurance carriers.\nEMPLOYEES\nAs of December 31, 1995, the Company had 53 full-time and 11 part-time employees. Seven employees are engaged in electronic data process services, five in managerial positions, three in marketing and 38 in general, administrative and support positions. The employees of the Company are not subject to collective bargaining and the Company does not have a profit sharing or retirement plan for employees. The Company believes its labor relations are good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. DESCRIPTION OF PROPERTY. -----------------------\nThe Company leases approximately 10,168 square feet of executive and administrative offices in Uniondale, New York. The lease expires on January 31, 2003. The base annual rent is $230,952.00, plus real estate taxes, for the rental year ended January 31, 1996, with an increase of 4% each rental year thereafter during the term of the lease.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS. -----------------\nThere are no material pending legal proceedings, other than ordinary routine litigation incidental to the business, to which the Company or any of its subsidiaries is a party or by which any of their properties is subject.\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 1995 to a vote of security holders.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER -------------------------------------------------------------- MATTERS. --------\nThe Company's Common Stock is traded in the over-the-counter market under the National Association of Securities Dealers Automated Quotation System (\"NASDAQ\") under the symbol HPLX. The following table sets forth the high and low bid prices in the NASDAQ system for the Common Stock for each calendar quarter indicated, as reported by NASDAQ. The prices represent quotations between dealers and do not include certain mark-ups, mark-downs or commissions, and do not necessarily represent actual transactions.\nCommon Stock ------------ High Low ---- --- Calendar 1994 - -------------\nFirst quarter 3 1 7\/8 Second quarter 4 1 3\/4 Third quarter 2 1\/2 1 3\/4 Fourth quarter 2 1 1\/16\nCommon Stock ------------ High Low ---- --- Calendar 1995 - ------------- First quarter 1 9\/32 1 Second quarter 1 1\/2 7\/8 Third quarter 1 11\/16 1 1\/16 Fourth quarter 1 1\/8 3\/4\nBased upon information provided by the Company's transfer agent, as of March 15, 1996, the Company had 128 stockholders of record. The Company believes that there are in excess of 500 beneficial holders of the Company's Common Stock.\nThe Company has paid no dividends to date and it does not anticipate paying dividends in the foreseeable future. It is expected that the Company will retain earnings, if any, to finance the development and expansion of its business.\nITEM 6.","section_6":"ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND --------------------------------------------------------------- RESULTS OF OPERATIONS. ---------------------\nFor The Years Ended December 31, 1995 and 1994 - ----------------------------------------------\nRESULTS OF OPERATIONS - ---------------------\nNet income decreased to $70,926 during 1995 as compared to $91,128 during 1994. Gross margins increased 2.8% or $99,054 to $3,667,501 during 1995 as compared to $3,568,447 during 1994. Contributing to this increase in gross margin was an increase in administrative service income of $139,961 resulting from the fruition of continuing marketing efforts to obtain new administrative business. Gross margins from service revenues decreased to 55.5% during 1995 from 55.0% during 1994. Gross margins from premium income decreased to 16.8% during 1995 from 17.4% during 1994, primarily as a result of increased claims utilization.\nThe Company recognized interest and dividend income of $120,533 during 1995 as compared to $109,668 during 1994,resulting from the Company's decision to commit a greater portion of its cash in short-term investments over the last two years.\nLIABILITY AND CAPITAL RESOURCES - -------------------------------\nDuring 1995, the Company had a decrease in cash and cash equivalents of $33,291. Operating activities accounted for a $259,541 increase in cash and $4,996 was provided by a decrease in short-term investments. These increases were offset by, among other things, repayment of $132,217 of long-term bank debt and the purchase of fixed assets of $163,242.\nITEM 7.","section_7":"ITEM 7. FINANCIAL STATEMENTS. --------------------\nLIBERO & KAPPEL CERTIFIED PUBLIC ACCOUNTANTS 57 OLD COUNTRY ROAD WESTBURY, NY 11590 (516) 333-5511\nINDEPENDENT AUDITOR'S REPORT ----------------------------\nTo the Board of Directors and Stockholders of Healthplex, Inc. 60 Charles Lindbergh Boulevard Uniondale, New York 11553\nWe have audited the consolidated balance sheets of Healthplex, Inc. and Subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations, 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 audited standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as 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 statement referred to above present fairly, in all material respects, the consolidated financial position of Healthplex, Inc. and Subsidiaries as of December 31, 1995 and 1994, and the results of their operations and their cash flows for the years then ended in conformity with generally accepted accounting principles.\nLibero & Kappel\nWestbury, New York March 20, 1996\nHEALTHPLEX, INC. & SUBSIDIARIES - ------------------------------- CONSOLIDATED BALANCE SHEETS - --------------------------- AS OF DECEMBER 31, 1995 AND 1994 - --------------------------------\nASSETS 1995 1994 - ------ --------- ---------\nCurrent assets: - --------------- Cash and cash equivalents $ 440,989 $ 474,280 Investments-available for sale (note 5) 691,509 621,049 Accounts receivable 426,459 349,128 Note receivable - current portion (note 17,050 26,916 4) Other receivables 22,933 19,717 Prepaid expenses 0 5,861 --------- --------- Total current assets 1,598,940 1,496,951\nFixed assets, net of depreciation 867,890 758,715 (notes 2 & 3) Note receivable - less current portion 77,533 73,054 (note 4) Investments-available for sale (note 5) 758,243 722,516 Security deposits 24,138 16,382 Goodwill, less accumulated amortization of $10,832 in 1995 and $9,478 in 1994 16,251 17,605 Other assets 7,278 14,433 Loan to Dentcare Delivery Systems, Inc. 515,820 515,820 (note 10) --------- --------- $ 3,866,093 $ 3,615,476\nLIABILITIES AND STOCKHOLDERS' EQUITY - ------------------------------------\nCurrent liabilities: - -------------------- Accounts payable $ 437,126 $ 387,847 Current portion of capitalized lease 140,391 107,697 obligations (note 6) Accrued expenses and taxes 179,462 184,569 Due to Dentcare Delivery Systems, Inc. 134,199 120,110 Federal Income tax payable (notes 2 & 7) 35,748 52,291 --------- --------- Total current liabilities 926,926 852,514\nCapitalized lease obligations, less 160,104 161,546 current portion (note 6) Deferred Federal income tax payable 37,941 42,403 (notes 2 & 7) --------- --------- Total liabilities 1,124,971 1,056,463\nCommitments and Contingencies (note 8)\nStockholders' equity: Common stock $.001 par value, authorized 20,000,000 shares; issued & outstanding 3,586,682 in 1995 and 1994 3,587 3,587 Paid-in capital 1,971,328 1,971,328\nUnrealized gain (loss) on investments- 39,249 (71,934) available for sale Retained earnings 726,958 656,032 --------- --------- Total stockholders' equity 2,741,122 2,559,013 --------- --------- $ 3,866,093 $ 3,615,476 --------- --------- --------- ---------\nThe accompanying notes are an integral part of the financial statements.\nHEALTHPLEX, INC. & SUBSIDIARIES - ------------------------------- CONSOLIDATED STATEMENTS OF OPERATIONS - ------------------------------------- FOR THE YEARS ENDED DECEMBER 31, 1995 AND 1994 - ----------------------------------------------\nRevenues 1995 1994 - -------- ---------- ---------- Service fee income (note 10)$ 2,253,903 2,284,035 Administrative service income 2,222,163 2,082,202 ---------- ---------- Total service fee income 4,476,066 4,366,237 Premium income 6,801,010 6,238,706 Sales-computer services 79,564 109,265 ---------- ---------- Total revenues 11,356,640 10,714,208 ---------- ----------\nCost of Revenues - ---------------- Direct expenses - related to service fees 1,991,921 1,919,604 Dental expenses - related to premium income 5,658,191 5,155,693 Cost of sales-computer services 39,027 70,464 ---------- ---------- 7,689,139 7,145,761 ---------- ---------- Gross Margin on Revenues 3,667,501 3,568,447 - ------------------------ ---------- ---------- Interest expense 39,293 32,061 Selling, general and administrative expense 3,649,267 3,439,447 ---------- ---------- 3,688,560 3,471,508 ---------- ---------- Income (loss) from operations (21,059) 96,939 Other income (expenses) (Loss) on sale of securities 0 (21,546) Dividend income 16,492 37,678 Interest income 104,041 71,990 Miscellaneous (7,155) (2,463) ---------- ---------- Income before income taxes 92,319 182,598 Provision for income taxes (notes 2 & 7) 21,393 91,470 ---------- ---------- Net income 70,926 91,128 ---------- ---------- ---------- ----------\nEarnings per share (note 2) Primary 0.02 0.03 ---------- ---------- ---------- ---------- Fully diluted 0.02 0.03 ---------- ---------- ---------- ---------- Weighted average number of shares of common stock outstanding Primary 3,586,682 3,586,682 ---------- ---------- ---------- ----------\nFully diluted 3,627,500 3,627,500 ---------- ---------- ---------- ----------\nThe accompanying notes are an integral part of the financial statements.\nHEALTHPLEX, INC. & SUBSIDIARIES - ------------------------------- CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY - -----------------------------------------------\nUnrealized Gain (Loss) Common Paid-In On Retained Stock Capital Investments Earnings Total ----- --------- ----------- -------- ---------- Bal., December 31, 1993 3,587 $ 1,971,328 $ 0 $ 564,904 $ 2,539,819 - -----------------------\nNet income for the year ended December 31, 1994 0 0 0 91,128 91,128\nUnrealized (loss) on investments available for sale 0 0 (71,934) 0 (71,934) ----- --------- -------- ------- ---------- Bal., December 31, 1994 3,587 1,971,328 (71,934) 656,032 2,559,013 - -----------------------\nNet income for the year ended December 31, 1995 0 0 0 70,926 70,926\nUnrealized gain on investments available for sale 0 0 111,183 0 111,183 ----- --------- -------- ------- ----------\nBal., December 31, 1995 $ 3,587 $ 1,971,328 39,249 $ 726,958 $ 2,741,122 - ----------------------- ----- --------- ------- ------- ---------- ----- --------- ------- ------- ----------\nThe accompanying notes are an integral part of the financial statements.\nHEALTHPLEX, INC. & SUBSIDIARIES - ------------------------------- CONSOLIDATED STATEMENTS OF CASH FLOWS - ------------------------------------- FOR THE YEARS ENDED DECEMBER 31, 1995 AND 1994 - ----------------------------------------------\n1995 1994 -------- -------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS\nCash flows from operating activities: Net income $ 70,926 $ 91,128 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization 218,890 247,762\n(Increase) decrease in: Accounts receivable (77,331) (7,718) Other receivables (3,216) (1,691) Due from plans 0 6,000 Prepaid expenses 5,861 6,055 Other assets 7,155 2,463 Increase (decrease) in: Accounts payable 49,279 (46,294) Accrued expenses and taxes (5,107) 126,711\nDue to Dentcare Delivery Systems, 14,089 (88,084) Inc. Federal income tax payable (16,543) 52,291 Deferred federal income tax payable (4,462) (5,797) -------- -------- Net cash provided by operating activities 259,541 382,826 -------- --------\nCash flows from investing activities: Security deposits (7,756) 22,000 Capital expenditures (163,242) (95,028) Sale of investments 4,996 17,006 Reduction of notes receivable 5,387 10,355 --------- -------- Net cash used in investing activities (160,615) (45,667)\nCash flows used in financing activities: Repayment of long-term debt (132,217) (107,697) --------- ---------\nNet increase (decrease) in cash (33,291) 229,462 Cash and cash equivalents at beginning of 474,280 244,818 year --------- --------- Cash and cash equivalents at end of year $ 440,989 $ 474,280 --------- ---------- --------- ----------\nSupplemental disclosures of cash flows\nCash paid during the year for: Interest $ 39,293 $ 32,061 --------- ---------- --------- ---------- Income taxes $ 51,560 $ 16,735 --------- ---------- --------- ----------\nSchedule of non-cash investing and financing transactions: Unrealized gain (loss) on investments $ 111,183 $ (71,934) available for sale ---------- ---------- ---------- ---------- Purchase of equipment with capitalized $ 163,470 $ 0 lease obligation ---------- ---------- ---------- ----------\nThe accompanying notes are an integral part of the financial statements.\nHEALTHPLEX, INC. & SUBSIDIARIES - ------------------------------- NOTES TO FINANCIAL STATEMENTS - -----------------------------\nNOTE 1: NATURE OF BUSINESS - --------------------------\nThe Company and its subsidiaries furnish marketing, claims processing, electronic data processing, printing, consulting and related services under an exclusive agreement with an affiliated dental health service corporation, Dentcare Delivery Systems, Inc. (\"Dentcare\"). The Company operates a second plan through a wholly-owned subsidiary, International Healthcare Services, Inc. (together, \"The Plans\"). The Company also provides services to other plans on an administrative services only basis. OASYS Corporation (OASYS) is a wholly-owned subsidiary that markets document imaging systems, including hardware and software components.\nMost of the Company's business activity is with customers located in New York and New Jersey. A significant portion of the revenues that the Company reports are derived from the Plans. The Company has entered into service agreements with the Plans, subject to provisions providing for annual renewal. The termination of the service agreements would have a material adverse effect on the business of the Company.\nNOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - --------------------------------------------------\nPrinciples of Consolidation --------------------------- The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries International Healthcare Services, Inc.; and OASYS Corporation. All intercompany transactions and accounts have been eliminated.\nCash and Cash Equivalents ------------------------- For purposes of the statements of cash flows, the Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.\nAllowance for Doubtful Accounts ------------------------------- The Company considers accounts receivable to be fully collectible; accordingly, no allowance for doubtful accounts is required.\nFixed Assets ------------ Property and equipment are carried at cost. Depreciation for financial reporting purposes is on a straight-line basis over the estimated useful lives of the assets.\nExpenditures representing maintenance and repairs are charged to operations as incurred. Major expenditures, renewals and betterments are capitalized and depreciated over their useful life. At the time properties are retired or otherwise disposed of, appropriate adjustments are made in property accounts and the gain or loss is reflected in operations.\nHEALTHPLEX, INC. & SUBSIDIARIES - ------------------------------- NOTES TO FINANCIAL STATEMENTS - -----------------------------\nNOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED - -------------------------------------------------------------\nRevenue Recognition ------------------- The Company derives revenues from the exclusive service agreements it has entered into with the plans. Under these agreements, the service fee revenue permitted to the Company is determined by applicable state law (a percentage of premium revenue of the applicable Plan). Premium income and administrative service income are recognized on an as billed basis according to the contracts with each group. Sales of computer services are recognized when the sale is made.\nIncome Taxes ------------ The provision for income taxes include federal and state taxes currently payable and deferred taxes arising from temporary differences between financial and tax accounting income. These temporary differences principally result from additional deductions available through the use of accelerated depreciation methods for income tax accounting purposes.\nEarnings Per Share ------------------ Primary earnings per share are computed based on the weighted average number of shares of common stock outstanding during each year.\nFully diluted earnings per share are computed based on an increased number of shares to be issued by the exercise of options.\nGoodwill -------- Goodwill represents the excess of the cost to acquire one of the Company's subsidiaries over the fair value of its net assets at acquisition and is being amortized over a twenty-year period. Amortization expense charged to operations was $1,354 in 1995 and 1994.\nConcentration of Credit Risk ---------------------------- Concentrations of credit risk with respect to accounts receivable are limited due to the large number of customers comprising the Company's customer base. The Company does not require collateral from its customers.\nThe Company maintains cash balances with several banks, which frequently exceed federally insured limits and invests its cash primarily in U.S. Government backed securities.\nMajor Customers --------------- The Company received more than 10% of its revenues from two customers that accounted for approximately $4,500,000 of revenue in 1995 and 1994. The Company has receivables of approximately $80,000 from one customer which represents more than 10% of the Company's total receivables in 1995 and 1994.\nHEALTHPLEX, INC. & SUBSIDIARIES - ------------------------------- NOTES TO FINANCIAL STATEMENTS - -----------------------------\nNOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED - -------------------------------------------------------------\nEstimates --------- 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.\nReclassification ---------------- Certain accounts relating to the prior year have been reclassified to conform to the current year presentation with no effect on previously reported net income. These reclassifications relate primarily to investments - available for sale and the corresponding equity component.\nNOTE 3: FIXED ASSETS - -------------------- 1995 1994 ---- ----\nFixed assets at December 31, consist of: Furniture, fixtures & equipment $ 1,094,516 $ 1,358,024 Capitalized leased equipment 969,465 805,995 Leasehold improvements 43,598 40,129 Leasehold 38,853 38,853 --------- --------- 2,146,432 2,243,001 Accumulated depreciation and amortization 1,278,542 1,484,286 --------- --------- $ 867,890 $ 758,715 --------- ---------\nThe annual depreciation rates used by the Company are as follows:\nFurniture, -fixtures & equipment 5 - 8 Years Capitalized leased equipment 8 Years Leasehold improvements 5 Years Leasehold 1 0 Years\nDepreciation and amortization expenses charged to operations was $218,890 and $247,762 in 1995 and 1994, respectively.\nHEALTHPLEX, INC. & SUBSIDIARIES - ------------------------------- NOTES TO FINANCIAL STATEMENTS - -----------------------------\nNOTE 4: NOTE RECEIVABLE - ----------------------- 1995 1994 -------- -------- Note receivable at December 31, consists of: Compu-Lan Inc. monthly payments of $2,000 including interest at 10 %, due August 1, 1999. $94,583 $99,970\nLess: current maturities 17,050 26,916 -------- -------- $77,533 $73,054 -------- -------- -------- --------\nNOTE 5: INVESTMENTS - -------------------\nInvestment securities consist of bond funds, governmental obligations and United States Treasury Notes with a maturity of more than three months when purchased.\nThe Company's investment securities are classified as \"available-for- sale\". Accordingly, unrealized gains and losses are excluded from earnings and reported in a separate component of stockholders' equity. Realized gains or losses are computed on specific identification of the securities sold.\nInvestment securities at December 31, consist of:\n1995 1994 ---------- -----------\nU.S. treasury notes $ 731,931 $ 652,930 Governmental obligation 76,359 69,586 Bond funds 641,462 621,049 ---------- ---------- $ 1,449,752 $ 1,343,565 ---------- ----------\nThe following is an analysis of investment securities available for sale\nBalance at amortized cost $ 1,410,503 $ 1,415,499 Gross unrealized gains 39,249 901 Gross unrealized losses 0 (72,835) --------- ----------- $ 1,449,752 $ 1,343,565 --------- -----------\nAll investments available for sale which are classified as current mature in 1996.\nHEALTHPLEX, INC. & SUBSIDIARIES - ------------------------------- NOTES TO FINANCIAL STATEMENTS - -----------------------------\nNOTE 6: LEASES - --------------\nThe Company leases executive and administrative office space and equipment under leases expiring at various dates through 2003. The Company has classified its lease of executive and administrative office space as an operating lease. This lease provides for an annual increase of 4% throughout the entire term of the lease.\nThe Company capitalized its equipment leases and depreciates them over the useful life of the assets. The corresponding lease obligations reflect the present value of the future rental payments, discounted at the interest rate implicit in the lease:\nFuture minimum lease payments for all leases at December 31, 1995 are as follows:\nYear Ended December 31, Operating Capital ---------------------- --------- -------- 1996 239,420 182,364 1997 248,996 112,938 1998 258,956 43,514 1999 269,315 43,514 2000 280,088 10,878 Subsequent years 607,211 0 ---------- ---------- Total minimum lease payments: $ 1,903,986 393,208\nLess amount representing interest 92,713 ---------\nPresent value of net minimum lease payments 300,495\nLess current portion of obligations under capital leases 140,391 ---------\nCapitalized lease obligations, less current portion $ 160,104 --------\nThe rent expense under the operating lease was $237,351 and $233,833 for the years ended December 31, 1995 and 1994, respectively.\nHEALTHPLEX, INC. & SUBSIDIARIES - ------------------------------- NOTES TO FINANCIAL STATEMENTS - -----------------------------\nNOTE 7: INCOME TAXES - --------------------\nThe provision for income taxes consisted of the following at December 31:\n1995 1994 ---- ----\nFederal Current $35,748 $64,116 Prior Year (32,955) 0 Deferred (4,462) (5,797) State Current 23,062 33,151 --------- --------- $ 21,393 $ 91,470 --------- ---------\nThe provision for income taxes varies from the federal statutory income tax rate due to the following at December 31,\n1995 1994 ---- ---- Federal statutory rate applied to pre-tax income 39.0% 39.0% State income taxes, net of federal tax benefit 19.5 11.1 Prior years over accrual (35.7) 0.0 Other 0.4 0.0 ------ ------ 23.2% 50.1% ------ -------\nNOTE 8: COMMITMENTS AND CONTINGENCIES - -------------------------------------\nOn October 3, 1984, the Company entered into employment agreements with Drs. Stephen J. Cuchel, Martin Kane, and Bruce H. Safran, each a founder, principal stockholder, executive officer and director of the Company. These agreements may be terminated by either party upon thirty days written notice. Pursuant to these agreements, Drs. Cuchel, Kane and Safran each devote substantially all of their time and efforts to the business of the Company.\nHEALTHPLEX, INC. & SUBSIDIARIES - ------------------------------- NOTES TO FINANCIAL STATEMENTS - -----------------------------\nNOTE 9: STOCK OPTIONS - ---------------------\n1985 Incentive Stock Option Plan --------------------------------\nOn April 1, 1985, the board of directors of the Company adopted an incentive stock option plan pursuant to Section 422A of the Internal Revenue Code. An aggregate of 300,000 shares of the Company's common stock have been reserved for issuance under the plan.\nThe following is a summary of transactions:\nShares Under Option ------------------- 1995 1994 ------ ------ Outstanding - beginning of year 32,818 32,818 Granted during the year 0 0 Canceled during the year 0 0 Exercised during the year 0 0 ------ ------ Outstanding - end of year 32,818 32,818 ====== ======\nAt December 31, 1995 and 1994, there were 32,818 and 32,818 shares, respectively, excercisable at a price of $.60156250 per share.\n1985 Non-Qualified Stock Option Plan ------------------------------------\nOn April 1, 1985, the Company adopted a non-qualified stock option plan. An aggregate of 100,000 shares of the Company's common stock have been reserved for issuance under this plan.\nThe following is a summary of transactions: Shares Under Option ------------------- 1995 1994 ----- ----- Outstanding - beginning of year 8,000 8,000 Granted during the year 0 0 Canceled during the year 0 0 Exercised during the year 0 0 -------- -------- Outstanding - end of year 8,000 8,000 ===== =====\nAt December 31, 1995 and 1994, there were 8,000 and 8,000 shares respectively, excercisable at a price of $.60156250 per share.\nHEALTHPLEX, INC. & SUBSIDIARIES - ------------------------------- NOTES TO FINANCIAL STATEMENTS - -----------------------------\nNOTE 9: STOCK OPTIONS, CONTINUED - --------------------------------\n1992 Stock Incentive Plan -------------------------\nOn April 17, 1992, the Company reserved 1,500,000 shares of its common stock to be used under this plan. Both incentive stock options and non-qualified stock options, as defined under section 422 of the Internal Revenue Code, may be issued under this plan.\nThe following is a summary of transactions:\nShares Under Plan ----------------- 1995 1994 ------- -------\nOutstanding - beginning of year 317,500 0 Granted during the year 317,500 317,500 Canceled during the year 317,500 0 Exercised during the year 0 0 --------- -------- Outstanding - end of year 317,500 317,500 ======= =======\nEligible, end of year for exercise currently at prices ranging from $1.089 to $1.1979 per share.\n1992 Director Stock Incentive Plan ----------------------------------\nOn April 17, 1992 the Company reserved 500,000 shares of its common stock to be used under this plan. Only non-qualified stock options as defined under section 422 of the Internal Revenue Code, may be issued under this plan.\nThe following is a summary of transactions: Share Under Plan ---------------- 1995 1994 ------ ------ Outstanding - beginning of year 55,000 0 Granted during the year 55,000 55,000 Canceled during the year 55,000 0 Exercised during the year 0 0 ------- ------- Outstanding - end of year 55,000 55,000 ====== ======\nEligible, end of year for exercise currently at a price of $1.089 per share.\nHEALTHPLEX, INC. & SUBSIDIARIES - ------------------------------- NOTES TO FINANCIAL STATEMENTS - -----------------------------\nNOTE 9: STOCK OPTIONS, CONTINUED - --------------------------------\nOn November 29, 1994 the Company granted an option to purchase 8,000 shares of the Company's common stock to a consultant to the Company. These options were canceled on November 28, 1995. The Company then granted an option to purchase 8,000 shares of the Company's common stock to the same consultant on November 28, 1995. These new options are exercisable at $1.089 per share and expire on November 27, 2005.\nNOTE 10: DENTCARE DELIVERY SYSTEMS. INC. - --------------------------------------- On June 26, 1990, the Company advanced $250,000 to Dentcare Delivery Systems, Inc. (Dentcare) as part of a loan of $561,377 with a stated interest rate of 10% per year. The remainder of the loan was advanced over the eighteen-month period subsequent to July 1, 1990 in equal quarterly installments of $51,896.17. In addition, the Company advanced additional funds aggregating $111,761 under the same terms during 1992. No amounts have been advanced to Dentcare since 1992. Payment of principal and\/or interest on the loan is subject to the approval of the Superintendent of Insurance of the State of New York and the availability of excess funds. Due to the uncertainty as to Insurance Department approval of payment of the interest, the Company has elected not to recognize any interest income in the financial statements at this time. Additionally, the Company expects to receive full payment of its loan to Dentcare Delivery Systems, Inc. As such, no allowance has been provided against this loan.\nIn February 1994, the New York State Insurance Department and Dentcare entered into an agreement which required Dentcare to seek reimbursement of certain expenses from the Company for expenses paid by Dentcare during 1985 and 1986, which were originally incorporated as part of the loan between the Company and Dentcare. The Insurance Department agreed that this reimbursement would be met by a reduction of the loan by the Company to Dentcare. On February 23, 1994, the Company and Dentcare agreed to this reimbursement.\nService fee income from this affiliate amounts to $2,253,903 and $2,284,035 in 1995 and 1994, respectively.\nNOTE 11: EMPLOYEE BENEFIT PLAN ------------------------------\nThe Company has adopted a 401 (K) plan which allows employees to defer a percentage of their wages. The plan requires the Company to match 25% of employee deferrals up to 5% of the employee's wages. The Company's matching contribution was approximately $8,000 in 1995 and $11,000 in 1994.\nHEALTHPLEX, INC. & SUBSIDIARIES - ------------------------------- NOTES TO FINANCIAL STATEMENTS - -----------------------------\nNOTE 12: FAIR VALUE- OF FINANCIAL INSTRUMENTS - ---------------------------------------------\nEstimated fair values of the Company's financial instruments are as follows at December 31:\n1995 1994 ---- ----\nCarrying Fair Carrying Fair Amount Value Amount Value ---------- ---------- ---------- ----------\nCash & short-term investments $ 1,102,498 $ 1,102,498 $ 1,095,329 $ 1,095,329\nReceivables 117,516 117,516 119,687 119,687\nLong-term investments 758,243 758,243 722,516 722,516\nCapitalized lease obligations 300,495 300,495 269,243 269,243\nThe fair value of financial instruments classified as current assets or liabilities approximate carrying value due to the short-term maturity of the investment. The fair value of receivables approximates market. For long-term investments, fair values are estimates based on quoted market prices. The fair value of capitalized lease obligations is based on current rates at which the Company could borrow funds with similar remaining maturities.\nThe fair value of the loan to Dentcare Delivery Systems, Inc. is not disclosed because it is not practicable to estimate its fair value (note 10).\nITEM 8.","section_7A":"","section_8":"ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND --------------------------------------------------------------- FINANCIAL DISCLOSURE. --------------------\nNone.\nPART III\nITEM 9.","section_9":"ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; ------------------------------------------------------------- COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT. -------------------------------------------------\nEach of the Directors serves from the date of his election until the next annual meeting of stockholders and until his successor is elected and qualified. Officers serve at the discretion of the Board of Directors.\nInformation concerning the executive officers and directors of the Company are set forth below:\nName Age Office Held ---- --- ----------- Stephen J. Cuchel 57 Chairman of the Board, Co-Chief Executive Officer and a Director\nMartin Kane 56 President, Co-Chief Executive Officer and a Director\nBruce H. Safran 46 Vice President, Secretary and a Director\nGeorge Kane 52 Vice President, Treasurer and a Director\nPhilip J. Rizzuto 52 Vice President, Management Information Systems and a Director\nDouglas L. King 54 a Director\nJohn Forte 53 Vice President and Chief Accounting Officer\nDr. Stephen J. Cuchel has been Chairman of the Board, Co-Chief Executive Officer and a Director of the Company for more than the past five years. He is a Director of IHS, President of the American Dental Research Foundation, a partner in a group dental practice with Drs. George Kane and Martin Kane, Assistant Professor at New York University Medical Center and a lecturer at C.W. Post Long Island University. He is a member of the 9th Dental Society, North Eastern Conference of Health, Welfare and Pension Plans. He is also a member of the board of directors of the Health Services Administration, Nassau and Suffolk counties. Dr. Cuchel received a B.S. from Union College in 1960\nand a D.D.S. from New York University College of Dentistry in 1964. He has also completed post-graduate training at New York Institute of Clinical Oral Pathology, and a residency at Long Island College Hospital in Anesthesiology and Dentistry for Handicapped Children.\nDr. Martin Kane has been President, Co-Chief Executive Officer and a Director of the Company for more than the past five years. He is also a Director of IHS. He, with Drs. George Kane and Stephen Cuchel, operate a group dental practice from four private offices in New York City and environs. Between 1964 and 1976 he and Dr. Cuchel established various dental offices in the New York metropolitan area. Dr. Kane received a B.S. from City College of New York in 1960 and a D.D.S. from New York University College of Dentistry in 1964. He is a member of the American Dental Association, SED Professional Fraternity for Continuing Education, Conference of Oral Medicine, North Eastern Conference of Health, Welfare and Pension Funds and is dental care adviser to Local 1125 Retail Menswear Union.\nDr. Bruce H. Safran has been a Secretary, Vice President and a Director ofthe Company for more than the past five years. His duties include professional relations and the marketing of image services. He is also President and a Director of IHS (having served since 1981). Dr. Safran is licensed to practice dentistry in New York and New Jersey, was a solo practitioner between 1974 and 1982 and occasionally serves as a dental consultant to private dental offices. Dr. Safran attended Ohio State University between 1967 and 1970, received a D.D.S. in 1974 from the University of Maryland and an M.B.A. in 1989 from the University of New Haven. He is a member of the American, New York State and Nassau County Dental Societies, as well as the American Health Information Management Association, the American Records Management Association, the Self Insurance Institute of America, the Council of Dental Benefit Processing Stardards, the National Association of Dental Plans, the International Foundation of Employee Benefit Plans and the Association for Information and Image Management.\nDr. George Kane has been a Vice President and a Director of the Company since July 1984, and has been Treasurer of the Company since February 1988. He is a Director and Vice President of IHS. Together with his brother, Martin Kane, and Stephen J. Cuchel, Dr. Kane operates a group dental practice from four offices in New York City and environs. He is a member of the American Dental Association, SED Professional Fraternity for Continuing Education, Academy of General Dentistry, American Endodontic Society, American Society of Preventive Dentistry and Yonkers New York Chamber of Commerce. He received his B.A. from The State University, Rutgers, New Jersey in 1965 and a D.D.S. from New York University College of Dentistry in 1969.\nPhilip J. Rizzuto has been a Director of the Company and Vice President of Management Information Systems since March 1990. He was a Director, Chief\nExecutive Officer, Secretary and Treasurer of the Healthplex Computer Group from December 1987 until July 31, 1993. His duties include providing technical support services for in-house computer and imaging systems and providing market support for all products. Prior thereto, and at various times since 1982, he was a self-employed consultant to the Company and to other companies. From August 1982 through 1986, Mr. Rizzuto was a Director and Vice President of Management Information Systems for AGS International, Ltd., a privately-held concern. From 1981 to August 1982, Mr. Rizzuto was a Senior Director of Information Systems for the New York City Transit Authority. Mr. Rizzuto received his B.S., Cum Laude, in Computer Technology in 1975 from New York Institute of Technology.\nDouglas L. King has been a Director of the Company for more than the past five years. Mr. King has also been President and Chief Executive Officer of Smyth, Sanford and Gerard Reinsurance Intermediaries, Inc. and a director of United States Surgical Corporation for more than the past five years. He is also President and Chief Executive Officer of C.C. King & Co., Inc. Mr. King received his B.A. in 1963 from Stanford University, his J.D. from Stanford University in 1966 and a Masters of Philosophy from the University of London in 1968. He is a member of the Association of the Bar of the State of California.\nJohn Forte has been with the Company for more than the past five years and is a Vice President and Chief Accounting Officer of the Company. Since July 1991, Mr. Forte has served as a Vice President of the Company. Mr.Forte received his A.A.S. from Brooklyn College, New York in 1962 and his B.B.A. from the City College of New York in 1966. He is a certified public accountant and has been a member of the New York State Society of Certified Public Accountants and A.I.C.P.A. since 1969. Mr. Forte also maintains a private accounting practice for his own clients and devotes approximately one day per week to such practice.\nDrs. Martin Kane and George Kane are brothers.\nBased on a review of the Forms 3 and 4, and any amendments thereto, filed during the year ended December 31, 1995 by those individuals required to file and furnish to the Company such reports and the written representation furnished to the Company by each such individual that he is not required to file a Form 5, the Company knows of no delinquent filing of, or failure to file, any such Form which was required to be filed during such year other than the following: Mr. Philip Rizzuto had one late report relating to one transaction and he was unaware of the need to file at the relevant time. The transaction related to the disposition of 75,000 shares in May 1995 in connection with a property settlement with his former spouse, and Mr. Rizzuto accurately reported his shareholdings in connection with a subsequent Form 4 filing made in connection with an unrelated transaction. A Form 5 has been filed to report the May 1995 disposition of shares.\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. EXECUTIVE COMPENSATION. ----------------------\nThe Summary Compensation Table below sets forth the compensation for services paid or accrued for services in all capacities during the last three fiscal years by the Company and its subsidiaries to the two Co-Chief Executive Officers and the other most highly compensated executive officers whose annual compensation exceeded $100,000:\nSUMMARY COMPENSATION\nAnnual Compensation Long Term Compensation ------------------- ---------------------- Name and Principal Position - ------------------ Fiscal Options\/ All other Year Salary SARs (No.) Compensation1 ------ -------- ---------- -------- Stephen J. Cuchel, 1995 $158,445 65,000 (2) $12,000 Chairman of the 1994 $140,861 65,000 $ 7,158 Board 1993 $122,180 -- $ 6,552 Co-Chief Executive Officer and a Director\nMartin Kane, 1995 $158,185 65,000 (2) $ 8,900 President, 1994 $140,861 65,000 $ 7,676 Co-Chief Executive 1993 $122,524 -- $ 6,545 Officer and a Director\nBruce H. Safran, 1995 $136,597 50,000 (2) $ 7,402 Vice President, 1994 $128,112 50,000 $ 8,820 Secretary and a 1993 $114,014 -- $ 3,632 Director\nJohn F. Forte, 1995 $103,290 25,000 (2) $ 6,468 Vice President, 1994 $ 98,600 25,000 $ 5,768 Chief Accounting 1993 $ 91,650 -- $ 5,418 Officer\n1 Consists of (i) matching contributions to the Retirement Savings Plan of the Company for the years 1993, 1994 and 1995 for each of Drs. Cuchel ($ 1,552, $1,701, $1,627), Martin Kane ($1,545, $1,701, $1,646) and Safran ($1,507, $1,418, $1,323) and (ii) insurance premiums paid by the Company for the years 1993, 1994 and 1995 for each of Drs. Cuchel ($5,000, $5,457, $12,000), Martin Kane ($5,000, $5,975, $8,900), Safran ($2,125, $7,402, $7,402),and John Forte ($5,418, $5,768, $6,468) on life insurance policies payable to beneficiaries respectively designated by each insured.\n2 These options were issued in replacement of a like numbers of options granted to the named executive in 1994.\nAGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR \/ OPTION VALUES AT FISCAL YEAR END ----------------------------------\nDuring 1995, neither the co-Chief Executive Officers of the Company nor any of the most highly compensated executive officers whose annual compensation exceeded $100,000 exercised options to purchase Common Stock of the Corporation.\nThe following table presents information regarding the number of options to purchase the Company's Common Stock granted by the Company to the named executive officers during the year ended December 31, 1995, the percentage of each named executive officer's share of all such options granted to all employees of the Company, the exercise price of each such executive officer's options, and the expiration date of each such executive officer's options.\nOption Grants in Last Fiscal Year (Individual Grants) -------------------\nNo. of Percent Exercise Expiration Date Securities of Total or Name Underlying Options Base Options Granted price Granted (#) to ($\/Sh) Employees (1) in Fiscal Year - ----------------- ----------- --------- ------ ------------------- Stephen J. Cuchel 65,000 17.08 1.1979 November 27, 2000\nMartin Kane 65,000 17.08 1.1979 November 27, 2000\nBruce H. Safran 50,000 13.14 1.089 November 27, 2005\nJohn Forte 25,000 6.57 1.089 November 27, 2005\n(1) Consists of Incentive Stock Options which were granted to the named executive officers on November 28, 1995. In the case of Messrs. Cuchel and M. Kane, the options are exercisable for a period of five years from the date of grant and were granted at 110% of the Formula Price. The options granted to Messers. Safran and Forte exercisable for a period of ten years and were granted at the Formula Price. The \"Formula Price\" is equal to the average of the mean between the closing bid and ask prices for the Company's Common Stock on the National Association of Securities Dealers Automatic Quotation System during the 20 trading days preceding the date of grant, eliminating from such calculation the two high and two low bid and asked prices.\nDuring 1995, the Company paid a director's fee of $12,000 to one outside director and a director's fee of $25,000 to another director of the Company.\nDuring 1995, the Company, acting upon the unanimous written consent of the Company's Stock Option Committees which administer the Company's various Stock Option Plans, issued replacement grants of stock options to the named executive officers at a reduced exercise price in order to take into acoount the declining market price of the Company's stock. The replacement grants were issued to the named executive officers in exchange for the cancellation of certain stock options to purchase an identical number of shares of Common Stock which were granted by the Company to the named executive officers in fiscal 1994. The replacement grants were undertaken in accordance with the terms and conditions of the Company's various Stock Option Plans.\nThe exercise price of the replacement grants of stock options to the named executive officers were determined by calculating the amount equal to the average of the mean between the closing bid and ask prices for the Company's Common Stock on the National Association of Securities Dealers Automatic Quotation System during the 20 trading days immediately preceding the date of grant, which was November 28, 1995, eliminating from such calculation the two high and low bid and asked prices.\nITEM 11.","section_11":"ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. --------------------------------------------------------------\nThe following table sets forth the number and percentage of shares of the Company's Common Stock, par value $.001 per share, held by each director, by each executive officer named in the compensation tables of Item 10, by each person known by the Company to own in excess of five percent of the Company's Common Stock and by all directors and officers as a group as of March 15, 1996.\nName and address of Shares Percent Beneficial owner Beneficially Owned of Class - --------------------- ------------------ -------- Stephen J. Cuchel (1) 519,918 14.23% 60 Charles Lindbergh Blvd. Uniondale, NY 11553\nMartin Kane (2) 499,400 13.67 60 Charles Lindbergh Blvd. Uniondale, NY 11553\nBruce H. Safran (3) 342,200 9.40 60 Charles Lindbergh Blvd. Uniondale, NY 11553\nGeorge Kane (4) 477,000 13.15 50 Rustic Gate Lane Dix Hills, NY 11746\nDouglas L. King (5) 23,000 0.63 535 Center Island Road Oyster Bay, NY 11771\nPhilip J. Rizzuto (6) 132,818 3.64 1904 Gardenia Avenue North Merrick, NY 11566\nAll Directors and 2,019,336 51.65 Officers as a group (seven persons)(7)\n(1) Includes 10,280 shares held in custody for certain members of Mr. Cuchel's family; and 65,000 shares which Mr. Cuchel may acquire upon exercise of an Incentive Stock Option which is exercisable at a price of $1.1979 per share.\n(2) Includes 65,000 shares which Mr. Kane may acquire upon exercise of an Incentive Stock Option which is exercisable at a price of $1.1979 per share. George Kane and Martin Kane are brothers. Each disclaims any voting or investment power over the shares of Common Stock owned by the other.\n(3) Includes 50,000 shares which Mr. Safran may acquire upon exercise of an Incentive Stock Option which is exercisable at a price of $1.089 per share.\n(4) Includes 45,000 shares which Mr. Kane may acquire upon exercise of an Incentive Stock Option which is exercisable at a price of $1.089 per share. George Kane and Martin Kane are brothers. Each disclaims any voting or investment power over the shares of Common Stock owned by the other.\n(5) Includes 6,000 shares held in a trust of which Mr. King is a one- third beneficiary; 10,000 shares which Mr. King may acquire upon exercise of a Non-Qualified Stock Option which is exercisable at a price of $1.089 per share; and 5,000 shares which Mr. King may acquire upon exercise of a Non-Qualified Stock Option which is exercisable at a price of $.6015625 per share.\n(6) Includes 25,000 shares which Mr. Rizzuto may acquire upon exercise of an Incentive Stock Option which is exercisable at a price of $1.089 per share; and 32,818 shares which Mr. Rizzuto may acquire upon exercise of an Incentive Stock Option which is exercisable at a price of $.6015625 per share.\n(7) Includes the shares and options referred to in Footnotes (1) through and 25,000 shares issuable to an officer of the Company upon exercise of an Incentive Stock Option exercisable at a price of $1.089 per share.\nITEM 12.","section_12":"ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. -----------------------------------------------\nDuring the year ended December 31, 1995, the Company derived revenues from Dentcare of $2,253,903.\nDrs. Martin Kane, Stephen J. Cuchel, Bruce H. Safran and George Kane are directors of IHS and Drs. Bruce H. Safran and George Kane are also officers of IHS.\nITEM 13.","section_13":"ITEM 13. EXHIBITS, LIST AND REPORTS ON FORM 8-K. --------------------------------------\nFinancial Statements and Schedules - ----------------------------------\nThe following financial statements and schedules are included in PART II, Item 7.\nIndependent Auditor's Report\nConsolidated Balance Sheets - December 31, 1995 and December 31, 1994\nConsolidated Statements of Operations for the Two Years Ended December 31, 1995\nConsolidated Statement of Stockholders' Equity for the Two Years Ended December 31, 1995\nConsolidated Statements of Cash Flows for the Two Years Ended December 31, 1995\nNotes to Consolidated Financial Statements\nSupplementary Schedules:\nReport of Independent Auditors on Schedules\nSchedule I - Marketable Securities - Other Investments\nSchedule V - Fixed Assets\nSchedule VI - Accumulated Depreciation of Fixed Assets\nSchedule X - Supplementary Income Statement Information\nInformation required by other schedules called for under Regulation S-X is either not applicable or is included in the consolidated financial statements or notes thereto.\nEXHIBITS - --------\n3.1 Certificate of Incorporation of the Company, as amended, incorporated herein by reference to Exhibit 3.1 to the Company's Annual Report on Form 10-K for the year ended 1987, Commission File No. 0-14236.\n3.2 By-Laws of the Company incorporated herein by reference to Exhibit 3.2 to the Company's Registration Statement on Form S- 18, Commission File No. 2-98215-NY.\n10.1 Service Agreement, dated April 30, 1986, between the Company and International Healthcare Services, Inc. (\"IHS\") incorporated herein by reference to Exhibit 10.2 to the Company's Annual Report on Form 10-K for the year ended 1986, Commission File No. 0-14236.\n10.2 Service Agreement, dated September 28, 1984, as amended on November 4, 1985, between the Company and Garden State Dental Service Corporation (\"Garden State\") incorporated herein by reference to Exhibits 10.3 and 10.28 to the Company's Registration Statement on Form S-18, Commission File No. 2- 98215-NY.\n10.3 Service Agreement between the Company and Dentcare Delivery Systems, Inc. (\"Dentcare\") incorporated herein by reference to Exhibit 10.4 to the Company's Annual Report on Form 10-K for the year ended 1986, Commission File No. 0-14236.\n10.4 Agreement, dated December 13, 1983, between Dentshield and Dascit\/White & Winston, Inc. incorporated herein by reference to Exhibit 10.5 to the Company's Registration Statement on Form S-18, Commission File No. 2-98215-NY.\n10.5 General Agent Agreement, dated October 1983, between Dentshield and The Only Company t\/a Capital Marketing incorporated herein by reference to Exhibit 10.6 to the Company's Registration Statement on Form S-18, Commission File No. 2-98215-NY.\n10.6 Incentive Stock Option Plan incorporated herein by reference to Exhibit 10.10 to the Company's Registration Statement on Form S-18, Commission File No. 2-98215-NY.\n10.7 Non-Qualified Stock Option Plan incorporated herein by reference to Exhibit 10.11 to the Company's Registration Statement on Form S-18, Commission File No. 2-98215-NY.\n10.8 Incentive Stock Compensation Plan incorporated herein by reference to Exhibit 10.8 to the Company's Annual Report or Form 10-K for the year ended 1989, Commission File No. 0-14236.\n10.9 Employment Agreement, dated October 3, 1984, as amended on October 17, 1985, between the Company and Martin Kane incorporated herein by reference to Exhibits 10.14 and 10.25 to the Company's Registration Statement on Form S-18, Commission File No. 2-98215-NY.\n10.10 Employment Agreement, dated October 3, 1984, as amended on October 17, 1985, between the Company and Stephen J. Cuchel incorporated herein by reference to Exhibits 10.15 and 10.25 to the Company's Registration Statement on Form S-18, Commission File No. 2-98215-NY.\n10.11 Employment Agreement, dated October 3, 1984, as amended on October 17, 1985, between the Company and Bruce H. Safran incorporated herein by reference to Exhibits 10.17 and 10.25 to the Company's Registration Statement on Form S-18, Commission File No. 2-98215-NY.\n10.12 Agreement, dated August 30, 1985, among the Company and certain individuals, regarding certain computer, telephone and printing\nequipment incorporated by reference to Exhibit 10.22 to the Company's Registration Statement on Form S-18, Commission File No. 2-98215-NY.\n10.13 1992 Stock Incentive Plan, incorporated herein by reference to Exhibit 4.7 to the Company's Registration Statement on Form S- 8, Commission File No. 33-56758.\n10.14 1992 Director Stock Incentive Plan, incorporated herein by reference to Exhibit 4.11 to the Company's Registration Statement on Form S-8, Commission File No. 33-56758.\n10.15 Lease Agreement between Reckson Associates and the Company dated as of February 1, 1993, incorporated herein by reference to Exhibit 10.16 to the Company's Annual Report on Form 10-KSB for the year ended December 31, 1992, Commission File No. 0- 14236.\n10.16 Stock Purchase Agreement dated as of July 30, 1993 by and between the Company and Compu-Lan, Inc., incorporated herein by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-QSB for the quarter ended June 30, 1993, Commission File No. 0-14236.\n10.17 Nonqualified Stock Option Agreement dated as of November 28, 1995 between the Company and Paul Osher.\n22.1 Subsidiaries of the Company incorporated herein by reference to Exhibit 22.1 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992, Commission File No. 0-14236.\n23.1 Consent of Independent Auditors relating to the Company's Registration Statement on Form S-8, Commission File No. 33- 56758.\n28.1 Flexible Benefits Cafeteria Plan of the Company and its affiliates effective January 1, 1989 incorporated herein by reference to Exhibit 28.1 to the Company's Annual Report on Form 10-K for the year ended 1988, Commission File No. 0-14236.\n28.2 Retirement Savings Plan of the Company effective January 1, 1989 incorporated herein by reference to Exhibit 28.2 to the Company's Annual Report on Form 10-K for the year ended 1988, Commission File No. 0-14236.\nReports on Form 8-K - -------------------\nNo report on Form 8-K was filed during the fiscal quarter ended December 31, 1995.\nSIGNATURES\nIn accordance with 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.\nHEALTHPLEX, INC.\nBy:\/s\/ MARTIN KANE --------------- Martin Kane, President Date: March 30, 1996\nIn accordance with the Securities Exchange Act of 1934, 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\/ Stephen J. Cuchel Chairman of the Board March 30, 1996 - --------------------- of Directors, Co-Chief Stephen J. Cuchel Executive Officer and a Director (Co-Principal Executive Officer)\n\/s\/ Martin Kane President, Co-Chief March 30, 1996 - --------------- Executive Officer and a Martin Kane Director (Co-Principal Executive Officer)\n\/s\/ Bruce H. Safran Vice President, March 30, 1996 - ------------------- Secretary and a Bruce H. Safran Director\n\/s\/ George Kane Vice President, March 30, 1996 - --------------- Treasurer and a George Kane Director\n\/s\/ Douglas L. King a Director March 30, 1996 - ------------------- Douglas L. King\n\/s\/ Philip J. Rizzuto Vice President and a March 30, 1996 - --------------------- Director Philip J. Rizzuto\n\/s\/ John Forte Vice President and March 30, 1996 - -------------- Chief Accounting John Forte Officer\nINDEX TO EXHIBITS -----------------\nSequentially Exhibit Number Description Numbered Page - -------------- ---------------------- -------------\n10.17 Nonqualified Stock -- Option Agreement dated as of November 28,\n23.1 Consent of Certified -- Public Accountant\nEXHIBIT 10.17 -------------\nNonqualified Stock ------------------ Option Agreement dated ---------------------- as of November 28, 1995 -----------------------\nNON-QUALIFIED STOCK OPTION AGREEMENT ------------------------------------\nHealthplex, Inc., a Delaware corporation (the \"Company\"), has granted to Dr. Paul Osher (the \"Grantee\") an option (the \"Option\") to purchase 8,000 shares (the \"Shares\") of the Company's Common Stock, par value $.001 per Share, for a total purchase price (the \"Option Price\") of $1.089 per share, subject to adjustment pursuant to Section 11. The Option has been granted as a bonus in respect of services rendered as a dental services provider under dental health plans operated by one of the Company's affiliates (the \"Plans\"), and shall be subject to the terms and conditions of this Agreement:\n1. Cancellation of Outstanding Option. The Option is granted in exchange for the cancellation of a Non-Qualified Stock Option (the \"Canceled Option\") to purchase 8,000 shares of Common Stock at an exercise price of $1.5762 per share, which was granted by the Company to the Grantee on November 29, 1994. The Canceled Option is hereby deemed null and void and of no further force or effect.\n2. Term. The Option shall be exercisable at any time on or after November 28, 1995 and prior to November 28, 2005; provided that the Grantee continues to be, at the time of exercise, a dental services provider under one or more of the Plans.\n3 Method of Exercise. At any time when the Option is exercisable under this Agreement, the Option shall be exercisable from time to time by written notice to the Company which shall:\n3.1 state that the Option is thereby being exercised, the number of Shares with respect to which the Option is being exercised, each person in whose name any certificates for the Shares should be registered and his or her address and social security number;\n3.2 be signed by the person or persons entitled hereunder to exercise the Option and, if the Option is being exercised by anyone other than the Grantee, be accompanied by proof satisfactory to counsel for the Company of the right of such person or persons to exercise the Option hereunder and under all applicable laws and regulations; and\n3.3 confirm that the representations and agreements with respect to the investment intent set forth in the letter attached hereto as Annex 1 continue, as of the date of such exercise, to be true and binding upon the Grantee and any such person or persons.\n4. Payment of Price. Upon exercise of the Option with respect to any of the Shares as described above, the Company shall deliver a certificate or certificates for those Shares to the specified person or persons upon receipt of the full purchase price for those Shares by certified or bank cashier's check.\n5. Transferability. The Option shall not be transferable by the Grantee other than by will or by the laws of descent and distribution. During the lifetime of the Grantee, the Option shall be exercisable (subject to any other applicable restrictions on exercise) only by the Grantee or, in the case of his mental disability, his guardian or legal representative, for his own account. Upon the death of the Grantee, the Option shall be exercisable (subject to any other applicable restrictions on exercise) only by the executor or administrator of the Grantee's estate.\n6. Termination of Relationship. If the Grantee ceases to be a dental services provider, or in the sole judgment of the Company fails to provide sufficient levels of dental services, under the Plans or if Grantee breaches any obligation owed by him to the Company or any of the Plans, then the Option or any unexercised portion of the Option which otherwise would be exercisable shall immediately terminate; provided that, if the Grantee ceases to be a dental services provider under the Plans by reason of his disability, as determined by the Company in its discretion, or death, then the Option (or any unexercised portion of the Option) shall continue to be exercisable for a period of six months after the date of disability or death or until the expiration of the original term of the Option, if sooner.\n7. Non-qualified Stock Option. The Option is not intended to qualify as an \"incentive stock option\" under Section 422 of the Internal Revenue Code of 1986, as amended.\n8. Listing and Registration of Shares. The Company shall not be required to issue or deliver any Shares upon the exercise of the Option prior to (a) the admission of such Shares to listing on any stock exchange on which the Company's Common Stock may then be listed, and (b) the completion of such registration or other qualification of such Shares under any State or Federal law, rule or regulation, as the Company shall determine to be necessary or advisable. The Company shall not be required to issue or deliver any Shares upon the exercise of the Option free of transfer restrictions, of any kind or character, imposed upon applicable State or Federal law, rules or regulations.\n9. Restrictions on Exercise. The Option is subject to all restrictions in this Agreement. As a condition of any exercise of the Option, the Company may require the grantee or his successor to make any representation and warranties to the Company as may be necessary to comply with any applicable law or regulation or to confirm to the Company as may be necessary any factual matters reasonably requested by counsel for the Company.\n10. Rights as Stockholder. Neither the Grantee nor his heirs, legatees, guardians or legal representatives shall be or have any rights or privileges of a stockholder of the Company in respect of any of the Shares unless and until certificates representing such Shares shall have been issued, executed, delivered and registered on the Company's transfer books.\n11. Adjustment of Option Price. The Option Price may be adjusted by the Board of Directors of the Company in the event of any change in the outstanding shares of Common Stock by reason of stock splits, stock dividends or any other increase or reduction of the number of outstanding shares of Common Stock without receiving consideration in the form of money, services or property or any other recapitalization or merger, consolidation or other reorganization of the Company.\n12. Binding Agreement. The Grantee agrees to be bound by all of the terms and conditions of this Agreement. The Board of Directors of the Company is vested with final authority to interpret and construe this Agreement and the terms of the Option granted hereunder.\n13. Governing Law. This Agreement shall be construed and enforced in accordance with, and governed by, the laws of the State of New York.\nDATE OF GRANT: November 28, 1995\nHEALTHPLEX, INC.\nBy: \/S\/Bruce H. Safran ----------------------\nACCEPTANCE OF AGREEMENT -----------------------\nThe Grantee hereby accepts this Agreement and the Option granted to him\/her under this Agreement, subject to all provisions of this Agreement.\n\/S\/ Paul Osher ------------------------- Grantee's Signature\n###-##-#### ----------- Grantee's Social Security No.\nDr. Paul Osher 170 Eva Drive Lido Beach, New York 11561\nAs of November 25, 1995\nHealthplex, Inc. 60 Charles Lindbergh Boulevard Uniondale, New York 11553\nGentlemen:\nThis is to advise you that I am acquiring an option to purchase (the `Option'') 8,000 shares (the ``Shares'') of Common Stock, per value $.001 per share, of Healthplex, Inc., a Delaware corporation (the `Company''), as compensation for my services as a dental services provider under the dental health plans operated by one of the Company's affiliates. Upon exercise of the Option, I or the executor or administrator of my estate or my heirs, legatees, guardians or legal representatives, as the case may be, shall acquire the Shares for investment and not with a view to or intention of distributing, selling or otherwise disposing of all or any part of such Shares. My financial condition and investments are such that I am in a financial position to hold the Shares purchased by me for an indefinite period of time and to bear the economic risk of, and withstand a complete loss of, my investment in the Shares.\nBy virtue of my expertise, the advice available to me and my previous investment experience, I have sufficient knowledge and experience in financial and business matters, investments, securities and private placements to evaluate the merits and risks of acquiring the Shares.\nI or my representatives have been granted such access to the Company's books, records and financial statements, as well as any, information concerning its securities as I have requested and have had the opportunity to question and to receive answers from representatives of the Company with respect to the acquisition of the Shares. We understand that the Shares have not been registered under the Securities Act of 1933, as amended (the `Securities Act'), by reason of their issuance in a transaction exempt from the registration requirements of the Securities Act pursuant to the exemption provided in Section 4(2) thereof, and that, upon issuance, such Shares may not be sold or otherwise disposed of unless registered under the Securities Act or exempted from registration. We further understand that the exemption from registration afforded by Rule 144 promulgated under the Securities Act (\"Rule 144) depends on the satisfaction of various conditions and that, if applicable, Rule 144 may afford the basis for the sale of the Shares only in limited amounts. As evidence of the restrictions on transfer, a restrictive legend will be placed on the certificates representing the Shares.\nHealthplex, Inc. As of November 25,1995 In furtherance of the restrictions imposed hereunder, I acknowledge that the certificate evidencing the Shares shall bear the following legend:\n\"THE SHARES REPRESENTED BY THIS CERTIFICATE HAVE BEEN ACQUIRED FOR INVESTMENT AND HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933. THE SHARES MAY NOT BE SOLD OR TRANSFERRED IN THE ABSENCE OF SUCH REGISTRATION OR AN EXEMPTION THEREFROM UNDER SAID ACT AND AN OPINION OF COUNSEL SATISFACTORY TO THE COMPANY TO THE EFFECT THAT SUCH SALE OR TRANSFER WILL NOT RESULT IN A VIOLATION OF SAID ACT\".\nI have received and had the opportunity to review the Company's Form 10-K for the fiscal year ended December 31, 1994 and the Company's Form 10-Q for the quarter ended September 30, 1995. I have had access to all pertinent business records and the opportunity to discuss the Company's affairs with its management. I have had the opportunity to discuss this acquisition with my attorney and accountant, if any, who also have had the opportunity to review all relevant documents and financial information. I have been thoroughly advised of the high risks involved with this acquisition. I do not desire to receive any further information. I am aware that there is no assurance that the future operations of the Company, if any, will be profitable. Accordingly, I understand that my investment is subject to substantial risk and may become worthless.\nVery truly yours,\n\/S\/ Paul Osher Paul Osher PW\/lac\nEXHIBIT 23.1 ------------\nConsent of Certified -------------------- Public Accountant -----------------\nCONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS\nAs independent public accountants, we hereby consent to the incorporation by reference in the Registration Statement of Form S-8 (Registration No. 33-56758) pertaining to the 1992 Stock Incentive Plan , 1992 Director Stock Incentive Plan, 1989 Incentive Stock Compensation Plan, 1985 Nonqualified Stock Option Plan and 1985 Incentive Stock Option Plan. Healthplex, Inc., and related prospectuses, of our reports dated March 20, 1996 with respect to the consolidated financial statements and the financial statement schedules included in the Healthplex, Inc. Annual Report on Form 10-KSB for the year ended December 31, 1995.\nLibero & Kappel Certified Public Accountants\nWestbury, New York March 20, 1996\nNew York, New York March 29, 1996\nSecurities and Commission 450 Fifth Street, N.W. Washington, D.C. 20549\nRe: Healthplex, Inc. Commission File No. 0-14236 1995 Form 1O-KSB -----------------\nGentlemen:\nPursuant to the requirements of the Securities Exchange Act of 1934, as amended, we deliver herewith a Form 10-KSB for Healthplex, Inc. (the \"Company\") for the fiscal year ended December 31, 1995, which form is being filed with the Securities and Exchange Commission (the \"SEC\") electronically via the Electronic Data Gathering, Analysis and Retrieval (EDGAR) System. The amount of $250.00, representing the filing fee payable in connection with the filing, has been paid to the SEC via wire transfer to the Mellon Bank in Pittsburgh, Pennsylvania.\nVery truly yours,\nHEALTHPLEX, INC.\nBy: \/s\/ John Forte --------------------- Name: John Forte Title: Vice President","section_14":"","section_15":""}
{"filename":"100378_1995.txt","cik":"100378","year":"1995","section_1":"Item 1. Business\nThe Company is engaged in one line of business. Twin Disc designs, manufactures and sells heavy duty off-highway power transmission equipment. Products offered include: hydraulic torque converters; power-shift transmissions; marine transmissions and surface drives; universal joints; gas turbine starting drives; power take-offs and reduction gears; industrial clutches; fluid couplings and control systems. Principal markets are: construction equipment, industrial equipment, government, marine, energy and natural resources and agriculture. The Company's worldwide sales to both domestic and foreign customers are transacted through a direct sales force and a distributor network. There have been no significant changes in products or markets since the beginning of the fiscal year. The products described above have accounted for more than 90% of revenues in each of the last three fiscal years.\nThe Company acquired certain assets of Southern Diesel Engine Repair during fiscal year 1993. During 1995, the Company purchased the outstanding stock of Marine Diffusion, S.R.L. The acquisition did not require significant capital investment. A further description of these acquisitions appears in Note N to the consolidated financial statements on page 37 of the 1995 Annual Report which financial statements are incorporated by reference in this Form 10-K Annual Report in Part II.\nIn July 1994, the Company acquired a minority interest in Palmer Johnson Distributors, LLC, a major distributor of Twin Disc products. A further description of this transaction appears in Note E to the consolidated financial statements on page 29 of the 1995 Annual Report which financial statements are incorporated by reference in this Form 10-K Annual Report in Part II. The Company also began operations of a fully owned marketing subsidiary in Madrid, Spain in fiscal year 1994. The establishment of this subsidiary did not require significant capital investment.\nThe Company's products receive direct widespread competition, including from divisions of other larger independent manufacturers. The Company also competes for business with parts manufacturing divisions of some of its major customers. Ten customers accounted for approximately 44% of the Company's consolidated net sales during the year ended June 30, 1995. Caterpillar Inc. accounted for approximately 12% of consolidated net sales in 1995.\nUnfilled open orders for the next six months of $72,183,000 at June 30, 1995 compares to $47,395,000 at June 30, 1994. Since orders are subject to cancellation and rescheduling by the customer, the six-month order backlog is considered more representative of operating conditions than total backlog. However, as procurement and manufacturing \"lead times\" change, the backlog will increase or decrease; and thus it does not necessarily provide a valid indicator of the shipping rate. Cancellations are generally the result of rescheduling activity and do not represent a material change in backlog. Most of the Company's products are machined from cast iron, forgings, cast aluminum and bar steel which generally are available from multiple sources and which are believed to be in adequate supply.\nThe Company has pursued a policy of applying for patents in both the United States and certain foreign countries on inventions made in the course of its development work for which commercial applications are considered probable. The Company regards its patents collectively as important but does not consider its business dependent upon any one of such patents. (2)\nEngineering and development costs include research and development expenses for new product development and major improvements to existing products, and other charges for ongoing efforts to refine existing products. Research and development costs charged to operations totalled $2,718,000, $2,649,000 and $2,129,000 in 1995, 1994 and 1993, respectively. Total engineering and development costs were $7,411,000, $6,843,000 and $7,093,000 in 1995, 1994 and 1993, respectively.\nCompliance with federal, state and local provisions regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, is not anticipated to have a material effect on capital expenditures, earnings or the competitive position of the Company.\nThe number of persons employed by the Company at June 30, 1995 was 1,097.\nThe business is not considered to be seasonal except to the extent that vacations are taken mainly in the months of July and August curtailing production during that period.\nManagement recognizes that there are attendant risks that foreign governments may place restrictions on dividend payments and other movements of money, but these risks are considered minimal due to the political relations the United States maintains with the countries in which the Company operates or the relatively low investment within individual countries.\nA summary of financial data by geographic area for the years ended June 30, 1995, 1994 and 1993 appears in Note D to the consolidated financial statements on pages 27 through 29 of the 1995 Annual Report to Shareholders which financial statements are incorporated by reference in this Form 10-K Annual Report in Part II.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company owns three manufacturing, assembly and office facilities in Racine, Wisconsin, U.S.A. and one in Nivelles, Belgium. The aggregate floor space of these four plants approximates 750,000 square feet. The Racine facility includes office space which is the location of the Company's corporate headquarters.\nThe Company also has operations in the following locations all of which are used for sales offices, warehousing and light assembly or product service. The following properties are leased except for the Johannesburg, South Africa location, which is owned:\nJacksonville, Florida, U.S.A. Brisbane, Queensland, Australia Miami, Florida, U.S.A. Perth, Western Australia, Australia Loves Park, Illinois, U.S.A. Viareggio, Italy Coburg, Oregon, U.S.A. Singapore Seattle, Washington, U.S.A. Johannesburg, South Africa Madrid, Spain\nThe properties are generally suitable for operations and are utilized in the manner for which they were designed. Manufacturing facilities are currently operating at less than 70% capacity and are adequate to meet foreseeable needs of the Company. (3)\nItem 3.","section_3":"Item 3. Legal Proceedings\nTwin Disc is a defendant in several product liability or related claims considered either adequately covered by appropriate liability insurance or involving amounts not deemed material to the business or financial condition of the Company.\nThe Company has joined with a group of potentially responsible parties in signing a consent decree with the Illinois Environmental Protection Agency to conduct a remedial investigation and feasibility study at the Interstate Pollution Control facility in Rockford, Illinois. The consent decree was signed on October 17, 1991, and filed with the federal court in the Northern District of Illinois. The Company's total potential liability on the site cannot be estimated with particularity until completion of the remedial investigation. Based upon current assumptions, however, the Company anticipates potential liability of $300,000 to $400,000.\nThe Company also is involved with other potentially responsible parties in various stages of investigation and remediation relating to other hazardous waste sites, some of which are on the United States EPA National Priorities List (Superfund sites). While it is impossible at this time to determine with certainty the ultimate outcome of such environmental matters, they are not expected to materially affect 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\n(Pursuant to General Instruction G(3) of Form 10-K, the following list is included as an unnumbered Item in Part I of this Report in lieu of being included in the Proxy Statement for the Annual Meeting of Shareholders to be held on October 20, 1995.)\nOfficers are elected annually by the Board of Directors at the first meeting of the Board held after each Annual Meeting of the Shareholders. Each officer shall hold office until his successor has been duly elected, or until he shall resign or shall have been removed from office.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Stock and Related Shareholder Matters\nThe dividends per share and stock price range information set forth under the caption \"Sales and Earnings by Quarter\" on page 1 of the Annual Report for the year ended June 30, 1995 are incorporated into this report by reference.\nAs of June 30, 1995 there were 1,124 shareholder accounts. The Company's stock is traded on the New York Stock Exchange. The market price of the Company's common stock as of the close of business on September 1, 1995 was $24.75 per share.\nPursuant to a shareholder rights plan (the \"Rights Plan\"), on June 17, 1988, the Board of Directors declared a dividend distribution, payable to shareholders of record on July 1, 1988, of one Preferred Stock Purchase Right for each outstanding share of Common Stock. The Rights will expire 10 years after issuance, and will be exercisable only if a person or group becomes the beneficial owner of 20% or more (or 30% in the case of any person or group which currently owns 20% or more of the shares or who shall become the Beneficial Owner of 20% or more of the shares as a result of any transfer by reason of the death of or by gift from any other person who is an Affiliate or an Associate of such existing holder or by succeeding such a person as trustee of a trust existing on the Record Date) of the Common Stock (such person or group, an \"Acquiring Person\") or commences a tender or exchange offer which would result in the offeror beneficially owning 30% or more of the Common Stock. A person who is not an Acquiring Person will not be deemed to have become an Acquiring Person solely as a result of a reduction in the number of shares of Common Stock outstanding due to a repurchase of Common Stock by the Company until such person becomes beneficial owner of any additional shares of Common Stock. Each Right will entitle shareholders to buy one newly issued unit of one one-hundredth of a share of Series A Junior Preferred Stock at an exercise price of $80, subject to certain antidilution adjustments. The Company will generally be entitled to redeem the Rights at $.05 per Right at any time prior to 10 business days after a public announcement of the existence of an Acquiring Person. (5)\nIf (i) a person or group accumulates more than 30% of the Common Stock (except pursuant to an offer for all outstanding shares of Common Stock which the independent directors determine to be fair to and otherwise in the best interests of the Company and its shareholders and except solely due to a reduction in the number of shares of Common Stock outstanding due to the repurchase of Common Stock by the Company), (ii) a merger takes place with an Acquiring Person where the Company is the surviving corporation and its Common Stock is not changed or exchanged, (iii) an Acquiring Person engages in certain self-dealing transactions, or (iv) during such time as there is an Acquiring Person, an event occurs which results in such Acquiring Person's ownership interest being increased by more than 1% (e.g., a reverse stock split), each Right (other than Rights held by such Acquiring Person and certain related parties which become void) will represent the right to purchase, at the exercise price, Common Stock (or in certain circumstances, a combination of securities and\/or assets) having a value of twice the exercise price. In addition, if following the public announcement of the existence of an Acquiring Person the Company is acquired in a merger or other business combination transaction, except a merger or other business combination transaction that takes place after the consummation of an offer for all outstanding shares of Common Stock that the independent directors have determined to be fair, or a sale or transfer of 50% or more of the Company's assets or earning power is made, each Right (unless previously voided) will represent the right to purchase, at the exercise price, common stock of the acquiring entity having a value of twice the exercise price at the time.\nThe Rights have certain anti-takeover effects. The Rights will cause substantial dilution to a person or group that attempts to acquire the Company without conditioning the offer on a substantial number of Rights being acquired. However, the Rights are not intended to prevent a take-over, but rather are designed to enhance the ability of the Board of Directors to negotiate with an acquiror on behalf of all of the shareholders. In addition, the Rights should not interfere with a proxy contest.\nThe Rights should not interfere with any merger or other business combination approved by the Board of Directors since the Rights may be redeemed by the Company at $.05 per Right prior to 10 business days (as such period may be extended) after the public announcement of the existence of an Acquiring Person.\nThe press release announcing the declaration of the Rights dividend, dated June 20, 1988, and a letter to the Company's shareholders, dated June 22, 1988, explaining the Rights, filed as Item 14(a)(3), Exhibits 4(a) and (b) of Part IV of the Annual Report on Form 10-K for the year ended June 30, 1988 are hereby incorporated by reference. Item 6.","section_6":"Item 6. Selected Financial Data\nThe information set forth under the caption \"Ten-Year Financial Summary\" on pages 40 and 41 of the Annual Report to Shareholders for the year ended June 30, 1995 is incorporated into this report 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\" on pages 19 through 21 of the Annual Report to Shareholders for the year ended June 30, 1995 is incorporated into this report by reference. (6)\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe following Consolidated Financial Statements of Twin Disc, Incorporated and Subsidiaries set forth on pages 22 through 39 of the Annual Report to Shareholders for the year ended June 30, 1995 are incorporated into this report by reference:\nConsolidated Balance Sheets, June 30, 1995 and 1994\nConsolidated Statements of Operations for the years ended June 30, 1995, 1994 and 1993\nConsolidated Statements of Cash Flows for the years ended June 30, 1995, 1994 and 1993\nConsolidated Statements of Changes in Shareholders' Equity for the years ended June 30, 1995, 1994 and 1993\nNotes to Consolidated Financial Statements\nReport of Independent Accountants\nThe supplementary data regarding quarterly results of operations set forth under the caption \"Sales and Earnings by Quarter\" on page 1 of the Annual Report to Shareholders for the year ended June 30, 1995 is incorporated into this report 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\nFor information with respect to the executive officers of the Registrant, see \"Executive Officers of the Registrant\" at the end of Part I of this report. For information with respect to the Directors of the Registrant, see \"Election of Directors\" on pages 5 through 7 of the Proxy Statement for the Annual Meeting of Shareholders to be held October 20, 1995, which is incorporated into this report by reference.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe information set forth under the captions \"Compensation of Executive Officers\", \"Stock Options\" and \"Compensation Pursuant to Plans\" on pages 8 through 10 of the Proxy Statement for the Annual Meeting of Shareholders to be held on October 20, 1995 is incorporated into this report by reference. Discussion in the Proxy Statement under the captions \"Board Executive Selection and Salary Committee Report on Executive Compensation\" and \"Corporate Performance Graph\" is not incorporated by reference and shall not be deemed \"filed\" as part of this report. (7) Item 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nSecurity ownership of certain beneficial owners and management is set forth on pages 3 and 4 of the Proxy Statement for the Annual Meeting of Shareholders to be held on October 20, 1995 under the caption \"Principal Shareholders and Share Ownership of Directors and Executive Officers\" and incorporated into this report by reference.\nThere are no arrangements known to the Registrant, the operation of 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\nNone.\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 Twin Disc, Incorporated and Subsidiaries set forth on pages 22 through 39 of the Annual Report to Shareholders for the year ended June 30, 1995 are incorporated by reference into this report in Part II:\nConsolidated Balance Sheets, June 30, 1995 and 1994\nConsolidated Statements of Operations for the years ended June 30, 1995, 1994 and 1993\nConsolidated Statements of Cash Flows for the years ended June 30, 1995, 1994 and 1993\nConsolidated Statements of Changes in Shareholders' Equity for the years ended June 30, 1995, 1994 and 1993\nNotes to Consolidated Financial Statements\nReport of Independent Accountants\nThe supplementary data regarding quarterly results of operations under the caption \"Sales and Earnings by Quarter\" on page 1 of the Annual Report to Shareholders for the year ended June 30, 1995 is incorporated by reference into this report in Part II hereof.\nIndividual financial statements of the 50% or less owned entities accounted for by the equity method are not required because such 50% or less owned entities do not constitute significant subsidiaries. (8) (a)(2) Consolidated Financial Statement Schedule (numbered in accordance with Regulation S-X) for the three years ended June 30, 1995:\nPage\nReport of Independent Accountants 13\nSchedule II-Valuation and Qualifying Accounts 14\nSchedules, other than those listed, are omitted for the reason that they are inapplicable, are not required, or the information required is shown in the financial statements or the related notes thereto.\nThe Report of the Independent Accountants of the Registrant with respect to the above-listed consolidated financial statement schedule appears on page 13 of this report.\n(a)(3) List of Exhibits: (numbered in accordance with Item 601 of Regulation S-K)\n2 Not applicable\n3 a) Articles of Incorporation, as restated October 21, 1988 (Incorporated by reference to Exhibit 3(a) of the Company's Form 10-K for the year ended June 30, 1989).\nb) Corporate Bylaws, amended through June 16, 1995.\n4 Instruments defining the rights of security holders, including indentures\na) Form of Rights Agreement dated as of June 17, 1988 by and between the Company and the First Wisconsin Trust Company, as Rights Agent, with Form of Rights Certificate (Incorporated by reference to Exhibits 1 and 2 of the Company's Form 8-A dated June 27, 1988).\nb) Announcement of Shareholder Rights Plan per press release dated June 20, 1988 and explanation of plan per letter to Company's shareholders dated June 20, 1988 (Incorporated by reference to Exhibit 4(a) and (b), respectively, of the Company's Form 10-K for the year ended June 30, 1988).\n9 Not applicable (9) 10 Material Contracts a) * The 1988 Incentive Stock Option Plan (Incorporated by reference to Exhibit B of the Proxy Statement for the Annual Meeting of Shareholders held on October 21, 1988).\nb) * The 1988 Non-Qualified Stock Option Plan for Officers, Key Employees and Directors (Incorporated by reference to Exhibit C of the Proxy Statement for the Annual Meeting of Shareholders held on October 21,1988).\nc) * Amendment to 1988 Incentive Stock Option Plan of Twin Disc, Incorporated (Incorporated by reference to Exhibit A of the Proxy Statement for the Annual Meeting of Shareholders held on October 15, 1993).\nd) * Amendment to 1988 Non-Qualified Incentive Stock Option Plan for Officers, Key Employees and Directors of Twin Disc, Incorporated (Incorporated by reference to Exhibit B of the Proxy Statement for the Annual Meeting of Shareholders held on October 15, 1993).\ne) * Form of Severance Agreement for Senior Officers and form of Severance Agreement for Other Officers (Incorporated by reference to Exhibit 10(c) and (d), respectively, of the Company's Form 10-K for the year ended June 30, 1989).\nf) * Supplemental Retirement Plan (Incorporated by reference to Exhibit 10(a) of the Company's Form 10-K for the year ended June 30, 1986).\ng) * Director Tenure and Retirement Policy (Incorporated by reference to Exhibit 10(f) of the Company's Form 10-K for the year ended June 30, 1993).\nh) * Form of Twin Disc, Incorporated Corporate Short Term Incentive Plan (Incorporated by reference to Exhibit 10(g) of the Company's Form 10-K for the year ended June 30, 1993). * Denotes management contract or compensatory plan or arrangement.\n11 Not applicable\n12 Not applicable\n13 Annual Report of the Registrant for the year ended June 30, 1995 is separately filed as Exhibit (13) to this Report (except for those portions of such Annual Report separately incorporated by reference into this Report, such Annual Report is furnished for the information of the Securities and Exchange Commission and shall not be deemed \"filed\" as part of this report).\n18 Not applicable\n21 Subsidiaries of the registrant\n22 Not applicable\n23 Consent of Independent Accountants (10) 24 Power of Attorney\n27 Financial Data Schedule for the year ended June 30, 1995 is separately filed as Exhibit (27) to this report. (This schedule is furnished for the information of the Securities and Exchange Commission and shall not be deemed \"filed\" for purposes of Section 11 of the Securities Act or Section 18 of the Exchange Act.)\n28 Not applicable\n99 Foreign Affiliate Separate Financial Statements a) Niigata Converter Co., Ltd. financial statements for the year ended March 31, 1995 prepared in accordance with Japanese Commercial Code are separately filed as Exhibit (99a) to this report. (This schedule is furnished for the information of the Securities and Exchange Commission.)\nb) Niigata Converter Co., Ltd. financial statements for the year ended March 31, 1994 prepared in accordance with Japanese Commercial Code are separately filed as Exhibit (99b) to this report. (This schedule is furnished for the information of the Securities and Exchange Commission.)\nc) Niigata Converter Co., Ltd. financial statements for the year ended March 31, 1993 prepared in accordance with Japanese Commercial Code are separately filed as Exhibit (99c) to this report. (This schedule is furnished for the information of the Securities and Exchange Commission.)\nd) Niigata Converter Co., Ltd. financial statements for the year ended March 31, 1992 prepared in accordance with Japanese Commercial Code are separately filed as Exhibit (99d) to this report. (This schedule is furnished for the information of the Securities and Exchange Commission.)\nCopies of exhibits filed as a part of this Annual Report on Form 10-K may be obtained by shareholders of record upon written request directed to the Secretary, Twin Disc, Incorporated, 1328 Racine Street, Racine, Wisconsin 53403. (11) SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nTWIN DISC, INCORPORATED\nBy FRED H. TIMM -------------------------------------- Fred H. Timm, Corporate Controller and Secretary (Chief Accounting Officer)\nSeptember 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.\nBy MICHAEL E. BATTEN -------------------------------------- Michael E. Batten, Chairman, Chief Executive Officer and Director\nSeptember 15, 1995 By MICHAEL H. JOYCE -------------------------------------- Michael H. Joyce, President, Chief Operating Officer and Director\nBy JAMES O. PARRISH -------------------------------------- James O. Parrish, Vice President- Finance, Treasurer and Director (Chief Financial Officer)\nWilliam W. Goessel, Director Jerome K. Green, Director John L. Murray, Director Paul J. Powers, Director September 15, 1995 Richard T. Savage, Director David L. Swift, Director Stuart W. Tisdale, Director David R. Zimmer, Director\nBy JAMES O. PARRISH -------------------------------------- James O. Parrish, Attorney in Fact (12) REPORT OF INDEPENDENT ACCOUNTANTS (See Item 14) Consolidated Financial Statement Schedule of Twin Disc, Incorporated and Subsidiaries\nTo the Shareholders Twin Disc, Incorporated Racine, Wisconsin\nOur report on the consolidated financial statements of Twin Disc, Incorporated and Subsidiaries has been incorporated by reference in this Form 10-K from page 39 of the 1995 annual report to shareholders of Twin Disc, Incorporated and Subsidiaries. In connection with our audits of such financial statements, we have also audited the related financial statement schedule listed in the index on page 9 of this Form 10-K.\nIn our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information required to be included therein.\nCOOPERS & LYBRAND L. L. P.\nMilwaukee, Wisconsin July 28, 1995 (13)\n(14)\n(16)","section_15":""}
{"filename":"107819_1995.txt","cik":"107819","year":"1995","section_1":"Item 1. BUSINESS\n(a) General\nWisconsin Gas Company (the \"Company\" or \"Wisconsin Gas\") is a Wisconsin corporation and a wholly-owned subsidiary of WICOR, Inc. (\"WICOR\") and maintains its principal executive offices in Milwaukee, Wisconsin. The Company is the largest natural gas distribution public utility in Wisconsin. At December 31, 1995, Wisconsin Gas distributed gas to approximately 505,000 residen- tial, commercial and industrial customers in 503 communities throughout Wisconsin having an estimated population of nearly 2,000,000 based on the State of Wisconsin's estimates for 1995. The Company is subject to the jurisdiction of the Public Service Commission of Wisconsin (\"PSCW\") as to various phases of its operations, including rates, service and issuance of securities.\nWisconsin Gas' business is highly seasonal, particularly as to residential and commercial sales for space heating purposes, with a substantial portion of its sales occurring in the winter heating season. The following table sets forth the volumes of natural gas delivered by Wisconsin Gas to its customers.\n*One therm equals 100,000 BTU's\nThe volumes shown as transported represent customer-owned gas that was delivered by Wisconsin Gas to such customers. The remaining volumes represent quantities sold and delivered to customers by the Company.\n(b) Gas Supply, Pipeline Capacity and Storage\n(1) General\nPrior to the Federal Energy Regulatory Commission's (\"FERC\") Order No. 636, the interstate pipelines serving Wisconsin Gas were the primary suppliers of natural gas to Wisconsin Gas. During the transition period prior to the issuance of Order No. 636, Wisconsin Gas gradually assumed responsibility for the acquisition of supply in the production areas of North America, as well as the management of transportation and storage capacities to deliver that supply to its market area. On November 1, 1993, Wisconsin Gas commenced full operation and responsibility for its supply and capacity under the requirements of Order No. 636.\nOne of the provisions of Order No. 636 is capacity release. Capacity release creates a secondary market for pipeline capacity and gas supplies. Local distribution companies, such as Wisconsin Gas, must contract for capacity and supply sufficient to meet the peak day firm demand of their customers. Peak or near peak days occur only a few times each year, so capacity release facilitates higher utilization of capacity during those times when the capacity is not needed by the utility. Through pre-arranged agreements and day-to-day electronic bulletin board postings, interested parties can purchase that capacity. The proceeds from these transactions are passed-through to the ratepayers, thereby helping to offset the costs associated with holding the capacity. During 1995, Wisconsin Gas was an active participant in the capacity release market.\nOperating under Order No. 636, Wisconsin Gas Company has been able to meet its contractual obligations with both its suppliers and its customers despite periods of severe cold and unseasonably warm weather, including the record cold weather in late January and early February, 1996.\n(2) Pipeline Capacity and Storage\nInterstate pipelines serving Wisconsin originate in three major gas producing areas of North America: the Oklahoma and Texas basins, the Gulf of Mexico and western Canada. Wisconsin Gas has contracted for long-term firm capacity on a relatively equal basis from each of these areas. This strategy reflects management's belief that overall supply security is enhanced by geographic diversification of the Company's supply portfolio and that Canada represents an important long-term source of reliable, competitively priced gas.\nBecause of the seasonal variations in gas usage in Wisconsin, Wisconsin Gas has also contracted with ANR and NNG for substantial underground storage capacity, primarily in Michigan. There are no known underground storage formations in Wisconsin capable of commercialization. Storage enables Wisconsin Gas to optimize its overall gas supply and capacity costs. In summer, gas in excess of market demand is transported into the storage fields, and in winter, gas is withdrawn from storage and combined with gas purchased in or near the production areas (\"flowing gas\") to meet the increased winter market demand. As a result, Wisconsin Gas can contract for less pipeline capacity than would otherwise be necessary, and it can purchase gas on a more uniform daily basis from suppliers year- round. Each of these capabilities enables Wisconsin Gas to reduce its overall costs.\nWisconsin Gas also maintains high deliverability storage in the production area which is designed to deliver gas when other supplies cannot be delivered during extremely cold weather.\nWisconsin Gas' firm winter daily transportation and storage capacity entitlements from pipelines under long-term contracts are set forth below. Maximum (Thousands Pipeline of Therms*) ----------- ANR Mainline 2,999 Storage 4,879 NNG Mainline 1,085 Storage 150 Viking Mainline 72 Peaking Facilities 69 ----------- Total 9,254 =========== *One therm equals 100,000 BTU's.\n(3) Term Gas Supply\nWisconsin Gas has contracts for firm supplies with terms in excess of 30 days with approximately 30 gas suppliers for gas produced in each of the three producing areas discussed above. The term contracts have varying durations so that only a portion of the Company's gas supply expires in any year. the Company believes the volume of gas under contract is sufficient to meet its forecasted firm peak day demand. The following table sets forth Wisconsin Gas' winter season maximum daily firm total gas supply.\nMaximum (Thousands of Therms*) ----------- Domestic flowing gas 2,350 Canadian flowing gas 1,482 Storage withdrawals 5,029 ----------- Total 8,861 =========== *One therm equal 100,000 BTU's.\n(4) Spot Market Gas Supply\nWisconsin Gas expects to continue to make gas purchases in the 30-day spot market as price and other circumstances dictate. The Company has purchased spot market gas since 1985 and has supply relationships with a number of sellers from whom it purchases spot gas.\n(c) Employees\nThe Company had 1,089 full-time equivalent active employees at December 31, 1995\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nWisconsin Gas owns a distribution system which, on Decem- ber 31, 1995, included approximately 8,300 miles of distribution and transmission mains, 414,000 services and 539,000 active meters. The Company's distribution system consists almost entirely of plastic and coated steel pipe. The Company owns its main office building in Milwaukee, office buildings in certain other communities in which it serves, gas regulating and meter- ing stations, peaking facilities and its major service centers, including garage and warehouse facilities. The Milwaukee and other office buildings, the principal service facilities and the gas distribution systems of Wisconsin Gas are owned by it in fee subject to the lien of its Indenture of Mortgage and Deed of Trust, dated as of November 1, 1950, under which its first mortgage bonds are issued, and to permissible encumbrances as therein defined.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nThere are no material legal proceedings pending, other than ordinary routine litigation incidental to the Company's busi- ness, to which the Company is a party, except as discussed below. There are no material legal proceedings to which any officer or director is a party or has a material interest adverse to the Company's. There are no material administrative or judicial proceedings arising under environmental quality or civil rights statutes pending or known to be contemplated by governmental agencies to which the Company is or would be a party.\nWisconsin Gas has identified two previously owned sites on which it operated manufactured gas plants that are of environmental concern. Such plants ceased operations prior to the mid-1950's. Wisconsin Gas has engaged an environmental consultant to help determine the nature and extent of the contamination at these sites. Based on the test results obtained and the possible remediation alternatives available, the Company has estimated that cleanup costs could range from $22 million to $75 million. As of December 31, 1995, the Company has accrued $36.4 million for future cleanup costs. These estimates are based on current undiscounted costs. It should also be noted that the numerous assumptions such as the type and extent of contamination, available remediation techniques, and regulatory requirements which are used in developing these estimates are subject to change as new information becomes available. Any such changes in assumptions could have a significant impact on the potential liability. Due to anticipated regulatory treatment, changes in the recorded liability do not immediately impact net income.\nThe Wisconsin Department of Natural Resources (\"WDNR\") issued a Probable Responsible Party letter to Wisconsin Gas for these two sites in September 1994. Following receipt of this letter, Wisconsin Gas and the WDNR held an initial meeting to discuss the sites. At the meeting it was agreed that Wisconsin Gas would prepare a remedial action options report from which it will select specific remedial actions for recommendation to the WDNR. During 1995, the Company gathered additional environmental data regarding these two sites, held extensive discussions concerning remedial options with current land owners and solicited information from environmental consulting and remediation firms on technology and approaches that would best suit the sites. The efforts were directed toward preparing a remedial action options report and recommendations for presentation to the WDNR in 1996. Once such a plan is approved, initial remediation work will begin. Expenditures over the next three years are expected to total approximately $20 million. Although most of the work and costs are expected to be incurred in the first few years of the plan, monitoring of sites and other necessary actions may be undertaken for up to 30 years.\nIn March 1994, Wisconsin Gas commenced suit against nine insurance carriers seeking a declaratory judgment regarding insurance coverage for the two sites. Settlements were reached with each of the carriers during 1994. Additional insurance recoveries are being pursued. The Company expects full recovery of incurred remediation costs, less amounts recovered from insurance carriers. If the amount recovered from the insurance carriers is insufficient to remediate both sites, expenditures not recovered are expected to be allowed full recovery (other than for carrying costs) in rates based upon recent PSCW orders. Accordingly, a regulatory asset has been recorded for the accrued cost. Certain related investigation costs incurred to date are currently being recovered in utility rates. However, any incurred costs not yet recovered in rates are not allowed by the PSCW to earn a return. As of December 31, 1995, $4.8 million of such costs had been incurred.\nWisconsin Gas also owns a service center that is constructed on a site that was previously owned by the City of Milwaukee and was used by the City as a public dump site. The Company has conducted a site assessment at the request of the WDNR and has sent the report of its assessment to the WDNR. Management cannot predict whether or not the WDNR will require any remediation action, nor the extent or cost of any remediation actions that may be required. In the judgment of management, any remediation costs incurred by the Company will be recoverable from the City of Milwaukee or in Wisconsin Gas' rates under the PSC orders discussed above.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nOmitted pursuant to General Instruction J (2) (c).\nPART II\nItem 5.","section_5":"Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nWICOR owns all the issued and outstanding common stock of the Company. The Wisconsin Business Corporation Law, the Company's Indenture of Mortgage and Deed of Trust and the indentures supplemental thereto, and the agreements under which debt is outstanding each contain certain restrictions on the payment of dividends on common stock. By order of the PSCW, Wisconsin Gas is generally permitted to pay dividends up to the amount projected in its rate case ($16 million). The Company may pay dividends in excess of $16 million so long as the payment will not cause its common equity ratio to fall below 48.43%. If payment of projected dividends would cause its common equity ratio to fall below 43% of total capitalization (including short-term debt), or if payment of additional dividends would cause its common equity ratio to fall below 48.43%, Wisconsin Gas must obtain PSCW approval to pay such dividends. Wisconsin Gas has projected the payment of $19 million of dividends during the 12 months ending October 31, 1996. See Note 6 of Notes to Financial Statements contained in Exhibit 13, the WICOR 1995 Annual Report to Shareholders, which note is incorporated herein by reference. The PSCW desires Wisconsin Gas to target its common equity level at 43% to 50% of total capitalization. For the year ended December 31, 1995, the Company's average common equity level was 51%.\nThe Company paid cash dividends of $16,000,000 on common stock to WICOR in 1995 and 1994, respectively.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA\nOmitted pursuant to General Instruction J(2)(a).\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION\nReference is made to the section entitled \"Financial Review\" set forth in the WICOR 1995 Annual Report to Shareholders. Such section is included in Exhibit 13, which, insofar as it pertains to the Company, is hereby incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nFinancial statements for the Company together with the report of independent public accountants are included in Part IV of this report.\nItem 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThere has been no change in or disagreement with the Company's independent auditors on any matter of accounting principles or practices or financial statement disclosure re- quired to be reported pursuant to this item.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nOmitted pursuant to General Instruction J(2)(c).\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION\nOmitted pursuant to General Instruction J(2)(c).\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nOmitted pursuant to General Instruction J(2)(c).\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nOmitted pursuant to General Instruction J(2)(c).\nPART IV\nItem 14.","section_14":"Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) The following documents are filed as part of this Annual Report on Form 10-K:\n1. All Financial Statements and Report of Independent Public Accountants.\nStatement of Income.\nBalance Sheet.\nStatement of Cash Flows.\nStatement of Common Equity.\nStatement of Capitalization.\nNotes to Financial Statements.\n2. Financial Statement Schedules.\nNot required.\n3. Exhibits\n3.1 Wisconsin Gas Company Restated Articles of Incorporation, as amended (incorporated by reference to Exhibit 3.1 to the Company's Form 10-K Annual Report for 1988).\n3.2 Amendment to Wisconsin Gas Company By-laws, effective February 28, 1995 (incorporated by reference to Exhibit 3.2 to the Company's Form 10-K Annual Report for 1994).\n3.3 Wisconsin Gas Company By-laws, as amended (incorporated by reference to Exhibit 3.3 to the Company's Form 10-K Annual Report for 1994).\n4.1 Indenture of Mortgage and Deed of Trust dated as of November 1, 1950, between Milwaukee Gas Light Company and Mellon National Bank and Trust Company and D. A. Hazlett, Trustees (incorporated by reference to Exhibit 7-E to the Company's Registration Statement No. 2-8631).\n4.2 Bond Purchase Agreement dated December 31, 1981, between Wisconsin Gas Company and Teachers Insurance and Annuity Association of America relating to the issuance and sale of $30,000,000 principal amount of First Mortgage Bonds, Adjustable Rate Series due 2002 (incorporated by reference to Exhibit 4-6 to the Company's Form S-3 Registration Statement No. 33-43729).\n4.3 Indenture dated as of September 1, 1990, between Wisconsin Gas Company and First Wisconsin Trust Company, Trustee (incorporated by reference to Exhibit 4.11 to the Company's Form S-3 Registration Statement No. 33-36639).\n4.4 Officers' Certificate dated as of November 19, 1991, setting forth the terms of Wisconsin Gas Company's 7-1\/2% Notes due 1998 (incorporated by reference to Exhibit 4.1 to Wisconsin Gas Company's Form 8-K Current Report dated November 19, 1991).\n4.5 Officers' Certificate, dated as of September 15, 1993, setting forth the terms of the Company's 6.60% debentures due 2013 (incorporated by reference to Exhibit 4.1 to the Company's Form 8-K Current Report for September, 1993).\n4.6 Officers' Certificate, dated as of November 7, 1995, setting forth the terms of the Company's 6-3\/8% Notes due 2005 (incorporated by reference to the Company's Form 8-K Current Report dated November 7, 1995.\n4.7 Revolving Credit and Term Loan Agreement dated as of March 29, 1993, among Wisconsin Gas Company and the Bank of New York, Citibank, N.A., Firstar Bank of Milwaukee, N. A. Harris Trust & Savings Bank, M&I Marshall & Ilsley Bank and Citibank, N.A., as Agent (incorporated by reference to Exhibit 4.2 to the Company's Quarterly Report on Form 10-Q dated as of August 9, 1993).\n4.8 Extension of Revolving Credit and Term Loan Agreement dated as of March 29, 1994, among Wisconsin Gas Company and Citibank, N.A., Firstar Bank Milwaukee, Harris Trust and Savings Bank, M&I Marshall & Ilsley Bank and Citibank, N.A., as Agent (incorporated by reference to Exhibit 4.9 to the Company's Form 10-K Annual Report of 1994).\n4.9 Loan Agreement dated as of November 4, 1991, by and among M&I Marshall & Ilsley Bank, Wisconsin Gas Company Employee's Savings Plans Trust and WICOR, Inc. (incorporated by reference to Exhibit 4.16 to the Company's Form 10-K Annual Report for 1991).\n4.10 Loan Agreement Amendment effective December 21, 1995, by and among Wisconsin Gas Company Employees' Savings Plan Trust, WICOR, Inc., and M&I Marshall and Ilsley Bank.\n10.1 Service Agreement dated as of June 1, 1994, among WICOR, Inc., Wisconsin Gas Company, WEXCO of Delaware, Inc., Sta-Rite Industries, Inc. and SHURflo Pump Manufacturing Co.\n10.2# WICOR, Inc. 1987 Stock Option Plan, as amended (incorporated by reference to Exhibit 4.1 to the WICOR, Inc. Form S-8 Registration Statement No. 33-67134).\n10.3# Forms of nonstatutory stock option agreement used in connection with the WICOR, Inc. 1987 Stock Option Plan (incorporated by reference to Exhibit 10.20 to the Company's Form 10-K Annual Report for 1991).\n10.4# WICOR, Inc. 1992 Director Stock Option Plan (incorporated by reference to Exhibit 4.1 to WICOR, Inc.'s Form S-8 Registration No. 33-67132).\n10.5# Form of nonstatutory stock agreement used in conjunction with the WICOR, Inc. 1992 Director Stock Option Plan (incorporated by reference to Exhibit 4.2 to WICOR, Inc.'s Form S-8 Registration Statement No. 37-67132).\n10.6# WICOR, Inc. 1994 Long-Term Performance Plan (incorporated by reference to Exhibit 4.1 to the WICOR, Inc. Form S-8 Registration Statement No. 33-55755).\n10.7# Form of nonstatutory stock option agreement used in connection with the WICOR, Inc. 1994 Long-Term Performance Plan (incorporated by reference to Exhibit 4.2 to the WICOR, Inc. Form S-8 Registration Statement No. 33-55755).\n10.8# Form of restricted stock agreement used in connection with the WICOR, Inc. 1994 Long-Term Performance Plan (incorporated by reference to Exhibit 4.3 to the WICOR, Inc. Form S-8 Registration Statement No. 33-55755).\n10.9# Wisconsin Gas Company Principal Officers' Supplemental Retirement Income Program (incorporated by reference to Exhibit 10.6 to the Company's Form 10-K Annual Report for 1993).\n10.10# Wisconsin Gas Company 1996 Officers' Incentive Compensation Plan.\n10.11# Wisconsin Gas Company Group Travel Accident Plan (incorporated by reference to Exhibit 10.23 to the Company's Form 10-K Annual Report for 1992).\n10.12# Form of Deferred Compensation Agreement between Wisconsin Gas Company and certain of its officers (incorporated by reference to Exhibit 10.25 to the Company's Form 10-K Annual Report for 1991).\n10.13# WICOR, Inc. Retirement Plan for Directors, as amended (incorporated by reference to Exhibit 10.25 to the Company's Form 10-K Annual Report for 1992).\n13 \"Financial Review\" portions of WICOR, Inc. 1995 Annual Report to Shareholders.\n27 Financial Data Schedule. (EDGAR version only)\n(b) Reports on Form 8-K.\nForm 8-K Current Report dated November 7, 1995.\n# Indicates a plan under which compensation is paid or payable to directors or executive officers 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.\nWISCONSIN GAS COMPANY\nDate: March 12, 1996 By JOSEPH P. WENZLER Joseph P. Wenzler Vice President and Chief Financial Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed on the succeeding pages by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nWISCONSIN GAS COMPANY\nSignature Title Date\nTHOMAS F. SCHRADER Thomas F. Schrader President, Chief Executive Officer and Director (Principal Executive Officer) March 12, 1996\nJOSEPH P. WENZLER Joseph P. Wenzler Vice President and March 12, 1996 Chief Financial Officer (Principal Financial and Principal Accounting Officer)\nWENDELL F. BUECHE Wendell F. Bueche Director March 12, 1996\nWILLIE D. DAVIS Director March 12, 1996 Willie D. Davis\nJERE D. MCGAFFEY Jere D. McGaffey Director March 12, 1996\nDANIEL F. MCKEITHAN, JR. Dan F.McKeithan,Jr Director March 12, 1996\nGUY A. OSBORN Guy A. Osborn Director March 12, 1996\nSTUART W. TISDALE Stuart W. Tisdale Director March 12, 1996\nGEORGE E. WARDEBERG George E Wardeberg Director March 12, 1996\nESSIE M. WHITELAW Essie M. Whitelaw Director March 12, 1996\nWILLIAM B. WINTER William B. Winter Director March 12, 1996\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo Wisconsin Gas Company:\nWe have audited the accompanying balance sheet and statements of capitalization of WISCONSIN GAS COMPANY (a Wisconsin corporation and a wholly owned subsidiary of WICOR, Inc.) as of December 31, 1995 and 1994, and the related statements of income, common equity and cash flows for each of the three years in the period ended December 31, 1995. 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 Wisconsin Gas Company as of December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\nARTHUR ANDERSEN LLP\nMilwaukee, Wisconsin, January 22, 1996\nWISCONSIN GAS COMPANY Statements of Income\nThe accompanying notes are an integral part of these statements. WISCONSIN GAS COMPANY Balance Sheet\nThe accompanying notes are an integral part of these statements.\nWISCONSIN GAS COMPANY Balance Sheet\nThe accompanying notes are an integral part of these statements. WISCONSIN GAS COMPANY Statements of Cash Flow Increase (Decrease) in Cash and Cash Equivalents\nThe accompanying notes are an integral part of these statements. WISCONSIN GAS COMPANY Statements of Common Equity\nThe accompanying notes are an integral part of these statements. WISCONSIN GAS COMPANY Statements of Capitalization\nThe accompanying notes are an integral part of these statements. Wisconsin Gas Company Notes to Financial statements\n1. ACCOUNTING POLICIES\na. Business\nWisconsin Gas Company (Wisconsin Gas), the oldest and largest natural gas distribution utility in Wisconsin, is a public utility engaged in the distribution of natural gas throughout Wisconsin. Most of its revenues, however, are derived from gas delivered in southeastern Wisconsin. Wisconsin Gas is subject to regulation by the Public Service Commission of Wisconsin (PSCW) and gives recognition to ratemaking policies substantially in accordance with the Federal Energy Regulatory Commission (FERC) System of Accounts. At December 31, 1995, Wisconsin Gas served approximately 505,000 customers in 503 communities.\nb. Gas Distribution Revenues and Purchased Gas Costs\nUtility billings are rendered on a cycle basis. Revenues include estimated amounts accrued for service provided but not yet billed. Wisconsin Gas' rate schedules contain purchased gas adjustment (PGA) provisions which permit the recovery of actual purchased gas costs incurred. The difference between actual gas costs incurred and costs recovered through rates, adjusted for inventory activity, is deferred as a current asset or liability. The deferred balance is returned to or recovered from customers at intervals throughout the year and any residual balance at the annual October 31 reconciliation date is subsequently refunded to or recovered from customers. The PSCW is currently permitting Wisconsin Gas to recover pipeline supplier take-or-pay settlement costs, allocating a portion of the direct-billed costs to each customer class, including transportation customers.\nc. Plant and Depreciation\nGas distribution property, plant and equipment is stated at original cost, including overhead allocations. Upon ordinary retirement of plant assets, their cost plus cost of removal, net of salvage, is charged to accumulated depreciation, and no gain or loss is recognized. The depreciation of Wisconsin Gas' assets is computed using straight-line rates over estimated useful lives and considers salvage value. These rates have been consistently used for ratemaking purposes. The composite rates are 4.2%, 4.5% and 4.7% for 1995, 1994 and 1993, respectively.\nd. Regulatory Accounting\nWisconsin Gas accounts for its regulated operations in accordance with Statement of Financial Accounting Standards (SFAS) No. 71, \"Accounting for the Effects of Certain Types of Regulation.\" This statement sets forth the application of generally accepted accounting principles to those companies whose rates are determined by an independent third-party regulator. The economic effects of regulation can result in regulated companies recording costs that have been or are expected to be allowed in the ratemaking process in a period different from the period in which the costs would be charged to expense by an unregulated enterprise. When this occurs, costs are deferred as assets in the balance sheet (regulatory assets) and recorded as expenses as those same amounts are reflected in rates. Additionally, regulators can impose liabilities upon a regulated company for amounts previously collected from customers and for amounts that are expected to be refunded to customers (regulatory liabilities).\nThe amounts recorded as regulatory assets and regulatory liabilities in the balance sheet at December 31, 1995 and 1994 are as follows:\n(Thousands of Dollars) 1995 1994 ---------- ---------- Regulatory assets: Postretirement benefit costs (Note 8) $ 45,054 $ 47,832 Deferred environmental costs 41,457 41,942 Income tax-related amounts due from customers (Note 2) 3,357 3,711 Pipeline transition costs 261 7,411 Other 14,016 16,000 ---------- ---------- $ 104,145 $ 116,896 ========== ========== Regulatory liabilities: Income tax-related amounts due to customers (Note 2) $ 22,891 $ 24,098 Pension costs (Note 8) 19,482 22,333 Other 22,523 14,469 ---------- ---------- $ 64,896 $ 60,900 ========== ==========\nConsistent with PSCW regulation, Wisconsin Gas has capitalized computer systems development costs and amortizes the costs to expense over a five- to ten- year period. Wisconsin Gas is precluded from discontinuing service to residential customers within its service area during a certain portion of the heating season. Any differences between doubtful account provisions based on actual experience and provisions allowed for ratemaking purposes by the PSCW are deferred for later recovery in rates as a cost of service. The most recent PSCW rate order provides for a $13.9 million allowable annual provision for doubtful accounts, including amortization of prior deferred amounts. See Notes 6 and 8 for discussion of additional deferred charges.\ne. Income Taxes\nWisconsin Gas as a wholly owned subsidiary of WICOR, Inc. is included in WICOR's consolidated Federal income tax return. WICOR allocates Federal current tax expense or credits to Wisconsin Gas based on its respective separate tax computation. Investment tax credits were recorded as a deferred credit on the balance sheet and are being amortized to income over the applicable service lives of the related properties in accordance with regulatory treatment.\nf. Cash Flows\nWisconsin Gas considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents. Due to the short maturity of these instruments, market value approximates cost.\nFor purposes of the Consolidated Statements of Cash Flow, income taxes paid (net of refunds) and interest paid were as follows for each of the years ended December 31, 1995, 1994 and 1993:\n(Thousands of Dollars) 1995 1994 1993 - ----------------------- ---------- ---------- ---------- Income taxes paid $ 19,928 $ 30,059 $ 8,188 Interest paid $ 13,636 $ 13,374 $ 15,043\ng. Derivative Financial Instruments\nWisconsin Gas has a limited involvement with derivative financial instruments and does not use them for trading or speculative purposes. The Company purchased options in 1995 to hedge a small portion of gas costs incurred for resale. The cost of options and any gains or losses realized do not affect income since they are accounted for under the purchased gas adjustment clause.\nh. Use of Estimates\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those results.\ni. Reclassifications\nCertain prior year financial statement amounts have been reclassified to conform to their current year presentation.\n2. INCOME TAXES\nThe current and deferred components of income tax expense for each of the years ended December 31, are as follows:\n(Thousands of Dollars) 1995 1994 1993 - ------------------------ ---------- ---------- ---------- Current Federal $ 23,474 $ 19,245 $ 15,082 State 5,808 4,771 3,761 ---------- ---------- ---------- Total Current 29,282 24,016 18,843 ---------- ---------- ---------- Deferred Federal (10,101) (10,789) (6,432) State (2,084) (2,234) (1,131) ---------- ---------- ---------- Total Deferred (12,185) (13,023) (7,563) ---------- ---------- ---------- Total Provision $ 17,097 $ 10,993 $ 11,280 ========== ========== ==========\nThe provision for income taxes differs from the amount of income tax determined by applying the applicable U.S. statutory federal income tax rate to pre-tax income as a result of the following differences:\nThe components of deferred income tax assets and liabilities at December 31, 1995 and 1994 are as follows:\n(Thousands of Dollars) 1995 1994 - -------------------------- ---------- ---------- Deferred Income Tax Assets Recoverable gas costs $ 13,416 $ 7,258 Inventory 2,614 3,755 Deferred compensation 1,667 1,335 Other (916) 835 ---------- ---------- $ 16,781 $ 13,183 ========== ========== Deferred Income Tax Liabilities Property related $ 37,715 $ 34,643 Systems development costs 11,586 13,675 Pension benefits 3,070 1,276 Gas transition costs 105 2,974 Investment tax credit (5,109) (5,416) Environmental (4,725) (1,669) Postretirement benefits (3,177) (3,122) Deferred compensation (2,119) (2,160) Other (692) (179) ---------- ---------- $ 36,654 $ 40,022 ========== ==========\n3. SHORT-TERM BORROWINGS\nAs of December 31, 1995 and 1994, Wisconsin Gas had total unsecured lines of credit available from banks of $120.0 million and $135.0 million, respectively. At December 31, 1995, $57.5 million of commercial paper was outstanding at a weighted average interest rate of 5.9%. At December 31, 1994, $85.0 million of commercial paper was outstanding at a weighted average interest rate of 5.9%. These borrowing arrangements may require the maintenance of average compensating balances which are generally satisfied by balances maintained for normal business operations and may be withdrawn at any time.\n4. LONG-TERM DEBT\nIn November 1995, Wisconsin Gas issued $65 million of 6 3\/8% Notes due in 2005, a portion of the proceeds were used to redeem $50 million of 9 1\/8% Notes due in 1997. In September 1993, Wisconsin Gas issued $45 million of 6.6% Notes due in 2013, the proceeds of which were used to refinance $45 million of first mortgage bonds. Substantially all gas distribution property is subject to a first mortgage lien. Maturities and sinking fund requirements during the succeeding five years on all long-term debt total $4.0 million, $2.0 million, $42.0 million, $2.0 million and zero in 1996, 1997, 1998, 1999 and 2000, respectively.\n5. RESTRICTIONS\nA November 1993 rate order issued by the PSCW sets an equity range of 43% to 50% for the utility and also requires Wisconsin Gas to request PSCW approval prior to the payment of dividends on its common stock to WICOR if the payment would reduce its common equity (net assets) below 43% of total capitalization (including short-term debt). Under this requirement, $26.8 million of Wisconsin Gas' net assets at December 31, 1995, plus future earnings, were available for such dividends without PSCW approval. In addition, the PSCW must also approve any dividends in excess of $16 million for any 12 month period beginning November 1 if such dividends would dilute Wisconsin Gas' total equity below 48.43% of its total capitalization. Wisconsin Gas paid $4 million in dividends in November 1995 and expects to pay $19 million in dividends for the 12 months ending October, 1996.\n6. COMMITMENTS AND CONTINGENCIES\na. Gas Supply Wisconsin Gas has agreements for firm pipeline and storage capacity that expire at various dates through 2008. The aggregate amount of required payments under such agreements totals approximately $1,010 million, with annual required payments of $133 million in 1996, $132 million in 1997, $125 million in 1998, $123 million in 1999 and $123 million in 2000. Wisconsin Gas' total payments of fixed charges under all agreements were $130.5 million in 1995, $130.4 million in 1994 and $133.9 million in 1993. The purchased gas adjustment provisions of Wisconsin Gas' rate schedules permit the recovery of gas costs from its customers. In 1992, the FERC issued Order No. 636 that, among other things, mandated the unbundling of interstate pipeline sales service and established certain open access transportation regulations that became effective beginning in the 1993-94 heating season. Order No. 636 permits pipeline suppliers to pass through to Wisconsin Gas any prudently incurred transition costs, such as unrecovered gas costs, gas supply realignment costs and stranded investment costs. Wisconsin Gas estimates its portion of such costs from all of its pipeline suppliers would approximate $14.5 million at December 31, 1995 based upon prior filings with FERC by the pipeline suppliers. The pipeline suppliers will continue to file quarterly with the FERC for recovery of actual costs incurred. The FERC has allowed ANR Pipeline Company to recover capacity and \"above market\" supply costs associated with quantities purchased from Dakota Gasification Company (\"Dakota\") under a long-term contract expiring in the year 2009. Consistent with guidelines set forth in Order No. 636, ANR has allocated 90% of Dakota costs to firm transportation service recoverable through a reservation rate surcharge and 10% to interruptible service. ANR and other pipelines reached a settlement with Dakota governing the price of Dakota gas. A FERC administrative law judge (\"ALJ\") has overturned the settlement and ordered refunds of amounts collected from pipeline customers. The ALJ's decision is subject to review by FERC. Pending a final resolution, ANR currently recovers the difference between costs paid to Dakota and the current market price. Based on Wisconsin Gas contracted quantities with ANR, Wisconsin Gas is currently paying approximately $500,000 per month of Dakota costs. This amount varies month-to-month and across years based on the spread between ANR contract terms with Dakota and the market indices for pricing spot gas. Transition costs billed to Wisconsin Gas are being recovered from customers under the purchased gas provisions within its rate schedules. Assuming no drastic changes in the market for natural gas, Wisconsin Gas does not expect transition costs to significantly affect the total cost of gas to its customers because (1) Wisconsin Gas will purchase its wellhead gas supplies based upon market prices that should be below the cost of gas previously embedded in the bundled pipeline sales service and (2) many elements of transition costs were previously embedded in the rates for the pipelines' bundled sales service. The unbundling of pipeline sales service requires Wisconsin Gas to contract directly and separately for wellhead gas supply and firm transportation services. As a result of FERC Order No. 636, Wisconsin Gas has contracted directly for underground storage since 1993.\nb. Capital Expenditures Certain commitments have been made in connection with 1996 capital expenditures. Wisconsin Gas capital expenditures for 1996 are estimated at $48 million.\nc. Environmental Matters Wisconsin Gas has identified two previously owned sites on which it operated manufactured gas plants that are of environmental concern. Such plants ceased operations prior to the mid-1950's. Wisconsin Gas has engaged an environmental consultant to help determine the nature and extent of the contamination at these sites. Based on the test results obtained and the possible remediation alternatives available, the Company has estimated that cleanup costs could range from $22 million to $75 million. As of December 31, 1995, the Company has accrued $36.4 million for future cleanup costs. These estimates are based on current undiscounted costs. It should also be noted that the numerous assumptions such as the type and extent of contamination, available remediation techniques, and regulatory requirements which are used in developing these estimates are subject to change as new information becomes available. Any such changes in assumptions could have a significant impact on the potential liability. Due to anticipated regulatory treatment, as discussed below, changes in the recorded liability do not immediately impact net income. The Wisconsin Department of Natural Resources (WDNR) issued a Probable Responsible Party letter to Wisconsin Gas for these two sites in September 1994. Following receipt of this letter, Wisconsin Gas and WDNR held an initial meeting to discuss the sites. At the meeting it was agreed that Wisconsin Gas would prepare a remedial action options report from which it will select specific remedial actions for recommendation to the WDNR. During 1995, the Company gathered additional environmental data regarding these two sites, held extensive discussions concerning remedial options with current land owners and solicited information from environmental consulting and remediation firms on technology and approaches that would best suite the sites. These efforts were directed toward preparing a remedial action options report and recommendations for presentation to the WDNR during 1996. Once such a plan is approved, initial remediation work will begin. Expenditures over the next three years are expected to total approximately $20.0 million. Although most of the work and the cost are expected to be incurred in the first few years of the plan, monitoring of sites and other necessary actions may be undertaken for up to 30 years.\nIn March 1994, Wisconsin Gas commenced suit against nine insurance carriers seeking a declaratory judgment regarding insurance coverage for the two sites. Settlements were reached with each of the carriers during 1994. Additional insurance recoveries are being pursued. Under recent PSCW rate orders, the Company expects full recovery of incurred remediation costs, less amounts recovered from insurance carriers. If the amount recovered from the insurance carriers is insufficient to remediate both sites, expenditures not recovered will be allowed full recovery (other than for carrying costs) in rates based upon recent PSCW orders. Accordingly, the accrual for future remediation costs has been deferred as a regulatory asset. Accordingly, a regulatory asset has been recorded for the accrued cost. Certain related investigation costs incurred to date are currently being recovered in utility rates. However, any incurred costs not yet recovered in rates are not allowed by the PSCW to earn a return. As of December 31, 1995, $4.8 million of such costs had been incurred.\nd. Other The Company is party to various legal proceedings arising in the ordinary course of business which are not expected to have a material effect on the Company's financial position or results of operation.\n7. COMMON STOCK AND OTHER PAID-IN CAPITAL\nDuring 1994 and 1993, WICOR invested in Wisconsin Gas, $5 million and $12 million, respectively. No amounts were invested by WICOR in 1995.\n8. BENEFIT PLANS\na. Pension Plans Wisconsin Gas has non-contributory pension plans which cover substantially all its employees and include benefits based on levels of compensation and years of service. Employer contributions and funding policies are consistent with funding requirements of Federal law and regulations. Commencing November 1, 1992, Wisconsin Gas pension costs or credits included in the utility cost of service have been calculated in accordance with SFAS No. 87 and are recoverable from customers. Prior to this date, pension costs were recoverable in rates as funded.\nThe following table sets forth the funded status of pension plans at December 31, 1995 and 1994. The cumulative difference between the amounts funded and the amounts based on SFAS No. 87 through November 1, 1992 is recorded as a regulatory liability and is being amortized as a reduction of pension expense over an eight-year period effective November 1, 1994.\nThe weighted average discount rate assumptions used in determining the actuarial present value of the projected benefit obligation were 7.5%, 8.25% and 7.5% for 1995, 1994 and 1993, respectively. The expected long-term rate of return on assets was 8.5%, 8.5% and 8.0% for 1995, 1994 and 1993, respectively. The expected long-term rate of compensation growth was 5.0%, 5.5% and 6.0% for 1995, 1994 and 1993, respectively. Net pension costs for each of the years ended December 31, include the following (income) expense:\n(Thousands of Dollars) 1995 1994 1993 - -------------------------- ---------- ---------- ---------- Service costs $ 3,529 $ 4,265 $ 4,872 Interest costs on projected benefit obligations 9,305 8,860 9,023 Actual (gain) loss on plan assets (21,057) 1,880 (13,474) Net amortization\/deferral 7,232 (15,195) (1,424) Gain on early retirement incentive - (268) - Amortization of regulatory liability (2,851) (475) - ---------- ---------- ---------- Net pension income $ (3,842) $ (933) $ (1,003) ========== ========== ==========\nb. Postretirement Health Care and Life Insurance In addition to providing pension benefits, Wisconsin Gas provides certain health care and life insurance benefits for retired employees when they reach normal retirement age while working for the Company. Wisconsin Gas funds the accrual annually based on the maximum tax deductible amount. Commencing January 1, 1992, Wisconsin Gas postretirement benefit costs have been calculated in accordance with SFAS No. 106 and are recoverable from customers. The cumulative difference between the amounts funded and the amounts based on SFAS No. 106 through January 1, 1992 is recorded as a regulatory asset and is being amortized over a twenty-year period effective January 1, 1992. Net postretirement health care and life insurance costs for each of the years ended December 31, consisted of the following components:\n(Thousands of Dollars) 1995 1994 1993 - ---------------------- ---------- ---------- ---------- Service cost $ 1,847 $ 2,492 $ 2,575 Interest cost on projected benefit obligation 5,336 5,665 5,396 Actual (gain) loss on plan assets (6,185) 147 (1,414) Amortize regulatory asset 2,778 2,778 2,651 Net amortization\/deferral 2,477 (2,628) - Loss on early retirement incentive - 3,650 - ---------- ---------- ---------- Net postretirement benefit cost $ 6,253 $ 12,104 $ 9,208 ========== ========== ==========\nThe 1994 postretirement benefit cost was increased due to the early retirement of 131 employees under a voluntary early retirement incentive plan for employees age 55 and over.\nThe following table sets forth the plans' funded status, reconciled with amounts recognized in the Company's Statement of Financial Position at December 31, 1995 and 1994, respectively.\nAccumulated benefit obligation (Thousands of Dollars) 1995 1994 - ------------------------------------- ---------- ---------- Retirees $ (38,966) $ (40,510) Active employees (37,633) (26,716) ---------- ---------- Accumulated benefit obligation (76,599) (67,226) Plan assets at fair value 39,417 30,666 ---------- ---------- Accumulated benefit obligation in excess of plan assets (37,182) (36,560) Unrecognized prior service costs (15,915) (16,347) Unrecognized actuarial (gain) loss 129 (2,717) ---------- ---------- Accrued postretirement benefit $ (52,968) $ (55,624) ========== ==========\nThe postretirement benefit cost components for 1995 were calculated assuming health care cost trend rates beginning at 11% in 1995 and decreasing to 6% in 23 years. The health care cost trend rate has a significant effect on the amounts reported. Increasing the assumed health care cost trend rates by one percentage point in each year would increase the APBO as of December 31, 1995 by $12.4 million and the aggregate of the service and interest cost components of postretirement expense by $1.7 million. The assumed discount rate used in determining the actuarial present value of the accumulated postretirement benefit obligation was 7.5%, 8.25% and 7.50% in 1995, 1994 and 1993, respectively. Plan assets are primarily invested in equities and fixed income securities.\nc. Retirement Savings Plans Wisconsin Gas maintains various employee savings plans, which provide employees a mechanism to contribute amounts up to 16% of their compensation for the year. Company matching contributions may be made for up to 5% of eligible compensation including 1% for the Employee Stock Ownership Plan (ESOP). See Note 8.d. Total contributions were valued at $1.2 million in 1995, $1.3 million in 1994 and $1.3 million in 1993.\nd. Employee Stock Ownership Plan In November 1991, WICOR established an ESOP covering non- union employees of Wisconsin Gas. The ESOP funds employee benefits of up to 1% of compensation with Company common stock distributed through the ESOP. The ESOP used the proceeds from a $10 million, 3-year adjustable rate loan with a 6.44% interest rate at December 31, 1995, guaranteed by WICOR, to purchase 431,266 shares of original issue WICOR common stock. The ESOP extended the adjustable rate loan, with similar terms, until March 29, 1996. WICOR expects to refinance the adjustable rate loan in the first quarter of 1996. Because WICOR has guaranteed the loan, the unpaid balance ($5.3 million) is shown as long-term debt with a like amount of unearned compensation being recorded as a reduction of common equity on WICOR's balance sheet. The ESOP trustee is repaying the $10 million loan with dividends on shares of WICOR common stock in the ESOP and with Wisconsin Gas contributions to the ESOP.\ne. Postemployment Benefit Plans Effective January 1, 1994 the Company adopted SFAS No. 112, \"Employers' Accounting for Postemployment Benefits,\" which requires accrual for all other postemployment benefits. Total postemployment benefit expense was $0.6 million in 1995 and 1994, respectively, including a one-time cumulative adjustment in 1994. The incremental costs of adopting this statement are insignificant on an ongoing basis.\n9. FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe carrying value of cash and cash equivalents, accounts receivable and short-term borrowings approximates fair value due the short-term maturities of these instruments.\nThe fair value of Wisconsin Gas' long-term debt is estimated based on the quoted market prices of U.S. Treasury issues having a similar term to maturity, adjusted for the Company's bond rating and the present value of future cash flows. Because Wisconsin Gas operates in a regulated environment, shareholders would probably not be affected by realization of gains or losses on extinguishment of its outstanding fixed-rate debt. Realized gains would be refunded to and losses would be recovered from customers through gas rates. The estimated fair value of Wisconsin Gas' long-term debt at December 31, is as follows:\n10. QUARTERLY FINANCIAL DATA (Unaudited)\nBecause seasonal factors significantly affect Wisconsin Gas operations, the following data is not comparable between quarters:\n(Thousands of dollars) First Second Third Fourth - ----------------------- -------- --------- --------- --------\nOperating Revenues $192,484 $ 93,985 $ 70,959 $161,970 Operating Income (Loss) $ 38,572 $ 2,226 $ (8,492) $ 27,356 Net Income (Loss) $ 21,532 $ (570) $ (7,332) $ 14,447\nOperating Revenues $242,148 $ 99,349 $ 76,675 $138,415 Operating Income (Loss) $ 43,331 $ (3,680) $(13,172) $ 17,885 Net Income (Loss) $ 24,878 $ (4,292) $(10,485) $ 8,795 \/TABLE\nEXHIBIT INDEX\n3.1 Wisconsin Gas Company Restated Articles of Incorporation, as amended (incorporated by reference to Exhibit 3.1 to the Company's Form 10-K Annual Report for 1988).\n3.2 Amendment to Wisconsin Gas Company By-laws, effective February 28, 1995 (incorporated by reference to Exhibit 3.2 to the Company's Form 10-K Annual Report for 1994).\n3.3 Wisconsin Gas Company By-laws, as amended (incorporated by reference to Exhibit 3.3 to the Company's Form 10-K Annual Report for 1994).\n4.1 Indenture of Mortgage and Deed of Trust dated as of November 1, 1950, between Milwaukee Gas Light Company and Mellon National Bank and Trust Company and D. A. Hazlett, Trustees (incorporated by reference to Exhibit 7-E to the Company's Registration Statement No. 2-8631).\n4.2 Bond Purchase Agreement dated December 31, 1981, between Wisconsin Gas Company and Teachers Insurance and Annuity Association of America relating to the issuance and sale of $30,000,000 principal amount of First Mortgage Bonds, Adjustable Rate Series due 2002 (incorporated by reference to Exhibit 4-6 to the Company's Form S-3 Registration Statement No. 33-43729).\n4.3 Indenture dated as of September 1, 1990, between Wisconsin Gas Company and First Wisconsin Trust Company, Trustee (incorporated by reference to Exhibit 4.11 to the Company's Form S-3 Registration Statement No. 33-36639).\n4.4 Officers' Certificate dated as of November 19, 1991, setting forth the terms of Wisconsin Gas Company's 7-1\/2% Notes due 1998 (incorporated by reference to Exhibit 4.1 to Wisconsin Gas Company's Form 8-K Current Report dated November 19, 1991).\n4.5 Officers' Certificate, dated as of September 15, 1993, setting forth the terms of the Company's 6.60% debentures due 2013 (incorporated by reference to Exhibit 4.1 to the Company's Form 8-K Current Report for September, 1993).\n4.6 Officers' Certificate, dated as of November 7, 1995, setting forth the terms of the Company's 6-3\/8% Notes due 2005 (incorporated by reference to the Company's Form 8-K Current Report dated November 7, 1995.\n4.7 Revolving Credit and Term Loan Agreement dated as of March 29, 1993, among Wisconsin Gas Company and the Bank of New York, Citibank, N.A., Firstar Bank of Milwaukee, N. A. Harris Trust & Savings Bank, M&I Marshall & Ilsley Bank and Citibank, N.A., as Agent (incorporated by reference to Exhibit 4.2 to the Company's Quarterly Report on Form 10-Q dated as of August 9, 1993).\n4.8 Extension of Revolving Credit and Term Loan Agreement dated as of March 29, 1994, among Wisconsin Gas Company and Citibank, N.A., Firstar Bank Milwaukee, Harris Trust and Savings Bank, M&I Marshall & Ilsley Bank and Citibank, N.A., as Agent (incorporated by reference to Exhibit 4.9 to the Company's Form 10-K Annual Report of 1994).\n4.9 Loan Agreement dated as of November 4, 1991, by and among M&I Marshall & Ilsley Bank, Wisconsin Gas Company Employee's Savings Plans Trust and WICOR, Inc. (incorporated by reference to Exhibit 4.16 to the Company's Form 10-K Annual Report for 1991).\n4.10* Loan Agreement Amendment effective December 21, 1995, by and among Wisconsin Gas Company Employees' Savings Plan Trust, WICOR, Inc., and M&I Marshall and Ilsley Bank.\n10.1 Service Agreement dated as of June 1, 1994, among WICOR, Inc., Wisconsin Gas Company, WEXCO of Delaware, Inc., Sta-Rite Industries, Inc. and SHURflo Pump Manufacturing Co.\n10.2# WICOR, Inc. 1987 Stock Option Plan, as amended (incorporated by reference to Exhibit 4.1 to the WICOR, Inc. Form S-8 Registration Statement No. 33-67134).\n10.3# Forms of nonstatutory stock option agreement used in connection with the WICOR, Inc. 1987 Stock Option Plan (incorporated by reference to Exhibit 10.20 to the Company's Form 10-K Annual Report for 1991).\n10.4# WICOR, Inc. 1992 Director Stock Option Plan (incorporated by reference to Exhibit 4.1 to WICOR, Inc.'s Form S-8 Registration No. 33-67132).\n10.5# Form of nonstatutory stock agreement used in conjunction with the WICOR, Inc. 1992 Director Stock Option Plan (incorporated by reference to Exhibit 4.2 to WICOR, Inc.'s Form S-8 Registration Statement No. 37-67132).\n10.6# WICOR, Inc. 1994 Long-Term Performance Plan (incorporated by reference to Exhibit 4.1 to the WICOR, Inc. Form S-8 Registration Statement No. 33-55755).\n10.7# Form of nonstatutory stock option agreement used in connection with the WICOR, Inc. 1994 Long-Term Performance Plan (incorporated by reference to Exhibit 4.2 to the WICOR, Inc. Form S-8 Registration Statement No. 33-55755).\n10.8# Form of restricted stock agreement used in connection with the WICOR, Inc. 1994 Long-Term Performance Plan (incorporated by reference to Exhibit 4.3 to the WICOR, Inc. Form S-8 Registration Statement No. 33-55755).\n10.9# Wisconsin Gas Company Principal Officers' Supplemental Retirement Income Program (incorporated by reference to Exhibit 10.6 to the Company's Form 10-K Annual Report for 1993).\n10.10#* Wisconsin Gas Company 1996 Officers' Incentive Compensation Plan.\n10.11# Wisconsin Gas Company Group Travel Accident Plan (incorporated by reference to Exhibit 10.23 to the Company's Form 10-K Annual Report for 1992).\n10.12# Form of Deferred Compensation Agreement between Wisconsin Gas Company and certain of its officers (incorporated by reference to Exhibit 10.25 to the Company's Form 10-K Annual Report for 1991).\n10.13# WICOR, Inc. Retirement Plan for Directors, as amended (incorporated by reference to Exhibit 10.25 to the Company's Form 10-K Annual Report for 1992).\n13* \"Financial Review\" portions of WICOR, Inc. 1995 Annual Report to Shareholders.\n27* Financial Data Schedule. (EDGAR version only)\n* Indicates document filed herewith\n# Indicates a plan under which compensation is paid or payable to directors or executive officers of the Company","section_15":""}
{"filename":"88205_1995.txt","cik":"88205","year":"1995","section_1":"ITEM 1. BUSINESS\nSPX Corporation (\"SPX\" or the \"company\") is a global participant in the design, manufacture and marketing of products for the motor vehicle industry. Its operations are focused on the markets for specialty service tools and equipment used in vehicular repair and maintenance, and original equipment components for the manufacture and repair of motor vehicles.\nThe company was organized in 1911 under the laws of Michigan, and reincorporated in Delaware in 1968. It was known as The Piston Ring Company until 1931, when it changed its name to Sealed Power Corporation. The name was changed again in 1988, when it became SPX Corporation. Today, SPX Corporation is a multi-national corporation with operations in 14 nations. The corporate headquarters is located in Muskegon, Michigan.\nRECENT DEVELOPMENTS\nDuring 1995, the following significant events and initiatives were undertaken:\n- During the second quarter, the Board of Directors accepted Dale A. Johnson's resignation and began the search for a permanent Chief Executive. Charles E. Johnson II, a member of the board, became Chairman and Chief Executive Officer on an interim basis. At the December meeting, the board elected John B. Blystone as the company's new Chairman, President and Chief Executive Officer.\n- At the end of the first quarter, the company reduced the cost structure at the Automotive Diagnostics division by reducing headcount by approximately 140 people. This resulted in a severance charge of approximately $1.1 million, but generated an estimated $7 million in annual savings.\n- The company completed the sale of SPX Credit Corporation in the third quarter. The buyer will continue to provide the company's customers with a lease financing option for the company's products. The company believes it has a strong relationship with the buyer. Additionally, proceeds from this sale, over $70 million, were used to reduce the company's debt.\n- During the fourth quarter, the company initiated a significant restructuring within the Specialty Service Tool segment that consolidated five divisions into two divisions. The company combined the Kent-Moore division, the Dealer Equipment Service division and the program tool portion of the OTC division to form the OE Tool and Equipment division and combined the Automotive Diagnostics division, the Robinair division and the aftermarket tool portion of the OTC division to form the Aftermarket Tool and Equipment division. The restructuring includes closing two manufacturing facilities, a distribution facility and an operation in Europe. Additionally, the restructuring will combine sales, marketing, engineering and administrative functions at these units. The estimated overall cost of this restructuring is approximately $18 million, and annual savings are estimated to be $23 million by 1998.\n- During the fourth quarter, the company decided to close its unprofitable foundry operation at SP Europe Germany. The company recorded a $3.7 million restructuring charge to accrue for termination benefits for the 200 employees that are affected by the closing. The company obtained significant wage concessions and improved work rule flexibility from the employees that will continue to produce piston rings and cylinder sleeves at this plant. Additionally, the company obtained a reduction in the cost of utilities and other locally provided services to the plant. The company anticipates that the cumulative effect of these actions will improve this operation in the future.\nBUSINESS SEGMENTS\nThe company is comprised of two business segments. Specialty Service Tools includes operations that design, manufacture and market a wide range of specialty service tools and diagnostic equipment, primarily to the global motor vehicle industry. Original Equipment Components includes operations that design, manufacture and market component parts for light and heavy duty vehicle markets.\nPreviously, SPX Credit Corporation was reported as a segment, but was discontinued in 1995 and is now presented as a discontinued operation on the company's financial statements. SPX Credit Corporation provided Specialty Service Tool customers with a leasing option for purchasing higher dollar value diagnostic testing, emission testing and wheel service equipment.\nThe following table summarizes revenue by segment for the last three years. Revenues for 1995 and 1994 are actual revenues for the company and its consolidated subsidiaries. Unaudited proforma revenues for 1993 reflect the acquisition of Allen Testproducts, the divestiture of the Sealed Power Replacement and Truth divisions, the acquisition of Sealed Power Technologies Limited Partnership (\"SPT\") and the consolidation of Sealed Power Europe Limited Partnership (\"SP Europe\") as if they had occurred at the beginning of 1993. Please refer to Note 6 to the consolidated financial statements for further explanation of the 1993 proforma revenues.\nSPECIALTY SERVICE TOOLS\nOver the past 12 years, the company has made significant investments in the specialty service tool market. The company acquired Kent-Moore and Robinair in 1982, OTC and Power Team in 1985, VL Churchill (United Kingdom) in 1985, and Bear Automotive in 1988. It created Dealer Equipment and Services in 1989, acquired Miller Special Tools in 1991, and acquired Allen Testproducts and Lowener (Germany) in 1993. The specialty service tool market continues to be a source of opportunity due to the increasing complexity of repairing motor vehicles.\nThe Specialty Service Tools segment includes three operating divisions that design, manufacture and market a wide range of specialty service tools and diagnostic equipment primarily to the worldwide motor vehicle industry. Approximately 18% of revenues are to non-North American customers.\nThe company competes with numerous companies that specialize in certain lines of its Specialty Service Tools. The company believes it is the world leader in offering specialty service tools for motor vehicle manufacturers' dealership networks. The company is a major producer of electronic engine diagnostic equipment, emissions testing equipment and wheel service equipment in North America and Europe. The key competitive factors influencing the sale of Specialty Service Tools are design expertise, timeliness of delivery, quality, service and price. Sales of specialty service tools essential to dealerships tend to vary with changes in vehicle design and the number of dealerships and are not directly dependent on the volume of vehicles that are produced by the motor vehicle manufacturers.\nDesign of specialty service tools is critical to their functionality and generally requires close coordination with either the motor vehicle manufacturers or with the ultimate users of the tools or instruments. These products are marketed as solutions to service problems and as aids to performance improvements. After the design is completed, the company manufactures, assembles or outsources these products. The company also markets a broad line of equipment of other manufacturers through dealership equipment programs coordinated with certain motor vehicle manufacturers and aftermarket service organizations.\nOE Tool and Equipment -- This division provides automotive and heavy duty vehicle, agricultural and construction dealerships of motor vehicle manufacturers with essential program and general specialty service tools, dealer equipment and other services. These products and services are sold or provided using the brands and trade names of Kent-Moore, OTC, VL Churchill, Lowener, Miller Special Tools, Jurubatech, Dealer Equipment and Services, and, in some cases, the motor vehicle manufacturer's identity.\nEssential program and general specialty service tools include specialty hand-held mechanical tools and specialty handheld electronic diagnostic instruments and related software. These products are based on customer needs, primarily to perform warranty and other service work at franchised dealers. The division's technical product development and sales staff works closely with the original equipment manufacturers to design tools to meet the exacting needs of specialty repair work. Products are sold to franchised dealers under both essential and general programs. Essential programs are those in which the motor vehicle manufacturer requires its dealers to purchase and maintain the tools for warranty and service work.\nAdditionally, the division administers seventeen dealer equipment programs in North America and Europe. Included are programs for General Motors, Chrysler, Saturn, Opel, Nissan, Toyota and Hyundai. Under the motor vehicle manufacturer's identity, the division supplies service equipment and support material to dealerships, develops and distributes equipment catalogues, and helps dealerships assess and meet their service equipment needs.\nThe division has manufacturing operations in the United States and Spain. Sales and marketing operations exist in the United States, Switzerland, the United Kingdom, France, Australia, Spain, and Brazil. The division also manages the company's 50% interest in JATEK, a Japanese company that markets specialty service tools and equipment in the Pacific Rim.\nAftermarket Tool and Equipment -- This division provides the motor vehicle service aftermarket with a wide range of specialty service tools. These products are marketed under the name brands of Allen Testproducts, Bear, Litchfield, OTC, Robinair, and V.L. Churchill. Certain of the division's products are marketed to the company's OE Tool and Equipment division, which in turn markets these products to dealers of motor vehicle manufacturers. The division also markets a portion of its products to the appliance, refrigeration, and non-vehicular service repair market.\nProducts include specialized mechanical, electronic, and hydraulic service tools, electronic diagnostic equipment, refrigeration vacuum pumps, recharging equipment and leak detection equipment, refrigerant and engine coolant recovery and recycling equipment, vehicle emissions testing equipment, wheel service equipment and shop equipment. The division distributes its products through warehouse distributors and jobbers, a direct salesforce, OEM distribution and independent distributorships, primarily in foreign countries. In-house sales and technical staffs support these various types of distribution. In North America, the division is supported by a network of distribution and service centers.\nThe division's manufacturing facilities are located in the United States. Sales and marketing operations exist in the United States, Canada, Germany, the United Kingdom, Italy, Switzerland, Spain, and Australia.\nPower Team -- This division is a leading producer and marketer of precision quality high-pressure hydraulic pumps, rams, valves, pullers and other equipment. The division markets these products through industrial distributors, its own sales force and independent agents. The sales and marketing effort is supported by a strong technical support staff as products must be designed to exacting specifications to meet the multitude of applications for these products. Approximately three-fourths of the division's sales are related to the motor vehicle service industry, while the balance of sales are made in non-transportation markets such as construction, aerospace and industrial maintenance.\nThe division has sales, marketing and manufacturing operations in the United States. Additionally, sales and marketing offices are located in Australia, The Netherlands, and Singapore.\nThe company is one of two major producers in this marketplace, which is also supplied by many niche companies.\nORIGINAL EQUIPMENT COMPONENTS\nDuring 1993, the company implemented its strategy to focus on its position as an original equipment component supplier. As of December 31, 1993, the purchase of Riken Corporation's 49% interest in SPT\nprovided the company with control and ownership of SPT's four original equipment divisions. Combined with the company's Acutex division and SP Europe, the company has a broad range of products for both original equipment manufacturers and aftermarket customers. Each of the Original Equipment Components segment's operating divisions has achieved various OEM customer quality recognition and awards.\nThe Original Equipment Components segment includes five operating divisions that design, manufacture and market component parts for light and heavy duty vehicle markets. The component parts for the light and heavy duty vehicle market are composed of two primary sectors: (i) the OEM sector and (ii) the vehicle maintenance and repair sector, the so-called replacement market or aftermarket. The U.S. - Canadian - European OEM sector is composed primarily of four classes of customers: (a) U.S. manufacturers, dominated by General Motors, Ford and Chrysler, but including other vehicle manufacturers such as Navistar International and Mack Trucks; (b) foreign companies producing vehicles in North America and Europe (\"transplants\"); (c) European vehicle manufacturers, sometimes sourcing the company's products through assemblies; and (d) vehicle manufacturers producing vehicles outside the U.S., Canada and Europe. Aftermarket customers include the service organizations of OEMs, automotive parts manufacturers and distributors and private brand distributors such as Federal-Mogul and Allied Signal.\nOEM contracts typically are from one to five years in length with the one year contracts typically being renewed or renegotiated, depending on part changes, in the ordinary course of business and the longer term contracts typically containing material cost pass-through and productivity improvement clauses. Sales of products to OEMs are affected, to a large extent, by vehicle production which, in turn, is dependent on general economic conditions. Historically, global vehicle production has been cyclical.\nAftermarket sales are tied to the age of vehicles in service and the need for replacement parts. Sales of products to the aftermarket historically have been less affected by general economic conditions than OEM sales since vehicle owners are more likely to repair vehicles than purchase new ones during recessionary periods.\nIn its main product areas, the company competes with a small number of principal competitors (including the OEMs in certain product categories), some of which are larger in size and have greater financial resources than the company. Competitive factors influencing sales include quality, technology, service and price.\nAcutex -- This division produces solenoid valves and related assemblies for major vehicle and transmission manufacturers around the world. Acutex's proprietary solenoid valve products interface between the electronic signals of a vehicle's on-board computer and the vehicle's hydraulic systems. The company is using this technology in designing and manufacturing solenoid valves for electronically controlled automatic transmissions.\nContech -- This division produces precision aluminum and magnesium die cast parts for automotive steering and air conditioning systems, and other assorted automotive\/light truck uses. Primary products in this area include steering column parts, rack-and-pinion components and other castings such as components for air conditioning compressors, fuel systems, clutches, and transmissions. Approximately one-half of the castings are machined by the division prior to delivery to customers.\nProducts are sold almost exclusively to automotive OEMs through the division's marketing and sales personnel who are assisted by an outside sales organization. The market is driven primarily by major OEM model and assembly programs.\nThe division has recently completed a major investment in magnesium die casting. The benefits of magnesium, including less weight and higher strength-to-weight ratio, will increase the division's proportion of future sales that are magnesium die castings.\nFiltran -- This division is a leading producer of automatic transmission filters and other filter products and has a leading position in the U.S. and Canadian OEM market and aftermarket. A typical transmission filter product consists of a composite plastic\/metal or all metal housing which contains a\nhighly specialized non-woven felt, polymesh, or metal screen filter element designed to capture foreign particles.\nThe division sells filters directly to the worldwide OEM market and aftermarket. Approximately two-thirds of sales are to the aftermarket which includes the OEM parts and service organizations as well as private brand manufacturers and assorted transmission rebuilders, repackagers, and \"quick lube\" shops.\nThe division participates in the worldwide OEM market in two different arenas. In Europe, the company's 50% owned joint venture, IBS Filtran, manufactures and distributes filters to OEM customers. In the Pacific Rim, the division exports filters to OEM manufacturers in Japan, Korea and Australia.\nHy-Lift -- This division is a domestic supplier of a variety of valve train components, including tappets, lash adjusters and roller rocker arms. Sales are made to both the domestic OEM market and the domestic aftermarket. Sales to the aftermarket, comprising approximately one-third of total sales, are made through several channels, including direct sales to the OEM parts and service organizations and sales to private brand customers.\nSealed Power Division -- The division is the leading North American producer of automotive piston rings and among the largest independent producers of cylinder liners for automotive and heavy duty engines. The division also produces sealing rings for automatic transmissions.\nThere is a continuing trend in the automotive industry to reduce the weight of vehicles, which increases gas mileage. This trend has resulted in the development of aluminum engine blocks that require cast iron cylinder liners. Automotive engine blocks made of cast iron do not require a cylinder liner. The division has been successful in obtaining contracts from the OEMs for these high volume automotive cylinder liner applications. In 1994, the division invested heavily in cylinder liner automated casting equipment and machining cells to support increases in customer demand for cylinder liners. The level of investment continued into 1995.\nThe division's products are purchased by both automotive\/light truck and heavy duty engine OEMs. The division utilizes a technical sales force that works with OEM engine and transmission designers to provide high quality rings and cylinder liners.\nApproximately one-fourth of the division's sales are to the aftermarket. In addition to OEM parts and service organizations, the division supplies the aftermarket through private brand organizations, which sell these products under various private labels.\nSP Europe, like its North American counterpart, Sealed Power division, is a designer, producer and distributor of automotive and heavy duty piston rings and cylinder liners. Its sales are predominately to European OEMs and to the European aftermarket. SP Europe's primary European customers are VW, Federal-Mogul, Mahle, Kolbenschmidt, Alcan, Audi, Volvo and Mercedes Benz. SP Europe was created by the company in June of 1991 after acquiring the European piston ring and cylinder liner manufacturing business of TRW, Inc. In October of 1992, Mahle GmbH contributed its Spanish piston ring operation to SP Europe in exchange for a 30% ownership interest in SP Europe. The Sealed Power division has managed SP Europe since its inception.\nThe division manages a 50% owned investment in Allied Ring Corporation, a U.S. joint venture with Riken, which manufactures and distributes piston rings primarily to foreign companies producing engines in North America (\"transplants\").\nThe division is also responsible for managing the company's 40% equity investment in Promec, a Mexican company that manufactures and distributes piston rings and cylinder liners in Mexico.\nINTERNATIONAL OPERATIONS\nThe company has wholly owned operations located in Australia, Brazil, Canada, France, Germany, Italy, The Netherlands, Singapore, Spain, Switzerland and the United Kingdom. The company also has a 70% ownership in SP Europe, located in France, Germany and Spain.\nAdditionally, the company has the following non U.S. equity investments:\nJATEK (50%). A Japanese company that sells various products into the Asia Pacific Rim market, including many of the company's specialty service tool products.\nPromec (40%). A Mexican company which, through its subsidiaries, manufactures and distributes piston ring and cylinder liner products in Mexico.\nIBS Filtran (50%). A German company that manufacturers and distributes automotive transmission filters to the European market.\nDuring the fourth quarter, the company sold its 50% interest in RSV, a Japanese company that utilizes the company's technology to develop and manufacture solenoid valves for the Pacific Rim markets, to the joint venture partner. The company maintains a royalty arrangement to license its solenoid valve technology to RSV.\nThe company has a cross-licensing agreement for piston rings with Riken Corporation.\nThe company's international operations are subject to the risk of possible currency devaluation and blockage, nationalization or restrictive legislation regulating foreign investments and other risks attendant to the countries in which they are located.\nThe company's total export sales, to both affiliated and unaffiliated customers, from the United States, were as follows:\n1993 export sales do not include export sales of SPT as it was not consolidated until December 31, 1993. Historically, SPT's export sales were less than 10% of its total sales.\nRESEARCH AND DEVELOPMENT\nThe company is actively engaged in research and development programs designed to improve existing products and manufacturing methods and to develop new products. These engineering efforts encompass all of the company's products with divisional engineering teams coordinating their resources.\nParticular emphasis has been placed on the development of new products that are compatible with, and build upon, the manufacturing and marketing capabilities of the company. To assist the company in meeting customer requirements, computer aided design (CAD) systems, that provide rapid integration of computers in mechanical design, model testing and manufacturing control, are used extensively.\nThe company expended approximately $26.3 million on research activities relating to the development and improvement of its products in 1995, $26.4 million in 1994 and $17.6 million in 1993. There was no customer sponsored research activity in these years. Research and development expenditures for 1993 do not include SPT as it was not consolidated until December 31, 1993. SPT's research and development expenditures were $3.4 million in 1993.\nPATENTS\/TRADEMARKS\nThe company owns numerous domestic and foreign patents covering a variety of its products and methods of manufacture and owns a number of registered trademarks. Although in the aggregate its patents and trademarks are of considerable importance in the operation of its businesses, the company does not consider any single patent or trademark to be of such material importance that its absence would adversely affect the company's ability to conduct its businesses as presently constituted.\nRAW MATERIALS\nThe company's manufactured products are made predominately from iron, steel, aluminum, magnesium, plastics and electronic components. These raw materials are generally purchased from multiple sources of supply and the company has not experienced any significant disruptions in its businesses due to shortages.\nOTHER MATTERS\nAt the end of 1995, the company's employment was 8,296 persons. Approximately one-third of the company's 3,927 U.S. production and maintenance employees are covered by collective bargaining agreements with various unions. These agreements expire at different times over the next several years. The company's collective bargaining agreement with Local 473 of the International Association of Bridge, Structural and Ornamental Iron Workers covering approximately 218 employees expires in April 1996. In addition, the company's collective bargaining agreement with Local 2492 of the International Association of Machinists and Aerospace Workers covering approximately 88 employees expires in September 1996. Also, the company's collective bargaining agreement with Local 7629 of the United Paperworkers International covering approximately 164 employees expiring in June 1996 has been extended until the plant is closed. Management believes it has generally good relations with its employees and anticipates that all of its collective bargaining agreements will be extended or renegotiated in the ordinary course of business. Certain contracts with OEM customers require the company to build inventories of critical components prior to the expiration of collective bargaining agreements.\nApproximately 20% in 1995, 16% in 1994 and 9% in 1993 of the company's consolidated sales were made to General Motors Corporation and its various divisions, dealers and distributors. Approximately 12% in 1995, 12% in 1994 and 2% in 1993 of the company's consolidated sales were made to Ford Motor Company and its various divisions, dealers and distributors. Approximately 5% in 1995, 7% in 1994 and 6% in 1993 of the company's consolidated sales were made to Chrysler Corporation and its various divisions, dealers and distributors. No other customer or group of customers under common control accounted for more than 10% of consolidated sales for any of these years. On a proforma basis, approximately 17%, 10% and 8% of consolidated sales were to General Motors, Ford and Chrysler in 1993, respectively.\nThe company does not believe that order backlog is a significant factor in the specialty service tools segment. Within the original equipment components segment, long term contracts and the related level of new vehicle production are significant to future sales.\nAll of the company's businesses are required to maintain sufficient levels of working capital to support customer requirements, particularly inventory. Sales terms and payment terms are in line with the practices of the industries in which they compete, none of which are unusual.\nThe majority of the company's businesses tend to be nonseasonal and closely follow changes in vehicle design, vehicle production, and general economic conditions. However, specific markets such as air conditioning service and repair follow the seasonal trends associated with the weather (sales are typically higher in spring and summer). Government regulations, such as the Clean Air Act, can also impact the timing and level of certain specialty service tool sales.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nUNITED STATES -- The principal properties used by the company for manufacturing, administration and warehousing consist of 46 separate facilities totaling approximately 3.8 million square feet. These facilities are\nlocated in Georgia, Illinois, Indiana, Kentucky, Michigan, Minnesota, Missouri, Ohio, and Pennsylvania. All facilities are owned, except for 9, which are leased (all non manufacturing). These leased facilities aggregate 361,000 square feet and have an average lease term of 4+ years.\nThe company also has 30 distribution and service centers located throughout the United States for distribution and servicing of its Specialty Service Tools. These distribution and service centers aggregate 126,000 square feet and all are leased. No single distribution and service center is of material significance to the company's business.\nINTERNATIONAL -- The company owns approximately 113,000 square feet and leases approximately 944,000 square feet of manufacturing, administration and distribution facilities in Australia, Brazil, Canada, France, Germany, Italy, The Netherlands, Singapore, Spain, Switzerland and the United Kingdom.\nThe company's properties used for manufacturing, administration and warehousing are adequate to meet its needs as of December 31, 1995. The company configures and maintains these facilities as required by their business use. At December 31, 1995, the company believes that it does not have significant excess capacity at any of its major facilities. Three facilities are directly affected by the current restructuring process. Two of these facilities in Michigan, a 110,000 square foot manufacturing plant and a 98,000 square foot distribution center, will be closed during 1996 as activity will be combined with other facilities. Both of these facilities are owned and the company believes that the facilities can be readily sold. The other facility, a 157,000 square foot manufacturing plant in Pennsylvania, will be closed in late 1996 or early 1997 as activity will be combined with another facility. This facility is not considered to be readily marketable and its carrying value has been reserved for as part of the restructuring charge.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nCertain claims, including environmental matters, suits and complaints arising in the ordinary course of business, have been filed or are pending against the company. In the opinion of management, all such matters are without merit or are of such kind, or involve such amounts, as would not have a significant effect on the financial position or results of operations of the company if disposed of unfavorably.\nThe company has, for at least the last two and one-half years, been engaged in discussions with Snap-on Corporation regarding claims which the company has against Snap-on and which Snap-on believes it has against the company. As of August 26, 1993, the company had asserted a number of patent infringement claims against Snap-on, relating to products marketed either by Snap-on or by Sun Electric Corporation, a company whose stock Snap-on purchased in 1992. As of August 26, 1993, Snap-on had asserted claims of violation of securities laws against one of its executives arising out of his former employment with Sun Electric and against the company as an aider and abettor of those violations. On that date, a Standstill Agreement was executed between the parties which preserved the parties' rights while permitting settlement discussions. Since that time, Snap-on has raised patent infringement claims against the company which, by agreement, are covered by the August 26, 1993 Standstill Agreement, as well as another independent patent infringement claim for which a lawsuit was filed in California in late December 1995. On January 8, 1996, after extensive but unsuccessful negotiations to resolve all asserted claims, Snap-on Corporation and Sun Electric Corporation notified the company of the termination of the Standstill Agreement. Under the terms of that Agreement, the standstill will terminate March 8, 1996. The company has been advised that after that date, Snap-on and Sun will initiate litigation and assert their claims. If they do not do so, the company intends to begin litigation of its claims against Snap-on and Sun. The company has what it believes to be meritorious defenses as well as counterclaims which it will raise and intends to vigorously prosecute any litigation. The asserted value of the claims against the company and those to be brought by the company are in the multiple millions of dollars. It is not, however, possible to assess the ultimate outcome of the claims at this point.\nThe company's operations and properties are subject to federal, state, local, and foreign regulatory requirements relating to environmental protection. It is the company's policy to comply fully with all such applicable requirements. As part of its effort to comply, management has established an ongoing internal compliance auditing program which has been in place since 1989. Based on current information, management believes that the company's operations are in substantial compliance with applicable environmental laws and\nregulations and the company is not aware of any violation that could have a material adverse effect on the business, financial conditions, results of operations, or cash flows of the company. There can be no assurance, however, that currently unknown matters, new laws and regulations, or stricter interpretations of existing laws and regulations will not materially affect the company's business or operations in the future.\nIn addition, it is the company's practice to reduce use of environmentally sensitive materials as much as possible. First, it reduces the risk to the environment in that such use could result in adverse environmental affects either from operations or utilization of the end product. Second, a reduction in environmentally sensitive materials reduces the ongoing burden and resulting cost of handling, controlling emissions, and disposing of wastes that may be generated from such materials.\nThe company is also subject to potential liability for the costs of environmental remediation. This liability may be based upon the ownership or operation of industrial facilities where contamination may be found as well as contribution to contamination existing at offsite, non-owned facilities. These offsite remediation costs cannot be quantified with any degree of certainty. At this time, management can estimate the environmental remediation costs only in terms of possibilities and probabilities based on available information.\nThe company is involved as a potentially responsible party (\"PRP\") under the Comprehensive, Environmental Response, Compensation and Liability Act of 1980 (\"CERCLA\"), as amended, or similar state superfund statutes in ten proceedings involving off-site waste disposal facilities. At seven of these sites it has been established that the company is a de minimis contributor. A determination has not been made with respect to the remaining three sites, but the company believes that it will be found to be a de minimis contributor at two of them. Of these remaining sites, one is approaching settlement with the Environmental Protection Agency with an expected cost to the company of approximately $200,000, another is expected to be resolved at a cost not to exceed $50,000, and the final site is under investigation with an expected cost of approximately $150,000. Based on information available to the company, which in most cases includes estimates from PRPs and\/or federal or state regulatory agencies for the investigation, clean up costs at those sites, and data related to the quantities and characteristics of materials generated at or shipped to each site, the company believes that the costs for each site are not material and in total the anticipated clean up costs of current PRP actions would not have a material adverse effect on the company's business, financial condition, results of operations, or cash flows.\nIn the case of contamination existing upon properties owned or controlled by the company, the company has established reserves which it deems adequate to meet its current remediation obligations.\nThere can be no assurance that the company will not be required to pay environmental compliance costs or incur liabilities that may be material in amount due to matters which arise in the future or are not currently known to the company.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone\nITEM -- EXECUTIVE OFFICERS OF REGISTRANT\nThe following table sets forth with respect to each executive officer or other significant employee of the company, his name, age, all positions and offices with the company held by him, the term during which he has been an officer of the company and, if he has been an officer of the company for less than five years, his business experience during the past five years.\n- ---------------\nSee page 58 for a complete list of all executive compensation plans and arrangements.\n(1) Effective November 1995, Mr. Blystone was elected Chairman, President and Chief Executive Officer. From September 1994 through November 1995, he served as President and Chief Executive Officer, Nuovo Pignone, an 80% owned subsidiary of General Electric Company. From November 1991 through August 1994 he served as Vice President, General Manager, Superabrasives of General Electric Company. From October 1988 though November 1991 he served as Senior Vice President, Components Division of J.I. Case Division, Tenneco, Inc.\n(2) Effective February 1996, Mr. Huff was appointed Vice President, Procurement. From February 1994 through February of 1996, he was Treasurer. From April 1989 through February of 1994, he was Vice President, Finance of SPT.\n(3) Effective November 1994, Mr. Trubeck was elected Senior Vice President Finance, Chief Financial Officer. In February of 1996, he assumed the additional position as Treasurer. From June 1993 through October 1994, he served as Senior Vice President and Chief Financial Officer at Honeywell, Inc. From February 1991 through May 1993 he served as Chief Financial Officer at White & Case, a New York law firm. From March 1989 through October 1990 he served as Executive Vice President, Finance and Chief Financial Officer of NWA, Inc. and Northwest Airlines.\n(4) Effective February 1994, Mr. Zagotta was elected Executive Vice President. From October 1991 through February 1994, he served as President and Chief Executive Officer of SPT. Prior to October 1991, he served as Vice President, General Manager of the Sealed Power Division.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS\nThe company's common stock is traded on the New York Stock Exchange and Pacific Stock Exchange under the symbol \"SPW\".\nSet forth below are the high and low sales prices for the company's common stock as reported on the New York Stock Exchange composite transaction reporting system and dividends paid per share for each quarterly period during the past two years:\nThe approximate number of record holders of the company's Common Stock as of December 31, 1995 was 7,592.\nThe company is subject to a number of restrictive covenants under various debt agreements. Please see Note 18 to the consolidated financial statements for further discussion.\nFuture dividends will depend upon the earnings and financial condition of the company and other relevant factors. The revolving credit agreement includes a covenant that limits dividends. Please see Note 18 to the consolidated financial statements for further explanation. The company has no present intention to discontinue its dividend policy and believes that dividends will continue at current levels during 1996.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\n- ---------------\n(1) Includes a restructuring charge of $10.7 million. Refer to Note 7 to the consolidated financial statements for explanation.\n(2) In 1993, the company acquired Allen Testproducts and Sealed Power Technologies Limited Partnership and divested the Sealed Power Replacement and Truth divisions. Refer to Note 5 to the consolidated financial statements for explanation.\n(3) Includes a restructuring charge of $27.5 million. Refer to Note 7 to the consolidated financial statements for explanation.\n(4) Reflects the gain on the divestitures of the Sealed Power Replacement and Truth divisions. Refer to Note 5 to the consolidated financial statements for explanation.\n(5) Includes a restructuring charge of $18.2 million.\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 company's consolidated financial statements and the related footnotes.\nOVERVIEW\nSignificant 1995 Events and Initiatives\nDuring 1995, the following significant events and initiatives were undertaken:\n- At the end of the first quarter, the company reduced the cost structure at the Automotive Diagnostics division by reducing headcount by approximately 140 people. This resulted in a severance charge of approximately $1.1 million, but generated an estimated $7 million in annual savings.\n- The company completed the sale of SPX Credit Corporation in the third quarter. The buyer will continue to provide the company's customers with a lease financing option for the company's products. The company believes it has a strong relationship with the buyer. Additionally, proceeds from this sale, over $70 million, were used to reduce the company's debt.\n- During the fourth quarter, the company initiated a significant restructuring within the Specialty Service Tool segment that consolidated five divisions into two divisions. The company combined the Kent-Moore division, the Dealer Equipment Service division and the program tool portion of the OTC division to form the OE Tool and Equipment division and combined the Automotive Diagnostics division, the Robinair division and the aftermarket tool portion of the OTC division to form the Aftermarket Tool and Equipment division. The restructuring includes closing two manufacturing facilities, a distribution facility and an operation in Europe. Additionally, the restructuring will combine sales, marketing, engineering and administrative functions at these units. The estimated overall cost of this restructuring is approximately $18 million, and annual savings are estimated to be $23 million by 1998.\n- During the fourth quarter, the company decided to close its unprofitable foundry operation at SP Europe Germany. The company recorded a $3.7 million restructuring charge to accrue for termination benefits for the 200 employees that are affected by the closing. The company obtained significant wage concessions and improved work rule flexibility from the employees that will continue to produce piston rings and cylinder liners at this plant. Additionally, the company obtained a reduction in the cost of utilities and other locally provided services to the plant. The company anticipates that the cumulative effect of these actions will improve this operation in the future.\nRevenues\nOverall revenues for 1995, while up 1.7% from 1994, reflect mixed strengths and weakness. The market for Specialty Service Tools was solid for essential program tools, dealer equipment, aftermarket tools and high-pressure hydraulics. However, sales of environmentally driven products did not reach expectations. Uncertainties in implementation of various state auto emission programs and limited enforcement of environmental laws led to lower sales of gas emission testing equipment and refrigerant recovery and recycling equipment. Revenues of Original Equipment Components suffered from lower production volumes (especially in the last half of 1995), softness in the replacement aftermarket and delays in replacing significant lost valve train component business.\nCurrent prospects for 1996 look sound for most of the company's business lines. Program tool sales will be down slightly from 1995 due to fewer new model introductions. U.S. vehicle production forecasts anticipate slightly lower levels from 1995. Market indications include improvements in the component aftermarket. Of course, this presumes a continuing stable U.S. economy. Upsides to 1996 revenues include the realization of replacement business for valve train components and increased dealer equipment business due to new customers. The realization of environment related equipment sales remains a major uncertainty. While several\nstates and regions still indicate initiation of enhanced gas emissions testing programs in 1996, previous experience indicates that this could change.\nOperating Income from Continuing Operations\nOperating income from continuing operations in 1995 was $31.1 million compared to $57.4 million in 1994. Without the $10.7 million restructuring charge, the 1995 operating income would have been $41.8 million. This still falls $15.6 million short of 1994 operating income. This shortfall was primarily attributable to lower production volume for the original equipment market, and softness in the aftermarket. Additionally, continued pricing pressures by original equipment manufacturers and the lost valve train business contributed to the reduced operating income from 1994.\n1996 operating income will be significantly impacted by additional incremental costs to be recorded for the Specialty Service Tool restructuring, which are currently estimated at $11 million.\nCash Flow and Debt Levels\nDuring 1995, the company reduced its total debt levels by $95.4 million and cash balances increased by $7.2 million. The majority of the reduction in total debt was a result of the proceeds from the sale of SPX Credit Corporation and receipt of tax refunds. Cash generated by operations was approximately $66.4 million, which included approximately $28 million in tax refunds. Capital expenditures were approximately $31 million, which was slightly less than depreciation. No significant cash expenditures related to the restructurings were made in 1995.\n1996 cash flow will be impacted as expenditures related to the restructurings are made. Management is closely monitoring planned 1996 capital expenditures which are anticipated to be approximately $30 million.\nRESULTS OF OPERATIONS -- COMPARISON OF FISCAL YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nIn the following discussion, references to 1993 \"proforma\" information are included in certain instances to enhance the comparative discussion. This proforma information refers to unaudited 1993 proforma financial information and is based upon the assumption that certain transactions occurred as of the beginning of 1993. Please refer to Note 6 to the consolidated financial statements for further explanation of the proforma financial information.\nCONSOLIDATED\nOn the following pages, revenues, operating income (loss) and related items are discussed by segment. The following provides an explanation of general corporate expenses and other consolidated items that are not allocated to the segments.\nGeneral Corporate expense (SG&A) -- These expenses represent general unallocated expenses. 1995 expenses included a $1.8 million charge related to the early retirement costs of three officers and severance costs associated with six employees at the corporate office. The 1995 expense was reduced due to lower incentive compensation and the impact of cost reductions. 1994 expenses increased over 1993 primarily as a result of additional corporate expenses resulting from the consolidation of SPT. 1993 also included favorable long-term employee benefit adjustments.\nOther expense (income), net -- Represents expenses not included in the determination of operating results, including gains or losses on currency exchange, translation gains or losses due to translation of financial\nstatements in highly inflationary countries, the fees incurred on the sale of accounts receivable under the company's accounts receivable securitization program, gains or losses on the sale of fixed assets and unusual non-operational gains or losses.\n1995 reflects a $1.5 million gain on the sale of the company's aftermarket export distribution business, a $.9 million gain on the sale of the company's 50% investment in RSV, and a $.6 million gain on the sale of a company airplane. 1994 included a $2.1 million charge for the settlement of a dispute regarding the sale of a non-core business in 1989.\nInterest expense, net -- A portion of interest expense has been allocated to the discontinued operation, SPX Credit Corporation, for all years. 1995 interest expense was comparable to 1994 and reflects the debt structure in place after the early 1994 refinancing. 1994 interest expense, net was substantially higher than 1993 due to the higher debt levels associated with the purchase of SPT and Allen Testproducts in 1993. The increase in debt levels was partially offset by the proceeds from the sales of the Sealed Power Replacement and Truth divisions in 1993.\nGain on Sale of Businesses -- A $105.4 million pretax gain on the sale of the Sealed Power Replacement ($52.4 million) and the Truth ($53.0 million) divisions was recorded in 1993. The results of these units were included through their divestitures in the fourth quarter of 1993.\nProvision (benefit) for income taxes -- The 1995 effective income tax rate of 14.4% was impacted by a $1.3 million benefit recorded on the sale of the company's 50% interest in RSV and by not being able to tax benefit the minority interest charge of $4.8 million recorded in the fourth quarter. Without these unusual items, the 1995 effective income tax rate would have been approximately 41%, which was comparable to the 1994 effective income tax rate. The 1995 effective income tax rate, before the unusual items, and the 1994 effective income tax rate of approximately 41%, exceed the 35% U.S. federal income tax rate due primarily to the effect of non-deductible goodwill and intangibles amortization and the net effect of not being able to tax benefit certain foreign losses because certain foreign operations are in net operating loss carryforward positions. The 1993 effective income tax rate of 68.2% was high due to the inability to tax benefit the $21.5 million of SP Europe's equity losses as its foreign subsidiaries were in net operating loss carryforward positions, because certain items within the Automotive Diagnostics restructuring charge were not tax benefited, and because of the cumulative effect of adjusting net deferred tax liabilities for the change in the U.S. federal income tax rate from 34% to 35% in 1993.\nIncome (loss) from discontinued operations -- The results of operations of SPX Credit Corporation, net of allocated interest and income taxes, are presented as a discontinued operation. In 1995, the company recorded a loss on the sale and on costs to close the operation of $4.8 million.\nCumulative effect of change in accounting methods, net of tax -- In 1993, the company adopted two new accounting methods relating to its ESOP and postretirement benefits other than pensions. See Note 2 to the Consolidated Financial Statements for a detailed explanation of these changes.\nExtraordinary loss, net of taxes -- During 1995, the company purchased $31.7 million of its 11 3\/4% senior subordinated notes. These notes were repurchased in the market at a premium of $1.1 million, net of income taxes.\nDuring the fourth quarter of 1993, the company decided to refinance both SPX and SPT debt. As a result, the company recorded an extraordinary charge of $37.0 million ($24.0 million after-tax) for costs associated with the early retirement of approximately $400 million (principal amount) of debt.\nSPECIALTY SERVICE TOOLS\nRevenues\n1995 revenues were up $21.7 million, or 3.9%, over 1994 revenues, primarily from increased program service tool, high-pressure hydraulics and refrigeration related tool sales. However, sales of electronic diagnostic equipment and service tools to the aftermarket were down from 1994.\n1994 revenues were up $47 million, or 9.3%, over 1993 revenues, principally due to the inclusion of a full year of Allen Testproducts revenues in 1994, whereas, 1993 included only seven months of revenues. Allen Testproducts was acquired in June of 1993. 1994 revenues also increased over 1993 revenues due to overall improved revenues of specialty service tools, particularly dealer equipment programs and high-pressure hydraulics.\n1994 revenues show general improvements over proforma 1993 revenues due to the improvement in essential tool programs, electronic hand-held diagnostics, mechanical tools, and hydraulics sales. These improved sales have been offset, however, by gradually declining sales of higher priced electronic diagnostic equipment.\nGross Profit\n1995 gross profit as a percentage of revenues (\"gross margin\") of 32.1% was slightly lower than the 32.9% in 1994. This decrease was attributable to a higher portion of revenues consisting of product purchased for resale in 1995. Such purchased product tends to carry lower gross margin than manufactured product. 1994 gross margin of 32.9% was comparable to 1993 gross margin of 32.8%.\n1994 gross margin of 32.9% was less than proforma 1993 gross margin of 34.7%. The decrease in 1994 was principally due to the higher portion of revenues represented by dealer equipment programs than in proforma 1993. Note that the proforma 1993 gross margin includes estimates of cost reductions from the combination of Bear Automotive and Allen Testproducts.\nSelling, General and Administrative Expense (\"SG&A\")\n1995 SG&A was 25.7% of revenues compared to 26.7% in 1994. This decrease resulted from the effect of lower sales of electronic diagnostic equipment which have higher proportionate selling costs and from cost reductions in 1995. 1994 SG&A was 26.7% of revenues compared to 28.7% in 1993. This decrease from 1993 was primarily the result of increased dealer equipment program sales which have lower SG&A as a percentage of revenues and the impact of cost reductions achieved through the combination of Bear Automotive and Allen Testproducts. Also, 1994 SG&A included a full year of Allen Testproducts' SG&A, whereas 1993 only\nincluded seven months. Allen Testproducts' SG&A as a percentage of revenues was higher than overall historical percentages.\n1994 SG&A as a percentage of revenues compares favorably to proforma 1993 due to higher dealer equipment revenues in 1994 and due to general cost reductions. Note that the proforma 1993 SG&A includes estimates of cost reductions from the combination of Bear Automotive and Allen Testproducts.\nGoodwill\/Intangible amortization\nNoncash goodwill and intangible amortization generally results from excess purchase price over fair value of assets in acquisition. The increase in 1995 and 1994 amortization over 1993 was the effect of additional goodwill recorded to acquire Allen Testproducts in June 1993.\nEarnings from Equity Interests\nIncluded in this segment are the equity earnings of JATEK, a 50% owned joint venture in Japan. JATEK's 1995 and 1994 earnings were negatively impacted by economic conditions in the Pacific Rim, particularly Japan.\nRestructuring Charge\nIn the fourth quarter of 1995, the company initiated the aforementioned restructuring of its Specialty Service Tool segment. The charge included $7.0 million of restructuring costs to recognize severance and benefits for the employees to be terminated ($4.4 million), estimated holding costs of vacated facilities ($1.1 million), and to reflect the estimated fair market value of one manufacturing facility ($1.5 million).\nIn the third quarter of 1993, the company recorded a $27.5 million restructuring charge to combine the existing Bear Automotive division with Allen Testproducts into the new Automotive Diagnostics division. The restructuring charge included approximately $16.0 million for work force reductions and related costs. The restructuring charge also included approximately $9.3 million of facility duplication and shutdown costs, including the writedown of excess assets of $4.2 million (non-cash).\nOperating Income (Loss)\n1995 operating income of $31.4 million (excluding the $7.0 restructuring charge) was up over 1994 operating income of $29.4 million. The improvement was primarily attributable to the higher revenue.\n1994 operating income of $29.4 million was up significantly over 1993 operating income of $16.6 million (excluding the $27.5 million restructuring charge). This improvement was attributable to increased revenues and associated gross profit levels, while holding SG&A at comparable levels to 1993. The cost reductions associated with the combination of Bear Automotive and Allen Testproducts contributed to achieving the SG&A levels in 1994.\n1994 operating income of $29.4 million was comparable to proforma 1993 operating income of $27.5 million (excluding the $27.5 million restructuring charge).\nCapital Expenditures\nCapital expenditures for 1995 of $7.4 million were approximately $3 million lower than in 1994 due to incremental spending to improve manufacturing capability and systems to better support customers in 1994. Management estimates that annual capital expenditures of approximately $5 million are required to maintain the company's specialty service tool operations. 1996 capital expenditures are expected to approximate $10 million which will include approximately $2 million of incremental spending to support the restructuring.\nIdentifiable Assets\nIdentifiable assets decreased in 1995 from 1994 levels as a result of inventory reductions and capital expenditures being less than depreciation and amortization. The company believes that additional working\ncapital reductions, particularly inventory, are available and will continue to pursue programs to enhance working capital utilization.\nORIGINAL EQUIPMENT COMPONENTS:\nRevenues\nRevenues for 1995 were down $3.5 million from 1994 revenues principally due to the significant loss of hydraulic valve train business with a major customer. Mitigating this significant loss of revenue, were higher European revenues and increased metal costs passed on to customers. Revenues for 1994 were up significantly over 1993 revenues due to the inclusion of SPT and SP Europe revenues in 1994 (SPT and SP Europe were consolidated as of December 31, 1993). 1993 revenues include the company's solenoid valve operation.\n1994 revenues were up significantly over proforma 1993 revenues (which include SPT and SP Europe). The significant increase was attributable to strong increases in sales to original equipment manufacturers as vehicle production increased significantly in 1994. Revenues from sales to aftermarket customers also increased in 1994.\nGross Profit\n1995 gross profit as a percentage of revenues (\"gross margin\") was 11.6% compared to 14.6% in 1994. Several factors contributed to this decrease as follows:\n- The valve train business reduced production and incurred downsizing costs due to the loss of business with a major customer.\n- The die-cast metal cost pass through to customers reduced gross margin percentage as the increase in revenues equaled the increase in cost.\n- During the first quarter of 1995, the company purchased approximately $6 million of inventory from an aftermarket customer and began to package this inventory for the customer. A $1.2 million charge was taken in connection with this purchase to reduce the inventory to cost.\n- SP Europe incurred approximately $1 million in severance costs, incurred additional costs associated with the ongoing process to achieve profitability, and realized poor efficiencies and increased costs while rumors regarding the closure of the German plant circulated during the last two months of 1995.\n1994 gross margin was not comparable to 1993 gross margin as 1994 includes SPT and SP Europe while 1993 does not include SPT and SP Europe.\n1994 gross margin of 14.6% was significantly higher than proforma 1993 gross margin of 11.3%. The primary reason for this increase was the significant increase in production volumes and productivity associated with the higher revenues. Proforma 1993 gross margin was negatively impacted by $5 million or 1.1% of revenues due to costs relating to a strike at a foundry, costs associated with closing that foundry and an adjustment to writedown manufacturing assets used in the production of a product line that was discontinued.\nSelling, General, & Administrative Expense\n1995 SG&A of $27.8 million, or 5.3% of revenues, compares to 1994 SG&A of $31.3 million, or 5.9% of revenues. The reduction reflects continuing cost controls. 1994 SG&A as a percentage of revenues decreased from proforma 1993 levels due primarily to the increased revenues.\nGoodwill and Intangible Amortization\n1995 and 1994 goodwill and intangible amortization was a result of the excess purchase price over fair value of the assets recorded upon the acquisition of 51% of SPT at the end of 1993. 1994 amortization was lower than 1995 as the company was recording income related to negative goodwill associated with SP Europe. The recognition of negative goodwill amortization was completed during the second quarter of 1994.\nMinority Interest (Income)\n1995 and 1994 results reflect the 30% partner's minority interest in SP Europe. SP Europe incurred significant losses in 1995, 1994 and proforma 1993. In the fourth quarter of 1995, the company's partner in SP Europe stated that it will limit its participation by not fully funding its 30% share of this partnership. Due to this limited participation, the company recorded a $4.8 million charge for the cumulative losses previously attributed to this partner to minority interest. Prospectively, the company will record 100% of SP Europe's income or loss.\nEarnings from Equity Interests\nEarnings from equity interests includes the company's equity share of earnings or losses in RSV, Promec, IBS Filtran and Allied Ring Corporation (\"ARC\"). Promec, IBS Filtran and ARC interests were acquired as part of the company's purchase of 51% of SPT at the end of 1993. Through the end of 1993, RSV and ARC were in various stages of development and were incurring losses. In 1995 and 1994, ARC generated operating profits. In December of 1995, the company's 50% interest in RSV was sold to the joint venture partner.\nRestructuring Charge\nDuring the fourth quarter of 1995, the company initiated the aforementioned restructuring at SP Europe. The $3.7 million restructuring charge accrued severance that will be paid to affected employees. Additional costs to complete this restructuring in 1996 are not expected to be significant.\nSPT Equity Losses and SP Europe Equity Losses\nSPT and SP Europe were consolidated as of December 31, 1993. The 1993 amounts reflect the company's equity losses in these units prior to the consolidation.\nOperating Income (Loss)\n1995 operating income of $26.2 million was down significantly from 1994 operating income of $48.0 million. The reduction was a result of the lower gross margins, recording of $3.3 million of minority interest loss in 1995 compared to $2.2 of minority interest income in 1994, and the $3.7 million restructuring charge.\n1994 operating income exceeds proforma 1993 operating income principally from the significant increase in revenues. Additionally, cost reduction efforts, including the charges in proforma 1993 to writeoff nonproductive capacity, benefited 1994.\nCapital Expenditures\nCapital expenditures for 1995 of $23.2 million were approximately $12.7 million lower than in 1994 as 1994 included the purchase of an additional solenoid valve assembly line, additional die-casting capacity for high strength heat treated aluminum die-castings for air bag steering columns, additional hydraulic lash adjuster capacity, significant additional automated cylinder liner casting and machining capacity to meet the demand for aluminum block engines and productivity enhancing equipment. Management estimates that annual capital expenditures of approximately $15 million are required to maintain the company's original equipment component operations. 1996 capital expenditures are expected to approximate $20 million and will be focused upon cost reductions and maintenance of the operations.\nIdentifiable Assets\n1995 identifiable assets decreased approximately $6 million over 1994 due principally to decreases in accounts receivable. The decrease in accounts receivable was due to lower revenue activity in the fourth quarter of 1995 when compared to the fourth quarter of 1994.\nBUSINESSES SOLD IN 1993:\nDuring the fourth quarter of 1993, the company recorded a $105.4 million pretax gain on the sale of the SPR and Truth divisions. The results of these operations are included in the consolidated results of operations through their dates of divestiture.\nFACTORS THAT MAY AFFECT FUTURE RESULTS\nGeneral Business Conditions -- The company operates within the motor vehicle industry and future results may be affected by a number of factors including industry conditions, economic conditions in principally the U.S. and Europe, and the economic strength of motor vehicle dealerships. The majority of the company's revenues are not subject to seasonal variation. Revenues within the Original Equipment Component segment are predominantly dependent upon domestic and foreign motor vehicle production which is cyclical and dependent on general economic conditions and other factors. Revenues within the Specialty Service Tool segment are dependent upon new vehicle introductions, environmental regulations, and the general economic status of motor vehicle dealerships and aftermarket maintenance facilities. These factors can, therefore, affect the company's working capital requirements. However, as the company receives production forecasts from original equipment manufacturers and is knowledgeable about new vehicle introductions, it is able to anticipate and manage these requirements.\nAutomotive Diagnostics Goodwill -- At December 31, 1995, $69.2 million of goodwill relates to the Automotive Diagnostics operating unit. This operating unit has incurred significant operating losses in 1995 and in prior years. The company projects that, in the near future, the cost savings, market synergies and other factors which, in part, will be realized from the Bear Automotive and Allen Testproducts combination and the 1995 restructuring described in Note 7 will result in non-discounted operating income sufficient to exceed goodwill amortization.\nThe market for certain portions of the Automotive Diagnostics operating unit's products is highly cyclical. The demand for vehicle emissions test equipment is significantly impacted by changes in U.S. federal and state government regulations designed to improve air quality by imposing more stringent limitations on emissions and discharges to the environment from motor vehicles. Management also believes that these regulations have a related impact on the market for engine performance testing equipment. Certain of the company's products perform tests of both engine performance and emissions.\nThe company's projections for this operating unit over the near term (after 1996) include significant incremental revenues, operating profit and cash flows associated with market opportunities that will be created by enacted federal and state regulations mandated by the 1990 Clean Air Act Amendment (the \"Act\"). Over the longer term, the company's projections include the cyclical impact of further legislation in the U.S. and in certain international markets in which the company participates. As a result of the Act, certain geographic regions were designated as \"enhanced emissions areas.\" Areas so designated are required to implement more rigorous testing standards. This change creates additional market opportunity for the company, in particular, for testing equipment capable of testing for nitrites of oxygen. However, due to politically driven factors, various states have delayed implementation of the provisions of the Act in these \"enhanced emissions areas.\" To date, no changes have been made to the Act for implementation or enforcement. Further, the company expects debate to continue during 1996 at both the federal and state level over the merits of this legislation. Future changes in legislation could significantly diminish or eliminate these incremental market opportunities for motor vehicle gas emissions testing equipment.\nIt is not possible to predict the extent to which the company or the market for motor vehicle gas emissions testing equipment in general might be affected by the matters described above. However, should the company's projections require downward revisions based upon changed events, circumstances or legislation, this operating unit's goodwill may require writedown. Although having no cash flow impact, the resulting charge, if any, could materially reduce the company's future reported results of operations and shareholders' equity. At this time, based upon present information, projections and strategic plans, the company has concluded that there has been no permanent impairment of the Automotive Diagnostics operating unit's tangible or intangible assets.\nFinancial Leverage of the Company -- The company is highly levered with indebtedness. Should economic and general business conditions deteriorate and impact the company's business activity, thereby creating increased borrowing costs, the company might not be able to adequately service its indebtedness or maintain current dividend levels.\nImpact of Inflation -- The company believes that inflation has not had a significant impact on operations during the period 1993 through 1995 in any of the countries in which the company operates.\nEnvironmental -- The company's operations and properties are subject to federal, state, local, and foreign regulatory requirements relating to environmental protection. It is the company's policy to comply fully with all such applicable requirements. As part of its effort to comply, management has established an ongoing internal compliance auditing program which has been in place since 1989. Based on current information, management believes that the company's operations are in substantial compliance with applicable environmental laws and regulations and the company is not aware of any violation that could have a material adverse effect on the business, financial condition, or results of operations of the company. There can be no assurance, however, that currently unknown matters, new laws and regulations, or stricter interpretations of existing laws and regulations will not materially affect the company's business or operations in the future. See Note 17 of the consolidated financial statements for further discussion.\nAccounting Pronouncements -- As of the beginning of 1996, the company must adopt Statement of Financial Accounting Standards, No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.\" This standard requires long-lived assets to be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. The effect of adopting this statement is not expected to have a significant impact on the company's consolidated financial position or results of operations.\nLIQUIDITY AND FINANCIAL CONDITION\nThe company's liquidity needs arise primarily from capital investment in new equipment, funding working capital requirements and to meet interest costs.\nThe company is highly levered with indebtedness. This financial leverage requires management to focus on cash flows to meet interest costs and to maintain dividends. Management believes that operations and the credit arrangements will be sufficient to supply funds needed by the company in 1996.\nCash Flow\n1995 operating cash flow was positively impacted by $28 million of federal income tax refunds received, reductions in accounts receivable and inventory, and the non-cash (in current year) unusual items included in the net loss, principally the restructuring charges and the minority interest loss. Negatively impacting 1995 operating cash flow was the reduction in accounts payable as the ending 1994 balance was high due to significant capital expenditures.\n1994 operating cash flow was positively impacted by the improved operating income, inventory reductions of $10.7 million principally from inventory consolidation at Automotive Diagnostics, and significantly higher accounts payable levels due to year-end purchasing activity (particularly capital expenditures). 1994 operating cash flow was reduced due to the $7 million (including interest) settlement with the U.S. Internal Revenue Service to resolve a dispute regarding the company's tax deferred treatment of the 1989 transaction in which several operating units were contributed to SPT. 1994 operating cash flow was also reduced due to cash outflows related to the restructuring combination of Bear Automotive and Allen Testproducts ($12.5 million).\n1995 cash flows from investing activities include the $73.2 million received from the sale of SPX Credit Corporation and $31.0 million of capital expenditures. The 1995 capital expenditures were $17.5 million less than 1994 as 1994 included significant investments made to expand manufacturing capacity, including cylinder liners, die-casting, and other new business opportunities. Planned 1996 capital expenditures are expected to be approximately $30 million.\n1994 cash flows from investing activities reflect high capital expenditures and a $39 million payment to Riken to purchase the additional ownership of SPT. 1993 cash flows from investing activities reflect the net proceeds from the divestiture of SPR and Truth of approximately $189 million and the purchase of Allen Testproducts and Allen Group Leasing for approximately $102 million. In addition, 1993 includes $19.9 million of advances to SP Europe prior to it being consolidated into the balance sheet.\n1995 cash flows from financing activities principally reflect the reduction of debt by approximately $95 million. This reduction was made possible by the proceeds from the sale of SPX Credit Corporation and cash from operations. 1994 cash flows from financing activities reflect the changes in the company's debt\nstructure resulting from the debt refinancing that occurred in the first half of 1994, including the payment of approximately $34 million in fees related to the restructuring.\nCapitalization\nAt December 31, 1995, the company's total debt was comprised primarily of borrowings on its $225 million revolving credit facility obtained in March of 1994 and on its $228.3 million of 11-3\/4% senior subordinated notes issued during the second quarter of 1994. At December 31, 1995, the weighted average interest rate on outstanding revolving credit borrowing was 7.0%. The company has three interest rate cap agreements which entitle the company to receive the amounts, if any, by which LIBOR exceeds 8.5% on $25 million and 9.0% on $75 million. These agreements expire in 1997 and 1998.\nAs of December 31, 1995, the following summarizes the debt outstanding and unused credit availability:\n- ---------------\n(a) Decreased by $17.5 million of facility letters of credit outstanding at December 31, 1995 which reduce the unused credit availability.\nAt December 31, 1995, the company was in compliance with all restrictive covenants contained in the revolving credit agreement, as amended, and the senior subordinated note indenture. Under the most restrictive of these covenants, the company was required to:\n- Maintain a leverage ratio, as defined, of 78% or less, declining on a graduated scale to 65% in 1999. The leverage ratio at December 31, 1995 was 69%.\n- Maintain an interest expense coverage ratio, as defined, of 1.70:1 or greater in 1995 rising on a graduated scale to 3.50:1 or greater in 1998 and thereafter. The interest expense coverage ratio as of December 31, 1995 was 2.13:1.\n- Maintain a fixed charge coverage ratio, as defined, of 1.50:1 or greater in 1995 and 1996, and 2:1 or greater thereafter. The fixed charge coverage ratio as of December 31, 1995 was 1.78:1.\n- Limit dividends paid during the preceding twelve months to 10% of operating income plus depreciation and amortization (EBITDA) for the twelve month period. Dividends paid for the twelve month period ended December 31, 1995 were $5.3 million and 10% of EBITDA for the period was $7.6 million.\nCovenants also limit capital expenditures, investments and transactions with affiliates. The amended revolving credit agreement also limits the company's prospective purchase of 11-3\/4% senior subordinated\nnotes to $15 million. The company is currently negotiating an amendment with the revolving credit facility lenders to increase the amount of notes that can be purchased to $50 million. These negotiations also include the reduction of the revolving credit facility's commitment from $225 million to $175 million. It is anticipated that this amendment will be obtained by mid to late March 1996.\nManagement believes that the unused credit availability is sufficient to meet operating cash needs including working capital requirements and capital expenditures planned for 1996. Aggregate future maturities of total debt are not material for 1996 through 1998 (see Note 18 to the consolidated financial statements). In 1999, the revolving credit agreement expires and borrowings on the revolver would become due, however, management believes that the revolving credit agreement would likely be extended or that alternate financing will be available to the company. ------------------------\nThe foregoing discussion in \"Management's Discussion and Analysis of Financial Conditions and Results of Operations\" contains forward-looking statements which reflect management's current views with respect to future events and financial performance. These forward-looking statements are subject to certain risks and uncertainties, including but not limited to those matters discussed under the caption \"Factors That may Affect Future Results\" above and under Part I, Item 3, \"Legal Proceedings.\" Due to such uncertainties and risks, readers are cautioned not to place undue reliance on such forward-looking statements, which speak only as of the date hereof.\nITEM 8.","section_7A":"","section_8":"ITEM 8.\nSPX CORPORATION AND SUBSIDIARIES\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1995\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Shareholders and Board of Directors of SPX Corporation:\nWe have audited the accompanying consolidated balance sheets of SPX CORPORATION (a Delaware corporation) AND SUBSIDIARIES as of December 31, 1995 and 1994, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1995. 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 SPX Corporation and subsidiaries as of December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\nAs discussed in Note 2 to the consolidated financial statements, effective January 1, 1993, the company changed its method of Employee Stock Ownership Plan (ESOP) accounting and Sealed Power Technologies Limited Partnership changed its method of accounting for postretirement benefits other than pensions.\nARTHUR ANDERSEN LLP\nChicago, Illinois, February 9, 1996\nSPX CORPORATION AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\nThe accompanying notes are an integral part of these statements.\nSPX CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF INCOME\nThe accompanying notes are an integral part of these statements.\nSPX CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY\nThe accompanying notes are an integral part of these statements.\nSPX CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nThe accompanying notes are an integral part of these statements.\nSPX CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1995\n(1) SUMMARY OF ACCOUNTING POLICIES\nAll dollar amounts in the Notes to Consolidated Financial Statements are in thousands, except per share amounts.\nThe accounting and financial policies which affect significant elements of the consolidated financial statements of SPX Corporation (the \"company\") and which are not apparent on the face of the statements, or in other notes to the consolidated financial statements, are described below.\nBasis of Presentation -- The preparation of the company's consolidated 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 consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nConsolidation -- The consolidated financial statements include the accounts of the company and all of its majority-owned subsidiaries after the elimination of all significant intercompany accounts and transactions. Amounts representing the company's percentage interest in the underlying net assets of less than majority-owned companies in which a significant equity ownership interest is held are included in \"Investments.\"\nForeign Currency Translation -- Translation of the company's subsidiaries results in unrealized translation adjustments being reflected as cumulative translation adjustment in shareholders' equity.\nRevenue Recognition -- The company recognizes revenues from product sales upon shipment to the customer. Revenue from service contracts and long-term maintenance arrangements is deferred and is recognized as revenue on a pro rata basis over the agreement periods.\nResearch and Development Costs -- The company expenses currently all costs for development of products. Research and development costs were $26,300 in 1995, $26,400 in 1994, and $17,600 in 1993.\nEnvironmental Remediation Costs -- Costs incurred to investigate and remediate environmental conservation issues are expensed unless the costs incurred extend the economic useful life of related assets employed by the company. Liabilities are recorded and expenses are reported when it is probable that an obligation has been incurred and the amounts can be reasonably estimated.\nEarnings Per Share -- Primary earnings per share is computed by dividing net income by the weighted average number of common shares outstanding. Common shares outstanding includes issued shares less shares held in treasury and unallocated and uncommitted shares held by the ESOP trust. The potential dilutive effect from the exercise of stock options is not material.\nProperty, Plant and Equipment -- The company uses principally the straight line method for computing depreciation expense over the useful lives of the property, plant and equipment. For income tax purposes, the company uses accelerated methods where permitted. Asset additions and improvements are added to the property accounts while maintenance and repairs, which do not renew or extend the lives of the respective assets, are expensed currently. Upon sale or retirement of depreciable properties, the related cost and accumulated depreciation are removed from the property accounts. The net gain or loss on disposition of property is reflected in income.\nDerivatives -- Premiums paid for purchased interest rate cap agreements are amortized to interest expense over the terms of the caps. Unamortized premiums are included in other assets in the consolidated balance sheets. Amounts receivable under cap agreements, if any, are accrued as a reduction of interest expense. Gains and losses related to qualifying hedges of firm commitments or anticipated\nSPX CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1995\ntransactions are deferred and are recognized in income or as adjustments of carrying amounts when the hedged transaction occurs.\nReclassifications -- Certain 1994 and 1993 amounts have been reclassified to conform to the 1995 presentation. This reclassification had no effect on net income for any period.\n(2) CHANGES IN ACCOUNTING METHODS\nIn 1993, the company adopted two new accounting methods relating to its Employee Stock Ownership Plan (\"ESOP\") and postretirement benefits. The effect of the change to these new accounting methods have been reflected in the consolidated statements of income as \"Cumulative effect of change in accounting methods.\"\nEffective January 1, 1993, the company elected to adopt new accounting for its ESOP in accordance with Statement of Position 93-6 of the Accounting Standards Division of the American Institute of Certified Public Accountants, issued in November of 1993. As part of this change, the company recorded a cumulative charge of $5,100 pretax, or $3,300 after-tax. This charge recognizes the cumulative difference of expense since the inception of the ESOP until January 1, 1993 to reflect the shares allocated method of accounting for ESOPs.\nEffective January 1, 1993, Sealed Power Technologies Limited Partnership adopted Statement of Financial Accounting Standards (SFAS) No. 106 -- \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" using the immediate recognition transition option. SFAS No. 106 requires recognition, during the employees' service with the company, of the cost of their retiree health and life insurance benefits. At that date, the full accumulated postretirement benefit obligation was $89,500 pretax. The company recorded its 49% share of this transition obligation, $28,500, net of deferred taxes of $15,400 in the first quarter.\nAs of the beginning of 1996, the company must adopt Statement of Financial Accounting Standards, No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.\" This standard requires long-lived assets to be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. The effect of adopting this statement is not expected to have a significant impact on the company's consolidated financial position or results of operations.\nAs of the beginning of 1996, the company must adopt Statement of Financial Accounting Standards, No. 123, \"Accounting for Stock-Based Compensation.\" This standard recommends the adoption of the fair value based method for stock-based compensation. The standard allows the company to continue to measure stock-based compensation cost using the intrinsic value based method of accounting prescribed by Accounting Principles Board Opinion No. 25, \"Accounting for Stock Issued to Employees.\" The company has elected to continue to measure stock-based compensation cost using APB No. 25, as such, the effect of this new statement will be limited to additional required disclosures beginning in 1996.\n(3) BUSINESS DESCRIPTION\nThe company is comprised of two business segments. Specialty Service Tools includes operations that design, manufacture and market a wide range of specialty service tools and diagnostic equipment primarily to the motor vehicle industry, principally in North America and Europe. Major customers of this segment are franchised dealerships of motor vehicle original equipment manufacturers, aftermarket vehicle service facilities, and independent distributors. Original Equipment Components includes operations that design, manufacture and market engine, transmission and steering component parts for light and heavy duty vehicle markets, principally in North America and Europe. Major customers of this segment are vehicle manufacturers and aftermarket private brand distributors.\nSPX CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1995\nRevenues by business segment represent sales to unaffiliated customers. Intercompany sales between segments are not significant. Operating income (loss) by segment does not include general unallocated corporate expense, other expense (income), net, interest expense, income taxes and extraordinary items.\nIdentifiable assets by business segment are those used in company operations in each segment. General corporate assets are principally cash, deferred tax assets, and certain prepaid expenses.\n- ---------------\n(a) 1995 includes a $7,000 restructuring charge to combine five divisions into two divisions. 1993 includes a $27,500 restructuring charge to merge Allen Testproducts and Bear Automotive into Automotive Diagnostics.\n(b) 1995 includes a $3,724 restructuring charge to close a foundry operation in Germany. 1993 includes $26,845 of SPT equity losses and $21,500 of SP Europe equity losses.\n(c) Decrease in 1994 was primarily due to the use of $108,100 in cash to purchase SPT and to complete the debt refinancing in 1994.\nSPX CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1995\n- ---------------\n(a) Included in the United States revenues are export sales to unconsolidated customers of $83,000 in 1995, $95,700 in 1994 and $74,400 in 1993.\n(b) 1995 includes a $7,000 restructuring charge to merge five specialty service tool divisions into two divisions. 1993 includes a $27,500 restructuring charge to merge Allen Testproducts and Bear Automotive into Automotive Diagnostics and $26,845 of SPT equity losses.\n(c) 1995 includes a $3,724 restructuring charge to close a foundry operation in Germany. 1993 includes $21,500 of SP Europe equity losses.\nApproximately 20% in 1995, 16% in 1994 and 9% in 1993 of the company's consolidated sales were made to General Motors Corporation and its various divisions, dealers and distributors. Approximately 12% in 1995, 12% in 1994 and 2% in 1993 of the company's consolidated sales were made to Ford Motor Company and its various divisions, dealers and distributors. Approximately 5% in 1995, 7% in 1994 and 6% in 1993 of the company's consolidated sales were made to Chrysler Corporation and its various divisions, dealers and distributors. No other customer or group of customers under common control accounted for more than 10% of consolidated sales for any of these years. On a proforma 1993 basis, approximately 17%, 10% and 8% of consolidated sales were to General Motors, Ford and Chrysler, respectively.\n(4) DISCONTINUED OPERATION\nOn September 29, 1995, the company sold the majority of its SPX Credit Corporation operations and lease financing receivables to Textron Financial Corporation (\"TFC\"), a subsidiary of Textron Inc. The sales\nSPX CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1995\nproceeds were $73,183. The company recorded a $2,987 after-tax loss ($4,817 pretax) on the sale on costs associated with closing the remaining leasing operation. Proceeds from the sale were used to reduce a portion of the company's debt. TFC will provide SPX customers with financing previously provided by SPX Credit Corporation. SPX's agreement with TFC includes provisions for the company to repurchase equipment resulting from future lease defaults. See Note 19 for further explanation of repurchase and recourse provisions of this agreement.\nThe results of operations, net of taxes, and the net assets of SPX Credit Corporation are presented in the accompanying consolidated financial statements as a discontinued operation through the end of the third quarter of 1995. Consolidated interest expense has been allocated based upon the ratio of the net assets of the discontinued operation to the consolidated capitalization of the company. Income taxes have been allocated to the discontinued operation at approximately 41% of pretax income. No general corporate expenses have been allocated to the discontinued operation. The results of the discontinued operation are not necessarily indicative of the results of operations which may have been obtained had continuing and discontinued operations been operating independently.\nThe following summarizes the results of operations for the nine months ended September 29, 1995 and the twelve months ended December 31, 1994 and 1993 and net assets of SPX Credit Corporation at December 31, 1994:\n(5) ACQUISITIONS AND DIVESTITURES\nACQUISITIONS\nAllen Testproducts (\"ATP\") and Allen Group Leasing (\"AGL\") -- On June 10, 1993, the company acquired ATP and its related leasing company, AGL, from the Allen Group, Inc. for $102,000. ATP is a manufacturer and marketer of vehicular test and service equipment. This acquisition was recorded using the purchase method of accounting, and the results of ATP and AGL have been included in the company's consolidated statements of income since June 10, 1993.\nSealed Power Technologies Limited Partnership (\"SPT\") -- Effective December 31, 1993, the company acquired Riken Corporation's 49% and management's 2% interests in SPT for $39,000 and $2,700,\nSPX CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1995\nrespectively. The company previously owned 49% of SPT. Accordingly, the net assets of SPT have been included in the accompanying consolidated balance sheet as of December 31, 1993. Prior to this acquisition, the company accounted for its investment using the equity method. Beginning in the first quarter of 1994, results of operations of SPT are reflected in the consolidated statements of income and cash flows. Prior to 1994, the pro rata share of earnings or losses and the amortization of the company's investment in SPT is reflected as \"SPT equity losses\" on the consolidated statements of income.\nDIVESTITURES\nSealed Power Replacement (\"SPR\") -- On October 22, 1993, the company sold SPR to Federal-Mogul Corporation for approximately $141,000 in cash. SPR distributed engine and undervehicle parts into the U.S. and Canadian aftermarket. Net proceeds, after income taxes, were approximately $117,500. The company recorded a pretax gain of $52,400 after transaction and facility reduction expenses, or $32,400 after-tax.\nTruth -- On November 5, 1993, the company sold Truth to Danks America Corporation, an affiliate of FKI Industries, Inc. for approximately $92,500 in cash. In addition, the company will receive an annual royalty ranging from 1.0% to 1.5% of Truth's annual sales for a five year period following the closing (cumulatively not to exceed $7,500) which will be recorded as other income as received. Truth manufactures and markets window and door hardware primarily in the U.S. and Canada. Net proceeds, after income taxes, were approximately $71,600. The company recorded a pretax gain of $53,000 after transaction expenses, or $31,800 after-tax.\n(6) PROFORMA RESULTS OF OPERATIONS (UNAUDITED)\nThe following 1993 unaudited proforma selected financial data reflects the acquisition of Allen Testproducts and related restructuring, the divestiture of the SPR and Truth divisions, the acquisition of 51% of SPT, and the consolidation of SP Europe as if they had occurred as of January 1, 1993.\nThe unaudited proforma selected results of operations does not purport to represent what the company's results of continuing operations would actually have been had the above transactions in fact occurred as of January 1, 1993 or project the results of operations for any future date or period.\nSPX CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1995\n(7) RESTRUCTURING CHARGES\n1995 RESTRUCTURING CHARGE\nDuring the fourth quarter of 1995, management authorized and committed the company to undertake two significant restructurings and recorded a combined restructuring charge of $10,724. The first restructuring plan will consolidate five Specialty Service Tool divisions into two divisions. The second restructuring plan will close SP Europe's German foundry operation and transfer certain piston ring operations to other manufacturing facilities.\nSpecialty Service Tool Restructuring -- In order to improve customer service, reduce costs and improve productivity and asset utilization, the company decided to consolidate five existing Specialty Service Tool divisions into two divisions. This restructuring plan involves closing two company owned manufacturing facilities, a company owned distribution facility, four leased service centers and a leased sales facility in France. Additionally, the plan includes combining selling, engineering and administrative functions. This restructuring plan is expected to be completed by the end of 1996. The plan includes the termination of approximately 570 employees which will result in a net reduction of approximately 310 employee positions after considering staffing requirements at remaining facilities.\nThe company recorded a $7,000 restructuring charge to recognize severance and benefits for the employees to be terminated ($4,400), estimated holding costs of vacated facilities ($1,100), and to reflect the fair market value of one manufacturing facility to be closed ($1,500). The other company owned manufacturing facility and the distribution facility are expected to be sold at prices in excess of their net carrying value ($3,000). Also, the charge for severance and benefits for the employees to be terminated is net of a $3,127 curtailment gain for pension and postretirement health care benefits. At December 31, 1995, no costs have been charged against these restructuring accruals.\nThe company is also estimating that approximately $11,000 of incremental costs associated with this restructuring will be incurred in 1996. These incremental costs will benefit future operations and do not qualify for accrual in 1995. Examples of these incremental costs include machinery and equipment and inventory moving costs, employee relocation costs, etc. Also, the company will record an approximate $1,000 restructuring charge in the first quarter of 1996 to reflect incremental early retirement costs for 55 of these employees who elected (in January 1996) to participate in an early retirement program.\nSP Europe Restructuring -- German Plant -- The company will close its unprofitable foundry operations at SP Europe and transfer certain piston ring operations to other facilities. This closing will result in the elimination of approximately 200 employees and is planned to be completed by the end of the third quarter of 1996. The company recorded a $3,724 restructuring charge to accrue severance that will be paid to these affected employees. Additional costs to complete this restructuring in 1996 are not expected to be significant. At December 31, 1995, no costs have been charged against this restructuring accrual.\n1993 RESTRUCTURING CHARGE\nIn the third quarter of 1993, the company initiated the merger of Allen Testproducts (acquired in June of 1993) with the company's Bear Automotive division to form a single business unit called Automotive Diagnostics. The company recorded a pretax $27,500 restructuring charge ($18,500 after-tax) to provide for substantial reduction in workforce and facilities related to the merger. Of the $27,500 restructuring charge, approximately $16,000 related to workforce reduction of approximately 600 employees and associated costs. The charge also included $9,300 of facility duplication and shutdown costs, including the write down of excess assets of $4,200 (non-cash).\nSPX CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1995\n(8) EXTRAORDINARY LOSS\n1995 -- Beginning in the first quarter of 1995, the company began to purchase some of its 11 3\/4% senior subordinated notes. As of December 31, 1995, $31,690 of these notes had been purchased at a premium of $1,797. This premium, net of income taxes of $719, has been recorded as the extraordinary loss.\n1993 -- In the fourth quarter of 1993, the company recorded an extraordinary charge of $37,000 ($24,000 after-tax) for early retirement extinguishment costs associated with debt refinanced in 1994. During the first half of 1994, approximately $400,000 (December 31, 1993 principal amount) of debt was refinanced. As of the end of the second quarter of 1994, the refinancing was completed and all costs to extinguish this debt were charged to the reserve established at the end of 1993.\n(9) EMPLOYEE BENEFIT PLANS\nDEFINED BENEFIT PENSION PLANS\nThe company has defined benefit pension plans which cover substantially all domestic employees. These plans provide pension benefits that are principally based on the employees' years of credited service and levels of earnings. Contributions in excess of pension expense are considered prepayments for financial accounting purposes. The company has determined that foreign defined benefit pension plans are immaterial to the consolidated financial statements. Net periodic pension cost (benefit) included the following components:\nSPX CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1995\nPlan assets principally consist of equity and fixed income security investments. The following table sets forth the plans' funded status and amounts recognized in the company's consolidated balance sheets as Other Assets for its U.S. pension plans:\nIn the fourth quarter of 1995, the company recorded a curtailment gain of $1,853 associated with employee terminations included in the Specialty Service Tool restructuring and the gain has been included in the restructuring charge. As part of the 1993 divestitures of the SPR and Truth divisions, the company recorded curtailment gains of $4,100 and the gain was included in the gain recognized on the sale of these divisions.\nPOSTRETIREMENT HEALTH CARE AND LIFE INSURANCE\nPostretirement health and life insurance expense was as follows:\nThe accumulated postretirement benefit obligation was actuarially determined based on assumptions regarding the discount rate and health care trend rates. The health care trend assumption applies to postretirement medical and dental benefits. Different trend rates are used for pre-age 65 and post-age 65 medical claims and for expected dental claims. The trend rate used for the medical plan was 13% in 1995, grading to a 6% ultimate rate by 1% each year for pre-65 claims; and 9.5% in 1995 grading to 6% by .5% each year for post-age 65 claims. The trend rate for the dental plan was 6% each year. The liability was discounted using the pension rates. Increasing the health care trend rate by one percentage point would increase the\nSPX CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1995\naccumulated postretirement benefit obligation by $4,700 and would increase the 1995 postretirement benefit cost by $400.\nThe following table summarizes the accumulated benefit obligation (in thousands):\nIn the fourth quarter of 1995, the company recorded a curtailment gain of $1,274 associated with employee terminations included in the Specialty Service Tool restructuring and the gain has been included in the restructuring charge.\nRETIREMENT SAVINGS AND EMPLOYEE STOCK OWNERSHIP PLAN (\"KSOP\")\nBeginning in 1994, the company combined its former Retirement Savings Plan and its Employee Stock Ownership Plan (\"ESOP\") into a single plan, the KSOP. The plan provides benefits to approximately 3,000 domestic employees. These employees can contribute up to 15% of their earnings. The company matches a portion of the employee's contribution with shares from the plan's trust. In 1995 and 1994, 211,882 and 163,908 shares, respectively, were allocated to employees under the plan. In 1993, 114,588 shares were allocated to eligible employees under the ESOP plan and cash contributions to the participants of the former Retirement Savings Plan were $875. Compensation expense is recorded based upon the market value of shares as the shares are allocated to the employees. In 1995, 1994 and 1993, $3,027, $2,778 and $1,925 was recorded as compensation expense, respectively.\nThe ESOP was established in 1989 when the ESOP borrowed $50,000, which was guaranteed by the company, and used the proceeds to purchase 1,746,725 shares of common stock issued directly by the company. Employees may vote allocated shares directly, while the ESOP trustee will vote the unallocated shares proportionally on the same basis as the allocated shares were voted. At December 31, 1995, there were 870,555 unallocated shares in the ESOP trust. The fair market value of the unallocated shares was $13,800 at December 31, 1995. Also, the company recorded third party interest expense incurred by the ESOP trust for third party borrowings of $950 in 1994 and $3,902 in 1993. The third party borrowings of the ESOP trust were extinguished during the first half of 1994 and replaced by a loan from the company to the ESOP trust.\nOTHER\nThe company provides defined contribution pension plans for substantially all employees not covered by defined benefit pension plans. Collectively, the company's contributions to these plans were $1,519 in 1995, $1,308 in 1994 and $683 in 1993.\nSPX CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1995\nThe company provides a Retirement Savings Plan for certain eligible domestic employees that are not included in the KSOP. These employees can contribute up to 15% of their earnings. The company matches a portion of the employee's contribution with cash. The company's cash contribution to this plan was $1,033 in 1995 and $1,019 in 1994.\n(10) RECEIVABLES\nChanges in the reserve for losses on receivables were as follows:\n(11) INVENTORIES\nDomestic inventories, amounting to $111,300 and $116,100 at December 31, 1995 and 1994, respectively, are based on the last-in, first-out (LIFO) method. Such inventories, if priced on the first-in, first-out (FIFO) method, would have been approximately $18,900 and $18,200 greater at December 31, 1995 and 1994, respectively. During 1995, 1994 and 1993, certain inventory quantities were reduced resulting in liquidations of LIFO inventory quantities carried at lower costs prevailing in prior years. The effect was to increase net income in 1995 by $173, in 1994 by $223 and in 1993 by $455. Substantially all foreign inventories are valued at FIFO costs. Inventories include material, labor and factory overhead costs. None of the inventories exceed realizable values.\nThe components of inventory at year-end were as follows:\nSPX CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1995\n(12) INCOME TAXES\nIncome (loss) before income taxes and the related provision (benefit) for income taxes from continuing operations consists of the following:\nA reconciliation of the effective rate for income taxes shown in the consolidated statements of income with the U.S. statutory rate of 35% is shown below:\nNo provision has been made for income and withholding taxes which would become payable upon distribution of the undistributed earnings of foreign subsidiaries and affiliates. It is the company's present intention to permanently reinvest these earnings in its foreign operations. The amount of undistributed earnings which have been reinvested in foreign subsidiaries and affiliates at December 31, 1995, was $31,700. It is not practical to determine the hypothetical U.S. federal income tax liability if all such earnings were remitted, but distribution as dividends at the end of 1995 would have resulted in payment of withholding taxes of approximately $2,100.\nSPX CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1995\nThe components of the net deferred income tax assets (liabilities) were as follows:\nIncluded on the consolidated balance sheets are U.S. federal income tax refunds and receivables of $10,270 in 1995 and $19,009 in 1994.\nAt December 31, 1995, the company has net operating loss carryforwards attributable to foreign operations of $18,200 available to offset future taxable income. These loss carryforwards expire as follows: $0 in 1996, $600 in 1997, $2,400 in 1998, $100 in 1999, $300 in 2000 and $14,800 thereafter. During 1995, the company utilized $2,600 of net operating loss carryforwards attributable to foreign operations, resulting in tax benefits of $1,000. The deferred tax asset related to the net operating loss carryforwards has been reserved in the valuation allowance.\n(13) INVESTMENTS AND SP EUROPE\nINVESTMENTS\nAs of December 31, 1995, investments, as shown on the consolidated balance sheet, include equity investments in non-majority owned subsidiaries. These investments include the company's 50% owned interest in a U.S. joint venture, a 50% owned interest in a joint venture in Japan, a 40% interest in a Mexican company and a 50% interest in a German company. All of these investments are accounted for using the equity method. These investments, both individually and collectively, are not material to the company's consolidated financial statements.\nIn the fourth quarter of 1995, the company sold its 50% ownership in RSV, a Japanese joint venture, to the joint venture partner. The company recorded a gain of $950, which represented equity losses previously recorded in excess of the original investment. Additionally, the company recorded a $1,295 tax benefit to reflect the utilization of the capital loss generated by selling the investment.\nSPX CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1995\nSP EUROPE\nIn the fourth quarter of 1995, the company's partner in SP Europe announced its decision to limit its participation by not fully funding its 30% share of this partnership. The company had accounted for this minority partner's 30% share of SP Europe's losses as minority interest income and recorded the cumulative losses attributed to the partner as \"minority interest\" in the equity section of the consolidated balance sheets. Although the company's partner in SP Europe currently retains a 30% interest in this partnership, the company will receive 100% of the income or losses of SP Europe until such time as the deficit in the partners' capital accounts is recovered. Due to the partner's decision to not fully fund its 30% share and inherent uncertainties associated with the future recovery of this deficit, the company recorded a $4,767 charge for the cumulative losses previously attributed to this partner to minority interest (income) loss.\nUntil December 31, 1993, the company reported that it held a 50% interest in SP Europe. As of December 31, 1993, Riken's pending 20% participation in SP Europe reverted to the company in connection with the transaction to acquire Riken's 49% in SPT. SP Europe had not been previously consolidated due to the company's deemed temporary control and because nonrecourse (to the partners) financing was being pursued. Up to December 31, 1993, the company carried its investment in SP Europe at zero. Due to the resulting 70% ownership, the company recorded its share of cumulative losses since the partnership formation in mid-1991 of $21,500. As of December 31, 1993, the balance sheet of this partnership is included in the consolidated financial statements, reflecting the company's 70% ownership and Mahle GmbH's 30% minority interest. Beginning in the first quarter of 1994, results of operations of SP Europe are reflected in the consolidated statements of income and cash flows.\n(14) PROPERTY, PLANT AND EQUIPMENT\nThe major classes are as follows:\n(15) COSTS IN EXCESS OF NET ASSETS OF BUSINESSES ACQUIRED\nAt December 31, 1995 and 1994, total costs in excess of net assets of businesses acquired was $224,291, and accumulated amortization of costs in excess of net assets of businesses acquired was $31,957 and $25,146, respectively. Amortization was $6,811 in 1995, $6,007 in 1994 and $3,382 in 1993.\nThe company amortizes costs in excess of the net assets of businesses acquired (\"goodwill\") on a straight-line method over the estimated periods benefited, not to exceed 40 years. After an acquisition, the company continually reviews whether subsequent events and circumstances have occurred that indicate the remaining estimated useful life of goodwill may warrant revision or that the remaining balance of goodwill may not be recoverable. If events and circumstances indicate that goodwill related to a particular business should be reviewed for possible impairment, the company uses projections to assess whether future operating income on a non-discounted basis (before goodwill amortization) of the unit is likely to exceed the goodwill\nSPX CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1995\namortization over the remaining life of the goodwill, to determine whether a writedown of goodwill to recoverable value is appropriate.\nAt December 31, 1995, $69,217 of goodwill relates to the Automotive Diagnostics operating unit. This operating unit has incurred significant operating losses in 1995 and in prior years. The company projects that, in the near future, the cost savings, market synergies and other factors which, in part, will be realized from the Bear Automotive and Allen Testproducts combination and the 1995 restructuring described in Note 7 will result in non-discounted operating income sufficient to exceed goodwill amortization.\nThe market for certain portions of the Automotive Diagnostics operating unit's products is highly cyclical. The demand for vehicle emissions test equipment is significantly impacted by changes in U.S. federal and state government regulations designed to improve air quality by imposing more stringent limitations on emissions and discharges to the environment from motor vehicles. Management also believes that these regulations have a related impact on the market for engine performance testing equipment. Certain of the company's products perform tests of both engine performance and emissions.\nThe company's projections for this operating unit over the near term (after 1996) include significant incremental revenues, operating profit and cash flows associated with market opportunities that will be created by enacted federal and state regulations mandated by the 1990 Clean Air Act Amendment (the \"Act\"). Over the longer term, the company's projections include the cyclical impact of further legislation in the U.S. and in certain international markets in which the company participates. As a result of the Act, certain geographic regions were designated as \"enhanced emissions areas.\" Areas so designated are required to implement more rigorous testing standards. This change creates additional market opportunity for the company, in particular, for testing equipment capable of testing for nitrites of oxygen. However, due to politically driven factors, various states have delayed implementation of the provisions of the Act in these \"enhanced emissions areas.\" To date, no changes have been made to the Act for implementation or enforcement. Further, the company expects debate to continue during 1996 at both the federal and state level over the merits of this legislation. Future changes in legislation could significantly diminish or eliminate these incremental market opportunities for motor vehicle gas emissions testing equipment.\nIt is not possible to predict the extent to which the company or the market for motor vehicle gas emissions testing equipment in general might be affected by the matters described above. However, should the company's projections require downward revisions based upon changed events, circumstances or legislation, this operating unit's goodwill may require writedown. Although having no cash flow impact, the resulting charge, if any, could materially reduce the company's future reported results of operations and shareholders' equity. At this time, based upon present information, projections and strategic plans, the company has concluded that there has been no permanent impairment of the Automotive Diagnostics operating unit's tangible or intangible assets.\nSPX CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1995\n(16) ACCRUED LIABILITIES\nDetails of accrued liabilities is as follows:\n(17) COMMITMENTS AND CONTINGENT LIABILITIES\nOPERATING LEASES\nThe company leases certain offices, warehouses and equipment under lease agreements which expire at various dates through 2007. Future minimum rental commitments under non-cancelable operating leases are $12,100 for 1996, $8,900 for 1997, $6,200 for 1998, $4,800 for 1999, $3,700 for 2000 and aggregate $11,100 thereafter. Rentals on these leases were $14,800 in 1995, $11,400 in 1994 and $12,900 in 1993.\nGENERAL\nCertain claims, including environmental matters, suits and complaints arising in the ordinary course of business, have been filed or are pending against the company. In the opinion of management, all such matters are without merit or are of such kind, or involve such amounts, as would not have a significant effect on the financial position or results of operations of the company if disposed of unfavorably.\nThe company has, for at least the last two and one-half years, been engaged in discussions with Snap-on Corporation regarding claims which the company has against Snap-on and which Snap-on believes it has against the company. As of August 26, 1993, the company had asserted a number of patent infringement claims against Snap-on, relating to products marketed either by Snap-on or by Sun Electric Corporation, a company whose stock Snap-on purchased in 1992. As of August 26, 1993, Snap-on had asserted claims of violation of securities laws against one of its executives arising out of his former employment with Sun Electric and against the company as an aider and abettor of those violations. On that date, a Standstill Agreement was executed between the parties which preserved the parties' rights while permitting settlement discussions. Since that time, Snap-on has raised patent infringement claims against the company which, by agreement, are covered by the August 26, 1993 Standstill Agreement, as well as another independent patent infringement claim for which a lawsuit was filed in California in late December 1995. On January 8, 1996, after extensive but unsuccessful negotiations to resolve all asserted claims, Snap-on Corporation and Sun Electric Corporation notified the company of the termination of the Standstill Agreement. Under the terms of that Agreement, the standstill will terminate March 8, 1996. The company has been advised that after that date, Snap-on and Sun will initiate litigation and assert their claims. If they do not do so, the company intends to begin litigation of its claims against Snap-on and Sun. The company has what it believes to be meritorious defenses as well as counterclaims which it will raise and intends to vigorously prosecute any litigation. The asserted value of the claims against the company and those to be brought by the company are in the multiple millions of dollars. It is not, however, possible to assess the ultimate outcome of the claims at this point.\nSPX CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1995\nDuring the first quarter of 1995, the company reached agreement to settle a dispute involving a non-core business sold in 1989. As of December 31, 1994, the company recorded a $2,100 charge for this settlement. The company expects this agreement to resolve all issues pertaining to the sale of this business.\nENVIRONMENTAL\nThe company's operations and properties are subject to federal, state, local, and foreign regulatory requirements relating to environmental protection. It is the company's policy to comply fully with all such applicable requirements. As part of its effort to comply, management has established an ongoing internal compliance auditing program which has been in place since 1989. Based on current information, management believes that the company's operations are in substantial compliance with applicable environmental laws and regulations and the company is not aware of any violation that could have a material adverse effect on the business, financial conditions, results of operations, or cash flows of the company. There can be no assurance, however, that currently unknown matters, new laws and regulations, or stricter interpretations of existing laws and regulations will not materially affect the company's business or operations in the future.\nThe company is also subject to potential liability for the costs of environmental remediation. This liability may be based upon the ownership or operation of industrial facilities where contamination may be found as well as contribution to contamination existing at offsite, non-owned facilities. These offsite remediation costs cannot be quantified with any degree of certainty. At this time, management can estimate the environmental remediation costs only in terms of possibilities and probabilities based on available information.\nThe company is involved as a potentially responsible party (\"PRP\") under the Comprehensive, Environmental Response, Compensation and Liability Act of 1980 (\"CERCLA\"), as amended, or similar state superfund statutes in ten proceedings involving off-site waste disposal facilities. At seven of these sites it has been established that the company is a de minimis contributor. A determination has not been made with respect to the remaining three sites, but the company believes that it will be found to be a de minimis contributor at two of them. Of these remaining sites, one is approaching settlement with the Environmental Protection Agency with an expected cost to the company of approximately $200, another is expected to be resolved at a cost not to exceed $50, and the final site is under investigation with an expected cost of approximately $150. Based on information available to the company, which in most cases includes estimates from PRPs and\/or federal or state regulatory agencies for the investigation, clean up costs at those sites, and data related to the quantities and characteristics of materials generated at or shipped to each site, the company believes that the costs for each site are not material and in total the anticipated clean up costs of current PRP actions would not have a material adverse effect on the company's business, financial condition, results of operations, or cash flows.\nIn the case of contamination existing upon properties owned or controlled by the company, the company has established reserves which it deems adequate to meet its current remediation obligations.\nThere can be no assurance that the company will not be required to pay environmental compliance costs or incur liabilities that may be material in amount due to matters which arise in the future or are not currently known to the company.\nEXECUTIVE SEVERANCE AGREEMENTS\nDuring 1988, the company's Board of Directors adopted executive severance agreements which create certain liabilities in the event of the termination of the covered executives following a change of control of the company. The aggregate commitment under these executive severance agreements should all eight covered employees be terminated is approximately $12,800. Additionally, should a change in control occur, restrictions\nSPX CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1995\non any outstanding restricted stock and stock options granted under the 1992 Stock Compensation Plan would lapse.\n(18) NOTES PAYABLE AND DEBT\nAggregate maturities of total debt are $893 in 1996, $9,017 in 1997, $3,393 in 1998, $62,000 in 1999, $0 in 2000 and $244,484 thereafter.\nREVOLVING CREDIT AGREEMENT -- The company has a credit agreement, as amended, with a syndicate of banks which provides unsecured revolving credit commitments in an aggregate amount not to exceed $225,000. The agreement, dated March 24, 1994, has a termination date of March 15, 1999 with mandatory revolving credit commitment reductions of $12,500 in June and December of 1997 and 1998, respectively. At the option of the company, revolving credit advances may be Floating rate advances or Eurodollar advances. Floating rate advances bear interest at the prime rate, and Eurodollar advances bear interest at LIBOR plus 1.0% for an interest period of one, two, three or six months, selected by the company prior to each Eurodollar advance. At December 31, 1995, the weighted average interest rate on outstanding revolving credit borrowings was 7.0%.\nThe agreement also provides a letter of credit facility, which is available for the issuance of standby letters of credit in an aggregate amount of $35,000. Standby letters of credit issued under this facility reduce the aggregate amount available under the revolving credit commitment.\nThe company must pay a commitment fee of .375% per annum on the aggregate revolving credit commitment, minus the sum of the outstanding balance of the revolving credit loans and the letter of credit facility obligations.\nThe company also has a $5,000 swingline loan facility to assist in managing daily cash requirements. Loans under the swingline bear interest at the prime rate and are due in 90 days.\nSENIOR SUBORDINATED NOTES -- In May 1994, the company issued $260,000 of senior subordinated notes which bear interest of 11.75%, payable semi-annually and are due June 1, 2002. The notes are redeemable at the option of the company after June 1, 1998 at a premium which declines to par in the year 2000. In addition, up to $78,000 of the notes are redeemable prior to June 1, 1996, at the option of the company, within 45 days of the sale of capital stock in a public equity offering from the net proceeds of such sale at a redemption price equal to 110.75% of the principal amount to be redeemed, together with accrued and unpaid interest, if any, thereon to the date of redemption.\nSPX CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1995\nRESTRICTIVE COVENANTS -- The company's revolving credit agreement and senior subordinated note indenture contain covenants. Late in 1995 and in the first quarter of 1996, the revolving credit agreement was amended to adjust certain covenants. At December 31, 1995, the company was in compliance with such amended covenants. Under the most restrictive of these covenants, the company was required to:\n- Maintain a leverage ratio, as defined, of 78% or less, declining on a graduated scale to 65% in 1999. The leverage ratio at December 31, 1995 was 69%.\n- Maintain an interest expense coverage ratio, as defined, of 1.70:1 or greater in 1995 rising on a graduated scale to 3.50:1 or greater in 1998 and thereafter. The interest expense coverage ratio as of December 31, 1995 was 2.13:1.\n- Maintain a fixed charge coverage ratio, as defined, of 1.50:1 or greater in 1995 and 1996, and 2:1 or greater thereafter. The fixed charge coverage ratio as of December 31, 1995 was 1.78:1.\n- Limit dividends paid during the preceding twelve months to 10% of operating income plus depreciation and amortization (EBITDA) for the twelve month period. Dividends paid for the twelve month period ended December 31, 1995 were $5,274 and 10% of EBITDA for the period was $7,613.\nCovenants also limit capital expenditures, investments and transactions with affiliates. The amended revolving credit agreement also limits the company's prospective purchase of 11-3\/4% senior subordinated notes to $15 million. The company is currently negotiating an amendment with the revolving credit facility lenders to increase the amount of notes that can be purchased to $50 million. These negotiations also include the reduction of the revolving credit facility's commitment from $225 million to $175 million. It is anticipated that this amendment will be obtained by mid to late March 1996.\n(19) FINANCIAL INSTRUMENTS\nDERIVATIVE FINANCIAL INSTRUMENTS\nThe company has only limited involvement with derivative financial instruments and does not use them for trading purposes. They are used to manage well-defined interest rate and transaction specific foreign exchange risks.\nInterest rate cap agreements are used to reduce the potential impact of increases in interest rates on floating rate long-term debt. At December 31, 1995, the company was party to three interest rate cap agreements which expire in 1997 and 1998. The agreements entitle the company to receive from the counterparties on a quarterly basis the amounts, if any, by which LIBOR exceeds 8.5% on $25,000 and 9.0% on $75,000.\nThe company enters into foreign exchange contracts to hedge specific purchase and sale transactions involving more than one currency. The company's forward exchange contracts and futures hedge transactions are principally denominated in European currencies. Some of the contracts involve the exchange of two foreign currencies, according to local needs in foreign subsidiaries. The term of the currency derivatives is rarely more than six months. The purpose of the company's foreign currency hedging activities is to protect the company from the risk that the eventual total dollar net cash inflows resulting from transactions will be adversely affected by changes in exchange rates. At December 31, 1995, the company had no foreign exchanges contracts outstanding. At December 31, 1994, the company had foreign exchange contracts maturing during 1995 to sell the equivalent of $718 and to purchase the equivalent of $718 in foreign currency.\nSPX CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1995\nOFF-BALANCE SHEET RISK\nAs collateral for performance on contracts and as credit guarantees to banks and insurers, the company is contingently liable under standby letters of credit in the amount of $22,467 and $26,406 at December 31, 1995 and 1994, respectively. These standby letters of credit are generally in force for one year, for which the company pays fees to various banks that generally range from 0 to 1.25 percent per annum of their face value. If the company was required to obtain replacement standby letters of credit as of December 31, 1995 for those currently outstanding, it is the company's opinion that the replacement costs for such standby letters of credit would not significantly vary from the present fee structure.\nFAIR VALUE OF FINANCIAL INSTRUMENTS\nThe carrying amounts and fair values of the company's financial instruments at December 31 are as follows:\nThe following methods and assumptions were used by the company in estimating its fair value disclosures:\n- Cash and temporary investments, and receivables: The carrying amount reported on the consolidated balance sheet approximates its fair value because of the short maturity of those instruments.\n- Other assets (derivatives): The amount reported relates to the interest rate cap agreements. The carrying amount comprises the unamortized premiums paid for the contracts. The fair value is estimated using option pricing models and essentially values the potential for the cap to become in-the-money through changes in interest rates during the remaining term.\n- Notes payable and current maturities of long-term debt and Long-term debt: The fair value of the company's debt either approximates its carrying value or is estimated based on quoted market prices.\n- Letters of credit: The company utilizes letters of credit to back certain financing instruments and insurance policies. The letters of credit reflect fair value as a condition of their underlying purpose and are subject to fees competitively determined in the marketplace.\nRECEIVABLES SOLD WITH REPURCHASE AND RECOURSE PROVISIONS\nThe company retained certain repurchase and recourse liability related to lease receivables sold to Textron Financial Corporation (\"TFC\"). As of December 31, 1995, approximately $12,000 of lease receivables held by TFC are subject to recourse equal to their net lease balance. The company's allowance for this recourse liability, net of the estimated recoverable value, was $3,200 at December 31, 1995. Additionally, as of December 31, 1995, TFC holds approximately $55,500 of net lease receivables that provide for limited\nSPX CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1995\nrepurchase liability to the company. The company's analysis indicates that this limited repurchase liability approximates the estimated recoverable value.\nThe company retained limited recourse liability related to certain lease receivables which were sold to financial institutions prior to 1994. In the event of default by a lessee, the financial institution has recourse equal to their net lease receivable. In return, the company receives the collateralized lease equipment. At December 31, 1995 and 1994, financial institutions held lease receivables, which are subject to limited recourse, of $7,586 and $20,365, respectively. Correspondingly, allowances for recourse liabilities, net of recoverable value, were $455 and $1,470 at December 31, 1995 and 1994.\nThe company has a three year agreement, expiring in April 1997, with a financial institution whereby the company agreed to sell undivided fractional interests in designated pools of domestic trade accounts receivable, in an amount not to exceed $30,000. In order to maintain the balance in the designated pools of trade accounts receivable sold, the company sells participating interests in new receivables as existing receivables are collected. At December 31, 1995 and 1994, the company had sold $25,950 of trade accounts receivable under this and previous programs. Under the terms of this agreement, the company is obligated to pay fees which approximate the purchasers' cost of issuing a like amount in commercial paper plus certain administrative costs. The amount of such fees in 1995, 1994 and 1993 were $1,860, $1,390 and $1,215 respectively and are included in other expense, net.\nCONCENTRATIONS OF CREDIT RISK\nFinancial instruments that potentially subject the company to significant concentrations of credit risk consist principally of cash and temporary investments, trade accounts receivable and its interest rate cap agreements.\nCash and temporary investments are placed with various high credit quality financial institutions throughout the world and exposure is limited at any one institution. The company periodically evaluates the relative credit standing of these financial institutions.\nConcentrations of credit risk arising from trade accounts receivable are due to the company selling to a large number of customers operating in the motor vehicle industry, particularly in the United States. The company performs ongoing credit evaluations of its customers' financial conditions and does obtain collateral or other security when appropriate. The company's three largest customers including their divisions, dealers and distributors, General Motors Corporation, Ford Motor Company and Chrysler Corporation, accounted for approximately 37% of sales in 1995.\nThe company is exposed to credit losses in the event of nonperformance by counterparties to its interest rate cap agreements, but has no off-balance-sheet credit risk of accounting loss. The company anticipates, however, that counterparties will be able to fully satisfy their obligations under the contracts. The company does not obtain collateral or other security to support financial instruments subject to credit risk but monitors the credit standing of counterparties.\nSPX CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1995\n(20) CAPITAL STOCK\nAuthorized shares of common stock (par value $10.00) total 50,000,000 shares. Common shares issued and outstanding are summarized in the table below.\nThe company's treasury stock was purchased in 1989 at an average cost of $30 5\/8 per share. The company has 3,000,000 shares of preferred stock, no par value, authorized, but no shares have been issued.\nIn June 1989, the company established an employee stock ownership plan (ESOP). 1,746,725 shares of common stock were issued to the ESOP trust in exchange for $50,000. These shares were issued at market value ($28 5\/8 per share) and are included in common stock and paid in capital.\nThe company restated, amended and renamed its 1982 Stock Option Plan to the 1992 Stock Compensation Plan, effective December 15, 1992. Under the new Stock Compensation Plan, up to 700,000 shares of the company's common stock may be granted to key employees with those shares still available for use under the 1982 Stock Option Plan being carried forward and forming a part of the 700,000 shares. Awards of incentive stock options, nonqualified stock options, stock appreciation rights (SAR's), performance units and restricted stock may be made under the Plan although no more than 200,000 shares may be granted in the form of restricted stock. The Plan also authorizes the granting of stock options to directors.\nStock options may be granted to key employees in the form of incentive stock options or nonqualified stock options at an option price per share of no less than the fair market value of the common stock of the company on the date of grant. The options become exercisable six months after the date of the grant and expire no later than 10 years from the date of grant (or 10 years and 1 day with respect to nonqualified stock options).\nSAR's may be granted to key employees either in conjunction with the awarding of nonqualified stock options or on a stand-alone basis. The SAR's entitle the holder to receive a cash payment equal to the excess of the fair market value of a share of common stock of the company over the exercise price of the right at the date of exercise of the right.\nPerformance units, which are equivalent to a share of common stock, may be granted to key employees and may be earned, in whole or in part, dependent upon the attainment of performance goals established at the time of grant.\nRestricted stock may be granted to key individuals to recognize or foster extraordinary performance, promotion, recruitment or retention. At the time of the grant, restrictions are placed on ownership of the shares for a stated period of time during which a participant will not be able to dispose of the restricted shares. Upon lapse of the restriction period, complete ownership is vested in the participant and the shares become freely transferable.\nSPX CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1995\nA summary of common stock options and restricted stock issued under the company's stock compensation plans is as follows:\nAll options outstanding at December 31, 1995 can be exercised.\nIn 1995, the Board of Directors awarded the Chairman, President, and Chief Executive Officer of the company, as part of his employment agreement, a ten year non-qualified option to purchase 125,000 shares of common stock of the company at a price equal to the closing price on the New York Stock Exchange on the date of grant ($15.75 per share). The options, which are not a part of the 1992 Stock Compensation Plan, cannot be exercised until May 1996.\nThe company issued 125,000 shares of restricted common stock to the Chairman, President, and Chief Executive Officer of the company, as part of his employment agreement, in November 1995. The restricted shares will vest twenty percent per year beginning December 1, 1996. These shares carry voting and dividend rights; however, sale of the shares is restricted prior to vesting. The restricted shares were recorded at their fair market value on the date of grant with a corresponding charge to shareholders' equity representing the unearned portion of the award. The unearned portion is being amortized as compensation expense on a straight-line basis over the vesting period. The shares are not a part of the 1992 Stock Compensation Plan.\nPreferred stock is issuable in series with the Board of Directors having the authority to determine, among other things, the stated value of each series, dividend rate, conversion rights and preferences in liquidation or redemption.\nOn June 25, 1986, the company entered into a Rights Agreement which was amended and restated as of October 20, 1988. Pursuant to the Rights Agreement, in July 1986, the company issued a dividend of one preferred stock purchase right on each outstanding share of common stock. Each right entitles the holder, upon the occurrence of certain events, to purchase one one-hundredth of a share of a new series of junior participating preferred stock for $100. Furthermore, if the company is involved in a merger or other business combination at any time after the rights become exercisable, the rights will entitle the holder to buy the number of shares of common stock of the acquiring company having a market value of twice the then current exercise price of each right. Alternatively, if a 20% or more shareholder acquires the company by means of a reverse merger in which the company and its stock survive, or engages in self-dealing transactions with the company, or if any person acquires 20% or more of the company's common stock, then each right not owned by a 20% or more shareholder will become exercisable for the number of shares of common stock of the company having a market value of twice the then current exercise price of each right. The rights, which do not have voting rights, expire on July 15, 1996, and may be redeemed by the company at a price of $.05 per right at any time prior to their expiration.\nSPX CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1995\n(21) SPT AND SP EUROPE\nThe company consolidated SPT and SP Europe (unaudited) at December 31, 1993. Selected 1993 financial information on these entities was as follows:\n(22) QUARTERLY RESULTS (UNAUDITED)\n- ---------------\n* Includes a pretax restructuring charge of $10,724 ($6,972 after-tax).\nSPX CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1995\n- ---------------\n* Includes a pretax restructuring charge of $27,500 ($18,500 after-tax).\n** Includes SP Europe equity losses, $21,500 after-tax, and a pretax gain on the sale of businesses of $105,400 ($64,200 after-tax).\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\n(a) Directors of the company.\nSee the company's Proxy Statement, incorporated by reference as Part III of this Form 10-K, under the caption \"Election of Directors\".\n(b) Executive Officers of the company.\nSee Part I of this Form 10-K at page 10.\nITEM 11.","section_11":"ITEM 11. MANAGEMENT REMUNERATION AND TRANSACTIONS\nSee the company's Proxy Statement, incorporated by reference as Part III of this Form 10-K, under the headings \"Compensation of Executive Officers\" and \"Directors' Compensation\".\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nSee the company's Proxy Statement, incorporated by reference as Part III of this Form 10-K, under the caption \"Stock Ownership of Management and Certain Beneficial Owners\".\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nPeter H. Merlin, a Director of the company, is a Partner of the law firm of Gardner, Carton & Douglas which the company has retained in 1995 and many prior years and anticipates retaining in 1996 and thereafter.\nAlbert A. Zagotta and Robert C. Huff were elected executive officers of the company in 1994 as part of the transactions in which the company acquired full ownership of Sealed Power Technologies Limited Partnership (\"SPT\") from Riken Corporation. In April 1995, the company made payments for the shares of SPT owned by Mr. Zagotta and Mr. Huff, who were formerly executive officers of SPT, as well as four other managers of the former SPT businesses all as part of the reacquisition transactions. Mr. Zagotta received $242,760.00, and Mr. Huff received $277,440.00. The amounts were determined on the same basis per share as was paid to Riken Corporation for its interests in SPT.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) The following documents are filed, or incorporated by reference, as part of this Form 10-K:\n1. All financial statements. See Index to Consolidated Financial Statements on page 26 of this Form 10-K.\n2. Financial Statement Schedules. None required. See page 26 of this Form 10-K.\n3. Exhibits\n(b) Reports on Form 8-K.\nThe Company, on October 11, 1995, filed Form 8-K which provided the information regarding the sale of SPX Credit Corporation.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on this 27th day of March, 1996.\nSPX CORPORATION (Registrant)\nBy \/s\/ WILLIAM L. TRUBECK ------------------------------------ William L. Trubeck Senior Vice President, Finance, Chief Financial Officer and Accounting Officer\nPOWER OF ATTORNEY\nThe undersigned officers and directors of SPX Corporation hereby severally constitute John B. Blystone, James M. Sheridan or William L. Trubeck and each of them singly our true and lawful attorneys, with full power to them and each of them singly, to sign for us in our names in the capacities indicated below the Annual Report on Form 10-K filed herewith and any and all amendments thereto, and generally to do all such things in our name and on our behalf in our capacities as officers and directors to enable SPX Corporation to comply with the provisions of the Securities Exchange Act of 1934, as amended, and all requirements of the Securities and Exchange Commission, hereby ratifying and confirming our signatures as they may be signed by our said attorneys, or any one of them, on the Annual Report on Form 10-K and any and all amendments thereto.\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the undersigned have signed this report on this 27th day of March, 1996.\n\/s\/ JOHN B. BLYSTONE \/s\/ WILLIAM L. TRUBECK - -------------------------------------- -------------------------------------- John B. Blystone William L. Trubeck Chairman, President and Senior Vice President, Chief Executive Officer Finance, Chief Financial Director and Accounting Officer\n\/s\/ J. KERMIT CAMPBELL \/s\/ SARAH R. COFFIN - -------------------------------------- -------------------------------------- J. Kermit Campbell Sarah R. Coffin Director Director\n\/s\/ FRANK A. EHMANN \/s\/ EDWARD D. HOPKINS - -------------------------------------- -------------------------------------- Frank A. Ehmann Edward D. Hopkins Director Director\n\/s\/ CHARLES E. JOHNSON II \/s\/ RONALD L. KERBER - -------------------------------------- -------------------------------------- Charles E. Johnson II Ronald L. Kerber Director Director\n\/s\/ PETER H. MERLIN \/s\/ DAVID P. WILLIAMS - -------------------------------------- -------------------------------------- Peter H. Merlin David P. Williams Director Director","section_15":""}
{"filename":"17797_1995.txt","cik":"17797","year":"1995","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 7,203 employees at December 31, 1995. 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 of North Carolina extending to the Atlantic coast between the Pamlico River and the South Carolina border, the lower Piedmont section of 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 3.75 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, 3 municipalities and 2 electric membership corporations (North Carolina Electric Membership Corporation, which has 27 members, 17 of which are served by the Company's system, and French Broad Electric Membership Corporation). At December 31, 1995, the Company was furnishing electric service to approximately 1,087,000 customers.\n3. SALES. During 1995, 32% of operating revenues was derived from residential sales, 21% from commercial sales, 24% from industrial sales, 16% from resale sales and 7% from other sources. Of such operating revenues, approximately 67% was derived from North Carolina retail customers, 14% from South Carolina retail customers, 16% from wholesale customers under contract and 3% from bulk power sales. For the twelve months ended December 31, 1995, average revenues per kilowatt-hour (kWh) sold to residential, commercial and industrial customers were 8.03 cents, 6.67 cents and 5.12 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 ____ _______ _______ _______\n1991 12,472 $1,040.70 8.34 cents 1992 12,396 1,029.82 8.31 1993 13,167 1,090.16 8.28 1994 12,559 1,032.00 8.22 1995 13,242 1,062.82 8.03\n4. PEAK DEMAND.\na. A 60-minute system peak demand record of 10,156 megawatts (MW) was reached on August 14, 1995. 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 7.0%.\nb. Total system peak demand for 1993 increased by 3.8%, for 1994 increased by 5.8%, and for 1995 increased by 0.12%, as compared with the preceding year. The Company currently projects that system peak demand will increase at an average annual growth rate of approximately 2.5% 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 1993-1995 were 59.0%, 56.0% and 58.9%, respectively. The Company forecasts capacity margins of 12.5% over anticipated system peak load for 1996 and 11.5% for 1997. 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 PART I, 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 PART I, ITEM 1, \"Generating Capability,\" paragraph 1.\nGENERATING CAPABILITY _____________________\n1. FACILITIES. The Company has a total system installed generating capability (including Power Agency's share) 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, 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 _____________________________________\nYear 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____________\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 1995. Over the next ten years, system sales growth is forecasted to average approximately 2.5% per year and annual growth in system peak demand is projected to average approximately 2.5%. The Company's generation additions schedule, which is updated annually, reflects no additions until 1997, when two new combustion turbine generating units, construction of which began in 1995, are currently scheduled to commence commercial operation. These units, having a total generating capacity of approximately 240 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 $65 million. In December 1994, the Company filed preliminary plans with the North Carolina Utilities Commission (NCUC) and the North Carolina Division of Environmental Management to install up to 1200 MW of new combustion turbine generating units adjacent to the Company's Lee Steam Electric Plant in Wayne County, North Carolina. The Company's current plan is to add 500 MW of combustion turbine capacity in 1998. The units would primarily be used during periods of summer and winter peak demands. The Company filed an Application for a Certificate of Public Convenience and Necessity with the NCUC on September 27, 1995 seeking permission to construct the 500 MW of capacity. The schedule, which is subject to change, calls for construction of the 500 MW of combustion turbine capacity to begin in 1996, with the aggregate cost expected to approximate $135 million and commercial operation anticipated to begin in 1998. The NCUC hearing in this matter was held on January 9, 1996, but the NCUC has not yet rendered its decision. In addition to the proposed Wayne County project, the generation addition schedule provides for the addition of 2,400 MW in combustion turbine capacity, and 1,800 MW of combined cycle capacity at undesignated sites over the period 1999 to 2010, and a 500 MW baseload coal unit in 2010 at an undesignated site.\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 Power Company (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. 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. On January 20, 1995, the FERC issued an order accepting the purchase power contract. The estimated minimum annual payment for power under the six-year agreement is $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 $63.8 million in 1995.\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 2009. The upgrade to the transmission interconnection in the Company's western service area was completed in 1992, and the Company recently announced plans to upgrade an existing 138 kV transmission line between Person County, North Carolina and Danville, Virginia, rather than establishing a new interconnection in its eastern service area. The upgrade is currently expected to be completed by mid-1998. 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, and energy-related operation and maintenance expenses. Purchases under this agreement, including transmission use charges, totaled $61.8 million in 1995.\n4. POWER AGENCY. Pursuant to a 1981 Power Coordination Agreement, as amended, entered into between the Company and 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 $26 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 $39.4 million in 1995.\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 power supply.\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\nexempt 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 after existing contracts expire, or new opportunities are created for the Company to expand its wholesale load.\nOn March 29, 1995, the FERC issued a Notice of Proposed Rulemaking (Proposal) that would establish guidelines for wholesale wheeling of electric power. The Proposal would require utilities to provide open access to their interstate power transmission network and not give themselves preferential access to their own services. Currently, such power transfers are negotiated case-by-case or under long-term contracts. The FERC's Proposal would establish a standard generic set of terms and conditions, and would define the terms under which independent power producers and others could gain access to a utility's transmission grid to sell power to a wholesale customer such as a municipality or rural electric cooperative. The Company does not favor the Proposal, which is expected to be finalized sometime in 1996, but rather favors the continued evolution of wholesale electric markets. The Company filed comments regarding the Proposal with the FERC on August 7, 1995. In those comments, the Company disagreed with the FERC's approach to regulating wholesale wheeling, and indicated that in issuing the proposed guidelines the FERC exceeded its authority. The Company also suggested ways to improve the proposed guidelines, in the event that they are enacted. On August 11, 1995, the Company filed comments concerning the FERC's inquiry regarding the potential environmental impact of the Proposal. In those comments, the Company noted the FERC's failure to comply with several requirements of the National Environmental Policy Act. On October 4, 1995, the Company filed reply comments which addressed a number of specific points made in the initial comments other parties filed regarding the Proposal. The Company cannot predict the outcome of this matter or the impact of the Proposal on its future results of operations and financial position.\nAlthough 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 competition 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 competition. 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 electric competition would be in the public interest, how it could be implemented in North Carolina and whether it could be implemented without changing state law. On July 21, 1995, the NCUC issued an order indicating that it will not convene a formal hearing to investigate these issues at this time. The NCUC's order noted that North Carolina's territorial assignment statute appears to prohibit retail competition, and the issue involves a number of jurisdictional uncertainties. The NCUC concluded that for the time being, it should monitor developments in other states and at the FERC regarding jurisdictional and other issues affecting retail competition. Instead of convening a hearing, the NCUC requested that interested parties suggest, by mid-September 1995, specific issues for further consideration in this docket. On September 19, 1995, the Company filed with the NCUC a list of specific issues it believes should be addressed prior to any form of retail competition being allowed in the state of North Carolina. The issues include, but are not limited to: (i) concerns about system planning and service reliability; (ii) the drastic changes to the laws governing utility regulation that would need to be implemented before retail competition could be allowed; (iii) whether retail choice promotes cost reduction rather than cost shifting; and (iv) how stranded costs will be determined and recovered. The NCUC also indicated that it is considering holding informal proceedings in the future to gather more information on competition issues. The Company cannot predict the outcome of this matter.\nThe issues described above have created greater planning uncertainty and risks for the Company. The Company has been addressing these risks in the wholesale sector by securing long-term contracts with all of its wholesale customers, representing approximately 16% of the Company's 1995 operating revenues. These long-term contracts will allow the Company flexibility in managing its load and efficiently planning its future resource requirements; however, NCEMC does have the contractual right, subject to five years' advance notice, to reduce the baseload capacity it purchases from the Company after December 31, 2000. See PART I, ITEM 1, \"Competition and Franchises,\" paragraph 1.d for further discussion of the contract between the Company and NCEMC. In the industrial sector, the Company is continuing to work to meet the energy needs of its customers. Other elements of the Company's strategy for responding 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.\nc. By order issued May 13, 1994, the NCUC established a docket (Docket No. E-100, Sub 73) to consider proposed self-generation deferral rate guidelines, and dispersed energy facilities and economic development rates. By order issued July 21, 1994, the NCUC approved and adopted guidelines to apply to requests for self-generation deferral rates. The guidelines allow the Company to adjust rates to retain certain loads for which self-generation is feasible. 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. In addition, on June 8, 1995, and July 5, 1995, the Company filed with the NCUC and the SCPSC, respectively, an Economic Development Rider which will permit the Company to provide a discount on the first five years of electric service it provides to businesses that locate to or expand within the Company's service territory if they meet certain criteria, including thresholds for the size of new load, the amount of investment and the number of new jobs provided by the businesses. The Economic Development Rider was approved by the NCUC on July 10, 1995, and by the SCPSC on July 21, 1995.\nd. In June 1994, the FERC granted final approval of a Power Coordination Agreement (PCA) and an Interchange Agreement, both dated August 27, 1993, which set forth explicitly the future relationship between the Company and NCEMC, and established a framework under which they will operate (Project Nos. 432-004 and 2748-000). 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 allowed 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. Pursuant to this authority, NCEMC's board of directors awarded a power-supply contract for 200 MW to another supplier beginning on January 1, 1996. The contract, which has been accepted by the FERC, displaced 200 MW of baseload capacity that NCEMC previously purchased from the Company; however, the Company expects to continue to supply not less than 1000 MW of electricity to NCEMC from January 1, 1996 until at least December 31, 2000. Load reductions beyond the year 2000 are subject to specific limits and require five years' advance notice. NCEMC has not officially notified the Company that any of the baseload power to be supplied to NCEMC by the Company beginning in 2001 will be provided by another entity; however, on November 4, 1994, NCEMC issued two requests for proposals (RFP) to provide up to 225 MW (for a minimum of ten years) of baseload power NCEMC would otherwise purchase from the Company beginning in 2001, an additional block of up to 225 MW per year beginning in 2002, and a third block of up to 225 MW per year beginning in 2003. On March 3, 1995, the Company submitted a bid in response to each RFP to compete for this load. On September 13, 1995, NCEMC notified the Company that it had decided to suspend negotiations regarding the Company's bids at this time, but requested that the Company leave its bids open for future consideration. Negotiations between the Company and NCEMC have resumed. The Company cannot predict the outcome of these matters.\ne. By order issued February 24, 1994, the NCUC established a docket (Docket No. E-100, Sub 71), 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 NCUC also opened a related docket (Docket No. M-100, Sub 124)to determine 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. By orders issued in October 1995, the NCUC issued a new rule, as well as a set of guidelines, that require natural gas and electric utility companies to obtain NCUC approval prior to offering anyone incentives, of more than nominal value, that are intended to influence the recipient's fuel choice. This rule sets forth the procedures a utility must follow to gain such approval, and the guidelines identify the substantive issues that must be addressed by any utility seeking to offer such incentives. The NCUC also ruled that it would not consider the impact of a utility's program involving the provision of an incentive on competitors of the utility.\nBy order issued September 30, 1994, the SCPSC established a docket for a similar generic proceeding (Docket No. 94-618-E\/G). The filing of testimony and scheduling of hearings in the SCPSC proceeding have been indefinitely postponed. The Company cannot predict the outcome of this matter.\nf. On March 29, 1995, a bill was introduced in the North Carolina General Assembly (General Assembly) to facilitate the construction of an interstate natural gas pipeline to be built from Aiken, South Carolina to Leland, North Carolina. The bill, as originally introduced, proposed to, among other things, exempt from utility regulation all power generating facilities that receive gas from the pipeline as fuel. On July 29, 1995, the General Assembly passed a bill directing the Joint Utility Review Committee of the General Assembly (Utility Review Committee) to study whether or not the extension of interstate natural gas pipelines into North Carolina can and should be encouraged by amending the North Carolina Public Utilities Act (Public Utilities Act) to exempt from regulation as public utilities facilities that sell electric power and thermal energy generated with natural gas from these pipelines. The bill also directs the Utility Review Committee to study whether the Public Utilities Act should be amended to encourage the construction of new interstate pipelines in North Carolina. The bill orders the Utility Review Committee to report its findings and any recommendations regarding these matters before the General Assembly convenes on May 13, 1996. The Company cannot predict the outcome of this matter.\ng. On March 22, 1995, a bill was introduced in the General Assembly that would change fundamentally the nature of public power agencies in the state. The bill, as originally introduced, proposed to, among other things, permit certain organizational changes among the state's municipal power agencies and provide additional authority for the marketing of excess capacity and energy. A substantially amended version of this bill, which authorizes internal reorganization of the state's municipal power agencies, and orders the Utility Review Committee to study other issues contained in the original legislation and report its findings and any recommendations to the General Assembly in 1996, was passed by the General Assembly effective July 11, 1995. On January 11, 1996, representatives of the state's municipal power agencies informed the Utility Review Committee that they do not wish to pursue additional statutory changes during the 1996 session of the General Assembly. The Company cannot predict the outcome of this matter.\nh. In late 1995, one of the Company's industrial customers in the City of Darlington, South Carolina (\"City\"), requested that the City become a municipal electric utility and provide retail electric service to the area. If it were to become a municipal electric utility, the City would possibly seek to purchase bulk power from a supplier other than the Company. The Company has undertaken efforts to educate the City's residents, businesses and industries regarding the many costs and legal issues associated with a municipalization effort. The City plans to undertake studies to determine the feasibility of the municipalization proposal. The results of those studies will likely determine whether the proposal is presented to the City's voters. The Company cannot predict the outcome of this matter.\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 1995 the Company expended approximately $610 million for capital requirements. The Company revised its capital program in 1995 as part of its annual business planning process. Capital requirements, including anticipated construction expenditures for plant modifications, for the years 1996 through 1998 are set forth below. These estimates include Clean Air Act compliance expenditures of approximately $55 million, and generating facility addition expenditures of approximately $327 million. See PART I, 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)\n1996 1997 1998 TOTAL ____ ____ ____ _____\nConstruction Expenditures $406 $489 $447 $1,342 Nuclear Fuel Expenditures 103 64 105 272 AFUDC (15) (18) (33) (66) ____ ____ ____ ______ Net expenditures (a) 494 535 519 1,548 Mandatory Redemptions of 105 100 205 410 Long-Term Debt ____ _____ ____ ______ Long-Term Debt TOTAL $599 $635 $724 $1,958 ==== ==== ==== ======\n_________________\n(a) Reflects reductions of approximately $12 million, $7 million and $9 million for 1996, 1997 and 1998, 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. Based on the Company's most recent estimate of capital requirements, the Company does not expect to have external funding requirements in 1996. External funding requirements, which do not include early redemptions of long-term debt or redemptions of preferred stock, are expected to approximate $14 million in 1997 and $76 million in 1998. 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 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 PART II, 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), under which an aggregate of $450 million principal amount of First Mortgage Bonds, and an additional $125 million combined aggregate principal amount of First Mortgage Bonds and\/or unsecured debt securities of the Company remain available for issuance.\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 1995 included:\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.\n- On April 21, 1995, the Company issued $125 million principal amount of Quarterly Income Capital Securities (Series A Subordinated Deferrable Interest Debentures) (\"Capital Securities\") at an interest rate of 8.55%, for net proceeds to the Company of approximately $121 million. The proceeds from the issuance of the Capital Securities were applied to the Company's ongoing maintenance and construction program, and for other general corporate purposes.\n4. REDEMPTIONS\/RETIREMENTS. Redemptions and retirements during 1995 and early 1996 included:\n- The retirement on January 1, 1995, of $125 million principal amount of First Mortgage Bonds, 5.20% Series, which matured on that date.\n- The retirement on April 1, 1995, of $77.1 million principal amount of First Mortgage Bonds, 9.14% Series, which matured on that date.\n- The retirement on June 8, 1995, of $25 million principal amount of First Mortgage Bonds, 8.92% Secured Medium-Term Notes, Series A, which matured on that date.\n- The retirement on July 20, 1995, of $25 million principal amount of First Mortgage Bonds, 8.86% Secured Medium-Term Notes, Series A, which matured on that date.\n- The retirement on November 1, 1995, of $23 million principal amount of First Mortgage Bonds, 8.85% Secured Medium-Term Notes, Series A, which matured on that date.\n- The redemption on February 27, 1996, of $125 million principal amount of First Mortgage Bonds, 8 7\/8% Series due February 15, 2021, at 105.69% of the principal amount of such bonds plus accrued interest to the date of redemption.\n- The redemption on March 26, 1996, of $22.626 million principal amount of First Mortgage Bonds, 8 1\/8% Series due November 1, 2003, at 100.52% of the principal amount of such bonds plus accrued interest to the date of redemption.\n- The redemption on March 26, 1996, of $100 million principal amount of First Mortgage Bonds, 7 3\/4% Series due 2003, at 100.18% of the principal amount of such bonds plus accrued interest to the date of redemption.\n5. CREDIT FACILITIES. The Company's credit facilities presently total $685 million, consisting of long-term agreements totaling $585 million and a $100 million short-term agreement. The Company is required to pay minimal annual commitment fees to maintain its credit facilities. See PART II, ITEM 8, Notes to Consolidated Financial Statements, Note 3, for a more detailed discussion of the Company's credit facilities.\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 and service 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) ______________________________________________________________________\nCapital 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% =====\n1988 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, safety and the environment. Utilities are required to file their Integrated Resource Plans (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 Company filed its 1995 IRP with the NCUC on April 28, 1995, and with the SCPSC on July 3, 1995. By order dated February 20, 1996, the NCUC approved the Company's 1995 IRP as filed. The SCPSC established April 8, 1996 as the deadline for parties to intervene and\/or submit comments regarding the Company's 1995 IRP. The Company cannot predict the outcome of this matter.\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. 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. By order dated September 6, 1995, the NCUC approved the Company's request for a reduction in the fuel expense portion of the Company's rates, reflecting the Company's improved nuclear performance, and refunding approximately $44 million in fuel-related revenues, which exceeded actual costs for the test period, and $6 million in related interest. The new fuel factor became effective on September 15, 1995, and will remain in effect for one year. The Company's 1996 fuel case hearing is scheduled to begin on August 6, 1996.\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 1996 fuel case hearing was held on March 14, 1996, but the SCPSC has not yet issued an order in this proceeding.\nThe Company cannot predict the outcome of these matters.\n6. AVOIDED COST PROCEEDINGS. The NCUC opened Docket No. E-100, Sub 74 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 hearings in this docket concluded on March 9, 1995, and on June 23, 1995, the NCUC approved, with one minor exception, the Company's proposed lower avoided cost rates. The Company anticipates that the revised lower rates will result in reduced purchase power expense to the Company, as it enters into new purchase agreements with qualifying facilities. The next NCUC avoided cost proceeding will be held in 1997.\nWHOLESALE RATE MATTERS ______________________\n1. GENERAL. The 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; however, wholesale rates have been adjusted since that time through contractual negotiations.\n2. FERC MATTERS.\na. By letter dated May 31, 1995, the Company requested that the FERC (Docket No. 95-1139) establish a return on equity (ROE) in connection with the formula rates provided in the PCA dated August 27, 1993 between the Company and NCEMC. The requested ROE is consistent with the rate of return on common equity approved by the NCUC in the Company's 1988 rate case. On February 6, 1996, the Company filed an offer of settlement with the FERC to set the ROE at 10.75 percent. The FERC staff filed comments supporting the settlement on February 14, 1996. The Company cannot predict the outcome of this matter.\nb. On May 31, 1995, the Company filed a petition with the FERC (Docket No. EL95-50) seeking to recover certain fuel costs from the Company's wholesale customers. These costs are related to the Company's $6.8 million buyout of its contractual agreement with The Arch Coal Sales Company (Arch Coal). As a result of this buyout, the Company will purchase less coal from Arch Coal in the future and will pay a lower purchase price for that coal. The Company cannot predict the outcome of this matter.\nc. On July 7, 1995, Smithfield Foods, Inc., doing business as Carolina Foods Processors, Inc. (Carolina Foods), filed a Complaint with the FERC (Docket No. EL95-60) alleging that certain charges imposed upon NCEMC under the PCA between the Company and NCEMC are unreasonable. These charges are related to generation installed by Carolina Foods, which receives electric service from Four County EMC (a customer of NCEMC). The Company filed its response to the Complaint on August 10, 1995. The Company cannot predict the outcome of this matter.\nd. On March 1, 1996, the Company and Power Agency entered into a contractual agreement which provides that Power Agency will delay construction and startup of its 183.7 MW combustion turbine generating project until 2004. (That project was scheduled to begin commercial operation in June of 1998.) Pursuant to a 1981 Power Coordination Agreement, as amended, between Power Agency and the Company, Power Agency is obligated to purchase this electricity from the Company from 1995 through May 31, 1998. As a result of the new agreement, Power Agency will purchase peaking capacity from the Company as follows: 110 MW from June 1, 1998 through December 31, 1998, 116 MW in 1999 and 183.7 MW from 2000 through 2003. The new agreement must be submitted to the FERC for approval. The Company cannot predict the outcome of this matter.\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. 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 1996 through 1998, are included in the estimates of capital requirements under PART I, 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 for these emissions, which had to be met by January 1, 1995. The Act's Phase II require- ments, which contain more stringent provisions, will become effective January 1, 2000. The Act required that a Title IV permit application, including certifications regarding compliance with the Phase II sulfur dioxide and nitrogen oxides emissions requirements, be submitted to the appropriate permitting authority for each of the Company's plants by January 1, 1996. The Company submitted its Title IV permit applications in late 1995. The Company plans to meet the Phase II sulfur dioxide emissions requirements by utilizing the most economical combination of lower sulfur coal and sulfur dioxide emission allowances. Each sulfur dioxide emission allowance allows a utility to emit one ton of sulfur dioxide. The has Company purchased emission allowances under the Environmental Protection Agency's (EPA) emission allowance trading program in order to supplement the allowances the EPA granted to the Company. Installation of additional equipment will be necessary to reduce nitrogen oxides emissions. The Company estimates that future capital costs necessary to comply with Phase II of the Act will approximate $180 million. Increased operating and maintenance costs, including emission allowance expense, and increased fuel costs are not expected to be material to the results of operations of the Company. As the Company's plans for compliance with the Act's requirements are subject to change, the amount required for capital expenditures and for increased operating, maintenance and fuel expenditures cannot be determined with certainty at this time. 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, a low-level nuclear waste disposal site located 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 low-level radioactive 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.\nOn 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. On June 5, 1995, a De Maximus Consent Decree (Consent Decree) was filed on behalf of the Maxey Flats Steering Committee in the United States District Court for the Eastern District of Kentucky (Civil Action No. 95-58). The Consent Decree provides for the performance of the Initial Remediation Phase and the Balance of Remediation Phase, and for the reimbursement of certain response costs incurred by the EPA. The Department of Justice received comments relating to the proposed Consent Decree until August 18, 1995 and is awaiting court approval of the Consent Decree. 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, on-site cleanup activities were completed in July 1995, and the operation and maintenance (O&M) phase began. During the O&M phase, twenty-three groundwater monitoring wells will be sampled quarterly for a minimum 10-year period. There is currently over 90% participation by the PRPs in the site cleanup. The Company contributed approximately $293,000 to the waste generators' group. In late December 1995, the Rose Chemicals Steering Committee (a group of PRPs with respect to the Rose site) issued refunds of excess monies collected for site remediation. The Company received a refund of $158,639. Although the Company cannot predict the outcome of this matter, it does not anticipate that it will be required to contribute additional funds to complete remediation of this site.\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 on 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 has submitted a final report to the EPA. On July 12, 1995, the Company was informed that the EPA had approved the final report regarding the site on October 13, 1994. Now that the final report has been approved, the settlement agreement between the Company and the Elliot's Auto Parts PRP Committee will be implemented. In this settlement, the Company 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 (AOC) with the EPA. Although the Company cannot predict the outcome of this matter, it does not anticipate that future costs associated with this site, 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 Little Rock, 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. The wastes sent from the Company's facilities to the Seaboard site consisted primarily of cleaning and degreasing solvents, solvent contaminated oils and paint-related waste. 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 AOC 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 has joined the Seaboard Group II (a group of PRPs formed to conduct additional work at the Seaboard site). The Seaboard Group II, the City of High Point, North Carolina and the DEHNR have negotiated an AOC that requires the Seaboard Group II and the City of High Point to conduct a joint Remedial Investigation (RI). The Company has executed that AOC. The City of High Point operated a landfill that bounds the Seaboard site on three sides. The City of High Point has conducted studies of groundwater on its site and those studies have indicated that a joint RI is appropriate. 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. Wastes disposed of at the Macon-Dockery site\ninclude antifreeze, used oils, metals, paint, solvent wastes, and waste acids and bases. The Company made arrangements in the past for the transportation and sale of waste oil and residual oil to C&M Oil Distributors, a company that operated an oil reprocessing facility at the Macon-Dockery site. However, the information available to the Company indicates that no hazardous wastes from Company facilities were sent to the site. In 1987, the EPA notified the Company that it believed the Company was a PRP for costs associated with the EPA's cleanup action at the Macon-Dockery site. The EPA initiated a lawsuit in federal district court against entities other than the Company to recover its cleanup costs. Some of the defendants in that lawsuit brought claims against the Company. In 1989, the Company signed a Consent Decree with the EPA which obligated the Company to pay $15,000 and settled the Company's liability, if any, for third party contribution claims.\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. Discovery in this matter is currently underway. Although the Company cannot predict the outcome of this matter, it does not anticipate that costs associated with this site, if any, 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. There are 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. The Company continues to investigate the identities of parties connected to individual MGP sites in North Carolina, 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.\nDue 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.\nOn April 21, 1989, the DEM requested that, in response to a 1979 spill of No. 2 fuel oil, the Company install a groundwater compliance monitoring system at the Company's Wilmington Oil Terminal located in New Hanover County, North Carolina. During the second half of 1989, six groundwater monitoring wells were installed. One of the six wells indicated gasoline contamination and samples from a second well indicated No. 2 fuel oil contamination. In February 1993, the DEM approved a corrective action plan (CAP) for addressing gasoline and No. 2 fuel oil contamination. In 1995, the Company confirmed the presence of off-site gasoline contamination; however, it is not clear that the Company is responsible for off-site gasoline contamination. The Company is proceeding to seek approval to modify the CAP so that on and off-site contamination will be remediated by natural attenuation and degradation factors. The Company sold the Wilmington Oil Terminal on March 1, 1996, but will continue to address existing on- and off-site gasoline and No. 2 fuel oil contamination. 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.\n5. ENVIRONMENTAL ACCRUAL.\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.\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 noncompliance, 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 both disposal facilities for low-level radioactive waste and storage facilities for spent nuclear fuel. See paragraphs 2 and 3 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 1996, 1997 and 1998 are expected to total approximately $50 million, $34 million and $41 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 use 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, 1995, sufficient on-site spent nuclear fuel storage capability is available for the full-core discharge of Brunswick Unit No. 1 through 1997, Brunswick Unit No. 2 through 1998, and Robinson Unit No. 2 through 1997 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, at the Company's request, the NRC suspended 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 PART I, 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 were participants in the Southeast regional compact and disposed of waste at a disposal site in South Carolina along with other members of the compact. Effective July 1, 1995, South Carolina withdrew from the Southeast regional compact and excluded North Carolina waste generators from the existing disposal site in South Carolina. As a result, the State of North Carolina does not have access to a low-level radioactive waste disposal facility. 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, has submitted a license application for the site it selected in Wake County, North Carolina to the North Carolina Division of Radiation Protection. 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. The Company's nuclear plants in North Carolina are currently storing low-level waste on site and are developing additional storage capacity to accommodate future needs. The Company's nuclear plant in South Carolina has access to the existing disposal site in South Carolina. Although the Company cannot predict the outcome of this matter, it does not expect the cost of providing additional on-site storage capacity for low-level radioactive waste to be material to the results of operations or financial position of the Company.\n4. DECOMMISSIONING.\na. Pursuant to an 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 an 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 agreements. Decommissioning cost provisions, which are included in depreciation and amortization, were $31.2 million in 1995, $29.5 million in 1994 and $34.0 million in 1993. Accumulated decommissioning costs, which are included in accumulated depreciation, were $288.4 million at December 31, 1995, and $252.7 million at December 31, 1994, 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 $110.2 million at December 31, 1995, and $67.6 million at December 31, 1994. Trust earnings, which increase the trust balance with a corresponding increase in accumulated decommissioning, were $4.5 million in 1995, $1.5 million in 1994, and $1.2 million in 1993. 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 the Brunswick and Harris nuclear 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 PART I, ITEM 1, \"Generating Capabilities,\" paragraph 1.\nc. The Financial Accounting Standards Board has reached several tentative conclusions with respect to its project regarding accounting practices related to closure and removal of long-lived assets. The primary conclusions as they relate to nuclear decommissioning are: 1) the cost of decommissioning should be accounted for as a liability and accrued as the obligation is incurred; 2) recognition of a liability for decommissioning results in recognition of an increase to the cost of the plant; 3) the decommissioning liability should be measured based on discounted cash flows using a risk-free rate; and 4) decommissioning trust funds should not be offset against the decommissioning liability. An exposure draft was issued in February 1996, and it is uncertain what impacts, if any, the final statement may have on the Company's accounting for nuclear decommissioning and other closure and removal costs.\n5. OPERATING LICENSES. Facility Operating Licenses, issued by the NRC, for the Company's nuclear facilities allow for a full 40 years of commercial operation. Expiration dates for these licenses 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. 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. Although the Company cannot predict the outcome of this matter, it does not expect the impacts of the new rule to be material to the Company's results of operations.\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. In June 1995, the Company completed and submitted the results of the second phase of the IPEs (for externally initiated events) for the Company's three nuclear plants. The results of the IPEs indicated that some procedural changes may be required for the Harris and Brunswick Plants. Those results also indicated that both minor procedural changes and minor plant modifications will be required for the Robinson Plant. The Company has filed an implementation plan with the NRC which calls for all IPE actions to be implemented by 1998. Although the Company cannot predict at this time the exact magnitude of the financial and operational impacts of the second phase of the IPEs, it does not expect those impacts to be material to the results of operations or financial position of the Company.\nc. Degradation of tubing internal to steam generators in pressurized water reactor power plants (PWR's) due to intergranular stress corrosion cracking has been an on-going industry phenomenon. The Company has determined that the steam generators at the Harris Plant are subject to steam generator degradation and the Company is closely monitoring the steam generator performance. Experience and testing conducted to date indicate that the Harris Plant steam generators will not require replacement before 2001. The steam generators at the H.B. Robinson plant were replaced in 1982 and are expected to perform until the plant's operating license expires. Although the Company cannot predict the outcome of this matter, it does not expect the cost of replacing the steam generators at the Harris Plant to be material to the results of operations or financial position of the Company.\nd. 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. For a more detailed discussion of nuclear liability insurance, see PART II, ITEM 8, Notes to Consolidated Financial Statements Note 10.B.\nFUEL ____\n1. SOURCES OF GENERATION. Total system generation (including Power Agency's share) by primary energy source, along with purchased power, for the years 1992 through 1996 is set forth below:\n1992 1993 1994 1995 1996 (estimated) ____ ____ ____ ____ ___________\nFossil 56% 54% 43% 44% 47% Nuclear 27 31 42 42 42 Purchased Power 15 13 13 13 10 Hydro 2 2 2 1 1\n2. COAL. The Company has intermediate and long-term agreements from which it expects to receive approximately 73% of its coal burn requirements in 1996. During 1994 and 1995, the Company obtained approximately 84% (8,120,220 tons), and 86% (7,531,172 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 1995, the Company maintained from 35 to 99 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 PART I, ITEM 1, \"Environmental Matters,\" paragraph 2. The Company purchased approximately 1,690,000 tons of coal in the spot market during 1994 and 1,306,000 tons in 1995. The Company's contract coal purchase prices during 1995 ranged from approximately $23.00 to $54.00 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 ____ _____ ________________\n1991 47.40 190 1992 43.25 174 1993 43.10 172 1994 43.36 174 1995 44.46 179\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 12.6 million and 8.8 million gallons of No. 2 oil during 1994 and 1995, 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 1.6 % of the Company's total burned fuel cost. In 1995, No. 2 oil, natural gas and propane accounted for 1.2 % 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 1997, Brunswick Unit No. 1 through 1998, Brunswick Unit No. 2 through 1998, and the Harris Plant through 1999. The Company expects to meet its future U3O8 requirements 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 a discussion of the Company's plans with respect to spent fuel storage, see PART I, ITEM 1, \"Nuclear Matters,\" paragraph 2.\n5. DOE ENRICHMENT FACILITIES DECONTAMINATION AND DECOMMISSION 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 are being 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, 1995, the Company had a recorded liability of $61.8 million representing its estimated share of the contributions. The Company is recovering a corresponding regulatory asset as a component of fuel cost.\n6. PURCHASED POWER. In 1995 the Company purchased 6,974,597 MWh or approximately 13% of its system energy requirements (including Power Agency) and had available 1,596 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, Subpart 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 hazard to a high hazard classification. In accordance with the change in regulatory jurisdiction, the Company developed an emergency action plan which meets FERC 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. In March 1995 the Company received comments on the report from the FERC. As a result of these comments, and a meeting with FERC officials, the Company was requested to perform further analyses and submit its findings to the FERC. The Company subsequently submitted the first phase of the requested analyses to the FERC by letter dated September 15, 1995. Depending on the outcome of the FERC's review, 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 dispute. The District Court action has been stayed pending a decision by the FERC. Both parties have submitted briefs in the FERC matter and are awaiting the FERC's decision. 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. On December 19, 1995, the jury returned a verdict in favor of the U. S. Government. The Company has filed an appeal of the jury's verdict. The Company cannot predict the outcome of this matter.\n5. CARONET, INC. On November 29, 1994, the Company established a wholly-owned subsidiary, CaroNet, Inc., (CaroNet) and the subsidiary joined a regional partnership, BellSouth Carolinas PCS, L. P. (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. BellSouth is the general partner and handles day-to-day management of the business. In anticipation of infra- structure construction, the Company invested $50 million in CaroNet on April 28, 1995. The Partnership began construction of the PCS system infra- structure during the summer of 1995, and service start-up is anticipated by mid-1996. CaroNet owns a ten percent limited partnership interest in the Partnership and participates on the Partnership's executive committee. On May 15, 1995 and May 22, 1995, CaroNet filed applications with the NCUC and the SCPSC, respectively, for a Certificate of Public Convenience and Necessity, seeking permission to provide wholesale intrastate telecommunications services in North Carolina and South Carolina. By order dated November 3, 1995, the NCUC stated that it will no longer regulate the provision of wholesale intrastate telecommunications services. As a result of this order, the application CaroNet filed with the NCUC was withdrawn. The hearing regarding the application filed with the SCPSC was held on November 1, 1995, and on November 14, 1995, the SCPSC issued an order granting CaroNet permission to provide wholesale services in South Carolina.\n6. CAROCAPITAL, INC. On January 22, 1996, the Company established a wholly-owned subsidiary, CaroCapital, Inc., (CaroCapital), which purchased a minority equity interest in Knowledge Builders, Inc. (Knowledge Builders), an energy-management software and control systems company. The Company invested $5 million in CaroCapital on January 25, 1996, and anticipates that its total investment through 2001 could reach $12 million, subject to the terms and conditions of a Stock Purchase Agreement, which includes certain sales and profitability targets. Although Knowledge Builders and its subsidiaries will continue to operate independently, CaroCapital has designated two directors who are currently serving on the Knowledge Builders' board of directors.\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 (including Power Agency's share) 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, 1995, the Company had 5,853 pole miles of transmission lines including 292 miles of 500 kV and 2,821 miles of 230 kV lines, and distribution lines of approximately 40,087 pole miles of overhead lines and approximately 8,302 miles of underground lines. Distribution and transmission substations in service had a transformer capacity of approximately 36,036 kVA in 2,263 transformers. Distribution line transformers numbered 399,972 with an aggregate 16,247,000 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) - During the period January 1, 1991 through December 31, 1995, there was added to the Company's utility plant accounts $1,810,966,031, there was retired $554,503,996 of property and there were transfers to other accounts and adjustments for a net decrease of $4,927,241 resulting in net additions during the period of $1,251,564,794 or an increase of approximately 14.25%.\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 1995.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nName Age Recent Business Experience ____ ___ __________________________\nSherwood H. Smith, Jr. 61 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 57 PRESIDENT AND CHIEF OPERATING OFFICER, September 1992 to present; Group President - Energy Supply, Entergy Corporation, July 1992; Chairman and Chief Executive Officer, 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., 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. 65 EXECUTIVE VICE PRESIDENT AND CHIEF FINANCIAL OFFICER - Finance and Administration, November 1990 to August 1995 (retired); 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 (retired May 1995).\nGlenn E. Harder 44 EXECUTIVE VICE PRESIDENT AND CHEIF FINANCIAL OFFICER, Financial Services, August 1, 1995 to present; Senior Vice President, Group Executive -Financial Services, October 1994 to August 1995; 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.\nWilliam S. Orser 51 EXECUTIVE VICE PRESIDENT - Nuclear Generation, April 1993 to present; Executive Vice President - Nuclear Generation, Detroit Edison Company, 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. 65 SENIOR VICE PRESIDENT, Group Executive - Power Operations, June 1986 to present; Senior Vice President - Operations Support Group, August 1983.\nNorris L. Edge 64 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 53 SENIOR VICE PRESIDENT, Human Resources and Support Services, March 1995-present; Vice President - Human Resources (formerly Employee Relations Department), May 1983 to March 1995.\nRichard E. Jones 58 SENIOR VICE PRESIDENT, GENERAL COUNSEL AND SECRETARY, Group Executive - Public and Corporate Relations, November 1990 to present; Vice President, General Counsel and Secretary, November 1989 to November 1990; Vice President and General Counsel, July 1987 to November 1989; Vice President, Senior Counsel and Manager - Legal Department, May 1982.\nPaul S. Bradshaw 58 VICE PRESIDENT AND CONTROLLER, March 1980 to September 1, 1995 (retired)\nMark F. Mulhern 36 VICE PRESIDENT AND CONTROLLER, March 1996; Vice President of Finance and Treasurer, HYDRA-CO Enterprises, Inc., a subsidiary of Niagara Mohawk Power Corporation, 1994-1996; Director of Finance and Accounting, HYDRA-CO Enterprises, Inc., 1992-1994; Controller, HYDRA-CO Enterprises, Inc., 1991-1992. Prior to 1991, Mr. Mulhern held various positions with the accounting firm of Price Waterhouse & Co.\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:\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\n1995 High Low Dividends Paid ____ ____ ___ ______________\nFirst Quarter $28 5\/8 $26 3\/8 $ .440 Second Quarter 30 3\/4 26 3\/4 .440 Third Quarter 34 29 1\/2 .440 Fourth Quarter 34 1\/2 32 3\/8 .440\nThe December 31 closing price of the Company's Common Stock was $26 5\/8 in 1994 and $ 34 1\/2 in 1995.\nAs of February 29, 1996, the Company had 65,581 holders of record of Common Stock.\nOn July 13, 1994, the Board of Directors of the Company (Board) authorized the repurchase of up to 10 million shares of the Company's Common Stock on the open market. Under this stock repurchase program, the Company purchased approximately 4.2 million shares in 1995 and 4.4 million shares in 1994.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS _______ __________________________________________________\nRESULTS OF OPERATIONS _____________________\nRevenues ________\nRevenue fluctuations as compared to the prior year are due to the following factors (in millions).\n1995 1994 Increase Increase (Decrease) (Decrease) ________ ________\nCustomer growth\/changes in usage patterns $ 96 $ 101 Weather 64 (86) Sales to other utilities 46 30 Price (62) (45) Sales to North Carolina Eastern Municipal Power Agency (14) (19) _____ ______ $130 $ (19) ===== ======\nThe return of more normal weather in 1995 generated a $64 million increase in revenues as compared to 1994 when the Company's service territory experienced unusually mild weather. In 1994, this unusually mild weather resulted in a revenue decrease of $86 million compared to the prior year. For 1995 as compared to 1994, approximately half of the price decrease was due to a decrease in the fuel cost component of customer rates and approximately half was due to the expiration in July 1994 of a North Carolina rate rider under which the Company was allowed to recover certain abandoned plant costs. The reduction in revenue due to the expiration of the rate rider did not significan- tly affect net income due to a corresponding decrease in amortization expense. The price decrease from 1993 to 1994 was due primarily to the expiration of the rate rider. For both comparison periods, sales to North Carolina Eastern Municipal Power Agency (Power Agency) decreased due to the increased availability of generating units owned jointly by the Company and Power Agency. The increased availability of all generating units allowed the Company to increase sales to other utilities during the 1993 to 1995 period. In addition, sales to other utilities increased in 1995 as a result of the Company aggressively seeking bulk power sales. For 1995, approximately $5 million of the increase in sales to other utilities related to capacity and certain energy costs and, therefore, resulted in an increase in net income.\nOperating expenses __________________\nFuel expense increased in 1995 primarily as a result of higher total generation. Generation increased approximately 9.6% due to higher sales. Fuel expense decreased in 1994 primarily due to 1993 settlement agreements between the Company and its regulators, which required the Company to forgo recovery of certain deferred fuel costs.\nAs a result of a 1993 agreement with Power Agency, the Company's purchase of capacity and energy from Power Agency's ownership interest in the Harris Plant decreased from 50% in 1994 to 33% in 1995. This change in buyback percentage reduced purchased power in 1995 by $20 million as compared to 1994. Partially offsetting this decrease in 1995 were increases in purchases from other utilities and cogenerators. For 1994 as compared to 1993, purchased power increased primarily due to an agreement under which the Company began purchasing 400 megawatts of generating capacity from Duke Power Company in mid-1993.\nOperation and maintenance expense decreased in 1995 primarily due to lower nuclear outage-related expenses. Partially offsetting this decrease was an increase of $13 million in severance-related costs and a 1994 insurance reserve adjustment of $23 million, which reduced expense in that year. The increase in operation and maintenance expense 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 the 1994 insurance reserve adjustment.\nDepreciation and amortization expense decreased from 1993 to 1995. This decrease reflects the completion in July 1994 of the amortization of certain abandoned plant costs associated with a North Carolina rate rider and the completion of the amortization of abandoned plant costs for Harris Unit No. 2 in October 1994. The decreases related to these items totaled $42 million for 1995 as compared to 1994 and $25 million for 1994 compared to 1993.\nOther income ____________\nThe high level of Harris Plant carrying costs in 1993 reflects the Company's settlement with North Carolina Electric Membership Corporation (NCEMC) 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.\nIn 1993, interest income included interest income associated with the Company's 1993 settlement with Westinghouse Electric Corporation (Westinghouse) and interest income related to the Company's qualified employee stock ownership plan (ESOP) loan. In 1994, the recognition of interest income related to the Company's qualified ESOP loan was discontinued as required by Statement of Position 93-6, \"Employers' Accounting for Employee Stock Ownership Plans.\"\nIn 1995, other income, net, decreased due to an increase in charitable contributions of approximately $7 million and decreases in various other items, none of which was individually significant. Other income decreased in 1994 primarily due to the change in accounting for ESOPs.\nInterest charges ________________\nThe 1995 increase in other interest charges is primarily due to a $6 million interest accrual related to the 1995 North Carolina Utilities Commission (NCUC) Fuel Order. Because of the improved performance of the Company's nuclear facilities during the test year ended March 31, 1995, the fuel component of customer rates exceeded actual fuel costs. As a result, the Company is refunding this over-recovery of fuel costs with interest over the twelve-month period beginning September 15, 1995. Interest charges on long-term debt decreased in 1994 as compared to 1993 due to long-term debt refinancings that allowed the Company to take advantage of lower interest rates.\n1993 settlements ________________\nIn 1993, the Company reached several agreements that affected the Company's 1993 results of operations. 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 increased the Company's earnings by $17.3 million, net of tax, or $.11 per common share. 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. As part of the agreement, the Company recorded a write-off of approximately $14.7 million, net of tax, or $.09 per common share. In addition, the Company and NCEMC entered into a settlement agreement that pro- vided for the continuation of existing wholesale rate levels and resolved a wholesale fuel clause billing issue through June 30, 1993. The impact of this settlement totaled approximately $8 million, net of tax, and decreased the Company's earnings by $.05 per common share.\nLIQUIDITY AND CAPITAL RESOURCES _______________________________\nCapital requirements ____________________\nEstimated capital requirements for the period 1996 through 1998 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).\n1996 1997 1998 ____ ____ ____\nConstruction expenditures $406 $489 $447 Nuclear fuel expenditures 103 64 105 AFUDC (15) (18) (33) Mandatory redemptions of long-term debt 105 100 205 ____ ____ ____ Total $599 $635 $724 ==== ==== ====\nThe table above includes Clean Air Act expenditures of approximately $55 million and generating facility addition expenditures of approximately $327 million. 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 2001.\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 power purchases under this agreement 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 1995, purchases under this agreement totaled $61.8 million, including transmission use charges. The agreement expires in December 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 power purchases under this agreement 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 $63.8 million in 1995.\nIn addition, pursuant to the terms of the 1981 Power Coordination Agreement, as amended, between the Company and 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 $26 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 $39.4 million in 1995.\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.\nIn 1994, the Board of Directors of the Company authorized the repurchase of up to 10 million shares of the Company's common stock on the open market. Under this stock repurchase program, the Company purchased approximately 4.2 million shares in 1995 and 4.4 million shares in 1994.\nThe Company has on file with the Securities and Exchange Commission (SEC) a shelf registration statement under which an aggregate of $450 million principal amount of first mortgage bonds and an additional $125 million combined aggregate principal amount of first mortgage bonds and\/or unsecured debt securities of the Company remain available for issuance. The Company can also issue up to $180 million of additional preferred stock under a shelf registration statement on file with the SEC.\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 $3.7 billion in first mortgage bonds and an additional 23 million shares of preferred stock at an assumed price of $100 per share and a $7.51 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 credit facilities total $685 million, consisting of $585 million in long-term agreements and a $100 million short-term agreement. The Company is required to pay minimal annual commitment fees to maintain its credit facilities. The Company had $73.7 million of commercial paper outstanding at December 31, 1995, which Moody's Investors Service, Standard & Poors and Duff & Phelps have rated P-1, A-1 and D-1, respectively.\nDuring 1995, the Company issued $185 million in long-term debt. The proceeds of these issuances, along with internally generated funds, were primarily used to redeem or retire $276.1 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 $14 million in 1997 and $76 million in 1998. 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.\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. The Company continues to investigate the identities of parties connected to MGP sites in North Carolina, 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 expect costs associated with these sites to be material to the results of operations of the Company.\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.\nDue 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.\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 for these emissions, 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. The Company plans to meet the Phase II sulfur dioxide emissions requirements by the most economical combination of fuel-switching and utilization of sulfur dioxide emission allowances. Each sulfur dioxide emission allowance allows a utility to emit one ton of sulfur dioxide. The Company has purchased emission allowances under the Environmental Protection Agency (EPA)'s emission allowance trading program in order to supplement the allowances the EPA has granted to the Company. Installation of additional equipment will be necessary to reduce nitrogen oxides emissions.\nThe Company estimates that future capital costs necessary to comply with Phase II of the Act will approximate $180 million. Increased operating and maintenance costs, including emission allowance expense, and increased fuel costs are not expected to be material to the results of operations of the Company. As plans for compliance with the Act's requirements are subject to change, the amount required for capital expenditures and for increased operating, maintenance and fuel expenditures cannot be determined with certainty at this time.\nNuclear _______\nIn the Company's retail jurisdictions, provisions for nuclear decommissioning costs were approved by the NCUC and the South Carolina Public Service Commission (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 agreements. 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 the Brunswick and Harris nuclear 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 reached several tentative conclusions with respect to its project regarding accounting practices related to closure and removal of long-lived assets. The primary conclusions as they relate to nuclear decommissioning are: 1) the cost of decommissioning should be accounted for as a liability and accrued as the obligation is incurred; 2) recognition of a liability for decommissioning results in recognition of an increase to the cost of the plant; 3) the decommissioning liability should be measured based on discounted cash flows using a risk-free rate; and 4) decommissioning trust funds should not be offset against the decommissioning liability. An exposure draft was issued in February 1996, and it is uncertain what impacts, if any, the final statement may have on the Company's accounting for nuclear decommissioning and other closure and removal 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.\nOther Business ______________\nIn 1994, the Company established a wholly-owned subsidiary, CaroNet, Inc., which owns a ten percent interest in BellSouth Carolinas PCS, L. P. a limited partnership led by BellSouth Personal Communications, Inc. (BellSouth) and participates in the partnership's executive committee. In 1995, BellSouth won its bid for a Federal Communications Commission license for the limited 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. BellSouth is the general partner and handles day-to-day management of the business. The Company has invested $50 million in CaroNet, Inc. in anticipation of infrastructure construction by BellSouth. Construction began in 1995 and service start-up is expected by mid-1996. In addition to participating in the limited partnership, CaroNet, Inc. will be providing intrastate and interstate telecommunications services in North Carolina and South Carolina.\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 after existing contracts expire or new opportunities are created for the Company to expand its wholesale load.\nIn 1995, the FERC proposed a rule designed to bring greater competition to the wholesale electric markets. The major provisions of the proposed rule are: 1) electric utilities under FERC jurisdiction that own or control transmission systems would be required to file with the FERC a tariff that would allow buyers and sellers of bulk power equal and open access to their transmission systems; 2) utilities with transmission systems would be required to provide all new wholesale buyers and sellers of electricity the same equal and open access to the utilities' transmission systems; and 3) these utilities would be permitted to recover certain stranded investments incurred as a result of the restructuring order. The Company does not favor the proposed rule, which is expected to be finalized sometime in 1996, but rather favors the continued evolution of wholesale electric markets. The Company cannot predict the impact of this proposed rule on its future results of operations and financial position.\nThe 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, or instituting experimental programs, 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 competition in the Company's retail jurisdictions. In 1995, the Carolina Utility Consumers Association, Inc., a group of industrial customers conducting business in North Carolina, filed a petition with the NCUC requesting that the NCUC hold a generic hearing to investigate retail electric competition. The NCUC has ruled that it would not convene a formal hearing to investigate the issue at this time. The NCUC's order noted that North Carolina's territorial assignment statute appears to prohibit retail competition, and the issue involves a number of jurisdictional uncertainties. Both the NCUC and the SCPSC have indicated that they will monitor other states' activities regarding generation competition and allow interested parties to submit information on the subject. The Company cannot predict the outcome of these matters.\nThe issues described above have created greater planning uncertainty and risks for the Company. The Company has been addressing these risks in the wholesale sector by securing long-term contracts with all of its wholesale customers, representing approximately 16% of the Company's 1995 operating revenue. These long-term contracts will allow the Company flexibility in managing its load and efficiently planning its future resource requirements; however, NCEMC does have the contractual right, subject to five years' advance notice, to reduce the baseload capacity it purchases from the Company after December 31, 2000. In the industrial sector, the Company is continuing to work to meet the energy needs of its customers. 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. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ____________________________________________________________________\nThe following consolidated financial statements, supplementary data and consolidated financial statement schedules are included herein:\nPage(s)\nIndependent Auditors' Report 43\nConsolidated Financial Statements:\nConsolidated Statements of Income for the Years Ended December 31, 1995, 1994 and 1993 44 Consolidated Statements of Cash Flows for the Years Ended December 31, 1995, 1994 and 1993 45 Consolidated Balance Sheets as of December 31, 1995 and 1994 46-47 Consolidated Schedules of Capitalization as of December 31, 1995 and 1994 48 Consolidated Statements of Retained Earnings for the Years Ended December 31, 1995, 1994 and 1993 49 Consolidated Quarterly Financial Data 49 Notes to Consolidated Financial Statements 50-61\nConsolidated Financial Statement Schedules for the Years Ended December 31, 1995, 1994 and 1993:\nII - Reserves 62-64\nAll other schedules have been omitted as not applicable or not required or because the information required to be shown is included in the Consolidated Financial Statements or the accompanying Notes to Consolidated Financial Statements.\nINDEPENDENT AUDITORS' REPORT\nTo the Board of Directors and Shareholders of Carolina Power & Light Company\nWe have audited the accompanying consolidated balance sheets and schedules of capitalization of Carolina Power & Light Company and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of income, retained earnings, and cash flows for each of the three years in the period ended December 31, 1995. 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 consolidated financial statements present fairly, in all material respects, the financial position of Carolina Power & Light Company and subsidiaries at December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995 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.\nWe have also previously audited, in accordance with generally accepted auditing standards, the consolidated balance sheets and schedules of capitalization as of December 31, 1993, 1992 and 1991, and the related consolidated statements of income, retained earnings and cash flows for the years ended December 31, 1992 and 1991 (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, 1995, appearing at Item 6, is fairly presented in all material respects in relation to the consolidated financial statements from which it has been derived.\n\/s\/ Deloitte & Touche LLP Raleigh, North Carolina February 12, 1996\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS ___________________________________________\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nA. GENERAL\nThe Company is a public service corporation engaged in the generation, transmission, distribution and sale of electricity in portions of North Carolina and South Carolina.\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 1994 and 1993 have been reclassified to conform to the 1995 presentation.\nB. USE OF ESTIMATES\nIn preparing financial statements that conform with generally accepted accounting principles, management must make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and amounts of revenues and expenses reflected during the reporting period. Actual results could differ from those estimates.\nC. 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.\nThe balances of electric utility plant in service at December 31 are listed below (in millions).\n1995 1994\n____ ____\nProduction plant $ 6,014.1 $ 5,911.2 Transmission plant 912.7 879.6 Distribution plant 2,037.6 1,929.5 General plant and other 476.0 470.6 -------- -------- Electric utility plant in service $ 9,440.4 $ 9,190.9 ======== ========\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 and the borrowed funds portion is credited to interest charges. The composite AFUDC rate was 8.0% in 1995, 8.4% in 1994 and 8.8% in 1993.\nD. 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 1E), as a percent of average depreciable property other than nuclear fuel, were approximately 3.8% in 1995, 1994 and 1993. Depreciation expense totaled $344.0 million in 1995, $335.1 million in 1994 and $325.4 million in 1993. Depreciation and amortization expense also includes amortization of plant abandonment costs (see Note 8).\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 expense. Costs related to obligations to the DOE for the decommissioning and decontamination of enrichment facilities are also charged to fuel expense.\nE. 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 agreements. Decommissioning cost provisions, which are included in depreciation and amortization, were $31.2 million in 1995, $29.5 million in 1994 and $34.0 million in 1993.\nAccumulated decommissioning costs, which are included in accumulated depreciation, were $288.4 million at December 31, 1995 and $252.7 million at December 31, 1994. These costs 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 $110.2 million at December 31, 1995 and $67.6 million at December 31, 1994. Trust earnings, which increase the trust balance with a corresponding increase in accumulated decommissioning, were $4.5 million in 1995, $1.5 million in 1994 and $1.2 million in 1993. 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 the Brunswick and Harris nuclear 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 reached several tentative conclusions with respect to its project regarding accounting practices related to closure and removal of long-lived assets. The primary conclusions as they relate to nuclear decommissioning are: 1) the cost of decommissioning should be accounted for as a liability and accrued as the obligation is incurred; 2) recognition of a liability for decommissioning results in recognition of an increase to the cost of the plant; 3) the decommissioning liability should be measured based on discounted cash flows using a risk-free rate; and 4) decommissioning trust funds should not be offset against the decommissioning liability. An exposure draft was issued in February 1996, and it is uncertain what impacts, if any, the final statement may have on the Company's accounting for nuclear decommissioning and other closure and removal costs.\nF. REGULATORY ASSETS AND LIABILITIES\nAs a regulated entity, the Company is subject to the provisions of Statement of Financial Accounting Standards No. 71, \"Accounting for the Effects of Certain Types of Regulation. \"Accordingly, the Company records certain assets and liabilities resulting from the effects of the ratemaking process, which would not be recorded under generally accepted accounting principles for non-regulated entities. At December 31, 1995, the balances of the Company's regulatory assets were as follows: 1) $387.2 million for income taxes recoverable through future rates; 2) $108.0 million for Harris Plant deferred costs; 3) $57.1 million for abandonment costs; 4) $50.4 million for loss on reacquired debt, which is included in unamortized debt expense; 5) $60.5 million for deferred DOE enrichment facilities-related cost, which is included in other assets and deferred debits; and 6) $11.8 million of other regulatory assets included in other assets and deferred debits. At December 31, 1995, the Company had a regulatory liability of $27.5 million related to deferred fuel.\nG. OTHER POLICIES\nThe Company's financial statements reflect consolidation of its majority-owned subsidiaries. Significant intercompany balances and transactions have been eliminated.\nCustomers' meters are read and bills are rendered on a cycle basis. Revenues are accrued for services rendered but unbilled at the end of each accounting period.\nFuel expense includes 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. 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 $2.3 million at December 31, 1995 and $2.5 million at December 31, 1994. 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 Consolidated Statements of Cash Flows, the Company considers all highly-liquid investments with original maturities of three months or less to be cash equivalents.\n2. 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):\n1995 1994 1993 ____ ____ ____\nActual return on plan assets $(103,381) $ 4,897 $(43,604) Variance from expected return, deferred 59,425 (47,219) 4,490 -------- ------- ------- Expected return on plan assets (43,956) (42,322) (39,114) Service cost 16,344 19,686 16,776 Interest cost on projected benefit obligation 35,592 35,108 31,928 Net amortization (3,580) 831 (2,390) -------- ------- ------- Net periodic pension cost $ 4,400 $ 13,303 $ 7,200 ======== ======= =======\nReconciliations of the funded status of the pension plan at December 31 are (in thousands):\n1995 1994 ____ ____\nActuarial present value of benefits for services rendered to date Accumulated benefits based on salaries to date, including vested benefits of $345.1 million for 1995 and $287.7 million for 1994 $ 392,768 $ 330,361 Additional benefits based on estimated future salary levels 130,167 103,766 -------- -------- Projected benefit obligation 522,935 434,127 Fair market value of plan assets, invested primarily in equity and fixed-income securities 610,278 506,605 -------- -------- Funded status 87,343 72,478 Unrecognized prior service costs 8,747 9,471 Unrecognized actuarial gain (124,383) (124,447) Unrecognized transition obligation, amortized over 18.5 years beginning January 1, 1987 1,005 1,110 -------- -------- Accrued pension costs recognized in the Consolidated Balance Sheets $ (27,288) $ (41,388) ======== ========\nThe assumptions used to measure the projected benefit obligation are:\n1995 1994 ____ ____\nWeighted-average discount rate 7.75% 8.50% Assumed rate of increase in future compensation 4.20% 4.20%\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 1995, 1994 and 1993. In addition to pension benefits, the Company provides contributory postretirement benefits (OPEB), including certain health care and life insurance benefits, for substantially all retired employees.\nThe components of net periodic OPEB cost are (in thousands):\n1995 1994 1993 ____ ____ ____\nActual return on plan assets $(2,514) $ 42 $ (497) Variance from expected return, deferred 1,420 (682) 9 ------ ------ ------ Expected return on plan assets (1,094) (640) (488) Service cost 7,498 8,039 6,797 Interest cost on accumulated benefit obligation 10,595 9,463 9,662 Net amortization 5,530 5,966 5,966 ------ ------ ------ Net periodic OPEB cost $22,529 $22,828 $21,937 ====== ====== ======\nReconciliations of the funded status of the OPEB plans at December 31 are (in thousands):\n1995 1994 ____ ____ Actuarial present value of benefits for services rendered to date Current retirees $ 59,809 $ 55,799 Active employees eligible to retire 17,942 11,933 Active employees not eligible to retire 68,819 63,164 ------- -------- Accumulated postretirement benefit obligation 146,570 130,896 Fair market value of plan assets, invested primarily in equity and fixed-income securities 20,869 12,142 ------- -------- Funded status (125,701) (118,754) Unrecognized actuarial gain (15,132) (15,125) Unrecognized transition obligation, amortized over 20 years beginning January 1, 1993 101,414 107,379 ------- -------- Accrued OPEB costs recognized in the Consolidated Balance Sheets $ (39,419) $ (26,500) ======= ========\nThe assumptions used to measure the accumulated postretirement benefit obligation are:\n1995 1994\nWeighted-average discount rate 7.75% 8.50% Initial medical cost trend rate for pre-medicare benefits 8.40% 9.60% Initial medical cost trend rate for post-medicare benefits 8.20% 8.70% Ultimate medical cost trend rate 5.25% 6.00% 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 1995, 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 1995 would increase by $2.5 million, and the accumulated postretirement benefit obligation at December 31, 1995, would increase by $16.5 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.\n3. SHORT-TERM DEBT AND REVOLVING CREDIT FACILITIES\nAt December 31, 1995 and 1994, the Company's short-term debt balances were $73.7 million and $68.1 million, respectively. The weighted-average interest rates of these borrowings were 5.86% at December 31, 1995, and 6.18% at December 31, 1994. The Company's commercial paper borrowings are supported by revolving credit facilities. At December 31, 1995, the Company's unused and readily available revolving credit facilities totaled $335 million, consisting of long-term agreements totaling $235 million and a $100 million short-term agreement. The Company is required to pay minimal annual commitment fees to maintain its credit facilities.\n4. 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 $2.76 billion at December 31, 1995, and $2.86 billion at December 31, 1994. The estimated fair value of this debt, which was obtained from an independent pricing service, was $2.85 billion at December 31, 1995, and $2.70 billion at December 31, 1994. 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.\n5. CAPITALIZATION\nIn 1994, the Board of Directors of the Company authorized the repurchase of up to 10 million shares of the Company's common stock on the open market. Under this stock repurchase program, the Company purchased approximately 4.2 million shares in 1995 and 4.4 million shares in 1994.\nAt December 31, 1995, 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 Stock Purchase-Savings Plan (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, 1995, there were no significant restrictions on the use of retained earnings.\nAt December 31, 1995, long-term debt maturities for the years 1996 through 2000 were $105.8 million, $100 million, $205 million, $50 million and $197.3 million, respectively. Person 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 Consolidated Balance Sheets. This classification is 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.\n6. EMPLOYEE STOCK OWNERSHIP PLAN\nThe Company sponsors an 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 to acquire 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. The common stock 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. Such dividends are deductible for income tax purposes.\nThere were 8,697,316 ESOP suspense shares at December 31, 1995, with a fair value of $300.1 million. ESOP shares allocated to plan participants totaled 14,507,665 at December 31, 1995. 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, $194.9 million at December 31, 1995, 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 had not been committed to be released to participants' accounts were no longer considered outstanding for the determination of earnings per common share; 2) dividends on unallocated ESOP shares were no longer recognized for financial statement purposes; 3) interest income related to the qualified ESOP loan was no longer recognized; 4) the difference between the acquisition and allocation prices of ESOP shares, which was previously recorded as other income, net, is recorded directly to common stock; and 5) all tax benefits of ESOP dividends are recorded to non-operating income tax expense, whereas in 1993, a portion of the tax benefits was recorded directly to retained earnings. In addition, pursuant to SOP 93-6, ESOP loan transactions between the Company and the SPSP Trustee were no longer reflected in the Consolidated Statements of Cash Flows. The implementation of SOP 93-6 resulted in an increase in earnings per common share of approximately $.04 for 1994.\n7. INCOME TAXES\nDeferred income taxes are provided for temporary differences between book and tax bases of assets and liabilities. Income 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.\nNet accumulated deferred income tax liabilities at December 31 are (in thousands):\n1995 1994\nAccelerated depreciation and property cost differences $1,613,752 $1,504,187 Deferred costs, net 133,139 144,751 Miscellaneous other temporary differences, net (12,487) (7,173) --------- --------- Net accumulated deferred income tax liability $1,734,404 $1,641,765 ========= =========\nTotal deferred income tax liabilities were $2.17 billion and $1.94 billion at December 31, 1995, and 1994, respectively. Total deferred income tax assets were $434 million at December 31, 1995, and $297 million at December 31, 1994.\nA reconciliation of the Company's effective income tax rate to the statutory federal income tax rate follows.\n1995 1994 1993\nEffective income tax rate 39.2% 37.6% 35.4% State income taxes, net of federal income tax benefit (5.0) (5.5) (5.1) Investment tax credit amortization 1.6 2.4 2.3 Other differences, net (0.8) 0.5 2.4 ---- ---- ---- Statutory federal income tax rate 35.0% 35.0% 35.0% ==== ==== ====\nThe provisions for income tax expense are comprised of (in thousands):\n1995 1994 1993\nIncluded in Operating Expenses Income tax expense (credit) Current - federal $143,440 $143,461 $108,935 state 41,826 39,185 29,687 Deferred - federal 75,442 23,926 50,719 state 7,860 3,500 11,588 Investment tax credit (9,344) (11,537) (11,612) ------- ------- ------- Subtotal 259,224 198,535 189,317 ------- ------- ------- Harris Plant deferred costs Investment tax credit (297) (297) 218 ------- ------- ------- Total included in operating expenses 258,927 198,238 189,535 ------- ------- -------\nIncluded in Other Income Income tax expense (credit) Current - federal (20,669) (15,732) (6,168) state (4,251) (3,507) (1,291) Deferred - federal 5,254 8,065 7,483 state 1,125 1,749 1,562 Investment tax credit -- -- (1,194) ------- ------- ------- Total included in other income (18,541) (9,425) 392 ------- ------- ------- Total income tax expense $240,386 $188,813 $189,927 ======= ======= =======\n8. PLANT-RELATED DEFERRED COSTS\nThe Company abandoned efforts to complete 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 No. 2 costs was completed in 1994. In the 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 $18.3 million in 1995, $60.5 million in 1994 and $100.7 million in 1993. 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 $4.3 million in 1995, $6.6 million in 1994 and $13.2 million in 1993 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 $38.4 million at December 31, 1995, and $60.8 million at December 31, 1994.\n9. JOINT OWNERSHIP OF GENERATING FACILITIES\nPower Agency 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 Consolidated Statements of Income.\nThe Company's share of the jointly-owned generating facilities is listed below with related information as of December 31, 1995 (dollars in millions).\nCompany Megawatt Ownership Plant Accumulated Under Facility Capability Interest Investment Depreciation Construction ________ __________ ________ __________ ____________ ____________\nMayo Plant 745 83.83% $ 432.9 $ 159.0 $ 7.2 Harris Plant 860 83.83% $ 3,006.6 $ 750.6 $ 8.6 Brunswick Plant 1,521 81.67% $ 1,361.3 $ 758.7 $ 35.8 Roxboro Unit No.4 700 87.06% $ 223.2 $ 91.9 $ 3.1\nIn the table above, plant investment and accumulated depreciation, which includes accumulated nuclear decommissioning, are not reduced by the regulatory disallowances related to the Harris Plant.\n10. COMMITMENTS AND CONTINGENCIES\nA. PURCHASED POWER Pursuant to the terms of the 1981 Power Coordination Agreement, as amended, between the Company and Power Agency, the 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 $26 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 $39.4 million for 1995, $60.4 million for 1994 and $52.6 million for 1993. 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, 1995 and 1994, the Company had deferred purchased capacity costs, including carrying costs accrued on the deferred balances, of $72.7 million and $70.9 million, respectively. Increased purchases resulting from the 1993 agreement with Power Agency, which were approximately $10 million for 1995 and $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 (Rockport) and 400 megawatts of generating capacity from Duke Power Company (Duke). The estimated minimum annual payment for power under these contracts is approximately $30 million for Rockport and $43 million for Duke, representing capital-related capacity costs. Other power costs include demand-related production expenses, fuel and energy-related operation and maintenance expenses for Rockport and fuel and energy-related operation and maintenance expenses for Duke. Purchases, including transmission use charges, for Rockport and Duke, respectively, totaled $61.8 million and $63.8 million for 1995, $61.9 million and $62.9 million for 1994 and $60.2 million and $37.1 million for 1993. The Rockport agreement expires in December 2009 and the Duke agreement expires in mid-1999.\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 $20 million in the event that losses at insured facilities exceed premiums, reserves, reinsurance and other NML resources, which are at present more than $763 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 $1.5 million at Brunswick Unit No. 1, $1.4 million at Brunswick Unit No. 2, $1.7 million at the Harris Plant and $1.4 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 per incident. 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 $7.6 million with respect to the incremental replacement power costs coverage and $42.9 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 $2.2 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 nuclear 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 nuclear units.\nC. CLAIMS AND UNCERTAINTIES (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. The Company continues to investigate the identities of parties connected to MGP sites in North Carolina, 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 expect costs associated with these sites to be material to the results of operations of the Company.\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.\nDue 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 1996 definitive proxy statement dated March 29, 1996, 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 1996 definitive proxy statement dated March 29, 1996, 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, 1995, owned 9,511,913 shares of Common Stock (6.2% 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 1996 definitive proxy statement dated March 29, 1996, 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 1996 definitive proxy statement dated March 29, 1996, and incorporated by reference herein.\nPART IV\nITEM 14. EXHIBITS, CONSOLIDATED FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. ___________________________________________________________________\na) 1. Consolidated Financial Statements Filed:\nSee ITEM 8 - Consolidated Financial Statements and Supplementary Data.\n2. Consolidated Financial Statement Schedules Filed:\nSee ITEM 8 - Consolidated Financial Statements and Supplementary Data.\n3. Exhibits Filed:\nExhibit No. *3a(1) Restated Charter of the Company, as amended May 10, 1995 (filed as Exhibit No. 3(i) to quarterly report on Form 10-Q for the quarterly period ended June 30, 1995, File No. 1-3382).\nExhibit No. *3a(2) By-laws of the Company, as amended May 10, 1995 (filed as Exhibit No. 3(ii) to quarterly report on Form 10-Q for the quarterly period ended June 30, 1995, File No. 1-3382).\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. *4c(1) Indenture, dated as of March 1, 1995, between the Company and Bankers Trust Company, as Trustee, with respect to Unsecured Subordinated Debt Securities (filed as Exhibit No. 4(c) to Current Report on Form 8-K dated April 13, 1995, File No. 1-3382).\nExhibit No. *4c(2) Resolutions adopted by the Executive Committee of the Board of Directors at a meeting held on April 13, 1995, establishing the terms of the 8.55% Quarterly Income Capital Securities (Series A Subordinated Deferrable Interest Debentures) (filed as Exhibit 4(b) to Current Report on Form 8-K dated April 13, 1995, File No. 1-3382).\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. *10b(1) Directors Deferred Compensation Plan effective January 1, 1982 as amended (filed as Exhibit 10(g), File No. 33-25560).\n+Exhibit No. *10b(2) Supplemental Executive Retirement Plan effective January 1, 1984 (filed as Exhibit 10(h), File No. 33-25560).\n+Exhibit No. *10b(3) Retirement Plan for Outside Directors (filed as Exhibit 10) (i), File No. 33-25560).\n+Exhibit No. *10b(4) Executive Deferred Compensation Plan effective May 1, 1982 as amended (filed as Exhibit 10(j), File No. 33-25560).\n+Exhibit No. *10b(5) Key Management Deferred Compensation Plan (filed as Exhibit 10(k), File No. 33-25560).\n+Exhibit No. *10b(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. *10b(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. *10b(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.\nExhibit No. 27 Financial Data Schedule\nExhibit No. 18 Letter re: Change in Accounting Principles\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 1995 and the portion of the first quarter of 1996 prior to the filing of this 10-K:\nDate of Report Item Reported ______________ _____________\nNONE\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 25th day of March, 1996.\nCAROLINA POWER & LIGHT COMPANY (Registrant)\nBy \/s\/ Glenn E. Harder 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 Title Date _________ _____ ____\n\/s\/ Sherwood H. Smith, Jr. Principal Executive (Chairman and Chief Executive Officer and Director Officer)\n\/s\/ Glenn E. Harder Principal Financial (Executive Vice President and Officer Chief Financial Officer)\n\/s\/ Leslie M. Baker, Jr. Director\n\/s\/ Edwin B. Borden Director March 25, 1996\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\/ Richard L. Daugherty 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 ________\nRevenue fluctuations as compared to the prior year are due to the following factors (in millions).\n1995 1994 Increase Increase (Decrease) (Decrease) ________ ________\nCustomer growth\/changes in usage patterns $ 96 $ 101 Weather 64 (86) Sales to other utilities 46 30 Price (62) (45) Sales to North Carolina Eastern Municipal Power Agency (14) (19) _____ ______ $130 $ (19) ===== ======\nThe return of more normal weather in 1995 generated a $64 million increase in revenues as compared to 1994 when the Company's service territory experienced unusually mild weather. In 1994, this unusually mild weather resulted in a revenue decrease of $86 million compared to the prior year. For 1995 as compared to 1994, approximately half of the price decrease was due to a decrease in the fuel cost component of customer rates and approximately half was due to the expiration in July 1994 of a North Carolina rate rider under which the Company was allowed to recover certain abandoned plant costs. The reduction in revenue due to the expiration of the rate rider did not significan- tly affect net income due to a corresponding decrease in amortization expense. The price decrease from 1993 to 1994 was due primarily to the expiration of the rate rider. For both comparison periods, sales to North Carolina Eastern Municipal Power Agency (Power Agency) decreased due to the increased availability of generating units owned jointly by the Company and Power Agency. The increased availability of all generating units allowed the Company to increase sales to other utilities during the 1993 to 1995 period. In addition, sales to other utilities increased in 1995 as a result of the Company aggressively seeking bulk power sales. For 1995, approximately $5 million of the increase in sales to other utilities related to capacity and certain energy costs and, therefore, resulted in an increase in net income.\nOperating expenses __________________\nFuel expense increased in 1995 primarily as a result of higher total generation. Generation increased approximately 9.6% due to higher sales. Fuel expense decreased in 1994 primarily due to 1993 settlement agreements between the Company and its regulators, which required the Company to forgo recovery of certain deferred fuel costs.\nAs a result of a 1993 agreement with Power Agency, the Company's purchase of capacity and energy from Power Agency's ownership interest in the Harris Plant decreased from 50% in 1994 to 33% in 1995. This change in buyback percentage reduced purchased power in 1995 by $20 million as compared to 1994. Partially offsetting this decrease in 1995 were increases in purchases from other utilities and cogenerators. For 1994 as compared to 1993, purchased power increased primarily due to an agreement under which the Company began purchasing 400 megawatts of generating capacity from Duke Power Company in mid-1993.\nOperation and maintenance expense decreased in 1995 primarily due to lower nuclear outage-related expenses. Partially offsetting this decrease was an increase of $13 million in severance-related costs and a 1994 insurance reserve adjustment of $23 million, which reduced expense in that year. The increase in operation and maintenance expense 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 the 1994 insurance reserve adjustment.\nDepreciation and amortization expense decreased from 1993 to 1995. This decrease reflects the completion in July 1994 of the amortization of certain abandoned plant costs associated with a North Carolina rate rider and the completion of the amortization of abandoned plant costs for Harris Unit No. 2 in October 1994. The decreases related to these items totaled $42 million for 1995 as compared to 1994 and $25 million for 1994 compared to 1993.\nOther income ____________\nThe high level of Harris Plant carrying costs in 1993 reflects the Company's settlement with North Carolina Electric Membership Corporation (NCEMC) 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.\nIn 1993, interest income included interest income associated with the Company's 1993 settlement with Westinghouse Electric Corporation (Westinghouse) and interest income related to the Company's qualified employee stock ownership plan (ESOP) loan. In 1994, the recognition of interest income related to the Company's qualified ESOP loan was discontinued as required by Statement of Position 93-6, \"Employers' Accounting for Employee Stock Ownership Plans.\"\nIn 1995, other income, net, decreased due to an increase in charitable contributions of approximately $7 million and decreases in various other items, none of which was individually significant. Other income decreased in 1994 primarily due to the change in accounting for ESOPs.\nInterest charges ________________\nThe 1995 increase in other interest charges is primarily due to a $6 million interest accrual related to the 1995 North Carolina Utilities Commission (NCUC) Fuel Order. Because of the improved performance of the Company's nuclear facilities during the test year ended March 31, 1995, the fuel component of customer rates exceeded actual fuel costs. As a result, the Company is refunding this over-recovery of fuel costs with interest over the twelve-month period beginning September 15, 1995. Interest charges on long-term debt decreased in 1994 as compared to 1993 due to long-term debt refinancings that allowed the Company to take advantage of lower interest rates.\n1993 settlements ________________\nIn 1993, the Company reached several agreements that affected the Company's 1993 results of operations. 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 increased the Company's earnings by $17.3 million, net of tax, or $.11 per common share. 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. As part of the agreement, the Company recorded a write-off of approximately $14.7 million, net of tax, or $.09 per common share. In addition, the Company and NCEMC entered into a settlement agreement that pro- vided for the continuation of existing wholesale rate levels and resolved a wholesale fuel clause billing issue through June 30, 1993. The impact of this settlement totaled approximately $8 million, net of tax, and decreased the Company's earnings by $.05 per common share.\nLIQUIDITY AND CAPITAL RESOURCES _______________________________\nCapital requirements ____________________\nEstimated capital requirements for the period 1996 through 1998 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).\n1996 1997 1998 ____ ____ ____\nConstruction expenditures $406 $489 $447 Nuclear fuel expenditures 103 64 105 AFUDC (15) (18) (33) Mandatory redemptions of long-term debt 105 100 205 ____ ____ ____ Total $599 $635 $724 ==== ==== ====\nThe table above includes Clean Air Act expenditures of approximately $55 million and generating facility addition expenditures of approximately $327 million. 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 2001.\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 power purchases under this agreement 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 1995, purchases under this agreement totaled $61.8 million, including transmission use charges. The agreement expires in December 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 power purchases under this agreement 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 $63.8 million in 1995.\nIn addition, pursuant to the terms of the 1981 Power Coordination Agreement, as amended, between the Company and 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 $26 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 $39.4 million in 1995.\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.\nIn 1994, the Board of Directors of the Company authorized the repurchase of up to 10 million shares of the Company's common stock on the open market. Under this stock repurchase program, the Company purchased approximately 4.2 million shares in 1995 and 4.4 million shares in 1994.\nThe Company has on file with the Securities and Exchange Commission (SEC) a shelf registration statement under which an aggregate of $450 million principal amount of first mortgage bonds and an additional $125 million combined aggregate principal amount of first mortgage bonds and\/or unsecured debt securities of the Company remain available for issuance. The Company can also issue up to $180 million of additional preferred stock under a shelf registration statement on file with the SEC.\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 $3.7 billion in first mortgage bonds and an additional 23 million shares of preferred stock at an assumed price of $100 per share and a $7.51 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 credit facilities total $685 million, consisting of $585 million in long-term agreements and a $100 million short-term agreement. The Company is required to pay minimal annual commitment fees to maintain its credit facilities. The Company had $73.7 million of commercial paper outstanding at December 31, 1995, which Moody's Investors Service, Standard & Poors and Duff & Phelps have rated P-1, A-1 and D-1, respectively.\nDuring 1995, the Company issued $185 million in long-term debt. The proceeds of these issuances, along with internally generated funds, were primarily used to redeem or retire $276.1 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 $14 million in 1997 and $76 million in 1998. 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.\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. The Company continues to investigate the identities of parties connected to MGP sites in North Carolina, 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 expect costs associated with these sites to be material to the results of operations of the Company.\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.\nDue 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.\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 for these emissions, 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. The Company plans to meet the Phase II sulfur dioxide emissions requirements by the most economical combination of fuel-switching and utilization of sulfur dioxide emission allowances. Each sulfur dioxide emission allowance allows a utility to emit one ton of sulfur dioxide. The Company has purchased emission allowances under the Environmental Protection Agency (EPA)'s emission allowance trading program in order to supplement the allowances the EPA has granted to the Company. Installation of additional equipment will be necessary to reduce nitrogen oxides emissions.\nThe Company estimates that future capital costs necessary to comply with Phase II of the Act will approximate $180 million. Increased operating and maintenance costs, including emission allowance expense, and increased fuel costs are not expected to be material to the results of operations of the Company. As plans for compliance with the Act's requirements are subject to change, the amount required for capital expenditures and for increased operating, maintenance and fuel expenditures cannot be determined with certainty at this time.\nNuclear _______\nIn the Company's retail jurisdictions, provisions for nuclear decommissioning costs were approved by the NCUC and the South Carolina Public Service Commission (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 agreements. 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 the Brunswick and Harris nuclear 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 reached several tentative conclusions with respect to its project regarding accounting practices related to closure and removal of long-lived assets. The primary conclusions as they relate to nuclear decommissioning are: 1) the cost of decommissioning should be accounted for as a liability and accrued as the obligation is incurred; 2) recognition of a liability for decommissioning results in recognition of an increase to the cost of the plant; 3) the decommissioning liability should be measured based on discounted cash flows using a risk-free rate; and 4) decommissioning trust funds should not be offset against the decommissioning liability. An exposure draft was issued in February 1996, and it is uncertain what impacts, if any, the final statement may have on the Company's accounting for nuclear decommissioning and other closure and removal 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.\nOther Business ______________\nIn 1994, the Company established a wholly-owned subsidiary, CaroNet, Inc., which owns a ten percent interest in BellSouth Carolinas PCS, L. P. a limited partnership led by BellSouth Personal Communications, Inc. (BellSouth) and participates in the partnership's executive committee. In 1995, BellSouth won its bid for a Federal Communications Commission license for the limited 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. BellSouth is the general partner and handles day-to-day management of the business. The Company has invested $50 million in CaroNet, Inc. in anticipation of infrastructure construction by BellSouth. Construction began in 1995 and service start-up is expected by mid-1996. In addition to participating in the limited partnership, CaroNet, Inc. will be providing intrastate and interstate telecommunications services in North Carolina and South Carolina.\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 after existing contracts expire or new opportunities are created for the Company to expand its wholesale load.\nIn 1995, the FERC proposed a rule designed to bring greater competition to the wholesale electric markets. The major provisions of the proposed rule are: 1) electric utilities under FERC jurisdiction that own or control transmission systems would be required to file with the FERC a tariff that would allow buyers and sellers of bulk power equal and open access to their transmission systems; 2) utilities with transmission systems would be required to provide all new wholesale buyers and sellers of electricity the same equal and open access to the utilities' transmission systems; and 3) these utilities would be permitted to recover certain stranded investments incurred as a result of the restructuring order. The Company does not favor the proposed rule, which is expected to be finalized sometime in 1996, but rather favors the continued evolution of wholesale electric markets. The Company cannot predict the impact of this proposed rule on its future results of operations and financial position.\nThe 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, or instituting experimental programs, 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 competition in the Company's retail jurisdictions. In 1995, the Carolina Utility Consumers Association, Inc., a group of industrial customers conducting business in North Carolina, filed a petition with the NCUC requesting that the NCUC hold a generic hearing to investigate retail electric competition. The NCUC has ruled that it would not convene a formal hearing to investigate the issue at this time. The NCUC's order noted that North Carolina's territorial assignment statute appears to prohibit retail competition, and the issue involves a number of jurisdictional uncertainties. Both the NCUC and the SCPSC have indicated that they will monitor other states' activities regarding generation competition and allow interested parties to submit information on the subject. The Company cannot predict the outcome of these matters.\nThe issues described above have created greater planning uncertainty and risks for the Company. The Company has been addressing these risks in the wholesale sector by securing long-term contracts with all of its wholesale customers, representing approximately 16% of the Company's 1995 operating revenue. These long-term contracts will allow the Company flexibility in managing its load and efficiently planning its future resource requirements; however, NCEMC does have the contractual right, subject to five years' advance notice, to reduce the baseload capacity it purchases from the Company after December 31, 2000. In the industrial sector, the Company is continuing to work to meet the energy needs of its customers. 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. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ____________________________________________________________________\nThe following consolidated financial statements, supplementary data and consolidated financial statement schedules are included herein:\nPage(s)\nIndependent Auditors' Report 43\nConsolidated Financial Statements:\nConsolidated Statements of Income for the Years Ended December 31, 1995, 1994 and 1993 44 Consolidated Statements of Cash Flows for the Years Ended December 31, 1995, 1994 and 1993 45 Consolidated Balance Sheets as of December 31, 1995 and 1994 46-47 Consolidated Schedules of Capitalization as of December 31, 1995 and 1994 48 Consolidated Statements of Retained Earnings for the Years Ended December 31, 1995, 1994 and 1993 49 Consolidated Quarterly Financial Data 49 Notes to Consolidated Financial Statements 50-61\nConsolidated Financial Statement Schedules for the Years Ended December 31, 1995, 1994 and 1993:\nII - Reserves 62-64\nAll other schedules have been omitted as not applicable or not required or because the information required to be shown is included in the Consolidated Financial Statements or the accompanying Notes to Consolidated Financial Statements.\nINDEPENDENT AUDITORS' REPORT\nTo the Board of Directors and Shareholders of Carolina Power & Light Company\nWe have audited the accompanying consolidated balance sheets and schedules of capitalization of Carolina Power & Light Company and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of income, retained earnings, and cash flows for each of the three years in the period ended December 31, 1995. 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 consolidated financial statements present fairly, in all material respects, the financial position of Carolina Power & Light Company and subsidiaries at December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995 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.\nWe have also previously audited, in accordance with generally accepted auditing standards, the consolidated balance sheets and schedules of capitalization as of December 31, 1993, 1992 and 1991, and the related consolidated statements of income, retained earnings and cash flows for the years ended December 31, 1992 and 1991 (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, 1995, appearing at Item 6, is fairly presented in all material respects in relation to the consolidated financial statements from which it has been derived.\n\/s\/ Deloitte & Touche LLP Raleigh, North Carolina February 12, 1996\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS ___________________________________________\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nA. GENERAL\nThe Company is a public service corporation engaged in the generation, transmission, distribution and sale of electricity in portions of North Carolina and South Carolina.\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 1994 and 1993 have been reclassified to conform to the 1995 presentation.\nB. USE OF ESTIMATES\nIn preparing financial statements that conform with generally accepted accounting principles, management must make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and amounts of revenues and expenses reflected during the reporting period. Actual results could differ from those estimates.\nC. 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.\nThe balances of electric utility plant in service at December 31 are listed below (in millions).\n1995 1994\n____ ____\nProduction plant $ 6,014.1 $ 5,911.2 Transmission plant 912.7 879.6 Distribution plant 2,037.6 1,929.5 General plant and other 476.0 470.6 -------- -------- Electric utility plant in service $ 9,440.4 $ 9,190.9 ======== ========\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 and the borrowed funds portion is credited to interest charges. The composite AFUDC rate was 8.0% in 1995, 8.4% in 1994 and 8.8% in 1993.\nD. 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 1E), as a percent of average depreciable property other than nuclear fuel, were approximately 3.8% in 1995, 1994 and 1993. Depreciation expense totaled $344.0 million in 1995, $335.1 million in 1994 and $325.4 million in 1993. Depreciation and amortization expense also includes amortization of plant abandonment costs (see Note 8).\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 expense. Costs related to obligations to the DOE for the decommissioning and decontamination of enrichment facilities are also charged to fuel expense.\nE. 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 agreements. Decommissioning cost provisions, which are included in depreciation and amortization, were $31.2 million in 1995, $29.5 million in 1994 and $34.0 million in 1993.\nAccumulated decommissioning costs, which are included in accumulated depreciation, were $288.4 million at December 31, 1995 and $252.7 million at December 31, 1994. These costs 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 $110.2 million at December 31, 1995 and $67.6 million at December 31, 1994. Trust earnings, which increase the trust balance with a corresponding increase in accumulated decommissioning, were $4.5 million in 1995, $1.5 million in 1994 and $1.2 million in 1993. 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 the Brunswick and Harris nuclear 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 reached several tentative conclusions with respect to its project regarding accounting practices related to closure and removal of long-lived assets. The primary conclusions as they relate to nuclear decommissioning are: 1) the cost of decommissioning should be accounted for as a liability and accrued as the obligation is incurred; 2) recognition of a liability for decommissioning results in recognition of an increase to the cost of the plant; 3) the decommissioning liability should be measured based on discounted cash flows using a risk-free rate; and 4) decommissioning trust funds should not be offset against the decommissioning liability. An exposure draft was issued in February 1996, and it is uncertain what impacts, if any, the final statement may have on the Company's accounting for nuclear decommissioning and other closure and removal costs.\nF. REGULATORY ASSETS AND LIABILITIES\nAs a regulated entity, the Company is subject to the provisions of Statement of Financial Accounting Standards No. 71, \"Accounting for the Effects of Certain Types of Regulation. \"Accordingly, the Company records certain assets and liabilities resulting from the effects of the ratemaking process, which would not be recorded under generally accepted accounting principles for non-regulated entities. At December 31, 1995, the balances of the Company's regulatory assets were as follows: 1) $387.2 million for income taxes recoverable through future rates; 2) $108.0 million for Harris Plant deferred costs; 3) $57.1 million for abandonment costs; 4) $50.4 million for loss on reacquired debt, which is included in unamortized debt expense; 5) $60.5 million for deferred DOE enrichment facilities-related cost, which is included in other assets and deferred debits; and 6) $11.8 million of other regulatory assets included in other assets and deferred debits. At December 31, 1995, the Company had a regulatory liability of $27.5 million related to deferred fuel.\nG. OTHER POLICIES\nThe Company's financial statements reflect consolidation of its majority-owned subsidiaries. Significant intercompany balances and transactions have been eliminated.\nCustomers' meters are read and bills are rendered on a cycle basis. Revenues are accrued for services rendered but unbilled at the end of each accounting period.\nFuel expense includes 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. 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 $2.3 million at December 31, 1995 and $2.5 million at December 31, 1994. 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 Consolidated Statements of Cash Flows, the Company considers all highly-liquid investments with original maturities of three months or less to be cash equivalents.\n2. 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):\n1995 1994 1993 ____ ____ ____\nActual return on plan assets $(103,381) $ 4,897 $(43,604) Variance from expected return, deferred 59,425 (47,219) 4,490 -------- ------- ------- Expected return on plan assets (43,956) (42,322) (39,114) Service cost 16,344 19,686 16,776 Interest cost on projected benefit obligation 35,592 35,108 31,928 Net amortization (3,580) 831 (2,390) -------- ------- ------- Net periodic pension cost $ 4,400 $ 13,303 $ 7,200 ======== ======= =======\nReconciliations of the funded status of the pension plan at December 31 are (in thousands):\n1995 1994 ____ ____\nActuarial present value of benefits for services rendered to date Accumulated benefits based on salaries to date, including vested benefits of $345.1 million for 1995 and $287.7 million for 1994 $ 392,768 $ 330,361 Additional benefits based on estimated future salary levels 130,167 103,766 -------- -------- Projected benefit obligation 522,935 434,127 Fair market value of plan assets, invested primarily in equity and fixed-income securities 610,278 506,605 -------- -------- Funded status 87,343 72,478 Unrecognized prior service costs 8,747 9,471 Unrecognized actuarial gain (124,383) (124,447) Unrecognized transition obligation, amortized over 18.5 years beginning January 1, 1987 1,005 1,110 -------- -------- Accrued pension costs recognized in the Consolidated Balance Sheets $ (27,288) $ (41,388) ======== ========\nThe assumptions used to measure the projected benefit obligation are:\n1995 1994 ____ ____\nWeighted-average discount rate 7.75% 8.50% Assumed rate of increase in future compensation 4.20% 4.20%\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 1995, 1994 and 1993. In addition to pension benefits, the Company provides contributory postretirement benefits (OPEB), including certain health care and life insurance benefits, for substantially all retired employees.\nThe components of net periodic OPEB cost are (in thousands):\n1995 1994 1993 ____ ____ ____\nActual return on plan assets $(2,514) $ 42 $ (497) Variance from expected return, deferred 1,420 (682) 9 ------ ------ ------ Expected return on plan assets (1,094) (640) (488) Service cost 7,498 8,039 6,797 Interest cost on accumulated benefit obligation 10,595 9,463 9,662 Net amortization 5,530 5,966 5,966 ------ ------ ------ Net periodic OPEB cost $22,529 $22,828 $21,937 ====== ====== ======\nReconciliations of the funded status of the OPEB plans at December 31 are (in thousands):\n1995 1994 ____ ____ Actuarial present value of benefits for services rendered to date Current retirees $ 59,809 $ 55,799 Active employees eligible to retire 17,942 11,933 Active employees not eligible to retire 68,819 63,164 ------- -------- Accumulated postretirement benefit obligation 146,570 130,896 Fair market value of plan assets, invested primarily in equity and fixed-income securities 20,869 12,142 ------- -------- Funded status (125,701) (118,754) Unrecognized actuarial gain (15,132) (15,125) Unrecognized transition obligation, amortized over 20 years beginning January 1, 1993 101,414 107,379 ------- -------- Accrued OPEB costs recognized in the Consolidated Balance Sheets $ (39,419) $ (26,500) ======= ========\nThe assumptions used to measure the accumulated postretirement benefit obligation are:\n1995 1994\nWeighted-average discount rate 7.75% 8.50% Initial medical cost trend rate for pre-medicare benefits 8.40% 9.60% Initial medical cost trend rate for post-medicare benefits 8.20% 8.70% Ultimate medical cost trend rate 5.25% 6.00% 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 1995, 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 1995 would increase by $2.5 million, and the accumulated postretirement benefit obligation at December 31, 1995, would increase by $16.5 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.\n3. SHORT-TERM DEBT AND REVOLVING CREDIT FACILITIES\nAt December 31, 1995 and 1994, the Company's short-term debt balances were $73.7 million and $68.1 million, respectively. The weighted-average interest rates of these borrowings were 5.86% at December 31, 1995, and 6.18% at December 31, 1994. The Company's commercial paper borrowings are supported by revolving credit facilities. At December 31, 1995, the Company's unused and readily available revolving credit facilities totaled $335 million, consisting of long-term agreements totaling $235 million and a $100 million short-term agreement. The Company is required to pay minimal annual commitment fees to maintain its credit facilities.\n4. 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 $2.76 billion at December 31, 1995, and $2.86 billion at December 31, 1994. The estimated fair value of this debt, which was obtained from an independent pricing service, was $2.85 billion at December 31, 1995, and $2.70 billion at December 31, 1994. 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.\n5. CAPITALIZATION\nIn 1994, the Board of Directors of the Company authorized the repurchase of up to 10 million shares of the Company's common stock on the open market. Under this stock repurchase program, the Company purchased approximately 4.2 million shares in 1995 and 4.4 million shares in 1994.\nAt December 31, 1995, 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 Stock Purchase-Savings Plan (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, 1995, there were no significant restrictions on the use of retained earnings.\nAt December 31, 1995, long-term debt maturities for the years 1996 through 2000 were $105.8 million, $100 million, $205 million, $50 million and $197.3 million, respectively. Person 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 Consolidated Balance Sheets. This classification is 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.\n6. EMPLOYEE STOCK OWNERSHIP PLAN\nThe Company sponsors an 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 to acquire 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. The common stock 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. Such dividends are deductible for income tax purposes.\nThere were 8,697,316 ESOP suspense shares at December 31, 1995, with a fair value of $300.1 million. ESOP shares allocated to plan participants totaled 14,507,665 at December 31, 1995. 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, $194.9 million at December 31, 1995, 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 had not been committed to be released to participants' accounts were no longer considered outstanding for the determination of earnings per common share; 2) dividends on unallocated ESOP shares were no longer recognized for financial statement purposes; 3) interest income related to the qualified ESOP loan was no longer recognized; 4) the difference between the acquisition and allocation prices of ESOP shares, which was previously recorded as other income, net, is recorded directly to common stock; and 5) all tax benefits of ESOP dividends are recorded to non-operating income tax expense, whereas in 1993, a portion of the tax benefits was recorded directly to retained earnings. In addition, pursuant to SOP 93-6, ESOP loan transactions between the Company and the SPSP Trustee were no longer reflected in the Consolidated Statements of Cash Flows. The implementation of SOP 93-6 resulted in an increase in earnings per common share of approximately $.04 for 1994.\n7. INCOME TAXES\nDeferred income taxes are provided for temporary differences between book and tax bases of assets and liabilities. Income 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.\nNet accumulated deferred income tax liabilities at December 31 are (in thousands):\n1995 1994\nAccelerated depreciation and property cost differences $1,613,752 $1,504,187 Deferred costs, net 133,139 144,751 Miscellaneous other temporary differences, net (12,487) (7,173) --------- --------- Net accumulated deferred income tax liability $1,734,404 $1,641,765 ========= =========\nTotal deferred income tax liabilities were $2.17 billion and $1.94 billion at December 31, 1995, and 1994, respectively. Total deferred income tax assets were $434 million at December 31, 1995, and $297 million at December 31, 1994.\nA reconciliation of the Company's effective income tax rate to the statutory federal income tax rate follows.\n1995 1994 1993\nEffective income tax rate 39.2% 37.6% 35.4% State income taxes, net of federal income tax benefit (5.0) (5.5) (5.1) Investment tax credit amortization 1.6 2.4 2.3 Other differences, net (0.8) 0.5 2.4 ---- ---- ---- Statutory federal income tax rate 35.0% 35.0% 35.0% ==== ==== ====\nThe provisions for income tax expense are comprised of (in thousands):\n1995 1994 1993\nIncluded in Operating Expenses Income tax expense (credit) Current - federal $143,440 $143,461 $108,935 state 41,826 39,185 29,687 Deferred - federal 75,442 23,926 50,719 state 7,860 3,500 11,588 Investment tax credit (9,344) (11,537) (11,612) ------- ------- ------- Subtotal 259,224 198,535 189,317 ------- ------- ------- Harris Plant deferred costs Investment tax credit (297) (297) 218 ------- ------- ------- Total included in operating expenses 258,927 198,238 189,535 ------- ------- -------\nIncluded in Other Income Income tax expense (credit) Current - federal (20,669) (15,732) (6,168) state (4,251) (3,507) (1,291) Deferred - federal 5,254 8,065 7,483 state 1,125 1,749 1,562 Investment tax credit -- -- (1,194) ------- ------- ------- Total included in other income (18,541) (9,425) 392 ------- ------- ------- Total income tax expense $240,386 $188,813 $189,927 ======= ======= =======\n8. PLANT-RELATED DEFERRED COSTS\nThe Company abandoned efforts to complete 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 No. 2 costs was completed in 1994. In the 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 $18.3 million in 1995, $60.5 million in 1994 and $100.7 million in 1993. 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 $4.3 million in 1995, $6.6 million in 1994 and $13.2 million in 1993 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 $38.4 million at December 31, 1995, and $60.8 million at December 31, 1994.\n9. JOINT OWNERSHIP OF GENERATING FACILITIES\nPower Agency 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 Consolidated Statements of Income.\nThe Company's share of the jointly-owned generating facilities is listed below with related information as of December 31, 1995 (dollars in millions).\nCompany Megawatt Ownership Plant Accumulated Under Facility Capability Interest Investment Depreciation Construction ________ __________ ________ __________ ____________ ____________\nMayo Plant 745 83.83% $ 432.9 $ 159.0 $ 7.2 Harris Plant 860 83.83% $ 3,006.6 $ 750.6 $ 8.6 Brunswick Plant 1,521 81.67% $ 1,361.3 $ 758.7 $ 35.8 Roxboro Unit No.4 700 87.06% $ 223.2 $ 91.9 $ 3.1\nIn the table above, plant investment and accumulated depreciation, which includes accumulated nuclear decommissioning, are not reduced by the regulatory disallowances related to the Harris Plant.\n10. COMMITMENTS AND CONTINGENCIES\nA. PURCHASED POWER Pursuant to the terms of the 1981 Power Coordination Agreement, as amended, between the Company and Power Agency, the 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 $26 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 $39.4 million for 1995, $60.4 million for 1994 and $52.6 million for 1993. 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, 1995 and 1994, the Company had deferred purchased capacity costs, including carrying costs accrued on the deferred balances, of $72.7 million and $70.9 million, respectively. Increased purchases resulting from the 1993 agreement with Power Agency, which were approximately $10 million for 1995 and $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 (Rockport) and 400 megawatts of generating capacity from Duke Power Company (Duke). The estimated minimum annual payment for power under these contracts is approximately $30 million for Rockport and $43 million for Duke, representing capital-related capacity costs. Other power costs include demand-related production expenses, fuel and energy-related operation and maintenance expenses for Rockport and fuel and energy-related operation and maintenance expenses for Duke. Purchases, including transmission use charges, for Rockport and Duke, respectively, totaled $61.8 million and $63.8 million for 1995, $61.9 million and $62.9 million for 1994 and $60.2 million and $37.1 million for 1993. The Rockport agreement expires in December 2009 and the Duke agreement expires in mid-1999.\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 $20 million in the event that losses at insured facilities exceed premiums, reserves, reinsurance and other NML resources, which are at present more than $763 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 $1.5 million at Brunswick Unit No. 1, $1.4 million at Brunswick Unit No. 2, $1.7 million at the Harris Plant and $1.4 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 per incident. 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 $7.6 million with respect to the incremental replacement power costs coverage and $42.9 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 $2.2 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 nuclear 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 nuclear units.\nC. CLAIMS AND UNCERTAINTIES (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. The Company continues to investigate the identities of parties connected to MGP sites in North Carolina, 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 expect costs associated with these sites to be material to the results of operations of the Company.\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.\nDue 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 1996 definitive proxy statement dated March 29, 1996, 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 1996 definitive proxy statement dated March 29, 1996, 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, 1995, owned 9,511,913 shares of Common Stock (6.2% 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 1996 definitive proxy statement dated March 29, 1996, 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 1996 definitive proxy statement dated March 29, 1996, and incorporated by reference herein.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, CONSOLIDATED FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. ___________________________________________________________________\na) 1. Consolidated Financial Statements Filed:\nSee ITEM 8 - Consolidated Financial Statements and Supplementary Data.\n2. Consolidated Financial Statement Schedules Filed:\nSee ITEM 8 - Consolidated Financial Statements and Supplementary Data.\n3. Exhibits Filed:\nExhibit No. *3a(1) Restated Charter of the Company, as amended May 10, 1995 (filed as Exhibit No. 3(i) to quarterly report on Form 10-Q for the quarterly period ended June 30, 1995, File No. 1-3382).\nExhibit No. *3a(2) By-laws of the Company, as amended May 10, 1995 (filed as Exhibit No. 3(ii) to quarterly report on Form 10-Q for the quarterly period ended June 30, 1995, File No. 1-3382).\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. *4c(1) Indenture, dated as of March 1, 1995, between the Company and Bankers Trust Company, as Trustee, with respect to Unsecured Subordinated Debt Securities (filed as Exhibit No. 4(c) to Current Report on Form 8-K dated April 13, 1995, File No. 1-3382).\nExhibit No. *4c(2) Resolutions adopted by the Executive Committee of the Board of Directors at a meeting held on April 13, 1995, establishing the terms of the 8.55% Quarterly Income Capital Securities (Series A Subordinated Deferrable Interest Debentures) (filed as Exhibit 4(b) to Current Report on Form 8-K dated April 13, 1995, File No. 1-3382).\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. *10b(1) Directors Deferred Compensation Plan effective January 1, 1982 as amended (filed as Exhibit 10(g), File No. 33-25560).\n+Exhibit No. *10b(2) Supplemental Executive Retirement Plan effective January 1, 1984 (filed as Exhibit 10(h), File No. 33-25560).\n+Exhibit No. *10b(3) Retirement Plan for Outside Directors (filed as Exhibit 10) (i), File No. 33-25560).\n+Exhibit No. *10b(4) Executive Deferred Compensation Plan effective May 1, 1982 as amended (filed as Exhibit 10(j), File No. 33-25560).\n+Exhibit No. *10b(5) Key Management Deferred Compensation Plan (filed as Exhibit 10(k), File No. 33-25560).\n+Exhibit No. *10b(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. *10b(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. *10b(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.\nExhibit No. 27 Financial Data Schedule\nExhibit No. 18 Letter re: Change in Accounting Principles\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 1995 and the portion of the first quarter of 1996 prior to the filing of this 10-K:\nDate of Report Item Reported ______________ _____________\nNONE\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 25th day of March, 1996.\nCAROLINA POWER & LIGHT COMPANY (Registrant)\nBy \/s\/ Glenn E. Harder 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 Title Date _________ _____ ____\n\/s\/ Sherwood H. Smith, Jr. Principal Executive (Chairman and Chief Executive Officer and Director Officer)\n\/s\/ Glenn E. Harder Principal Financial (Executive Vice President and Officer Chief Financial Officer)\n\/s\/ Leslie M. Baker, Jr. Director\n\/s\/ Edwin B. Borden Director March 25, 1996\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\/ Richard L. Daugherty 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":"705356_1995.txt","cik":"705356","year":"1995","section_1":"ITEM 1. BUSINESS.\nNational Bancorp of Alaska, Inc. (the Corporation) is a Delaware corporation organized on June 21, 1982, and registered as a Bank holding company under the Bank Holding Company Act of 1956.\nThe Corporation's principal asset is its investment in National Bank of Alaska (the Bank), a wholly-owned subsidiary. Through its subsidiary, the Corporation engages in commercial banking and trust activities.\nFor additional information concerning the business of National Bancorp of Alaska, Inc. and its subsidiaries, see pages 2 through 20 of National Bancorp of Alaska, Inc.'s 1995 Annual Report to Shareholders (Annual Report), which is incorporated in this Item 1 by reference.\nThe Bank\nThe Bank was established as a state-chartered bank in 1916 and converted to a national banking association in 1950.\nGeneral Banking Services\nThe Bank engages in general banking business offering checking accounts, savings accounts, money market accounts, Time Certificates of Deposit, securities sold under agreements to repurchase, Individual Retirement Accounts, commercial loans, home equity loans, unsecured lines of credit, consumer loans, construction and mortgage loans, lease financing, safe deposit services, night depositories, Visa credit cards (Classic and Gold), walk-up and drive-in banking with an international automated teller machine network and other services incidental to serving the banking needs of individuals, corporations, government and quasi-government bodies.\nAs of December 31, 1995, the Bank's banking operations are conducted from 52 banking offices and 48 electronic branches located throughout the state of Alaska, including 15 offices and 19 electronic branches in Anchorage.\nTrust Services\nThe Bank's Trust Department offers services to individuals and corporations throughout Alaska including estate planning, settlement of estates, administration of living and testamentary trusts, management of investment agency accounts, custodianships, and administration of employee benefit trusts. The Bank had trust assets of approximately $804 million under its supervision as of December 31, 1995.\nInternational Banking\nThe Bank's International Department offers customer services in connection with international business. The Department maintains correspondent relationships with banks located in certain world trade centers, including Tokyo and New York. Transactions handled by this Department include cable, wire, and mail transfers of funds, negotiating and advancing funds under export Letters of Credit, buying and selling foreign currencies, handling collection from foreign banks, and financing imports and exports.\nAn Edge Act subsidiary, National Bank of Alaska International Banking, Corp., has a branch located in Seattle, Washington with its head office in Anchorage, Alaska.\nCompetition\nThe Bank competes actively with national and state banks and other financial institutions, including savings and loan associations, savings banks, brokerage houses, money market funds, and credit unions located both in Alaska and other states. The bank maintains a competitive position by providing convenient service in the branch network located throughout the state and by competitive pricing of the products mentioned above.\nAlaska allows out-of-state bank holding companies to acquire banks and domestic bank holding companies located in Alaska. The law does not require reciprocal provisions by the home state of out-of-state bank holding companies. Management is of the opinion that to the extent that out-of-state bank holding companies enter the Alaskan market, the Corporation may encounter intensified competition.\nEmployment\nThe Bank employs approximately 1,101 people. Management considers employment relations to be good. None of the Bank's employees are covered by a collective bargaining agreement.\nSUPERVISION AND REGULATION\nNational Bancorp of Alaska, Inc. is a bank holding company subject to regulation under the Bank Holding Company Act of 1956. A bank holding company is required to file with the Federal Reserve Board annual reports and other information regarding the business operations of itself and its subsidiaries and is also subject to examination by the Federal Reserve Board. A bank holding company must obtain Federal Reserve Board approval prior to acquiring, directly and indirectly, ownership or control of any voting shares of any bank if, after such acquisition, it would own or control, directly or indirectly, more than 5% of the voting stock of such bank unless it already owns a majority of the voting stock of such bank. Furthermore, a bank holding company is, with limited exceptions, prohibited from acquiring direct or indirect ownership or control of any voting stock of any company which is not a bank or a bank holding company, and must engage only in the business of banking or managing or controlling banks or furnishing services to or performing services for its subsidiary banks. One of the exceptions to this prohibition is the ownership of shares of a company the activities of which the Federal Reserve Board has determined to be so closely related to banking or managing or controlling banks as to be a proper incident thereto.\nA bank holding company and its subsidiaries are prohibited from acquiring any voting shares of, or interest in, any banks located outside of the state in which the operations of the bank holding company's banking subsidiaries are located, unless the acquisition is specifically authorized by the statutes of the state in which the bank is located. Further, a bank holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with the extension of credit or provision of any property or service. Thus, an affiliate may not extend credit, lease, sell property or furnish any services or fix or vary the consideration for these on the condition that (i) the customer must obtain or provide some additional credit, property or service from or to its bank holding company or subsidiaries thereof or (ii) the customer may not obtain some other credit, property or services from a competitor, except to the extent reasonable conditions are imposed to assure soundness of credit extended.\nIn approving acquisitions by bank holding companies of banks and companies engaged in the banking-related activities, the Federal Reserve Board considers a number of factors, including the benefit to the public such as greater convenience, increased competition, conflicts of interest, or unsound banking practices. The Federal Reserve Board is also empowered to differentiate between new activities and activities commenced through acquisition of a going concern.\nAlaska law permits bank holding companies to acquire and own all or any portion of the voting securities or other capital stock of, or all or substantially all of the assets of, one or more banks or bank holding companies unless the bank is a state or national bank conducting a banking business in Alaska that commenced the business of banking in Alaska on or after July 1, 1982, and that has not been in existence and continuously operating in Alaska for three years or more. It is permissible under Alaska state law for out-of-state bank holding companies to acquire banks and domestic bank holding companies located in Alaska.\nThe banking laws of Alaska permit banks located in the state to establish branches throughout the state.\nThe Bank is subject to regulation and supervision, of which regular bank examinations are a part, by the Office of the Comptroller of the Currently (OCC). The Bank is also a member of the Federal Deposit Insurance Corporation (FDIC), which currently insures the deposits of each member bank to a maximum of $100,000 per depositor. For this protection, each bank pays a semiannual statutory assessment and is subject to the rules and regulations of the FDIC. The Corporation is an \"affiliate\" of the Bank, which imposes restrictions on loans by the Bank to the Corporation, on investments by the Bank in the stock or securities of the Corporation and on the use of such stock or securities as collateral security for loans by the Bank to any borrower. The Corporation is also subject to certain restrictions with respect to engaging in the business of issuing, flotation, underwriting, public sale and distribution of securities.\nThe ability of the Corporation to pay dividends will largely depend upon the amount of dividends declared by the Bank and any subsequently acquired companies. Approval of the OCC will be required for any dividend to the Corporation by the Bank, if the total of all dividends, including any proposed dividend, declared by the Bank in any calendar year exceeds the total of its net profits for that year combined with its retained net profits for the preceding two years, less any required transfers to surplus. In the event that the Bank were to experience either significant loan losses or rapid growth of loans or deposits, the Corporation, as the sole stockholder, could be compelled by bank regulatory authorities to invest additional capital.\nStatistical Disclosure\nThe information as required by the Securities and Exchange Commission's Guide 3 - - Statistical Disclosure by Bank Holding Companies is incorporated herein by reference to the Registrant's 1995 Annual Report to Shareholders.\nDescription Annual Report Page Numbers\nI. Distribution of Assets, Liabilities and Stockholders' Equity; Interest Rate and Interest Differential:\nA. and B. Average Balance Sheet Combined with an Analysis of Net Interest Earnings.......................46-47\nC. Analysis of Changes in Net Interest Income due to rate and volume...........................47\nII. Investment Portfolio:\nA. Book Value of Investments...............................40\nB. Weighted Average Yield..................................40\nIII. Loan Portfolio:\nA. Types of Loans for Each Reported Period.................41\nB. Maturities and Sensitivity to Changes in Interest Rates..........................................41\nC. Risk Elements...........................................42\nIV. Summary of Loan Loss Experience:\nA. Analysis of Allowances for Loan Loss Experience.........................................43\nV. Deposits:\nA. Average Balance by Type.................................44\nB. Large TCD Maturities - Over $100,000....................41\nVI. Return on Equity and Assets Selected Ratios for Each Reported Period...........................45\nVII. Short-Term Borrowings..............................................44\nSchedules Included Herein\nIII. Loan Portfolio\nC. Risk Elements.\nPotential Problem Loans\nAt December 31, 1995, an additional $17,082,000 in loans are being closely monitored by management. These loans are not included in any category of non- performing loans. However, management has concern about the borrowers' abilities to comply with their present loan repayment terms. These loans are reviewed monthly to assess any change in collectability.\nForeign Outstandings\nThere were no foreign outstandings to individual countries as of December 31, 1995.\nIV. Summary of Loan Loss Experience:\nB. Allocation of the Allowance for Loan Losses:\nAllocation of Reserves To Loan Categories Loan Category As a % % of Total Amount of of Total Loans Reserve Reserves(000's) December 31, 1995 Commercial and Industrial 35.5% 2.2% $468 Real Estate Construction 1.9 - 3 Real Estate Long-Term 31.9 1.2 267 Installment 25.0 15.3 3,288 Nontaxable 4.8 0.4 81 Lease Financing 0.9 - - Unallocated - 80.9 17,422 ----------------------------------------- 100.0% 100.0% $21,529\nDecember 31, 1994 Commercial and Industrial 35.9% 5.4% $1,035 Real Estate Construction 1.8 0.9 165 Real Estate Long-Term 33.9 2.3 442 Installment 22.1 13.8 2,664 Nontaxable 5.5 0.8 152 Lease Financing 0.8 - - Unallocated - 76.8 14,768 ----------------------------------------- 100.0% 100.0% $19,226\nDecember 31, 1993 Commercial and Industrial 37.9% 21.3% $3,704 Real Estate Construction 2.6 0.2 35 Real Estate Long-Term 33.9 13.0 2,271 Installment 18.2 6.9 1,195 Nontaxable 6.5 3.4 587 Lease Financing 0.9 - - Unallocated - 55.2 9,616 ----------------------------------------- 100.0% 100.0% $17,408\nDecember 31, 1992 Commercial and Industrial 44.5% 21.3% $4,547 Real Estate Construction 2.0 1.3 269 Real Estate Long-Term 26.3 5.5 1,183 Installment 17.6 5.2 1,103 Nontaxable 8.8 3.8 807 Lease Financing 0.8 - - Unallocated - 62.9 13,429 ----------------------------------------- 100.0% 100.0% $21,338\nDecember 31, 1991 Commercial and Industrial 46.7% 20.3% $4,314 Real Estate Construction 4.3 2.8 589 Real Estate Long-Term 24.4 4.4 947 Installment 14.7 2.7 572 Nontaxable 8.8 4.0 848 Lease Financing 1.1 - - Unallocated - 65.8 14,014 ----------------------------------------- 100.0% 100.0% $21,284\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Bank's main banking office is at its headquarters building, which is located at Northern Lights Boulevard and C Street, Anchorage, Alaska.\nIn addition to its headquarters building, the Bank owns 39 of its banking offices (including four which are subject to ground leases) and leases 61 other banking offices under agreements expiring between 1996 and 2031.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nFor information concerning legal proceedings, see Note 10 of \"Notes to Financial Statements\" at page 32 of the Annual Report, which is incorporated herein by reference.\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 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nFor information concerning market for the registrant's common equity and related stockholder matters, reference is made to page 48 of the Annual Report, which is incorporated herein by reference.\nThe above-referenced schedule shows the high and low bid quotations of the Corporation's stock as reported by the National Association of Securities Dealers Automated Quotations System (NASDAQ). National Bancorp of Alaska, Inc. common stock is traded in the over-the-counter market. Such over-the-counter market quotations reflect interdealer prices, without retail markup, markdown, or commission and may not necessarily represent actual transactions.\nThe Corporation has engaged Salomon Brothers, Inc. for financial advisory and investment banking services.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nSelected financial data for the prior ten years is incorporated herein by reference on pages 22-23 of the Annual Report.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nFor management's discussion and analysis of financial condition and results of operations see \"Management Discussion and Analysis\" at pages 38 through 47, and the Chairman's message to shareholders on inside cover of the Annual Report, which are incorporated herein by reference.\nCapital Resources\nThe Federal Reserve Board has standards for measuring capital adequacy based on \"risk-adjusted\" assets. As of December 31, 1992, banks and bank holding companies are expected to meet target risk-based capital ratio of 8.00%. Effective September 7, 1990, the Federal Reserve Board implemented regulations that establish a minimum leverage capital ratio of 3% of Tier 1 capital to total assets less goodwill. The table below illustrates the Corporation's regulatory capital ratios as of December 31:\n1995 1994 Tier 1 Capital $343,954 $314,243 Tier 2 Capital 21,529 19,226 -------------------- Total Qualifying Capital $365,483 $333,469 ==================== Risk Adjusted Total Assets (including off-balance sheet exposure) $1,869,720 $1,692,316 ====================== Total Risk-Based Capital Ratio 19.55% 19.70% ================= Leverage Ratio 13.90% 13.20% =================\nManagement monitors the asset and liability position closely. As market and business conditon change, asset and liability positions and pricing structures are adjusted to control the risks associated with interest rate movement and to generate a stable growth in net interest income. The table above reflects the contractual repricing dates for interest sensitive assets and liabilities. Interest bearing demand and savings accounts with no stated maturity totaling $743,653,000 are included in the 1 to 90-day category. These deposits reprice at management's discretion and have normally repriced less frequently than those products indexed to market rates. Due to the continuing policy of analyzing rate sensitivity, management believes National Bancorp of Alaska is reasonably well positioned for subsequent rate movements.\nNonperforming Assets\nOther real estate owned decreased from $4.3 million at December 31, 1994 to $3.1 million at December 31, 1995. During 1995, nonaccrual loans totaling $0.4 million were transferred to other real estate owned. Assets with a book value of $2.2 million were sold. Restructured loans decreased from $1.7 million at December 31, 1994 to $0.3 million at December 31, 1995.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe report of independent auditors and the consolidated financial statements and notes to consolidated financial statements on pages 24 through 37 of the Annual Report are incorporated herein by reference.\nThe quarterly financial data on page 48 of the Annual Report is incorporated herein by reference.\nITEM 9.","section_9":"ITEM 9. CHANGE IN ACCOUNTANTS\nNot Applicable\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nFor information concerning directors and executive officers of National Bancorp of Alaska, Inc., see \"Election of Directors\" at pages 2 through 5 of the Proxy Statement for the March 19, 1996, Annual Meeting of Shareholders, which is incorporated herein by reference.\nThe following table sets forth the executive officers of the Bank, all of whom serve at the discretion of the Board, their ages and their positions with the Bank:\nServed as an Positions and Offices Currently Held Executive Officer Name Age with Bank Since\nDonald L. Mellish 68 Chairman of the Executive Committee 1964 Edward B. Rasmuson 55 Chairman of the Board of Directors 1972 Richard Strutz 45 President 1985 Kathleen Soderberg 47 Executive Vice President and Treasurer 1982 B. John Shipe 46 Executive Vice President 1984 Gary Dalton 41 Executive Vice President 1988\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nReference is made to pages 5 through 9 of the Proxy Statement for the March 19, 1996, Annual Meeting of Shareholders, which is incorporated herein by reference for information concerning management remuneration and transactions.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nFor information concerning the Corporation's security ownership by certain beneficial owners and management, reference is made to pages 1 through 9 of the Proxy Statement, which is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nFor information concerning certain relationships and related transactions, see page 10 of the Proxy Statement, which is incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS FORM 8-K\n(a) The following documents are filed as part of the report:\n1. Financial Statements\nThe following consolidated financial statements of National Bancorp of Alaska, Inc. and its subsidiaries and report of independent auditors are incorporated in Item 8 by reference from the 1995 Annual Report to Shareholders. Page number references are to the Annual Report:\nNational Bancorp of Alaska and subsidiaries: Page\nConsolidated Statements of Condition December 31, 1995 and 1994.............................25\nConsolidated Statements of Income Years ended December 31, 1995, 1994, and 1993..........24\nConsolidated Statements of Cash Flows Years ended December 31, 1995, 1994, and 1993..........26\nConsolidated Statements of Changes in Shareholders' Equity Years ended December 31, 1995, 1994, and 1993...27\nNotes to Consolidated Financial Statements.............27-36\nReport of Independent Auditors.........................37\n2. Financial Statement Schedules\nAll schedules are omitted because they are not applicable, not material or because the information is included in the financial statements or the notes thereto.\n3. Exhibits\n(3) Articles of incorporation and bylaws are incorporated herein by reference to Exhibit (3) to Registration on Form S-14, File No. 2-78795 dated August 11, 1982.\n(4) Instruments defining the rights of security holders - specimen of stock certificate to be issued by the Registrant (as amended to date) is incorporated herein by reference to Exhibit (4) to Registration on Form S-14, File No. 2-78795 dated August 11, 1982.\n(13) Annual Report to shareholders for the year ended December 31, 1995.\n(21) Subsidiaries of the registrant are as follows:\nBusiness Name State Incorporated\nNational Bank of Alaska and subsidiaries Alaska\nNational Bank of Alaska Leasing Corporation Alaska\nNBA Advertising, Inc. Alaska\nNational Bank of Alaska International Banking Corporation Washington\nAlaska Bankcard Center, Inc. Alaska\nNBA Mortgage Corporation Delaware\nNorthland Credit Corporation Alaska\nNB Aviation, Inc. Delaware\n(22) There were no matters submitted to a vote of security holders during the fourth quarter of 1995.\n(27) Financial Data Schedule\n(b) Reports on Form 8-K\nThere were no reports on Form 8-K filed during the quarter ended December 31, 1995.\n(c) Exhibits - See list of exhibits set forth above at Item 14(a)3.\n(d) Financial Statement Schedules\nSchedules required to be filed in response to this portion of Item 14 are listed above in Item 14(a)2.\nReport of independent auditors for Form 10-K for the year ended December 31, 1995, is incorporated herein by reference in Item 14(a)1.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nNATIONAL BANCORP OF ALASKA, INC.\nMarch 19, 1996 By \/s\/Edward B. Rasmuson Date Edward B. Rasmuson, Chairman of the Board and Director (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:\nMarch 19, 1996 \/s\/Edward B. Rasmuson Date Edward B. Rasmuson, Chairman of the Board and Director (Principal Executive Officer)\nMarch 19, 1996 \/s\/Richard Strutz Date Richard Strutz, President and Director (Principal Financial Officer)\nMarch 19, 1996 \/s\/Gary Dalton Date Gary Dalton, Senior Vice President (Principal Accounting Officer)\nMarch 19, 1996 \/s\/Gary M. Baugh Date Gary M. Baugh, Director\nMarch 19, 1996 \/s\/Carl F. Brady, Jr. Date Carl F. Brady, Jr., Director\nMarch 19, 1996 \/s\/Alec W. Brindle Date Alec W. Brindle, Director\nMarch 19, 1996 \/s\/Sharon Burrell Date Sharon Burrell, Director\nMarch 19, 1996 \/s\/James O. Campbell Date James O. Campbell, Director\nMarch 19, 1996 \/s\/Jeffrey J. Cook Date Jeffrey J. Cook, Director\nMarch 19, 1996 \/s\/Patrick S. Cowan Date Patrick S. Cowan, Director\nMarch 19, 1996 \/s\/Roy Huhndorf Date Roy Huhndorf, Director\nMarch 19, 1996 \/s\/James H. Jansen Date James H. Jansen, Director\nMarch 19, 1996 \/s\/Donald L. Mellish Date Donald L. Mellish, Director\nMarch 19, 1996 \/s\/Tennys B. Owens Date Tennys B. Owens, Director\nMarch 19, 1996 \/s\/Eugene A. Parrish Date Eugene a. Parrish, Director\nMarch 19, 1996 \/s\/Michael Pate, Date Michael Pate, Director\nMarch 19, 1996 \/s\/Martin R. Pihl, Date Michael Pate, Director\nMarch 19, 1996 By \/s\/Edward F. Randolph Date Edward F. Randolph, Director\nMarch 19, 1996 By \/s\/Major General John Schaeffer Date Major General John Schaefer(Ret.) Director\nMarch 19, 1996 By \/s\/Michael K. Snowden Date Michael K. Snowden, Director\nMarch 19, 1996 By \/s\/George S. Suddock Date George S. Suddock, Director\nMarch 19, 1996 By \/s\/Richard A. Wien Date Richard A. Wien, Director","section_15":""}
{"filename":"70262_1995.txt","cik":"70262","year":"1995","section_1":"Item 1. Business\nGENERAL\nAndal Corp. (the \"Company\" or \"Andal\"), through its Multi-Arc Inc. subsidiary (\"Multi-Arc\"), is engaged in surface enhancement which is the utilization of advanced technologies to apply thin-film coatings of various metals, metal compounds, and other substances to base materials to enhance their hardness, wear and corrosion resistance, lubricity, and appearance. Multi-Arc owns and operates seven coating centers in the United States, one in Canada, and one in England, and has royalty or equity interests or to which it licenses technology in 25 coating centers in Europe, Japan, India, Korea, Taiwan, Singapore, People's Republic of China, Brazil, and Argentina. These centers offer coating services on a fee basis to manufacturers and end-users of industrial tools, components, and other products. Multi-Arc also engages in the design, manufacture, assembly, and sale of proprietary coating equipment systems to manufacturers and large volume end-users of tools, consumer products, and other products that benefit from surface enhancement, as well as to its own joint venture coating centers. See Note 20 of the Notes to Consolidated Financial Statements included elsewhere in this Report for certain segment information, including revenues, operating profit (loss) and identifiable assets, and other information about foreign operations of the Company for each of the three years in the period ending September 30, 1995.\nUBC Option\nThe Company, through a wholly-owned subsidiary, UBC Virginia Corp. (\"UBC Corp.\"), owns an option (the \"Option\") to purchase a parcel of real estate (the \"UBC Property\") located on 61st Street and First Avenue in New York City, which Option has been carried on the books of the Company at nil value for many years. The Option grants the Company the right to purchase the UBC Property for approximately $3 million in cash and is exercisable only after the death of the later to die of two of the principals of the corporation that granted the Option. The Option expires 91 (ninety-one) days after the Company has been given formal notice of such death by the Optionor (the \"Option Notice\"). The Company was given formal notice of such death on September 22, 1995. The Company does not have the $3 million of cash that is required to exercise the Option, and it does not believe it will be able to raise such a sum through borrowings from unrelated parties or through the sale of assets other than the Option. However, under the terms of the loan described below, the Company is obligated to exercise the Option. Accordingly, on October 13, 1995 the Company gave the Optionor formal notice of its election to exercise the Option; and the parties have agreed that the transaction must be closed on or before February 27, 1996.\nThe capital stock of UBC Corp. was pledged as security for a $5 million loan, hereafter referred to as the \"UBC Loan,\" made to the Company in 1990 by Alan N. Cohen, President and a Director of the Company, Paul Milstein, who was then a Director of the Company, and Frankhill Associates, a limited partnership of which Andrew J. Frankel, Chairman of the Board and a Director of the Company, is a general partner (collectively, in such capacity, the \"UBC Lenders\").\nAs of September 30, 1995, the principal balance of the loan, after adjustment for a restructuring which occurred in 1992, is $5,571,285 which is due and payable on the earlier of March 31, 1997, or the day after certain other indebtedness to shareholders of the Company, including the individuals mentioned above, has been paid in full.\nThe capital stock of UBC Corp. also serves as security (second lien) for a $2,043,000 loan (hereafter referred to as the \"Fleet Assignee Loan\") outstanding as of September 30, 1995 ($1,793,000 as of December 29, 1995) between the Company and certain of its directors and a stockholder who was formerly a director.\nThe Company's failure to pay the $3 million purchase price for the UBC Property will result in an event of default under the UBC Loan, which will give the UBC Lenders the right to exercise the Option on the Company's behalf and to declare the loan immediately due and payable, including all sums advanced by the UBC Lenders in exercising the Option. In addition, the UBC Lenders will have all of the remedies available to them under applicable law for secured lenders, including, without limitation, the public or private sale of the UBC Property acquired by exercise of the Option. Default under the UBC Loan will also result in default under the Fleet Assignee Loan.\nUntil January 1995, the Company had been under contract to sell the Option to an unrelated real estate developer, who had contracted to purchase the Option in 1984. The developer was unable to obtain financing to consummate the purchase; and, as a result, the Company terminated the contract. Upon termination of the contract, the Company has attempted to sell the Option to various other parties. In addition, after the Company received the Option Notice from the Optionor, the Company made contact with several brokers, which brokers have not been able to identify a buyer. To date, the Company has not received a bona fide offer from a third party for the Option.\nThe UBC Lenders have expressed an interest in acquiring the UBC Property in satisfaction of the amount outstanding on the UBC Loan. In that event, the Company would no longer be obligated with respect to the $3 million purchase price obligation due on the UBC Option exercise.\nThe Board of Directors of the Company met on October 5, 1995 to discuss the difficulties entailed in the Company's exercise of the Option, including the Company's lack of cash flow, diminished borrowing power, debt structure, and difficulties in raising funds through a private placement of Multi-Arc's common stock and subordinated debentures (see \"Sale of Minority Interest in Multi-Arc Inc.\" included elsewhere in this Report). After discussion, the Board members who are not UBC Lenders (Messrs. Flood and Glickman) authorized the officers of the Company to engage an independent appraiser to conduct an appraisal of the UBC Property, following which such Board members would seek to negotiate a transaction with the UBC Lenders taking into account, in addition to the appraisal, all material circumstances relating to the UBC Property, including, without limitation, the inability of the Company to raise sufficient funds required to exercise the Option, the time constraints within which the Company must exercise the Option, and the consequent probability that, without a sale to a related party, the Option will expire worthless.\nOn November 21, 1995, the Company received a report from the independent appraiser it had retained which concluded that the range for the market value of the UBC Property was between $9.9 million and $11.9 million (before deducting the $3 million that would have to be paid to exercise the Option), depending on the ultimate cost of complying with zoning restrictions and other costs that would be incurred in the development of the UBC Property. The appraiser's conclusion was based on a number of assumptions, including the assumption that a sale would occur after a reasonable exposure in a competitive market under all conditions requisite for a fair sale, with the buyer and seller acting prudently, knowledgeably, for self-interest, and not under undue duress.\nThe members of the Company's Board of Directors who are not UBC Lenders and the UBC Lenders are each considering the results of the appraisal. The Company expects that formal negotiations between the Company and the UBC Lenders will commence in early January 1996.\nSale of Minority Interest in Multi-Arc Inc.\nIn December 1994, Andal sold, for $500,000, approximately 2-1\/2% of the common stock of Multi-Arc to Multi-Arc's management; and Multi-Arc issued $500,000 of convertible subordinated debentures (convertible into approximately 2% of Multi-Arc common stock) to such management, the proceeds of which were remitted to Andal as a return of capital. Both the sale of the common stock and the issuance of the debentures were funded through non-recourse loans of $1 million made to the management by Multi-Arc utilizing Multi-Arc's revolving credit facility with First Fidelity Bank. Because of the non-recourse nature of the loans, the gain of approximately $396,000 on the sale of the Multi-Arc common stock to its management has been deferred until such time as the management loans are repaid.\nIn June and September 1995, Andal sold, for $1,010,000, approximately 4.9% of the common stock of Multi-Arc to certain foreign licensees and other investors; and Multi-Arc sold to such licensees and other investors $1,010,000 of convertible subordinated debentures (convertible into approximately 3.8% of Multi-Arc common stock), the cash proceeds of which were remitted to Andal as a return of capital. These debentures bear interest at 6% and are payable on December 15, 2004. Approximately $450,000 of the proceeds of the common stock sold, and $450,000 principal amount of the debentures sold are evidenced by a promissory note which requires monthly principal payments over three years, plus interest at 6% per annum. An additional $153,000 of common stock and $153,000 principal amount of the debentures were sold on open account. The gain on these sales of Multi-Arc common stock was $800,000, of which $452,000 was deferred and will be recognized as the amounts are collected.\nThe Company had agreed, in principal, to a total $3.5 million in stock sales and $3.5 million of Multi-Arc debenture issuances to its foreign licensees and other investors. However, the offer was not fully subscribed; and the unsubscribed portion of the offer has been withdrawn.\nOther\nIn November 1994, Multi-Arc India Ltd. (\"India\") completed an initial public offering and was listed on the Bombay Stock Exchange which reduced the Company's interest in India from 40% to 21%. Andal recorded a pretax gain of $85,000 as a result of this transaction.\nOn June 30, 1995, an appeals tribunal dismissed a claim against the Company by a local taxing authority for income taxes relating to certain of its discontinued operations. Income from discontinued operations for the year ended September 30, 1995 includes the reversal of a reserve for income taxes, plus accrued interest, in the aggregate amount of $996,000.\nIn September 1995, the Company refinanced the debt of its subsidiary, Multi-Arc (UK) Ltd., with First Fidelity Bank N. A. The new credit facilities consist of a five-year term loan in the principal amount of Pounds Sterling1,500,000 repayable in quarterly installments of Pounds Sterling54,000 commencing in December 1995 and a final installment of Pounds Sterling474,000 due in September 2000. Proceeds of the term loan were used to repay outstanding indebtedness to Siemens Financial Services and the Bank of Scotland, to advance an inter-corporate loan to Multi-Arc Inc., and for acquisition of new equipment. In addition to the term loan, First Fidelity has extended a Pounds Sterling250,000 overdraft facility for working capital purposes.\nThe Company currently owns 352,700 shares, or approximately 3% of the outstanding Class A common stock of Integrated Brands Inc., formerly named Steve's Homemade Ice Cream, Inc. (\"Integrated\"), a company which markets, distributes, and sells a variety of branded frozen dessert products and franchises ice cream parlors, dip shops, and family-style restaurants throughout the United States and certain foreign countries.\nThe Company was incorporated in New York in 1966 and maintains its principal executive offices at 909 Third Avenue, New York, New York 10022. Its telephone number is (212) 376-5545.\nSURFACE ENHANCEMENT\nSurface enhancement is the exploitation of a variety of technological processes to produce new or changed surface properties of materials by the deposition of thin films only microns thick (a micron is one millionth of a meter).\nThe electric arc technology utilized by Multi-Arc in its Physical Vapor Deposition (\"PVD\") process (ION BONDR) was originally developed in the Soviet Union, and Multi-Arc acquired a patent and know-how license from the former U. S. S. R. in 1979. Multi-Arc also employs a Chemical Vapor Deposition (\"CVD\") process.\nMulti-Arc first introduced the ION BONDR process on a commercial basis in the United States in 1981 and has continually improved and enhanced the original technology. Initially, the principal application of the ION BONDR process was the coating of metal cutting tools, such as drills, used in metal-working industries to increase the useful life and productivity of such tools. However, Multi-Arc has been successful in developing additional commercial applications for its processes, including the coating of metal forming tools, such as dies, molds and punches, jewelry, carbide inserts, plastic injection molds and screws, and medical instruments and implants. Multi-Arc has also effected improvements in CVD technology which it employs for the coating of steel and carbide aterials.\nMulti-Arc derives revenues from (i) the nine coating centers owned and operated by Multi-Arc located in the United States, Canada, and England, and the 5 coating centers in which it has varying royalty or equity interests or to which it licenses technology located in Europe, Japan, India, Korea, Taiwan, Singapore, People's Republic of China, Brazil, and Argentina, all of which coating centers perform coating services on a fee basis; (ii) the design, manufacture, assembly, and sale of proprietary coating equipment systems to coating centers and to manufacturers of, and large volume end-users of, tools and other industrial products, such as component parts requiring a high degree of wear resistance; (iii) royalties paid by system purchasers for licenses to use the coating technology which the systems employ; and (iv) research and development contracts.\nSales and Marketing\nMulti-Arc's coating systems and services are marketed throughout the United States by its own sales personnel, through independent sales representatives, and through the use of direct marketing catalogues and the display of its products at trade shows. Sales personnel at each of the coating centers are involved in marketing the services performed at such centers.\nCompetition\nThere are several manufacturers in the United States, Europe, and Japan which produce coating equipment utilizing a PVD process; and Multi-Arc anticipates that additional PVD technologies will be developed as the surface enhancement industry develops. Moreover, there are numerous manufacturers of CVD equipment which compete with the CVD systems manufactured by Multi-Arc, as well as with its PVD systems in certain applications. There are also several technologies other than the PVD and CVD processes, some of which involve surface enhancement, which are currently being used by numerous other firms to extend the useful lives and productivity of metal-cutting tools and other items.\nAlthough there are several companies which operate coating centers in the United States that utilize PVD or CVD technology, only one is a significant national and international competitor of the Company. The Company also competes with numerous coating centers in the United States that employ technologies other than PVD and CVD.\nThe Company competes in the manufacture of coating systems primarily on the basis of quality and technical innovation, as well as price. In the operating of coating centers, quality, price, and service are the principal competitive factors.\nBacklog\nThe approximate dollar amount of Multi-Arc's backlog of coating systems, ancillary equipment, and coating services orders at September 30, 1995 and 1994 was $390,000 and $1,707,000, respectively. The decline in backlog is due to the timing of equipment sales. The Company believes that all of its backlog orders at September 30, 1995 will be shipped within the Company's current fiscal year.\nPatents and Trademarks\nMulti-Arc has been issued a number of patents. Although the Company considers these patent rights to be significant, it believes that its competitive position and its continued operations are more dependent on its technical knowledge, its processes, and its research and development programs, than on patent protection. The Company intends to continue to apply for patent protection with respect to new inventions in order to protect its competitive position. The Company has registered several trademarks, the principal ones being \"Multi-ArcR\" and \"ION BONDR\". Although these trademarks afford Multi-Arc a degree of recognition in the industry and are valuable assets, the Company does not regard them as material to its overall business.\nResearch and Development\nMulti-Arc is engaged in ongoing research and development in connection with new and existing products. Research and development expenditures have been expensed as incurred and amounted to $1,628,000, $1,400,000, and $1,222,000 for fiscal 1995, 1994, and 1993, respectively. In addition, the Company has research and development agreements with several licensees pursuant to which each company makes known to the others the results of research undertaken by it in the field of surface enhancement.\nEnvironmental Considerations\nCompliance with Federal, state, and local provisions which have been enacted or adopted regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, is not expected to have a material effect on the Company's capital expenditures, earnings, or competitive position.\nEmployees\nAs of September 30, 1995, Multi-Arc employed approximately 325 persons, none of whom are covered by collective bargaining agreements. Multi-Arc believes that its relationship with its employees is good. Item 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company's executive office is located in approximately 3,800 square feet of leased space at 909 Third Avenue, New York, New York.\nMulti-Arc's administrative offices and Northeast Coating Center are located in a 20,400 square foot building located in Rockaway, New Jersey. The building, which the Company has an option to purchase, at market value, leases for a base rent of $226,900 per year. The seven other coating centers which are owned and operated by the Company in the United States and Canada occupy leased facilities containing an aggregate of approximately 88,000 square feet, at an aggregate annual rental of approximately $605,000. In addition, the Company leases a 25,000 square foot coating facility in the United Kingdom for Pounds Sterling32,250 (approximately $51,000) per year.\nAll of the foregoing facilities are suitably equipped and adequate for their current use.\nItem 3.","section_3":"Item 3. Legal Proceedings\nIn August 1982, National States Electric Corp. (\"NSEC\"), a subsidiary of the Company then engaged in the electrical contracting business, commenced an action in the New York Supreme Court, County of New York, against LFO Construction Company (\"LFO\") for breach of contract. The action arose out of a subcontract agreement between NSEC and LFO in connection with a New York City construction project for which LFO served as construction manager. LFO, in response, asserted various counterclaims and set-offs against NSEC; and, in October 1982, LFO and two other parties commenced an action in the same court against NSEC, the Company, and Andrew J. Frankel, Chairman of the Board of the Company, in which the plaintiffs essentially realleged the counterclaims and set-offs. These actions were tried in October 1992. The court dismissed the claims against the Company and Mr. Frankel on the merits and with prejudice; but the jury returned a verdict against NSEC for approximately $3.8 million, including interest and costs; and a judgement was entered on the verdict in November 1992. LFO and its associates appealed from that part of the judgement which dismissed the action against the Company and Mr. Frankel. NSEC, in turn, appealed from the judgement against it. In April 1994, the Appellate Division affirmed the dismissal of the claims against the Company and Mr. Frankel. In addition, the Court struck the award for damages against NSEC and remanded the matter to the trial court for a new trial as to damages. In January 1995, NSEC settled the issue of damages with LFO by assigning to LFO its only asset which consisted of a claim it had against the New York City Transit Authority for work it performed for the Authority many years ago. The claim has been carried on the books of NSEC at no value; and, accordingly, the settlement did not result in any loss to the Company.\nThe Company, as successor to Circle Industries Corp. (\"Circle\"), its former subsidiary engaged in the installation of flooring, is a defendant in an action before the Supreme Court, New York County, commenced in May 1983 by Manhattan Plaza Associates against Circle and others alleging negligent installation of flooring and installation of defective flooring resulting in damages allegedly in excess of $5 million. The Company has filed an answer denying liability, asserting defenses and cross-claiming against Masonite Corporation, the manufacturer of the flooring. In June 1994, a similar action against the Company was settled for a cash payment by the Company of approximately $100,000. The Company cannot determine what effect the outcome of the aforementioned legal proceeding will have on the Company's financial position, results of operations, or liquidity. No liability has been accrued for this matter, as it is not considered probable that a liability has been incurred.\nThe Company is aware of various other lawsuits, claims, and administrative roceedings which are pending involving it and its subsidiaries.\nIn the opinion of the Company's management, these matters will not result in any material adverse effect on the Company's consolidated 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 Company's Common Equity and Related Stockholder Matters\nAlthough the Company's common stock is listed on the NASD OTC Bulletin Board, transactions in and quotations of the stock have been limited and sporadic and, in the Company's opinion, do not constitute an established public trading market. The following table sets forth the range of high and low bid prices per share of the common stock as reported by the Pink Sheets and the NASD OTC Bulletin Board. Such quotations reflect inter-dealer prices without retail mark-up, mark-down, or commission and may not necessarily represent actual prices.\nBID PRICES High Low FISCAL 1995\nFirst Quarter $2.50 $2.00 Second Quarter $2.25 $2.25 Third Quarter $2.25 $2.25 Fourth Quarter $2.25 $2.25\nFISCAL 1994\nFirst Quarter $2.00 $2.00 Second Quarter $2.00 $2.00 Third Quarter $3.00 $2.00 Fourth Quarter $3.00 $2.00\nAs of December 29, 1995, the number of registered holders of the Company's common stock was 1,145.\nThe Company has never paid a cash dividend on its common stock and does not anticipate paying such dividends in the foreseeable future.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe following table sets forth selected financial data as of the fiscal year-end of each respective year and for the year then ended:\nSeptember 30, 1995 1994 1993 1992 1991 (Thousands of dollars, except per share amounts)\nOperating revenues $30,383 $27,077 $24,887 $20,834 $41,892 Inc. (loss) from operations 2,414 1,627 832 (1,048) (1,926) Income (loss) from continuing\noperations 879 (771) (433) (2,733) (21,865) Income (loss) from discontinued operations 1,007 (350) (527) (2,067) (2,000) Net income (loss) 1,886 (1,121) (960) (4,800) (23,865) Income (loss) per share from\ncontinuing operations 2.67 (2.34) (1.31) (8.29) (66.29) Net income (loss) per share 5.72 (3.40) (2.91) (14.55) (72.35) Average number of common shares\noutstanding (000) 330 330 330 330 330 Total assets $23,625 $20,457 $23,475 $24,282 $29,544 Long-term obligations (excluding\ncurrent maturities) 17,585 16,141 18,721 20,398 7,715 Shareholders' equity (deficit) (5,098) (6,984) (5,863) (4,903) (103) Book value (deficit) per share at\nyear end (15.46) (21.17) (17.77) (14.86) (0.31)\nSee Item 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nResults of Operations\n1995 vs. 1994\nA summary of business segment information for the three fiscal years ended September 30, 1995 is provided in Note 20. All note references in this discussion and analysis are to the Notes to Consolidated Financial Statements included elsewhere in this Report.\nAndal's consolidated revenues, entirely attributable to Multi-Arc, for the year ended September 30, 1995 were $30.4 million compared with $27.1 million in 1994. The increase was the result of both higher coating services revenues of approximately $1.9 million or 8% and higher revenues from equipment sales of $1.4 million. Coating services revenues benefitted particularly from an increase of $830,000 or 29% in the United Kingdom which reflected better economic conditions and significantly improved market penetration. Coating service revenues in the United States rose as a result of moderately better economic conditions. Equipment sales (which approximated 12% of 1995 revenues) were up because of increased system deliveries with sales in the United States, Taiwan, and India. Royalty and commission income decreased $106,000 from the prior year which reflects the final effects of Multi-Arc's restructuring of its European licensee arrangements. Equity in foreign joint ventures provided income of $53,000 in 1995 compared with a loss of $16,000 in 1994. The 1995 amount includes income from Multi-Arc India Ltd. (\"India\") of $163,000 offset by a loss from Multi-Arc's Singapore joint venture of $110,000. Earnings in India are up as a result of increased demand for decorative products.\nIncome (loss) from continuing operations was $879,000 in 1995 compared with $(771,000) in 1994.\nOperating profits of Multi-Arc increased $1.4 million in 1995 which is attributable to an increase in coating services operating revenues which contributed $1,050,000 in additional operating profits, principally from Multi-Arc (UK) Ltd. The improved operating income in the coating services business is the direct result of higher volume, slightly improved margins, and lower depreciation expense. Operating profits from equipment sales rose approximately $570,000 due to higher sales and consistent margins with the prior year. Equity in earnings of foreign affiliates rose $69,000 over prior year entirely due to improved results in India. Operating profit was adversely effected by the lower royalty and commission income and increased spending of $228,000 on research and development.\nSelling, general, and administrative expenses rose $767,000 from the prior year. Approximately $582,000 of the increase related to higher personnel costs at Multi-Arc due to continued expansion of its selling and marketing efforts. Multi-Arc's administrative costs also increased $421,000 due to additional personnel, higher volume, and higher incentive compensation expense related to higher profitability. Andal's general corporate expenses declined $436,000 as the result of lower rent, depreciation, insurance, and legal costs, principally related to the prior year's financial restructuring.\nDuring 1995, the Company sold approximately 7.4% of its interest in Multi-Arc to management, foreign licensees, and other investors for cash and notes and recognized a gain of $348,000 on the transaction (see Note 3). In addition to this gain, a gain of $396,000 related to the portion of this sale to management has been deferred as the sales were financed by non-recourse loans. Another $452,000 of gain has also been deferred relating to sales made to foreign investors with deferred payment arrangements. The minority interest in net income of Multi-Arc resulted in a first-time charge of $152,000 for 1995.\nIn November 1994, Multi-Arc India Ltd. completed an initial public offering on the Bombay stock exchange which reduced Multi-Arc's interest in India from 40% to 21%; and the Company recorded a pretax gain of $85,000 on this transaction (see Note 4). Investment and other income increased to $37,000 from a loss of $756,000 in 1994. The 1994 amount was adversely impacted by the loss of $766,000 on the sale of a substantial portion of the Company's interest in Integrated's stock (see Note 7).\nInterest expense for 1995 was $1.8 million compared with $1.6 million in 1994. The increase was a function primarily of higher interest rates. Although debt levels have increased from the prior year, such increase principally occurred in the fourth quarter.\nOperating revenues and operating income attributable to foreign operations rose $1.0 million and $494,000, respectively, over 1994 principally as a result of a substantial improvement in operations in the United Kingdom.\n1994 vs. 1993\nAndal's consolidated revenues for the year ended September 30, 1994 were $27.1 million compared with $24.9 million in 1993. The increase was the result of higher coating services revenues of $3.3 million or 15% which reflects improved economic conditions in North America and the United Kingdom. Revenues from equipment sales, which comprised 8% of total revenue in 1994, declined $875,000 from the prior year due to fewer system deliveries, particularly export sales in the fourth quarter. Royalty and commission income decreased $82,000 from the prior year which reflects the effects of Multi-Arc's restructuring of its European licensee arrangements. Equity in foreign joint ventures was a loss of $16,000 in 1994 which includes income from Multi-Arc India Ltd. of $95,000 and a loss from Multi-Arc's Singapore joint venture of $111,000. (See Note 4.)\nIncome (loss) from continuing operations was $(771,000) in 1994 compared with $(433,000) in 1993.\nOperating profits of Multi-Arc increased $1.1 million in 1994 which is directly attributable to the increase in coating services operating revenues which contributed $1.4 million in additional operating profits, as well as improved margins in coating center services which contributed $700,000 of increased operating profits in 1994. The improved margins in the coating center business are the result of higher revenues, improved operating efficiency, and continued emphasis on cost reduction. Operating profit was adversely effected by the lower royalty and commission income, equity losses, and higher spending on research and development of $178,000. Operating profits from equipment sales remained flat despite a decline in revenues. In 1993, such profits had been adversely affected as the Company wrote off $343,000 of deferred costs in anticipation of the restructuring of its European licensee royalty arrangements.\nSelling, general, and administrative expenses rose $1.1 million from the prior year. Approximately $360,000 of the increase related to increased personnel costs at Multi-Arc due to expanded sales and marketing efforts. Multi-Arc's administrative costs also increased $400,000 due to some additional personnel, the effects of higher volume, and higher incentive compensation expense related to improved profitability. Andal's general corporate expenses rose $384,000, from higher legal expenses ($353,000 compared with $119,000) principally related to restructuring activities in the fourth quarter.\nInvestment and other income declined $920,000 as a result of the loss of $766,000 on the sale of a substantial portion of the Company's interest in Integrated's stock (see Note 7), compared with a gain of $60,000 on the sale of Integrated's stock in 1993 and a gain of $77,000 in 1993 on forgiveness of debt in the United Kingdom (see Note 12). Equity in earnings of Integrated decreased to nil from $234,000 in 1993. Effective June 23, 1993, the Company began to account for its ownership of Integrated by the cost method (see Note 7).\nOperating revenues and operating income attributable to foreign operations in 1994 rose $282,000 and $153,000, respectively, over 1993 due to an increase in coating center revenues in the United Kingdom and Canada of approximately 18% offset, in part, by the fact that 1993 included the first-time sale of equipment in the United Kingdom with no similar sales in 1994.\nEffects of Inflation\nInflation has a minimal effect on Andal's operations.\nLiquidity and Capital Resources\nCash decreased $293,000 during 1995 as cash provided by operating activities of $2.1 million and financing activities of $803,000 were offset by cash used by investing activities of $3.2 million.\nCash flow provided by operating activities of $2.1 million in 1995 compared with $3.6 million in 1994 and $2.1 million in 1993. In 1995, the Company benefitted from income from continuing operations before income taxes of $933,000 which was an improvement of $1.7 million over the prior year. However, in 1995, receivables increased $954,000 over the prior year, primarily related to the timing of the collection of equipment sales receivables and a decrease of $200,000 in inventories due to September deliveries. In 1994, the Company realized cash from a decrease of $1.1 million in accounts receivable, primarily due to the collections of equipment sales receivables, offset by an increase of $459,000 in inventories, both related to timing. In 1993, the Company sustained a substantial increase in accounts receivable over the prior year, again primarily due to the timing of equipment sales, offset by reductions in inventories and high levels of current liabilities which were also related to timing. Also, in 1994, the Company recorded non-cash losses of $766,000 from the sale of Integrated's stock (see Note 7) and, in 1993, wrote off $343,000 of deferred expenses in anticipation of the reorganization of its European licensing arrangements. The Company's operating costs continue to bear a very high level of depreciation and amortization charges.\nCash flow from operating activities in 1995 includes the adverse effect of $309,000 of cash used by discontinued operations to fund legal costs, offset by proceeds of $141,000 from the settlement of a construction claim. Cash flow from operating activities in 1994 includes the adverse effect of $747,000 of cash used by discontinued operations to fund legal costs, offset by proceeds of $500,000 from the sale of the Company's remaining investment in OMC (see Note 5), compared with $386,000 of cash used by discontinued operations in 1993 to fund legal costs.\nCash flow provided by financing activities of $803,000 in 1995 reflects new long term debt of $3.9 million which is comprised of proceeds from the refinancing of the debt of Multi-Arc (UK) Ltd. of $2.4 million and borrowings on Multi-Arc's revolving credit facilities of $1.5 million. (See Note 12.) Of the latter borrowing, $1.0 million was loaned to the management of Multi-Arc Inc. for its participation in the Company's sale of a minority interest in Multi-Arc Inc. (see Note 3). The sale of minority interest in Multi-Arc Inc. generated proceeds of $1.7 million. During 1995, the Company retired $3.0 million of long term debt, of which $786,000 related to Multi-Arc's U. S. term loan with First Fidelity Bank and the retirement of debt in the United Kingdom in connection with the refinancing of Multi-Arc (UK) Ltd. Multi-Arc also negotiated modifications to the agreement covering its revolving credit facility and term loan which made certain financial covenants less restrictive with respect to its cash flow.\nCash flow used by financing activities of $1,979,000 in 1994 reflects the Company's continued reduction of debt levels in both the United States and the United Kingdom. In September 1994, Multi-Arc obtained a $6.0 million term loan from First Fidelity Bank, N. A.; and the proceeds were ultimately used to retire a substantial portion of Andal's bank indebtedness (see Note 12). In 1993, the Company benefitted from the favorable effect of interest deferrals on restructured debt of $460,000.\nCash flow used by investing activities of $3.2 million in 1995 includes $3 million of capital expenditures and net investments of $211,000 in Multi-Arc's foreign joint ventures. Cash flow used by investing activities of $910,000 in 1994 includes approximately $2.0 million of capital expenditures and net investments of $188,000 in Multi-Arc's foreign joint ventures, net of dividends in Multi-Arc India Ltd. Also during 1994, the Company received $1,661,000 of cash from the sale of 2,129,500 shares of Integrated (see Note 7). Cash flow used by investing activities of $1.5 million in 1993 included approximately $1.3 million of capital expenditures which included funds for the elimination of freon from the Multi-Arc process in accordance with government environmental regulations. Also during 1993, the Company received $134,000 of cash from the sale of 65,000 shares of Integrated and invested $176,000 in a Multi-Arc joint venture in Singapore.\nThe Company's only source of cash flow, other than from the sale of capital assets, is Multi-Arc. Pursuant to the terms of the 1994 restructuring of Multi-Arc and of Multi-Arc's term loan and revolving credit facility with First Fidelity Bank, Multi-Arc is not permitted to pay dividends or make loans to Andal, except that Multi-Arc is permitted to pay cash to Andal to the extent that it utilizes any of Andal's federal, state, and local net operating loss carry forwards for income tax purposes. However, such payments cannot exceed $1 million per year for fiscal 1995 and 1996, after which no further payments are permitted (See Notes 1, 12, and 13 for additional information regarding the 1994 restructuring of Multi-Arc and of the Company's senior indebtedness). Andal could also raise cash by making sales of the remaining Integrated stock it owns, as market conditions permit (approximately $440,000 at the current market value); and, in fiscal 1996, Andal expects to receive approximately $750,000 from the 1995 sales of Multi-Arc stock and debentures (see Note 3).\nThe Company's fiscal 1996 cash requirements are estimated to be $2 million for operating cash needs, $3 million for the required exercise of the UBC Option described in Notes 1 and 2, and $1 million for principal payments on shareholder debt as described in Note 13. In addition, the Company may also require cash to fund litigation costs related to discontinued operations and\/or to make payments to creditors who have yet to make payment demands. As discussed in Note 2, the Company is currently negotiating to restructure its indebtedness to shareholders by selling the UBC Option to them. Unless the Company can accomplish a restructuring of its indebtedness to its shareholder lenders which will allow it to meet its fiscal 1996 cash needs, either through the sale of the UBC Option to them or otherwise, there may be no alternative to the Company other than to enter into bankruptcy proceedings. (See Notes 1, 12, and 13 of the Notes to Consolidated Financial Statements and Report of Independent Auditors included elsewhere in this report.)\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nSee Index to Financial Statements and Schedules at page 33 below.\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\nThe following table sets forth certain information regarding the Directors and executive officers of the Company as of November 30, 1995.\nName Age Positions and Offices with the Company\nAndrew J. Frankel 63 Chairman of the Board of Directors and Chief Executive Officer\nAlan N. Cohen 64 President and Director\nMichael S. Huber 52 Senior Vice President, Chief Financial Officer and Treasurer\nWalter N. Kreil, Jr. 48 Vice President, Chief Accounting Officer, and Controller\nPeter D. Flood 52 Director\nCarl D. Glickman 69 Director\nThe Company's Directors are elected annually and hold office until their successors are elected and qualified.\nAndrew J. Frankel has been Chairman of the Board of Directors and Chief Executive Officer of the Company since 1971. He served as a member of the Board of Directors of Integrated Brands Inc. from December 1985 until June 1993.\nAlan N. Cohen has been a Director of the Company since October 1979 and has been President of the Company since October 1981. Between January 1981 and October 1981, Mr. Cohen served as Vice Chairman of the Board of the Company. Mr. Cohen was a member of the Board of Directors of Integrated Brands Inc. from December 1985 until June 1993. From December 1986 until September 1993, Mr. Cohen was Vice Chairman of the Board and Treasurer of Celtics, Inc., the general partner of Boston Celtics Limited Partnership.\nMichael S. Huber joined the Company in December, 1987 as Senior Vice President, Chief Financial Officer, and Treasurer. From June 1991 through October 1992, Mr. Huber was also employed as an officer and director of Salem Tube, Inc., the company that purchased the assets and certain liabilities of the subsidiary of the Company that formerly bore that name; and he served as a financial consultant to that company, pursuant to a consulting agreement from November 1992 to June 1994. Mr. Huber was separately compensated by Salem for such employee and consulting activities. Mr. Huber devotes approximately one-third of his time to the affairs of the Company.\nWalter N. Kreil, Jr. was elected a Vice President of the Company in September 1987 and serves as the Company's Controller and Chief Accounting Officer and as Vice President and Chief Financial Officer of Multi-Arc. Mr. Kreil joined the Company as Assistant Vice President and Controller in June 1984.\nPeter D. Flood has been a Director of the Company since December 1985 and the Chief Executive Officer of Multi-Arc since March 1981.\nCarl D. Glickman has been a Director of the Company since May 1981. Mr. Glickman is presently, and has been for more than the past five years, a private investor. He is president of the Glickman Organization and serves as a member of the Board of Directors of the following companies: The Bear Stearns Companies, Inc.; Continental Health Affiliates; Franklin Holdings, Inc.; Alliance Tyre and Rubber Company; Custodial Trust Company; Infu Tech Inc.; Lexington Corp. Properties; Jerusalem Economic Corp.; and Office Max Inc.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe following table sets forth information concerning the compensation for the past three fiscal years of the Chief Executive Officer of the Company and all other executive officers whose annual salary exceeded $100,000 for the year ended September 30, 1995.\nSUMMARY COMPENSATION TABLE Annual Compensation\nLong All Other Term Compensation Other Annual Options\/ ($) Name and Salary Bonuses Compensation SARs (401K Plan Principal Position Year ($) ($) (1) (#) Contributions)\nAndrew J. Frankel 1995 244,000 0 33,333 0 0 Chief Exec. Off. 1994 144,000 0 27,858 0 0 1993 120,000 0 27,557 0 0\nAlan N. Cohen 1995 244,000 0 16,000 0 0 President 1994 144,000 0 13,720 0 0 1993 120,000 0 13,264 0 0\nPeter D. Flood 1995 250,000 151,000 (2) 2,500(3) 4,620 CEO of Multi-Arc 1994 250,000 85,000 (2) 0 4,620 1993 250,000 33,000 (2) 0 2,248\nWalterN.Kreil,Jr. 1995 135,200 50,000 (2) 500(3) 4,620 CFO of Multi-Arc 1994 132,600 24,000 (2) 0 4,620 1993 130,000 12,000 (2) 0 2,248\nNo other bonuses, restricted stock awards, long term incentive plan payouts, or other compensation was awarded or paid to the named executives during the periods indicated.\n(1) Other Annual Compensation includes professional services and supplemental life and medical insurance, as follows:\nAndrew J. Frankel Alan N. Cohen Professional Supplemental Professional Services Insurance Services 1995 10,000 5,194 10,000 1994 10,000 4,007 10,000 1993 10,000 6,090 10,000\n(2) Amounts were less than 10% of salary.\n(3) Options to acquire common stock of Multi-Arc Inc. at $205.13 per share.\nStock Options\nNo stock options or stock appreciation rights were granted by the Company during the fiscal year ended September 30, 1995 to the Chief Executive Officer of the Company and all other executive officers whose annual salary exceeded $100,000 for the fiscal year ended September 30, 1995.\nIn December 1995, Multi-Arc Inc. granted options to purchase 2,500 shares and 500 shares, respectively, of its common stock to Messrs. Flood and Kreil. The exercise price of the options is $205.13 per share. The options become exercisable 20% per year, and the options expire ten years from date of grant.\nThe following table sets forth information with respect to the individual grants of stock options made during fiscal 1995 to the Chief Executive Officer and all other executive officers whose annual salary exceeded $100,000 for the fiscal year ended September 30, 1995:\nOPTION\/SAR GRANTS IN LAST FISCAL YEAR\nPotential Realizable Value of Assumed Annual Rates of Stock Individual Grants Price -------------------------------------------- Appreciation for Option Term Number of Percent of --------------- Securities Total underlying Options\/SARs Exercise Option\/SARs Granted to of Base Granted (#) Employees in Price Expiration Name (1) Fiscal Year ($\/Sh) Date 5% ($) 10% ($)\nAndrew J. Frankel 0 0 0 0 0 0 Alan N. Cohen 0 0 0 0 0 0 Peter D. Flood 2,500 (1) 50% $205.13 12\/16\/2004$322,513 $817,310 WalterN.Kreil,Jr. 500 (1) 10% $205.13 12\/16\/2004 $64,503 $163,462\n(1) Options to purchase common stock of Multi-Arc Inc.\nThe following table sets forth information with respect to the exercise during fiscal 1995 and the value as of September 30, 1995 of unexercised stock options and stock appreciation rights for the Chief Executive Officer and all other executive officers whose annual salary exceeded $100,000 for the fiscal year ended September 30, 1995.\nAGGREGATED OPTION\/SAR EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR END OPTION\/SAR VALUES\nNumber of Value of Unexercised Unexercised In-the-Money Shares Options\/SARs at Options\/SARs at Acquired Value Fiscal Year End (#) Fiscal Year End ($) on Exercise Realized Exercisable\/ Exercisable\/ Name (#) ($) Unexercisable Unexercisable\nAndrew J. Frankel 0 0 0\/0 0\/0 Alan N. Cohen 0 0 0\/0 0\/0 Peter D. Flood 0 0 7,500\/5,000(1) 0\/0 0\/2,500(2) 0\/0 WalterN.Kreil,Jr. 0 0 0\/750(1) 0\/0 0\/500(2) 0\/0\nThe Company does not have a long term incentive compensation plan for its executives.\n(1) Options on Andal Corp. common stock. (2) Options on Multi-Arc Inc. common stock.\nPension Plan\nMessrs. Frankel and Cohen were members of a noncontributory pension plan of the Company which was terminated effective January 1, 1985. Upon the termination of the plan, the Company purchased straight life annuity policies sufficient to pay each of the individuals upon their retirement at normal retirement age the benefits they had accrued under the plan up to January 1, 1985. The amounts payable annually at normal retirement of each of these persons are as follows:\nAnnual Benefit upon Name Retirement\nAndrew J. Frankel $61,402 Alan N. Cohen 36,988\nCompensation of Directors\nDirectors who are not employed by Andal are entitled to fees of $5,000 per annum plus $250 for each meeting of the Board they attend and $250 for each meeting of a committee of the Board they attend which is held on a day that the Board does not meet. During 1995, these directors have served and currently serve without compensation. Directors are reimbursed for travel expenses incurred in attending Board and Committee meetings. Mr. Glickman was paid $12,000 during fiscal 1995 for consulting services.\nEmployment Agreement\nMr. Flood is employed by the Company as President and Chief Executive Officer of Multi-Arc under an employment agreement expiring on September 30, 1999 under which he is entitled to receive a base salary of $250,000 per year plus incentive compensation equal to 7-1\/2% of the first $2,000,000 of annual pretax income of Multi-Arc in excess of $1,000,000 and 5% thereafter.\nRepricing of Options\/SARs\nAs reflected in the following table, the Executive Committee approved the repricing of stock options previously granted to Peter D. Flood and Walter N. Kreil, Jr. The Committee took these actions because the decline in the market price of the Company's common stock during 1992-1995 caused the pre-existing options held by these individuals to be so far \"out of the money\" as to provide little, if any, incentive, as there was no prospect for long-term reward. The repriced options were granted at the market value of the Company's stock at time of grant.\nTEN-YEAR OPTION\/SAR REPRICINGS\nMarket Price of Exercise Length of Stock at Price at Original Time of Time of Option Term Number of Repricing Repricing Remaining at Options\/SAR's or or New Date of Repriced or Amendment Amendment Exercise Repricing or Name Date Amended (#) ($) ($) Price ($) Amendment\nPeter D. Flood 7\/8\/92 5,000 $10.00 $32.50 $10.00 47 Months CEO of Multi-Arc 7\/25\/95 5,000 $2.25 $10.00 $2.25 24 Months\nWalterN.Kreil,Jr. 7\/8\/92 500 $10.00 $122.50 $10.00 8 Months CFO of Multi-Arc 7\/8\/92 250 $10.00 $112.50 $112.50 18 Months 7\/25\/95 750 $2.25 $10.00 $2.25 24 Months\nAdditional Information with Respect to Compensation Committee Interlocks and Insider Participation in Compensation Decisions\nThe Company's Compensation Committee is comprised of Andrew J. Frankel, Chairman of the Board of Directors and Chief Executive Officer of the Company and a principal shareholder, and Alan N. Cohen, Director and President of the Company and a principal shareholder. See \"Security Ownership of Certain Beneficial Owners and Management\" and \"Certain Relationships and Related Transactions\" for information with respect to transactions between these individuals and the Company and the percentage ownership of the Company by them.\nBoard Compensation Committee Report on Executive Compensation\nOn October 5, 1995, the Compensation Committee submitted the following report concerning compensation paid to executive officers during 1995:\nMessrs. Frankel and Cohen, who comprise the Compensation Committee and are also, respectively, the Chief Executive Officer and President of the Company, increased their 1995 salary by $100,000 each to $244,000 each per annum. The $100,000 increase has been deferred and is payable on January 1, 1997. Interest on the deferred compensation accrues at the rate of 7% per annum. Such salaries were not, they believe, reflective of their true worth to the Company but were the most the Company could afford to pay them in its strained financial circumstances. Except as an indication of the continuing financial problems of the Company, there was not intended to be any relationship between their compensation and their performance.\nPursuant to an employment agreement which expires on September 30, 1999, the salary of Mr. Flood, the Chief Executive Officer of Multi-Arc, was not changed in 1995. The salary of Mr. Kreil, Vice President and Chief Financial Officer of Multi-Arc, was increased 2% for 1995. In view of the limited resources of the Company, a more substantial increase which might have been warranted could not be considered.\nA bonus of $151,000 was awarded to Mr. Flood pursuant to his employment agreement. A bonus of $35,000 was awarded to Mr. Kreil in accordance with Multi-Arc's Corporate Management Incentive Plan which provides for a bonus pool to be divided proportionally based on normal compensation, among three of Multi-Arc's senior executives (other than Mr. Flood). The pool is calculated at 1 1\/2% of earnings before interest and taxes up to $1 million, plus 2% of such earnings between $1 to $2 million, plus 2 1\/2% of such earnings over $2 million. Mr. Kreil also received a special bonus of $15,000 from Andal in recognition for his efforts in refinancing Multi-Arc Inc.\nRespectfully submitted,\nAndrew J. Frankel Alan N. Cohen\nPerformance Graph\nThe following line graph compares the cumulative total return of the company's common stock to the American Stock Exchange Market Value and Industrial Service Company Indices for the period October 1, 1990 to September 30, 1995.\nCUMULATIVE TOTAL RETURN Andal Shares vs. Amex Indices\nMeasurement Period Andal Invested AMEX MV Invested AMEX Ind. Invested\n9\/30\/90 $100.00 $100.00 $100.00 9\/30\/91 15.91 124.19 92.92 9\/30\/92 5.68 124.89 96.72 9\/30\/93 0.00 152.63 138.39 9\/30\/94 1.82 152.11 128.39 9\/30\/95 2.05 180.59 156.55\nAssumes $100 invested on September 30, 1990 in Andal Corp. Common Stock, the Amex Market Value Index and the Amex Industrial Service Company Index.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThe following table sets forth information as of November 30, 1995, with respect to all shareholders known by Andal to be the beneficial owners of more than 5% of its outstanding common stock, each director, and all officers and directors as a group.\nName and Address of Amount and Nature of Percent Beneficial Owner Beneficial Ownership of Class\nFrankhill Associates 77,215 shs. (1) (13) 23.4% c\/o Andal Corp. 909 Third Avenue New York, NY 10022\nAndrew J. Frankel 1,730 (1) c\/o Andal Corp. 77,215 (2) (13) 909 Third Avenue 2,019 (3) New York, NY 10022 498 (4) ------ 81,462 shs. 24.7%\nAlan N. Cohen 29,825 (1) (13) c\/o Andal Corp. 4,250 (5) 909 Third Avenue ------ New York, NY 10022 34,075 shs. 10.3%\nPeter D. Flood 4,114 shs. (9) 1.2% c\/o Multi-Arc Inc. 200 Roundhill Drive Rockaway, NJ 07866\nCarl D. Glickman 1,750 shs. 0.5% c\/o Andal Corp. 909 Third Avenue New York, NY 10022\nBuiltland Partners 63,294 shs. (1)(6) 19.2% c\/o Milstein Properties 1271 Avenue of the Americas New York,, NY 10020\nPaul Milstein 84,337 shs. (7)(8) 25.6% c\/o Milstein Properties 1271 Avenue of the Americas New York, NY 10020\nTroster Singer Division 35,405 shs. (11) 10.7% of Spear, Leeds & Kellogg 115 Broadway New York, New York 10006\nAll officers and directors as a group (8 persons) 121,561 shs. (12) 36.8%\n(1) Direct record and beneficial ownership.\n(2) As a general partner of, or person designated to exercise voting power or investment power on behalf of, Frankhill Associates, the record holder of these shares.\n(3) Held as co-trustee with his sister, with whom Mr. Frankel shares voting power. Mr. Frankel and his children have an interest in one-half of the principal and income of the trust.\n(4) Held as co-trustee with his wife of a trust for Mr. Frankel's three children.\n(5) Includes 4,250 shares held by a not-for-profit corporation of which Mr. Cohen is an officer and director. Mr. Cohen disclaims beneficial ownership of such shares owned by the Corporation.\n(6) Builtland Partners is a New York General Partnership comprised of Seymour Milstein, Paul Milstein, and members of their respective families.\n(7) Includes all the shares owned by Builtland Partners, as well as shares wholly beneficially owned by Paul Milstein, directly and indirectly.\n(8) Includes 4,845 shares owned by Milstein Family Foundation, Inc., a New York not-for-profit corporation of which Mr. Milstein is president and a director. Mr. Milstein disclaims any beneficial interest in such shares.\n(9) Consists of 4,114 shares owned of record and beneficially by Mr. Flood.\n(10) Not used\n(11) Beneficial ownership based upon information obtained from the company during December 1995.\n(12) Includes the shares owned directly or indirectly by the officers and directors of the Company as set forth in the table, plus shares owned by officers not named in the table.\n(13) Includes 278 shares issuable upon conversion of debentures.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nOn July 5, 1990, the Company borrowed an aggregate of $5 million from Messrs. Alan N. Cohen, President and a director of the Company, Paul Milstein, who was then a director of the Company, and Frankhill Associates, a limited partnership of which Andrew J. Frankel, Chairman of the Board and a director of the Company, is a general partner (collectively, in such capacity, the \"UBC Lenders\"). The proceeds of the loan (the \"UBC Loan\") were used to reduce then-outstanding indebtedness and for general corporate and working capital purposes.\nThe UBC Loan is secured by a pledge of the capital stock of UBC Virginia Corp. (\"UBC Corp.\"), a subsidiary of the Company which holds an option (the \"Option\") to purchase a parcel of real estate located at 61st Street and First Avenue in New York City (the \"UBC Property\"). In addition, the Company paid the UBC Lenders a $50,000 commitment fee and issued to them an aggregate of 25,000 warrants, each entitling the holder to purchase one share of the Company's common stock at an exercise price of $80.00 per share. The closing market price of Andal's common stock on July 5, 1990 was $65.00 per share. The warrants were exercisable from December 31, 1990 until July 5, 1995, at which time they lapsed unexercised.\nIn May 1992, the Company restructured the UBC Loan, as well as its loans with Chemical Bank and Fleet Bank, most of which were originally made over 15 years ago and were used for general corporate purposes. Under the terms of such restructuring, the interest rate on all such loans was reduced to the prime rate; and interest accrued from October 1, 1991 through March 31, 1993 of $571,285 on the UBC Loan was deferred and added to the principal. Since March 31, 1993, the aggregate principal balance of the UBC Loan has been $5,571,285. The UBC Loan is due and payable on the earlier of March 31, 1997, or the day after the Company's bank loans have been paid in full. In addition to requiring prepayment of the UBC Loan in the event of a sale of the Company's interest in the UBC Property, the restructuring agreement also requires prepayments of such loans if the Company obtains cash recoveries on various claims and litigations relating to its discontinued construction contracting operations or if the Company's cash flow from operations exceeds a specified amount.\nIn connection with the 1992 restructuring, the banks consented to the Company's grant to the UBC Lenders of a second lien on those assets of the Company which serve as collateral for the bank loans; and the UBC Lenders consented to the Company's grant to the banks of a second lien on the stock of UBC Corp.\nIn March 1994, after discussions initiated by Fleet Bank, which had indicated that it desired to dispose of its portion of the Company's bank loans, Frankhill Associates, Alan N. Cohen, and Paul Milstein (collectively, in such capacity, the \"Fleet Assignees\") each purchased a one-third interest in the Company's indebtedness to Fleet Bank (the \"Fleet Indebtedness\"), which indebtedness totalled $3,042,000. The terms of such indebtedness did not change as a result of this purchase. In November 1994, Peter D. Flood, a director of the Company and Chief Executive Officer of Multi-Arc Inc., purchased an aggregate of 6.4% of the Fleet Indebtedness from Frankhill Associates, Alan N. Cohen, and Paul Milstein.\nIn September 1994, in order to facilitate the restructuring and refinancing of Multi-Arc, the Fleet Assignees agreed to yield their lien on Multi-Arc's assets and to defer the approximately $1.6 million payment to which they would have otherwise been entitled; and Chemical Bank agreed to accept a $255,000 discount for payment in full to it of the Company's outstanding debt. In consideration for the concessions agreed to by the Fleet Assignees, the Company's Board of Directors (Messrs. Frankel and Cohen not voting) approved a payment of $255,000 by the Company to the Fleet Assignees. The May 1992 Restructuring Agreement was amended to provide for principal payments on the Fleet Assignee debt at the rate of $250,000 per quarter beginning March 31, 1995, with the remaining principal balance becoming due on March 31, 1997. The payment that was due on September 30, 1995 was made on October 24, 1995. Furthermore, Andal is required to make prepayments to the extent that it sells any of its capital assets or receives capital distributions from Multi-Arc. The UBC Loan continues to be due and payable on the earlier of March 31, 1997, or the day after the Fleet Assignee debt has been paid in full.\nAndal's remaining obligation to Chemical Bank consists of $941,000 of aggregate liability under outstanding letters of credit issued by Chemical Bank in connection with an appeal bond and in connection with its discontinued real estate development activities. Because of Andal's inability to fund the liabilities represented by the letters of credit, in order to secure the release of collateral held by Chemical Bank so that Multi-Arc could obtain its term loan and revolving credit facility from First Fidelity Bank, Messrs. Andrew J. Frankel, Paul A. Milstein, and Alan N. Cohen each personally guaranteed one-third of the letter of credit liabilities, for which Andal has agreed to pay to Messrs. Frankel, Milstein, and Cohen an aggregate annual guarantee fee equal to 2% of the letters of credit outstanding.\nSee Item 1. Business. General. for a discussion of the 1995 developments concerning the UBC Property and the possible sale of it to the UBC Lenders in satisfaction of the UBC Loan.\nIn December 1994, Andal sold, for $500,000, approximately 2-1\/2% of the common stock of Multi-Arc to Multi-Arc's management; and Multi-Arc issued $500,000 of convertible subordinated debentures (convertible into 2% of Multi- Arc common stock) to such management. Both the sale of the common stock and the issuance of the debentures were funded through non-recourse loans made to its management by Multi-Arc using Multi-Arc's revolving credit facility with First Fidelity Bank. The management loans included $500,000 and $100,000, respectively, to Peter D. Flood, a Director of the Company and Chief Executive Officer of Multi-Arc, and Walter N. Kreil, Jr., an officer of the Company and Vice President and Chief Financial Officer of Multi-Arc. These loans bear interest at 8.35% and are repayable on December 15, 2004, or upon termination of employment. The loans are secured by common stock and debentures of Multi- Arc. The Notes evidencing these loans are pledged by Multi-Arc to First Fidelity Bank.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(a)(1) Financial Statements\nSee Index to Financial Statements and Schedules at page 33 below.\n(a)(2) Financial Statement Schedules\nSee Index to Financial Statements and Schedules at page 33 below.\n(b) Reports on Form 8-K\nThe Company did not file any reports on Form 8-K for the quarter ended September 30, 1995.\n(c) Exhibits\nThe following exhibits are filed herewith unless otherwise indicated:\n3(a) Restated Certificate of Incorporation of the Company as filed with the Secretary of State of New York on March 16, 1972 (the \"Certificate of Incorporation\") (incorporated by reference to Exhibit 3(a) to Company's Annual Report on Form 10-K for fiscal year ended September 30, 1986).\n3(b) Certificate of Amendment of the Certificate of Incorporation as filed with the Secretary of State of New York on November 5, 1979 (incorporated by reference to Exhibit 3(b) to Company's Annual Report on Form 10-K for fiscal year ended September 30, 1986).\n3(c) Certificate of Amendment of the Certificate of Incorporation as filed with the Secretary of State of New York on October 22, 1981 (incorporated by reference to Exhibit 3(c) to Company's Annual Report on Form 10-K for fiscal year ended September 30, 1986).\n3(d) Certificate of Amendment of the Certificate of Incorporation as filed with the Secretary of State of New York on November 7, 1983 (incorporated by reference to Exhibit 3(d) to Company's Annual Report on Form 10-K for fiscal year ended September 30, 1986).\n3(e) Certificate of Amendment of the Certificate of Incorporation as filed with the Secretary of State of New York on April 8, 1987 (incorporated by reference to Exhibit 4.5 to Company's Registration Statement on Form S-8 as filed with the Securities and Exchange Commission on May 5, 1987).\n3(f) Certificate of Amendment of the Certificate of Incorporation as filed with the Secretary of State of New York on June 15, 1993 (incorporated by reference to Exhibit 3(f) to Company's Annual Report on Form 10-K for Fiscal Year ended September 30, 1993).\n3(g) By-laws of the Company (incorporated by reference to Exhibit 4.6 to Company's Registration Statement on Form S-8 as filed with the Securities and Exchange Commission on May 5, 1987).\n4(a) Indenture dated as of September 15, 1972 between the Company and Manufacturers Hanover Trust Company, as Trustee, relating to the Company's 5 1\/2% convertible subordinated debentures due September 15, 1997 (incorporated by reference to Exhibit 4(a) to Company's Annual Report on Form 10-K for fiscal year ended September 30, 1986).\n4(b) First Supplemental Indenture dated as of January 12, 1982 between the Company and United States Trust Company of New York, as Trustee, relating to the Company's 5 1\/2% convertible subordinated debentures due September 15, 1997 (incorporated by reference to Exhibit 4(b) to Company's Annual Report on Form 10-K for fiscal year ended September 30, 1986).\n10(a) 1987 Stock Option Plan of the Company (incorporated by reference to Exhibit 10(c) to the Company's Annual Report on Form 10-K for fiscal year ended September 30, 1987).\n10(b) Option Agreement dated as of August 1, 1982 between Schnurmacher Corp. and the Company (incorporated by reference to Exhibit 10(v) to Company's Annual Report on Form 10-K for fiscal year ended September 30, 1986).\n10(c) Lease dated May 11, 1988, containing an Option to Purchase, between Roundhill Associates and the Company (incorporated by reference to Exhibit 10(ag) to Company's Annual Report on Form 10-K for fiscal year ended September 30, 1988).\n10(d) Intercreditor Agreement among Frankhill Associates, Paul Milstein, Alan N. Cohen, and Andal Corp. dated July 5, 1990 (incorporated by reference to Exhibit 10(ac) to the Company's Annual Report on Form 10-K for the year ended September 30, 1990).\n10(e) Stock Pledge Agreement among Andal Corp., Frankhill Associates, Paul Milstein, and Alan N. Cohen dated July 5, 1990 (incorporated by reference to Exhibit 10(ad) to the Company's Annual Report on Form 10-K for the year ended September 30, 1990).\n10(f) Warranty Agreement among Andal Corp., Frankhill Associates, Paul Milstein, and Alan N. Cohen dated July 5, 1990 (incorporated by reference to Exhibit 10(ae) to the Company's Annual Report on Form 10-K for the year ended September 30, 1990).\n10(g) Restructuring Agreement, Amendment, Guarantee, and Security Agreement dated May 27, 1992 (\"Restructuring Agreement\") by and among Andal Corp., certain subsidiaries of Andal Corp., Norstar Bank, Manufacturers Hanover Trust Company, Manufacturers Hanover Trust Company as agent for the banks, Alan N. Cohen, Paul Milstein, Frankhill Associates, and the Bank of New York as collateral agent for the Lenders (incorporated by reference to Exhibit 10(t) to the Company's Annual Report on Form 10-K for the year ended September 30, 1992).\n10(h) First Amendment to the Restructuring Agreement dated June 5, 1992 (incorporated by reference to Exhibit 10(s) to the Company's Annual Report on Form 10-K for the year ended September 30, 1992).\n10(i) Plan of Restructuring adopted by the Board of Directors and Andal Corp. as approved by the Shareholders on August 16, 1994 (incorporated by reference to Exhibit 10(j) to the Company's Annual Report on Form 10-K for the year ended September 30, 1994).\n10(j) Loan and Security Agreement dated September 30, 1994 by and between First Fidelity Bank, N.A. and Scientific Coatings of Illinois, Inc., Scientific Coatings, Inc., and SCI Coatings Southwest, Inc. (incorporated by reference to Exhibit 10(k) to the Company's Annual Report on Form 10-K for the year ended September 30, 1994).\n10(k) Subordination Agreement dated September 30, 1994 of Multi-Arc Inc. as debtor and Andal Corp. as subordinated lender in favor of First Fidelity Bank, N.A. (incorporated by reference to Exhibit 10(l) to the Company's Annual Report on Form 10-K for the year ended September 30, 1994).\n10(l) Security Agreement dated September 30, 1994 by and between First Fidelity Bank, N.A. and Vagle Technology, Inc., Multi-Arc, Inc. (a Minnesota corporation), Multi-Arc Inc., Multi-Arc of Ohio, Inc., and S. C. I. Coatings Limited (incorporated by reference to Exhibit 10(m) to the Company's Annual Report on Form 10-K for the year ended September 30, 1994).\n10(m) Amendment dated September 30, 1994 to the Restructuring Agreement, Amendment, Guarantee, and Security Agreement dated May 27, 1992 among Andal Corp. and certain subsidiaries, Fleet Bank, Chemical Bank, Alan N. Cohen, Paul Milstein, Frankhill Associates, and The Bank of New York as collateral agent (incorporated by reference to Exhibit 10(m) to the Company's Annual Report on Form 10-K for the year ended September 30, 1994).\n10(n) Multi-Arc Inc., Andal Corp., and United States Trust Company of New York, Trustee. Second Supplemental Indenture dated as of September 30, 1994 5 1\/2% Convertible Subordinated Debentures due 1997 (incorporated by reference to Exhibit 10(o) to the Company's Annual Report on Form 10-K for the year ended September 30, 1994).\n10(o) Pledge and Security Agreement dated September 30, 1994 by and among Andal Corp. and First Fidelity Bank, N.A. (incorporated by reference to Exhibit 10(p) to the Company's Annual Report on Form 10-K for the year ended September 30, 1994).\n10(p) Form of Multi-Arc Inc. 6% Convertible Subordinated Debenture due December 15, 2004.\n10(q) Form of Multi-Arc Inc. Stockholders Agreement dated June 15, 1995.\n10(r) 1994 Multi-Arc Inc. Stock Option Plan.\n10(s) Loan Agreement dated September 21, 1995 between First Fidelity Bank N. A. and Multi-Arc (UK) Ltd.\n10(t) Overdraft Facility Agreement between First Fidelity Bank N. A. and Multi-Arc (UK) Ltd. dated September 21, 1995.\n10(u) 61st Street Option Exercise.\n22 Subsidiaries of the Company\n24(a) Consent of Kelly Graham Myska & Partners.\n24(b) Consent of KPMG Peat Marwick.\n24(c) Consent of BDO Seidman.\n27 Financial Data Schedule\nIndex to Financial Statements and Schedules\nFinancial Statements Page\nReport of Independent Auditors on Financial Statements 36\nConsolidated Balance Sheet--September 30, 1995 and September 30, 1994\nConsolidated Statement of Operations--Years ended September 30, 1995, 1994, and 1993\nConsolidated Statement of Shareholders' Equity (Deficit) --Years Ended September 30, 1995, 1994, and 1993\nConsolidated Statement of Cash Flows--Years Ended September 30, 1995, 1994, and 1993\nNotes to Consolidated Financial Statements\nAll schedules are omitted because they are not applicable, not required, or the other information required to be set forth therein is included in the Consolidated Financial Statements or in the Notes thereto.\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.\nANDAL CORP. (Registrant)\nBy \/s\/ Andrew J. Frankel Andrew J. Frankel Chairman of the Board of Directors\nDated: January 5, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, 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\nPrincipal Executive Officer:\n\/s\/ Andrew J. Frankel Chairman of the Board of January 5, 1996 (Andrew J. Frankel) Directors, Chief Executive Officer, and Director\nPrincipal Financial Officer:\n\/s\/ Michael S. Huber Senior Vice President, January 5, 1996 (Michael S. Huber) Chief Financial Officer, and Treasurer\nPrincipal Accounting Officer:\n\/s\/ Walter N. Kreil, Jr. Vice President, Chief January 5, 1996 (Walter N. Kreil, Jr.) Accounting Officer, and Controller\nDirectors:\n\/s\/ Alan N. Cohen Director January 5, 1996 (Alan N. Cohen)\n\/s\/ Peter D. Flood Director January 5, 1996 (Peter D. Flood)\n\/s\/ Carl D. Glickman Director January 5, 1996 (Carl D. Glickman)\nREPORT OF INDEPENDENT AUDITORS\nBoard of Directors and Shareholders Andal Corp.\nWe have audited the accompanying consolidated balance sheets of Andal Corp. and subsidiaries as of September 30, 1995 and 1994, and the related consolidated statements of operations, shareholders' equity (deficit) and cash flows or each of the three years in the period ended September 30, 1995. 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 consolidated subsidiaries, which statements reflect total assets constituting 26% in 1994 and total revenues constituting 16% in 1994 and 1993 of the related consolidated totals. The financial statements of Steve's Homemade Ice Cream, Inc. (an equity method investee in 1993) also have not been audited by us. Those statements were audited by other auditors whose reports have been furnished to us and our opinion, insofar as it relates to the amounts included for such subsidiaries and investee, is based solely on the reports of other auditors.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits and the reports of other auditors provide a reasonable basis for our opinion.\nIn our opinion, based on our audits and the reports of other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Andal Corp. and subsidiaries at September 30, 1995 and 1994, and the consolidated results of their operations and their cash flows for each of the three years in the period ended September 30, 1995, in conformity with generally accepted accounting principles.\nThe accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern. As more fully described in Notes 1 and 2, the Company has incurred losses in 1994 and 1993 and has a working capital deficiency and a shareholders' deficit at September 30, 1995. In addition, the Company is obligated under one of its loan agreements to exercise an option it holds on certain property, for which the Company currently does not have sufficient resources. These conditions raise substantial doubt about the Company's ability to continue as a going concern. The consolidated financial statements do not include any adjustment to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the possible inability of the Company to continue as a going concern.\nAs described in Note 17, in 1994 the Company changed its method of accounting for income taxes.\nERNST & YOUNG LLP November 15, 1995 except for Note 12 as to which the date is January 5, 1996\nANDAL CORP. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET\nASSETS September 30, 1995 1994 Current assets: Cash $ 850,000 $ 1,143,000 Accounts receivable 4,998,000 4,028,000 Inventories 1,073,000 1,254,000 Prepaid expenses 307,000 317,000 Other current assets 906,000 216,000 ------------ ------------- Total current assets 8,134,000 6,958,000\nInvestments in joint ventures 1,268,000 842,000 Property and equipment 10,789,000 9,732,000 Loans due from Multi-Arc Inc. management 1,000,000 0 Other assets 2,434,000 2,925,000 ------------ ------------ $23,625,000 $20,457,000 ============ ============\nLIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)\nCurrent liabilities: Short term borrowings, including current portion of long term debt $ 1,206,000 $ 1,425,000 Current portion of debt due shareholders 1,250,000 750,000 Accounts payable 1,606,000 1,764,000 Other accrued expenses 5,106,000 5,834,000 ------------- ------------- Total current liabilities 9,168,000 9,773,000\nLong-term debt 7,886,000 6,952,000 Debt due shareholders 6,364,000 7,364,000 Other deferred income 1,430,000 1,527,000 Convertible subordinated debentures 3,335,000 1,825,000 Minority interest in Multi-Arc Inc. 540,000 0\nShareholders' equity (deficit): Common shares, par value $20 per share, 1,500,000 authorized and 370,496 issued 7,410,000 7,410,000 Paid-in-capital 31,625,000 31,625,000 Deficit (38,472,000) (40,358,000) Less 40,637 common shares held in treasury, at cost (5,661,000) (5,661,000) ------------- ------------ Total shareholders' equity (deficit) (5,098,000) (6,984,000) ------------ ------------ $23,625,000 $20,457,000 =========== ===========\nSee accompanying notes.\nANDAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF OPERATIONS\nYear Ended September 30 1995 1994 1993 Operating revenues: Trade sales $30,015,000 $26,672,000 $24,384,000 Royalties and commissions 315,000 421,000 503,000 Equity in net income (loss) of\nforeign joint ventures 53,000 (16,000) 0 ------------ ------------ ------------ 30,383,000 27,077,000 24,887,000 Operating costs and expenses:\nCost of revenues 15,545,000 13,466,000 13,052,000 Depreciation expense 1,907,000 2,234,000 2,336,000 Selling, general and administrative expenses 10,517,000 9,750,000 8,667,000 ------------ ------------ ------------ 27,969,000 25,450,000 24,055,000\nIncome from operations 2,414,000 1,627,000 832,000 Other income (expense):\nGain on sale of minority interest in Multi-Arc Inc. 348,000 0 0 Minority interest in net income of Multi-Arc Inc. (152,000) 0 0 Gain from initial public offering of Multi-Arc India Ltd. 85,000 0 0 Investment and other income, net 37,000 (756,000) 164,000 Interest expense (1,799,000) (1,625,000) (1,663,000) ------------ ------------ ----------- (1,481,000) (2,381,000) (1,499,000) Equity in net income of Integrated Brands Inc. 0 0 234,000 ----------- ------------ ----------- Income (loss) from continuing\noperations before income taxes 933,000 (754,000) (433,000) Provision for income taxes (54,000) (17,000) 0 ----------- ------------ ----------- Inc. (loss) from continuing operations 879,000 (771,000) (433,000) Income (loss) from discontinued operations 1,007,000 (350,000) (527,000) ----------- ------------ ----------- Net income (loss) $1,886,000 $(1,121,000) $(960,000) ========== ============ ==========\nIncome (loss) per common share:\nIncome (loss) from continuing operation $2.67 $(2.34) $(1.31) Income (loss) from discontinued operations 3.05 (1.06) (1.60) ----- ------- ------- Net income (loss) $5.72 $(3.40) $(2.91) ===== ======= ======= See accompanying notes.\nANDAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (DEFICIT)\nRetained Common Paid-in- Earnings Treasury Stock Capital (Deficit) Stock Total\nBalance at Sept. 30, 1992 $7,399,000 $31,636,000 $(38,277,000) $(5,661,000) $(4,903,000) Effects of reverse split 11,000 (11,000) 0 0 Net loss for 1993 0 0 (960,000) 0 (960,000) Balance at\nSept. 30, 1993 7,410,000 31,625,000 (39,237,000) (5,661,000) (5,863,000) Net loss for 1994 0 0 (1,121,000) 0 (1,121,000) Balance at\nSept. 30, 1994 7,410,000 31,625,000 (40,358,000) (5,661,000) (6,984,000) Net income for 1995 0 0 1,886,000 0 1,886,000 Balance at Sept. 30, 1995 $7,410,000 $31,625,000 $(38,472,000) $(5,661,000) $(5,098,000)\nSee accompanying notes.\nANDAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS\nYear Ended September 30, 1995 1994 1993 Cash provided (used) by operations: Income (loss) from continuing operations before income taxes $ 933,000 $ (754,000) $ (433,000) Adjustments to reconcile income\n(loss) from continuing operations\nto net cash provided by operations\nDepreciation 1,907,000 2,234,000 2,336,000 Gain on sale of minority interest in Multi-Arc Inc. (348,000) 0 0 Minority interest in net income of Multi-Arc Inc. 152,000 0 0 Amortization of patents, trademarks, and license rights 192,000 186,000 760,000 Equity in net (income) loss\nof foreign joint ventures (53,000) 16,000 0 Equity in (income) of Integrated 0 0 (234,000) Deferred income accrued 64,000 40,000 153,000 Amortization of deferred income (149,000) (95,000) (156,000) Provision (credit) for bad debts (16,000) 42,000 71,000 Losses (gains) on investment transactions 0 766,000 (137,000) Gain from initial public offering of Multi-Arc India Ltd. (85,000) 0 0 Other, net 28,000 39,000 112,000\nChange in operating assets and liabilities: (Increase) decrease in accounts receivable (954,000) 1,127,000 (1,755,000) Decrease (increase) in inventories 200,000 (459,000) 605,000 Decrease (increase) in other current assets 76,000 60,000 (22,000) Increase in accounts payable and accrued liabilities 369,000 634,000 1,200,000 Cash (used) by discontinued operations (168,000) (247,000) (386,000) Income taxes paid (87,000) (34,000) (29,000) ------------ ----------- ----------- Net cash provided by operating activities 2,061,000 3,555,000 2,085,000\nCash flows from financing activities: Proceeds from long-term debt 3,870,000 6,162,000 50,000 Loans to Multi-Arc management (1,000,000) 0 0 Proceeds from sale of common stock and debentures of Multi-Arc Inc. 1,714,000 0 0 Additions to principal for interest deferral 0 0 460,000 Deferred financing costs (126,000) 0 0 Reductions of long-term debt (3,024,000) (7,743,000) (996,000) Decrease in debt due within one year (631,000) (398,000) (130,000) ----------- ----------- ----------- Net cash provided (used) by financing activities 803,000 (1,979,000) (616,000) ----------- ----------- -----------\nCash flows from investing activities: Reduction of (investment in) affiliated companies (211,000) 1,459,000 (42,000) Gross additions to property and equipment (2,964,000) (1,999,000) (1,268,000) Other, net 18,000 (370,000) (222,000) ----------- ----------- ----------- Net cash (used) by investing activities (3,157,000) (910,000) (1,532,000) ----------- ----------- ----------- Increase (decrease) in cash (293,000) 666,000 (63,000) Cash at beginning of year 1,143,000 477,000 540,000 ----------- ----------- ----------- Cash at end of year $ 850,000 $1,143,000 $477,000 ========== ========== ========\nSee accompanying notes.\nANDAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBasis of Presentation\nThe accompanying consolidated financial statements have been prepared on a going concern basis which contemplates the realization of assets and the liquidation of liabilities in the ordinary course of business. Andal Corp. (the \"Company\" or \"Andal\") has incurred losses in 1994 and 1993 and has a working capital deficiency of $1,034,000 and a shareholders' deficit of $5,098,000 at September 30, 1995. The Company's only source of cash flow, other than from the sale of capital assets, is Multi-Arc. Pursuant to the terms of the 1994 restructuring of Multi-Arc and of Multi-Arc's term loan and revolving credit facility with First Fidelity Bank, Multi-Arc is not permitted to pay dividends or make loans to Andal, except that Multi-Arc is permitted to pay cash to Andal to the extent that it utilizes any of Andal's federal, state, and local net operating loss carry forwards for income tax purposes. However, such payments cannot exceed $1 million per year for fiscal 1995 and 1996, after which no further payments are permitted (see Note 12 for additional information regarding the restructuring of Multi-Arc). Andal could also raise cash by making sales of the remaining Integrated stock it owns, as market conditions permit (approximately $440,000 at the current market value) and, in fiscal 1996, expects to receive approximately $750,000 for the 1995 sales of Multi-Arc stock and debentures (see Note 3).\nThe Company's fiscal 1996 cash requirements are estimated to be $2 million for operating cash needs, $3 million for the required exercise of the Option described in Note 2, and $1 million for principal payments on shareholder debt as described in Note 13. In addition, the Company may also require cash to fund litigation costs related to discontinued operations and\/or to make payments to creditors who have yet to make payment demands. As discussed in Note 2, the Company is currently negotiating to restructure its indebtedness to shareholders by selling the Option to them. Unless the Company can accomplish a restructuring of its indebtedness to its shareholder lenders which will allow it to meet its fiscal 1996 cash needs, either through the sale of the UBC Option to them or otherwise, there may be no alternative to the Company other than to enter into bankruptcy proceedings. The accompanying consolidated financial statements do not include any adjustments relating to the possible effect on the recoverability and classification of assets or the amounts and classification of liabilities that may be necessary should the Company be unable to continue as a going concern.\nPrinciples of Consolidation\nThe consolidated financial statements include the accounts of Andal Corp. and its subsidiaries. Foreign affiliates in which Andal owns 20% to 50% are accounted for using the equity method. Andal's remaining operating business is Multi-Arc. All significant intercompany transactions and accounts are eliminated in consolidation.\nInventories\nInventories are stated at lower of cost (determined principally by the first-in, first-out method) or market.\nProperty and Equipment\nProperty and equipment are recorded at cost and depreciated over estimated useful lives on a straight-line basis.\nRevenue and Deferred Income\nRevenue is recognized when it is earned. In the case of Multi-Arc system sales, the point for revenue recognition normally corresponds to the date when the system is shipped to the customer. To the extent the Company sells coating systems or license rights to its joint ventures, a proportionate percentage of the profit on these is deferred and subsequently amortized into revenue. Such amortization offsets the related depreciation or license rights expense recorded by the corresponding joint venture company.\nResearch and Development Expenses\nResearch and development expenditures ($1,628,000 in 1995, $1,400,000 in 1994, and $1,222,000 in 1993) are charged to cost of revenues as incurred.\nIncome (Loss) per Share\nPrimary income (loss) per common share for all periods was computed based on the average number of shares outstanding during each of the respective periods. Fully diluted per share amounts are not shown for the periods, as the effects would be anti-dilutive.\nThe average number of shares used in computing primary income\/(loss) per share was 329,859 in each of 1995, 1994, and 1993.\n2. UBC OPTION\nThe Company, through a wholly-owned subsidiary, UBC Virginia Corp. (\"UBC Corp.\"), owns an option (the \"Option\") to purchase a parcel of real estate (the \"UBC Property\") located on 61st Street and First Avenue in New York City, which Option has been carried on the books of the Company at nil value for many years. The Option grants the Company the right to purchase the UBC Property for approximately $3 million in cash and is exercisable only after the death of the later to die of two of the principals of the corporation that granted the Option. The Option expires 91 (ninety-one) days after the Company has been given formal notice of such death by the Optionor. The Company was given formal notice of such death on September 22, 1995. The Company does not have the $3 million of cash that is required to exercise the Option, and it does not believe it will be able to raise such a sum through borrowings from unrelated parties or through the sale of assets other than the Option. However, under the terms of the loan described below, the Company is obligated to exercise the Option. Accordingly, on October 13, 1995 the Company gave the Optionor formal notice of its election to exercise the Option; and the parties have agreed that the transaction must be closed on or before February 27, 1996.\nThe capital stock of UBC Corp. was pledged as security for a $5 million loan, hereafter referred to as the \"UBC Loan,\" made to the Company in 1990 by Alan N. Cohen, President and a Director of the Company, Paul Milstein, who was then a Director of the Company, and Frankhill Associates, a limited partnership of which Andrew J. Frankel, Chairman of the Board and a Director of the Company, is a general partner (collectively, in such capacity, the \"UBC Lenders\").\nAs of September 30, 1995, the principal balance of the loan, after adjustment for a restructuring which occurred in 1992, is $5,571,285 which is due and payable on the earlier of March 31, 1997, or the day after certain other indebtedness to shareholders of the Company, including the individuals mentioned above, has been paid in full.\nThe capital stock of UBC Corp. also serves as security (second lien) for a $2,043,000 loan (hereafter referred to as the \"Fleet Assignee Loan\") outstanding as of September 30, 1995 between the Company and certain of its directors and a stockholder who was formerly a director.\nThe Company's failure to pay the $3 million purchase price for the UBC Property will result in an event of default under the UBC Loan, which will give the UBC Lenders the right to exercise the Option on the Company's behalf and to declare the loan immediately due and payable, including all sums advanced by the UBC Lenders in exercising the Option. In addition, the UBC Lenders will have all of the remedies available to them under applicable law for secured lenders, including, without limitation, the public or private sale of the UBC Property acquired by exercise of the Option. Default under the UBC Loan will also result in default under the Fleet Assignee Loan.\nUntil January 1995, the Company had been under contract to sell the option to an unrelated real estate developer, who had contracted to purchase the option in 1984. The developer was unable to obtain financing to consummate the purchase; and, as a result, the Company terminated the contract. Upon termination of the contract, the Company has attempted to sell the option to various other parties. In addition, after the Company received the Option Notice from the Optionor, the Company made contact with several brokers who have not been able to identify a buyer. To date, the Company has not received a bona fide offer from a third party for the option.\nThe UBC Lenders have expressed an interest in acquiring the UBC Property in satisfaction of the amount outstanding on the UBC Loan. In that event, the Company would no longer be obligated with respect to the $3 million purchase price obligation due on the UBC Option exercise.\nThe Board of Directors of the Company met on October 5, 1995 to discuss the difficulties entailed in the Company's exercise of the Option, including the Company's lack of cash flow, diminished borrowing power, debt structure, and difficulties in raising funds through a private placement of Multi-Arc's common stock and subordinated debentures (see \"Sale of Minority Interest in Multi-Arc Inc.\" included elsewhere in this Report). After discussion, the Board members who are not UBC Lenders (Messrs. Flood and Glickman) authorized the officers of the Company to engage an independent appraiser to conduct an appraisal of the UBC Property, following which such Board members would seek to negotiate a transaction with the UBC Lenders taking into account, in addition to the appraisal, all material circumstances relating to the UBC Property, including, without limitation, the inability of the Company to raise sufficient funds required to exercise the Option, the time constraints within which the Company must exercise the Option, and the consequent probability that, without a sale to a related party, the Option will expire worthless.\nOn November 21, 1995, the Company received a report from the independent appraiser it had retained which concluded that the range for the market value of the UBC Property was between $9.9 million and $11.9 million (before deducting the $3 million that would have to be paid to exercise the UBC Option), depending on the ultimate cost of complying with zoning restrictions and other costs that would be incurred in the development of the UBC Property. The appraiser's conclusion was based on a number of assumptions, including the assumption that a sale would occur after a reasonable exposure in a competitive market under all conditions requisite for a fair sale, with the buyer and seller acting prudently, knowledgeably, for self-interest, and not under undue duress.\nThe members of the Company's Board of Directors who are not UBC Lenders and the UBC Lenders are each considering the results of the appraisal. The Company expects that formal negotiations between the Company and the UBC Lenders will commence in early January 1996.\n3. SALE OF MINORITY INTEREST IN MULTI-ARC INC.\nIn December 1994, Andal sold, for $500,000 approximately 2-1\/2% of the common stock of Multi-Arc to Multi-Arc's management; and Multi-Arc issued $500,000 of convertible subordinated debentures (convertible into approximately 2% of Multi-Arc common stock) to such management, the proceeds of which were remitted to Andal as a return of capital. Both the sale of the common stock and the issuance of the debentures were funded through non-recourse loans of $1 million made to the management by Multi-Arc utilizing Multi-Arc's revolving facility with First Fidelity Bank. These loans bear interest from 6% to 8.35% and are repayable on December 15, 2004 or upon termination of employment. The loans are secured by common stock and debentures of Multi-Arc. The Notes evidencing these loans are pledged by Multi-Arc to First Fidelity Bank. Because of the non-recourse nature of the loans, the gain on the sale of Multi- Arc common stock of approximately $396,000 has been deferred until such time as the management loans are repaid.\nIn June and September 1995, Andal sold, for $1,010,000, approximately 4.9% of the common stock of Multi-Arc to certain foreign licensees and other investors; and Multi-Arc sold to such licensees and other investors $1,010,000 of convertible subordinated debentures (convertible into approximately 3.8% of Multi-Arc common stock), the cash proceeds of which were remitted to Andal as a return of capital. These debentures bear interest at 6% and are payable on December 15, 2004. Approximately $450,000 of the common stock sold, and $450,000 principal amount of the debentures sold are evidenced by a promissory note which require monthly principal payments over three years plus interest at 6% per annum. An additional $153,000 of common stock and $153,000 principal amount of the debentures were sold on open account. The gain on these sales of Multi-Arc common stock was $800,000, of which $452,000 was deferred and will be recognized as the amounts are collected.\nThe Company had agreed, in principal, to a total $3.5 million in stock sales and $3.5 million of Multi-Arc debenture issuances to its foreign licensees and other investors. However, the offer was not fully subscribed; and the unsubscribed portion of the offer has been withdrawn.\n4. MULTI-ARC JOINT VENTURES\nIn 1993, Multi-Arc acquired a 29% interest in Multi-Arc Scientific Coatings (S) Pte. Ltd. (\"Singapore\"), a joint venture which commenced operations in August 1993. Multi-Arc's share of Singapore's net income (loss), recorded on the equity method, for the years ended September 30, 1995 and 1994 was $(110,000) and $(111,000), respectively. During fiscal 1995, the Company invested an additional $247,000 in cash and converted a long term receivable of $77,000 into equity. At September 30, 1995, Investments in Affiliates include the Company's investment in Singapore of $293,000 ($79,000 at September 30, 1994).\nMulti-Arc had a 40% equity interest in Multi-Arc India Ltd. (\"India\") which has a fiscal year end of March 31. In November 1994, India completed an initial public offering and was listed on the Bombay Stock Exchange. As a result of this transaction, Multi-Arc's interest in India was reduced to 21% and the Company recorded a pretax gain of $85,000. Multi-Arc's share of India's net income (loss), recorded on the equity method, for the years ended September 30, 1995, 1994, and 1993 was $163,000 $95,000, and $-0-, respectively. During fiscal 1995, the Company received $36,000 of dividends in cash. During fiscal 1994, the Company made additional equity investments in India of $218,000 in cash and received $30,000 of dividends in cash. At September 30, 1995, Investments in Affiliates includes Andal's investment in India of $975,000 ($763,000 at September 30, 1994).\n5. DISCONTINUED OPERATIONS\nThe income (loss) from discontinued operations in 1995, 1994, and 1993 is comprised of the following:\n1995 1994 1993\nGain on divestiture of OMC $ 0 $ 69,000 $ 0 Reversal of reserve for income taxes 996,000 0 0 Income (loss) on discontinued construction operations 11,000 (419,000) (527,000) ---------- ---------- ---------- $1,007,000 $(350,000) $(527,000) ========== ========== ==========\nOn June 30, 1995, an appeals tribunal dismissed a claim against the Company by a local taxing authority for income taxes relating to certain of its discontinued operations. Income from discontinued operations for the year ended September 30, 1995 includes the reversal of a reserve for income taxes, plus accrued interest, in the aggregate amount of $996,000. The 1995 amount also includes income of $141,000 related to settlement of a construction claim and legal expenses of $130,000.\nConstruction operations consisted of construction subcontracting businesses involved in wall, flooring and ceiling installation and plumbing, heating, and electrical subcontracting. The Company commenced a program to discontinue these businesses in 1981 which program was completed in 1983. The loss on discontinued construction operations for 1994 and 1993 is due to legal expenses incurred and settlements on litigation related to those businesses.\nAt September 30, 1993, the Company's remaining investment in Olsher Metals Corporations (\"OMC\") consisted of 19.5% of OMC's common stock valued at $431,000 which approximated its share of the underlying book value of OMC. In January 1994, the Company sold its remaining investment in OMC for $500,000 in cash. The proceeds were used to repay debt. The gain on this transaction has been included in income (loss) from discontinued operations.\n6. SALE OF SALEM TUBE, INC.\nOn June 18, 1991, the Company completed the sale of substantially all of the assets and liabilities of its wholly-owned subsidiary, Salem Tube, Inc.(\"Salem\"). The sales price included a $700,000 subordinated promissory note due in equal quarterly installments beginning on September 30, 1994. The selling price of the net assets of Salem was approximately $700,000 in excess of Andal's carrying value at June 18, 1991. This gain was deferred and was to be recognized as the subordinated note payments were received. On August 4, 1994, the purchaser of Salem filed a voluntary petition for bankruptcy under Chapter 11 of the Federal Bankruptcy Code. In June 1995, the Bankruptcy Court approved Salem's Plan of Reorganization. Under the Plan, Andal received $100,000 in June 1995, is scheduled to receive $50,000 in December 1995, and may receive another $70,000 at an unspecified time in the future, depending on the recovery of certain preference payments. All recoveries have been and will be, when and if received, credited to discontinued operations.\n7. INTEGRATED BRANDS INC.\nIn December 1985, Andal purchased 46.5% of the common stock of Integrated Brands Inc. (\"Integrated\"), formerly Steve's Homemade Ice Cream, Inc. Through a series of transactions, Andal's interest has been reduced to 3%. At September 30, 1995 and 1994, Other Assets includes Andal's investment in Integrated of $393,000.\nOn June 22, 1993, the Company's Chairman and President resigned as directors of Integrated and the Company was not in a position to exercise significant influence over the operating and financial policies of Integrated's. Accordingly, on June 23, 1993, the Company began to account for its then 21% ownership of the common stock of Integrated by the cost method.\nIn August 1993, the Company sold 65,000 shares of Integrated stock for $134,000 in cash and recorded a gain of $60,000 on the transaction. During 1994, the Company disposed of 129,500 shares of Integrated in various transactions for $161,000 in cash and recorded a net gain of $14,000. In an additional transaction in August 1994, the Company sold 2,000,000 shares of Integrated for $1,500,000 in cash and recorded a loss of $780,000. All proceeds were used to repay debt.\n8. ACCOUNTS RECEIVABLE\nReceivables consist of the following:\nSeptember 30,\n1995 1994 Accounts receivable $5,096,000 $4,142,000 Allowance for doubtful accounts (98,000) (114,000) ----------- ----------- $4,998,000 $4,028,000 ========== ==========\n9. INVENTORIES\nInventories consist of the following:\nSeptember 30,\n1995 1994 Raw materials and supplies $ 820,000 $1,198,000 Work in progress 253,000 56,000 ---------- ---------- $1,073,000 $1,254,000 ========== ==========\n10. PROPERTY AND EQUIPMENT\nProperty and equipment consist of the following:\nSeptember 30, 1995 1994\nBuilding and leasehold improvements $ 2,521,000 $ 2,987,000 Furniture and equipment 24,098,000 23,403,000 ------------ ------------ 26,619,000 26,390,000 Less accumulated depreciation and amortization (15,830,000) (16,658,000) ------------ ------------ $10,789,000 $ 9,732,000 =========== =========== Substantially all property and equipment at September 30, 1995 is pledged as collateral pursuant to loan agreements.\nIn addition to property owned, the company leases various operating facilities and equipment. Rent expense under operating leases was $1,321,000, $1,305,000, and $1,457,000 for the three years ended September 30, 1995, 1994, and 1993, respectively.\nThe aggregate minimum rental commitments under operating leases as of September 30, 1995 for each of the fiscal years ended September 30 are as follows: 1996, $1,130,000; 1997, $1,016,000; 1998, $758,000; 1999, $501,000; 2000, $234,000, and $95,000 thereafter.\n11. 401K PLANS\nThe Company maintains several defined contribution 401K savings plans for the benefit of its employees. Annual contributions to the plans are at the discretion of management. Aggregate expense related to all plans amounted to $294,000 in 1995, $225,000 in 1994, and $97,000 in 1993.\n12. CREDIT FACILITIES AND LONG TERM DEBT\nLong term debt consists of the following:\nSeptember 30, 1995 1994 First Fidelity Bank, N. A. U. S. -Term loan $ 5,214,000 $ 6,000,000 Revolving credit facility 1,500,000 0 U. K. - Term loan 2,370,000 0 Siemens Financial Services 0 1,766,000 Bank of Scotland 0 358,000 Capital Leases 0 123,000 Other 8,000 70,000 ------------ ----------- 9,092,000 8,317,000 Less current portion (1,206,000) (1,365,000) ----------- -----------\n$7,886,000 $6,952,000 ========== ========== In September 1995, the Company refinanced the debt of its subsidiary, Multi-Arc (UK) Ltd., with First Fidelity Bank N. A. The new credit facilities consist of a five-year term loan in the principal amount of Pounds Sterling1,500,000 repayable in quarterly installments of Pounds Sterling 54,000 commencing in December 1995 and a final installment of Pounds Sterling 474,000 due in September 2000. Proceeds of the term loan were used to repay outstanding indebtedness to Siemens Financial Services and Bank of Scotland, to advance an inter-corporate loan to Multi-Arc Inc., and for acquisition of new equipment. In addition to the term loan, First Fidelity has extended a Pounds Sterling250,000 overdraft facility for working capital purposes. At September 30, 1995, no borrowings had been made under this facility.\nDuring 1994, the Company's Board of Directors (and subsequently the shareholders) approved a Plan of Restructuring that caused substantially all of the assets and liabilities of its Multi-Arc Scientific Coatings division to be transferred to Multi-Arc Inc. In connection with the restructuring, Multi- Arc Inc. assumed the Company's obligations under its 5 1\/2% convertible subordinated debentures due in 1997 and the related indenture (see Note 14). The debentures continue to be convertible into Andal common stock. Also, in connection with the restructuring, Multi-Arc Inc. obtained a $6 million term loan repayable in equal monthly installments over seven years from First Fidelity Bank, N.A. with interest at 8.36%. Proceeds of the term loan were used to retire intercompany indebtedness to Andal; and Andal, in turn, applied a substantial portion of the proceeds to the prepayment of its bank indebtedness to Chemical Bank. In addition to the term loan, First Fidelity Bank has extended a $4 million revolving credit facility, due March 31, 1997, to Multi-Arc for working capital purposes. Borrowings under this facility are limited based on specified percentages of eligible receivables and inventories, and bear interest at the prime rate. At September 30, 1995, Multi-Arc had an additional $1,550,000 available under this facility.\nAndal's remaining obligation to Chemical Bank consists of $941,000 of aggregate liability under outstanding letters of credit issued by Chemical Bank in connection with an appeal bond and in connection with its discontinued real estate development activities. Because of Andal's inability to fund the liabilities represented by the letters of credit, in order to secure the release of collateral held by Chemical Bank so that Multi-Arc could obtain its term loan and revolving credit facility from First Fidelity Bank, Messrs. Andrew J. Frankel, Paul A. Milstein, and Alan N. Cohen each personally guaranteed one-third of the letter of credit liabilities, for which Andal has agreed to pay to Messrs. Frankel, Milstein, and Cohen an aggregate annual guarantee fee equal to 2% of the letters of credit outstanding.\nIn July 1993, Multi-Arc (UK) Ltd. rescheduled its debt due Siemens Financial Services into a fixed rate, five-year term loan repayable in equal monthly installments with interest at 7-3\/8% and, in connection therewith, received forgiveness of debt in the amount of $77,000 which was recorded as income in 1993.\nSubstantially all of the Company's assets serve as collateral for the various term loans and lines of credit. The various term loan agreements require the Company to maintain compliance with certain financial ratios and other covenants. As of September 30, 1995, the Company was in compliance with or has obtained waivers of all such covenants for which it was not in compliance. The agreement covering the U. S. term loan and revolving credit facility has been modified to make certain financial covenants less restrictive.\nThe aggregate annual maturities of long term debt during the next five fiscal years (including the debt due shareholders) are: 1996, $2,456,000; 1997, $9,062,000; 1998, $1,198,000; 1999, $1,198,000; and 2000, $1,198,000. Interest paid during the fiscal years ended September 30, 1995, 1994, and 1993 amounted to $1,631,000, $1,650,000, and $1,125,000, respectively.\n13. DEBT DUE SHAREHOLDERS\nDebt due shareholders consists of:\nSeptember 30, 1995 1994\nUBC Lenders $5,571,000 $5,571,000 Fleet Assignees 2,043,000 2,543,000 ----------- -----------\n7,614,000 8,114,000 Less current portion (1,250,000) (750,000) ----------- -----------\n$6,364,000 $7,364,000 ========== ==========\nOn July 5, 1990, Andal borrowed an aggregate of $5 million from Alan N. Cohen, Paul Milstein, and a partnership controlled by Andrew J. Frankel, collectively referred to as the \"UBC Lenders.\" Messrs. Frankel and Cohen are officers, directors, and principal shareholders; and Mr. Milstein is a principal shareholder and former director of Andal. The proceeds of the loan were used to reduce current indebtedness and for general corporate and working capital purposes.\nThe loan is secured by a pledge of the stock of a subsidiary which holds Andal's option to purchase a parcel of real estate located at 61st Street and First Avenue in New York City (the \"UBC Property\") and must be prepaid in the event of a sale of the Company's interest in that property. (See Note 2.) In connection with the loan, the Company paid the UBC Lenders a $50,000 commitment fee and issued to them an aggregate of 25,000 warrants, each entitling the holder to purchase one share of common stock for $80.00 per share. The closing market price of Andal's common stock on July 5, 1990 was $65.00 per share. The warrants were exercisable from December 31, 1990 until July 5, 1995 at which time they lapsed unexercised. The Company agreed to pay the UBC Lenders' expenses incurred in connection with the loans and to indemnify the UBC Lenders against any claims which may be asserted against them by reason of the loans.\nIn May 1992, the Company restructured this indebtedness. Under the terms of the restructuring, the interest rate was reduced from 2 1\/2% over the prime rate to the prime rate; and interest accrued from October 1, 1991 through March 31, 1993 was deferred and added to principal. The principal amount of the loans and all accrued and unpaid interest has been rescheduled to be payable on the earlier of March 31, 1997 or the day after the Company's obligations to banks have been paid in full. In addition to prepayment in the event of a sale of the Company's interest in the UBC Property (see Note 2), the restructuring agreement also requires prepayments if the Company obtains cash recoveries on various claims and litigations relating to its discontinued construction operations and\/or if the Company's cash flow from operations exceeds a specified amount.\nIn consideration for the restructuring, the banks consented to the Company granting to the UBC Lenders a second lien on all of the assets of the Company which serve as collateral for the bank loans; and the UBC Lenders consented to the Company's granting to the banks a second lien on the stock of the subsidiary of the Company which holds the Company's interest in the UBC Option.\nIn March 1994, after discussions initiated by Fleet Bank, which had indicated that it desired to dispose of its portion of the Company's bank loans, Frankhill Associates, Alan N. Cohen, and Paul Milstein (collectively, in such capacity, the \"Fleet Assignees\") each purchased a one-third interest in the Company's indebtedness to Fleet Bank (the \"Fleet Indebtedness\"), which indebtedness totalled $3,042,000. The terms of such indebtedness did not change as a result of this purchase. In November 1994, Peter D. Flood, a director of the Company and Chief Executive Officer of Multi-Arc Inc., purchased an aggregate of 6.4% of the Fleet Indebtedness from Frankhill Associates, Alan N. Cohen, and Paul Milstein.\nAs part of the restructuring, Andal has renegotiated the repayment schedule on $2,543,000 due to the Fleet Assignees. Principal payments on this debt, at the rate of $250,000 per quarter, did not begin until March 31, 1995, with the remaining principal balance becoming due on March 31, 1997. The payment that was due on September 30, 1995 was made on October 24, 1995. Furthermore, Andal is required to make prepayments to the extent that it sells any of its capital assets or receives capital distributions from Multi-Arc. The Fleet Indebtedness bears interest at 1% over the prime rate payable quarterly. The UBC Loans continue to be due and payable on the earlier of March 31, 1997 or the day after the Fleet Assignee debt has been paid in full.\nIn order to facilitate the restructuring, the Fleet Assignees agreed to yield their lien on Multi-Arc's assets and to defer the approximately $1.6 million payment to which they would have otherwise been entitled; and Chemical Bank agreed to accept a $255,000 discount for payment in full to it of the Company's outstanding debt. In consideration for the concessions agreed to by the Fleet Assignees, the Company's Board of Directors (Messrs. Frankel and Cohen not voting) approved a payment of $255,000 by the Company to the Fleet Assignees.\nSee Notes 1 and 2 for a discussion of the potential sale of the UBC Property to the UBC Lenders in satisfaction of the UBC Loan.\n14. CONVERTIBLE SUBORDINATED DEBT\nConvertible subordinated debt at September 30, 1995 and 1994 consists of $1,825,000 of Andal's 5 1\/2% convertible subordinated debentures due in 1997 and, at September 30, 1995, $1,510,000 of Multi-Arc's 6% convertible subordinated debentures due in 2004 (see Note 3).\nAndal's 5 1\/2% convertible subordinated debentures are (i) at Andal's election, redeemable (with accrued interest) at 100% of the principal amount; and (ii) convertible into one common share for each $450.00 of principal amount, subject to usual anti-dilution provisions, or a total of 4,056 common shares at September 30, 1995. All sinking fund requirements have been met. (See Note 12.)\nThe Multi-Arc debentures are convertible into approximately 5.7% of the common stock of Multi-Arc Inc. at any time after September 30, 1996.\n15. CAPITAL SHARES\nAt September 30, 1995, common shares reserved for future issuance were as follows:\nIssuable under stock option plans 15,000 Issuable upon conversion of convertible subordinated debentures 4,056\n16. STOCK OPTIONS\nIn 1987, Andal adopted a Stock Option Plan under which options covering up to 15,000 shares of Andal common stock may be granted to eligible key employees. Options granted under the plan may be either \"incentive stock options\" or non-qualified options. Under the plan, the purchase price per share for stock options granted must equal or exceed the market value of Andal's common stock at the time of grant. All options granted under the plan expire no later than five years from the date of grant. Options may not be exercised for a period of 30 months after grant. After 30 months, 40% of the option shares may be exercised; after 42 months, 60% of such shares may be exercised; and, after 48 months, all of such shares may be exercised. The options expire 60 months after grant. The Board of Directors or the Compensation Committee thereof may accelerate, in whole or in part, the time or times at which such options may be exercised. In the case of incentive stock options, whether granted under this plan or any earlier plan of the Company, no more than $100,000 in value of shares (determined on the date of grant) may become exercisable by any single optionee during any calendar year.\nThe plan also permits the granting of stock appreciation rights either at the time that an option is granted or a later time under which an optionee may, instead of paying the option price and receiving the full number of shares covered by the exercised option, receive instead the then excess of the value of the shares subject to the option over the option price. Payment under a stock appreciation right may be in shares of stock (at current fair market value), or cash, or any combination thereof.\nNo options were converted or exercised under this plan in 1995, 1994, and 1993.\nAt September 30, 1995, there were 6,050 shares (6,170 at September 30, 1994) reserved for future grant of options. At September 30, 1995 and 1994, none of the outstanding options were exercisable. A summary of stock option transactions follows:\n1987 Stock Option Plan\nAverage Price per Number of Shares Share\nOptions outstanding at September 30, 1992 11,630 $ 41.80 Cancelled during 1993 (2,700) $143.52 Options outstanding at September 30, 1993 8,930 $ 11.15 Cancelled during 1994 (100) $112.50 Options outstanding at September 30, 1994 8,830 $ 10.00 Cancelled during 1995 (8,830) $ 10.00 Granted during 1995 8,950 $ 2.25 Options outstanding at September 30, 1995 8,950 $ 2.25\nIn December, 1994, Multi-Arc adopted the Multi-Arc Inc. 1994 Incentive and Non-Statutory Stock Option Plan (the \"Multi-Arc Plan\") under which options covering up to 5,000 shares of Multi-Arc common stock may be granted to by employees. Under the Plan, the purchase price per share for stock options granted must equal or exceed the market value of Multi-Arc's stock at time of grant. Options may be exercised at the rate of 20% per annum. The options expire ten years after date of grant.\nDuring 1995, Multi-Arc Inc. granted options for 5,000 shares to eligible employees at $205.13 per share. No further shares are available for grant under the Multi-Arc Plan.\n17. INCOME TAXES\nAndal and its subsidiaries file a consolidated federal income tax return, and state and local tax returns are generally filed on a combined basis. The provision (credit) for income taxes principally represents federal taxes in 1994 and state and local taxes for each of the years ended September 30, 1995, 1994, and 1993.\nThe Company has adopted the provisions of the Financial Accounting Standards Board Statement No. 109, \"Accounting for Income Taxes,\" effective October 1, 1993. As permitted by the Statement, prior years' financial statements have not been restated to reflect the change in accounting method. There was no cumulative effect on the Company's financial statements as of October 1, 1993 for adopting Statement No. 109.\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 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 the adoption of Statement 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.\nAt September 30, 1995, the Company had net operating loss carryforwards (\"NOL's\") for federal income tax purposes of approximately $31.5 million which expire in varying amounts in years 1995 through 2008. In addition, the Company's subsidiary in the United Kingdom had unrelieved corporation tax losses of approximately $2.8 million.\nDeferred income taxes reflect the net 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. Significant components of the Company's deferred tax assets and liabilities as of September 30, 1995 and 1994 are as follows:\n1995 1994 Deferred Tax Assets:\nAccruals and Reserves $ 3,074,000 $2,514,300 Installment Note 258,000 279,600 Deferred Gain on Sale of Subsidiary Stock 181,000 0 Future Tax Benefit of NOL Carryforwards 13,329,000 13,354,200 Future Tax Benefit of Credit Carryforwards 564,000 473,000 ------------ ----------\nGross Deferred Tax Assets 17,406,000 16,621,100\n------------ ---------- Deferred Tax Liabilities: Fixed Assets and Intangibles 1,053,000 354,000 Foreign income 498,000 167,000 Investment in Foreign Joint Ventures 124,000 0 ----------- ----------\nDeferred Tax Liabilities 1,675,000 521,000 ----------- ---------- Net Deferred Tax Assets 15,731,000 16,100,100 Valuation Allowance (15,731,000) (16,100,100)\n------------ ------------ Net Deferred Taxes $ 0 $ 0 =========== =========== The Company has provided a valuation allowance because it is more likely than not that the net deferred tax assets will not be realized.\nThe reconciliation of income taxes computed at the U. S. statutory rate to income tax expense for the year ended September 30, 1995 and 1994 is:\n1995 1994\nTax expense (benefit) at U. S. statutory rate $317,000 $(387,000) State taxes, net of federal benefit 46,000 0 Utilization of federal and state net operating losses (300,000) 551,300 Foreign earnings permanently reinvested (16,000) (145,000) Other items 7,000 (2,300)\nIncome tax expense (benefit) $ 54,000 $(17,000)\n18. LITIGATION\nIn August 1982, National States Electric Corp. (\"NSEC\"), a subsidiary of the Company then engaged in the electrical contracting business, commenced an action in the New York Supreme Court, County of New York, against LFO Construction Company (\"LFO\") for breach of contract. The action arose out of a subcontract agreement between NSEC and LFO in connection with a New York City construction project for which LFO served as construction manager. LFO, in response, asserted various counterclaims and set-offs against NSEC; and, in October 1982, LFO and two other parties commenced an action in the same court against NSEC, the Company, and Andrew J. Frankel, Chairman of the Board of the Company, in which the plaintiffs essentially realleged the counterclaims and set-offs. These actions were tried in October 1992. The court dismissed the claims against the Company and Mr. Frankel on the merits and with prejudice; but the jury returned a verdict against NSEC for approximately $3.8 million, including interest and costs; and a judgement was entered on the verdict in November 1992. LFO and its associates appealed from that part of the judgement which dismissed the action against the Company and Mr. Frankel. NSEC, in turn, appealed from the judgement against it. In April 1994, the Appellate Division affirmed the dismissal of the claims against the Company and Mr. Frankel. In addition, the Court struck the award for damages against NSEC and remanded the matter to the trial court for a new trial as to damages. In January 1995, NSEC settled the issue of damages with LFO by assigning to LFO its only asset which consisted of a claim it had against the New York City Transit Authority for work it performed for the Authority many years ago. The claim has been carried on the books of NSEC at no value; and, accordingly, the settlement did not result in any loss to the Company.\nThe Company, as successor to Circle Industries Corp. (\"Circle\"), its former subsidiary engaged in the installation of flooring, is a defendant in an action before the Supreme Court, New York County, commenced in May 1983 by Manhattan Plaza Associates against Circle and others alleging negligent installation of flooring and installation of defective flooring resulting in damages allegedly in excess of $5 million. The Company has filed an answer denying liability, asserting defenses and cross-claiming against Masonite Corporation, the manufacturer of the flooring. In June 1994, a similar action against the Company was settled for a cash payment by the Company of approximately $100,000. The Company cannot determine what effect the outcome of the aformentioned legal proceeding will have on the Company's financial position, results of operations, or liquidity. No liability has been accrued for this matter, as it is not considered probable that a liability has been incurred.\nThe Company is aware of various other lawsuits, claims, and administrative proceedings which are pending involving it and its subsidiaries.\nIn the opinion of the Company's management, these matters will not result in any material adverse effect on the Company's consolidated financial position.\n19. QUARTERLY FINANCIAL DATA (UNAUDITED)\nQuarterly results of operations for the fiscal years ended September 30, 1995 and 1994 are summarized in the following table:\nFirst Second Third Fourth Quarter Quarter Quarter Quarter (Thousands of Dollars, except per Share Amounts)\nOperating revenues $6,507 $8,404 $7,753 $7,719 Income (loss) from operations 277 1,069 542 526 Income (loss) from continuing operations (81) 595 241 124 Net income (loss) (192) 696 1,273 109 Income (loss) per common share: Income (loss) from continuing operations (.24) 1.80 .73 .38 Net income (loss) (.58) 2.11 3.86 .33\nOperating revenues $5,897 $7,833 $6,942 $6,405 Income (loss) from operations 147 978 501 1 Income (loss) from continuing operations (231) 591 111 (1,242) Net income (loss) (553) 591 91 (1,250) Income (loss) per common share: Income (loss) from continuing operations (.70) 1.79 .34 (3.77) Net income (loss) (1.68) 1.79 .28 (3.79)\nIn the fourth quarter of 1995, the Company recorded additional gains of $160,000 on the sale of minority interest in Multi-Arc Inc. and additional minority interest in the net income of Multi-Arc Inc. of $93,000.\nIn the fourth quarter of 1994, the Company recorded a loss of $780,000 on the sale of Integrated stock (see Note 6) and incurred $218,000 of legal expenses in connection with restructuring activities.\n20. INDUSTRY SEGMENT INFORMATION\nAndal, through its Multi-Arc Inc. subsidiary, is engaged in surface enhancement, the business of coating materials, primarily metals. Multi-Arc is also engaged in the design, manufacture, assembly, and sale of proprietary coating equipment systems.\nOperating profit (loss) is computed as total revenue less operating expenses. The computation includes other income but excludes interest expense, general corporate overhead, and income taxes. Identifiable assets by industry are those assets that are used in Andal's operations in each industry segment.\nExport sales of coating system equipment amounted to $2,630,000 in 1993, principally to the Far East.\nThe following table sets forth information on the effects of foreign operations (principally in the United Kingdom) as of and for the years ended September 30, 1995, 1994, and 1993:\nSeptember 30, 1995 1994 1993 (Thousands of Dollars)\nRevenues $5,255 $4,268 $3,986 Operating profits 1,363 869 713 Identifiable assets 6,463 5,352 5,467 Capital expenditures 1,411 340 193 Depreciation and amortization 547 622 615\nSECURITIES AND EXCHANGE COMMISSION\nWashington, D. C. 20549\nEXHIBITS\nto\nANNUAL REPORT ON FORM 10-K\nFOR THE FISCAL YEAR ENDED\nSEPTEMBER 30, 1995\nANDAL CORP.\nEXHIBIT INDEX\nEXHIBIT DESCRIPTION OF EXHIBIT\n3(a) Restated Certificate of Incorporation of the Company as filed with the Secretary of State of New York on March 16, 1972 (the \"Certificate of Incorporation\") (incorporated by reference to Exhibit 3(a) to Company's Annual Report on Form 10-K for fiscal year ended September 30, 1986).\n3(b) Certificate of Amendment of the Certificate of Incorporation as filed with the Secretary of State of New York on November 5, 1979 (incorporated by reference to Exhibit 3(b) to Company's Annual Report on Form 10-K for fiscal year ended September 30, 1986).\n3(c) Certificate of Amendment of the Certificate of Incorporation as filed with the Secretary of State of New York on October 22, 1981 (incorporated by reference to Exhibit 3(c) to Company's Annual Report on Form 10-K for fiscal year ended September 30, 1986).\n3(d) Certificate of Amendment of the Certificate of Incorporation as filed with the Secretary of State of New York on November 7, 1983 (incorporated by reference to Exhibit 3(d) to Company's Annual Report on Form 10-K for fiscal year ended September 30, 1986).\n3(e) Certificate of Amendment of the Certificate of Incorporation as filed with the Secretary of State of New York on April 8, 1987 (incorporated by reference to Exhibit 4.5 to Company's Registration Statement on Form S-8 as filed with the Securities and Exchange Commission on May 5, 1987).\n3(f) Certificate of Amendment of the Certificate of Incorporation as filed with the Secretary of State of New York on June 15, 1993 (incorporated by reference to Exhibit 3(f) to Company's Annual Report on Form 10-K for Fiscal Year ended September 30, 1993).\n3(g) By-laws of the Company (incorporated by reference to Exhibit 4.6 to Company's Registration Statement on Form S-8 as filed with the Securities and Exchange Commission on May 5, 1987).\n4(a) Indenture dated as of September 15, 1972 between the Company and Manufacturers Hanover Trust Company, as Trustee, relating to the Company's 5 1\/2% convertible subordinated debentures due September 15, 1997 (incorporated by reference to Exhibit 4(a) to Company's Annual Report on Form 10-K for fiscal year ended September 30, 1986).\n4(b) First Supplemental Indenture dated as of January 12, 1982 between the Company and United States Trust Company of New York, as Trustee, relating to the Company's 5 1\/2% convertible subordinated debentures due September 15, 1997 (incorporated by reference to Exhibit 4(b) to Company's Annual Report on Form 10-K for fiscal year ended September 30, 1986).\n10(a) 1987 Stock Option Plan of the Company (incorporated by reference to Exhibit 10(c) to the Company's Annual Report on Form 10-K for fiscal year ended September 30, 1987).\n10(b) Option Agreement dated as of August 1, 1982 between Schnurmacher Corp. and the Company (incorporated by reference to Exhibit 10(v) to Company's Annual Report on Form 10-K for fiscal year ended September 30, 1986).\n10(c) Lease dated May 11, 1988, containing an Option to Purchase, between Roundhill Associates and the Company (incorporated by reference to Exhibit 10(ag) to Company's Annual Report on Form 10-K for fiscal year ended September 30, 1988).\n10(d) Intercreditor Agreement among Frankhill Associates, Paul Milstein, Alan N. Cohen, and Andal Corp. dated July 5, 1990 (incorporated by reference to Exhibit 10(ac) to the Company's Annual Report on Form 10-K for the year ended September 30, 1990).\n10(e) Stock Pledge Agreement among Andal Corp., Frankhill Associates, Paul Milstein, and Alan N. Cohen dated July 5, 1990 (incorporated by reference to Exhibit 10(ad) to the Company's Annual Report on Form 10-K for the year ended September 30, 1990).\n10(f) Warranty Agreement among Andal Corp., Frankhill Associates, Paul Milstein, and Alan N. Cohen dated July 5, 1990 (incorporated by reference to Exhibit 10(ae) to the Company's Annual Report on Form 10-K for the year ended September 30, 1990).\n10(g) Employment Agreement dated as of January 1, 1991, by and between the Company and Peter D. Flood (incorporated by reference to Exhibit 10(x) to the Company's Annual Report on Form 10-K for the year ended September 30, 1991).\n10(h) Restructuring Agreement, Amendment, Guarantee, and Security Agreement dated May 27, 1992 (\"Restructuring Agreement\") by and among Andal Corp., certain subsidiaries of Andal Corp., Norstar Bank, Manufacturers Hanover Trust Company, Manufacturers Hanover Trust Company as agent for the banks, Alan N. Cohen, Paul Milstein, Frankhill Associates, and the Bank of New York as collateral agent for the Lenders (incorporated by reference to Exhibit 10(t) to the Company's Annual Report on Form 10-K for the year ended September 30, 1992).\n10(i) First Amendment to the Restructuring Agreement dated June 5, 1992 (incorporated by reference to Exhibit 10(s) to the Company's Annual Report on Form 10-K for the year ended September 30, 1992).\n10(j) Plan of Restructuring adopted by the Board of Directors and Andal Corp. as approved by the Shareholders on August 16, 1994.\n10(k) Loan and Security Agreement dated September 30, 1994 by and between First Fidelity Bank, N.A. and Scientific Coatings of Illinois, Inc., Scientific Coatings, Inc., and SCI Coatings Southwest, Inc.\n10(l) Subordination Agreement dated September 30, 1994 of Multi-Arc Inc. as debtor and Andal Corp. as subordinated lender in favor of First Fidelity Bank, N.A.\n10(m) Security Agreement dated September 30, 1994 by and between First Fidelity Bank, N.A. and Vagle Technology, Inc., Multi-Arc, Inc. (a Minnesota corporation), Multi-Arc Inc., Multi-Arc of Ohio, Inc., and S. C. I. Coatings Limited.\n10(n) Amendment dated September 30, 1994 to the Restructuring Agreement, Amendment, Guarantee, and Security Agreement dated May 27, 1992 among Andal Corp. and certain subsidiaries, Fleet Bank, Chemical Bank, Alan N. Cohen, Paul Milstein, Frankhill Associates, and The Bank of New York as collateral agent.\n10(o) Multi-Arc Inc., Andal Corp., and United States Trust Company of New York, Trustee. Second Supplemental Indenture dated as of September 30, 1994 5 1\/2% Convertible Subordinated Debentures due 1997.\n10(p) Pledge and Security Agreement dated September 30, 1994 by and among Andal Corp. and First Fidelity Bank, N.A.\n22 Subsidiaries of the Company\n24(a) Consent of Kelly Graham Myska & Partners.\n24(b) Consent of KPMG Peat Marwick.\n24(c) Consent of BDO Seidman.\n27 Financial Data Schedule\nEXHIBIT 10(p)\nNo. A-(Number) $(Amount #)\nMULTI-ARC INC. Rockaway, New Jersey Issue Date: September 15, 1995\n6% Convertible Subordinated Debenture Due December 15, 2004\nMulti-Arc Inc., a Delaware corporation (the \"Corporation\"), for value received, promises to pay to (Name) or registered assigns, the sum of (Amount Written) Dollars ($(Amount #)) on December 15, 2004 upon presentation and surrender of this Debenture at the office of the Corporation in Rockaway, New Jersey, and to pay interest at the rate of six percent (6%) per annum semi- annually on the first day of January and July of each year, computed from the Issue Date, until payment of the principal amount of this Debenture has been made. Payment of principal and interest shall be made at the offices of the Corporation, in lawful money of the United States of America, and shall be mailed to the registered owner or owners hereof at the address appearing on the books of the Corporation.\n1. The Debenture. This Debenture is one of a duly authorized issue of $4,000,000 of debentures of the Corporation designated as its 6% Convertible Subordinated Debentures due December 15, 2004 (the \"Debentures\") and issued in denominations of $1,000, all of like date, tenor and maturity, except variations necessary to express the number and payee of each debenture and except for the Issue Date.\n2. Equal Rank. All debentures of this issue and series rank equally and ratably without priority over one another.\n3. Conversion. The holder or holders of this Debenture may convert, at any time prior to the maturity hereof, after September 30, 1996 (or at any time before that date if the Corporation shall then have sold in a registered public offering at least $5,000,000 of its Common Stock) the principal amount of this Debenture into common stock of the Corporation at the conversion ratio of $266.6667 of debenture principal for one share of common stock, or at the adjusted conversion price (as provided for herein) in effect at the time of the conversion; provided that if the Corporation has called this Debenture for redemption, the right to convert shall terminate at the close of business on the second business day prior to the day fixed as the date for the redemption.\nTo convert this Debenture, the holder or holders must surrender the same at the office of the Corporation, accompanied by a written notice of conversion and by a written instrument of transfer in a form satisfactory to the Corporation, properly completed and executed by the registered holder or holders hereof or a duly authorized attorney.\nThe shares to be delivered upon conversion of this Debenture are to be repurchased by the Corporation from its parent Andal Corp. pursuant to that certain Contingent Repurchase Agreement dated December 16, 1994 between the Corporation and Andal Corp. which the Corporation acknowledges has been entered into for the benefit of the holder hereof.\n4. Fractional Shares. The Corporation shall convert this debenture into fractional shares to at least the fifth decimal place rounded even. No cash shall be paid in lieu of any remaining fraction.\n5. Adjustments to Conversion Ratio. If the Corporation at any time pays to the holders of its common stock a dividend in common stock, the number of shares of common stock issuable upon the conversion of this Debenture shall be proportionally increased, effective at the close of business on the record date for determination of the holders of the common stock entitled to the dividend.\nIf the Corporation at any time subdivides or combines in a larger or smaller number of shares its outstanding shares of common stock, then the number of shares of common stock issuable upon the conversion of this Debenture shall be proportionally increased in the case of a subdivision and decreased in the case of a combination, effective in either case at the close of business on the date that the subdivision or combination becomes effective.\nIf the Corporation is recapitalized, consolidated with or merged into any other corporation, or sells or conveys to any other corporation all or substantially all of its property as an entity, provision shall be made as part of the terms of any such transaction so that the holder or holders of this Debenture may receive, in lieu of the common stock otherwise issuable to them upon conversion hereof, at the same conversion ratio, the same kind and amount of securities or assets as may be distributable upon the recapitalization, consolidation, merger, sale, or conveyance with respect to the common stock.\n6. Subordination.\n(a) Anything herein or in the Debenture to the contrary notwithstanding, the indebtedness evidenced by the Debenture and the payment of principal of and interest on the Debenture shall be subordinate and junior in right of payment, to the extent and in the manner hereinafter set forth, to all Senior Indebtedness of the Corporation, as defined herein, whether outstanding at the date of this Agreement or incurred after the date of this Agreement:\n(i) The indebtedness evidenced by this Debenture shall not have any claim to the assets of the Corporation on a parity with or prior to the claim of the Senior Indebtedness, and, unless and until the Senior Indebtedness shall have been fully paid and satisfied, no holder of the Debenture will (a) take, demand or receive, and the Corporation will not make, give or permit, directly or indirectly, by set-off, redemption, purchase or in any other manner, any payment or security for the whole or any part of the principal of or interest on the indebtedness evidenced by the Debenture; provided, however, that so long as no default or event of default with respect to any Senior Indebtedness has occurred and is continuing, and so long as no default hereunder has occurred and is continuing, payments of interest on the Debenture may be made when due or within ten (10) days in advance thereof, in accordance with the terms hereof; or (b) commence any proceeding to enforce payment of the indebtedness evidenced by this Debenture, or join with any other creditors of the Corporation in commencing any proceeding against the Corporation under any bankruptcy, reorganization, readjustment of debt, dissolution, receivership or liquidation proceeding or otherwise exercise any remedies otherwise permitted by applicable law upon a default hereunder.\n(ii) In the event of any insolvency or bankruptcy proceedings, and any receivership, liquidation, reorganization or other similar proceedings in connection therewith, relative to the Corporation or to its creditors, as such, or to its property, and in the event of any proceedings for voluntary or involuntary liquidation, dissolution or other winding-up of the Corporation whether or not involving insolvency or bankruptcy, then the holders of Senior Indebtedness shall be entitled to receive payment in full of all principal and interest on all Senior Indebtedness before the holder of the Debenture are entitled to receive any payment on account of principal or interest upon the Debenture, and to that end, the holders of Senior Indebtedness shall be entitled to receive for application in payment thereof any payment or distribution of any kind or character, whether in cash or property or securities, which may be payable or deliverable in any such proceedings in respect of the Debenture, except securities which are subordinate and junior in right of payment to the payment of all Senior Indebtedness then outstanding;\n(iii) In the event that this Debenture is declared due and payable before its expressed maturity because of the occurrence of a default hereunder (under circumstances when the provisions of the foregoing clause (ii) shall not be applicable), the holders of the Senior Indebtedness shall be entitled to receive payment in full of all principal and interest on all Senior Indebtedness before the holders of the Debenture is entitled to receive any payment on account of the principal or interest upon the Debenture; and\n(iv) If any payment or distribution or security, or the proceeds of any thereof, is collected or received by any holder of the Debenture in respect of any of the indebtedness evidenced by the Debenture prior to the full payment and satisfaction of the Senior Indebtedness, and such collection or receipt is not expressly permitted under this Agreement, such holder of the Debenture will forthwith deliver the same, in precisely the form received (except for the endorsement or assignment of such holder of the Debenture where necessary), to the holders of Senior Indebtedness, or to their representative or representatives to be turned over to the holders of Senior Indebtedness, for application as a payment on account of the Senior Indebtedness, and unless so delivered by such holder of the Debenture, the same shall be held in trust by such holder of the Debenture as the property of the holders of Senior Indebtedness.\n(b) The holder of the Debenture undertakes and agrees for the benefit of each holder of Senior Indebtedness to execute, verify, deliver and file any proofs of claim, consents, assignments or other instruments which any holder of Senior Indebtedness may at any time require in order to prove and realize upon any rights or claims pertaining to the Debenture and to effectuate the full benefit of the subordination contained herein; and upon failure of the holder of any Debenture so to do, any such holder of Senior Indebtedness shall be deemed to be irrevocably appointed the agent and attorney-in-fact of the holder of the Debenture to execute, verify, deliver and file any such proofs of claim, consents, assignments or other instrument.\n(c) Without the necessity of any reservation of rights against the holder of the Debenture, without notice to or further assent by any holder of the Debenture, without affecting the liabilities and obligations hereunder of any holder of the Debenture and without affecting the subordination provisions provided for herein, any present or future holder of Senior Indebtedness may modify or amend the terms of such Senior Indebtedness or any security or guaranty therefor (including but not limited to extending the time of payment) and may increase the amount of such Senior Indebtedness and may release, sell or exchange such security or guaranty and otherwise deal freely with the Corporation and any other party obligated to such Holder with respect to such Senior Indebtedness.\n(d) No present or future holder of Senior Indebtedness shall be prejudiced in his right to enforce subordination of the Debenture by any act or failure to act or delay in acting on the part of the Corporation or such holder. The provisions of this Section are solely for the purpose of defining the relative rights of the holders of Senior Indebtedness on the one hand and the holder of the Debenture on the other hand, and nothing herein shall impair as between the Corporation and the holder of the Debenture the obligation of the Corporation, which is unconditional and absolute, to pay to the holder thereof the principal, premium, if any, and interest thereon in accordance with its terms, nor shall anything therein prevent the holder of the Debenture from exercising all remedies otherwise permitted by applicable law or hereunder upon default hereunder subject to the rights under this Section of holders of Senior Indebtedness to receive cash, property or securities otherwise payable or deliverable to holder of the Debenture.\n(e) The Corporation agrees, for the benefit of the holders of Senior Indebtedness, that in the event that the Debenture is declared due and payable before its expressed maturity because of the occurrence of a default hereunder (i) the Corporation will give prompt notice in writing of such happening to the holders of Senior Indebtedness and (ii) absent the written consent of the holder of such Senior Indebtedness to the Corporation all Senior Indebtedness shall forthwith become immediately due and payable upon demand regardless of the expressed maturity thereof.\n(f) Subject to the payment in full of all Senior Indebtedness, the holder of the Debenture shall be subrogated to the rights of the holders of Senior Indebtedness to receive payments or distributions of cash, property or securities of the Corporation applicable to the Senior Indebtedness until the principal of, premium, if any, and interest on the Debenture shall be paid in full and no such payments or distributions to the holder of the Debenture of cash, property or securities otherwise distributable to the holders of the Senior Indebtedness shall, as between the Corporation, its creditors, other than the holders of Senior Indebtedness, and the holder of the Debenture, be deemed to be a payment by the Corporation to or on account of the Debenture. It is understood that these subordination provisions are and are intended solely for the purpose of defining the relative rights of the holder of the Debenture, on the one hand, and the holders of the Senior Indebtedness, on the other hand. Nothing contained herein is intended to or shall impair, as between the Corporation, its creditors, other than the holders of Senior Indebtedness, and the holder of the Debenture, the obligation of the Corporation, which is unconditional and absolute, to pay to the holder of the Debenture the principal of, premium, if any, and interest on the Debenture as and when the same shall become due and payable in accordance with its terms, or to affect the relative rights of the holder of the Debenture and creditors of the Corporation, other than the holders of the Senior Indebtedness.\n(g) The term \"Senior Indebtedness\" shall mean the principal of (and premium, if any) and unpaid interest on (i) indebtedness of the Corporation, whether outstanding on the date of execution of this Debenture or thereafter created, incurred or assumed, which is (a) for money borrowed or (b) evidenced by a note, debenture or other similar instrument given in connection with the acquisition of any property or assets, including securities, (ii) any indebtedness of others of the kinds described in the preceding clause (i) guaranteed by the Corporation or for which the Corporation is otherwise liable, and (iii) amendments, modifications, renewals, extensions and refundings of any such indebtedness, including without limitation, the FFB Indebtedness; provided, however, that the term shall not include any indebtedness of the character described in clauses (i) or (ii) above, or any amendment, increases, renewal, extension or refunding of any such indebtedness if in the instrument creating or evidencing the same or pursuant to which the same is outstanding, it is expressly provided that such indebtedness, or such amendment, renewal, extension or refunding thereof is not senior in right of payment to the Debenture.\n(h) The term \"FFB Indebtedness\" shall mean the indebtedness of the Corporation to First Fidelity Bank, N.A. (\"FFB\") under a Guaranty and Suretyship Agreement- NJ - Corporation dated September 30, 1994 by the Corporation and others in favor of FFB, pursuant to which, inter alia, the Corporation guaranteed all the then existing and thereafter incurred indebtedness of Scientific Coatings of Illinois, Inc., Scientific Coatings, Inc. and SCI Coatings Southwest, Inc. to FFB.\n7. Default. If any of the following events occur (\"Event of Default\"), the entire unpaid principal amount of, and accrued and unpaid interest on, this Debenture shall immediately be due and payable:\n(a) The Corporation fails to pay any interest on this Debenture when it is due and payable, and the failure continues for a period of 30 days;\n(b) The Corporation fails to pay the principal of this Debenture at its maturity;\n(c) The Corporation commences any voluntary proceeding under any bankruptcy, reorganization, arrangement, insolvency, readjustment of debt, receivership, dissolution, or liquidation law or statute, of any jurisdiction, whether now or subsequently in effect; or the Corporation is adjudicated insolvent or bankrupt by a court of competent jurisdiction; or the Corporation petitions or applies for, acquiesces in, or consents to, the appointment of any receiver or trustee of the Corporation or for all or substantially all of its property or assets; or the Corporation makes an assignment for the benefit of its creditors; or the Corporation admits in writing its inability to pay its debts as they mature; or\n(d) There is commenced against the Corporation any proceeding relating to the Corporation under any bankruptcy, reorganization, arrangement, insolvency, readjustment of debt, receivership, dissolution, or liquidation law or statute, of any jurisdiction, whether now or subsequently in effect, and the proceeding remains undismissed for a period of 60 days or the Corporation by any act indicates its consent to, approval of, or acquiescence in, the proceeding; or a receiver or trustee is appointed for the Corpora- tion or for all or substantially all of its property or assets, and the receivership or trusteeship remains undischarged for a period of 60 days; or a warrant of attachment, execution or similar process is issued against any substantial part of the property or assets of the Corporation, and the warrant or similar process is not dismissed or bonded within 60 days after the levy.\n8. Redemption. This Debenture may be redeemed at any time on or after October 1, 1996, prior to maturity, as a whole at any time or in part from time to time, at the office of the Corporation, upon the notice referred to below, at the following redemption prices (expressed in common percentages of the principal amount of this Debenture) together with accrued interest to the date of redemption:\nIf Redeemed During Percentage 12 Month Period of Principal Beginning Amount\nDecember 16, 1995 . . . . . . . . . . . . . . . . . . . . 106 December 16, 1996 . . . . . . . . . . . . . . . . . . . . 105 December 16, 1997 . . . . . . . . . . . . . . . . . . . . 104 December 16, 1998 . . . . . . . . . . . . . . . . . . . . 104 December 16, 1999 . . . . . . . . . . . . . . . . . . . . 103 December 16, 2000 . . . . . . . . . . . . . . . . . . . . 103 December 16, 2001 . . . . . . . . . . . . . . . . . . . . 102 December 16, 2002 . . . . . . . . . . . . . . . . . . . . 102 December 16, 2003 . . . . . . . . . . . . . . . . . . . . 101\n9. Notice of redemption, etc. Notice of redemption shall be mailed to the holder of the Debenture not less than 30 nor more than 60 days prior to the date fixed for redemption at their last addresses as they appear upon the records of the Corporation. If this Debenture is redeemed in part, the Corporation shall, without charge to the holder or holders hereof, either (1) execute and deliver to the holder or holders a debenture for the unredeemed balance of the principal amount hereof, or (2) make note hereon of the principal amount called for redemption and redeemed, upon surrender of this Debenture at the office of the Corporation. Following the date fixed for redemption, interest shall be payable only on the portion of this Debenture not called for redemption.\n10. Exchange. The holder of this Debenture may, at any time on or before the date of its maturity or the date fixed for its redemption, by surrendering this Debenture to the Corporation at its office, exchange this Debenture and\/or any other of the Debentures for another debenture or debentures of a like principal amount and of like tenor, date and maturity in denominations of $1,000 or any multiple of that amount.\n11. Transfer. This Debenture may be transferred only at the office of the Corporation by the surrender hereof for cancellation, and upon the payment of any stamp tax or other governmental charge connected with the transfer. If this Debenture is transferred, a new debenture or debentures of like tenor, date and maturity shall be issued to the transferee.\n12. Registered owner. The Corporation may treat the person or persons whose name or names appear hereon as the absolute owner or owners of this Debenture for the purpose of receiving payment of, or on account of, the principal and interest due on this Debenture and for all other purposes, and it shall not be affected by any notice to the contrary.\n13. Corporate obligation. The holder or holders of this Debenture shall not have any recourse for the payment in whole or of any part of the principal or interest on this Debenture against any incorporator, or present or future stockholder of the Corporation by virtue of any law, or by the enforcement of any assessment, or otherwise, or against any officer or director of the Corporation by reason of any matter prior to the delivery of this Debenture, or against any present or future officer or director of the Corporation. The holder of this Debenture, by the acceptance hereof and as a part of the consideration for this Debenture, expressly agree that the Debenture is an obligation solely of the Corporation and expressly release all claims and waive all liability against the foregoing persons in connection with this Debenture.\nIN WITNESS WHEREOF, the Corporation has signed and sealed this 6% Convertible Subordinated Debenture due December 16, 2004 this 15th day of September, 1995.\nMULTI-ARC INC.\nCorporate \/s\/ Peter D. Flood Seal Peter D. Flood, President\n\/s\/ Walter N. Kreil, Jr. Walter N. Kreil, Jr., Secretary\nTHIS SECURITY HAS NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE \"SECURITIES ACT\"). THE HOLDER HEREOF, BY PURCHASING THIS SECURITY, AGREES FOR THE BENEFIT OF MULTI-ARC INC. (THE \"COMPANY\") THAT THIS SECURITY MAY BE RESOLD, PLEDGED OR OTHERWISE TRANSFERRED ONLY: (1) TO THE COMPANY (UPON REPURCHASE THEREOF OR OTHERWISE), (2) SO LONG AS THIS SECURITY IS ELIGIBLE FOR RESALE PURSUANT TO RULE 144A, TO A PERSON WHOM THE SELLER REASONABLY BELIEVES IS A QUALIFIED INSTITUTIONAL BUYER WITHIN THE MEANING OF RULE 144A UNDER THE SECURITIES ACT, PURCHASING FOR ITS OWN ACCOUNT OR FOR THE ACCOUNT OF A QUALIFIED INSTITUTIONAL BUYER TO WHOM NOTICE IS GIVEN THAT THE RESALE, PLEDGE OR OTHER TRANSFER IS BEING MADE IN RELIANCE ON RULE 144A, (3) IN AN OFFSHORE TRANSACTION IN ACCORDANCE WITH THE MEANING OF REGULATION S UNDER THE SECURITIES ACT, PROVIDED THAT THERE ARE NO DIRECTED SELLING EFFORTS IN THE UNITED STATES AND OTHER ADDITIONAL CONDITIONS OF REGULATION S FOR RESALES HAVE BEEN SATISFIED, (4) PURSUANT TO AN EXEMPTION FROM REGISTRATIONIN ACCORDANCE WITH RULE 144 (IF AVAILABLE) UNDER THE SECURITIES ACT, (5) IN RELIANCE ON ANOTHER EXEMPTION FROM THE REGISTRATION REQUIREMENTS OF THE SECURITIES ACT, AND SUBJECT TO THE RECEIPT BY THE COMPANY OF AN OPINION OF COUNSEL TO THE EFFECT THAT SUCH TRANSFER DOES NOT REQUIRE REGISTRATION UNDER THE SECURITIES ACT, OR (6) PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT UNDER THE SECURITIES ACT, IN EACH CASE IN ACCORDANCE WITH APPLICABLE SECURITIES LAWS OF ANY STATE OF THE UNITED STATES.\nTHE SALE, TRANSFER, ASSIGNMENT, PLEDGE, OR ENCUMBRANCE OF THE SECURITIES REPRESENTED BY THIS CERTIFICATE AND\/OR THE RIGHTS OF THE HOLDER OF SUCH SECURITIES IN RESPECT OF THE ELECTION OF DIRECTORS ARE SUBJECT TO THE TERMS AND CONDITIONS OF AN AMENDED AND RESTATED STOCKHOLDERS' AGREEMENT DATED AS OF MAY 15, 1995, AS AMENDED, AMONG MULTI-ARC INC. AND CERTAIN HOLDERS OF OUTSTANDING COMMON STOCK OF SUCH CORPORATION, OUTSTANDING CONVERTIBLE SUBORDINATED DEBENTURES OR STOCK OPTIONS. COPIES OF SUCH AGREEMENT MAY BE OBTAINED AT NO COST BY WRITTEN REQUEST MADE BY ANY HOLDER OF THIS CERTIFICATE ADDRESSED TO THE SECRETARY OF MULTI-ARC INC.\nEXHIBIT 10(q)\nMULTI-ARC INC. AMENDED AND RESTATED STOCKHOLDERS' AGREEMENT\nThis AMENDED AND RESTATED STOCKHOLDERS' AGREEMENT dated May 15, 1995 Multi-Arc Inc., a Delaware corporation (the \"Corporation\"), and Andal Corp. (\"Andal\"), Peter D. Flood, Walter N. Kreil, Jr., Multi-Arc India Ltd. and the stockholders listed on Exhibit A hereto (collectively, the \"Stockholders\").\nWHEREAS, the Corporation is a corporation duly organized and existing under the laws of the State of Delaware having issued and outstanding 100,000 shares of common stock $0.01 par value (the \"Common Stock\") and each of the Stockholders owns that number of shares of Common Stock and the principal amount of 6% Convertible Subordinated Debentures due December 16, 2004 of the Corporation (the \"Debentures\") and the employee stock options (the \"Options\") set forth opposite its or his name on Schedule I attached hereto; and\nWHEREAS, Mr. Flood and Mr. Kreil have on December 16, 1994 purchased their shares of Common Stock from Andal and their Debentures from the Corporation on the express condition that this Agreement be entered into; and\nWHEREAS, it is deemed to be in the best interests of the Corporation and the Stockholders that provision be made for the continuity and stability of the business and policies of the Corporation and, to that end, the Corporation and the Stockholders hereby set forth their agreement with respect to the shares of Common Stock owned by the Stockholders; and\nWHEREAS, all Stockholders and the Corporation entered into a Stockholders Agreement dated December 16, 1994 and desire to amend and restate that Agreement to permit the extension from April 15, 1995 to June 15, 1995 the time for completion of an offering of Common Stock and Debentures.\nNOW, THEREFORE, in consideration of the premises and of the mutual consents and obligations hereinafter set forth, the parties hereto hereby agree as follows:\nSECTION 1. Definitions. As used herein, the following terms shall have the following respective meanings:\n(a) Affiliate shall mean a person that directly, or indirectly through one or more intermediaries, controls, or is controlled by, or is under common control with, any Stockholder.\n(b) Eligible Group shall mean any Stockholder Group except a Selling Group or a Group which includes a Stockholder as to whom or which an Event of Option shall have occurred.\n(c) Event of Option shall mean the occurrence of one or more of the following events:\n(i) a Stockholder shall be declared bankrupt or a receiver, executor, administrator, guardian, legal committee or other legal custodian of his or its property (including any Stock owned by such Stockholder) shall be appointed; provided, however that no appointment of any executor or administrator of the property of a Stockholder who is an individual, upon the death of such Stockholder, shall be deemed an Event of Option as to any Stock owned by such Stockholder until and unless such executor or administrator, or any successor thereof, shall have disposed of such Stock other than by transferring it to a member or members of the Group of such Stockholder, which member or members shall have agreed in writing, at the time of such transfer, to be bound by and to comply with, to the same extent as the Stockholder as a result of whose death such Stock was distributed, all applicable provisions of this Agreement and to be deemed a member of such Stockholder's Group;\n(ii) a Stockholder shall Sell any Stock in violation of Section 2, 3 or 5;\n(iii) a Stockholder who became a Stockholder only by virtue of being an Affiliate ceases to be an Affiliate (in a manner other than as contemplated by Section l(c)(i)) while it owns any Stock; or\n(iv) a writ of attachment or levy or other court order shall prevent a Stockholder from exercising his or its voting and other rights with respect to any Stock.\nAn Event of Option shall be deemed to be continuing until the procedures set forth in Section 4 with respect to the Stock affected thereby have been exhausted.\n(d) Fair Value shall mean, as of the date of determination, the fair value of each share of Common Stock determined in good faith by a majority of the Board of Directors of the Corporation which may be on the basis, in the case of Common Stock, of $205.13 a share plus or minus net income or net loss per share from October 1, 1994.\n(e) Group shall mean:\n(i) In the case of a Stockholder who is an individual, (A) such Stockholder, (B) the spouse, parents, siblings and lineal descendants of such Stockholder, (C) a trust for the benefit of any of the foregoing and (D) any corporation or partnership controlled by such Stockholder;\n(ii) In the case of a Stockholder which is a partnership, (A) such partnership and any of its limited or general partners, (B) any corporation or other business organization to which such partnership shall sell all or substantially all of its assets or with which it shall be merged and (C) any Affiliate of such partnership;\n(iii) In the case of a Stockholder which is a corporation, (A) any of its subsidiaries, (B) any corporation or other business organization to which it shall sell all or substantially all of its assets or with which it shall be managed, (C) any Affiliate of the corporation and (D) any officer of such corporation; and\n(iv) In the case of any Investor or Stockholder which is a trust, (A) such trust and (B) the beneficiaries of such trust.\n(f) Prohibited Transferee shall mean any individual, corporation, firm or other legal entity receiving or holding any Stock, directly or indirectly, as the result of the occurrence of an Event of Option.\n(g) Proportionate Percentage shall mean the pro rata percentage of a class of Stock (A) being offered by a Selling Group pursuant to Section 3 which each Eligible Group shall be entitled to purchase, if any, or (B) which each Eligible Group shall be entitled to purchase from the Stockholder as to which an Event of Option has occurred, his or its representatives or assigns, or the Prohibited Transferee, as the case may be. Such pro rata percentage, as to each Eligible Group, shall be the percentage figure which expresses the ratio, based upon voting power, assuming full conversion of Debentures and\/or full exercise of Options, between the number of shares of Common Stock that would then be outstanding owned by such Eligible Group and the aggregate number of such shares of Common Stock that would be owned by all Eligible Groups.\n(h) Sell as to any Security, shall mean to sell, or in any other way directly or indirectly transfer, assign, distribute, encumber or otherwise dispose of, either voluntarily or involuntarily.\n(i) Selling Group shall mean a Group of a Stockholder proposing to Sell its Security, or which has delivered a notice of intention to Sell, pursuant to Section 3.\n(j) Securities shall mean (1) the presently issued and outstanding shares of Common Stock, (2) any additional shares of capital stock hereafter issued and outstanding and (3) any securities or options which may be converted into or exercised for shares of capital stock of the Corporation\n(k) Stockholders shall mean those persons identified on Schedule I attached hereto as the holders of Securities and shall include any other person who agrees in writing with the parties hereto to be bound by and to comply with all applicable provisions of this Agreement as contemplated by Sections 2(b) and 2(c).\nSECTION 2. Limitations on Sales of Securities -- General. Each Stockholder, and each member of the Group of such Stockholder, hereby agrees that he or it shall not at any time during the term of this Agreement Sell any Securities except:\n(a) by sale in accordance with Sections 3 and 6;\n(b) by pledge which creates a mere security interest in the Securities; provided, that the pledgee thereof shall agree in writing in advance with the parties hereto to be bound by and comply with all applicable provisions of this Agreement to the same extent as if it were the Stockholder making such pledge; or\n(c) by transfer to another member of the Group to which such Stockholder belongs; provided, that the recipient of such Securities shall agree in writing with the parties hereto to be bound by and to comply with all applicable provisions of this Agreement and to be deemed a member of such Group; or\n(d) by pledge or other transfer to First Fidelity Bank, National Association (\"First Fidelity\") pursuant to the Loan and Security Agreement dated September 30, 1994 with First Fidelity or any Agreement entered into in connection therewith or any revision or substitution thereof; or\n(e) by a sale made prior to June 15, 1995 provided the purchaser shall agree to become a party to this Agreement.\n(f) by surrender to the Corporation in satisfaction of any note given to enable the purchase of the Securities by the members of management of the Corporation.\nSECTION 3. Procedures on Sale of Stock. Except as otherwise expressly provided herein, each Stockholder and each member of the Group to which such Stockholder belongs hereby agrees that it or he shall not Sell any Securities except in accordance with the following procedures:\n(a) The Selling Group shall first deliver to the Corporation and each Eligible Group a written notice, which shall be irrevocable for a period of 10 days after delivery thereof, offering all or any part of the Securities owned by the Selling Group at the purchase price and on the terms specified therein, whereupon (i) first, the Corporation shall have the right and option to purchase all of the Securities so offered at the purchase price and on the terms stated in the notice of intention to Sell (such acceptance to be made by the delivery of a written notice to the Selling Group and each Eligible Group within the 10-day period after delivery of the aforesaid notice of intention to Sell); and (ii) second, if and only if the Corporation shall have failed to accept or shall have rejected in writing the foregoing offer, each Eligible Group shall have the right and option (subject to the provisions of Section 3(e)), to accept its Proportionate Percentage or some portion thereof of the Securities so offered at the purchase price and on the terms stated in the notice of intention to Sell, such acceptance to be made by the delivery of a written notice to the Selling Group within a 10-day period after the Corporation's failure to accept or rejection in writing of the foregoing offer.\n(b) If any Eligible Group shall fail to accept, or shall reject in writing, or only partly accept the offer made pursuant to Section 3(a), then, upon the earlier of the expiration of such 10-day period or the receipt of written notices of acceptance, or written rejections of such offer, from all Eligible Groups, the Selling Group's then remaining Securities formerly subject to such offer shall be reoffered to the remaining Eligible Groups, if any, which accepted their Proportionate Percentage of such offer for an additional 5-day period. Such subsequent offer shall be on the terms and subject to acceptance in the manner provided in Section 3(a), except that the Eligible Groups receiving such subsequent offer shall have the further right and option to offer, in any written notice of acceptance, to purchase any of such Securities not purchased by other Eligible Groups, in which case such Securities not accepted by the other Eligible Groups shall be deemed to have been offered to and accepted by the Eligible Groups which exercised their further right and option, pro rata in accordance with their respective Proportionate Percentages, and on the above-described terms and conditions.\n(c) Sales of Securities under the terms of Sections 3(a) and (b) above shall be made at the offices of the Corporation on a mutually satisfactory business day within 15 days after the expiration of the aforesaid periods. Delivery of certificates or other instruments evidencing such Stock duly endorsed for transfer to the Corporation or members of the Eligible Groups, as applicable, shall be made on such date against payment of the purchase price therefor.\n(d) If effective acceptance shall not be received pursuant to Sections 3(a) and (b) above with respect to all or any part of the Securities offered for sale pursuant to the aforesaid written notice, then the Selling Group may sell all or any part of the remaining Securities so offered for sale at a price not less than the price, and on terms not more favorable to the purchaser thereof than the terms, stated in the written notice of intention to Sell, at any time within 120 days after the expiration of the offer required by Sections 3(a) and (b) above. In the event the remaining Securities are not sold by the Selling Group during such 120-day period, the right of the Selling Group to Sell such remaining Securities shall expire and the obligations of this Section 3 shall be reinstated; provided, however, that in the event the Selling Group determines, at any time during such 120-day period, that the sale of all or any part of the remaining Securities on the terms set forth in the written notice of intention to Sell is impractical, the Selling Group can terminate the offer and reinstate the procedure provided in this Section 3 without waiting for the expiration of such 120-day period.\n(e) Notwithstanding Sections 3(a) and 3(b), if the Selling Group holds shares originally sold to management of the Corporation, Eligible Groups holding stock issued to the other management shall have the first option to purchase such shares.\n(f) Notwithstanding Sections 3(a) and 3(b), Andal may deliver shares to the Corporation pursuant to that certain Contingent Purchase Agreement dated December 16, 1994.\n(g) Notwithstanding Sections 3(a) and 3(b), all Stockholders may sell shares pursuant to the offering described in Section 13, hereof.\nSECTION 4. Event of Option. (a) If an Event of Option shall occur, each Eligible Group shall have the right and option to give the Corporation and the Stockholder (or his representatives or assigns) as to which such Event of Option has occurred, or the Prohibited Transferee, as the case may be, notice of its election to have the Fair Value of the Securities held determined, whereupon the Stockholders shall cause such determination to be made with reasonable promptness. Upon the completion of such determination, each Eligible Group shall have the right and option for a period of 10 days after such determination, to purchase from such Stockholder, his representatives or assigns, or the Prohibited Transferee, as the case may be, for cash, and at the Fair Value, its Proportionate Percentage (but not less than its Proportionate Percentage) of the Securities as to which such Event of Option has occurred, which option shall be exercised by delivery to the Corporation, during such 10- day period, of a written notice of election to purchase such Securities, whereupon the Corporation shall forthwith transmit any written notice of election to purchase delivered pursuant to this Section 4(a) to the Stockholder as to which such Event of Option has occurred, its representatives or assigns, or the Prohibited Transferee, as the case may be, but failure of the Corporation so to transmit any such notice shall in no way invalidate such notice; provided, however, that the Eligible Groups delivering such notice of election to purchase shall have the further right and option to purchase, in any such written notice of election to purchase, any such Stock not purchased by other Eligible Groups, in which case such Stock not accepted by the other Eligible Groups shall be deemed to have been offered to and accepted by the Eligible Groups which exercised their option hereunder, pro rata in accordance with their respective Proportionate Percentages, and on the above--described terms and conditions.\n(b) Sales of Securities effected under the terms of Section 4(a) shall be made at the offices of the Corporation on a mutually acceptable business day within 15 days after the expiration of the period referred to in Section 4(a). Delivery of certificates or other instruments evidencing such Securities duly endorsed for transfer shall be made on such date against payment of the purchase price therefor.\n(c) If any Securities as to which an Event of Option shall have occurred shall not be purchased in accordance with Section 4(a) for any reason other than failure of the owner thereof to comply with the provisions of this Agreement, such Securities shall thereupon cease to be subject to this Agreement; provided, however, that if such Securities are thereafter acquired by a member of any Group, they shall once again be deemed to be subject to this Agreement.\n(d) So long as a Stockholder belonging to an Eligible Group complies with the provisions of this Section 4, the provisions of Section 3 shall not apply to the sale of Stock being effected pursuant to this Section 4.\nSECTION 5. Right of Co-Sale. In the event any Stockholder or member of the Group to which such Stockholder belongs receives a bona fide offer from a third party which is not an Affiliate to purchase from such Stockholder or member of the Group of such Stockholder an amount of stock, when aggregated with contemporaneous offer amount to not less than 20% of the Common Stock then outstanding, assuming full conversion of Debentures or exercise of Options for a specified price payable in cash or otherwise and on specified terms and conditions (a \"Section 5 Offer\"), such Stockholder or member of such Group shall promptly forward a copy of the Section 5 Offer to the Corporation, and to the other Stockholders. Each such Stockholder or member of such Group shall not sell any such Securities to the Section 5 Offeror unless the terms of the Section 5 Offer are extended to the other Stockholders on a pro rata basis (being the ratio, based upon voting power, between the number of such shares owned by such Stockholder or member of such Group and all Stockholders). Such other Stockholders shall have 20 days from the date of the foregoing offer to accept such offer. Before the Stockholder or member of the Group who had received the Section 5 Offer extends such Section 5 Offer to the other Stockholders pursuant to this Section 5, such Stockholder or member of such Group shall first comply with the provisions of Section 3.\nSECTION 6. Board of Directors. At such time as Andal holds less than 90% of the Common Stock, the Board of Directors of the Corporation shall consist of eight members and shall include:\n(i) four directors who shall be designated by Andal;\n(ii) one director who shall be designated by Peter D. Flood;\n(iii) three directors who shall be non-management affiliated, non-Andal affiliated Stockholders who shall be designated in the first instance by the Board as a whole and then determined by the three outgoing directors.\nAll Stockholders agree to vote all shares held by them at any Annual or Special Meeting of Shareholders for such nominees and this Agreement is intended to be specifically enforceable should a dispute arise.\nSECTION 7. Legend on Stock Certificates. Each certificate of the signatories hereto representing Securities shall bear the following legend, until such time as the Securities represented thereby are no longer subject to the provisions hereof:\n\"THE SALE, TRANSFER, ASSIGNMENT, PLEDGE, OR ENCUMBRANCE OF THE SECURITIES REPRESENTED BY THIS CERTIFICATE AND\/OR THE RIGHTS OF THE HOLDER OF SUCH SECURITIES IN RESPECT OF THE ELECTION OF DIRECTORS ARE SUBJECT TO THE TERMS AND CONDITIONS OF A STOCKHOLDERS' AGREEMENT DATED AS OF DECEMBER 16, 1994, AMONG MULTI-ARC INC. AND CERTAIN HOLDERS OF OUTSTANDING COMMON STOCK OF SUCH CORPORATION, OUTSTANDING CONVERTIBLE SUBORDINATED DEBENTURES OR STOCK OPTIONS. COPIES OF SUCH AGREEMENT MAY BE OBTAINED AT NO COST BY WRITTEN REQUEST MADE BY ANY HOLDER OF THIS CERTIFICATE ADDRESSED TO THE SECRETARY OF MULTI-ARC INC.\"\nAll of the Securities are presently pledged. The foregoing legend will be placed on the certificates representing these pledged shares upon their release by the pledgee.\nSECTION 8. Duration of Agreement. The rights and obligations of each Stockholder under this Agreement shall terminate as to such Stockholder upon the earlier to occur of (i) the transfer of all Stock owned by the Group of which such Stockholder is a member in accordance with this Agreement, (ii) on the tenth anniversary of the date hereof or (iii) the consummation of an underwritten public offering of the Corporation's Common Stock registered pursuant to the Securities Act of 1933, as amended.\nSECTION 9. Severability; Governing Law. If any provision of this Agreement shall be determined to be illegal and unenforceable by any court of law, the remaining provisions shall be severable and enforceable in accordance with their terms. This Agreement shall be governed by, and construed in accordance with, the laws of the State of New Jersey.\nSECTION 10. Benefits of Agreement. This Agreement shall be binding upon and inure to the benefit of the parties and their respective successors and assigns, legal representatives and heirs.\nSECTION 11. Notices. All notices, advices and communications to be given or otherwise made to any party to this Agreement, or to the Group of any such party, shall be deemed to be sufficient if contained in a written instrument delivered in person or duly sent by first class registered or certified mail, postage prepaid, addressed to such party at the address set forth below or at such other address as may hereafter be designated in writing by the addressee:\nIf to the Corporation:\nMulti-Arc Inc. 200 Roundhill Drive Rockaway, New Jersey 07866\nIf to the Stockholders:\nAt their respective addresses set forth in Schedule I attached hereto\nor to such other address or addresses as shall have been designated by notice in writing to the parties hereto.\nAll such notices, advices and communications shall be deemed to have been received (a) in the case of personal delivery, on the date of such delivery and (b) in the case of mailing, on the third business day following such mailing.\nSECTION 12. Modification. Except as otherwise provided herein, neither this Agreement nor any provision hereof can be modified, changed, discharged or terminated except by an instrument in writing signed by the party against whom the enforcement of any modification, change, discharge or termination is sought or by the agreement of holders of 90% in voting power, assuming conversion of all outstanding Debentures and exercise of all outstanding Options, of all shares of Common Stock subject to this Agreement; provided, however that no modification or amendment shall be effective to reduce the percentage of the shares of Common Stock the consent of the holders of which is required under this Section 12, and provided that no modifications shall be made prior to June 15, 1995.\nSECTION 13. Offering by Prospectus. Andal agrees to offer to licensees of Multi-Arc Inc. 17,062.5 shares (7\/8th of 19,500 shares) of Multi-Arc Inc. Common Stock and Multi-Arc Inc. agrees to offer to such licensees $3,500,000 principal amount of its Debentures by offering by prospectus and in connection therewith Mr. Flood agrees to reoffer to management of Multi-Arc Inc. 975 shares of Common Stock and $200,000 principal amount of the Debentures. The offering price of the Common Stock shall be $205.1282 per share and the Debentures will be offered at par. The offering shall be conducted as soon as practical and close no later than June 15, 1995. Each purchaser in such offering, as a condition of their purchase, shall first agree in writing to become a party to this Agreement and Schedule I hereto shall thereupon be revised.\nSECTION 14. Captions. The captions herein are inserted for convenience only and shall not define, limit, extend or describe the scope of this Agreement or affect the construction hereof.\nSECTION 15. Nouns and Pronouns. Whenever the context may require, any pronouns used herein shall include the corresponding masculine, feminine or neuter forms, and the singular form of names and pronouns shall include the plural and vice versa.\nSECTION 16. Jurisdiction. Each party hereto hereby irrevocably and unconditionally submits to the nonexclusive jurisdiction of any New Jersey State court and Federal court of the United States of America sitting in the State of New Jersey, and any appellate court from any thereof, in any action or proceeding arising out of or relating to this Agreement.\nSECTION 17. Merger Provision. This Agreement constitutes the entire agreement among the parties pertaining to the subject matter hereof and supersedes all prior and contemporaneous agreements and understandings of the parties in connection therewith.\nSECTION 18. Counterparts. This Agreement may be executed in one or more counterparts, each of which shall be deemed to be an original, but all of which taken together shall constitute one and the same instrument.\nIN WITNESS WHEREOF, the parties hereto have executed this Agreement on the date first above written.\nMULTI-ARC INC.\nBy: \/s\/ Peter D. Flood Peter D. Flood, President\nANDAL CORP.\nBy: \/s\/ Walter N. Kreil, Jr. Walter N. Kreil, Jr. Vice President and Controller\n\/s\/ Peter D. Flood Peter D. Flood\n\/s\/ Walter N. Kreil, Jr. Walter N. Kreil, Jr.\nMULTI-ARC INDIA LTD.\nBy: Name: Title:\nTHE STOCKHOLDERS LISTED ON EXHIBIT A HERETO\nBy:\/s\/ Peter D. Flood Peter D. Flood Attorney-in-Fact\nSCHEDULE I\nName and Common Address Stock Debentures Options\nAndal Corp. 94,562.50 0 0 909 Third Avenue New York, NY 10022\nPeter D. Flood 2,193.75 $450,000 2,500 31 Old Armstead Road Chester, NJ 07930\nWalter N. Kreil, Jr. 243.75 $ 50,000 500 875 Bradford Avenue Westfield, NJ 07090\nMulti-Arc India Ltd. 1,218.75 $ 250,000 0 17, Kadamgirl Complex Hanuman Road Vlle Parle (East) Bombay - 400 057 India\nEXHIBIT 10(r)\nINCENTIVE STOCK OPTION AGREEMENT\nThis INCENTIVE STOCK OPTION AGREEMENT, dated as of June 15, 1995, between MULTI-ARC INC., a Delaware corporation (the \"Corporation\"), having is principal place of business at 200 Roundhill Drive, Rockaway, New Jersey 07866 and (Name), an employee of the Corporation or its subsidiary (herein \"Employee\") residing at (Address).\nThe Corporation desires, by affording the Employee an opportunity to purchase shares of its Common Stock $.01 Par Value (the \"Common Stock\"), to provide the Employee with an added incentive to continue in the employ of the Corporation and to continue and increase the Employee's efforts in that connection. This Incentive Stock Option Agreement (this \"Agreement\") is being entered into pursuant to the Multi-Arc Inc. 1994 Incentive and Non-Statutory Stock Option Plan (the \"Plan\") and is subject to the provisions thereof, including the determinations to be made by the Board of Directors of the Corporation (the \"Board\") pursuant to the Plan.\nIn consideration of the mutual covenants hereinafter set forth and for other good and valuable consideration, the parties hereto hereby agree as follows:\n1. Grant. The Corporation with the approval and direction of the Board irrevocably grants the employee the right and option (the \"Option\") to purchase all or any part of an aggregate of Two Hundred (200) shares of Common Stock on the terms and conditions herein set forth. This Option shall be an Incentive Stock Option.\n2. Price. The purchase price of the shares of Common Stock covered by the Option shall be $205.1282 per share, being the fair market value of the Common Stock on the date hereof.\n3. Time of Exercise. The term of the Option shall be for a period of ten (10) years from the date hereof, subject to earlier termination as provided in this Agreement. Except as provided in Paragraphs 5 and 6 hereof, the Option may not be exercised unless the Employee shall at the time of exercise be an employee of the Corporation. Neither the Option nor any rights related to the Option shall be exercisable for a period of one year from the date hereof when twenty percent (20%) of the Option shall become exercisable, except that if the Employee shall die, retire or become disabled then the Option shall be fully exercisable commencing upon such event. An additional twenty percent (20%) of the Option shall become exercisable each of the four successive anniversaries of the date hereof until the Option shall be fully exercisable. Notwithstanding the foregoing, no Option may be exercised prior to October 1, 1996.\n4. No Transfer. The Option shall not be transferable by the Employee otherwise than by Will or the laws of descent and distribution, and the Option may be exercised during his lifetime only by the Employee. The Option may not be assigned, transferred (except as aforesaid), pledged or hypothecated in any way (whether by operation of law or otherwise) and shall not be subject to execution, attachment or similar process. Any attempted assignment, transfer, pledge, hypothecation or other disposition of the Option contrary to the provisions hereof and the levy of any attachment or similar process upon the Option shall be null and void and without effect.\n5. Termination. In the event the employment of the Employee shall be terminated by reason of retirement (or early retirement pursuant to any pension or profit sharing retirement plan provided by the Corporation or any 50% or more owned subsidiary (a \"Subsidiary\") or disability, the Option may be exercised by the Employee at any time within thirty (30) days after such date (or one year after such date if the Employee is disabled within the meaning of Internal Revenue Code Section 22(e)(3)), but in no event after the expiration of ten (10) years from the date hereof, and only if and to the extent that he was entitled to exercise the Option at the date of his retirement (or early retirement)). The Option shall not be affected (i) by any change of duties or position so long as the Employee continues to be an employee of the Corporation or a Subsidiary or (ii) by any temporary leave of absence that does not sever the employment relationship, which leave of absence is approved, if for a period of not more than three months, by an officer of the Corporation, or if for a period of more than three months, by the Board.\n6. Death of Employee. If the Employee shall die while entitled to exercise the Option, the Option may be exercised by the legatee or legatees of the Option under the Employee's Will, the personal representative or distributees of the Employee to the extent that the Option would otherwise have been exercisable by the Employee at any time within a period of one (1) year after the date of the Employee's death, but this provision shall not otherwise extend the ten (10) year duration of the Option.\n7. Anti-Dilution Adjustments. In the event of any change in the outstanding Common Stock of the Corporation by reason of stock dividends, stock splits, recapitalizations, mergers, consolidations, combinations or exchanges of shares, split-ups, split-offs, liquidations or other similar changes in capitalization, or any distributions to common stockholders other than cash dividends, the numbers, class and prices of shares covered by this Option shall be appropriately adjusted by the Board of Directors, whose determination shall be conclusive; provided, however, that no such adjustment shall give the Employee any additional benefits under the Option.\n8. Corporate Transactions. Notwithstanding the provisions of Paragraph 7, if any \"corporate transaction\" as defined in Section 1.425-1 of the Treasury Regulations promulgated under the Internal Revenue Code of 1986 occurs after the date of this Agreement, and in connection with such corporate transaction, the Corporation and another corporation enter into an agreement providing for the issuance of substitute stock options in exchange for the Option or the assumption of the Option, in either case giving the Employee the right to purchase the largest whole number of shares of Common Stock of the Corporation or of any other corporation at the lowest option price permitted by said Section 1.425-1, the Option shall be deemed to provide for the purchase of such number of shares of Common Stock at such option price as shall be agreed upon by the Corporation and such other corporation, and the term \"Corporation\" herein shall mean the issuer of the stock then covered by the Option and the term \"Common Stock\" shall mean such stock.\n9. No Employment Agreement. This Agreement does not confer upon the Employee any right to continue in the employ of the Corporation nor does it interfere in any way with the right of the Corporation or the right of the Employee to terminate the employment of the Employee at any time.\n10. Restrictions. The obligation of the Corporation to sell and deliver shares of Common Stock with respect to the Option shall be subject to (i) all applicable laws, rules, regulations and such approvals by any governmental agencies as may be required, including the effectiveness of a registration statement under the Securities Act of 1933, as amended and (ii) the condition that the shares of Common Stock to be received upon exercise of the Option shall have been duly listed, upon official notice of issuance, on a stock exchange (to the extent that the Common Stock of the Corporation is then listed on any such stock exchange). In the event that the shares shall be delivered otherwise than in accordance with an applicable registration statement, the Corporation's obligation to deliver the shares is subject to the further condition that the Employee will execute and deliver to the Corporation an undertaking in form and substance satisfactory to the Corporation that (i) it is the Employee's intention to acquire and hold such shares for investment and not for resale or distribution, (ii) the shares will not be sold without registration or exemption from the requirement of registration under the Securities Act and (iii) the Employee will indemnify the Corporation for any costs, liabilities and expenses which it may sustain by reason of any violation of the Securities Act or any other law regulating the sale or purchase of securities occasioned by any act on his part with respect to such shares. The Corporation may require that any certificate or certificates evidencing shares issued pursuant to the Plan bear a restrictive legend intended to effect compliance with the Securities Act or any other applicable regulatory measures, and stop transfer instructions with respect to the certificates representing the shares may be given to the transfer agent.\n11. Exercise. Subject to the terms and conditions of this Agreement, the Option may be exercised only by written notice delivered to the Corporation at its principal business office, attention of the Chief Financial Officer, of intention to exercise such Option and by making payment of the purchase price of such shares against delivery of a certificate or certificates therefor as hereinafter provided. Such written notice shall:\n(a) state the election to exercise the Option and the number of shares in respect of which it is being exercised;\n(b) fix a date not less than seven (7) business days from the date such notice is received by the Corporation for delivery of the certificate or certificates for said shares and the payment of the purchase price therefor, and\n(c) be signed by the person or persons so exercising the Option and in the event the Option is being exercised by any person or persons other than the Employee, be accompanied by appro- priate proof of the right of such person or persons to exercise the Option.\nOn the date fixed in said written notice, a certificate or certificates for the shares as to which the Option shall have been so exercised, registered in the name of the person or persons so exercising the Option, shall be issued by the Corporation and delivered to or upon the order of such person or persons against payment in full at the above-mentioned address of the purchase price of said shares in cash, by check or by surrender or delivery to the Corporation of shares of the Corporation's Common Stock with a fair market value equal to or less than the Option price, plus cash equal to any difference. All shares issued as provided herein will be fully paid and nonassessable. The Employee shall not have any of the rights of the stockholder with respect to the shares of Common Stock subject to the Option until the certificate evidencing such shares shall be issued to him upon the due exercise of the Option.\n12. Option to Repurchase. So long as the Corporation's Common Stock is neither listed for trading nor traded in the over-the-counter market, the Corporation shall have the right to repurchase any and all shares of Common Stock acquired upon exercise of the option at such time as the Employee terminates his employment or the Employee's employment with the Corporation or any subsidiary is terminated for any reason (including death or disability) and this option shall continue for thirty (30) days after the date of termination or the date of any exercise of the stock option, whichever is later. The repurchase price shall be fair market value. A legend to this effect shall be conspicuously noted of each certificate for shares acquired pursuant to this Agreement.\n13. Availability of Shares. The Corporation shall at all times during the term of the Option reserve and keep available or contract for the availability of such number of shares of Common Stock as will be sufficient to satisfy the requirements of this Agreement, shall pay all original issue taxes with respect to the issue of shares pursuant hereto and all other fees and expenses necessarily incurred by the Corporation in connection therewith and will from time to time use its best efforts to comply with all laws and regulations which in the opinion of counsel for the Corporation shall be applicable thereto.\n14. Fair Market Value. As used herein, the \"fair market value\" of a share of Common Stock shall be:\n(a) if the Common Stock is listed on a national securities exchange, the closing price of the Common Stock on the Composite Tape on the trading day immediately preceding such given date;\n(b) if the Common Stock is traded on the over-the-counter market, the average of the bid and the asked price for the Common Stock as reported by the Wall Street Journal at the close of trading on the trading day immediately preceding such given date, and\n(c) if the Common Stock is neither listed on a national securities exchange or traded on the over-the-counter market, such value as the Board in good faith shall determine, which determination shall be conclusive.\n15. Repurchase Option. If the Employee is not employed by the Company on the date of exercise, or if subsequent to the date of exercise the employee ceases to be employed by the Company, the Company shall have the option for thirty (30) days from the later of (1) the date of termination, or (2) the date of exercise of the option (such later date being the \"Repurchase Date\") to elect to repurchase the Option Shares at the fair market value of the shares on the Repurchase Date.\n16. The Plan. The Option is granted pursuant to the terms of the Plan, which terms are incorporated herein by reference, and the Option shall in all respects be interpreted in accordance with the Plan. The Board of Directors shall interpret and construe the Plan and this Agreement, and the Board's interpretations and determinations shall be conclusive and binding on the parties hereto and any other person claiming an interest hereunder with respect to any issue arising hereunder or thereunder.\n17. Governing Law. This Agreement has been entered into and shall be construed in accordance with the laws of the State of New Jersey.\nIN WITNESS WHEREOF, the Corporation has caused this Agreement to be duly executed and sealed by its duly authorized officers and the Employee has hereunder set his hand, all as of the day and year first above written.\nATTEST: MULTI-ARC INC.\n\/s\/ Walter N. Kreil, Jr. By:\/s\/ Peter D. Flood Walter N. Kreil, Jr., Secretary Peter D. Flood, President\nEMPLOYEE\n____________________________________ (Name)\nEXHIBIT 10(s)\nFirst Fidelity Bank NA London Branch 1 Bishopsgate London EC2N 3AB ENGLAND Telephone: 0171-621 1477 Telex: 883432 Facs: 0171-929 4644\nThe Directors of Multi-Arc (U.K.) Limited Number One Industrial Estate Unit 36, Medomsley Road Consett County Durham DH8 6TS\nDate: 21st September 1995\nDear Sirs\nWe are pleased to advise you that First Fidelity Bank N.A. (the \"Bank\") (which expression shall include its successors, transferees and assigns) is agreeable to making available to Multi-Arc (U.K.) Limited, a company incorporated in England and Wales under registered number 1665506 (the \"Borrower\") and having an address at Number One Industrial Estate, Unit 36, Medomsley Road, Consett, County Durham, DH8 6TS a loan facility of a principal amount of Pounds Sterling1,500,000 by way of a single cash advance (the \"Loan Facility\") on the following terms and subject to the following conditions:\n1. DEFINITIONS\nIn this Agreement:-\n\"Agreement\" means the agreement resulting from the Borrower countersigning this letter;\n\"Bank Basis\" means a calculation made on the basis of the actual number of days elapsed or, as the case may be, to elapse and a 365 day year;\n\"Borrowed Money\" means Indebtedness incurred in respect of (I) money borrowed or raised, (ii) any bond, note, loan stock, debenture, bill of exchange, commercial paper or similar instrument (including share capital carrying a right to a preferential dividend redeemable at the option of shareholders or the issuer thereof at any time), (iii) acceptance or documentary credit facilities, (iv) rental payments under leases and hire- purchase agreements so far as attributable to payments of capital (in all cases whether in respect of land, buildings, machinery, equipment or otherwise) entered into primarily as a method of raising finance or of financing the acquisition of the asset the subject thereof, (v) obligations under conditional or instalment sale agreements or any other obligation to pay the deferred purchase or construction price of assets or services, except trade accounts arising in the normal course of day-to-day trading, and (vi) all other Indebtedness under any arrangement entered into primarily as a method of raising finance (and not in the normal course of, and as part of, day-to-day trading) and which is not referred to in the foregoing paragraphs of this definition and for the purposes of Clause 11.1(1) as shown in the latest accounts of the Borrower delivered pursuant to this Agreement. PROVIDED THAT Borrowed Money expressed in or calculated by reference to a currency other than Sterling shall be converted into Sterling by reference to the rate of exchange used for the conversion of such currency in the preparation of the relevant accounts or, if the relevant currency was not thereby involved, by reference to such rate of exchange or approximate rate of exchange ruling on the date of such determination as the Bank may in its absolute discretion determine or approve;\n\"Business Day\" means a day on which commercial banks are open in London for transactions of the type of business contemplated by this Agreement;\n\"Capital Expenditure\" means capital expenditure as determined in accordance with generally accepted accounting principles and bases and as shown in the relevant accounts of the Borrower delivered pursuant to this Agreement for the relevant period;\n\"Cash Flow\" means, in respect of the Borrower and the period being measured, net income (including for the avoidance of doubt interest received) after adding back Debt Payments, depreciation and any other non-cash charges, less capital expenditure all as shown in the relevant accounts of the Borrower delivered pursuant to this Agreement;\n\"Charge over Shares\" means the charge over shares to be entered into by the Guarantor in favour of the Bank in form and substance satisfactory to the Bank;\n\"Current Assets\" means, at any time, the assets of the Borrower which, in accordance with generally accepted accounting principles and bases, are classified as such in the latest accounts of the Borrower delivered pursuant to this Agreement, after deducting all reserves properly deductible in respect of such assets (again as shown in the latest accounts of the Borrower delivered pursuant to this Agreement);\n\"Current Liabilities\" means, at any time, the aggregate of the liabilities of the Borrower falling due within one year of the date of computation as shown in the latest accounts of the Borrower delivered pursuant to this Agreement;\n\"Current Ratio\" means the ratio of Current Assets to Current Liabilities;\n\"Dangerous Substances\" means any radioactive emissions and any natural or artificial substances (whether in solid or liquid form or in the form of a gas or vapour and whether alone or in combination with any other substances) capable of causing harm to man or any other living organism supported by the environment, or damaging the environment or public health or welfare, including any controlled, special, hazardous, toxic, radioactive or dangerous waste;\n\"Debt Payments\" means in respect of the Borrower and the period being measured, interest accruing pursuant to the Overdraft Facility, interest accruing pursuant to the terms hereof and all payments of principal due and\/or made hereunder together with all and any interest, commission, fees or other similar financing costs accruing or, as the case may be, incurred and all payments of principal due and\/or made under or in connection with any Borrowed Money, all as shown in the relevant accounts of the Borrower delivered pursuant to this Agreement;\n\"Debt Service Coverage Ratio\" means the ratio of Cash Flow to Debt Payments of the Borrower;\n\"Environmental Law\" means all laws, regulations, codes of practice, circulars, guidance notices and the like binding on the Borrower, (whether of the United Kingdom or elsewhere and including any directive of the European Community which is so binding) concerning the protection of human health or the environment or the conditions of the workplace or the generation, transportation, storage, treatment or disposal of Dangerous Substances;\n\"Environmental Licences\" means any permit, licence, authorisation, consent or other approval required by any Environmental Law;\n\"Event of Default\" means any one of the events specified in Clause 12 or any event which with the passing of time or the giving of notice or the making of any determination, formation of any opinion or fulfilment of any other condition would constitute such an event;\n\"Finance Documents\" means this Agreement, the Overdraft Facility, each of the Security Documents, any certificates or notices given pursuant to any of the same and any other document as between any of the Borrower, the Guarantor and the Bank designated as such by the Bank;\n\"Fixed Rate\" means the fixed rate of interest which the Bank is prepared to offer the Borrower in connection with the Loan Facility and which is notified to the Borrower prior to the latest time for the issue of the Notice of Drawing or, prior to the date on which a Notice of Fixed Interest Rate Selection is to take effect (as applicable);\n\"Guarantor\" means Multi-Arc, Inc;\n\"Indebtedness\" includes any obligation whether as principal or as surety for the payment or repayment of money, whether present or future, actual or contingent;\n\"Interbank Rate\" means in relation to any Interest Period the rate (rounded upwards if necessary to 4 decimal places) at which the Bank is offered deposits of Sterling by leading banks in the London Interbank Market at or about 11.00 a.m. (London time) on the first day of such Interest Period for a period equal to such Interest Period and in an amount comparable with the amount to be outstanding during such Interest Period;\n\"Interest Payment Date\" in relation to any Interest Period means the last day of such Interest Period;\n\"Interest Period\" means:\n(A) if the fixed interest rate option is chosen in the Notice of Drawing, a period ending on each Repayment Date with the first such period commencing on the date the Loan is made and each subsequent Interest Period commencing forthwith upon the expiry of the previous Interest Period; or\n(B) in relation to the period after a Notice of Fixed Interest Rate Selection has been given to the Bank, a period ending on each subsequent Repayment Date with the first such period commencing on the date the Notice of Fixed Interest Rate Selection is to take effect and each subsequent Interest Period commencing forthwith upon the expiry of the previous Interest Period; or\n(C) if the variable interest rate option is chosen in the Notice of Drawing and no Notice of Fixed Interest Rate Selection has been given to the Bank, subject as provided below, a period of three months, but so that:-\n(1) the first Interest Period shall commence on the date the Loan is made;\n(2) each subsequent Interest Period will commence forthwith upon the expiry of the previous Interest Period;\n(3) if any Interest Period would otherwise end on a day which is not a Business Day, that Interest Period shall be extended to the next succeeding Business Day unless such succeeding Business Day falls in another calendar month in which event the Interest Period shall end upon the immediately preceding Business Day; and\n(4) if any Interest Period would otherwise end after the Final Repayment Date, it shall be shortened so as to end on the Final Repayment Date.\n\"Loan\" means the Pounds Sterling1,500,000 to be lent to the Borrower in accordance with Clause 5, or, where the context so requires, the principal amount thereof outstanding from time to time;\n\"Margin\" means one and one half per cent (1-1\/2%) per annum;\n\"MLA Cost Rate\" means in relation to any Interest Period, the cost to the Bank of complying with all reserve, special deposit, capital adequacy, solvency, liquidity ratios or other requirements of or imposed by the Bank of England or any other governmental or regulatory authority for the time being attributable to the Loan (rounded up if necessary to 4 decimal places) as conclusively determined by the Bank;\n\"Mortgage Debenture\" means the mortgage debenture to be entered into by the Borrower in favour of the Bank in form and substance satisfactory to the Bank;\n\"Notice of Drawing\" means a notice requesting drawing substantially in the form set out in the Schedule;\n\"Notice of Fixed Interest Rate Selection\" means a notice to be given to the Bank no later than two Business Days prior to an Interest Payment Date to take effect on that Interest Payment Date and stating that the Borrower wishes to switch to the Fixed Rate for the remainder of the term of the Loan.\n\"Overdraft Facility\" means the overdraft facility to be entered into by the Borrower and the Bank together with an ancillary letter from the Bank to the Borrower setting out further details pursuant to which an overdraft facility is to be made available to the Borrower by the Bank;\n\"Multi-Arc. Inc Guarantee\" means the guarantee to be given by Multi-Arc, Inc in favour of the Bank for the obligations of the Borrower to the Bank hereunder and under the Overdraft Facility;\n\"Multi-Arc (U.K.) Limited Guarantee\" means the guarantee to be given by the Borrower in favour of the Bank for the obligations of the Guarantor to the Bank under the SC Guarantee;\n\"Permitted Encumbrance\" means any Security Interest (or in the case of (b) only, any lien):-\n(a) created or outstanding with the prior written consent of the Bank;\n(b) arising by operation of law (and not as a result of any default or omission on the part of the Borrower) in the ordinary course of business and securing obligations not more than three months overdue;\n(c) arising under any retention of title arrangements (other than \"all moneys\" retention of title arrangements) entered into in the ordinary course of trading and not entered into primarily for the purpose of securing any Indebtedness;\n(d) over goods or documents of title to goods arising in the ordinary course of trading in connection with documentary credit transactions where such Security Interest secures only so much of the acquisition cost or selling price (and amounts incidental thereto) of such goods and products which is required to be paid within 180 days after the date upon which the same was first incurred;\n(e) on assets acquired after the date of this Agreement, or on assets of a body corporate which becomes a Subsidiary by acquisition after the date of this Agreement, provided that:\n(i) any such Security Interest is in existence prior to such acquisition and is not created in contemplation of such acquisition; and\n(ii) the amount secured by such Security Interest does not exceed, at any time, the maximum amount secured or agreed to be secured by it (in accordance with the original terms on which such Security Interest was created) as at the date of acquisition;\n(iii) such Security Interest is discharged within a period of 3 months after the acquisition; and\n(iv) no guarantee is given by the Borrower in respect of such Security Interest or the amount secured by it;\n(f) securing Indebtedness incurred to refinance other Indebtedness permitted to be secured under paragraphs (a) to (e) above inclusive and\/or this paragraph (f), provided that the aggregate principal amount of the Indebtedness secured by such Security Interest is not increased and such Security Interest does not extend to any assets other than those which were subject to the original Security Interest securing the refinanced Indebtedness;\n\"Repayment Date\" means the date falling 90 days after the date of drawdown of the Loan and each date falling three months after the previous Repayment Date, and the \"Final Repayment Date\" shall mean the date falling five years after the date of drawdown of the Loan;\n\"SC Borrowers\" means all and each of Scientific Coatings of Illinois, Inc., Scientific Coatings, Inc. and SCI Coatings Southwest, Inc;\n\"SC Facility Agreement\" means the Loan and Security Agreement dated 30 September 1994 and made between the Bank and the SC Borrowers;\n\"SC Guarantee\" means the guarantee dated 30 September 1994, as the same is or has been varied, amended, supplemented, substituted, novated or assigned from time to time given by Vagle Technology, Inc and the Guarantor in favour of the Bank for the obligations of the SC Borrowers under, inter alia, the SC Facilities;\n\"Security Documents\" means the Mortgage Debenture, the Charge over Shares, the Multi-Arc, Inc Guarantee, any interest rate hedging agreement from time to time entered into by the Borrower, any certificates or notices given pursuant to any of the same and any other document designated as such by the Bank;\n\"Security Interest\" means any mortgage, charge, pledge, lien, encumbrance, conditional sale or other title retention agreement, trust arrangement, preferential right or other agreement or arrangement the economic or commercial effect of which is similar to security or any other security interest whatsoever, howsoever created or arising;\n\"Sterling\" or \"Pounds Sterling\" means the lawful currency of the United Kingdom;\n\"subsidiary\" and \"subsidiary undertaking\" shall have the meanings given to them by Sections 736 and 258 (respectively) of the Companies Act 1985 (as amended);\n\"Tangible Net Worth\" means the aggregate of the amounts paid-up or credited as paid-up on the Borrower's issued share capital and the amount of the consolidated capital and revenue reserves of the Borrower (including any share premium account, merger reserve, capital redemption reserve, revaluation reserve and retained earnings) and the balance on the Borrower's profit and loss account all as shown by the latest accounts of the Borrower delivered pursuant to this Agreement from time to time but after:-\n(i) deducting any amount shown in respect of goodwill (including goodwill arising on consolidation), patents, trade marks, copyrights, brands, research and development expenditure and other intangible assets;\n(ii) deducting any amounts distributed or proposed to be distributed out of the profits accrued prior to the date of such financial statements to the extent that such distribution is not provided for therein;\n(iii) excluding any sums set aside or otherwise reserved or provided for losses, taxation or expenses;\n(iv) excluding any amounts as in the opinion of the auditors of the Borrower for the time being are attributable to any write ups of fixed assets in the books of the Borrower made after the date hereof; and\n(v) making such adjustments to reflect any variations which shall have occurred since the date of such financial statements:-\n(a) in the amounts paid up or credited as paid up on the issued share capital of the Borrower (including any share premium account, merger reserve, capital redemption reserve, revaluation reserve and retained earnings); and\n(b) to reflect any changes in generally accepted accounting principles and bases and the application of standards and practices since then as may be appropriate in the opinion of the auditors for the time being of the Borrower;\nHeadings in this Agreement are inserted for convenience only and shall be ignored in construing this Agreement.\nExpressions herein defined shall have the same meanings herein.\nUnless the context otherwise requires, words denoting the singular number only shall include the plural and vice versa and words denoting persons shall include companies, corporations and partnerships and vice versa.\nReferences to Clauses and Schedules are to be construed as references to Clauses of and Schedules to this Agreement unless the context otherwise requires.\nA time of day is a reference to London time.\nAny reference in this Agreement to an agreement or document shall be construed as a reference to that agreement or document as the same may have been, or may from time to time be, varied, amended, supplemented, substituted, novated or assigned.\nReferences in this Agreement to statutes and\/or statutory provisions shall be construed as referring to such statutes or statutory provisions as respectively replaced, amended, extended, consolidated or re-enacted from time to time and shall include any order, regulation, instrument or other subordinate legislation made under the relevant statute or statutory provisions.\n2. PURPOSE\nThe Borrower undertakes to the Bank that the Loan Facility shall only be applied in and towards the refinancing of term debt from Siemens Financial Services Limited, The Governor and Company of The Bank of Scotland, Derwentside District Council and British Coal Enterprise Limited, the purchase of equipment from Multi-Arc, Inc on arms length terms, the making of a loan by the Borrower to Multi-Arc Inc and\/or the refinancing of term debt from British Steel.\n3. AMOUNT\nSubject to the terms and conditions of this Agreement, the Bank agrees to make available to the Borrower the Loan Facility.\n4. CONDITIONS PRECEDENT\nThe rights of the Borrower under this Agreement to draw down the Loan Facility are conditional upon the Bank having received, in form and substance satisfactory to it, all of the following:-\n(A) a copy, certified by a director of the Borrower to be true, complete and up to date, of the memorandum and articles of association, certificate of incorporation and any certificates of incorporation on change of name of the Borrower;\n(B) a copy, certified by a director of the Borrower to be true, complete and up to date, of minutes of the meeting(s) of the board of directors of the Borrower at which valid resolutions were adopted approving the Finance Documents to which it is a party and all the other documents relating thereto and authorising a person or persons to sign and deliver (or execute as a deed, if appropriate) the Finance Documents to which it is a party and to sign and deliver or despatch all other such documents and all notices, communications or documents to be given by it pursuant to or in connection with such Finance Documents;\n(C) a copy, certified by a director of the Guarantor to be true, complete and up to date, of minutes of the meeting(s) of the board of directors of the Guarantor at which valid resolutions were adopted approving the Finance Documents to which it is a party and all the other documents relating thereto and authorising a person or persons to sign and deliver (or execute as a deed, if appropriate) the Finance Documents to which it is a party and to sign and deliver or despatch all other such documents and all notices, communications or documents to be given by it pursuant to or in connection with such Finance Documents;\n(D) a list of names and specimen signatures, certified as aforesaid, of each of the persons referred to in Clauses 4(B) and 4(C);\n(E) a certificate signed by a director of the Borrower stating, inter alia, that the signing of the Finance Documents to which it is a party is within its corporate powers and will not cause any limitation on its borrowing or other powers or on the right of its directors to exercise any such powers (whether contained in its constitutional documentation or in any agreement or instrument or imposed by statute or regulation or otherwise) to be exceeded;\n(F) the Security Documents and the Multi-Arc (U.K.) Limited Guarantee duly executed by the parties thereto (except the Bank) and all documents required to be delivered to the Bank pursuant to the Security Documents, including without limitation all documents of title and all insurance policies;\n(G) relevant bank mandates and other forms required for the operation of any account of the Borrower;\n(H) evidence that satisfactory insurance cover (including public liability cover and terrorism risk) in respect of the assets of the Borrower has been taken out and that the premium payments are up to date and that the Bank is a joint insured under all such insurance or the Bank's interest as mortgagee has been noted on the policy(ies) and full details of such insurance;\n(I) the initial fee payable pursuant to Clause 13.1;\n(J) written confirmation from the Borrower's auditors that they are aware that the Bank will be relying on the Borrower's audited financial statements from time to time for the purposes hereof; and\n(K) such other documents and information as the Bank may require.\nDRAWING THE LOAN\nSubject to:-\n(1) the conditions set out in Clause 4 having been fulfilled by no later than 11.00 am on the second Business Day preceding the date on which the Loan is to be drawn;\n(2) no Event of Default having occurred; and\n(3) the Bank having received a Notice of Drawing by no later than 9.30 a.m. on the second Business Day preceding the date on which the Loan is to be drawn (or such later time as the Bank may agree), duly completed and signed by the Borrower together with evidence showing that the Loan will be used for one or more of its agreed purposes and the amounts of the loan to be used for each of such purposes in form and substance satisfactory to the Bank,\nthe Bank shall, upon and subject to the terms and conditions of this Agreement, make available the Loan by way of a single drawing on the day and to the person(s) specified in such Notice of Drawing, or if such day is not a Business Day on the next succeeding Business Day, provided that if the Loan shall not have been drawn down on or prior to 30th October 1995 the obligation of the Bank to make the Loan available hereunder shall be cancelled.\n6. INTEREST\n6.1 (A) The rate of interest applicable to each Interest Period shall be the rate determined by the Bank to be the aggregate of (I) the Margin and (ii) the Fixed Rate, if the fixed interest rate option has been chosen in the Notice of Drawing or a Notice of Fixed Interest Rate Selection has been given to the Bank, or the aggregate of (I) the Margin, (ii) the Interbank Rate, and (iii) the MLA Cost Rate if the variable interest rate option has been chosen in the Notice of Drawing and no Notice of Fixed Interest Rate Selection has been given to the Bank;\n(B) Interest on the Loan at the rate(s) aforesaid shall be calculated for each Interest Period on the Bank Basis, shall accrue from day to day and be paid on each Repayment Date (in the case of the fixed interest rate option) or on each Interest Payment Date (in the case of the variable interest rate option); and\n(C) On repayment or prepayment of the Loan in whole or in part, all interest accrued and unpaid on the amount to be repaid or prepaid shall be paid by the Borrower to the Bank.\n6.2 If any sum due and payable by the Borrower hereunder is not paid on the due date therefor or if any sum due and payable by the Borrower under any judgment of any court in connection herewith is not paid on the date of such judgment, such unpaid sum shall bear interest until the obligation of the Borrower to pay any such sum is discharged in full at the rate per annum which is determined by the Bank to be the aggregate of (1) the Margin, (2) Midland Bank plc's base rate from time to time and (3) two per cent (2%) with such interest being compounded monthly in arrear on the last day of each calendar month.\n7. ALTERNATIVE INTEREST RATES\n7.1 Notwithstanding anything to the contrary herein contained, if the variable interest rate option has been chosen in the Notice of Drawing and prior to the commencement of any Interest Period relating thereto, the Bank shall have determined that:-\n(A) by reason of circumstances affecting the London Interbank Market adequate and fair means do not exist for ascertaining the Interbank Rate applicable to such Interest Period pursuant to Clause 6.1; or\n(B) deposits in Sterling are not or will not be available to the Bank in the London Interbank Market in sufficient amounts in the ordinary course of business to fund the Loan for such Interest Period,\nthen the Bank shall as soon as practicable give written notice of such determination or notice to the Borrower.\n7.2 In the case of Clause 7.1 if the Loan has not yet been advanced it shall not be so advanced and if the Loan has been advanced the liability of the Bank to maintain the Loan shall cease except, in each case, in accordance with the following provisions of this Clause 7.\n7.3 During the period of thirty days from the date of any such notice given pursuant to Clause 7.1 the Bank shall establish (in consultation with the Borrower) an alternative basis (in this Clause 7 referred to as the \"Substitute Basis\") for funding the Loan (including but without limiting the generality hereof, agreeing a suitable alternative length of Interest Period and agreeing the fixing of an alternative interest rate to be substituted for the rate which would otherwise have been fixed pursuant to Clause 6). The Substitute Basis shall reflect all costs to the Bank of making available the Loan and the Margin and shall be computed in a manner and for a period as similar to those provided in Clause 6.1 as is reasonably possible.\n7.4 If the Bank shall agree such Substitute Basis with the Borrower it shall again be open to the Borrower (subject to all the other terms of this Agreement) to request that the Loan be made or to request that the Bank maintain the Loan, as the case may be, and the Borrower shall, until the circumstances specified above no longer exist, pay interest on the Loan on such Substitute Basis. In default of agreement upon a mutually acceptable Substitute Basis within 30 days of the notice referred to in Clause 7.1 the Bank shall be discharged from any further obligation to make available the Loan or to maintain the Loan, as the case may be, and if the Loan shall be outstanding, the Borrower shall repay forthwith to the Bank the Loan together with interest thereon to the date of repayment at a rate equal to the Bank's cost of funding the same and all other amounts payable to the Bank hereunder.\n7.5 The certificates, confirmations and determinations of the Bank as to any of the matters referred to in this Clause 7 shall, save for manifest error, be conclusive and binding on the Borrower.\n8. REPAYMENT\nSubject as otherwise provided in this Agreement, the Borrower shall repay the Loan by twenty quarterly instalments. The first nineteen instalments will be of Pounds Sterling54,000 and paid on the first nineteen Repayment Dates with the final instalment of Pounds Sterling474,000 being paid on the Final Repayment Date. Each instalment is to be paid on a Repayment Date, and the Borrower shall ensure that the Loan, together with all interest accrued thereon is repaid, on the Final Repayment Date.\n9. PREPAYMENT\n9.1 The Borrower may on giving thirty days' written notice at any time prepay (upon payment to the Bank of the sum of Pounds Sterling10,000 (the \"Prepayment Fee\") (other than where prepayment is effected pursuant to Clause 7.4 and\/or Clause 14) and subject to Clause 16.1) the whole of the Loan together with interest thereon accrued to the date of prepayment, such notice specifying the date and the amount of the prepayment and (where appropriate) accompanied by the Prepayment Fee and evidence satisfactory to the Bank that all authorisations, consents and approvals, if any, necessary for such prepayment have been obtained.\n9.2 Any notice of intended prepayment pursuant to this Clause 9 shall be irrevocable and it shall be obligatory for the Borrower to make the prepayment in accordance with such notice.\n9.3 The Borrower shall not be entitled to prepay the Loan or any part thereof otherwise than in accordance with the provisions of this Agreement. Any amount prepaid may not be reborrowed.\n10. REPRESENTATIONS AND WARRANTIES\nThe Borrower represents and warrants to the Bank on each date that any amount remains outstanding, or capable of being drawn down, under any of the Finance Documents as follows:-\n(A) it is duly incorporated and validly existing under the laws of the jurisdiction in which it is incorporated as a limited liability company and is duly authorised and empowered under the said laws to own its assets and to carry on its business and it has the power to execute, deliver and perform and has taken all necessary corporate action to authorise the execution and delivery of and the performance of its obligations under the Finance Documents to which it is a party and all other documents referred to herein or therein to which it is a party;\n(B) each of the Finance Documents to which it is a party has been duly executed on its behalf and constitutes its legal, valid and binding obligations enforceable in accordance with its terms and the execution and performance of all of such documents will not breach, conflict with or contravene any provisions of any law, statute, rule, regulation, agreement, indenture, undertaking, memorandum and articles of association or other constitutional documentation or any other instrument binding upon it or on any of its assets or give cause for acceleration of any of its Indebtedness or result in the existence of or oblige it to create any Security Interest (other than as created by the Security Documents) over all or any of its present or future revenues, assets or properties;\n(C) it is not in default under any agreement, instrument, arrangement, obligation or duty to which it is a party or by which it is or may be bound and there is no action, litigation, lawsuit or proceeding taking place or pending or threatened against or affecting it before any court, judicial, administrative, arbitral or governmental body or agency which in any such case could result in any material adverse change in its financial condition, assets, business or operations taken as a whole;\n(D) all actions, licences, consents, exemptions and registrations (including, without limitation filings with all governmental or any other regulatory body, authority, bureau or agency and any consents or approvals required for the execution of, or the performance by the Borrower of its obligations under, the Finance Documents to which it is a party) required for the validity, performance and enforceability of the Finance Documents to which it is a party have been obtained and are in full force and effect and any condition contained therein or otherwise applicable thereto has been fulfilled or complied with;\n(E) all its obligations and liabilities under the Finance Documents to which it is a party constitute its direct, unconditional and general obligations and rank ahead in point of security and priority of all its other present and future Indebtedness and liabilities (with the exception of any obligations which are mandatorily preferred by law and not by contract);\n(F) all the factual information provided by it, any of its officers or any person on its behalf to the Bank in connection with this Agreement and any of the matters referred to in Clause 2 is true and accurate in all material respects and it is not aware of any material facts or circumstances that have not been disclosed to the Bank and which, if disclosed, could adversely affect the decision of a person considering whether or not to provide finance to the Borrower on the terms and subject to the conditions of this Agreement;\n(G) its latest audited accounts give a true and fair view of its financial condition as at the date to which such accounts are made up;\n(H) no Dangerous Substance has been used, disposed of, generated, stored, transported, dumped, deposited, buried or omitted at, on, from or under any premises (whether or not owned, leased, occupied or controlled by the Borrower) in circumstances where this might result in a liability on the Borrower, which, if proven, might in the opinion of the Bank have a material adverse affect on its ability to perform its obligations under the Finance Documents;\n(I) all requisite Environmental Licences have been obtained and all Environmental Licences and other applicable Environmental Law have at all times been complied with;\n(J) no Event of Default has occurred; and\n(K) the Borrower has no trading subsidiaries or subsidiary undertakings.\n11. COVENANTS AND UNDERTAKINGS\n11.1 Positive Covenants\nThe Borrower covenants and undertakes with the Bank that so long as any amount remains outstanding, or capable of being drawn down or any liability to the Bank subsists, under any of the Finance Documents it shall:-\n(A) ensure that each of its financial years ends on 30th September and it shall furnish to the Bank within 90 days of the end of each of their respective financial years a copy of its and the Guarantor's respective audited financial statements (consolidated in the case of the Guarantor) prepared in accordance with generally accepted accounting principles and bases in its place of incorporation consistently applied, audited by a firm of auditors acceptable to the Bank and representing a true and fair view of its financial position at the date of such statements and the results of its operations for the period ended on such date together with a certificate from the auditors confirming that the Borrower is in compliance with the covenant contained in Clauses II.I(H), (1), (J), (K) and (L);\n(B) furnish to the Bank within 20 days of the end of each calender month a copy of its and the Guarantor's respective internal monthly management accounts certified by its finance director (or the Guarantor's finance director, as appropriate) as representing a true and fair view of its financial position at the date of such accounts and the results of its operations for the period ended on such date together with an aged receivables analysis in such format as the Bank may require certified by its finance director as representing a true and fair view of the receivables of the Borrower for the period(s) in question;\n(C) promptly furnish to the Bank such additional financial or other information as the Bank may from time to time reasonably require;\n(D) comply with all lawful and applicable laws (including all Environmental Law) and regulations of all governmental and regulatory authorities relating to or affecting any of the Borrower's assets and\/or its business and will obtain and promptly renew from time to time and comply with the terms of all consents, approvals, authorisations, licences (including all Environmental Licences) and\/or exemptions which may be necessary to enable it properly to operate its business and to carry out its obligations under each of the Finance Documents;\n(E) notify the Bank in writing promptly on becoming aware of any Event of Default with a description of any steps which it is taking or considering taking in order to remedy or mitigate the effect of the Event of Default or otherwise in connection with it;\n(F) notify the Bank promptly, and in any event within 14 days of its becoming aware of the same, in writing of any litigation or proceeding which is commenced, pending or threatened in respect of the Borrower, where the litigation concerned could result in a liability of more than Pounds Sterling 25,000 on the part of the Borrower;\n(G) ensure that at all times it is able to pay its debts as they fall due and that any obligation owed to a creditor of the Borrower is met on the due date therefor or within any applicable originally agreed credit period or otherwise within time limits customarily adhered to by the Borrower;\n(H) ensure that Debt Service Coverage Ratio shall not be less than 1.5:1 for any twelve month period ending on 31 March, 30 June, 30 September and 31 December:\n(I) ensure that the ratio of Borrowed Money to Tangible Net Worth shall not at any time be greater than 2:1;\n(J) ensure that its Capital Expenditure does not, in any financial year of the Borrower, exceed Pounds Sterling350,000 in aggregate, without the prior written consent of the Bank;\n(K) ensure that the Current Assets exceed the Current Liabilities, at all times, by a minimum of Pounds Sterling25; and\n(L) ensure that Tangible Net Worth is at all times in excess of Pounds Sterling800,000.\n11. 2 Negative Covenants\nThe Borrower covenants and undertakes with the Bank that so long as any amount remains outstanding, or capable of being drawn down or any liability to the Bank subsists, under any of the Finance Documents it shall not:-\n(A) without the prior written consent of the Bank, create or attempt to create or permit to subsist any Security Interest of any kind, other than any Permitted Encumbrances, over the whole or any part of its respective undertaking, property, assets or revenues save as permitted pursuant to the Mortgage Debenture;\n(B) carry out any business other than the business it presently carries out at the date hereof, nor shall it make or permit any change in the scope or nature of its business or cease to carry on its business;\n(C) sell, transfer, assign, lease, charter, lend or otherwise dispose of or part with possession or the ownership of or any interest in any of its property, assets, revenues or undertaking or any part thereof save in the ordinary course of business and shall not enter into or undertake any invoice discounting or factoring arrangements;\n(D) it shall not issue any shares, debentures or other securities without the prior written consent of the Bank;\n(E) enter into banking or other credit facility arrangements of whatsoever nature or any interest rate or other exchange or hedging agreement other than with the Bank or otherwise incur any Indebtedness in relation to Borrowed Money (excluding for this purpose rental payments under leases and hire-purchase agreements provided that the cost of any assets the subject of such leases or hire purchase agreements purchased in any one financial year of the Borrower when aggregated with the cost of any other such assets purchased in that financial year does not exceed Pounds Sterling350,000) other than under the Finance Documents;\n(F) acquire, establish or permit to subsist any subsidiary or subsidiary undertaking or acquire any interest in, enter into or form any partnership or joint venture without the prior written consent of the Bank and shall not permit any dormant subsidiary or subsidiary undertaking to carry out any activity or take any action which would result in such subsidiary or subsidiary undertaking ceasing to be dormant;\n(G) amend its memorandum or articles of association in any way without the prior written consent of the Bank; or\n(H) make any loans to, grant credit to, grant indemnities in respect of, or guarantees in support of, or invest in, any third party otherwise than in the ordinary course of its trading activities or, in the case of loans, to Multi-Arc, Inc provided that no Event of Default has occurred prior to the making of any such loan.\n12. EVENTS OF DEFAULT\nIn the event that:-\n(A) the Borrower shall fail to pay any sum required to be paid under any Finance Document in the case of principal or interest on the due date therefor or in the case of any other payment within 7 Business Days of the due date therefor; or\n(B) the Borrower or the Guarantor shall default in the due performance or observance of any other covenant, undertaking, condition or provision on its part contained in any Finance Document and such default is not capable of remedy, or if in the opinion of the Bank capable of remedy, shall not have been remedied to the satisfaction of the Bank within10 days of the earlier of the Bank serving notice on the Borrower or the Guarantor requiring the same to be remedied and the Borrower or the Guarantor becoming aware of the same; or\n(C) any representation, warranty or statement made or deemed to be made by the Borrower in or pursuant to any Finance Document to which it is a party (including in any certificate or notice made or delivered pursuant thereto) and which the Bank considers to be material shall be untrue or incorrect in any material respect when made or repeated or if any event occurs as a result of which any such representation, warranty or statement if repeated at any time hereafter with reference to the facts subsisting at the time of such repetition, would be untrue or incorrect in any material respect; or\n(D) any other Borrowed Money exceeding in aggregate Pounds Sterling25,000 of the Borrower shall by reason of breach or default become due and payable prior to its stated maturity or due date or if any such Borrowed Money is not paid at the maturity thereof or due date therefor (or within any originally stated applicable grace period therefor) or, if payable on demand, is not paid on demand or if the Borrower fails to pay when due any amount payable by it under any present or future guarantee or indemnity in respect of Borrowed Money or if any Security Interest in respect of Borrowed Money created by it becomes enforceable and steps are taken to enforce the same; or\n(E) any Event of Default (as defined in the SC Facility Agreement) occurs; or\n(F) the Borrower or the Guarantor becomes insolvent or applies for or consents to or suffers the appointment of a liquidator, administrator, receiver, administrative receiver, encumbrancer, trustee in bankruptcy or similar official of the whole or any part of its assets, business, property, revenues or undertaking or a petition for the appointment of an administrator or liquidator of the Borrower or the Guarantor is presented (and not, unless the same has been advertised, withdrawn within 21 days of presentation) or the Borrower or the Guarantor takes any proceedings under any law, regulation or procedure for adjustment, deferment or rescheduling of its indebtedness or any part thereof or makes or enters into a general assignment or arrangement or composition with or for the benefit of its creditors or a moratorium shall be declared on any of its indebtedness or any creditor of the Borrower or the Guarantor exercises a contractual right to take over the financial management of the Borrower or the Guarantor (as applicable) or the Borrower or the Guarantor is unable to pay its debts as defined in section 123 Insolvency Act 1986 or the Borrower or the Guarantor fails generally to pay its debts as and when they fall due or if proceedings are commenced or threatened against the Borrower or the Guarantor which, if adversely determined, would result in a liability on the part of the Borrower or the Guarantor (as applicable) in excess of Pounds Sterling25,000 or any similar event or occurrence shall take place under the laws of any other jurisdiction applicable to the Borrower or the Guarantor; or\n(G) an order is made or resolution is passed for the winding-up, liquidation or dissolution of the Borrower or the Guarantor or if analogous proceedings are taken or the Borrower or the Guarantor stops or threatens to stop payments generally or the Borrower or the Guarantor ceases or threatens to cease to carry on its business or any part thereof or the Borrower or the Guarantor merges, consolidates or amalgamates with or into any other company, corporation or entity; or\n(H) it becomes unlawful or impossible or contrary to the terms of any consent, authority or other permission for the Borrower or the Guarantor to perform or to continue to perform any of its obligations under any of the Finance Documents to which it is a party or if any of such documents ceases to be in full force and effect or ceases to constitute the legal, valid and binding obligations of the Borrower or the Guarantor, as applicable, enforceable in accordance with its respective terms; or\n(I) any event or series of events (including without limitation any adverse change in the business, assets or financial condition of the Borrower or the Guarantor) shall occur giving reasonable grounds in the opinion of the Bank for the belief that the Borrower (or, as the case may be, the Guarantor) will not, or will not be able, to perform or comply with any of its obligations expressed to be assumed by it under or in connection with any of the Finance Documents to which it is a party; or\n(J) if any governmental authority or any person or entity acting or purporting to act under any governmental authority shall have taken any action in order to condemn, seize or appropriate, or to assume custody or control of the Borrower or of all or any substantial part of the property or assets of the Borrower or shall have taken any action to curtail the authority in the overall conduct of its business or operations of the Borrower; or\n(K) if the Bank shall reasonably consider any of its security under the Security Documents shall be in jeopardy; or\n(L) if the audited financial statements of the Borrower or the Guarantor delivered pursuant to Clause 11. I (A) are qualified to the effect that they do not or may not give a true and fair view of the financial position of the Borrower; or\n(M) if the Borrower ceases to be a subsidiary of Multi-Arc, Inc, or if Multi-Arc, Inc at any time owns (legally and beneficially) less than ninety-nine per cent of the issued share capital of the Borrower;\nthen in any such case and at any time thereafter while such event is continuing, the Bank may by written notice to the Borrower:-\n(1) declare that the obligations of the Bank to make or, as the case may be, maintain the Loan shall be cancelled, whereupon the same shall be cancelled; and\/or\n(2) declare the whole or any part of the principal of and interest relating to the Loan and any other sums payable under the Finance Documents to be due and payable, whereupon the same shall become immediately due and payable together with accrued interest thereon to the date of actual payment; and\/or\n(3) declare the Loan shall henceforth be repayable on demand; and\/or\n(4) direct enforcement of, or take any other action in relation to, any of the Security Documents in accordance with its terms;\n(5) apply the rate of interest referred to in Clause 6.2 to all or any part of the principal amount of the Loan, any accrued interest and any other sums payable under the Finance Documents; or\n(6) waive the Event of Default.\n13. FEES AND EXPENSES\n13.1 The Borrower will pay to the Bank an initial fee of Pounds Sterling7,500 on the date the Loan is drawndown pursuant to Clause 5.\n13.2 The Borrower shall reimburse the Bank promptly on demand (and without prejudice to such obligations and notwithstanding the other provisions of this Agreement authorises the Bank to deduct the same from any account of the Borrower with the Bank from time to time to the extent that any of the following are outstanding) and on a full indemnity basis, for all reasonable fees and all expenses (including but not limited to all legal, travel and other out-of-pocket expenses and all V.A.T. thereon) incurred by the Bank in connection with the preparation, negotiation, completion, execution and, where applicable, registration and filing of the Finance Documents and all documents in connection herewith and therewith and with granting waivers under or agreeing amendments to or variations in any of the same or in protecting any of its rights hereunder or thereunder or in suing for or recovering any sums due to it or in the preservation or enforcement of any of its rights under this Agreement or any of the above mentioned documents connected herewith.\n13.3 The Borrower shall reimburse the Bank on demand in respect of liability to all stamp, registration and other like duties and taxes (including all VAT), if any, in each case payable in connection with the execution, delivery and performance of the Finance Documents and all other documents in connection therewith whether by the Borrower or the Bank or any other party thereto and whether arising as a result of an election or otherwise or in connection with the enforcement of any of the Finance Documents and all such other documents and will indemnify the Bank from any and all liabilities with respect to or resulting from any delay or omission to pay such duties or taxes.\n13.4 Upon the occurrence of any Event of Default the Borrower shall reimburse the Bank for any subsequent operating and\/or management charges or costs of the Bank relating to the Finance Documents, the matters contemplated thereby and the Loan, as determined by the Bank.\n14. CHANGES IN CIRCUMSTANCES\n14.1 If after the date of this Agreement by reason of (1) the introduction of or any change in law or in its interpretation, administration or application and\/or (other than a general change in the rates of taxation of income in the United Kingdom or elsewhere) (2) compliance with any new request, directive or requirement of whatsoever nature, from or requirement of any central bank or other fiscal, monetary or competent authority (whether or not having the force of law):-\n(A) there is any increase in the cost to the Bank of agreeing to issue, make, fund or maintain or of issuing, making, funding or maintaining all or any part of the Loan or any unpaid sums due to it under any of the Finance Documents; or\n(B) the Bank suffers a reduction in the amount of any payment received or receivable by it or forgoes any interest or other return on or in relation to the Loan or suffers a reduction in return on capital as a result of having entered into any of the Finance Documents and performed its obligations thereunder; or\n(C) the Bank becomes liable to make any payment on or calculated by reference to the amount of any sum received or receivable by it or owed to it under any of the Finance Documents (other than tax on its overall net income or profits),\nthen the Borrower shall from time to time promptly on demand pay to the Bank amounts sufficient to indemnify the Bank against, as the case may be, any such cost, reduction, forgoing or liability provided always and it is hereby agreed that:-\n(i) the Bank shall promptly notify the Borrower of the happening of such event giving reasonable details of how such cost, reduction or liability has been calculated and attributed to the Loan Facility or the Overdraft Facility; and\n(ii) at any time after receipt of notice under paragraph (i) and so long as the circumstances giving rise to such cost, reduction, forgoing or liability continue, the Borrower may on giving the Bank not less than five Business Days' irrevocable notice, cancel the Bank's obligation to make or, as the case may be, to maintain the Loan and repay the whole (but not part only) of the Loan together with all interest and other sums payable by the Borrowers to the Bank pursuant to any of the Finance Documents but excluding, for the avoidance of doubt, the Prepayment Fee.\n14.2 In the event that by reason of any change in applicable law, regulation or regulatory requirement or in the interpretation or application thereof after the date hereof the Bank shall be of the opinion that it has become unlawful, illegal or otherwise prohibited for the Bank to maintain or give effect to all or any of its obligations as contemplated by any of the Finance Documents, the Bank shall give notice to the Borrower to that effect and thereupon, the liability of the Bank to make or, as the case may be, to maintain the Loan shall cease and the Borrower shall repay to the Bank on or before the latest day (being, if possible, the last day of any Interest Period) permitted by such law, regulation or regulatory requirement the whole of the Loan, together with all interest and other sums payable by the Borrower to the Bank pursuant to any of the Finance Documents but\n15. PAYMENTS\n15.1 For the purposes of this Agreement, any payment to be made by the Borrower shall be made in Sterling in cleared immediately available funds not later than 11.00 a.m. on the due date to the account of the Borrower at First Fidelity Bank N.A., London Branch (or to any other account at such bank and place which the Bank may from time to time specify).\n15.2 All sums received by the Bank under any of the Finance Documents, whether in respect of principal, interest, fees, costs or otherwise, shall be received in full without any set-off or counter-claim by the Borrower free and clear of and without any deduction or withholding for or on account of any present or future income or other taxes, levies, imposts, duties, charges or withholdings of any nature whatsoever. In the event that any such deduction or withholding from any payment for the account of the Bank under any of the Finance Documents shall be required or in the event that any payment on or in relation to any amount received by the Bank on account of tax or otherwise shall be required to be made, in each case under any present or future law, directive, regulation or practice, then the Borrower shall forthwith pay to the Bank such additional amounts as will result (after the making of such deduction, withholding or payment) in the receipt and retention by the Bank of the same amount which would otherwise have been received and retained by it pursuant to such Finance Document had no such deduction, withholding or payment been made.\n15.3 If any sum becomes due for payment pursuant to any Finance Document on a day which is not a Business Day, such payment shall be made on the next succeeding Business Day unless such Business Day falls in a new calendar month in which event such payment shall be made on the immediately preceding Business Day and the amount of any interest or other fee shall, if not already taken into account, be adjusted accordingly.\n15.4 In the case of a partial payment under any Finance Document, the Bank may appropriate such amount in satisfaction of the obligations of the Borrower in such order as it shall in its absolute discretion think fit and any such appropriation shall override any appropriation made by the Borrower or any guarantor.\n15.5 If the Borrower or any Guarantor pays any increased amount under Clause 15.2 and the Bank actually receives or is granted a credit against or remission for any income or corporation tax payable by it, the Bank shall, to the extent that it can do so without prejudice to the retention of the full amount of such credit or remission, reimburse to the Borrower or Guarantor (as applicable) such amount of such credit or remission as the Bank shall in its sole opinion have concluded to be applicable to such deduction or withholding. Nothing herein contained shall affect the right of the Bank to arrange its tax affairs as it thinks fit and in particular, the Bank shall be under no obligation to claim relief from any tax on its corporate profits or similar tax liability in respect of the imposition of such tax and, if the Bank does claim any such relief, it shall be under no obligation to claim the same in priority to any other claims, reliefs, credits or deductions available to it and shall not in any event be obliged to disclose any matter relating to its tax affairs or computations to any person.\n15.6 The Bank warrants to the Borrower that it is a person recognised by the Inland Revenue as carrying on through its London Branch a bona fide banking business in the United Kingdom for the purpose of S.349(3) of the Income and Corporation Taxes Act 1985 and which brings any interest payable under this Agreement into account as a trading receipt of that business.\n15.7 If, otherwise than as a result of the introduction of or any change in the interpretation or application of any law or regulation or practice of the Inland Revenue after the date of this Agreement, the Bank is not or ceases to be a person as specified in Clause 15.6, the Borrower shall not be liable to pay to or for the account of, the Bank any increased sum under Clause 15.2.\n15.8 The provisions of Clause 15.5 shall apply to the payment of interest pursuant to the Overdraft Facility and\/or any of the Security Documents.\n16. PAYMENT AND CURRENCY INDEMNITIES\n16.1 The Borrower shall on demand by the Bank indemnify the Bank for all amounts as the Bank may certify to be necessary to compensate it for all costs, expenses, liabilities and losses sustained or incurred by it as a result of (I) any default in payment by any of the Borrower of any sum under any of the Finance Documents when due, (2) any failure (by reason of any breach or default of any of the Borrower) to borrow in accordance with Clause 5, (3) the happening of any Event of Default and\/or (4) any repayment or prepayment of the Loan or any part thereof otherwise than on the Final Repayment Date (if the fixed rate option has been chosen in the Notice of Drawing or any Notice of Fixed Interest Rate Selection), or on an Interest Payment Date (if the variable rate option has been chosen in the Notice of Drawing) relative thereto, (including in each case but not limited to any losses or expenses sustained or incurred in liquidating or re-deploying deposits from third parties acquired to effect or maintain any amounts paid or carried by the Bank, loss of interest and\/or loss of Margin). The certificate of the Bank as to the aforesaid amounts shall, save for any manifest error, be conclusive.\n16.2 Any payment or payments made to the Bank in a currency (the currency in which the relevant payment is being made is hereinafter referred to as the \"Relevant Currency\") other than the currency in which it is expressed to be due hereunder (the \"Due Currency\") shall only constitute a discharge to the Borrower to the extent of the Due Currency amount which the Bank is able, on the date or dates of receipt by the Bank of such payment or payments in the Relevant Currency (or, in the case of any such date which is not a Business Day, on the next succeeding Business Day) to purchase with the amounts so received by the Bank on such date or dates. If the amount of Due Currency which the Bank is so able to purchase falls short of the Due Currency amount originally due to the Bank under this Agreement the Borrower shall immediately reimburse the Bank in the Due Currency any such shortfall and shall indemnify the Bank against any direct loss or damage arising as a result of a failure to make such reimbursement. This indemnity shall constitute a separate and independent obligation from the other obligations contained in this Agreement.\n16.3 If the Borrower is or becomes bound to pay any increased amount under clause 15.2 or to make any payment under Clause 14.1 for the account of the Bank then, so long as such obligation continues, it shall be entitled at any time on giving to the Bank not less than 7 days' notice (which shall be irrevocable) to prepay the whole (but not part only) of the Loan together with accrued interest and any other amount payable under this Agreement but subject always to Clauses 16.1 and 16.2.\n17. SET-OFF\nThe Borrower hereby authorises the Bank to apply any credit balance (whether matured or unmatured) to which it is entitled on any of its accounts with the Bank, including without limitation the Accounts, in or towards satisfaction of any sum due to the Bank by the Borrower under any of the Finance Documents. For this purpose, the Bank is hereby authorised in the name of the Borrower to do all acts (including breaking time deposits) and to sign all documents as may be required to effect such application. The Bank shall not be obliged to exercise any right conferred or acknowledged by this Clause 17 and nothing expressed or implied in any of the Finance Documents shall in any way affect any rights which the Bank may have under applicable law.\n18. ACCOUNTS\nThe Bank shall open and maintain on its books in accordance with its normal practice a loan account evidencing the amounts from time to time advanced by and owing to it hereunder which loan account shall be prima facie evidence of such amounts.\n19. WAIVERS\nNo delay or omission of the Bank in exercising any right, power or privilege under any of the Finance Documents shall operate to impair such right, power or privilege or be construed as a waiver thereof and any single or partial exercise of any such right, power or privilege shall not preclude any other or future exercise thereof or the exercise of any other right, power or privilege. The rights and remedies provided under any of the Finance Documents are cumulative and not exclusive of any rights or remedies provided by law.\n20. ASSIGNMENT\n20.1 This Agreement shall be binding upon and enure for the benefit of the Borrower, the Bank and their respective successors.\n20.2 The Borrower shall not assign or transfer any of its rights and\/or obligations under any of the Finance Documents.\n20.3 The Bank at any time may transfer all or any part of its rights, benefits and obligations under the Finance Documents by assigning to any one or more other banks (each of which is hereinafter in this Clause 20 called an \"Assignee Bank\") all or any part of the Bank's rights and benefits thereunder provided that (I) such Assignee Bank shall agree to perform that percentage of the Bank's obligations hereunder as corresponds to that percentage of the Bank's rights and benefits so assigned to the Assignee Bank and (2) such Assignee Bank shall, by delivery of such undertaking or agreement as the Bank may approve, have become bound by the terms of the Finance Documents, and in such circumstances the Bank may, if it so determines, act as agent for itself and the Assignee Bank for the purposes of the Finance Documents subject to receipt of appropriate indemnities and the Bank entering into such appropriate documentation with the Assignee Bank and the Borrower as the Bank may require. Notice of any such transfer shall promptly be given to the Borrower and the Borrower shall execute such documents as the Bank shall require in order to give effect to any such transfer. For this purpose and for the purpose of entering into any contractual arrangements with any person in relation to the matters contemplated by this Agreement the Bank may disclose to a potential Assignee Bank or any such person such information about the Borrower and its assets and condition as the Borrower shall have made available to the Bank hereunder or as shall be known to the Bank otherwise howsoever. The Bank shall consult with the Borrower prior to any such transfer.\n20.4 If the Bank transfers its right, benefits and obligations under the Finance Documents as provided in Clause 20.3, all references in the Finance Documents to the Bank shall thereafter be construed as references to the Bank and its Assignee Bank(s) to the extent of their respective participations, if any, and the Borrower shall thereafter look only to the Assignee Bank(s) (to the exclusion of the Bank) in respect of that proportion of the Bank's obligations thereunder as corresponds to such Assignee Bank's respective participation therein and accordingly such Bank's maximum liability hereunder shall be appropriately reduced and the Assignee Bank shall proportionately assume a maximum liability equivalent to such reduction in such Bank's maximum liability.\n21. NOTICES\n21.1 Save as otherwise provided herein, each notice, request, demand or other communication to be given or made under this Agreement shall be given in writing delivered personally or by letter by first class mail, or facsimile to the address or facsimile number of the addressee set out below:-\n(1) in the case of the Bank, if by facsimile to it at 0171929 4644 and if delivered personally or by letter to it at London Branch, 1 Bishopsgate, London, EC2N 3AB, in each case marked for the attention of Ian G. Morrison, Vice President;\n(2) in the case of the Borrower, if by facsimile to it at 01207 590254 and if delivered personally or by letter to it at Number One, Industrial Estate, Unit 36, Medomsley Road, Consett, County Durham, DH8 6TS,\nor at any other numbers or addresses or marked for the attention of such other person as the parties hereto may from time to time notify to each other.\n21.2 Any notice, request, demand or other communication to be given or made under this Agreement shall be deemed to have been delivered, in the case of any notice, request, demand or other communication given or made by personal delivery or facsimile, on despatch to the correct facsimile number or delivery to the correct address unless delivered outside normal business hours when it shall be deemed to be delivered on the next Business Day and, in the case of any notice, request, demand or other communication given or made by letter, two Business Days after being posted by first class mail, provided that any notice, request, demand or other communication to be made or delivered by the Borrower to the Bank shall only be effective when received by the Bank.\n22. PARTIAL INVALIDITY\n22.1 In the case that one or more of the provisions contained in this Agreement should prove to be invalid, illegal or unenforceable in any respect, the validity, legality and enforceability of the remaining provisions hereof shall not in any way be affected or impaired thereby.\n23. GOVERNING LAW\n23.1 The law of England and Wales is the law applicable to this Agreement.\nPlease confirm your agreement to and acceptance of the terms and conditions set out above on the attached copy of this letter. The offer of the Facilities shall lapse and shall be deemed to have been withdrawn if the Borrower does not agree and accept the terms hereof within 5 Business Days of the date of this Agreement.\nYours faithfully \/s\/ duly authorised for n behalf of FIRST FIDELITY BANK N.A.\nWe hereby acknowledge our agreement to and acceptance of the terms and conditions set out in the letter of which the above is a true copy. \/s\/ duly authorised for and on behalf of MULTI-ARC (U.K.) LIMITED\nSCHEDULE Notice of Drawdown [On the headed notepaper of Multi-Arc (U.K.) Limited]\nTo: First Fidelity Bank N.A.\nDear Sirs,\n1. We refer to the facility agreement (as from time to time amended, varied, novated or supplemented) (the \"Facility Agreement\") dated 1995 and made between Multi-Arc (U.K.) Limited as Borrower and First Fidelity Bank N.A. as Bank. Terms used herein shall have the meanings ascribed to them in the Facility Agreement unless the context otherwise requires.\n2. We hereby give you notice that, pursuant to the Facility Agreement and on [date of proposed Advance], we wish to borrow the amount of [ ] pounds ([ ]) upon the terms and subject to the conditions contained therein.\n3. Of the amount referred to in paragraph 2 above [Pounds Sterling ] is to be used to [specify each purpose] and we attach [specify evidence to be attached] as evidence that such amount is to be used for each one of the purposes set out in Clause 2 of the Facility Agreement.\n4. The amount referred to in paragraph 2 should be credited to the account of [specify account(s) into which such amount is to be transferred] for value on [date of proposed drawdown].\n5. We hereby elect for [the fixed interest rate option\/the variable interest rate option] referred to in the Facility Agreement.\n6. We confirm that, at the date hereof, the representations and warranties set out in Clause 10 of the Facility Agreement are true and no Event of Default has occurred.\nYours sincerely\n\/s\/ for and on behalf of Multi-Arc (U.K.) Limited\nEXHIBIT 10(t) OVERDRAFT FACILITY\nFIRST FIDELITY BANK\nFIRST FIDELITY BANK N.A\nTo FIRST FIDELITY BANK N.A. London Branch 1 Bishopsgate London EC2N 3AB (hereinafter referred to as \"the Bank\")\nWE MULTI-ARC (U.K.) LIMITED\nof Number One Industrial Estate, Unit 36, Medomsley Road, Consett, County Durham DH8 6TS.\n(hereinafter called \"we\") in consideration of your from time to time granting or continuing to make available credit or other banking facilities and accommodation to us (\"the Facility\") hereby undertake and agree with you as follows:\nUnless otherwise agreed in writing between us in respect of any other specific facility:-\n1. In respect of any overdraft or part thereof made available pursuant to the Facility, you shall be entitled in your sole discretion to call in amounts outstanding under the Facility and\/or to cancel the Facility (or any part thereof) and\/or to issue legal proceedings in respect of the Facility without first having made demand on us.\n2. You shall be entitled to your sole discretion and as conclusively determined by you at any time from time to time increase or decrease the Facility limit (including multiple currency facility limits).\n3. We will pay to you interest on the amount from time to time outstanding under the Facility for the relevant interest period as determined by you at the rate determined by you being the aggregate of:\n(a) either (i) A margin of 1 5% per annum above the rate (as conclusively determined by you in accordance with your normal procedures) at which the Bank is offered deposits in currency of the Facility at or about 11:00 a.m. London time on the relevant dealing day on or before the commencement of the relevant interest period (as determined by you by banks in the London interbank market for deposits in tho currency of the Facility of similar amount and for a similar interest period as that of the Facility; or at your option; or\n(ii) the base rate of the Bank from time to time as conclusively certified by you \"Base Rate\") plus a margin of 1.5% per annum;\nAND\n(b) the rate reflecting the cost to you (as determined by you) of complying with the existing requirements of the Bank of England or other regulatory authority affecting mandatory liquid assets, special deposits, reserve, capital adequacy or other requirements of whatever nature and attributable to the Facility (rounded up, if necessary, to four decimal places) including any reduction in the rate of return on your capital resources. A certificate by you as to the amount of such cost shall be conclusive in the absence of manifest error.\nAll interest payable shall accrue from day to day and shall be calculated on the basis of a 360 day year (save in the case of pounds sterling a 365 day year) for the actual number of days elapsed and shall be paid in the currency of the Facility. Interest shall be due and payable and debited to our account on a monthly basis.\n4. We will pay to you interest on any amount due hereunder which is not paid on the due date for payment therefore for the period from such due date up to tho date of actual receipt by you (as well after judgment as before) on demand at the rate of 2% per annum above the aggregate interest rate and cost to you referred to in Clause 3 above (as conclusively determined by you) for such periods as you may select. Upon expiry of each such period such rate shall be recalculated on the same basis save that unpaid interest accrued during the previous periods shall be added to the amount in respect of which we are in default.\n5. We agree to indemnify you upon demand for all costs, charges and expenses (including legal fees) incurred by you in connection with the drafting, preparation negotiation and execution of this Agreement and any documents relative thereto and of any amendment, variation or extension thereof or the granting of any waiver or consent under this Agreement and the presentation and enforcement or attempted enforcement of your rights and powers under this Agreement.\n6. The terms and conditions of this Agreement are in addition to and not in substitution for any other agreements between us and you.\n7. All sums payable by us hereunder shall be paid in the currency of the Facility or such other currency as you may from time to time direct in immediately available funds to the account maintained in respect of the Facility or such other account at such ;bank as you may from time to time specify and without any set-off or counterclaim whatsoever and, save as required by law, without any deduction or withholding for or on account of any present or future taxes, levies, imposts, duties, charges or withholdings of any nature whatsoever. We shall pay all present or future taxes or similar charges due with respect to such payments which may be imposed by any competent fiscal authority, except taxes on your overall income. If any such deduction or withholding has to be made by law from any such payment we will pay to you an increased amount so that after any deduction or withholding you receive and retain a net amount equal to the amount which you would have received and retained had no such deduction or withholding been made.\n8. We hereby irrevocably authorise you (but without obligation on your part) in the event of non-payment of any amounts when due hereunder at any time without demand and without further notice to set off any credit balance in any currency standing upon any of our account with you or at any of your branches or any of your subsidiary, holding or associated companies or any of the subsidiaries of First Fidelity Bancorporation in or towards payment of any amount due to you hereunder and in our name to do all such acts and to sign all such documents as may be required to effect such application. Where such set-off requires the conversion of one currency into another, such conversion shall be calculated at the spot rate as conclusively determined by you for purchasing one currency with the other.\n9. Statements of account shall be issued on written application or by arrangement with the Bank. Failure by us to object to a statement of account within thirty days after receipt thereof shall be deemed approval of all entries contained therein and in the absence of any such objections the statement of account shall be final and binding on us.\n10. The certificate signed by one of your duly authorised officers as to any of the matters referred to in this Agreement including the balance of an account or the amount owing by us to you shall save for manifest error, be conclusive and binding on us.\n11. We hereby irrevocably appoint the following as our agent to accept service of all legal process issued out of the High Court of Justice in London in any local action or proceedings against us\/our assets arising out of or in connection with any transaction or dealing between us and you:\nName: Address: Telex: Fax: (\"the Service Agent\")\nWe agree that any notice demand or other legal communication to be given hereunder and any legal process shall be sufficiently served if delivered to the Service Agent at its address stated in this Agreement or such other address in England as we may have notified to you for such purpose.\nThis Agreement is to be governed by and construed in accordance with the laws of England and we hereby submit to the non-exclusive jurisdiction of the English courts.\nEXECUTION by Company EXECUTED as a deed and delivered by the Customer pursuant to a resolution of its board of directors duly passed dated by Director \/s\/ John Alan Stevenson John Alan Stevenson Director or Secretary \/s\/ Walter N. Kreil, Jr. Walter N. Kreil, Jr.\nEXHIBIT 10(u) UBC VIRGINIA CORPORATION c\/o Andal Corp. 909 Third Avenue New York, New York 10022\nOctober 13, 1995\nCERTIFIED MAIL - RETURN RECEIPT REQUESTED\nSchnurmacher Corp. 1114 First Avenue New York, New York 10021 Attn: Ira J. Weinstein\nNotice of Exercise of Option Pursuant to Section 1.3 of Option Agreement dated as of August 1, 1982 covering 1110 First Avenue, New York, New York (the \"Option Agreement\")\nGentlemen:\nThe undersigned is the optionee under the Option Agreement. We are in receipt of your letter dated September 22, 1995 advising of the death of Irwin Schnurmacher, the later to die of Adolph and Irwin Schnurmacher.\nThis letter constitutes notice to you of our election to exercise the option to purchase 1110 First Avenue, New York, New York (the \"Premises\") pursuant to Section 1.3 of the Option Agreement and, in furtherance thereof, enclosed is our good certified check payable to your order in the amount of $10,000, representing the \"Option Exercise Payment\" required to be remitted to you together with this letter pursuant to the terms of the Option Agreement.\nWe understand from your letter that you would prefer to close title to the Premises during the month of February, 1996. We are agreeable and would propose February 27, 1996 at a time and place to be agreed on.\nSince the closing will occur more than thirty (30) days after the date of this letter (as now required by the Option Agreement), we would appreciate it if you would agree to waive such thirty (30) day provision by signing a copy of this letter.\nWe also want to advise you of the possibility that the Option Agreement and Lease may be assigned before the closing to Messrs. Paul Milstein and Alan Cohen and Frankhill Associates, a limited partnership, in which case the assignees will assume all of our obligations under the Lease and Option Agreement and Contract of Sale annexed thereto. In that event, we will give notice of such assignment to you not later than thirty (30) days prior to February 27, 1996, together with executed counterparts of the Transferee and Transferor Questionnaires required for filing with the Department of Taxation and Finance in furtherance of the New York State Real Property Transfer Gains Tax.\nIf the foregoing is satisfactory, please execute a copy of this letter to evidence (a) your acknowledgment that the option has been duly exercised by the undersigned, (b) your agreement to the waiver of the thirty (30) day provision of the Option Agreement and the Contract of Sale, and (c) your agreement that in the event of assignment of the Lease and Option Agreement to Messrs. Milstein and Cohen and Frankhill Associates, and their assumption of the obligations thereunder, the assignees may properly consummate the closing under the Option Agreement.\nVery truly yours,\nUBC VIRGINIA CORPORATION\nBy: \/s\/ Michael S. Huber Name: Michael S. Huber Title: Senior Vice President\nAccepted and agreed to this 25 day of October, 1995.\nSCHNURMACHER CORP.\nBy: \/s\/ Ira J. Weinstein Name: Ira J. Weinstein Title: President\nUBC VIRGINIA CORPORATION c\/o Andal Corp. 909 Third Avenue New York, New York 10022\nOctober 23, 1995\nCERTIFIED MAIL - RETURN RECEIPT REQUESTED\nSchnurmacher Corp. 1114 First Avenue New York, New York 10021 Attn: Ira J. Weinstein\nGentlemen:\nBy letter dated October 13, 1995 (the \"Letter of Exercise\") the undersigned exercised an option to purchase 1110 First Avenue, New York, New York, pursuant to Section 1.3 of that certain Option Agreement dated as of August 1, 1982 between Schnurmacher Corp., as Optionor, and National Kinney Corp., as Optionee. Capitalized terms used but not otherwise defined herein shall have the respective meanings ascribed thereto in the Letter of Exercise.\nIn the Letter of Exercise, the undersigned advised you of the possibility that the Option Agreement and Lease may be assigned before the closing to Messrs. Paul Milstein and Alan Cohen and Frankhill Associates, a limited partnership (collectively, the \"Permitted Assignees\"), and requested your agreement that the Permitted Assignees may properly consummate the closing under the Option Agreement and\/or the Contract of Sale annexed thereto.\nWe understand that you have consented to such assignment and to the closing of such acquisition by the Permitted Assignees, conditioned upon our agreement to assume all liability under the New York State Real Property Transfer Gains Tax (the \"Gains Tax\") which Schnurmacher Corp. may suffer or incur on the sale of the Premises pursuant to the Option Agreement and\/or the Contract of Sale annexed thereto solely by reason of such assignment, and\/or by reason of the assignment of the Option Agreement to the undersigned by National Kinney Corp., including, without limitation, all Gains Tax due on any consideration which may be paid to the undersigned by the Permitted Assignees for and\/or on account of such assignment.\nThis letter will serve to evidence our agreement to assume all such Gains Tax liability.\nPlease evidence your acceptance of the foregoing by executing a copy of this letter where indicated below and return the same to the undersigned by hand-delivery.\nThank you for your consideration.\nVery truly yours,\nUBC VIRGINIA CORPORATION\nBy: \/s\/ Michael S. Huber Name: Michael S. Huber Title: Senior Vice President\nAccepted and agreed to this 25 day of October, 1995.\nSCHNURMACHER CORP.\nBy: \/s\/ Ira J. Weinstein Name: Ira J. Weinstein Title: President\nEXHIBIT 22\nSUBSIDIARIES OF THE COMPANY\nState or Other Jurisdiction of Incorporation or Name Organization\nAndal Corp. (parent) New York Cathedral Equity Corp. Delaware Circle Acoustics Corp. New York National States Electric Corp. Delaware Wadif Corp. New York Salem Liquidating Corp. Delaware Uris Mechanical Maintenance, Inc. New York UBC Westfair Corporation New York UBC Virginia Corporation New York Multi-Arc Inc. Delaware Multi-Arc Scientific Coatings, Inc. New Jersey Multi-Arc, Inc. Minnesota Multi-Arc India Limited India Multi-Arc (U. K.) Ltd. United Kingdom Multi-Arc Management Corp. New Jersey Multi-Arc Scientific Coatings(S)Pte Ltd. Singapore Vagle Technology, Inc. Michigan SCI Coatings Southwest, Inc. Texas Scientific Coatings, Inc. Michigan Multi-Arc Inc. Canada Scientific Coatings of Illinois, Inc. Michigan\nEXHIBIT 24(a) Kelly Graham Myska & Partners Chartered Accountants\nWe consent to the use of our reports on the statement of earnings, financial position and changes in cash position for the fiscal year ended September 30, 1995 of Multi-Arc Inc. included in the Annual Report of Form 10-K of Andal Corporation and the Registration Statement S-8 of Andal Corporation which incorporates such Annual Report by reference.\nCambridge, Ontario November 3, 1995 \/s\/ Kelly Graham Myska & Partners Chartered Accountants\n211 Water Street North, P.O. Box 880, Cambridge, Ontario N1R 5X9 Telephone (519)623-1870 FAX (519) 623-9490\nKelly Graham Myska & Partners Chartered Accountants\nAUDITORS' REPORT\nTO THE SHAREHOLDER OF MULTI-ARC INC.\nWE HAVE AUDITED THE FINANCIAL POSITION OF MULTI-ARC INC. AS AT SEPTEMBER 30, 1995 AND THE STATEMENTS OF OPERATIONS, RETAINED EARNINGS AND CHANGES IN CASH POSITION FOR THE YEAR THEN ENDED. THESE FINANCIAL STATEMENTS ARE THE RESPONSIBILITY OF THE COMPANY'S MANAGEMENT. OUR RESPONSIBILITY IS TO EXPRESS AN OPINION ON THESE FINANCIAL STATEMENTS BASED ON OUR AUDIT.\nWE CONDUCTED OUR AUDIT IN ACCORDANCE WITH GENERALLY ACCEPTED AUDITING STANDARDS. THOSE STANDARDS REQUIRE THAT WE PLAN AND PERFORM AN AUDIT TO OBTAIN REASONABLE ASSURANCE WHETHER THE FINANCIAL STATEMENTS ARE FREE OF MATERIAL MISSTATEMENT. AN AUDIT INCLUDES EXAMINING, ON A TEST BASIS, EVIDENCE SUPPORTING THE AMOUNTS AND DISCLOSURES IN THE FINANCIAL STATEMENTS. AN AUDIT ALSO INCLUDES ASSESSING THE ACCOUNTING PRINCIPLES USED AND SIGNIFICANT ESTIMATES MADE BY MANAGEMENT, AS WELL AS EVALUATING THE OVERALL FINANCIAL STATEMENT PRESENTATION.\nIN OUR OPINION, THESE FINANCIAL STATEMENTS PRESENT FAIRLY, IN ALL MATERIAL RESPECTS, THE FINANCIAL POSITION OF THE COMPANY AS AT SEPTEMBER 30, 1995 AND THE RESULTS OF ITS OPERATIONS AND THE CHANGES IN ITS CASH POSITION FOR THE YEAR THEN ENDED IN ACCORDANCE WITH GENERALLY CCEPTED ACCOUNTING PRINCIPLES.\nCAMBRIDGE, ONTARIO \/s\/KELLY GRAHAM MYSKA & PARTNERS NOVEMBER 2, 1995 CHARTERED ACCOUNTANTS\nEXHIBIT 24(b) KPMG Maybrook House Tel +44 (0)191 232 8815 27 Grainger Street Fax +44 (0)191 232 3391 Newcastle upon Tyne NEl 5JT\nPrivate & confidential\nWN Kreil Esq Mlllti-Arc Scientific Coatings 200 Roundhill Drive Rockaway NJ 07866 United States of America\n14 December 1995\nDear Sir\nMulti-Arc (UK) Limited\nOur ref pbm\/32 1\nContact Paul Moran Tel 0191 2328815\nOn 14 December 1994 we gave our consent to the use of our audit reports for the purposes of the 1994 filing requirements of Andal. These audit reports were issued on the financial statements of Multi-Arc (UK) Limited for the year ended 30 September 1994 and were contained in our letter of 14 December 1994. We hereby confirm that we consent to the use of these reports for the purposes of the 1995 filing requirements of Andal.\nYours faithfully \/s\/KPMG KPMG\nKPMG is registered by the Institute of business is 8 Salisbury to carry on audit work and Chartered Accountants inSquare, London EC4Y 8BB authorized to carry on England and Wales. The where a list of partners' investment business principal place of names is open to inspection.\nEXHIBIT 24(c) BDO Seidman, LLP Accountants and Consultants 330 Madison Avenue New York, New York 10017 Telephone: (212) 885-8000 Fax: (212) 697-1299\nCONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nAndal Corp. New York, New York\nWe hereby consent to the incorporation by reference in the Form 10K of Andal Corp. of our report dated March 26, 1993, expect to Note 1 which is as of April 9, 1993, relating to the consolidated financial statements and schedules of Steve's Homemade Ice Cream, Inc. appearing in the Company's Annual Report on Form 10-K for the year ended January 2, 1993.\n\/s\/ BDO Seidman, LLP BDO Seidman, LLP\nDecember 21, 1995","section_15":""}
{"filename":"748592_1995.txt","cik":"748592","year":"1995","section_1":"ITEM 1. BUSINESS. ---------\nFORMATION\nNTN Communications, Inc. (\"NTN\") was originally incorporated in the State of Delaware on April 13, 1984 under the name of Alroy Industries. Alroy completed a public offering of its common stock on November 26, 1984. On April 15, 1985, Alroy acquired all of the outstanding stock of National Telecommunicator Network, Inc. In connection with the acquisition, Alroy changed its name to NTN Communications, Inc. In 1993, NTN completed a merger with New World Computing, Inc. (\"New World\") pursuant to which New World became a wholly-owned subsidiary of NTN. In 1994, the Company formed LearnStar, Inc. (LearnStar) and IWN, Inc. (IWN), both currently partially-owned subsidiaries. Unless otherwise indicated, references herein to the \"Company\" include NTN and its consolidated subsidiaries, including New World, LearnStar and IWN.\nRECENT DEVELOPMENTS\nA discussion of the general development of the Company for the fiscal year ended December 31, 1995 is set forth in the letter to the Company's shareholders contained in the Company's Annual Report to Shareholders and is incorporated herein by reference. A copy of the Annual Report to Shareholders is included as Exhibit 13 to this Report.\nIn 1995, the Company purchased the shares of LearnStar, Inc. owned by ACT III Communications to increase its ownership in LearnStar Inc. to 100%. In December, the Company sold a 45% interest in LearnStar to Associated Ventures Management Inc., an unaffiliated company, for $2,500,000.\nIn December 1995 the Company sold a 10% interest in IWN, Inc. to Symphony LLC, an unaffiliated company for $350,000. Symphony LLC also became a limited partner in IWN L.P., an unconsolidated limited partnership in which IWN, Inc. is the general partner by agreeing to contribute $2,650,000 to the partnership.\nPRINCIPAL SERVICES AND PRODUCTS\nNTN Communications, Inc. (\"NTN\" or the \"Company\"), through its business units and subsidiaries, develops, produces and distributes individual and multi-player interactive programs to a variety of media platforms. These interactive sports, trivia game and educational programs permit multiple viewers to simultaneously respond to and participate with the programming content. NTN has exclusive licensing agreements with the National Football League (\"NFL\"), Major League Baseball, the National Hockey League and others to provide interactive play- along programming, such as its proprietary QB1(R) football game, in conjunction with live television events. The Company broadcasts a wide variety of popular games, trivia and informational programming to group viewing locations such as hotels, sports bars and restaurants through its own interactive NTN Network. In addition, NTN brings multi-player interactive games into consumer households through personal computer on-line services, the Internet and interactive television services. NTN currently has two patents pending with respect to its interactive technology systems. Since NTN distributes its programs via satellite, cable, telephone and wireless transmission technologies, its applications are independent of hardware or technical platforms.\nThe Company currently provides its products and services through six business units or subsidiaries in various stages of development.\nOf these six, three are considered to be the Core of the Company's business, that is, directly related to multi-player interactive entertainment programs. The three Core business units which will be used throughout this document are as follows:\nCORE ----\nHospitality Services (\"Hospitality\") - Interactive television network (\"NTN Network\") featuring sports and trivia games which are broadcast to group environments.\nInternational Licensing (\"International Licensing\") - Providing the NTN Network through exclusive licensing agreements internationally.\nHome Interactive Services (\"Home\") - Marketing many of the same live interactive sports and trivia games currently broadcast over the NTN Network to the home consumer market via third-party providers.\nThree others are considered to be Non-Core business units, that is, they are indirectly related to the Core business but in different markets and\/or in early stages of development. The three Non-Core business units which will be used throughout this document are as follows:\nNON - CORE ----------\nLearnStar, Inc. (\"LearnStar\") - Providing an interactive, multimedia, curriculum-based educational system to schools.\nIWN, Inc. (\"IWN\") - Developing, distributing and marketing interactive and transaction processing software and technology for the gaming industry.\nNew World Computing, Inc. (\"New World\") - Designing, developing and publishing interactive computer games in CD-ROM and floppy disk formats.\nThe following is a summary of the revenues, total expenses and operating income for each of the Core and Non-Core business units followed by a brief description of each:\nTOTAL TOTAL OPERATING CORE UNITS REVENUES EXPENSES INCOME (LOSS) - ----------------- ----------- ----------- ------------- Hospitality $21,720,000 $18,173,000 $ 3,547,000 International 747,000 1,610,000 (863,000) Home 690,000 1,532,000 (842,000)\nTOTAL TOTAL OPERATING NON-CORE UNITS REVENUES EXPENSES INCOME (LOSS) - ----------------- ----------- ----------- ------------- LearnStar 1,095,000 3,244,000 (2,149,000) IWN 600,000 0 600,000 New World 5,379,000 5,252,000 127,000\nHospitality--Hospitality represents the majority of the Company's business, providing a 24-hour-a-day interactive television broadcast network featuring sports, trivia and informational programming to over 3,000 hospitality sites in the U.S. and Canada. These sites include bars, restaurant chains (e.g., TGI Friday's, Ruby Tuesdays, Black Angus), national hotel chains (e.g., Hilton, Holiday Inn, Marriott, Radisson, Sheraton), local and\nregional bowling alleys, pizzerias, sports complexes and military bases. Through various platforms including satellite, cable and wireless transmission sources, Hospitality can link its subscribers to encourage local, regional and national competitions for its programming.\nInternational Licensing--The Company has licensed independent companies to broadcast in Australia\/New Zealand and South Africa. Its exclusive licensees, NTN Australasia, Ltd. and MultiChoice, Ltd., operate broadcast centers in Australia\/New Zealand, and South Africa, respectively. Further, the Company licenses its programs and software to a company in Canada. Licensees, except in Canada, operate their own broadcast center and produce interactive programs specifically geared to the local culture and society. The Canadian licensee uses the broadcast provided by the Company on the NTN Network.\nHome--The Company provides to the home consumer market many of the same services as Hospitality, via on-line services and interactive television networks. Home is not dependent on any particular technology or method of transmission to deliver its programming. For example, through an agreement with America Online (\"AOL\"), NTN delivered QB1(R) to AOL customers during Super Bowl XXX. In addition to the same sports and trivia games which are currently broadcast over the NTN Network, Home provides other multi-player interactive games expressly designed for the home environment. Home is divided into two sub-markets, on-line services (\"On-Line Services\"), and interactive television services (\"ITV Services\"). Currently, Home receives revenues from 1) play-along services, in which NTN services are broadcast along with live events generating subscription fees from interactive game participation, or \"pay-per-play\", and 2) information services, where NTN'S database is provided as a value-added information service to subscribers who want statistical data. Home's customers include the AT&T Imagination Network, General Electric's GEnie, and GTE MainStreet.\nLearnStar--LearnStar, a partially-owned subsidiary of NTN, was formed in 1994. LearnStar owns the exclusive license for NTN's proprietary software technology for educational applications in the United States. With a comprehensive library of over 1,000 interactive academic competitions covering 16 subject areas, LearnStar offers teachers a new and exciting way to encourage learning and motivation in kindergarten through 12th grade students.\nIWN--IWN, a partially owned subsidiary of NTN, was established in 1993 to develop, distribute and market interactive and transaction services for the gaming industry. NTN has granted IWN the exclusive international license for all software and technology developed by NTN for use in gaming applications. IWN subsequently sold these rights to IWN L.P., an unconsolidated limited partnership in which IWN is the general partner. IWN is currently pursuing its business interests entirely through IWN, L.P. IWN, L.P. has two proprietary software products, focusing on the pari-mutuel wagering industry which are, near completion. Through IWN L.P., IWN is developing the IWN Gaming Host System (\"Gaming Host System\"), an on-line transaction processing engine that provides security, administration, processing and switching services. The Gaming Host System is designed to provide the back-end system and support for all of IWN's products, regardless of market niche application or technical platform.\nNew World--New World is an internationally recognized designer, developer and publisher of interactive computer games. New World has a portfolio of over 30 games for DOS, Windows and Macintosh applications in CD-ROM and floppy disk formats. Popular titles include casino-themed games such as Vegas Games(TM), fantasy role playing games such as Heroes of Might and Magic(TM), and strategy adventure games such as Anvil of Dawn(TM). New World's products are designed for general consumer use on a variety of home personal computers and console entertainment systems, such as SEGA and Nintendo.\nMARKETING AND DISTRIBUTION OF SERVICES AND PRODUCTS\nHospitality's NTN Network. The NTN Network is currently marketed primarily to public viewing locations such as bars and lounges, that are principally located in hotels and restaurants, as well as to military bases and country clubs (\"Locations\"). The NTN Network serves over 3,000 locations throughout all 50 of the United States\nand in Canada. Locations in Canada are further served by the Company's licensee, NTN Interactive Network (\"NTN Canada\").\nThe NTN Network presently features from 14 hours to 17 hours, depending on the time zone, of interactive sports and entertainment trivia game programming on weekdays, with extended programming hours on weekends. The balance of broadcast time is devoted to an audible graphics-based service transmitting information, including sports and upcoming program promotion.\nOriginal programming for the NTN Network is developed and produced at the Company's corporate offices in Carlsbad, California for distribution to Locations. The Company's facilities are equipped with video, satellite and communications equipment, and sophisticated multimedia computers. The Company can provide simultaneous transmission of up to 16 live events for interactive play and a multitude of interactive games and other programs, allowing distribution of different programs to customers in different geographical locations.\nThe Company uses two independent services to distribute NTN programming via satellite to customers, although it is not dependent upon either service because there are several other providers that offer similar services. The Company attempts to use the most effective and least expensive multiple data transmission techniques to distribute data from the Company's facilities to customers, including FM radio transmission, direct satellite broadcast, and television transmission via vertical blanking interval.\nEach Location receives NTN proprietary equipment (a \"Location System\") including a personal computer, a satellite data receiving unit (usually a small satellite dish), and a minimum of ten hand-held, portable keypads (\"Playmakers(TM)\") which players use to make their selections. During live interactive program, players participate in the play-along programs using two television screens. One screen features the live broadcast from the television network (e.g., ABC's Monday Night Football), while the second screen displays the NTN Network program. Participants play the game by entering their selection on Playmakers(TM), which transmit a radio signal to the on-site computer or through connection to the NTN broadcast center (the \"Broadcast Center\") in Carlsbad, California. At the conclusion of the broadcast, total scores are calculated and sent via phone lines. Within seconds, results are tabulated and scores at each participating Location are transmitted back to such Location via the NTN Network. This allows players to compete not only with other patrons at their Location, but against all players across the nation who are participating interactively on the Network. The following diagram depicts the transmissions for a typical real-time, interactive game via satellite.\n[SATELLITE FIGURE GOES HERE]\nIn addition to tabulating Playmaker(TM) responses at the Location and communicating with the Company's offices, the Location System can manipulate videotext inserts at the direction of the Location, and call up high-resolution computer generated graphics as directed by the Company's computers. Accordingly, the Company offers both national and local advertising.\nInteractive Sports Game Programs. Hospitality offers a variety of sports and entertainment trivia games that challenge players skill and knowledge and create significant customer loyalty. An example of interactive sports programming is QB1(R), the Company's first and most renowned game program. QB1(R) is an interactive football strategy game exclusively licensed by the NFL which tests a player's ability to predict an offensive team's plays during a live televised football game. Points are awarded based on the accuracy of the player's prediction, rather than whether the team scores or advances the ball. The Company broadcasts QB1(R) in conjunction with every NFL game and selected Canadian Football League games and college football games.\nThe NTN Network presently features the following interactive sports games programs:\nNTN Play-Along Games--Interactive games played in conjunction with live, televised events. Games include the following:\nNTN Fantasy Games--Fantasy league games that are played in conjunction with sporting events or rotisserie leagues. Games include the following:\nInteractive Trivia Game Programs. During trivia game programs, each Location System simultaneously displays selected trivia questions which are displayed on the NTN television monitor at each Location. Participants use the Playmaker(TM) to select answers, which are collected, transmitted and tabulated in a similar manner to NTN's interactive sports games. Participants' scores are displayed on the dedicated television monitors, along with national, regional and local rankings, as applicable.\nWhile certain of the Company's sports games are available only during the seasons when the respective sports are played, the trivia game programs allow the Company to offer year-round interactive programming. The NTN Network generally provides the trivia programming during evening hours, when Locations, particularly restaurants and bars, tend to be busiest. Currently, the Company broadcasts between 14 and 17 hours of interactive programs per day. The NTN Network presently features the following interactive trivia games programs:\nNTN Premium Trivia Games--Promotion-oriented weekly game shows that generally require 1-2 hours of participation. Prizes are awarded to the top finishers. Games include the following:\nNTN Trivia Games--General-themed, standard games typically one-half hour in length. Games include the following:\nSince 1987, Hospitality has broadcast the NTN Awards Show(TM) to all sites in connection with the live Academy Awards telecast. The NTN Awards Show(TM) contains movie trivia and biographical information on nominees and allows players to predict winners up to the actual announcement and compete with other players via the Network, in a manner similar to QB1(R).\nInformation Programming. During the hours in which the Company is not broadcasting interactive games, the Company uses its broadcast network to transmit sports information as well as NTN Network programming information. The Company obtains the majority of its sports information (for which it pays a monthly fee) from Sports Ticker wire service, electronically formats the information and then retransmits it for broadcast to Locations.\nAdvertising. Hospitality operates in a manner similar to the television broadcast medium in that a number of minutes of a broadcast hour are set aside for advertising, promotional spots (promoting Hospitality's competitions and special events), \"tune-in spots\" (promoting Hospitality's programming schedule), and public service announcements.\nHospitality has currently set aside fourteen minutes each hour for advertising, promotional spots and \"tune-in spots.\" Each of the spots are designed to be fifteen seconds in length for a total of 56 spots per hour. Hospitality can insert advertising messages into its interactive sports and trivia programming at any number of Locations. Further, messages can be broadcast over the Network or custom-tailored for a specific Location or several Locations.\nHospitality sells advertising in blocks of two-fifteen second ad spots per hour for a total of fourteen hours per day. Hospitality has innovatively blended programming content with the advertiser's logo and message. For example, the Miller Lite Countdown(R) and Cuervo 1800 Countdown(R) Shows provide 30 minutes of commercial exposure to Miller and Cuervo products. Sponsorships of programs are also available and provide advertisers with specific premium exposure within a sponsored program.\nAdvertisers are also given the opportunity to communicate directly with Hospitality's Players Plus(R) (\"Players Plus(R)\") members, numbering over 250,000. Players Plus(R) is a frequent player club which members join by entering their name, address, zip code and identification number into a Playmaker(TM), which is then captured at the Broadcast Center. A member earns points each time they play and also a chance to win prizes in the monthly Players Plus(R) sweepstakes. Sponsors are capable of receiving feedback through interaction with customers in the form of customer surveys.\nSpecial Events. The Company provides interactive services to corporate customers for special events such as trade shows, conventions, major sporting events, polling, auctions, and corporate training. The NTN Special Event System is highly portable and adaptable. It can be used in a variety of settings including convention centers, theaters, conference centers, and major gathering areas such as arenas and stadiums. Specific programs are tailored to the needs of the customer for each special event, resulting in an attractive, high-tech interactive production. The following is a partial list of customers and events for which the NTN Special Event System was utilized in 1995:\nNational Football League - The NFL Experience NFL Hall of Fame - Permanent Display Major League Baseball - Fanfest Major League Baseball - Hall of Fame Dinner National Hockey League - Hockey Hall of Fame Lexus-Toyota Motor Sales - Car Auctions National Restaurant Association - Trade Show\nInteractive Programming Under Development. The Company is continuing to develop and market-test other interactive game programs. These include interactive programming in conjunction with live broadcasts of basketball games and award shows, as well as additional trivia and stand-alone interactive games. The Company is also developing interactive games for broadcast with television game shows, allowing NTN Network viewers to play a televised game show simultaneously with studio contestants.\nInternational Licensing. NTN continues to expand its international services though licensing agreements. For many years, NTN has provided service to customers in Canada through its unaffiliated licensee, NTN Canada. In 1993, NTN issued a 20-year license to an unaffiliated company in Australia (\"NTN Australasia\"), to create the first interactive television network in Australia and New Zealand. In 1994, NTN issued a license to MultiChoice Ltd., an unaffiliated company, to develop and operate an interactive broadcast network in South Africa. Generally, the company licenses operations in foreign countries by granting the rights to use NTN's exclusive interactive broadcast technology. NTN provides licensees with technological know-how and assistance to build a broadcast center, and to develop interactive products and programs.\nHome. The Company provides many of the same services and programs as Hospitality to the home consumer market via Home Interactive Services (\"Home\"). Home provides multi-player interactive games, which have already garnered brand recognition via Hospitality, into the consumers' households through personal computer on-line services and interactive television services. In addition, Home provides other multi-player interactive games designed expressly for the home environment. Home offers the games to end users via third party networks such as America Online, ImagiNation Network, and GTE MainStreet. The Company receives development fees and monthly broadcast revenues based upon usage and certain minimum guarantees from these third-party networks. The end-user does not pay NTN directly, but pays the distributor who is responsible for paying the Company.\nThe current focus of home distribution is PC on-line services, such as AOL, where a substantial customer base already exists. The Company's interactive sports and trivia games are available on-line 24 hours a day, seven days a week. The Company distributes games through PC on-line services in return for a share of the customer revenue in excess of a minimum monthly fee. The end-user purchases services from a distributor such as AOL who, in turn, pays NTN.\nMost of the interactive sports and trivia games currently broadcast over the NTN Network into Hospitality locations are available directly to customers in their homes through a variety of media, including computer on-line services and ITV networks. Home is a unique content provider since its program is not dependent upon, and consequently not bound by, any particular technology or method of transmission. Regardless of which technology emerges as the primary means of transmission on the \"information highway\", management believes Home's programming content will be available to the household.\nIn addition to the games developed by Hospitality, Home currently offers three on-line games: Hockey Trivia(TM), Baseball Trivia(TM), and Pigskin Picks(TM), and four ITV games: Blackjack, Poker, Reversi and Checkers. In 1996, over two million households had access to play QB1(R) during Super Bowl XXX. Further, the NTN Awards Show(TM) was available to over three million households which could play along and predict the outcome of the 1996 Academy Awards telecast.\nHome distributes games to on-line and ITV networks, also known as content distributors. These games, in turn, are made available to their customer base for a fee. The diagram below depicts the transmissions necessary for a Home customer to play a Home game.\n[VIA CABLE\/TELEPHONE FIGURE]\nLearnStar. NTN formed and granted to LearnStar the exclusive license for its proprietary technology for educational applications in the U.S. The LearnStar teaching system (the \"LearnStar System\") was developed as a natural extension of the Network and its Hospitality applications. The LearnStar System is targeted at schools and teachers who are seeking an educational tool to increase student interest in learning via interactive competitions in the classroom.\nThe LearnStar System enables a school to evaluate the academic proficiency of the students, while creating an enjoyable environment in which students seem more apt to participate. Using similar technology to that used for the NTN Network, the LearnStar interactive learning system can conduct academic competitions, collect data for\nsurveys and provides local, regional and national testing capabilities. All of these services can be utilized within a single classroom, at one distinct site, or at multiple schools throughout the country, all with instantaneous feedback.\nStudents test their comprehension of material by viewing an academic competition on a television screen, then answer questions interactively via hand-held keypads that broadcast signals to and from the LearnStar System. The questions are posed in a multiple choice format, similar to the nationally administered Scholastic Aptitude Test. Many competitions feature full-motion video, colorful graphics and sound. Students work individually or in teams to answer the questions, with scores and team rankings displayed on the television screen after each question. The LearnStar System offers flexibility - it can be utilized as a stand-alone resource, moving on a portable cart from classroom to classroom for use by the entire school, or the LearnStar System can be linked via satellite on the NTN Network for live national competitions with schools throughout the US. Teachers can also develop unique lesson plans by editing the existing competitions or creating their own customized quizzes to include current events and to highlight important information.\nThe LearnStar System includes a dedicated computer control system with Pentium processor, CD-ROM unit, proprietary software, printer, satellite dish, receiver, wireless keypad transceiver, classroom keypad pack with charging trays, and LearnStar component cart. The LearnStar System allows teachers to customize existing learning materials in the library to match their personal lesson plans with proprietary editing software that allows the editing of existing competitions, or creation of new competitions, utilizing either a PC or Macintosh platform.\nThe multimedia, interactive LearnStar software features over 1,000 academic competitions in 16 subject areas written by experienced educators, instructional designers and software programmers. LearnStar academic competitions are carefully written according to state guidelines, national standards, relevant topics and age appropriateness.\nIWN. IWN, a partially owned subsidiary of NTN, was established in 1993 to develop, distribute and market interactive and transaction processing services for the gaming wagering industry. IWN is a general partner in IWN L.P. which has been granted the exclusive worldwide license for all existing and future software and technology related to gaming applications. IWN, L.P. will continue to develop its products and services for eventual mass marketing.\nInitially, IWN focused on the domestic pari-mutuel market as the point of entry due to the enabling legislation that already exists in several states. This legislation currently allows racing fans to establish and fund an account at the racetrack, and call in via telephone to either a live operator or an interactive voice response unit to place their wager. New York and Connecticut presently allow non-residents to establish accounts and place interstate telephone wagers. Ohio and Pennsylvania are considering allowing non-resident accounts and interstate telephone wagering.\nIWN's first product, HomeStretch(TM), turns a personal computer into a gateway for pari-mutuel wagering. The Windows 95-based product will allow players to establish and fund an account at the racetrack, review race information, and create wagers. Using a modem, the player will connect to IWN's Gaming Host System, located in Carlsbad, California, which upon completion will provide connectivity to the racetrack system, funds transfer system, and information providers. The Gaming Host System will be an on-line transaction processing engine that will provide the security, administration, financial transaction processing services and switching capabilities necessary to support interactive gaming and wagering from the home or virtually anywhere.\nNew World. New World was acquired in 1993 to broaden the Company's game portfolio and to develop new platforms beyond TV to cable, satellite and wireless networks. New World is an internationally recognized designer, developer and publisher of interactive computer games, currently offering games in CD-ROM and floppy disk formats. Since its inception, New World has published over 30 titles for DOS, Windows and Macintosh applications in CD-ROM and floppy disk formats emphasizing sequel-based fantasy role playing games. New World primarily publishes games, most of which are developed under contract by independent producers concentrating on original games.\nMARKETING AND EXPANSION STRATEGY\nHospitality. Hospitality markets its services to customers primarily through advertising in national trade periodicals, national and regional industry trade shows, telemarketing, direct mail and direct contact through the field representatives. All sales prospects are organized and tracked through Hospitality's distributed database software. Hospitality utilizes a full-time telemarketing staff to set appointments for field representatives, pursue trade show and magazine inquiries and accommodate in-bound sales calls. The telemarketing staff plans, organizes and implements the direct mail program and the subsequent follow-up strategy. This staff also telemarkets to prospects generated from industry lists acquired by hospitality. Currently Hospitality sells its services through its two-person management team and utilizes direct salespersons as well as over 30 independent representatives. The representatives' agreements are typically three-year agreements, subject to earlier termination by the Company in the event the representative does not meet certain performance goals. Customers generally execute a renewable one-year contract to obtain the Company's services and pay a monthly fee of approximately $600.\nThe Company's future business strategy related to Hospitality is to continue to increase available programming for the NTN Network and market the NTN Network to additional group viewing Locations. In addition, the Company intends to develop additional revenue sources for the NTN Network such as advertising, and increase its special event services to other types of businesses. No assurance can be given as to whether the Company will be successful in the implementation of its business strategy.\nHome. Since the end-user is technically the distributor's customer, Home relies on the distributor's marketing efforts to promote its products. However, home works in conjunction with distributors to develop the promotions and advertisements. For example, AOL may include the Company's game logo on an initial \"start-up\" screen which millions of its subscribers can access at no expense to NTN. Furthermore, Home supplies distributors such as GTE MainStreet with existing marketing materials used by Hospitality, but GTE MainStreet absorbs the majority of the cost associated with promoting Home's games to GTE MainStreet customers. The company has long-term agreements with its customers to provide its services and products. Home's customers generally pay the company a fee based on the amount of time that consumers have participated with Home's games and services.\nIn the future, Home expects its products to elicit more exposure from the distributors as a result of increased brand recognition and continued promotions. Home will continue to take a proactive position with respect to marketing products to each distributor to ensure inclusion in as many of their promotional efforts as possible. Home expects its direct marketing costs to continue to be minimal. No assurance can be given as to whether the Company will be successful in the implementation of its business strategy.\nLearnStar. To date, LearnStar has utilized a direct sales force to target individual schools. In the future, management plans to increase the marketing effort by targeting inner-city school districts, the nationwide Catholic archdiocese school system and others. LearnStar is seeking sponsorship from public and private foundations as well as funding from federal, state and local government agencies. LearnStar derives its revenues from selling the LearnStar system and a site license to its customers. Current prices for the LearnStar system range from $18,000 to $23,000 dependent upon volume and other factors.\nLearnStar also is pursuing corporate sponsorship, whereby corporations will finance the costs of an academic competition in return for promotional consideration. Marketing and sales efforts are focused on large population centers in states with funds designated specifically for technology in education. Sales efforts are currently underway in Mississippi, Georgia, North Carolina, Pennsylvania, Ohio, Missouri, Illinois and Michigan. No assurance can be given as to whether the Company will be successful in the implementation of its business strategy.\nIWN. IWN's marketing strategy is to promote the acceptance of interactive applications to existing gaming and wagering enthusiasts, on-line services users and interactive television participants. IWN's marketing strategy for HomeStretch(TM) in the interactive pari-mutuel wagering market, is to target both the racing organization and the\nracing end-user. The development of this business will depend on the adoption of enabling legislation in many states and countries. Utilizing database marketing, IWN will initially target racing fans who currently use computers for handicapping. This group has been identified as \"early adopters\". IWN intends to expand the market to include on-line services users and other demographic groups which are comfortable with technology and have an interest in sports. IWN will seek to utilize resources from both the Hospitality and Home businesses to generate potential customer lists. Targeted direct mail, on-line advertising and telemarketing will all be utilized to promote the IWN services. IWN will generate revenue through fees charged to process data including wagers and switching and transfer services.\nPromotion to the racing industry will be through trade shows and direct sales. IWN's management team has over twenty-five years of combined experience marketing services to the gaming and wagering industry. IWN has a relationship with Autotote Corporation, a public company which processes approximately 75% of the pari-mutuel handle in the U.S. and which is the exclusive licensee for operating off-track betting establishments for the State of Connecticut. In addition, IWN has a relationship with the Ontario Jockey Club, Canada's premier racing organization, with plans to develop an interactive wagering system for the Canadian market. Implementation is expected in the third quarter of 1996. No assurance can be given as to whether the Company will be successful in the implementation of its business strategy.\nNew World. Since its inception, New World has published over 30 titles for DOS, Windows and Macintosh applications in CD-ROM and floppy disk formats focusing on sequel-based fantasy role playing games (\"RPGS\"). New World primarily publishes games, most of which are developed under contract by independent producers, but also has an internal core group of professionals to support developers and to produce a selected number of titles in-house. New World focuses on bringing original games to market rather than paying premiums to license TV or movie titles from outside parties as do many of its competitors. The product development cycle normally takes between 12 and 18 months from concept to production. A large percentage of sales occur in the last four months of the year during the peak Christmas holiday sales season.\nThe Company's current list of PC based, CD-ROM and entertainment center-based game Products consists of the following:\nFantasy Games -------------\nMight and Magic I & II Combo Might and Magic III, Isles of Terra Might and Magic: Clouds of Xeen Might and Magic: Darkside of Xeen Might and Magic: World of Xeen Heroes of Might and Magic Might and Magic: Trilogy\nAdventure\/Strategy Games -------------------------\nSpaceward Ho! Spaceward Ho! IV Empire Deluxe Empire Deluxe: The Scenarios. Empire II Iron Cross Hammer of the Gods Inherit the Earth Zephyr Wetlands\nEntertainment Games -------------------\nJoe & Mac: Caveman Ninja Vegas Games More Vegas Games Celebrity Poker Mind Games Family Card Games\nProductivity\/Connectivity Software ----------------------------------\nMacIntercomm Lite\nNew World is involved solely in the software aspect of the computer and video game industry. It is not involved in the manufacturing or sales\/distribution of computer hardware other than in the form of licensing and bundling Products with hardware manufacturers. The Company's Products are sold through mass merchants or retailers and subsequently installed directly onto the consumer's computer.\nTechnical support for questions relating to video game software is provided to the consumer free of charge. In addition, consumers have access to the 24- hour bulletin board system for video game hints and updates. To eliminate technical problems, the Company employs several full-time quality control personnel who conduct tests on the various aspects of each Product.\nAdvertising for computer games and video game software incorporates both traditional and non-traditional media placements. Traditional media include magazines, trade journals, direct mail, telemarketing and newspaper advertising. Non-traditional media include on-line marketing (including the Internet), encrypted CD-ROM marketing and trade show promotions. New World also utilizes cooperative advertising in conjunction with retailers in order to capture end- caps and shelf space. New World currently advertises in leading industry publications such as Computer Gaming World, Computer Game Review, PC Go, PC Data and PC News. New releases are promoted through advertisements as well as reviews in these publications. Retail prices for New World games range from $19.95 to $59.95.\nNew World distributes directly to its largest 50 customers through a three person sales force that covers both domestic and international markets. All other sales are made through distributors. Distributors are paid a 5% commission for every title sold. The majority of sales are made by software specialty retailers including Egghead, Electronics Boutique and Software Etc. New World products are also distributed through computer superstores (CompUSA, Computer City), warehouse clubs (Price\/Costco, Sam's) and consumer electronics retailers (Circuit City, Best Buy and Good Guys!).\nNew World software is also distributed through mail order catalogs such as Mac\/Micro Warehouse and PC MacConnection. New World recently expanded distribution capabilities in Europe by entering into an arrangement with an independent company to produce, market and distribute New World's products for which it will receive royalties. As a result of this and other pending arrangements, New World does not employ any sales representatives in foreign countries.\nNew World's future business strategy related to the software development and distribution segment, is to produce the highest quality, most entertaining Products in the marketplace, and to expand its distribution, both domestically and internationally. In this regard, New World intends to increase its product line and release additional Products in 1996 and actively pursue publishing its own video games on additional technical platforms including SONY Playstation systems and SEGA Genesis systems. New World will also seek out further opportunities to publish and distribute products developed by others, and other development avenues. In furtherance of its business strategy, New World plans to continue to research the needs of the consumer, develop innovative technology, improve and enhance game design, graphics, sound and musical effects and expand its\nstory lines. No assurance can be given as to whether the Company will be successful in the implementation of its business strategy.\nSOURCES OF REVENUE\nThe following table sets forth information with respect to the principal sources of the Company's revenues during the years ended December 31, 1995, 1994 and 1993.\nDistribution Revenue. The primary market for the NTN Network has been the Hospitality market comprised of approximately 330,000 bars and restaurants in North America, but potential Locations may also be found among approximately 30,000 hotels, 800 military bases, 3,000 college campuses, 24,000 hospitals, and 100,000 other group viewing Locations such as country clubs, fraternal organizations, and bowling centers.\nTo date, the NTN Network customers have generally been bars and lounges, principally in hotels and restaurants. Many of the Company's Locations have multiple sites such as hotel and restaurant chains. Locations generally enter into a one-year broadcast service agreement with the Company pursuant to which they pay a monthly broadcast fee of approximately $600 per Location. The Company currently serves over 3,000 Locations located in all 50 States and in Canada. Fees from distribution services account for approximately 50% of the Company's revenue.\nThrough Home, the Company also provides its services to on-line users and ITV services pursuant to the agreements with various system providers such as AOL, GEnie, GTE and Imagination Network. The on-line computer industry is one of the fastest growing consumer markets in terms of subscribers. Industry analysts project that by 1999 more than 100 million consumers will be connected to on- line computer services. Distribution fees from on-line services and ITV services are based on the actual use of the NTN interactive programs by their underlying customers. Revenues from these services were $690,000 in 1995.\nIn 1986, the Company entered into a license with NTN Canada (the \"Canadian License\"), pursuant to which NTN Canada solicits Locations to the NTN Network in Canada. Under the Canadian License, the Company broadcasts NTN Network programs to Canadian Locations in exchange for an annual license fee payable in monthly installments based upon the number of Locations in Canada, which presently number approximately 450.\nThe Canadian License also grants NTN Canada the exclusive right to market NTN interactive services to cable\/on-line viewers in Canada. The Company is entitled to receive a royalty equal to 25% of revenues generated from Canadian home customers. There are as yet no cable\/on-line customers in Canada, and no assurance can be given that any such royalties will be received by the Company.\nEquipment Sales. Equipment sales of Location Systems and LearnStar Systems is a major source of revenue for the Company. Typically, Location Systems are sold to leasing companies under sale and leaseback agreements,\nand provided by the Company to Locations. The Company also sells interactive equipment, particularly Playmakers(TM), to its licensees in Canada, Australia, New Zealand and South Africa. LearnStar Systems are sold to schools and other education providers. Equipment is generally sold to customers with no return rights except in the case of defect.\nLicensing of Technology. NTN has entered into license agreements with unaffiliated companies in Australia\/New Zealand and South Africa. Those license agreements provide for the Company to assist licensees in establishing a broadcast network, and for the company to receive a flat license fee. In addition, a monthly fee based upon the number of Playmakers(TM) in use plus a percentage of gross advertising revenue is earned by NTN. The Australia\/New Zealand licensee commenced operation of a broadcast network in 1993. The South Africa licensee began operation of its broadcast center in 1995. In 1994 and 1995, IWN licensed IWN L.P., an affiliated unconsolidated limited partnership, for worldwide rights to its interactive gaming technology. No assurances can be given that any significant revenues to the Company will result from future licensing activities.\nProduct Sales of Video Game Software. A majority of the Company's software sales are through software specialty retailers, including Egghead, Electronics Boutique, Software Etc., and Babbages. The Company has entered into distribution arrangements with distributors who supply retailers.\nThe Company distributes its Products to computer superstores, such as CompUSA, Computer City, Micro Center, Fry's Electronics and Future Shop (Canada); warehouse clubs, such as Price\/Cost Co., Inc. and Sam's; consumer electronics retailers such as Best Buy, Inc. and Circuit City and mail order catalogues, including Mac\/Micro Warehouse, PC MacConnection, MAC Zones and Multiple Zones. Additional orders are obtained through direct mail campaigns through the Company's 800-sales line and product catalogues included in every product box.\nNorth American sales accounted for nearly all of video game Product sales for the year ended December 31, 1995. The Company's video games are distributed in Japan and other Asian countries through independent retailers and distributors and in the United Kingdom, Europe and Asia by means of independent distributors through license agreements.\nRAW MATERIALS\nFor media platforms such as cable and on-line services, the Company distributes its programs to the recipients who maintain their own receiving, translation and re-broadcasting equipment. Accordingly, the Company has no raw materials or equipment needs for these customers. For media platforms such as the NTN Network and LearnStar applications, the System is assembled from off- the-shelf components available from a variety of sources, except for the Playmaker(TM) package. The Company installs and maintains service of the Location Systems and LearnStar Systems. The Playmaker(TM) package is currently manufactured to the Company's specifications by a non-affiliated manufacturer in Taiwan. The Company believes that there are numerous other manufacturers who could supply Playmakers(TM), although no assurances can be given that, if necessary, such alternative sources could be secured at commercially reasonable costs and without undue delay.\nComputer and video game Products are manufactured by third-party fulfillment houses using printed and pre-packaged materials, computer disks and compact discs (CD's). These materials are readily available from a variety of sources and the Company is not dependent on any one source for materials.\nLICENSING, TRADEMARKS, COPYRIGHTS AND PATENTS\nThe Company's sports games make use of simultaneous telecasts of sporting events. The promoters of such events take the position that the use of simultaneous telecasts requires express permission from the owners of the pertinent rights. In addition, the Company believes that a license is required to utilize the trademarks and logos of national teams and leagues in connection with the playing of an interactive game.\nThe Company is party to an exclusive license from the NFL, which grants the Company the exclusive right to use the trademarks and service marks of the NFL in connection with the playing and marketing of QB1(R). The NFL license grants the Company the exclusive data broadcast rights to conduct interactive games in conjunction with the broadcast of NFL football games, for which the NFL receives a royalty based on revenues billed by the Company in connection with QB1(R) play. The agreement with the NFL had an initial term of five years which expired in 1995. The Company's exclusive agreement with the NFL was extended for two years and the parties are presently engaged in negotiations with respect to their future relationship. There can be no guarantee that the Company will be able to renew the license in the future. Further, it is uncertain as to whether the Company's failure to renew the license will have a material adverse effect on the Company.\nIn 1994, the Company entered into a three-year exclusive contract with the Canadian Football League (\"CFL\") granting the Company the exclusive rights to the simulcast of data accounts of the events occurring at CFL games, for which the Company paid a royalty fee to the CFL. The license also includes the exclusive right to use the CFL trademarks and logos for an interactive game in connection with the playing and marketing of QB1(R).\nThe Company currently has non-exclusive licenses from Major League Baseball and the National Hockey League to use live broadcasts of their respective games in conjunction with broadcasts of \"NTN DiamondBall(R)\" and \"NTN PowerPlay(R)\" in Canada. The Company does not possess such licenses with respect to the United States and other territories. The Company may ultimately seek United States licenses for \"NTN DiamondBall(R)\" and\/or \"NTN PowerPlay(R)\", though under the circumstances, no assurances can be given that the Company will be able to secure such new licenses given the current moratorium, nor is it certain that the Company will be able to secure new licenses on satisfactory terms.\nNo action has been brought against the Company by the owners of the applicable rights with respect to any of the Company's broadcasts of interactive games in conjunction with live sports events.\nIn connection with a settlement of a lawsuit that the Company brought in 1986 to challenge the validity of Interactive Network (\"IN\")'s US Patent, the Company entered into an agreement with IN in 1987 to take a license under that Patent which grants the Company an irrevocable, worldwide, royalty-free license for QB1(R) such that IN cannot challenge QB1(R) as played on the NTN Network based upon a claim of patent infringement. Non-live events in the United States, such as the Company's popular trivia games, do not utilize IN's US Patent. In addition, any of the Company's programming, as played on any of the on-line services, similarly do not utilize the IN\/US Patent. IN also holds the IN\/Canada Patent, issued in October, 1990, which, but for one additional claim, is identical to the IN\/US Patent. Since the issuance of the IN\/Canada Patent, the Company filed an action in Canada for a declaration that the Company's operations in Canada do not infringe the IN\/Canada Patent. In response, IN instituted its own lawsuit in Canada seeking a declaration of infringement. The existence of IN's claim against the Company has not precluded the Company from broadcasting in Canada. In the event that it is determined that the Company's programs do utilize the IN\/Canada Patent, the Company could be required to pay royalties for such programming, with the exception of QB1(R), for which the Company has an irrevocable, worldwide and royalty-free license. Alternatively, the Company can reconfigure the systems by which it distributes, stores, processes or collects data to and from Canadian Locations in the course of its interactive broadcasts at an insignificant cost. See \"Legal Proceedings\".\nThe Company keeps confidential as trade secrets the software used in the production of its programs. The hardware used in the Company's operations is virtually off-the-shelf, except for the Playmaker(TM) keypads. The Company owns copyrights to all of its NTN Network programming. In addition to the registration of the trademark for QB1(R), the Company has either received, or is presently applying for, trademark protection for the names of its other proprietary programming, to the extent that trademark protection is available for same.\nDuring 1994, the Company commenced a program directed to the protection of its intellectual property assets. As part of this program, the Company presently has two patents pending for an Interactive Learning System and Automated System for Conducting Auctions with Participants in Remote Locations.\nThe Company has licensed certain of its out-of-print titles to others for inclusion in packages along with other software titles on a domestic basis. The Company also licenses out-of-print and current titles to publishers throughout Europe and Asia. No assurance can be given that the Company will continue to generate significant revenues from its out-of-print titles, domestically or internationally.\n\"New World Computing, Inc.\" and its logo are registered trademarks of New World, Inc., a wholly owned subsidiary of NTN. \"LearnStar\" and its logo are registered trademarks of LearnStar, Inc. a partially owned subsidiary of NTN. \"IWN\" and its logo are registered trademarks of IWN, Inc., a partially-owned subsidiary of NTN. The Company actively trademarks and copyrights all of its proprietary software, game titles, game logos and software tools.\nSEASONAL BUSINESS\nOverall, the Company's business is not generally seasonal. However, sales of new Locations have traditionally been higher in the Summer and early Fall months compared to the rest of the year. Revenue from Interactive Television and Entertainment services is billed monthly based on broadcast and production services as provided to customers. Sales of LearnStar Systems occurred for the first time in 1995, but management believes that sales will be higher in the early part of the year and at the traditional beginning of school in September with little or no activity during the Summer break period. Sales of video game Products have been more heavily weighted in the late third quarter and fourth quarter for the past few years but can fluctuate based on the timing of the release of new Products.\nWORKING CAPITAL\nThe discussion under \"Liquidity and Capital Resources\" included in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, is incorporated herein by reference.\nSIGNIFICANT CUSTOMERS\nThe Company's customers are diverse and varied in size as well as location. The distribution services are provided point to multi-point so that the Company is not dependent on any one, or a few customers. The Company does not have any individual customers who accounted for 10% or more of its consolidated revenues in 1995, 1994 or 1993.\nBACKLOG\nThe Company generally does not have a significant backlog at any time because the Company normally can deliver and install new Location Systems within the delivery schedule requested by customers (generally within two weeks) related to the NTN Network, with a similar delivery and installation pattern for the LearnStar System. At December 31, 1995, the Company had a backlog of uninstalled Location Systems of approximately 100 new Locations which were installed in January and February, 1996. For other distribution platforms, there is no backlog because services are generally distributed point to multi- point and the Company does not have to provide specific equipment to the customer, making it relatively simple to add new customers.\nProducts provided to retail outlets are not backlogged since the selling season for any given video product is generally limited and production time to create any additionally needed copies is very short. The Company uses a number of fulfillment houses to duplicate disks and CD-ROM's.\nGOVERNMENT CONTRACTS\nThe Company provides its distribution services to a small number of government agencies (usually military base recreation units), however the number of government customers is small compared to the overall customer base. Contracts with government agencies are provided under the same terms and conditions as other corporate customers and are not subject to renegotiation at the election of the government agency.\nCOMPETITIVE CONDITIONS\nThe Interactive Entertainment industry is in its formative stage, but currently may be divided into three major segments: (1) media distribution services such as on-line services, telephone companies and cable television companies and Hospitality's NTN Network; (2) equipment providers such as computer and peripheral equipment manufacturers; and (3) content and programming providers, such as movie studios, NTN, and software publishers. The Company does not act as a direct provider of equipment to consumers. The Company operates as a media distribution service through its own NTN Network. Also, the Company is a program provider to an array of other media distribution services to consumers utilizing a variety of equipment.\nNTN has a growing number of competitors in the programming segment of the Interactive Entertainment industry. The Company's programming content is not dependent upon, and consequently not bound by, any particular technology or method of distribution to the consumer. The Company's programming is, therefore, readily available to consumers on a wide variety of entertainment and media services including: the NTN Network; on-line services including America Online, GEnie, and The ImagiNation Network; and cable television, including GTE MainStreet, which is available to households in certain regions.\nThe Interactive Television industry is still in its infancy. Few companies have developed the technological capabilities to broadcast Interactive Entertainment to large audiences that can compare to the nature and scope of programming broadcast on the NTN Network. Although few companies, if any, have products or services identical to those provided by NTN, the Company does compete with other companies for total entertainment dollars in the marketplace. The Company's programming competes generally with broadcast television, pay-per- view, and other content offered on cable television. On other mediums, the Company competes with other content and services available to the consumer through on-line services. The Company's programming is interactive in nature but is distinguished from other forms of interactive programming by its simultaneous multi-player format and the two-way interactive features. Presently, the technological capabilities of transmitting entertainment products to the consumer exceed the supply of quality programming and services available on the existing delivery systems. The Company is able to utilize the wide variety of services available for transmission of entertainment products to the consumer by forming strategic alliances with service providers to supply the Company's programs for re-transmission. The Company's programming thus becomes available to the consumer over a multitude of media platforms and delivery systems.\nHospitality. Currently, Hospitality has no competitors that furnish live, multi-player interactive entertainment in a similar scope and nature as provided by Hospitality. Although Hospitality has no direct competitors, it does compete for total entertainment dollars in the marketplace. Other forms of entertainment provided in public eating and drinking establishments include music-based systems and cable and pay-per-view television. However, evidence provided by customers indicates that patrons are inclined to stay longer and consume more food and drink when Hospitality's interactive games are offered as the main source of entertainment. Accordingly, Hospitality customers generally tend to view Hospitality services as a profit generator rather than a cost center.\nHome. In Home's market, the consumer has a plethora of entertainment options from which to choose, ranging from cable television to telephone based services to computer on-line providers. Home offers the only live, multi-player games and services which are broadcast to multiple interactive platforms in the home today. However, Home competes for a share of the total home entertainment dollars against broadcast television, pay-per-view and other content offered on cable television. Home also competes with other programming available to\nconsumers through on-line services such as AOL and Prodigy. Cable television, in its various forms, provides consumers the opportunity to make viewing selections from anywhere between 30 to 100 free and pay channels, thus limiting the amount of time devoted to any particular channel. For the most part, cable television is predominantly a passive medium, and does not offer the viewer the opportunity to participate in its programming, and even less frequently, does it offer programming designed for active participation. On-line services, such as AOL, can provide literally thousands of options for content and entertainment, however, such on-line services have traditionally been confined to that company's subscriber base. Interaction among viewers is thus limited to the particular program as offered only on the specific on-line service. The Company, on the other hand, offers consumers the opportunity to participate and compete against other viewers who are seeing the identical program over several different technological media, including interactive television, personal computers and\/or the NTN network.\nLearnStar. Products and services to education customers utilizing the LearnStar System were sold beginning in 1995. The Company competes with some established businesses which offer educational products, however, the majority of existing products in the marketplace are passive, rather than interactive. Such companies include Jostens' Learning, C.C.C. and the Eduquest Division of IBM. The competitive advantage of the LearnStar System is that it provides an easy to use, two-way interactive learning method, is very competitively priced and requires less equipment than traditional systems. Moreover, the LearnStar System is adaptable to the particular needs of the individual users and is designed such that it can be used for local, regional, and national competitions on a mass basis utilizing existing satellite technology. Although the market for providing learning services to schools is mature, the company believes that the market for advanced educational products which use computers, interactive software and satellite technology is embryonic.\nIWN. The U.S. gaming industry is growing at a rapid pace. In 1994, Americans wagered over $400 billion on legal commercial gaming compared to $126 billion in 1982. A 1995 survey showed that 61% of American adults wagered in one or more types of government-approved gambling last year. In 1994, the total handle for pari-mutuel was $16.6 billion, of which $10.2 billion was horse racing. In comparison, $5.8 billion was spent at the cinema and $5.7 billion was spent on spectator sports.\nOne of the reasons for the growth in gaming has been the favorable regulatory and legislative environment. Many states have accepted gaming as a means to raise tax revenue and encourage economic development. There are approximately 200-250 pari-mutuel facilities in the U.S., and seven states have legalized account-based telephone wagering, including New York and Connecticut, which allow interstate telephone wagering.\nPari-mutuel wagering is the fourth largest segment in the gaming industry. Analysts estimate that in 1994 approximately $10.2 billion was wagered on U.S. thoroughbred horse racing, compared with $9.6 billion in 1993.\nWhile the overall growth of the pari-mutuel handle has been stagnant over the last five years, particularly when compared to the significant growth in the overall gaming industry, the shift from on-track wagering to off-track betting is an important trend. With the total U.S. thoroughbred horse racing handle in the $10 billion range, off-track betting increased from $2.2 billion in 1987 to $4.5 billion in 1992 to $6.1 billion in 1994. Off-track betting is allowed in 20 of the 40 states where pari-mutuel wagering is legal and is an increasingly important source of revenue for racetracks and state governments. IWN's HomeStretch(TM) product is intended to leverage the trend to off-track wagering by allowing fans to place wagers from virtually anywhere to their account at the racetrack.\nIWN will eventually compete for total entertainment dollars in the market place. Within the gaming and wagering industry, competition for the pari-mutuel wagering dollar comes from expanded alternative gaming opportunities. Outside the industry, pari-mutuel wagering competes with all forms of entertainment vying for consumer spending dollars. Potential competitors in the interactive pari-mutuel wagering and gaming market include:\nNew World. The video game and entertainment software industry is very competitive. Competitive factors include access to licenses, brand name recognition, product features and quality, access to distribution channels and price. New World competes with other developers of PC and video game entertainment software. Competitors vary in size from small companies with limited resources to very large companies such as Microsoft, Broderbund Software and Electronic Arts.\nThe industry has evolved into a very large and fragmented market in which New World is a small competitor. Most of the industry leaders produce CD-ROM titles and most have greater financial and marketing capabilities than New World. However, the market is still relatively young, especially for CD-ROM technology, and is likely to continue to grow rapidly as PC's increase their household penetration.\nWith the entrance of motion picture, cable and TV companies, competition in the Interactive Entertainment and multimedia industries will likely intensify in the future. Moreover, new technologies, such as on-line networks and the Internet, provide computer users an alternative to video games and entertainment software, but also offer companies like New World an opportunity to deliver product via new media. The Company seeks to compete by providing high quality products at reasonable prices, thereby establishing a favorable reputation among frequent buyers, thus providing repeat sales on sequels and other products manufactured and\/or distributed by the Company. Many companies compete in the arena due to the relative ease of production and distribution of the products, but no one company dominates or has a market share in excess of ten percent (10%).\nRESEARCH AND DEVELOPMENT\nDuring the three years ended December 31, 1995, the Company expended $1,471,000, $1,972,000, and $1,073,000 respectively, on Company-sponsored research and development projects, including projects performed by consultants for the Company.\nThe Company is currently engaged in the development of enhancements to its interactive software for several media platforms and continues its research into new and enhanced graphics of software for video game products. There is no assurance that the Company will successfully complete current or planned development projects or will do so within the time parameters and budgets established by the Company, and there is no assurance that a market will develop for any product successfully developed.\nThe Company works closely with independent user groups in an attempt to develop enhancements and new services and products in response to customer needs.\nGOVERNMENT REGULATIONS\nCompliance with federal, state and local laws have not had a material effect upon the Company's capital expenditures, earnings or competitive position to date. The Company does not anticipate that it will have to incur any material expenses in the future in order to comply with federal, state or local laws because of the nature of its current services and products. Gaming laws in many states currently restrict the ability of individuals to place wagers off-site from a regulated wagering facility. The ability of IWN to carry out its business objective will be dependent upon enabling legislation in states and other countries.\nEMPLOYEES\nThe Company and its subsidiaries employ approximately 215 people on a full- time basis and 60 people on a part-time basis, and utilizes independent contractors on a project basis. In addition, NTN retains a number of non- affiliated programming and systems consultants. It is expected that as the Company expands, additional employees and consultants will be required. The Company believes that its present employees and consultants have the technical knowledge necessary for the operation of the Company and that it will experience no particular difficulties in engaging additional personnel with the necessary technical skills when required. None of the Company's employees are represented by a union and the Company believes its employee relations are satisfactory.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES. -----------\nThe Company has a membership in a limited liability company that owns \"The Campus\", the three-building complex that houses the Company's headquarters. The Company has a six-year lease for approximately 39,000 square feet of office and warehouse space, at a rent of approximately $23,000 per month. The Company also leases approximately 10,000 square feet of space under a lease that runs through September, 1998, at a rent of approximately $15,000 per month. The Company does not anticipate leasing additional space in the next year.\nThe Company maintains its offices for its computer and video software division (New World) at 29800 Agoura Road, Suite 200, Agoura Hills, California. The Company leases approximately 12,000 square feet of office space, under a lease that runs through March, 1999, at a rent of approximately $10,000 per month.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS. ------------------\n1. NTN Communications, Inc. vs. Interactive Network, United States District ------------------------------------------------ Court for the Northern District of California, filed June 11, 1992 and related award of attorneys' fees.\n2. NTN Communications, Inc. vs. Interactive Network, filed in the Superior ------------------------------------------------ Court for the County of Santa Clara, California, on April 28, 1993.\n3. Interactive Network vs. NTN Communications, Inc., filed in the Superior ------------------------------------------------ Court for the County of Santa Clara, California, on February 28, 1994.\n4. NTN Communications, Inc., NTN Sports, Inc. and NTN Canada, Inc. vs. ------------------------------------------------------------------- David Lockton and Interactive Network, Inc., filed in the Federal Court of - ------------------------------------------- Canada, Trial Division, on June 12, 1992.\n5. Interactive Network vs. NTN Communications, Inc., NTN Sports, Inc. and ---------------------------------------------------------------------- NTN Canada, filed in the Federal Court of Canada, Trial Division, on June 18, - ---------- 1992.\nAll litigation between the Company and Interactive Network has been suspended pending substantive discussions regarding a global resolution of all disputes.\nThe Company is also defending litigation filed by various shareholders of the Company. The case, originally filed in June, 1993, in the United States District Court for the Southern District of California (San Diego), is a consolidation of four lawsuits seeking class action status to recover unspecified damages for a drop in the market price of the Company's common stock following an announcement that an anticipated agreement under which the Company would sell certain equipment and services to an arm of the Mexican government may be put out for bid. Whereas the Company has vigorously defended this litigation and believes, in part, based upon the opinion of outside counsel, in the merits of its defense, the Company has entered into substantive negotiations to resolve this matter out-of-court to avoid costly and protracted litigation, in the best interests of its shareholders. A\npreliminary framework for such a resolution has been reached, however, any proposed settlement between the parties will be subject to notification to each of the class members and final court approval.\nOn April 18, 1995, a class action lawsuit was filed in the United States District Court for the Southern District of California (San Diego). The lawsuit seeks unspecified damages and alleges violations of securities laws based upon the Company's projections for the fourth quarter of 1994 and for fiscal year 1994, and further alleges that certain insiders sold stock on information not generally known to the public. The Company has denied liability based upon the allegations contained in the Complaint which does not contain any statement or demand for a specific amount of damages. Much discovery has been undertaken and, at this time, the Company intends to continue to vigorously contest the matter.\nOn July 3, 1995, a single shareholder filed a separate lawsuit in Texas containing allegations essentially identical to those raised in the shareholder lawsuit filed in April, 1995. The Company denies the allegations in the complaint and has filed its own counterclaim against third parties for indemnification. Upon the Company's motion, this case has been transferred from Texas to California, where no action has been taken since the date of transfer.\nThere can be no assurance that any or all of the preceding actions will be decided in favor of the Company. The Company believes, based in part on the advice of outside, independent counsel, that the costs of defending and prosecuting these actions will not have a material adverse effect on the Company's financial position or results of operations and that any adverse outcome of the litigation involving IN also will not result in a material adverse effect on the Company's financial position or results of operation, or the Company's position in the interactive industry.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS. -------------------------------------------------\nNo matters were submitted to a vote of security holders through the solicitations of proxies or otherwise during the fourth quarter of the fiscal year ended December 31, 1995.\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 American Stock Exchange, under the symbol \"NTN.\" The prices below are the high and low sales prices for the Common Stock reported by the American Stock Exchange for the two most recent fiscal years.\nOn April 11, 1996, the closing price for the Common Stock reported on the American Stock Exchange was $4-1\/16. On that date, there were 3,999 record owners of the Common Stock.\nTo date, the Company has not declared or paid any cash dividends with respect to its Common Stock, and the current policy of the Board of Directors is to retain earnings, if any, after payment of dividends on the Preferred Stock to provide for the growth of the Company. Consequently, no cash dividends are expected to be paid on the Company's Common Stock in the foreseeable future. Further, there can be no assurance that the proposed\noperations of the Company will generate the revenues and cash flow needed to declare a cash dividend or that the Company will have legally available funds to pay dividends.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA. ------------------------\nThe following table furnishes information with respect to selected consolidated financial data of the Company over the past five years.\n(1) Adjusted for a 1-for-20 reverse stock split effective June 14, 1991. (2) At June 14, 1991, the Company realized an extraordinary gain on debt restructuring, net of tax, of $3,889,000.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND --------------------------------------------------------------- RESULTS OF OPERATIONS. ----------------------\nGENERAL\nManagement's discussion and analysis of financial condition and results of operations should be read in conjunction with the selected financial data and consolidated financial statements and notes thereto included elsewhere herein.\nThe Company uses existing technology to develop, produce and distribute two- way multi-player interactive live events and also produces and distributes its own original interactive programs. The Company's principal sources of revenue from distribution activities are derived from (a) distribution fees in the United States; (b) advertising fees, (c) sales of equipment; (d) distribution fees from foreign licensees; (e) licensing fees from foreign and domestic licensees; and (f) the licensing of the Company's technology and equipment sales to other users.\nThe Company also develops and publishes interactive entertainment software and video games for general consumer use on a variety of home personal computers and console entertainment systems. The principal sources of revenue from software and video game activities are derived from (a) domestic retail sales through mass merchants, warehouse clubs, general retailers and mail order catalogues, and (b) license fees and royalties from international licensees who translate and publish the video games in over a dozen countries around the world.\nRESULTS OF OPERATIONS\nFollowing is a comparative discussion by fiscal year of the results of operations for the last three years ended December 31, 1995. The Company believes that inflation has not had a material effect on its operations to date.\nYEAR ENDED DECEMBER 31, 1995 AS COMPARED TO THE YEAR ENDED DECEMBER 31, 1994\nThe Company reported a net loss of $3,948,000 for the year ended December 31, 1995 compared to net earnings of $707,000 for the year ended December 31, 1994.\nIn 1994, the Company formed LearnStar to pursue interactive educational applications in the United States. Most of 1994 was devoted to beta testing the product and conducting preliminary market tests. In 1995, LearnStar began marketing and selling its product on a full-time basis. Due to start-up costs and relatively higher marketing costs during the first year of operations, LearnStar recognized a net loss of $2,149,000 for the year ended December 31, 1995.\nIn late 1995 the Company entered into a sale and purchase agreement to sell 45% of the stock of its subsidiary, LearnStar, Inc. Although the sale was legally consummated, the recognition of the gain of $3,354,000 was deferred in accordance with generally accepted accounting principles and will be recognized when principal payments are received in 1996 and 1997. Also in late 1995, the Company set up a allowance of $1,000,000 for inventory in connection with the upgrading of its broadcast distribution system and expensed $754,000 of costs incurred in connection with the development of the market in Mexico. Further, in 1995 the Company experienced a substantial increase in legal expenses due to increased activities in litigation and other legal matters along with increased costs of developing and providing products and services, and increased marketing expenditures. Total revenues increased 29% from $24,646,000 to $31,771,000. This increase is the result of growth in many of the Company's principal revenue activities.\nDistribution and Production Services increased 41% from $12,244,000 to $17,307,000. The increase in broadcast revenue is primarily due to an expansion in the number of subscriber locations and on-line customers contracting for services from the Company.\nEquipment Sales increased 55% from $4,387,000 to $6,784,000. Equipment sales include both sale and leaseback transactions and direct sales to the Company's customers. Equipment sales have been highly volatile in the past and are expected to remain so, as they are dependent on the Company's ability to engage in lease financing, the timing of expansion plans of the Company's foreign licensees and, its educational subscribers. As of\nDecember 31, 1995, the Company had sold and leased back subscriber systems in place at a majority of the United States subscriber locations. The Company's ability to make additional sales will be dependent on increases in the number of subscriber locations, as well as the availability of financing, as to which there can be no assurance.\nProduct Sales related to video and computer games decreased 26% from $5,263,000 to $3,884,000. Sales of video and computer game products are typically seasonal and will vary with the number of new products released in any period. The decrease in net revenue is primarily due to the glut of competing products in the market, the timing of new products released during the year and the use of more conservative amounts provided for potential returns.\nLicense Fees and Royalties increased 12% from $1,934,000 in 1994 to $2,167,000 in 1995. License Fees in 1994 predominantly relate to NTN's Hospitality and International Licensing operations whereas in 1995 license revenues predominantly relate to the Company's New World operations. Licensing arrangements are not dependent upon seasonal forces and will vary in type and amount from period to period.\nOther Revenue increased from $818,000 to $1,629,000 in the current year's period. Other revenue in 1995 relates to a gain from the sale of a 10% interest in the IWN subsidiary of $329,000 and reimbursement of previously incurred legal expenses from the Company's insurance carrier of approximately $1,000,000. Other Revenue in 1994 primarily consisted of inventory transferred to the Company by its United Kingdom licensee in exchange for release from a license agreement. Other Revenue has historically varied widely.\nCost of Services-Distribution and Production Services, which increased 68% from $5,198,000 in the prior year to $8,756,000 in the current year, reflects increased costs of equipment leases and other costs associated with the expansion in the number of subscribers contracting for distribution services. The gross margin on distribution and production services decreased from 58% to 49% as a result of increased costs related to commissions, service fees and increased costs of equipment leases. Cost of Sales - Product Sales relates to the Company's video game products increased from $1,502,000 to $1,844,000 or 23%. These costs vary depending upon the timing of products released, the volume of products sold, the complexity of the games and the development costs associated with each product. The gross margin on product sales decreased from 71% to 53% as the result of amortizing deferred development costs related to specific products sold in 1995. The increase in Cost of Sales-Equipment from $2,753,000 to $4,981,000, an increase of 81%, is due to the increase in equipment sales, which can vary from period to period. Before the one-time charge to earnings of $1,000,000 to upgrade the broadcast distribution system, the gross margin from equipment sales increased from 37% to 41% due to lower costs associated with certain equipment, but after consideration of this charge, the gross margin decreased to 27%.\nOperating Expenses rose from $14,898,000 in the prior year to $20,160,000 in the current year, an increase of 35%. Legal and Professional Fees increased 214% from $590,000 to $1,851,000 due to substantial legal expenses incurred relating to litigation and other legal matters. Selling, General and Administrative expenses increased 36% from $12,336,000 to $16,838,000 due to an increase in the number of employees hired to develop and produce new products and services and large increases in marketing activities related to the development of the LearnStar products and services. Research and Development expense decreased from $1,972,000 to $1,471,000, or 25% as the Company increased its efforts in projects in current production.\nNet Investment Income decreased from $412,000 to $22,000 as a result of decreased interest-bearing investments, the addition of new debt and the losses attributed to the IWN L.P. limited partnership allocated to the Company as the general partner of $286,000. Income Tax expense was zero in both years. The lack of tax expense is due to the losses, the nature of revenues and expenses in each year and net operating loss carryforwards available to the Company. The Company currently has available approximately $26,000,000 of net operating loss carryovers for federal tax purposes.\nYEAR ENDED DECEMBER 31, 1994 AS COMPARED TO THE YEAR ENDED DECEMBER 31, 1993\nThe Company reported net income of $707,000 for the year ended December 31, 1994 and a net loss $1,301,000 for the year ended December 31, 1993.\nFor the year ended 1994, revenues grew 43% to $24,646,000 from $17,258,000 for the year ended 1993. This increase is the result of growth in the number of Locations contracting for the Company's distribution services, license fee revenue and royalties from licensees and increased equipment sales. Distribution revenues from Locations increased 81% to $12,244,000 in 1994 from $6,778,000 in 1993 and equipment sales increased 11% to $4,387,000 in 1994 from $3,970,000 in 1993. License fees and royalties in 1994 were $1,934,000 compared to $802,000 in 1993, an increase of 141%, which resulted from new licenses granted to both foreign and domestic companies. Retail sales of Products decreased 4% to $5,263,000 from $5,468,000 due to the glut of competing products on the market and the timing of new Product releases by the Company during the year.\nTotal Cost of Sales grew to $9,453,000 in 1994 from $7,514,000 in 1993, an increase of 26%, a result of increased sales. The Company improved its gross margin on equipment sales to 37% from 32% as a result of Management's continuing efforts in controlling equipment costs and higher marginal sales. The rise in Cost of Services - Distribution and Production Services of $1,937,000 to $5,198,000 in 1994 from $3,261,000 in 1993 is due to the greater number of subscribers served. The Company improved its gross margin on Distribution and Production Services to 58% from 52% as the result of decreasing costs associated with service fees, equipment rentals and freight charges.\nThe Company's total operating expenses increased 33% to $14,898,000 in 1994 from $11,198,000 in 1993 as a result of the Company's expanding its overall activities. Selling, General and Administrative expenses increased 32% to $12,336,000 in 1994 from $9,347,000 in 1993 as the result of an increase in the number of employees and continuing increased marketing and sales activities. Research and Development expenses increased 84% to $1,972,000 in 1994 from $1,073,000 in 1993 as the Company increased its research and development efforts. The Company also expended $3,264,000 on software development projects qualifying for capitalization in 1994 compared to $726,000 in the prior year.\nInterest expense of $54,000 for the year ended December 31, 1994 was reduced from $71,000 for the year ended December 31, 1993. Interest income in 1994 totaled $466,000 compared to $505,000 in 1993. The decrease in net interest income resulted from the use of funds for operations and investments in developed software in 1994.\nIncome tax expense was zero in 1994 compared to $281,000 in 1993. The decrease in tax expense was due to the nature of the revenues and expenses in each year and net operating loss carryforwards available to the Company.\nLIQUIDITY AND CAPITAL RESOURCES\nFollowing is a discussion of the Company's recent and future sources of and demands on liquidity, as well as an analysis of liquidity levels.\nExpenditures have exceeded revenues from operations through most of the Company's history and may do so in the future. The Company plans to fund any such deficiency from its existing cash and, if necessary, from other sources, as discussed below.\nTotal assets increased 37% from $31,239,000 to $42,813,000 from December 31, 1994 to December 31, 1995. Cash and Marketable Securities - Available for Sale increased from $3,429,000 to $6,475,000 at December 31, 1995. The change reflects additional cash proceeds from debt and equity sources net of cash used to fund operations and invest in the development of future products and services for the NTN Network and video game products.\nThe 11% decrease in Accounts Receivable - Trade from $5,881,000 to $5,247,000 at December 31, 1995, reflects an enhancement in the collection efforts as well as an increase in the allowance for returns and doubtful accounts. Accounts Receivable -Other increased from $600,000 to $1,750,000, primarily the result of a large equipment sale transaction in the third quarter. The increase in Inventory from $4,628,000 to $6,503,000 is primarily the result continued expansion of the NTN Network and development of additional video game Products. Prepaid Expenses increased from $1,769,000 to $2,325,000 from December 31, 1994 to December 31, 1995 primarily due to increased prepaid expenses, and security deposits held by the Company.\nInterest bearing Security Deposits (both current and non-current) increased 18% from $3,200,000 to $3,525,000 as the result of increased leasing transactions related to the increase in new Locations. Software Development Costs (both current and non-current) increased 66% from $3,405,000 to $5,669,000 as the result of substantial investments made in the development of new software and Products. Net Fixed Assets increased 49% primarily due to the move to the new headquarters and expansion of the NTN Broadcast Center. Notes Receivable (both current and long term) increased from $3,262,000 to $5,206,000 or 60% primarily as the result of finalizing terms related to the sales of LearnStar of IWN and the sale of a license to IWN L.P.\nTotal liabilities increased 62% from $5,782,000 to $9,362,000 from December 31, 1994 to December 31, 1995. The increase in Accounts Payable and Accrued Liabilities from $2,744,000 to $3,713,000 reflects the overall growth of the Company and the timing of payments. Customer Deposits increased from $1,006,000 to $1,284,000 from December 31, 1994 to December 31, 1995 due to deposits received from new customers throughout the year.\nThe increase in aggregate Deferred Revenue (long-term and current) from $1,556,000 to $2,270,000 reflects additional deferred gains on the sale of the equipment involved in lease transactions, which are amortized to revenue over three-year periods Debt (long-term and current) increased from $476,000 to $2,095,000 as a result of additional borrowings to augment working capital needed for operational expenses, new software and product development, marketing of services and purchase of broadcast-related equipment.\nThe increase in Common Stock and Additional Paid-in-Capital reflects the issuance of 3,000,000 shares of Common Stock and conversion of preferred stock and the exercise of warrants during 1995. In late 1995 the Company began to repurchase its own shares and at year end had 50,000 shares of treasury stock. Overall, shareholders' equity increased $7,994,000 due to equity contributions of $12,164,000, less $222,000 for treasury stock purchases and the net loss of $3,948,000.\nOverall, the Company's working capital increased from $13,886,000 at December 31, 1994 to $18,566,000 at December 31, 1995, primarily due to significant proceeds from financing activities. The Company may continue to require additional working capital for operational expenses, new software and product development, marketing of services and purchase of hardware components relating to its services. There can be no assurance that the Company's currently available resources will be sufficient to allow the Company to support its operations until such time, if any, as its internally generated cash flow is able to consistently sustain the Company.\nThe Company is exploring alternative capital financing possibilities that may include (i) additional lines of credit, (ii) lease financing of equipment the Company furnishes to subscribers, (iii) licensing of the Company's technology, (iv) sale of interests in subsidiaries, or (v) sale of additional debt or equity securities. With respect to lease financing, the Company has\nleased for three-year terms expiring in various amounts over the next three years, the Location Systems at a majority of its United States Locations. The Company has issued licenses and has received revenue for certain products and services for Australia, South Africa and Canada. The Company will continue to negotiate for additional lease financing and additional foreign licensing.\nMARKETING AND EXPANSION PLAN\nThe Company's plan to maintain profitability includes the following elements: (i) increasing sales staff; (ii) increasing advertising sales on the NTN Network; (iii) expanding Company services to corporate and education customers; (iv) pursuit of additional foreign licensing opportunities; (v) increasing use of distributors who service retailers, (vi) sale of interests in subsidiaries, and (vii) expanding products and services to a wider variety of technological platforms.\nThroughout the Company's history, the principal component of its revenues has been derived from distribution services from Locations in the Hospitality industry (restaurants, bars and hotels). Management believes that this component will continue to grow in total revenues within the next year, but may decline as a percentage of the Company's total revenues. To increase the number of Locations, the Company has taken several steps. It increased its sales staff to accommodate the growth in 1995 and the anticipated growth in 1996. The Company offers sales and technical support to its independent distributors, who are responsible for marketing the Company's services to potential Locations. In 1996, the Company will continue to attend national and regional hospitality industry trade shows and has increased its budget for advertising in trade publications.\nIn 1995, the Company enhanced its graphics capabilities and obtained additional advertising revenues from national advertisers. The Company has a full-time Director of Advertising Sales and is currently negotiating with several potential advertisers for commercial spots on the NTN Network.\nThe Company has produced special event and corporate training programs in which the customer uses the Company's interactive equipment to increase participant interest in training and product knowledge and to communicate rapidly with a large number of participants. Management believes special event and corporate training may offer an opportunity for growth, and has a full-time Director of Sales for special event and corporate training. In addition, the Company has commenced the development of marketing materials and a direct mail campaign for corporate training services. To enhance the Company's capabilities for use in special events and corporate training, the Company has developed a system that allows up to 800 Playmakers(TM) to be used at a single event.\nRevenues from sales of equipment used in Locations has historically been a material component of the Company's revenue. Potential growth in this area, however, is largely dependent on the Company's success in increasing the number of Locations and the business of the Company's foreign licensees.\nManagement believes that another market segment with potential for long-term growth is the market for interactive television services in the home. The Company expects to remain a provider of specialized programming to networks operated by other organizations, such as cable networks, computer on-line systems and wireless or telephone-based communication networks. The Company expects to deliver the video portion of its programming directly to cable television systems, with viewer responses using equipment developed by others. In light of this, the Company expects that any significant revenues from home use of the Company's services will be dependent upon an expansion in the overall home viewer market for home interactive information and entertainment services. The Company maintains excellent working relationships with major providers of home interactive information and entertainment services. As the market for home interactive information and entertainment services expands, the Company will seek to capitalize on this market. Revenues to date from in-home programming have not been significant.\nThe Company has plans to expand its penetration in the education sector as well. Currently, the LearnStar System is operational at over 100 schools throughout the nation. In 1995, the Company will focus efforts to expand into additional schools in many states. Revenues from these sources have not been significant in the past and no assurance can be given that plans to expand the education market will be successful.\nRevenues from Product sales of interactive software and video games have been fairly consistent over the past few years. In 1996, the Company plans to expand its available Products through the publication of software developed by independent sources and by continuing to internally create new games and Products. Further, the Company intends to publish Products on additional technological platforms such as the SONY Playstation and other similar type entertainment systems. Further, the Company intends to offer its services and Products to new media platforms such as on-line services and the Internet.\nAlthough there can be no assurance that the Company will prove to be successful in implementing its marketing and expansion plan, Management believes that the Company's prospects have been materially improved by the growth of the core business units and increased customer awareness.\nThe Company has several lawsuits pending as previously described in \"Legal Proceedings.\" There can be no assurance that any or all of the described actions will be decided in favor of the Company. The Company believes, based in part on the advice of outside, independent counsel, that the costs of defending and prosecuting these actions will not have a material adverse effect on the Company's financial position or results of operations and that any adverse outcome of the litigation involving IN also will not result in a material adverse effect on the Company's financial position or results of operation, or the Company's position in the interactive industry.\nIn March 1995, the Financial Accounting Standards Board issued Statement of Financial Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of\" (\"SFAS 121\"). SFAS 121 requires that impairment losses for long lived assets be recognized if the estimated undiscounted future cash flows, without interest, is less than the carrying amount of the asset. The standard also requires that assets designated to be disposed of are to be recorded at the lower of the asset carrying value or fair value less cost to sell. The Company has not adopted SFAS 121. The adoption of SFAS 121 is not expected to have a material impact on the Company's financial position or results of operations.\nIn October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, \"Accounting for Stock-based Compensation\" (SFAS 123\"), effective for fiscal years beginning after December 31, 1995. SFAS 123 establishes the fair value method of accounting for stock- based compensation arrangements, under which compensation cost is determined using the fair value of the stock option at the grant date and the number of options vested, and is recognized over the period in which the related services are rendered. If the Company were to retain its current intrinsic value based method, as allowed by SFAS 123, it will be required to disclose the pro forma effect of adopting the fair value based method. The Company will adopt SFAS 123 using the pro forma disclosure method.\nITEM 8.","section_7A":"","section_8":"ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. ---------------------------------------------------------\nSee Index to Consolidated Financial Statements and Schedule on page, which is incorporated herein by reference, for a listing of the Consolidated Financial Statements and Schedule filed with this report.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND --------------------------------------------------------------- FINANCIAL DISCLOSURE. ---------------------\nNone\nPART III\nMANAGEMENT\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. ---------------------------------------------------\nIncorporated by reference to Registrant's definitive Proxy Statement for its July, 1996 meeting of stockholders, which will be filed with the Securities and Exchange Commission within 120 days from December 31, 1995.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION. -----------------------\nIncorporated by reference to Registrant's definitive Proxy Statement for its July, 1996 meeting of stockholders.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. ---------------------------------------------------------------\nIncorporated by reference to Registrant's definitive Proxy Statement for its July, 1996 meeting of stockholders.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. -----------------------------------------------\nIncorporated by reference to Registrant's definitive Proxy Statement for its July, 1996 meeting of stockholders.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, CONSOLIDATED FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON ------------------------------------------------------------------- FORM 8-K. ---------\n(a) The following documents are filed as a part of this report:\n1,2. Consolidated Financial Statements and Schedule.\nThe consolidated financial statements and schedule of the Company and its consolidated subsidiaries are set forth in the \"Index to Consolidated Financial Statements\" on page.\n3. Exhibits. The following exhibits are filed as a part of this report:\n10.1 Certificate of Incorporation of the Company (1) 10.2 By-laws of the Company (2) 10.3 1985 Incentive Stock Option Plan, as amended (2) 10.4 VTV Entertainment UK Licensing Agreement (3) 10.5 Agreement with TWIN (4) 10.6* Form of Employment Agreements dated as of January 1, 1990 between the Company and Patrick Downs, Daniel Downs, Gerald McLaughlin and Ronald Hogan (4) 10.7* 1985 Nonqualified Stock Option Plan, as amended (4) 10.8 Lease of Executive Offices (4) 10.9 License Agreement with NTN Canada (4) 10.10 National Football League License Agreement (4) 10.11* Promissory Notes issued June 15, 1993 between the Company and Patrick Downs, Daniel Downs, Donald Klosterman, Ronald Hogan and Gerald McLaughlin Agreement and the Tax Indemnity and Loan dated June 6, 1993 (6) 10.12* Warrants dated January 15, 1993 issued by the Company in favor of Patrick Downs, Daniel Downs, Mike Downs and the Oracle Group (6) 10.13 Registration Rights Agreement dated December 30, 1993 between the Company and Jon Van Caneghem (5)\n10.14* Employment Agreement dated as of January 3, 1994 among the Company, New World Computing, Inc. and Jon Van Caneghem (5) 10.15 Revolving Line of Credit Agreement between New World Computing, Inc. and Merrill Lynch Business Financial Services, Inc. (7) 10.16 The Campus Limited Liability Company Agreement (7) 10.17 Lease of Office with The Campus L.L.C. (7) 10.18 Investment Agreement, dated as of December 31, 1995, among NTN Communications, Inc., IWN, Inc. and Symphony Management Associates, Inc., without exhibits 10.19 Third Amended and Restated Agreement of Limited Partnership of IWN, L.P., dated as of Decmber 31, 1995. 10.20 First Amendment to the Third Amended and Restated Agreement of Limited Partnership of IWN, L.P., dated as of March 11, 1996. 10.21 Stock Purchase Agreement, dated as of December 31, 1995, between NTN Communications Inc., IWN, Inc. and Symphony Management Associates, Inc. 10.22 Stockholders Agreement, dated as of December 31, 1995, between NTN Communications Inc., and Symphony Management Associates, Inc. 10.23 Registration Rights Agreement, dated as of December 31, 1995, between NTN Communications Inc., and Symphony Management Associates, Inc. 10.24 Guaranty, dated as of December 31, 1995, from Symphony Management Associates, Inc. in favor of IWN, Inc. and IWN, L.P. 10.25 Amended and Restated Technology and Trademark License Agreement, dated as of December 31, 1995, between NTN Communication, Inc. and IWN, Inc. 10.26 Amended and Restated Technology and Trademark Sub-license Agreement, dated as of December 31, 1995, between IWN, Inc. and IWN, L.P. 10.27 Worldwide Technology and Trademark Agreement, dated as of December 31, 1995, between IWN, Inc. and IWN, L.P. 10.28 Non-competition Agreement, dated as of December 31, 1995, between IWN, Inc. and IWN, L.P.\n10.29 Non-competition Agreement, dated as of December 31, 1995, between IWN, L.P. in favor of NTN Communications, Inc. and IWN, Inc. 10.30 Composite copy of Investment Agreements, dated as of April 24, 1995, between NTN Communications, Inc. and the investors named therein 10.31 Composite copy of Investment Agreements, dated as of September 29, 1995, between NTN Communications, Inc. and the investors named therein 10.32 Composite copy of Investment Agreements, dated as of October 4, 1995 between NTN Communications, Inc. and the investors named therin. 10.33 Stock Purchase Agreement by and between NTN Communications, Inc. and Associated Ventures Management, Inc., dated as of December 22, 1995 10.34 Non Recourse Secured Promissory Note issued by the Company to Associated Ventures Management, Inc., dated December 22, 1995 10.35* Management Agreement between NTN Communications, Inc. and Associated Ventures Management, Inc., dated December 22, 1995 23.00 Consent of KPMG Peat Marwick LLP, incorporated by reference. 27 Financial Data Schedule.\n- ---------------------------- * Management Contract or Compensatory Plan.\n(1) Previously filed as an exhibit to the Company's report on Form 10-Q for the quarter ended June 30, 1991, and incorporated by reference.\n(2) Previously filed as an exhibit to the Company's registration statement on Form S-8, File No. 33-75732, and incorporated by reference.\n(3) Previously filed as an exhibit to the Company's report on Form 10-K for the year ended December 31, 1989, and incorporated by reference.\n(4) Previously filed as an exhibit to the Company's report on Form 10-K for the year ended December 31, 1990, and incorporated by reference.\n(5) Previously filed as an exhibit to the Company's report on Form 8-K dated December 31, 1993, and incorporated by reference.\n(6) Previously filed as an exhibit to the Company's report on Form 10-K for the year ended December 31, 1993, and incorporated herein by reference.\n(7) Previously filed as an exhibit to the Company's report on Form 10-K for the year ended December 31, 1994, and incorporated herein by reference.\n(b) Reports on Form 8-K.\nNone.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nDATED: April 11, 1996 NTN COMMUNICATIONS, INC.\nBy: \/s\/ PATRICK J. DOWNS ------------------------------------ Patrick J. Downs, Chairman and Chief Executive Officer\nBy: \/s\/ RONALD E. HOGAN ------------------------------------ Ronald E. Hogan, 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.\nMTN COMMUNICATIONS, INC. AND SUBSIDIARIES\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE\nPage ----\nIndependent Auditors' Report...........................................\nConsolidated Financial Statements\nConsolidated Balance Sheets as December 31, 1995 and 1994......\nConsolidated Statements of Operations for the years ended December 31, 1995, 1994 and 1993......................\nConsolidated Statements of Shareholders' Equity for the years ended December 31, 1995, 1994 and 1993........\nConsolidated Statements of Cash Flows for the years ended December 31, 1995, 1994 and 1993......................\nNotes to Consolidated Financial Statements.............................\nSchedule II............................................................F-20\nIndependent Auditors' Report ----------------------------\nThe Board of Directors and Shareholders NTN Communications, Inc.:\nWe have audited the accompanying consolidated balance sheets of NTN Communications, Inc. and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1995. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule as listed in 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 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 NTN Communications, Inc. and subsidiaries as of December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1995, 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 1 to the consolidated financial statements, the Company changed its method of accounting for investments in debt and equity securities in 1994.\nSan Diego, California April 12, 1996 KPMG Peat Marwick LLP\nNTN COMMUNICATIONS, INC. AND SUBSIDIARIES\nConsolidated Balance Sheets\nDecember 31, 1995 and 1994\nSee accompanying notes to consolidated financial statements.\nNTN COMMUNICATIONS, INC. AND SUBSIDIARIES\nConsolidated Statements of Operations\nFor the years ended December 31, 1995, 1994 and 1993\nSee accompanying notes to consolidated financial statements.\nNTN COMMUNICATIONS, INC. AND SUBSIDIARIES\nConsolidated Statements of Shareholders' Equity\nFor the years ended December 31, 1995, 1994 and 1993\nSee accompanying notes to consolidated financial statements.\nNTN COMMUNICATIONS, INC. AND SUBSIDIARIES\nConsolidated Statements of Cash Flows\nFor the years ended December 31, 1995, 1994 and 1993\nSee accompanying notes to consolidated financial statements.\nNTN COMMUNICATIONS, INC. AND SUBSIDIARIES\nConsolidated Statements of Cash Flows, Continued\nFor the years ended December 31, 1995, 1994 and 1993\nSee accompanying notes to consolidated financial statements.\nNTN COMMUNICATIONS, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\nFor the years ended December 31, 1995, 1994 and 1993\n(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nORGANIZATION\nNTN Communications, Inc. and subsidiaries (\"The Company\") was organized under the laws of the state of Delaware in 1984 for the purpose of investing in various business ventures. The Company, through its business units and subsidiaries develops, produces and distributes individual and multi-player interactive entertainment and education programs to a variety of media platforms.\nThe Company is also engaged in the development and distribution of interactive video game software. The Company operates under several distribution and license agreements in the United States, United Kingdom, Australia, Germany, France and Switzerland. These products are sold primarily to wholesale distributors. Royalties result from licensing rights sold to foreign publishers.\nBASIS OF ACCOUNTING PRESENTATION\nThe consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, National Telecommunicator Network, Inc. and New World Computing, Inc., and its partially-owned subsidiaries IWN Corporation, Inc. and LearnStar Inc. (LearnStar). During most of 1995, the Company owned 50% of LearnStar, however the Company funded all operations of LearnStar, and accordingly LearnStar has been consolidated as if it were wholly-owned. All significant intercompany balances and transactions have been eliminated in consolidation.\nCASH AND CASH EQUIVALENTS\nFor the purpose of financial statement presentation, the Company considers all highly liquid debt instruments with original maturities of three months or less to be cash equivalents. Cash and cash equivalents at December 31, 1995 and 1994, consist of operational cash accounts and certificates of deposit with original maturities of three months or less.\nMARKETABLE SECURITIES - AVAILABLE FOR SALE\nEffective January 1, 1994, the Company adopted the provisions of Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" (SFAS 115). The Company has classified applicable investments as \"available for sale\".\nSecurities available for sale 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 sold is based on the specific identification method.\nAt December 31, 1994 marketable securities available for sale consisted of mutual funds invested in government-backed debt instruments. The fair value of available for sale securities approximated cost.\nProceeds from the sale of investment securities available for sale was $930,000 in 1995 and gross realized losses included in income in 1995 was $70,000.\nNTN COMMUNICATIONS, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\nDEPRECIATION\nDepreciation of fixed assets is computed using the straight-line method over the estimated useful lives of the assets (three to five years).\nINVENTORY\nInventory is valued at the lower of cost (first-in, first-out) or market and consists principally of finished goods and equipment.\nDEPOSITS AND OTHER ASSETS\nDeposits and other assets include long-term life insurance contracts and other assets. These contracts are carried at cost which approximates market value.\nREVENUE RECOGNITION\nDistribution and Production Services Revenue: Revenue is recognized as the service is provided by the Company.\nProduct Sales: Revenue is recognized when the product is shipped. Subject to limitations, the Company permits customers to obtain exchanges within certain specified periods, and provides price protection on certain unsold merchandise. Revenue is reflected net of an allowance for returns.\nEquipment Sales: Revenue is recognized when equipment is shipped or transferred to the purchaser.\nLicense Fees and Royalties: For those agreements which provide the customers the right to multiple copies in exchange for guaranteed amounts, revenue is recognized upon execution of the agreement since the Company has no remaining obligations or incremental costs. Per copy royalties on sales that exceed the guarantee are recognized as earned. For those agreements which provide for the marketing rights and the future use of the Company's name, technology and trademarks, revenue is recognized when all material services or conditions relating to the sale have been performed or satisfied.\nINCOME TAXES\nIncome taxes are accounted for 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, 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. 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.\nVALUATION OF STOCK TRANSACTIONS\nFor stock issued in return for services, the transactions have been recorded at the value of the services received, if determinable; if such value was not determinable, the transactions were recorded at the fair market value of the stock issued.\nNTN COMMUNICATIONS, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\nSOFTWARE DEVELOPMENT COSTS\nThe Company capitalizes costs related to the development of certain software products. In accordance with Statement of Financial Accounting Standards No. 86, \"Accounting for the Cost of Computer Software to be Sold, Leased or Otherwise Marketed,\" capitalization of costs begins when technological feasibility has been established and ends when the product is available for general release to customers. Amortization of costs for specific products is recognized on the relative value basis over the estimated economic life of each specific product, generally within one year. Amortization of costs related to interactive programs is recognized on a straight line basis over three to five years.\nADVERTISING COSTS\nThe Company accounts for advertising costs in accordance with SOP No. 93-7, Reporting on Advertising Costs. Direct response advertising is capitalized only if customer sales can be directly correlated to the advertising costs and if future benefit can be demonstrated. Capitalized advertising costs are amortized using the straight-line method over the estimated benefit period. Advertising expense for 1995, 1994 and 1993 was $290,000, $136,000, and $172,000, respectively. Amounts capitalized at December 31, 1995 and 1994 was $310,000 and $243,000, respectively.\nUSE OF ESTIMATES\nManagement of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period to prepare these financial statements in conformity with generally accepted accounting principles. Actual results could differ from those estimates.\nEARNINGS (LOSS) PER SHARE\nEarnings per share amounts are computed by dividing net earnings increased by preferred dividends resulting from the assumed exercise of stock options and warrants and the assumed conversion of convertible preferred shares, by the weighted average number of common and common equivalent shares outstanding during the period. Common stock equivalents represent the dilutive effect of the assumed exercise of certain outstanding options and warrants and preferred stock. The impact of the outstanding stock options and warrants and conversion of preferred stock would have had an anti-dilutive effect in years where losses are reported, and accordingly, have not been included in the computation.\nRECLASSIFICATIONS\nCertain items in the 1994 and 1993 consolidated financial statements have been reclassified to conform to the 1995 presentation.\n(2) MERGER\nOn December 31, 1993, a subsidiary of the Company completed its merger with New World Computing, Inc. (New World), a developer and distributor of interactive video game software. The Company issued 1,025,000 shares of common stock for all of the outstanding common stock of New World. The transaction was accounted for as a pooling of interests. The consolidated financial statements for 1993 were restated to reflect the merger.\nNTN COMMUNICATIONS, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\n(3) SALE OF SUBSIDIARY INTERESTS\nIn December 1995 the Company purchased the shares of LearnStar owned by ACT III Communications to increase its ownership in LearnStar to 100%. Also in December 1995, the Company sold a 45% interest in LearnStar to an unaffiliated company for $2,500,000 in return for a note receivable in the amount of $2,500,000. As the Company's basis in LearnStar is negative, the gain on the sale of the stock was $3,354,000. The gain was deferred and will be recognized as the Company receives proceeds on the note receivable arising from the sale.\nIn December 1995, the Company entered into a sale and purchase agreement to sell 10% of its interest in IWN Inc. to an unaffiliated company for $350,000 A gain of $329,000 was recognized upon consummation of the sale.\n(4) NOTES RECEIVABLE - RELATED PARTIES\nNotes receivable - related parties is as follows:\nNTN COMMUNICATIONS, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\nNotes receivable from officers and directors include amounts advanced to officers and directors to obtain a federal or state income tax deduction for the Company. In 1993, the Company obtained a deduction of $6,900,000 related to compensation to officers and directors in prior years. The amount has been recorded as an addition to the Company's existing net operating loss carryforward. In order to obtain the deduction, the Company was required to withhold and to deposit amounts with the appropriate government taxing authorities on behalf of the officers and directors. In 1995, the Company converted $435,000 of accrued unpaid interest to principal.\nIn 1995, the Company entered into a sale agreement to sell 45% of its shares in LearnStar in exchange for a note of $2,500,000. The gain has been deferred and will be recognized as the company receives proceeds on the note receivable rising from the sale.\n(5) FIXED ASSETS\nFixed assets are recorded at cost and consist of the following:\n(6) SHORT-TERM BORROWINGS AND LONG-TERM DEBT\nNTN COMMUNICATIONS, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\nThe aggregate maturities of long-term debt for years subsequent to December 31, 1995 are as follows: 1996, $2,093,000; 1997, $2,000.\n(7) INCOME TAXES\nThe company accounts for income taxes in accordance with Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes,\" (\"SFAS 109\"). Under the assets and liability method of SFAS 109, deferred tax assets and liabilities are recognized for the estimated future consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax balances.\nDeferred 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.\nThe Company has no net taxable temporary differences which would require recognition of deferred tax liabilities, and due to the uncertainty of future realizability has recorded a valuation allowance against any deferred tax assets for deductible temporary differences and tax operating loss carryforwards, and accordingly, no deferred taxes are contained in the accompanying consolidated financial statements. The Company increased its valuation allowance by approximately $1,300,000 and $300,000 for the years ended December 31, 1995 and 1994, respectively, primarily as a result of the increase in tax operating loss carryforwards.\nAt December 31, 1995, the Company has available net operating loss carryforwards of approximately $26,000,000 for federal income tax purposes, which begin to expire in 2006. The net operating loss carryforwards for state purposes, which begin to expire in 1996 are less than 50% of the federal tax amounts. The Company may have additional net operating loss carryforwards available subject to annual limitations under Internal Revenue Code 382.\nIn 1995, the Company did not recognize income tax expense as a result of their utilization of net operating loss carryforwards. Due to certain tax regulations relating to the merger completed in 1993, the Company was unable to utilize its net operating loss carryforwards to offset earnings of its subsidiary, New World, in 1993. Income taxes for 1993 resulted from the operations of New World, and amounted to $281,000.\n(8) COMMON STOCK AND COMMON STOCK OPTIONS\nIn 1995, The Company sold and issued an aggregate of 3,000,000 shares of common stock. In September and October 1995, 2,400,000 of these shares were issued at an initial price of $4.00 per share to certain institutional investors (Investors). Pursuant to the terms of the sale, the initial purchase price paid by the Investors is subject to adjustment based on the average of the closing prices (\"Average Share Price\") of the Common Stock for all trading days during the 60-day period commencing on January 15, 1996 (\"Valuation Period\"). Under the agreement, if the Average Share Price during the Valuation Period is less than $4.70, the Company will issue to the Investors, at no additional cost to the Investors, additional shares of common stock so as to result in a purchase price per share of common stock equal to 85% of the Average Share Price. Conversely, if the Average Sales Price exceeded $4.70 during the Valuation Period, the Investors are obligated to pay to the Company the dollar amount by which the product of 85% of the Average Share Price during the Valuation Period and 2,400,000 exceeds the amount provided to the Company. As a result of these terms, the Company anticipates that it will issue approximately 1,200,000 additional shares to the Investors in 1996.\nNTN COMMUNICATIONS, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\nThe Company has a qualified incentive stock option plan under which 2,000,000 restricted common shares are authorized for grant. Options granted in or after 1993 generally vest 33% annually, commencing one year from the date of grant and expire five years from the date of final vesting. A summary of the status of the Company's qualified incentive stock option plan follows:\nThe Company previously had a non-qualified stock option plan under which 1,455,000 restricted common shares were granted. Non-qualified options vest 50% annually, commencing one year from the date of grant and expire five years from the date of grant. A summary of the status of the non-qualified stock options follows:\nNTN COMMUNICATIONS, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\n(8) 10% CUMULATIVE CONVERTIBLE PREFERRED STOCK\nThe Company has authorized 10,000,000 shares of 10% cumulative convertible preferred stock, of which 162,612 and 197,612 were issued and outstanding at December 31, 1995 and 1994, respectively. The stock has no voting rights. At December 31, 1995, each share is currently convertible into .2801 shares of common stock at the option of the holder. During 1995, 35,000 shares of cumulative convertible preferred stock converted into 9,804 shares of common stock.\n(10) WARRANTS\nThe Company has issued various warrants to purchase common stock, all of which are exercisable as of December 31, 1995. The following summarizes warrants issued and outstanding:\nNTN COMMUNICATIONS, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\n(11) BUSINESS SEGMENT AND EXPORT SALES DATA\nOperating results and other financial data are presented for the principal business segments of the Company for the years ended December 31, 1995, 1994 and 1993. The Company's principal business units are its Hospitality Network (Hospitality Interactive Services), Learnstar, Inc. (Education Interactive Services) and New World (Software Development and Distribution). Corporate and Other includes other smaller segments and the corporate operations.\nNTN COMMUNICATIONS, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\n(12) RETIREMENT AND SAVINGS PLANS\nDEFINED BENEFIT PENSION PLAN\nThe Company has established a non-qualified, con-contributory pension plan covering certain key executives. This plan is subject to modification at any time. The plan provides retirement benefits based on years of service and compensation. Net pension expense was $7,000 and $5,000 in 1995 and 1994 respectively. Accrued pension liability totaled $12,000 and $5,000 at December 31, 1995 and 1994, respectively.\nDEFINED CONTRIBUTION PLAN\nDuring 1994, the Company also established a defined contribution plan which is organized under Section 401(k) of the Internal Revenue Code, which allows employees who have completed at least six months of service or reached age 21, whichever is later, to defer up to 15% of their pay on a pre-tax basis. The Company, at its discretion, may contribute to the plan. For the year ended December 31, 1995 and 1994 the Company made no such contributions.\nDEFERRED COMPENSATION PLAN\nThe Company also maintains an unfunded, non-qualified deferred compensation plan, which was created in 1994 for certain members of management. This plan allows participants to defer a minimum of $5,000 up to limits set by the Internal Revenue Code.\n(13) FAIR VALUE OF FINANCIAL INSTRUMENTS\nStatement of Financial Accounting Standards No. 107, \"Disclosures about Fair Value of Financial Instruments\", defines the fair value of a financial instrument as the amount at which the instrument could be exchanged in a current transaction between willing parties. The Company believes that the fair value of financial instrument assets and financial instrument liabilities approximate their carrying value, except that the carrying value of notes receivable at December 31, 1995 exceeds the fair value by approximately $250,000. The following methods and assumptions were used to estimate the fair value of financial instruments:\nThe carrying values of cash and cash equivalents, marketable securities, accounts receivable, other assets, accounts payable and accrued liabilities and short-term borrowings approximates fair value because of the short maturity of those instruments. The fair value of notes receivable and interest-bearing security deposits are determined as the present value of expected future cash flows discounted at the interest rate currently offered by the Company which approximates rates currently offered by local lending institutions for instruments of similar terms and risks.\nNTN COMMUNICATIONS, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\n(14) COMMITMENTS AND CONTINGENCIES\nThe Company leases office and production facilities and equipment under agreements which expire at various dates. In 1995, the Company entered into a noncancelable operating lease with an entity which is partially owned by the Company. The Company incurred no lease expense under the lease in 1994 and 1993. Certain leases contain renewal provisions and generally require the Company to pay utilities, insurance, taxes and other operating expenses. Additionally, the Company has entered into agreements for the sale and leaseback of certain equipment used in broadcast operations. Deferred gains on sale and leaseback transactions is amortized to operations over the three year lease terms. Each lease provides an option to the Company to repurchase the equipment at the estimated fair market value at the end of the lease terms. Included in assets are interest-bearing security deposits totaling $3,775,000 relating to these agreements. Lease expense under operating leases totaled $4,763,000, $3,272,000 and $1,425,000 in 1995, 1994 and 1993, respectively.\nFuture minimum lease obligations under noncancelable operating leases at December 31, 1995 are as follows:\nThe Company provides services to group viewing locations, generally bars and lounges, and to third party distributors primarily throughout the United States. In addition, the Company licenses its technology and products to licensees outside of the United States. Concentration of credit risk with respect to trade receivables are limited due to the large number of customers comprising the Company's customer base, and their dispersion across many different industries and geographies. The Company performs ongoing credit evaluations of its customers financial condition and, generally, requires deposits from its customers. At December 31, 1995, the Company had no significant concentration of credit risk.\n(15) LEGAL ACTIONS\nBeginning in 1992 the Company has been involved in various lawsuits with Interactive Network, Inc. The remaining lawsuits have all been suspended pending substantive discussions regarding a global resolution of all disputes. The Company believes, based in part on the advice of outside independent counsel, that these actions and possible resolutions will not have a material adverse effect on the Company's financial position or results of operations.\nThe Company is also defending litigation filed by various shareholders of the Company. The class action suit seeks to recover unspecified damages for a drop in the market price of the Company's Common Stock following an announcement that an anticipated agreement under which the Company would sell certain equipment and services to an arm of the Mexican Government may be put out for bid. Whereas the Company has vigorously defended this litigation and believes, in part, based upon the opinion of outside counsel, on the merits of its defense, the Company has\nNTN COMMUNICATIONS, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\nentered into substantive negotiations to resolve this matter out-of-court to avoid costly and protracted litigation, in the best interests of its shareholders. A preliminary framework for such a resolution has been reached, however, any proposed settlement between the parties will be subject to notification to each of the class members and final court approval.\nIn April 1995, a second class action lawsuit was filed against the Company. The lawsuit seeks unspecified damages and alleges violations of securities laws based upon the Company's projections for the fourth quarter of 1994 and for fiscal year 1994, and further alleges that certain insiders sold stock on information not generally known to the public. In July 1995, a single shareholder filed a separate lawsuit in Texas containing allegations essentially identical to those raised in the shareholder lawsuit filed in April, 1995. The Company denies the allegations in the complaints and has filed its own counterclaim against third parties for indemnification. The Company has denied liability based upon the allegations contained in the complaints which do not contain any statement or demand for a specific amount of damages. Much discovery has been undertaken and, at this time, the Company intends to continue to vigorously contest these matters.\nThere can be no assurance that any or all of the preceding actions will be decided in favor of the Company. The Company believes, based in part on the advice of outside, independent legal counsel, that the costs of defending and prosecuting these actions will not have a material adverse effect on the Company's financial position or results of operations.\nSchedule II -----------\nNTN COMMUNICATIONS, INC. AND SUBSIDIARIES\nValuation and Qualifying Accounts\nYears ended December 31, 1995, 1994 and 1993\n(a) Reflects trade accounts receivable written off during the year.\n(b) Reflects actual returns and allowances charged against the allowance during the year.","section_15":""}
{"filename":"823533_1995.txt","cik":"823533","year":"1995","section_1":"ITEM 1. BUSINESS\n\"Fortis Benefits\/Fortis Financial Group Member\" on page 8, and Further Information About Fortis Benefits\" on pages 17 through 23 of the prospectus attached hereto as Exhibit No. 99 are incorporated herein.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\n\"Employees and Facilities\" from page 21 of the prospectus attached hereto as Exhibit No. 99 is incorporated herein by reference.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is a defendant in various lawsuits, none of which, in the opinion of the Company counsel, will result in a material liability.\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\nNot applicable.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\n\"Selected Financial Data\" from page 18 of the prospectus attached hereto as Exhibit No. 99, is incorporated herein by reference.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\n\"Management's Discussion and Analysis of Financial Condition and Results of Operations\" on pages 18 through 23 of the prospectus attached hereto as Exhibit No. 99 is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\n\"FORTIS BENEFITS Financial Statements\" contained in the prospectus attached hereto as Exhibit No. 99 is incorporated 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\"Directors and Executive Officers of the Registrant\" on page 21 of the prospectus attached hereto as Exhibit No. 99 is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\n\"Executive Compensation\" on pages 22 and 23 of the prospectus attached hereto as Exhibit No. 99 is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\n- ------------------------\n(1) All of Fortis Benefits' outstanding shares are owned by Time Insurance Company, 515 West Wells, Milwaukee, WI, 53201, which is itself wholly owned by Fortis, Inc., One World Trade Center, Suite 5001, New York, NY 10048. Fortis, Inc. in turn is wholly owned by Fortis International, Inc., which is wholly owned by AMEV\/VSB 1990 N.B. both of which share the same address with N.V. AMEV., Archimiedeslaan 10, 3584 BA, Utrecht, The Netherlands. AMEV\/VSB 1990 N.V. is 50% owned by N.V. AMEV and 50% owned, through certain subsidiaries, by Compaignie Financiere et de Reassurance du Groupe AG, Boulevard Emile Jacqmain 53, 1000 Brussels, Belgium.\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)The following financial statements of Fortis Benefits Insurance Company are included in Item 8:\nReport of Independent Auditors\nBalance Sheets at December 31, 1995 and 1994\nStatements of Income for the years ended December 31, 1995, 1994 and 1993\nStatements of Changes in Shareholder's Equity for the years ended December 31, 1995, 1994 and 1993\nStatements of Cash Flows for the years ended December 31, 1995, 1994 and 1993.\nNotes to Financial Statements\n(2) The following financial statement schedules of Fortis Benefits Insurance Company are included in Item 8:\nI. Summary of Investments--Other than investments in Related Parties.\nIV. Reinsurance.\nV. Valuation and Qualifying Accounts.\nAll other schedules to the financial statements required by Article 7 of the Regulation S-X are not required under the related instructions or are inapplicable and therefore have been omitted.\n(3) Listing of Exhibits\n3.(a) Articles of Incorporation of Fortis Benefits Insurance Company (incorporated by reference from Form S-6 Registration Statement of Fortis Benefits and its Variable Account C filed on March 17, 1986, File No. 33-03919);\n(b) By-laws of Fortis Benefits Insurance Company (incorporated by reference from Form S-6 Registration Statement of Fortis Benefits and its Variable Account C filed on March 17, 1986, File No. 33-03919);\n(c) Amendments to Articles of Incorporation and By-laws dated November 21, 1991 (incorporated by reference from Post-Effective Amendment No. 1 to the Form N-4 Registration Statement of Fortis Benefits and its Variable Account D filed on March 2, 1992, File No. 33-37577).\n4.(a) Form of Combination Fixed and Variable Group Annuity Contract (incorporated by reference from Post-Effective Amendment No. 1 to the Form N-4 Registration Statement of Fortis Benefits and its Variable Account D filed on March 2, 1992, File No. 33-37577);\n(b) Form of Certificate to be used in connection with Contract filed as Exhibit 4(a) (incorporated by reference from the Post-Effective Amendment No. 1 to the Form N-4 Registration Statement of Fortis Benefits and its Variable Account D filed on March 2, 1992, File No. 33-37577);\n(c) Form of Application to be used in connection with Certificate filed as Exhibit 4(b) (incorporated by reference from Post-Effective Amendment No. 1 to the Form N-4 Registration Statement of Fortis Benefits and its Variable Account D filed on March 2, 1992, File No. 33-37577);\n(d) Form of IRA Endorsement (incorporated by reference from Pre-Effective Amendment No. 1 to Form N-4 Registration Statement of Fortis Benefits and its Variable Account D filed on March 28, 1991, File No. 33-37577);\n(e) Form of Section 403(b) Annuity Endorsement (incorporated by reference from Post-Effective Amendment No. 3 to the Form N-4 Registration Statement of Fortis Benefits and its Variable Account D filed on March 1, 1990, File No. 33-19421);\n(f) Annuity Contract Exchange Form (incorporated by reference from Pre-Effective Amendment No. 1 to the Form N-4 Registration Statement of Fortis Benefits and its Variable Account D filed on April 19, 1988, File No. 33-19421).\n10. Fortis, Inc. Executive Incentive Compensation Plan (incorporated by reference from Amendment No. 1 to Form S-1 Registration Statement of Fortis Benefits filed on March 28, 1991, File No. 33-37576).\n24. Power of Attorney for Messrs. Freedman, Gaddy, Mackin, Meler, Mahoney, Clancy, Keller, Greiter and Clayton (incorporated by reference from Exhibit 11 to Form S-6 registration statement of Fortis Benefits, File No. 33-73138 filed on December 17, 1993).\n99. Form of prospectus to be filed as part of Form S-1 Amended Registration Statement of Fortis Benefits.\n(b) Reports on Form 8-K filed in the fourth quarter of 1995\nNone\n(c) Exhibits\nIncluded in 14 (a)(3) above\n(d) Financial Statements Schedules\nIncluded in 14 (a)(2) above\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nFORTIS BENEFITS INSURANCE COMPANY Registrant\nMarch 28, 1996 By ----------------------------------------- Robert B. Pollock, PRESIDENT AND CHIEF EXECUTIVE OFFICER\nMarch 28, 1996 By ----------------------------------------- Michael J. Peninger, SENIOR VICE PRESIDENT AND CHIEF FINANCIAL OFFICER\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been duly signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. The following persons represent a majority of the Board of Directors of Fortis Benefits Insurance Company:\nBy* ------------------------------------- Chairman of the March 28, 1996 Allen Royal Freedman Board\nBy ------------------------------------- President and Chief March 28, 1996 Robert B. Pollock Executive Officer\nBy ------------------------------------- Senior Vice March 28, 1996 Dean C. Kopperud President\nBy* ------------------------------------- Executive Vice March 28, 1996 Thomas Michael Keller President\nBy* ------------------------------------- Director March 28, 1996 Henry Carrol Mackin\nBy* ------------------------------------- Robert B. Pollock, ATTORNEY-IN-FACT","section_15":""}
{"filename":"798139_1995.txt","cik":"798139","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nSmith Environmental Technologies Corporation (formerly Canonie Environmental Services Corp.), a Delaware corporation (the \"Company\"), was initially formed as a Michigan corporation under the former name in 1980. It changed its name to Canonie Engineers, Inc. in 1983 and operated under that name until a merger, effective July 25, 1986, of Canonie Engineers, Inc. with and into Canonie Environmental Services Corp., with the Company being the surviving corporation. The Company changed its name to Smith Environmental Technologies Corporation on February 28, 1995. The principal business of the Company is the performance of comprehensive environmental consulting, engineering, and on-site remediation services throughout the United States for clients, including federal, state and local government agencies, with regard to properties contaminated with hazardous materials. Because the performance of specific projects may be affected by seasonal weather conditions and other factors that affect the economy generally, particularly in the Company's fourth quarter, quarterly results or other interim reports should not be considered indicative of results to be expected for any quarter or full fiscal year. The Company's operations are considered to be concentrated in one industry segment.\nBUSINESS DEVELOPMENT\nCHANGE IN CONTROL. On December 30, 1993, Smith Holding Corporation, a Delaware corporation, formerly known as Smith Environmental Technologies Corporation (\"Smith Holding\") acquired 2,653,720 shares, or 46.6 percent, of the Company's common stock from W. R. Grace & Co. (\"Grace\"). The Board of Directors appointed E. Brian Smith Chief Executive Officer of the Company on January 1, 1994, and Chairman on January 28, 1994.\nCHANGE IN BUSINESS STRATEGY. In connection with the 1993 change in ownership, the Company adopted a new strategic plan which included an acquisition program to improve the Company's competitive position in its industry segment. The primary focus of the acquisition program is medium-sized ($30-$80 million annual revenue) environmental consulting, engineering, and remediation services companies.\nDESCRIPTION OF ACQUISITIONS. On September 28, 1994, the Company purchased all of the outstanding common stock of BCM Engineers Inc. (\"BCM\"), an environmental consulting and engineering company, for cash of $5.0 million and 78,000 shares of Redeemable Preferred Stock with an estimated fair value of $6.9 million on the date of issuance and a redemption value of $7.8 million. The Redeemable Preferred Stock has a 5 percent cumulative dividend requirement and is redeemable in equal installments on the fifth, sixth and seventh anniversaries of its issuance (see Note 12 of Notes to Consolidated Financial Statements). The Company also repaid $9.5 million of indebtedness of BCM from the proceeds from borrowings under its Loan and Security Agreement with LaSalle Business Credit, Inc. (the \"Loan Agreement\"). BCM reported revenues of approximately $62 million for the year ended December 31, 1993.\nOn November 21, 1994, the Company purchased all of the capital stock of Riedel Environmental Services, Inc. (\"RES\"), an environmental remediation services firm, from Riedel Environmental Technologies, Inc. The purchase price of approximately $19 million, subject to adjustments, was paid in cash. In conjunction with the acquisition of RES, the Company issued a $10 million Convertible Senior Subordinated Note (the \"Convertible Senior Subordinated Note\") and a $2 million Senior Note (the \"Senior Note\" and collectively with the Convertible Senior Subordinated Note, the \"Notes\"). The Notes were purchased by 399 Venture Partners, Inc., an affiliate of Citicorp Venture Partners. The proceeds of the Notes were used to provide funds for the RES acquisition. RES reported revenues of approximately $76 million for the year ended December 31, 1993.\nOn January 13, 1995, the Company acquired from RESNA Industries, Inc. (\"RESNA\") substantially all of the tangible assets, contracts and certain intangible assets of RESNA's environmental assessment and remediation business in exchange for the assumption by the Company of $1.5 million of debt owed to RESNA's principal lender. At the time of purchase, RESNA's backlog of remaining work was approximately $10 million. Although RESNA's size is below that of the Company's stated acquisition strategy, the business location and market were attractive considering the purchase price.\nThe Company has focused on acquiring companies that provide a broader range of services, better geographic coverage and additional market share. By merging their operations into its current organizational structure, the Company believes it is able to reduce overall operating costs by consolidating existing administrative, financial, information systems and human resources functions. The Company also believes that through increased market presence and size it can augment its traditionally strong relationships with its private sector clients and secure additional environmental consulting and remediation business with governmental clients, particularly the Departments of Defense and Energy and the Environmental Protection Agency (\"EPA\").\nJOINT BUSINESS VENTURE\nThe Company owns 100 percent of the issued and outstanding capital stock of Canonie Technologies, Inc., a Delaware corporation (\"CT\"). CT, in turn, owns a 50 percent interest in SoilTech ATP Systems, Inc., a Delaware corporation (\"STI\"). STI is a corporate venture that was formed to use sublicense rights and the related waste material processing equipment for the remediation of contaminated soils. STI has the exclusive U.S. sublicense through June 2012 of a pyrolysis technology developed and licensed by UMA Group Ltd. This technology has proven to be an efficient treatment of waste materials containing mixtures of hydrocarbons, water, and soils. In fiscal year 1991, STI completed the first commercial application of this technology at a Superfund site in New York to remove polychlorinated biphenyls (\"PCBs\") from contaminated soils. STI completed its fourth major project in fiscal year 1995 as a subcontractor to the Company for a project requiring excavation and treatment of approximately 34,000 tons of contaminated soil.\nDESCRIPTION OF SERVICES\nThe Company's principal business is to provide advice regarding and\/or correct and prevent the effects of pollutants in air, water and soil and in facilities of all types. The Company achieves this by assessing environmental regulations, investigating contaminated sites, and designing and engineering methods to correct or prevent the contamination. The Company will also perform the remedial actions including the construction and operation of required facilities, as well as, perform emergency response actions involving spills and accidental releases of hazardous waste. The Company uses a wide variety of technologies and construction processes and techniques to meet the needs of its clients in solving the problems created by environmental pollutants. The Company addresses hazardous and non-hazardous contaminants in municipal and industrial water supplies, in wastewater and storm water from municipal, industrial and military installations, in groundwater, soils, and air space surrounding these types of complexes, and contaminants in the buildings and facilities themselves, such as asbestos, lead-based paint, and radioactive contamination.\nThe Company's objective in rendering its services is to provide clients with remedial solutions that integrate the various aspects of a project and that are well documented, practical, cost-effective, and acceptable to regulatory agencies and the public. To accomplish this objective, the Company has assembled an experienced staff of engineers, scientists, and construction professionals. For remediation work, the Company offers an integrated approach to remediate sites which the Company believes can reduce the time and cost required to complete a project and may relieve the client of the responsibility and premium costs associated with coordinating the efforts of independent consultants, engineers, and contractors. The Company believes it is one of the few companies capable of providing such a broad range of services for the remediation of contaminated sites.\nThe Company's environmental consulting work has included the design of hundreds of potable water treatment plants for municipalities and a similar number of sewage and wastewater plants for public and industrial applications. It performs environmental assessments and impact studies to gauge the effect of new buildings and facilities on the environment and assesses the resulting added risk to people and wildlife and recommends alternatives which meet its clients' objectives while maintaining environmental standards. The Company's current environmental consulting assignments range in value from a few thousand dollars to $15 million with an average value of approximately $50,000. The Company believes that its experience with remediation projects makes it a more effective consultant; in addition, the Company is able to offer a \"turn-key\" approach to clients.\nConsistent with the Company's strategy of providing complete solutions to clients' environmental problems, the Company provides construction and remediation services which can implement the solutions designed by its consulting and engineering group or designed by others. The Company also provides hazardous waste cleanup, landfill design and construction, water management systems, wastewater system construction and operation, decommissioning and demolition of facilities and process systems, storage tank management, and operation of on-site thermal treatment systems.\nThe Company's hazardous waste remediation projects have included the design and construction of on-site facilities to separate, destroy, detoxify, or isolate hazardous wastes existing in air, soils, and surface and subsurface water, and the decontamination or demolition of equipment and facilities related to the production and use of hazardous substances. The Company also performs assessment, design and construction of landfill facilities for on-site disposal of hazardous materials and facilities for use as regional disposal sites. Waste remediation projects undertaken by the Company range in duration from one month to several years and from $100,000 to approximately $30 million.\nAlthough the Company's projects vary widely in objectives, scope and duration, each project involves the Company providing one or more of the following services: strategic planning; environmental assessment and security; remedial investigation; feasibility study; design and construction of remediation facilities, provision of remediation services, and operation of facilities which purify water sources, treat wastewater streams, prevent hazardous waste generation at its source, separate, destroy, detoxify, or isolate hazardous wastes; close and monitor previously contaminated sites; and emergency response. The following is a brief description of these services:\nSTRATEGIC PLANNING. On each of its projects, the Company attempts as early as possible to formulate a complete strategy for directing all efforts toward solving the contamination problem. The Company's strategic plans, including alternative contingency plans, are designed to satisfy the demands of regulatory agencies and the public, sometimes under emergency conditions. Strategic planning is especially critical when a municipality or industry is building infrastructure to meet its needs for several decades. The Company provides consulting services to not only meet the client's needs but also to ensure these needs are met in a manner that is environmentally acceptable. The Company's track record of successful project completions is due in part to its strategic planning capability made possible by its integrated, interdisciplinary approach and its experience in addressing regulatory and public concerns.\nENVIRONMENTAL ASSESSMENT AND SECURITY. In conducting an environmental site assessment, the Company determines the basic characteristics of a site as well as any specific conditions pertaining to that site, including for example: the traffic patterns at a site; climatological considerations; and the proximity and degree of residential development. The assessment may also include identification of the presence of endangered flora and fauna and a risk evaluation to human life and ecological conditions. Assessments, performed in varying degrees of detail, may be used to assess potential risk for a property buyer, serve as the problem definition phase for an owner who wishes to clean up a site, or as a baseline against which an owner can measure and defend the environmental acceptability of his future land use plans. An assessment may also provide the basis for the selection of a technology to treat water or wastewater streams for a federal, state or local client.\nThe Company is especially experienced in responding to conditions which pose a potential immediate threat to human life and health, often under emergency conditions. In such cases, site security measures must be quickly implemented. In providing site security, the Company's services include assessing the hazardous condition, restricting access to the affected area, assisting in the preparation of any necessary evacuation plans, eliminating or reducing potential risks of fire or explosion, containing or removing hazardous materials which might pose additional risk, and implementing measures to reduce or halt the spread of hazardous substances into adjacent areas.\nREMEDIAL INVESTIGATION. Remedial investigation involves the detailed assessment of an affected area to determine the nature and extent of hazardous materials present. In conducting such an investigation, the Company takes samples and performs numerous physical tests and uses the resources of analytical laboratories. A remedial investigation also involves the study of the geographic, geologic, hydrogeologic, and atmospheric characteristics of the affected area and the surrounding environment and a determination of the risks posed by the hazardous materials determined to be located in the affected area. In conducting such investigations, the Company often reviews the construction of a facility and past storage and handling practices regarding hazardous materials. Sophisticated air and groundwater modeling techniques may also be performed by the Company's scientists and engineers to predict the unseen extent of the contamination.\nFEASIBILITY STUDY. The feasibility study addresses measures which may be implemented to remove hazardous wastes from a site; treat, stabilize, or contain such wastes on-site; or otherwise mitigate the effects of hazardous wastes. Such a study takes into account such factors as available technology, regulatory considerations and the cost\/benefit relationship of alternative measures. Also, the Company reviews the project and alternative remedial measures in light of legitimate public concerns.\nDESIGN AND CONSTRUCTION OF REMEDIATION FACILITIES, PROVISION OF REMEDIATION SERVICES AND OPERATION OF REMEDIAL FACILITIES. Based on the results of assessments, remedial investigation and the feasibility study, the Company uses its engineering and construction expertise to design and\/or construct an appropriate structure or system for use at a particular site and, directly, or through subcontractors, performs the necessary construction and remediation activities. In the case of water and wastewater treatment facilities, engineering requirements may include major storage and basin designs, gathering and distribution pipeline systems, and sophisticated technology scale-up designs.\nRemediation services for contaminated sites might include such measures as construction of a slurry wall to contain hazardous wastes, demolition and removal of an entire structure or facility, construction and operation of a pumping and filtration system to decontaminate surface or subsurface waters, or construction and operation of an integrated system to excavate contaminated soil and treat it on-site to remove hazardous substances. In designing remedial measures, the Company has used more than 21 different technologies for on-site treatment of various contaminants.\nCLOSURE PLANNING AND SITE MONITORING. The Resource Conservation and Recovery Act of 1976 (\"RCRA\") requires the planning of closure and post- closure monitoring for all licensed secure hazardous landfills, treatment facilities, and on-site hazardous waste storage areas. The Company plans facility closures and post-closure monitoring programs and furnishes cost estimates required by RCRA. The Company also performs closures and post- closure monitoring and provides the engineering certification of completion required by RCRA. The Company uses in-house computerized data management systems to manage the post-closure monitoring programs and to generate reports in tabular and graphic form, which are provided to clients and regulatory agencies. While certain monitoring requirements are mandated by RCRA, particularly National Priority List sites, many sites that have at some time contained hazardous waste may also require frequent monitoring. The Company provides monitoring and the corresponding data management services for such sites.\nEMERGENCY RESPONSE. Many of the Company's remediation projects are in response to hazardous substance emergencies. Examples include oil and chemical spills on water, highway accidents involving transporters of oil or chemical substances, fires at chemical or hazardous waste facilities, railroad accidents involving hazardous materials, transformer fires or explosions involving PCBs, and other unanticipated instances where hazardous substances pose an immediate threat to humans or the environment.\nTo respond to these emergencies, the Company has mobile response units strategically located in various locations in the western, central and southern United States. The Company believes it is the only company with such an extensive system. Through this network, the Company believes it is well-positioned to respond and effectively manage major environmental related emergencies in the western, central and southern United States. When the Company receives a request for emergency response services, the Company immediately mobilizes the available equipment closest to the emergency and dispatches trained personnel from one of its offices or from field locations to the site. The Company has a 24-hour telephone \"hot- line\" for emergency service calls: 1-800-334-0004.\nThe Company generally provides its emergency response services under written contracts and has over 375 master service agreements in place. The Company has contracts with private organizations and governmental entities, including oil and chemical companies, cooperatives, railroads, the EPA, the Coast Guard and several states including Oregon, California, Washington, Idaho, Montana, Missouri, Kansas, Illinois, Mississippi, Louisiana and Texas. Certain of these contracts require the Company to maintain equipment in locations convenient to the customer and to respond to calls for assistance within specified response times. Services are provided on the basis of a schedule of fees for equipment, personnel, materials and travel. In some cases an annual retainer fee is charged.\nWith the acquisition of RES in November of 1994, the Company generates a substantial portion of revenues under its Emergency Response Cleanup Services (ERCS) contracts. The Company is the prime contractor for removal of hazardous substances in ERCS Zone 4A, comprising 15 midwestern and southern states, and ERCS Region 5, comprising 6 states bordering the Great Lakes. ERCS Zone 4A and ERCS Region 5 contracts are renewable for one year periods through February 1996 and September 1997, respectively.\nRevenues from ERCS contracts for the three months in fiscal 1995 since RES was acquired in November 1994, were $6.6 million (or approximately 16 percent of fourth quarter revenues). Annual revenues from ERCS contracts for RES in the years prior to the Company's acquisition averaged approximately $35 million. The Company anticipates that it will receive a similar level of revenues from this source in fiscal 1996. However, the annual revenues generated from these contracts depend on the amount of work authorized up to the contractual maximum amount. The Company intends to actively seek the award of future ERCS contracts and the renewal of the existing contracts.\nTECHNOLOGIES EMPLOYED\nThe Company utilizes a wide range of physical, chemical, biological, and thermal treatment technologies in performing its remediation activities. Physical treatment technologies generally involve filtration, aeration, and soil-washing techniques and are used to separate contaminants from soils, slurries, or water. Chemical treatment technologies generally involve flocculation, clarification, precipitation, polymer addition, and stabilization. The Company also custom designs vapor- and liquid-phase carbon absorption systems to remove contaminants from exhaust air and wastewater streams. Depending on the contaminants present and the site characteristics, these technologies are combined into integrated treatment systems which reduce contaminant concentrations to levels consistent with prescribed regulatory standards. To optimally design these treatment systems, the Company routinely performs extensive computer modeling of contaminant transport and aquifer performance.\nThe Company has been involved in projects which seek to develop new technologies into cost-effective alternatives to existing treatment methodologies. The Company has successfully developed mechanical treatment technology and soil washing technology for the physical removal of contaminants from battery casings and soils. The battery separation process, designed to physically separate and recycle waste from used battery components, received full approval from the EPA in 1991. In addition, the Company, through its affiliate, STI, has the exclusive U.S. sublicense of a pyrolysis technology until June 2012. This four-zoned Anaerobic Thermal Processor is an efficient treatment of waste materials containing mixtures of hydrocarbon emulsions and coal tar residues. There are few other technologies available in the United States that have proven to compete with this technology.\nThe Company has developed a Low-Temperature Thermal Aeration (\"LTTA - Registered Trademark-\") soil remediation system. The LTTA -Registered Trademark- system removes, through vaporization, volatile organic compounds from soils to prevent migration of these compounds to ground waters. Treated soils are suitable for on-site backfill and the vaporized contaminants are captured in activated carbon beds. The Company currently operates one transportable plant utilizing the LTTA-Registered Trademark- system which can be configured to treat off-gases by different methods. The Company has not licensed the LTTA - Registered Trademark- technology, which is only one of the thermal treatment technologies available to the Company. The Company's revenues are not significantly dependent upon the LTTA -Registered Trademark- System.\nIn summary, it is the Company's business to assist its clients in complying with the constantly changing regulatory requirements under which they must operate. The Company believes it is able to address its clients' needs during any phase of the work, from earliest assessment to long-term monitoring of a closed site.\nREGULATION\nThe business of the Company and its clients is subject to extensive, stringent, and evolving regulation by the EPA and various other federal, state, and local environmental authorities. These regulations directly impact the demand for the services offered by the Company. In addition, the Company is subject to the Federal Occupational Safety & Health Act, which imposes requirements for employee safety and health. The Company believes it is in substantial compliance with all federal, state, and local laws governing its business.\nRESOURCE CONSERVATION AND RECOVERY ACT (\"RCRA\"). RCRA is the principal federal statute governing hazardous waste generation, treatment, storage, and disposal. RCRA, or EPA-approved state programs at least as stringent, may govern any waste-handling activities involving wastes classified as \"hazardous.\"\nThe EPA issues regulations under RCRA for hazardous waste generators, transporters, and owners and operators of treatment, storage, and disposal facilities, such as surface impoundments and landfills; design and operating requirements also are mandated. When the Company's remedial activities at any site involve the treatment, storage, or disposal of hazardous waste, it must adhere to the substantive requirements of these regulations. However, the Company is not required to obtain permits required by RCRA for the ownership or operation of a hazardous waste treatment, storage or disposal facility.\nCOMPREHENSIVE ENVIRONMENTAL RESPONSE, COMPENSATION, AND LIABILITY ACT OF 1980 (\"CERCLA\" OR THE \"SUPERFUND ACT\"). CERCLA generally addresses cleanup of inactive sites at which hazardous waste treatment, storage, or disposal occurred. CERCLA imposes joint and several liability for costs of cleanup and damage to natural resources on any person who: then currently or at the time of disposal of a hazardous substance, owned or operated any facility at which hazardous substances were disposed of; by contract, agreement, or otherwise arranged for disposal or treatment, or arranged with a transporter for transportation of hazardous substances owned or possessed by such person for disposal or treatment; or accepted hazardous substances for transportation to disposal or treatment facilities or sites from which there is a release or threatened release. Among other things, CERCLA authorizes the federal government either to clean up these sites itself or to order persons responsible for the situation to do so. CERCLA created a fund to be used by the federal government to pay for the cleanup efforts. The federal government may seek reimbursement of funds spent for remedial activities from the potentially responsible parties (\"PRPs\"). At present, there are 1,238 Superfund sites and another 51 proposed to be added to the National Priority List requiring extensive monitoring and remediation work.\nSUPERFUND AMENDMENT AND REAUTHORIZATION ACT (\"SARA\"). In October 1986, SARA was enacted to impose more stringent cleanup standards and accelerated timetables. SARA authorized additional federal expenditures, and contains provisions which expand the EPA's enforcement power and are intended to encourage and facilitate settlements with PRPs. In October 1990, SARA was reauthorized for an additional five-year period.\nFunding for the Superfund Act expires at the end of the federal government's 1995 fiscal year. The Company anticipates that Congress will take some action to continue funding CERCLA beyond the end of the fiscal year. In connection with any such action, Congress may enact substantive changes. The Company expects that, if substantive changes are made to the Superfund Act, the revised act will contain less stringent standards of clean up and will be designed to force remediation efforts to take place more quickly. While this could diminish the theoretical size of the remediation market, the net effect could be to increase both the amount of remediation work performed and the speed with which it is commenced by lowering barriers to the approval and implementation of this work.\nThe Company believes that, even without funding authorized by the Superfund Act or SARA, commercial, industrial and governmental entities will continue to take action to resolve hazardous waste problems because of their need to comply with other statutory and regulatory requirements and to avoid liability to private parties.\nThe liability imposed by the Superfund Act could, under certain factual circumstances, apply to a broad range of possible activities by the Company, including generation or transportation of hazardous substances; releases of hazardous substances; failure to properly design a cleanup, removal, or remedial plan; failure to achieve required cleanup standards; leakage of removed wastes in transit or at the final storage site; and remedial operations on ground water. Superfund liability can be joint and several where other parties are involved. The Company believes it has and will continue to operate its business in such a manner so as not to incur any Superfund liability. To date, the Company has not been subject to any Superfund liability.\nFEDERAL FACILITIES COMPLIANCE ACT. Congress recently clarified that facilities owned and operated by the federal government, such as defense installations, must meet the standards imposed by environmental laws. The level of future activity at these sites is dependent on the portion of the federal budget allocated to these activities and on possible Congressional action to amend RCRA and CERCLA. It is uncertain what impact, if any, such Congressional action would have on the Company's remediation work.\nCLEAN AIR ACT (\"CAA\"). Congress amended the CAA in 1990. As amended, the CAA charges EPA with promulgating more than 400 regulations and developing numerous guidelines and procedures. The amendments establish a national permit program and a stronger enforcement program. In particular, the amended CAA is designed to address acid rain, urban air pollution and emissions of hazardous air pollutants. The Company believes that activity related to CAA compliance may be a source of future work.\nOther laws that the Company's operations are subject to, which protect the environment, include the Clean Water Act, Safe Drinking Water Act, and the Toxic Substances Control Act. Many states have also enacted statutes regulating the handling of hazardous substances, some of which are broader and more stringent than the federal laws and regulations, and the Company could be subject to liability under these statutes if it is responsible for the mishandling or release of hazardous substances.\nCOMPETITION\nAs a result of the acquisitions of BCM and RES, the Company competes on a national basis with a large number of environmental service firms. These range in size from small local companies to large national firms, many of which have considerably greater resources than the Company. While the service capabilities of these competitors overlap with several of the service areas provided by the Company, few compete in all areas of the Company's markets. Factors influencing the Company's competitiveness are price, reputation for quality, the availability and skills of engineering and construction personnel, financial strength, knowledge of markets, site conditions and estimating abilities. Although the environmental business is highly competitive, particularly for competitively bid projects, the Company believes its experience and skill make it well positioned to compete effectively.\nCONTRACT PROVISIONS AND SUBCONTRACTING\nThe Company has a mix of contracts ranging from reimbursement of labor and materials on a cost plus basis to \"fixed price\" or \"fixed unit price\" contracts under which the Company provides materials or services required by a project at a fixed price or a fixed unit price (for example, dollars per ton of material treated or cubic yards of earth excavated). While the fixed unit price contract generally shifts the risk of estimating the quantity of units required for a particular project to the customer, the cost of performing each such unit is the Company's responsibility and risk. The Company's contracts are obtained primarily through competitive bidding in response to proposal requests by private parties and federal, state and local government agencies.\nAll federal government contracts and many of the Company's private contracts provide for termination of the contract for the convenience of the party contracting with the Company. In addition, some of the Company's contracts are subject to certain completion schedule requirements with liquidated damages in the event schedules are not met.\nThe Company acts as prime contractor on most of the projects it undertakes. The Company accomplishes the majority of its projects with its own resources and subcontracts specialized activities such as transportation and disposal, drilling, electrical and mechanical work. As prime contractor, the Company is responsible for the performance of the entire contract, including subcontract work. While the Company can be subject to increased costs associated with the failure of one or more subcontractors to perform as anticipated, it does not expect that any such failure will have a material adverse effect on the operations of the Company.\nINSURANCE AND BONDING\nThe Company maintains commercial general liability, automobile liability, workers' compensation, employer's liability, and excess liability insurance policies. The Company also maintains protection and indemnity coverage and hull insurance to protect against risks arising from the Company's marine activities, and a combined consultant's environmental and professional liability policy to protect against claims arising out of actual, alleged, or threatened discharge, dispersal, or release of pollutants, asbestos-related claims, and alleged errors or omissions in performance of the Company's professional services which claims are excluded from the aforementioned liability policies. The environmental and professional policy limits of liability are $5 million for each loss and an aggregate of $5 million for all losses. The Company also maintains contractor's pollution liability insurance policies that cover certain specific jobsite pollution exposures of the Company. There can be no assurance that any liability that may be incurred by the Company will be covered by its insurance or that the dollar amount of any such liability will not exceed the Company's policy limits. Difficulty in obtaining insurance may also impair the Company's ability to obtain future contracts, which are in many cases conditioned on the availability of adequate insurance coverage. To date, the Company has not experienced significant difficulty in obtaining insurance.\nIn connection with its business, the Company often is required to provide various types of surety bonds guaranteeing its performance under certain public and private sector contracts. The Company's ability to obtain surety bonds depends upon its capitalization, working capital, past performance, management expertise and other factors. Surety companies consider such factors in light of the amount of surety bonds then outstanding for the Company and their current underwriting standards, which may change from time to time. The Company currently has bonding programs in place which it believes are sufficient for its needs. Although the Company has no assurance future bonding will be available, it believes it will continue to meet its bonding requirements through a U.S. Treasury listed surety.\nCLIENTS AND MARKETING\nThe Company's marketing efforts have focused upon providing private industry clients with practical and effective solutions to their site contamination problems. The Company has recently broadened its marketing efforts to include selected public-sector projects, particularly for the Departments of Defense and Energy and the EPA. The Company has performed work at numerous major project sites nationwide, including 172 Superfund sites and numerous RCRA facilities. The Company has worked for a significant number of the Fortune 500 companies. The Company's clients include PRP groups, petroleum and chemical companies, electronics manufacturing firms, railroads, waste disposal firms, utilities, other industrial companies, and governmental agencies. The Company has initiated a National Accounts Program to develop and establish comprehensive and long-term relationships between the management of clients and the Company. The Company's marketing strategy features and reinforces the Company's ability to deliver comprehensive and specialized technological services to meet the environmental needs of clients at every level. The Company markets its services from offices nationwide and augments its marketing staff with management and technical and professional specialists.\nThe Company generates its revenues from an existing account base as well as new clients developed during the year. While the Company receives a significant portion of its revenue from a relatively small number of clients, these customers are not necessarily the same each year. In addition, there were only two customers in fiscal 1995 who accounted for 10 percent or more or the Company's annual revenues.\nBACKLOG\nAs of February 28, 1995, the Company had a contract backlog of orders of approximately $105 million, of which the Company anticipates performing $90 million in fiscal 1996. As of February 28, 1995, the value of unfunded or indefinite delivery order contracts (\"IDO\") was approximately $170 million and when combined with contract backlog totals $275 million. The ultimate value of the backlog is subject to change as the scope of work on projects changes. Customers often retain the right to change the scope of work with an appropriate increase or decrease in the contract price. At February 28, 1994, the Company had a backlog of orders of approximately $60 million. There was no unfunded backlog at February 28, 1994.\nEMPLOYEES\nAs of May 12, 1994, the Company had 1,260 full-time employees of whom approximately 1,100 were in operations and 160 were in sales, marketing and administrative positions. Of these employees, 122 are represented by the International Organization of Masters, Mates and Pilots (IOMMP) and are employed under a collective bargaining agreement which has been extended for one year and is pending renegotiation. The Company considers its relations with its employees to be good and has never had a work stoppage. The Company's ability to continue to retain and expand its staff of qualified engineers, scientists, and construction professionals will be an important factor in determining the Company's future success.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company leases and, in some cases, owns office and warehouse space in various locations throughout the United States. The facility space has been improved, as required, to fit the needs of the engineering, construction management and remediation services areas. With the acquisitions of BCM and Riedel in the third quarter of fiscal 1995 (as described in Note 2 of Notes to Consolidated Financial Statements), the Company has closed and\/or combined certain offices to reduce its facilities costs. The Company will continue to combine or consolidate its facilities to achieve the best possible utilization. Following is a summary of the major office and warehouse facilities:\nPlymouth Meeting, Pennsylvania (1) 91,000 sq. ft. Leased Mobile, Alabama (2) 57,000 sq. ft. Leased Dallas, Texas 13,000 sq. ft. Leased Porter, Indiana 33,000 sq. ft. Owned St. Louis, Missouri 12,000 sq. ft. Owned St. Louis, Missouri 10,000 sq. ft. Leased New Orleans, Louisiana 33,000 sq. ft. Leased Houston, Texas 16,000 sq. ft. Leased Jackson, Mississippi (3) 17,000 sq. ft. Leased Denver, Colorado (3) 35,000 sq. ft. Leased Chicago, Illinois (3) 25,000 sq. ft. Leased Detroit, Michigan (3) 20,000 sq. ft. Leased San Francisco, California (4) 36,000 sq. ft. Leased Los Angeles, California 31,000 sq. ft. Owned Bakersfield, California 15,000 sq. ft. Leased Portland, Oregon (4) 20,000 sq. ft. Leased Burlington, New Jersey 10,000 sq. ft. Leased Pittsburgh, Pennsylvania 10,000 sq. ft. Owned Washington, D.C. 10,000 sq. ft. Leased\n(1) 19,000 square feet are vacant and the Company intends to sublet the space. (2) Four locations. 5,000 square feet are vacant and the Company intends to sublet the space. (3) Two locations. The Company intends to consolidate into one location and reduce total square footage. (4) Two primary locations: a Regional office and operations facilities.\nThe Company also has offices in Panama City, Florida; Stockton, California; Albuquerque, New Mexico; Pocono Summit, Pennsylvania; and Bozeman, Montana totaling approximately 13,000 square feet. The Company believes office and warehouse space, as listed, and the availability of space is adequate for its present needs.\nThe Company's senior lender has been granted a security interest in substantially all assets of the Company and its subsidiaries.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nCANONIE ENVIRONMENTAL SERVICES CORP. (THE \"COMPANY\") VS. NL INDUSTRIES, INC. ET AL. (THE \"PRPS\")\nThe Company filed an action for breach of contract and rescission against seven PRPs in the Circuit Court, Multnomah County, Oregon in February 1995. The Company is pursuing recovery for amounts due as a result of the performance of services, including $1.3 million of accounts receivable and retainage, $2.5 million of unrecovered equipment investment and other damages resulting in a total claim exceeding $6.5 million. Prior to the Company's claim, activity at the site had been suspended pending approval by the EPA of changes in the remedial activities proposed by the PRPs and supported by independent engineering reports which acknowledge significant differences in the waste at the site from those conditions specified in the EPA Record of Decision and in the initial remedial investigation performed by others at the site. The court action has been abated pending the arbitration before the American Arbitration Association demanded by the PRPs who are seeking reimbursement from the Company of approximately $18 million paid for work performed under the contract. The Company will vigorously defend its position and intends to aggressively pursue all amounts recoverable related to its performance at this site.\nCINDRA BROWN, ET AL. VS. RIEDEL ENVIRONMENTAL SERVICES, INC. (\"RES\"), ET AL.\nIn November 1993, second amended complaints and initial complaints were filed in the Circuit Court of the State of Mississippi, County of Jackson, which included RES along with a number of other defendants in claims pending in 27 separate civil actions. These civil actions involve approximately 219 plaintiffs and include two wrongful death claims. Plaintiffs allege that RES was negligent in transferring and clean-up activities of the chemical diethylamine, released from an overturned tanker. The Company rejects every allegation in its defense. The matter is in the discovery phase. The Company is vigorously defending the described litigation.\nOTHER MATTERS\nThe Company is also currently a party to other litigation incidental to its business. While such litigation, including the matters specifically described above, could result in judgments against the Company, management believes that the outcome of such litigation will not have a material adverse effect on the future financial condition or results of operations 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 stockholders during the fourth quarter of fiscal year 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nAs of May 12, 1995, the Company had more than 250 holders of record of its Common Stock. The Company has not paid cash dividends on its Common Stock and is limited from doing so under the terms of its credit facility with the Company's senior Lenders. The Company anticipates that for the foreseeable future any earnings will be retained for use in its business, and no cash dividends will be paid on the Common Stock. Declaration of Common Stock dividends will remain within the discretion of the Company's Board of Directors and will depend upon the Company's growth, profitability, financial condition and other relevant factors.\nThe Company's Common Stock is listed with the NASDAQ National Market System under NASDAQ symbol \"SMTH.\" The table below reflects the high and low bid and ask quotations for each of the Company's fiscal quarters for the latest two fiscal years. The prices reflect inter-dealer prices, without retail mark-up, mark-down or commission and do not necessarily represent actual transactions.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe selected financial data shown below have been derived from the audited consolidated financial statements of the Company. The balance sheet data is presented as of the end of the fiscal years shown. The information set forth below 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 included elsewhere herein.\nSee Note 15 of Notes to Consolidated Financial Statements for a discussion of contract cost overruns and claims, special charges, and write-offs of investments in fiscal 1993 and 1994.\nNo cash dividends were paid on common shares for any period.\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 percentages which certain items from the consolidated statements of operations bear to the revenues of the Company. This table and the Management's Discussion and Analysis of Results of Operations and Financial Condition should be read in conjunction with the selected financial data, the consolidated financial statements and the notes to the consolidated financial statements of the Company included elsewhere herein.\nGENERAL\nThe Company provides a broad range of comprehensive environmental consulting, engineering, remediation and construction services to clients with sites contaminated with hazardous materials, primarily throughout the United States including various federal, state and local government agencies. 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' activities. Due to these changes in demand, the Company's quarterly and annual revenues fluctuate. Generally, in the Company's fourth quarter, a lower level of work is performed due to weather related factors. Accordingly, quarterly or other interim results should not be considered indicative of results to be expected for any quarter or full fiscal year.\nThe Company's consolidated financial statements at February 28, 1995 include the results of operations for BCM and Riedel since their acquisitions by the Company in September 1994 and November 1994, respectively. RESNA, from which certain assets and selected contracts for services were acquired by the Company, is also included beginning January 1, 1995. The Company uses the equity method of accounting for incorporated joint ventures and affiliated companies where ownership ranges from 20 percent to 50 percent.\nAll references to fiscal 1995, 1994 and 1993 refer to the twelve month periods ended February 28, 1995, 1994 and 1993, respectively. Certain amounts in fiscal 1994 and 1993 have been reclassified to conform with the fiscal 1995 presentation. Certain costs related to regional operations for prior periods have been reclassified from selling, general and administrative (SG&A) expenses to cost of revenues. The costs reclassified for fiscal 1994 and fiscal 1993 were $6.5 million and $7.9 million, respectively.\n1995 COMPARED WITH 1994\nRevenues for fiscal 1995 were $104.7 million which was $45.2 million, or 76 percent, greater than fiscal 1994 revenues of $59.5 million. The increase in revenues was primarily attributable to the acquisition of BCM and RES in September and November 1994, respectively. Revenues of BCM and RES included in fiscal 1995 were approximately $24 million and $15 million, respectively.\nGross profit for fiscal 1995 was $14.8 million, an $11.4 million increase from the $3.4 million reported in fiscal 1994. Gross profit as a percentage of revenues was 14.1 percent in fiscal 1995 compared with 5.8 percent in fiscal 1994. Included in fiscal 1995 and 1994 revenues and cost of revenues were $8.0 million and $4.6 million related to work subcontracted to STI, a 50 percent owned affiliate, in fiscal 1995 and 1994, respectively. Fiscal 1994 cost of revenues included approximately $2.3 million of additional costs attributable to changes in profit estimates related to construction projects substantially completed prior to fiscal 1994. Gross profit as a percentage of revenues for fiscal 1995 and fiscal 1994, exclusive of the subcontracted work to STI and additional costs was 15.3 percent and 10.6 percent, respectively. The increase in gross profit in fiscal 1995 was primarily due to the inclusion of five months of the operating results of BCM, which as an engineering division generates higher gross profit margins, and a reduction in regional operations expenses. In fiscal 1995, the Company operated with three fewer regional offices.\nSelling, general and administrative expenses for fiscal 1995 were $10.8 million, a $5.0 million or 87.6 percent increase, compared with $5.8 million for fiscal 1994. SG&A expenses as a percentage of revenue were 10.3 percent in fiscal 1995 compared with 9.7 percent in fiscal 1994. The increase resulted primarily from the inclusion of five months of BCM and three months of RES and the related SG&A expenses, increases in incentive compensation expenses, goodwill and loan transaction fee amortization, and increased administrative management costs.\nIn fiscal 1994, the Company recorded special charges aggregating $4.3 million associated with management's focus on resolving ongoing operational issues, such as new information systems, staff reductions and office closings. These charges, which are comprised of $1.5 million of asset writedowns and $2.8 million of incurred and anticipated cash expenditures including estimated costs in the following material areas: employee separation and office closure costs aggregating approximately $1.8 million; write-off of an investment in a non-core business no longer fitting the strategic direction of the Company of approximately $600,000; asset write-off resulting from the implementation of a new information system of approximately $440,000; writedown of process equipment determined to have impaired value of approximately $490,000; and an accrual of costs associated with litigation of $1 million.\nNet interest expense for fiscal 1995 was $1.2 million compared with $412,000 in fiscal 1994. An increase in bank borrowings in connection with acquisitions of BCM and Riedel resulted in an $817,000 increase in net interest expense from fiscal 1994.\nIn fiscal 1995, the Company provided for income taxes of $558,000 at an effective tax rate of 20 percent. The effective tax rate differs from the federal statutory rate of 35 percent as a result of state income taxes and the utilization of net operating loss carryforwards. In fiscal 1994, the Company provided $135,000 for state income taxes while federal income taxes were reduced by the utilization of available net operating loss carryforwards. A valuation allowance has been recorded to reduce the deferred tax asset related to these carryforwards and other deferred tax assets to zero since the realization of such is not assured.\nThe Company had net operating loss and net capital loss carryforwards for federal income tax purposes of approximately $4.5 million and $3.3 million, respectively, at February 28, 1995. If unused, the net operating loss will expire beginning in fiscal 2008. The capital loss carryforward, if unused, will expire beginning in fiscal 1999. Future tax benefits from the carryforwards will reduce income tax expense when realized. Due to a greater than 50% change in ownership of the Company within the past three fiscal years, use of the carryforwards to reduce future taxable income will be limited to approximately $900,000 annually. However, future recognition of these net operating loss and net capital loss carryforwards will occur only if the operations of the Company generate sufficient earnings before their respective expiration.\nThe Company's share of earnings of its unconsolidated affiliate, STI, in fiscal 1995 was $539,000 compared with a loss of $221,000 in fiscal 1994. STI performed on two significant contracts for the Company in fiscal 1995 at a profit. STI was not engaged in significant contract work prior to the fourth quarter of fiscal 1994 and incurred a loss. Also, in fiscal 1994, the Company wrote off $2.7 million representing its investment in a joint venture involving an incineration project which was impaired by more stringent regulations and greater costs to complete than was anticipated and a decline in the demand for incineration.\n1994 COMPARED WITH 1993\nRevenues for fiscal 1994 were $59.5 million which was $11.9 million, or 17 percent, less than reported fiscal 1993 revenues of $71.4 million. Fiscal 1993 revenues were reported net of a $7.7 million write-off of claims recognized as revenue prior to fiscal 1993. Giving effect to this write-off, revenues actually declined $19.6 million in fiscal 1994 from fiscal 1993. The decrease in revenues was a result of lower private sector market demand, the absence of large dollar value excavation and transportation projects and increased selectivity in the bidding process during fiscal 1994.\nGross profit for fiscal 1994 was $3.4 million, a $3.9 million improvement from the $498,000 gross loss in fiscal 1993. The gross loss in fiscal 1993 was caused primarily by the $7.7 million write-off of claims from prior periods mentioned above. Fiscal 1994 cost of revenues included approximately $2.3 million attributable to additional costs related to construction projects substantially completed prior to fiscal 1994. Also, included in fiscal 1994 revenues and cost of revenues were $4.6 million related to work subcontracted to STI. Gross profit as a percentage of revenue for fiscal 1994 and fiscal 1993, exclusive of the additional costs, subcontracted costs to STI and the write-off of claims relating to prior periods, was 10.6 percent and 9.2 percent, respectively.\nSelling, general and administrative expenses for fiscal 1994 were $5.8 million, a $800,000 or 12.8 percent decrease, compared with $6.6 million for fiscal 1993. The decrease resulted primarily from staff reductions, consolidation of and reduction in the size of offices and other reorganization actions as the Company attempted to \"right size\" its administrative operations. SG&A expenses as a percentage of revenue was 9.7 percent in fiscal 1994 compared with 9.2 percent in fiscal 1993. The percentage increase was primarily the result of the diminished revenue levels in fiscal 1994.\nIn fiscal 1994, the Company, as mentioned above, recorded special charges of $4.3 million associated with management's focus on resolving operational issues, such as new information systems, staff reductions and the closure of certain offices. In fiscal 1993, the Company also recorded special charges of $4.4 million consisting of a $2.6 million reduction of the carrying value of a trade note receivable, $1.6 million for severance, office consolidation and other costs associated with reorganization of administrative operations and $200,000 for the loss on sale of a subsidiary.\nNet interest expense for fiscal 1994 was $412,000 primarily from borrowings under the Company's bank credit agreement and fees related to an interest rate swap which was canceled. An increase in bank borrowings caused the $269,000 increase in net interest expense from fiscal 1993.\nIn fiscal 1994, the Company paid $135,000 in state income taxes. Federal income taxes were offset by the utilization of available net operating loss carryforwards. In fiscal 1993, the Company recorded income tax benefits of $2.6 million from a carryback of its net operating loss.\nThe Company's share of operating losses of unconsolidated affiliates in fiscal 1994 was $221,000, a $680,000 decrease from fiscal 1993. The decrease in losses resulted from higher margin work and lower general and administrative expenses. Also, in fiscal 1994, the Company, as mentioned above, wrote off $2.7 million representing its investment in a joint venture involved in an incineration project.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company's principal sources of funds are cash, cash flows generated from operations and available borrowings under the Company's existing credit facility. Cash totaled $2.3 million at February 28, 1995 compared with $2.3 million at February 28, 1994. The Company's working capital increased to $11.1 million at February 28, 1995 from $3.3 million at February 28, 1994. The increase in working capital is primarily a result of increases in accounts receivable and unbilled costs resulting from the acquisition of BCM, RES and certain assets of RESNA during 1995, partially offset by increases in accrued compensation and related fringes and other accrued liabilities, primarily project and acquisition related costs.\nAt February 28, 1995, the Company had a $30.0 million credit facility consisting of a $4.5 million term loan facility and a $25.5 million revolving credit facility, subject to limitations pursuant to the calculation of a defined borrowing base. At February 28, 1995, $22.1 million of borrowing capacity was available to the Company against which the Company had outstanding borrowings of $19.1 million. The calculation of the borrowing base is based, in large part, on eligible accounts receivable, as defined in the credit agreement with the lender. As a result, changes in the borrowing base can occur due to the magnitude and timing of the Company's billings for services performed, which in turn are impacted by, among other things, contractual terms and seasonal considerations, the timing of collection of billed receivables, and other factors.\nOn May 5, 1995, the Company and its lender amended the credit agreement to increase the eligible borrowing base by an amount up to $4 million with the creation of an \"Unbilled Account Subline\" whereby unbilled receivables, previously excluded from the borrowing base calculation, are now included, subject to limitations, in the calculation of the borrowing base. Availability under the Unbilled Account Subline is automatically and permanently reduced in monthly increments of $500,000 commencing on August 1, 1995 and reduces to zero upon the Company's receipt of at least $10 million through the sale and issuance of its equity securities. The interest rate charged under the amended revolving credit facility has been increased by three-quarters of a percent (3\/4%) until all amounts advanced under the Unbilled Account Subline, and interest accrued thereon, have been paid and the occurrence of an increase in equity described herein. In order to facilitate the additional borrowings, E. Brian Smith, Chairman, President and Chief Executive Officer of the Company agreed to pledge 800,000 shares of Company common stock contemporaneously with the transaction. Pending the pledge of such stock, Mr. Smith has personally guaranteed repayment of amounts advanced to the Company under the agreement, as amended, up to $4 million. The personal guarantee will terminate upon the pledge of 800,000 shares of Company common stock and the passage of a period of 91 days following such pledge; the repayment of all amounts advanced under the Unbilled Account Subline and the termination of that subline; or a $10 million increase in equity. At May 26, 1995, $22.4 million of borrowing capacity was available to the Company pursuant to the credit facility, as amended, against which the Company had outstanding borrowings of $21.4 million.\nThe Company's funding requirements arise primarily from its operating expenses and the debt service and acquisition related expenses incurred in fiscal 1995. Historically, the Company has met such requirements primarily with cash flows generated by operations and limited debt financing. During fiscal 1995, the Company substantially increased its size through the acquisition of BCM, RES, and certain assets of RESNA, and in the process, incurred long-term debt of approximately $31 million and issued $7.8 million of redeemable preferred stock. At February 28, 1995, the components of debt were outstanding borrowings under the Company's credit facility of approximately $19 million, a $10 million convertible senior note, and a $2 million senior note. Subsequent to the BCM, Riedel and RESNA acquisitions, cash has been used to reduce the vendor financing previously used by the acquired businesses.\nDuring fiscal 1994 and continuing in fiscal 1995, management of the Company has focused on resolving ongoing operational issues, taking actions to increase the efficiency of the Company's operations and improving the management of its working capital. Management of the Company believes these actions will enhance the Company's ability to fund its obligations in fiscal 1996.\nThe Company is currently in discussions with additional sources of capital to meet its working capital requirements as well as to fund future expansion. Management believes, based on its discussions with sources of potential financing, that it will be able to raise capital through additional debt and\/or equity. However, in the event the Company fails to improve the management of its working capital and is unable to raise additional capital on a timely basis, its liquidity and financial position could be materially adversely impacted.\nBACKLOG\nAs of February 28, 1995, the Company had a contract backlog of orders of approximately $105 million, of which the Company anticipates performing approximately $90 million in fiscal 1996. As of February 28, 1995, the value of unfunded or indefinite delivery order contracts (\"IDO\") was approximately $170 million and when combined with contract backlog totals $275 million. The ultimate value of the backlog is subject to change as the scope of work on projects changes. Customers often retain the right to change the scope of work with an appropriate increase or decrease in the contract price. At February 28, 1994, the Company had a backlog of orders of approximately $60 million. There was no unfunded backlog at February 28, 1994.\nOTHER ITEMS AFFECTING OPERATING RESULTS\nThe Company has significant customers who, on an annual basis, individually account for more than ten percent of annual revenues. In each of fiscal 1995 and fiscal 1994, the Company had two significant customers from which revenues received aggregated $24.3 and $16.5 million, or 23.2 percent and 27.7 percent, respectively, of revenues in those years. In fiscal 1993, the Company did not have a significant customer who generated more than 10% of annual revenues.\nWith the acquisition of RES in November of 1994 (See Note 2 of Notes To Consolidated Financial Statements), the Company now generates a significant portion of revenues under its contracts with the EPA. Under its current Emergency Response Cleanup Services (\"ERCS\") contracts, the Company is the prime contractor for removal of hazardous substances in ERCS Zone 4A, comprising 15 midwestern and southern states, and ERCS Region 5, comprising 6 states bordering the Great Lakes. ERCS Zone 4A and ERCS Region 5 contracts are renewable for one year periods through February 1996 and September 1997, respectively.\nRevenues from EPA contracts for the three months in fiscal 1995 since RES was acquired in November 1994, were $6.6 million. Annual revenues from EPA contracts for RES in the years prior to the Company's acquisition averaged approximately $35 million. The Company anticipates that it will receive a similar level of revenues in fiscal 1996. The Company intends to actively seek the award of future EPA contracts as the requests for proposals are issued.\nIn April and May 1994, the EPA Office of Inspector General for Audits (\"OIG\") performed a review of the financial condition of RES in order to render an opinion on its financial capability to perform on EPA and other federal government agency contracts. The review included an evaluation of RES' existing and future financial capabilities to continue its operations and financial restructuring process and its relationship with its bank. The OIG submitted its report in May 1994. The report recommended that the EPA require RES to submit periodic reports relating to its financial condition, as well as to provide updates on the RES financial restructuring process. Management believes that RES has submitted reports as required and that, as a result of the acquisition of RES by the Company in November 1994, there will not be any material changes in RES' federal government contract relationships.\nThe market for environmental services is primarily driven by legislation. Environmental engineering, consulting and remediation services are purchased because of legal or regulatory requirements to clean up problems. The delays in extending or creating new legislation, primarily Superfund, has resulted in much slower growth expectations in the engineering, consulting and private remediation markets and may continue pending new legislation. This reduced activity has resulted in increased competition and lower profitability leading to considerable downsizing in small to midsize environmental service companies and, in a number of cases, has led to consolidation.\nThe key laws affecting the environmental market are the Response Conservation and Recovery Act, as amended in 1984 and 1986; the Comprehensive Environmental Response, Compensation and Liability Act, also known as the Superfund law; the Clean Air Act, the Federal Water Pollution Control Act, also known as the Clean Water Act, the Toxic Substances Control Act, and the Federal Facilities Compliance Act of 1992.\nThe Company's operations have not been, nor are they expected in the near term, to be materially affected by inflation.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe consolidated financial statements and supplementary data are indexed in Item 14 hereof and incorporated in this item by reference thereto.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\n(a) Previous independent auditors\n(i) On January 31, 1994, the Company dismissed BDO Seidman as its independent auditors.\n(ii) The reports of BDO Seidman on the consolidated financial statements for the past three fiscal years contained no adverse opinion or disclaimer of opinion and were not qualified or modified as to uncertainty, audit scope or accounting principle.\n(iii) The Registrant's Board of Directors participated in and approved the decision to change independent auditors.\n(iv) In connection with its audits for the three most recent fiscal years and through January 31, 1994, there have been no disagreements with BDO Seidman on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which would have caused BDO Seidman to make reference thereto in their report on the financial statements for such years.\n(v) During the two most recent fiscal years and through January 31, 1994, there have been no reportable events (as defined in Regulation S-K Item 304(a)(1)(v)).\n(vi) The Registrant requested and BDO Seidman furnished a letter addressed to the SEC stating that it agrees with the above statements. A copy of such letter was filed as Exhibit 1 to Form 8-K dated January 31, 1994.\n(b) New independent auditors\n(i) The Registrant engaged Ernst & Young LLP as its new independent auditors as of January 31, 1994. During the three most recent fiscal years and through January 31, 1994, the Registrant has not consulted with Ernst & Young LLP on items which (1) were or should have been subject to SAS 50 or (2) concerned the subject matter of a disagreement or reportable event with the former auditor (as described in Regulation S-K Item 304(a)(2)).\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nInformation with respect to the Directors of the Company will be set forth in the Company's definitive Proxy Statement (the \"Proxy Statement\"), to be filed prior to the expiration of the 120 day period provided for in General Instruction G(3) of Form 10-K, for the Annual Meeting of Stockholders under the heading \"Election of Directors\" and information on the requirement of filings by directors and executive officers under Section 16(a) of the Securities and Exchange Act of 1934, as amended, is set forth under the subheading \"Other Matters\" in such Proxy Statement and is incorporated herein by reference. Information regarding the Company's executive officers is as follows:\nEXECUTIVE OFFICERS OF THE REGISTRANT\nE. Brian Smith has served as Chief Executive Officer since January 1, 1994, Chairman of the Board since January 28, 1994, and President of the Company since February 1995, when the Company changed its name. In August 1993, Mr. Smith formed Smith Holding Corporation, a company formed to seek investments in environmental consulting and remediation firms. Mr. Smith serves as Chairman, President and Chief Executive Officer of Smith Holding Corporation. From July 1992 to August 1993, Mr. Smith was employed as a consultant to International Technology Corporation. Mr. Smith was President and Chief Operating Officer of International Technology Corporation from 1988 to July 1992. Mr. Smith holds a B.S. in Electrical Engineering from Purdue University and an M.S. in Financial Management from George Washington University.\nWilliam T. Campbell, C.P.A., has served as Vice President - Finance since February 1995. He joined the Company as Vice President - Controller in March 1994. From 1984 to 1994, Mr. Campbell served in a variety of positions at International Technology Corporation, including Vice President - Government Contract Compliance from April 1992 to March 1994, Vice President - Controller from April 1990 to April 1992, and Operations Controller from March 1989 to April 1990. Mr. Campbell received a B.S. in Accounting from Pennsylvania State University.\nC. Robert Conner serves as Vice President - Engineering and Consulting Services. Prior to joining the Company in January 1995, Mr. Conner was founder and President of CRC Environmental, Inc., an engineering and business development firm from 1992 to 1994. Mr. Conner was employed by International Technology Corporation from 1989 to 1992, most recently as Regional Director in Cincinnati, Ohio, and Westinghouse Electric Corporation from 1979 to 1989 in several environmental management positions involving site assessment and remediation. Mr. Conner has a B.S. in Physics and Mathematics from Memphis State University and an M.S. in Nuclear Engineering from Carnegie Mellon Institute.\nAnthony J. Dury, Ph.D. has served as Vice President - Chief Administrative Officer since February 1995. He joined the Company as Vice President of Administration and Human Resources in January 1994. Prior to joining the Company, Dr. Dury was at International Technology Corporation from 1984, most recently serving as Vice President - Human Resources. Dr. Dury received a Ph.D. from the University of Pittsburgh in Higher Education in 1979, a M.Ed. from Towson University and B.S. from Pennsylvania State University.\nFrank J. Loscavio will join the Company effective June 19, 1995 as Vice President - Construction and Remediation Services. From 1992 until May 1995, Mr. Loscavio served as Vice President of Kenetech Corporation, CNF Constructors. Mr. Loscavio served as President of Brinderson Corporation, a national general construction firm, from 1987 through 1991. Mr. Loscavio has a degree in Mechanical Engineering from the State University of New York.\nWilfrid D. Nelson is Vice President - General Counsel and Secretary. He joined the Company in October 1993 as General Counsel and Secretary. Prior to joining the Company, he served as Vice President and General Counsel\/Risk Manager of American NuKem Corporation and its subsidiary ENSR Corporation from April 1988 to October 1993 and as an Assistant General Counsel of Brown & Root, Inc. from 1976 to 1988. Mr. Nelson, a member of the Texas Bar, holds an undergraduate degree in Commerce\/Accounting from Kansas State University and is a graduate of the University of Texas School of Law.\nJohn W. Poling has served as Vice President - Treasurer and Assistant Secretary since February 1995. He joined the Company in November 1994 as Controller. Mr. Poling has held financial positions with environmental companies, including Vice President Finance and Chief Financial Officer of Envirogen, Inc. from September 1993 to October 1994, President of Tier, Inc., an environmental remediation services company, from August 1992 to September 1993, and Vice President and Chief Financial Officer of Roy F. Weston, Inc. from 1989 to 1992. Mr. Poling received a B.S. in Accounting from Rutgers University.\nDaniel M. Rice, C.P.A., joined the Company in February 1995, and serves as Vice President - Controller. From 1988 to 1995, Mr. Rice was an independent financial consultant servicing clients in several industries. Most recently he was a consultant to BCM Engineers Inc. from March 1994 until joining the Company. Mr. Rice holds a B.S. in Accounting from LaSalle University in Philadelphia and is a member of the Pennsylvania Institute of Certified Public Accountants.\nRichard A. Zartler has served as Vice President - Construction and Remediation Services since February 1995. Mr. Zartler joined the Company in January 1993 as President and Chief Executive Officer and served as President until February 1995. Mr. Zartler had been President and Chief Executive Officer of Grace Drilling Company, a subsidiary of Grace Energy Corporation, a position he held since 1988. Mr. Zartler received his B.A. degree in Engineering Science from Dartmouth College and his M.B.A. from Harvard Business School. Mr. Zartler has elected to retire as of June 9, 1995.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation with respect to executive compensation is set forth under the headings \"Director Compensation,\" \"Executive Compensation,\" and \"Compensation Committee Report on Executive Compensation,\" and under the subheading \"Compensation Committee Interlocks and Insider Participation\" in the Proxy Statement and is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation with respect to the ownership of securities of the Company by certain persons is set forth under the headings \"Principal Stockholders\" and \"Election of Directors\" in the Proxy Statement and such information is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation with respect to transactions with management and others is set forth in the Proxy Statement under the heading \"Certain Relationships and Related Transactions\" and is incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) Financial Statements and Exhibits\n(1) Consolidated Financial Statements:\nThe following financial statements are incorporated herein by this reference.\nReports of Independent Auditors........................F-1\nConsolidated Balance Sheets at February 28, 1995 and 1994..........................................F-3\nConsolidated Statements of Operations for each of the Three Years Ended February 28, 1995....................F-5\nConsolidated Statements of Common Stockholders' Equity for each of the Three Years Ended February 28, 1995....F-6\nConsolidated Statements of Cash Flows for each of the Three Years Ended February 28, 1995....................F-7\nNotes to Consolidated Financial Statements.............F-8\n(2) Financial Statement Schedule for the Three Years Ended February 28, 1995\nII - Valuation and Qualifying Accounts.................F-22\nOther schedules are omitted because of the absence of conditions under which they are required or because the required information is included in the consolidated financial statements or notes thereto.\nEXHIBIT INDEX\n(3) 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.\nSMITH ENVIRONMENTAL SERVICES CORP. (Registrant)\nBy: \/s\/ William T. Campbell ---------------------------- William T. Campbell Vice President - Finance\nMay 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 indicated on the 30th day of May 1995.\nSignature Title --------- -----\n\/s\/ E. Brian Smith* Chief Executive Officer, President and ------------------------- Director (Principal Executive Officer) E. Brian Smith\n\/s\/ William T. Campbell Vice President - Finance ------------------------- (Principal Financial Officer) William T. Campbell\n\/s\/ Daniel M. Rice Vice President - Controller ------------------------- (Principal Accounting Officer) Daniel M. Rice\n\/s\/ Melvin Chiogioji* Director ------------------------- Melvin Chiogioji\n\/s\/ Robert L. Guyett* Director ------------------------- Robert L. Guyett\n\/s\/ John Paul Jones, Jr.* Director ------------------------- John Paul Jones, Jr.\n\/s\/ Byron Lee, Jr.* Director ------------------------- Byron Lee, Jr.\n\/s\/ Hugh G. Robinson* Director ------------------------- Hugh G. Robinson\n\/s\/ Arthur A. Riedel* Director ------------------------- Arthur A. Riedel\n\/s\/ Richard M. Cashin* Director ------------------------- Richard M. Cashin\n* By \/s\/ Wilfrid D. Nelson\nWilfrid D. Nelson, pursuant to Powers of Attorney filed herewith\nREPORTS OF INDEPENDENT AUDITORS\nBoard of Directors and Stockholders Smith Environmental Technologies Corporation\nWe have audited the accompanying consolidated balance sheets of Smith Environmental Technologies Corporation (formerly Canonie Environmental Services Corp.) as of February 28, 1995 and 1994 and the related consolidated statements of operations, common stockholders' equity, and cash flows for the years then ended. Our audit also included the financial statement schedule listed in the Index at Item 14(a) for the years ended February 28, 1995 and 1994. These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. The financial statements of SoilTech ATP Systems, Inc. (a corporation in which the Company has a 50% interest) have been audited by other auditors whose report has been furnished to us; insofar as our opinion on the consolidated financial statements relates to data included for SoilTech ATP Systems, Inc., it is based solely on their report.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Smith Environmental Technologies Corporation as of February 28, 1995 and 1994, 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.\nDallas, Texas ERNST & YOUNG LLP May 10, 1995\nREPORTS OF INDEPENDENT AUDITORS\nBoard of Directors and Stockholders Smith Environmental Technologies Corporation\nWe have audited the accompanying consolidated statements of operations, common stockholders' equity, and cash flows of Smith Environmental Technologies Corporation (formerly Canonie Environmental Services Corp.) for the year ended February 28, 1993. Our audit also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements 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 to material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the results of operations and cash flows of Smith Environmental Technologies Corporation for the year ended February 28, 1993, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.\nKalamazoo, Michigan BDO Seidman April 16, 1993 Certified Public Accountants\nTo the Stockholders of SoilTech ATP Systems, Inc. King of Prussia, Pennsylvania\nWe have audited the balance sheets of SoilTech ATP Systems, Inc. as of December 31, 1994 and 1993, and the related statements of operations and deficit and cash flows for the years then ended (not included herein). These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of SoilTech ATP Systems, Inc. at 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.\nKalamazoo, Michigan BDO Seidman January 24, 1995 Certified Public Accountants\nSMITH ENVIRONMENTAL TECHNOLOGIES CORPORATION (FORMERLY CANONIE ENVIRONMENTAL SERVICES CORP.) CONSOLIDATED BALANCE SHEETS (In thousands)\nSMITH ENVIRONMENTAL TECHNOLOGIES CORPORATION (FORMERLY CANONIE ENVIRONMENTAL SERVICES CORP.) CONSOLIDATED BALANCE SHEETS (CONTINUED) (In thousands)\nSee accompanying notes to consolidated financial statements.\nSMITH ENVIRONMENTAL TECHNOLOGIES CORPORATION (FORMERLY CANONIE ENVIRONMENTAL SERVICES CORP.) CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except share data)\nSee accompanying notes to consolidated financial statements.\nSMITH ENVIRONMENTAL TECHNOLOGIES CORPORATION (FORMERLY CANONIE ENVIRONMENTAL SERVICES CORP.) CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDERS' EQUITY (In thousands, except common share data)\nSee accompanying notes to consolidated financial statements.\nSMITH ENVIRONMENTAL TECHNOLOGIES CORPORATION (FORMERLY CANONIE ENVIRONMENTAL SERVICES CORP.) CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)\nSee accompanying notes to consolidated financial statements.\nSMITH ENVIRONMENTAL TECHNOLOGIES CORPORATION (FORMERLY CANONIE ENVIRONMENTAL SERVICES CORP.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1 - BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBUSINESS\nSmith Environmental Technologies Corporation (formerly Canonie Environmental Services Corp.), a Delaware corporation (the Company), provides a broad range of comprehensive environmental consulting, engineering, and on-site remediation services for clients, including federal, state and municipal government agencies, with properties contaminated with hazardous materials throughout the United States. During the year ended February 28, 1995, the Company completed three acquisitions which significantly increased its services, core competencies and geographic coverage. See Note 2 for description of acquisitions.\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the accounts of the Company and its subsidiaries. All material intercompany accounts and transactions are eliminated. The Company uses the equity method of accounting for incorporated joint ventures and affiliated companies where ownership ranges from 20 percent to 50 percent.\nCertain amounts in prior years have been reclassified to conform with the fiscal 1995 presentation. Certain costs related to regional operations have been reclassified from selling, general and administrative expenses to cost of revenues. The costs reclassified for fiscal 1994 and fiscal 1993 were $6.5 million and $7.9 million, respectively.\nREVENUE AND COST RECOGNITION\nRevenues from engineering and remediation service contracts are generally recognized as the services are provided, principally under cost-plus-fee and time and materials contracts. The Company recognizes revenues on fixed price, long-term contracts on the percentage-of-completion method, primarily based on contract costs incurred to date compared with total estimated contract costs. Where appropriate, contracts are segmented between engineering and construction efforts and, accordingly, gross margin related to each activity is recognized as those separate services are rendered. Contract costs include all direct material, labor, and subcontract costs and other direct costs related to contract performance. Indirect costs, classified as cost of revenues, and selling, general, and administrative costs are charged to expense as incurred. Changes to total estimated contract costs and losses, if any, are recognized in the period they are determined. Revenues recognized in excess of amounts billed are classified under current assets as costs and estimated earnings on long-term contracts in excess of billings. It is anticipated that the incurred costs associated with contract work in progress at February 28, 1995, will be billed and collected in fiscal 1996. Amounts received from clients in excess of revenues recognized to date are classified under current liabilities as billings on long-term contracts in excess of costs and estimated earnings. An amount equal to contract costs attributable to claims, if any, is included in revenues when realization is probable and the amount can be reasonably estimated.\nPROPERTY, EQUIPMENT, AND DEPRECIATION\nProperty and equipment are stated at cost. Depreciation is provided primarily on the straight-line method except for process equipment which is depreciated based on units of production and cost recovery methods. Depreciation is based on the following estimated useful lives:\n- --------------------------------------------------------------------------------\nBuilding and improvements 33-35 years Leasehold improvements 3-10 years Office, process and field equipment 3-7 years\n- --------------------------------------------------------------------------------\nINCOME TAXES\nThe Company utilizes a liability approach to financial accounting and reporting for income taxes. This method 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.\nACCRETION ON REDEEMABLE PREFERRED STOCK\nThe Company's Redeemable Preferred Stock was recorded at its estimated fair value at the date of issuance. The $932,000 excess redemption value of the Redeemable Preferred Stock over its carrying value is being accreted using the interest method so that the carrying value will equal the redemption value on the scheduled redemption dates. The accretion to redemption value on the Redeemable Preferred Stock aggregated $55,000 for fiscal 1995.\nINCOME (LOSS) APPLICABLE TO COMMON STOCK\nIncome (loss) applicable to common stock represents the portion of the Company's earnings applicable to its common stockholders. Such amount is calculated by adjusting net income (loss) for the accretion and dividend requirements on the Company's Redeemable Preferred Stock in the amount of $218,000 for fiscal 1995.\nEARNINGS PER SHARE\nEarnings per share are computed on the basis of the weighted average number of common and common equivalent shares outstanding (5,865,782 in fiscal 1995 and 5,700,783 in fiscal 1994 and 1993). The dilutive effect of the Company's stock options was calculated using the treasury stock method in fiscal 1995. The effect of the Company's stock options was excluded from the calculation of earnings per share in fiscal 1994 and 1993 due to their anti-dilutive impact. Other potentially dilutive securities at February 28, 1995 consist of the Company's Convertible Senior Subordinated Note (see Note 8). Conversion of the Convertible Senior Subordinated Note for fiscal 1995 was not considered since assumed conversion did not result in significant dilution.\nAMORTIZATION OF COST IN EXCESS OF NET ASSETS OF BUSINESSES ACQUIRED\nThe excess of cost over fair value of net assets of businesses acquired (goodwill) is amortized on a straight-line basis over a period not exceeding thirty years. The Company periodically reviews goodwill to assess recoverability. Impairments will be recognized in operating results if a permanent diminution in value were to occur. Amortization recorded for fiscal 1995 was $310,000.\nSTATEMENT OF CASH FLOWS\nSupplemental cash flow information for fiscal years 1995, 1994 and 1993, is summarized as follows (in thousands):\nNOTE 2 - ACQUISITIONS\nOn September 28, 1994, the Company purchased all of the outstanding common stock of BCM Engineers Inc. (BCM), an environmental consulting and engineering company, for cash of $5.0 million and 78,000 shares of Redeemable Preferred Stock with an estimated fair value of $6.9 million on the date of issuance and a redemption value of $7.8 million. The Redeemable Preferred Stock has a 5 percent cumulative dividend requirement and is redeemable in equal installments on the fifth, sixth and seventh anniversaries of its issuance (see Note 12). The Company also repaid $9.5 million of indebtedness of BCM from the proceeds under its Loan Agreement.\nOn November 21, 1994, the Company purchased all of the capital stock of Riedel Environmental Services, Inc. (RES), an Oregon corporation, from Riedel Environmental Technologies, Inc.. RES is an environmental remediation firm. The purchase price, paid in cash, was approximately $19 million, subject to certain adjustments as determined by a final audit of the acquired assets. The RES acquisition was funded by the Company's issuance of a $10 million Convertible Senior Subordinated Note and a $2 million Senior Note (see Note 8) and borrowings under the Company's revolving and term credit facilities.\nOn December 30, 1994, the Company entered into a definitive agreement with RESNA Industries, Inc. (RESNA) to acquire substantially all of RESNA's assets in exchange for the assumption by the Company of RESNA's debt to its principal bank lender of $1.5 million, of which $1.1 million was paid at closing with proceeds from the Company's revolving credit facility. The Company also assumed certain other liabilities in connection with the operations of RESNA. RESNA, based in California, operates a full service environmental remediation business which focuses primarily on the soil and groundwater contamination market and cleanups related to underground storage tanks.\nThe transactions were accounted for as purchases; accordingly, the purchase prices have been allocated to assets and liabilities based on estimated fair values as of the acquisition dates and the results of operations of the acquired companies have been included in the Company's statement of operations for fiscal 1995 since their respective acquisitions dates. The cost in excess of the estimated fair value of the net assets acquired was recorded as goodwill in the amount of $28.8 million ($14.7 million relating to BCM, $12.6 million relating to RES, and $1.5 million relating to RESNA) and is being amortized on a straight-line basis over a period of 30 years.\nThe following pro forma combined revenues, net loss and loss per share data which summarize the results of operations for the year ended February 28, 1995 and 1994 as if BCM, RES and RESNA had been acquired as of the beginning of fiscal 1994.\nThe unaudited pro forma combined financial information is based on historical information and does not necessarily reflect the results of operations which would have occurred had such transactions been consummated at the beginning of fiscal 1994 or the Company's results of operations for any future period. Further, no effect has been given in the pro forma information for consolidation cost savings and other synergistic benefits expected to be realized subsequent to the consummation of the acquisitions.\nThe above pro forma data include adjustments to eliminate inter-company revenues and cost of revenues, adjust interest expense in connection with additional borrowings, eliminate ESOP expenses related to BCM, eliminate revenues and operating results in connection with the BCM laboratory which is held for sale, adjust depreciation, recognize preferred stock dividend requirements, and record the amortization of cost in excess of net assets acquired.\nNOTE 3 - ACCOUNTS RECEIVABLE\nAccounts receivable at February 28, 1995 and 1994 are comprised of the following (in thousands):\nUnbilled recoverable costs and estimated earnings represents revenue earned and recognized on contracts which are not yet billable according to contract terms, which usually consider the passage of time, achievement of certain milestones, or the completion of the project. Retention of $4.2 million is expected to be substantially collected during fiscal 1996.\nDue to the nature of the services provided by the Company, it may derive revenue from a single customer which exceeds 10% of its revenues for the year. During fiscal 1995, the Company had two customers with revenues of $12.2 million and $12.1 million. For fiscal 1994, the Company had two customers, who were different from the customers in fiscal 1995, with revenues of $9.9 million and $6.6 million.\nThe Company, as a result of the acquisition of RES, had revenues for fiscal 1995 derived from the United States Environmental Protection Agency (EPA) for Emergency Response Cleanup Services (ERCS). Under the ERCS contracts, the Company is the prime contractor for scheduled and emergency removal of hazardous substances. The Company derived approximately $6.6 million of revenue from the EPA during the quarter ended February 28, 1995.\nPrior to the acquisition of RES by the Company, the EPA Office of Inspector General for Audits (OIG) performed a review of the financial condition of RES in order to render an opinion on its financial capability to perform on EPA and other federal government contracts. The review included an evaluation of RES' existing and future financial capabilities to continue its operations and financial restructuring process and its relationship with its bank. The OIG submitted its reports in May 1994. The report recommended that the EPA require RES to submit periodic reports relating to its financial condition as well as to provide updates on the RES' financial restructuring process. Management believes that, as a result of the acquisition by the Company, there will not be any material changes in RES' contractual relationship with the federal government.\nNOTE 4 - LONG-TERM CONTRACTS AND RECEIVABLES\nLong-term contracts in process accounted for using the percentage-of- completion method are as follows (in thousands):\nThe long-term construction contracts are shown in the accompanying balance sheets as follows (in thousands):\nNOTE 5 - CONSOLIDATED SUBSIDIARY AND UNCONSOLIDATED AFFILIATE COMPANIES\nThe Company owns a 100% interest in Canonie Technologies, Inc. (CT). CT owns a 50% interest in SoilTech ATP Systems, Inc. (STI).\nSTI is a corporate joint venture that was formed to use sublicense rights and the related waste material processing equipment for remediation of contaminated sites. STI has the sole U.S. license until June 2012 of a pyrolysis technology developed by a Canadian quasi governmental agency. Under the equity method of accounting for this unconsolidated affiliate, the Company's investment in STI has been adjusted by the Company's proportionate share of the earnings and losses incurred by STI over the years. STI's accumulated stockholders' deficit at December 31, 1994 is $3.3 million. The Company's investment and advances to STI, which is classified in other assets on the accompanying balance sheets, on February 28, 1995 was $1.8 million compared with $2.5 million at February 28, 1994. The Company's management continues to believe its investment of $1.8 million at February 28, 1995, will be realized through STI's future undiscounted cash flows. The Company's balance sheet includes $1.1 million in subcontracts payable with respect to STI at February 28, 1995.\nIn addition, the Company owns a 20% interest in LaPosta Recycling Center, Inc. (LRC). LRC was formed to develop a full service hazardous waste treatment facility and recycling center. The Company wrote off its investment in and advances to LRC in fiscal 1994 and has no further financial commitment to LRC.\nA summary of the unconsolidated affiliates' combined financial position and results of operations (STI and LRC fiscal 1993 and STI in fiscal 1994 and 1995) is as follows (in thousands):\nThe Company derived revenues from engineering services performed for various affiliated companies, primarily STI in fiscal 1995 and 1994 and a former significant shareholder in 1993. In addition, the Company's cost of revenues include costs associated with services provided by affiliated companies, primarily STI, as subcontractors on its remediation contracts. These transactions with affiliates are summarized as follows (in thousands):\nNOTE 6 - OTHER ASSETS\nOther assets at February 28, 1995 and 1994 include a trade note receivable with a $1.5 million carrying value which accrues interest at 1 percent below the prime rate, is secured by real estate, and is due May 2002. Repayment terms are accelerated upon a transfer or a modified utilization of the real estate or abandonment of efforts to obtain waste permits. The real estate, located in Santa Barbara County, California, includes a former toxic waste site. Based on an independent appraisal, management adjusted the carrying value of the note in fiscal 1993 from $4.1 million to $1.5 million to reflect the fair market value of the real estate securing the note.\nIncluded in other assets at February 28, 1995 are $1.4 million of loan closing fees, which are net of $201,000 of accumulated amortization, related to the loans obtained in connections with the acquisition of BCM and RES. The original amount of loan fees of $1.6 million are being amortized over 36 months, the term of the loan agreements.\nNOTE 7 - DEBT\nLong-term debt consists of the following (in thousands):\nAt February 28, 1995, the Company's Loan and Security Agreement (the Agreement) with LaSalle Business Credit, Inc. (Lender), consists of a $25.5 million revolving credit facility and a $4.5 million term loan facility. The Company may issue up to $3.0 million for letters of credit under the Agreement which reduces availability under the revolving credit facility. The Company can choose an interest rate equal to 1.50 percent over the prime rate or 3.25 percent over the London Interbank Offered Rate (LIBOR) on revolving credit borrowings and 1.75 percent over the prime rate or 3.5 percent over LIBOR on term loan borrowings. At February 28, 1995, $10.0 million of the revolving credit facility and $3.5 million of the term loan facility was bearing interest based on LIBOR at 9.438 percent and 9.688 percent, respectively. Interest rates on the remaining amounts due under the revolving and term loan facilities were 10.50 percent and 10.75 percent, respectively, and were based on the prime rate. Outstanding letters of credit issued pursuant to the Agreement aggregated $450,000 at February 28, 1995. The Agreement provides for various covenants including requirements as to the Company's net income, tangible net worth, interest coverage, current ratio, and debt service coverage ratio. Additionally, the Agreement provides for limitations on business combinations, capital expenditures and dividends on common stock. LaSalle Business Credit, Inc. acts as agent for other Lenders participating in the amended credit facility. The initial term of the credit facility is three years and expires on September 28, 1997, unless extended by the Company and the Lender. If the Company elects to terminate the Agreement during the initial term, it will be subject to prepayment fees of the entire credit facility of 2.50 percent during the first year of the Agreement; 1.25 percent during the second year of the agreement; and 0.50 percent during the third year of the Agreement. No prepayment fees will be imposed if the Agreement is terminated during any renewal term.\nBorrowings pursuant to the Agreement are secured by substantially all of the assets of the Company and its subsidiaries. Under the revolving credit facility, the Company may borrow up to 80% of eligible billed accounts receivable, as defined by the Agreement. The amount of availability fluctuates based on the timing of customer invoicing and eligible accounts receivable. The unused credit facility at February 28, 1995 was $3.0 million. The term loans are based on eligible property and equipment at the time of the loans and are being amortized and paid over 60 months, but are due on September 27, 1997 if the revolving credit facility is not renewed by the Company and the Lender.\nMaturities of long-term debt for years ending February 28, are as follows (in thousands):\nOn May 5, 1995, the Company and Lender amended its Agreement to increase the eligible borrowing base by an amount up to $4 million with the creation of an \"Unbilled Account Subline\" whereby unbilled receivables, previously excluded from the borrowing base calculation, are now included, subject to limitations, in the calculation of the borrowing base. Advances relating to the Unbilled Account Subline may not exceed 50 percent of eligible unbilled accounts receivable. Availability under the Unbilled Account Subline is automatically and permanently reduced in monthly increments of $500,000 commencing on August 1, 1995 and reduces to zero upon the Company's receipt of at least $10 million through the sale and issuance of its equity securities. The interest rate charged under the amended revolving credit facility has been increased by three-quarters of a percent (3\/4%) until all amounts under the Unbilled Account Subline, and interest accrued thereon, have been paid and\/or the occurrence of an increase of equity described above. If the Company does not obtain $10 million of equity by November 1, 1995, the Company will be required to pay a monthly fee of $20,000 until such equity is obtained. In order to facilitate the additional borrowings, E. Brian Smith, Chairman, President and Chief Executive Officer of the Company agreed to pledge 800,000 shares of Company Common Stock contemporaneously with the transaction. Pending the pledge of such stock, Mr. Smith has personally guaranteed repayment of amounts advanced to the Company under the Agreement, as amended, up to $4 million. The personal guarantee will terminate upon the pledge of 800,000 shares of Company Common Stock and the passage of a period of 91 days following such pledge; the repayment of all amounts advanced under the Unbilled Account Subline and the termination of the subline; or a $10.0 million increase in equity.\nNOTE 8 - CONVERTIBLE SUBORDINATED NOTE\nOn November 15, 1994, the Company entered into an Amended and Restated Note Purchase Agreement with 399 Venture Partners, Inc. (the Investor), an affiliate of Citicorp Venture Capital, Ltd., in connection with the purchase of RES, pursuant to which the Company issued, and the Investor purchased, $10 million aggregate principal amount of a Convertible Senior Subordinated Note (the Convertible Senior Subordinated Note) and $2 million aggregate principal amount of a Senior Note (the Senior Note and collectively with the Convertible Senior Subordinated Note, the Notes). The Notes mature on November 21, 2004. Interest on the Convertible Senior Subordinated Note is payable semi-annually at 10 percent per annum. Interest on the Senior Note accrues at a rate per annum equal to the higher of 10 percent or the prime interest rate plus 1.75 percent. In the event that the Senior Note is not repaid in full with interest on or before October 21, 1995, interest will accrue thereunder and the Company thereafter will pay, on a semi-annual basis, interest in cash in respect of a restated principal amount equal to the then outstanding principal amount plus the amount of accrued but unpaid interest under the Senior Note through October 21, 1995. The Convertible Senior Subordinated Note is convertible by the holder at any time prior to maturity into approximately 305,000 shares of Junior Convertible Preferred Stock, par value $.01 per share, (the Junior Convertible Preferred Stock), and the Junior Convertible Preferred Stock is in turn convertible to Common Stock, par value $.01 per share, of the Company. Subject to certain adjustments for future below market stock issuances and similar events, the Convertible Senior Subordinated Note, if fully converted for Common Stock, would be convertible into approximately 3.05 million shares of Common Stock. If not paid by October 21, 1995, the Senior Note, including accrued and unpaid interest, is convertible by the holder at any time subsequent to October 21, 1995, on the same basis as the Convertible Senior Subordinated Note. Subject to certain adjustments for future below market issuances, stock splits and similar events, the Senior Note, if fully converted, including accrued and unpaid interest, would be convertible into approximately 665,000 shares of Common Stock. The Company has reserved 3,715,000 shares of Common Stock for issuance in the event of conversion of the Junior Convertible Preferred Stock.\nThe holder of the Convertible Senior Subordinated Note and the Senior Note is not entitled to voting rights as stockholders of the Company. Upon conversion of the Notes to Junior Convertible Preferred Stock, the holder is entitled to participate with Common Stock, on an as-if converted basis, with respect to dividends, certain voting rights and, upon liquidation, dissolution and winding up of the Company; provided, however, that, except as required by law and as to matters which the Junior Convertible Preferred Stock is entitled to vote separately as a class, the total voting power of the Junior Convertible Preferred Stock will not represent more than 19.9 percent of the total voting power of the then outstanding Common Stock and Junior Convertible Preferred Stock, taken together.\nThe Company has the right to prepay the Convertible Senior Subordinated Note, subject to certain rights of the Company's Lenders pursuant to the Loan and Security Agreement discussed in Note 7, and prepay the Senior Note. However, with respect to the Convertible Senior Subordinated Note, if prepayment occurs prior to November 21, 1999, and prior to the later of a two year period ending November 21, 1996 or the \"Positive Development Trading Date\", which date occurs after the Common Stock of the Company has traded above $7.00 per share for ninety consecutive days, and, with respect to the Senior Note, after October 21, 1995, the Holder is entitled to a prepayment premium of up to 5 percent which reduces over time. Additionally, the Holder of the Note retains an exercise right, in the event prepayment occurs prior to the later of November 21, 1996 and the \"Positive Development Trading Date\", to purchase shares of Junior Convertible Preferred Stock, at the same terms as were provided in the Notes, within a one year exercise period. The Company was required by the National Association of Securities Dealers, Inc. to obtain the written indication of support from the holders of a majority of its Common Stock for the issuance of the Notes containing the terms of conversion and to submit the matter to the stockholders for approval at the next annual meeting.\nNOTE 9 - LEASES\nThe Company leases office space and various equipment under non-cancelable leases expiring through 2000.\nTotal lease expense charged to operations was approximately $7.1 million in fiscal 1995, $3.6 million in fiscal 1994 and $4.9 million in fiscal 1993 and includes rentals under short-term cancelable leases.\nAs of February 28, 1995, future minimum rental payments required under operating leases that have initial or remaining non-cancelable terms in excess of one year are as follows (in thousands):\nNOTE 10 - INCOME TAXES\nProvisions (benefits) for federal and state income taxes are comprised of the following components (in thousands):\nSignificant components of the Company's deferred tax assets and liabilities as of February 28, 1995 and 1994 are as follows (in thousands):\nThe Company had net operating loss and net capital loss carryforwards for federal income tax purposes of approximately $4.5 million and $3.3 million, respectively, at February 28, 1995. If unused, the net operating loss will expire beginning in fiscal 2008. The capital loss carryforward, if unused, will expire beginning in fiscal 1999. For financial reporting purposes, a valuation allowance has been recorded to reduce the deferred tax asset related to these carryforwards and other deferred tax assets, including approximately $1.3 million of deferred tax assets related to companies acquired in fiscal 1995, net of deferred tax liabilities, to zero since the realization of such amounts is not assured. Future tax benefits from the carryforwards will reduce income tax expense when realized. Future tax benefits associated with the unrecognized net deferred tax asset of the companies acquired in fiscal 1995 will reduce goodwill when realized. Due to a greater than 50% change in ownership of the Company within the past three fiscal years, use of the carryforwards to reduce future taxable income will be limited to approximately $900,000 annually.\nA reconciliation of income taxes (benefit) to amounts computed using federal statutory rates are shown below (in thousands):\nNOTE 11 - EMPLOYEE BENEFIT PLAN\nThe Company has a defined contribution plan covering substantially all employees. Under the plan, employees may make tax deferred voluntary contributions which, at the discretion of the Company's Board of Directors, are matched within certain limits by the Company. In addition, the Company may make additional discretionary contributions to the plan as profit sharing contributions. All contributions to the plan are limited by applicable Internal Revenue Code regulations. For fiscal 1995, the Company accrued matching contributions of $161,000. There were no Company contributions for fiscal 1994 and 1993.\nNOTE 12 - REDEEMABLE PREFERRED STOCK\nIn connection with the acquisition of BCM, the Company authorized and issued 78,000 shares of Redeemable Preferred Stock (the Redeemable Preferred Stock). Each share has a $100 redemption value, is senior to the Company's Common Stock and has a liquidation preference of $100 per share plus accrued and unpaid dividends. The Redeemable Preferred Stock was recorded at its initial fair value of $6,868,000 on the date of issuance. The excess of the redemption value over the carrying value is being accreted to redemption value by periodic charges to retained earnings using the interest method and an effective annual rate of return of 7.50 percent. The Redeemable Preferred Stock has a 5.0 percent per annum cumulative dividend payable quarterly. If the Company fails for any reason to make a scheduled quarterly dividend payment on the Redeemable Preferred Stock, the rate of the dividends shall increase from 5 percent per annum to 7.50 percent per annum per share, and if failure to pay a quarterly dividend occurs a second consecutive time, the rate of dividends shall increase to 10 percent per annum per share. When all accrued but unpaid dividends have been paid in full at the adjusted rate, the dividend rate for future dividends will return to the initial rate of 5.0 percent per annum. The Redeemable Preferred Stock shall not have any right or power to vote on any question or in any proceeding or to be represented at any meeting of the Company's stockholders. The Company at its option may redeem shares of Redeemable\nPreferred Stock, in whole or in part, at any time. The Company is required to redeem at a redemption price of $100 per share plus accrued but unpaid dividends, and to the extent such redemption payments are permitted in accordance with the covenant set forth therein, no later than each of the fifth, sixth and seventh anniversaries of the date of issuance of the shares of Redeemable Preferred Stock, not less than one-third of the total shares originally authorized and issued. In the event the Company fails to make a scheduled redemption payment, the redemption date for all remaining shares of Redeemable Preferred Stock is accelerated and the rate of dividends increases to 15% per annum.\nThe Redeemable Preferred Stock issued in connection with the acquisition of BCM is held by the BCM Employee Stock Ownership Trust (the ESOP) for the future benefit of vested participants. Effective September 28, 1994, the ESOP was amended to fully vest all participants who were employed by BCM on September 28, 1994 and to provide that no further contributions are to be made to the ESOP. The Company has entered into a Trust and Security Agreement which created a trust (the Trust) to secure payment of certain current and future obligations of the Company arising in connection with the acquisition of BCM, principally the payment of dividends on and the redemption of the Redeemable Preferred Stock. Participants become eligible for distribution of the Redeemable Preferred Stock held for their account in the ESOP upon retirement, death, disability or in the sixth year following termination of employment. The participants can put the Redeemable Preferred Stock back to the Company at the $100 redemption value in exchange for cash or cash and a subordinated note payable. Payments to a participant by the Company are limited to the greater of 20% of the redemption value of the shares of Redeemable Preferred Stock or $10,000 per year. Certain insurance policies on the lives of former and present employees of BCM, with aggregate death benefits of approximately $41 million and an aggregate cash surrender value (net of policy loans) of approximately $750,000, are held by the Trust for the benefit of the beneficiaries. The Company is obligated to contribute $100,000 each fiscal quarter to fund premium payments on the insurance policies. The Trust will terminate after all secured indebtedness has been satisfied, and any remaining assets will be returned to the Company.\nNOTE 13 - STOCK OPTION PLANS\nThe Company has various plans which provide for the grant of incentive awards to employees, advisors and non-employee directors. During fiscal 1994, the 1986 Employee Stock Option Plan and the 1992 Non-employee Directors Stock Option Plans were terminated except as to options then outstanding. The terminated plans were replaced by the 1994 Stock Incentive Plan and the 1994 Non-employee Directors Stock Option Plan (1994 Directors' Plan). A maximum of 1,200,000 and 250,000 shares of the Company's common stock are issuable in connection with awards granted under the 1994 Stock Option Incentive Plan and 1994 Directors' Plan, respectively.\nThe 1994 Stock Incentive Plan provides for the granting of incentive stock options and other stock-based awards to key employees and advisors. The exercise price of options granted under the plan is 100 percent of the fair market value of common stock on the date the option is granted. Options become exercisable as determined at the date of grant by a committee of the Board of Directors and expire ten years after the date of grant unless an earlier expiration date is set at the time of grant. At February 28, 1995, there were no shares outstanding pursuant to other stock-based awards under the plan.\nThe 1994 Directors' Plan provides for the granting of options to acquire the Company's common stock to non-employee directors. The exercise price of options granted under the plan is 100 percent of the fair market value of common stock on the date the option is granted. Options become exercisable one to three years after the grant date and expire ten years after the date of grant unless an earlier expiration date is set at the time of grant.\nThe following table summarizes activity under the Company's stock plans:\nAt February 28, 1995, 911,906 shares of the Company's Common Stock were reserved for future grant under the plans and options for 358,617 shares were exercisable.\nNOTE 14 - COMMITMENT AND CONTINGENCIES\nThe Company filed an action for breach of contract and rescission against seven potentially responsible parties (the PRP's) in the Circuit Court, Multnomah County, Oregon in February 1995. The Company is pursuing recovery for amounts due as a result of its performance of services, including $1.3 million of accounts receivable and retainage, $2.5 million of unrecovered equipment investment and other damages resulting in a total claim exceeding $6.5 million. Prior to the Company's claim, activity at the site had been suspended pending approval by EPA of changes in the remedial activities proposed by the PRP's and supported by independent engineering reports which acknowledge significant differences in the waste at the site from those conditions specified in the EPA Record of Decision and in the initial Remedial Investigation performed by others at the site. The court action has been abated pending the arbitration before the American Arbitration Association of issues initiated by the PRP's seeking reimbursement by the Company of $18.0 million paid for work performed under the contract. The Company will vigorously defend its position and intends to aggressively pursue all amounts recoverable related to the performance at this site.\nIn November 1993, second amended complaints and initial complaints were filed in the Circuit Court of the State of Mississippi, County of Jackson, which included RES along with a number of other defendants in claims pending in 27 separate civil actions. These civil actions involve approximately 219 plaintiffs and include two wrongful death claims. Plaintiffs allege that RES was negligent in transferring and clean-up activities of the chemical diethylamine, released from an overturned tanker. The Company rejects every allegation in its defense. The matter is in the discovery phase. The Company is vigorously defending the described litigation.\nThe Company is also currently a party to other litigation to its business. While such litigation, including the matters described above, could result in judgments against the Company, management believes that the outcome of the administrative complaint and other litigation described above and incidental litigation will not have material adverse effect on the future financial condition or results of operations of the Company and that adequate reserves have been established at February 28, 1995.\nNOTE 15 - SPECIAL ITEMS\nIn the second and fourth quarters of fiscal 1994, the Company recorded special items aggregating $9.3 million associated with management's focus on resolving ongoing operational issues, such as project specific claims issues, investments in non-core business activities, and new information systems, staff reductions and office closings.\nOf the $9.3 million of aggregate special items, $2.3 million was attributable to additional costs and changes in profit estimates related to construction contracts and is included in cost of revenues and $2.7 million related primarily to the write-off of the Company's equity method investment in LRC, a joint venture formed to develop an incinerator (Note 2), and is included in losses of unconsolidated affiliates. The remaining $4.3 million in charges is included in special charges. These charges, which are comprised of $1.5 million of asset write-downs and $2.8 million of incurred and anticipated cash expenditures include estimated costs related to: employee separation and office closure costs aggregating approximately $1.8 million; write-off of an investment in a non-core business no longer fitting the strategic direction of the Company of approximately $600,000; asset write-off resulting from the implementation of a new information system of approximately $440,000; write-down of process equipment determined to have impaired value of approximately $490,000; and an accrual for costs associated with litigation of approximately $1 million.\nIn the second quarter of fiscal 1993, the Company implemented a plan to \"right size\" administrative operations resulting in a special charge of $500,000, primarily for severance. In the fourth quarter of fiscal 1993, the Company recorded special items of $10.6 million. The fourth quarter special items occurred primarily from the Company's change in the pursuit of its outstanding claims on contracts and the reduction in the carrying value of a trade note receivable (see Note 6). Of the $12.1 million in aggregate adjustments, approximately $7.7 million was attributable to the write-off of claims previously recognized as revenues. The remaining $4.4 million is included in special charges and includes a $2.6 million charge to reduce the carrying value of a trade note receivable, a $1.6 million charge for severance, office consolidation and other reorganizational moves, and $200,000 for the loss on the sale of a subsidiary.\nSMITH ENVIRONMENTAL TECHNOLOGIES CORPORATION (FORMERLY CANONIE ENVIRONMENTAL SERVICES CORP.) SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS (IN THOUSANDS)","section_15":""}
{"filename":"922404_1995.txt","cik":"922404","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThe Company and its subsidiaries are defendants in various routine litigation incident to its business, none of which is expected to have a material adverse effect on the Company's financial position or results of operations.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nThe Company held its annual shareholder meeting on June 26, 1995. The only matter presented for a vote was the re-election of Jim J. Shoemake as a director. Mr. Shoemake was re-elected with 1,579,225 votes cast in favor and no votes cast against, withheld or abstaining. The term of office of the following directors continued after the meeting: Paul S. Lindsey, Jr., Douglas A. Brown, Kristin L. Lindsey, and Bruce M. Withers, Jr.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nAs of September 15, 1995, the Company's Common Stock was held of record by 9 shareholders. There is currently no active trading market in the Company's Common Stock.\nAs of September 15, 1995, there are outstanding warrants to purchase 175,536 shares of the Company's Common Stock.\nNo dividends on the Common Stock of the Company were paid during the Company's 1994 or 1995 fiscal years. The indenture relating to the 12 7\/8% Senior Secured Notes due 2004 and the terms of the Company's revolving credit facility each contain dividend restrictions that prohibit the Company from paying common stock cash dividends. As a result, the Company has no current intention of paying cash dividends on the Common Stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe following table presents selected consolidated operating and balance sheet data of Empire Gas as of and for each of the years in the five-year period ended June 30, 1995. The financial data of the Company as of and for each of the years in the five-year period ended June 30, 1995 were derived from the Company's audited consolidated financial statements. The financial and other data set forth below should be read in conjunction with the Company's consolidated financial statements, including the notes thereto, included with this report. Because the operating data for the period ending June 30, 1994 do not take into account the effects of the Transaction on the Company, the data for that period are not comparable to the data for the year ended June 30, 1995.\n8 of 55\n10 of 55\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nThe following discussion and analysis of the Company's results of operations, financial condition and liquidity should be read in conjunction with the historical consolidated financial statements of Empire Gas and the notes thereto included in this Report.\nResults of Operations\nGeneral\nEmpire Gas' primary source of revenue is retail propane sales, which accounted for approximately 89% of its revenue in fiscal year 1995. Other sources of revenue include sales of gas appliances and rental of customer tanks.\nThe Company's operating revenue is subject to both price and volume fluctuations. Price fluctuations are generally caused by changes in the wholesale cost of propane. The Company is not materially affected by these price fluctuations, inasmuch as it can generally recover any cost increase through a corresponding increase in retail prices. Consequently, the Company's gross profit per retail gallon is relatively stable from year to year within each customer class. Volume fluctuations from year to year are generally caused by variations in the winter weather from year to year. Because a substantial amount of the propane sold by the Company to residential and commercial customers is used for heating, the severity of the weather will affect the volume sold. Volume fluctuations do materially affect the Company's operations because lower volume produces less revenue to cover the Company's fixed costs, including any debt service costs.\nThe Company's expenses consist primarily of cost of products sold, general and administrative expenses and, to a much lesser extent, depreciation and amortization and interest expense. Purchases of propane inventory account for the vast majority of the cost of products sold. The Company's general and administrative expenses consist mainly of salaries and related employee benefits, vehicle expenses, and insurance. The Company's interest expense consists primarily of interest on its existing credit facility and the 12 7\/8% Senior Secured Notes due 2004 (the \"Senior Secured Notes\"). Interest expense increased significantly between 1994 and 1995 as a result of issuance of the Senior Secured Notes at the end of June, 1994. Through 1999 a significant portion of the increase will be non-cash interest expense.\nHistorical financial data for years ended prior to June 30, 1994 do not reflect either the transfer of Energy or the acquisition of the assets of PSNC in the Transaction and therefore historical data for those periods are not comparable to results for the periods subsequent to June 30, 1994. In general, these transactions have resulted in a net reduction in the number of gallons sold, and thus in results (including operating revenue, cost of products sold, gross profit, and provisions for doubtful accounts) that are related to the number of gallons sold. General and administrative expenses have also declined as a result of the elimination of salaries and related expenses of departing officers, the termination of certain agreements between the Company and its former principal shareholder or entities controlled by him, and the elimination of costs related to service centers that are no longer part of the Company.\n11 of 55\nFiscal Years Ended June 30, 1995 and June 30, 1994\nOperating revenue. Operating revenue decreased $49.9 million to $74.6 million in fiscal year 1995 as compared to $124.5 million in fiscal year 1994. The decrease was primarily due to the disposition of service centers in the Transaction, offset by increases due to the acquisition of service centers from PSNC in the Transaction. Operating revenue from service centers retained in the Transaction and acquired from PSNC was $74.8 million in fiscal year 1994. The decrease of $200,000, or .3%, in fiscal year 1995 was due to a $1.9 million decrease in gas sales offset by increases of $1.0 million in gas systems and appliances, $400,000 in miscellaneous income, and $300,000 in service labor. The decrease in gas sales was due to an approximately $.06 per gallon decrease in the average net sales price of propane created by competitive pressures resulting from decreased demand due to warm weather. The decrease was partially offset by a 3.9 million gallons volume increase due to the addition of retail service centers through five acquisitions and ten new startups during fiscal year 1995. The increase in miscellaneous income was due primarily to the gain on assets sold including six retail service centers. The increase in service labor is due to the increased installations from greater appliance sales and the increased service market created by the acquisitions discussed above.\nCost of products sold. Cost of products sold decreased $22.3 million to $35.6 million in fiscal year 1995 as compared to $57.9 million in fiscal year 1994, primarily as a result of the Transaction. Cost of product sold from service centers retained in the Transaction and acquired from PSNC was $35.1 million in fiscal year 1994. The increase of $500,000, or 1.4%, is the result of the 3.9 million gallon volume increase, partially offset by a $.01 reduction in the cost of propane and an increase in gas systems and appliances cost due to the volume of sales.\nGross profit. The Company's gross profit for the year decreased $27.6 million to $39.0 million in fiscal year 1995 as compared to $66.6 million in fiscal year 1994, primarily as a result of the Transaction. Gross profit from service centers retained in the Transaction and acquired from PSNC was $39.7 million in fiscal year 1994. The decrease of $700,000, or 1.8%, was caused by the .3% decrease in operating revenue and the 1.4% increase in cost of products sold. The Company's gross profit per gallon decreased from $.43 in 1994 for service centers retained in the Transaction and acquired from PSNC to $.38 in fiscal year 1995, as a result of the decrease in sales price of $.06 per gallon offset by the $.01 reduction in the cost of propane.\nGeneral and administrative expense. General and administrative expenses decreased $15.4 million to $28.6 million in fiscal year 1995 from $43.9 million in fiscal year 1994, primarily as a result of savings resulting from the reduction of personnel in connection with the Transaction. As a percentage of total revenues, general and administrative expenses increased to 38.3% in fiscal year 1995 from 35.3% in fiscal year 1994. The increase is due primarily to increases as a percent of total revenues of 2.2% in salaries and commissions, .6% in professional fees, .3% in both rent and maintenance and taxes and licenses, and .4% in office expenses. These increases were partially offset by a decrease of .5% in vehicle fuel and maintenance and .4% in insurance and liability claims. Other smaller increases were incurred in miscellaneous expenses and travel and entertainment and advertising.\n12 of 55\nThe increase in salaries and commissions was due to several factors including 1) increased retail salary expense due primarily to additional employees as a result of acquisitions and startups and increased commissions as a result of increased emphasis on new customers and tank sets and 2) increased home office salary expense as a result primarily of additional operational employees due to acquisitions and additional marketing employees as a result of the Company's emphasis on enhanced sales efforts. The increase in professional fees is due to fees related to the formation of a 401k plan, fees resulting from a state income tax audit, and fees for a supply purchase consulting agreement. The increase in rent and maintenance of buildings is primarily due to increased tank painting, building and maintenance in converting certain rental facilities to a new identity in connection with the restructuring and an increase in the rental of facilities primarily related to the six retail service centers acquired in June 1994. The increase in taxes and licenses relates primarily to property taxes paid for six retail service centers acquired in June 1994. The increase in office expenses is primarily due to additional spending required for the change of identity for several retail sites and additional mailings to customers. The decrease in insurance and liability claims is due to a reduction in liability claims expense as a result of reduced claims. The decrease in vehicle fuel and maintenance is due to the replacement of older vehicles occurring at the end of fiscal year 1994 and in early fiscal year 1995 resulting in lower maintenance expenses.\nProvision for doubtful accounts. The provision for doubtful accounts increased approximately $80,000 to a little over $1.1 million in fiscal year 1995 from a little under $1.1 million in 1994. The increase is due to the final determination of management regarding the aged balances of accounts after substantial collection efforts during fiscal year 1995 offset in part by a reduction in the level of accounts receivable as a result of the transfer of Energy.\nDepreciation and amortization. Depreciation and amortization costs decreased by $4.0 million to $6.2 million from $10.2 million primarily as a result of the reduction in assets as a result of the Transaction. Depreciation and amortization on assets retained in the Transaction or acquired from PSNC increased by $700,000, or 12.7%, from $5.5 million for the year ended June 30, 1994 due to amortization of noncompete agreements acquired with new service centers and depreciation of the related assets purchased in June 1994 and fiscal 1995.\nInterest expense. Interest expense increased by approximately $2.4 million, or 25.9%, to $10.7 million in fiscal year 1995 as compared to $8.5 million in 1994, due to the approximately $45 million face value of additional long-term debt outstanding as compared to the same period of the prior year, partially offset by an overall lower rate of interest, principally on the new senior secured notes issued in June 1994, as compared to the higher rates on debt repaid with the June 1994 offering.\nFiscal Years Ended June 30, 1994 and June 30, 1993\nOperating revenue. Operating revenue decreased $3.8 million or 3.0%, from $128.4 million in fiscal year 1993 to $124.6 million in fiscal year 1994. This decrease was the result of a $4.0 million decrease in propane sales and a $300,000 decrease in other revenue, offset by a $500,000 increase in sales of parts and gas appliances. The decrease in propane sales was caused by a 1.9% decrease in gallons sold and a 1.1% decrease in\n13 of 55\nthe average gross sales price per gallon. The decreased volume reflects the results of slightly warmer winter weather.\nCost of products sold. Cost of products sold decreased $2.3 million, or 3.8%, from $60.2 million in fiscal year 1993 to $57.9 million in fiscal year 1994. The decrease resulted from the 1.9% decrease in gallons sold, which reflects the slightly warmer winter weather, and a 3.7% decrease in the wholesale cost of propane.\nGross profit. The Company's gross profit for the year decreased $1.6 million, or 2.3%. The decrease was caused by the 3.0% decrease in operating revenue partially offset by the 3.8% decrease in cost of products sold. The Company's gross profit per gallon was relatively constant at $.430 in fiscal year 1994 and $.429 in fiscal year 1993.\nGeneral and administrative expense. General and administrative expenses increased $3.0 million, or 7.5% from $40.4 million in fiscal year 1993 to $43.5 million in fiscal year 1994. The increase was due primarily to increases of $1.0 million in insurance and liability claims, $800,000 in salaries and commissions, and $400,000 in professional fees. The increase in insurance and liability claims was due primarily to increased claims. The increase in salaries and commissions was due to annual pay increases combined with a slight decrease in the total number of employees. The increase in professional fees was due to increased litigation fees relating to liability claims and increased accounting and other fees related to the Transaction that were not capitalized. Other smaller increases were incurred in transportation, office expenses, taxes and licenses, rent and maintenance, payroll taxes and employee benefits, travel and entertainment, and advertising.\nProvision for doubtful accounts. The provision for doubtful accounts increased $100,000 from $960,000 in fiscal year 1993 to $1.1 million in fiscal year 1994. This increase was the result of a slightly older aging of accounts receivable at June 30, 1994, compared to June 30, 1993.\nDepreciation and amortization. Depreciation and amortization remained relatively constant, decreasing by $200,000, or 1.9%, from $10.4 million in fiscal year 1993 to $10.2 million in fiscal year 1994.\nInterest expense. Cash interest expense decreased by approximately $1.3 million, or 13.1%, from $9.8 million in fiscal year 1993 to $8.5 million in fiscal year 1994. This decrease was the result of lower interest rates and reduced borrowing levels as compared to the prior year. Amortization of debt discount and expense increased $300,000, or 19.6%, from $1.7 million in 1993 to $2.0 million in 1994. This increase related to increased amortization of the discounts on the Company's 1998 9% Subordinated Debentures, 2007 9% Subordinated Debentures, and 12% Senior Subordinated Debentures, as well as amortization of expenses related to the Company's credit facility.\nRecapitalization costs. During fiscal years 1994 and 1993, the Company incurred $398,000 and $223,000, respectively, in expenses relating to proposed recapitalizations that the Company later decided not to pursue.\nIncome taxes. The effective tax rate for the fiscal year\n14 of 55\nended June 30, 1994, was approximately 41.7% compared to 47.8% for the fiscal year ended June 30, 1993. The Company had a positive effective tax rate in 1994 despite its reported loss primarily because of the amortization of the excess of cost over fair value of assets sold and state income taxes imposed on operations that were profitable in individual states.\nLiquidity and Capital Resources\nThe Company's liquidity requirements have arisen primarily from funding its working capital needs, capital expenditures and debt service obligations. Historically, the Company has met these requirements from cash flows generated by operations and from borrowings under its working capital facility.\nCash flow provided from operating activities was $1.4 million in fiscal year 1995 as compared to $12.9 million in fiscal year 1994. This reduction in cash flow resulted from the $8.3 million decrease in operating income which was caused by the Transaction occurring at June 30, 1994 and the negative sales impact of warmer winter weather in fiscal 1995. In addition to the reduction in operating income, cash flow provided by operations was affected by the following factors: (i) inventories and accounts receivable decreased $700,000 in 1995 and (ii) accounts payable and accrued expenses increased by $5.0 million, primarily due to accrued interest on the senior secured notes, offset by (iii) a decrease in checks in process of collection of $1.7 million and (iv) an increase in refundable income taxes and prepaid expenses of $2.3 million. The working capital items noted above that increased cash flow by $1.7 million in 1995 contributed to an increase in cash flow of $3.8 million in 1994.\nPursuant to the indenture for the 12 7\/8% Senior Secured Notes, the Company was required to make a $4.5 million, semi-annual interest payment on July 15, 1995. (The July 15 payment was not required in 1994 because the Senior Secured Notes were not issued until shortly before that date.) The Company met this interest payment requirement and funding for its acquisition program through operating cash flows, the proceeds of previously planned sales of marginally profitable retail service centers and properties pursuant to its long-range business plan, expanding its customer advance purchase program for future retail propane deliveries and scheduling its payments for equipment purchases in the fall of 1995. After the interest payment was made the Company continued its long-range plan by divesting an additional five marginally profitable retail service centers for approximately $1.6 million.\nIn August 1995, the Company acquired a minority interest in another propane retailer, SYN, Inc. As part of this acquisition, the Company contracted to provide administrative and related services to the retail operations of SYN, Inc. in exchange for an annual management fee payment of $500,000 and overhead cost reimbursement of $3.25 million.\nThe Company's high degree of leverage makes it vulnerable to adverse changes in the weather and could limit its ability to respond to market conditions, to capitalize on business opportunities, and to meet its contractual and financial obligations. Fluctuations in interest rates will affect the Company's financial condition inasmuch as the Company's working capital facility bears interest at a floating rate. The Company believes that, based on current levels of operations and assuming winter weather that is not substantially warmer in the various regions in which it operates than 15 of 55\nthe historical average of winter temperatures for those regions, it will be able to fund its debt service obligations from funds generated from operations including the additional funds from the SYN, Inc. Management Agreement discussed above, proceeds of potential sales of service centers and funds available under its working capital facility.\nThe seasonal nature of the Company's business will require it to rely on borrowings under its $15.0 million credit facility as well as cash from operations, particularly during the summer and fall months when the Company is building its inventory in preparation for the winter heating season. While approximately two-thirds of the Company's operating revenue is earned in the second and third quarters of its fiscal year, certain expense items such as general and administrative expense are recognized on a more annualized basis. Interest expense also tends to be higher during the summer and fall months because the Company relies in part on increased borrowings on its revolving credit line to finance inventory purchases in preparation for the Company's winter heating season.\nThe Company's capital expenditures consist of routine expenditures for existing operations as well as non-recurring expenditures, purchases of assets for the start-up of new retail service centers, and acquisition costs (including costs of acquiring retail service centers). Routine expenditures usually consist of expenditures relating to the Company's bulk delivery trucks, customer tanks, and costs associated with the installation of new tanks.\nThe Company's capital expenditures in fiscal year 1995, were $11.9 million which decreased approximately $8.1 million from the preceding year. The decrease was due primarily to a decrease of $4.6 million, from $12.3 million in fiscal year 1994 to $7.7 million in fiscal year 1995, in acquisitions of retail service centers resulting from the 1994 purchases of PSNC Propane Corporation and an additional service center in Colorado compared to the 1995 purchases of four service centers and the addition of several new start-ups. The remaining decrease of $3.5 million is due primarily to the reduced size of the Company as a result of the Transaction and the large amount of new transportation equipment purchased in 1994. During fiscal year 1995, the Company raised $3.0 million from the planned sale of marginally profitable service centers, and raised an additional $4.5 million since June 30, 1995.\nThe Company intends to fund its routine capital expenditures and the purchase of assets for new retail service centers with cash from operations, borrowings under its credit facility, or other bank financing. The Company intends to fund acquisitions with seller financing, to the extent feasible, and with cash from operations or bank financing. The Company is exploring the possibility of making modifications to its underground storage facility, and has obtained from an engineering and construction company a study of the costs of rehabilitating and opening the facilities, which range from $500,000 to $3,000,000. The Company is currently exploring options for financing these modifications, and there is no assurance that such financing will be available. If the rehabilitation work is not performed and the facilities cannot be sold, then the Company would be required to close the facilities at a cost which the Company believes will not exceed $500,000.\n16 of 55\nThe Company's credit facility and the indenture for the Senior Secured Notes impose restrictions on the Company's ability to incur additional indebtedness. Such restrictions, together with the highly leveraged position of the Company, could restrict the ability of the Company to acquire financing for capital expenditures and other corporate activities. These restrictions permit additional indebtedness of $6 million for the current fiscal year for the purpose of financing acquisitions but allow additional indebtedness to be incurred by subsidiaries formed for the purpose of making acquisitions as long as the Company does not transfer over $3,000,000 (in the aggregate) of assets to such subsidiaries. The credit facility also contains tangible net worth, capital expenditures, interest coverage and debt restrictions. At June 30, 1995, the Company was not in compliance with the original capital expenditures and interest coverage ratio covenants. The bank has amended the covenants, and the company is now in compliance with the amended covenants.\nThe Company's $15.0 million credit facility will mature on or about July, 1997, at which time the Company will have to refinance or replace some portion of the facility and may be required to pay some portion of any outstanding balance. There can be no assurance that the Company will be able to refinance or replace the credit facility, or the terms upon which any such financing may occur. Beginning in fiscal year 1999, the cash interest rate on the Senior Secured Notes will increase to 12 7\/8%. The Company believes cash from operations will be sufficient to meet the increased interest payments.\nChange in Accounting Principle\nEffective July 1, 1993, the Company adopted the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS 109\"). As a result of this change, there was no material effect upon the Company's financial statements. SFAS 109 requires recognition of deferred tax liabilities and assets for the difference between the financial statement and tax basis of assets and liabilities. Under this new standard, a valuation allowance is established to reduce deferred tax assets if it is more likely than not that a deferred tax asset will not be realized. Prior to fiscal year 1994, deferred taxes were determined using the Statement of Financial Accounting Standards No. 96.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nSee the Consolidated Financial Statements included elsewhere herein.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNone.\n17 of 55\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nThe directors and executive officers of the Company are as follows:\nName Age Position Held with the Company ____ ___ ______________________________ and Principal Occupation ________________________\nPaul S. Lindsey, Jr. 50 Chairman of the Board, Chief Executive Officer, and President since June 1994; previously Vice Chairman of the Board (since February 1987) and Chief Operating Officer (since March 1988); term as director expires 1997\nDouglas A. Brown 35 Director since July 1994; member Holding Capital Group, Inc. (since 1989); term as director expires 1997\nKristin L. Lindsey 47 Director\/Vice President since June 1994; previously pursued charitable and other personal interests; term as director expires 1996\nBruce M. Withers, Jr. 68 Director since July 1994; Chairman and Chief Executive Officer of Trident NGL Holding, Inc. (since August 1991) and President of the Transmission and Processing Division of Mitchell Energy Corporation (1979 to 1991); term as director expires 1996\nJim J. Shoemake 57 Director since July 1994; partner of Guilfoil, Petzall & Shoemake (since 1970); term as director expires 1998\nValeria Schall 41 Vice President since 1992; Corporate Secretary since 1985 and Assistant to the Chairman (Assistant to the Vice Chairman prior to June 1994) since 1987\nMark Castaneda 31 Vice President Finance and Administration since August 1995; previously Controller of Skelgas Propane since 1991 and an accountant at Deloitte & Touche since 1986.\nWillis D. Green 58 Controller since 1989\nAfter expiration of the initial terms of directors as set forth above, each director will serve for a term of three years. Officers of the Company are elected by the Board of Directors of the Company and will 18 of 55\nserve at the discretion of the Board, except for Mr. Lindsey who is employed pursuant to an employment agreement that expires June 24, 1999 (subject to extension).\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nExecutive Compensation\nThe following table provides compensation information for each of the years ended June 30, 1995, 1994, and 1993 for (i) the Chief Executive Officer of the Company, (ii) the four other executive officers of the Company who are most highly compensated and whose total compensation exceeded $100,000 for the most recent fiscal year (of which there were none) and (iii) those persons who are no longer executive officers of the Company but were among the four most highly compensated and whose total compensation exceeded $100,000 for the most recent year (of which there were none).\nEmployment Agreements\nOn June 24, 1994, the Company entered into an employment agreement with Mr. Lindsey. The agreement has a five-year term and provides for the payment of an annual salary of $350,000 and reimbursement for reasonable travel and business expenses. The agreement requires Mr. Lindsey to devote substantially all of his time to the Company's business. The agreement is for a term of five years, but is automatically renewed for one year unless either party elects to terminate the agreement at least four 19 of 55\nmonths prior to the end of the term or any extension. The agreement may be terminated by Mr. Lindsey or the Company, but if the agreement is terminated by the Company and without cause, the Company must pay one year's salary as severance pay.\nIncentive Stock Option Plan\nThere were no options granted to the named officer nor exercised by him during fiscal year 1995 and no unexercised options held by him as of the end of the 1995 fiscal year.\nCompensation Committee Interlocks and Insider Participation\nA compensation committee was formed in July 1994, consisting of Messrs. Withers, Shoemake and Brown. Mr. Lindsey makes the initial recommendation concerning executive compensation for the executive officers of the Company, other than recommendations concerning his own and his wife's compensation, which are then approved by the compensation committee. The compensation committee determines the compensation of Mr. Lindsey's wife and, subject to the employment agreement described above, Mr. Lindsey.\nDirector Compensation\nDuring the last completed fiscal year, the directors of Empire Gas received an annual fee of $25,000, payable quarterly, for their services. In addition, directors other than Mr. Lindsey and Kristin L. Lindsey received options pursuant to the Company's stock option plan, with Mr. Brown receiving options for 122,830 shares and Messrs. Shoemake and Withers each receiving options for 17,548 shares. Each of the options is exercisable at a price of $7.00 per share, and the options are exercisable until January 23, 2005.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe table below sets forth information with respect to the beneficial ownership of shares of Common Stock of the Company as of September 15, 1995, by persons owning more than five percent of any class, by all directors of the Company, by the individuals named in the Summary Compensation Table owning shares, and by all directors and executive officers of the Company as a group.\nNumber of Shares Name of Beneficial Owner Beneficially Owned Percent ____________________________ __________________ _______ Paul S. Lindsey, Jr. 1,507,610 95.5% Kristin L. Lindsey 753,805 47.7 Douglas A. Brown 122,830 7.2 Bruce M. Withers, Jr. 17,548 1.1 Jim J. Shoemake 17,548 1.1 All directors and executive officers as a group (8 persons) 1,689,939 97.3\n20 of 55\n_________________\n[FN]\nThe address of each of the beneficial owners is c\/o Empire Gas Corporation, P. O. Box 303, 1700 South Jefferson Street, Lebanon, Missouri 65536.\nMr. Lindsey's shares consist of 753,805 shares owned by the Paul S. Lindsey, Jr. Trust established January 24, 1992 and 753,805 shares owned by the Kristin L. Lindsey Trust established January 24, 1992. Mr. Lindsey has the power to vote and to dispose of the shares held in the Kristin L. Lindsey Trust. Mrs. Lindsey's shares consist of the shares owned by the Kristin L. Lindsey Trust. Mrs. Lindsey disclaims ownership of the shares held by her husband in the Paul S. Lindsey, Jr. Trust.\nThe amounts shown include the shares beneficially owned by Mr. Lindsey and Acreman, and Mrs. Lindsey as set forth above, and 30,132 shares owned by other executive officers.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nMrs. Kristin L. Lindsey, who beneficially owns approximately 47.7% of the Company's outstanding Common Stock and became a director of the Company upon consummation of the Transaction, is the majority stockholder in a company that supplies paint to the Company. The Company's purchases of paint from this company totalled $157,842 in Fiscal year 1995 and $210,400 in fiscal year 1994.\nThe Company has entered into an agreement with each shareholder (all of whom are directors or employees of the Company) providing the Company with a right of first refusal with respect to the sale of any shares by such shareholders. In addition, the Company has the right to purchase from such shareholders all shares they hold at the time of their termination of employment with the Company at the then current fair market value of the shares. The fair market value is determined in the first instance by the Board of Directors and by an independent appraisal (the cost of which is split between the Company and the departing shareholder) if the departing shareholder disputes the board's determination.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.\n(a)(i) Financial Statements\nReport of Independent Accountants Consolidated Balance Sheets as of June 30, 1995 and 1994 Consolidated Statement of Operations for the Years Ended June 30, 1995, 1994 and 1993 Consolidated Statements of Stockholders' Equity (Deficit) for the Years Ended June 30, 1995, 1994 and 1993 Consolidated Statements of Cash Flows for the Years Ended June 30, 1995, 1994 and 1993\n21 of 55\n(a)(2) Financial Statement Schedules\nSchedule II Valuation and qualifying accounts\n(a)(3) Exhibits\nExhibit No. Description ___ ___________\n3.1 Articles of Incorporation of the Company (incorporated herein by reference to Exhibit 3.1 to the Company's Registration Statement on Form S-1 (No. 33-53343))\n3.2 Certificate of Amendment of the Certificate of Incorporation of the Company, dated April 26, 1994, relating to the change of name (incorporated herein by reference to Exhibit 3.2 to the Company's Registration Statement on Form S-1 (No. 33- 53343))\n3.3 By-laws of the Company (incorporated herein by reference to Exhibit 3.3 to the Company's Registration Statement on Form S-1 (No. 33-53343))\n4.1 Indenture between Empire Gas Corporation and J. Henry Schroder Bank & Trust Company, Trustee, relating to the 9% Subordinated Debentures due December 31, 2007 and the form of 9% Subordinated Debentures due December 31, 2007 (incorporated herein by reference to Exhibit 4(a) to the Empire Incorporated and Exco Acquisition Corp. (Commission File No. 2-83683) Registration Statement on Form S-14 filed with the Commission on May 11, 1983); and First Supplemental Indenture thereto between Empire Gas Corporation (now known as EGOC) and IBJ Schroder Bank & Trust Co., dated as of December 13, 1989 (incorporated herein by reference to Exhibit 4(c) to Empire Gas Corporation (now known as EGOC) Registration Statement on Form 8-B filed with the Commission on February 1, 1990)\n4.2 Indenture between the Company and Shawmut Bank Connecticut, National Association, Trustee, relating to the 12 7\/8% Senior Secured Notes due 2004, including the 12 7\/8% Senior Secured Notes due 2004, the Guarantee and the Pledge Agreement (incorporated herein by reference to Exhibit 4.2 to the Registrant's Annual Report on Form 10-K for the year ended June 30, 1994)\n4.3 Warrant Agreement (incorporated herein by reference to Exhibit 4.3 to the Registrant's Annual Report on Form 10-K for the year ended June 30, 1994)\n10.1 Shareholder Agreement, dated as of October 28, 1988, by and among Empire Gas Acquisition Corporation and Robert W. Plaster Trust, Robert W. Plaster, Trustee; Paul S. Lindsey, Jr.; Stephen R. Plaster Trust, Lynn C. Hoover, Trustee; Cheryl Plaster Schaefer Trust, Lynn C. Hoover, Trustee;\n22 of 55\nRobert L. Wooldridge; Gwendolyn B. VanDerhoef; Dwight Gilpin; Luther Henry Gill; Valeria Schall; Floyd J. Waterman; Larry W. Bisig; Larry Weis; Robert Heagerty; Murl J. Waterman; Earl L. Noe; Thomas Flak; Michael Kent St. John; James E. Acreman; Carolyn S. Rein; Dan Weatherly; Nina Irene Craighead; Joyce Sue Kinnett; Edwin H. McMahon; Paul Stahlman; Ralph Wilson; Alan Simer; Ferrell Stamper; and Empire Gas Corporation Employee Stock Ownership Plan, Robert W. Plaster, Trustee (incorporated herein by reference to Exhibit 10.1 to the Company's Registration Statement on Form S-1 (No. 33-53343))\n10.2 1995 Stock Option Plan of Empire Gas Company\n10.3 Credit Agreement between the Company and Continental Bank, as agent (incorporated herein by reference to Exhibit 10.3 to the Registrant's Annual Report on Form 10-K for the year ended June 30, 1994)\n10.4 Lease Agreement, dated May 7, 1994, between the Company and Evergreen National Corporation (incorporated herein by reference to Exhibit F of Exhibit 10.1 to the Empire Gas Operating Corporation (Commission File No. 1-6537-3) Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 1994)\n10.5 Services Agreement, dated May 7, 1994, between the Company and Empire Service Corporation (incorporated herein by reference to Exhibit G of Exhibit 10.1 to the Empire Gas Operating Corporation (Commission File No. 1-6537-3) Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 1994)\n10.6 Non-Competition Agreement, dated May 7, 1994, by and among the Company, Energy, Robert W. Plaster, Stephen R. Plaster, Joseph L. Schaefer, Paul S. Lindsey, Jr. (incorporated herein by reference to Exhibit E of Exhibit 10.1 to the Empire Gas Operating Corporation (Commission File No. 1-6537-3) Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 1994)\n10.7 Employment Agreement between the Company and Paul S. Lindsey, Jr. (incorporated herein by reference to Exhibit 10.7 to the Company's Registration Statement on Form S-1 (No. 33-53343))\n10.8 Asset Purchase Agreement by and among the Company, Empire Gas, Inc. of North Carolina, PSNC Propane Corporation, and Public Service Company of North Carolina, Incorporated (incorporated herein by reference to Exhibit 10.8 to the Company's Registration Statement on Form S-1 (No. 33-53343))\n10.9 Indemnification Agreement between the Company and Douglas A. Brown (incorporated herein by reference to Exhibit 10.9 to the Company's Registration Statement on Form S-1 (No. 33- 53343))\n23 of 55\n10.10 Tax Indemnification Agreement between the Company and Energy (incorporated herein by reference to Exhibit 10.10 to the Company's Registration Statement on Form S-1 (No. 33-53343))\n10.11 Supply Contract No. 1, dated June 1, 1993, between EGOC and Warren Petroleum Company (incorporated herein by reference to Exhibit 10.20 to the Company's Registration Statement on Form S-1 (No. 33-53343))\n10.12 Supply Contract No. 2, dated June 1, 1993, between EGOC and Warren Petroleum Company (incorporated herein by reference to Exhibit 10.21 to the Company's Registration Statement on Form S-1 (No. 33-53343))\n10.13 Management Agreement between Empire Gas Company, Northwestern Growth Corporation and SYN, Inc. dated May 17,\n10.14 Agreement Among Initial Stockholders and SYN, Inc. dated May 17, 1995\n10.15 Waiver Agreement dated April 29, 1995 by and among Empire Gas Corporation, SYN, Inc., Paul S. Lindsey, Jr., Northwestern Growth Corporation, Empire Energy Corporation, Robert W. Plaster and Stephen R. Plaster\n10.16+ Propane Sales Agreement dated August 24, 1995 between Empire Gas Corporation and Warren Petroleum Company\n10.17+ Supply Contract dated April 27, 1995 between Empire Gas Corporation and Phillips 66 Company\n10.18+ Dealer Sale Contract dated January 20, 1995 between Empire Gas Corporation and Conoco Inc.\n10.19+ Supply Contract dated April 24, 1995 between Empire Gas Corporation and Enron Gas Liquids, Inc.\n10.20 Amendment No. 1 to Supplement A to Loan and Securities Agreement dated June 29, 1995 between Empire Gas Corporation and Bank of America Illinois\n21.1 Subsidiaries of the Company\n27.1 Financial Data Schedules\n(b) Reports on Form 8-K\nNone\n(c) Exhibits\nSee (a)(2) above.\n24 of 55\n(d) Financial Statements\nSee (a)(2) above.\n+ Confidential treatment has been requested. The copy filed as an exhibit omits the information subject to the confidentially request.\n25 of 55\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nEmpire Gas Corporation\nBy: \/s\/ Paul S. Lindsey, Jr. _________________________ Paul S. Lindsey, Jr.\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\n26 of 55\nFINANCIAL STATEMENT INDEX _________________________\nEmpire Gas Corporation - Consolidated Financial Statements for June 30, 1995 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28\nIndependent Accountants' Report . . . . . . . . . . . . . . . . . . . . . 27\nConsolidated Balance Sheets as of June 30, 1995 and 1994. . . . . . . . . 28\nConsolidated Statements of Operations - Years Ended June 30, 1995, 1994, and 1993. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30\nConsolidated Statements of Stockholder's Equity - Years Ended June 30, 1995, 1994, and 1993 . . . . . . . . . . . . . . . . . . . . . 33\nConsolidated Statements of Cash Flows - Years Ended June 30, 1995, 1994, and 1993. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34\nNotes to Consolidated Financial Statements. . . . . . . . . . . . . . . . 36\nFINANCIAL STATEMENT SCHEDULE INDEX __________________________________\nIndependent Accountants' Report . . . . . . . . . . . . . . . . . . . . . 54\nSchedule II - Valuation and Qualifying Accounts . . . . . . . . . . . . . 55\n27 of 55\nIndependent Accountants' Report _______________________________\nBoard of Directors and Stockholders Empire Gas Corporation Lebanon, Missouri\nWe have audited the accompanying consolidated balance sheets of EMPIRE GAS CORPORATION as of June 30, 1995 and 1994, and the related consolidated statements of operations, stockholders' equity (deficit) and cash flows for each of the three years in the period ended June 30, 1995. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of EMPIRE GAS CORPORATION as of June 30, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended June 30, 1995, in conformity with generally accepted accounting principles.\nAs discussed in Note 5, the Company changed its method of accounting for income taxes in 1994.\nBaird, Kurtz & Dobson\nSpringfield, Missouri August 25, 1995 28 of 55\n30 of 55\n32 of 55\n33 of 55\nof 55\nEMPIRE GAS CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nJUNE 30, 1995\nNOTE 1: ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nNature of Business __________________\nThe Company's principal operations are the sale of LP gas at retail and wholesale. Most of the Company's customers are owners of residential single or multi-family dwellings who make periodic purchases on credit. Such customers are located throughout the United States with the larger number concentrated in the central and western states and along the Pacific coast. At acquisition date, asset and liability values were recorded at their market values with respect to the purchase price. At June 30, 1994, the Company's ownership and management was changed. See Note 2 for a description of this restructuring transaction.\nPrinciples of Consolidation ___________________________\nThe consolidated financial statements include the accounts of Empire Gas Corporation and its subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation.\nRevenue Recognition Policy __________________________\nSales and related cost of product sold are recognized upon delivery of the product or service.\nInventories ___________\nInventories are valued at the lower of cost or market. Cost is determined by the first-in, first-out method for retail operations and specific identification method for wholesale operations. At June 30 the inventories were:\n40 of 55\nEMPIRE GAS CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nJUNE 30, 1995\nNOTE 3: RELATED-PARTY TRANSACTIONS\nDuring 1995, 1994 and 1993, the Company has purchased $157,842, $210,400, and $68,900, respectively, of paint from a corporation owned by the spouse of the Principal Shareholder of the Company.\nDuring fiscal year 1994, the Company paid an investment banking firm affiliated with a director of the Company $400,000 in return for services rendered in connection with the negotiation of the Company's revolving credit facility and with the Restructuring Transaction.\nBeginning July 1, 1994, the Company entered into a seven-year services agreement with a subsidiary of Energy to provide data processing and management information services. The services agreement provides for payments by the Company to be based on an allocation of the subsidiary's actual costs based on the gallons of LP gas sold by the Company as a percentage of the gallons of LP gas sold by the Company and Energy. For the year ended June 30, 1995, total expenses related to this services agreement were $1.1 million.\nBeginning July 1, 1994, the Company entered into a new lease agreement with a corporation owned principally by the Former Shareholder to lease its corporate office space. The new lease requires annual rent payments of $75,000 for a period of seven years, with two three-year renewal options.\nPrior to the Restructuring described in Note 2, the Company had various related party transactions with its Former Shareholder as described below.\nThe Company leased the corporate home office, land, buildings and equipment from a corporation principally owned by the Former Shareholder. The Company paid $200,000 during each of the years ended June 30, 1994 and 1993, related to this lease. This lease was terminated effective June 30, 1994, at no additional expense to the Company.\nIn connection with the stock purchase described in Note 2, the Company repurchased, at face value, $4.7 million principal amount of the Company's 2007 9% Subordinated Debentures from the Former Shareholder and purchased, at face value, $285,000 principal amount of the Company's 2007 9% Subordinated Debentures from certain departing officers and employees of the Company.\nDuring 1994 and 1993, the Company provided data processing, office rent and other clerical services to two corporations owned principally by the Former Shareholder and was being reimbursed $7,000 per month for these services. The Company has discontinued providing these services as of June 30, 1994.\nIn 1994 and 1993, the Company leased a jet aircraft and an airport hanger from a corporation owned by the Former Shareholder. The 41 of 55\nlease required annual rent payments of $100,000 beginning April 1, 1992. In addition to direct lease payments, the Company was also responsible for the\nEMPIRE GAS CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nJune 30, 1995\nNOTE 3: RELATED-PARTY TRANSACTIONS (Continued)\noperating costs of the aircraft and the hanger. During the years ended June 30, 1994 and 1993, the Company paid direct rent of $75,000 and $100,000, respectively. This lease was terminated effective June 30, 1994, at no additional expense to the Company.\nThe Company paid $150,000 in each of the years ended June 30, 1994 and 1993, to a corporation owned by the Former Shareholder pursuant to an agreement providing the Company the right to use business guest facilities owned by the corporation. This agreement was terminated effective June 30, 1994, at no additional expense to the Company.\nThe Company borrowed funds from its Former Shareholder and from individuals and corporations related to the Former Shareholder during the year ended June 30, 1994. The maximum amounts borrowed during this period was $3,000,000. The interest rate on this borrowing was equal to or below the rates available through the working capital facility. Interest expense incurred on this related-party borrowing was $200,000. During November 1992 the Former Shareholder loaned under a separate agreement $13.25 million to the Company to repay the acquisition credit facility. Interest expense incurred on this related-party borrowing for the year ended June 30, 1993, was $749,000. In June 1993, all outstanding borrowings from the Former Shareholder were repaid using the proceeds from the term credit facility.\nNOTE 4: LONG-TERM DEBT\n42 of 55\nEMPIRE GAS CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nJUNE 30, 1995\nNOTE 4: LONG-TERM DEBT (Continued)\n(A) The working capital facility was provided to the Company in June 1994 in conjunction with the offering of the 12 7\/8% Senior Secured Notes, due 2004. All of the Company's receivables and inventories are pledged to the agreement,which contains tangible net worth, capital expenditures, interest coverage ratio, debt and certain dividend restrictions. These dividend restrictions prohibit the Company from paying common stock cash dividends. At June 30, 1995, the Company was not in compliance with the original capital expenditures and interest coverage ratio covenants. The bank has amended the covenants, and the Company is in compliance with the amended covenants.\nThe facility provides for borrowings up to $15 million, subject to a sufficient borrowing base. The borrowing base generally limits the Company's total borrowings to 85% of eligible accounts receivable and 55% of eligible inventory. In addition, the Company can borrow an additional $1.5 million during the period July 1, 1995, to January 31, 1996 (overadvance option). The facility bears interest at either 1% over prime or 2.5% over the LIBOR rate. The agreement provides for a commitment fee of .375% per annum of the unadvanced portion of the commitment. The Company's available revolving credit line amounted to $334,000 at June 30, 1995, after considering $1,501,000 of outstanding letters of credit. The letters of credit are principally related to the Company's self-insurance program (Note 6).\n(B) The notes were issued June 1994 at a discount and bear interest at 7% through July 15, 1999, and at 12 7\/8% thereafter. The notes are redeemable at the Company's option. Prior to July 15, 1999, only 35% of the original principal issued may be redeemed, as a whole or in part, at 110% of the principal amount through July 15, 1997, and at declining percentages thereafter. The notes are guaranteed by the subsidiaries of the Company and secured by the common stock of the subsidiaries of the Company.\nThe original principal amount of the notes issued ($127,200,000) was adjusted ($27,980,000) to give effect for the original issue discount and the common stock purchase warrants (effective interest rate of 13.0%). The discount on these notes is being amortized over the remaining life of the notes using the effective interest, bonds outstanding method. The face value of notes outstanding at June 30, 1995 and 1994, is $127,200,000.\n43 of 55\nThe proceeds from this new offering were used to repay existing debt; fund an acquisition; repurchase Company stock and for working capital (Note 2).\nSeparate financial statements of the guarantor subsidiaries are not included because such subsidiaries have jointly and severally guaranteed the notes on a full and unconditional basis, the aggregate assets and liabilities of the guarantor\nEMPIRE GAS CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nJUNE 30, 1995\nNOTE 4: LONG-TERM DEBT (Continued)\nsubsidiaries are substantially equivalent to the assets and liabilities of the parent on a consolidated basis and the separate financial statements and other disclosures concerning the subsidiary guarantors are not deemed to be material.\nThe guarantor subsidiaries are restricted from paying dividends to the Company during any periods of default under the respective debt agreements or in periods where the Company has borrowed under the overadvance option described above.\n(C) The debentures, issued June 1983, are redeemable at the Company's option, as a whole or in part, at par value. A sinking fund payment sufficient to retire $191,000 of principal outstanding is required on December 31, 2005. In June 1994, the Company used proceeds from the issuance of the 12 7\/8% Senior Secured Notes, due 2004, to repurchase $16,201,200 face value of these debentures at a discount which resulted in an extraordinary charge (Note 2).\nThe original principal amount of debentures issued ($27,313,000) was adjusted to market at issuance (effective interest rate of 16.5%). The remaining discount on these debentures is being amortized over the remaining life of the debentures using the effective interest, bonds outstanding method. The face value of debentures outstanding at June 30, 1995 and 1994, is $9,745,800.\n(D) Purchase contract obligations arise from the purchase of operating businesses and are collateralized by the equipment and real estate acquired in the respective acquisitions. At June 30, 1995 and 1994, these obligations carried interest rates from 7% to 10% and are due periodically through 1999.\n44 of 55\nEMPIRE GAS CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nJUNE 30, 1995\nNOTE 4: LONG-TERM DEBT (Continued)\nAggregate annual maturities and sinking fund requirements (in thousands) of the long-term debt outstanding at June 30, 1995, are:\n1996 $ 504 1997 5,568 1998 658 1999 357 2000 83 Thereafter 108,477 ________ $115,647 ________ ________\nNOTE 5: INCOME TAXES\nEffective July 1, 1993, the Company adopted the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (SFAS 109). As a result of the change, there was no effect on income tax expense, and the effect on current-noncurrent classification of deferred tax assets and liabilities was not material.\nSFAS 109 requires recognition of deferred tax liabilities and assets for the difference between the financial statement and tax basis of assets and liabilities. Under this new standard, a valuation allowance is established to reduce deferred tax assets if it is more likely than not that a deferred tax asset will not be realized.\nPrior to July 1, 1993, deferred taxes were determined using the Statement of Financial Accounting Standards No. 96.\n45 of 55\n46 of 55\nEMPIRE GAS CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nJUNE 30, 1995\nNOTE 5: INCOME TAXES (Continued)\nThe above net deferred tax asset (liability) is presented on the June 30 balance sheet as follows:\n1995 1994 ____ ____ (In Thousands)\nDeferred Tax Assets ___________________ Deferred tax asset - current $ 1,350 $ 631 Deferred tax liability - long-term (13,140) (15,421) ________ ________\nNet deferred tax liability $ (11,790) $ (14,790) ________ ________\nA reconciliation of income tax expense at the statutory rate to the Company's actual income tax expense is shown below:\nNOTE 6: SELF INSURANCE AND RELATED CONTINGENCIES\nUnder the Company's current insurance program, coverage for comprehensive general liability and vehicle liability is obtained for catastrophic exposures as well as those risks required to be insured by law or contract. The Company retains a significant portion of certain expected losses related primarily to comprehensive general and vehicle liability. Under these\n47 of 55\ncurrent insurance programs, the Company self-insures the first $500,000 of coverage (per incident). Effective July 1994, the Company reduced its EMPIRE GAS CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nJUNE 30, 1995\nNOTE 6: SELF INSURANCE AND RELATED CONTINGENCIES (Continued)\nself-insured retention for vehicle liability to $250,000 per incident. Effective July 1995, the Company returned its self-insured retention for vehicle liability to $500,000 per incident. The Company obtains excess coverage from carriers for these programs on occurrence and claims-made basis policies. The excess coverage for comprehensive general liability provides a loss limitation that limits the Company's aggregate of self- insured losses to $1 million per policy period. The aggregate cost of obtaining this excess coverage from carriers for the years ended June 30, 1995, 1994 and 1993, was $1,237,000, $1,634,000 and $1,441,000, respectively.\nFor the policy periods prior to July 1, 1991, July 1, 1992, through June 30, 1993, and July 1, 1993, through June 30, 1994, the Company has provided for aggregate comprehensive general liability losses through the policies' $1 million loss limit. Additional losses, if any, are insured by the excess carrier and should not result in additional expense to the Company. As of June 30, 1995, the Company estimates losses for the comprehensive general liability policy periods July 1, 1991, through June 30, 1992, and July 1, 1994, through June 30, 1995, will not reach the $1 million loss limits and has provided accordingly.\nDuring the year ended June 30, 1993, the Company had obtained workers' compensation coverage from carriers and state insurance pools at an annual cost of $1,743,000. Effective July 1, 1993, the Company changed its policy to self-insure the first $500,000 of workers' compensation coverage (per incident). The Company purchased excess coverage from carriers for workers' compensation claims in excess of the self-insured coverage. Provisions for losses expected under this program were recorded based upon the Company's estimates of the aggregate liability for claims incurred. The Company provided letters of credit aggregating approximately $2.3 million in connection with this program of which $1,141,400 is outstanding at June 30, 1995. Effective July 16, 1994, the Company changed its policy so that it will obtain workers' compensation coverage from carriers and state insurance pools.\nProvisions for self-insured losses are recorded based upon the Company's estimates of the aggregate self-insured liability for claims incurred. A summary of the self-insurance liability, general, vehicle and workers' compensation liabilities (in thousands) for the years ended June 30, 1995, 1994 and 1993, are:\n48 of 55\nThe ending accrued liability includes $400,000 for incurred but not reported claims at June 30, 1995, $125,000 at June 30, 1994, and $500,000 at June 30, 1993. The current portion of the ending liability of $500,000, $500,000, and $460,000 at June 30, 1995, 1994 and 1993, respectively, is included in accrued expenses in the consolidated balance sheets. The noncurrent portion at the end of each period is included in accrued self- insurance liability.\nThe Company and its subsidiaries are also defendants in various lawsuits related to the self-insurance program which are not expected to have a material adverse effect on the Company's financial position or results of operations.\nThe Company currently self insures health benefits provided to the employees of the Company and its subsidiaries. Provisions for losses expected under this program are recorded based upon the Company's estimate of the aggregate liability for claims incurred. The aggregate cost of providing the health benefits was $240,000, $979,000 and $873,000 for the years ended June 30, 1995, 1994 and 1993, respectively.\nIn conjunction with the restructuring transaction (Note 2) the Company and Energy have agreed to share on a percentage basis the self-insured liabilities incurred prior to June 30, 1994, including both reported and unreported claims. The self-insured liabilities included under this agreement include general, vehicle, workers' compensation and health insurance liabilities. Under the agreement, the Company assumed 52.3% of the liability with Energy assuming the remaining 47.7%.\n49 of 55\nEMPIRE GAS CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nJUNE 30, 1995\nNOTE 7: LITIGATION CONTINGENCIES\nThe Company's federal income tax returns have been settled through June 30, 1991. The Company has no federal income tax audits in process at June 30, 1995.\nThe Company and its subsidiaries are presently involved in two state income tax audits and are also defendants in other business-related lawsuits which are not expected to have a material adverse effect on the Company's financial position or results of operations.\nIn conjunction with the restructuring transaction (Note 2) the Company and Energy have agreed to share on a percentage basis amounts incurred related to federal and state audits and other business related lawsuits incurred prior to June 30, 1994. The liability recorded at June 30, 1995 and 1994, in the Company's financial statements related to these contingencies represents its 52.3% portion of the total liability as of that date.\nNOTE 8: STOCK OPTIONS AND WARRANTS\nStock Options _____________\nThe table below summarizes transactions under the Company's stock option plan:\nNumber of Shares Option Price _________ _____________\nBalance June 30, 1992 467,929 $ .377 - 1.50 Exercised (338,679) .377 - 1.50 _________\nBalance June 30, 1993 129,250 1.12 - 1.50 Exercised (129,250) 1.12 - 1.50 _________\nBalance June 30, 1994 -0- Issued 377,926 $ 7.00 _______\nBalance June 30, 1995 377,926 _______ _______\n50 of 55\nEMPIRE GAS CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nJUNE 30, 1995\nNOTE 8: STOCK OPTIONS AND WARRANTS (Continued)\nAt June 30, 1994, all outstanding stock options were exercised in connection with the restructuring transaction (see Note 2). During the year ended June 30, 1995, a new stock option plan was approved resulting in the issuance of additional options. These options consist of 220,000 shares issued to employees, of which one-fifth become exercisable in January 1996 and each year thereafter. The remaining 157,926 shares were issued to directors of the Company and are exercisable at June 30, 1995.\nCommon Stock Purchase Warrants ______________________________\nIn connection with the Company's restructuring, the Company attached warrants to purchase common stock to the new issuance of 12 7\/8% Senior Secured Notes, due 2004. Each warrant represents the right to purchase one share of the Company's common stock for $.01 per warrant. The warrants are exercisable after January 15, 1995, and will expire on July 15, 2004.\nThe table below summarizes warrant activity of the Company:\nNumber of Shares Exercise Price _________ ______________\nIssued 175,536 $.01 _______\nBalance at June 30, 1995 175,536 $.01 _______ _______\nNOTE 9: ADDITIONAL CASH FLOW INFORMATION (In Thousands)\n1995 1994 ____ ____\nNoncash Investing and Financing Activities __________________________________________\nPurchase contract obligations incurred $ 1,433 $ 1,015 Debt acquisition costs in accounts payable -- $ 746 Purchase of treasury stock, net of option exercise price, in accounts payable -- $ 180\n51 of 55\nEMPIRE GAS CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nJUNE 30, 1995\nNOTE 9: ADDITIONAL CASH FLOW INFORMATION (In Thousands) (Continued)\nDistribution of operating assets other than cash with Empire Energy Corporation:\n____\nCurrent assets 8,185 Fixed assets, net 51,620 Other assets 3,822 Current liabilities (2,697) Long-term liabilities (15,926) ________ $ 45,004 ________ ________\n1995 1994 1993 ____ ____ ____\nAdditional Cash Payment Information ___________________________________\nInterest paid $ 7,196 $ 9,191 $ 12,185 Income taxes paid (net of refunds) $ -- $ 2,620 $ 3,434\nNOTE 10: EMPLOYEE BENEFIT PLAN\nThe Company formed in fiscal year 1995 a defined contribution retirement plan eligible to substantially all employees. Employees who elect to participate may contribute a percentage of their salaries to the plan. The Company may make contributions to the plan at the discretion of its Board of Directors. No contributions to the plan were made by the Company during the year ended June 30, 1995.\nNOTE 11: RESTRUCTURING PROPOSAL COSTS\nDuring the years ended June 30, 1994 and 1993, the Company was considering proposals to restructure the debt and equity of the Company. The Company abandoned the proposals and expensed the related costs of $398,000 and $223,000 in 1994 and 1993, respectively.\n52 of 55\nEMPIRE GAS CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nJUNE 30, 1995\nNOTE 12: UNDERGROUND STORAGE FACILITY\nThe Company owns salt cavern LPG underground storage facilities which are not in use and are subject to a consent agreement with the state of Kansas. Under the agreement, the Company was to submit a plan to the state for resuming use of the facilities or permanently closing them. The due date of the plan was initially January 1, 1994. The state has granted a final extension to December 1, 1995.\nThe Company has obtained from an engineering and construction company a study of the costs of rehabilitating and opening the facilities, which range from $500,000 to $3.0 million.\nManagement is presently evaluating several options after rehabilitation of the facility, including use as expanded storage for company inventories, use as leased storage to customers and other distributors and the sale of the facility. If the rehabilitation work is not performed and the facilities cannot be sold, then the Company would be required to close the facilities at a cost which the Company believes will not exceed $500,000.\nDue to the uncertainties outlined above, the Company has taken a charge of $924,000 and $1.4 million against 1995 and 1994 earnings, respectively, thereby eliminating the carrying value of the facilities.\nNOTE 13: SUBSEQUENT SALES OF SUBSIDIARIES\nSubsequent to year end, the Company sold eleven retail service centers for sales prices totaling approximately $4.5 million. Fiscal year 1995 summary data of the facilities sold were as follows:\n53 of 55\nEMPIRE GAS CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nJUNE 30, 1995\nNOTE 13: SUBSEQUENT SALES OF SUBSIDIARIES (Continued)\nIn Thousands ____________\nOperating revenue $ 3,268 Cost of sales 1,811 Gross profit $ 1,457 _____\nWorking capital $ 391 ___\nNet property, plant and equipment $ 2,494 _____ _____\nNOTE 14: SUBSEQUENT EVENT\nOn August 15, 1995, the Company entered into a joint venture with Northwestern Growth Corporation, a subsidiary of Northwestern Public Service Corporation, to acquire the assets of Synergy Group Incorporated, the nation's fifth largest LP gas distributor. The Company has acquired for $10,000 10% of the common stock of SYN, Inc., the acquisition entity, and has an option to acquire an additional 20% of the common stock of SYN, Inc. for $20,000. The Company has entered into a Management Agreement pursuant to which the Company manages the joint entity. Under the terms of the Management Agreement, the Company provides all management of the retail facilities and accounting services at the central office. In exchange for those services, the Company receives a $500,000 annual management fee and $3.25 million annual overhead cost reimbursement, both paid on a monthly basis.\n54 of 55\nIndependent Accountants' Report on Financial Statement Schedules ________________________________________________________________\nBoard of Directors and Stockholders Empire Gas Corporation Lebanon, Missouri\nIn connection with our audit of the financial statements of EMPIRE GAS CORPORATION for each of the three years in the period ended June 30, 1995, we have also audited the following financial statement schedules. These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statement schedules based on our audits of the basic financial statements. The schedules are presented for purposes of complying with the Securities and Exchange Commission's rules and regulations and are not a required part of the consolidated financial statements.\nIn our opinion, the financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.\nBaird, Kurtz & Dobson\nSpringfield, Missouri August 25, 1995\n55 of 55","section_15":""}
{"filename":"312667_1995.txt","cik":"312667","year":"1995","section_1":"ITEM 1. BUSINESS\nINTRODUCTION\nSpelling Entertainment Group Inc. (the \"Company\") is a fully-integrated producer and distributor of television series, mini-series, movies-for-television, interactive video games and feature films (collectively referred to hereinafter as \"entertainment product\"). The Company has an extensive library of entertainment product, which it distributes worldwide. The Company also licenses and otherwise exploits ancillary rights in this product, such as music and merchandising rights. Unless the context indicates otherwise, \"Spelling\" or the \"Company\" refers to Spelling Entertainment Group Inc. and its subsidiaries.\nThe Company (formerly The Charter Company) was originally incorporated in Florida in 1959. The Company was formerly engaged in petroleum marketing operations, but substantially all of its remaining operations in this area were sold in 1992. (See Note 10 to the Company's Consolidated Financial Statements; references to Notes hereinafter are to the notes to such financial statements.) It began production and distribution of entertainment product when it acquired 82% of Spelling Entertainment Inc. (\"SEI\") in May 1991. It acquired the remaining shares of SEI in July 1992. The Company acquired all of the stock of Republic Entertainment Inc. (formerly Republic Pictures Corporation, with its subsidiaries, hereinafter \"Republic\") on April 26, 1994 and approximately 91% of the ordinary shares of Virgin Interactive Entertainment Limited (\"VIEL\") on July 30, 1994. (See Note 2.) Currently, the Company operates in a single industry segment, the entertainment industry. (See Note 12.)\nThe Company's production operations are conducted by Torand Productions Inc. and its subsidiaries, including Spelling Television Inc. (\"Spelling Television\"); Big Ticket Television Inc. and its subsidiaries (\"Big Ticket Television\"); Spelling Films Inc. and its subsidiaries (\"Spelling Films\"); and VIEL and its subsidiaries (collectively, \"VIE\"). Distribution operations are conducted by Spelling Films; Republic; Worldvision Enterprises, Inc. and its subsidiaries (\"Worldvision\"); and VIE. The Company's licensing and merchandising operations are conducted by Hamilton Projects, Inc. (\"Hamilton Projects\").\nApproximately 48% of the Company's Common Stock was owned by American Financial Corporation and its subsidiaries (\"AFC\") until March 31, 1993, when AFC sold the Common Stock it owned to Blockbuster Entertainment Corporation (\"BEC\"). BEC acquired additional Common Stock during 1993 and 1994, both from third parties and from the Company. (See Note 6.) Effective as of September 29, 1994, BEC merged with and into Viacom Inc. (\"Viacom\"), with Viacom being the surviving corporation. As a result of the merger, Viacom currently owns approximately 75% of the Company's Common Stock.\nViacom is exploring the sale of the Company. Viacom also has indicated its intention to acquire the Company's interest in VIE in connection with such sale. An independent committee of the Company's board of directors has been formed to negotiate the terms of any proposed VIE transaction.\nThe Company has its principal executive offices at 5700 Wilshire Boulevard, Los Angeles, California 90036, telephone (213) 965-5700. Effective May 26, 1995, the Company changed its state of incorporation to Delaware.\nDEVELOPMENT AND PRODUCTION\nNETWORK PROGRAMMING\nThe Company develops and produces network programming through Spelling Television and Big Ticket Television. Scripts for potential television programming are usually developed by the Company in conjunction with one of the U.S. television networks. If the network accepts the script, it will typically order production of a pilot, for which it will pay the Company a negotiated fixed license fee. If the network decides to order episodes of the series, the license agreement generally provides for a minimum number of episodes to be delivered, with the\nnetwork having certain rights to order additional episodes. The license agreement normally grants the network the right to exhibit the episodes a limited number of times in the United States during the license period. All other ownership and distribution rights are retained by the Company, subject to certain network-related holdbacks.\nNetwork license fees are normally less than the Company's costs of producing the related programming, resulting in a deficit for the Company. In recent years, the size of the series deficits incurred by the Company has generally increased as escalations in license fees have failed to keep pace with escalations in production costs. However, in the case of its drama series, the Company has generally been successful in obtaining sufficient revenue from Worldvision's international sales efforts to substantially offset such production deficits. See \"Distribution.\"\nAaron Spelling, Chairman and Chief Executive Officer of Spelling Television, has a history of successful network television production, including more than 3,000 hours of television series, movies-for-television, mini-series and pilots, as well as feature films. In association with a variety of partnerships, Aaron Spelling has consistently been one of the industry's most creative and prolific producers of network television programming, producing such successful series as \"Beverly Hills, 90210,\" \"Melrose Place,\" \"The Love Boat,\" \"Dynasty,\" \"Hotel,\" \"Vegas\" and \"Matt Houston.\" He has also produced \"Fantasy Island,\" \"Charlie's Angels,\" \"Starsky and Hutch,\" \"Family\" and \"Hart to Hart,\" all series in which the Company has no financial interest. Mr. Spelling's employment agreement with Spelling Television expires in April 1996. The Company has entered into preliminary discussions concerning the extension of Mr. Spelling's employment agreement.\nSpelling Television is currently producing five one-hour drama television series. \"Beverly Hills, 90210,\" which is currently in its sixth season, has been ordered by Fox Broadcasting Company (\"FBC\") for an additional season. \"Melrose Place\" is now in its fourth season, and has also been ordered by FBC for an additional season. Spelling Television is also producing twelve episodes of \"Savannah,\" which is airing on The WB Television Network (\"WB\"); and has received an order from WB for 13 more episodes; seven episodes of \"Kindred: The Embraced,\" which is airing on FBC; and a two-hour movie and six episodes of \"Malibu Shores,\" which will air on NBC. It also has a number of movies for television in development or production, including a four-hour mini-series, \"A Season In Purgatory,\" and a two-hour movie, \"After Jimmy,\" for CBS.\nBig Ticket Television was established in November 1994 primarily to develop and produce half-hour comedy television series for the U.S. television networks, but also to develop and produce programming for cable and first-run syndication television (see below). Big Ticket Television has had projects in development at the four networks (ABC, NBC, CBS and FBC) as well as the recently launched United Paramount Network (\"UPN\") and WB. Big Ticket Television is currently producing 15 episodes of a half-hour situation comedy, \"Moesha\", which is airing on UPN, and has received an additional order of 22 episodes for the 1996-97 season.\nThe Company had revenue from FBC in 1995, 1994 and 1993 representing 15%, 15% and 22% of revenue, respectively.\nFIRST-RUN SYNDICATED PROGRAMMING\nFirst-run syndicated television series are produced and sold directly to television stations in the United States without any prior network broadcast. These programs are licensed to individual or groups of television stations, on a market by market basis, in contrast to network distribution, which provides centralized access to a national audience.\nIn first-run syndication, programming is licensed domestically in exchange for cash payments, advertising time (\"barter\") or a combination of both. Internationally, Worldvision distributes this programming for cash license fees. In cash licensing, a broadcaster normally agrees to pay a fixed license fee in one or more installments in exchange for the right to broadcast the programming a specified number of times over the license term. When programming is licensed on a barter basis, the producer receives a specified amount of advertising time during the broadcast, and the producer subsequently sells this advertising time for cash. Worldvision carries out this function on behalf of the Company through an internal advertising sales organization.\nAs compared to programming produced for the network, the Company exercises greater control over creative and production decisions related to its first-run syndicated programming. However, there is much greater financial risk\nassociated with such programming, as there is no third-party network to share the production costs. While the license fees paid by a network for television programming are fixed by contract, barter revenue derived from distribution of first-run syndicated programming is not fixed in amount, but varies depending on the ratings success of the programming. Such ratings may vary significantly between different genres of programming, as well as between individual programs within each genre. Even when a first-run syndicated program is ultimately successful, during the initial years of the program its revenue is often less than the Company's costs of producing the program. However, if a program has strong ratings, the advertising revenue which may be realized by the Company through its barter arrangements could be substantial.\nIn 1994 and 1995, Worldvision distributed in first-run barter syndication three one-hour drama series, \"Heaven Help Us,\" \"Robin's Hoods\" and \"University Hospital,\" which were produced by Spelling Television. Big Ticket Television is producing twenty-six episodes of an original nighttime comedy entitled \"Night Stand with Dick Dietrick,\" distributed in first-run syndication by Worldvision, beginning in September 1995. Worldvision also is distributing \"Jim J. & Ann,\" a one-hour talk show.\nINTERACTIVE ENTERTAINMENT\nThe interactive entertainment market in which the Company competes consists primarily of video games for use on Nintendo, Sega, Sony and other home entertainment systems, and for use on multimedia personal computers. There is an ongoing evolution in hardware platforms. During 1995, new 32-bit console systems were introduced by Sega and Sony, and Nintendo is expected to introduce a 64-bit system during 1996. Other hardware manufacturers (e.g., 3DO, Apple, Atari, etc.) seek to compete with them. In recent years an increasing number of games have been developed for use on systems equipped with CD-ROM drives, instead of systems using cartridges and floppy disks. As compared to games developed for cartridge platforms, games developed for CD-based platforms require a significantly longer development period, and accordingly the Company's development costs for each game are proportionately higher. However, the cost of manufacturing the individual games for CD-based platforms is significantly lower than the cost of manufacturing game cartridges, thereby often offsetting the additional development costs. VIE's strategy is to develop content that is generally platform-independent and adapt these titles to different commercially successful platforms in order to minimize its reliance on the success of any one hardware system. This strategy reduces the risk associated with specific platform failure or obsolescence.\nThe Company believes that VIE's entertainment product must become increasingly sophisticated and challenging in order to remain competitive in meeting consumer expectations. In order to meet these expectations, VIE has been expanding its internal resources to develop and produce titles over a wide range of genres including action, strategy, sports simulation, role-playing and licensed character-based games. VIE's internal development gives it the control to enable it to improve its design capabilities, better manage the development process and create and enhance unique tools and techniques relating to key and emerging technologies. While VIE will occasionally distribute edutainment or infotainment product created by third parties, it does not develop or produce these types of products.\nIn addition to its internal product development, VIE continues to obtain a considerable portion of its entertainment product from third-party software developers. Development agreements are established for each project, either on a work-for-hire basis, whereby flat fees are paid to the developer, or under a royalty arrangement, whereby advances are paid to the developer against royalties to be earned from the exploitation of the related product. In certain instances, VIE has taken minority interests in third-party developers in order to secure access to their product.\nVIE also seeks, on a selective basis, to obtain licenses for properties which enjoy a high degree of consumer awareness, in order to incorporate these licensed characters, trademarks, themes and\/or personalities into its products to capitalize on their name recognition. Some of VIE's designs and products have been inspired by well-\nknown animated and feature films, famous sports personalities, prominent corporate logos and popular board games.\nDuring 1995, VIE released, among other titles, \"The 11th Hour: The Sequel to 7th Guest,\" \"Command & Conquer,\" \"Daedelus Encounter,\" \"Agile Warrior\" and \"Monopoly.\"\nFEATURE FILMS\nIn 1990, the Company began the acquisition and distribution of theatrical feature films through the formation of Spelling Films. Spelling Films typically acquires all international distribution rights to such films by paying a guaranteed advance to the producer against the producer's share of distribution receipts. Such advances are normally payable upon the producer's delivery of the completed film. Spelling Films then presells distribution rights, generally on an all-rights, territory-by-territory basis. Under this approach, Spelling Films generally covers all or a substantial portion of its acquisition cost, reducing its risk and capital requirements, but also limiting its upside profit potential.\nSince its inception, Spelling Films has acquired international distribution rights to \"The Player,\" \"Short Cuts\" and \"Shadowlands.\" Recent films include \"The Usual Suspects,\" which received two Oscar awards and was released domestically by Gramercy Pictures in August 1995; and \"Moll Flanders,\" starring Robin Wright and Morgan Freeman, and \"Unforgettable,\" starring Ray Liotta and Linda Fiorentino, both of which are being distributed domestically by Metro-Goldwyn-Mayer Pictures, Inc.\nWithin the last eighteen months, Spelling Films has expanded its focus and presence in the feature film area by developing and producing, on a fully-financed basis, moderately budgeted theatrical feature films for which it will retain all distribution rights on a worldwide basis. Spelling Films typically enters into agreements with domestic film companies to handle domestic theatrical distribution, but distributes the films in all other markets and media through the Company's own distribution operations. Spelling Films currently has two fully-financed feature films in postproduction, \"Stephen King's Thinner,\" starring Robert John Burke and Joe Mantegna, and \"Night Falls on Manhattan,\" starring Andy Garcia, Lena Olin and Richard Dreyfuss. Both of these films are scheduled for domestic theatrical release in 1996.\nRepublic acquires varying distribution rights to feature films primarily for initial release in the domestic home video marketplace, typically by paying a guaranteed advance. Republic released approximately 36 films in 1995 and expects to release approximately 40 in 1996. Most of the films have production budgets in the $2-3 million range, and Republic's acquisition costs for such films are a percentage of such budgets, based on a variety of factors.\nDEVELOPMENT AND PRODUCTION RISKS\nAs discussed above, the Company has various development and production operations encompassing television programming, feature films and interactive entertainment product. There are a number of factors outside the control of the Company which may affect the timely completion of the development, production and\/or release of the Company's entertainment product, including availability of talent and other resources integral to these processes. The Company attempts to minimize such risks to the greatest extent possible through the active management of the development and production process. See \"Competition\" and \"Technology\" below.\nDISTRIBUTION\nIn addition to its production activities, the Company is actively engaged in the worldwide distribution of entertainment product, either directly or through subdistributors. Historically, the Company's distribution activities have focused on the distribution of its network television programming. However, with the formation of Spelling\nFilms and the acquisition of Republic and VIE, the Company's distribution activities have been extended to include both feature films and interactive entertainment product. As a result of these activities, as of December 31, 1995, the Company had contractual agreements with licensees covering entertainment product which provide for approximately $133,549,000 in future revenue, approximately 43% of which is expected to be recognized after 1996. As of December 31, 1994, the Company had contractual agreements which provided for approximately $178,199,000 in future revenue.\nTHEATRICAL DISTRIBUTION\nSpelling Films generally sells or licenses the international theatrical, home video and\/or television rights to its films to various subdistributors in each territory in exchange for a guaranteed advance plus, in most cases, a share of future profits. For certain films, Spelling Films may elect to presell some territories but enter into distribution arrangements in other territories. In the latter cases, Spelling Films receives no advance; however, the subdistributor retains a lower distribution fee and Spelling Films receives the balance of any revenue generated. In certain cases where Spelling Films is able to retain the home video and television rights, Republic and Worldvision distribute such rights for Spelling Films.\nTo the extent that Spelling Films and\/or Republic desire to exploit feature films in the United States and Canadian theatrical markets, they will engage a third party to handle such distribution. With respect to two of its films, Spelling Films has engaged Paramount Pictures Corporation to handle domestic theatrical distribution.\nHOME VIDEO DISTRIBUTION\nRepublic has been engaged in the production and distribution of entertainment product for over sixty years. Its library includes more than 1,400 films and over 1,000 hours of off-network television programming, as well as certain distribution rights to over 2,000 hours of pre-1974 NBC television series and specials (the \"Republic Library\"). Republic currently handles the marketing and sale, either directly or through licensees, of all the Company's entertainment product in the worldwide home video market.\nDomestically, videocassettes are sold by Republic through its own sales force to independent wholesalers for resale to retail outlets, or in some instances, directly to retailers. Internationally, the Company licenses third parties to distribute its product in the home video market, generally in exchange for a minimum guarantee against a royalty. The Republic Library has previously been licensed in most territories outside of North America, and little additional revenue is anticipated in the near term from such territories.\nTELEVISION DISTRIBUTION\nWorldvision has been engaged in the distribution of entertainment product in the worldwide television market for over thirty-five years, originally serving as the distribution arm of the ABC network. Today, Worldvision is a leading worldwide distributor with rights to more than 8,000 hours of television programming available for domestic television distribution and more than 18,000 hours of television programming for international television distribution, including both the original ABC library and the original NBC library recently acquired through Republic. Worldvision currently distributes such programming in 110 countries through offices or representatives in London, Paris, Rome, Toronto, Sydney, Tokyo and Rio de Janeiro.\nDemand for American-made entertainment product in international markets has increased in recent years due to the increase in the number of international television stations, cable systems and satellite delivery systems in those markets and, in some territories, the privatization of the local television industry. The Company typically begins to earn international television revenue from its television programming during the same season such programming is originally broadcast on domestic television, or soon thereafter. Substantially all of the Company's television programming has been or is presently being distributed by Worldvision in international television markets. The\nRepublic Library has previously been licensed for various terms in many territories around the world and will not all be available for the Company's exploitation in the near term.\nIn March 1993, Spelling Satellite Networks (\"SSN\") launched its first cable channel, TeleUNO, which currently reaches more than four million homes in Latin America, including Mexico, Argentina and Brazil. TeleUNO generates both subscription fees and advertising revenue. SSN is also currently exploring the possibility of launching additional channels in partnership with programmers or others in other markets around the world, including direct to home satellite transmission.\nTelevision revenue from the distribution of feature films is generally delayed until after the films have been exploited in the theatrical and home video markets in each territory.\nThe profitability of the Company's television programming continues to depend substantially on the consumer's acceptance of the programming in the domestic marketplace after initial network exhibition or first-run syndication. However, in recent years the revenue obtainable from this secondary market has declined, and is expected to continue to decline, due in part to the increase in original programming available to independent stations from the emergence of UPN and WB, and the increased production of programming produced specifically for first-run syndication.\nExpected revenue per episode in this market normally increases for longer running series. In the Company's experience, at least four broadcast seasons of a series are generally required to successfully market repeat showings of a series in the domestic syndication market. For example, Worldvision is currently distributing \"Beverly Hills, 90210\" in the domestic syndication market. Episodes from a series normally become available for secondary syndication distribution four or five years after the series' initial telecast.\nDomestic basic cable television potentially represents an increasingly significant market for the Company's product. The series \"Melrose Place,\" \"Models, Inc.,\" \"Hotel,\" \"Vegas\" and \"Dynasty\" among others, have been licensed to cable television. Cable exhibition has effectively developed as an alternative market, albeit traditionally a less lucrative one than domestic syndication. Each year a greater number of relatively successful network television series are being licensed to basic cable in lieu of domestic syndication. Additionally, cable exhibitors in some instances have purchased rights to short-running television series which do not include sufficient episodes to allow for traditional off-network syndication distribution.\nCable television operations outside the U.S., while still in development in many countries, have also been growing rapidly.\nSee \"Governmental Regulation\" for restrictions placed on exhibition of the Company's entertainment product in certain markets.\nINTERACTIVE ENTERTAINMENT\nVIE sells its entertainment product in North America using its in-house sales organization. This approach has reduced its costs, strengthened its distribution capabilities and has helped to attract third-party developers and publishers to VIE. VIE's primary retail accounts include toy stores, general or mass merchandise retailers, electronics appliance stores, computer software and specialty stores, warehouse clubs, office supply warehouses and video rental stores.\nVIE markets and\/or sells its product internationally through its offices in the U.K., France, Germany, Spain, Singapore and Japan to various local distributors and retailers. VIE has appointed national or territorial distributors to serve customers in other international markets. These operations normally generate revenue denominated in foreign currencies and, accordingly, the Company may experience gains and losses resulting from foreign currency exchange rate fluctuations.\nLICENSING AND MERCHANDISING\nHamilton Projects is a full service consumer product and promotional licensing agency, providing its clients with strategic planning, concept development and product marketing program management. Hamilton Projects typically earns its fees through a commission based upon the royalties earned by its clients from the sale of licensed consumer products, promotions and books based upon the copyrights, trademarks and trade names of the companies it represents. In addition to managing the consumer product merchandising programs for \"Beverly Hills, 90210\" and \"Melrose Place,\" Hamilton Projects also represents several third parties, such as Jeep(R), Dr. Scholl's(R) and the United States Postal Service. Through the efforts of Hamilton Projects the Company has taken advantage of various consumer product and promotional opportunities such as a dedicated show on the Q2 channel of QVC and phone cards to market \"Melrose Place\" merchandise, the operation of World Wide Web sites on the Internet, the introduction of the Melrose Place Fragrance, as well as the traditional merchandising of clothing, posters, calendars and books.\nCOMPETITION\nThe entertainment industry is highly competitive with many companies competing for available literary properties, creative personnel, talent, production personnel, distribution channels and financing which are essential to acquire, develop, produce and distribute entertainment product. The Company's competitors include major motion picture and television companies as well as a broad range of independent production and distribution companies. Certain of the Company's competitors have greater financial resources than those of the Company. Moreover, the repeal of certain governmental regulations permits the television networks to acquire financial interests in, and syndication rights to, television programs, which intensifies competition in the television industry. See \"Governmental Regulation.\"\nDespite the fact that the Company may receive an order from the networks for the production of a pilot, series, movie or mini-series, the networks are under no obligation to actually broadcast the Company's product. The Company's successful off-network domestic sale of a network series generally depends upon the ratings achieved through network exhibition of such a series over a number of years. In turn, the Company's overall success in achieving multiple years of network exhibition of a series is dependent upon unpredictable factors such as the viewing public's acceptance as reflected in the ratings and critical reviews.\nIn addition to its internally produced product, the Company must continue to acquire distribution rights to entertainment product produced by third parties to maintain its competitive position. In order to acquire rights to distribute new third-party product, the Company may be required to increase its guaranteed advance payments to producers and\/or reduce the distribution fees it charges.\nLicensing television programming to broadcasters and cable networks has also become increasingly competitive as new programming continually enters the market and certain of the Company's competitors attempt to develop their own programming services and\/or align themselves with the existing networks.\nLikewise, Spelling Films is competing with numerous well-financed, established companies engaged in feature film production and distribution. The Company has had a short operating history in this area and does not possess the theatrical distribution capabilities or track record of some of its competitors.\nThe Company's ability to compete in certain countries is affected by local restrictions and quotas. Governments of certain countries require that a minimum percentage of locally produced programming be broadcast.\nIn addition to the competitive facts applicable to all areas of the entertainment industry, the market for interactive entertainment is also characterized by the frequent introduction of new, ever-evolving hardware systems. Among VIE's competitors are companies which manufacture and sell such hardware systems in addition to publishing and distributing interactive entertainment software product.\nTRADEMARKS, SERVICE MARKS AND COPYRIGHTS\nThe Company or its subsidiaries own various United States trademarks and service marks, including SPELLING(R), BEVERLY HILLS, 90210(R), MELROSE PLACE(R), COMMAND AND CONQUER(R), REPUBLIC(R), SPELLING FILMS(TM) and BIG TICKET TELEVISION(R), and has applied for registration for numerous other marks relating to its entertainment products in the United States and foreign countries. The Company uses the VIRGIN name and trademark under a license which expires in 2004. The Company or its subsidiaries own various foreign trademark and service mark registrations and have pursued licensing and\/or merchandising opportunities related to the use of these marks. The Company registers and endeavors to take the necessary actions to protect the marks created and acquired in its businesses. See \"Distribution - Licensing and Merchandising.\"\nThe Company regularly obtains copyright protection for each episode of its television programs, for its feature films and for other entertainment product. Certain of the Company's copyrights, trademarks and service marks may be considered material to the Company's business.\nTECHNOLOGY\nThe Company is dependent on various forms of technology for the production and distribution of its entertainment product. As a result, the Company is subject to business risks as a result of changing technologies in the media, communications and computer industries. Changes in the hardware platforms, new digital disk systems, direct to home satellite systems and other new delivery systems also provide new opportunities and markets for the Company. The Company endeavors to minimize the risk of technological change to or obsolescence of a particular hardware platform or media and take advantage of new markets created by changing technologies. Additionally, the risk of illegal manufacture and distribution (\"piracy\") of the Company's entertainment product may increase with the advancement and proliferation of various technologies. It is difficult for the Company to determine the impact of such piracy and there can be no assurance that such activities will not have a material impact on the Company.\nGOVERNMENT REGULATION\nThe production and distribution of television programming by independent producers is not directly regulated by the federal or state governments, but the marketplace for television programming is substantially affected by regulations of the Federal Communications Commission (\"FCC\") applicable to television stations, television networks and cable television systems. The FCC's syndicated program exclusivity rules affect the sale of programming to commercial television stations, regional superstations and cable networks. Pursuant to these rules, commercial television stations can bargain for the right to exclusive showing of programming generally within a 35-mile radius and separately to require cable television systems with 1,000 or more subscribers to black out showings of the same programming on certain television stations they carry in order to preserve contracted exclusivity. The FCC also allows regional superstations (such as WTBS in Atlanta and WGN in Chicago) and group owners to purchase rights to programming on a nationwide basis.\nThe Cable Television Consumer Protection and Competition Act of 1992 (\"Cable Act\") prohibits certain unfair or discriminatory practices in the distribution of the signal from satellite superstations or in the sale of satellite cable programming by entities affiliated with cable operators. The Telecommunications Act of 1996 (\"1996 Act\") extends these rules to entities affiliated with common carriers. The Cable Act also strictly limits entities affiliated with cable operators in offering exclusive contracts for satellite cable programming or superstations. Furthermore, the Cable Act prohibits certain coercive and discriminatory acts by cable operators and satellite program vendors against multichannel video program distributors. In addition, the Cable Act provides all commercial television stations with the right to bargain for and withhold consent to the local retransmission of their signals by cable television systems, and certain local stations have the option to demand carriage on cable systems. These provisions are subject to interpretation by the FCC. Moreover, judicial appeals relating to various aspects of these rules are pending. Accordingly, the Company cannot predict the specific impact of the Cable Act on its business.\nThe 1996 Act eliminates the numerical restrictions on the number of television stations that one entity may own and increases the national audience reach limitation by one entity from 25% to 35%. In addition, the FCC is directed to revise its dual network rule which prohibits a TV station from affiliating with an entity maintaining two or more networks of television broadcast stations. The FCC must now permit such affiliations unless certain limited circumstances pertain. The FCC must also amend its rules to permit common ownership or control of a broadcast network and cable systems. These changes in the FCC's ownership rules could have an adverse effect on the Company in that the number of potential customers for its programming may be reduced.\nIn 1989, the twelve-member European Community (\"EC\") adopted a directive that its member states ensure that more than 50% of the programming shown on their television stations be European-produced \"where practicable.\" These guidelines could restrict the amount of American television programming and feature films that are shown on European television. In the recently concluded General Agreement on Trade & Tariffs, the EC refused to make any commitment to modify these guidelines or to refrain from adopting additional barriers. Because of significant questions regarding the interpretation and enforcement as well as the possible future modification of the current guidelines, the Company cannot predict what effect they may have on its business. In addition, certain European countries have adopted individual national restrictions on broadcasting of programming based on origin. Other countries in which the Company distributes its programming may adopt similar restrictions, which may have an adverse effect on its ability to distribute its programs or create stronger incentives for the Company to establish ventures with international firms.\nThe effect of the foregoing regulations on the Company's operations cannot be accurately assessed at this time.\nOn September 6, 1995, the FCC released an order repealing its rules governing financial interests in and syndication of programming by the broadcast television networks (the \"Fin Syn Rules\"). The earlier decision of the FCC to permit the expiration of the Fin Syn Rules was recently upheld by the United States Court of Appeals for the Seventh Circuit.\nIn 1993, a Federal district court vacated certain provisions of consent decrees which prohibited television networks from acquiring financial interests and syndication rights in television programming produced by non-network suppliers such as the Company. The repeal of the Fin Syn Rules and the court's action could have a material adverse effect on the operations of the Company.\nEMPLOYEES\nAt December 31, 1995, the Company had approximately 900 employees. In addition, the Company employs a large number of individuals for particular television and feature film productions. As a result, the total number of employees can vary substantially during the course of a year depending upon the number and scheduling of its productions.\nCertain of the Company's subsidiaries are signatories to collective bargaining agreements relating to the engagement of various individuals in the many different job classifications required to produce entertainment product. These agreements set forth wage scales and fringe benefits which are generally applicable to the production of television programming and feature films. In the United States, the agreements are industrywide, whereas in Canada they are negotiated on a company by company basis. These employees include writers, directors, actors, musicians and studio technicians and craftsmen. The following table sets forth the union contracts to which certain of the Company's subsidiaries are parties, and the relevant expiration dates:\n(a) Cancelable by one year's notice. (b) Canadian guilds.\nAlthough the Company considers its guilds and union relationships to be satisfactory at present, the renewal of union contracts does not depend on its activities or decisions alone and is largely out of the Company's control. If the relevant union and the motion picture and television industry were unable to come to a new agreement prior to these expiration dates, any resulting work stoppage could adversely affect the Company's production activities.\nDISCONTINUED OPERATIONS\nThe Company, formerly known as The Charter Company, was historically engaged in petroleum marketing operations, all of which have been sold or discontinued. Additional information relating to discontinued operations, including information regarding environmental contingencies, is provided in the accompanying financial statements. (See Item 7. \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Discontinued Operations\" and Note 10.)\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company leases office space of approximately 183,000 square feet in Southern California, 37,000 square feet in Las Vegas, 27,000 square feet in London and 54,000 square feet in New York City. In addition, the Company leases offices in other cities in the United States and in various other countries throughout the world in connection with its international distribution activities. The Company also rents facilities on a short-term basis for the production of its entertainment product, including a facility in Vancouver, British Columbia. Management believes comparable space is readily available should any lease expire without the prospect of renewal.\nThe Company also owns a 43,000 square foot building in Los Angeles, formerly occupied by Republic, which is now housed at the Company's corporate offices. The Company intends to sell the building in the near future.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is subject to various lawsuits, claims and other legal matters in the course of conducting its entertainment business operations. The Company believes such lawsuits, claims and other legal matters should not have a material adverse effect on the Company's consolidated results of operations or financial condition.\nThe Company is involved in a number of legal actions including threatened claims, pending lawsuits and contract disputes in connection with certain bankruptcy and environmental matters relating to the Company's discontinued operations, as well as other matters. While the outcome of these suits and claims cannot be predicted with certainty, the Company believes based upon its current knowledge of the facts and circumstances and its understanding of the applicable law that the ultimate resolution of such suits and claims will not have a material adverse effect on the Company's results of operations or financial condition. This belief is also based upon the allowances which have been established in connection with these matters and the Company's coverage under an insurance-type indemnity agreement which covers up to $35 million of certain such liabilities in excess of a threshold amount of $25 million, subject to certain adjustments. Substantial portions of such allowances and indemnity are intended to cover environmental costs associated with the Company's former petroleum operations. Although there are significant uncertainties inherent in estimating environmental liabilities, based upon the Company's experience it is considered unlikely that the amount of possible environmental liabilities and Chapter 11 disputed claims would exceed the amount of the allowances by more than $50 million, a substantial portion of which would be covered by the indemnity discussed above. (See Note 10.)\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.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Company's Common Stock is traded on the New York and Pacific Stock Exchanges under the symbol SP. The table below sets forth the low and high sales prices for the Common Stock as reported on the Composite Tape.\nThe number of holders of record of the Company's Common Stock as of March 22, 1996, was approximately 9,900. Dividend payments were discontinued by the Board of Directors as of the fourth quarter of 1994.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following table sets forth certain data for the years ended December 31 (in thousands, except per share data):\n(a) Due to the acquisition of SEI in the second quarter of 1991, amounts are not comparable to the prior year.\n(b) Per share amounts for 1991 and 1992 are calculated after preferred dividends of $810,000 and in 1993 after preferred dividends of $724,000.\n(c) The Company acquired Republic on April 26, 1994 and VIE on July 30, 1994, and, accordingly, amounts are not comparable to 1995 or to prior years.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe following discussion should be read in conjunction with the Consolidated Financial Statements of the Company and the related notes.\nBUSINESS COMBINATIONS AND ACQUISITIONS\nThe Company makes its decisions to acquire or invest in businesses based on financial and strategic considerations. The Company may from time to time invest in or acquire businesses or assets in addition to those described below.\nIn May 1991, the Company acquired ownership of approximately 82% of the common stock of SEI and acquired the remainder in July 1992. This acquisition was accounted for using the purchase method of accounting and, accordingly, the operations of SEI have been included in the Company's financial statements from the original date of acquisition.\nIn April 1994, the Company and Republic consummated a merger (the \"Merger\") in which the Company acquired all of the outstanding shares of common stock of Republic for $13 per share in cash, including the approximate 35% interest in Republic held by BEC. The total consideration was approximately $101,000,000, which was funded through borrowings under the Company's credit arrangements with BEC. (See Notes 2 and 4 and \"Financial Condition\" below.)\nOn July 30, 1994, the Company and BEC entered into an exchange agreement (the \"Exchange Agreement\") and consummated the transactions contemplated thereby (the \"Acquisition\"). Pursuant to the Exchange Agreement, BEC delivered to the Company 8,686,984 ordinary shares (the \"Ordinary Shares\") of VIEL and an option to acquire 550,000 Ordinary Shares of VIEL (collectively, the \"VIE Interests\") in exchange for 22,015,062 shares of the Company's Common Stock. BEC had acquired a majority of the VIE Interests from third parties on July 29, 1994. As a result of the Acquisition, the Company acquired approximately 91% of VIEL's Ordinary Shares.\nIn connection with the Acquisition, the Company also entered into put-and call-option agreements with respect to the Ordinary Shares of VIEL not owned by the Company. Under these agreements, the Company may acquire, or be required by Blockbuster Entertainment Group, a division of Viacom (\"BEG\"), to purchase, these shares from BEG at an agreed-upon price. At the option of the Company, such purchase price may be paid in cash or shares of the Company's Common Stock. On June 8, 1995, BEG acquired the remaining Ordinary Shares of VIEL not owned by the Company for approximately $22,973,000 plus other costs associated with the transaction. BEG and the Company have executed amendments to extend the put-and call-option agreements, which originally expired in July 1995, through May 5, 1996. (See \"Financial Condition\" below and Note 1 regarding the potential sale of VIE to Viacom.)\nRESULTS OF CONTINUING OPERATIONS\nResults of operations for the years ended December 31, 1995, 1994 and 1993 are not comparable due to the business combinations and acquisitions above.\nAdditionally, the results of operations for any period are significantly affected by the quantity and performance of the Company's entertainment product which is licensed or sold to, and available for exhibition by, licensees or customers in various media and territories. Consequently, results of operations may vary significantly between periods, and the results of operations in any one period may not be indicative of results of operations in future periods.\nThe success of the Company's television programming business depends, in large part, upon the successful network exhibition of its television series over a sufficient number of years to allow for off-network exhibition opportunities. During the initial years of a one-hour television series, network and international license fees normally approximate the production costs of the series, and accordingly the Company recognizes only minimal profit or loss during this period. With respect to half-hour network programming, the production costs can substantially exceed the combination of the network and international license fees, and the Company recognizes\nlosses during this period. However, if a sufficient number of episodes of a series are produced, the Company is reasonably assured that it will also be able to sell the series in the domestic off-network market, and the Company would then expect to be able to realize a substantial profit with respect to the series.\nThe Company's business in general is affected by the public's acceptance of its product, which is unpredictable and subject to change, and by conditions within the entertainment industry, including, but not limited to, the quality and availability of creative talent and the negotiation and renewal of union contracts relating to writers, directors, actors, musicians and studio technicians and craftsmen as well as any changes in the law and governmental regulation. In 1993, a Federal district court vacated certain provisions of a consent decree which prohibited television networks from acquiring financial interests and syndication rights in television programming produced by program suppliers such as the Company. The Telecommunications Act of 1996 eliminates the restrictions on the number of television stations that one entity may own and increases the national audience reach limitation by one entity from 25% - 35%. Accordingly, the networks will be able to own the programming which they broadcast, and increasingly become competitors of the Company in the production and distribution of programming.\nThe following paragraphs discuss significant items in the Consolidated Statements of Operations for the three years ended December 31, 1995.\nREVENUE\nThe following table sets forth the major components of the Company's revenue for the three years ended December 31 (in thousands):\n* Includes eight months of operations of Republic and five months of operations of VIE.\nWorldwide television revenue increased $22,507,000 (7%) and $119,102,000 (57%) in 1995 and 1994, respectively. The increase in 1995 arose primarily from (i) higher per episode network license fees; (ii) the continued distribution of programming in the first-run syndication market; (iii) higher revenue from the exploitation of the Company's library; and (iv) the effect recorded in the first quarter of 1995 of conforming the Company's accounting policies to those of Viacom (see Note 1); however, these increases were offset by the effect of fewer hours of programming being delivered to the networks. The increase in 1994 was primarily due to (i) substantially more hours of programming being delivered to the networks; (ii) the release of \"Beverly Hills, 90210\" in domestic syndication; (iii) the increase in programming available for distribution, including the Republic Library; and (iv) the distribution of two one-hour dramas in first-run syndication.\nWorldwide interactive entertainment revenue increased $28,843,000, or 16%, in 1995 from 1994 primarily as a result of having twelve months of operations of VIE (acquired July 30, 1994) included in the 1995 results as compared to only five months of operations in 1994. Revenue in the last six months of 1995 was adversely affected by delays in the release of a significant number of VIE's titles from 1995 to 1996, as well as fewer than anticipated shipments to retailers reflecting in part the continuing reluctance by consumers to purchase interactive software product until the new generation hardware platforms achieve a higher installed base. The Company continues to\nactively work with hardware manufacturers to develop and adapt its titles to different platforms as they become commercially viable.\nIn general, VIE's revenue is highest in the fourth quarter of each year. VIE released \"The Lion King\" interactive game, VIE's highest grossing title ever, on various cartridge formats in October 1994. This game contributed a very significant portion of the worldwide interactive entertainment revenue realized by the Company during 1994 while there was no release of similar significance in 1995. (See \"Financial Condition\" below and Note 1 regarding the potential sale of VIE to Viacom.)\nHome video revenue increased $14,858,000, or 26%, in 1995 as compared to 1994 and $26,203,000, or 84%, in 1994 as compared to 1993. The increase in 1995 is primarily a result of having twelve months of operations of Republic (acquired April 26, 1994, with significant home video distribution operations) being included in the 1995 results as compared to only eight months of operations in 1994. The increase in 1994 was also primarily the result of the acquisition of Republic's home video operation in that year. In addition, the Company released \"James A. Michener's TEXAS\" and \"The Stand\" in the domestic home video marketplace in 1994.\nInternational film distribution revenue remained relatively stable in 1995 as compared to 1994 and decreased $4,362,000, or 27%, in 1994 as compared to 1993. During 1995 the Company released the successful film \"The Usual Suspects.\" During 1994 the Company released a group of ten films with the overall title of \"The Young and The Reckless;\" such films individually generated relatively modest levels of revenue. During 1993, the Company released two feature films, \"Short Cuts\" and \"Shadowlands.\"\nLicensing and merchandising revenue decreased $2,316,000, or 13%, in 1995 as compared to 1994 and increased $1,118,000, or 7%, in 1994 as compared to 1993. The decrease in 1995 was primarily due to the continued decline in licensing revenue related to \"Beverly Hills, 90210.\" The increase from 1993 to 1994 was primarily due to revenue related to third-party product, which more than offset a decline in licensing revenue from \"Beverly Hills, 90210.\"\nCertain of the operations of the Company generate significant revenue denominated in foreign currencies, and, as a result, fluctuations in foreign currency exchange rates may affect operating results. In particular, the Company generates revenue denominated in pounds sterling, French francs, deutsche marks, Canadian dollars, Mexican pesos and Japanese yen, among others. These currency exposures are partially offset by the fact that certain of the Company's manufacturing costs and overhead are also denominated in the same currencies, and certain of the Company's bank debt is denominated in foreign currencies.\nENTERTAINMENT PRODUCT COSTS\nEntertainment product costs consist primarily of the amortization of capitalized product costs and the accrual of third-party participations and residuals. (See Note 1.) Such costs increased $36,023,000 and $282,078,000 in 1995 and 1994, respectively, from the comparable prior year periods. The increases primarily resulted from the increases in revenue discussed above, including the increase in worldwide interactive entertainment revenue as a result of the acquisition of VIE. Additionally, the percentage relationship between such costs and the related revenue was 78%, 81% and 73% in 1995, 1994 and 1993, respectively. This percentage relationship is a function of (i) the mix of entertainment product generating revenue in each period and (ii) changes in the projected profitability of individual entertainment product based on the Company's estimates of such product's ultimate revenue and costs. The Company recorded write-downs to net realizable value with respect to its entertainment product of $24,876,000, $25,687,000 and $6,177,000 in 1995, 1994 and 1993, respectively. The write-downs in 1995 were primarily attributable to the Company's continued activities in first-run syndication, delivery by the Company of five television series pilots, which traditionally cost more than the related network license fees, and losses related to interactive titles. The increase in 1994 was primarily attributable to the Company's increased activities in first-run syndication and half-hour comedy programming.\nSELLING, GENERAL AND ADMINISTRATIVE\nSelling, general and administrative costs in 1995 increased $36,733,000, or 56%, as compared to 1994 and in 1994 increased $31,846,000, or 94%, as compared to 1993. The increase in 1995 and 1994 resulted primarily from the\nselling, general and administrative costs related to the operations of VIE and Republic, including the amortization of intangible assets, for the full twelve month period in 1995 and since their respective acquisition dates in 1994. In addition, there were increased administrative costs commensurate with the Company's growth in both years.\nINTEREST INCOME\nInterest income remained relatively stable in 1995 as compared to 1994 and decreased $2,559,000, or 53%, in 1994 as compared to 1993. The decrease in 1994 resulted from (i) lower interest rates on certain international cash balances and (ii) lower discount amortization on certain acquired receivables, as a result of a portion of these receivables being collected in 1994.\nINTEREST EXPENSE\nInterest expense increased $7,623,000, or 89%, and $665,000, or 8%, in 1995 and 1994, respectively. The increase in both years was attributable to higher average borrowings which was partially offset by lower average interest rates. (See Note 4 and \"Financial Condition\" below.) The Company's interest expense is dependent upon the interest rates on its outstanding obligations, which are largely tied to the interest rates under Viacom's separate credit facilities, and the Company could experience significant increases or decreases resulting solely from increases or decreases in such interest rates.\nMINORITY INTEREST\nThe Company had minority interest (income) expense of $(1,382,000) and $680,000 in 1995 and 1994, respectively, relating to the operations of VIE, as it owns approximately 91% of VIE. The Company has put- and call-option agreements with BEG with respect to the remaining minority interest in VIE. (See Note 2.)\nPROVISION FOR INCOME TAXES\nDuring 1995, the Company's provision for income taxes decreased $5,924,000, or 30%, compared to the provision in 1994 due primarily to the decrease in income from continuing operations before income taxes and minority interest, partially offset by an increase in the effective tax rate. The effective tax rate increased to 48% in 1995 from 44% in 1994, largely as a result of the changes in the relationship between revenue and expenses composing income from continuing operations, partially offset by the effect of the reversal of reserves as a result of the favorable settlement of certain tax controversies.\nDuring 1994, the Company's provision for income taxes increased $6,639,000, or 51%, as compared to 1993. The effective tax rate increased to 44% in 1994 from 36% in 1993 primarily as a result of the effect of a non-recurring favorable adjustment to a valuation allowance in 1993 (see below). The provision increased in 1994 largely as a result of the increase in income from continuing operations and the increase in the effective tax rate. (See Note 9.)\nDISCONTINUED OPERATIONS\nThe Company, formerly known as The Charter Company, was engaged in petroleum marketing operations, and in 1992 sold substantially all of the remaining such operations without material gain or loss. The Company continues to sell the few remaining assets of the discontinued operations whenever possible and to resolve remaining claims and liabilities. (See Note 10.)\nThe financial position of the discontinued operations is presented in the balance sheets under the caption \"Net liabilities related to discontinued operations.\" Included in such amounts are certain allowances for estimated expenses related to environmental matters and disputed claims relating to the reorganization in 1986 under Chapter\n11 of the Bankruptcy Code. These allowances totaled approximately $12,194,000 and $20,368,000 at December 31, 1995 and 1994, respectively. (See Note 10.)\nThe Company is involved in a number of legal actions including threatened claims, pending lawsuits and contract disputes, environmental clean-up assessments, damages from alleged dioxin contamination and other matters. Some of the parties involved in such actions seek damages in very large amounts. While the outcome of these suits and claims cannot be predicted with certainty, the Company believes based upon its current knowledge of the facts and circumstances and its understanding of the applicable law that the ultimate resolution of such suits and claims will not have a material adverse effect on the Company's results of operations or financial condition. This belief is also based upon the allowances described above and the Company's coverage under an insurance-type indemnity agreement which covers up to $35 million of certain such liabilities in excess of a threshold amount of $25 million, subject to certain adjustments. Substantial portions of such allowances and indemnity are intended to cover environmental costs associated with the Company's former petroleum operations. Although there are significant uncertainties inherent in estimating environmental liabilities, based upon the Company's experience it is considered unlikely that the amount of possible environmental liabilities and Chapter 11 disputed claims would exceed the amount of the allowances by more than $50 million, a substantial portion of which would be covered by the indemnity discussed above. (See Note 10.)\nIn 1993, the Company had a net loss from discontinued operations of $3,971,000 after an income tax benefit of $2,529,000. This loss resulted primarily from the premium paid for the insurance-type indemnity described above.\nEXTRAORDINARY ITEM\nIn connection with the early extinguishment of certain indebtedness in 1993, the Company recorded an extraordinary loss of $2,022,000 (net of a tax benefit of $1,287,000) from the write-off of remaining unamortized discount and debt issuance costs.\nFINANCIAL CONDITION\nThe Company's operations require the production of entertainment product and the acquisition of distribution rights to entertainment product produced by third parties. The Company's expenditures in this regard totaled $436,373,000 and $444,475,000 in 1995 and 1994, respectively. The cost of producing network television programming is largely funded through the receipt of the related network license fees. The deficit financing of its network programming and the cost of other production and acquisition activities is funded through the Company's operating cash flow and borrowings under its credit arrangements.\nIn connection with the Merger, the Company in October 1993 issued 13,362,215 shares of the Company's Common Stock to BEC in exchange for 3,652,542 shares of BEC common stock. The BEC shares were subsequently resold, with the Company realizing approximately $100,445,000 in proceeds. The Company subsequently used the proceeds to redeem, pay or prepay all its subordinated debt and a substantial portion of its bank debt. (See Notes 2, 4 and 6.) The Company borrowed the funds required to complete the Merger in the second quarter of 1994.\nThe Company's principal credit agreement is with Viacom (the \"Viacom Facility\"). (See Note 4.) The Viacom Facility provides for a three-year term loan facility of $100,000,000 which funded the Company's acquisition of Republic and a revolving credit facility of $140,000,000 (increased in November 1995 from $100,000,000) to fund the Company's working capital and other requirements. Viacom has agreed to provide a further increase of up to $115,000,000 in the amount available under the Viacom Facility and it is anticipated that an amendment reflecting such increase will be executed.\nA wholly-owned subsidiary of VIEL has a multi-currency credit agreement for $100,000,000 with a bank in the U.S. (the \"Credit Agreement\"). As of December 31, 1994, the Company had $5,816,000 in letters of credit outstanding under the Credit Agreement to guarantee its purchases of entertainment product. There were no letters of credit outstanding under the Credit Agreement at December 31, 1995. Viacom has guaranteed all of the borrowings under the Credit Agreement, which are due March 31, 1997. (See Note 4.)\nAnother wholly-owned subsidiary of VIEL has a 10,000,000 pounds sterling credit facility (the \"UK Facility\") with a bank in the United Kingdom, which the Company has guaranteed. The UK Facility matures in 2005. (See Note 4.) As of December 31, 1995, the Company had approximately $2,200,000 in letters of credit outstanding under the UK Facility to guarantee its purchases of entertainment product. Letters of credit outstanding under this facility at December 31, 1994 were not material.\nAs a result of the merger of BEC into Viacom in September 1994, Viacom currently owns approximately 75% of the Company's Common Stock. Pursuant to the separate credit facilities under which Viacom is a borrower, certain subsidiaries of Viacom, including the Company, are restricted from incurring indebtedness (other than indebtedness owing to Viacom) without the prior consent of Viacom's lenders. Such consent has been given with respect to the Credit Agreement and the UK Facility.\nViacom is exploring the sale of the Company. Viacom also has indicated its intent to acquire the Company's interest in VIE in connection with such sale. An independent committee of the Company's board of directors has been formed to negotiate the terms of any proposed VIE transaction. The following table summarizes the revenue and earnings (loss) before interest, taxes, depreciation and amortization (\"EBITDA\") from the operations of VIE:\nThe Company believes that its financial condition remains strong and that it has the financial resources necessary to meet its anticipated capital requirements. The Company expects to have sufficient resources available from the cash provided by operating activities and that available under its credit facility, including the anticipated amendment to the Viacom Facility, to meet its ongoing plans for the production and acquisition of entertainment product and to take advantage of internal and external development and growth opportunities. A change in control of the Company, which would result from a sale of the Company (see Note 1), constitutes an event of default under the Viacom Facility and would accelerate any outstanding borrowings under the Viacom Facility. The Company expects the resolution of these matters would be negotiated in connection with any proposed sale of the Company.\nRECENTLY ISSUED ACCOUNTING STANDARDS\nIn 1995, the Financial Accounting Standards Board (\"FASB\") issued Statement of Financial Accounting Standards (\"SFAS\") No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,\" and SFAS No. 123, \"Accounting for Stock-Based Compensation,\" both effective for fiscal years beginning after December 15, 1995. Management does not anticipate either statement will have a material effect on the Company's results of operations or financial condition. (See Notes 1 and 6.)\nIn 1994, the American Institute of Certified Public Accountants issued Statement of Position (\"SOP\") 94-6, \"Disclosure of Certain Significant Risks and Uncertainties,\" effective for fiscal years ending after December 15, 1995. The Company adopted SOP 94-6 in the accompanying financial statements. (See Note 1.)\nEffective January 1994, the Company became subject to SFAS No. 112, \"Employers' Accounting for Postemployment Benefits,\" and SFAS No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" SFAS No. 112 did not have an effect on the Company's results of operations or financial condition\nbecause the Company does not provide such benefits. However, the adoption of SFAS No. 115 required the Company to adjust the carrying value of a common stock investment to fair market value with a corresponding adjustment, net of tax, to its Shareholders' Equity. (See Notes 1 and 6.)\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nINDEX\nREPORT OF INDEPENDENT ACCOUNTANTS\nTO THE BOARD OF DIRECTORS AND SHAREHOLDERS OF SPELLING ENTERTAINMENT GROUP INC.\nWe have audited the accompanying consolidated balance sheets of Spelling Entertainment Group Inc. (a Delaware Corporation) and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations, of shareholders' equity and of cash flows for the years then ended. These financial statements and the financial statement schedule for the years ended December 31, 1995 and 1994 listed in the index at Item 14 (a) 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 audited by us present fairly, in all material respects, the financial position of Spelling Entertainment Group Inc. and subsidiaries as of December 31, 1995 and 1994, and the results of their operations and their cash flows for the years then ended in conformity with generally accepted accounting principles.\nOur audits also included an audit of the financial statement schedule listed in item 14(a) of this Form 10-K. In our opinion, this financial statement schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.\nPRICE WATERHOUSE LLP\nLos Angeles, California February 6, 1996\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTO SPELLING ENTERTAINMENT GROUP INC.\nWe have audited the accompanying consolidated balance sheet of Spelling Entertainment Group Inc. (a Delaware Corporation) and subsidiaries as of December 31, 1993 (not presented herein), and the related consolidated statements of operations, shareholders' equity, and cash flows for the year then ended. These financial statements and the schedule for the year ended December 31, 1993 listed in the index at Item 14 (a) 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 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 Spelling Entertainment Group Inc. and subsidiaries as of December 31, 1993, and the results of their operations and their cash flows for the year then ended in conformity with generally accepted accounting principles.\nOur audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule for the year ended December 31, 1993 listed in the index at Item 14 (a) 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\nLos Angeles, California February 1, 1994\nSPELLING ENTERTAINMENT GROUP INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA)\nThe accompanying Notes to Consolidated Financial Statements are an integral part of these statements.\nSPELLING ENTERTAINMENT GROUP INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA)\nThe accompanying Notes to Consolidated Financial Statements are an integral part of these statements.\nSPELLING ENTERTAINMENT GROUP INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (IN THOUSANDS, EXCEPT NUMBER OF SHARES)\nThe accompanying Notes to Consolidated Financial Statements are an integral part of these statements.\n(a) Includes 9,000 shares of preferred stock at $9,000,000 which were redeemed in 1993.\nSPELLING ENTERTAINMENT GROUP INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)\nThe accompanying Notes to Consolidated Financial Statements are an integral part of these statements.\nSPELLING ENTERTAINMENT GROUP INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBASIS OF PRESENTATION. The consolidated financial statements present the consolidated financial position and results of operations of Spelling Entertainment Group Inc. and subsidiaries (the \"Company\" or \"Spelling\"). All material intercompany accounts and transactions have been eliminated. Certain reclassifications have been made to prior periods to conform to the current year's presentation.\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could subsequently differ from those estimates.\nAssets and liabilities of international operations are translated at year end rates of exchange while results of operations are translated at average rates of exchange in effect for the applicable period. Translation gains or losses are shown as a separate component of Shareholders' Equity.\nSee Note 2 regarding the acquisition of Republic Entertainment Inc. (formerly Republic Pictures Corporation, together with its subsidiaries, \"Republic\") and Virgin Interactive Entertainment Limited (\"VIEL,\" together with its subsidiaries, \"VIE\").\nUntil March 31, 1993, American Financial Corporation and subsidiaries (\"AFC\") owned 24,594,215 shares (48%) of the Company's common stock, $.10 par value (\"Common Stock\"), and 9,000 shares (100%) of the Company's preferred stock, $.10 par value (\"Preferred Stock\"); at that date, AFC sold the shares of Common Stock to Blockbuster Entertainment Corporation (\"BEC\"). Subsequently, BEC increased its ownership to 67,673,702 shares of the Company's Common Stock. (See Note 6.) On September 29, 1994, BEC merged with and into Viacom Inc. (\"Viacom\"), with Viacom being the surviving corporation. As a result of the merger, Viacom currently owns approximately 75% of the Company's Common Stock.\nEffective May 26, 1995, the Company changed its place of incorporation from Florida to Delaware by merging into a newly-formed Delaware corporation. As a result of the Company's reincorporation, each share of the Company's common stock then issued was converted into and exchanged for one share of common stock, par value $.001 per share, of the Delaware corporation. There was no change in the business, properties or management of the Company as a result of this reincorporation.\nViacom is exploring the sale of the Company. Viacom also has indicated its intention to acquire the Company's interest in VIE in connection with such sale. An independent committee of the Company's board of directors has been formed to negotiate the terms of any proposed VIE transaction.\nCASH AND CASH EQUIVALENTS. Cash equivalents consist of interest-bearing securities with original maturities of less than ninety days.\nACCOUNTS RECEIVABLE, NET. Accounts receivable are net of allowances for doubtful accounts and returns of $30,357,000 and $35,218,000 at December 31, 1995 and 1994, respectively.\nENTERTAINMENT PRODUCT, NET. Entertainment product, net, includes production or acquisition costs (including advance payments to producers), capitalized overhead and interest, home video and interactive manufacturing costs, and prints, advertising and other related distribution costs expected to benefit future periods. These costs are amortized, and third-party participations and residuals are accrued, generally on an individual product basis in the ratio that current year gross revenue bears to estimated future gross revenue. Domestic syndication and basic cable revenue estimates are not included in estimated future gross revenue of television programming until such sales are probable.\nSPELLING ENTERTAINMENT GROUP INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nEntertainment product, net, is stated at the lower of cost less amortization or estimated net realizable value. Estimates of total gross revenue, costs and participations are reviewed quarterly and revised as necessary. When estimates of total revenue and costs indicate that an individual product will realize an ultimate loss, additional amortization is provided to fully recognize such loss in that period.\nPROPERTY AND EQUIPMENT, NET. The carrying values of property and equipment are based on cost, and provision for depreciation is made principally on the straight-line method over estimated useful lives, ranging from 5 to 10 years. Property and equipment are net of accumulated depreciation of $15,137,000 and $10,160,000 at December 31, 1995 and 1994, respectively.\nOTHER ASSETS. Included in other assets is a common stock investment at a carrying value (at fair value) of $5,480,000 and $8,712,000 at December 31, 1995 and 1994, respectively. (Viacom owns a significant number of shares in the same company, accounted for under the equity method.) The Financial Accounting Standards Board (\"FASB\") issued Statement of Financial Accounting Standards (\"SFAS\") No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" which became effective in 1994. This statement requires the Company to adjust the carrying value of this asset, which is classified as \"available for sale\" under the applicable provisions of SFAS No. 115, to fair market value based on its over-the-counter market price, with a corresponding adjustment, net of tax, to Shareholders' Equity. It is not clear that the Company could realize such a value if the investment were to be sold due to the low trading volume of such shares relative to the number of shares owned by the Company.\nINTANGIBLE ASSETS, NET. Intangible assets represent the acquisition costs of Spelling Entertainment Inc., Republic and VIE in excess of the value of their identified net assets. (See Note 2.) These costs are being amortized on a straight-line basis over 40 years. Amortization expense relating to such intangible assets was $10,352,000, $7,144,000 and $3,825,000 for the three years ended December 31, 1995, respectively. Intangible assets are net of accumulated amortization of $28,023,000 and $17,671,000 at December 31, 1995 and 1994, respectively. It is the Company's policy to evaluate the carrying value of such costs on a regular basis, and to recognize impairment if it becomes probable that such costs would not be recoverable. In March 1995, the FASB issued SFAS No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,\" which the Company will be required to adopt in 1996. SFAS No. 121 establishes accounting standards for the impairment of long-lived assets, certain identifiable intangibles and goodwill related to those assets to be held and used and for long-lived assets and certain identifiable intangibles to be disposed of. The Company does not anticipate the adoption of this statement will have a material effect on the Company's results of operations or financial condition.\nDEFERRED REVENUE. A substantial portion of the network license fees related to television programming are received prior to the time the programming is completed or delivered to the network. Such fees, and other monies received prior to the time that the related entertainment product is available to the licensee, are recorded on the balance sheet as deferred revenue. Such amounts are normally repayable by the Company only if it fails to deliver the related product to the licensee.\nREVENUE RECOGNITION. Revenue from licensing agreements covering entertainment product owned by the Company is recognized when the entertainment product is available to the licensee for telecast, exhibition or distribution, and other conditions of the licensing agreements have been met. Long-term noninterest-bearing receivables arising from such agreements are discounted to present value. Prior to 1995, revenue from television distribution of entertainment product not owned by the Company was recognized as billed. In the first quarter of 1995, the Company conformed its accounting policies, with respect to SFAS No. 53, to those of Viacom.\nRevenue from direct distribution of home video and interactive entertainment product is recognized, net of an allowance for estimated returns and discounts, together with related costs, in the period in which the product is shipped to the Company's customers.\nSPELLING ENTERTAINMENT GROUP INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nACCOUNTING FOR ENVIRONMENTAL MATTERS. The allowances for estimated expenses and disputed claims reported in Note 10 include accruals for environmental liabilities, including anticipated remediation costs of properties held for sale. Such accruals are determined independently of the estimated net realizable value of any related asset, and are recorded without discount or offset for either (i) time value of money prior to the anticipated date of payment, or (ii) expected recoveries from insurance or contribution claims against unaffiliated entities. The allowances are reviewed quarterly and revised as necessary.\nNET INCOME PER COMMON AND COMMON EQUIVALENT SHARE. Net income per common and common equivalent share amounts are based on the weighted average common and common equivalent shares outstanding during the respective period. Primary and fully-diluted net income per common and common equivalent share are not presented as they result in a dilution of less than 3% from basic net income per common and common equivalent share.\n2. BUSINESS COMBINATIONS AND ACQUISITIONS\nOn April 26, 1994, DE Acquisition Corporation, a wholly-owned subsidiary of the Company, merged with and into Republic (the \"Merger\"). As a result of the Merger, Republic became a wholly-owned subsidiary of the Company, and each share of the common stock of Republic (the \"Republic Common Stock\") outstanding immediately prior to the Merger was converted into the right to receive $13.00 in cash, without interest.\nImmediately prior to the Merger, BEC owned 2,550,000 shares of Republic Common Stock and warrants to purchase 810,000 additional shares of Republic Common Stock at an exercise price of $11.50 per share. In accordance with the terms of the Merger, the Company purchased the 2,550,000 shares of Republic Common Stock from BEC for $33,150,000, and the warrants owned by BEC were converted into warrants to purchase 1,337,148 shares of the Company's Common Stock at an exercise price of $6.97 per share. Certain other parties held warrants to purchase 500,000 shares of Republic Common Stock at an exercise price of $12.50 per share. In accordance with the terms of the Merger, these warrants were converted into warrants to purchase 825,400 shares of the Company's Common Stock at an exercise price of $7.57 per share, of which 725,400 were exercised in December 1995. (See Note 6.)\nOn July 30, 1994, the Company and BEC entered into an exchange agreement (the \"Exchange Agreement\") and consummated the transactions contemplated thereby (the \"Acquisition\"). Pursuant to the Exchange Agreement, BEC delivered to the Company 8,686,984 ordinary shares (the \"Ordinary Shares\") of VIEL and an option to acquire 550,000 Ordinary Shares of VIEL (collectively, the \"VIE Interests\") in exchange for 22,015,062 shares of the Company's Common Stock. BEC had acquired a majority of the VIE Interests from third parties on July 29, 1994. As a result of the Acquisition, the Company acquired approximately 91% of VIEL's Ordinary Shares. (See Note 6.)\nIn connection with the Acquisition, the Company also entered into put- and call-option agreements with respect to the Ordinary Shares of VIEL not owned by the Company. Under these agreements, the Company may acquire, or be required by Blockbuster Entertainment Group, a division of Viacom (\"BEG\"), to purchase, these shares from BEG at an agreed-upon price. At the option of the Company, such purchase price may be paid in cash or shares of the Company's Common Stock. On June 8, 1995, BEG acquired the remaining Ordinary Shares of VIEL not owned by the Company for approximately $22,973,000 plus other costs associated with the transaction. BEG and the Company have executed amendments to extend the put- and call-option agreements, which originally expired in July 1995, through May 5, 1996. See Note 1 regarding the potential sale of VIE to Viacom.\nSPELLING ENTERTAINMENT GROUP INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nThe Company has accounted for the Merger and the Acquisition under the purchase method of accounting. However, with respect to the Merger, the Company has recorded an adjustment of $6,670,000 to Shareholders' Equity to reflect the excess of the cash consideration paid for BEC's ownership interest in Republic Common Stock (see above) over BEC's carrying value for such interest. (See Note 6.) Further, because BEC controlled both the Company and VIE at the time of the Acquisition, the Company's purchase price for the VIE Interests has been determined by reference to the purchase price paid by BEC for the VIE Interests.\nThe assets and liabilities of Republic and VIE are included in the accompanying consolidated balance sheets as of December 31, 1995 and 1994 at fair value, with the differences between the total purchase price and such fair values being included in intangible assets. The excess of the purchase price over net assets and liabilities acquired is being amortized on a straight-line basis over forty years.\nThe results of operations of Republic since April 26, 1994, and the results of operations of VIE since July 30, 1994, are included in the accompanying consolidated statements of operations. The following table presents the unaudited pro forma results of operations assuming that the Merger and the Acquisition had both occurred on January 1, 1993 (in thousands, except per share amounts).\nThe pro forma results set forth in the preceding tables are not necessarily indicative of the results that would have been realized had these transactions actually taken place on the applicable dates or of the results which may occur in the future.\n3. ENTERTAINMENT PRODUCT, NET\nEntertainment product, net, is comprised of the following at December 31 (in thousands):\nEntertainment product rights include advances to producers for distribution rights and other entertainment product not produced by the Company.\nBased on the Company's estimates of future gross revenue as of December 31, 1995, approximately 70% of unamortized released entertainment product and entertainment product rights will be amortized during the three years ending December 31, 1998.\nSPELLING ENTERTAINMENT GROUP INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n4. DEBT\nDebt consisted of the following at December 31 (in thousands):\nIn January 1994, the Company entered into a three-year credit agreement with BEC. As a result of the merger of BEC with and into Viacom, Viacom succeeded to BEC's position under the credit agreement (the \"Viacom Facility\"). This agreement was amended and restated in January 1995 to reflect certain amendments to the facility which were effective as of December 7, 1994, including a $25,000,000 increase in the amount available under the facility. In November 1995, the agreement was again amended to provide a further $40,000,000 increase in the amount available under the Viacom Facility. The Viacom Facility, as amended, provides for (i) a term loan of $100,000,000 which funded the Company's merger with Republic (see Note 2) and (ii) a revolving credit facility of $140,000,000 to fund the Company's working capital and other requirements. All outstanding borrowings mature on March 31, 1997. Viacom has agreed to provide a further increase of up to $115,000,000 in the amount available under the Viacom Facility and it is anticipated that an amendment reflecting such increase will be executed.\nUnder the Viacom Facility, the Company pays an annual fee (currently 0.3125%) based on the unused portion of the facility, as well as certain facility and administration fees, all based on the similar fees payable by Viacom under its separate credit facilities. Interest on all outstanding borrowings is payable, at the Company's option, at LIBOR plus a spread (currently 1.0%) or at prime rate; both rates are principally determined by reference to the corresponding rates payable by Viacom under its separate credit facilities. Borrowings under the Viacom Facility are secured by all of the assets of the Company and its domestic subsidiaries and the entire amount outstanding under the Viacom Facility may be accelerated if Viacom's borrowings under its separate credit facilities were to be accelerated. Borrowings under the Viacom Facility will be accelerated in the event of a \"change in control,\" as defined in the Viacom Facility, of the Company. (See Note 1.)\nOn December 23, 1993, a wholly-owned subsidiary of VIEL established a multi-currency credit agreement with a bank in the U.S. (the \"Credit Agreement\"). The Credit Agreement initially provided for maximum borrowings of $15,000,000, subject to a borrowing base test. Following the Acquisition, the amount of borrowings allowable under the Credit Agreement was increased to $75,000,000, and the borrowing base test and other ratio tests were eliminated, based on the guarantee of all borrowings under the Credit Agreement by BEC (now Viacom). During 1995, the borrowings allowable under the Credit Agreement were increased to $100,000,000 and the term was extended to March 31, 1997. Interest is payable monthly at the bank's reference rate or, at the Company's option, certain alternative rates. Additionally, the Company must pay a commitment fee of 0.125% on the unused portion of the available credit. As of December 31, 1994, the Company had approximately $5,816,000 in letters of credit outstanding under the Credit Agreement to guarantee its purchases of interactive entertainment product. There were no letters of credit outstanding under the Credit Agreement at December 31, 1995.\nOn September 8, 1993, another wholly-owned subsidiary of VIEL established a 5,000,000 pounds sterling credit facility (the \"UK Facility\") with a bank in the United Kingdom. On April 12, 1994, the UK Facility was increased to 10,000,000 pounds sterling, based in part on the personal guarantee of two of the directors of the subsidiary.\nSPELLING ENTERTAINMENT GROUP INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nFollowing the Acquisition, the Company guaranteed the UK Facility and the guarantees of the two directors were terminated. (See Note 2.) Advances under the credit facility bear interest at the bank's prime rate plus 1.5%. The UK Facility matures on April 30, 2005. As of December 31, 1995, the Company had approximately $2,200,000 in letters of credit outstanding under the UK Facility to guarantee its purchases of entertainment product. Letters of credit outstanding under this facility at December 31, 1994 were not material.\nAs of December 31, 1994, the Company had several other credit facilities, all of which were paid off and terminated during the first quarter of 1995. As of December 31, 1993, the Company had a credit facility with a group of banks. This facility was terminated in January 1994 when the Company entered into the Viacom Facility. In 1993, the Company redeemed, paid or prepaid all of its subordinated debt and a substantial portion of its bank debt. (See Note 5.)\nPursuant to the separate credit facilities under which Viacom is a borrower, certain subsidiaries of Viacom, including the Company, are restricted from incurring indebtedness (other than indebtedness owing to Viacom) without the prior consent of Viacom's lenders. Such consent has been given with respect to the Credit Agreement and the UK Facility.\nThe Company made cash interest payments of $13,514,000 in 1995, $8,436,000 in 1994 and $7,800,000 in 1993.\nAt December 31, 1995, the carrying value of all of the Company's debt approximated fair value.\n5. EXTRAORDINARY ITEM\nFor the year ended December 31, 1993, the Company recorded an extraordinary loss of $2,022,000, net of a benefit for income taxes of $1,287,000, as a result of the write-off of unamortized discount and debt issuance costs relating to the early extinguishment of certain indebtedness. (See Note 4.)\n6. SHAREHOLDERS' EQUITY\nPREFERRED STOCK. At December 31, 1995 and 1994, there were 20,000,000 shares of Preferred Stock authorized but none outstanding. In November 1993, the Company redeemed all 9,000 shares then outstanding of the Series A Preferred Stock, with a dividend yield of 9% and a liquidation value of $1,000 per share.\nCOMMON STOCK. Effective May 26, 1995, in connection with the reincorporation of the Company in Delaware, the par value of its Common Stock was reduced from $0.10 per share to $0.001 per share. The Company recorded an adjustment of $8,744,000 to Common Stock in order to reflect this reduction, with a corresponding increase to Capital in Excess of Par Value. (See Note 1.)\nThe Company declared and paid cash dividends on its Common Stock of $.06 and $.08 for the years ended December 31, 1994 and 1993, respectively. Dividends were discontinued by the Board of Directors as of the fourth quarter of 1994.\nAt the Company's Annual Meeting of Shareholders on May 18, 1994, the shareholders approved an increase in the number of authorized shares of the Company's Common Stock from 200,000,000 to 300,000,000.\nSee Note 2 regarding the existence of certain warrants to purchase 1,437,148 shares of Common Stock.\nSPELLING ENTERTAINMENT GROUP INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nSALE OF COMMON STOCK. In October 1993, in connection with the negotiation of the Merger (see Note 2.), the Company sold 13,362,215 shares of its Common Stock to BEC in exchange for 3,652,542 shares of BEC's common stock. The BEC shares were subsequently sold, with the Company realizing approximately $100,445,000 in cash proceeds.\nISSUANCE OF COMMON STOCK. See Note 2 regarding the issuance of 22,015,062 shares of the Company's Common Stock in connection with the acquisition of VIE.\nCAPITAL IN EXCESS OF PAR VALUE. See Note 2 regarding adjustments to the accumulated deficit related to the acquisition of Republic Common Stock from BEC. An adjustment of $4,318,000 has been recorded to Capital in Excess of Par Value to reflect the tax benefit obtained by the Company with respect to nonqualified stock options exercised by its employees. (See Note 10.)\nACCUMULATED DEFICIT. See Note 10 regarding adjustments to the accumulated deficit related to the Company's pension plan and Note 1 regarding adjustments related to a common stock investment.\nSTOCK OPTIONS. The Company has stock option plans under which both incentive and nonqualified stock options may be granted to certain key employees and directors to purchase up to approximately five million shares of Common Stock. Options may be granted at a price not less than the fair value of the underlying Common Stock on the date of grant, in the case of incentive stock options, or 50% thereof, in the case of nonqualified options. Each option may be granted subject to various terms and conditions established on the date of grant, including exercise and expiration dates; provided, however, that all options will expire no later than ten years from their date of grant. The options typically become exercisable at the rate of 20% or 25% annually, beginning one year after the date of grant. Stock option data follows:\nIn connection with the Merger and the Acquisition, the Company converted outstanding options under the respective stock option plans of Republic and VIE to options to purchase the Company's Common Stock, which are included in options granted in the 1994 table above.\nOptions to acquire shares of Republic common stock outstanding under the Republic stock options plan(s) were converted into the right to receive, upon payment of the exercise price as adjusted, 1.6508 shares of the Company's Common Stock for each share of Republic common stock into which such option was exercisable. The exercise price of Republic options was adjusted by multiplying such exercise price by .6058.\nSPELLING ENTERTAINMENT GROUP INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nOptions to acquire ordinary shares of VIE were converted into the right to receive, upon payment of the adjusted exercise price, shares of the Company's Common Stock. A conversion ratio of 2.4022 was determined based on the relative fair values of the ordinary shares to the shares of the Company's Common Stock at that time. The exercise price of VIE options was adjusted by dividing by the conversion ratio.\nThe times at which the previously outstanding Republic and VIE options may be exercised remains unchanged. No additional options may be granted pursuant to the pre-existing Republic and VIE plans, and the issuance of options to acquire the Company's Common Stock to Republic and VIE plan participants did not reduce the amounts available under the Company's current plans.\nIn October 1995, the FASB issued SFAS No. 123, \"Accounting for Stock-Based Compensation,\" which establishes a fair value based method of accounting for compensation cost related to stock option plans and other forms of stock-based compensation plans as an alternative to the intrinsic value based method of accounting defined under Accounting Principles Board Opinion No. 25. Companies that do not elect the new method of accounting for 1996 will be required to provide proforma disclosures as if the fair value based method had been applied for the current period and prior comparable period. The Company intends to adopt SFAS No. 123 by providing the pro forma disclosures.\n7. BENEFIT PLANS\nEffective January 1, 1993, the Company adopted a 401(k) Contribution Plan (the \"Plan\"). Expenses under the various employee retirement plans were $1,494,000, $1,564,000 and $915,000 for the three years ended December 31, 1995, 1994 and 1993, respectively. The Company's matching contribution to the Plan and its discretionary profit-sharing contributions to the Plan are made in cash and are restricted to investment in the Company's Common Stock, which is purchased by the Plan's trustee in the open market.\nA significant number of the Company's production employees are covered by union sponsored, collectively bargained, multi-employer pension plans. The Company contributed approximately $9,044,000, $8,771,000 and $4,259,000 to such plans for the three years ended December 31, 1995, 1994 and 1993, respectively.\nThe FASB has issued SFAS No. 112 \"Employers' Accounting for Postemployment Benefits\" (effective in 1994). The Company does not provide any postemployment benefits.\n8. RELATED PARTY TRANSACTIONS\nSee Note 4 regarding the Company's credit facility with Viacom and Viacom's guarantee of the Company's credit agreement with a bank. The Company was charged interest and fees by Viacom of $13,558,000 and $3,016,000\nSPELLING ENTERTAINMENT GROUP INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nfor the years ended December 31, 1995 and 1994, respectively. The Company was charged interest and fees by BEC of $4,787,000 for the year ended December 31, 1994.\nSee Note 6 regarding the Company's sale and issuance of Common Stock to BEC in 1994 and 1993, respectively.\nFrom their issuance in May 1991 until their repayment in October 1993, a director of the Company held $18,287,500 principal amount of the Company's 10% Senior Subordinated Notes. The Company paid $1,791,000 in interest on these obligations during 1993.\nDuring 1993, the Company paid AFC a premium of $5,000,000 for an insurance-type indemnity against up to $35,000,000 of certain costs it may have to pay in excess of $25,000,000, subject to certain adjustments, in resolving environmental and bankruptcy related claims through March 31, 2005. (See Note 10.)\nAFC provided the Company with management services during early 1993 for which the Company was charged $1,283,000. BEC, and subsequently BEG, provided similar services to the Company in 1993, 1994 and 1995, for which the Company was charged $380,000, $500,000 and $600,000, respectively. As of December 31, 1995 the Company had a net payable to Viacom of $1,264,000 with respect to these and other expenses.\nDuring 1995, 1994 and 1993, the Company sold home video and interactive entertainment product to BEG. Additionally, prior and subsequent to the merger of BEC into Viacom, the Company licensed certain entertainment product to (i) Showtime Networks Inc., a subsidiary of Viacom, (ii) certain television stations owned by Viacom, and (iii) USA Network and Sci-Fi Channel in which Viacom has equity interests. For the three years ended December 31, 1995, these transactions are not material.\nRepublic has entered into agreements with, and in certain cases has advanced funds to, BEG, Showtime and Viacom to distribute certain of their productions in the home video market.\nThe Company has entered into agreements with Paramount Pictures Corporation (\"Paramount\") with respect to the domestic distribution of two of the Company's upcoming feature film releases, \"Night Falls on Manhattan\" and \"Stephen King's Thinner,\" in the theatrical, non-theatrical and pay television markets.\nIn the ordinary course of business, the Company has and expects to continue to do business with Viacom and its affiliates, including BEG, Showtime, Nickelodeon and Paramount.\n9. INCOME TAXES\nThe provision for income taxes for continuing operations, discontinued operations and extraordinary item for each of the three years ended December 31 include (in thousands):\nSPELLING ENTERTAINMENT GROUP INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nIn 1995, an income tax benefit attributable to employee stock option transactions was allocated to shareholders' equity. (See Note 6.)\nEffective January 1, 1993, the Company adopted SFAS No. 109, \"Accounting for Income Taxes\" (\"SFAS 109\"). SFAS 109 requires an asset and liability approach in accounting for income taxes. Under this method, deferred income taxes are recognized, at enacted rates, to reflect the future effects of tax loss and credit (\"tax attribute\") carryforwards and temporary differences arising between the tax bases of assets and liabilities and their financial reporting amounts at each year-end. Deferred tax assets and liabilities are adjusted for tax rate changes when they occur. This statement also eliminated the concept of recognizing the benefits of subsequent period utilization of tax attribute carryforwards as extraordinary items, by requiring the immediate recognition of attributes in the year incurred, subject to realization. The cumulative effect of adopting SFAS 109 was not material.\nThe temporary differences and tax attribute carryforwards which gave rise to deferred tax assets and liabilities at December 31, 1995 and 1994 were as follows (in thousands):\nSPELLING ENTERTAINMENT GROUP INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nIn connection with adopting SFAS 109, the Company established a valuation allowance against certain of its tax attribute carryforwards. During 1993, the Company reassessed (under the criteria of SFAS 109) the realizability of the tax attribute carryforwards in light of factors arising from, or related to, the acquisition of a majority of the Company's Common Stock by BEC. Based on this reassessment, the Company reduced the valuation allowance by approximately $4,200,000 and reflected a corresponding benefit in its provision for income taxes for the third quarter of 1993.\nThe increase in the valuation allowance in 1994 was caused by the acquisition of VIE, which had previously recorded an allowance in the amount of $2,153,000, which the Company has determined is reasonable.\nThe further increase in the valuation allowance during 1995 was due to the Company's determination that certain additional tax attribute carryforwards recorded in 1995 are not realizable under a more likely than not standard, partially offset by a reduction in the valuation allowance attributable to the expiration of certain foreign tax credit carryforwards during the year.\nThe components of income from continuing operations before the provision for income taxes in 1995, 1994 and 1993 were as follows (in thousands):\nThe primary reasons for the effective tax rates on the income from continuing operations differing from the statutory federal tax rates for each of the three years ended December 31 are summarized as follows:\nAs of December 31, 1995, the Company had available net operating loss carryforwards of approximately $63,712,000, capital loss carryforwards of $4,829,000, foreign tax credit carryforwards of $5,217,000, investment tax credit carryforwards of $4,677,000 and AMT credit carryforwards of $3,963,000. The use of these attributes, which except for the AMT credit will expire in 1996 through 2007, is subject to certain limitations as a result of BEC's acquisition of a majority interest in the Company during 1993.\nSPELLING ENTERTAINMENT GROUP INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nTotal cash income tax payments were $11,798,000, $7,661,000 and $6,300,000, respectively for 1995, 1994 and 1993. In addition, the Company received $1,116,000 and $8,950,000 of income tax refunds during 1995 and 1994, respectively, the receipt of which had previously been accrued. However, the Company did recognize benefits of $1,740,000 and $547,000 during 1995 and 1994, respectively, as a result of the favorable resolution of certain tax controversies. Additionally, the Company is subject to audit by taxing authorities for varying periods in various tax jurisdictions. Management believes that any required adjustments to the Company's tax liabilities resulting from such audits will not have a material adverse impact on its financial position or results of operations.\n10. DISCONTINUED OPERATIONS\nAll of the Company's former industry segments are reported as discontinued. For the year ended December 31, 1993, the Company reported a net loss from discontinued operations of $3,971,000, net of an income tax benefit of $2,529,000, primarily as a result of a one-time payment for an insurance-type indemnity agreement (see discussion below). This resulted in a net loss from discontinued operations of $0.07 per common and common equivalent share.\nNet assets (liabilities) of discontinued operations which are held for disposition consisted of the following at December 31 (in thousands):\nCONTINGENCIES. Contingent liabilities relating to discontinued operations include contract disputes, remaining disputed claims under the joint plan of reorganization of the Company and certain of its subsidiaries (the \"Joint Plan\"), environmental clean-up assessments, damages from alleged dioxin contamination and others. Some of the parties seek damages from the Company in very large amounts, however, as discussed below, management does not believe the ultimate resolution of these matters should have a material adverse effect on its financial condition and its results of operations.\n(A) The Company and its insurers paid approximately $15.5 million and $33 million, respectively, over a ten year period to resolve government and private party actions arising from the alleged improper disposal by a subsidiary in 1971 of waste material, which later was determined to contain dioxin, at a number of sites in Missouri. The Company has written off its investment in the subsidiary. The Company filed an action against its insurers to secure coverage for the dioxin claims. In 1995 there was a final determination of that action, holding that the insurers had no further coverage obligation. The only remaining claim against the Company is by a codefendant, which also has spent substantial amounts in respect of the dioxin claims and which filed a $200,000 proof of claim in the Company's Chapter 11 proceedings in 1986. The Company believes it has defenses to such claim, and that future claims are unlikely.\nSPELLING ENTERTAINMENT GROUP INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(B) The Company has had contact with various governmental agencies regarding possible contamination of soil and groundwater at six properties that are or have been owned or leased by the Company's subsidiaries. Private actions also have been brought or threatened with respect to such possible contamination at an additional two locations. Notification of possible responsibility has also been received regarding nine other sites where waste materials allegedly were delivered. The Company may be assessed for cleanup costs or damages under relevant environmental laws, and future claims could be asserted with respect to other properties. The Company's liability insurers have been placed on notice of many of these claims and have taken the position that there is no coverage under their policies. While the Company does not agree that coverage is not available under its past policies, there is no assurance that pending or future claims will be covered by such insurance. Although comprehensive evaluations of liability and of the extent of contamination have not been performed in all cases, the following claims are believed by the Company at this time to be potentially the most significant.\nA subsidiary is engaged in the cleanup of a petroleum terminal property owned by the subsidiary in Tiverton, Rhode Island. The remaining cost could be in the range of $6.5 million, which is fully provided for in the allowances for estimated expenses for environmental matters. The subsidiary has filed a cost recovery action against two former owners of the terminal, and is continuing to investigate whether its insurers may be liable for a portion of the cost. A third former owner has resolved its potential liability at the site by agreeing to pay the Company $800,000.\nIn 1990, a subsidiary declined to join a settlement agreement among the United States, a state government and 15 companies regarding the Sullivan's Ledge superfund site in New Bedford, Massachusetts, based upon certain legal defenses and the belief that any liability the subsidiary may have should be less than a pro rata allocation among the settling parties. Under such agreement, the subsidiary would have been obligated to pay between $2 million and $3 million in cleanup costs. The subsidiary subsequently settled its liability to the United States separately for $215,000, but is appealing the requisite court approval thereof because the court did not determine whether such separate settlement provides a defense to a private cost recovery action filed by the 15 parties to the original agreement who are performing the cleanup.\nA subsidiary has been informed that it is one of thirteen identified potentially responsible parties at the Sikes superfund site in Crosby, Texas, and that a cleanup plan estimated to cost approximately $89 million has been selected and is being implemented by the EPA. Although joint and several liability is possible with respect to such sites, and there is little relevant information presently available, management believes that there are meritorious defenses against any material liability.\nWhile the results of such actions cannot be predicted with certainty, based upon its current knowledge of the facts and circumstances and its understanding of the applicable laws, the Company believes the ultimate resolution of these matters should not have a material adverse effect on its financial condition and its results of operations. This belief is also based upon (i) allowances that have been established for estimated expenses related to environmental matters and remaining Chapter 11 disputed claims (see table above), and (ii) an insurance-type indemnity agreement with AFC. Although there are significant uncertainties inherent in estimating environmental-related liabilities, based upon the Company's experience it is considered unlikely that the amount of possible environmental liabilities and Joint Plan disputed claims would exceed the amount of the allowances by more than $50 million, a substantial portion of which would be covered by the AFC indemnity.\nThe AFC indemnity, which was agreed to in exchange for a one-time payment of $5 million expensed by the Company as part of discontinued operations in the first quarter of 1993, provides for the reimbursement to the Company of liabilities it may have to pay in resolving environmental and bankruptcy related claims through March 31,\nSPELLING ENTERTAINMENT GROUP INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n2005. The indemnity covers up to $35 million of such liabilities in excess of a threshold amount of $25 million, subject to certain adjustments.\nPENSION PLAN. The Company has a noncontributory, defined benefit pension plan which covers employees of the discontinued operations, a significant number of which have vested benefits. Contributions are made on an actuarial basis in amounts primarily based on employees' years of service and average salary when employed.\nIn 1993, the Company recorded an additional minimum pension liability of $5,217,000 (net of a tax benefit of $3,321,000), with an offsetting charge to Shareholders' Equity, to reflect the adjustment to pension liability resulting from the reduction in the discount rate from 8.5% in 1992 to 7% in 1993. An increase in the discount rate to 8.25% resulted in an adjustment to reduce the additional minimum liability and related tax benefit with an offsetting credit to Shareholders' Equity of $380,000 in 1994. The additional minimum pension liability was further reduced in 1995 by $829,000 (net of a tax benefit adjustment of $519,000) with an offsetting credit to Shareholders' Equity.\nThe following table sets forth the plan's funded status and amounts recognized as of December 31 (in thousands):\nDuring 1994, the Company transferred all obligations and assets relating to annuities guaranteed by insurance to a third party. Such obligations or assets are therefore not reflected in the plan balances on December 31, 1994.\nNet pension costs for the years ended December 31, which were charged against net liabilities related to discontinued operations in the balance sheet, are as follows (in thousands):\nThe weighted-average discount rates used in determining the actuarial present value of the projected benefit obligation were 7%, 8.25% and 7% for the years ended December 31, 1995, 1994 and 1993, respectively. The expected long-term rates of return on assets were 8%, 8% and 9%, respectively. The plan assets are invested\nSPELLING ENTERTAINMENT GROUP INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nprimarily in fixed income securities. Included in the plan assets at December 31, 1993, was $5.5 million principal amount of AFC 12.25% debentures due 2003. This asset was sold in 1994.\n11. COMMITMENTS AND CONTINGENCIES\nThe Company continues to be involved in a number of legal and other actions including threatened claims and pending litigation. While the results of such actions cannot be predicted with certainty, based upon its current knowledge of the facts and circumstances and its understanding of the applicable laws, the Company believes that the ultimate resolution of all disputed claims, pending litigation and threatened claims will not have a material adverse effect on its financial condition or its results of operations. See Note 10 for contingencies relating to discontinued operations.\nAs of December 31, 1995, the Company had operating leases for offices and equipment. The rental expense, net of amounts capitalized, for the three years ended December 31, 1995 was $7.1 million, $4.2 million and $3.3 million, respectively. The future minimum annual rental commitments under non-cancelable operating leases, excluding renewal options, for the subsequent five years and thereafter for continuing operations are as follow (in thousands):\n12. INDUSTRY SEGMENTS\nThe Company's continuing business activities consist of one industry segment, the entertainment industry. The Company had revenue from one customer in 1995, 1994 and 1993 representing 15%, 15%, and 22% of revenue, respectively. The Company does not believe it has any significant concentration of credit risk with respect to its operations.\nRevenue, operating profit and identifiable assets of the Company's international operations were not material related to consolidated amounts as of and for the year ended December 31, 1993. Due to the acquisition of VIE in 1994, international operations, primarily in Europe, have increased in significance related to the consolidated operations of the Company. Information with respect to the revenue, operating profit and identifiable assets by geographic area, as of and for the years ended December 31 follows (in thousands):\nExport sales for the years ended December 31, 1995, 1994 and 1993 totaled approximately $167,830,000, $120,903,000 and $97,813,000, respectively. Export sales to Europe for the years ended December 31, 1995, 1994 and 1993 were $86,462,000, $67,952,000 and $47,579,000, respectively.\nSPELLING ENTERTAINMENT GROUP INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n13. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)\nThe following table presents quarterly results of operations for the years ended December 31, 1995 and 1994 (in thousands, except per share data).\nSPELLING ENTERTAINMENT GROUP INC. SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS YEAR ENDED DECEMBER 31, (IN THOUSANDS)\n(a) Existing allowances at the dates of acquisition of Republic and VIE.\n(b) During 1993, all allowances for disputed claims and other items were reclassed into estimated expenses and disputed claims.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nThe information required by the following items will be included in the Company's definitive Proxy Statement, which will be filed with the Securities and Exchange Commission in connection with the 1996 Annual Meeting of Shareholders, and is incorporated herein by reference:\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\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) Documents filed as part of this Report: 1. Financial Statements are included in Part II, Item 8.\n2. Financial Statement Schedules:\nA. Selected Quarterly Financial Data is included in Note 13 to the Company's Consolidated Financial Statements\nB. Schedules filed herewith for 1995, 1994 and 1993:\nPAGE\nI - Condensed Financial Information of Registrant This schedule has been omitted since the debt which restricted net assets was repaid. (See Note 4.) The current debt agreement does not contain any restrictions in this regard; accordingly, the schedule is no longer relevant.\nII - Valuation and Qualifying Accounts 47\nAll other schedules for which provisions are made in the applicable regulation of the Securities and Exchange Commission have been omitted as they are not applicable, not required, or the information required thereby is set forth in the Consolidated Financial Statements or the notes thereto.\n3. Exhibits 53\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.\nPursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nSPELLING ENTERTAINMENT GROUP INC.\nINDEX TO EXHIBITS\nNUMBER EXHIBIT DESCRIPTION - ------ -------------------\n2.1 Certificate of Merger merging Spelling Entertainment Group Inc. with and into Spelling Merger Corporation.\n3.1 Certificate of Incorporation of Spelling Merger Corporation (incorporated by reference to Spelling Entertainment Group Inc.'s Notice of Annual Meeting and Proxy Statement dated April 14, 1995).\n3.2 ByLaws of Spelling Merger Corporation (incorporated by reference to Spelling Entertainment Group Inc.'s Notice of Annual Meeting and Proxy Statement dated April 14, 1995).\n10.1 Amended and Restated Credit Agreement dated as of January 31, 1995, by and among the Registrant, certain subsidiaries of the Registrant and Viacom Inc. (incorporated by reference to Exhibit 4.1 to Registrant's Form 10-K for fiscal year ended December 31, 1994).\n10.2 Amended and Restated Pledge and Security Agreement dated as of January 31, 1995, by and among the Registrant, certain subsidiaries of the Registrant and Viacom Inc. (incorporated by reference to Exhibit 4.2 to Registrant's Form 10-K for fiscal year ended December 31, 1994).\n10.3 Amended and Restated Copyright Mortgage and Assignment; Power of Attorney dated as of January 31, 1995, by the Registrant and certain subsidiaries of the Registrant in favor of Viacom Inc. (incorporated by reference to Exhibit 4.3 to Registrant's Form 10-K for fiscal year ended December 31, 1994).\n10.4 Amendment 1 to Amended and Restated Credit Agreement dated as of November 28, 1995, by and among the Registrant, certain subsidiaries of the Registrant and Viacom Inc.\n10.5 Second Amended and Restated Credit Agreement dated as of December 1, 1994 between Virgin Interactive Entertainment, Inc. and Bank of America National Trust and Savings Association (incorporated by reference to Exhibit 10(i) to Registrant's Form 10-Q for quarterly period ended June 30, 1995).\n10.6 First Amendment to Second Amended and Restated Credit Agreement dated March 31, 1995, between Virgin Interactive Entertainment, Inc. and Bank of America National Trust and Savings Association (incorporated by reference to Exhibit 10(ii) to Registrant's Form 10-Q for quarterly period ended June 30, 1995).\n10.7 Second Amendment to Second Amended and Restated Credit Agreement dated June 1, 1995, between Virgin Interactive Entertainment, Inc. and Bank of America National Trust and Savings Association (incorporated by reference to Exhibit 10(iii) to Registrant's Form 10-Q for quarterly period ended June 30, 1995).\nSPELLING ENTERTAINMENT GROUP INC.\nINDEX TO EXHIBITS\nNUMBER EXHIBIT DESCRIPTION - ------ -------------------\n10.8 Third Amendment to Second Amended and Restated Credit Agreement dated as of December 20, 1995, between Virgin Interactive Entertainment, Inc. and Bank of America National Trust and Savings Association.\n10.9 Amended and Restated Agreement and Plan of Merger dated May 22, 1992, by and among the Registrant, SEI Acquisition Corp. and Spelling Entertainment Inc.(incorporated by reference to Spelling Entertainment Inc.'s Notice of Annual Meeting and Proxy Statement dated June 24, 1992).\n10.10 Stock Purchase Agreement dated as of March 7, 1993, among Blockbuster Entertainment Corporation, BPH Subsidiary, Inc., American Financial Corporation and certain subsidiaries of American Financial Corporation (includes insurance-type indemnity reference in Note 10 to the Registrant's consolidated financial statements) (incorporated by reference to Exhibit 28.1 to Blockbuster Entertainment Corporation's Current Report on Form 8-K dated March 7, 1993).\n10.11 Agreement and Plan of Merger dated December 8, 1993, by and among the Registrant, DE Acquisition Corporation and Republic Pictures Corporation (incorporated by reference to Exhibit 99.1 to the Registrant's Current Report on Form 8-K dated December 8, 1993).\n10.12 Exchange Agreement dated July 30, 1994, by and among Spelling Entertainment Group Inc., Blockbuster Entertainment Corporation and Blockbuster Interactive Entertainment, Inc. (incorporated by reference to Exhibit 2 to Registrant's Form 8-K dated July 30, 1994).\n10.13 Amendment No. 1 to Exchange Agreement dated as of July 8, 1995 by and among the Registrant, Blockbuster Entertainment Group on behalf of Viacom Inc. and Blockbuster Interactive Entertainment, Inc. (incorporated by reference to Exhibit 10 (i) to Registrant's Form 10-Q for the quarterly period ended September 30, 1995).\n10.14 Amendment No. 2 to Exchange Agreement dated as of November 7, 1995, by and among the Registrant, Blockbuster Entertainment Group on behalf of Viacom Inc. and Blockbuster Interactive Entertainment, Inc. (incorporated by reference to Exhibit 10 (ii) to Registrant's Form 10-Q for the quarterly period ended September 30, 1995).\n10.15 Amendment No. 3 to Exchange Agreement dated as of February 22, 1996, by and among the Registrant, Blockbuster Entertainment Group on behalf of Viacom Inc. and Blockbuster Interactive Entertainment, Inc.\n10.16 Registrant's Stock Option Plan and Amendment Nos. One through Five thereto (incorporated by reference to Exhibit 4.03 to the Registrant's Registration Statement No. 33-61914 on Form S-8).\nSPELLING ENTERTAINMENT GROUP INC.\nINDEX TO EXHIBITS\nNUMBER EXHIBIT DESCRIPTION - ------ -------------------\n10.17 Registrant's 1994 Stock Option Plan (incorporated by reference to Annex A to Registrant's Notice of Annual Meeting and Proxy Statement dated April 27, 1994).\n10.18 Employment Agreement, dated March 1, 1989, by and between Spelling Entertainment Inc. and Aaron Spelling (incorporated by reference to Exhibit 10.50 to Spelling Entertainment Inc.'s Registration Statement No. 33-26497 on Form S-4).\n10.19 Amendment to Employment Agreement, dated November 7, 1991, by and among Spelling Entertainment Inc., Aaron Spelling Productions, Inc. and Aaron Spelling (incorporated by reference to Exhibit 10.7 to Registrant's Form 10-K for fiscal year ended December 31, 1993).\n10.20 Amendment No. 2 to Employment Agreement, dated May 6, 1993, by and among Spelling Entertainment Inc., Aaron Spelling Productions, Inc. and Aaron Spelling (incorporated by reference to Exhibit 10.8 to Registrant's Form 10-K for fiscal year ended December 31, 1993).\n10.21 Employment Agreement dated as of September 26, 1994, between Registrant and Peter Bachmann (incorporated by reference to Exhibit 10.15 to Registrant's Form 10-K for fiscal year ended December 31, 1994).\n10.22 Employment Agreement dated as of September 1, 1994, between Registrant and Tom Carson (incorporated by reference to Exhibit 10.16 to Registrant's Form 10-K for fiscal year ended December 31, 1994).\n10.23 Employment Agreement dated as of January 10, 1994, between Registrant and Kathleen Coughlan and Amendment to Employment Agreement, dated as of September 1, 1994 (incorporated by reference to Exhibit 10.18 to Registrant's Form 10-Q for the quarterly period ended March 31, 1995).\n10.24 Amendment No. 2 to Employment Agreement, dated as of February 8, 1996, between Registrant and Kathleen Coughlan.\n10.25 Employment Agreement dated as of January 1, 1995, between Registrant and Sally Suchil.\n11 Computation of net income per common and common equivalent share.\n21 Subsidiaries of the Registrant.\n23.1 Consent of Price Waterhouse LLP.\n23.2 Consent of Arthur Andersen LLP.\n27 Financial Data Schedule.","section_15":""}
{"filename":"48948_1995.txt","cik":"48948","year":"1995","section_1":"ITEM 1. BUSINESS\nGeneral Development of Business\nHudson General Corporation (the \"Company\" or \"Registrant\") was organized in Delaware in 1961. The Company is principally engaged in providing a broad range of services to the aviation industry. The services, which are conducted by the Company and its subsidiaries, include aircraft ground handling; aircraft deicing; aircraft fueling; ground transportation services; snow removal; fuel management; cargo warehousing; ramp sweeping and glycol recovery; the sale, leasing and maintenance of ground support equipment; specialized maintenance services and the leasing of hangar, office and tie-down space to private aircraft owners. On October 31, 1994, the Company ceased its fixed base operations in Canada (see Note 4 to Item 14(a)(1) Financial Statements). In addition to its aviation services, the Company is a 50% partner with Oxford First Corporation in a joint venture for the development and sale of land on the Island of Hawaii (see Note 6 to Item 14(a)(1) Financial Statements).\nNarrative Description of Business\nThe Company's snow removal and aircraft deicing services are seasonal in nature. The results of these operations are normally reflected in the second and third quarters of the fiscal year, and fluctuate depending upon the severity of the winter season. Additional information required to be provided under this item is incorporated by reference from pages 3-8 of the Registrant's 1995 Annual Report to Shareholders.\nGeneral Information\nThe Company does not spend a material amount for research or development activities.\nDuring the years ended June 30, 1995, 1994, and 1993, sources of\nthe Company's revenues which exceeded 10% of consolidated revenues in any year were: aircraft ground handling services (including deicing) $74,334,000, $68,291,000 and $67,811,000; aircraft fueling services (including fixed base operations) $22,923,000, $21,936,000 and $23,586,000; ground transportation services $23,802,000, $22,171,000 and $20,567,000; and snow removal services $3,706,000, $17,871,000 and $8,933,000, respectively (Note: Foreign revenues included above are translated at the average rates of exchange in their respective fiscal years).\nNo customer of the Company accounted for more than 10% of consolidated revenues during fiscal 1995.\nThe Company's services are generally subject to competitive bidding, and the Company competes principally with airlines and other aviation services companies, some of which are larger and have resources greater than the Company. The major bases of competition are the prices at which services are offered and the quality and efficiency in the performance of services.\nThe compliance with federal, state and local provisions which have been enacted or adopted regulating the discharge of materials into the environment has not to date had a material effect upon the Company's capital expenditures, results of operations or competitive position. However, the federal government and many state and local governments have enacted or proposed legislation and regulations with respect to storage facilities for fuel, petroleum-based products and chemicals, the disposal of hazardous waste materials, storm water discharges, and financial responsibility for possible liability exposures relating to fuel storage facilities. Compliance with such legislation and regulations has resulted in expenditures by the Company, including expenditures for the testing, decommissioning and\/or replacement of certain of its fuel and deicing fluid storage facilities, and the clean-up of fuel spills. The Company is presently engaged in several such decommissioning, replacement and clean-up projects, and it is anticipated that additional such expenditures, the amount of which is presently not\nexpected to be material, will be required.\nIn addition, airport authorities are coming under increasing pressure to clean-up previous contamination at their facilities, and are seeking financial contributions from airport tenants and companies which operate at their airports. The Company cannot predict at this time, the amount, if any, that it may be required to pay in connection with such airport authority initiatives.\nThe Company employs an aggregate of approximately 3,700 persons.\nFinancial Information About Foreign and Domestic Operations and Export Sales\nThe Company operates in only one industry segment. For information as to foreign operations, see Note 4 to Item 14(a)(1) Financial Statements. For information relating to the Company's investment in a joint venture to develop and sell land in Hawaii (the Venture), see Note 6 to Item 14(a)(1) Financial Statements.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's executive offices at 111 Great Neck Road, Great Neck, New York contain approximately 13,000 square feet and are under lease through December 31, 2002.\nThe Company also leases office, warehouse, hangar and maintenance shop space as well as fuel storage facilities at various airport locations in the United States and Canada. These leases expire at various dates through 2005 and contain various renewal options through 2020. A portion of this leased space has been sublet to non-affiliated sublessees. The properties owned and leased by the Company are suitable and adequate to conduct its business.\nFor information relating to the Company's interest in land in Hawaii, see Note 6 to Item 14(a)(1) Financial Statements and page 8 of the Registrant's 1995 Annual Report to Shareholders.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIn 1988, Texaco Canada Inc. (Texaco) (now known as McColl- Frontenac Inc.) instituted a suit in the Supreme Court of Ontario, Canada against the Company and Petro-Canada, Inc., the corporation which supplied aviation fuel for the Company's Canadian fixed base operations. The suit's allegations, as amended in 1992, are that the defendants interfered with contractual and fiduciary relations and induced the breach of a fuel supply agreement between Texaco and Innotech Aviation Limited (Innotech) in connection with the purchase by the Company from Innotech in 1984 of certain assets of Innotech's airport ground services business. The suit seeks compensatory and punitive damages totaling $110,000,000 (Canadian) (approximately $80,000,000 (U.S.)) plus all profits earned by the defendants subsequent to the alleged breach. A trial date has been set for May 1996.\nInnotech (which due to a name change is now called Aerospace Realties (1986) Limited) has agreed to defend and indemnify the Company against claims of whatever nature asserted in connection with, arising out of or resulting from the fuel supply agreement with Texaco, and is defending the Company in the suit by Texaco.\nCompany management believes, and counsel for the Company has advised based on available facts, that the Company will successfully defend this action.\nIn March 1994 a jury in New York State Supreme Court in Manhattan, New York rendered a verdict against the Company in a civil lawsuit for personal injuries and awarded the plaintiff a total of $21,436,000 in damages, of which $19,186,000 is covered by insurance. The suit arose from an accident involving a collision between a Company vehicle and another vehicle at JFK International Airport in New York. At March 31, 1994, the Company accrued a provision for the entire uninsured punitive damage amount of $2,250,000 in the Company's consolidated statements of operations. In\nJune 1994, as a result of a ruling by the judge in the case vacating the uninsured punitive damage award against the Company, the Company reversed the $2,250,000 provision which it had previously accrued. The judge also ruled that the jury's award of compensatory damages was excessive in several respects, and held that this award should be reduced to $9,600,000. The compensatory damages are fully covered by insurance. The Company's insurance carrier has appealed the judge's ruling, seeking to further reduce the jury's award. As a result, it is anticipated that the plaintiff will cross-appeal the judge's ruling, seeking to reinstate the jury award including punitive damages. Company management and appellate counsel for the Company believe that the Appellate Division is unlikely to award punitive damages to the plaintiff.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - Not Applicable\nADDITIONAL ITEM\nEXECUTIVE OFFICERS OF THE COMPANY\nNo family relationships exist among the executive officers of the Company. Each of the executive officers holds office at the pleasure of the Board of Directors, except as noted below.\nMr. Langner has served as a Director of the Company since 1961 and as Chairman since 1977. He has served as President since 1989 and previously served in such capacity from 1961 until 1979. The Company has an employment contract with Mr. Langner pursuant to which Mr. Langner has agreed to render services to the Company as Chairman, President and Chief Executive Officer for a period ending January 31, 1998.\nMr. Pollack has served as Executive Vice President and Chief Operating Officer of the Company since 1990, and prior thereto as Senior Vice President since 1984. He has been employed in various capacities with the Company, including as a divisional officer, since 1968. Mr. Pollack is a Certified Public Accountant.\nMr. Rubin has served as Executive Vice President and Chief Financial Officer of the Company since 1990, and has been Treasurer of the Company since 1983. Previously, Mr. Rubin had been Vice President-Finance\nsince 1985. He has been employed in various capacities with the Company since 1971. Mr. Rubin is a Certified Public Accountant.\nMr. Rieder has served as Senior Vice President and Chief Marketing Officer of the Company since 1990, and prior thereto as Vice President - Marketing since 1984. He has been employed in various capacities with the Company, including as a divisional officer, since 1967.\nMr. DiBenedetto has served as Senior Vice President-Operations since July 26, 1994. Prior thereto he was Vice President- Operations since 1984. He has been employed in various capacities with the Company, including as a divisional officer, since 1970.\nMr. Croot has served as Vice President-Canadian Operations of the Company since 1989. He has been employed in various capacities with the Company, including as a divisional officer, since 1968.\nMr. Rockowitz has served as Vice President-General Counsel since 1985 and as Secretary since 1986. Prior to joining the Company in 1985, he had been Corporate Secretary and Assistant General Counsel of Belco Petroleum Corporation since 1978.\nThe Company has employment contracts with Messrs. Pollack, Rubin, Rieder, DiBenedetto and Rockowitz which currently extend until December 31, 1995 and are subject to extension for additional two year periods unless on or before the September 30th preceeding any then-existing expiration date, the Company notifies the executive that it elects not to so extend the term. The Company also has an employment contract with Mr. Croot which may be terminated by the Company as of any December 31st.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nThe information required to be provided under Part II, Item 5(a) and (c) is incorporated by reference from page 13 of the Registrant's 1995 Annual Report to Shareholders under the caption \"Selected Consolidated Financial Data\". At June 30, 1995, there were 220 holders of record of the Company's common stock.\nThe Company's Revolving Credit Agreement, as amended (Credit Agreement), contains certain limitations on the payment of dividends (see Note 5 to Item 14(a)(1) Financial Statements) including limiting the payment of dividends (other than stock dividends) and the purchase, redemption or retirement by the Company of its stock to an annual amount not to exceed the lesser of (i) $1,200,000 or (ii) 50% of consolidated net income, as defined, for the most recently ended fiscal year. In addition, the Company is restricted from paying cash dividends or purchasing, redeeming or retiring its stock unless tangible net worth (TNW), as defined, is greater than $16,500,000. At June 30, 1995 TNW was $22,298,000. The Credit Agreement also permits the Company, until March 31, 1996, to expend up to an additional $3,000,000 to repurchase shares of its common stock so long as no proceeds from borrowings under the Credit Agreement are utilized for such purpose. The Board of Directors has approved the repurchase of up to 150,000 shares of the Company's common stock from time to time in either open market or privately negotiated transactions. As of August 25, 1995 the Company had repurchased 112,800 shares in the open market for an aggregate purchase price of approximately $2,000,000 pursuant to this authorization.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe information required to be provided under Part II, Item 6 is incorporated by reference from page 13 of the Registrant's 1995 Annual Report to Shareholders under the caption \"Selected Consolidated Financial Data\".\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe information required to be provided under Part II, Item 7 is incorporated by reference from pages 9-12 of the Registrant's 1995 Annual Report to Shareholders under the caption \"Management's Discussion and Analysis of Financial Condition and Results of Operations\".\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe consolidated financial statements of the Company and the independent auditors' report thereon of KPMG Peat Marwick LLP, independent certified public accountants, for the Company's fiscal years ended June 30, 1995, 1994 and 1993 are filed pursuant to Item 14(a)(1) of this Report. The financial statements and the required financial statement schedule of the Venture and the independent auditors' report thereon of KPMG Peat Marwick LLP, independent certified public accountants, for the fiscal years ended June 30, 1995, 1994 and 1993 are filed pursuant to Item 14(d) of this Report. All such financial statements and financial statement schedule are incorporated herein by reference.\nSelected quarterly financial data of the Registrant for the fiscal years ended June 30, 1995 and 1994 appears in Note 12 to Item 14(a)(1) Financial Statements.\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 information required to be provided under Part III, Item 10, relative to Directors of the Registrant is incorporated by reference from the Registrant's 1995 definitive proxy statement to be filed with the Securities and Exchange Commission (the \"Commission\") pursuant to Regulation 14A no later than 120 days after the close of its fiscal year and, relative to executive officers, to Part I of this report under the caption \"Executive Officers of the Company\".\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required to be provided under Part III, Items 11, 12 and 13 is incorporated by reference from the Registrant's 1995 definitive proxy statement to be filed with the Commission pursuant to Regulation 14A no later than 120 days after the close of its fiscal year.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a)(1)\nFinancial Statements of the Registrant, all of which are incorporated herein by reference to the Registrant's 1995 Annual Report to Shareholders.\nIndependent Auditors' Report of KPMG Peat Marwick LLP, independent auditors, appearing on page 24 of the 1995 Annual Report to Shareholders.\nConsolidated Balance Sheets of Hudson General Corporation and Subsidiaries at June 30, 1995 and 1994, appearing on page 15 of the 1995 Annual Report to Shareholders.\nConsolidated Statements of Operations of Hudson General Corporation and Subsidiaries for the Years Ended June 30, 1995, 1994 and 1993, appearing on page 14 of the 1995 Annual Report to Shareholders.\nConsolidated Statements of Cash Flows of Hudson General Corporation and Subsidiaries for the Years Ended June 30, 1995, 1994 and 1993, appearing on page 17 of the 1995 Annual Report to Shareholders.\nConsolidated Statements of Stockholders' Equity of Hudson General Corporation and Subsidiaries for the Years Ended June 30, 1995, 1994 and 1993 appearing on page 16 of the 1995 Annual Report to Shareholders.\nNotes to Consolidated Financial Statements appearing on pages 18-24 of the 1995 Annual Report to Shareholders.\n(a)(3) Exhibits\nEXHIBIT NO. EXHIBIT DESCRIPTION ------- ---------------------------------------------------------\n3.1 Restated Certificate of Incorporation of the Registrant, as amended to date, filed as Exhibit 3.1 to Quarterly Report on Form 10-Q for the quarter ended December 31, 1986, incorporated herein by reference.\n3.2 By-laws of the Registrant, as amended to date, filed as Exhibit 3.2(b) to Quarterly Report on Form 10-Q for the quarter ended December 31, 1991, incorporated herein by reference.\n4.4(a) Revolving Credit and Term Loan Agreement dated as of November 25, 1992 among the Registrant, various banking institutions named therein and The First National Bank of Boston, as agent, filed as Exhibit 4.4(h) to Current Report on Form 8-K filed December 4, 1992, incorporated herein by reference.\n4.4(b) First Amendment to the Revolving Credit and Term Loan Agreement dated as of November 25, 1992 among the Registrant, various banking institutions named therein and The First National Bank of Boston, as agent, dated as of August 31, 1993 filed as Exhibit 4.4(i) to Annual Report on Form 10-K for the fiscal year ended June 30, 1993, incorporated herein by reference.\n4.4(c) Second Amendment to the Revolving Credit and Term Loan Agreement dated as of November 25, 1992 among the Registrant, various banking institutions named therein and The First National Bank of Boston, as agent, dated as of December 21, 1993 filed as Exhibit 4.4(j) to Quarterly Report on Form 10-Q for the quarter ended December 31, 1993, incorporated herein by reference.\n4.4(d) Third Amendment to the Revolving Credit and Term Loan Agreement dated as of November 25, 1992 among Registrant, various banking institutions named therein and The First National Bank of Boston, as agent, dated as of March 15, 1995 filed as Exhibit 4.4(k) to Quarterly Report on Form 10-Q for the quarter ended March 31, 1995, incorporated herein by reference.\n4.4(e) Revolving Credit Agreement dated as of November 25, 1992 among Hudson General Aviation Services Inc., various banking institutions named therein and Bank of Boston Canada, as agent, filed as Exhibit 4.4(i) to Quarterly Report on Form 10-Q for the quarter ended March 31, 1993, incorporated herein by reference.\n4.4(f) First Amendment to the Revolving Credit Agreement dated as of November 25, 1992 among Hudson General Aviation Services Inc., various banking institutions named therein and The Chase Manhattan Bank of Canada, as successor agent, dated as of March 15, 1995.\n4.6 Indenture dated as of July 1, 1986 between the Registrant and Chemical Bank (Delaware), relating to the Registrant's 7% Convertible Subordinated Debentures Due 2011, filed as Exhibit 4.1 to Amendment No. 1 to Form S-2 Registration Statement under the Securities Act of 1933, Registration No. 33-6689, incorporated herein by reference.\n10.1(a) Development Agreement dated April 29, 1981 between Kahua Ranch, Limited, and the Registrant, filed as Exhibit 3 to Quarterly Report on Form 10-Q for the quarter ended March 31, 1981, incorporated herein by reference.\n10.1(b) Amended and Restated Joint Venture Agreement dated April 29, 1981 between Hudson Kohala Inc. and The Hilton Head Company of Hawaii, Inc. (now Oxford Kohala, Inc.), filed as Exhibit 4 to Quarterly Report on Form 10-Q for the quarter ended March 31, 1981, incorporated herein by reference.\n10.1(c) First Amendment to the Joint Venture Agreement, Amendment and Restatement dated April 29, 1981, such Amendment being effective as of June 30, 1984, filed as Exhibit 10 to Quarterly Report on Form 10-Q for the quarter ended September 30, 1984, incorporated herein by reference.\n10.1(d) Receivable Sales Agreement dated January 3, 1990, with amendment letters dated June 22, 1990 and August 2, 1990, between the Registrant and Oxford First Corporation and Oxford Kohala, Inc., filed as Exhibit 10.1(d) to Annual Report on Form 10-K for the fiscal year ended June 30, 1990, incorporated herein by reference.\n10.1(e) Commitment Agreement to Purchase Receivables dated January 3, 1990, with amendment letter dated August 2, 1990, between Kohala Joint Venture and The Oxford Finance Companies, Inc., filed as Exhibit 10.1(e) to Annual Report on Form 10-K for the fiscal year ended June 30, 1990, incorporated herein by reference.\n10.1(f) Agreement constituting an amendment to the Joint Venture Agreement, Amendment and Restatement dated April 29, 1981, dated November 2, 1990 among the Registrant, Hudson Kohala Inc., Oxford Kohala, Inc. and Oxford First Corporation relating to receivables of the Kohala Joint Venture, filed as Exhibit 10.1(f) to Quarterly Report on Form 10-Q for the quarter ended September 30, 1990, incorporated herein by reference.\n10.1(g) Agreement constituting an amendment to the Joint Venture Agreement, Amendment and Restatement dated April 29, 1981, dated September 5, 1991 among the Registrant, Hudson Kohala Inc., Oxford Kohala, Inc. and Oxford First Corporation relating to distributions from the Kohala Joint Venture, filed as Exhibit 10.1(g) to Annual Report on Form 10-K for the fiscal year ended June 30, 1991, incorporated herein by reference.\n10.1(h) Agreement constituting an amendment to the Joint Venture Agreement, Amendment and Restatement dated April 29, 1981, dated September 26, 1991 among the Registrant, Hudson Kohala Inc., Oxford Kohala, Inc. and Oxford First Corporation relating to distributions from the Kohala Joint Venture, filed as Exhibit 10.1(h) to Quarterly Report on Form 10-Q for the quarter ended September 30, 1991, incorporated herein by reference.\n10.1(i) Second Amendment to the Joint Venture Agreement, Amendment and Restatement dated April 29, 1981, such Amendment being effective as of October 1, 1994, filed as Exhibit 10.1(i) to Quarterly Report on Form 10-Q for the quarter ended September 30, 1994, incorporated herein by reference.\n10.2* 1981 Non-Qualified Stock Option and Stock Appreciation Rights Plan, filed as Exhibit 15.1 to Form S-8 Registration Statement under the Securities Act of 1933, Registration No. 2-75137, incorporated herein by reference.\n10.3* 1981 Incentive Stock Option and Stock Appreciation Rights Plan, filed as Exhibit 15.2 to Form S-8 Registration Statement under the Securities Act of 1933, Registration No. 2-75137, incorporated herein by reference.\n10.4(a)* Form of Severance Agreement, dated as of June 3, 1986, between the Registrant and Michael Rubin, filed as Exhibit 10.5(a) to Annual Report on Form 10-K for the fiscal year ended June 30, 1988, incorporated herein by reference.\n10.4(b)* Amended schedule of executive officers entitled to benefits of Severance Agreements, filed as Exhibit 10.4(b) to Annual Report on Form 10-K for the fiscal year ended June 30, 1990, incorporated herein by reference.\n10.5(a)* Employment Agreement dated July 28, 1988, between the Registrant and Jay B. Langner, filed as Exhibit 10.6(a) to Annual Report on Form 10-K for the fiscal year ended June 30, 1988, incorporated herein by reference.\n10.5(b)* Amendment dated April 16, 1990, amending the Employment Agreement between the Registrant and Jay B. Langner dated as of July 28, 1988, filed as Exhibit 10.5(b) to Annual Report on Form 10-K for the fiscal year ended June 30, 1990, incorporated herein by reference.\n10.5(c)* Amendment dated August 16, 1994, amending the Employment Agreement between the Registrant and Jay B. Langner dated as of July 28, 1988, as amended, filed as Exhibit 10.5(c) to Annual Report on Form 10-K for the fiscal year ended June 30, 1994, incorporated herein by reference.\n10.5(d)* Severance Agreement dated April 16, 1990 between the Registrant and Jay B. Langner, filed as Exhibit 10.5(c) to Annual Report on Form 10-K for the fiscal year ended June 30, 1990, incorporated herein by reference.\n10.7(a)* Form of Employment Agreement, dated February 8, 1990, between the Registrant and Michael Rubin, filed as Exhibit 10.7(a) to Annual Report on Form 10-K for the fiscal year ended June 30, 1990, incorporated herein by reference.\n10.7(b)* Schedule of executive officers entitled to benefits of Employment Agreements, filed as Exhibit 10.7(b) to Annual Report on Form 10-K for the fiscal year ended June 30, 1990, incorporated herein by reference.\n10.8* Employment Agreement dated September 21, 1990 between the Registrant and Donald S. Croot, filed as Exhibit 10.9 to Annual Report on Form 10-K for the fiscal year ended June 30, 1991, incorporated herein by reference.\n10.9* Description of Executive Incentive Program adopted by the Compensation Committee of the Board of Directors on December 1, 1993, filed as Exhibit 10.9 to Quarterly Report on Form 10-Q for the quarter ended December 31, 1993, incorporated herein by reference.\n11 Computation of Earnings (Loss) Per Share Information - primary and fully diluted.\n13 The Registrant's 1995 Annual Report to Shareholders, which report, except for those portions thereof which are expressly incorporated by reference in this filing, is furnished for the information of the Commission and is not to be deemed to be filed as part of this filing.\n21 Subsidiaries of the Registrant.\n23 Consent of KPMG Peat Marwick LLP, the Company's independent auditors, to the incorporation by reference into the Company's Registration Statement on Form S-8, as amended, Registration No. 2-75137.\n(b) No reports on Form 8-K have been filed by Registrant during the last quarter of the period covered by this report.\n(c) Reference is made to Item 14(a)(3) above.\n(d) Reference is made to Item 14(a)(2) above.\n* Denotes management contract for compensatory 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 Chief Executive, Chief Financial and Chief Accounting Officers, thereunto duly authorized on the 15th day of September 1995.\nHUDSON GENERAL 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 their capacities as Directors on the 15th day of September 1995.\nKOHALA JOINT VENTURE AND SUBSIDIARY\nCONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE (FORM 10-K)\nJUNE 30, 1995, 1994 AND 1993\n(WITH INDEPENDENT AUDITORS' REPORT THEREON)\nIndependent Auditors' Report\nThe Board of Directors Hudson General Corporation\nThe Board of Directors Oxford First Corporation:\nWe have audited the accompanying consolidated balance sheets of the Kohala Joint Venture and subsidiary as of June 30, 1995 and 1994 and the related consolidated statements of operations and partners' deficit, and cash flows for each of the years in the three-year period ended June 30, 1995. We have also audited financial statement schedule II. These consolidated financial statements and the financial statement schedule are the responsibility of the Venture'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.\nFor the years ended June 30, 1995, 1994 and 1993, the Venture incurred net losses of $5,495,300, $3,601,800 and $5,575,500, respectively, and at June 30, 1995 the amount of the partners' deficit was $9,331,900. Additionally, in 1995, 1994 and 1993 the partners advanced $2,346,100, $1,740,000 and $2,150,000, respectively, to the Venture. Unless land sales increase significantly, additional contributions from the partners will be required in fiscal 1996.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Kohala Joint Venture and subsidiary as of June 30, 1995 and 1994 and the results of their operations and their cash flows for each of the years in the three-year period ended June 30, 1995, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.\nKPMG PEAT MARWICK LLP\nJericho, New York August 16, 1995\nKOHALA JOINT VENTURE AND SUBSIDIARY\nConsolidated Balance Sheets\nJune 30, 1995 and 1994\nSee accompanying notes to consolidated financial statements.\nKOHALA JOINT VENTURE AND SUBSIDIARY\nConsolidated Statements of Operations and Partners' Deficit\nYears ended June 30, 1995, 1994 and 1993\nSee accompanying notes to consolidated financial statements.\nKOHALA JOINT VENTURE AND SUBSIDIARY\nConsolidated Statements of Cash Flows\nYears ended June 30, 1995, 1994 and 1993\nSee accompanying notes to consolidated financial statements.\nKOHALA JOINT VENTURE AND SUBSIDIARY\nNotes to Consolidated Financial Statements\nJune 30, 1995, 1994 and 1993\n(1) Summary of Significant Accounting Policies\n(a) Principles of Consolidation\nThe consolidated financial statements include the accounts of the Kohala Joint Venture (the Venture) and its 99% owned subsidiary, the Kohala Ranch Water Company (KRWC)(note 7). All significant intercompany accounts and transactions have been eliminated in consolidation.\n(b) Business\nThe Venture is a partnership which was formed to acquire, develop and sell approximately 4,000 contiguous acres of land in Hawaii (the Project). The Partners in the Venture are Hudson Kohala, Inc. (Hudson, a wholly-owned subsidiary of Hudson General Corporation) and Oxford Kohala, Inc. (Oxford, a wholly-owned subsidiary of Oxford First Corporation) (Oxford First)) (together, the Partners). The terms of the partnership are contained in the Restated Joint Venture Agreement dated April 29, 1981, as amended (the Agreement). The Project is being developed in four successive phases. The first two phases, containing approximately 2,100 acres, have been developed and substantially sold. The third phase, containing approximately 550 acres, has also been developed and has 86 parcels available for sale. The fourth phase has yet to be developed, except to the extent common improvements (main roadway, water wells, etc.) have been completed.\n(c) Partners' Capital and Allocation of Profits and Losses\nPartners' capital (deficit) includes the Partners' capital accounts in the Venture and the minority interest (the remaining 1%) of the Partners in KRWC.\nIn accordance with the Agreement, profits are shared equally by the Partners. Losses are shared by the Partners on a pro-rata basis, based first on their respective capital accounts and then on their respective combined advances to the Venture including accrued interest (note 5).\n(d) Revenue Recognition and Land Sales\nAll sales to date have been from the first, second and third phases of the Project. Revenue is being recognized under the full accrual method of accounting.\n(e) Capitalization of Costs\nLand and development costs (including interest) are initially capitalized and subsequently carried at the lower of average cost or net realizable value. These costs are charged to costs of sales when the corresponding land sale is recorded based upon the relative fair value of the parcel sold to the aggregate fair value of all parcels in the phase. Although the Venture believes its estimates are reasonable, there can be no assurance that the estimated future selling prices can be realized or that the actual costs for Phases III or IV will not exceed such estimates.\nThe Venture has capitalized interest costs, as appropriate, for each phase of the Project. During fiscal 1991, 1989 and 1987, the capitalization of interest costs relating to the third, second and first phases,\n(Continued)\nKOHALA JOINT VENTURE AND SUBSIDIARY\nNotes to Consolidated Financial Statements, Continued\nrespectively, was discontinued, as these phases were substantially completed during the respective periods and ready for their intended use. Effective July 1, 1994, as a result of the lack of further development activity, capitalization of interest relating to the fourth phase has been discontinued (note 3).\n(f) Estimated Costs to Complete\nAt June 30, 1995, the Venture estimated that $2,478,800 of additional costs were necessary to complete the development of Phase III. The portion of such amount relating to unsold parcels has been offset against land and development costs in the accompanying consolidated balance sheets.\n(g) Property, Plant and Equipment\nProperty, plant and equipment is recorded at the lower of cost or net realizable value. Depreciation is provided on the straight-line method. The number of years over which major classes of assets are depreciated and the costs and related accumulated depreciation as of June 30, 1995 and 1994 are set forth:\nContributions in aid of construction represent contributions by customers for plant additions to be made for the benefit of the customer. Accordingly, such contributions are recorded as a reduction against property, plant and equipment.\nDuring fiscal 1993, the Venture began depreciating the model home based upon an estimated residual value of $500,000, and a five year useful life. Included in both fiscal 1995 and 1994 depreciation expense was $93,600 relating to the model home.\nDepreciation expense was $176,400, $177,400 and $180,200 for fiscal 1995, 1994 and 1993, respectively.\n(h) Income Taxes\nAs a partnership, the Venture is not a taxable entity under the provisions of the Internal Revenue Code. The taxable results and available tax credits of the Venture and KRWC pass directly to the Partners' corporate income tax returns in the manner prescribed in the Agreement.\n(Continued)\nKOHALA JOINT VENTURE AND SUBSIDIARY\nNotes to Consolidated Financial Statements, Continued\n(i) Statements of Cash Flows\nFor the purposes of presenting the consolidated statements of cash flows, the Venture considers all securities with an original maturity of three months or less at the date of acquisition to be cash equivalents.\nA reconciliation of net loss to net cash provided by (used in) operating activities for fiscal 1995, 1994 and 1993 is as follows:\n(2) Mortgage Notes Receivable\nAt June 30, 1995 and 1994, mortgage notes receivable from land sales consisted of the following:\nThe Venture typically provides financing in connection with the sale of land parcels. None of the Venture's mortgage notes receivable comprised more than 5% of the total mortgage notes receivable\n(Continued)\nKOHALA JOINT VENTURE AND SUBSIDIARY\nNotes to Consolidated Financial Statements, Continued\nbalance at June 30, 1995. The collectibility of mortgage notes receivable is affected by general economic conditions.\nPurchasers of land parcels are entitled to discounts if certain conditions are met. Discounts ranging from 10-20% are generally given if the purchase price is paid in cash at the closing. If the cash is paid within specified periods after the closing, a reduced sales discount is given. Reserves have been established for estimated discounts to be taken by purchasers under the various discount programs.\nStated interest rates on mortgage notes receivable outstanding at June 30, 1995 and 1994, range from 6% to 11% (averaging 9.6% as of June 30, 1995 and 9.8% as of June 30, 1994). Interest is not accrued on mortgage notes receivable in arrears 90 days or more. The minimum down payment for sales to unrelated parties is 10% (see note 8 for sales to related parties).\nAt June 30, 1995, mortgage notes receivable 90 days or more in arrears were comprised of 29 mortgage notes aggregating $5,174,200, of which $314,200 represents receivables from related parties (see note 8 for sales to related parties).\nScheduled collections of principal during the next five fiscal years and thereafter are as follows:\n(3) Land and Development Costs\nLand and development costs include all costs directly associated with the acquisition and development of the land parcels. The land was acquired by the Venture from Hudson and recorded at cost. Major components of land and development costs are the initial costs to acquire the land, roadways, water, drainage, electrical and telephone lines, and various project management expenditures, as well as unamortized capitalized interest of $6,706,300 and $6,736,000 as of June 30 1995 and 1994, respectively. Interest costs capitalized in fiscal 1994 approximated $502,900.\n(4) Foreclosed Real Estate\nForeclosed real estate represents land parcels that were reacquired in connection with previously financed mortgages. Such parcels are valued at the lower of their remaining receivable balance outstanding, or their net estimated realizable value, as follows:\n(Continued)\nKOHALA JOINT VENTURE AND SUBSIDIARY\nNotes to Consolidated Financial Statements, Continued\n(5) Partner Advances Payable\nThe Partners have agreed to make equal advances to the Venture for all costs necessary for the orderly development of the Project. Advances earn interest from the date of the advance compounded quarterly at the prime rate minus 1% (8% and 6% at June 30, 1995 and 1994, respectively).\nOn October 13, 1994, Oxford First filed for reorganization under Chapter 11 of the Bankruptcy Code. Pursuant to an order of the Bankruptcy Court dated November 28, 1994, Oxford First (through its subsidiary, the Oxford Finance Companies, Inc.) was permitted to transfer funds to Oxford in an aggregate amount not to exceed $375,800 with respect to the period October 1, 1994 through March 31, 1995, which amounts were intended to enable Oxford to make its share of advances required by the Venture. The amount so authorized by the Bankruptcy Court was not sufficient to allow Oxford to make its full share of required advances. To date, Hudson has opted to make additional advances (the Additional Advances) to cover Oxford's funding deficiency. As of June 30, 1995, the amount of the Additional Advances made by Hudson was $548,000. Hudson has filed a claim with the Bankruptcy Court in an amount equal to the Additional Advances. In addition, Oxford First has filed an amended reorganization plan with the Bankruptcy Court contemplating Oxford First's transfer of funds to Oxford in amounts set forth in the plan covering periods through December 31, 1997. The Venture, at present, is unable to determine whether the Bankruptcy Court will confirm Oxford First's reorganization plan so as to enable Oxford First to transfer additional funds to Oxford or whether any transfers authorized by the Bankruptcy Court will be sufficient in order for Oxford to make its share of future advances to the Venture. Unless land sales increase significantly, additional contributions from the Partners will be required in fiscal 1996. It is anticipated that Hudson will fund, subject to its right of reimbursement, any advances required in fiscal 1996 in the event Oxford is not able to make its share of advances. Hudson may be required to obtain approval from its banks before making additional advances.\nDuring fiscal 1995, 1994 and 1993, advances accrued an average rate of interest of 7.2%, 5.2% and 7%, respectively.\n(6) Notes Payable\nDuring fiscal 1991, the Venture entered into agreements with banks pursuant to which $8,797,000 of the Venture's mortgage receivables were sold. An additional sale of $3,148,000 of mortgage receivables to a bank was completed during fiscal 1992. Since the Venture has accounted for these transactions as financing arrangements, the unpaid balances of the mortgage receivables in the amounts of $2,826,200 and $4,758,400 at June 30, 1995 and 1994, respectively, are shown as notes payable in the accompanying consolidated balance sheets. These notes are collateralized by $775,800 and $1,491,500 of other Venture owned mortgage receivables as of June 30, 1995 and 1994, respectively. The maximum amounts outstanding during fiscal 1995, 1994 and 1993 were $4,758,500, $8,031,800 and $9,851,000, respectively. The average amounts outstanding for fiscal 1995, 1994 and 1993, based upon month-end balances, were $3,860,100, $6,091,500 and $9,063,900, respectively. The agreements with the banks require that all payments received in connection with the underlying mortgage receivables be remitted to the banks until fiscal 1996 under the fiscal 1991 sales and until fiscal 1997 under the fiscal 1992 sale, when any unpaid balance due to the banks is to be paid by the Venture. In addition, the Venture is required to make additional payments to the banks should the yield to the banks be less than 11-3\/4% for the fiscal 1991 sales, or\n(Continued)\nKOHALA JOINT VENTURE AND SUBSIDIARY\nNotes to Consolidated Financial Statements, Continued\nless than 2% over the prime rate (as defined) for the fiscal 1992 sale. The Venture remitted $96,600 and $129,000 during fiscal 1995 and 1994, respectively, for such purpose. The weighted average interest rates for fiscal 1995, 1994 and 1993 were 11.9%, 11.2%, 10.8%, respectively. The weighted average interest rates on borrowings outstanding as of June 30, 1995 and 1994, based upon month-end balances, were 11.6% and 11.2%, respectively.\nThe Company also has a note payable outstanding for $576,200 relating to certain development costs. The note matures in December 1996 and bears interest at the prime rate plus 1%.\n(7) Kohala Ranch Water Company\nKRWC provides water to the Project and is owned by the Venture (99%), Hudson (.5%), and Oxford (.5%). The assets of KRWC are comprised principally of property, plant and equipment. KRWC recorded revenues of $250,975, $248,500 and $238,500 and incurred net losses of $487,000, $512,200 and $498,800 for fiscal 1995, 1994 and 1993, respectively.\n(8) Related Party Transactions\nDuring years prior to fiscal 1993, certain directors and officers of the Partners and certain employees of the Venture purchased parcels in the Project at discounts from prices generally offered to the general public. The Venture provided mortgage financing on all such sales pursuant to which the Venture received a down payment equal to 5% of the gross sales price before discounts and a purchase money mortgage. The purchase money mortgages bear interest at a rate of 8% or 9% per annum and provide for monthly principal payments based on a 30 year amortization schedule with a balloon payment due after seven years. Certain balloon payments on such mortgages have been extended for one year. At June 30, 1995 and 1994, mortgages receivable of $1,073,600 and $1,508,700, respectively, were due from such related parties. As of June 30, 1995, two of the remaining eight outstanding balances were delinquent.\nDuring fiscal 1993, an officer of one of the Partners exchanged his previously purchased parcel for a new parcel with no additional consideration.\n(9) Contingencies\nDuring fiscal 1992, the County of Hawaii passed an ordinance pursuant to which the Venture, after subdivision approvals are obtained, would be able to develop and subdivide the fourth phase of the project into 1,490 units. Shortly after passage of the ordinance, a lawsuit against the County of Hawaii was filed by two local residents of Hawaii (Plaintiffs) seeking to invalidate such ordinance on various grounds including that the ordinance was adopted without following State of Hawaii procedure relating to the preparation of an Environmental Impact Statement. During fiscal 1993, the judge in this action granted Plaintiffs' motion for partial summary judgment without indicating any effect on zoning of the fourth phase. The County and the Venture have appealed this ruling. The appeal was heard before the Hawaii Supreme Court in March 1994, and the Court has taken the matter under advisement. The Venture cannot, at this time, determine the impact of the Court's ruling on the timing of the development of the fourth phase or the expenditures related thereto.\nDuring fiscal 1993, the Venture made a $600,000 provision for a 4% Hawaii excise tax relating to the collection of interest on mortgage notes receivable. The Venture recorded an additional $224,000 during fiscal 1994. The Venture has paid $530,400 relating to this matter through June 30, 1995.\n(Continued)\nKOHALA JOINT VENTURE AND SUBSIDIARY\nNotes to Consolidated Financial Statements, Continued\n(10) Impact of New Accounting Standards\nIn May 1993, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 114, \"Accounting by Creditors for Impairment of a Loan\" (SFAS No. 114). SFAS No. 114 addresses the accounting by creditors for impairment of a loan by specifying how allowances for credit losses related to certain loans should be determined. In October 1994, the FASB issued Statement of Financial Accounting Standards No. 118, \"Accounting by Creditors for Impairment of a Loan -- Income Recognition and Disclosures\", (SFAS No. 118) which amends SFAS No. 114 by expanding disclosure requirements and permitting use of existing methods for recognizing interest income on impaired loans. SFAS Nos. 114 and 118 are effective for fiscal years beginning after December 15, 1994.\nIn March 1995, the FASB issued Statement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long Lived Assets and for Long Lived Assets to Be Disposed Of\" (SFAS No. 121). SFAS No. 121 addresses accounting for the impairment of long-lived assets (including real estate), certain identifiable intangibles, and goodwill relating to those assets to be held and used and for long-lived assets and certain identifiable intangibles to be disposed of.\nThe Venture believes that the adoption of these new standards will not have a material effect on the Venture's financial position and\/or results of operations.\nSchedule II\nKOHALA JOINT VENTURE AND SUBSIDIARY\nValuation and Qualifying Accounts\nYears ended June 30, 1995, 1994 and 1993\n___________________\n(A) Transfers (B) Recoveries and other adjustments (C) Write-offs\nHUDSON GENERAL CORPORATION & SUBSIDIARIES\nEXHIBIT INDEX","section_15":""}
{"filename":"817945_1995.txt","cik":"817945","year":"1995","section_1":"ITEM 1. BUSINESS\nThe Company provides a broad line of protective services for its customers, including guard, alarm, armored and courier services. The Company believes that, based on revenues and the variety of services offered, it is the largest and broadest-based supplier in the protective services industry in the United States.\nCOMPANY'S BUSINESS UNITS\nThe Company's protective services business is divided into four business units: guard services, alarm services, armored services and courier services. Information concerning the revenues, operating profit or loss and identifiable assets attributable to each of the Company's business units is incorporated herein by reference to Note 9 of the Notes to Consolidated Financial Statements.\nGUARD SERVICES\nThe guard services unit provides a variety of guard and related security services under the Wells Fargo(R), Burns(R), Globe(R) and other service marks to approximately 14,000 government and business customers from approximately 281 locations throughout the United States, and in Canada, Colombia and the United Kingdom. The Company believes that its guard services unit is the largest contract guard services operation in the world, measured by revenues.\nThe Company's guard services unit supplies contract uniformed and plainclothes security officers, who may or may not be armed, to perform a wide variety of tasks. These security officers patrol and monitor commercial, financial, industrial, residential and governmental facilities providing deterrence against crime and breach of governmental security regulations and detection of fire, accidents and other casualties. The security officers also monitor electronic systems and control public and employee access to facilities. Specialized assignments include nuclear and conventional electric power plant security, pre-departure screening of passengers and luggage at airports, mailroom services and investigative services, including background investigations of prospective employees.\nThe guard services unit employs approximately 70,000 security officers. Security officers undergo a standardized pre-employment screening program that features mandatory drug screening, criminal record checks at the county and municipal court level and verification of consumer credit reports, Social Security information and drivers' license records. Security officers receive classroom orientation and field training in safety, first aid and security techniques and in the handling of specific problems applicable to particular industries or situations.\nThe guard services unit markets guard services through approximately 150 sales representatives nationwide and in Canada, Colombia and the United Kingdom. Sales personnel operate out of local branch and sales offices. The guard services unit also bids on contracts with governmental agencies.\nGuard services contracts generally provide for such services on a continuing basis and generally are terminable by either party upon 30 to 60 days notice. Charges for guard services are negotiated with customers and are based upon payment of a specified amount per guard hour. Typically, such charges are adjusted for any change in any law, ruling or collective bargaining agreement causing a change in work hours, wage rates, working conditions or other costs. Investigative services are generally provided under specific arrangements, with charges varying according to the nature of the assignment.\nALARM SERVICES\nThe alarm services unit provides electronic security services in the United States and Canada under the Wells Fargo(R) service mark for its commercial customers and under the Pony Express(R) service mark for its residential customers. In addition, this unit provides an integrated guard, patrol and alarm service to Bel Air, Beverly Hills and other suburbs of Los Angeles under the trade name Bel-Air Patrol. The Company believes that its alarm services unit is one of the largest electronic security service operations in the United States, measured by revenues. The unit has approximately 2,440 employees.\nCommercial. The alarm services unit designs, installs, monitors and services electronic detection systems located at customers' premises. These systems are tailored to customers' needs and may include intrusion and fire detection, critical process and sprinkler monitoring, access control and closed-circuit television monitoring systems. The Company's alarm systems and devices may be monitored on the premises of the customer by the customer's own personnel or linked through telephone lines or long range radio to one of 12 central stations operated by the Company in the United States and Canada. The Company also services its installed systems.\nThe alarm services unit services approximately 109,000 security systems in financial institutions, industrial and commercial businesses and complexes, warehouses, facilities of federal, state and local governments, defense installations, and health care and educational facilities.\nThe majority of the Company's monitoring contracts are for an initial five- year period with automatic renewal for additional one-year terms, unless terminated by either party. Upon installation, a customer pays an installation fee and agrees to pay an annual service charge for ordinary maintenance and monitoring during the life of the contract. It has been the unit's experience that its customers generally continue the service after expiration of the initial term of the contract and enter into new five-year monitoring contracts.\nThe alarm services unit conducts its sales, installation and service operations from 37 branch offices in the United States and Canada, some of which are on the same premises as a monitoring station, and additional satellite offices. The alarm services unit has a nationwide sales force that is separated into broad-based commercial groups, as well as specialized sales teams that address the specific needs of the financial community, engineered systems market and other high growth segments of the industry. One group, for example, focuses on multi-location companies such as national retail chains and fast food outlets that require a single point of control for planning, servicing, monitoring and reporting for all locations.\nThe alarm services unit also makes direct sales of security equipment to government and commercial users (including other companies in the alarm business) and designs, assembles and sells engineered systems for commercial fire suppression.\nResidential. The alarm services unit also installs fire and intrusion protection systems for residential customers under the Pony Express(R) service mark. Residential customer sales and service are generally performed from the same facilities as for commercial accounts. Residential systems are installed by the Company with monitoring agreements and often with maintenance agreements. The majority of the residential monitoring contracts are for an initial period of three to five years with automatic renewal for additional one-year terms, unless terminated by either party. The unit services approximately 25,600 residential security systems.\nBel-Air Patrol. The Company also provides a complete protective package, including central station alarm service and surveillance systems, security guards and day and night patrols, to residents in Bel Air and Beverly Hills and other nearby communities of Los Angeles. The Company provides these services to approximately 12,000 customers under the trade name Bel-Air Patrol.\nThe alarm services unit purchases electronic equipment and component parts for systems from a number of suppliers, and is not dependent upon any single source for such equipment or parts.\nARMORED SERVICES\nThe armored services unit is a security-related cash services business that provides traditional armored transport services, automatic teller machine (\"ATM\") services and cash management services in the United States under the Wells Fargo(R) service mark. The unit employs approximately 6,100 employees at approximately 136 facilities throughout the United States and Puerto Rico. The Company's armored and ATM businesses use a fleet of approximately 1,770 vehicles to transport approximately $5 billion of currency and securities each business day. The Company believes it is the second largest armored transportation operation in the United States, measured by revenues.\nArmored Transport. The Company provides vault storage and specialized, secure transportation services using armed guards in carrying currency, securities and other valuables for banks and national and local retail customers.\nThe Company provides armored transport services for over 14,000 customers. Most of the customer contracts are for a multi-year term with automatic renewal for additional one-year terms, unless terminated by either party. It has been the unit's experience that its customers generally continue the service after the initial term of the contract.\nThe armored transport services operation has a sales force of approximately 40 people dedicated to the solicitation of transportation-related accounts and a separate sales force that focuses solely on transportation-related accounts for national retail customers. In recent years the Company has expanded its armored express service, which offers deposit pick-up services in small to medium sized markets for retailers who have not traditionally used armored transport services.\nGenerally, the Company assumes responsibility for the safe arrival at the destination of transported commodities. The armored transport unit maintains a risk management department that is responsible for loss prevention, security investigation, employee safety and training and coordination with local and federal law enforcement personnel.\nATM Servicing. The armored transport unit also provides special services to approximately 25,000 ATMs on a national basis. The Company believes it is the leading servicer of ATMs in the United States, measured by both revenues and the number of ATMs serviced.\nThe Company controls its ATM services through an automated national dispatching center located in Columbia, Maryland. The dispatch center coordinates all customer requests and directs field technicians throughout the country. The automation system provides detailed service confirmation data both internally and to the customer. ATM servicing is a time-critical business and the Company guarantees a response time of 90 minutes or less to its major accounts.\nThe Company offers financial institutions a complete range of management and maintenance services for ATM networks. The Company provides cash preparation and replenishment, deposit collection and verification, on-site balancing of ATM funds, preventive maintenance and first and second line maintenance services, including necessary hardware maintenance. The Company also sells refurbished ATM equipment.\nThe Company's ATM servicing unit has a sales force of approximately five persons. Most of the customer contracts are for a multi-year term with automatic renewal for additional one-year terms, unless terminated by either party.\nCash Management Services. The armored transport unit also provides cash management services to approximately 500 financial institutions and retail customers. These highly automated services include currency storage and preparation, micro-encoding of checks, deposit verification and consolidation, coin wrapping and storage and food stamp processing. Most of the customer contracts are for a multi-year term with automatic renewal for additional one- year terms, unless terminated by either party.\nCOURIER SERVICES\nThe courier services unit transports time-sensitive packages for commercial businesses and non-negotiable financial documents for Federal Reserve banks and financial institutions through 34 branch and 82 satellite offices in 32 states under the Pony Express(R) service mark. The unit provides ground courier services through a fleet of approximately 3,300 vehicles and commercial and charter air service for longer distance or extremely time-critical shipments.\nAlthough the Pony Express service mark traces its roots to the Pony Express of Old West fame, the present courier operation began as a financial commodity courier transporting cancelled checks and other non-negotiable financial documents among financial institutions as a part of the armored transportation unit. While shipments of non-negotiable financial documents are still a substantial part of the unit's business, the courier services unit also delivers small packages, particularly business-to-business shipments of parts, extremely urgent mail, film, medical and pharmaceutical supplies and other commodities. The primary focus of the courier service unit is same-day or next-day service by ground transportation in intrastate and regional interstate markets. The typical customer ships multiple, time-critical, small shipments on a daily or weekly basis from one or more locations to one or more other locations within a 500- mile radius. The Company may design a customized distribution system initially for one or two large customers and make available to smaller customers the excess capacity on such system.\nThe courier services unit attempts to meet customer needs for secure transportation through flexible and customized services. Shipments are picked up and delivered by uniformed courier guards who are trained in security measures. The unit has developed sophisticated information systems that provide automated billing, computer-assisted routing and package tracking and other programs that enhance customer service. The unit is expanding its use of PonyTrak\/TM\/, an electronic tracking system that uses a hand-held scanner to record pickup and delivery times, dates and locations by reading package bar codes. The Company offers services outside of normal business hours that sometimes require couriers to unlock and enter customer premises and secure premises when leaving.\nThe unit employs approximately 4,800 persons. The unit leases approximately 60 percent of its vehicles from its employees. The Company believes such lease arrangements provide a competitive advantage because such employees tend to provide\nbetter customer service, drive more safely and have a more vested interest in the success of the business.\nThe courier services unit operates both as a common and contract carrier and uses a combination of tariffs and shipping contracts to control the terms, conditions and rates applicable to the transportation of shipments. Rates are dependent upon many factors, including the weight and type of the shipped item, the distance and urgency of the shipment and the geographical location.\nCOMPETITION\nThe guard services unit competes with major national firms and numerous smaller regional and local companies providing similar services. Competition in the security guard industry is based on price in relation to the quality of service, the scope of services performed, the extent and quality of guard supervision, recruiting and training and name recognition.\nThe alarm services unit competes with major national firms and numerous smaller regional and local companies. Competition in the alarm services industry is based on price in relation to the quality of service, the scope of alarm installation and service, and the level of technological and engineering sophistication.\nThe armored services unit competes with major national firms and numerous smaller regional and local companies. Competition in the armored transport industry is based primarily on price in relation to quality of service, the scope of services performed, quality of cargo insurance and name recognition.\nThe courier services unit competes with numerous regional and local courier companies. Competition in the courier industry is based primarily on price in relation to quality of service and size and configuration of distribution routes. Because of low barriers to entry in some areas, smaller local competitors with substantially lower overhead expenses are often able to compete effectively with the Company for local shipments.\nREGULATION\nDue to the nature of the Company's business, its operations are subject to a variety of federal, state, county and municipal laws, regulations and licensing requirements. The Company believes that its operations are in substantial compliance with those laws, regulations and requirements.\nThe Company's guard services operations are subject to a variety of city, county and state firearm and occupational licensing laws. In addition, many states have laws requiring training and registration of security officers, regulating the use of badges, identification cards and uniforms and imposing minimum bond surety and insurance requirements.\nFederal legislation has been introduced relating to security officer qualification and training. Similar legislation is pending in several states. The Company generally supports the creation of standards for the industry and does not expect that the establishment of such standards will have a material affect on its guard services operations.\nThe Company's alarm services operations are subject to regulatory requirements of federal, state and local authorities. In addition, this unit relies upon the use of telephone lines to transmit signals, and the cost of such lines and the type of equipment which may be used are currently regulated by both federal and state governments. In some instances, the Company contracts with the local government to permit it to link a customer's business or home directly into the local police or fire department station for which it may pay a fee to such local government. As a result of a high incidence of false alarms in some communities, some local governments have imposed assessments, fines and penalties on customers based on the number of false alarms reported, or have restricted police response to systems producing excessive false alarms.\nFederal legislation became effective in 1995 that abolished all intrastate regulatory control over prices, routes and services to which the Company's armored and courier units had previously been subject. Such operations are subject to regulation by federal and state agencies with respect to safety of employees, operations and equipment, vehicle emissions and underground fuel storage tanks.\nFrom time to time, in the ordinary course of business, the Company is subjected to penalties or fines as the result of licensing irregularities or the misconduct of one or more of its agents or employees. In addition, under principles of common law, the Company can generally be held liable for acts or omissions of its agents or employees performed in the course and scope of their employment. In addition, some states have statutes that expressly impose on the Company legal responsibility for the conduct of its employees.\nRISK MANAGEMENT\nThe nature of the services provided by the Company potentially exposes it to greater risks of liability for employee acts, injuries (including workers' compensation claims) or omissions than may be posed by other service businesses.\nThe Company often obtains customer indemnification or liability limitations in its contracts to mitigate this risk exposure. In addition to self-insurance reserves, the Company carries insurance of various types, including general liability coverage. The Company obtains such insurance at rates and upon terms negotiated periodically with various underwriters. The loss experience of the Company and, to some extent, other protective services companies affects premium rates charged to the Company. The Company generally maintains insurance coverage for punitive damages, although the laws of many states limit or prohibit insurance coverage for liability for punitive damages. The Company does not believe that limitations on, or the uncertainty of, insurance\ncoverage for punitive damages in certain states in which it operates is likely to be material, based upon the Company's prior experience with punitive damages claims. The Company also attempts to manage its risk liability through analysis of customer facilities and transportation routes and employee screening, training, supervision and evaluation.\nEMPLOYEES\nThe Company's business is labor intensive and, accordingly, is affected by the availability of qualified personnel and the cost of labor. Although the protective services industry is characterized generally by high turnover, the Company believes its experience compares favorably with that of the industry. The Company has not experienced any material difficulty in employing suitable numbers of qualified security guards and other employees. The Company considers its relations with its employees to be generally satisfactory.\nThe Company is a party to collective bargaining agreements with various local unions covering approximately 8,100 employees. The collective bargaining agreements expire at various dates from 1996 to 1999 and relate, among other things, to wages, hours and conditions of employment. Under section 9(b)(3) of the National Labor Relations Act, if a union admits to membership, or is affiliated directly or indirectly with a union that admits to membership, employees other than guards, an employer of guards can refuse to bargain with such union and such union cannot be certified as the representative of a unit of guards. As a result, the Company has in many instances refused to recognize or withdrawn recognition of labor organizations that admit as members employees other than guards.\nThe NLRB has certified various locals of the International Brotherhood of Teamsters, Chauffeurs, Warehousemen and Helpers of America as the exclusive collective bargaining representative of certain of its courier services employees. The unit is engaged in contract negotiations with such representative.\nTRADEMARKS AND PATENTS\nThe Wells Fargo(R), Pony Express(R) and Burns(R) service marks are especially important to the Company's business. The Company believes that its rights in these marks are adequately protected and of unlimited duration. While the Company has patents it considers to be important to the overall conduct of its business, it does not consider any particular patent, or group of related patents, essential to its operations. The Company's 13 United States patents, which generally relate to the Company's alarm services unit, expire between 1997 and 2008, and the Company's 18 foreign patents, which generally relate to the Company's alarm services unit, expire between 1995 and 2009. For both the United States and the foreign patents, their expiration, individually, and in the aggregate, is not expected to have any material effect on the Company's financial condition or results of operations.\nEXECUTIVE OFFICERS\nSet forth below are the names, ages, positions and certain other information concerning the executive officers of the Company as of March 1, 1996.\nMr. Adorjan has been a director of the Company since 1993, Chairman of the Board (since January 1996), Chief Executive Officer (since October 1995) and President (since April 1995). Mr. Adorjan was President of Emerson Electric Co. from 1992 to 1995 and Chairman and Chief Executive Officer of ESCO Electronics Corporation from 1990 to 1992. Mr. Adorjan is also a director of California Microwave, Inc. and ESCO Electronics Corporation.\nMr. O'Brien has been Senior Vice President of the Company since 1993 and was Vice President of the Company from 1987 to 1993.\nMr. Wood has been Vice President, Finance of the Company since 1994 and was Vice President and Controller of the Company from 1987 to 1994.\nEach of the executive officers named above was elected by the Board of Directors to serve in the office indicated until his successor is elected and qualified.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company and its subsidiaries maintain armored and courier terminals, central alarm stations, plants and general offices in various cities in the United States, Puerto Rico, Canada, the United Kingdom and Colombia. At December 31, 1995, the guard services unit occupied approximately 281 branch and satellite offices, all but one of which were leased. At December 31, 1995, the alarm services unit operated 12 central stations, of which 4 were leased and 37 additional branch and 15 separate satellite offices, all of which were leased. At December 31, 1995, the armored services unit occupied 136 facilities, of which 100 were leased, and 61 of which contained vaults. At December 31, 1995, the courier services unit occupied approximately 116 branches and satellites, of\nwhich all but three were leased. The Company leases approximately 57,000 square feet of office space in Chicago, Illinois for its executive offices. The Company 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\nThe Company is presently, and is from time to time, subject to claims and suits arising in the ordinary course of its business. In certain of such actions, plaintiffs request punitive or other damages that may not be covered by insurance. In addition, the Company has been subject to claims and suits relating to certain discontinued operations. The most important of these legal proceedings are discussed below. The Company believes that the various asserted claims and litigation in which it is currently involved will not materially affect its financial position or future operating results, although no assurance can be given with respect to the ultimate outcome for any such claim or litigation. The Company believes that it has established adequate provisions for litigation liabilities in its financial statements in accordance with generally accepted accounting principles. These provisions include both legal fees and possible outcomes of legal proceedings (including the environmental matters discussed below).\nCentaur Litigation\nCentaur Insurance Company (\"Centaur\"), a discontinued property and casualty insurance subsidiary, ceased writing insurance in 1984 and has been operating under rehabilitation since September 1987. Rehabilitation is a process supervised by the Illinois Director of Insurance to attempt to compromise liabilities at an aggregate level that is not in excess of Centaur's assets. In rehabilitation, Centaur's assets are currently being used to satisfy claim liabilities under direct insurance policies written by Centaur. Any remaining assets will be applied to Centaur's obligations to other insurance companies under reinsurance contracts. The foregoing has resulted in one pending lawsuit against the Company for recovery of alleged damages from the failure of Centaur to satisfy its reinsurance obligations. Certain former officers and directors of the Company's current and former subsidiaries have been named as defendants in such lawsuit and the Company has agreed to indemnify such individuals. Centaur is not a defendant in this lawsuit against the Company. Although the Illinois Director of Insurance has not made any claims against the Company for any of Centaur's liabilities, the Illinois Director of Insurance has requested, and the Company has agreed to, an extension of the statute of limitations for any such claims.\nAs of December 31, 1993, Centaur's total liabilities were $135 million and its deficit in net worth was $54.7 million, according to financial statements submitted on behalf of the Illinois Director of Insurance. Such financial statements were presented on a liquidating basis with assets carried at their market value or estimated realizable value\nand liabilities carried at their present value through the provision of a present value discount. Although Centaur is a subsidiary of the Company, the Company does not operate Centaur and has no responsibility for, nor does it participate in the preparation of, such financial statements. Centaur's financial results, assets and liabilities are not reflected in the Company's financial statements.\nIn June 1988, the Insurance Commissioner of the State of California as trustee of Mission Insurance Trust and four other affiliated insurance companies filed a complaint in the Superior Court of the State of California, County of Los Angeles, against the Company and certain of its current and former subsidiaries alleging damages resulting from the failure of Centaur to satisfy its reinsurance obligations. This lawsuit alleges damages to plaintiff, as Trustee of Mission Insurance Company, Mission National Insurance Company, Enterprise Insurance Company, Holland-America Insurance Company and Mission Reinsurance Corporation, based on (i) conduct justifying piercing the corporate veil, (ii) fraud and (iii) negligent misrepresentation. Plaintiff seeks judgment in the amount of the insurance companies' current losses, which allegedly total approximately $14.2 million, plus a declaratory order that the Company pay future losses alleged to exceed $66 million. The complaint was amended in 1989 to add 11 former officers and directors of the Company's current and former subsidiaries as defendants and to allege additional causes of action based on (i) breach of fiduciary duty and imposition of personal liability, (ii) fraudulent conveyance, (iii) constructive trust and (iv) conspiracy and additional current losses totalling more than $9.8 million and to add a claim for punitive damages in the amount of $270 million.\nIn 1989, the Company filed a motion to dismiss or stay the action, pending resolution of Centaur's rehabilitation in Illinois. The court declined to dismiss the action, but entered an order staying the action until the rehabilitation proceeding is resolved, except that the parties may pursue discovery to preserve evidence. In 1992, the Centaur rehabilitator filed a motion to intervene and dismiss the complaint on the grounds that the plaintiff lacked standing and that its claims were not ripe for adjudication. The motion is pending. In 1993, six of the 11 individual defendants were dismissed from the lawsuit. In September 1994, the court effectively lifted its stay. Active discovery is now being pursued. The Company intends to defend this lawsuit vigorously.\nThe Company believes that any damages for failure to satisfy reinsurance obligations are solely the responsibility of Centaur and that the resolution of the lawsuit relating to Centaur, including the Company's indemnification obligations to former officers and directors, will not have a material adverse effect on its financial position or future operating results; however, no assurance can be given as to the ultimate outcome with respect to such lawsuit.\nEnvironmental Proceedings\nThe Company and certain of its current and former subsidiaries have been identified by the U.S. Environmental Protection Agency and certain state environmental agencies as potentially responsible parties (\"PRPs\") at a number of hazardous waste disposal sites under the Comprehensive Environmental Response, Compensation and Liability Act (\"Superfund\") and equivalent state laws and, as such, may be liable for the cost of cleanup and other remedial activities at these sites. Responsibility for cleanup and other remedial activities at a Superfund site is typically shared among PRPs based on an allocation formula. The Company believes that none of these matters individually or in the aggregate will have a material adverse affect on its financial position or future operating results, generally either because the maximum potential liability at a site is not large or because liability will be shared with other PRPs, although no assurance can be given with respect to the ultimate outcome of any such liability. Based on its estimate of allocations of liability among PRPs, the probability that other PRPs, many of whom are large, solvent public companies, will fully pay the costs allocated to them, currently available information concerning the scope of contamination at such sites, estimated remediation costs at such sites, estimated legal fees and other factors, the Company has made provisions for indicated environmental liabilities in its financial statements in the aggregate amount of approximately $10 million (relating to environmental matters with respect to discontinued operations of the Company). The Company believes that such provisions for indicated environmental liabilities have been established on a basis consistent with generally accepted accounting principles. If any environmental liability claim relating to the Company's former chemical and plastics business is made, the Company is indemnified by the purchaser of such business, General Electric Company. Since the disposition, the Company has notified General Electric Company of various claims made with respect to the Company's former chemical and plastics business and General Electric Company has assumed all of such claims and has not contested its indemnification obligations. There is no dollar limitation on the General Electric Company's indemnification obligations and there are no other material limitations or exclusions with respect thereto. If any environmental liability claim relating to the operations of Borg-Warner Automotive, Inc. is made, the Company will be indemnified by Borg-Warner Automotive. There is no dollar limitation on such indemnification obligations and there are no other material limitations or exclusions with respect thereto.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThere were no matters submitted to the security holders of the Company during the fourth quarter of 1995.\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS.\nOn January 20, 1993, the Company's Common Stock was listed for trading on the New York Stock Exchange. Prior to that date, there was no established public trading market for shares of Common Stock. As of March 5, 1996, there were approximately 217 holders of record of Common Stock.\nThe Company has neither paid nor declared any cash dividends on its Common Stock during the last two years. The payment of dividends by the Company prohibited under the terms of the Company's indebtedness. The Company currently intends to retain earnings for acquisitions, working capital, capital expenditures, general corporate purposes and reduction of outstanding indebtedness. Accordingly, the Company does not expect to be able to nor does it expect to pay cash dividends in the foreseeable future.\nHigh and low sales prices (as reported on the New York Stock Exchange composite tape) for the Common Stock for each quarter during 1994 and 1995 were:\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe selected financial data for the five years ended December 31, 1995, with respect to the following line items shown under the \"Consolidated Statistical Review\" (set forth on page 12) in the Annual Report is incorporated herein by reference and made a part of this report: Net service revenues; earnings (loss) from continuing operations; earnings (loss) from continuing operations per share; total assets and total debt.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe Management's Discussion and Analysis of Results of Operations and Financial\nCondition (set forth on pages 14 through 19) in the Annual Report are incorporated herein by reference and made a part of this report.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe consolidated financial statements (including the notes thereto) of the Company (set forth on pages 20 through 38) in the Annual Report are incorporated herein by reference and made a part of this report. Supplementary financial information regarding quarterly results of operations (unaudited) for the years ended December 31, 1995 and 1994 is set forth in Note 14 of the Notes to Consolidated Financial Statements. For a list of financial statements and schedules filed as part of this report, see the \"Index to Financial Statements and Financial Statement Schedules.\"\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nInapplicable.\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nInformation with respect to directors and nominees for election as directors of the Company is incorporated herein by reference to the information under the caption \"Election of Directors\" on pages 1 through 3 of the Company's proxy statement for the 1996 annual meeting of stockholders. Information with respect to executive officers of the Company is set forth in part I of this report. Information concerning compliance with Section 16(a) of the Exchange Act is incorporated by reference to the information under the caption \"Section 16(a) Compliance\" on page 6 of the Company's proxy statement for the 1996 annual meeting of stockholders.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation with respect to compensation of executive officers and directors of the Company is incorporated herein by reference to the information under the captions \"Executive Compensation\" on pages 6 through 9, and \"Compensation of Directors\" on page 4, of the Company's proxy statement for the 1996 annual meeting of stockholders.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation with respect to security ownership by persons known to the Company to\nbeneficially own more than five percent of the Company's common stock, by directors and nominees for director of the Company and by all directors and executive officers of the Company as a group is incorporated herein by reference to the information under the caption \"Stock Ownership\" on pages 5 and 6 of the Company's proxy statement for the 1996 annual meeting of stockholders.\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 information under the caption \"Certain Relationships and Related Transactions\" on pages 13 and 14 of the Company's proxy statement for the 1996 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) The following consolidated financial statements of the registrant and its consolidated subsidiaries, set forth on pages 20 through 38 of the Annual Report, and the report of Deloitte & Touche set forth on page 39 of the Annual Report, are incorporated herein by reference:\nConsolidated Balance Sheet--December 31, 1995 and 1994\nConsolidated Statement of Operations--three years ended December 31,\nConsolidated Statement of Cash Flows--three years ended December 31,\nConsolidated Statement of Stockholders' Equity--three years ended December 31, 1995\nNotes to Consolidated Financial Statements\n(a)(2) The following report of independent auditors and financial statement schedule of the registrant and its consolidated subsidiaries are included herein:\nReport of Deloitte & Touche LLP, independent auditors\nII Valuation and Qualifying Accounts\nCertain schedules for which provisions are made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted.\n(a)(3) The exhibits listed in the \"Exhibit Index.\"\n(b) Reports on Form 8-K.\nNo reports on Form 8-K were filed by the Company during the three-month period ended December 31, 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.\nBORG-WARNER SECURITY CORPORATION\nBy \/s\/ J. Joe Adorjan -------------------- J. Joe Adorjan Chairman of the Board, Chief Executive Officer and President\nDate: March 18, 1996\nPursuant to the requirements of the 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 this day of March 18, 1996.\nSignature Title - --------- ------\n\/s\/ J. Joe Adorjan Chairman of the Board, Chief - ------------------------------- Executive Officer and President and J. Joe Adorjan Director (Principal Executive Officer)\n\/s\/ Timothy M. Wood Vice President, Finance - ------------------------------- (Principal Financial and Accounting Timothy M. Wood Officer)\n\/s\/ James J. Burke, Jr. Director - ------------------------------- James J. Burke, Jr.\n\/s\/ Albert J. Fitzgibbons, III Director - ------------------------------- Albert J. Fitzgibbons, III\nDirector - ------------------------------- Arthur F. Golden\n\/s\/ Dale W. Lang Director - ------------------------------- Dale W. Lang Director - ------------------------------- Robert A. McCabe\n- ------------------------------- Andrew McNally IV Director\n\/s\/ Alexis P. Michas Director - ------------------------------- Alexis P. Michas\n\/s\/ H. Norman Schwarzkopf Director - ------------------------------- H. Norman Schwarzkopf\n\/s\/ Donald C. Trauscht Director - ------------------------------- Donald C. Trauscht\nINDEPENDENT AUDITORS' REPORT\nTo the Board of Directors and Stockholders Borg-Warner Security Corporation\nWe have audited the consolidated financial statements of Borg-Warner Security Corporation as of December 31, 1995 and 1994, and for each of the three years in the period ended December 31, 1995, and have issued our report thereon dated February 5, 1996; such consolidated financial statements and report are included in your 1995 Annual Report to Stockholders and are incorporated herein by reference. Our audits also included the financial statement schedule of Borg- Warner Security Corporation listed in Item 14 of this Annual Report on Form 10- K. This financial statement schedule is the responsibility of the Corporation's management. Our responsibility is to express an opinion based on our audits. In our opinion, the financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.\nDELOITTE & TOUCHE LLP\nChicago, Illinois February 5, 1996\nSCHEDULE II\nBORG-WARNER SECURITY CORPORATION\nVALUATION AND QUALIFYING ACCOUNTS\n(dollars in millions)\nEXHIBIT INDEX\nEXHIBIT NUMBER DOCUMENT DESCRIPTION ------ --------------------\n*3.1 Amended and Restated Certificate of Incorporation of the Company (incorporated by reference to Exhibit 3.1 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992).\n*3.2 Amended and Restated Bylaws of the Company (incorporated by reference to Exhibit 3.2 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992).\n*4.1 Credit Agreement dated as of January 27, 1993 (\"Credit Agreement\") among the Company, the lenders party thereto and the administrative agent named therein (incorporated by reference to Exhibit 4.3 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992), as amended by the First Amendment thereto (incorporated by reference to Exhibit 4.1 to the Company's Quarterly Report on Form 10-Q for the quarterly period ending June 30, 1994), as amended by the Second Amendment and Consent to Credit Agreement dated as of March 15, 1995 (incorporated by reference to Exhibit 4.8 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994), and as amended by the Third Amendment to Credit Agreement and Consent dated as of October 16, 1995 (incorporated by reference to Exhibit 4.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1995).\n*4.2 Credit Agreement dated as of January 27, 1993 (\"L\/C Agreement\") among the Company, the banks party thereto and the agent named therein (incorporated by reference to Exhibit 4.4 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992), as amended by the First Amendment thereto (incorporated by reference to Exhibit 4.2 to the Company's Quarterly Report on Form 10-Q for the quarterly period ending June 30, 1994), as amended by the Fifth Amendment to L\/C Agreement dated as of March 15, 1995 (incorporated by reference to Exhibit 4.9 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994), and as amended by Amendment No. 6 dated as of October 16, 1995 (incorporated by reference to Exhibit 4.3 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1995).\nB-1\nEXHIBIT NUMBER DOCUMENT DESCRIPTION ------ --------------------\n*4.3 Credit Agreement dated as of October 16, 1995 (\"Term Loan Agreement\") among the Company, various lenders and Bankers Trust Company, as agent (incorporated by reference to Exhibit 4.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1995).\n*4.4 Indenture dated as of January 15, 1983 by and between Borg-Warner and Harris Trust & Savings Bank, Trustee, entered into in connection with the registration of up to $150 million of debt securities and under which Borg-Warner issued 8% Notes due April 1, 1996 (incorporated by reference to Exhibit 9(d) to Registration Statement No. 2-81437).\n*4.5 Supplemental Indenture dated as of December 31, 1987 to the Indenture dated as of January 15, 1983 by and between the Company and Harris Trust and Savings Bank (incorporated by reference to Exhibit 4.7 to the Company's Annual Report on Form 10-K for the Ten Months ended October 31, 1987).\n*4.6 Form of Security for 8% Notes due April 1, 1996 (incorporated by reference to Exhibit 4.8 to Registration Statement No. 33-53480).\n*4.7 Indenture dated as of April 1, 1986 by and between Borg-Warner and Harris Trust and Savings Bank, entered into in connection with the registration of up to $150,000,000 of Debt Securities and Warrants to Purchase Debt Securities for issuance under a shelf registration on Form S-3 (incorporated by reference to Registration Statement No. 33-4670).\n*4.8 Indenture dated as of May 3, 1993 by and between the Company and The First National Bank of Chicago (incorporated by reference to Exhibit 4.1 to the Company's Quarterly Report on Form 10-Q for the quarterly period ended March 31, 1993).\n+*10.1 Borg-Warner Security Corporation Directors Stock Appreciation Rights Plan (incorporated by reference to Exhibit 10.5 to the Company's Annual Report on Form 10-K for the year ended December 31, 1988).\n+*10.2 Borg-Warner Corporation Management Stock Option Plan, as amended through January 19, 1993 (incorporated by reference to Exhibit 10.7 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992).\n+*10.3 Borg-Warner Security Corporation 1993 Stock Incentive Plan\nB-2\nEXHIBIT NUMBER DOCUMENT DESCRIPTION ------ --------------------\n(incorporated by reference to Exhibit 10.19 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992).\n+*10.4 Employment Agreement dated as of March 28, 1995 for J.J. Adorjan (incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1995).\n+*10.5 Form of Employment Agreement for Messrs. O'Brien and Wood (incorporated by reference to Exhibit 10.26 to Registration Statement No. 33-15419), as amended by Form of Amendment of Employment Agreement dated January 19, 1989 (incorporated by reference to Exhibit 10.11 to the Company's Annual Report on Form 10-K for the year ended December 31, 1988).\n*10.6 Form of Indemnification Agreement dated September 23, 1986 between the Company and Messrs. O'Brien and Wood (incorporated by reference to Exhibit 10.17 to Borg-Warner's Annual Report on Form 10-K for the year ended December 31, 1986).\n+*10.7 Agreement dated as of March 28, 1995 with D.C. Trauscht (incorporated by reference to Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1995).\n+*10.8 Borg-Warner Retirement Savings Plan, as amended through January 1, 1995 (incorporated by reference to Exhibit 10.9 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994).\n+*10.9 Borg-Warner Security Corporation Retirement Savings Excess Benefit Plan, as amended and restated through January 1, 1995 (incorporated by reference to Exhibit 10.21 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994).\n+*10.10 Borg-Warner Security Corporation Supplemental Benefits Compensation Program (incorporated by reference to Exhibit 10.10 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994).\n*10.11 Consulting Agreement dated as of September 1, 1993 between the Company and H. Norman Schwarzkopf (incorporated by reference to Exhibit 10.20 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993).\nB-3\nEXHIBIT NUMBER DOCUMENT DESCRIPTION ------ --------------------\n10.12 Consulting Agreement dated as of January 1, 1996 between the Company and D.C. Trauscht.\n11 Computation of earnings per share.\n13 1995 Annual Report to Stockholders.\n21 Subsidiaries of the Company.\n23 Consent of Deloitte & Touche LLP.\n27 Financial Data Schedule. - --------------------\n* Incorporated by reference. + Indicates a management contract or compensatory plan or arrangement required to be filed pursuant to Item 14(c).\nB-4","section_15":""}
{"filename":"789895_1995.txt","cik":"789895","year":"1995","section_1":"Item 1. Business\nThe principal objectives of Polaris Aircraft Income Fund II, A California Limited Partnership (PAIF-II or the Partnership), are to purchase and lease used commercial jet aircraft in order to provide quarterly distributions of cash from operations, to maximize the residual values of aircraft upon sale and to protect Partnership capital through experienced management and diversification. PAIF-II was organized as a California limited partnership on June 27, 1984 and will terminate no later than December 2010.\nPAIF-II has many competitors in the aircraft leasing market, including airlines, aircraft leasing companies, other limited partnerships, banks and several other types of financial institutions. This market is highly competitive and there is no single competitor who has a significant influence on the industry. In addition to other competitors, the general partner, Polaris Investment Management Corporation (PIMC), and its affiliates, including GE Capital Aviation Services, Inc. (GECAS), Polaris Aircraft Leasing Corporation (PALC), Polaris Holding Company (PHC) and General Electric Capital Corporation (GE Capital), acquire, lease, finance, sell and remarket aircraft for their own accounts and for existing aircraft and aircraft leasing programs managed by them. Further, GECAS provides a significant range of management services to GPA Group plc, a public limited company organized in Ireland, together with its consolidated subsidiaries (GPA), which acquires, leases and sells aircraft. Accordingly, in seeking to re-lease and sell its aircraft, the Partnership may be in competition with the general partner, its affiliates, and GPA.\nA brief description of the aircraft owned by the Partnership is set forth in Item 2.","section_1A":"","section_1B":"","section_2":"Item 2. The following table describes certain material terms of the Partnership's leases to Trans World Airlines, Inc. (TWA), Viscount Air Services, Inc. (Viscount), Continental Micronesia, Inc. (Continental Micronesia) and Continental Airlines, Inc. (Continental) as of December 31, 1995. As discussed in Items 7 and 8, Viscount defaulted on certain payments due to the Partnership. Viscount was then notified on January 9, 1996 that the Partnership had elected to terminate the lease (which is disputed by Viscount). Viscount subsequently filed a petition for protection under Chapter 11 of the United States Bankruptcy Code (Items 3, 7 and 8) and the Partnership's aircraft is currently in the possession of Tucson Aerospace, a maintenance facility located in Arizona, as discussed below. Viscount's ultimate compliance or non-compliance with end of lease maintenance return conditions may require the Partnership to evaluate whether a sale or a re-lease of the Partnership's aircraft would be most beneficial for the Partnership's unit holders. As a result of Viscount's defaults and Chapter 11 bankruptcy filing, the Partnership may incur maintenance, remarketing, transition and legal costs related to the Partnership's aircraft.\nScheduled Number of Lease Lessee Aircraft Type Aircraft Expiration Renewal Options - ------ ------------- -------- ---------- --------------- TWA McDonnell Douglas DC-9-30 16 2\/98 (1) none McDonnell Douglas DC-9-40 1 11\/98 (1) none McDonnell Douglas DC-9-30 1 11\/98 (1) none\nViscount Boeing 737-200 1 11\/97 (2) none\nContinental Boeing 727-200 Advanced 1 4\/98 (3) none\nContinental Micronesia Boeing 727-200 Advanced 2 4\/98 (4) none\n(1) TWA may specify a lease expiration date for each aircraft up to six months before the date shown, provided the average date for the 16 aircraft is February 1998, and the average expiration date for the remaining two aircraft is November 1998. The TWA leases were modified in 1991. The leases for the 16 aircraft were extended for an aggregate of 75 months beyond the initial lease expiration date in November 1991 at approximately 46% of the original lease rates. The leases for the remaining two aircraft were extended for 72 months beyond the initial lease expiration dates in November 1992 at approximately 42% of the original lease rates. The Partnership also agreed to share in the costs of certain Airworthiness Directives (ADs). If such costs are incurred by TWA, they will be credited against rental payments, subject to annual limitations with a maximum of $500,000 per aircraft over the lease terms.\nAs discussed in Item 7, in October 1994, TWA notified its creditors, including the Partnership, of a proposed restructuring of its debt. Subsequently, GECAS negotiated a standstill agreement with TWA which was approved on behalf of the Partnership by PIMC. That agreement provided for a moratorium of the rent due the Partnership in November 1994 and 75% of the rents due the Partnership from December 1994 through March 1995. The deferred rents, which aggregated $3.6 million, plus interest were repaid in monthly installments beginning in May 1995 through October 1995. The Partnership received as consideration for the agreement $218,071 and warrants for TWA Common Stock (Item 7).\n(2) This aircraft was previously on lease to SABA Airlines, S.A. (SABA). The lease rate to Viscount was approximately 56% of the prior lease rate. Items 3, 7 and 8 contain additional discussions of the Viscount default, lease termination notification and Viscount's subsequent bankruptcy filing.\nDuring 1995, Viscount delivered the aircraft to Tucson Aerospace, a maintenance facility located in Arizona, to perform a heavy maintenance check on the aircraft. The Partnership has paid to Tucson Aerospace approximately $565,000 from maintenance reserves and cash reserves for this aircraft as progress payments on this maintenance check. Work on the maintenance check was suspended prior to the filing of the Chapter 11 petition by Viscount. Tucson Aerospace asserts that Viscount owes it approximately $866,000 for work done on the aircraft. The aircraft is currently in the possession of Tucson Aerospace and it may assert a lien against the aircraft to secure payment of its claim. In addition, a third party vendor, who claims it provided personnel to work on the aircraft, is asserting a claim against Tucson Aerospace and a lien against the aircraft in the amount of $720,000. Another third party vendor, which claims it provided inspectors, is claiming $185,000 from Tucson Aerospace. The Partnership has been in discussions with the various parties to resolve these disputes and is currently evaluating all of its options, including alternative procedures to obtain repossession of this aircraft.\n(3) This aircraft, previously on lease to Alaska Airlines, Inc. (Alaska), was leased to Continental in April 1993. The lease rate is approximately 55% of the prior lease rate. The lease stipulates that Continental may assign the lease to its affiliate Continental Micronesia under certain conditions. The lease also stipulates that the Partnership will reimburse costs for cockpit modifications up to $600,000, C-check labor costs up to $300,000 and the actual cost of C-check parts for the aircraft. In addition, the Partnership will provide financing up to $815,000 for new image modifications to be repaid with interest over the lease term. In accordance with the cost sharing agreement, in January 1994, the Partnership reimbursed Continental $600,000 for cockpit modifications and $338,189 for C-check labor and parts. In addition, the Partnership financed\n$719,784 for new image modifications, which is being repaid with interest over the lease term of the aircraft. The lease also stipulates that the Partnership share in the cost of meeting certain ADs, which cannot be estimated at this time.\n(4) These two aircraft, previously on lease to Alaska, were leased to Continental Micronesia in May and June 1993. The lease rates are approximately 55% of the prior lease rates. The leases stipulate that the Partnership will reimburse costs for cockpit modifications up to $600,000 per aircraft, C-check labor costs up to $300,000 for one of the aircraft and the actual cost of C-check parts for one of the aircraft. In addition, the Partnership will provide financing up to $815,000 for new image modifications to be repaid with interest over the lease term for each aircraft. In accordance with the cost sharing agreement, in January 1994, the Partnership reimbursed Continental (on behalf of its affiliate Continental Micronesia) $1.2 million for cockpit modifications and $404,136 for C-check labor and parts. In addition, the Partnership financed $1,457,749 for new image modifications, which is being repaid with interest over the lease terms of the aircraft. The leases also stipulate that the Partnership share in the cost of meeting certain ADs, which cannot be estimated at this time.\nThe Partnership transferred six Boeing 727-200 aircraft, formerly leased to Pan American World Airways, Inc. (Pan Am), to aircraft inventory in 1992. These aircraft were disassembled for sale of their component parts as discussed in Note 5 to the financial statements (Item 8). The Partnership sold one Boeing 727-200 aircraft equipped with a hushkit (described below), formerly leased to Delta Airlines, Inc. (Delta), to American International Airways, Inc. (AIA) in February 1995 as discussed in Item 7.\nThe lease of one Boeing 737-200 Combi aircraft to Northwest Territorial Airways, Ltd. (NWT) expired in October 1995. As specified in the lease, NWT was required to perform certain maintenance work on the aircraft prior to its return. NWT returned the aircraft without performing the required maintenance work, which constituted a default under the lease. The Partnership and NWT subsequently reached an agreement by which NWT paid to the Partnership in December 1995 approximately $457,000 and the Partnership was entitled to retain NWT's security deposit of approximately $101,000 in lieu of NWT's performing the required maintenance work on the aircraft. The airframe and one engine from this aircraft were subsequently sold to Westjet Airlines, Ltd. (Westjet) in March 1996 as discussed in Items 7 and 8. The Partnership is currently remarketing the remaining engine for sale.\nIndustry-wide, approximately 475 commercial aircraft are currently available for sale or lease, approximately 125 less than a year ago. From 1991 through 1994, depressed demand for air travel limited airline expansion plans, with new aircraft orders and scheduled deliveries being canceled or substantially deferred. As profitability declined, many airlines took action to downsize or liquidate assets and some airlines were forced to file for bankruptcy protection. Following two years of good traffic growth accompanied by rising yields, this trend is improving with new aircraft orders last year exceeding deliveries for the first time since 1990. To date, this recovery has mainly benefited Stage 3 narrow-bodies and younger Stage 2 narrow-bodies, many of which are now being upgraded with noise suppression hardware, commonly known as \"hushkits,\" which, when installed on the aircraft, bring Stage 2 aircraft into compliance with Federal Aviation Administration (FAA) Stage 3 noise restrictions as discussed in the Industry Update section of Item 7. Older Stage 2 narrow-bodies have shown marginal signs of recovery. The Partnership has been forced to adjust its estimates of the residual values realizable from its aircraft and aircraft inventory, which resulted in an increase in depreciation expense, as discussed in Items 7 and 8. A discussion of the current market condition for the type of aircraft owned by the Partnership follows:\nBoeing 727-200 Advanced - The Boeing 727 was the first tri-jet introduced into commercial service. The Boeing 727 is a short- to medium-range jet used for trips of up to 1,500 nautical miles. In 1972, Boeing introduced the Boeing 727-200 Advanced model, a higher gross weight version with increased fuel capacity as compared with the non-advanced model. Hushkits which bring the Boeing 727-200 Advanced into compliance with FAA Stage 3 noise restrictions, are now available at an average cost of approximately $2.6 million per aircraft. Hushkits may not be cost effective on all aircraft due to the age of some of the aircraft and the time required to fully amortize the additional investment. Certain ADs applicable to all models of the Boeing 727 have been issued to prevent fatigue cracks and control corrosion as discussed in Item 7. The market for this type of aircraft, as for all Stage 2 narrowbody aircraft, has improved over the previous year.\nBoeing 737-200 - The Boeing 737-200 aircraft was introduced in 1967 and 150 were delivered from 1967 through 1971. This two-engine, two-pilot aircraft provides operators with 107 to 130 seats, meeting their requirements for economical lift in the 1,100 nautical mile range. Hushkits which bring Boeing 737-200 aircraft into compliance with FAA Stage 3 noise restrictions, are now available at a cost of approximately $1.5 million per aircraft. Hushkits may not be cost effective on all aircraft due to the age of some of the aircraft and the time required to fully amortize the additional investment. Certain ADs applicable to all models of the Boeing 737 have been issued to prevent fatigue cracks and control corrosion as discussed in Item 7. The market for this type of aircraft, as for all Stage 2 narrowbody aircraft, has improved over the previous year.\nMcDonnell Douglas DC-9-30\/40 - The McDonnell Douglas DC-9-30\/40 is a short- to medium-range twin-engine jet that was introduced in 1967. Providing reliable, inexpensive lift, these aircraft fill thin niche markets, mostly in the United States. Hushkits are available to bring these aircraft into compliance with Stage 3 requirements at a cost of approximately $1.7 million per aircraft. Hushkits may not be cost effective on all aircraft due to the age of some of the aircraft and the time required to fully amortize the additional investment. Certain ADs applicable to the McDonnell Douglas DC-9 have been issued to prevent fatigue cracks and control corrosion as discussed in Item 7. The market for this type of aircraft, as for all Stage 2 narrowbody aircraft, has improved over the previous year.\nThe general partner believes that, in addition to the factors cited above, the deteriorated market for the Partnership's aircraft reflects the airline industry's reaction to the significant expenditures potentially necessary to bring these aircraft into compliance with certain ADs issued by the FAA relating to aging aircraft, corrosion prevention and control and structural inspection and modification as discussed in the Industry Update section of Item 7.\nItem 2. Properties\nPAIF-II owns 17 McDonnell Douglas DC-9-30 and one McDonnell Douglas DC-9-40 aircraft leased to TWA, one Boeing 727-200 Advanced aircraft leased to Continental, two Boeing 727-200 Advanced aircraft leased to Continental Micronesia and one Boeing 737-200 aircraft currently in the possession of Tucson Aerospace, a maintenance facility located in Arizona, as discussed in Items 1, 7 and 8. The Partnership's entire fleet consists of Stage 2 aircraft. All leases are operating leases. The Partnership transferred six Boeing 727-200 aircraft, previously leased to Pan Am, to aircraft inventory in 1992. These aircraft, which are not included in the following table, have been disassembled for sale of their component parts. The Partnership sold one Boeing 727-200 aircraft equipped with a hushkit in February 1995. The Partnership sold the airframe and\none engine from the Boeing 737-200 Combi aircraft in March 1996. The Partnership is currently remarketing the remaining engine for sale or lease.\nThe following table describes the Partnership's current aircraft portfolio in greater detail:\nYear of Cycles Aircraft Type Serial Number Manufacture As of 11\/30\/95 (1) - ------------- ------------- ----------- ------------------ Boeing 727-200 Advanced 21426 1977 31,219 Boeing 727-200 Advanced 21427 1977 29,839 Boeing 727-200 Advanced 21947 1979 26,478 Boeing 737-200 19609 1968 63,364 McDonnell Douglas DC-9-30 47082 1967 74,237 McDonnell Douglas DC-9-30 47096 1967 74,827 McDonnell Douglas DC-9-30 47135 1968 75,617 McDonnell Douglas DC-9-30 47137 1968 74,503 McDonnell Douglas DC-9-30 47249 1968 80,841 McDonnell Douglas DC-9-30 47251 1968 78,987 McDonnell Douglas DC-9-30 47343 1969 77,813 McDonnell Douglas DC-9-30 47345 1969 76,153 McDonnell Douglas DC-9-30 47411 1969 73,554 McDonnell Douglas DC-9-30 47412 1969 73,532 McDonnell Douglas DC-9-30 47027 1967 79,456 McDonnell Douglas DC-9-30 47107 1968 79,422 McDonnell Douglas DC-9-30 47108 1968 76,136 McDonnell Douglas DC-9-30 47174 1968 76,809 McDonnell Douglas DC-9-30 47324 1969 73,349 McDonnell Douglas DC-9-30 47357 1969 73,009 McDonnell Douglas DC-9-30 47734 1977 43,628 McDonnell Douglas DC-9-40 47617 1975 42,691\n(1) Cycle information as of 12\/31\/95 is not yet available.\nItem 3.","section_3":"Item 3. Legal Proceedings\nBraniff, Inc. (Braniff) Bankruptcy - In September 1989, Braniff filed a petition under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the Middle District of Florida, Orlando Division. On September 26, 1990 the Partnership filed a proof of claim to recover unpaid rent and other damages, and on November 27, 1990, the Partnership filed a proof of administrative claim to recover damages for detention of aircraft, non-compliance with court orders and post-petition use of engines as well as liquidated damages. On July 27, 1992, the Bankruptcy Court approved a stipulation embodying a settlement among the Partnership, the Braniff creditor committees and Braniff in which it was agreed that the Partnership would be allowed an administrative claim in the bankruptcy proceeding of approximately $230,769. The Partnership has received a check from the bankruptcy estate in full payment of the allowed administrative claim, subject, however, to the requirement of the stipulation that 25% of such proceeds be held in a separate, interest-bearing account pending notification by Braniff that all the allowed administrative claims have been satisfied. In the third quarter of 1994, the Partnership was authorized to release one-half of the 25% portion of the Partnership's administrative claim segregated pursuant to the stipulation approved in 1992. At the end of 1994, the Partnership was advised that the\nremaining one-half balance of the 25% segregated portion of the administrative claim payment could be released. As the final disposition of the Partnership's claim in the Bankruptcy proceedings, the Partnership was permitted by the Bankruptcy Court to exchange a portion of its unsecured claim for Braniff's right (commonly referred to as a \"Stage 2 Base Level right\") under the FAA noise regulations to operate one Stage 2 aircraft and has been allowed a net remaining unsecured claim of $769,231 in the proceedings. The unsecured claim will not be recorded as revenue by the Partnership until it is received. It cannot be estimated at this time when and if this claim will be paid.\nPan American World Airways, Inc. (Pan Am) - As discussed in the Partnership's 1990 and 1991 Forms 10-K, Pan Am commenced reorganization proceedings under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the Southern District of New York on January 8, 1991. On November 8, 1991, the Partnership filed a proof a claim in Pan Am's bankruptcy proceeding to recover damages for lost rent and for Pan Am's failure to meet return conditions with respect to the Partnership's aircraft on lease to Pan Am. Pan Am's reorganization under Chapter 11 was ultimately unsuccessful, and Pan Am ceased operations in December 1991. On July 10, 1995, Pan Am entered into a proposed Stipulation and Order with the Partnership pursuant to which Pan Am agreed to allow the Partnership $2.5 million as an administrative expense priority claim and $56 million as a general unsecured claim. This Stipulation and Order was approved by the Bankruptcy Court, at a hearing held on August 17, 1995. The claims will not be recorded as revenue by the Partnership until they are received. It cannot be estimated at this time when and if these claims will be paid.\nTrans World Airlines, Inc. (TWA) - On June 30, 1995, TWA filed a reorganization proceeding under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the Eastern District of Missouri. Immediately before the filing, the Partnership and TWA entered into an Amended Deferral Agreement, pursuant to which TWA agreed to bring lease rents current over a period of several months and to confirm all of its leases with the Partnership. As agreed, TWA proposed a plan of reorganization in which, among other things, it confirmed all of its leases with the Partnership, and the plan was confirmed by the Bankruptcy Court on August 4, 1995. TWA has emerged from its bankruptcy proceeding and has repaid all outstanding rent deferrals in accordance with its commitment to the Partnership and in accordance with its plan of reorganization. TWA has since remained current on all of its payment obligations to the Partnership.\nViscount Air Services, Inc. (Viscount) Bankruptcy - On January 24, 1996, Viscount filed a petition for protection under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the District of Arizona. Polaris Holding Company, the Partnership, Polaris Aircraft Income Fund II, Polaris Aircraft Income Fund IV, and Polaris Aircraft Investors XVIII (collectively, Polaris Entities) lease a total of ten aircraft and two spare engines to Viscount. The aggregate outstanding obligations of Viscount to the Polaris Entities is approximately $11.0 million. GE Capital Aviation Services, Inc. (GECAS), as agent for the Polaris Entities, terminated the aircraft and engine leases pre-petition, but Viscount disputes the effectiveness of the termination and currently has possession of the aircraft and engines, with the exception of the Partnership's aircraft, which is currently in the possession of Tucson Aerospace, a maintenance facility located in Arizona. GECAS and Viscount are currently negotiating to determine if they can resolve their differences by agreement. The outcome of this Chapter 11 proceeding cannot be predicted.\nKepford, et al. v. Prudential Securities, et al. - On April 13, 1994, an action entitled Kepford, et al. v. Prudential Securities, Inc. was filed in the District Court of Harris County, Texas. The complaint names Polaris Investment Management Corporation, Polaris Securities Corporation, Polaris Holding Company, Polaris Aircraft Leasing Corporation, the Partnership, Polaris Aircraft Income\nFund I, Polaris Aircraft Income Fund III, Polaris Aircraft Income Fund IV, Polaris Aircraft Income Fund V, Polaris Aircraft Income Fund VI, General Electric Capital Corporation, Prudential Securities, Inc., Prudential Insurance Company of America and James J. Darr, as defendants. Certain defendants were served with a summons and original petition on or about May 2, 1994. Plaintiffs' original petition alleges that defendants violated the Texas Securities Act, the Texas Deceptive Trade Practices Act, sections 11 and 12 of the Securities Act of 1933 and committed common law fraud, fraud in the inducement, negligent misrepresentation, negligence, breach of fiduciary duty and civil conspiracy by misrepresenting and failing to disclose material facts in connection with the sale of limited partnership units in the Partnership and the other Polaris Aircraft Income Funds. Plaintiffs seek, among other things, an award of compensatory damages in an unspecified amount plus interest thereon, and double and treble damages under the Texas Deceptive Trade Practices Act.\nCertain defendants, including Polaris Investment Management Corporation and the Partnership, filed a general denial on June 29, 1994 and a motion for summary judgment on June 17, 1994 on the basis that the statute of limitations has expired. On June 29, 1994 and July 14, 1994, respectively, plaintiffs filed their first amended original petition and second amended original petition, both of which added plaintiffs. On July 18, 1994, plaintiffs filed their response and opposition to defendants' motion for partial summary judgment and also moved for a continuance on the motion for partial summary judgment. On August 11, 1994, after plaintiffs again amended their petition to add numerous plaintiffs, the defendants withdrew their summary judgment motion and motion to stay discovery, without prejudice to refiling these motions at a later date.\nRiskind, et al. v. Prudential Securities, Inc., et al. - An action entitled Riskind, et al. v. Prudential Securities, Inc., et al. has been filed in the District Court of the 165 Judicial District, Maverick County, Texas. This action is on behalf of over 3,000 individual investors who purchased units in \"various Polaris Aircraft Income Funds,\" including the Partnership. The Partnership and Polaris Investment Management Corporation received service of plaintiffs' second amended original petition and, on June 13, 1994, filed an original answer containing a general denial.\nThe second amended original petition names the Partnership, Polaris Investment Management Corporation, Prudential Securities, Inc. and others as defendants and alleges that these defendants violated the Texas Securities Act and the Texas Deceptive Trade Practices Act and committed common law fraud, fraud in the inducement, negligent misrepresentation, negligent breach of fiduciary duty and civil conspiracy by misrepresenting and failing to disclose material facts in connection with the sale of limited partnership units in the Partnership and the other Polaris Aircraft Income Funds. Plaintiffs seek, among other things, an award of compensatory damages in an unspecified amount plus interest thereon, and double and treble damages under the Texas Deceptive Trade Practices Act. Kidder, Peabody & Co. was added as an additional defendant by virtue of an Intervenor's Amended Plea in Intervention filed on or about April 7, 1995.\nPrudential Securities, Inc. reached a settlement with the plaintiffs. The trial of the claims of one plaintiff, Robert W. Wilson, against Polaris Aircraft Income Funds I-VI, Polaris Investment Management Corporation and various affiliates of Polaris Investment Management Corporation, including General Electric Capital Corporation, was commenced on July 10, 1995. On July 26, 1995, the jury returned a verdict in favor of the defendants on all counts. Subsequent to this verdict, all of the defendants (with the exception of Prudential Securities, Inc., which had previously settled) entered into a settlement with the plaintiffs. None of the Polaris Aircraft Income Funds were required to contribute to this settlement.\nHowland, et al. v. Polaris Holding Company, et al. - On or about February 4, 1994, a purported class action entitled Howland, et al. v. Polaris Holding\nCompany, et al. was filed in the United States District Court for the District of Arizona on behalf of investors in Polaris Aircraft Income Funds I-VI. The complaint names each of Polaris Investment Management Corporation, Polaris Securities Corporation, Polaris Holding Company, Polaris Aircraft Leasing Corporation, the Partnership, Polaris Aircraft Income Fund I, Polaris Aircraft Income Fund III, Polaris Aircraft Income Fund IV, Polaris Aircraft Income Fund V, Polaris Aircraft Income Fund VI, General Electric Capital Corporation, Prudential Securities, Inc., Prudential Securities Group, Inc., Prudential Insurance Company of America, George W. Ball, Robert J. Sherman, James J. Darr, Paul J. Proscia, Frank W. Giordano, William A. Pittman, Joseph H. Quinn, Joe W. Defur, James M. Kelso and Brian J. Martin, as defendants. The complaint alleges that defendants violated federal RICO statutes, committed negligent misrepresentations, and breached their fiduciary duties by misrepresenting and failing to disclose material facts in connection with the sale of limited partnership units in the Partnership and the other Polaris Aircraft Income Funds. Plaintiffs seek, among other things, an accounting of all monies invested by plaintiffs and the class and the uses made thereof by defendants, an award of compensatory, punitive and treble damages in unspecified amounts plus interest thereon, rescission, attorneys' fees and costs. On August 3, 1994, the action was transferred to the Multi-District Litigation in the Southern District of New York entitled In re Prudential Securities Limited Partnerships Litigation, discussed in Part III, Item 10 below.\nMary C. Scott v. Prudential Securities Inc. et al. - On or around August 15, 1995, a complaint entitled Mary C. Scott v. Prudential Securities Inc. et al. was filed in the Court of Common Pleas, County of Summit, Ohio. The complaint names as defendants Prudential Securities Inc., the Partnership, Polaris Aircraft Income Fund III, Polaris Aircraft Income Fund IV, Polaris Aircraft Income Fund VI, P-Bache\/A.G. Spanos Genesis Income Partners LP 1, Prudential-Bache Properties, Inc., A.G. Spanos Residential Partners - 86, Polaris Securities Corporation and Robert Bryan Fitzpatrick. Plaintiff alleges claims of fraud and violation of Ohio securities law arising out of the public offerings of the Partnership, Polaris Aircraft Income Fund III, Polaris Aircraft Income Fund IV, Polaris Aircraft Income Fund VI, and P-Bache\/A.G. Spanos Genesis Income Partners LP 1. Plaintiff seeks compensatory damages, general, consequential and incidental damages, punitive damages, rescission, costs, attorneys' fees and other and further relief as the Court deems just and proper. On September 15, 1995, defendants removed this action to the United States District Court, Eastern District of Ohio. On September 18, 1995, defendants sought the transfer of this action to the Multi-District Litigation and sought a stay of all proceedings by the district court, which stay was granted on September 25, 1995. The Judicial Panel transferred this action to the Multi-District Litigation on or about February 7, 1996.\nOther Proceedings - Part III, Item 10 discusses certain other actions which have been filed against the general partner in connection with certain public offerings, including that of the Partnership. With the exception of Novak, et al v. Polaris Holding Company, et al, where the Partnership is named as a defendant, the Partnership is not a party to these actions. In Novak, a derivative action, the Partnership is named as a defendant for procedural purposes but the plaintiffs in such lawsuit do not seek an award from the Partnership.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNone.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters\na) Polaris Aircraft Income Fund II's (PAIF-II or the Partnership) limited partnership interests (Units) are not publicly traded. Currently there is no market for PAIF-II's Units and it is unlikely that any market will develop.\nb) Number of Security Holders:\nNumber of Record Holders Title of Class as of December 31, 1995 ----------------------------- ------------------------\nLimited Partnership Interest: 16,426 General Partnership Interest: 1\nc) Dividends:\nThe Partnership distributed cash to partners on a quarterly basis beginning July 1986. Cash distributions to limited partners during 1995 and 1994 totaled $6,874,959 and $12,499,925, respectively. Cash distributions per limited partnership unit were $13.75 and $25.00 in 1995 and 1994, respectively.\n* The portion of such distributions which represents a return of capital on an economic basis will depend in part on the residual sale value of the Partnership's aircraft and thus will not be ultimately determinable until the Partnership disposes of its aircraft. However, such portion may be significant and may equal, exceed or be smaller than the amount shown in the above table.\nItem 7.","section_6":"","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nPolaris Aircraft Income Fund II (the Partnership) owns a portfolio of 22 used commercial jet aircraft, one spare engine and certain inventoried aircraft parts out of its original portfolio of 30 aircraft. The portfolio consists of 17 McDonnell Douglas DC-9-30 aircraft and one McDonnell Douglas DC-9-40 aircraft leased to Trans World Airlines, Inc. (TWA); one Boeing 737-200 aircraft, previously leased to Viscount Air Services, Inc. (Viscount) which has filed for Chapter 11 bankruptcy protection in January 1996, as discussed below and in Items 3 and 8, is currently in the possession of Tucson Aerospace, a maintenance facility located in Arizona; two Boeing 727-200 Advanced aircraft leased to Continental Micronesia, Inc. (Continental Micronesia); and one Boeing 727-200 Advanced aircraft leased to Continental Airlines, Inc. (Continental). The Partnership transferred six Boeing 727-200 aircraft, previously leased to Pan American World Airways, Inc., to aircraft inventory in 1992. These aircraft have been disassembled for sale of their component parts. The Partnership sold one Boeing 727-200 aircraft, formerly leased to Delta Airlines, Inc. (Delta), in February 1995 as discussed below. The Partnership sold the airframe and one engine from the Boeing 737-200 Combi aircraft, formerly leased to Northwest Territorial Airways, Ltd. (NWT), in March 1996 as discussed below. The Partnership is currently remarketing the remaining engine for sale.\nRemarketing Update\nSale of Boeing 727-200 Aircraft - The Partnership sold one Boeing 727-200 aircraft equipped with a hushkit, formerly leased to Delta, to AIA in February 1995 for a sales price of approximately $1.77 million. The Partnership agreed to accept payment of the sales price in 36 monthly installments of $55,000, with interest at a rate of 7.5% per annum, beginning in March 1995.\nSale of Boeing 737-200 Combi Airframe and Engine - In March 1996, the Partnership sold the airframe and one engine from the Boeing 737-200 Combi Aircraft, formerly on lease to NWT, to Westjet Airlines, Ltd. (Westjet). The Partnership is currently remarketing the remaining engine for sale or lease. The security deposit of approximately $88,000, received from Westjet in December 1995, was applied to the sales price of approximately $896,000. The Partnership agreed to accept payment of the balance of the sales price in 22 monthly installments, with interest at a rate of 10% per annum beginning in March 1996.\nPartnership Operations\nThe Partnership recorded net income of $5,717,065, or $9.94 per limited partnership unit for the year ended December 31, 1995, compared a net loss of $3,217,172, or $8.87 per limited partnership unit and net income of $48,114, or an allocated net loss of $1.91 per limited partnership unit, for the years ended December 31, 1994 and 1993, respectively. The net loss in 1994 resulted primarily from a decrease in rental revenue recognized from the Partnership's leases with TWA combined with maintenance expenses incurred from the TWA leases. Further impacting the decline in operating results in 1994 as compared to 1993, depreciation expense was substantially increased in 1994 for declines in the estimated realizable values of the Partnership's aircraft and aircraft inventory, as discussed later in the Industry Update section. The significant improvement in operating results in 1995 was primarily the result of substantially increased revenues combined with lower operating expenses in 1995 as compared to 1994.\nRental revenues, net of related management fees, declined during 1994 as compared to 1993 primarily as a result of a decrease in rental revenue recognized in 1994 on the Partnership's leases with TWA. In December 1994, GE Capital Aviation Services, Inc. (GECAS) negotiated a standstill agreement with TWA. That agreement provided for a deferral of the rent due the Partnership in November 1994 and 75% of the rents due the Partnership from December 1994 through March 1995. The Partnership did not recognize the rental amount deferred in 1994 of $1,575,000 as rental revenue until it was received in 1995. The Partnership has received from TWA all scheduled rent payments beginning in April 1995 and all scheduled deferred rental payments beginning in May 1995 through October 1995, including interest at a rate of 12% per annum. The increase in rental revenues in 1995, as compared to 1994, was partially offset by a provision for credit losses of $241,964 recorded in 1995 for certain rent, deferred rent and accrued interest receivables from Viscount as discussed below.\nIn consideration for the rent deferral, TWA agreed to make a lump sum payment of $1,000,000 to GECAS for the TWA lessors for whom GECAS provides management services and who agreed to the Deferral Agreement. The Partnership received $218,171 in January 1995 as its share of such payment by TWA. This amount was recognized as other revenue in 1995. In addition, TWA agreed to issue warrants to the Partnership for TWA Common Stock. The Partnership received warrants to purchase 227,133 shares of TWA Common Stock from TWA in November 1995 and has recognized the net warrant value as of the date of receipt of $1,772,206 as revenue in 1995. The Partnership exercised the warrants on December 29, 1995 for the strike price of $0.01 per share and has recognized a gain on the value of the warrants of $582,028 in 1995. In addition, the Partnership recognized as other revenue in 1995 payments received from NWT aggregating approximately $647,000 in lieu of NWT performing required maintenance work on the aircraft it was leasing prior to its return to the Partnership. The Partnership also recognized as other revenue in 1995 maintenance reserves aggregating approximately $91,000 that were previously paid to the Partnership by Delta for the aircraft that was sold to AIA in February 1995.\nOperating expenses significantly decreased in 1995 as compared to 1994 and 1993. As part of the TWA lease extension in 1991 as discussed in Note 6 to the financial statements (Item 8), the Partnership agreed to share the cost of meeting certain Airworthiness Directives (ADs) after TWA successfully reorganized in 1993. The agreement stipulated that such costs incurred by TWA may be credited against monthly rentals, subject to annual limitations and a maximum of $500,000 per aircraft through the end of the leases. In accordance with the cost sharing agreement, the Partnership recognized as operating expense $3.6 million and $2.7 million of these AD expenses during 1994 and 1993, respectively. No operating expenses relating to the TWA aircraft were recognized by the Partnership during 1995.\nAs discussed later in the Industry Update section, if the projected net cash flow for each aircraft (projected rental revenue, net of management fees, less projected maintenance costs, if any, plus the adjusted estimated residual value) is less than the carrying value of the aircraft, the Partnership recognizes the deficiency currently as increased depreciation expense. The Partnership recognized approximately $2.4 million and approximately $1.6 million of this deficiency as increased depreciation expense in 1995 and 1994, respectively. The 1995 downward adjustment was the result of the reduction of the net book value to the estimated net realizable value of the Boeing 737-200 Combi aircraft sold to Westjet in 1996 as previously discussed. Approximately $1.03 million of the 1994 adjustment was the result of the reduction of the net book value to the estimated net realizable value of the Boeing 727-200 aircraft sold to AIA in February 1995 as previously discussed.\nThe increased depreciation expense reduces the aircraft's carrying value and reduces the amount of future depreciation expense that the Partnership will\nrecognize over the projected remaining economic life of the aircraft. The Partnership also made downward adjustments to the estimated residual value of certain of its on-lease aircraft as of December 31, 1995, 1994 and 1993. For any downward adjustment to the estimated residual values, future depreciation expense over the projected remaining economic life of the aircraft is increased. The Partnership's earnings are impacted by the net effect of the adjustments to the aircraft carrying values recorded in 1995 and 1994 and the downward adjustments to the estimated residual values recorded in 1995, 1994 and 1993 as discussed later in the Industry Update section.\nLiquidity and Cash Distributions\nLiquidity - The Partnership received all lease payments due from NWT, Continental, Continental Micronesia and TWA. As discussed above, TWA repaid its deferred rents in full with interest by October 1995. The Partnership also received from TWA warrants to purchase 227,133 shares of TWA Common Stock and a payment of $218,171 in consideration for the rent deferral. The Partnership exercised the warrants in 1995 and sold the TWA Common Stock in the first quarter of 1996, net of broker commissions, for $2,406,479.\nAs discussed below, prior to January 1, 1996, the Partnership had been in discussions with Viscount to restructure certain of Viscount's existing financial obligations to the Partnership. While such discussions were underway, Viscount had undertaken to pay in full, by the end of each month, beginning in June 1995, the current month's obligations by making partial periodic payments during that month. Viscount is presently in default on its financial obligations to the Partnership, and as discussed below, the aircraft Viscount was leasing is currently in the possession of a maintenance facility located in Arizona. On January 24, 1996, Viscount filed a petition for protection under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court in Tucson, Arizona. Legal counsel has been retained and the general partner is evaluating the rights, remedies and courses of action available to the Partnership with respect to Viscount's default and bankruptcy filing. All payments due from Viscount may be affected by Viscount's filing for protection under Chapter 11.\nAs of December 31, 1995, the Partnership's rent, maintenance reserve, loan and interest receivables from Viscount aggregated approximately $336,000. Viscount's failure to perform on its financial obligations with the Partnership is expected to have an adverse effect on the Partnership's financial position. As a result of Viscount's defaults and Chapter 11 bankruptcy filing, the Partnership may incur maintenance, remarketing, transition and legal costs related to the Partnership's aircraft.\nAs discussed above, the Partnership agreed to share in the cost of meeting certain ADs with TWA. In accordance with the cost-sharing agreement, TWA may offset up to an additional $2.7 million against rental payments, subject to annual limitations, over the remaining lease terms.\nAs specified in the Partnership's leases with Continental Micronesia and Continental, in January 1994, the Partnership reimbursed Continental (partially on behalf of its affiliate Continental Micronesia) an aggregate of $1.8 million for cockpit modifications and $742,325 for C-check labor and parts for the three aircraft. In addition, in January 1994, the Partnership financed an aggregate of $2,177,533 for new image modifications, which is being repaid with interest over the terms of the aircraft leases. The leases with Continental and Continental Micronesia also stipulate that the Partnership share in the cost of meeting certain ADs, which cannot be estimated at this time.\nALG, Inc. (ALG) was required to pay the Partnership a balloon payment of $897,932 in January 1995 on their promissory note. ALG paid to the Partnership $19,138 of the balloon payment in January 1995, originating an event of default under the note. The Partnership and ALG subsequently restructured the terms of the promissory note. The renegotiated terms specified payment by ALG of the note balance with interest at a rate of 13% per annum with one lump sum payment in January 1995 of $254,733, eleven monthly payments of $25,600 beginning in February 1995, and a balloon payment in January 1996 of $416,631. The Partnership received all scheduled renegotiated payments due from ALG through December 31, 1995. ALG did not pay the balloon payment due in January 1996. The Partnership and ALG once again restructured the terms of the promissory note. The renegotiated terms specify payment by ALG of the note balance with interest at a rate of 13% per annum with one lump sum payment in January 1996 of $135,258 and eleven payments of $27,272 beginning in February 1996 through December 1996. ALG is current on the renegotiated payments.\nThe Partnership sold one Boeing 727-200 aircraft equipped with a hushkit to AIA in February 1995 as previously discussed. The agreement with AIA specifies payment of the sales price in 36 monthly installments of $55,000 beginning in March 1995. The Partnership has received all scheduled payments due from AIA.\nIn March 1996, the Partnership sold the airframe and one engine from its Boeing 737-200 Combi aircraft to Westjet as previously discussed. The Partnership received a security deposit of approximately $88,000 from Westjet in December 1995 which was applied to the sales price of approximately $896,000. The Partnership agreed to accept payment of the balance of the sales price in 22 monthly installments, with interest at a rate of 10% per annum beginning in March 1996. The Partnership has received all scheduled payments from Westjet.\nThe Partnership receives maintenance reserve payments from certain of its lessees that may be reimbursed to the lessee or applied against certain costs incurred by the Partnership for maintenance work performed on the Partnership's aircraft, as specified in the leases. Maintenance reserve balances, if any, remaining at the termination of the lease may be used by the Partnership to offset future maintenance expenses or recognized as revenue. The net maintenance reserves balances aggregate $179,185 as of December 31, 1995.\nPayments of $275,130 have been received during 1995 from the sale of inventoried parts from the six disassembled aircraft. The Partnership is retaining cash reserves to meet obligations under the TWA, Continental and Continental Micronesia lease agreements and to cover the potential costs that the Partnership may incur relating to the Viscount default and bankruptcy filing, including potential aircraft maintenance, remarketing and transition costs.\nCash Distributions - Cash distributions to limited partners were $6,874,959, $12,499,925 and $9,999,940 in 1995, 1994 and 1993, respectively. Cash distributions per limited partnership unit were $13.75, $25.00 and $20.00 per limited partnership unit in 1995, 1994 and 1993, respectively. The timing and amount of future cash distributions are not yet known and will depend on the Partnership's future cash requirements including the potential costs that may be incurred relating to the Viscount default and bankruptcy; the receipt of rental payments from TWA, Continental and Continental Micronesia; the receipt of modification financing payments from Continental and Continental Micronesia; the receipt of sales proceeds from AIA and Westjet; the receipt of renegotiated promissory note payments from ALG; the receipt of payments generated from the aircraft disassembly process; and the receipt of current and delinquent rental and loan payments from Viscount.\nTWA Restructuring\nIn October 1994, TWA notified its creditors, including the Partnership, of another proposed restructuring of its debt. Subsequently, GECAS negotiated a standstill arrangement, as set forth in a letter agreement dated December 16, 1994 (the Deferral Agreement), with TWA for the 46 aircraft that are managed by GECAS, 18 of which are owned by the Partnership. As required by its terms, the Deferral Agreement (which has since been amended as discussed below) was approved by PIMC on behalf of the Partnership with respect to the Partnership's aircraft.\nThe Deferral Agreement provided for (i) a moratorium on all the rent due to the Partnership in November 1994 and on 75% of the rents due to the Partnership from December 1994 through March 1995, and (ii) all of the deferred rents, together with interest thereon, to be repaid in monthly installments beginning in May 1995 and ending in December 1995. The repayment schedule was subsequently accelerated upon confirmation of TWA's bankruptcy plan. The Partnership recorded a note receivable and corresponding allowance for credit losses equal to the total of the 1994 deferred rents of $1.575 million, the net of which was reflected in the Partnership's 1994 balance sheet (Item 8). The Partnership did not recognize either the $1.575 million rental amount deferred in 1994 or the $2.025 million rental amount deferred during the first quarter of 1995 as rental revenue until the deferred rents were received. The note receivable and corresponding allowance for credit losses were reduced by the principal portion of the payments received. The Partnership received all scheduled rent payments beginning in April 1995 and all scheduled deferred rental payments beginning in May 1995, including interest at a rate of 12% per annum, from TWA and has recognized the $3.6 million deferred rents as rental revenue during 1995. The deferred rents were paid in full by October 1995.\nIn consideration for the partial rent moratorium described above, TWA agreed to make a lump sum payment of $1,000,000 to GECAS for the TWA lessors for whom GECAS provides management services and who agreed to the Deferral Agreement. The Partnership received $218,171 in January 1995 as its share of such payment by TWA. This amount was recognized as other revenue in the Partnership's 1995 statement of operations (Item 8). In addition, TWA agreed to issue warrants to the Partnership for TWA Common Stock.\nIn order to resolve certain issues that arose after the execution of the Deferral Agreement, TWA and GECAS entered into a letter agreement dated June 27, 1995, pursuant to which they agreed to amend certain provisions of the Deferral Agreement (as so amended, the Amended Deferral Agreement). The effect of the Amended Deferral Agreement, which was approved by PIMC with respect to the Partnership's aircraft, is that TWA, in addition to agreeing to repay the deferred rents to the Partnership, agreed (i) to a fixed payment amount (payable in warrants, the number of which was determined by a formula) in consideration for the aircraft owners' agreement to defer rent under the Deferral Agreement, and, (ii) to the extent the market value of the warrants is less than the payment amount, to supply maintenance services to the aircraft owners having a value equal to such deficiency. The payment amount was determined by subtracting certain maintenance reimbursements owed to TWA by certain aircraft owners, including the Partnership, from the aggregate amount of deferred rents. The amount of such maintenance reimbursement has not been finally determined.\nTWA agreed that, upon filing of its prepackaged plan, it would take all reasonable steps to implement the terms of the Amended Deferral Agreement and would immediately assume all of the Partnership's leases. TWA also agreed that, not withstanding the 60-day cure period provided by section 1110 of the United States Bankruptcy Code, it would remain current on the performance of its obligations under the leases, as amended by the Amended Deferral Agreement.\nOn June 30, 1995, TWA filed its prepackaged Chapter 11 bankruptcy in the United States Bankruptcy Court for the Eastern District of Missouri. On August 4, 1995, the Bankruptcy Court confirmed TWA's plan of reorganization, which became effective on August 23, 1995. Pursuant to the Amended Deferral Agreement, on the confirmation date of the plan, August 4, 1995, the Partnership received a payment of $1,217,989 from TWA which represented fifty percent (50%) of the deferred rent outstanding plus interest as of such date. The remaining balance of deferred rent plus interest was paid in full to the Partnership on October 2, 1995. While TWA has committed to an uninterrupted flow of lease payments, there is no assurance that TWA will continue to honor its obligations in the future.\nThe Partnership received warrants to purchase 227,133 shares of TWA Common Stock from TWA in November 1995 and has recognized the net warrant value as of the date of receipt of $1,772,206 as revenue in the 1995 statement of operations. The Partnership exercised the warrants on December 29, 1995 for the strike price of $0.01 per share and has recognized a gain on the value of the warrants of $582,028 in the 1995 statement of operations. The TWA Common Stock is classified as trading securities because the Partnership intends to sell the stock in the near term. The fair market value of the TWA stock at December 31, 1995 of $2,356,506 is reflected in the Partnership's December 31, 1995 balance sheet (Item 8). The Partnership sold the TWA Common Stock in the first quarter of 1996, net of broker commissions, for $2,406,479.\nViscount Default and Bankruptcy Filing\nIn July 1994, the Partnership entered into a restructuring agreement with Viscount to defer certain rents due the Partnership which aggregated $196,800; to extend a line of credit to Viscount for a total of $127,000 to be used primarily for maintenance expenses relating to the Partnership's aircraft; and to give the Partnership the option to acquire approximately 0.6% of the issued and outstanding shares of Viscount stock as of July 26, 1994 for an option price of approximately $91,000. It was not practicable to estimate the fair value of the stock options as of December 31, 1995, as they are not publicly traded, although Viscount's recent bankruptcy filing would have an adverse impact on the value of the stock options, if any.\nThe deferred rents, which were being repaid by Viscount with interest at a rate of 6% per annum over the remaining terms of the leases, were recognized as revenue in the period earned. The unpaid balances of the deferred rents, which are reflected in rent and other receivables in the December 31, 1995 and 1994 balance sheets (Item 8), were $130,511 and $182,982, respectively. The line of credit, which was advanced to Viscount during 1994, was being repaid by Viscount over a 30-month period, beginning in January 1995, with interest at a rate of 11.53% per annum. The line of credit balances, which are reflected in notes receivable in the December 31, 1995 and 1994 balance sheets, were $88,641 and $127,000, respectively.\nDuring 1995, the Partnership had been in discussions with Viscount to restructure additional existing financial obligations of Viscount to the Partnership. While such discussions were underway, Viscount had undertaken to pay in full, by the end of each month, beginning in June 1995, the current month's obligations by making partial periodic payments during that month. Viscount is presently in default on these financial obligations to the Partnership. On December 13, 1995, the Partnership issued a notice of default to Viscount demanding, within 10 days, full payment of all delinquent amounts due the Partnership. On January 9, 1996, Viscount was notified that the Partnership had elected to terminate the lease and the Partnership demanded return of the aircraft. On January 24, 1996, Viscount filed a petition for protection under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court in Tucson, Arizona. As discussed below, Tucson Aerospace, a maintenance\nfacility located in Arizona, presently has possession of the Partnership's aircraft. Legal counsel has been retained and the general partner is evaluating the rights, remedies and courses of action available to the Partnership with respect to Viscount's default and bankruptcy filing. The Partnership has received no additional payments from Viscount subsequent to December 31, 1995.\nOne of the Partnership's Boeing 737-200 commercial jet aircraft was on lease to Viscount prior to the lease termination notification. As of December 31, 1995, the Partnership's aggregate rent, maintenance reserve, loan and interest receivable from Viscount was approximately $336,000. All payments due from Viscount may be affected by Viscount's filing for protection under Chapter 11.\nDuring 1995, Viscount delivered the aircraft to Tucson Aerospace, a maintenance facility located in Arizona, to perform a heavy maintenance check on the aircraft. The Partnership has paid to Tucson Aerospace approximately $565,000 from maintenance reserves and cash reserves for this aircraft as progress payments on this maintenance check. Work on the maintenance check was suspended prior to the filing of the Chapter 11 petition by Viscount. Tucson Aerospace asserts that Viscount owes it approximately $866,000 for work done on the aircraft. The aircraft is currently in the possession of Tucson Aerospace and it may assert a lien against the aircraft to secure payment of its claim. In addition, a third party vendor, who claims it provided personnel to work on the aircraft, is asserting a claim against Tucson Aerospace and a lien against the aircraft in the amount of $720,000. Another third party vendor, who claims it provided inspectors, is claiming $185,000 from Tucson Aerospace. The Partnership has been in discussions with the various parties to resolve these disputes and is currently evaluating all of its options, including alternative procedures to obtain repossession of this aircraft.\nThe balance of the line of credit advanced to Viscount in 1994 of $88,641 at December 31, 1995, plus accrued interest, is guaranteed by certain affiliates of the principal shareholder of Viscount and an allowance for credit losses has not been provided for this note. The Partnership has recorded an allowance for credit losses for the remaining unsecured receivable balances from Viscount including the aggregate of the unpaid rents, outstanding deferred rent balance and accrued interest as of December 31, 1995. The aggregate allowance for credit losses of $241,964 for these obligations is reflected in the provision for credit losses in the Partnership's 1995 statement of operations (Item 8). Viscount's failure to perform on its financial obligations with the Partnership is expected to have an adverse effect on the Partnership's financial position. As a result of Viscount's defaults and Chapter 11 bankruptcy filing, the Partnership may incur maintenance, remarketing, transition and legal costs related to the Partnership's aircraft and engines, which cannot be estimated at this time. The outcome of Viscount's Chapter 11 proceeding cannot be predicted.\nIndustry Update\nMaintenance of Aging Aircraft - The process of aircraft maintenance begins at the aircraft design stage. For aircraft operating under Federal Aviation Administration (FAA) regulations, a review board consisting of representatives of the manufacturer, FAA representatives and operating airline representatives is responsible for specifying the aircraft's initial maintenance program. The general partner understands that this program is constantly reviewed and modified throughout the aircraft's operational life.\nSince 1988, the FAA, working with the aircraft manufacturers and operators, has issued a series of ADs which mandate that operators conduct more intensive inspections, primarily of the aircraft fuselages. The results of these mandatory inspections may result in the need for repairs or structural modifications that may not have been required under pre-existing maintenance programs.\nIn addition, an AD adopted in 1990 requires replacement or modification of certain structural items on a specific timetable. These structural items were formerly subject to periodic inspection, with replacement when necessary. The FAA estimates the cost of compliance with this AD to be approximately $1.0 million and $900,000 per Boeing 727 and Boeing 737 aircraft, respectively, if none of the required work had been done previously. The FAA also issued several ADs in 1993 updating inspection and modification requirements for Boeing 737 aircraft. The FAA estimates the cost of these requirements to be approximately $90,000 per aircraft. In general, the new maintenance requirements must be completed by the later of March 1994, or 75,000 and 60,000 cycles for each Boeing 737 and 727, respectively. A similar AD was adopted on September 24, 1990, applicable to McDonnell Douglas aircraft. The AD requires specific work to be performed at various cycle thresholds between 50,000 and 100,000 cycles, and on specific date or age thresholds. The estimated cost of compliance with all of the components of this AD is approximately $850,000 per aircraft. The extent of modifications required to an aircraft varies according to the level of incorporation of design improvements at manufacture.\nIn December 1990, the FAA adopted another AD intended to mitigate corrosion of structural components, which would require repeated inspections from 5 years of age throughout the life of an aircraft, with replacement of corroded components as needed. Integration of the new inspections into each aircraft operator's maintenance program was required by December 31, 1991 on Boeing aircraft.\nThe Partnership's existing leases require the lessees to maintain the Partnership's aircraft in accordance with an FAA-approved maintenance program during the lease term. At the end of the leases, each lessee is generally required to return the aircraft in airworthy condition including compliance with all ADs for which action is mandated by the FAA during the lease term. An aircraft returned to the Partnership as a result of a lease default would most likely not be returned to the Partnership in compliance with all return conditions required by the lease. The Partnership has agreed to bear a portion of the costs of compliance with certain ADs with respect to the aircraft leased to TWA, Continental and Continental Micronesia, as described in Item 1. In negotiating subsequent leases, market conditions may require that the Partnership bear some or all of the costs of compliance with future ADs or ADs that have been issued, but which did not require action during the previous lease term. The ultimate effect on the Partnership of compliance with the FAA maintenance standards is not determinable at this time and will depend on a variety of factors, including the state of the commercial aircraft industry, the timing of the issuance of ADs, and the status of compliance therewith at the expiration of the current leases.\nAircraft Noise - Another issue which has affected the airline industry is that of aircraft noise levels. The FAA has categorized aircraft according to their noise levels. Stage 1 aircraft, which have the highest noise level, are no longer allowed to operate from civil airports in the United States. Stage 2 aircraft meet current FAA requirements, subject to the phase-out rules discussed below. Stage 3 aircraft are the most quiet and Stage 3 is the standard for all new aircraft.\nOn September 24, 1991, the FAA issued final rules on the phase-out of Stage 2 aircraft by the end of this decade. The current U.S. fleet is comprised of approximately 68% Stage 3 aircraft and 32% Stage 2 aircraft. The key features of the rule include:\n- Compliance can be accomplished through a gradual process of phase-in or phase-out (see below) on each of three interim compliance dates: December 31, 1994, 1996, and 1998. All Stage 2 aircraft must be phased out of operations in the contiguous United States by December 31, 1999, with waivers available in certain specific cases to December 31, 2003.\n- All operators have the option of achieving compliance through a gradual phase-out of Stage 2 aircraft (i.e., eliminate 25% of its Stage 2 fleet on each of the compliance dates noted above), or a gradual phase-in of Stage 3 aircraft (i.e., 55%, 65% and 75% of an operator's fleet must consist of Stage 3 aircraft by the respective interim compliance dates noted above).\nThe federal rule does not prohibit local airports from issuing more stringent phase-out rules. In fact, several local airports have adopted more stringent noise requirements which restrict the operation of Stage 2 and certain Stage 3 aircraft.\nOther countries have also adopted noise policies. The European Union (EU) adopted a non-addition rule in 1989, which directed each member country to pass the necessary legislation to prohibit airlines from adding Stage 2 aircraft to their fleets after November 1, 1990, with all Stage 2 aircraft phased-out by the year 2002. The International Civil Aviation Organization has also endorsed the phase-out of Stage 2 aircraft on a world-wide basis by the year 2002.\nThe Partnership's entire fleet consists of Stage 2 aircraft. Hushkit modifications, which allow Stage 2 aircraft to meet Stage 3 requirements, are currently available for the Partnership's aircraft. However, while technically feasible, hushkits may not be cost effective due to the age of the aircraft and the time required to fully amortize the additional investment. The general partner will evaluate, as appropriate, the potential benefits of installing hushkits on some or all of the Partnership's aircraft. It is unlikely, however, that the Partnership would incur such costs unless they can be substantially recovered through a lease.\nImplementation of the Stage 3 standards has adversely affected the value of Stage 2 aircraft, as these aircraft will require eventual modification to be operated in the U.S. or other countries with Stage 3 standards after the applicable dates.\nDemand for Aircraft - Industry-wide, approximately 475 commercial aircraft are currently available for sale or lease, approximately 125 less than a year ago. From 1991 through 1994, depressed demand for air travel limited airline expansion plans, with new aircraft orders and scheduled deliveries being canceled or substantially deferred. As profitability declined, many airlines took action to downsize or liquidate assets and some airlines were forced to file for bankruptcy protection. Following two years of good traffic growth accompanied by rising yields, this trend is now improving with new aircraft orders last year exceeding deliveries for the first time since 1990. To date, this recovery has mainly benefited Stage 3 narrow-bodies and younger Stage 2 narrow-bodies, many of which are now being ungraded with hushkits, whereas older Stage 2 narrow-bodies have shown marginal signs of recovery.\nThe general partner believes that, in addition to the factors cited above, the deteriorated market for the Partnership's aircraft reflects the airline industry's reaction to the significant expenditures potentially necessary to bring these aircraft into compliance with certain ADs issued by the FAA relating to aging aircraft, corrosion prevention and control and structural inspection and modification as previously discussed.\nEffects on the Partnership's Aircraft - The Partnership periodically reviews the estimated realizability of the residual values at the projected end of each aircraft's economic life based on estimated residual values obtained from independent parties which provide current and future estimated aircraft values by aircraft type. The Partnership made downward adjustments to the estimated residual value of certain of its on-lease aircraft as of December 31, 1995, 1994 and 1993. For any downward adjustment in estimated residual value or decrease in the projected remaining economic life, the depreciation expense over the projected remaining economic life of the aircraft is increased.\nIf the projected net cash flow for each aircraft (projected rental revenue, net of management fees, less projected maintenance costs, if any, plus the estimated residual value) is less than the carrying value of the aircraft, the Partnership recognizes the deficiency currently as increased depreciation expense. The Partnership recognized approximately $2.4 million and approximately $1.6 million, or $4.75 and $3.18 per limited Partnership unit, of this deficiency as increased depreciation expense in 1995 and 1994, respectively. The 1995 downward adjustment was the result of the reduction of the net book value to the estimated net realizable value of the Boeing 737-200 Combi aircraft sold to Westjet in 1996. Approximately $1.03 million of the 1994 adjustment was the result of the reduction of the net book value to the estimated net realizable value of the Boeing 727-200 aircraft sold to AIA in February 1995. The increased depreciation expense reduces the aircraft's carrying value and reduces the amount of future depreciation expense that the Partnership will recognize over the projected remaining economic life of the aircraft.\nThe Partnership's future earnings are impacted by the net effect of the adjustments to the carrying value of the aircraft recorded in 1995 and 1994 (which has the effect of decreasing future depreciation expense) and the downward adjustments to the estimated residual values recorded in 1995, 1994 and 1993 (which has the effect of increasing future depreciation expense). No additional depreciation expense was recorded in 1993. Therefore, as a result of the downward adjustments to the residual values in 1993, the Partnership is recognizing increased depreciation expense of approximately $514,000 per year beginning in 1994 through the end of the estimated economic lives of the aircraft. The net effect of the 1994 adjustments to the estimated residual values and the adjustments to the carrying value of the aircraft recorded in 1994 is to cause the Partnership to recognize increased depreciation expense of approximately $626,000 per year beginning in 1995 through the end of the estimated economic lives of the aircraft. The net effect of the 1995 adjustments to the estimated residual values and the adjustments to the carrying value of the aircraft recorded in 1995 is to cause the Partnership to recognize increased depreciation expense of approximately $866,000 per year beginning in 1996 through the end of the estimated economic lives of the aircraft.\nEffective January 1, 1996, the Partnership adopted SFAS No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of.\" This statement requires that long-lived assets be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In performing the review for recoverability, the statement provides that the Partnership should estimate the future cash flows expected to result from the use of the asset and its eventual disposition. If the projected net cash flow for each aircraft (projected rental revenue, net of management fees, less projected maintenance costs, if any, plus the estimated residual value) is less than the carrying value of the aircraft, an impairment loss is recognized. Pursuant to the statement, measurement of an impairment loss for long-lived assets will be based on the \"fair value\" of the asset as defined in the statement.\nSFAS No. 121 states that the fair value of an asset is the amount at which the asset could be bought or sold in a current transaction between willing parties,\ni.e., other than in a forced or liquidation sale. Quoted market prices in active markets are the best evidence of fair value and will be used as the basis for the measurement, if available. If quoted market prices are not available, the estimate of fair value will be based on the best information available in the circumstances. Pursuant to the statement, the estimate of fair value will consider prices for similar assets and the results of valuation techniques to the extent available in the circumstances. Examples of valuation techniques include the present value of estimated expected future cash flows using a discount rate commensurate with the risks involved, option-pricing models, matrix pricing, option-adjusted spread models, and fundamental analysis.\nBeginning in 1996, the Partnership will periodically review its aircraft for impairment in accordance with SFAS No. 121. Using an estimate of the fair value of the Partnership's aircraft to measure impairment may result in greater write-downs than would be recognized under the accounting method currently applied by the Partnership. The Partnership uses information obtained from third party valuation services in arriving at its estimate of fair value for purposes of determining residual values. The Partnership will use similar information, plus available information and estimates related to the Partnership's aircraft, to determine an estimate of fair value to measure impairment as required by the statement. The estimates of fair value can vary dramatically depending on the condition of the specific aircraft and the actual marketplace conditions at the time of the actual disposition of the asset. If assets are deemed impaired, there could be substantial write-downs in the future.\nTo the extent that the Partnership's Boeing and McDonnell Douglas aircraft continue to be adversely affected by industry events, the Partnership will evaluate each aircraft as it comes off lease or is returned to the Partnership to determine whether a re-lease or a sale at the then-current market rates would be most beneficial for unit holders.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nPOLARIS AIRCRAFT INCOME FUND II, A California Limited Partnership\nFINANCIAL STATEMENTS AS OF DECEMBER 31, 1995 AND 1994\nTOGETHER WITH\nAUDITORS' REPORT\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Partners of Polaris Aircraft Income Fund II, A California Limited Partnership:\nWe have audited the accompanying balance sheets of Polaris Aircraft Income Fund II, A California Limited Partnership as of December 31, 1995 and 1994, and the related statements of operations, changes in partners' capital (deficit) and cash flows for each of the three years in the period ended December 31, 1995. These financial statements are the responsibility of the general partner. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by the general partner, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Polaris Aircraft Income Fund II, A California Limited Partnership as of December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\nARTHUR ANDERSEN LLP\nSan Francisco, California, January 31, 1996 (except with respect to the matters discussed in Note 12 , as to which the date is March 22, 1996)\nPOLARIS AIRCRAFT INCOME FUND II, A California Limited Partnership\nBALANCE SHEETS\nDECEMBER 31, 1995 AND 1994\n1995 1994 ---- ---- ASSETS:\nCASH AND CASH EQUIVALENTS $ 25,884,742 $ 14,662,147\nMARKETABLE SECURITIES, trading 2,356,506 --\nRENT AND OTHER RECEIVABLES, net of allowance for credit losses of $241,964 in 1995 and $0 in 1994 8,965 292,061\nNOTES RECEIVABLE, net of allowance for credit losses of $0 in 1995 and $1,575,000 in 1994 2,679,486 2,781,432\nAIRCRAFT, net of accumulated depreciation of $97,407,528 in 1995 and $90,004,933 in 1994 76,487,365 91,954,354\nAIRCRAFT INVENTORY 373,483 848,613\nOTHER ASSETS 29,770 29,770 ------------- -------------\n$ 107,820,317 $ 110,568,377 ============= =============\nLIABILITIES AND PARTNERS' CAPITAL (DEFICIT):\nPAYABLE TO AFFILIATES $ 92,511 $ 702,841\nACCOUNTS PAYABLE AND ACCRUED LIABILITIES 87,356 38,663\nSECURITY DEPOSITS 450,000 171,140\nMAINTENANCE RESERVES 179,185 722,690\nDEFERRED INCOME 642,742 642,742 ------------- -------------\nTotal Liabilities 1,451,794 2,278,076 ------------- -------------\nPARTNERS' CAPITAL (DEFICIT): General Partner (1,139,155) (1,119,868) Limited Partners, 499,997 units issued and outstanding 107,507,678 109,410,169 ------------- -------------\nTotal Partners' Capital 106,368,523 108,290,301 ------------- -------------\n$ 107,820,317 $ 110,568,377 ============= =============\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.\nPOLARIS AIRCRAFT INCOME FUND II, A California Limited Partnership\nNOTES TO FINANCIAL STATEMENTS\nDECEMBER 31, 1995\n1. Accounting Principles and Policies\nAccounting Method - Polaris Aircraft Income Fund II, A California Limited Partnership (PAIF-II or the Partnership), maintains its accounting records, prepares its financial statements and files its tax returns on the accrual basis of accounting. 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. The most significant estimates with regard to these financial statements are related to the projected cash flows analysis in determining the fair value of assets.\nCash and Cash Equivalents - This includes deposits at banks and investments in money market funds.\nMarketable Securities, trading - Marketable Securities, trading, are carried at fair value, which was determined based on quoted market prices. These securities are held for sale in the near term (Note 6).\nAircraft and Depreciation - The aircraft are recorded at cost, which includes acquisition costs. Depreciation to an estimated residual value is computed using the straight-line method over the estimated economic life of the aircraft which was originally estimated to be 30 years from the date of manufacture. Depreciation in the year of acquisition was calculated based upon the number of days that the aircraft were in service.\nThe Partnership periodically reviews the estimated realizability of the residual values at the projected end of each aircraft's economic life based on estimated residual values obtained from independent parties which provide current and future estimated aircraft values by aircraft type. For any downward adjustment in estimated residual value or decrease in the projected remaining economic life, the depreciation expense over the projected remaining economic life of the aircraft is increased.\nIf the projected net cash flow for each aircraft (projected rental revenue, net of management fees, less projected maintenance costs, if any, plus the estimated residual value) is less than the carrying value of the aircraft, the Partnership recognizes the deficiency currently as increased depreciation expense. Off-lease aircraft are carried at the lower of depreciated cost or estimated net realizable value.\nCapitalized Costs - Aircraft modification and maintenance costs which are determined to increase the value or extend the useful life of the aircraft are capitalized and amortized using the straight-line method over the estimated useful life of the improvement. These costs are also subject to periodic evaluation as discussed above.\nAircraft Inventory - Aircraft held in inventory for sale are reflected at the lower of depreciated cost or estimated net realizable value. Proceeds from sales are applied against inventory until the book value is fully recovered.\nOperating Leases - The aircraft leases are accounted for as operating leases. Lease revenues are recognized in equal installments over the terms of the leases.\nMaintenance Reserves - The Partnership receives maintenance reserve payments from certain of its lessees that may be reimbursed to the lessee or applied against certain costs incurred by the Partnership or lessee for maintenance work performed on the Partnership's aircraft or engines, as specified in the leases. Maintenance reserve payments are recognized when received and balances remaining at the termination of the lease, if any, may be used by the Partnership to offset future maintenance expenses or recognized as revenue.\nOperating Expenses - Operating expenses include costs incurred to maintain, insure, lease and sell the Partnership's aircraft, including costs related to lessee defaults and costs of disassembling aircraft inventory.\nNet Income (Loss) Per Limited Partnership Unit - Net income (loss) per limited partnership unit is based on the limited partners' share of net income or loss and the number of units outstanding for the years ended December 31, 1995, 1994 and 1993.\nIncome Taxes - The Partnership files federal and state information income tax returns only. Taxable income or loss is reportable by the individual partners.\nReclassification - Certain 1994 and 1993 balances have been reclassified to conform to the 1995 presentation.\nFinancial Accounting Pronouncements - The Partnership adopted Statement of Financial Accounting Standards (SFAS) No. 114, \"Accounting by Creditors for Impairment of a Loan,\" and the related SFAS No. 118 as of January 1, 1995. SFAS No. 114 and SFAS No. 118 require that certain impaired loans be measured based on the present value of expected cash flows discounted at the loan's effective interest rate; or, alternatively, at the loan's observable market price or the fair value of the collateral if the loan is collateral dependent. The Partnership had previously measured the allowance for credit losses using methods similar to that prescribed in SFAS No. 114. As a result, no additional provision was required by the adoption of this pronouncement. The Partnership has recorded an allowance for credit losses for certain impaired loan and rents receivable as a result of uncertainties regarding their collection. The Partnership recognizes revenue on impaired loans and receivables only as payments are received.\n---- Impaired loans or receivables with allowances for credit losses $ 241,964 Impaired loans or receivables without allowances for credit losses 412,761 ----------- Total impaired loans 654,725 Allowance for credit losses (241,964) -----------\n$ 412,761 ===========\nAllowance for credit losses, beginning of year $(1,575,000) Provision for credit losses (241,964) Write-downs -- Collections 1,575,000 ----------- Allowance for credit losses, end of year $ (241,964) ===========\nSFAS No. 107, \"Disclosures about Fair Value of Financial Instruments,\" requires the Partnership to disclose the fair value of financial instruments. Cash and Cash Equivalents are stated at cost, which approximates fair value. Marketable Securities, trading (Note 6) are carried at fair value, which was determined based on quoted market prices. The fair value of the notes receivable is estimated by discounting future estimated cash flows using current interest rates at which similar loans would be made to borrowers with similar credit ratings and remaining maturities. The carrying value of the note receivable from Continental Airlines, Inc. (Continental) discussed in Note 3, the note receivable from American International Airways, Inc. (AIA) discussed in Note 3 and the note receivable from ALG, Inc. (ALG) discussed in Note 4 approximate their estimated fair value. The carrying value of the line of credit note receivable from Viscount discussed in Note 7 approximates its estimated fair value as this note is guaranteed by certain affiliates of Viscount. The carrying value of the rents receivable from Viscount is zero due to a recorded allowance for credit losses equal to the balance of the outstanding rents. As of December 31, 1995, the estimated fair value of the rents receivable from Viscount was also zero.\nSFAS No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,\" requires that long-lived assets and certain identifiable intangibles to be held and used by an entity be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. This statement will be adopted by the Partnership as of January 1, 1996 and will be applied prospectively. The Partnership estimates that the adoption of this pronouncement will not have an immediate material impact on the Partnership's financial position or results of operations unless events or circumstances change that would cause projected net cash flows to be adjusted. The estimate of fair value and measurement of impairment loss is described in Note 3.\n2. Organization and the Partnership\nThe Partnership was formed on June 27, 1984 for the purpose of acquiring and leasing aircraft. The Partnership will terminate no later than December 2010. Upon organization, both the general partner and the initial limited partner contributed $500. The Partnership recognized no profits or losses during the\nperiods ended December 31, 1985 and 1984. The offering of limited partnership units terminated on December 31, 1986, at which time the Partnership had sold 499,997 units of $500, representing $249,998,500. All partners were admitted to the Partnership on or before December 1, 1986.\nPolaris Investment Management Corporation (PIMC), the sole general partner of the Partnership, supervises the day-to-day operations of the Partnership. PIMC is a wholly-owned subsidiary of Polaris Aircraft Leasing Corporation (PALC). Polaris Holding Company (PHC) is the parent company of PALC. General Electric Capital Corporation (GE Capital), an affiliate of General Electric Company, owns 100% of PHC's outstanding common stock. PIMC has entered into a services agreement dated as of July 1, 1994 with GE Capital Aviation Services, Inc. (GECAS). Allocations to related parties are described in Note 9.\n3. Aircraft\nThe Partnership owns 23 aircraft and certain inventoried aircraft parts from its original portfolio of 30 used commercial jet aircraft, which were acquired, leased or sold as discussed below, including one airframe and engine which were sold in March 1996 as discussed in Note 12. All aircraft acquired from an affiliate were purchased within one year of the affiliate's acquisition at the affiliate's original price paid. The aircraft leases are net operating leases, requiring the lessees to pay all operating expenses associated with the aircraft during the lease term. While the leases require the lessees to comply with Airworthiness Directives (ADs) which have been or may be issued by the Federal Aviation Administration (FAA) and require compliance during the lease term, in certain of the leases the Partnership has agreed to share in the cost of compliance with ADs. In addition to basic rent, certain lessees are required to pay supplemental amounts based on flight hours or cycles into a maintenance reserve account, to be used for heavy maintenance of the engines or airframe. The leases generally state a minimum acceptable return condition for which the lessee is liable under the terms of the lease agreement. In the event of a lessee default, these return conditions are not likely to be met. Certain leases also provide that, if the aircraft are returned at a level above the minimum acceptable level, the Partnership must reimburse the lessee for the related excess, subject to certain limitations. The related liability to these lessees, if any, cannot currently be estimated and therefore is not reflected in the financial statements.\nThe following table describes the Partnership's current aircraft portfolio in greater detail:\nYear of Aircraft Type Serial Number Manufacture - ------------- ------------- ----------- Boeing 727-200 Advanced 21426 1977 Boeing 727-200 Advanced 21427 1977 Boeing 727-200 Advanced 21947 1979 Boeing 737-200 19609 1968 Boeing 737-200 Combi (1) 19743 1969 McDonnell Douglas DC-9-30 47082 1967 McDonnell Douglas DC-9-30 47096 1967 McDonnell Douglas DC-9-30 47135 1968 McDonnell Douglas DC-9-30 47137 1968 McDonnell Douglas DC-9-30 47249 1968 McDonnell Douglas DC-9-30 47251 1968 McDonnell Douglas DC-9-30 47343 1969 McDonnell Douglas DC-9-30 47345 1969 McDonnell Douglas DC-9-30 47411 1969 McDonnell Douglas DC-9-30 47412 1969 McDonnell Douglas DC-9-30 47027 1967 McDonnell Douglas DC-9-30 47107 1968 McDonnell Douglas DC-9-30 47108 1968 McDonnell Douglas DC-9-30 47174 1968 McDonnell Douglas DC-9-30 47324 1969 McDonnell Douglas DC-9-30 47357 1969 McDonnell Douglas DC-9-30 47734 1977 McDonnell Douglas DC-9-40 47617 1975\n(1) Aircraft sold in 1996 (Note 12)\nOne Boeing 737-200 - This aircraft was acquired for $6,766,166 in 1986 and leased to various lessees until 1989, when Braniff, Inc. (Braniff) defaulted on its lease. The aircraft remained off lease until March 1991. The aircraft was then leased to SABA Airlines, S.A. (SABA) at approximately 70% of the prior rate until February 1992, when the aircraft was repossessed by the Partnership after SABA defaulted under its lease. In November 1992, the aircraft was re-leased for five years to Viscount Air Services, Inc. (Viscount) at approximately 56% of the prior lease rate. The lease specifies that Viscount, a charter carrier based in Arizona, has the option to purchase the aircraft for the then-current fair market value at the end of the lease term. As discussed in Note 7, at December 31, 1995 Viscount was in default on certain payments due to the Partnership. Note 12 contains a further discussion of the Viscount situation subsequent to December 31, 1995. An engine for the aircraft has been leased from an affiliate (Note 9) following the return of an inoperable engine from SABA as discussed in Note 4. The Partnership has an agreement with Viscount to defer certain rents due the Partnership and to provide financing to Viscount for maintenance expenses relating to the Partnership's aircraft (Note 7).\nSeven Boeing 727-200 - These aircraft were acquired for $38,986,145 during 1986 and leased to Pan American World Airways, Inc. (Pan Am) until 1991, when the lease was terminated due to Pan Am's bankruptcy filing. The Partnership has transferred six of these aircraft to aircraft inventory and has disassembled them for sale of the component parts (Note 5). One hushkit set from the aircraft was sold in January 1993 and two additional hushkit sets from the aircraft were sold in September 1993 (Note 4).\nThe remaining aircraft was leased to Delta Airlines, Inc. (Delta) in September 1991. Delta returned the aircraft at the end of September 1993, following several month-by-month lease extensions since the original lease termination date in April 1993. The Partnership has adjusted the book value of this aircraft to its estimated net realizable value by increasing depreciation expense approximately $1.03 million in 1994. During 1995, the Partnership recognized as other revenue maintenance reserves aggregating approximately $91,000 that were previously paid to the Partnership by Delta. The aircraft was sold to AIA in February 1995 for a sales price of $1,771,805. The Partnership recorded no gain or loss on the sale, as the sales price equaled the net book value of the aircraft and hushkit. The Partnership agreed to accept payment of the sales price in 36 monthly installments of $55,000, with interest at a rate of 7.5% per annum, beginning in March 1995. The Partnership recorded a note receivable for the sales price and has received all scheduled principal and interest payments due from AIA through December 31, 1995, including one additional principal payment of $410,229 received in May 1995. The note receivable balance as of December 31, 1995 was $889,351.\nOne Boeing 737-200 Combi - This aircraft was acquired for $7,582,572 in 1986 and leased to Presidential Airways, Inc. (Presidential), until Presidential's default in 1989. The aircraft remained off lease until June 1990, when it was leased to Air Zaire, Inc. (Air Zaire). The lease required that Air Zaire maintain the aircraft in accordance with FAA requirements. However, Air Zaire was unable to obtain FAA approval for its proposed maintenance program, thus prompting the early termination of the lease in 1991. Air Zaire provided a $610,000 letter of credit, the proceeds of which the Partnership applied to outstanding rent, reserves and interest due in 1991. Air Zaire paid additional amounts in 1993 and 1992 as a result of legal action commenced by the Partnership (Note 8).\nIn August 1992, the Partnership leased the aircraft to Northwest Territorial Airways, Ltd. (NWT) through March 1993 at approximately 45% of the prior rental rate, then extended the lease through March 1994 at approximately 80% of the previous rental rate. An engine for the aircraft was leased from an affiliate through April 1994 (Note 9). The aircraft was returned to the Partnership in April 1994 and NWT subsequently paid to the Partnership approximately $860,000 in lieu of meeting return conditions as specified in the lease. During the off-lease period, the Partnership performed certain maintenance and modification work on the aircraft which was offset by the payment received from NWT. The Partnership recognized the balance of approximately $89,000 as other revenue in the accompanying 1995 statement of operations.\nThe Partnership negotiated a new lease with NWT for 16 months commencing in June 1994. The new lease rate was approximately 108% of NWT's prior rental rate. The new lease expired in October 1995. As specified in the lease, NWT was required to perform certain maintenance work on the aircraft prior to its return. NWT returned the aircraft without performing the required maintenance work, which constituted a default under the lease. The Partnership and NWT subsequently reached an agreement by which NWT paid to the Partnership in December 1995 approximately $457,000 and the Partnership was entitled to retain NWT's security deposit of approximately $101,000 in lieu of NWT performing the required maintenance work on the aircraft. The Partnership recorded these amounts as other revenue in the accompanying 1995 statement of operations.\nThe airframe and one engine from this aircraft were subsequently sold to Westjet Airlines, Ltd. (Westjet) in March 1996 as discussed in Note 12. The Partnership has adjusted the net book value of this aircraft to its estimated net realizable value by increasing depreciation expense approximately $2.4 million in the 1995 statement of operations. The Partnership is currently remarketing the remaining engine for sale.\n17 McDonnell Douglas DC-9-30 and One McDonnell Douglas DC-9-40 - These aircraft were acquired for $122,222,040 during 1986 and leased to Ozark Air Lines, Inc. (Ozark). In 1987, Trans World Airlines, Inc. (TWA) merged with Ozark and assumed the leases. The leases were modified and extended in 1991 prior to TWA's bankruptcy filing as discussed in Note 6.\nThree Boeing 727-200 Advanced - These aircraft were acquired for $36,364,929 during 1987 and leased to Alaska Airlines, Inc. (Alaska) until September 1992. Upon return of the aircraft, an additional amount of $509,000 was received from Alaska for deferred maintenance and applied in 1993 as an offset to maintenance expenses incurred on the aircraft. One of the aircraft was re-leased to Continental from April 1993 until April 1998. The remaining two aircraft were released to Continental Micronesia, Inc. (Continental Micronesia), an affiliate of Continental, from May and June 1993 until April 1998. All three of the aircraft are leased at approximately 55% of the prior lease rates. The three leases stipulate that the Partnership will reimburse costs for cockpit modifications up to $600,000 per aircraft, C-check labor costs up to $300,000 per aircraft for two of the aircraft and the actual cost of C-check parts for these two aircraft. In addition, the Partnership will provide financing of up to $815,000 for new image modifications, to be repaid with interest over the lease term for each aircraft. In accordance with the cost sharing agreement, in January 1994, the Partnership reimbursed Continental (partially on behalf of its affiliate Continental Micronesia) $1.8 million for cockpit modifications. The Partnership also reimbursed Continental $742,325 for C-check labor and parts, which was included in operating expense in the statement of operations for the year ended December 31, 1993. In addition, the Partnership financed $2,177,533 for new image modifications, which is being repaid with interest over the lease terms of the aircraft, beginning in February 1994. The Partnership has received all scheduled principal and interest payments due from Continental and Continental Micronesia through December 31, 1995. The aggregate note receivable balance as of December 31, 1995 and 1994 was $1,289,328 and $1,764,167, respectively. The leases with Continental and Continental Micronesia also stipulate that the Partnership share in the cost of meeting certain ADs, which cannot be estimated at this time.\nThe following is a schedule by year of future minimum rental revenue under the existing leases but excluding rental payments for one aircraft leased to Viscount due to the bankruptcy filing discussed in Notes 7 and 12:\nYear Amount ---- ------ 1996 $13,680,000 1997 13,680,000 1998 3,410,000 1999 and thereafter - -----------\nTotal $30,770,000 ===========\nFuture minimum rental payments may be offset or reduced by future costs as described above and in Note 6.\nAs discussed in Note 1, the Partnership periodically reviews the estimated realizability of the residual values at the projected end of each aircraft's economic life based on estimated residual values obtained from independent parties which provide current and future estimated aircraft values by aircraft type. The Partnership made downward adjustments to the estimated residual value of certain of its on-lease aircraft as of December 31, 1995, 1994 and 1993. For any downward adjustment in estimated residual value or decrease in the projected\nremaining economic life, the depreciation expense over the projected remaining economic life of the aircraft is increased.\nAs discussed in Note 1, if the projected net cash flow for each aircraft (projected rental revenue, net of management fees, less projected maintenance costs, if any, plus the estimated residual value) is less than the carrying value of the aircraft, the Partnership recognizes the deficiency currently as increased depreciation expense. The Partnership recognized approximately $2.4 million and approximately $1.6 million, or $4.75 and $3.18 per limited Partnership unit, of this deficiency as increased depreciation expense in 1995 and 1994, respectively. The 1995 downward adjustment was the result of the reduction of the net book value to the estimated net realizable value of the Boeing 737-200 Combi aircraft sold to Westjet in 1996 as discussed in Note 12. Approximately $1.03 million of the 1994 adjustment was the result of the reduction of the net book value to the estimated net realizable value of the Boeing 727-200 aircraft sold to AIA in February 1995 as previously discussed. The increased depreciation expense reduces the aircraft's net book value and therefore reduces the amount of future depreciation expense that the Partnership will recognize over the projected remaining economic life of the aircraft.\nThe Partnership's future earnings are impacted by the net effect of the adjustments to the carrying values of the aircraft recorded in 1995 and 1994 (which has the effect of decreasing future depreciation expense) and the downward adjustments to the estimated residual values recorded in 1995, 1994 and 1993 (which has the effect of increasing future depreciation expense). No additional depreciation expense was recorded in 1993. Therefore, as a result of the downward adjustments to the residual values in 1993, the Partnership is recognizing increased depreciation expense of approximately $514,000 per year beginning in 1994 through the end of the estimated economic lives of the aircraft. The net effect of the 1994 adjustments to the estimated residual values and the adjustments to the carrying values of the aircraft recorded in 1994 is to cause the Partnership to recognize increased depreciation expense of approximately $626,000 per year beginning in 1995 through the end of the estimated economic lives of the aircraft. The net effect of the 1995 adjustments to the estimated residual values and the adjustments to the carrying values of the aircraft recorded in 1995 is to cause the Partnership to recognize increased depreciation expense of approximately $866,000 per year beginning in 1996 through the end of the estimated economic lives of the aircraft.\nEffective January 1, 1996, the Partnership adopted SFAS No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of.\" This statement requires that long-lived assets be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In performing the review for recoverability, the statement provides that the Partnership should estimate the future cash flows expected to result from the use of the asset and its eventual disposition. If the projected net cash flow for each aircraft (projected rental revenue, net of management fees, less projected maintenance costs, if any, plus the estimated residual value) is less than the carrying value of the aircraft, an impairment loss is recognized. Pursuant to the statement, measurement of an impairment loss for long-lived assets will be based on the \"fair value\" of the asset as defined in the statement.\nSFAS No. 121 states that the fair value of an asset is the amount at which the asset could be bought or sold in a current transaction between willing parties, i.e., other than in a forced or liquidation sale. Quoted market prices in active markets are the best evidence of fair value and will be used as the basis for the measurement, if available. If quoted market prices are not available, the estimate of fair value will be based on the best information available in the circumstances. Pursuant to the statement, the estimate of fair value will consider prices for similar assets and the results of valuation techniques to\nthe extent available in the circumstances. Examples of valuation techniques include the present value of estimated expected future cash flows using a discount rate commensurate with the risks involved, option-pricing models, matrix pricing, option-adjusted spread models, and fundamental analysis.\nBeginning in 1996, the Partnership will periodically review its aircraft for impairment in accordance with SFAS No. 121. Using an estimate of the fair value of the Partnership's aircraft to measure impairment may result in greater write-downs than would be recognized under the accounting method currently applied by the Partnership. The Partnership uses information obtained from third party valuation services in arriving at its estimate of fair value for purposes of determining residual values. The Partnership will use similar information, plus available information and estimates related to the Partnership's aircraft, to determine an estimate of fair value to measure impairment as required by the statement. The estimates of fair value can vary dramatically depending on the condition of the specific aircraft and the actual marketplace conditions at the time of the actual disposition of the asset. If assets are deemed impaired, there could be substantial write-downs in the future.\n4. Sale of Equipment\nOne hushkit set from the aircraft formerly leased to Pan Am (Note 3) was sold in January 1993 to ALG for $1,750,000, which resulted in a $259,809 gain in 1993. ALG paid cash for a portion of the sales price and issued an 11% interest-bearing promissory note for the balance of $1,132,363, which specified 23 equal monthly payments and a balloon payment of $897,932 due in January 1995. ALG paid to the Partnership $19,138 of the balloon payment in January 1995, originating an event of default under the note. The Partnership and ALG subsequently restructured the terms of the promissory note. The renegotiated terms specify payment by ALG of the note balance with interest at a rate of 13% per annum with one lump sum payment in January 1995 of $254,733, eleven monthly payments of $25,600 beginning in February 1995, and a balloon payment in January 1996 of $416,631. The Partnership has received all scheduled renegotiated payments due from ALG through December 31, 1995. The note receivable balances as of December 31, 1995, 1994 and 1993 were $412,166, $890,265 and $1,022,308, respectively. In January 1996, the Partnership and ALG once again restructured the terms of the promissory note as discussed in Note 12. No allowance for credit losses is provided for ALG receivables in 1995 or 1994.\nIn September 1993, two additional hushkit sets from the disassembled Pan Am aircraft were sold to Emery Worldwide Airlines for $1,250,000 each, which resulted in a $398,192 aggregate loss. The decline in sales price from the previous hushkit sale in January 1993 reflected a softening market for this equipment.\nThe Partnership sold one used engine to International Aircraft Support, L.P. in July 1993 for $85,000, which resulted in a $375,012 loss. The engine, along with its airframe, was repossessed from the former lessee, SABA in February 1992. At the time of its default, SABA had not maintained the aircraft as required under the lease agreement, rendering the engine inoperable. The Partnership determined the costs to repair the engine would be in excess of the amounts recoverable from sale or lease. As a result, the engine was sold for its component parts.\n5. Disassembly of aircraft\nIn an attempt to maximize the economic return from the remaining six aircraft formerly leased to Pan Am, the Partnership entered into an agreement with\nSoundair, Inc. (Soundair) in October 1992, for the disassembly and sale of certain of the Partnership's aircraft. The Partnership has incurred the cost of disassembly and will receive the proceeds from the sale of such parts, net of overhaul expenses if necessary, and commissions paid to Soundair. Disassembly of the six aircraft has been completed. During 1993 and 1992, the Partnership paid $327,750 and $135,750, respectively, for aircraft disassembly costs. The Partnership has received net proceeds from the sale of aircraft inventory of $275,130, $323,448 and $1,169,483 during 1995, 1994 and 1993, respectively.\nThe six aircraft were recorded as aircraft inventory in the amount of $3.0 million in 1992 as discussed in Note 3. During 1995, 1994 and 1993, the Partnership recorded downward adjustments to the inventory value of $200,000, $72,000 and $300,000, respectively, to reflect the then current estimate of net realizable aircraft inventory value. These adjustments are reflected as increased depreciation expense in the accompanying statements of operations.\n6. TWA Reorganization\nDuring 1991, TWA defaulted under its leases with the Partnership when it failed to pay its March lease payments. In December 1991, the leases for all 18 aircraft were amended, with extensions to various dates in 1998. The renegotiated lease rates represent approximately 46% of the initial lease rates. In addition, the Partnership agreed to share in the costs of certain ADs after TWA successfully reorganized. The agreement stipulated that such costs incurred by TWA may be credited against monthly rentals, subject to annual limitations and a maximum of $500,000 per aircraft through the end of the applicable lease. Pursuant to this cost-sharing agreement, since TWA emerged from its reorganization proceedings in 1993, expenses totaling $6.3 million ($2.7 million in 1993 and $3.6 million in 1994) have been offset against rental payments. Under the terms of this agreement, TWA may offset up to an additional $2.7 million against rental payments, subject to annual limitations, over the remaining lease terms.\nIn October 1994, TWA notified its creditors, including the Partnership, of another proposed restructuring of its debt. Subsequently, GECAS negotiated a standstill arrangement, as set forth in a letter agreement dated December 16, 1994 (the Deferral Agreement), with TWA for the 46 aircraft that are managed by GECAS, 18 of which are owned by the Partnership. As required by its terms, the Deferral Agreement (which has since been amended as discussed below) was approved by PIMC on behalf of the Partnership with respect to the Partnership's aircraft.\nThe Deferral Agreement provided for (i) a moratorium on all the rent due to the Partnership in November 1994 and on 75% of the rents due to the Partnership from December 1994 through March 1995, and (ii) all of the deferred rents, together with interest thereon, to be repaid in monthly installments beginning in May 1995 and ending in December 1995. The repayment schedule was subsequently accelerated upon confirmation of TWA's bankruptcy plan. The Partnership recorded a note receivable and corresponding allowance for credit losses equal to the total of the 1994 deferred rents of $1.575 million, the net of which was reflected in the accompanying 1994 balance sheet. The Partnership did not recognize either the $1.575 million rental amount deferred in 1994 or the $2.025 million rental amount deferred during the first quarter of 1995 as rental revenue until the deferred rents were received. The note receivable and corresponding allowance for credit losses were reduced by the principal portion of the payments received. The Partnership received all scheduled rent payments beginning in April 1995 and all scheduled deferred rental payments beginning in May 1995, including interest at a rate of 12% per annum, from TWA and has recognized the $3.6 million deferred rents as rental revenue during 1995. The deferred rents were paid in full by October 1995.\nIn consideration for the partial rent moratorium described above, TWA agreed to make a lump sum payment of $1,000,000 to GECAS for the TWA lessors for whom GECAS provides management services and who agreed to the Deferral Agreement. The Partnership received $218,171 in January 1995 as its share of such payment by TWA. This amount was recognized as other revenue in the accompanying 1995 statement of operations. In addition, TWA agreed to issue warrants to the Partnership for TWA Common Stock.\nIn order to resolve certain issues that arose after the execution of the Deferral Agreement, TWA and GECAS entered into a letter agreement dated June 27, 1995, pursuant to which they agreed to amend certain provisions of the Deferral Agreement (as so amended, the Amended Deferral Agreement). The effect of the Amended Deferral Agreement, which was approved by PIMC with respect to the Partnership's aircraft, is that TWA, in addition to agreeing to repay the deferred rents to the Partnership, agreed (i) to a fixed payment amount (payable in warrants, the number of which was determined by a formula) in consideration for the aircraft owners' agreement to defer rent under the Deferral Agreement, and, (ii) to the extent the market value of the warrants is less than the payment amount, to supply maintenance services to the aircraft owners having a value equal to such deficiency. The payment amount was determined by subtracting certain maintenance reimbursements owed to TWA by certain aircraft owners, including the Partnership, from the aggregate amount of deferred rents. The amount of such maintenance reimbursement has not been finally determined.\nThe Partnership received warrants to purchase 227,133 shares of TWA Common Stock from TWA in November 1995 and has recognized the net warrant value as of the date of receipt of $1,772,206 as revenue in the 1995 statement of operations. The Partnership exercised the warrants on December 29, 1995 for the strike price of $.01 per share and has recognized a gain on the value of the warrants of $582,028 in the 1995 statement of operations. The TWA Common Stock is classified as trading securities because the Partnership intends to sell the stock in the near term. The fair market value of the TWA stock at December 31, 1995 of $2,356,506 is reflected in the accompanying December 31, 1995 balance sheet. As discussed in Note 12, the Partnership sold the TWA Common Stock in the first quarter of 1996.\nTWA agreed that, upon filing of its prepackaged plan, it would take all reasonable steps to implement the terms of the Amended Deferral Agreement and would immediately assume all of the Partnership's leases. TWA also agreed that, not withstanding the 60-day cure period provided by section 1110 of the United States Bankruptcy Code, it would remain current on the performance of its obligations under the leases, as amended by the Amended Deferral Agreement.\nOn June 30, 1995, TWA filed its prepackaged Chapter 11 bankruptcy in the United States Bankruptcy Court for the Eastern District of Missouri. On August 4, 1995, the Bankruptcy Court confirmed TWA's plan of reorganization, which became effective on August 23, 1995. Pursuant to the Amended Deferral Agreement, on the confirmation date of the plan, August 4, 1995, the Partnership received a payment of $1,217,989 from TWA which represented fifty percent (50%) of the deferred rent outstanding plus interest as of such date. The remaining balance of deferred rent plus interest was paid in full to the Partnership on October 2, 1995. While TWA has committed to an uninterrupted flow of lease payments, there is no assurance that TWA will continue to honor its obligations in the future.\n7. Viscount Restructuring Agreement and Default\nIn July 1994, the Partnership entered into a restructuring agreement with Viscount to defer certain rents due the Partnership which aggregated $196,800; to extend a line of credit to Viscount for a total of $127,000 to be used primarily for maintenance expenses relating to the Partnership's aircraft; and to give the Partnership the option to acquire approximately 0.6% of the issued and outstanding shares of Viscount stock as of July 26, 1994 for an option price of approximately $91,000. It was not practicable to estimate the fair value of the stock options as of December 31, 1995, as they are not publicly traded, although Viscount's recent bankruptcy filing (Note 12) would have an adverse impact on the value of the stock options, if any.\nThe deferred rents, which were being repaid by Viscount with interest at a rate of 6% per annum over the remaining terms of the leases, were recognized as revenue in the period earned. The unpaid balances of the deferred rents, which are reflected in rent and other receivables in the December 31, 1995 and 1994 balance sheets, were $130,511 and $182,982, respectively. The line of credit, which was advanced to Viscount during 1994, was being repaid by Viscount over a 30- month period, beginning in January 1995, with interest at a rate of 11.53% per annum. The line of credit balances, which are reflected in notes receivable in the December 31, 1995 and 1994 balance sheets, were $88,641 and $127,000, respectively.\nDuring 1995, the Partnership had been in discussions with Viscount to restructure additional existing financial obligations of Viscount to the Partnership. While such discussions were underway, Viscount had undertaken to pay in full, by the end of each month, beginning in June 1995, the current month's obligations by making partial periodic payments during that month. Viscount is presently in default on these financial obligations to the Partnership. On December 13, 1995, the Partnership issued a notice of default to Viscount demanding, within 10 days, full payment of all delinquent amounts due the Partnership. Note 12 contains a further discussion of the Viscount situation subsequent to December 31, 1995 including the Partnership's notice of termination of the lease with Viscount and Viscount's subsequent filing for protection under Chapter 11 of the United States Bankruptcy Code.\nOne of the Partnership's Boeing 737-200 commercial jet aircraft was on lease to Viscount prior to the lease termination notification. As of December 31, 1995, the Partnership's aggregate rent, maintenance reserve, loan and interest receivable from Viscount was approximately $336,000. All payments due from Viscount may be affected by Viscount's filing for protection under Chapter 11.\nThe balance of the line of credit advanced to Viscount in 1994 of $88,641 at December 31, 1995, plus accrued interest, is guaranteed by certain affiliates of the principal shareholder of Viscount. An allowance for credit losses has not been provided for this note. The Partnership has recorded an allowance for credit losses for the remaining unsecured receivable balances from Viscount for the aggregate of the unpaid rents, outstanding deferred rent balance and accrued interest as of December 31, 1995. The aggregate allowance for credit losses of $241,964 for these obligations is reflected in the provision for credit losses in the accompanying 1995 statement of operations. Viscount's failure to perform on its financial obligations with the Partnership is expected to have an adverse effect on the Partnership's financial position.\n8. Claims Related to Lessee Defaults\nReceipt of Braniff Bankruptcy Claim - In July 1992, the Bankruptcy Court approved a stipulation embodying a settlement among the Partnership, the Braniff creditor committees and Braniff in which it was agreed that the Partnership\nwould be allowed an administrative claim in the bankruptcy proceeding of approximately $230,769. In 1992, the Partnership received full payment of the claim subject to the requirement that 25% of total proceeds be held by PIMC in a separate, interest-bearing account pending notification by Braniff that all of the allowed administrative claims have been satisfied. The Partnership recognized 75% of the total claim as other revenue in 1992. During 1994, the Partnership was advised that the 25% portion of the administrative claim proceeds with interest could be released by PIMC to the Partnership. As a result, the Partnership recognized $67,958 as other revenue in the 1994 statement of operations.\nAir Zaire - As a result of legal action commenced by the general partner, a final settlement was reached with Air Zaire. Air Zaire paid to the Partnership approximately $2,885,000, of which approximately $1,570,000 has been applied to legal and maintenance expenses related to the default. The final expenses were paid in 1993 and approximately $915,000 was reflected as other revenue in the 1993 statement of operations. The remaining amount of $400,000 was recognized as other revenue in 1994.\n9. Related Parties\nUnder the Limited Partnership Agreement (Partnership Agreement), the Partnership paid or agreed to pay the following amounts to PIMC and\/or its affiliates in connection with services rendered:\na. An aircraft management fee equal to 5% of gross rental revenues with respect to operating leases or 2% of gross rental revenues with respect to full payout leases of the Partnership, payable upon receipt of the rent. In 1995, 1994 and 1993, the Partnership paid management fees to PIMC of $763,774, $604,551 and $681,241, respectively. Management fees payable to PIMC at December 31, 1995 and 1994 were zero and $11,389, respectively.\nb. Reimbursement of certain out-of-pocket expenses incurred in connection with the management of the Partnership and supervision of its assets. In 1995, 1994 and 1993, $299,588, $228,357 and $407,582, respectively, were reimbursed by the Partnership for administrative expenses. Administrative reimbursements of $63,159, and $101,277 were payable at December 31, 1995 and 1994, respectively. Reimbursements for maintenance and remarketing costs of $972,284, $305,200 and $2,608,523 were paid by the Partnership in 1995, 1994 and 1993, respectively. Maintenance and remarketing reimbursements of $29,352 and $590,175 were payable at December 31, 1995 and 1994, respectively.\nc. A 10% interest to PIMC in all cash distributions and sales proceeds, gross income in an amount equal to 9.09% of distributed cash available from operations and 1% of net income or loss and taxable income or loss, as such terms are defined in the Partnership Agreement.\nd. A subordinated sales commission to PIMC of 3% of the gross sales price of each aircraft for services performed upon disposition and reimbursement of out-of-pocket and other disposition expenses. Subordinated sales commissions will be paid only after limited partners have received distributions in an aggregate amount equal to their capital contributions plus a cumulative non-compounded 8% per annum return on their adjusted capital contributions, as defined in the Partnership Agreement. The Partnership did not pay or accrue a sales commission on any aircraft sales to date as the above subordination threshold has not been met.\ne. One engine owned by Polaris Aircraft Income Fund I (PAIF-I) is leased to Viscount beginning in April 1993 through a joint venture with the Partnership. The rental payments of $146,000, $146,000 and $98,000 were offset against rent from operating leases in the 1995, 1994 and 1993 statement of operations, respectively. Viscount is currently in default with respect to this lease agreement as discussed in Notes 7 and 12.\nf. One engine was leased from PHC from September 1993 through April 1994 for use on the aircraft leased to NWT. The rental payments of $38,400 and $42,000 were offset against rent from operating leases in the 1994 and 1993 statement of operations, respectively.\n10. Income Taxes\nFederal and state income tax regulations provide that taxes on the income or loss of the Partnership are reportable by the partners in their individual income tax returns. Accordingly, no provision for such taxes has been made in the financial statements.\nThe net differences between the tax basis and the reported amounts of the Partnership's assets and liabilities at December 31, 1995 and 1994 are as follows:\nReported Amounts Tax Basis Net Difference ---------------- --------- --------------\n1995: Assets $107,820,317 $103,582,640 $4,237,677 Liabilities 1,451,794 698,747 753,047\n1994: Assets $110,568,377 $108,560,932 $2,007,445 Liabilities 2,278,076 1,049,849 1,228,227\n11. Reconciliation of Net Book Income (Loss) to Taxable Net Income (Loss)\nThe differences between net income and loss for book purposes and net income and loss for tax purposes result from the temporary differences of certain revenue and deductions.\nFor book purposes, rental revenue is generally recorded as it is earned. For tax purposes, certain temporary differences exist in the recognition of revenue. For tax purposes, management fee expense is accrued in the same year as the tax basis rental revenue. Increases in the Partnership's book maintenance reserve liability were recognized as rental revenue for tax purposes. Disbursements from the Partnership's book maintenance reserves are capitalized or expensed for tax purposes, as appropriate.\nThe Partnership computes depreciation using the straight-line method for financial reporting purposes and generally an accelerated method for tax purposes. As a result, the current year tax depreciation expense is greater than the book depreciation expense. The Partnership also periodically evaluates the ultimate recoverability of the carrying values and the economic lives of its aircraft for book purposes and, accordingly, recognized adjustments which increased book depreciation expense. These differences in depreciation methods result in book to tax differences on the sale of aircraft. In addition, certain costs were capitalized for tax purposes and expensed for book purposes.\nFor book purposes, aircraft held in inventory are reflected at the lower of depreciable cost or estimated net realizable value. Differences in book and tax revenue and loss from inventory result from the differences in the book and tax carrying value of the inventory.\n12. Subsequent Events\nSale of Boeing 737-200 Combi Airframe and Engine - In March 1996, the Partnership sold the airframe and one engine from the Boeing 737-200 Combi Aircraft, formerly on lease to NWT as discussed in Note 3, to Westjet. The security deposit of approximately $88,000 received from Westjet in December 1995 was applied to the sales price of approximately $896,000. The Partnership agreed to accept payment of the balance of the sales price in 22 monthly installments, with interest at a rate of 10% per annum, beginning in March 1996. Westjet is current on its scheduled payments to the Partnership.\nSale of TWA Common Stock - As discussed in Note 6, the Partnership exercised the TWA warrants on December 29, 1995. The fair market value of the TWA stock at December 31, 1995 was $2,356,506. The Partnership sold the TWA Common Stock by February 1996 for $2,406,479 and will recognize a gain on trading securities of $49,973 in the first quarter of 1996.\nPromissory Note from ALG - As discussed in Note 4, the promissory note from ALG required a balloon payment of $416,631 due in January 1996. The Partnership and ALG restructured the terms of the promissory note. The renegotiated terms specify payment by ALG of the note balance with interest at a rate of 13% per annum with a lump sum payment in January 1996 of $135,258 and eleven payments of $27,272 beginning in February 1996 through December 1996. ALG is current on the renegotiated payments.\nViscount Default and Bankruptcy Filing - As discussed in Note 7, as of December 31, 1995 Viscount was delinquent on certain rent, deferred rent, maintenance reserve and note payments due the Partnership. On January 9, 1996, Viscount was notified that the Partnership had elected to terminate the lease (which is disputed by Viscount) and the Partnership demanded return of the aircraft. On January 24, 1996, Viscount filed a petition for protection under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court in\nTucson, Arizona. Legal counsel has been retained and the general partner is evaluating the rights, remedies and courses of action available to the Partnership with respect to Viscount's default and bankruptcy filing. The Partnership has received no additional payments from Viscount subsequent to December 31, 1995. As a result of Viscount's defaults and Chapter 11 bankruptcy filing, the Partnership may incur maintenance, legal, remarketing, transition and sale costs related to the Partnership's aircraft and engines, which cannot be estimated at this time. The outcome of Viscount's Chapter 11 proceeding cannot be predicted.\nDuring 1995, Viscount delivered the aircraft to Tucson Aerospace, a maintenance facility located in Arizona, to perform a heavy maintenance check on the aircraft. The Partnership has paid to Tucson Aerospace approximately $565,000 from maintenance reserves and cash reserves for this aircraft as progress payments on this maintenance check. Work on the maintenance check was suspended prior to the filing of the Chapter 11 petition by Viscount. Tucson Aerospace asserts that Viscount owes it approximately $866,000 for work done on the aircraft. The aircraft is currently in the possession of Tucson Aerospace and it may assert a lien against the aircraft to secure payment of its claim. In addition, a third party vendor, who claims it provided personnel to work on the aircraft, is asserting a claim against Tucson Aerospace and a lien against the aircraft in the amount of $720,000. Another third party vendor, who claims it provided inspectors, is claiming $185,000 from Tucson Aerospace. The Partnership has been in discussions with the various parties to resolve these disputes and is currently evaluating all of its options, including alternative procedures to obtain repossession of this aircraft.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nPolaris Aircraft Income Fund II, A California Limited Partnership (PAIF-II or the Partnership) has no directors or officers. Polaris Holding Company (PHC) and its subsidiaries, including Polaris Aircraft Leasing Corporation (PALC) and Polaris Investment Management Corporation (PIMC), the general partner of the Partnership (collectively Polaris), restructured their operations and businesses (the Polaris Restructuring) in 1994. In connection therewith, PIMC entered into a services agreement dated as of July 1, 1994 (the Services Agreement) with GE Capital Aviation Services, Inc. (the Servicer or GECAS), a Delaware corporation which is a wholly owned subsidiary of General Electric Capital Corporation, a New York corporation (GE Capital). GE Capital has been PHC's parent company since 1986. As subsidiaries of GE Capital, the Servicer and PIMC are affiliates.\nThe officers and directors of PIMC are:\nName PIMC Title ---- -----------\nJames W. Linnan President; Director Richard J. Adams Vice President; Director Norman C. T. Liu Vice President; Director Edward Sun Vice President John E. Flynn Vice President Robert W. Dillon Vice President; Assistant Secretary Marc A. Meiches Chief Financial Officer Richard L. Blume Secretary\nSubstantially all of these management personnel will devote only such portion of their time to the business and affairs of PIMC as deemed necessary or appropriate.\nMr. Linnan, 54, assumed the position of President and Director of PIMC effective March 31, 1995. Mr. Linnan had previously held the positions of Vice President of PIMC effective July 1, 1994, Vice President - Financial Management of PIMC and PALC effective April 1991, and Vice President - Investor Marketing of PIMC and PALC since July 1986.\nMr. Adams, 62, Senior Vice President - Aircraft Marketing, North America, served as Senior Vice President - Aircraft Sales and Leasing of PIMC and PALC effective August 1992, having previously served as Vice President - Aircraft Sales & Leasing - Vice President, North America, and Vice President - Corporate Aircraft since he joined PALC in August 1986. Effective July 1, 1994, Mr. Adams held the positions of Vice President and Director of PIMC.\nMr. Liu, 38, has assumed the position of Vice President of PIMC effective May 1, 1995 and has assumed the position of Director of PIMC effective July 31, 1995. Mr. Liu presently holds the position of Executive Vice President - Marketing of GECAS, having previously held the position of Executive Vice President - Capital Funding and Portfolio Management of GECAS. Prior to joining GECAS, Mr. Liu was with General Electric Capital Corporation for nine years. He has held management positions in corporate Business Development and in Syndications and Leasing for Transportation and Industrial Funding Corporation (TIFC). Mr. Liu previously held the position of managing director of Kidder, Peabody & Co., Incorporated.\nMr. Sun, 46, has assumed the position of Vice President of PIMC effective May 1, 1995. Mr. Sun presently holds the position of Senior Vice President - Structured Finance of GECAS. Prior to joining GECAS, Mr. Sun held various positions with TIFC since 1990.\nMr. Flynn, 55, Vice President - Marketing of GECAS, served as Senior Vice President - Aircraft Marketing for PIMC and PALC effective April 1991, having previously served as Vice President North America of PIMC and PALC effective July 1989. Mr. Flynn joined PALC in March 1989 as Vice President - Cargo. For the two years prior to joining PALC, Mr. Flynn was a transportation consultant. Effective July 1, 1994, Mr. Flynn held the position of Vice President of PIMC.\nMr. Dillon, 54, became Vice President - Aviation Legal and Insurance Affairs, effective April 1989. Previously, he served as General Counsel of PIMC and PALC effective January 1986. Effective July 1, 1994, Mr. Dillon held the positions of Vice President and Assistant Secretary of PIMC. Mr. Dillon presently holds the position of Senior Vice President of GECAS.\nMr. Blume, 54, has assumed the position of Secretary of PIMC effective May 1, 1995. Mr. Blume presently holds the position of Executive Vice President and General Counsel of GECAS. Prior to joining GECAS, Mr. Blume was counsel at GE Aircraft Engines since 1987.\nMr. Meiches, 43, has assumed the position of Chief Financial Officer of PIMC effective October 9, 1995. Mr. Meiches presently holds the positions of Executive Vice President and Chief Financial Officer of GECAS. Prior to joining GECAS, Mr. Meiches has been with General Electric Company (GE) and its subsidiaries since 1978. Since 1992, Mr. Meiches held the position of Vice President of the General Electric Capital Corporation Audit Staff. Between 1987 and 1992, Mr. Meiches held Manager of Finance positions for GE Re-entry Systems, GE Government Communications Systems and the GE Astro-Space Division.\nCertain Legal Proceedings:\nOn October 27, 1992, a class action complaint entitled Weisl, Jr. et al., v. Polaris Holding Company, et al. was filed in the Supreme Court of the State of New York for the County of New York. The complaint sets forth various causes of action which include allegations against certain or all of the defendants (i) for alleged fraud in connection with certain public offerings, including that of the Partnership, on the basis of alleged misrepresentation and alleged omissions contained in the written offering materials and all presentations allegedly made to investors; (ii) for alleged negligent misrepresentation in connection with such offerings; (iii) for alleged breach of fiduciary duties; (iv) for alleged breach of third party beneficiary contracts; (v) for alleged violations of the NASD Rules of Fair Practice by certain registered broker dealers; and (vi) for alleged breach of implied covenants in the customer agreements by certain registered brokers. The complaint seeks an award of compensatory and other damages and remedies. On January 19, 1993, plaintiffs filed a motion for class certification. On March 1, 1993, defendants filed motions to dismiss the complaint on numerous grounds, including failure to state a cause of action and statute of limitations. On July 20, 1994, the court entered an order dismissing almost all of the claims in the complaint and amended complaint. Certain claims, however, remain pending. Plaintiffs filed a notice of appeal on September 2, 1994. The Partnership is not named as a defendant in this action.\nOn or around February 17, 1993, a civil action entitled Einhorn, et al. v. Polaris Public Income Funds, et al., was filed in the Circuit Court of the 11th Judicial Circuit in and for Dade County, Florida against, among others, Polaris Investment Management Corporation and Polaris Depositary Company. Plaintiffs seek class action certification on behalf of a class of investors in Polaris Aircraft Income Fund IV, Polaris Aircraft Income Fund V and Polaris Aircraft Income Fund VI who purchased their interests while residing in Florida. Plaintiffs allege the violation of Section 517.301, Florida Statutes, in connection with the offering and sale of units in such Polaris Aircraft Income Funds. Among other things, plaintiffs assert that the defendants sold interests in such Polaris Aircraft Income Funds while \"omitting and failing to disclose the material facts questioning the economic efficacy of\" such Polaris Aircraft Income Funds. Plaintiffs seek rescission or damages, in addition to interest, costs, and attorneys' fees. On April 5, 1993, defendants filed a motion to stay this action pending the final determination of a prior filed action in the Supreme Court for the State of New York entitled Weisl v. Polaris Holding Company. On that date, defendants also filed a motion to dismiss the complaint on the grounds of failure to attach necessary documents, failure to plead fraud with particularity and failure to plead reasonable reliance. On April 13, 1993, the court denied the defendants' motion to stay. On May 7, 1993, the court stayed the action pending an appeal of the denial of the motion to stay. Defendants subsequently filed with the Third District Court of Appeal a petition for writ of certiorari to review the lower court's order denying the motion to stay. On October 19, 1993, the Court of Appeal granted the writ of certiorari, quashed the order, and remanded the action with instruction to grant the stay. The Partnership is not named as a defendant in this action.\nOn or around May 14, 1993, a purported class action entitled Moross, et al., v. Polaris Holding Company, et al., was filed in the United States District Court for the District of Arizona. This purported class action was filed on behalf of investors in Polaris Aircraft Income Funds I - VI by nine investors in such Polaris Aircraft Income Funds. The complaint alleges that defendants violated Arizona state securities statutes and committed negligent misrepresentation and breach of fiduciary duty by misrepresenting and failing to disclose material facts in connection with the sale of limited partnership units in the above-named funds. An amended complaint was filed on September 17, 1993, but has not been served upon defendants. On or around October 4, 1993, defendants filed a notice of removal to the United States District Court for the District of Arizona. Defendants also filed a motion to stay the action pending the final\ndetermination of a prior filed action in the Supreme Court for the State of New York entitled Weisl v. Polaris Holding Company (\"Weisl\") and to defendants' time to respond to the complaint until 20 days after disposition of the motion to action pending resolution of the motions for class certification and motions to dismiss pending in Weisl. On January 20, 1994, the court stayed the action and required defendants to file status reports every sixty days setting forth the status of the motions in Weisl. On April 18, 1995, this action was transferred to the Multi-District Litigation described below. The Partnership is not named as a defendant in this action.\nOn September 21, 1993, a purported derivative action entitled Novak, et al., v. Polaris Holding Company, et al., was filed in the Supreme Court of the State of New York, County of New York. This action was brought on behalf of the Partnership, Polaris Aircraft Income Fund I and Polaris Aircraft Income Fund III. The complaint names as defendants Polaris Holding Company, its affiliates and others. Each of the Partnership, Polaris Aircraft Income Fund I and Polaris Aircraft Income Fund III is named as a defendant for procedural purposes, but no recovery is sought from these defendants. The complaint alleges, among other things, that defendants mismanaged the Partnership and the other Polaris Aircraft Income Funds, engaged in self-dealing transactions that were detrimental to the Partnership and the other Polaris Aircraft Income Funds and failed to make required disclosure in connection with the sale of the units in the Partnership and the other Polaris Aircraft Income Funds. The complaint alleges claims of breach of fiduciary duty and constructive fraud and seeks, among other things an award of compensatory and punitive damages in an unspecified amount, re-judgment interest, and attorneys' fees and costs. On January 13, 1994, certain of the defendants, including Polaris Holding Company, filed motions to dismiss the complaint on the grounds of, among others, failure to state a cause of action and failure to plead the alleged wrong in detail. On August 11, 1994, the court denied in part and granted in part defendants' motions to dismiss. Specifically, the court denied the motions as to the claims for breach of fiduciary duty, but dismissed plaintiffs' claim for constructive fraud with leave to replead. On October 7, 1994, defendants filed a notice of appeal. On November 15, 1994, defendants submitted an answer to the remaining causes of action. On July 7, 1995, defendants filed briefs in support of their appeal from that portion of the trial court's order denying the motion to dismiss. On March 14, 1996, the appellate court reversed the trial court's order denying the motion to dismiss, and dismissed the complaint.\nOn or around March 13, 1993, a purported class action entitled Kahn v. Polaris Holding Company, et al., was filed in the Supreme Court of the State of New York, County of New York. This purported class action on behalf of investors in Polaris Aircraft Income Fund V was filed by one investor in the fund. The complaint names as defendants Polaris Investment Management Corporation, Polaris Holding Company, its affiliates and others. The complaint charges defendants with common law fraud, negligent misrepresentation and breach of fiduciary duty in connection with certain misrepresentations and omissions allegedly made in connection with the sale of interests in Polaris Aircraft Income Fund V. Plaintiffs seek compensatory and consequential damages in an unspecified amount, plus interest, disgorgement and restitution of all earnings, profits and other benefits received by defendants as a result of their alleged practices, and attorneys' fees and costs. Defendants' time to move, answer or otherwise plead with respect to the complaint was extended by stipulation up to and including April 24, 1995. On April 18, 1995, the action was discontinued without prejudice. The Partnership is not named as a defendant in this action.\nOn June 8, 1994, a consolidated complaint captioned In re Prudential Securities Inc. Limited Partnerships Litigation was filed in the United States District Court for the Southern District of New York, purportedly consolidating cases that had been transferred from other federal courts by the Judicial Panel on Multi-District Litigation. The consolidated complaint names as defendants Prudential entities and various other sponsors of limited partnerships sold by\nPrudential, including Polaris Holding Company, one of its former officers, Polaris Aircraft Leasing Corporation, Polaris Investment Management Corporation and Polaris Securities Corporation. The complaint alleges that the Prudential defendants created a scheme for the sale of approximately $8-billion of limited partnership interests in 700 assertedly high-risk limited partnerships, including the Partnership, to approximately 350,000 investors by means of false and misleading offering materials; that the sponsoring organizations (including the Polaris entities) participated with the Prudential defendants with respect to, among other things, the partnerships that each sponsored; and that all of the defendants conspired to engage in a nationwide pattern of fraudulent conduct in the marketing of all limited partnerships sold by Prudential. The complaint alleges violations of the federal Racketeer Influenced and Corrupt Organizations Act and the New Jersey counterpart thereof, fraud, negligent misrepresentation, breach of fiduciary duty and breach of contract. The complaint seeks rescission, unspecified compensatory damages, treble damages, disgorgement of profits derived from the alleged acts, costs and attorneys fees. On October 31, 1994, Polaris Investment Management Corporation and other Polaris entities filed a motion to dismiss the consolidated complaint on the grounds of, inter alia, statute of limitations and failure to state a claim. The Partnership is not named as a defendant in this action. Prudential Securities, Inc., on behalf of itself and its affiliates has made an Offer of Settlement. A class has been certified for purposes of the Prudential Settlement and notice to the class has been sent. Any questions concerning Prudential's Offer of Settlement should be directed to 1-800- 327-3664, or write to the Claims Administrator at:\nPrudential Securities Limited Partnerships Litigation Claims Administrator P.O. Box 9388 Garden City, New York 11530-9388\nA further litigation captioned Romano v. Ball et. al, an action by Prudential Insurance Company policyholders against many of the same defendants (including Polaris Investment Management Corporation and Polaris Aircraft Leasing Corporation), has also been commenced by policy holders of the Prudential Insurance Company as a purported derivative action on behalf of the Prudential Insurance Company. The complaint alleges claims under the federal Racketeer Influenced and Corrupt Organizations Act, as well as claims for waste, mismanagement and intentional and negligent misrepresentation, and seeks unspecified compensatory, treble and punitive damages. The case is being coordinated with In re Prudential.\nOn or about February 13, 1995, an action entitled Adams, et al. v. Prudential Securities, Inc. et al. was filed in the Court of Common Pleas, Stark County, Ohio. The action names Prudential Securities, Inc., Prudential Insurance Company of America, Polaris Investment Management Corporation, Polaris Securities Corporation, Polaris Aircraft Leasing Corporation, Polaris Holding Company, General Electric Capital Corporation, Polaris Aircraft Income Fund I, Polaris Aircraft Income Fund IV, Polaris Aircraft Income Fund V and James Darr as defendants. The complaint alleges that defendants committed common law fraud, fraud in the inducement, negligent misrepresentation, negligence, breach of fiduciary duty and civil conspiracy by misrepresenting and failing to disclose material facts in connection with the sale of limited partnership units in Polaris Aircraft Income Fund I, Polaris Aircraft Income Fund IV, and Polaris Aircraft Income Fund V. Plaintiffs seek, among other things, rescission of their investments in the Polaris Aircraft Income Funds, an award of compensatory damages in an unspecified amount plus interest thereon, and punitive damages in an unspecified amount. On or about March 15, 1995, this action was removed to the United States District Court for the Northern District of Ohio, Eastern Division. Subsequently, the Judicial Panel transferred this action to the Multi-District Litigation filed in the United States District Court for the Southern District of New York, discussed above. The Partnership is not named as a defendant in this action.\nOn or about February 6, 1995, a class action complaint entitled Cohen, et al. v. J.B. Hanauer & Company, et al. was filed in the Circuit Court of the Fifteenth Judicial Circuit in and for Palm Beach County, Florida. The complaint names J.B. Hanauer & Company, General Electric Capital Corporation, General Electric Financial Services, Inc., and General Electric Company as defendants. The action purports to be on behalf of \"approximately 5,000 persons throughout the United States\" who purchased units in Polaris Aircraft Income Funds I through VI. The complaint sets forth various causes of action which include allegations against certain or all of the defendants (i) for violation of Section 12(2) of the Securities Act of 1933, as amended, by a registered broker dealer and for violation of Section 15 of such act by all defendants in connection with certain public offerings, including that of the Partnership, on the basis of alleged misrepresentation and alleged omissions contained in the written offering materials and all presentations allegedly made to investors; (ii) for alleged fraud in connection with such offerings; (iii) for alleged negligent misrepresentation in connection with such offerings; (iv) for alleged breach of fiduciary duties; (v) for alleged breach of third party beneficiary contracts; (vi) for alleged violations of the NASD Rules of Fair Practice by a registered broker dealer; and (vii) for alleged breach of implied covenants in the customer agreements by a registered broker dealer. The complaint seeks an award of compensatory and punitive damages and other remedies. On June 7, 1995, plaintiffs filed an amended complaint which did not include as defendants General Electric Capital Corporation, General Electric Financial Services, Inc., and General Electric Company, thus effectively dismissing without prejudice the case against these entities. The Partnership is not named as a defendant in this action.\nOn or about January 12, 1995, a class action complaint entitled Cohen, et al. v. Kidder Peabody & Company, Inc., et al. was filed in the Circuit Court of the Fifteenth Judicial Circuit in and for Palm Beach County, Florida, and on March 31, 1995 the case was removed to the United States District Court for the Southern District of Florida. An amended class action complaint (the \"amended complaint\"), which re-named this action Bashein, et al. v. Kidder, Peabody & Company Inc., et al., was filed on June 13, 1995. The amended complaint names Kidder Peabody & Company, Inc., General Electric Capital Corporation, General Electric Financial Services, Inc., and General Electric Company as defendants. The action purports to be on behalf of \"approximately 20,000 persons throughout the United States\" who purchased units in Polaris Aircraft Income Funds III through VI. The amended complaint sets forth various causes of action purportedly arising in connection with the public offerings of Polaris Aircraft Income Fund III, Polaris Aircraft Income Fund IV, Polaris Aircraft Income Fund V, and Polaris Aircraft Income Fund VI. Specifically, plaintiffs assert claims for violation of Sections 12(2) and 15 of the Securities Act of 1933, fraud, negligent misrepresentation, breach of fiduciary duty, breach of third party beneficiary contract, violation of NASD Rules of Fair Practice, breach of implied covenant, and breach of contract. Plaintiffs seek compensatory damages, interest, punitive damages, costs and attorneys' fees, as well as any other relief the court deems just and proper. Defendants moved to dismiss the amended complaint on June 26, 1995. On October 2, 1995, the court denied the defendants' motion to dismiss. The Partnership is not named as a defendant in this action.\nOn or around April 13, 1995, a class action complaint entitled B & L Industries, Inc., et al. v. Polaris Holding Company, et al. was filed in the Supreme Court of the State of New York. The complaint names as defendants Polaris Holding Company, Polaris Aircraft Leasing Corporation, Polaris Investment Management Corporation, Polaris Securities Corporation, Peter G. Pfendler, Marc P. Desautels, General Electric Capital Corporation, General Electric Financial Services, Inc., General Electric Company, Prudential Securities Inc., and Kidder Peabody & Company Incorporated. The complaint sets forth various causes of action purportedly arising out of the public offerings of Polaris Aircraft Income Fund III and Polaris Aircraft Income Fund IV. Plaintiffs allege claims of fraud, negligent misrepresentation, breach of fiduciary duty, knowingly inducing or participating in breach of fiduciary duty, breach of third party beneficiary\ncontract, violation of NASD Rules of Fair Practice, breach of implied covenant, and unjust enrichment. Plaintiffs seek compensatory damages, interest, general, consequential and incidental damages, exemplary and punitive damages, disgorgement, rescission, costs, attorneys' fees, accountants' and experts' fees, and other legal and equitable relief as the court deems just and proper. On October 2, 1995, defendants moved to dismiss the complaint. The Partnership is not named as a defendant in this action.\nOn or around September 27, 1995, a complaint entitled Martha J. Harrison v. General Electric Company, et al., was filed in the Civil District Court for the Parish of Orleans, State of Louisiana. The complaint names as defendants General Electric Company and Prudential Securities Incorporated. Plaintiff alleges claims of tort, breach of fiduciary duty in tort, contract and quasi-contract, violation of sections of the Louisiana Blue Sky Law and violation of the Louisiana Civil Code concerning the inducement and solicitation of purchases arising out of the public offering of Polaris Aircraft Income Fund IV. Plaintiff seeks compensatory damages, attorney's fees, interest, costs and general relief. The Partnership is not named as a defendant in this action.\nOn or around December 8, 1995, a complaint entitled Overby, et al. v. General Electric Company, et al. was filed in the Civil District Court for the Parish of Orleans, State of Louisiana. The complaint names as defendants General Electric Company and General Electric Capital Corporation. Plaintiffs allege claim of tort, breach of fiduciary duty, in tort, contract and quasi-contract, violation of sections of the Louisiana Blue Sky Law and violation of the Louisiana Civil Code in connection with the public offering of Polaris Aircraft Income Funds III and IV. Plaintiffs seek compensatory damages, attorneys' fees, interest, costs and general relief. The Partnership is not named as a defendant in this action.\nIn or around November 1994, a complaint entitled Lucy R. Neeb, et al. v. Prudential Securities Incorporated et al., was filed in the Civil District Court for the Parish of Orleans, State of Louisiana. The complaint named as defendants Prudential Securities, Incorporated and Stephen Derby Gisclair. On or about December 20, 1995, plaintiffs filed a First Supplemental and Amending Petition adding as additional defendants General Electric Company, General Electric Capital Corporation and Smith Barney, Inc. Plaintiffs allege claims of tort, breach of fiduciary duty, in tort, contract and quasi-contract, violation of sections of the Louisiana Blue Sky Law and violation of the Louisiana Civil Code in connection with the public offering of Polaris Aircraft Income Funds III and IV. Plaintiffs seek compensatory damages, attorneys' fees, interest, costs and general relief. The Partnership is not named as a defendant in this action.\nIn or about January of 1995, a complaint entitled Albert B. Murphy, Jr. v. Prudential Securities, Incorporated et al., was filed in the Civil District Court for the Parish of Orleans, State of Louisiana. The complaint named as defendants Prudential Securities Incorporated and Stephen Derby Gisclair. On or about January 18, 1996, plaintiff filed a First Supplemental and Amending Petition adding defendants General Electric Company and General Electric Capital Corporation. Plaintiff alleges claims of tort, breach of fiduciary duty in tort, contract and quasi-contract, violation of sections of the Louisiana Blue Sky Law and violation of the Louisiana Civil Code in connection with the public offering of Polaris Aircraft Income Funds III and IV. Plaintiffs seek compensatory damages, attorneys' fees, interest, costs and general relief. The Partnership is not named as a defendant in this action.\nOn or about January 22, 1996, a complaint entitled Mrs. Rita Chambers, et al. v. General Electric Co., et al., was filed in the Civil District Court for the Parish of Orleans, State of Louisiana. The complaint names as defendants General Electric Company and General Electric Capital Corporation. Plaintiffs allege claims of tort, breach of fiduciary duty in tort, contract and quasi-contract, violation of sections of the Louisiana Blue Sky Law and violation of the\nLouisiana Civil Code in connection with the public offering of Polaris Aircraft Income Fund IV. Plaintiffs seek compensatory damages, attorneys' fees, interest, costs and general relief. The Partnership is not named as a defendant in this action.\nOther Proceedings - Part I, Item 3 discusses certain other actions arising out of certain public offerings, including that of the Partnership, to which both the Partnership and its general partner are parties.\nDisclosure pursuant to Section 16, Item 405 of Regulation S-K:\nBased solely on its review of the copies of such forms received or written representations from certain reporting persons that no Forms 3, 4, or 5 were required for those persons, the Partnership believes that, during 1995 all filing requirements applicable to its officers, directors and greater than ten percent beneficial owners were met.\nItem 11.","section_11":"Item 11. Executive Compensation\nPAIF-II has no directors or officers. PAIF-II is managed by PIMC, the General Partner. In connection with management services provided, management and advisory fees of $763,773 were paid to PIMC in 1995 in addition to a 10% interest in all cash distributions as described in Note 9 to the financial statements (Item 8).\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\na) No person owns of record, or is known by PAIF-II to own beneficially, more than five percent of any class of voting securities of PAIF-II.\nb) The General Partner of PAIF-II owns the equity securities of PAIF-II as set forth in the following table:\nTitle Name of Amount and Nature of Percent of Class Beneficial Owner Beneficial Ownership of Class - -------- ---------------- -------------------- --------\nGeneral Polaris Investment Represents a 10.0% interest of all cash 100% Partner Management distributions, gross income in an Interest Corporation amount equal to 9.09% of distributed cash available from operations, and a 1% interest in net income or loss\nc) There are no arrangements known to PAIF-II, including any pledge by any person of securities of PAIF-II, the operation of which may at a subsequent date result in a change in control of PAIF-II.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nNone.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\n1. Financial Statements.\nThe following are included in Part II of this report: Page No.\nReport of Independent Public Accountants 24 Balance Sheets 25 Statements of Operations 26 Statements of Changes in Partners' Capital (Deficit) 27 Statements of Cash Flows 28 Notes to Financial Statements 29\n2. Reports on Form 8-K.\nNone.\n3. Exhibits required to be filed by Item 601 of Regulation S-K.\n27. Financial Data Schedules (Filed electronically only).\n4. Financial Statement Schedules.\nAll financial statement schedules are omitted because they are not applicable, not required or because the required information is included in the financial statements or notes thereto.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nPOLARIS AIRCRAFT INCOME FUND II, A California Limited Partnership (REGISTRANT) By: Polaris Investment Management Corporation General Partner\nMarch 25, 1996 By: \/S\/ James W. Linnan - ------------------------------- ------------------- Date James W. Linnan, President\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nSignature Title Date\n\/S\/James W. Linnan President and Director of Polaris March 25, 1996 - ------------------ Investment Management Corporation, -------------- (James W. Linnan) General Partner of the Registrant\n\/S\/Norman C. T. Liu Vice President and Director of Polaris March 25, 1996 - ------------------- Investment Management Corporation, -------------- (Norman C. T. Liu) General Partner of the Registrant\n\/S\/Marc A. Meiches Chief Financial Officer of Polaris March 25, 1996 - ------------------ Investment Management Corporation, -------------- (Marc A. Meiches) General Partner of the Registrant","section_15":""}
{"filename":"53281_1995.txt","cik":"53281","year":"1995","section_1":"ITEM 1. BUSINESS\nDESCRIPTION AND GENERAL DEVELOPMENT\nSummit Family Restaurants Inc. (the \"Company\") is a Delaware corporation organized in l985 as the successor to a California corporation which was organized in l963. Effective April 4, 1995, the Company changed its corporate name to Summit Family Restaurants Inc. from JB's Restaurants, Inc. The name change was made to reflect the Company's diverse family restaurant concepts.\nOn November 30, 1995, an Agreement and Plan of Merger and Reorganization (the \"Merger Agreement\") was executed between the Company and CKE Restaurants, Inc., a Delaware corporation (\"CKE\"), pursuant to which a wholly-owned subsidiary of CKE will merge with the Company, and CKE's wholly-owned subsidiary will be the surviving entity. Consideration for the merger to be paid to the Company's shareholders for each share of common stock and for each share of preferred stock will consist of $3.00 in cash and .20513 shares of CKE common stock, provided that the average CKE common stock price is between $12.25 per share and $17.00 per share at the closing. If the average CKE common stock price is higher than $17.00 or lower than $12.25 at the closing, the exchange ratio may be adjusted accordingly. The transaction is conditioned upon the Company's shareholders approving the transaction and the usual and customary conditions to closing, including, without limitation, accuracy of the parties' representations and warranties, performance of the parties' covenants and obligations under the Merger Agreement and obtaining proper consents of third parties as necessary. Certain conditions under the Merger Agreement have not been met and CKE and the Company are holding discussions with regard to the alternatives available.\nAs of September 25, 1995, the Company operated 80 JB's Restaurants: forty in Arizona, seven in Idaho, five in Montana, eight in New Mexico, fifteen in Utah, one in Washington and four in Wyoming, and franchised twenty-four JB's Restaurants: five in Arizona, three in Idaho, two in Montana, one in New Mexico, two in South Dakota, five in Utah, two in Washington and four in Wyoming. The Company also operated six Galaxy Diners: one in Arizona, one in Idaho and four in Utah, and sixteen franchised HomeTown Buffet restaurants: eight in Arizona, two in Colorado, two in New Mexico, three in Utah and one in Wyoming.\nA summary of the number of Company operated restaurants in operation in each of the last three fiscal years follows:\n(1) - Included 3 Sbarro restaurants and 5 JB's Restaurants (2) - Included 10 Sbarro restaurants and 4 JB's Restaurants\nIn November 1991, the Company invested $3.8 million with Americana Entertainment Group, Inc., the predecessor of HomeTown Buffet, Inc. for capital stock and options. In July 1993, the Company sold shares of preferred stock in HomeTown Buffet, Inc. (\"HTBB\") for $2.5 million. In the fourth quarter of fiscal 1993, HTBB concluded an initial public offering (\"IPO\") of its common stock. In the third quarter of fiscal 1994, the Company sold shares of HTBB common stock for $16.8 million resulting in a pre-tax gain of $14.7\nmillion. On September 25, 1995, the estimated fair value of the Company's ownership of HTBB common stock was $13.25 per share or $7.0 million. Since September 25, 1995, the Company has sold shares of HTBB common stock for $4.8 million resulting in a pre-tax gain of $4.0 million. As of December 15, 1995, the Company owns 130,000 shares of HTBB common stock.\nJB'S RESTAURANTS\nMENU AND FORMAT. JB's Restaurants are family style restaurants offering a variety of breakfast, lunch and dinner selections at moderate prices. The breakfast menu, in the majority of JB's Restaurants, features an \"All-You-Can-Eat\" breakfast buffet, four new \"Fast Break Breakfasts\" currently priced at $1.98 to $2.29 along with skillets and other traditional breakfast fare. The lunch and dinner menu consists of a variety of sandwiches including JB's popular new hoagie sandwiches as well as steak, chicken, pasta and seafood entrees and features a soup and salad bar add-on for a modest upcharge. The restaurants' soup and salad bar features homestyle soups, salads, fresh fruits and vegetables. The restaurants also feature the JB's Bakery with a full line of freshly baked products including cookies, muffins, pecan sticky buns and gourmet double-crust and cream-filled pies.\nThe Company's JB's Restaurants range in size from 3,600 square feet to 7,600 square feet with an average of 4,875 square feet. Seating capacity for the Company's JB's Restaurants ranges from approximately 95 to 240. The JB's Restaurants decor is designed to provide an appealing and relaxed atmosphere.\nThe Company's JB's Restaurants are typically open l8 hours a day, seven days a week. With the exception of the breakfast buffet and the soup and salad bar, all entrees are cooked to order and served by waiters and waitresses with an average check of approximately $5.00.\nThe Company seeks to locate its JB's Restaurants in commercial districts adjacent to middle and upper income residential areas. The restaurant buildings are typically free standing and located on the corner of main arteries.\nREMODELING PROGRAM. Remodeling is an integral part of the Company's strategic plan. The JB's Restaurants typically have been remodeled every five to seven years with 16 of the current 104 JB's Restaurants having been remodeled to the current remodeling scheme. The Company's present remodeling program is designed to improve the image of the Company's existing JB's Restaurants to a much warmer and more charming look featuring new custom designed carpets and specialty fabrics for the upholstery, both with a variety of pleasing patterns and colors, and extensive decorative artifacts and wall hangings, giving the restaurant a more appealing \"country charm\" look.\nOPERATIONS. The Company's JB's Restaurant concept is organized into two divisions, each supervised by a Division Vice President who reports to the Senior Vice President, Family Restaurant Operations, who reports to the Company's President. Within each division are five or six District Managers who are each responsible for the operations of approximately six to nine restaurants.\nEach JB's Restaurant has a general manager who directs the restaurant's daily operations and two assistant managers. To become a general manager, an employee generally must complete the Company's management training program and, unless previously experienced as a full service restaurant general manager, serve as an assistant manager for approximately one year. General managers are responsible for hiring, providing ongoing staff training, and for the overall operation of the restaurant. General and assistant managers participate in a performance based incentive program in addition to a competitive base salary.\nADVERTISING AND PROMOTIONS. As part of the Company's strategy to focus on improving its core markets and increasing revenues from existing stores, the Company executes a marketing program focusing on television and newspaper advertising. Advertising spending was approximately 4.0% of JB's Restaurant revenues in fiscal 1995 and the Company expects to continue this level of advertising spending in the future.\nFRANCHISING. The Company is presently concentrating on franchise development of new JB's Restaurants in small towns in states where JB's Restaurants already operate and in states contiguous to current markets. In addition, the Company continues to franchise current Company operated JB's Restaurants in small isolated cities and other strategically advantageous situations.\nThe Company's franchise agreement presently requires the payment of an initial franchise fee of $35,000 per restaurant and requires the payment of continuing royalty fees of 4% of gross revenues. Under the Company's \"Employee Ownership Program\", which is designed to offer management employees the opportunity to become franchisees, individuals receive a credit against the initial franchise fee for one franchised restaurant based on the number of years of service with the Company. A credit of $12,500 is given for 10-14 years of service, $18,750 for 15-19 years of service and $25,000 for over 20 years of service.\nThe Company has the right to audit and receive annual financial statements from franchisees. Franchise agreements generally have an initial term of 20 years with no renewal options. The Company also retains the right to terminate a franchise agreement for a variety of reasons, including insolvency or bankruptcy, failure to operate the restaurant according to standards or failure to pay fees.\nDuring the six fiscal years ended September 25, 1995, the Company transferred a total of fifteen operating JB's Restaurants to franchisees. At the end of fiscal 1995, the Company had twenty-four franchised restaurants: five in Arizona, three in Idaho, two in Montana, one in New Mexico, two in South Dakota, five in Utah, two in Washington and four in Wyoming. Since September 25, 1995, the Company has transferred one additional operating JB's Restaurant located in Wyoming to a franchisee.\nGALAXY DINERS\nGENERAL. In fiscal year 1994, the Company developed the Galaxy Diner concept intended to be used initially as a conversion vehicle for underperforming JB's Restaurants. Longer-term, subject to available financing, the Company expects to open new Company operated Galaxy Diners as well as potentially franchise the concept. The Company converted its first underperforming JB's Restaurant to a Galaxy Diner in June, 1994 and five additional conversions were completed in fiscal year 1995.\nMENU AND FORMAT. The Galaxy Diner is designed to bring back memories of '57 Chevy's, Elvis, the Jitterbug and great home-cooked food. The Galaxy Diner offers a high energy, fun atmosphere, and offers outstanding food.\nThe interior of each Galaxy Diner features two distinct dining areas - one centered around a full 1950's soda fountain with black, white and red tile, stainless steel, faux marble and mirrors, while the other dining area is more family oriented and casual, with star-patterned carpeting and mahogany colored tables and chairs. Other decor features include nostalgic signs, black and white photographs of 1950's film and music celebrities, and an entire wall dedicated to photos and memorabilia depicting local hometown sports and celebrity personalities of the era. In the front lobby a Wurlitzer juke box plays all the favorite golden oldies while neon blue stars on the ceiling welcome guests to this \"blast from the past\".\nEven the employee uniforms reflect the 50's period with red and white bowling shirts on the servers, poodle skirts on the hostesses, and checkered pants and paper hats on the soda jerks. Many of the popular uniform pieces, along with other trendy signature apparel is on display and available for sale at the Galaxy Diner.\nThe award winning menu covers all dayparts - breakfast, lunch and dinner, plus special menus have been devised for the soda fountain and a full kids menu on a separate activity sheet. Included in the eight page main menu are entrees such as \"Monster Mash\" Hash, \"Blueberry Hill\" Flapjacks, the \"best burgers in the Galaxy\", \"Ty Cobb\" Salad, \"Route 66\" Pileup appetizer, \"Bring My Baby Back\" Ribs, and selections from the \"Mama's and the Pastas\". The soda fountain brings back many of the traditional favorites, including flavored cokes, malts and shakes, and ice cream sodas. One of the house fountain specialties is the Hollywood Boulevard Brownie Sundae built with fudge brownies cut in the shape of stars.\nThe Galaxy Diners have an average check of approximately $6.00.\nOPERATIONS. The Galaxy Diners are supervised by a District Manager, who reports to the Senior Vice President, Family Restaurant Operations, who reports to the Company's President. Each Galaxy Diner has a general manager who directs the restaurant's daily operations and three managers or assistant managers. Managers are required to attend formal training sessions in management and operations of the restaurant. In addition, each restaurant manager is required to comply with an extensive operations manual to assure uniformity of operations and consistent high quality products. The Company has a performance based incentive program covering all its restaurant managers in addition to a competitive base salary.\nHOMETOWN BUFFET RESTAURANTS\nGENERAL. The Company has a franchise and exclusive area development agreement with HomeTown Buffet, Inc., under which, as amended, the Company has the exclusive rights to develop and operate HomeTown Buffet restaurants, as a franchisee, in Arizona, Colorado, Idaho, Montana, Nevada, New Mexico, Utah and Wyoming. Under the terms of the agreement, the Company is required to open a minimum of 17 HomeTown Buffet restaurants in these states prior to June 30, 1996. As of December 15, 1995, the Company operated 16 HomeTown Buffet restaurants.\nUnder the terms of the development agreement, the Company pays an initial fee of $25,000 for each location. After the third location opened, the Company paid a development fee of $100,000 and an additional $50,000 was paid at the time the eleventh location was opened. The development fee is being applied against the $25,000 initial fee in increments of $10,000 per location for each of the next 15 locations. In addition, the Company had two one year options to extend the exclusive area development agreement which requires the Company to open 5 additional locations in each option period. The Company has exercised the first option. A $50,000 fee is due upon the execution of the franchise agreement for the 18th location which will be applied against the $25,000 initial fee in increments of $10,000 per location for each of the next 5 locations. The second option expires December 31, 1997.\nFor each location, the Company enters into a franchise agreement which requires among other items, the payment of a continuing royalty fee. The royalty fee is based on the aggregate gross sales of all the Company's HomeTown Buffet restaurants at the following rates:\nCONCEPT AND MENU. HomeTown Buffet restaurants are located both in shopping \"strip centers\" and as free standing restaurants. The restaurants occupy between 8,000 - 13,000 square feet, seat 265 - 460 people and employ 75 - 100 people. HomeTown Buffet restaurants are generally open seven days per week, 12 hours per day serving lunch, dinner and dessert items with a special brunch offering on Sundays.\nHomeTown Buffet restaurants feature a \"scatter bar\" buffet system with eight separate food islands in an \"all-you-can-eat\" format, offering a wide variety of fresh \"made in the kitchen\" menu items including soups, salads, hot entrees, vegetables, non-alcoholic beverages, and a dessert bar. It also features a display bakery where customers can see the desserts and baked goods prepared fresh throughout the day. Customers pay upon entry to the restaurant and select the items and portions of their choice. This system allows customers to serve themselves from the food island of their choice without standing in long lines. The concept has an average check of approximately $5.50.\nOPERATIONS. The franchised HomeTown Buffet restaurants are operated through a 100% wholly-owned subsidiary of the Company, HTB Restaurants, Inc., and are operated and supervised separately from the JB's Restaurant and Galaxy Diner operations. The HomeTown Buffet restaurants are supervised directly by two\ndistrict managers who report to the Senior Vice President, HomeTown Buffet Operations, who reports to the Company's President.\nEach HomeTown Buffet restaurant has a general manager and at least three co-managers or assistant managers. Managers are required to attend formal training sessions in management and operations of the restaurant. In addition, each restaurant manager is required to comply with an extensive operations manual to assure uniformity of operations and consistent high quality of products. The Company has a performance based incentive program covering its general and assistant managers in addition to a competitive base salary.\nPURCHASING\nPurchasing for all of the Company's restaurants is supervised by the Senior Vice President, Food Services. Two national food service distributors distribute substantially all non-perishable items to the restaurants twice per week. Perishable items are generally purchased locally. The Company believes that there are other distributors who are able to service the Company's needs and that alternative sources of supply are generally available for all items regularly used in the restaurants.\nINFORMATION AND REPORTING SYSTEMS\nThrough the use of management information systems including a computerized point of sale system in each unit, the Company maintains centralized financial and accounting controls for all of its restaurants. Weekly reports of individual restaurant sales, labor costs, food costs and other expenses together with comparisons to preceding weeks, give management current indications of its operations on a per-unit basis as well as on a Company-wide basis.\nLICENSES, TRADEMARKS AND SERVICE MARKS\nUnder franchise agreements with HomeTown Buffet, Inc., the Company has exclusive rights to operate and develop HomeTown Buffet restaurants in Arizona, Colorado, Idaho, Montana, Nevada, New Mexico, Utah and Wyoming. The term of the franchise right, including the use of trademarks and service marks, for each restaurant is the shorter of 20 years or the lease term with a right to renew for additional 10-year periods. The Company's franchise rights are subject to termination if the Company fails to comply with the provisions of the franchise agreements, including the payment of franchise fees.\nThe Company believes that its rights in its trademarks and service marks are important to its marketing efforts and a valuable part of its business. The Company owns a number of trademarks and service marks that have been registered, or for which applications are pending, with the United States Patent and Trademark Office including, but not limited to, JB's(R), JB's Restaurants(R), JB's Bakery(R), JB's is family(R), fast break breakfast,SM fast break,SM and Galaxy Diner(R). It is the Company's policy to pursue registration of its marks whenever possible and to vigorously oppose any infringement of its marks.\nSEASONALITY\nThe Company's business is seasonal in nature with the spring and summer quarters being the highest volume periods. The Company's lowest volume periods typically occur during the fall and winter fiscal quarters.\nCOMPETITION\nThe restaurant business is highly competitive with respect to price, service, restaurant location and food quality and is often affected by changes in consumer tastes, economic conditions, population and traffic patterns. The Company competes within each market with locally-owned restaurants as well as with national and regional restaurant chains, many of which operate more restaurants and have greater financial resources and longer operating histories than the Company. There is also active competition for management and hourly personnel, as well as for attractive commercial real estate sites suitable for restaurants.\nGOVERNMENTAL REGULATION\nThe Company's business is subject to and affected by various federal, state and local laws. Each restaurant must comply with state, county and municipal licensing and regulation requirements relating to health, safety, sanitation, building construction and fire prevention. Difficulties in obtaining or failure to obtain required licenses or approvals could delay or prevent the development of additional restaurants.\nThe Company is subject to Federal Trade Commission (\"FTC\") regulation and various state laws that regulate the offer and sale of franchises. The FTC requires the Company to provide prospective franchisees with a franchise offering circular containing prescribed information about the Company and its franchise operations. Some states in which the Company has existing franchisees and a number of states in which the Company might consider franchising regulate the sale of franchises; several states require the registration of franchise offering circulars. Beyond state registration requirements, several states regulate the substance of the franchisor-franchisee relationship and, from time to time, bills are introduced in Congress aimed at imposing federal registration on franchisors. Many of the state franchise laws limit, among other things, the duration and scope of noncompetition and termination provisions of franchise agreements.\nThe Company's restaurants are subject to federal and state laws governing wages, working conditions, citizenship requirements and overtime. From time to time legislative proposals are considered by governmental authorities that could, if enacted, have a material effect on the Company's business. Examples of recently considered legislation include mandatory health insurance for the Company's employees and increased state or federal minimum wages. These types of proposals could materially increase the Company's operating costs. There is no assurance that the Company would be able to pass such increased costs on to its guests or that, if it was able to do so, it could do so in a short period of time.\nEMPLOYEES\nAs of December 15, l995 the Company employed approximately 4,500 persons, of whom approximately 57 were corporate personnel. All other employees are involved directly in the operation of the Company's restaurants.\nThe Company considers its employee relations to be good and believes that its employee turnover rate is consistent with the industry average. Most employees, other than restaurant management and corporate personnel, are paid on an hourly basis. The Company believes that it provides working conditions and wages that are comparable with those of its competition. The Company's employees are not covered by a collective bargaining agreement.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's home offices are located at 440 Lawndale Drive in Salt Lake City, Utah, which the Company leases.\nThe following is a summary of the Company's restaurant properties as of September 25, 1995:\n*At September 25, 1995, the Company had 24 franchised restaurants of which it is sublessor for the 17 properties noted.\n**Of the 9 non-operating properties; 8 are subleased. The ninth non-operating property was subleased in fiscal year 1996.\nLease terms range from 10 to 25 years with most leases providing for 20-year terms with options to renew for an additional 5 to 20 years. In most instances, the Company has acquired lease or sublease rights to leases whose remaining initial terms are from five to twenty years. The amount of rent paid and the method of computing rent vary; most leases provide for a fixed rental to be applied against a percentage of gross sales, usually 2.5% to 7% for a JB's Restaurant or Galaxy Diner and 3% to 5% for a HomeTown Buffet restaurant. Typically, the Company is responsible for maintenance and repair of the leased premises and the payment of real estate taxes and insurance related to the restaurant.\nManagement believes that the properties are adequate for their intended purposes.\nThe following is a geographic summary of the Company and franchised restaurant locations as of September 25, 1995:\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nDuring the fourth quarter of fiscal year 1995, the plaintiff in the matter of Robbins v. HomeTown Buffet, Inc. et al., dismissed with prejudice the action which had been filed in U.S. District Court for the Southern District of California on October 27, 1994, and alleged violations of federal securities laws. The action had named the Company and two of its officers among the 21 defendants. No consideration was paid by the Company or any other defendant in connection with the dismissal.\nIn addition, the Company is engaged in ordinary and routine litigation incidental to its business. Management does not anticipate that any amount which it may be required to pay by reason thereof will have a material effect on the Company's consolidated statements of operations or financial position.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNot applicable.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Company's common stock is traded in the over-the-counter market on the NASDAQ National Market System under the symbol SMFR. The following table sets forth, for the quarters indicated, the high and low closing sales prices per share as reported on the National Market System.\nAs of December 18, 1995, there were 521 holders of record of the Company's common stock.\nThe Company has not declared a cash dividend in the last three fiscal years. The Company currently reinvests its financial resources into the growth of the business and consequently does not expect to pay cash dividends in the foreseeable future. The Company's Series A Convertible Preferred Stock, issued in October 1993, contains a restriction on the payment of dividends until August 18, 1996.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe selected consolidated financial data presented below, except store data, has been derived from the historical consolidated financial statements of the Company. The selected consolidated financial data for the years ended September 30, 1991, September 28, 1992, September 27, 1993, September 26, 1994, and September 25, 1995 have been derived from financial statements which were audited by KPMG Peat Marwick LLP, independent public accountants.\nThe selected financial information and other data presented below should be read in conjunction with the \"Consolidated Financial Statements\", and \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" included elsewhere in this Form 10-K.\n(1) Fiscal 1994 is net of a charge for property dispositions of $2.0 million.\n(2) Fiscal 1993 is net of a charge for property dispositions of $4.3 million.\n(3) Fiscal 1992 is net of a charge for property dispositions of $3.2 million.\n(4) Fiscal 1991 is net of a charge for property dispositions of $3.1 million and a deferred compensation revaluation of $0.4 million.\n(5) Fiscal 1994 is net of a charge for property dispositions of $2.0 million, a loss on the disposition of a note receivable of $1.6 million and a gain on the sale of HomeTown Buffet, Inc. common stock of $14.7 million.\n(6) Fiscal 1993 is net of a charge for property dispositions of $4.3 million, and a gain on the sale of HomeTown Buffet, Inc. preferred stock of $1.7 million.\n(7) Fiscal 1994 is net of an extraordinary loss of $350,000 (net of tax benefit) resulting from extinguishment of debt.\n(8) Fiscal 1992 is net of the cumulative effect of a change in accounting principle of $214,000.\n(9) Excludes 946,714 shares of Series A Convertible Preferred Stock as they are anti-dilutive.\n(10) Includes 946,714 shares of Series A Convertible Preferred Stock.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\nREVENUES AND SELECTED OPERATING DATA. The following table sets forth for the periods indicated, certain information regarding the Company's revenues and selected operating data for the last three fiscal years. All references herein to years, i.e., \"1995,\" \"1994\" or \"1993,\" are to fiscal years.\n(1) Average annual sales per unit, percentage change from prior year and same store sales percentage change from prior year data is either not available or is not presented due to the relatively small number of units open for a full year.\nIn 1995, as compared with 1994, total revenues increased 5.0% primarily due to an increase in the number of HomeTown Buffet restaurants and Galaxy Diners in operation which more than offset the decline in revenues resulting from the decrease in the number of JB's Restaurants and the 3.6% decline in JB's Restaurants same store sales. The average annual sales decrease per JB's Restaurant of 1.4% reflected a decrease in average guest counts of 1.7% partially offset by a 0.3% increase in the average guest purchase.\nIn 1994, as compared with 1993, total revenues increased 0.5%, primarily due to the opening of eight new HomeTown Buffet restaurants in 1994 partially offset by the closure of four underperforming JB's Restaurants, the franchising of three JB's Restaurants, the disposition of all Sbarro restaurants and a 3.2% decline in JB's Restaurants same store sales. The average annual sales increase per JB's Restaurant of 1.5% reflected an increase in the average guest purchase of 3.7% partially offset by a decrease in average guest counts of 2.2%.\nCOSTS AND EXPENSES; STATEMENT OF OPERATIONS DATA. The following table sets forth costs as a percentage of revenues during the last three fiscal years as well as statement of operations data:\nFOOD COSTS. The increase in food costs as a percentage of total revenues in 1995, as compared with 1994, was primarily the result of an increase in the number of HomeTown Buffet restaurants, which operate at a higher food cost percentage than the Company's JB's Restaurants and Galaxy Diners, and higher produce prices in all restaurant concepts during the third quarter of 1995 due to the inclement weather in California. The increase in food costs as a percentage of total revenues in 1994, as compared with 1993, was primarily the result of an increase in the number of HomeTown Buffet restaurants which operate at a higher food cost percentage than the Company's JB's Restaurants.\nLABOR COSTS. The increase in labor costs as a percentage of total revenues in 1995, as compared to 1994, was primarily due to the decline in same store sales in the JB's Restaurants along with an increase in manager salaries (0.5 percentage points) offset by lower workers compensation costs (-0.4 percentage points). The increase in labor costs as a percentage of total revenues in 1994, as compared to 1993, was primarily due to costs incurred in training and increased scheduling designed to improve customer service in the JB's Restaurants along with a decrease in same store sales.\nOCCUPANCY AND OTHER EXPENSES. The increase in occupancy and other expenses as a percentage of total revenues in 1995, as compared to 1994, primarily reflected higher pre-opening costs along with the decline in JB's Restaurants same store sales. The increase in occupancy and other expenses as a percentage of total revenues in 1994, as compared to 1993, primarily reflected higher equipment rent as the Company leased most equipment in its new HomeTown Buffet restaurants (0.5 percentage points), higher smallware and supply costs (0.4 percentage points), higher pre-opening costs resulting from the increased number of HomeTown Buffet restaurant openings (0.2 percentage points) along with the decline in JB's Restaurants same store sales partially offset by a decrease in marketing expenditures (-0.6 percentage points).\nGENERAL AND ADMINISTRATIVE EXPENSES. The decrease in general and administrative expenses as a percentage of total revenues in 1995, as compared to 1994, was primarily due to reduced employee relocation costs along with the 5.0% increase in total revenues. The increase in general and administrative expenses as a percentage of total revenues in 1994, as compared with 1993, was primarily the result of an increase in salaries (0.6 percentage points) and relocation costs (0.2 percentage points) resulting from upgrading the Company's administrative staff support and an increase in legal expenses (0.2 percentage points). Additionally, in 1993 the Company incurred one-time executive search costs and wrote-off financing costs that were not incurred in 1994 (-0.4 percentage points).\nDEPRECIATION AND AMORTIZATION. The increase in depreciation and amortization as a percentage of total revenues in 1995, as compared with 1994, primarily reflected depreciation associated with remodeled JB's Restaurants and Galaxy Diner conversions and the decrease in same store JB's Restaurants sales partially offset by the increase in the number of HomeTown Buffet restaurants which operate with lower depreciation and amortization as a percent of revenues. The decrease in depreciation and amortization as a percentage of total revenues in 1994, as compared with 1993, primarily reflected higher per store revenue resulting from the disposition of underperforming restaurants and the increase in the number of HomeTown Buffet restaurants which operate with lower depreciation and amortization as a percent of revenues.\nCHARGE FOR PROPERTY DISPOSITIONS. The charge of $1,982,000 for 1994 was primarily related to the disposition of JB's Restaurants. The charge of $4,264,000 for 1993, was primarily related to the disposition of certain JB's Restaurants, Sbarro restaurants, non-operating properties and the termination of exclusive area development rights with Sbarro, Inc.\nINTEREST EXPENSE. The decrease in interest expense as a percentage of total revenues in 1995, as compared with 1994, reflected lower outstanding debt balances along with the 5.0% increase in total revenues. The decrease in interest expense as a percentage of total revenues in 1994, as compared to 1993, reflected lower outstanding debt partially resulting from the prepayment, in April 1994, of $4.6 million of outstanding 11.1% interest bearing debt payable to financial institutions.\nINTEREST INCOME. The decrease in interest income as a percentage of total revenues in 1995, as compared with 1994, was primarily a result of lower cash and short term investment balances. The increase in interest income as a percentage of total revenues in 1994, as compared to 1993 primarily resulted from an increase in invested cash balances and an increase in notes receivable resulting from the sale of restaurants to franchisees.\nGAIN ON SALE OF HOMETOWN BUFFET, INC. STOCK. The $14.7 million gain in 1994 reflected the sale of 1,056,780 shares of HomeTown Buffet, Inc. (\"HTBB\") common stock. The $1.7 million gain in 1993 reflected the sale of 250,000 shares of HTBB preferred stock.\nLOSS ON DISPOSITION OF NOTE RECEIVABLE. The charge of $1,564,000 in 1994 reflected the Company's acceptance of $2.5 million as full repayment of a note receivable related to the sale of a combined restaurant and motel.\nINCOME TAXES. The Company's effective income tax rate was 17.3%, 39.8% and 39.1% in 1995, 1994 and 1993, respectively. The effective tax rate in all three years reflected federal and state income tax rates offset (benefited) by targeted jobs tax credits. The 1995 tax rate is further impacted by a $1,535,000 reserve against net deferred tax assets that may not be realized in the future.\nEXTRAORDINARY LOSS RESULTING FROM EXTINGUISHMENT OF DEBT. The charge of $350,000 (net of tax) in 1994 reflected the prepayment premium and the write-off of unamortized loan acquisition costs associated with the Company's prepayment of $4.6 million of outstanding 11.1% interest bearing debt payable to financial institutions.\nLIQUIDITY & CAPITAL RESOURCES\nThe Company's primary sources of working capital have been cash flow from operations, borrowings and sale of assets. The Company requires capital principally for the acquisition and construction of new restaurants, remodeling and conversion of existing restaurants, and renewals of equipment and leasehold improvements. During 1996, the Company anticipates its capital requirements will be primarily for renewals of equipment and leasehold improvements and expects to fund these capital requirements through cash on hand at the end of the year, internally generated funds and the sale of all, or a portion of, the Company's investment in HTBB common stock.\nDuring the fiscal year ended September 25, 1995, cash and cash equivalents were provided by the following sources:\nDuring 1995, cash used exceeded cash provided by $3.4 million due primarily to capital expenditures associated with the conversion of five underperforming JB's Restaurants to Galaxy Diners, the remodeling of four JB's Restaurants and the construction of two HomeTown Buffet restaurants.\nThe current ratio at the end of 1995 was 0.3:1.0 compared to 0.8:1.0 at the end of 1994. Management does not consider the fact that the current ratio is less than one to be, itself, an indication of a liquidity problem as the restaurant business has practically no receivables and minimum inventories that typically turn faster than accounts payable to suppliers.\nAt the end of 1995, the Company had $2.0 million in letters of credit and $2.2 million in bank loans which were secured by the Company's 528,220 shares of HTBB common stock and by certain properties owned by the Company. During the third quarter of 1995, the Company terminated its $3.0 million line of credit in exchange for the release of the lien on an office\/warehouse property which the Company sold generating net proceeds of approximately $1.5 million. The Company was not in compliance with certain covenants in its lending agreements at the end of the year. The Company obtained a waiver from the bank with respect to these covenants.\nAs of September 25, 1995, the Company held 528,220 shares of HTBB common stock. Between September 25, 1995, and December 11, 1995, the Company sold 398,220 shares of HTBB common stock generating net proceeds of $4.8 million resulting in a pre-tax gain of $4.0 million. $2.1 million of these proceeds were used to repay the Company's bank loans in full, $700,000 remains in escrow as partial security against the $2.0 million in letters of credit with the remaining $2.0 million retained by the Company. The letters of credit are secured by certain properties owned by the Company, by the remaining 130,000 shares of HTBB common stock and by the escrow account noted above.\nIn August 1994, the Company entered into a master lease agreement (the \"Agreement\") to finance equipment for new HomeTown Buffet restaurants. The Agreement, among other things, required the Company to maintain a minimum tangible net worth of at least $40 million. Operating results during fiscal 1995 reduced the Company's net worth to less than $40 million as of September 25, 1995. On December 7, 1995, the lessor notified the Company it was in default under the terms of the Agreement and demanded a default payment in the amount of $1,493,938 which represents all remaining rent and other payments due to the lessor. Upon receipt of the default payment, the lessor is obligated to transfer to the Company all rights of ownership to the leased assets. Management is contesting the default and seeks a resolution with the lessor that would allow the Company to continue periodic rent payments as stipulated under the Agreement. While the final outcome of this matter cannot be determined at this time, management, in consultation with legal counsel, believes that such a resolution can be reached.\nThe Company opened two new HomeTown Buffet restaurants during 1995, bringing the total number of HomeTown Buffet restaurants in operation to 16. The Company's exclusive area development agreement with HomeTown Buffet, Inc. was amended during the third quarter of 1995 to extend the Company's requirement to open a minimum of 17 HomeTown Buffet restaurants to June 30, 1996 from December 31, 1995. In addition, in order to maintain its exclusive area development agreement with HomeTown Buffet, Inc., the Company is required to open an additional 5 HomeTown Buffet restaurants by December 31, 1996. Should the Company not open the required number of HomeTown Buffet restaurants, the Company would lose its exclusive area rights.\nDuring 1995, the Company remodeled four of its higher performing JB's Restaurants bringing to 11 the total number of Company operated JB's Restaurants remodeled to the latest remodeling scheme. The Company currently has no plans to remodel any further JB's Restaurants in 1996. The Company continues to routinely repair and maintain the Company's restaurants. In addition, the Company, in 1995, converted an additional five of its lower performing JB's Restaurants to Galaxy Diners bringing the number of Galaxy Diners to six at the end of 1995. Future Galaxy Diner conversions, JB's Restaurants remodels and new HomeTown Buffet restaurants will be dependent upon the Company improving internal cash flow and\/or finding additional sources of capital including the potential sale of assets. To the extent that these assets secure certain letters of credit, the Company expects that it will maintain cash collateral for the letters of credit when the assets are sold in accordance with the Company's agreement with the bank noted above. If the Company's earnings do not improve or other sources of financing are not obtained, the Company would not have the available financing for capital spending beyond maintenance level capital additions.\nPursuant to certain change of control agreements, the Company may be obligated to pay benefits to the President and seven Senior Vice Presidents in the event of a significant change in ownership of the Company.\nThe Merger Agreement described in Item 1 titled \"Business\" triggered a provision in the change of control agreements that requires the Company to place in escrow accounts approximately $1.7 million. Payment of benefits is made upon involuntary termination of those individuals noted above between the signing of the Merger Agreement and one year after consummation of the merger or upon the voluntary termination of employment during the second 90 days following consummation of the merger. The Company has not yet funded the escrow accounts.\nSEASONALITY\nThe Company's business is seasonal in nature with the spring and summer quarters being the highest volume periods. The Company's lowest volume periods typically occur during the fall and winter fiscal quarters.\nIMPACT OF INFLATION\nMany of the Company's employees are paid hourly rates related to the federal and state minimum wage laws. Accordingly, increases in the minimum wage could materially increase the Company's labor costs. Currently, there are no further scheduled increases in the federal minimum wage. In addition, the cost of food commodities utilized by the Company are subject to market supply and demand pressures as is evidenced by the recent increase in produce prices (lettuce in particular) resulting from the unusual weather conditions in the western U.S. growing regions. Shifts in these costs may have a significant impact on the Company's food costs. The Company anticipates that increases in these costs can be offset through pricing and other cost control efforts; however, there is no assurance that the Company would be able to pass such costs on to its guests or if it were able to do so, it could do so in a short period of time.\nACCOUNTING STANDARDS ISSUED BUT NOT YET ADOPTED\nIn December 1991, the Financial Accounting Standards Board (\"FASB\") issued Statement of Financial Accounting Standards (\"SFAS\") No. 107 \"Disclosures about Fair Value of Financial Instruments\". SFAS No. 107 extends existing fair value disclosure practices by requiring all entities to disclose, where practicable, the fair value of financial instruments, both assets and liabilities, recognized and not recognized, in the statement of financial position. SFAS No. 107 is effective for the Company's fiscal year 1996. Management has not yet determined for which of its financial instruments it is practicable to determine fair value. It is management's intent to implement SFAS No. 107 in fiscal year 1996.\nIn May 1993, the FASB issued SFAS No. 114 \"Accounting by Creditors for Impairment of a Loan\". SFAS No. 114 addresses the accounting by creditors for impairment of certain loans and requires impaired loans to be measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical alternative, at the loan's observable market price or the fair value of the collateral if the loan is collateralized. A loan is impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due under the terms of the loan agreement. SFAS No. 114 is effective for the Company's fiscal year 1996. Management believes that, if implemented currently, SFAS No. 114 would not have a material effect on its financial position as of September 25, 1995. It is management's intent to adopt SFAS No. 114 in fiscal year 1996.\nIn March 1995, the FASB issued SFAS No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of.\" SFAS No. 121 requires the assessment of certain long-lived assets, including many intangible assets, for possible impairment when events or circumstances indicate the carrying amounts of these assets may not be recoverable. SFAS No. 121 is effective for the Company's fiscal year 1997 and, upon adoption, any impairment losses recognized for assets to be held and used must be recorded in continuing operations while such losses attributable to assets to be disposed of must be reported as a cumulative effect of a change in accounting principle. The Company has not yet completed all of the analysis required to estimate the impact of SFAS No. 121. It is management's intent to implement SFAS No. 121 in fiscal year 1997.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nSee the Index included at \"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\".\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nBOARD OF DIRECTORS\nFREDERICK L. BRYANT. Mr. Bryant, 41, is a general partner of ABS Capital Partners, L.P. and has been a Managing Director of Alex. Brown & Sons Incorporated, an investment banking firm, since January 1, 1990. Mr. Bryant was a Principal at Alex. Brown & Sons Incorporated from January 1, 1988 through December 31, 1989. Mr. Bryant has been a director of the Company since October 1993 and serves on the Company's Audit Committee and Special Committee. Mr. Bryant also serves as a director of Transaction Systems Architects, Inc., a computer software company.\nNORMAN N. HABERMANN. Mr. Habermann, 62, is the President of Scobrett Associates, Inc., which is involved in venture capital and consulting activities. From December 1986 to February 1994, Mr. Habermann was President and Chief Executive Officer of The Restaurant Enterprises Group, Inc., and its predecessors. Mr. Habermann has been a member of the Board since November 23, 1994, when he was appointed by the Board to fill a vacancy. Mr. Habermann is also a member of the Company's Audit Committee and serves as Chair of the Company's Special Committee. Mr. Habermann serves as a director of International Food & Beverage, Inc., a food manufacturer.\nCARL R. HAYS. Mr. Hays, 58, is currently a franchisee of Outback Steakhouse, Inc., a restaurant company. Mr. Hays was Chief Operating Officer of Al Copeland Enterprises, Inc. from November 1989 to November 1992. Mr. Hays has served as a director of the Company since 1987 and is Chair of the Company's Compensation Committee and a member of the Nominating Committee. Mr. Hays also serves as a director of Fresh Choice, Inc., a restaurant company.\nCLARK D. JONES. Mr. Jones, 60, has been Chairman of the Board of the Company since 1981. On June 30, 1995, Mr. Jones retired as an employee of the Company, but remains Chairman of the Board. Since July 1995, Mr. Jones is also one of three commissioners on the State of Utah Public Service Commission. Mr. Jones served as Chief Executive Officer of the Company from 1981 to October 1, 1991. Mr. Jones served as interim President and Chief Executive Officer of the Company from May 31, 1993 to January 3, 1994. Mr. Jones has served as a director of the Company since 1971. He is Chair of the Company's Nominating Committee. Mr. Jones serves as a director of MDT Corporation, a medical technology company.\nDON M. MCCOMAS. Mr. McComas, 51, has been President, Chief Executive Officer and a director of the Company since January 3, 1994. From February 1993 through December 1993 he was President and Chief Executive Officer of El Torito Restaurants, Inc. From January 1988 to January 1993, Mr. McComas served as President and Chief Executive Officer of Carrows Restaurants, Inc.\nNORTON PARKER. Mr. Parker, 69, retired in April 1994 from his position of more than five years as President and Chief Executive Officer of Capital City Bank. Mr. Parker has served as a director of the Company since 1976 and is Chair of the Company's Audit Committee and a member of the Company's Nominating Committee.\nWILLIAM L. PATERNOTTE. Mr. Paternotte, 50, has been a Managing Director of Alex, Brown & Sons Incorporated, an investment banking firm, for more than five years, and is currently the Director of Marketing and Client Services. Mr. Paternotte has served as a director of the Company since 1985 and is a member of the Company's Compensation and Nominating Committees. Mr. Paternotte serves as a director of Miami Subs Corporation, a restaurant company.\nRONALD N. PAUL. Mr. Paul, 61, has been President of Technomic, Inc., a marketing consulting firm, for more than five years. Mr. Paul has served as a director of the Company since 1989 and is a member of the Company's Audit Committee and Special Committee.\nTHOMAS J. RUSSO. Mr. Russo, 54, is the President, Chairman and Chief Executive Officer of Miami Subs Corporation, a restaurant company. Until January 1994, Mr. Russo was Group Chairman and Chief Executive\nOfficer of the Housewares Division of Hanson Industries for more than five years. Mr. Russo has served as a director of the Company since 1990 and is a member of the Company's Compensation Committee.\nOFFICERS\nIDENTIFICATION OF EXECUTIVE OFFICERS\nThe Company's executive officers are elected annually at the first meeting of the Board of Directors following each annual shareholders' meeting. The Company's executive officers as of December 1, 1995 are:\nINFORMATION ABOUT MR. MCCOMAS IS SET FORTH IN THE BOARD OF DIRECTORS SECTION OF ITEM 10 OF PART III.\nGARY A. BALES. Mr. Bales has been Vice President of Marketing since 1987. In February 1993, Mr. Bales was given the additional title of Vice President of Development. In April 1994, Mr. Bales' title was changed to Senior Vice President of Marketing and Development.\nGEORGE H. GEHLING. Mr. Gehling has been Vice President of Human Resources since November 1988. In February 1993, Mr. Gehling was given the additional title of Vice President of Franchising. In April 1994, Mr. Gehling's title was changed to Senior Vice President of Franchising and Human Resources.\nJOSEPH J. HOLLENCAMP. Mr. Hollencamp has been the executive responsible for HomeTown Buffet Operations since August 1991. In June 1993, Mr. Hollencamp was named Vice President of HomeTown Buffet Operations, and in April 1994, Mr. Hollencamp's title was changed to Senior Vice President. From August 1990 to August 1991, Mr. Hollencamp was a private contractor for CSI, a cable television company.\nCHARLOTTE L. MILLER. Ms. Miller has been Vice President, General Counsel and Secretary since November 1992. In April 1994, Ms. Miller's title was changed to Senior Vice President, General Counsel and Secretary. Prior to November 1992, Ms. Miller was an attorney with the firm of Janove & Miller from January 1992 to November 1992 and with the firm of Watkiss & Saperstein from December 1988 to January 1992.\nDAVID E. PERTL. Mr. Pertl has been Vice President and Chief Financial Officer of the Company since September 1989. In November 1992, Mr. Pertl was also named Treasurer. In April 1994, Mr. Pertl's title was changed to Senior Vice President, Chief Financial Officer and Treasurer.\nRONALD L. SACKS. Mr. Sacks joined the Company in April 1990 as Vice President of Operations. During 1989 and 1990 Mr. Sacks was Vice President of Restaurant Operations for Country Hospitality, a Carlson Company. In April 1994, Mr. Sacks' title was changed to Senior Vice President of Family Restaurant Operations.\nDANIEL YANEZ. Mr. Yanez joined the Company in March 1994 as Vice President of Food Services. In April 1994, Mr. Yanez' title was changed to Senior Vice President. From 1969 to March 1994, Mr. Yanez was employed by Carrows Restaurants, Inc. in various capacities, including Food and Beverage Vice President from 1984 to March 1994.\nFILING OF STOCK OWNERSHIP REPORTS BY DIRECTORS AND OFFICERS\nSection 16(a) of the Securities Exchange Act of 1934 requires the Company's executive officers, directors and more than 10% shareholders to file certain reports of stock ownership with the Securities and Exchange Commission and with the National Association of Securities Dealers. These persons are also required to furnish the Company with copies of all Section 16(a) forms they file. Based solely on its review of copies of the forms received by it, or on written representations from reporting persons, the Company believes that there were no late filings on Forms 3, 4 or 5, or unreported transactions, during fiscal 1995.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nSUMMARY COMPENSATION TABLE\nThe following table sets forth the compensation of the Company's Chief Executive Officer in fiscal 1995 and the five named executive officers whose total annual salary and bonus exceeded $100,000 in fiscal 1995 (the \"Named Executive Officers\"):\n(1) Perquisites for each executive officer for each of the three fiscal years was less than 10% of each executive's salary and bonus combined. The amounts shown for Messrs. McComas and Yanez for fiscal 1994 are payments made as a result of taxes incurred in connection with relocation expenses paid by the Company.\n(2) Of the amount shown for Mr. Jones for fiscal 1995, $15,851 is paid retirement benefits, $440 is ESOP Company contributions, $338 is 401(k) Company contributions, $666 is life insurance premiums paid by the Company and $3,750 is director fees paid to Mr. Jones as a non-employee director. Of the amount shown for Mr. McComas for fiscal 1994, $111,690 is relocation expenses and $2,396 is life insurance premiums paid by the Company on behalf of Mr. McComas. Of the amount shown for Mr. Yanez for fiscal 1994, $54,057 is relocation expenses and $568 is life insurance premiums paid by the Company on behalf of Mr. Yanez. The amounts shown for the other Named Executive Officers represent life insurance premiums paid by the Company, 401(k) Company contributions to the Named Executive Officer's account, and ESOP Company contributions to the Named Executive Officer's account. For fiscal 1995, the amounts are as follows:\n(3) The amount indicated is Mr. McComas' actual salary received during fiscal 1994 which is less than his annualized salary of $200,000 because his employment with the Company did not commence until January 3, 1994.\n(4) The amount indicated is Mr. Jones' actual salary received during fiscal 1995 which is less than his annualized salary of $175,000 because his employment with the Company ended on June 30, 1995.\n(5) The amount indicated is Mr. Yanez' actual salary received during fiscal 1994 which is less than his annualized salary of $115,000 because his employment with the Company did not commence until March 14, 1994.\nOPTION\/SAR GRANTS IN LAST FISCAL YEAR\nThe following table sets forth information concerning individual grants of stock options made during fiscal 1995 to the Chief Executive Officer and to the Named Executive Officers:\n(1) The exercise price is equal to the fair market value of the stock on the date of the grant.\n(2) All values shown are pre-tax and are rounded to the nearest whole dollar. No gain to the optionees is possible without an increase in the market price of the Company's Common Stock above the market price on the date of grant. If such increase occurs, shareholders will benefit commensurately. If no increase in the market price occurs, optionees will realize no value from stock options.\n(3) None of the options listed are currently exercisable. Twenty percent (20%) of the options listed will become exercisable January 3, 1996, and each year thereafter until fully vested. The options have a term of 10 years.\n(4) These options were canceled on June 21, 1995.\n(5) These are nonqualified stock options all of which are immediately exercisable. The options have a term of 10 years.\n(6) Twenty percent (20%) of the options listed are exercisable and an additional twenty percent (20%) will become exercisable October 11, 1996, and each year thereafter until fully vested. The options have a term of 10 years.\n(7) None of the options listed are currently exercisable. Twenty percent (20%) of the options listed will become exercisable September 19, 1996, and each year thereafter until fully vested. The options have a term of 10 years.\n(8) None of the options listed are currently exercisable. Twenty percent (20%) of the options listed will become exercisable April 15, 1996, and each year thereafter until fully vested. The options have a term of 10 years.\n(9) None of the options listed are currently exercisable. Twenty percent (20%) of the options listed will become exercisable April 19, 1996, and each year thereafter until fully vested. The options have a term of 10 years.\n(10) None of the options listed are currently exercisable. Twenty percent (20%) of the options listed will become exercisable March 15, 1996, and each year thereafter until fully vested. The options have a term of 10 years.\n(11) None of the options listed are currently exercisable. Twenty percent (20%) of the options listed will become exercisable April 13, 1996, and each year thereafter until fully vested. The options have a term of 10 years.\nAGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR END OPTION VALUES\nThe following table sets forth information regarding individual exercises of stock options made during fiscal 1995 by the Chief Executive Officer and each of the Named Executive Officers:\n(1) All values shown are pre-tax and are rounded to the nearest whole dollar.\n(2) Based on the 1995 fiscal year-end fair market value of $4.625 per share of Common Stock as quoted by the National Association of Securities Dealers Automated Quotation System.\nDirectors' Compensation\nFor serving on the Board of Directors, each director who is not an employee of the Company is paid $250 per month and $1,500 per board meeting, with no additional compensation for committee meetings if the committee meeting is held on the same day as a board meeting. Fees for committee meetings, with the exception of the Special Committee, are $500 per meeting or $750 per meeting for serving as chair. Members of the Special Committee are paid $1,000 per meeting attended in person, plus $1,000 per month to Mr. Habermann, as Chair of the Special Committee, and $250 per month to the other members of the Special Committee, as long as the Special committee is continuing its assignment.\nDuring fiscal 1995, Mr. Jones was granted nonqualified stock options to purchase 23,000 shares. Also, Mr. Habermann was granted nonqualified stock options to purchase 5,000 shares, and Messrs. Bryant, Hays, Parker,\nPaternotte, Paul and Russo each were granted nonqualified stock options to purchase 2,000 shares pursuant to the Formula Grant provisions of the 1992 Stock Option Plan (the \"Formula Grants\").\nEXECUTIVE AGREEMENTS\nEMPLOYMENT AGREEMENT FOR PRESIDENT AND CHIEF EXECUTIVE OFFICER\nThe Company entered into an Employment Agreement with Don M. McComas on November 24, 1993, with a commencement date of January 3, 1994. The Employment Agreement is for a term of three years and shall automatically renew for two years on January 3, 1997, and every two years thereafter unless either party provides written notice of intent not to renew 90 days or more prior to the renewal date. Pursuant to the Employment Agreement, Mr. McComas initially received a base salary of $200,000 which will be reviewed annually, and moving and transition allowances. In addition, Mr. McComas receives an automobile allowance and participates in the Executive Incentive Compensation Plan, the Executive Long Term Incentive Plan and the 1992 Executive Long-Term Stock Award Plan. Pursuant to the Employment Agreement, the Compensation Committee granted options to Mr. McComas to purchase 75,000 shares of the Company's stock under the incentive stock option provisions of the 1992 Stock Option Plan and 25,000 shares under the nonqualified stock option provisions of the 1992 Stock Option Plan. The Employment Agreement includes a change of control provision under which Mr. McComas would be paid one dollar less than three times his annual base salary upon a change of control of the Company, and other provisions as described below.\nEXECUTIVE CHANGE OF CONTROL AGREEMENTS\nThe Company has entered into agreements with the Named Executive Officers (except Messrs. Jones and McComas) providing for certain termination benefits in the event of any actual change in control of the Company. In the event the Company is acquired, a change in control of the Company occurs, or certain events likely to result in a change of control (that are enumerated in the change of control agreements) occur, the Company must pay to an escrow account one and one half times (1.5) the base salary of the participants which amount they may demand be paid to them in the event (i) the participants' employment terminates voluntarily other than for cause, disability, retirement or death during the first 90 days following the change of control, or (ii) the participants' employment terminates involuntarily other than for cause, disability, retirement or death following the change of control; provided however, the participant's right to demand such payments shall terminate upon the earlier of (a) two years after the funds have been deposited in the escrow account, or (b) one year from the date of a change of control. These agreements are dated August 17, 1995 and expire on September 30, 1996 (unless renewed), and replace prior similar agreements which have expired.\nAmendments to the change of control agreements dated December 1, 1995 state that in the event the merger contemplated by the Agreement and Plan of Merger and Reorganization dated November 30, 1995 between the Company and CKE Restaurants, Inc. (the \"CKE Merger\") is consummated, the participants may demand the amount in their escrow account be paid to them if (i) the participants' employment terminates involuntarily other than for cause, disability, retirement or death during the first 90 days following the CKE Merger, (ii) the participants' employment terminates voluntarily other than for cause, disability, retirement or death during the second 90 days following the CKE Merger, or (iii) the participants' employment terminates involuntarily other than for cause, disability, retirement or death following the CKE Merger; provided however, the participant's right to demand such payments shall terminate upon the earlier of (a) two years after the funds have been deposited in the escrow account, or (b) one year from the date of the CKE Merger. All other provisions of the change of control agreements remain as originally set forth.\nMr. McComas' Employment Agreement, which is described above, contains change of control provisions that provide for payment of one dollar less than three times Mr. McComas' annual base salary upon termination of employment under similar conditions as described above for the Named Executive Officers.\nRETIREMENT AGREEMENT\nIn 1985, the Company adopted an unfunded, noncontributory Supplemental Executive Retirement Plan. No current executives participate in this plan. Six retired individuals are currently receiving payments under this plan. The Company does not intend to utilize the plan in the future for any other executives. Benefits are determined using the participant's average annual base salary of the five consecutive years during the ten-year period prior to the participant's retirement which yields the highest average (\"Final Average Earnings\"), and are affected by the participant's years of service and age at retirement. Actual amounts payable under this plan are reduced by benefits paid to the participant from the Company's Employee Stock Ownership Plan and 401(k) Plan.\nUpon his retirement, Mr. Jones received credit for fifteen years of service to the Company, which is the maximum credit allowed under the plan.\nWhen he retired on June 30, 1995, Mr. Jones' Final Average Earnings were $182,455. As of December 5, 1995, Mr. Jones' annual retirement benefit equaled $60,636, including reductions due to early retirement and due to benefits paid to Mr. Jones from the Company's Employee Stock Ownership Plan and 401(k) Plan.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nSECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS\nThe following table sets forth certain information as of December 1, 1995, except as noted, with respect to the voting securities of the Company held by each person who owns of record, or is known by the Company to own beneficially, more than five percent of any class of voting securities.\n(1) Holdings as of December 5, 1995.\n(2) The shareholder has sole voting and sole dispositive power over all shares listed.\n(3) As disclosed by the shareholder in a telephone conversation on December 5, 1995, as of December 5, 1995, Heartland Advisors, Inc. held sold dispositive power over all of the shares listed. Heartland Advisors, Inc. has no direct voting control over any of the shares listed; however, Heartland Group, Inc., a company advised by Heartland Advisors, Inc., has sole voting power over 430,000 of the shares listed.\n(4) As disclosed by the shareholder in a telephone conversation on December 5, 1995, as of September 30, 1995, Dimensional Fund Advisors Inc. held sole voting power over 211,750 shares; however, persons who are officers of Dimensional Fund Advisors Inc. also serve as officers of DFA Investment Dimensions Group Inc. (the \"Fund\"), and The DFA Investment Trust Company (the \"Trust\"), each an open-end management investment company registered under the Investment Company Act of 1940. In their capacity as officers of the Fund and the Trust, these persons vote 81,300 shares which are owned by the Fund and 22,100 shares which are owned by the Trust. Dimensional Fund Advisors Inc. holds sole dispositive power over 315,150 shares.\nSECURITY OWNERSHIP OF DIRECTORS AND MANAGEMENT\nThe following table sets forth certain information as of December 1, 1995, except as noted, regarding the voting securities of the Company held by directors and the Named Executive Officers.\n(1) Except as indicated all shares are beneficially owned and sole voting and investment power is held by the persons named. Does not include shares issuable upon exercise of options to purchase shares unless they are exercisable within 60 days.\n(2) Includes 7,000 shares subject to presently exercisable options.\n(3) Does not include 946,714 shares of Series A Stock owned by ABS MB (JB) Limited Partnership, an entity related to Alex. Brown & Sons Incorporated, of which Messrs. Bryant and Paternotte are Managing Directors.\n(4) Includes 5,000 shares subject to presently exercisable options.\n(5) Includes 11,500 shares subject to presently exercisable options.\n(6) Includes 43,000 shares subject to presently exercisable options, 5,469 shares in the Employee Stock Ownership Plan and 206 shares held in Mr. Jones' IRA.\n(7) Includes 55,000 shares subject to presently exercisable options.\n(8) Includes 14,000 shares subject to presently exercisable options.\n(9) Includes 15,400 shares subject to presently exercisable options, 623 shares in the Employee Stock Ownership Plan and 178 shares in the Company's 401(k) Plan.\n(10) Includes 18,600 shares subject to presently exercisable options, 292 shares in the Employee Stock Ownership Plan and 205 shares in the Company's 401(k) Plan.\n(11) Includes 13,400 shares subject to presently exercisable options, 264 shares in the Employee Stock Ownership Plan and 69 shares in the Company's 401(k) Plan.\n(12) Includes 12,000 shares subject to presently exercisable options.\n(13) Includes 277,200 shares subject to presently exercisable options, 7,029 shares in the Employee Stock Ownership Plan and 724 shares in the Company's 401(k) Plan.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nCERTAIN TRANSACTIONS INVOLVING MANAGEMENT\nOn October 13, 1993, the Company executed a Certificate of Designations, Preferences and Rights of Series A Stock and issued 946,714 shares of Series A Stock. The sole owner of the Series A Stock is ABS MB (JB) Limited Partnership (\"ABS\"), of which ABS MB Ltd. is the general partner. ABS MB Ltd. is a wholly owned subsidiary of Alex. Brown Incorporated, which also owns Alex. Brown & Sons Incorporated. Messrs. Bryant and Paternotte, two of the Company's directors, are employees of Alex. Brown & Sons Incorporated. Personal funds of Messrs. Paternotte and Bryant are invested in ABS MB II Employees Limited Partnership which is one of the limited partners of ABS. Mr. Bryant is Vice President of ABS MB Ltd. The 946,714 Series A Stock shares owned by ABS represents an approximate 16% ownership position in the Company. As a holder of Series A Stock, ABS has the right to elect two members to the Board of Directors of the Company. Messrs. Paternotte and Bryant are the current designees of ABS. The Series A Stock is nondividend bearing and is convertible to Common Stock on a one-for-one basis at the option of ABS subject to certain conditions. ABS is entitled to liquidation preferences, rights to approve certain significant corporate transactions and certain registration rights.\nMr. McComas and Pam McComas, his wife, are each fifty percent shareholders in Wheels-Up Aircraft Co., an entity that owns an aircraft utilized by the Company for employee travel. The Company pays a fee to Wheels-Up Aircraft for the use of the aircraft. The amounts paid to Wheels-Up Aircraft are reasonable and competitive. During fiscal 1995 the total amount paid by the Company to Wheels-Up Aircraft was $42,000.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\nThe financial statements referred to below are attached as pages to.\n(A) (2) FINANCIAL STATEMENT SCHEDULES:\nAll schedules to the Financial Statements for which provision is made in Article 5 of Regulation S-X are not required under related instructions, or the information is included in the Consolidated Financial Statements or notes thereto or are inapplicable and therefore have been omitted.\n(A) (3) EXHIBITS:\nThe exhibits listed on the accompanying Index to Exhibits are filed as part of this Form 10-K.\nEXHIBIT INDEX\n*This exhibit is a compensatory plan or management contract filed pursuant to Item 14(c) of Form 10-K.\n(B) REPORTS ON FORM 8-K:\nThe Company has not filed any report on Form 8-K for the quarter ended September 25, 1995.\n(C) EXHIBITS:\nExhibits required to be filed in response to this paragraph of Item 14 are listed above in subparagraph (a)(3).\n(D) FINANCIAL STATEMENT SCHEDULES:\nSchedules and report thereon by independent auditors required to be filed in response to this paragraph of Item 14 are listed above in subparagraph (a)(2). - -------------- 1 Previously filed with the Commission as an exhibit to the Company's Annual Report on Form 10-K for the year ended September 29, 1985 and is incorporated herein by reference.\n2 Previously filed with the Commission as an exhibit to the Company's Annual Report on Form 10-K for the year ended September 28, 1986 and is incorporated herein by reference.\n3 Previously filed with the Commission as an exhibit to the Company's Annual Report on Form 10-K for the year ended September 27, 1987 and is incorporated herein by reference.\n4 Previously filed with the Commission as an exhibit to the Company's Annual Report on Form 10-K for the year ended September 25, 1988 and is incorporated herein by reference.\n5 Previously filed with the Commission as an exhibit to the Company's Annual Report on Form 10-K for the year ended September 24, 1990 and is incorporated herein by reference.\n6 Previously filed with the Commission as an exhibit to the Company's Annual Report on Form 10-K for the year ended September 30, 1991 and is incorporated herein by reference.\n7 Previously filed with the Commission as an exhibit to the Company's Annual Report on Form 10-K for the year ended September 28, 1992 and is incorporated herein by reference.\n8 Previously filed with the Commission as an exhibit to the Company's Annual Report on Form 10-K for the year ended September 27, 1993 and is incorporated herein by reference.\n9 Previously filed with the Commission as an exhibit to the Company's Annual Report on Form 10-K for the year ended September 26, 1994 and is incorporated herein by reference.\nSIGNATURES\nPursuant to the requirements 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.\nSUMMIT FAMILY RESTAURANTS INC. (Registrant)\nDecember 20, 1995 By: \/s\/ Don M. McComas --------------------------------------- Don M. McComas President and Chief Executive Officer (principal executive officer)\nDecember 20, 1995 By: \/s\/ David E. Pertl --------------------------------------- David E. Pertl Senior Vice President, Chief Financial Officer, and Treasurer (principal financial officer)\nDecember 20, 1995 By: \/s\/ Theodore Abajian --------------------------------------- Theodore Abajian Vice President and Controller (principal accounting 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.\nREPORT OF INDEPENDENT AUDITORS\nThe Stockholders and Board of Directors of Summit Family Restaurants Inc., Salt Lake City, Utah\nWe have audited the accompanying consolidated balance sheets of Summit Family Restaurants Inc. and subsidiaries as of September 25, 1995 and September 26, 1994, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the years in the three-year period ended September 25, 1995. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Summit Family Restaurants Inc. and subsidiaries as of September 25, 1995 and September 26, 1994, and the results of their operations and their cash flows for each of the years in the three-year period ended September 25, 1995, in conformity with generally accepted accounting principles.\nAs discussed in notes 1 and 6 to the consolidated financial statements, the Company changed its method of accounting for investments to adopt the provisions of SFAS No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" during the first quarter of fiscal 1994.\n\/s\/ KPMG Peat Marwick LLP - -------------------------------------- KPMG Peat Marwick LLP\nSalt Lake City, Utah November 3, 1995, except as to Note 15 which is as of December 11, 1995.\nSee accompanying notes to consolidated financial statements.\nSee accompanying notes to consolidated financial statements.\nSUMMIT FAMILY RESTAURANTS INC. & SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY\nSee accompanying notes to consolidated financial statements.\nSUMMIT FAMILY RESTAURANTS INC. & SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS\nSUMMIT FAMILY RESTAURANTS INC. & SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (CONT.)\nSee accompanying notes to consolidated financial statements.\nSUMMIT FAMILY RESTAURANTS INC. & SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nCONSOLIDATION\nThe consolidated financial statements include the accounts of Summit Family Restaurants Inc. and its wholly owned subsidiaries (the \"Company\"). All intercompany accounts and transactions have been eliminated in consolidation.\nFISCAL YEAR\nThe Company utilizes a 52\/53 week fiscal year which ends on the last Monday in September. Fiscal years 1995, 1994 and 1993 contain 52 weeks.\nINVENTORIES\nInventories consist of food, beverages and restaurant supplies and are valued at the lower of cost, determined by the first-in first-out method, or market.\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\" during the first quarter of fiscal 1994. As discussed in Note 6, the Company's investment in HomeTown Buffet, Inc. common stock is treated as an available-for-sale security and is reported at fair market value in the accompanying consolidated balance sheets. Unrealized holding gains are shown as a separate component of stockholders equity, net of tax.\nShort term investments in the accompanying consolidated balance sheets (consisting primarily of certificates of deposits, with original maturities of greater than three months) represent held-to-maturity securities, and accordingly, have been stated at their cost.\nPROPERTY, BUILDINGS AND EQUIPMENT\nProperty, buildings and equipment and real property under capitalized leases are carried at cost, less accumulated depreciation and amortization. Depreciation and amortization are provided using the straight-line method over the following useful lives: buildings and leaseholds - lesser of lease life or 20 years; equipment - 5 to 8 years; capitalized leases - lesser of lease life or 20 years.\nINTANGIBLE ASSETS\nLease acquisition costs are amortized using the straight-line method over the remaining terms of the leases, which range from 3-1\/2 to 25 years. Other intangible assets are amortized using the straight-line method over the estimated period of value, which ranges from 1 to 40 years.\nAccumulated amortization totaled $1,913,000 and $1,901,000 in fiscal years 1995 and 1994, respectively.\nPRE-OPENING COSTS\nPre-opening costs, which represent expenses incurred for hiring and training personnel relating to new restaurants and expenses for promotion of new store openings, are capitalized and amortized over the restaurant's first year of operation.\nFRANCHISING REVENUES AND EXPENSES\nThe Company is a franchisor of JB's Restaurants and a franchisee of HomeTown Buffet restaurants. Gains or losses on Company operated JB's Restaurants sold to franchisees are recognized as a gain or loss in the period the transaction is completed provided the down payment received from the franchisee represents 20% or more of the total purchase price. Otherwise, the gain or loss is deferred and recognized over the period of the franchise agreement. Initial franchise fees received are recognized as revenue in the period the franchised restaurant opens. Franchise royalty revenues and all franchising costs are recognized on the accrual basis.\nInitial franchise fee payments related to HomeTown Buffet restaurants are amortized using the straight-line method over the life of the franchise agreement. Royalty costs and all other franchise costs are recognized as expense on the accrual basis.\nPROPERTY DISPOSITIONS\nAssets which have been identified for closure and held for sale are written down to management's best estimate of realizable value, including related costs of disposition.\nCASH EQUIVALENTS\nCash equivalents consist of short-term liquid assets with original maturities of 3 months or less.\nINCOME TAXES\nIncome taxes are recorded using the asset and liability method under which 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. The effect on deferred tax assets and liabilities of a change in tax rates is recognized as income or expense in the period that includes the enactment date. A reserve is recorded for net deferred tax assets that may not be realized in the future.\nNET INCOME (LOSS) PER COMMON SHARE\nNet income (loss) per common share is computed using the weighted average number of shares of common stock and dilutive common stock equivalents outstanding during each period.\nPRESENTATION\nCertain prior year amounts in the consolidated financial statements have been reclassified to conform with the current year presentation.\n2. PROPERTY, BUILDINGS AND EQUIPMENT AND REAL PROPERTY UNDER CAPITALIZED LEASES\nThe components of property, buildings and equipment and real property under capitalized leases are as follows:\n3. OTHER RECEIVABLES\nThe components of other receivables are as follows:\n4. NOTES RECEIVABLE\nNotes receivable consist of amounts due from corporations and individuals resulting primarily from the sale of property, buildings and equipment. The components of notes receivable are as follows:\nIn August 1994, the Company accepted $2.5 million as full repayment of the note receivable related to the sale of a combined restaurant and motel, resulting in a loss of $1,564,000. The note had a principal and accrued interest balance of $4.1 million and was due in October 1994. The Company had received no payments on the note since January 1994 and elected to accept the lesser payment to eliminate the risks of collection of the full amount and to generate cash for use in restaurant operations.\nThe Company has 14 notes relating to the sales of restaurants to franchisees which are unsecured or secured by receivables, inventory and equipment. Eleven of the notes bear interest at 10.0%. Two notes bear interest at prime plus 3.0% and another bears interest at prime plus 0.5%. Payments are made using a 15-year\namortization with 13 of the notes having a 5-year balloon payment and the other note having a 10-year balloon payment.\nDuring 1991, the Company entered into a lease with a franchisee on the land and building for a new JB's Restaurant. The Company's net investment in the direct financing lease is as follows:\nAt September 25, 1995, future minimum lease payments are as follows: $61,000 in 1996, $61,000 in 1997, $61,000 in 1998, $61,000 in 1999, $61,000 in 2000 and $608,000 thereafter.\n5. CHARGE FOR PROPERTY DISPOSITIONS\nIn 1994, the charge for property dispositions of $1,982,000 is primarily related to the disposition of certain JB's Restaurants. The charge of $4,264,000 for 1993 is primarily related to the disposition of certain JB's Restaurants, Sbarro restaurants, and the termination of its exclusive area development rights with Sbarro, Inc.\n6. INVESTMENT IN HOMETOWN BUFFET, INC.\nIn November 1991, the Company invested $3.8 million with Americana Entertainment Group, Inc., the predecessor of HomeTown Buffet, Inc. (\"HTBB\"), in exchange for 1,266,667 shares of convertible preferred stock. In July 1993, the Company sold 250,000 shares of its preferred stock investment in HTBB for $2.5 million, resulting in a pre-tax gain of $1.7 million. In the fourth quarter of fiscal 1993, HTBB concluded an initial public offering (\"IPO\") of its common stock and commenced trading on NASDAQ under the symbol HTBB. At the completion of the IPO the outstanding preferred stock automatically was converted to common stock. During the second quarter of fiscal 1994, the Company exercised its option to purchase 60,000 shares of HTBB common stock and HTBB announced a three for two stock split increasing the Company's ownership of HTBB common stock to 1,585,000 shares. In the third quarter of fiscal 1994, the Company sold 1,056,780 shares of HTBB common stock as a selling shareholder in HTBB's secondary public offering for $16.8 million resulting in a pre-tax gain of $14.7 million. The Company's remaining 528,220 shares of HTBB common stock at September 25, 1995, is pledged as security on certain notes payable (see notes 7 and 15).\nOn September 27, 1993, the Company reported its investment in HTBB at cost. During the first quarter of fiscal 1994, the Company elected early adoption of Statement of Financial Accounting Standards (\"SFAS\") No. 115 \"Accounting for Certain Investments in Debt and Equity Securities\". In accordance with SFAS No. 115, the Company's investment in the common stock of HTBB meets the definition of available-for-sale securities and, as such, is reported at fair value. On September 25, 1995 and November 3, 1995, the estimated fair value of the Company's 528,220 shares of HTBB common stock was $13.25 and $12.88 per share or $7.0 million and $6.8 million respectively. The unrealized gain of $3.6 million (net of tax) at the fiscal 1995 year-end is recorded as a separate component of stockholders' equity.\nIn addition, the Company has a franchise and exclusive area development agreement with HTBB, under which, as amended, the Company has the exclusive rights to develop and operate HomeTown Buffet restaurants, as a franchisee, in eight western states. Under the terms of the agreement, the Company is required to open a minimum of 17 HomeTown Buffet restaurants in these states prior to June 30, 1996, and open an additional 5 HomeTown Buffet restaurants prior to December 31, 1996.\n7. LONG-TERM DEBT\nAnnual aggregate maturities of long-term debt, including obligations under capitalized leases, are as follows: $2,928,000 in 1996; $799,000 in 1997; $848,000 in 1998; $863,000 in 1999; $918,000 in 2000; and $6,722,000 thereafter.\nOn April 1, 1994, the Company used $5.1 million of the proceeds from the sale of HTBB common stock to prepay outstanding 11.1% interest bearing debt payable to financial institutions. The $5.1 million payment included a prepayment premium of $442,000 and $85,000 of accrued interest. The $442,000 prepayment premium combined with the write-off of unamortized loan acquisition costs of $141,000 are recorded as an extraordinary loss on extinguishment of debt of $350,000, net of tax, in the accompanying 1994 consolidated statements of operations.\nIn connection with the issuance of certain secured notes payable to financial institutions, the Company issued 8,000 nondetachable warrants, with each warrant consisting of an option to purchase, as adjusted, 27.4 shares of the Company's common stock. The warrants are exercisable until July 30, 1996 at $203.25 per warrant ($7.42 per share of common stock). As of September 25, 1995, no warrants had been exercised.\n8. LONG-TERM LEASES\nThe Company occupies certain of its restaurants under long-term leases expiring at various dates through 2035. Most restaurant leases have renewal options for terms of five to twenty years, and substantially all require the payment of real estate taxes and insurance. Certain of the leases provide for rent to be the greater of a stipulated minimum rent or a specified percentage of sales.\nRent expense for fiscal years 1995, 1994 and 1993, was $6,942,000, $5,938,000, and $5,696,000, respectively. Contingent rentals measured as a percentage of sales, included in rent expense for fiscal years 1995, 1994 and 1993 were $292,000, $615,000, and $706,000, respectively.\nFuture aggregate minimum rental payments on noncancellable leases as of September 25, 1995, exclusive of taxes, insurance and percentage rentals based on sales are as follows:\nGains related to sale and leaseback transactions have been deferred for financial reporting purposes and are being amortized over the term of the leases. Deferred gains of $560,000 at September 25, 1995 and $620,000 at September 26, 1994 are reflected as a reduction of real property under capitalized leases in the accompanying consolidated financial statements.\n9. INCOME TAXES\nThe income tax expense (benefit) consists of the following:\nThe income tax expense (benefit) attributable to income (loss) before income taxes and extraordinary item differs from the amounts computed by applying the U.S. federal statutory tax rate as follows:\nThe tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities are summarized below:\nThe valuation allowance for deferred tax assets as of September 25, 1995, and September 26, 1994, was $1,925,000 and $390,000, respectively.\nAt September 25, 1995, the Company has general business credit carryforwards for federal income tax purposes of approximately $2,214,000 which are available to reduce future federal income taxes, if any, through 2006. In addition, the Company has alternative minimum tax credit carryforwards of approximately $508,000 which are available to reduce future federal regular income taxes, if any, over an indefinite period.\n10. PREFERRED STOCK\nIn October 1993, the Company issued 946,714 shares of Series A Convertible Preferred Stock to ABS MB (JB) Limited Partnership (\"ABS\"), the general partner of which is ABS MB Ltd., a merchant banking affiliate of Alex. Brown & Sons Incorporated for approximately $5.0 million. The preferred stock has a par value of $1.00, is nondividend bearing and is convertible to common stock on a one-for-one basis at the option of ABS subject to certain conditions. The 946,714 preferred shares represent an approximate 16% ownership position in the Company. As holder of the preferred stock, ABS is entitled to liquidation preferences, rights to approve certain significant corporate transactions and certain registration rights. Also, as holder of the preferred stock ABS has the right to elect two of the Company's nine Board members.\n11. EMPLOYEE BENEFIT PLANS\nEMPLOYEE STOCK OWNERSHIP PLAN\nThe Company has an employee stock ownership plan to which the Company contributes funds as authorized by the Board of Directors. The plan has the authority to purchase shares of the Company's common stock. All employees of the Company who have one year of service and are over age 21 participate in the plan.\nParticipant vesting begins with the third year of participation in the plan at the rate of 20 percent per year. Funds contributed to the plan are used to retire debt previously incurred, to pay participants who are entitled to benefits under the plan and to purchase shares of the Company's common stock. Allocated shares within the plan were 92,737 and 114,857 at September 25, 1995, and September 26, 1994, respectively. Contributions to the employee stock ownership plan totaled $0, $85,000 and $90,000 in fiscal years 1995, 1994, and 1993, respectively.\n401 (K) PLAN\nThe Company has a 401(k) plan covering all employees who have attained age 21 and completed one year of service. The plan allows participants to allocate up to 10% of their annual compensation before taxes for investment in several investment alternatives. From January 1, 1995, until September 25, 1995, and in calendar 1994 and 1993, the Company made annual matching contributions of the Company's stock to the employees' investment portfolio of up to 25% of the first 3% of annual compensation contributed by the employee. An employee must be employed on December 31 to receive a matching contribution. The Company provided contributions of $26,000 and $27,000 in fiscal years 1995 and 1994, respectively, and the Company made no contribution in fiscal 1993.\nDEFERRED COMPENSATION PLAN\nThe Company has a deferred compensation plan covering the Chairman and certain former executives, which requires payment upon retirement or disability. Under the plan, participants receive benefits based upon a multiple of compensation prior to retirement and years of service (not to exceed 50 percent of average annual compensation for the highest five-year period) reduced for benefits payable from the Company's profit sharing and employee stock ownership plans. The Company expects that participation in the plan will be limited to those individuals with previously approved deferred compensation agreements. Accruals for this plan were $133,000, $158,000 and $153,000 for fiscal years 1995, 1994, and 1993, respectively.\n12. STOCK OPTION AND AWARD PLANS\nSTOCK OPTION PLANS\nThe Company has stock option plans under which options to purchase the Company's common stock may be granted to employees and directors at the fair market value of the stock at the date of grant. Under the plans, options may be granted for a term of not more than ten years. Incentive stock options granted to employees through April 7, 1994, become exercisable over a four-year period. Incentive stock options granted after April 7, 1994 become exercisable over a five-year period. Nonqualified stock options issued to directors are not subject to vesting. As of September 25, 1995, shares under option total 782,400 shares of which 489,350 shares were exercisable at prices ranging from $4.00 to $7.88 per share.\nThe following table presents, for the periods indicated, activity with respect to the Company's stock option plans:\nEXECUTIVE LONG-TERM STOCK AWARD PLAN\nThe Company has an Executive Stock Award Plan (the \"Plan\") adopted in September 1992 by the Board of Directors and approved in February 1993 by the Company's shareholders. There are 100,000 shares authorized under the Plan to be awarded to key employees based on the achievement of certain performance objectives established by the Compensation Committee of the Board of Directors. There were no shares awarded for fiscal years 1995, 1994 or 1993 under this Plan.\n13. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)\nThe following summarizes financial information by quarter for the two years ended September 25, 1995 and September 26, 1994:\n(1) Includes a charge for property dispositions of $1,982,000, a loss on the disposition of a note receivable of $1,564,000, an extraordinary loss of $350,000 (net of tax benefit) resulting from the extinguishment of debt and a gain on the sale of HomeTown Buffet, Inc., common stock of $14,700,000. See Notes 4, 5, 6 and 7.\nEach quarter of the 52 week fiscal years 1995 and 1994 contain 12 weeks, except for the third quarter, which contains 16 weeks.\n14. COMMITMENTS AND CONTINGENCIES\nIn connection with the sale of restaurants, the Company has assigned its rights and obligations under real property leases to the buyer. As such, the Company remains contingently liable for these obligations. Future minimum payments under these leases amount to $1,294,000 in 1996; $1,245,000 in 1997; $1,202,000 in 1998; $1,164,000 in 1999; $1,069,000 in 2000; and $3,287,000 thereafter.\nIn addition, the Company is engaged in ordinary and routine litigation incidental to its business. Management does not anticipate that any amounts which it may be required to pay by reason thereof will have a material effect on the Company's consolidated statements of operations or financial position.\n15. SUBSEQUENT EVENTS\nAGREEMENT AND PLAN OF MERGER AND REORGANIZATION\nOn November 30, 1995, an Agreement and Plan of Merger and Reorganization (\"Merger Agreement\") was executed between the Company and CKE Restaurants, Inc., a Delaware corporation (\"CKE\"), pursuant to which a wholly-owned subsidiary of CKE will merge with the Company, and CKE's wholly-owned subsidiary will be the surviving entity. Consideration for the merger to be paid to the Company's shareholders for each share of common stock and for each share of preferred stock will consist of $3.00 in cash and .20513 shares of CKE common stock, provided that the average CKE common stock price is between $12.25 per share and $17.00 per share at the closing. If the average CKE common stock price is higher than $17.00 or lower than $12.25 at the closing, the exchange ratio may be adjusted accordingly. The transaction is currently expected to close during the first calendar quarter of 1996, or as soon as practicable thereafter. The transaction is conditioned upon the Company's shareholders approving the transaction and the usual and customary conditions to closing, including,\nwithout limitation, accuracy of the parties' representations and warranties, performance of the parties' covenants and obligations under the Merger Agreement and obtaining proper consents of third parties as necessary.\nCHANGE IN CONTROL AGREEMENTS\nPursuant to certain change of control agreements, the Company may be obligated to pay benefits to the President and seven Senior Vice Presidents in the event of a significant change in ownership of the Company.\nThe Merger Agreement described above triggered a provision in the change of control agreements that requires the Company to place in escrow accounts approximately $1.7 million. Payment of benefits is made upon involuntary termination of those individuals noted above between the signing of the Merger Agreement and one year after consummation of the merger or upon the voluntary termination of employment during the second 90 days following consummation of the merger. The Company has not yet funded the escrow accounts.\nLEASE COMMITMENT\nIn August 1994, the Company entered into a master lease agreement (the \"Agreement\") to finance equipment for new HomeTown Buffet restaurants. The agreement, among other things, required the Company to maintain minimum tangible net worth of at least $40 million.\nOperating results during fiscal 1995 reduced the Company's net worth to less than $40 million as of September 25, 1995. On December 7, 1995, the lessor notified the Company it was in default under the terms of the Agreement and demanded a default payment in the amount of $1,493,938 which represents all remaining rent and other payments due to the lessor. Upon receipt of the default payment, the lessor is obligated to transfer to the Company all rights of ownership to the leased assets.\nManagement is contesting the default and seeks a resolution with the lessor that would allow the Company to continue periodic rent payments as stipulated under the Agreement. While the final outcome of this matter cannot be determined at this time, management, in consultation with legal counsel, believes that such a resolution can be reached.\nINVESTMENT IN HOMETOWN BUFFET, INC. COMMON STOCK\nAs of September 25, 1995, the Company held 528,220 shares of HTBB common stock. Between September 25, 1995, and December 11, 1995, the Company sold 398,220 shares of HTBB common stock generating net proceeds of $4.8 million resulting in a pre-tax gain of $4.0 million. $2.1 million of these proceeds were used to repay the Company's bank loans in full, $700,000 remains in escrow as partial security against $2.0 million in letters of credit with the remaining $2.0 million retained by the Company. The letters of credit are secured by certain properties owned by the Company, by the remaining 130,000 shares of HTBB common stock and by the escrow account noted above.\nEXHIBIT INDEX\n*This exhibit is a compensatory plan or management contract filed pursuant to Item 14(c) of Form 10-K.","section_15":""}
{"filename":"726601_1995.txt","cik":"726601","year":"1995","section_1":"Item 1. Business 3 Item 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nCapital City Bank Group, Inc., is headquartered in Tallahassee, Florida. The Company's offices are in the Capital City Bank building located on the corner of Tennessee and Monroe Streets in downtown Tallahassee. The building is owned by Capital City Bank but is located, in part, on land leased under a long-term agreement.\nCapital City Bank's Parkway Office is located on land leased from the Smith Interests General Partnership in which several directors and officers have an interest. Lease payments during 1995 totaled approximately $53,000.\nAs of March 1, 1996 the Company had 30 banking locations. Of the 30 locations, the Company leases either the land or buildings (or both) at 4 locations and owns the land and buildings at the remaining 26.\nItem 3.","section_3":"Item 3. Legal Proceedings\nNot Applicable\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNot Applicable\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Securities and Related Stockholder Matters\nThere is currently no established trading market for the common stock of Capital City Bank Group, Inc., and therefore, no bid or sale quotations are generally available. Based on sales of stock of which the Company has knowledge, the stock has traded in a range of $26.00 to $33.00 per share for the two-year period ended December 31, 1995, with the most recent trades at $33.00 per share.\nItem 6.","section_6":"Item 6. Selected Financial And Other Data\nFor the Years Ended December 31,\n1995 1994 1993 1992 1991 (Dollars in Thousands, Except Per Share Data)\nInterest Income $ 54,477 $ 47,891 $ 46,395 $ 48,306 $54,801 Net Interest Income 33,989 33,166 31,555 29,775 28,195 Provision for Loan Losses 293 1,246 960 1,216 1,817 Income Before Accounting Change 9,522 8,825 8,728 8,376 7,272 Net Income 9,522 8,825 8,244 8,376 7,272\nPer Common Share: Income Before Accounting Change $ 3.34 $ 3.10 $ 2.99 $ 2.86 $ 2.46 Net Income 3.34 3.10 2.82 2.86 2.46 Cash Dividends Declared 1.00 .91 .83 .78 .73 Book Value 28.44 25.44 23.56 21.59 19.55\nBased on Net Income: Return on Average Assets Before Accounting Change 1.25% 1.18% 1.21% 1.27% 1.15% Return on Average Assets 1.25 1.18 1.14 1.27 1.15 Return on Average Equity Before Accounting Change 12.32 12.51 13.15 13.71 13.07 Return on Average Equity 12.32 12.51 12.43 13.71 13.07 Dividend Payout Ratio 29.94 29.34 29.44 27.25 29.65\nAverages for the Year: Loans, Net of Unearned Interest $432,313 $406,873 $381,807 $358,876 $368,555 Earning Assets 681,186 666,919 651,042 598,127 571,165 Assets 763,697 745,334 722,286 662,150 633,963 Deposits 657,384 647,254 630,324 573,162 546,291 Long-Term Debt 71 1,144 1,381 3,156 5,555 Shareholders' Equity 77,259 70,563 66,328 61,078 55,635\nYear-End Balances: Loans, Net of Unearned Interest $443,973 $420,804 $399,424 $369,911 $364,773 Earning Assets 716,170 645,832 675,273 619,929 568,720 Assets 813,659 742,630 762,335 686,966 639,540 Deposits 699,579 648,174 662,745 597,497 555,092 Long-Term Debt 1,982 - 1,900 2,000 4,000 Shareholders' Equity 81,158 72,400 67,140 63,169 57,723 Equity to Assets Ratio 9.97% 9.75% 8.81% 9.20% 9.03%\nOther Data: Average Shares Outstanding 2,853,234 2,847,492 2,924,022 2,932,123 2,958,920 Shareholders of Record* 933 761 754 748 731 Banking Locations* 30 29 30 27 27 Full-Time Equivalent Employees* 503 489 476 466 469\n*As of March 1st of the following year.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Codition and Results of Operations\nFINANCIAL REVIEW\nThis section provides supplemental information which should be read in conjunction with the consolidated financial statements and related notes. The Financial Review is divided into three subsections entitled Earnings Analysis, Financial Condition, and Liquidity and Capital Resources. Information therein should facilitate a better understanding of the major factors and trends which affect the Company's earnings performance and financial condition, and how the Company's performance during 1995 compares with prior years. Throughout this section, Capital City Bank Group, Inc., and its subsidiaries, collectively, are referred to as \"CCBG\" or the \"Company\". The subsidiaries, collectively, are referred to as Group Banks.\nOn January 1, 1995, the Company completed a corporate reorganization whereby seven of the Company's ten banking subsidiaries were merged to form one bank. The new bank, Capital City Bank, is headquartered in Tallahassee and has twenty-one offices covering four counties. See Note 17 in the Notes to Consolidated Financial Statements for further information.\nThe year-to-date averages used in this report are based on daily balances for each respective year. In certain circumstances comparing average balances for the fourth quarter of consecutive years may be more meaningful than simply analyzing year-to-date averages. Therefore, where appropriate, fourth quarter averages have been presented for analysis and have been clearly noted as such.\nOn December 10, 1995, the Company executed an Agreement and Plan of Merger to acquire First Financial Bancorp, Inc., (\"FFB\") for $22.00 per share in cash, or a total purchase price of approximately $20.3 million. First Financial is a $230 million federal savings bank headquartered in Tallahassee, Florida, with six offices located in five Florida counties. It is anticipated the transaction will close during the second half of 1996, expanding the number of counties served by the Company from seven to eleven and increasing the number of offices from thirty to thirty-five.\nEARNINGS ANALYSIS\nIn 1995, the Company's earnings were $9.5 million, or $3.34 per share. This compares to earnings of $8.8 million, or $3.10 per share in 1994, and $8.2 million, or $2.82 per share in 1993. The earnings in 1993 were impacted by the adoption of Statement of Financial Accounting Standards No. 109 (\"Accounting for Income Taxes\"), which resulted in a one-time, non-cash charge of $484,000, or $.17 per share.\nOn a per share basis, earnings increased 7.7% in 1995 versus 9.9% in 1994. Growth in operating revenues and a reduction in the provision for loan losses were significant factors which contributed to stronger earnings in 1995. These and other factors are discussed throughout the Financial Review. A condensed earnings summary is presented in Table 1.\nTable 1\nCONDENSED SUMMARY OF EARNINGS (Dollars in Thousands, Except Per Share Data) For the Years Ended December 31, 1995 1994 1993\nInterest Income $54,477 $47,891 $46,395 Taxable Equivalent Adjustments 1,591 1,657 1,663 Total Interest Income 56,068 49,548 48,058 Interest Expense 20,488 14,725 14,840 Net Interest Income 35,580 34,823 33,218 Provision for Loan Losses 293 1,246 960 Taxable Equivalent Adjustments 1,591 1,657 1,663 Net Interest Income After Provision for Loan Losses 33,696 31,920 30,595 Noninterest Income 13,170 13,009 12,478 Noninterest Expense 33,466 32,711 31,036 Income Before Income Taxes 13,400 12,218 12,037 Income Taxes 3,878 3,393 3,309 Income Before Accounting Change 9,522 8,825 8,728 Cumulative Effect of Accounting Change - - (484) Net Income $ 9,522 $ 8,825 $ 8,244 Income Per Share Before Accounting Change $ 3.34 $ 3.10 $ 2.99 Net Income Per Share $ 3.34 $ 3.10 $ 2.82\nNet Interest Income\nNet interest income represents the Company's single largest source of earnings and is equal to interest income and fees generated by earning assets less interest expense paid on interest bearing liabilities. An analysis of the Company's net interest income, including average yields and rates, is presented in Tables 2 and 3. This information is presented on a \"taxable equivalent\" basis to reflect the tax-exempt status of income earned on certain loans and investments, the majority of which are state and local government debt obligations.\nIn 1995, taxable-equivalent net interest income increased $757,000, or 2.2%. This follows an increase of $1.6 million, or 4.8% in 1994, and $1.9 million, or 5.9% in 1993. During 1995, higher levels of earning assets and growth in the loan portfolio were the primary factors contributing to the Company's overall increase in taxable equivalent net interest income.\nInterest rates, after declining for several years began increasing in early 1994 and peaked during the first quarter of 1995. During this fifteen month period, the prime rate rose from 6% to 9% and the federal funds rate increased from approximately 3% to 6%. Subsequent to the first quarter of 1995, however, rates declined. The prime rate fell from 9.0% to 8.5% at December 31, 1995, and the federal funds rate declined from 6.0% to 5.5%. Although rates fell during the latter half of the year, the current interest rate environment is still well above that of early 1994.\nThe Company's taxable equivalent yield on average earning assets of 8.23% represents an 80 basis point increase over 1994, compared to only a five basis point improvement in 1994 over 1993. The higher yield in 1995 is reflective of both higher interest rates and loan volume, which increased steadily throughout the year. The loan portfolio, which is the largest and highest yielding component of earning assets, increased from 58.9% in the first quarter of 1994 to 63.4% in the fourth quarter of 1995. The lower yields on earning assets in 1994 and 1993 are reflective of the interest rate environment during those years and a less favorable mix of earning assets.\nThe average rate paid on interest bearing liabilities in 1995 was 3.96% versus 2.88% in 1994 and 2.97% in 1993. The increase is attributable to higher interest rates and a less favorable deposit mix. As interest rates increased in 1994 and early 1995, depositors sought higher yields by investing in certificates of deposits versus non-maturity deposits such as money market and savings accounts. The increase also reflects the results of promotions during the year in which the Company raised in excess of $30 million in certificates of deposit. As certificates of deposit generally represent a higher cost deposit product, this shift in depositor preference increased the Company's cost of funds. Certificates of deposit as a percent of total deposits increased from 32.1% in the first quarter of 1994 to 38.9% in the fourth quarter of 1995. In prior years, the lower average rates are reflective of lower interest rates and a more favorable deposit mix.\nThe Company's interest rate spread (defined as the taxable equivalent yield on average earning assets less the average rate paid on interest bearing liabilities) decreased 28 basis points in 1995 and increased 14 basis points in 1994. The reduction in spread in 1995 is attributable to the higher cost of funds.\nThe Company's net interest margin (defined as taxable equivalent interest income less interest expense divided by average earning assets) was 5.22% in 1995, compared to 5.22% in 1994, and 5.10% in 1993. Although the Company experienced an increase in its cost of funds during 1995, the increase in interest income was sufficient to enable the Company to maintain its margin of 5.22%. The increase in 1994 over 1993 is attributable to an improved spread and a reduction in the volume of earning assets funded through interest bearing liabilities.\nA further discussion of the Company's earning assets and funding sources can be found in the section entitled \"Financial Condition\".\nProvision for Loan Losses\nThe provision for loan losses was $293,000 in 1995 versus $1.2 million in 1994 and $960,000 in 1993. The reduction in the provision over prior years reflects improved credit quality and a relatively low level of charge-offs. At December 31, 1995, the allowance for loan losses totaled $6.5 million compared to $7.6 million in 1994 and $7.6 million in 1993. Management considers the allowance to be adequate based on the current level of nonperforming loans and the potential for loss inherent in the portfolio at year-end. See the section entitled \"Financial Condition\" for further information regarding the allowance for loan losses. Selected loss coverage ratios are presented below:\n1995 1994 1993 Provision for Loan Losses as a Multiple of Net Charge-offs .2x 1.0x 1.0x Pre-tax Income Plus Provision for Loan Losses as Multiple of Net Charge-offs 10.0x 10.4x 13.7x\nNoninterest Income\nNoninterest income increased $161,000, or 1.2%, in 1995 compared with $531,000, or 4.3%, in 1994. Factors affecting noninterest income are discussed below.\nService charges on deposit accounts increased $241,000, or 4.5%, in 1995, compared to a decrease of $193,000, or 3.4%, in 1994. Service charge revenues in any one year are dependent on the number of accounts, primarily transaction accounts, and the level of activity subject to service charges.\nData processing revenues increased $174,000, or 7.1%, in 1995 versus an increase of $54,000, or 2.3%, in 1994. The data processing center provides computer services to both financial and non-financial clients in North Florida and South Georgia. In recent years, a significant portion of the growth in revenues has been provided by processing for clients other than financial institutions. Processing revenues for non-financial entities represented approximately 52% of the total processing revenues in 1995.\nIn 1995, trust fees increased $262,000, or 38.5%. In January 1995, the Company changed its method of income recognition for Capital City Trust Company (\"CCTC\") from cash to accrual. This change in method resulted in a one-time adjustment which increased CCTC revenues by $166,000 during the first quarter of 1995. The remaining increase in fees of approximately $96,000 is attributable to the growth in assets under management which grew $12.6 million, or 12.2%. Assets under management totaled $116.0 million at December 31, 1995. Trust fees increased $37,000, or 5.8%, in 1994, attributable to growth in assets under management.\nNet gains from the sale of securities recognized during 1995 were not material. The net loss recognized in 1994 consisted of gross gains of $13,000 and losses of $160,000. Of the $160,000 in losses, $152,000 reflects management's decision to sell approximately $7,000,000 in securities (including U.S. Governments and municipals) and reinvest the proceeds in higher yielding securities. All other gains and losses recognized in 1995 and 1994 were related to the redemption of principal from mortgage-backed securities and bonds which were called during the year.\nOther noninterest income decreased $671,000, or 14.5%, in 1995 versus an increase of $808,000, or 21.1% in 1994. The decrease in 1995 is attributable to real estate gains recognized in 1994 and a reduction in mortgage origination fees. During 1994, the Company recognized gains on the sale of real estate (including other real estate and bank premises) totaling $827,000, compared to $94,000 in 1995. Mortgage origination volume declined $9.4 million, or 27.0% in 1995, resulting in a reduction in mortgage fees of $220,000, or 30.8%. These reductions in income were partially offset by a $295,000 increase in credit card income which was primarily attributable to higher volume. The primary factors impacting the increase in noninterest income in 1994 as compared to 1993 were gains on the sale of real estate of $827,000, an increase in credit card fees of $290,000 and a reduction in mortgage origination fees of $374,000. Gains on the sale of real estate were comprised of $430,000 recognized on the sale of other real estate and $397,000 on the sale of bank premises. While several factors impacted credit card fees, the majority of the increase in 1994 is attributable to volume. Mortgage loan origination volume fell from $55.5 million in 1993 to $34.8 million in 1994, contributing to the 38% decline in origination fees.\nNoninterest income as a percent of average earning assets represented 1.93% in 1995 compared to 1.95% in 1994 and 1.92% in 1993.\nNoninterest Expense\nTotal noninterest expense for 1995 was $33.5 million, an increase of $755,000, or 2.3%, over 1994, compared with an increase of $1.7 million, or 5.4% in 1994 over 1993. Factors impacting the Company's noninterest expense during 1995 and 1994 are discussed below.\nThe Company's compensation expense totaled $18.0 million, an increase of $872,000, or 5.1%, over 1994. Salaries increased $530,000, or 3.8%, due to normal annual raises. Employee insurance and expenses associated with the Company's stock incentive plan accounted for the remaining increase of $342,000. Stock compensation expense in 1995 was $424,000 compared to $258,000 in the prior year. In 1994, compensation expense totaled $17.1 million, an increase of $904,000, or 5.6%, over 1993. Salaries and wages increased $732,000, or 4.5%, due to annual raises and an increase in the number of offices opened for a full year in 1994. Additionally, the Company's pension expense increased $214,000, or 31.7%. In 1994 management revised the interest rate assumptions incorporated in the pension plan to reflect the lower interest rate environment. Lower rates reduced projected earnings on the plan assets and increased current funding requirements, both of which resulted in higher pension expense.\nOccupancy expense (including furniture, fixtures & equipment) was up by $631,000, or 12.0% in 1995. The increase is attributable to higher depreciation expense which increased $447,000 and maintenance and repairs which increased $195,000. In 1994, occupancy expense was up $161,000, or 3.2%. During 1994, the Company completed building renovations, opened a new operations center and acquired an additional banking location. Depreciation, property taxes, and maintenance and repairs associated with the new and existing facilities were the primary expense categories contributing to the overall increase.\nOther noninterest expense decreased $748,000, or 7.2%, in 1995, compared to an increase of $610,000, or 6.3%, in 1994. The decrease in 1995 is primarily attributable to a reduction in FDIC insurance premiums and corporate reorganization expenses. Effective June 1, 1995, the Federal Deposit Insurance Corporation reduced deposit insurance premiums from $.23 per $100 in deposits to $.04 per $100. This resulted in a reduction of premiums for 1995 of $700,000. For 1996, insurance premiums have been completely eliminated which will result in additional savings to the Company of approximately $240,000 based on the current level of deposits. Corporate reorganization expenses incurred in 1994 totaled $731,000 and thus the elimination of these expenses in 1995 contributed to the overall expense reduction in this category. The increase in 1994 of $610,000 is primarily attributable to expenses associated with the corporate reorganization.\nNet noninterest expense (defined as noninterest income minus noninterest expense) as a percent of average earning assets was 2.98% in 1995 compared to 2.95% in 1994 and 2.85% in 1993.\nIncome Taxes\nThe consolidated provision for federal and state income taxes was $3.9 million in 1995 compared to $3.4 million in 1994 and $3.3 million in 1993. The increases in the tax provision over the last three years is primarily attributable to the higher level of taxable income.\nThe effective tax rate was 28.9% in 1995, 27.8 in 1994 and 27.5% in 1993. These rates differ from the statutory tax rates due primarily to tax-exempt income. The increase in the effective tax rate is primarily attributable to the decreasing level of tax-exempt income relative to pre-tax income. Tax-exempt income (net of the adjustment for disallowed interest) as a percent of pre-tax income was 23.0% in 1995, 25.1% in 1994 and 26.8% in 1993.\nChange in Accounting Principle\nOn January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\", which changed the method of accounting to the \"liability\" method from the \"deferred\" method previously required by Accounting Principles Board Opinion No. 11. The cumulative effect of adopting the new accounting standard was a reduction in the Company's net income of $484,000, which was recognized in the first quarter of 1993. See Note 1 in the Notes to Consolidated Financial Statements.\nFINANCIAL CONDITION\nAverage assets increased $18.4 million, or 2.5%, from $745.3 million in 1994 to $763.7 million in 1995. Average earning assets increased to $681.2 million in 1995, a $14.3 million, or 2.1% increase over 1994. After experiencing a reduction in loans in 1992, loan volume has improved. Average loans have grown from $358.9 million in 1992 to $432.3 million in 1995, including growth of $25.4 million, or 6.3% during 1995. Growth in the loan portfolio in 1995 was primarily funded through deposit growth of $10.1 million and a reduction in the Company's investment portfolio and federal funds sold position of $7.8 million and $3.4 million, respectively.\nTable 2 provides information on average balances while Table 4 highlights the changing mix of the Company's earning assets over the last three years.\nLoans\nLocal markets served by Group banks were generally improved during 1995. Loan demand was fairly steady and slightly stronger during the second half. Price and product competition strengthened during 1995 and there was increasing demand for fixed rate financing. Real estate lending, an area of primary focus, continued to improve. Other areas reflecting stronger demand include home equity and indirect automobile lending. While the markets were generally good, perhaps the most significant contributor to loan growth was the Company's recent restructuring and an increased emphasis on product marketing.\nLending is a major component of the Company's business and is key to profitability. While management strives to grow the Company's loan portfolio, it can do so only by adhering to sound banking principles applied in a prudent and consistent manner. Management is hopeful the improvements noted in 1994 and 1995 will continue during 1996, affording opportunities to increase loans outstanding and enhance the portfolio's overall contribution to earnings.\nTable 4\nSOURCES OF EARNING ASSET GROWTH (Average Balances - Dollars in Thousands)\n1994 to Percentage Components 1995 of Total of Total Earning Assets Change Change 1995 1994 1993 Loans: Commercial, Financial and Agricultural $ 4,266 29.9% 7.1% 6.6% 6.5% Real Estate - Construction 4,986 35.0 3.7 3.1 3.2 Real Estate - Mortgage 3,100 21.7 37.7 38.0 35.5 Consumer 13,088 91.7 15.0 13.3 13.5 Total Loans 25,440 178.3 63.5 61.0 58.7\nSecurities: Taxable (6,853) (48.0) 20.5 22.0 21.5 Tax-Exempt (910) (6.4) 10.4 10.8 10.0 Total Securities (7,763) (54.4) 30.9 32.8 31.5\nFunds Sold (3,410) (23.9) 5.6 6.2 9.8\nTotal Earning Assets $14,267 100.0% 100.0% 100.0% 100.0%\nThe composition of the Company's loan portfolio at December 31 for each of the past five years is shown in Table 5. Consistent with bank regulatory reporting requirements, Bankers' Acceptances purchased (as opposed to originated) and Term Federal Funds (funds placed with another financial institution generally having a maturity of less than 90 days) are classified as loans and included in the commercial loan category. Management views these instruments not as loans but as investment alternatives in managing short-term liquidity. While there were no Bankers' Acceptances or Term Federal Funds outstanding at December 31, 1995, they totaled $1.0 million at year-end 1994 and $6.5 million at year- end 1993.\nThe Company's average loan-to-deposit ratio increased from 62.9% in 1994 to 65.8% in 1995 and reached a level of 66.0% in the fourth quarter. The average loan-to-deposit ratio for 1993 was 60.6%.\nReal estate construction and mortgage loans, combined, represented 64.8% of total loans (net of unearned interest) in 1995 versus 66.6% in 1994. See the section entitled \"Risk Element Assets\" for a discussion concerning loan concentrations.\nTable 6 arrays the Company's total loan portfolio as of December 31, 1995, based upon maturities. Loans are arrayed as to those which mature in one year or less, over one through five years and over five years. Demand loans and overdrafts are reported in the category of one year or less. As a percent of the total portfolio, loans with a fixed interest rate have declined from 40.2% in 1994 to 30.2% in 1995.\nAllowance for Loan Losses\nManagement attempts to maintain the allowance for loan losses at a level sufficient to provide for potential losses inherent in the loan portfolio. The allowance for loan losses is established through a provision charged to expense. Loans are charged against the allowance when management believes collection of the principal is unlikely.\nManagement evaluates the adequacy of the allowance for loan losses on a quarterly basis. The evaluations are based on the collectibility of loans and take into consideration such factors as growth and composition of the loan portfolio, evaluation of potential losses, past loss experience and general economic conditions. As part of these evaluations, management reviews all loans which have been classified internally or through regulatory examination and, if appropriate, allocates a specific reserve to each of these individual loans. Further, management establishes a general reserve to provide for losses inherent in the loan portfolio which are not specifically identified. The general reserve is based upon management's evaluation of the current and forecasted operating and economic environment coupled with historical experience. The allowance for loan losses is compared against the sum of the specific reserves plus the general reserve and adjustments are made, as appropriate. Table 7 analyzes the activity in the allowance over the last five years.\nEffective January 1, 1995, the Company adopted Statement of Financial Accounting Standards No. 114, Accounting by Creditors for Impairment of a Loan, as amended, which prescribes how the allowance for loan losses related to impaired loans should be determined. Certain loan categories including residential, consumer and credit card loans are excluded from the scope of this statement.\nImpaired loans for Capital City Bank Group are primarily defined as all nonaccruing loans for the categories which are included within the scope of Statement No. 114. Adoption of Statement No. 114 had no significant impact on the financial condition or results of operations of the Company. See Note 5 in the Notes to Consolidated Financial Statements for further information.\nTable 5\nLOANS BY CATEGORY (Dollars in Thousands) As of December 31, 1995 1994 1993 1992 1991 Commercial, Financial and Agricultural $ 46,149 $ 39,288 $ 46,963 $ 57,188 $ 57,692 Real Estate - Construction 28,391 24,314 22,968 19,103 18,714 Real Estate - Mortgage 259,503 255,755 242,741 212,080 208,091 Consumer 113,736 106,656 93,895 89,848 89,529 Total Loans $447,779 $426,013 $406,567 $378,219 $374,026\nTable 6\nLOAN MATURITIES (Dollars in Thousands) Maturity Periods\nOver One Over One Year Through Five Or Less Five Years Years Total Commercial, Financial and Agricultural $ 33,632 $ 11,658 $ 859 $46,149 Real Estate 222,831 42,753 22,310 287,894 Consumer 32,509 80,878 349 113,736 Total $288,972 $135,289 $23,518 $447,779\nLoans with Fixed Rates $ 88,899 $ 37,266 $ 8,915 $135,080 Loans with Floating or Adjustable Rates 200,073 98,023 14,603 312,699\nTotal $288,972 $135,289 $23,518 $447,779\nThe allowance for loan losses at December 31, 1995 of $6.5 million compares to $7.6 million at year-end 1994 and 1993. The allowance as a percent of total loans declined from 1.79% in 1994 to 1.46% in 1995. The lower percentage is attributable to a reduction in the Company's nonperforming loans and continued low levels of net charge-offs. See the section entitled \"Risk Element Assets\" for a further discussion.\nThere can be no assurance that in particular periods the Company will not sustain loan losses which are substantial in relation to the size of the allowance. When establishing the allowance, management makes various estimates regarding the value of collateral and future economic events. Actual experience may differ from these estimates. It is management's opinion that the allowance at December 31, 1995, is adequate to absorb losses from loans in the portfolio as of year-end.\nTable 8 provides an allocation of the allowance for loan losses to specific loan categories for each of the last five years. The allocation of the allowance is developed using management's best estimates based upon available information such as regulatory examinations, internal loan reviews and historical data and trends. The allocation by loan category reflects a base level allocation derived primarily by analyzing the level of problem loans, specific reserves and historical charge-off data. Current and forecasted economic conditions, and other judgmental factors which cannot be easily quantified (e.g. concentrations) are not presumed to be included in the base level allocations, but instead are covered by the unallocated portion of the reserve. The Company faces a geographic concentration as well as a concentration in real estate lending. Both risks are cyclical in nature and must be considered in establishing the overall allowance for loan losses. Reserves in excess of the base level reserves are maintained in order to properly reserve for the losses inherent in the Company's portfolio due to these concentrations and anticipated periods of economic difficulties.\nTable 7\nANALYSIS OF ALLOWANCE FOR LOAN LOSSES (Dollars in Thousands) For the Years Ended December 31, 1995 1994 1993 1992 1991\nBalance at Beginning of Year $7,551 $7,594 $7,585 $7,670 $7,526 Charge-Offs: Commercial, Financial and Agricultural 520 575 556 511 724 Real Estate-Construction - - - 33 - Real Estate-Mortgage 139 315 81 460 175 Consumer 1,237 865 884 929 1,263 Total Charge-Offs 1,896 1,755 1,521 1,933 2,162\nRecoveries: Commercial, Financial and Agricultural 157 104 198 231 177 Real Estate - Construction - - - - Real Estate - Mortgage - 12 8 7 18 Consumer 369 350 364 394 294 Total Recoveries 526 466 570 632 489\nNet Charge-Offs 1,370 1,289 951 1,301 1,673\nProvision for Loan Losses 293 1,246 960 1,216 1,817\nBalance at End of Year $6,474 $7,551 $7,594 $7,585 $7,670\nRatio of Net Charge-Offs During Year to Average Loans Out- standing, Net of Unearned Interest .32% .32% .25% .36% .45%\nAllowance for Loan Losses as a Percente of Loans, Net of Un- earned Interest, at End of Year 1.46% 1.79% 1.90% 2.05% 2.10%\nAllowance for Loan Losses as a Multiple of Net Charge-Offs 4.73x 5.86x 7.99x 5.83x 4.58x\nRisk Element Assets\nRisk element assets consist of nonaccrual loans, renegotiated loans, other real estate, loans past due 90 days or more, potential problem loans and loan concentrations. Table 9 depicts certain categories of the Company's risk element assets as of December 31, for each of the last five years. Potential problem loans and loan concentrations are discussed within the narrative portion of this section.\nThe Company's nonperforming loans decreased $1.3 million, or 21.6%, from a level of $6.0 million at December 31, 1994 to $4.7 million at December 31, 1995. During 1995, loans totaling approximately $2.4 million were placed on nonaccrual, while loans totaling $3.7 million were removed from nonaccruing status. Of the $2.4 million added, three credit relationships comprised $1.1 million of the total. All three relationships are secured with real estate and management has allocated specific reserves to these credits to absorb anticipated losses. Of the $3.7 million removed from the nonaccrual category, $2.3 million consists of principal reductions, $647,000 consists of loans transferred to ORE and loans totaling $451,000 were charged off. The remaining decrease of $349,000 represents loans which were either brought current and returned to an accrual status or refinanced.\nTable 9\nRISK ELEMENT ASSETS (Dollars in Thousands) As of December 31, 1995 1994 1993 1992 1991\nNonaccruing Loans $2,996 $4,278 $ 9,353 $ 6,987 $ 8,423 Restructured 1,686 1,694 65 169 176 Total Nonperforming Loans 4,682 5,972 9,418 7,156 8,599 Other Real Estate 1,001 1,581 3,466 4,416 4,385 Total Nonperforming Assets $5,683 $7,553 $12,884 $11,572 $12,984\nPast Due 90 Days or More $ 273 $ 258 $ 104 $ 2,564 $ 622\nNonperforming Loans to Loans, Net of Unearned Interest 1.05% 1.42% 2.36% 1.93% 2.36% Nonperforming Assets to Loans, Net of Unearned Interest, Plus Other Real Estate 1.28% 1.79% 3.20% 3.09% 3.52% Nonperforming Assets to Capital(1) 6.49% 9.45% 17.24% 16.36% 19.86% Reserve to Nonperforming Loans 138.27% 126.44% 80.64% 105.99% 89.20%\n(1) For computation of this percentage, \"capital\" refers to shareholders' equity plus the allowance for loan losses.\nThe majority of nonaccrual loans are collateralized with real estate. Management continually reviews these loans and believes specific reserve allocations are sufficient to cover the loss exposure associated with these loans.\nInterest on nonaccrual loans is recognized only when received. Cash collected on nonaccrual loans is applied against the principal balance or recognized as interest income based upon management's expectations as to the ultimate collectibility of principal and interest in full. If nonaccruing loans had been on a fully accruing basis, interest income recorded would have been $285,000 higher for the year ended December 31, 1995.\nRestructured loans are loans with reduced interest rates or deferred payment terms due to deterioration in the financial position of the borrower. The difference in interest income which would have been recorded under the original terms of the restructured loans and the interest income recognized for the year ended December 31, 1995 was $35,000. Restructured loans at December 31, 1995 consisted primarily of one large relationship which was classified as restructured in accordance with Statement of Financial Accounting Standards No. 15, prior to the adoption of Statement No. 114 in January 1995. Loans restructured subsequent to January 1, 1995, are deemed impaired, as that term is defined in Statement No. 114, and will be accounted for accordingly.\nOther real estate totaled $1.0 million at December 31, 1995, versus $1.6 million at December 31, 1994. This category includes property owned by Group Banks which was acquired either through foreclosure procedures or by receiving a deed in lieu of foreclosure. During 1995, the Company added properties totaling $647,000 and liquidated, partially or completely, properties totaling $1.2 million, resulting in a net reduction in other real estate of $580,000. Management does not anticipate any significant losses associated with other real estate.\nPotential problem loans are defined as those loans which are now current but where management has doubt as to the borrower's ability to comply with present loan repayment terms. Potential problem loans totaled $1.3 million at December 31, 1995.\nLoan concentrations are considered to exist when there are amounts loaned to a multiple number of borrowers engaged in similar activities which cause them to be similarly impacted by economic or other conditions and such amounts exceed 10% of total loans. Due to the lack of diversified industry within the markets served by the Group banks, and the relatively close proximity of the markets, the Company has both geographic concentrations as well as concentrations in the types of loans funded. Capital City Bank, which operates predominately in a three county market area in North Florida, comprised 83% of the Company's total loans at year-end. Further, due to the nature of the Company's markets, a significant portion of the portfolio is associated either directly or indirectly with real estate. At December 31, 1995, approximately 64% of the portfolio consisted of real estate loans. Residential properties comprise approximately 55% of the real estate portfolio.\nManagement is continually analyzing its loan portfolio in an effort to identify and resolve its problem assets as quickly and efficiently as possible. As of December 31, 1995, management believes it has identified and adequately reserved for such problem assets. However, management recognizes that many factors can adversely impact various segments of its markets, creating financial difficulties for certain borrowers. As such, management will continue to focus its attention on promptly identifying and providing for potential losses as they arise.\nInvestment Securities\nThe Company's average investment portfolio decreased $7.8 million, or 3.6%, during 1995. This followed an increase of $13.3 million, or 6.5%, in 1994. As a percent of average earning assets, the investment portfolio represented 30.9% in 1995, compared to 32.8% in 1994. In recent years, other than 1995, the investment portfolio increased in size relative to total earning assets as a result of the slowdown in loan production. In 1991, the comparable percentage was 21.9%. This recent trend reversed itself somewhat in 1995, as the growth in loans exceeded the overall growth in earning assets.\nIn 1995, average taxable investments decreased $6.9 million, or 4.7%, while tax-exempt investments decreased $910,000, or 1.3%. Since the enactment of the Tax Reform Act of 1986, which significantly reduced the tax benefits associated with tax-exempt investments, management has monitored the level of tax-exempt investments and, until 1992, consistently reduced its holdings. Even with the growth in tax-exempt investments in 1993 and 1994, the tax-exempt portfolio as a percent of average earning assets has declined from 18.9% in 1986 to 10.4% in 1995. Management will continue to purchase \"bank qualified\" municipal issues when it considers the yield to be attractive and the Company can do so without adversely impacting its tax position.\nThe investment portfolio is a significant component of the Company's operations and, as such, it functions as a key element of liquidity and asset\/liability management. In 1994, the Company adopted SFAS No. 115 -- \"Accounting for Investments in Certain Debt and Equity Securities\". In accordance with the new accounting pronouncement, securities are to be classified as held-to-maturity, available-for-sale or trading. To be classified as Held-to-Maturity, management must have both the ability and the positive intent to hold securities to maturity. Securities in this category are recorded at amortized cost. It is not management's intent nor practice to participate in the trading of investment securities for the purpose of recognizing gains and therefore the Company does not maintain a\nTrading portfolio. However, management felt it was prudent to establish an Available-for-Sale portfolio in order to provide the flexibility necessary to properly manage the Company's interest rate risk and liquidity position. Upon adoption of SFAS No. 115 in 1994, management classified approximately 30% of the total investment portfolio as Available-for-Sale. Following a determination by the regulatory agencies during 1995 that the net unrealized gain (loss) would be excluded from the computation of regulatory capital, the Financial Accounting Standards Board offered companies a one- time opportunity to transfer securities from held-to-maturity category to the available-for-sale category without penalty. On December 27, 1995, management transferred all securities classified as held-to-maturity to available-for-sale. Securities transferred totaled $122.6 million with an net unrealized gain after tax of $503,000. This transfer of securities offers management full flexibility in managing its liquidity position and interest rate sensitivity without adversely impacting its regulatory capital levels. Securities in the Available-for-Sale portfolio are recorded at fair value and unrealized gains and losses associated with these securities are recorded, net of tax, as a separate component of shareholders' equity. At December 31, 1995 shareholders' equity included a net unrealized gain of $968,000. See the section entitled \"Accounting Pronouncements\" and Note 1 in the Notes to Consolidated Financial Statements for a further discussion of SFAS No. 115.\nHistorically, when purchasing securities, management has had both the ability and intent to hold the securities for the foreseeable future and sales, including the gains or losses recognized from such sales, were minimal. This was true in 1995 as well. However, in 1994, in order to invest in higher yielding securities, the Company sold approximately $7.0 million in securities, incurring a net pre-tax loss of $152,000. These securities were sold from the available-for-sale portfolio and there were no sales from the held-to-maturity portfolio in 1995 or 1994.\nIn 1995, proceeds from the sale of securities were nominal. However, proceeds from \"called\" bonds and principal redemption of mortgage-backed securities totaled $22.5 million and the related gains and losses totaled $11,000 and $3,000, respectively.\nThe average maturity of the total portfolio at December 31, 1995 and 1994, was 2.62 and 2.41 years, respectively. See Table 11 for a breakdown of maturities by portfolio.\nThe weighted average taxable-equivalent yield of the investment portfolio at December 31, 1995, was 6.20% versus 5.73% in 1994. The quality of the municipal portfolio at such date is depicted in the chart below. There were no investments in obligations, other than U.S. Governments, of any one state, municipality, political subdivision or any other issuer that exceeded 10% of the Company's shareholders' equity at December 31, 1995.\nThe net unrealized gain in the total portfolio at December 31, 1995, of $1.5 million compares with a loss of $6.8 million at December 31, 1994. See Note 3 in the Notes to Consolidated Financial Statements for a breakdown of unrealized gains and losses. Tables 10 and 11 present a detailed analysis of the Company's investment securities as to type, maturity and yield.\nMUNICIPAL PORTFOLIO QUALITY (Dollars in Thousands)\nAmortized Cost Moody's Rating (000's) Percentage\nAAA $46,684 61.4% AA-1 1,810 2.4 AA 3,955 5.2 A-1 5,525 7.3 A 8,680 11.4 BAA 1,000 1.3 Not Rated(1) 8,332 11.0 Total $75,986 100.0% (1) Of the securities not rated by Moody's, $4.9 million are rated \"A\" or higher by S&P.\nTable 10 DISTRIBUTION OF INVESTMENT SECURITIES\n(Dollars in Thousands)\nAmortized Unrealized Unrealized Market Available-For-Sale Cost Gains Losses Value\nU.S. Treasury $ 72,289 $ 470 $ 54 $72,705 U.S. Government Agencies and Corporations 70,883 264 96 71,051 States and Political Subdivisions 75,986 1,037 143 76,880 Mortgage Backed Securities 5,965 47 26 5,986 Other Securities 4,107 19 1 4,125 Total Investment Securities $229,230 $1,837 $320 $230,747\nTable 11\nMATURITY DISTRIBUTION OF INVESTMENT SECURITIES (Dollars in Thousands)\nAs of December 31, 1995 Weighted Amortized Cost Market Value Average Yield(1) U. S. GOVERNMENTS Due in 1 year or less $ 64,543 $ 64,604 5.45% Due over 1 year thru 5 years 78,629 79,152 5.76% Due over 5 years thru 10 years - - - Due over 10 years - - - TOTAL 143,172 143,756 5.92%\nSTATE & POLITICAL SUBDIVISIONS Due in 1 year or less 7,803 7,781 8.13% Due over 1 year thru 5 years 47,146 47,796 6.65% Due over 5 years thru 10 years 18,847 19,102 6.01% Due over 10 years 2,190 2,201 7.53% TOTAL 75,986 76,880 6.68%\nMORTGAGE BACKED SECURITIES Due in 1 year or less 444 451 6.98% Due over 1 year thru 5 years 4,083 4,100 6.51% Due over 5 years thru 10 years 582 594 7.68% Due over 10 years 856 841 6.30% TOTAL 5,965 5,986 6.62%\nOTHER SECURITIES Due in 1 Year or less 1,354 1,365 5.98% Due over 1 year thru 5 years 149 179 5.59% Due over 5 years thru 10 years 252 229 5.68% Due over 10 years* 2,352 2,352 6.81% TOTAL 4,107 4,125 6.40%\nTotal Investment Securities $229,230 $230,747 6.20%\n*Federal Home Loan Bank Stock and Federal Reserve Bank Stock do not have a stated maturities.\nAVERAGE MATURITY (In Years) AS OF DECEMBER 31, 1995 Available For Sale\nU. S. Governments 1.98 State and Political Subdivisions 3.81 Mortgaged Backed Securities 3.78 TOTAL 2.62\n(1) Weighted average yields are calculated on the basis of the amortized cost of the security. The weighted average yields on tax-exempt obligations are computed on a taxable-equivalent basis using a 34% tax rate.\nDeposits And Funds Purchased\nAverage total deposits increased from $647.3 million in 1994 to $657.4 million in 1995, representing an increase of $10.1 million, or 1.6%. In 1994, deposits increased $16.9 million, or 2.7%. The Company experienced a notable increase in competition for deposits during 1995, in terms of both rate and product.\nFrom 1991 to 1994, the Company experienced growth in noninterest bearing deposits and a shift in funding sources from certificates of deposits to other deposit categories. This pattern ran counter to the Company's historical trends in which a majority of the growth was generated from certificates of deposits. As rates rose during 1994 and early 1995, however, depositors returned to more historical patterns shifting funds from non-maturity deposits to certificates of deposit and investing new funds in certificates. Average certificates of deposit increased $35.8 million, or 16.7%, over 1994. The growth in certificates of deposit was partially offset by a reduction in money market accounts of $6.0 million, or 7.9%, and savings of $22.3 million, or 20.7%. This shift in deposits during 1995 put additional pressure on the Company's net interest margin.\nTable 2 provides an analysis of the Company's average deposits, by category, and average rates paid thereon for each of the last three years. Table 12 reflects the shift in the Company's deposit mix over the last three years and Table 13 provides a maturity distribution of time deposits in denominations of $100,000 and over.\nAverage funds purchased, which include federal funds purchased and securities sold under agreements to repurchase, increased $1.0 million, or 5.6%.\nFederal Funds Purchased and Securities Sold Under Repurchase Agreements (Dollars in Thousands)\n1995 1994 1993\nYear End Balance $17,367 $13,964 $23,264 Rate at Year End 4.79% 5.38% 2.78% Average Balance $19,308 $18,291 $17,765 Average Rate 5.45% 3.55% 3.08% Maximum Outstanding at Month-End $27,806 $35,516 $27,449\nAt December 31, 1995, the Company had $2.0 million in debt outstanding to the Federal Home Loan Bank of Atlanta. The debt, which has a fixed rate of interest of 6.04%, requires annual principal reductions of approximately $110,000 with the remaining balance due at maturity in 2005. The debt was used to match-fund selected lending activities and is secured by first mortgage residential loans which are included in the Company's loan portfolio. See Note 8 in the Notes to Consolidated Financial Statements.\nTable 12\nSOURCES OF DEPOSIT GROWTH (Average Balances - Dollars in Thousands)\n1994 to Percentage 1995 of Total Components of Total Deposits Change Change 1995 1994 1993\nNoninterest Bearing Deposits $ 4,586 45.3% 24.4% 24.1% 23.7% NOW Accounts (1,897) (18.7) 13.9 14.3 12.4 Money Market Accounts (5,985) (59.1) 10.7 11.8 12.7 Savings (22,333) (220.5) 13.0 16.7 18.1 Other Time 35,759 353.0 38.0 33.1 33.1 Total Deposits $10,130 100.0% 100.0% 100.0% 100.0%\nTable 13\nMATURITY DISTRIBUTION OF CERTIFICATES OF DEPOSIT $100,000 OR OVER (Dollars in Thousands)\nDecember 31, 1995 Time Certificates of Deposit Percent\nThree months or less $15,798 34.8% Over three through six months 13,732 30.3 Over six through twelve months 6,496 14.3 Over twelve months 9,340 20.6 Total $45,366 100.0%\nLiquidity and Capital Resources\nLiquidity for a banking institution is the availability of funds to meet increased loan demand and\/or excessive deposit withdrawals. Management monitors the Company's financial position to ensure it has ready access to sufficient liquid funds to meet normal transaction requirements, take advantage of investment opportunities and cover unforeseen liquidity demands. In addition to core deposit growth, sources of funds available to meet liquidity demands include cash received through ordinary business activities such as the collection of interest and fees, federal funds sold, loan and investment maturities, bank lines of credit for the Company and approved lines for the purchase of federal funds by the Group Banks.\nAs of December 31, 1995, the Company has available a $25.0 million credit facility. The facility offers the Company an unsecured, revolving line of credit for a period of three years which matures in November 1998. Upon expiration of the revolving line of credit, the outstanding balance may be converted to a term loan and repaid over a period of seven years. The term\nloan is to be secured by stock of a subsidiary bank equal to at least 125% of the principal balance of the term loan. The Company, at its option, may select from various loan rates including Prime, LIBOR or the Certificate of Deposit (\"CD\") rate, plus or minus increments thereof. The LIBOR or CD rates may be fixed for a period of up to six months. During 1995, the Company had no long-term debt outstanding under this credit facility. The new facility was established to increase the Company's borrowing capacity and to consolidate two existing credit facilities in the amount of $6.0 million each. It is anticipated the Company may borrow up to $20 million in connection with the proposed acquisition of First Financial Bancorp, Inc., which is expected to close during the second half of 1996. See Notes 2 and 8 in the Notes to Consolidated Financial Statements.\nThe Company's new credit facility imposes certain limitations on the level of the Company's equity capital, and federal and state regulatory agencies have established regulations which govern the payment of dividends to a bank holding company by its bank subsidiaries. Based on the Company's current financial condition, these limitations and\/or regulations do not impair the Company's ability to meet its cash obligations or limit the Company's ability to pay future dividends on its common stock. See Notes 8 and 12 in the Notes to Consolidated Financial Statements for additional information.\nAt December 31, 1995, the Company had $2.0 million in debt outstanding to the Federal Home Loan Bank of Atlanta. The debt, which has a fixed rate of interest of 6.04%, requires annual principal reductions of approximately $110,000 with the remaining balance due at maturity in 2005. The debt was used to match-fund selected lending activities and is secured by first mortgage residential loans which are included in the Company's loan portfolio. See Note 8 in the Notes to Financial Statements.\nThe Company is a party to financial instruments with off-balance-sheet risks in the normal course of business to meet the financing needs of its customers. At December 31, 1995, the Company had $111.2 million in commitments to extend credit and $1.8 million in standby letters of credit. Commitments to extend credit are agreements to lend to a customer so long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The Company uses the same credit policies in establishing commitments and issuing letters of credit as it does for on-balance-sheet instruments. If obligations arising from these financial instruments continue to require funding at historical levels, management does not anticipate that such funding will adversely impact its ability to meet on-going obligations.\nIt is anticipated capital expenditures, excluding the purchase of First Financial Bancorp, Inc., will approximate $5.0 million to $7.0 million over the next twelve months. Management believes these capital expenditures can be funded internally without impairing the Company's ability to meet its on-going obligations.\nShareholders' equity as of December 31, for each of the last three years is presented below.\nShareholders' Equity (Dollars in Thousands) 1995 1994 1993\nCommon Stock $ 31 $ 31 $ 31 Additional Paid in Capital 5,868 5,852 5,857 Retained Earnings 80,658 73,989 67,753 Subtotal 86,557 79,872 73,641 Treasury Stock (6,367) (6,588) (6,502) Unrealized Gains (Losses) 968 (884) - Total Shareholders' Equity $81,158 $72,400 $67,139\nThe Company continues to maintain a strong capital position. The ratio of shareholders' equity to total assets at year-end was 9.97%, 9.75%, and 8.81% in 1995, 1994, and 1993, respectively, which ratios exceeded all minimum required regulatory capital levels. The lower capital ratio in 1993 primarily reflects the purchase of $1.8 million in treasury stock during the year. The Company has traditionally satisfied its regulatory capital requirements through earnings and expects to continue to do so.\nThe Company is subject to risk-based capital guidelines that measure capital relative to risk weighted assets and off-balance-sheet financial instruments. Capital guidelines issued by the Federal Reserve Board in effect at December 31, 1995 require bank holding companies to have a minimum total risk-based capital ratio of 8.00%, with at least half of the total capital in the form of Tier 1 capital. Capital City Bank Group, Inc., significantly exceeded these capital guidelines, with a total risk-based capital ratio of 19.26% and a Tier 1 ratio of 18.02%. The proposed acquisition of First Financial Bancorp, Inc., will be treated, when consummated, as a purchase for accounting purposes and thus result in a lower risk-based capital ratio. On a proforma basis as of December 31, 1995, the total risk-based capital ratio would have been 13.06% versus 19.26%.\nIn addition, a tangible leverage ratio is now being used in connection with the risk-based capital standards and is defined as Tier 1 capital divided by average assets. The minimum leverage ratio under this standard is 3% for the highest-rated bank holding companies which are not undertaking significant expansion programs. An additional 1% to 2% may be required for other companies, depending upon their regulatory ratings and expansion plans. On December 31, 1995, the Company had a leverage ratio of 9.84%, which is in excess of regulatory requirements. On a proforma basis as of December 31, 1995, the acquisition of First Financial Bancorp, Inc., would have reduced this ratio to 6.73%.\nIn 1995, the Board of Directors declared dividends totaling $1.00 per share, consisting of $.11 per share payable in July 1995 and $.89 per share payable in January 1996. The Company declared dividends of $.91 per share in 1994 and $.83 per share in 1993. The dividend payout ratio was 29.9%, 29.3%, and 29.4% for 1995, 1994, and 1993, respectively. Dividends declared per share in 1995 represented a 9.9% increase over 1994.\nAt December 31, 1995, the Company's common stock had a book value of $28.44 per share compared to $25.44 in 1994 and $23.56 in 1993. In 1994 and 1995, book value was impacted by the adoption of SFAS No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" which requires the unrealized gains or losses on securities held in the available-for-sale securities portfolio be recorded, net of taxes, as a component of the Company's equity capital. At December 31, 1995, the net unrealized gain was $968,000. At December 31, 1994, the Company had a net unrealized loss of $884,000 and thus the net impact on equity for the year was $1.9 million, or $.65 per share. See Note 1 in the Notes to Consolidated Financial Statements for further discussion of SFAS No. 115.\nThere is currently no established trading market for the common stock of Capital City Bank Group, Inc., and therefore, no bid or sale quotations are generally available. Based on sales of stock of which the Company has knowledge, the stock has traded in a range of $26.00 to $33.00 per share for the two-year period ended December 31, 1995, with the most recent trades at December 31, 1995, being at $33.00 per share.\nThe Company began a stock repurchase plan in 1989, which remains in effect and provides for the repurchase of up to 300,000 shares. As of December 31, 1995, the Company has repurchased 263,580 shares under the plan. No shares were repurchased during 1995. On January 26, 1996, 1,692 shares were issued to certain employees for achieving established performance goals for the year ended December 31, 1995. The total value of the shares issued was $56,000 based on a stock price of $33.00 per share.\nInterest Rate Sensitivity\nTable 14 presents the Company's consolidated interest rate sensitivity position as of year-end 1995. The objective of interest rate sensitivity analysis is to attempt to measure the impact on the Company's net interest income due to fluctuations in interest rates. Interest rate sensitivity is managed at the bank level, enabling bank management to incorporate its own interest rate projections, liquidity needs and factors specific to the local market into the analysis. The information in Table 14 has been prepared on a consolidated basis and is assembled and presented in response to regulatory reporting requirements.\nThe asset and liability values presented in Table 14 are as of December 31, 1995, which may not necessarily be indicative of the Company's interest rate sensitivity over an extended period of time. The information, as presented, incorporates certain assumptions which are set-forth in the footnotes to the table.\nThe Company is currently liability sensitive which generally indicates that in a period of rising interest rates the net interest margin will be adversely impacted as the velocity and\/or volume of liabilities being repriced exceeds assets. However, as general interest rates rise or fall, other factors such as current market conditions and competition may impact how the Company responds to changing rates and thus impact the magnitude of change in net interest income.\nInflation\nThe impact of inflation on the banking industry differs significantly from that of other industries in which a large portion of total resources are invested in fixed assets such as property, plant and equipment.\nAssets and liabilities of financial institutions are virtually all monetary in nature, and therefore are primarily impacted by interest rates rather than changing prices. While the general level of inflation underlies most interest rates, interest rates react more to change in the expected rate of inflation and to changes in monetary and fiscal policy. Net interest income and the interest rate spread are good measures of the Company's ability to react to changing interest rates and are discussed in further detail in the section entitled \"Earnings Analysis\".\nAccounting Pronouncements\nAs discussed in Note 1 in the Notes to Consolidated Financial Statements, on January 1, 1994, the Company adopted SFAS No. 115, which changed the accounting for certain debt and equity securities from amortized cost to fair value. Those securities classified as available-for-sale were reported at fair value of $230.7 million on December 31, 1995. As required by the new accounting standard, the net unrealized gain or loss on investment securities in the available-for-sale portfolio was recorded, net of taxes, as a separate component of shareholders' equity. At December 31, 1995, the net unrealized gain totaled $968,000 versus a net unrealized loss of $884,000 at December 31, 1994. As a result of a Financial Accounting Standards Board (FASB) interpretation allowing a one-time transfer of securities from the held-to-maturity category, investment securities with an amortized cost of $122.6 million were transferred from held-to-maturity to available-for-sale on December 27, 1995. At December 31, 1995, there were no securities classified as held-to-maturity. See Note 3 in the Notes to Consolidated Financial Statements for further information.\nIn 1993, the Company adopted SFAS No. 109, \"Accounting for Income Taxes,\" which changed the accounting for income taxes to the asset and liability method from the deferral method previously required by Accounting\nPrinciples Board Opinion 11. A tax expense of $484,000 reflecting the cumulative effect of adopting this new standard is included in 1993 net income. The adoption of SFAS No. 109 did not impact the effective tax rate. However, since SFAS No. 109 requires that deferred tax assets and liabilities be adjusted to reflect the effect of tax law or rate changes, the outcome of tax legislation may have an impact on future income tax expense.\nOn January 1, 1995, the Company adopted SFAS No. 114 - \"Accounting by Creditors for Impairment of a Loan\". As a result of applying the new rules, certain impaired loans are reported at the present value of expected future cash flows using 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. The adoption of the standard did not have a material impact on the Company's financial position or results of operations. See Note 5 in the Notes to Financial Statements for further information.\nIn March 1995, the FASB issued SFAS No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of. The statement was adopted by the Company on January 1, 1996. The adoption of this standard did not have a significant impact on the financial condition or results of operations of the Company.\nIn May 1995, the FASB issued SFAS No. 122, \"Accounting for Mortgage Servicing Rights\". The statement requires that an enterprise recognize as separate assets the rights to service mortgage loans for others, however those servicing rights are acquired. Additionally, the enterprise must periodically assess its capitalized mortgage servicing rights for impairment based on the fair value of those rights. This statement was adopted by the Company on January 1, 1996. The adoption of this statement did not have a material impact on the financial condition or results of operations of the Company.\nCONSOLIDATED FINANCIAL STATEMENTS\nReport of Independent Certified Public Accountants\nConsolidated Statements of Financial Condition\nConsolidated Statements of Income\nConsolidated Statements of Changes in Shareholders' Equity\nConsolidated Statements of Cash Flows\nNotes to Consolidated Financial Statements\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nTo the Shareholders and Board of Directors of Capital City Bank Group, Inc. Tallahassee, Florida\nWe have audited the accompanying consolidated statements of financial condition of Capital City Bank Group, Inc. (a Florida Corporation) and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of income, changes in shareholders' equity, and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. The consolidated financial statements of Capital City Bank Group, Inc. and subsidiaries as of December 31, 1993, were audited by other auditors whose report dated February 4, 1994, on those statements was unqualified and included an explanatory paragraph that described the change in the Company's method of accounting for income taxes in 1993, as discussed in Note 1 to the consolidated financial 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 Capital City Bank Group, Inc. and subsidiaries as of December 31, 1995 and 1994, and the results of their operations and their cash flows for the years then ended in conformity with generally accepted accounting principles.\nARTHUR ANDERSEN LLP Atlanta, Georgia January 26, 1996\nCONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (Dollars in Thousands) As of December 31, 1995 1994 ASSETS Cash and Due From Banks (Note 7) $ 61,613 $63,327 Federal Funds Sold 41,150 25,740 Interest Bearing Deposits in Other Banks 300 - Investment Securities Held-to-Maturity (market value of $145,003 in 1994) (Note 3) - 150,441 Investment Securities Available-for-Sale (Note 3) 230,747 48,847\nLoans (Notes 4 and 5) 447,779 426,013 Unearned Interest (3,806) (5,209) Allowance for Loan Losses (6,474) (7,551) Loans, Net 437,499 413,253\nPremises and Equipment (Note 6) 26,240 24,292 Accrued Interest Receivable 7,339 5,546 Intangibles (Note 1) 1,129 1,379 Other Assets 7,642 9,805\nTotal Assets $813,659 $742,630\nLIABILITIES Deposits: Noninterest Bearing Deposits $168,566 $167,711 Interest Bearing Deposits (Note 7) 531,013 480,463 Total Deposits 699,579 648,174\nFederal Funds Purchased and Securities Sold Under Repurchase Agreements 17,367 13,964 Other Short-Term Borrowings (Note 8) 2,400 999 Long-Term Debt (Note 8) 1,982 - Other Liabilities 11,173 7,093 Total Liabilities 732,501 670,230\nSHAREHOLDERS' EQUITY Common Stock, $.01 par value; 4,000,000 shares authorized; 3,105,243 issued 31 31 Additional Paid In Capital 5,868 5,852 Retained Earnings 80,658 73,989 Treasury Stock: 251,527 shares in 1995 and 259,428 shares in 1994, at cost (6,367) (6,588) Net Unrealized Gain (Loss) on Available- for-Sale Securities 968 (884) Total Shareholders' Equity 81,158 72,400 Total Liabilities and Shareholders' Equity $813,659 $742,630\nThe accompanying Notes to Consolidated Financial Statements are an integral part of these statements.\nCONSOLIDATED STATEMENTS OF INCOME (Dollars In Thousands, Except Per Share Data) For the Years Ended December 31, 1995 1994 1993 INTEREST INCOME Interest and Fees on Loans $40,826 $35,490 $33,554 Investment Securities: U.S. Treasury 4,205 4,967 5,564 U.S. Government Agencies and Corporations 3,500 1,991 1,621 States and Political Subdivisions 3,444 3,461 3,492 Other Securities 261 313 210 Deposits in Other Banks 2 17 119 Federal Funds Sold 2,239 1,652 1,835 Total Interest Income 54,477 47,891 46,395\nINTEREST EXPENSE Deposits (Note 7) 19,382 13,990 14,213 Federal Funds Purchased and Securities Sold Under Repurchase Agreements 1,053 650 548 Other Short-Term Borrowings (Note 8) 49 31 23 Long-Term Debt (Note 8) 4 54 56 Total Interest Expense 20,488 14,725 14,840\nNet Interest Income 33,989 33,166 31,555 Provision for Loan Losses (Note 5) 293 1,246 960 Net Interest Income After Provision for Loan Losses 33,696 31,920 30,595\nNONINTEREST INCOME\nService Charges on Deposit Accounts 5,649 5,408 5,601 Data Processing 2,608 2,434 2,380 Income from Fiduciary Activities 942 680 643 Securities Transactions (Note 3) 8 (147) 28 Other (Note 13) 3,963 4,634 3,826 Total Noninterest Income 13,170 13,009 12,478\nNONINTEREST EXPENSE Salaries and Employee Benefits (Note 10) 17,959 17,087 16,183 Occupancy, Net 2,538 2,343 2,183 Furniture and Equipment 3,346 2,910 2,909 Other (Note 13) 9,623 10,371 9,761 Total Noninterest Expense 33,466 32,711 31,036\nIncome Before Income Taxes and Accounting Change 13,400 12,218 12,037 Income Taxes (Note 9) 3,878 3,393 3,309 Income Before Accounting Change 9,522 8,825 8,728 Cumulative Effect of a Change in Accounting Method (Note 1) - - (484) NET INCOME $ 9,522 $ 8,825 $ 8,244 Net Income Per Share Before Accounting Change $ 3.34 $ 3.10 $ 2.99 Net Income Per Share $ 3.34 $ 3.10 $ 2.82\nAverage Common Shares Outstanding 2,853 2,847 2,924\nThe accompanying Notes to Consolidated Financial Statements are an integral part of these statements.\nCONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in Thousands) For the Years Ended December 31, 1995 1994 1993\nNet Income $ 9,522 $ 8,825 $ 8,244 Adjustments to Reconcile Net Income to Cash Provided by Operating Activities: Provision for Loan Losses 293 1,246 960 Depreciation 2,363 1,916 1,881 Net Loss on Sale of Properties 83 812 144 Amortization of Intangible Assets 250 341 338 Non-Cash Compensation 206 70 - Deferred Income Taxes 893 101 74 Cumulative Effect of Accounting Change - - 484 Net (Increase) Decrease in Interest Receivable (1,793) (79) (339) Net (Increase) Decrease in Other Assets 1,284 (79) (1,537) Net Increase (Decrease) in Other Liabilities 3,817 604 319 Net Cash Provided by Operating Activities 16,918 13,757 10,568\nCash Flows Used in Investing Activities: Proceeds from Payments\/Maturities of Investment Securities Held-To-Maturity 48,529 77,324 82,541 Proceeds from Payments\/Maturities of Investment Securities Available-for-Sale 32,486 17,389 - Purchase of Investment Securities Held to Maturity (27,000) (64,865) (114,726) Purchase of Investment Securities Available for Sale (83,621) (11,398) - Net Increase in Loans (24,539) (22,669) (17,235) Purchase of Premises & Equipment (4,482) (6,065) (6,952) Sales of Premises & Equipment 89 279 1,008 Cash Acquired in Bank Acquisitions - - 28,811 Net Cash Used in Investing Activities (58,538) (10,005) (26,553)\nCash Flows Provided by (Used in) Financing Activities: Net Increase (Decrease) in Deposits 51,405 (14,571) 21,150 Net Increase (Decrease) in Federal Funds Purchased 3,403 (9,300) 5,703 Net Increase (Decrease) in Other Short-Term Borrowings 1,401 (202) (20) Addition to Long-Term Debt 1,982 - 1,400 Repayment of Long-Term Debt - (1,900) (1,500) Dividends Paid (2,590) (2,447) (2,282) Sale (Purchase) of Treasury Stock 15 (156) (1,846) Net Cash Provided by (Used in) Financing Activities 55,616 (28,576) 22,605\nNet Increase (Decrease) in Cash and Cash Equivalents 13,996 (24,824) 6,620 Cash and Cash Equivalents at Beginning of Year 89,067 113,891 107,271 Cash and Cash Equivalents at End of Year $103,063 $ 89,067 $113,891\nSupplemental Disclosures:\nInterest on Deposits $ 18,441 $14,381 $14,944 Interest on Debt 1,106 $ 735 $ 627 Taxes Paid $ 2,868 $ 3,614 $ 3,013 Securities Transferred from Held-To-Maturity To Available-for-Sale $122,630 $ - $ - Loans Transferred To Other Real Estate $ 647 $ 453 $ 910\nThe accompanying Notes to Consolidated Financial Statements are an integral part of these statements.\nNotes to Consolidated Financial Statements\nNote 1\nSIGNIFICANT ACCOUNTING POLICIES\nThe consolidated financial statements include the accounts of Capital City Bank Group, Inc., and its subsidiaries (the \"Company\"), all of which are wholly- owned. All material intercompany transactions and accounts have been eliminated.\nThe Company follows generally accepted accounting principles and reporting practices applicable to the banking industry. Prior year financial statements and other information have been reclassified to conform to the current year presentation. The principles which materially affect the financial position, results of operations and cash flows are summarized below.\nUse of Estimates\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could vary from these estimates; however, in the opinion of management, such variances would not be material.\nCash and Cash Equivalents\nCash and cash equivalents include cash and due from banks, interest-bearing deposits in other banks, securities purchased under agreements to resell and federal funds sold. Generally, federal funds are purchased and sold for one-day periods and all items have an initial maturity of ninety days or less.\nInvestment Securities\nThe Company adopted Statement of Financial Accounting Standards (SFAS) No. 115, Accounting for Certain Investments in Debt and Equity Securities, as of January 1, 1994. Prior to January 1, 1994, all investment securities were classified as held-for-investment and recorded at amortized cost. In accordance with SFAS No. 115, investment securities are classified as either held-to-maturity or available-for-sale.\nInvestment securities classified as held-to-maturity are stated at cost, adjusted for amortization of premiums and accretion of discounts. Held-to- maturity securities are carried at amortized cost as the Company has the ability and positive intent to hold these securities to maturity. Investment securities in the available-for-sale portfolio are carried at fair value and represent securities that are available to meet liquidity and\/or other needs of the Company. The Company does not maintain a trading account.\nGains and losses are recognized and shown separately in the Consolidated Statements of Income upon realization or when impairment of values is deemed to be other than temporary. These gains or losses are recognized using the specific identification method. Unrealized holding gains and losses for securities in the available-for-sale portfolio are excluded from the Consolidated Statements of Income and reported net of taxes as a separate component of shareholders' equity until realized.\nLoans\nLoans are stated at the principal amount outstanding. Interest income on certain loans, which are made on a discount basis, is recognized using the sum-of-the-months-digits method which does not differ materially from the interest method.\nInterest income on all other loans, except for those designated as nonaccrual loans, is accrued based on the outstanding daily balances. Fees charged to originate loans and loan origination costs are deferred and amortized over the life of the loan as a yield adjustment.\nAllowance for Loan Losses\nProvisions for loan losses are charged to operating expenses and added to the allowance to maintain it at a level deemed appropriate by management to absorb known and inherent risks in the loan portfolio. When establishing the allowance, management makes various estimates regarding the value of collateral and future economic events. Actual future experience may differ from these estimates.\nRecognized loan losses are charged to the allowance when loans are deemed to be uncollectible due to such factors as the borrower's failure to pay principal and interest or when loans are classified as losses under internal or external review criteria. Recoveries of principal on loans previously charged-off are added to the allowance.\nLoans are placed on a nonaccrual status when management believes the borrower's financial condition, after giving consideration to economic conditions and collection efforts, is such that collection of interest is doubtful. Generally, loans are placed on nonaccrual status when interest becomes past due 90 days or more, or management deems the ultimate collection of principal and interest is in doubt.\nStatement of Financial Accounting Standards No. 114 -- \"Accounting by Creditors for Impairment of a Loan\", as amended, requires impaired loans to be measured based on the present value of expected future cash flows discounted at the loan's effective interest rate, or at the loan's observable market price, or at the fair value of the collateral if the loan is collateral dependent. This accounting pronouncement, which was adopted on a prospective basis on January 1, 1995, did not have a material impact on the Company's financial condition, results of operations, or allowance for loan loss.\nLong-Lived Assets\nPremises and equipment are stated at cost less accumulated depreciation, computed on the straight-line method over the estimated useful lives for each type of asset. Additions and major facilities are capitalized and depreciated in the same manner. Repairs and maintenance are charged to operating expense as incurred.\nIntangible assets consist primarily of core deposit assets which were recognized in connection with prior acquisitions. Core deposit is separate and distinct from goodwill and is an intangible asset which represents the present value of the future stream of income to be derived from investing the core deposits of the acquired bank. All intangible assets are being amortized on the straight-line method over various periods ranging from one to twenty five years with the majority being written off over an average life of approximately ten years.\nThe pretax amortization of all intangible assets was approximately $250,000 in 1995, $341,000 in 1994 and $338,000 in 1993. The Company adopted, SFAS No. 122, accounting for Mortgage Servicing Rights on January 1, 1996. The adoption of SFAS No 122 did not have a significant impact on the financial condition or results of operations of the Company.\nLong-lived assets are evaluated regularly for other than temporary impairment. If circumstances suggest that their value may be impaired and the write down would be material, as assessment of recoverability is performed prior to any write down of the asset. SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of must be adopted on or before January 1, 1996. The Company adopted the standard on January 1, 1996, and the adoption did not have a significant impact on the financial condition or results of operations of the Company.\nOther Real Estate\nOther real estate includes property owned by the Company which was acquired either through foreclosure or by receiving a deed in lieu of foreclosure. The properties are included in \"other assets\" in the statement of financial condition and are recorded at the estimated properties' fair value. Other real estate totaled $1.0 million and $1.6 million at December 31, 1995 and 1994, respectively.\nIncome Taxes\nThe Company files consolidated federal and state income tax returns. In general, the parent company and its subsidiaries compute their tax provisions (benefits) as separate entities prior to recognition of any tax expenses (benefits) which may accrue from filing a consolidated return.\nEffective January 1, 1993, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes\", which mandates the asset and liability method of accounting for deferred income taxes. The Company had previously accounted for deferred taxes under the deferral method required by Accounting Principles Board (APB) Opinion 11. The cumulative effect of adopting the new accounting standard was a reduction in the Company's net income of $484,000, which was recognized in the first quarter of 1993. See Note 9 for further discussion.\nNote 2\nACQUISITIONS\nDuring 1993, the Company consummated the purchase and assumption of four branch offices. Assets and liabilities acquired through acquisition, on a combined basis, are as follows:\n(Dollars in Thousands)\nLoans $(13,229) Premises & Equipment (855) Intangible Assets (1,236) Other Assets (70) Total Assets $(15,390) Deposits 44,097 Other Liabilities 104 Cash Acquired in Acquisitions $ 28,811\nOn December 10, 1995, the Company executed an Agreement and Plan of Merger to acquire First Financial Bancorp, Inc., (\"FFB\") for $22.00 per share in cash, or a total purchase price of approximately $20.3 million. First Financial is a $230 million federal savings bank headquartered in Tallahassee, Florida, with six offices located in five Florida counties. It is anticipated the transaction will close during the second half of 1996, expanding the number of counties served by the Company from seven to eleven and increasing the number of offices to thirty five.\nNote 3\nINVESTMENT SECURITIES\nAs a result of a Financial Accounting Standards Board (FASB) interpretation allowing a one-time transfer of securities from the held-to-maturity category, investment securities with an amortized cost of $122,630,000 and net unrealized appreciation of $503,000 were transferred from held-to- maturity to available-for-sale on December 27, 1995.\nThe amortized cost and related market value of investment securities at December 31, were as follows:\n(Dollars in Thousands) Amortized Unrealized Unrealized Market Available-for-Sale Cost Gains Losses Value\nU.S. Treasury $ 72,289 $ 470 $ 54 $72,705 U.S. Government Agencies and Corporations 70,883 264 96 71,051 States and Political Subdivisions 75,986 1,037 143 76,880 Mortgaged Backed Securities 5,965 47 26 5,986 Other Securities 4,107 19 1 4,125 Total Investment Securities $229,230 $1,837 $320 $230,747\nAmortized Unrealized Unrealized Market Held-To-Maturity Cost Gains Losses Value\nU.S. Treasury $ 72,979 $ 1 $1,681 $ 71,299 U.S. Government Agencies and Corporations 23,018 2 1,415 21,605 States and Political Subdivisions 49,125 134 2,026 47,233 Mortgage Backed Securities 3,005 2 183 2,824 Other Securities 2,314 - 272 2,042 Total Investment Securities $150,441 $ 139 $5,577 $145,003\nAmortized Unrealized Unrealized Market Available-for-Sale Cost Gains Losses Value\nU.S. Treasury $ 18,634 $ - $ 180 $ 18,454 U.S. Government Agencies and Corporations 7,041 3 443 6,601 States and Political Subdivisions 19,641 77 805 18,913 Mortgage Backed Securities 2,932 - 32 2,900 Other Securities 1,981 - 2 1,979 Total Investment Securities $ 50,229 $80 $1,462 $ 48,847\nThe total proceeds from the sale of investment securities and the gross realized gains and losses from the sale of such securities for each of the last three years is presented below:\n(Dollars in Thousands)\nTotal Gross Gross Year Proceeds Realized Gains Realized Losses\n1995 $25,296 $11 $ 3 1994 $11,476 $13 $160 1993 $31,681 $70 $ 42\nTotal proceeds include principal reductions in mortgage backed securities and proceeds from securities which were called of $22,546,000, $4,033,000, and $31,581,000, in 1995, 1994, and 1993, respectively.\nAs of December 31, 1995, the Company's investment securities had the following maturity distribution:\n(Dollars in Thousands)\nAmortized Cost Market Value\nDue in one year or less $ 74,144 $ 74,201 Due after one through five years 130,007 131,227 Due after five through ten years 19,681 19,925 Over ten years 5,398 5,394 Total Investment Securities $229,230 $230,747\nExpected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.\nSecurities with an amortized cost of $60,289,000 at December 31, 1995, were pledged to secure public deposits and for other purposes.\nNote 4\nLOANS\nAt December 31, the composition of the Company's loan portfolio was as follows:\n(Dollars in Thousands)\n1995 1994\nCommercial, Financial and Agricultural $ 46,149 $ 39,288 Real Estate - Construction 28,391 24,314 Real Estate - Mortgage 259,503 255,755 Consumer 113,736 106,656 Total Gross Loans $447,779 $426,013\nNonaccruing loans amounted to $2,996,000 and $4,278,000 at December 31, 1995 and 1994, respectively. Restructured loans amounted to $1,686,000 and $1,694,000 at December 31, 1995 and 1994, respectively. If such nonaccruing and restructured loans had been on a fully accruing basis, interest income would have been $320,000 higher in 1995 and $529,000 higher in 1994.\nNote 5\nALLOWANCE FOR LOAN LOSSES\nAn analysis of the changes in the allowance for loan losses for the years ended December 31, is as follows:\n(Dollars in Thousands) 1995 1994 1993\nBalance, Beginning of Year $7,551 $7,594 $7,585 Provision for Loan Losses 293 1,246 960 Recoveries on Loans Previously Charged-Off 526 466 570 Loans Charged-Off (1,896) (1,755) (1,521) Balance, End of Year $6,474 $7,551 $7,594\nThe value of a loan which is deemed \"impaired\" is measured based on the present value of expected future cash flows discounted at the loan's initial effective interest rate or the fair value of the collateral, if the loan is collateral dependent. If the value of a loan is less than its recorded investment, a valuation allowance is established. This valuation allowance is included in the total allowance for loan losses, which is established to cover losses inherent in the portfolio as a whole. Certain loan categories including residential, consumer and credit card loans are excluded from the scope of this statement. Adoption of SFAS No. 114 did not have a material impact on the level of the allowance for loan losses.\nAs of January 1, 1995, loans which were previously deemed insubstance foreclosures and classified as other real estate have been reclassified as loans. Insubstance foreclosures are not material and have not been reclassified for prior periods.\nImpaired loans are primarily defined as all nonaccruing loans. Selected information pertaining to impaired loans at December 31, 1995 is depicted in the table below.\n(Dollars in Thousands) Valuation Balance Allowance Impaired Loans: With Related Credit Allowance $ 946 $ 334 Without Related Credit Allowance $ 1,962 $ - Average Recorded Investment for the Period $ 3,282 $ *\n* Not Applicable\nThe Company recognizes income on impaired loans primarily on the cash basis. Any change in the present value of expected cash flows is recognized through the allowance for loan losses. For the period ended December 31, 1995, the Company recognized $93,000 in interest income on impaired loans, of which $75,000 was collected in cash.\nNote 6\nPREMISES AND EQUIPMENT\nThe composition of the Company's premises and equipment at December 31, was as follows:\n(Dollars in Thousands) 1995 1994\nLand $ 5,705 $ 5,286 Buildings 21,120 20,001 Fixtures and Equipment 18,409 16,656 Total 45,234 41,943 Accumulated Depreciation (18,994) (17,651) Premises and Equipment, Net $ 26,240 $ 24,292\nNote 7\nDEPOSITS\nInterest bearing deposits, by category, as of December 31, are as follows:\n(Dollars in Thousands)\n1995 1994\nNOW Accounts $122,517 $ 95,540 Money Market Accounts 67,942 71,763 Savings Accounts 78,522 101,009 Other Time Deposits 262,032 212,151 Total $531,013 $480,463\nTime deposits in denominations of $100,000 or more totaled $45,366,000 and $40,774,000, at December 31, 1995 and 1994, respectively.\nThe average balances maintained on deposit with the Federal Reserve Bank for the years ended December 31, 1995 and 1994, were $29,811,000 and $27,600,000, respectively.\nInterest expense on deposits for the three years ended December 31, is as follows:\n(Dollars in Thousands) 1995 1994 1993\nNOW Accounts $ 1,806 $ 1,809 $ 1,617 Money Market Accounts 2,108 1,731 1,779 Savings Accounts 1,942 2,597 2,953 Other Time Deposits 13,526 7,853 7,864 Total $19,382 $13,990 $14,213\nNote 8\nDEBT\nAs of December 31, 1995, the Company has available a $25.0 million credit facility. The facility offers the Company an unsecured, revolving line of credit for a period of three years which matures in November 1998. Upon expiration of the revolving line of credit, the outstanding balance may be converted to a term loan and repaid over a period of seven years. The term loan is to be secured by stock of a subsidiary bank equal to at least 125% of the principal balance of the term loan. The Company, at its option, may select from various loan rates including Prime, LIBOR or the Certificate of Deposit (\"CD\") rate, plus or minus increments thereof. The LIBOR or CD rates may be fixed for a period of up to six months. During 1995, the Company had no long-term debt outstanding under this credit facility. The existing loan agreement places certain restrictions on the amount of capital which must be maintained by the Company. On December 31, 1995, the Company's capital exceeded the most restrictive covenants of the agreement.\nAt December 31, 1995, the Company had $2.0 million in debt outstanding to the Federal Home Loan Bank of Atlanta. The debt, which has a fixed rate of interest of 6.04%, requires annual principal reductions of approximately $110,000 with the remaining balance due at maturity in 2005. The debt was used to match-fund selected lending activities and is secured by first mortgage residential loans which are included in the Company's loan portfolio.\nAs of December 31, 1995 and 1994, the Company had other short-term borrowings totaling $2.4 million and $1.0 million, respectively. These notes are secured by investment securities and the average interest rates were 4.23% and 3.67% for the years ended 1995 and 1994, respectively.\nNote 9\nINCOME TAXES\nThe provision for income taxes reflected in the statement of income was comprised of the following components:\n(Dollars in Thousands) 1995 1994 1993 Currently Payable: Federal $2,646 $2,894 $2,848 State 339 398 387 Deferred: Federal 762 87 59 State 131 14 15 Total $3,878 $3,393 $3,309\nThe net deferred tax asset and liability and the temporary differences comprising those balances at December 31, 1995 and 1994, are as follows:\n(Dollars in Thousands) 1995 1994 Deferred Tax Asset: Allowance for Loan Losses $2,438 $2,842 Deferred Loan Fees - 338 Unrealized Losses on Investment Securities - 497 Stock Incentive Plan 261 206 Writedown of Real Estate Held for Sale 25 38 Other 81 140 Total Deferred Tax Asset $2,805 $4,061\nDeferred Tax Liability: Premises and Equipment $ 851 $ 845 Employee Benefits 593 374 Unrealized Gains on Investment Securities 549 - FDIC Premiums - 254 Deferred Loan Fees 109 - Other 84 30 Total Deferred Tax Liability 2,186 1,503 Net Deferred Tax Asset $ 619 $2,558\nIncome taxes amounted to less than the tax expense computed by applying the statutory federal income tax rates to income. The reasons for these differences are as follows:\n(Dollars in Thousands) 1995 1994 1993\nComputed Tax Expense $4,556 $4,154 $4,093 Increases (Decreases) Resulting From: Tax-Exempt Interest Income (1,046) (1,079) (1,087) State Income Taxes, Net of Federal Income Tax Benefit 310 272 265 Other 58 46 38 Actual Tax Expense $3,878 $3,393 $3,309\nNote 10\nEMPLOYEE BENEFITS\nThe Company sponsors a noncontributory pension plan covering substantially all of its employees. Benefits under this plan generally are based on the employee's years of service and compensation during the years immediately preceding retirement. The Company's general funding policy is to contribute amounts deductible for federal income tax purposes.\nThe following table details the components of pension expense, the funded status of the plan and amounts recognized in the Company's consolidated statements of financial condition, and major assumptions used to determine these amounts.\n(Dollars in Thousands) 1995 1994 1993 Components of Pension Expense: Service Cost $ 774 $ 764 $ 685 Interest Cost 983 848 845 Actual Return on Plan Assets (3,029) (318) (525) Net Amortization and Deferral 2,173 (406) (331) Total $ 901 $ 888 $ 674\nActuarial Present Value of Projected Benefit Obligations:\nAccumulated Benefit Obligations: Vested $ 8,353 $6,861 $6,896 Nonvested 1,695 1,097 1,067 $10,048 $7,958 $7,963\nPlan Assets at Fair Value (primarily listed stocks and bonds, U.S. Government Secur- ities and interest bearing deposits) $ 15,946 $ 12,156 $ 10,898 Projected Benefit Obligation (14,565) (11,672) (11,825) Plan Assets in Excess of Projected Benefit Obligation 1,381 484 (927) Unrecognized Net Loss 1,636 2,187 3,466 Unrecognized Net Asset (1,412) (1,648) (1,884) Prepaid Pension Cost $ 1,605 $ 1,023 $ 655 Major Assumptions: Discount Rate 7.50% 8.25% 7.50% Rate of Increase in Compensation Levels 5.50% 5.50% 5.50% Expected Long-Term Rate of Return on Plan Assets 7.50% 7.50% 7.50%\nThe Company has a stock incentive plan under which shares of the Company's stock are issued as incentive awards to selected participants. The expense recorded related to this plan was approximately $424,000, $258,000 and $354,000 in 1995, 1994 and 1993, respectively.\nThe Company has an Employee Stock Purchase Plan under which employees may elect to make a monthly contribution towards the purchase of company stock on a semiannual basis. One hundred fifty thousand (150,000) shares of common stock are reserved for issuance under the Stock Purchase Plan. The Company will issue 6,660 shares under the plan in 1996, for the period ended December 31, 1995.\nNote 11\nRELATED PARTY TRANSACTIONS\nThe Chairman of the Board of Capital City Bank Group, Inc., is chairman of the law firm which serves as general counsel to the Company and its subsidiaries. Fees paid by the Company and its subsidiaries for these services, in aggregate, approximated $225,000, $242,000, and $266,000 during 1995, 1994, and 1993, respectively.\nUnder a lease agreement expiring in 2024, a bank subsidiary leases land from a partnership in which several directors and officers have an interest. The lease agreement provides for annual lease payments of approximately $53,000, to be adjusted for inflation in future years.\nAt December 31, 1995 and 1994, certain officers and directors were indebted to the Company's bank subsidiaries in the aggregate amount of $11,669,000 and $11,514,000, respectively. During 1995, $12,298,000 in new loans were made and repayments totaled $12,143,000. These loans were made on similar terms as loans to other individuals of comparable creditworthiness.\nNote 12\nDIVIDEND RESTRICTIONS\nThe approval of the appropriate regulatory authority is required if the total of all dividends declared by a subsidiary bank in any calendar year exceeds the bank's net profits (as defined) for that year combined with its retained net profits for the preceding two calendar years. In 1996, the bank subsidiaries may declare dividends without regulatory approval of $9.8 million plus an additional amount equal to the net profits of the Company's subsidiary banks for 1996 up to the date of any such dividend declaration.\nNote 13\nSUPPLEMENTARY INFORMATION\nComponents of noninterest income and noninterest expense in excess of 1% of total operating income, which are not disclosed separately elsewhere, are presented below for each of the respective periods.\n(Dollars in Thousands) 1995 1994 1993 Noninterest Income: Merchant Fee Income $1,227 $ 932 $ 642 Noninterest Expense: Employee Insurance 1,068 932 954 Payroll Taxes 963 927 879 Maintenance and Repairs 1,955 1,760 1,689 Professional Fees 565* 667 659 Advertising 494* 706 659 Printing & Supplies 1,634 1,129 1,065 Telephone 662* 700 561* Insurance (including FDIC Premium) 1,042 1,285 1,209 Commission\/Service Fees 878 890* 695* *Less than 1% of operating income in the year reported.\nNote 14\nFINANCIAL INSTRUMENTS AND CONCENTRATIONS OF CREDIT RISKS\nThe Company is a party to financial instruments with off-balance-sheet risks 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 does not participate in financial guarantees, options, interest rate caps and floors, interest rate swaps or futures contracts.\nThe Company's maximum exposure to credit loss under standby letters of credit and commitments to extend credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in establishing commitments and issuing letters of credit as it does for on- balance-sheet instruments. As of December 31, 1995, the amounts associated with the Company's off-balance-sheet obligations were as follows:\nAmount\nCommitments to Extend Credit(1) $111,248 Standby Letters of Credit $ 1,812\n(1) Commitments include unfunded loans, revolving lines of credit (including credit card lines) and other unused commitments.\nCommitments to extend credit are agreements to lend to a customer so long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.\nStandby letters of credit are conditional commitments issued by the corporation to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities. In general, management does not anticipate any material losses as a result of participating in these types of transactions.\nHowever, any potential losses arising from such transactions are reserved for in the same manner as management reserves for its other credit facilities.\nFor both on and off-balance-sheet financial instruments, the Company requires collateral to support such instruments when it is deemed necessary. The Company evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained upon extension of credit is based on management's credit evaluation of the counterpart. Collateral held varies, but may include deposits held in financial institutions; U.S. Treasury securities; other marketable securities; real estate; accounts receivable; property, plant and equipment; and inventory.\nDue to the close proximity and the nature of the markets served by the Company's subsidiary banks, the Company has both a geographic concentration as well as a concentration in the types of loans funded. Capital City Bank, which is headquartered in North Florida, accounts for approximately 82% of the Companys total loan volume. At December 31, 1995 approximately 64% of the Company's loan portfolio consisted of real estate related loans.\nNote 15\nFAIR VALUE OF FINANCIAL INSTRUMENTS\nMany of the Company's assets and liabilities are short-term financial instruments whose carrying values approximate fair value. These items include Cash and Due From Banks, Interest Bearing Balances with Other Banks, Federal Funds Sold, Federal Funds Purchased and Securities Sold Under Repurchase Agreements, and Short-term Borrowings. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. The resulting fair values may be significantly affected by the assumptions used, including the discount rates and estimates of future cash flows.\nThe methods and assumptions used to estimate the fair value of the Company's other financial instruments are as follows:\nInvestment Securities - Fair values for investment securities are based on quoted market prices. If a quoted market price is not available, fair value is estimated using market prices for similar securities.\nLoans - The loan portfolio is segregated into categories and the fair value of each loan category is calculated using present value techniques based upon projected cash flows and estimated discount rates. The calculated present values are then reduced by an allocation of the allowance for loan losses against each respective loan category.\nDeposits - The fair value of Noninterest Bearing Deposits, NOW Accounts, Money Market Accounts and Savings Accounts are the amounts payable on demand at the reporting date. The fair value of fixed maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities.\nLong-Term Debt - The carrying value of the Company's long-term debt approximates fair value.\nCommitments to Extend Credit and Standby Letters of Credit - The fair value of commitments to extend credit is estimated using the fees currently charged to enter into similar agreements, taking into account the present creditworthiness of the counterparties. Fair value of these fees is not material.\nThe Company's financial instruments which have estimated fair values differing from their respective carrying values are presented below:\n(Dollars in Thousands) At December 31, 1995 1994 Estimated Estimated Carrying Fair Carrying Fair Value Value Value Value\nFinancial Assets: Investment Securities (1) $230,747 $230,747 $199,288 $193,850 Loans, Net of Allowance for Loan Losses 437,499 441,446 413,253 405,899\nFinancial Liabilities: Deposits 699,579 700,868 648,174 646,354\n(1) At December 31, 1995 all investment securities were carried at fair value. See Note 3 for further information.\nCertain financial instruments and all nonfinancial instruments are excluded from the disclosure requirements. The disclosures also do not include certain intangible assets such as customer relationships, deposit base intangibles and goodwill. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.\nNote 16\nPARENT COMPANY FINANCIAL INFORMATION\nThe following are condensed statements of financial condition of the parent company at December 31:\nParent Company Statements of Financial Condition\n(Dollars in Thousands) 1995 1994 ASSETS\nCash and Due from Group Banks $ 4,378 $ 2,820 Investment in Group Banks 80,143 72,442 Other Assets 227 351 Total Assets $84,748 $75,613\nLIABILITIES\nDividends Payable $ 2,539 $ 2,277 Long-Term Debt (Note 8) - - Other Liabilities 1,051 936 Total Liabilities 3,590 3,213\nSHAREHOLDERS' EQUITY\nCommon Stock, $.01 par value; 4,000,000 shares authorized; 3,105,243 issued 31 31 Additional Paid in Capital 5,868 5,852 Retained Earnings 80,658 73,989\nTreasury Stock: 251,527 shares in 1995 and 259,428 shares in 1994, at cost (6,367) (6,588) Net Unrealized Gain (Loss) on Available-for- Sale Securities 968 (884) Total Shareholders' Equity 81,158 72,400 Total Liabilities and Shareholders' Equity $84,748 $75,613\nThe operating results of the parent company for the three years ended December 31, are shown below:\nParent Company Statements of Income\n(Dollars in Thousands)\n1995 1994 1993\nOPERATING INCOME Income Received from Group Banks:\nDividends (Note 12) $3,884 $4,615 $4,675 Group Overhead Fees 2,702 2,311 1,986 Total Operating Income 6,586 6,926 6,661\nOPERATING EXPENSE Salaries and Employee Benefits 2,064 1,565 1,617 Legal Fees 48 74 63 Professional Fees 243 157 171 Advertising 391 594 433 Travel and Entertainment 52 72 63 Amortization of Excess of Purchase Price Over Book Value of Net Assets Acquired 52 52 52 Interest on Debt - 54 56 Dues and Memberships 46 49 42 Other 204 361 180 Total Operating Expense 3,100 2,978 2,677\nIncome Before Income Taxes and Equity in Undistributed Earnings of Group Banks 3,486 3,948 3,984 Income Tax Benefit (135) (233) (230) Income Before Equity in Undistributed Earnings of Group Banks 3,621 4,181 4,214 Equity in Undistributed Earnings of Group Banks 5,901 4,644 4,030 Net Income $9,522 $8,825 $8,244\nThe cash flows for the parent company for the three years ended December 31, were as follows:\nParent Company Statements of Cash Flows\n1995 1994 1993\nNet Income $9,522 $8,825 $8,244 Adjustments to Reconcile Net Income to Cash Provided by Operating Activities: Equity in undistributed Earnings of Group Banks (5,901) (4,644) (4,030) Non-Cash Compensation 206 70 - Amortization of Excess of Purchase Price Over Book Value of Net Assets Acquired 52 52 51 (Increase) Decrease in Other Assets 140 3 (189) Net Increase in Other Liabilities 114 228 333 Net Cash Provided by Operating Activities 4,133 4,534 4,409\nCash Flows Used in Financing Activities: Addition to Long-Term Debt - - 1,400 Repayment of Long-Term Debt - (1,900) (1,500) Payment of Dividends (2,590) (2,447) (2,282) Sale (Purchase) of Treasury Stock, Net 15 (156) (1,846) Net Cash Used in Financing Activities (2,575) (4,503) (4,228) Net Increase in Cash 1,558 31 181 Cash at Beginning of Period 2,820 2,789 2,608 Cash at End of Period $4,378 $2,820 $ 2,789\nNote 17\nCORPORATE REORGANIZATION\nOn July 25, 1994, Capital City First National Bank, Capital City Second National Bank, Industrial National Bank, City National Bank, Havana State Bank, First National Bank of Jefferson County and Gadsden National Bank, each being\nwholly-owned subsidiaries of Capital City Bank Group, Inc., entered into a \"Plan of Merger and Merger Agreement\" under which the six national banks where merged into and with Havana State Bank, a state banking corporation. The effective date of the merger was January 1, 1995. Simultaneous with the merger, the name and headquarters was changed from Havana State Bank, Havana, Florida to Capital City Bank, Tallahassee, Florida. Capital City Bank is a member of the Federal Reserve Bank of Atlanta and its deposits are insured by the Federal Deposit Insurance Corporation. At the time of merger, Capital City Bank had 20 banking locations and represented approximately 82% of the Company's total assets. The Company's operating results for 1994 included pre-tax charges of $731,000 which were attributable to corporate reorganization.\nNet Income and Balance Sheet Information By Bank (Unaudited)\nCapital Levy Farmers & Branford City County Merchants State Bank* State Bank Bank of Trenton Bank (Dollars In Thousands)\nFor the Year: 1995 $ 7,743 $ 909 $ 576 $ 557 Net Income 1994 7,337 1,000 503 419 1993 7,088 777 477 364\nAt December 31:\nLoans, Net of Unearned 1995 $362,462 $42,313 $21,384 $17,714 Interest 1994 342,606 42,343 20,021 15,834 1993 323,272 43,366 19,498 13,288\nAssets 1995 $699,697 $78,020 $36,898 $32,247 1994 611,923 71,004 33,457 28,953 1993 623,972 75,583 32,950 30,181\nNoninterest Bearing Deposits 1995 $154,241 $12,321 $ 5,163 $5,362 1994 152,450 11,104 5,903 4,897 1993 156,634 9,782 5,049 4,407\nInterest Bearing 1995 $424,228 $56,636 $27,176 $22,974 Deposits 1994 383,991 51,983 23,749 20,740 1993 386,229 57,835 24,553 22,143\nShareholders' Equity 1995 $ 63,756 $ 8,156 $ 3,971 $ 3,547 1994 57,607 7,497 3,537 3,036 1993 54,766 7,060 3,317 2,774\n*Information for Capital City Bank is presented on a proforma basis for years prior to 1995.\nItem 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures.\nThe Board of Directors has appointed Arthur Andersen LLP, independent certified public accountants, as independent auditors for Capital City Bank Group, Inc., and its subsidiaries for the current fiscal year ending December 31, 1996, subject to ratification by the shareholders. Fiscal 1996 will be the third year Arthur Andersen LLP will audit the books and records of the Company. The decision to change the Company's independent auditors from James D. A. Holley & Co. to Arthur Andersen LLP was made by the Company's Board of Directors on January 21, 1994. Arthur Andersen LLP was engaged on April 5, 1994. During the periods in which James D. A. Holley & Co. audited the books and records of the Company, none of the reports issued by such firm on the financial statements of the Company contained an adverse opinion or disclaimer of opinion, or was qualified or modified as to uncertainty, audit scope or accounting principles. The Company has never had any disagreements with James D. A. Holley & Co. or Arthur Andersen LLP on any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedure.\nItem 10. Directors and Executive Officers of the Registrant\nIncorporated herein by reference to the sections entitled \"Election of Directors\" and \"Executive Officers, Compensation and Other Information\" in the Registrant's Proxy Statement dated April 10, 1996 to be filed on or before April 10, 1996.\nItem 11. Executive Compensation\nIncorporated herein by reference to the section entitled \"Executive Officers, Compensation and Other Information\" in the Registrant's Proxy Statement dated April 10, 1996, to be filed on or before April 10, 1996.\nItem 12. Security Ownership of Certain Beneficial Owners and Management\nIncorporated herein by reference to the subsection entitled \"Information Concerning Nominees\" under the section entitled \"Election of Directors\", and \"Principal Shareholders\" in the Registrant's Proxy Statement dated April 10, 1996, to be filed on or before April 10, 1996.\nItem 13. Certain Relationships and Related Transactions\nIncorporated herein by reference to the subsection entitled \"Compensation Committee Interlocks and Insider Participation\" under the section entitled \"Executive Officers, Compensation and Other Information\" in the Registrant's Proxy Statement dated April 10, 1996 to be filed on or before April 10, 1996.\nPART IV\nItem 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\nEXHIBITS\n2(a) Agreement and Plan of Merger, dated as of December 10, 1995, by and among Capital City Bank Group, Inc.; a Florida corporation to be formed as a direct wholly-owned subsidiary of the Company; and First Financial Bancorp, Inc.*\n3(a) Articles of Incorporation, as amended, of Capital City Bank Group, Inc., were filed as Exhibit 3(a) to the Registrant's Form S-14 filed on August 26, 1983 (File No. 2-86158), and are incorporated herein by reference.\n3(b) By-Laws, as amended, of Capital City Bank Group, Inc. are incorporated herein by reference to Exhibit 3(b) of the Company's 1983 Form 10-K (File No. 2-86158).\n10(a) Merger Agreement and Plan of Merger, dated July 25, 1994, by and among Capital City First National Bank, Capital City Second National Bank, Industrial National Bank, City National Bank, Havana State Bank, First National Bank of Jefferson County and Gadsden National Bank, is incorporated herein by reference to Exhibit A in Registrant's Form 10K-A, dated April 5, 1995.\n10(b) Promissory Note and Pledge and Security Agreement evidencing a line of credit by and between Registrant and SunTrust, dated November 18, 1995.\n10(c) Capital City Bank Group, Inc. 1992 Stock Incentive Plan is incorporated herein by reference to Exhibit A of the Registrant's 1992 Proxy Statement, dated Aril 8, 1992.\n10(d) Capital City Bank Group, Inc. 1995 Associate Stock Purchase Plan is incorporated herein by reference to Exhibit A of the Registrant's 1995 Proxy Statement, dated April 7, 1995.\n10(e) Capital City Bank Group, Inc. 1996 Associate Incentive Plan is incorporated herein by reference to Exhibit A of the Registrant's 1996 Proxy, dated onor about April 10, 1996.\n21 For a listing of Capital City Bank Group's subsidiaries See Item I.\n22 (a) Report of Independent Accountants\n27 Financial Data Schedule\n*To be filed as an amendment to this Form 10K\nFINANCIAL STATEMENT SCHEDULES\nOther schedules and exhibits are omitted because the required information either is not applicable or is shown in the financial statements or the notes thereto.\nREPORTS ON FORM 8-K\nCapital City Bank Group, Inc. (\"CCBG\") filed no Form 8-K during the fourth quarter of 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 March 22, 1996, 1996 on its behalf by the undersigned, thereunto duly authorized.\nCAPITAL CITY BANK GROUP, INC.\n\/s\/ William G. Smith President (Principal Executive Officer)\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed on March 22, 1996 by the following persons in the capacities indicated.\n\/s\/ WILLIAM G. SMITH William G. Smith President (Principal Executive Officer)\n\/s\/ J. KIMBROUGH DAVIS J. Kimbrough Davis Senior Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)\nDirectors:\n\/s\/ DuBose Ausley DuBose Ausley\n\/s\/ Thomas A. Barron Thomas A. Barron\n\/s\/ Cader B. Cox, III Cader B. Cox, III\n\/s\/ John K. Humphress John K. Humphress\n\/s\/ Payne H. Midyette, Jr. Payne H. Midyette, Jr.\n\/s\/ Godfrey Smith Godfrey Smith\n\/s\/ William G. Smith, Jr. William G. Smith, Jr.","section_7A":"","section_8":"","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures.\nThe Board of Directors has appointed Arthur Andersen LLP, independent certified public accountants, as independent auditors for Capital City Bank Group, Inc., and its subsidiaries for the current fiscal year ending December 31, 1996, subject to ratification by the shareholders. Fiscal 1996 will be the third year Arthur Andersen LLP will audit the books and records of the Company. The decision to change the Company's independent auditors from James D. A. Holley & Co. to Arthur Andersen LLP was made by the Company's Board of Directors on January 21, 1994. Arthur Andersen LLP was engaged on April 5, 1994. During the periods in which James D. A. Holley & Co. audited the books and records of the Company, none of the reports issued by such firm on the financial statements of the Company contained an adverse opinion or disclaimer of opinion, or was qualified or modified as to uncertainty, audit scope or accounting principles. The Company has never had any disagreements with James D. A. Holley & Co. or Arthur Andersen LLP on any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedure.\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nIncorporated herein by reference to the sections entitled \"Election of Directors\" and \"Executive Officers, Compensation and Other Information\" in the Registrant's Proxy Statement dated April 10, 1996 to be filed on or before April 10, 1996.\nItem 11.","section_11":"Item 11. Executive Compensation\nIncorporated herein by reference to the section entitled \"Executive Officers, Compensation and Other Information\" in the Registrant's Proxy Statement dated April 10, 1996, to be filed on or before April 10, 1996.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nIncorporated herein by reference to the subsection entitled \"Information Concerning Nominees\" under the section entitled \"Election of Directors\", and \"Principal Shareholders\" in the Registrant's Proxy Statement dated April 10, 1996, to be filed on or before April 10, 1996.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nIncorporated herein by reference to the subsection entitled \"Compensation Committee Interlocks and Insider Participation\" under the section entitled \"Executive Officers, Compensation and Other Information\" in the Registrant's Proxy Statement dated April 10, 1996 to be filed on or before April 10, 1996.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\nEXHIBITS\n2(a) Agreement and Plan of Merger, dated as of December 10, 1995, by and among Capital City Bank Group, Inc.; a Florida corporation to be formed as a direct wholly-owned subsidiary of the Company; and First Financial Bancorp, Inc.*\n3(a) Articles of Incorporation, as amended, of Capital City Bank Group, Inc., were filed as Exhibit 3(a) to the Registrant's Form S-14 filed on August 26, 1983 (File No. 2-86158), and are incorporated herein by reference.\n3(b) By-Laws, as amended, of Capital City Bank Group, Inc. are incorporated herein by reference to Exhibit 3(b) of the Company's 1983 Form 10-K (File No. 2-86158).\n10(a) Merger Agreement and Plan of Merger, dated July 25, 1994, by and among Capital City First National Bank, Capital City Second National Bank, Industrial National Bank, City National Bank, Havana State Bank, First National Bank of Jefferson County and Gadsden National Bank, is incorporated herein by reference to Exhibit A in Registrant's Form 10K-A, dated April 5, 1995.\n10(b) Promissory Note and Pledge and Security Agreement evidencing a line of credit by and between Registrant and SunTrust, dated November 18, 1995.\n10(c) Capital City Bank Group, Inc. 1992 Stock Incentive Plan is incorporated herein by reference to Exhibit A of the Registrant's 1992 Proxy Statement, dated Aril 8, 1992.\n10(d) Capital City Bank Group, Inc. 1995 Associate Stock Purchase Plan is incorporated herein by reference to Exhibit A of the Registrant's 1995 Proxy Statement, dated April 7, 1995.\n10(e) Capital City Bank Group, Inc. 1996 Associate Incentive Plan is incorporated herein by reference to Exhibit A of the Registrant's 1996 Proxy, dated onor about April 10, 1996.\n21 For a listing of Capital City Bank Group's subsidiaries See Item I.\n22 (a) Report of Independent Accountants\n27 Financial Data Schedule\n*To be filed as an amendment to this Form 10K\nFINANCIAL STATEMENT SCHEDULES\nOther schedules and exhibits are omitted because the required information either is not applicable or is shown in the financial statements or the notes thereto.\nREPORTS ON FORM 8-K\nCapital City Bank Group, Inc. (\"CCBG\") filed no Form 8-K during the fourth quarter of 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 March 22, 1996, 1996 on its behalf by the undersigned, thereunto duly authorized.\nCAPITAL CITY BANK GROUP, INC.\n\/s\/ William G. Smith President (Principal Executive Officer)\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed on March 22, 1996 by the following persons in the capacities indicated.\n\/s\/ WILLIAM G. SMITH William G. Smith President (Principal Executive Officer)\n\/s\/ J. KIMBROUGH DAVIS J. Kimbrough Davis Senior Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)\nDirectors:\n\/s\/ DuBose Ausley DuBose Ausley\n\/s\/ Thomas A. Barron Thomas A. Barron\n\/s\/ Cader B. Cox, III Cader B. Cox, III\n\/s\/ John K. Humphress John K. Humphress\n\/s\/ Payne H. Midyette, Jr. Payne H. Midyette, Jr.\n\/s\/ Godfrey Smith Godfrey Smith\n\/s\/ William G. Smith, Jr. William G. Smith, Jr.","section_15":""}
{"filename":"202584_1995.txt","cik":"202584","year":"1995","section_1":"Item 1. Business\nBUSINESS OF ENTERGY\nGeneral\nEntergy Corporation was originally incorporated under the laws of the State of Florida on May 27, 1949. On December 31, 1993, Entergy Corporation merged with and into Entergy-GSU Holdings, Inc., a Delaware corporation, which then changed its name to Entergy Corporation. Entergy Corporation is a public utility holding company registered under PUHCA and does not own or operate any significant assets other than the stock of its subsidiaries. Entergy Corporation owns all of the outstanding common stock of five domestic retail operating electric utility subsidiaries, AP&L, GSU, LP&L, MP&L, and NOPSI. AP&L was incorporated under the laws of the State of Arkansas in 1926; GSU was incorporated under the laws of the State of Texas in 1925; LP&L and NOPSI were incorporated under the laws of the State of Louisiana in 1974 and 1926, respectively; and MP&L was incorporated under the laws of the State of Mississippi in 1963. As of December 31, 1995, the Operating Companies provided electric service to approximately 2.4 million customers in the States of Arkansas, Louisiana, Mississippi, Tennessee, and Texas. In addition, GSU furnishes natural gas utility service in the Baton Rouge, Louisiana area, and NOPSI furnishes natural gas utility service in the New Orleans, Louisiana area. GSU produces and sells, on a nonregulated basis, process steam and by-product electricity supplied from its steam electric extraction plant to a large industrial customer. The business of the Operating Companies is subject to seasonal fluctuations with the peak period occurring during the third quarter. During 1995, the System's electric sales as a percentage of total System electric sales were: residential - - - - - 26.8%; commercial - 20%; and industrial - 40.8%. Electric revenues from these sectors as a percentage of total System electric revenues were: 35.6% - residential; 24.4% - commercial; and 29.6% - industrial. Sales to governmental and municipal sectors and to nonaffiliated utilities accounted for the balance of energy sales. The System's major industrial customers are in the chemical processing, petroleum refining, paper products, and food products industries.\nEntergy Corporation also owns directly all of the outstanding common stock of the following subsidiary companies: System Energy, Entergy Services, Entergy Operations, Entergy Power, Entergy Enterprises, Entergy S.A., Entergy Argentina S.A., Entergy Argentina S.A., Ltd., Entergy Power Development Corporation, Entergy Transener S.A., Entergy Power Marketing Corporation, Entergy Power Development International Holdings, Inc., and Entergy Power Development International Corporation. System Energy is a nuclear generating company that was incorporated under the laws of the State of Arkansas in 1974. System Energy sells at wholesale the capacity and energy from its 90% interest in Grand Gulf 1 to its only customers, AP&L, LP&L, MP&L, and NOPSI (see \"CAPITAL REQUIREMENTS AND FUTURE FINANCING - Certain System Financial and Support Agreements - Unit Power Sales Agreement,\" below). System Energy has approximately a 78.5% ownership interest and an 11.5% leasehold interest in Grand Gulf 1. Entergy Services, a Delaware corporation, provides general executive, advisory, administrative, accounting, legal, engineering, and other services to the Operating Companies, generally at cost. Entergy Operations, a Delaware corporation, is a nuclear management company that operates ANO, River Bend, Waterford 3, and Grand Gulf 1, subject to the owner oversight of AP&L, GSU, LP&L, and System Energy, respectively. Entergy Power, a Delaware corporation, is an independent power producer that owns 809 MW of generating capacity and markets its capacity and energy in the wholesale market and in other markets not otherwise presently served by the System. (For further information on regulatory proceedings related to Entergy Power, see \"RATE MATTERS AND REGULATION - - - - - Rate Matters - Wholesale Rate Matters - Entergy Power,\" below). Entergy Enterprises is a nonutility company incorporated under Delaware law that invests in and develops energy-related projects and other businesses that are or may be of benefit to the System's utility business (see \"Domestic and Foreign Energy-Related Investments,\" below). Entergy Enterprises also markets outside the System technical expertise, products, and services developed by the Operating Companies that have commercial value beyond their use in the System's operations and provides services to certain nonutility companies in the System. Entergy Corporation also has subsidiaries that participate in utility projects located outside the System's retail service territory, both domestically and internationally. See \"Domestic and Foreign Energy- Related Investments\" and \"CitiPower Acquisition,\" below) for a discussion of these subsidiaries.\nAP&L, LP&L, MP&L, and NOPSI own 35%, 33%, 19%, and 13%, respectively, of all the common stock of System Fuels, a non-profit subsidiary incorporated in Louisiana that implements and\/or maintains certain programs to procure, deliver, and store fuel supplies for the Operating Companies.\nGSU has four wholly owned subsidiaries: Varibus Corporation, GSG&T, Inc., Southern Gulf Railway Company, and Prudential Oil & Gas, Inc. Varibus Corporation operates intrastate gas pipelines in Louisiana, which are used primarily to transport fuel to two of GSU's generating stations. GSG&T, Inc. owns the Lewis Creek Station, a gas- fired generating plant, which is leased to and operated by GSU. Southern Gulf Railway Company owns and will operate several miles of rail track being constructed in Louisiana for the purpose of transporting coal for use as a boiler fuel at Nelson Unit 6. Prudential Oil & Gas, Inc., which was formerly in the business of exploring, developing, and operating oil and gas properties in Texas and Louisiana, is presently inactive.\nEntergy Corporation-GSU Merger\nOn December 31, 1993, GSU became a wholly owned subsidiary of Entergy Corporation. As consideration to GSU's shareholders, Entergy Corporation paid $250 million in cash and issued 56,695,724 shares of its common stock, based upon a valuation of $35.8417 per share, in exchange for outstanding shares of GSU common stock.\nUnless otherwise noted, consolidated financial position and statistical information contained in this report for the years ended December 31, 1995, 1994, and 1993 (such as assets, liabilities, and property) includes the associated GSU amounts. Consolidated financial results and statistical information (such as revenues, sales, and expenses) for the years ended December 31, 1995 and 1994 includes such GSU amounts, while periods ending before January 1, 1994, do not include GSU amounts; those amounts are presented separately for GSU in this report.\nCertain Industry and System Challenges\nThe System's business is affected by various challenges and issues, many of which confront the electric utility industry generally. These issues and challenges include:\n- responding to an increasingly competitive environment (see \"MANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS - SIGNIFICANT FACTORS AND KNOWN TRENDS\");\n- addressing current and proposed structural changes in the electric utility industry and changes in the regulation of generation and transmission of electricity (see \"MANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS - SIGNIFICANT FACTORS AND KNOWN TRENDS\");\n- achieving cost savings anticipated with the Merger;\n- complying with regulatory requirements with respect to nuclear operations (see \"RATE MATTERS AND REGULATION - Regulation - Regulation of the Nuclear Power Industry,\" below) and environmental matters (see \"RATE MATTERS AND REGULATION - Regulation - Environmental Regulation,\" below);\n- resolving GSU's major contingencies, including potential write-offs and refunds related to River Bend (see \"RATE MATTERS AND REGULATION - Rate Matters - Retail Rate Matters - GSU,\" below), litigation with Cajun relating to its ownership interest in River Bend, and Cajun's bankruptcy proceedings (see \"RATE MATTERS AND REGULATION - Regulation - Other Regulation and Litigation - Cajun - River Bend Litigation,\" below); and\n- implementing a new accounting standard that describes the circumstances in which assets are determined to be impaired, which may eventually be applied to \"stranded costs\" (costs not recoverable from those customers for whose benefit the costs were incurred) resulting from increased competition (see \"MANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS - SIGNIFICANT FACTORS AND KNOWN TRENDS,\");\n- achieving high levels of operating efficiencies, cost control, and returns on investments in Entergy Corporation's growing portfolio of non utility and overseas business ventures (see \"Domestic and Foreign Energy-Related Investments\" and \"CitiPower Acquisition,\" below).\nDomestic and Foreign Energy-Related Investments\nEntergy Corporation seeks opportunities to expand its energy- related businesses that are not regulated by state and local regulatory authorities (nonregulated businesses). These nonregulated businesses currently include power development and new technology related to the utility business. Entergy Corporation's strategy is to identify and pursue nonregulated business opportunities that have the potential to earn a greater return than its regulated utility operations. Entergy Corporation has expanded its investments in nonregulated business opportunities overseas as well as in the United States. Through the end of 1995, Entergy Corporation had participated in foreign non- regulated electric ventures in Pakistan, Argentina, and Peru. As of December 31, 1995, Entergy Corporation had invested $555.5 million in equity capital (reduced by accumulated losses of $169 million) in nonregulated businesses. See the discussion below of Entergy Corporation's acquisition of CitiPower on January 5, 1996.\nDuring 1995, Entergy Corporation's nonregulated businesses activities included the following:\n(1) Entergy Power's $246.7 million debt obligation to Entergy Corporation was converted into equity in April 1995. Entergy Power sells capacity and energy from its 100% and 31.5% interest in Ritchie 2 and Independence 2, respectively. Entergy Power purchased an interest in these plants from AP&L in 1990. Entergy Corporation originally financed Entergy Power principally with a loan to Entergy Power. Entergy Power was formed to compete with other utilities and independent power producers in the bulk power market.\n(2) In April 1995, Entergy Systems and Service, Inc. (Entergy SASI) and Systems and Service International, Inc. (SASI), amended their existing distribution agreement. As a result, Entergy SASI liquidated its equity interest in SASI. Previously, Entergy SASI, a subsidiary of Entergy Enterprises, held a 9.95% equity interest in SASI, a manufacturer of efficient lighting products. Entergy SASI distributes such products purchased under a distribution agreement with SASI, in conjunction with providing various energy management services to its customers. The amended distribution agreement discussed above provided for a reduction in SASI's profit margin on its sale of products to Entergy SASI and transferred the rights to certain of SASI's energy efficient technologies to Entergy SASI. In exchange, among other things, Entergy SASI transferred to SASI all of its equity ownership in SASI.\n(3) In June 1995, Entergy Corporation contributed $125 million in equity capital to Entergy SASI through Entergy Enterprises, Inc., thus allowing Entergy SASI to retire its debt obligation to Entergy Corporation. Entergy Corporation had previously provided loans to Entergy SASI to fund Entergy SASI's business expansion.\n(4) As of December 31, 1995, Entergy Enterprises wrote down its equity interest in First Pacific Networks (FPN), a communications company, by $9.3 million to reflect what management believes is a permanent decline in market value. Entergy Enterprises holds a 7.9% equity interest in FPN. The total cost of Entergy Enterprises' investment in FPN as of December 31, 1995, was approximately $1.2 million.\n(5) In June 1995, Entergy Corporation received SEC authorization to invest up to $350 million through December 31, 1997, in Entergy Enterprises. Such investments may take the form of purchases of common stock, capital contributions, loans, and\/or guarantees of indebtedness or other obligations of Entergy Enterprises or certain of its affiliated companies. In January 1995 Entergy Corporation guaranteed $65 million of EP Edegel, Inc., a subsidiary of Entergy Corporation, obligations.\n(6) In 1995, Entergy Corporation has requested approval from the SEC to form a new nonregulated subsidiary named Entergy Technologies Company (ETC). ETC would offer bulk interstate telecommunications service to telecommunications carriers which in turn would market that service to third parties. The recently enacted Telecommunications Reform Act of 1996 permits Entergy to market such a service, pending state and local regulatory approval. See MANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS - SIGNIFICANT FACTORS AND KNOWN TRENDS for a discussion of the Telecommunications Act of 1996 and its impact on Entergy.\n(7) During the third quarter of 1995, Entergy Corporation's subsidiary, Entergy S.A., purchased 3.9% of the outstanding stock of the Central Buenos Aires Project (CBA Project) for $1.7 million. Entergy S.A., owns a 10% interest in a consortium with other nonaffiliated companies that acquired a 60% interest in Central Costanera, S.A. (Costanera), a steam electric generating facility located in Argentina. Through Entergy S.A.'s interest in Costanera, Entergy S.A. indirectly purchased an additional 3% of the outstanding stock of the CBA Project. In October 1995, Entergy Power Holding Limited, a wholly owned subsidiary of Entergy Corporation, purchased Entergy S.A.'s interest in the CBA Project and purchased an additional 3.9% of the outstanding stock of the CBA Project for $1.9 million. The CBA Project includes the addition of a 220 MW combustion turbine and heat recovery boiler to a generating unit at the Costanera steam electric generating facility. This addition will provide electricity to the Argentina transmission grid and steam to the Costanera generating unit. The open cycle portion of the CBA Project, providing electricity to the Argentina grid, was placed into operation at the end of October 1995. The steam recovery portion, which will provide steam to the Costanera generating unit, is expected to be in operation in October 1996.\n(8) On November 30, 1995, Entergy Corporation's subsidiary, Entergy Power Development Corporation, purchased through a consortium 20.8% of Edegel, S.A. for $100 million in equity and $65 million of debt guaranteed by Entergy Corporation. Edegel S.A. is a privatization project in Lima, Peru consisting of 5 hydroelectric generation stations (totaling 539 MW) and one thermal station (154 MW) supporting 345 miles of transmission lines. An additional 100 MW of thermal load capacity is required to be installed within one year. The additional plant is expected to be financed by Edegel S.A.\n(9) In early October 1995, FERC issued an order granting exempt wholesale generator status to Entergy Power Marketing Corporation (EPM), a wholly owned subsidiary of Entergy Corporation. EPM was created during 1995 to become a buyer and seller of electrical energy and its generating fuels. In February 1996, FERC approved market-based rate sales of electricity by EPM. Such approval will allow EPM to begin providing wholesale customers with a variety of products including physical and financial trading. Pending approval from the SEC, EPM expects to begin financial trading by the summer of 1996.\nEntergy Corporation's net investment in nonregulated subsidiaries, reduced by accumulated losses, as of December 31, 1995 and 1994, is as follows:\nNet Investment Nonregulated Subsidiary 1995* 1994 ----------------------- --------- -------- (In Millions)\nEntergy Power Development $ 180.6 $ 80.8 Corporation Entergy Power, Inc. 173.1 154.4 Entergy Enterprises, Inc. 112.0 22.2 Entergy Argentina S.A., Ltd. 42.0 41.1 Entergy Transener 19.0 22.7 Entergy Argentina 17.4 17.1 Entergy S.A. 11.4 13.3 -------- -------- Total $ 555.5 $351.6 ======== =======\n* Excludes Entergy Corporation's equity investment in CitiPower completed on January 5, 1996. See \"CitiPower Acquisition\" below.\nIn 1995, Entergy Corporation's nonregulated investments reduced consolidated net income by approximately $64.8 million. In the near term, these investments are unlikely to have a positive effect on Entergy Corporation's earnings, but management believes that these investments will contribute to future earnings growth. Certain of these investments may involve a higher degree of risk than domestic regulated utility enterprises.\nInternational operations are subject to the risks inherent in conducting business abroad, including possible nationalization or expropriation, price and currency exchange controls, limitations on foreign participation in local energy-related enterprises, and other restrictions. Changes in the relative value of currencies occur from time to time and their effects may be favorable or unfavorable on results of operations. In addition, there are exchange control restrictions in certain countries relating to repatriation of earnings.\nCitiPower Acquisition\nOn January 5, 1996, Entergy Corporation finalized its acquisition of CitiPower, an electric distribution company serving Melbourne, Australia, and surrounding suburbs. The purchase price of CitiPower was approximately $1.2 billion, of which $294 million represented an equity investment by Entergy Corporation, and the remainder represented debt. Entergy Corporation funded the majority of the equity portion of the investment by using $230 million of its $300 million line of credit. CitiPower serves approximately 234,500 customers, the majority of which are commercial customers. At the time of the acquisition, CitiPower had 846 employees.\nSelected Data\nSelected domestic customer and sales data for 1995 are summarized in the following tables:\n1995 - Selected Electric Energy Sales Data\nNOPSI sold 16,782,805 MCF of natural gas to retail customers in 1995. Revenues from natural gas operations for each of the three years in the period ended December 31, 1995, were material for NOPSI, but not material for the System (see \"INDUSTRY SEGMENTS\" below for a description of NOPSI's business segments).\nGSU sold 6,476,496 MCF of natural gas to retail customers in 1995. Revenues from natural gas operations for each of the three years in the period ended December 31, 1995, were not material for GSU.\nSee \"ENTERGY CORPORATION AND SUBSIDIARIES SELECTED FINANCIAL DATA - - - - - FIVE-YEAR COMPARISON,\" and \"SELECTED FINANCIAL DATA - FIVE-YEAR COMPARISON OF AP&L, GSU, LP&L, MP&L, NOPSI, and SYSTEM ENERGY,\" (which follow each company's financial statements in this report) for further information with respect to operating statistics.\nEmployees\nAs of December 31, 1995, Entergy had 13,521 employees as follows:\nFull-time: Entergy Corporation - AP&L 1,647 GSU 1,833 LP&L 1,082 MP&L 892 NOPSI 489 System Energy - Entergy Operations 4,102 Entergy Services 2,529 Other Subsidiaries 869 ------ Total Full-time 13,443 Part-time 78 ------ Total Entergy System 13,521 ====== Competition\nRefer to \"MANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS - SIGNIFICANT FACTORS AND KNOWN TRENDS\" for a detailed discussion of competitive challenges Entergy faces in the utility industry.\nCAPITAL REQUIREMENTS AND FUTURE FINANCING\nConstruction expenditures by company (including environmental expenditures, which are immaterial, and AFUDC, but excluding nuclear fuel) for the period 1996-1998 are estimated as follows:\nNo significant construction costs are expected in connection with the System's generating facilities. Actual construction costs may vary from these estimates because of a number of factors, including changes in load growth estimates, changes in environmental regulations, modifications to nuclear units to meet regulatory requirements, increasing costs of labor, equipment and materials, and cost of capital. In addition to construction expenditure requirements, the System must meet scheduled long-term debt and preferred stock maturities and cash sinking fund requirements. See Notes 4, 5, and 6 to the financial statements for further capital requirements and financing information.\nEntergy Corporation's primary capital requirements are to invest periodically in, or make loans to, its subsidiaries and to invest in new energy-related enterprises. See \"MANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS - LIQUIDITY AND CAPITAL RESOURCES,\" for additional discussion of Entergy Corporation's current and future planned investments in its subsidiaries and financial sources for such investments. One source of funds for Entergy is dividend distributions from its subsidiaries. Certain events could limit the amount of these distributions. Such events include River Bend rate appeals and pending litigation with Cajun. Substantial write-offs or charges resulting from adverse rulings in these matters could adversely affect GSU's ability to continue to pay dividends. See Notes 2 and 8 to the financial statements regarding River Bend rate appeals and pending litigation with Cajun.\nCertain System Financial and Support Agreements\nUnit Power Sales Agreement (AP&L, LP&L, MP&L, NOPSI, and System Energy)\nThe Unit Power Sales Agreement allocates capacity and energy from System Energy's 90% ownership and leasehold interests in Grand Gulf 1 (and the related costs) to AP&L (36%), LP&L (14%), MP&L (33%), and NOPSI (17%). AP&L, LP&L, MP&L, and NOPSI make payments to System Energy for their respective entitlements of capacity and energy on a full cost-of-service basis regardless of the quantity of energy delivered, so long as Grand Gulf 1 remains in commercial operation. Payments under the Unit Power Sales Agreement are System Energy's only source of operating revenues. The financial condition of System Energy depends upon the continued commercial operation of Grand Gulf 1 and the receipt of payments from AP&L, LP&L, MP&L, and NOPSI. Payments made by AP&L, LP&L, MP&L, and NOPSI under the Unit Power Sales Agreement are generally recovered through rates. In the case of AP&L and LP&L, payments are also recovered through sales of electricity from their respective retained shares of Grand Gulf 1. See Note 1 to the financial statements for further information regarding retained shares.\nAvailability Agreement (AP&L, LP&L, MP&L, NOPSI, and System Energy)\nThe Availability Agreement among System Energy and AP&L, LP&L, MP&L, and NOPSI was entered into in 1974 in connection with the financing by System Energy of Grand Gulf. The agreement provided that System Energy would join in the agreement among AP&L, LP&L, MP&L, and NOPSI for the sharing of generating capacity and other capacity and energy resources on or before the date on which Grand Gulf 1 was placed in commercial operation. It also provided that System Energy would make available to AP&L, LP&L, MP&L, and NOPSI all capacity and energy available from System Energy's share of Grand Gulf.\nAP&L, LP&L, MP&L, and NOPSI also agreed severally to pay System Energy monthly for the right to receive capacity and energy available from Grand Gulf in amounts that (when added to any amounts received by System Energy under the Unit Power Sales Agreement, or otherwise) would at least equal System Energy's total operating expenses for Grand Gulf (including depreciation at a specified rate) and interest charges.\nAs amended to date, the Availability Agreement provides that:\n- the obligations of AP&L, LP&L, MP&L, and NOPSI for payments for Grand Gulf 1 become effective upon commercial operation of Grand Gulf 1 on July 1, 1985;\n- the sale of capacity and energy generated by Grand Gulf may be governed by a separate power purchase agreement among System Energy and AP&L, LP&L, MP&L, and NOPSI;\n- the September 1989 write-off of System Energy's investment in Grand Gulf 2, amounting to approximately $900 million, will be amortized for Availability Agreement purposes over 27 years rather than in the month the write-off was recognized on System Energy's books; and\n- the allocation percentages under the Availability Agreement are fixed as follows: AP&L - 17.1%; LP&L - 26.9%; MP&L - 31.3%; and NOPSI - 24.7%.\nAs noted above, the Unit Power Sales Agreement provides for different allocation percentages for sales of capacity and energy from Grand Gulf 1. However, the allocation percentages under the Availability Agreement remain in effect and would govern payments made under such agreement in the event of a shortfall of funds available to System Energy from other sources, including payments by AP&L, LP&L, MP&L, and NOPSI to System Energy under the Unit Power Sales Agreement.\nSystem Energy has assigned its rights to payments and advances from AP&L, LP&L, MP&L, and NOPSI under the Availability Agreement as security for its first mortgage bonds and reimbursement obligations to certain banks providing the letters of credit in connection with the equity funding of the sale and leaseback transactions described in Note 9 to the financial statements under \"Sale and Leaseback Transactions - Grand Gulf 1 Lease Obligations (System Energy).\" In these assignments, AP&L, LP&L, MP&L, and NOPSI further agreed that, in the event they were prohibited by governmental action from making payments under the Availability Agreement (if, for example, FERC reduced or disallowed such payments as constituting excessive rates), they would then make subordinated advances to System Energy in the same amounts and at the same times as the prohibited payments. System Energy would not be allowed to repay these subordinated advances so long as it remained in default under the related indebtedness or in other similar circumstances.\nEach of the assignment agreements relating to the Availability Agreement provides that AP&L, LP&L, MP&L, and NOPSI shall make payments directly to System Energy. However, if there is an event of default, AP&L, LP&L, MP&L, and NOPSI must make those payments directly to the holders of indebtedness that are the beneficiaries of such assignment agreements. The payments must be made pro rata according to the amount of the respective obligations secured.\nThe obligations of AP&L, LP&L, MP&L, and NOPSI to make payments under the Availability Agreement are subject to the receipt and continued effectiveness of all necessary regulatory approvals. Sales of capacity and energy under the Availability Agreement would require that the Availability Agreement be submitted to FERC for approval with respect to the terms of such sale. No such filing with FERC has been made because sales of capacity and energy from Grand Gulf are being made pursuant to the Unit Power Sales Agreement. Other aspects of the Availability Agreement, including the obligations of AP&L, LP&L, MP&L, and NOPSI to make subordinated advances, are subject to the jurisdiction of the SEC under PUHCA, whose approval has been obtained. If, for any reason, sales of capacity and energy are made in the future pursuant to the Availability Agreement, the jurisdictional portions of the Availability Agreement would be submitted to FERC for approval.\nSince commercial operation of Grand Gulf 1 began, payments under the Unit Power Sales Agreement to System Energy have exceeded the amounts payable under the Availability Agreement. Accordingly, no payments under the Availability Agreement by AP&L, LP&L, MP&L, and NOPSI have ever been required. In the event such payments were required, the ability of AP&L, LP&L, MP&L, and NOPSI to recover from their customers amounts paid under the Availability Agreement, or under the assignments thereof, would depend upon the outcome of rate proceedings before state and local regulatory authorities. In view of the controversies that arose over the allocation of capacity and energy from Grand Gulf 1 pursuant to the Unit Power Sales Agreement, opposition to full recovery would be likely and the outcome of such proceedings, should they occur, is not predictable.\nCapital Funds Agreement (Entergy Corporation and System Energy)\nSystem Energy and Entergy Corporation have entered into the Capital Funds Agreement whereby Entergy Corporation has agreed to supply System Energy with sufficient capital to (1) maintain System Energy's equity capital at an amount equal to a minimum of 35% of its total capitalization (excluding short-term debt) and (2) permit the continued commercial operation of Grand Gulf 1 and pay in full all indebtedness for borrowed money of System Energy when due under any circumstances.\nEntergy Corporation has entered into various supplements to the Capital Funds Agreement, and System Energy has assigned its rights under such supplements as security for its first mortgage bonds and for reimbursement obligations to certain banks providing letters of credit in connection with the equity funding of the sale and leaseback transactions described in Note 9 to the financial statements under \"Sale and Leaseback Transactions - Grand Gulf 1 Lease Obligations (System Energy).\" Each such supplement provides that permitted indebtedness for borrowed money incurred by System Energy in connection with the financing of Grand Gulf may be secured by System Energy's rights under the Capital Funds Agreement on a pro rata basis (except for the Specific Payments, as defined below). In addition, in the supplements to the Capital Funds Agreement relating to the specific indebtedness being secured, Entergy Corporation has agreed to make cash capital contributions directly to System Energy sufficient to enable System Energy to make payments when due on such indebtedness (Specific Payments). However, if there is an event of default, Entergy Corporation must make those payments directly to the holders of indebtedness benefiting from the supplemental agreements. The payments (other than the Specific Payments) must be made pro rata according to the amount of the respective obligations benefiting from the supplemental agreements.\nRATE MATTERS AND REGULATION\nRate Matters\nThe Operating Companies' retail rates are regulated by state and\/or local regulatory authorities, as described below. FERC regulates their wholesale rates (including intrasystem sales pursuant to the System Agreement) and interstate transmission of electricity, as well as rates for System Energy's sales of capacity and energy from Grand Gulf 1 to AP&L, LP&L, MP&L, and NOPSI pursuant to the Unit Power Sales Agreement.\nWholesale Rate Matters\nSystem Energy\nAs described above under \"Certain System Financial and Support Agreements,\" System Energy recovers costs related to its interest in Grand Gulf 1 through rates charged to AP&L, LP&L, MP&L, and NOPSI for capacity and energy under the Unit Power Sales Agreement.\nOn December 12, 1995, System Energy implemented a $65.5 million rate increase, subject to refund. Refer to Note 2 for a discussion of the rate increase filed by System Energy with FERC.\nEntergy Power\nIn 1990, authorizations were obtained from the SEC, FERC, the APSC, and the Public Service Commission of Missouri for Entergy Power to purchase AP&L's interest in Independence 2 and Ritchie 2, and to begin marketing the capacity and energy from the units in certain wholesale markets. The SEC order was appealed to the D.C. Circuit by various intervenors. The D.C. Circuit reversed a portion of the SEC order and remanded the case to the SEC for consideration of the effect of the transfers on the System's future costs of replacement generating capacity and fuel. On September 9, 1993, the City of New Orleans and the LPSC each requested a hearing. However, on January 5, 1994, the City of New Orleans withdrew from the proceeding, pursuant to its settlement with NOPSI of various issues related to the Merger. In November 1995, the SEC issued an order in which the SEC reaffirmed its prior order authorizing the acquisition and formation of Entergy Power and denying the LPSC's request for a hearing. The November 1995 order was not appealed, and the statutory period for such an appeal has expired.\nIn a related matter, on August 20, l990, the City of New Orleans filed a complaint against Entergy Corporation, AP&L, LP&L, MP&L, NOPSI, and System Energy, requesting that FERC investigate AP&L's transfer of its interest in Independence 2 and Ritchie 2 to Entergy Power and the effect of the transfer on AP&L, LP&L, MP&L, NOPSI, and their ratepayers. On October 20, 1995, the D.C. Circuit affirmed FERC's original orders that the transfer and its effect on current rates was prudent. However, a determination of the prudency of the transfer on future replacement costs was deferred until a time when the need for such replacement capacity occurs.\nSystem Agreement (Energy Corporation, AP&L, GSU, LP&L, MP&L, NOPSI, and System Energy)\nAP&L, GSU, LP&L, MP&L, and NOPSI engage in the coordinated planning, construction, and operation of generation and transmission facilities pursuant to the terms of the System Agreement as described under \"PROPERTY - Generating Stations,\" below.\nIn connection with the Merger, FERC approved certain rate schedule changes to integrate GSU into the System Agreement. Certain commitments were also adopted to assure that the ratepayers of AP&L, LP&L, MP&L, and NOPSI will not be allocated higher costs. Such commitments included: (1) a tracking mechanism to protect these companies from certain unexpected increases in fuel costs; (2) the exclusion of GSU from the distribution of profits from power sales contracts entered into prior to the Merger; (3) a methodology to estimate the cost of capital in future FERC proceedings; and (4) a stipulation that these companies be insulated from certain direct effects on capacity equalization payments if GSU should acquire Cajun's 30% share in River Bend. See \"Regulation - Other Regulation and Litigation,\" for information on appeals of FERC Merger orders and related pending rate schedule changes.\nIn the December 15, 1993, order approving the Merger, FERC also initiated a new proceeding to consider whether the System Agreement permits certain out-of-service generating units to be included in reserve equalization calculations under Service Schedule MSS-1 of that agreement. In connection with this proceeding, the LPSC and the MPSC submitted testimony seeking retroactive refunds for LP&L and MP&L (estimated at $22.6 million and $13.2 million, respectively). The FERC staff subsequently submitted testimony concluding that Entergy's treatment was reasonable. However, because it concluded that Entergy's treatment violated the tariff, FERC staff maintained that refunds of approximately $7.2 million should be ordered. Entergy submitted testimony on September 23, 1994, describing the potential impacts (not including interest) on Service Schedule MSS-1 calculations if extended reserve shutdown units were not included in the MSS-1 calculations during the period 1987 through 1993. Under such a theory, LP&L and MP&L would have been overbilled by $10.6 and $8.8 million respectively, and AP&L and NOPSI would have been underbilled by $6.3 and $13.1 million respectively. The amounts potentially subject to refund will continue to accrue while the case is pending.\nOn March 3, 1995, a FERC ALJ issued an opinion holding that the practice of including the out-of-service units in the reserve equalization calculations during the period 1987 through 1993 was not permitted by Service Schedule MSS-1 and, therefore, constituted a violation of the System Agreement. However, the ALJ found that the violation was in good faith and had benefited the customers of the System as a whole. Accordingly, the ALJ recommended that no retroactive refunds should be ordered. The ALJ also held that the System Agreement should be amended to allow out-of-service units to be included in reserve equalization as proposed in an offer of settlement filed by Entergy on February 16, 1994. The ALJ's opinion is subject to review by FERC. If FERC concurs with the finding that the System Agreement was violated, it would have the discretion to order that refunds be made. If that were to occur, certain Operating Companies may be required to refund some or all of the amount by which they were underbilled pursuant to the System Agreement. The Operating Companies cannot determine at this time whether they would be authorized to recover through retail rates any amounts associated with refunds that might be ordered by FERC in this proceeding. The matter remains pending before FERC.\nOn March 14, 1995, the LPSC filed a complaint with FERC alleging that the System Agreement results in unjust and unreasonable rates and requested that FERC order a hearing on this matter. The LPSC contends that the failure of the System Agreement to exclude curtailable load from the determination of an Operating Company's responsibility for reserve equalization and transmission equalization costs results in an unjust and unreasonable cost allocation to the Operating Companies that does not cause these costs to be incurred, and also results in cross- subsidization among the Operating Companies. Further, the LPSC alleges that the mechanism by which the Operating Companies purchase energy under the System Agreement results in unjust and unreasonable rates because it does not permit Operating Companies that engage in real time pricing to be charged the marginal cost of the energy generated for the real time pricing customer. In May 1995, the LPSC amended its original complaint and Entergy subsequently filed an answer to the LPSC's amended complaint. The LPSC's amended complaint asserts that the System Agreement should be revised to exclude curtailable load from the cost allocation determination due to conflicts with federal policies under PURPA and with Entergy's system planning philosophy. Entergy's response asserts that both the provisions under PURPA and the Entergy system planning philosophy referred to in the LPSC's amended complaint are applicable only to retail sales.\nIn June 1995, the APSC filed a complaint with FERC alleging that, because of changed circumstances, FERC's allocation of nuclear decommissioning costs in the System is no longer just and reasonable. The APSC proposes that the System Agreement be amended to provide a new schedule that would equalize nuclear decommissioning costs according to load responsibility among the pre-merger operating companies.\nOpen Access Transmission (Entergy Corporation, AP&L, GSU, LP&L, MP&L, and NOPSI)\nOn August 2, 1991, Entergy Services, as agent for AP&L, LP&L, MP&L, NOPSI, and Entergy Power, submitted to FERC (1) proposed tariffs that, subject to certain conditions, would provide to electric utilities \"open access\" to the System's integrated transmission system, and (2) rate schedules providing for sales of wholesale power at market- based rates. FERC approved the filing in August 1992, and various parties filed appeals with the D.C. Circuit. The case was remanded to FERC in July 1994 for further proceedings. On October 31, 1994, Entergy Services as agent for AP&L, GSU, LP&L, MP&L, and NOPSI filed revised transmission tariffs. On January 6, 1995, FERC issued an order accepting the tariffs for filing and made them effective, subject to refund. These tariffs provide both point-to-point and network transmission service, and are intended to provide \"comparability of service\" over the Entergy transmission network. In that order FERC also ordered that Entergy Power's market pricing authority be investigated, thereby making Entergy Power's market price rate schedules subject to refund. An order in the market price rate investigation is expected to be issued by January 1997. Entergy expects that no refunds relating to market price rates will be required.\nOn March 29, 1995, FERC issued a supplemental notice of proposed rulemaking (Mega-NOPR) which would require public utilities to provide non-discriminatory open access transmission service to wholesale customers, and which would also provide guidance on the recovery of wholesale and retail stranded costs. Under the proposal, public utilities would be required to file transmission tariffs for both point- to-point and network service. Model transmission tariffs were included in the proposal. With regard to pending proceedings, including Entergy's tariff proceeding, FERC directed the parties to proceed with their cases while taking into account FERC's views expressed in the proposed rule. Hearings relating to Entergy Services' open access tariffs concluded on February 22, 1996.\nIn September 1995 and January 1996, Entergy Services filed offers of partial settlement accepting certain provisions of the transmission tariffs contained in the Mega-NOPR and resolving certain rate issues. The remaining rate and tariff issues will be resolved as part of the FERC's rulemaking in the Mega-NOPR, or after scheduled hearings. In August 1995, EPM filed an application for permission to make market- based sales, but subsequently asked that action not be taken on that request until the open access transmission service proceeding discussed above is resolved. On December 13, 1995, Entergy Services filed revised transmission tariffs in a separate proceeding proposing terms and conditions for open access transmission service that are substantially identical to the terms and conditions contained in the Mega-NOPR transmission tariffs with rates to be the same as those determined in the pending proceeding. On February 14, 1996, FERC accepted for filing the revised transmission tariffs making rates subject to the outcome of the pending proceeding and conditionally accepted EPM's application for market based sales.\nWholesale Contract (AP&L)\nIn March 1994, North Little Rock, Arkansas awarded to AP&L a wholesale power contract that will provide estimated revenues of $347 million over 11 years. Under the contract, the price per KWh was reduced 18% with increases in price through the year 2004. AP&L, which has been serving North Little Rock for over 40 years, was awarded the contract after intense bidding with several competitors. On May 22, 1994, FERC accepted the contract. Rehearings were requested by one of AP&L's competitors. In September 1995, FERC denied the petition for rehearing.\nRetail Rate Matters\nGeneral (AP&L, GSU, LP&L, MP&L, and NOPSI)\nCertain costs related to Grand Gulf 1, Waterford 3, and River Bend were phased into retail rates over a period of years in order to avoid the \"rate shock\" associated with increasing rates to reflect all such costs at once. The deferral period in which costs are incurred but not currently recovered has expired for all of these programs, and AP&L, GSU, LP&L, MP&L, and NOPSI are now recovering those costs that were previously deferred.\nGSU is involved in several rate proceedings involving, among other things, recovery of costs associated with River Bend. Some rate relief has been received, but GSU has been unable to obtain recognition in rates for a substantial portion of its River Bend investment. Recovery of certain costs was disallowed while other costs were deferred for future recovery, held in abeyance pending further regulatory action, or treated as investments in deregulated assets. Rate proceedings and appeals relating to these issues are ongoing as discussed in \"GSU\" below.\nAs a means of minimizing the need for retail rate increases, the System is committed to containing costs to the greatest degree practicable. In accordance with this retail rate policy, the Operating Companies have agreed to retail rate caps and\/or rate freezes for specified periods of time.\nThe retail regulatory philosophy is shifting in some jurisdictions from traditional cost of service regulation to incentive rate regulation. System management believes incentive and performance-based rate plans encourage efficiencies and productivity while permitting utilities and their customers to share in the resulting benefits. MP&L implemented an incentive-rate plan in March 1994, and, in June 1995, LP&L implemented a performance-based formula rate plan. Recognizing that many industrial customers have energy alternatives, Entergy continues to work with these customers to address their needs. In certain cases, competitive prices are negotiated using variable-rate designs.\nLeast Cost Integrated Resource Planning (AP&L, GSU, LP&L, MP&L, and NOPSI)\nThe System continues to utilize integrated resource planning (IRP), also known as least cost planning, in order to compete more effectively in both retail and wholesale markets. IRP is the development of integrated supply and demand side strategies to meet future electricity demands reliably, at the lowest possible cost, and in a more competitive manner.\nIn 1992, AP&L, LP&L, MP&L, and NOPSI each filed a Least Cost Integrated Resource Plan (LCIRP) with its respective regulator. However, in 1994 the System substantially revised its approach to IRP, and AP&L, LP&L, MP&L, and NOPSI requested that their retail regulators allow for significant changes in the IRP process. At MP&L's request, the MPSC dismissed MP&L's LCIRP filing. Due to the increasingly competitive nature of the electric service market, the System believes that changes in the IRP process are required. Entergy has adopted a streamlined process that focuses on minimizing the cost of incremental resources and maximizing the System's flexibility to adapt its resource plans to the changing environment in which electric utilities now operate.\nOn October 10, 1995, despite Entergy's request, the APSC issued an order requiring that Arkansas utilities file current integrated resource plans at least every three years. In this order, the APSC emphasized that planning processes must continue to evolve and publicly available information on utility resource plans must be maintained. The LPSC has established generic hearings to address IRP issues for all electric utilities within its jurisdiction. These proceedings are currently ongoing. The Council has suspended the requirement to file an LCIRP with the Council and has received testimony and held public hearings regarding the revision of its IRP Ordinance. LP&L and NOPSI are awaiting an order from the Council that would resolve the matter of IRP. Currently, the PUCT does not have formal IRP rules in place. Legislation passed in 1995 requires that the PUCT have IRP rules in place by September of 1996. This rulemaking process has been initiated by the PUCT, and GSU is actively participating in this process.\nIn the fourth quarter of 1995, the System provided to its retail regulators (the APSC, the Council, the LPSC, the MPSC, and the PUCT) a new IRP for informational purposes only. The new IRP provides for a flexible resource strategy to meet the System's additional resource requirements over the next ten years. The IRP provides for the utilization of capacity currently in extended reserve shutdown to meet additional load growth, but also provides the flexibility to rely on short-term power purchases, upgrades to existing nuclear capacity, or cogeneration when these resources are more economical.\nAP&L\nRate Freeze\nIn connection with the settlement of various issues related to the Merger, AP&L agreed that it will not request any general retail rate increase that would take effect before November 3, 1998, except for certain instances. See Note 2 for a discussion of the rate freeze as well as other aspects of the settlement agreement between AP&L and the APSC.\nRecovery of Grand Gulf 1 Costs\nUnder the settlement agreement entered into with the APSC in 1985 and amended in 1988, AP&L agreed to retain a portion of its Grand Gulf l-related costs, recover a portion of such costs currently, and defer a portion of such costs for future recovery. In 1995 and subsequent years, AP&L retains 22% of its 36% interest in Grand Gulf 1 costs and recovers the remaining 78%. Deferrals ceased in l990, and AP&L is recovering a portion of the previously deferred costs each year through l998. As of December 31, l995, the balance of deferred costs was $360 million. AP&L is permitted to recover on a current basis the incremental costs of financing the unrecovered deferrals.\nAP&L has the right to sell capacity and energy from its retained share of Grand Gulf 1 to third parties and to sell such energy to its retail customers at a price equal to AP&L's avoided energy cost. Proceeds of sales to third parties of AP&L's retained share of Grand Gulf l capacity and energy accrue to the benefit of AP&L's stockholder.\nFuel Adjustment Clause\nAP&L's retail rate schedules include a fuel adjustment clause to recover the excess cost of fuel and purchased power incurred in the second prior month. The fuel adjustment clause also contains a nuclear reserve fund designed to cover the cost of replacement energy during scheduled maintenance and refueling outages at ANO, and an incentive provision that permits over- or under-recovery of the excess cost of replacement energy when ANO is operating or down for reasons other than refueling.\nGSU\nRate Cap and Other Merger-Related Rate Agreements\nIn 1993, the LPSC and the PUCT approved separate regulatory proposals, which included the implementation of a five-year Rate Cap on GSU's retail electric base rates in the respective states and provisions for passing fuel and nonfuel savings created by the Merger on to the customers. See Note 2 for a discussion of the Rate Cap as well as other aspects of the settlement agreement between GSU and the LPSC and the PUCT.\nRecovery of River Bend Costs\nGSU deferred approximately $369 million of River Bend operating costs, purchased power costs, and accrued carrying charges pursuant to a 1986 PUCT accounting order. Approximately $182 million of these costs are being amortized over a 20-year period ending in the year 2009, and the remaining $187 million are not being amortized pending the ultimate outcome of the Rate Appeal as discussed in \"Texas Jurisdiction - River Bend,\" below. As of December 31, 1995, the unamortized balance of these costs was $312 million. Further, GSU deferred approximately $400.4 million of similar costs pursuant to a 1986 LPSC accounting order. These costs, of which approximately $83 million are unamortized as of December 31, 1995, are being amortized over a 10-year period ending in 1998.\nIn accordance with a phase-in plan approved by the LPSC, GSU deferred $294 million of its River Bend costs related to the period February 1988 through February 1991. GSU has amortized $172 million through December 31, 1995, and the remaining $122 million will be recovered over approximately 2.2 years.\nTexas Jurisdiction - River Bend\nIn May 1988, the PUCT granted GSU a permanent increase in annual revenues of $59.9 million resulting from the inclusion in rate base of approximately $1.6 billion of company-wide River Bend plant investment and approximately $182 million of related Texas retail jurisdiction deferred River Bend costs (Allowed Deferrals). In addition, the PUCT disallowed as imprudent $63.5 million of company-wide River Bend plant costs and placed in abeyance, with no finding as to prudence, approximately $1.4 billion of company-wide River Bend plant investment and approximately $157 million of Texas retail jurisdiction deferred River Bend operating and carrying costs.\nAs discussed in Note 2, various appeals of the PUCT's order have been filed. GSU has filed an appeal with the Texas Supreme Court. On February 9, 1996, the Texas Supreme Court agreed to hear the appeal. Oral arguments are scheduled for March 19, 1996.\nAs of December 31, 1995, the River Bend plant costs disallowed for retail ratemaking purposes in Texas, the River Bend plant costs held in abeyance, and the related operating and carrying cost deferrals totaled (net of taxes) approximately $13 million, $276 million (both net of depreciation), and $169 million, respectively. Allowed Deferrals were approximately $83 million, net of taxes and amortization, as of December 31, 1995. GSU estimates it has recorded approximately $182 million of revenues as of December 31, 1995, as a result of the originally ordered rate treatment by the PUCT of these deferred costs. If recovery of the Allowed Deferrals is not upheld, future revenues based upon those allowed deferrals could be lost, and no assurance can be given as to whether or not refunds to customers of revenue received based upon such deferred costs will be required.\nAs discussed in Note 2, as of December 31, 1995, GSU has made no write-offs or reserves for the River Bend-related costs. See below for a discussion of the write-off of deferred operating and carrying costs required under SFAS 121 in 1996. Based on advice from Clark, Thomas & Winters, A Professional Corporation, legal counsel of record in the Rate Appeal, management believes that it is reasonably possible that the case will be remanded to the PUCT, and that the PUCT will be allowed to rule on the prudence of the abeyed River Bend plant costs. Management and legal counsel are unable to predict the amount, if any, of abeyed and previously disallowed River Bend plant costs that ultimately may be disallowed by the PUCT. As of December 31, 1995, a net of tax write-off of up to $289 million could be required if the PUCT ultimately issues an adverse ruling on the abeyed and disallowed plant costs.\nThe following factors support management's position that a loss contingency requiring accrual has not occurred, and that all, or substantially all, of the abeyed plant costs will ultimately be recovered:\n1. The $1.4 billion of abeyed River Bend plant costs have never been ruled imprudent and disallowed by the PUCT; 2. Analysis by Sandlin Associates, management consultants with expertise in the cost of nuclear power plants, which supports the prudence of substantially all of the abeyed construction costs; 3. Historical inclusion by the PUCT of prudent construction costs in rate base; and 4. The analysis of GSU's legal staff, which has considerable experience in Texas rate case litigation.\nAdditionally, based on advice from Clark, Thomas & Winters, A Professional Corporation, legal counsel of record in the Rate Appeal, management believes that it is reasonably possible that the Allowed Deferrals will continue to be recovered in rates, and that it is reasonably possible that the deferred costs related to the $1.4 billion of abeyed River Bend plant costs will be recovered in rates to the extent that the $1.4 billion of abeyed River Bend plant is recovered.\nThe adoption of SFAS 121, \"Accounting for the Impairment of Long- Lived Assets and for Long-Lived Assets to Be Disposed Of\" (SFAS 121), became effective January 1, 1996. SFAS 121 changes the standard for continued recognition of regulatory assets, and as a result in 1996 GSU will be required to write-off $169 million of rate deferrals discussed above. The standard also describes circumstances that may result in assets being impaired and provides criteria for recognition and measurement of asset impairment. See Note 1 for further information regarding SFAS 121.\nNISCO Unrecovered Costs\nIn 1986, the PUCT ordered that the purchased power costs from NISCO in excess of GSU's avoided costs be disallowed. The PUCT disallowance resulted in approximately $12 million to $15 million of unrecovered purchased power costs on an annual basis, which GSU continued to expense as the costs were incurred. In April 1991, the Texas Supreme Court, on the appeal of such order, ordered the PUCT to allow GSU to recover purchased power payments in excess of its avoided cost in future proceedings if GSU established to the PUCT's satisfaction that the payments were reasonable and necessary expenses.\nIn January 1992, GSU applied to the PUCT for a new fixed fuel factor and requested a final reconciliation of fuel and purchased power costs incurred between December 1, 1986 and September 30, 1991. GSU proposed to recover net under-recoveries and interest (including under- recoveries related to NISCO) over a twelve-month period. In June 1993, the PUCT concluded that the purchased power payments made to NISCO in excess of GSU's avoided cost were not reasonably incurred. In October 1993, GSU appealed the PUCT's order to the Travis County District Court where the matter is still pending. As of December 31, 1995, GSU has expensed $119.4 million of unrecovered purchased power costs and deferred revenue pending the appeal of the District Court. No assurance can be given as to the timing or outcome of the appeal.\nPUCT Fuel Cost Review\nOn January 9, 1995, GSU and various parties reached an agreement for the reconciliation of over- and under-recovery of fuel and purchased power expenses for the period October 1, 1991, through December 31, 1993. On April 17, 1995, the PUCT issued a final order approving the settlement. As a result of the PUCT order, $7.6 million of prior period fuel costs were refunded to customers through the fuel adjustment clause.\nRetail Rate Proceedings\nRefer to Note 2 for a discussion of additional retail rate proceedings which have been resolved during the current year and\/or are currently outstanding in the regulatory jurisdictions in which GSU operates.\nFuel Recovery\nGSU's Texas rate schedules include a fixed fuel factor to recover fuel and purchased power costs not recovered in base rates. The fixed factor may be revised every six months in accordance with a schedule set by the PUCT for each utility. To the extent actual costs vary from the fixed factor, refunds or surcharges are required or permitted, respectively. Fuel costs are also subject to reconciliation proceedings every three years. GSU's Louisiana electric rate schedules include a fuel adjustment clause to reflect the cost of fuel and purchased power costs in the second prior month, adjusted by a surcharge for deferred fuel expense arising from the monthly reconciliation of actual fuel cost incurred with fuel revenues billed to customers.\nGSU's Louisiana gas rates include a purchased gas adjustment to recover the cost of purchased gas.\nSteam Customer Contract\nGSU is currently negotiating with its only steam customer whose contract is scheduled to expire in 1997. It is anticipated that GSU will be successful in such negotiations and the contract will be renewed. During 1995 sales to this customer contributed $44.5 million in base revenues to GSU.\nLP&L\nRecovery of Waterford 3 and Grand Gulf 1 Costs\nIn a series of LPSC orders, court decisions, and agreements from late 1985 to mid-1988, LP&L was granted rate relief with respect to costs associated with Waterford 3 and LP&L's share of capacity and energy from Grand Gulf l, subject to certain terms and conditions. With respect to Waterford 3, LP&L was granted an increase aggregating $170.9 million over the period 1985-1988, and LP&L agreed to permanently absorb, and not recover from retail ratepayers, $284 million of its investment in the unit and to defer $266 million of its costs related to the years 1985-1988 to be recovered over approximately 8.6 years beginning in April 1988. As of December 31, 1995, LP&L's unrecovered deferral balance was $26 million.\nWith respect to Grand Gulf l, LP&L agreed to retain, and not recover from retail ratepayers, 18% of its 14% share or, approximately 2.52% of the costs of Grand Gulf l's capacity and energy. LP&L is allowed to recover, through the fuel adjustment clause, 4.6 cents per KWh for the energy related to its retained portion of these costs. Alternatively, LP&L may sell such energy to nonaffiliated parties at prices above the fuel adjustment clause recovery amount, subject to the LPSC's approval.\nPerformance-Based Formula Rate Plan\nIn June 1995, in conjunction with the LPSC's rate review, a performance-based formula rate plan previously proposed by LP&L was approved with certain modifications. At the same time, the LPSC ordered a $49.4 million reduction in base rates. For a discussion of LP&L's approved performance-based formula rate plan, LP&L's subsequent appeal of the LPSC's June 1995 rate order, and the final settlement of this appeal, see Note 2.\nFuel Adjustment Clause\nLP&L's rate schedules include a fuel adjustment clause to reflect the cost of fuel and purchased power in the second prior month. The fuel adjustment also reflects a surcharge for deferred fuel expense arising from the monthly reconciliation of actual fuel cost incurred with fuel revenues billed to customers.\nMP&L\nRetail Rate Proceedings\nRefer to Note 2 for a discussion of the retail rate proceedings which have been resolved during the current year and\/or are currently outstanding in the regulatory jurisdictions in which MP&L operates.\nRate Freeze\nIn connection with the settlement of various issues related to the Merger, MP&L agreed that it will not request any general retail rate increase to take effect before November 3, 1998, except for certain instances. See Note 2 for a discussion of the rate freeze as well as other aspects of the settlement agreement between MP&L and the MPSC.\nRecovery of Grand Gulf 1 Costs\nIn 1988 the MPSC granted MP&L an annual base rate increase of approximately $326.5 million in connection with its allocated share of Grand Gulf 1 costs. The MPSC also provided for the deferral of a portion of such costs that were incurred each year through 1992, and recovery of these deferrals over a period of six years ending in 1998. As of December 31, 1995, the uncollected balance of MP&L's deferred costs was approximately $378 million. MP&L is permitted to recover the carrying charges on all deferred amounts on a current basis.\nFormula Rate Plan\nUnder a formulary incentive rate plan (Formula Rate Plan) effective March 25, 1994, MP&L's earned rate of return is calculated automatically every 12 months and compared to and adjusted against a benchmark rate of return (calculated under a separate formula within the Formula Rate Plan). The Formula Rate Plan allows for periodic small adjustments in rates based on a comparison of actual earned returns to benchmark returns and upon certain performance factors. Pursuant to a stipulation with the MPSC's Public Utilities Staff, MP&L did not request an adjustment in rates based on its earned rate of return for the 12-months ended December 31, 1994.\nFuel Adjustment Clause\nMP&L's rate schedules include a fuel adjustment clause that recovers changes in cost of fuel and purchased power. The monthly fuel adjustment rate is based on projected sales and costs for the month, adjusted for differences between actual and estimated costs and KWh sales for the second prior month.\nNOPSI\nRecovery of Grand Gulf 1 Costs\nUnder NOPSI's various Rate Settlements with the Council in 1986, 1988, and 1991, NOPSI agreed to absorb and not recover from ratepayers a total of $96.2 million of its Grand Gulf 1 costs. NOPSI was permitted to implement annual rate increases in decreasing amounts each year through 1995, and to defer certain costs and related carrying charges, for recovery on a schedule extending from 1991 through 2001. As of December 31, 1995, the uncollected balance of NOPSI's deferred costs was $171 million. The 1994 NOPSI Settlement did not affect the scheduled Grand Gulf 1 phase-in rate increases.\n1994 NOPSI Settlement\nIn a settlement with the Council that was approved on December 29, 1994, NOPSI agreed to reduce electric and gas rates and issue credits and refunds to customers. Effective January 1, 1995, NOPSI implemented a $31.8 million permanent reduction in electric base rates and a $3.1 million permanent reduction in gas base rates. The 1994 NOPSI Settlement also required NOPSI to credit its customers $25 million over a 21-month period, beginning January 1, 1995, in order to resolve disputes with the Council regarding the interpretation of the 1991 NOPSI Settlement. See Note 2 for additional discussion of the rate reductions and refunds ordered by the Council in the 1994 NOPSI settlement, as well as the 1995 and 1996 annual earnings reviews required by the Council.\nFuel Adjustment Clause\nNOPSI's electric rate schedules include a fuel adjustment clause to reflect the cost of fuel in the second prior month, adjusted by a surcharge for deferred fuel expense arising from the monthly reconciliation of actual fuel incurred with fuel cost revenues billed to customers. The adjustment, on a monthly basis, also reflects the difference between nonfuel Grand Gulf 1 costs paid by NOPSI and the estimate of such costs provided in NOPSI's Grand Gulf 1 Rate Settlements. NOPSI's gas rate schedules include an adjustment to reflect gas costs in excess of those collected in base rates, adjusted by a surcharge similar to that included in the electric fuel adjustment clause.\nRegulation\nFederal Regulation (Entergy Corporation, AP&L, GSU, LP&L, MP&L, NOPSI, and System Energy)\nPUHCA\nEntergy Corporation is a public utility holding company registered under PUHCA. As such, Entergy Corporation and its various direct and indirect subsidiaries (with the exception of its EWG and foreign utility subsidiaries) are subject to the broad regulatory provisions of that Act. Except with respect to investments in certain domestic power projects, foreign utility company projects, and telecommunication projects, PUHCA limits the operations of a registered holding company system to a single, integrated public utility system, plus additional systems and businesses as provided by that section. See \"MANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS - SIGNIFICANT FACTORS AND KNOWN TRENDS,\" for a discussion of the Telecommunications Act.\nEntergy Corporation and other electric utility holding companies, have supported legislation in the United States Congress which would repeal PUHCA, which requires detailed oversight by the SEC of many business practices and activities of utility holding companies and their subsidiaries. The proposed legislation would transfer certain aspects of the oversight of public utility holding companies from the SEC to FERC.\nEntergy believes that PUHCA inhibits its ability to compete in the evolving electric energy marketplace and largely duplicates the oversight activities already performed by FERC and state and local regulators. In June 1995, the SEC adopted a report proposing options for the repeal or significant modification of PUHCA and proposed rule changes that would reduce the regulations governing utility holding companies. One rule change adopted as a result of such proposals eliminated the requirement to receive prior authorization for capital contributions made by a parent company to its nonutility subsidiary companies and for financing its non utility subsidiary companies. Such rule was appealed to the D.C. Circuit by the City of New Orleans where the appeal was denied in January 1996.\nFederal Power Act\nThe Operating Companies, System Energy, and Entergy Power are subject to the Federal Power Act as administered by FERC and the DOE. The Federal Power Act provides for regulatory jurisdiction over the licensing of certain hydroelectric projects, the transmission and wholesale sale of electric energy in interstate commerce, and certain other activities, including accounting policies and practices. Such regulation includes jurisdiction over the rates charged by System Energy for capacity and energy provided to AP&L, LP&L, MP&L, and NOPSI from Grand Gulf 1.\nAP&L holds a license for two hydroelectric projects (70 MW) that was renewed on July 2, 1980. This license, granted by FERC, will expire in February 2003.\nRegulation of the Nuclear Power Industry (Entergy Corporation, AP&L, GSU, LP&L, and System Energy)\nGeneral\nUnder the Atomic Energy Act of 1954 and the Energy Reorganization Act of 1974, operation of nuclear plants is intensively regulated by the NRC, which has broad power to impose licensing and safety-related requirements. In the event of non-compliance, the NRC has the authority to impose fines or shut down a unit, or both, depending upon its assessment of the severity of the situation, until compliance is achieved. AP&L, GSU, LP&L, and System Energy, as owners of all or a portion of ANO, River Bend, Waterford 3, and Grand Gulf 1, respectively, and Entergy Operations, as the operator of these units, are subject to the jurisdiction of the NRC. Revised safety requirements promulgated by the NRC have, in the past, necessitated substantial capital expenditures at these nuclear plants, and additional such expenditures could be required in the future.\nThe nuclear power industry faces uncertainties with respect to the cost and long-term availability of sites for disposal of spent nuclear fuel and other radioactive waste, nuclear plant operations, the technological and financial aspects of decommissioning plants at the end of their licensed lives, and requirements relating to nuclear insurance. These matters are briefly discussed below.\nSpent Fuel and Other High-Level Radioactive Waste\nUnder the Nuclear Waste Policy Act of 1982, the DOE is required, for a specified fee, to construct storage facilities for, and to dispose of, all spent nuclear fuel and other high-level radioactive waste generated by domestic nuclear power reactors. However, the DOE has not yet identified a permanent storage repository and, as a result, future expenditures may be required to increase spent fuel storage capacity at the plant sites. For further information concerning spent fuel disposal contracts with the DOE, schedules for initial shipments of spent nuclear fuel, current on-site storage capacity, and costs of providing additional on-site storage, see Note 8.\nLow-Level Radioactive Waste\nThe availability and cost of disposal facilities for low-level radioactive waste resulting from normal nuclear plant operations are subject to a number of uncertainties. Under the Low-Level Radioactive Waste Policy Act of 1980, as amended, each state is responsible for disposal of its own waste, and states may participate in regional compacts to fulfill their responsibilities jointly. The States of Arkansas and Louisiana participate in the Central States Compact, and the State of Mississippi participates in the Southeast Compact. Two disposal sites are currently operating in the United States, and until recently both were closed to out-of-region generators. The Barnwell Disposal Facility (Barnwell), located in South Carolina and operated by the Southeast Compact, reopened to out-of-region generators in July 1995. The South Carolina State legislative action reopening Barnwell must be renewed annually. The availability of Barnwell provides only temporary relief from low-level radioactive waste storage and does not alleviate the need to develop new disposal capacity.\nBoth the Central States Compact and the Southeast Compact are working to establish additional disposal sites. The System, along with other waste generators, funds the development costs for new disposal facilities. As of December 1995, the System's cumulative expenditures for the development of new disposal facilities totaled approximately $38 million. Future levels of expenditures cannot be predicted. Until long-term disposal facilities are established, the System will seek continued access to existing facilities. If such access is unavailable, the System will store low-level waste at its nuclear plant sites.\nDecommissioning\nAP&L, GSU, LP&L, and System Energy are recovering from ratepayers portions of their estimated decommissioning costs for ANO, River Bend, Waterford 3, and Grand Gulf 1, respectively. These amounts are deposited in trust funds that, together with the related earnings, can only be used for future decommissioning costs. Estimated decommissioning costs are periodically reviewed and updated to reflect inflation and changes in regulatory requirements and technology, and applications are periodically made to appropriate regulatory authorities to reflect in rates any future changes in projected decommissioning costs. For additional information with respect to decommissioning costs for ANO, River Bend, Waterford 3, and Grand Gulf 1, see Note 8.\nUranium Enrichment Decontamination and Decommissioning Fees\nThe EPAct requires all electric utilities (including AP&L, GSU, LP&L, and System Energy) that have purchased uranium enrichment services from the DOE to contribute up to a total of $150 million annually, adjusted for inflation, up to a total of $2.25 billion over approximately 15 years, for decontamination and decommissioning of enrichment facilities. In accordance with the EPAct, contributions to decontamination and decommissioning funds are recovered through rates in the same manner as other fuel costs. See Note 8 for the estimated annual contributions by the System companies for decontamination and decommissioning fees.\nNuclear Insurance\nThe Price-Anderson Act limits public liability for a single nuclear incident to approximately $8.92 billion. AP&L, GSU, LP&L, and System Energy have protection with respect to this liability through a combination of private insurance and an industry assessment program, and also have insurance for property damage, costs of replacement power, and other risks relating to nuclear generating units. For a discussion of insurance applicable to the nuclear programs of AP&L, GSU, LP&L, and System Energy, see Note 8.\nNuclear Operations\nGeneral (Entergy Corporation, AP&L, GSU, LP&L, and System Energy)\nEntergy Operations operates ANO, River Bend, Waterford 3, and Grand Gulf 1, subject to the owner oversight of AP&L, GSU, LP&L, and System Energy, respectively. AP&L, GSU, LP&L, and System Energy, and the other Grand Gulf 1 and River Bend co-owners, have retained their ownership interests in their respective nuclear generating units. AP&L, GSU, LP&L, and System Energy have also retained their associated capacity and energy entitlements, and pay directly or reimburse Entergy Operations at cost for its operation of the units.\nANO Matters (Entergy Corporation and AP&L)\nEntergy Operations has made inspections and repairs from time to time on ANO 2's steam generators. During the October 1995 inspection, additional cracks in the tubes were discovered. Currently, Entergy Operations is monitoring the development of the cracks and assessing various options for the repair or the replacement of ANO 2's steam generators. See Note 8 for additional information.\nRiver Bend (Entergy Corporation and GSU)\nIn connection with the Merger, GSU filed two applications with the NRC in January 1993 to amend the River Bend operating license. The applications sought the NRC's consent to the Merger and to a change in the licensed operator of the facility from GSU to Entergy Operations. In August 1993 Cajun filed a petition to intervene and a request for a hearing in the proceeding. In January 1994, the presiding NRC Atomic Safety and Licensing Board (ASLB) issued an order granting Cajun's petition to intervene and ordering a hearing on one of Cajun's contentions. In 1994, subsequent to Cajun's intervention in such proceedings, the NRC Staff issued the two license amendments for River Bend, which were effective immediately upon consummation of the Merger. A hearing on the proceeding before the ASLB has been postponed, pending approval of a petition by Cajun to withdraw such a proceeding. On February 14, 1994, Cajun filed with the D.C. Circuit petitions for review of the two license amendments for River Bend. In March 1995, the D.C. Circuit ordered the original NRC order and license amendments be set aside, and remanded the case to the NRC for further consideration. Subsequently, the NRC affirmed its original findings and reissued the two license amendments approving the Merger and the change in the licensed operator of River Bend. Cajun has filed a petition for review with the D. C. Circuit, and oral arguments are expected to be heard in May 1996. These two amendments are in full force and effect, but are subject to the outcome of the two proceedings.\nState Regulation (AP&L, GSU, LP&L, MP&L, and NOPSI)\nGeneral\nEach of the Operating Companies is subject to regulation by state and\/or local regulatory authorities having jurisdiction over the areas in which it operates. Such regulation includes authority to set rates for retail electric and gas service. (See \"RATE MATTERS AND REGULATION - - - - - Rate Matters - Retail Rate Matters,\" above.)\nAP&L is subject to regulation by the APSC and the Tennessee Public Service Commission (TPSC). APSC regulation includes the authority to set rates, determine reasonable and adequate service, fix the value of property used and useful, require proper accounting, control leasing, control the acquisition or sale of any public utility plant or property constituting an operating unit or system, set rates of depreciation, issue certificates of convenience and necessity and certificates of environmental compatibility and public need, and control the issuance and sale of securities. Regulation by the TPSC includes the authority to set standards of service and rates for service to customers in the state, require proper accounting, control the issuance and sale of securities, and issue certificates of convenience and necessity.\nGSU is subject to the jurisdiction of the municipal authorities of incorporated cities in Texas as to retail rates and services within their boundaries, with appellate jurisdiction over such matters residing in the PUCT. GSU is also subject to regulation by the PUCT as to retail rates and services in rural areas, certification of new generating plants, and extensions of service into new areas. GSU is subject to regulation by the LPSC as to electric and gas service, rates and charges, certification of generating facilities and power or capacity purchase contracts, depreciation, accounting, and other matters.\nLP&L is subject to regulation by the LPSC as to electric service, rates and charges, certification of generating facilities and power or capacity purchase contracts, depreciation, accounting, and other matters. LP&L is also subject to the jurisdiction of the Council with respect to such matters within Algiers.\nMP&L is subject to regulation as to service, service areas, facilities, and retail rates by the MPSC. MP&L is also subject to regulation by the APSC as to the certificate of environmental compatibility and public need for the Independence Station.\nNOPSI is subject to regulation by the Council as to electric and gas service, rates and charges, standards of service, depreciation, accounting, issuance of certain securities, and other matters.\nFranchises\nAP&L holds exclusive franchises to provide electric service in 300 incorporated cities and towns in Arkansas. These franchises are unlimited in duration and continue until such a time when the municipalities purchase the utility property. In Arkansas, franchises are considered to be contracts and, therefore, are terminable upon breach of the contract.\nGSU holds non-exclusive franchises, permits, or certificates of convenience and necessity to provide electric and gas service in 55 incorporated villages, cities, and towns in Louisiana and 64 incorporated cities and towns in Texas. GSU ordinarily holds 50-year franchises in Texas and 60-year franchises in Louisiana. GSU's current electric franchises will expire in 2007 - 2036 in Texas and in 2015 - 2046 in Louisiana. The natural gas franchise in the City of Baton Rouge will expire in 2015. In addition, GSU has received from the PUCT a certificate of convenience and necessity to provide electric service to areas within 21 counties in eastern Texas.\nLP&L holds non-exclusive franchises to provide electric service in 116 incorporated villages, cities, and towns. Most of these municipal franchises have 25-year terms, although six municipalities have granted LP&L 60-year franchises. LP&L also supplies electric service in 353 unincorporated communities, all of which are located in parishes in which LP&L holds non-exclusive franchises.\nMP&L has received from the MPSC certificates of public convenience and necessity to provide electric service to areas within 45 counties in western Mississippi, which include a number of municipalities. Under Mississippi statutory law, such certificates are exclusive. MP&L may continue to serve in such municipalities upon payment of a statutory franchise fee, regardless of whether an original municipal franchise is still in existence.\nNOPSI provides electric and gas service in the City of New Orleans pursuant to city ordinances, which state, among other things, that the City has a continuing option to purchase NOPSI's electric and gas utility properties.\nSystem Energy has no distribution franchises. Its business is currently limited to wholesale power sales.\nEnvironmental Regulation\nGeneral\nIn the areas of air quality, water quality, control of toxic substances and hazardous and solid wastes, and other environmental matters, the facilities and operations of the System companies are subject to regulation by various federal, state, and local authorities. The System companies believe they are in substantial compliance with environmental regulations currently applicable to their respective facilities and operations. They have incurred significant costs in meeting environmental protection standards. Because environmental regulations are continually changing, the ultimate compliance costs to the System companies cannot be precisely estimated. However, management currently estimates that ultimate capital expenditures for environmental compliance purposes, including those discussed in \"Clean Air Legislation,\" below, will not be material for the System as a whole.\nClean Air Legislation\nThe Clean Air Act Amendments of 1990 (the Act) set up three programs that affect the System companies: an acid rain program for control of sulfur dioxide (SO2) and nitrogen oxides (NOx), an ozone nonattainment area program for control of NOx and volatile organic compounds, and an operating permits program for administration and enforcement of these and other Clean Air Act programs.\nUnder the acid rain program, no additional control equipment is expected to be required by the System to control SO2. The Act provides \"allowances\" to most of the affected System companies' generating units for emissions based upon past emission levels and operating characteristics. Each allowance is an entitlement to emit one ton of SO2 per year. Under the Act, utilities will be required to possess allowances for SO2 emissions from affected generating units. All of the Entergy company generating units are classified as \"Phase II\" units under the Act and are subject to SO2 allowance requirements beginning in the year 2000. Based on operating history, the System companies are considered \"clean\" utilities and have been allocated more allowances than are currently necessary for normal operations. Management believes that it will be able to operate its units efficiently without installing scrubbers or purchasing allowances from outside sources, and that one or more of the System companies may have excess allowances available for sale.\nThe System companies have installed continuous emission monitoring (CEM) equipment at their fossil generating units to comply with EPA regulations under the Act, and CEM software and computer equipment is currently being updated at AP&L, MP&L, LP&L, and NOPSI generating units. Such CEM equipment resulted in approximately $5.2 million of capital costs during 1995. No material costs for CEM equipment are expected in 1996.\nControl equipment may eventually be required for NOx reductions due to the ozone nonattainment status of the areas served by GSU in and around Beaumont and Houston, Texas. Texas environmental authorities are studying the causes of ozone pollution and will decide during 1996 whether to require controls. If Texas decides to regulate NOx, the cost of such control equipment for the affected GSU plants is estimated at $10.4 million through the year 2000.\nIn accordance with the Act, the EPA promulgated operating permit regulations in 1994 that may set new operating criteria for fossil plants relating to fuels, emissions, and equipment maintenance practices. Some or all Entergy Companies may also have to install additional CEM equipment as a result of these regulations. The cost will be determined on a state-by-state basis as the plants are granted permits during 1996 and 1997. Related capital and operation and maintenance costs are expected to begin in 1996, but are not expected to be material. The authority to impose permit fees under this program has been delegated to the states by the EPA and, depending on the outcomes of various decisions of each state regulatory authority, total permit fees for the System could range from $1.6 to $5.0 million annually.\nOther Environmental Matters\nThe 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 or operators of any such site, to clean-up the site or reimburse such clean-up costs. CERCLA has been interpreted to impose joint and several liability on responsible parties. The System companies sent waste materials to various disposal sites over the years. Also, certain operating procedures and maintenance practices, that historically were not subject to regulation, are now regulated by environmental laws. Some of these sites have been the subject of governmental action under CERCLA, as a result of which the System companies have become involved with site clean-up activities. The System companies have participated to various degrees in accordance with their potential liability in such site clean-ups and have developed experience with clean-up costs. The System companies have established reserves for such environmental clean-up\/restoration activities. In the aggregate, the cost of such remediation is not considered material to the System.\nAP&L\nAP&L has received notices from time to time from the EPA, the Arkansas Department of Pollution Control and Ecology (ADPC&E), and others alleging that it, along with others, may be a PRP for clean-up costs associated with various sites in Arkansas. Most of these sites are neither owned nor operated by any System company. Contaminants at the sites include polychlorinated biphenyls (PCBs), lead, and other hazardous substances.\nIn response to such notices from the EPA and the ADPC&E, the sites discussed below have been remediated:\nAt the EPA's request, AP&L voluntarily performed stabilization activities at the Benton Salvage site in Saline County, Arkansas. While the EPA has not named PRPs for this site, AP&L has negotiated an agreement with the EPA to remove waste stored at the site. AP&L will spend approximately $250,000 to remove and dispose of waste material at the Benton Salvage site. Although GSU and LP&L have had minor involvement in the Benton Salvage site, no remediation action is anticipated by these companies.\nAs a result of an internal investigation, AP&L has identified soil contamination at AP&L-owned sites located in Blytheville and Pine Bluff, Arkansas. The contamination appears to be a result of operating procedures that were performed prior to any applicable environmental regulation. Remediation of the Blytheville and Pine Bluff sites was completed in 1995 at a total cost of approximately $2.25 million.\nReynolds Metals Company (Reynolds) and AP&L notified the EPA in 1989 of possible PCB contamination at two former Reynolds plant sites (Jones Mill and Patterson) in Arkansas to which AP&L had supplied power. Subsequently, AP&L completed remediation at the substations serving the plant sites at a cost of $1.7 million. Additional PCB contamination was found in a portion of a drainage ditch that flows from the Patterson facility to the Ouachita River. Reynolds demanded that AP&L participate in remediation efforts with respect to the ditch. AP&L and independent contractors engaged by AP&L conducted an investigation of the ditch contamination and the possible migration of PCBs from the electrical equipment that AP&L maintained at the plant. The investigation concluded that little, if any, of the contamination was caused by AP&L. AP&L has thus far expended approximately $150,000 on investigation of the ditch. In May 1995, AP&L was named as a defendant in a suit by Reynolds seeking to recover a share of its costs associated with the clean-up of hazardous substances at the Patterson site. Reynolds alleges that it has spent $11.2 million to clean-up the site, and that AP&L bears some responsibility for PCB contamination at the site. AP&L believes that it has no liability for contamination at the Patterson site and is contesting the lawsuit.\nAP&L entered into a Consent Administrative Order, dated February 21, 1991, with the ADPC&E that named AP&L as a PRP for the initial stabilization associated with contamination at the Utilities Services, Inc. state Superfund site located near Rison, Arkansas. This site was found to have soil contaminated by PCBs and pentachlorophenol (a wood preservative). Containers and drums that contained PCBs and other hazardous substances were found at the site. AP&L's share of total remediation costs is estimated to range between $3.0 and $5.0 million. AP&L is attempting to identify and notify other PRPs with respect to this site. AP&L has received assurances that the ADPC&E will use its enforcement authority to allocate remediation expenses among AP&L and any other PRPs that can be identified. Approximately 20 PRPs have been identified to date. AP&L has performed the activities necessary to stabilize the site, at a cost of approximately $350,000. AP&L believes that its potential liability for this site will not be material.\nGSU\nGSU has been designated by the EPA as a PRP for the clean-up of certain hazardous waste disposal sites. GSU is currently negotiating with the EPA and state authorities regarding the clean-up of these sites. Several class action and other suits have been filed in state and federal courts seeking relief from GSU and others for damages caused by the disposal of hazardous waste and for asbestos-related disease allegedly resulting from exposure on GSU premises (see \"Other Regulation and Litigation\" below). While the amounts at issue may be substantial, GSU believes that its results of operations and financial condition will not be materially adversely affected by the outcome of the suits. Through December 31, 1995, $7.9 million has been expended on clean-up activities. As of December 31, 1995, a remaining recorded liability of $21.7 million existed relating to the clean-up of five sites at which GSU has been designated a PRP.\nIn 1971, GSU purchased property near its Sabine generating station, known as the Bailey site, for possible expansion of cooling water facilities. Although it was not known to GSU at the time, the property was utilized by area industries in the 1950's and 1960's as an industrial waste dump. GSU sold the property in 1984. In October 1984, an abandoned waste site on the property was included on the Superfund National Priorities List (NPL) by the EPA. GSU has pursued negotiations with the EPA and is a member of a task force with other PRPs for the voluntary clean-up of the waste site. A Consent Decree has been signed by all PRPs for the voluntary clean-up of the Bailey site. Additional wastes have been discovered at the site since the original clean-up costs were estimated. Remediation of the Bailey site is being redesigned and costs are currently expected to be approximately $33 million. GSU is expected to be responsible for 2.26% of the estimated clean-up cost. Federal and state agencies are presently examining potential liabilities associated with natural resource damages. This matter is currently under negotiation with the other PRPs and the agencies. GSU does not believe that its ultimate responsibility with respect to this site will be material after allowance for the existing clean-up reserve in the amount of $760,000.\nGSU is currently involved in a multi-phased remedial investigation of an abandoned manufactured gas plant (MGP) site, known as the Lake Charles Service Center, located in Lake Charles, Louisiana. The property was the site of an MGP that is believed to have operated from approximately 1916 to 1931. Coal tar, a by-product of the distillation process employed at MGPs, was apparently routed to a portion of the property for disposal. The same area has also been used as a landfill. Under an order issued by the Louisiana Department of Environmental Quality (LDEQ), which is currently stayed, GSU was required to investigate and, if necessary, take remedial action at the site. Preliminary estimates of remediation costs are approximately $20 million. On February 13, 1995, the EPA published a proposed rule adding the Lake Charles Service Center to the NPL. Another PRP has been identified and is believed to have had a role in the ownership and operation of the MGP. Negotiations with that company for joint participation and possible remedial action have been held and are expected to continue. GSU currently is awaiting notification from the EPA before initiating additional clean-up negotiations or actions. GSU does not presently believe that its ultimate responsibility with respect to this site will be material, after allowance for the existing clean-up reserve of $19.8 million.\nGSU along with LP&L has been named as a PRP for an abandoned waste oil recycling plant site in Livingston Parish, Louisiana, known as Combustion, Inc., which is included on the NPL. Although most surface remediation has been completed, additional studies related to residual groundwater contamination are expected to continue in 1996. GSU and LP&L have been named as defendants in a class action lawsuit lodged against a group of PRPs associated with the site. (For information regarding litigation in connection with the Combustion, Inc. site, see \"Other Regulation and Litigation\" below.) GSU does not presently believe that its ultimate responsibility with respect to this site will be material.\nGSU received notification in 1992 from the EPA of potential liability at a site located in Iota, Louisiana. This site was the depository of a variety of wastes, including medical and chemical wastes. In addition to GSU, over 200 parties have been named as PRPs. The EPA has completed remediation at the Iota site. However, it is continuing its investigation of the site and has notified the PRPs of the possibility of this site being linked to other sites. GSU does not believe it is implicated in these other sites. GSU has not received notification of liability or location with regard to the other sites, and does not believe that its ultimate responsibility with respect to these other sites will be material.\nGSU, along with AP&L and LP&L, has been notified of its potential liability with respect to the Benton Salvage site located in Saline County, Arkansas. Although GSU and LP&L have had minor involvement in the Benton Salvage site, no remediation action is anticipated by these companies. See \"AP&L\" above for a discussion of the Benton Salvage site.\nLP&L, NOPSI, and System Energy\nLP&L, NOPSI, and System Energy have received notices from the EPA and\/or the states of Louisiana and Mississippi that one or more than one company may be a PRP for disposal sites that are neither owned nor operated by any System company. In response to such notices the sites discussed below have been remediated:\nLP&L and NOPSI have completed remediation at the Rose Chemical site located in Missouri and the aggregate remaining costs are considered immaterial.\nLP&L, along with AP&L and GSU, was notified in 1990 of its potential liability at the Benton Salvage site located in Saline County, Arkansas. Although GSU and LP&L have been involved in the Benton Salvage site, their contributions are considered minor; and therefore, no remediation action is required by these companies. See \"AP&L\" above for a discussion of the Benton Salvage site.\nThe EPA named LP&L and System Energy as two of the 44 PRPs for the Disposal Systems, Inc. site in Mississippi. The State of Mississippi has indicated that it intends to have the PRPs conduct a clean-up of the Disposal Systems, Inc. site but has not yet taken formal action. LP&L has settled this matter with the EPA. The State of Mississippi is continuing to evaluate whether additional remediation measures are necessary. However, further remediation costs at the Disposal Systems, Inc. site are not expected to be material.\nNOPSI received notice from the EPA with respect to a Mississippi site, known as Pike County, in the fall of 1994. The EPA alleged that NOPSI sold and shipped hazardous waste to the Pike County site during 1983 and 1984. NOPSI has negotiated a final settlement with the EPA for remediation of the site and no further costs are expected.\nFrom 1992 to 1994, LP&L performed site assessments and remedial activities at three retired power plants, known as the Homer, Jonesboro, and Thibodaux municipal sites, previously owned and operated by Louisiana municipalities. LP&L purchased the power plants as part of the acquisition of municipal electric systems after operating them for the last few years of their useful lives. The site assessments indicated some subsurface contamination from fuel oil. LP&L has completed all remediation work to the LDEQ's satisfaction for these three former generating plants, and follow-up sampling has been completed at the Homer site. Sampling at the Jonesboro and Thibodaux sites is expected to be completed in 1996. The costs incurred through December 31, 1995 for the Homer, Jonesboro, and Thibodaux sites are $22,000, $156,000, and $34,000, respectively. Any remaining costs are considered immaterial.\nThere are certain disposal sites in which LP&L and NOPSI have been named by the EPA as PRPs for associated clean-up costs, but management believes no liability exists in connection with these sites for LP&L and NOPSI. Such Louisiana sites include Combustion Inc., an abandoned waste oil recycling plant site located in Livingston Parish (involving at least 70 PRPs, including GSU), and the Dutchtown site (also included on the NPL and involving 57 PRPs). LP&L has found no evidence of its involvement in the Combustion Inc. site. (For information regarding litigation in connection with the Livingston Parish site, see \"Other Regulation and Litigation,\" below). With respect to the Dutchtown site, NOPSI believes it has no liability because the material it sent to this site was not a hazardous substance.\nDuring 1993, the LDEQ issued new rules for solid waste regulation, including regulation of waste water impoundments. LP&L has determined that certain of its power plant waste water impoundments were affected by these regulations and has chosen to upgrade or close them. As a result, a remaining recorded liability in the amount of $10.6 million existed at December 31, 1995, for waste water upgrades and closures to be completed by the end of 1996. Cumulative expenditures relating to the upgrades and closures of waste water impoundments were $5.6 million as of December 31, 1995.\nOther Regulation and Litigation\nMerger (Entergy Corporation and GSU)\nIn July and August 1992, Entergy Corporation and GSU filed applications with FERC, the LPSC, and the PUCT, and Entergy Corporation, Entergy Operations, and Entergy Services filed an application with the SEC under PUHCA, seeking authorization of various aspects of the Merger. In January 1993, GSU filed two applications with the NRC seeking approval of the change in ownership of GSU and an amendment to the operating license for River Bend to reflect its operation by Entergy Operations. All regulatory approvals were obtained in 1993 and the Merger was consummated on December 31, 1993.\nFERC's December 15, 1993, and May 17, 1994, orders approving the Merger were appealed to the D.C. Circuit by Entergy Services, the City, the Arkansas Electric Energy Consumers (AEEC), the APSC, Cajun, the MPSC, the American Forest and Paper Association, the State of Mississippi, the City of Benton and other cities, and Occidental Chemical Corporation (Occidental). Entergy seeks review of FERC's deletion of a 40% cap on the amount of fuel savings GSU may be required to transfer to other Entergy operating companies under a tracking mechanism designed to protect the other companies from certain unexpected increases in fuel costs. The other parties are seeking to overturn FERC's decisions on various grounds, including the issues of whether FERC appropriately conditioned the Merger to protect various interested parties from alleged harm and FERC's reliance on Entergy's transmission tariff to mitigate any potential anticompetitive impacts of the Merger.\nOn November 18, 1994, the D. C. Circuit denied motions filed by Cajun, Occidental, and AEEC for a remand to FERC and a partial summary grant of the petitions for review. At the same time, the D.C. Circuit ordered that the cases be held in abeyance pending FERC's issuance of (1) a final order on remand in the proceedings on Entergy's transmission tariff, see discussion of tariff case in \"RATE MATTERS AND REGULATION - Rate Matters - Wholesale Rate Matters - Open Access Transmission\" above, and (2) a final order on competition issues in the proceedings on the Merger.\nOn December 30, 1993, Entergy Services submitted to FERC tariff revisions to comply with FERC's order dated December 15, 1993, approving the Merger. On February 4, 1994, the APSC and AEEC filed with FERC a joint protest to the compliance filing. They alleged that Entergy must insulate the ratepayers of AP&L, LP&L, MP&L, and NOPSI from all litigation liabilities related to GSU's River Bend nuclear facility. In its May 17, 1994, order on rehearing, FERC addressed Entergy's commitment to insulate the customers of AP&L, LP&L, MP&L, and NOPSI against liability resulting from certain litigation involving River Bend. In response to FERC's clarification of Entergy's commitment, Entergy Services filed a compliance filing on June 16, 1994, which amended certain System Agreement language submitted with the December 30, 1993, filing. APSC and AEEC subsequently filed protests questioning the adequacy of Entergy's June 16, 1994, compliance filing. Entergy filed an answer to the protest reiterating its full compliance with the requirements of FERC's May 17, 1994, order on rehearing. FERC has not yet acted on the compliance filings.\nRequests for rehearing of the SEC order were filed with the SEC by Houston Industries Incorporated and Houston Lighting & Power Company on December 28, 1993, and petitions for review seeking to set aside the SEC order were filed with the D.C. Circuit by these parties and by Cajun in February 1994. The matter has been remanded by the D.C. Circuit to the SEC for further consideration in light of developments at FERC relating to Entergy's transmission tariffs.\nAppeals seeking to set aside the LPSC order related to the Merger were filed in the 19th Judicial District Court for the Parish of East Baton Rouge, Louisiana, by Houston Lighting & Power Company on August 13, 1993, and by the Alliance for Affordable Energy, Inc. on August 20, 1993. Subsequently, on February 9, 1994, Houston Lighting & Power Company filed a motion voluntarily dismissing its appeal. In judgments issued in February and November 1995, the 19th Judicial District Court dismissed the appeals of the Alliance for Affordable Energy, Inc.\nFlowage Easement Suits (AP&L)\nThree lawsuits (subsequently consolidated into one) were filed in the Arkansas District Court by numerous plaintiffs against AP&L and Entergy Services in connection with the operation of two dams during a period of heavy rainfall and flooding in May 1990. The consolidated lawsuits sought approximately $14.4 million in property losses and other compensatory damages, and $500 million in punitive damages. In their responses to these complaints, AP&L and Entergy Services asserted, among other things, that AP&L owns flowage easements giving it the permanent right to inundate the lands owned or occupied by the plaintiffs in connection with the operation of the dams. Rulings issued by the Arkansas District Court in June and November 1991 found that AP&L had the right to enforce its flowage easements and that Entergy Services was entitled to the benefit of AP&L's flowage easements. Such rulings removed from consideration damages in the approximate amount of $13.5 million alleged to have occurred within the areas covered by the easements. As a result, over 300 plaintiffs claiming damage within the easements were dismissed from the consolidated case in December 1991. Certain plaintiffs appealed the Arkansas District Court rulings to the Eighth Circuit, and these appeals were ultimately denied in December 1993. The remaining plaintiffs, to whom the flowage easements did not apply, had obtained a stay and an administrative termination of their claims, pending the outcome of the appeal. On February 10, 1995, such plaintiffs petitioned the Arkansas District Court to reopen the proceedings as to their claims. In March 1995, the Arkansas District Court ordered the reopening of the proceedings relating to the plaintiffs' claims which were previously stayed and administratively terminated, and the claims were subsequently tried. On November 9, 1995, the Arkansas District Court dismissed all remaining plaintiffs' claims, resolving the case in favor of AP&L.\nAsbestos and Hazardous Waste Suits\n(GSU and LP&L)\nA number of plaintiffs who allegedly suffered damage or injury, or are survivors of persons who allegedly died, as a result of exposure to \"hazardous toxic waste\" that emanated from a site in Livingston Parish, sued GSU and approximately 70 other defendants, including LP&L, in 17 suits filed in the Livingston Parish, Louisiana District Court (State District Court). The plaintiffs alleged that the defendants generated, transported, or participated in the storage of such wastes at the facility, which was previously operated as a waste oil recycling facility. These State District Court suits, which seek damages in total amounts ranging from $1 million to $10 billion and are now consolidated in a class action, and three federal suits in three states other than Louisiana involving issues arising from the same facility, have been removed and transferred, respectively, to the U.S. District Court for the Middle District of Louisiana. No assurances can be given to the timing or outcome of these suits.\n(GSU)\nA total of six suits have been filed on behalf of approximately 3,415 plantiffs in state and federal courts in Jefferson County, Texas. These suits seek relief from GSU as well as numerous other defendants for damages caused by the alleged exposure to hazardous waste and asbestos on the defendants' premises. At least five other individual suits have been filed in Beaumont against GSU and others, seeking damages for alleged asbestos exposure. All of the plaintiffs in such suits are also suing GSU and all other defendants on a conspiracy count. It is not yet known how many of the plantiffs in the suits discussed above worked on GSU's premises. There have been approximately 55 asbestos-related law suits filed in the District Court of Calcasieu Parish in Lake Charles, Louisiana, on behalf of an aggregate of 119 plaintiffs naming numerous defendants including GSU, and GSU expects additional cases to be filed. The suits allege that each plaintiff contracted an asbestos-related disease from exposure to asbestos insulation products on the premises of such defendants. Settlements of the two largest of the Jefferson County suits (involving about 1,660 groups of claimants) and 38 suits in Calcasieu Parish (involving approximately 91 plantiffs) have been consummated. GSU was named as one of a number of defendants in nearly all of the suits. GSU's share of the settlements of these cases was not material to its financial position or results of operations.\nCajun - River Bend Litigation (Entergy Corporation and GSU)\nGSU has significant business relationships with Cajun, including co-ownership of River Bend (operated by GSU) and Big Cajun 2, Unit 3 (operated by Cajun). GSU and Cajun, respectively, own 70% and 30% undivided interests in River Bend and 42% and 58% undivided interests in Big Cajun 2, Unit 3. Cajun is currently in reorganization proceedings under the United States Bankruptcy Code.\nIn June 1989, Cajun filed a civil action against GSU in the United States District Court for the Middle District of Louisiana (District Court). Cajun's complaint seeks to annul, rescind, terminate and\/or dissolve the Joint Ownership Participation and Operating Agreement (Operating Agreement) entered into on August 28, 1979 relating to River Bend. Cajun alleges fraud and error by GSU, breach of its fiduciary duties owed to Cajun and\/or GSU's repudiation, renunciation, abandonment or dissolution of its core obligations under the Operating Agreement, as well as the lack or failure of cause and\/or consideration for Cajun's performance under the Operating Agreement. The suit also seeks to recover Cajun's alleged $1.6 billion investment in the unit as damages, plus attorneys' fees, interest, and costs. Two member cooperatives of Cajun have brought an independent action to declare the Operating Agreement void, based upon failure to get prior LPSC approval alleged to be necessary. GSU believes the suits are without merit and is contesting them vigorously.\nA trial on the portion of the suit by Cajun to rescind the Operating Agreement began in April 1994 and was completed in March 1995. On October 24, 1995, the District Court issued a memorandum opinion ruling in favor of GSU. The District Court found that Cajun did not prove that GSU fraudulently induced it to execute the Operating Agreement and that Cajun failed to timely assert its claim. A final judgment on this portion of the suit is not expected to be entered until all claims asserted by Cajun have been heard. The trial of the second portion of the suit currently is scheduled to begin on July 2, 1996. If GSU is ultimately unsuccessful in this litigation and is required to pay substantial damages, GSU would probably be unable to make such payments and could be forced to seek relief from its creditors under the United States Bankruptcy Code. If GSU prevails in this litigation, there can be no assurance that the United States Bankruptcy Court will allow funding by Cajun of all required costs of ownership in River Bend.\nIn the bankruptcy proceedings, Cajun filed a motion to reject the Operating Agreement as a burdensome executory contract. GSU responded on January 10, 1995, with a memorandum opposing Cajun's motion. If the District Court were to grant Cajun's motion to reject the Operating Agreement, Cajun would be relieved of its financial obligations under the contract, while GSU would likely have a substantial damage claim arising from any such rejection. Although GSU believes that Cajun's motion to reject the Operating Agreement is without merit, it is not possible to predict the outcome or ultimate impact of these proceedings.\nSee Note 8 for additional information regarding the Cajun litigation, Cajun's bankruptcy filing, related filings, and the ongoing potential effects of these matters upon GSU.\nAs the result of an order issued by the District Court in August 1995, a former federal bankruptcy judge, Ralph Mabey, was appointed as trustee to oversee Cajun in bankruptcy. The LPSC and Cajun appealed the appointment of a trustee to the Fifth Circuit where the action of the District Court was reversed and remanded for further proceedings. However, in January 1996, the Fifth Circuit reversed its original position and affirmed the appointment of the trustee.\nIn October 1995, the appeals court affirmed the District Court's preliminary injunction in the Cajun litigation. The preliminary injunction stipulated that GSU should make payments for its portion of expenses for Big Cajun 2, Unit 3 into the registry of the District Court. As of December 31, 1995, $38 million had been paid by GSU into the registry of the District Court.\nCajun has not paid its full share of capital costs, operating and maintenance expenses and other costs for repairs and improvements to River Bend since 1992. However, Cajun continues to pay its share of decommissioning costs for River Bend. Cajun's unpaid portion of River Bend operating and maintenance expenses (including nuclear fuel) and capital costs for 1995 was approximately $58.7 million. The cumulative cost (excluding nuclear fuel) to GSU resulting from Cajun's failure to pay its full share of River Bend-related costs, reduced by the proceeds from the sale by GSU of Cajun's share of River Bend power and payments for GSU's portion of expenses for Big Cajun 2, Unit 3 into the registry of the District Court, was $31.1 million as of December 31, 1995. These amounts are reflected in long-term receivables with an offsetting reserve in other deferred credits. Cajun's bankruptcy may affect the ultimate collectibility of the amounts owed to GSU, including any amounts that may be awarded in litigation.\nCajun - Transmission Service (Entergy Corporation and GSU)\nGSU and Cajun are parties to FERC proceedings relating to transmission service charge disputes. See Note 8 for additional information regarding these FERC proceedings, FERC orders issued as a result of such proceedings and the potential effects of these proceedings upon GSU.\nOn December 7, 1993, Cajun filed a complaint in the Middle District of Louisiana alleging that GSU failed to provide Cajun an opportunity to construct certain facilities that allegedly would have reduced its rates under Service Schedule CTOC, and is seeking an order compelling the conveyance of certain facilities and awarding unspecified damages. GSU has moved to dismiss the complaint on the basis, among others, that FERC has already addressed the matter in the proceedings described in Note 8.\nService Area Dispute\n(Entergy Corporation and GSU)\nGSU was requested by Cajun and Jefferson Davis Electric Cooperative, Inc. (Jefferson Davis), to provide the transmission of power over GSU's system for delivery to an area near Lake Charles, Louisiana. GSU provides electric service to industrial and other customers in this area, and Cajun and Jefferson Davis do not. In October 1989, Cajun filed a complaint at FERC contending that GSU wrongfully refused to provide Cajun certain transmission services so that its member, Jefferson Davis, could provide service to certain industrial customers, and it requested FERC to order GSU to provide the service. Subsequently, the FERC summarily dismissed Cajun's complaint, but the D.C. Circuit reversed FERC's summary determination and remanded the case to FERC for a hearing. Ultimately, in March 1994, the FERC issued an order dismissing Cajun's complaint and finding that GSU properly exercised its contractual right to refuse to provide transmission service to Cajun. In August 1994, the FERC denied a rehearing. Subsequently, Cajun filed a petition for review of the FERC's orders in the D.C. Circuit. In October 1995, the D.C. Circuit affirmed the FERC's previous opinion in its entirety.\nCajun and Jefferson Davis also brought a related action in federal court in the Western District of Louisiana alleging that GSU breached its obligations under the parties' contract and violated the antitrust laws by refusing to provide the transmission service described above. Cajun and Jefferson Davis seek an injunction requiring GSU to provide the requested service and unspecified treble damages for GSU's refusal to provide the service. In November 1989, the district court denied Cajun's and Jefferson Davis' motion for a preliminary injunction. In May 1991, the judge stayed the proceeding pending final resolution of the matters still pending before FERC.\n(Entergy Corporation and MP&L)\nOn October 11, 1994, twelve Mississippi cities filed a complaint in state court against MP&L and eight electric power associations seeking a judgment from the court declaring unconstitutional certain Mississippi statutes that establish the procedure that must be followed before a municipality can acquire the facilities and certificate rights of a utility serving in the municipality. Specifically, the suit requests that the court declare unconstitutional certain 1987 amendments to the Mississippi Public Utilities Act that require that the MPSC cancel a utility's certificate to serve in the municipality before a municipality may acquire a utility's facilities located in the municipality. The suit also requests that the court find that Mississippi municipalities can serve any consumer in the boundaries of the municipality and within one mile thereof. On January 6, 1995, MP&L and the other defendants filed motions to dismiss. In October 1995, the state court dismissed the complaint. The plaintiffs have appealed the dismissal to the Mississippi Supreme Court.\nCajun\/River Bend Repairs (Entergy Corporation and GSU)\nIn December 1991, Cajun filed a complaint seeking declaratory and injunctive relief from the U. S. District Court for the Middle District of Louisiana. The complaint concerns GSU's position that Cajun has defaulted on the payment of its share of certain expenditures to repair corrosion damage in the service water system, to repair a feedwater nozzle crack and to repair a turbine rotor. Cajun alleges that it has no obligation to pay its share of such costs and seeks a declaration that it may elect not to participate in the funding of such costs and that GSU may not demand payment or attempt to implement default provisions in the Operating Agreement. Cajun alleges that if it is required to pay its share of such costs it would be forced to default on other obligations. See \"Cajun - River Bend\" above for information regarding Cajun's bankruptcy filing. GSU believes that Cajun is in default under the provisions of the Operating Agreement. No assurance can be given as to the outcome or timing of this action brought by Cajun.\nTaxes Paid Under Protest (Entergy Corporation and LP&L)\nSince the mid-1980's, LP&L and the tax authorities of St. Charles Parish, Louisiana (Parish), the parish in which Waterford 3 is located, have disputed use taxes paid on nuclear fuel ($4.9 million through 1989) under protest by LP&L. LP&L continues to be successful in lawsuits in the Parish with regard to recovering these taxes, plus interest, and also with regard to Parish lease tax issues pertaining to fuel financing arrangements. In October 1994, Parish tax authorities sued LP&L and Entergy Corporation in the Civil District Court of Orleans Parish, Louisiana, claiming that $1.4 million of sales and use and lease taxes paid under protest by LP&L with respect to newly acquired nuclear fuel were not, in fact, paid under protest, and that unspecified additional taxes, interest, and penalties are due. Subsequently, the suit filed by the Parish tax authorities was dismissed. In September 1995, LP&L similarly paid use tax under protest in the amount of $209,000 with regard to the delivery of a new batch of fuel. In June 1995, LP&L received a favorable decision from the Louisiana Fifth Circuit Court of Appeals that confirmed that no such use taxes are due. The Parish and LP&L are currently discussing a possible settlement of all pending tax-related litigation including the likely return of the amounts paid under protest in October 1994 and September 1995. The suits by LP&L with regard to state use tax paid under protest on nuclear fuel are still pending.\nFederal Income Tax Audit (Entergy Corporation, LP&L, and System Energy)\nIn August 1994, Entergy received an IRS report covering the federal income tax audit of Entergy Corporation and subsidiaries for the years 1988 - 1990. The report asserts an $80 million tax deficiency for the 1990 consolidated federal income tax returns related primarily to the application of accelerated investment tax credits associated with Waterford 3 and Grand Gulf nuclear plants. Entergy Corporation believes there is no material tax deficiency and is vigorously contesting the proposed assessment.\nPanda Energy Corporation Complaint (Entergy Corporation)\nPanda Energy Corporation (Panda) has commenced litigation in the Dallas District Court naming Entergy Corporation, Energy Enterprises, Entergy Power, Entergy Power Asia, Ltd., and Entergy Power Development Corporation as defendants. The allegations against the defendants include, among others, tortious interference with contractual relations, conspiracy, misappropriation of corporate opportunity, unfair competition and fraud, and constructive trust issues. Panda seeks damages of approximately $4.8 billion, of which $3.6 billion is claimed in punitive damages. Entergy believes that this lawsuit is without merit, that the damages claimed are insupportable, and that some or all of the claims against Entergy will be dismissed. However, no assurance can be given as to the timing or outcome of this matter.\nCatalyst Technologies, Inc. (Entergy Corporation)\nIn June 1993 Catalyst Technologies, Inc. (CTI) filed a petition against Electec, Inc. (Electec), the predecessor to Entergy Enterprises. Prior to the filing of the petition, CTI and Electec entered into an agreement whereby CTI was required to raise a specified amount of funding in exchange for the right to acquire Electec's computer software technology marketing rights. CTI alleges that due to actions of Electec, it was unable to secure the necessary funding, and therefore, was not able to meet the terms of the agreement. The petition alleges breach of contract, breach of the obligation of good- faith and fair dealing, and bad-faith breach of contract against Electec. Subsequent to the filing of the petition, CTI indicated that it is seeking to recover approximately $36 million from Entergy Enterprises. No trial date has been set at this time. No assurance can be given as to the timing or outcome of this matter.\nEARNINGS RATIOS OF OPERATING COMPANIES AND SYSTEM ENERGY\nThe Operating Companies and System Energy's ratios of earnings to fixed charges and ratios of earnings to fixed charges and preferred dividends pursuant to Item 503 of SEC Regulation S-K are as follows:\n(a) \"Preferred Dividends\" in the case of GSU also include dividends on preference stock.\n(b) Earnings for the year ended December 31, 1991, include the $90 million effect of the 1991 NOPSI Settlement.\n(c) Earnings for the year ended December 31, 1993, include approximately $81 million, $52 million, and $18 million for AP&L, MP&L, and NOPSI, respectively, related to the change in accounting principle to provide for the accrual of estimated unbilled revenues.\n(d) Earnings for the year ended December 31, 1994, for GSU were not adequate to cover fixed charges and combined fixed charges and preferred dividends by $144.8 million and $197.1 million, respectively.\nINDUSTRY SEGMENTS\nNOPSI\nNarrative Description of NOPSI Industry Segments\nElectric Service\nNOPSI supplied retail electric service to 190,332 customers as of December 31, 1995. During 1995, 39% of electric operating revenues was derived from residential sales, 40% from commercial sales, 6% from industrial sales, and 15% from sales to governmental and municipal customers.\nNatural Gas Service\nNOPSI supplied retail natural gas service to 153,370 customers as of December 31, 1995. During 1995, 56% of gas operating revenues was derived from residential sales, 19% from commercial sales, 9% from industrial sales, and 16% from sales to governmental and municipal customers. (See \"FUEL SUPPLY - Natural Gas Purchased for Resale.\")\nSelected Financial Information Relating to Industry Segments\nFor selected financial information relating to NOPSI's industry segments, see NOPSI's financial statements and Note 14.\nEmployees by Segment\nNOPSI's full-time employees by industry segment as of December 31, 1995, were as follows:\nElectric 378 Natural Gas 111 --- Total 489 ===\n(For further information with respect to NOPSI's segments, see \"PROPERTY.\")\nGSU\nFor the year ended December 31, 1995, 96% of GSU's operating revenues was derived from the electric utility business. Of the remaining operating revenues 3% was derived from the steam business and 1% from the natural gas business.\nPROPERTY\nGenerating Stations\nThe total capability of the System's owned and leased generating stations as of December 31, 1995, by company and by fuel type, is indicated below:\n(1) \"Owned and Leased Capability\" is the dependable load carrying capability as demonstrated under actual operating conditions based on the primary fuel (assuming no curtailments) that each station was designed to utilize.\n(2) Excludes the capacity of fossil-fueled generating stations placed on extended reserve as follows: AP&L - 506 MW; GSU - 405 MW; LP&L - 157 MW; MP&L - 73 MW; and NOPSI - 143 MW. Generating stations that are not expected to be utilized in the near-term to meet load requirements are placed in extended reserve shutdown in order to minimize operating expenses.\n(3) Excludes net capability of generating facilities owned by Entergy Power, which owns 809 MW of fossil-fueled capacity.\n(4) Includes 188 MW of capacity leased by AP&L through 1999.\nLoad and capacity projections are regularly reviewed in order to coordinate and recommend the location and time of installation of additional generating capacity and of interconnections in light of the availability of power, the location of new loads, and maximum economy to the System. Based on load and capability projections and bulk power availability, the System has no current need to install additional generating capacity. When new generation resources are needed, the System plans to meet this need with a variety of sources other than construction of new base load generating capacity. In the meantime, the System will meet capacity needs by, among other things, purchasing power in the wholesale power market and\/or removing generating stations from extended reserve shutdown.\nUnder the terms of the System Agreement, certain generating capacity and other power resources are shared among the Operating Companies. Among other things, the System Agreement provides that parties having generating capacity greater than their load requirements (long companies) shall sell receive payments from those parties having deficiencies in generating capacity (short companies) and an amount sufficient to cover certain of the long companies' costs, including operating expenses, fixed charges on debt, dividend requirements on preferred and preference stock, and a fair rate of return on common equity investment. Under the System Agreement, these charges are based on costs associated with the long companies' steam electric generating units fueled by oil or gas. In addition, for all energy exchanged among the Operating Companies under the System Agreement, the short companies are required to pay the cost of fuel consumed in generating such energy plus a charge to cover other associated costs (see \"RATE MATTERS AND REGULATION - Rate Matters - Wholesale Rate Matters - System Agreement,\" above, for a discussion of FERC proceedings relating to the System Agreement).\nThe System's business is subject to seasonal fluctuations, with the peak period occurring in the summer months. The System's 1995 (and all-time) peak demand of 19,590 MW occurred on August 16, 1995. The net System capability at the time of peak was 21,100 MW, net of off- system firm sales of 302 MW. The capacity margin at the time of the peak was approximately 7.2%, excluding units placed on extended reserve and capacity owned by Entergy Power.\nInterconnections\nThe electric power supply facilities of Entergy consist principally of steam-electric production facilities strategically located with reference to availability of fuel, protection of local loads, and other controlling economic factors. These are interconnected by a transmission system operating at various voltages up to 500 kilovolts. Generally, with the exception of Grand Gulf 1, Entergy Power's capacity and a small portion of MP&L's capacity, operating facilities or interests therein are owned by the System operating company serving the area in which the facilities are located. However, all of the System's generating facilities are centrally dispatched and operated in order to obtain the lowest cost sources of energy with a minimum of investment and the most efficient use of plant.\nIn addition to the many neighboring utilities with which the Operating Companies interconnect, the Operating Companies are members of the Southwest Power Pool, the primary purpose of which is to ensure the reliability and adequacy of the electric bulk power supply in the southwest region of the United States. The Southwest Power Pool is a member of the North American Electric Reliability Council. The Operating Companies are also members of the Western Systems Power Pool.\nGas Property\nAs of December 31, 1995, NOPSI distributed and transported natural gas for distribution solely within the limits of the City of New Orleans through a total of 1,421 miles of gas distribution mains and 40 miles of gas transmission lines. Koch Gateway Pipeline Company is a principal supplier of natural gas to NOPSI, delivering to 6 of NOPSI's 14 delivery points.\nAs of December 31, 1995, the gas properties of GSU were not material to GSU.\nTitles\nThe System's generating stations are generally located on properties owned in fee simple. The greater portion of the transmission and distribution lines of the Operating Companies has been constructed over property of private owners pursuant to easements or on public highways and streets pursuant to appropriate franchises. The rights of each Operating Company in the realty on which its facilities are located are considered by it to be adequate for its use in the conduct of its business. Minor defects and irregularities customarily found in properties of like size and character exist, but such defects and irregularities do not materially impair the use of the properties affected thereby. The Operating Companies generally have the right of eminent domain, whereby they may, if necessary, perfect or secure titles to, or easements or servitudes on, privately-held lands used or to be used in their utility operations.\nSubstantially all the physical properties owned by each Operating Company and System Energy, respectively, are subject to the lien of a mortgage and deed of trust securing the first mortgage bonds of such company. The Lewis Creek generating station is owned by GSG&T, Inc., and is not subject to the lien of the GSU mortgage securing the first mortgage bonds of GSU, but is leased to and operated by GSU. In the case of LP&L, certain properties are also subject to the liens of second mortgages securing other obligations of LP&L. In the case of MP&L and NOPSI, substantially all of their properties and assets are also subject to the second mortgage lien of their respective general and refunding mortgage bond indentures.\nFUEL SUPPLY\nEntergy's sources of generation and average fuel cost per KWh, excluding Entergy Power, for the years 1993-1995 were:\nThe System's actual 1995 and projected 1996 sources of generation, excluding Entergy Power, are:\n(a)Capacity and energy from System Energy's interest in Grand Gulf 1 is allocated as follows: AP&L - 36%; LP&L - 14%; MP&L - 33%; and NOPSI - 17%.\nThe balance of generation, which was immaterial, was provided by hydroelectric power.\nNatural Gas\nThe Operating Companies have long-term firm and short-term interruptible gas contracts. Long-term firm contracts comprise less than 40% of total System requirements but can be called upon, if necessary, to satisfy a significant percentage of the System's needs. Additional gas requirements are satisfied by short-term contracts and spot-market purchases. GSU has a transportation service agreement with a gas supplier that provides flexible natural gas service to certain generating stations by using such supplier's pipeline and gas storage facility.\nMany factors, including wellhead deliverability, storage and pipeline capacity, and demand requirements of end users influence the availability and price of natural gas supplies for power plants. Demand is tied to regional weather conditions as well as to the prices of other energy sources. Supplies of natural gas are expected to be adequate in 1996. However, pursuant to federal and state regulations, gas supplies to power plants may be interrupted during periods of shortage. To the extent natural gas supplies may be disrupted, the Operating Companies will use alternate fuels, such as oil, or rely on coal and nuclear generation.\nCoal\nAP&L has long-term contracts with mines in the State of Wyoming for the supply of low-sulfur coal for the White Bluff Steam Electric Generating Station and Independence. These contracts, which expire in 2002 and 2011, provide for approximately 85% of AP&L's expected annual coal requirements. Additional requirements are satisfied by annual spot market purchases. GSU has a contract for a supply of low-sulfur Wyoming coal for Nelson Unit 6, which should be sufficient to satisfy the fuel requirements at Nelson Unit 6 through 2004. Cajun has advised GSU that it has contracts that should provide an adequate supply of coal until 1999 for the operation of Big Cajun 2, Unit 3.\nNuclear Fuel\nThe nuclear fuel cycle involves the mining and milling of uranium ore to produce a concentrate, the conversion of uranium concentrate to uranium hexafluoride gas, enrichment of that gas, fabrication of nuclear fuel assemblies for use in fueling nuclear reactors, and disposal of the spent fuel.\nSystem Fuels is responsible for contracts to acquire nuclear material to be used in fueling AP&L's, LP&L's, and System Energy's nuclear units and maintaining inventories of such materials during the various stages of processing. Each of these companies contracts for the fabrication of its own nuclear fuel and purchases the required enriched uranium hexafluoride from System Fuels. The requirements for GSU's River Bend plant are covered by contracts made by GSU. Entergy Operations acts as agent for System Fuels and GSU in negotiating and\/or administering nuclear fuel contracts.\nIn October 1989, System Fuels entered into a revolving credit agreement with a bank that provides up to $45 million in borrowings to finance its nuclear materials and services inventory. Should System Fuels default on its obligations under its credit agreement, AP&L, LP&L, and System Energy have agreed to purchase nuclear materials and services under the agreement.\nBased upon the planned fuel cycles for the System's nuclear units, the following tabulation shows the years through which existing contracts and inventory will provide materials and services:\n(1) Current contracts will provide a significant percentage of these materials and services through termination dates ranging from 1996-1999. Additional materials and services required beyond these dates are estimated to be available for the foreseeable future.\n(2) Current contracts will provide a significant percentage of these materials and services through approximately 2000.\n(3) The Nuclear Waste Policy Act of 1982 provides for the disposal of spent nuclear fuel or high level waste by the DOE.\nThe System will enter into additional arrangements to acquire nuclear fuel beyond the dates shown above. Except as noted above, Entergy cannot predict the ultimate availability or cost of such arrangements at this time.\nAP&L, GSU, LP&L, and System Energy currently have arrangements to lease nuclear fuel and related equipment and services in aggregate amounts up to $130 million, $70 million, $80 million, and $80 million, respectively. As of December 31, 1995, the unrecovered cost base of AP&L's, GSU's, LP&L's, and System Energy's nuclear fuel leases amounted to approximately $98.7 million, $69.9 million, $72.9 million, and $71.4 million, respectively. The lessors finance the acquisition and ownership of nuclear fuel through credit agreements and the issuance of notes. These agreements are subject to annual renewal with, in LP&L's and GSU's case, the consent of the lenders. The credit agreements for AP&L, GSU, LP&L, and System Energy have been extended and now have termination dates of December 1998, December 1998, January 1999, and February 1999, respectively. The debt securities issued pursuant to these fuel lease arrangements have varying maturities through January 31, 1999. It is expected that the credit agreements will be extended or alternative financing will be secured by each lessor upon the maturity of the current arrangements. If extensions or alternative financing cannot be arranged, the lessee in each case must purchase sufficient nuclear fuel to allow the lessor to retire such borrowings.\nNatural Gas Purchased for Resale\nNOPSI has several suppliers of natural gas for resale. Its system is interconnected with three interstate and three intrastate pipelines. Presently, NOPSI's primary suppliers are Koch Gas Services Company (KGS), an interstate gas marketer, and Bridgeline and Pontchartrain, intrastate pipelines. NOPSI has a firm gas purchase contract with KGS. The KGS gas supply is transported to NOPSI pursuant to a \"No-Notice\" transportation service agreement with Koch Gateway Pipeline Company (KGPC). This service is subject to FERC-approved rates. NOPSI has firm contracts with its two intrastate suppliers and also makes interruptible spot market purchases. In recent years, natural gas deliveries have been subject primarily to weather-related curtailments. However, NOPSI has experienced no such curtailments.\nAfter the implementation of FERC-mandated interstate pipeline restructuring in 1993, curtailments of interstate gas supply could occur if NOPSI's suppliers failed to perform their obligations to deliver gas under their supply agreements. KGPC could curtail transportation capacity only in the event of pipeline system constraints. Based on the current supply of natural gas, and absent extreme weather-related curtailments, NOPSI does not anticipate any interruptions in natural gas deliveries to its customers.\nGSU purchases natural gas for resale under a \"No-Notice\" type of agreement from Mid Louisiana Gas Company. Abandonment of service by the present supplier would be subject to abandonment proceedings by FERC.\nResearch\nAP&L, GSU, LP&L, MP&L, and NOPSI are members of the Electric Power Research Institute (EPRI). EPRI conducts a broad range of research in major technical fields related to the electric utility industry. Entergy participates in various EPRI projects based on Entergy's needs and available resources. During 1995, 1994, and 1993, the System contributed approximately $9 million, $18 million, and $17 million, respectively, for the various research programs in which Entergy was involved.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nRefer to Item 1. \"Business - PROPERTY,\" for information regarding the properties of the registrants.\nItem 3.","section_3":"Item 3. Legal Proceedings\nRefer to Item 1. \"Business - RATE MATTERS AND REGULATION,\" for details of the registrants' material rate proceedings and other regulatory proceedings and litigation that are pending or that terminated in the fourth quarter of 1995.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nDuring the fourth quarter of 1995, no matters were submitted to a vote of the security holders of Entergy Corporation, AP&L, GSU, LP&L, MP&L, NOPSI, or System Energy.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrants' Common Equity and Related Stockholder Matters\nEntergy Corporation\nThe shares of Entergy Corporation's common stock are listed on the New York, Chicago, and Pacific Stock Exchanges.\nThe high and low prices of Entergy Corporation's common stock for each quarterly period in 1995 and 1994 were as follows:\nDividends of 45 cents per share were paid on Entergy Corporation's common stock in each of the quarters of 1995 and 1994.\nAs of February 29, 1996, there were 98,911 stockholders of record of Entergy Corporation.\nFor information with respect to Entergy Corporation's future ability to pay dividends, refer to Note 7, \"DIVIDEND RESTRICTIONS.\" In addition to the restrictions described in Note 7, PUHCA provides that, without approval of the SEC, the unrestricted, undistributed retained earnings of any Entergy Corporation subsidiary are not available for distribution to Entergy Corporation's common stockholders until such earnings are made available to Entergy Corporation through the declaration of dividends by such subsidiaries.\nAP&L, GSU, LP&L, MP&L, NOPSI, and System Energy\nThere is no market for the common stock of Entergy Corporation's subsidiaries as all shares are owned by Entergy Corporation. Cash dividends on common stock paid by the subsidiaries to Entergy Corporation during 1995 and 1994, were as follows:\nIn February 1996, Entergy Corporation received common stock dividend payments from its subsidiaries totaling $48.7 million. For information with respect to restrictions that limit the ability of System Energy and the Operating Companies to pay dividends, see Note 7.\nItem 6.","section_6":"Item 6. Selected Financial Data\nEntergy Corporation. Refer to information under the heading \"ENTERGY CORPORATION AND SUBSIDIARIES SELECTED FINANCIAL DATA - FIVE- YEAR COMPARISON.\"\nAP&L. Refer to information under the heading \"ARKANSAS POWER & LIGHT COMPANY SELECTED FINANCIAL DATA - FIVE-YEAR COMPARISON.\"\nGSU. Refer to information under the heading \"GULF STATES UTILITIES COMPANY SELECTED FINANCIAL DATA - FIVE-YEAR COMPARISON.\"\nLP&L. Refer to information under the heading \"LOUISIANA POWER & LIGHT COMPANY SELECTED FINANCIAL DATA - FIVE-YEAR COMPARISON.\"\nMP&L. Refer to information under the heading \"MISSISSIPPI POWER & LIGHT COMPANY SELECTED FINANCIAL DATA - FIVE-YEAR COMPARISON.\"\nNOPSI. Refer to information under the heading \"NEW ORLEANS PUBLIC SERVICE INC. SELECTED FINANCIAL DATA - FIVE-YEAR COMPARISON.\"\nSystem Energy. Refer to information under the heading \"SYSTEM ENERGY RESOURCES, INC. SELECTED FINANCIAL DATA - FIVE-YEAR COMPARISON.\"\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nEntergy Corporation and Subsidiaries. Refer to information under the heading \"ENTERGY CORPORATION AND SUBSIDIARIES MANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS - LIQUIDITY AND CAPITAL RESOURCES,\" \" - - - - - SIGNIFICANT FACTORS AND KNOWN TRENDS,\" and \"- RESULTS OF OPERATIONS.\"\nAP&L. Refer to information under the heading \"ARKANSAS POWER & LIGHT COMPANY MANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS - RESULTS OF OPERATIONS.\"\nGSU. Refer to information under the heading \"GULF STATES UTILITIES COMPANY MANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS - RESULTS OF OPERATIONS.\"\nLP&L. Refer to information under the heading \"LOUISIANA POWER & LIGHT COMPANY MANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS - RESULTS OF OPERATIONS.\"\nMP&L. Refer to information under the heading \"MISSISSIPPI POWER & LIGHT COMPANY MANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS - RESULTS OF OPERATIONS.\"\nNOPSI. Refer to information under the heading \"NEW ORLEANS PUBLIC SERVICE INC. MANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS - RESULTS OF OPERATIONS.\"\nSystem Energy. Refer to information under the heading \"SYSTEM ENERGY RESOURCES, INC. MANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS - RESULTS OF OPERATIONS.\"\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nEntergy Corporation and Subsidiaries: Report of Management 44 Audit Committee Chairperson's Letter 45 Management's Financial Discussion and Analysis for Entergy 46 Corporation and Subsidiaries Report of Independent Accountants for Entergy Corporation 55 and Subsidiaries Independent Auditors' Report for Entergy Corporation and 56 Subsidiaries Management's Financial Discussion and Analysis for Entergy 57 Corporation and Subsidiaries Statements of Consolidated Income For the Years Ended December 31, 1995, 1994, and 1993 for Entergy Corporation and 59 Subsidiaries Statements of Consolidated Cash Flows For the Years Ended December 31, 1995, 1994, and 1993 for Entergy Corporation and 60 Subsidiaries Balance Sheets, December 31, 1995 and 1994 for Entergy 62 Corporation and Subsidiaries Statements of Consolidated Retained Earnings and Paid-In Capital for the Years Ended December 31, 1995, 1994, and 1993 64 for Entergy Corporation and Subsidiaries Selected Financial Data - Five-Year Comparison for Entergy 65 Corporation and Subsidiaries Report of Independent Accountants for Arkansas Power & Light 66 Company Independent Auditors' Report for Arkansas Power & Light 67 Company Management's Financial Discussion and Analysis for Arkansas 68 Power & Light Company Statements of Income For the Years Ended December 31, 1995, 1994, and 1993 for Arkansas Power & Light Company 70 Statements of Cash Flows For the Years Ended December 31, 1995, 1994, and 1993 for Arkansas Power & Light Company 71 Balance Sheets, December 31, 1995 and 1994 for Arkansas 72 Power & Light Company Statements of Retained Earnings for the Years Ended December 31, 1995, 1994, and 1993 for Arkansas Power & Light Company 74 Selected Financial Data - Five-Year Comparison for Arkansas 75 Power & Light Company Report of Independent Accountants for Gulf States Utilities 76 Company Management's Financial Discussion and Analysis for Gulf 78 States Utilities Company Statements of Income For the Years Ended December 31, 1995, 1994, and 1993 for Gulf States Utilities Company 80 Statements of Cash Flows For the Years Ended December 31, 1995, 1994, and 1993 for Gulf States Utilities Company 81 Balance Sheets, December 31, 1995 and 1994 for Gulf States 82 Utilities Company Statements of Retained Earnings and Paid-In Capital for the Years Ended December 31, 1995, 1994, and 1993 for Gulf States 84 Utilities Company Selected Financial Data - Five-Year Comparison for Gulf 85 States Utilities Company Report of Independent Accountants for Louisiana Power & 86 Light Company Independent Auditors' Report for Louisiana Power & Light 87 Company Management's Financial Discussion and Analysis for Louisiana 88 Power & Light Company Statements of Income For the Years Ended December 31, 1995, 1994, and 1993 for Louisiana Power & Light Company 90 Statements of Cash Flows For the Years Ended December 31, 1995, 1994, and 1993 for Louisiana Power & Light Company 91 Balance Sheets, December 31, 1995 and 1994 for Louisiana 92 Power & Light Company Statements of Retained Earnings for the Years Ended December 31, 1995, 1994, and 1993 for Louisiana Power & Light Company 94 Selected Financial Data - Five-Year Comparison for Louisiana 95 Power & Light Company Report of Independent Accountants for Mississippi Power & 96 Light Company Independent Auditors' Report for Mississippi Power & Light 97 Company Management's Financial Discussion and Analysis for 98 Mississippi Power & Light Company Statements of Income For the Years Ended December 31, 1995, 1994, and 1993 for Mississippi Power & Light Company 100 Statements of Cash Flows For the Years Ended December 31, 1995, 1994, and 1993 for Mississippi Power & Light Company 101 Balance Sheets, December 31, 1995 and 1994 for Mississippi 102 Power & Light Company Statements of Retained Earnings for the Years Ended December 31, 1995, 1994, and 1993 for Mississippi Power & Light Company 104 Selected Financial Data - Five-Year Comparison for 105 Mississippi Power & Light Company Report of Independent Accountants for New Orleans Public 106 Service Inc. Independent Auditors' Report for New Orleans Public Service 107 Inc. Management's Financial Discussion and Analysis for New 108 Orleans Public Service Inc. Statements of Income For the Years Ended December 31, 1995, 1994, and 1993 for New Orleans Public Service Inc. 110 Statements of Cash Flows For the Years Ended December 31, 1995, 1994, and 1993 for New Orleans Public Service Inc. 111 Balance Sheets, December 31, 1995 and 1994 for New Orleans 112 Public Service Inc. Statements of Retained Earnings for the Years Ended December 31, 1995, 1994, and 1993 for New Orleans Public Service Inc. 114 Selected Financial Data - Five-Year Comparison for New 115 Orleans Public Service Inc. Report of Independent Accountants for System Energy 116 Resources, Inc. Independent Auditors' Report for System Energy Resources, 117 Inc. Management's Financial Discussion and Analysis for System 119 Energy Resources, Inc. Statements of Income For the Years Ended December 31, 1995, 1994, and 1993 for System Energy Resources, Inc. 120 Statements of Cash Flows For the Years Ended December 31, 1995, 1994, and 1993 for System Energy Resources, Inc. 121 Balance Sheets, December 31, 1995 and 1994 for System Energy 122 Resources, Inc. Statements of Retained Earnings for the Years Ended December 31, 1995, 1994, and 1993 for System Energy Resources, Inc. 124 Selected Financial Data - Five-Year Comparison for System 125 Energy Resources, Inc.. Notes to Financial Statements for Entergy Corporation and 126 Subsidiaries\nENTERGY CORPORATION AND SUBSIDIARIES\nREPORT OF MANAGEMENT\nThe management of Entergy Corporation and Subsidiaries has prepared and is responsible for the financial statements and related financial information included herein. The financial statements are based on generally accepted accounting principles. Financial information included elsewhere in this report is consistent with the financial statements.\nTo meet its responsibilities with respect to financial information, management maintains and enforces a system of internal accounting controls that is designed to provide reasonable assurance, on a cost-effective basis, as to the integrity, objectivity, and reliability of the financial records, and as to the protection of assets. This system includes communication through written policies and procedures, an employee Code of Conduct, and an organizational structure that provides for appropriate division of responsibility and the training of personnel. This system is also tested by a comprehensive internal audit program.\nThe independent public accountants provide an objective assessment of the degree to which management meets its responsibility for fairness of financial reporting. They regularly evaluate the system of internal accounting controls and perform such tests and other procedures as they deem necessary to reach and express an opinion on the fairness of the financial statements.\nManagement believes that these policies and procedures provide reasonable assurance that its operations are carried out with a high standard of business conduct.\n\/s\/Ed Lupberger \/s\/Gerald D. McInvale ED LUPBERGER GERALD D. MCINVALE Chairman, President, and Chief Executive Vice President and Executive Officer of Entergy Chief Financial Officer Corporation, AP&L, GSU, LP&L, MP&L and NOPSI\n\/s\/Donald C. Hintz DONALD C. HINTZ President and Chief Executive Officer of System Energy\nENTERGY CORPORATION AND SUBSIDIARIES\nAUDIT COMMITTEE CHAIRPERSON'S LETTER\nThe Entergy Corporation Board of Directors' Audit Committee is comprised of four directors who are not officers of Entergy Corporation: Lucie J. Fjeldstad, Chairperson, Dr. Norman C. Francis, James R. Nichols, and H. Duke Shackelford. The committee held four meetings during 1995.\nThe Audit Committee oversees Entergy Corporation's financial reporting process on behalf of the Board of Directors and provides reasonable assurance to the Board that sufficient operating, accounting, and financial controls are in existence and are adequately reviewed by programs of internal and external audits.\nThe Audit Committee discussed with Entergy's internal auditors and the independent public accountants (Coopers & Lybrand L.L.P.) the overall scope and specific plans for their respective audits, as well as Entergy Corporation's financial statements and the adequacy of Entergy Corporation's internal controls. The committee met, together and separately, with Entergy's internal auditors and independent public accountants, without management present, to discuss the results of their audits, their evaluation of Entergy Corporation's internal controls, and the overall quality of Entergy Corporation's financial reporting. The meetings also were designed to facilitate and encourage private communication between the committee and the internal auditors and independent public accountants.\n\/s\/Lucie J. Fjeldstad LUCIE J. FJELDSTAD Chairperson, Audit Committee\nENTERGY CORPORATION AND SUBSIDIARIES\nMANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS\nLIQUIDITY AND CAPITAL RESOURCES\nEntergy, AP&L, GSU, LP&L, MP&L, NOPSI, and System Energy\nCash Flows\nEntergy is involved in capital-intensive businesses, which require large investments in long-lived assets. While capital expenditures for the construction of new generating capacity are not currently planned, the System does require significant capital resources for the periodic maturity of debt and preferred stock, ongoing construction expenditures, and increasing investments in domestic and foreign energy- related businesses. Net cash flow from operations totaled $1.397 billion, $1.538 billion, and $1.074 billion in 1995, 1994, and 1993, respectively. Net cash flow from operations for the Operating Companies and System Energy was as follows:\nIn 1995, AP&L's net cash flow from operations decreased because of increases in customer accounts receivables due to increased 1995 sales and the replenishment of coal inventory which was depleted in 1994. This decrease was partially offset by lower other operation and maintenance expense. GSU's net cash flow from operations increased in 1995 due to higher revenues and lower operation and maintenance expenses. This increase was partially offset by a Texas retail rate refund, recorded in 1994 and paid in 1995. LP&L's net cash flow from operations increased in 1995 as a result of lower operation and maintenance expenses partially offset by a rate reduction in April 1995. MP&L's net cash flow from operations decreased in 1995 because of increased accounts receivable balances due to increased 1995 sales, partially offset by lower other operation and maintenance expenses. NOPSI's net cash flow from operations was higher in 1995 than 1994 because refunds that were made in 1994 as a result of the NOPSI settlement did not impact 1995 cash flow. Lower operation and maintenance expenses in 1995 for NOPSI also contributed to the increase. System Energy's net cash flow from operations decreased in 1995 due to refunds made to associated companies in 1995 as the result of a 1994 FERC audit settlement, and higher income tax payments in 1995.\nFinancing Sources\nIn recent years, cash flows of the Operating Companies, supplemented by cash on hand, have been sufficient to meet substantially all investing and financing requirements, including capital expenditures, dividends and debt\/preferred stock maturities. Entergy's ability to fund these capital requirements with cash from operations results, in part, from continued efforts to streamline operations and reduce costs, as well as from collections under rate phase-in plans that exceed current cash requirements for the related costs. (In the income statement, these revenue collections are offset by the amortization of previously deferred costs; therefore, there is no effect on net income.) These phase-in plans will continue to contribute to Entergy's cash position for the next several years. Specifically, the Grand Gulf 1 phase-in plans will expire in 1998 for AP&L and MP&L, and in 2001 for NOPSI.\nENTERGY CORPORATION AND SUBSIDIARIES\nMANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS\nLIQUIDITY AND CAPITAL RESOURCES\nGSU's phase-in plan for River Bend will expire in 1998, and LP&L's phase-in plan for Waterford 3 expires in 1996. In addition, the Operating Companies and System Energy have the ability to meet future capital requirements through future debt or preferred stock issuances, as discussed below. Also, to the extent current market interest and dividend rates allow, the Operating Companies and System Energy may continue to refinance high-cost debt and preferred stock prior to maturity. See Notes 5, 6, and 8 for additional information on the System's capital and refinancing requirements in 1996 - 2000.\nEntergy Corporation periodically reviews its capital structure to determine its future needs for debt and equity financing. Certain agreements and restrictions limit the amount of mortgage bonds and preferred stock that can be issued by the Operating Companies and System Energy. Based on the most restrictive applicable tests as of December 31, 1995, and assumed annual interest or dividend rates of 8.25% for bonds and 8.50% for preferred stock, each of the Operating Companies and System Energy could have issued mortgage bonds or preferred stock in the following amounts:\n(a) GSU was precluded from issuing preferred stock at December 31, 1995. (b) System Energy's charter does not presently provide for the issuance of preferred stock.\nIn addition to these amounts, the Operating Companies and System Energy have the ability, subject to certain conditions, to issue bonds against retired bonds. Such amounts may be significant in some instances, and, in some cases, no earnings coverage test is required. AP&L may also issue preferred stock to refund outstanding preferred stock without meeting an earnings coverage test. GSU has no earnings coverage limitations on the issuance of preference stock. In January of 1996, the Boards of Directors of AP&L and LP&L authorized the officers of those companies to deposit cash with the trustees under their respective first mortgage indentures to satisfy the annual maintenance and replacement fund requirements thereunder, and to require the trustees to use such cash to redeem all or a part of certain series of first mortgage bonds at par as permitted by the respective first mortgage indentures. See Notes 5 and 6 for long-term debt and preferred stock issuances and retirements. See Note 4 for information on the System's short-term borrowings.\nENTERGY CORPORATION AND SUBSIDIARIES\nMANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS\nLIQUIDITY AND CAPITAL RESOURCES\nFinancing Requirements\nProductive investment by Entergy Corporation is necessary to enhance the long-term value of its common stock. Entergy Corporation has been expanding its investments in nonregulated business opportunities overseas as well as in the United States. Through the end of 1995, Entergy Corporation had participated in foreign non regulated electric ventures in Pakistan, Argentina, and Peru. As of December 31, 1995, Entergy Corporation had invested $555.5 million in equity capital (reduced by $169 million of accumulated losses) in nonregulated businesses. See Note 15 for a discussion of Entergy Corporation's acquisition of CitiPower on January 5, 1996.\nIn addition to investing in nonregulated businesses, Entergy Corporation's capital requirements include periodically investing in, or making loans to, its subsidiaries, and sustaining its dividends. To meet such capital requirements, Entergy Corporation will utilize internally generated funds, cash on hand, and the $70 million remaining on its $300 million credit facility ($230 million of this credit facility was used for the CitiPower acquisition). Entergy Corporation receives funds through dividend payments from its subsidiaries. During 1995, such common stock dividend payments from subsidiaries totaled $565.6 million, none of which was contributed by GSU. Entergy Corporation, in turn, paid $408.6 million of dividends on its common stock. Declarations of dividends on common stock are made at the discretion of Entergy Corporation's Board of Directors. It is anticipated that management will not recommend future dividend increases to the Board unless such increases are justified by sustained earnings growth of Entergy Corporation and its subsidiaries. See Note 7 for information on dividend restrictions.\nEntergy Corporation and GSU\nSee Notes 2 and 8 regarding River Bend rate appeals and litigation with Cajun. Adverse rulings in the River Bend rate appeal could result in approximately $289 million of potential write-offs (net of tax) and $182 million in refunds of previously collected revenue. Such write- offs and charges, as well as the application of SFAS 121 (see Note 1), could result in substantial net losses being reported in the future by Entergy Corporation and GSU, with resulting adverse adjustments to common equity of Entergy Corporation and GSU. Adverse resolution of these matters could adversely affect GSU's ability to obtain financing, which could in turn affect GSU's liquidity and ability to pay dividends. Although Entergy Corporation's common shareholders experienced some dilution in earnings as a result of the Merger, Entergy believes that the Merger will ultimately be beneficial to common shareholders in terms of strategic benefits as well as economies and efficiencies produced.\nEntergy Corporation and System Energy\nUnder the Capital Funds Agreement, Entergy Corporation has agreed to supply to System Energy sufficient capital to maintain System Energy's equity capital at a minimum of 35% of its total capitalization (excluding short-term debt), to permit the continued commercial operation of Grand Gulf 1, and to pay in full all indebtedness for borrowed money of System Energy when due under any circumstances. In addition, under supplements to the Capital Funds Agreement assigning System Energy's rights as security for specific debt of System Energy, Entergy Corporation has agreed to make cash capital contributions, if required, to enable System Energy to make payments on such debt when due. The Capital Funds Agreement can be terminated by the parties thereto, subject to consent of certain creditors.\nENTERGY CORPORATION AND SUBSIDIARIES\nMANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS\nSIGNIFICANT FACTORS AND KNOWN TRENDS\nCompetition and Industry Challenges\nElectric utilities traditionally have operated as regulated monopolies in which there was little opportunity for direct competition in the provision of electric service. In return for the ability to receive a reasonable return on and of their investments, utilities were obligated to provide service and meet future customer requirements. However, the electric utility industry is now undergoing a transition to an environment of increased retail and wholesale competition.\nPressures that underlie the movement toward increasing competition are numerous and complex. They include legislative and regulatory changes, technological advances, consumer demands, greater availability of natural gas, environmental needs, and other factors. The increasingly competitive environment presents opportunities to compete for new customers, as well as the risk of loss of existing customers. Competition presents Entergy with many challenges. The following have been identified by Entergy as its major competitive challenges.\nThe Energy Policy Act of 1992\nThe EPAct addresses a wide range of energy issues and is being implemented by both FERC and state regulators. The EPAct is designed to promote competition among utility and non utility generators by amending PUHCA to exempt from regulation a class of EWGs, among others, consisting of utility affiliates and non utilities that own and operate facilities for the generation and transmission of power for sale at wholesale. The EPAct also gave FERC the authority to order investor- owned utilities to transmit power and energy to or for wholesale purchasers and sellers. This creates potential for electric utilities and other power producers to gain increased access to the transmission systems of other utilities to facilitate wholesale sales.\nIn response to the EPAct, FERC issued a notice of proposed rulemaking in mid-1994. This rulemaking concerns a regulatory framework for dealing with recovery of costs that were prudently incurred by electric utilities to serve customers under the traditional regulatory framework. These costs may become \"stranded\" as a result of increased competition. On March 29, 1995, FERC issued a supplemental notice of proposed rulemaking in this proceeding that would require public utilities to provide nondiscriminatory open access transmission service to wholesale customers and would also provide guidance on the recovery of wholesale and retail stranded costs. The risk of exposure to stranded costs that may result from competition in the industry will depend on the extent and timing of retail competition, the resolution of jurisdictional issues concerning stranded cost recovery, and the extent to which such costs are recovered from departing or remaining customers.\nWith regard to pending proceedings, including Entergy's open access transmission tariff proceedings originally filed in 1991 and amended in 1994 and 1995, FERC directed the parties to proceed with their cases while taking into account FERC's proposed rule. Comments and reply comments on the proposed rulemaking have now been filed with FERC by interested parties. Certain of the parties filing comments have proposed that FERC should order the immediate unbundling of all retail services as part of the final rulemaking in this proceeding, which is expected in the second quarter of 1996. In its comments in the proposed rulemaking, Entergy urged FERC to exercise its authority and responsibility to serve as a \"backstop\" in the event a state is unable or unwilling to provide for stranded-cost recovery -- particularly in the case of multi state utilities (such as the System), where cost shifting among jurisdictions might otherwise occur.\nENTERGY CORPORATION AND SUBSIDIARIES\nMANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS\nSIGNIFICANT FACTORS AND KNOWN TRENDS\nRetail and Wholesale Rate Issues\nThe retail regulatory philosophy is shifting in some jurisdictions from traditional cost-of-service regulation to incentive-rate regulation. Incentive and performance-based rate plans encourage efficiencies and productivity while permitting utilities and their customers to share in the results. MP&L implemented an incentive-rate plan in March 1994 and, in June 1995, the LPSC implemented a performance-based formula rate plan for LP&L. The continuing pattern of rate reductions is a characteristic of the competitive environment in which Entergy operates.\nSeveral of the Operating Companies have recently been ordered to grant base rate reductions and have refunded or credited customers for previous overcollections of rates. See Note 2 for additional discussion of rate reductions and incentive-rate regulation.\nIn connection with the Merger, AP&L and MP&L agreed with their respective retail regulators not to request any general retail rate increases that would take effect before November 1998, with certain exceptions. MP&L also agreed that during this period retail base rates under its formula rate plan would not be increased above the level of rates in effect on November 1, 1993. In connection with the Merger, NOPSI agreed with the Council to reduce its annual electric base rates by $4.8 million, effective for bills rendered on or after November 1, 1993. GSU agreed with the LPSC and PUCT to a five-year Rate Cap on retail electric rates, and to pass through to retail customers the fuel savings and a certain percentage of the nonfuel savings created by the Merger. Under the terms of their respective Merger agreements, the LPSC and PUCT have reviewed GSU's base rates during the first post-Merger earnings analysis and ordered rate reductions. See Note 2 for additional discussion of GSU's post-Merger filings with the LPSC and the PUCT.\nSystem Energy implemented a $65.5 million rate increase, subject to refund, in December 1995.\nPotential Changes in the Electric Utility Industry\nRetail wheeling, the transmission by an electric utility of energy produced by another entity over the utility's transmission and distribution system to a retail customer in the electric utility's area of service, continues to evolve. Approximately 40 states have initiated studies of the concept of retail competition or are considering it as part of industry restructuring. Within the area served by the Operating Companies, the City of New Orleans, Louisiana, and Texas are conducting such studies.\nIn January 1996, the Council voted to investigate retail utility service competition. Although no date has been set, the investigation will focus on the impact of competition, service unbundling, and utility restructuring on consumers of retail electric and gas utility service in New Orleans. Earlier in 1995, a newly incorporated entity, Crescent City Utilities, Inc., submitted to the Council a draft resolution intended to permit the use of NOPSI's gas and electric transmission and distribution facilities by any other franchised utility to supply electricity and gas to retail customers in New Orleans. The Council has not scheduled hearings relating to this resolution.\nENTERGY CORPORATION AND SUBSIDIARIES\nMANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS\nSIGNIFICANT FACTORS AND KNOWN TRENDS\nThe PUCT is currently developing rules that will permit greater wholesale electric competition in Texas, as mandated by the Texas legislature in its 1995 session. These wholesale transmission access rules are expected to be in place by the first quarter of 1996. In addition, the PUCT is developing information to be contained in reports that will be submitted to the 1997 legislature concerning broader competitive issues such as the unbundling of electric utility operations, market-based pricing, performance-based ratemaking, and the identification and recovery of potential stranded costs as part of the transition to a more competitive electric industry environment. This information will be developed through a series of workshops and comments by interested parties throughout 1996. In addition, during 1995, the Texas legislature revised the Public Utility Regulatory Act, the law regulating electric utilities in Texas. The revised law permits utility and non utility EWGs and power marketers to sell wholesale power in the state. The revised law also permits the discounting of rates with certain conditions, but does not change the current law governing retail wheeling or the treatment of federal income taxes.\nDuring the second quarter of 1995, the Louisiana legislature considered a bill permitting local retail wheeling. The bill was defeated, but similar bills are likely to be introduced in the future. During the same time period, the LPSC initiated a generic docket to investigate retail, wholesale, and affiliate wheeling of electricity. Currently, no procedural schedule has been set for this docket.\nDuring January 1996, a bill entitled the \"Electric Power Competition Act of 1996\" was introduced into the United States House of Representatives. The bill proposes to amend certain provisions under PURPA for the purpose of facilitating future deregulation of the electric power industry.\nIn some areas of the country, municipalities (or comparable entities) whose residents are served at retail by an investor-owned utility pursuant to a franchise, are exploring the possibility of establishing new electric distribution systems, or extending existing ones. In some cases, municipalities are also seeking new delivery points in order to serve retail customers, especially large industrial customers, which currently receive service from an investor-owned utility. Where successful, however, the establishment of a municipal system or the acquisition by a municipal system of a utility's customers could result in the utility's inability to recover costs that it has incurred for the purpose of serving those customers.\nSignificant Industrial Cogeneration Effects\nMany of Entergy's industrial customers, whose costs structures are energy-sensitive, have energy alternatives available to them such as fuel switching, cogeneration, and production shifting. Cogeneration is generally defined as the combined production of electricity and some other useful form of heat, typically steam. Cogenerated power may either be sold by its producer to the local utility at its avoided cost under PURPA, and\/or utilized by the cogenerator to displace purchases from the utility. To the extent that cogeneration is used by industrial customers to meet their own power requirements, the System may suffer loss of industrial load. It is the practice of the Operating Companies to negotiate the renewal of contracts with large industrial customers prior to their expiration. In certain cases (particularly for GSU and LP&L), contracts or special tariffs that use flexible pricing have been negotiated with industrial customers to keep these customers on the System. The pricing agreements are not at full cost of service. Such rates may fully recover all related costs, but provide only a minimal return, if any, on investment. In 1995, KWh sales to GSU's and LP&L's industrial customers at less than full cost- of-service rates made up approximately 27% and 39% of GSU's and LP&L's total industrial class sales, respectively.\nENTERGY CORPORATION AND SUBSIDIARIES\nMANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS\nSIGNIFICANT FACTORS AND KNOWN TRENDS\nSince PURPA was enacted in 1978, the Operating Companies have been largely successful in retaining industrial load. The Operating Companies anticipate they will be successful in renegotiating such contracts with large industrial customers. However, this competitive challenge will likely increase. There can be no assurance that the Operating Companies will be successful or that future revenues will not be lost to other forms of generation.\nThe Council has recently approved a resolution requiring its prior approval of regulatory treatment of any lost contribution to fixed costs as a result of incentive-rate agreements with large industrial or commercial customers entered into for the purposes of retaining those customers. The resolution also requires prior approval by the Council of the regulatory treatment of stranded costs resulting from the loss of large customers.\nDuring 1995, LP&L received separate notices from two large industrial customers that will proceed with proposed cogeneration projects for the purpose of fulfilling their future electric energy needs. These customers will continue to purchase their energy requirements from LP&L until their cogeneration facilities are completed and operational, which is expected to occur between the years 1997 and 1998. After that time these customers will still purchase energy from LP&L, but at a reduced level. During 1995, these two customers represented an aggregate of approximately 18% of total LP&L industrial sales, and provided 12% of total industrial base revenues.\nDomestic and Foreign Energy-Related Investments\nEntergy Corporation seeks opportunities to expand its domestic energy-related businesses that are not regulated by state and local regulatory authorities, as well as foreign power investments that provide returns in excess of similar domestic investments. Such business ventures currently include power development and new technology related to the utility business. Entergy Corporation's strategy is to identify and pursue business opportunities that have the potential to earn a greater return than its regulated utility operations. Refer to \"MANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS - LIQUIDITY AND CAPITAL RESOURCES\" for a discussion of Entergy Corporation's 1995 investment in domestic and foreign energy-related businesses. These investments may involve a greater risk than domestically regulated utility enterprises. In 1995, Entergy Corporation's investments in domestic and foreign energy-related investments reduced consolidated net income by approximately $64.8 million. While such investments did not have a positive effect on 1995 earnings, management believes they will show profits in the near term.\nIn an effort to expand into new energy-related businesses, Entergy plans to commercialize its fiber optic telecommunications network that connects system facilities and supports its internal business needs. Entergy will provide long-haul fiber optic capacity to major telecommunications carriers, which in turn will market that service to third parties. The recently enacted Telecommunications Act of 1996 permits Entergy to market such a service, pending state and local regulatory approval. On February 8, 1996, the President of the United States signed the Telecommunications Act into law. This new law contains an exemption from PUHCA that will permit registered utility holding companies to form and capitalize subsidiaries to engage in telephone, telecommunications, and information service businesses without SEC approval. However, the law requires that such telecommunications subsidiaries file for exemption with the Federal Communications Commission, and that they not engage in transactions with utility affiliates within their holding company systems or acquire utility affiliates' property without state or local regulatory approval. Entergy Corporation has requested approval from the SEC to form a new nonregulated subsidiary named Entergy Technologies Company to commercialize the Entergy telecommunications network.\nENTERGY CORPORATION AND SUBSIDIARIES\nMANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS\nSIGNIFICANT FACTORS AND KNOWN TRENDS\nIn early October 1995, FERC issued an order granting EWG status to Entergy Power Marketing Corporation (EPM), a wholly owned subsidiary of Entergy Corporation. EPM was created during 1995 to become a buyer and seller of electrical energy and its generating fuels. In February 1996, FERC approved market-based rate sales of electricity by EPM. Such approval will allow EPM to begin providing wholesale customers with a variety of services including physical and financial trading. Pending approval from the SEC, EPM expects to begin financial trading by the summer of 1996.\nOn January 5, 1996, Entergy Corporation finalized its acquisition of CitiPower, an electric distribution company serving Melbourne, Australia, and surrounding suburbs. The purchase price of CitiPower was approximately $1.2 billion, of which $294 million represented an equity investment by Entergy Corporation, and the remainder represented debt. Entergy Corporation funded the majority of the equity portion of the investment by using $230 million of its $300 million line of credit. CitiPower serves approximately 234,500 customers, the majority of which are commercial customers. At the time of the acquisition, CitiPower had 846 employees.\nANO Matters\nEntergy Operations has made inspections and repairs from time to time on ANO 2's steam generators. During the October 1995 inspection, additional cracks in the tubes were discovered. Currently, Entergy Operations is in the process of gathering information and assessing various options for the repair or replacement of ANO 2's steam generators. See Note 8 for additional information.\nDeregulated Utility Operations\nGSU discontinued regulatory accounting principles for its wholesale jurisdiction and steam department and the Louisiana deregulated portion of River Bend during 1989 and 1991, respectively. The operating income (loss) from these operations was $7.2 million in 1995, $(5.2) million in 1994, and $(2.9) million in 1993.\nThe increase in 1995 net income from deregulated operations was due to increased revenues and reduced operation and maintenance expenses, partially offset by increased depreciation. The larger net loss from deregulated operations in 1994 was principally due to a smaller income tax benefit. The future impact of the deregulated utility operations on Entergy and GSU's results of operations and financial position will depend on future operating costs, the efficiency and availability of generating units, and the future market for energy over the remaining life of the assets. Entergy expects the performance of its deregulated utility operations to improve, due to continued reductions in operation and maintenance expenses. The deregulated operations will be subject to the requirements of SFAS 121, as discussed in Note 1, in determining the recognition of any asset impairment.\nProperty Tax Exemptions\nLP&L and GSU are working with tax authorities to determine the method for calculating the amount of property taxes to be paid once Waterford 3 and River Bend's local property tax exemptions expire. Waterford 3's exemption expired in December 1995 and River Bend's exemption expires in December 1996. LP&L expects that the LPSC will address the accounting treatment and recovery of Waterford 3's property taxes in April 1996, in conjunction with the annual filing required under its performance-based formula rate plan.\nENTERGY CORPORATION AND SUBSIDIARIES\nMANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS\nSIGNIFICANT FACTORS AND KNOWN TRENDS\nEnvironmental Issues\nGSU has been notified by the U. S. Environmental Protection Agency (EPA) that it has been designated as a PRP for the clean-up of certain hazardous waste disposal sites. See Note 8 for additional information.\nAs a consequence of rules for solid waste regulation issued by the Louisiana Department of Environmental Quality in 1993, LP&L has determined that certain of its power plant wastewater impoundments must be upgraded or closed. See Note 8 for additional information.\nAccounting Issues\nNew Accounting Standard - In March 1995, the FASB issued SFAS 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of\" (SFAS 121), effective January 1, 1996. This standard describes circumstances that may result in assets being impaired and provides criteria for recognition and measurement of asset impairment. See Notes 1 and 2 for information regarding the potential impacts of the new accounting standard on Entergy.\nContinued Application of SFAS 71 - As a result of the EPAct and actions of regulatory commissions, the electric utility industry is moving toward a combination of competition and a modified regulatory environment. The System's financial statements currently reflect, for the most part, assets and costs based on current cost-based ratemaking regulations in accordance with SFAS 71, \"Accounting for the Effects of Certain Types of Regulation\" (SFAS 71). Continued applicability of SFAS 71 to the System's financial statements requires that rates set by an independent regulator on a cost-of-service basis can actually be charged to and collected from customers.\nIn the event that all or a portion of a utility's operations cease to meet those criteria for various reasons, including deregulation, a change in the method of regulation, or a change in the competitive environment for the utility's regulated services, the utility should discontinue application of SFAS 71 for the relevant portion. That discontinuation should be reported by elimination from the balance sheet of the effects of any actions of regulators recorded as regulatory assets and liabilities.\nAs of December 31, 1995, and for the foreseeable future, the System's financial statements continue to follow SFAS 71, except for certain portions of GSU's business. See Note 1 for additional discussion of Entergy's application of SFAS 71.\nAccounting for Decommissioning Costs - The staff of the SEC has been reviewing the financial accounting practices of the electric utility industry regarding the recognition, measurement, and classification of nuclear decommissioning costs for nuclear generating stations in the financial statements of electric utilities. In February 1996 the FASB issued an exposure draft of the proposed SFAS addressing the accounting for decommissioning costs as well as liabilities related to the closure and removal of all long-lived assets. See Note 8 for a discussion of proposed changes in the accounting for decommissioning\/closure costs and the potential impact of these changes on Entergy.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholders of Entergy Corporation\nWe have audited the accompanying consolidated balance sheets of Entergy Corporation and Subsidiaries as of December 31, 1995 and 1994, and the related statements of consolidated income, retained earnings and paid-in-capital and cash flows for the years then ended. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audits. The consolidated financial statements of Entergy Corporation and Subsidiaries for the year ended December 31, 1993, were audited by other auditors, whose report, dated February 11, 1994, included explanatory paragraphs that (i) described changes in 1993 in the method of accounting for revenues by certain of the Corporation's subsidiaries (Note 1); (ii) uncertainties regarding costs capitalized by Gulf States Utilities Company for its River Bend Unit I Nuclear Generating Plant (River Bend) and other rate-related contingencies which may result in a refund of revenues previously collected (Note 2); and, (iii) an uncertainty regarding civil actions against Gulf States Utilities Company (Note 8).\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as 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 Entergy Corporation and Subsidiaries as of December 31, 1995 and 1994, and the results of their operations and their cash flows for the years then ended in conformity with generally accepted accounting principles.\nAs discussed in Note 2 to the consolidated financial statements, the net amount of capitalized costs for River Bend exceed those costs currently being recovered through rates. At December 31, 1995, approximately $482 million is not currently being recovered through rates. If current regulatory and court orders are not modified, a write-off of all or a portion of such costs may be required. Additionally, other rate-related contingencies exist which may result in refunds of revenues previously collected. The extent of such write- off of capitalized River Bend costs or refunds of revenues previously collected, if any, will not be determined until appropriate rate proceedings and court appeals have been concluded. Accordingly, the accompanying consolidated financial statements do not include any adjustments or provision for write-off or refund that might result from the outcome of these uncertainties. As also discussed in Note 2, approximately $187 million of additional deferred River Bend operating costs which exceed those costs currently being recovered through rates are expected to be written-off upon the adoption of Statement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.\" Adoption of this Statement is required on January 1, 1996.\nAs discussed in Note 8 to the consolidated financial statements, civil actions have been initiated against Gulf States Utilities Company to, among other things, recover the co-owner's investment in River Bend and to annul the River Bend Joint Ownership Participation and Operating Agreement. The ultimate outcome of these proceedings cannot presently be determined.\nAs discussed in Note 1 to the consolidated financial statements, in 1995 one of the Corporation's subsidiaries changed its method of accounting for incremental nuclear plant outage maintenance costs.\nCOOPERS & LYBRAND L.L.P. New Orleans, Louisiana February 14, 1996\nINDEPENDENT AUDITORS' REPORT\nTo the Board of the Directors and the Shareholders of Entergy Corporation:\nWe have audited the accompanying statements of consolidated income, retained earnings and paid-in capital, and cash flows of Entergy Corporation and subsidiaries for the year ended December 31, 1993. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audit. We did not audit the financial statements of Gulf States Utilities Company (a consolidated subsidiary acquired on December 31, 1993), which statements reflect total assets constituting 31% of consolidated total assets at December 31, 1993. Those statements were audited by other auditors whose report (which included explanatory paragraphs regarding the uncertainties discussed in the fourth and fifth paragraphs below) has been furnished to us, and our opinion, insofar as it relates to the amounts included for Gulf States Utilities Company, is based solely on the report of such auditors.\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 and the report of the other auditors provide a reasonable basis for our opinion.\nIn our opinion, based on our audit and the report of the other auditors, such consolidated financial statements present fairly, in all material respects, the results of Entergy Corporation and subsidiaries' operations and their cash flows for the year ended December 31, 1993 in conformity with generally accepted accounting principles.\nThe Corporation acquired a 70% interest in River Bend Unit 1 Nuclear Generating Plant (River Bend) through its acquisition of Gulf States Utilities Company on December 31, 1993. As discussed in Note 2 to the consolidated financial statements, the net amount of capitalized costs for River Bend exceed those costs currently being recovered through rates. If current regulatory and court orders are not modified, a write-off of all or a portion of such costs may be required. Additionally, as discussed in Note 2 to the consolidated financial statements, other rate-related contingencies exist which may result in a refund of revenues previously collected. The extent of such write-off of capitalized River Bend costs or refund of revenue previously collected, if any, will not be determined until appropriate rate proceedings and court appeals have been concluded. Accordingly, the accompanying 1993 consolidated financial statements do not include any adjustments that might result from the outcome of these uncertainties.\nAs discussed in Note 8 to the consolidated financial statements, civil actions have been initiated against Gulf States Utilities Company to, among other things, recover the co-owner's investment in River Bend and to annul the related joint ownership participation and operating agreement. The ultimate outcome of these proceedings, including their impact on Gulf States Utilities Company, cannot presently be determined. Accordingly, the accompanying 1993 consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.\nAs discussed in Note 1 to the consolidated financial statements, certain of the Corporation's subsidiaries changed their method of accounting for revenues in 1993.\nDELOITTE & TOUCHE LLP New Orleans, Louisiana February 11, 1994\nENTERGY CORPORATION AND SUBSIDIARIES\nMANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS\nRESULTS OF OPERATIONS\nOn December 31, 1993, GSU became a subsidiary of Entergy Corporation. In accordance with the purchase method of accounting, the results of operations for the twelve months ended December 31, 1993, of Entergy Corporation and Subsidiaries reported in its Statements of Consolidated Income and Cash Flows do not include GSU's results of operations. However, the following discussion is presented with GSU's 1993 results of operations included for comparative purposes.\nNet Income\nConsolidated net income increased in 1995 due primarily to increased electric operating revenues, decreased other operation and maintenance expenses, the onetime recording of the cumulative effect of the change in accounting method for incremental nuclear refueling outage maintenance costs at AP&L, and decreased interest expense, partially offset by increased income taxes and decreased miscellaneous income - net.\nConsolidated net income decreased in 1994 due primarily to the one time recording in 1993 of the cumulative effect of the change in accounting principle for unbilled revenues for AP&L, GSU, MP&L, and NOPSI, and a base-rate reduction ordered by the PUCT. In addition, net income was impacted by a decrease in revenues, increased Merger- related costs, certain restructuring costs, and decreased miscellaneous income - net, partially offset by a decrease in interest on long-term debt and preferred dividend requirements.\nSignificant factors affecting the results of operations and causing variances between the years 1995 and 1994, and 1994 and 1993, are discussed under \"Revenues and Sales,\" \"Expenses,\" and \"Other\" below.\nRevenues and Sales\nSee \"SELECTED FINANCIAL DATA - FIVE-YEAR COMPARISON,\" following the notes, for information on operating revenues by source and KWh sales.\nThe changes in electric operating revenues for the twelve months ended December 31, 1995, are as follows:\nIncrease\/ Description (Decrease) ----------------------- ------------ (In Millions)\nChange in base revenues $6.6 Rate riders 15.3 Fuel cost recovery (28.0) Sales volume\/weather 141.3 Other revenue (including 4.3 unbilled) Sales for resale 49.5 System Energy-FERC Settlement 120.5 ------- Total $309.5 =======\nENTERGY CORPORATION AND SUBSIDIARIES\nMANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS\nRESULTS OF OPERATIONS\nElectric operating revenues increased in 1995 as a result of an increase in retail energy sales, the effects of the 1994 FERC Settlement, and increased wholesale revenues, partially offset by rate reductions at GSU, LP&L, and NOPSI and lower fuel adjustment revenues. Warmer weather and non-weather related volume growth contributed equally to the increase in retail electric energy sales. The increase in sales for resale was primarily from increased energy sales outside of Entergy's service area. The increase in other revenues was due to the effects of the 1994 FERC Settlement and the 1994 NOPSI Settlement.\nElectric operating revenues decreased in 1994 due primarily to rate reductions at GSU, MP&L, and NOPSI, the effects of the 1994 NOPSI Settlement and the FERC Settlement, and decreased fuel adjustment revenues, partially offset by increased retail energy sales and increased collections of previously deferred Grand Gulf 1-related costs.\nGas operating revenues decreased in 1995 because of a milder winter than in 1994, gas rate reductions agreed to in the 1994 NOPSI Settlement, and a lower unit price for gas purchased for resale. Gas operating revenues decreased slightly in 1994 as a result of lower weather-related sales.\nExpenses\nOperating expenses increased in 1995 due to increased income taxes related to higher pre-tax book income and the effects of the 1994 FERC Settlement. In addition, nuclear refueling outage expenses increased due to a 1995 refueling outage at Grand Gulf 1 and the adoption of the change in accounting method at AP&L. The increase in operating expenses was partially offset by a reduction in other operation and maintenance expenses. Other operation and maintenance expenses decreased primarily because of lower payroll-related expenses resulting from the restructuring program discussed in Note 11 and 1994 Merger-related costs.\nOperating expenses decreased in 1994 due primarily to decreased power purchases from nonassociated utilities and to changes in generation requirements for the Operating Companies, decreased nuclear refueling outage expenses as the result of Grand Gulf 1 outage expenses incurred in 1993, decreased income taxes due primarily to lower pre-tax book income, and the effects of the FERC Settlement.\nInterest charges decreased in 1995 and 1994 as a result of the retirement and refinancing of higher cost long-term debt.\nPreferred dividend requirements decreased in 1995 and 1994 due to stock redemption activities.\nOther\nMiscellaneous other income - net decreased in 1995 due primarily to expansion activities in nonregulated businesses.\nMiscellaneous other income - net decreased in 1994 due primarily to the amortization of the plant acquisition adjustment related to the GSU Merger, the adoption of SFAS 116, \"Accounting for Contributions Made and Contributions Received,\" and reduced Grand Gulf 1 carrying charges at AP&L.\nENTERGY CORPORATION AND SUBSIDIARIES STATEMENTS OF CONSOLIDATED INCOME\nENTERGY CORPORATION AND SUBSIDIARIES STATEMENTS OF CONSOLIDATED CASH FLOWS\nENTERGY CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS ASSETS\nENTERGY CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS CAPITALIZATION AND LIABILITIES\nENTERGY CORPORATION AND SUBSIDIARIES STATEMENTS OF CONSOLIDATED RETAINED EARNINGS AND PAID-IN CAPITAL\nENTERGY CORPORATION AND SUBSIDIARIES\nSELECTED FINANCIAL DATA - FIVE-YEAR COMPARISON\n(1) Includes long-term debt (excluding currently maturing debt), preferred and preference stock with sinking fund, and noncurrent capital lease obligations.\n(2) 1993 amounts include the effects of the Merger in accordance with the purchase method of accounting for combinations.\n(1)1994 includes the effects of the FERC Settlement, the 1994 NOPSI Settlement, and a GSU reserve for rate refund.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholders of Arkansas Power & Light Company\nWe have audited the accompanying balance sheets of Arkansas Power & Light Company as of December 31, 1995 and 1994, and the related statements of income, retained earnings and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. The financial statements of the Company for the year ended December 31, 1993, were audited by other auditors, whose report, dated February 11, 1994, included an explanatory paragraph that described a change in the method of accounting for revenues, which is discussed in Note 1 to these financial 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 financial position of the Company as of December 31, 1995 and 1994, and the results of its operations and its cash flows for the years then ended in conformity with generally accepted accounting principles.\nAs discussed in Note 1 to the financial statements, in 1995 the Company changed its method of accounting for incremental nuclear plant outage maintenance costs.\nCOOPERS & LYBRAND L.L.P. New Orleans, Louisiana February 14, 1996\nINDEPENDENT AUDITORS' REPORT\nTo the Shareholders and the Board of Directors of Arkansas Power & Light Company:\nWe have audited the accompanying statements of income, retained earnings, and cash flows of Arkansas Power & Light Company (AP&L) for the year ended December 31, 1993. These financial statements are the responsibility of AP&L's management. Our responsibility is to express an opinion on these financial statements based on our audit.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, such financial statements present fairly, in all material respects, the results of AP&L's operations and its cash flows for the year ended December 31, 1993 in conformity with generally accepted accounting principles.\nAs discussed in Note 1 to the financial statements, AP&L changed its method of accounting for revenues in 1993.\nDELOITTE & TOUCHE LLP New Orleans, Louisiana February 11, 1994\nARKANSAS POWER & LIGHT COMPANY\nMANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS\nRESULTS OF OPERATIONS\nNet Income\nNet income increased in 1995 due primarily to the onetime recording of the cumulative effect of the change in accounting method for incremental nuclear refueling outage maintenance costs as discussed in Note 1. Excluding the above mentioned item, net income for 1995 decreased due to an increase in depreciation, amortization, and decommissioning expenses and income tax expense offset by an increase in revenues from retail energy sales and a decrease in other operation and maintenance expenses.\nNet income decreased in 1994 due primarily to the onetime recording in the first quarter of 1993 of the cumulative effect of the change in accounting principle for unbilled revenues and its ongoing effects, and to increased other operation and maintenance expenses resulting from restructuring and storm damage costs during 1994.\nSignificant factors affecting the results of operations and causing variances between the years 1995 and 1994, and 1994 and 1993, are discussed under \"Revenues and Sales,\" \"Expenses,\" and \"Other\" below.\nRevenues and Sales\nSee \"SELECTED FINANCIAL DATA - FIVE-YEAR COMPARISON,\" following the notes to financial statements, for information on operating revenues by source and KWh sales.\nThe changes in electric operating revenues for the twelve months ended December 31, 1995, are as follows:\nIncrease\/ Description (Decrease) ------------------------- ------------- (In Millions)\nChange in base revenues $(3.4) Rate riders 15.9 Fuel cost recovery 25.1 Sales volume\/weather 38.2 Other revenue (including unbilled) 9.7 Sales for resale (28.0) ------- Total $57.5 ======\nElectric operating revenues increased for 1995 due primarily to increased retail energy sales and fuel adjustment revenues partially offset by a decrease in sales for resale to associated companies. The increase in sales volume\/weather resulted from increased customers and associated usage, while the remainder resulted from warmer weather in the summer months. The decrease in sales for resale to associated companies was caused by changes in generation availability and requirements among the Operating Companies.\nTotal revenues remained relatively unchanged in 1994. Retail revenues decreased primarily due to lower recovery of fuel revenues during the year offset by increased sales for resale to associated companies in 1994, caused by changes in generation availability and requirements among the Operating Companies.\nARKANSAS POWER & LIGHT COMPANY\nMANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS\nRESULTS OF OPERATIONS\nExpenses\nOperating expenses increased in 1995 because of an increase in depreciation, amortization, and decommissioning expenses and income tax expense, offset by a decrease in other operation and maintenance expenses. Depreciation, amortization, and decommissioning expenses increased primarily due to additions and upgrades at ANO and additions to transmission lines, substations, and other equipment. Also, decommissioning expense increased due to the implementation of the decommissioning rate rider which resulted from the decommissioning study performed in 1994. Income tax expense increased primarily due to the write-off in 1994 of investment tax credits in accordance with the FERC Settlement, as discussed below. Income tax expense also increased due to higher pre-tax income in 1995. The decrease in other operation and maintenance expenses is largely due to restructuring costs and storm damage costs recorded in 1994 .\nOperating expenses increased in 1994 due primarily to increased other operation and maintenance expenses and increased amortization of rate deferrals partially offset by lower purchased power expenses. Other operation and maintenance expenses increased in 1994 primarily due to the storm damage and restructuring costs as discussed in Note 11. The decrease in 1994 purchased power expenses is primarily due to the decrease in the price of purchased power. Total income taxes decreased during 1994 primarily due to the write-off of unamortized deferred investment tax credit of $27.3 million due to a FERC settlement and due to lower pretax income in 1994. This decrease was partially offset by an increase in tax expense due to the true-up of actual income tax expense for 1993 determined during 1994.\nOther\nMiscellaneous other income - net decreased in 1994 due primarily to reduced Grand Gulf 1 carrying charges. Other income taxes decreased in 1994 primarily due to a lower pretax income as discussed above. Interest on long-term debt decreased in 1994 due primarily to the continued retirement and refinancing of high-cost debt.\nARKANSAS POWER & LIGHT COMPANY STATEMENTS OF INCOME\nARKANSAS POWER & LIGHT COMPANY STATEMENTS OF CASH FLOWS\nARKANSAS POWER & LIGHT COMPANY BALANCE SHEETS ASSETS\nARKANSAS POWER & LIGHT COMPANY BALANCE SHEETS CAPITALIZATION AND LIABILITIES\nARKANSAS POWER & LIGHT COMPANY STATEMENTS OF RETAINED EARNINGS\nARKANSAS POWER & LIGHT COMPANY\nSELECTED FINANCIAL DATA - FIVE-YEAR COMPARISON\n(1) Includes long-term debt (excluding currently maturing debt), preferred stock with sinking fund, and noncurrent capital lease obligations.\nSee Notes 1, 3, and 10 for the effect of accounting changes in 1995 and 1993 .\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholders of Gulf States Utilities Company\nWe have audited the accompanying balance sheets of Gulf States Utilities Company as of December 31, 1995 and 1994 and the related statements of income (loss), retained earnings and paid-in-capital and cash flows for each of the three years in the period ended December 31, 1995. 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 as of December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles.\nAs discussed in Note 2 to the financial statements, the net amount of capitalized costs for its River Bend Unit I Nuclear Generating Plant (River Bend) exceed those costs currently being recovered through rates. At December 31, 1995, approximately $482 million is not currently being recovered through rates. If current regulatory and court orders are not modified, a write-off of all or a portion of such costs may be required. Additionally, other rate-related contingencies exist which may result in refunds of revenues previously collected. The extent of such write-off of capitalized River Bend costs or refunds of revenues previously collected, if any, will not be determined until appropriate rate proceedings and court appeals have been concluded. Accordingly, the accompanying financial statements do not include any adjustments or provision for write-off or refund that might result from the outcome of these uncertainties. As also discussed in Note 2, approximately $187 million of additional deferred River Bend operating costs which exceed those costs currently being recovered through rates are expected to be written-off upon the adoption of Statement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.\" Adoption of this Statement is required on January 1, 1996.\nAs discussed in Note 8 to the financial statements, civil actions have been initiated against Gulf States Utilities Company to, among other things, recover the co-owner's investment in River Bend and to annul the River Bend Joint Ownership Participation and Operating Agreement. The ultimate outcome of these proceedings cannot presently be determined.\nAs discussed in Note 13 to the financial statements, the common stock of the Company was acquired on December 31, 1993.\nAs discussed in Note 3 to the financial statements, in 1993, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\" As discussed in Note 10 to the financial statements, the Company adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" as of January 1, 1993. As discussed in Note 1 to the financial statements, as of January 1, 1993, the Company began accruing revenues for energy delivered to customers but not yet billed.\nCOOPERS & LYBRAND L.L.P. New Orleans, Louisiana February 14, 1996\nGULF STATES UTILITIES COMPANY\nMANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS\nRESULTS OF OPERATIONS\nNet Income\nNet income increased in 1995 principally as the result of an increase in electric operating revenues, a decrease in other operation and maintenance expenses, and an increase in other income. These changes were partially offset by higher income taxes.\nNet income decreased in 1994 due primarily to write-offs and charges associated with the resolution of contingencies and additional Merger-related costs aggregating $137 million, a base rate reduction ordered by the PUCT applied retroactively to March 1994, and restructuring costs. See Note 2 and Note 11 for additional information.\nSignificant factors affecting the results of operations and causing variances between the years 1995 and 1994, and 1994 and 1993, are discussed under \"Revenues and Sales,\" \"Expenses,\" and \"Other\" below.\nRevenues and Sales\nSee \"SELECTED FINANCIAL DATA - FIVE-YEAR COMPARISON,\" following the notes to financial statements, for information on operating revenues by source and KWh sales.\nThe changes in electric operating revenues for the twelve months ended December 31, 1995, are as follows:\nIncrease\/ Description (Decrease) ------------------------- --------- (In Millions)\nChange in base revenues $32.0 Fuel cost recovery (29.6) Sales volume\/weather 35.0 Other revenue (including unbilled) 1.1 Sales for resale 31.3 ------- Total $69.8 =======\nElectric operating revenues increased in 1995 primarily due to increased sales volume\/weather and higher sales for resale. These increases were partially offset by lower fuel adjustment revenues, which do not affect net income. Base revenues also increased in 1995 as a result of rate refund reserves established in 1994, as discussed below, which were subsequently reduced as a result of an amended PUCT order. The increase in base revenues was partially offset by rate reductions in effect for Texas and Louisiana. Sales volume\/weather increased because of warmer than normal weather and an increase in usage by all customer classes. Sales for resale increased as a result of changes in generation availability and requirements among the Operating Companies.\nElectric operating revenues decreased in 1994 due primarily to a base rate reduction ordered by the PUCT applied retroactively to March 1994, see Note 2 for additional information, and lower retail fuel revenues partially offset by increased wholesale revenues associated with higher sales for resale and increased retail base revenue. The decrease in retail revenues is primarily due to a decrease in fuel recovery revenue and a November 1993 rate reduction in Texas. Energy sales increased due primarily to higher sales for resale as a result of GSU's participation in the System power pool.\nGULF STATES UTILITIES COMPANY\nMANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS\nRESULTS OF OPERATIONS\nGas operating revenues decreased for 1995 primarily due to a decrease in residential sales. This decrease was the result of a milder winter than in 1994.\nExpenses\nOperating expenses decreased in 1995 as a result of lower other operation and maintenance expenses and purchased power expenses, partially offset by higher income taxes. Other operation and maintenance expenses decreased primarily due to charges made in 1994 for Merger-related costs, restructuring costs, and certain pre- acquisition contingencies including unfunded Cajun-River Bend costs and environmental clean-up costs. Purchased power expenses decreased because of the availability of less expensive gas and nuclear fuel for use in electric generation as well as changes in the generation requirements among the Operating Companies. In addition, the decrease in purchased power expenses in 1995 was the result of the recording of a provision for refund of disallowed purchased power expenses in 1994. Income taxes increased primarily due to higher pre-tax income in 1995.\nOperating expenses increased in 1994 due primarily to higher purchased power and other operation and maintenance expenses, partially offset by lower fuel for electric generation and fuel-related expense and lower income tax expense. Purchased power expenses increased in 1994 due to GSU's participation in joint dispatch through the System power pool resulting from increased energy sales as discussed above. The increase in purchased power expenses in 1994 was also due to the recording of a provision for refund of disallowed purchased power costs resulting from a Louisiana Supreme Court ruling. Fuel, fuel-related expenses, and gas purchased for resale decreased in 1994 primarily due to lower gas prices.\nOther operation and maintenance expenses increased in 1994 due primarily to charges associated with certain pre-acquisition contingencies, additional Merger-related costs and restructuring costs as discussed in Note 11.\nIncome taxes decreased in 1994 due primarily to lower pretax income resulting from the charges discussed above.\nOther\nOther miscellaneous income increased in 1995 as the result of certain adjustments made in 1994 related to pre-acquisition contingencies including Cajun-River Bend litigation (see Note 8 for additional information) the write-off of previously disallowed rate deferrals, and plant held for future use. As a result of these charges, income taxes on other income were significantly higher in 1995 compared to 1994.\nOther miscellaneous income decreased in 1994 due to the write-off of plant held for future use, establishment of a reserve related to the Cajun-River Bend litigation, the write-off of previously disallowed rate deferrals, and obsolete spare parts. These charges were partially offset by lower interest expense as a result of the continued refinancing of high-cost debt.\nIncome taxes decreased in 1994 due primarily to the charges discussed above.\nGULF STATES UTILITIES COMPANY STATEMENTS OF INCOME (LOSS)\nGULF STATES UTILITIES COMPANY STATEMENTS OF CASH FLOWS\nGULF STATES UTILITIES COMPANY BALANCE SHEETS ASSETS\nGULF STATES UTILITIES COMPANY BALANCE SHEETS CAPITALIZATION AND LIABILITIES\nGULF STATES UTILITIES COMPANY STATEMENTS OF RETAINED EARNINGS AND PAID-IN CAPITAL\nGULF STATES UTILITIES COMPANY\nSELECTED FINANCIAL DATA - FIVE-YEAR COMPARISON\n(1) Includes long-term debt (excluding currently maturing debt), preferred and preference stock with sinking fund, and noncurrent capital lease obligations.\nSee Notes 1 and 10 for the effect of accounting changes in 1993 and Notes 2 and 8 regarding River Bend rate appeals and litigation with Cajun.\n(1) 1994 includes the effects of a GSU reserve for rate refund.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholders of Louisiana Power & Light Company\nWe have audited the accompanying balance sheets of Louisiana Power & Light Company as of December 31, 1995 and 1994, and the related statements of income, retained earnings and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. The financial statements of the Company for the year ended December 31, 1993, were audited by other auditors, whose report, dated February 11, 1994, expressed an unqualified opinion on these financial 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 financial position of the Company as of December 31, 1995 and 1994, and the results of its operations and its cash flows for the years then ended in conformity with generally accepted accounting principles.\nCOOPERS & LYBRAND L.L.P. New Orleans, Louisiana February 14, 1996\nINDEPENDENT AUDITORS' REPORT\nTo the Shareholders and the Board of Directors of Louisiana Power & Light Company:\nWe have audited the accompanying statements of income, retained earnings, and cash flows of Louisiana Power & Light Company (LP&L) for the year ended December 31, 1993. These financial statements are the responsibility of LP&L's management. Our responsibility is to express an opinion on these financial statements based on our audit.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, such financial statements present fairly, in all material respects, the results of LP&L's operations and its cash flows for the year ended December 31, 1993 in conformity with generally accepted accounting principles.\nDELOITTE & TOUCHE LLP New Orleans, Louisiana February 11, 1994\nLOUISIANA POWER & LIGHT COMPANY\nMANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS\nRESULTS OF OPERATIONS\nNet Income\nNet income decreased in 1995 due to an April 1995 rate reduction and higher income taxes, partially offset by lower other operation and maintenance expenses. Net income increased in 1994 due primarily to the fourth quarter write-off of unamortized balances of deferred investment tax credits, partially offset by lower operating revenues and higher other operation and maintenance expenses.\nSignificant factors affecting the results of operations and causing variances between the years 1995 and 1994, and 1994 and 1993, are discussed under \"Revenues and Sales\" and \"Expenses\" below.\nRevenues and Sales\nSee \"SELECTED FINANCIAL DATA - FIVE-YEAR COMPARISON,\" following the notes to financial statements, for information on operating revenues by source and KWh sales.\nThe changes in operating revenues for the twelve months ended December 31, 1995, are as follows:\nIncrease\/ Description (Decrease) ------------------------ -------------- (In Millions)\nChange in base revenues $(29.9) Fuel cost recovery (35.9) Sales volume\/weather 40.7 Other revenue (including unbilled) (23.3) Sales for resale 12.9 ------- Total $(35.5) =======\nOperating revenues were lower in 1995 due primarily to a base rate reduction in the second quarter of 1995 and to lower fuel adjustment revenues, which do not affect net income. This decrease was partially offset by increased customer usage, principally caused by warmer summer weather. The completion of the amortization of proceeds from litigation with a gas supplier in the second quarter of 1994 also contributed to the decrease in other revenue, partially offset by higher sales to non-associated utilities.\nOperating revenues were lower in 1994 due primarily to the completion of the amortization of the proceeds resulting from litigation with a gas supplier in the second quarter and lower wholesale revenues partially offset by higher retail revenues. Wholesale revenues decreased due primarily to lower sales to non- associated utilities. Retail revenues increased due primarily to increases in sales to industrial and commercial customers.\nLOUISIANA POWER & LIGHT COMPANY\nMANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS\nRESULTS OF OPERATIONS\nExpenses\nOperating expenses decreased in 1995 due to decreases in fuel expenses, including purchased power, and other operation and maintenance expenses, partially offset by an increase in depreciation and income taxes. The decrease in fuel expenses is due to lower fuel prices partially offset by an increase in generation. Other operation and maintenance expenses decreased because of lower payroll-related expenses as a result of the restructuring program discussed in Note 11, power plant waste water site closures in 1994, and a court settlement reducing legal expense. Depreciation expense increased due to capital improvements to distribution lines and substations and to an increase in the depreciation rate associated with Waterford 3. Income taxes increased due to the write-off in 1994 of deferred investment tax credits in accordance with the 1994 FERC Settlement, a decrease in tax depreciation associated with Waterford 3, and higher pre-tax income.\nOperating expenses decreased in 1994 due primarily to a decrease in income tax expense as a result of the write-off of deferred investment tax credits pursuant to a FERC settlement and lower fuel expenses partially offset by higher other operation and maintenance expenses. The decrease in fuel and purchased power expenses is due primarily to lower fuel and purchased power prices. The increase in other operation and maintenance expenses is due primarily to restructuring costs and power plant waste water site closures. Interest expense decreased in 1994 as a result of the retirement and refinancing of high-cost debt.\nLOUISIANA POWER & LIGHT COMPANY STATEMENTS OF INCOME\nLOUISIANA POWER & LIGHT COMPANY STATEMENTS OF CASH FLOWS\nLOUISIANA POWER & LIGHT COMPANY BALANCE SHEETS ASSETS\nLOUISIANA POWER & LIGHT COMPANY BALANCE SHEETS CAPITALIZATION AND LIABILITIES\nLOUISIANA POWER & LIGHT COMPANY STATEMENTS OF RETAINED EARNINGS\nLOUISIANA POWER & LIGHT COMPANY\nSELECTED FINANCIAL DATA - FIVE-YEAR COMPARISON\n(1) Includes long-term debt (excluding currently maturing debt), preferred stock with sinking fund, and noncurrent capital lease obligations.\nSee Notes 3 and 10 for the effect of accounting changes in 1993.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholders of Mississippi Power & Light Company\nWe have audited the accompanying balance sheets of Mississippi Power & Light Company as of December 31, 1995 and 1994, and the related statements of income, retained earnings and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. The financial statements of the Company for the year ended December 31, 1993, were audited by other auditors, whose report, dated February 11, 1994, included an explanatory paragraph that described a change in the method of accounting for revenues, which is discussed in Note 1 to these financial 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 financial position of the Company as of December 31, 1995 and 1994, and the results of its operations and its cash flows for the years then ended in conformity with generally accepted accounting principles.\nCOOPERS & LYBRAND L.L.P. New Orleans, Louisiana February 14, 1996\nINDEPENDENT AUDITORS' REPORT\nTo the Shareholders and the Board of Directors of Mississippi Power & Light Company:\nWe have audited the accompanying statements of income, retained earnings, and cash flows of Mississippi Power & Light Company (MP&L) for the year ended December 31, 1993. These financial statements are the responsibility of MP&L's management. Our responsibility is to express an opinion on these financial statements based on our audit.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, such financial statements present fairly, in all material respects, the results of MP&L's operations and its cash flows for the year ended December 31, 1993 in conformity with generally accepted accounting principles.\nAs discussed in Note 1 to the financial statements, MP&L changed its method of accounting for revenues in 1993.\nDELOITTE & TOUCHE LLP New Orleans, Louisiana February 11, 1994\nMISSISSIPPI POWER & LIGHT COMPANY\nMANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS\nRESULTS OF OPERATIONS\nNet Income\nNet income increased in 1995 primarily due to increased revenues and a decrease in other operation and maintenance expenses partially offset by an increase in income tax expense. Net income decreased in 1994 due primarily to the onetime recording in the first quarter of 1993 of the cumulative effect of the change in accounting principle for unbilled revenues. In addition, net income was reduced by the rate reduction in connection with the formula incentive-rate plan, partially offset by a FERC settlement.\nSignificant factors affecting the results of operations and causing variances between the years 1995 and 1994, and 1994 and 1993, are discussed under \"Revenues and Sales,\" \"Expenses,\" and \"Other\" below.\nRevenues and Sales\nSee \"SELECTED FINANCIAL DATA - FIVE-YEAR COMPARISON,\" following the notes to financial statements, for information on operating revenues by source and KWh sales.\nThe changes in electric operating revenues for the twelve months ended December 31, 1995, are as follows:\nIncrease\/ Description (Decrease) ------------------------ ------------- (In Millions)\nChange in base revenues $(6.1) Grand Gulf Rate Rider (0.6) Fuel cost recovery 12.8 Sales volume\/weather 14.9 Other revenue (including unbilled) 5.6 Sales for resale 3.4 ------ Total $30.0 ======\nOperating revenues increased in 1995 primarily due to an increase in retail and wholesale energy sales and higher fuel adjustment revenues, partially offset by rate reductions. Retail energy sales increased primarily due to the impact of weather and increased customer usage. Fuel adjustment revenues increased in response to higher fuel costs and do not impact net income. Operating revenues decreased in 1994 due to the impact of the rate reduction in connection with the incentive-rate plan that went into effect in March 1994, partially offset by higher energy sales. In addition to the factors cited above for revenues, accrued unbilled revenues decreased due to a change in the cycle billing dates offset by an increase in billed revenues. This decrease was partially offset by increased commercial and industrial retail sales.\nExpenses\nOperating expenses increased in 1995 due primarily to an increase in income tax expense partially offset by a decrease in other operation and maintenance expenses. Operating expenses increased in 1994 due primarily to increased amortization of rate deferrals partially offset by lower fuel\/purchased power and income tax expenses.\nMISSISSIPPI POWER & LIGHT COMPANY\nMANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS\nRESULTS OF OPERATIONS\nIncome tax expense increased in 1995 due primarily to the 1994 write-off of unamortized deferred investment tax credits and higher pretax income in 1995. Income taxes decreased in 1994 due primary to lower pretax income, and the write-off of unamortized deferred investment tax credits in accordance with a FERC settlement.\nOther operation and maintenance expense decreased in 1995 due primarily to 1994 Merger-related costs allocated to MP&L and payroll expenses. No significant Merger-related costs were allocated to MP&L during the current year. Payroll expenses decreased as a result of the restructuring program announced and accrued for during the third quarter of 1994. The restructuring program included a reduction in the number of MP&L employees during 1995. In addition, maintenance expenses decreased at various power plants.\nPurchased power expense decreased in 1994 due primarily to changes in generation availability and requirements among the Operating Companies and a lower per unit price for power purchased.\nThe amortization of rate deferrals increased in 1994 reflecting the fact that MP&L, based on the Revised Plan, collected more Grand Gulf 1-related costs from its customers in 1994 than in 1993.\nOther\nInterest expense decreased in 1994 due primarily to the retirement and refinancing of high-cost debt.\nMISSISSIPPI POWER & LIGHT COMPANY STATEMENTS OF INCOME\nMISSISSIPPI POWER & LIGHT COMPANY STATEMENTS OF CASH FLOWS\nMISSISSIPPI POWER & LIGHT COMPANY BALANCE SHEETS ASSETS\nMISSISSIPPI POWER & LIGHT COMPANY BALANCE SHEETS CAPITALIZATION AND LIABILITIES\nMISSISSIPPI POWER & LIGHT COMPANY STATEMENTS OF RETAINED EARNINGS\nMISSISSIPPI POWER & LIGHT COMPANY\nSELECTED FINANCIAL DATA - FIVE-YEAR COMPARISON\n(1) Includes long-term debt (excluding currently maturing debt), preferred stock with sinking fund, and noncurrent capital lease obligations.\nSee Notes 1, 3, and 9 for the effect of accounting changes in 1993.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholders of New Orleans Public Service Inc.\nWe have audited the accompanying balance sheets of New Orleans Public Service Inc. as of December 31, 1995 and 1994, and the related statements of income, retained earnings and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. The financial statements of the Company for the year ended December 31, 1993, were audited by other auditors, whose report, dated February 11, 1994, included an explanatory paragraph that described a change in the method of accounting for revenues, which is discussed in Note 1 to these financial 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 financial position of the Company as of December 31, 1995 and 1994, and the results of its operations and its cash flows for the years then ended in conformity with generally accepted accounting principles.\nCOOPERS & LYBRAND L.L.P. New Orleans, Louisiana February 14, 1996\nINDEPENDENT AUDITORS' REPORT\nTo the Shareholders and the Board of Directors of New Orleans Public Service Inc.\nWe have audited the accompanying statements of income, retained earnings, and cash flows of New Orleans Public Service Inc. (NOPSI) for the year ended December 31, 1993. These financial statements are the responsibility of NOPSI's management. Our responsibility is to express an opinion on these financial statements based on our audit.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, such financial statements present fairly, in all material respects, the results of NOPSI's operations and its cash flows for the year ended December 31, 1993 in conformity with generally accepted accounting principles.\nAs discussed in Note 1 to the financial statements, NOPSI changed its method of accounting for revenues in 1993.\nDELOITTE & TOUCHE LLP New Orleans, Louisiana February 11, 1994\nNEW ORLEANS PUBLIC SERVICE INC.\nMANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS\nRESULTS OF OPERATIONS\nNet Income\nNet income increased in 1995 principally due to 1994 refunds associated with the 1994 NOPSI Settlement and a decrease in other operation and maintenance expense, partially offset by a permanent rate reduction that took place January 1, 1995. Net income decreased in 1994 due to the effects of the 1994 NOPSI Settlement and the one- time recording of the cumulative effect of the change in accounting principle for unbilled revenues in 1993, partially offset by lower operating expenses. See Note 2 for a discussion of the 1994 NOPSI Settlement.\nSignificant factors affecting the results of operations and causing variances between the years 1995 and 1994, and 1994 and 1993, are discussed under \"Revenues and Sales\" and \"Expenses\" below.\nRevenues and Sales\nSee \"SELECTED FINANCIAL DATA-FIVE-YEAR COMPARISON,\" following the notes to financial statements, for information on electric operating revenues by source and KWh sales.\nThe changes in electric operating revenues for the twelve months ended December 31, 1995, are as follows:\nIncrease\/ Description (Decrease) -------------------- ------------- (In Millions)\nChange in base revenues $12.2 Fuel cost recovery (0.3) Sales volume\/weather 12.5 Other revenue (including 6.1 unbilled) Sales for resale 3.5 ------ Total $34.0 ======\nElectric operating revenues increased in 1995 as a result of refunds in 1994 associated with the 1994 NOPSI Settlement and an increase in energy sales. The increase in energy sales is primarily due to weather effects on retail sales and an increase in sales for resale. Electric operating revenues decreased in 1994 due primarily to the effects of the 1994 NOPSI Settlement as discussed in Note 2. Electric energy sales increased slightly in 1994.\nGas operating revenues decreased in 1995 primarily due to the rate reduction agreed to in the NOPSI Settlement effective January 1, 1995, and a lower unit purchase price for gas purchased for resale. Gas operating revenues decreased slightly in 1994 as a result of lower gas sales.\nExpenses\nOperating expenses increased in 1995 due primarily to an increase in income taxes and the increased amortization of rate deferrals, partially offset by a decrease in fuel and other operation and maintenance expenses. Fuel expenses decreased in 1995 primarily due to a decrease in fuel prices. Other operation and maintenance expenses decreased primarily due to a decrease in maintenance activity and lower payroll expenses. The decrease in payroll expenses is the result of the 1994 restructuring and the related decrease in employees. Operating expenses decreased in 1994 due primarily to lower purchased power expenses and lower income tax expenses.\nNEW ORLEANS PUBLIC SERVICE INC.\nMANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS\nRESULTS OF OPERATIONS\nPurchased power expenses decreased in 1994 due primarily to changes in generation availability and requirements among the Operating Companies and lower costs.\nGas purchased for resale decreased in 1995 due lower gas prices. Gas purchased for resale decreased in 1994 due to decreased gas sales.\nIncome taxes increased in 1995 as a result of lower pretax income in 1994 due to the 1994 NOPSI Settlement and the write-off of the unamortized balances of deferred investment tax credits pursuant to the FERC Settlement in 1994. Income taxes decreased in 1994 due primarily to lower pretax income, resulting from the 1994 NOPSI Settlement, and the write-off of the unamortized balances of deferred investment tax credits pursuant to the FERC Settlement.\nThe increases in the amortization of rate deferrals in 1995 and 1994 are primarily a result of the collection of larger amounts of previously deferred costs under the 1991 NOPSI Settlement, which allowed NOPSI to record an additional $90 million of previously incurred Grand Gulf 1-related costs.\nNEW ORLEANS PUBLIC SERVICE INC. STATEMENTS OF INCOME\nNEW ORLEANS PUBLIC SERVICE INC. STATEMENTS OF CASH FLOWS\nNEW ORLEANS PUBLIC SERVICE INC. BALANCE SHEETS ASSETS\nNEW ORLEANS PUBLIC SERVICE INC. BALANCE SHEETS CAPITALIZATION AND LIABILITIES\nNEW ORLEANS PUBLIC SERVICE INC. STATEMENTS OF RETAINED EARNINGS\nNEW ORLEANS PUBLIC SERVICE INC.\nSELECTED FINANCIAL DATA - FIVE-YEAR COMPARISON\n(1) Includes long-term debt (excluding currently maturing debt) and preferred stock with sinking fund.\nSee Notes 1, 3, and 9 for the effect of accounting changes in 1993.\n(1) 1994 includes the effects of the 1994 NOPSI Settlement.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholder of System Energy Resources, Inc.\nWe have audited the accompanying balance sheets of System Energy Resources, Inc. as of December 31, 1995 and 1994, and the related statements of income, retained earnings and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. The financial statements of the Company for the year ended December 31, 1993, were audited by other auditors, whose report, dated February 11, 1994, expressed an unqualified opinion on these financial 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 financial position of the Company as of December 31, 1995 and 1994, and the results of its operations and its cash flows for the years then ended in conformity with generally accepted accounting principles.\nCOOPERS & LYBRAND L.L.P. New Orleans, Louisiana February 14, 1996\nINDEPENDENT AUDITORS' REPORT\nTo the Shareholders and the Board of Directors of System Energy Resources, Inc.\nWe have audited the accompanying statements of income, retained earnings, and cash flows of System Energy Resources, Inc. (System Energy) for the year ended December 31, 1993. These financial statements are the responsibility of System Energy's management. Our responsibility is to express an opinion on these financial statements based on our audit.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, such financial statements present fairly, in all material respects, the results of System Energy's operations and its cash flows for the year ended December 31, 1993 in conformity with generally accepted accounting principles.\nDELOITTE & TOUCHE LLP New Orleans, Louisiana February 11, 1994 (November 30, 1994 as to Note 2, \"Rate and Regulatory Matters - FERC Settlement\")\nSYSTEM ENERGY RESOURCES, INC.\nMANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS\nRESULTS OF OPERATIONS\nNet Income\nNet income increased in 1995 primarily due to the effect of the FERC Settlement which reduced 1994 net income by $80.2 million. See Note 2 for a discussion of the FERC Settlement. This was partially offset by revenues being adversely impacted by a lower return on System Energy's decreasing investment in Grand Gulf 1. These factors also resulted in the decrease in 1994 net income.\nSignificant factors affecting the results of operations and causing variances between the years 1995 and 1994, and 1994 and 1993, are discussed under \"Revenues\" and \"Expenses\" below.\nRevenues\nOperating revenues increased in 1995 due primarily to the effect of the FERC Settlement on 1994 revenues as discussed in \"Net Income\" above and the recovery of increased expenses in connection with a Grand Gulf 1 refueling outage offset by a lower return on System Energy's decreasing investment in Grand Gulf 1. Revenues attributable to the return on investment are expected to continue to decline each year as a result of the depreciation of System Energy's investment in Grand Gulf 1.\nOperating revenues decreased in 1994 due primarily to the effect of the FERC Settlement as discussed in \"Net Income\" above, a lower return on System Energy's decreasing investment in Grand Gulf 1, and decreased operation and maintenance expenses. See Note 1 for a description of the components of System Energy's operating revenues.\nExpenses\nOperating expenses increased in 1995 due primarily to higher nuclear refueling outage expenses, higher depreciation, amortization, and decommissioning, and higher income taxes, partially offset by lower fuel expenses as a result of the refueling outage. Grand Gulf 1 was on-line for 285 days in 1995 as compared with 345 days in 1994. The difference in the on-line days was primarily due to the unit's seventh refueling outage that lasted from April 15, 1995, to June 21, 1995 (68 days), and, to a lesser extent, unplanned outages in 1995 totaling 12 days, compared to 20 days in 1994. Depreciation, amortization, and decommissioning increased due to a $4 million increase in amortization (as a result of the reclassification of $81 million of Grand Gulf 1 costs and the accelerated amortization of the reclassified costs over a ten-year period in accordance with the 1994 FERC Settlement) and $1 million in decommissioning. Total income taxes increased in 1995 due primarily to higher pretax book income.\nOperating expenses decreased in 1994 due primarily to lower other operation and maintenance expenses and lower income taxes. The lower level of outages for 1994 increased fuel for electric generation, but was partially offset by less expensive nuclear fuel and increased operating efficiency. Nonfuel operation and maintenance expenses decreased significantly in 1994 due to declines in contract work expenses, employee benefits, and materials and supplies expenses. Total income taxes decreased in 1994 due primarily to lower pretax book income\nInterest charges decreased in both 1995 and 1994 due primarily to the retirement and refinancing of high-cost long-term debt partially offset by interest associated with the FERC Settlement refunds.\nSYSTEM ENERGY RESOURCES, INC. STATEMENTS OF INCOME\nSYSTEM ENERGY RESOURCES, INC. STATEMENTS OF CASH FLOWS\nSYSTEM ENERGY RESOURCES, INC. BALANCE SHEETS ASSETS\nSYSTEM ENERGY RESOURCES, INC. BALANCE SHEETS CAPITALIZATION AND LIABILITIES\nSYSTEM ENERGY RESOURCES, INC. STATEMENTS OF RETAINED EARNINGS\nSYSTEM ENERGY RESOURCES, INC.\nSELECTED FINANCIAL DATA - FIVE-YEAR COMPARISON\n(1) Includes long-term debt (excluding current maturities) and noncurrent capital lease obligations.\nSee Note 2 for information with respect to refunds and charges resulting from the FERC Settlement in 1994 and Note 3 for the effect of the accounting change for income taxes in 1993.\nENTERGY CORPORATION AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Entergy Corporation, AP&L, GSU, LP&L, MP&L, NOPSI, and System Energy)\nThe accompanying consolidated financial statements include the accounts of Entergy Corporation and its direct subsidiaries: AP&L, GSU, LP&L, MP&L, NOPSI, System Energy, Entergy Services, Entergy Operations, Entergy Power, Entergy Enterprises, System Fuels, Entergy S.A., Entergy Argentina S.A., Entergy Power Marketing Corporation, Entergy Power Development Corporation, Entergy Argentina S.A., Ltd., Entergy Transener S.A., Entergy Power Development International Holdings, Inc., and Entergy Power Development International Holdings. A number of these subsidiaries have additional subsidiaries.\nBecause the acquisition of GSU was consummated on December 31, 1993, under the purchase method of accounting, GSU's operations were not included in the consolidated amounts for the year ended December 31, 1993. GSU is included in all of the consolidated financial statements for 1994 and 1995. All references made to Entergy or the System as of, and subsequent to, the Merger closing date include amounts and information pertaining to GSU as an Entergy company. All significant intercompany transactions have been eliminated. Entergy Corporation's utility subsidiaries maintain accounts in accordance with FERC and other regulatory guidelines. Certain previously reported amounts have been reclassified to conform to current classifications with no effect on net income or shareholders' equity.\nUse of Estimates in the Preparation of Financial Statements - - - - -----------------------------------------------------------\nThe preparation of Entergy Corporation and its subsidiaries' financial statements, in conformity with generally accepted accounting principles, requires management to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of December 31, 1995 and 1994, and the reported amounts of revenues and expenses during fiscal years 1995, 1994, and 1993. Adjustments to the reported amounts of assets and liabilities may be necessary in the future to the extent that future estimates or actual results are different from the estimates used in 1995 financial statements.\nRevenues and Fuel Costs - - - - -----------------------\nAP&L, LP&L, and MP&L generate, transmit, and distribute electricity (primarily to retail customers) in the States of Arkansas, Louisiana, and Mississippi, respectively. GSU generates, transmits, and distributes electricity primarily to retail customers in the States of Texas and Louisiana; distributes gas at retail in the City of Baton Rouge, Louisiana, and vicinity; and also sells steam to a large refinery complex in Baton Rouge. NOPSI sells both electricity and gas to retail customers in the city of New Orleans (except for Algiers where LP&L is the electricity supplier).\nSystem Energy's operating revenues recover operating expenses, depreciation, and capital costs attributable to Grand Gulf 1 from AP&L, LP&L, MP&L, and NOPSI. Capital costs are computed by allowing a return on System Energy's common equity funds allocable to its net investment in Grand Gulf 1, plus System Energy's effective interest cost for its debt allocable to its investment in Grand Gulf 1. See Note 2 for a discussion of System Energy's proposed rate increase.\nA portion of AP&L's and LP&L's purchase of power from Grand Gulf has not been included in the determination of the cost of service to retail customers by the APSC and LPSC, respectively, as described in Note 2.\nThe Operating Companies accrue estimated revenues for energy delivered since the latest billings. However, prior to January 1, 1993, AP&L, GSU, MP&L, and NOPSI recognized electric and gas revenues when billed. To provide a better matching of revenues and expenses, effective January 1, 1993, AP&L, GSU, MP&L, and NOPSI adopted a change in accounting principle to provide for the accrual of estimated unbilled revenues. The cumulative effect (excluding GSU) of this accounting change as of January 1, 1993, increased System 1993 net income by $93.8 million (net of income taxes of $57.2 million), or $0.54 per share. The impacts on the individual operating companies are shown below:\nNet of Tax Total Tax Effect ------------ ---------- --------- (In Thousands)\nAP&L $81,327 $31,140 $50,187 MP&L 52,162 19,456 32,706 NOPSI 17,540 6,592 10,948 ------------ ---------- --------- System $151,029 $57,188 $93,841 ============= =========== ==========\nIn accordance with a LPSC rate order, GSU recorded a deferred credit of $16.6 million for the January 1, 1993, amount of unbilled revenues. See Note 2 regarding GSU's subsequent appeals of the LPSC order regarding deferred unbilled revenues.\nThe Operating Companies' rate schedules (except GSU's Texas retail rate schedules) include fuel adjustment clauses that allow either current recovery or deferrals of fuel costs until such costs are reflected in the related revenues. GSU's Texas retail rate schedules include a fixed fuel factor approved by the PUCT, which remains in effect until changed as part of a general rate case, fuel reconciliation, or fixed fuel factor filing.\nUtility Plant - - - - -------------\nUtility plant is stated at original cost. The original cost of utility plant retired or removed, plus the applicable removal costs, less salvage, is charged to accumulated depreciation. Maintenance, repairs, and minor replacement costs are charged to operating expenses. Substantially all of the utility plant is subject to liens of the subsidiaries' mortgage bond indentures.\nUtility plant includes the portions of Grand Gulf 1 and Waterford 3 that were sold and currently are leased back. For financial reporting purposes, these sale and leaseback transactions are reflected as financing transactions.\nNet electric utility plant in service, by company and functional category, as of December 31, 1995 (excluding owned and leased nuclear fuel and the plant acquisition adjustment related to the Merger), is shown below:\nDepreciation is computed on the straight-line basis at rates based on the estimated service lives and costs of removal of the various classes of property. Depreciation rates on average depreciable property are shown below:\nAFUDC represents the approximate net composite interest cost of borrowed funds and a reasonable return on the equity funds used for construction. Although AFUDC increases both utility plant and earnings, it is only realized in cash through depreciation provisions included in rates.\nJointly-Owned Generating Stations - - - - ---------------------------------\nCertain Entergy Corporation subsidiaries own undivided interests in several jointly-owned electric generating facilities and record the investments and expenses associated with these generating stations to the extent of their respective ownership interests. As of December 31, 1995, the subsidiaries' investment and accumulated depreciation in each of these generating stations were as follows:\nIncome Taxes - - - - ------------\nEntergy Corporation and its subsidiaries file a consolidated federal income tax return. Income taxes are allocated to the System companies in proportion to their contribution to consolidated taxable income. SEC regulations require that no Entergy Corporation subsidiary pay more taxes than it would have paid if a separate income tax return had been filed. Deferred income taxes are recorded for all temporary differences between the book and tax basis of assets and liabilities and for certain credits available for carryforward.\nDeferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.\nInvestment tax credits are deferred and amortized based upon the average useful life of the related property in accordance with rate treatment. As discussed in Note 3, in 1993 Entergy changed its accounting for income taxes to conform with SFAS 109, \"Accounting for Income Taxes.\"\nAcquisition Adjustment - - - - ----------------------\nEntergy Corporation, upon completion of the Merger in December 1993, recorded an acquisition adjustment in utility plant in the amount of $380 million, representing the excess of the purchase price over the historical cost of the GSU net assets acquired. During 1994, Entergy recorded an additional $124 million of acquisition adjustment related to the resolution of certain preacquisition contingencies and appropriate allocation of purchase price.\nThe acquisition adjustment is being amortized on a straight-line basis over a 31-year period beginning January 1, 1994, which approximates the remaining average book life of the plant acquired as a result of the Merger. As of December 31, 1995, the unamortized balance of the acquisition adjustment was $472 million. The System anticipates that its future net cash flows will be sufficient to recover such amortization.\nReacquired Debt - - - - ---------------\nThe premiums and costs associated with reacquired debt are being amortized over the life of the related new issuances, in accordance with ratemaking treatment.\nCash and Cash Equivalents - - - - -------------------------\nEntergy considers all unrestricted highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents.\nContinued Application of SFAS 71 - - - - --------------------------------\nAs a result of the EPAct, other Federal laws, and actions of regulatory commissions, the electric utility industry is moving toward a combination of competition and a modified regulatory environment. The Operating Companies' and System Energy's financial statements currently reflect, for the most part, assets and costs based on cost- based ratemaking regulation, in accordance with SFAS 71, \"Accounting for the Effects of Certain Types of Regulation.\" Continued applicability of SFAS 71 to the System's financial statements requires that rates set by an independent regulator on a cost-of-service basis (including a reasonable rate of return on invested capital) can actually be charged to and collected from customers.\nIn the event either all or a portion of a utility's operations cease to meet those criteria for various reasons, including deregulation, a change in the method of regulation or a change in the competitive environment for the utility's regulated services, the utility should discontinue application of SFAS 71 for the relevant portion. That discontinuation would be reported by elimination from the balance sheet of the effects of any actions of regulators recorded as regulatory assets and liabilities.\nAs of December 31, 1995, and for the foreseeable future, the System's financial statements continue to follow SFAS 71, with the exceptions noted below.\nSFAS 101 - - - - --------\nSFAS 101, \"Accounting for the Discontinuation of Application of FASB Statement No. 71,\" specifies how an enterprise that ceases to meet the criteria for application of SFAS 71 to all or part of its operations should report that event in its financial statements. GSU discontinued regulatory accounting principles for its wholesale jurisdiction and its steam department during 1989 and for the Louisiana retail deregulated portion of River Bend in 1991. The results of Entergy's deregulated operations (before interest charges) for the years ended December 31, 1995, 1994, and 1993 are as follows:\nSFAS 121 - - - - --------\nIn March 1995, the FASB issued SFAS 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of\" (SFAS 121), which became effective January 1, 1996. This statement describes circumstances that may result in assets (including goodwill such as the Merger acquisition adjustment, discussed above) being impaired. The statement also provides criteria for recognition and measurement of asset impairment. Note 2 describes regulatory assets of $169 million (net of tax) related to Texas retail deferred River Bend operating and carrying costs. These deferred costs will be required to be written off upon the adoption of SFAS 121.\nCertain other assets and operations of the Operating Companies totaling approximately $1.7 billion (pre-tax) could be affected by SFAS 121 in the future. Those assets include AP&L's and LP&L's retained shares of Grand Gulf 1, GSU's Louisiana deregulated asset plan, and its Texas jurisdiction abeyed portion of the River Bend plant, in addition to the wholesale jurisdiction and steam department operations of GSU. As discussed above, GSU has previously discontinued the application of SFAS 71 for the Louisiana deregulated asset plan, operations under the wholesale jurisdiction, and the steam department.\nEntergy periodically reviews these assets and operations in order to determine if the carrying value of such assets will be recovered. Generally, this determination is based on the net cash flows expected to result from such operations and assets. Projected net cash flows depend on the future operating costs associated with the assets, the efficiency and availability of the assets and generating units, and the future market and price for energy over the remaining life of the assets. Based on current estimates of future cash flows as prescribed under SFAS 121, management anticipates that future revenues from such assets and operations of Entergy will fully recover all related costs.\nChange in Accounting for Nuclear Refueling Outage Costs (Entergy - - - - ------------------------------------------------------- Corporation and AP&L)\nIn December 1995, at the recommendation of FERC, AP&L changed its method of accounting for nuclear refueling outage costs. The change, effective January 1, 1995, results in AP&L deferring incremental maintenance costs incurred during an outage and amortizing those costs over the operating period immediately following the nuclear refueling outage, which is the period that the charges are billed to customers. Previously, estimated costs of refueling outages were accrued over the period (generally 18 months) preceding each scheduled outage. The effect of the change for the year ended December 31, 1995, was to decrease net income by $5.1 million (net of income taxes of $3.3 million) or $.02 per share. The cumulative effect of the change was to increase net income $35.4 million (net of income taxes of $22.9 million) or $.15 per share. The pro forma effects of the change in accounting for nuclear refueling outages in 1994 and 1993, assuming the new method was applied retroactively to those years, would have been to decrease net income $3.2 million (net of income taxes of $2.1 million) and $6.5 million (net of income taxes of $4.2 million), respectively, or $.01 per share and $.04 per share, respectively.\nFair Value Disclosures - - - - ----------------------\nThe estimated fair value of financial instruments was determined using bid prices reported by dealer markets and by nationally recognized investment banking firms. Considerable judgment is required in developing the estimates of fair value. Therefore, estimates are not necessarily indicative of the amounts that Entergy could realize in a current market exchange. In addition, gains or losses realized on financial instruments may be reflected in future rates and not accrue to the benefit of stockholders.\nEntergy considers the carrying amounts of financial instruments classified as current assets and liabilities to be a reasonable estimate of their fair value because of the short maturity of these instruments. In addition, Entergy does not expect that performance of its obligations will be required in connection with certain off-balance sheet commitments and guarantees considered financial instruments. Due to this factor, and because of the related-party nature of these commitments and guarantees, determination of fair value is not considered practicable. See Notes 5, 6, and 8 for additional disclosure concerning fair value methodologies.\nNOTE 2. RATE AND REGULATORY MATTERS\nMerger-Related Rate Agreements (Entergy Corporation, AP&L, GSU, LP&L, - - - - ------------------------------ MP&L, and NOPSI)\nIn November 1993, Entergy Corporation, AP&L, MP&L, and NOPSI entered into separate settlement agreements whereby the APSC, MPSC, and Council agreed to withdraw from the SEC proceeding related to the Merger. In return AP&L, MP&L, and NOPSI agreed, among other things, that their retail ratepayers would be protected from (1) increases in the cost of capital resulting from risks associated with the Merger, (2) recovery of any portion of the acquisition premium or transactional costs associated with the Merger, (3) certain direct allocations of costs associated with GSU's River Bend nuclear unit, and (4) any losses of GSU resulting from resolution of litigation in connection with its ownership of River Bend. AP&L and MP&L agreed not to request any general retail rate increase that would take effect before November 1998, except for, among other things, increases associated with the recovery of certain Grand Gulf 1-related costs, recovery of certain taxes, and catastrophic events, and in the case of AP&L, excess capacity costs and costs related to the adoption of SFAS 106 that were previously deferred. MP&L agreed that retail base rates under the formula rate plan would not be increased above November 1, 1993, levels for a period of five years beginning November 9, 1993.\nIn 1993, the LPSC and the PUCT approved separate regulatory proposals for GSU that include the following elements: (1) a five-year Rate Cap on GSU's retail electric base rates in the respective states, except for force majeure (defined to include, among other things, war, natural catastrophes, and high inflation); (2) a provision for passing through to retail customers the jurisdictional portion of the fuel savings created by the Merger; and (3) a mechanism for tracking nonfuel operation and maintenance savings created by the Merger. The LPSC regulatory plan provides that such nonfuel savings will be shared 60% by shareholders and 40% by ratepayers during the eight years following the Merger. The LPSC plan requires annual regulatory filings by the end of May through the year 2001. The PUCT regulatory plan provides that such savings will be shared equally by shareholders and ratepayers, except that the shareholders' portion will be reduced by $2.6 million per year on a total company basis in years four through eight. The PUCT plan also requires a series of future regulatory filings in November 1996, 1998, and 2001 to ensure that the ratepayers' share of such savings be reflected in rates on a timely basis. In addition, the plan requires Entergy Corporation to hold GSU's Texas retail customers harmless from the effects of the removal by FERC of a 40% cap on the amount of fuel savings GSU may be required to transfer to other Operating Companies under the FERC tracking mechanism (see below). On January 14, 1994, Entergy Corporation filed a petition for review before the D.C. Circuit seeking review of FERC's deletion of the 40% cap provision in the fuel cost protection mechanism. The matter is currently being held in abeyance.\nFERC approved GSU's inclusion in the System Agreement. Commitments were adopted to provide reasonable assurance that the ratepayers of AP&L, LP&L, MP&L, and NOPSI will not be allocated higher costs including, among other things, (1) a tracking mechanism to protect AP&L, LP&L, MP&L, and NOPSI from certain unexpected increases in fuel costs, (2) the distribution of profits from power sales contracts entered into prior to the Merger, (3) a methodology to estimate the cost of capital in future FERC proceedings, and (4) a stipulation that AP&L, LP&L, MP&L, and NOPSI will be insulated from certain direct effects on capacity equalization payments if GSU were to acquire Cajun's 30% share in River Bend. The Operating Companies' regulatory authorities can elect to \"opt out\" of the fuel tracker, but are not required to make such an election until FERC has approved the respective Operating Company's compliance filing. The City and the MPSC have made such an election.\nRiver Bend (Entergy Corporation and GSU) - - - - -----------\nIn May 1988, the PUCT granted GSU a permanent increase in annual revenues of $59.9 million resulting from the inclusion in rate base of approximately $1.6 billion of company-wide River Bend plant investment and approximately $182 million of related Texas retail jurisdiction deferred River Bend costs (Allowed Deferrals). In addition, the PUCT disallowed as imprudent $63.5 million of company-wide River Bend plant costs and placed in abeyance, with no finding of prudence, approximately $1.4 billion of company-wide River Bend plant investment and approximately $157 million of Texas retail jurisdiction deferred River Bend operating and carrying costs. The PUCT affirmed that the rate treatment of such amounts would be subject to future demonstration of the prudence of such costs. GSU and intervening parties appealed this order (Rate Appeal) and GSU filed a separate rate case asking, among other things, that the abeyed River Bend plant costs be found prudent (Separate Rate Case). Intervening parties filed suit in a Texas district court to prohibit the Separate Rate Case and prevailed. The district court's decision in favor of the intervenors was ultimately appealed to the Texas Supreme Court, which ruled in 1990 that the prudence of the purported abeyed costs could not be relitigated in a separate rate proceeding. The Texas Supreme Court's decision stated that all issues relating to the merits of the original PUCT order, including the prudence of all River Bend-related costs, should be addressed in the Rate Appeal.\nIn October 1991, the Texas district court in the Rate Appeal issued an order holding that, while it was clear the PUCT made an error in assuming it could set aside $1.4 billion of the total costs of River Bend and consider them in a later proceeding, the PUCT, nevertheless, found that GSU had not met its burden of proof related to the amounts placed in abeyance. The court also ruled that the Allowed Deferrals should not be included in rate base. The court further stated that the PUCT had erred in reducing GSU's deferred costs by $1.50 for each $1.00 of revenue collected under the interim rate increases authorized in 1987 and 1988. The court remanded the case to the PUCT with instructions as to the proper handling of the Allowed Deferrals. GSU's motion for rehearing was denied and, in December 1991, GSU filed an appeal of the October 1991 district court order. The PUCT also appealed the October 1991 district court order, which served to supersede the district court's judgment, rendering it unenforceable under Texas law.\nIn August 1994, the Texas Third District Court of Appeals (the Appellate Court) affirmed the district court's decision that there was substantial evidence to support the PUCT's 1988 decision not to include the abeyed construction costs in GSU's rate base. While acknowledging that the PUCT had exceeded its authority in attempting to defer a decision on the inclusion of those costs in rate base in order to allow GSU a further opportunity to demonstrate the prudence of those costs in a subsequent proceeding, the Appellate Court found that GSU had suffered no harm or lack of due process as a result of the PUCT's error. Accordingly, the Appellate Court held that the PUCT's action had the effect of disallowing the company-wide $1.4 billion of River Bend construction costs for ratemaking purposes. In its August 1994 opinion, the Appellate Court also held that GSU's deferred operating and maintenance costs associated with the allowed portion of River Bend, as well as GSU's deferred River Bend carrying costs included in the Allowed Deferrals, should be included in rate base. The Appellate Court's August 1994 opinion affirmed the PUCT's original order in this case.\nThe Appellate Court's August 1994 opinion was entered by two judges, with a third judge dissenting. The dissenting opinion stated that the result of the majority opinion was, among other things, to deprive GSU of due process at the PUCT because the PUCT never reached a finding on the $1.4 billion of construction costs.\nIn October 1994, the Appellate Court denied GSU's motion for rehearing on the August 1994 opinion as to the $1.4 billion in River Bend construction costs and other matters. GSU appealed the Appellate Court's decision to the Texas Supreme Court. On February 9, 1996, the Texas Supreme Court agreed to hear the appeal. Oral arguments are scheduled for March 19, 1996.\nAs of December 31, 1995, the River Bend plant costs disallowed for retail ratemaking purposes in Texas, the River Bend plant costs held in abeyance, and the related operating and carrying cost deferrals totaled (net of taxes) approximately $13 million, $276 million (both net of depreciation), and $169 million, respectively. Allowed Deferrals were approximately $83 million, net of taxes and amortization, as of December 31, 1995. GSU estimates it has collected approximately $182 million of revenues as of December 31, 1995, as a result of the originally ordered rate treatment by the PUCT of these deferred costs. If recovery of the Allowed Deferrals is not upheld, future revenues based upon those allowed deferrals could also be lost, and no assurance can be given as to whether or not refunds to customers of revenue received based upon such deferred costs will be required.\nNo assurance can be given as to the timing or outcome of the remands or appeals described above. Pending further developments in these cases, GSU has made no write-offs or reserves for the River Bend- related costs. See below for a discussion of the write-off of deferred operating and carrying cost required under SFAS 121 in 1996. Based on advice from Clark, Thomas & Winters, A Professional Corporation, legal counsel of record in the Rate Appeal, management believes that it is reasonably possible that the case will be remanded to the PUCT, and the PUCT will be allowed to rule on the prudence of the abeyed River Bend plant costs. At this time, management and legal counsel are unable to predict the amount, if any, of the abeyed and previously disallowed River Bend plant costs that ultimately may be disallowed by the PUCT. A net of tax write-off as of December 31, 1995, of up to $289 million could be required based on an ultimate adverse ruling by the PUCT on the abeyed and disallowed costs.\nIn prior proceedings, the PUCT has held that the original cost of nuclear power plants will be included in rates to the extent those costs were prudently incurred. Based upon the PUCT's prior decisions, management believes that River Bend construction costs were prudently incurred and that it is reasonably possible that it will recover in rate base, or otherwise through means such as a deregulated asset plan, all or substantially all of the abeyed River Bend plant costs. However, management also recognizes that it is reasonably possible that not all of the abeyed River Bend plant costs may ultimately be recovered.\nAs part of its direct case in the Separate Rate Case, GSU filed a cost reconciliation study prepared by Sandlin Associates, management consultants with expertise in the cost analysis of nuclear power plants, which supports the reasonableness of the River Bend costs held in abeyance by the PUCT. This reconciliation study determined that approximately 82% of the River Bend cost increase above the amount included by the PUCT in rate base was a result of changes in federal nuclear safety requirements, and provided other support for the remainder of the abeyed amounts.\nThere have been four other rate proceedings in Texas involving nuclear power plants. Disallowed investment in the plants ranged from 0% to 15%. Each case was unique, and the disallowances in each were made for different reasons. Appeals of two of these PUCT decisions are currently pending.\nThe following factors support management's position that a loss contingency requiring accrual has not occurred, and its belief that all, or substantially all, of the abeyed plant costs will ultimately be recovered:\n1. The $1.4 billion of abeyed River Bend plant costs have never been ruled imprudent and disallowed by the PUCT; 2. Analysis by Sandlin Associates, which supports the prudence of substantially all of the abeyed construction costs; 3. Historical inclusion by the PUCT of prudent construction costs in rate base; and 4. The analysis of GSU's legal staff, which has considerable experience in Texas rate case litigation.\nBased on advice from Clark, Thomas & Winters, A Professional Corporation, legal counsel of record in the Rate Appeal, management believes that it is reasonably possible that the Allowed Deferrals will continue to be recovered in rates, and that it is reasonably possible that the deferred costs related to the $1.4 billion of abeyed River Bend plant costs will be recovered in rates to the extent that the $1.4 billion of abeyed River Bend plant is recovered.\nThe adoption of SFAS 121 became effective January 1, 1996. SFAS 121 changes the standard for continued recognition of regulatory assets and, as a result GSU will be required to write-off $169 million of rate deferrals in 1996. The standard also describes circumstances that may result in assets being impaired and provides criteria for recognition and measurement of asset impairment. See Note 1 for further information regarding SFAS 121.\nFilings with the PUCT and Texas Cities (Entergy Corporation and GSU) - - - - --------------------------------------\nIn March 1994, the Texas Office of Public Utility Counsel and certain cities served by GSU instituted an investigation of the reasonableness of GSU's rates. On March 20, 1995, the PUCT ordered a $72.9 million annual base rate reduction for the period March 31, 1994, through September 1, 1994, decreasing to an annual base rate reduction of $52.9 million after September 1, 1994. In accordance with the Merger agreement, the rate reduction was applied retroactively to March 31, 1994.\nOn May 26, 1995, the PUCT amended its previously issued March 20, 1995 rate order, reducing the $52.9 million annual base rate reduction to an annual level of $36.5 million. The PUCT's action was based, in part, upon a Texas Supreme Court decision not to require a utility to use the prospective tax benefits generated by disallowed expenses to reduce rates. The PUCT's May 26, 1995, amended order no longer required GSU to pass such prospective tax benefits onto its customers. The rate refund, retroactive to March 31, 1994, was approximately $61.8 million (including interest) and was refunded to customers in September, October, and November 1995. GSU and other parties have appealed the PUCT order, but no assurance can be given as to the timing or outcome of the appeal.\nFilings with the LPSC - - - - --------------------- (Entergy Corporation and GSU)\nIn May 1994, GSU filed a required earnings analysis with the LPSC for the test year preceding the Merger (1993). On December 14, 1994, the LPSC ordered a $12.7 million annual rate reduction for GSU, effective January 1995. GSU received a preliminary injunction from the District Court regarding $8.3 million of the reduction relating to the earnings effect of a 1994 change in accounting for unbilled revenues. On January 1, 1995, GSU reduced rates by $4.4 million. GSU filed an appeal of the entire $12.7 million rate reduction with the District Court, which denied the appeal in July 1995. GSU has appealed the order to the Louisiana Supreme Court. The preliminary injunction relating to $8.3 million of the reduction will remain in effect during the appeal.\nOn May 31, 1995, GSU filed its second required post-Merger earnings analysis with the LPSC. Hearings on this review were held and a decision is expected in mid-1996.\n(Entergy Corporation and LP&L)\nIn August 1994, LP&L filed a performance-based formula rate plan with the LPSC. The proposed formula rate plan would continue existing LP&L rates at current levels, while providing a financial incentive to reduce costs and maintain high levels of customer satisfaction and system reliability. The plan would allow LP&L the opportunity to earn a higher rate of return if it improves performance over time. Conversely, if performance declines, the rate of return LP&L could earn would be lowered. This would provide a financial incentive for LP&L to continuously improve in all three performance categories (price, customer satisfaction, and service reliability).\nOn June 2, 1995, as a result of the LPSC's earnings review of LP&L's performance-based formula rate plan, a $49.4 million reduction in base rates was ordered. This included $10.5 million of rate reductions previously made through the fuel adjustment clause. The net effect of the LPSC order was to reduce rates by $38.9 million. The LPSC approved LP&L's proposed formula rate plan with the following modifications. An earnings band was established with a range from 10.4% to 12% for return on equity. If LP&L's earnings fall within the bandwidth, no adjustment in rates occurs. However, if LP&L's earnings are above or below the established earnings band, prospective rate decreases or increases will occur. The LPSC also reduced LP&L's authorized rate of return from 12.76% to 11.2%. The LPSC rate order was retroactive to April 27, 1995.\nOn June 9, 1995, LP&L appealed the $49.4 million rate reduction and filed a petition for injunctive relief from implementation of $14.7 million of the reduction. The $14.7 million portion of the rate reduction represents revenue imputed to LP&L as a result of the LPSC's conclusion that LP&L charged unreasonably low rates to three industrial customers. Subsequently, a request for a $14.7 million rate increase was filed by LP&L. On July 13, 1995, LP&L was granted a preliminary injunction by the District Court on $14.7 million of the rate reduction pending a final LPSC order. Exclusive of the $14.7 million stayed under the preliminary injunction, the rate refund was retroactive to April 27, 1995, and amounted to approximately $8.2 million. Customers received the refunds in the months of September and October 1995.\nIn an order issued on January 31, 1996, the LPSC approved a settlement reducing the $14.7 million portion of the rate reduction to $12.35 million. Rate refunds subject to this settlement were retroactive to April 27, 1995, and were made in the months of January and February 1996. The refunds and related interest resulting from the settlement amounted to $8.9 million. The District Court case discussed above was dismissed as part of the settlement.\nLPSC Fuel Cost Review (Entergy Corporation and GSU) - - - - ---------------------\nIn November 1993, the LPSC ordered a review of GSU's fuel costs for the period October 1988 through September 1991 (Phase 1) based on the number of outages at River Bend and the findings in the June 1993 PUCT fuel reconciliation case. In July 1994, the LPSC ruled in the Phase 1 fuel review case and ordered GSU to refund approximately $27 million to its customers. Under the order, a refund of $13.1 million was made through a billing credit on August 1994 bills. In August 1994, GSU appealed the remaining $13.9 million of the LPSC-ordered refund to the district court. GSU has made no reserve for the remaining portion, pending outcome of the district court appeal, and no assurance can be given as to the timing or outcome of the appeal.\nThe LPSC is currently conducting the second phase of its review of GSU's fuel costs for the period October 1991 through December 1994. On June 30, 1995, the LPSC consultants filed testimony recommending a disallowance of $38.7 million of fuel costs. Hearings began in December 1995 and are expected to be completed in early March 1996.\nDeregulated Asset Plan (Entergy Corporation and GSU) - - - - ----------------------\nA deregulated asset plan representing an unregulated portion (approximately 24%) of River Bend (plant costs, generation, revenues, and expenses) was established pursuant to a January 1992 LPSC order. The plan allows GSU to sell such generation to Louisiana retail customers at 4.6 cents per KWh or off-system at higher prices, with certain sharing provisions for sharing such incremental revenue above 4.6 cents per KWh between ratepayers and shareholders.\nRiver Bend Cost Deferrals (Entergy Corporation and GSU) - - - - -------------------------\nGSU deferred approximately $369 million of River Bend operating and purchased power costs, and accrued carrying charges, pursuant to a 1986 PUCT accounting order. Approximately $182 million of these costs are being amortized over a 20-year period, and the remaining $187 million are not being amortized pending the outcome of the Rate Appeal. As of December 31, 1995, the unamortized balance of these costs was $312 million. GSU deferred approximately $400.4 million of similar costs pursuant to a 1986 LPSC accounting order, of which approximately $83 million were unamortized as of December 31, 1995, and are being amortized over a 10-year period ending in 1998.\nIn accordance with a phase-in plan approved by the LPSC, GSU deferred $294 million of its River Bend costs related to the period February 1988 through February 1991. GSU has amortized $172 million through December 31, 1995. The remainder of $122 million will be recovered over approximately 2.2 years.\nGrand Gulf 1 and Waterford 3 Deferrals - - - - -------------------------------------- (Entergy Corporation and AP&L)\nUnder the settlement agreement entered into with the APSC in 1985 and amended in 1988, AP&L agreed to retain a portion of its Grand Gulf 1-related costs, recover a portion of such costs currently, and defer a portion of such costs for future recovery. In 1995 and subsequent years, AP&L retains 22% of its 36% interest in Grand Gulf 1 costs and recovers the remaining 78%. The deferrals ceased in l990, and AP&L is recovering a portion of the previously deferred costs each year through l998. As of December 31, l995, the balance of deferred costs was $360 million. AP&L is permitted to recover on a current basis the incremental costs of financing the unrecovered deferrals. In the event AP&L is not able to sell its retained share to third parties, it may sell such energy to its retail customers at a price equal to its avoided energy cost, which is currently less than AP&L's cost of energy from its retained share.\n(Entergy Corporation and LP&L)\nIn a series of LPSC orders, court decisions, and agreements from late 1985 to mid-1988, LP&L was granted rate relief with respect to costs associated with Waterford 3 and LP&L's share of capacity and energy from Grand Gulf 1, subject to certain terms and conditions. With respect to Waterford 3, LP&L was granted an increase aggregating $170.9 million over the period 1985-1988, and agreed to permanently absorb, and not recover from retail ratepayers, $284 million of its investment in the unit and to defer $266 million of its costs related to the years 1985-1988 to be recovered over approximately 8.6 years beginning in April 1988. As of December 31, 1995, LP&L's unrecovered deferral balance was $26 million.\nWith respect to Grand Gulf 1, in November 1988, LP&L agreed to retain and not recover from retail ratepayers, 18% of its 14% share (approximately 2.52%) of the costs of Grand Gulf 1 capacity and energy. LP&L is allowed to recover through the fuel adjustment clause 4.6 cents per KWh for the energy related to its retained portion of these costs. Alternatively, LP&L may sell such energy to nonaffiliated parties at prices above the fuel adjustment clause recovery amount, subject to the LPSC's approval.\n(Entergy Corporation and MP&L)\nMP&L entered into a revised plan with the MPSC that provides, among other things, for the recovery by MP&L, in equal annual installments over ten years beginning October 1, 1988, of all Grand Gulf 1-related costs deferred through September 30, 1988, pursuant to a final order by the MPSC. Additionally, the plan provides that MP&L defer, in decreasing amounts, a portion of its Grand Gulf 1-related costs over four years beginning October 1, 1988. These deferrals are being recovered by MP&L over a six-year period beginning in October 1992 and ending in September 1998. As of December 31, 1995, the uncollected balance of MP&L's deferred costs was approximately $378 million. The plan also allows for the current recovery of carrying charges on all deferred amounts.\n(Entergy Corporation and NOPSI)\nUnder NOPSI's various Rate Settlements with the Council in 1986, 1988, and 1991, NOPSI agreed to absorb and not recover from ratepayers a total of $96.2 million of its Grand Gulf 1 costs. NOPSI was permitted to implement annual rate increases in decreasing amounts each year through 1995, and to defer certain costs and related carrying charges for recovery on a schedule extending from 1991 through 2001. As of December 31, 1995, the uncollected balance of NOPSI's deferred costs was $171 million.\nFebruary 1994 Ice Storm\/Rate Rider (Entergy Corporation and MP&L) - - - - ---------------------------------- In early February 1994, an ice storm left more than 80,000 MP&L customers without electric power across the service area. The storm was the most severe natural disaster ever to affect the System, causing damage to transmission and distribution lines, equipment, poles, and facilities in certain areas, primarily in Mississippi. Repair costs totaled approximately $77.2 million, with $64.6 million of these amounts capitalized as plant-related costs. The remaining balances were recorded as a deferred debit.\nSubsequent to a request by MP&L for rate recovery, the MPSC approved a stipulation in September 1994, with respect to the recovery of ice storm costs recorded through April 30, 1994. Under the stipulation, MP&L implemented an ice storm rate rider, which increased rates approximately $8 million for a period of five years beginning on September 29, 1994. This stipulation also stated that at the end of the five-year period, the revenue requirement associated with the undepreciated ice storm capitalized costs will be included in MP&L's base rates to the extent that this revenue requirement does not result in MP&L's rate of return on rate base being above the benchmark rate of return under MP&L's Formula Rate Plan.\nIn September 1995, the MPSC approved a second stipulation which allows for a $2.5 million rate increase for a period of four years beginning September 28, 1995, to recover costs related to the ice storm that were recorded after April 30, 1994. The stipulation also allows for undepreciated ice storm capital costs recorded after April 30, 1994, to be treated as described above.\n1994 NOPSI Settlement (Entergy Corporation and NOPSI) - - - - --------------------- In a settlement with the Council that was approved on December 29, 1994, NOPSI agreed to reduce electric and gas rates and issue credits and refunds to customers. Effective January 1, 1995, NOPSI implemented a $31.8 million permanent reduction in electric base rates and a $3.1 million permanent reduction in gas base rates. These adjustments resolved issues associated with NOPSI's return on equity exceeding 13.76% for the test year ended September 30, 1994. Under the 1991 NOPSI Settlement, NOPSI is recovering from its retail customers its allocable share of certain costs related to Grand Gulf 1. NOPSI's base rates to recover those costs were derived from estimates of those costs made at that time. Any overrecovery of costs is required to be returned to customers. Grand Gulf 1 has experienced lower operating costs than previously estimated, and NOPSI accordingly is reducing its base rates in two steps to match more accurately the current costs related to Grand Gulf 1. On January 1, 1995, NOPSI implemented a $10 million permanent reduction in base electric rates to reflect the reduced costs related to Grand Gulf 1, which was followed by an additional $4.4 million rate reduction on October 31, 1995. These Grand Gulf rate reductions, which are expected to be largely offset by lower operating costs, may reduce NOPSI's after-tax net income by approximately $1.4 million per year beginning November 1, 1995. The Grand Gulf 1 phase-in rate increase in the amount of $4.4 million on October 31, 1995, was not affected by the 1994 NOPSI Settlement.\nThe 1994 NOPSI Settlement also required NOPSI to credit its customers $25 million over a 21-month period beginning January 1, 1995, in order to resolve disputes with the Council regarding the interpretation of the 1991 NOPSI Settlement. NOPSI reduced its revenues by $25 million and recorded a $15.4 million net-of-tax reserve associated with the credit in the fourth quarter of 1994. The 1994 NOPSI Settlement further required NOPSI to refund, in December 1994, $13.3 million of credits previously scheduled to be made to customers during the period January 1995 through July 1995. These credits were associated with a July 7, 1994, Council resolution that ordered a $24.95 million rate reduction based on NOPSI's overearnings during the test year ended September 30, 1993. Accordingly, NOPSI recorded an $8 million net-of-tax charge in the fourth quarter of 1994.\nThe 1994 NOPSI Settlement also required NOPSI to refund $9.3 million of overcollections associated with Grand Gulf 1 operating costs, and $10.5 million of refunds associated with the settlement by System Energy of a FERC tax audit. The settlement of the FERC tax audit by System Energy required refunds to be passed on to NOPSI and to other Entergy subsidiaries and then on to customers. These refunds have no effect on current period net income.\nPursuant to the 1994 NOPSI Settlement, NOPSI is required to make earnings filings with the Council for the 1995 and 1996 rate years. A review of NOPSI's earnings for the test year ending September 30, 1995, will require NOPSI to credit customers $6.2 million over a 12-month period beginning March 11, 1996. Hearings with the Council as to the reasonableness and prudence of NOPSI's deferred Least Cost Intergrated Resource Planning expenses for cost recovery purposes are scheduled for April 1996.\nProposed Rate Increase - - - - ---------------------- (System Energy)\nSystem Energy filed an application with FERC on May 12, 1995, for a $65.5 million rate increase. The request seeks changes to System Energy's rate schedule, including increases in the revenue requirement associated with decommissioning costs, the depreciation rate, and the rate of return on common equity. On December 12, 1995, System Energy implemented a $65.5 million rate increase, subject to refund. Hearings on System Energy's request began in January 1996 and were completed in February 1996. The ALJ's initial decision is expected in 1996.\n(MP&L)\nMP&L's allocation of the proposed System Energy wholesale rate increase is $21.6 million. In July 1995, MP&L filed a schedule with the MPSC that will defer the ultimate amount of the System Energy rate increase. The deferral plan, which was approved by the MPSC, began in December 1995, the effective date of the System Energy rate increase, and will end after the issuance of a final order by FERC. The deferred rate increase is to be amortized over 48 months beginning October 1998.\n(NOPSI)\nNOPSI's allocation of the proposed System Energy wholesale rate increase is $11.1 million. In February 1996, NOPSI filed a plan with the City to defer 50% of the amount of the System Energy rate increase. The deferral began with the February 1996 bill to NOPSI from System Energy and will end after the issuance of a final order by FERC.\nFERC Settlement (Entergy Corporation and System Energy)\nIn November 1994, FERC approved an agreement settling a long- standing dispute involving income tax allocation procedures of System Energy. In accordance with the agreement, System Energy refunded approximately $61.7 million to AP&L, LP&L, MP&L, and NOPSI, each of which in turn has made refunds or credits to its customers (except for those portions attributable to AP&L's and LP&L's retained share of Grand Gulf 1 costs). Additionally, System Energy will refund a total of approximately $62 million, plus interest, to AP&L, LP&L, MP&L, and NOPSI over the period through June 2004. The settlement also required the write-off of certain related unamortized balances of deferred investment tax credits by AP&L, LP&L, MP&L, and NOPSI. The settlement reduced Entergy Corporation's consolidated net income for the year ended December 31, 1994, by approximately $68.2 million, offset by the write-off of the unamortized balances of related deferred investment tax credits of approximately $69.4 million ($2.9 million for Entergy Corporation; $27.3 million for AP&L; $31.5 million for LP&L; $6 million for MP&L; and $1.7 million for NOPSI). System Energy also reclassified from utility plant to other deferred debits approximately $81 million of other Grand Gulf 1 costs. Although such costs are excluded from rate base, System Energy is recovering them over a 10-year period. Interest on the $62 million refund and the loss of the return on the $81 million of other Grand Gulf 1 costs will reduce Entergy's and System Energy's net income by approximately $10 million annually over the next 10 years.\nFERC Return on Equity Case - - - - -------------------------- In August 1992, FERC instituted an investigation of the return on equity (ROE) component of all formula wholesale rates for System Energy as well as AP&L, LP&L, MP&L, and NOPSI. Rates under the Unit Power Sales Agreement are based on System Energy's cost of service, including a return on common equity which had been set at 13%.\nIn August 1993, Entergy and the state regulatory agencies that intervened in the proceeding reached an agreement (Settlement Agreement) in this matter. The Settlement Agreement, which was approved by FERC on October 25, 1993, provides that an 11.0% ROE will be included in the formula rates under the Unit Power Sales Agreement. System Energy's refunds payable to AP&L, LP&L, MP&L, and NOPSI, which were due prospectively from November 3, 1992, were reflected as a credit to their bills in October 1993. These refunds decreased System Energy's 1993 revenues and net income by approximately $29.4 million and $18.2 million, respectively. The Unit Power Sales Agreement formula rate, including the 11.0% ROE component, currently remains in effect. However, in December 1995, System Energy implemented a rate increase subject to refund, which included an increased return on common equity. Refer to above for a discussion of the proposed System Energy rate increase.\nNOTE 3. INCOME TAXES\nEntergy Corporation - - - - ------------------- Entergy Corporation's income tax expense consists of the following:\nEntergy Corporation's total income taxes differ from the amounts computed by applying the statutory Federal income tax rate to income before taxes. The reasons for the differences are:\nSignificant components of Entergy Corporation's net deferred tax liabilities as of December 31, 1995 and 1994, are as follows:\nArkansas Power & Light Company - - - - ------------------------------\nAP&L's income tax expense consists of the following:\nAP&L's total income taxes differ from the amounts computed by applying the statutory Federal income tax rate to income before taxes. The reasons for the differences are:\nSignificant components of AP&L's net deferred tax liabilities as of December 31, 1995 and 1994,are as follows:\nGulf States Utilities Company - - - - -----------------------------\nGSU's income tax expense consists of the following:\nGSU's total income taxes differ from the amounts computed by applying the statutory Federal income tax rate to income before taxes. The reasons for the differences are:\nSignificant components of GSU's net deferred tax liabilities as of December 31, 1995 and 1994, are as follows:\nLouisiana Power & Light Company - - - - -------------------------------\nLP&L's income tax expense consists of the following:\nLP&L's total income taxes differ from the amounts computed by applying the statutory Federal income tax rate to income before taxes. The reasons for the differences are:\nSignificant components of LP&L's net deferred tax liabilities as of December 31, 1995 and 1994, are as follows:\nMississippi Power & Light Company - - - - ---------------------------------\nMP&L's income tax expense consists of the following:\nMP&L's total income taxes differ from the amounts computed by applying the statutory federal income tax rate to income before taxes. The reasons for the differences are:\nSignificant components of MP&L's net deferred tax liabilities as of December 31, 1995 and 1994, are as follows:\nNew Orleans Public Service Inc. - - - - -------------------------------\nNOPSI's income tax expense consists of the following:\nNOPSI's total income taxes differ from the amounts computed by applying the statutory Federal income tax rate to income before taxes. The reasons for the differences are:\nSignificant components of NOPSI's net deferred tax liabilities as of December 31, 1995 and 1994, are as follows:\nSystem Energy Resources, Inc. - - - - -----------------------------\nSystem Energy's income tax expense consists of the following:\nSystem Energy's total income taxes differ from the amounts computed by applying the statutory Federal income tax rate to income before taxes. The reasons for the differences are:\nSignificant components of System Energy's net deferred tax liabilities as of December 31, 1995 and 1994, are as follows:\nAs of December 31, 1995, Entergy had investment tax credit (ITC) carryforwards of $167.7 million, federal net operating loss (NOL) carryforwards of $384.6 million and state NOL carryforwards of $355.0 million, all related to GSU operations. The ITC carryforwards include the 35% reduction required by the Tax Reform Act of 1986 and may be applied against federal income tax liability of only GSU and, if not utilized, will expire between 1996 and 2002. It is currently anticipated that approximately $44.6 million of ITC carryforward will expire unutilized. A valuation allowance has been provided for deferred tax assets relating to that amount. The alternative minimum tax (AMT) credit carryforwards as of December 31, 1995, were $130.7 million, including $39.7 million at GSU, $27.4 million at LP&L, and $63.6 million at SERI. This AMT credit can be carried forward indefinitely and will reduce the System's federal income tax liability in the future.\nIn accordance with the System Energy-FERC Settlement, the System wrote off $66.5 million of unamortized deferred investment tax credits in 1994, including $27.3 million at AP&L, $31.5 million at LP&L, $6.0 million at MP&L, and $1.7 million at NOPSI.\nIn 1993, the System adopted SFAS 109. SFAS 109 required that deferred income taxes be recorded for all carryforwards and temporary differences between the book and tax basis of assets and liabilities, and that deferred tax balances be based on enacted tax laws at tax rates that are expected to be in effect when the temporary differences reverse. SFAS 109 required that regulated enterprises recognize adjustments resulting from implementation as regulatory assets or liabilities if it is probable that such amounts will be recovered from or returned to customers in future rates. A substantial majority of the adjustments required by SFAS 109 was recorded to deferred tax balance sheet accounts with offsetting adjustments to regulatory assets and liabilities. As a result of the adoption of SFAS 109, Entergy's 1993 net income and earnings per share were decreased by $13.2 million and $0.08 per share, respectively, and assets and liabilities were increased by $822.7 million and $835.9 million, respectively. The cumulative effect of the adoption of SFAS 109 is included in income tax expense charged to operations. The following table shows the effect of the adoption of SFAS 109 on 1993 net income, assets and liabilities for AP&L, LP&L, MP&L, NOPSI, and SERI.\nGSU recorded the adoption of SFAS 109 by restating 1990, 1991, and 1992 financial statements and including a charge of $96.5 million for the cumulative effect of the adoption of SFAS 109 in 1990 primarily for that portion of the operations on which GSU has discontinued regulatory accounting principles.\nIn August 1994, Entergy received an IRS report covering the federal income tax audit of Entergy Corporation and subsidiaries for the years 1988 - 1990. The report asserts an $80 million tax deficiency for the 1990 consolidated federal income tax returns related primarily to the application of accelerated investment tax credits associated with Waterford 3 and Grand Gulf nuclear plants. Entergy believes there is no material tax deficiency and is vigorously contesting the proposed assessment.\nNOTE 4. LINES OF CREDIT AND RELATED BORROWINGS (Entergy Corporation, AP&L, GSU, LP&L, MP&L, NOPSI, and System Energy)\nThe SEC has authorized AP&L, GSU, LP&L, MP&L, NOPSI, and System Energy to effect short-term borrowings up to $125 million, $125 million, $150 million, $100 million, $39 million, and $125 million, respectively (for a total of $664 million). These limits may be increased to as much as $1.216 billion in total (subject to individual authorizations for each company) after further SEC approval. These authorizations are effective through November 30, 1996. Of these companies, only LP&L and System Energy had borrowings outstanding as of December 31, 1995. LP&L had $76.5 million of borrowings outstanding, including $61.5 million under the money pool, an intra-System borrowing arrangement designed to reduce the System's dependence on external short-term borrowings. LP&L had unused bank lines of credit in the amount of $2.7 million. System Energy had money pool borrowings outstanding of approximately $3 million at December 31, 1995. AP&L and MP&L had undrawn lines of credit as of December 31, 1995, of $34 million and $30 million, respectively.\nOn July 27, 1995, Entergy Corporation received SEC authorization for a $300 million bank credit facility. Thereafter, a three-year credit agreement was signed with a group of banks on October 10, 1995, to provide up to $300 million of loans to Entergy Corporation. As of December 31, 1995, no amounts were outstanding against this credit facility. However, on January 4, 1996, $230 million was borrowed against the facility for use in the acquisition of CitiPower. See Note 15 for a discussion of the acquisition.\nOther Entergy companies have financing agreements and facilities permitting them to borrow up to $135 million, of which $30 million was outstanding as of December 31, 1995. Some of these borrowings are restricted as to use, and are secured by certain assets.\nIn total, the System had commitments in the amount of $516.7 million at December 31, 1995, of which $471.7 million was unused. The weighted average interest rate on the outstanding borrowings at December 31, 1995, and December 31, 1994, was 6.35% and 7.18%, respectively. Commitment fees on the lines of credit for AP&L, LP&L, and MP&L are 0.125% of the undrawn amounts. The commitment fee for Entergy Corporation's $300 million credit facility is currently 0.17%, but can fluctuate depending on the senior debt ratings of the Operating Companies.\nNOTE 5. PREFERRED, PREFERENCE, AND COMMON STOCK (Entergy Corporation, AP&L, GSU, LP&L, MP&L, and NOPSI)\nThe number of shares, authorized and outstanding, and dollar value of preferred and preference stock for Entergy, AP&L, GSU, LP&L, MP&L, and NOPSI as of December 31, 1995, and 1994 were:\n(a) The total dollar value represents the involuntary liquidation value of $25 per share. (b) These series are not redeemable as of December 31, 1995. (c) Rates are as of December 31, 1995. (d) Fair values were determined using bid prices reported by dealer markets and by nationally recognized investment banking firms. See Note 1 for additional disclosure of fair value of financial instruments.\nChanges in the preferred stock, with and without sinking fund, preference stock, and common stock of AP&L, GSU, LP&L, MP&L, and NOPSI during the last three years were:\nCash sinking fund requirements for the next five years for preferred stock, outstanding as of December 31, 1995 are:\n(a) AP&L, GSU, LP&L, and MP&L have the annual noncumulative option to redeem, at par, additional amounts of certain series of their outstanding preferred stock.\nOn December 31, 1993, Entergy Corporation issued 56,695,724 shares of common stock in connection with the Merger. In addition, Entergy Corporation redeemed 174,552,011 shares of $5 par value common stock and reissued 174,552,011 shares of $0.01 par value common stock resulting in an increase in paid-in capital of $871 million.\nEntergy Corporation had a program in which it repurchased and retired (returned to authorized but unissued status) 1,230,000 shares of common stock at a cost of $30.7 million in 1994. In addition, 627,000 shares of treasury stock were purchased for cash during 1993 at a cost of $20.6 million. A portion of the treasury shares purchased in 1993 was subsequently reissued, and in connection with the Merger on December 31, 1993, the remaining balance of 579,274 shares of treasury stock was canceled.\nEntergy Corporation from time to time acquires shares of its common stock to be held as treasury shares and to be reissued to meet the requirements of the Stock Plan for Outside Directors (Directors' Plan), the Equity Ownership Plan of Entergy Corporation and Subsidiaries (Equity Plan), and certain other stock benefit plans. Under this program, 2,805,000 of treasury shares were purchased in 1994 at a cost of $88.8 million. The Directors' Plan awards nonemployee directors a portion of their compensation in the form of a fixed number of shares of Entergy Corporation common stock. Shares awarded under the Directors' Plan were 9,251, 18,757, and 12,550 during 1995, 1994, and 1993, respectively. The Equity Plan grants stock options, restricted shares, and equity awards to key employees of the System companies. The costs of awards are charged to income over the period of the grant or restricted period, as appropriate. Amounts charged to compensation expense in 1995 were immaterial. Stock options, which comprise 50% of the shares targeted for distribution under the Equity Plan, are granted at exercise prices not less than market value on the date of grant. The options are generally exercisable no less than six months nor more than 10 years after the date of grant.\nNonstatutory stock option transactions are summarized as follows:\n(a) Options were not exercisable as of December 31, 1995.\nThe Employee Stock Investment Plan (ESIP) is authorized to issue or acquire, through March 31, 1997, up to 2,000,000 shares of its common stock to be held as treasury shares and reissued to meet the requirements of the ESIP. Under the ESIP, employees may be granted the opportunity to purchase (for up to 10% of their regular annual salary, but not more than $25,000) common stock at 85% of the market value on the first or last business day of the plan year, whichever is lower. Through this program, employees purchased 329,863 shares for the 1994 plan year. The 1995 plan year runs from April 1, 1995, to March 31, 1996.\nNOTE 6. LONG - TERM DEBT (Entergy Corporation, AP&L, GSU, LP&L, MP&L, NOPSI, and System Energy)\nThe long-term debt of Entergy Corporation's subsidiaries, AP&L, GSU, LP&L, MP&L, NOPSI, and System Energy, as of December 31, 1995, was:\nThe long-term debt of Entergy Corporation's subsidiaries, AP&L, GSU, LP&L, MP&L, NOPSI, and System Energy, as of December 31, 1994, was:\n(a) $20 million of MP&L's 14.95% Series G&R Bonds and $9.2 million of NOPSI's 13.9% Series G&R Bonds were due 2\/1\/95. All other series are at interest rates within the range of 6.95% - 11.2%.\n(b) Consists of pollution control bonds, certain series of which are secured by non-interest bearing first mortgage bonds.\n(c) The fair value excludes lease obligations, long-term DOE obligations, and other long-term debt and was determined using bid prices reported by dealer markets and by nationally recognized investment banking firms. See Note 1 for additional information on disclosure of fair value of financial instruments.\nThe annual long-term debt maturities (excluding lease obligations) and annual cash sinking fund requirements for the next five years follow:\nSystem Entergy (a) AP&L (b) GSU (c) LP&L (d) MP&L (e) NOPSI Energy (Dollars In Thousands)\n1996 558,650 28,700 145,425 35,260 61,015 38,250 250,000 1997 361,270 33,065 160,865 34,325 96,015 27,000 10,000 1998 314,920 18,710 190,890 35,300 20 - 70,000 1999 172,391 1,225 100,915 231 20 - 70,000 2000 143,015 1,825 945 100,225 20 - 40,000\n(a) Not included are other sinking fund requirements of approximately $20.4 million annually which may be satisfied by cash or by certification of property additions at the rate of 167% of such requirements.\n(b) Not included are other sinking fund requirements of approximately $1.1 million annually which may be satisfied by cash or by certification of property additions at the rate of 167% of such requirements.\n(c) Not included are other sinking fund requirements of approximately $13.8 million annually which may be satisfied by cash or by certification of property additions at the rate of 167% of such requirements.\n(d) Not included are other sinking fund requirements of approximately $5.5 million annually which may be satisfied by cash or by certification of property additions at the rate of 167% of such requirements.\n(e) Not included are other sinking fund requirements of approximately $0.1 million for 1996 which may be satisfied by cash or by certification of property additions at the rate of 167% of such requirements.\nGSU has two outstanding series of pollution control bonds collateralized by irrevocable letters of credit, which are scheduled to expire before the scheduled maturity of the bonds. The letter of credit collateralizing the $28.4 million variable rate series, due December 1, 2015, expires in September 1996 and the letter of credit collateralizing the $20 million variable rate series, due April 1, 2016, expires in April 1996. GSU plans to refinance these series or renew the letters of credit.\nUnder MP&L's G&R Mortgage, G&R Bonds are issuable based upon 70% of bondable property additions, based upon 50% of accumulated deferred Grand Gulf 1 related costs, based upon the retirement of certain bonds previously outstanding, or based upon the deposit of cash with the trustee. MP&L's G&R Mortgage prohibits the issuance of additional first mortgage bonds (including for refunding purposes) under MP&L's first mortgage indenture, except such first mortgage bonds as may hereafter be issued from time to time at MP&L's option to the corporate trustee under the G&R Mortgage to provide additional security for MP&L's G&R Bonds.\nUnder NOPSI's G&R Mortgage, G&R Bonds are issuable based upon 70% of bondable property additions or based upon 50% of accumulated deferred Grand Gulf 1-related costs. The G&R Mortgage precludes the issuance of any additional bonds based upon property additions if the total amount of outstanding Rate Recovery Mortgage Bonds issued on the basis of the uncollected balance of deferred Grand Gulf 1-related costs exceeds 66 2\/3% of the balance of such deferred costs. As of December 31, 1995, the total amount of Rate Recovery Mortgage Bonds outstanding aggregated $30.0 million, or 17.3% of NOPSI's accumulated deferred Grand Gulf 1-related costs.\nNOTE 7. DIVIDEND RESTRICTIONS - (Entergy Corporation, AP&L, GSU, LP&L, MP&L, NOPSI, and System Energy)\nProvisions within the Articles of Incorporation or pertinent Indentures and various other agreements related to the long-term debt and preferred stock of Entergy Corporation's subsidiaries restrict the payment of cash dividends or other distributions on their common and preferred stock. Additionally, PUHCA prohibits Entergy Corporation's subsidiaries from making loans or advances to Entergy Corporation. Detailed below are the restricted common equity and restricted retained earnings unavailable for distribution to Entergy Corporation by subsidiary.\nRestricted Restricted Company Equity Earnings (In Millions)\nAP&L $ 882.6 $ 291.3 GSU 1,266.5 - LP&L 1,084.1 - MP&L 334.8 135.7 NOPSI 85.2 15.2 System Energy 808.1 18.7 ----------- ---------- Entergy $ 4,461.3 $ 460.9 =========== ==========\nNOTE 8. COMMITMENTS AND CONTINGENCIES\nCajun - River Bend Litigation (Entergy Corporation and GSU)\nGSU has significant business relationships with Cajun, including co-ownership of River Bend (operated by GSU) and Big Cajun 2, Unit 3 (operated by Cajun). GSU and Cajun, respectively, own 70% and 30% undivided interests in River Bend and 42% and 58% undivided interests in Big Cajun 2, Unit 3.\nIn June 1989, Cajun filed a civil action against GSU in the United States District Court for the Middle District of Louisiana (District Court). Cajun's complaint seeks to annul, rescind, terminate, and\/or dissolve the Joint Ownership Participation and Operating Agreement (Operating Agreement) entered into on August 28, 1979, relating to River Bend. Cajun alleges fraud and error by GSU, breach of its fiduciary duties owed to Cajun, and\/or GSU's repudiation, renunciation, abandonment, or dissolution of its core obligations under the Operating Agreement, as well as the lack or failure of cause and\/or consideration for Cajun's performance under the Operating Agreement. The suit also seeks to recover Cajun's alleged $1.6 billion investment in the unit as damages, plus attorneys' fees, interest, and costs. Two member cooperatives of Cajun have brought an independent action to declare the Operating Agreement void, based upon failure to get prior LPSC approval alleged to be necessary. GSU believes the suits are without merit and is contesting them vigorously.\nA trial on the portion of the suit by Cajun to rescind the Operating Agreement began in April 1994 and was completed in March 1995. On October 24, 1995, the District Court issued a memorandum opinion ruling in favor of GSU. The District Court found that Cajun did not prove that GSU fraudulently induced it to execute the Operating Agreement and that Cajun failed to timely assert its claim. A final judgment on this portion of the suit will not be entered until all claims asserted by Cajun have been heard. The second portion of the suit is scheduled to begin on July 2, 1996. If GSU is ultimately unsuccessful in this litigation and is required to pay substantial damages, GSU would probably be unable to make such payments and could be forced to seek relief from its creditors under the United States Bankruptcy Code. If GSU prevails in this litigation, there can be no assurance that the United States Bankruptcy Court will allow funding of all required costs of Cajun's ownership in River Bend.\nCajun has not paid its full share of capital costs, operating and maintenance expenses, or other costs for repairs and improvements to River Bend since 1992. In addition, certain costs and expenses paid by Cajun were paid under protest. These actions were taken by Cajun based on its contention, with which GSU disagrees, that River Bend's operating and maintenance expenses were excessive. Cajun's unpaid portion of River Bend operating and maintenance expenses (including nuclear fuel) and capital costs for 1995 was approximately $58.7 million. Cajun continues to pay its share of decommissioning costs for River Bend.\nDuring the period in which Cajun is not paying its share of River Bend costs, GSU intends to fund all costs necessary for the safe, continuing operation of the unit. The responsibilities of Entergy Operations as the licensed operator of River Bend, for safely operating and maintaining the unit, are not affected by Cajun's actions.\nIn view of Cajun's failure to fund its share of River Bend-related operating, maintenance, and capital costs, GSU has (i) credited GSU's share of expenses for Big Cajun 2, Unit 3 against amounts due from Cajun to GSU, and (ii) sought to market Cajun's share of the power from River Bend and apply the proceeds to the amounts due from Cajun to GSU. As a result, on November 2, 1994, Cajun discontinued supplying GSU with its share of power from Big Cajun 2, Unit 3. GSU requested an order from the District Court requiring Cajun to supply GSU with this energy and allowing GSU to credit amounts due to Cajun for Big Cajun 2, Unit 3 energy against amounts Cajun owed to GSU for River Bend. In December 1994, by means of a preliminary injunction, the District Court ordered Cajun to supply GSU with its share of energy from Big Cajun 2, Unit 3 and ordered GSU to make payments for its share of Big Cajun 2, Unit 3 expenses to the registry of the District Court. In October 1995, the Fifth Circuit affirmed the District Court's preliminary injunction. As of December 31, 1995, $38 million had been paid by GSU into the registry of the District Court.\nOn December 21, 1994, Cajun filed a petition in the United States Bankruptcy Court for the Middle District of Louisiana seeking bankruptcy relief under Chapter 11 of the Bankruptcy Code. Cajun's bankruptcy could have a material adverse effect on GSU. However, GSU is taking appropriate steps to protect its interests and its claims against Cajun arising from the co-ownership in River Bend and Big Cajun 2, Unit 3. On December 31, 1994, the District Court issued an order lifting an automatic stay as to certain proceedings, with the result that the preliminary injunction granted by the Court in December 1994 remains in effect. Cajun filed a Notice of Appeal on January 18, 1995, to the Fifth Circuit seeking a reversal of the District Court's grant of the preliminary injunction. No hearing date has been set on Cajun's appeal.\nIn the bankruptcy proceedings, Cajun filed on January 10, 1995, a motion to reject the Operating Agreement as a burdensome executory contract. GSU responded on January 10, 1995, with a memorandum opposing Cajun's motion. Should the court grant Cajun's motion to reject the Operating Agreement, Cajun would be relieved of its financial obligations under the contract, while GSU would likely have a substantial damage claim arising from any such rejection. Although GSU believes that Cajun's motion to reject the Operating Agreement is without merit, it is not possible to predict the outcome or ultimate impact of these proceedings.\nThe cumulative cost (excluding nuclear fuel) to GSU resulting from Cajun's failure to pay its full share of River Bend-related costs, reduced by the proceeds from the sale by GSU of Cajun's share of River Bend power and payments for GSU's portion of expenses for Big Cajun 2, Unit 3 into the registry of the District Court, was $31.1 million as of December 31, 1995. These amounts are reflected in long-term receivables with an offsetting reserve in other deferred credits. Cajun's bankruptcy may affect the ultimate collectibility of the amounts owed to GSU, including any amounts that may be awarded in litigation.\nCajun - Transmission Service (Entergy Corporation and GSU)\nGSU and Cajun are parties to FERC proceedings relating to transmission service charge disputes. In April 1992, FERC issued a final order in these disputes. In May 1992, GSU and Cajun filed motions for rehearings on certain portions of the order, which are still pending at FERC. In June 1992, GSU filed a petition for review in the United States Court of Appeals regarding certain of the other issues decided by FERC. In August 1993, the United States Court of Appeals rendered an opinion reversing FERC's order regarding the portion of such disputes relating to the calculations of certain credits and equalization charges under GSU's service schedules with Cajun. The opinion remanded the issues to FERC for further proceedings consistent with its opinion. In February 1995, FERC eliminated an issue from the remand that GSU believes the Court of Appeals directed FERC to reconsider. In orders issued on August 3, 1995, and October 2, 1995, FERC affirmed an April 1995 ruling by an ALJ in the remanded portion of GSU's and Cajun's ongoing transmission service charge disputes before FERC. Both GSU and Cajun have petitioned for appeal. No hearing dates have been set in the appeals.\nUnder GSU's interpretation of the 1992 FERC order, as modified by its August 3, 1995, and October 2, 1995, orders, Cajun would owe GSU approximately $64.9 million as of December 31, 1995. GSU further estimates that if it were to prevail in its May 1992 motion for rehearing and on certain other issues decided adversely to GSU in the February 1995, August 1995, and October 1995 FERC orders, which GSU has appealed, Cajun would owe GSU approximately $143.5 million, as of December 31, 1995. If Cajun were to prevail in its May 1992 motion for rehearing to FERC, and if GSU were not to prevail in its May 1992 motion for rehearing to FERC, and if Cajun were to prevail in appealing FERC's August and October 1995 orders, GSU estimates it would owe Cajun approximately $96.4 million as of December 31, 1995. The above amounts are exclusive of a $7.3 million payment by Cajun on December 31, 1990, which the parties agreed to apply to the disputed transmission service charges. Pending FERC's ruling on the May 1992 motions for rehearing, GSU has continued to bill Cajun, utilizing the historical billing methodology, and has recorded underpaid transmission charges, including interest, in the amount of $137.2 million as of December 31, 1995. This amount is reflected in long-term receivables, with an offsetting reserve in other deferred credits. Cajun's bankruptcy may affect GSU's collection of the above amounts. FERC has determined that the collection of the pre-petition debt of Cajun is an issue properly decided in the bankruptcy proceeding.\nCapital Requirements and Financing (Entergy Corporation, AP&L, GSU, LP&L, MP&L, NOPSI, and System Energy)\nConstruction expenditures (excluding nuclear fuel) for the years 1996, 1997, and 1998 are estimated to total $571 million, $510 million, and $507 million, respectively. The System will also require $1.3 billion during the period 1996-1998 to meet long-term debt and preferred stock maturities and cash sinking fund requirements. The System plans to meet the above requirements primarily with internally generated funds and cash on hand, supplemented by the issuance of debt and preferred stock and the use of its outstanding credit facility. Certain System companies may also continue with the acquisition or refinancing of all or a portion of certain outstanding series of preferred stock and long-term debt. See Notes 5 and 6 for further information.\nGrand Gulf 1-Related Agreements\nCapital Funds Agreement (Entergy Corporation and System Energy)\nEntergy Corporation has agreed to supply System Energy with sufficient capital to (1) maintain System Energy's equity capital at an amount equal to a minimum of 35% of its total capitalization (excluding short-term debt), and (2) permit the continued commercial operation of Grand Gulf 1 and pay in full all indebtedness for borrowed money of System Energy when due under any circumstances. In addition, under supplements to the Capital Funds Agreement assigning System Energy's rights as security for specific debt of System Energy, Entergy Corporation has agreed to make cash capital contributions to enable System Energy to make payments on such debt when due.\nSystem Energy has entered into various agreements with AP&L, LP&L, MP&L, and NOPSI whereby they are obligated to purchase their respective entitlements of capacity and energy from System Energy's 90% ownership and leasehold interest in Grand Gulf 1, and to make payments that, together with other available funds, are adequate to cover System Energy's operating expenses. System Energy would have to secure funds from other sources, including Entergy Corporation's obligations under the Capital Funds Agreement, to cover any shortfalls from payments received from AP&L, LP&L, MP&L, and NOPSI under these agreements.\nUnit Power Sales Agreement (AP&L, LP&L, MP&L, NOPSI, and System Energy)\nSystem Energy has agreed to sell all of its 90% owned and leased share of capacity and energy from Grand Gulf 1 to AP&L, LP&L, MP&L, and NOPSI in accordance with specified percentages (AP&L-36%, LP&L-14%, MP&L-33% and NOPSI-17%) as ordered by FERC. Charges under this agreement are paid in consideration for the purchasing companies' respective entitlement to receive capacity and energy and are payable irrespective of the quantity of energy delivered so long as the unit remains in commercial operation. The agreement will remain in effect until terminated by the parties and approved by FERC, most likely upon Grand Gulf 1's retirement from service. Monthly obligations for payments, including the rate increase which was placed into effect in December 1995, subject to refund, under the agreement are approximately $21 million, $8 million, $19 million, and $10 million for AP&L, LP&L, MP&L, and NOPSI, respectively.\nAvailability Agreement (AP&L, LP&L, MP&L, NOPSI, and System Energy)\nAP&L, LP&L, MP&L, and NOPSI are individually obligated to make payments or subordinated advances to System Energy in accordance with stated percentages (AP&L-17.1%, LP&L-26.9%, MP&L-31.3%, and NOPSI- 24.7%) in amounts that when added to amounts received under the Unit Power Sales Agreement or otherwise, are adequate to cover all of System Energy's operating expenses as defined, including an amount sufficient to amortize Grand Gulf 2 over 27 years. (See Reallocation Agreement terms below.) System Energy has assigned its rights to payments and advances to certain creditors as security for certain obligations. Since commercial operation of Grand Gulf 1, payments under the Unit Power Sales Agreement have exceeded the amounts payable under the Availability Agreement. Accordingly, no payments have ever been required. If AP&L or MP&L fails to make its Unit Power Sales Agreement payments, and System Energy is unable to obtain funds from other sources, LP&L and NOPSI could become subject to claims or demands by System Energy or its creditors for payments or advances under the Availability Agreement (or the assignments thereof) equal to the difference between their required Unit Power Sales Agreement payments and their required Availability Agreement payments.\nReallocation Agreement (AP&L, LP&L, MP&L, NOPSI, and System Energy)\nSystem Energy and AP&L, LP&L, MP&L, and NOPSI entered into the Reallocation Agreement relating to the sale of capacity and energy from the Grand Gulf and the related costs, in which LP&L, MP&L, and NOPSI agreed to assume all of AP&L's responsibilities and obligations with respect to the Grand Gulf under the Availability Agreement. FERC's decision allocating a portion of Grand Gulf 1 capacity and energy to AP&L supersedes the Reallocation Agreement as it relates to Grand Gulf 1. Responsibility for any Grand Gulf 2 amortization amounts has been individually allocated (LP&L-26.23%, MP&L-43.97%, and NOPSI-29.80%) under the terms of the Reallocation Agreement. However, the Reallocation Agreement does not affect AP&L's obligation to System Energy's lenders under the assignments referred to in the preceding paragraph. AP&L would be liable for its share of such amounts if LP&L, MP&L, and NOPSI were unable to meet their contractual obligations. No payments of any amortization amounts will be required as long as amounts paid to System Energy under the Unit Power Sales Agreement, including other funds available to System Energy, exceed amounts required under the Availability Agreement, which is expected to be the case for the foreseeable future.\nReimbursement Agreement (System Energy)\nIn December 1988, System Energy entered into two entirely separate, but identical, arrangements for the sales and leasebacks of an approximate aggregate 11.5% ownership interest in Grand Gulf 1 (see Note 9). In connection with the equity funding of the sale and leaseback arrangements, letters of credit are required to be maintained to secure certain amounts payable for the benefit of the equity investors by System Energy under the leases. The current letters of credit are effective until January 15, 1997.\nUnder the provisions of a bank letter of credit reimbursement agreement, System Energy has agreed to a number of covenants relating to the maintenance of certain capitalization and fixed charge coverage ratios. System Energy agreed, during the term of the reimbursement agreement, to maintain its equity at not less than 33% of its adjusted capitalization (defined in the reimbursement agreement to include certain amounts not included in capitalization for financial statement purposes). In addition, System Energy must maintain, with respect to each fiscal quarter during the term of the reimbursement agreement, a ratio of adjusted net income to interest expense (calculated, in each case, as specified in the reimbursement agreement) of at least 1.60 times earnings. As of December 31, 1995, System Energy's equity approximated 34.8% of its adjusted capitalization, and its fixed charge coverage ratio was 2.11.\nFuel Purchase Agreements\n(AP&L and MP&L)\nAP&L has long-term contracts with mines in the State of Wyoming for the supply of low-sulfur coal for the White Bluff Steam Electric Generating Station and Independence (which is 25% owned by MP&L). These contracts, which expire in 2002 and 2011, provide for approximately 85% of AP&L's expected annual coal requirements. Additional requirements are satisfied by annual spot market purchases.\n(GSU)\nGSU has a contract for a supply of low-sulfur Wyoming coal for Nelson Unit 6, which should be sufficient to satisfy the fuel requirements at Nelson Unit 6 through 2004. Cajun has advised GSU that it has contracts that should provide an adequate supply of coal until 1999 for the operation of Big Cajun 2, Unit 3.\nGSU has long-term gas contracts, which will satisfy approximately 75% of its annual requirements. Such contracts generally require GSU to purchase in the range of 40% of expected total gas needs. Additional gas requirements are satisfied under less expensive short- term contracts. GSU has a transportation service agreement with a gas supplier that provides flexible natural gas service to the Sabine and Lewis Creek generating stations. This service is provided by the supplier's pipeline and salt dome gas storage facility, which has a present capacity of 5.3 billion cubic feet of natural gas.\n(LP&L)\nIn June 1992, LP&L agreed to a renegotiated 20-year natural gas supply contract. LP&L agreed to purchase natural gas in annual amounts equal to approximately one-third of its projected annual fuel requirements for certain generating units. Annual demand charges associated with this contract are estimated to be $8.6 million through 1997, and a total of $116.6 million for the years 1998 through 2012. LP&L recovers the cost of fuel consumed during the generation of electricity through its fuel adjustment clause.\nPower Purchases\/Sales Agreements\n(GSU)\nIn 1988, GSU entered into a joint venture with a primary term of 20 years with Conoco, Inc., Citgo Petroleum Corporation, and Vista Chemical Company (Industrial Participants) whereby GSU's Nelson Units 1 and 2 were sold to a partnership (NISCO) consisting of the Industrial Participants and GSU. The Industrial Participants supply the fuel for the units, while GSU operates the units at the discretion of the Industrial Participants and purchases the electricity produced by the units. GSU is continuing to sell electricity to the Industrial Participants. For the years ended December 31, 1995, 1994, and 1993, the purchases by GSU of electricity from the joint venture totaled $59.7 million, $58.3 million, and $62.6 million, respectively.\n(LP&L)\nLP&L has a long-term agreement through the year 2031 to purchase energy generated by a hydroelectric facility. During 1995, 1994, and 1993, LP&L made payments under the contract of approximately $55.7 million, $56.3 million, and $66.9 million, respectively. If the maximum percentage (94%) of the energy is made available to LP&L, current production projections would require estimated payments of approximately $47 million in 1996, $54 million in 1997, and a total of $3.5 billion for the years 1998 through 2031. LP&L recovers the costs of purchased energy through its fuel adjustment clause.\nSystem Fuels (AP&L, LP&L, MP&L, NOPSI, and System Energy)\nAP&L, LP&L, MP&L, and NOPSI have interests in System Fuels of 35%, 33%, 19%, and 13%, respectively. The parent companies of System Fuels agreed to make loans to System Fuels to finance its fuel procurement, delivery, and storage activities. As of December 31, 1995, AP&L, LP&L, MP&L, and NOPSI had, respectively, approximately $11 million, $14.2 million, $5.5 million, and $3.3 million in loans outstanding to System Fuels which mature in 2008.\nIn addition, System Fuels entered into a revolving credit agreement with a bank that provides $45 million in borrowings to finance System Fuels' nuclear materials and services inventory. Should System Fuels default on its obligations under its credit agreement, AP&L, LP&L, and System Energy have agreed to purchase nuclear materials and services financed under the agreement.\nNuclear Insurance (Entergy Corporation, AP&L, GSU, LP&L, MP&L, NOPSI, and System Energy)\nThe Price-Anderson Act limits public liability for a single nuclear incident to approximately $8.92 billion. The System has protection for this liability through a combination of private insurance (currently $200 million each for AP&L, GSU, LP&L, and System Energy) and an industry assessment program. Under the assessment program, the maximum payment requirement for each nuclear incident would be $79.3 million per reactor, payable at a rate of $10 million per licensed reactor per incident per year. The System has five licensed reactors. As a co-licensee of Grand Gulf 1 with System Energy, SMEPA would share 10% of this obligation. With respect to River Bend, any assessments pertaining to this program are allocated in accordance with the respective ownership interests of GSU and Cajun. In addition, the System participates in a private insurance program which provides coverage for worker tort claims filed for bodily injury caused by radiation exposure. The program provides for a maximum assessment of approximately $16 million for the System's five nuclear units in the event losses exceed accumulated reserve funds.\nAP&L, GSU, LP&L, and System Energy are also members of certain insurance programs that provide coverage for property damage, including decontamination and premature decommissioning expense, to members' nuclear generating plants. As of December 31, 1995, AP&L, GSU, LP&L, and System Energy each was insured against such losses up to $2.75 billion. In addition, AP&L, GSU, LP&L, MP&L, and NOPSI are members of an insurance program that covers certain replacement power and business interruption costs incurred due to prolonged nuclear unit outages. Under the property damage and replacement power\/business interruption insurance programs, these System companies could be subject to assessments if losses exceed the accumulated funds available to the insurers. As of December 31, 1995, the maximum amounts of such possible assessments were: AP&L - $36.3 million; GSU - $22.0 million; LP&L - $33.2 million; MP&L - $0.8 million; NOPSI - $0.5 million; and System Energy - $29.0 million. Under its agreement with System Energy, SMEPA would share in System Energy's obligation. Cajun shares approximately $4.6 million of GSU's obligation.\nThe amount of property insurance presently carried by the System exceeds the NRC's minimum requirement for nuclear power plant licensees of $1.06 billion per site. NRC regulations provide that the proceeds of this insurance must be used, first, to place and maintain the reactor in a safe and stable condition and, second, to complete decontamination operations. Only after proceeds are dedicated for such use and regulatory approval is secured would any remaining proceeds be made available for the benefit of plant owners or their creditors.\nSpent Nuclear Fuel and Decommissioning Costs (Entergy Corporation, AP&L, GSU, LP&L, and System Energy)\nAP&L, GSU, LP&L, and System Energy provide for estimated future disposal costs for spent nuclear fuel in accordance with the Nuclear Waste Policy Act of 1982. The affected System companies entered into contracts with the DOE, whereby the DOE will furnish disposal service at a cost of one mill per net KWh generated and sold after April 7, 1983, plus a onetime fee for generation prior to that date. AP&L, the only System company that generated electricity with nuclear fuel prior to that date, elected to pay the onetime fee plus accrued interest, no earlier than 1998, and has recorded a liability as of December 31, 1995, of approximately $111 million for generation subsequent to 1983. The fees payable to the DOE may be adjusted in the future to assure full recovery. The System considers all costs incurred or to be incurred, except accrued interest, for the disposal of spent nuclear fuel to be proper components of nuclear fuel expense, and provisions to recover such costs have been or will be made in applications to regulatory authorities.\nDelays have occurred in the DOE's program for the acceptance and disposal of spent nuclear fuel at a permanent repository. In a statement released February 17, 1993, the DOE asserted that it does not have a legal obligation to accept spent nuclear fuel without an operational repository for which it has not yet arranged. Currently, the DOE projects it will begin to accept spent fuel no earlier than 2015. In the meantime, all System companies are responsible for spent fuel storage. Current on-site spent fuel storage capacity at River Bend, Waterford 3, and Grand Gulf 1 is estimated to be sufficient until 2003, 2000, and 2004, respectively. Thereafter, the affected companies will provide additional storage. Current on-site spent fuel storage capacity at ANO is estimated to be sufficient until mid-1998, at which time an ANO storage facility using dry casks will begin operation. This facility is estimated to provide sufficient storage until 2000, with the capability of being expanded further as required. The initial cost of providing the additional on-site spent fuel storage capability required at ANO, River Bend, Waterford 3, and Grand Gulf 1 is expected to be approximately $5 million to $10 million per unit. In addition, about $3 million to $5 million per unit will be required every two to three years subsequent to 2000 for ANO and every four to five years subsequent to 2003, 2000, and 2004 for River Bend, Waterford 3, and Grand Gulf 1, respectively, until the DOE's repository begins accepting such units' spent fuel.\nEntergy Operations and System Fuels joined in lawsuits against the DOE, seeking clarification of the DOE's responsibility to receive spent nuclear fuel beginning in 1998. The original suits, filed June 20, 1994, asked for a ruling stating that the Nuclear Waste Policy Act require the DOE to begin taking title to the spent fuel and to start removing it from nuclear power plants in 1998, a mandate for the DOE's nuclear waste management program to begin accepting fuel in 1998 and court monitoring of the program, and the potential for escrow of payments to a nuclear waste fund instead of directly to the DOE.\nTotal decommissioning costs at December 31, 1995, for the System nuclear power plants, excluding co-owner shares, have been estimated as follows:\nAP&L and LP&L are authorized to recover in rates amounts that, when added to estimated investment income, should be sufficient to meet the above estimated decommissioning costs for ANO and Waterford 3, respectively. In the Texas retail jurisdiction, GSU is recovering in rates decommissioning costs (based on the 1991 cost study) that, with adjustments, total $204.9 million. In the Louisiana retail jurisdiction, GSU is currently recovering in rates decommissioning costs (based on a 1985 cost study) which total $141 million. GSU included decommissioning costs (based on the 1991 study) in the LPSC rate review filed in May 1995 which has not yet been concluded. System Energy was previously recovering in rates amounts sufficient to fund $198 million (in 1989 dollars) of its decommissioning costs. System Energy included decommissioning costs (based on the 1994 study) in its rate increase filing with FERC. Rates in this proceeding were placed into effect in December 1995, subject to refund. AP&L, GSU, LP&L, and System Energy periodically review and update estimated decommissioning costs. Although the System is presently underrecovering based on the above estimates, applications are periodically made to the appropriate regulatory authorities to reflect in rates any future change in projected decommissioning costs. The amounts recovered in rates are deposited in trust funds and reported at market value as quoted on nationally traded markets. These trust fund assets largely offset the accumulated decommissioning liability that is recorded as accumulated depreciation for AP&L, GSU, and LP&L, and as other deferred credits for System Energy.\nThe cumulative liabilities and actual decommissioning expenses recorded in 1995 by the System companies were as follows:\nCumulative 1995 1995 Cumulative Liabilities as of Trust Decommissioning Liabilities as of December 31, 1994 Earnings Expenses December 31, 1995 (In Millions)\nANO 1 and ANO 2 $137.4 $13.9 $17.7 $169.0 River Bend 22.2 1.4 8.1 31.7 Waterford 3 28.2 1.7 7.5 37.4 Grand Gulf 1 31.9 2.1 5.4 39.4 ------ ----- ----- ------ $219.7 $19.1 $38.7 $277.5 ====== ===== ===== ======\nIn 1994 and 1993, ANO's decommissioning expense was $12.2 million and $11.0 million, respectively; River Bend's decommissioning expense was $3.0 million, respectively; Waterford 3's decommissioning expense was $4.8 million and $4.0 million, respectively; and Grand Gulf 1's decommissioning expense was $5.2 million and $4.9 million, respectively. The actual decommissioning costs may vary from the estimates because of regulatory requirements, changes in technology, and increased costs of labor, materials, and equipment. Management believes that actual decommissioning costs are likely to be higher than the estimated amounts presented above.\nThe staff of the SEC has questioned certain of the financial accounting practices of the electric utility industry regarding the recognition, measurement, and classification of decommissioning costs for nuclear generating stations in the financial statements of electric utilities. In response to these questions, the FASB has been reviewing the accounting for decommissioning and has expanded the scope of its review to include liabilities related to the closure and removal of all long-lived assets. An exposure draft of the proposed SFAS was issued in February 1996 would be effective in 1997. The proposed SFAS would require measurement of the liability for closure and removal of long- lived assets (including decommissioning) based on discounted future cash flows. Those future cash flows should be determined by estimating current costs and adjusting for inflation, efficiencies that may be gained from experience with similar activities, and consideration of reasonable future advances in technology. It also would require that changes in the decommissioning\/closure cost liability resulting from changes in assumptions should be recognized with a corresponding adjustment to the plant asset, and depreciation should be revised prospectively. The proposed SFAS stated that the initial recognition of the decommissioning\/closure cost liability would result in an asset that should be presented with other plant costs on the financial statements because the cost of decommissioning\/closing the plant is recognized as part of the total cost of the plant asset. In addition there would be a regulatory asset recognized on the financial statements to the extent the initial decommissioning\/closure liability has increased due to the passage of time, and such costs are probable of future recovery.\nIf current electric utility industry accounting practices with respect to nuclear decommissioning and other closure costs are changed, annual provisions for such costs could increase, the estimated cost for decommissioning\/closure could be recorded as a liability rather than as accumulated depreciation, and trust fund income from decommissioning trusts could be reported as investment income rather than as a reduction to decommissioning expense.\nThe EPAct has a provision that assesses domestic nuclear utilities with fees for the decontamination and decommissioning of the DOE's past uranium enrichment operations. The decontamination and decommissioning assessments will be used to set up a fund into which contributions from utilities and the federal government will be placed. AP&L, GSU, LP&L, and System Energy's annual assessments, which will be adjusted annually for inflation, are approximately $3.4 million, $0.9 million, $1.3 million, and $1.4 million (in 1995 dollars), respectively, for approximately 15 years. At December 31, 1995, AP&L, GSU, LP&L, and System Energy had recorded liabilities of $35.3 million, $6.0 million, $13.2 million, and $12.8 million, respectively, for decontamination and decommissioning fees in other current liabilities and other noncurrent liabilities, and these liabilities were offset in the consolidated financial statements by regulatory assets. FERC requires that utilities treat these assessments as costs of fuel as they are amortized and are recovered through rates in the same manner as other fuel costs.\nANO Matters (Entergy Corporation and AP&L)\nCracks in steam generator tubes at ANO 2 were discovered and repaired during an outage in March 1992. Further inspections and repairs were conducted at subsequent refueling and mid-cycle outages, including the most recent refueling outage in October 1995. Beginning in January 1995, ANO 2's output was reduced 15 megawatts or 1.6% due to secondary side fouling, tube plugging, and reduction of primary temperature. During the October 1995 inspection, additional cracks in the tubes were discovered. The unit may be approaching the limit for the number of steam generator tubes that can be plugged with the unit in operation. If the currently established limit is reached, Entergy Operations could be required during future outages to insert sleeves in some of the steam generator tubes that were previously plugged. Entergy Operations is monitoring the development of the cracks and assessing various options for the repair or the replacement of ANO 2's steam generators. Certain of these options could, in the future, require significant capital expenditures and result in additional outages. However, a decision as to the repair or replacement of ANO 2's steam generators is not expected prior to 1997. Entergy Operations periodically meets with the NRC to discuss the results of inspections of the generator tubes, as well as the timing of future inspections.\nEnvironmental Issues\n(AP&L)\nIn May 1995, AP&L was named as a defendant in a suit by Reynolds Metals Company (Reynolds), seeking to recover a share of the costs associated with the clean-up of hazardous substances at a site south of Arkadelphia, Arkansas. Reynolds alleges that it has spent $11.2 million to clean-up the site, and that the site was contaminated in part with PCBs for which AP&L bears some responsibility. AP&L, voluntarily, at its expense, has already completed remediation at a nearby substation site and believes that it has no liability for contamination at the site that is subject to the Reynolds suit and is contesting the lawsuit. Regardless of the outcome, AP&L does not believe this matter would have a materially adverse effect on its financial condition or results of operations.\n(GSU)\nGSU has been designated as a PRP for the clean-up of certain hazardous waste disposal sites. GSU is currently negotiating with the EPA and state authorities regarding the clean-up of these sites. Several class action and other suits have been filed in state and federal courts seeking relief from GSU and others for damages caused by the disposal of hazardous waste and for asbestos-related disease allegedly resulting from exposure on GSU premises. While the amounts at issue in the clean-up efforts and suits may be substantial, GSU believes that its results of operations and financial condition will not be materially adversely affected by the outcome of the suits. Through December 31, 1995, $7.9 million has been expended on the clean-up. As of December 31, 1995, a remaining recorded liability of $21.7 million existed relating to the clean-up of five sites at which GSU has been designated a PRP.\n(LP&L)\nDuring 1993, the LDEQ issued new rules for solid waste regulation, including regulation of wastewater impoundments. LP&L has determined that certain of its power plant wastewater impoundments were affected by these regulations and has chosen to upgrade or close them. As a result, a remaining recorded liability in the amount of $10.6 million existed at December 31, 1995, for wastewater upgrades and closures to be completed in 1996. Cumulative expenditures relating to the upgrades and closures of wastewater impoundments were $5.6 million as of December 31, 1995.\nCity Franchise Ordinances (NOPSI)\nNOPSI provides electric and gas service in the City of New Orleans pursuant to City franchise ordinances that state, among other things, that the City has a continuing option to purchase NOPSI's electric and gas utility properties.\nNOTE 9. LEASES\nGeneral\nAs of December 31, 1995, the System had capital leases and noncancelable operating leases for equipment, buildings, vehicles, and fuel storage facilities (excluding nuclear fuel leases and the sale and leaseback transactions) with minimum lease payments as follows:\nCapital Leases\nYear Entergy AP&L GSU (In Thousands)\n1996 $ 29,054 $ 11,126 $ 12,475 1997 24,653 8,293 12,475 1998 24,634 8,293 12,475 1999 24,610 8,294 12,475 2000 22,872 6,987 12,049 Years thereafter 113,421 41,708 69,331 Minimum lease payments 239,244 84,701 131,280 Less: Amount representing interest 87,284 34,360 47,921 --------- ---------- ---------- Present value of net minimum lease payments $ 151,960 $ 50,341 $ 83,359 ========= ========== ==========\nOperating Leases\nYear Entergy AP&L GSU LP&L (In Thousands)\n1996 $ 76,866 $ 36,498 $ 12,871 $ 4,820 1997 66,009 29,460 12,566 4,369 1998 65,914 29,047 16,499 4,256 1999 63,198 27,304 16,499 3,990 2000 59,760 25,722 16,326 3,846 Years thereafter 214,577 71,272 60,518 1,905 --------- --------- --------- ---------- Minimum lease payments $ 546,324 $ 219,303 $ 135,279 $ 23,186 ========= ========= ========= ==========\nRental expense for the System leases (excluding nuclear fuel leases and the sale and leaseback transactions) amounted to approximately $67.8 million, $64.8 million, and $62.7 million in 1995, 1994, and 1993, respectively. These amounts include $27.7 million, $26.4 million, and $23.2 million, respectively, for AP&L, $15.1 million, $15.3 million, and $31.9 million, respectively for GSU, and $14.8 million, $12.1 million, and $6.6 million, respectively, for LP&L.\nNuclear Fuel Leases\nAP&L, GSU, LP&L, and System Energy each has arrangements to lease nuclear fuel in an aggregate amount up to $395 million as of December 31, 1995. The lessors finance the acquisition and ownership of nuclear fuel through credit agreements and the issuance of notes. These agreements are subject to annual renewal with, in LP&L's and GSU's case, the consent of the lenders. The credit agreements for AP&L, GSU, LP&L, and System Energy have been extended and now have termination dates of December 1998, December 1998, January 1999, and February 1999, respectively. The debt securities issued pursuant to these fuel lease arrangements have varying maturities through January 31, 1999. It is expected that the credit agreements will be extended or alternative financing will be secured by each lessor upon the maturity of the current arrangements. If extensions or alternative financing cannot be arranged, the lessee in each case must purchase sufficient nuclear fuel to allow the lessor to retire such borrowings.\nLease payments are based on nuclear fuel use. Nuclear fuel lease expense charged to operations by the System in 1995, 1994, and 1993 was $153.5 million (including interest of $22.1 million), $163.4 million (including interest of $27.3 million), and $145.8 million (excluding GSU and including interest of $20.5 million), respectively. Specifically, in 1995, 1994, and 1993, AP&L's expense was $46.8 million, $56.2 million, and $69.7 million (including interest of $6.7 million, $7.5 million, and $10.6 million), respectively; GSU's expense was $41.4 million, $37.2 million, and $43.6 million (including interest of $6.0 million, $8.7 million, and $10.2 million), respectively; LP&L's expense was $30.8 million, $32.2 million, and $39.9 million (including interest of $3.7 million, $4.3 million, and $4.9 million), respectively; System Energy's expense was $34.5 million, $37.8 million, and $36.2 million (including interest of $5.7 million, $6.8 million, and $5.1 million), respectively.\nSale and Leaseback Transactions\nWaterford 3 Lease Obligations (LP&L)\nOn September 28, 1989, LP&L entered into three transactions for the sale (for an aggregate cash consideration of $353.6 million) and leaseback of three undivided portions of its 100% ownership interest in Waterford 3. The three undivided interests in Waterford 3 sold and leased back exclude certain transmission, pollution control, and other facilities that are part of Waterford 3. The interests sold and leased back are equivalent on an aggregate cost basis to approximately a 9.3% undivided interest in Waterford 3. LP&L is leasing back the interests on a net lease basis over an approximate 28-year basic lease term. LP&L has options to terminate the lease and to repurchase the interests in Waterford 3 at certain intervals during the basic lease term. Further, at the end of the basic lease term, LP&L has an option to renew the lease or to repurchase the undivided interests in Waterford 3.\nInterests were acquired from LP&L with funds obtained from the issuance and sale by the purchasers of intermediate-term and long-term secured lease obligation bonds. The lease payments to be made by LP&L will be sufficient to service such debt.\nLP&L did not exercise its option to repurchase the undivided interests in Waterford 3 in September 1994. As a result, LP&L was required to provide collateral for the equity portion of certain amounts payable by LP&L under the leases. Such collateral was in the form of a new series of non interest-bearing first mortgage bonds in the aggregate principal amount of $208.2 million issued by LP&L in September 1994.\nUpon the occurrence of certain adverse events (including lease events of default, events of loss, deemed loss events or certain adverse \"Financial Events\" with respect to LP&L), LP&L may be obligated to pay amounts sufficient to permit the termination of the lease transactions and may be required to assume the outstanding indebtedness issued to finance the acquisition of the undivided interests in Waterford 3. \"Financial Events\" include, among other things, failure by LP&L, following the expiration of any applicable grace or cure periods, to maintain (1) as of the end of any fiscal quarter, total equity capital (including preferred stock) at least equal to 30% of adjusted capitalization, or (2) in respect of the 12-month period ending on the last day of any fiscal quarter, a fixed charge coverage ratio of at least 1.50. As of December 31, 1995, LP&L's total equity capital (including preferred stock) was 48.7% of adjusted capitalization and its fixed charge coverage ratio was 3.29.\nAs of December 31, 1995, LP&L had future minimum lease payments (reflecting an overall implicit rate of 8.76%) in connection with the Waterford 3 sale and leaseback transactions as follows (in thousands):\n1996 $ 35,165 1997 39,805 1998 41,447 1999 50,530 2000 47,510 Years thereafter 628,704 ----------- Total 843,161 Less: Amount representing interest 489,561 ----------- Present value of net minimum lease payments $ 353,600 ===========\nGrand Gulf 1 Lease Obligations (System Energy)\nOn December 28, 1988, System Energy entered into two arrangements for the sale and leaseback of an aggregate 11.5% undivided ownership interest in Grand Gulf 1 for an aggregate cash consideration of $500 million. System Energy is leasing back the undivided interest on a net lease basis over a 26 1\/2-year basic lease term. System Energy has options to terminate the leases and to repurchase the undivided interest in Grand Gulf 1 at certain intervals during the basic lease term. Further, at the end of the basic lease term, System Energy has an option to renew the leases or to repurchase the undivided interest in Grand Gulf 1. See Note 8 with respect to certain other terms of the transactions.\nIn accordance with SFAS 98, \"Accounting for Leases,\" due to \"continuing involvement\" by System Energy, the sale and leaseback arrangements of the undivided portions of Grand Gulf 1, as described above, are required to be reflected for financial reporting purposes as financing transactions in System Energy's financial statements. The amounts charged to expense for financial reporting purposes include the interest portion of the lease obligations and depreciation of the plant. However, operating revenues include the recovery of the lease payments because the transactions are accounted for as sales and leasebacks for rate-making purposes. The total of interest and depreciation expense exceeds the corresponding revenues realized during the early part of the lease term. Consistent with a recommendation contained in a FERC audit report, System Energy recorded as a deferred asset the difference between the recovery of the lease payments and the amounts expensed for interest and depreciation and is recording such difference as a deferred asset on an ongoing basis. The amount of this deferred asset was $85.8 million and $78.5 million as of December 31, 1995, and 1994, respectively.\nAs of December 31, 1995, System Energy had future minimum lease payments (reflecting an implicit rate of 7.02% after the above refinancing) as follows (in thousands):\n1996 $ 42,753 1997 42,753 1998 42,753 1999 42,753 2000 42,753 Years thereafter 760,067 ----------- Total 973,832 Less: Amount representing interest 473,832 ----------- Present value of net minimum lease payments $ 500,000 ===========\nNOTE 10. POSTRETIREMENT BENEFITS (Entergy Corporation, AP&L, GSU, LP&L, MP&L, NOPSI, and System Energy)\nPension Plans\nThe System companies have various postretirement benefit plans covering substantially all of their employees. The pension plans are noncontributory and provide pension benefits that are based on employees' credited service and compensation during the final years before retirement. Entergy Corporation and its subsidiaries fund pension costs in accordance with contribution guidelines established by the Employee Retirement Income Security Act of 1974, as amended, and the Internal Revenue Code of 1986, as amended. The assets of the plans include common and preferred stocks, fixed income securities, interest in a money market fund, and insurance contracts. Prior to January 1, 1995, all System Companies' non-bargaining employees were generally included in a plan sponsored by the System company where they were employed. However, NOPSI was a participating employer in a plan sponsored by LP&L. Effective January 1, 1995, these employees became participants in a new plan with provisions substantially identical to their previous plan.\nTotal 1995, 1994, and 1993 pension cost of Entergy Corporation and its subsidiaries (excluding GSU for 1993 for the Entergy Corporation total), including amounts capitalized, included the following components (in thousands):\nThe funded status of Entergy's various pension plans as of December 31, 1995 and 1994 was (in thousands):\nThe significant actuarial assumptions used in computing the information above for 1995, 1994, and 1993 (only 1995 and 1994 with respect to GSU being included in the Entergy Corporation total), were as follows: weighted average discount rate, 7.5% for 1995, 8.5% for 1994, and 7.5% for 1993, weighted average rate of increase in future compensation levels, 4.6% for 1995, 5.1% for 1994 and 5.6% (5% for GSU) for 1993; and expected long-term rate of return on plan assets, 8.5% . Transition assets of the System are being amortized over the greater of the remaining service period of active participants or 15 years.\nIn 1994, GSU recorded an $18.0 million charge related to early retirement programs in connection with the Merger, of which $15.2 million was expensed.\nOther Postretirement Benefits\nThe System companies also provide certain health care and life insurance benefits for retired employees. Substantially all employees may become eligible for these benefits if they reach retirement age while still working for the System companies.\nEffective January 1, 1993, Entergy adopted SFAS 106. The new standard required a change from a cash method to an accrual method of accounting for postretirement benefits other than pensions. The Operating Companies, other than MP&L and NOPSI, continue to fund these benefits on a pay-as-you-go basis. During 1994, pursuant to regulatory directives, MP&L and NOPSI began to fund their postretirement benefit obligation. These assets are invested in a money market fund. At January 1, 1993, the actuarially determined accumulated postretirement benefit obligation (APBO) earned by retirees and active employees was estimated to be approximately $241.4 million and $128 million for Entergy (other than GSU) and for GSU, respectively. Such obligations are being amortized over a 20-year period beginning in 1993.\nThe Operating Companies have sought approval, in their respective regulatory jurisdictions, to implement the appropriate accounting requirements related to SFAS 106 for ratemaking purposes. AP&L has received an order permitting deferral, as a regulatory asset, of the difference between its annual cash expenditures for postretirement benefits other than pensions and the SFAS 106 accrual, for up to a five- year period commencing January 1, 1993. MP&L is expensing its SFAS 106 costs, which are reflected in rates pursuant to an order from the MPSC in connection with MP&L's formulary incentive-rate plan (see Note 2). The LPSC ordered GSU and LP&L to continue the use of the pay-as-you-go method for ratemaking purposes for postretirement benefits other than pensions, but the LPSC retains the flexibility to examine individual companies' accounting for postretirement benefits to determine if special exceptions to this order are warranted. NOPSI is expensing its SFAS 106 costs. Pursuant to resolutions adopted in November 1993 by the Council related to the Merger, NOPSI's SFAS 106 expenses through October 31, 1996, will be allowed by the Council for purposes of evaluating the appropriateness of NOPSI's rates. Pursuant to the PUCT's May 26, 1995, amended order, GSU is currently collecting its SFAS 106 costs in rates.\nTotal 1995, 1994 and 1993 postretirement benefit cost of Entergy Corporation and its subsidiaries (excluding GSU for the Entergy Corporation total for 1993), including amounts capitalized and deferred, included the following components (in thousands):\nThe funded status of Entergy's postretirement plans as of December 31, 1995 and 1994, was (in thousands):\nThe assumed health care cost trend rate used in measuring the APBO of the System companies was 8.4% for 1996, gradually decreasing each successive year until it reaches 5.0% in 2005. A one percentage-point increase in the assumed health care cost trend rate for each year would have increased the APBO of the System companies, as of December 31, 1995, by 11.3% (AP&L-11.8%, GSU-10.4%, LP&L-11.8%, MP&L-12.2% and NOPSI- 10.0%), and the sum of the service cost and interest cost by approximately 14.1% (AP&L-15.0%, GSU-12.8%, LP&L-14.4%, MP&L-14.4% and NOPSI-12.8%). The assumed discount rate and rate of increase in future compensation used in determining the APBO were 7.5% for 1995, 8.5% for 1994 and 7.5% for 1993, and 4.6% for 1995, 5.1% for 1994 and 5.5% (5% for GSU) for 1993, respectively. The expected long-term rate of return on plan assets was 8.5% for 1995.\nNOTE 11. RESTRUCTURING COSTS (Entergy Corporation, AP&L, GSU, LP&L, MP&L, and NOPSI)\nThe restructuring programs announced by Entergy in 1994 and 1995 included anticipated reductions in the number of employees and the consolidation of offices and facilities. The programs are designed to reduce costs, improve operating efficiencies, and increase shareholder value in order to enable Entergy to become a low-cost producer. The balances as of December 31, 1994, and 1995, for restructuring liabilities associated with these programs are shown below by company along with the actual termination benefits paid under the programs.\nRestructuring Restructuring Liability as of Additional Payments Liability as of December 31, 1995 Made in December 31, Company 1994 Charges 1995 1995 (In Millions)\nAP&L $12.2 $16.2 ($20.1) $8.3 GSU 6.5 13.1 (14.2) $5.4 LP&L 6.8 6.4 (11.0) $2.2 MP&L 6.2 2.9 (6.6) $2.5 NOPSI 3.4 0.2 (3.0) $0.6 Other - 9.6 (4.4) $5.2 ----- ----- ------ ----- Total $35.1 $48.4 ($59.3) $24.2 ===== ===== ====== =====\nThe restructuring charges shown above primarily included employee severance costs related to the expected termination of approximately 2,750 employees in various groups. As of December 31, 1995, 2,100 employees had either been terminated or accepted voluntary separation packages under the restructuring plan.\nAdditionally, the System recorded $24.3 million in 1994 (of which $23.8 million was recorded by GSU) for remaining severance and augmented retirement benefits related to the Merger. Actual termination benefits paid under the program during 1995 amounted to $21.6 million. During that same period, adjustments to the allocation of the total liability were made among the System companies. At December 31, 1995, the total remaining System liability for expected future Merger-related outlays was $2.8 million, comprised principally of GSU's liability of $2.3 million.\nNOTE 12. TRANSACTIONS WITH AFFILIATES (AP&L, GSU, LP&L, MP&L, NOPSI, and System Energy)\nThe various Operating Companies purchase electricity from and\/or sell electricity to other Operating Companies, System Energy, and Entergy Power (in the case of AP&L) under rate schedules filed with FERC. In addition, the Operating Companies and System Energy purchase fuel from System Fuels, receive technical, advisory, and administrative services from Entergy Services, and receive management and operating services from Entergy Operations.\nAs described in Note 1, all of System Energy's operating revenues consist of billings to AP&L, LP&L, MP&L, and NOPSI.\nThe tables below contain the various affiliate transactions among the Operating Companies and System Entergy (in millions).\nIntercompany Revenues\nSystem AP&L GSU LP&L MP&L NOPSI Energy\n1995 $ 195.5 $62.7 $ 1.6 $ 43.3 $ 3.2 $ 605.6 1994 $ 232.6 $44.4 $ 1.0 $ 45.8 $ 2.1 $ 475.0 1993 $ 175.8 $ - $ 4.8 $ 40.7 $ 2.5 $ 650.8\nIntercompany Operating Expenses\nSystem AP&L(1) GSU LP&L MP&L NOPSI Energy\n1995 $ 316.0 $ 266.5 $ 335.5 $ 262.6 $ 164.4 $ 6.5 1994 $ 310.7 $ 296.9 $ 365.8 $ 280.2 $ 170.1 $ 10.5 1993 $ 323.2 $ 25.5 $ 322.0 $ 360.5 $ 176.3 $ 12.3\n(1) Includes $31.0 million in 1995, $25.7 million in 1994, and $16.8 million in 1993 for power purchased from Entergy Power.\nOperating Expenses Paid or Reimbursed to Entergy Operations\nSystem AP&L GSU LP&L Energy\n1995 $ 189.8 $ 129.1 $ 122.6 $ 116.9 1994 $ 221.2 $ 210.2 $ 152.5 $ 179.6 1993 $ 226.3 $ - $ 118.9 $ 151.3\nIn addition, certain materials and services required for fabrication of nuclear fuel are acquired and financed by System Fuels and then sold to System Energy as needed. Charges for these materials and services, which represent additions to nuclear fuel, amounted to approximately $51.5 million in 1995, $26.4 million in 1994, and $32.8 million in 1993.\nNOTE 13. ENTERGY CORPORATION-GSU MERGER\nOn December 31, 1993, Entergy Corporation and GSU consummated the Merger. GSU became a wholly owned subsidiary of Entergy Corporation and continues to operate as an electric utility corporation under the regulation of FERC, the SEC, the PUCT, and the LPSC. As consideration to GSU's shareholders, Entergy Corporation paid $250 million and issued 56,695,724 shares of its common stock in exchange for the 114,055,065 outstanding shares of GSU common stock. In addition, $33.5 million of transaction costs were capitalized in connection with the Merger. Note 1 describes the accounting for the acquisition adjustment recorded in connection with the Merger.\nThe pro forma combined revenues, net income, earnings per common share before extraordinary items, cumulative effect of accounting changes, and earnings per common share of Entergy Corporation presented below give effect to the Merger as if it had occurred at January 1, 1992. This unaudited pro forma information is not necessarily indicative of the results of operations that would have occurred had the Merger been consummated for the period for which it is being given effect.\nYears Ended December 31 1993 1992 (In Thousands, Except Per Share Amounts)\nRevenues $6,286,999 $5,850,973 Net income $ 595,211 $ 521,783 Earnings per average common share before extraordinary items and cumulative effect of accounting changes $ 2.10 $ 2.26 Earnings per average common share $ 2.57 $ 2.24\nNOTE 14. BUSINESS SEGMENT INFORMATION\nNOPSI supplies electric and natural gas services in the City. NOPSI's segment information follows:\n(1) NOPSI's intersegment transactions are not material (less than 1% of sales to unaffiliated customers).\nNOTE 15. SUBSEQUENT EVENT (UNAUDITED)\nAcquisition of CitiPower (Entergy Corporation)\nOn January 5, 1996, Entergy Corporation finalized its acquisition of CitiPower, an electric distribution utility serving Melbourne, Australia. Entergy Corporation made an equity investment of $294 million in CitiPower and the remainder of the total purchase price of approximately $1.2 billion was made up of new CitiPower debt. CitiPower has 234,500 customers, the majority of which are commercial customers.\nNOTE 16. QUARTERLY FINANCIAL DATA (UNAUDITED) (Entergy Corporation, AP&L, GSU, LP&L, MP&L, NOPSI, and System Energy)\nThe business of the System is subject to seasonal fluctuations with the peak period occurring during the third quarter. Operating results for the four quarters of 1995 and 1994 were:\n(a)See Note 2 for information regarding the recording of a reserve for rate refund in December 1994. (b)See Note 11 for information regarding the recording of certain restructuring costs in 1994 and 1995. (c)See Note 3 for information regarding the write-off of certain unamortized deferred investment tax credits in the fourth quarter of 1994. (d)See Note 2 for information regarding credits and refunds recorded in 1994 as a result of the 1994 NOPSI Settlement. (e)See Note 2 for information regarding the recording of refunds in connection with the FERC Settlement in November 1994. (f)The fourth quarter of 1995 reflects an increase in net income of $35.4 million (net of income taxes of $22.9 million) and an increase in earnings per share of $.15 due to the recording of the cumulative effect of the change in accounting method for incremental nuclear refueling outage maintenance costs. See Note 1 for a discussion of the change in accounting method.\nEarnings (Loss) per Average Common Share (Entergy Corporation)\n1995 1994\nFirst Quarter $0.40 $ 0.31 Second Quarter $0.71 $ 0.63 Third Quarter $1.16 $ 0.63 Fourth Quarter (f) $0.02 $(0.07)\nItem 9.","section_9":"Item 9. Changes In and Disagreements With Accountants On Accounting and Financial Disclosure.\nNo event that would be described in response to this item has occurred with respect to Entergy, System Energy, AP&L, GSU, LP&L, MP&L, or NOPSI.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrants.\nAll officers and directors listed below held the specified positions with their respective companies as of the date of filing this report.\nENTERGY CORPORATION\nDirectors\nInformation required by this item concerning directors of Entergy Corporation is set forth under the heading \"Election of Directors\" contained in the Proxy Statement of Entergy Corporation to be filed in connection with its Annual Meeting of Stockholders to be held May 17, 1996, and is incorporated herein by reference.\n(a) Mr. Lupberger is a director of First Commerce Corporation, New Orleans, LA, International Shipholding Corporation, New Orleans, LA, and First National Bank of Commerce, New Orleans, LA.\n(b) Mr. Bemis is a director of Deposit Guaranty National Bank, Jackson, MS and Deposit Guaranty Corporation, Jackson, MS.\n(c) Mr. Meiners is a director of Trustmark National Bank, Jackson, MS, and Trustmark Corporation, Jackson, MS.\nEach director and officer of the applicable System company is elected yearly to serve until the first Board Meeting following the Annual Meeting of Stockholders or until a successor is elected and qualified. Annual meetings are currently expected to be held as follows:\nEntergy Corporation - May 17, 1996 AP&L - May 13, 1996 GSU - May 13, 1996 LP&L - May 13, 1996 MP&L - May 13, 1996 NOPSI - May 13, 1996 System Energy - May 13, 1996\nDirectorships shown above are generally limited to entities subject to Section 12 or 15(d) of the Securities and Exchange Act of 1934 or to the Investment Company Act of 1940.\nSection 16(a) of the Exchange Act and Section 17(a) of the Public Utility Holding Company Act of 1935, as amended, require the Corporation's officers, directors and persons who own more than 10% of a registered class of the Corporation's equity securities to file reports of ownership and changes in ownership concerning the securities of the Corporation and its subsidiaries with the SEC and to furnish the Corporation with copies of all Section 16(a) and 17(a) forms they file. Terry L. Ogletree, an officer of Entergy Enterprises, Inc., filed a Form 3 in March of 1995, which inadvertently failed to report ownership of 5,000 restricted shares of the Corporation's stock. This has now been correctly reported.\nItem 11.","section_11":"Item 11. Executive Compensation\nENTERGY CORPORATION\nInformation called for by this item concerning the directors and officers of Entergy Corporation and the Personnel Committee of Entergy Corporation's Board of Directors is set forth under the headings \"Executive Compensation\" and \"Personnel Committee Interlocks and Insider Participation\" contained in the Proxy Statement of Entergy Corporation to be filed in connection with its Annual Meeting of Stockholders to be held on May 17, 1996, which information is incorporated herein by reference.\nAP&L, GSU, LP&L, MP&L, NOPSI, AND SYSTEM ENERGY\nSummary Compensation Table\nThe following table includes the Chief Executive Officers and the four other most highly compensated executive officers in office as of December 31, 1995 at AP&L, GSU, LP&L, MP&L, NOPSI, and System Energy. This determination was based on total annual base salary and bonuses (including bonuses of an extraordinary and nonrecurring nature) from all System sources earned by each officer during the year 1995. See Item 10, \"Directors and Executive Officers of the Registrants,\" incorporated herein by reference, for information on the principal positions of the executive officers named in the table below.\nAP&L, GSU, LP&L, MP&L, NOPSI, and System Energy\nAs shown in Item 10, most executive officers named below are employed by several System companies. Because it would be impracticable to allocate such officers' salaries among the various companies, the table below includes aggregate compensation paid by all System companies.\n* Chief Executive Officer of System Energy.\n** Chief Executive Officer of AP&L, GSU, LP&L, MP&L, and NOPSI.\n(a) Includes bonuses earned pursuant to the Annual Incentive Plan.\n(b) Amounts include the value of restricted shares that vested in 1995, 1994, and 1993 (see note (d) below) under Entergy's Equity Ownership Plan.\n(c) Includes the following:\n(1) 1995 employer payments for Executive Medical Plan premiums as follows: Mr. Bemis $3,019; Mr. Blount $3,019; Mr. Hintz $3,019; Mr. Jackson $3,019; Mr. Lupberger $3,019; Mr. Maulden $3,019; Mr. McInvale $3,019; Mr. Regan $2,013.\n(2) 1995 benefit accruals under the Defined Contribution Restoration Plan as follows: Mr. Bemis $4,200; Mr. Hintz $5,250; Mr. Jackson $5,250; Mr. Lupberger $16,500; Mr. Maulden $8,550; Mr. McInvale $3,164.\n(3) 1995 employer contributions to the System Savings Plan as follows: Mr. Bemis $4,500; Mr. Blount $3,576; Mr. Hintz $4,500; Mr. Jackson $4,500; Mr. Lupberger $4,500; Mr. Maulden $4,500; Mr. McInvale $4,500; Mr. Regan $877.\n(4) 1995 reimbursements under the Executive Financial Counseling Program as follows: Mr. Bemis $2,625; Mr. Jackson $1,225; Mr. Lupberger $3,100; Mr. Maulden $2,715; Mr. McInvale $680.\n(5) 1995 payments for personal use under the Private Ownership Vehicle Plan as follows: Mr. Bemis $9,900; Mr. Blount $7,200; Mr. Hintz $10,800; Mr. Jackson $10,800; Mr. Lupberger $6,023; Mr. Maulden $9,720; Mr. McInvale $9,900; Mr. Regan $4,800.\n(6) 1995 earnings under the Entergy Stock Investment Plan as follows: Mr. Bemis $3,363; Mr. Blount $1,910.\n(7) 1995 reimbursements for moving expenses paid to Mr. Regan in the amount of $6,943.\n(d) There were no restricted stock awards in 1995 under the Equity Ownership Plan. At December 31, 1995, the number and value of the aggregate restricted stock holdings were as follows: Mr. Bemis: 4,000 shares, $117,000; Mr. Hintz: 5,429 shares, $158,798; Mr. Jackson: 5,500 shares, $160,875; Mr. Lupberger: 10,900 shares, $318,825; Mr. Maulden: 5,500 shares, $160,875; and Mr. McInvale: 4,000 shares, $117,000. Accumulated dividends are paid on restricted stock when vested. The value of stock for which restrictions were lifted in 1995, and the applicable portion of accumulated cash dividends, are reported in the LTIP Payouts column in the above table. The value of restricted stock awards as of December 31, 1995 are determined by multiplying the total number of shares awarded by the closing market price of Entergy Corporation common stock on the New York Stock Exchange Composite Transactions on December 29, 1995 ($29.25 per share).\nOption Grants in 1995\nThe following table summarizes option grants during 1995 to the executive officers named in the Summary Compensation Table above. The absence, in the table below, of any named officer indicates that no options were granted to such officer.\nAP&L, GSU, LP&L, MP&L, NOPSI, and System Entergy\n(a) Options were granted on January 26, 1995, pursuant to the Equity Ownership Plan. All options granted on this date have an exercise price equal to the closing price of Entergy Corporation common stock on the New York Stock Exchange Composite Transactions on January 26, 1995. These options became exercisable on July 26, 1995.\n(b) Options were granted on March 31, 1995, pursuant to the Equity Ownership Plan. All options granted on this date have an exercise price equal to the closing price of Entergy Corporation common stock on the New York Stock Exchange Composite Transactions on March 31, 1995. These options will become exercisable on March 31, 1998.\n(c) Calculation based on the market price of the underlying securities over a ten-year period assuming annual compounding. The column presents estimates of potential values based on simple mathematical assumptions. The actual value, if any, an executive officer may realize is dependent upon the market price on the date of option exercise.\nAggregated Option Exercises in 1995 and December 31, 1995 Option Values\nThe following table summarizes the number and value of options exercised during 1995, as well as the number and value of unexercised options, as of December 31, 1995, held by the executive officers named in the Summary Compensation Table above.\n(a) Based on the difference between the closing price of the Corporation's Common Stock on the New York Stock Exchange Composite Transactions on the exercise date of November 17, 1995, and the option exercise price.\n(b) Based on the difference between the closing price of the Corporation's Common Stock on the New York Stock Exchange Composite Transactions on December 29, 1995, and the option exercise price.\nPension Plan Tables\nAP&L, GSU, LP&L, MP&L, NOPSI, and System Energy\nRetirement Income Plan Table\nAnnual Covered Years of Service Compensation 15 20 25 30 35 $100,000 $22,500 $30,000 $37,500 $45,000 $ 52,000 200,000 45,500 60,000 75,000 90,000 105,000 300,000 67,500 90,000 112,500 135,000 157,500 400,000 90,000 120,000 150,000 180,000 210,000 500,000 112,500 150,000 187,500 225,000 262,500 850,000 191,250 255,000 318,750 382,500 446,250\nAll of the named officers of AP&L, GSU, LP&L, MP&L, NOPSI and System Energy participate in a Retirement Income Plan (a defined benefit plan) that provides a benefit for employees at retirement from the System based upon (1) generally all years of service beginning at age 21 through termination, with a forty-year maximum, multiplied by (2) 1.5%, multiplied by (3) the final average compensation. Final average compensation is based on the highest consecutive 60 months of covered compensation in the last 120 months of service. The normal form of benefit for a single employee is a lifetime annuity and for a married employee is a 50% joint and survivor annuity. Other actuarially equivalent options are available to each retiree. Retirement benefits are not subject to any deduction for Social Security or other offset amounts. The amount of the named executive officers' annual compensation covered by the plan as of December 31, 1995, is represented by the salary column in the Summary Compensation Table above.\nThe maximum benefit under each Retirement Income Plan is limited by Sections 401 and 415 of the Internal Revenue Code of 1986, as amended; however, AP&L, GSU, LP&L, MP&L, NOPSI, and System Energy have elected to participate in the Pension Equalization Plan sponsored by Entergy Corporation. Under this plan, certain executives, including the named executive officers, would receive an amount equal to the benefit payable under the Retirement Income Plans, without regard to the limitations, less the amount actually payable under the Retirement Income Plans.\nEffective January 1, 1995, the System Companies Retirement Income Plans were amended to transfer assets and related liabilities to a single Entergy Corporation Retirement Plan for all non- bargaining unit employees. Each Retirement Income Plan (except GSU) was amended effective February 1, 1991, to provide a minimum accrued benefit as of that date to any employee who was vested as of that date. For purposes of calculating such minimum accrued benefit, each eligible employee was deemed to have had an additional five years of service and age as of that date. The additional years of age did not count toward eligibility for early retirement, but served only to reduce the early retirement discount factor for those employees who were at least age 50 as of that date.\nThe credited years of service under the Retirement Income Plan (without giving effect to the five additional years of service credited pursuant to the February 1, 1991 amendment as discussed above) as of December 31, 1995, for the following executive officers named in the Summary Compensation Table above were: Mr. Bemis 13; Mr. Blount 11; and Mr. Maulden 30.\nThe credited years of service under the respective Retirement Income Plan, as amended, as of December 31, 1995 for the following executive officers named in the Summary Compensation Table, as a result of entering into supplemental retirement agreements, were as follows: Mr. Hintz 24; Mr. Jackson 16; Mr. Lupberger 32; and Mr. McInvale 23.\nIn addition to the Retirement Income Plan discussed above, AP&L, LP&L, MP&L, NOPSI, and System Energy participate in the Supplemental Retirement Plan of Entergy Corporation and Subsidiaries (SRP) and the Post-Retirement Plan of Entergy Corporation and Subsidiaries (PRP). Participation is limited to one of these two plans and is at the invitation of AP&L, LP&L, MP&L, NOPSI, and System Energy. The participant may receive from the appropriate System company a monthly benefit payment not in excess of .025 (under the SRP) or .0333 (under the PRP) times the participant's average basic annual salary (as defined in the plans) for a maximum of 120 months. Mr. Hintz has entered into a SRP participation contract, and all of the other executive officers of AP&L, LP&L, MP&L, NOPSI, and System Energy named in the Summary Compensation Table (except for Mr. Blount, Mr. McInvale and Mr. Regan) have entered into PRP participation contracts. Current estimates indicate that the annual payments to a named executive officer under the above plans would be less than the payments to that officer under the System Executive Retirement Plan.\nSystem Executive Retirement Plan Table (1)\nAnnual Covered Years of Service Compensation 15 20 25 30+ $ 200,000 $ 90,000 $100,000 $110,000 $120,000 300,000 135,000 150,000 165,000 180,000 400,000 180,000 200,000 220,000 240,000 500,000 225,000 250,000 275,000 300,000 600,000 270,000 300,000 330,000 360,000 700,000 315,000 350,000 385,000 420,000 1,000,000 450,000 500,000 550,000 600,000 ___________\n(1)Benefits shown are based on a target replacement ratio of 50% based on the years of service and covered compensation shown. The benefits for 10, 15, and 20 or more years of service at the 45% and 55% replacement levels would decrease (in the case of 45%) or increase (in the case of 55%) by the following percentages: 3.0%, 4.5%, and 5.0%, respectively.\nIn 1993, Entergy Corporation adopted the System Executive Retirement Plan (SERP). AP&L, GSU, LP&L, MP&L, NOPSI, and System Energy are participating employers in the SERP. The SERP is an unfunded defined benefit plan offered at retirement to certain senior executives, which would currently include all the executive officers (except Mr. Blount) named in the Summary Compensation Table above. Participating executives choose, at retirement, between the retirement benefits paid under provisions of the SERP or those payable under the executive retirement benefit plans discussed above. Covered pay under the SERP includes final annual base salary (see the Summary Compensation Table above, for the base salary covered by the SERP as of December 31, 1995) plus the Target Incentive Award (i.e., a percentage of final annual base salary) for the participant in effect at retirement. Benefits paid under the SERP are calculated by multiplying the covered pay times target pay replacement ratios (45%, 50%, or 55%, dependent on job rating at retirement) that are attained, according to plan design, at 20 years of credited service. The target ratios are increased by 1% for each year of service over 20 years, up to a maximum of 30 years of service. In accordance with the SERP formula, the target ratios are reduced for each year of service below 20 years. The credited years of service under this plan are identical to the years of service for named executive officers (other than Mr. Bemis, Mr. Jackson, and Mr. McInvale) disclosed above in the \"Pension Plan Tables-Retirement Income Plan Table\" section. Mr. Bemis, Mr. Jackson, and Mr. McInvale have 23 years, 22 years, and 14 years, respectively, of credited service under this plan.\nThe normal form of benefit for a single employee is a lifetime annuity and for a married employee is a 50% joint and survivor annuity. All SERP payments are guaranteed for ten years. Other actuarially equivalent options are available to each retiree. SERP benefits are offset by any and all defined benefit plan payments from the System and from prior employers. SERP benefits are not subject to Social Security offsets.\nEligibility for and receipt of benefits under any of the executive plans described above are contingent upon several factors. The participant must agree that, without the specific consent of the System company for which such participant was last employed, he may take no employment after retirement with any entity that is in competition with, or similar in nature to, AP&L, GSU, LP&L, MP&L, NOPSI, and System Energy or any affiliate thereof. Eligibility for benefits is forfeitable for various reasons, including violation of an agreement with AP&L, GSU, LP&L, MP&L, NOPSI, and System Energy, resignation of employment, or termination for cause.\nIn addition to the non-bargaining unit employees Retirement Income Plan discussed above, GSU provides, among other benefits to officers, an Executive Income Security Plan for key managerial personnel. The plan provides participants with certain retirement, disability, termination, and survivors' benefits. To the extent that such benefits are not funded by the employee benefit plans of GSU or by vested benefits payable by the participants' former employers, GSU is obligated to make supplemental payments to participants or their survivors. The plan provides that upon the death or disability of a participant during his employment, he or his designated survivors will receive (i) during the first year following his death or disability an amount not to exceed his annual base salary, and (ii) thereafter for a number of years until the participant attains or would have attained age 65, but not less than nine years, an amount equal to one-half of the participant's annual base salary. The plan also provides supplemental retirement benefits for life for participants retiring after reaching age 65 equal to 1\/2 of the participant's average final compensation rate, with 1\/2 of such benefit upon the death of the participant being payable to a surviving spouse for life.\nGSU amended and restated the plan effective March 1, 1991, to provide such benefits for life upon termination of employment of a participating officer or key managerial employee without cause (as defined in the plan) or if the participant separates from employment for good reason (as defined in the plan), with 1\/2 of such benefits to be payable to a surviving spouse for life. Further, the plan was amended to provide medical benefits for a participant and his family when the participant separates from service. These medical benefits generally continue until the participant is eligible to receive medical benefits from a subsequent employer; but in the case of a participant who is over 50 at the time of separation and was participating in the plan on March 1, 1991, medical benefits continue for life. By virtue of the 1991 amendment and restatement, benefits for a participant under such plan cannot be modified once he becomes eligible to participate in the plan.\nCompensation of Directors\nAP&L, GSU, LP&L, MP&L, NOPSI, and System Energy currently have no non-employee directors, and none of the current directors is compensated for his responsibilities as director.\nRetired non-employee directors of AP&L, LP&L, MP&L, and NOPSI with a minimum of five years of service on the respective Boards of Directors are paid $200 a month for a term of years corresponding to the number of years of active service as directors. Retired non- employee directors with over ten years of service receive a lifetime benefit of $200 a month. Years of service as an advisory director are included in calculating this benefit. System Energy has no retired non-employee directors.\nRetired non-employee directors of GSU receive retirement benefits under a plan in which all directors who served continuously for a period of years will receive a percentage of their retainer fee in effect at the time of their retirement for life. The retirement benefit is 30 percent of the retainer fee for service of not less than five nor more than nine years, 40 percent for service of not less than ten nor more than fourteen years, and 50 percent for fifteen or more years of service. For those directors who retired prior to the retirement age, their benefits will be reduced. The plan also provides disability retirement and optional hospital and medical coverage if the director has served at least five years prior to the disability. The retired director pays one-third of the premium for such optional hospital and medical coverage and GSU pays the remaining two-thirds. Years of service as an advisory director are included in calculating these benefits.\nEmployment Contracts and Termination of Employment and Change-in- Control Arrangements\nGSU\nOn January 18, 1991, GSU established an Executive Continuity Plan for elected and appointed officers providing for severance benefits equal to 2.99 times the officer's annual compensation upon termination of employment for reasons other than cause or upon a resignation of employment for good reason within two years after a change in control of GSU. Benefits are prorated if the officer is within three years of normal retirement age (65) at termination of employment. The plan further provides for continued participation in medical, dental, and life insurance programs for three years following termination unless such benefits are available from a subsequent employer. The plan provides for outplacement assistance to aid a terminated officer in securing another position. Upon consummation of the Merger on December 31, 1993, GSU made a one time contribution of $16,330,693 to a trust equivalent to the then present value of the maximum benefits which might be payable under the plan. As of December 31, 1995, the balance in the trust had been reduced to $7,678,628. If and to the extent outstanding benefits are not paid to the participants, the balance in the trust will be returned to GSU.\nAs a result of the Merger, GSU is obligated to pay benefits under the Executive Income Security Plan to those persons who were participants at the time of the Merger and who later terminated their employment under circumstances described in the plan. For additional description of the benefits under the Executive Income Security Plan, see the \"Pension Plan Tables-System Executive Retirement Plan Table\" section noted above.\nPersonnel Committee Interlocks and Insider Participation\nThe compensation of AP&L, GSU, LP&L, MP&L, NOPSI, and System Energy executive officers was set by the Personnel Committee of Entergy Corporation's Board of Directors for 1995. No officers or employees of such companies participated in deliberations concerning compensation during 1995. The Personnel Committee of Entergy Corporation's Board of Directors is set forth under the heading \"Report of Personnel Committee on Executive Compensation\" contained in the Proxy Statement of Entergy Corporation to be filed in connection with its Annual Meeting of Stockholders to be held May 17, 1996, and is incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nEntergy Corporation owns 100% of the outstanding common stock of registrants AP&L, GSU, LP&L, MP&L, NOPSI, and System Energy. The information with respect to persons known by Entergy Corporation to be beneficial owners of more than 5% of Entergy Corporation's common stock is included under the heading \"Voting Securities Outstanding\" in the Proxy Statement of Entergy Corporation to be filed in connection with its Annual Meeting of Stockholders to be held May 17, 1996, which information is incorporated herein by reference. The registrants know of no contractual arrangements that may, at a subsequent date, result in a change in control of any of the registrants.\nThe directors, the executive officers named in the Summary Compensation Table above, and the directors and officers as a group for Entergy Corporation, AP&L, GSU, LP&L, MP&L, NOPSI, and System Energy, respectively, beneficially owned directly or indirectly the cumulative preferred stock of an Operating Company and common stock of Entergy Corporation as indicated:\n* Director of the respective Company ** Named Executive Officer of the respective Company *** Officer and Director of the respective Company\n(a) Stock ownership amounts refer to 6,000 shares of AP&L's $0.01 Par Value ($25 liquidation value) Preferred Stock held by the John A. Cooper Trust, and 3,500 shares of AP&L's $0.01 Par Value ($25 liquidation value) Preferred Stock held by Eugene H. Owen. Mr. Cooper disclaims any personal interest in these shares.\n(b) Based on information furnished by the respective individuals. The ownership amounts shown for each individual and for all directors and executive officers as a group do not exceed one percent of the outstanding securities of any class of security so owned.\n(c) Includes all shares as to which the individual has the sole voting power and powers of disposition, or power to direct the voting and disposition.\n(d) Includes, for the named persons, shares of Entergy Corporation common stock held in the Employee Stock Ownership Plan of the registrants as follows: Michael B. Bemis, 767 shares; Joseph L. Blount, 810 shares; John J. Cordaro, 1,082 shares; Frank F. Gallaher, 1,011 shares; William D. Hamilton, 617 shares; Donald C. Hintz, 810 shares; Jerry D. Jackson, 810 shares; R. Drake Keith, 810 shares; Edwin Lupberger, 886 shares; Jerry L. Maulden, 856 shares; Gerald D. McInvale, 118 shares; and Donald E. Meiners, 594 shares.\n(e) Includes, for the named persons, shares of Entergy Corporation common stock held in the System Savings Plan company account as follows: Michael B. Bemis, 5,140 shares; Joseph L. Blount, 1,809 shares; John J. Cordaro, 2,003 shares; Frank F. Gallaher, 3,930 shares; William D. Hamilton, 1,591 shares; Donald C. Hintz, 1,412 shares; Jerry D. Jackson, 2,427 shares; R. Drake Keith, 4,336 shares; Edwin Lupberger, 6,771 shares; Jerry L. Maulden, 10,460 shares; Gerald D. McInvale, 802 shares; Donald E. Meiners, 4,950 shares; William J. Regan, 15 shares.\n(f) Includes, for the named persons, unvested restricted shares of Entergy Corporation common stock held in the Equity Ownership Plan as follows: Michael B. Bemis, 4,000 shares; John J. Cordaro, 1,200 shares; Frank F. Gallaher, 5,175 shares; Donald C. Hintz, 5,429 shares; Jerry D. Jackson, 5,500 shares; R. Drake Keith, 250 shares; Edwin Lupberger, 10,900 shares; Jerry L. Maulden, 5,500 shares; Gerald D. McInvale, 4,000 shares; and Donald E. Meiners, 250 shares.\n(g) Includes, for the named persons, shares of Entergy Corporation common stock in the form of unexercised stock options awarded pursuant to the Equity Ownership Plan as follows: Michael B. Bemis, 35,000 shares; John J. Cordaro 7,500 shares; Frank F. Gallaher, 32,500 shares; Donald C. Hintz, 42,500 shares; Jerry D. Jackson, 39,411 shares; R. Drake Keith, 7,174 shares; Edwin Lupberger, 88,824 shares; Jerry L. Maulden, 45,000 shares; Gerald D. McInvale, 35,000 shares; and Donald E. Meiners, 10,000 shares.\n(h) Includes 1,500 shares of Entergy Corporation common stock held jointly between Edwin Lupberger and Ms. E. H. Lupberger.\n(i) Includes, for the named persons, shares of Entergy Corporation common stock held by their spouses. The named persons disclaim any personal interest in these shares as follows: Edwin Lupberger, 2,500 shares; Robert D. Pugh, 10,000 shares; and H. Duke Shackelford, 3,950 shares.\n(j) Includes 752 shares of Entergy Corporation common stock held jointly with spouse.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nInformation called for by this item concerning the directors and officers of Entergy Corporation is set forth under the heading \"Certain Transactions\" in the Proxy Statement of Entergy Corporation to be filed in connection with its Annual Meeting of Stockholders to be held on May 17, 1996, which information is incorporated herein by reference.\nSee Item 10, \"Directors and Executive Officers of the Registrants,\" for information on certain relationships and transactions required to be reported under this item.\nOther than as provided under applicable corporate laws, the System companies do not have policies whereby transactions involving executive officers and directors of the System are approved by a majority of disinterested directors. However, pursuant to the Entergy Corporation Code of Conduct, transactions involving a System company and its executive officers must have prior approval by the next higher reporting level of that individual, and transactions involving a System company and its directors must be reported to the secretary of the appropriate System company.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.\n(a)1. Financial Statements and Independent Auditors' Reports for Entergy, AP&L, GSU, LP&L, MP&L, NOPSI, and System Energy are listed in the Index to Financial Statements (see pages 42 and 43)\n(a)2. Financial Statement Schedules\nReports of Independent Accountants on Financial Statement Schedules (see pages 218 and 219)\nFinancial Statement Schedules are listed in the Index to Financial Statement Schedules (see page S-1)\n(a)3. Exhibits\nExhibits for Entergy, AP&L, GSU, LP&L, MP&L, NOPSI, and System Energy are listed in the Exhibit Index (see page E-1). Each management contract or compensatory plan or arrangement required to be filed as an exhibit hereto is identified as such by footnote in the Exhibit Index.\n(b) Reports on Form 8-K\nEntergy and NOPSI\nA current report on Form 8-K, dated April 20, 1995, was filed with the SEC on April 26, 1995, reporting information under Item 5. \"Other Events\".\nEntergy and GSU\nA current report on Form 8-K, dated July 26, 1995, was filed with the SEC on July 26, 1995, reporting information under Item 5. \"Other Events\".\nA current report on Form 8-K, dated October 25, 1995, was filed with the SEC on October 25, 1995, reporting information under Item 5. \"Other Events\".\nEXPERTS\nThe statements attributed to Clark, Thomas & Winters, a professional corporation, as to legal conclusions with respect to GSU's rate regulation in Texas under Item 1. \"Rate Matters and Regulation - Rate Matters - Retail Rate Matters - GSU\" and in Note 2 to Entergy Corporation and Subsidiaries Consolidated Financial Statements and GSU's Financial Statements, \"Rate and Regulatory Matters,\" have been reviewed by such firm and are included herein upon the authority of such firm as experts.\nThe statements attributed to Sandlin Associates regarding the analysis of River Bend Construction costs of GSU under Item 1. \"Rate Matters and Regulation - Rate Matters - Retail Rate Matters - GSU\" and in Note 2 to Entergy Corporation and Subsidiaries Consolidated Financial Statements and GSU's Financial Statements, \"Rate and Regulatory Matters,\" have been reviewed by such firm and are included herein upon the authority of such firm as experts.\nENTERGY CORPORATION\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company and any subsidiaries thereof.\nENTERGY CORPORATION\nBy \/s\/ Louis E. Buck, Jr. Louis E. Buck, Jr., Vice President and Chief Accounting Officer\nDate: March 11, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. The signature of each of the undersigned shall be deemed to relate only to matters having reference to the above-named company and any subsidiaries thereof.\nSignature Title Date\n\/s\/ Louis E. Buck, Jr. Louis E. Buck, Jr. Vice President and March 11, 1996 Chief Accounting Officer (Principal Accounting Officer)\nEdwin Lupberger (Chairman of the Board, Chief Executive Officer and Director; Principal Executive Officer); Gerald D. McInvale (Executive Vice President and Chief Financial Officer; Principal Financial Officer); W. Frank Blount, John A. Cooper, Jr., Lucie J. Fjeldstad, N. C. Francis, Kaneaster Hodges, Jr., Robert v.d. Luft, Kinnaird R. McKee, Paul W. Murrill, James R. Nichols, Eugene H. Owen, John N. Palmer, Sr., Robert D. Pugh, H. Duke Shackelford, Wm. Clifford Smith, and Bismark A. Steinhagen (Directors).\nBy: \/s\/ Louis E. Buck, Jr. March 11, 1996 (Louis E. Buck, Jr., Attorney-in-fact)\nARKANSAS POWER & LIGHT COMPANY\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company and any subsidiaries thereof.\nARKANSAS POWER & LIGHT COMPANY\nBy \/s\/ Louis E. Buck, Jr. Louis E. Buck, Jr., Vice President, Chief Accounting Officer and Assistant Secretary\nDate: March 11, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. The signature of each of the undersigned shall be deemed to relate only to matters having reference to the above-named company and any subsidiaries thereof.\nSignature Title Date\n\/s\/ Louis E. Buck, Jr. Louis E. Buck, Jr. Vice President, Chief Accounting March 11, 1996 Officer and Assistant Secretary (Principal Accounting Officer)\nEdwin Lupberger (Chairman of the Board, Chief Executive Officer and Director; Principal Executive Officer); Gerald D. McInvale (Executive Vice President, Chief Financial Officer, and Director; Principal Financial Officer); Michael B. Bemis, Donald C. Hintz, Jerry D. Jackson, R. Drake Keith, and Jerry L. Maulden (Directors).\nBy: \/s\/ Louis E. Buck, Jr. March 11, 1996 (Louis E. Buck, Jr., Attorney-in-fact)\nGULF STATES UTILITIES COMPANY\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company and any subsidiaries thereof.\nGULF STATES UTILITIES COMPANY\nBy \/s\/ Louis E. Buck, Jr. Louis E. Buck, Jr., Vice President, Chief Accounting Officer and Assistant Secretary\nDate: March 11, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. The signature of each of the undersigned shall be deemed to relate only to matters having reference to the above-named company and any subsidiaries thereof.\nSignature Title Date\n\/s\/ Louis E. Buck, Jr. Louis E. Buck, Jr. Vice President, Chief Accounting March 11, 1996 Officer and Assistant Secretary (Principal Accounting Officer)\nEdwin Lupberger (Chairman of the Board, Chief Executive Officer and Director; Principal Executive Officer); Gerald D. McInvale (Executive Vice President, Chief Financial Officer, and Director; Principal Financial Officer); Michael B. Bemis, Frank F. Gallaher, Donald C. Hintz, Jerry D. Jackson, and Jerry L. Maulden (Directors).\nBy: \/s\/ Louis E. Buck, Jr. March 11, 1996 (Louis E. Buck, Jr., Attorney-in-fact)\nLOUISIANA POWER & LIGHT COMPANY\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company and any subsidiaries thereof.\nLOUISIANA POWER & LIGHT COMPANY\nBy \/s\/ Louis E. Buck, Jr. Louis E. Buck, Jr., Vice President, Chief Accounting Officer and Assistant Secretary\nDate: March 11, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. The signature of each of the undersigned shall be deemed to relate only to matters having reference to the above-named company and any subsidiaries thereof.\nSignature Title Date\n\/s\/ Louis E. Buck, Jr. Louis E. Buck, Jr. Vice President, Chief Accounting March 11, 1996 Officer and Assistant Secretary (Principal Accounting Officer)\nEdwin Lupberger (Chairman of the Board, Chief Executive Officer and Director; Principal Executive Officer); Gerald D. McInvale (Executive Vice President, Chief Financial Officer, and Director; Principal Financial Officer); Michael B. Bemis, John J. Cordaro, Donald C. Hintz, Jerry D. Jackson, and Jerry L. Maulden (Directors).\nBy: \/s\/ Louis E. Buck, Jr. March 11, 1996 (Louis E. Buck, Jr., Attorney-in-fact)\nMISSISSIPPI POWER & LIGHT COMPANY\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company and any subsidiaries thereof.\nMISSISSIPPI POWER & LIGHT COMPANY\nBy \/s\/ Louis E. Buck, Jr. Louis E. Buck, Jr., Vice President, Chief Accounting Officer and Assistant Secretary\nDate: March 11, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. The signature of each of the undersigned shall be deemed to relate only to matters having reference to the above-named company and any subsidiaries thereof.\nSignature Title Date\n\/s\/ Louis E. Buck, Jr. Louis E. Buck, Jr. Vice President, Chief Accounting March 11, 1996 Officer and Assistant Secretary (Principal Accounting Officer)\nEdwin Lupberger (Chairman of the Board, Chief Executive Officer and Director; Principal Executive Officer); Gerald D. McInvale (Executive Vice President, Chief Financial Officer, and Director; Principal Financial Officer); Michael B. Bemis, Donald C. Hintz, Jerry D. Jackson, Jerry L. Maulden, and Donald E. Meiners (Directors).\nBy: \/s\/ Louis E. Buck, Jr. March 11, 1996 (Louis E. Buck, Jr., Attorney-in-fact)\nNEW ORLEANS PUBLIC SERVICE 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. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company and any subsidiaries thereof.\nNEW ORLEANS PUBLIC SERVICE INC.\nBy \/s\/ Louis E. Buck, Jr. Louis E. Buck, Jr., Vice President, Chief Accounting Officer and Assistant Secretary\nDate: March 11, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. The signature of each of the undersigned shall be deemed to relate only to matters having reference to the above-named company and any subsidiaries thereof.\nSignature Title Date\n\/s\/ Louis E. Buck, Jr. Louis E. Buck, Jr. Vice President, Chief Accounting March 11, 1996 Officer and Assistant Secretary (Principal Accounting Officer)\nEdwin Lupberger (Chairman of the Board, Chief Executive Officer and Director; Principal Executive Officer); Gerald D. McInvale (Executive Vice President, Chief Financial Officer, and Director; Principal Financial Officer); John J. Cordaro, Jerry D. Jackson, and Jerry L. Maulden (Directors).\nBy: \/s\/ Louis E. Buck, Jr. March 11, 1996 (Louis E. Buck, Jr., Attorney-in-fact)\nSYSTEM ENERGY RESOURCES, 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. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company and any subsidiaries thereof.\nSYSTEM ENERGY RESOURCES, INC.\nBy \/s\/ Louis E. Buck, Jr. Louis E. Buck, Jr., Vice President and Chief Accounting Officer\nDate: March 11, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. The signature of each of the undersigned shall be deemed to relate only to matters having reference to the above-named company and any subsidiaries thereof.\nSignature Title Date\n\/s\/ Louis E. Buck, Jr. Louis E. Buck, Jr. Vice President and March 11, 1996 Chief Accounting Officer (Principal Accounting Officer)\nDonald C. Hintz (President, Chief Executive Officer and Director; Principal Executive Officer); Gerald D. McInvale (Executive Vice President, Chief Financial Officer, and Director; Principal Financial Officer); Edwin Lupberger (Chairman of the Board), and Jerry L. Maulden (Directors).\nBy: \/s\/ Louis E. Buck, Jr. March 11, 1996 (Louis E. Buck, Jr., Attorney-in-fact)\nEXHIBIT 23(a) CONSENT OF INDEPENDENT ACCOUNTANTS\nWe consent to the incorporation by reference in Post-Effective Amendment Nos. 2, 3, 4A, and 5A on Form S-8 and the related Prospectuses to registration statement of Entergy Corporation on Form S- 4 (File Number 33-54298), of our reports dated February 14, 1996, on our audits of the financial statements and financial statement schedules of Entergy Corporation as of and for the years ended December 31, 1995 and 1994, which reports include emphasis paragraphs related to rate-related contingencies and legal proceedings and a 1995 change of accounting method for incremental nuclear plant outage maintenance costs by one of the Corporation's subsidiaries, and are included in this Annual Report on Form 10-K.\nWe consent to the incorporation by reference in the registration statements and the related Prospectuses of Arkansas Power & Light Company on Form S-3 (File Numbers 33-36149, 33-48356, 33-50289 and 333- 00103) of our reports dated February 14, 1996, on our audits of the financial statements and financial statement schedule of Arkansas Power & Light Company as of and for the years ended December 31, 1995 and 1994, which reports include an emphasis paragraph related to the Company's 1995 change in its method of accounting for incremental nuclear plant outage maintenance costs, and are included in this Annual Report on Form 10-K.\nWe consent to the incorporation by reference in registration statements and the related Prospectuses of Gulf States Utilities Company on Form S-3 (File Numbers 33-49739 and 33-51181) and Form S-8 (File Numbers 2-76551 and 2-98011) of our reports dated February 14, 1996, on our audits of the financial statements and financial statement schedule of Gulf States Utilities Company as of December 31, 1995 and 1994 and for the three years ended December 31, 1995, which reports include emphasis paragraphs related to rate-related contingencies, legal proceedings and changes in accounting for income taxes, postretirement benefits and unbilled revenue, and are included in this Annual Report on Form 10-K.\nWe consent to the incorporation by reference in the registration statements and the related Prospectuses of Louisiana Power & Light Company on Form S-3 (File Numbers 33-46085, 33-39221, 33-50937, 333- 00105, and 333-01329) of our reports dated February 14, 1996, on our audits of the financial statements and financial statement schedule of Louisiana Power & Light Company as of and for the years ended December 31, 1995 and 1994, which are included in this Annual Report on Form 10- K.\nWe consent to the incorporation by reference in the registration statements and the related Prospectuses of Mississippi Power & Light Company on Form S-3 (File Numbers 33-53004, 33-55826 and 33-50507) of our reports dated February 14, 1996, on our audits of the financial statements and financial statement schedule of Mississippi Power & Light Company as of and for the years ended December 31, 1995 and 1994, which are included in this Annual Report on Form 10-K.\nWe consent to the incorporation by reference in the registration statements and the related Prospectuses of New Orleans Public Service Inc. on Form S-3 (File Numbers 33-57926 and 333-00255) of our reports dated February 14, 1996, on our audits of the financial statement and financial statement schedules of New Orleans Public Service Inc. as of and for the years ended December 31, 1995 and 1994, which are included in this Annual Report on Form 10-K.\nWe consent to the incorporation by reference in the registration statements and the related Prospectuses of System Energy Resources, Inc. on Form S-3 (File Numbers 33-47662 and 33-61189) of our reports dated February 14, 1996, on our audits of the financial statements of System Energy Resources, Inc. as of and for the years ended December 31, 1995 and 1994, which are included in this Annual Report on Form 10- K.\nCOOPERS & LYBRAND L.L.P. New Orleans, Louisiana March 8, 1996\nEXHIBIT 23(b) INDEPENDENT AUDITORS' CONSENT\nWe consent to the incorporation by reference in Post-Effective Amendments Nos. 2, 3, 4A, and 5A on Form S-8 to Registration Statement No. 33-54298 of Entergy Corporation on Form S-4, and the related Prospectuses, of our reports dated February 11, 1994, appearing in this Annual Report on Form 10-K of Entergy Corporation.\nWe also consent to the incorporation by reference in Registration Statements Nos. 333-00103, 33-36149, 33-48356 and 33-50289 of Arkansas Power & Light Company on Form S-3, and the related Prospectuses, of our reports dated February 11, 1994, appearing in this Annual Report on Form 10-K of Arkansas Power & Light Company.\nWe also consent to the incorporation by reference in Registration Statements Nos. 333-01329, 333-00105, 33-46085, 33-39221 and 33-50937 of Louisiana Power & Light Company on Form S-3, and the related Prospectuses, of our reports dated February 11, 1994, appearing in this Annual Report on Form 10-K of Louisiana Power & Light Company.\nWe also consent to the incorporation by reference in Registration Statements Nos. 33-53004, 33-55826 and 33-50507 of Mississippi Power & Light Company on Form S-3, and the related Prospectuses, of our reports dated February 11, 1994, appearing in this Annual Report on Form 10-K of Mississippi Power & Light Company.\nWe also consent to the incorporation by reference in Registration Statement Nos. 333-00255 and 33-57926 of New Orleans Public Service Inc. on Form S-3, and the related Prospectuses, of our reports dated February 11, 1994, appearing in this Annual Report on Form 10-K of New Orleans Public Service Inc.\nWe also consent to the incorporation by reference in Registration Statement Nos. 33-61189 and 33-47662 of System Energy Resources, Inc. on Form S-3, and the related Prospectuses, of our reports dated February 11, 1994 (November 30, 1994 as to Note 2, \"Rate and Regulatory Matters - FERC Settlement\"), appearing in this Annual Report on Form 10-K of System Energy Resources, Inc.\nDELOITTE & TOUCHE LLP New Orleans, Louisiana March 8, 1996\nEXHIBIT 23(c)\nCONSENT\nWe consent to the reference to our firm under the heading \"Experts\", and to the inclusion in this Annual Report on Form 10-K of Gulf States Utilities Company (\"GSU\") of the statements of legal conclusions attributed to us herein (the Statements of Legal Conclusions) under Part I, Item 1. Business - \"Rate Matters and Regulation\" and in the discussion of Texas jurisdictional matters set forth in Note 2 to GSU's Financial Statements and Note 2 to Entergy Corporation and Subsidiaries Consolidated Financial Statements appearing as Item 8. of Part II of this Form 10-K, which Statements of Legal Conclusions have been prepared or reviewed by us (Clark, Thomas & Winters, a Professional Corporation). We also consent to the incorporation by reference in the registration statements of GSU on Form S-3 and Form S-8 (File Numbers 2-76551, 2-98011, 33-49739, and 33-51181) of such reference and Statements of Legal Conclusions.]\nCLARK, THOMAS & WINTERS A Professional Corporation\nAustin, Texas March 11, 1996\nEXHIBIT 23(d)\nCONSENT\nWe consent to the reference to our firm under the heading \"Experts\" and to the inclusion in this Annual Report on Form 10-K of Gulf States Utilities Company (\"GSU\") of the statements (Statements) regarding the analysis by our Firm of River Bend construction costs which are made herein under Part I, Item 1. Business - \"Rate Matters and Regulation\" and in the discussion of Texas jurisdictional matters set forth in Note 2 to GSU's Financial Statements and Note 2 to Entergy Corporation and Subsidiaries' Consolidated Financial Statements appearing as Item 8. of Part II of this Form 10-K, which Statements have been prepared or reviewed by us (Sandlin Associates). We also consent to the incorporation by reference in the registration statements of GSU on Form S-3 and Form S-8 (File Numbers 2-76551, 2- 98011, 33-49739 and 33-51181) of such reference and Statements.\nSANDLIN ASSOCIATES Management Consultants\nPasco, Washington March 11, 1996\nREPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULES\nTo the Board of Directors and Shareholders of Entergy Corporation\nWe have audited the consolidated financial statements of Entergy Corporation and Subsidiaries and the financial statements of Arkansas Power & Light Company, Louisiana Power & Light Company, Mississippi Power & Light Company, New Orleans Public Service Inc., and System Energy Resources, Inc. as of and for the years ended December 31, 1995 and 1994, and the financial statements of Gulf States Utilities Company as of December 31, 1995 and 1994, and for each of the three years in the period ended December 31, 1995, and have issued our reports, included elsewhere in this Form 10-K, thereon dated February 14, 1996, which reports as to Entergy Corporation and Gulf States Utilities Company include emphasis paragraphs related to rate-related contingencies and legal proceedings, and which report as to Gulf States Utilities Company includes an emphasis paragraph related to changes in accounting for income taxes, postretirement benefits and unbilled revenue, and which reports as to Entergy Corporation and Arkansas Power & Light Company include an emphasis paragraph related to changes in accounting for incremental nuclear plant outage maintenance expenses. In connection with our audits of such financial statements, we have also audited the related financial statement schedules included 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 L.L.P.\nNew Orleans, Louisiana February 14, 1996\nINDEPENDENT AUDITORS' REPORT ON FINANCIAL STATEMENT SCHEDULES\nTo the Shareholders and the Board of Directors of Entergy Corporation\nWe have audited the consolidated financial statements of Entergy Corporation and subsidiaries and the financial statements of Arkansas Power & Light Company, Louisiana Power & Light Company, Mississippi Power & Light Company, New Orleans Public Service Inc., and System Energy Resources, Inc. for the year ended December 31, 1993, and have issued our reports thereon dated February 11, 1994, which report as to Entergy Corporation includes explanatory paragraphs as to uncertainties because of certain regulatory and litigation matters, and which report as to System Energy Resources, Inc. is dated November 30, 1994 as to Note 2, \"Rate and Regulatory Matters - FERC Settlement\"; such reports are included elsewhere in this Form 10-K. Our audit also included the 1993 financial statement schedules of these companies, listed in Item 14(a)2. These financial statement schedules are the responsibility of the companies' managements. Our responsibility is to express an opinion based on our audit. We did not audit the financial statements of Gulf States Utilities Company (a consolidated subsidiary of Entergy Corporation acquired on December 31, 1993), which statements reflect total assets constituting 31% of consolidated total assets at December 31, 1993. Those statements were audited by other auditors whose report (which included explanatory paragraphs regarding uncertainties because of certain regulatory and litigation matters) has been furnished to us, and our opinion, insofar as it relates to the amounts included for Gulf States Utilities Company, is based solely on the report of such other auditors. In our opinion, based on our audit and the report of the other auditors, such financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nDELOITTE & TOUCHE LLP New Orleans, Louisiana February 11, 1994\nINDEX TO FINANCIAL STATEMENT SCHEDULES\nSchedule Page\nI Financial Statements of Entergy Corporation: Statements of Income - For the Years Ended December 31, 1995, 1994, and 1993 S-2 Statements of Cash Flows - For the Years Ended December 31, 1995, 1994, and 1993 S-3 Balance Sheets, December 31, 1995 and 1994 S-4 Statements of Retained Earnings and Paid-In Capital - For the Years Ended December 31, 1995, 1994, and 1993 S-5 II Valuation and Qualifying Accounts 1995, 1994, and 1993: Entergy Corporation and Subsidiaries S-6 Arkansas Power & Light Company S-7 Gulf States Utilities Company S-8 Louisiana Power & Light Company S-9 Mississippi Power & Light Company S-10 New Orleans Public Service Inc. S-11\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.\nColumns have been omitted from schedules filed because the information is not applicable.\nENTERGY CORPORATION SCHEDULE I-FINANCIAL STATEMENTS OF ENTERGY CORPORATION STATEMENTS OF INCOME\nFor the Years Ended December 31, 1995 1994 1993 (In Thousands)\nIncome: Equity in income of subsidiaries $549,144 $369,701 $557,681 Interest on temporary investments 20,641 25,496 18,520 -------- -------- -------- Total 569,785 395,197 576,201 -------- -------- -------- Expenses and Other Deductions: Administrative and general expenses 53,872 57,846 25,129 Income taxes (credit) (5,383) (6,350) 3,587 Taxes other than income (credit) 1,102 465 (696) Interest (credit) 214 1,395 (3,749) -------- -------- -------- Total 49,805 53,356 24,271 -------- -------- -------- Net Income $519,980 $341,841 $551,930 ======== ======== ========\nSee Entergy Corporation and Subsidiaries Notes to Financial Statements in Part II, Item 8.\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. The exhibits marked with a (+) are management contracts or compensatory plans or arrangements required to be filed herewith and required to be identified as such by Item 14 of Form 10-K. Reference is made to a duplicate list of exhibits being filed as a part of this Form 10-K, which list, prepared in accordance with Item 102 of Regulation S-T of the SEC, immediately precedes the exhibits being physically filed with this Form 10-K.\n(3) (i) Articles of Incorporation\nEntergy Corporation\n(a) 1 -- Certificate of Incorporation of Entergy Corporation dated December 31, 1993 (A-1(a) to Rule 24 Certificate in 70-8059).\nSystem Energy\n(b) 1 -- Amended and Restated Articles of Incorporation of System Energy and amendments thereto through April 28, 1989 (A-1(a) to Form U-1 in 70-5399).\nAP&L\n(c) 1 -- Amended and Restated Articles of Incorporation of AP&L and amendments thereto through May 27, 1992 (4(c) in 33-50289).\nGSU\n(d) 1 -- Restated Articles of Incorporation of GSU and amendments thereto through May 28, 1993 (A-11 in 70- 8059).\n(d) 2 -- Statement of Resolution amending Restated Articles of Incorporation, as amended, of GSU (A-11(a) in 70- 8059).\nLP&L\n(e) 1 -- Restated Articles of Incorporation of LP&L and amendments thereto through July 21, 1994 (3(a) to Form 10- Q for the quarter ended June 30, 1994 in 1-8474).\nMP&L\n*(f) 1 -- Restated Articles of Incorporation of MP&L and amendments thereto through January 19, 1996.\nNOPSI\n(g) 1 -- Restatement of Articles of Incorporation of NOPSI and amendments thereto through July 21, 1994 (3(c) to Form 10-Q for the quarter ended June 30, 1994 in 0-5807).\n(3) (ii) By-Laws\n(a) -- By-Laws of Entergy Corporation effective August 25, 1992, and as presently in effect (A-2(a) to Rule 24 Certificate in 70-8059).\n(b) -- By-Laws of System Energy effective May 4, 1989, and as presently in effect (A-2(a) in 70-5399).\n(c) -- By-Laws of AP&L as amended effective May 5, 1994, and as presently in effect (4(f) in 33-50289).\n(d) -- By-Laws of GSU as amended effective May 5, 1994, and as presently in effect (A-12 in 70-8059).\n(e) -- By-Laws of LP&L effective January 23, 1984, and as presently in effect (A-4 in 70-6962).\n*(f) -- By-Laws of MP&L effective April 5, 1995, and as presently in effect.\n(g) -- By-Laws of NOPSI effective May 5, 1994, and as presently in effect (3(b) to Form 10-Q for the quarter ended September 30, 1989 in 0-5807).\n(4) Instruments Defining Rights of Security Holders, Including Indentures\nEntergy Corporation\n(a) 1 -- See (4)(b) through (4)(g) below for instruments defining the rights of holders of long-term debt of System Energy, AP&L, GSU, LP&L, MP&L and NOPSI.\n(a) 2 -- Credit Agreement, dated as of October 3, 1989, between System Fuels and The Yasuda Trust and Banking Co., Ltd., New York Branch, as agent (B-1(c) to Rule 24 Certificate, dated October 6, 1989, in 70-7668).\n(a) 3 -- First Amendment, dated as of March 1, 1992, to Credit Agreement, dated as of October 3, 1989, between System Fuels and The Yasuda Trust and Banking Co., Ltd., New York Branch, as agent (4(a)5 to Form 10-K for the year ended December 31, 1991 in 1-3517).\n(a) 4 -- Second Amendment, dated as of September 30, 1992, to Credit Agreement dated as of October 3, 1989, between System Fuels and The Yasuda Trust and Banking Co., Ltd., New York Branch, as agent (4(a)6 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n(a) 5 -- Security Agreement, dated as of October 3, 1989, as amended, between System Fuels and The Yasuda Trust and Banking Co., Ltd., New York Branch, as agent (B-3(c) to Rule 24 Certificate, dated October 6, 1989, in 70-7668), as amended by First Amendment to Security Agreement, dated as of March 14, 1990 (A to Rule 24 Certificate, dated March 7, 1990, in 70-7668).\n(a) 6 -- Consent and Agreement, dated as of October 3, 1989, among System Fuels, The Yasuda Trust and Banking Co., Ltd., New York Branch, as agent, AP&L, LP&L, and System Energy (B-5(c) to Rule 24 Certificate, dated October 6, 1989, in 70-7668).\n(a) 7 -- Credit Agreement, dated as of October 10, 1995, among Entergy, the Banks (Bank of America National Trust & Savings Association, The Bank of New York, Chemical Bank, Citibank, N.A., Union Bank of Switzerland, ABN AMRO Bank N.V., the Bank of Nova Scotia, Canadian Imperial Bank of Commerce, Bank N.A., First National Bank of Commerce and Whitney National Bank) and Citibank, N.A., as Agent (Exhibit B to Rule 24 Certificate dated October 20, 1995 in File No. 70-8149).\nSystem Energy\n(b) 1 -- Mortgage and Deed of Trust, dated as of June 15, 1977, as amended by nineteen Supplemental Indentures (A-1 in 70-5890 (Mortgage); B and C to Rule 24 Certificate in 70-5890 (First); B to Rule 24 Certificate in 70-6259 (Second); 20(a)-5 to Form 10-Q for the quarter ended June 30, 1981, in 1-3517 (Third); A-1(e)-1 to Rule 24 Certificate in 70-6985 (Fourth); B to Rule 24 Certificate in 70-7021 (Fifth); B to Rule 24 Certificate in 70-7021 (Sixth); A-3(b) to Rule 24 Certificate in 70-7026 (Seventh); A-3(b) to Rule 24 Certificate in 70-7158 (Eighth); B to Rule 24 Certificate in 70-7123 (Ninth); B-1 to Rule 24 Certificate in 70-7272 (Tenth); B-2 to Rule 24 Certificate in 70-7272 (Eleventh); B-3 to Rule 24 Certificate in 70-7272 (Twelfth); B-1 to Rule 24 Certificate in 70-7382 (Thirteenth); B-2 to Rule 24 Certificate in 70-7382 (Fourteenth); A-2(c) to Rule 24 Certificate in 70-7946 (Fifteenth); A-2(c) to Rule 24 Certificate in 70-7946 (Sixteenth); A-2(d) to Rule 24 Certificate in 70-7946 (Seventeenth); A-2(e) to Rule 24 Certificate dated May 4, 1993 in 70-7946 (Eighteenth); and A-2(g) to Rule 24 Certificate dated May 6, 1994, in 70-7946 (Nineteenth)).\n(b) 2 -- Facility Lease No. 1, dated as of December 1, 1988, between Meridian Trust Company and Stephen M. Carta (Steven Kaba, successor), as Owner Trustees, and System Energy (B-2(c)(1) to Rule 24 Certificate dated January 9, 1989 in 70-7561), as supplemented by Lease Supplement No. 1 dated as of April 1, 1989 (B-22(b) (1) to Rule 24 Certificate dated April 21, 1989 in 70-7561) and Lease Supplement No. 2 dated as of January 1, 1994 (B- 3(d) to Rule 24 Certificate dated January 31, 1994 in 70- 8215).\n(b) 3 -- Facility Lease No. 2, dated as of December 1, 1988 between Meridian Trust Company and Stephen M. Carta (Steven Kaba, successor), as Owner Trustees, and System Energy (B-2(c)(2) to Rule 24 Certificate dated January 9, 1989 in 70-7561), as supplemented by Lease Supplement No. 1 dated as of April 1, 1989 (B-22(b) (2) to Rule 24 Certificate dated April 21, 1989 in 70-7561) and Lease Supplement No. 2 dated as of January 1, 1994 (B-4(d) Rule 24 Certificate dated January 31, 1994 in 70-8215).\n(b) 4 -- Indenture (for Unsecured Debt Securities), dated as of September 1, 1995, between System Energy Resources, Inc., and Chemical Bank (B-10(a) to Rule 24 Certificate in 70-8511).\nAP&L\n(c) 1 -- Mortgage and Deed of Trust, dated as of October 1, 1944, as amended by fifty-two Supplemental Indentures (7(d) in 2-5463 (Mortgage); 7(b) in 2-7121 (First); 7(c) in 2-7605 (Second); 7(d) in 2-8100 (Third); 7(a)-4 in 2-8482 (Fourth); 7(a)-5 in 2-9149 (Fifth); 4(a)-6 in 2-9789 (Sixth); 4(a)-7 in 2-10261 (Seventh); 4(a)-8 in 2-11043 (Eighth); 2(b)-9 in 2-11468 (Ninth); 2(b)-10 in 2-15767 (Tenth); D in 70-3952 (Eleventh); D in 70-4099 (Twelfth); 4(d) in 2-23185 (Thirteenth); 2(c) in 2-24414 (Fourteenth); 2(c) in 2-25913 (Fifteenth); 2(c) in 2-28869 (Sixteenth); 2(d) in 2-28869 (Seventeenth); 2(c) in 2-35107 (Eighteenth); 2(d) in 2-36646 (Nineteenth); 2(c) in 2-39253 (Twentieth); 2(c) in 2-41080 (Twenty-first); C-1 to Rule 24 Certificate in 70-5151 (Twenty-second); C-1 to Rule 24 Certificate in 70-5257 (Twenty-third); C to Rule 24 Certificate in 70-5343 (Twenty-fourth); C-1 to Rule 24 Certificate in 70-5404 (Twenty-fifth); C to Rule 24 Certificate in 70-5502 (Twenty-sixth); C-1 to Rule 24 Certificate in 70-5556 (Twenty-seventh); C-1 to Rule 24 Certificate in 70-5693 (Twenty-eighth); C-1 to Rule 24 Certificate in 70-6078 (Twenty-ninth); C-1 to Rule 24 Certificate in 70-6174 (Thirtieth); C-1 to Rule 24 Certificate in 70-6246 (Thirty-first); C-1 to Rule 24 Certificate in 70-6498 (Thirty-second); A-4b-2 to Rule 24 Certificate in 70-6326 (Thirty-third); C-1 to Rule 24 Certificate in 70-6607 (Thirty-fourth); C-1 to Rule 24 Certificate in 70-6650 (Thirty-fifth); C-1 to Rule 24 Certificate, dated December 1, 1982, in 70-6774 (Thirty-sixth); C-1 to Rule 24 Certificate, dated February 17, 1983, in 70-6774 (Thirty-seventh); A-2(a) to Rule 24 Certificate, dated December 5, 1984, in 70-6858 (Thirty-eighth); A-3(a) to Rule 24 Certificate in 70-7127 (Thirty-ninth); A-7 to Rule 24 Certificate in 70-7068 (Fortieth); A-8(b) to Rule 24 Certificate dated July 6, 1989 in 70-7346 (Forty-first); A-8(c) to Rule 24 Certificate, dated February 1, 1990 in 70-7346 (Forty-second); 4 to Form 10-Q for the quarter ended September 30, 1990 in 1-10764 (Forty-third); A-2(a) to Rule 24 Certificate, dated November 30, 1990, in 70-7802 (Forty-fourth); A-2(b) to Rule 24 Certificate, dated January 24, 1991, in 70-7802 (Forty-fifth); 4(d)(2) in 33-54298 (Forty-sixth); 4(c)(2) to Form 10-K for the year ended December 31, 1992 in 1- 10764 (Forty-seventh); 4(b) to Form 10-Q for the quarter ended June 30, 1993 in 1-10764 (Forty-eighth); 4(c) to Form 10-Q for the quarter ended June 30, 1993 in 1-10764 (Forty-ninth); 4(b) to Form 10-Q for the quarter ended September 30, 1993 in 1-10764 (Fiftieth); 4(c) to Form 10- Q for the quarter ended September 30, 1993 in 1-10764 (Fifty-first); and 4(a) to Form 10-Q for the quarter ended June 30, 1994 (Fifty-second)).\nGSU\n(d) 1 -- Indenture of Mortgage, dated September 1, 1926, as amended by certain Supplemental Indentures (B-a-I-1 in Registration No. 2-2449 (Mortgage); 7-A-9 in Registration No. 2-6893 (Seventh); B to Form 8-K dated September 1, 1959 (Eighteenth); B to Form 8-K dated February 1, 1966 (Twenty-second); B to Form 8-K dated March 1, 1967 (Twenty-third); C to Form 8-K dated March 1, 1968 (Twenty- fourth); B to Form 8-K dated November 1, 1968 (Twenty- fifth); B to Form 8-K dated April 1, 1969 (Twenty-sixth); 2-A-8 in Registration No. 2-66612 (Thirty-eighth); 4-2 to Form 10-K for the year ended December 31, 1984 in 1-2703 (Forty-eighth); 4-2 to Form 10-K for the year ended December 31, 1988 in 1-2703 (Fifty-second); 4 to Form 10- K for the year ended December 31, 1991 in 1-2703 (Fifty- third); 4 to Form 8-K dated July 29, 1992 in 1-2703 (Fifth-fourth); 4 to Form 10-K dated December 31, 1992 in 1-2703 (Fifty-fifth); 4 to Form 10-Q for the quarter ended March 31, 1993 in 1-2703 (Fifty-sixth); and 4-2 to Amendment No. 9 to Registration No. 2-76551 (Fifty- seventh)).\n(d) 2 -- Indenture, dated March 21, 1939, accepting resignation of The Chase National Bank of the City of New York as trustee and appointing Central Hanover Bank and Trust Company as successor trustee (B-a-1-6 in Registration No. 2-4076).\n(d) 3 -- Trust Indenture for 9.72% Debentures due July 1, 1998 (4 in Registration No. 33-40113).\nLP&L\n(e) 1 -- Mortgage and Deed of Trust, dated as of April 1, 1944, as amended by fifty Supplemental Indentures (7(d) in 2-5317 (Mortgage); 7(b) in 2-7408 (First); 7(c) in 2-8636 (Second); 4(b)-3 in 2-10412 (Third); 4(b)-4 in 2-12264 (Fourth); 2(b)-5 in 2-12936 (Fifth); D in 70-3862 (Sixth); 2(b)-7 in 2-22340 (Seventh); 2(c) in 2-24429 (Eighth); 4(c)-9 in 2-25801 (Ninth); 4(c)-10 in 2-26911 (Tenth); 2(c) in 2-28123 (Eleventh); 2(c) in 2-34659 (Twelfth); C to Rule 24 Certificate in 70-4793 (Thirteenth); 2(b)-2 in 2-38378 (Fourteenth); 2(b)-2 in 2-39437 (Fifteenth); 2(b)-2 in 2-42523 (Sixteenth); C to Rule 24 Certificate in 70-5242 (Seventeenth); C to Rule 24 Certificate in 70-5330 (Eighteenth); C-1 to Rule 24 Certificate in 70-5449 (Nineteenth); C-1 to Rule 24 Certificate in 70-5550 (Twentieth); A-6(a) to Rule 24 Certificate in 70-5598 (Twenty-first); C-1 to Rule 24 Certificate in 70-5711 (Twenty-second); C-1 to Rule 24 Certificate in 70-5919 (Twenty-third); C-1 to Rule 24 Certificate in 70-6102 (Twenty-fourth); C-1 to Rule 24 Certificate in 70-6169 (Twenty-fifth); C-1 to Rule 24 Certificate in 70-6278 (Twenty-sixth); C-1 to Rule 24 Certificate in 70-6355 (Twenty-seventh); C-1 to Rule 24 Certificate in 70-6508 (Twenty-eighth); C-1 to Rule 24 Certificate in 70-6556 (Twenty-ninth); C-1 to Rule 24 Certificate in 70-6635 (Thirtieth); C-1 to Rule 24 Certificate in 70-6834 (Thirty-first); C-1 to Rule 24 Certificate in 70-6886 (Thirty-second); C-1 to Rule 24 Certificate in 70-6993 (Thirty-third); C-2 to Rule 24 Certificate in 70-6993 (Thirty-fourth); C-3 to Rule 24 Certificate in 70-6993 (Thirty-fifth); A-2(a) to Rule 24 Certificate in 70-7166 (Thirty-sixth); A-2(a) in 70-7226 (Thirty-seventh); C-1 to Rule 24 Certificate in 70-7270 (Thirty-eighth); 4(a) to Quarterly Report on Form 10-Q for the quarter ended June 30, 1988, in 1-8474 (Thirty-ninth); A-2(b) to Rule 24 Certificate in 70-7553 (Fortieth); A-2(d) to Rule 24 Certificate in 70-7553 (Forty-first); A-3(a) to Rule 24 Certificate in 70-7822 (Forty-second); A-3(b) to Rule 24 Certificate in 70-7822 (Forty-third); A-2(b) to Rule 24 Certificate in File No. 70-7822 (Forty-fourth); A-3(c) to Rule 24 Certificate in 70-7822 (Forty-fifth); A-2(c) to Rule 24 Certificate dated April 7, 1993 in 70-7822 (Forty-sixth); A-3(d) to Rule 24 Certificate dated June 4, 1993 in 70-7822 (Forth- seventh); A-3(e) to Rule 24 Certificate dated December 21, 1993 in 70-7822 (Forty-eighth); A-3(f) to Rule 24 Certificate dated August 1, 1994 in 70-7822 (Forty-ninth) and A-4(c) to Rule 24 Certificate dated September 28, 1994 in 70-7653 (Fiftieth)).\n(e) 2 -- Facility Lease No. 1, dated as of September 1, 1989, between First National Bank of Commerce, as Owner Trustee, and LP&L (4(c)-1 in Registration No. 33-30660).\n(e) 3 -- Facility Lease No. 2, dated as of September 1, 1989, between First National Bank of Commerce, as Owner Trustee, and LP&L (4(c)-2 in Registration No. 33-30660).\n(e) 4 -- Facility Lease No. 3, dated as of September 1, 1989, between First National Bank of Commerce, as Owner Trustee, and LP&L (4(c)-3 in Registration No. 33-30660).\nMP&L\n(f) 1 -- Mortgage and Deed of Trust, dated as of September 1, 1944, as amended by twenty-five Supplemental Indentures (7(d) in 2-5437 (Mortgage); 7(b) in 2-7051 (First); 7(c) in 2-7763 (Second); 7(d) in 2-8484 (Third); 4(b)-4 in 2-10059 (Fourth); 2(b)-5 in 2-13942 (Fifth); A-11 to Form U-1 in 70-4116 (Sixth); 2(b)-7 in 2-23084 (Seventh); 4(c)-9 in 2-24234 (Eighth); 2(b)-9(a) in 2-25502 (Ninth); A-11(a) to Form U-1 in 70-4803 (Tenth); A-12(a) to Form U-1 in 70-4892 (Eleventh); A-13(a) to Form U-1 in 70-5165 (Twelfth); A-14(a) to Form U-1 in 70-5286 (Thirteenth); A-15(a) to Form U-1 in 70-5371 (Fourteenth); A-16(a) to Form U-1 in 70-5417 (Fifteenth); A-17 to Form U-1 in 70-5484 (Sixteenth); 2(a)-19 in 2-54234 (Seventeenth); C-1 to Rule 24 Certificate in 70-6619 (Eighteenth); A-2(c) to Rule 24 Certificate in 70-6672 (Nineteenth); A-2(d) to Rule 24 Certificate in 70-6672 (Twentieth); C-1(a) to Rule 24 Certificate in 70-6816 (Twenty-first); C-1(a) to Rule 24 Certificate in 70-7020 (Twenty-second); C-1(b) to Rule 24 Certificate in 70-7020 (Twenty-third); C-1(a) to Rule 24 Certificate in 70-7230 (Twenty-fourth); and A-2(a) to Rule 24 Certificate in 70-7419 (Twenty-fifth)).\n(f) 2 -- Mortgage and Deed of Trust, dated as of February 1, 1988, as amended by tenth Supplemental Indentures (A-2(a)-2 to Rule 24 Certificate in 70-7461 (Mortgage); A-2(b)-2 in 70-7461 (First); A-5(b) to Rule 24 Certificate in 70-7419 (Second); A-4(b) to Rule 24 Certificate in 70-7554 (Third); A-1(b)-1 to Rule 24 Certificate in 70-7737 (Fourth); A-2(b) to Rule 24 Certificate dated November 24, 1992 in 70-7914 (Fifth); A-2(e) to Rule 24 Certificate dated January 22, 1993 in 70-7914 (Sixth); A-2(g) to Form U-1 in 70-7914 (Seventh); A-2(i) to Rule 24 Certificate dated November 10, 1993 in 70-7914 (Eighth); A-2(j) to Rule 24 Certificate dated July 22, 1994 in 70-7914 (Ninth); and (A-2(l) to Rule 24 Certificate dated April 21, 1995 in File 70-7914 (Tenth)).\nNOPSI\n(g) 1 -- Mortgage and Deed of Trust, dated as of July 1, 1944, as amended by eleven Supplemental Indentures (B-3 in 2-5411 (Mortgage); 7(b) in 2-7674 (First); 4(a)-2 in 2-10126 (Second); 4(b) in 2-12136 (Third); 2(b)-4 in 2-17959 (Fourth); 2(b)-5 in 2-19807 (Fifth); D to Rule 24 Certificate in 70-4023 (Sixth); 2(c) in 2-24523 (Seventh); 4(c)-9 in 2-26031 (Eighth); 2(a)-3 in 2-50438 (Ninth); 2(a)-3 in 2-62575 (Tenth); and A-2(b) to Rule 24 Certificate in 70-7262 (Eleventh)).\n(g) 2 -- Mortgage and Deed of Trust, dated as of May 1, 1987, as amended by four Supplemental Indentures (A-2(c) to Rule 24 Certificate in 70-7350 (Mortgage); A-5(b) to Rule 24 Certificate in 70-7350 (First); A-4(b) to Rule 24 Certificate in 70-7448 (Second); 4(f)4 to Form 10-K for the year ended December 31, 1992 in 0-5807 (Third); 4(a) to Form 10-Q for the quarter ended September 30, 1993 in 0-5807 (Fourth); and 4(a) to Form 8-K dated April 26, 1995 in File No. 0-5807 (Fifth)).\n(10) Material Contracts\nEntergy Corporation\n(a) 1 -- Agreement, dated April 23, 1982, among certain System companies, relating to System Planning and Development and Intra-System Transactions (10(a)1 to Form 10-K for the year ended December 31, 1982, in 1-3517).\n(a) 2 -- Middle South Utilities System Agency Agreement, dated December 11, 1970 (5(a)-2 in 2-41080).\n(a) 3 -- Amendment, dated February 10, 1971, to Middle South Utilities System Agency Agreement, dated December 11, 1970 (5(a)-4 in 2-41080).\n(a) 4 -- Amendment, dated May 12, 1988, to Middle South Utilities System Agency Agreement, dated December 11, 1970 (5(a)-4 in 2-41080).\n(a) 5 -- Middle South Utilities System Agency Coordination Agreement, dated December 11, 1970 (5(a)-3 in 2-41080).\n(a) 6 -- Service Agreement with Entergy Services, dated as of April 1, 1963 (5(a)-5 in 2-41080).\n(a) 7 -- Amendment, dated January 1, 1972, to Service Agreement with Entergy Services (5(a)-6 in 2-43175).\n(a) 8 -- Amendment, dated April 27, 1984, to Service Agreement with Entergy Services (10(a)-7 to Form 10-K for the year ended December 31, 1984, in 1-3517).\n(a) 9 -- Amendment, dated August 1, 1988, to Service Agreement with Entergy Services (10(a)-8 to Form 10-K for the year ended December 31, 1988, in 1-3517).\n(a) 10-- Amendment, dated January 1, 1991, to Service Agreement with Entergy Services (10(a)-9 to Form 10-K for the year ended December 31, 1990, in 1-3517).\n(a) 11-- Amendment, dated January 1, 1992, to Service Agreement with Entergy Services (10(a)-11 for the year ended December 31, 1994 in 1-3517).\n(a) 12-- Availability Agreement, dated June 21, 1974, among System Energy and certain other System companies (B to Rule 24 Certificate, dated June 24, 1974, in 70-5399).\n(a) 13-- First Amendment to Availability Agreement, dated as of June 30, 1977 (B to Rule 24 Certificate, dated June 24, 1977, in 70-5399).\n(a) 14-- Second Amendment to Availability Agreement, dated as of June 15, 1981 (E to Rule 24 Certificate, dated July 1, 1981, in 70-6592).\n(a) 15-- Third Amendment to Availability Agreement, dated as of June 28, 1984 (B-13(a) to Rule 24 Certificate, dated July 6, 1984, in 70-6985).\n(a) 16-- Fourth Amendment to Availability Agreement, dated as of June 1, 1989 (A to Rule 24 Certificate, dated June 8, 1989, in 70-5399).\n(a) 17-- Fifteenth Assignment of Availability Agreement, Consent and Agreement, dated as of May 1, 1986, with Deposit Guaranty National Bank, United States Trust Company of New York and Malcolm J. Hood, as Trustees (B-3(b) to Rule 24 Certificate, dated June 5, 1986, in 70-7158).\n(a) 18-- Eighteenth Assignment of Availability Agreement, Consent and Agreement, dated as of September 1, 1986, with United States Trust Company of New York and Gerard F. Ganey, as Trustees (C-2 to Rule 24 Certificate, dated October 1, 1986, in 70-7272).\n(a) 19-- Nineteenth Assignment of Availability Agreement, Consent and Agreement, dated as of September 1, 1986, with United States Trust Company of New York and Gerard F. Ganey, as Trustees (C-3 to Rule 24 Certificate, dated October 1, 1986, in 70-7272).\n(a) 20-- Twenty-sixth Assignment of Availability Agreement, Consent and Agreement, dated as of October 1, 1992, with United States Trust Company of New York and Gerard F. Ganey, as Trustees (B-2(c) to Rule 24 Certificate, dated November 2, 1992, in 70-7946).\n(a) 21-- Twenty-seventh Assignment of Availability Agreement, Consent and Agreement, dated as of April 1, 1993, with United States Trust Company of New York and Gerard F. Ganey as Trustees (B-2(d) to Rule 24 Certificate dated May 4, 1993 in 70-7946).\n(a) 22-- Twenty-eighth Assignment of Availability Agreement, Consent and Agreement, dated as of December 17, 1993, with Chemical Bank, as Agent (B-2(a) to Rule 24 Certificate dated December 22, 1993 in 70-7561).\n(a) 23-- Twenty-ninth Assignment of Availability Agreement, Consent and Agreement, dated as of April 1, 1994, with United States Trust Company of New York and Gerard F. Ganey as Trustees (B-2(f) to Rule 24 Certificate dated May 6, 1994, in 70-7946).\n(a) 24-- Capital Funds Agreement, dated June 21, 1974, between Entergy Corporation and System Energy (C to Rule 24 Certificate, dated June 24, 1974, in 70-5399).\n(a) 25-- First Amendment to Capital Funds Agreement, dated as of June 1, 1989 (B to Rule 24 Certificate, dated June 8, 1989, in 70-5399).\n(a) 26-- Fifteenth Supplementary Capital Funds Agreement and Assignment, dated as of May 1, 1986, with Deposit Guaranty National Bank, United States Trust Company of New York and Malcolm J. Hood, as Trustees (B-4(b) to Rule 24 Certificate, dated June 5, 1986, in 70-7158).\n(a) 27-- Eighteenth Supplementary Capital Funds Agreement and Assignment, dated as of September 1, 1986, with United States Trust Company of New York and Gerard F. Ganey, as Trustees (D-2 to Rule 24 Certificate, dated October 1, 1986, in 70-7272).\n(a) 28-- Nineteenth Supplementary Capital Funds Agreement and Assignment, dated as of September 1, 1986, with United States Trust Company of New York and Gerard F. Ganey, as Trustees (D-3 to Rule 24 Certificate, dated October 1, 1986, in 70-7272).\n(a) 29-- Twenty-sixth Supplementary Capital Funds Agreement and Assignment, dated as of October 1, 1992, with United States Trust Company of New York and Gerard F. Ganey, as Trustees (B-3(c) to Rule 24 Certificate dated November 2, 1992 in 70-7946).\n(a) 30-- Twenty-seventh Supplementary Capital Funds Agreement and Assignment, dated as of April 1, 1993, with United States Trust Company of New York and Gerard F. Ganey, as Trustees (B-3(d) to Rule 24 Certificate dated May 4, 1993 in 70-7946).\n(a) 31-- Twenty-eighth Supplementary Capital Funds Agreement and Assignment, dated as of December 17, 1993, with Chemical Bank, as Agent (B-3(a) to Rule 24 Certificate dated December 22, 1993 in 70-7561).\n(a) 32-- Twenty-ninth Supplementary Capital Funds Agreement and Assignment, dated as of April 1, 1994, with United States Trust Company of New York and Gerard F. Ganey, as Trustees (B-3(f) to Rule 24 Certificate dated May 6, 1994, in 70-7946).\n(a) 33-- First Amendment to Supplementary Capital Funds Agreements and Assignments, dated as of June 1, 1989, by and between Entergy Corporation, System Energy, Deposit Guaranty National Bank, United States Trust Company of New York and Gerard F. Ganey (C to Rule 24 Certificate, dated June 8, 1989, in 70-7026).\n(a) 34-- First Amendment to Supplementary Capital Funds Agreements and Assignments, dated as of June 1, 1989, by and between Entergy Corporation, System Energy, United States Trust Company of New York and Gerard F. Ganey (C to Rule 24 Certificate, dated June 8, 1989, in 70-7123).\n(a) 35-- First Amendment to Supplementary Capital Funds Agreement and Assignment, dated as of June 1, 1989, by and between Entergy Corporation, System Energy and Chemical Bank (C to Rule 24 Certificate, dated June 8, 1989, in 70-7561).\n+(a) 36-- Agreement between Entergy Corporation and Edwin Lupberger (10(a)-42 to Form 10-K for the year ended December 31, 1985, in 1-3517).\n(a) 37-- Reallocation Agreement, dated as of July 28, 1981, among System Energy and certain other System companies (B-1(a) in 70-6624).\n(a) 38-- Joint Construction, Acquisition and Ownership Agreement, dated as of May 1, 1980, between System Energy and SMEPA (B-1(a) in 70-6337), as amended by Amendment No. 1, dated as of May 1, 1980 (B-1(c) in 70-6337) and Amendment No. 2, dated as of October 31, 1980 (1 to Rule 24 Certificate, dated October 30, 1981, in 70-6337).\n(a) 39-- Operating Agreement dated as of May 1, 1980, between System Energy and SMEPA (B(2)(a) in 70-6337).\n(a) 40-- Assignment, Assumption and Further Agreement No. 1, dated as of December 1, 1988, among System Energy, Meridian Trust Company and Stephen M. Carta, and SMEPA (B-7(c)(1) to Rule 24 Certificate, dated January 9, 1989, in 70-7561).\n(a) 41-- Assignment, Assumption and Further Agreement No. 2, dated as of December 1, 1988, among System Energy, Meridian Trust Company and Stephen M. Carta, and SMEPA (B-7(c)(2) to Rule 24 Certificate, dated January 9, 1989, in 70-7561).\n(a) 42-- Substitute Power Agreement, dated as of May 1, 1980, among MP&L, System Energy and SMEPA (B(3)(a) in 70-6337).\n(a) 43-- Grand Gulf Unit No. 2 Supplementary Agreement, dated as of February 7, 1986, between System Energy and SMEPA (10(aaa) in 33-4033).\n(a) 44-- Compromise and Settlement Agreement, dated June 4, 1982, between Texaco, Inc. and LP&L (28(a) to Form 8-K, dated June 4, 1982, in 1-3517).\n+(a) 45-- Post-Retirement Plan (10(a)37 to Form 10-K for the year ended December 31, 1983, in 1-3517).\n(a) 46-- Unit Power Sales Agreement, dated as of June 10, 1982, between System Energy and AP&L, LP&L, MP&L and NOPSI (10(a)-39 to Form 10-K for the year ended December 31, 1982, in 1-3517).\n(a) 47-- First Amendment to Unit Power Sales Agreement, dated as of June 28, 1984, between System Energy and AP&L, LP&L, MP&L and NOPSI (19 to Form 10-Q for the quarter ended September 30, 1984, in 1-3517).\n(a) 48-- Revised Unit Power Sales Agreement (10(ss) in 33-4033).\n(a) 49-- Middle South Utilities Inc. and Subsidiary Companies Intercompany Income Tax Allocation Agreement, dated April 28, 1988 (Exhibit D-1 to Form U5S for the year ended December 31, 1987).\n(a) 50-- First Amendment, dated January 1, 1990, to the Middle South Utilities Inc. and Subsidiary Companies Intercompany Income Tax Allocation Agreement (D-2 to Form U5S for the year ended December 31, 1989).\n(a) 51-- Second Amendment dated January 1, 1992, to the Entergy Corporation and Subsidiary Companies Intercompany Income Tax Allocation Agreement (D-3 to Form U5S for the year ended December 31, 1992).\n(a) 52-- Third Amendment dated January 1, 1994 to Entergy Corporation and Subsidiary Companies Intercompany Income Tax Allocation Agreement (D-3(a) to Form U5S for the year ended December 31, 1993).\n(a) 53-- Guaranty Agreement between Entergy Corporation and AP&L, dated as of September 20, 1990 (B-1(a) to Rule 24 Certificate, dated September 27, 1990, in 70-7757).\n(a) 54-- Guarantee Agreement between Entergy Corporation and LP&L, dated as of September 20, 1990 (B-2(a) to Rule 24 Certificate, dated September 27, 1990, in 70-7757).\n(a) 55-- Guarantee Agreement between Entergy Corporation and System Energy, dated as of September 20, 1990 (B-3(a) to Rule 24 Certificate, dated September 27, 1990, in 70- 7757).\n(a) 56-- Loan Agreement between Entergy Operations and Entergy Corporation, dated as of September 20, 1990 (B-12(b) to Rule 24 Certificate, dated June 15, 1990, in 70-7679).\n(a) 57-- Loan Agreement between Entergy Power and Entergy Corporation, dated as of August 28, 1990 (A-4(b) to Rule 24 Certificate, dated September 6, 1990, in 70-7684).\n(a) 58-- Loan Agreement between Entergy Corporation and Entergy Systems and Service, Inc., dated as of December 29, 1992 (A-4(b) to Rule 24 Certificate in 70-7947).\n+(a) 59-- Executive Financial Counseling Program of Entergy Corporation and Subsidiaries (10(a) 52 to Form 10-K for the year ended December 31, 1989, in 1-3517).\n+(a) 60-- Entergy Corporation Annual Incentive Plan (10(a) 54 to Form 10-K for the year ended December 31, 1989, in 1-3517).\n+(a) 61-- Equity Ownership Plan of Entergy Corporation and Subsidiaries (A-4(a) to Rule 24 Certificate, dated May 24, 1991, in 70-7831).\n+(a) 62-- Retired Outside Director Benefit Plan (10(a)63 to Form 10-K for the year ended December 31, 1991, in 1-3517).\n+(a) 63-- Agreement between Entergy Corporation and Jerry D. Jackson. (10(a) 67 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(a) 64-- Agreement between Entergy Services, Inc., a subsidiary of Entergy Corporation, and Gerald D. McInvale (10(a) 68 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(a) 65-- Supplemental Retirement Plan (10(a) 69 to Form 10- K for the year ended December 31, 1992 in 1-3517).\n+(a) 66-- Defined Contribution Restoration Plan of Entergy Corporation and Subsidiaries (10(a)53 to Form 10-K for the year ended December 31, 1989 in 1-3517).\n+(a) 67-- Amendment No. 1 to the Equity Ownership Plan of Entergy Corporation and Subsidiaries (10(a) 71 to Form 10- K for the year ended December 31, 1992 in 1-3517).\n+(a) 68-- Executive Disability Plan of Entergy Corporation and Subsidiaries (10(a) 72 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(a) 69-- Executive Medical Plan of Entergy Corporation and Subsidiaries (10(a) 73 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(a) 70-- Stock Plan for Outside Directors of Entergy Corporation and Subsidiaries, as amended (10(a) 74 to Form 10-K for the year ended December 31, 1992 in 1- 3517).\n+(a) 71-- Summary Description of Private Ownership Vehicle Plan of Entergy Corporation and Subsidiaries (10(a) 75 to Form 10-K for the year ended December 31, 1992 in 1- 3517).\n(a) 72-- Agreement and Plan of Reorganization Between Entergy Corporation and Gulf States Utilities Company, dated June 5, 1992 (1 to Current Report on Form 8-K dated June 5, 1992 in 1-3517).\n+(a) 73-- Amendment to Defined Contribution Restoration Plan of Entergy Corporation and Subsidiaries (10(a) 81 to Form 10-K for the year ended December 31, 1993 in 1-11299).\n+(a) 74-- System Executive Retirement Plan (10(a) 82 to Form 10-K for the year ended December 31, 1993 in 1-11299).\nSystem Energy\n(b) 1 through (b) 12-- See 10(a)-12 through 10(a)-23 above.\n(b) 13 through (b) 24-- See 10(a)-24 through 10(a)-35 above.\n(b) 25-- Reallocation Agreement, dated as of July 28, 1981, among System Energy and certain other System companies (B-1(a) in 70-6624).\n(b) 26-- Joint Construction, Acquisition and Ownership Agreement, dated as of May 1, 1980, between System Energy and SMEPA (B-1(a) in 70-6337), as amended by Amendment No. 1, dated as of May 1, 1980 (B-1(c) in 70-6337) and Amendment No. 2, dated as of October 31, 1980 (1 to Rule 24 Certificate, dated October 30, 1981, in 70-6337).\n(b) 27-- Operating Agreement, dated as of May 1, 1980, between System Energy and SMEPA (B(2)(a) in 70-6337).\n(b) 28-- Installment Sale Agreement, dated as of December 1, 1983 between System Energy and Claiborne County, Mississippi (B-1 to First Rule 24 Certificate in 70-6913).\n(b) 29-- Installment Sale Agreement, dated as of June 1, 1984, between System Energy and Claiborne County, Mississippi (B-2 to Second Rule 24 Certificate in 70-6913).\n(b) 30-- Installment Sale Agreement, dated as of December 1, 1984, between System Energy and Claiborne County, Mississippi (B-1 to First Rule 24 Certificate in 70-7026).\n(b) 31-- Installment Sale Agreement, dated as of May 1, 1986, between System Energy and Claiborne County, Mississippi (B-1(b) to Rule 24 Certificate in 70-7158).\n(b) 32-- Amended and Restated Installment Sale Agreement, dated as of May 1, 1995, between System Energy and Claiborne County, Mississippi (B-6(a) to Rule 24 Certificate in 70-8511).\n(b) 33-- Facility Lease No. 1, dated as of December 1, 1988, between Meridian Trust Company and Stephen M. Carta (Stephen J. Kaba, successor), as Owner Trustees, and System Energy (B-2(c)(1) to Rule 24 Certificate dated January 9, 1989 in 70-7561), as supplemented by Lease Supplement No. 1 dated as of April 1, 1989 (B-22(b) (1) to Rule 24 Certificate dated April 21, 1989 in 70-7561) and Lease Supplement No. 2 dated as of January 1, 1994 (B- 3(d) to Rule 24 Certificate dated January 31, 1994 in 70- 8215).\n(b) 34-- Facility Lease No. 2, dated as of December 1, 1988 between Meridian Trust Company and Stephen M. Carta (Stephen J. Kaba, successor), as Owner Trustees, and System Energy (B-2(c)(2) to Rule 24 Certificate dated January 9, 1989 in 70-7561), as supplemented by Lease Supplement No. 1 dated as of April 1, 1989 (B-22(b) (2) to Rule 24 Certificate dated April 21, 1989 in 70-7561) and Lease Supplement No. 2 dated as of January 1, 1994 (B- 4(d) Rule 24 Certificate dated January 31, 1994 in 70- 8215).\n(b) 35-- Assignment, Assumption and Further Agreement No. 1, dated as of December 1, 1988, among System Energy, Meridian Trust Company and Stephen M. Carta, and SMEPA (B-7(c)(1) to Rule 24 Certificate, dated January 9, 1989, in 70-7561).\n(b) 36-- Assignment, Assumption and Further Agreement No. 2, dated as of December 1, 1988, among System Energy, Meridian Trust Company and Stephen M. Carta, and SMEPA (B-7(c)(2) to Rule 24 Certificate, dated January 9, 1989, in 70-7561).\n(b) 37-- Collateral Trust Indenture, dated as of January 1, 1994, among System Energy, GG1B Funding Corporation and Bankers Trust Company, as Trustee (A-3(e) to Rule 24 Certificate dated January 31, 1994, in 70-8215), as supplemented by Supplemental Indenture No. 1 dated January 1, 1994, (A-3(f) to Rule 24 Certificate dated January 31, 1994, in 70-8215).\n(b) 38-- Substitute Power Agreement, dated as of May 1, 1980, among MP&L, System Energy and SMEPA (B(3)(a) in 70-6337).\n(b) 39-- Grand Gulf Unit No. 2 Supplementary Agreement, dated as of February 7, 1986, between System Energy and SMEPA (10(aaa) in 33-4033).\n(b) 40-- Unit Power Sales Agreement, dated as of June 10, 1982, between System Energy and AP&L, LP&L, MP&L and NOPSI (10(a)-39 to Form 10-K for the year ended December 31, 1982, in 1-3517).\n(b) 41-- First Amendment to the Unit Power Sales Agreement, dated as of June 28, 1984, between System Energy and AP&L, LP&L, MP&L and NOPSI (19 to Form 10-Q for the quarter ended September 30, 1984, in 1-3517).\n(b) 42-- Revised Unit Power Sales Agreement (10(ss) in 33-4033).\n(b) 43-- Fuel Lease, dated as of February 24, 1989, between River Fuel Funding Company #3, Inc. and System Energy (B-1(b) to Rule 24 Certificate, dated March 3, 1989, in 70-7604).\n(b) 44-- System Energy's Consent, dated January 31, 1995, pursuant to Fuel Lease, dated as of February 24, 1989, between River Fuel Funding Company #3, Inc. and System Energy (B-1(c) to Rule 24 Certificate, dated February 13, 1995 in 70-7604).\n(b) 45-- Sales Agreement, dated as of June 21, 1974, between System Energy and MP&L (D to Rule 24 Certificate, dated June 26, 1974, in 70-5399).\n(b) 46-- Service Agreement, dated as of June 21, 1974, between System Energy and MP&L (E to Rule 24 Certificate, dated June 26, 1974, in 70-5399).\n(b) 47-- Partial Termination Agreement, dated as of December 1, 1986, between System Energy and MP&L (A-2 to Rule 24 Certificate, dated January 8, 1987, in 70-5399).\n(b) 48-- Middle South Utilities, Inc. and Subsidiary Companies Intercompany Income Tax Allocation Agreement, dated April 28, 1988 (D-1 to Form U5S for the year ended December 31, 1987).\n(b) 49-- First Amendment, dated January 1, 1990 to the Middle South Utilities Inc. and Subsidiary Companies Intercompany Income Tax Allocation Agreement (D-2 to Form U5S for the year ended December 31, 1989).\n(b) 50-- Second Amendment dated January 1, 1992, to the Entergy Corporation and Subsidiary Companies Intercompany Income Tax Allocation Agreement (D-3 to Form U5S for the year ended December 31, 1992).\n(b) 51-- Third Amendment dated January 1, 1994 to Entergy Corporation and Subsidiary Companies Intercompany Income Tax Allocation Agreement (D-3(a) to Form U5S for the year ended December 31, 1993).\n(b) 52-- Service Agreement with Entergy Services, dated as of July 16, 1974, as amended (10(b)-43 to Form 10-K for the year ended December 31, 1988, in 1-9067).\n(b) 53-- Amendment, dated January 1, 1991, to Service Agreement with Entergy Services (10(b)-45 to Form 10-K for the year ended December 31, 1990, in 1-9067).\n(b) 54-- Amendment, dated January 1, 1992, to Service Agreement with Entergy Services (10(a) -11 to Form 10-K for the year ended December 31, 1994 in 1-3517).\n(b) 55-- Operating Agreement between Entergy Operations and System Energy, dated as of June 6, 1990 (B-3(b) to Rule 24 Certificate, dated June 15, 1990, in 70-7679).\n(b) 56-- Guarantee Agreement between Entergy Corporation and System Energy, dated as of September 20, 1990 (B-3(a) to Rule 24 Certificate, dated September 27, 1990, in 70-7757).\n+(b) 57-- Agreement between System Energy and Donald C. Hintz (10(b)47 to Form 10-K for the year ended December 31, 1991, in 1-9067).\n+(b) 58-- Agreement between Entergy Corporation and Edwin Lupberger (10(a)-42 to Form 10-K for the year ended December 31, 1985 in 1-3517).\n+(b) 59-- Agreement between Entergy Services and Gerald D. McInvale (10(a)-69 to Form 10-K for the year ended December 31, 1992 in 1-3517).\nAP&L\n(c) 1 -- Agreement, dated April 23, 1982, among AP&L and certain other System companies, relating to System Planning and Development and Intra-System Transactions (10(a) 1 to Form 10-K for the year ended December 31, 1982, in 1-3517).\n(c) 2 -- Middle South Utilities System Agency Agreement, dated December 11, 1970 (5(a)2 in 2-41080).\n(c) 3 -- Amendment, dated February 10, 1971, to Middle South Utilities System Agency Agreement, dated December 11, 1970 (5(a)-4 in 2-41080).\n(c) 4 -- Amendment, dated May 12, 1988, to Middle South Utilities System Agency Agreement, dated December 11, 1970 (5(a) 4 in 2-41080).\n(c) 5 -- Middle South Utilities System Agency Coordination Agreement, dated December 11, 1970 (5(a)-3 in 2-41080).\n(c) 6 -- Service Agreement with Entergy Services, dated as of April 1, 1963 (5(a)-5 in 2-41080).\n(c) 7 -- Amendment, dated January 1, 1972, to Service Agreement with Entergy Services (5(a)- 6 in 2-43175).\n(c) 8 -- Amendment, dated April 27, 1984, to Service Agreement, with Entergy Services (10(a)- 7 to Form 10-K for the year ended December 31, 1984, in 1-3517).\n(c) 9 -- Amendment, dated August 1, 1988, to Service Agreement with Entergy Services (10(c)- 8 to Form 10-K for the year ended December 31, 1988, in 1-10764).\n(c) 10-- Amendment, dated January 1, 1991, to Service Agreement with Entergy Services (10(c)-9 to Form 10-K for the year ended December 31, 1990, in 1-10764).\n(c) 11-- Amendment, dated January 1, 1992, to Service Agreement with Entergy Services (10(a)-11 to Form 10-K for the year ended December 31, 1994 in 1-3517).\n(c) 12 through (c) 23-- See 10(a)-12 through 10(a)-23 above.\n(c) 24-- Agreement, dated August 20, 1954, between AP&L and the United States of America (SPA)(13(h) in 2-11467).\n(c) 25-- Amendment, dated April 19, 1955, to the United States of America (SPA) Contract, dated August 20, 1954 (5(d)-2 in 2-41080).\n(c) 26-- Amendment, dated January 3, 1964, to the United States of America (SPA) Contract, dated August 20, 1954 (5(d)-3 in 2-41080).\n(c) 27-- Amendment, dated September 5, 1968, to the United States of America (SPA) Contract, dated August 20, 1954 (5(d)-4 in 2-41080).\n(c) 28-- Amendment, dated November 19, 1970, to the United States of America (SPA) Contract, dated August 20, 1954 (5(d)-5 in 2-41080).\n(c) 29-- Amendment, dated July 18, 1961, to the United States of America (SPA) Contract, dated August 20, 1954 (5(d)-6 in 2-41080).\n(c) 30-- Amendment, dated December 27, 1961, to the United States of America (SPA) Contract, dated August 20, 1954 (5(d)-7 in 2-41080).\n(c) 31-- Amendment, dated January 25, 1968, to the United States of America (SPA) Contract, dated August 20, 1954 (5(d)-8 in 2-41080).\n(c) 32-- Amendment, dated October 14, 1971, to the United States of America (SPA) Contract, dated August 20, 1954 (5(d)-9 in 2-43175).\n(c) 33-- Amendment, dated January 10, 1977, to the United States of America (SPA) Contract, dated August 20, 1954 (5(d)-10 in 2-60233).\n(c) 34-- Agreement, dated May 14, 1971, between AP&L and the United States of America (SPA) (5(e) in 2-41080).\n(c) 35-- Amendment, dated January 10, 1977, to the United States of America (SPA) Contract, dated May 14, 1971 (5(e)-1 in 2-60233).\n(c) 36-- Contract, dated May 28, 1943, Amendment to Contract, dated July 21, 1949, and Supplement to Amendment to Contract, dated December 30, 1949, between AP&L and McKamie Gas Cleaning Company; Agreements, dated as of September 30, 1965, between AP&L and former stockholders of McKamie Gas Cleaning Company; and Letter Agreement, dated June 22, 1966, by Humble Oil & Refining Company accepted by AP&L on June 24, 1966 (5(k)-7 in 2-41080).\n(c) 37-- Agreement, dated April 3, 1972, between Entergy Services and Gulf United Nuclear Fuels Corporation (5(l)-3 in 2-46152).\n(c) 38-- Fuel Lease, dated as of December 22, 1988, between River Fuel Trust #1 and AP&L (B-1(b) to Rule 24 Certificate in 70-7571).\n(c) 39-- White Bluff Operating Agreement, dated June 27, 1977, among AP&L and Arkansas Electric Cooperative Corporation and City Water and Light Plant of the City of Jonesboro, Arkansas (B-2(a) to Rule 24 Certificate, dated June 30, 1977, in 70-6009).\n(c) 40-- White Bluff Ownership Agreement, dated June 27, 1977, among AP&L and Arkansas Electric Cooperative Corporation and City Water and Light Plant of the City of Jonesboro, Arkansas (B-1(a) to Rule 24 Certificate, dated June 30, 1977, in 70-6009).\n(c) 41-- Agreement, dated June 29, 1979, between AP&L and City of Conway, Arkansas (5(r)-3 in 2-66235).\n(c) 42-- Transmission Agreement, dated August 2, 1977, between AP&L and City Water and Light Plant of the City of Jonesboro, Arkansas (5(r)-3 in 2-60233).\n(c) 43-- Power Coordination, Interchange and Transmission Service Agreement, dated as of June 27, 1977, between Arkansas Electric Cooperative Corporation and AP&L (5(r)-4 in 2-60233).\n(c) 44-- Independence Steam Electric Station Operating Agreement, dated July 31, 1979, among AP&L and Arkansas Electric Cooperative Corporation and City Water and Light Plant of the City of Jonesboro, Arkansas and City of Conway, Arkansas (5(r)-6 in 2-66235).\n(c) 45-- Amendment, dated December 4, 1984, to the Independence Steam Electric Station Operating Agreement (10(c) 51 to Form 10-K for the year ended December 31, 1984, in 1-10764).\n(c) 46-- Independence Steam Electric Station Ownership Agreement, dated July 31, 1979, among AP&L and Arkansas Electric Cooperative Corporation and City Water and Light Plant of the City of Jonesboro, Arkansas and City of Conway, Arkansas (5(r)-7 in 2-66235).\n(c) 47-- Amendment, dated December 28, 1979, to the Independence Steam Electric Station Ownership Agreement (5(r)-7(a) in 2-66235).\n(c) 48-- Amendment, dated December 4, 1984, to the Independence Steam Electric Station Ownership Agreement (10(c) 54 to Form 10-K for the year ended December 31, 1984, in 1-10764).\n(c) 49-- Owner's Agreement, dated November 28, 1984, among AP&L, MP&L, other co-owners of the Independence Station (10(c) 55 to Form 10-K for the year ended December 31, 1984, in 1-10764).\n(c) 50-- Consent, Agreement and Assumption, dated December 4, 1984, among AP&L, MP&L, other co-owners of the Independence Station and United States Trust Company of New York, as Trustee (10(c) 56 to Form 10-K for the year ended December 31, 1984, in 1-10764).\n(c) 51-- Power Coordination, Interchange and Transmission Service Agreement, dated as of July 31, 1979, between AP&L and City Water and Light Plant of the City of Jonesboro, Arkansas (5(r)-8 in 2-66235).\n(c) 52-- Power Coordination, Interchange and Transmission Agreement, dated as of June 29, 1979, between City of Conway, Arkansas and AP&L (5(r)-9 in 2-66235).\n(c) 53-- Agreement, dated June 21, 1979, between AP&L and Reeves E. Ritchie ((10)(b)-90 to Form 10-K for the year ended December 31, 1980, in 1-10764).\n(c) 54-- Reallocation Agreement, dated as of July 28, 1981, among System Energy and certain other System companies (B-1(a) in 70-6624).\n+(c) 55-- Post-Retirement Plan (10(b) 55 to Form 10-K for the year ended December 31, 1983, in 1-10764).\n(c) 56-- Unit Power Sales Agreement, dated as of June 10, 1982, between System Energy and AP&L, LP&L, MP&L, and NOPSI (10(a) 39 to Form 10-K for the year ended December 31, 1982, in 1-3517).\n(c) 57-- First Amendment to Unit Power Sales Agreement, dated as of June 28, 1984, between System Energy, AP&L, LP&L, MP&L, and NOPSI (19 to Form 10-Q for the quarter ended September 30, 1984, in 1-3517).\n(c) 58-- Revised Unit Power Sales Agreement (10(ss) in 33-4033).\n(c) 59-- Contract For Disposal of Spent Nuclear Fuel and\/or High-Level Radioactive Waste, dated June 30, 1983, among the DOE, System Fuels and AP&L (10(b)-57 to Form 10-K for the year ended December 31, 1983, in 1-10764).\n(c) 60-- Middle South Utilities, Inc. and Subsidiary Companies Intercompany Income Tax Allocation Agreement, dated April 28, 1988 (D-1 to Form U5S for the year ended December 31, 1987).\n(c) 61-- First Amendment, dated January 1, 1990, to the Middle South Utilities, Inc. and Subsidiary Companies Intercompany Income Tax Allocation Agreement (D-2 to Form U5S for the year ended December 31, 1989).\n(c) 62-- Second Amendment dated January 1, 1992, to the Entergy Corporation and Subsidiary Companies Intercompany Income Tax Allocation Agreement (D-3 to Form U5S for the year ended December 31, 1992).\n(c) 63-- Third Amendment dated January 1, 1994, to Entergy Corporation and Subsidiary Companies Intercompany Income Tax Allocation Agreement (D-3(a) to Form U5S for the year ended December 31, 1993).\n(c) 64-- Assignment of Coal Supply Agreement, dated December 1, 1987, between System Fuels and AP&L (B to Rule 24 letter filing, dated November 10, 1987, in 70-5964).\n(c) 65-- Coal Supply Agreement, dated December 22, 1976, between System Fuels and Antelope Coal Company (B-1 in 70-5964), as amended by First Amendment (A to Rule 24 Certificate in 70-5964); Second Amendment (A to Rule 24 letter filing, dated December 16, 1983, in 70-5964); and Third Amendment (A to Rule 24 letter filing, dated November 10, 1987 in 70-5964).\n(c) 66-- Operating Agreement between Entergy Operations and AP&L, dated as of June 6, 1990 (B-1(b) to Rule 24 Certificate, dated June 15, 1990, in 70-7679).\n(c) 67-- Guaranty Agreement between Entergy Corporation and AP&L, dated as of September 20, 1990 (B-1(a) to Rule 24 Certificate, dated September 27, 1990, in 70-7757).\n(c) 68-- Agreement for Purchase and Sale of Independence Unit 2 between AP&L and Entergy Power, dated as of August 28, 1990 (B-3(c) to Rule 24 Certificate, dated September 6, 1990, in 70-7684).\n(c) 69-- Agreement for Purchase and Sale of Ritchie Unit 2 between AP&L and Entergy Power, dated as of August 28, 1990 (B-4(d) to Rule 24 Certificate, dated September 6, 1990, in 70-7684).\n(c) 70-- Ritchie Steam Electric Station Unit No. 2 Operating Agreement between AP&L and Entergy Power, dated as of August 28, 1990 (B-5(a) to Rule 24 Certificate, dated September 6, 1990, in 70-7684).\n(c) 71-- Ritchie Steam Electric Station Unit No. 2 Ownership Agreement between AP&L and Entergy Power, dated as of August 28, 1990 (B-6(a) to Rule 24 Certificate, dated September 6, 1990, in 70-7684).\n(c) 72-- Power Coordination, Interchange and Transmission Service Agreement between Entergy Power and AP&L, dated as of August 28, 1990 (10(c)-71 to Form 10-K for the year ended December 31, 1990, in 1-10764).\n+(c) 73-- Executive Financial Counseling Program of Entergy Corporation and Subsidiaries (10(a)52 to Form 10-K for the year ended December 31, 1989, in 1-3517).\n+(c) 74-- Entergy Corporation Annual Incentive Plan (10(a)54 to Form 10-K for the year ended December 31, 1989, in 1-3517).\n+(c) 75-- Equity Ownership Plan of Entergy Corporation and Subsidiaries (A-4(a) to Rule 24 Certificate, dated May 24, 1991, in 70-7831).\n+(c) 76-- Agreement between Arkansas Power & Light Company and R. Drake Keith. (10(c) 78 to Form 10-K for the year ended December 31, 1992 in 1-10764).\n+(c) 77-- Supplemental Retirement Plan (10(a)69 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(c) 78-- Defined Contribution Restoration Plan of Entergy Corporation and Subsidiaries (10(a)53 to Form 10-K for the year ended December 31, 1989 in 1-3517).\n+(c) 79-- Amendment No. 1 to the Equity Ownership Plan of Entergy Corporation and Subsidiaries (10(a)71 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(c) 80-- Executive Disability Plan of Entergy Corporation and Subsidiaries (10(a)72 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(c) 81-- Executive Medical Plan of Entergy Corporation and Subsidiaries (10(a)73 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(c) 82-- Stock Plan for Outside Directors of Entergy Corporation and Subsidiaries, as amended (10(a)74 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(c) 83-- Summary Description of Private Ownership Vehicle Plan of Entergy Corporation and Subsidiaries (10(a)75 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(c) 84-- Agreement between Entergy Corporation and Edwin Lupberger (10(a)-42 to Form 10-K for the year ended December 31, 1985 in 1-3517).\n+(c) 85-- Agreement between Entergy Corporation and Jerry D. Jackson (10(a)-68 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(c) 86-- Agreement between Entergy Services and Gerald D. McInvale (10(a)-69 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(c) 87-- Agreement between System Energy and Donald C. Hintz (10(b)-47 to Form 10-K for the year ended December 31, 1991 in 1-9067).\n+(c) 88-- Summary Description of Retired Outside Director Benefit Plan. (10(c) 90 to Form 10-K for the year ended December 31, 1992 in 1-10764).\n+(c) 89-- Amendment to Defined Contribution Restoration Plan of Entergy Corporation and Subsidiaries (10(a) 81 to Form 10-K for the year ended December 31, 1993 in 1-11299).\n+(c) 90-- System Executive Retirement Plan (10(a) 82 to Form 10-K for the year ended December 31, 1993 in 1-11299).\n(c) 91-- Loan Agreement dated June 15, 1993, between AP&L and Independence Country, Arkansas (B-1 (a) to Rule 24 Certificate dated July 9, 1993 in 70-8171).\n(c) 92-- Installment Sale Agreement dated January 1, 1991, between AP&L and Pope Country, Arkansas (B-1 (b) to Rule 24 Certificate dated January 24, 1991 in 70-7802).\n(c) 93-- Installment Sale Agreement dated November 1, 1990, between AP&L and Pope Country, Arkansas (B-1 (a) to Rule 24 Certificate dated November 30, 1990 in70-7802).\n(c) 94-- Loan Agreement dated June 15, 1994, between AP&L and Jefferson County, Arkansas (B-1(a) to Rule 24 Certificate dated June 30, 1994 in 70-8405).\n(c) 95-- Loan Agreement dated June 15, 1994, between AP&L and Pope County, Arkansas (B-1(b) to Rule 24 Certificate in 70-8405).\n*(c) 96-- Loan Agreement dated November 15, 1995, between AP&L and Pope County, Arkansas.\nGSU\n(d) 1 -- Guaranty Agreement, dated July 1, 1976, between GSU and American Bank and Trust Company (C and D to Form 8-K, dated August 6, 1976 in 1-2703).\n(d) 2 -- Lease of Railroad Equipment, dated as of December 1, 1981, between The Connecticut Bank and Trust Company as Lessor and GSU as Lessee and First Supplement, dated as of December 31, 1981, relating to 605 One Hundred-Ton Unit Train Steel Coal Porter Cars (4-12 to Form 10-K for the year ended December 31, 1981 in 1-2703).\n(d) 3 -- Guaranty Agreement, dated August 1, 1992, between GSU and Hibernia National Bank, relating to Pollution Control Revenue Refunding Bonds of the Industrial Development Board of the Parish of Calcasieu, Inc. (Louisiana) (10-1 to Form 10-K for the year ended December 31, 1992 in 1-2703).\n(d) 4 -- Guaranty Agreement, dated January 1, 1993, between GSU and Hancock Bank of Louisiana, relating to Pollution Control Revenue Refunding Bonds of the Parish of Pointe Coupee (Louisiana) (10-2 to Form 10-K for the year ended December 31, 1992 in 1-2703).\n(d) 5 -- Deposit Agreement, dated as of December 1, 1983 between GSU, Morgan Guaranty Trust Co. as Depositary and the Holders of Despositary Receipts, relating to the Issue of 900,000 Depositary Preferred Shares, each representing 1\/2 share of Adjustable Rate Cumulative Preferred Stock, Series E-$100 Par Value (4-17 to Form 10- K for the year ended December 31, 1983 in 1-2703).\n(d) 6 -- Letter of Credit and Reimbursement Agreement, dated December 27, 1985, between GSU and Westpack Banking Corporation relating to Variable Rate Demand Pollution Control Revenue Bonds of the Parish of West Feliciana, State of Louisiana, Series 1985-D (4-26 to Form 10-K for the year ended December 31, 1985 in 1-2703) and Letter Agreement amending same dated October 20, 1992 (10-3 to Form 10-K for the year ended December 31, 1992 in 1- 2703).\n(d) 7 -- Reimbursement and Loan Agreement, dated as of April 23, 1986, by and between GSU and The Long-Term Credit Bank of Japan, Ltd., relating to Multiple Rate Demand Pollution Control Revenue Bonds of the Parish of West Feliciana, State of Louisiana, Series 1985 (4-26 to Form 10-K, for the year ended December 31, 1986 in 1- 2703) and Letter Agreement amending same, dated February 19, 1993 (10 to Form 10-K for the year ended December 31, 1992 in 1-2703).\n(d) 8 -- Agreement effective February 1, 1964, between Sabine River Authority, State of Louisiana, and Sabine River Authority of Texas, and GSU, Central Louisiana Electric Company, Inc., and Louisiana Power & Light Company, as supplemented (B to Form 8-K, dated May 6, 1964, A to Form 8-K, dated October 5, 1967, A to Form 8- K, dated May 5, 1969, and A to Form 8-K, dated December 1, 1969, in 1-2708).\n(d) 9 -- Joint Ownership Participation and Operating Agreement regarding River Bend Unit 1 Nuclear Plant, dated August 20, 1979, between GSU, Cajun, and SRG&T; Power Interconnection Agreement with Cajun, dated June 26, 1978, and approved by the REA on August 16, 1979, between GSU and Cajun; and Letter Agreement regarding CEPCO buybacks, dated August 28, 1979, between GSU and Cajun (2, 3, and 4, respectively, to Form 8-K, dated September 7, 1979, in 1-2703).\n(d) 10-- Ground Lease, dated August 15, 1980, between Statmont Associates Limited Partnership (Statmont) and GSU, as amended (3 to Form 8-K, dated August 19, 1980, and A-3-b to Form 10-Q for the quarter ended September 30, 1983 in 1-2703).\n(d) 11-- Lease and Sublease Agreement, dated August 15, 1980, between Statmont and GSU, as amended (4 to Form 8- K, dated August 19, 1980, and A-3-c to Form 10-Q for the quarter ended September 30, 1983 in 1-2703).\n(d) 12-- Lease Agreement, dated September 18, 1980, between BLC Corporation and GSU (1 to Form 8-K, dated October 6, 1980 in 1-2703).\n(d) 13-- Joint Ownership Participation and Operating Agreement for Big Cajun, between GSU, Cajun Electric Power Cooperative, Inc., and Sam Rayburn G&T, Inc, dated November 14, 1980 (6 to Form 8-K, dated January 29, 1981 in 1-2703); Amendment No. 1, dated December 12, 1980 (7 to Form 8-K, dated January 29, 1981 in 1-2703); Amendment No. 2, dated December 29, 1980 (8 to Form 8-K, dated January 29, 1981 in 1-2703).\n(d) 14-- Agreement of Joint Ownership Participation between SRMPA, SRG&T and GSU, dated June 6, 1980, for Nelson Station, Coal Unit #6, as amended (8 to Form 8-K, dated June 11, 1980, A-2-b to Form 10-Q For the quarter ended June 30, 1982; and 10-1 to Form 8-K, dated February 19, 1988 in 1-2703).\n(d) 15-- Agreements between Southern Company and GSU, dated February 25, 1982, which cover the construction of a 140- mile transmission line to connect the two systems, purchase of power and use of transmission facilities (10- 31 to Form 10-K, for the year ended December 31, 1981 in 1-2703).\n+(d) 16-- Executive Income Security Plan, effective October 1, 1980, as amended, continued and completely restated effective as of March 1, 1991 (10-2 to Form 10-K for the year ended December 31, 1991 in 1-2703).\n(d) 17-- Transmission Facilities Agreement between GSU and Mississippi Power Company, dated February 28, 1982, and Amendment, dated May 12, 1982 (A-2-c to Form 10-Q for the quarter ended March 31, 1982 in 1-2703) and Amendment, dated December 6, 1983 (10-43 to Form 10-K, for the year ended December 31, 1983 in 1-2703).\n(d) 18-- Lease Agreement dated as of June 29, 1983, between GSU and City National Bank of Baton Rouge, as Owner Trustee, in connection with the leasing of a Simulator and Training Center for River Bend Unit 1 (A-2-a to Form 10-Q for the quarter ended June 30, 1983 in 1-2703) and Amendment, dated December 14, 1984 (10-55 to Form 10-K, for the year ended December 31, 1984 in 1-2703).\n(d) 19-- Participation Agreement, dated as of June 29, 1983, among GSU, City National Bank of Baton Rouge, PruFunding, Inc. Bank of the Southwest National Association, Houston and Bankers Life Company, in connection with the leasing of a Simulator and Training Center of River Bend Unit 1 (A-2-b to Form 10-Q for the quarter ended June 30, 1983 in 1-2703).\n(d) 20-- Tax Indemnity Agreement, dated as of June 29, 1983, between GSU and Prufunding, Inc., in connection with the leasing of a Simulator and Training Center for River Bend Unit I (A-2-c to Form 10-Q for the quarter ended June 30, 1993 in 1-2703).\n(d) 21-- Agreement to Lease, dated as of August 28, 1985, among GSU, City National Bank of Baton Rouge, as Owner Trustee, and Prudential Interfunding Corp., as Trustor, in connection with the leasing of improvement to a Simulator and Training Facility for River Bend Unit I (10- 69 to Form 10-K, for the year ended December 31, 1985 in 1-2703).\n(d) 22-- First Amended Power Sales Agreement, dated December 1, 1985 between Sabine River Authority, State of Louisiana, and Sabine River Authority, State of Texas, and GSU, Central Louisiana Electric Co., Inc., and Louisiana Power and Light Company (10-72 to Form 10-K for the year ended December 31, 1985 in 1-2703).\n+(d) 23-- Deferred Compensation Plan for Directors of GSU and Varibus Corporation, as amended January 8, 1987, and effective January 1, 1987 (10-77 to Form 10-K for the year ended December 31, 1986 in 1-2703). Amendment dated December 4, 1991 (10-3 to Amendment No. 8 in Registration No. 2-76551).\n+(d) 24-- Trust Agreement for Deferred Payments to be made by GSU pursuant to the Executive Income Security Plan, by and between GSU and Bankers Trust Company, effective November 1, 1986 (10-78 to Form 10-K for the year ended December 31, 1986 in 1-2703).\n+(d) 25-- Trust Agreement for Deferred Installments under GSU's Management Incentive Compensation Plan and Administrative Guidelines by and between GSU and Bankers Trust Company, effective June 1, 1986 (10-79 to Form 10-K for the year ended December 31, 1986 in 1-2703).\n+(d) 26-- Nonqualified Deferred Compensation Plan for Officers, Nonemployee Directors and Designated Key Employees, effective December 1, 1985, as amended, continued and completely restated effective as of March 1, 1991 (10-3 to Amendment No. 8 in Registration No. 2- 76551).\n+(d) 27-- Trust Agreement for GSU's Nonqualified Directors and Designated Key Employees by and between GSU and First City Bank, Texas-Beaumont, N.A. (now Texas Commerce Bank), effective July 1, 1991 (10-4 to Form 10-K for the year ended December 31, 1992 in 1-2703).\n(d) 28-- Lease Agreement, dated as of June 29, 1987, among GSG&T, Inc., and GSU related to the leaseback of the Lewis Creek generating station (10-83 to Form 10-K for the year ended December 31, 1988 in 1-2703).\n(d) 29-- Nuclear Fuel Lease Agreement between GSU and River Bend Fuel Services, Inc. to lease the fuel for River Bend Unit 1, dated February 7, 1989 (10-64 to Form 10-K for the year ended December 31, 1988 in 1-2703).\n(d) 30-- Trust and Investment Management Agreement between GSU and Morgan Guaranty and Trust Company of New York (the \"Decommissioning Trust Agreement) with respect to decommissioning funds authorized to be collected by GSU, dated March 15, 1989 (10-66 to Form 10-K for the year ended December 31, 1988 in 1-2703).\n*(d) 31-- Amendment No. 2 dated November 1, 1995 between GSU and Mellon Bank to Decommissioning Trust Agreement.\n(d) 32-- Credit Agreement, dated as of December 29, 1993, among River Bend Fuel Services, Inc. and Certain Commercial Lending Institutions and CIBC Inc. as Agent for the Lenders ((d) 34 to Form 10-K for year ended December 31, 1994).\n*(d) 33-- Amendment No. 1 dated as of January 31, 1996 to Credit Agreement, dated as of December 31, 1993, among River Bend Fuel Services, Inc. and certain commercial lending institutions and CIBC Inc. as agent for Lenders.\n(d) 34-- Partnership Agreement by and among Conoco Inc., and GSU, CITGO Petroleum Corporation and Vista Chemical Company, dated April 28, 1988 (10-67 to Form 10-K for the year ended December 31, 1988 in 1-2703).\n+(d) 35-- Gulf States Utilities Company Executive Continuity Plan, dated January 18, 1991 (10-6 to Form 10-K for the year ended December 31, 1990 in 1-2703).\n+(d) 36-- Trust Agreement for GSU's Executive Continuity Plan, by and between GSU and First City Bank, Texas- Beaumont, N.A. (now Texas Commerce Bank), effective May 20, 1991 (10-5 to Form 10-K for the year ended December 31, 1992 in 1-2703).\n+(d) 37-- Gulf States Utilities Board of Directors' Retirement Plan, dated February 15, 1991 (10-8 to Form 10- K for the year ended December 31, 1990 in 1-2703).\n+(d) 38-- Gulf States Utilities Company Employees' Trustee Retirement Plan effective July 1, 1955 as amended, continued and completely restated effective January 1, 1989; and Amendment No.1 effective January 1, 1993 (10-6 to Form 10-K for the year ended December 31, 1992 in 1- 2703).\n(d) 39-- Agreement and Plan of Reorganization, dated June 5, 1992, between GSU and Entergy Corporation (2 to Form 8- K, dated June 8, 1992 in 1-2703).\n+(d) 40-- Gulf States Utilities Company Employee Stock Ownership Plan, as amended, continued, and completely restated effective January 1, 1984, and January 1, 1985 (A to Form 11-K, dated December 31, 1985 in 1-2703).\n+(d) 41-- Trust Agreement under the Gulf States Utilities Company Employee Stock Ownership Plan, dated December 30, 1976, between GSU and the Louisiana National Bank, as Trustee (2-A to Registration No. 2-62395).\n+(d) 42-- Letter Agreement dated September 7, 1977 between GSU and the Trustee, delegating certain of the Trustee's functions to the ESOP Committee (2-B to Registration Statement No. 2-62395).\n+(d) 43-- Gulf States Utilities Company Employees Thrift Plan as amended, continued and completely restated effective as of January 1, 1992 (28-1 to Amendment No. 8 to Registration No. 2-76551).\n+(d) 44-- Restatement of Trust Agreement under the Gulf States Utilities Company Employees Thrift Plan, reflecting changes made through January 1, 1989, between GSU and First City Bank, Texas-Beaumont, N.A., (now Texas Commerce Bank ), as Trustee (2-A to Form 8-K dated October 20, 1989 in 1-2703).\n(d) 45-- Operating Agreement between Entergy Operations and GSU, dated as of December 31, 1993 (B-2(f) to Rule 24 Certificate in 70-8059).\n(d) 46-- Guarantee Agreement between Entergy Corporation and GSU, dated as of December 31, 1993 (B-5(a) to Rule 24 Certificate in 70-8059).\n(d) 47-- Service Agreement with Entergy Services, dated as of December 31, 1993 (B-6(c) to Rule 24 Certificate in 70-8059).\n+(d) 48-- Amendment to Employment Agreement between J. L. Donnelly and GSU, dated December 22, 1993 (10(d) 57 to Form 10-K for the year ended December 31, 1993 in 1- 2703).\n(d) 49-- Assignment, Assumption and Amendment Agreement to Letter of Credit and Reimbursement Agreement between GSU, Canadian Imperial Bank of Commerce and Westpac Banking Corporation (10(d) 58 to Form 10-K for the year ended December 31, 1993 in 1-2703).\n(d) 50-- Third Amendment, dated January 1, 1994, to Entergy Corporation and Subsidiary Companies Intercompany Income Tax Allocation Agreement (D-3(a) to Form U5S for the year ended December 31, 1993).\n(d) 51-- Refunding Agreement between GSU and West Feliciana Parish (dated December 20, 1994 (B-12(a) to Rule 24 Certificate dated December 30, 1994 in 70-8375).\nLP&L\n(e) 1 -- Agreement, dated April 23, 1982, among LP&L and certain other System companies, relating to System Planning and Development and Intra-System Transactions (10(a) 1 to Form 10-K for the year ended December 31, 1982, in 1-3517).\n(e) 2 -- Middle South Utilities System Agency Agreement, dated December 11, 1970 (5(a)-2 in 2-41080).\n(e) 3 -- Amendment, dated as of February 10, 1971, to Middle South Utilities System Agency Agreement, dated December 11, 1970 (5(a)-4 in 2-41080).\n(e) 4 -- Amendment, dated May 12, 1988, to Middle South Utilities System Agency Agreement, dated December 11, 1970 (5(a) 4 in 2-41080).\n(e) 5 -- Middle South Utilities System Agency Coordination Agreement, dated December 11, 1970 (5(a)-3 in 2-41080).\n(e) 6 -- Service Agreement with Entergy Services, dated as of April 1, 1963 (5(a)-5 in 2-42523).\n(e) 7 -- Amendment, dated as of January 1, 1972, to Service Agreement with Entergy Services (4(a)-6 in 2-45916).\n(e) 8 -- Amendment, dated as of April 27, 1984, to Service Agreement with Entergy Services (10(a) 7 to Form 10-K for the year ended December 31, 1984, in 1-3517).\n(e) 9 -- Amendment, dated as of August 1, 1988, to Service Agreement with Entergy Services (10(d)-8 to Form 10-K for the year ended December 31, 1988, in 1-8474).\n(e) 10-- Amendment, dated January 1, 1991, to Service Agreement with Entergy Services (10(d)-9 to Form 10-K for the year ended December 31, 1990, in 1-8474).\n(e) 11-- Amendment, dated January 1, 1992, to Service Agreement with Entergy Services (10(a)-11 to Form 10-K for the year ended December 31, 1994 in 1-3517).\n(e) 12 through (e) 23-- See 10(a)-12 through 10(a)-23 above.\n(e) 24-- Fuel Lease, dated as of January 31, 1989, between River Fuel Company #2, Inc., and LP&L (B-1(b) to Rule 24 Certificate in 70-7580).\n(e) 25-- Reallocation Agreement, dated as of July 28, 1981, among System Energy and certain other System companies (B-1(a) in 70-6624).\n(e) 26-- Compromise and Settlement Agreement, dated June 4, 1982, between Texaco, Inc. and LP&L (28(a) to Form 8-K, dated June 4, 1982, in 1-8474).\n+(e) 27-- Post-Retirement Plan (10(c)23 to Form 10-K for the year ended December 31, 1983, in 1-8474).\n(e) 28-- Unit Power Sales Agreement, dated as of June 10, 1982, between System Energy and AP&L, LP&L, MP&L and NOPSI (10(a) 39 to Form 10-K for the year ended December 31, 1982, in 1-3517).\n(e) 29-- First Amendment to the Unit Power Sales Agreement, dated as of June 28, 1984, between System Energy and AP&L, LP&L, MP&L and NOPSI (19 to Form 10-Q for the quarter ended September 30, 1984, in 1-3517).\n(e) 30-- Revised Unit Power Sales Agreement (10(ss) in 33-4033).\n(e) 31-- Middle South Utilities, Inc. and Subsidiary Companies Intercompany Tax Allocation Agreement, dated April 28, 1988 (D-1 to Form U5S for the year ended December 31, 1987).\n(e) 32-- First Amendment, dated January 1, 1990, to the Middle South Utilities, Inc. and Subsidiary Companies Intercompany Income Tax Allocation Agreement, dated January 1, 1990 (D-2 to Form U5S for the year ended December 31, 1989).\n(e) 33-- Second Amendment dated January 1, 1992, to the Entergy Corporation and Subsidiary Companies Intercompany Income Tax Allocation Agreement (D-3 to Form U5S for the year ended December 31, 1992).\n(e) 34-- Third Amendment dated January 1, 1994 to Entergy Corporation and Subsidiary Companies Intercompany Income Tax Allocation Agreement (D-3(a) to Form U5S for the year ended December 31, 1993).\n(e) 35-- Contract for Disposal of Spent Nuclear Fuel and\/or High-Level Radioactive Waste, dated February 2, 1984, among DOE, System Fuels and LP&L (10(d)33 to Form 10-K for the year ended December 31, 1984, in 1-8474).\n(e) 36-- Operating Agreement between Entergy Operations and LP&L, dated as of June 6, 1990 (B-2(c) to Rule 24 Certificate, dated June 15, 1990, in 70-7679).\n(e) 37-- Guarantee Agreement between Entergy Corporation and LP&L, dated as of September 20, 1990 (B-2(a), to Rule 24 Certificate, dated September 27, 1990, in 70-7757).\n+(e) 38-- Executive Financial Counseling Program of Entergy Corporation and Subsidiaries (10(a) 52 to Form 10-K for the year ended December 31, 1989, in 1-3517).\n+(e) 39-- Entergy Corporation Annual Incentive Plan (10(a) 54 to Form 10-K for the year ended December 31, 1989, in 1-3517).\n+(e) 40-- Equity Ownership Plan of Entergy Corporation and Subsidiaries (A-4(a) to Rule 24 Certificate, dated May 24, 1991, in 70-7831).\n+(e) 41-- Supplemental Retirement Plan (10(a) 69 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(e) 42-- Defined Contribution Restoration Plan of Entergy Corporation and Subsidiaries (10(a) 53 to Form 10-K for the year ended December 31, 1989 in 1-3517).\n+(e) 43-- Amendment No. 1 to the Equity Ownership Plan of Entergy Corporation and Subsidiaries (10(a) 71 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(e) 44-- Executive Disability Plan of Entergy Corporation and Subsidiaries (10(a) 72 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(e) 45-- Executive Medical Plan of Entergy Corporation and Subsidiaries (10(a) 73 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(e) 46-- Stock Plan for Outside Directors of Entergy Corporation and Subsidiaries (10(a) 74 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(e) 47-- Summary Description of Private Ownership Vehicle Plan of Entergy Corporation and Subsidiaries (10(a) 75 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(e) 48-- Agreement between Entergy Corporation and Edwin Lupberger (10(a) 42 to Form 10-K for the year ended December 31, 1985 in 1-3517).\n+(e) 49-- Agreement between Entergy Corporation and Jerry D. Jackson (10(a) 68 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(e) 50-- Agreement between Entergy Services and Gerald D. McInvale (10(a) 69 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(e) 51-- Agreement between System Energy and Donald C. Hintz (10(b) 47 to Form 10-K for the year ended December 31, 1991 in 1-9067).\n+(e) 52-- Summary Description of Retired Outside Director Benefit Plan (10(c)90 to Form 10-K for the year ended December 31, 1992 in 1-10764).\n+(e) 53-- Amendment to Defined Contribution Restoration Plan of Entergy Corporation and Subsidiaries (10(a) 81 to Form 10-K for the year ended December 31, 1993 in 1-11299).\n+(e) 54-- System Executive Retirement Plan (10(a) 82 to Form 10-K for the year ended December 31, 1993 in 1-11299).\n(e) 55-- Installment Sale Agreement, dated July 20, 1994, between LP&L and St. Charles Parish, Louisiana (B-6(e) to Rule 24 Certificate dated August 1, 1994 in 70-7822).\n(e) 56-- Installment Sale Agreement, dated November 1, 1995, between LP&L and St. Charles Parish, Louisiana (B- 6(a) to Rule 24 Certificate dated December 19, 1995 in 70- 8487).\nMP&L\n(f) 1 -- Agreement dated April 23, 1982, among MP&L and certain other System companies, relating to System Planning and Development and Intra-System Transactions (10(a) 1 to Form 10-K for the year ended December 31, 1982, in 1-3517).\n(f) 2 -- Middle South Utilities System Agency Agreement, dated December 11, 1970 (5(a)-2 in 2-41080).\n(f) 3 -- Amendment, dated February 10, 1971, to Middle South Utilities System Agency Agreement, dated December 11, 1970 (5(a) 4 in 2-41080).\n(f) 4 -- Amendment, dated May 12, 1988, to Middle South Utilities System Agency Agreement, dated December 11, 1970 (5(a) 4 in 2-41080).\n(f) 5 -- Middle South Utilities System Agency Coordination Agreement, dated December 11, 1970 (5(a)-3 in 2-41080).\n(f) 6 -- Service Agreement with Entergy Services, dated as of April 1, 1963 (D in 37-63).\n(f) 7 -- Amendment, dated January 1, 1972, to Service Agreement with Entergy Services (A to Notice, dated October 14, 1971, in 37-63).\n(f) 8 -- Amendment, dated April 27, 1984, to Service Agreement with Entergy Services (10(a) 7 to Form 10-K for the year ended December 31, 1984, in 1-3517).\n(f) 9 -- Amendment, dated as of August 1, 1988, to Service Agreement with Entergy Services (10(e) 8 to Form 10-K for the year ended December 31, 1988, in 0-320).\n(f) 10-- Amendment, dated January 1, 1991, to Service Agreement with Entergy Services (10(e) 9 to Form 10-K for the year ended December 31, 1990, in 0-320).\n(f) 11-- Amendment, dated January 1, 1992, to Service Agreement with Entergy Services (10(a)-11 to Form 10-K for the year ended December 31, 1994 in 1-3517).\n(f) 12 though (f) 23-- See 10(a)-12 - 10(a)-23 above.\n(f) 24-- Installment Sale Agreement, dated as of June 1, 1974, between MP&L and Washington County, Mississippi (B- 2(a) to Rule 24 Certificate, dated August 1, 1974, in 70- 5504).\n(f) 25-- Installment Sale Agreement, dated as of July 1, 1982, between MP&L and Independence County, Arkansas, (B- 1(c) to Rule 24 Certificate dated July 21, 1982, in 70- 6672).\n(f) 26-- Installment Sale Agreement, dated as of December 1, 1982, between MP&L and Independence County, Arkansas, (B-1(d) to Rule 24 Certificate dated December 7, 1982, in 70-6672).\n(f) 27-- Amended and Restated Installment Sale Agreement, dated as of April 1, 1994, between MP&L and Warren County, Mississippi, (B-6(a) to Rule 24 Certificate dated May 4, 1994, in 70-7914).\n(f) 28-- Amended and Restated Installment Sale Agreement, dated as of April 1, 1994, between MP&L and Washington County, Mississippi, (B-6(b) to Rule 24 Certificate dated May 4, 1994, in 70-7914).\n(f) 29-- Substitute Power Agreement, dated as of May 1, 1980, among MP&L, System Energy and SMEPA (B-3(a) in 70-6337).\n(f) 30-- Amendment, dated December 4, 1984, to the Independence Steam Electric Station Operating Agreement (10(c) 51 to Form 10-K for the year ended December 31, 1984, in 0-375).\n(f) 31-- Amendment, dated December 4, 1984, to the Independence Steam Electric Station Ownership Agreement (10(c) 54 to Form 10-K for the year ended December 31, 1984, in 0-375).\n(f) 32-- Owners Agreement, dated November 28, 1984, among AP&L, MP&L and other co- owners of the Independence Station (10(c) 55 to Form 10-K for the year ended December 31, 1984, in 0-375).\n(f) 33-- Consent, Agreement and Assumption, dated December 4, 1984, among AP&L, MP&L, other co-owners of the Independence Station and United States Trust Company of New York, as Trustee (10(c) 56 to Form 10-K for the year ended December 31, 1984, in 0-375).\n(f) 34-- Reallocation Agreement, dated as of July 28, 1981, among System Energy and certain other System companies (B-1(a) in 70-6624).\n+(f) 35-- Post-Retirement Plan (10(d) 24 to Form 10-K for the year ended December 31, 1983, in 0-320).\n(f) 36-- Unit Power Sales Agreement, dated as of June 10, 1982, between System Energy and AP&L, LP&L, MP&L, and NOPSI (10(a) 39 to Form 10-K for the year ended December 31, 1982, in 1-3517).\n(f) 37-- First Amendment to the Unit Power Sales Agreement, dated as of June 28, 1984, between System Energy and AP&L, LP&L, MP&L, and NOPSI (19 to Form 10-Q for the quarter ended September 30, 1984, in 1-3517).\n(f) 38-- Revised Unit Power Sales Agreement (10(ss) in 33-4033).\n(f) 39-- Sales Agreement, dated as of June 21, 1974, between System Energy and MP&L (D to Rule 24 Certificate, dated June 26, 1974, in 70-5399).\n(f) 40-- Service Agreement, dated as of June 21, 1974, between System Energy and MP&L (E to Rule 24 Certificate, dated June 26, 1974, in 70-5399).\n(f) 41-- Partial Termination Agreement, dated as of December 1, 1986, between System Energy and MP&L (A-2 to Rule 24 Certificate dated January 8, 1987, in 70-5399).\n(f) 42-- Middle South Utilities, Inc. and Subsidiary Companies Intercompany Income Tax Allocation Agreement, dated April 28, 1988 (D-1 to Form U5S for the year ended December 31, 1987).\n(f) 43-- First Amendment dated January 1, 1990 to the Middle South Utilities Inc. and Subsidiary Companies Intercompany Tax Allocation Agreement (D-2 to Form U5S for the year ended December 31, 1989).\n(f) 44-- Second Amendment dated January 1, 1992, to the Entergy Corporation and Subsidiary Companies Intercompany Income Tax Allocation Agreement (D-3 to Form U5S for the year ended December 31, 1992).\n(f) 45-- Third Amendment dated January 1, 1994 to Entergy Corporation and Subsidiary Companies Intercompany Income Tax Allocation Agreement (D-3(a) to Form U5S for the year ended December 31, 1993).\n+(f) 46-- Executive Financial Counseling Program of Entergy Corporation and Subsidiaries (10(a) 52 to Form 10-K for the year ended December 31, 1989, in 1-3517).\n+(f) 47-- Entergy Corporation Annual Incentive Plan (10(a) 54 to Form 10-K for the year ended December 31, 1989, in 1-3517).\n+(f) 48-- Equity Ownership Plan of Entergy Corporation and Subsidiaries (A-4(a) to Rule 24 Certificate, dated May 24, 1991, in 70-7831).\n+(f) 49-- Supplemental Retirement Plan (10(a)69 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(f) 50-- Defined Contribution Restoration Plan of Entergy Corporation and Subsidiaries (10(a)53 to Form 10-K for the year ended December 31, 1989 in 1-3517).\n+(f) 51-- Amendment No. 1 to the Equity Ownership Plan of Entergy Corporation and Subsidiaries (10(a)71 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(f) 52-- Executive Disability Plan of Entergy Corporation and Subsidiaries (10(a)72 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(f) 53-- Executive Medical Plan of Entergy Corporation and Subsidiaries (10(a)73 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(f) 54-- Stock Plan for Outside Directors of Entergy Corporation and Subsidiaries, as amended (10(a)74 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(f) 55-- Summary Description of Private Ownership Vehicle Plan of Entergy Corporation and Subsidiaries (10(a)75 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(f) 56-- Agreement between Entergy Corporation and Edwin Lupberger (10(a)-42 to Form 10-K for the year ended December 31, 1985 in 1-3517).\n+(f) 57-- Agreement between Entergy Corporation and Jerry D. Jackson (10(a)-68 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(f) 58-- Agreement between Entergy Services and Gerald D. McInvale (10(a)-69 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(f) 59-- Agreement between System Energy and Donald C. Hintz (10(b)-47 to Form 10-K for the year ended December 31, 1991 in 1-9067).\n+(f) 60-- Summary Description of Retired Outside Director Benefit Plan (10(c)-90 to Form 10-K for the year ended December 31, 1992 in 1-10764).\n+(f) 61-- Amendment to Defined Contribution Restoration Plan of Entergy Corporation and Subsidiaries (10(a) 81 to Form 10-K for the year ended December 31, 1993 in 1-11299).\n+(f) 62-- System Executive Retirement Plan (10(a) 82 to Form 10-K for the year ended December 31, 1993 in 1-11299).\nNOPSI\n(g) 1 -- Agreement, dated April 23, 1982, among NOPSI and certain other System companies, relating to System Planning and Development and Intra-System Transactions (10(a)-1 to Form 10-K for the year ended December 31, 1982, in 1-3517).\n(g) 2 -- Middle South Utilities System Agency Agreement, dated December 11, 1970 (5(a)-2 in 2-41080).\n(g) 3 -- Amendment dated as of February 10, 1971, to Middle South Utilities System Agency Agreement, dated December 11, 1970 (5(a)-4 in 2-41080).\n(g) 4 -- Amendment, dated May 12, 1988, to Middle South Utilities System Agency Agreement, dated December 11, 1970 (5(a) 4 in 2-41080).\n(g) 5 -- Middle South Utilities System Agency Coordination Agreement, dated December 11, 1970 (5(a)-3 in 2-41080).\n(g) 6 -- Service Agreement with Entergy Services dated as of April 1, 1963 (5(a)-5 in 2-42523).\n(g) 7 -- Amendment, dated as of January 1, 1972, to Service Agreement with Entergy Services (4(a)-6 in 2-45916).\n(g) 8 -- Amendment, dated as of April 27, 1984, to Service Agreement with Entergy Services (10(a)7 to Form 10-K for the year ended December 31, 1984, in 1-3517).\n(g) 9 -- Amendment, dated as of August 1, 1988, to Service Agreement with Entergy Services (10(f)-8 to Form 10-K for the year ended December 31, 1988, in 0-5807).\n(g) 10-- Amendment, dated January 1, 1991, to Service Agreement with Entergy Services (10(f)-9 to Form 10-K for the year ended December 31, 1990, in 0-5807).\n(g) 11-- Amendment, dated January 1, 1992, to Service Agreement with Entergy Services (10(a)-11 to Form 10-K for year ended December 31, 1994 in 1-3517).\n(g) 12 (g) 23-- See 10(a)-12 - 10(a)-23 above.\n(g) 24-- Reallocation Agreement, dated as of July 28, 1981, among System Energy and certain other System companies (B-1(a) in 70-6624).\n+(g) 25-- Post-Retirement Plan (10(e) 22 to Form 10-K for the year ended December 31, 1983, in 1-1319).\n(g) 26-- Unit Power Sales Agreement, dated as of June 10, 1982, between System Energy and AP&L, LP&L, MP&L and NOPSI (10(a) 39 to Form 10-K for the year ended December 31, 1982, in 1-3517).\n(g) 27-- First Amendment to the Unit Power Sales Agreement, dated as of June 28, 1984, between System Energy and AP&L, LP&L, MP&L and NOPSI (19 to Form 10-Q for the quarter ended September 30, 1984, in 1-3517).\n(g) 28-- Revised Unit Power Sales Agreement (10(ss) in 33-4033).\n(g) 29-- Transfer Agreement, dated as of June 28, 1983, among the City of New Orleans, NOPSI and Regional Transit Authority (2(a) to Form 8-K, dated June 24, 1983, in 1-1319).\n(g) 30-- Middle South Utilities, Inc. and Subsidiary Companies Intercompany Income Tax Allocation Agreement, dated April 28, 1988 (D-1 to Form U5S for the year ended December 31, 1987).\n(g) 31-- First Amendment, dated January 1, 1990, to the Middle South Utilities, Inc. and Subsidiary Companies Intercompany Income Tax Allocation Agreement (D-2 to Form U5S for the year ended December 31, 1989).\n(g) 32-- Second Amendment dated January 1, 1992, to the Entergy Corporation and Subsidiary Companies Intercompany Income Tax Allocation Agreement (D-3 to Form U5S for the year ended December 31, 1992).\n(g) 33-- Third Amendment dated January 1, 1994 to Entergy Corporation and Subsidiary Companies Intercompany Income Tax Allocation Agreement (D-3(a) to Form U5S for the year ended December 31, 1993).\n+(g) 34-- Executive Financial Counseling Program of Entergy Corporation and Subsidiaries (10(a)52 to Form 10-K for the year ended December 31, 1989, in 1-3517).\n+(g) 35-- Entergy Corporation Annual Incentive Plan (10(a)54 to Form 10-K for the year ended December 31, 1989, in 1-3517).\n+(g) 36-- Equity Ownership Plan of Entergy Corporation and Subsidiaries (A-4(a) to Rule 24 Certificate, dated May 24, 1991, in 70-7831).\n+(g) 37-- Supplemental Retirement Plan (10(a)69 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(g) 38-- Defined Contribution Restoration Plan of Entergy Corporation and Subsidiaries (10(a)53 to Form 10-K for the year ended December 31, 1989 in 1-3517).\n+(g) 39-- Amendment No. 1 to the Equity Ownership Plan of Entergy Corporation and Subsidiaries (10(a)71 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(g) 40-- Executive Disability Plan of Entergy Corporation and Subsidiaries (10(a)72 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(g) 41-- Executive Medical Plan of Entergy Corporation and Subsidiaries (10(a)73 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(g) 42-- Stock Plan for Outside Directors of Entergy Corporation and Subsidiaries, as amended (10(a)74 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(g) 43-- Summary Description of Private Ownership Vehicle Plan of Entergy Corporation and Subsidiaries (10(a)75 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(g) 44-- Agreement between Entergy Corporation and Edwin Lupberger (10(a)-42 to Form 10-K for the year ended December 31, 1985 in 1-3517).\n+(g) 45-- Agreement between Entergy Corporation and Jerry D. Jackson (10(a)-68 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(g) 46-- Agreement between Entergy Services and Gerald D. McInvale (10(a)-69 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(g) 47-- Agreement between System Energy and Donald C. Hintz (10(b)-47 to Form 10-K for the year ended December 31, 1991 in 1-9067).\n+(g) 48-- Summary Description of Retired Outside Director Benefit Plan (10(c)-90 to Form 10-K for the year ended December 31, 1992 in 1-10764).\n+(g) 49-- Amendment to Defined Contribution Restoration Plan of Entergy Corporation and Subsidiaries (10(a) 81 to Form 10-K for the year ended December 31, 1993 in 1-11299).\n+(g) 50-- System Executive Retirement Plan (10(a) 82 to Form 10-K for the year ended December 31, 1993 in 1-11299).\n(12) Statement Re Computation of Ratios\n*(a) AP&L's Computation of Ratios of Earnings to Fixed Charges and of Earnings to Fixed Charges and Preferred Dividends, as defined.\n*(b) GSU's Computation of Ratios of Earnings to Fixed Charges and of Earnings to Fixed Charges and Preferred Dividends, as defined.\n*(c) LP&L's Computation of Ratios of Earnings to Fixed Charges and of Earnings to Fixed Charges and Preferred Dividends, as defined.\n*(d) MP&L's Computation of Ratios of Earnings to Fixed Charges and of Earnings to Fixed Charges and Preferred Dividends, as defined.\n*(e) NOPSI's Computation of Ratios of Earnings to Fixed Charges and of Earnings to Fixed Charges and Preferred Dividends, as defined.\n*(f) System Energy's Computation of Ratios of Earnings to Fixed Charges, as defined.\n(18) Letter Re Change in Accounting Principles\n*(a) Letter from Coopers & Lybrand L.L.P. regarding change in accounting principles for AP&L.\n*(b) Letter from Coopers & Lybrand L.L.P. regarding change in accounting principles for Entergy.\n*(21) Subsidiaries of the Registrants\n(23) Consents of Experts and Counsel\n*(a) The consent of Coopers & Lybrand L.L.P. is contained herein at page 214.\n*(b) The consent of Deloitte & Touche LLP is contained herein at page 215.\n*(c) The consent of Clark, Thomas & Winters is contained herein at page 216.\n*(d) The consent of Sandlin Associates is contained herein at page 217.\n*(24) Powers of Attorney\n(27) Financial Data Schedule\n*(a) Financial Data Schedule for Entergy Corporation and Subsidiaries as of December 31, 1995.\n*(b) Financial Data Schedule for AP&L as of December 31, 1995.\n*(c) Financial Data Schedule for GSU as of December 31, 1995.\n*(d) Financial Data Schedule for LP&L as of December 31, 1995.\n*(e) Financial Data Schedule for MP&L as of December 31, 1995.\n*(f) Financial Data Schedule for NOPSI as of December 31, 1995.\n*(g) Financial Data Schedule for System Energy as of December 31, 1995.\n(99) Additional Exhibits\nGSU\n(a) 1 Opinion of Clark, Thomas & Winters, a professional corporation, dated September 30, 1992 regarding the effect of the October 1, 1991 judgment in GSU v. PUCT in the District Court of Travis County, Texas (99-1 in Registration No. 33-48889).\n(a) 2 Opinion of Clark, Thomas & Winters, a professional corporation, dated August 8, 1994 regarding recovery of costs deferred purusant to PUCT order in Docket 6525 (99 (j) to Quarterly Report on Form 10-Q for the quarter ended June 30, 1994 in No. 1-2703).\n*(a) 3 Opinion of Clark, Thomas & Winters, a professional corporation, confirming its opinions dated September 30, 1992 and August 8, 1994.\n_________________\n* Filed herewith. + Management contracts or compensatory plans or arrangements.","section_15":""}
{"filename":"805370_1995.txt","cik":"805370","year":"1995","section_1":"ITEM 1. BUSINESS\nBACKGROUND -----------\ndick clark productions, inc. was incorporated in California in 1977 as part of a group of companies which had been producing television programming since 1957. dick clark productions, inc. was reincorporated in November 1986 as a Delaware corporation. As used in this Report, unless the context otherwise expressly requires, the term \"Company\" refers to dick clark productions, inc. and its predecessors and their respective subsidiaries.\nThe Company develops and produces a wide range of television programming for the television networks, first-run domestic syndicators (which provide programming for independent and network affiliated stations), cable television and advertisers. Since 1957, the Company has been a significant supplier of television programming and has produced 33 television series; 271 annual, recurring and other specials; and 15 television movies. The Company also licenses the rebroadcast of segments of its programming and produces home videos. In addition, the Company, on a limited basis with third-party financing and without any financing obligation on the part of the Company, develops and produces theatrical motion pictures, having developed and produced eight theatrical motion pictures since its inception.\nSince fiscal 1990, the Company has operated entertainment-themed restaurants known as Dick Clark's American Bandstand Grill(R). In fiscal 1992, the first restaurant developed by the Company was opened in Overland Park, Kansas, a suburb of Kansas City. During fiscal 1994, Dick Clark's American Bandstand Grill restaurants were also opened in Columbus, Ohio, and Indianapolis, Indiana. The Company also opened a dance-club-only version of the restaurant, \"Dick Clark's American Bandstand Club,\" located in Reno, Nevada. The Company has a majority interest in the joint venture that operates the dance club, which opened in August 1993. Although the dance club concept has been profitable, the Company has chosen to focus its expansion efforts primarily on the restaurant concept, which the Company believes has a broader market appeal and greater potential for future revenue growth. It is the Company's long-term objective to continue to develop its entertainment-themed restaurant concept by opening additional Company-operated restaurants in strategically desirable markets. The Company anticipates opening a restaurant in Cincinnati, Ohio in early 1996 and is actively negotiating for additional sites for new restaurants in this growing national chain.\nIn January 1991, the Company established a subsidiary, dick clark corporate productions, inc. (\"dccp\"), in order to enter the corporate communication business. This subsidiary assists companies in communicating with customers, employees, the general public and other constituencies. The Company's strategy is to combine its entertainment resources, business relationships and talent contacts with experienced corporate communications professionals in order to offer to its corporate clients new product introductions; special events and event marketing; trade shows and exhibits; film and video production; themed- entertainment attractions; and sales and recognition meetings.\nSince its inception, the Company's principal stockholder has been Richard (\"Dick\") W. Clark, who the Company believes to be one of the best-known personalities in the entertainment industry. Many of the Company's television and corporate programs involve the executive producing services and creative input of Mr. Clark. However, Mr. Clark's performance services are not exclusive to the Company.\nThe Company's principal lines of business according to industry segments are television production and related activities (including, without limitation, the aforementioned operations of dccp) and restaurant operations (principally consolidated through dick clark restaurants, inc. and other subsidiaries). For financial information about the Company's industry segments with respect to each of the fiscal years in the three-year period ended June 30,\n1995, see Note 9 \"Business Segment Information\" to the Company's Consolidated Financial Statements on page 31.\nDESCRIPTION OF BUSINESS\nTELEVISION PRODUCTION AND RELATED BUSINESS ------------------------------------------\nIntroduction - ------------\nHistorically, the Company has produced music, variety and comedy entertainment television programming for daytime, primetime and late night telecast, as well as television movies. Over the years, the Company has gained a reputation in the television industry as a versatile supplier of innovative and quality programming and is capable of developing and producing programming within limited time schedules and production budgets if necessary. The Company believes that its success over the years is attributable, in part, to its ability to anticipate popular trends and to create innovative programming ideas.\nThe Company has generally been able to fund its production costs from license fees paid by the recipients of the programming. However, the proliferation of cable networks over the last decade, among other factors, has resulted in smaller license fees being paid by networks and other broadcasters. In particular, the development and production of situation comedies and dramatic series generally now require substantial deficit financing, because the license fees payable for such programs do not cover production costs. Consequently, the Company is selective in its development efforts in the dramatic and situation comedy series area.\nProgramming in which the Company owns the distribution rights and which are not subject to restrictions associated with the initial license agreement may be marketed by the Company in ancillary markets which include, among others, cable television, foreign and domestic rerun syndication and home video. Successful television series and television movies can have significant rerun syndication and other ancillary value. However, a television series must normally be broadcast for at least three or four television seasons before rerun syndication is feasible. Consequently, a relatively low percentage of television series are successful enough to be syndicated. Game show series generally have little rerun syndication value after their initial broadcast, regardless of how many television seasons they are broadcast.\nTelevision Market, Production and Licensing - -------------------------------------------\nMarket. The market for television programming is composed primarily of ------ the major television networks (ABC, CBS, NBC and Fox Broadcasting Company), syndicators of first-run programming (such as Columbia, Inc. and Time Warner, Inc.), which license programs on a station-by-station basis, and basic and pay cable networks (such as Lifetime, Turner Network Television and USA Network). The Company also deals directly with companies such as Sea World and Taco Bell, which finance the production of specials on which they intend to advertise their products. The Company also works closely with dccp to provide television expertise to those corporations seeking television outlets for their events and promotions.\nProduction. The production of television programming involves the ----------- development of a format based on a creative concept or literary property into a television script or teleplay, the selection of talent and, in most cases, the filming or taping, technical and post-production work necessary to create a finished product. The Company is continuously engaged in developing and acquiring concepts and literary properties, the most promising of which serve as the basis of a format, which is a summary of the plot or concept, a description of the principal characters or performers, and which, in the case of a dramatic presentation, may contain sample dialogue.\nThe development of a project often begins with a meeting of the Company's development personnel,\nproducers, directors and\/or writers, to review the concept. Most of the Company's projects are originated by its own staff, although due to the Company's reputation in the television industry, concepts for development are frequently brought to the Company by persons who are not affiliated with the Company. If a concept is attractive, the Company will present it to a prospective licensee: either one of the television networks, a first-run syndicator, a cable network or an advertiser. Alternatively, a prospective licensee, in particular, an advertiser, will often request the Company to develop a concept for a particular time period or type of audience.\nIf a concept is accepted for further development, the prospective licensee will usually commission and pay for a script prior to committing itself to the production of a program. However, in the case of the Company's entertainment programming as well as its awards specials, the licensee will generally order production of the program based on the initial presentation. Only a small percentage of the concepts and scripts presented each year are selected to be produced.\nGenerally, the network or other licensee retains the right to approve the principal creative elements of a television production. Once a script is approved by the licensee, a license fee is negotiated and pre-production and production activities are undertaken. In the case of a game show, a finished pilot episode usually is submitted for acceptance as a series before additional episodes are ordered. A production order for a series is usually for a specified number of episodes with the network or other licensee retaining an option to renew the license. The production of additional episodes for a series or additional versions of a special is usually dependent on the ratings obtained by the initial run of episodes of the program.\nLicensing. A majority of the Company's revenues are derived from the --------- production and licensing of television programming. The Company's television programming is licensed to the major television networks, cable networks, domestic and foreign syndicators and advertisers. The Company also receives production fees from program buyers who retain ownership of the programming. The Company has sold or licensed its programs to all the major networks and to a number of first-run syndicators, cable broadcasters and advertisers. During one or more of the three fiscal years, ended June 30, 1995, at least one but not more than three customers has individually accounted for more than 10% but in no event greater than 35% of the Company's revenues. See Note 2 \"Summary of Significant Accounting Policies\" to the Company's Consolidated Financial Statements on page 25. The Company is not committed exclusively to any one network, syndicator, cable network or other licensee for the licensing of the initial broadcast rights to all or any substantial part of the Company's programming.\nThe Company's strategy is to develop programming that does not require deficit financing, such as reality and variety series and award and other event specials, which have the potential to be profitable in the first year of release as well as to be renewed annually. The typical license agreement provides for a fixed license fee to be paid in installments by the licensee to the Company for the right to broadcast a program or series in the United States for a specified number of times during a limited period of time. In some instances, the Company shares its percentage of net profits from distribution with third parties who contributed to the production of the program. In the case of license agreements involving specials or music, variety, and game show series, the fixed license fee is ordinarily in excess of production and distribution costs. For selected projects, however, the Company may elect to produce programming for which the initial license fees will not cover its production and distribution costs in the first year of a project's release. For example, among the specials the Company produced in fiscal 1994 was the Chrysler American Great 18 Golf Championship for -------------------------------------------- ABC. In a departure from the Company's usual practice of licensing specials to the networks for a fee, the Company funded the cost of production and purchase of advertising time on the network for this special and was responsible for selling the advertising time.\nDuring the term of a first-run broadcast license, the Company generally retains all other distribution rights associated with the program, including all foreign distribution rights. In the case of television movies, the Company will often presell domestic, foreign and other rights in order to cover all of the production and distribution costs for the television movie. From time to time, the Company has entered into non-exclusive agreements with companies such as Alfred Haber, Inc., and Astral Bellevue Pathe, Inc. for the foreign distribution of certain of its series, specials and television movies. The Company also occasionally licenses its programming directly to foreign\nbroadcasters.\nAfter the expiration of a first-run broadcast license, the Company makes the program available for other types of domestic distribution when it has retained ownership and\/or distribution rights to the program. In fiscal 1993, the Company, on behalf of the C&C Joint Venture (described hereinafter), licensed previously produced series episodes of TV's Bloopers & Practical Jokes ------------------------------- (\"Bloopers\") to E! Entertainment Television, the cable network. The license provides for a three-year term and a maximum of nine repeat broadcasts, with the broadcast rights reverting back to the C&C Joint Venture after the expiration of the license term. The Company also licenses the syndication rights to television movies from its library, which the Company is often able to syndicate a number of times over a period of many years. In each of fiscal 1993, 1994 and 1995, the Company licensed the previously broadcast television movie The Man in the Santa -------------------- Claus Suit. However, a majority of the Company's programming to date has - ---------- generally consisted of annual, recurring and individual entertainment and music specials, which generally do not have significant rerun syndication or other ancillary value.\nThe Company has also used its library of entertainment and music specials to create new programming. For example, in fiscal 1994 the Company used its library to produce and deliver American Bandstand Presents the Teen Idols and ------------------------------------------ American Bandstand Presents the Number 1 Hits. - ---------------------------------------------\nTelevision Programming - ----------------------\nThe Company has in development and production numerous television projects for broadcast on network television, first-run syndication and cable television. The Company has an established reputation among the major networks and cable broadcasters as a premier producer of television awards programming. The Company is also strongly committed to the ongoing development of entertainment specials and series which include music, variety and comedy programming formats as well as reality-based programming. The Company employs experienced producers responsible for the development and production in each of these varied programming formats.\nAnnual Recurring and Other Specials. The Company is a leading television ----------------------------------- producer of award specials, which are a significant part of the Company's television production business and contribute a consistent revenue stream. The Company's award specials have enjoyed sustained growth, and several such programs have been produced by the Company for more than 15 years. Many of these award specials have been renewed for fiscal 1996, and certain of the specials have been renewed for a period of several years, thereby providing the Company with a foundation for future revenues.\nThe award specials produced by the Company for broadcast during fiscal 1995 were all well received, and many have been renewed for fiscal 1996. The Company's award specials during fiscal 1995 included The 22nd Annual American ------------------------ Music Awards (ABC), the Company's most enduring award special and one of the - ------------ music industry's biggest events; The 52nd Annual Golden Globe Awards (TBS), the ----------------------------------- Company's thirteenth annual production for the Hollywood Foreign Press Association, acknowledging excellence in television and motion pictures; The --- 11th Annual Soap Opera Awards (NBC), produced for the eighth consecutive year; - ----------------------------- The 30th Annual Academy of Country Music Awards (NBC), another popular, long- - ----------------------------------------------- running awards production; The Jim Thorpe Pro Sports Awards (ABC); and The 22nd -------------------------------- -------- Annual Daytime Emmy Awards (NBC), presented by the National Academy of - -------------------------- Television Arts & Sciences to daytime television shows and artists (our third year of production). The Company has an agreement with the ABC television network to produce The American Music Awards annually through the year 2000. The Company has entered into a new contract to move the Golden Globe Awards show to the NBC Television Network in fiscal 1996 also with improved contract revenues.\nThe following award specials aired in fiscal 1994 and placed first in their time periods: The 21st Annual American Music Awards (ABC); The 10th Annual ------------------------------------- --------------- Soap Opera Awards (NBC); and The 29th Annual Academy of Country Music Awards - ----------------- ----------------------------------------------- (NBC). Also produced and broadcast in fiscal 1994 were The 51st Annual Golden ---------------------- Globe Awards for TBS and The Jim Thorpe Pro Sports Awards (ABC). - ------------ --------------------------------\nThe following award specials aired in fiscal 1993 and placed first in their time periods: The 20th Annual American Music Awards (ABC); The 9th Annual ------------------------------------- -------------- Soap Opera Awards (NBC); The 28th Annual Academy of Country Music Awards, which - ----------------- - ------------------------------------------------ for the first time was a three-hour program. Also produced and broadcast in fiscal 1993 were The 50th Annual Golden Globe Awards for TBS and The 14th Annual ----------------------------------- --------------- Cable ACE Awards for Lifetime Television. - ----------------\nIn addition to producing award specials for television, the Company is constantly developing new concepts for television specials. Two important aspects of the Company's production of specials are that the specials may serve as pilots for the development of series programming and that specials may be produced on an annual or recurring basis. For instance, the Bloopers programs (NBC) evolved from an entertainment special to a series. The original special, which was aired in 1981, developed into a one-hour primetime series on NBC and ran for three seasons ending with the 1985\/1986 television season. In fiscal 1991, NBC ordered 12 additional Bloopers episodes as a series. The Company produced The Return of TV Censored Bloopers I and II in fiscal 1994 and The ------------------------------------------- --- Return of TV Censored Bloopers III and IV in fiscal 1995. These new specials, - ----------------------------------------- which are based upon the successful \"Bloopers\" format, are wholly owned by the Company.\nOver the years, the Company has earned the reputation of delivering quality entertainment specials on time and on budget. As a result, many specials have become annual events or have developed into a series of specials. The Company produced the following specials during fiscal 1995: Dick Clark's New ---------------- Year's Rockin' Eve 1995 (ABC), which was broadcast for the 23rd consecutive - ----------------------- year; Will You Marry Me 2 and 3, the latest two installments of a series of ------------------------- specials produced for ABC; Christmas at Home With the Stars (ABC), a special -------------------------------- showcasing individual music stars preparing for Christmas celebration with their families; When Stars were Kids (NBC), a special highlighting the childhood of -------------------- celebrities; Rudy Coby: The Coolest Magician on Earth (Fox), a magic special ---------------------------------------- that first aired in fiscal 1995 and has been picked up by Fox for a second show in fiscal 1996; and Party for the Planet (CBS), the latest in a series of -------------------- specials sponsored by Busch Gardens\/Sea World recognizing environmental efforts by America's youth (the Company's eighth year of production). The Company has an agreement with ABC to produce Dick Clark's New Year's Rockin' Eve through the ----------------------------------- year 2000.\nAmong productions during fiscal 1994 were: Dick Clark's New Year's ----------------------- Rockin' Eve 1994 (ABC), which was broadcast for the 22nd consecutive year; Hot - ---------------- ---- County Jam '94 (NBC), which brought together preeminent country performers for a - -------------- live broadcast from Nashville, Tennessee, based upon the Company's Hot Country ------------ Nights television series; The Sea World\/Busch Gardens Summer Celebration 1994 - ------ --------------------------------------------------- (CBS); American Bandstand Presents the Teen Idols (NBC), which showcased major ------------------------------------------ performances as they originally appeared in the popular American Bandstand series; American Bandstand Presents the Number 1 Hits (NBC), which assembled --------------------------------------------- celebrated aspects of music captured over 30 years of the American Bandstand series; World Cup '94: The Final Draw, which was telecast in the United States ----------------------------- on ESPN and was viewed by an estimated worldwide audience of over 750,000,000, featured stars from the soccer and entertainment worlds and was one of the first major events leading to the 1994 World Cup games; Universal Studios Summer Blast ----------------- ------------ (NBC), which introduced the upcoming summer schedule at the Universal Studios theme parks; and Will You Marry Me? (ABC), a Valentine's Day special which ----------------- explored celebrity and non-celebrity marriage proposals. In addition, The --- Chrysler American Great 18 Golf Championship, the Company's venture into sports - -------------------------------------------- entertainment, featured PGA Tour professionals John Daly, Tom Kite, Davis Love, and Fuzzy Zoeller competing in a round of golf on challenging holes at eighteen distinctive golf courses across the United States.\nThe Company produced eight entertainment and concept specials in fiscal 1993. Three of these recurred as annual specials: Dick Clark's New Year's ----------------------- Rockin' Eve (ABC), The Return of TV Censored Bloopers (NBC) and Sea World\/Busch - ----------- ---------------------------------- --------------- Gardens Summer Celebration. Other specials produced during fiscal 1993 included - -------------------------- the following: The Olsen Twins' Mother's Day Special (ABC), featuring Mary-Kate ------------------------------------- and Ashley Olsen of the TV sitcom Full House; The Academy of Country Music's ------------------------------ Greatest Hits (NBC), hosted by Naomi Judd and Clint Black; and The Olympic Flag - ------------- ---------------- Jam, a special for the Atlanta Committee for the Olympic Games, Inc. - --- In addition to the production of new programming, the Company markets material from previously produced programs for new development projects. Programs such as The Academy of Country Music's Greatest Hits, produced and -------------------------------------------- delivered in fiscal 1993 for NBC, utilize footage from previous programs. In fiscal 1994, the Company produced The American Music Awards 20th Anniversary ------------------------------------------ Special (NBC), which featured live performances by prior - -------\nAmerican Music Award winners, as well as clips of nearly 200 stars from the first twenty years of the Awards; and The Golden Globes 50th Anniversary ---------------------------------- Celebration, which spotlighted honorees and film experts from prior years. - -----------\nSeries. The Company is actively developing programs and ideas for ------- potential series production. During fiscal 1995 the Company carefully nurtured one key series through the development process - Tempestt. This series was --------- developed in the Fall of 1994, in conjunction with Columbia TriStar Television, the distributor of the highly successful The Ricki Lake Show. The Company ------------------- produced a pilot, which was used to clear 195 markets covering 95% of the country by June 1995. Series preproduction began in July 1995 leading to the September 11, 1995 premiere. Hosted by Tempestt Bledsoe, one of the stars of the immensely successful The Cosby Show, this series is targeted to attract the -------------- important talk show audience from age 18 to 49. Also, in the series area, the Company has been engaged by The Nashville Network to produce a 5-day per week country talk variety show which is tentatively scheduled to begin in January 1996.\nSome of the Company's previously produced specials, such as American -------- Bandstand: One More Time and Caught in the Act, can also serve as a basis for a - ------------------------ ----------------- series. Several other pilot\/specials are currently in various stages of development.\nDramatic and Situation Comedy Programming. The Company believes that the ----------------------------------------- present market conditions do not create a prudent risk-reward ratio for situation comedies and dramatic series in light of the deficit financing costs associated with producing such programs. The Company is being selective in developing only those ideas and concepts that require minimal deficit investment.\nMovies. Capitalizing on its experience in the television industry, the -------- Company develops television movies that require little or no deficit financing. Elvis and the Colonel: The Untold Story, starring Beau Bridges as Colonel Tom - --------------------------------------- Parker, was produced and aired on NBC in fiscal 1993. During fiscal 1994, the Company delivered a television movie starring Beau Bridges and Lloyd Bridges entitled Secret Sins of the Father, which aired on NBC. The Company presently ------------------------- has television movie projects in funded development for ABC, NBC, and CBS.\nBy working with major studios that can provide financing, the Company also develops theatrical film projects on a limited basis. During fiscal 1995, the Company developed a feature film project, National Lampoon's Senior Trip, which ------------------------------ was produced and distributed by New Line Cinema.\nMedia Archives and Home Video - -----------------------------\nThe Company believes that it owns one of the largest collections of musical performance footage, including 16mm films that have been enhanced and transferred to video tape, and keeps an updated, computerized index of available material. The Company also occasionally acquires from others the rights to license classic performances by popular recording artists. These rights are acquired from the copyright holders and then licensed for television, film, cable and home video. Although the Company's archives are used primarily as source material for the Company's productions, the Company has expanded its role of acquiring rights to performances and licensing them to third parties. In fiscal 1995, the Company licensed footage from its library to ABC, NBC, CBS, Paramount Television, The BBC and Picture Music International, among others.\nIn fiscal 1995, the Company licensed clips from American Bandstand and ------------------ other television programs to Time-Life Music in connection with an infomercial, which was designed to market a compact disc or cassette series entitled Dick ---- Clark's Rock & Roll Era. The licensing agreement provides for a royalty to be - ----------------------- paid to the Company for each sale.\nThe Company also uses its media archives to produce programs intended directly for the home video market. The Company's previously produced home videos include The Rock & Roll Collection: Dick Clark's Golden Greats, a compilation of episodes from the series of the same name; Best of Bandstand Volumes I & II, a collection of clips from the American Bandstand series; Elvis, The Movie; and several other television movies from the Company's library. These home video releases are distributed by various independent distribution companies.\nEntertainment-Related Businesses - --------------------------------\nThe Company has built upon its strong foundation and continued success in the television industry by expanding into businesses that capitalize on the strength of its expertise, and on trademarks, such as American Bandstand(R), as well as the Company's goodwill, existing business relationships and other assets.\ndick clark corporate productions, inc. The Company's efforts to identify ------------------------------------- new markets for its production expertise resulted in the launch of dick clark corporate productions, inc. in fiscal 1991. dccp specializes in providing corporate production services to help businesses communicate with customers, employees, the general public and other constituencies. Using the entertainment resources of the Company, dccp is able to provide solutions to businesses seeking alternatives to the traditional forms of communication to reach their intended audiences.\ndccp combines the Company's entertainment resources, business relationships and talent contacts with experienced corporate communications professionals. Through this combination, dccp can provide services for new product introductions; special events and event marketing; trade shows and exhibits; film and video production; themed-entertainment attractions; and sales and recognition meetings.\nDuring fiscal 1995 dccp delivered the following projects: The Apple USA ------------- FY'95 Sales Conference in Atlanta Georgia, created and produced to communicate - ---------------------- business plans and objectives for the coming year, as well as to recognize outstanding individual and team achievements; Wendy's 25th Anniversary Franchise ---------------------------------- Meeting in Dallas, Texas for Wendy's International, Inc. created and produced to - ------- convey business plans, recognize outstanding franchisees and celebrate the company's 25th anniversary; A Mazda Motor of America auto show presentation ----------------------------------------------- designed to launch Mazda's new Protege Sedan; an exhibit for the PC Expo in New York for Apple Computers; certain elements of a broad ranging marketing program to introduce the new BMW Z3 Roadster (this project, which includes event marketing, image development, public relations and product placement, will be implemented primarily during fiscal 1996).\ndccp's fiscal 1994 projects included: the introduction of the 777 jetliner for the Boeing Company, which was widely covered by domestic and international media and was viewed by an audience of 100,000 during a one-day presentation at the Boeing facility in Everett, Washington; the 1995 Model Year --------------- Dealer Meeting for Mazda at Bally's Hotel in Las Vegas, which introduced the new - ------------------------ Mazda \"Millennia\" luxury sedan to the national dealer network; The Journey ----------- Inside, an IMAX film underwritten by Intel Corporation through its Intel Digital - ------ Education and Arts (IDEA) group, which was the first narrative IMAX film to combine Hollywood feature-film talent and production skills with IMAX technology; the main live entertainment event for the 1994 VISA International ----------------------- Annual Conference in Cancun, Mexico, which was attended by representatives from - ----------------- over 60 countries around the world; Borland International's Fall 1993 Workgroup ------------------------------------------- Strategy announcement show in a live television show format, which introduced an - -------- important new product platform for Borland; and The Worlds of Intel 25th ------------------------ Anniversary Summer Tour, celebrating Intel Corporation's first quarter-century - ----------------------- of success, which traveled to five cities in six weeks, entertained nearly 30,000 persons, and was produced in venues including indoor convention centers and outdoor fields.\nFor fiscal 1993, dccp's projects included: AT&T Consumer Products event which was staged at the winter Consumer Electronics Show in Las Vegas; the Olympic Flag Jam '92 for the Atlanta Committee for the Olympic Games, which - -------------------- marked the official transfer of the Olympic flag from Barcelona to Atlanta; and The Sunkist Story - A Heritage of Quality, a 26-minute film that chronicled the - ----------------------------------------- events and history for the first 100 years of the Company. dccp also developed a series of corporate meetings for IBM's top business partners in fiscal 1993, which was held at the Palace of Fine Arts and the Warfield Theater in San Francisco.\nFor fiscal 1996, the Company has already built a client list which includes such organizations as IBM, Honda, Hyundai and Apple.\nDirect Marketing. Direct marketing to consumers through cable shopping ---------------- networks, television infomercials and print advertising is a growing industry, and the Company is exploring various avenues for business opportunities in this growing market.\nIn late fiscal 1993, the Company launched geviderm, inc., a wholly-owned subsidiary, which is developing and sold various skin care products. The Company has an agreement with Olive Enterprises, Inc., a Company controlled by Mr. Clark, to provide the performance services of Dick Clark, to sponsor geviderm inc.'s products for a fee of 6% of net sales. The Company is exploring other marketing approaches for the geviderm(R) skin care line in fiscal 1996.\nIn fiscal 1994, the Company established the CLICK Records\/(TM)\/ Inc. (\"CLICK\") label in association with SONY Music for worldwide distribution of its recordings. Under the terms of the Company's agreement with Sony Music, the Company is not responsible for financing the production or distribution costs of its recordings. The strategy for the label involves enlisting the talent of popular recording artists of the '60s, '70s and '80s to perform classic as well as contemporary songs by varied composers and groups, resulting in recordings with wide appeal.\nThe first album released in fiscal 1995 was featuring The 5th Dimension recording songs by such composers and groups as Stevie Wonder, The Bee Gees, 5th Dimension in the House and Brenda Russell. Artists contributing performances to this premiere album include Smokey Robinson, Philip Bailey of Earth, Wind & Fire, Brenda Russell, Wanda Vaughn of the Emotions, Billy Preston and Melvin Franklin of the Temptations. CLICK will release one more album then the Company will re-evaluate the profitability of the label.\nDESCRIPTION OF BUSINESS -----------------------\nRESTAURANT OPERATIONS ---------------------\nIntroduction - ------------\nThe Company's restaurant operations are conducted by dick clark restaurants, inc. (\"dcri\"), a wholly-owned subsidiary of the Company, and dcri's wholly-owned subsidiaries. The restaurant operations includes food and beverage service as well as music, dancing and merchandising activities. Capitalizing on the popularity of the American Bandstand television show and over 40 years of ------------------ contemporary music, \"Dick Clark's American Bandstand Grill\" entertainment theme restaurants are a natural extension of the Company's business. Elements of the theme include: the \"Great American Food ExperienceTM\", a unique menu concept featuring a variety of delicious regional specialties from around the country; a design featuring a one-of-a-kind entertainment atmosphere based on the American -------- Bandstand television show and the music industry over the last four decades; a - --------- dance club area within the restaurant with a state-of-the-art audio-visual entertainment system; and signature \"American Bandstand Grill\" merchandise for customers to purchase. Each \"Dick Clark's American Bandstand Grill\" also features memorabilia and other items generally associated with rock n' roll and the Company's activities throughout the years, including, vintage photos, gold and platinum albums, original stage costumes, concert programs, rock stars' musical instruments and rare posters.\ndcri and Harmon Entertainment Corporation, a New Jersey corporation (\"Harmon\"), were originally partners in Entertainment Restaurants, a New York partnership (the \"Partnership\"), which was created to own, operate and manage \"Dick Clark's American Bandstand Grill\" restaurants. The first restaurant developed by the Partnership was opened in March 1990 in Miami, Florida, under the name \"Dick Clark's American Bandstand Grill\". The Partnership purchased Harmon's interest in the Partnership pursuant to a Redemption and Settlement Agreement (\"Redemption Agreement\") dated as of June 14, 1990. Upon such redemption, dcri became the sole owner of all of the assets of the Partnership. In January 1993, the Company re-evaluated the Miami restaurant and negotiated a termination of the lease with the lessor, Bayside Center Limited Partnership (\"Bayside\"). As a result of the termination agreement, the Miami restaurant was closed on June 22, 1993. In connection with the termination of this lease, the Company wrote off $695,000 in leasehold improvements. The cost of closing the Miami restaurant was offset in part by payments to be made by Bayside pursuant to the lease termination agreement. The closing costs, net of these payments and a reserve established in fiscal 1992, had an immaterial effect on the results of operations for fiscal 1993. In August 1992, the Company opened the first Company operated - \"Dick Clark's American Bandstand Grill\" restaurant in Overland Park, Kansas. In fiscal 1994, additional \"Dick Clark's American Bandstand Grill\" restaurants were opened in Indianapolis, Indiana, and Columbus, Ohio.\nPursuant to the Redemption Agreement, the Company had an obligation to pay Harmon a royalty of up to $10,000,000 at a rate of 1.5% of all restaurant revenues of which $1,000,000 was advanced to Harmon at the time the Redemption Agreement was entered into by the parties thereto. Pursuant to a modification dated December 31, 1994 to the Redemption Agreement, the Company paid Harmon $3,128,000 as pre-payment of the remaining portion of this obligation. As part of this transaction, Harmon paid the Company $358,000 in settlement of amounts owed to the Company by Harmon pursuant to the findings of an audit conducted in connection with the Redemption Agreement. As a result of the pre-payment, the Company has satisfied in full its royalty obligation to Harmon under the Redemption Agreement. Harmon also dropped a previously asserted claim that it was owed certain other amounts under the Redemption Agreement. The Company will amortize the prepaid royalty at the rate of 1.5% of revenues after the $1,000,000 advanced to Harmon is recouped.\ndcri has numerous memorabilia displayed in its restaurants and such memorabilia are an integral part of the restaurant's theme. Some of the memorabilia is owned by Olive Enterprises, Inc. (\"Olive\"), an affiliated company which is owned by Mr. Clark and Mr. LaMaina the Company's Chief Operating Officer and loaned to dcri without charge. In fiscal 1995 dcri began acquiring memorabilia for its own use.\nOperations - ----------\nSignificant resources are devoted to ensure that \"Dick Clark's American Bandstand Grill\" restaurants offer the highest quality food and service. Through its managerial personnel, the Company standardizes specifications for the preparation and service of its food, the maintenance and repair of its premises and the appearance and conduct of its employees. Operating specifications and procedures are documented in a series of manuals. Emphasis is placed on ensuring that quality ingredients are delivered to the restaurants, continuously developing and improving restaurant food production systems, and ensuring that all employees are dedicated to delivering consistently high-quality food and service.\nThe primary commodities purchased by the \"Dick Clark's American Bandstand Grill\" restaurants are beef, poultry, seafood and produce. The Company monitors the current and future prices and availability of the primary commodities purchased by the Company to minimize the impact of fluctuations in price and availability and to make advance purchases of commodities when considered to be advantageous. However, purchasing remains subject to price fluctuations in certain commodities, particularly produce. All essential food and beverage products are available, or upon short notice can be made available, from alternative qualified suppliers.\nThe Company maintains centralized financial and accounting controls for \"Dick Clark's American Bandstand Grill\" restaurants, which it believes are important in analyzing profit margins. The restaurants utilize a computerized POS system which provides point-of-sale transaction data and accumulation of pertinent marketing information. Sales data are collected and analyzed on a daily basis by management.\nLocations. The success of any restaurant depends, to a large extent, on ---------- its location. The site selection process for the Company's restaurants consists of three main phases: strategic planning, site identification and detailed site review. The strategic planning phase ensures that restaurants are located in population areas with demographics that support the entertainment concept. In the site identification phase, the major trade areas within a market area are analyzed and a potential site identified. The final and most time-consuming phase is the detailed site review. In this phase, the site's demographics, traffic and pedestrian counts, visibility, building constraints, and competition are studied in detail. A detailed budget and return-on-investment analysis are also completed. Senior management inspects and approves each restaurant site prior to its lease, acquisition or construction.\nThe Company currently expects to use two fixed configurations in building new restaurants. The lease configuration provides seating for an average of 300 customers and requires an average investment to date of approximately $1.8 million. The purchase-and-build configuration is expected to cost approximately $3 million. The Overland Park and Indianapolis restaurants are leased facilities. The Columbus restaurant was built on land purchased by the Company.\nAs a result of the success of the Company-originated restaurants to date, the Company's objective is to continue its expansion efforts by opening Company- operated units in key regional markets across America.\nIntended as a market test, last year the Company, through a joint venture, opened a dance-club only variation of the \"Dick Clark's American Bandstand Grill\" in the legendary Harold's Club in Reno, Nevada. Although the concept has been profitable, the Company has chosen to focus its expansion efforts on restaurants, which the Company believes have a broader market appeal and greater potential for future revenue growth.\nGENERAL INFORMATION -------------------\nJoint Ventures - --------------\nThe Company from time to time enters into joint ventures with parties not otherwise affiliated with the Company whose purpose is the production of entertainment programing and other entertainment related activities associated with the Company's business.\nThe C&C Joint Venture was organized by the Company and Freedom Productions in 1983 to develop and produce the Bloopers series. In December 1988, the Company acquired a controlling interest in the C&C Joint Venture, and the Company's share of net profits and losses in that venture is now 51%.\nDestroyer Productions II was organized by the Company and Appledown Films, Inc. (\"Appledown\") in 1981 to develop and produce feature films based upon the series of novels known as the \"Destroyer\" series, written by Warren Murphy and Richard Sapir. Destroyer Productions II produced Remo Williams: The Adventure ---------------------------- Begins, which was financed and distributed by Orion Pictures Corporation. - ------\nDick Clark's American Bandstand Club, a joint venture between Reno Entertainment, Inc., a wholly-owned subsidiary of dcri, and RLWH, Inc., was organized to own and operate a dance club version of \"Dick Clark's American Bandstand Grill\" in Reno, Nevada. Through its ownership in dcri, the Company owns a 51% controlling interest in this venture.\nTrademarks - ----------\nThe Company licenses from Olive the United States registered service mark American Bandstand(R) and various variations thereof. This license terminates in 1996. In addition, the Company licenses from Olive the service marks and trademarks American Bandstand Grill\/(TM)\/, Dick Clark's American Bandstand Grill\/(TM)\/ and AB (Stylized)\/(TM)\/, which are currently pending registration at the U.S. Patent and Trademark office. This license also terminates in 1996. The Company and Olive have agreed to extend the license on a long-term basis without any license fees payable by the Company. The Company also owns many other trademarks and service marks, including federal registration for such trademarks and service marks related to its television programming and other businesses.\nCertain of the Company's trademarks and service marks may be considered to be material to the Company, such as, the trademark used in connection with the Company's restaurant operations.\nBacklog and Deferred Revenue - ----------------------------\nThe Company's backlog consists of orders by networks, first-run syndicators and cable networks for television programming to be delivered for the 1995\/1996 television season as well as contractual arrangements for the services of dccp. At June 30, 1995, the Company had received orders for 1 series, 9 specials, and 3 corporate production events which are expected to total $39,653,000. At June 30, 1994, the Company had received orders for 11 specials, and two corporate production events and one rerun of a special originally broadcasted in fiscal 1994 which were expected to total approximately $20,511,000. At June 30, 1993, the Company had received orders for eight specials, one movie for television, and three corporate productions events, which were expected to total approximately $26,426,000.\nThe Company receives payment installments in advance of and during production of its television programs. These payments are included in deferred revenue in the Company's consolidated balance sheets and are recognized as revenue when the program is delivered to the licensee. At June 30, 1995, 1994 and 1993, such deferred revenue totaled $4,097,000, $2,286,000, and $7,383,000, respectively.\nCompetition - -----------\nCompetition in the television industry is intense. The most important competitive factors include quality, variety of product, and marketing. Many companies compete to obtain the literary properties, production personnel, and financing, which are essential to market acceptance of the Company's products. Competition for viewers of the Company's programs has been heightened by the proliferation of cable networks, which has resulted in the fragmentation of the viewing audience. The Company also competes for distribution and pre-sale arrangements, as well as the public's interest in, and acceptance of its products. The Company's success is highly dependent upon such unpredictable factors as the viewing public's taste. Public taste changes, and a shift in demand could cause the Company's present programming to lose its appeal, therefore, acceptance of future programming cannot be assured. Television and feature films compete with many other forms of entertainment and leisure time activities, some of which involve new areas of technology.\nThe Company's principal competitors in television production are the television production divisions of the major television networks and motion picture companies, which are also engaged in the television and feature film distribution business, and many independent distributors. Many of the Company's principal competitors have greater financial resources and more personnel engaged in the acquisition, development and distribution of television programming. At present there is substantial competition in the first-run syndication marketplace, resulting in fragmentation of ratings and advertising revenues.\nCertain of the Company's customers and the television networks may also be considered competitors of the Company in that they produce programming for themselves. Effective June 5, 1993, the Federal Communications Commission (the \"FCC\") adopted substantial modifications to the Financial Interest and Syndication Rule (the \"FinSyn Rule\") originally adopted in 1970 and initially amended in 1992, dealing with network ownership of programming and syndication activities.\nOn September 21, 1995, the FinSyn Rule, as amended, expired, thereby eliminating the interim restrictions of the major networks in the areas of programming ownership and syndication. The new rule allows, among other things, the three major networks to produce and syndicate, in house, all of their primetime entertainment schedule, eliminating a 40% cap on network in-house productions previously imposed in 1992. The networks may continue to obtain a passive financial interest in domestic and foreign syndication rights in all of the remaining programming. Prior to 1992, the networks were limited from negotiating for such ancillary rights on all producer initiated programming for 30 days, allowing the producer to search for other favorable distribution agreements. Prior to the FCC rule changes, the major networks were bound by antitrust decrees which restricted their ability to produce their own programming. With the easing of these restrictions, the major networks have begun to increase the amount of programming they produce through their own production companies. Numerous consolidations have also occurred, further restricting the Company's ability to sell its entertainment programming.\nAs a result of the substantial modifications to the FinSyn Rule, the Company has encountered increased competition in the domestic and foreign syndication of future television programming, and the Company's rerun syndication revenues could be adversely impacted by such modification. In addition, there is increased competition from emerging networks, which are exempt from all restrictions imposed by the FinSyn Rule. The Company believes, however, that it can continue to compete successfully in the highly-competitive market for television programming. This belief is based on management's extensive experience in the industry, the Company's reputation for prompt, cost- efficient completion of production commitments and the Company's ability to attract creative talents.\nCompetition in the restaurant industry can be divided into three main categories: casual dining, and fine dining. The casual dining segment (which includes the Company's restaurant operations) includes a much smaller number of national chains than the fast-food segment but does include many local and regional chains as well as thousands of independent operators. The fine dining segment consists primarily of small independent operations in addition to several regional chains.\nThe restaurant industry is a highly-competitive industry that is affected by many factors including changes in\nthe economy, changes in socio-demographic characteristics of areas in which restaurants are located, changes in customer tastes and preferences, and increases in the number of restaurants. The degree to which such factors may affect the restaurant industry, however, are not generally predictable.\nThe market for corporate production services is large and growing. However, competition in the corporate production services segment is fierce. dccp's principal competitors are other producers of corporate events and films (including Jack Morton Productions and Carabiner, Inc.), which have been in business longer and are more established. The Company believes that dccp can compete successfully in this market by utilizing the Company's experience in producing live events for television and its existing talent and business relationships.\nEmployees - Television Production & Related Activities - ------------------------------------------------------\nAt June 30, 1995, the Company had approximately 75 full-time employees in connection with the Company's television production and related activities. The Company meets a substantial part of these personnel needs by retaining directors, actors, technicians and other specialized personnel on a per production, weekly or per diem basis. Such persons frequently are members of unions or guilds and generally are retained pursuant to the rules of such organizations.\nThe Company is a signatory to numerous collective bargaining agreements relating to various types of employees such as directors, actors, writers and musicians. The Company's union wage scales and fringe benefits follow prevailing industry standards. The Company is a party to one contract with the American Federation of Television and Radio Artists, which expires in November 1997, two contracts with the American Federation of Musicians which expired in February and May of 1992 (the Company is currently operating under the provisions of the contracts which expired and is in negotiations with this union, and expects to renew these contracts in the near future), two contracts with the Directors Guild of America, both of which expire in June 1996, one contract with the Writers Guild of America which expires in May 1998 and two contracts with the Screen Actors Guild, both of which expired in June 1998. The renewal of these union contracts does not depend on the Company's activities or decisions alone. If the relevant union and the industry are unable to come to new agreements on a timely basis, any resulting work stoppage could adversely affect the Company.\nEmployees - Restaurants - -----------------------\nAt June 30, 1995, the Company had approximately 400 employees in its restaurant operations. Employees are paid on an hourly basis, except restaurant managers and certain senior executives involved in the restaurants operations. A majority of the employees are employed on a part-time, hourly basis to provide services necessary during peak periods of restaurant operations. The Company's restaurant operations have not experienced any significant work stoppages and believes its labor relations are good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company leases from Olive under a triple net lease approximately 30,000 square feet of office space and equipment in two buildings located in Burbank, California, for its principal executive offices. The current annual base rent is $568,000 (payable monthly commencing January 1, 1992) and the lease expires on December 31, 2000. The lease agreement provides for rental adjustments every two years, commencing January 1, 1992, based on increases in the Consumer Price Index during the two-year period. The Company subleases approximately 10,000 square feet of space to third parties and affiliated companies on a month-to-month basis. The Company believes that the subleases to affiliated companies are no less favorable to the Company than could be obtained from unaffiliated third parties on an arms-length basis.\nIn January 1993, the Company re-evaluated its Miami restaurant and negotiated a termination of the lease between dcri and its lessor, Bayside. As a result of the termination agreement, the Miami restaurant was closed in June 1993. The cost of closing the restaurant was offset in part by payments to be made by Bayside pursuant to the\ntermination agreement. The closing costs, net of these payments and a reserve established in fiscal 1992, had an immaterial impact on the financial statements in fiscal 1993.\ndcri's subsidiary, Metcalf Restaurants, Inc., is a lessee under a lease agreement with VTB III, a Kansas general partnership, for approximately 12,400 square feet for the site of the American Bandstand Grill restaurant in Overland Park, Kansas. The lease expires on August 14, 2002, subject to two five-year options to extend the lease term. The current annual base rent is $144,000, with percentage rent of 4% on annual sales in excess of $3.6 million.\nHoosier Entertainment, Inc. a subsidiary of dcri is a lessee under a lease agreement with Keystone at Crossings, Inc., an Ohio corporation, for approximately 10,900 square feet for the site of the American Bandstand Grill restaurant in Indianapolis, Indiana. The lease expires on June 30, 2005, subject to an eight-year option to extend the lease term. The current annual base rent is $125,000, with percentage rent of 5% on annual sales in excess of $3.6 million but less than $4.1 million and 3% in sales in excess of $4.1 million.\ndcri's subsidiary Kenwood Entertainment, Inc., is a lessee under a lease agreement with Strategic Retail Trust, a Georgia Trust, for approximately 18,000 square feet for the site of the \"Dick Clark's American Bandstand Grill\" restaurant in Cincinnati, Ohio. The lease expires December 1, 2010, subject to two five-year options to extend the lease term. The current annual base rent is $176,000, with percentage rent of 3% on annual sales in excess of $4.4 million.\ndcpi's subsidiary, dccp, is a lessee under a lease agreement with Chelsea Atrium Associates, a New York Partnership, for approximately 5,000 square feet for the site of the dccp office in New York, New York. The lease expires November 1, 1999. The current annual base rent is $85,000. This amount increases 3.5% annually.\ndccp was a sublessee under a sublease agreement with Rohla Communications International (\"RCI\") for approximately 2,500 square feet for dccp's office in Princeton, New Jersey. Trudi Rohla, who was previously the president of dccp, is the President and principal shareholder of RCI. The sublease expired on June 30, 1995. The Company believes that the terms of the sublease are generally as favorable as the Company could obtain in an arm's-length transaction.\nDick Clark's American Bandstand Club is a lessee under a lease agreement with Fitzgerald's Reno, Inc. for approximately 8,000 square feet for the site of Dick Clark's American Bandstand Club in Reno, Nevada. The lease term expires in August 1998, subject to one five-year option to extend the lease term. The annual base rent was $100.\nThe Company believes the properties and facilities it leases are suitable and adequate for the Company's present business and operations.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is involved in certain litigation in the ordinary course of its business, none of which, in the opinion of management, is material to the Company's financial position. The Company, dcri, and certain Company officers had been named as defendants in a lawsuit brought by Robert Harmon and Harmon. The claim was dropped by Harmon pursuant to a modification of the Redemption Agreement (see Note 4 on Page 27).\nA legal proceeding had been instituted by Immudyne, Inc. against the Company, Mr. Clark and geviderm, inc. in the Federal District Court for the Southern District of Texas, Houston Division. The Company entered into an out of court settlement in May 1995 with Immundyne, Inc. for an amount which management believes,is not material to the Company's results of operations in any reporting period or to the Company's financial position.\nA claim has been filed against the Company by two former employees relating to certain matters occurring prior to the termination of those former employees. Management intends to defend these claims and believes, based on the opinion of outside counsel, that the ultimate outcome will not be material to the Company's results of operations in\nany reporting period or to 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 STOCKHOLDER MATTERS\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\n\/1\/Represents the sum of cash, marketable securities and accounts receivable less accounts payable.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe purpose of the following discussion and analysis is to explain the major factors and variances between periods of the Company's results of operations. This analysis should be read in conjunction with the financial statements and the accompanying notes which begin on page 21.\nIntroduction\nA majority of the Company's revenues are derived from the production and licensing of television programming. The Company's television programming is licensed to the major television networks, cable networks, domestic and foreign syndicators and advertisers. The Company also receives production fees from program buyers who retain ownership of the programming. In addition, the Company derives revenues from the rerun broadcast of its programs on network and cable television and in foreign markets as well as the licensing of its media and film archives to third parties for use in feature films and television movies, specials and commercials. The Company, on a limited basis, also develops theatrical films in association with established studios that provide the financing necessary for production.\nThe Company also derives substantial revenue from its entertainment-related businesses including restaurants (dick clark restaurants, inc., and its subsidiaries), corporate events and production (dick clark corporate productions, inc.) and skin care (geviderm, inc.). These businesses, on a combined basis contributed approximately 40%, 34% and 37% to the Company's consolidated revenues for the fiscal years ended June 30, 1995, 1994, and 1993, respectively.\nGeneral\nLicense fees for the production of television programming are paid to the Company pursuant to license agreements during production and upon delivery of the programs or shortly thereafter. Revenues from network and cable television license agreements are recognized for financial statement purposes upon delivery of each program or episode. Revenues from rerun broadcast (both domestic and foreign) are recognized for each program when it becomes contractually available for broadcast.\nProduction costs of television programs are capitalized and charged to operations on an individual program basis in the ratio that the current year's gross revenues bear to management's estimate of the total revenues for each program from all sources. Substantially all television production costs are amortized in the initial year of delivery, except for successful television series and television movies where there is likely to be future revenues earned in domestic syndication and other markets. Successful television series and television movies can achieve substantial revenues from rerun broadcasts in both foreign and domestic markets after their initial broadcast, thereby allowing a portion of the production costs to be amortized against future revenues. Distribution costs of television programs are expensed in the period incurred.\n(continued on next page)\nDuring fiscal 1995, 100% of the production costs of television shows delivered during the year were amortized.\nDepending upon the type of contract, revenues for dick clark corporate productions, inc. are recognized when the services are completed for a live event, or when a tape or film is delivered to a customer, or when services are completed pursuant to a particular phase of a contract which provides for periodic payments. Costs of corporate event productions are capitalized and expensed as revenues are recognized.\nLiquidity and Capital Resources\nThe Company's capital resources are more than adequate to meet current working capital requirements. The Company had cash and marketable securities of approximately $29,066,000 as of June 30, 1995 compared to $28,684,000 as of June 30, 1994. The Company has no outstanding bank borrowings or other indebtedness for borrowed money.\nMarketable securities consist primarily of investments in United States Treasury Bills and Treasury Notes. In fiscal year 1994, the Company adopted Statement of Financial Accounting Standards No. 115. This Statement requires investments in debt and equity securities, other than debt securities classified as \"held-to-maturity,\" to be reported at fair value. However, because the Company classifies investments in marketable securities as \"held-to-maturity\", it will continue to carry its investments at cost.\nHistorically, the Company has funded its investment in program costs primarily through installment payments of license fees and minimum guaranteed license payments from program buyers. To the extent the Company produces television movies and television series, the Company may be required to finance the portion of its program costs for these programs not covered by guaranteed license payments from program buyers. During fiscal 1994, the Company, departing from its normal practice, was responsible for deficit financing the costs of the network broadcast time and the production and distribution costs for a sports special. The Company does not anticipate incurring any material deficit financing of programs which are currently in development.\nNet cash provided by operating activities was approximately $24.6 million, $38.3 million and $34.4 million in fiscal 1995, 1994 and 1993, respectively. Net cash used in investing activities was approximately $25.6 million, $36.8 million and $33.5 million in fiscal 1995, 1994 and 1993, respectively. The fluctuations in cash provided by operations and cash used for investing activities for those years primarily reflect general increases and decreases in production activity and the construction of two \"Dick Clark's American Bandstand Grill\" restaurants in fiscal 1994 and two in fiscal 1993.\nThe Company expects that the opening of additional American Bandstand Grill restaurants will be financed from available capital and alternative financing methods such as joint ventures and limited recourse borrowings. The Company anticipates opening two additional locations in fiscal 1996 at an estimated capital investment of $5 million which will be funded by the Company.\nCapital requirements for the Company's corporate events and production business, dick clark corporate productions, inc., are anticipated to be immaterial to the Company's overall capital position in fiscal 1996.\nThe Company expects that its available capital base and cash generated from operations will be more than sufficient to meet its cash requirements for the foreseeable future.\nResults of Operations\nRevenues -- Revenues for the year ended June 30, 1995 were $46,645,000 compared to $58,296,000 for the year ended June 30, 1994 and $43,428,000 for the year ended June 30, 1993. The decrease in revenues in fiscal 1995 as compared to fiscal 1994 is primarily due to the delivery of one time anniversary and tribute specials in fiscal year 1994, as well as reduced revenues from the Company's corporate events and production\nbusiness. This decrease is further explained by a reduction in the number of movies for television produced by the Company in fiscal 1995 as compared to fiscal 1994. The decrease in revenues was offset in part by an increase in revenues generated by the Company's restaurant business principally due to the opening of two new \"Dick Clark's American Bandstand Grill\" restaurants in April and May of 1994.\nThe increase in revenues in fiscal 1994 as compared to fiscal 1993 is primarily attributable to an increase in the number of television specials produced; revenues from the operations of two additional American Bandstand Grill restaurants (Columbus, Ohio which opened in April 1994 and Indianapolis, Indiana which opened in May 1994); and additional and improved production contract rights negotiated through the year 2000 for certain recurring television specials.\nDuring fiscal 1995, revenues from a recurring annual special represented approximately 20% of total revenues. During fiscal 1994, revenues from a recurring annual special represented approximately 15% of total revenues. During fiscal 1993, revenues from a project produced for a corporate events and productions business client represented 17% of total revenues. No other production or project accounted for more than 10% of total revenues for fiscal 1995, 1994 or 1993.\nGross Profits -- Gross profit as a percentage of revenues was 19%, 18% and 12% for fiscal 1995, 1994 and 1993, respectively. The increase in gross profits in fiscal 1994 as compared to fiscal 1993 is primarily attributable to improved production contracts negotiated through the year 2000 for certain recurring specials which were delivered during fiscal 1994 as well as an increase in the number of television specials produced. The increase in gross profits in fiscal 1994 is also attributable to improved gross profits from the Company's restaurant operations.\nOther -- Minority interest expense decreased in fiscal 1995 as compared to fiscal 1994 primarily as a result of the rebroadcast of previously-produced \"Super Bloopers and New Practical Jokes\" during fiscal 1994, which resulted in higher gross profits contributed by the C&C Joint Venture during that period. There were no such rebroadcasts in fiscal 1995. The C&C Joint Venture, of which the Company has a 51% interest, produced the \"Super Bloopers and New Practical Jokes\" television specials. The Bloopers Specials currently being produced by the Company do not include the practical joke segments and are owned 100% by the Company and there is therefore no minority interest expense associated with them.\nThe increase in general and administrative expenses for fiscal 1994 as compared to fiscal 1993 is primarily due to the recognition of profit participations earned as a result of the increased profitability of the Company.\nIncome Taxes\nIn connection with the implementation of Statement of Financial Accounting Standards No. 109 during fiscal 1994, the Company recorded $262,000 of income which represents the cumulative effect of this accounting change. The credit for income taxes in fiscal 1993 is the result of an adjustment to reduce a previously established reserve for federal income taxes. The adjustment resulted from a final report received by the Company in the second quarter of fiscal 1993 from the Internal Revenue Service pursuant to its examination of certain of the Company's federal income tax returns. The report concluded that certain investment tax credits claimed by the Company during fiscal years 1979 through 1984 were allowable. Accordingly, in the second quarter of fiscal 1993 the Company reversed $1,440,000 from a previously established reserve.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nConsolidated Balance Sheets\nThe accompanying notes are an integral part of these consolidated financial statements.\nConsolidated Statements of Operations\nThe accompanying notes are an integral part of these consolidated financial statements.\nConsolidated Statements of Stockholders' Equity\nThe accompanying notes are an integral part of these consolidated financial statements.\nConsolidated Statements of Cash Flows\nThe accompanying notes are an integral part of these consolidated financial statements.\nNotes to Consolidated Financial Statements\n1] Basis of Financial Statement Presentation\nThe consolidated financial statements include the accounts of dick clark productions, inc., its wholly owned subsidiaries and majority owned joint ventures, collectively referred to as the \"Company\". For financial statement reporting purposes, the accounts are consolidated using historical data. All significant intercompany balances and transactions have been eliminated in consolidation.\nThe common stock of the Company is entitled to one vote per share on all the matters submitted to a vote of stockholders, and the Class A common stock is entitled to 10 votes per share. Holders of Class A common stock are entitled to a dividend equal to 85% of any declared cash dividends on the shares of common stock. On liquidation of the Company, holders of the common stock are entitled to receive $2.00 per share before any payment is made to the holders of Class A common stock, and thereafter the holders of Class A common stock are entitled to share ratably with the holders of common stock in the net assets available for distribution.\n2] Summary of Significant Accounting Policies\nRevenues -- A majority of the Company's revenues are derived from the development and production of television programming. Revenues from television program licensing agreements are recognized when each program becomes contractually available for broadcast or when a program is delivered to the buyer. Revenues earned currently which are to be received in future periods are discounted to their present value using the effective interest method.\nDepending on the type of contract, revenues for dick clark corporate productions, inc. are recognized when services are completed for a live event or when a tape or film is delivered to a customer or when services are completed pursuant to a phase of a contract which provides for periodic payment. Revenues for the Company's skin care business are recognized as the products are shipped.\nRevenues by significant customer as a percentage of total revenues are as follows:\nProgram Cost -- Program costs, which include acquired film rights, residual costs, third-party participations and indirect production costs (production overhead) are charged to operations on an individual program basis in the ratio that the current year's gross revenues for each program bears to management's estimate of total ultimate gross revenue (for the current and future years) for that program from all sources. This method of accounting is commonly referred to as the individual-film-forecast method. For the fiscal years ended June 30, 1995, 1994 and 1993 there are $3,576,000, $3,171,000 and $2,555,000, respectively, of production overhead included within program costs.\nProgram costs are stated at the lower of unamortized cost or estimated net realizable value on an individual program basis. Ultimate revenue forecasts for programs are periodically reviewed by management and revised if warranted by changing conditions. When estimates of total revenue indicate that a program will result in an ultimate loss, the entire loss is recognized. There were no significant write downs of program costs in the fiscal years ended June 30, 1995, 1994 and 1993.\nNotes to Consolidated Financial Statements\nThe Company periodically reviews the status of projects in development. If, in the opinion of the Company's management, any such projects are not planned for production, the costs and any reimbursements and earned advances related thereto are charged to the appropriate profit and loss accounts. Substantially all production and distribution costs are amortized in the initial year of availability, except with respect to successful television series and television movies. During fiscal 1995, 100% of production costs for shows delivered during the year were amortized.\nMarketable Securities -- Marketable securities consist primarily of investments in United States Treasury Bills and Treasury Notes. In fiscal year 1994, the Company adopted Statement of Financial Accounting Standards No. 115. This statement requires investments in debt and equity securities, other than debt securities classified as \"held-to-maturity\", to be reported at fair value. However, because the Company intends to classify investments in marketable securities as held-to-maturity it will continue to carry the investments at cost. The cost as of June 30, 1995 and 1994 was $25,769,000 and $24,348,000, respectively, and the market value as of June 30, 1995 and 1994 was $25,558,000 and $23,743,000, respectively. As of June 30, 1995, the recorded cost of marketable securities maturing in fiscal 1996, 1997, 1998, 1999 and 2000 are $11,886,000, $10,079,000, $2,603,000, $1,178,000, and $23,000 respectively.\nCash and Cash Equivalents -- Cash equivalents consist of investments in interest-bearing instruments issued by banks and other financial institutions with original maturities of 90 days or less. Such investments are stated at cost, which approximates market value.\nLeasehold Improvements and Equipment -- Included in leasehold improvements and equipment for 1995 and 1994 are land, buildings, leasehold improvements, and furniture and fixtures of $7,523,000, and $7,170,000, respectively; production and other equipment of $1,606,000 and $1,434,000, respectively; and construction-in-progress of $388,000 and $73,000, respectively. Total accumulated depreciation for leasehold improvements and equipment amounted to $2,365,000 and $1,515,000 for those years, respectively.\nDepreciation is calculated using the straight-line method based on estimated useful lives of the applicable property or asset. Useful lives range from 3 to 30 years for buildings and leasehold improvements, 3 years for furniture and fixtures and computer software, and 3 to 5 years for transportation, computer and other equipment.\nIn January 1993, the Company re-evaluated its Miami restaurant and negotiated a termination of the lease with the lessor, Bayside Center Limited Partnership (\"Bayside\"). As a result of the termination agreement, the Miami restaurant was closed on June 22, 1993. In connection with the termination of this lease, the Company wrote off $695,000 in leasehold improvements. The costs of closing this restaurant were offset in part by payments to be made by Bayside pursuant to the termination agreement. The closing costs, net of these payments, and a reserve established in fiscal 1992 had an immaterial effect on the results of operations for fiscal 1993.\nThe cost of normal maintenance and repairs to properties and assets are charged to expense when incurred. Major improvements to properties and assets are capitalized.\nGoodwill and Other Assets -- Goodwill resulting from the Company's acquisition of Entertainment Restaurants (see Note 4) in fiscal 1990 is amortized on a straight-line basis over 20 years. Other assets include capitalized organizational costs and pre-opening costs which are amortized over 5 years and 12 months, respectively. Organizational costs include legal and other expenses relating to the acquisition of Entertainment Restaurants and other activities. Pre-opening costs are limited to direct, incremental costs relating to the Company's start-up activities. Accumulated amortization of goodwill and other assets at June 30, 1995 and 1994 was $1,521,000 and $783,000, respectively.\nUnclassified Balance Sheet -- In accordance with the provisions of Statement of Financial Accounting Standards No. 53, the Company has elected to present an unclassified balance sheet.\nJoint Ventures -- The Company has a controlling interest in several joint venture arrangements in which the Company's share of profits and losses exceed 50%. As a result, the assets, liabilities, revenues and expenses of such joint ventures are included in the consolidated balance sheets and statements of operations of the Company with the amounts due to others shown as minority interest.\nReclassifications -- The consolidated financial statements of prior years reflect certain reclassifications to conform with classifications adopted in the current year.\nNotes to Consolidated Financial Statements\n3] Program Costs\nThe Company is engaged, as one of its principal activities, in the development and production of a wide range of television and corporate programming. Program costs consist of the following:\nThe increase in program costs in process from June 30, 1994 to June 30, 1995 is primarily the result of costs incurred toward the end of fiscal year 1995 with respect to The Tempestt Bledsoe Show and a project for a corporate client.\nManagement's estimate of forecasted revenues related to released programs exceeds the unamortized costs on an individual program basis. Such forecasted revenue is subject to revision in future periods if warranted by changing conditions such as market appeal and availability of new markets. The Company currently anticipates that all of such revenue and related amortization will be recognized under the individual-film-forecast method where programs are available for broadcast in certain secondary markets in years ranging from 1996 through 2001. While management can forecast ultimate revenue based on experience and current market conditions, specific annual amortization charges to operations are not predictable because revenue recognition is dependent upon various external factors including expiration of network license agreements and availability for broadcasting in certain secondary markets. Program costs associated with corporate productions are amortized as projects or identifiable elements pursuant to a contract are delivered.\nBased on management's estimates of gross revenues as of June 30, 1995, approximately 66% of the $257,000 in unamortized program costs applicable to released programs will be amortized during the three years ending June 30, 1998.\n4] Prepaid Royalty\nPursuant to a redemption and settlement agreement dated June 14, 1990 (the \"Redemption Agreement\") between Harmon Entertainment Corporation (\"Harmon\"), a previous co-venturer with the Company in its restaurant business, the Company, dick clark restaurants, inc. (\"dcri\") and certain other parties, the Company had an obligation to pay Harmon a royalty of up to $10,000,000 at a rate of 1.5% of all restaurant revenues of which $1,000,000 was advanced to Harmon at the time the Redemption Agreement was entered into by the parties thereto. Pursuant to a modification dated December 31, 1994 to the Redemption Agreement, the Company paid Harmon $3,128,000 as pre-payment of the remaining portion of this obligation. As part of this transaction, Harmon paid the Company $358,000 in settlement of amounts owed to the Company by Harmon pursuant to the findings of an audit conducted in connection with the Redemption Agreement. As a result of the pre-payment, the Company has satisfied in full its royalty obligation to Harmon under the Redemption Agreement. Harmon also dropped a previously asserted claim that it was owed certain other amounts under the Redemption Agreement. The Company will amortize the prepaid royalty at the rate of 1.5% of revenues after the $1,000,000 advanced to Harmon is recouped.\nNotes to Consolidated Financial Statements\n5] Income Taxes The provision for income taxes consists of the following:\nDeferred income tax expense for fiscal 1993 results from timing differences in the recognition of expense for tax and financial statement reporting purposes. The primary source of these timing differences is the amortization of program costs.\nA reconciliation of the difference between the statutory federal tax rate and the Company's effective tax rate on a historical basis is as follows:\nIn connection with an examination of certain of the Company's federal income tax returns by the Internal Revenue Service (\"the Service\"), the Company received a final report relating to certain investment tax credits previously claimed by the Company with respect to fiscal years 1979 through 1984. The Company had previously established a reserve pending the results of the Service's final report. Based upon the Service's final report, which concluded that the claimed credits were allowable, the reserve was adjusted and the resulting credit of $1,440,000 was recorded against income tax expense in fiscal 1993.\nStatement of Financial Accounting Standards No. 109 requires recognition of deferred tax liabilities and assets for the expected future tax consequences of events that have been included in 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. In connection with the implementation of Statement of Financial Accounting Standards No. 109, the Company recorded $262,000 of income during the first quarter of fiscal 1994 which represents the cumulative effect of this accounting change.\nThe Company paid $2,030,000, $3,357,000 and $1,559,000 for income taxes during the fiscal years 1995, 1994, and 1993, respectively.\nThe components of current and deferred income taxes were as follows:\nNotes to Consolidated Financial Statements\n6] Related Party Transactions\nThe Company is a tenant under a triple net lease (the \"Burbank Lease\") with Olive Enterprises, Inc. (\"Olive\"), a company owned by the Company's principal stockholders, covering the premises occupied by the Company in Burbank, California (see Note 7 for a summary of the terms of the Burbank Lease). The Company subleases a portion of the space covered by the Burbank Lease to Olive and to unrelated third parties on a month-to-month basis. In fiscal years 1995, 1994 and 1993 the sublease income paid by Olive was $12,000, $15,000 and $12,000, respectively. The Company believes that the terms of the Burbank Lease and sublease to Olive are no less favorable to the Company than could have been obtained from unaffiliated third parties on an arms-length basis. No significant leasehold improvements were made in fiscal years 1995 or 1994. The Company also paid Olive $97,000 for storage services during fiscal 1995.\nThe Company provided management and other services to Olive and other companies owned by the Company's principal stockholders of $159,000, $226,000 and $279,000 for the fiscal years 1995, 1994, and 1993, respectively.\nThe Company retained the services of Dick Clark as host for certain of its television programs during fiscal 1995, 1994 and 1993 and paid him host fees of $267,000, $412,000 and $78,000, respectively. Management believes that the fees paid by the Company are no more than it would have paid to an unaffiliated third party on an arms-length basis.\nThe Company licenses the United States registered service mark \"American Bandstand\" and all variations thereof from Olive. This license terminates in fiscal 1996. However, the Company is currently negotiating an extension of the license with Olive. The Company does not pay any license fees to Olive under the current license arrangement.\n7] Commitments and Contingencies\nThe Company has entered into employment agreements with certain key employees requiring payment of annual compensation of $2,941,000, $2,327,000, $553,000, $525,000 and $525,000 for the years ending June 30, 1996, 1997, 1998, 1999 and 2000, respectively. Several agreements also provide for the payment by the Company of certain profit participations based upon the profits from specific programs, and\/or individual subsidiaries or the Company as a consolidated entity, as provided in the applicable agreements. Several agreements have renewal options of up to two additional years. Some of these employment agreements also provide for bonus compensation based on the Company's pre-tax profits (as defined in the applicable contract).\nThe Company renegotiated its Burbank Lease with Olive for the term commencing June 1, 1989 and terminating December 31, 2000. The Burbank Lease expense for the years ended June 30, 1995, 1994, and 1993 was $601,000, $568,000 and $546,000, respectively. The Burbank Lease provides for rent increases every two years commencing January 1, 1992 based on increases in the Consumer Price Index during the two-year period.\nIn January 1993, the Company terminated its lease for the Miami restaurant (see Note 4 for further details).\nA subsidiary of the Company entered into a lease agreement for a restaurant located in Overland Park, Kansas commencing August 1, 1992 which is guaranteed by the Company through August 1, 1997 and terminates July 31, 2002. In September 1993, another subsidiary of the Company also entered into a lease agreement for a restaurant located in Indianapolis, Indiana, commencing December 1, 1993 and terminating June 29, 2005. In March of 1995, another subsidiary of the Company also entered into a lease agreement for a restaurant located in Cincinatti, Ohio commencing December 1, 1995 and terminating November 30, 2010.\nNotes to Consolidated Financial Statements\nTotal lease expense for the Company for the years ended June 30, 1995, 1994 and 1993 was $1,058,000, $868,000, and $1,028,000, respectively. The various operating leases to which the Company is presently subject require minimum lease payments as follows:\nA claim has been filed against the Company by a former employee relating to certain matters occurring prior to the termination of that former employee. The Company is in the process of defending this claim as well as other claims arising in the ordinary course of business. Management believes, based on the opinion of outside counsel, that the ultimate outcome for any of the aforementioned actions, as well as any other legal matters, will not be material to the Company's financial position or to the Company's results of operations in any reporting period.\n8] Stock Options\nIn September 1987, the Company's Board of Directors approved an employee stock option plan which was ratified by the stockholders in November 1987. The plan provides for issuance of up to 1,000,000 shares of the Company's common stock. Options granted under the plan may be either incentive stock options or non- qualified stock options. The exercise price of the incentive and non- qualified stock options must be equal to at least 100 percent or 85 percent, respectively, of the fair market value of the underlying shares as of the date of grant. During fiscal years 1995, 1994 and 1993, respectively, 7,500, 34,000 and 6,000 incentive stock options were granted to certain employees of the Company to purchase shares at prices ranging from $4.50 to $6.50.\nDuring fiscal 1993, 5,000 options expired pursuant to the terms of one of the employment agreements. As of June 30, 1995, 287,950 of the options granted were exercisable at prices ranging from $3.88 to $6.00. The remainder become exercisable as follows: 2,500 in fiscal 1996 and 2,500 in fiscal 1997. As of June 30, 1995, 20,000 of the options granted are exercisable upon certain employees achieving specified goals, none of which have been achieved. The exercise price of these options is set at the stock price at the date of the grant. During fiscal 1995 and 1994, 1,500 and 12,000 options respectively, were exercised. No other options had been exercised prior to fiscal 1994. The dilutive effect of these stock options is not significant to the fiscal 1995, 1994 and 1993 number of shares outstanding and was therefore not included in net income per share.\nNotes to Consolidated Financial Statements\n9] Business Segment Information\nThe Company's business activities consist of two business segments: entertainment operations and restaurant operations. The revenues and gross profits of each of these business segments are reported in the following table. Inter-segment revenues are insignificant.\n\/+\/ Does not include corporate overhead of $1,961,000, $2,185,000 and $1,842,000 for fiscal years 1995, 1994 and 1993, respectively.\nResults of Operations by Quarter\nMarket and Dividend Information\nThe Company's common stock is traded over-the-counter and is quoted on the NASDAQ National Market System (symbol DCPI). The preceding table sets forth the range of prices (which represent actual transactions) by quarters as provided by the National Association of Securities Dealers, Inc.\nThe Company has not paid a dividend during the past two years and does not anticipate paying any dividends in fiscal 1996.\nReport of Independent Public Accountants\n[LOGO OF ARTHUR ANDERSEN & CO. APPEARS HERE]\nTo the Stockholders of dick clark productions, inc.:\nWe have audited the accompanying consolidated balance sheets of dick clark productions, inc. (a Delaware corporation) and subsidiaries as of June 30, 1995 and 1994, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended June 30, 1995. 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 dick clark productions, inc. and subsidiaries as of June 30, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 1995, in conformity with generally accepted accounting principles.\nLos Angeles, California August 25, 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 REGISTRANTS\nThe information required by this item will be included in the Company's definitive proxy statement for its 1995 Annual Meeting of Stockholder (the \"Proxy Statement\") to be filed pursuant to regulation 14A, and such information is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by this item will be included in the Company's definitive Proxy Statement to be filed pursuant to regulation 14A 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 included in the Company's definitive Proxy Statement to be filed pursuant to regulation 14A, and such information is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by this item will be included in the Company's definitive Proxy Statement to be filed pursuant to regulation 14A, and such information is incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) 1 and 2 - Index to Financial Statements and Financial Statements Schedules.\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.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\ndick clark productions, inc.\nBy: \/s\/ Richard W. Clark ------------------------------------ Richard W. Clark Chairman and Chief Executive Officer September 27, 1995\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 W. Clark Chairman September 27, 1995 - ------------------------ Chief Executive Officer Richard W. Clark and Director (Principal Executive Officer)\n\/s\/ Francis C. La Maina President, Chief September 27, 1995 - ------------------------ Operating Officer and Francis C. La Maina Director\n\/s\/ Karen W. Clark Director September 27, 1995 - ------------------------ Karen W. Clark\n\/s\/ Lewis Klein Director - ------------------------ Lewis Klein\n\/s\/ Enrique F. Senior Director - ------------------------ Enrique F. Senior\n\/s\/ Kenneth H. Ferguson Vice President, September 27, 1995 - ------------------------ Treasurer and Chief Kenneth H. Ferguson Financial Officer (Principal Financial and Accounting Officer)\ndick clark productions inc. Marketable Securities For the Year Ended June 30, 1995\nReport of Independent Public Accountants on Supplemental Schedule\nTo the Stockholders of dick clark productions, inc.:\nWe have audited in accordance with generally accepted auditing standards, the financial statements included in dick clark productions, inc.'s annual report to shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated August 25, 1995. Our audit was made for the purpose of forming an opinion on those statements taken as a whole. The schedule of Marketable Securities 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\nLos Angeles, California August 25, 1995\nExhibit Number Description of Document - ------ -----------------------\n3.1 Certificate of Incorporation of the Registrant dated October 31, 1986 and Certificate of Correction dated November 3, 1986, (incorporated by reference to Exhibit 3.1 of the Registrant's Registration Statement No. 33-9955 on Form S-1 (the \"Registration Statement\").\n3.2 By-Laws of the Registrant (incorporated by reference to Exhibit 3.2 of the Registration Statement).\n4.1 Form of Warrant issued to Allen & Company Incorporated and L.F. Rothschild, Unterberg, Towbin, Inc. (incorporated by reference to Exhibit 4.1 of the Registration Statement).\n4.2 Form of certificate for shares of the Registrant's Common Stock (incorporated by reference to Exhibit 4.2 of the Registration Statement).\n9.1 Agreement dated October 31, 1986, between Richard W. Clark and Karen W. Clark with form of voting trust agreement attached (incorporated by reference to Exhibit 9.1 of the Registration Statement).\n10.1 Asset Exchange Agreement dated December 15, 1986, between the Registrant and Olive Enterprises, Inc. (\"Olive\") (incorporated by reference to Exhibit 10.1 of the Registration Statement).\n10.2 Asset Exchange Agreement dated December 15, 1986, among the Registrant and Richard W. Clark, Karen W. Clark and Francis C. La Maina (incorporated by reference to Exhibit 10.2 of the Registration Statement).\n10.3 Bill of Sale and Assignment and Assumption Agreement dated October 30, 1986, between the dick clark company, inc. and dick clark radio network, inc. (incorporated by reference to Exhibit 10.3 of the Registration Statement).\n10.4 License Agreement dated December 15, 1986, between the Registrant and Olive (incorporated by reference to Exhibit 10.5 of the Registration Statement).\n10.5 Lease dated November 1, 1986, between the Registrant and Olive (incorporated by reference to Exhibit 10.5 of the Registration Statement).\n10.6 Shareholders' Agreement dated as of December 23, 1986, among Richard W. Clark, Karen W. Clark and Francis C. La Maina (incorporated by reference to Exhibit 10.14 of the Registration Statement).\n10.7 Agreement and Plan of Merger dated March 1, 1985, between the dick clark company, inc. and La Maina Enterprises, Inc. (incorporated by Registration Statement).\n10.8 Letter Agreement dated July 2, 1986, between the dick clark company, inc. and Lewis J. Korman (incorporated by reference to Exhibit 10.16 of the Registration Statement).\n10.9 1987 Employee Stock Option Plan (incorporated by reference to Registrant's Annual Report on Form 10-K for 1989).\n10.10 Lease Amendment No. 1 dated June 30, 1989, between Olive Enterprises, Inc. and the Registrant amending Lease referred to as Exhibit 10.5 (incorporated by reference to Registrant's Annual Report on Form 10-K for 1989).\n10.11 Redemption and Settlement Agreement dated June 14, 1990, between the Registrant and Harmon Entertainment Corporation (incorporated by reference to Registrant's Current Report on Form 8-K dated June 28, 1990).\n10.12 Sublease Agreement dated December 14, 1990, between Rohla Communications International, Inc. and the Registrant (incorporated by reference to Registrant's Annual Report on Form 10-K for 1991).\n10.13 Letter Agreement dated May 15, 1990. between Alfred Haber, Inc. and the Registrant (incorporated by reference to Registrant's Annual Report on Form 10-K for 1991).\n10.14 Employment Agreement dated as of July 1, 1992, between the Registrant and Richard W. Clark (incorporated by reference to Registrant's Annual Report on Form 10-K for 1991).\n10.15 Employment Agreement dated as of July 2, 1993, between the Registrant and Karen W. Clark (incorporated by reference to Registrants Annual Report on Form 10-K for 1994).\n10.16 Letter Agreement dated as of June 4, 1993, between Olive Enterprises, Inc. for the promotional\/endorsement\/spokesman services of Dick Clark and Geviderm, inc., Inc. in connection with the Geviderm, inc. Skin Care line (incorporated by reference to Registrants Annual Report on Form 10-K for 1994).\n10.17 Joint Venture Agreement dated as of June 22, 1993, between Reno Entertainment, Inc. and RLWH, Inc (incorporated by reference to Registrants Annual Report on Form 10-K for 1994).\n10.18 Employment Agreement dated as of July 1, 1994, between the Registrant and Kenneth H. Ferguson.\n10.19 Agreement dated December 31, 1994 to amend the Redemption Agreement dated June 30, 1990 between Herman Entertainment Corporation, a New Jersy corporation and dick clark restaurants, inc.\n10.20 Employment Agreement dated as of March 1, 1995 between the Registrant and Francis C. LaMaina.\n21.1 List of subsidiaries.\n23.1 Consent of Independent Public Accountants.","section_15":""}
{"filename":"808434_1995.txt","cik":"808434","year":"1995","section_1":"Item 1. Business\nThe Registrant, Inland Mortgage Investors Fund, L.P.-II (the \"Partnership\"), was formed on December 24, 1986 pursuant to the Delaware Revised Uniform Limited Partnership Act. On February 10, 1987, the Partnership commenced an offering of 40,000 Limited Partnership Units (the \"Units\") at $500 per Unit, pursuant to a Registration Statement on Form S-11 under the Securities Act of 1933. The Offering terminated on August 10, 1988, with total sales of 18,776.32 Units, resulting in gross offering proceeds of $9,388,158, which does not include the General Partner's contribution of $500. All of the holders of these Units were admitted to the Partnership. The Partnership funded fifteen loans between December 1987 and June 1992 utilizing $8,131,884 of capital proceeds collected, net of participations. The Limited Partners of the Partnership share in the benefits of ownership of the Partnership's mortgage receivable investments in proportion to the number of Units held. Inland Real Estate Investment Corporation is the General Partner.\nThe Partnership is engaged solely in the business of making and acquiring loans collateralized by mortgages on improved, income producing properties. As of December 31, 1995, the Partnership made and acquired fifteen mortgage loans in or near Chicago, Illinois. The loans are being serviced by Inland Mortgage Servicing Corporation, a subsidiary of the General Partner. The Partnership does not segregate revenues or assets by geographic region, and such a presentation would not be material to an understanding of the Partnership's business taken as a whole.\nThe Partnership had no employees during 1995.\nThe terms of transactions between the Partnership and Affiliates of the General Partner of the Partnership are set forth in Item 11 below and Note (3) of the Notes to Financial Statements (Item 8 of this Annual Report) to which reference is hereby made.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Registrant owns no real properties.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe Partnership is not subject to any material pending legal proceedings.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nThere were no matters submitted to a vote of security holders during 1995.\nPART II\nItem 5.","section_5":"Item 5. Market for the Partnership's Limited Partnership Units and Related Security Holder Matters\nAs of December 31, 1995, there were 789 holders of Units of the Partnership. There is no public market for Units nor is it anticipated that any public market for Units will develop. Reference is made to Item 6","section_6":"Item 6. Selected Financial Data\nINLAND MORTGAGE INVESTORS FUND, L.P.-II (a limited partnership)\nFor the years ended December 31, 1995, 1994, 1993, 1992 and 1991\n(not covered by Report of Independent Accountants)\n1995 1994 1993 1992 1991 ---- ---- ---- ---- ----\nTotal assets........... $ 3,660,678 3,919,522 4,725,413 5,332,066 7,898,981 =========== ========== ========== ========== ==========\nTotal income........... $ 397,275 407,501 478,280 828,210 955,772 =========== ========== ========== ========== ==========\nNet income............. $ 331,245 337,951 410,547 754,132 874,340 =========== ========== ========== ========== ========== Net income allocated to the one General Partner Unit......... $ 12,782 10,149 21,332 33,637 42,104 =========== ========== ========== ========== ========== Net income allocated per Limited Partner Unit (b)............. $ 16.96 17.46 20.73 38.37 44.32 =========== ========== ========== ========== ==========\nDistributions to Limited Partners from: Operations............. 331,076 375,976 429,753 690,951 854,116 Repayment proceeds..... 260,833 768,027 562,984 2,592,104 617,198 ---------- ----------- ---------- ---------- ---------- $ 591,909 1,144,003 992,737 3,283,055 1,471,314 =========== ========== ========== ========== ========== Distributions per Unit to Limited Partners from (b): Operations............. 17.63 20.02 22.89 36.80 45.49 Repayment proceeds..... 13.89 40.91 29.98 138.05 32.87 ---------- ----------- ---------- ---------- ---------- $ 31.52 60.93 52.87 174.85 78.36 =========== ========== ========== ========== ==========\n(a) The above selected financial data should be read in conjunction with the financial statements and related notes and management's discussion (Items 7 and 8) appearing elsewhere in this Annual Report.\n(b) The net income per Unit and distributions per Unit are based upon the weighted average number of Units outstanding of 18,776.32.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nLiquidity and Capital Resources\nOn February 10, 1987, the Partnership commenced an Offering of 40,000 Limited Partnership Units pursuant to a Registration Statement on Form S-11 under the Securities Act of 1933. The Offering terminated on August 10, 1988 with a total of 18,776.32 Units being sold to the public at $500 per Unit resulting in $9,388,158 gross offering proceeds which were received by the Partnership, which does not include the General Partner's $500 contribution. The Partnership funded fifteen loans between December 1987 and June 1992 utilizing $8,131,884 of capital proceeds collected, net of participations. As of December 31, 1995 cumulative distributions to Limited Partners totaled $9,801,687. A total of $5,725,926 of mortgage receivables has been repaid by borrowers, of which $966,160 has been reloaned and $4,753,429 was repayment proceeds and principal amortization distributed to Limited Partners and $6,337 was added to the working capital reserve.\nThe source of future liquidity and distributions is expected to be through cash generated by earnings from the Partnership's mortgage investments and through the repayment of such investments. To the extent that cash flow is insufficient to meet the minimum 7% annualized distribution to investors, as well as any other financial needs, the Partnership may rely on Supplemental Capital Contributions from the General Partner, advances from Affiliates of the General Partner or other short term financing.\nAs of December 31, 1995, the Partnership had cash and cash equivalents of $251,654. The Partnership intends to use such remaining funds to pay distributions and for working capital requirements.\nResults of Operations\nInterest income on mortgage loans receivable decreased for the year ended December 31, 1995, as compared to the year ended December 31, 1994, due to the partial payoff of the loan collateralized by the Richton Park Shopping Center in June 1994, the payoff of the loan collateralized by the property located at 9716-18 and 9806-12 Mayline in July 1995 and the partial paydowns of the loan collateralized by the property located at 7432 Washington in the second and third quarters of 1995. This decrease was partially offset as interest rates on approximately 65% of the mortgage loan receivable portfolio adjusted upward in late 1994 and early 1995 reflecting market conditions.\nInterest income on mortgage loan receivables decreased for the year ended December 31, 1994, as compared to the year ended December 31, 1993, as a result of several factors. During 1993, interest rates on approximately 16% of the mortgage receivable portfolio adjusted downward reflecting the market conditions. Additionally, interest income on mortgage receivables decreased in 1994 due to the payoffs of the Kirchoff Road and Richmond\/Belle Plaine loans in January and August 1993, respectively and the partial payoff of the Richton Park Shopping Center loan in June 1994.\nInterest on short-term investments increased for the years ended December 31, 1995 and 1994, as compared to the year ended December 31, 1993, as repayment proceeds were temporarily invested.\nOther income for the year ended December 31, 1993 includes a $2,644 prepayment penalty on the payoff of the Richmond\/Belle Plaine loan. In 1995, the Partnership received $6,219 of late charge income.\nThe decrease in general and administrative expenses to Affiliates for the year ended December 31, 1995, as compared to the year ended December 31, 1994, is due to decreases in mortgage servicing fees and data processing expense.\nGeneral and administrative expenses to non-affiliates decreased for the years ended December 31, 1995 and 1994, as compared to the year ended December 31, 1993, due to decreases in the Illinois Replacement Tax.\nInflation\nThe Partnership's right to additional interest in connection with certain mortgage notes as described in Note (4) of the Notes to Financial Statements, (Item 8","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nINLAND MORTGAGE INVESTORS FUND, L.P.-II (a limited partnership)\nIndex ----- Page\nReport of Independent Accountants........................................ 9\nFinancial Statements:\nBalance Sheets, December 31, 1995 and 1994............................. 10\nStatements of Operations, for the years ended December 31, 1995, 1994 and 1993..................................... 11\nStatements of Partners' Capital, for the years ended December 31, 1995, 1994 and 1993..................................... 12\nStatements of Cash Flows, for the years ended December 31, 1995, 1994 and 1993..................................... 13\nNotes to Financial Statements.......................................... 14\nSchedules not filed:\nAll schedules have been omitted as the required information is inapplicable or the information is presented in the financial statements or related notes.\n1549-71 Sherman, Evanston, Illinois:\nReport of Independent Certified Public Accountants* Statement of Operating Income and Expenses for the year ended December 31, 1995* Notes to Statement of Operating Income and Expenses for the year ended December 31, 1995*\n* The Partnership will subsequently file these reports on or before May 15, 1996.\nREPORT OF INDEPENDENT ACCOUNTANTS\nThe Partners of Inland Mortgage Investors Fund, L.P. - II\nWe have audited the financial statements of Inland Mortgage Investors Fund, L.P. - II listed in the index on page 8 of this Form 10-K. 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 Inland Mortgage Investors Fund, L.P. - II as of December 31, 1995 and 1994 and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles.\nCOOPERS & LYBRAND L.L.P.\nChicago, Illinois March 25, 1996\nINLAND MORTGAGE INVESTORS FUND, L.P.-II (a limited partnership)\nBalance Sheets\nDecember 31, 1995 and 1994\nSee accompanying notes to financial statements.\nINLAND MORTGAGE INVESTORS FUND, L.P.-II (a limited partnership)\nStatements of Operations\nFor the years ended December 31, 1995, 1994 and 1993\nSee accompanying notes to financial statements.\nINLAND MORTGAGE INVESTORS FUND, L.P.-II (a limited partnership)\nStatements of Partners' Capital\nFor the years ended December 31, 1995, 1994 and 1993\nSee accompanying notes to financial statements.\nINLAND MORTGAGE INVESTORS FUND, L.P.-II (a limited partnership)\nStatements of Cash Flows\nFor the years ended December 31, 1995, 1994 and 1993\nSee accompanying notes to financial statements.\nINLAND MORTGAGE INVESTORS FUND, L.P.-II (a limited partnership)\nNotes to Financial Statements\nFor the years ended December 31, 1995, 1994 and 1993\n(1) Organization and Basis of Accounting\nInland Mortgage Investors Fund, L.P.-II (the \"Partnership\"), was formed on December 24, 1986, pursuant to the Delaware Revised Uniform Limited Partnership Act to make or acquire loans collateralized by mortgages on improved, income producing properties. On February 10, 1987, the Partnership commenced an offering of 40,000 Limited Partnership Units (\"Units\") at $500 per Unit, pursuant to a Registration Statement on Form S-11 under the Securities Act of 1933. The Offering terminated on August 10, 1988, with total sales of 18,776.32 Units, resulting in gross offering proceeds of $9,388,158, which does not include the General Partner's contribution of $500. All of the holders of these Units were admitted to the Partnership. Inland Real Estate Investment Corporation is the General Partner.\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.\nOffering costs have been offset against the Limited Partners' capital accounts.\nLoan assumption fees received are deferred as unearned income and amortized over the remaining life of the related loan.\nThe Partnership considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents and are carried at cost which approximates fair value due to the short maturity of those instruments.\nThe Partnership sells participations in mortgage receivables which may yield the Partnership a return which is greater than the return based on the stated interest rate of the instrument. The differential between the stated rate and the interest rate paid to the participant is recognized as income over the term of the mortgage loan.\nInterest income on mortgage loans receivable is accrued when earned. The accrual of interest, on loans that are in default, is discontinued when, in the opinion of the General Partner, the borrower has not complied with loan work-out arrangements. Once a loan has been placed on a non-accrual status, all cash received is applied against the outstanding loan balance until such time as the borrower has demonstrated an ability to make payments under the terms of the original or renegotiated loan agreement. The Partnership intends to pursue collection of all amounts currently due from the borrowers.\nINLAND MORTGAGE INVESTORS FUND, L.P.-II (a limited partnership)\nNotes to Financial Statements (continued)\nDisclosure 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.\" The estimated fair value amounts have been determined by using available market information and appropriate valuation methodologies.\nThe fair value of the mortgage loans receivable and related mortgage interest receivable is based upon contractual payments to be received and current market interest rates for issuance of mortgage loans with similar terms and maturities. The estimated fair value of the mortgage loans receivable at December 31, 1995 approximates their carrying value.\nNo provision for Federal income taxes has been made as the liability for such taxes is that of the Partners rather than the Partnership.\nThe Partnership records are maintained on the accrual basis of accounting in accordance with generally accepted accounting principles (\"GAAP\"). The Federal income tax return has been prepared from such records after making appropriate adjustments to reflect the Partnership's accounts as adjusted for Federal income tax reporting purposes. Such adjustments are not recorded on the records of the Partnership. The net effect of these items is summarized as follows:\n1995 1994 ----------------------- -------------------- GAAP Tax GAAP Tax Basis Basis Basis Basis ---------- --------- --------- -------- Total assets................ $3,660,678 3,660,678 3,919,522 3,919,522\nPartners' capital: General Partner........... 6,131 10,988 1,913 10,988 Limited Partners.......... 3,644,165 3,639,308 3,909,500 3,900,425\nNet income (loss): General Partner........... 12,782 621 10,149 (130) Limited Partners.......... 318,463 330,624 327,802 338,081\nNet income per Limited Partnership Unit.......... 16.96 17.61 17.46 18.01\nThe net income per Limited Partnership Unit is based upon the weighted average number of Units outstanding of 18,776.32.\nINLAND MORTGAGE INVESTORS FUND, L.P.-II (a limited partnership)\nNotes to Financial Statements (continued)\n(2) Partnership Agreement\nThe Partnership Agreement defines the distribution of Operating Cash Flow. Such Operating Cash Flow will be distributed 90% to the Limited Partners and 10% to the General Partner. Of the 10% of Operating Cash Flow allocated to the General Partner, one-half shall be subordinated to the Limited Partners' receipt of a Cumulative Preferred Return of 11% per annum. Distributions of Loan Repayment Proceeds will be distributed first to the Limited Partners in proportion to their Participating Percentages until they have received an amount equal to their Invested Capital plus any deficiency in the Cumulative Preferred Return. Thereafter, any remaining Repayment Proceeds which are available for distribution will be distributed 90% to the Limited Partners and 10% to the General Partner.\nThe General Partner will be allocated net operating profits in an amount equal to the greater of 1% of net operating profits or the amount of the General Partner's distributive share of Operating Cash Flow, with the balance of such net operating profits allocated to the Limited Partners. The General Partner will be allocated net operating profits from repayments in an amount equal to the General Partner's distributive share of Repayment Proceeds, with the balance of such net operating profits allocated to the Limited Partners. Net operating losses will be allocated 1% to the General Partner and 99% to the Limited Partners.\n(3) Transactions with Affiliates\nThe General Partner and its Affiliates are entitled to reimbursement for salaries and expenses of employees of the General Partner and its Affiliates relating to the administration of the Partnership. Such costs are included in the professional services to Affiliates and general and administrative expenses to Affiliates, of which $3,778 and $200 remained unpaid at December 31, 1995 and 1994, respectively.\nInland Mortgage Servicing Corporation, a subsidiary of the General Partner, services the Partnership's mortgage loans receivable. Its services include processing mortgage loan collections and escrow deposits and maintaining related records. For these services, the Partnership is obligated to pay fees at an annual rate equal to 1\/4 of 1% of the outstanding mortgage loans receivable balance of the Partnership. Such fees of $9,325 in 1995, $10,325 in 1994 and $11,564 in 1993 have been incurred and paid to the subsidiary of the General Partner and are included in the Partnership's general and administrative expenses to Affiliates.\nThe General Partner is required to make Supplemental Capital Contributions, if necessary, from time to time in sufficient amounts to allow the Partnership to make distributions to the Limited Partners amounting to at least 7% per annum on their Invested Capital. The cumulative amount of such Supplemental Capital Contributions at December 31, 1995 is $23,562, all of which has been received from the General Partner.\nINLAND MORTGAGE INVESTORS FUND, L.P.-II (a limited partnership)\nNotes to Financial Statements (continued)\n(4) Mortgage Loans Receivable\nMortgage loans receivable are collateralized principally by first mortgages and wrap mortgages on multi-family residential properties located in Chicago, Illinois or its surrounding metropolitan area, except for the Evanston, Illinois loan which is collateralized by a multi-use retail and office building and the Richton Park, Illinois loan which is collateralized by a shopping mall. As additional collateral, the Partnership holds assignments of rents and leases or personal guarantees of the borrowers. Generally, the mortgage notes are payable in equal monthly installments based on 20 or 30 year amortization periods.\nMortgage loans receivable consist of the following:\nINLAND MORTGAGE INVESTORS FUND, L.P.-II (a limited partnership)\nNotes to Financial Statements (continued)\n(A) On March 24, 1989, in accordance with a pre-existing agreement, the Partnership amended its Participation Agreements with Inland Mortgage Corporation (IMC), a subsidiary of the General Partner, and an unaffiliated third party participant in the loans collateralized by the Sherman and Grove properties. The Partnership repurchased all of IMC's interest of $135,000 to resell this interest to the unaffiliated third party participant. Upon completion of the transaction the third party's total interest in the $2,700,000 original loan amount was $985,000.\nTerms of the November 1988 Participation Agreement were modified so that the entire $985,000 participating interest earned interest at 11.55% per annum through December 1989. On January 1, 1990 and each succeeding January 1, the interest rate adjusts to 2.82% over the yield of one-year U.S. Treasury Bills, with a cap of 13.75% and a floor of 8.75% per annum. The installments were interest only until February 1990 and currently consist of principal and interest (based on a 25 year amortization) with the final installment due in October 1997.\n(B) In August 1991, the loan collateralized by the property at 3900 Cornelia and 3510 Springfield was assumed by another borrower. The terms of the loan were not changed by the assumption and the Partnership's approval of the new borrower was required prior to the assumption. The Partnership received a fee of 1% of the outstanding loan balance in connection with the assumption which is being amortized and recognized as income over the remaining term of the loan.\n(C) In November 1988, the Partnership purchased this loan from Inland Mortgage Corporation, a subsidiary of the General Partner. The cost of the loan was $467,556, including the principal balance of $463,500 and accrued interest of $4,056. This loan currently bears interest at the rate of 9.380% per annum and adjusts annually to 3.75% above the One Year Treasury Constant Maturity Average.\nINLAND MORTGAGE INVESTORS FUND, L.P.-II (a limited partnership)\nNotes to Financial Statements (continued)\n(D) On May 23, 1989, the Partnership purchased a $1,095,000 interest in a first mortgage loan funded originally on behalf of the Partnership by Inland Mortgage Corporation (IMC), a subsidiary of the General Partner. The loan was in the amount of $2,600,000 and was collateralized by a first mortgage on the Richton Park Plaza Shopping Mall. The initial interest rate on the loan was 11.21% and adjusted annually to 3% over the One Year Treasury Constant Maturity Average beginning in January 1990. Payments adjusted annually with the interest rate. The loan matured on January 1, 1994, at which time the Partnership extended the maturity date of the loan. On June 30, 1994 the Partnership modified the loan and received $735,827 in principal and accrued interest, as a result of the partial payoff of this loan. Under the loan modification, the remaining principal balance of $330,402 is collateralized by a second mortgage on the property and requires principal and interest payments at the rate of 10% per annum with a final balloon payment due January 1, 1999. The interest rate adjusts annually on January 1st to three points over the One Year Treasury Constant Maturity Average. The borrower has paid a $3,300 extension fee to the Partnership.\n(E) The loan was funded in March 1990 for $566,160 and bears an interest rate which adjusts annually after the fifth loan year to a rate equal to 3.5% over the Federal Home Loan Bank 11th District Cost of Funds.\nThe Partnership had not received any payments on the $522,194 loan collateralized by the properties at 1881, 1885 and 1889 Edgebrook since August 1994. As a result of the default and negotiations with the borrower, an affiliate of the General Partner began managing the properties during October 1994. Monthly principal and interest payments on the loan were $5,349. During 1995, a subsidiary of the General Partner obtained a deed in lieu of foreclosure, brought the loan current and assumed responsibility for future payments.\n(F) In June 1992, the Partnership funded two $700,000 loans to refinance existing mortgages owed to an Affiliate of the General Partner and sold a $500,000 interest in each of the loans to Inland Mortgage Investors Fund III, L.P. (\"Participant\"), which is another publicly registered partnership sponsored by the General Partner. Therefore, the net funds invested by the Partnership in each of the loans was $200,000. The loans have a fixed interest rate and require monthly payments of interest only. The Partnership will receive its percentage share of all such payments.\nINLAND MORTGAGE INVESTORS FUND, L.P.-II (a limited partnership)\nNotes to Financial Statements (continued)\nIn November 1994, the borrower on the loan collateralized by the property located at 7432 Washington made a partial paydown on the mortgage. The Partnership received $9,343, its proportionate share of the total paydown.\nDuring 1995, the borrower on the loan collateralized by the property located at 7432 Washington made additional partial paydowns on the mortgage. The Partnership received $16,200, its proportionate share of the total paydowns.\nIn July 1995, the loan collateralized by the property located at 9716-18 and 9806-12 Mayline was prepaid by the borrower. The Partnership received $200,704, its proportionate share of the total prepayment.\n(5) Subsequent Events\nIn January 1996, the Partnership paid a distribution of $154,589, of which $150,371 was distributed to Limited Partners, including $8,237 of repayment proceeds, $62,000 of original working capital reserve and $80,134 of operating cash flow.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nThere were no disagreements on accounting or financial disclosure during 1995.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nThe General Partner of the Partnership, Inland Real Estate Investment Corporation, was organized in 1984 for the purpose of acting as general partner of limited partnerships formed to acquire, own and operate real property, and make and acquire loans collateralized by mortgages on improved, income producing multi-family residential properties. The General Partner is a wholly-owned subsidiary of The Inland Group, Inc. In 1990, Inland Real Estate Investment Corporation became the replacement General Partner for an additional 301 privately-offered real estate limited partnerships syndicated by Affiliates. The General Partner has responsibility for all aspects of the Partnership's operations. The relationship of the General Partner to its Affiliates is described under the caption \"Conflicts of Interest\" at pages 10 and 11 of the Prospectus, incorporated herein by reference.\nOfficers and Directors\nThe officers, directors and key employees of The Inland Group, Inc. and its Affiliates (\"Inland\") that are likely to provide services to the Partnership are as follows:\nFunctional Title\nDaniel L. Goodwin.......... Chairman and Chief Executive Officer Robert H. Baum............. Executive Vice President-General Counsel G. Joseph Cosenza.......... Senior Vice President-Acquisitions Robert D. Parks............ Senior Vice President-Investments Catherine L. Lynch......... Treasurer Roberta S. Matlin.......... Assistant Vice President-Investments Mark Zalatoris............. Assistant Vice President-Due Diligence Patricia A. Challenger..... Vice President-Asset Management Frances C. Panico.......... Vice President-Mortgage Corporation Raymond E. Petersen........ Vice President-Mortgage Corporation Paul J. Wheeler............ Vice President-Personal Financial Services Group Cynthia M. Hassett......... Assistant Vice President-Partnership Accounting Venton J. Carlston......... Assistant Controller\nDANIEL L. GOODWIN (age 52) is Chairman of the Board of Directors of The Inland Group, Inc., a billion-dollar real estate and financial organization located in Oak Brook, Illinois. Among Inland's subsidiaries is the largest property management firm in Illinois and one of the largest commercial real estate and mortgage banking firms in the Midwest.\nMr. Goodwin has served as Director of the Avenue Bank of Oak Park and as a Director of the Continental Bank of Oakbrook Terrace. He was also Chairman of the Bank Holding Company of American National Bank of DuPage. Currently he is the President of Inland Mortgage Investment Corporation.\nMr. Goodwin has been in the housing industry for more than 25 years, and has demonstrated a lifelong interest in housing-related issues. He is a licensed real estate broker and a member of the National Association of Realtors. He has developed thousands of housing units in the Midwest, New England, Florida, and the Southwest. He is also the author of a nationally recognized reference book for the management of residential properties.\nMr. Goodwin serves on the Board of the Illinois State Affordable Housing Trust Fund for the past 6 years. He is an advisor for the Office of Housing Coordination Services of the State of Illinois, and a member of the Seniors Housing Committee of the National Multi-Housing Council. Recently, Governor Edgar appointed him Chairman of the Housing Production Committee for the Illinois State Affordable Housing Conference. He also served as a member of the Cook County Commissioner's Economic Housing Development Committee, and he was the Chairman of the DuPage County Affordable Housing Task Force. The 1992 Catholic Charities Award was presented to Mr. Goodwin for his work in addressing affordable housing needs. The City of Hope designated him as the 1980's Man of the Year for the Illinois construction industry. In 1989, the Chicago Metropolitan Coalition on Aging presented Mr. Goodwin with an award in recognition of his efforts in making housing more affordable to Chicago's Senior Citizens. On May 4, 1995, PADS, Inc. (Public Action to Deliver Shelter) presented Mr. Goodwin with an award, recognizing The Inland Group as the leading corporate provider of transitional housing for the homeless people of DuPage County.\nMr. Goodwin is a product of Chicago-area schools, and obtained his Bachelor's and Master's Degrees from Illinois Universities. Following graduation, he taught for five years in Chicago Public Schools. His commitment to education has continued through his work with the Better Boys Foundation's Pilot Elementary School in Chicago, and the development of the Inland Vocational Training Center for the Handicapped located at Little City in Palatine, Illinois. He personally established an endowment which funds a perpetual scholarship program for inner- city disadvantaged youth. In 1990 he received the Northeastern Illinois University President's Meritorious Service Award. Mr. Goodwin holds a Master's Degree in Education from Northern Illinois University, and in 1986, he was awarded an Honorary Doctorate from Northeastern Illinois University College of Education. He served as a member of the Board of Governors of Illinois State Colleges and Universities, and he is currently a trustee of Illinois Benedictine College. He was elected Chairman of Northeastern Illinois University Board of Trustees in January 1996.\nMr. Goodwin served as a member of Governor Jim Edgar's Transition Team. In 1988 he received the Outstanding Business Leader Award from the Oak Brook Jaycees. He also serves as the Chairman of the Illinois Speaker of the House of Representatives Club, and has been the General Chairman of the National Football League Players Association Mackey Awards for the benefit of inner-city youth. In March 1994, he won the Excellence in Business Award from the DuPage Area Association of Business and Industry. Additionally, he was honored by Little Friends on May 17, 1995 for rescuing their Parent-Handicapped Infant Program when they lost their lease last year, and on June 9, he received the 1995 March of Dimes Birth Defects Foundation Life Achievement Award.\nROBERT H. BAUM (age 52) has been with Inland since 1968 and is one of the four original principals. Mr. Baum is Vice Chairman and Executive Vice President-General Counsel of The Inland Group, Inc. In his capacity as General Counsel, Mr. Baum is responsible for the supervision of the legal activities of The Inland Group, Inc. and its affiliates. This responsibility includes the supervision of The Inland Law Department and serving as liaison with all outside counsel. Mr. Baum has served as a member of the North American Securities Administrators Association Real Estate Advisory Committee and as a member of the Securities Advisory Committee to the Secretary of State of Illinois. He is a member of the American Corporation Counsel Association, as well as a member of several bar associations. Mr. Baum has been admitted to practice before the Supreme Courts of the United States and the State of Illinois, as well as the bars of several federal courts of appeals and federal district courts. He received his B.S. Degree from the University of Wisconsin and his J.D. Degree from Northwestern University School of Law. Mr. Baum has served as a director of American National Bank of DuPage and is a member of the Governing Council of Wellness House, a charitable organization that provides emotional support for cancer patients and their families.\nG. JOSEPH COSENZA (age 52) joined Inland in 1968. Mr. Cosenza, is a director, Vice Chairman and Chief Executive Officer of the Inland Group Inc. Mr. Cosenza oversees, coordinates and directs Inland's many enterprises and, in addition, immediately supervises a staff of five persons who engage in property acquisition. Mr. Cosenza has been a consultant to other real estate entities and lending institutions on property appraisal methods. Mr. Cosenza received his B.A. degree from Northeastern Illinois University and his M.S. degree from Northern Illinois University. From 1967 to 1968, Mr. Cosenza taught at the LaGrange School District in Hodgkins, and from 1968 to 1972, he served as Assistant Principal and teacher in the Wheeling School District. He has been a licensed real estate broker since 1968 and an active member of various national and local real estate associations, including the National Association of Realtors and the Urban Land Institute. Mr. Cosenza has also been Chairman of the Board of American National Bank of DuPage and part owner of American National Bank of DuPage and Burbank State Bank, and has served on the Board of Directors of Continental Bank of Oakbrook Terrace.\nROBERT D. PARKS (age 52) joined Inland in 1968. He is Director of The Inland Group, Inc. and is President, Chairman and Chief Executive Officer of Inland Real Estate Investment Corporation and is Director of Inland Securities Corporation. Mr. Parks is responsible for the ongoing administration of existing partnerships, corporate budgeting and administration for Inland Real Estate Investment Corporation. He oversees and coordinates the marketing of all limited partnership interests nationwide and has overall responsibility for the portfolio management of all partnership investments and investor relations. Mr. Parks received his B.A. degree from Northeastern Illinois University and M.A. degree from the University of Chicago. He is a registered Direct Participation Program Principal with the National Association of Securities Dealers, Inc., and a licensed real estate broker. He is a member of the Real Estate Investment Association and a member of the board of NAREIT.\nCATHERINE L. LYNCH (age 37) joined Inland in 1989 and is the Treasurer of Inland Real Estate Investment Corporation. Ms. Lynch is responsible for managing the Corporate Accounting Department. Prior to joining Inland, Ms. Lynch worked in the field of public accounting for KPMG Peat Marwick since 1980. She received her B.S. degree in Accounting from Illinois State University. Ms. Lynch is a Certified Public Accountant and a member of the American Institute of Certified Public Accountants. She is registered with the National Association of Securities Dealers as a Financial Operations Principal.\nROBERTA S. MATLIN (age 51) joined Inland in 1984 as Director of Investor Administration and currently serves as Senior Vice President-Investments. Prior to that, Ms. Matlin spent 11 years with the Chicago Region of the Social Security Administration of the United States Department of Health and Human Services. As Senior Vice President-Investments, she directs the day-to-day internal operations of the General Partner. Ms. Matlin received her B.A. degree from the University of Illinois. She is registered with the National Association of Securities Dealers, Inc. as a General Securities Principal.\nMARK ZALATORIS (age 38) joined Inland in 1985 and currently serves as Vice President of Inland Real Estate Investment Corporation. His responsibilities include the coordination of due diligence activities by selling broker\/dealers and is also involved with limited partnership asset management including the mortgage funds. Mr. Zalatoris is a graduate of the University of Illinois where he received a Bachelors degree in Finance and a Masters degree in Accounting and Taxation. He is a Certified Public Accountant and holds a General Securities License with Inland Securities Corporation.\nPATRICIA A. CHALLENGER (age 43) joined Inland in 1985. Ms. Challenger serves as Senior Vice President of Inland Real Estate Investment Corporation in the area of Asset Management. As head of the Asset Management Department, she develops operating and disposition strategies for all investment-owned properties. Ms. Challenger received her bachelor's degree from George Washington University and her master's from Virginia Tech University. Ms. Challenger was selected and served from 1980-1984 as Presidential Management Intern, where she was part of a special government-wide task force to eliminate waste, fraud and abuse in government contracting and also served as Senior Contract Specialist responsible for capital improvements in 109 government properties. Ms. Challenger is a licensed real estate salesperson, NASD registered securities sales representative and is a member of the Urban Land Institute.\nFRANCES C. PANICO (age 46) joined Inland in 1972 and is currently President of Inland Mortgage Servicing Corporation. Ms. Panico oversees the operation of loan services, which has a loan portfolio in excess of $612 million. She previously supervised the origination, processing and underwriting of single- family mortgages, and she packaged and sold mortgages to secondary markets. Ms. Panico's other primary duties at Inland have included coordinating collection procedures and overseeing the default analysis and resolution process. Ms. Panico received her B.A. in Business and Communication from Northern Illinois University in 1972.\nRAYMOND E. PETERSEN (age 56) joined Inland in 1981. Mr. Petersen is responsible for the selection and approval of all corporate and limited partnership financing, as well as for the daily supervision of the commercial lending activity of Inland Mortgage Corporation, where he is President. For the six years prior to joining Inland, Mr. Petersen was affiliated with the mortgage banking firm of Downs, Mohl Mortgage Corporation, serving as President and Chief Executive Officer. Previously he was also associated with the mortgage banking houses of B.B. Cohen & Company and Percy Wilson Mortgage and Finance Corporation. Mr. Petersen's professional credentials include a B.A. degree from DePaul University, senior membership in the National Association of Review Appraisers, state license as a real estate broker and licensed securities representative. Mr. Petersen was also a Director and Chairman of the Asset and Liability Committee of American National Bank of Downers Grove.\nPAUL J. WHEELER (age 43) joined Inland in 1982 and is currently the President of Inland Property Sales, Inc. and President of Inland Securities Corporation, Inland's broker\/dealer. Mr. Wheeler received his B.A. degree in Economics from DePauw University and an M.B.A. in Finance\/Accounting from Northwestern University. Mr. Wheeler is a Certified Public Accountant, a licensed real estate broker and is registered with the National Association of Securities Dealers, Inc. as a General Securities Principal. For three years prior to joining Inland, Mr. Wheeler was Vice President\/Finance at the real estate brokerage firm of Quinlan & Tyson, Inc.\nCYNTHIA M. HASSETT (age 37) joined Inland in 1983 and is a Vice President of Inland Real Estate Investment Corporation. Ms. Hassett is responsible for the Investment Accounting Department which includes all public partnership accounting functions along with quarterly and annual SEC filings. Prior to joining Inland, Ms. Hassett was on the audit staff of Altschuler, Melvoin and Glasser since 1980. She received her B.S. degree in Accounting from Illinois State University. Ms. Hassett is a Certified Public Accountant and a member of the American Institute of Certified Public Accountants.\nVENTON J. CARLSTON (age 38) joined Inland in 1985 and is the Assistant Controller of Inland Real Estate Investment Corporation where he supervises the corporate bookkeeping staff and is responsible for financial statement preparation and budgeting for Inland Real Estate Investment Corporation and its subsidiaries. Prior to joining Inland, Mr. Carlston was a partnership accountant with JMB Realty. He received his B.S. degree in Accounting from Southern Illinois University. Mr. Carlston is a Certified Public Accountant and a member of the American Institute of Certified Public Accountants and the Illinois CPA Society. He is registered with the National Association of Securities Dealers, Inc. as a Financial Operations Principal.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe General Partner is entitled to receive a share of cash distributions, when and as cash distributions are made to the Limited Partners, as described under the caption \"Cash Distributions\" and a share of profits or losses as described under the caption \"Allocation of Profits and Losses\" of the Prospectus.\nThe Partnership is permitted to engage in various transactions involving Affiliates of the General Partner of the Partnership, as described under the captions \"Compensation and Fees\" at pages 8 and 9, \"Conflicts of Interest\" at pages 10 and 11 of the Prospectus and at pages A-9 through A-17 of the Partnership Agreement, included as an exhibit to the Prospectus, which is hereby incorporated herein by reference. The relationship of the General Partner (and its directors and officers) to its Affiliates is set forth above in Item 10.\nThe General Partner may be reimbursed for salaries and direct expenses of employees of the General Partner and its Affiliates for the administration of the Partnership. In 1995, costs relating to such services were $30,239, of which $3,778 was unpaid at December 31, 1995.\nA subsidiary of the General Partner earned mortgage servicing fees of $9,325 in 1995, in connection with servicing the Partnership's mortgage loans receivable.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\n(a) The Liquidity Plan (page 19 of the Prospectus of the Partnership dated February 10, 1987, which is incorporated herein by reference) owns the following Units of the Partnership as of December 31, 1995:\nAmount and Nature of Beneficial Percent Title of Class Ownership of Class -------------- ----------------- ------------\nLimited Partnership 4,814.63 Units, Directly 25.64% Units\n(b) The officers and directors of the General Partner of the Partnership own as a group the following Units of the Partnership as of December 31, 1994:\nAmount and Nature of Beneficial Percent Title of Class Ownership of Class -------------- ----------------- -------------\nLimited Partnership One Unit Directly Less than 1% Units\nNo officer or director of the General Partner of the Partnership possesses a right to acquire beneficial ownership of Units of the Partnership.\nAll of the outstanding shares of the General Partner of the Partnership are owned by an Affiliate of its officers and directors as set forth above in Item 10.\n(c) There exists no arrangement, known to the Partnership, the operation of which may at a subsequent date result in a change in control of the Partnership.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThere were no significant transactions or business relationships with the General Partner, Affiliates or their management other than those described in Items 10 and 11 above and Note (3) of the Notes to Financial Statements (Item 8 of this Annual Report).\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(a) The Financial Statements listed in the index on page 8 of this Annual Report are filed as part of this Annual Report.\n(b) Exhibits. The following documents are filed as part of this Report:\n3 Amended and Restated Agreement of Limited Partnership and Certificate of Limited Partnership, included as Exhibits A and B to the Prospectus dated February 10, 1987, as supplemented, are incorporated herein by reference thereto.\n28 Prospectus dated February 10, 1987, as supplemented, included in post-effective Amendment No. 2 to Form S-11 Registration Statement, File No. 33-11110, is incorporated herein by reference thereto.\n(c) Financial Statement Schedules:\nAll schedules have been omitted as the required information is inapplicable or the information is presented in the Financial Statements or related notes.\n(d) Reports on Form 8-K\nNone\nNo Annual Report or proxy material for the year 1995 has been sent to the Partners of the Partnership. An Annual Report will be sent to the Partners subsequent to this filing and the Partnership will furnish copies of such report to the Commission when it is sent to the Partners.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nINLAND MORTGAGE INVESTORS FUND, L.P.-II Inland Real Estate Investment Corporation General Partner\nBy: Robert D. Parks Chairman of the Board and Chief Executive Officer Date: March 28, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, 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: Inland Real Estate Investment Corporation General Partner\nBy: Robert D. Parks Chairman of the Board and Chief Executive Officer Date: March 28, 1996\nBy: Mark Zalatoris Vice President Date: March 28, 1996\nBy: Cynthia M. Hassett Principal Financial Officer and Principal Accounting Officer Date: March 28, 1996\nBy: Daniel L. Goodwin Director Date: March 28, 1996\nBy: Robert H. Baum Director Date: March 28, 1996","section_15":""}
{"filename":"731190_1995.txt","cik":"731190","year":"1995","section_1":"ITEM 1. BUSINESS.\nGENERAL\nInternational Technology Corporation, a Delaware corporation (the Company or IT), provides a wide range of environmental management services and technologies including the assessment, decontamination, and remediation of situations involving hazardous materials and pollution prevention and minimization. The Company was incorporated in 1983; the earliest antecedent of the Company commenced operations in California in 1926.\nThe Company's services are provided to a broad array of governmental and commercial entities predominantly in the U.S. market. Additionally, the Company pursues selected international business opportunities on a project-specific basis. The Company's business strategy is to provide its environmental services on a full-service basis, particularly by focusing on its capabilities to manage complex environmental issues from the initial assessment of the level and extent of contamination through the design, engineering and execution of a solution. In recent years, the Company has worked on several hundred Superfund sites for various governmental and commercial clients. The success of the Company in developing its capabilities is demonstrated by IT's designation by Engineering News-Record as the largest hazardous waste design firm for each of the last six years.\nDemand for the Company's services is heavily influenced by the level of enforcement of environmental laws and regulations, funding levels for government projects and spending patterns of commercial clients. Over the last several years, spending by commercial clients has slowed primarily due to reduced implementation and enforcement activities by government regulatory agencies, an uncertain regulatory climate and weak economic conditions. In recent years, the Company's revenues have been derived primarily from its business with federal, state and local governmental clients. Revenues attributable to contracts with governmental agencies accounted for 71%, 63% and 62% of total revenues in fiscal 1995, 1994 and 1993, respectively. In the last three years, IT's business with the U.S. Department of Defense (DOD) has increased significantly, growing from 19% of revenues in fiscal 1993 to 33% of revenues in fiscal 1994 and 47% of revenues in fiscal 1995. The Company expects that revenues attributable to federal, state and local governmental agency contracts, particularly those with DOD, will continue to represent a substantial percentage of total revenues in the near term. Efforts to constrain the federal budget deficit may impact the level of spending on environmental restoration by the DOD, the U.S. Department of Energy (DOE) and other federal governmental agencies. (See Business - Operations - Customers.)\nThe operations of the Company are performed subject to a comprehensive federal, state, and local environmental regulatory structure which is currently the subject of proposals for significant change. (See Business - Operations - Regulations.) Although this regulatory structure creates opportunities for the Company, the analysis, assessment, and remediation of hazardous substances necessarily involves significant risks, including the possibility of damages or injuries caused by the escape of hazardous substances into the environment. (See Business - Operations - Environmental Contractor Risks, and Legal Proceedings.)\nIn June 1994, the Company and an affiliate of Corning Incorporated (Corning) combined the two companies' environmental analytical services businesses into a newly formed 50\/50 jointly-owned company (Quanterra). Since its formation, Quanterra has had the highest revenues of any environmental analytical services laboratory company in the United States. Quanterra operates independently with a separate board of directors which has representation from IT and Corning, and provides services primarily to third parties as well as to the Company. (See Business - Operations - Quanterra.)\nIn April 1995, an outside investment banker retained by the Company completed a review of the Company's business and financial strategy. Based on this strategic review, the Company intends to emphasize exploitation of the Company's strong market position in consulting, engineering, design and remediation and continued improvement of operating fundamentals. The\nCompany also expects to consider external growth and diversification opportunities, including possible acquisitions. Additionally, the Company is evaluating alternatives to refinance its $50,000,000 of outstanding senior notes due July 1, 1996.\nBACKGROUND\nHazardous materials management and remediation as well as air and water pollution control are widely acknowledged as significant national priorities. As of May 1995, the U.S. Environmental Protection Agency (USEPA) had designated approximately 1,300 sites as Superfund locations with significant concentrations of hazardous materials, although only approximately 30% of these sites had undergone substantial remediation. In addition, there are a large number of small commercial and governmental sites that will require cleanup. The assessment, decontamination and remediation of hazardous sites are governed by complex environmental and occupational safety and health regulations administered by numerous federal, state and local agencies.\nMany of the Company's clients, both governmental and commercial, are continuing to require a full-service solution, in which a single supplier or team takes responsibility for the entire process from identification and assessment through remediation. Successful remediation of hazardous sites requires a multidisciplinary approach, since such sites typically involve a variety of waste which affects air, soil and\/or water. Depending on the circumstances, the required skills may include analytical chemistry, risk assessment, computer modeling, ambient air monitoring, process and design engineering, and construction\/remediation. The application of these disciplines to solve client problems requires substantial operational know-how, and the Company believes that it is well-positioned to solve client problems because of the combination of its capabilities and experience. Additionally, the Company's technical expertise and operational experience are sought by other firms for project-specific teaming and joint venture relationships, thereby allowing the Company access to an increased number of large scale governmental and commercial programs.\nOver the past several years, the environmental management and hazardous waste remediation industry has been characterized by an increasing number of well-capitalized competitors, reduced government enforcement of environmental regulations and regulatory uncertainty. This has resulted in reduced commercial spending on environmental cleanup and intense pricing competition for hazardous waste cleanup projects. Lower demand in the private sector has been offset to a certain extent by new major project opportunities in the public sector, primarily major cleanup projects at DOD and DOE installations. These major projects require a broad range of project management and field execution skills, limiting the number of potential bidders. As a result of the changes impacting the industry, consolidation has occurred through downsizing and mergers. The Company's strategy is to be a strong competitor for the major project opportunities offered by the DOD and DOE, to continue to actively serve the commercial market, and, to the extent it is able, to participate selectively in the ongoing consolidation in the industry.\nOPERATIONS\nGeneral - -------\nThe major part of IT's business is the management of complex hazardous waste remediation projects involving the assessment, planning and execution of the decontamination and restoration of property, plant and equipment that have been contaminated by hazardous substances. These projects include the cleanup of land disposal sites where hazardous or toxic substances have been improperly disposed and pose a threat to the surrounding environment; rivers, streams and groundwater contaminated by chemical substances and buildings, production facilities and storage sites contaminated with hazardous chemical and\/or radioactive materials. These projects require considerable engineering and analytical effort to determine the substances involved, the extent of the contamination, the appropriate alternatives for containing or removing the contamination, and the selection of the technologies for treatment, including transportable treatment equipment, to perform the cleanup of the site. The Company is involved in many areas of the United States in the assessment or cleanup phases of site remedial action projects.\nAdditionally, the Company performs a variety of consulting services for clients to help them comply with environmental and\/or health and safety regulations. The Company also provides assistance to these clients in\ndeveloping corporate policies and procedures in areas such as pollution prevention and waste minimization that integrate environmental regulations into their business decisions.\nNew Organizational Structure - ----------------------------\nPrior to the June 1994 formation of Quanterra, the Company was organized into three business areas, Environmental Services, Construction and Remediation, and Analytical Services. Subsequent to June 1994, the Company has operated in the first two of these business areas. Effective April 1, 1995, the Company implemented organizational structure changes in an effort to deliver more cost-effective services to clients. The Company's operations are now principally managed under a structure consisting of three regions with full service capabilities. Each region has its own technical, project management, sales and administrative support functions. The Construction and Remediation group's project management capabilities and related infrastructure have been integrated throughout the Company to strengthen project execution skills and enhance client service on a company-wide basis. Accordingly, IT offers all of its services in each region in which it operates. The Company currently operates 43 offices, including project offices, located across the United States.\nConsulting, Engineering and Design - ----------------------------------\nThe Company's clients may have need for consulting, engineering and design services with respect to contamination of air, water or soil. Federal legislation such as the Clean Air Act and Safe Drinking Water Act provide environmental regulations which require compliance by the Company's clients. Environmental problems generally require multidisciplinary capabilities. Each region is staffed by professionals with expertise in a variety of disciplines and the operating experience required to provide clients with full-service, cost-effective environmental solutions. The full-service strategy supports the Company's marketing efforts toward developing partnering arrangements with clients in which IT is the primary supplier of all client environmental management services.\nThe Company's revenues related to air pollution assessment and control grew substantially in the past year, reflecting the general increase in demand for air quality services and the Company's expansion of its capabilities in this area.\nThe Company provides a wide range of consulting, engineering and design services including remedial design, environmental permitting, facility siting and design, environmental compliance\/auditing, risk assessment\/ management, environmental assessment\/characterization, consulting engineering, pollution prevention, waste minimization, permitting assistance, and equipment design, installation, and start-up services.\nRemediation - -----------\nThe Company provides full-service capabilities for major projects, primarily in the area of DOD and DOE delivery order program management, remedial construction, mobile treatment, and decontamination\/decommissioning capabilities. In the area of remedial construction, IT offers diverse services, such as excavation and isolation, installation of subsurface recovery systems, thermal treatment solutions, bioremediation approaches, chemical treatment, soil washing, fixation or stabilization, facility or site closures, solidification, landfill cell construction, and slurry wall and cap installation. IT also offers other remedial services such as chemical packaging services, underground storage tank (UST) or aboveground storage tank (AST) management and emergency response.\nOn large scale remediation projects, IT uses various capabilities to assess, design, and implement environmental solutions, and design treatment systems. A solution to many hazardous waste remediation projects is to locate treatment equipment on site. IT's transportable proprietary Hybrid Thermal Treatment System (HTTS) was designed by the Company to incinerate large quantities of hazardous waste on-site. The HTTS technology has found principal applications on large scale remediation projects and is suitable for use at integrated hazardous waste treatment facilities. From the introduction of HTTS technology in 1987 through fiscal year 1995, the Company has processed approximately 900,000 tons of contaminated materials at various projects, representing more materials than those processed through\nincineration by all other companies using on-site, rather than fixed-base, treatments in the aggregate. (See Business - Operations - Regulations - Resource Conservation and Recovery Act of 1976.)\nDuring fiscal year 1995, the Company completed the cleanup of the Sikes Disposal Pits Superfund site near Houston, Texas using the HTTS technology. Currently, IT is utilizing an HTTS unit for the incineration of hazardous materials at the Bayou Bonfouca Superfund site in Slidell, Louisiana, which is nearing completion. In September 1992, the Company was awarded the thermal remediation contract at the Superfund site in Times Beach, Missouri. Permits for incineration at this site were received in April 1995 and significant preparatory work on the project is now underway. In April 1994, IT with a partner, was the apparent low bidder on a contract utilizing an HTTS unit at the Texarkana Wood Processing Company (Texarkana) Superfund site in Texarkana, Texas. However, the award of this project has been delayed pending a review of the use of incineration technology at that site and all contractors' bids, including IT's, were allowed to expire. (See Business - Operations - Regulations - Resource Conservation and Recovery Act of 1976.) In June 1994, the Company was awarded a contract utilizing an HTTS unit at the American Creosote site in Winnfield, Louisiana.\nQuanterra - ---------\nIn June 1994, the Company and Corning combined the two companies' environmental analytical services businesses into a newly formed joint company, Quanterra. Since its formation, Quanterra has had the highest revenues of any environmental analytical services laboratory company in the United States. Quanterra operates independently with a separate board of directors which has representation from IT and Corning, and provides services primarily to third parties, as well as to the Company. In Quanterra's first nine months of operation, approximately 13% of its revenues were derived from services provided to the Company. The Company has agreed to use reasonable efforts to use Quanterra's services in its projects, and Quanterra has agreed to provide services to the Company on terms at least as favorable as those offered by Quanterra to third parties.\nIn connection with the formation, IT and Corning contributed the net assets of their respective laboratory businesses to Quanterra and IT issued to Corning 333,000 shares of IT common stock and a five-year warrant to purchase 2,000,000 shares of IT common stock at $5.00 per share. Quanterra has a $60,000,000 bank line of credit. IT's 50 percent investment in Quanterra is accounted for under the equity method.\nQuanterra provides qualitative and quantitative analytical chemistry services to governmental and commercial clients. Quanterra operates 12 analytical laboratories located across the U.S., along with 13 mobile field laboratories. These labs provide routine and specialty chemical analyses of organic, inorganic, and biological constituents in chemical and radiochemical mixed wastes, air, water and soil; and non-routine analyses of dioxin, pesticides and polychlorinated biphenyl compounds (PCBs). Quanterra provides specialized analyses of radioactive and radiochemical mixed wastes including bioassay, immunoassay, and environmental radiochemistry. The majority of Quanterra's revenues result from analytical work performed for federal, state and local governmental agencies or commercial clients, both directly and as a subcontractor to IT and other environmental management firms.\nAn integration plan was implemented in the early stages of Quanterra's operations. The plan included consolidation and closure of redundant laboratory facilities and equipment, a reduction in work force to eliminate duplicative overhead and excess capacity and a consolidation of laboratory management and accounting systems. IT reported a pre-tax charge of $9,264,000 related to the integration in its consolidated statement of operations for the quarter ended June 30, 1994.\nInternational - -------------\nThe Company currently is pursuing selected international opportunities on a project-specific basis with a focus in the Far East and Mexico. In the Far East, the Company has sought projects in several countries. Currently, the Company is performing a project utilizing its thermal process engineering and construction expertise in South Korea. In Mexico, the Company has entered into a joint marketing agreement with a major Mexican engineering\nand construction firm, for the purpose of jointly pursuing projects. The Company sold or closed its remaining European operations in fiscal years 1993 and 1994.\nTechnology Development - ----------------------\nIT emphasizes the innovative application of existing technologies and methods and technology development, principally through client projects. The Company's technology development program is primarily directed toward the evaluation and implementation of technologies developed outside the Company which present commercialization opportunities for IT. The program also includes efforts directed to internal development of technologies. The Company's commitment to technology development is demonstrated by the IT Technical Associates Program, which recognizes associates who have a unique value to the Company due to their technical qualifications and accomplishments. This program provides a forum for communication of IT's latest advances in various technical disciplines to associates and clients. Additionally, the Company continues to defend and expand its patent position in thermal incineration technology, bioremediation and various soil cleaning processes.\nThrough the Company's technology development program, IT has obtained an exclusive license for photocatalytic oxidation technology applied to the destruction of air toxics. Development efforts have advanced to the field demonstration phase, with demonstrations anticipated at several sites in fiscal year 1996. The technology has also been sub-licensed for use in room air conditioners. IT has also licensed a chemically enhanced soil- or waste-washing process for the treatment of certain refinery wastes. A project to treat certain refinery wastes has been completed successfully. Early market introduction of a licensed analytical method to identify a particular class of toxic substances in oil industry wastewaters has also generated interest from refineries. In addition, the Company operates the USEPA Test & Evaluation Facility in Cincinnati, Ohio, which is available for private-party use in treatability and technology testing for various types of contaminated wastewaters, sludges and soils.\nCustomers - ---------\nThe Company's services are provided to a broad range of federal, state and local governmental and commercial clients in the U.S. market. Over the last several fiscal years, the Company has experienced a significant shift in its revenues from the commercial sector to the governmental sector.\nFederal, State and Local Governmental Clients ---------------------------------------------\nDue to its technical expertise, project management experience and full-service capabilities, the Company has successfully bid on and executed contracts with federal and other governmental agencies for the performance of various CERCLA and RCRA (as defined below) activities. (See Business - Operations - Regulations.) The Company's governmental contracts are often multi-year but can generally be canceled, delayed or modified at the sole option of the client. Additionally, government contracts are typically subject to annual funding limitations and public sector budgeting constraints. Some of these contracts (indefinite delivery order contracts or IDOs) provide a maximum contractual amount of services that may be performed by the Company with the specific services to be performed authorized from time to time by the government agency through a series of task orders under the master contract. The Company may be asked to perform services for the full amount of an IDO or for only a portion thereof. IDOs generated approximately 37% of the Company's revenues in fiscal year 1995. The major contracts with federal government agencies typically involve a competitive bidding process pursuant to federal procurement policies involving several bidders and result in a period of contract negotiation after a successful bidder is selected. Although the Company generally serves as the prime contractor on its contracts or as a part of a joint venture which is a prime contractor, the Company serves as a subcontractor to other prime contractors on some federal government programs. As has recently become typical in the industry, the Company has entered into joint venture or teaming arrangements with competitors when bidding on certain of the largest, most complex contracts with federal governmental agencies, in order to provide the increased work force capacity and breadth of technical expertise required for the project.\nThe following table shows, for the last three years, the Company's revenues attributable to federal, state and local governmental contracts as a percentage of the Company's consolidated revenues, including Analytical Services through June 1994:\nYear ended March 31, --------------------------------- Source 1995 1994 1993 ------ ---- ---- ---- Federal government: DOD................................... 47% 33% 19% DOE................................... 12 15 16 Other federal agencies................ 4 5 10 -- -- -- 63 53 45\nState and local governments............... 8 10 17 -- -- -- Total..................................... 71% 63% 62% == == ==\nCommercial Clients ------------------\nThe Company serves numerous commercial clients including chemical, petroleum and other manufacturing firms, utilities, and real estate and transportation service companies. A substantial portion of the Company's commercial work represents new contracts awarded by existing clients. No single commercial client accounted for 10% or more of the Company's consolidated revenues in fiscal years 1995, 1994 or 1993.\nCompetition - -----------\nThe environmental management industry is very competitive and requires professional personnel with technical and project management skills. The Company believes that the principal competitive factors in all areas of its business are operational experience, technical proficiency, breadth of services offered, local presence and, often most importantly, price.\nThe Company faces competition from a diverse array of small and large organizations including national or regional environmental management firms; national, regional and local architectural, engineering and construction firms; environmental management divisions or subsidiaries of international engineering, construction and aerospace companies; and hazardous waste generators which have developed in-house capabilities similar to those of the Company. Major competitors in consulting, engineering and design include Bechtel, CH2M Hill, Dames and Moore, Earth Technology, ERM Group, Fluor, Jacobs Engineering, and Roy F. Weston. Major competitors in remediation include Bechtel, Fluor, Groundwater Technology, Handex, Jacobs Engineering, Morrison-Knudsen, OHM, and Smith Environmental.\nIncreased competition, combined with changes in client procurement procedures, has resulted in general market trends over the past several years toward lower contract margins, unfavorable changes in contract terms and conditions in areas such as indemnification, and a client preference for fixed-price arrangements for environmental management contracts. Additionally, certain of the Company's larger competitors benefit from certain economies of scale and have greater financial resources which allow for better access to bonding and insurance markets at a lower cost. These larger competitors have a competitive advantage over the Company in providing the financial assurance instruments which are frequently required by clients. The entry of aerospace and other defense contractors and international construction and engineering firms into the environmental management industry has materially increased the level of competition for major federal governmental contracts and programs, which have been the primary source of the Company's revenue over the past several years. Over the past several years, there has been consolidation in the industry as the larger corporations have acquired smaller firms, which may impact the level of competition.\nQuanterra competes with a few national, several regional and many single-location analytical services firms; analytical services divisions or subsidiaries of national or regional environmental management companies; and laboratory operations associated with universities or other nonprofit or governmental agencies. Due to the fragmented nature of this market, pricing for analytical services is highly competitive.\nRegulations - -----------\nThe Company and its clients are subject to extensive and rapidly evolving environmental laws and regulations which affect the demand for many of the services offered by the Company (see Business - Operations - Environmental Contractor Risks) and create certain significant risks for the Company in providing its services and at its inactive disposal sites in Northern California. (See Notes to Consolidated Financial Statements - Discontinued operations - Transportation, treatment and disposal.)\nRecently, a number of significant changes to existing environmental legislation have been proposed. Some of the proposed changes are a part of legislation commonly referred to as the Republican Party's \"Contract With America.\" Portions of that legislation, which have passed the U.S. House of Representatives, would overhaul the government regulatory process by instituting a Congressional \"veto\" on regulations, requiring regulatory risk assessments and cost-benefit analyses, restricting enactment of unfunded mandates on state and local governments, and reducing requirements for reporting to the government. The impact of these proposed changes upon the Company's business cannot yet be predicted. The Company believes that it generally has benefitted from increased environmental regulations affecting business, and from more stringent enforcement of those regulations. The currently contemplated changes in regulations could decrease the demand for certain of the Company's services, as customers anticipate and adjust to the new regulations. However, the proposed legislation could also result in increased demand for certain of the Company's services if regulatory changes decrease the cost of remediation projects or result in more funds being spent for actual remediation. The ultimate impact of the proposed changes will depend upon a number of factors, including the overall strength of the economy and customers' views on the cost effectiveness of remedies available under the changed regulations.\nThe principal environmental legislation affecting the Company and its clients is described below:\nNational Environmental Policy Act of 1969 (NEPA). Under NEPA, all federal agencies must consider ecological factors when dealing with activities that may have an impact on the environment. Among other things, NEPA was the first federal legislation to establish guidelines and requirements for environmental baseline studies, impact assessments and mitigation studies for a variety of major industrial and governmental projects, including development and construction of power plants and transmission lines, pipelines, highways, landfills, mines, reservoirs and residential and commercial developments.\nResource Conservation and Recovery Act of 1976 (RCRA). RCRA regulates the treatment, storage and disposal of hazardous and solid wastes. The 1984 Hazardous and Solid Waste Amendments to RCRA (HSWA) expanded RCRA's scope by providing for the listing of additional wastes as hazardous and lowering the quantity threshold of wastes subject to regulation. HSWA also imposed restrictions on land disposal of certain wastes, prescribed more stringent management standards for hazardous waste disposal sites, set standards for UST management and provided for corrective action procedures. Under RCRA, liability and stringent management standards are imposed on a person who is an RCRA permit holder, namely a generator or transporter of hazardous waste or an owner or operator of a waste treatment, storage or disposal facility.\nRCRA's standards for waste disposal and treatment facilities apply to hazardous waste incinerators. Changes in these standards have impacted the market for the Company's mobile, on-site incineration services using the HTTS technology. The USEPA, on May 18, 1993, citing its authority under RCRA, announced a draft strategy involving an 18-month freeze on the permitting of any new fixed-base hazardous waste incinerators or cement kilns, and a proposed policy imposing additional requirements and costs on such facilities. In public remarks at the time these plans were announced, USEPA stated that its freeze would not affect on-site incineration of hazardous waste at Superfund sites, such as projects utilizing the Company's HTTS on-site incineration units. In May 1994, the USEPA issued a new policy which, while\nseemingly affirming incineration as an allowable remedy under CERCLA (as defined below), called for additional procedures and studies to be conducted before incineration may be selected as a remedy, or which may result in the deselection of incineration as a remedy, at a Superfund site. In November 1994, the USEPA finalized its strategy, which continued the draft strategy's policy of granting a lower priority to consideration of new fixed-base hazardous waste incinerators or cement kilns. Additionally, the USEPA finalized its direction of favoring waste minimization over com- bustion\/incineration and of increasing regulatory burdens upon combustion and incineration facilities, whether fixed-based or on-site. Furthermore, incineration as a remediation remedy continues to be the subject of considerable public opposition and controversy. In May 1995, the Company was served with a notice by a group of residents in Slidell, Louisiana of its intent to sue the USEPA, the Company and others in connection with the USEPA's proposal to use the Company's HTTS incinerator erected at the Bayou Bonfouca Superfund site to receive and remediate waste from the nearby Southern Shipbuilders Superfund site. The notice claims certain deficiencies in the USEPA's proposals to use the Company's incinerator to remediate the waste from the Southern Shipbuilders site.\nThe USEPA strategy has impacted the demand for, and use of, the Company's HTTS technology. In July 1994, the Company was advised by the USEPA and the Texas Natural Resources Conservation Commission that incineration at the Texarkana Superfund site would be delayed until the Congressional Office of Technology Assessment (OTA) completed a study on the safety of incineration and the assessment of possible alternatives to incineration and that all offerors' bids, including IT's, were allowed to expire. In April 1995, however, the State of Missouri granted the Company's applications to erect and operate its HTTS units at the Times Beach Superfund site, after a significant delay.\nThe heightened scrutiny and higher cost of, and public opposition to, incineration as a treatment solution may lead to delays and added costs in permitting the Company's HTTS units, or may also cause the USEPA and\/or private parties to prefer other remedies in Superfund remediations. Such actions may have a material adverse impact on the Company's business. (See Management's Discussion and Analysis of Results of Operations and Financial Condition - Results of Operations - Continuing Operations - Revenues.)\nComprehensive Environmental Response, Compensation and Liability Act of 1980 (CERCLA). CERCLA addresses cleanup of sites at which there has been or may be a release of hazardous substances into the environment. CERCLA assigns liability for costs of cleanup and damage to natural resources to any person who, currently or at the time of disposal of a hazardous substance, owned or operated any facility at which hazardous substances were released; to any person who by agreement or otherwise arranged for disposal or treatment, or arranged with a transporter for transport of hazardous substances owned or possessed by such person for disposal or treatment by others; and to any person who accepted hazardous substances for transport to disposal or treatment facilities or sites from which there is a release or threatened release of hazardous substances. CERCLA authorizes the federal government either to clean up these sites itself or to order persons responsible for the situation to do so. CERCLA created the Superfund to be used by the federal government to pay for the cleanup efforts. Where the federal government expends money for remedial activities, it must seek reimbursement from the potentially responsible parties (PRPs). CERCLA generally imposes strict, joint and several retroactive liability upon such parties. CERCLA was amended in 1986 by the Superfund Amendments and Reauthorization Act (SARA) which authorized increased federal expenditures and imposed more stringent cleanup standards and accelerated timetables. SARA also contained provisions which expanded the enforcement powers of the USEPA.\nCERCLA was scheduled to be reauthorized in 1994, but has not, to-date, been reauthorized, as the interested parties and Congress have been unable to come to agreement on the proposed legislation. CERCLA's authorization to expend funds originally expired in September 1994, but Congress appropriated operating funds for the current governmental fiscal year. CERCLA's taxing authority, from which appropriations are made, expires in December 1995.\nA number of changes to CERCLA have been proposed as a part of the reauthorizing legislation. Amendments to repeal CERCLA's retroactive liability aspect have been introduced. It has also been proposed that CERCLA's preference for permanent treatment remedies such as incineration be changed to favor confinement and containment remedies. The current standards for acceptable cleanups have also been the subject of proposals for change.\nAt the same time, legislation has been enacted to reduce the current governmental fiscal year environmental cleanup budgets of DOD and DOE, by $300,000,000 (6%) and $200,000,000 (4%), respectively. Additional reductions for DOE's cleanup budget, as well as USEPA's Superfund, and state clean water and safe drinking water revolving funds, are currently being considered. President Clinton has also proposed that DOE's waste management and cleanup budget be further reduced over the next five years by $4,400,000,000, or approximately 15%. Congress has before it recommendations for funding levels in each environmental cleanup budget below those requested by the President. Such reductions in current and future environmental restoration budgets as a result of the November 1994 elections may adversely affect future government contracting opportunities and funding of the Company's contracted backlog.\nAlthough the impact upon the Company of the failure, to-date, of Congress to reauthorize CERCLA cannot be determined, delays may adversely impact the environmental industry in which the Company participates. Failure of Congress to reauthorize CERCLA, or substantial changes in or uncertainty concerning the details of the legislation, cleanup standards, and remedy selection (such as proposed changes that would change CERCLA's preference for permanent treatment remedies such as incineration in favor of confinement and containment), may result in project delays and\/or the failure of clients to initiate or proceed with projects.\nClean Air Act and 1990 Amendments. The Clean Air Act requires compliance with ambient air quality standards and empowers the USEPA to establish and enforce limits on the emission of various pollutants from specific types of facilities. The Clean Air Act Amendments of 1990 modified the Clean Air Act in a number of significant areas. Among other things, they established emissions allowances for sulfur and nitrogen oxides, established strict requirements applicable to ozone emissions and other air toxics, established a national permit program for all major sources of pollutants and create significant new penalties, both civil and criminal, for violations of the Clean Air Act. It is anticipated that changes will be proposed in the Clean Air Act, including in the Act's emissions monitoring and facility permitting provisions.\nOther Federal and State Environmental Laws. The Company's services are also utilized by its clients in complying with, and the Company's operations are subject to regulation under, among others, the following federal laws: the Toxic Substances Control Act, the Clean Water Act, the Safe Drinking Water Act, the Occupational Safety and Health Act and the Hazardous Materials Transportation Act. In addition, many states passed Superfund-type legislation and other regulations and policies to cover more detailed aspects of hazardous materials management. This legislation addressed such topics as air pollution control, UST and AST management, water quality, solid waste, hazardous waste, surface impoundments, site cleanup and wastewater discharge.\nMost important environmental laws are currently overdue for Congressional reauthorization, including RCRA, CERCLA, the Clean Water Act and the Safe Drinking Water Act. Delays in reauthorization and attendant lack of regulatory direction and enforcement could adversely affect the environmental industry. In addition, many states that passed Superfund-type legislation and other environmental regulations are now reviewing those laws and regulations because of their alleged adverse impact upon business and competitiveness.\nEnvironmental Contractor Risks - ------------------------------\nAlthough the Company believes that it generally benefits from increased environmental regulations affecting business, and from enforcement of those regulations, increased regulation and enforcement also create significant risks for the Company. These risks include potentially large civil and criminal liabilities from violations of environmental laws and regulations and liabilities to customers and to third parties for damages arising from performing services for clients. (For a discussion of the environmental regulatory risks posed by the Company's Northern California sites, see Notes to Consolidated Financial Statements - Discontinued operations - Transportation, treatment and disposal.)\nLiabilities Arising out of Environmental Laws and Regulations -------------------------------------------------------------\nAll facets of the Company's business are conducted in the context of an extensive and rapidly changing statutory and regulatory framework. The Company's operations and services are affected by and subject to regulation by a number of federal agencies including the USEPA, Occupational Safety and Health Administration (OSHA), and Nuclear Regulatory Commission as well as\napplicable state and local regulatory agencies. (For a description of certain applicable laws and regulations, see Business - Operations - Regulations.)\nThere have been efforts by litigants to expand the reach of CERCLA and RCRA to make contractor firms responsible for cleanup costs through claims that environmental contractors are owners or operators of hazardous waste facilities or that they arranged for treatment, transportation or disposal of hazardous substances. Although no clear direction has emerged from the cases decided to date, several recent court decisions have accepted these claims. Should the Company be held responsible under CERCLA or RCRA for damages caused while performing services or otherwise, it may be forced to bear such liability by itself, notwithstanding the potential availability of contribution or indemnity from other parties.\nOther environmental statutes and regulations also pose risks for the Company. For example, the Company's employee health and safety practices, particularly its activities at hazardous waste sites, are extensively regulated by OSHA. RCRA and similar state statutes regulate the Company's practices for the treatment, transportation, storage, disposal and other handling of hazardous materials. Substantial fines and penalties may be imposed not only for the mishandling of such substances, but also for failure to keep proper records and other administrative practices. The Company's failure to observe such laws and\/or the terms and conditions of licenses and permits it holds under these and other laws, could adversely impact the Company's ability to carry on one or more of its businesses as presently constituted.\nPotential Liabilities Involving Customers and Third Parties -----------------------------------------------------------\nIn performing services for its customers, the Company could potentially be liable for breach of contract, personal injury, property damage, and negligence, including claims for lack of timely performance and\/or for failure to deliver the service promised (including improper or negligent performance or design, failure to meet specifications, and breaches of express or implied warranties). The damages available to a customer, should it prevail in its claims, are potentially large and could include consequential damages.\nMany of those contracting for environmental management services, particularly those involving large scale remediations, seek to shift to contractors the risk of completing the project in the event the contamination is either more extensive or difficult to resolve than originally anticipated. The Company has from time to time been involved in claims and litigation involving disputes over such issues. (See Legal Proceedings.)\nEnvironmental management contractors, in connection with work performed for customers, also potentially face liabilities to third parties from various claims including claims for property damage or personal injury stemming from a release of toxic substances or otherwise. Claims for damage to third parties could arise in a number of ways, including through a release or discharge of contaminants or pollutants during the performance of services, or through reliance by others on reports prepared by the Company. Personal injury claims could arise contemporaneously with performance of the work or long after completion of the project as a result of alleged exposure to toxic substances. In addition, increasing numbers of claimants assert that companies performing environmental remediation should be adjudged strictly liable, i.e., liable for damages even though its services were performed using reasonable care, on the grounds that the Company's services involved \"abnormally dangerous activities\".\nCustomers frequently attempt to shift various of the 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. (See Business - Operations - Insurance and Risk Management.)\nOver the past several years, the USEPA has constricted significantly the circumstances under which it will indemnify its contractors against liabilities incurred in connection with CERCLA projects and continues its attempts to renegotiate previously agreed indemnities. Other federal agencies continue to resist offering indemnification to contractors for third party claims. While Congress last year considered broadening the\navailability of indemnification, and is expected to do so again this year, there is no assurance that Congress will change federal government indemnification policies. The continued lack of indemnification may have a material adverse effect on the Company's business.\nGovernment Contracting Risk ---------------------------\nAs a major provider of services to governmental agencies, the Company also faces the risks associated with government contracting, which include substantial civil and criminal fines and penalties for, among other matters, failure to follow procurement integrity and bidding rules, employing improper billing practices or otherwise failing to follow cost accounting standards, receiving\/paying kickbacks or filing false claims. Government contracting requirements are complex, highly technical and subject to varying interpretations. As a result of its government contracting business, the Company has been, is, and expects in the future to be, the subject of audits and investigations by governmental agencies. (See Legal Proceedings.) In addition to the potential damage to the Company's business reputation, the failure to comply with the terms of one or more of its government contracts could also result in the Company's suspension or debarment from future government contract projects for a significant period of time. The fines and penalties which could result from non-compliance with appropriate standards and regulations, or the Company's suspension or 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 governmental agencies. (See Business - Operations - Customers.)\nInsurance and Risk Management - -----------------------------\nThe Company has adopted a range of insurance and risk management programs designed to reduce potential liabilities, including insurance policies, programs to seek indemnity where possible in its contracts, other contract administration procedures, and employee health, safety, training, and environmental monitoring programs. In addition, as a result of the substantial increase over the past several years in the percentage of the Company's revenues derived from work for governmental agencies, the Company has been actively implementing a government contracts compliance program. The Company cannot assure the adequacy of the program and compliance failure could have a material adverse effect on the Company's business.\nThe Company's insurance program includes policies of $5,000,000 per fiscal year for each of commercial general liability, product liability and automotive liability. With respect to all such coverages, the Company's captive insurance company (the Captive) generally is obligated to indemnify the carrier against liabilities and costs of defense, subject to certain limitations. Letters of credit are provided to support the indemnity commitment; at present, the aggregate amount of such letters of credit is $12,060,000. From a risk management perspective, the policies provided by the Captive are, in effect, a self-insurance layer. The Company has $70,000,000 in excess liability policies insuring claims in excess of the $5,000,000 covered by the policies noted above. The Company also has other insurance policies with various retentions or deductibles for the management of its risk including but not limited to all risk property coverage, workers' compensation, employer's liability, consultants' environmental liability (including errors and omissions) and directors' and officers' liability insurance coverage.\nEnvironmental Impairment Liability coverage for IT's inactive treatment, storage and disposal sites located in Northern California is provided through the Captive which has issued a $32,000,000 policy which meets the current requirements of both federal and state law. (See Notes to Consolidated Financial Statements - Discontinued operations - Transportation, treatment and disposal.)\nAlthough the Company believes its insurance program to be appropriate for the management of its risk, its insurance policies may not fully cover risks arising from the Company's operations. The exclusion of certain pollution and other liabilities, such as punitive damages, from some insurance policies, or losses in excess of the coverage, may cause all or a portion of one or more losses not to be covered by such insurance. Further, the cost and limited availability of insurance has resulted in the Company's use of self-insurance through the Captive, thus exposing the Company to additional liabilities.\nDISCONTINUED OPERATIONS\nPollution Control Manufacturing - -------------------------------\nIn 1992, the Company sold the manufacturing operations of IT's Pollution Control Systems division. This business, located in Tulsa, Oklahoma and Hull, England, designed and manufactured combustion, hydrocarbon vapor recovery, waste treatment and other environmental control systems for domestic and international clients.\nTransportation, Treatment and Disposal - --------------------------------------\nIn December 1987, the Company's Board of Directors adopted a strategic restructuring program which included a formal plan to divest the transporta- tion, treatment and disposal operations through sale of some facilities and closure of certain other facilities. These operations included the handling and transportation of clients' wastes and their treatment and\/or disposal at Company or third party-owned facilities. In June 1989, the Company completed the sale of IT's active treatment and disposal operations in Imperial Valley and at Bakersfield, California, as well as its transportation business. The Company's four inactive treatment, storage and disposal sites located in Northern California were not included in this transaction. Substantial progress has been made to date toward the closure of these facilities, with two of these sites closed and the others in the process of closure.\nThere are substantial financial implications related to the Transportation, Treatment and Disposal discontinued operations. For further information regarding the Company's discontinued operations, see Notes to Consolidated Financial Statements - Discontinued operations, Management's Discussion and Analysis of Results of Operations and Financial Condition - Liquidity and Capital Resources, and Legal Proceedings.\nEMPLOYEES - ---------\nAt March 31, 1995, the Company employed 2,766 regular employees. Of these employees, 340 were in sales, corporate office and group administration and the remainder were in operations. The Company's professional and technical employees engage in disciplines which include chemical and civil engineering, geology, hydrology\/hydrogeology and computer\/data processing. Over 500 of the Company's employees hold advanced degrees. Growth in the Company's operations is partially dependent upon its ability to attract, train and retain qualified professional staff.\nAt March 31, 1995, none of the Company's employees were represented by labor unions under collective bargaining agreements. The Company employs union labor from time to time on a project basis. The Company cannot predict whether any of its employees who currently are not represented by unions will elect to be so represented in the future. The Company considers its relations with its employees to be good and has not experienced a significant work stoppage in the past ten years.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nIT owns or leases property in 24 states and the United Kingdom. Excluding its discontinued operations, the Company owns approximately 50 acres and leases approximately 930,000 square feet of property for various uses, including regional and project offices, technology and process development laboratories, equipment yards and a corporate office. Management considers the facilities adequate for the present and anticipated activities of the Company.\nAdditionally, the Company owns approximately 3,900 acres related to its discontinued operations, principally in Northern California and Louisiana, of which approximately 500 acres have been used for hazardous waste disposal facilities and approximately 2,200 are adjacent to those facilities.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nClass Action Lawsuit - --------------------\nMancino et al. v. International Technology Corporation, et al., (U.S.D.C. - - Central District No. 89 - 7244 RMT) is a class action lawsuit filed in federal court in December 1989, on behalf of stockholders of the Company alleging violations of the federal Securities Exchange Act of 1934 in connection with the purchase of shares of the Company's common stock by members of the purported class between January 1986 and April 1987. The complaint also names as defendants the underwriters who performed services in connection with the Company's senior note offering in July 1986. In addition, the com- plaint alleges that certain of the Company's officers and directors sold shares of the Company's common stock at artificially inflated prices based on undisclosed information about the Company. The plaintiffs seek unspecified damages, plus costs associated with the litigation. Discovery concerning the facts underlying the action has been substantially completed and trial in this action is now set for November 28, 1995. Although the Company is defending the action vigorously, at the request of the plaintiffs, the parties have participated in voluntary, mediated settlement discussions, but have thus far been unable to reach a settlement. Although it is not possible to determine the ultimate outcome of the litigation, the Company intends to further pursue settlement of the matter and has recorded a charge of $3,800,000 in the fourth quarter of fiscal year 1995 to provide for potential settlement and defense costs.\nAfter consultation with outside counsel and in consideration of the availability of insurance coverage and the Company's $3,800,000 provision, management believes the ultimate outcome of the Mancino action will not have a material adverse effect on the consolidated financial condition of the Company.\nMotco - -----\nOn December 4, 1991, the Company announced the suspension of work on the Motco project, the cleanup of a Superfund site in Texas, and the filing of a $56,000,000 breach of contract lawsuit, captioned IT Corporation v. Motco Site Trust Fund and Monsanto Company in the United States District Court for the Southern District of Texas, Houston Division, Civil Action No. H-91-3532, against the Motco Trust, the PRP group that agreed to finance remediation of the site, and Monsanto Company, the leader of the PRP group.\nIn January 1988, the Company was retained by the Motco Trust to destroy waste contained in pits at the site using two transportable incinerators designed and operated by IT. Based on information provided to IT in the Motco Trust's request for proposal, the Company bid and was awarded a fixed-price contract which was subsequently increased through change orders. In early 1991, IT advised the Motco Trust and Monsanto that it would cost substantially more to complete the project because the scope of work had changed and because the chemical makeup, quantities and mixture of waste at the site were dramatically different from that portrayed by data provided to IT in Motco Trust's request for proposal. Additionally, the project was impacted by other actions of the Motco Trust and Monsanto, including the pumping of contaminated water and waste into the Motco pits from an unrelated project which was managed by the Motco Trust and Monsanto.\nIT continued work at the site in good faith while negotiations were occurring with the Motco Trust and Monsanto. Approximately $31,000,000 of direct costs were incurred in excess of those recovered under the contract and were recorded as a contract claim receivable and are included in noncurrent assets in the Company's consolidated balance sheets at March 31, 1995 and 1994. IT has not recognized any overhead cost recovery or profit on this project to date. IT sued to recover costs and profit of approximately $56,000,000.\nOn December 26, 1991, the Motco Trust and Monsanto filed an answer to IT's lawsuit and asserted a counterclaim against IT. In their answers to IT's lawsuit, the Motco Trust and Monsanto denied liability to IT on the grounds that the Motco Trust had previously executed a change order addressing many of the claims and purported underlying events alleged in the lawsuit and had received a full release from IT regarding those matters, that IT had failed to mitigate its alleged damages, that IT had failed to manage and control its costs on the project, and that IT's lawsuit failed to state a claim upon which relief could be granted as it claimed extra-contractual compensation.\nIn its counterclaim, the Motco Trust sought recovery of $27,000,000 monetary damages including all payments to third parties to complete performance of the project, all penalties or other liabilities to any governmental entity, and any related damages which occurred as a result of the breach of contract by IT which is alleged to have occurred upon the filing of the lawsuit by IT and concurrent suspension of work at the site.\nThe case was tried before a jury during March and April of 1994. As a result of that trial, the jury rendered a verdict in IT's behalf wherein they found that Monsanto had breached its contract with IT, had defrauded IT and had provided IT with information which constituted a negligent misrepresentation as to the waste characteristics. The jury found that the amount of damages caused IT as a result of these acts was in the amount of $52,800,000. The jury also found that Monsanto should pay punitive damages in the amount of $28,550,000, together with attorneys' fees in the amount of approximately $2,300,000. The jury further found that IT was excused from performance and that Motco Trust should not recover on its $27,000,000 counterclaim.\nOn December 14, 1994, the court ruled that IT was entitled to a judgment in the amount of $43,700,000 plus prejudgment interest and attorneys' fees. The court's order reduced the jury's previous compensatory damage award by $9,100,000 and set aside the jury's award of $28,550,000 in punitive damages. On May 8, 1995, the court entered a final judgment in the approximate amount of $66,000,000, consisting of the $43,700,000 in compensatory damages, and $2,300,000 in attorneys' fees, plus prejudgment interest of approximately $20,000,000. On June 20, 1995, the court denied all pending postjudgment motions. Notices of appeal have been filed by both the Company and Monsanto. The final judgment amount accrues postjudgment interest at the one- year U.S. Treasury rate (approximately 6.3%) in effect at the time of judgment from the date the judgment is entered until paid. While it is not possible to predict, the appellate process could take as long as two years.\nAfter consideration of the merits of the Company's position in the lawsuit and after consultations with its outside counsel, management believes that, subject to the inherent uncertainties of litigation, the Company more likely than not will recover the contract claim receivable recorded to date and prevail on Motco Trust's counterclaim. However, if this matter is resolved in an amount significantly lower than the contract claim receivable of approximately $31,000,000 recorded by IT or if the Motco Trust prevails in its counterclaim and recovers any significant amount of damages, a material adverse effect to the consolidated financial condition of the Company would result.\nCentral Garden - --------------\nOn July 14, 1992, the Company responded to an emergency call to clean up a chemical spill at a finished product warehouse facility leased by Central Garden & Pet Supply Company (Central) in Baton Rouge, Louisiana. While cleanup was under way, a fire began which damaged the warehouse facility. In addition to the owner of the facility, Central and two other lessees of the finished product warehouse facility (an electrical supply company and a pharmaceutical company) incurred significant property damage and substantial loss of inventory. A total of nine lawsuits arising from the fire have now been filed and these cases have been consolidated for discovery purposes only.\nOn August 2, 1992, in the first action to be filed (Gravois et al. v. IT Corporation, et al., #92-649, U.S. District Court, Central District of Louisiana), residents of a nearby apartment complex filed a petition for damages against the Company and Central alleging personal injuries caused by the release of hazardous and noxious materials into the atmosphere as a result of the fire. Central filed an answer, cross-claim, and third-party complaint. Central alleged, among other things, that the Company was the cause of the fire in failing to exercise proper care in the cleanup of the spill, and was responsible for the property damage, loss of contents, loss of profits and other economic injury, and expenses incurred in the cleanup. Further, Central claimed a set-off for monies due the Company for cleanup services rendered by the Company after the fire and seeks indemnity for any damages assessed against Central. The Company responded by alleging, among other things, improper storage and handling of hazardous materials by Central. In August 1993, this case was remanded to state court (19th Judicial District, Parish of East Baton Rouge, Louisiana, #383,887). The Company also filed its own cross-complaint against Central for services rendered after the fire and denied responsibility for the fire, raised certain defenses, and further claimed that Central was not entitled to a set-off. The monies due the Company for services rendered to Central approximate $1,700,000 and are included in accounts receivable in the Company's consolidated balance sheets at March 31, 1995 and 1994.\nThe Company believes that the allegations in the other actions arising out of the fire are substantially duplicative of the Gravois case and each other. For example, the insurer for the electrical supply company, American Manufacturers Mutual Insurance Company, also filed a complaint in state court (19th Judicial District Court, Parish of East Baton Rouge, Louisiana, #390,241) against the Company, Central, the lessor and certain insurers. The owner of the adjacent pharmaceutical company, Bergen Brunswig Company, and its insurers filed suit against the Company, Central, the lessor, a construction company which built a fire wall that allegedly did not meet the building code, the manufacturer of the chemicals which were spilled and certain insurers (19th Judicial District Court, Parish of East Baton Rouge, Louisiana, #393,056). The lessor also filed a cross-claim and third party complaint against the Company and others in this action.\nPursuant to a Case Management Order entered in the Gravois action and applicable to all of the filed cases, a schedule has been established for the completion of discovery and the submission of reports concerning damages claimed and the causation of the fire. In March 1995, pursuant to the Case Management Order, the parties propounded to each other reports concerning the types and amount of damages sought. These reports collectively claim a total of $23,000,000 from all of the defendants but do not apportion the damages claimed among the various defendants. The largest single claim is by Bergen Brunswig, which claims approximately $11,000,000, principally for lost inventory. In its report, Central claims approximately $4,400,000, including approximately $1,000,000 in damages resulting from the postponement of its initial public offering, and the $1,700,000 sought by the Company for services rendered in cleaning up after the fire. The personal injury plaintiffs in the Gravois and related actions claim approximately $2,400,000 in damages. In addition, most of the claimants demand punitive damages in unspecified amounts. The Company believes that certain of the claimants' damage claims are inflated and contain elements that are not legally recoverable or are not properly documented.\nWhile the Company is pursuing settlement of this matter, the Company is defending the actions vigorously and believes that it has meritorious challenges to some of the damages claimed and meritorious claims for contribution against some parties. Additionally, the Company believes that it is likely that it will recover from Central, by collection or set-off, on breach of contract claims for the cleanup services provided. The parties have agreed to submit the case to nonbinding mediation in October 1995. Trial is scheduled for May 1996. Based on discovery to date, there is a risk that the Company will be found liable for at least some damages. If the Company is held liable for damages, there is the further risk that the Company could be held liable for punitive damages. Discovery has not been completed; the Company cannot predict the amount or range of damages for which it and\/or the other parties may be found responsible.\nThe Company's insurance carrier has been notified of the matter and is a defendant in one of the actions. The Company's carrier is defending the actions subject to a reservation of its rights to contest coverage at a later date. The Company previously filed a protective lawsuit seeking determination of coverage, but later agreed to a dismissal of the action in accordance with a standstill agreement with the carrier pursuant to which, subject to applicable policy limits, the carrier has agreed to fund provisionally any final judgment or settlement of the matter. However, the insurer has retained its right to challenge coverage under the policy after any such funding. If the Company settles the matter or is held liable for damages and the insurance carrier funds the settlement or judgment, the Company may face reimbursement claims by its carrier, based on assertions that the Company's policies do not cover damages resulting from the fire because of allegations that such damages are excluded pollution liabilities or punitive damages. (See Business - Operations - Environmental Contractor Risks and Insurance and Risk Management.)\nIn the fourth quarter of fiscal year 1995, the Company recorded a $5,300,000 charge, covering both defense and potential settlement costs, to provide for its self-insured retention under its general liability insurance coverage for the Central Garden matter. Should the cases result in a significant award of damages against the Company or payment by the Company of a significant amount in settlement, either of which is not substantially covered by the Company's insurance policies, additional litigation costs would be recorded related to the matter.\nHelen Kramer Contract - ---------------------\nOn May 3, 1993, the Company received an administrative subpoena from the Office of the Inspector General (OIG) of the USEPA seeking documents relating to certain of the Company's claims which were submitted to the U.S.\nArmy Corps of Engineers with regard to the Helen Kramer remediation contract, a completed project which the Company performed in joint venture. Since August 1992, the Defense Contract Audit Agency (DCAA) has been conducting an audit of certain claims submitted by the joint venture. The Company has been informed that there is a federal civil and criminal investigation into the claims. In April 1995, the Company was informed that several of its joint venture partner's employees have been subpoenaed to discuss their knowledge of the matter.\nIn October 1993, a shareholder of the Company alleged that the acts giving rise to the Helen Kramer investigation constituted, among other things, a waste of the Company's assets and demanded that the Company institute an action against those responsible for the alleged wrongdoing. The Audit Committee (Committee) of the Board of Directors investigated the allegations of the OIG. The Committee, acting with the assistance of outside counsel and experts, determined that there was no evidence of intentional wrongdoing or negligence by the Company or any employee. The Board approved the report of the Committee and advised counsel to the shareholder of its conclusions on September 2, 1994. (See Business - Operations - Environmental Contractor Risks and Notes to Consolidated Financial Statements - Summary of significant accounting policies - Contract accounting and accounts receivable.)\nDiscontinued Operations Legal Proceedings - -----------------------------------------\nThe actions discussed below relate to the transportation, treatment and disposal discontinued operations of the Company and have been considered in the provision for loss on disposition. (See Notes to Consolidated Financial Statements - Discontinued operations - Transportation, treatment and disposal.)\nOperating Industries, Inc. Superfund Site -----------------------------------------\nUnder CERCLA, the USEPA and the California EPA Department of Toxic Substances Control (DTSC) have investigated and are continuing to investigate the operation of and shipments of wastes to certain disposal sites in California and elsewhere, including the Operating Industries, Inc. (OII) Superfund site in Monterey Park, California. In June 1986, USEPA notified a number of entities, including the Company, that they were PRPs under CERCLA with respect to OII and, as such, faced joint and several liability for the cost to investigate and clean up this site. USEPA requested these entities to work as a single group to settle with USEPA and DTSC their alleged liability for certain past response costs and to perform future remedial work. A number of these PRPs subsequently formed the OII Steering Committee (Steering Committee) and negotiated a series of settlements addressing cost reimbursement demands and performing certain interim remedial measures (IRMs). The Company did not join the Steering Committee or enter these settlements. USEPA currently contends that the Company remains a PRP and is liable for its share of costs associated with the past settlements which total approximately $8,500,000 (including a premium but not interest). The Steering Committee also contends the Company is liable to it for a share of these settlement costs and has quantified the Company's share of the first two settlements at approximately $2,700,000. On October 11, 1994, the Company was served with a summons and complaint in a cost recovery action brought by members of the Steering Committee (National Railroad Passenger Corporation, et al. v. Harshaw Filtrol, U.S.D.C. Central District No. CV 94 2861 WMB (GHKx)). The action seeks (1) recovery from the Company of a portion of certain of plaintiffs' costs incurred at OII allegedly attributable to the Company and (2) a declaration from the court as to the Company's share of future costs in the OII response action. The Company is defending this action vigorously while continuing to attempt a joint settlement with both the Steering Committee and the USEPA. Trial in this action, which was set for July 17, 1995, has been taken off the calendar and has not been rescheduled.\nThe Company believes the USEPA's and the Steering Committee's claims essentially overlap. Both assume the Company or its predecessor and subsidiaries arranged for the disposal of the identical volume of wastes at OII and are based on the relative percentage of that volume to the known volume of liquid wastes sent to the site. The Steering Committee has not quantified and the USEPA claim does not specifically address future costs for site remediation and long-term monitoring and maintenance. These figures are not known but are expected to be substantial. Based on the available information regarding the operations of the Company's subsidiaries and predecessor in handling the wastes, the Company believes its share of responsibility for the site, if any, is less than the share attributed to it by the USEPA and the Steering Committee. Accordingly, the Company has not been able to agree to USEPA's or the Steering Committee's claims. IT has met with USEPA attempting to settle its response cost claims and is continuing\nto negotiate for a settlement. No settlement has been reached. Instead, in October 1994, USEPA advised the Company in writing that it continued to regard the Company and its subsidiaries as liable for response costs. In that notice, USEPA provided the Company and other non-Steering Committee PRPs the opportunity to make a limited challenge as to USEPA's volume determinations. Subject to its review of that challenge, USEPA further stated it intended to offer the Company and other non-settling PRPs, another opportunity to resolve their liability for response costs by paying the amount determined by USEPA based on volume plus a substantial premium based on failure to join the earlier settlements. The Company submitted a volume challenge on January 10, 1995, but has received no response from USEPA although it is continuing to pursue settlement discussions.\nThe inability of the Company to effect a satisfactory settlement with the Steering Committee and the USEPA could have a material adverse effect on the consolidated financial condition of the Company. The Company has advised its liability insurance carriers as to the pendency of the USEPA's and the Steering Committee's claims and requested indemnification and legal representation. The carriers dispute their obligations to the Company.\nGBF Pittsburg Superfund Site ----------------------------\nOn September 25, 1987, the Company was served with a Remedial Action Order (RAO) issued by the California Department of Health Services, now the DTSC, concerning the GBF Pittsburg landfill site near Antioch, California, a site which has been proposed by the USEPA to be added to the National Priorities List under CERCLA. IT and 17 other firms and individuals were characterized as responsible parties in the RAO and directed to undertake investigation and potential remediation of the site which consists of two contiguous parcels. From 1968 through 1974, a predecessor to IT Corporation operated a portion of one parcel as a liquid hazardous waste site. The activity ceased in 1974, and the disposal site was closed pursuant to a closure plan approved by the appropriate Regional Water Quality Control Board (RWQCB). Both of the parcels then served as a municipal and industrial waste site and, until 1991, continued to accept municipal waste. Water quality samples from monitoring wells in the vicinity of the site were analyzed by the property owner in August 1986 and indicated the presence of volatile organics and heavy metals along the periphery of the site.\nAdditional PRPs, consisting primarily of known waste generators, were subsequently served with an amended RAO by the DTSC. IT and other PRPs (the PRP group) are participating on a voluntary basis to further investigate the nature and extent of any subsurface contamination beneath the site and beyond its borders. During fiscal year 1992, the PRP group submitted Remedial Investigation and Feasibility Study reports to the DTSC. The studies indicate that groundwater quality impact is not affecting drinking water supplies and is not attributable solely to the portion of the site previously operated by IT's predecessor. The current owner\/operator at the site was ordered to cease the municipal landfill operations and close the site and, pursuant to a court approved settlement, ceased accepting waste and is proceeding with the capping of the landfill.\nIn July 1993, the Company, along with the other PRPs at the site, was issued a revised RAO and Imminent and Substantial Endangerment Order that, although it appears primarily to restate previous RAOs, also directs all previously named PRPs to undertake specific additional tasks including the closure of the municipal landfill.\nIn July 1994, the DTSC issued to the Company and 49 other alleged PRPs a proposed determination of non-compliance with the July 1993 DTSC order to prepare a work plan for specified remediation at the site. The Company and a group of cooperating PRPs submitted a draft work plan in compliance with the order and are currently taking measures to attempt to obtain reimbursement from those PRPs who do not contribute their appropriate share of response costs at the site.\nEnvironmental Protection Corporation Superfund Site ---------------------------------------------------\nOn March 23, 1995, IT was notified by the DTSC that it was among 13 companies identified as potentially responsible for costs associated with investigation and cleanup of the Environmental Protection Corporation (EPC) site known as the Eastside Facility near Bakersfield, California. The DTSC\nnotice letter states that IT is believed to have arranged for disposal of hazardous substances at the Eastside Facility during the period between 1972 and 1985 when it was permitted and operated as a land treatment facility.\nIT transported various waste streams on behalf of its customers to the Eastside Facility at various times during that facility's operations and it was a minority shareholder in EPC for a period of its operations. DTSC has directed IT and the other parties which were notified to form a group and to respond to a proposed administrative order directing them to characterize the facility and undertake any appropriate remedial action to deal with any releases or threatened releases identified.\nIT has no estimate of the potential costs associated with investigation and remediation of the Eastside Facility. IT has had preliminary discussions with the other parties which were notified, is reviewing the draft administrative order and is evaluating its options.\nYakima Railroad Area Superfund Site -----------------------------------\nOn July 14, 1994 the Company was notified that the State of Washington Department of Ecology (WDOE) considers the Company a PRP at the Yakima Railroad Area (YRRA) state superfund site in Yakima, Washington, based upon its alleged disposal of materials at a carbon recycling facility within the YRRA site. WDOE alleges that groundwater in a six square mile area of the YRRA has been contaminated with hazardous substances from 15 facilities, including the carbon recycling facility, and is supplying alternative water sources for residents whose wells are alleged to have been affected. The Company disputes its alleged liability, but is cooperating with the other PRPs in attempting to locate and notify other PRPs and in investigating the contamination at the carbon recycling facility.\nOther Site Cleanup Actions --------------------------\nThe Company, as a major provider of hazardous waste transportation, treatment and disposal operations in California prior to the December 1987 adoption of its strategic restructuring program, has been named a PRP at a number of other sites and may, from time to time be so named at additional sites and may also face damage claims by third parties for alleged releases or discharges of contaminants or pollutants arising out of its transportation, treatment and disposal discontinued operations. The Company has either denied responsibility and\/or is participating with others named by the USEPA and\/or the DTSC in conducting investigations as to the nature and extent of contamination at the sites.\nOther - -----\nThe Company is subject to other claims and lawsuits in the ordinary course of its business. In the opinion of management, all such other pending claims are either adequately covered by insurance or, if not insured, will not individually or in the aggregate result in a material adverse effect on the consolidated financial condition of the Company.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SHAREHOLDERS.\nThere were no matters submitted to a vote of the Company's common shareholders during the fourth quarter of fiscal year 1995.\nEXECUTIVE OFFICERS OF THE COMPANY\nThe following table provides information as of June 26, 1995 regarding the Company's executive officers and the positions they hold with the Company. The officers are appointed annually by the Board of Directors to serve at the discretion of the Board.\nFirst elected as Term as director or director officer of Name Age Position expires the Company ---- --- -------- -------- -----------\nRobert B. Sheh 55 President and Chief 1997 1992 Executive Officer Larry M. Hart 54 Senior Vice President and ---- 1993 Chief Operating Officer Franklin E. Coffman 53 Senior Vice President, ---- 1984 Government and Commercial Program Development Anthony J. DeLuca 48 Senior Vice President and ---- 1990 Chief Financial Officer James R. Mahoney 56 Senior Vice President, ---- 1991 Regional and Technical Operations and Corporate Development Raymond J. Pompe 61 Senior Vice President, ---- 1988 Project Operations Eric Schwartz 48 Senior Vice President, Law ---- 1992 and Administration, General Counsel and Secretary\nMr. Sheh joined the Company in July 1992 as President and Chief Executive Officer and a Director. Prior to joining the Company, Mr. Sheh was President of The Ralph M. Parsons Company, a subsidiary of The Parsons Corporation, since 1989. Mr. Sheh had a broad range of management responsibilities during his 21 years with Parsons, including international operations, corporate business development and management of major divisional operations. Parsons is a major international engineering and construction company, which serves the energy, natural resource, environmental and defense industries. Mr. Sheh serves on the Board of Directors of Davidson & Associates, Inc.\nMr. Hart joined the Company in November 1993 as Senior Vice President and Chief Operating Officer. Prior to joining the Company, Mr. Hart served from 1967 to 1993 in several capacities for Fluor Daniel, Inc., a major engineering and construction firm. At Fluor Daniel, Inc., Mr. Hart served as Project Director for several multi-million dollar engineering and construction projects, President of the Power Business Sector, and a Fluor Daniel Group Executive.\nMr. Coffman joined the Company in October 1984 as Vice President, Government Programs and was named Senior Vice President, Government and Commercial Program Development, in March 1995. Prior to joining the Company, Mr. Coffman served in various capacities for DOE including Deputy Assistant Secretary of Waste Management, Director of the Office of Advanced Nuclear Systems and Projects, and Director of the Division of Fusion Development and Technology. Previously, he was employed in the Atomic Energy Commission as Chief, Energy Research Development Agency, Fusion Systems and Applications - Applications Studies Branch, Washington, D.C. and as a health physicist.\nMr. DeLuca joined the Company in April 1990 as Senior Vice President and Chief Financial Officer. Prior to then, he was with the public accounting firm Ernst & Young LLP for 20 years, including the last 8 years as a partner in the firm.\nMr. Mahoney who joined the Company in January 1991 as Senior Vice President and Director of Technology was named Senior Vice President, Corporate Development and Sales in April 1992 and Senior Vice President, Regional and Technical Operations and Corporate Development in March 1995. Prior to joining the Company, Mr. Mahoney was Director of the National Acid Precipitation Assessment Program, a U.S. government research and assessment program, from 1988 to 1991. From 1984 to 1988, Mr. Mahoney served in various environmental managerial capacities with Bechtel Group, Incorporated, a major construction firm.\nMr. Pompe joined the Company in 1988 as Vice President, Construction and Remediation and was named Senior Vice President, Project Operations, in March 1995. Prior to joining the Company, Mr. Pompe was employed by Dravo Corporation, a major construction firm, from 1956 to 1988 in various executive capacities, most recently as Senior Vice President responsible for construction projects.\nMr. Schwartz joined the Company in October 1992. Prior to joining the Company, Mr. Schwartz served in various capacities for Tosco Corporation, an energy company, from 1978 to 1992, including that of Executive Vice President, Finance, Administration and General Counsel, a member of its Board of Directors and a consultant. From 1972 to 1978, Mr. Schwartz was associated with the law firm of Cleary, Gottlieb, Steen & Hamilton.\nPART II\nITEM 5.","section_5":"ITEM 5.MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS.\nThe Company's common stock is listed on the New York Stock Exchange (NYSE) under the symbol of ITX. The following table sets forth the high and low sale prices, as reported by the NYSE.\nQuarter ended High Low ------------- ---- ---\nJune 30, 1993..................................... $5 7\/8 $4 5\/8 September 30, 1993................................ 5 7\/8 4 December 31, 1993................................. 4 1\/4 3 3\/8 March 31, 1994.................................... 3 3\/4 2 3\/4 June 30, 1994..................................... 3 1\/4 2 September 30, 1994................................ 3 7\/8 2 3\/8 December 31, 1994................................. 4 1\/2 2 3\/4 March 31, 1995.................................... 3 1\/4 2 1\/4\nOn June 14, 1995, the closing sale price of the common stock on the NYSE as reported by The Wall Street Journal was $2 7\/8 per share. On that date there were 2,286 shareholders of record.\nThe Company has not paid a cash dividend on its common stock for the three years ended March 31, 1995. The Company has no present intention to pay cash dividends on its common stock for the foreseeable future in order to retain all earnings for investment in the Company's business. IT's credit agreements prohibit cash dividends on common stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe following table sets forth income statement information for the Company's continuing operations and other financial information for each of the five years in the period ended March 31, 1995. (See Notes to Consolidated Financial Statements - Discontinued operations.)\nYear ended March 31, ------------------------------------------- 1995 1994 1993 1992 1991 ---- ---- ---- ---- ---- (In thousands, except per share data) INCOME STATEMENT INFORMATION Revenues $423,972 $392,803 $410,539 $420,453 $373,085\nIncome (loss) from continuing operations (net of preferred stock dividends) (7,880) (3,241) (2,082) 8,895 14,618\nIncome (loss) per share from continuing operations (.22) (.09) (.06) .27 .44\nWeighted average shares 35,557 34,762 33,530 33,425 33,401\nOTHER FINANCIAL INFORMATION Working capital $ 73,838 $ 63,522 $ 60,281 $ 71,730 $ 48,788\nTotal assets 362,152 359,203 369,178 382,317 356,459\nLong-term debt 80,189 68,625 115,811 136,413 101,408\nLong-term accrued liabilities 45,207 38,993 52,470 56,500 59,554\nStockholders' equity 145,921 160,548 106,178 98,531 105,687\nNo cash dividends were paid on common shares for any period.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION.\nRESULTS OF OPERATIONS\nCONTINUING OPERATIONS\nOverview - --------\nThe Company operates in one industry segment and provides a broad range of environmental management services to clients principally in the United States. The Company's principal strategy is to market its services on a full-service basis. There are operating and economic synergies between its service areas, as they are complementary and often used in combination.\nIn fiscal year 1995, the Company increased its volume of business in the federal governmental sector as spending programs remained strong, particularly because of remediation work performed by the Company's Construction and Remediation business area. Additionally, the Company experienced lower overhead and administrative costs due to cost reduction efforts and the transfer of certain costs related to the formation of Quanterra. (See Quanterra.) Project margins continued to be negatively impacted by weak market demand in the commercial sector, due to reduced levels of\nenvironmental regulation and enforcement, leading to increased competition and in the governmental sector, due to the entry or expanded presence of certain major firms as competitors.\nNew Organizational Structure - ----------------------------\nPrior to the June 1994 formation of Quanterra, the Company was organized into three business areas, Environmental Services, Construction and Remediation, and Analytical Services. Subsequent to June 1994, the Company has operated in the first two of these business areas. Effective April 1, 1995, the Company implemented organizational structure changes in an effort to deliver more cost-effective services to clients. The Company's operations are now principally managed under a structure consisting of three regions with full service capabilities. Each region has its own technical, project management, sales and administrative support functions. The Construction and Remediation group's project management capabilities and related infrastructure have been integrated throughout the Company to strengthen project execution skills and enhance client service on a company-wide basis. Accordingly, IT offers all of its services in each region in which it operates. The Company currently operates 43 offices, including project offices, located across the United States.\nRevenues - --------\nThe following table provides information on revenues attributable to the business areas of the Company.\nRevenues for fiscal year 1995 increased $31,169,000, or 7.9%, from fiscal year 1994 levels as both the Environmental Services and the Construction and Remediation business areas reported revenue growth. Effective with the inception of operations for Quanterra in the second quarter of fiscal year 1995, the Company no longer records any revenue in the Analytical Services area. However, since approximately 30 percent of Analytical Services revenues had been derived from Environmental Services or Construction and Remediation projects, additional revenue now is being recorded in those two business areas related to analytical services subcontracts performed by Quanterra for IT, similar to other third party contracts. After excluding current and prior year Analtyical Services revenues other than those provided to Environmental Services and Construction and Remediation projects, revenues for the Company increased 16.6% for fiscal year 1995 due primarily to an increased number of remediation contracts under federal governmental agency programs.\nRevenues for fiscal year 1994 declined $17,736,000, or 4.3%, from fiscal year 1993 levels as revenue decreases were experienced in Environmental Services and Analytical Services due to weak demand and lower pricing. Construction and Remediation experienced a significant 26.3% year-to-year increase in revenues primarily because of higher levels of work performed on large thermal remediation projects and various federal governmental agency programs.\nAn increasing percentage of the Company's revenues during the three years ended March 31, 1995 was earned through executing governmental contracts for various federal, state and local agencies. Although governmental clients continued to spend at high levels through fiscal year 1995, many commercial clients have reduced and deferred environmental expenditures in anticipation of proposed legislative and regulatory changes. However, efforts to\nconstrain the federal budget deficit may impact the level of spending by the U.S. Department of Defense (DOD), the U.S. Department of Energy (DOE) and other federal governmental agencies. Revenues from federal, state and local governmental agency contracts accounted for 71% of the Company's revenues in fiscal year 1995, compared to 63% and 62% in fiscal years 1994 and 1993, respectively. Federal governmental revenues are derived principally from work performed for the DOD and, to a lesser extent, the DOE. A transition by DOE to emphasize remediation over studies is expected to be positive for the Company based on the Company's favorable experience in winning and executing similar work for the DOD as well as the Company's experience with DOE related to its past performance of DOE studies. In the near term, the Company expects that the percentage of total revenues from the execution of federal, state and local governmental agency contracts will continue to be substantial.\nDuring fiscal year 1995, a significant though declining percentage of the Company's revenues continued to be derived from large, complex thermal remediation contracts utilizing the Company's Hybrid Thermal Treatment System (HTTS ) technology, many of which are fixed-price. This type of contract accounted for 32% of Construction and Remediation revenues in fiscal year 1995 compared to 63% in fiscal year 1994 and 58% in fiscal year 1993. In fiscal year 1995, the Company substantially completed one HTTS contract. Another HTTS contract is expected to be completed in fiscal year 1996. Permits for incineration were received at another site in April 1995 and significant preparatory work at that project is now underway with incineration expected to begin later in fiscal year 1996. The Company was awarded another HTTS contract in fiscal year 1995 where work is expected to commence in fiscal year 1997. Certain of the contracts are executed in joint venture with other companies.\nIncineration as an allowable remedy under the Comprehensive Environmental Response, Compensation andLiability Act (CERCLA) continues to come under legislative and regulatory pressures. In May 1993, the U.S. Environmental Protection Agency (USEPA), citing its authority under the Resource Conservation and Recovery Act (RCRA), announced a draft strategy imposing additional requirements and costs on incineration facilities, the effect of which was a \"freeze\" on the permitting of any new fixed-base hazardous waste incinerators or cement kilns. In May 1994, the USEPA issued a new policy which, while seemingly affirming incineration as an allowable remedy under CERCLA, calls for additional procedures and studies to be conducted before incineration may be selected as a remedy, or which may result in the deselection of incineration as a remedy, at a Superfund site. In November 1994, the USEPA finalized its strategy, which continued the draft strategy's policy of granting a lower priority to consideration of new fixed-base hazardous waste incinerators or cement kilns. The final strategy also finalized the USEPA's direction of favoring waste minimization over combustion\/incineration and of increasing regulatory burdens upon combustion and incineration facilities whether fixed-base or on-site. If policies were implemented or regulations were changed such that the Company was unable to permit and use incinerators on remediation projects due to either regulatory or market factors, the Company would have to find alternative uses for its HTTS equipment, which currently has a net book value of approximately $29,000,000. If alternative uses, such as foreign installations, were not found or were uneconomical, there could be a material adverse effect to the Company's consolidated financial condition due to impairment of HTTS assets as well as lost project opportunities.\nThe Company's total funded and unfunded backlog at March 31, 1995 was approximately $1,176,000,000 (including approximately $294,000,000 of contracted backlog scheduled to be completed during fiscal year 1996 and between $30,000,000 and $60,000,000 of additional project work expected to be defined and performed in fiscal year 1996 under existing governmental indefinite delivery order contracts). This compares to $1,099,000,000 at March 31, 1994 excluding the $141,000,000 of backlog of the Analytical business at that date which was transferred to Quanterra. Backlog revenues are expected to be earned primarily over the next one to five years, with a substantial portion of the backlog consisting of governmental contracts, many of which are subject to annual funding and definition of project scope. The backlog amounts at March 31, 1995 and 1994 include $760,000,000 and $600,000,000, respectively, of future work the Company estimates it will receive (based on historical experience) under existing governmental indefinite delivery order programs which provide for a general undefined scope of work. In accordance with industry practices, substantially all of the Company's contracts are subject to cancellation, delay or modification by the customer. Prior to fiscal year 1995, the Company had not experienced cancellations which had a material effect on backlog. During fiscal year 1995, the Company experienced a substantial reduction in backlog on its DOE Hanford contract where project responsibilities were modified such that IT will not have any subcontract procurement responsibilities and the scope of IT's overall assignment has been reduced due to budget cutbacks. Accordingly, the Company\nhas reduced its backlog on this contract to approximately $54,000,000 at March 31, 1995 from approximately $140,000,000 at December 31, 1994. Although the Company will receive a slightly higher margin percentage than originally anticipated on this contract, overall profit will decline significantly due to the loss of revenue.\nThe Company's backlog at any given time is subject to changes in scope of services required by the contracts as well as increases or decreases in costs relating to the contracts in backlog. The increased volume of contracts performed subject to such scope changes has also increased the number of contract claims requiring negotiations with clients in the ordinary course of business, leading to some estimates of claim amounts being included in revenues. When such amounts are finalized, any changes from the estimates are reflected in earnings.\nThe Company cannot predict the impact upon the Company of the failure, to-date, of Congress to reauthorize CERCLA, or of the many legislative and regulatory changes proposed since the November 1994 elections. Delays in the reauthorization of CERCLA may adversely impact the environmental industry in which the Company participates. Failure of Congress to reauthorize CERCLA, or substantial changes in or uncertainty concerning the details of the legislation, cleanup standards, and remedy selection (such as proposed changes that would change CERCLA's preference for permanent treatment remedies such as incineration in favor of confinement and containment), may result in project delays and\/or the failure of clients to initiate or proceed with projects. Additionally, reductions in current and future environmental restoration budgets as a result of the November 1994 elections may adversely affect future government contracting opportunities and funding of the Company's backlog. The Company believes that it generally has benefitted from increased environmental regulations affecting business, and from more stringent enforcement of those regulations. The currently contemplated changes in regulations could decrease the demand for certain of the Company's services, as customers anticipate and adjust to the new regulations. However, the proposed legislation could also result in increased demand for certain of the Company's services if regulatory changes decrease the cost of remediation projects or result in more funds being spent for actual remediation. The ultimate impact of the proposed changes will depend upon a number of factors, including the overall strength of the economy and customers' views on the cost effectiveness of remedies available under the changed regulations.\nGross Margin - ------------\nGross margin increased $3,729,000 or 6.4% in fiscal year 1995 compared to fiscal year 1994 principally due to the increase in revenues. Environmental Services' gross margins in fiscal year 1995 declined from those of the prior year because of a $5,300,000 provision for anticipated costs associated with major litigation which was recorded in the fourth quarter of fiscal year 1995 (see Notes to Consolidated Financial Statements - Commitments and contingencies - Central Garden) and lower pricing. These factors, however, were substantially offset by the impact of higher staff utilization and productivity gains experienced throughout fiscal year 1995. Excluding the provision for litigation, Environmental Services gross margin would have increased from 16.0% to 18.0% of revenues. In fiscal year 1994, Environmental Services' gross margin percentage declined from the prior year level due to overall pricing pressure resulting from generally lower commercial client demand leading to increased competition. Such factors have caused lower hourly billing rates on time-and-material contracts as well as lower bidding margins required to win small remediation and groundwater services projects.\nIn fiscal year 1995, Construction and Remediation experienced a decline in gross margin percentage from 13.4% to 13.1% in the prior fiscal year because competitive conditions required the Company to offer contract terms with lower margins than those in the prior fiscal year, primarily with respect to major DOD remedial action programs. This trend is expected to continue in the future. Construction and Remediation gross margin percentage decreased in fiscal year 1994 from 15.6% to 13.4% primarily because fiscal year 1993 gross margin was favorably affected by a positive margin adjustment related to the closeout of a thermal remediation project which was completed in a prior fiscal year.\nAnalytical Services experienced a significant decline in gross margin percentage in its one quarter of operations in fiscal year 1995 due to competitive market conditions as well as operational inefficiencies related to the planned start-up of Quanterra in June 1994. In fiscal year 1994, Analytical Services reported a decrease in gross margin percentage from 15.2% to 10.1% because of increased pricing pressure in the chemical analysis area due to weak customer demand, and decreased utilization of\nlaboratory capacity resulting from start-up delays on certain governmental projects in the radiochemical analysis area.\nThe Company's ability to maintain its gross margins is heavily dependent on increasing utilization of professional staff, properly executing projects, and successfully bidding new contracts at adequate margin levels. The Company does not expect any significant margin improvement until current industry pricing pressures are relieved as a result of commercial clients requiring increased services. Additionally, since the cost of HTTS equipment is generally recovered over three or more projects, margins in Construction and Remediation are dependent on successful performance of existing contracts and on winning new contracts utilizing existing HTTS equipment upon the completion of previous projects; otherwise, depreciation on HTTS equipment idle for significant periods of time will continue to negatively affect gross margin.\nSelling, General and Administrative Expenses - --------------------------------------------\nSelling, general and administrative expenses were 10.0%, 12.4% and 11.9% of revenues in fiscal years 1995, 1994 and 1993, respectively. Selling, general and administrative expenses in fiscal year 1995 were $42,476,000, a decrease of $6,168,000 from the fiscal year 1994 level. This decrease is principally attributable to a special charge of $4,500,000 in fiscal year 1994 which is described in the following paragraph. Additionally, in the last nine months of fiscal year 1995, the Company experienced a decline in selling, general and administrative expenses as certain expenses were eliminated or transferred from the Company upon the formation of Quanterra in June 1994. Selling, general and administrative expenses also declined in fiscal year 1995 as a percentage of revenues due to ongoing cost containment measures.\nIn the fourth quarter of fiscal year 1994, selling, general and administrative expenses included $4,500,000 related to the actuarially determined value of contractual retirement benefits to be provided to its former Chairman of the Board (who was also Chief Executive Officer from 1975 through 1992) who retired from that position effective April 1, 1994. Ongoing selling, general and administrative expense for discount amortization related to this retirement agreement is initially approximately $300,000 per year and will decline over time.\nSelling, general and administrative expenses declined $260,000 from $48,904,000 in fiscal year 1993 to $48,644,000 in fiscal year 1994. Selling, general and administrative expenses excluding the retirement agreement described above decreased in fiscal year 1994 from the prior year level due to the elimination of management layers in the Environmental Services area as a result of actions taken in late fiscal year 1993 involving organizational realignment, the elimination of administrative costs in Europe, and ongoing reductions in certain corporate office administrative costs. Excluding the $4,500,000 charge, selling, general and administrative expenses would have been 11.2% of revenues in fiscal year 1994, down from 11.9% of revenues in the prior year.\nQuanterra - ---------\nIn June 1994, the Company and an affiliate of Corning Incorporated (Corning) combined the two companies' environmental analytical services businesses into a newly formed 50\/50 jointly-owned company (Quanterra). Quanterra operates independently with a separate board of directors which has representation from IT and Corning, and provides services primarily to third parties as well as to the Company. (See Notes to Consolidated Financial Statements - Quanterra.) IT's 50 percent investment in Quanterra is accounted for under the equity method. An integration plan was implemented in the early stages of Quanterra's operations. The plan included consolidation and closure of redundant lab facilities and equipment, a reduction in force to eliminate duplicative overhead and excess capacity and a consolidation of laboratory management and accounting systems. IT reported a pre-tax charge of $9,264,000 related to the integration in its operating results for the quarter ended June 30, 1994. Although the implementation of the integration plan has resulted in operational efficiencies and cost reductions, the environmental laboratory business continues to be faced with excess capacity and intense price competition. Consequently, in the nine months ended March 31, 1995, the initial period of Quanterra's operations, the Company reported equity in net loss of\nQuanterra of $563,000 and this trend is expected to continue for at least the early part of fiscal year 1996. However, there are operating and strategic activities underway to improve these operating trends.\nRestructuring Charge - --------------------\nIn connection with the realignment and streamlining of the Company's organization which was initiated in the fourth quarter of fiscal year 1993, the Company incurred a pre-tax restructuring charge of $8,378,000, which represented 2.0% of revenues. The restructuring charge included costs for the consolidation of facilities in the United States through office combinations or shutdowns, related asset writeoffs, severance payments to employees, and the disposition of most of the Company's European operations through either closure or sale. At March 31, 1995, most of the costs included in the restructuring charge had been paid. However, $1,500,000 of the charge ($1,800,000 at March 31, 1994) remained to be paid, principally related to certain long-term lease obligations for facilities no longer used by the Company.\nOther Expense - -------------\nIn the fourth quarter of fiscal year 1995, the Company recorded a charge of $3,800,000 to provide for potential settlement and defense costs related to certain class action shareholder litigation. (See Notes to Consolidated Financial Statements - Commitments and contingencies - Class action lawsuit.)\nIn April 1994, the Company was notified that planning permission was denied for an integrated treatment facility located in Salt End, North Humberside, England. The Company wrote off its investment in the facility, reporting a $2,500,000 non-cash charge to continuing operations in the fourth quarter of fiscal year 1994.\nAt December 31, 1992, the Company recorded a provision of $1,981,000 for the writeoff of nonrecoverable costs invested in a U.K. joint venture.\nAt December 31, 1992, the Company recorded a provision of $6,300,000 for the anticipated settlement of certain class action shareholder litigation. The litigation was tentatively settled in the quarter ended March 31, 1993, and an additional $1,000,000 provision was recorded at that time, principally for related litigation costs. (See Notes to Consolidated Financial Statements - Shareholder class action lawsuit.)\nIn the first quarter of fiscal year 1993, the Company, in connection with a secondary public offering, sold its investment in stock options of EXEL Limited, an offshore casualty insurance company, and reported a pre-tax gain of $3,483,000.\nInterest, Net - -------------\nNet interest expense has averaged 2.2% of revenues for the past three fiscal years. Net interest expense was 1.7%, 2.1% and 2.7% of revenues in fiscal years 1995, 1994 and 1993, respectively. The following table shows net interest expense for the three fiscal years ended March 31, 1995.\nYear ended March 31, ------------------------------ 1995 1994 1993 ---- ---- ---- (In thousands) Interest incurred..................... $ 8,065 $ 9,326 $11,716 Interest incurred allocated to discontinued operations............. - - (40) Capitalized interest.................. (484) (893) (518) Interest income....................... (471) (160) (43) ------ ------ ------ Interest, net....................... $ 7,110 $ 8,273 $11,115 ====== ====== ======\nFor fiscal year 1995, the decline in interest incurred is due principally to lower levels of outstanding debt during the first half of the fiscal year compared to the first half of fiscal year 1994. The decline resulted principally from debt repayments which occurred in mid-fiscal year 1994 out of the proceeds of an offering of depositary shares. The net proceeds of\n$57,130,000 received by the Company from the public offering (see Notes to Consolidated Financial Statements - Preferred stock) were utilized to repay $30,000,000 of outstanding cash advances at September 30, 1993 under the Company's revolving credit facility and to repay $25,000,000 of the Company's senior notes (see Notes to Consolidated Financial Statements - Long- term debt). The effect of the debt reduction was only partly offset by higher bank borrowing costs resulting from the general increase in interest rates during fiscal year 1995. Capitalized interest for fiscal year 1995 declined $409,000 or 45.8% from the level of the prior fiscal year due to the cessation of capitalized interest on the Company's major company-wide systems project, which was substantially completed during the fiscal year. Additionally, the Company received a combined $278,000 of interest income resulting from a settlement of a lawsuit and an income tax refund during fiscal year 1995.\nIn fiscal year 1994, interest incurred declined $2,390,000 or 20.4% from the level of the prior fiscal year due to the mid-year debt repayments noted above. This significantly reduced interest incurred for the third and fourth quarters of fiscal year 1994. During the first six months of fiscal year 1994, which were prior to the public offering, net interest expense declined slightly from the level of the prior year primarily because of lower average borrowings under the Company's revolving credit facility resulting from improved cash flows from the Company's operating activities. For fiscal year 1994, capitalized interest increased because of the higher level of capitalized costs related to a major company-wide systems project.\nIncome Taxes - ------------\nFor fiscal year 1995, in which the Company reported a loss from continuing operations before income taxes of $1,297,000, the Company recorded a $2,383,000 income tax provision from continuing operations due to the nondeductibility of certain expenses, including a significant portion of the charge for integration related to the formation of Quanterra. (See Notes to Consolidated Financial Statements - Quanterra.)\nIn fiscal year 1994, the Company recorded an income tax benefit of $124,000. This amount differs from the $418,000 benefit which would be implied at a 34% federal statutory rate primarily due to the partial nondeductibility of certain expenses and a provision for state taxes.\nDuring the third quarter of fiscal year 1993, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (SFAS No. 109), effective April 1, 1992. The cumulative effect on prior years of this change in accounting principle increased net income in fiscal year 1993 by $13,000,000. Under the new standard, the Company's tax provision from continuing operations at March 31, 1993, exclusive of the one-time cumulative adjustment, was $1,160,000, despite the fact the Company realized a pre-tax loss of $922,000. The income tax provision differs from the $313,000 benefit which would be implied at a 34% federal statutory rate as a result of the partial nondeductibility of certain expenses as well as a provision for state taxes. (See Notes to Consolidated Financial Statements - - Income taxes.)\nLoss from Continuing Operations and Impact of Special Items - -----------------------------------------------------------\nThe Company recorded a loss from continuing operations for each of the three years ended March 31, 1995. The results of operations of these years, however, contain certain special items. Management believes that an understanding of the trends in the business is enhanced by evaluating the impact of these special items upon the results presented. The following table is a pro forma presentation of income from continuing operations for the three years after rounded net of tax adjustments for the various special items.\nYear ended March 31, ---------------------------- 1995 1994 1993 ---- ---- ---- (In thousands) Loss from continuing operations, as reported, net of preferred stock dividends of $4,200,000 and $2,135,000 in 1995 and 1994, respectively........................... $(7,900) $(3,200) $(2,100) Litigation charges............................. 6,500 - 6,100 Integration charge related to formation of Quanterra................................. 8,000 - - Write-off of U.K. treatment facilities......... - 1,600 1,700 Contractual benefits provided to former Chairman..................................... - 3,000 - Restructuring charge........................... - - 5,900 Gain on sale of EXEL stock options............. - - (2,200) ------ ------ ------ Pro forma income from continuing operations $ 6,600 $ 1,400 $ 9,400 ====== ====== ======\nDISCONTINUED OPERATIONS\nPollution Control Manufacturing - -------------------------------\nIn the third quarter of fiscal year 1993, the Company recorded a charge of $3,809,000 (net of income tax benefit of $2,176,000) to adjust the net gain of $13,088,000 (net of provision for income taxes of $575,000) which had been recorded in fiscal year 1992 from the sale of the manufacturing operations of IT's Pollution Control Systems division located in Tulsa, Oklahoma and Hull, England. This charge resulted from unexpected cost overruns in connection with the completion and closeout of certain projects retained by the Company as well as some difficulties the Company experienced in collecting receivables and limiting its warranty obligations on certain projects. At March 31, 1995, a limited number of warranty issues remain open, including one matter which is in litigation.\nTransportation, Treatment and Disposal - --------------------------------------\nIn the fourth quarter of fiscal year 1995, the Company recorded an increase in the provision for loss on disposition of its discontinued transportation, treatment and disposal business of $10,603,000 (net of income tax benefit of $6,397,000). This increased provision primarily relates to expected additional costs resulting from delays in the regulatory approval process at the Company's inactive disposal sites located in Northern California and an additional accrual for estimated costs related to certain waste disposal sites where IT has been named as a potentially responsible party. A smaller portion of the provision is related to anticipated increased closure construction costs due to plan revisions and to additional costs experienced due to the unusually heavy rainfall experienced in Northern California in January through March 1995.\nIn the fourth quarter of fiscal year 1993, the Company recorded an increase in the provision for loss on disposition of its discontinued transportation, treatment and disposal business of $6,800,000, with no offsetting income tax benefit. This increased provision principally related to additional costs resulting from delays in the regulatory approval process and associated closure plan revisions pertaining to the closure of the Company's inactive disposal sites located in Northern California.\nFor further information regarding the Company's discontinued operations, see Notes to Consolidated Financial Statements - Discontinued operations.\nLIQUIDITY AND CAPITAL RESOURCES\nWorking capital increased by $10,316,000 or 16.2%, to $73,838,000 at March 31, 1995 from $63,522,000 at March 31, 1994. The current ratio at March 31, 1995 was 1.81:1 which compares to 1.70:1 at March 31, 1994.\nCash provided by operating activities for fiscal year 1995 totaled $13,575,000, a $4,423,000 decrease from the $17,998,000 of cash provided by operating activities in the prior fiscal year. Capital expenditures were $10,533,000, $14,745,000 and $15,624,000 for fiscal years 1995, 1994 and 1993, respectively. During fiscal year 1995, capital expenditures were reduced from the fiscal year 1994 level due principally to the elimination of all capital requirements for the Analytical Services business as a result of the formation of Quanterra. Management believes capital expenditures in fiscal year 1996 will approximate fiscal year 1995 levels. Additionally, depreciation has declined due to the Quanterra transaction. Closure costs at the Company's inactive disposal sites in fiscal year 1996 are expected to be higher than the $11,324,000 spent in fiscal year 1995 as interim construction costs are anticipated to increase at the Vine Hill site while continuing at a similar level at the Panoche site. At March 31, 1995, the Company's consolidated balance sheet included accrued liabilities of approximately $53,700,000 to complete the closure and post-closure of its disposal sites and related matters, most of which is expected to be spent through fiscal year 1999.\nLong-term debt increased to $80,189,000 at March 31, 1995 from $68,625,000 at March 31, 1994 principally to finance the higher working capital levels required by the increase in revenues. The Company's ratio of debt (including current portion) to equity was 0.56:1, 0.46:1 and 1.13:1 at March 31, 1995, 1994 and 1993, respectively.\nOn September 27, 1993, the Company completed a public offering at $25 per share of 2,400,000 depositary shares, each representing 1\/100th of a share of 7% Cumulative Convertible Exchangeable Preferred Stock (see Notes to Consolidated Financial Statements - Preferred stock). The Company received net cash proceeds of $57,130,000 from the public offering. On November 15, 1993, the Company prepaid at par value $25,000,000 of its 9 3\/8% Senior Notes (the Notes), utilizing proceeds from the public offering of depositary shares. (See Notes to Consolidated Financial Statements - Long-term debt.)\nWith regard to the transportation, treatment and disposal discontinued operations, a number of items could potentially affect the liquidity and capital resources of the Company, including changes in closure and post-closure costs, realization of excess and residual land values, demon- stration of financial assurance and resolution of other regulatory and legal contingencies. (See Notes to Consolidated Financial Statements - Discontinued operations - Transportation, treatment and disposal.)\nAt March 31, 1995, a deferred tax asset in the amount of $19,175,000 (net of a valuation allowance of $12,650,000) is included in the Company's consolidated balance sheet. The asset represents the tax benefit of future tax deductions and net operating loss, alternative minimum and investment tax carryforwards. The asset will be realized principally as closure expenditures related to the Company's inactive disposal sites over the next several years are deductible in the years the expenditures are made, but only to the extent the Company has sufficient levels of taxable income. The Company will have to generate approximately $50,000,000 of pre-tax income to realize its deferred tax asset. At current levels of pre-tax income from continuing operations, excluding reserves for major litigation and the integration charge related to the formation of Quanterra, the Company would realize the full amount of its deferred tax asset in approximately three years. The Company will evaluate the adequacy of the valuation allowance and the realizability of the deferred tax asset on an ongoing basis.\nThe Company's current banking arrangement provides for a revolving credit facility of up to $95,000,000 through July 31, 1996. At March 31, 1995, letters of credit totaling approximately $33,300,000 were outstanding against the Company's credit facility, including $13,200,000 issued to partially fulfill financial assurance requirements of the Company's inactive disposal sites, with the remainder being used to satisfy insurance and bonding requirements. Additionally, the Company had $30,000,000 of cash advances outstanding under the line, for total line usage of approximately $63,300,000. The amount of current availability is limited to the amount of collateral available to secure the loan as calculated in accordance with the loan agreement, principally 70-80 percent of the Company's eligible accounts receivable. At March 31, 1995, approximately $31,700,000 was available under the line, all of which could be used based on available collateral, subject to a limitation that cash advances under the line may not exceed $45,000,000 at any time, with such limitation being reduced to $25,000,000 upon collection of the Company's judgment in the Motco litigation. (See Notes to Consolidated Financial Statements - Commitments and contingencies - Motco.) Due to the Company's fourth quarter loss in fiscal year 1995, an amendment was required to certain of the Company's loan covenants in order to maintain\ncompliance. Terms of this amendment were approved subsequent to March 31, 1995 and the Company is in compliance with such amended terms.\nAt March 31, 1995, the Company had a remaining balance of $883,000 on a five-year 11.63% loan amortizing through May 31, 1995 secured by certain HTTS equipment. This balance was paid in full in April and May 1995 and the collateral was released.\nThe Company's agreements with Corning relating to Quanterra contain general provisions which could affect the Company's liquidity, including restrictions on Quanterra's dividends to the partners, requirements that the Company indemnify Quanterra and Corning from certain liabilities arising prior to the closing of the transaction and buy-sell provisions obligating the Company to sell its interests in Quanterra in certain circumstances and to contribute up to an additional $5,000,000 to Quanterra under certain circumstances. Although there are operating and strategic activities underway to improve Quanterra's current weak operating trends, IT anticipates that it will be required to contribute the $5,000,000 during fiscal year 1996, subject to certain limitations under the Company's revolving credit facility. Add the credit agreements for Quanterra prohibit the Company from pledging its interest in Quanterra to other lenders, including the Company's current lenders.\nOver the past three years, the Company's liquidity has required careful management. Although consummation of the September 1993 public offering and application of the net proceeds principally to reduce debt improved the Company's financial leverage and provided it with greater liquidity and flexibility to address its cash needs, the Company will continue to have significant cash requirements, including working capital, capital expenditures, expenditures for the closure of its inactive disposal sites and PRP matters, debt service, dividend obligations on the depositary shares and contingent liabilities. Proceeds related to the disposition of the Motco litigation could be used to address the above cash needs of the Company.\nAlthough the Company paid down $25,000,000 of the Notes in fiscal year 1994, the remaining $50,000,000 of Notes outstanding will come due on July 1, 1996, if not repaid prior to that time. The Company is evaluating alternatives to refinance the Notes at this time. Proceeds from a refinancing in excess of $50,000,000, if any, would be used to pay down bank debt in the near term, but would ultimately be applied to the above noted cash requirements or to pursue external growth opportunities including acquisitions and possible diversification.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE FOR THE THREE YEARS IN THE PERIOD ENDED MARCH 31, 1995\nConsolidated Financial Statements. Page ----\nReport of Ernst & Young LLP, Independent Auditors................. 34 Consolidated Balance Sheets ----- March 31, 1995 and 1994.......... 35 Consolidated Statements of Operations ----- Three Years Ended March 31, 1995................................................... 36 Consolidated Statements of Stockholders' Equity ----- Three Years Ended March 31, 1995....................................... 37 Consolidated Statements of Cash Flows ----- Three Years Ended March 31, 1995................................................... 38 Notes to Consolidated Financial Statements......................... 39\nFinancial Statement Schedule.\nII. Valuation and qualifying accounts............................. S-1\nSchedules not filed herewith are omitted because of the absence of condi- tions under which they are required or because the information called for is shown in the consolidated financial statements or notes thereto.\nREPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS\nThe Board of Directors International Technology Corporation\nWe have audited the accompanying consolidated financial statements and financial statement schedule of International Technology Corporation 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 stan- dards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as 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 and schedule referred to above present fairly, in all material respects, the consolidated financial position of International Technology Corporation at March 31, 1995 and 1994 and the consolidated results of operations and cash flows for each of the three years in the period ended March 31, 1995 in conformity with generally accepted accounting principles.\nIn December 1987, the Company adopted a plan to divest the transportation, treatment and disposal operations through sale and in part closure. In con- nection with the plan, the Company recorded a provision, which was subsequently increased, for the estimated net loss involved in the ultimate divestiture of these operations. Although the basis for the provision appears reasonable, as more fully explained in the note \"Discontinued operations - Transportation, treatment and disposal,\" the ultimate effect of the divestiture is dependent on future events, the outcome of which cannot be determined at this time. Accordingly, the ultimate loss could be greater or less than the amount recorded.\nAs more fully explained in the note \"Commitments and contingencies - Motco,\" the Company has recorded a contract claim receivable related to the Motco Site Trust Fund (Motco Trust) contract, the realization of which is deendent on future events involving the final resolution of the Company's lawsuit against Motco Trust and Motco Trust's counterclaim against the Company. Although a trial court judgment awarding the Company an amount in excess of its recorded claim receivable and denying Motco Trust's counterclaim has been rendered, the ultimate outcome of this litigation cannot be determined at this time.\nERNST & YOUNG LLP\nLos Angeles, California May 17, 1995\nINTERNATIONAL TECHNOLOGY CORPORATION CONSOLIDATED BALANCE SHEETS March 31, ------------------------ 1995 1994 ------ ------ ASSETS (In thousands) Current assets: Cash and cash equivalents......................... $ 6,547 $ 10,646 Accounts receivable, less allowance for doubtful accounts of $3,107,000 and $3,183,000, respectively.................................... 137,896 126,910 Prepaid expenses and other current assets......... 5,630 7,674 Deferred income taxes............................. 14,600 9,329 ------- ------- Total current assets............................ 164,673 154,559 ------- ------- Property, plant and equipment, at cost: Land and land improvements........................ 1,766 2,127 Buildings and leasehold improvements.............. 9,561 25,930 Machinery and equipment........................... 140,800 154,929 ------- ------- 152,127 182,986 Less accumulated depreciation and amortization.................................. 82,324 91,557 ------- ------- Net property, plant and equipment............. 69,803 91,429 ------- ------- Construction-in-progress........................... 2,381 19,451 Cost in excess of net assets of acquired businesses....................................... 7,728 10,469 Investment in Quanterra............................ 36,316 - Other assets....................................... 34,971 36,129 Deferred income taxes.............................. 4,575 5,461 Long-term assets of discontinued operations........ 41,705 41,705 ------- ------- Total assets...................................... $362,152 $359,203 ======= =======\nLIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable.................................. $ 28,823 $ 27,314 Accrued wages and related liabilities............. 20,175 20,297 Billings in excess of revenues.................... 3,977 9,315 Other accrued liabilities......................... 22,485 12,365 Short-term debt, including current portion of long-term debt.................................. 1,154 5,268 Net current liabilities of discontinued operations.................................... 14,221 16,478 ------- ------- Total current liabilities..................... 90,835 91,037 ------- ------- Long-term debt..................................... 80,189 68,625 Long-term accrued liabilities of discontinued operations....................................... 39,480 32,547 Other long-term accrued liabilities................ 5,727 6,446 Commitments and contingencies Stockholders' equity: Preferred stock, $100 par value; 180,000 shares authorized; 24,000 shares issued and outstanding..................................... 2,400 2,400 Common stock, $1 par value; 100,000,000 shares authorized; 35,737,313 and 35,201,052 shares issued and outstanding, respectively..... 35,737 35,201 Additional paid-in capital........................ 172,137 168,817 Deficit........................................... (64,353) (45,870) ------- ------- Total stockholders' equity...................... 145,921 160,548 ------- ------- Total liabilities and stockholders' equity........ $362,152 $359,203 ======= =======\nSee accompanying notes to consolidated financial statements.\nINTERNATIONAL TECHNOLOGY CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share data)\nYear ended March 31, ---------------------------- 1995 1994 1993 ---- ---- ---- Revenues..................................... $423,972 $392,803 $410,539 Cost and expenses: Cost of revenues............................ 362,056 334,616 337,266 Selling, general and administrative expenses.................................. 42,476 48,644 48,904 Equity in net loss of Quanterra............. 563 - - Integration charge related to the formation of Quanterra.................... 9,264 - - Restructuring charge........................ - - 8,378 ------- ------- ------- Operating income............................. 9,613 9,543 15,991 Interest, net................................ 7,110 8,273 11,115 Other expense................................ 3,800 2,500 5,798 ------- ------- ------- Loss from continuing operations before income taxes................................ (1,297) (1,230) (922) (Provision) benefit for income taxes.......... (2,383) 124 (1,160) ------- ------- ------- Loss from continuing operations.............. (3,680) (1,106) (2,082) Discontinued operations (net of income taxes): Loss from disposition: Pollution control manufacturing........... - - (3,809) Transportation, treatment and disposal.... (10,603) - (6,800) ------- ------- ------- Loss before cumulative effect of change in accounting for income taxes................ (14,283) (1,106) (12,691) Cumulative effect of change in accounting for income taxes............................... - - 13,000 ------- ------- ------- Net income (loss)............................ (14,283) (1,106) 309 Less preferred stock dividends............... (4,200) (2,135) - ------- ------- ------- Net income (loss) applicable to common stock...................................... $(18,483) $ (3,241) $ 309 ======= ======= =======\nNet income (loss) per share: Continuing operations (net of preferred stock dividends).......................... $ (.22) $ (.09) $ (.06) Discontinued operations: From disposition.......................... (.30) - (.32) ------- ------- -------- (.52) (.09) (.38) Cumulative effect of change in accounting for income taxes.............................. - - .39 ------- ------- ------- $ (.52) $ (.09) $ .01 ======= ======= =======\nSee accompanying notes to consolidated financial statements.\nINTERNATIONAL TECHNOLOGY CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY For the three years ended March 31, 1995 (In thousands)\nSee accompanying notes to consolidated financial statements.\nINTERNATIONAL TECHNOLOGY CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)\nYear ended March 31, ---------------------------- 1995 1994 1993 ---- ---- ---- Cash flows from operating activities: Net income (loss)........................... $(14,283) $ (1,106) $ 309 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Net loss from disposition of discontinued operations............... 10,603 - 10,609 Depreciation and amortization........... 19,150 22,372 19,771 Deferred income taxes................... (4,385) (654) 52 Equity in net loss of Quanterra......... 563 - - Integration charge related to the formation of Quanterra............ 9,264 - - Provision for settlement of lawsuits.... 9,100 - 6,350 Writeoff of costs incurred in U.K. investments........................... - 2,500 1,981 Gain on sale of investment in EXEL Limited............................... - - (3,483) Cumulative effect of change in accounting for income taxes...................... - - (13,000) Changes in assets and liabilities, net of effects from acquisitions and dispositions of businesses: (Increase) decrease in receivables...... (21,149) 2,914 (8,879) Decrease (increase) in prepaid expenses and other current assets.............. 486 (2,475) (597) Increase (decrease) in accounts payable. 2,681 (10,732) 2,291 Increase (decrease) in accrued wages and related liabilities............... 1,636 (1,501) 2,941 (Decrease) increase in billings in excess of revenues................... (5,338) 6,786 (2,760) Increase (decrease) in other accrued liabilities................... 5,966 (3,374) 803 (Decrease) increase in other long-term accrued liabilities................... (719) 3,268 699 ------- ------- ------- Net cash provided by operating activities.. 13,575 17,998 17,087 ------- ------- ------- Cash flows from investing activities: Capital expenditures........................ (10,533) (14,745) (15,624) Investment in Quanterra..................... (1,208) - - Proceeds from sale of pollution control manufacturing business.................... - - 22,677 Proceeds from sale of investment in EXEL Limited.............................. - - 3,733 Other, net.................................. 1,198 2,050 1,319 Investment activities of transportation, treatment and disposal discontinued operations................................ (11,324) (12,179) (10,671) ------- ------- ------- Net cash (used for) provided by investing activities................................ (21,867) (24,874) 1,434 ------- ------- ------- Cash flows from financing activities: Repayments of long-term borrowings.......... (55,965) (89,648) (50,550) Long-term borrowings........................ 63,802 43,035 30,440 Net proceeds from public offering of depositary shares...................... - 57,130 - Dividends paid on preferred stock........... (4,200) (2,135) - Issuances of common stock................... 556 481 804 ------- ------- ------- Net cash provided by (used for) financing activities................................ 4,193 8,863 (19,306) ------- ------- ------- Net (decrease) increase in cash and cash equivalents................................. (4,099) 1,987 (785) Cash and cash equivalents at beginning of year........................................ 10,646 8,659 9,444 ------- ------- ------ Cash and cash equivalents at end of year...... $ 6,547 $ 10,646 $ 8,659 ======= ======= ====== See accompanying notes to consolidated financial statements.\nINTERNATIONAL TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nSummary of significant accounting policies: - ------------------------------------------\nBasis of presentation and principles of consolidation -----------------------------------------------------\nThe consolidated financial statements include International Technology Corporation (IT or the Company) and its wholly owned subsidiaries. The Company also includes its proportionate interest in joint ventures which were entered into for the purpose of executing large remediation projects and in which the Company does not have in excess of 50% of voting control. Intercompany transactions are eliminated. Certain reclassifications have been made to prior years' consolidated financial statements in order to conform to the current year presentation.\nCash equivalents ----------------\nCash equivalents include highly liquid investments with an original maturity of three months or less, principally commercial paper.\nContract accounting and accounts receivable -------------------------------------------\nThe Company primarily derives its revenues from providing environmental management services in the United States, principally to federal, state and local governmental entities, large industrial companies, utilities and waste generators. Services are performed under time-and-material, cost-reim- bursement, fixed-price and unit-bid contracts.\nRevenues from time-and-material and cost-reimbursement contracts are recognized as costs are incurred. Estimated fees on such contracts and revenues on fixed-price and certain unit-bid contracts are recognized under the percentage-of-completion method determined based on the ratio of costs incurred to estimated total costs. Anticipated losses on contracts are recorded as identified. Certain contracts include provisions for revenue adjustments to reflect scope changes and other matters, including claims, which require negotiations with clients in the ordinary course of business, leading to some estimates of claim amounts being included in revenues. When such amounts are finalized, any changes from the estimates are reflected in earnings.\nUnbilled receivables typically represent amounts earned under the Company's contracts but not yet billable according to the contract terms, which usually consider the passage of time, achievement of certain milestones or completion of the project. Unbilled receivables, included in accounts receivable, were $20,869,000 and $16,316,000 at March 31, 1995 and 1994, respectively. Generally, unbilled receivables are expected to be billed and collected in the subsequent fiscal year. Included in unbilled receivables at March 31, 1995 is approximately $8,000,000 of claims related to the Helen Kramer project which is subject to a governmental investigation. (See Commitments and contingencies.)\nAt March 31, 1995 and 1994, an approximately $31,000,000 claim receivable related to the Motco Site Trust Fund (Motco) contract, a major fixed-price remediation contract, is included in noncurrent other assets as a result of the Company's lawsuit involving the Motco Trust. (See Commitments and contingencies.)\nBillings in excess of revenues represent amounts billed in accordance with contract terms, which are in excess of the amounts includable in revenue determined based on the policies discussed above.\nAt March 31, 1995, accounts receivable are primarily concentrated in federal, state and local governmental entities and in commercial clients in which the Company does not believe there is any undue credit risk.\nINTERNATIONAL TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nProperty, plant and equipment -----------------------------\nThe cost of property, plant and equipment is depreciated using the straight-line method over the estimated useful lives of the individual assets, except for the Hybrid Thermal Treatment System (HTTS ) transportable incineration units, which are generally depreciated on the basis of operating days.\nCapitalized interest -------------------- Interest incurred on qualified capital expenditures is capitalized and is included in the cost of such constructed assets. Interest incurred was $8,065,000, $9,326,000 and $11,716,000 for fiscal years 1995, 1994 and 1993, respectively. Total interest capitalized was $484,000, $893,000 and $518,000 for fiscal years 1995, 1994 and 1993, respectively.\nIncome taxes ------------\nThe Company adopted Statement of Financial Accounting Standards No. 109 (SFAS No. 109) as of April 1, 1992 and reported the cumulative effect of the change in accounting for income taxes in the consolidated statement of operations for fiscal year 1993. The Company reported the effect of the adoption of SFAS No. 109 as a cumulative effect of a change in accounting principle. (See Income taxes.)\nIntangible assets -----------------\nCost in excess of net assets of acquired businesses is amortized over 20 years on a straight-line basis. At March 31, 1995 and 1994, accumulated amortization is $6,584,000 and $6,671,000, respectively. Other intangibles, arising principally from acquisitions, are amortized on a straight-line basis over periods not exceeding 20 years. The Company regularly reviews the individual components of its intangible assets and recognizes, on a current basis, any diminution in value.\nPer share information ---------------------\nPer share information is based on the weighted average number of out- standing common shares and common share equivalents during each period which aggregated 35,557,309 in 1995, 34,762,280 in 1994 and 33,530,420 in 1993.\nCommon share equivalents include dilutive stock options and, in 1994 and 1993, common shares to be issued in connection with the settlement of a class action stockholders' lawsuit. (See Shareholder class action lawsuit.)\nIn fiscal years 1995 and 1994, the computation of net income per share, assuming the conversion into common shares of the Company's 7% Cumulative Convertible Exchangeable Preferred Stock, is antidilutive. (See Preferred stock.)\nFair value of financial instruments -----------------------------------\nIn accordance with the requirements of Statement of Financial Accounting Standards No. 107, \"Disclosures about Fair Value of Financial Instruments,\" the following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments:\nCash and cash equivalents: The carrying amount reported in the balance sheet approximates its fair value.\nINTERNATIONAL TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nLong and short-term debt: The fair value of the 9 3\/8% senior notes is based upon the quoted market price. The carrying amount of other debt, including borrowings under the Company's revolving credit facility and the 11.63% secured loan due May 31, 1995, approximates its fair value at March 31, 1995.\nThe carrying amounts and estimated fair values of the Company's financial instruments are:\nMarch 31, ---------------------------------------------- 1995 1994 ----------------------- -------------------- Carrying Estimated Carrying Estimated amount fair value amount fair value -------- ---------- -------- ---------- (In thousands) Cash and cash equivalents $ 6,547 $ 6,547 $10,646 $10,646\nLong and short-term debt: 9 3\/8% senior notes 50,000 48,875 50,000 49,375 11.63% secured loan 883 883 5,835 5,927 Revolving credit facility 30,000 30,000 17,000 17,000 Other 460 460 1,058 1,058\nAccrued contractual retirement benefits ---------------------------------------\nIn the fourth quarter of fiscal year 1994, the Company recorded a $4,500,000 provision to selling, general and administrative expenses in the consolidated statement of operations related to the actuarially determined present value of contractual retirement benefits to be provided to its former Chairman of the Board (who was also Chief Executive Officer from 1975 through 1992) who retired from that position effective April 1, 1994. The retirement agreement was approved by the Board of Directors, following approval by the Compensation Committee and advice of an independent compensation consulting firm.\nAs a result of concerns expressed by shareholders, in June 1994 the Board of Directors formed a special committee comprised of four non-employee directors to review this retirement agreement. The special committee engaged independent legal counsel and a new independent compensation consulting firm to assist it in the review process. Following its review of the retirement agreement, the special committee recommended that the agreement be modified in various respects and engaged in negotiations with the former Chairman concerning the proposed modifications.\nThose negotiations resulted in an amended agreement which reduced the present value of the contractual benefits by approximately $500,000. The amended agreement was approved by the noninterested directors of the Board on the recommendation of the special committee of the Board and on the advice of counsel and an independent compensation consulting firm and executed on January 6, 1995. Terms of the amended agreement provide for payments by the Company of approximately $300,000 per year for the duration of the former executive's lifetime.\nINTERNATIONAL TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nConsolidated statements of cash flows supplemental disclosures: - --------------------------------------------------------------\nSupplemental cash flow information is: Year ended March 31, ------------------------------ 1995 1994 1993 ---- ---- ---- (In thousands) Interest paid, net of amounts capitalized $ 7,230 $ 8,767 $10,869 Interest received 317 107 32 Income taxes paid 782 1,241 1,243 Income tax refunds received 989 1,783 724\nQuanterra: - ---------\nFormation of Quanterra ----------------------\nOn June 28, 1994, pursuant to a definitive agreement signed on May 2, 1994, the Company and an affiliate of Corning Incorporated (Corning) combined the two companies' environmental analytical services businesses into a newly formed 50\/50 jointly-owned company (Quanterra). Quanterra operates independently with a separate board of directors which has representation from IT and Corning, and provides services primarily to third parties, as well as to the Company.\nIn connection with the formation, the Company contributed the $38,766,000 net assets of its analytical business into Quanterra. Additionally, IT incurred cash costs of $1,208,000 and issued to Corning 333,000 shares of IT common stock and a five-year warrant to purchase 2,000,000 shares of IT common stock at $5.00 per share which are valued in the aggregate at $3,300,000. The Company's initial investment, recorded at historical cost, consisted of the following at June 28, 1994 (in thousands):\nCash $ 1,208 Other current assets 11,721 Net property, plant and equipment 28,084 Other noncurrent assets 2,704 Current liabilities (3,404) Noncurrent liabilities (339) Common stock and warrants 3,300 ------- Initial investment in Quanterra $ 43,274 =======\nINTERNATIONAL TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nSummarized financial data for investment in Quanterra -----------------------------------------------------\nCondensed financial information of Quanterra is presented below (in thousands):\nFrom inception through March 31, -------------- Condensed statement of operations: Revenues (including $12,000 from the Company) $ 92,448 Operating income before integration charge 1,957 Integration charge (20,878) Operating loss (18,921) Net loss (12,879)\nAt March 31, ----------- Condensed balance sheet: Assets: Current assets $ 55,887 Net property, plant and equipment 58,481 Other noncurrent assets 11,154 ------- $125,522 ======= Liabilities and stockholders' equity: Current liabilities $ 33,535 Noncurrent liabilities 44,134 Stockholders' equity 47,853 ------- $125,522 =======\nIT's 50 percent investment in Quanterra is accounted for under the equity method. Quanterra recorded the net assets contributed to it at its stockholders' historical cost. Upon closing the transaction, an integration plan was implemented to eliminate redundant laboratory facilities and duplicative overhead and systems. The net impact, after income tax benefit, of the $20,878,000 integration charge on Quanterra's net earnings was $12,790,000. In the quarter ended June 30, 1994, IT's portion of the charge for integration was $9,264,000 including integration costs of $2,869,000 incurred directly by IT.\nQuanterra has a $60,000,000 bank line of credit. The Company's agreements with Corning relating to Quanterra contain general provisions including restrictions on dividends to the partners, buy-sell provisions obligating the Company to sell its interests in Quanterra in certain circumstances and to contribute up to an additional $5,000,000 to Quanterra under certain circumstances, and requirements that the Company indemnify Quanterra and Corning from certain liabilities arising prior to closing the transaction.\nINTERNATIONAL TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nThe following summarizes the status and results of the Company's investment in Quanterra through March 31, 1995 (in thousands):\nInitial investment (historical cost of net assets transferred to Quanterra plus other costs incurred) upon formation of Quanterra on June 28, 1994 $ 43,274\nIntegration charge related to the formation of Quanterra (6,395)\nEquity in net loss of Quanterra from inception through March 31, 1995 (563) ------- Ending investment $ 36,316 =======\nAt March 31, 1995, the unamortized portion of the Company's initial investment in Quanterra in excess of its 50% share of Quanterra's stockholders' equity at the date of its formation was $12,428,000. This excess amount is being amortized over 20 years. Amortization expense of $484,000 is included in \"Equity in net loss of Quanterra\" of $563,000 for the fiscal year ended March 31, 1995.\nDiscontinued operations: - -----------------------\nPollution control manufacturing -------------------------------\nIn the third quarter of fiscal year 1993, the Company recorded a charge of $3,809,000 (net of income tax benefit of $2,176,000) to adjust the net gain of $13,088,000 (net of provision for income taxes of $575,000) which had been recorded in fiscal year 1992 from the sale of the manufacturing operations of IT's Pollution Control Systems division located in Tulsa, Oklahoma and Hull, England. This charge resulted from unexpected cost overruns in connection with the completion and closeout of certain projects retained by the Company as well as some difficulties the Company experienced in collecting receivables and limiting its warranty obligations on certain projects. At March 31, 1995, a limited number of warranty issues remain open, including one matter which is in litigation.\nTransportation, treatment and disposal -------------------------------------- In December 1987, the Company's Board of Directors adopted a strategic restructuring program which included a formal plan to divest the transporta- tion, treatment and disposal operations through sale of some facilities and closure of certain other facilities. As of March 31, 1995, two of the Company's inactive disposal sites have been formally closed and the other two are in the process of closure. In connection with the divestiture, at December 31, 1987, the Company recorded a provision for loss on disposition of transportation, treatment and disposal discontinued operations in the amount of $110,069,000, net of income tax benefit of $24,202,000, which included the estimated net loss on sale or closure and the results of operations of the active disposal sites and the transportation business through the then estimated sale date. At March 31, 1992, the Company increased the provision for loss on disposition by the amount of $32,720,000, net of income tax benefit of $2,280,000, principally due to the writeoff of the $30,400,000 contingent purchase price from the earlier sale of certain assets. The remaining loss represented expected costs related to a waste disposal site where IT has been named as a potentially responsible party (PRP) and an increase in costs related to the closure of the Company's disposal sites in Northern California, principally due to delays in the regulatory approval process. At March 31, 1993, the Company increased the provision for loss on disposition by $6,800,000, with no offsetting income tax benefit, related to estimated additional costs resulting from further delays in the regulatory approval process and associated closure plan revisions. At March 31, 1995, the Company recorded an increase in the provision for loss on disposition of $10,603,000, net of income tax benefit of $6,397,000, primarily for estimated increased costs resulting from additional delays in the regulatory approval process at the Company's inactive disposal sites in Northern California and an additional accrual for estimated costs related to certain waste disposal sites where IT has been named as a PRP. A smaller portion of the fiscal year 1995 provision increase is related to anticipated increased closure construction costs due to plan revisions and to additional costs experienced due to the unusually heavy rainfall experienced in Northern California in January through March 1995.\nINTERNATIONAL TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nThe Company has incurred costs of $11,324,000 in 1995, $12,179,000 in 1994 and $10,671,000 in 1993 relating to the site closure plans and related construction. The Company expects to incur significant closure and post-closure costs over the next several years. At March 31, 1995, the Company's consolidated balance sheet included accrued liabilities of approximately $53,700,000 to complete the closure and post-closure of its disposal sites and related matters.\nThe Company has closed two of the inactive disposal sites and is pursuing formal permanent closure of its Panoche and Vine Hill disposal sites, for which there will be significant closure and post-closure costs over the next several years. Closure and post-closure plans for the Panoche facility were revised to incorporate regulatory agency comments in March 1991 and an Environmental Impact Report (EIR), required by California law prior to plan approval, is being prepared by the California EPA Department of Toxic Substances Control (DTSC). While difficult to predict, the Company expects final determination on those closure plans in fiscal year 1996 or early fiscal year 1997. The Company is targeting completion of the closure for fiscal year 1999. The California Supreme Court in December 1991 reversed a lower court decision regarding an aspect of the closure plan at Panoche relating to the County of Solano's authority in the closure process and the method of closure of peripheral waste areas at the facility (the Buffer Zone Areas). During fiscal year 1993, the Company was required to submit additional information and closure designs for the Buffer Zone Areas, including a design for excavation and relocation on-site of significant quantities of wastes and soils. Clean closure by excavation and relocation on-site of materials in the Buffer Zone Areas will be evaluated in the EIR. The additional study of this and other alternatives has resulted in delays to the closure plan approval. The delays have resulted in additional costs for monitoring and maintaining the facility, conducting engineering and permitting activities, and charges for the EIR contractor. A determination to excavate and relocate a substantial amount of materials in the Buffer Zone Areas would increase costs substantially which would have a material adverse effect on the consolidated financial condition of the Company.\nProgress on the Vine Hill Complex facility closure plan continues, with a revised closure plan submitted to the DTSC in August 1991. In April 1992, the Company received and subsequently responded to comments on the plan from DTSC. In March 1995, the DTSC determined that the Company had met all the technical requirements in its comments and published the administrative draft of the EIR for the closure and post-closure plans. The Company expects the plan to be approved in fiscal year 1996; however, significant work which will ultimately be required for closure will have been completed by that time. The Company is targeting completion of the closure for fiscal year 1998.\nClosure construction was completed for the Montezuma Hills site and the Benson Ridge facility in December 1991 and December 1992, respectively. Upon completion of closure construction, the Company is required to perform post-closure monitoring and maintenance of its disposal sites for at least 30 years. Operation of the sites in the closure and post-closure periods is subject to numerous federal, state and local regulations. The Company may be required to perform unexpected remediation work at the sites in the future or to pay penalties for alleged noncompliance with regulatory permit conditions.\nRegulations of the DTSC and the U.S. Environmental Protection Agency (USEPA) require that owners and operators of hazardous waste treatment, storage and disposal facilities provide financial assurance for closure and post-closure costs of those facilities. The Company has provided financial assurance equal to its estimate for closure costs at March 31, 1995, which could be subject to increase at a later time as a result of regulatory requirements, in the form of a corporate guarantee of approximately $10,600,000, letters of credit totaling approximately $13,200,000 and a trust fund containing approximately $9,700,000, and has purchased annuities which will ultimately mature over the next 30 years to pay for its estimates of post-closure costs as part of a consent order with the DTSC entered on June 27, 1989. Among other provisions, the consent order requires IT to revise its financial assurance estimates on March 1 of each year to reflect inflation adjustments and any changes in the cost estimates resulting from completion of interim closure procedures and from revisions in the closure and post-closure plans. Thereafter, the Company has 60 days to adjust its financial assurance mechanisms to reflect the changed costs. IT has completed cost revisions required at March 1, 1995 and the DTSC has approved the revised amounts. The Company has provided financial assurance on the amounts called for by the cost revisions.\nIT's inactive disposal sites are subject to the Resource Conservation and Recovery Act and other federal laws including the Toxic Substances Control Act, the Clean Water Act, the Clean Air Act and the regulations of\nINTERNATIONAL TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nthe Occupational Safety and Health Act. The provisions of the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA) and its amendments generally do not presently affect the Company's four inactive disposal sites, but do apply in some cases to former business operations where the Company is an alleged generator or transporter of waste or former operator of a disposal site owned by others. California has been one of the leading states in regulating the transportation, treatment and disposal of hazardous waste substances. Under the Hazardous Waste Control Act, the DTSC administers a comprehensive regulatory program. California operations are also subject to regulation by the State Water Resources Control Board, the California Air Resources Board, Regional Water Quality Control Boards (RWQCBs), Air Quality Management Districts and various other state authorities. At the local level, treatment and disposal sites are also subject to zoning and land use restrictions, and other ordinances.\nThe California Toxic Pits Cleanup Act of 1984 (TPCA) required operators of certain surface impoundments to cease discharging liquid hazardous wastes into these units by a statutory deadline, unless the units were retrofitted to meet minimum technology requirements. The Company has taken reasonable measures and has made substantial progress toward compliance at the Vine Hill Complex, but cannot fully meet statutory requirements until final closure plans have been approved. The Company has discussed its TPCA compliance activities with the applicable RWQCB. Although substantial civil penalties are available for noncompliance with TPCA, the Company does not expect that penalties, if imposed, would be material to the Company's financial condition, given the circumstances and the Company's good faith efforts to achieve compliance and conclude closure.\nClosure and post-closure costs are incurred over a significant number of years and are subject to a number of variables including, among others, completion of negotiations regarding specific site closure and post-closure plans with applicable regulatory agencies. Such closure costs are comprised principally of engineering, design and construction costs and of caretaker and monitoring costs during closure. The Company has estimated the impact of closure and post-closure costs in the provision for loss on disposition of transportation, treatment and disposal discontinued operations; however, closure and post-closure costs could be higher than estimated if regulatory agencies were to require closure and\/or post-closure procedures significantly different than those in the plans developed by the Company or if there are additional delays in the closure plan approval process. Certain revisions to the closure procedures could also result in impairment of the residual land values attributed to certain of the sites.\nThe carrying value of the long-term assets of transportation, treatment and disposal discontinued operations of $41,705,000 at March 31, 1995 is principally comprised of residual land at the inactive disposal sites and assumes that sales will occur at current market prices estimated by the Company based on certain assumptions (entitlements, development agreements, etc.), taking into account market value information provided by independent real estate appraisers. During fiscal year 1992, the Company entered into an agreement with a real estate developer to develop some of this property as part of a larger development in the local area involving a group of developers. The entitlement process has been delayed due to uncertainties over the Company's closure plans for its adjacent disposal site and local community review of growth strategy. If the developers' plans change or the developers are unable to obtain entitlements as planned, the carrying value of this property could be significantly impaired. With regard to this property or any of the other residual land, there is no assurance as to the timing of sales or the Company's ability to ultimately liquidate the land for the sale prices assumed. If the assumptions used to determine such prices are not realized, the value of the land could be materially different from the current carrying value.\nUnder CERCLA, the USEPA and the DTSC have investigated and are continuing to investigate the operation of and shipments of wastes to certain disposal sites in California and elsewhere, including the Operating Industries, Inc. (OII) Superfund site in Monterey Park, California. In June 1986, USEPA notified a number of entities, including the Company, that they were PRPs under CERCLA with respect to OII and, as such, faced joint and several liability for the cost to investigate and cleanup this site. USEPA requested these entities to work as a single group to settle with USEPA and DTSC their alleged liability for certain past response costs and to perform future remedial work. A number of these PRPs subsequently formed the OII Steering Committee (Steering Committee) and negotiated a series of settlements addressing cost reimbursement demands and performing certain interim remedial measures (IRMs). The Company did not join the Steering Committee or enter these settlements. USEPA currently contends that the Company remains a PRP and is liable for its share of costs associated with the past settlements which total approximately $8,500,000 (including a premium for failure to contribute to the earlier settlements but not interest). The Steering Committee also contends the Company is liable to it for a share of\nINTERNATIONAL TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nthese settlement costs and has quantified the Company's share of the first two settlements at approximately $2,700,000. On October 11, 1994, the Company was served with a summons and complaint in a cost recovery action brought by members of the Steering Committee. The action seeks (1) recovery from the Company of a portion of certain of plaintiffs' costs incurred at OII allegedly attributable to the Company and (2) a declaration from the court as to the Company's share of future costs in the OII response action. The Company is defending this action vigorously while continuing to attempt a joint settlement with both the Steering Committee and the USEPA. Trial in this action, which was set for July 17, 1995, has been taken off the calendar and has not been rescheduled.\nThe Company believes the USEPA's and the Steering Committee's claims essentially overlap. Both assume the Company or its predecessor and subsidiaries arranged for the disposal of the same volume of wastes at OII and are based on the relative percentage of that volume to the known volume of liquid wastes sent to the site. The Steering Committee has not quantified and the USEPA claim does not specifically address future costs for site remediation and long-term monitoring and maintenance. These figures are not known but are expected to be substantial. Based on the available information regarding the operations of the Company's subsidiaries and predecessor in handling the wastes, the Company believes its share of responsibility for the site, if any, is less than the share attributed to it by the USEPA and the Steering Committee. Accordingly, the Company has not been able to agree to USEPA's or the Steering Committee's claims. IT has met with USEPA attempting to settle its response cost claims and is continuing to negotiate for a settlement. No settlement has been reached. Instead, in October 1994, USEPA advised the Company in writing that it continued to regard the Company and its subsidiaries as liable for response costs. In that notice, USEPA provided the Company and other non-Steering Committee PRPs the opportunity to make a limited challenge as to USEPA's volume determinations. Subject to its review of that challenge, USEPA further stated it intended to offer the Company and other non-settling PRPs, another opportunity to resolve their liability for response costs by paying the amount determined by USEPA based on volume plus a substantial premium based on failure to join the earlier settlements. The Company submitted a volume challenge on January 10, 1995, but has received no response from USEPA although it is continuing to pursue settlement discussions.\nThe inability of the Company to effect a satisfactory settlement with the Steering Committee and the USEPA could have a material adverse effect on the consolidated financial condition of the Company. The Company has advised its liability insurance carriers as to the pendency of the USEPA's and the Steering Committee's claims and requested indemnification and legal representation. The carriers dispute their obligations to the Company. The Company, as a major provider of hazardous waste transportation, treatment and disposal operations in California prior to the December 1987 adoption of its strategic restructuring program, has been named a PRP at other sites and may, from time to time be so named at additional sites and may also face damage claims by third parties for alleged releases or discharges of contaminants or pollutants arising out of its transportation, treatment and disposal discontinued operations. The Company has either denied responsibility and\/or is participating with others named by the USEPA, the DTSC or other state governmental agencies in conducting investigations as to the nature and extent of contamination at the sites.\nThe provision for loss on disposition of transportation, treatment and disposal discontinued operations is based on various assumptions and estimates, including those discussed above. The adequacy of the provision for loss has been currently reevaluated in light of the developments since the adoption of the divestiture plan, and management believes that the provision as adjusted is reasonable; however, the ultimate effect of the divestiture on the consolidated financial condition of the Company is dependent upon future events, the outcome of which cannot be determined at this time. Outcomes significantly different from those used to estimate the provision for loss could result in a material adverse effect on the consolidated financial condition of the Company.\nINTERNATIONAL TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nLong-term debt: - --------------\nLong-term debt consists of the following: March 31, -------------------------- 1995 1994 ---- ---- (In thousands)\n9 3\/8% senior notes, due 1996 . . . $ 50,000 $ 50,000 11.63% secured loan . . . . . . . . 883 5,835 Revolving credit facility . . . . . 30,000 17,000 Other . . . . . . . . . . . . . . . 460 1,058 ------- ------- 81,343 73,893 Less current portion . . . . . . . 1,154 5,268 ------- ------- $ 80,189 $ 68,625 ======= =======\nAggregate amounts of long-term debt maturing in the five years following March 31, 1995 are $1,154,000, $80,109,000, $29,000, $30,000, and $21,000, respectively.\nIn July 1986, the Company issued $75,000,000 principal amount of senior notes, 9 3\/8%, due July 1, 1996, with interest payable semiannually. The notes are redeemable at the Company's option at par after July 1, 1993. On November 15, 1993, the Company prepaid at par value $25,000,000 of the senior notes, utilizing the proceeds from the public offering of depositary shares (see Preferred stock).\nOn June 25, 1990, an asset-based lender funded a $25,000,000 five-year installment loan at a fixed interest rate of 11.63%. The loan was secured by certain of the Company's HTTS equipment. In March 1994, the Company prepaid the $4,952,000 balloon payment due June 30, 1995 on the loan in return for a partial release of collateral. At March 31, 1995, the Company had a remaining balance of $883,000 on the loan. In May 1995, the Company paid the final regular installment on the loan and the collateral was released.\nThe Company's current banking arrangement provides for a revolving credit facility of up to $95,000,000 through July 31, 1996 and is secured principally by accounts receivable. At March 31, 1995, interest on borrowings under this line is at the bank's reference rate plus 1.5%, or in the case of Eurodollar borrowings, at the interbank offered rate plus 2.5%. The Company is subject to a 0.5% per annum charge on the unused portion of the commitment. The line of credit agreement stipulates that the Company must maintain certain minimum working capital, financial ratios and net worth requirements. In addition, the agreement includes certain other restrictive covenants, including prohibitions on the payment of cash dividends on common stock and, if the Company is in default under the line, on the preferred stock), and on the repurchase of stock other than to fund IT's compensation plans. Additionally, the agreement contains limitations on the purchase or sale of significant assets, the aggregate amount of capital expenditures, other liens on the Company's assets and the incurrence of other debt. Due to the Company's fourth quarter loss in fiscal year 1995, amendments were required to certain of the Company's loan covenants in order to maintain compliance. Terms of these amendments were approved subsequent to March 31, 1995 and the Company is in compliance with such amended terms.\nAt March 31, 1995, the Company had $30,000,000 of borrowings outstanding against its credit facility. Additionally, standby letters of credit totaling approximately $33,300,000 were outstanding at March 31, 1995 related to financial assurance for the Company's inactive disposal facilities (see Discontinued operations - Transportation, treatment and disposal), and the Company's insurance and bonding requirements, for total line usage of approximately $63,300,000. The amount of current availability under the Company's line is limited to the amount of collateral available in accordance with the loan agreement, principally 70-80 percent of the Company's eligible accounts receivable. At March 31, 1995, approximately $31,700,000 was available under the line and collateral available at March 31, 1995 allowed for use of the entire amount, subject to a limitation that cash advances under the line may not exceed $45,000,000 at any time, with such limitation being reduced to $25,000,000 upon collection of the Company's judgment in the Motco litigation. (See Commitments and Contingencies - Motco.)\nINTERNATIONAL TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nIncome taxes: - ------------\nThe benefit for income taxes consists of the following:\nYear ended March 31, ----------------------------- 1995 1994 1993 ---- ---- ---- (In thousands) Current: Federal $ - $ (104) $ (2,356) State 371 422 1,288 ------- ------- ------- 371 318 (1,068) ------- ------- ------- Deferred: Federal (1,828) (442) 831 State (2,557) - (779) ------- ------- ------- (4,385) (442) 52 ------- ------- ------- Total benefit $ (4,014) $ (124) $ (1,016) ======= ======= =======\nThe provision (benefit) for income taxes is included in the statements of operations as follows:\nYear ended March 31, ----------------------------- 1995 1994 1993 ---- ---- ---- (In thousands) Continuing operations $ 2,383 $ (124) $ 1,160 Discontinued operations (6,397) - (2,176) ------- ------- ------- Total benefit $ (4,014) $ (124) $ (1,016) ======= ======= =======\nA reconciliation of the provision (benefit) for income taxes on continuing operations computed by applying the federal statutory rate of 34% to loss from continuing operations before income taxes and the reported provision (benefit) for income taxes of continuing operations is as follows:\nYear ended March 31, ------------------------------ 1995 1994 1993 ---- ---- ---- (In thousands) Income tax benefit computed at statutory federal income tax rate $ (441) $ (418) $ (313) State income taxes, net of federal tax benefit, if any 424 422 650 Equity in income (loss) of foreign subsidiaries 57 (374) - Amortization of cost in excess of net assets of acquired businesses 200 212 212 Integration charge related to and equity in net loss of Quanterra 2,366 - - Research credit (212) - - Other (principally nondeductible items) (11) 34 611 ------- ------- ------- Total provision (benefit) $ 2,383 $ (124) $ 1,160 ======= ======= =======\nAt March 31, 1995, the Company had net operating loss (NOL) carryforwards of approximately $46,247,000 for tax reporting purposes expiring primarily in 2007 through 2010. The Company also has tax credit carryforwards of approximately $2,708,000 which expire in various years through 2009 and Alternative Minimum Tax credit carryforwards of approximately $1,809,000.\nINTERNATIONAL TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nAs of April 1, 1992, the Company adopted SFAS No. 109. As allowed under SFAS No. 109, the Company reported the effect of such adoption as a cumulative effect of a change in accounting for income taxes of $13,000,000 of income, as of the date of adoption, and prior years' consolidated financial statements were not restated. Upon adoption of SFAS No. 109, the Company recorded a deferred tax asset and established a valuation allowance of $7,700,000 against that asset. During the year ended March 31, 1993, the Company increased the valuation allowance to $10,119,000 due to the relative uncertainty that the tax benefits from the additional provision for loss from discontinued operations recorded in that year would be realized. During the year ended March 31, 1994, the Company increased the valuation allowance to $13,519,000, principally due to the recognition of additional state deferred tax assets, primarily state NOL carryforwards, and the relative uncertainty that such state benefits will be fully utilized. During the year ended March 31, 1995, the Company decreased the valuation allowance to $12,650,000, principally to offset an adjustment made to reduce the gross deferred tax asset to recognize the federal benefit of net operating losses for state purposes. At March 31, 1995 and 1994, the Company had deferred tax assets and liabilities as follows:\nMarch 31, ---------------- 1995 1994 ---- ---- (In thousands) Deferred tax assets: Closure accruals - discontinued operations $ 28,211 $ 25,197 Net operating loss carryforwards 20,145 22,462 Alternative minimum tax credit carryforwards 1,809 1,809 Investment and other tax credit carryforwards 2,708 2,496 Other accrued liabilities 10,082 6,832 Other, net 3,658 3,526 ------- ------- Gross deferred tax asset 66,613 62,322 Valuation allowance for deferred tax asset (12,650) (13,519) ------- ------- Total deferred tax asset 53,963 48,803 ------- -------\nDeferred tax liabilities: Tax depreciation in excess of book depreciation (14,381) (13,736) Asset basis difference - discontinued operations (11,997) (11,997) Other, net (8,410) (8,280) ------- ------- Total deferred tax liabilities (34,788) (34,013) ------- ------- Net deferred tax asset $ 19,175 $ 14,790 ======= =======\nNet current asset $ 14,600 $ 9,329 Net noncurrent asset 4,575 5,461 ------- ------- Net deferred tax asset $ 19,175 $ 14,790 ======= =======\nCommitments and contingencies: - -----------------------------\nLease commitments -----------------\nThe Company's operating lease obligations are principally for buildings and equipment. Generally, the Company is responsible for property taxes and insurance on its leased property. At March 31, 1995, future minimum rental commitments under noncancelable operating leases with terms longer than one year aggregate $36,550,000 and require payments in the five succeeding years and thereafter of $9,260,000, $8,483,000, $5,479,000, $4,204,000, $2,832,000, and $6,292,000, respectively.\nINTERNATIONAL TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nRental expense related to continuing operations was $11,550,000, $14,912,000 and $17,467,000 (including $2,014,000 of the restructuring charge) for fiscal years 1995, 1994 and 1993, respectively.\nContingencies -------------\nClass action lawsuit --------------------\nIn December 1989, a purported class action lawsuit was filed in federal court on behalf of stockholders of the Company alleging violations of the federal Securities Exchange Act of 1934 in connection with the purchase of shares of the Company's common stock by members of the purported class between January 1986 and April 1987. The complaint also names as defendants the underwriters who performed services in connection with the Company's senior note offering in July 1986. In addition, the complaint alleges that certain of the Company's officers and directors sold shares of the Company's common stock at artificially inflated prices based on undisclosed information about the Company. The plaintiffs seek unspecified damages, plus costs associated with the litigation. Discovery concerning the facts underlying the action has been substantially completed and trial in this action is now set for November 28, 1995. Although the Company is defending the action vigorously, at the request of the plaintiffs, the parties have participated in voluntary, mediated settlement discussions, but have thus far been unable to reach a settlement. Although it is not possible to determine the ultimate outcome of the litigation, the Company intends to further pursue settlement of the matter and has recorded a charge of $3,800,000 in the fourth quarter of fiscal year 1995 to provide for potential settlement and defense costs.\nAfter consultation with outside counsel and in consideration of the availability of insurance coverage and the Company's $3,800,000 provision, management believes the ultimate outcome of this matter will not have a material adverse effect on the consolidated financial condition of the Company.\nMotco -----\nOn December 4, 1991, the Company announced the suspension of work on the Motco project, the cleanup of a Superfund site in Texas, and the filing of a $56,000,000 breach of contract lawsuit against the Motco Trust, the PRP group that agreed to finance remediation of the site, and Monsanto Company, the leader of the PRP group.\nIn January 1988, the Company was retained by the Motco Trust to destroy waste contained in pits at the site using two transportable incinerators designed and operated by IT. Based on information provided to IT in the Motco Trust's request for proposal, the Company bid and was awarded a fixed-price contract which was subsequently increased through change orders. In early 1991, IT advised the Motco Trust and Monsanto that it would cost substantially more to complete the project because the scope of work had changed and because the chemical makeup, quantities and mixture of waste at the site were dramatically different from that portrayed by data provided to IT in Motco Trust's request for proposal. Additionally, the project was impacted by other actions of the Motco Trust and Monsanto, including the pumping of contaminated water and waste into the Motco pits from an unrelated project which was managed by the Motco Trust and Monsanto.\nIT continued work at the site in good faith while negotiations were occurring with the Motco Trust and Monsanto. Approximately $31,000,000 of direct costs were incurred in excess of those recovered under the contract and were recorded as a contract claim receivable and are included in noncurrent assets in the Company's consolidated balance sheets at March 31, 1995 and 1994. IT has not recognized any overhead cost recovery or profit on this project to date. IT sued to recover costs and profit of approximately $56,000,000.\nOn December 26, 1991, the Motco Trust and Monsanto filed an answer to IT's lawsuit and asserted a counterclaim against IT. In their answers to IT's lawsuit, the Motco Trust and Monsanto denied liability to IT on the grounds that the Motco Trust had previously executed a change order addressing many of the claims and purported underlying events alleged in the lawsuit and had\nINTERNATIONAL TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nreceived a full release from IT regarding those matters, that IT had failed to mitigate its alleged damages, that IT had failed to manage and control its costs on the project, and that IT's lawsuit failed to state a claim upon which relief could be granted as it claimed extra-contractual compensation.\nIn its counterclaim, the Motco Trust sought recovery of $27,000,000 monetary damages including all payments to third parties to complete performance of the project, all penalties or other liabilities to any governmental entity, and any related damages which occurred as a result of the breach of contract by IT which is alleged to have occurred upon the filing of the lawsuit by IT and concurrent suspension of work at the site.\nThe case was tried before a jury during March and April of 1994. As a result of that trial, the jury rendered a verdict in IT's behalf wherein they found that Monsanto had breached its contract with IT, had defrauded IT and had provided IT with information which constituted a negligent misrepresentation as to the waste characteristics. The jury found that the amount of damages caused IT as a result of these acts was in the amount of $52,800,000. The jury also found that Monsanto should pay punitive damages in the amount of $28,550,000, together with attorneys' fees in the amount of approximately $2,300,000. The jury further found that IT was excused from performance and that Motco Trust should not recover on its $27,000,000 counterclaim.\nOn December 14, 1994, the court ruled that IT was entitled to a judgment in the amount of $43,700,000 plus prejudgment interest and attorneys' fees. The court's order reduced the jury's previous compensatory damage award by $9,100,000 and set aside the jury's award of $28,550,000 in punitive damages. On May 8, 1995, the court entered a final judgment in the approximate amount of $66,000,000, consisting of the $43,700,000 in compensatory damages, and $2,300,000 in attorneys' fees, plus prejudgment interest of approximately $20,000,000. The final judgment amount is subject to appeals by the parties and accrues postjudgment interest at the one-year U.S. Treasury rate (approximately 6.3%) in effect at the time of judgment from the date the judgment is entered until paid. While it is not possible to predict, the appellate process could take as long as two years.\nAfter consideration of the merits of the Company's position in the lawsuit and after consultations with its outside counsel, management believes that, subject to the inherent uncertainties of litigation, the Company more likely than not will recover the contract claim receivable recorded to date and prevail on Motco Trust's counterclaim. However, if this matter is resolved in an amount significantly lower than the contract claim receivable of approximately $31,000,000 recorded by IT or if the Motco Trust prevails in its counterclaim and recovers any significant amount of damages, a material adverse effect to the consolidated financial condition of the Company would result.\nCentral Garden --------------\nOn July 14, 1992, the Company responded to an emergency call to clean up a chemical spill at a finished product warehouse facility leased by Central Garden & Pet Supply Company (Central) in Baton Rouge, Louisiana. While cleanup was under way, a fire began which damaged the warehouse facility. In addition to the owner of the facility, Central and two other lessees of the finished product warehouse facility (an electrical supply company and a pharmaceutical company) incurred significant property damage and substantial loss of inventory. A total of nine lawsuits arising from the fire have now been filed and these cases have been consolidated for discovery purposes only.\nOn August 2, 1992, in the first action to be filed, residents of a nearby apartment complex filed a petition for damages against the Company and Central alleging personal injuries caused by the release of hazardous and noxious materials into the atmosphere as a result of the fire. Central filed an answer, cross-claim, and third-party complaint. Central alleged, among other things, that the Company was the cause of the fire in failing to exercise proper care in the cleanup of the spill, and was responsible for the property damage, loss of contents, loss of profits and other economic injury, and expenses incurred in the cleanup. Further, Central claimed a set-off or monies due the Company for cleanup services rendered by the Company after the fire and seeks indemnity for any damages assessed against Central. The Company responded by alleging, among other things, improper storage and handling of hazardous materials by Central. In August 1993, this case was\nINTERNATIONAL TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nremanded to state court. The Company also filed its own cross-complaint against Central for services rendered after the fire and denied responsibility for the fire, raised certain defenses, and further claimed that Central was not entitled to a set-off. The monies due the Company for services rendered to Central approximate $1,700,000 and are included in accounts receivable in the Company's consolidated balance sheets at March 31, 1995 and 1994.\nThe Company believes that the allegations in the other actions arising out of the fire are substantially duplicative of each other. For example, the insurer for the electrical supply company, American Manufacturers Mutual Insurance Company, also filed a complaint against the Company, Central, the lessor and certain insurers. The owner of the adjacent pharmaceutical company, Bergen Brunswig Company, and its insurers filed suit against the Company, Central, the lessor, a construction company which built a fire wall that allegedly did not meet the building code, the manufacturer of the chemicals which were spilled and certain insurers. The lessor also filed a cross-claim and third party complaint against the Company and others in this action.\nPursuant to a Case Management Order applicable to all of the filed cases, a schedule has been established for the completion of discovery and the submission of reports concerning damages claimed and the causation of the fire. In March 1995, pursuant to the Case Management Order, the parties propounded to each other reports concerning the types and amount of damages sought. These reports collectively claim a total of $23,000,000 from all of the defendants but do not apportion the damages claimed between the various defendants. The largest single claim is by Bergen Brunswig, which claims approximately $11,000,000, principally for lost inventory. In its report, Central claims approximately $4,400,000, including approximately $1,000,000 in damages resulting from the postponement of its initial public offering, and the $1,700,000 sought by the Company for services rendered in cleaning up after the fire. The personal injury plaintiffs claim approximately $2,400,000 in damages. In addition, most of the claimants demand punitive damages in unspecified amounts. The Company believes that certain of the claimants' damage claims are inflated and contain elements that are not legally recoverable or are not properly documented.\nWhile the Company is pursuing settlement of this matter, the Company is defending the actions vigorously and believes that it has meritorious challenges to some of the damages claimed and meritorious claims for contribution against some parties. Additionally, the Company believes that it is likely that it will recover from Central, by collection or set-off, on breach of contract claims for the cleanup services provided. The parties have agreed to submit the case to nonbinding mediation in October 1995. Trial is scheduled for May 1996. Based on discovery to date, there is a risk that the Company will be found liable for at least some damages. If the Company is held liable for damages, there is the further risk that the Company could be held liable for punitive damages. Discovery has not been completed; the Company cannot predict the amount or range of damages for which it and\/or the other parties may be found responsible.\nThe Company's insurance carrier has been notified on the matter and is a defendant in one of the actions. The Company's carrier is defending the actions subject to a reservation of its rights to contest coverage at a later date. The Company previously filed a protective lawsuit seeking determination of coverage, but later agreed to a dismissal of the action in accordance with a standstill agreement with the carrier pursuant to which, subject to applicable policy limits, the carrier has agreed to fund provisionally any final judgment or settlement of the matter. However, the insurer has retained its right to challenge coverage under the policy after any such funding. If the Company settles the matter or is held liable for damages and the insurance carrier funds the settlement or judgment, the Company may face reimbursement claims by its carrier, based on assertions that the Company's policies do not cover damages resulting from the fire because of allegations that such damages are excluded pollution liabilities or punitive damages.\nIn the fourth quarter of fiscal year 1995, the Company recorded a $5,300,000 charge, covering both defense and potential settlement costs, to provide for its self-insured retention under its general liability insurance coverage for the Central Garden matter. Should the cases result in a significant award of damages against the Company or payment by the Company of a significant amount in settlement, either of which is not substantially covered by the Company's insurance policies, additional litigation costs would be recorded related to the matter.\nINTERNATIONAL TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nHelen Kramer Contract ---------------------\nOn May 3, 1993, the Company received an administrative subpoena from the Office of the Inspector General (OIG) of the USEPA seeking documents relating to certain of the Company's claims which were submitted to the U.S. Army Corps of Engineers with regard to the Helen Kramer remediation contract, a completed project which the Company performed in joint venture. Since August 1992, the Defense Contract Audit Agency (DCAA) has been conducting an audit of certain claims submitted by the joint venture. The Company has been informed that there is a federal civil and criminal investigation into the claims. In April 1995, the Company was informed that several of its joint venture partner's employees have been subpoenaed to discuss their knowledge of the matter.\nIn October 1993, a shareholder of the Company alleged that the acts giving rise to the Helen Kramer investigation constituted, among other things, a waste of the Company's assets and demanded that the Company institute an action against those responsible for the alleged wrongdoing. The Audit Committee (Committee) of the Board of Directors investigated the allegations of the OIG. The Committee, acting with the assistance of outside counsel and experts, determined that there was no evidence of intentional wrongdoing or negligence by the Company or any employee. The Board approved the report of the Committee and advised counsel to the shareholder of its conclusions on September 2, 1994.\nOther -----\nThe Company is subject to other claims and lawsuits in the ordinary course of its business. In the opinion of management, all such other pending claims are either adequately covered by insurance or, if not insured, will not individually or in the aggregate result in a material adverse effect on the consolidated financial condition of the Company.\nThe Company maintains a liability insurance program which includes commercial general liability, product liability, automotive liability, employers' liability, workers' compensation, all risk property coverage, contractor's pollution liability, professional errors and omissions, and directors' and officers' liability insurance coverage. A portion of the Company's commercial general liability, automotive liability and workers' compensation insurance is provided through arrangements which require the Company to indemnify the insurance carriers for all losses and expenses under the policies and to support the indemnity commitments with letters of credit.\nEnvironmental Impairment Liability coverage for IT's inactive treatment, storage and disposal sites located in Northern California is provided through the Company's captive insurance subsidiary, which has issued a $32,000,000 policy which meets the current requirements of both federal and state law. See Discontinued operations - Transportation, treatment and disposal for information regarding certain legal and governmental proceedings affecting the Company's treatment, storage and disposal sites.\nRestructuring charge: - --------------------\nIn connection with the realignment and streamlining of the Company's organization which was initiated in the fourth quarter of fiscal year 1993, the Company incurred a pre-tax restructuring charge of $8,378,000. The restructuring charge included costs for the consolidation of facilities in the United States through office combinations or shutdowns, related asset writeoffs, severance payments to employees, and the disposition of most of the Company's European operations through either closure or sale. At March 31, 1995, most of the costs included in the restructuring charge had been paid. However, $1,500,000 of the charge ($1,800,000 at March 31, 1994) remained to be paid, principally related to certain long-term lease obligations for facilities no longer used by the Company.\nINTERNATIONAL TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nGovernmental regulation: - -----------------------\nThe Company is subject to extensive regulation by applicable federal, state and local agencies. All facets of the Company's business are conducted in the context of a rapidly changing statutory, regulatory and governmental enforcement framework and a highly visible political environment. The Company's operations must satisfy stringent laws and regulations applicable to performance. Future changes in regulations may have an adverse effect on the Company's business.\nPreferred stock: - ---------------\nIn a September 1993 public offering, the Company issued 2,400,000 depositary shares, each representing a 1\/100th interest in a share of the Company's 7% Cumulative Convertible Exchangeable Preferred Stock (Preferred Stock). The depositary shares entitle the holder to all proportional rights and preferences of the Preferred Stock, including dividend, liquidation, conversion, redemption and voting rights and preferences. The net proceeds from the issuance were $57,130,000.\nThe Preferred Stock ranks as to dividends and liquidation, prior to the Company's common stock and Series A Junior Participating Cumulative Preferred Stock, if issued. (See Stockholder Rights Plan.) The dividend per annum and liquidation preference for each share of Preferred Stock are $175 and $2,500, respectively, and for each depositary share are $1.75 and $25, respectively. Dividends on the Preferred Stock and depositary shares are cumulative and payable quarterly.\nThe Preferred Stock is convertible at the option of the holder into shares of the Company's common stock at a conversion price of $5.84 per share, subject to adjustment under certain circumstances. On any dividend payment date on or after September 30, 1996, the Preferred Stock is exchangeable at the option of the Company, in whole but not in part, for 7% Convertible Sub- ordinated Debentures Due 2008 in a principal amount equal to $2,500 per share of Preferred Stock (equivalent to $25 per depositary share). The Preferred Stock may be redeemed at any time on or after September 30, 1996, at the option of the Company, in whole or in part, initially at a price of $2,622.50 per share of Preferred Stock (equivalent to $26.225 per depositary share) and thereafter at prices declining to $2,500 per share of Preferred Stock (equivalent to $25 per depositary share) on or after September 30, 2003.\nAdditionally, the Preferred Stock has a special conversion right that becomes effective in the event of certain significant transactions affecting ownership or control of the Company. In such situations, the special conversion right would, for a limited period, reduce the then prevailing conversion price to the market value of the common stock, except that the conversion right will not be reduced below $3.17 per share. Generally and with certain exceptions, the special conversion right becomes effective if (1) a person or group acquires at least 50% of the Company's common stock, (2) if the Company sells all or substantially all of its assets or (3) if the Company participates in a merger or consolidation in which the Company is not the surviving company or the holders of the Company's common stock immediately prior to such merger or consolidation do not hold, directly or indirectly, at least a majority of the common stock of the merger after such a transaction. The form of consideration issued (cash, securities or other property) upon the exercise of the special conversion right by a holder of Preferred Stock depends upon, among other things, the type of transaction that gives rise to the special conversion right.\nThe Preferred Stock is non-voting, except that holders are entitled to vote as a separate class to elect two directors if the equivalent of six or more quarterly dividends (whether consecutive or not) on the Preferred Stock is in arrears. Such voting rights will continue until such time as the dividend arrearage on the Preferred Stock has been paid in full.\nINTERNATIONAL TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nStock incentive plans: - ---------------------\nThe Company has a 1991 Stock Incentive Plan (1991 Plan) which provides for the issuance of the Company's common stock or any other security or benefit with a value derived from the value of its common stock. Options are granted at exercise prices equal to or greater than the quoted market price at the date of the grant. At March 31, 1995, the maximum number of shares of the Company's common stock that may be issued pursuant to awards that have not yet been granted under the 1991 Plan is 574,390. At April 1 of each fiscal year, the maximum number of shares available for award under the 1991 Plan will be increased by an amount which represents 2% of the number of shares of the Company's common stock which are issued and outstanding at that date. Beginning in fiscal year 1994, options were granted under the 1991 Plan, which expires in fiscal year 1996.\nThe Company also had a 1983 Stock Incentive Plan (1983 Plan) which provided for the granting of incentive and non-qualified stock options and stock appreciation rights and the issuance of restricted common stock. Options granted under the 1983 Plan and outstanding at March 31, 1995 will expire at various dates through July 3, 2003. No stock appreciation rights were granted under the 1983 Plan. No shares are available for grant under the 1983 Plan, which expired in September 1993.\nChanges in the number of shares represented by outstanding options under the 1991 Plan and the 1983 Plan during the fiscal years ended March 31, 1995, 1994 and 1993 are summarized as follows:\nYear ended March 31, ----------------------------- 1995 1994 1993 ---- ---- ---- Outstanding at beginning of year 3,187,019 2,787,152 2,640,578\nOptions granted (1995, $2.50 - $3.625 per share; 1994, $3.125 - $5.875 per share; 1993, $4.875 - $7.00 per share) 1,453,605 1,007,200 797,500\nOptions exercised (1995, $2.875 per share; 1994, $2.75 - $4.625 per share; 1993, $3.00 - $5.50 per share) (10,060) (170,583) (239,539)\nOptions expired and forfeited (1,388,061) (436,750) (411,387) --------- --------- ---------\nOutstanding at end of year (1995, $2.50 - $8.188 per share) 3,242,503 3,187,019 2,787,152 ========= ========= =========\nVested options 1,392,422 1,484,947 1,390,574 ========= ========= =========\nStockholder Rights Plan: - -----------------------\nOn December 14, 1989, the Company adopted a Stockholder Rights Plan (the Rights Plan), pursuant to which the Company distributed one stock purchase right (a Right) with respect to each share of common stock outstanding on the December 26, 1989 record date. The Rights Plan provides that in the event that any person becomes the beneficial owner of 20% or more of the outstanding shares of common stock (a 20% Stockholder) or commences a tender offer or exchange offer, the consummation of which would cause such person to become a 20% Stockholder, each Right will entitle the holder (other than a 20% Stockholder) to purchase, at any time on or after the tenth business day\nINTERNATIONAL TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nfollowing the date of such event, at the then-current exercise price (initially $35), one two-thousand-five-hundredth of a share of Series A Junior Participating Cumulative Preferred Stock, par value $100, of the Company, which one two-thousand-five-hundredth of a share is designed to have a value approximately equal to the value of one share of common stock. In the event that any person becomes a 20% Stockholder, each previously unexercised Right will entitle the holder (other than the 20% to purchase, at any time on or after the tenth business day following the date of such event, shares of common stock having a market value equal to two times the then-current exercise price. In the event that, at any time on or after the date that a person becomes a 20% Stockholder, the Company is merged into another corporation or 50% or more of the Company's assets are sold, then each previously unexercised Right will entitle the holder (other than the 20% Stockholder) to purchase, at any time on or after such date, shares of common stock of the acquiring corporation having a market value equal to two times the exercise price. In connection with the Rights Plan, the Company has designated 40,000 shares of its authorized preferred stock as Series A Junior Participating Cumulative Preferred Stock. The Rights do not have voting rights and are not entitled to dividends.\nThe Rights may be redeemed by the Company at a price of $.01 per Right at any time until they become exercisable to purchase common stock of the Company or another corporation. The Company may redeem the Rights only with the concurrence of a majority (but not less than three) of the independent directors.\nThe Rights Plan, as adopted, provided that the Rights expired on December 14, 1999. On April 6, 1995, the Board of Directors approved an amendment to the Rights Plan which was subsequently executed, providing that the Rights shall expire on September 7, 1995.\nShareholder class action lawsuit: - --------------------------------\nIn fiscal year 1994, 1,872,759 shares of common stock valued at $6,350,000 were issued in settlement of a class action lawsuit alleging certain securities law violations emanating from a 1987 offering of common stock. A charge of $7,300,000 was taken to other expense in the consolidated statement of operations in fiscal year 1993 to provide for this settlement and related expenses.\nMajor customers: - ---------------\nA total of 63%, 53% and 45% of the Company's revenues during fiscal years 1995, 1994 and 1993, respectively, were from federal governmental agencies, primarily the U.S. Department of Defense (DOD) and the U.S. Department of Energy (DOE). In fiscal years 1995, 1994 and 1993, the DOD provided 47%, 33% and 19%, respectively, of the Company's revenues. The DOE provided 12%, 15% and 16% of the Company's revenues during fiscal years 1995, 1994 and 1993, respectively.\nEmployee benefit plans: - ----------------------\nThe Company has a defined contribution, contributory pension and profit sharing plan (the Plan), covering all employees with one year of continuous service. The Company funds current costs as accrued, and there are no unfunded vested benefits. The Plan requires a minimum annual Company contribution of 4% and allows a maximum contribution of up to 8% of participants' eligible compensation up to $150,000, $235,840 and $228,860 for fiscal years 1995, 1994 and 1993, respectively. In fiscal year 1995, 5% of participants' eligible compensation was contributed to the Plan. In each of fiscal years 1993 and 1994, 4% of participants' eligible compensation was contributed to the Plan.\nPension and profit sharing expense was $4,081,000, $3,987,000 and $3,580,000 for fiscal years 1995, 1994 and 1993, respectively.\nThe Company presently provides certain health care benefits for retirees who are over age 60 and have completed a specified number of years of service. In fiscal year 1995, the Company contributed approximately $20,000\ntoward these benefits. Statement of Financial Accounting Standards No. 106 (SFAS No. 106), \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" which became effective for the Company in fiscal year 1994, requires accrual, during the years that the employee renders the necessary service, of the expected cost of providing these benefits to an employee and the employee's covered dependents. Under SFAS No. 106, the Company is recognizing its Accumulated Postretirement Benefit Obligation (APBO or Transition Obligation) of $733,000 on a delayed basis as a component of net periodic postretirement benefit cost and will amortize this cost over 20 years. Annual total expense for postretirement benefits under SFAS No. 106 including amortization of the APBO in fiscal year 1995 was $220,000.\nQuarterly results of operations (In thousands, except per share data) - -------------------------------------------------------------------- (unaudited): - ----------- First Second Third Fourth quarter quarter quarter quarter ------- ------- ------- -------\n1995: Revenues....................... $108,568 $102,509 $102,403 $110,492 Gross margin................... 15,918 16,428 16,689 12,881 Income (loss) from continuing operations........ (6,286) 2,891 2,681 (2,966) Loss from discontinued operations................... - - - (10,603) Net income (loss) applicable to common stock.............. (7,336) 1,841 1,631 (14,619) Net income (loss) per share: Continuing operations (net of preferred stock dividends).................. $ (.21) $ .05 $ .05 $ (.11) Discontinued operations...... - - - (.30) ------- ------ ------ ------ $ (.21) $ .05 $ .05 $ (.41) ======= ====== ====== =======\n1994: Revenues...................... $102,549 $100,665 $ 92,524 $97,065 Gross margin.................. 17,249 16,319 13,380 11,239\nIncome (loss) from continuing operations.................. 1,962 1,692 726 (5,486) Net income (loss) applicable to common stock............. 1,962 1,657 (324) (6,536) Income (loss) from continuing operations per share (net of preferred stock dividends) $ .06 $ .05 $ (.01) $ (.19) ====== ====== ===== ======\nBeginning with the second quarter of fiscal year 1994, net income (loss) applicable to common stock represents net income (loss) after preferred dividends on the Company's 7% Cumulative Convertible Exchangeable Preferred Stock. (See Preferred stock.)\nIn the fourth quarter of fiscal year 1995, the Company accrued a $2,700,000 ($.08 per share) after tax provision for anticipated costs related to certain class action shareholder litigation. In addition, the results of continuing operations were impacted by an approximate $3,800,000 ($.10 per share) after tax charge to provide for anticipated costs related to certain other major litigation. (See Commitments and contingencies.)\nIn the first quarter of fiscal year 1995, the Company recorded an approximate $8,000,000 ($.23 per share) after tax charge for integration related to the formation of Quanterra. (See Quanterra).\nIn the fourth quarter of fiscal year 1994, the Company recorded a $3,000,000 ($.09 per share ) after tax provision related to the actuarially determined value of contractual retirement benefits to be provided to its former Chairman and Chief Executive Officer. (See Summary of significant accounting policies - Accrued contractual retirement benefits.) In addition, the Company wrote off its investment in a planned treatment facility in the U.K. in the amount of $1,600,000 ($.05 per share) after tax in the fourth quarter of fiscal year 1994.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nThere were none.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nThe section entitled \"Election of Directors\" in the registrant's Definitive Proxy Statement to be filed with the Securities and Exchange Commission for the Annual Meeting of Stockholders scheduled for September 7, 1995 (the Proxy Statement) is incorporated herein by reference. See also \"Executive Officers of the Company\" in Part I of this report for certain information concerning the Company's executive officers.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe section entitled \"Executive Compensation\" in the Proxy Statement is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe section entitled \"Beneficial Ownership of Shares\" in the Proxy Statement is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe section entitled \"Certain Transactions\" in the Proxy Statement is incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K.\nSeparate Financial Statements of Subsidiaries not Consolidated and Fifty Percent Owned Persons\nQuanterra Inc. Financial Statements - December 31, 1994 and June 28, 1994\nExhibits - --------\nThese Exhibits are numbered in accordance with the Exhibit Table of Item 601 of Regulation S-K.\nExhibit No. Description ---------- -----------\n2 Omitted - Inapplicable.\n3(i) Certificate of Incorporation of the registrant as amended by Amendment to Certificate of Incorporation filed September 17, 1987, with Delaware Secretary of State.(2)\n3(ii) Bylaws of the registrant as amended through June 2, 1994.(11)\n4(i) 1. Rights Agreement dated as of December 14, 1989 by and between International Technology Corporation and Bank of America National Trust and Savings Association, as Rights Agent.(9)\n2. Amendment No. 1 to Rights Agreement.(9)\n3. Amendment dated as of April 6, 1995 to Rights Agreement.(3)\n4. Certificate of Designations of Series A Junior Participating Cumulative Preferred Stock, $100 par value.(8)\n5. Certificate of Amendment of Certificate of Designations of Series A Junior Participating Cumulative Preferred Stock, $100 par value.(9)\n6. Certificate of Designations with respect to the registrant's 7% Cumulative Convertible Exchangeable Preferred Stock, $100 par value.(9)\n4(ii) 1. Indenture dated as of June 15, 1986 between International Technology Corporation and Continental Illinois National Bank and Trust Company of Chicago relating to the Company's 9 3\/8% Senior Notes due 1996.(1)\n2. Indenture for the registrant's 7% Convertible Subordinated Debentures Due 2008.(9)\n9 Omitted - Inapplicable.\n10(ii) 1. Secured Loan Agreement dated as of April 20, 1990 among the registrant, IT Corporation and Household Commercial of California, Inc.(5)\n2. First Amendment to Secured Loan Agreement among the registrant, IT Corporation, Household Bank, f.s.b. as assignee of Household Commercial of California, Inc. dated as of June 16, 1992.(9)\nExhibit No. Description ----------- -----------\n3. Second Amendment to Secured Loan Agreement among the registrant, IT Corporation, Household Bank, f.s.b. as assignee of Household Commercial of California, Inc. dated as of June 28, 1993.(9)\n4. Third Amendment to Secured Loan Agreement among the registrant, IT Corporation, Household Bank, f.s.b. as assignee of Household Commercial of California, Inc. dated as of November 11, 1993.(11)\n5. Fourth Amendment to Secured Loan Agreement among the registrant, IT Corporation, Household Bank, f.s.b. as assignee of Household Commercial of California, Inc. dated as of February 11, 1994.(11)\n6. Fifth Amendment to Secured Loan Agreement among the registrant, IT Corporation, Household Bank, f.s.b. as as assignee of Household Commercial of California, Inc. dated as of March 31, 1994.(11)\n7. Sixth Amendment to Secured Loan Agreement among the registrant, IT Corporation, Household Bank, f.s.b. as assignee of Household Commercial of California, Inc. dated as of June 28, 1994.(11)\n8. Syndicated Credit Agreement dated as of August 27, 1991 among the registrant, IT Corporation and Bank of America National Trust and Savings Association, as agent for the bank group.(7)\n9. First Amendment to Credit Agreement and Waiver among the registrant, IT Corporation, Bank of America National Trust and Savings Association and certain other signatory banks, dated as of June 19, 1992.(9)\n10. Second Amendment to Credit Agreement and Waiver among the registrant, IT Corporation, Bank of America National Trust and Savings Association and certain other signatory banks, dated as of June 28, 1993.(9)\n11. Third Amendment to Credit Agreement and Waiver among the registrant, IT Corporation, Bank of America National Trust and Savings Association and certain other signatory banks, dated as of March 24, 1994.(11)\n12. Fourth Amendment to Credit Agreement and Waiver among the registrant, IT Corporation, Bank of America National Trust and Savings Association and certain other signatory banks, dated as of June 24, 1994. (11)\n13. Fifth Amendment to Credit Agreement and Waiver among the registrant, IT Corporation, Bank Savings Association and certain other signatory banks, dated as of September 30, 1994.\n14. Sixth Amendment to Credit Agreement and Waiver among the registrant, IT Corporation, Bank of America Savings Association and certain other signatory banks, dated as of May 15, 1995.\n15. Asset Transfer Agreement among MetPath Inc., the registrant and IT Corporation dated as of May 2, 1994.(11)\n16. Securities Acquisition Agreement between the registrant and MetPath Inc. dated as of May 2, 1994. (11)\nExhibit No. Description ---------- -----------\n17. Shareholders' Agreement between the registrant, IT Corporation, Quanterra Incorporated and MetPath Inc. dated as of June 28, 1994.\n18. Equity Investors' Undertaking, dated June 28, 1994, from MetPath, Inc., the Company and IT Corporation in favor of Quanterra Incorporated, Citibank, N.A., Citicorp USA, Inc. and others.\n19. Portions of Amendment and Waiver, dated June 27, 1995, amending Section 2(a) of the Equity Investors's Undertaking, dated June 28, 1994, by and among Corning Life Sciences, Inc. (formerly MetPath, Inc.), the Company and IT Corporation, Quanterra Incorporated, Citibank, N.A., Citicorp USA, Inc., and others.\n10(iii) 1. Non-Employee Directors' Retirement Plan, as amended and restated June 2, 1994.(10)\n2. Description of the Special Turn-a-Round Plan (Fiscal Year 1995 Management Incentive Plan) of the registrant.(10)(11)\n3. 1983 Stock Incentive Plan, as amended.(8)(10)\n4. Retirement Plan of IT, 1993 Restatement.(10)\n5. Form of Severance Benefit Agreement between the registrant and certain officers of the registrant. (5)(10)\n6. 1991 Stock Incentive Plan.(6)(10)\n7. Agreement dated July 14, 1992 between Robert B. Sheh and the registrant.(8)(10)\n8. Agreement dated November 4, 1993 between Larry M. Hart and the registrant.(10)(11)\n9. Agreements dated November 5, 1993 between E. Brian Smith and the registrant.(10)(11)\n10. Retirement Agreement dated March 3, 1994 between Murray H. Hutchison and the registrant.(10)(11)\n11. First Amendment dated January 6, 1995 to the Retirement Agreement dated March 3, 1994 between Murray H. Hutchison and the registrant.(10)(12)\n11 1. Computation of Per Share Earnings for the three years ended March 31, 1995.\n12 Omitted - Inapplicable.\n13 Omitted - Inapplicable.\n16 Omitted - Inapplicable.\n18 Omitted - Inapplicable.\n21 1. List of the registrant's subsidiaries.\n22 Omitted - Inapplicable.\n23 Consent of Ernst & Young LLP, Independent Auditors.\n24 Omitted - Inapplicable.\nExhibit No. Description ---------- ------------\n27 1. Financial Data Schedule for the year ended March 31, 1995.\n2. Financial Data Schedule for the quarter ended March 31, 1995.\n28 Omitted - Inapplicable.\n99 Omitted - Inapplicable. __________ (1) Previously filed with the Securities and Exchange Commission as an Exhibit to the registrant's Registration Statement on Form S-l (No. 33-6310) and incorporated herein by reference. (2) Previously filed with the Securities and Exchange Commission as an Exhibit to the registrant's Annual Report on Form 10-K for the year ended March 31, 1988 and incorporated herein by reference. (3) Previously filed with the Securities and Exchange Commission as an Exhibit to the registrant's Form 8-K dated May 2, 1995 and incorporated herein by reference. (4) Previously filed with the Securities and Exchange Commission as an Exhibit to the registrant's Annual Report on Form 10-K for the year ended March 31, 1989 and incorporated herein by reference. (5) Previously filed with the Securities and Exchange Commission as an Exhibit to the registrant's Amended Annual Report on Form 10-K for the year ended March 31, 1990 and incorporated herein by reference. (6) Previously filed with the Securities and Exchange Commission as an Exhibit to the registrant's Registration Statement on Form S-8 (No. 33-52974) and incorporated herein by reference. (7) Previously filed with the Securities and Exchange Commission as an Exhibit to registrant's Form 8-K dated September 4, 1991 and incorporated herein by reference. (8) Previously filed with the Securities and Exchange Commission as an Exhibit to the registrant's Annual Report on Form 10-K for the year ended March 31, 1993 and incorporated herein by reference. (9) Previously filed with the Securities and Exchange Commission as an Exhibit to registrant's Registration Statement on Form S-3 (No. 33-65988) and incorporated herein by reference. (10) Filed as a management compensation plan or arrangement per Item 14(a)(3) of the Securities Exchange Act. (11) Previously filed with the Securities and Exchange Commission as an Exhibit to the registrant's Annual Report on Form 10-K for the year ended March 31, 1994 and incorporated herein by reference. (12) Previously filed with the Securities and Exchange Commission as an Exhibit to the registrant's Quanterly Report on Form 10-Q for the quarter ended December 31, 1994 and incorporated herein by reference.\nReports on Form 8-K - -------------------\nNo Current Reports on Form 8-K were filed during the quarter ended March 31, 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, in Torrance, California on the 29th day of June 1995.\nINTERNATIONAL TECHNOLOGY CORPORATION\nBy \/s\/ ROBERT B. SHEH -------------- Robert B. Sheh President and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\n\/s\/ E. MARTIN GIBSON - ------------------------ E. Martin Gibson Chairman of the Board of June 29, 1995 Directors\n\/s\/ ROBERT B. SHEH - ------------------------ June 29, 1995 Robert B. Sheh Director, President and Chief Executive Officer\n\/s\/ DONALD S. BURNS - ------------------------ Donald S. Burns Director June 29, 1995\n\/s\/ RALPH S. CUNNINGHAM - ------------------------ Ralph S. Cunningham Director June 29, 1995\n\/s\/ JOHN H. HUTCHISON Director June 29, 1995 - ------------------------ John H. Hutchison\n\/s\/ MURRAY H. HUTCHISON - ------------------------ Murray H. Hutchison Director June 29, 1995\n\/s\/ W. SCOTT MARTIN - ------------------------ W. Scott Martin Director June 29, 1995\n\/s\/ JAMES C. MCGILL - ------------------------ James C. McGill Director June 29, 1995\n\/s\/ JACK O. VANCE - ------------------------ Jack O. Vance Director June 29, 1995\n\/s\/ ANTHONY J. DELUCA - ----------------------- Anthony J. DeLuca Senior Vice President June 29, 1995 and Chief Financial Officer (Principal Financial Officer)\n\/s\/ PHILIP H. OCKELMANN June 29, 1995 - ------------------------- Philip H. Ockelmann Vice President, Treasurer and Controller (Principal Accounting Officer)\nINTERNATIONAL TECHNOLOGY CORPORATION Schedule II -- Valuation and qualifying accounts (In thousands)\n(1) Represents allowance for doubtful accounts at June 28, 1994 for receivables transferred to Quanterra, an environmental analytical services company which is jointly owned by IT and an affiliate of Corning Incorporated. (See Notes to Consolidated Financial Statements - Quanterra.)\n(2) Represents benefit for income taxes.\nExhibit 11.1\nINTERNATIONAL TECHNOLOGY CORPORATION COMPUTATION OF PER SHARE EARNINGS (In thousands, except per share data)\nYear ended March 31, ------------------------------ 1995 1994 1993 ---- ---- ----\nPrimary earnings per share:\nLoss from continuing operations......... $ (3,680) $ (1,106) $ (2,082) Discontinued operations (net of income taxes): Loss from disposition: Pollution control manufacturing...... - - (3,809) Transportation, treatment and disposal .......................... (10,603) - (6,800) ------- ------- ------- Loss before cumulative effect of change in accounting for income taxes.. (14,283) (1,106) (12,691) Cumulative effect of change in accounting for income taxes....................... - - 13,000 ------- ------- ------- Net income (loss)........................ (14,283) (1,106) 309 Less preferred stock dividends........... (4,200) (2,135) - ------- ------- ------- Net income (loss) applicable to common stock................................ $(18,483) $ (3,241) $ 309 ======= ======= =======\nAverage number of common shares outstanding............................ 35,474 33,484 33,058 Average common equivalent shares from stock options computed on the treasury stock method using average market prices...... 83 24 180 Average number of common shares to be issued.............................. - 1,254 292 ------- ------- ------- Shares used in computation.................... 35,557 34,762 33,530 ======= ======= =======\nNet income (loss) per share: Continuing operations (net of preferred stock dividends)............ $ (.22) $ (.09) $ (.06) Discontinued operations: From disposition...................... (.30) - (.32) ------ ------- ------ (.52) (.09) (.38) Cumulative effect of change in accounting for income taxes........................ - - .39 ------ ------- ------ Net income (loss) per share................... $ (.52) $ (.09) $ .01 ====== ======= ======\n- -----------------------\nFully diluted earnings per share result in less than 3% dilution and therefore are not presented.\nExhibit 21.1\nINTERNATIONAL TECHNOLOGY CORPORATION\nLIST OF SUBSIDIARY COMPANIES\nISOBAR, Inc. IT Corporation IT Environmental Programs, Inc. IT Environmental Services, Inc. IT Hanford, Inc. IT Italia, s.r.l. IT Tulsa Holdings, Inc. (formerly IT-McGill Pollution Control Systems, Inc.) International Technology Corporation of Delaware International Technology Europe PLC McKittrick Mud Company, Inc. Princeton Aqua Science Underground Resource Management, Inc. Universal Professional Insurance Company IT Corporacion de Mexico, S.A. de C.V. IT Corporation Limited (formerly IT-McGill Limited) IT Europe Pollution Control Engineering, Ltd. (formerly IT-McGill Pollution Control Systems, Ltd.) IT International Holdings, Inc. IT International Technology Espana, S.A. IT International Technology Deutschland GmbH\nEXHIBIT 23\nCONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS\nWe consent to the incorporation by reference in the Registration Statements (Form S-8; No. 2-95647 and No. 33-11486) and in the related Prospectuses pertaining to the International Technology Corporation 1983 Stock Incentive Plan, in the Registration Statement (Form S-3; No. 33-24040) of International Technology Corporation and in the related Prospectus, and in the Registration Statement (Form S-8; No. 33-52974) and in the related Prospectus pertaining to the International Technology Corporation 1991 Stock Option Plan of our report dated May 17, 1995 with respect to the consolidated financial statements and schedule of International Technology Corporation included in this Annual Report (Form 10-K) for the year ended March 31, 1995.\nERNST & YOUNG LLP Los Angeles, California June 29, 1995","section_15":""}
{"filename":"760462_1995.txt","cik":"760462","year":"1995","section_1":"Item 1. Description of Business ________________________________ (a) Business Development.\nData National Corporation (the Company) was formed under the laws of the State of Colorado in November 1982. On March 23, 1987, the Company acquired through an exchange of shares 97.8% of the outstanding shares of Data National Inc. (DNI), which resulted in a complete change in control of the Company. In June 1986, DNI acquired, through an exchange of its common stock, 100% of the outstanding common stock of Service Business Systems, Inc. (SBS) and National COM-LINK Systems, Inc. (COM-LINK). The Company acts as a holding company for these subsidiaries and coordinates their activities.\nSBS is the only active entity, although during 1994, COM-LINK received royalties from licensing a trademarked name.\n(b) Business of Issuer.\nPrincipal Products and Services\nThe Company derives revenue from products and services provided by its subsidiary, SBS. SBS markets and sells the Autotrac system to the service stations of major oil companies, auto repair facilities that specialize in tire sales, quick-lube facilities, tune-up facilities, and independent repair facilities that are members of national groups (subscribers). The Autotrac system is designed to increase repeat business to such subscribers through the mailing of postcards to customers thanking them for the business, reminding them that it is time for regular servicing (such as a tune-up or oil change), or reminding customers that certain parts need to be replaced for safety reasons (e.g., brakes, tires, or shocks). To utilize the services provided by SBS, participating subscribers send SBS copies of their repair orders that include information about a specific customer, their vehicle, and the services performed at the repair facility. SBS extracts certain information and enters it into a computer database. Each subscriber then selects when and what types of cards are to be sent, and reminder cards are produced and mailed directly to the subscriber's customers. The subscriber also selects the messages to be printed on the cards, the promotions and\/or specials to be offered, etc. The subscriber can update or change the messages, as desired.\nAs an integral part of the reminder system, SBS provides subscribers with monthly management reports detailing information concerning customers served and services performed, a customer zip code analysis of new versus repeat customers, and other information based on the data collected by SBS from the repair orders submitted by the subscriber.\nSBS also markets and sells products that utilize information regarding the customer of the facility that uses Autotrac. The products are as follows:\n1. Greeting Cards. Using the subscriber's database, SBS mails holiday greeting cards to customers of the subscriber.\n2. New Residence. SBS mails promotional material to individuals who have moved into the subscriber's market area.\n3. Cashier Handout. SBS produces point-of-sale coupons that can be used to increase the repair business of the subscriber.\n4. Customer Surveys. SBS sends survey cards to the facility's customers and reports the results of the survey to the subscriber.\nThe key to the services provided by SBS is being able to utilize the existing customer database of the subscriber.\nSBS also derives revenue from providing creative services to the subscriber.\nThe Company is expanding their customer base in fiscal 1996, and has contracted with a commonly controlled auto dealerships and a mortgage loan origination company to provide marketing services. The Company will focus its efforts on expansion of new markets and their existing customer base.\nEmployees\nSBS employs all of the employees of the Company. As of September 30, 1995, SBS had 21 full-time employees working in the office of the Company. In addition, SBS has approximately 20 employees for coding and inputting the information received from repair facilities into the SBS computer system, some of whom are part- time. These employees are home based.\nStatus of Products\nThe Autotrac system requires customer information to be input into the database maintained by SBS. The information is either input by the SBS home-based computer operators or downloaded directly from the subscriber's computer. The information is processed by the computer, and the database for the customer is updated. Notices are printed and mailed to the customers in the database. The Autotrac system uses a Novell network that includes PC equipment. The system also includes three production printers. In addition, SBS has numerous PC work stations for use by the account executives and data entry personnel. Management of SBS believes this equipment, supplemented by additions in fiscal 1996 estimated at $75,000, will permit SBS to handle all of its present and foreseeable data processing needs through September 30, 1996.\nSources and Availability of Raw Materials\nThe Company has experienced no significant difficulty with the delivery and availability of supplies that it sells to its customers, and no difficulty is forecast for the immediate future.\nPatents, Licenses, Franchises, Concessions, Etc.\nThe Company has no patent protection for its existing products that the Company considers to be proprietary items. Except in unusual circumstances, which do not apply to the Company, computer software is generally not patentable, but is protected by copyright and trade secret laws, as well as contractual and nondisclosure provisions of the Company's licensing agreements.\nSeasonality\nSBS produces holiday greeting cards in November and December. For the year ended September 30, 1995, SBS received revenues of approximately $228,000 as a result of the holiday greeting card program. There is no other seasonal factor to the Company's business.\nDependence Upon Small Number of Customers\nThe business of SBS is very dependent upon a few major customers; the loss of any one or more of these customers could have a materially adverse effect on the business and operations of the Company. During the fiscal year ended September 30, 1995, major customers represented approximately the following proportion of the SBS gross revenues:\nCompany A - 40.1% Company B - 18.1% Company C - 12.2%\nCompetition\nSBS has approximately 20 competitors that compete directly with them in the automotive aftermarket business. Most of the competitors are small companies like SBS with none of them having a market share of more than 20%. However, the largest competitor is Moore\/BCS, a division of Moore Business Forms in Toronto, Canada, a billion dollar conglomerate. Mailmark, Inc., based in Canoga Park, California, is a direct marketing\/data processing company, which provides a specialized service reminder\/customer contact program for the automotive industry. Other companies like Reynolds and Reynolds, Brandt Contact Services, Computer Care, and InteliMail are known competitors.\nA competitive analysis suggests that there are many potential entrants in this industry primarily because technology today allows just about anyone with a computer to enter the business. Suppliers\nto SBS, such as printing companies and direct mail companies could become competitors if they choose to expand their own channels of distribution. Repair facilities could also decide that they have all of the information necessary to do their own marketing and evaluations.\nHowever, SBS believes that its marketing strategy permits it to effectively compete with these companies. With economies of scale and a national account strategy, SBS believes that the service provided is more cost effective.\nResearch and Development Expenditures\nAlthough no costs were classified as research and development during each of the past two fiscal years, the Company expends considerable effort for software improvements on an annual basis. Such effort is a necessary element for maintaining the competitiveness of its software modules, and such costs are recorded as normal operating expenses.\nGovernmental Regulation and Compliance\nThere are no governmental regulations pertinent to operations that would differ from those applicable to any small manufacturer. There is no need for government approval of the Company's products. Any costs or effects of compliance with environmental laws are de minimis.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Description of Property ________________________________\nThe Company occupies office space under two 3-year leases that expire in April 1997 and require an aggregate monthly payment of $2,800.\nItem 3.","section_3":"Item 3. Legal Proceedings __________________________\nIn October 1993, a corporation filed suit against the Company and others in the United States District Court for Northern District of Texas, alleging copyright infringement, unfair competition, and misappropriation of trade secrets. Basically, it has been alleged that certain computer programs formerly marketed by the Company infringed on the plaintiff's copyright, through the use of software developed by another defendant who had formerly worked for the plaintiff. The plaintiff requested actual and punitive damages in excess of $5,000,000.\nOn November 6, 1995, the Court granted the Company's motion for summary judgement on the statute of limitations and dismissed the case with prejudice. However, the plaintiff has moved to reconsider, and the time for appeal has not expired. Accordingly, there is still the possibility of an adverse verdict.\nIn December 1995, the Company's former president (president in 1994 and part of 1995) sued the Company for $36,000 relating to alleged unreimbursed moving expenses and $18,000 in damages. In 1994, the Company and the former president verbally agreed the Company would pay him up to $36,000 in shares of the company's common stock as a reimbursement for certain moving expenses. The Company was to determine the number of shares and the former president was to provide proper documentation of the expenses. The stock was never issued, and in February, 1995, the former president informed the Company that he did not want the stock as there was no market for the stock. In June of 1995, the Company offered to pay this amount in cash in return for certain releases regarding the departure of the former president. The Company was also under the impression that the former president had executed various covenants as a condition of his employment. The Company determined the covenants had not been executed and demanded their execution as a condition of the payment. The former president refused to sign the release and the covenants, and in December 1995 sued the Company for $36,000 and $18,000 in damages. Management has accrued $36,000 at September 30, 1993 to recognize the estimated liability, and believes that settlement of the claim will not be material to the accompanying 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 ended September 30, 1995 to a vote of security holders, through the solicitation of proxies or otherwise.\nPART II\nItem 5.","section_5":"Item 5. Market for Company's Common Equity and Related Stockholder Matters _____________________________________________________________________\n(a) Market Information.\nThe Company's common stock has not been traded on the over-the- counter market. Because of the lack of any viable trading market for the Company's securities, no accurate market information is currently available.\n(b) Holders.\nThe number of holders of record of the Company's $.0001 par value common stock at September 30, 1995, was approximately 1,332.\n(c) Dividends.\nHolders of common stock are entitled to receive such dividends as may be declared by the Company's Board of Directors. No dividends have been paid with respect to the Company's common stock and no dividends are anticipated to be paid in the foreseeable future.\nItem 6.","section_6":"Item 6. Management's Discussion and Analysis or Plan of Operation _________________________________________________________________\nManagement's Discussion and Analysis of Financial Condition and Results of Operations\nSeptember 30, 1995 as Compared to September 30, 1994\nThe Company's working capital increased from $132,331 at September 30, 1994, to $173,347 at September 30, 1995. Cash flow from operations amounted to $80,389 in 1995, as a result of net income of $87,487. Included in the net cash flow from operations was a settlement payment with the State of Colorado Department of Revenue of $37,600, which was substantially offset by a non-cash charge for depreciation of $32,280. $63,035 was used to acquire additional equipment, primarily computers, and $11,102 was used to repay capital leases.\nThe Company is not obligated by contract for additional capital expenditures at September 30, 1995, but may be expected to continue to upgrade its systems, given the nature of its business. Management estimates capital expenditures of up to $75,000 in fiscal 1996.\nThe Company remains dependent upon the Dillon note for financing, and almost certainly would cease operations if the note were deemed in default and called for payment or not refinanced. The maturity date is presently extended to October 1, 1997.\nAs disclosed in the financial statements, the Company was named as a defendant, along with other parties, in a lawsuit filed in October 1993 in which the plaintiff requested actual and punitive damages in excess of $5,000,000. On November 6, 1995, the court granted the Company's motion for summary judgement on the statute of limitations and dismissed the case with prejudice. However, the plaintiff has moved to reconsider, and the time for appeal has not expired. Accordingly, there is still the possibility of an adverse verdict.\nThe Company believes that favorable operating results will continue and provide adequate liquidity for the near-term future.\nResults of Operations\n1995 Compared to 1994\nFor the year ended September 30, 1995, the nature of the Company's operations was unchanged and focused on providing marketing services to repair facilities and similar entities, nationally. One major customer accounted for 40.1% of net sales in 1995, as compared to 41% in 1994, and loss of this customer would have a materially adverse\neffect, including possible cessation of operations. Another customer accounted for 18.1% of net sales in 1995, as compared to 12.2% in 1994. One other group of customers, affiliated with a national oil company, has been aggregated and constituted 12.2% of net sales in 1995 but did not exceed 10% in 1994. However, this group of customers is not subject to the same contractual relationship as the other two major customers discussed above and presumably subjects the Company to less risk through potential loss of the contract.\nSales were practically unchanged in 1995 as compared to 1994. Cost of sales increased from 51% of sales in 1994 to 53% in 1995, primarily because production salaries increased by approximately $45,000 as new positions were created. The other components of cost of sales (postage and card inventory) remained stable as a percentage of sales (22.1% in 1995 and 1994 for postage, and 6.8% versus 7.1% in 1995 and 1994, respectively, for materials).\nSelling and marketing expenses decreased by $55,682, or 13.2%, in 1995. The decrease resulted primarily from the elimination of certain consulting fees, approximately $18,000 to an independent party and $12,000 to a member of the Board of Directors. Such services are now provided by Company staff. Other changes that resulted in cost reduction included not attending trade shows of two major customers, which occur biannually, and termination of employment of the Company president in July, which reduced travel and related expenses.\nGeneral and administrative expenses increased by $36,694, or 6.8%, in 1995. Executive salaries increased approximately $14,200 because of a raise for the former president and employment of a Chief Operating Officer in July 1995. Administrative salaries also increased by approximately $10,500, a result of raises for existing employees and employment of additional clerical staff. There were no other significant changes in individual expense accounts.\nInterest expense is substantially all related to the Dillon note, as described above, and is expected to remain a significant cost in the near future.\nItem 7.","section_7":"Item 7. Financial Statements _____________________________\nTo the Stockholders and Board of Directors Data National Corporation\nI have audited the consolidated balance sheets of Data National Corporation and subsidiaries as of September 30, 1995 and September 30, 1994, and the related consolidated statements of income, changes in stockholders' equity, and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. My responsibility is to express an opinion on these financial statements based on my audits.\nI conducted my audits in accordance with generally accepted auditing standards. Those standards require that I 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. I believe that my audits provide a reasonable basis for my opinion.\nIn my opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Data National Corporation and subsidiaries as of September 30, 1995 and 1994, and the consolidated results of their operations and their consolidated cash flows for the years then ended, in conformity with generally accepted accounting principles.\nLittleton, Colorado January 10, 1996\nDATA NATIONAL CORPORATION\nConsolidated Balance Sheets\nSeptember 30, 1995 and 1994\nSee accompanying notes to financial statements.\nDATA NATIONAL CORPORATION\nConsolidated Income Statements\nYears Ended September 30, 1995 and 1994\nSee accompanying notes to financial statements.\nDATA NATIONAL CORPORATION\nConsolidated Statement of Changes in Stockholders' Equity\nYears Ended September 30, 1995 and 1994\nSee accompanying notes to financial statements.\nDATA NATIONAL CORPORATION\nConsolidated Statements of Cash Flows\nYears Ended September 30, 1995 and 1994\nSee accompanying notes to financial statements.\nDATA NATIONAL CORPORATION\nNotes to Consolidated Financial Statements\nSeptember 30, 1995 and 1994\n(1) Organization, Operations, and Significant Accounting Policies\nOrganization and Operations\nData National Corporation (DNC) was incorporated under the laws of the State of Colorado on November 5, 1982.\nOn March 23, 1987, and in a subsequent exchange, DNC acquired 97.8% of the outstanding common stock of Data National, Inc. (DNI) in exchange for 168,688,240 shares of DNC's common stock, plus warrants to certain shareholders of DNI. The combination of the two companies was accounted for as a recapitalization, with DNI considered as the acquiring company (although DNC itself is the surviving corporation).\nOn June 2, 1986, DNI acquired 100% of the outstanding common stock of Service Business Systems (SBS) and National Com- Link Systems, Inc. (Com-Link) by exchanging 1,050,000 shares of its common stock. The combination of these companies was accounted for as a pooling of interests.\nThe Company derives revenue from products and services provided by its subsidiary, SBS, which is the only operating subsidiary. SBS markets and sells the Autotrac system to the service stations of major oil companies, auto repair facilities that specialize in tire sales, quick-lube facilities, tune-up facilities, and independent repair facilities that are members of national groups. The Autotrac system is designed to increase repeat business to such facilities through the mailing of postcards to customers thanking them for their business, reminding them that it is time for regular servicing (such as a tune-up or oil change), or reminding customers that certain parts need to be replaced for safety reasons (e.g., brakes, tires, or shocks).\nAs an integral part of the system, SBS provides the repair facilities with monthly management reports detailing information concerning customers served and services performed, a customer zip code analysis, new versus repeat customers, and other information based on the data collected by SBS from the repair orders submitted by the facility.\nSBS also markets and sells products that utilize information regarding the customer and\/or auto repair facility that uses Autotrac. The products are as follows:\n1. Using the facility's database, SBS mails holiday greeting cards to customers of the facility.\n2. SBS mails promotional material to individuals who have moved into the facility's market.\n3. SBS produces point-of-sale coupons that can be used to increase the repair business of the facility.\n4. SBS sends survey cards to the facility's customers and reports the results of the survey to the facility.\nSBS also derives revenue from providing creative services to the facilities.\nPrinciples of Consolidation\nThe consolidated financial statements include the accounts of DNC, DNI, SBS, and Com-Link (collectively, the Company). All material intercompany accounts and transactions are eliminated in consolidation.\nRevenue and Credit Risk\nRevenue is recognized upon production and shipping of products.\nSales are substantially made by extending credit to customers on a short-term basis, using informal credit evaluations, and are on an uncollateralized basis. See Note 5 for disclosure of major customers for further information on credit risk.\nInventory\nInventory consists of unprinted card stock, and is carried at cost determined on a first-in-first-out basis.\nProperty and Equipment\nProperty and equipment are stated at cost, and are depreciated over useful lines of from 5 to 7 years primarily using the straight-line method. A summary of property and equipment at September 30, 1995 and 1994 follows:\nThis amount may be further limited by separate return year limitations for the years 1984 to 1987, which aggregate $437,000 and would reduce the carry forwards with expirations from 1999 to 2002.\nDeferred Revenue\nPrepayments for products are recorded as deferred revenue until the product is delivered.\nAdvertising\nThe Company expenses advertising costs when incurred. Such costs amounted to $6,001 and $13,385 in 1995 and 1994, respectively.\nReclassification of Accounts\nCertain depreciation in the amount of $28,000 has been reclassified from general and administrative expense to cost of sales in 1994 to conform with the presentation for the current year.\nUse of Estimates\nPreparation of financial statements in accordance with generally accepted accounting principles requires the use of estimates.\n(2) Related Party Transactions\nThe Company refinanced certain existing indebtedness to two individuals (father and son), considered collectively in the note, in October 1991. One of the two individuals is now Chairman of the Board of Directors and owns or controls 104,793,403 shares of the Company's common stock. The principal amount of the note is $869,072, with interest at 10%, originally due on or before October 1, 1996, including $182,441 in accrued interest from prior indebtedness. The note is secured by inventory; trade receivables; the right to the name, \"Data National Corporation,\" and related trademarks, licensing agreements, patents, and similar rights; bank accounts; and the stock of DNI and all of its subsidiary corporations.\nIn conjunction with the refinancing, the two individuals also received warrants to purchase 64,000,000 shares of the common stock of Data National Corporation. The warrants are exercisable on or before September 30, 1996, at a purchase price of $.0005 per share.\nOn January 10, 1996, the Note was extended to mature on October 1, 1997.\nThe two individuals have entered into an agreement with the (then) president (now chief financial officer) whereby, in consideration for him becoming president, they sold to him certain shares of stock, agreed to pay him 10% of any principal paid to them (i.e., the original principal of $737,000 referred to above), agreed to pay him 50% of interest payments collected by them, and assigned the warrants to purchase 64,000,000 shares of common stock to him. There have not been any (original) principal repayments to date. Interest expense amounted to $86,860, and $91,358, in 1995 and 1994, respectively.\nA member of the Board of Directors received $3,000 per month in 1994 and for 8 months in 1995 for consulting services. Additionally, a company that he controls was indebted to the Company in the amount of $2,924 at September 30, 1995 and 1994 for certain health insurance premiums. At September 30, 1995, the Company was indebted to this individual for $3,000.\nThe son of the chief financial officer leases equipment to the Company under three capital leases, which are summarized in Note 3.\n(3) Capital Leases\nThe Company leases various equipment under capital leases. Following is a summary of minimum lease payments required under capital leases as of September 30, 1995:\nAssets held under capital leases are summarized as follows:\nA summary of capital leases follows:\nAmortization of capital leases is included in depreciation expense.\n(4) Commitments\nOffice Lease\nThe Company occupies office space under two 3-year leases that expire in April 1997 and require monthly payments of $2,800. Following is a summary of future rental commitments under these leases:\nRent expenses and related charges amounted to $33,600 and $34,900 in 1995 and 1994, respectively.\nIncentive Plans\nIn July 1994, the Company adopted an Employee Incentive Plan, which provides for a contribution to the Plan of 5% of quarterly sales in excess of $480,000. For the quarters ended September 30, 1995 and 1994, this contribution amounted to $1,424 and $1,422, respectively, and has been accrued in the accompanying balance sheet.\nAlso in July 1994, the Company adopted an Executive Compensation Incentive Plan, which provides for a contribution to the Plan of 20% of quarterly net income in excess of $75,000. Through September 30, 1995, there were no contributions due.\nProfit-Sharing Plan\nIn August 1992, the Company adopted a 401-K Profit Sharing Plan, which covers all employees with one quarter of a year's service who are at least 21 years old. A participant may defer a maximum of 15% of compensation to a statutory limit, and the Company matches the first 5% of the deferral. In 1995 and 1994, such contributions amounted to $1,433 and $1,300, respectively.\n(5) Major Customers\nThe following customers each accounted for more than 10% of sales in 1995 or 1994:\n(6) Subsequent Events\nLitigation\nIn October 1993, a corporation filed suit against the Company and others in the United States District Court for Northern District of Texas, alleging copyright infringement, unfair competition, and misappropriation of trade secrets. Basically, it has been alleged that certain computer programs formerly marketed by the Company infringed on the plaintiff's copyright, through the use of software developed by another defendant who had formerly worked for the plaintiff. The plaintiff requested actual and punitive damages in excess of $5,000,000.\nOn November 6, 1995, the Court granted the Company's motion for summary judgement on the statute of limitations and dismissed the case with prejudice. However, the plaintiff has moved to reconsider, and the time for appeal has not expired. Accordingly, there is still the possibility of an adverse verdict.\nIn 1994, the Company and its former president (who was at that time president) verbally agreed that the Company would pay him up to $36,000 in shares of the Company's common stock as reimbursement for certain moving expenses upon proper documentation of the expenses. The stock was never issued, and in February 1995, the former president informed the Company that he did not want the stock as there was no market for it. In June 1995, the Company offered to pay this amount in cash in return for certain releases and covenants and documentation of the claimed expenses. The former president refused to sign the releases and covenants, and in December 1995 sued the Company for $36,000 and $18,000 in damages. Management accrued $36,000 at September 30, 1993 to recognize the estimated liability, and believes that settlement of the claim will not be material to the accompanying financial statements.\nItem 8.","section_7A":"","section_8":"Item 8. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure _________________________________________________________________ In June 1994, the Company reported a change in its independent accountant. The firm of Miller and McCollom had performed the last audit of the Company's financial statements as of September 30, 1989, and for the year then ended. There were no reportable disagreements with that firm, and its report for 1989 was qualified regarding the Company's ability to continue as a going concern.\nThe Company engaged the firm of William G. Lajoie, P.C., to audit its financial statements for the years ending September 30, 1993, 1994, and 1995.\nThese actions were approved by the Company's Board of Directors.\nPART III\nItem 9.","section_9":"Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance With Section 16(a) of the Exchange Act of the Company ___________________________________________________________________________ The Directors and Officers of the Company at September 30, 1995, are as follows:\nThere is no family relationship between any director, executive officer, or person nominated or chosen by the Company to become a director or executive officer. All directors will hold office until the next annual meeting of shareholders. There are no arrangements or understandings between any director of the Company or any other person or persons pursuant to which such director was or is to be selected as a director.\nThe Board of Directors held two meetings during the past fiscal year, and all of the members then on the Board were present at all of the meetings. There were no meetings of any of the committees of the Board of Directors during the past fiscal year.\nAll officers of the Company hold office at the discretion of the Board of Directors. Except as set forth herein, there is no arrangement or understanding between any such officer or any other person pursuant to which such officer is to be selected as an officer of the Company. There is no person who is not a designated officer who is expected to make any significant contribution to the business of the Company.\nThe following sets forth biographical information as to the business experience of each officer and director of the Company.\nRichard Simms is the Vice President of Finance of the Company. He was President and Chief Executive Officer of the Company from October 1990 to July 1993. He has been a Director of the Company since March 23, 1987, and of DNI since its inception. Since 1986, he has practiced as a certified public accountant and an independent financial advisor. Mr. Simms is a CPA registered in Colorado. Mr. Simms devotes part of his time to the business of the Company and its subsidiaries.\nRay E. Dillon III has been a Director of the Company since March 23, 1987, and of DNI since its inception. He is Vice President of Dillon Investments, a private trust management company for the Dillon family, where he has been employed since 1985. Mr. Dillon devotes only such time to the business of the Company as is necessary in his position.\nDonald V. Warriner is President and CEO of the Company as of August 1995. Prior to joining the Company, Mr. Warriner was employed by Cherry Creek Mortgage Company. Prior to working for Cherry Creek, Mr. Warriner was President of Bainbridge International, a company that was involved in acquisitions and buy outs of small- to medium-sized firms. Mr. Warriner devotes all of his time to the business of the Company.\nCompliance with Section 16(a) of the Exchange Act\nSection 16(a) of the Securities Exchange Act of 1934 does not require any of the Company's officers, directors or persons who own more than ten percent of the Company's equity securities to file any reports of ownership or changes in ownership with the Securities and Exchange Commission because the Company does not currently have any class of securities registered under Section 12 of that Act.\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Executive Compensation ________________________________ The following table sets forth the compensation paid or accrued to the Chief Executive Officer and each executive officer of the Company and its subsidiaries who received compensation in excess of $100,000 during the fiscal year ended September 30, 1995 and 1994:\n________________________________\n(1) There were no executive officers whose compensation exceeded $100,000 in either 1994 or 1995. (2) As described earlier, Mr. Eyerdom was offered certain restricted stock as reimbursement for moving expenses incurred in 1993. However, such stock was refused and the payment of the expenses is the subject of litigation filed in December of 1995 and more adequately explained under Item 3. (3) Represents the value of a leased automobile and reimbursement of gas and certain maintenance charges.\nThe following table shows certain information with respect to stock options granted to the Company's executive officers during the fiscal year ended 1995:\nOption\/SAR Grants in Last Fiscal Year\nThe following table sets forth certain information with respect to option exercises during the fiscal year ended September 30, 1995 by the executive officers of the Company and the value of each such officer's unexercised options at September 30, 1995:\nAggregated Option\/SAR Exercises in Last Fiscal Year and Fiscal Year - End Option\/SAR Values\nEstimated Future Payouts under Non-Stock Price-Based Plans _________________________________________\nItem 11.","section_11":"Item 11. Security Ownership of Certain Beneficial Owners and Management __________________________________________________________________ The following table sets forth information as of December 31, 1995, with respect to the beneficial ownership of the Company's $0.0001 par value common stock by (a) each person known by the Company to be beneficial owner of 5% or more of the Company's outstanding Common stock, (b) the directors of the Company, and (c) the directors and officers of the Company as a group:\n(1) Includes warrants to purchase 64,000,000 shares. See Item 11 - Certain Relationships and Related Transactions. Includes shares owned by the Simms Family Partnership, controlled by Mr. Simms. (2) Includes 30,506,959 shares owned by other members of the Dillon family. (3) There are no additional officers or directors who own shares of the Company's common stock, but the Company has agreed to sell and grant certain employees shares of common stock.\nItem 12.","section_12":"Item 12. Certain Relationships and Related Transactions _________________________________________________________ No director and executive officer of the Company, nominee for election as a director, security holder who is known to the Company to own of record or beneficially more than 5% of any class of the Company's voting securities, or any member of the immediate family of any such persons, has had any transaction or series of similar transactions, during the Company's last two fiscal years, or had any currently proposed transaction, or series of similar transactions, to which the Company was or is to be a party, in which the amount involved exceeds $60,000 or in which any of such persons had or will have any direct or indirect material interest, except as follows:\nThe Company refinanced certain existing indebtedness to two individuals (father and son), considered collectively in the note (the \"Dillon note\"), in October 1991. One of the two individuals is now Chairman of the Board of Directors and owns and controls 104,793,403 shares of the Company's common stock. The principal amount of the note is $737,000, with interest at 10%, and was originally due on or before October 1, 1996. Additionally, the Company owed $182,441 in accrued interest from the prior indebtedness. The note and this accrued interest are secured by\ninventory; trade receivables; the right to the name, \"Data National Corporation,\" and related trademarks, licensing agreements, patents, and similar rights; bank accounts; and the stock of DNI and all of its subsidiary corporations.\nIn conjunction with the refinancing, the two individuals also received warrants to purchase 64,000,000 shares of the common stock of Data National Corporation. The warrants are exercisable on or before September 30, 1996, at a purchase price of $.0005 per share.\nThe two individuals have entered into an agreement with the (then) president (now chief financial officer) whereby, in consideration for him becoming president, they sold to him certain shares of stock, agreed to pay him 10% of any principal paid to them (i.e., the $737,000 referred to above), agreed to pay him 50% of interest payments collected by them, and assigned the warrants to purchase 64,000,000 shares of common stock to him. There have not been any (original) principal repayments to date. Interest expense amounted to $86,860, and $91,358, in 1995 and 1994, respectively.\nOn January 10, 1996, the Dillon note was extended to mature on October 1, 1997.\nThe Company has agreed to sell and grant restricted common stock to the new President and CEO and the new Vice President and COO (management team). The Company has agreed to sell approximately 150,000,000 shares of stock of the Company to the new management team at a price of $.0006 per share. The Company will grant approximately 50,000,000 shares of common stock to the new management team. It is anticipated the sale and grant of shares will take place before January 31, 1996.\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.\nDATA NATIONAL CORPORATION Registrant\nDate: January 12, 1996 By:\/s\/ Richard Simms Richard Simms, Chief Financial Officer, Treasurer and Director\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nDate: January 12, 1996 By:\/s\/ Richard Simms Richard Simms, Chief Financial Officer, Director and Treasurer\nDate: January 12,1996 By:\/s\/ Ray E. Dillon Ray E. Dillon III, Chairman of the Board and Director\nDate: January 12, 1996 By:\/s\/ Donald Warriner Donald Warriner, Chief Executive Officer and Director\n[ARTICLE] 5","section_13":"","section_14":"","section_15":""}
{"filename":"1969_1995.txt","cik":"1969","year":"1995","section_1":"Item 1. BUSINESS\nGeneral.\nAMETECH, Inc. (the \"Company\") is an Oklahoma corporation and was formed in 1967.\nMoorpark Holdings, Inc., a Delaware corporation (\"Moorpark\"), and its parent company, Bank of America of Illinois, would be considered to beneficially own 10,367,122 shares, or approximately 75.2% of the 13,785,032 shares of voting securities of the Company issued and outstanding as of April 9, 1996. As a result, Moorpark and its parent companies would be considered to be the controlling persons of the Company. Moorpark has advised the Company that it has acquired such shares as a passive investor and will hold such shares for investment purposes only. See \"Security Ownership of Certain Beneficial Owners and Management -- Security Ownership of Certain Beneficial Owners\".\nOn August 17, 1995, the Company, through a wholly-owned subsidiary, Environmental Transportation Services, Inc., an Oklahoma corporation (\"ETS\"), acquired all of the outstanding capital stock of Dwight Trucking, Inc., a California corporation (\"Dwight Trucking\"). Dwight Trucking is a transporter of hazardous and non- hazardous waste, with its principal offices and transportation terminal located in Bakersfield, California. In February, 1996, the Company merged Dwight Trucking into ETS and the Company intends to continue to operate the business of transporting hazardous waste and non-hazardous waste from the Bakersfield, California terminal through its subsidiary, ETS. The accompanying combined financial statements for the year ended December 31, 1995, aggregates the results of operations for the Company and Dwight Trucking as if such transaction has occurred on July 1, 1995.\nOn July 20, 1995, the Company's wholly-owned subsidiary, ETS, acquired substantially all of the assets of Arthur E. Smith & Son Trucking, Inc., a Nebraska corporation (\"Smith Trucking\"). The assets acquired from Smith Trucking are used in the transportation of hazardous waste from a terminal located in Denver, Colorado. The City of Denver requires a special use permit in order to operate a hazardous waste transportation terminal and to transfer such waste from one truck to another at such terminal. ETS is currently operating its terminal in Denver without having obtained such a special use permit. Failure to obtain such permit will require ETS to relocate its Denver terminal to another city in Colorado in which such a special use permit may be obtained.\nSubsequent Events\nIn March, 1996, the Company's subsidiary, Environmental Transportation Services, Inc. (\"ETS\"), began leasing from Sullivan Trucking Company, Inc. (\"Sullivan\"), a certain number of hazardous waste tractors and trailers and has begun to utilize such equipment to transport waste for Sullivan's and ETS' customers. In connection with such lease, ETS is to pay Sullivan approximately $35,000 a month to lease from Sullivan such tractors and trailers and a certain number of roll-off boxes.\nIn connection with the transaction with Sullivan, the Company has reached a tentative agreement to acquire from Sullivan its customer list, good will, inventory, and other business aspects of Sullivan's hazardous waste transportation business. The Company believes that, in addition to the above-described lease arrangement, the Company will pay Sullivan approximately 1.4 million shares of the Company's common stock and will lease from Sullivan its transportation terminal in Ponca City, Oklahoma, for a term of approximately four (4) years at a rental of $3,800 per month. The Company and Sullivan are in the process of finalizing definitive agreements relating to these transactions.\nSegment Information and Foreign and Domestic Operations and Export Sales.\nThe Company's principal business is providing environmental- related activities consisting primarily of transporting hazardous and non-hazardous waste, and, as a result, the Company believes that it is in only one business segment.\nOther than its minority ownership (approximately 10%) in a waste company in Mexico, the Company had no foreign operations or export sales in 1995.\n(a) Environmental Business\nThe Company's principal business (through its subsidiaries) is the transportation of hazardous and non-hazardous waste.\nThe Company's transportation business is provided primarily to generators and brokers of and disposal companies handling hazardous and non-hazardous waste. The Company's transportation subsidiary generally transports waste from the generator's location to disposal, storage or treatment sites operated and owned by others. The Company currently has transportation terminals in California, Colorado, Florida, Kansas, Ohio, Oklahoma, Tennessee, Texas, Utah, Virginia, and Washington. See \"PROPERTIES\". In 1995, approximately 95% of the Company's consolidated revenues were related to its transportation operations.\nThe Company and its subsidiaries own or lease specifically constructed multi-purpose vehicles which are used in the collection and transportation of hazardous and non-hazardous waste. The vehicles used to transport hazardous waste are specially designed tractors and semi-trailers to comply with applicable regulations of the U. S. Department of Transportation (\"DOT\") relating to the transportation of hazardous waste. The transportation of hazardous waste requires the Company to annually increase and\/or update its fleet of these specially designed vehicles.\nIn the past, the Company, through subsidiaries, also performed brokerage services for certain generator-customers. These services required the Company to act as an intermediary for the generator- customer with the disposal facility. In 1994, the Company decided to deemphasize its brokering services due to the low margins and the potential liability related to such business. As a result, less than 1% of the Company's consolidated revenues for 1995 were related to the Company's brokerage activities.\nA subsidiary of the Company operates a non-RCRA storage, bulking and transfer facility located in Green Cove Springs, Florida, under a permit granted by the State of Florida. This facility began operation in May, 1994, and is used to collect, store, and treat solid and semi-solid wastes which are non-hazardous in nature. The waste is then separated, processed and shipped to suitable disposal facilities. In connection with this permit, the Company owns a building on four acres of land. See \"PROPERTIES\". In addition to business explained above, this subsidiary also brokers non-hazardous waste. Revenues from this subsidiary accounted for approximately 3% and 1% of consolidated revenues in 1995 and 1994, respectively.\n(b) Customers\nThe major customers of the Company in the environmental related business are hazardous waste management companies and hazardous waste brokers. For 1995, approximately 31% of the Company's consolidated revenues were derived from transportation-related activities for Laidlaw Environmental Services, Inc. and its affiliates, as compared to approximately 34% for 1994.\n(c) Competition\nThe environmental services industry is highly fragmented and competition is intense. Competition is based on, among other factors, work quality and timeliness of performance, safety and efficiency, availability of personnel and equipment, and pricing. The Company believes that its expertise and its reputation within the industry for providing timely services allow it to compete effectively. The industry, however, is, and is likely to continue to be, dominated by much larger and better capitalized companies than the Company. Many of the major companies that own disposal\nfacilities for hazardous and non-hazardous waste, which the Company does not, compete with the Company's transportation subsidiary by offering to their customers transportation services of such waste from the site of generation to their disposal facilities.\n(d) Environmental Damages and Personal Injury\nThe environmental activities involve significant risks inherent in the management of hazardous waste. Although the Company believes that its operations are conducted in a safe and prudent manner, spillage, uncontrolled release or mishandling of hazardous waste could create liability for the Company as the result of environmental damage or personal injury. Such an occurrence could have a material adverse effect on the business and financial condition of the Company.\n(e) Regulation and Permits\nThe transportation business is subject to extensive and increasing federal, state, and local laws and regulations. In addition to imposing requirements on the Company's activities regarding hazardous waste, these regulations require the Company to maintain various permits in order to conduct its current transportation business. Permits are generally required by most, if not all, states for the transportation of hazardous waste in such states. These permits need to be renewed periodically and may be subject to revocation, modification, denial or nonrenewal for various reasons, including failure of the Company's transportation subsidiary to satisfy regulatory concerns. Regulations will require the Company to obtain additional permits in the future to expand its transportation business into new states.\nIn addition, the State of Florida requires the Company's subsidiary conducting the non-hazardous waste activities in Florida to obtain and maintain a permit to store and process non-hazardous waste at its facility in Florida. See \"BUSINESS--Environmental Business\".\nThe City of Denver, Colorado requires a special use permit to operate a hazardous waste terminal to transfer such waste from one truck to another at such terminal. ETS is currently operating its terminal in Denver without having obtained such a special use permit. Failure to obtain such permit will require ETS to relocate its Denver terminal to another city in Colorado in which such a special use permit may be obtained.\nFailure by the Company to obtain and maintain necessary permits would have a material adverse effect on its business and financial condition. The Company believes it is in substantial compliance with existing regulatory requirements; however, the Company cannot predict what impact future laws, rules or regulations will have on its business or financial condition. Further, sometimes justifiable\ndifferences in interpretations of laws and regulations could result in unforeseen liabilities. A failure to comply with such laws, rules and regulations could subject the Company to fines and penalties and\/or revocation of permits issued by a state, which could have a material adverse effect on the Company.\nA discussion of the principal environmental laws affecting the Company's Environmental Business is set forth below.\n(i) RCRA and Federal Transportation Laws. The Resource Conservation and Recovery Act, as amended (\"RCRA\"), provides a comprehensive framework to regulate the generation, transportation, disposal, storage and treatment of hazardous waste. The purpose of RCRA is to control hazardous waste from the time such is generated to the time of disposal. RCRA requires that the Environmental Protection Agency's (\"EPA\") regulations as to the transportation of hazardous waste be consistent with the federal Department of Transportation (\"DOT\") regulations under the Hazardous Materials Transportation Act (\"HWTA\").\nRCRA and HMTA regulate any party who transports hazardous waste, whether in interstate or intrastate commerce. These laws and the regulations promulgated thereunder regulate, among other things, the transportation of hazardous waste and provide that such is subject to a manifest system, regulates the record keeping concerning the source and deliver points of hazardous waste, the proper labeling of transported waste, equipment specifications and insurance requirements. In addition, these laws and the regulations promulgated thereunder require that a transporter must deliver waste in accordance with the manifest prepared by the generator of the waste and may only deliver such to a disposal, treatment or storage facility having a RCRA permit or interim status under RCRA.\nDemand for the Company's transportation services is substantially dependent upon the continuation of the regulation of the treatment, disposal and transportation of hazardous waste under federal and state laws and regulations. The repeal of these laws or any significant relaxation of their requirements as to the transportation of hazardous waste could significantly reduce the demand for the transportation services offered by the Company and could have a material adverse effect on its business and financial condition.\n(ii) Non-Hazardous Waste Management Activities in Florida. The State of Florida has adopted the Florida Solid and Hazardous Waste Management Act (\"Florida Act\"), which provides, among other things, that no non-hazardous waste management facility shall be constructed, operated, maintained, modified or closed in Florida without first obtaining a permit issued by the Florida Department of Environmental Regulations (\"Florida Department\"), with certain limited exceptions. In March, 1994, and before the Company's subsidiary began construction or operation of the facility in\nFlorida, such subsidiary was granted a permit by the Florida Department to construct and operate the non-hazardous waste storage, bulking and transfer facility in Florida. This law and the regulations promulgated thereunder regulate non-hazardous waste management facilities, such as the non-hazardous waste facility being operated by the Company's subsidiary in Florida.\n(iii) Health and Safety Regulations. The operations of the Company's Environmental Business are subject to the requirements of the Occupational Safety and Health Act (\"OSHA\") and comparable state laws. Regulations promulgated under OSHA and the Department of Labor require employers of persons in the transportation and environmental industries, including independent contractors, to implement work practices and personal protection programs in order to protect employees from equipment safety hazards and exposure to hazardous chemicals. It is also anticipated that oversight of the Company's operations by regulatory agencies charged with protecting health and safety will increase, resulting in increased cost and a greater potential for imposition of penalties for noncompliance. The Company has used its best efforts to establish programs for complying with health and safety regulations. While the Company believes it operates safely and prudently, there can be no assurance that accidents will not occur or that the Company will not incur substantial liability in connection with the operation of its business. The Company could, for example, be subjected to litigation in the event of an accident, such as a traffic accident or inhalation of harmful chemicals. To the extent that any such claim was not covered or only partially covered by insurance, the Company could be materially adversely affected.\n(iv) Superfund. In 1980, the Comprehensive Environmental Response, Compensation and Liability Act of 1980, commonly known as \"Superfund\" or \"CERCLA\", was enacted.\nSuperfund provides for EPA-coordinated response and removal actions 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. Superfund also provides for the recovery of cost in connection with the clean-up of a site where hazardous substances have been released. Superfund attempts to allocate these responses and other related costs among parties involved in the generation, transportation and disposal of such hazardous substances. Superfund has been interpreted as creating among liable parties strict, joint and several liability for costs of removal and remediation, other necessary response costs and damage to natural resources. Liability under Superfund extends to four categories of parties: (i) owners and operators of a facility from which a release occurs, (ii) persons who owned or operated a facility at the time the hazardous substances were disposed of at such a facility, (iii) persons who arranged for disposal or treatment of a hazardous\nsubstance at or transportation of a hazardous substance to such facility (i.e., generators of such hazardous substances), and (iv) transporters who selected such facility for treatment or disposal of hazardous substances.\nSuperfund also authorizes (i) private litigants who have incurred response costs in the clean-up of a site contaminated with hazardous substances to bring an action, under certain conditions, for contribution against other parties who may be liable under Superfund, and (ii) authorizes citizens suits under certain conditions against any person, including the United States, who is alleged to be in violation of any standard, regulation, condition or order which has become effective under Superfund.\nIn addition to Superfund, certain individual states have enacted their own statutory schemes to respond to release of hazardous substances, to order responsible parties to conduct removal action from liable parties. Parties who could be liable under the states' mini-Superfund statutes are generally the same parties that are liable under Superfund.\n(f) Insurance\nThe Company is required to maintain specified types and amounts of insurance in order to conduct its current business of transportation of hazardous and non-hazardous waste. The availability of adequate insurance is a problem faced by the hazarded waste industry as a whole due to the limited number of insurers and the increasing cost of coverage. To the best of the Company's knowledge, the Company currently has insurance sufficient to satisfy all applicable regulatory requirements. Although the Company believes that it will be able to obtain renewals of, or replacements for its existing coverage, there can be no assurance that the Company will be able to maintain insurance in compliance with regulatory requirements. Failure to satisfy these regulatory insurance requirements could have a material adverse effect on the Company's business and financial condition.\n(g) Employees\nAs of December 31, 1995, the Environmental Business of the Company had approximately 150 full-time employees, none of whom were represented by a union.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nThe Company's environmental business is conducted through both owned and leased facilities. The Company and\/or one of its subsidiaries owns a six-acre tract of land in Oklahoma City, Oklahoma, subject to a mortgage, which contains an office building of approximately 15,000 square feet. This facility is being used by the Company as its executive office, as well as the Company's\nOklahoma City transportation terminal. In addition, the Company owns approximately 7.2 acres of land in LaPorte, Texas, subject to a mortgage, on which the Company's subsidiary has constructed a 14,000 square foot truck terminal. The Company's subsidiary completed construction of the LaPorte terminal in February, 1994.\nIn addition, the Company and\/or its subsidiaries leases transportation terminals in Bakersfield, California; Denver, Colorado; Jacksonville, Florida; Chanute, Kansas; Atoka, Tennessee; Salt Lake City, Utah; Martinsville, Virginia; and, Centralia, Washington. The Company's subsidiary also owns a terminal in Chattanooga, Tennessee, subject to a mortgage. The facilities in Bakersfield, California; Elyria, Ohio; Chattanooga, Tennessee; and LaPorte, Texas, contain office facilities. See \"Business-- Regulations and Permits\".\nAdditionally, a subsidiary of the Company owns approximately four acres of land and a 12,000 square foot building in Green Cove Springs, Florida. This facility is used for the bulking and transfer of non-hazardous waste under a permit granted by the State of Florida.\nThe Company believes that the above properties are suitable and adequate for the Company's presently anticipated needs.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nIn March, 1993, the Company was advised that its insurance carrier had denied coverage relating to a lawsuit filed by seven (7) individuals against Dyna-Turn of Oklahoma Incorporated (\"Dyna-Turn\") and a subsidiary of the Company, Environmental Transportation Services, Inc. (\"ETS\"), styled Darrell Stafford, et al. v. Dyna-Turn of Oklahoma Incorporated, et al., pending in the District Court of Oklahoma County, Oklahoma (the \"Lawsuit\"). The Lawsuit was filed in January, 1992. The plaintiffs were employees of a waste incineration facility and allege that (i) Dyna-Turn generated certain waste contaminated with toxic and hazardous chemicals; (ii) that the waste was transported by ETS, and (iii) that Dyna-Turn was negligent in the generation and ETS was negligent in the transportation of such waste and in failing to warn these plaintiffs of the hazardous nature of the waste. In the Lawsuit, the plaintiffs are alleging that they sustained certain personal injuries and are seeking unspecified damages in excess of $10,000 and punitive damages. The Lawsuit is presently in the discovery stage. The Company believes that it has defenses to the Lawsuit, but at this stage is unable to determine the amount of any potential exposure that it may incur as a result thereof. The Company intends to vigorously defend itself in the Lawsuit. At this time, the Company does not anticipate that the Lawsuit will have a material adverse effect on the Company or its financial condition, but there are no assurances to that effect.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNot applicable.\nItem 4A. EXECUTIVE OFFICERS OF THE COMPANY\nThe following are the executive officers of the Company:\nAt April 9, 1996, there were 1,143 holders of record of the Company's common stock, par value $.01.\nThe Company did not declare a cash dividend on its common stock in 1995 or 1994. It is anticipated that for the foreseeable future any earnings which may be generated from the operations of the Company will be used to finance its growth and that cash dividends will not be paid to holders of the common stock of the Company. Any decision by the Board of Directors of the Company to pay cash dividends in the future will depend upon, among other factors, the Company's earnings, financial condition and capital requirements.\nPursuant to the terms of the loan agreement between ETS, the principal operating subsidiary of the Company, and its lender, ETS is prohibited from, among other things, (i) declaring and paying any dividends, (ii) making any distributions on account of its stock, (iii) making any loans to the Company, or (iv) invest in the Company. Since the Company is a holding company, it is dependent upon its subsidiaries to pay dividends and make distributions to the Company before the Company is able to pay any dividends.\nItem 6.","section_5":"","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 Management's Discussion and Analysis should be read in conjunction with a review of the Company's December 31, 1995, Consolidated Financial Statements included elsewhere in this Form 10-K.\nItem 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe following Management's Discussion and Analysis should be read in conjunction with a review of the Company's December 31, 1995, Consolidated Financial Statements included elsewhere in this Form 10-K.\nResults of Operations Year Ended December 31, 1995 Compared to Year Ended December 31, 1994.\nThe net loss for 1995 was $362,000, as compared to net income in 1994 of $80,000. This decrease was due primarily to a decrease in the gross margin (revenues less operating costs) of $423,000, increased general and administrative costs of $245,000 and higher interest expense of $272,000.\nTotal revenues were $17,650,000 and $14,945,000 for 1995 and 1994, respectively, an increase of $2,705,000 or 18%. Revenues from transportation and related activities increased $2,325,000 while waste brokerage revenue decreased $160,000. Additionally, revenues related to BMH Materials, Inc. (\"BMH\"), the Company's subsidiary involved in the processing, brokering, and disposal of non-hazardous waste in Florida increased $341,000 over 1994. BMH began operations in May 1994. Other revenues consisting of site remediation and training services increased from $174,000 in 1994 to $377,000 in 1995, due to one remediation project.\nTransportation and related revenues were $16,751,000 and $14,426,000 for 1995 and 1994, respectively; comprising 95% and 97% of total revenues. This increase is primarily attributable to an increase in transportation revenue of $2,398,000 resulting from the purchase of additional tractors, the purchase of Dwight Trucking, Inc.,(\"Dwight\"), and the addition of tractors owned by owner\/operators. The Company's transportation fleet logged 9,700,000 miles for 1995 as compared to 7,400,000 miles for 1994. This increase in miles was partially offset by a decrease in the running mile rate of $0.06.\nWaste brokerage revenue decreased $160,000 from 1994 to 1995 as the Company continues to de-emphasize its brokerage business due to the lower margins and the potential liability related to the brokerage business.\nTotal operating costs increased from $10,082,000 in 1994 to $13,210,000 in 1995. This translates to an increase of 7.3 percentage points when expressed as a percentage of total revenue.\nOperating costs related to transportation services increased $3,002,000 from 1994 to 1995. When expressed as a percentage of transportation and related revenues, operating costs were 75% and 66% of revenues for 1994 and 1995, respectively. This increase of nine percentage points is primarily attributable to the lower running mile rate as discussed earlier and to increased owner\/operator and trailer rental expenses.\nOperating costs for 1995 and 1994 related to waste brokerage services were $8,000 and $133,000, respectively, a decrease of $125,000, as a result of the Company de-emphasizing its brokerage activity as discussed above.\nOperating costs related to the Company's non-hazardous waste facility in Florida increased $167,000 from 1994 to 1995. This facility began operations in May, 1994, and the increase is due principally to such facility being in operation a full year for 1995, as compared to seven months in 1994.\nOperating costs related to site remediation increased $218,000 due to the project mentioned earlier.\nGeneral and administrative expenses increased $245,000, from 1994 to 1995 due primarily to increased travel and contract labor expenses and also to the general and administrative expenses incurred by Dwight.\nOther expense decreased $49,000 due primarily to lower consulting fees.\nDepreciation expense decreased $106,000 from 1994 to 1995. This decrease was due to increasing the useful life on tractors from seven to ten years which decreased depreciation for 1995 by $408,000.\nInterest expense increased $272,000 due to higher interest rates and increased debt.\nResults of Operations Year Ended December 31, 1994 Compared to Year Ended December 31, 1993.\nThe net income for 1994 was $80,000, as compared to a net loss of $184,000 for 1993. This increase of $264,000 was largely attrib- utable to a decrease in bad debt expense from 1993 to 1994 of $595,000, partially offset by a decrease in the gross margin (revenues less operating costs) of $208,000 from 1993 to 1994.\nTotal revenues were $14,945,000 and $14,377,000 for 1994 and 1993, respectively, an increase of $568,000. Revenues from transportation and related activities increased $997,000 while waste brokerage revenue decreased $752,000. Additionally, revenues related to BMH Materials, Inc. (\"BMH\"), the Company's subsidiary involved in the processing, brokering, and disposal of non-hazardous waste increased $176,000 over 1993. Other revenues consisting of site remediation and training services increased from zero in 1993 to $147,000 in 1994, due to one remediation project.\nTransportation and related revenues were $14,426,000 and $13,429,000 for 1994 and 1993, respectively. These amounts represent 97% and 93% of total revenues for 1994 and 1993. This increase of $997,000 is attributable to 1) an increase in transportation revenue of $322,000; 2) an increase in subcontract and trip-leasing revenue of $518,000; and 3) an increase in other accessorial revenues of $212,000. These increases were partially offset by a decrease in roll-off box rental of $55,000. The Company's transportation fleet logged 7,400,000 miles for 1994, as compared to 7,200,000 for 1993. However, the running mile rate decreased $.01 per mile, partially offsetting the increase in volume.\nWaste brokerage revenue decreased $752,000 from 1993 to 1994 as the Company continues to de-emphasize its brokerage business due to the lower margins and the potential liability related to the brokerage business.\nTotal operating costs were $10,082,000 and $9,306,000 for 1994 and 1993, respectively, an increase of $776,000 which translates to an increase of 2.7 percentage points when expressed as a percentage of sales.\nOperating costs related to transportation activities were $9,573,000 in 1994 and $8,439,000 in 1993, an increase of $1,134,000. These costs were 66.4% and 62.8% of transportation revenues in 1994 and 1993, respectively. These costs increased due to increased volume as well as higher operating costs. Some of the higher operating costs include 1) drivers' wages; 2) repair and maintenance costs; 3) owner\/operator expenses; and 4) communications costs. Additionally, transportation related operating costs were higher in 1994 due to increased sub-contracting and trip-leasing expenses. The Company anticipates that drivers' wages will continue to increase, and it is unknown at this time whether such increased cost can be offset by increases in transportation revenues.\nOperating costs for 1994 and 1993 related to waste brokerage services were $133,0000 and $794,000, respectively, a decrease of $661,000, as a result of the Company de-emphasizing its brokerage activity as discussed above.\nOperating costs related to BMH were $215,000 and $7,000 for 1994 and 1993, respectively. This increase is primarily a result of the opening of the Florida non-hazardous waste facility in 1994. See \"BUSINESS -- Environmental Business\"..\nOperating costs related to site remediation and training services were $193,000 and $68,000 for 1994 and 1993, respectively. This increase was largely due to the one remediation project mentioned earlier.\nGeneral and administrative expenses decreased $19,000, from $2,304,000 in 1993 to $2,285,000 in 1994. When expressed as a percentage of sales, this results in a decrease of one percentage point from 1993 to 1994. While general and administrative expenses related to transportation activities actually decreased by $123,000, this was offset by BMH's general and administrative costs which increased in 1994 by $104,000, as a result of the start up of the Florida non-hazardous waste facility.\nOther expense decreased $688,000 from 1993 to 1994 as shown in the schedule below:\nBad debt expense was higher in 1993 than in 1994, due to the write-off of the loans and accounts receivable related to Green Alternatives, Inc. Additionally, the Company sold some older tractors in 1994, resulting in a gain on sale of equipment of approximately $96,000.\nRecently, several major waste management companies have eliminated, or are in the process of eliminating, their trans- portation operations. As a result, it is expected that those waste management companies that have eliminated, or will eliminate, their transportation operations will be employing the services of com- panies, such as the Company, to transport their hazardous and non- hazardous waste. The Company expects that such will have a favor-\nable impact on the Company, but there are no assurances to that effect.\nSubsequent Events\nIn March, 1996, the Company's subsidiary, Environmental Transportation Services, Inc. (\"ETS\"), began leasing from Sullivan Trucking Company, Inc. (\"Sullivan\"), a certain number of hazardous waste tractors and trailers and has begun to utilize such equipment to transport waste for Sullivan's and ETS' customers. In connection with such lease, ETS is to pay Sullivan approximately $35,000 a month to lease from Sullivan such tractors and trailers and a certain number of roll-off boxes.\nIn connection with the transaction with Sullivan, the Company has reached a tentative agreement to acquire from Sullivan its customer list, good will, inventory, and other business aspects of Sullivan's hazardous waste transportation business. The Company believes that, in addition to the above-described lease arrangement, the Company will pay Sullivan approximately 1.4 million shares of the Company's common stock and will lease from Sullivan its transportation terminal in Ponca City, Oklahoma, for a term of approximately four (4) years at a rental of $3,800 per month. The Company and Sullivan are in the process of finalizing definitive agreements relating to these transactions.\nLiquidity and Capital Resources\nWorking capital increased from $192,000 at December 31, 1994 to $508,000 at December 31, 1995. This increase resulted primarily from decreased current maturities of long-term debt but was partially offset by cash used to fund certain capital expenditures that were not financed through the Company's existing equipment financing sources and to unprofitable operations. Additionally, working capital increased due to an increase in prepaid expenses of $200,000 related to capitalizing tires (see Note 3 of Notes to Consolidated Financial Statements).\nIn February 1996, the Company entered into a new credit Agreement, (the \"Agreement\") with a new lender which provides for a $3,000,000 line of credit for working capital purposes. This line of credit 1) is collateralized by accounts receivable, deposit accounts and certain intangible assets, 2) bears interest at the prime rate published by The Chase Manhattan Bank, N.A. plus 1.875%, and 3) provides for advances at 80% of eligible receivables. The note is due February 6, 1998 and there are no financial covenants associated with the Agreement. The interest on the note is payable monthly and principal payments are made as accounts receivable are collected. At December 31, 1995 and 1994, the Company had borrowed $1,549,000 and $1,559,000, respectively, under the former credit line. At April 10, 1996, the Company had borrowed $2,206,000 under the new line and had $96,000 of unused available borrowing capacity.\nIn March 1995, the Company entered into a third amended agreement with an equipment lender which was made a part of an existing agreement between the Company and this lender. Under the original agreement, the Company had refinanced a majority of its transportation equipment with this lender in September 1993. The third amended agreement provides for additional equipment financing for up to approximately $2,200,000 of equipment purchases. The terms under this third amendment are substantially the same as those contained in the original agreement. At December 31, 1995, the Company had borrowed $1,846,000 under this agreement. At December 31, 1995, the Company was not in compliance with certain loan covenants contained in the loan agreement. The Company has since renegotiated the loan covenants to accommodate the lower earnings expected in 1996 and is now in compliance with the loan covenants. Additionally, the lender has increased the interest rate by one percentage point. In 1996, The Company paid only the interest portion of the February and March loan payments due to a temporary cash flow shortage. The lender has agreed to let the Company pay the February and March principal payments in September and October 1996.\nThe Company made capital expenditures of $2,803,000 in 1995, which consisted primarily of transportation equipment. Additionally the Company purchased Dwight and certain assets of SST which required expenditures of $1,626,000 (net of cash acquired).\nEffective July 20, 1995, the Company, wholly-owned transportation subsidiary, Environmental Transportation Services, Inc. (\"ETS\"), purchased from Smith Systems Transportation, Inc. (\"SST\"), certain of SST's transportation-related assets, which consisted primarily of assets comprising the hazardous waste transportation activities of SST. The Company paid approximately $519,000 for such assets, with approximately $495,000 borrowed by the Company under its equipment line of credit and the balance paid from working capital. In addition, ETS agreed that for a period of three years from July 20, 1995, to pay SST an amount equal to 4% of the net revenues collected and received by ETS from certain of SST's existing customers at the time of such acquisition, with certain limited exceptions, which will be paid from ETS' working capital. ETS did not assume any of the debts, obligations or liabilities of SST in connection with the acquisition of the assets. ETS leased a terminal previously utilized by SST, located in Denver, Colorado.\nOn August 17, 1995, ETS, the Company's wholly-owned transportation subsidiary, acquired all of the outstanding capital stock of Dwight, located in Bakersfield, California. Dwight is a hazardous waste transporter. Although the transaction was consummated on August 17, 1995 (the \"Closing Date\"), the parties agreed that for all purposes the transaction was to be deemed effective as of July 1, 1995 (\"Effective Date\"). The purchase price for the stock of Dwight was approximately $1,272,029 (\"Purchase price\"), which consisted of (i) $973,000, (ii) approximately\n$160,657, which represented the aggregate amount of cash held by Dwight as of the closing, less cash (a) relating to services rendered or performed by Dwight on or after July 1, 1995, and (b) which constitutes deposits for future services, trust funds, escrow accounts or which is owned by parties other than Dwight, (iii) approximately $108,244, which represented an amount equal to ordinary and necessary business expenses of Dwight paid by Dwight from July 1, 1995, to the closing, (iv) $55,229, which represented an amount equal to the outstanding receivables of Dwight as of June 30, 1995, not collected as of the Closing Date (the \"Receivables\"), less (v) the liabilities of Dwight set forth on Dwight's balance sheet, dated June 30, 1995. At the Closing Date the Company paid approximately $1,216,800 of the Purchase Price, with approximately $160,651 being from cash held by Dwight, $233,144 from working capital and the balance through borrowings under the Company's equipment line of credit. Approximately $55,229 of the Purchase Price, being an amount equal to the Receivables, is to be paid in installments on or before the fifth business day of each month following the Closing Date. The amount of each installment shall be equal to the Receivables actually collected, in good funds, after the Closing Date by Dwight during the previous month. If any Receivables have not been collected by July 31, 1996, Dwight is to assign, without recourse and any representations or warranties, the unpaid Receivables in full satisfaction of the Company's obligation to pay the balance of the Purchase Price. In addition, the Company leased from the sellers of the stock of Dwight the transportation terminal located in Bakersfield, California, for a period of five years, at a rental of $2,900 per month, with an option to extend for another five-year term at a rental of $2,900 per month adjusted for cumulative increase in the consumer price index for the Southern California Region form commencement of the initial five-year lease term.\nIn February 1996, Carl Anderson, Jr., CEO and acting President, loaned the Company $195,000 bearing interest at 10% per annum. The loan is payable upon demand and the interest is payable monthly. The loan was for the Company's working capital purposes and is unsecured. The current outstanding balance on the loan is $195,000.\nIn order to generate additional liquidity, the Company is attempting to sell certain assets. With its present working capital line of credit and the anticipated proceeds resulting from the sale of certain assets, together with the collection of its receivables and expected income tax refund, the Company believes that it will be able to meet its presently foreseeable working capital requirements. This is a forward-looking statement and involves a number of uncertainties that could cause actual results regarding the Company's ability to meet its presently foreseeable working capital requirements to differ materially, including, but not limited to, the inability of the Company to sell such assets, the Company not being able to return to profitability in 1996 or its revenues materially decreasing from that anticipated in 1996, the\nCompany's inability to generate sufficient eligible receivables in order to fully utilize its present working capital line of credit, a material amount of receivables are not collected when anticipated and\/or the Company does not receive the tax refund as expected.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe Company has included the financial statements and supplementary financial information required by this item immediately following Part IV of this report and hereby incorporates by reference the relevant portions of those statements and information into this Item 8.\nItem 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNot applicable.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. DIRECTORS AND EXECUTIVE OFFICERS\nDirectors.\nThe Certificate of Incorporation of the Company provides that the number of directors shall be as set forth in the Bylaws, and the Bylaws provide for no less than four (4) nor more than nine (9) directors. Pursuant to the Bylaws, the Board of Directors has set the number of directors at four (4). Each director serves for a term of one (1) year or until their respective successors are duly elected and qualified.\nFamily Relationships. There are no family relationships between the members of the Board of Directors of the Company.\nCompliance with Section 16(a) of the Exchange Act. Based solely on review of copies of the Forms 3, 4 and 5 and amendments thereto furnished to the Company with respect to 1995, or written representations that no such reports were required to be filed with the Securities and Exchange Commission, the Company believes that during 1995 all directors and officers of the Company and beneficial owners of more than ten percent (10%) of any class of equity securities of the Company registered pursuant to Section 12 of the Securities Exchange Act of 1934 (the \"Exchange Act\") filed timely all Forms 3, 4, or 5, as required by Section 16(a) of the Exchange Act, except (i) Jay T. Edwards filed one late Form 3 to report his election to the Company's Board of Directors, and (ii) Mark Helm and Craig Schroder each filed one late Form 3 to report their election as officers of the Company.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION\nThe following table shows the aggregate cash compensation which the Company and its subsidiaries paid or accrued to the Chief Executive Officer of the Company. None of the four most highly paid executive officers of the Company received total compensation, including salary and bonus, for the last completed fiscal year in excess of $100,000. The table below includes cash distributed for services rendered during 1995, plus any cash distributed during 1995 for services rendered in a prior year, plus amounts deferred at the election of the named executive officer, less any amount relating to those services previously included in the cash compensation table for a prior year.\n401-K. The Company has adopted an Employee Savings Plan (\"401- K Plan\") for its employees of the Company and its subsidiaries, with certain exceptions. The 401-K Plan provides for employee contribution, and further provides the Company may, in the Company's sole discretion, contribute to the 401-K Plan matching contributions in an amount determined by the Company. Under the 401-K Plan the Company may choose not to make matching contributions. For an employee to be eligible to participate under the 401-K Plan, the employee must complete six months of service, attain the age of 21 years and enter into a written salary reduction agreement with the Company. An employee may not contribute more than 15% of his annual compensation into the 401-K Plan. If the Company, in its sole discretion, decides to make any matching contribution in a particular year, such match will be allocated only to employee participants who make a salary reduction contribution to the 401-K Plan of at least 5% of their compensation during the plan year based on a formula set forth in the 401-K Plan. The employee partici- pants' contributions to the 401-K Plan are 100% vested when made, and any match made by the Company becomes 100% vested when allocated. The employee participant may, at his election, allocate his contribution and the contributions of the Company among one or more of four (4) investment alternatives, including the Company common stock. The Company did not make matching contributions to the 401-K Plan during 1995.\nCompensation Pursuant to Stock Option Plans. The Company has adopted an incentive stock option plan (the \"Plan\") in order to attract, retain and motivate, and to encourage stock ownership by key employees and officers of the Company and its subsidiaries. A Stock Option Committee of the Board of Directors administers the Plan and selects the officers and employees to whom options may be granted and determines the number of shares to be governed by each. None of the executive officers of the Company named in the above Summary Compensation Table were granted options in 1995.\nThe total number of shares of Company common stock for which options may be granted under the Plan shall be 400,000 shares, less the number of shares subject to options outstanding as of October 3, 1989, and granted on or after June 12, 1980, and prior to October 3, 1989, under the stock option plan then in effect. In the event that options granted under the Plan, or options outstanding on October 3, 1989, under the predecessor to the Plan, shall lapse without being exercised in whole or in part, other options may be granted covering the shares not purchased under such lapsed options. The aggregate fair market value of shares as of the date of the grant with respect to which options are exercisable for the first time may not exceed $100,000. The exercise price of each option granted under the Plan may not be less than 100% of the fair market value of the common stock on the date of the grant (110% in the case of options granted to employees owning more than 10% of common stock of the Company). Each option granted under the Plan will not be exercisable more than 5 years from the date the option is granted.\nIn addition, the Company has adopted a stock option plan for non-employee directors of the Company (\"Non-Employee Director Plan\"). Under the Non-Employee Director Plan the Company may grant options to non-employee directors of the Company to purchase up to 100,000 shares of the Company's common stock. The maximum aggregate number of shares of Company common stock which may be subject to options granted under the Non-Employee Director Plan to any one non- employee director may not exceed 20,000 shares. Any option granted under the Non-Employee Director Plan may not exceed a term of five (5) years and the exercise price of such option may not be less than the fair market value of the Company's common stock on the date of the grant. Under the Non-Employee Director Plan, a Stock Option Committee of the Board of Directors supervises the administration of such plan and determines the number of shares to be subject to each option granted under the Non-Employee Director Plan. No options were granted under the Non-Employee Director Plan in 1995.\nCompensation of Directors. In 1995, the Company compensated the non-employee directors of the Company in the amount of $500.00 for each meeting of the Board of Directors attended, and compensated Mr. Anderson $1,000.00 per month for his services as Chairman of the Board. Directors that also are employees of the Company or its sub- sidiaries are not paid for serving as a director. The Board of Directors held five (5) meetings during 1995.\nCompensation Committee Interlocks and Insider Participation. The compensation of all officers of the Company is set by the Board of Directors. As noted, Carl B. Anderson, Jr. is both a director and an officer of the Company.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS\nThe following persons or entities are known to the Company to be beneficial owners of more than 5% of the Company's common stock as of April 9, 1996. Due to the requirements of the Securities and Exchange Commission as to the method of determining the amount of shares an individual or entity may beneficially own, the amounts shown below for an individual or entity may also include shares also considered beneficially owned by others.\nSecurity Ownership of Directors and Executive Officers. The following table sets forth the number and percentage of the outstanding shares of the Company's common stock beneficially owned by each current director, each of the officers named in the \"Summary Compensation Table\" and by all directors and officers as a group as of April 9, 1996. Because of the requirements of the Securities and Exchange Commission as to the method of determining the amount of shares an individual or entity may beneficially own, the amounts shown below for an individual or entity may include shares also considered beneficially owned by others.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nDuring the Company's course of business, the Company purchased 20 roll-off boxes in 1995 at an aggregate purchase price of $120,844 from 5-Star Fabrication, Inc. (\"5-Star\"). In addition, the Company utilizes the services of 5-Star in the repair of the Company's roll-off boxes. Mr. Anderson is the owner of approximately 50% of 5-Star. The The Company believes that its transactions with 5-Star are on a basis which is favorable to the Company.\nIn February 1996, Carl Anderson, Jr., CEO and acting President, loaned the Company $195,000 bearing interest at 10% per annum. The loan is payable upon demand and the interest is payable monthly. The loan was for the Company's working capital purposes and is unsecured. The current outstanding balance on the loan is $195,000.\nPART IV\nItem 14.","section_14":"Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES,AND REPORTS ON FORM 8-K\n(a)(1) Financial Statements. The following consolidated financial statements of the Company appear immediately following this Part IV:\nReport of Independent Certified Public Accountants\nBoard of Directors AMETECH, Inc.\nWe have audited the accompanying consolidated balance sheets of AMETECH, Inc. (an Oklahoma corporation) and subsidiaries, as of December 31, 1995 and 1994, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1995. 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 AMETECH, Inc. and subsidiaries, as of December 31, 1995 and 1994, and the consolidated results of their operations and their consolidated cash flows for each of the three years in the period ended December 31, 1995 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 tires in service in 1995.\nGRANT THORNTON LLP\nOklahoma City, Oklahoma February 9, 1996 (except for the penultimate paragraph of Note 6, as to which the date is April 12, 1996)\nThe accompanying notes are an integral part of these financial statements.\nThe accompanying notes are an integral part of these financial statements.\nThe accompanying notes are an integral part of these financial statements.\nThe accompanying notes are an integral part of these financial statements.\nThe accompanying notes are an integral part of these financial statements.\nThe accompanying notes are an integral part of these financial statements.\nThe accompanying notes are an integral part of these financial statements.\nSUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES\nDuring the year ended December 31, 1994, the Company acquired property and equipment at $62,000 through trade accounts payable.\nThe Company purchased businesses in the year ended December 31, 1995. In conjunction with the acquisitions, liabilities were assumed as follows:\nThe accompanying notes are an integral part of these financial statements.\nAMETECH, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1995, 1994, and 1993\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND NATURE OF OPERATIONS\nAMETECH, Inc., an Oklahoma corporation, and its subsidiaries (the Company) are engaged primarily in the transportation of hazardous and non-hazardous waste on a nation-wide basis. The Company is a majority owned subsidiary of Moorpark Holding, Inc., a Delaware Corporation. The Company's accounting policies are described below.\nBasis of Consolidation - The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, Environmental Transportation Services, Inc. (ETS), Environmental Field Services, Inc. (EFS), BMH Materials, Inc. (BMH), Dwight Trucking, Inc. (Dwight), and Compliance Training Services, Inc. (CTS), after elimination of significant intercompany transactions and balances.\nAccounts Receivable - The Company provides reserves on specific accounts based upon whether the Company reasonably believes that collection of a specific account is questionable plus a general reserve on uncollected balances based on the aging of accounts receivable. If the Company reasonably believes that the collection of a specific account, or a portion thereof, is questionable, after examination of that account, then the Company will reserve that portion on which it feels collection is questionable. The Company provides a bad debt reserve each month based on historically uncollectible amounts as adjusted for current economic conditions. The allowance for estimated uncollectible amounts was $79,000 and $58,000 at December 31, 1995 and 1994, respectively. The Company grants credit to various customers, primarily hazardous waste management companies and hazardous waste brokers, under customary trade terms. To mitigate the risk of credit loss, the Company performs a credit review of new customers and establishes credit limits before extending credit.\nMajor Customers - At December 31, 1995, one customer accounted for 19% of the accounts receivable balance. During 1995, one customer accounted for 31% of the total revenue. During 1994, one customer accounted for 34% of total revenue and during 1993, one customer accounted for 28% of total revenue.\nAMETECH, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND NATURE OF OPERATIONS (Continued)\nProperty and Equipment - Depreciation of transportation and other equipment is computed using the straight-line method over the estimated useful lives of the respective assets, which range from three to ten years.\nBuildings are depreciated on the straight-line method over 30 years. Expenditures for repairs and maintenance are charged to expense when incurred, whereas major betterments are capitalized.\nInventories - Supply inventory is priced at cost, not in excess of market. Supplies are charged to expense when utilized for repair or maintenance of equipment. Supply inventory of $220,000 and $177,000 at December 31, 1995 and 1994, respectively, are included in other current assets on the Consolidated Balance Sheets.\nIncome Taxes - Effective January 1, 1993, the Company adopted the Statement of Financial Accounting Standards No. 109 (SFAS 109), \"Accounting for Income Taxes.\" SFAS 109 required a change from the deferred method to the liability method of accounting for income taxes. Under the liability method, deferred taxes are recognized for the tax consequences of temporary differences by applying enacted statutory tax rates applicable to future years to differences between the carrying amounts and the tax bases of existing assets and liabilities. See note 8.\nEarnings (Loss) Per Share - Earnings (Loss) per common share for 1995, 1994, and 1993 are based upon the weighted average number of common shares and dilutive common share equivalents outstanding during the respective years.\nCash Equivalents - The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents.\nIntangible Assets - Cost in excess of net assets of businesses acquired is amortized on the straight line basis over a fifteen year period. The Company assesses the recoverability of costs in excess of net assets of businesses acquired by determining whether the amortization of the asset balance over its remaining life can be recovered through the undiscounted future operating cash flows of the acquired operation. The amount of impairment, if any, is based on projected future operating cash flows. The Company believes that no impairment has occurred and that no reduction in the estimated useful life is warranted.\nAMETECH, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND NATURE OF OPERATIONS (Continued)\nTires in Service - The cost of new and replacement tires is capitalized and included in prepaid assets and amortized on a straight-line basis over the estimated useful life of the tires of one to two years.\nUse of Estimates - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect certain reported amounts and disclosures. Accordingly, actual results could differ from those estimates.\n2. FINANCIAL INSTRUMENTS\nThe following table includes various estimated fair value information as of December 31, 1995 as required by Statement of Financial Accounting Standards No. 107, \"Disclosures about Fair Value of Financial Instruments\" (SFAS 107). Such information, which pertains to the Company's financial instruments, is based on the requirements set forth in SFAS 107 and does not purport to represent the aggregate net fair value of the Company. The carrying amounts in the table are the amounts at which the financial instruments are reported in the consolidated financial statements.\nAll of the Company's financial instruments are held for purposes other than trading.\nThe following methods and assumptions were used to estimate the fair value of each class of financial instruments:\n1. Cash and Cash Equivalents\nThe carrying amount approximates fair value because the Company has the contractual right to receive immediate payment on the deposit accounts.\n2. Notes Receivable\nThe discounted amount of future cash flows using the rate that the Company would expect to obtain on similar transactions is used to estimate fair value.\nAMETECH, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n2. FINANCIAL INSTRUMENTS (Continued)\n3. Fixed Rate Long-Term Debt\nThe discounted amount of future cash flows using the Company's current incremental rate of borrowing for similar liabilities is used to estimate fair value.\n4. Floating Rate Long-Term Debt\nThe carrying amount approximates fair value because interest rates adjust to market rates.\nThe carrying amounts and estimated fair values of the Company's financial instruments are as follows:\n3. CHANGES IN ACCOUNTING PRINCIPLE AND ESTIMATE\nEffective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109 (SFAS 109), \"Accounting for Income Taxes.\" SFAS 109 required a change from the deferred method to the liability method of accounting for income taxes. Prior years were not restated and the cumulative effect of the change, which is $4,000, is shown as a charge to earnings in the 1993 Statement of Operations.\nAdditionally, the Company changed its method of accounting for replacement tires effective January 1, 1995. The Company now capitalizes the cost of replacement tires to more closely approximate their useful lives. The capitalized cost of the tires is included in prepaid assets and is amortized over the estimated useful life of the tires of one to two years.\nPrior years were not restated and the cumulative effect of the change is to decrease the net loss for 1995 by $132,000, net of income taxes of $42,000, or $.01 per share. The pro forma amounts on the income statement show the net earnings (loss) and net earnings (loss) per share as if the new accounting method had been in effect for the periods presented.\nAMETECH, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n3. CHANGES IN ACCOUNTING PRINCIPLE AND ESTIMATE (Continued)\nEffective January 1, 1995, the Company changed the estimated useful life for tractors from seven to ten years to more closely approximate the useful lives of such assets. The effect of this change was to decrease the net loss for 1995 by $319,000 ($.02 per share), summarized as follows:\n4. DISPOSITION OF SUBSIDIARY\nIn January 1992, the Company sold its wholly owned subsidiary which operated the \"One-Call Business.\" The transaction was valued at approximately $900,000 which included $200,000 in cash, a note receivable for $485,000 payable in monthly installments over seven years, 60,000 shares of the Company's common stock, and an agreement requiring the purchaser to pay an additional $125,000 in the future. The transaction resulted in an approximate gain of $192,000 which is being recognized over the term of the note (through February 1998). $50,000, $27,000 and $23,000 of such gain was recognized in 1995, 1994 and 1993, respectively. The balance of the note receivable and the additional amount due in the future was $290,000 and $388,000 at December 31, 1995 and 1994, respectively. The long-term portion of such amounts are included in Other Assets on the Consolidated Balance Sheets ($197,000 and $288,000 at December 31, 1995 and 1994, respectively) and the current portion of such amounts are included in Accounts Receivable ($93,000 and $100,000 at December 31, 1995 and 1994, respectively).\nAMETECH, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n5. PROPERTY AND EQUIPMENT\nProperty and equipment consist of the following:\nAMETECH, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n6. LONG-TERM OBLIGATIONS\nLong-term obligations consist of the following:\nAMETECH, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n6. LONG-TERM OBLIGATIONS (continued):\nAMETECH, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n6. LONG-TERM OBLIGATIONS (continued):\nAt December 31, 1995, the aggregate yearly maturities due on long- term obligations are as follows:\nIn October, 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123 (\"SFAS No. 123\"), \"Accounting for Stock-Based Compensation\". Application of SFAS 123 will require the Company to make an election to value stock options under a fair value based method as prescribed by SFAS No. 123 or continue using the method as prescribed by APB Opinion No. 25, \"Accounting For Stock Issued to Employees\". Initial adoption is required in 1996. The Company has not yet decided on which valuation method will be elected.\nAMETECH, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n8. INCOME TAX EXPENSE\nTax expense consists of the following:\nThe income tax provision reconciled to the tax computed at the statutory Federal rate was:\nAMETECH, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n8. INCOME TAX EXPENSE (continued)\nAmounts of deferred tax assets, valuation allowance, and deferred tax liabilities at December 31, 1995 and December 31, 1994 are as follows:\nAt December 31, 1995, the Company has income tax refunds of $312,000 for amounts paid for estimated income taxes and taxes paid in prior years, primarily resulting from the net operating loss carryback provisions of the Internal Revenue code. These amounts are included in Other Current Assets on the Consolidated Balance Sheet.\nAMETECH, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n9. RECONCILIATION OF NET EARNINGS (LOSS) TO NET CASH PROVIDED BY OPERATING ACTIVITIES\nThe reconciliation of net earnings (loss) to net cash provided by operating activities for the years ended December 31, 1995, 1994, and 1993, is as follows:\nAMETECH, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n10. COMMITMENTS AND CONTINGENCIES\nAt December 31, 1995, the Company had outstanding letters of credit of $216,000. The letters of credit serve as security to obtain licenses in certain states, for uninsured workman's compensation deposits and for performance of services. Such letters of credit reduce the amounts which can be drawn under the Company's $2,000,000 line of credit (Note 6).\nThe Company is partially uninsured on its workers' compensation insurance for Oklahoma employees. The Company s retention under this plan is $500,000, after which coverage under the excess workers' compensation insurance plan becomes effective. The Company accrues estimated losses monthly based on a review of claims filed and claims incurred but not reported. The claim and premium expense incurred under the partially uninsured workers' compensation plan was $133,000, $58,000 and $48,000 for 1995, 1994 and 1993, respectively.\nThe Company is also partially uninsured for its employee group health insurance coverage. Under this program, the Company is liable for up to of $35,000 per covered person per year with an aggregate liability not to exceed $450,000 per year for the total group. The excess insurance coverage becomes effective when the aforementioned limits are reached. The Company accrues estimated losses monthly based on a review of claims filed and claims incurred but not reported. The claim and premium expense incurred under the Company's partially uninsured group health insurance plan was $233,000, $250,000 and $218,000 for 1995 1994 and 1993, respectively.\nThe Company leases transportation terminals and office space under operating lease arrangements. The following is a schedule by year of future minimum lease payments under these operating leases.\nYear Ending December 31, Total ___________ ___________\n1996 $ 85,000 1997 51,000 1998 30,000 1999 25,000 2000 10,000 ___________ $201,000 ===========\nAMETECH, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n10. COMMITMENTS AND CONTINGENCIES (Continued)\nTotal lease expense for the years ended December 31, 1995, 1994, and 1993 was approximately $135,000, $113,000, and $128,000, respectively.\nThe Company provides an employee savings plan (\"401-K Plan\") for its employees. The 401-K Plan provides for employee contributions, and further provides the Company may, at its discretion, make a matching contribution to the 401-K Plan in an amount determined by the Company. If the Company decides to make any matching contribution, such match will be allocated only to employee participants who make a salary reduction contribution of at least 5% of their compensation. Under the Company's Plan, up to 10% of the fair market value of the Plan's assets may be used to purchase company stock. The Plan purchased 67,824, 76,662, and 53,444, shares for $16,000, $22,000, and $30,000 in 1995, 1994, and 1993, respectively. There was no Company contribution to the 401-K Plan for 1995, 1994, or 1993.\nThe Company has employment agreements with certain of its key employees which provide for salary continuation for a specified number of months upon a change of control of the Company. In addition, certain stock options to those employees immediately vest upon a change of control.\nOn January 3, 1992, seven individual plaintiffs filed a Petition against the Company's transportation subsidiary, Environmental Transportation Services, Inc. (\"ETS\"), and Dyna- Turn of Oklahoma Incorporated (\"Dyna-Turn\"), in the District Court of Oklahoma County. The seven plaintiffs, who were employees at a waste incineration facility in Miami, Oklahoma, claim that Dyna-Turn generated solid waste which was contaminated with toxic and hazardous chemicals, and that this solid waste was transported by ETS to the incineration facility for disposal. The plaintiffs claim that Dyna-Turn and ETS were engaged in ultra-hazardous activities during the generation and transportation of the waste, were negligent during the generation and transportation of the waste, and failed to warn the plaintiffs of the hazardous nature of the waste or of its harmful side effects.\nThe plaintiffs claim they sustained personal injuries and lost earnings and are seeking unspecified actual damages in excess of $10,000 and punitive damages.\nAMETECH, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n10. COMMITMENTS AND CONTINGENCIES (Continued)\nIn March 1993, the Company learned that its insurance carrier had denied coverage for the plaintiffs' claims. The Company has instructed its attorneys to vigorously defend the litigation. The case is in its early stages and involves facts yet unknown to the Company. The Company believes that ETS has valid defenses to the plaintiffs' claims, and while the ultimate resolution is unknown, management believes the final outcome will not have a material adverse impact on the Company's financial position or results of operations.\nThe Company is involved in various other legal actions arising in the normal course of business. After taking into consideration available insurance coverage, legal counsel s evaluation of such actions, and other relevant information, management is of the opinion that their outcome will not have a significant effect on the Company s consolidated financial position or results of operations\n11. RELATED PARTY TRANSACTIONS\nDuring 1995, 1994 and 1993, the Company purchased certain fixed assets totaling approximately $147,000, $187,000, and $34,000, respectively from a company partially owned by a director and officer of the Company.\n12. ACQUISITION OF ASSETS OF SMITH SYSTEMS TRANSPORTATION, INC.\nEffective July 20, 1995, the Company purchased from Smith Systems Transportation, Inc. (\"SST\"), certain of SST's transportation-related assets, which consisted primarily of assets comprising the hazardous waste transportation activities of SST, for approximately $519,000. Pursuant to the agreement between the Company and SST, the Company is to also pay to SST an amount equal to 4% of net revenues collected and received by ETS from certain of SST's existing customers at time of closing, with certain limited exceptions, during the period of the first three years from the date of the agreement. In the purchase transaction, the Company did not assume any of the liabilities of SST and the operations of the acquisition have been included since July 20, 1995. Such operations do not constitute a significant business acquisition and pro forma results are not presented.\nAMETECH, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n13. ACQUISITION OF DWIGHT TRUCKING, INC.\nEffective July 1, 1995, the Company acquired a hazardous and non-hazardous waste transporter, Dwight Trucking, Inc. (\"Dwight\"), located in Bakersfield, California. The purchase price was approximately $1,204,000 and has been accounted for as a purchase transaction. As a result the Company has allocated the total cost of the acquisition to the acquired assets and assumed liabilities, based on their relative fair values. The results of operations of Dwight have been included in the Company s consolidated financial statements since July 1, 1995. Cost in excess of the net assets acquired was approximately $323,000 which is included in other assets at December 31, 1995.\nIn addition, the Company leased from the sellers of the stock of Dwight the transportation terminal located in Bakersfield, California, utilized by Dwight, for a period of five years, at a rental of $2,900 per month, with an option to extend for another five-year term at a rental of $2,900 per month adjusted for cumulative increase in the consumer price index for the Southern California Region from commencement of the initial five-year lease term.\nThe following summarized pro forma unaudited information assumes the acquisition had occurred on January 1, 1994:","section_15":""}
{"filename":"813794_1995.txt","cik":"813794","year":"1995","section_1":"Item 1. Business\nGeneral\nThe North Carolina Railroad Company (the \"Registrant\") was incorporated in 1849 in the State of North Carolina. The Registrant owns approximately 317 miles of continuous railroad line running from Charlotte, North Carolina to Morehead City, North Carolina. The Registrant has one office located at 234 Fayetteville Street Mall, Raleigh, North Carolina (27602) and three full time employees.\nBackground of Railroad Leases\nThe Registrant conducted railroad operations beginning in 1856. In 1871, the Registrant leased substantially all of its assets to the Richmond & Danville Railroad Company, a predecessor of Southern Railway Company, for a term of thirty years. In 1895, the Registrant leased substantially all of its assets to Southern Railway Company, now known as Norfolk Southern Railway Company (\"NSR\"), for ninety-nine years (the \"1895 Lease\"). In 1989, the Registrant acquired the Atlantic and North Carolina Railroad Company, the assets of which were subject to a lease dating to 1939 with the Atlantic & East Carolina Railway Company (\"AECR\"), a wholly-owned subsidiary of Norfolk Southern Railway Company (the \"1939 Lease\"). NSR and AECR are hereinafter referred to as \"Norfolk Southern.\" Information about the 1895 and 1939 Leases has been disclosed by the Registrant in prior quarterly and annual reports to the Securities and Exchange Commission (\"Commission\").\nThe terms of the 1895 Lease and 1939 Lease provided for expiration on January 1, 1995 and December 31, 1994, respectively, and did not require either the Registrant or Norfolk Southern to renew the leases. However, Norfolk Southern's operation of the Registrant's railroad line may not be discontinued unless discontinuance is authorized by the Surface Transportation Board of the United States Department of Transportation (\"STB\"), the successor agency to the Interstate Commerce Commission (\"ICC\"). Neither the Registrant nor Norfolk Southern have sought regulatory authority for discontinuance of service by Norfolk Southern (see \"Regulatory Matters,\" below), and Norfolk Southern is continuing to operate the Registrant's railroad line under the circumstances described below.\nDuring the fourth quarter of 1994, the Registrant and Norfolk Southern reached tentative agreement on the primary terms of a long term agreement to extend the 1895 and 1939 Leases. However, a definitive agreement had not been reached as of the expiration dates of the 1895 and 1939 Leases at the end of 1994, and the Registrant and Norfolk Southern entered into a temporary\narrangement to continue the rental and other terms of the 1895 and 1939 Leases beginning in 1995. During 1995, Norfolk Southern continued to make rental payments under the terms of the 1895 and 1939 Leases.\nLease Extension Agreement\nOn August 10, 1995, the Board of Directors of the Registrant approved a Lease Extension Agreement in the form attached as an exhibit hereto (the \"Lease Extension\"). The Lease Extension extends the terms of the 1895 Lease and the 1939 Lease, and its effectiveness is retroactive to January 1, 1995. On August 24, 1995, the Board of Directors of NSR and the Board of Directors of AECR approved the Lease Extension.\nConditions to effectiveness of the Lease Extension were as follows: (i) approval or exemption from approval from the ICC or any successor entity, (ii) obtaining all required governmental and corporate approvals and (iii) the expiration or termination of any existing court-ordered injunctions. The Board of Directors of the Registrant, pursuant to North Carolina law, voted to condition approval of the Lease Extension upon a majority of the votes cast at the meeting in person or by proxy held by shareholders other than the State of North Carolina. In a decision effective December 22, 1995, the ICC exempted the Lease Extension from the prior approval requirements of the Interstate Commerce Act. On December 22, 1995, the Governor and Council of State of the State of North Carolina approved the Lease Extension Agreement pursuant to North Carolina law. On December 15, 1995, the shareholders of the Registrant voted to approve the Lease Extension. However, a shareholder has commenced a legal action challenging the validity of shareholder approval. See Item 4, Submission of Matters to Vote of Security Holders, regarding shareholder approval of the Lease Extension. Other shareholder derivative litigation seeking to enjoin the Lease Extension is also pending. See Item 3, Legal Proceedings, for a description of the actions.\nThe Lease Extension, which has been executed by the Registrant and Norfolk Southern, is being held in escrow by a third party pursuant to an escrow agreement. The escrow agreement provides for the Escrow Agent to retain the original execution copies of the Lease Extension until the Escrow Agent receives satisfactory evidence that either (i) all remaining approvals of the Lease Extension have been received, or (ii) the remaining approvals cannot be obtained. If neither of these events occurs by March 31, 1997, the escrow agreement makes provision for further disposition or destruction of the original execution copies of the Lease Extension. As a result of the shareholder action challenging the validity of shareholder approval, neither the Registrant nor Norfolk Southern has made demand to the Escrow Agent to release the Lease Extension documents, and the Registrant has not indicated to Norfolk\nSouthern that it considers the Lease Extension to be effective.\nNotwithstanding Norfolk Southern's knowledge of the shareholder derivative actions challenging approval of the Lease Extension and the Registrant's failure to confirm the effectiveness of the Lease Extension, on December 28, 1995 Norfolk Southern paid the Registrant approximately $7.8 million, which, along with other amounts paid by Norfolk Southern in 1995, is the amount that would have been owed to the Registrant under the terms of the Lease Extension had the Lease Extension become retroactively effective as of January 1, 1995. During 1996 to date, Norfolk Southern has continued to make monthly payments to the Registrant in amounts that would be due if the Lease Extension is effective. The Registrant has not returned such payments to Norfolk Southern, but has not indicated to Norfolk Southern that the Lease Extension is effective. If the December 15, 1995 approval by the shareholders of the Registrant of the Lease Extension is determined to be invalid, it is the intention of the Registrant to retain any payments made by Norfolk Southern to the Registrant as payment for use of the assets of the Registrant since the beginning of 1995 or for other claims the Registrant may have under the 1895 and 1939 Leases. The Registrant may also seek payment of additional amounts for use of the Registrant's assets by Norfolk Southern and other claims. The Registrant does not know what position Norfolk Southern would take with respect to payments made to the Registrant, but Norfolk Southern's position could include a claim against the Registrant seeking recovery of such payments from the Registrant. In such event, the Registrant intends both to aggressively defend any legal action Norfolk Southern may bring and to assert other claims of the Registrant against Norfolk Southern. See \"Alternatives to Lease Extension\" below regarding alternatives in the event shareholder approval of the Lease Extension is invalidated or if the Lease Extension is enjoined.\nThe Lease Extension provides for Norfolk Southern to make a one-time settlement payment of $5 million, plus interest, to the Registrant in exchange for the Registrant's release of Norfolk Southern from certain contractual obligations relating to certain personal property upon expiration of the 1895 Lease and 1939 Lease. The Registrant and Norfolk Southern entered into an agreement dated August 10, 1995, whereby the settlement payment was made in early December 1995 in order to facilitate the Registrant seeking Real Estate Investment Trust (\"REIT\") status at the earliest practicable date. The Registrant is seeking a ruling from the Internal Revenue Service as to the effect of the payment with respect to the timing of the Registrant's REIT election, but the Registrant has not yet received such ruling. The Lease Extension does not waive or otherwise affect any claims of the Registrant to railroad yards or other such property or facilities, but provides that such claims are postponed until the termination of the Lease Extension and any renewal pursuant to its terms.\nSet forth below is a summary of some of the material terms of the Lease Extension, which summary should be read in conjunction with the complete terms of the Lease Extension.\n(1) The base annual rental under the Lease Extension is eight million dollars ($8,000,000) for the period from January 1, 1995 through December 31, 1995.\n(2) Annual base rent for 1996 and each year thereafter will be adjusted each year to account for inflation during the preceding calendar year according to the implicit price deflator for the gross domestic product (IPD- GDP). In no event, however, will the base annual rental for any calendar year be less than eight million dollars ($8,000,000). The base rent adjustment in any year cannot exceed the sum of: (i) four (4%) percent of the base rent for the preceding year, plus (ii) seventy-five (75%) percent of the IPD-GDP in excess of four (4%) percent. There is a one-year delay in application of the IPD-GDP. For example, adjustment of 1995 rental payments to determine 1996 rental payments is based upon the IPD-GDP for 1994.\n(3) The Leases are extended for an initial term of thirty (30) years, through December 31, 2024 and are extendable for an additional twenty (20) years at the option of Norfolk Southern. Exercise of the twenty- year extension option requires that Norfolk Southern pay to the Registrant an option fee equal to the lesser of (i) twenty-five (25%) percent of the base rent in effect during the year prior to Norfolk Southern giving notice to exercise its extension option or (ii) $5 million. If the extension option is exercised by Norfolk Southern, the Registrant expects to recognize the renewal fee ratably over the 20-year lease renewal term.\n(4) 317 miles of railroad property (including the railroad right of way and certain improvements to yard areas and other structures situated adjacent to, under or along the lines) located between Morehead City and Charlotte, North Carolina, are covered by the Lease Extension. The Registrant has the right, however, to have certain properties outside the right of way not used in operating a railroad released from the 1895 and 1939 Leases. Norfolk Southern's rental payments will not be reduced if the Registrant exercises this right. The Registrant intends to exercise its right to have released from the Leases those properties it determines have income-generating potential in excess of projected expenses. The Registrant estimates these properties currently are producing less than $100,000 of annual lease income. The Registrant will determine which properties it will seek to have released after\nevaluating potential environmental liability and other relevant factors.\n(5) Norfolk Southern is required to pay to the Registrant seventy-five (75%) of any revenues (in excess of de minimis amounts) obtained by Norfolk Southern for longitudinal leases and licenses granted by Norfolk Southern to third parties for certain fiber optic and other uses.\n(6) The Lease Extension contains extensive provisions governing the rights and obligations of the parties for various environmental liabilities and expenses.\n(7) Norfolk Southern is required to pay the expenses to maintain and operate the leased railroad lines and facilities, to fulfill all railroad common carrier duties pertaining to the leased railroad lines and to indemnify the Registrant from certain liability claims by third parties.\nExcept as modified or supplemented by the Lease Extension, the terms of the 1895 and 1939 Leases continue in full force and effect.\nNorfolk Southern beneficially owns 113,855 shares of the common stock of the Registrant, which represents an ownership interest of 2.7% of the Registrant.\nReal Estate Investment Trust Election\nOn August 10, 1995, the Board of Directors of the Registrant voted to cause the Registrant to elect REIT status for income tax purposes, in connection with the Lease Extension. If the Registrant qualifies for taxation as a REIT, it generally will not be subject to federal corporate income taxes on that portion of its ordinary income or capital gain that is currently distributed to its shareholders. The REIT provisions of the Internal Revenue Code (\"I.R.C.\") generally allow a REIT to deduct distributions paid to its stockholders. The Registrant received an opinion of counsel that the Registrant can qualify as a REIT based upon the effectiveness and terms of the Lease Extension. However, the Registrant is seeking a ruling from the Internal Revenue Service (\"I.R.S.\") as to the effect of the $5 million one-time settlement payment with respect to the timing of the Registrant's REIT election, but the Registrant has not yet received such ruling. In addition, certain shareholder litigation could enjoin, delay, or otherwise affect the effectiveness of the Lease Extension, the terms of the Lease Extension, or the timing or amount of shareholder distributions. In that event, the litigation may delay or even cause the Registrant to be unable to qualify for REIT status, which would substantially decrease the after-tax net income available for\ndistribution to shareholders of the Registrant. See Item 3, Legal Proceedings, for a description of the shareholder litigation.\nIn order to be taxed as a REIT, the Registrant is required to distribute dividends (other than capital gain dividends) to its stockholders in an amount at least equal to (a) the sum of (i) 95% of the Registrant's \"REIT taxable income\" (computed without regard to the dividends-paid deduction and the Registrant's capital gain) and (ii) 95% of the net income, if any, from foreclosure property in excess of the special tax on income from foreclosure property, minus (b) the sum of certain items of non-cash income. Such distributions must be paid in the taxable year to which they relate, or in the following taxable year if declared before the Registrant timely files its Federal income tax return for such year and if paid on or before the first regular dividend payment after such declaration. Even if the Registrant satisfies the foregoing distribution requirements, to the extent that the Registrant should fail to distribute during each calendar year at least the sum of (a) 85% of its ordinary income for that year, (b) 95% of its capital gain net income for that year and (c) any undistributed taxable income from prior periods, the Registrant would be subject to a 4% excise tax on the excess of such required distribution over the amounts actually distributed. Under certain circumstances, the Registrant may be able to rectify a failure to meet the distribution requirements for a year by paying \"deficiency dividends\" to shareholders in a later year, which may be included in the Registrant's deduction for dividends paid for the earlier year. Thus, the Registrant may be able to avoid being taxed on amounts distributed as deficiency dividends. The Registrant will, however, be required to pay interest based upon the amount of any deduction taken for deficiency dividends.\nDue to the uncertainty over the effectiveness of the Lease Extension caused by the shareholder derivative actions challenging the validity of shareholder approval of the Lease Extension, the Registrant has determined to delay a decision as to whether to elect REIT status for its 1995 taxable year until the earlier of the date the uncertainty has been resolved or the latest date by which the Registrant may make an election to be taxed as a REIT for 1995. The Registrant believes it may be able to qualify for 1995. If the Lease Extension is invalidated, the Registrant does not know whether its income, if any, for 1996 and later years will qualify the Registrant for REIT status for taxable years after 1995. The I.R.C. provides that if a taxpayer's REIT election is terminated by its failure to satisfy the qualification requirements, the taxpayer may not make a new election to be taxed as a REIT prior to the fifth taxable year after disqualification, unless the taxpayer fits within certain narrow exceptions. Distributions to shareholders in any year in which the Registrant fails to qualify as a REIT will not be deductible by the Registrant nor will they be required to be\nmade. Accordingly, the Registrant will evaluate the tax benefits to be gained by electing REIT tax status for 1995 compared to the possible detriment to the Registrant if the Registrant is disqualified from REIT tax status for four subsequent taxable years. The provisions of the I.R.C. and related regulations governing the federal income tax treatment of REIT's are highly technical and complex. There can be no assurance that the Registrant can qualify for REIT status for 1995 or later years. (See Note B to the financial statements regarding pro forma information in the event the Registrant qualifies for REIT status for 1995.)\nTo ensure that the decision about electing REIT tax status for 1995 is made with the most reliable information available under the circumstances, the Registrant has filed applications for an extension of the time to file its tax returns for tax year 1995 until September 15, 1996. On or before that date, the Registrant will evaluate all relevant factors in determining whether to make a REIT election for its 1995 taxable year. Such factors will include, for example, the status of the shareholder derivative actions, any discussions with Norfolk Southern about the Lease Extension, alternatives to the Lease Extension, advice from the Registrant's professional advisers about the feasibility of qualifying for REIT tax status if the Lease Extension does not become effective, and the tax consequences of the Registrant electing REIT status for 1995, but failing to qualify as a REIT for 1996, 1997 or later years.\nIf the Registrant makes a REIT election for its 1995 taxable year, by delaying certain distributions of 1995 income past January 31, 1996, the Registrant would incur a Federal excise tax liability of approximately $315,000 for 1995. If the Registrant does not elect REIT tax status for 1995, the Registrant would incur an additional 1995 income tax liability of approximately $3 million, in addition to income tax liability of approximately $2 million attributable primarily to taxes on the $5 million property settlement payment. Under the original terms of the 1895 Lease, which pursuant to a temporary arrangement between the Registrant and Norfolk Southern are applicable to Norfolk Southern's continued operation after the end of 1994, all taxes, including income taxes of the Registrant attributable to the Lease, were the responsibility of Norfolk Southern as lessee. It is unclear at this time, however, how such a temporary arrangement would be interpreted by the courts with respect to tax liability reimbursement.\nAlternatives to the Lease Extension Agreement\nIn light of the uncertainty about the status of the Lease Extension and the need to make an informed decision regarding electing REIT tax status for 1995 and later years, the Registrant is evaluating its strategic goals and the alternatives available\nto achieve such goals. Alternatives under consideration by the Registrant include resubmitting the Lease Extension for approval by the shareholders of the Registrant, seeking to negotiate with Norfolk Southern terms more favorable to the Registrant than those afforded by the Lease Extension submitted to the shareholders in December 1995, litigation against Norfolk Southern, leasing all or part of its properties to one or more independent railroad operators, or operating all or part of its properties as an independent railroad. Prior to approval of the Lease Extension, the Registrant evaluated many of the foregoing alternatives. For example, the Registrant and its financial advisors attempted to interest alternative lessees\/operators in its railroad properties. Such efforts did not produce a satisfactory alternative to the Lease Extension.\nThe Registrant has not determined whether to pursue any of these alternatives, but depending upon future circumstances the Registrant may decide to pursue one or more or a combination of such alternatives. The Registrant also may solicit shareholders opinions about these or other alternatives. Over the past several years, certain shareholders have met with representatives of the State of North Carolina (\"State\") to discuss a sale or reorganization of the Registrant and the Registrant has been advised by the State that a buy-out or reorganization is being evaluated along with other options, but the Registrant is not aware of the seriousness of such discussions or whether the State will decide to pursue such a transaction. Although certain State officials have discussed in public a buy-out of the other shareholders as being in the interest of the State, other officials have also indicated that it may be in the State's interest to sell all or part of its stock. The Registrant is not aware of any decision by the State to buy-out the other shareholders and is not aware of what legislative or other government approvals would be required for such a transaction.\nUnder the Lease Extension discussed above, Norfolk Southern would continue to assume maintenance, capital improvement, and common carrier obligations with respect to the leased properties, as is the case under the 1895 and 1939 Leases. The Registrant has been advised by its ICC\/STB counsel that it may have a residual common carrier duty if Norfolk Southern were to discontinue railroad service. If the Registrant were to operate the railroad lines itself, the Registrant anticipates that it would have to incur substantial capital expenditures. See Item 7, Registrant's Discussion and Analysis of Financial Condition and Results of Operation, below.\nIf the Registrant operates its railroad lines, it would not be eligible to seek qualification as a REIT for income tax purposes, but instead would be treated as an operating railroad for income tax purposes, in which event ordinary corporate income tax treatment would apply to the Registrant. See \"Real Estate Investment Trust Election\" above regarding a failure of the\nRegistrant to qualify for REIT status for 1995 or later years.\nIt is possible that Norfolk Southern would seek to discontinue its responsibility as a common carrier to operate all or part of the Registrant's lines and\/or to re-route certain railroad traffic that does not either originate or terminate on the Registrant's lines (known as \"overhead traffic\") to other Norfolk Southern controlled lines. The Registrant does not have complete or reliable information about the overhead traffic because Norfolk Southern refused to disclose overhead traffic data to the Registrant, but the Registrant believes that a substantial majority of the traffic on its lines is overhead traffic according to analyses of ICC carload waybill sample information for 1994 and prior years. A portion of the property leased by the Registrant, the segment between Greensboro, North Carolina and Charlotte, North Carolina, forms part of a major system route for Norfolk Southern.\nThe Registrant believes the volume and type of overhead traffic diverted by Norfolk Southern would be the most significant factor in determining the revenues of the Registrant or any other operator of the Registrant's railroad lines. Many of the factors affecting routing of overhead traffic would be beyond the control of the Registrant. Other factors that would likely affect the profitability of operating the railroad include whether the operator would lose traffic to trucking companies or other competitors, the percentage of revenues required for operation (railway operating ratio), the revenues the operator would receive for traffic moving to and from connecting railroads, including Norfolk Southern, and revenues and expenses associated with operations of National Rail Passenger Corporation (\"Amtrak\"), which operations are governed in part by federal law.\nOther Leases\nUnder a lease dated December 31, 1968 (the \"1968 Lease\"), the Registrant and Norfolk Southern renegotiated a portion of the 1895 Lease. Three parcels of land located in Charlotte, North Carolina were released from the 1895 Lease and became subject to the 1968 Lease. This lease expires on December 31, 2067, and provides for an annual rental of $81,319 until 2018, when the rent becomes six percent (6%) annually of the current value of the leased land as determined by the parties.\nIn 1862, the Registrant entered into an agreement with the Chatham Railroad Company (\"Chatham\"), a predecessor of CSX Transportation Inc. (\"CSXT\"), for parallel construction and operation of a railroad track by Chatham within the Registrant's right of way between Raleigh and Cary, North Carolina, a distance of approximately eight miles (hereinafter referred to as the \"1862 agreement\"). The 1862 agreement made no provision for rental to be paid to the Registrant by Chatham. CSXT succeeded to the interests of\nChatham and the railroad track and facilities subject to the agreement are currently operated by CSXT as a part of its branch line between Henderson and Hamlet, North Carolina. The Registrant is currently negotiating with CSXT for renewal and modification of the 1862 agreement.\nIn addition to the leases and agreements described above, the Registrant leases several small parcels of property producing approximately $700 of lease revenues monthly.\nRegulatory Matters\nRailroads and other transportation companies are subject to state and federal regulations administered by agencies such as the STB (successor agency to the ICC), United States Department of Transportation (\"DOT\"), Federal Railroad Administration, state departments of transportation and state utilities commissions. During the past thirteen years, regulatory agencies have exhibited a trend toward less regulation of transportation industries. Effective January 1, 1996, under the ICC Termination Act of 1995 (\"ICCTA\"), federal jurisdiction over the economic regulation of railroads was modified and transferred by Congress to the STB, a department within DOT. The ICCTA also gave the STB exclusive jurisdiction over the economic regulation of railroads and preempted remedies under state law. The Registrant is evaluating the effect of the ICCTA upon the Registrant, including the extent to which the prior law was retained, modified, or repealed.\nRailroads are affected not only by the regulation of the railroad industry, but by regulation of other modes of transportation, which can change the cost structures of competitive modes of transportation. For example, proposals to have regulations changed to increase the size and weight limits of certain trucks are submitted to Congress from time to time. If permitted, such increases could have a material adverse effect upon railroads by decreasing the cost of shipping goods by truck. The Registrant monitors the regulation of railroads and competing modes of transportation on a regular basis, primarily through railroad industry publications.\nOther Matters - Environmental\nThe Registrant and its lessees are responsible for compliance with state, federal, local or other provisions relating to discharge of materials or the protection of the environment. State and federal environmental provisions may impose joint and several liability upon the Registrant and its lessees and sublessees for environmental damage or clean up (or associated costs) of any real properties owned by the Registrant and adjoining properties if the source of any problem is the property of the Registrant. The Registrant believes that damage\nor clean up (or the associated costs) would be the responsibility of the lessees and any sublessees or other parties who may have created any actionable environmental condition. The Lease Extension contains extensive provisions governing the rights and obligations of the parties for various environmental liabilities and expenses. If the Lease Extension is invalidated or enjoined, the Registrant may determine it is in its interest to initiate substantial environmental assessments of its properties and commence environmental litigation against Norfolk Southern and its sublessees or other parties who may have created or who are responsible for any actionable environmental conditions. If such parties are not able to meet their responsibilities, under certain statutes, regulations, and rules, the Registrant could ultimately be held responsible. See Item 7, Legal Proceedings, regarding the Peele site environmental matter.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe principal asset of the Registrant is 317 miles of railroad property, averaging less than 200 feet in width, between Morehead City, North Carolina, and Charlotte, North Carolina. Some of the property is owned in fee, and the majority of the road extends over rights of way and perpetual easements purchased or granted in the 19th century. The line extends from Morehead City in an arc across North Carolina westward through New Bern, Kinston, Goldsboro, Selma, Raleigh, Research Triangle Park (unincorporated), Durham, Mebane, Burlington, Greensboro, High Point, Lexington, Salisbury, Kannapolis, and Charlotte. The route between Greensboro and Charlotte is a primary line of Norfolk Southern's north-south freight route between Washington, D.C. and Atlanta, Georgia. The Registrant's line intersects CSXT railroad lines at Selma, Goldsboro, Raleigh, Durham, and Charlotte, North Carolina.\nThe Registrant's tracks on the Greensboro to Charlotte segment have been upgraded since original construction so that today the track is laid with 132-lb. continuous welded rail with alternating double and single track. Speeds of up to 79 miles per hour may be maintained over substantial portions of the line, and centralized traffic control exists for the entire stretch. On the Greensboro to Goldsboro segment, the line is constructed with both welded and jointed rail of varying weights. No signal system is in use on this segment. Speeds of up to 50 miles per hour (higher for passenger trains) may be maintained over substantial portions of this segment. The road segment from Goldsboro to Morehead City is unsignalled, single-trackage with continuous welded and jointed rail of 85- to 132-lb. weight. Several short segments of the line are operated jointly with railroads other than the Registrant's lessees. The Registrant's line between New Bern and Morehead City currently provides Norfolk Southern's only access to the port at Morehead City. At\nthe current time, Amtrak operates passenger trains on the Registrant's railroad line between Selma and Charlotte, North Carolina.\nThe Registrant also owns approximately 208 acres of land divided into 24 parcels (non-operating property) that mostly adjoin its rail corridor. Among these parcels are the three in Mecklenburg County which are located in the downtown Charlotte business district and subject to the 1968 Lease with Norfolk Southern. Some of the properties have improvements, the ownership of which depends on the terms of the arrangements with the sublessees of the properties. Pursuant to the Lease Extension, the Registrant has the right to have certain properties outside the right of way not used in operating a railroad released to the Registrant from the Lease Extension. Norfolk Southern's rental payments will not be reduced if the Registrant exercises this right. The Registrant intends to exercise its right to have released from the Leases those properties it determines have income-generating potential in excess of projected expenses. The Registrant estimates these properties currently are producing less than $100,000 of annual lease income. The Registrant will determine which properties it will seek to have released to it after evaluating potential environmental liability and other relevant factors.\nItem 3.","section_3":"Item 3. Legal Proceedings\nExcept as described below, there are no legal proceedings pending to which the Registrant is a party that are material to the operation of the Registrant.\nPeele Site\nDuring the fourth quarter of 1989, the Registrant was notified by the North Carolina Department of Environment, Health, and Natural Resources (\"DEHNR\") that DEHNR had been notified of a possible abandoned pesticide disposal site on property owned by the Registrant in Johnston County, North Carolina. Information about the site has been disclosed by the Registrant in prior quarterly and annual reports to the Securities and Exchange Commission. Since 1991, the site had been included in the DEHNR Inactive Hazardous Waste Sites Priority List. The sites on the Priority List are ranked in decreasing order of danger to the public health and environment based on a ranking system administered by DEHNR. In February 1996, the site ranked 122 out of a total of 183 sites on the Priority List.\nIn January, 1994, DEHNR initiated a lawsuit against the Registrant and other parties seeking reimbursement of $84,354 in response costs incurred by DEHNR and remediation of the site. On February 1, 1995, the Court granted partial summary judgement\nholding all of the defendants, including the Registrant, jointly and severally liable. The Court has not yet ruled on apportionment of liability or cost sharing among the defendants. According to a preliminary study conducted by the Registrant, the estimated costs of remediation range between $500,000 to in excess of $2,000,000. The Registrant will vigorously defend the action by DEHNR, and will aggressively pursue any other parties who may be liable for any remediation, removal, or clean-up. The ultimate costs of any remediation, removal, or clean-up are not known. However, if such costs are not paid by other parties, the financial position of the Registrant could be materially adversely affected.\nShareholder Litigation\nFour shareholder derivative actions were filed in the United States District Court for the Eastern District of North Carolina during December 1994 and January and February 1995 by shareholders of the Registrant. Information about the actions has been disclosed in prior quarterly and annual reports to the Securities and Exchange Commission. On March 30, 1995, the court consolidated the actions into one proceeding. The Registrant, along with the co-defendants, filed motions to dismiss or stay the actions. On October 18, 1995, the court denied the motions to dismiss, granted the motions to stay the proceeding until such time as the shareholders voted on the Lease Extension, and granted a motion by the plaintiffs for leave to supplement their pleadings. On February 26, 1996, the court again stayed the proceeding until after the court rules on whether a quorum of private shareholders was present at the December 15, 1995 shareholder meeting of the Registrant.\nOn December 21, 1995, a shareholder derivative legal action was filed in Federal District Court in the Eastern District of North Carolina, Rucker v. North Carolina Railroad Company, et al., Case No. 5-95-CV-1054-BO(2). The action seeks to enjoin the Lease Extension or invalidate the December 15, 1995 shareholders meeting held to approve the Lease Extension on the basis of a lack of a quorum of shareholders other than the State of North Carolina, and makes other allegations against the defendants, including alleged proxy rule violations. The court has not enjoined the Lease Extension. The bylaws of the Registrant provide that, in order to constitute a quorum for a shareholders' meeting, a majority of the shares of stock of the Registrant held by shareholders other than the State of North Carolina, must be represented, in person or by proxy, at the meeting. The plaintiff also sought a temporary restraining order seeking permission to review the proxy records of the shareholder meeting, which access was granted by the court. On February 26, 1996 the court granted a motion by the Registrant to accelerate discovery on the issue whether a quorum of private shareholders was present at the December 15, 1995 shareholder meeting, and\nstayed discovery with respect to all other issues. See Item 1, Business, regarding the possible effects of the shareholder litigation on the Registrant's ability to qualify for REIT status, and Item 4, Submission of Matters to a Vote of Security Holders regarding the shareholder meeting. The Registrant is considering bringing a counterclaim or separate legal action against certain shareholders of the Registrant for proxy rules violations.\nThe Registrant is defending the aspects of the shareholder suits relating to the shareholder meeting, the effectiveness of the Lease Extension, and attempts to enjoin the Lease Extension. The directors and officers named as defendants in the suits, represented by separate counsel, are defending damage claims brought against the directors and officers. The bylaws of the Registrant provide that its directors and officers shall have the right to be indemnified by the Registrant, to the fullest extent permitted by law, against liabilities and expenses arising out of their status as Directors. To the extent the directors' and officers' conduct meets the standard of conduct for indemnification set forth by the North Carolina Business Corporation Act (\"NCBCA\"), as described below, they will be so indemnified by the Registrant in connection with the shareholder derivative actions described herein. The Registrant will oppose the actions brought by the plaintiffs to the extent the actions seek to enjoin any lease arrangement or seek recovery against the Registrant or seek any remedy against the best interests of Registrant or its shareholders.\nUnder the NCBCA, a corporation is permitted to indemnify a director or officer who conducted himself in good faith and reasonably believed: (i) in the case of conduct in his official capacity with the corporation, that his conduct was in the best interest of the corporation and (ii) in all other cases, that his conduct was at least not opposed to the corporation's best interest. In the case of any criminal proceeding, the director or officer must not have had any reasonable cause to believe his conduct was unlawful. In any proceeding by or in the right of a corporation (such as the shareholder derivative actions described herein), a corporation may not voluntarily indemnify a director or officer if the director or officer is adjudged liable to the corporation. In addition, a corporation may not indemnify a director or officer if the director or officer is adjudged liable on the basis that personal benefit was improperly received by him. Where a proceeding is by or in the right of a corporation, indemnification of a director or officer is limited to reasonable expenses if the proceeding is concluded without a final adjudication on the issue of liability. The NCBCA permits an advance for expenses incurred by a director or officer in defending a proceeding. The expenses may be paid by a corporation in advance of the final disposition of the legal action, upon receipt of an undertaking by or on behalf of the\ndirector or officer to repay such amounts unless it is ultimately determined that he is entitled to be indemnified by the corporation against such expenses. The directors and officers of the Registrant who have executed such undertaking are receiving advances for expenses incurred in defending the actions brought against them in connection with the Lease Extension. Additionally, the NCBCA provides that a corporation may purchase and maintain insurance on behalf of a director or officer of the corporation against any liability asserted against or incurred by him in that capacity or arising from his status as a director or officer. The Registrant has an insurance policy that covers the Registrant against the indemnification liability of the Registrant to its directors and officers. The policy has a aggregate limit of $5 million and a $75,000 retention per occurrence. The Registrant's liability exposure to its directors and officers will, therefore, not be material, unless (i) the directors or officers satisfy the requirements for being indemnified as described above and (ii) the indemnified liabilities and expenses exceed the Registrant's insurance coverage. The Registrant is unable to determine this early in the legal proceedings whether either of the foregoing conditions will occur.\nCharlotte Convention Center Litigation\nOn December 10, 1991, the Registrant initiated a lawsuit in the Mecklenburg County, North Carolina, Superior Court regarding its railroad corridor through downtown Charlotte. The Registrant alleged that both the City of Charlotte and Norfolk Southern have breached contract obligations and obligations based on real property rights to the Registrant. The litigation has been disclosed by the Registrant in prior quarterly and annual reports to the Securities and Exchange Commission. On December 7, 1993, the North Carolina Court of Appeals ruled against the defendants' appeal and against the Registrant's cross-appeal. Norfolk Southern then petitioned the Supreme Court of North Carolina to review the decision of the North Carolina Court of Appeals, which petition was denied. Norfolk Southern then petitioned the United States Supreme Court for review. On June 12, 1995, the United States Supreme Court denied the petition, and the lawsuit will continue in Superior Court, Mecklenburg County, North Carolina. The Registrant is engaging in negotiations to settle the litigation, but there can be no assurance of any settlement or the terms of any such settlement.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nThe Registrant's annual meeting of shareholders was held on December 15, 1995. The bylaws of the Registrant provide that a majority of the outstanding shares of the Registrant entitled to vote, represented in person or by proxy, constitutes a quorum at\na meeting of shareholders, provided, that a majority of the shares held by shareholders other than the State of North Carolina (the \"private\" shares) are represented at the meeting, in person or by proxy. At the meeting, the Registrant submitted the Lease Extension to the shareholders of the Registrant for approval pursuant to North Carolina law. See Item 3, Legal Proceedings, regarding shareholder litigation over whether a quorum of shareholders was present at the shareholder meeting. In connection with shareholder litigation challenging the quorum, and the tabulation by the Registrant's stock transfer agent, the Registrant retained a professional inspector of elections to audit the tabulation of the number of shares present at the meeting in person or by proxy and the votes cast at the meeting by shareholders other than the State of North Carolina. The tables below reflect the final quorum tabulation and voting results.\nPursuant to the charter of the Registrant, the State of North Carolina elects a total of ten directors and the remaining shareholders elect a total of five directors. Directors are elected to three-year staggered terms.\n(a) Quorum (\"private\" shares)\nNumber of \"Private\" Shares required to be represented: 538,149 Number of \"Private\" Shares represented: 539,169\nThe quorum margin, according to the Registrant's audited tabulation described above, is 1,020 shares. The plaintiff in the quorum litigation has challenged proxy votes exceeding 30,000 shares. Until a final determination is made by the court, there can be no assurance that the Registrant's tabulations are legally valid. The Registrant cannot predict if or when a final determination will be made by the court or when any appeals of any court ruling may be exhausted.\n(b) Votes Cast Abstain\/ Broker For Against Withheld Non Votes --------- --------- -------- ---------- 1. Approval of the Lease Extension Agreement\nBy the \"Private\" 374,453 30,451 2,555* 131,460 Shareholders:\nBy the State of 3,207,173 North Carolina:\n(*) an additional 250 shares were represented at the meeting in person and not voted.\n2. Election of Directors\nBy the \"Private\" Shareholders:\nP. C. Barwick, Jr. 516,947 -0- 21,972\nBy the State of North Carolina:\nMarvin D. Gentry 3,207,173 -0- -0- Robert W. Griffin 3,207,173 -0- -0- William H. Kincheloe 3,207,173 -0- -0- John S. Russell 3,207,173 -0- -0-\n3. Appointment of Independent Public Accountants\nRatification of the Selection of Ernst & Young LLP 3,729,346 11,728 6,018\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stock- holder Matters\n(a) Market Information\nCommon shares of the Registrant are currently traded in the over-the-counter market. Quarterly high and low bids are as follows for fiscal years 1994 and 1995:\n1995 1994 Low High Low High 1st 1st 24 1\/4 26 35 35 2nd 2nd 25 1\/2 30 1\/2 37 1\/2 40 1\/2 3rd 3rd 26 35 36 39 4th 4th 25 30 24 3\/4 38\nThese over-the-counter market quotations reflect interdealer prices, without retail markup, markdown or commission, and may not necessarily represent market transactions.\n(b) Holders\nThere were approximately 752 holders of common shares of the Registrant of record as of March 4, 1996.\n(c) Dividends\nIn 1995, no dividends were declared. In 1994 and 1993, the Registrant declared regular cash dividends of $.03 per share, or $128,504. The amount and timing of future dividends will depend upon the requirements for shareholder distributions if the Registrant elects REIT status for income tax purposes, the shareholder litigation, and the future profitability of the Registrant. See Item 3, Legal Proceedings, regarding certain shareholder litigation seeking to enjoin the Lease Extension. The Registrant expects to continue to have substantial uncertainty with respect to the shareholder litigation and the effect of the litigation upon the Registrant's qualification for REIT status for 1995 and future periods. See \"Real Estate Investment Trust Election\" under Item 1, Business, above, regarding the relationship between tax matters and dividend policy, and Note C to the financial statements.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe following selected financial data are derived from the financial statements of the Registrant. The data should be read in conjunction with the financial statements, related notes and other financial information included herein.\nSelected Financial Data At December 31 or For the Year Ended December 31 ----------------------------------------------------------\nSee notes to financial statements.\nSTATEMENTS OF INCOME\nNORTH CAROLINA RAILROAD COMPANY\nSee notes to financial statements.\nSTATEMENTS OF SHAREHOLDERS' EQUITY\nNORTH CAROLINA RAILROAD COMPANY\nSee notes to financial statements.\nSTATEMENTS OF CASH FLOWS\nNORTH CAROLINA RAILROAD COMPANY\nSee notes to financial statements.\nNOTES TO FINANCIAL STATEMENTS\nNORTH CAROLINA RAILROAD COMPANY\nDecember 31, 1995\nNOTE A--SIGNIFICANT ACCOUNTING POLICIES\nORGANIZATION: The North Carolina Railroad Company (the \"Company\"), owns approximately 317 miles of continuous railroad line extending from Charlotte, North Carolina to Morehead City, North Carolina. On August 10, 1995, the Board of Directors of the Company approved a Lease Extension Agreement (\"Lease Extension\") with Norfolk Southern to extend two prior leases of substantially all of the Company's property. (See Note C.)\nPROPERTIES: Buildings and equipment are reported at cost. Depreciation is computed on the straight-line method over the estimated useful lives of the assets. Buildings are depreciated over thirty years and equipment is depreciated over three to five years.\nProperties in the roadway and land account are carried at an amount which approximates the 1916 valuation by the Interstate Commerce Commission. These properties are not depreciated because they represent fully depreciated roadway or non- depreciable land. However, a rehabilitation project of $200,000 was amortized over a five-year period during the 1940's.\nREVENUE RECOGNITION: Revenue is reflected in the statements of income when earned in accordance with the Company's lease arrangements on the accrual method. (See Note C.)\nINCOME TAXES: Prior to 1995, income tax expense was disproportionate to income before income taxes because the lessee of certain of the properties, pursuant to the terms of the 1895 Lease, was responsible for all income taxes attributable to the lease arrangement. The Company considered the lessee's share of the amortization of roadway costs to be a permanent difference and no deferred taxes were provided thereon.\nUnder the Lease Extension, all income taxes become the responsibility of the Company as of January 1, 1995. The 1995 income tax provision does not take into account the Company's possible Real Estate Investment Trust (\"REIT\") election for 1995 or Norfolk Southern's potential liability for the Company's taxes should the Lease Extension not be effective. (See Note B and Note D.)\nCASH AND CASH EQUIVALENTS: Cash and cash equivalents include investments in commercial paper, U. S. Treasury Bills, and\ncertificates of deposit with original maturities of three months or less. Cash deposits are placed with high credit quality financial institutions. At times, deposits exceed amounts insured by the Federal Deposit Insurance Corporation.\nSHORT-TERM INVESTMENTS: Short-term investments include investments in high quality commercial paper and U. S. Treasury Bills with maturities within one year of the balance sheet date. These investments are held-to-maturity and are carried at cost, which approximates market.\nLEASE\/TRANSACTION COSTS: Certain lease negotiation costs have been capitalized and will be amortized over the life of the lease agreement.\nUSE OF ESTIMATES: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.\nRESTRICTED ASSETS: Under terms of its lease agreement with AECR, the Company had maintained a restricted cash account. All restrictions expired on December 31, 1994, and the assets became the unrestricted property of the Company. (See Note C.)\nFASB STATEMENT NO. 121: In March 1995, the Financial Accounting Standards Board (\"FASB\") issued Statement No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long- Lived Assets to be Disposed of,\" which requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by these assets are less than the assets' carrying amount. Statement 121 also addresses the accounting for long-lived assets that are expected to be disposed of. The Company will adopt Statement No. 121 in the first quarter of 1996 and, based on current circumstances, does not believe the effect of adoption will be material.\nNOTE B--REAL ESTATE INVESTMENT TRUST\nOn August 10, 1995, the Board of Directors of the Company voted to cause the Company to elect REIT status for income tax purposes, in connection with the Lease Extension. (See Note C.) The REIT provisions of the Internal Revenue Code (\"I.R.C.\") generally allow a REIT to deduct distributions paid to its stockholders. The Company received an opinion of counsel that the Company can qualify as a REIT based upon the effectiveness and terms of the Lease Extension. However, certain shareholder litigation could enjoin, delay, or otherwise affect the effectiveness of the Lease Extension, the terms of the Lease\nExtension, or the timing or amount of shareholder distributions. The Company is also seeking a ruling from the Internal Revenue Service as to the effect of a one-time $5 million settlement payment with respect to the timing of the Company's REIT election, but the Company has not yet received such ruling. (See Note F.) There can be no assurance that the Company can qualify for REIT status for 1995 or later years.\nIf the Company qualifies for and elects to become a REIT for the year ended December 31, 1995, lease revenue, income before income taxes, income taxes, net income, and earnings per share on a pro-forma basis would be as follows:\nThe pro forma effect of REIT election for 1995 would be $.61 per share.\nNOTE C--LEASES ON ROADWAY AND LAND\nIn 1895, the Company leased substantially all of its assets to Southern Railway Company, now known as Norfolk Southern Railway Company (\"NSR\"), for ninety-nine years (the \"1895 Lease\"). In 1989, the Company acquired the Atlantic and North Carolina Railroad Company, the assets of which were subject to a lease dating to 1939 with the Atlantic & East Carolina Railway Company (\"AECR\"), a wholly-owned subsidiary of Norfolk Southern Railway Company (the \"1939 Lease\"). NSR and AECR are hereinafter referred to as \"Norfolk Southern\". The terms of the 1895 Lease and 1939 Lease provided for expiration on January 1, 1995 and December 31, 1994, respectively, and did not require either the Company or Norfolk Southern to renew the leases.\nOn August 10, 1995, the Board of Directors of the Company approved a Lease Extension Agreement to extend the terms of the 1895 Lease and the 1939 Lease, with its effectiveness retroactive to January 1, 1995. However, a shareholder has commenced a legal action challenging the validity of shareholder approval. Other shareholder derivative litigation seeking to enjoin the Lease Extension is also pending. The base annual rental under the Lease Extension is eight million dollars ($8,000,000) for the period from January 1, 1995 through December 31, 1995. Annual base rent for 1996 and each year thereafter will be adjusted each year to account for inflation during the preceding calendar year according to the implicit price deflator for the gross domestic product (IPD-GDP). In no event, however, will the base annual\nrental for any calendar year be less than eight million dollars ($8,000,000). The base rent adjustment in any year cannot exceed the sum of: (i) four (4%) percent of the base rent for the preceding year, plus (ii) seventy-five (75%) percent of the IPD- GDP in excess of four (4%) percent. There is a one-year delay in application of the IPD-GDP. For example, adjustment of 1995 rental payments to determine 1996 rental payments is based upon the IPD-GDP for 1994. The 1895 and 1939 Leases are extended for an initial term of thirty (30) years, through December 31, 2024 and are extendable for an additional twenty (20) years at the option of Norfolk Southern.\nA third lease to Norfolk Southern (the \"1968 Lease\") expires on December 31, 2067, and provides for an annual rental of $81,319 through December 2017 for certain properties in Charlotte, North Carolina. Beginning on January 1, 2018, 6% of the appraised value of the property will be the annual rental for the remaining term of the 1968 Lease. Under the terms of the 1968 Lease, all taxes connected with the property, except income taxes, are paid by the lessee. The 1968 Lease would not be affected by the Lease Extension.\nNOTE D--INCOME TAXES\nEffective January 1, 1993, the Company changed its method of accounting for income taxes from the deferred method to the liability method required by FASB Statement No. 109, \"Accounting for Income Taxes.\" As permitted under the new rules, prior years' financial statements were not restated. The cumulative effect of adopting Statement No. 109 as of January 1, 1993 was a reduction of income of $140,902.\nSignificant components of the provision for income taxes attributable to continuing operations are as follows:\nDeferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes.\nSignificant components of the Company's deferred tax liability as of December 31 are as follows:\nThe Company may be eligible for REIT status for 1995, which would substantially reduce the Company's income tax expense for 1995 by approximately $2.6 million, or $.61 per share. (See Note B).\nNOTE E--COMMITMENTS AND CONTINGENCIES\nDuring the fourth quarter of 1989, the Company was notified by the North Carolina Department of Environment, Health, and Natural Resources (\"DEHNR\") of a possible abandoned pesticide disposal site on property owned by the Company in Johnston County, North Carolina. It is believed that the site was used by a predecessor owner to burn and\/or bury surplus pesticides from the predecessor's business, which was not located at the site. In January, 1994, DEHNR initiated a lawsuit against the Company and other parties seeking reimbursement of $84,354 in response costs incurred by DEHNR and remediation of the site. On February 1, 1995, the Court granted partial summary judgment holding all of the defendants, including the Company, jointly and severally liable for the site. The Court has not yet ruled on apportionment of liability or cost sharing among the defendants. According to a preliminary study conducted by the Company, the estimated costs of remediation range between $500,000 to in excess of $2,000,000. The Company will vigorously defend the action brought by DEHNR and will aggressively pursue any other parties who may be liable for any remediation, removal, or clean- up. The ultimate costs of any remediation, removal, or clean-up are not known. However, if such costs are not paid by other parties, the financial position of the Company could be materially adversely affected.\nFour shareholder derivative actions were filed in the United States District Court for the Eastern District of North Carolina during December 1994 and January and February 1995 by shareholders of the Company. The complaints name the directors of the Company as defendants and the Company as \"nominal defendant.\" Two of the actions seek to enjoin a purported lease between the Company and Norfolk Southern and seek to recover for the Company unspecified damages and other relief from the directors. Two other actions seek similar relief and also name the State of North Carolina, the Governor of North Carolina, and Norfolk Southern as defendants. On December 21, 1995, a shareholder derivative legal action was filed. The action seeks to enjoin the Lease Extension or invalidate the December 15, 1995 shareholders meeting held to approve the Lease Extension on the basis of a lack of a quorum of shareholders other than the State of North Carolina, and makes other allegations against the\ndefendants, including alleged proxy rule violations. The Company is defending the aspects of the shareholder suits relating to the shareholder meeting, the effectiveness of the Lease Extension, and attempts to enjoin the Lease Extension. The directors and officers named as defendants in the suits, represented by separate counsel, are defending damage claims brought against the directors and officers. The Company's officers and directors are indemnified in the bylaws of the Company for certain claims and liabilities alleged in the actions, including the defense costs and expenses. The Company notified its directors and officers insurance carrier of claims as a result of the actions, which claims have been acknowledged by the insurance carrier. The directors and officers insurance policy has an aggregate limit of $5,000,000 and a $75,000 retention per occurrence.\nOn December 10, 1991, the Company initiated a lawsuit in the Mecklenburg County, North Carolina Superior Court regarding its railroad corridor through downtown Charlotte. The Company alleged that both the City of Charlotte and Norfolk Southern have breached contract obligations and obligations based on real property rights to the Company. The litigation has been disclosed by the Company in prior quarterly and annual reports to the Securities and Exchange Commission. On December 7, 1993, the North Carolina Court of Appeals ruled against the defendants' appeal and against the Company's cross-appeal. Norfolk Southern then petitioned the Supreme Court of North Carolina to review the decision of the North Carolina Court of Appeals, which petition was denied. Norfolk Southern then petitioned the United States Supreme Court for review. On June 12, 1995, the United States Supreme Court denied the petition, and the lawsuit will continue in Superior Court, Mecklenburg County, North Carolina. The Company is engaging in negotiations to settle the litigation, but there can be no assurance of any settlement or the terms of any such settlement.\nNOTE F--SETTLEMENT INCOME\nOn December 1, 1995, Norfolk Southern made a one-time settlement payment of $5 million, plus interest, to the Company, as provided in the Lease Extension, in exchange for the Company's release of Norfolk Southern from certain contractual obligations relating to certain personal property upon expiration of the 1895 Lease and 1939 Lease. The Company and Norfolk Southern entered into an agreement dated August 10, 1995, whereby the settlement payment was made in early December 1995 in order to facilitate the Company seeking REIT status at the earliest practicable date. The Company is seeking a ruling from the Internal Revenue Service as to the effect of the payment with respect to the timing of the Company's REIT election, but the Company has not yet received such ruling. In the event the Lease Extension is invalidated, the Company is entitled to retain the payment and interest for application against any future rental or other amounts due from Norfolk Southern.","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_1995.txt","cik":"812094","year":"1995","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 Partnership Agreement provides that the proceeds from any sale or refinancing of the Centre will not be reinvested in new acquisitions. The Registrant's operations consist exclusively of investment in and operation of income producing real property, and all financial information included in this report relates to this industry segment.\nThe Centre is subject to certain competitive conditions in the market in which the property is located. See Item 7. Liquidity and Capital Resources for additional information.\nOverall, the investment real estate market saw gradual improvement over the last year. This improvement has taken place in an environment of generally low interest rates and little or no new supply, parameters which may not exist in the next few years. Demand for real estate space, while projected to improve in line with the overall economy, is also vulnerable to external forces. The major challenges facing the real estate industry today include increased international competition, corporate restructurings, new computer and communications technologies, an aging population and potential revisions of the tax code. In addition, the increased flow of capital to real estate through new vehicles such as commercial mortgage-backed securities and REITs could spur new construction at unsupportable levels, as well as impact existing property values.\nShopping centers are the most troubled asset class in real estate currently. Unlike other asset classes, construction of power shopping centers, those with a preponderance of \"big box\" retailers, occurred at a brisk pace during the early 1990s, and now a shake-out of retailers is taking place. Retailers posted lackluster sales in 1995, particularly in the latter half of the year, and similar results are expected for 1996. The slight rise in interest rates in 1995 also contributed to low sales growth in interest rate sensitive sectors such as automobiles and home furnishings. Nevertheless, retail properties are particularly unique, and those with strong tenant alignments should better weather the current slowdown. In the long-term, however, retail real estate is also vulnerable to technological changes (e.g. home shopping) which could drastically alter the retail distribution system.\nThe Registrant has one property which it continues to own and operate. The General Partner has no current plans to sell the property; however, the receipt of an attractive unsolicited offer or changing market conditions could change the current plan.\nActivity for the purchase of limited partnership interests (\"tender offer\") has increased in real estate limited partnerships generally. Many of these tender offers have been made by investors seeking to make a profit from the purchase of the interests. In the event a tender offer is made for interests in the Registrant, the General Partner will issue a response to limited partners expressing the General Partner's opinion regarding the offer. Certain administrative costs will be incurred to respond to a tender offer. The General Partner cannot predict with any certainty what impact a tender offer will have on the operations or management of the Registrant.\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, 1995, 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 1995.\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 1995. PART 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 Item 7. Liquidity and Capital Resources.\nAs of December 31, 1995, the number of record holders of Limited Partnership Interests of the Registrant was 2,049.\nItem 6.","section_6":"Item 6. Selected Financial Data - -------------------------------\nYear ended December 31, ---------------------------------------------------------- 1995 1994 1993 1992 1991 ---------- ---------- ---------- ---------- ----------\nTotal income $5,411,464 $ 5,500,853 $ 5,066,152 $ 5,654,459 $ 6,131,744 Net (loss) income (203,933) (118,837) (446,805) (217,234) 708,302 Net (loss) income per Limited Partnership Interest (6.73) (3.92) (14.74) (7.17) 23.37 Total assets 23,620,607 24,143,296 23,433,874 24,772,417 26,234,651 Mortgage note payable 12,568,420 12,692,502 11,543,885 11,664,937 11,771,694 Distributions per Limited Partnership Interest (A) 5.527 None 27.625 44.20 44.20\n(A) No distributions of original capital were made in any of the last five years.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and - ----------------------------------------------------------------------- Results of Operations - ---------------------\nOperations - ----------\nSummary of Operations - ---------------------\nProperty operations decreased at the Centre during 1995 as compared to 1994. This resulted in an increase in the Partnership's net loss during 1995 when compared to 1994. Lower administrative expense partially offset the decrease in property operations. The Centre's operations stabilized and began to improve during 1994 due to renovations and leasing efforts undertaken during 1994 and 1993. As a result, the net loss decreased during 1994 as compared to 1993. Further discussion of the operations of Outlet Centre Partners (the \"Partnership\") is summarized below.\n1995 Compared to 1994 - ---------------------\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 periodic adjustment of billings during 1994, combined with slightly lower occupancy at the Centre during 1995, have resulted in a decrease in service income during 1995 when compared to 1994.\nAs a result of higher interest rates and higher average cash balances, interest income on short-term investments increased during 1995 when compared to 1994.\nAs a result of legal, portfolio management and other professional fees incurred during 1994 in connection with the June 1994 refinancing, administrative expenses decreased during 1995 when compared to 1994.\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 caused an increase in percentage and base rents, resulting in an increase in rental income during 1994 when compared to 1993.\nAn increase in the amount billable, combined with the periodic adjustment of billings during 1994, resulted in an increase in service income during 1994 when 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 when compared to 1993.\nAdditional capitalized improvements at the Centre resulted in an increase in depreciation expense during 1994 when 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 and repair upgrades to the Centre's heating and air conditioning system, resulting in a decrease in property operating expense 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 when compared to 1993.\nHigher portfolio management, legal and accounting fees incurred in connection with the June 1994 refinancing of the Centre's mortgage loan caused an increase in administrative expenses during 1994 when compared to 1993. Liquidity and Capital Resources - -------------------------------\nThe cash position of the Partnership increased as of December 31, 1995 when compared to December 31, 1994. The cash flow provided by the Partnership's operating activities reflects operations of the Centre plus interest income earned on short-term investments, partially offset by administrative expenses of the Partnership. The Partnership used cash to fund its investing activity consisting of the funding of tenant improvements and its financing activities consisting of the payment of distributions to Limited Partners and the payment of principal on the mortgage note payable.\nAs of December 31, 1995, the occupancy rate at the Centre was 86%, and during each of 1995 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.\nThe Centre experienced a high rate of lease expirations during 1995. However, through successful leasing strategies and efforts, many tenant leases were renewed. These leasing strategies and efforts are continuing as additional tenant leases expire. 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 which may be generated by the Centre, as well as the future sale price which may be obtained by the Partnership. Lakeside Marketplace, an outlet strip center located three miles south of the Centre, has announced construction of their third phase which they anticipate to have completed by the fourth quarter of 1996. This 120,000 square foot expansion may impact the ability to lease the Centre as well as tenant sales.\nThe Partnership made distributions totaling $5.53 and $27.63 per Interest in 1995 and 1993, respectively. See Statement of Partners Capital for additional information. All of these distributions were comprised of Net Cash Receipts. In January 1994, quarterly distributions to Limited Partners were suspended in order to provide the working capital necessary to complete the refinancing of the Centre's mortgage note payable. With the completion of the refinancing in June 1994 and the subsequent replenishing of cash reserves from operations, the Partnership resumed quarterly distributions in October 1995. In January 1996, the Partnership paid $165,810 ($5.527 per Interest) to the holders of Limited Partnership Interests for the fourth quarter of 1995. Including the January 1996 distribution, investors have received distributions of Net Cash Receipts of $277.37 and Net Cash Proceeds of $263.08, totaling $540.45 per $1,000 Interest.\nThe Partnership has one property which it continues to own and operate. The General Partner has no current plans to sell the property; however, the receipt of an attractive unsolicited offer or changing market conditions could change the current plan.\nIn 1995, the Financial Accounting Standards Board issued Statement No. 121 \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of\" which establishes accounting standards for impairment of long-lived assets and long-lived assets to be disposed of. This statement has been adopted by the Partnership as of January 1, 1995, and did not have a material impact on the financial position or results of operations of the Partnership. Inflation 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 $203,933 during the year ended December 31, 1995, whereas net income of approximately $1,348,000 was originally forecasted for this period. The difference was primarily a result of lower than forecasted rental income and higher expenditures related to the ongoing media and marketing campaign and various improvements at the Centre. The General Partner anticipates that the actual operations for 1996 will also be significantly lower than the forecasted operations for 1996 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 in the future. 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, 1995 December 31, 1994 ----------------------- ------------------------- Financial Tax Financial Tax Statements Returns Statements Returns ---------- --------- ---------- ---------\nTotal assets $23,620,607 $27,809,423 $24,143,296 $28,071,202 Partners' capital (deficit): General Partner (1,155,107) (522,372) (1,153,068) (523,491) Limited Partners 11,389,169 15,000,191 11,756,873 15,055,201 Net (loss) income: General Partner (2,039) 1,119 (1,188) 3,665 Limited Partners (201,894) 110,800 (117,649) 18,520 Per Limited Partner- ship Interest (6.73) 3.69 (3.92) .60 Item 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and - ----------------------------------------------------------------------- Financial Disclosure - --------------------\nEffective October 18, 1995, the Registrant has terminated its audit agreement with Arthur Andersen LLP to act as the Registrant's independent accounting firm and has engaged Coopers & Lybrand L.L.P. as its new independent accounting firm. The report of Arthur Andersen LLP on the financial statements of the Registrant in the past two years did not contain any adverse opinion or any disclaimer of opinion, nor was it qualified or modified as to uncertainty, audit scope, or accounting principles. There existed no disagreements relating to any matter of accounting principles or practices, financial statement disclosures, auditing scope and procedures or compliance with applicable rules which resulted in the termination of Arthur Andersen LLP as the Registrant's independent accounting firm. The decision to change accounting firms was approved by the General Partner of the Registrant. PART 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 Senior Vice President Alexander J. Darragh Senior Vice President Josette V. Goldberg Senior Vice President Alan G. Lieberman Senior Vice President, Chief Brian D. Parker Financial Officer, Treasurer and Assistant Secretary Senior Vice President John K. Powell, Jr.\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. He is also Senior Vice President of American Express Company and is responsible for its real estate operations worldwide. 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.\nAlexander J. Darragh (February 1955) joined Balcor in September 1988 and is responsible for due diligence analysis and real estate advisory services for Balcor and American Express Company. He also has supervisory responsibility for Balcor's environmental matters. Mr. Darragh received masters' degrees in Urban Geography from Queen's University and in Urban Planning from Northwestern University.\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 MIS functions. 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 Balcor's property sales and capital markets functions. Mr. Lieberman is a Certified Public Accountant.\nBrian D. Parker (June 1951) joined Balcor in March 1986 and, as Chief Financial Officer and Chief Accounting Officer, is responsible for Balcor's financial, legal and treasury functions. He is a Director of The Balcor Company. Mr. Parker is a Certified Public Accountant and holds an M.S. degree in Accountancy from DePaul University. John K. Powell Jr. (June 1950) joined Balcor in September 1985 and is responsible for portfolio and asset management matters relating to Balcor's partnerships. Mr. Powell also has supervisory responsibility for Balcor's risk management and investor services functions. He received a Master of Planning degree from the University of Virginia. Mr. Powell 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.\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 1995.\nItem 11.","section_11":"Item 11. Executive Compensation - -------------------------------\nThe Registrant has not paid and does not propose to pay any remuneration to the executive officers and directors of the General Partner. Certain of these officers receive compensation from The Balcor Company (but not from the Registrant) for services performed for various affiliated entities, which may include services performed for the Registrant. However, the General Partner believes that any such compensation attributable to services performed for the Registrant is immaterial to the Registrant. See Note 7 of Notes to Financial Statements for the information relating to transactions with affiliates.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management - -----------------------------------------------------------------------\n(a) No person owns of record or is known by the Registrant to own beneficially more than 5% of the 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 do not own any interests.\n(c) The Registrant is not aware of any arrangements, the operation of which may result in a change of control of the Registrant.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions - -------------------------------------------------------\n(a & b) See Note 7 of Notes to Financial Statements for additional information relating to transactions with affiliates.\nSee Note 3 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. PART 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 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(16) Letter from Arthur Anderson LLP dated October 18, 1995 regarding the change in the Registrant's certifying accountant previously filed as Exhibit 16 to the Registrant's Current Report on Form 8-K dated October 18, 1995(Commission File No. 0-16717) is incorporated herein by reference.\n(27) Financial Data Schedule of the Registrant for 1995 is attached hereto.\n(b) Reports on Form 8-K: A Current Report on Form 8-K dated October 18, 1995 was filed (Commission File No. 0-16717) reporting a change in the Registrant's certifying accountant.\n(c) Exhibits: See Item 14(a)(3) above. SIGNATURES\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\/Brian D. Parker ------------------------- Brian D. Parker Senior Vice President, and Chief Financial Officer (Principal Accounting and Financial Officer) of Balcor Partners-XXII, the General Partner\nDate: March 28, 1996 --------------\nPursuant to the requirements of the Securities Exchange Act of 1934, 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 28, 1996 - -------------------- -------------- Thomas E. Meador\nSenior Vice President, and Chief Financial Officer (Principal Accounting and Financial Officer) of Balcor Partners-XXII, \/s\/Brian D. Parker the General Partner March 28, 1996 - -------------------- -------------- Brian D. Parker\nReports of Independent Accountants\nFinancial Statements:\nBalance Sheets, December 31, 1995 and 1994\nStatements of Partners' Capital, for the years ended December 31, 1995, 1994 and 1993\nStatements of Income and Expenses, for the years ended December 31, 1995, 1994 and 1993\nStatements of Cash Flows, for the years ended December 31, 1995, 1994 and 1993\nNotes to Financial Statements\nFinancial Statement Schedules:\nFinancial Statement Schedules are omitted for the reason that they are inapplicable or equivalent information has been included elsewhere herein. REPORT OF INDEPENDENT ACCOUNTANTS\nTo The Partners of Outlet Centre Partners:\nWe have audited the accompanying balance sheet of Outlet Centre Partners (an Illinois Limited Partnership) as of December 31, 1995 and the related statements of partners' capital, income and expenses, and cash flows 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 Outlet Centre Partners as of December 31, 1995, and the results of its operations and its cash flows for the year then ended in conformity with generally accepted accounting principles.\nCOOPERS & LYBRAND L.L.P.\nChicago, Illinois March 27, 1996 REPORT OF INDEPENDENT ACCOUNTANTS\nTo The Partners of Outlet Centre Partners:\nWe have audited the accompanying balance sheet of OUTLET CENTER PARTNERS (an Illinois Limited Partnership) as of December 31, 1994, and the related statements of partners' capital, income and expenses, and cash flows for each of the two 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 the results of its operations and its cash flows for each of the two years in the period ended December 31, 1994 in conformity with generally accepted accounting principles.\nARTHUR ANDERSEN LLP\nChicago, Illinois February 10, 1995 OUTLET CENTRE PARTNERS (An Illinois Limited Partnership)\nBALANCE SHEETS December 31, 1995 and 1994\nASSETS\n1995 1994 -------------- ------------- Cash and cash equivalents $ 2,406,064 $ 1,819,294 Accounts and accrued interest receivable 40,445 74,981 Escrow deposits 961,250 929,674 Prepaid expenses 33,798 Deferred expenses, net of accumulated amortization of $124,688 in 1995 and $41,563 in 1994 290,937 374,062 -------------- ------------- 3,732,494 3,198,011 -------------- ------------- Investment in real estate: Land 2,871,183 2,871,183 Buildings and improvements 27,565,202 27,299,367 -------------- ------------- 30,436,385 30,170,550 Less accumulated depreciation 10,548,272 9,225,265 -------------- ------------- Investment in real estate, net of accumulated depreciation 19,888,113 20,945,285 -------------- ------------- $ 23,620,607 $ 24,143,296 ============== =============\nLIABILITIES AND PARTNERS' CAPITAL\nAccounts payable $ 137,181 $ 204,154 Due to affiliates 13,933 47,693 Accrued liabilities - principally real estate taxes 618,892 545,840 Security deposits 48,119 49,302 Mortgage note payable 12,568,420 12,692,502 -------------- ------------- Total liabilities 13,386,545 13,539,491 -------------- ------------- Limited Partners' capital (30,000 Interests issued and outstanding) 11,389,169 11,756,873 General Partner's deficit (1,155,107) (1,153,068) -------------- ------------- Total partners' capital 10,234,062 10,603,805 -------------- ------------- $ 23,620,607 $ 24,143,296 ============== =============\nThe accompanying notes are an integral part of the financial statements. OUTLET CENTRE PARTNERS (An Illinois Limited Partnership)\nSTATEMENTS OF PARTNERS' CAPITAL for the years ended December 31, 1995, 1994, and 1993\nPartners' Capital (Deficit) Accounts ------------------------------------------ General Limited Total Partner Partners -------------- ------------- -------------\nBalance 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\nCash distributions to Limited Partners (A) (165,810) (165,810) Net loss for the year ended December 31, 1995 (203,933) (2,039) (201,894) -------------- ------------- ------------- Balance at December 31, 1995 $ 10,234,062 $ (1,155,107) $ 11,389,169 ============== ============= =============\n(A) Summary of cash distributions paid per Limited Partnership Interest:\n1995 1994 1993 -------------- ------------- -------------\nFirst Quarter None None $ 11.05 Second Quarter None None 5.525 Third Quarter None None 5.525 Fourth Quarter $ 5.527 None 5.525\nThe accompanying notes are an integral part of the financial statements. OUTLET CENTRE PARTNERS (An Illinois Limited Partnership)\nSTATEMENTS OF INCOME AND EXPENSES for the years ended December 31, 1995, 1994, and 1993\n1995 1994 1993 -------------- ------------- ------------- Income: Rental $ 3,131,371 $ 3,136,357 $ 2,848,289 Service 2,166,699 2,319,857 2,180,945 Interest on short-term investments 113,394 44,639 36,918 -------------- ------------- ------------- Total income 5,411,464 5,500,853 5,066,152 -------------- ------------- ------------- Expenses: Interest on mortgage note payable 1,281,358 1,223,270 1,131,748 Depreciation 1,323,007 1,280,011 1,196,548 Amortization 83,125 84,895 74,286 Property operating 1,841,214 1,896,235 1,907,441 Real estate taxes 563,950 545,840 719,102 Property management fees 257,806 244,587 234,499 Administrative 264,937 344,852 249,333 -------------- ------------- ------------- Total expenses 5,615,397 5,619,690 5,512,957 -------------- ------------- ------------- Net loss $ (203,933) $ (118,837) $ (446,805) ============== ============= ============= Net loss allocated to General Partner $ (2,039) $ (1,188) $ (4,468) ============== ============= ============= Net loss allocated to Limited Partners $ (201,894) $ (117,649) $ (442,337) ============== ============= ============= Net loss per Limited Partnership Interest (30,000 issued and outstanding) $ (6.73) $ (3.92) $ (14.74) ============== ============= =============\nThe accompanying notes are an integral part of the financial statements. OUTLET CENTRE PARTNERS (An Illinois Limited Partnership)\nSTATEMENTS OF CASH FLOWS for the years ended December 31, 1995, 1994, and 1993\n1995 1994 1993 -------------- ------------- ------------- Operating activities: Net loss $ (203,933) $ (118,837) $ (446,805) Adjustments to reconcile net loss to net cash provided by operating activities: Depreciation of property 1,323,007 1,280,011 1,196,548 Amortization of deferred expenses 83,125 84,895 74,286 Net change in: Accounts and accrued interest receivable 34,536 43,129 (13,014) Escrow deposits (31,576) (14,949) Prepaid expenses (33,798) Accounts payable (66,973) (143,509) 88,966 Due to affiliates (33,760) 12,438 3,090 Accrued liabilities 73,052 (173,262) (27,138) Security deposits (1,183) (16,025) (6,854) -------------- ------------- ------------- Net cash provided by operating activities 1,142,497 953,891 869,079 -------------- ------------- ------------- Investing activity: Improvements to property (265,835) (261,676) (426,216) -------------- ------------- ------------- Net cash used in investing activity (265,835) (261,676) (426,216) -------------- ------------- ------------- Financing activities: Distributions to Limited Partners (165,810) (828,750) Proceeds from refinancing of mortgage note payable 12,750,000 Repayment of mortgage note payable (11,468,631) Principal payments on mortgage note payable (124,082) (132,752) (121,052) Funding of capital improvement escrows (914,725) Payment of deferred expenses (415,625) -------------- ------------- ------------- Net cash used in finanacing activities (289,892) (181,733) (949,802) -------------- ------------- ------------- Net change in cash and cash equivalents 586,770 510,482 (506,939) Cash and cash equivalents at beginning of year 1,819,294 1,308,812 1,815,751 -------------- ------------- ------------- Cash and cash equivalents at end of year $ 2,406,064 $ 1,819,294 $ 1,308,812 ============== ============= =============\nThe accompanying notes are an integral part of the financial statements. OUTLET CENTRE PARTNERS (An Illinois Limited Partnership)\nNOTES TO FINANCIAL STATEMENTS\n1. Nature of the Partnership's Business:\nOutlet Centre Partners is engaged exclusively in the operation of retail real estate located in Bristol, Wisconsin.\n2. Accounting Policies:\n(a) The preparation of the financial statements in conformity with generally accepted accounting principles requires the General Partner 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 vary from those estimates.\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.\n(c) Effective January 1, 1995 the Partnership adopted Statement of Financial Accounting Standards, No. 121 (SFAS 121), (\"Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of\"). Under SFAS 121, the Partnership records its investments in real estate at the lower of cost or fair value, and periodically assesses, but not less than on an annual basis, possible impairment to the value of its properties. The General Partner estimates the fair value of its properties by dividing the property's expected net operating income by a risk adjusted rate of return which considers economic and demographic conditions in the market. In the event the General Partner determines an impairment in value has occurred, and the carrying amount of the real estate asset will not be recovered, a provision is recorded to reduce the carrying basis of the property to its estimated fair value. The General Partner considers the method referred to above to result in a reasonable measurement of a property's fair value, unless other factors affecting the property's value indicate otherwise.\n(d) Deferred expenses consist of financing fees which are amortized over the term of the loan agreement.\n(e) Revenue is recognized on an accrual basis in accordance with generally accepted accounting principles. Income from operating leases with significant abatements and\/or scheduled rent increases is recognized on a straight line basis over the respective lease term. Service income includes reimbursements from operating costs such as real estate taxes, maintenance and insurance and is recognized as revenue in the period the applicable costs are incurred.\n(f) The Financial Accounting Standard Board's Statement No. 107, \"Disclosures About Fair Value of Financial Instruments\", requires disclosure of fair value information about financial instruments for which it is practicable to estimate that value. Since quoted market prices are not available for the Partnership's financial instruments, fair values have been based on estimates using present value techniques. These techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, may not be realized in immediate settlement of the instrument. Statement No. 107 does not apply to all balance sheet items and excludes certain financial instruments and all non-financial instruments such as real estate from its disclosure requirements.\n(g) Cash and cash equivalents include all unrestricted, highly liquid investments with an original maturity of three months or less. At December 31, 1995, cash and cash equivalents are held or invested in primarily one type of commercial paper.\n(h) The Partnership is not liable for Federal income taxes as each partner recognizes his proportionate share of the Partnership income or loss in his tax return; therefore, no provision for income taxes is made in the financial statements of the Partnership.\n(i) A reclassification has been made to the previously reported 1993 and 1994 statements in order to conform with the classification used in 1995. This reclassification has not changed the 1993 or 1994 results.\n3. 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. 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.\n4. 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. The Centre, with a carrying value of $19,888,113 at December 31, 1995, was pledged as collateral for repayment of the mortgage loan.\nFuture maturities of the above note are approximately as follows:\n1996 $ 137,000 1997 152,000 1998 168,000 1999 12,112,000\nDuring the years ended December 31, 1995, 1994 and 1993, the Partnership incurred and paid interest expense on the mortgage notes payable of $1,281,358, $1,223,270 and $1,131,748, respectively.\n5. Management Agreement:\nAs of December 31, 1995, 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.\n6. 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 1995, 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 $315,852. The 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 $27,657,717. The total cost of the above mentioned is $30,528,900.\n7. Transactions with Affiliates:\nFees and expenses paid and payable by the Partnership to affiliates are:\nYear Ended Year Ended Year Ended 12\/31\/95 12\/31\/94 12\/31\/93 --------------- -------------- -------------- Paid Payable Paid Payable Paid Payable ------- -------- ------ ------- ------ -------\nProperty management fees None None $225,117 None $230,289 $23,799 Reimbursement of expenses to the General Partner, at cost: Accounting $26,881 $3,057 44,324 16,613 30,090 2,483 Data processing 7,362 845 14,181 3,089 9,210 1,979 Investor communica- tions 4,458 None 18,104 6,960 18,333 1,513 Legal 14,193 537 16,205 4,073 6,001 495 Portfolio management 56,781 9,476 35,774 13,117 24,833 2,049 Other 10,715 18 17,421 3,841 35,591 2,937\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; however, the General Partner is reimbursed for program expenses. The Partnership paid premiums to the deductible insurance program of $23,974, $27,307 and $18,499 for 1995, 1994 and 1993, respectively.\n8. 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, 1995 are approximately as follows:\n1996 $ 2,850,000 1997 2,248,000 1998 1,723,000 1999 1,317,000 2000 745,000 Thereafter 878,000\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 totaled approximately $224,000 for 1995, $221,000 for 1994 and $98,000 for 1993. The Partnership is subject to the usual business risks regarding the collection of the above-mentioned rentals.\n9. Fair Values of Financial Instruments:\nThe carrying amounts and fair values of the Partnership's financial instruments at December 31, 1995 are as follows:\nThe carrying value of cash and cash equivalents, accounts and accrued interest receivable, accounts and accrued interest payable approximates fair value.\nMortgage note payable: Based on borrowing rates available to the Partnership at the end of 1995 for mortgage loans with similar terms and maturities, the fair value of the mortgage note payable approximates the carrying value.\n10. Subsequent Event:\nIn January 1996, the Partnership paid $165,810 to Limited Partners representing the regular quarterly distribution of available Net Cash Receipts of $5.527 per Interest for the fourth quarter of 1995.","section_15":""}
{"filename":"34563_1995.txt","cik":"34563","year":"1995","section_1":"Item 1. Business\nGeneral: Farmer Bros. Co. (the Company or Registrant) was incorporated in California in 1923, and is engaged in the production and sale of coffee, spices and a variety of allied products to the institutional food service industry.\nRaw Materials and Supplies: Coffee is the largest product in the line and is responsible for approximately 63% of corporate revenues. Purchasing, roasting and packaging coffee takes place at Registrant's Torrance plant, which is also the distribution hub for its branches.\nGreen coffee is purchased through domestic commodity brokers. Agricultural commodities are subject to fluctuations of both price and supply. Registrant has not been confronted by shortages in the supply of green coffee, but has been faced with price fluctuations.\nTrademarks & Patents: Registrant owns approximately 23 registered U.S. trademarks which are integral to customer identification of its products. It is not possible to assess the impact of the loss of such identification.\nSeasonality: Registrant experiences some seasonal influences. The winter months are the best sales months. Registrant's product line and geographic diversity provides some sales stability during the summertime decline in coffee consumption during the warmer months.\nDistribution: Registrant's products are distributed by its selling divisions from 96 branches located in most urban centers in the western states. The diversity of the product line (over 300 products) and size of the area served requires each branch to stock a sizable inventory. Registrant maintains its own trucking fleet to better control the supply of these warehouses.\nCustomers: No single customer represents a large enough portion of sales to have a material effect on Registrant. The customer contact and service quality which is integral to Registrant's sales effort is often secondary to product pricing for customers with their own distribution systems.\nCompetition: Registrant faces competition from many sources, including multi-national firms like Procter and Gamble, Nestle and Philip Morris, grocery distributors like Sysco and Rykoff-Sexton and regional roasters like Boyd Coffee Co., Lingle Bros. and Royal Cup.\nRegistrant has some competitive advantages due to its longevity, strong regional roots and sales and service force. Registrant's customer base is price sensitive and the Company is often faced with price competition.\nWorking Capital: Registrant makes every effort to finance operations internally. Management believes that working capital from internal sources will be adequate for the coming year. Registrant maintains a $50,000,000 line of credit with First Interstate Bank of California. There is no commitment fee or compensating balance requirement and the line was not used in fiscal 1995.\nItem 1. Business, Continued\nForeign Operations: Registrant has no material revenues that result from foreign operations. Coffee brewing equipment is sold through distributors in Canada and Japan and manufactured in Europe under license.\nOther: On June 30, 1995, Registrant employed 1,172 employees, 486 are subject to collective bargaining agreements.\nThere have been no material effects of compliance with government provisions regulating discharge of materials into the environment.\nThe nature of Registrant's business does not provide for maintenance of or reliance upon a sales backlog.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nRegistrant's largest facility is the 474,000 sq. ft. roasting plant, warehouses and administrative offices in Torrance, California. Registrant believes the existing plant will continue to provide adequate production capacity for the foreseeable future.\nItem 3.","section_3":"Item 3. Legal Proceedings\nRegistrant is a defendant in various legal proceedings incidental to its business which are ordinary and routine. It is management's opinion that the resolution of these lawsuits will have no material financial impact on the Company.\nItem 4.","section_4":"Item 4. Submission of Matters to A Vote of Security Holders\nNone.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Shareholder Matters\nRegistrant has one class of common stock which is traded in the over the counter market. The bid prices indicated below are as reported by NASDAQ and represent prices between dealers, without including retail mark up, mark down or commission, and do not necessarily represent actual trades.\n1995 1994 High Low Dividend High Low Dividend 1st Quarter $134.00 $123.00 $ 0.50 $156.00 $145.00 $ 0.50 2nd Quarter 132.00 120.00 0.50 156.00 134.00 0.50 3rd Quarter 130.00 117.00 0.50 151.00 126.00 0.50 4th Quarter 132.00 120.00 0.50 148.00 123.00 0.50\nThere were 654 holders of record on June 30, 1995.\nItem 6.","section_6":"Item 6. Selected Financial Data (Dollars in thousands, except per share data)\n1995 1994 1993 Net sales $234,662 $193,861 $190,679 Income from operations 25,235 9,488 29,929 Net income 19,517 10,330 18,950* Net income per share $10.13 $5.36 $9.84* Total assets $244,340 $219,903 $216,266 Dividends declared per share $2.00 $2.00 $1.80\n1992 1991 Net sales $197,312 $196,232 Income from operations 27,494 28,016 Net income 20,226 21,394 Net income per share $10.50 $11.11 Total assets $190,714 $171,361 Dividends declared per share $1.60 $1.40\n* Includes the cumulative impact of adopting Statement of Financial Accounting Standards Nos. 109 (\"SFAS 109\"), \"Accounting for Income Taxes\" and 106 (\"SFAS 106\"), \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" as of July 1, 1992, which reduced net income for the year ended June 30, 1993 by approximately $5,294,000 or $2.75 per share. (See Notes F and G 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\nRegistrant continues to maintain a strong working capital position, and management believes cash requirements for the coming year will be provided by internal sources. Registrant has no major commitments for capital expenditures at this time. Construction of a new laboratory building in its Torrance compound will be completed this fall at an estimated cost of $2.5 million. The Company also has a branch warehouse nearing completion in Austin, Texas with a cost of $725,000 and expects to start construction of a similar facility in Memphis, Tennessee.\nThe Company maintains a $50 million line of credit with First Interstate Bank of California. There was no bank debt incurred during fiscal 1995.\n1995 1994 1993 (Dollars in thousands) Current assets $149,806 $103,375 $155,148 Current liabilities 18,724 12,488 15,269 Working capital $131,082 $ 90,887 $139,879 Quick ratio 5.73:1 4.76:1 7.77:1 Capital Expenditures $ 9,085 $ 6,658 $ 5,388\nResults of Operations\nThe volatile green coffee market continues to effect Registrant. Green coffee costs soared last year as Brazil, the world's largest coffee producer, sustained frost damage to the coffee crop. Speculation about the extent of crop losses spurred green coffee costs to eight year highs. Higher green coffee costs have been passed on to Registrant's customers with higher selling prices of roast coffee, but higher prices result in lower sales volume and customer resistance to higher prices result in smaller margins.\nNet sales increased 21% to $234,662,000 in 1995 as compared to $193,861,000 in 1994 as the result of higher roast coffee prices, offset by a 7% decrease in coffee volume. Gross profit increased to $112,899,000 in 1995, or 48% of sales, compared to $94,295,000, or 49% of sales, in 1994. This is still less than the $114,258,000 gross profit, or 60% of sales, reached in fiscal 1993. Other expenses increased 3% to $87,664,000 in 1995 from $84,807,000 in 1994 and $84,329,000 in 1993.\nIncome before taxes increased to $31,284,000 or 13% of sales in 1995, as compared to $16,689,000 or 9% of sales in 1994 and $39,538,000 or 21% of sales in 1993. 1994 earnings were depressed by a volatile increase in green coffee market costs. Net income for fiscal 1995 reached $19,517,000, or $10.13 per share, as compared to $10,330,000, or $5.36 per share, in 1994 and $18,950,000, or $9.84 per share, in 1993.\nRegistrant adopted the provisions of Statement of Financial Accounting Standards No. 115 (\"SFAS 115\"), \"Accounting for Certain Investments in Debt and Equity Securities\" during the first quarter of fiscal 1995. In accordance with SFAS 115, prior period financial statements have not been restated. The adoption of SFAS 115 did not have a significant effect upon the Company's financial condition or results of operation.\n1995 1994 1993* Income per share: Before accounting changes $10.13 $ 5.36 $12.59 Cumulative effect of accounting changes - - (2.75) Net income per share $10.13 $ 5.36 $ 9.84\nPercentage change: 1995 to 1994 1994 to 1993 Net sales 21.1% 1.7% Cost of goods sold 22.3% 30.3% Gross profit 19.7% (17.5%) Operating expenses 3.4% 0.6% Income from operations 166.0% (68.3%) Provision for income taxes 85.0% (58.4%) Income before accounting changes 88.9% (57.4%) Net income 88.9% (45.5%)\n* The Company adopted SFAS 106 and SFAS 109 in 1993.\nChange in Earnings Per Share A summary of the change in earnings per share, which highlights factors discussed earlier, is as follows: Per Share Earnings Per Share Earnings 1995 vs. 1994 1994 vs. 1993 Coffee: Prices $24.11 $ 1.66 Volume (4.08) (2.02) Cost (10.27) (11.10) Gross Profit 9.76 (11.46)\nAllied products: Gross Profit (0.10) 1.10 Operating expenses (1.48) (0.25) Other income (0.60) (1.25) Provision for income taxes (2.81) 4.63 Income before accounting changes 4.77 (7.23) Cumulative effect of accounting changes* - 2.75 Net income $4.77 $(4.48)\n* The Company adopted SFAS 106 and SFAS 109 in 1993.\nPrice Risk The Company's operations are significantly impacted by the world market for green coffee, its largest product. Coffee is an agricultural product and fundamental shifts in supply or demand can have a dramatic effect on its price. Coffee is traded domestically on the New York Coffee Tea and Cocoa Exchange, and is one of the largest and most volatile commodity markets. At present, the Company manages its exposure to price risk by managing its inventory level. Registrant is unable to predict either the direction or duration of coffee price swings, and cautions against using past results to predict future results.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholders of Farmer Bros. Co. and Subsidiary\nWe have audited the consolidated financial statements of Farmer Bros. Co. and Subsidiary (\"the Company\") as listed in Item 14(a) of this Form 10-K. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe 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 as of June 30, 1995 and 1994, and the consolidated results of its operations and its cash flows for each of the three years in the period ended June 30, 1995 in conformity with generally accepted accounting principles.\nAs discussed in Notes B, F and G to the consolidated financial statements, the Company changed its methods of accounting for certain investments in debt and equity securities in 1995 and for postretirement benefits other than pensions and income taxes in 1993.\nCoopers & Lybrand L.L.P.\nLos Angeles, California September 22, 1995\nFARMER BROS. CO. CONSOLIDATED BALANCE SHEETS (Dollars in thousands)\nJune 30, June 30, 1995 1994\nThe accompanying notes are an integral part of these financial statements.\nFARMER BROS. CO. CONSOLIDATED STATEMENTS OF INCOME (Dollars in thousands, except per share data)\nThe accompanying notes are an integral part of these financial statements.\nFARMER BROS. CO. CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands)\nThe accompanying notes are an integral part of these financial statements.\nFARMER BROS. CO CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands)\nThe accompanying notes are an integral part of these financial statements.\nFARMER BROS. CO. CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (Dollars in thousands, except per share data)\nThe accompanying notes are an integral part of these financial statements.\nNotes to Consolidated Financial Statements\nA. Summary of Significant Accounting Policies\nPrinciples of Consolidation The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary FBC Finance Company. All significant intercompany balances and transactions have been eliminated.\nCash Equivalents The Company considers all highly liquid investments with a maturity of 30 days or less when purchased to be cash equivalents, which approximate market.\nInvestments The Company adopted Statement of Financial Accounting Standards No. 115 (SFAS 115), Accounting for Certain Investments in Debt and Equity Securities, as of July 1, 1994. SFAS 115 specifies the accounting treatment of the Company's investments based on investment classifications defined in the statement. The Company's investments have been recorded at fair value and in accordance with SFAS 115 have been classified as \"available for sale\". Any unrealized gains or losses on such investments at June 30, 1995 have been recorded as a separate component of shareholders' equity (Note B).\nAs required by SFAS 115, prior year financial statements have not been restated. Therefore, investments in marketable equity securities as of June 30, 1994 are carried at the lower of cost or market. Other investments as of June 30, 1994 are carried at amortized cost which approximate market. A valuation allowance as of June 30, 1994 is included in shareholders' equity that represents any net unrealized loss from non-current investments.\nThe cost of investments sold is determined on the specific identification method. Dividend and interest income is accrued as earned.\nInventories Inventories are valued at the lower of cost or market. Costs of coffee and allied products are determined on the Last In, First Out (LIFO) basis. Costs of coffee brewing equipment manufactured are accounted for on the First In, First Out (FIFO) basis.\nIn the normal course of business, the Company enters into commodity purchase agreements with suppliers and futures contracts to minimize exposure to inventory price fluctuations. Decreases in the market value of the commodity purchase agreements, if any, are recognized in earnings currently. In the event of non-performance by the counterparties, the Company could be exposed to credit and supply risk. The Company monitors the financial viability of the counterparties. Futures contracts not designated as hedges are marked to market and changes are recognized in earnings currently.\nA. Summary of Significant Accounting Policies, Continued\nProperty, Plant and Equipment Property, plant and equipment is carried at cost, less accumulated depreciation. Depreciation of buildings and facilities is computed using the straight-line method. Other assets are depreciated using the sum-of- the-years' digits and straight line methods. The following useful lives are used:\nBuildings and facilities 10 to 30 years Machinery and equipment 3 to 5 years Office furniture and equipment 5 years\nWhen assets are sold or retired the asset and related depreciation allowance is eliminated from the records and any gain or loss on disposal is included in operations. Maintenance and repairs are charged to expense, betterments are capitalized.\nIncome Taxes Deferred income taxes are determined based on the difference between the financial reporting and tax bases of assets and liabilities, using enacted tax rates in effect for the year in which differences are expected to reverse.\nB. Investments 1995 1994 Fair Cost Value* Cost Market (In thousands) Current Assets U.S. Government Obligations $80,608 $80,530 $34,839* $34,924 $80,608 $80,530 $34,839 $34,924\nNon-Current Assets U.S. Government Obligations $ 8,617 $ 8,610 $39,599* $38,621 Corporate bonds 1,599 1,569 1,799* 1,796 Preferred stocks 30,456 31,896 28,260 27,216* Liquid asset fund and other 1,262 1,262 3,346* 3,346 $41,934 $43,337 $73,004 $70,979 * carrying value\nThe contractual maturities of debt securities classified as current and non- current available for sale are the following.\nFair Value Maturities 6\/30\/95 6\/30\/94 (In thousands) Within one year $80,530 $34,924 After 1 year through 5 years 8,610 38,621 After 5 years through 10 years 1,569 1,796 $90,709 $75,341\nB. Investments, Continued\nEffective July 1, 1994, the Company adopted SFAS 115. As of June 30, 1995 all investments held by the Company were classified as available for sale. The gross unrealized gains and (losses) on securities classified as available for sale were $1,732,000 and ($407,000), respectively, in 1995. Gross realized gains from available for sale securities were $1,857,000.\nThe Company hedges interest rate risk in its portfolio of preferred stock. As of June 30, 1995, a substantial portion of the preferred stock portfolio was hedged with put options on US Treasury futures traded on a national exchange. Deferred losses at June 30, 1995, associated with the hedge were $1,329,000. Such deferred losses will be recognized in other income as the related unrealized gains in the preferred stock portfolio are realized.\nC. Allowance for Doubtful Accounts and Notes Receivable\n1995 1994 1993 (In thousands)\nBalance at beginning of year $445 $530 $614 Additions 527 184 339 Deductions (427) (269) (423) Balance at end of year $545 $445 $530\nD. Inventories\nJune 30, 1995 Processed Unprocessed Total (In thousands)\nCoffee $ 3,093 $10,809 $13,902 Allied products 11,308 4,096 15,404 Coffee brewing equipment 2,120 5,335 7,455 $16,521 $20,240 $36,761\nJune 30, 1994 Processed Unprocessed Total\nCoffee $ 3,182 $10,829 $14,011 Allied products 10,395 3,022 13,417 Coffee brewing equipment 1,712 5,770 7,482 $15,289 $19,621 $34,910\nCurrent cost of coffee and allied products inventories exceeds the LIFO cost by approximately $30,246,000, and $6,700,000 as of June 30, 1995 and 1994, respectively.\nFor the year ended June 30, 1995, a decrease in the Company's green coffee inventories resulted in a LIFO decrement which increased current year pre- tax income by approximately $1,008,000.\nE. Property, Plant and Equipment 1995 1994 (In thousands)\nBuildings and facilities $26,902 $23,760 Machinery and equipment 43,099 46,237 Office furniture and equipment 8,362 2,217 78,363 72,214 Accumulated depreciation (49,980) (47,997) Land 4,830 4,726 $33,213 $28,943\nMaintenance and repairs charged to expense for the years ended June 30, 1995, 1994 and 1993 were $10,545,000, $9,137,000 and $9,056,000, respectively.\nF. Retirement Plans\nThe Company has a contributory defined benefit pension plan for all employees not covered under a collective bargaining agreement (Farmer Bros. Co.) and a non-contributory defined benefit pension plan for certain hourly employees covered under a collective bargaining agreement (Brewmatic Co.). The Company's funding policy is to contribute annually at a rate that is intended to fund benefits as a level percentage of salary (Farmer Bros. Co.) and as a level dollar cost per participant (Brewmatic Co.) over the working lifetime of the plan participants. Benefit payments are determined under a final pay formula (Farmer Bros. Co.) and flat benefit formula (Brewmatic Co.)\nThe net periodic pension benefit for 1995, 1994 and 1993 are comprised of the following:\nFarmer Bros. Co. Brewmatic Co. (In thousands) Service cost $ 875 $ 16 Interest cost 2,083 119 Actual return on assets (5,358) 304 Net amortization and deferral 1,738 (507) Net periodic pension benefit $ (662) $ (68) Service cost $ 594 $ 14 Interest cost 1,869 116 Actual return on assets (94) 6 Net amortization and deferral (3,651) (216) Net periodic pension benefit $(1,282) $ (80) Service cost $ 588 $ 16 Interest cost 1,629 110 Actual return on assets (5,870) (260) Net amortization and deferral 2,719 76 Net periodic pension benefit $ (934) $ (58)\nF. Retirement Plans, Continued\nThe funded status of the plans at June 30, 1995 was as follows: Farmer Bros. Co. Brewmatic Co. (In thousands) Actuarial present value of benefit obligations: Vested $27,133 $1,621 Non-vested 154 - Accumulated benefit obligations 27,287 1,621 Effect of projected salary increases 3,075 - Projected benefit obligations 30,362 1,621 Plan assets at fair value (43,121) (2,509) Plan assets at fair value in excess of projected benefit obligations (12,759) (888) Unrecognized net asset at June 30, 1995 4,965 292 Unrecognized prior service cost (1,763) (104) Unrecognized net gain (loss) 565 (40) Prepaid pension cost $(8,992) $ (740)\nAssumptions for 1995: Discount rate for plan obligations 7.75% 7.75% Assumed long term return on assets 8.00% 8.00% Projected compensation increases for pay related plans 3.10% -\nThe funded status of the plans at June 30, 1994 was as follows: Farmer Bros. Co. Brewmatic Co. (In thousands) Actuarial present value of benefit obligations: Vested $ 22,710 $ 1,590 Non-vested 110 - Accumulated benefit obligations 22,820 1,590 Effect of projected salary increases 3,724 - Projected benefit obligations 26,544 1,590 Plan assets at fair value (39,111) (2,295) Plan assets at fair value in excess of projected benefit obligations (12,567) (705) Unrecognized net asset at June 30, 1994 5,585 329 Unrecognized prior service cost (304) (117) Unrecognized net loss (1,045) (167) Prepaid pension cost $ (8,331) $ (660)\nAssumptions for 1994: Discount rate for plan obligations 7.75% 7.75% Assumed long term return on assets 8.00% 8.00% Projected compensation increases for pay related plans 3.10% -\nThe assets of each plan are primarily invested in publicly traded stocks and bonds, U.S. government securities and money market funds. The Farmer Bros. Co. Retirement Plan owned 21,765 shares of the Company's common stock at June 30, 1995 and 1994 with a fair value of approximately $2,666,000 and $2,677,000, respectively.\nF. Retirement Plans, Continued\nThe Company contributes to two multi-employer defined benefit plans for certain union employees. The contributions to these multi-employer pension plans were approximately $1,635,000, $1,615,000 and $1,610,000, for 1995, 1994 and 1993, respectively. The Company also has a defined contribution plan for eligible non-union employees. No Company contributions have been made nor required to be made to this plan.\nFarmer Bros. Co. sponsors defined benefit postretirement medical and dental plans that cover non-union employees and retirees, and certain union locals. The plan is contributory; retirees contributions are fixed at a current level. The plan is unfunded.\nThe Plan's accumulated postretirement benefit obligation (APBO) is as follows: June 30, June 30, 1995 1994 (In thousands) Retirees and dependents $5,387 $5,276 Fully eligible active participants 5,869 3,300 Other active plan participants 7,575 2,030 Total APBO $18,831 $10,606\nUnrecognized net (loss) gain (2,828) (596) Unrecognized prior service cost (4,498) - Accrued postretirement benefit cost $11,505 $10,010\nNet periodic postretirement benefit costs included the following components: For the years ended June 30, 1995 1994 1993 (In thousands) Service cost $587 $496 $457 Interest cost 1,042 756 681 Amortization of unrecognized net loss 58 - - Unrecognized Prior Service Cost 71 - - Net periodic postretirement benefit cost $1,758 $1,252 $1,138\nA 9.5 percent annual rate increase in the per capita costs of covered medical care benefits was assumed for the fiscal year ending June 30, 1995, gradually decreasing to 5.5 percent by the fiscal year ending June 30, 2003 and remaining level thereafter. A 6 percent annual rate increase in the per capita costs of covered dental care benefits was assumed for all years. Increasing the assumed health care costs trend rates by one percentage point each year would increase the accumulated postretirement benefit obligation as of June 30, 1995 by $1,318,000 and increase the aggregate of the service cost and interest cost components of net periodic postretirement benefit cost for the fiscal year ending June 30, 1995 by $134,000. A discount rate of 8.0% was used to calculate net periodic postretirement benefit cost for the fiscal year ending June 30, 1995, and\nF. Retirement Plans, Continued\n7.75% was used to determine the accumulated postretirement benefit obligation as of June 30, 1995.\nDuring fiscal 1995, the Company added prescription drug coverage for retirees covered under the medical and dental plan. The additional retiree health benefits increased the unrecognized prior service cost by approximately $4,498,000 as of June 30, 1995.\nA 10 percent annual rate increase in the per capita costs of covered medical care benefits was assumed for the fiscal year ending June 30, 1994, gradually decreasing to 5.5 percent by the fiscal year ending June 30, 2004 and remaining level thereafter. A 6 percent annual rate increase in the per capita costs of covered dental care benefits was assumed for all years. Increasing the assumed health care costs trend rates by one percentage point in each year would increase the accumulated postretirement benefit obligation as of June 30, 1994 by $876,000 and increase the aggregate of the service cost and interest cost components of net periodic postretirement benefit cost for the fiscal year ending June 30, 1994 by $109,000. A discount rate of 8.5% was used to calculate net periodic postretirement benefit cost for the fiscal year ending June 30, 1994, and 8.0% was used to determine the accumulated postretirement benefit obligation as of June 30, 1994.\nIn 1993, the Company adopted Statement of Financial Accounting Standards No. 106 (\"SFAS 106\"), \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" SFAS 106 requires the accrual method of accounting for these benefits rather than the Company's previous policy of recording these benefits when paid. The Company recognized the Accumulated Postretirement Benefit Obligation as of July 1, 1992 of $8,130,000. On an after-tax basis, the cumulative effect of this charge was $4,901,000 or $2.55 per share.\nG. Income Taxes\nEffective July 1, 1992, the Company adopted Statement of Financial Accounting Standards No. 109 (\"SFAS 109\"), \"Accounting for Income Taxes.\" The cumulative effect of adopting SFAS 109 resulted in a charge of $393,000 or $.20 per share.\nG. Income Taxes, Continued\nThe primary components of temporary differences which give rise to the Company's net deferred tax asset at June 30, 1995 and June 30, 1994 are as follows:\nJune 30, June 30, 1995 1994 (In thousands) Deferred tax assets: Postretirement benefits $4,700 $4,068 Accrued liabilities 1,307 2,014 State taxes 543 287 Other 1,242 922 7,792 7,291\nDeferred tax liabilities: Pension assets 3,976 3,653 Other 22 14 3,998 3,667 Net deferred tax asset $3,794 $3,624\nDeferred tax assets are expected to be realized against future taxable income and have not been reduced by a valuation allowance.\nThe current and deferred components of the provision for income taxes consist of the following:\n1995 1994 1993 (In thousands) Current: Federal $ 9,529 $ 4,385 $11,991 State 2,406 1,276 2,837 11,935 5,661 14,828\nDeferred: Federal (145) 642 372 State (23) 56 94 (168) 698 466 $11,767 $ 6,359 $15,294\nA reconciliation of the provision for income taxes to the statutory federal income tax expense is as follows:\n1995 1994 1993 (In thousands, except percentages) Statutory tax rate 35.0% 35.0% 34.5% Income tax expense at statutory rate $10,949 $ 5,841 $13,641 State income tax (net of federal tax benefit) 1,549 865 1,856 Dividend income exclusion (581) (324) (302) Other (net) (150) (23) 99 $11,767 $ 6,359 $15,294\nIncome taxes paid $10,908 $10,993 $15,636\nH. Other Current Liabilities 1995 1994 (In thousands) Accrued workers' compensation liabilities $3,178 $ 3,112 Dividends payable 963 963 Other 464 468 $4,605 $ 4,543\nI. Line of Credit\nThe Company has a credit line of $50,000,000. The line has no fee or compensating balance requirement.\nJ. Commitments and Contingencies\nThe Company incurred rent expense of approximately $678,000, $666,000, and $686,000, for the years ended June 30, 1995, 1994 and 1993, respectively, and is obligated under leases for branch warehouses with terms not exceeding five years. Certain leases contain renewal options.\nFuture minimum lease payments are as follows:\nJune 30, (In thousands)\n1996 $519 1997 368 1998 255 1999 57 2000 10\nThe Company is a party to various pending legal and administrative proceedings. It is management's opinion that the outcome of such proceedings will have no material financial impact on the Company.\nConcentration of Credit Risk: At June 30, 1995, financial instruments which potentially subject the Company to concentrations of credit risk consist of cash in financial institutions (which periodically exceed federally insured limits), cash equivalents (principally commercial paper), short term investments and investments in the preferred stocks of other companies. Commercial paper investments are not concentrated by issuer, industry or geographic area. Maturities are generally shorter than 90 days. Other investments are in U.S. government securities. Investment in the preferred stocks of other companies are limited to high quality issuers and are not concentrated by geographic area or issuer.\nK. Quarterly Financial Data (Unaudited)\nQuarter Ended\n09\/30\/94 12\/31\/94 03\/31\/95 06\/30\/95 (In thousands, except per share data) Net sales $54,182 $62,598 $59,514 $58,368 Gross profit 25,908 30,085 26,818 30,088 Income from operations 4,514 8,023 4,448 8,250 Net income 3,757 5,706 3,220 6,834 Net income per share $1.95 $2.96 $1.67 $3.55\nQuarter Ended\n09\/30\/93 12\/31\/93 03\/31\/94 06\/30\/94* (In thousands, except per share data) Net sales $46,998 $49,564 $48,628 $48,671 Gross profit 26,010 27,621 26,811 13,853 Income (loss) from operations 5,244 5,889 4,679 (6,324) Net income (loss) 4,365 4,196 3,932 (2,163) Net income (loss) per share $2.27 $2.18 $2.04 $(1.13)\n* Results were negatively impacted by the sudden increase in green coffee prices which occurred in the fourth quarter of 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\nReference is made to the information to be set forth in the section entitled \"Election of Directors\" in the definitive proxy statement involving the election of directors in connection with the Annual Meeting of Shareholders to be held on November 27, 1995 (the \"Proxy Statement\") which section is incorporated herein by reference. The Proxy statement will be filed with the Securities and Exchange Commission no later than 120 days after June 30, 1995, pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended.\nName Age Position\nRoy F. Farmer 79 Chairman of Board of Directors since 1951.\nRoy E. Farmer 43 President since 1993; various positions since 1976, son of Chairman of the Board, R.F. Farmer.\nGuenter W. Berger 58 Vice President of Production, Director since 1980; various positions since 1960.\nKenneth R. Carson 55 Vice President of Sales since 1990; Sales Management since 1968.\nDavid W. Uhley 54 Secretary since 1985; various positions since 1968.\nJohn E. Simmons 44 Treasurer since 1985; various positions since 1980.\nAll officers are elected annually by the Board of Directors and serve at the pleasure of the Board.\nItem 11.","section_11":"Item 11. Executive Compensation\nReference is made to the information to be set forth in the section entitled \"Management Remuneration\" in the Proxy Statement, 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 information to be set forth in the sections entitled \"Principal Shareholders\" and \"Election of Directors\" in the Proxy Statement, which is incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nReference is made to the information to be set forth in the sections entitled \"Principal Shareholders\" and \"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.\n(a) List of Financial Statements and Financial Statement Schedules 1. Financial Statements included in Item 8: Consolidated Balance Sheets as of June 30, 1995 and 1994. Consolidated Statements of Income For the Years Ended June 30, 1995, 1994 and 1993. Consolidated Statements of Cash Flows For the Years Ended June 30, 1995, 1994 and 1993. Consolidated Statements of Shareholders' Equity For the Years Ended June 30, 1995, 1994 and 1993. Notes to Consolidated Financial Statements\n2. Financial Statement Schedules: Financial Statement Schedules are omitted as they are not applicable, or the required information is given in the consolidated financial statements or notes thereto.\n3. Exhibits required by Item 601 of Regulation S-K. See item (c) below.\n(b) Reports on Form 8-K. Registrant did not file any reports on Form 8-K during the quarter ended June 30, 1995.\n(c) Exhibits required by Item 601 of Regulation S-K.\nExhibits 3. Articles of incorporation and by-laws. Filed with the Form 10-K for the fiscal year ended June 30, 1986. 4. Instruments defining the rights of security holders, including indentures. Not applicable. 9. Voting trust agreement. Not applicable. 10. Material contracts Not applicable. 11. Statement re computation of per share earnings. Not applicable. 12. Statements re computation of ratios. Not applicable. 13. Annual report to security holders, Form 10-Q or quarterly report to security holders. Not applicable. 18. Letter re change in accounting principles. Not applicable. 19. Previously unfiled documents. Not applicable.\nItem 14. Exhibits, Financial Statement Schedules and Reports on Form 8K, Continued\n22. Subsidiaries of the Registrant. Not applicable. 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. 28. Additional exhibits. Not applicable. 29. Information from reports furnished to state insurance regulatory authorities. Not applicable.\n(d) Financial statements required by Regulation S-X but excluded from the annual report to shareholders by Rule 14a - 3(b). 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.\nFarmer Bros. Co.\nBy: Roy F. Farmer (Roy F. Farmer, Chief Executive Officer and Chairman of the Board of Directors) Date: September 25, 1995\nBy: John E. Simmons (John E. Simmons, Treasurer and Chief Financial and Accounting Officer) Date: September 25, 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.\nRoy E. Farmer Roy E. Farmer, President and Director Date: September 25, 1995\nGuenter W. Berger Guenter W. Berger, Vice President and Director Date: September 25, 1995\nLewis A. Coffman Lewis A. Coffman, Director Date: September 25, 1995\nJohn M. Anglin, Director Date: September 25, 1995\nCatherine E. Crowe, Director Date: September 25, 1995","section_15":""}
{"filename":"858452_1995.txt","cik":"858452","year":"1995","section_1":"ITEM 1. BUSINESS\nBACKGROUND\nOn January 10, 1995, TriCare acquired Transcend Services, Inc., a Georgia corporation (\"Transcend\") by the merger of Transcend into First Western Health Corporation (\"Merger\"). On May 31, 1995, Transcend Services, Inc., a California corporation following its January 10, 1995 merger into TriCare, and Veritas Healthcare Management, a California corporation owned by TriCare, merged into the TriCare corporation, whose name was then changed to \"Transcend Services, Inc.\" Transcend Services, Inc. Now operates as a Delaware corporation. Inasmuch as the Merger is being treated for financial accounting purposes as the acquisition of TriCare by Transcend, following the merger, the historical financial statements of Transcend have become the financial statements of TriCare and include the businesses of both companies after the effective date of the merger. As a result, the operations of Sullivan (acquired by TriCare in June, 1994) prior to January 1995 are excluded from the historical financial statements. Transcend is a hospital services company focused on the outsourcing of Health Information Management (HIM) for health care providers.\nTriCare was incorporated in California in 1976 and was reorganized as a Delaware corporation in 1988. The Company's applicant related service businesses of First Western Health Corporation (\"First Western\") and Veritas Healthcare Management (\"Veritas\") were discontinued on April 30, 1993 and substantially all of the assets and liabilities of another subsidiary, Occu-Care, inc. (\"Occu-Care\") were sold on September 16, 1994. The net assets of discontinued operations are shown on the combined balance sheet and the related statement of cash flows as a separate line item and included the discontinued operations of First Western and Veritas.\nTRANSCEND\nGENERAL\nTranscend provides health information management services (also referred to as \"outsourcing\"), medical transcription services and consulting and reimbursement coding services to hospitals. In addition, Transcend, through its 100% wholly-owned subsidiary Sullivan Health and Rehabilitation Services, provides healthcare case management and cost containment and rehabilitation services to the insurance and risk management industry.\nTranscend currently operates, on a contract management basis, the health information management, or medical records departments of fourteen (14) general acute care hospitals, located in\neleven states and the District of Columbia. In addition, Transcend provides full contract management outsourcing services in the patient access (admitting) departments for five (5) of those fourteen hospitals. Transcend also provides, through outsourcing as well as other contracts, medical records transcription services through computer and telephone links from centralized facilities to approximately 100 hospital customers. Transcend also serves as an independent consultant to hospitals, providing health information management and reimbursement coding services to multiple accounts.\nTranscend was organized in 1984 and was initially engaged in the business of providing consulting services regarding medical records management, quality and utilization management, and records coding, as well as development of records management software until 1992 when the strategic direction of Transcend was changed to focus on total outsourcing, or contract management, of hospital medical records departments. The resulting change in orientation and emphasis of Transcend's business necessitated a period of development, testing and marketing of concepts new to Transcend's traditional lines of business, which extended through most of 1992. Transcend entered into its first long- term agreement for management of a hospital's medical records department at the end of 1992. During 1993, Transcend sold its records management software division, and acquired a medical transcription business, dataLogix (which now operates as a division of Transcend). Transcend purchased the assets of a second medical transcription business, Script-Ease, on September 30, 1994; a third, International Dictating Services, Inc. on January 31, 1995; and a fourth, Medical Transcription of Atlanta, Inc., on April 19, 1995. Through its January 10, 1995 Merger with TriCare, Transcend owns 100% of Sullivan Health and Rehabilitation Services.\nThe following table sets forth for Transcend's fiscal years ending December 31, 1994 and December 31, 1995, the dollar amount of its total revenues from each of its principal lines of business during such periods:\nTranscend has committed to a strategy of growth in its contract management, medical transcription and its consulting business. Transcend has expanded the range of its contract management services to include management of other functional areas of hospitals associated with health information management, such as management of patient access (admissions), utilization review and quality assurance. For example, Transcend began managing the patient intake services at one of its existing hospital sites in October, 1994. Transcend is actively seeking engagements to provide this expanded range of service to its current and future hospital customers. Furthermore, consistent with its overall\nexpansion strategy, Transcend is exploring the uses of additional technological tools, such as electronic data management using optical imaging equipment, in connection with its management service offerings. Transcend has successfully partnered with a small imaging company to develop and beta test an electronic data management product (trademarked \"TransChart\"). Transcend has now installed this optical scanning product in two (2) of its contract management sites. Transcend will either use its own TransChart product or partner with qualified technology providers to establish optical scanning capabilities at its sites in an effort to achieve optimal customer service levels and superior financial performance. It is the belief of management that the integration of these and similar information management functions and tools, and their operation by experienced information management personnel on a fixed-cost contract basis, will prove attractive to hospitals operating in a managed care environment.\nCONTRACT MANAGEMENT OF MEDICAL RECORDS DEPARTMENTS\nTranscend's principal source of revenues is from long-term contracts for outsourcing, or contract management, of the health information services, or medical records, departments of hospitals. Transcend currently has contracts covering fourteen (14) hospitals ranging in bed size from 56 beds to 541 beds; one of these contracts also covers an additional 33-bed satellite hospital. The initial contract terms of Transcend's current contracts range from two to five years and are generally terminable without cause upon expiration of the initial term or for cause at any time during the initial term thereof. Transcend's existing contracts currently have remaining terms ranging from approximately one to five years. Due to its limited operating history in medical records management, Transcend is unable to assess or predict its contract renewal rate.\nUnder the terms of its outsourcing contracts, Transcend is obligated to provide the contracting medical facility with complete day-to-day management and operation of the facility's medical records department, including maintenance of patient records, monitoring and reduction of backlog in record keeping and chart completion, compliance with record keeping and record retention requirements of governmental and other third-party payors, implementation of record coding functions to optimize reimbursement, medical record abstracting and maintenance of record storage and retrieval systems.\nWith respect to staffing requirements, Transcend's outsourcing contracts are of two types. The first is a \"Management Only\" contract in which Transcend provides a Department Director, having a designated level of training and experience in medical records management and coding, to supervise a hospital's health information management\/medical records department, and employs the departmental supervisory personnel. All other employees of the department remain on the hospital's payroll. Five (5) of Transcend's 14 contracts are \"Management Only\" with most of those signed in the 1993-1994 timeframe. The second type is a full contract management services agreement in which Transcend provides not only a records-management director but also hires all the employees of the department as Transcend's employees. Transcend prefers, whenever possible, to transition all the department staff of a contract department to employment by Transcend. Six (6) of the last eight (8) outsourcing contracts signed and nine (9) of the 14 total contracts have been full contract management service agreements\nwhere Transcend has initially transitioned all of the employees to its payroll.\nUnder each of its current contracts, Transcend is paid a fixed annual fee for its contract management services. Transcend's contracts currently provide for management fees ranging from $420,000 per year to $6,504,000 per year. For most of its contracts, Transcend has also charged a one-time implementation fee (ranging from $10,000 to $75,000, depending on the size of the hospital) for its initial costs in setting up its management systems. Transcend has sought to negotiate its fees on a basis which will represent an immediate savings to the contracting hospital over its historical cost of operating the medical records\/health information management function. For this purpose, Transcend has elected to utilize fixed-installment fee arrangements which do not parallel the operating efficiencies which Transcend expects to achieve over time in the long-term operation of an outsourced department. As a result, Transcend's management anticipates that a disproportionate share of any profit in its long-term outsourcing contracts will be realized in the later portions of such contracts. Management believes that the effects of this pricing strategy on Transcend's overall operations should be alleviated in the future as Transcend obtains outsourcing contracts with a larger number of hospitals and begins to experience renewals from existing hospital clients.\nUnder the terms of five contracts, Transcend has undertaken to provide not only health information management (medical records) services, but also to manage that hospital's patient access (admissions\/registration) function, as well as its social services, utilization management and quality management functions. Transcend believes that management of multiple information management and processing functions on an integrated basis, as contemplated by these contracts, will permit it to provide more efficient and cost effective services to the healthcare institutions, thus permitting more effective and predictable cost-control for such functions. Management believes that increasing emphasis on cost containment, throughout the healthcare industry, will make such integrated-services outsourcing increasingly attractive. Accordingly, it is the intention of Transcend to seek more outsourcing contracts providing fully-integrated health information management, across multiple departments of the same institution, for a single fee. Transcend management believes that such contracts will prove not only attractive to healthcare provider institutions, but ultimately provide a larger revenue base and greater profit opportunity to Transcend. There can be no assurance, in light of Transcend's lack of any prior experience with such integrated outsourcing arrangements, that such arrangements will meet Transcend's current expectations.\nMEDICAL TRANSCRIPTION SERVICES\nTranscend entered the medical transcription business on April 29, 1993, when the Company acquired, for a cash purchase price of $1,100,000, substantially all of the assets of dataLogix Transcription, Inc., a medical transcription service which now operates as a division of Transcend. On September 30, 1994, Transcend acquired the assets of Script-Ease, Inc. (\"Script-Ease\"), a medical transcription business based in Pittsburgh, Pennsylvania, for an acquisition price of approximately $1,300,000. On January 31, 1995, Transcend acquired the assets of International Dictating Services, Inc. (\"IDS\"), a Boston-based transcription service company for an acquisition price of approximately\n$832,000. On April 19, 1995, the Company acquired the assets of Medical Transcription of Atlanta, Inc. (\"MTA\") for approximately $1,372,000. Script-Ease, IDS and MTA, as with dataLogix, are operated by the transcription division of Transcend.\nTranscend provides a computer-based service for transcription of physician dictation for hospitals. While its service arrangements vary from institution to institution, some of which require transcription to be performed on-site or by hospital employees, the transcription division's services are primarily defined as transcription of dictations at remote locations, and transmission via modem or similar telephone link into the computer data base of the contracting hospital. As a result, while it currently provides services to over 100 different medical institutions in the eastern half of the United States (including nine (9) hospitals with which Transcend has outsourcing contracts), the transcription division is able to provide such services from a central office and therefore many of its transcription employees are able to work as \"telecommuters\" using networked computer terminals in their homes.\nTranscend is typically paid for its transcription services on a production basis, at rates determined on a per-line-transcribed basis. Where transcription services are included as part of the services provided in Transcend's outsourcing contracts for health information management, the transcription services are provided internally by Transcend's transcription sites as part of the overall services provided by Transcend for a set contract fee. Transcend seeks wherever possible to cross-market its transcription services with its outsourcing contract services, and to use the institutions with which it has such contracts as a base for generation of additional transcription business.\nTranscend is seeking other opportunities through acquisitions in the healthcare services industry predominantly in the area of medical transcription services. Although it presently has no agreements with any party regarding any such acquisition, additional sources of financing may be required by the Company to complete future acquisitions, if any, see \"Liquidity and Capital Resources - TriCare\/Transcend\" below for further information.\nCONSULTING AND CODING SERVICES\nTranscend continues to offer its services as an independent consultant, on a case by case basis, providing advice with respect to management and operations of medical records departments and related health information management, particularly reimbursement coding (or \"optimization\" services). Transcend also provides consultation services regarding the health information aspects of hospitals' utilization management and quality management functions. Such services, which can also include interim medical records department management and related services, are provided on a negotiated fee for service basis. Transcend's consulting and coding department includes specialists in various aspects of records coding and management.\nSALES AND MARKETING\nTranscend currently employs eight full time sales personnel in the contract management area of its business. Because Transcend's outsourcing services are relatively new in the hospital industry, marketing of those services has, to date, proceeded principally on the basis of personal contacts by Transcend's sales personnel with hospital administrators and Health Information Management directors, as well as referrals from its consulting clients. Beginning in early 1996, Transcend has added a telemarketing program in an effort to significantly improve qualified sales leads and shorten the overall sales cycle. Each of Transcend's sales and marketing personnel is compensated through a combination of salary with commissions and bonuses based on the volume of outsourcing contract business sold. Having established its initial base of outsourcing contract clientele, Transcend expects to increase its sales force by at least one additional employee in 1996, seeking to establish sales force coverage in each of the principal geographic regions of the country. Transcend's 1995 marketing program has recently been changed in favor of a more comprehensive 1996 marketing campaign. This new campaign includes targeted advertising in industry trade publications, direct mailings, customer testimonials and other literature that emphasizes Transcend's market leadership position, its management expertise and its track record with current clients.\nTranscend's transcription and consulting services have historically been marketed primarily through personal contacts and referrals from existing clients. While management believes that this is an appropriate marketing strategy, particularly for consulting services, Transcend has begun to implement a broader marketing campaign for its transcription services, particularly in those markets in which its transcription offices are located.\nPRINCIPAL CUSTOMERS\nBased on revenues for the fiscal year ended December 31, 1995, the same hospitals continued to account for more than five percent (5%) of Transcend's total revenues, but in differing percentages, as follows: Good Samaritan (9%), Greater Southeast Community (including Fort Washington Medical Center) (8%), Tulane University Hospital and Clinic (8%) and Memorial Medical Center of Jacksonville (6%). Based on its revenues for the fiscal year ended December 31, 1994, fees paid by each of the following hospitals accounted for more than five percent (5%) of Transcend's revenues in such period: Good Samaritan Hospital, Downers Grove, Illinois (14%); Greater Southeast Community Hospital, Washington, D.C. (including Fort Washington Medical Center, Fort Washington, Maryland) (15%); Tulane University Hospital and Clinic, New Orleans, Louisiana (16%); and Memorial Medical Center of Jacksonville, Jacksonville, Florida (15%). The \"same hospital\" percentage of revenue comparisons listed here (from 1994 to 1995) have declined significantly and as long-term outsourcing contracts are secured in the future and as the Company expands in the transcription area, management expects the percentages of Transcend's revenues represented by business from any single institution to continue to decline significantly.\nCOMPETITION\nWhile the concept of contract management of clinical, housekeeping and dietary departments is well established, Transcend's management believes that outsourcing or contract management of health information services departments is still a relatively new concept in the hospital industry. Management believes that while Transcend is clearly a pioneer in developing outsourcing of health information management functions on a national basis, there are currently 3-4 regional\/national firms currently engaged in the same business (but believed by management to hold significantly fewer outsourcing contracts than Transcend). Transcend expects that as the concept of outsourcing becomes accepted, it will encounter further competition from some or all of the following sources: other traditional healthcare information management consultants; coding consultants; multi-specialty healthcare services businesses which currently provide contract management to clinical, housekeeping, dietary or other non-medical services departments of hospitals; management information services providers, particularly developers and vendors of management software; and other parties in contract management businesses (for example, business or financial management services) desiring to enter the healthcare field. Transcend expects that competitive factors will include reputation for expertise in health information management, size and scope of referenceable accounts, prior experience in outsourcing, and pricing. While Transcend believes that it can be competitive in these areas, it should be noted that some of its potential competitors (as described above) are larger, better known and better capitalized than Transcend, and such factors could affect Transcend's ability to withstand such competition over the long term.\nTranscend experiences competition with respect to both its transcription and consulting business from a variety of sources, including, in each case, both local and national businesses. The markets both for medical transcription services and for medical records coding and consultation services are highly fragmented, and no competitor or identifiable group of competitors could be said to be dominant. Management believes the principal competitive factors in each case include reputation and prior experience, and in the case of transcription services, pricing, timeliness (i.e., turnaround times on transcribed documents) and accuracy of performance. In both fields, Transcend will be, in some cases, competing against larger, better known and better capitalized competitors.\nSULLIVAN\nOn June 15, 1994, TriCare completed the acquisition of Sullivan Health & Rehabilitation Services. Sullivan operates as a 100% wholly owned subsidiary of Transcend. Sullivan provides healthcare case management and cost containment and rehabilitation services to the insurance and risk management industry, primarily in the Southeast. Sullivan maintains offices in Decatur, Georgia; St. Petersburg, Florida and Dallas, Texas.\nMedical case management, which is the core business for Sullivan, provides assessment, care planning, recommendations, and care coordination services for injured and ill persons covered by insurance carriers or self- insured employers. Sullivan employs or contracts with registered nurses who\nact as a coordinator between the patient, the healthcare providers and the insurance carriers, seeking to ensure the provision of optimal healthcare with an efficient use of resources. Case Management typically involves routine onsite visits to the patient and monthly reporting to the insurance carriers. Sullivan has been providing medical case management services since 1982. Sullivan provides vocational evaluations and computerized skills assessments for clients covered by insurance programs, workers' compensation, long-term disability and Social Security disability.\nSullivan is a smaller, regional competitor with most of its case management business concentrated in the workers' compensation insurance market with larger employers (Fortune 1000 companies).\nDISCONTINUED OPERATIONS\nFirst Western \/ Veritas\nThe net assets of the discontinued operations of TriCare's healthcare subsidiaries, First Western and Veritas (now part of Transcend), both of which ceased operations as of April 30, 1993, are shown on the combined balance sheet and the related statement of cash flows as a separate line item.\nThe net assets related to the discontinued operations at December 31, 1995 were $2,893,000. This amount consisted of $479,000 in prepaid legal fees and $2,414,000 in net accounts receivable. The collection liabilities of First Western & Veritas have been deducted in determining net accounts receivable.\nOn October 14, 1995, the Company sold approximately 38% of it's discontinued operations' gross accounts receivable balance to Medical Receivables Finance, LLC (\"MRF\"), a Delaware limited liability company for:\n- Approximately $932,000 in cash ($882,000 in cash at closing; $50,000 held in escrow) - An opportunity to share in future cash receipts based on MRF's collection activity.\nAs a result, the Company closed its California-based collections operation. The future costs associated with the collection of the accounts receivable have been netted with the assets related to discontinued operations.\nThe sale agreement with MRF is not expected to result in any material gain or loss for the Company. The Company will continue to re-evaluate the realizability of the net assets related to its discontinued operations which were not sold. Any such re-evaluation could result in an adjustment that may potentially be material to the carrying value of this asset.\nIn addition to the above, the Company has contracted with MRF to have MRF for the servicing\nand managing of the remaining 62% of the accounts receivable balance.\nOn September 17, 1993, TriCare and its healthcare subsidiaries (now part of Transcend) and the physician-owned medical groups that have contracts with the healthcare subsidiaries initiated a lawsuit in the Superior Court of the State of California, County of Los Angeles, against twenty-two insurance carriers seeking $115 million in compensatory damages claiming abuse of process, intentional interference with contractual and prospective economic relations and unfair business practices which led to the discontinuation of the business of TriCare's healthcare subsidiaries and their contracting associated medical groups in April 1993 (the \"Lawsuit\"). Certain of the defendants in the Lawsuit have filed cross complaints seeking restitution from TriCare, its healthcare subsidiaries and their associated managed medical groups for funds previously paid to the medical groups and other damages. The costs associated with the above claims cannot be ascertained with any certainty but are expected to be substantial. The Company intends to defer such costs until resolution of the litigation. There can be no assurance as to the outcome of this litigation, including potential recovery, if any, of the Company's claims, or damages if any. Based upon facts and circumstances known to date, in the opinion of management, final resolution of the cross complaint will not have a material adverse effect on the Company's financial condition or results of operations.\nPrior to its acquisition by Transcend, TriCare sold substantially all of the assets and liabilities of its wholly-owned subsidiary, Occu-Care to AmHealth, Inc. (\"AmHealth\") for a purchase price of $4,000,000. The purchase price included $1,500,000 in cash paid at closing; AmHealth's Series A Note in the face amount of $1,500,000 bearing interest of 8% per annum commencing December 1, 1994, payable quarterly thereafter, with the principal payable on or prior to December 1, 1995; and AmHealth's Series B Note in the face amount of $1,000,000 bearing interest of 8% per annum commencing December 1, 1994, payable quarterly thereafter, with the principal payable in equal quarterly installments starting December 1, 1995 and continuing until September 1, 2000. TriCare did not receive its first interest payment on its $2,500,000 note receivable from its sale of the assets of Occu-Care, which constituted an event of default and, therefore, TriCare deferred recognition of the gain from the transaction in the amount of $450,000. On December 30, 1994, TriCare entered into negotiations with AmHealth which resulted in an agreement to exchange its note receivable of $2,500,000 for 2,500,000 shares of $1.00 convertible redeemable preferred stock which pay cumulative dividends at a rate of 6.5% per annum. In conjunction with the Merger on January 10, 1995, Transcend recorded these securities at their fair value of $2,050,000. Under certain circumstances and at the Company's option, the preferred stock is convertible into common stock of AmHealth. The preferred stock is subject to mandatory redemption as follows: 1,500,000 shares (less any shares previously converted) on December 1, 1995, and the balance in nineteen quarterly installments commencing December 1, 1995 which was consistent with the payment schedule of the original notes. The redemption on December 1, 1995 did not occur and discussions are underway with AmHealth to determine a future course of action with regard to the redemption of these securities.\nIn December, 1995, AmHealth signed a Letter of Intent with CORE, Inc. (NASDAQ; CORE) for CORE to purchase substantially all the assets of AmHealth primarily in exchange for CORE stock. The transaction is expected to close by May, 1996. If the above transaction occurs, Transcend would\nlikely settle AmHealth's $2.5 million obligation to Transcend in exchange for CORE stock. However, there can be no assurances that these transactions will take place. The amount the Company will ultimately realize could differ materially from the carrying value of the investments as reflected in the financial statements due to changes in the financial condition of the purchaser and\/or the ultimate valuation of its obligation to Transcend in any purchase of AmHealth by CORE, Inc. or any other third party.\nThe securities from the sale of AmHealth and the accrued liabilities related to the sale of AmHealth are shown as separate line items on the balance sheet. The related statement of cash flows is shown as a separate line item along with First Western and Veritas as discontinued operations.\nEMPLOYEES\nAs of December 31, 1995, Transcend had approximately 569 full-time employees and 137 part-time employees, including 14 administrative and executive employees at its headquarters office in Atlanta, Georgia; 20 employees in sales and marketing or consultative functions; and 307 employees at outsourcing sites, as well as 157 employees in its medical transcription operations. Sullivan has 71 full-time employees and contracts with over 52 part-time registered nurses who are not employees of the Company. Transcend also supervises an additional 162 employees of contracting hospitals at outsourcing sites, pursuant to the terms of its outsourcing agreements. Neither Transcend nor any of the employees it supervises is currently a party to any collective bargaining agreement; the hospital employees at one outsourcing site have been solicited by union representatives, but no definitive action toward representation has been taken. Transcend has not experienced any strikes or work stoppages, and believes that its relations with its employees are good.\nEXECUTIVE OFFICERS\nThe following table contains information regarding executive officers who are not directors of the Company. See \"Item 10. Directors and Executive Officers of the Registrant\".\nLarry G. Gerdes (age 47) has served as Chief Executive Officer of Transcend since May, 1993. Since 1991, Mr. Gerdes has been a general partner of Gerdes Huff Investments (\"GHI\"), an Atlanta-based partnership which invests in predominantly southeastern based early to middle stage companies. For the five years prior to 1991, Mr. Gerdes held various executive positions with HBO & Company,\na provider of information services to the healthcare industry, the last of which was Executive Vice President. Mr. Gerdes has served as a director of Transcend since June 1985. Mr. Gerdes also serves as a director of Delphi Information Systems, Inc.\nJulian L. Cohen (age 40) joined the Company in October 1994 as President and Chief Executive Officer of Sullivan. Mr. Cohen's current position with Transcend is Chief Operating Officer. Mr. Cohen served in various capacities at MCC Behavioral Care, Inc., a provider of managed behavioral health products and services from November 1987 to September 1994, including President from October 1992 to September 1994. Mr. Cohen has his Bachelor's Degree and Masters in Public Health from the University of Pittsburgh.\nG. Scott Dillon (age 45) joined the Company in September, 1995 as Chief Development Officer. Mr. Dillon served as Executive Vice President and Chief Development Officer for Coastal Physician Services from September 1992 to August 1995. Mr. Dillon has his undergraduate degree from Drake University and his graduate degree from North Dakota State University.\nDavid W. Murphy (age 38) joined the Company in September, 1994, as Vice-President of Acquisitions and became Chief Financial Officer of Transcend in May, 1995. Prior to joining the Company, Mr. Murphy was a founder and General Partner of an investment company and served in various financial, operating and M&A positions with companies such as Hutchinson SA (France), First Boston and International Paper Company. Mr. Murphy received his Bachelor's degree from the University of Notre Dame and his Masters in Business Administration from Dartmouth's Amos Tuck Graduate School of Business.\nExecutive Officers are elected by and serve at the pleasure of the Board of Directors of the Company.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nTranscend leases the space for its principal offices in Atlanta, Georgia, and space for satellite sales office in Dallas, Texas and Newton, Pennsylvania. It also leases space for its transcription offices in Chicago, Illinois; Pittsburgh and Erie, Pennsylvania; Boston and Worcester, Massachusetts; and Atlanta, Georgia.\nTranscend also leases space for it case management business (Sullivan) in Decatur, Georgia; St. Petersburg, Florida; and Dallas, Texas.\nTranscend's lease obligation in Irvine, California, which it assumed from TriCare in the Merger, expires May, 1996.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is subject to certain claims in the ordinary course of business which are not material. Prior to Coastal, Mr. Dillon served as Executive Vice President of the Fischer Mangold Group from January 1991 to September 1992.\nOn September 17, 1993, the Company and its healthcare subsidiaries (now part of Transcend) and the physician-owned medical groups that have contracts with the healthcare subsidiaries initiated a lawsuit in the Superior Court of the State of California, County of Los Angeles, against twenty-two insurance carriers seeking $115 million in compensatory damages claiming abuse of process, intentional interference with contractual and prospective economic relations and unfair business practices which led to the discontinuation of the business of the Company's healthcare subsidiaries and their contracting associated medical groups in April 1993 (the \"Lawsuit\"). Certain of the defendants in the Lawsuit have filed cross complaints seeking restitution from the Company, its healthcare subsidiaries and their associated managed medical groups for funds previously paid to the medical groups and other damages. The costs associated with the above claims cannot be ascertained with any certainty but are expected to be substantial. The Company intends to defer such costs until resolution of the litigation. There can be no assurance as to the outcome of this litigation, including potential recovery, if any, of the Company's claims, or damages if any. Based upon facts and circumstances known to date, in the opinion of management, final resolution of this cross complaint will not have a material adverse effect on the Company's financial condition or results of operations.\nOn June 22, 1995, an action was filed by Timothy S. Priest in his capacity as administrator of the estate of Robert V. Taylor against Carol Brown, Debbie Ostwald, Sullivan Health & Rehabilitation Management, Inc. (\"Sullivan\") and Fireman's Fund Insurance Company, in the Circuit Court of Franklin County, Tennessee, alleging breach of the duty to provide reasonably competent nursing care to an injured individual (now deceased). The Company's subsidiary, Sullivan, and a former employee of Sullivan are defendants in the case. The Plaintiff demands compensatory damages in the amount of $1 million and punitive damages in the amount of $2 million, plus costs. Management of the Company believes that Sullivan has meritorious defenses to the allegations and intends to vigorously contest liability in this matter. At the present time, management of the Company cannot predict the outcome of this litigation, but does not believe that the resolution of the litigation will have a material adverse effect on the Company's financial condition or results of operations.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matters were submitted to a vote of security holders during the last quarter of the twelve month period ended December 31, 1995.\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nTranscend Common Stock is quoted on the NASDAQ-NM. As of March 11, 1996 there were approximately 450 holders of record of Transcend Common Stock. The table below sets forth for the fiscal periods indicated the high and low bid prices per share of Transcend Common Stock as reported on the NASDAQ-NM. The policy of the Board of Directors of the Company is to retain earnings for the expansion and development of the Company's business. Future dividend policy and the payment of dividends, if any, will be determined by the Board of Directors in light of circumstances then existing, including the Company's earnings, financial condition and other factors deemed relevant by the Board.\nITEM 6.","section_6":"ITEM 6. SELECTED COMBINED FINANCIAL DATA\nOn January 10, 1995, TriCare acquired Transcend by the merger of Transcend into First Western Health Corporation. Inasmuch as the merger is being treated for financial accounting purposes as the acquisition of TriCare by Transcend, following the merger, the historical financial statements of Transcend have become the financial statements of TriCare and include the business of both companies after the effective date of the Merger (January 10, 1995).\nSELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA\nThe following table sets forth selected historical consolidated financial data of Transcend for the periods indicated, derived from the consolidated financial statements of Transcend. The selected financial data should be read in conjunction with \"TRANSCEND MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\" and Transcend's consolidated financial statements and notes thereto included elsewhere.\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\nGENERAL\nTranscend is an organization committed to the outsourcing of Health Information along a continuum spanning patient access (admitting) through health information management (medical records) and extending to the business office of a health care provider. The Company provides long term value to its health care provider customers through i) the cost efficient management of services, guaranteeing its contract management customers operating cost savings through a capitated fixed fee pricing structure while at the same time guaranteeing service deliverables and ii) by converting data into quality information to allow them to effectively compete in a dynamic marketplace.\nTranscend provides value-add along four (4) distinct service lines:\n- Contract Management: The management of patient information - both clinical and financial - from pre-admission to post discharge. The health care provider outsources the Health Information Management (HIM) function to Transcend in the form of a 3-5 year contract. Transcend assumes full responsibility for the daily operation of the HIM department, Patient Access and\/or Business Office, including having all of the hospital employees become employees of Transcend.\n- Medical Transcription: The transcription service allows for the transcribing of physician dictation and provides Transcend the opportunity to significantly impact the quality of service (i.e., accuracy, turnaround time) and the margin it achieves for its Contract Management (CM) outsourced customers. In addition, medical transcription is currently being delivered to 100+ non-CM customers.\n- Consulting and Coding: Transcend continues to offer its services as an independent consultant, on a case by case basis, providing advice with respect to management and operations of medical records departments and related health information management, particularly reimbursement coding (or \"optimization\" services). Transcend also provides consultation services regarding the health information aspects of hospitals' utilization management and quality management functions.\n- Case Management: Through its Sullivan subsidiary, the Company provides Worker's Compensation Case Management and Disability Management. Sullivan's primary customers include: insurance carriers, third party administrators and self-insured employers.\nTranscend is a service company and refrains from researching\/developing any of its own proprietary technology; rather, it chooses to work closely with outside partners to develop the tools (i.e., technology) required to deliver its services at optimal cost and quality levels.\nRESULTS OF OPERATIONS\nThe following discussion should be read in conjunction with the consolidated financial statements of Transcend contained elsewhere herein. See Item 8.","section_7A":"","section_8":"Item 8.\nYear Ended December 31, 1995 Compared with Year Ended December 31, 1994\nNet revenues increased 109% to $25,882,000 in 1995 from $12,393,000 in 1994. The increase in net revenues is primarily attributable to the Company's contract management division, contributing $5,058,000 of the overall increase due to the addition of six (6) new outsourcing contracts helped revenues increase from $9,242,000 in 1994 to $14,300,000 in 1995. Medical Transcription grew from $2,428,000 in 1994 revenues to $6,662,000 in revenues for 1995, primarily due to the acquisition of IDS and MTA. Sullivan's 1994 revenues are not included as they were prior to the TriCare\/Transcend Merger (January, 1995).\nGross profit increased 121% to $3,548,000 in 1995 from $1,606,000 in 1994. Gross profit as a percentage of revenues increased to 13.7% in 1995 from 12.9% in 1994. This increase was primarily attributable to the addition of Sullivan's case management revenues reflecting an overall 21% gross margin. Gross margins in contract outsourcing increased to 14% from 11% in 1994. Average transcription margins decreased from 19% to 14% as a result of the Script- Ease and IDS acquisitions. This decline is expected to be temporary as changes have been implemented that should positively impact gross margin levels at these two sites. As an example, gross margin in the transcription division, as a percentage of total revenue, were 17.4% in the fourth quarter of 1995.\nTranscend believes that, with respect to contract outsourcing revenues from any particular medical records management contract, the Company's profit margin should increase over the life of the contract, due both to the nature of Transcend's pricing of its contract outsourcing services and to operating efficiencies expected to be achieved over the life of such a contract. Transcend negotiates its contract management fees on a basis which will represent, at contract inception, immediate savings to the contracting hospital over historical costs of operating the managed functions, and for this purpose, Transcend utilizes fixed installment fee payment arrangements. In the early term of such a contract,\nTranscend's expenses in providing the contract services remain relatively high (as a percentage of contract revenues received) as set-up and training costs are incurred, new procedures are implemented and departmental reorganizations are implemented. Completion of such steps can be expected to result in lower operating expenses, which in turn should increase the profit margin of a constant revenue stream over time. Also, as Transcend increases the number of its contract outsourcing clients and builds to a customer base with critical mass in some geographic areas, the potential exists for the possible centralization of certain of the services provided to multiple clients, as well as related economies of scale, and this could also contribute to a trend of higher profit margins on contract outsourcing revenues.\nMarketing and sales expenses increased 135% to $2,186,000 in 1995 from $929,000 in 1994 and increased as a percentage of revenues to 8.4% from 7.5% in 1994. The increase is attributable to expenses associated with the concentrated effort in sales to heighten market awareness of Transcend and contract outsourcing; the expansion of Transcend's sales force; an increase in commission compensation relating to the six new outsourcing contracts in the third quarter and the additional sales costs related to the case management services of transcription and Sullivan.\nGeneral and administrative expenses increased 175% to $4,604,000 in 1995 from $1,673,000 in 1994 and increased as a percentage of revenues to 17.8% from 13.5%. The increase reflects additional expense for increased management and support staff to position the Company for future growth, as well as the additional overhead of TriCare and Sullivan due to the January 10, 1995 Merger.\nThe increase in amortization expenses to $633,000 in 1995 from $357,000 in 1994 reflects the full impact of the intangible assets associated with the three named medical transcription acquisitions and the additional amortization expense related to the Merger.\nTranscend's loss from operations increased to $3,875,000 in 1995 from $1,353,000 in 1994; however, the Company realized an improving trend with regard to minimizing its loss from operations beginning in the second quarter, 1995. Transcend's loss from operations was $1,393,000 in the second quarter ending June 30, 1995. The loss from operations for the third quarter ended September 30, 1995 was $867,000, and this compares to a fourth quarter loss from operations of $527,000 for the quarter ended December 31, 1995.\nOther expense decreased to $21,000 in 1995 from $40,000 in 1994, primarily as the result of Transcend's recognition of higher interest income as applied against interest expense.\nYear Ended December 31, 1994 Compared With Year Ended December 31, 1993\nNet revenues increased 99.6% to $12,393,000 in 1994 from $6,208,000 in 1993. This increase in net revenues is primarily attributable to increased sales in the contract outsourcing division, reflecting the full year impact of contracts to manage the records department in five hospitals entered into in 1993 and another hospital contract entered into on June 1, 1994 and to a lesser extent the transcription\nacquisition of Script-Ease on September 1, 1994 and the full year impact of the 1993 dataLogix acquisition.\nGross profit increased 48.3% to $1,606,000 in 1994 from $1,083,000 in 1993. Gross profit as a percentage of revenues declined to 12.9% in 1994 from 17.5% in 1993. This decrease was primarily attributable to an increase in the portion of the overall revenue mix provided by contract management revenues. Transcend believes that with respect to revenues from any particular medical records management contract, Transcend's profit margin should increase over the life of the contract as a result of operating efficiences expected to be achieved over the life of such a contract. Transcription profit margins increased from 12% in 1993 to 20% in 1994 due to efficiencies implemented in 1994 at the transcription office in Chicago. Consulting and coding margins declined in 1994 due to a greater emphasis on contract management.\nMarketing and sales expenses increased 145.8% to $929,000 in 1994 from $378,000 in 1993 and increased as a percentage of revenues to 7.5% from 6.1% in 1993. The increase reflects increased expenses associated with additional marketing efforts in the contract management division and expansion of the contract management\/outsourcing sales force. A majority of the increase in costs in this category was in the form of additional salaries and sales commissions. It is expected that these expenses will continue to increase in 1995.\nGeneral and administrative expenses increased 25.8% to $1,673,000 in 1994 from $1,330,000 in 1993 but decreased as a percentage of revenues, to 13.5% from 21.4%. The increase reflects additional expense for increased management and support staff to support Transcend's present and future growth.\nThe increase in amortization expenses to $357,000 in 1994 from $310,000 in 1993 reflects the full impact of the intangible assets associated with the dataLogix transcription business, which was acquired in April 1993 and the additional amortization expense related to the acquisition of Script-Ease which occurred on September 30, 1994.\nTranscend's loss from operations increased to $1,353,000 in 1994 from $953,000 in 1993.\nOther expense increased to $40,000 in 1994 from $31,000 in 1993, primarily as the result of Transcend's recognition of a gain of $100,000 from the sale of the software division in April 1993 vs. the recognition of only a $25,000 gain in 1994.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company's primary sources of cash are its cash on hand, internally generated funds and collections from the net assets of the Company's discontinued operations (expected to be collected over the next several years under provisions of the sale and service agreements signed with MRF).\nThe Company expended $1,232,000 in cash to acquire the medical transcription businesses of IDS and MTA in 1995, and, as a result, the Company raised $2.0 million in cash through the private placement of Subordinated Convertible Debt which took place on August 15, 1995. Key terms of the debt are:\n- Convertible, by the holder, for five (5) years at $3.50 per share of Transcend's common stock as recorded on August 15, 1995, the \"Closing Price\".\n- Convertible by the Company if Transcend's common stock trades at three (3) times the Closing Price for 30 consecutive trading days.\nThe Company's working capital position improved during the twelve months ended December 31, 1995, from a deficit position of approximately ($3,000,000) at December 31, 1994 to $870,000 at December 31, 1995. This improvement in the Company's working capital position arises from a combination of several factors. The Merger increased working capital by $6,195,000 and the private placement by $2,000,000, which was offset by the following: first, the acquisition of two additional transcription businesses (IDS and MTA) as described below; second, the financing from current cash sources of capital expenditures for equipment during the twelve months ended December 31, 1995, as described below; and finally, the continued funding of losses from Transcend's operations. The latter factor results from increases in Transcend's administrative and marketing cost structures (relative to actual new sales realized), which increased significantly beginning in the fourth quarter of 1994, in anticipation of targeted increases in Transcend's contract management business, as well as some temporary costs associated with the Script-Ease and IDS transcription acquisitions. Such cost increases should be offset by operating contributions from the Company's continued growth in its contract management\/outsourcing, medical transcription and case management businesses, although there can be no assurances in that regard.\nDuring the twelve months ended December 31, 1995, Transcend's cash balance increased from $150,000 to $1,073,000. This change resulted primarily from $7,483,000 in cash received from the Merger; $77,000 received in cash from the IDS and MTA acquisitions; $2,000,000 in cash received from the subordinated convertible debt placement; $268,000 in cash proceeds received from the\nexercise of employee stock options; offset by: the use of cash reserves to repay Transcend's outstanding indebtedness under both of Transcend's bank credit facilities totaling $2,025,000; $4,133,000 used in operating activities including approximately $450,000 in merger costs; capital expenditures of $1,220,000 (principally computer and optical imaging equipment); $285,000 for the final payment related to the acquisition of Sullivan; and approximately $1,232,000 related to the acquisitions of IDS and MTA in January and April, 1995, respectively.\nNet cash provided by discontinued operations for the twelve months ended December 31, 1995 was $202,000. The majority of the cash contributed from discontinued operations was generated by the collection of accounts receivable from the discontinued applicant medical\/legal evaluation business of First Western and Veritas, including net cash contributed of $932,000 ($882,000 in cash received at Closing; $50,000 placed in Escrow) received upon the sale of certain accounts receivable to MRF, offset by the related costs of First Western and Veritas. Going forward, net cash contributed from discontinued operations will consist of any future cash collected under 1) a shared arrangement under the sales agreement based on MRF achieving certain collection targets and 2) the on-going service agreement that the Company signed with MRF pertaining to a specific portfolio of old receivables from discontinued operations. Management believes the ultimate collectability of its accounts receivable has been properly reflected in the Company's financial statements and that the subsequent agreements entered into between the Company and MRF on October 14, 1995 for the sale and service of its discontinued operation's accounts receivable balances did not result in a gain or loss to the Company.\nThe Company continues to experience negative cash flow from operations. For the twelve months ended December 31, 1995, negative cash flow from operations was $4,133,000, which included\na payment of approximately $500,000 of aged payables immediately following the Merger (January, 1995) and $450,000 in Merger costs. There were also cash outlays for acquisitions totaling $1,232,000 and capital expenditures of $1,221,000. Notwithstanding the foregoing, the Company anticipates that margin contribution will come from: expected new contract outsourcing sales; expected new sales opportunities in transcription and consulting; expected new case management sales from Sullivan; and increasing margins from existing operations (contract outsourcing, transcription, consulting and coding and Sullivan case management). Moreover, the Company's selling, general and administrative costs as a percentage of revenues is expected to decrease.\nTo illustrate this point, the chart below highlights a favorable trend with regard to the Company's cash flow beginning in the second quarter of 1995:\nBased on the foregoing, the Company anticipates that cash on hand, together with internally generated funds and cash collected from discontinued operations will be sufficient to finance continuing operations and the cash requirements associated with its civil litigation action against certain insurance carriers for the next twelve months.\nThe Company will continue to pursue strategic acquisitions subject to having the necessary resources to fund any specific transaction. Such funding could include the issuance, in all or in part, of its securities, the issuance of promissory notes to sellers and\/or the payment of cash, either from the Company's existing cash resources or through a credit facility established to help finance the acquisition. At the current time, no such credit facility exists for the Company, though the Company is in the process of negotiating with several financial institutions about providing a line of credit facility. There can be no assurances, however, that any such credit facility will be established.\nINFLATION\nInflation has not had a material effect on the Company to date. However, the effects of inflation on future operating results will depend in part, on the Company's ability to increase prices and\/or lower expenses in amounts offsetting inflationary cost increases and on reimbursement levels established by state authorities.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Board of Directors and Shareholders of Transcend Services, Inc.:\nWe have audited the accompanying consolidated balance sheets of Transcend Services, Inc. (a Delaware corporation) and subsidiaries as of December 31, 1994 and 1995 and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1995. 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 Transcend Services, Inc. and subsidiaries as of December 31, 1994 and 1995 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles.\nARTHUR ANDERSEN LLP\nAtlanta, Georgia February 13, 1996\nTRANSCEND SERVICES, INC.\nCONSOLIDATED BALANCE SHEETS\nThe accompanying notes are an integral part of these consolidated balance sheets.\nTRANSCEND SERVICES, INC.\nCONSOLIDATED STATEMENTS OF OPERATIONS\nThe accompanying notes are an integral part of these consolidated statements.\nTRANSCEND SERVICES, INC.\nCONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY\nThe accompanying notes are an integral part of these consolidated statements.\nTRANSCEND SERVICES, INC.\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nTRANSCEND SERVICES, INC.\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nThe accompanying notes are an integral part of these consolidated statements.\nTRANSCEND SERVICES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1993, 1994 AND 1995\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nNATURE OF BUSINESS\nTranscend Services, Inc. (the \"Company\"), established in 1984, is engaged in the field of contract outsourcing of the health information management\/medical records and patient access functions of hospitals. The Company offers operations evaluation, consulting, reimbursement coding, transcription, and other services generally resident in the medical records department of hospitals. Currently, it emphasizes three- to five-year contractual relationships for management of the entire hospital medical records and patient access departments. The Company's three largest hospital contracts accounted for approximately 58%, 50% and 24% of sales in 1993, 1994, and 1995, respectively.\nOn January 10, 1995, TriCare, Inc., acquired Transcend Services, Inc., a Georgia corporation by the merger of Transcend into First Western Health Corporation (\"Merger\"). On May 31, 1995, Transcend Services, Inc., a California corporation following its January 10, 1995 merger into TriCare, and Veritas Healthcare Management, a California corporation owned by TriCare, merged into the TriCare corporation, whose name was then changed to \"Transcend Services, Inc.\" Transcend Services, Inc. now operates as a Delaware corporation. Inasmuch as the Merger is being treated for financial accounting purposes as the acquisition of TriCare by Transcend, following the Merger, the historical financial statements of Transcend have become the financial statements of TriCare and include the businesses of both companies after the effective date of the merger.\nBASIS OF PRESENTATION\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nThe consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.\nCASH AND CASH EQUIVALENTS\nThe Company considers all highly-liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents.\nACCOUNTS RECEIVABLE\nAn allowance for doubtful accounts has been established to provide for losses on uncollectible accounts based on management's estimates and historical collection. Bad debt expense amounted to $30,000, $9,000 and $0 in 1993, 1994 and 1995, respectively.\nREVENUE AND COST RECOGNITION\nRevenue is recognized monthly as the work is performed. One-time nonrefundable contract implementation fees have been amortized over the first three months of a contract to match when the costs are incurred for implementation. Direct costs are expensed as incurred. Gross margins vary by contract. Direct costs include contract labor costs related to medical records processing, transcription, coding costs and case management costs, as well as purchased services, such as microfilming, record storage, software licenses, etc.\nDEPRECIATION AND AMORTIZATION\nDepreciation and amortization are computed using the straight-line method over the estimated useful lives of the respective assets which range from three to seven years.\nINCOME TAXES\nThe Company follows Statement of Financial Accounting Standards No 109 (\"SFAS 109\"). Under the asset and liability method of SFAS 109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to 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 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.\nDEPOSITS AND OTHER ASSETS\nDeposits and other assets includes $360,000 in restricted cash used as collateral for a letter of\ncredit related to a contract outsourcing agreement which expires in September, 1996.\nGOODWILL AND OTHER INTANGIBLE ASSETS\nGoodwill and other intangible assets are currently being amortized over periods ranging from three to thirty years. The Company periodically evaluates whether events and circumstances since acquisition have occurred that indicate that the remaining estimated useful life of goodwill may warrant revision or that the remaining balance of goodwill may not be recoverable. When factors (such as a change in law or regulatory environment or forecasts showing changing long-term profitability) indicate that goodwill should be evaluated for possible impairment, the Company uses an estimate of the related business unit's undiscounted net income over the remaining life of the goodwill to measure whether the goodwill is recoverable.\nFAIR VALUE OF DEBT\nIn accordance with SFAS No. 107, \"Disclosures About Fair Value of Financial Investments\", the fair value of short-term debt is estimated to be its carrying value. The fair value of long-term debt is estimated based on approximate market interest rates for similar issues. The estimated fair value of long-term debt at December 31, 1995 was equal to the carrying amount included in the accompanying balance sheet.\nNET LOSS PER COMMON SHARE AND COMMON SHARE EQUIVALENT\nNet loss per common share has been computed based on the weighted average number of the Company's common shares outstanding as of December 31, 1993, 1994, and 1995. The common stock equivalents related to stock options were not included in the computation due to their antidilutive effect.\nRESTATEMENT OF PRIOR YEAR BALANCES\nCertain prior year balances have been restated to conform with current year presentation.\n2. DISCONTINUED OPERATIONS\nLEGAL PROCEEDINGS\nOn September 17, 1993, TriCare and its healthcare subsidiaries (now part of Transcend) and the physician-owned medical groups that have contracts with the healthcare subsidiaries initiated a lawsuit in the Superior Court of the State of California, County of Los Angeles, against twenty-two insurance carriers seeking $115 million in compensatory damages claiming abuse of process, intentional interference with contractual and prospective economic relations and unfair business practices which led to the discontinuation of the business of TriCare's healthcare subsidiaries and their contracting associated medical groups in April 1993 (the \"Lawsuit\"). Certain of the defendants in the Lawsuit have filed cross complaints seeking restitution from TriCare, its healthcare subsidiaries and their associated managed medical groups for funds previously paid to the medical groups and other damages. The costs associated with the above claims cannot be ascertained with any certainty but are expected to be substantial. The Company intends to defer such costs until resolution of the litigation and has $479,000 of prepaid legal fees included in net assets from discontinued operations at December 31, 1995. There can be no assurance as to the outcome of this litigation, including potential recovery, if any, of the Company's claims, or damages if any. Based upon facts and circumstances known to date, in the opinion of management, final resolution of the cross complaint will not have a material adverse effect on the Company's financial condition or results of operations.\nFIRST WESTERN\/VERITAS The net assets of the discontinued operations of Tricare's healthcare subsidiaries, First Western and Veritas (now part of Transcend), both of which ceased operations as of April 30, 1993, are shown on the combined balance sheet and the related statement of cash flows as a separate line item.\nThe net assets related to the discontinued operations at December 31, 1995 were $2,893,000. This amount consisted of $479,000 in prepaid legal fees and $2,414,000 in net accounts receivable. Collection liabilities of First Western and Veritas have been deducted in determining net accounts receivable.\nOn October 14, 1995, the Company sold approximately 38% of its discontinued operations' gross accounts receivable balance to Medical Receivables Finance, LLC (\"MRF\"), a Delaware limited liability company for:\n- Approximately $932,000 in cash ($882,000 in cash at closing; $50,000 held in escrow)\n- An opportunity to share in future cash receipts based on MRF's collection activity.\nAs a result, the Company closed its California-based collections operation. The future costs associated with the collection of the accounts receivable have been netted with the assets related to discontinued operations.\nThe sale agreement with MRF did not result in any gain or loss for the Company. The Company will continue to re-evaluate the realizability of the net assets related to its discontinued operations which were not sold. Any such re-evaluation could result in an adjustment that may potentially be material to the carrying value of this asset.\nIn addition to the above, the Company has contracted with MRF for the servicing and managing of the remaining 62% of the accounts receivable balance.\nSECURITIES OF AMHEALTH\nPrior to its acquisition by Transcend, TriCare sold substantially all of the assets and liabilities of its wholly-owned subsidiary, Occu-Care to AmHealth, Inc. (\"AmHealth\") for a purchase price of $4,000,000. The purchase price included $1,500,000 in cash paid at closing; AmHealth's Series A Note in the face amount of $1,500,000 bearing interest of 8% per annum commencing December 1, 1994, payable quarterly thereafter, with the principal payable on or prior to December 1, 1995; and AmHealth's Series B Note in the face amount of $1,000,000 bearing interest of 8% per annum commencing December 1, 1994, payable quarterly thereafter, with the principal payable in equal quarterly installments starting December 1, 1995 and continuing until September 1, 2000. TriCare did not receive its first interest payment on its $2,500,000 note receivable from its sale of the assets of Occu-Care, which constituted an event of default and, therefore, TriCare deferred recognition of the gain from the transaction in the amount of $450,000. On December 30, 1994, TriCare entered into negotiations with AmHealth which resulted in an agreement to exchange its note receivable of $2,500,000 for 2,500,000 shares of $1.00 convertible redeemable preferred stock which pay cumulative dividends at a rate of 6.5% per annum. In conjunction with the Merger on January 10, 1995, Transcend recorded these securities at their fair value of $2,050,000. Under certain circumstances and at the Company's option, the preferred stock is convertible into common stock of AmHealth. The preferred stock is subject to mandatory redemption as follows: 1,500,000 shares (less any shares previously converted) on December 1, 1995, and the balance in nineteen quarterly installments commencing December 1, 1995 which was consistent with the payment schedule of the original notes. The redemption on December 1, 1995 did not occur and discussions are underway with AmHealth to determine a future course of action with regard to the redemption of these securities.\nIn December, 1995, AmHealth signed a Letter of Intent with CORE, Inc. (NASDAQ; CORE) for CORE to purchase substantially all the assets of AmHealth primarily in exchange for CORE stock. The transaction is expected to close by May, 1996. If the above transaction occurs, Transcend would likely settle AmHealth's $2.5 million obligation to Transcend in exchange for CORE stock. However, there can be no assurances that these transactions will take place. The amount the Company will ultimately realize could differ materially from the carrying value of the investments as reflected in the financial statements due to changes in the financial condition of the purchaser and\/or the ultimate valuation of its obligation to Transcend in any purchase of AmHealth by CORE, Inc. or any other third party.\n3. OFFICE FURNITURE AND EQUIPMENT\nThe summary of office furniture and equipment at December 31, 1994 and 1995 is as follows:\n4. INDEBTEDNESS\nLong-term debt is summarized as follows at December 31, 1994 and 1995;\nThe revolving line of credit expired in January, 1995 and was not renewed. The outstanding balance of both credit facilities at the time of the merger of TriCare and Transcend was $2,200,000 and was paid off with cash received in the Merger (Note 1).\nThe Company expended $1,232,000 in cash to acquire the medical transcription businesses of IDS and MTA in 1995 and, as a result, the Company issued $2.0 million in Subordinated Convertible Debt, which took place on August 15, 1995. Key terms of the debt are:\nConvertible Features:\n- Convertible for five (5) years at $3.50 per share of Transcend's common stock as recorded on August 15, 1995, the \"Closing Price\". - Convertible by the Company if Transcend's common stock trades at three (3) times the Closing Price for 30 consecutive trading days.\n5. SUPPLEMENTAL CASH FLOW INFORMATION\nCash paid for interest was $31,000, $36,000 and $56,000 for 1993, 1994 and 1995, respectively.\n6. LEASE COMMITMENTS AND CONTINGENCIES\nLEASE COMMITMENTS\nThe Company has entered into operating leases for certain office facilities. At December 31, 1994, the minimum rental payments due under noncancelable operating lease agreements are as follows:\nRental expense for the operating leases amounted to approximately $97,000, $150,000 and $443,000 for 1993, 1994 and 1995, respectively.\nLITIGATION\nOn June 22, 1995, an action was filed by Timothy S. Priest in his capacity as administrator of the estate of Robert V. Taylor against Carol Brown, Debbie Ostwald, Sullivan Health & Rehabilitation Management, Inc. (\"Sullivan\") and Fireman's Fund Insurance Company, in the Circuit Court of Franklin County, Tennessee, alleging breach of the duty to provide reasonably competent nursing care to an injured individual (now deceased). The Company's subsidiary, Sullivan, and a former employee of Sullivan are defendants in the case. The Plaintiff demands compensatory damages in the amount of $1 million and punitive damages in the amount of $2 million, plus costs. Management of the Company believes that Sullivan has meritorious defenses to the allegations and intends to vigorously contest liability in this matter. At the present time, management of the Company cannot predict the outcome of this litigation, but does not believe that the resolution of the litigation will have a material adverse effect on the Company's financial condition or results of operations.\nSee Note 2 for additional litigation discussion.\n7. RETIREMENT PLAN\nThe Company sponsors a 401(k) retirement plan that covers substantially all employees after satisfying certain requirements as to length of service. Employees are eligible to contribute amounts to the plan subject to certain minimum and maximum limitations. The Company matches employee contributions on a discretionary basis as determined by the Company's board of directors . In 1993 and 1994, the Company matched employee contributions at a rate of 10% of employee contributions up to 6% of salary. For 1993, 1994 and 1995, the expense was approximately $6,000, $17,000 and $0 respectively.\n8. TRANSACTIONS WITH RELATED PARTIES\nApproximately 23% of the subordinated debt (Note 4) is held by parties affiliated with certain members of the board of directors.\nDuring 1993, the Company paid $91,000 in management fees to a shareholder.\nDuring 1993, the Company issued warrants to purchase 146,000 shares to the controlling\nshareholders in consideration of such shareholders' personal guarantee of the loan to purchase dataLogix (Note 12). The warrants are exercisable at $.01 per warrant and were exercised during 1994. The difference between fair value and exercise price of these warrants of $104,000 was expensed in 1993.\n9. SHAREHOLDERS' EQUITY\nThe historical shareholders' equity of Transcend prior to the merger has been retroactively restated for the equivalent number of shares received in the Merger (2.34 to 1). Earnings per share for the periods prior to the Merger are restated to reflect the number of equivalent shares received.\nIn 1995, the Company increased the authorized common stock to 30,000,000 shares. The Company has authorized 21,000,000 shares of preferred stock, $.01 par value.\n10. STOCK OPTIONS AND WARRANTS\nThe Company has established a stock option plan for the employees of the Company. The plan authorizes the grant of \"incentive stock options\" and \"nonstatutory options.\" Under this plan, options are granted for the Company's common stock at the approximate fair value, as defined in the option agreement. The following is a summary of transactions:\nThe directors who were not employees of the Company were granted non-qualified stock options to purchase shares of the Company's common stock prior to May 31, 1991. These options, which expire ten years from the date of grant, were granted at prices between $2.00 and $5.17 per share, the fair market value on the date of grant, and are all exercisable. During the twelve (12) months ended December 31, 1995, no options were exercised and options to purchase 7,500 shares are still outstanding.\nAt December 31, 1995 there were a total of 159,000 shares of common stock reserved for this plan.\n11. INCOME TAXES\nThe components of the net deferred tax (liability) asset as of December 31, 1994 and 1995 were as follows:\nAt December 31, 1995, the Company had net operating loss carryforwards of approximately $8,001,000 which can be used to reduce future income taxes. If not utilized these carryforwards will expire in 2007. The tax benefit differed from the amount computed using the statutory Federal income tax rate due primarily to the increase in the valuation allowance for the past three years. The Company has established a valuation allowance of $934,000 and $1,831,000 at December 31, 1994 and 1995, respectively due to the uncertainty regarding the realizability of certain deferred tax assets, including its net operating loss carryforward.\n12. ACQUISITIONS\nOn April 29, 1993, the Company acquired dataLogix, a supplier of medical record transcription services, for $1,100,000. The Company accounted for the acquisition under the purchase method of accounting. The results of operations for dataLogix are included in the statement of loss of the Company beginning on the date of acquisition. The fair value of tangible assets acquired and liabilities assumed was $315,000 and $37,000, respectively. The majority of the excess purchase price over net\ntangible assets relate to non-compete agreements and customer contracts which are being amortized over three years, using an accelerated method of amortization.\nOn September 30, 1994, the Company acquired the assets of Script-Ease, Inc., a Pittsburgh-based medical transcription business for $1,000,000. The Company accounted for the acquisition under the purchase method of accounting. The results of operations for Script-Ease are included in the statement of loss of the Company beginning on the date of the acquisition. The fair value of tangible assets acquired and liabilities assumed was $259,000 and $161,000, respectively. The majority of the excess purchase price over net tangible assets related to customer lists, which is being amortized over seven years and a non-compete agreement that is being amortized over a three year period. The balance of the additional intangibles is goodwill which is being amortized over thirty years.\nOn January 10, 1995, Transcend acquired TriCare, Inc. in a merger accounted for as a reverse merger (Note 1). The acquisition was treated as a purchase. There were approximately 7.7 million shares issued in the transaction resulting in goodwill of approximately $3.2 million. This goodwill is being amortized over twenty years. On June 15, 1994, TriCare had completed the acquisition of Sullivan for an adjusted purchase price of $3,285,000. Subsequent to the Merger, the Company issued a final payment of $285,000 in lieu of the $1,260,000 obligation which was payable in stock in January 1995 and July 1995, to the former owners of Sullivan Health and Rehabilitation in full satisfaction of its long-term obligation related to the acquisition of Sullivan and gave the former owners a release from any and all further liabilities in connection therewith.\nOn January 31, 1995, the Company acquired the assets of International Dictating Services (\"IDS\"), a Boston based medical transcription business for approximately $832,000, which consisted of approximately $682,000 paid in cash at closing with the balance payable to the sellers over the next two years. The Company accounted for the acquisition under the purchase method of accounting. The results of operations for IDS are included in the statement of loss of the Company beginning on the date of acquisition. The fair value of tangible assets acquired and liabilities assumed was $245,000 and $86,000, respectively. The intangible related to customer lists is being amortized over seven years and a non-compete agreement is being amortized over a two year period. The balance of the additional intangible asset is goodwill which is being amortized over twenty years.\nOn April 19, 1995, the Company acquired the assets of Medical Transcription of Atlanta, Inc. (\"MTA\") for $1,372,000, consisting of $550,000 paid in cash at closing, promissory notes of $650,000, and 60,000 shares of Transcend common stock valued at $172,000 at the time of the acquisition. The Company accounted for the acquisition under the purchase method of accounting. The results of operations for MTA are included in the statement of loss of the Company beginning on the date of acquisition. The fair value of tangible assets acquired and liabilities assumed was $363,000 and $27,000, respectively. The intangible related to customer lists is being amortized over seven years and a non-compete agreement is being amortized over a three-year period. The balance of the additional intangible is goodwill which is being amortized over twenty years.\nThe following pro-forma amounts presented below represent the results of operations (excluding discontinued operations) of the Company adjusted to include TriCare; Script-Ease, Inc.; MTA and IDS as if these transactions had been consummated at the beginning of each period presented.\nITEM 9.","section_9":"ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information set forth under the caption \"Election of Directors\" in the Company's Proxy Statement for the 1996 Annual Meeting of Stockholders which will be filed within 120 days of December 31, 1995 and the information in Part I of this Form 10-K set forth under the caption \"Executive Officers of the Registrant\", is hereby incorporated by reference in response to this item.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information set forth under the captions \"Election of Directors, and \"Executive Compensation\" in the Company's Proxy Statement for the Annual Meeting of Stockholders which will be filed within 120 days of December 31, 1995 is hereby incorporated by reference in response to this item.\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\" in the Company's Proxy Statement for the 1996 Annual Meeting of Stockholders which will be filed within 120 days of December 31, 1995, is hereby incorporated by reference in response to this item.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information set forth under the caption \"Certain Transactions\" in the Company's Proxy Statement for the 1996 Annual Meeting of Stockholders which will be filed within 120 days of December 31, 1995 is hereby incorporated by reference in response to this item.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.\n(a) The following documents are filed as a part of this Annual Report for Transcend Services, Inc.:\n(1) Financial Statements- Transcend\nThe Combined Financial Statements, the Notes to Combined Financial Statements and the Reports of Independent Public Accountants listed below appear as Item 8.\nReports of Independent Public Accountants.\nConsolidated Balance Sheets as of December 31, 1994 and 1995.\nConsolidated Statements of Loss for the three years ended December 31, 1995.\nConsolidated Statements of Shareholder's Equity for the three years ended December 31, 1995\nConsolidated Statements of Cash Flows for the three years ended December 31, 1995.\nNotes to Consolidated Financial statements\nNo financial statement schedules are required\n(b) Reports on Form 8-K. Since the last quarter of the period covered by this report, the Company has not filed reports on Form 8-K.\n(c) Exhibits (each management contract or compensation plan or arrangement required to be filed as an exhibit is marked with an asterisk). The following exhibits are filed as part of this Form 10-K:\nThe following exhibits filed with the Securities and Exchange Commission are incorporated by reference as shown below.\nThe following exhibit is incorporated by reference to Transcend's Form 10-Q for the quarter ended September 30, 1995;\nThe following exhibit is incorporated by reference to Transcend's Form 10-Q for the quarter ended June 30, 1995;\nThe following exhibit is incorporated by reference to Transcend's Form 10-Q for the quarter ended November 30, 1995;\nThe following exhibits are incorporated by reference to the Company's registration statement on Form S-4 (file No. 33-83344) as declared effective by the Commission on December 2, 1993:\nThe following exhibit is incorporated by reference to TriCare's Form 8-K relating to an event which occurred September 16, 1994:\nThe following exhibits are incorporated by reference to TriCare's Form 8-K relating to an event which occurred June 15, 1994.\nThe following exhibits are incorporated by reference to TriCare's Form 10-K for the fiscal year ended May 31, 1993.\nThe following exhibits are incorporated by reference to TriCare's Form 10-K for the fiscal year ended May 31, 1992.\nThe following exhibit is incorporated by reference to TriCare's registration statement on Form S-8 (File No. 33-57072) filed with the Commission on January 15, 1993.\nThe following exhibit is incorporated by reference to TriCare's Form 8-K relating to an event which occurred March 1, 1992;\nThe following exhibits are incorporated by reference to TriCare's Registration Statement on Form S-1 (File No. 33-41361) filed with the Commission on June 26, 1991, as amended.\nThe following exhibit is incorporated by reference to TriCare's Registration Statement on Form S-8 (File No. 33-37685) filed with the Commission on November 8, 1990.\nThe following exhibits are incorporated by reference to TriCare's Form 10-K for the year ended May 31, 1990.\nThe following exhibits are incorporated by reference to TriCare's Registration Statement on Form S-1 (File No. 33-32587) filed with the Commission on December 14, 1989, as amended:\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.\nTRANSCEND SERVICES, INC.\nDate: March 25, 1996 By: \/s\/ LARRY G. GERDES ----------------------------------- Larry G. Gerdes 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:","section_15":""}
{"filename":"849213_1995.txt","cik":"849213","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nPlum Creek Timber Company, L.P. (the \"Partnership\"), a Delaware limited partnership organized in 1989, Plum Creek Manufacturing, L.P. (\"Manufacturing\"), and Plum Creek Marketing, Inc. (\"Marketing\"), own, manage, and operate 2.0 million acres of timberland and ten wood products conversion facilities in Montana, Washington and Idaho. The Partnership owns 98 percent of Manufacturing, and 96 percent of Marketing. Plum Creek Management Company, L.P., (the \"General Partner\"), manages the businesses of the Partnership, Manufacturing and Marketing and owns the remaining two percent and four percent of Manufacturing and Marketing, respectively. As used herein, \"Company\" refers to the combined entities of the Partnership, Manufacturing and Marketing.\nSEGMENT INFORMATION\nAs used herein, \"Resources Segment\" refers to the combined timber and land management business of the Partnership. \"Manufacturing Segment\" refers to the combined business of Manufacturing and Marketing. Certain financial information for each business segment is included in Note 12 of Notes to Combined Financial Statements.\nRESOURCES SEGMENT\nGENERAL. The Resources Segment consists of approximately 2.0 million acres of timberland in the Pacific Northwest (the \"Timberlands\"). The Timberlands are geographically segregated into two regions, the Cascade Region in western Washington, and the Rocky Mountain Region in western Montana, northern Idaho and eastern Washington. At December 31, 1995, the 2.0 million acres of Timberland contained an estimated timber inventory of 10.1 billion board feet (\"BBF\") of standing timber of which 2.2 BBF and 7.9 BBF were located in the Cascade and Rocky Mountain Regions, respectively.\nThe Resources Segment grows and harvests timber for sale in export and domestic markets and sells, on an opportunistic basis, land which is designated as having a higher and better use than for forest management.\nThe following summarizes the major components of the Resources Segment's operating income:\nOperating income from export log sales decreased primarily due to a decrease in sales volume. The decrease in sales volume was due to shifting lower quality export logs to domestic markets, as a result of a weaker Japanese economy, and a planned decrease in harvest levels. Export log revenues represented approximately 10%, 12% and 14% of combined revenues for 1995, 1994 and 1993, respectively. Operating income from domestic log sales decreased in 1995 due to a decrease in sales prices resulting primarily from weaker lumber markets. Operating income in 1994 from domestic log sales increased from 1993 primarily due to increased sales volume and higher prices. The increase in sales volume was due to higher harvest levels as a result of the Montana Timberland Acquisition (see below). Higher prices in 1994 were attributed to timber supply constraints as well as increased wood product demand. Domestic log revenues represented approximately 21%, 22% and 19% of combined revenues for 1995, 1994 and 1993, respectively. In 1995, the Partnership implemented an in-woods chipping operation, which utilizes the small tops of trees and small trees from thinning operations, due to the strength of the pulp markets. Pulp log and wood chip sales contributed an additional $7.0 million to operating income in 1995. Prior to 1995, operating income from pulp log sales was insignificant. Land sales contributed $1.6 million, $1.9 million and $7.7 million to operating income in 1995, 1994 and 1993, respectively. Land sales have declined, primarily due to the Partnership's strategy of deferring land sales until the completion of state and county growth management processes.\nCASCADE REGION. The Cascade Region consists of approximately 330,000 acres of timberland. Approximately 38% of the total timber harvest in the Cascade Region (compared to 47% and 49% in 1994 and 1993) was sold for export to Pacific Rim countries, principally Japan. Logs not sold for export were sold to domestic mills owned by third parties, as the Company does not own mills in the Cascade Region. Logs sold for export are generally of higher quality than logs sold into the domestic market. Sales of export logs decreased as a relative percentage of total sales in 1995, as compared to 1994, due to the shifting of lower quality export logs into domestic markets as a result of a weaker export market.\nROCKY MOUNTAIN REGION. The Rocky Mountain Region consists of approximately 1,712,000 acres of timberland. During 1995, 59% of the total timber harvest in the Rocky Mountain Region was sold to the Manufacturing Segment (compared to 58% and 59% in 1994 and 1993, respectively), with the remainder sold to third-party domestic mills.\nOn November 1, 1993, the Partnership purchased approximately 865,000 acres of timberland and other timber related assets (the \"Montana Timberland Acquisition\") from Champion International Corporation for approximately $260 million. These timberlands are located in western Montana in close proximity to existing Company assets. Management believes the Montana\nTimberland Acquisition provides operating flexibility by allowing Manufacturing to be more self-sufficient from a raw material standpoint.\nSimultaneous to the Montana Timberland Acquisition, the Partnership entered into a log sourcing agreement with Stimson Lumber Company (\"Stimson\") to supply Stimson's Montana mills with 950 million board feet (\"MMBF\") of logs, at prevailing market prices, over a ten year period ending in 2003. At December 31, 1995, the Partnership had a remaining commitment of approximately 703 MMBF.\nTIMBER MANAGEMENT STRATEGY. The Partnership's resource operations involve timber management and harvesting operations, which include road construction and reforestation, as well as wildlife and watershed management. These activities are based on data concerning tree species, site productivity indices as to the type and number of trees by size and age classification, classification of soils, stocking per acre, and information on forest management costs. From this data, coupled with current economic and market conditions, the Partnership develops its annual harvesting plan based upon silvicultural considerations, balancing ecological demands of the forest with a view toward maximizing the value of its timber and timberland assets.\nThe Partnership employs a number of traditional and newly developed harvesting techniques on its lands based on site specific characteristics and other considerations. The Partnership practices \"Environmental Forestry\" on 100% of its Timberlands. Environmental Forestry attempts to better protect and maintain the ecosystem while providing for a reasonable harvest. As a part of this, the Partnership has adopted a technique, used on a portion of the Timberlands, which prescribes retention of a mix of green and dead trees at the harvest site, including some large trees, snags and downed logs to enrich and protect the soil for successive generations of trees, and to provide habitat for a variety of wildlife species. The Partnership intends to continue to expand as appropriate, this component of Environmental Forestry.\nThe Partnership's forestry operations encompass a variety of climatic conditions, topographic features and vegetation types. Particular forestry practices vary by geographic region and depend upon factors such as soil productivity, tree size, age and stocking. For instance, harvesting on steep slopes or during wet seasons is often done using cable yarding systems to prevent damage to soils. Harvesting methods include a variety of partial removals such as seed trees, shelterwood, overstory removal and selective harvests, as well as sometimes clear-cutting. The method chosen depends on tree species, terrain, visual concerns and regeneration objectives. Forest stands may be thinned periodically to improve growth and stand quality until they are harvested. Environmental factors, such as length of growing season, also affect the period of time between harvest. This period, called rotation, can be as short as 40 years in the Cascade Region and as long as 80 years in the Rocky Mountain Region.\nDifferent areas within a forest may be planted or seeded in successive years to provide a variety of age classes within the forest. A variety of age classes tends to provide a regular source of cash flow as the various timber stands within the forest reach harvestable age. The timing of harvests of merchantable timber depends in part on maturity cycles and in part on economic conditions. The Partnership will continue to develop its forest management operations to take\nadvantage of technological, biological and genetic advances to improve timber yields to the greatest extent possible. The Partnership's forestry practices now include thinning of some timber stands, controlled burning, fertilization of timber plantations where cost effective, disease and pest control and reforestation.\nIt is the Partnership's policy to ensure that every acre harvested is promptly reforested. Based on the geographic and climatic conditions of the harvest site, harvested areas may be regenerated naturally by leaving mature trees to reseed the area. Natural regeneration methods are widely used in the Rocky Mountain Region. During 1995, the Partnership planted over 4.7 million seedlings, mostly in the Cascade Region where about 95% of the reforestation is done by planting. Seedlings, which are from one to three years old when planted, are obtained partially from Plum Creek's nursery in Pablo, Montana.\nThe Partnership manages its forest inventory with the use of a computerized timber inventory system. The timber inventory is calculated using statistical information obtained by physical measurements, site maps and photo-types. In addition, the system incorporates estimates related to growth which considers species, topographical information, soil types, and other factors, as well as specifications on merchantability. During 1993, 1994 and 1995, the Partnership implemented Geographical Information Systems (\"GIS\") to further enhance timber management activities. The GIS stores spatial and attribute data related to the Timberlands and provide a wide array of mapping and analytical tools. Various data bases include geographic information, species, volume and diameter specifications for each site.\nForests are subject to a number of natural hazards, including damage by fire, insects and diseases. Severe weather conditions and other natural disasters can also reduce the productivity of forest lands and can interfere with the processing and delivery of forest products. However, damage from natural causes is typically localized and would only affect a portion of the Timberlands at any given time. Nevertheless, such hazards are to a large extent unpredictable and there can be no assurance that losses will be so limited. The size, species, diversity and checker-board ownership of the Timberlands, as well as the Partnership's forest management practices, should help to minimize these risks. Consistent with the practices of other large timber companies, the Partnership does not maintain insurance against loss to standing timber on the Timberlands, but maintains insurance for loss of logs due to fire and other occurrences following harvesting.\nMANUFACTURING SEGMENT\nGENERAL. The Manufacturing Segment consists of four lumber mills, two plywood plants, a lumber remanufacturing facility and a medium density fiberboard (\"MDF\") facility in western Montana and a lumber mill and a wood chip plant in Washington, collectively known as the \"Conversion Facilities\". The Conversion Facilities produce a wide variety of lumber, plywood and MDF products that are sold to Marketing which markets and sells the products. Marketing targets the products to retail home centers and various specialty niche markets which are less cyclical than the traditional housing related markets. In addition, in order to enhance customer service and\nprovide prompt deliveries, Marketing has established a network of 39 independent warehouses located strategically throughout the United States.\nThe lumber remanufacturing facility was constructed in 1994. This plant produces finger-jointed lumber for the home center market. Finger-jointing is an engineered process which produces usable lumber by connecting short pieces of lumber formerly sold as lower value lumber products or relegated to the wood chipper and sold as a lower valued by-product.\nRAW MATERIALS. Manufacturing obtains the majority of its raw logs from the Partnership's Timberlands. The Resources Segment provided 73%, 63%, and 51% of Manufacturing's raw log needs in 1995, 1994 and 1993, respectively. The increase in sourcing from the Resources Segment was primarily due to increased harvest levels as a result of the Montana Timberland Acquisition. The price of logs obtained from the Partnership is determined quarterly based upon estimated market prices and terms in effect at the time.\nManufacturing has and will continue to purchase stumpage and logs from external sources, which include the United States Forest Service (\"USFS\"), Bureau of Indian Affairs (\"BIA\"), Bureau of Land Management (\"BLM\") and state and private timberland owners. At December 31, 1995 and 1994, Manufacturing had 75 MMBF and 100 MMBF, respectively, of timber under contract from external sources which may be harvested over the next three years. The USFS harvest plan, which includes volume from the recent salvage legislation, is expected to provide for a 1996 harvest of 350 MMBF in the geographic area of the Conversion Facilities. However, due in part to legal challenges and changes in public policy, the USFS will most likely sell less than that volume. Manufacturing is permitted to bid on up to approximately fifty percent annually of this USFS volume, with the remainder set aside for small businesses. In addition, approximately 545 MMBF of timber is expected to be made available annually from other sources. The geographic area in which the Conversion Facilities operate may expand or contract from year to year as the cost of logs and value of manufactured products fluctuate. (For further discussion of other timber supply issues see \"Federal and State Regulations\".)\nPRODUCTS AND MARKETS\nLUMBER. Manufacturing produces a diverse line of lumber products, including boards and studs which are manufactured at two studmills, three random-length lumber mills and a lumber remanufacturing plant. For the years ended December 31, 1995, 1994 and 1993 these mills produced 433 MMBF, 388 MMBF, and 352 MMBF of lumber, respectively. Production increased in 1995 and 1994 due to the addition of the lumber remanufacturing plant, which began operations in late November 1994, higher productivity due to improved log merchandising specifications and capital improvements, and additional production shifts. Lumber product revenues represented approximately 38% of combined revenues for 1995, 1994 and 1993.\nThe Manufacturing Segment targets its lumber sales towards domestic lumber retailers, such as retail home center chains, for use in repair and remodeling projects. Value-added products such as consumer appearance boards, pull-to-length boards, premium furring strips, premium studs and pattern boards, aimed at retail and other specialty markets, have made the Manufacturing Segment\nless dependent on the cyclical housing related market. In 1995, 61% of Manufacturing's lumber products were sold into retail markets, 18% to industrial and remanufactured product markets, 17% to stocking distributors and 4% to export markets. These amounts compare to 62%, 20%, 12% and 6% for these same markets, respectively, in 1994.\nPLYWOOD. Manufacturing produces high-grade plywood which is primarily sold into specialized industrial markets. Plywood products are manufactured at the Company's two plywood facilities. For the years ended December 31, 1995, 1994 and 1993 the plywood plants produced 294 million square feet (\"MMSF\") (3\/8\" basis), 290 MMSF, and 289 MMSF of plywood, respectively. Plywood product revenues represented 18%, 17% and 18% of combined revenues in 1995, 1994 and 1993, respectively. During 1995, capital improvements were made that expanded production to include medium-density overlay plywood and scarfed (joined together) plywood to produce longer lengths for specialty products. During 1993 and 1994, automated layup lines were installed in the plywood plants. These lines have increased productivity, enhanced wood recovery and produced a superior product for the industrial markets served.\nDuring 1995 and 1994, 71% and 80%, respectively, of Manufacturing's plywood products were sold in specialty industrial markets, including carpet strip, recreational boat, recreational vehicle and fiberglass-reinforced panel markets. The decrease in sales to industrial markets was the result of relative weakness in the industrial markets as a result of high field inventory levels and extended downtime in the recreational vehicle and recreational boat markets during model year changes. Manufacturing's plywood products are generally of higher quality and value than commodity construction grade products, which makes them more valuable in these specialty niche markets.\nMEDIUM DENSITY FIBERBOARD. Manufacturing produces MDF products which are primarily sold to distributors, commercial store fixture producers, furniture manufacturers and molding manufacturers. During 1995, the manufacturing process was redesigned to produce MDF2, a higher quality MDF product that can be machined and finished more efficiently. For the years ended December 31, 1995, 1994 and 1993 the plant produced 102 MMSF (3\/4\" basis), 123 MMSF, and 106 MMSF of MDF, respectively. The decrease in production in 1995 was the result of downtime associated with issues encountered during the start-up of new high-energy refiners for our new MDF2 product and deterioration in demand. The increased production volume in 1994 was due to improvements in the production process. The 1993 production was down slightly due to a February fire at the plant which caused production delays.\nThe Manufacturing Segment supplies high quality MDF to markets primarily in North America and Pacific Rim countries. In 1995, the Manufacturing Segment sold approximately 50% of its MDF directly to domestic industrial manufacturers or fabricators, 30% to stocking distributors, 14% into overseas export markets, primarily Pacific Rim countries, and 6% to retail and other markets. These amounts compare to 47%, 32%, 17% and 4% to the same markets, respectively, in 1994.\nCHIPS. Manufacturing's lumber and plywood mills produce residual wood chips as a by-product from the conversion of raw logs into finished products. These wood chips are sold to regional paper and pulp mills. The Company's lumber and plywood facilities produced 297 thousand\nbone dry tons (\"MBDT\"), 288 MBDT and 257 MBDT of chips in 1995, 1994 and 1993, respectively. Residual wood chip sales volume has increased annually due to increased lumber and plywood production and increased chip recoveries.\nManufacturing also produces wood chips at its Cle Elum, Washington chip plant. The chip plant produced 38 MBDT, 54 MBDT and 76 MBDT in 1995, 1994 and 1993, respectively. The decrease in production in 1995 resulted from production curtailments for approximately five months due to log supply shortages. The decrease in production in 1994 was caused by halting production for three months due to log supply shortages in the chip market.\nSEASONALITY\nDomestic log sales volumes are typically at their lowest point in the second quarter of each year during spring break-up, when warming weather thaws and softens roadbeds, restricting access to logging sites. Revenues from export log sales are affected in part by variations in inventory in the countries where such logs are sold as well as by weather conditions. Winter logging activity in the Pacific Northwest takes place at lower elevations, where predominantly second growth logs are found, affecting the volume of higher quality export logs sold during this time of the year.\nDemand for manufactured products is generally lower in the fall and winter quarters when activity in the construction, industrial and repair and remodeling markets is slower, and higher in the spring and summer quarters when these markets are more active. Working capital varies with seasonal fluctuations. Log inventories increase going into the winter season to prepare for reduced harvest during spring break-up.\nFEDERAL AND STATE REGULATIONS\nGENERAL. The activities of the Company are subject to various federal and state environmental laws and regulations which impose limitations on the discharge of pollutants into the air and water and which also establish standards for the treatment, storage and disposal of solid and hazardous waste, and govern the discharge of runoff stormwater and wastewater. The General Partner believes that the Company is in substantial compliance with such laws and regulations. (See Item 3. Legal Proceedings.)\nThe activities of the Company are also subject to federal and state regulations regarding natural resources and forestry operations and the requirements of the federal Occupational Safety and Health Act and comparable state statutes relating to the health and safety of the Company's employees. The General Partner believes that the Company is in substantial compliance with such laws and regulations.\nThe Company conducts operations in or near significant environmentally sensitive areas which include the habitats of numerous species including a number of threatened or endangered species. As a result, the Company's activities in such areas may be subject to restrictions relating to the harvesting of timber and the construction of roads.\nTHREATENED AND ENDANGERED SPECIES. In July 1990, the United States Fish and Wildlife Service (\"USFWS\") listed the Northern Spotted Owl (\"Owl\") as a threatened species throughout its range in Washington, Oregon and California under the federal Endangered Species Act (\"ESA\").\nAt the time of the listing, the USFWS issued suggested guidelines (\"Guidelines\") to be followed by landowners in order to comply with the ESA's prohibition against harming or harassing Owls. These Guidelines were rescinded in response to an industry lawsuit, but continue to serve as the basis for USFWS enforcement of the ESA. The Guidelines impose several requirements, including the restriction and preclusion of harvest activities in areas within a 1.8 mile radius (approximately 6,600 acres) of known nest sites or activity centers for pairs of Owls or territorial single Owls (\"Activity Areas\"). Under the Guidelines, at least 40% in the aggregate of the area within Activity Areas has to be maintained as suitable Owl habitat. In addition, 70 acres immediately around nest sites have to be preserved.\nIn June 1992, the Washington State Forest Practices Board (the \"Board\") adopted temporary regulations related to all forest practice applications (\"FPAs\") which require that FPAs comply with the Washington State Environmental Policy Act (\"SEPA\") for all activities within the 500 acres of habitat surrounding nest sites or activity centers. In November 1995, the Forest Practices Board adopted a final Owl rule that will take effect in July 1996. Until the final rule takes effect, the temporary rule will govern. Under the final rule, restrictions substantially similar to those contained in the Guidelines would apply in designated Owl special emphasis areas (\"SEAs\"). Outside of SEAs, only 70 acres surrounding Activity Areas would be protected during the breeding season only. As a result, the final rule will result in the same level of regulation on areas within SEAs and fewer restrictions on the Partnership's activities in areas outside of SEAs due to the Owl. Approximately 60% of the Partnership's lands in the Cascade Region are within SEAs.\nIn February 1995, the USFWS announced that it is proposing to draft a special rule (\"Special Rule\") to redefine private landowner obligations with regard to Owls under the ESA. The final Washington state Owl rule is expected to form the basis for the Special Rule in Washington state.\nOn July 16, 1993, the Clinton Administration proposed a new forest policy (the \"Forest Plan\") that would substantially reduce harvest from public lands in Owl forests and provide for the conservation of the Owl and numerous other species. In December 1994, the Forest Plan was approved by a Federal District Court.\nIMPACT OF REGULATIONS ON PARTNERSHIP. Under the Guidelines issued by the USFWS in 1990, approximately 111,000 acres of the 330,000 acres in the Partnership's Cascade Region lie within Activity Areas. Compliance with the ESA and SEPA is causing delays and in some cases modification of Partnership FPAs in Owl Activity Areas and may cause denials of future Partnership FPAs.\nIn October 1995, the Partnership formally applied for a multi-species, 50 year permit under the ESA from the USFWS and the National Marine Fisheries Service (\"NMFS\") that would cover the Partnership's forest management on 170,000 acres within SEAs in the Cascade Region (the \"Planning Area\"). As a part of the permit application, the Partnership prepared a habitat\nconservation plan (\"HCP\") that would govern the Partnership's management activities in the Planning Area. The Partnership expects to receive the permit in the second quarter of 1996, following completion of the public review process. There are, however, no assurances that the permit will ultimately be issued by the USFWS and NMFS.\nThe permit, if issued, would authorize the incidental take in the Planning Area of the Owl, Marbled Murrelet, Grizzly Bear and Gray Wolf, which are currently listed under the ESA, as well as numerous other species should they become listed during the term of the permit. In addition, as an incentive to the Partnership to create additional wildlife habitat in the Planning Area, the permit may extend for an additional 50 years if wildlife habitat exceeds levels authorized in the HCP. The permit thus would provide long-term certainty and predictability to the Partnership's harvest activities. Under the ESA, the permit may allow impacts on species incidental to normal management activities in exchange for mitigating measures agreed to by the landowner in the HCP. The restrictions in the HCP would replace restrictions for Owls under the final Washington state Owl rule, the Guidelines, the Special Rule, if adopted, and SEPA.\nThe ESA also prohibits the federal government from causing jeopardy to species listed under the ESA or from destroying or adversely modifying their designated critical habitat. Private landowners are potentially affected by this restriction if a private activity requires federal action, such as the granting of access or federal funding. Where there is such a federal connection, the federal agency involved must consult with the USFWS or NMFS, in the case of anadromous fish, to determine that the proposed activity would not cause jeopardy to the listed species or cause direct or indirect adverse modification of its designated critical habitat. If the landowner's proposed activity would cause jeopardy, the USFWS or NMFS must propose, where possible, alternatives or modifications to the proposed activity. The Partnership's Timberlands are often intermingled with federal land in or near areas that include the habitats of a number of threatened or endangered species such as the Owl and the Grizzly Bear. Thus, access across federal lands to certain of the Partnership's Timberlands in such areas has been, and is likely to continue to be, delayed by the administrative process and legal challenges and may be subjected to restriction under the ESA.\nIn December 1995, the Company entered into a Grizzly Bear Conservation Agreement with the USFWS, the USFS, and the state of Montana covering 370,000 acres in the Swan Valley in western Montana. Under this agreement, the Company has received a permit that authorizes incidental take of Grizzly Bears in the Swan Valley. Moreover the agreement will facilitate future consultations with the USFWS over road access projects and land exchanges in the Swan Valley.\nThe ultimate impact of the Owl listing, as well as listings of additional species under the ESA, on the Partnership will depend on (i) the number of Activity Areas actually found on or near Partnership Timberlands, (ii) the availability and amount of suitable habitat within individual Activity Areas, (iii) the outcome of the Clinton Administration's forest policy, (iv) future regulations and restrictions placed on private and public lands, (v) promulgation, interpretation and application of wildlife regulations by both the USFWS (including the proposed Special Rule) and the Washington State Department of Natural Resources, (vi) the outcome of the Partnership's efforts to obtain a multi-species permit from the USFWS and NMFS, (vii) the impact of reduced harvests upon stumpage prices, and (viii) the outcome of litigation.\nAlthough the continuing uncertainty surrounding efforts to conserve the Owl make it difficult to assess the future impact of the Owl listing on the Partnership, at this time the General Partner does not believe that federal and state laws and regulations related to the Owl will have a materially adverse effect on the financial position of the Company, its results of operations or liquidity. There can be no assurances, however, that (i) future interpretation or administration of current laws and regulations, (ii) changes in laws or regulations, (iii) increases in the number of Owls on or near Partnership lands, or (iv) decreases in suitable habitat adjacent to Partnership lands will not adversely affect the operations, financial position or liquidity of the Company.\nThe General Partner anticipates that increasingly strict laws and regulations relating to the environment, natural resources, forestry operations, and health and safety matters, as well as increased social concern over environmental issues, may result in additional restrictions on the Company causing increased costs, additional capital expenditures and reduced operating flexibility.\nLEGISLATION RESTRICTING LOG EXPORTS. Federal legislation currently prohibits the sale of unprocessed logs harvested from federal lands located in the western half of the U.S. if such logs will be exported from the U.S. by the purchaser thereof, or if such logs will be used by the purchaser thereof, as a substitute for timber from private lands which is exported by such purchaser. In order to enforce this substitution prohibition, the legislation requires persons who export private logs and who wish to purchase federal timber to obtain an approved federal timber \"sourcing area\". To win approval it must be shown that the desired federal timber sourcing area is economically and geographically separate from the area from which such person exports private logs. In 1991, the Company applied for and obtained an approved sourcing area for the Partnership's conversion facilities. Under the legislation, sourcing areas are subject to review and renewal at least every five years. The Partnership's sourcing area may, therefore, be reviewed in 1996.\nIn October 1995, the USFS issued final regulations implementing the 1990 legislation that could have made it more difficult to obtain sourcing areas. These regulations, however, have been temporarily withdrawn pursuant to Congressional action to allow time for further public comment and for Congress to consider modifications to the export law. Revisions to the law and regulations have not yet been proposed. Although the uncertainty surrounding the export regulations makes it difficult to predict the timing or the outcome of a review, the Company believes that its sourcing area meets the current statutory test and should be renewed.\nIn addition, federal legislation prohibits the export of unprocessed logs harvested from certain state lands. Initially, Washington and Oregon prohibited the export of all logs harvested from state lands. The legislation provided, however, that the ban in Washington state on the export of state logs would become a partial ban beginning January 1, 1996. Pending finalization of the rules, the full ban is being maintained. Proposals have also been made from time to time, but to date have been unsuccessful, to either ban or tax the export of unprocessed logs harvested from private lands.\nINCOME TAX CONSIDERATIONS\nPARTNERSHIP STATUS. The Partnership is not a taxable entity and incurs no federal income tax liability. Each partner is required to take into account in computing his or her federal income tax liability, his or her allocable share of income, gains, losses, deductions and credits of the Partnership, regardless of whether cash distributions are made. Distributions by the Partnership to a partner are generally not taxable.\nPublicly traded partnerships will, as a general rule, be taxed as corporations. However, an exception (the \"Qualifying Income Exception\") exists with respect to publicly traded partnerships of which 90% or more of the gross income for every taxable year consists of qualifying income. Qualifying income includes income from the processing, refining, marketing or transportation of timber. The Partnership's principal sources of income include income from the sale of timber, the transportation of timber, the operation of sawmills and the production of plywood and MDF. The Internal Revenue Service (\"IRS\") has issued two rulings to the Partnership that income from the operation of sawmills and the production of plywood and MDF is qualified for this purpose.\nSECTION 754 ELECTION. The Partnership has made the election permitted by Section 754 of the Internal Revenue Code (the \"Code\"). The election requires a purchaser of depositary units representing limited partner interests (\"Units\") to adjust his or her share of the basis in the Partnership's properties (\"Inside Basis\") pursuant to Section 743(b) of the Code to fair market value (as reflected by his or her Unit cost). A Unitholder's allocable share of Partnership income, gains, losses and deductions is determined in accordance with the Unitholder's unique basis under this election. Such election is irrevocable and may not be changed without the consent of the IRS. The Section 743(b) adjustment is attributed solely to a purchaser of Units and is not added to the basis of the Partnership's assets associated with all of the Unitholders.\nFEDERAL INCOME TAXATION - GENERAL. Marketing, organized as a separate corporation, reports all of its income, gains, losses, deductions and credits arising from its operations on its own tax return and pays a corporate tax on any resulting net income. Under current law, Marketing's net income is subject to federal income tax at rates of up to 35%. Losses realized by Marketing do not flow through to the Partnership, but are carried back and forward, within certain limitations, to offset taxable income of Marketing in past or future years. Distributions, if any, received by the Partnership from Marketing generally would be characterized as either taxable dividends of current or accumulated earnings and profits or in the absence of earnings and profits, as a nontaxable return of capital (to the extent of the Partnership's tax basis in Marketing's stock) or as taxable capital gain (after the Partnership's basis in such stock is reduced to zero).\nSTATE TAX INFORMATION. The Partnership conducts operations in three states, two of which (Idaho and Montana) have a state income tax. To simplify the Unitholders' state filing requirements, the Partnership files composite returns in each of those states and pays the state income tax due for non-resident Unitholders. Marketing conducts operations in approximately 25 states for which it pays state corporate income taxes.\nTAX-EXEMPT ENTITIES. Certain entities otherwise generally exempt from federal income taxes (such as individual retirement accounts (\"IRAs\"), employee benefit plans and other charitable or exempt organizations) may be subject to federal income tax if their share of Unrelated Business Taxable Income (\"UBTI\") exceeds $1,000. For years prior to 1994, all income derived from publicly traded partnerships was classified as UBTI. For years after 1993, income is classified as UBTI dependent upon source. Most of the Partnership's income continues to be classified as UBTI. Regulated investment companies are required to derive 90% or more of their gross income from qualified sources, such as interest or security trading income; gross income from the Partnership is not qualifying income for purposes of this test.\nTIMBER INCOME. Section 631 of the Code provides special rules by which gains from the sale of timber or cut logs, which would otherwise be taxable as ordinary income, are treated in whole or in part as capital gains from the sale of property used in a trade or business. The Partnership has elected to apply the provisions of Section 631. Substantially all of the Partnership's 1995 taxable income is expected to qualify for capital gains treatment.\nENCUMBRANCES\nUnder the terms of the Senior Notes due 2007, the Senior Notes due 2009 and the Lines of Credit, the Partnership has agreed not to pledge, assign or transfer the Timberlands, except under limited circumstances. Under the terms of the First Mortgage Notes of Manufacturing, the holders of these notes have a first mortgage lien on substantially all of the Conversion Facilities. In addition, the Partnership guarantees the First Mortgage Notes of Manufacturing.\nThe Partnership's title to the timberlands acquired during the formation of the Company on June 8, 1989 includes the related hard rock mineral interests. However, the Partnership did not obtain the hard rock mineral interests to the 865,000 acres of timberland purchased in the Montana Timberland Acquisition. In addition, the Partnership does not own oil and gas interests to any of its Timberlands. The title to the Timberlands is subject to presently existing easements, rights of way, flowage and flooding rights, servitudes, cemeteries, camping sites, hunting and other leases, licenses and permits, none of which materially adversely affect the value of the Timberlands or materially restrict the harvesting of timber or other operations of the Partnership.\nCOMPETITION\nRESOURCES SEGMENT. In export log markets, the Partnership competes with other U.S. companies, Chile, New Zealand, Russia, Canada and Scandinavia, all of which have abundant timber resources. Competitive factors generally will include price, species and grade and ability to meet delivery requirements.\nIn domestic log markets, the Partnership competes with numerous private land and timber owners in the Northwestern U.S. and the states of Idaho, Montana, Oregon and Washington, as well as lesser amounts of foreign imports, primarily from Chile and New Zealand. In addition, the Partnership competes with the U.S. Government, principally the USFS and the BLM, and the BIA.\nTimber supplied from the U.S. Government, Washington and Oregon land is restricted from export, and is sold solely into domestic markets. (See Federal and State Regulations.)\nDomestic wood and fiber consuming facilities tend to purchase raw materials within relatively small geographic areas, generally within a 200 mile radius, due to log transportation costs. Competitive factors within a market area generally will include price, species and grade, proximity to wood consuming facilities and ability to meet delivery requirements.\nMANUFACTURING SEGMENT. Markets for forest products are highly competitive in terms of price and quality. The Manufacturing Segment competes in domestic lumber markets primarily with other U.S. and Canadian companies. Canadian lumber producers have increased their penetration into the U.S. market due to their low cost advantage and favorable exchange rates. The U.S. and Canadian governments are currently negotiating a timber trade agreement which may result in less favorable exporting conditions for Canadian producers. The lumber market is also subject to competition from substitute products, primarily in shelving, window and door markets. The Manufacturing Segment competes in the Japanese lumber market primarily with Japanese, Canadian, Russian and Scandinavian companies. The domestic plywood market is characterized by numerous large and small producers and is subject to competition from oriented strand board and waferboard, which are less expensive, but generally lower quality substitutes. Significant capacity expansion of oriented strand board production is planned in 1996. The Manufacturing Segment competes in domestic MDF markets primarily with other U.S. and Canadian companies that produce high quality MDF. Significant MDF capacity expansion is planned in this market in 1996. Competition in export markets primarily consists of Japanese, Korean and Malaysian companies.\nCompetition in the markets for commodity-grade lumber and plywood is primarily based on pricing strategies. Sales in specialty niche industrial markets and retail markets are strongly influenced by product quality, customer service, efficiency of distribution and the ability to supply products in the future, in addition to price. The ability to provide companion products and a variety of substitute products is also used as a marketing strategy for certain products. MDF producers typically compete on a global scale. Accordingly, sales are generally determined by price, product quality and level of customized services the producer can provide, rather than by geographic location.\nEMPLOYEES\nThe Company currently has approximately 350 salaried and 1,500 hourly employees, including employees of the General Partner that manage the businesses of the Company. The Company believes that its employee relations are good. The Company's wage scale and benefits are generally competitive with other forest products companies. The Company's employees are not unionized. The harvesting and delivery of logs are conducted by independent contractors who are not employees of the Company.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company believes that its Timberlands and Conversion Facilities are suitable and adequate for current operations. The Conversion Facilities are modern, state of the art operations maintained through on-going capital investments, regular maintenance and equipment upgrades. The Company owns substantially all of the Conversion Facilities. All of the Conversion Facilities are operated at near maximum capacity levels year round. See Item 1. Business for discussion of the location and description of properties and encumbrances related to properties.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nOn June 7, 1995, the Company received a Compliance Order (\"Order\") from the Environmental Protection Agency (\"EPA\") under the Clean Air Act. The Order alleges that the installation in 1990 of a boiler at the Company's Pablo sawmill did not undergo new source performance review. Work on the boiler project commenced in March of 1989, when the applicable regulation did not require a review. Prior to final installation of the boiler, however, new rules were proposed that required such review. The EPA has taken the position that the new rules applied, and is seeking compliance with the new source performance standards. To help resolve this issue, Plum Creek voluntarily installed both a pollution control device on the boiler and an opacity monitor in December 1995 and is in full compliance with the Order.\nThere is no pending litigation, and to the knowledge of the General Partner there is no threatened litigation involving the Company which would have a material adverse effect on the financial position, the results of operations or liquidity 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 UNITHOLDER MATTERS\nThe Partnership's Units are traded on the New York Stock Exchange. As of January 31, 1996, there were approximately 53,400 beneficial owners of 40,608,300 outstanding Units.\nTrading price data, as reported by the New York Stock Exchange, and declared cash distribution information for 1995 and 1994 are as follows:\nCash distributions are paid from available cash as defined by the Partnership's partnership agreement. It is the Company's intention to maintain the distribution into the foreseeable future; however, there can be no guarantee. In addition, the Company's debt agreements have certain restrictive covenants limiting the amount of cash distributions.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\n(1) Revenues and fee timber harvest increased in 1995 and 1994 in part due to the November 1993 Montana Timberland Acquisition.\n(2) During 1993, the Company elected to change its method for valuing inventories from average cost to the last-in, first-out (\"LIFO\") method. This change in accounting lowered 1993 earnings by $8.0 million or $0.18 per Unit. The cumulative effect of the accounting change and pro forma effects on prior years' earnings have not been included because such effects are not reasonably determinable. In addition, on August 30, 1993, the Partnership redeemed the 1.25 million DPIs (on a pre-Unit split basis) for $63.0 million.\n(3) Per Unit amounts have been restated for the December 6, 1993 three-for-one Unit split.\n(4) Included in 1993 capital expenditures was $255.3 million paid for the timberlands acquired as part of the Montana Timberland Acquisition.\n(5) Included in 1992 results of operations was the sale of the 164,000 acre Gallatin Unit, together with the Belgrade sawmill for $23 million plus the value of inventory. The sale resulted in a net gain of $15.6 million.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nGENERAL\nPlum Creek Timber Company, L.P. (the \"Partnership\"), a Delaware limited partnership, Plum Creek Manufacturing, L.P. (\"Manufacturing\"), and Plum Creek Marketing, Inc., (\"Marketing\"), own, manage, and operate 2.0 million acres of timberland and ten wood products conversion facilities in Montana, Washington and Idaho. The Partnership owns 98 percent of Manufacturing and 96 percent of Marketing. Plum Creek Management Company, L.P., (the \"General Partner\"), manages the businesses of the Partnership, Manufacturing and Marketing and owns the remaining two percent and four percent of Manufacturing and Marketing, respectively. As used herein, \"Company\" refers to the combined entities of the Partnership, Manufacturing and Marketing. \"Resources Segment\" refers to the combined timber and land management business of the Partnership. \"Manufacturing Segment\" refers to the combined business of Manufacturing and Marketing.\nEVENTS AND TRENDS AFFECTING OPERATING RESULTS\nMARKET FORCES. The demand for logs and manufactured wood products depends upon international and domestic market conditions, the value of the U.S. dollar in foreign exchange markets, competition, the availability of substitute products and other factors. In particular, the demand for logs, lumber, plywood and MDF is affected by residential and industrial construction, and repair and remodel activity. These activities are subject to fluctuations due to changes in economic conditions, tariffs, interest rates, population growth and other economic, demographic and environmental factors.\nCURRENT MARKET CONDITIONS. Prices for domestic logs in the Cascade Region for 1995 increased from levels experienced in 1994, primarily as a result of strong pulp and paper markets competing for logs in the domestic market during the first three quarters of the year and the diverting of export quality logs to the domestic market during the second half of the year as a result of a weakening Japanese market. At year-end 1995, Douglas-fir prices were holding steady due to a lack of supply, and whitewood prices were declining as a result of falling chip prices. Domestic log prices in the Rockies Region were lower than prices experienced in 1994, as a result of weaker lumber markets, aggressive competition from Canadian lumber producers and a fourth quarter decline in both commodity plywood prices and chip prices. Export log prices for 1995 increased slightly over 1994 prices as a result of the diversion of lower quality export logs to the domestic market and near record high price levels in the first quarter of 1995 due to low inventory levels in Japan and the U.S. west coast. At year end, there was upward price pressure on export logs due to the short supply of logs in both Japan and the U.S. west coast.\nIndustry composite indices for lumber commodity prices were 18% lower in 1995 than in 1994. The decrease in prices was primarily due to relative weakness in the housing market, aggressive pricing and competition from Canadian lumber producers, and increased competition from substitutes. Industry composite indices for plywood commodity prices and prices for MDF\nin 1995 approximately equaled levels experienced in 1994. Commodity plywood prices began declining during the fourth quarter due to a slowing housing market and the significant oriented strand board capacity expansion projected in 1996. MDF prices have fallen significantly as compared to price levels at year-end 1994 due to a decline in demand for ready-to-assemble furniture as a result of lower repair & modeling activity, high end-user inventories, and capacity expansion by Pacific Rim manufacturers. Prices for pulp logs and chips improved significantly during the first and second quarter of 1995 due to strong pulp and paper markets. Prices peaked during the summer and have since retreated due to the oversupply of logs and chips that was brought on by these higher prices.\nFINANCIAL CONDITION AND LIQUIDITY\nNet cash provided by operating activities was $165.2 million, $155.1 million and $115.3 million for 1995, 1994 and 1993, respectively. In 1994, operating cash flow was reduced by $9.2 million, net of expense, for the funding of certain employee benefit plans. There was no such funding in 1995. Future funding of these benefit plans is contingent on meeting targets as defined in the plans. For further discussion of these benefit plans, see Note 10 of Notes to Combined Financial Statements. On December 31, 1995, the Company had $87.6 million of cash and cash equivalents.\nThe Partnership has two unsecured revolving lines of credit (\"Lines of Credit\") with a group of banks that permit the Partnership to borrow up to $135 million for general corporate purposes, including up to $5 million of standby letters of credit issued on behalf of the Partnership or Manufacturing. The Lines of Credit bear a floating rate of interest. One line of credit allows the Partnership to borrow $100 million through October 31, 2000, of which $82.5 million was outstanding at December 31, 1995. The other line of credit allows the Partnership to borrow $35 million through October 28, 1996 (any borrowings outstanding at that time are payable in quarterly installments, at the option of the Partnership, due January 1997 through October 1998), of which $15 million was outstanding at December 31, 1995. As of December 31, 1995, there were letters of credit outstanding in the amount of $0.8 million. Borrowings on the Lines of Credit fluctuate daily based on cash needs. As of January 4, 1996, all borrowings on the Lines of Credit were repaid.\nThe Company's long-term debt agreements and Lines of Credit contain certain restrictive covenants, including limitations on harvest levels, sale of assets, cash distributions and the amount of future indebtedness. The Company was in compliance with such covenants as of December 31, 1995 and 1994. The First Mortgage Notes limit distributions from the Manufacturing Segment to the Partnership.\nThe Partnership will distribute $0.49 per Unit for the fourth quarter of 1995. The distribution will equal $25.9 million (including $6.0 million to the General Partner), and will be paid on March 1, 1996 to Unitholders of record on February 15, 1996. The computation of cash available for distribution includes a required reserve for the payment of principal and interest, as well as other reserves established at the discretion of the General Partner, for working capital, capital expenditures or future cash distributions.\nCash required to meet the Partnership's quarterly cash distributions, capital expenditures and to satisfy interest and principal payments on the Company's debt will be significant. The General Partner expects that all debt service will be funded from cash generated by operations. The Partnership expects to make cash distributions from current funds and cash generated from operations. It is anticipated that future capital expenditures will be funded from current funds and cash generated from operations.\nThe Company is involved in certain environmental and regulatory proceedings and other related matters. Although it is possible that new information or future developments could require the Company to reassess its potential exposure related to these matters, the Company believes, based upon available information, that the resolution of these issues will not have a materially adverse effect on its results of operations, financial position or liquidity.\nCAPITAL EXPENDITURES\nCapital expenditures for the Resources Segment were $8.5 million, $7.1 million and $260.5 million for 1995, 1994 and 1993, respectively. Resources Segment capital expenditures included the construction of logging roads and reforestation. Resources Segment capital expenditures for 1993 included $255.3 million of timberlands purchased as part of the Montana Timberland Acquisition, as well as construction of logging roads and reforestation. Capital expenditures for the Manufacturing Segment were $22.2 million, $18.7 million and $24.1 million for 1995, 1994 and 1993, respectively. Manufacturing Segment capital expenditures in 1995 included a project in the MDF plant to produce Super-Refined MDF2, a higher quality MDF product that can be machined and finished more efficiently, adding significant value to the MDF product line, air quality pollution control equipment at the MDF plant, various lumber and plywood value-added projects, and equipment upgrades to meet environmental requirements.\nPlanned capital expenditures for the Resources Segment in 1996 are $9 million, primarily for logging roads and reforestation. The Manufacturing Segment's 1996 planned capital expenditures are $11 million which includes the purchase and installation of various lumber and plywood optimization projects, as well as replacements and upgrades of other equipment in several of the Conversion Facilities.\nRESULTS OF OPERATIONS\nThe following table compares operating income by segment for the years ended December 31, 1995, 1994 and 1993.\nOperating Income by Segment (In Thousands)\n1995 COMPARED TO 1994\nResources Segment revenues were $327.0 million and $324.4 million for the years ended 1995 and 1994, respectively. Revenues were $2.6 million higher in 1995, primarily due to a $21.7 million increase in revenues from pulpwood and chip sales offset in part by lower export log sales volume and lower domestic log prices. The increase in pulpwood and chip revenues was due to the addition of in-woods chipping operations, which utilize small tops of trees and small trees from thinning operations, and a significant increase in pulp log prices and sales volume as compared to 1994 due to strong pulp and paper markets. Export log sales volume decreased by 18%, as compared to 1994, due to the shifting of lower quality export logs to the domestic market as a result of a weaker Japanese economy and a planned reduction in harvest levels. Domestic log prices, as compared to 1994, decreased by 8%. The decrease was attributable entirely to the Rockies Region and was due to weak lumber markets and aggressive competition from Canadian lumber producers.\nResources Segment costs and expenses were $187.8 million and $173.7 million for the years ended 1995 and 1994, respectively. Costs and expenses were $14.1 million higher in 1995 primarily due to the costs relating to higher volumes of pulpwood and chip sales.\nManufacturing Segment revenues were $375.7 million and $372.2 million for the years ended 1995 and 1994, respectively. Revenues were $3.5 million higher in 1995 due to an increase in lumber sales volume and a 60% increase in revenues from residual chip sales, offset in part by lower lumber prices and lower MDF sales volume. Lumber sales volume increased by 8% in 1995, as compared to 1994, due to increased production as a result of the new lumber remanufacturing facility, higher productivity due to improved log merchandising specifications and capital improvements, and additional production shifts. Lumber prices decreased by 13% as compared to 1994 due to a weaker housing market as a result of generally slower economic conditions, and increased competition from both Canadian imports and substitute products. While our lumber prices\nare influenced by commodity prices, we are able to maintain sales volume due to our high concentration of sales in the repair & remodel and industrial markets, which are less impacted by the slow housing market. MDF sales volume decreased by 15% as a result of production downtime associated with weak market conditions and issues encountered during the start-up of new high-energy refiners for our new MDF2 product. Residual chip revenues increased due to a substantial increase in prices over 1994 due to strong pulp and paper markets.\nManufacturing Segment costs and expenses were $340.1 million for the years ended 1995 and 1994. Increased costs due to increased lumber sales volumes were offset by lower log costs (14% and 4% lower for lumber and plywood, respectively) and lower MDF production costs as a result of downtime.\nOther Costs and Eliminations (which consists of corporate overhead, intercompany log profit elimination, and intercompany LIFO elimination) decreased operating income by $3.0 million less in 1995 as compared to 1994. The variance was primarily due to lower intercompany profit elimination, offset in part by an increase in the intercompany LIFO elimination. On a combined basis, the Resources Segment's profit on intercompany log sales is deferred until Manufacturing converts existing log inventories into finished products and sells them to third parties. The 1995 intercompany profit elimination was lower than the prior year's due to a decrease in log inventory levels, and a lower log transfer price as a result of a weaker domestic log market. On a combined basis, the LIFO impact related to price fluctuations on the sale of intercompany logs is eliminated. The 1995 intercompany LIFO elimination was greater than the prior year's due to a lower log transfer price, which resulted in a greater decrement in Manufacturing's separate company LIFO reserve as compared to the combined LIFO reserve.\nNet other expense decreased by $2.6 million in 1995 as compared to 1994 primarily due to a decrease in fixed asset retirements, a charge in 1994 for the write-off of capitalized debt issue costs as a result of refinancing the lines of credit, and a decrease in the expense for state taxes payable on behalf of non-resident Unitholders.\nThe income allocated to the General Partner increased by $6.2 million during 1995 compared to 1994 as a result of higher quarterly distributions to the Unitholders which increased the incentive distribution paid to the General Partner. Net income is allocated to the General Partner based on two percent of the Company's net income (adjusted for the incentive distribution paid), plus the incentive distribution. The incentive distribution is based on a percentage of the quarterly distribution paid which totaled $1.90 per Unit for the year ended 1995, compared to $1.62 per Unit in 1994.\n1994 COMPARED TO 1993\nResources Segment revenues were $324.4 million and $266.1 million for the years ended 1994 and 1993, respectively. Revenues were $58.3 million higher in 1994, primarily due to increased sales volumes and higher prices for domestic logs, offset in part by lower export log sales volumes and lower land sales. Domestic log sales volume increased by 24% as compared to 1993 primarily due to increased harvest levels. The Company's 1994 fee timber harvest was 559 MMBF which was 101 MMBF higher than 1993, primarily as a result of the Montana Timberland Acquisition. Domestic log prices increased in 1994 by 8% as compared to 1993. The higher prices were primarily the result of increased demand for wood products as well as from log shortages in the Northwest caused in part by legal challenges to federal timber sales and changes in federal timber policy. In addition, 1994 land sales were $6.4 million lower than 1993. Land sales declined in 1994, primarily due to the Partnership's strategy of deferring land sales until the completion of state and county growth management processes.\nResources Segment costs and expenses were $173.7 million and $130.9 million for the years ended 1994 and 1993, respectively. Costs and expenses were $42.8 million higher in 1994 primarily due to the increase in the production volumes of domestic logs, higher log and haul costs resulting from longer hauling distances and higher road amortization and timber depletion rates resulting from the additional roads and timber obtained in the Montana Timberland Acquisition.\nManufacturing Segment revenues were $372.2 million and $324.6 million for the years ended 1994 and 1993, respectively. Revenues were $47.6 million higher in 1994 due to sales volume increases and higher prices in all product lines. Lumber, plywood, and MDF prices increased in 1994 by 7%, 7% and 22%, respectively, over 1993. The higher prices were the result of improved domestic wood product demand and the impact of the log supply shortage. Lumber sales volumes were 7% higher in 1994 as compared to 1993, primarily due to increased production. MDF sales volumes increased by 15% in 1994 due to increased production as a result of production improvements.\nManufacturing Segment costs and expenses were $340.1 million and $313.1 million for the years ended 1994 and 1993, respectively. The $27.0 million of higher costs and expenses were primarily due to increased lumber and MDF production volumes and higher log costs (14% and 15% higher for lumber and plywood, respectively) which were the result of improving demand for finished wood products and the log supply shortage.\nOther Costs and Eliminations (which consists of corporate overhead, intercompany log profit elimination, and intercompany LIFO elimination) decreased by $1.4 million for the year ended 1994 as compared to 1993, primarily due to a decrease in the cost of employee benefit plans and a decrease in executive incentive compensation paid by the Partnership. Profit resulting from intercompany log sales is deferred until the Manufacturing Segment converts existing log inventories into finished products and sells them to third parties.\nInterest expense increased by $10.7 million in 1994 as compared to 1993 due to an increase in average debt outstanding in 1994, as a result of borrowings in November 1993 to finance the Montana Timberlands Acquisition. Net other expense increased by $4 million in 1994 as compared\nto 1993 primarily due to an increase in the minority interest elimination as a result of an increase in net income in the Manufacturing Segment, an increase in fixed asset retirements and an increase in the expense for state taxes payable on behalf of non-resident Unitholders.\nThe income allocated to the General Partner increased by $7.5 million during 1994 compared to 1993 as a result of higher net income and higher quarterly distributions to the Unitholders which increased the incentive distribution paid to the General Partner. Net income is allocated to the General Partner based on two percent of the Company's net income (adjusted for the incentive distribution paid), plus the incentive distribution. The incentive distribution is based on a percentage of the quarterly distribution paid which totaled $1.62 per Unit for the year ended 1994, compared to $1.30 per Unit in 1993 (1993 per Unit amounts were restated for the December 6, 1993 three-for- one Unit split).\nEXPORT SALES\nThe Company sells logs and finished wood products for export. These sales are denominated in U.S. dollars and are generally sold to Pacific Rim countries, principally Japan, and to Canada. Combined export revenues as a percentage of total revenues were 13%, 15% and 17% for 1995, 1994, and 1993, respectively.\nEFFECT OF INFLATION\nDuring recent years the Company has generally experienced increased costs due to the effect of inflation, particularly in the Manufacturing Segment, on the cost of raw materials, labor, supplies and energy. However, the Company utilizes the LIFO inventory valuation method for its raw materials, work-in-process and finished goods inventory which generally matches current costs to current revenues and thus, tends to reflect the impact of inflation on cost of goods sold.\nOTHER MATTERS\nIn March 1995, the Financial Accounting Standards Board (\"FASB\") issued Statement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of\" (\"FAS 121\"). FAS 121 requires that long-lived assets and certain intangibles be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. If impairment has occurred, an impairment loss must be recognized. Implementation of FAS 121 is required in 1996. The impact of the adoption of this standard is not expected to be material to the financial position, results of operations, or liquidity of the Company.\nIn October 1995, the Financial Accounting Standards Board (\"FASB\") issued Statement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation\" (\"FAS 123\"). FAS 123 establishes a fair value based method of accounting for stock-based compensation plans and encourages entities to adopt that method in place of the provisions of Accounting Principles Board Opinion No. 25 (\"APB 25\"). The Company intends to continue to apply the provisions of APB 25 in recognizing compensation expense related to Unit-based compensation plans.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY FINANCIAL INFORMATION\nPLUM CREEK TIMBER COMPANY, L. P. COMBINED STATEMENT OF INCOME\nSee accompanying Notes to Combined Financial Statements.\nPLUM CREEK TIMBER COMPANY, L. P. COMBINED BALANCE SHEET\nSee accompanying Notes to Combined Financial Statements.\nPLUM CREEK TIMBER COMPANY, L. P. COMBINED STATEMENT OF CASH FLOWS\nSee accompanying Notes to Combined Financial Statements.\nPLUM CREEK TIMBER COMPANY, L. P. NOTES TO COMBINED FINANCIAL STATEMENTS\nNOTE 1. ACCOUNTING POLICIES\nBASIS OF PRESENTATION. Plum Creek Timber Company, L.P. (the \"Partnership\"), a Delaware limited partnership, Plum Creek Manufacturing, L.P. (\"Manufacturing\"), and Plum Creek Marketing, Inc. (\"Marketing\"), own, manage and operate 2.0 million acres of timberland and ten wood products conversion facilities in Montana, Washington and Idaho. The Partnership owns 98 percent of Manufacturing and 96 percent of Marketing. Plum Creek Management Company, L.P. (the \"General Partner\"), manages the businesses of the Partnership, Manufacturing and Marketing and owns the remaining two percent general partner interest of Manufacturing and four percent of Marketing. As used herein, \"Company\" refers to the combined entities of the Partnership, Manufacturing and Marketing. \"Resources Segment\" refers to the timber and land management business of the Partnership, and \"Manufacturing Segment\" refers to the combined businesses of Manufacturing and Marketing.\nThe Resources Segment grows and harvests timber for sale in export markets, primarily Pacific Rim countries, and domestic markets, primarily in Washington, Idaho and Montana. The Manufacturing Segment produces a wide variety of lumber, plywood and medium density fiberboard (\"MDF\") products. The Manufacturing Segment targets these products to retail home centers and various specialty niche markets which are less cyclical than the traditional housing related markets. The principal markets for lumber and plywood products are in the United States. MDF markets primarily consist of North America and, to a lesser extent, Pacific Rim countries.\nThe combined financial statements of the Company include all the accounts of the Partnership, Manufacturing and Marketing. All significant intercompany transactions have been eliminated in combination. Certain financial statement reclassifications have been made to the 1994 and 1993 amounts presented for comparability purposes and have no impact on net income.\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nNET INCOME PER UNIT. Net income per Unit is calculated using the weighted average number of Units outstanding, net of redeemed Units, plus, in 1993, any unredeemed Deferred Participation Interests (\"DPIs\") divided into the combined Partnership net income, after adjusting for the General Partner Interest. The weighted average number of Units outstanding was 40,608,300, 40,608,300, and 43,084,327 for the years ended December 31, 1995, 1994 and 1993, respectively.\nREVENUE RECOGNITION. Revenues received from the sale of logs, wood products and by-products, primarily wood chips, are generally recorded as revenue at the time of shipment. Sales are denominated in U.S. dollars.\nCASH AND CASH EQUIVALENTS. The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents.\nINVENTORIES. Logs, work-in-process, and finished goods inventories are stated at the lower of cost or market on the last- in, first-out (\"LIFO\") method. Cost for manufactured inventories includes raw materials, labor, supplies, energy, depreciation and production overhead. Cost of log inventories includes timber depletion, stumpage, associated logging and harvesting costs, road costs and production overhead. The average cost method is used to value the Company's supplies inventories.\nTIMBER AND TIMBERLANDS. Timber and timberlands, including logging roads, are stated at cost less depletion for timber previously harvested and accumulated amortization. Cost of the Partnership's timber harvested is determined based on the volume of timber harvested in relation to the amount of estimated recoverable timber. The Partnership estimates its timber inventory using statistical information and data obtained from physical measurements, site maps, photo-types and other information gathering techniques. The cost of logging roads is amortized over the estimated useful life on a straight-line basis.\nPROPERTY, PLANT AND EQUIPMENT. Property, plant and equipment is stated at cost. Improvements and replacements are capitalized. Depreciation is provided for on a straight-line basis for buildings and on a unit-of-production basis for machinery and equipment, which approximates a straight-line basis. Maintenance and repairs necessary to maintain properties in operating condition are expensed as incurred. The cost and related accumulated depreciation of property sold or retired are removed from the accounts and any gain or loss is recorded.\nINCOME TAXES. The Partnership and Manufacturing are not subject to federal income tax and their income or loss is included in the tax returns of individual Unitholders. The Partnership files composite returns in the states in which it does business, paying taxes for nonresident Unitholders. Taxes paid for nonresident Unitholders are included in other expense. Marketing, as a separate taxable corporation, provides for income taxes on a separate company basis. Marketing provides for deferred taxes in order to reflect the tax consequences in future years of the difference between the financial statement and tax basis of assets and liabilities at year-end.\nUNIT-BASED COMPENSATION PLANS. The Company accounts for Unit-based compensation plans under the provisions of Accounting Principles Board Opinion No. 25 (\"APB 25\"). In October 1995, the Financial Accounting Standards Board (\"FASB\") issued Statement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation\" (\"FAS 123\"), which is effective for years beginning after December 15, 1995. FAS 123 establishes a fair value based method of accounting for stock-based compensation plans and encourages entities to adopt that method in place\nof the provisions of APB 25. The Company intends to continue to apply the provisions of APB 25 in recognizing compensation expense related to Unit-based compensation plans and disclose in the footnotes in 1996 the impact on net income had FAS 123 been adopted for expense recognition purposes. See Note 10 to Notes to Combined Financial Statements for discussion of the above referenced plans.\nNOTE 2. ACCOUNTS RECEIVABLE\nAccounts receivable were presented net of allowances for doubtful accounts of $1,316,000 and $1,160,000 at December 31, 1995 and 1994, respectively.\nNOTE 3. INVENTORIES\nInventories consisted of the following at December 31 (in thousands):\nExcluding supplies, which are valued at average cost, the cost of the LIFO inventories valued at the lower of average cost or market (which approximates current cost) at December 31, 1995 and 1994 was $46.3 million and $54.9 million, respectively.\nNOTE 4. TIMBER AND TIMBERLANDS AND PROPERTY, PLANT AND EQUIPMENT\nTimber and timberlands consisted of the following at December 31 (in thousands):\nProperty, plant and equipment consisted of the following at December 31 (in thousands):\nNOTE 5. BORROWINGS\nLong-term debt consisted of the following at December 31 (in thousands):\nOn August 1, 1994, the Partnership issued $150 million of senior notes due in full on August 1, 2009 (the \"Senior Notes due 2009\") which bear interest at 8.73%, payable semi-annually. The proceeds obtained from the issuance of the Senior Notes due 2009 were used to refinance a portion of the $260 million Line of Credit incurred to finance the November 1, 1993 Montana Timberland Acquisition.\nThe Senior Notes due 2007 and the First Mortgage Notes bear interest of 11.125%, payable semi-annually. The Senior Notes due 2007, the Senior Notes due 2009 and the First Mortgage Notes (collectively, the \"Note Agreements\") are redeemable prior to maturity subject to a premium on redemption, which is based upon interest rates of U.S. Treasury securities having similar average maturity as the Note Agreements. At December 31, 1995 and 1994, the premium that would have been due upon early retirement would have approximated $119 million and $57 million, respectively. The two series of senior notes are unsecured. The First Mortgage Notes are collateralized by the property, plant and equipment of Manufacturing and are guaranteed by the Partnership.\nThe Partnership has two unsecured revolving lines of credit (\"Lines of Credit\") with a group of banks that permit the Partnership to borrow up to $135 million for general corporate purposes, including up to $5 million of standby letters of credit issued on behalf of the Partnership or Manufacturing. The Lines of Credit bear a floating rate of interest (6.5% and 6.9% as of December 31, 1995 and 1994, respectively). One line of credit allows the Partnership to borrow $100 million through October 31, 2000, of which $82.5 million was outstanding at December 31, 1995. The other line of credit allows the Partnership to borrow $35 million through October 28, 1996 (any borrowings outstanding at that time are payable in quarterly installments, at the option of the Partnership, due January 1997 through October 1998), of which $15 million was outstanding at December 31, 1995. The $15 million was classified as long-term debt due in 2000 due to the Company's intent and ability to finance these borrowings on a long-term basis. As of December 31, 1995, there were letters of credit outstanding in the amount of $0.8 million. As of January 4, 1996, all borrowings on the Lines of Credit were repaid.\nThe annual principal payments on the Note Agreements and mandatory principal payments under the Lines of Credit are as follows (in thousands):\nAll principal and interest payments due under the Note Agreements and Lines of Credit are nonrecourse to the General Partner.\nThe Note Agreements and the Lines of Credit contain certain restrictive covenants, including limitations of harvest levels, sale of assets, cash distributions and the amount of future indebtedness.\nThe Company was in compliance with such covenants at December 31, 1995 and 1994. The First Mortgage Notes limit distributions from the Manufacturing Segment to the Partnership.\nNOTE 6. FINANCIAL INSTRUMENTS\nThe carrying amounts of cash and cash equivalents approximate fair value due to the short-term maturities of these instruments. The estimated fair value of the Company's debt, based on current interest rates for similar obligations with like maturities, was approximately $615 million and $570 million and was carried at $531 million and $544 million as of December 31, 1995 and 1994, respectively.\nNOTE 7. PARTNERS' CAPITAL\nThe changes in Partners' Capital were as follows (in thousands):\nThe total number of Units outstanding at December 31, 1995 and 1994 was 40,608,300. At January 1, 1993 there were 1.25 million DPIs (prior to the 1993 three-for-one Unit split) outstanding. The DPIs were redeemed on August 30, 1993.\nIn accordance with the Partnership Agreement, the General Partner is authorized to make quarterly cash distributions. For the years ended December 31, 1995, 1994 and 1993, the General Partner declared $1.96, $1.67 and $1.38 per Unit, respectively, to be paid to the Partnership's Unitholders. If quarterly cash distributions exceed $0.21-2\/3 per Unit, the General Partner is provided with an incentive distribution. See Note 10 to Notes to Combined Financial Statements.\nNOTE 8. INCOME TAXES\nThe provision for income taxes was as follows (in thousands):\nReconciliation of the federal statutory rate to the effective income tax rate was as follows:\nNOTE 9. EMPLOYEE PENSION AND RETIREMENT PLANS\nPENSION PLAN. The Company's pension plan is a non-contributory defined benefit plan covering substantially all employees. The salaried employee benefits are based on years of credited service and the highest five-year average compensation levels, and the hourly employee benefits are based on years of service. Contributions to the plan are based upon the Projected Unit Credit actuarial funding method and are limited to amounts that are currently deductible for tax purposes. The Company's pension expense was $1.2 million, $1.9 million and $2.1 million for 1995, 1994 and 1993, respectively.\nThe following table sets forth the funded status of the Company's pension plan at December 31 (in thousands):\nThe components of the Company's pension cost were as follows (in thousands):\nThe following assumptions were used in the accounting for the Company's pension plan as of December 31:\nThe Company adopted two nonqualified defined benefit pension plans for executives and key management employees effective January 1, 1993 and January 1, 1994, respectively. The projected benefit obligation for these plans was $4.4 million and $2.7 million as of December 31, 1995 and\n1994, respectively. The Company's pension expense for these plans was $0.6 million, $0.8 million and $0.4 million for 1995, 1994 and 1993, respectively.\nTHRIFT AND PROFIT SHARING PLAN. The Company sponsors an employee thrift and profit sharing plan under section 401 of the Internal Revenue Code. This plan covers substantially all full-time employees. The Company matches employee contributions of up to six percent of compensation at rates ranging from 35 to 75 percent, depending upon the Company's financial performance. Amounts charged to expense were $2.7 million, $2.0 million and $2.3 million during 1995, 1994 and 1993, respectively.\nOTHER BENEFIT PLANS. Certain executives and key employees of the General Partner participate in incentive benefit plans established by the General Partner which provide for the granting of Units and\/or cash bonuses upon meeting performance objectives. See Note 10 to Notes to Combined Financial Statements.\nNOTE 10. RELATED-PARTY TRANSACTIONS\nThe General Partner is responsible for all decisions related to the management of the Company. The General Partner has a two percent general partner interest in the income and cash distributions of the Partnership, subject to certain adjustments, and owns two percent and four percent interests in Manufacturing and Marketing, respectively. The Company reimburses the General Partner for the actual cost of administering its businesses. Amounts reimbursed to the General Partner for such costs were $5.6 million and $5.0 million for the years ended December 31, 1995 and 1994, respectively. During 1993, the Company directly paid the costs associated with administering the businesses.\nEffective October 1, 1993, the General Partner established a Long-Term Incentive Plan (\"LTIP\") which provides for granting Unit Appreciation Rights (\"UARs\") to certain executives of the General Partner. When any of five Unit Value Targets (\"UVTs\") established by the LTIP are met through a combination of Unit market appreciation plus Partnership cash distributions, a percentage of the UARs is triggered and Units are credited to the executives' accounts. The performance period under the LTIP during which UVTs may be met ends December 31, 1998, at which time any earned Units will be distributed. Costs incurred by the General Partner in administering and funding the LTIP are borne by the Partnership.\nThe General Partner has granted 1,330,000 UARs, net of forfeitures, which could result in a total of 668,802 Units being earned under the LTIP if all UVTs are met. Units in the executives' accounts will earn additional Units equal to the amount of any subsequent Partnership cash distributions. As of December 31, 1995, two UVTs have been achieved and 167,200 Units have been allocated to the executives' accounts. Total compensation expense with respect to the achievement of these two UVTs will be approximately $4.5 million, of which $1.0 million and $0.8 million was recognized in 1995 and 1994, respectively. The remaining compensation expense will be recognized\nover the remaining performance period ending December 31, 1998.\nEffective January 1, 1994, the General Partner established a Key Employee Long-Term Incentive Plan (\"KLTIP\") for certain of its other key employees. The KLTIP provisions are similar to the LTIP described above. The General Partner has granted 380,000 UARs, net of forfeitures, which could result in a total of 191,086 Units being earned under the KLTIP if all UVTs are met. Units in the participants' accounts will earn additional Units equal to the amount of any subsequent Partnership cash distributions. As of December 31, 1995, two UVTs have been achieved and 47,772 Units have been allocated to the key employees' accounts. Total compensation expense with respect to the achievement of these two UVTs will be approximately $1.2 million, of which $0.5 million was recognized in 1995. The remaining compensation expense will be recognized over the remaining performance period ending December 31, 1998. Costs incurred by the General Partner in administering and funding the plan are borne by the Partnership.\nThe Partnership is required under the Partnership agreement to reimburse the General Partner for compensation costs related to the management of the Partnership, including the purchase of Units associated with these benefit plans. During 1994, the Partnership paid the General Partner for its purchase of 496,800 Units at a total cost of $12.8 million, of which $10.5 million was funded from current operations and $2.3 million from funds held by an employee benefit trust of the Partnership.\nEffective January 1, 1994, the General Partner established a Management Incentive Plan (\"MIP\") for certain executives of the General Partner. An annual bonus of up to 100% of the respective executive's base salary may be awarded if certain performance objectives established by the General Partner are met by the Company and by the executive. One-half of the bonus will be paid annually in cash and the remaining half will be converted into Units at fair market value and will be distributed at the end of three years. Units in executives' accounts will earn additional Units equal to the amount of any subsequent Partnership cash distributions. Costs incurred in administering and funding the plan are borne by the General Partner.\nNet income is allocated to the General Partner based on two percent of the Company's combined net income (adjusted for the incentive distribution), plus the incentive distribution, as provided by the Partnership Agreement. The incentive distributions paid in 1995, 1994 and 1993 were approximately $20.7 million, $14.4 million and $7.2 million, respectively.\nCertain conflicts of interest could arise as a result of the relationships described above. The Board of Directors and management of the General Partner have a duty to manage the Company in the best interests of the Unitholders and, consequently, must exercise good faith and integrity in handling the assets and affairs of the Company. Related non-interest bearing receivables and payables between the General Partner and the Company are settled in the ordinary course of business. As of December 31, 1995, the Company had a payable to the General Partner of $42,000. As of December 31, 1994, the Company had a receivable from the General Partner of $176,000.\nNOTE 11. COMMITMENTS AND CONTINGENCIES\nA portion of the Company's log requirements is acquired through contracts with public and private sources. Except for required deposits, no amounts are recorded until such time as the Company harvests the timber. At December 31, 1995 and 1994, the unrecorded amounts of those contract commitments were approximately $21.5 million and $30.4 million, respectively. During 1993, the Partnership entered into a log sourcing contract to sell approximately 950 million board feet (\"MMBF\") of logs to a customer over a ten-year period ending in 2003, at prevailing market rates. At December 31, 1995, the Partnership had a remaining commitment of approximately 703 MMBF.\nThere are no contingent liabilities which would have a materially adverse effect on the financial position, the results of operations or liquidity of the Company.\nThe Company is subject to regulations regarding harvest practices and is involved in various legal proceedings, including environmental matters, incidental to its business. While administration of current regulations and any new regulations or proceedings have elements of uncertainty, the General Partner believes that none of the pending legal proceedings or regulatory matters will have a materially adverse effect on the financial position, the results of operations or liquidity of the Company.\nThe Company leases buildings and equipment under non-cancelable operating lease agreements. The Company's operating lease expense was $2.2 million, $1.8 million and $1.9 million for 1995, 1994 and 1993, respectively. The following summarizes the future minimum lease payments (in thousands):\nNOTE 12. SEGMENT INFORMATION\nRevenues include both sales to unaffiliated customers and intersegment sales. Intersegment sales prices are determined quarterly, based upon estimated market prices and terms in effect at that time and are eliminated in combination. Intersegment sales from the Resources Segment to the Manufacturing Segment were $117.6 million, $118.0 million and $89.7 million for 1995, 1994 and 1993, respectively.\nOperating income from the Resources Segment includes land sales of $1.6 million, $1.9 million and $7.7 million, for 1995, 1994 and 1993, respectively. Combined export revenues, primarily to Pacific Rim countries, as a percentage of total revenues were 13%, 15% and 17%, for 1995, 1994 and 1993, respectively.\nDuring 1995 and 1994, net sales to one Resources Segment customer were approximately 10% and 11% of combined revenues, respectively.\nNOTE 13. SUBSEQUENT EVENT\nOn January 23, 1996, the Board of Directors of the General Partner authorized the Partnership to make a distribution of $0.49 per Unit for the fourth quarter of 1995. Total distributions will approximate $25.9 million (including $6.0 million to the General Partner) and will be paid on March 1, 1996 to Unitholders of record on February 15, 1996.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Unitholders and Directors of the General Partner of Plum Creek Timber Company, L.P.\nWe have audited the accompanying combined balance sheet of Plum Creek Timber Company, L.P. as of December 31, 1995 and 1994, and the related combined statements of income and cash flows for each of the three years in the period ended December 31, 1995. 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 combined financial position of Plum Creek Timber Company, L.P. at December 31, 1995 and 1994, and the combined results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\n\/s\/ COOPERS & LYBRAND L.L.P.\nCoopers & Lybrand L.L.P. Seattle, Washington January 23, 1996\nSUPPLEMENTARY FINANCIAL INFORMATION\nCombined Quarterly Information (Unaudited) (In Thousands, Except per Unit)\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nItems 10. and 11. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT and EXECUTIVE COMPENSATION, Item 12.","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(A) THE FOLLOWING DOCUMENTS ARE FILED AS A PART OF THIS REPORT:\n(1) FINANCIAL STATEMENTS AND SUPPLEMENTARY FINANCIAL INFORMATION\nThe following combined financial statements of the Company are included in Part II, Item 8 of this Form 10-K:\n(2) FINANCIAL STATEMENT SCHEDULES\nNot applicable.\n(3) LIST OF EXHIBITS\nEach exhibit set forth below in the Index to Exhibits is filed as a part of this report. Exhibits not incorporated by reference to a prior filing are designated by an asterisk (\"*\"); all exhibits not so designated are incorporated herein by reference to a prior filing as indicated. Exhibits designated by a positive sign (\"+\") indicates management contracts or compensatory plans or arrangements required to be filed as an exhibit to this report.\nINDEX TO EXHIBITS\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.\nPLUM CREEK TIMBER COMPANY, L. P.\n(Registrant)\nBy: Plum Creek Management Company, L.P. as General Partner\nBY: \/s\/ RICK R. HOLLEY ---------------------------- Rick R. Holley 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, in the capacities and on the dates indicated, on behalf of, as applicable, Plum Creek Management Company, L.P., the registrant's general partner, and\/or PC Advisory Corp. I, the general partner of the managing general partner of the registrant's general partner.","section_15":""}
{"filename":"830340_1995.txt","cik":"830340","year":"1995","section_1":"ITEM 1. BUSINESS.\nThe Registrant, Dean Witter Realty Yield Plus II, L.P. (the \"Partnership\"), is a limited partnership formed in February 1988 under the laws of the State of Delaware for the purpose of investing in income- producing commercial and industrial properties. The primary investments are a participating mortgage loan, real estate and a land lease.\nThe Managing General Partner of the Partnership is Dean Witter Realty Yield Plus II Inc. (the \"Managing General Partner\"), a Delaware corporation which is wholly-owned by Dean Witter Realty Inc. (\"Realty\"). The Associate General Partner is Dean Witter Realty Yield Plus Associates II, L.P., a Delaware limited partnership, the general partner of which is the Managing General Partner. The Managing General Partner manages and controls all aspects of the business of the Partnership. The terms of transactions between the Partnership and its affiliates are set forth below in footnote 7 to the financial statements included in Item 8 and in Item 13.\nThe Partnership issued 173,164 units of limited partnership interest (the \"Units\") at $500 per Unit for $86,582,000. The offering has been terminated and no additional Units will be sold.\nThe proceeds from the offering were used to make investments in three participating mortgage loans and land leases secured by interests in three office buildings, one industrial property, and an office and parking garage complex. The Partnership subsequently acquired the real estate securing all but one of the foregoing loans through foreclosure or transfers of ownership in lieu of foreclosure. The Partnership's properties and investment in a participating mortgage loan are described in Item 2","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Partnership's principal offices are located at Two World Trade Center, New York, New York 10048. The Partnership has no other offices.\nThe Partnership owns directly or through a partnership interest the following three interests in real estate and real estate loans. Generally, the leases pertaining to the properties provide for pass- throughs to the tenants of their pro-rata share of certain operating expenses. In the opinion of the Managing General Partner, all of the properties are adequately covered by insurance.\nEach property has been built with on-site parking facilities.\nAn affiliate of Realty is the property manager for 2600 Michelson Drive and the Century Alameda Distribution Center.\nFurther information relating to the Partnership's properties is included in Item 7 and footnotes 4 and 5 to the financial statements included in Item 8 below.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nOn December 27, 1995, a class action lawsuit (the \"Grigsby Action\") naming various public real estate partnerships sponsored by Realty (including the Partnership and its Managing General Partner and Associate General Partner), Realty, Dean Witter Reynolds Inc. and others as defendants was filed in Superior Court in California. The complaint alleges fraud, negligent misrepresentation, intentional and negligent breach of fiduciary duty, unjust enrichment and related claims and seeks compensatory and punitive damages in unspecified amounts and injunctive and other equitable relief. The defendants have removed the case to the United States District Court for the Southern District of California. The parties have signed a stipulation requesting that the action be transferred to the United States District Court for the Southern District of New York. The defendants have not yet responded to the complaint and intend to vigorously defend the action.\nOn February 14, 1996, a class action lawsuit (the \"Schectman Action\") naming various public real estate partnerships sponsored by Realty (including the Partnership and its Managing General Partner), Realty, Dean Witter, Discover & Co., and Dean Witter Reynolds Inc. as defendants was filed in the Chancery Court of Delaware for New Castle County. The complaint alleges reckless and\/or negligent misrepresentation and nondisclosure, breach of fiduciary duty and related claims and seeks an accounting of profits and rescissory and\/or compensatory damages in unspecified amounts. The defendants have not yet responded to the complaint and intend to vigorously defend the action.\nOn February 23, 1996, a class action lawsuit (the \"Dosky Action\") naming various public real estate partnerships sponsored by Realty (including the Partnership and its Managing General Partner), Realty, Dean Witter, Discover & Co., Dean Witter Reynolds Inc. and others as defendants was filed in the Chancery Court of Delaware for New Castle County. The complaint alleges breach of fiduciary duty and seeks an accounting of profits, compensatory damages in unspecified amounts, possible liquidation of the Partnership under a receiver's supervision and other equitable relief. The defendants have not yet responded to the complaint and intend to vigorously defend the action.\nOn February 29, 1996, a class action lawsuit (the \"Segel Action\") naming various public real estate partnerships sponsored by Realty (including the Partnership and its Managing General Partner), Realty, Dean Witter, Reynolds Inc., Dean Witter, Discover & Co. and others as defendants was filed in the Chancery Court of Delaware for New Castle County. The complaint alleges breach of fiduciary duty and seeks an accounting of profits, compensatory damages in unspecified amounts, possible liquidation of the Partnership under a receiver's supervision and other equitable relief. The defendants have not yet responded to the complaint and intend to vigorously defend the action.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNo matter was submitted during the fourth quarter of the fiscal year to a vote of Unit holders.\nPART II.\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nAn established public trading market for the Units does not exist, and it is not anticipated that such a market will develop in the future. Accordingly, information as to the market value of a Unit at any given date is not available. However, the Partnership does allow limited partners (the \"Limited Partners\") to transfer their Units if a suitable buyer can be located.\nAs of March 18, 1996, there were 8,394 holders of limited partnership interests.\nThe Partnership is a limited partnership and, accordingly, does not pay dividends. It does, however, make quarterly distributions of cash to its partners. Pursuant to the Partnership Agreement, distributable cash, as defined, is paid 90% to the Limited Partners and 10% to the general partners (the \"General Partners\").\nThe Managing General Partner was obligated to (a) defer receipt of its share of distributable net cash flow, and (b) contribute additional capital to the Partnership, sufficient to fund any shortfalls between cash flow and a 7.5% annual distribution rate to Limited Partners during the offering period (which ended March 1990), and the twelve quarters thereafter. During the offering period, the Managing General Partner deferred receipt of distributions totalling $3,713,000, but was not required to make any additional capital contributions. Thereafter, the Managing General Partner contributed $2,003,710, $2,390,521 and $412,838 with respect to the years ended March 31, 1993, 1992 and 1991, respectively. The amounts with respect to the years ended March 31, 1992 and 1991 were paid in 1992.\nDuring the year ended December 31, 1995, the Partnership paid quarterly cash distributions aggregating $16.25 per Unit to Limited Partners. The total distribution amounted to $3,126,572 with $2,813,915 distributed to the Limited Partners and $312,657 distributed to the General Partners.\nDuring the year ended December 31, 1994, the Partnership paid quarterly cash distributions aggregating $20 per Unit to Limited Partners. The total distribution amounted to $3,848,088, with $3,463,279 distributed to the Limited Partners and $384,809 distributed to the General Partners.\nOn January 29, 1996, the Partnership paid the fourth quarter distribution of $3.125 per Unit to the Limited Partners. The cash distribution aggregated $601,264 with $541,138 distributed to the Limited Partners and $60,126 distributed to the General Partners.\nThe Partnership anticipates making regular distributions to its partners in the future.\nSale or financing proceeds will be distributed, to the extent available: first, 97% to the Limited Partners and 3% to the General Partners until each Limited Partner has received a return of their invested capital plus an amount sufficient to provide a 10% cumulative annual return thereon; second, 100% to the General Partners until they have received an amount equal to (i) any portion of their share of net cash flow previously deferred and not distributed, and (ii) any additional capital contributions made by the Managing General Partner to fund distributions to the Limited Partners in respect of the 7.5% minimum annual return described above; and third, 85% to the Limited Partners and 15% to the General Partners. To date, the Partnership has not distributed any sale or financing proceeds.\nTaxable income (subject to certain adjustments) will be allocated to the partners in proportion to the distribution of distributable cash or sale or financing proceeds, as the case may be (or 90% to the Limited Partners and 10% to the General Partners if there is no distributable cash or sale or financing proceeds). Tax losses, if any, will be allocated 90% to the Limited Partners and 10% to the General Partners.\nITEM 7.","section_6":"","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nLiquidity and Capital Resources\nThe Partnership raised $86,582,000 through a public offering which was terminated in 1990. The Partnership has no plans to raise additional capital.\nThe Partnership committed the gross proceeds raised in the offering to three investments. No additional investments are planned.\nMany real estate markets are stabilizing or improving, primarily due to the continued absence of significant construction activity. The relative absence of office construction as well as growth in business services has resulted in absorption of office space in cities such as Boston (the location of One Congress Street). In contrast, office vacancy levels in southern California (the location of 2600 Michelson Drive) remained essentially unchanged from the prior year as certain large corporations and financial companies continued to restructure and consolidate their operations. In most markets, office construction is limited to build-to-suit projects with significant pre-leasing. The overall economic recovery and a lack of warehouse construction over the past several years is benefiting industrial properties such as the Century Alameda Distribution Center. Industrial vacancy rates have declined nationally for the past six quarters. Most new warehouse construction is on a build-to-suit basis.\nThe Partnership's liquidity depends upon the cash flow from operations of its real estate investments, interest on the participating mortgage loan and expenditures for tenant improvements and leasing commissions in connection with the leasing of space. In 1995, both the Century Alameda property and the Michelson joint venture generated positive cash flow from operations, and it is anticipated that they will continue to do so.\nAs of December 31, 1995, the Partnership has commitments to fund approximately $282,000 at the Century Alameda property and to contribute approximately $1,055,000 to DW Michelson Associates, primarily for lease- related capital expenditures.\nSince existing cash reserves were projected to be insufficient to fund all of the anticipated costs of the properties owned by the Partnership and to accumulate reserves for future contingencies, the Partnership reduced its cash distribution from a 4% annual rate to 2.5% beginning with the second quarter 1995 distribution, which was paid in July.\nDuring the year ended December 31, 1995, Partnership cash flows from operations and distributions from DW Michelson Associates exceeded distributions to investors, capital expenditures and contributions to DW Michelson Associates. The Partnership expects that such cash flows and increased cash reserves resulting from the above-mentioned reduction of the distribution rate will be sufficient to fund capital expenditures, contributions to DW Michelson Associates and cash distributions in 1996.\nThe Partnership's participating mortgage loan is secured by the One Congress Street property. The General Services Administration (\"GSA\"), which leases all of the office space at the property, had a one-time option to cancel all or a portion of its lease at any time prior to its lease expiration in August 1997. In March 1996, GSA notified the owner\/borrower of the One Congress Street property that it will vacate approximately 67,500 Square feet (approximately 28%) of the office space at the property in June 1996. The borrower continues discussions with the GSA regarding renewal of its remaining space at the property as well as the pending claim against the GSA relating to the original construction of its space. If the borrower can not re-lease the space which GSA will vacate, property cash flow will be reduced, and the borrower may not be able to meet its minimum debt service obligation. See Note 4 to the consolidated financial statements.\nOn January 29, 1996, the Partnership paid a cash distribution of $3.125 per Unit to the Limited Partners. The cash distribution aggregated $601,264 with $541,138 distributed to the Limited Partners and $60,126 distributed to the General Partners.\nExcept as discussed above and in the financial statements, the Managing General Partner is not aware of any trends or events, commitments or uncertainties that will have a material impact on liquidity.\nOperations\nFluctuations in the Partnership's operating results for the year ended December 31, 1995 compared to 1994, and for 1994 compared to 1993 were primarily attributable to the following:\nRental income increased in 1995 compared to 1994 due to higher occupancy at the Century Alameda property resulting from the leasing to Goldenberg Plywood of approximately 28% of the space which had been vacant from April 1994 until July 1995. The space was vacant as a result of a tenant eviction in 1994.\nThe increase in equity in earnings of the unconsolidated partnership in 1995 compared to 1994 resulted from higher rental income because of the leasing of 22% of the property's vacant space to AVCO Financial and lower property operating expenses (resulting from a significant refund of prior year real estate taxes). The increase was partially offset by higher depreciation and amortization on expenditures for tenant improvements and leasing commissions. The decrease in 1994 compared to 1993 is due to lower rental income at 2600 Michelson Drive in 1994.\nThe decrease in interest and other income in 1994 compared to 1993 was primarily due to a fee reimbursement of approximately $219,000 relating to the One Congress Street investment in 1993.\nThe decreases in property operating expenses in 1995 compared to 1994 and in 1994 compared to 1993 are primarily due to the absence in 1995 of provisions made in 1994 and 1993 for uncollectible rents from a large tenant that was evicted from the Century Alameda property in April 1994.\nThe loss on impairment of the participating mortgage loan consists of the provision for loss on the One Congress Street loan in 1993.\nA summary of the office, retail and industrial building markets where the Partnership's properties, and the property underlying the Partnerships' investment in a participating mortgage loan are located, and the performance of each property, is as follows:\nThere has been no significant new construction in the industrial building market in Lynwood, California, the location of the Century Alameda Distribution Center. The number of tenants seeking larger space in this market has increased from a year ago, and the recent completion of the Century Freeway is anticipated to increase demand. As a result, space in this market is being absorbed at a slow and steady pace, and the current vacancy rate in this market is 9.5%. During 1995, average occupancy at the property was 86%, and at December 31, 1995, the property was 100% leased to 3 tenants. The leases of Goldenberg Plywood (for approximately 65% of the property's space), Tools Exchange (for approximately 22% of the property's space) and California Feather and Down (for approximately 13% of the space) expire in 2000, 1997 and 1997, respectively.\nFavorable lease rates are attracting tenants to the office market in Irvine, California, the location of 2600 Michelson Drive, where the market vacancy rate is approximately 15%. The steady absorption of space and the lack of new construction are leading to a tightening of available quality office space in this market. During 1995, average occupancy at the property was 87%, and at December 31, 1995,the property was 92% leased to 41 tenants. The lease of AVCO Financial (for approximately 22% of the property's space) expires in 2002. No other significant leases are scheduled to expire in the near future.\nThe vacancy level in the Boston office market, the location of One Congress Street, is approximately 10%, a decrease from approximately 12% at the beginning of the year. However, recent leasing activity has slowed from the 1994 pace and consolidations of banks with major office leases in Boston may add additional space to this market. The property may be affected by this because GSA has announced it will vacate 67,500 square feet of the property's space in June 1996 and its lease on the remaining space terminates in August 1997. Also, the retail space has been difficult to lease. During 1995, occupancy at the office and garage space remained at 100% and the retail space, which is not a significant portion of the overall space, is substantially vacant.\nInflation\nInflation has been consistently low during the periods presented in the financial statements and, as a result, has not had a significant effect on the operations of the Partnership or its properties.\n7. Leases\nMinimum future rental income under noncancellable operating leases as of December 31, 1995 is as follows: $8,941,582\nThe Partnership has determined that all leases relating to its properties are operating leases. Lease terms range from five to ten years, and generally provide for fixed minimum rents with rental escalation and\/or expense reimbursement clauses.\n8. Related Party Transactions\nAn affiliate of Realty provides property management services for 2600 Michelson Drive and the Century Alameda Distribution Center. For the years ended December 31, 1995, 1994 and 1993, the affiliate received property management fees of $106,543, $101,626 and $119,086, respectively. These amounts are included in property operating expenses.\nRealty performs administrative functions and processes certain investor tax information for the Partnership. For each of the three years in the period ended December 31, 1995, the Partnership incurred approximately $212,000, for these services. These amounts are included in general and administrative expenses.\nAs of December 31, 1995, the affiliates were owed a total of approximately $102,000 for these services.\n9. Litigation\nVarious public partnerships sponsored by Realty (including the Partnership and its Managing General Partner) have been named as defendants in four class actions lawsuits pending in state and federal courts. The complaints allege a variety of claims, including breach of fiduciary duty, fraud, misrepresentation and related claims, and seek compensatory and other damages and equitable relief. The defendants have not yet responded to the complaints and intend to vigorously defend the actions. It is impossible to predict the effect, if any, the outcome of these actions might have on the Partnership's financial statements.\n10. Subsequent Event\nOn January 29, 1996, the Partnership paid a cash distribution of $3.125 per Unit to Limited Partners. The cash distribution aggregated $601,264 with $541,138 distributed to the Limited Partners and $60,126 distributed to the General Partners.\nITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNone.\nPART III.\nITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nThe Partnership is a limited partnership which has no directors or officers.\nThe directors and executive officers of the Managing General Partner are as follows:\nAll of the directors have been elected to serve until the next annual meeting of the shareholder of the Managing General Partner or until their successors are elected and qualify. Each of the executive officers has been elected to serve until his successor is elected and qualifies.\nWilliam B. Smith, age 52, is a Managing Director of Dean Witter Realty Inc. and has been with Dean Witter Realty Inc. since 1982. He is an Executive Vice President of Dean Witter Reynolds Inc.\nE. Davisson Hardman, Jr., age 46, is a Managing Director of Dean Witter Realty Inc. and has been with Dean Witter Realty Inc. since 1982.\nLawrence Volpe, age 48, is a Director and the Controller of Dean Witter Realty Inc. He is a Senior Vice President and Controller of Dean Witter Reynolds, Inc., which he joined in 1983.\nRonald T. Carman, age 44, is a Director and the Secretary of Dean Witter Realty, Inc. He is a Senior Vice President of Dean Witter, Discover & Co. and Dean Witter Reynolds Inc., which he joined in 1984.\nThere is no family relationship among any of the foregoing persons.\nITEM 11. EXECUTIVE COMPENSATION\nThe General Partners are entitled to receive cash distributions, when and as cash distributions are made to the Limited Partners, and a share of taxable income or tax loss. Descriptions of such distributions and allocations are contained in Item 5 above. The General Partners received cash distributions of $312,652, $384,809 and $192,404 during the years ended December 31, 1995, 1994 and 1993, respectively.\nThe General Partners and their affiliates were paid certain fees and reimbursed for certain expenses. Information concerning such fees and reimbursements is contained in Note 8 to the Financial Statements in Item 8","section_7A":"","section_8":"","section_9":"","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\n(a) No person is known to the Partnership to be the beneficial owner of more than five percent of the Units.\n(b) The directors and executive officers of the Managing General Partner own the following Units as of December 31, 1995:\nMICHELSON COMPANY LIMITED PARTNERSHIP (A California Limited Partnership)\nNOTES TO FINANCIAL STATEMENTS\nDecember 31, 1995 and 1994\n1. Organization and restructuring\nMichelson Company Limited Partnership (the Partnership) was originally formed as a California general partnership under the name of Michelson Co. The original partnership was formed in 1984 between SC Enterprises (SC) and four individuals for the purpose of constructing and holding for investment a 16-story office building and a five-level parking structure at 2600 Michelson Drive (Michelson). The building and parking structure were completed in 1986. In addition, Michelson Co. acquired adjacent one-story and two-story office buildings at 18581 Teller Avenue (Teller). Michelson and Teller (the office buildings) are located on eight acres of land in Irvine, California.\nIn 1988, Michelson Co. entered into an arrangement with DW Michelson Associates (DW) whereby Michelson Co. simultaneously sold and leased back the land under a long-term ground lease with DW (Note 3) and refinanced the office buildings under a nonrecourse loan from DW (Note 4). DW is a California general partnership composed of two Dean Witter Realty Inc. affiliated limited partnerships.\nMichelson Co. incurred significant cash deficits from operations. These deficits were funded by loan proceeds from DW to the extent of the interest reserve under the loan and thereafter by capital contributions from SC. In November 1990, these fundings stopped and Michelson Co. defaulted on its mortgage note and ground lease obligations. As a consequence, DW took control over the cash and the parties commenced negotiations for restructuring.\nIn November 1991, the restructuring was completed. Michelson Co. became a limited partnership. DW was admitted as the managing general partner. SC converted to a limited partner, and the four individuals withdrew from the Partnership. DW converted approximately $37.9 million of the mortgage note to capital in the Partnership. The general partners of SC delivered two promissory notes totalling $1.2 million to DW. In July 1994, the note which was due in January 1993, was extended until December 31, 1999. At December 31, 1995, the balance of this note is approximately $1.2 million. In addition, the principal of SC became personally liable for $26 million of the remaining mortgage note payable, subject to certain restrictions and time limitations.\nThe restructuring also resulted in a revised profit and loss allocation among the partners. In general, profits are first allocated to DW for preferred return on its capital contribution and the balance is allocated to DW and SC in a 90-10 ratio. All losses are allocated to DW except for any losses allocable to SC in connection with its obligation for the mortgage note payable. Also, there was a special allocation of gross revenue of approximately $3 million to SC, which was fully utilized in 1992.\n2. Significant accounting policies\nThe Partnership's records are maintained on the accrual basis of accounting for financial reporting and tax purposes. 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.\nThe office buildings and tenant improvements are stated at their original cost, net of depreciation. Costs of improvements to the buildings are capitalized, and repairs are expensed. Depreciation is recorded on the straight-line method over the estimated useful lives of the related assets ranging from 10 to 40 years.\nEffective January 1, 1995, the Partnership adopted the provisions of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of\" (\"SFAS 121\"); adoption was not required prior to 1995. Pursuant to SFAS 121, at least annually, and more often if circumstances dictate, the Partnership evaluates the recoverability of the net carrying value of its real estate. As part of this evaluation, the fair values of each of the properties are estimated (in some cases with the assistance of independent real estate consultants) based on discounted cash flows. The fair values are compared to the properties' carrying amounts in the financial statements. A deficiency in fair value relative to carrying amount is an indication of the need for a writedown due to impairment.\nIn such case, the expected future net cash flows from the property are estimated for a period of approximately five years (or a shorter period if the Partnership expects that the property may be disposed of sooner), along with estimated sales proceeds at the end of the period. If the total of these future undiscounted cash flows were less than the carrying amount of the property, the property would be written down to its fair value, and a loss on impairment recognized by a charge to earnings.\nBecause the determination of fair value is based upon projections of future economic events such as property occupancy rates, rental rates, operating cost inflation and market capitalization rates which are inherently subjective, the amounts ultimately realized at disposition may differ materially from the net carrying value as of December 31, 1995. The cash flows used to determine fair value are based on good faith estimates and assumptions developed by the Managing General Partner. Unanticipated events and circumstances may occur and some assumptions may not materialize; therefore actual results may vary from the estimates and the variances may be material. The Partnership may provide additional write-downs, which could be material in subsequent years if real estate markets or local economic conditions change.\nThe Partnership has granted free rent periods under certain leases. In order to properly reflect the average rents earned under the leases, the Partnership reports rental revenues during the free rent periods and amortizes the concession amounts as reductions of rental revenues over the terms of the leases. The imputed rents of $710,987, $271,583 and $1,227,569 as of December 31, 1995, 1994 and 1993 respectively, represent the unamortized free rents and are reflected as assets in the accompanying balance sheets.\nLeasing commissions are amortized over the applicable lease terms. Leasing costs principally include the net cost of capitalized lease obligations assumed by the Partnership relative to former lessors of relocated tenants.\nLoan costs are amortized over the original loan term of ten years.\nCash and cash equivalents consist of cash and highly liquid investments with maturities, when purchased, of three months or less.\nNo provision for federal and state income taxes has been made in the financial statements, as the liability for such taxes is that of the partners rather than the Partnership.\n3. Leasing activities\nLeasing Revenues\nThe Partnership leases, as lessor, commercial office space under operating leases with terms from three to twelve years. Rental revenue is reported ratably over the lease terms. These leases generally provide for minimum rents subject to Consumer Price Index adjustments and for the tenants to reimburse the Partnership for certain operating expenses.\nThe minimum rents to be received from existing noncancelable operating leases as of December 31, 1995 are as follows:\nThe office buildings contain a total of approximately 394,000 square feet of rentable space. As of December 31, 1995, the buildings were approximately 90% leased.\nGround Lease\nThe Partnership has a land lease (the Lease) with DW for a term which expires in 55 years. The Lease provides for an annual base rent of $556,692, additional rent for property taxes and similar assessments, percentage rent representing 40% of net operating cash flows (as defined in the Lease), and participation in refinancing and sale proceeds. There was no percentage rent or participation paid or due as of December 31, 1995 or 1994.\n4. Mortgage note payable\nThe note is payable to DW and is secured by the office buildings and an assignment of rents. The note bears interest at 8.5% per annum and is due March 1998. Interest and principal are payable monthly, with a lump sum payment for unpaid interest and principal due at maturity.\nPrincipal payments due on the mortgage note payable are as follows: $ 26,548,487\n5. Related party transactions\nDW earns interest as a lender and ground rent as a lessor. An affiliate of DW earns fees and reimbursements for services provided to the Partnership. These amounts are summarized as follows:","section_13":"","section_14":"","section_15":""}
{"filename":"84557_1995.txt","cik":"84557","year":"1995","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, 1995 the Company had 2,046 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.\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\ndiscussion 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, 1995 was 5.39.\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, 1995 the amount of additional First Mortgage Bonds which could be issued on that basis was approximately $375,124,000. 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, 1995, the Company could issue $195,334,000 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\nproposed to be issued. For the twelve months ended December 31, 1995, the coverage ratio under (b) above (the more restrictive provision) was 2.31.\nFor information with respect to short-term borrowing arrangements and limitations see Item 8, Note 9 - Short-Term Debt.\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, 1995 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 PSC regulation of rates, service, and sale of securities, among other matters. The Company is also regulated by the Federal Energy Regulatory Commission (FERC) on a limited basis, in the areas of interstate sales and exchanges of electricity, intrastate sales of electricity for resale, transmission wheeling service for other utilities, and licensing of hydroelectric facilities. As a licensee of nuclear facilities, the Company is also subject to regulation by the Nuclear Regulatory Commission.\nOn August 17, 1995, the Company announced that a negotiated settlement had been reached with the Staff of the PSC and other parties which resolved various proceedings relative to its gas costs. The settlement was approved by the PSC on October 18, 1995. See Item 8, Note 10 under the heading \"Gas Cost Recovery\" for further information related to the 1995 Gas Settlement.\nSee Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations under the heading \"Rates and Regulatory Matters\" for summaries of recent PSC rate decisions, the 1993 Rate Agreement and the 1995 Rate Proposal.\nUnder its flexible pricing tariff for major industrial and commercial electric customers, the Company may negotiate competitive electric rates at discount prices to compete with alternative power sources, such as customer- owned generation facilities. Under the terms of the 1993 Rate Agreement, the Company would absorb 30 percent of any net revenues lost as a result of such discounts through June 1996, while the remaining 70 percent would be recovered from other customers. The Company has not sought recovery of that 70 percent from other customers. The portion recoverable after June 1996 is expected to be determined by the PSC as it considers the 1995 Rate Proposal. Under the flexible tariff provisions, the Company as of year-end 1995 had negotiated long- term electric supply contracts with twenty of its large industrial and commercial electric customers at discounted rates. The Company is negotiating long-term electric supply contracts with other large customers as the need and opportunity arise. The Company has not experienced any customer loss due to competitive alternative arrangements.\nThe United States Department of Justice, Antitrust Division, has issued a Civil Investigative Demand calling for the production of documents and answers to interrogatories concerning the electric industry and competititon. The Company has been informed that the Antitrust Division has not concluded that there is an antitrust violation, and that it is not a target of this investigation, since there are no targets. The Company is cooperating with the investigation.\nCOMPETITION\nThe Company is operating in an increasingly competitive environment. See Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations under the heading \"Competition\" for information on the competitive challenges the Company faces in its 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 1,244,000 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 1,425,000 Kw occurred on August 15, 1995\nThe percentages of electricity actually generated and purchased for the years 1991-1995 are as follows:\n* Beginning in 1996 Russell Station, Unit 1 (47Mw) is on cold standby.\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 22%, 21% and 20% for the years 1996, 1997 and 1998, respectively.\nThe Company's five major generating facilities are two nuclear units, the Ginna Nuclear Plant (Ginna Plant) and the Company's 14% share of Nine Mile Point Nuclear Plant Unit No. 2 (Nine Mile Two), and three fossil fuel generating\nstations, the Russell and Beebee Stations and the Company's 24% share of Oswego Unit Six. In terms of capacity these comprise 39%, 13%, 21%, 6% and 15%, respectively, of the Company's current electric generating system.\nNine Mile Two, a nuclear generating unit in Oswego County, New York with a capability of 1,143 megawatts (Mw)as estimated by Niagara Mohawk Power Corporation (Niagara), was completed and entered commercial service in Spring 1988. 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 share 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. Overly stringent environmental conditions or other governmental requirements could nullify or seriously impair the economic viability of one or more of these stations.\nThe Company's Ginna Plant, which has been in commercial operation since July 1, 1970, provides 480 Mw of the Company's electric generating capacity. In August 1991 the NRC approved the Company's application for amendment to extend the Ginna Plant operating license expiration date from April 25, 2006 to September 18, 2009. See Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations under the Liquidity and Capital Resources section for a discussion of the replacement of the steam generators at the Ginna Plant.\nThe gross and net book cost of the Ginna Plant as of December 31, 1995 are $503 million and $260 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 reviews such directives and implements a variety of modifications based on these directives and resulting analyses. Expenditures, including AFUDC, at the Ginna Plant (including the cost of these modifications and $51.0 million in 1996 for steam generator replacement) are estimated to be $60.2 million, $7.6 million and $5.2 million for the years 1996, 1997 and 1998, 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 5,230,000 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 conditions. 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 Management 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 238,267 residential gas spaceheating customers at December 31, 1995, 2,954 were added during 1995, and 25% of those were conversions from other fuels.\nApproximately 28% of the gas delivered to customers by the Company during 1995 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. Generally, 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 2002, 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 Plant uranium requirements. A second contract is in place to supply about 30% of the annual requirements for 1996 through 1999, and 100% of requirements in 2000. The remaining requirements are uncommitted.\n(4) Seventy percent of the conversion requirements have been procured through 1997 under one contract. A second contract is in place covering 30% of requirements through 1999 and 100% in 2000. Seventy percent of requirements remain to be purchased for 1998.\n(5) Thirty years from 1984 or life of reactor, whichever is less. See the following discussion.\nThe Company has a contract with United States Enrichment Corporation (USEC) 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:\nSee Note 10 of the Notes to Financial Statements under Item 8 for additional information regarding nuclear fuel disposal costs, nuclear plant decommissioning and DOE uranium enrichment facility decontamination and decommissioning.\nCoal. The Company's present annual coal requirement is approximately 560,000 tons. In 1995 approximately 70% of its requirements were purchased under contract and the balance on the open market. The Company is meeting its requirements during early 1996 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:\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 $3.6 million on a variety of projects and facility additions during 1995.\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\nresearch 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. The Company has interim storage capacity at the Ginna Plant 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 Two will be properly prepared to handle interim storage of low level radioactive waste for the next ten years.\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 $4.4 million for the year 1996 $6.2 million for the year 1997 and $4.3 million for the year 1998. 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 1995, 1994 and 1993 were $5.2 million, $7.3 million, and $8.3 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.\nElectric Department Statistics\nGas Department Statistics\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, 1995, the net generation of each plant for the year ended December 31, 1995, 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. * Beginning in 1996 Unit 1 (47Mw) on cold standby. ** As estimated by Niagara Mohawk Power Corporation.\nThe Company owns 147 distribution substations having an aggregate rated transformer capacity of approximately 2,092,354 Kva, of which 138, having an aggregate rated capacity of 1,913,188 Kva, were located on lands owned in fee, and nine of which, having an aggregate rated capacity of 179,166 Kva, were located on land under easements, leases or license agreements. The Company also has 75,131 line transformers with a capacity of 2,967,809 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 one, having a rated capacity of 74,667 Kva, was located on land under easements. The Company's transmission system consists of approximately 710 circuit miles of overhead lines and 399 circuit miles of underground lines. The distribution system consists of approximately 16,160 circuit miles of overhead lines, approximately 3,649 circuit miles of underground lines and 348,980 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 4,195 miles of gas mains and 286,807 installed meters. (See Item 1 - Business, \"Gas Operations\" and \"Gas Department Statistics\".\nOTHER PROPERTIES\nThe Company owns a ten-story office building centrally located in Rochester and other structures and property. The Company also leases approximately 485,000 square feet of facilities for administrative offices and operating activities in the Rochester area.\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.\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, 1995.\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 1995, 1994 and 1993 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 dividends at the current rate, 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 1996, the Company paid a cash dividend of $.45 per share on its Common Stock. The January 1996 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\nSELECTED FINANCIAL DATA\nCONSOLIDATED SUMMARY OF OPERATIONS\nCONDENSED CONSOLIDATED BALANCE SHEET\nFINANCIAL 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) The return on average common equity for 1995 excluding effects of the 1995 Gas Settlement is 12.10%. The rate of return on average common equity excluding effects of retirement enhancement programs recognized by the Company in 1994 and 1993 is 11.90% and 11.20%, respectively.\n(c) 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. Coverages in 1995 exclude the economic effect of the 1995 Gas Settlement ($44.2 million, pretax).\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\nA good summer cooling season, a modest increase in electric rates, and savings from prior years' work force reduction programs, together with other cost control efforts by the Company helped to boost operating earnings for 1995.\nPresented below is a table which summarizes the Company's Common Stock earnings on a per-share basis. Earnings per share, before non-recurring items, were $2.44 in 1995. Non-recurring items and their effect on earnings per share have been identified. Earnings per share as reported in 1995 were reduced by an aggregate pretax amount of $44.2 million, or $.75 per share net-of-tax, in connection with a negotiated settlement (see 1995 Gas Settlement) reached between the Company, Staff of the New York State Public Service Commission (PSC) and other parties resolving various proceedings to review issues affecting the Company's gas costs.\nFuture earnings will be affected, in part, by the Company's ability to control certain costs and its ability to remarket excess gas capacity as set under the terms of the 1995 Gas Settlement, which is discussed under Rates and Regulatory Matters.\nThe final outcome of a rate proposal submitted by the Company and currently pending before the PSC as well as the impact of developing competition in the energy marketplace are anticipated to affect future earnings.\nTo provide for increases in past due accounts, an additional expense accrual for doubtful accounts was recognized by the Company in 1995, reducing 1995 pretax earnings by $15.0 million, or $.26 per share.\nEarnings per share as reported in 1994 and 1993 reflect charges for work force reduction programs completed in 1994. By the end of 1994, a total of 572 persons, or about 22 percent of the work force, elected to participate in one of three programs which were offered. The overall after-tax savings of these programs are estimated to be about $61 million through 1998. In 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 purchased gas undercharges (see Rates and Regulatory Matters).\nCOMPETITION\nOverview. The Company is operating in a rapidly changing competitive marketplace for electric and gas service. In its electric business, this competitive environment includes a federal and State trend toward deregulation. The passage of the National Energy Policy Act of 1992 (Energy Act) encourages competition in the electric power industry at the wholesale level and promotes access to utility-owned transmission facilities upon payment of appropriate\nprices. At the State level, the PSC is currently investigating the establishment of an efficient wholesale electric competitive market, and various issues relating to retail electric service competition.\nCompetition in the Company's gas business was accelerated with the passage in April 1992 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 customers to investigate different electric supply options. Those options have included 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.\nPSC Competitive Opportunities Case. Phase I of a PSC proceeding to address various issues related to increasing competition in the New York State electric energy markets (the Competitive Opportunities Case) 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.\nUnder Phase II of the Competitive Opportunities Case, the PSC issued an Opinion in June 1995 establishing nine principles to guide the transition to competition in the electric industry. Among other things, the PSC endorsed increased emphasis on market-based approaches to research, environmental protections and energy efficiency, and it supported the concept that utilities should have a reasonable opportunity to recover expenditures and commitments made pursuant to historical obligations. The PSC also indicated that the current vertically integrated industry structure must be thoroughly examined to ensure that it does not impede effective wholesale or retail competition. In October 1995, formal submissions were made in support of, or opposition to, the various proposals being considered for restructuring the electric industry in New York State. The majority of submissions supported the concept that competition should extend to the level of individual retail customers. The Staff of the PSC endorsed the idea that existing utility companies should be required to separate generation from transmission and distribution facilities (including the possible divestiture of generating assets) to foster greater competition. The PSC Staff position also encouraged electric wholesale competition by 1997, retail competition by 1998, and stated that the New York investor-owned utilities should absorb a portion of any stranded investment. The Company does not support the PSC Staff position, but does agree with the spirit underlying the PSC's guiding principles as presented in June 1995. As discussed below, in October 1995 the Company, along with other New York utilities, presented a consensus position to the PSC under Phase II of the Competitive Opportunities Case through the Energy Association of New York State (the Energy Association), an electric utility industry association which is representing the Company and other utilities in the Competitive Opportunities Case.\nIn summary, the Energy Association endorses the following:\n- - the creation of a pool market mechanism through which all electricity producers would compete,\n- - creation of an independent system operator to coordinate bulk power transmission and the pool market mechanism,\n- - regulatory and tax reform that would reduce taxes paid by utilities and limit any increases in the price of electricity and,\n- - creation of a mechanism for generators to recover investments made pursuant to legal obligations to provide universal service.\nThe Energy Association stopped short of endorsing increased competition at the retail level, citing several unresolved issues created by different obligations to serve customers when more than one supplier is selling energy in a single area. The Company cannot predict if this proposal will be adopted by the\nPSC in its Competitive Opportunities Case or its effect on the Company because potential business risks faced by the Company will depend on the specific details of any plan ultimately adopted by the PSC.\nOn December 21, 1995 a Recommended Decision was issued by the Administrative Law Judge presiding over this proceeding. In summary, it provides:\n- - Competition in the generation or production section of the electric industry should be pursued, as long as steps are taken to ensure that unregulated monopoly does not result and that reliability is not impaired. A preferred competitive model, which includes, among other things, the establishment of an independent system operator to perform a variety of essential functions to ensure the reliable operation of the system was presented.\n- - Retail competition has the potential to benefit all customers by providing greater choice among their electricity providers as well as increased pricing and reliability options. But retail access brings with it significant risks and requires considerable caution, and should be provided only if it is in the best interests of all consumers.\n- - In order to ensure reliability, effective competition at the wholesale level should be established first, with an eye toward adding retail access as rapidly as possible once a market is established and reliability is ensured.\n- - Strandable costs must be determined to be prudent, verifiable, and incapable of being reduced before recovery is allowed. Recovery of strandable costs generally should be accomplished by a non-bypassable access charge or wires charge imposed by the distribution company. There must also be a \"reasonable opportunity\" for consumers to realize savings and receive reasonable prices. This requires a careful balancing of interests and expectations, and the level of recovery may vary utility by utility.\n- - In any model under which the production of electricity is deregulated, this function must be separated from transmission and distribution systems in order to limit the exercise of market power. Utilities should make individual proposals regarding preferable corporate structures, explaining how market power will be alleviated.\nA final ruling by the PSC on Phase II of the Competitive Opportunities Case is expected in the Spring of 1996. The Company is not able to predict what policies or guidelines may ultimately be adopted by the PSC under this proceeding. The nature and magnitude of the potential impact of any proposals ultimately adopted by the PSC on the business of the Company will depend on the specific details of any plan for increased competition and resolution of the complex issues related to competition at the retail level.\nFERC Open Transmission Proposals. In March 1995 FERC proposed new rules which would facilitate the development of competitive wholesale markets by requiring electric utilities to offer \"open-access\" transmission service on a non-discriminatory basis. A final rule would define the non-discriminatory terms and conditions under which unregulated generators, neighboring utilities, and other suppliers could gain access to a utility's transmission grid to deliver power to wholesale customers. A supplementary release by FERC states the principle that utilities are entitled to full recovery of \"legitimate, prudent and verifiable\" strandable costs at the state and federal level. This supplementary release concludes that FERC should be the principal forum for addressing wholesale strandable costs, while suggesting state regulatory authorities should address the recovery of strandable costs which may result from retail competition. The FERC sought comments on its proposals in August and October. The Company responded individually and as a member the New York Power Pool (NYPP). The NYPP is actively evaluating the requirements for implementing wholesale competition within the framework of the FERC proposals. Significant changes to NYPP pricing procedures are expected, but their projected effects on the Company's operations and financial performance are not substantial assuming continued vertical integration of the utility industry in New York State. FERC\nis continuing to solicit public comments and elicit public involvement on these proposals. A final ruling from FERC is not anticipated before mid-1996. At the present time, the Company cannot predict what effects regulations ultimately adopted by FERC will have, if any, on future operations or the financial condition of the Company.\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.\nPSC Gas Restructuring Case. In October 1993 the PSC initiated a proceeding to address issues involving the restructuring of gas utility services to respond to competition. Subsequently, in December 1994, the PSC issued an order which presented regulatory policies and guidelines for natural gas distributors. Requirements having the greatest impact on the Company are:\n- - 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.\n- - The Company may offer to package an individual supply of gas to an individual customer in cases that would lower the Company's overall cost of supplying gas.\n- - 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 gas on the Company's system.\n- - The PSC allows full recovery of the transition costs resulting from FERC Order 636 and requires that a share of these costs be borne by firm transportation customers.\nIn November 1995 the Company filed its response to this order. The Company's filing focused on setting transportation rates for an aggregation of all gas customers, reviewing the necessity for minimum gas transportation volumes, providing for the recovery of transition costs associated with FERC Order 636, and establishing requirements for the use of automatic recording meters. The impact on the Company's gas business as a result of this proceeding, however, will depend upon the guidelines and regulations ultimately approved by the PSC. At this time, the Company is unable to predict what regulations will ultimately be adopted by the PSC.\nCOMPETITION AND THE COMPANY'S PROSPECTIVE FINANCIAL POSITION. It has been suggested that certain New York State utilities should write down certain regulatory or generating assets in anticipation of the impact of competitive and regulatory changes. The Company currently believes its regulatory and generating assets are probable of recovery in rates, but 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 ultimately be necessary (see Note 10 of the Notes to Financial Statements).\nRegulatory Assets. The Company has deferred certain costs rather than recognize them on its books when incurred. Such deferred costs are then recognized as expenses when they are included in rates and recovered from customers. Such deferral accounting is permitted by Statement of Financial Accounting Standards No. 71 (SFAS-71). These deferred 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. Such cost deferral is appropriate under traditional regulated cost-of-service rate setting, where all prudently incurred costs are recovered through rates. In a purely competitive pricing environment, such costs might not have been incurred and could not have been deferred. Accordingly, if the Company's rate setting was changed from a cost-of-service approach, and it was no longer allowed to defer these costs under SFAS-71, these assets would be\nadjusted for any impairment to recovery (see discussion under Financial Accounting Standards No. 121). In certain cases, the entire amount could be written off.\nStrandable Assets. In a competitive electric market, strandable assets would arise when investments are made in facilities, or costs are incurred to service customers, and such costs are not fully recoverable in market-based rates. Examples include purchase power contracts (e.g., the Kamine\/Besicorp Allegany L.P. contract, see Projected Capital and Other Requirements) or high cost generating assets. Estimates of strandable assets are highly sensitive to the competitive wholesale market price assumed in the estimation. The amount of potentially strandable assets at December 31, 1995 cannot be determined at this time, but could be significant.\nFinancial Accounting Standards No. 121. In March 1995, the Financial Accounting Standards Board (FASB) issued Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of \" (SFAS-121). SFAS-121 amends SFAS-71 to require write-off of a regulatory asset or strandable asset if it is no longer probable that future revenues will cover the cost of the asset. SFAS-121 also requires a company to recognize a loss whenever events or circumstances occur which indicate that the carrying amount of an asset may not be fully recoverable. At December 31, 1995 the Company's regulatory assets totaled $311.2 million. At the current time, the Company believes its regulatory assets are probable of recovery, and, accordingly, the adoption of this accounting standard will not have a material impact on the financial position or results of operations of the Company.\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 responding to the impact of increased competition.\nBusiness Strategy. In May 1995 the Company set a new strategic business direction for the future. Highlights of that strategy include:\n- - the focus of the Company will be retail energy services,\n- - the Company's goal in that business is market leadership, and\n- - the Company will achieve that goal through operational excellence.\nThe Company's core business will be the marketing and providing of electricity, natural gas, transmission and distribution services, and other energy-related services to retail customers. A closely-aligned business will be providing gas transmission and gas and electric distribution services to other energy services companies.\nThe Company is continuously assessing various strategies which may enhance its ability to respond to competitive forces and regulatory change. These strategies are assessed in an effort to provide the greatest possible value to the Company's shareholders and customers giving consideration to changing economic, regulatory, and political circumstances. Such strategies may include business partnerships or combinations with other companies, internal restructuring involving a separation of some or all of the Company's wholesale or retail businesses, and acquisitions of related businesses. No assurances can be given as to whether any of these potential strategies will be pursued, or as to the corresponding results on the financial condition or competitive position of the Company.\nRATES AND REGULATORY MATTERS\nOVERVIEW. The Company is subject to PSC regulation of rates, service, and sale of securities, among other matters. The Company is also regulated by FERC on a limited basis, in the areas of interstate sales and exchanges of electricity, intrastate sales of electricity for resale, transmission wheeling service for other utilities, and licensing of hydroelectric facilities. As a licensee of nuclear facilities, the Company is also subject to regulation by the Nuclear Regulatory Commission.\n1995 Gas Settlement. The Company's purchased gas expense charged to customers was higher during the 1994-95 heating season compared with prior years, generating substantial customer concern. The action the Company took to reduce rates included refunding the weather normalization adjustment charged to customers in January 1995 and discontinuation of those charges through the remainder of the heating season ending in May 1995. The weather normalization adjustment provides for recovery of fixed charges by producing higher unit rates when the weather is warm and usage is low. Conversely, it would provide lower unit rates during colder periods of high usage.\nIn December 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.\nIn April 1995, the PSC issued a Department of Public Service staff report on the Company's 1994-1995 billing practices and procedures which presented recommendations regarding changes in the Company's natural gas purchasing, billing, meter reading and communication activities.\nOn August 17, 1995, the Company announced that a negotiated settlement had been reached with the Staff of the PSC and other parties which would resolve various PSC proceedings affecting the Company's gas costs. On October 18, 1995, the PSC approved, effective November 1, 1995, (1) the settlement discussed below, (2) elimination of the weather normalization clause in gas rates and (3) the Company's plan for improving its gas billing procedures (the 1995 Gas Settlement). This settlement affects the rate treatment of various gas costs through October 31, 1998.\nHighlights of the 1995 Gas Settlement are:\n- - The Company will forego, for three years, gas rate increases exclusive of the cost of natural gas and certain cost increases imposed by interstate pipelines.\n- - The Company has agreed not to charge customers for pipeline capacity costs in 1996, 1997 and 1998 of $22.5 million, $24.5 million, and $27.2 million, respectively. Under FERC rules, the Company may sell its excess transportation capacity in the market. The value of those sales can be used to offset the capacity costs that will not be charged to customers. These amounts that the Company will not be permitted to charge are subject to increase in the event of major increases in the overall cost of pipeline capacity during these years. The foregoing amounts include the cost of capacity to be purchased by replacement shippers. As discussed below, a substantial portion of this capacity is expected to be released and sold in the market pursuant to a marketing agreement with CNG Transmission Corporation (CNG), a supply agreement with MidCon Gas Services Corporation (MGSC), and other individual agreements.\n- - The Company agreed to write off excess gas pipeline capacity costs incurred through 1995.\n- - As part of a separate decision, the PSC agreed with the Company's request to eliminate the weather normalization clause effective November 1, 1995. The weather normalization clause had adjusted gas customer billing for abnormal weather variations.\nThe economic effect of the 1995 Gas Settlement on the Company's 1995 results of operations may be summarized as follows:\nUnder provisions of the 1995 Gas Settlement, the Company faces an economic risk of remarketing $74.2 million of excess gas capacity through 1998. The Company has entered into a marketing agreement with CNG that is expected to result in the release of approximately $29 million of this capacity through the period. CNG will assist the Company in obtaining permanent replacement customers for transportation capacity the Company will not require. To help manage the balance of the excess capacity costs at risk, the Company has retained MGSC which will work with the Company to identify and implement opportunities for temporary and permanent release of surplus pipeline capacity and advise in the management of the Company's gas supply, transportation and storage assets consistent with the goal of providing reliable service and reducing the cost of gas.\nThe ultimate financial impact of the 1995 Gas Settlement on the Company's business in 1996 and subsequent years will be largely determined by the degree of success achieved by the Company in remarketing its excess gas capacity and in controlling its local gas distribution costs.\n1995 Rate Proposal. With the current three-year electric and gas rate plan expiring in July 1996 (see 1993 Rate Agreement below), the Company in July 1995 filed a request with the PSC for new electric rate tariffs commencing in August 1996. Higher electric rates have been requested to cover increases in capital and operating costs that are not provided for in present rates and are not expected to be offset by increased revenues from sales. Highlights of the 1995 Rate Proposal filing are as follows:\n- - A request for electric rates to be increased by approximately $17.1 million or 2.4 percent annually (based on forecasted retail sales volumes).\n- - A requested 11.75 percent rate of return on equity.\nPSC Staff has proposed that electric rates be decreased 3.5 percent in each of the next two years based on a rate of return on equity of 10.50 percent.\nAlthough the Company's rate application is being litigated before a PSC Administrative Law Judge, the Company has been working with the PSC Staff and others to develop an agreement that could lead to a settlement of the Company's filing, replacing the Company's current rate agreement with a new agreement. The goal is to stabilize customer rates at as low a level as possible and establish guidelines that will allow the Company to assume more risk to take actions that could create increased earnings for shareholders.\nThe Company is unable to predict whether any settlement will be achieved, or what effect any ultimate PSC decision in this proceeding will have on the\nCompany's results of operation or its financial position. A PSC decision on the Company's rate filing is expected by August 1996. Negotiations were suspended late in 1995 after the various participants failed to reach a preliminary settlement. While the Company continues to believe a settlement of these issues would be in the best interest of all parties, it cannot predict the future course of negotiations.\n1993 Rate Agreement. In August 1993 the PSC approved a settlement agreement (1993 Rate Agreement) which determined the Company's rates through June 30, 1996 and includes certain incentive arrangements providing for both rewards and penalties. Under the 1993 Rate Agreement, the PSC approved an electric rate increase of 2.5% ($18.3 million) effective July 1, 1995. Recovery of approximately $20 million of incentive awards earned by the Company has been delayed for future consideration given the competitive environment and the Company's desire to minimize price impacts on its customers. A summary of recent PSC rate decisions under this agreement is included in the table titled Rate Increases.\nFlexible Pricing Tariff. Under its flexible pricing tariff for major industrial and commercial electric customers, the Company may negotiate competitive electric rates at discount prices to compete with alternative power sources, such as customer-owned generation facilities. Under the terms of the 1993 Rate Agreement, the Company would absorb 30 percent of any net revenues lost as a result of such discounts through June 1996, while the remaining 70 percent would be recovered from other customers. The Company has not sought recovery of that 70 percent from other customers. The portion recoverable after June 1996 is expected to be determined by the PSC as it considers the 1995 Rate Proposal. Under the flexible tariff provisions, the Company as of year-end 1995 had negotiated long-term electric supply contracts with twenty of its large industrial and commercial electric customers at discounted rates. The Company is negotiating long-term electric supply contracts with other large customers as the need and opportunity arise. The Company has not experienced any customer loss due to competitive alternative arrangements.\nPurchased Gas Undercharges. In March 1994 the PSC approved a December 1993 settlement among the Company, PSC Staff and another party regarding the Company's accounting for certain gas purchases for the period August 1990-August 1992 which resulted in undercharges to gas customers of approximately $7.5 million. 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 one cent per share, net of tax. Under the 1993 settlement, the Company was to collect $2.6 million from customers over a three-year period. Due to rate increase limitations established in the Company's 1993 Rate Agreement and certain provisions under the 1995 Gas Settlement; however, the Company is precluded from collecting the $2.6 million, and, accordingly, this amount was written off in 1995 and is reflected in Other Deductions on the Statement of Income.\nLIQUIDITY AND CAPITAL RESOURCES\nDuring 1995 cash flow from operations, together with proceeds from external financing activity (see Consolidated Statement of Cash Flows), provided the funds for construction expenditures and the retirement of all outstanding short-term borrowings. At December 31, 1995 the Company had cash and cash equivalents of $44.1 million. Capital requirements during 1996 are anticipated to be satisfied primarily from the combination of internally generated funds and temporary cash investments.\nPROJECTED CAPITAL AND OTHER REQUIREMENTS. The Company's capital requirements relate primarily to expenditures for electric generation, including the 1996 replacement of its Ginna steam generators, transmission and distribution facilities, and gas mains and services as well as the repayment of existing debt. The Company has no current plans to install additional baseload generation.\nIntegrated Resource Plan. The Company's 1992 Integrated Resource Plan (IRP) and 1993 IRP update explored options for complying with the 1990 Clean Air Act Amendments. Future options with regard to generating resources and alternative methods of meeting electric capacity requirements were also examined. Activities have been completed or 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, and\n- - Replace the two steam generators at the Ginna Nuclear Plant.\nAs the future of the electric competitive marketplace becomes more clear with the conclusion of the PSC Competitive Opportunities Case, the Company anticipates addressing a new full-scale planning review.\nGinna Steam Generator Replacement. Preparation for replacement of the two steam generators at the Ginna Nuclear Plant began in 1993 and will continue until the replacement in 1996. Much of the preliminary preparation has been done during the normal annual refueling and maintenance outages. The Company anticipates that the 1996 outage for refueling and replacement will begin in April and 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. Refueling is expected to take place on an 18-month cycle once the new steam generators are installed. The PSC order regarding this project provides that certain costs over $115 million, and savings under that amount, will be shared between the Company and its customers but the Company does not expect to exceed that amount.\nPurchased Power Requirement. 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). The Company was compelled by regulators to enter into a contract with Kamine\/Besicorp Allegheny L.P. (Kamine) for approximately 55 megawatts of capacity, the circumstances of which are discussed in Note 10 of the Notes to Financial Statements. The Kamine contract and the outcome of related litigation will have an important impact on the Company's electric rates and its ability to function effectively in a competitive environment. The Company has no other long-term obligations to purchase energy from Qualifying Facilities.\nCapital Requirements and Electric Operations. Electric production plant expenditures in 1995 included $41 million of expenditures made at the Company's Ginna Nuclear Plant, of which $29 million was incurred for preparation to replace the steam generators. The Company spent $16 million on this project in 1994 and $15 million in 1993. In addition, nuclear fuel expenditures of $16 million were incurred at Ginna during 1995.\nExclusive of fuel costs, the Company's 14 percent share of electric production plant expenditures at the Nine Mile Two nuclear facility totaled $6 million in 1995. Expenditures of $1 million during 1995 were also made for the Company's share of nuclear fuel at Nine Mile Two. On April 8, 1995 Nine Mile Two was taken out of service for a scheduled refueling outage and resumed full\noperation on June 2, 1995, the shortest refueling in the plant's history. The next refueling outage for Nine Mile Two is scheduled for late 1996.\nElectric transmission and distribution expenditures, as presented in the Capital Requirements table, totaled $22 million in 1995, of which $20.4 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 between Grand Island and Syracuse, New York is subject to PSC regulation and commenced operation in November 1993. The Company is participating as an equity owner of Empire through its wholly- owned subsidiary, Energyline Corporation (Energyline), along with subsidiaries of Coastal Corporation and Westcoast Energy Inc. Energyline has a total obligation of $20 million in Empire, made up of a $10.3 million equity investment, and $9.7 million in commitments under a credit agreement.\nConstruction requirements for gas property totaled $14 million in 1995 and were principally for the replacement 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.\nENVIRONMENTAL ISSUES. The production and delivery of energy are necessarily accompanied by the release of by-products subject to environmental controls. The Company has taken 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. A more detailed discussion concerning the Company's environmental matters, including a discussion of the federal Clean Air Act Amendments, can be found in Note 10 of the Notes to Financial Statements.\nREDEMPTION OF SECURITIES. In addition to first mortgage bond maturities and mandatory sinking fund obligations over the past three years, discretionary redemption of securities totaled $120 million in 1993, $24.5 million in 1994, and $1 million in 1995. There was no mandatory redemption of securities in 1995.\nCAPITAL REQUIREMENTS - SUMMARY. The 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 1993 to 1995 and the current estimate of capital requirements through 1998 are summarized in the Capital Requirements table.\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.\n* Excludes prospective refinancings.\nFINANCING AND CAPITAL STRUCTURE. The Company had no debt maturity or sinking fund obligations in 1995 and had no public issuance of securities during the year. Capital requirements in 1995 were satisfied primarily by a combination of internally generated funds and proceeds from the issuance of new shares of Common Stock through its Automatic Dividend Reinvestment and Stock Purchase Plan (ADR Plan). The Company foresees modest near-term financing requirements. Investments in short-term securities were approximately $37.5 million at December 31, 1995. Depending upon economic and market conditions at the time, the Company could use proceeds from these securities to meet construction requirements, undertake debt and\/or preferred stock redemptions, or consider investments in unregulated businesses. 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 and to move to a less leveraged capital structure.\nThe Company anticipates utilizing its credit agreements and unsecured lines of credit 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, redeem 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. For information with respect to short-term borrowing arrangements and limitations, see Note 9 of the Notes to Financial Statements.\nDuring 1995 approximately 783,000 new shares of Common Stock were sold through the Company's ADR Plan and an employee stock purchase plan, providing $17.1 million to help finance its capital expenditures program. New shares issued in 1995 and 1994 were purchased from the Company at a market price above the book value per share at the time of purchase. These plans permit the Company to issue new shares to participants or to purchase outstanding shares on the open market.\nCapital Structure. The Company's retained earnings at December 31, 1995 were $70.3 million, a decrease of approximately $4.2 million compared with a year\nearlier. Retained earnings were reduced by approximately $15 million in October 1995 resulting from a writeoff of certain gas costs, as discussed under the heading 1995 Gas Settlement. Common equity (including retained earnings) comprised 45.3 percent of the Company's capitalization at December 31, 1995, with the balance being comprised of 7.3 percent preferred equity and 47.4 percent long-term debt. Capitalization at December 31, 1995, including $18.0 million of long-term debt due within one year, was comprised of 44.9 percent common equity, 7.2 percent preferred equity, and 47.9 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. As financial market conditions warrant, the Company may, from time to time, issue securities to permit early redemption of higher-cost senior securities. 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.\nRESULTS OF OPERATIONS\nThe following financial review identifies the causes of significant changes in the amounts of revenues and expenses, comparing 1995 to 1994 and 1994 to 1993. The Notes to Financial Statements contain additional information.\nOPERATING REVENUES AND SALES. Compared with a year earlier, operating revenues were nearly unchanged in 1995 after rising five percent in 1994. Gas operating revenues declined in 1995 due to the milder weather during the first quarter of the year and as a result of the 1995 Gas Settlement discussed earlier. Customer electric revenue increased, reflecting higher kilowatt-hour sales and recovery of higher fuel costs. Revenues from the sale of electric energy to other utilities were up due, in part, to a new FERC-approved tariff which has greatly facilitated the Company's participation in two-party sales, or sales which are independent of the New York Power Pool. 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 and deferred fuel costs are included as a part of other revenues, and unbilled revenues are included in each caption as appropriate.\nChanges in fuel cost revenues, which include purchased power revenues, normally have been earnings neutral in the past. Under the 1993 Rate Agreement, however, fuel clause provisions 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 amounts. As a result of these sharing arrangements, discussed further in Note 1 of the Notes to Financial Statements, pretax earnings were increased by $3.9 million in 1994 and $6.6 million in 1995, reflecting, in part, 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 are also being recovered\nthrough the Company's electric fuel adjustment clauses. Certain transition costs incurred by gas supply pipeline companies and billed to the Company are recovered through the Company's gas fuel adjustment provisions.\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 normally refunded to or recovered from customers during a subsequent period. As part of the 1995 Gas Settlement, the Company agreed not to collect from customers and to write off $23.2 million of gas costs which had previously been incurred.\nThe effect of weather variations on operating revenues is most measurable in the Gas Department, where revenues from spaceheating customers comprise about 90 to 95 percent of total gas operating revenues. Weather in the Company's service area during 1994 and 1995 was warmer than normal, with the weather during 1995 being 2.4 percent warmer than 1994 on a calendar-month heating degree day basis. With elimination of the weather normalization clause in the Company's gas tariff, abnormal weather variations may have a more pronounced effect on future gas revenues. Warmer than normal summer weather during 1995 and 1994 boosted electric energy sales to meet the demand for air conditioning usage.\nCompared with a year earlier, kilowatt-hour sales of energy to retail customers were up 2.8 percent in 1995, after remaining nearly flat in 1994. Sales to industrial customers led the increase. This gain was driven by one large industrial customer who is purchasing more electric power as an alternative to power produced at its own plant. Electric demand for air conditioning usage had a significant impact on kilowatt-hour sales in 1994 and 1995. The Company had a net gain of nearly 2,600 new electric customers during 1995, including over 400 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. In contrast to 1994, revenues from sales to other electric utilities grew in 1995 reflecting increased kilowatt-hour sales and higher rates. In addition to sales through the New York Power Pool, the Company increased its participation in two-party sales, as discussed earlier. 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 is an important component of the Company's marketing mix. Company facilities are used to distribute this gas, which amounted to 14.6 million dekatherms in 1995 and 13.6 million dekatherms in 1994. 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 the Company's 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. The Company's objective is eventually to make gas transportation a viable option for every customer on its system. Under two new gas transportation tariffs currently pending before the PSC in its Gas Restructuring Case, minimum throughput levels to qualify for such service would be totally eliminated by July 1998, thereby allowing all customers to qualify for gas transportation service and to choose their own sources of gas supply. If approved by the PSC, these tariffs will be in place by July 1996.\nTherms of gas sold and transported, including unbilled sales, were nearly flat in 1995, after dropping two percent in 1994. 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 1.7 percent in 1995 over 1994, while nonresidential sales, including gas transported, would have increased approximately 2.0 percent in 1995. The average use per residential gas customer, when adjusted for normal weather conditions, was slightly up in 1995, following a modest decrease in 1994.\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. Operating expenses in 1995 reflect the first complete year of savings associated with the Company's early retirement programs in 1993 and 1994. The Company's continuing efforts to curtail increases in maintenance and other operation expenses are also reflected in 1995 results. Operating expenses are summarized in the table titled Operating Expenses.\nEnergy Costs - Electric. Lower fuel expense for electric generation in 1995 compared with a year earlier reflects primarily a drop in the average cost of coal used to generate power. Total Company electric generation was up 4.5 percent in 1995. For the 1994 comparison period, 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 nuclear fuel decreased in 1994 and was up slightly in 1995.\nThe Company normally 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. Under a contract with Kamine, however, the Company has been required to purchase unneeded energy at uneconomical rates (see Note 10 of the Notes to Financial Statements). The Company purchased 337 thousand megawatt-hours of energy from Kamine at a total price of $16.6 million in 1995. For the 1994 comparison period, the increase in purchased electricity expense was caused by an increase in kilowatt-hours purchased. Average rates for purchased electricity were up in 1995 after declining in 1994.\nEnergy Management and Costs - Gas. The Company purchases all of its required gas supply directly from numerous producers and marketers under contracts containing varying terms and conditions. The Company currently holds firm transportation capacity on ten major natural gas 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 system (7.2 billion cubic feet) and on the ANR Pipeline system (8.4 billion cubic feet) which is 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 occur in the winter months. The Company is committed to transportation capacity on Empire and the CNG pipeline system, as well as to upstream pipeline transportation and storage services. 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.\nAs a result of the restructuring of the gas transportation industry by FERC pursuant to Order No. 636 and related decisions, there have been and will be a number of changes in the gas portion of the Company's business over the next\nseveral 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. For additional information with respect to these transition costs, see Note 10 of the Notes to Financial Statements.\nGas purchased for resale expense declined in 1995 driven by a reduced volume of purchased gas resulting from a warmer than normal heating season. In addition, average purchased gas rates declined in 1995 compared with a year earlier, primarily due to lower commodity costs. Despite a decrease in the volume of gas purchased, gas purchased for resale expense was up in 1994 reflecting higher average purchased gas rates compared with 1993.\nOperating Expenses, Excluding Fuel. Other operation expense increased approximately $18.0 million in 1995, after remaining nearly flat in 1994. An additional expense accrual for doubtful accounts increased operating expenses by $15.0 million in 1995. This expense was partially offset by lower costs for payroll, employee welfare, and materials and supplies due, in part, to Company cost control efforts and the work reduction programs undertaken in 1994. The additional reserve in 1995 for doubtful accounts was recognized to provide for increases in past due accounts. The change in other operation expenses for the 1994 comparison period reflects increased demand side management and uncollectible expenses offset by lower payroll and welfare expense.\nLower maintenance expense in both comparison periods reflects reduced payroll and contractor costs.\nFor both comparison periods, the increase in depreciation expense reflects an increase in depreciable plant. When completed, replacement of the steam generators at the Ginna Nuclear Plant is anticipated to increase depreciation expense by approximately $11 million annually.\nTaxes Charged To Operating Expenses. The increase in local, state and other taxes in the 1995 comparison period reflects certain assessments for prior years' taxes. The 1994 comparison period reflects primarily an increase in revenues combined with increased property tax rates and generally higher property assessments.\nSee Note 2 of the Notes to Financial Statements for an analysis of federal income taxes.\nOTHER STATEMENT OF INCOME ITEMS. Variations 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 during the third and fourth quarters of 1993 and the third quarter of 1994. These programs are discussed under Earnings Summary.\nOther--Net Income and Deductions for 1993 and 1994 result 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 1995 comparison period, Other--Net Income and Deductions also reflects recognition of the employee incentive program, and additional depreciation of the Empire project to recognize the difference between a rateable method of computation versus a lesser amount currently included in rates.\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 1993-1995. The average short-term debt outstanding decreased in 1994 and 1995.\nDIVIDEND POLICY. The current annual dividend rate on the Company's Common Stock is $1.80 per share. 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. The Company believes that future dividend payments will need to be evaluated in the context of maintaining the financial\nstrength 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 dividends at the current rate, future dividends may be affected.\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, 1995.\nConsolidated Balance sheets at December 31, 1995 and 1994.\nConsolidated Statement of Cash Flows for each of the three years ended December 31, 1995.\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, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995, 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 3 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 19, 1996\nCONSOLIDATED STATEMENT OF INCOME\nCONSOLIDATED STATEMENT OF RETAINED EARNINGS\nThe accompanying notes are an integral part of the financial statements.\nCONSOLIDATED BALANCE SHEET\nThe accompanying notes are an integral part of the financial statements.\nCONSOLIDATED BALANCE SHEET\nThe accompanying notes are an integral part of the financial statements.\nCONSOLIDATED STATEMENT OF CASH FLOWS\n* Reclassified for comparative purposes. The accompanying notes are an integral part of the financial statements.\nNOTES TO FINANCIAL STATEMENTS\nNote 1. SUMMARY OF ACCOUNTING PRINCIPLES\nGENERAL. The Company supplies electric and gas services wholly within the State of New York. It produces and distributes electricity and distributes gas in parts of nine counties centering about the City of Rochester. 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. The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of 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.\nA description of the Company's principal accounting policies follows.\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.\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 make a net investment of up to $20 million in Empire. In June 1993 Empire secured a $150 million credit agreement, a portion of the proceeds of which were used to finance approximately 75% of the total construction cost and initial operating expenses. Energyline has a total obligation of $20 million in the Empire State Pipeline, made up of a $10.3 million equity investment, and $9.7 million in commitments under the credit agreement.\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 customers and the Company will share the effects of any variation from forecast monthly unit fuel costs on a 50%\/50% basis up to 60 basis points of common equity or approximately a $7.0 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 $4.1 million or above $7.1 million on sales to electric utilities be shared with retail customers on a 50%\/50% basis.\nIn addition, there is a similar 80%\/20% sharing process of variances from forecasted margins derived from sales and the transportation 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. The December 31, 1995 balance recoverable from customers is $9.3 million. The company is not currently recognizing ERAM amounts as part of income. The ultimate recognition, if any, will be determined as a part of the current rate filing with the PSC.\nIn prior years, retail customers who use gas for spaceheating were 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. Weather normalization adjustments lowered gas revenues in 1994 and 1993 by approximately $1.2 million in each year. On January 25, 1995 the Company\nsuspended the weather normalization adjustment in an effort to mitigate high billings due to the warm weather, and as discussed in Note 10, the suspension became permanent. This decreased 1995 pre-tax earnings from gas operations by $5.8 million.\nThe Company practices gas cost deferral accounting. 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 an annual depreciation provision of 2.9% in the three year period ended December 31, 1995. Reported other income deductions includes an additional charge of approximately $5 million to recognize the difference between a rateable method of computation versus a lesser amount currently included in rates for the Empire Pipeline.\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 5.0% to 3.9% during the three-year period ended December 31, 1995.\nThe Company did not accrue AFUDC on a portion of its investment in Nine Mile Two for which a cash return was allowed. Instead amounts were accumulated in deferred debit and credit accounts for use in conjunction with a rate phase-in plan equal to the amount of AFUDC which was no longer accrued.\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).\nCASH AND CASH EQUIVALENTS. Cash and cash equivalents consist of cash and short-term commercial paper. These investments have original maturity not exceeding three months. Such investments are stated at cost, which approximates fair value, and are considered cash equivalents for financial statement purposes.\nINVESTMENTS IN DEBT AND EQUITY SECURITIES. SFAS-115, Accounting for Certain Investments in Debt and Equity Securities, was adopted by the Company in 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.\nFUTURE CONTRACTS. The Company periodically hedges natural gas in storage against possible changes in price. Hedges are always backed by gas commodity in storage, and gains or losses resulting from these transactions are deferred until the corresponding gas is withdrawn from storage and delivered to customers. The Company had no open hedge contracts outstanding at December 31, 1995.\nALLOWANCE FOR DOUBTFUL ACCOUNTS. The Company's practice is to reserve an amount for doubtful accounts that corresponds to its write-off history. Recently, the Company experienced an increase in write-offs and extended collection periods. Accordingly, an additional $11 million was reserved in 1995.\nRESEARCH AND DEVELOPMENT COST. Research and Development charged to expense for the years 1995, 1994, and 1993 was $5.2 million, $7.3 million, and $8.3 million respectively.\nSALE OF PROPERTY. During 1995, the Company sold property at the location of its former operation center for approximately $11.5 million and entered into a 3 year lease-back arrangement with the buyer. The gain on the sale of the property has been deferred pending disposition by the PSC.\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, 1995 and 1994 was $189 million and $206 million, respectively. In conjunction with the recognition of this liability, a corresponding regulatory asset was also recognized.\nAs of December 31, 1995, the regulatory asset recognized by the Company as a result of adopting SFAS-109 is attributed to $166 million in depreciation, $21 million to property taxes, $18 million of deferred finance charges - Nine Mile Two and $4 million of Miscellaneous items offset by $17 million attributed to investment tax credits and $3 million of revenue taxes.\nNote 3. PENSION PLAN AND OTHER POST EMPLOYMENT 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. 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.\nNet pension cost included the following components:\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 ($9.6 million deferred for collection from customers), 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 a current discount rate of 8.25%.\nThe projected benefit obligation at December 31, 1995 and December 31, 1994 assumed discount rates of 6.75% and 8.50%, respectively, and a long-term rate of increase in future compensation levels of 5.00% and 6.00%, respectively. 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 1995, 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 1995, the health care benefit consisted of a contribution of up to $200 per retiree 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\", in 1992. 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 plan's funded status reconciled with the Company's balance sheet is as follows:\nNet periodic postretirement benefit cost included the following components:\nThe Accumulated Postretirement Benefit Obligation at December 31, 1995 and 1994 assumed discount rates of 6.75% and 8.50%, respectively, and long-term rate of increase in future compensation levels of 5.00% and 6.00%, respectively.\nSFAS-112, \"Employers' Accounting for Postemployment Benefits\", was adopted by the Company in 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.\nNote 4. DEPARTMENTAL FINANCIAL INFORMATION\nThe Company's records are maintained by operating departments, in accordance with PSC accounting policies. 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\nFIRST MORTGAGE BONDS\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\ndepositing cash with the Trustee. The 1995 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:\nPROMISSORY NOTES\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 3.68% for 1995, 2.82% for 1994 and 2.19% for 1993. 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, 1998. The annual interest rate was adjusted to 2.75% effective November 15, 1993, to 4.40% effective November 15, 1994 and to 3.75% effective November 15, 1995. 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 1995 of 6.69% 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 $780 million at December 31, 1995.\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.\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 1995 of 5.90% for Preferred Stock, subject to mandatory redemption, with similar terms and average maturities (6.66 years), the fair value of the Company's Preferred Stock, subject to mandatory redemption, is approximately $59 million at December 31, 1995.\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.\nNote 8. COMMON STOCK\nAt December 31, 1995, there were 50,000,000 shares of $5 par value Common Stock authorized, of which 38,453,163 were outstanding. No shares of Common Stock are reserved for options, warrants, conversions, or other rights. There were 1,369,062 shares of Common Stock reserved and unissued for shareholders under the Automatic Dividend Reinvestment and Stock Purchase Plan and 185,743 shares reserved and unissued for employees under the RG&E Savings Plus Plan.\nCapital stock expense increased in 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, 1995 the Company had no short-term debt outstanding. On December 31, 1994, the Company had short-term debt outstanding of $51.6 million. The weighted average interest rate on short-term debt borrowed during 1995 was 6.14%. For 1994, the weighted average interest rate on short-term debt outstanding at year end was 6.01% and was 4.50% for borrowings during the year.\nThe Company has a $90 million revolving credit agreement for a term of three years. In December of 1995 the Company was granted a one-year extension of the commitment termination date to December 31, 1998. Commitment fees related to this facility amounted to $165,000 in 1995 and $169,000 per year in 1994 and 1993.\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, 1995, the Company would be able to incur $63.4 million of additional unsecured debt under this provision. The Company has unsecured lines of credit totaling $92 million available from several banks, at their discretion. The aggregate borrowings outstanding at any time under these lines of credit cannot exceed the 15% Charter limitation.\nIn order to be able to use its $90 million 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. In addition, the Company has a Loan and Security Agreement to provide for borrowings up to $20 million for the exclusive purpose of financing Federal Energy Regulatory Commission Order 636 transition costs(636 Notes) 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.\nAt December 31, 1995, borrowings outstanding were $13.9 million of 636 Notes (recorded on the Balance Sheet as a deferred credit).\nNote 10. COMMITMENTS AND OTHER MATTERS\nCAPITAL EXPENDITURES\nThe Company's 1996 construction expenditures program is currently estimated at $150 million, including $51 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 decommissioning costs of approximately $78.9 million through December 31, 1995. In connection with the Company's rate settlement completed in August 1993, the PSC approved the collection during the rate year ending June 30, 1996 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 $169.5 million for Ginna and $38.6 million for the Company's 14% share of Nine Mile Two (January 1995 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.\nThe Company completed a site specific cost analysis of decommissioning at Ginna and incorporated the results of this study in its July 1995 rate filing with the PSC. Based on the site specific study the estimated decommissioning cost increased to $296.3 million (May 1995 dollars). The Company has received Niagara Mohawk's estimate of a site specific cost estimate for Nine Mile Two which indicates the Company's share of such costs could be as much as $113 million. This estimate is currently under review by the Company and the other co-tenants and the staff of the PSC. The Company cannot predict the timing or extent to which any additional estimates will be recognized in rates.\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. Since 1990, the Company has contributed $54.4 million to this fund and, including realized and unrealized investment returns, the fund has a balance of $71.5 million as of December 31, 1995. 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, 1995 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 waste, may require the Company to further increase funding. The Company continues to monitor these activities and although an increase in funding levels is likely, the Company 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 could increase, the estimated cost for decommissioning could be reclassified as a liability rather than as accumulated depreciation, the liability accounts and corresponding plant asset carrying accounts could be increased and trust fund\nincome from the external decommissioning trusts could be reported as investment income rather than as a reduction to decommissioning expense.\nIf annual decommissioning costs increased, the Company would expect to defer the effects of such costs pending disposition by the PSC.\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 three installments aggregating approximately $6.2 million have been paid through 1995. 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, 1995 is $17.5 million ($15.8 million as a long-term liability and $1.7 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 an 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 Nuclear Waste 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 $75.1 million at December 31, 1995. The Company is allowed by the PSC to recover these costs in rates. The estimated fees are classified as a long-term liability and interest is accrued at the current three-month Treasury bill rate, adjusted quarterly. The Nuclear Waste Act also requires the DOE to provide for the disposal of nuclear fuel irradiated after April 6, 1983, for a charge of one mill ($.001) per KWH of nuclear energy generated and sold. This charge (approximately $2.7 million per year) 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.\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 Act. 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 its Operating License in the year 2009.\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 to fund its obligations under the Nuclear Waste Act. 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, 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. Petitioners initial\nand reply briefs were filed in October and November, 1995, respectively and oral argument was completed in January, 1996. A decision is expected in the second quarter of 1996.\nNUCLEAR FUEL ENRICHMENT SERVICES. The Company has two contracts for enrichment services, one 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, 2004 and 2005. Additionally, the Company will accept only 70% of its required enrichment services from USEC in 1996 through 1999. A second enrichment service contract has been placed with Urenco, Inc., with enrichment facilities in Europe, to cover 30% of the Company's requirements from 1996 through 1999, and 100% of requirements in 2000 and 2001. The Company plans to meet its enrichment requirements for years beyond those already committed by making further arrangements with USEC, Urenco or by contracting with third parties. The estimated cost of enrichment services utilized every 18 months for the next seven years is expected to range from $10 million to $13 million.\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 $3.0 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 $3.8 million and $17.2 million in the event of losses under the replacement power and property damage coverages, respectively.\nLITIGATION WITH CO-GENERATOR\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). Under these statutes, a utility is required to pay for electricity from Qualifying Facilities at a rate that equals the cost to the utility of power it would otherwise produce itself or purchase from other sources (Avoided Cost). 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 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 agree to pay\nKamine 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 costs on which the contract was based have declined dramatically.\nIn September 1994, the Company commenced a lawsuit in New York State Supreme Court, Monroe County, seeking to void or, alternatively, to reform a Power Purchase Agreement with Kamine for the purchase of the electrical output of a cogeneration facility in the Town of Hume, Allegany County, New York, for a term of 25 years. The contract was negotiated pursuant to the specific pricing requirement of a State statute that was later repealed, as well as estimates of Avoided Costs by the PSC that subsequently were drastically reduced. As a result, the contract requires the Company to pay prices for Kamine's electrical output that dramatically exceed current Avoided Costs and current projections of Avoided Costs. The Company's lawsuit seeks to avoid payments to Kamine that exceed actual and currently projected Avoided Costs. Kamine answered the Company's complaint, seeking to force the Company to take and pay for power at the higher rates called for in the contract and claiming damages in an unspecified amount alleged to have been caused by the Company's conduct. The Company received test generation from the Kamine facility during the last quarter of 1994. Kamine contends that the facility went into commercial operation in December 1994 and that the Company is obligated to pay the full contract rate for it. The Company disputes this contention and refuses to pay the full contract rate. During 1995 Kamine filed a motion for summary judgement dismissing the Company's complaint and directing it to perform the Power Purchase Agreement. The court denied that motion and Kamine appealed. After argument of that appeal Kamine filed for protection under the Bankruptcy laws and sent to the Appellate Division a notice that all further proceedings were stayed. The Company is unable to predict the ultimate outcome of this litigation.\nIn addition, Kamine has filed a related complaint in the United States District Court for the Western District of New York alleging that the conduct which is the subject of the State court action violates the federal antitrust laws. The complaint seeks treble damages in the amount of $420,000,000, as well as preliminary and permanent injunctions. Subsequently, Kamine filed a motion for a preliminary injunction in the federal action to enjoin the Company from refusing to accept and purchase electric power from Kamine and enjoining the Company from terminating during the pendency of this lawsuit its performance under the contract. In November, 1995, the Court issued a decision denying Kamine's motion for a preliminary injunction, finding, among other things, that Kamine had not established the necessary likelihood of success on the merits of its action. Kamine filed a notice of appeal from that decision but has subsequently announced that it is withdrawing that appeal. The Company is unable to predict the ultimate outcome of this litigation.\nDuring 1995 the PSC invited the Company to file a petition requesting, among other things, that the Commission commence an investigation to determine whether at the time of claimed commercial operation the Hume plant was a cogeneration facility under New York law as required by the Power Purchase Agreement. The Company filed such a petition and Kamine filed papers in opposition. The Company is unable to predict the ultimate outcome of this proceeding.\nAlso during 1995 Kamine filed a petition before the FERC to waive certain requirements for federal Qualified Facility status for 1994. The Company and the PSC filed in opposition to the request. Subsequently FERC issued an order granting the waiver request and the Company has filed a motion for reconsideration.\nIn November 1995 Kamine filed in Newark, New Jersey for protection under the Bankruptcy laws and filed a complaint in an adversary proceeding seeking, among other things, specific performance of the Power Purchase Agreement. Kamine filed a motion to compel the Company to pay under its view of the terms of the Power Purchase Agreement during the pendency of the Adversary Proceeding. After hearing, the Bankruptcy Court denied that motion. The Court also denied various motions made by the Company to change the venue of the proceedings to New York State and to lift the automatic stay of the pending New York State Action. The Company has filed a notice of appeal to the District Court for the denial of its\nmotions. The PSC has filed a motion to lift the stay to permit it to proceed with its investigation of the Hume facility under New York State Law. General Electric Credit Corporation which had provided financing to the Hume project, has intervened in the Adversary Proceeding as a plaintiff. The Company has filed an answer with affirmative defenses and counterclaims in the Adversary Proceeding. The counterclaims seek, among other things, the relief sought in the New York State Court action described above. The parties are now engaged in discovery in connection with the Adversary Proceeding.\nThe existence of mandated high priced independent power purchase agreements is a significant problem throughout the State of New York and there are various efforts by State officials to resolve the problem. The Company continues to work to resolve this particular dispute in a fashion that is fair and equitable to all parties, however, we will continue to take aggressive action on behalf of customers and the Company to assure that their interests are respected in any resolution. The Company is unable to predict the ultimate outcome of these efforts on the legal proceedings.\nENVIRONMENTAL MATTERS\nThe following tables list various sites where past waste handling and disposal has or may have occurred that are discussed below:\nTABLE I - COMPANY-OWNED SITES\nTABLE II - SUPERFUND AND OTHER SITES\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 has recorded a total liability of approximately $11 million, $8 million of which it anticipates spending on SIR efforts at the six Company-owned sites listed in Table I above where past waste handling and disposal may have occurred. Concurrently, the Company recorded a similar increase in its Regulatory Assets. Approximately $4.5 million has been provided for in rates through June 1996 ($1.5 million annually) for recovery of\nSIR costs. To the extent actual expenditures differ from this amount, they will be deferred for future disposition and recovery as authorized by the PSC.\nIn mid-1995, the New York State Department of Environmental Conservation (NYSDEC) developed a listing of sites called \"The Hazardous Substance Site Inventory\". Under current New York State law, unless a site, which is determined to pose a public health or environmental risk, contains hazardous wastes, State \"Superfund\" monies cannot be used to assist in the clean-up. The State wanted to have some sense of the scale of this problem before the legislature considered other avenues of legal and financial redress than those currently available. The NYSDEC's \" Hazardous Substance Waste Disposal Site Study\" was developed to assess the number of and cost to remediate sites where hazardous chemicals, but not hazardous wastes are present. Of the six Company-owned sites listed in Table I above, three are listed in this inventory. These are East Station, Front Street and Brooks Avenue. In addition to these three sites, the inventory includes Ambrose Yard and Lindberg Heat Treating. The Company does not believe that additional SIR work for which the Company is responsible is required at either site, however the Company is unable to predict what action will be necessitated as a result of the listing.\nThe Company and its predecessors formerly owned and operated three manufactured gas facilities in the Rochester area. They are included in Table I. In September 1991, the Company initiated a study of subsurface 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 were temporarily suspended while the Company investigated more cost effective remedial technologies. Cleanup activities resumed in October 1995 and are scheduled to be concluded in April 1996. At the second of the three manufactured gas plant sites known as East Station, an interim remedial action was undertaken in late 1993. Ground water monitoring wells were also installed to assess the quality of the ground water 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 Rochester area property owned by the Company (Front Street) where gas manufacturing took place, a boring placed in the Fall of 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. Limited investigative work performed there during the Summer of 1995 has shown evidence of both the former gas manufacturing operations and leakage from fuel tanks. The NYSDEC was informed; the fuel tanks removed; and additional work planned for 1996. The SIR costs associated with these actions are included in Table I. The NYSDEC has not taken any action against the Company as a result of these findings.\nOn another portion of the Company's property in the Rochester area (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\nthis 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 the 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.\nThe NYSDEC did not include the site in its hazardous substance inventory, presumably pending negotiations with the County to pursue appropriate closure of the County's former retention pond area. The Company and the County continue to negotiate to resolve the issue. The Company is unable to assess the outcome of the negotiations or the implications of the NYSDEC's attempts to secure proper closure.\nMonitoring wells installed at another Company facility (Brooks Avenue) in 1989 revealed that an undetermined amount of leaded gasoline had reached the ground water. 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. It is estimated that further investigative work into this problem may cost up to $100,000. 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. While the cost of corrective actions cannot be determined until investigations are completed, preliminary estimates are in the range of $160-180 thousand.\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. The Company has signed orders on consent for five of these sites and recorded estimated liabilities totaling approximately $3 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 incurred 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. Subsequent work has indicated that the final cost is likely to be lower.\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\nthat 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) which will primarily affect air emissions from the Company's fossil-fueled electric generating facilities. A range of capital costs between $15 million and $25 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.\nGAS COST RECOVERY\nFERC 636 TRANSITION COSTS. As a result of the restructuring of the gas transportation industry by the FERC pursuant to Order No. 636 and related decisions, there have been and 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. The final amounts of such transition costs are subject to continuing negotiations with several pipelines and ongoing pipeline filings requiring FERC approval. The Company, as a customer, has estimated total costs of about $63.2 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 $36.2 million of these costs were paid to various suppliers, of which about $22.2 million has been included in purchased gas costs. At year- end, $41.0 million remains deferred for future collection from customers. The Company entered into a $20 million credit agreement with a domestic bank to provide funds for the Company's transition cost liability to CNG Transmission Corporation (CNG). At December 31, 1995 the Company had $13.9 million of borrowings outstanding under the credit agreement. The Company is collecting those costs through the Gas Clause Adjustment in its rates.\nThe Company is committed to transportation capacity on the Empire State Pipeline (Empire) 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.\n1995 GAS SETTLEMENT. The Company's purchased gas expense charged to customers was higher during the 1994-95 heating season compared with prior years, generating substantial customer concern. The action the Company took to reduce rates included refunding the weather normalization adjustment charged to customers in January 1995 and discontinuation of those charges through the remainder of the heating season ending in May 1995. The weather normalization adjustment provides for recovery of fixed charges by producing higher unit rates when the weather is warm and usage is low. Conversely, it would provide lower unit rates during colder periods of high usage.\nIn December 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.\nIn April 1995, the PSC issued a Department of Public Service staff report on the Company's 1994-1995 billing practices and procedures which presented recommendations regarding changes in the Company's natural gas purchasing, billing, meter reading and communication activities.\nOn August 17, 1995, the Company announced that a negotiated settlement had been reached with the Staff of the PSC and other parties which would resolve various PSC proceedings affecting the Company's gas costs. On October 18, 1995, the PSC approved, effective November 1, 1995, (1) the settlement discussed below, (2) elimination of the weather normalization clause in gas rates and (3) the Company's plan for improving its gas billing procedures (the 1995 Gas Settlement). This settlement affects the rate treatment of various gas costs through October 31, 1998.\nHighlights of the 1995 Gas Settlement are:\n- - The Company will forego, for three years, gas rate increases exclusive of the cost of natural gas and certain cost increases imposed by interstate pipelines.\n- - The Company has agreed not to charge customers for pipeline capacity costs in 1996, 1997 and 1998 of $22.5 million, $24.5 million, and $27.2 million, respectively. Under FERC rules, the Company may sell its excess transportation capacity in the market. The value of those sales can be used to offset the capacity costs that will not be charged to customers. These amounts that the Company will not be permitted to charge are subject to increase in the event of major increases in the overall cost of pipeline capacity during these years. The foregoing amounts include the cost of capacity to be purchased by replacement shippers. As discussed below, a substantial portion of this capacity is expected to be released and sold in the market pursuant to a marketing agreement with CNG, a supply agreement with MidCon Gas Services Corporation (MGSC), and other individual agreements.\n- - The Company agreed to write off excess gas pipeline capacity costs incurred through 1995.\n- - As part of a separate decision, the PSC agreed with the Company's request to eliminate the weather normalization clause effective November 1, 1995. The weather normalization clause had adjusted gas customer billing for abnormal weather variations.\nThe economic effect of the 1995 Gas Settlement on the Company's 1995 results of operations may be summarized as follows:\nUnder provisions of the 1995 Gas Settlement, the Company faces an economic risk of remarketing $74.2 million of excess gas capacity through 1998. The\nCompany has entered into a marketing agreement with CNG that is expected to result in the release of approximately $29 million of this capacity through the period. CNG will assist the Company in obtaining permanent replacement customers for transportation capacity the Company will not require. To help manage the balance of the excess capacity costs at risk, the Company has retained MGSC which will work with the Company to identify and implement opportunities for temporary and permanent release of surplus pipeline capacity and advise in the management of the Company's gas supply, transportation and storage assets consistent with the goal of providing reliable service and reducing the cost of gas.\nThe ultimate financial impact of the 1995 Gas Settlement on the Company's business in 1996 and subsequent years will be largely determined by the degree of success achieved by the Company in remarketing its excess gas capacity and in controlling its local gas distribution costs.\nPURCHASED GAS UNDERCHARGES\nIn March 1994 the PSC approved a December 1993 settlement among the Company, PSC Staff and another party regarding the Company's accounting for certain gas purchases for the period August 1990 - August 1992 which resulted in undercharges to gas customers of approximately $7.5 million. 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 one cent per share, net of tax. Under the 1993 settlement, the Company was to collect $2.6 million from customers over a three-year period. Due to rate increase limitations established in the Company's 1993 Rate Agreement and certain provisions under the 1995 Gas Settlement; however, the Company is precluded from collecting the $2.6 million and accordingly, this amount was written off in 1995 and is reflected in Other Deductions on the Statement of Income.\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 filed a protest of the IRS adjustments to its 1987-88 tax liability. The Company believes 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 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 filed a protest with the IRS.\nREGULATORY AND STRANDABLE ASSETS\nThe Company has deferred certain costs rather than recognize them on its books when incurred. Such deferred costs are then recognized as expenses when they are included in rates and recovered from customers. Such deferral accounting is permitted by Statement of Financial Accounting Standards No. 71 (SFAS-71). These deferred costs are shown as Regulatory Assets on the Company's Balance Sheet. Such cost deferral is appropriate under traditional regulated cost-of-service rate setting, where all prudently incurred costs are recovered through rates. In a purely competitive pricing environment, such costs might not\nhave been incurred and could not have been deferred. Accordingly, if the Company's rate setting was changed from a cost-of-service approach, and it was no longer allowed to defer these costs under SFAS-71, these assets would be adjusted for any impairment to recovery (see discussion under Financial Accounting Standards No. 121). In certain cases, the entire amount could be written off.\nBelow is a summarization of the Regulatory Assets as of December 31, 1995.\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 over the remaining life of the related property 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. The recovery of these costs has been approved by the PSC through the year 2002.\n- - Uranium Enrichment Decommissioning Deferral: The Energy Policy Act of 1992 requires utilities to contribute such amounts based on the amount of uranium enriched by DOE for each utility. This amount is mandated to be paid to DOE over the next 13 years. The recovery of these costs is through the Company's fuel adjustment clause, over a comparable period.\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. The majority of these costs will be recovered through the Company's gas cost adjustment over the next three years.\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. These costs are recoverable by the Company over the next five years.\nIn a competitive electric market, strandable assets would arise when investments are made in facilities, or costs are incurred to service customers, and such costs are not fully recoverable in market-based rates. Examples include purchase power contracts (e.g., the Kamine\/Besicorp Allegany L.P. contract), or high cost generating assets. Estimates of strandable assets are highly sensitive to the competitive wholesale market price assumed in the estimation. The amount of potentially strandable assets at December 31, 1995 cannot be determined at this time, but could be significant.\nFINANCIAL ACCOUNTING STANDARDS No. 121\nIn March 1995, the Financial Accounting Standards Board (FASB) issued Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long- Lived Assets and for Long-Lived Assets to be Disposed Of\" (SFAS-121). SFAS-121 amends SFAS-71 to require write-off of a regulatory asset or strandable asset if it is no longer probable that future revenues will cover the cost of the asset. SFAS-121 also requires a company to recognize a loss whenever events or circumstances occur which indicate that the carrying amount of an asset may not be fully recoverable. At December 31, 1995 the Company's regulatory assets totaled $311.2 million. At the current time, the Company believes its regulatory assets are probable of recovery, and, accordingly, the adoption of this\naccounting standard will not have a material impact on the financial position or results of operations of the Company.\nLEASE AGREEMENTS\nThe Company leases several buildings for administrative offices and operating activities. The total lease expense charged to operations was $2.4 million in 1995. For the years 1996, 1997, 1998, 1999 and 2000 the estimated lease expense charged to operations will be $4.1 million, $4.1 million, $4 million, $2.3 million and $2.3 million, respectively. Commitments under capital leases were not significant to the accompanying financial statements.\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\/1\/ Includes recognition of $28.7 million net-of-tax gas settlement adjustment. \/2\/ Includes recognition of $21.9 million net-of-tax pension plan curtailment. \/3\/ Includes recognition of $1.3 million net-of-tax pension plan curtailment. \/4\/ Includes recognition of $5.3 million net-of-tax pension plan curtailment.\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, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS 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 24, 1996, 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. Regis trant's definitive proxy statement dated March 12, 1996 will be filed with the Securities and Exchange Commission prior to April 30, 1996. The information required in Items 10 through 13 under the headings set forth above is incorpo rated 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 24, 1996 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, 1995.\nConsolidated Balance Sheets at December 31, 1995 and 1994.\nConsolidated Statement of Cash Flows for each of the three years ended December 31, 1995.\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, 1995.\nSchedule II - Valuation and Qualifying Accounts.\n(a) 3. Exhibits - See List of Exhibits.\n(b) Reports on Form 8-K - None.\nROCHESTER GAS AND ELECTRIC CORPORATION\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS\n(Thousands of Dollars)\nFOR THE YEAR ENDED DECEMBER 31, 1993\nFOR THE YEAR ENDED DECEMBER 31, 1994\nFOR THE YEAR ENDED DECEMBER 31, 1995\nBeginning in 1992 the Company no longer charges uncollectible expenses through the uncollectible reserve. The total amount written off directly to expense in 1993 was $6,241, in 1994 was $9,000 and in 1995 was $12,063.\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 Form 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. (Filed as Exhibit 10-3 in February 1995 on Form 10-K for the year ended December 31, 1994, SEC File No. 1-672-2)\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)\nExhibit 10-8 Agreement dated July 1, 1995 between the Company and MidCon Gas Services Corporation [not filed - subject to request for confidential treatment]\nExhibit 10-9* (A) 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)\nExhibit 10-10* (A) Rochester Gas and Electric Corporation Long Term Incentive Plan, Restatement of January 1, 1994. (Filed as Exhibit 10-10 in February 1995 on Form 10-K for the year ended December 31, 1994, SEC File No. 1-672-2)\nExhibit 10-11 (A) Rochester Gas and Electric Corporation Executive Incentive Plan, Restatement of January 1, 1995.\nExhibit 10-12 (A) RG&E Unfunded Retirement Income Plan Restatement as of July 1, 1995.\nExhibit 10-13 (A) Severance Agreement dated August 17, 1995 between the Company and Roger W. Kober, Chairman of the Board, President and Chief Executive Officer.\nExhibit 10-14 (A) Severance Agreement dated August 17, 1995 between the Company and Thomas S. Richards, Senior Vice President, Energy Services.\nExhibit 10-15 (A) Severance Agreement dated August 17, 1995 between the Company and Robert E. Smith, Senior Vice President, Energy Operations.\nExhibit 10-16 (A) Severance Agreement dated January 2, 1996 between the Company and J. Burt Stokes, Senior Vice President, Corporate Services and Chief Financial Officer.\nExhibit 23 Consent of Price Waterhouse, independent accountants\nExhibit 27 Financial Data 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: ROGER W. KOBER ----------------------------------- Roger W. Kober Chairman of the Board, President and Chief Executive Officer\nDATE: February 15, 1996\nPursuant to 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:\nROGER W. KOBER Chairman of the Board, February 15, 1996 - --------------------------- President and Chief (Roger W. Kober) Executive Officer\nPrincipal Financial Officer:\nJ. B. STOKES Senior Vice President February 15, 1996 - --------------------------- Corporate Services and (J. Burt Stokes) Chief Financial Officer\nPrincipal Accounting Officer:\nDANIEL J. BAIER Controller February 15,1996 - --------------------------- (Daniel J. Baier)\nSIGNATURE TITLE DATE - --------- ----- ----\nDirectors:\nWILLIAM BALDERSTON III Director February 15, 1996 - --------------------------- (William Balderston III)\nANGELO J. CHIARELLA Director February 15, 1996 - --------------------------- (Angelo J. Chiarella)\nALLAN E. DUGAN Director February 15, 1996 - --------------------------- (Allan E. Dugan)\nJAY T. HOLMES Director February 15, 1996 - --------------------------- (Jay T. Holmes)\nROGER W. KOBER Director February 15, 1996 - --------------------------- (Roger W. Kober)\nTHEODORE L. LEVINSON Director February 15, 1996 - --------------------------- (Theodore L. Levinson)\nCONSTANCE M. MITCHELL Director February 15, 1996 - --------------------------- (Constance M. Mitchell)\nCORNELIUS J. MURPHY Director February 15, 1996 - --------------------------- (Cornelius J. Murphy)\nARTHUR M. RICHARDSON Director February 15, 1996 - --------------------------- (Arthur M. Richardson)\nM. RICHARD ROSE Director February 15, 1996 - --------------------------- (M. Richard Rose)","section_15":""}
{"filename":"1010466_1995.txt","cik":"1010466","year":"1995","section_1":"ITEM 1. BUSINESS.\nThe Registrant issued Commercial Mortgage Pass-Through Certificates, Series 1995-MCF-2 (the \"Securities\") pursuant to a Pooling and Servicing Agreement dated as of December 1, 1995 (the \"Cut-off Date\"), among Prudential Securities Secured Financing Corporation, as Depositor, Midland Loan Services, L.P., as Servicer, Lennar Partners, Inc., as Special Servicer, LaSalle National Bank, as Trustee, and ABN AMRO Bank N.V., as Fiscal Agent of the Trustee (the \"Pooling and Servicing Agreement\"). The assets of the Trust consist primarily of a pool of eighty-four mortgage loans (the \"Mortgage Loans\") having an aggregate principal balance as of the Cut-off Date of approximately $222,286,173. The Mortgage Loans are secured by multi-family and commercial properties (each, a \"Mortgaged Property\"). Security Holders receive Monthly Reports regarding distributions.\nFurther information with respect to the performance of the Trust is summarized in the Monthly Reports to Security Holders, which are filed on Form 8-K.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nInformation regarding the Mortgaged Properties securing the Mortgage Loans is set forth in the Prospectus Supplement and the Monthly Reports to Security Holders, which are filed on Form 8-K. The Trust will acquire title to real estate only upon default of the mortgagors under the Mortgage Loans. Therefore, this item is inapplicable.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThere are no material pending legal proceedings involving the Trust or, with respect to the Trust or the Mortgage Loans, the Trustee, any custodian, the Servicer or the Depositor, other than ordinary routine litigation incidental to the Trustee's, any custodian's, the Servicer's or the Depositor's duties under the Pooling and Servicing Agreement.\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 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 Registrant's Series 1995-MCF-2 Securities represent non-recourse obligations of the Trust, such Trust having assets which consist of the Mortgage Loans. Strictly speaking, Registrant has no \"common equity,\" but for purposes of this Item only, Registrant's Commercial Mortgage Pass-Through Certificates, Series 1995-MCF-2 Securities are treated as \"common equity.\"\n(a) MARKET INFORMATION. There is no established public trading market for Registrant's Securities. Registrant believes the Securities are traded primarily in intra-dealer markets and non-centralized inter-dealer markets.\n(b) HOLDERS. The approximate number of registered holders of all classes of Securities as of December 31, 1995, was less than 25.\nPage 2 of 6\n(c) DIVIDENDS. Not applicable. The information regarding dividends required by sub-paragraph (c) of Item 201 of Regulation S-K is inapplicable because the Trust does not pay dividends. However, information as to distributions to Security Holders is provided in the Monthly Reports to Security Holders for each month of the fiscal year in which a distribution to Security Holders was made.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nNot Applicable. Because of the limited activities of the Trust information with respect to the performance of the Trust is summarized in the Monthly Reports to Security Holders, which are filed on a monthly basis on Form 8-K.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nNot Applicable. The information required by Item 303 of Regulation S-K is inapplicable because the Trust does not have management per se, but rather the Trust has a Trustee who causes the preparation of the Monthly Reports to Security Holders. Information concerning the Mortgage Loans and distributions to the Security Holders is contained in the Monthly Reports to Security Holders which are filed on Form 8-K, and on the Annual Statement of Compliance and the Annual Servicing Report filed under Item 14 of Form 10-K.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nNot Applicable. Information with respect to the Trust is contained in the Monthly Reports to Security Holders filed on a monthly basis on Form 8-K.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT.\nNot Applicable. The Trust does not have officers or directors. Therefore, the information requested by Items 401 and 405 of Regulation S-K is inapplicable.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nNot Applicable. The Trust does not have officers or directors to whom compensation needs to be paid. Therefore, the information requested by Item 402 of regulation S-K is inapplicable.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\n(a) SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS. Not Applicable. Under the Pooling and Servicing Agreement governing the Trust, the holders of the Securities generally do not have the right to vote and are prohibited from taking part in management of the Trust. Therefore, the information requested by Item 403(a) of Regulation S-K is inapplicable.\nPage 3 of 6\n(b) SECURITY OWNERSHIP OF MANAGEMENT. Not Applicable. The Trust does not have any officers or directors. Therefore, the information requested by Item 403(b) of Regulation S-K is inapplicable.\n(c) CHANGES IN CONTROL. Not Applicable. Because Security Holders do not possess, directly or indirectly, the power to direct or cause the direction of the management and policies of the Trust, other than with respect to certain required consents to amendments to the Pooling and Servicing Agreement and the ability of holders of specified amounts of the Securities to act as a group in the event of the occurrence of certain events which if continuing would constitute events of default under the Pooling and Servicing Agreement, the information requested with respect to Item 403(c) of Regulation S-K is inapplicable.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nNot Applicable. The Trust does not have officers or directors and under the Pooling and Servicing Agreement governing the Trust, the holders of the Securities generally do not have the right to vote. Therefore, the information requested by Item 404 of Regulation S-K is inapplicable.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(a) The following is a list of documents filed as part of this report:\nEXHIBITS --------\n4.1 Pooling and Servicing Agreement dated as of December 1, 1995, (hereby incorporated herein by reference as exhibit to Depositor's Current Report on Form 8-K filed with the Securities and Exchange Commission on January 5. 1996).\n(b) Reports on Form 8-K filed during the last quarter of the period covered by this Report:\nNONE\nThe following Report on Form 8-K describes an event which occurred during the last quarter of the period covered by this Report:\nDate Filed Event Reported ---------- --------------\nJanuary 5, 1996 Issuance of Securities on December 22, 1995\n(c) The exhibits required to be filed by Registrant pursuant to Item 601 of Regulation S-K are listed above and in the Exhibit Index that immediately follows the signature page hereof.\n(d) Not Applicable. The Trust does not have any subsidiaries or affiliates. Therefore, no financial statements are filed with respect to subsidiaries or affiliates.\nPage 4 of 6\nSUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT TO SECTION 15(D) BY REGISTRANTS WHICH HAVE NOT REGISTERED SECURITIES PURSUANT TO SECTION 12 OF THE ACT\nNo Annual report, proxy statement, form of proxy or other soliciting material has been sent to Security Holders, and the Registrant does not contemplate sending any such materials subsequent to the filing of this report.\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.\nMIDLAND LOAN SERVICES, L.P., not in its individual capacity but solely as a duly authorized agent of the Registrant pursuant to Section 3.20 of the Pooling and Servicing Agreement dated as of December 1, 1995\nBy: Midland Data Systems, Inc., its General Partner\nBy: \/s\/ Lawrence D. Ashley ------------------------------------------- Name: Lawrence D. Ashley Title: Director of MBS Programs\nDate: March 29, 1996\nPage 5 of 6\nEXHIBIT INDEX\nEXHIBIT DOCUMENT SEQUENTIAL - ------- -------- PAGE NUMBER -----------\n4.1 Pooling and Servicing Agreement dated as of * December 1, 1995 (hereby incorporated herein by reference as exhibit to Depositor's Current Report on Form 8-K filed with the Securities and Exchange Commission on January 5, 1996).\n- ------------------- * Incorporated by reference.\nPage 6 of 6","section_15":""}
{"filename":"6281_1995.txt","cik":"6281","year":"1995","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 general-purpose, standard-function linear and mixed-signal ICs (\"SLICs\"), special-purpose linear and mixed-signal ICs (\"SPLICs\") and digital signal processing ICs (\"DSP ICs\"). The Company also manufactures and markets devices using assembled product technology.\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 communications, computer, industrial, instrumentation, military\/aerospace and high-performance consumer electronics applications. The Company sells its products worldwide; approximately 44% of the Company's fiscal 1995 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 BACKGROUND\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, such as 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 10 to 15 years have led to substantial increases in the performance and functionality of ICs used for signal processing applications. These advances include 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 higher performance and more efficient signal processing.\nCOMPANY OVERVIEW AND STRATEGY\nAnalog believes it is 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. SLICs are sold to a very large customer base for a wide variety of applications, including applications in the medical, engineering and scientific instruments market, factory automation market and military\/aerospace market.\nOver the past five years, Analog has sought to balance its traditionally stable SLIC business with growth opportunities for SPLICs and DSP ICs. Building upon its expertise in linear IC technology, the Company has developed special-purpose linear and mixed-signal ICs tailored to specific high-volume applications in target markets. The Company also has extended its expertise in analog signal processing and data conversion to develop DSP ICs. The Company's SPLICs and DSP ICs address the emerging demand for high levels of performance in many communications, computer and other high-volume applications. These products have a high level of functionality (i.e., many functions on one chip) to satisfy OEMs' requirements for an integrated solution with low cost per function.\nTo build upon its position as a leader in real-world signal processing, Analog is pursuing strategies that include the following:\n- Expand Traditional SLIC Business. The Company has taken a three-pronged approach to grow its SLIC business. First, it is seeking to solidify its leading position in the market for general purpose operational amplifiers and data converters, particularly in instrumentation and factory automation applications. Second, it is expanding its SLIC product portfolio to address other market segments, such as power management ICs for mobile phones and laptop computers and interface ICs for modems and printers. Third, the Company is developing SLICs for new high-volume applications in the communications, computer and consumer markets, including radio frequency (\"RF\") products for both wireless and broadband wired communication applications.\n- Become a Major Supplier of General-Purpose DSP ICs. The Company's general-purpose DSP ICs consist of a family of programmable 16-bit fixed point and 32-bit floating point DSPs. These products offer processing speed, ease of programming and on-chip memory that allow system designers to cost effectively implement complex algorithms for signal processing applications. Analog believes that this product line will enable it to build a leading position in the general-purpose DSP market, principally for communications and computer applications.\n- Pursue Growth Opportunities for System-Level Signal-Processing ICs. The Company is leveraging its expertise in both analog signal processing and data conversion to develop SPLICs and DSP ICs that provide system-level solutions for various growth applications, particularly in the communications and computer markets. The Company's system-level ICs often replace a combination of SLICs and general-purpose DSPs that are used by customers in their initial product designs. The Company offers system-level ICs for wireless communications applications such as digital mobile phones and base stations, and for computer applications such as audio enhancement in multimedia PCs.\n- Leverage Core Technologies to Develop Innovative Products. The Company plans to continue applying its core technologies to develop a continuous flow of new products. In addition, the Company plans to continue to extend its core technologies to include new technologies, such as RF signal processing, which Analog has used primarily for wireless communications applications, and surface micromachining, which Analog has used to develop an accelerometer for automobile airbag systems. The Company intends to use its micromachining technology to address other applications outside the automotive industry.\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 four classifications: SLICs; SPLICs and DSP ICs; hard disk drive 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 four product groups for the past three fiscal years:\nSLICs\nAnalog believes that it is one of the world's largest suppliers of SLIC products. SLICs have been the foundation of the Company's business for more than 20 years. 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 SLIC products offered by the Company include 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. SLICs typically have long product life cycles. 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 commercial and consumer communications equipment, personal computers (PCs) and peripheral equipment used with PCs and computers.\nBy 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 combining a number of functions on a single circuit as opposed to a combination of SLICs and other ICs. These benefits include higher performance, lower cost per function, smaller size, lower weight, fewer parts and decreased power consumption. These products enable customers to achieve easier design-ins and faster time to market. The Company believes that 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.\nThe Company's general-purpose 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 address cost, performance and time-to- market constraints. 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.\nThe Company's DSP ICs include general-purpose DSPs 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 tailored to specific applications is increasing as customers continue to demand as much functionality as possible from a single chip.\nHARD DISK DRIVE ICs\nICs in this product category are used in hard disk drives that serve as rotating mass storage devices in end products such as PCs, workstations and network servers. These ICs process analog signals from a hard disk drive's read\/write head during read operations and position the read\/write head over the desired track on a hard disk drive platter during read and write operations.\nASSEMBLED PRODUCTS\nThe Company's assembled products consist of hybrids, printed-board modules and multi-chip modules (\"MCMs\"). A hybrid consists of several chips and discrete components mounted and wired together on a substrate. A printed-board module consists of surface-mount components assembled on a small printed board that is then encapsulated in a small plastic case. An MCM consists of several chips assembled in an automated fashion in a multilayer package that provides high interconnect density at low cost.\nRevenues from this product group have been declining since 1989, as hybrids have been replaced in many new designs with smaller, lower-cost monolithic ICs that offer higher levels of performance and integration. The Company plans to continue marketing printed-board modules (primarily input\/output modules used in industrial control and factory automation applications). Orders for assembled products overall showed a year-over-year increase in fiscal 1995 following several years of decline as demand for recently designed MCMs offset declining demand for older hybrid products.\nMARKET AND APPLICATIONS\nThe Company's products are sold primarily to OEMs that incorporate them in equipment, instruments and systems sold to end users for a wide variety of applications, including communications equipment; computers and computer peripherals; engineering, medical and scientific instruments; factory automation equipment; military\/aerospace equipment; high-end consumer electronics products; and automotive. The Company's growth has been aided both by the expansion of these markets and the increasing use of computer technology in the equipment and systems sold in these markets.\nFor fiscal 1995, Analog's 20 largest customers accounted for approximately 25% 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:\nCOMMUNICATIONS -- includes data and fax modems, digital cellular telephones and portable, wireless communications equipment and broadband wired applications. 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.\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; and enhanced sound input and output capability for business and entertainment applications.\nINSTRUMENTATION -- includes manufacturers of engineering, medical and scientific instruments. These products are usually designed using the highest performance SLICs available, where production volumes generally do not warrant custom or application-specific ICs.\nFACTORY 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, except in ATE applications where the high level of electronic circuitry required per tester has created opportunities for SPLICs.\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 appropriate military standards. In addition, many products can be supplied to meet the standards required for broadcast satellites and other commercial space 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.\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.\nAUTOMOTIVE -- Although the automotive market has historically been served with low-cost, low-performance ICs, demand has emerged 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. This product serves as an alternative to an electromechanical sensor. The Company began shipments of this device to Delco in 1994 for use in several 1995 model-year General Motors \"W body\" cars. It is also being used in, or has been selected for, several other manufacturers' airbag systems.\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 $134.3 million during fiscal 1995 for the design, development and improvement of new and existing products and processes, compared to $106.9 million during fiscal 1994 and $94.1 million during fiscal 1993.\nIn fiscal 1995, 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. In support of its research and development activities, the Company employs several hundred engineers involved in product and process development at several design centers and manufacturing sites located throughout the world.\nAs of October 28, 1995, the Company owned 311 U.S. patents and had 210 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 1995 revenue was derived from customers in North America. As of December 1, 1995, the Company had 15 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 28% of the Company's fiscal 1995 revenue was derived from sales to customers in Europe; 17% to customers in Japan; and 11% to customers in other international markets. As of December 1, 1995, the Company had direct sales offices in Australia, Austria, Denmark, France, Germany, Hong Kong, India, Israel, Italy, Japan, Korea, The Netherlands, Singapore, Sweden, Taiwan and the United Kingdom. The Company also had sales representatives and\/or distributors in approximately 27 countries outside North America, including countries where the Company also has direct sales offices.\nApproximately 42% of Analog's fiscal 1995 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 certain 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 rely primarily on its own facilities for production of wafers fabricated with linear and mixed-signal processes. The Company operates wafer fabrication facilities in Wilmington, Massachusetts; Santa Clara, California; and Limerick, Ireland for production of linear and mixed-signal devices. The Company also operates assembly and test facilities located in the United States, Ireland, the Philippines and Taiwan. The Company uses two principal foundries, Taiwan Semiconductor Manufacturing Company and Chartered Semiconductor Corporation for the production of digital and VLSI mixed-signal devices.\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.\nAs a result of strong demand for its products, the Company was manufacturing capacity constrained throughout most of fiscal 1995. While the Company is planning in fiscal 1996 to increase substantially its manufacturing capacity through both expansion of its production facilities and increased access to third-party wafer foundries, there can be no assurance that the Company will complete the expansion of its production facilities or secure increased access to third-party foundries in a timely manner, that the Company will not encounter unanticipated production problems at either its own facilities or at third-party foundries or that the increased capacity will be sufficient to satisfy demand for its products.\nBACKLOG\nBacklog at the end of fiscal year 1995 was approximately $286.8 million; it was approximately $152.8 million at the end of the fiscal year 1994. The 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, the Company may allow such orders to be canceled or deliveries delayed by the customer without significant penalty. In addition, the Company's backlog includes its orders from domestic distributors as to which revenues are not recognized until the products are sold by the distributors. Accordingly, the Company believes that its backlog at any time should not be used as a measure of future revenues.\nGOVERNMENT CONTRACTS\nThe Company estimates that approximately 13% 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 28, 1995, the Company employed approximately 6,000 persons. The Company's future success depends in large part on the continued service of its key technical and senior management personnel, and on its ability to continue to attract, retain and motivate qualified employees, particularly those highly skilled design, process and test engineers involved in the manufacture of existing products and the development of new products and processes. The competition for such personnel is intense, and the loss of key employees could have a material adverse effect on the Company. The Company believes that relations with its employees are good.\nINTERNATIONAL OPERATIONS\nAnalog has direct sales offices in 16 countries outside the United States. For fiscal 1995, Analog's international sales accounted for approximately 56% of total sales, the majority of which were made through its direct international sales offices while the balance, approximately 40% of the total, were made through distributors. In addition, the Company has manufacturing facilities in Ireland, 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.\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:\n(1) See Note 6 - \"Commitments and Contingencies\" in the Notes to Consolidated Financial Statements for information regarding contingent liabilities related to the lease of the Norwood, Massachusetts property. (2) The Westwood, Massachusetts facility is subject to a 25-year capital lease with an option to purchase.\nITEM 2. PROPERTIES -- (CONTINUED)\nIn addition to the principal leased properties listed in the previous table, the Company also leases sales offices and other premises at 25 locations in the United States and 25 locations overseas under operating lease agreements. These leases expire at various dates through the year 2010. 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. See Note 5 - \"Lease Commitments\" in the Notes to Consolidated Financial Statements for information concerning the Company's obligations under all operating and capital leases.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nTEXAS INSTRUMENTS LITIGATION\nThe Company was a defendant in two lawsuits brought in Texas by Texas Instruments, Inc. (\"TI\"), alleging patent infringement, including patent infringement arising from certain plastic encapsulation processes, and seeking an injunction and unspecified damages against the Company. The alleged infringement of one of these patents is also the subject matter of a proceeding brought by TI against the Company before the International Trade Commission (\"ITC\"). On 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), which prohibited the Company's importation of certain plastic encapsulated circuits, and seeking substantial penalties against the Company for these alleged violations. If it is determined that the Company has violated the cease and desist order, the ITC could seek to impose penalties of up to $100,000 per day of violation from the date of the cease and desist order (February 1992) or a sum equal to twice the value of the goods determined to be sold in violation of the order. In addition, in June 1992, the Company commenced a lawsuit against TI in Massachusetts alleging certain TI digital signal processors infringed one of the Company's patents.\nEffective April 1, 1995, the Company and TI settled both Texas lawsuits and the Massachusetts lawsuit principally by means of a royalty-free cross license of certain of the Company's and TI's patents. On April 25, 1995, the Company filed with the ITC a motion to terminate the ITC enforcement proceeding on the grounds that further action by the ITC is unnecessary in light of the Company's settlement with TI. On May 8 1995, an Administrative Law Judge issued a recommended determination to the ITC to grant the Company's motion to terminate the ITC proceeding. The investigative office of the ITC has opposed the motion, claiming that, notwithstanding the Company's settlement with TI, the Company's alleged violation of the ITC's cease and desist order warrants the imposition of substantial penalties. The Company's motion is pending before the ITC.\nMAXIM LITIGATION\nThe Company is a defendant in a lawsuit brought by Maxim Integrated Products, Inc. (\"Maxim\") in the United States District Court for the Northern District of California 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 improper restrictions 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 claimed 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. On September 7, 1994, Maxim's claim was dismissed for lack of evidence. Maxim has appealed this ruling and oral argument of the appeal was held in January 1996.\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\nIn 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 matters, patents, personal injury, environmental matters and product liability. Such litigation includes patent infringement actions brought against the Company by Sextant Avionique, S.A. (\"Sextant\") in Paris, France, which claims that the Company's accelerometer infringes certain Sextant patents and seeks to enjoin such infringement. While there can be no assurance that the Company will prevail in all of these matters, the Company does not believe that these matters will have a material adverse effect on the Company's consolidated financial position or consolidated results of operations. However, an adverse resolution could have an adverse effect on the Company's consolidated results of operations in the quarter in which these matters are resolved.\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 28, 1995.\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.\nThere is no family relationship among the named officers.\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 28, 1995, 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 3, 1996 to stockholders of record December 12, 1995. 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 January 30, 1993 to an amount not exceeding $29,734,000 plus 50% of the consolidated net income of the Company for the period from January 31, 1993 through the end of the Company's then most recent fiscal quarter. At October 28, 1995 this amount was equal to $144,782,000. 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 29, 1995 was 4,429. 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\n(1) All references to per share amounts have been restated to reflect the three-for-two stock split effected in the form of a 50% stock dividend distributed on January 3, 1996 to stockholders of record December 12, 1995.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\nFISCAL 1995 COMPARED TO FISCAL 1994\nThe Company reported net sales of $941.5 million in fiscal 1995, up $168 million or 22% from net sales of $773.5 million in fiscal 1994. Fiscal year 1995 sales growth was attributable to significant increases in sales volumes of both the Company's standard linear IC and system-level IC products as worldwide demand for precision integrated circuit products accelerated throughout fiscal 1995, exceeding the Company's expectations and capacity. Demand for the Company's ICs was strong both in its core industrial and instrumentation markets and in high-growth applications in the communications, computer and portable, wireless equipment markets. Total IC sales, representing both standard linear and system-level ICs, constituted approximately 92% of total sales in fiscal 1995, continuing the long-term trend of IC sales becoming a larger portion of the Company's revenues.\nSales of the Company's standard linear IC products, which make up the largest and most profitable part of the Company's business, increased approximately $137 million or nearly 30% in fiscal 1995. Standard linear IC sales also increased as a percentage of total sales, accounting for 64% of total sales in fiscal 1995 compared to 60% in fiscal 1994. The growth in sales of standard linear ICs was primarily driven by increased penetration of the Company's data converter and amplifier products in high-performance instrumentation and factory automation applications and greater use of standard linear IC products in new high-volume applications in the communications, computer and consumer markets including digital cellular handsets and base stations, video applications and imaging applications. As in fiscal 1994, the distributor channel continued to have a positive effect on the Company's standard linear IC product line in fiscal 1995; distribution has become the fastest growing channel for these products.\nSales of system-level ICs, excluding those used in hard disk drives, increased approximately $70 million or 46% in fiscal 1995, as the Company achieved substantial bookings and revenue gains in its general-purpose digital signal processing products and mixed-signal ICs for application-specific system-on-a-chip solutions. The strongest end user market growth for the Company's system-level IC products was experienced in wireless communications applications, including digital mobile phones and base stations, and computer applications, including audio enhancement in multimedia PCs. As a percentage of total sales, system-level IC products, with the exception of hard disk drive products, increased to 24% of total sales compared to 20% in fiscal 1994. Sales of hard disk drive products in fiscal 1995 declined $37 million or 53% compared to fiscal 1994 due to a combination of scarcity of wafers and the rapid movement of this market to digital PRML channels.\nSales of the Company's assembled products decreased approximately $2.5 million or 3% from fiscal 1994 to fiscal 1995 and as a percentage of total sales decreased from 11% to 8% over this same period. This sales decrease was comparatively less than in prior years as sales demand for newer multi-chip modules for the communications market began to offset the decline in older military hybrids.\nIn fiscal 1995, sales to North American customers increased $68.3 million or 20% over fiscal 1994 to $412.2 million. Sales to customers outside North America, primarily Europe, Japan and Southeast Asia, increased $99.7 million or 23% to $529.3 million. The distributor channel was a major contributor to sales growth in North America as well as in Europe and Japan especially for standard linear IC products. North American sales through distribution increased approximately 40% over the prior year while worldwide sales through distribution increased approximately 55% from fiscal 1994 to fiscal 1995. On a worldwide basis, sales through distribution accounted for approximately 42% of total sales in fiscal 1995 compared to 33% in fiscal 1994. Sales to European customers increased $66.4 million or 34% to $264 million, with much of this growth resulting from the Company's increased penetration of applications in the communications market, particularly in handsets and basestations used in the GSM (Global System for Mobile Communications) digital cellular telephone system now widely deployed in Western Europe. Sales in Japan increased $32.1 million or 24% to $165.1 million largely as a result of increased sales of standard linear IC products for factory automation and other industrial market applications. A weaker average U.S. dollar exchange rate also contributed to some of the improvement in European and Japanese sales. Sales to customers in Southeast Asia of $100 million were essentially flat compared to fiscal 1994 due to the significant decline in hard disk drive sales. As a percentage of total\nsales, North American and international sales accounted for 44% and 56%, respectively, unchanged from the comparable percentages in fiscal 1994.\nAs a result of strong demand for its products, the Company was manufacturing capacity constrained throughout most of fiscal 1995. The Company is pursuing a multi-faceted manufacturing capacity expansion program to substantially increase the number of fabricated wafers available to it in fiscal 1996 and beyond. See \"Liquidity and Capital Resources\" below for a discussion of the Company's efforts to address its capacity issues.\nGross margin increased to 50.7% of sales in fiscal 1995 compared to 49.0% of sales in fiscal 1994. The increase in gross margin was principally due to a higher proportion of standard linear IC products in the mix of products sold, which generally have higher gross margins than the Company's system-level IC products. The improvement in gross margin in fiscal 1995 was also attributable to greater capacity utilization, resulting in the absorption of fixed manufacturing costs over increased production volumes.\nResearch and development expenses increased approximately 26% in fiscal 1995 to $134.3 million or 14.3% of sales. This increase was mainly due to higher spending in the development of new products and technologies targeted for the communications, computer and automotive markets, including initiatives in general-purpose digital signal processing such as the Company's SHARC product family, system-level ICs for computer audio and wireless communications applications, RF signal processing, surface micromachining technology, accelerometer products and continued development of innovative SLIC products and processes. The increase in R&D expenditures in fiscal 1995 was also attributable to increased staffing of design engineering personnel and the start up of two new design centers. The Company believes that technical leadership in the semiconductor industry is critical to its future success and is committed to maintaining a high level of research and development effort.\nSelling, marketing, general and administrative (SMG&A) expense growth in fiscal 1995 was held to 8.6%, as SMG&A increased from $170.3 million in fiscal 1994 to $184.9 million in fiscal 1995. SMG&A expenses continued to decline as a percentage of sales to 19.6% in fiscal 1995 compared to 22.0% in fiscal 1994 and 23.8% in fiscal 1993, consistent with the Company's goal of constraining SMG&A spending growth to a rate significantly below sales growth. The increase in SMG&A expenses in absolute dollars was primarily related to higher incentive expenses associated with improved revenue and profitability levels, and greater product advertising and related promotional costs in support of the Company's product lines and customer base.\nOperating income grew 55% to 16.8% of sales compared to 13.2% of sales in fiscal 1994. This performance gain reflected the combination of accelerated demand for the Company's products, improved gross margin and continuing commitment to growing expenses more slowly than sales.\nNonoperating expenses decreased $6.6 million in fiscal 1995 due primarily to a $2.9 million decrease in interest expense and a $2.9 million increase in interest income. The reduction in interest expense from fiscal 1994 to fiscal 1995 was due in large part to the maturity of a $20 million term loan early in the first quarter of fiscal 1995 while the increase in interest income over this same period was attributable to a higher average level of cash investments and a higher weighted average investment rate in fiscal 1995 versus fiscal 1994. Interest expense in fiscal 1996 will increase from fiscal 1995 as a result of the issuance of $230,000,000 of 3- 1\/2% Convertible Subordinated Notes in December 1995.\nThe effective income tax rate increased to 25.2% in fiscal 1995 from 23.1% in fiscal 1994 due to earnings growth in higher tax rate jurisdictions including the U.S. The Company maintains a valuation allowance for deferred tax assets, which was $10.0 million at both October 28, 1995 and October 29, 1994, based on management's assessment that realization of such deferred tax assets was not assured for book and tax capital losses and book basis foreign tax credits.\nThe growth in sales, improved operating performance and lower nonoperating expenses yielded a 60% rise in net income to $119.3 million or 12.7% of sales compared to $74.5 million or 9.6% of sales. Earnings per share in fiscal 1995 grew 56% to $1.00 from $0.64 in fiscal 1994.\nThe Company has not yet adopted Statement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of\" and Statement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation\" which will require adoption in fiscal 1997. The Company is in the process of determining the effect of adoption of these statements on its consolidated financial statements and related disclosures.\nThe impact of inflation on the Company's business during the past three years has not been significant.\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 89% of total sales for fiscal 1994.\nStandard linear IC sales rose approximately $66.5 million or approximately 17% to $467.5 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.\nSales of system-level IC products grew approximately $49.0 million or approximately 28% to $224.0 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 9% from fiscal 1993 to fiscal 1994 and as a percentage of total sales decreased from 14% to 11% over the same period.\nSales to North American customers increased 18% over fiscal 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 were 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.\nR&D 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% in fiscal 1994 compared to 14.1% in fiscal 1993.\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% in fiscal 1993, consistent with the Company's emphasis on maintaining tight control over all costs in order to gain better operating leverage on increases in revenues.\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 percentage of sales and 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.\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. A deferred tax asset valuation allowance of $14.3 million was established at October 31, 1993 based on management's assessment that realization of such deferred tax assets was not assured for book and tax capital losses, book basis foreign tax credits, and general business tax credits. The net change in the valuation allowance for the year ended October 29, 1994 was a decrease of $4.3 million primarily from the utilization of general business tax credits.\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 in fiscal 1994 compared to $44.5 million or 6.7% of sales in fiscal 1993.\nLIQUIDITY AND CAPITAL RESOURCES\nAt October 28, 1995, the Company had $151.1 million of cash and cash equivalents and short-term investments compared to $181.8 million at October 29, 1994. The Company's operating activities generated net cash of $210.3 million, or 22.3% of sales, and $186.6 million, or 24.1% of sales, in fiscal 1995 and fiscal 1994, respectively. Investing activities used $238.7 million in fiscal 1995 and $166.8 million in fiscal 1994 while financing activities used $10.9 million in fiscal 1995 and generated $10.0 million in fiscal 1994. Working capital decreased to $271.6 million at the end of fiscal 1995 from $299.3 million at the end of fiscal 1994. This decrease was primarily due to lower cash, cash equivalents and short-term investments which were used in part to fund investing activities in fiscal 1995, and secondarily to increased accounts payable and accrued liabilities associated with an expanded scale of operations.\nThe Company's primary source of funds in fiscal years 1995 and 1994 was net cash generated by operations. The $23.7 million increase in operating cash flows from $186.6 million in fiscal 1994 to $210.3 million fiscal 1995 was largely attributable to higher net income and an increase in accounts payable and accrued liabilities, changes which were offset in large part by growth in inventories and accounts receivable. The noncash effect of depreciation and amortization expense was $64.1 million and $61.3 million in fiscal 1995 and fiscal 1994, respectively. As a result of internal capacity expansion, depreciation expense is expected to be higher in fiscal 1996 as these additions begin to ramp up.\nAccounts receivable of $181.3 million at the end of fiscal 1995 increased $19.0 million or 11.7% from $162.3 million at the end of fiscal 1994. This increase compared favorably to the 27% increase in fourth quarter sales between the two years as the rise in sales was more than offset by improved collection of receivables. As a percentage of annualized fourth quarter sales, accounts receivable was reduced to 17.6% at the end of fiscal 1995 compared to 20.0% at the end of fiscal 1994.\nInventories rose $13.2 million or 10.1% over the prior year to $144.0 million at the end of fiscal 1995. This increase was primarily due to a build in inventory levels needed to service increasing sales volumes. Year-end inventories as a percentage of annualized fourth quarter sales decreased from 16.1% in fiscal 1994 to 14.0% in fiscal 1995. In fiscal 1996, as additional manufacturing capacity becomes available, the Company intends to increase inventory levels in order to improve customer response times.\nAccounts payable and accrued liabilities increased $39.6 million or 29.4% compared to the balance at the end of fiscal 1994 due principally to increased expense activity related to the higher revenue level and increased capital expenditures in the fourth quarter of fiscal 1995 when compared to the year-earlier period. The increase in income taxes payable of 70.2% or $20.7 million was primarily attributable to increased profitability in fiscal 1995 as compared to fiscal 1994.\nThe Company's principal investment activities during fiscal 1995 were in support of its manufacturing capacity expansion programs and included capital expenditures of $212.7 million and an investment of $14.0 million in a wafer fabrication company in Singapore.\nCapital expenditures in fiscal 1995 were significantly higher than in fiscal 1994 with a significant portion of these expenditures related to the construction of the Company's first six-inch wafer fabrication module which was completed in fiscal 1995 at the Company's Limerick, Ireland manufacturing site. This module is now undergoing test and qualification and is expected to begin supplying production wafers before the end of the first half of fiscal 1996. It will be used initially to fabricate mixed-signal VLSI products on a 0.6 micron digital CMOS process. The capital expenditures and start-up costs associated with this expansion will be supported in part by grants of up to 10.1 million Irish Pounds (approximately $16.4 million at October 28, 1995) from the Industrial Development Authority (\"IDA\") of Ireland. As of October 28, 1995, the Company had not received any grant monies under this agreement.\nDuring fiscal 1995, the Company also began upgrading its existing Wilmington, Massachusetts wafer fabrication facility from four- inch to six-inch wafer production. This additional capacity, which will also become available in the latter half of fiscal 1996, will be used primarily for high-speed linear products. In addition, the Company purchased an existing six-inch wafer fabrication module located close to its Santa Clara, California site. This facility is being upgraded and modernized to produce advanced linear technology ICs, and is expected to go into production in the latter half of fiscal 1996. In the fourth quarter of fiscal 1995, the Company also completed construction of a new engineering, marketing and administrative facility in Wilmington, Massachusetts and commenced an expansion of the Company's test and back end facilities in the Philippines.\nIn fiscal 1995, the Company entered into a supply agreement with its primary wafer foundry, Taiwan Semiconductor Manufacturing Co., Ltd. (\"TSMC\"). Under this agreement, the Company will make a series of advance payments to TSMC aggregating $22.4 million, payable over a three-year period, in order to secure access to a minimum level of wafer capacity over the period from 1996 to 1999. The first of such payments pursuant to this agreement was made in June 1995 and remaining payments are due in June of each year through 1998. The advance payments will be repaid to the Company each year in the form of credits against the prices of wafers purchased by the Company when such wafer purchases exceed a defined minimum.\nIn fiscal 1995, the Company made an equity investment of $14.0 million in Chartered Semiconductor Manufacturing Pte., Ltd. (\"CSM\") in Singapore and invested an additional $6.0 million in January 1996, in exchange for a less than 5% ownership interest. This investment is structured to provide access to CSM's new eight-inch 0.5 micron wafer fabrication facility through wafer supply and pricing commitments beginning in 1996. The investment in CSM is classified in the balance sheet line item, \"Deferred Charges and Other Assets.\"\nIn January 1996, the Company entered into an additional agreement with CSM, whereby the Company will provide a total deposit of approximately $20.0 million to be paid in several installments in 1996 and 1997. Under the terms of this agreement, the deposit will guarantee access to certain quantities of sub-micron wafers through fiscal 2000. If the Company does not purchase the minimum quantities under the agreement, the deposit will be forfeited for the value of the wafer shortfall up to the total amount of $20.0 million. At the end of the agreement term, the Company's deposit will be returned, net of any forfeitures.\nThe Company currently plans to make capital expenditures of approximately $275 million in fiscal 1996, primarily in connection with the continued expansion of its manufacturing capacity. In addition, the Company is continuing to explore various options for increasing its manufacturing capacity, including joint ventures, acquisitions, equity investments in or loans to wafer suppliers and construction of additional facilities.\nCash used in the Company's financing activities was principally for the repayment of a $20.0 million term loan in the first quarter of fiscal 1995. Financing activities in fiscal 1995 also generated cash of $10.1 million from the issuance of common stock under stock purchase and stock option plans.\nAt October 28, 1995, the Company's principal sources of liquidity included $69.3 million of cash and cash equivalents and $81.8 million of short-term investments. Short-term investments at the end of fiscal 1995 consisted of commercial paper, bankers' acceptances and Euro time deposits with maturities greater than three months and less than six months at the time of acquisition. The Company also has various lines of credit both in the U.S. and overseas, including a $60 million credit facility in the U.S. which expires in 1998, all of which were substantially unused at the end of fiscal 1995. At the end of fiscal 1995, the Company's debt-to-equity ratio was 13%.\nOn December 18, 1995, the Company completed a public offering of $230,000,000 of five-year 3-1\/2% Convertible Subordinated Notes due December 1, 2000 with semiannual interest payments on June 1 and December 1 of each year, commencing June 1, 1996. The Notes are convertible, at the option of the holder, into the Company's common stock at any time after 60 days following the date of original issuance, unless previously redeemed, at a conversion price of $27.913 per share, subject to adjustment in certain events. The net proceeds from the sale of the Notes were approximately $224,000,000 after payment of the underwriting discount and expenses of the offering which will be amortized over the term of the Notes. As of December 31, 1995, the Company's total long-term debt was $310,000,000, comprised of the $230,000,000 of 3-1\/2% Convertible Subordinated Notes and $80,000,000 of 6 5\/8% Notes.\nThe Company believes that its existing sources of liquidity and cash expected to be generated from future operations, together with current and anticipated available long-term financing, will be sufficient to fund operations, capital expenditures and research and development efforts for the foreseeable future.\nLITIGATION\nAs set forth in Item 3 - \"Business-Legal Proceedings,\" the Company is engaged in an enforcement proceeding brought by the International Trade Commission (\"ITC\") related to previously settled patent infringement litigation with Texas Instruments, Inc. The Company is also engaged in antitrust litigation with Maxim Integrated Products, Inc.\nIf it is determined that the Company has violated the ITC's cease and desist order of February 1992 (as modified in July 1993), the ITC could seek to impose penalties of up to $100,000 per day of violation from the date of the cease and desist order (February 1992) or a sum equal to twice the value of goods determined to be sold in violation of the order.\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. Maxim asserted actual and consequential damages in the amount of $14.1 million and claimed 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. 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 operating results are difficult to predict and may be affected by a number of factors including the timing of new product announcements or introductions by the Company and its competitors, competitive pricing pressures, fluctuations in manufacturing yields, adequate availability of wafers and manufacturing capacity, changes in product mix and economic conditions in the United States and international markets. In addition, the semiconductor market has historically been cyclical and subject to significant economic downturns at various times. While the semiconductor industry in recent periods has experienced increased demand and production capacity constraints, it is uncertain how long these conditions will continue. As a result of these and other factors, there can be no assurance that the Company will not experience material fluctuations in future operating results on a quarterly or annual basis.\nThe Company's success depends in part on its continued ability to develop and market new products. There can be no assurance that the Company will be able to develop and introduce new products in a timely manner or that such products, if developed, will achieve market acceptance. In addition, the Company's growth is dependent on its continued ability to penetrate new markets such as the communications, computer and automotive segments of the electronics market, where the Company has limited experience and competition is intense. There can be no assurance that the markets being served by the Company will continue to grow; that the Company's existing and new products will meet the requirements of such markets; that the Company's products will achieve customer acceptance in such markets; that competitors will not force prices to an unacceptably low level or take market share from the Company; or 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.\nThe semiconductor industry is intensely competitive. Certain of the Company's competitors have greater technical, marketing, manufacturing and financial resources than the Company. The Company's competitors also include emerging companies attempting to sell products to specialized markets such as those served by the Company. Competitors of the Company have, in some cases, developed and marketed products having similar design and functionality as the Company's products. There can be no assurance that the Company will be able to compete successfully in the future against existing or new competitors or that the Company's operating results will not be adversely affected by increased price competition.\nThe Company's manufacturing facilities are operating at full capacity, and therefore the Company's business is currently constrained. While the Company is planning in fiscal 1996 to increase substantially its manufacturing capacity through both expansion of its production facilities and increased access to third-party foundries; there can be no assurance that the Company will complete the expansion of its production facilities or secure increased access to third party foundries in a timely manner; that the Company will not encounter unanticipated production problems at either its own facilities or at third-party foundries; or that the increased capacity will be sufficient to satisfy demand for its products. The Company relies, and plans to continue to rely, on third-party wafer fabricators to supply most of its wafers that can be manufactured using industry-standard digital processes, and such reliance involves several risks, including the absence of adequate guaranteed capacity and reduced control over delivery schedules, manufacturing yields and costs. Continued manufacturing capacity constraints could adversely affect the business of the Company's customers and cause them to seek alternative sources for the products currently obtained from the Company. In addition, the Company's capacity additions will result in a significant increase in operating expenses, and if revenue levels do not increase to offset these additional expense levels, the Company's future operating results could be adversely affected. The Company also believes that other semiconductor manufacturers are also expanding or planning to expand their production capacity over the next several years, and there can be no assurance that the expansion by the Company and its competitors will not lead to overcapacity in the Company's target markets, which could lead to price erosion that would adversely affect the Company's operating results.\nFor fiscal 1995, 56% of the Company's revenues were derived from customers in international markets. The Company has manufacturing facilities in Ireland, the Philippines and Taiwan. The Company is therefore subject to the economic and political risks inherent in international operations, including expropriation, air transportation disruptions, currency controls and changes in currency exchange rates, tax and tariff rates and freight rates. Although the Company engages in certain hedging transactions to reduce its exposure to currency exchange rate fluctuations, there can be no assurance that the Company's competitive position will not be adversely affected by changes in the exchange rate of the U.S. dollar against other currencies.\nThe semiconductor industry is characterized by frequent claims and litigation involving patent and other intellectual property rights. The Company has from time to time received, and may in the future receive, claims from third parties asserting that the Company's products or processes infringe their patents or other intellectual property rights. In the event a third party makes a valid intellectual property claim and a license is not available on commercially reasonable terms, the Company's operating results could be materially and adversely affected. Litigation may be necessary to enforce patents or other intellectual property rights of the Company or to defend the Company against claims of infringement, and such litigation can be costly and divert the attention of key personnel. See Item 3 - \"Legal Proceedings\" for information concerning pending litigation involving the Company. An adverse resolution of such litigation, may, in certain cases, 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 litigation is resolved.\nBecause 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 trading price of the Company's common stock may be subject to wide fluctuations in response to quarter-to-quarter variations in operating results, general conditions in the semiconductor industry, changes in earnings estimates and recommendations by analysts or other events.\nANALOG DEVICES, INC.\nANNUAL REPORT ON FORM 10-K\nYEAR ENDED OCTOBER 28, 1995\nITEM 8","section_7A":"","section_8":"ITEM 8\nFINANCIAL STATEMENTS AND SUPPLEMENTARY FINANCIAL INFORMATION\nANALOG DEVICES, INC.\nINDEX 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 28, 1995, October 29, 1994 and October 30, 1993, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended October 28, 1995. 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 based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as 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 28, 1995, October 29, 1994 and October 30, 1993, and the consolidated results of its operations and its cash flows for each of the three years in the period ended October 28, 1995, 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 November 28, 1995 except for the fifth paragraph of Note 4, as to which the date is December 18, 1995\nANALOG DEVICES, INC.\nCONSOLIDATED STATEMENTS OF INCOME\nSee accompanying notes.\nANALOG DEVICES, INC.\nCONSOLIDATED BALANCE SHEETS\nSee accompanying notes.\nANALOG DEVICES, INC.\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY\nSee accompanying notes.\nANALOG DEVICES, INC.\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nSee accompanying notes.\nANALOG DEVICES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED OCTOBER 28, 1995, OCTOBER 29, 1994 AND OCTOBER 30, 1993 (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. Upon consolidation, all significant intercompany accounts and transactions are eliminated. The Company's fiscal year ends on the Saturday closest to the last day in October. Fiscal years 1995, 1994 and 1993 were each 52-week years.\nCertain amounts reported in previous years have been reclassified to conform to the 1995 presentation.\nb. CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS\nCash and cash equivalents are highly liquid investments with insignificant interest rate risk and maturities of three months or less at the time of acquisition. Investments with maturities between three and twelve months at time of acquisition are considered short- term investments. Short-term investments consist of debt securities such as commercial paper, time deposits, certificates of deposit and bankers acceptances.\nEffective October 30, 1994, 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. FAS 115 requires investments in debt and equity securities to be classified as \"held-to-maturity,\" \"available-for-sale,\" or \"trading\" at the time of purchase and for such designation to be reevaluated as of each balance sheet date. Held-to-maturity securities, which are carried at amortized cost, include only those securities the Company has the positive intent and ability to hold to maturity. Available-for-sale securities are carried at fair value with unrealized gains and losses, net of related tax, if any, reported as a separate component of stockholders' equity. Realized gains and losses, declines in value judged to be other than temporary, and interest income on all securities are included in earnings. At October 28, 1995, the Company did not own any securities classified as trading.\nWhile it is the intent of management to hold securities to maturity, unforeseen events, while not generally expected, could cause the Company to liquidate certain securities prior to maturity. Accordingly, those securities which could readily be sold back to the seller are classified as available-for-sale. Securities, such as bank time deposits, which by their nature are typically held-to- maturity are classified as such. The following is a summary of available-for-sale and held-to-maturity securities at October 28, 1995:\nANALOG DEVICES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nSecurities classified as available-for-sale and held-to-maturity at October 28, 1995 have contractual maturities of six months or less at time of acquisition. Because of the short term to maturity, and hence relative price insensitivity to changes in market interest rates, amortized cost approximates fair value for all of these securities. As such, no unrealized gains or losses were recorded at year end. There were no proceeds, gross realized gains or gross realized losses from sales of any securities during the year.\nc. INVENTORIES\nInventories are valued at the lower of cost (first-in, first-out method) or market. Inventories at October 28, 1995, October 29, 1994 and October 30, 1993 were as follows:\nA director of a raw material supplier was also a director of the Company through January 1995. Total purchases from this supplier approximated $11,038,000 through January 1995, $28,435,000 in 1994 and $37,990,000 in 1993. Accounts payable to this supplier at October 29, 1994 and October 30, 1993 approximated $1,090,000 and $3,639,000, 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. 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:\nTotal depreciation and amortization of property, plant and equipment was $62,066,000, $59,240,000 and $57,732,000 in 1995, 1994 and 1993, respectively.\ne. INTANGIBLE ASSETS\nIntangible assets at October 28, 1995 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 seven to fifteen years. Amortization expense for all intangible assets was $2,032,000, $2,044,000 and $2,081,000 in 1995, 1994 and 1993, respectively. Accumulated amortization for all intangible assets was $10,668,000, $8,636,000 and $6,657,000 at October 28, 1995, October 29, 1994 and October 30, 1993, respectively. On a periodic basis, the Company estimates the future undiscounted cash flows of the businesses to which the intangible assets relate in order to ensure that the carrying value of such intangible assets has not been impaired.\nANALOG DEVICES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nf. GRANT ACCOUNTING\nThe Company's manufacturing facility in Limerick, Ireland has received various grants from the Industrial Development Authority of the Republic of Ireland. These grants include capital, employment, and research and development grants. Capital grants for the acquisition of property and equipment are netted against the related capital expenditures and amortized as a credit to depreciation expense over the useful life of the related asset. Employment grants, which relate to employee hiring and training, and research and development grants are recognized in earnings in the period in which the related expenditures are incurred by the Company.\ng. 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. Net foreign currency transaction gains or losses included in other expenses, net, were not material in fiscal 1995, 1994 and 1993.\nh. 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, primarily Japanese yen and European currencies. These foreign exchange contract, option and swap transactions are entered into to support product sales, purchases and financing transactions made in the normal course of business, and accordingly, are not speculative in nature.\nForward foreign exchange contracts are utilized to manage the risk associated with currency fluctuations on certain firm sales and purchase commitments denominated in foreign currencies and certain non-U.S. dollar denominated asset and liability positions. The Company's forward foreign exchange contracts are primarily denominated in Japanese yen and certain European currencies and are for periods consistent with the terms of the underlying transactions, generally one year or less. The forward foreign exchange contracts that relate to firm, foreign currency sales and purchase commitments are designated and effective as hedges of firm, identifiable foreign currency commitments, and accordingly, the gains and losses resulting from the impact of currency exchange rate movements on these contracts are not recognized in operations until the underlying hedged transactions are recognized. Upon recognition, such gains and losses are recorded in operations as an adjustment to the carrying amount of the underlying transactions in the period in which these transactions are recognized. Unrealized gains and losses resulting from the impact of currency exchange rate movements on forward foreign exchange contracts designated to offset certain non-U.S. dollar denominated assets and liabilities are recognized as other income or expense in the period in which the exchange rates change and offset the foreign currency gains and losses on the underlying exposures being hedged. The contract amounts of forward foreign exchange contracts outstanding were $181.7 million, $136.4 million and $107.9 million at October 28, 1995, October 29, 1994 and October 30, 1993, respectively.\nANALOG DEVICES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nThe Company also may periodically enter into foreign currency options contracts to offset certain probable anticipated, but not firmly committed, foreign currency transactions related to the sale of product during the ensuing nine months. When the dollar strengthens significantly against the foreign currencies, the decline in value of future currency cash flows is partially offset by the gains in value of the purchased currency options designated as hedges. Conversely, when the dollar weakens, the increase in value of future foreign currency cash flows is reduced only by the premium paid to acquire the options. The Company's foreign currency option contracts are primarily denominated in Japanese yen and generally have maturities which do not exceed six months. These foreign currency option contracts are designated and effective as hedges of anticipated foreign currency sales transactions, and accordingly, the premium cost and any realized gains associated with these contracts are deferred and included in the consolidated balance sheet as prepaid expenses and accrued liabilities, respectively, until such time as the underlying sales transactions are recognized. Upon recognition, such premium costs and any realized gains are recorded in sales as a component of the underlying sales transactions being hedged. The contract amounts of foreign currency option contracts outstanding were $26.9 million, $28.6 million and $29.0 million at October 28, 1995, October 29, 1994 and October 30, 1993, respectively. Deferred gains or losses attributable to foreign currency option contracts were not material at October 28, 1995.\nThe Company uses currency swap agreements to hedge the value of its net investment in certain of its 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, with the related amounts due to or from counterparties included in accrued liabilities or other current assets. The contract amount of currency swap agreements outstanding, which were principally denominated in Japanese yen, was $10.0 million at both October 28, 1995 and October 29, 1994. Currency swap agreements outstanding at October 28, 1995 have maturities of one year and generally remain in effect until expiration.\nThe Company enters into interest rate swap and cap agreements to manage its exposure to interest rate movements by effectively converting a portion of its debt and certain financing arrangements from fixed to variable rates. Maturity dates of interest rate swap and cap agreements generally match those of the underlying debt or financing arrangements. These agreements, which have maturities of up to twelve years involve the exchange of fixed rate payments for variable rate payments without the exchange of the underlying principal amounts. Variable rates are based on six-month U.S. dollar LIBOR and reset on a semiannual basis. The differential between fixed and variable rates to be paid or received is accrued as interest rates change in accordance with the agreements and recognized over the life of the agreements as an adjustment to interest expense. The notional principal amounts of interest rate swap and cap agreements outstanding were $50.3 million, $50.5 million and $40.0 million at October 28, 1995, October 29, 1994 and October 30, 1993.\nThe cash requirements of the above-described financial instruments approximate their fair value. Cash flows associated with these financial instruments are classified consistent with the cash flows from the transactions being hedged.\nANALOG DEVICES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDerivative financial instruments involve, to a varying degree, elements of market and credit risk not recognized in the consolidated financial statements. The market risk associated with these instruments resulting from currency exchange rate or interest rate movements is expected to offset the market risk of the underlying transactions, assets and liabilities being hedged. The counterparties to the agreements relating to the Company's foreign exchange and interest rate instruments consist of a number of major high credit quality international financial institutions. The Company does not believe that there is significant risk of nonperformance by these counterparties because the Company continually monitors the credit ratings of such counterparties, and limits the financial exposure and the amount of agreements entered into with any one financial institution. While the contract or notional amounts of derivative financial instruments provide one measure of the volume of these transactions, they do not represent the amount of the Company's exposure to credit risk. The amounts potentially subject to credit risk (arising from the possible inability of counterparties to meet the terms of their contracts) are generally limited to the amounts, if any, by which the counterparties' obligations under the contracts exceed the obligations of the Company to the counterparties.\ni. 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, communications, computers and peripherals, 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.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nj. FAIR VALUES 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.\nForeign currency option contracts and currency swap agreements-The fair values of foreign currency option contracts and currency swap agreements are obtained from dealer quotes. These values represent the estimated net amount the Company would receive or pay to terminate the agreements.\nANALOG DEVICES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nk. 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.\nl. 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. Deferred tax asset valuation allowances are recorded to offset deferred tax assets if it is more likely than not that some or all of the deferred tax asset will not be realized. The Company established a valuation allowance, primarily for financial and tax capital losses, based on the assessment that realization of such character of income is not assured.\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.\nm. STOCK SPLIT\nOn November 28, 1995, 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 3, 1996 to stockholders of record December 12, 1995. The split was accomplished through the issuance of common stock. All references to share and per share amounts in this report have been restated to reflect the split.\nn. 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.\no. NEW ACCOUNTING STANDARDS\nThe Company has not yet adopted Statement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of\" and Statement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation\" which will require adoption in fiscal 1997. The Company is in the process of determining the effect of adoption of these statements on its consolidated financial statements and related disclosures.\nANALOG DEVICES, INC.\nNOTES 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 $97,446,000, $96,700,000 and $71,542,000 in 1995, 1994 and 1993, respectively. 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 $23,190,000, $19,718,000 and $17,174,000 in 1995, 1994 and 1993, 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.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\n3. ACCRUED LIABILITIES\nAccrued liabilities at October 28, 1995, October 29, 1994 and October 30, 1993 consisted of the following:\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. 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 28, 1995, the net effective interest rate on $40 million of the Notes was 7.8% after giving effect to the interest rate swap agreement.\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 January 30, 1993 to an amount not exceeding $29,734,000 plus 50% of the consolidated net income of the Company for the period from January 31, 1993 through the end of the Company's then most recent fiscal quarter. At October 28, 1995 this amount was equal to $144,782,000. At October 28, 1995, 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.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nThe weighted average interest rate of U.S. dollar borrowings under the credit agreement and the uncommitted money market lines of credit was 4.0% during 1993. There were no variable rate U.S. dollar borrowings under the credit agreement or the uncommitted money market lines of credit during 1995 and 1994 nor were there any such borrowings outstanding at October 28, 1995, October 29, 1994 or October 30, 1993. The weighted average interest rates of foreign currency borrowings under foreign lines of credit were 7.2%, 8.7% and 10.9% during 1995, 1994 and 1993, respectively. The weighted average interest rates of foreign currency borrowings were 6.2%, 7.4% and 11.8% at October 28, 1995, October 29, 1994 and October 30, 1993, respectively. There were $2.3 million of foreign currency borrowings outstanding at October 28, 1995, 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.\nLong-term debt, including current maturities, at October 28, 1995, October 29, 1994 and October 30, 1993 consisted of the following:\nOn December 18, 1995, the Company completed a public offering of $230,000,000 of five-year 3-1\/2% Convertible Subordinated Notes due December 1, 2000 with semiannual interest payments on June 1 and December 1 of each year, commencing June 1, 1996. The Notes are convertible, at the option of the holder, into the Company's common stock at any time after 60 days following the date of original issuance, unless previously redeemed, at a conversion price of $27.913 per share, subject to adjustment in certain events. The net proceeds of the offering were approximately $224 million after payment of the underwriting discount and expenses of the offering which will be amortized over the term of the Notes. As of December 31, 1995, the Company's total long-term debt was $310,000,000 comprised of the $230,000,000 of 3-1\/2% Convertible Subordinated Notes and $80,000,000 of 6 5\/8% Notes.\nAggregate principal payments on long-term debt and short-term borrowings for the following fiscal years, after consideration of the $230.0 million of 3-1\/2% Convertible Subordinated Notes, are: 1996-$2.3 million; 2000-$80.0 million; and 2001-$230.0 million.\nANALOG DEVICES, INC.\nNOTES 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 $11,243,000, $9,985,000 and $8,853,000 in 1995, 1994 and 1993, respectively.\nThe following is a schedule of future minimum lease payments under capital leases and rental payments required under long-term operating leases at October 28, 1995:\nNet property, plant and equipment includes the following for capital leases:\n6. COMMITMENTS AND CONTINGENCIES\nLITIGATION\nThe Company was a defendant in two lawsuits brought in Texas by Texas Instruments, Inc. (\"TI\"), alleging patent infringement, including patent infringement arising from certain plastic encapsulation processes, and seeking an injunction and unspecified damages against the Company. The alleged infringement of one of these patents is also the subject matter of a proceeding brought by TI against the Company before the International Trade Commission (\"ITC\"). On 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), which prohibited the Company's importation of certain plastic encapsulated circuits, and seeking substantial penalties against the Company for these alleged violations. If it is determined that the Company has violated the cease and desist order, the ITC could seek to impose penalties of up to $100,000 per day of violation from the date of the cease and desist order (February 1992) or a sum equal to twice the value of the goods determined to be sold in violation of the order. In addition, in June 1992, the Company commenced a lawsuit against TI in Massachusetts alleging certain TI digital signal processors infringed one of the Company's patents.\nANALOG DEVICES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nEffective April 1, 1995, the Company and TI settled both Texas lawsuits and the Massachusetts lawsuit principally by means of a royalty-free cross license of certain of the Company's and TI's patents. On April 25, 1995, the Company filed with the ITC a motion to terminate the ITC enforcement proceeding on the grounds that further action by the ITC is unnecessary in light of the Company's settlement with TI. On May 8 1995, an Administrative Law Judge issued a recommended determination to the ITC to grant the Company's motion to terminate the ITC proceeding. The investigative office of the ITC has opposed the motion, claiming that, notwithstanding the Company's settlement with TI, the Company's alleged violation of the ITC's cease and desist order warrants the imposition of substantial penalties. The Company's motion is pending before the ITC.\nThe Company is a defendant in a lawsuit brought by Maxim Integrated Products, Inc. (\"Maxim\") in the United States District Court for the Northern District of California 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 improper restrictions 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 claimed 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. On September 7, 1994, Maxim's claim was dismissed for lack of evidence. Maxim has appealed this ruling and oral argument of the appeal was held in January 1996.\nAlthough the Company believes it should prevail in the matters described in the previous three 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.\nIn 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 matters, patents, personal injury, environmental matters and product liability. Such litigation includes patent infringement actions brought against the Company by Sextant Avionique, S.A. (\"Sextant\") in Paris, France, which claims that the Company's accelerometer infringes certain Sextant patents and seeks to enjoin such infringement. While there can be no assurance that the Company will prevail in all of these matters, the Company does not believe that these matters will have a material adverse effect on the Company's consolidated financial position or consolidated results of operations. However, an adverse resolution could have an adverse effect on the Company's consolidated results of operations in the quarter in which these matters are resolved.\nIRISH GRANTS\nDuring fiscal 1995, the Company's manufacturing facility in Limerick, Ireland entered into a grant agreement with Ireland's Industrial Development Authority (\"IDA\") under which the Company will receive grant monies of up to 10.1 million Irish Pounds (approximately $16.4 million at October 28, 1995) for capital and start-up costs associated with the wafer fabrication expansion at this facility. As of October 28, 1995, the Company had not received any grant monies under this agreement. The Company's Irish facility has previously received operating and capital grants from the IDA; a liability to repay up to $13.1 million of the grants received by the Company would arise in the unlikely event the Company should discontinue its Irish operations prior to the commitment periods noted in the grant agreements which expire at various dates through 1999.\nANALOG DEVICES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nWAFER SUPPLY AGREEMENTS\nIn May 1995, the Company entered into a wafer supply agreement with its primary foundry, Taiwan Semiconductor Manufacturing Co., Ltd. (\"TSMC\"). The terms of this agreement provide for a series of advance payments to TSMC aggregating $22.4 million, payable over a three-year period, to be used by TSMC in the expansion of their wafer fabrication facility in Taiwan. In return, the Company will be provided access to a minimum level of wafer capacity over the period from 1996 to 1999. The first payment to TSMC was made in June 1995. The remaining payments under the agreement are due in June 1996, June 1997 and June 1998. The advance payments will be repaid to the Company each year in the form of credits against the prices of wafers purchased by the Company when such wafer purchases exceed a defined minimum.\nIn March 1995, the Company entered into an agreement with an external wafer foundry, Chartered Semiconductor Manufacturing Pte., Ltd. (\"CSM\"), which provides for an equity investment of approximately $20.0 million to be applied primarily towards the construction of a new CSM eight-inch, 0.5 micron wafer fabrication facility in Singapore. In consideration for its investment, the Company receives a minority equity position of less than 5% in CSM and will receive guaranteed foundry capacity and pricing commitments for sub-micron wafers manufactured at CSM's new facility beginning in 1996. The Company invested $14.0 million in fiscal 1995 in connection with this agreement. The Company's investment in CSM is included in the balance sheet caption, \"Deferred Charges and Other Assets.\"\nOTHER\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 $10.3 million at October 28, 1995, 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 28, 1995, the Company's unrecorded financial risk of loss under this agreement was $2.0 million in the unlikely event of default.\n7. STOCKHOLDERS' EQUITY\nCOMMON STOCK\nIn March 1995, the stockholders approved 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. In December 1995, 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 300,000,000 to 450,000,000 subject to stockholder approval in March 1996.\nSTOCK PLANS\nThe 1988 Stock Option Plan provides for the issuance of nonstatutory and incentive stock options to purchase up to 15,525,000 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. In December 1995, the Board of Directors authorized an increase in the number of shares of common stock available for issuance under the 1988 Stock Option Plan from 15,525,000 to 22,425,000 subject to stockholder approval in March 1996.\nWhile the Company may grant options to employees which become exercisable at different times or within different periods, the Company has generally granted options to employees which are exercisable on a cumulative basis in annual installments of 33 1\/3% each on the third, fourth and fifth anniversaries of the date of grant.\nANALOG DEVICES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nUnder the 1994 Director Stock Option Plan, each nonemployee director is granted annually for four years a nonstatutory option to purchase 7,875 shares of common stock at an exercise price equal to the fair market value on the date of grant. A total of 300,000 shares of common stock may be issued under this plan. These options are exercisable on a cumulative basis in annual installments of 33 1\/3% each on the first, second and third anniversaries of the date of grant. The Company also has options outstanding under the 1992 Director Option Plan and the 1989 Director Stock Option Plan. Options granted under these plans are exercisable on a cumulative basis in annual installments of 33 1\/3% each on the third, fourth and fifth anniversaries of the date of grant.\nTransactions under the Company's stock option plans are summarized in the table below:\n(1) Options canceled which were originally issued from the 1988 Stock Option Plan are available for subsequent grants. The remaining options canceled in 1995, 1994 and 1993 were issued from the 1980 Stock Option and 1992 Director Option Plans under which no further options will be granted.\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 626,800 shares in 1995 (785,700 and 1,131,800 in 1994 and 1993, respectively) for $6.9 million ($6.0 million and $4.2 million in 1994 and 1993, respectively). At October 28, 1995, 1,505,700 common shares remained available for issuance under the stock purchase plan.\nANALOG DEVICES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nUnder the 1991 Restricted Stock Plan, a maximum of 1,575,000 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 5,529,600 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 1995, 1994 and 1993 were 15,000, 353,250 and 31,500, 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 1995, 1994 and 1993, $1,672,000, $1,851,000 and $1,716,000, respectively, of such compensation was charged to expense. At October 28, 1995, there were 444,000 shares of common stock available for issuance under the 1991 Restricted Stock Plan. In December 1995, the Board of Directors authorized an increase in the number of shares of common stock available for issuance under the 1991 Restricted Stock Plan from 1,575,000 to 2,025,000 subject to stockholder approval in March 1996.\nWARRANTS\nIn 1990, the Company issued warrants for the purchase of 2,250,000 shares of common stock. Each warrant entitles the holder to purchase one share of the Company's common stock at an exercise price of $5.33 per share, subject to certain adjustments, anytime prior to the expiration of the warrants on August 7, 1997. At October 28, 1995, all of the warrants were outstanding.\nAs of October 28, 1995, a total of 18,603,000 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 Stockholder Rights Plan which was amended in 1989. Pursuant to the Stockholder Rights Plan, each share of common stock has an associated right. Under certain circumstances, each right entitles the holder to purchase from the Company one share of common stock at an exercise price of $26.67 per share, subject to adjustment.\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.\nANALOG DEVICES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nThe rights have certain anti-takeover effects, in that they would cause substantial dilution to a person or group that attempts to acquire a significant interest in the Company on terms not approved by the Board of Directors. The rights expire on February 12, 1998 but may be redeemed by the Company for $.0089 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.\n8. RETIREMENT PLANS\nThe Company and its subsidiaries have various savings and retirement plans covering substantially all employees. The Company maintains a defined contribution plan for the benefit of its eligible United States employees. This plan provides 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 1995, 1994 and 1993 was $14.0 million, $12.6 million and $11.9 million, respectively, which primarily consists of costs related to the domestic defined contribution plan. Also included in total expense is pension expense related to foreign defined benefit plans of $2.5 million for 1995, $2.5 million for 1994 and $3.0 million for 1993. Summary data related to these foreign plans at October 28, 1995 is as follows: accumulated benefit obligation, substantially vested, of $22.2 million; projected benefit obligation of $35.2 million; plan assets at fair value of $32.4 million; discount rates ranging from 4% to 15%; compensation increase rates ranging from 3% to 12% and expected rate of return on assets ranging from 5% to 15%.\nIn fiscal 1995, the Company adopted Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits\" (FAS 112). 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 did not have a material impact on the Company's consolidated financial statements.\n9. INCOME TAXES\nAs discussed in Note 1(l), the Company adopted FAS 109 as of October 31, 1993.\nThe reconciliation of income tax computed at the U.S. federal statutory rates to income tax expense is as follows:\nANALOG DEVICES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nFor financial reporting purposes, income before income taxes includes the following components:\nThe components of the provision for income taxes are as follows:\nThe Company's practice is to reinvest indefinitely the earnings of certain international subsidiaries. Accordingly, no U.S. income taxes have been provided for approximately $277,308,000 of unremitted earnings of international subsidiaries.\nFor the Company's fiscal years ended October 28, 1995 and October 29, 1994 deferred income taxes reflect the tax effects of differences between the carrying amounts of assets and liabilities for financial reporting and income tax purposes. A deferred tax asset must be recognized for the tax benefit of deductible temporary differences, net operating losses, net capital losses and tax credit carryovers. A valuation allowance is recognized if it is \"more likely than not\" that some or all of the deferred tax asset will not be realized. The Company maintains a valuation allowance for deferred tax assets, which was $10.0 million at both October 28, 1995 and October 29, 1994. The Company believes that the realization of deferred tax assets was not assured for book and tax capital losses and book basis foreign tax credits. For tax purposes, the Company has a capital loss carryforward of approximately $6,453,000 expiring through the year 2000, principally in 1997.\nANALOG DEVICES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nThe significant components of the Company's deferred tax assets and liabilities for the fiscal years ended October 28, 1995 and October 29, 1994 are as follows:\nThe components of the provision for deferred income taxes for the fiscal year ended October 30, 1993 are as follows:\nANALOG DEVICES, INC.\nSUPPLEMENTARY FINANCIAL INFORMATION (UNAUDITED)\nQuarterly financial information for fiscal 1995 and fiscal 1994 (thousands of dollars except as noted):\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 12, 1996 (the \"1996 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 1996 Proxy Statement under the captions \"Directors' Compensation,\" \"Executive Compensation,\" \"Severance and Other Agreements,\" \"Approval of Amendment to 1988 Stock Option Plan\" and \"Approval of Amendment to 1991 Restricted Stock Plan,\" and is incorporated herein by reference.\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 1996 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 1996 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 28, 1995, October 29, 1994 and October 30, 1993 - Consolidated Balance Sheets as of October 28, 1995, October 29, 1994 and October 30, 1993 - Consolidated Statements of Stockholders' Equity for the years ended October 28, 1995, October 29, 1994 and October 30, 1993 - Consolidated Statements of Cash Flows for the years ended October 28, 1995, October 29, 1994 and October 30, 1993\n(a) 2. FINANCIAL STATEMENT SCHEDULES\nThe following consolidated financial statement schedules are included in Item 14(d):\nSchedule II - Valuation and Qualifying Accounts\nAll other schedules have been omitted since the required information is not present or not present in amounts sufficient to require submission of the schedule, or because the information required is included in the consolidated financial statements or the notes thereto.\n(a) 3. LISTING OF EXHIBITS\n* Management contracts and compensatory plan or arrangements required to be filed as an Exhibit pursuant to Item 14(c) of Form 10-K.\n** Confidential treatment has been granted as to certain portions of these Exhibits.\n(b) REPORTS ON FORM 8-K\nThe Company filed no reports on Form 8-K with the Securities and Exchange Commission during the fiscal quarter ended October 28, 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.\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 25, 1996 Date: January 25, 1996 ---------------------------- ------------------------------\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.\nANALOG DEVICES, INC.\nANNUAL REPORT ON FORM 10-K\nYEAR ENDED OCTOBER 28, 1995\nITEM 14(D)\nFINANCIAL STATEMENT SCHEDULE\nANALOG DEVICES, INC.\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS\nYEARS ENDED OCTOBER 28, 1995, OCTOBER 29, 1994 AND OCTOBER 30, 1993 (THOUSANDS)","section_15":""}
{"filename":"810363_1995.txt","cik":"810363","year":"1995","section_1":"Item 1. BUSINESS\nFidelity Leasing Income Fund IV, L.P. (the \"Fund\"), a Delaware limited partnership, was organized in 1986 and acquires equipment, primarily computer peripheral equipment, including printers, tape and disk storage devices, data communications equipment, computer terminals, data processing and office equipment, which is leased to third parties on a short-term basis. The Fund's principal objective is to generate leasing revenues for distribution. The Fund manages equipment, releasing or disposing of equipment as it comes off lease in order to achieve its principal objective. The Fund will not borrow funds to purchase equipment.\nThe Fund generally acquires equipment subject to a lease. Purchases of equipment for lease are typically made through equipment leasing brokers, under a sale-leaseback arrangement directly from lessees owning equipment, from the manufacturer either pursuant to a purchase agreement relating to significant quantities of equipment or on an ad hoc basis to meet the needs of a particular lessee.\nThe equipment leasing industry is highly competitive. The Fund competes with leasing companies, equipment manufacturers and distributors, and entities similar to the Fund (including similar programs sponsored by the General Partner), some of which have greater financial resources than the Fund and more experience in the equipment leasing business than the General Partner. Other leasing companies and equipment manufacturers and distributors may be in a position to offer equipment to prospective lessees on financial terms which are more favorable than those which the Fund can offer. They may also be in a position to offer trade-in-privileges, maintenance contracts and other services which the Fund may not be able to offer. Equipment manufacturers and distributors may offer to sell equipment on terms and conditions (such as liberal financing terms and exchange privileges) which will afford benefits to the purchaser similar to those obtained through leases. As a result of the advantages which certain of its competitors may have, the Fund may find it necessary to lease its equipment on a less favorable basis than certain of its competitors.\nThe computer equipment industry is extremely competitive as well. Competitive factors include pricing, technological innovation and methods of financing. Certain manufacturer-lessors maintain advantages through patent protection, where applicable, and through product protection by the use of a policy which combines service and hardware benefits with payment for such benefits accomplished through a single periodic charge.\nThe dominant factor in the marketplace is International Business Machines Corporation (\"IBM\"). Because of IBM's substantial resources and dominant position, revolutionary changes with respect to pricing, marketing practices, technological innovation and the availability of new and attractive financing plans could occur at almost any time. Significant action in any of these areas by IBM might materially adversely affect the General Partner's ability to identify and purchase appropriate equipment. It is the belief of the General Partner that IBM will continue to make advances in the computer equipment industry which may result in revolutionary changes with respect to small, medium and large computer systems.\nItem 1. BUSINESS (Continued)\nA brief description of the types of equipment in which the Fund has invested as of December 31, 1995, together with information concerning the users of such equipment is contained in Item 2, following.\nThe Fund does not have any employees. All persons who work on the Fund are employees of the General Partner.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nThe following schedules detail the type and aggregate purchase price of the various types of equipment acquired and leased by the Fund as of December 31, 1995, along with the percentage of total equipment represented by each type of equipment, a breakdown of equipment usage by industrial classification and the average initial term of leases:\nPurchase Price Percentage of Type of Equipment Acquired of Equipment Total Equipment\nCommunication Controllers $1,397,628 15.73% Disk Storage Systems 3,116,095 35.08 Network Communications 266,742 3.00 Personal Computers, Terminals and Display Stations 2,082,629 23.45 Printers 363,638 4.09 Tape Storage Systems 1,536,313 17.29 Other 120,480 1.36 __________ _____\nTotals $8,883,525 100.00% ========== ======\nBreakdown of Equipment Usage By Industrial Classification\nPurchase Price Percentage of Type of Business of Equipment Total Equipment\nComputer\/Data Processing $1,055,649 11.88% Diversified Financial\/Banking\/ Insurance 4,487,030 50.51 Manufacturing\/Refining 1,750,089 19.70 Publishing\/Printing 207,698 2.34 Retailing\/Consumer Goods 1,104,834 12.44 Telephone\/Telecommunications 23,122 0.26 Utilities 255,103 2.87 __________ ______\nTotals $8,883,525 100.00% ========== ======\nAverage Initial Term of Leases (in months): 34\nAll of the above equipment is currently leased under operating leases.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nNot applicable.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNot applicable.\nPART II\nItem 5.","section_5":"Item 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS\n(a) The Fund's limited partnership units are not publicly traded. There is no market for the Fund's limited partnership units and it is unlikely that any will develop.\n(b) Number of Equity Security Holders:\nNumber of Partners Title of Class as of December 31, 1995\nLimited Partnership Interests 1,565\nGeneral Partnership Interest 1\nItem 7.","section_6":"","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nResults of Operations\nThe Fund had revenues of $2,374,015, $2,689,758 and $3,657,867 for the years ended December 31, 1995, 1994 and 1993, respectively. The decrease in revenues between 1995, 1994 and 1993 is primarily caused by the decrease in rental income generated from equipment under operating leases. Rental income from the leasing of computer peripheral equipment accounted for 88%, 89%, and 86% of total income in 1995, 1994 and 1993, respectively. In 1995, rental income decreased by approximately $846,000 because of equipment which came off lease and was re-leased at lower rental rates or sold. This decrease, however, was offset by approximately $546,000 of rental income generated from equipment under operating leases purchased during 1995, as well as rental income from 1994 equipment purchases for which a full year of rental income was earned in 1995 and only a partial year was earned in 1994. In 1994, rental income decreased by approximately $1,069,000 because of equipment which came off lease and was re-leased at lower rental rates or sold. This decrease, however, was offset by approximately $300,000 of rental income generated from equipment purchased in 1994 as well as rental income from 1993 equipment purchases for which a full year of rental income was earned in 1994 and only a partial year was earned in 1993. Additionally, the Fund recognized a net gain on sale of equipment of $182,063, $138,714 and $353,326 for the twelve months ended December 31, 1995, 1994 and 1993, respectively which contributed to the fluctuation in total revenues for these years.\nExpenses were $1,635,579, $1,924,361, and $2,917,910 for the years ended December 31, 1995, 1994 and 1993, respectively. Depreciation expense comprised 75% of total expenses in 1995, 75% in 1994 and 77% in 1993. The decrease in expenses between these years is primarily attributable to a decrease in depreciation expense because of equipment which came off lease and was terminated or sold. Currently, the Fund's practice is to review the recoverability of its undepreciated costs of rental equipment quarterly. The Fund's policy, as part of this review, is to analyze such factors as re-leasing of equipment, technological developments and information provided in third party publications. In 1995, 1994 and 1993, approximately $94,000, $156,000 and $295,000, respectively, was charged to write-down of equipment to net realizable value. In accordance with Generally Accepted Accounting Principles, the Fund writes down its rental equipment to its estimated net realizable value when the amounts are reasonably estimated and only recognizes gains upon actual sales of its equipment. The General Partner believes, after analyzing the current equipment portfolio, that there are impending gains to be recognized upon the sale of certain equipment in future years.\nThe Fund's net income was $738,436, $765,397 and $739,957 for the years ended December 31, 1995, 1994 and 1993, respectively. The earnings per equivalent limited partnership unit, after earnings allocated to the General Partner, were $56.98, $47.84 and $32.84 for the years ended December 31, 1995, 1994 and 1993, respectively. The weighted average number of equivalent limited partnership units outstanding were 12,305, 15,527 and 21,215 for 1995, 1994 and 1993, respectively.\nItem 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nResults of Operations (Continued)\nThe Fund generated funds from operations of $1,871,187, $2,234,590 and $2,937,249 for the purpose of determining cash available for distribution and declared distributions of $1,865,582, $2,258,634 and $4,327,754 to partners for the years ended December 31, 1995, 1994 and 1993, respectively. The distributions for the years ended December 31, 1994 and 1993 include $24,044 and $1,390,505, respectively of cash available from previous years which was not distributed. For financial statement purposes, the Fund records cash distributions to partners on a cash basis in the period in which they are paid. During the fourth quarter of 1995, the General Partner revised its policy regarding cash distributions so that the distributions more accurately reflect the net income of the Fund over the most recent twelve months.\nAnalysis of Financial Condition\nThe Fund will continue to purchase computer equipment for lease with cash available from operations which is not distributed to partners. During the years ended December 31, 1995, 1994 and 1993, the Fund purchased $1,533,346, $1,239,461 and $949,385, respectively.\nThe cash position of the Fund is reviewed daily and cash is invested on a short-term basis.\nThe Fund's cash from operations is expected to continue to be adequate to cover all operating expenses and contingencies during the next fiscal year.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe response to this Item is submitted as a separate section of this report commencing on page.\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\nEffective September 1, 1995, The Fidelity Mutual Life Insurance Company (in Rehabilitation) sold Fidelity Leasing Corporation (FLC), the General Partner of the Fund, to Resource Leasing, Inc., a wholly owned subsidiary of Resource America, Inc. The Directors and Executive Officers of FLC are:\nFREDDIE M. KOTEK, age 39, Chairman of the Board of Directors, President and Chief Executive Officer of FLC since September 1995 and Senior Vice President of Resource America, Inc. since 1995. President of Resource Leasing, Inc. since September 1995. Executive Vice President of Resource Properties, Inc. (a wholly owned subsidiary of Resource America, Inc.) since 1993. First Vice President of Royal Alliance Associates from 1991 to 1993. Senior Vice President and Chief Financial Officer of Paine Webber Properties from 1990 to 1991.\nMICHAEL L. STAINES, age 46, Director and Secretary of FLC since September 1995 and Senior Vice President and Secretary of Resource America, Inc. since 1989.\nSCOTT F. SCHAEFFER, age 33, Director of FLC since September 1995 and Senior Vice President of Resource America, Inc. since 1995. Vice President-Real Estate of Resource America, Inc. and President of Resource Properties, Inc. (a wholly owned subsidiary of Resource America, Inc.) since 1992. Vice President of the Dover Group, Ltd. (a real estate investment company) from 1985 to 1992.\nMARK A. MAYPER, age 42, Senior Vice President of FLC overseeing the lease syndication business since 1987.\nOthers:\nSTEPHEN P. CASO, age 40, Vice President and Counsel of FLC since 1992.\nMARIANNE T. SCHUSTER, age 37, Vice President and Controller of FLC since 1984.\nKRISTIN L. CHRISTMAN, age 28, Portfolio Manager of FLC since December 1995 and Equipment Brokerage Manager since 1993.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION\nThe following table sets forth information relating to the aggregate compensation earned by the General Partner of the Fund during the year ended December 31, 1995:\nName of Individual or Capacities in Number in Group Which Served Compensation\nFidelity Leasing Corporation General Partner $123,347 (1) ========\n(1) This amount does not include the General Partner's share of cash distributions made to all partners.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\n(a) As of December 31, 1995, there was no person or group known to the Fund that owned more than 5% of the Fund's outstanding securities either beneficially or of record.\n(b) In 1986, the General Partner contributed $1,000 to the capital of the Fund but it does not own any of the Fund's outstanding securities. No individual director or officer of Fidelity Leasing Corporation nor such directors or officers as a group, owns more than one percent of the Fund's outstanding securities. The General Partner owns a general partnership interest which entitles it to receive 3.5% of cash distributions until the Limited Partners have received an amount equal to the purchase price of their Units plus a 10% compounded Priority Return; thereafter 10%. The General Partner will also share in net income equal to the greater of its cash distributions or 1% of net income or to the extent there are losses, 1% of such losses.\n(c) There are no arrangements known to the Fund that would, at any subsequent date, result in a change in control of the Fund.\nItem 13","section_13":"Item 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nDuring the year ended December 31, 1995, the Fund was charged $123,347 of management fees by the General Partner. The General Partner will continue to receive 6% or 3% of rental payments on equipment under operating leases or full pay-out leases, respectively for administrative and management services performed on behalf of the Fund. Full pay-out leases are noncancellable leases with terms in excess of 42 months and for which rental payments during the initial term are at least sufficient to recover the purchase price of the equipment, including acquisition fees.\nThe General Partner also receives 3.5% of cash distributions until the Limited Partners have received an amount equal to the purchase price of their Units plus a 10% compounded Priority Return. Thereafter, the General Partner will receive 10% of cash distributions. During the year ended December 31, 1995, the General Partner received $36,997 of cash distributions.\nThe Fund incurred $106,410 of reimbursable costs to the General Partner for services and materials provided in connection with the administration of the Fund during 1995.\nPART IV\nItem 14.","section_14":"Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) (1) and (2). The response to this portion of Item 14 is submitted as a separate section of this report commencing on page.\n(a) (3) and (c) Exhibits (numbered in accordance with Item 601 of Regulation S-K)\nExhibit Numbers Description Page Number\n3(a) & (4) Amended and Restated Agreement * of Limited Partnership\n(9) not applicable\n(10) not applicable\n(11) not applicable\n(12) not applicable\n(13) not applicable\n(18) not applicable\n(19) not applicable\n(22) not applicable\n(23) not applicable\n(24) not applicable\n(25) not applicable\n(28) not applicable\n* 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.\nFIDELITY LEASING INCOME FUND IV, L.P. A Delaware limited partnership\nBy: FIDELITY LEASING CORPORATION\nFreddie M. Kotek By: ___________________________ Freddie M. Kotek, Chairman and President\nDated March 26, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, this annual report has been signed below by the following persons, on behalf of the Registrant and in the capacities and on the date indicated:\nSignature Title Date\nFreddie M. Kotek ____________________________ Chairman of the Board of Directors 3-26-96 Freddie M. Kotek and President of Fidelity Leasing Corporation (Principal Executive Officer)\nMichael L. Staines ____________________________ Director of Fidelity Leasing 3-26-96 Michael L. Staines Corporation\nMarianne T. Schuster ____________________________ Vice President and Controller 3-26-96 Marianne T. Schuster of Fidelity Leasing Corporation (Principal Financial Officer)\nINDEX TO FINANCIAL STATEMENTS AND SCHEDULES\nPages\nReport of Independent Certified Public Accountants\nBalance Sheets as of December 31, 1995 and 1994\nStatements of Operations for the years ended December 31, 1995, 1994 and 1993\nStatements of Partners' Capital for the years ended December 31, 1995, 1994 and 1993\nStatements of Cash Flows for the years ended December 31, 1995, 1994 and 1993\nNotes to Financial Statements -\nAll schedules have been omitted because the required information is not applicable or is included in the Financial Statements or Notes thereto.\nReport of Independent Certified Public Accountants\nThe Partners Fidelity Leasing Income Fund IV, L.P.\nWe have audited the accompanying balance sheets of Fidelity Leasing Income Fund IV, L.P. as of December 31, 1995 and 1994, and the related statements of operations, changes in partners' capital and cash flows for each of the three years in the period ended December 31, 1995. 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 financial position of Fidelity Leasing Income Fund IV, L.P. as of December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles.\nGrant Thornton, LLP Philadelphia, Pennsylvania February 2, 1996\nFIDELITY LEASING INCOME FUND IV, L.P.\nBALANCE SHEETS\nThe accompanying notes are an integral part of these financial statements.\nFIDELITY LEASING INCOME FUND IV, L.P.\nThe accompanying notes are an integral part of these financial statements.\nFIDELITY LEASING INCOME FUND IV, L.P.\nThe accompanying notes are an integral part of these financial statements.\nFIDELITY LEASING INCOME FUND IV, L.P.\nThe accompanying notes are an integral part of these financial statements.\nFIDELITY LEASING INCOME FUND IV, L.P.\nNOTES TO FINANCIAL STATEMENTS\n1. ORGANIZATION\nFidelity Leasing Income Fund IV, L.P. (the \"Fund\") was formed in December 1986 with Fidelity Leasing Corporation (\"FLC\") as the General Partner. FLC is a wholly owned subsidiary of Resource Leasing, Inc., a wholly owned subsidiary of Resource America, Inc. The Fund is managed by the General Partner. The Fund's limited partnership interests are not publicly traded. There is no market for the Fund's limited partnership interests and it is unlikely that any will develop. The Fund acquires computer equipment including printers, tape and disk storage devices, data communications equipment, computer terminals, data processing and office equipment which is leased to third parties throughout the United States on a short-term basis.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nInvestment Securities Held to Maturity\nThe Fund adopted Statement of Financial Accounting Standard (SFAS) No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" on January 1, 1994. This new standard requires investments in securities to be classified in one of three categories: held to maturity, trading and available for sale. Debt securities that the Fund has the positive intent and ability to hold to maturity are classified as held to maturity and are reported at amortized cost. As the Fund does not engage in security trading, the balance, if any, of its debt securities and equity securities are classified as available for sale. Net unrealized gains and losses for securities available for sale are required to be recognized as a separate component of partners' capital and excluded from the determination of net income. The Fund adopted this new standard for the year ended December 31, 1994 with no resulting financial statement impact on the Fund. Prior to the adoption of SFAS No. 115, investment securities were carried at cost which approximates market.\nConcentration of Credit Risk\nFinancial instruments which potentially subject the Fund to concentrations of credit risk consist principally of temporary cash investments. The Fund places its temporary investments in securities backed by the United States Government, commercial paper with high credit quality institutions, bank money market funds and time deposits and certificates of deposit.\nConcentrations of credit risk with respect to accounts receivables are limited due to the dispersion of the Fund's leesees over different industries and geographies.\nEquipment Held for Sale or Lease\nEquipment held for sale or lease is carried at its estimated net realizable value.\nFIDELITY LEASING INCOME FUND IV, L.P.\nNOTES TO FINANCIAL STATEMENTS (Continued)\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)\nUse of Estimates\nIn preparing financial statements in conformity with generally accepted accounting principles, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses during the reporting period. Actual results could differ from those estimates.\nAccounting for Leases\nThe Fund's leasing operations consist only of operating leases. The cost of the leased equipment is recorded as an asset and depreciated on a straight-line basis over its estimated useful life, up to six years. Acquisition fees associated with lease placements are allocated to equipment when purchased and depreciated as part of equipment cost. Rental income consists primarily of monthly periodic rentals due under the terms of the leases. Generally, during the remaining terms of existing operating leases, the Fund will not recover all of the undepreciated cost and related expenses of its rental equipment and is prepared to remarket the equipment in future years. Upon sale or other disposition of assets, the cost and related accumulated depreciation are removed from the accounts and the resulting gain or loss, if any, is reflected in income.\nIncome Taxes\nFederal and State income tax regulations provide that taxes on the income or benefits from losses of the Fund are reportable by the partners in their individual income tax returns. Accordingly, no provision for such taxes has been made in the accompanying financial statements.\nStatements of Cash Flows\nFor purposes of the statements of cash flows, the Fund considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.\nNet Income per Equivalent Limited Partnership Unit\nNet income per equivalent limited partnership unit is computed by dividing net income allocated to limited partners by the weighted average number of equivalent limited partnership units outstanding during the year. The weighted average number of equivalent units outstanding during the year is computed based on the weighted average monthly limited partners' capital account balances, converted into equivalent units at $500 per unit.\nSignificant Fourth Quarter Adjustments\nCurrently, the Fund's practice is to review the recoverability of its undepreciated costs of rental equipment quarterly. The Fund's policy, as part of this review, is to analyze such factors as releasing of equipment, technological developments and information provided in third\nFIDELITY LEASING INCOME FUND IV, L.P.\nNOTES TO FINANCIAL STATEMENTS (Continued)\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)\nSignificant Fourth Quarter Adjustments (Continued)\nparty publications. Based upon this review, the Fund recorded an adjustment of approximately $156,000 and $295,000 or $10.05 and $13.91 per equivalent limited partnership unit to write down its rental equipment in the fourth quarter of 1994 and 1993, respectively. There were no significant fourth quarter adjustments in 1995.\nReclassification\nCertain amounts on the 1994 and 1993 financial statements have been reclassified to conform to the presentation adopted in 1995.\n3. ALLOCATION OF PARTNERSHIP INCOME, LOSS AND CASH DISTRIBUTIONS\nCash distributions (except for the period from January 1, 1992 through June 30, 1995), if any, are made quarterly as follows: 96.5% to the Limited Partners and 3.5% to the General Partner, until the Limited Partners have received an amount equal to the purchase price of their Units, plus a 10% compounded Priority Return (an amount equal to 10% compounded annually on the portion of the purchase price not previously distributed); thereafter, 90% to the Limited Partners and 10% to the General Partner.\nNet Losses are allocated 99% to the Limited Partners and 1% to the General Partner. The General Partner is allocated Net Income equal to its cash distributions, but not less than 1% of Net Income, with the balance allocated to the Limited Partners.\nNet Income (Losses) allocated to the Limited Partners are allocated to individual limited partners based on the ratio of the daily weighted average partner's net capital account balance (after deducting related commission expense) to the total daily weighted average of the Limited Partners' net capital account balances.\n4. EQUIPMENT LEASED\nEquipment on lease consists primarily of computer peripheral equipment under operating leases. The majority of the equipment was manufactured by IBM. The lessees have agreements with the manufacturer to provide maintenance for the leased equipment. The Fund's operating leases are for initial lease terms of 15 to 60 months.\nIn accordance with Generally Accepted Accounting Principles, the Fund writes down its rental equipment to its estimated net realizable value when the amounts are reasonably estimated and only recognizes gains upon actual sale of its rental equipment. As a result, in 1995, 1994 and 1993, approximately $94,000, $156,000 and $295,000, respectively was charged to write-down of equipment to net realizable value. However the General Partner believes, after analyzing the current equipment portfolio, that there are impending gains to be recognized upon the sale of certain of its equipment in future years.\nFIDELITY LEASING INCOME FUND IV, L.P.\nNOTES TO FINANCIAL STATEMENTS (Continued)\n4. EQUIPMENT LEASED (Continued)\nThe future approximate minimum rentals to be received on noncancellable operating leases as of December 31 are as follows:\n1996 $1,345,000 1997 733,000 1998 89,000 __________ $2,167,000 ==========\n5. RELATED PARTY TRANSACTIONS\nThe General Partner receives 6% or 3% of rental payments on equipment under operating leases and full pay-out leases, respectively, for administrative and management services performed on behalf of the Fund. Full pay-out leases are noncancellable leases with terms in excess of 42 months and for which rental payments during the initial term are at least sufficient to recover the purchase price of the equipment, including acquisition fees.\nThe General Partner may also receive up to 3% of the proceeds from the sale of the Fund's equipment for services and activities to be performed in connection with the disposition of equipment. The payment of this sales fee is deferred until the Limited Partners have received cash distributions equal to the purchase price of their units plus a 10% cumulative compounded Priority Return. Based on current estimates, it is not expected that the Fund will be required to pay the General Partner a sales fee.\nAdditionally, the General Partner and its affiliates are reimbursed by the Fund for certain costs of services and materials used by or for the Fund except those items covered by the above-mentioned fees. Following is a summary of fees and costs charged by the General Partner or its affiliates during the years ended December 31:\n1995 1994 1993\nManagement fee $123,347 $140,683 $186,149 Reimbursable costs 106,410 79,047 100,785\nAmounts due from related parties at December 31, 1995 and 1994 represent monies due to the Fund from the General Partner and\/or other affiliated funds for rentals and sales proceeds collected and not yet remitted the Fund.\nAmounts due to related parties at December 31, 1995 and 1994 represent monies due to the General Partner for the fees and costs mentioned above, as well as, rentals and sales proceeds collected by the Fund on behalf of other affiliated funds.\nFIDELITY LEASING INCOME FUND IV, L.P.\nNOTES TO FINANCIAL STATEMENTS (Continued)\n6. MAJOR CUSTOMERS\nFor the year ended December 31, 1995, two customers accounted for 18% each, one customer accounted for 17% and two customers accounted for 13% and 12% of the Fund's rental income. For the year ended December 31, 1994, three customers accounted for 21%, 15% and 13% of the Fund's rental income. For the year ended December 31, 1993, two customers accounted for 17% and 14% of the Fund's rental income.\n7. CASH DISTRIBUTIONS\nBelow is a summary of the quarterly cash distributions paid to partners during the years ended December 31:\nIn addition, the General Partner declared a cash distribution of $168,000 in February 1996 for the three months ended December 31, 1995, to all admitted partners as of December 31, 1995.","section_15":""}
{"filename":"795551_1995.txt","cik":"795551","year":"1995","section_1":"Item 1. Business\nTheragenics Corporation (\"Theragenics\" or the \"Company\") was incorporated in November 1981 to commercially engage in the development, manufacture, and marketing of therapeutic radiological pharmaceuticals and devices for use primarily in the treatment of cancer. The Company's products are intended to permit a physician to introduce short-range, short-lived radioactive material directly into cancerous tissue, thereby concentrating the impact of the radiation on the cancerous tissue to be destroyed while minimizing the effect on surrounding healthy tissue. To date the Company has internally developed two products - TheraSeed, a radioactive implant designed for the treatment of localized tumors, and TheraSphere, radioactive microspheres for the treatment of liver cancer. TheraSeed is being commercially distributed in the United States while TheraSphere is being commercially distributed in Canada.\nGeneral\nThe conventional treatments for cancer to date have been surgery, radiation and chemotherapy. The treatments which have been most successful are those which remove or kill all of the cancerous tissue while avoiding excessive damage to the surrounding healthy, normal tissue. When the cancerous tissue cannot be completely removed or killed, the cancer usually returns to the primary site often with metastases to other areas.\nThe Company's products are intended to permit a physician to place short-range, short-lived radioactive material near or into a cancerous tumor, thereby concentrating the impact of the radiation on the cancerous tissue to be destroyed. The Company's products are most effective on encapsulated, confined tumors. Each of the Company's products is based on established physical principles and has the simple objective of delivering sufficient radiation to the target cancer to kill it while minimizing the radiation to surrounding tissue.\nProducts\nTheraSeed, radioactive \"seeds\" approximately the size of a grain of rice which are implanted directly into a tumor, is presently marketed in the United States.\nTheraSphere, microscopic radioactive glass spheres used to treat liver cancer, is presently marketed in Canada by Nordion International Inc. (\"Nordion\") under sublicense from Theragenics. Additionally, Theragenics has granted to Nordion an exclusive worldwide sublicense to manufacture, distribute and sell\nTheraSphere for any application.\nPalladium-103 (\"Palladium\" or \"Pd-103\") is the radioactive isotope providing the therapeutic benefit in the Company's TheraSeed product. The Company will be exploring and investigating opportunities to use this isotope in other potential products as they are identified.\nTheraSeed Implants\nProstate cancer is expected to strike 317,100 men in the United States in 1996. The National Cancer Institute estimates that one in three men over 50 years of age have microscopic cancer of the prostate. This ratio is greater than the odds (one in eight, as estimated by the American Cancer Society) for a woman getting breast cancer. A projected 41,400 men in the United States will die of this disease in 1996. Not including experimental treatment options, treatments for prostate cancer include prostatectomy (surgical removal of the prostate gland), external beam radiation, radioactive implants, watchful waiting, hormone manipulation and castration. Not all of these treatments are for early stage disease. The Company's TheraSeed product is usually classified as a treatment for early stage disease.\nTheraSeed is best suited for solid localized tumors. To date the most prevalent use of TheraSeed has been in the treatment of prostate cancer, although it has been used to treat cancers of the pancreas, lung, head and neck, oral cavity, base of the skull, brain and eye.\nTreatment of early stage prostate cancer with TheraSeed is a one-time, minimally-invasive technique, usually performed under local anesthesia in an outpatient setting. The seeds are loaded into long hollow needles which are inserted through the perineum and into the prostate gland. This procedure is facilitated by the recent developments of imaging equipment such as CT scanning or transrectal ultrasound. While visualizing the gland, the physician can facilitate placement of the seeds allowing for a homogeneous distribution of the radiation.\nWhile providing equivalent success rates to external beam radiation and surgery, TheraSeed offers the advantage of a much lower incidence of impotence and incontinence. Because no major surgery is involved, many TheraSeed patients are up and around within 48 to 72 hours, compared to recovery periods as long as four to six weeks for radical surgery. TheraSeed treatment also offers a cost advantage to the patient (or insurance company) over both surgery and external beam radiation. Cost of the TheraSeed procedure is about one-half of the cost of surgical removal and two-thirds that of external radiation.\nTheraSeed does not represent the only currently available radioactive isotope for cancer treatment, but does offer a much\nshorter half-life and a significantly greater dose rate when compared to other isotopes.\nIt is an objective of the Company to explore and develop other potential uses for TheraSeed in addition to the treatment of prostate cancer whether oncological or non-oncological in application. Theragenics hopes to identify and pursue opportunities for TheraSeed use either through internal resources or partnering where significant synergies can be exploited.\nTheraSphere\nLiver cancer, either primary or secondary to colorectal cancer, incidence has changed very little from 1995 when it was expected to afflict approximately 5,200 Canadians and approximately ten times as many Americans. Associated deaths were estimated at approximately 4,200 Canadians and 43,000 Americans in 1995. Management estimates these North American statistics represent about one-third of the world wide incidence of primary liver cancer and liver cancer secondary to colorectal cancer in areas which would present marketing opportunities to the Company. From the point of diagnosis the average survival time for a liver cancer patient using conventional therapies is one year.\nTheraSphere is used to treat both primary liver cancer and secondary liver cancer in cases where the primary cancer has been or can be arrested.\nBefore the Canadian approval of TheraSphere, treatments for liver cancer were primarily limited to surgery, external radiation, and chemotherapy. Unfortunately surgery is indicated for only 25% of the cases mentioned above and only 25% of that number live for five years or more. External beam radiation has the drawback that the amount of radiation deliverable to the liver tumor is limited by the damage that can be done to healthy liver tissue as radiation passes from outside of the body to the tumor. Finally, chemotherapy, which is the indicated treatment for the majority of liver cancer patients, offers life extension (usually measured in months) but not without the nausea and other side effects commonly associated with it. Also, chemotherapy must be administered in a number of treatments over an extended period of time.\nA TheraSphere treatment dose (less than one-tenth of a teaspoonful of material) contains approximately five million yttrium-90 glass spheres which are each about half the diameter of a human hair. Here again as in the TheraSeed treatment, the key to effectiveness lies in the ability to get the radiation dose in closest proximity to the tumor in order to sufficiently irradiate the cancerous tissue while leaving healthy tissue unaffected. This is done by inserting a catheter into the hepatic artery which carries arterial blood to the liver and injecting the TheraSphere microspheres into this bloodstream. Because of\ngreater blood flow to tumors compared to healthy liver tissue, the microspheres concentrate in the capillaries feeding the tumor. The concentration of microspheres in healthy tissue is much lower. Because of the ability to place the radiation source in such close proximity to the tumor, TheraSphere can deliver a radiation dose to the tumor cells five-times as strong as that which can be delivered via external beam radiation.\nAlthough it is impossible to predict the number of liver cancer patients who might benefit from treatment with TheraSphere, the Company estimates that approximately 50% of the liver cancer patients identified above could be candidates for treatment with TheraSphere. Based on clinical data, TheraSphere offers life extension similar to the data for chemotherapy while producing less severe side effects. TheraSphere has the additional advantage of requiring only a single treatment. A series of chemotherapy treatments equivalent to a single TheraSphere treatment would cost $8,000 to $12,000 per patient.\nProduction\nTheraSeed Implants\nThe Company's TheraSeed devices have substantially the same external envelopes as other seeds in use today and thus supplies of the external envelope are readily available. The production of TheraSeed is dependent upon the availability of Pd-103. In January 1993, Theragenics completed construction of a manufacturing facility to house its first cyclotron. This cyclotron produces Pd-103 and ended the Company's dependence on unreliable outside vendors. In February 1995, a second cyclotron and a facility addition to house the cyclotron were completed. As reported in Theragenics' Form 8-K dated June 29, 1995, the Company entered into two agreements dated June 29 ,1995, each for the purchase of one cyclotron. These third and fourth cyclotrons are expected to be put into service in the late third quarter of 1996 and the mid to late first quarter of 1997, respectively. Cyclotron operations constitute only one component of the TheraSeed manufacturing processes performed at the Buford and Norcross facilities. Significant attention and effort are being focused on improving all aspects of the Company's manufacturing processes with the goal to improve efficiency and provide additional capacity for TheraSeed. Long lead-times (in excess of 18 months) associated with the purchase of a cyclotron and the specially designed facilities to house the equipment creates suboptimal conditions requiring order of this equipment long in advance of its need. This lead-time factor naturally places additional burden on the Company's ability to accurately forecast sales growth. Also at issue is the fact that very rapid sales growth may necessitate multiple purchases of equipment which would then place strain on the Company's ability to finance this type of growth. It is anticipated that if TheraSeed demand continues to expand rapidly, additional cyclotrons will be\nordered.\nTheraSphere\nProduction of TheraSphere requires the services of a number of outside vendors - all of which provide services which can be provided through alternative sources. Theragenics, through its exclusive worldwide sublicense of the TheraSphere product to Nordion, has given Nordion worldwide manufacturing responsibility for the product.\nMarketing\nTheraSeed Implants\nIncreased awareness of the TheraSeed product is the primary focus of Theragenics' Marketing program. In June of 1994, results of a five-year clinical study conducted by Dr. John Blasko, Director of the Northwest Tumor Institute in Seattle, Washington, showed seed therapy to be comparable if not superior to surgery or external beam radiation for early stage prostate cancer. In 1995 Theragenics continued its work to see that this data was available to the medical and lay communities. Theragenics continues to support the expansion of this study.\nThe Company continues to distribute patient information booklets to physician customers, patient support groups and any person calling the Company's Cancer Information Center.\nIn 1995, marketing efforts increased dramatically. A higher volume of advertising placements aimed at men over the age of 50 and retirement communities yielded significant benefits as indicated by increased sales and increased calls to the Company's Cancer Information Center.\nTheragenics continues to support the writing of scholarly articles by doctors using TheraSeed and the placement of these articles in prestigious medical journals. Attendance at small and large meetings of medical clinicians remains a top priority as physician acceptance continues to grow.\nThe Company is pleased that it was able to play a part in providing more equitable Medicare reimbursement for urologists and radiation oncologists who perform the seed implant procedure.\nTheraSphere\nThe Company does not directly market its TheraSphere product. Under a manufacturing and marketing licensing agreement with Nordion International, Inc. (\"Nordion\"), a Canadian company, Nordion has the right to produce and market the TheraSphere\nproduct worldwide for all applications. Also under the agreement, Nordion has substantially all responsibility for seeking regulatory approval of the product in the United States and other countries as it chooses. Nordion is a leading worldwide producer, marketer and supplier of radioisotope products and related equipment. Under a prior licensing agreement, Nordion has distributed the TheraSphere product in Canada since 1991.\nPatents and Licenses\nTheraSeed Implants\nTheragenics holds patents for certain TheraSeed technologies in the United States, Canada, South Africa, Japan and the ten countries of the European patent convention. Theragenics also holds patents in the United States and South Africa for additional TheraSeed technologies and has a PCT patent application on file for Japan, Australia, New Zealand, Canada, and Europe (representing 16 European countries) as well as a direct filing in Mexico.\nTheraSphere\nThe Company holds a worldwide exclusive license from the University of Missouri for the use of technology required for producing TheraSphere. Theragenics also holds the rights to all improvements developed by the University of Missouri on this technology. The Company, in turn, sublicenses exclusive worldwide rights to this technology and all improvements to Nordion International. The University of Missouri holds patents for the TheraSphere technology in several countries including the United States, Canada, Australia, South Africa, Japan and the ten countries of the European patent convention. Pursuant to its license agreement with the University of Missouri, the Company is obligated to pay the University the greater of a fixed annual amount or a percentage of the gross sales amount derived from the sale of TheraSphere.\nTheragenics holds patents for technology concerning methods for delivery of the product in several countries including the United States, Canada, Australia, Argentina, South Africa and the ten countries of the European patent convention and has patent applications on file in other countries including Japan. The Company licenses this technology to Nordion for worldwide use.\nOther\nTheragenics holds patents related to another product used in the treatment of brain cancer. Because of the significant investment required and the uncertain return, this product is not being commercially developed by Theragenics. Therefore, the Company is unable to determine the value of these patents, if any.\nThe Company may file additional patent applications from time-to-time and considers the ownership of patents important, but not necessarily essential, to its operations. In general, the Company will rely upon its personnel, trade secrets, and its products' current position in a highly regulated industry, as well as patent protection, to establish barriers-to-entry and to maintain its industry position. It is possible that others may independently develop similar technology or otherwise obtain access to the Company's know-how. It is not certain that any patents which may be granted to the Company will be valid and enforceable or will withstand a challenge by litigation.\nCompetition\nIn general, competition to TheraSeed stems from conventional methods of treating localized cancer such as surgery, chemotherapy, and external beam radiation. Presently, surgery and external beam radiation comprise the vast majority of the prostate cancer treatment market, and those methods are viewed as Theragenics' main competition. In addition, Iodine (I-125) (\"Iodine\") is commercially available as a permanent implant and also competes with TheraSeed. However, TheraSeed utilizes Palladium-103 (Pd-103) (\"Palladium\") as the isotope for its permanent implant whose properties are very different from Iodine. Iodine's dose rate is one-third that of Palladium and its half-life is three times longer than Palladium's. Such properties represent competitive advantages for Palladium in treating certain kinds of cancer. The Company is aware of no other similar radioactive products competing directly with TheraSeed. Theragenics is the only company in the world, known to management, that commercially produces Pd-103.\nLiver Cancer, which TheraSphere treats, can also be treated by surgery, external beam radiation, and chemotherapy. TheraSphere does not represent a cure for liver cancer but has been shown to prolong life expectancy of the patient and enhance the quality of life during that period. Theragenics is not aware of any other implant available for this type treatment.\nThere are many companies, both public and private, engaged in research on new and innovative methods of treating cancer. Also, there are many companies both public and private, including many large, well-known pharmaceutical, medical and chemical companies, engaged in radiological pharmaceutical and device research. Significant developments by any of these companies could lessen or eliminate the demand for any or all of the Company's products.\nGovernmental Regulation\nThe Company's present and intended future activities in the development, manufacture and sale of cancer therapy products are\nsubject to various laws and regulations, regulatory approvals and guidelines. Within the U.S., the Company's therapeutic radiological devices must comply with the United States Federal Food, Drug and Cosmetic Act which is enforced by the Food and Drug Administration (FDA). The Company's handling of radioactive materials is governed by the state of Georgia in agreement with the Nuclear Regulatory Commission of the United States Government. TheraSeed has regulatory approval for commercial distribution in the United States and Canada, while TheraSphere has regulatory approval for commercial distribution only in Canada. The Company to the best of its knowledge is in compliance with all its licenses for handling radioactive material.\nThe effect of various governments' regulations can delay the marketing of products for a considerable period of time or impose costly procedures upon the Company's activities.\nThe Company is not currently conducting any clinical trial of TheraSphere; but under the terms of the current licensing agreement with Theragenics, Nordion will attempt to obtain regulatory approvals in the United States, Europe, and other areas of the world at its expense and discretion. Regulatory approval of the TheraSphere product has been granted in Canada and the product is presently being marketed in that jurisdiction by Nordion.\nMost countries require approval for the sale of pharmaceuticals and medical devices. These approvals are time-consuming and expensive and can delay or discourage the marketing and development of a company's products in those areas.\nEmployees\nAs of March 20, 1996, the Company had 44 full-time employees (including executive personnel). Of this total, twenty-eight are engaged in development and\/or production of the Company's products. The balance of the Company's employees is engaged in marketing and general corporate activities.\nThe Company's ability to market its products and services, to develop marketable products and to establish and then maintain its competitive position in light of technological developments will depend, to a significant extent, upon its ability to attract and retain qualified personnel. In recognition of this, the Company has granted many of its employees stock options which are contingent on their continued employment. Competition for such personnel is, and should continue to be, intense.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company owns a 10,500 square foot, single story,\nprefabricated building in Buford, Georgia, leases a 10,752 square foot, single story, brick building in Norcross, Georgia and leases a 2,692 square foot, suite of offices in a four-story office building in Norcross, Georgia. The 10,752 square foot Norcross facility houses the Company's assembly, shipping, marketing and administrative operations. The 2,692 square foot Norcross facility provides executive office space while the Buford facility houses the Company's two cyclotrons and its raw material processing operations. The Buford facility is currently being expanded to house two additional cyclotrons. It is anticipated that the Buford facility and neighboring land will provide the core for expansion as manufacturing expands to meet increasing sales demand and will eventually be expanded to include all functions currently housed in the leased Norcross facility.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThere are currently no material legal proceedings pending or, to the knowledge of the Company, threatened against 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 its security holders during the fourth quarter of calendar 1995.\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 over the counter and reported on the National Association of Securities Dealers Automated Quotation (\"NASDAQ\") National Market System. The trading symbol for the Company's Common Stock is \"THRX.\" The high and low prices as reported by NASDAQ for the Company's Common Stock for each quarterly period in 1994 and 1995 are as follows:\nAs of March 20, 1996, the closing price of the Company's Common Stock was $7-7\/8 per share. Also, as of that date, there were approximately 681 holders of record of the Company's Common Stock. The number of record holders does not reflect the number of beneficial owners of the Company's Common Stock for whom shares are held by depositary trust companies, brokerage firms and others.\nDividend Policy\nThe Company has not paid cash dividends in the past and does not currently plan to do so. It is the present policy of the Company's Board of Directors to retain future earnings to finance the growth and development of the Company's business. Any change in current policy will depend upon the financial condition, capital requirements and earnings of the Company as well as other factors which the Board of Directors may deem relevant.\nItem 6.","section_6":"Item 6. Selected Financial Data\nSet forth below are selected financial data derived from the statements of operations of the Company for the years ended December 31, 1991, 1992, 1993, 1994 and 1995 and the balance sheets of the Company at December 31, 1991, 1992, 1993, 1994 and 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.\nTHERAGENICS CORPORATION\nSTATEMENTS OF CASH FLOWS - CONTINUED\nFOR THE THREE YEARS ENDING DECEMBER 31,\nSupplemental Schedule of Non Cash Financing Activities\nDuring 1995, the Company realized an income tax benefit from the exercise and early disposition of certain stock options, resulting in an increase in the deferred tax asset and additional paid in capital of $713,000.\nSupplementary Cash Flow Disclosure:\nThe accompanying notes are an integral part of these statements.\nTHERAGENICS CORPORATION\nNOTES TO FINANCIAL STATEMENTS\nDecember 31, 1994 and 1995\nNOTE A - ORGANIZATION AND DESCRIPTION OF BUSINESS\nTheragenics Corporation (the \"Company\") was organized in November 1981 to develop, manufacture, and market radiological pharmaceuticals and devices used in the treatment of cancer.\nThe Company manufactures and markets primarily one product, which is used in the treatment of cancer. Use of the Company's product is regulated by the U.S. Food and Drug Administration (FDA). The Company sells its product primarily to hospitals, physicians and other health service providers in the United States. The Company therefore is directly affected by FDA regulations and the well being of the health care industry.\nNOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nA summary of the significant accounting policies consistently applied in the preparation of the accompanying financial statements follows:\n1. Use of Estimates in Preparation of Financial Statements\nIn preparing financial statements in conformity with Generally Accepted Accounting Principles (\"GAAP\"), management is required to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses during the reporting period. Actual results could differ from those estimates.\n2. Accounts Receivable\nThe Company considers accounts receivable to be fully collectible; accordingly, no allowance for doubtful accounts is required. If amounts become uncollectible, they will be charged to operations when that determination is made.\n3. Inventories\nInventories are stated at the lower of cost or market. Cost is determined using the specific identification method. Inventory costs consist primarily of costs incurred in the extraction, purification and irradiation processes of an isotope which is the basic component of the Company's primary product.\nTHERAGENICS CORPORATION\nNOTES TO FINANCIAL STATEMENTS - CONTINUED\nDecember 31, 1994 and 1995\nNOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued\n4. Depreciation\nDepreciation is provided for in amounts sufficient to relate the cost of depreciable assets to operations over their estimated service lives on a straight-line basis. Estimated service lives are as follows:\nBuilding 30 years Machinery, leasehold improvements, furniture and equipment 5-10 years\nA significant portion of the Company's depreciable assets are utilized in the production of its product. Management periodically evaluates the realizability of its depreciable assets in light of its current industry environment. Management believes that no impairment of depreciable assets exists at December 31, 1995. It is possible, however, that management's estimates concerning the realizability of the Company's depreciable assets could change in the near term due to changes in the Company's technological and regulatory environment.\n5. Patent Costs\nThe Company capitalizes the costs of patent applications for its products. Amortization is computed on a straight line basis over the estimated economic lives of the patents, commencing at the date of grant of the related patent. Patent costs are net of accumulated amortization of $29,366 and $37,276 at December 31, 1994 and 1995, respectively.\n6. Research and Development Costs\nThe costs of research and development and consumable supplies and materials to be used for the development of the Company's intended products are expensed when incurred.\n7. Net Earnings Per Common Share\nThe net earnings per common share is based on the weighted average number of common shares and common equivalent shares outstanding during each period (11,709,218 in 1993, 11,582,793 in 1994 and 11,759,178 in 1995).\nTHERAGENICS CORPORATION\nNOTES TO FINANCIAL STATEMENTS - CONTINUED\nDecember 31, 1994 and 1995\nNOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued\nFully diluted information is not presented, as fully diluted earnings per share is not materially different from the primary earnings per share presented.\n8. Statements of Cash Flows\nFor purposes of reporting cash flows, cash and short-term investments include cash on hand, cash in banks and commercial paper with original maturities of less than 90 days.\n9. Marketable Securities\nThe Company adopted Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities (SFAS 115), effective January 1, 1994. The adoption of SFAS 115 had no effect upon prior periods.\nAt December 31, 1994, marketable securities are categorized as available for sale and as a result are stated at fair value, which approximated cost. The Company held no marketable securities at December 31, 1995.\n10. Stock Based Compensation\nThe Company stock option plans are accounted for under APB Opinion 25, Accounting for Stock Issued to Employees, and related interpretations.\nNOTE C - INVENTORIES\nInventory consists of the following:\nTHERAGENICS CORPORATION\nNOTES TO FINANCIAL STATEMENTS - CONTINUED\nDecember 31, 1994 and 1995\nNOTE C - INVENTORIES - CONTINUED\n\"Raw material to be recovered\" includes finished products which cannot be sold due to loss of radiation. The irradiated isotope contained in these products can be recovered and reused through a purification process.\nNOTE D - CONSTRUCTION IN PROGRESS\nAt December 31, 1995, construction in progress represented payments made for the construction of manufacturing equipment and facility expansion. Total cost of this project is expected to be approximately $9,000,000, and is expected to be completed in February 1997.\nAt December 31, 1994, construction in progress represented payments made for the construction of manufacturing equipment which was completed and placed in service during 1995.\nNOTE E - INCOME TAXES\nThe Financial Accounting Standards Board (\"FASB\") issued Statement of Financial Accounting Standards (\"SFAS\" and \"FASB\") No. 109, Accounting for Income Taxes, which requires a change from the deferred method to the asset and liability method of accounting for income taxes. Under the asset and liability method, deferred income taxes are recognized for the tax consequences of \"temporary differences\" by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities.\nThe Company implemented SFAS 109 as of January 1, 1993. The deferred tax asset recorded is primarily a result of the recognition of the Company's net operating loss carryforward. The cumulative effect on prior years of the change in accounting principle increased net earnings by $2,860,000 ($.24 per share) and is included in earnings for 1993. The effect of the change on 1993 was to decrease net earnings before cumulative effect of a change in accounting principle by $248,000 ($.02 per share) and increase net earnings by $2,612,000 ($.22 per share).\nTHERAGENICS CORPORATION\nNOTES TO FINANCIAL STATEMENTS - CONTINUED\nDecember 31, 1994 and 1995\nNOTE E - INCOME TAXES - Continued\nThe provision for income tax is summarized as follows:\nSignificant components of the deferred tax asset are as follows:\nThe significant portions of the operating loss carryforwards were incurred while the Company was in the development stage. Upon receiving clearance to market its \"TheraSeed \" product from the U.S. Food and Drug Administration (FDA) in 1986, the Company commenced manufacturing and distribution of its product in 1987. Since emerging from the development stage in 1989, the Company has utilized approximately $3,900,000 of these operating loss carryforwards through December 31, 1995 by generating taxable income. In order to realize income benefit from the remaining operating loss carryforwards at December 31, 1995, it will be necessary for the Company to generate future taxable income of approximately $5,900,000, prior to the expiration of the operating loss carryforward periods. Based on the Company's results of operations subsequent to receiving FDA clearance to market for its product, and on expected future results of operations, management believes that currently it is more likely than not that the income tax benefits of the operating loss carryforwards will be realized within the carryforward period. The amount of deferred tax asset considered realizable, however, could be reduced in the near term if estimates of future taxable income during the carryforward period are reduced.\nTHERAGENICS CORPORATION\nNOTES TO FINANCIAL STATEMENTS - CONTINUED\nDecember 31, 1993 and 1994\nNOTE E - INCOME TAXES - Continued\nThe provision for income taxes differs from the amount of income tax determined by applying the applicable federal rates due to the following:\nFor income tax purposes only, the Tax Reform Act of 1986 enacted an alternative minimum tax system for corporations (the \"AMT\"). AMT is imposed at a 20% rate on the Company's AMT income which is determined by making statutory adjustments to regular taxable income. A company pays the greater of the taxes computed under the \"regular\" tax system or the AMT system. Because AMT net operating loss carryforwards may only be utilized to offset 90% of the AMT income, the Company was subject to the AMT in 1993, 1994 and 1995, resulting in an alternative minimum tax of $6,000, $20,000 and $18,000, respectively. These amounts will be allowed as a credit carryover to reduce the regular tax liability in future years, but not below the AMT of such years.\nAt December 31, 1995, the Company had approximate net federal operating loss carryforwards for regular tax and AMT purposes as follows:\nTHERAGENICS CORPORATION\nNOTES TO FINANCIAL STATEMENTS - CONTINUED\nDecember 31, 1994 and 1995\nNOTE F - NOTES PAYABLE\nIn December 1995, the Company entered into an amended and restated loan and security agreement (the \"loan agreement\") with a financial institution. This loan agreement incorporated and restated the Company's existing term loan and line of credit facility. A summary of the applicable terms follows.\nTerm Loan\nThe term loan is payable in monthly installments of $51,862, including interest at 8.47%. $1,989,119 and $1,519,497 were outstanding under the term loan at December 31, 1994 and 1995, respectively. Interest expense of approximately $140,000 and $106,000 was capitalized with expansion of the manufacturing facility and construction of certain manufacturing equipment during 1994 and 1995, respectively.\nLine of Credit\nThe loan agreement provides for a line of credit of up to $1,000,000. Interest on outstanding borrowings is payable monthly at the prime rate or, at the Company's option, may be payable at the LIBOR rate plus 2%. There was no outstanding borrowings under the line of credit at December 31, 1994 or 1995.\nRevolving Credit Facility\nThe loan agreement also provides for a revolving credit facility of up to $2,000,000. The maximum borrowings under the revolving credit facility can be increased to $4,000,000 under certain conditions. These conditions include, among other things, that the Company achieve certain minimum earnings levels, as defined, for four consecutive quarters. The Company has met the minimum earnings requirements as of December 31, 1995, and management expects that the revolving credit facility will be increased to $4,000,000 during 1996. Interest on outstanding borrowings is payable monthly at the prime rate or, at the Company's option, may be payable at the LIBOR plus 2%. No amounts were outstanding under the revolving credit facility at December 31, 1995.\nAll outstanding borrowings under the revolving credit facility are due in April 1997. However, the outstanding borrowings can be repaid in sixty equal and consecutive monthly installments commencing in May 1997 if the Company meets certain minimum earnings levels, as defined, and certain other financial ratios\nTHERAGENICS CORPORATION\nNOTES TO FINANCIAL STATEMENTS - CONTINUED\nDecember 31, 1994 and 1995\nNOTE F - NOTES PAYABLE - Continued\nfor the year ending December 31, 1996. Additionally, certain mandatory repayments based on \"excess cash flow\", as defined, would be required commencing in May 1998 and annually thereafter.\nAll outstanding borrowings under the loan agreement are collateralized by substantially all of the Company's assets. Provisions of the loan agreement limit the amount of annual capital expenditures, the incurrence of additional debt and, among other things, require the maintenance of certain minimum financial ratios. As of December 31, 1995, the Company was in compliance with the provisions of the loan agreement.\nNOTE G - COMMITMENTS AND CONTINGENCIES\nLicensing Agreement\nThe Company holds a worldwide exclusive license from the University of Missouri for the use of technology, patented by the University, used in the Company's \"TheraSphere\" product. The licensing agreement provides for the payment of royalties based on the level of sales and on lump sum payments received pursuant to a licensing agreement with Nordion International, Inc. (see below).\nThe Company has granted certain of its geographical rights under the licensing agreement with the University of Missouri to Nordion International, Inc., a Canadian company which is a producer, marketer and supplier of radioisotope products and related equipment. Under the Nordion agreement, the Company will receive a licensing fee for each geographic area in which Nordion receives new drug approval. The Company will also be entitled to a percentage of future revenues earned by Nordion as royalties under he agreement. Royalties from this agreement for each of the three years in the period ended December 31, 1995 were not significant.\nIn March 1995, the Company received approximately $85,000 from Nordion for the right to use certain patents and to manufacture, distribute, and sell TheraSphere for all applications worldwide.\nLetter of Credit\nThe Company has a letter of credit outstanding for approximately $315,000 relating to regulatory requirements.\nTHERAGENICS CORPORATION\nNOTES TO FINANCIAL STATEMENTS - CONTINUED\nDecember 31, 1994 and 1995\nNOTE G - COMMITMENTS AND CONTINGENCIES - Continued\nLease Commitment\nThe Company leases office space under a noncancelable lease which expires in December 1998. Approximate minimum lease payments under the lease are as follows: 1996, $64,000; 1997, $67,000; 1998, $69,000.\nRent expense was approximately $70,000, $61,000 and $61,500 for the years ended December 31, 1993, 1994 and 1995, respectively\nNOTE H - TRANSACTIONS WITH RELATED PARTIES\nCertain shareholders and directors provide consulting services to the Company. Total consulting fees paid to shareholders and directors were approximately $77,500, $5,500 and $1,000 during the years ended December 31, 1993, 1994 and 1995, respectively.\nNOTE I - STOCK OPTIONS AND WARRANTS\nThe Company's board of directors has approved three stock option plans which in aggregate cover up to 2,200,000 shares of common stock. The plans provide for the expiration of options ten years from the date of grant and requires the exercise price of the options granted to be at least equal to 100% of market value on the date granted. Stock option transactions for the three years ended December 31, 1995 are summarized below:\nAs of December 31, 1995, options covering approximately 773,000\nTHERAGENICS CORPORATION\nNOTES TO FINANCIAL STATEMENTS - CONTINUED\nDecember 31, 1994 and 1995\nNOTE I - STOCK OPTIONS AND WARRANTS - Continued\nshares were exercisable. Expiration dates for these options range from 1996-2005.\nTwo hundred thousand warrants (200,000) were exercised during 1993, resulting in proceeds to the Company of $175,000. The Company also has warrants outstanding at December 31, 1995, covering 100,000 shares of common stock. The warrants are exercisable at a price of $7.50 per share and expire in May 1999.\nThe Company follows the practice of recording amounts received upon the exercise of options by crediting common stock and additional capital. No changes are reflected in the statements of operations as a result of the grant or exercise of options. The Company realizes an income tax benefit from the exercise or early disposition of certain stock options. This benefit results in an increase to the deferred tax asset and an increase in additional paid-in capital.\nNOTE J - MAJOR CUSTOMERS\nDuring 1994, there were sales to one major customer that equaled approximately ten percent of sales. During 1993 and 1995, there were no customers which individually comprised ten percent of sales.\nNOTE K - EMPLOYEE BENEFIT PLAN\nThe Company sponsors a defined contribution 401(k) Plan covering all employees with at least six months of service and at least 21 years of age. The Plan permits participants to defer a portion of their compensation through payroll deductions. The Company may, at its discretion, contribute to the Plan on behalf of participating employees. No such Company discretionary contributions have been made during any of the three years ended December 31, 1995.\nNote L - RECENTLY ISSUED ACCOUNTING STANDARD\nThe Company currently accounts for the issuance of stock options to employees in accordance with Accounting Principles Board Opinion (\"APB\") Number 25, \"Accounting for Stock Issued to Employees.\" In October 1995, the FASB issued SFAS Number 123 (\"SFAS 123\"), \"Accounting for Stock Based Compensation.\" SFAS 123 allows for the continued use of the method prescribed by APB 25, referred to as intrinsic value method. SFAS 123 also provides an\nTHERAGENICS CORPORATION\nNOTES TO FINANCIAL STATEMENTS - CONTINUED\nDecember 31, 1994 and 1995\nNOTE L - RECENTLY ISSUED ACCOUNTING STANDARD - Continued\nalternative method, referred to as the fair value method. If the intrinsic value method of accounting for the issuance of stock options is used, then SFAS 123 requires disclosure of pro forma net income and earnings per share, as if the fair value method had been used.\nManagement anticipates that the Company will continue to account for the issuance of stock options to employees in accordance with APB 25. Therefore, the only effect of adopting SFAS 123 will be the new disclosure requirements. These disclosure requirements are effective for the year ending December 31, 1996.\nFile No. 0-15443\nSECURITIES AND EXCHANGE COMMISSION\nWashington, D.C. 20549\nEXHIBITS FILED WITH\nANNUAL REPORT ON FORM 10-K\nFOR THE FISCAL YEAR ENDED\nDECEMBER 31, 1995\nunder\nThe Securities Exchange Act of 1934\nTHERAGENICS CORPORATION\n(Exact Name of Registrant as specified in its charter)\nTHERAGENICS CORPORATION\nINDEX TO EXHIBITS\nPage No.\n10.22 Line of Credit Facility and Revolving Credit 45 Facility between Theragenics Corporation and Bank South, N.A. 24.1 Consent of Independent Certified Public 89 Accountant for Incorporation by Reference of Audit Statement into Registration Statement","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":"923071_1995.txt","cik":"923071","year":"1995","section_1":"ITEM 1. BUSINESS\nIPC Information Systems, Inc. (\"IPC\" or the \"Company\") is a worldwide industry leader in providing global specialized voice, video and data solutions to the financial services industry. IPC, with a presence in over 30 countries, has the world's largest installed base of trading positions. IPC, with its subsidiary International Exchange Networks, Ltd. (\"IPC iXnet\"), is implementing a virtual trading environment to meet the financial industry's highly specialized global communication requirements.\nThe Company was established in 1973 as Interconnect Planning Corporation to provide telephone equipment specifically designed to perform in the demanding environment of the financial trading community. In 1984, the Company, then known as IPC Communications, Inc., sold shares of its common stock to the public. In 1986, the Company was purchased by Contel Corporation (\"Contel\") of Atlanta, Georgia, and became known as Contel IPC (the \"Predecessor Company\"). Also in that year, the Company opened its manufacturing facility in the United States and commenced operations in the United Kingdom. Contel, including the Predecessor Company, was acquired by GTE Corporation in early 1991. In October 1991, the Predecessor Company was acquired (the \"Acquisition\") and renamed IPC Information Systems, Inc.. In 1992, the Company elected to separate its operations in the United Kingdom from its operations in the United States (\"IPC-US\") for tax planning purposes. IPC-US also elected to be treated as an S corporation for federal income tax purposes. IPC Information Systems currently operates in the United Kingdom as a United Kingdom unlimited liability company (\"IPC-UK\"), and is 50% percent owned by each of HNG Corp. and RIE Corp.. HNG Corp. and RIE Corp. are direct wholly owned subsidiaries of IPC-US. On October 3, 1994 the Company completed an Initial Public Offering (the \"Offering\") of 3,250,000 shares of common stock at a price of $15.00 per share. Effective October 1, 1994, prior to completing the Offering, the Company terminated its S corporation status and became subject to corporate federal income taxes.\nDuring June, 1995 the Company acquired an 80% interest in IPC iXnet, which is building an international virtual private network to provide seamless global connectivity on a common technology platform and value added functionality that is tailored to the financial service industry's unique communications needs. System capabilities will include linkage of IPC's Tradenet MX digital voice communication systems, emulation of direct, private lines, dial-up video, automatic routing and other value-added services, features and products.\nThe Company's highly reliable, customized telecommunications systems are capable of providing high speed access to as many as 23,000 telephone lines and incorporate many features designed to increase user productivity, speed and quality of communication. The Company's systems are used on financial trading floors (where they are known as \"turrets\" or \"dealerboards\"), and in \"command and control\" systems by utilities and emergency service providers. IPC provides a high level of support for its products through annual or multi-year service contracts with its customers. The Company has also expanded into the design, integration, implementation and support of local (\"LAN\") and wide area networks (\"WAN\") to provide voice, data and video networking solutions for its customers, marketed as Information Transport Systems.\nDuring April, 1995 the Company acquired Bridge Electronics, Inc. (\"IPC Bridge\"), a recognized leader in the design, manufacture and marketing of specialized open-line speaker systems used by the foreign exchange community and other traders in the financial services industry and the industry's only provider of digital speaker systems.\nThe Industry\nGlobal Virtual Private Network. In fiscal 1996, IPC iXnet will provide an international virtual private network specifically designed for the financial services industry. An international virtual private network is a network, operating on a global basis, in which the user has all the services, capabilities and performance of a dedicated private network, but it is provided on a shared, switched network. The network will provide seamless global connectivity on a common technology platform and value added network functionality that is tailored to the financial services industry's unique communication needs. System capabilities will include linkage of IPC's Tradenet MX digital voice communication systems, emulation of direct private lines, dial up video, automatic routing, and other value-added services, features and products.\nInformation Transport Systems. As opposed to the monolithic network designs developed in the past, in which large mainframe computers served numerous \"dumb\" terminals, today's heterogeneous, distributed computing environment consists of networked desktop personal computers and workstations, print, facsimile and file servers, facsimile machines and LAN and WAN connections.\nThese components may have different communication protocols to be interfaced, and may involve hardware or software from a variety of vendors. In a heterogeneous, distributed computing environment, a wide range of physical media options, such as copper, coaxial or fiber optic cable, and physical and logical architectures may be present. Designing a network that optimally balances efficient, high- speed data flow, minimizes the cost of installation and ongoing maintenance and provides both maximum responsiveness and flexibility to the user can be extremely challenging. Selecting the best physical media and associated components for the network has become increasingly critical in network design. While devices such as intelligent hubs, routers and bridges have been developed to enable efficient data traffic flow throughout a network and increase network capacity, these devices only work to their optimum capabilities when all aspects of the network are properly designed. In choosing the physical media and associated components, network designers must allow not only for current use but also for network upgrade, expansion and reconfiguration.\nCommunications networks have become critically important as companies have realized that the worldwide distribution of information across their entire personnel base is vital to the success of the enterprise. For example, the distribution of market information in a financial services firm is no longer restricted to personnel on the trading floor. This increased need for information distribution and the advances in network design require companies to develop and maintain internal expertise or to outsource their needs to independent specialists. In response to its awareness of this increasing demand the Company implemented its Information Transport Systems program specifically designed to provide voice, data and video networking infrastructures to provide connectivity to all of the customer owned devices which require it. These systems are designed by the Information Transport Systems engineers, in accordance with industry standards, to be flexible and expandable. The Company's expertise in this field encompasses network design, integrating hubs, routers, bridges and similar components from various suppliers and all available physical media, including copper, fiber optic and coaxial cable.\nTurrets. The turret industry is characterized by a relatively small number of manufacturers of highly specialized telecommunications systems sold primarily to companies in the financial services industry. These systems must be exceptionally reliable to accommodate the time critical nature of trading activity. Trading floors may contain in excess of 1,000 turrets, each with access to as many as 600 telephone lines. Although turrets are installed in addition to, and communicate with the internal corporate telephone system (the \"PBX\"), turrets have a multitude of enhanced features when compared to the PBX, including: (i) superior speed and reliability; (ii) non-blocking capabilities even under the busiest trading conditions; (iii) log-on\/log-off features to enable trader mobility; (iv) line assignability to access additional direct telephone lines as needed; and (v) multiple programmable speakers.\nProducts and Services\nGlobal Virtual Private Network\nIn fiscal 1996, IPC iXnet will provide an international virtual private network specifically designed for the financial services industry. An international virtual private network is a network, operating on a global basis, in which the user has all the services, capabilities and performance of a dedicated private network, but it is provided on a shared, switched network. The network will provide seamless global connectivity on a common technology platform and value added network functionality that is tailored to the financial services industry's unique communication needs. System capabilities will include linkage of IPC's Tradenet MX digital voice communication systems, emulation of direct private lines, dial up video, automatic routing, and other value-added services, features and products.\nInitially, the network will provide customers certain benefits, including significantly faster connect times and global network management resulting from using a common equipment platform throughout the network, mitigating private line costs as a result of these faster connect times, and enhanced flexibility by providing customers with access on demand to better handle periods of increased network traffic, resulting in further savings to network users. Subsequently, software enhancements will be added to provide value added features specific to the financial services industry's application requirements.\nInformation Transport Systems\nThe Company markets its expertise in the design, implementation and maintenance of high speed data networks as Information Transport Systems. This business line includes three major product and service areas: structured wiring systems, networking products and network implementation and value added services. Information Transport Systems customers purchase these products and services on a stand alone basis or in bundled combinations.\nStructured Wiring Systems. Structured wiring systems provide physical connectivity among all communications devices, such as telephone switching equipment (turret or PBX), facsimile machines, computer networks and video conference facilities. These structured wiring systems are designed in accordance with industry standards to be flexible and expandable. Structured wiring systems employ a combination of fiber optic, coaxial and copper cabling systems. Providing a customer with a structured wiring system includes several distinct phases: network design, documentation, installation, certification and ongoing service and maintenance. The Company offers its structured wiring system customers design input on various system elements, including diversity of cable routing, uninterruptable power systems, security safeguards and cable management systems. The Company places special emphasis on the testing and certification phases of the project since today's high speed networks demand that products be installed in accordance with strict manufacturer specifications. Upon certification, the Company guarantees structured wiring system installations as to transmission characteristics against defects for a period of five years. The Company also offers extensive documentation of the network infrastructure, cable layouts and all device connections. This information is provided on hard copy and in computerized media. In computerized form, the customer can maintain detailed records of all changes and reconfigurations to the network.\nNetworking Products. In addition to structured wiring systems, the Company markets and services a full line of networking system products. These include local area network hubs, adapters, bridges, routers, network management software and protocol converters.\nThe Company sells these products on a stand alone basis or fully installed, configured and integrated with customer systems. These products and services allow the customer to choose the best technology from a wide variety of vendors and integrate these technologies to address the business needs of the organization.\nNetwork Implementation and Support. Complementing the structured wiring and networking products offerings, the Company offers a full line of technical and network implementation and support services. These services are available to customers on a project basis or as part of a long- term technical services contract. The purpose of the long term contract is to allow the customer to have continuous access to high quality technical expertise. These services enable customers to focus their resources on core business activities rather than internal systems support. Such customers will have access to a wide range of IPC technical and operational resources, including network engineering analysis, help desk support, user training and cabling and reconfiguration. These services provide the customers with a single point of access to a wide variety of technical services.\nValue Added Services. The Company provides a wide range of value added services including, total turnkey, virtual trading rooms with coordination of trading room design, consulting, engineering implemention, project management, the staging and burn-in of workstations, technology and operational outsourcing.\nTurrets\nA turret is designed to be a sophisticated telephone system consisting of desktop consoles and backroom switching equipment for personnel involved in activities that require rapid access to telephone lines, and a high degree of reliability, such as the trading activity of a financial services company, and is installed in addition to, and communicates with, the PBX. The turret system has enhanced features and is highly reliable compared to a PBX. The desk console often has multiple handsets and provides access to a much larger number of telephone lines (up to 600). Turrets are used by organizations that have mission critical communications systems, in which personnel need to have rapid access to a large number of lines to deliver or receive critical information. For example, on a trading floor a lost connection could result in a lost transaction. The system must be completely \"non-blocking\" and allow all users to be on the telephone at the same time even under the busiest conditions. In sharp contrast, a typical PBX is designed to accommodate only approximately 20% of users speaking at the same time.\nA turret system installation project involves extensive planning to ensure that all materials and labor are coordinated to achieve an on time, on budget completion. Detailed research is performed, defining all required features and lines. The cabling infrastructure is installed and tested prior to delivery of backroom switching equipment, usually a month before \"cut-over\" (the time when the system use begins). About two weeks prior to the cut-over, the desk consoles are installed and the complete system is rigorously tested. Currently, the largest trading floors have in excess of 1,200 turret positions with access to 8,000-10,000 telephone lines and can take up to a year to complete.\nIPC's design architecture is a major advantage of IPC's turret products. IPC's current systems have a totally distributed architecture with microprocessor units distributed throughout the circuitry. As a result, there is no single point in its turret system that can cause a failure of the entire system.\nTradenet MX. Tradenet MX, a fully digital, distributed architecture product, was designed on a patented mesh-switching fault tolerant network, which is not vulnerable to isolated component failure. Its totally distributed design avoids the disadvantages of centralized processing by equipping each circuit card with two SPARC microprocessors, providing a combined 25 MIPS of processing power per circuit board. Tradenet MX is designed as a platform combining hardware and software upon which new features and applications can be added to enhance the product. Because they are mainly software based, these enhancements can be made quickly to enable the Company to respond rapidly to developments in the market or to a customer's specific requests. The customer can have a continually up-to-date system by gradually upgrading. The Tradenet MX platform is designed with the capability to switch data and video as well as voice.\nMX Compact. During 1994, the Company determined that a more compact and less costly version of Tradenet MX was required for smaller sized locations, both in the financial services industry, and for utilities and emergency service providers. In June 1994, the Company introduced the MX Compact, designed with a capacity of 40 turrets with comparable features of Tradenet MX. The MX Compact is packaged in a single cabinet and competitively priced for smaller branch offices in smaller markets.\nTradenet. The Tradenet turret is an analog system which was introduced in 1989 and which incorporated significant advancements from previous-generation turrets in a number of areas. First, the Tradenet's console was upgraded to contain larger line and feature keys and a bright electroluminescent display. Additionally, the Tradenet was made easier to program and contained more features than previous turrets. Finally, the Tradenet was much smaller than the turrets it replaced, and allowed market data terminals to be placed on top of the turret console without obstructing line of sight between traders.\nExchangefone. Exchangefone, introduced in 1983, is an extremely ruggedized key telephone specifically designed for use on exchange floors. Exchangefone uses distributed microprocessor technology to provide ease of feature customization and a significant reduction in the cable between the trading floor and the backroom switching equipment.\nOpen Line Speaker Systems. The Company manufactures open line, digital, turnkey speaker systems for the financial services industry. These speaker systems provide full-duplex communications over two-wire or four-wire circuits that enable brokers to react instantaneously when trading. From a single microphone, brokers can broadcast simultaneously to numerous customers. Additionally, these speaker systems contain Digital Signal Processor software. This software enables the speaker systems to be utilized at increased volumes with minimal distortion, echo, feedback and sidetone.\nThe Company also manufactures multi-button key telephone sets and intercom and speaker systems sold in conjunction with turret positions. Additionally, IPC remarkets various other related products including, among others, PBX systems, video conferencing equipment and voice logging and recorder devices.\nTurret Service. Following a standard one year warranty period after installation of a turret system, a customer generally enters into an annual or multi-year service contract, paid either monthly or quarterly in advance. In addition, turret services include moves, additions and changes to system configurations.\nMarketing and Sales\nThe Company presently markets its products domestically and internationally through various distribution channels.\nThe Company has direct sales and service locations in New York, London, Atlanta, Boston, Chicago, Cincinnati, Dallas, Houston, Los Angeles, New Jersey, Philadelphia, Pittsburgh, San Francisco, St. Louis, Toronto, Canada and Washington D.C. The Company also has a strong network of established distribution partners in Argentina, Australia, Austria, Belgium, Bermuda, Brazil, Canada, France, Germany, Greece, Hong Kong, Indonesia, Ireland, Italy, Japan, Kuwait, Luxembourg, Malaysia, Mexico, the Netherlands, New Zealand, Singapore, Switzerland, Thailand and Turkey. In order to provide both turret and Information Transport Systems sales and service at each of these locations, IPC has increased the requirements for its distributors to include expertise in LAN design and installation. At a minimum, each distributor will provide a resident qualified systems engineer and will utilize IPC's proprietary system testing equipment at each location.\nIPC maintains a high profile in the financial services market, and increasingly in the utilities and emergency services markets, by using strategic advertising in industry publications and participating in relevant trade shows. The Company actively participates in industry seminars to communicate IPC's capabilities to prospective customers.\nFor information about the Company's geographic segments, see Note 11 to the Consolidated and Combined Financial Statements. Such information is set forth herein on page 36 of this Form 10-K.\nCustomers\nThe principal industries served by IPC include: financial services, banking and stock\/commodity exchanges. Other targeted industries may include utilities, pharmaceutical, health care, fashion, emergency services and insurance. Historically, almost all of the Company's revenues have been derived from sales to customers in the financial services industry. No single customer accounted for more than 10% of the Company's total revenues in fiscal 1995 or 1994.\nBacklog\nAs of September 30, 1995, the Company had a backlog of purchase contracts representing approximately $72.5 million of future revenues, as compared with approximately $70.5 million as of September 30, 1994. Due to the size and lead time of orders, which can vary substantially, and because the Company generally recognizes revenue upon the completion of an installation, the amount of backlog at any date may not be indicative of actual sales for any subsequent period. The Company's backlog includes only orders for new installations and does not reflect annual or multi-year service contracts or orders for the reconfiguration, alteration or expansion of existing systems, as such orders are normally completed within one month.\nResearch and Development\nSince 1973, IPC has designed several generations of products that have been market leaders in both functionality and reliability and continues to work closely with its customers to understand their future requirements. The capabilities of Tradenet MX to switch data and video as well as voice signals provide opportunities for the Company to integrate all of those services to the trader's desk. IPC also holds patents that it believes will enable it to provide important and marketable features to traders when certain ISDN facilities become widely available in the future. In addition, the Company is researching the provision of full motion video to the trading desk.\nATM is an emerging technology that represents a new method of switching and transporting data across disparate LANs and WANs. ATM offers two primary advantages over current networking technologies. First, ATM can move a wide range of data types, such as voice, video, data and graphics, at speeds of up to 2 gigabits per second. ATM provides a point-to-point connection between any two network nodes that makes available the full network bandwidth. Second, ATM allows the dynamic reconfiguration of networks to adapt to the constantly changing needs of workgroups. Today, LANs require the geographic proximity of workgroups to a LAN server while ATM allows the creation of logical networks independent of the location of the individual nodes. ATM is expected to provide low cost connectivity and the high bandwidth necessary to take advantage of the most advanced applications, such as video conferencing and interactive multimedia communications.\nThe Company is a member of the ATM Forum, a select group of technology companies that exchange development information regularly in order to enhance the participants' knowledge of the technology. IPC has already begun research on enhancements to its current digital switch that will enable it to connect to an ATM network.\nManufacturing\nThe Company manufactures its products at a leased 85,000 square foot building in Westbrook, Connecticut. The facility houses production lines, a repair department, inventory, a training center and various support functions, including production scheduling, purchasing and quality assurance personnel and production lines for circuit board assembly.\nManagement believes that the manufacturing facility and its resources are capable of handling expected demand for the foreseeable future. The Company believes that there are adequate supplies of labor in the immediate area of the Westbrook facility.\nMost components have a relatively short lead time of approximately 30 days. However, there are a few long lead time items, specifically displays and buttons, that need up to 24 weeks order time. The Company purchases certain key product components that are made to order from single source suppliers. Materials are ordered to a production forecast that is derived by constantly monitoring sales activity. The Company believes that its relationships with its suppliers are good, and it has not experienced supply difficulties due to a supplier not being able to produce goods.\nCompetition\nThe markets for sophisticated communications equipment and Information Transport Systems are highly competitive. Although some of the Company's competitors are substantially larger and have greater resources, management believes that IPC's strong market position is the result of its consistent ability to produce high quality products, its established reputation for the highest quality service, strong relationships with customers, experienced management and sales and technical staff.\nIn the worldwide market for trading turrets, IPC's main competitors are V Band Corporation and British Telecommunications plc. The Company also competes with Hitachi Ltd., Telaid, Etrali S.A., Telenorma Gmbh (a division of Robert Bosch Gmbh) and LM Ericsson. Management believes it has significant advantages over its competitors by providing superior quality products and outstanding customer service.\nDirect competition to IPC in the Information Transport Systems business is difficult to identify. Although a number of companies can compete for parts of what the Company includes in its customer solutions (for example, cable installation), management believes that its expertise and global capability to\nsupport the full range of Information Transport Systems requirements of large national and international customers provide it with significant competitive advantages.\nDirect competition to IPC iXnet is also difficult to identify. Although a large number of companies provide global telecommunication services, management believes that IPC iXnet will provide a unique value added service to the financial services industry that will provide IPC iXnet with significant competitive advantages.\nIntellectual Property\nThe Company relies on a combination of patents, trade secrets, trademarks, copyrights and other intellectual property law, nondisclosure agreements and other protective measures to protect its proprietary rights. The Company currently has 13 United States patents, including design patents, and five more pending patent applications for its technologies. The Company also relies on unpatented know-how and trade secrets and employs various methods, including confidentiality agreements with employees and consultants, to protect its trade secrets and know-how. The Company also may desire to develop, produce and market commercially viable new products, such as personal communications systems, that may require new or renewed licenses from others.\nEmployees\nAs of September 30, 1995, the Company had 598 full-time, non-union employees worldwide, including 512 in the United States and 86 in the United Kingdom. Of these, 56 were engaged in marketing and sales, 73 in research, development and product engineering, 106 in finance, branch and corporate administration, 178 in manufacturing and 185 in operations.\nAn additional 464 United States workers are represented by collective bargaining units, including 427 within the New York metropolitan area provided under labor pooling agreements between the Company and two of its affiliates. Contracts with unions are negotiated every three years. Current agreements expiring through June 11, 1998 provide benefits, wage rates, wage increases and grievance and termination procedures. The Company has never experienced a work stoppage. Management believes that its current relations with labor are good and that existing union contracts will be renewed.\nEnvironmental Matters\nThe Company is subject to various federal, state and local environmental laws and regulations, including those governing the use, discharge and disposal of hazardous substances in the ordinary course of its manufacturing process. Although management believes that its current manufacturing operations comply in all material respects with applicable environmental laws and regulations, there is no assurance that environmental legislation may not in the future be enacted or interpreted to create environmental liability with respect to the Company's facilities or operations.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company leases its manufacturing facility in Westbrook, Connecticut, its executive offices in New York City, its research and development facility in Stamford, Connecticut and its branch offices and sales offices in the United States and in the United Kingdom.\nThe Company believes that its current facilities are adequate for its immediate and short-term requirements and does not anticipate the need for significant expansion in the foreseeable future.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is a party to various legal proceedings and administrative actions, all of which are of an ordinary or routine nature incidental to the operations of the Company. In the opinion of the Company's management, such proceedings and actions should not, individually or in the aggregate, have a material adverse effect on the Company's financial condition or results of operations. See \"Certain Transactions and Relationships -- Contel Litigation\" contained in the Proxy Statement, for a discussion of certain pending legal proceedings, to which the Company is not a party, involving the Acquisition of the Predecessor Company.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone\nPART II\nITEM 5","section_5":"ITEM 5 MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nThe Company's common stock is listed on the Nasdaq National Market (Nasdaq - IPCI). The following table sets forth the high and low sales prices reported by the Nasdaq. The common stock began trading on September 27, 1994.\nFor the year ended:\nAs of November 30, 1995 there were 56 holders of record of the Company's stock.\nTo date, the Company has not paid any cash dividends to its stock holders. Any future payment 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 pay 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 (unaudited) (amounts in thousands, except earnings per share)\n[FN] (1)Net income includes the cumulative effect of the Company's termination of its S corporation status which resulted in a tax benefit of $ 3,295.\n(2) Pro forma earnings per share was computed by dividing pro forma net income (income before provision for income taxes less pro forma provision for income taxes) by pro forma weighted average number of shares outstanding. The pro forma provision for income taxes assumes that IPC-US was subject to corporate federal income taxes for the year and excludes the tax benefit associated with the termination of the Company's S corporation status (See (1) above). Pro forma weighted average number of shares outstanding is the historical weighted average number of shares outstanding during the year adjusted to give effect to the number of shares whose proceeds were necessary to pay the remaining S corporation distribution to pre-Offering stockholders.\n(3) Effective October 1, 1994, and in connection with the Company's initial public offering, IPC converted from an S corporation to a C corporation. Supplemental pro forma earnings per share for 1994 has been calculated using the Company's reported income before taxes and giving effect for both the Company's fiscal 1995 effective tax rate and weighted average shares outstanding.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe following tables set forth certain statements of operations data and its percentage to total revenues for the periods indicated:\nComparison of the year ended September 30, 1995 to the year ended September 30, 1994\nRevenues. Total revenues increased by $42.6 million or 26.0 %, to $206.3 million in the year ended September 30, 1995 from $163.7 million in the year ended September 30, 1994.\nRevenues from turret installation and related service increased by $29.3 million, or 24.1%, to $150.9 million in the year ended September 30, 1995 from $121.6 million in the year ended September 30, 1995. This increase is primarily attributable to the increased acceptance of Tradenet MX. Management anticipates that sales of Tradenet MX will generate the majority of turret sales and installation revenue for the foreseeable future.\nRevenues from Information Transport Systems sales and related service increased by $13.3 million, or 31.6% to $55.3 million in the year ended September 30, 1995 from $42.1 million in the year ended September 30, 1994. These increases were attributable to the continuing development and expansion of the Information Transport Systems business. Management expects its Information Transport Systems business will continue to grow more rapidly than the turret business and will represent an increasing proportion of total revenues.\nGross Profit. The gross profit as a percentage of total revenues increased to 30.6% for the year ended September 30, 1995 from 29.4% for the year ended September 30, 1994. This increase in gross profit percentage is due to continued installation efficiencies and manufacturing cost reductions.\nResearch and Development Expenses. Research and development expenses increased by $2.5 million, or 32.1%, to $10.1 million in the year ended September 30, 1995 from $7.7 million in the year ended September 30, 1994. The increase was due to the ongoing development of new products and enhancements to existing products. The Company believes that development of new products and enhancements to existing products are essential to its continuing success, and management intends to continue to devote substantial resources to research and product development in the future.\nSelling, General and Administrative Expenses. Selling, general and administrative expenses increased by $7.3 million, or 30.8 %, to $31.0 million in the year ended September 30, 1995 from $23.7 million in the year ended September 30, 1994. As a percentage of revenues, expenses increased to 15.0% for the year ended September 30, 1995, from 14.5% for the year ended September 30, 1994. These increases are attributable to a rise in headcount and other expenses to support higher business levels and the continued development and expansion of the Company's Information Transport Systems business.\nInterest Income \/ (Expense). Interest income \/ (expense) increased to $0.2 million in income for the year ended September 30, 1995 from $1.6 million in expense for the year ended September 30, 1994. This increase was due to the repayment of long-term debt from the proceeds of the Company's initial public offering in October 1994 and interest earned on temporary cash investments and short-term investments throughout fiscal 1995.\nGain on Renegotiation of Lease Obligation on Vacant Facilities. The Company renegotiated its obligation in connection with certain vacant facilities resulting in a $0.5 million gain for the year ended September 1994.\nProvision for Income Taxes. The Company's effective tax rate for the year ended September 30, 1995 was 41%. Effective October 1, 1994, the Company terminated its S corporation status and, as a result, was subject to corporate federal income taxes in fiscal 1995. Accordingly, the year ended September 30, 1995 reflects an increase in the provision for income taxes as the comparable prior year's tax provision was based on the Company's S corporation status. On a comparable basis, assuming the same effective tax rate and number of shares outstanding after the Company's October, 1994 initial public offering, net income\nwould have been $9.2 million or $0.88 per share for the year ended September 30, 1994.\nComparison of the Year Ended September 30, 1994 to the Year Ended September 30, 1993\nRevenues. Total revenues increased by $51.0 million or 45.2%, to $163.7 million in the year ended September 30, 1994 from $112.7 million in the year ended September 30, 1993.\nRevenues from turret sales and installation increased by $15.2 million, or 27.6%, to $70.2 million in the year ended September 30, 1994 from $55.0 million in the year ended September 30, 1993. This increase is primarily attributable to the increased acceptance of Tradenet MX and the continuing level of activity in the financial services industry. Management anticipates that sales of Tradenet MX will generate the majority of turret sales and installation revenue for the foreseeable future.\nRevenues from turret service increased by $5.8 million, or 12.8%, to $51.4 million in the year ended September 30, 1994 from $45.6 million in the year ended September 30, 1993. The increase was due to a higher level of moves, adds and changes to existing installations.\nRevenues from Information Transport Systems sales and installation increased by $24.7 million, or 284.5% to $33.4 million in the year ended September 30, 1994 from $8.7 million in the year ended September 30, 1993. Revenues from Information Transport Systems service increased by $5.2 million, or 150.5%, to $8.7 million in the year ended September 30, 1994 from $3.5 million in the year ended September 30, 1993. These increases were attributable to the continuing development and expansion of the Information Transport Systems business. Management expects its Information Transport Systems business will continue to grow more rapidly than the turret business and will represent an increasing proportion of total revenues. Management expects that service revenue from Information Transport Systems will experience growth as the sales and installation of Information Transport Systems products continue to increase.\nGross Profit. Total gross profit increased by $16.9 million or 54.2%, to $48.0 million in the year ended September 30, 1994 from $31.2 million in the year ended September 30, 1993. The improvement was primarily due to an increase in gross profit from turret sales and installation. The high level of market acceptance of Tradenet MX led to increased unit volumes and allowed the Company to reduce the level of discounts. This combined with continuing cost reduction and installation efficiency helped to increase gross profit margins for turret sales and installation.\nThe gross profit as a percentage of total revenues increased to 29.4% for the year ended September 30, 1994 from 27.6% for the year ended September 30, 1993. The increase in the gross profit percentage in turret sales and installation described above was partially offset by an increase in the proportion of total revenues attributable to the Information Transport Systems business which generally provide a lower margin. To establish the Company's Information Transport Systems business with certain large customers, the Company accepted several installations at lower margins which had an adverse effect on margins in the year ended September 30, 1994.\nResearch and Development Expenses. Research and development expenses remained relatively stable at $7.6 million in the year ended September 30, 1994 compared to $7.7 million in the year ended September 30, 1993 . The slight decrease resulted from a lower utilization of independent consultants. The Company believes that development of new products and enhancements to existing products are essential to its continuing success, and management intends to continue to devote substantial resources to research and product development in the future.\nSelling, General and Administrative Expenses. Selling, general and administrative expenses increased by $4.2 million or 21.4%, to $23.7 million in the year ended September 30, 1994 from $19.5\nmillion in the year ended September 30, 1993. As a percentage of revenues, such expenses were reduced to 14.5% for the year ended September 30, 1994, from 17.3% for the year ended September 30, 1993, as a result of increased revenues and controlled expenditure growth . A portion of the increase in the year ended September 30, 1994 relates to a $0.8 million charge relating to an employment agreement for a senior executive in connection with efforts associated with the Company's Offering and a $0.9 million charge for administrative service fees pursuant to labor pooling agreements entered into as of October 1, 1993. In addition, expenses have increased due to personnel additions to support expanding business levels.\nInterest Income \/ (Expense). Interest income \/(expense) increased to $1.6 million in net expense for the year ended September 30, 1994 from $1.4 million in net expense for the year ended September 30, 1993, due to increased usage of the Company's line of credit necessitated by the growth in its business and increased interest rates.\nGain on Renegotiation of Lease Obligation on Vacant Facilities. The Company renegotiated its obligation in connection with certain vacant facilities resulting in a $0.5 million gain for both the years ended September 1994 and 1993.\nProvision for Income Taxes. For the years ended September 30, 1994 and 1993, IPC-US was an S corporation for United States federal tax purposes. On September 29, 1994, IPC-US filed a notification terminating its S corporation status, effective October 1, 1994, and will be subject to corporate federal income taxes in fiscal 1995. The benefit for income taxes for the year ended September 30, 1994 of $0.9 million results from a tax benefit in the amount of $3.3 million in connection with the Company's termination of its S corporation status partially offset by a provision for state taxes and the taxes of IPC-UK. For the year ended September 30, 1994 the provision for income taxes of $1.3 million relates primarily to taxes payable for the taxable income of IPC-UK.\nLiquidity and Capital Resources\nOn October 3, 1994 the Company completed its Offering of 3,250,000 shares of common stock at $15.00 per share and received Offering proceeds of $45,337, net of underwriting discounts and commissions. During the year ended September 30, 1995, Offering proceeds were used to repay long-term debt of $10,663, repay notes payable to stockholders of $1,411 and pay an S corporation distribution of $18,530 to pre-Offering stockholders. The remaining proceeds were invested in temporary cash investments and short term investments\nNet cash provided by operations was $7.3 million for the year ended September 30, 1995. Net cash provided by operations resulted from operating profits and inventory decreases from production efficiencies, offset by increases in trade receivables primarily from higher sales levels.\nNet cash provided by operations was $7.3 million in the year ended September 30, 1994. Increases in inventory due to higher product demands and increases in trade receivables due to higher sales levels were more than offset by funds provided by increases in customer advances and deferred revenue and accounts payable and higher operating profits.\nNet cash used in operations was $5.2 million in the year ended September 30, 1993 primarily from the funding of inventory purchases required by increasing sales in the latter part of the fiscal year, which was partially offset by funds provided by accounts payable and customer advances and deferred revenue.\nCash used in investing activities was $8.5 million, $1.2 million and $1.5 million for the years ended September 30, 1995, 1994 and 1993, respectively. Net cash flows used in investing activities resulted from property, plant and equipment expenditures, primarily composed of machinery and equipment and leasehold improvements. In connection with the Bridge Electronics, Inc. (\"IPC Bridge\") acquisition payment\nscheduled for January, 1996 the Company purchased $2.0 million of short-term investments during 1995.\nIn December, 1994 the Company signed a promissory note with a bank for a line of credit up to $15 million. This line of credit was not utilized during the year ended September 30, 1995.\nIn June of 1995, the Company acquired a controlling interest in International Exchange Networks, Ltd. (\"IPC iXnet\"). The Company acquired 80% of IPC iXnet for providing $5.5 million in working capital. The acquisition was accounted for using the purchase method of accounting.\nIn April of 1995, the Company acquired the assets of IPC Bridge. The terms of the acquisition include a future payment of $2 million in cash, 76,923 shares of the Company's common stock and possible additional payments contingent on future performance. The acquisition was accounted for using the purchase method of accounting.\nThe Company believes that cash flows from operations and existing credit facilities will be sufficient to meet its working capital and capital expenditure needs for the near future.\nQuarterly Fluctuations and the Effects of Inflation\nThe size and lead time of new orders can vary substantially and, since the Company generally recognizes revenue from the sale and installation of turret systems and Information Transport Systems on the completion of an installation, the Company's quarterly results of operations may fluctuate significantly. Management does not believe that inflation has a significant effect on the Company's results.\nForeign Exchange\nThe Company's shipments to foreign distributors are generally invoiced in US Dollars. As a result, the Company believes its foreign exchange transaction exposure caused by these shipments is insignificant.\nSales to the Company's customers in the United Kingdom are denominated in British Pounds Sterling. The Company does not hedge its net asset exposure to fluctuations in the US Dollar\/British Pound Sterling exchange rate. Accordingly, the Company is subject to risks associated with such fluctuation. However, adjustments to the Company's financial position as a result of currency fluctuations have not been significant.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nSee Financial Statements and Financial Statement Schedule beginning on page 21.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND OTHER OFFICERS OF THE REGISTRANT\na. Identification of Directors:\nThe information required by this Item is incorporated herein by reference to the information contained under the caption, \"Election of Directors\" in the Proxy Statement which will be filed with the SEC within 120 days after the end of the fiscal year covered by this Form 10-K (the \"Proxy Statement\") . Such information is incorporated by reference pursuant to General Instruction G(3).\nb. Identification of Executive Officers:\nThe information required by this Item is incorporated herein by reference to the information contained under the captions \"Election of Directors\" and \"Management\" in the Proxy Statement. Such information is incorporated by reference, pursuant to General Instruction G(3).\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by this Item is incorporated herein by reference to the information contained under the caption \"Executive Compensation\" in the Proxy Statement. Such information is incorporated by reference, pursuant to General Instruction G(3).\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required by this Item is incorporated herein by reference to the information contained under the caption \"Security Ownership of Certain Beneficial Owners and Management\" in the Proxy Statement. Such information is incorporated by reference, pursuant to General Instruction G(3).\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe information required by this Item is incorporated herein by reference to the information contained under the caption \"Certain Transactions and Relationships\" in the Proxy Statement. Such information is incorporated by reference, pursuant to General Instruction G(3).\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.\n(a)(1) Financial Statements Page(s)\nReport of Independent Accountants 21\nConsolidated and Combined Balance Sheets as of 22 September 30, 1995 and 1994\nConsolidated and Combined Statements of Operations 23 for the Years Ended September 30, 1995, 1994 and 1993\nConsolidated and Combined Statements of Cash Flows 24 for the Years Ended September 30, 1995, 1994 and 1993\nConsolidated and Combined Statements of Stockholders' 25 Equity for the Years Ended September 30, 1995, 1994 and 1993\nNotes to Consolidated and Combined Financial Statements 26-37\n(a)(2) Financial Statement Schedule\nSchedule II - Valuation and Qualifying Accounts 38\nSchedules not listed have been omitted because they are not applicable or are not required or the information required to be set forth therein is included in the Consolidated and Combined Financial Statements or notes thereto.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nIPC INFORMATION SYSTEMS, INC.\nDate: December 29, 1995 By:\/s\/ RICHARD P. KLEINKNECHT Richard P. Kleinknecht 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.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Stockholders of IPC Information Systems, Inc.:\nWe have audited the consolidated and combined financial statements and the financial statement schedule of IPC Information Systems, Inc. listed in Item 14(a) 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 and combined financial position of IPC Information Systems, Inc. as of September 30, 1995 and 1994, respectively, and the consolidated results of their operations and their cash flows for the year ended September 30, 1995 and the combined results of their operations and their cash flows for the years ended September 30, 1994 and 1993, 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.\nNew York, New York December 8, 1995\nIPC INFORMATION SYSTEMS\nNOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS, continued\n(Dollars in Thousands, Except Per Share Amounts)\n1. Change in Capitalization:\nThe Company completed an initial public offering (the \"Offering\") of 3,250,000 shares of common stock at $15.00 per share on October 3, 1994. In connection with the Offering, on May 9, 1994, the Company's stockholders approved a change in the Company's capital stock to authorize 25,000,000 shares of $.01 par value common stock and 10,000,000 shares of $.01 par value preferred stock. Pre-Offering stockholders exchanged their shares for new common shares on a 620.991 for 1 basis prior to consummation of the Offering. The financial statements reflect this change in capitalization.\nPro Forma Information An unaudited pro forma balance sheet as of September 30, 1994 is presented with the historical balance sheets. The pro forma balance sheet includes adjustments for: (a) recording the proceeds of the Offering of $45,337, (b) charging the deferred costs of the Offering of $3,086 against the proceeds from the Offering and (c) payment of notes to stockholders of $1,411, long-term debt of $10,663 and the distribution of $18,530 to the pre-Offering stockholders from the proceeds of the Offering.\nPro forma provision for income taxes for 1994 assumes that IPC-US was subject to corporate federal income taxes for the year and excludes the tax benefit associated with the termination of the Company's S corporation status (see Note 10). The pro forma weighted average number of shares outstanding is the historical weighted average number of shares outstanding during the year adjusted to give effect to the number of shares, at the initial offering price of $15.00 per share, whose proceeds were necessary to pay the remaining S corporation distribution. The pro forma net income per share has been computed by dividing pro forma net income (income before provision for income taxes less pro forma provision for income taxes) by the pro forma weighted average number of shares outstanding.\n2. Summary of Significant Accounting Policies:\nPrinciples of Consolidation and Combination The consolidated financial statements include the accounts of IPC Information Systems, Inc. and its subsidiaries, substantially all of which are wholly-owned. The combined financial statements include the accounts of IPC-US and its affiliated company, IPC-UK. Intercompany balances and transactions have been eliminated.\nRevenue Recognition Revenue from product sales and installation is recognized upon completion of the installation except for revenue from sales to distributors, which is recognized upon shipment. Under contract provisions, customers are progress-billed prior to the completion of the installations. The revenue related to these advance payments is deferred until the system installations are completed. Revenues from \"time and material\" orders and other services are recognized upon completion of the services performed. Contracts for maintenance are billed in advance, and are recorded as deferred revenue and recognized ratably over the contractual periods.\nIPC INFORMATION SYSTEMS\nNOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS, continued\n(Dollars in Thousands, Except Per Share Amounts)\nCash and Temporary Cash Investments The Company places cash with several high quality financial institutions and thereby limits the amount of credit exposure to any single financial institution. Temporary cash investments with original maturities of less than three months are considered cash equivalents and consist of high grade municipal bond funds and time deposits. Temporary cash investments are stated at cost, which approximates fair value. These investments are not subject to significant market risk.\nTrade Receivables Trade accounts receivable potentially expose the Company to concentrations of credit risk, as a large volume of business is conducted with several major financial institutions, primarily companies in the brokerage, banking and financial services industries. To help reduce this risk, customers are progress-billed prior to the completion of the contract.\nInventories Inventories are stated at the lower of FIFO (first in, first out) cost or market. Inventory costs include all direct manufacturing costs and applied overhead.\nProperty, Plant and Equipment Property, plant and equipment are stated at cost and depreciated on a straight-line basis over their estimated useful lives. When property or equipment are sold, retired or otherwise disposed of, the asset cost and related accumulated depreciation are removed from the accounts; gains and losses on such dispositions are reflected in current operations.\nCapitalized Product Development Costs Capitalized product development costs represent costs incurred after technological feasibility is established for the related product. The amortization of capitalized product development costs is, the greater of the amounts computed based on the estimated revenue distribution over the products revenue-producing lives, or the straight-line basis, not to exceed four years, beginning when the product becomes available for general release to customers. No product development costs were capitalized in the years ended September 30, 1995 and 1994. Unamortized capitalized product development costs, which relate solely to the Tradenet MX product, were $626 and $1,251 at September 30, 1995 and 1994, respectively, and are included in other assets. Amortization expense for each of the years ended September 30, 1995, 1994 and 1993 was $626.\nIntangible Assets Intangible assets, which are carried at cost less accumulated amortization, consist primarily of acquired technology and goodwill. Goodwill represents the excess of the cost over the fair value of the identifiable tangible and intangible assets acquired in various acquisitions. Costs allocated to technology and goodwill acquired in acquisitions are amortized on a straight-line basis over the periods benefited, principally 4 to 10 years. The Company measures the recoverability of acquired technology and goodwill based on anticipated gross operating income.\nResearch and Development Research and development expenditures are charged to expense as incurred.\nIPC INFORMATION SYSTEMS\nNOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS, continued\n(Dollars in Thousands, Except Per Share Amounts)\nIncome Taxes In accordance with Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS No. 109\"), the Company recognizes deferred income taxes 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. Valuation allowances are established when necessary to reduce deferred tax assets to the amount that is \"more likely than not\" to be realized. Provision for income taxes is the tax payable for the period and the change during the period in deferred tax assets and liabilities.\nForeign Currency Translation Adjustment The balance sheets and statements of operations of IPC-UK are measured using the local currency as the functional currency. Assets and liabilities of IPC-UK are translated at the average rate of exchange prevailing during the year. Translation adjustments arising from the use of differing exchange rates from period to period are included in the cumulative translation adjustment account in stockholders equity.\nEarnings Per Share Earnings per share are based on the weighted average number of shares of common stock and common stock equivalents outstanding during the period, computed in accordance with the treasury stock method. Historical earnings per share were $2.27 and $0.24 for the years ended September 30, 1994 and 1993, respectively.\nReclassifications Certain reclassifications have been made to the previous years' financial statements in order to conform to the current period's presentation.\n3. Acquisitions During June, 1995 the Company acquired a controlling interest in International Exchange Networks, Ltd. (\"IPC iXnet\"). The Company acquired 80% of IPC iXnet for providing $5,500 in working capital. The acquisition was accounted for using the purchase method of accounting. Included in other assets at September 30, 1995 is $1,222, representing the excess of the cost over the fair value of the identifiable tangible assets acquired allocated to acquired technology.\nDuring April, 1995 the Company acquired the assets of Bridge Electronics, Inc. (\"IPC Bridge\"). The terms of the acquisition include a scheduled future payment in January, 1996 of $2,025 in cash, 76,923 shares of the Company's common stock, valued at $700, scheduled to be issued in January, 1996 and possible additional payments contingent on future performance. The acquisition was accounted for using the purchase method of accounting. Included in other assets at September 30, 1995 is $2,501, representing the excess of the cost over the fair value of the identifiable tangible and intangible assets acquired.\nIPC INFORMATION SYSTEMS\nNOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS, continued\n(Dollars in Thousands, Except Per Share Amounts)\n6. Long-Term Debt:\nAt September 30, 1994 the Company had outstanding debt from a revolving loan and credit agreement, as amended, which provided for revolving credit of up to $13,500. Borrowings bore interest at Chemical Bank's announced prime rate plus 2.75% per annum; the interest rate at September 30, 1994 was 10.5%. In October 1994, the Company repaid its debt in full from the proceeds of the Offering and terminated the agreement under which the debt was incurred. In December 1994, the Company signed a promissory note with a bank for a line of credit up to $15,000 of which none is outstanding at September 30, 1995.\n7. Deferred Compensation and Other Benefit Plans:\nThe Company has assumed responsibility for deferred compensation agreements with certain past key officers and employees. Amounts to be paid range from $20-$75 per individual per annum and are non-interest-bearing, with the payments commencing on specified dates. Payments began in 1992 and continue through 2019. The gross and discounted present value (using an interest rate of 7.5%), net of cash payments, of the amounts to be paid under these agreements, aggregated $7,450 and $3,606 at September 30, 1995 and $7,600 and $3,491 at September 30, 1994, respectively.\nIPC INFORMATION SYSTEMS\nNOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS, continued\n(Dollars in Thousands, Except Per Share Amounts)\nApproximate payments for subsequent annual periods related to the deferred compensation agreements, at September 30, 1995, are as follows:\nThe Company has accrued for the minimum annual rental and estimated building operating costs under noncancellable operating leases for vacated facilities. These leases extend through May 1998. The gross and discounted present value of the accrued liability, net of payments made, approximated $1,958 and $1,844 at September 30, 1995 and $3,367 and $3,086 at September 30, 1994, respectively. The discount rate applied was 6.8%.\nEmployment Agreements The Company has executed employment contracts for future services, that vary in length up to 5 years, with certain senior executives for which the Company has a minimum commitment aggregating approximately $9,300 at September 30, 1995.\nIPC INFORMATION SYSTEMS\nNOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS, continued\n(Dollars in Thousands, Except Per Share Amounts)\n9. Related Party Transactions:\nServices Provided Affiliated companies performed various services and provided certain equipment to the Company. Services and\/or equipment provided by affiliates are billed to the Company and settled through a periodic cash transfer to the affiliate. Approximately $38,666, $36,293 and $22,395 of technical labor, and $2,083, $1,767 and $1,746 of administrative labor was provided through agreements with KEC and KEC-NJ during the years ended September 30, 1995, 1994 and 1993, respectively.\nEffective October 1, 1993, the Company formalized in writing existing arrangements with KEC and KEC-NJ with respect to a pool of field technicians utilized by all three companies. KEC and KEC-NJ are responsible for administering the payroll and related services for these technical and clerical workers and the Company reimburses all compensation and benefits paid by KEC and KEC-NJ attributable to services performed for the Company plus a fee equal to 2.5% of such costs. For the years ended September 30, 1995 and 1994, KEC and KEC-NJ billed the Company payroll administrative services of $1,024 and $922, respectively.\nApproximately $2,986 of subcontract labor was provided by KEC during the year ended September 30, 1993. For the year ended September 30, 1993, KEC billed the Company administrative services of $200.\nA portion of the Company's New York branch operation is co- located with KEC in a building owned by the Principal Stockholders. For each of the years ended September 30, 1995, 1994 and 1993, the Company was charged approximately $430 for rent expense. In addition, for the years ended September 30, 1995, 1994 and 1993, the Company rented on a month to month basis two other facilities from entities controlled by the Principal Stockholders for which the Company was charged approximately $55, $130 and $98, respectively.\nEquipment Rentals Equipment rentals from an affiliated company were $975, $1,201 and $754 for the years ended September 30, 1995, 1994 and 1993, respectively.\nSubcontracts and Other The Company and other companies controlled by the Principal Stockholders periodically subcontract certain work to one another. Amounts charged to companies controlled by the Principal Stockholders under subcontracts with IPC for the years ended September 30, 1995 and 1994 were approximately $2,220 and $128, respectively, while amounts charged to IPC under subcontracts with companies controlled by the Principal Stockholders were approximately $587 and $993, respectively.\nIn addition to the foregoing, the Company, KEC and KEC-NJ entered into a 20 year agreement dated as of May 9, 1994, with respect to business opportunities regarding cabling of communication infrastructures. KEC and KEC-NJ have agreed not to bid for or accept cabling jobs in competition with the Company, if it intends to bid or accept such work. In addition, because the Company is not a licensed electrical contractor, it has agreed to refrain from bidding for or accepting without the consent of KEC or KEC-NJ, as the case may be, all opportunities that combine both electrical and cabling work. The Company has also agreed to continue to refer to KEC and KEC-NJ certain\nIPC INFORMATION SYSTEMS\nNOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS, continued\n(Dollars in Thousands, Except Per Share Amounts)\nelectrical contracting bid opportunities identified from time to time. Pursuant to such agreement, all estimates for cabling work shall be generated by the Company on behalf of KEC, and KEC will pay the Company a nominal amount for preparing such estimates.\nThe Company and companies controlled by the Principal Stockholders also charge each other certain miscellaneous expenses, including, but not limited to, office equipment rentals and certain other administrative expenses.\n10.Income Taxes:\nPretax earnings consisted of the following:\nEffective October 1, 1992, IPC-US elected to be treated as an S corporation for federal income tax purposes. In the years ended September 30, 1994 and 1993 the Company was not subject to federal income taxes. The Company's income was passed through and taxed directly to the stockholders.\nOn September 29, 1994, IPC-US filed a notification terminating its S corporation status, effective October 1, 1994. For the year ended September 30, 1995, the Company was subject to corporate federal income taxes.\nThe provision (benefit) for income taxes consisted of the following:\nIPC INFORMATION SYSTEMS\nNOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS, continued\n(Dollars in Thousands, Except Per Share Amounts)\nThe components of net deferred tax assets are as follows:\nThese net deferred tax assets arise from temporary differences related to depreciation, the amortization of intangible assets, the allowance for doubtful accounts, inventory valuation and the Company's various accruals. No valuation allowance was required at September 30, 1995 and 1994.\nA reconciliation between the statutory U.S. federal income tax rate and the Company's effective tax rate is:\nIPC INFORMATION SYSTEMS\nNOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS, continued\n(Dollars in Thousands, Except Per Share Amounts)\n11. Operations by Geographic Areas:\nInformation about the Company's operations by geographic area is as follows:\nIncluded in the United States revenues are export sales to unaffiliated customers of $17,063, $12,849 and $3,167 for the years ended September 30, 1995, 1994 and 1993, respectively. Transfers from the United States to the United Kingdom, eliminated in consolidation, were $7,999, $6,764 and $6,117 for the years ended September 30, 1995, 1994 and 1993, respectively.\nNo single customer accounted for 10% or more of total revenues. Corporate assets are principally prepaids, intangibles and other assets.\nIPC INFORMATION SYSTEMS\nNOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS, continued\n(Dollars in Thousands, Except Per Share Amounts)\n12. Quarterly Financial Information (Unaudited)\nThe following tables set forth unaudited quarterly financial information for the years ended September 30, 1995 and 1994:\nNet income in the fourth quarter of 1994 includes the cumulative effect of the Company's termination of its S corporation status which resulted in a tax benefit of $3,295.\nSchedule II","section_15":""}
{"filename":"771298_1995.txt","cik":"771298","year":"1995","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 one of the largest domestic producers of underwear and of activewear for the imprinted market, selling products principally under the FRUIT OF THE LOOM(R), BVD(R), SCREEN STARS(R), BEST(TM), MUNSINGWEAR(R), WILSON(R), BOTANY 500(R) and JOHN HENRY(R) 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(R) and OFFICIAL FAN(R) brands. The Company manufactures and markets men's and boys' basic and fashion underwear, activewear for the imprint market, casualwear, jeanswear using the GITANO(R) brand name, licensed sports apparel, women's and girls' underwear, infants' and toddlers' apparel and family socks.\nThe 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. 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 1995 the Company took several actions in an effort to substantially reduce the Company's cost structure, streamline operations and further improve customer service. These actions included the closing of certain domestic manufacturing operations, further consolidation of the Company's Gitano and licensed sportswear operations, the curtailment of selling and marketing activities in Mexico and the accelerated migration of some manufacturing cut and sew operations to lower cost, offshore locations. In addition, the Company reviewed the operations of Salem Sportswear Corporation (\"Salem\") and Gitano Fashions Limited (\"Gitano\") and decided to discontinue the use of the SALEM(R) brand and redeployed the other tangible assets relating to the Salem business to other brands within the Company's licensed sports apparel operations. The Company also implemented a plan to restructure the Gitano business and to improve Gitano's profitability. See \"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\" and \"SPECIAL CHARGES\" in the Notes to Consolidated Financial Statements.\nDuring the last five calendar years, the Company has been one of the market leaders in men's and boys' underwear, with an annual market share ranging from approximately 35% to 40%. In 1995, the Company's share in the men's and boys' underwear market was approximately 35%, roughly equal to the market share of its principal 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(TM)) 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(R), 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 35% of the screen print T-shirt market. The Company produces and sells blank T-shirts and fleecewear under the SCREEN STARS brand name and premium fleecewear and T-shirts under the FRUIT OF THE LOOM, LOFTEEZ(TM) and BEST(TM) BY FRUIT\nITEM 1. BUSINESS -- (CONTINUED) 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, improved distribution capabilities 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 basic styles of jersey and fleece tops, shorts and bottoms to mass merchandisers. 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 March 1994, the Company purchased certain assets of Gitano, including GITANO and other trademarks. Gitano designs, manufactures (including contract manufacturing) and markets women's and men's jeanswear and jeans related sportswear. 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. In 1995, the Company closed the Gitano New York office and consolidated all Gitano related management functions into the Company's existing operations.\nThe Company entered the imprinted licensed sportswear business through its acquisitions of 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 outerwear under the OFFICIAL FAN and PRO PLAYER 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 Warner Bros. for LOONEY TUNES(R). Under its PRO PLAYER brand, the Company designs 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. In 1995, certain of the Salem operating locations were consolidated into existing Company facilities.\nThe Company produces women's and girls' underwear 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 redesigned 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 1995, the Company's share in the women's and girls' underwear market was approximately 16% compared to a market share of 27% for the largest competing brand. No other competitor had more than a 4% market share in 1995.\nThe Company has granted a license to Warnaco Inc. for the manufacture and sale of 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 manufacturer of sheer hosiery.\nITEM 1. BUSINESS -- (CONTINUED) The Company offers a broad array of childrenswear including decorated underwear (generally with pictures of licensed movie or cartoon characters) under the FUNPALS(R) and FUNGALS(R) brand names and layette sets under the FRUIT OF THE LOOM brand and the WINNIE THE POOH(TM) license which includes both packaged and hanging sets.\nThe Company produces cotton socks for men, women, boys and girls under the FRUIT OF THE LOOM brand. These products are manufactured in a variety of styles and colors including tube, crew and anklets. The 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 an 11% 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 15 primary distribution centers.\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 approximately 62% of the women's and girls' underwear sold in the United States in 1995, up from approximately 59% and 54%, respectively, in 1991. The Company supplied approximately 45% of the men's and boys' underwear and approximately 23% of the women's and girls' underwear sold by discount and mass merchandisers in the United States in 1995. 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 19.5%, 15.6% and 13.4% of consolidated net sales in 1995, 1994 and 1993, respectively. Additionally, sales to a second customer amounted to approximately 10.8%, 11.8% and 12.3% of consolidated net sales in 1995, 1994 and 1993, 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 of 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, Japan and Mexico. The Company's approach has generally been to establish production in the Company's larger 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 cut fabrics from the Republic of Ireland are sewn and returned to Europe for sale.\nSince 1991, the Company's international sales have more than doubled. Sales from international operations during 1995 were $362,800,000 and were principally generated from products manufactured at the\nITEM 1. BUSINESS -- (CONTINUED) Company's foreign facilities. These international sales accounted for approximately 15.1% of the Company's net sales in 1995. 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.\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 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. 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 1995.\nAs part of the closure of the Gitano New York office, responsibility for denim manufacturing was transferred to existing Company manufacturing operations. Denim fabric, which has been purchased from numerous sources in the past and sewn in the Company's Jamaica facility, will now be produced in the Company's own facilities. Existing yarn spinning operations will produce yarn for denim. The Company has added new equipment for dyeing, slashing, weaving and washing which will make the production of jeans totally vertical. The new operations will give the Company the flexibility to produce a variety of fabric weights in the desired colors and shades as required by the retail market. Management believes that the vertical nature of the jeans manufacturing process will give it a competitive cost advantage versus other major jeans manufacturers which are not vertically integrated to this extent.\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 offshore 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.\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 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: BATMAN(TM), BATMAN FOREVER(TM), LOONEY TUNES, SONIC THE\nITEM 1. BUSINESS -- (CONTINUED) HEDGEHOG(TM), MIGHTY MORPHIN POWER RANGERS(TM), LAMB CHOP(R), VR TROOPERS(TM), SKELETON WARRIORS(TM), PEANUTS(TM), POCAHONTAS(TM) 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 boys' 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 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 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 offered for sale a variety of casualwear apparel products bearing the world famous DISNEY(R) characters in Europe, Eastern Europe and the Middle East. Collections offered included T-shirts, sweatshirts, sweatpants, shorts, shirts, turtlenecks, polos and leggings as well as a number of denim products. The Company terminated this license agreement in 1995.\nIMPORTS\nManagement believes that many domestic apparel manufacturers continue to move sewing operations offshore to lower costs and compete with enhanced import competition that is resulting from the Uruguay Round of the General Agreement on Tariffs and Trade agreement. To maintain the Company's position as a low cost manufacturer, the Company is increasing the percentage of garments sewn in the Caribbean and Central America and returned to the United States under Section 9802 of the tariff schedule. The Company also has assembly operations in Mexico. The Company believes that its domestic yarn spinning, knitting, bleaching and dyeing operations continue to provide it with a competitive advantage. Thus, the Company's strategy is to combine low cost textile manufacturing in the United States with a mix of sewing in the United States and offshore so that the Company can continue to offer value to its customers.\nImports from the Caribbean, Central America and Mexico likely will continue to rise more rapidly than imports from other parts of the world. This is because Section 9802 (previously Section 807) grants preferential quotas when United States made and cut fabrics are used, as customs 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.\nDirect imports accounted for approximately 23% of the United States men's and boys' underwear market (66% if Section 9802 imports are included) in 1995 and about 37% (90% including Section 9802 imports) of the women's and girls' underwear market. With regard to activewear and cotton socks, imports accounted for approximately 46% and 2% of these respective markets in 1994, the latest period for which data is available.\nConsequently, management does not believe that direct imports presently pose a significant threat to its business. United States tariffs and quotas established under the international agreement known as the Multifiber Arrangement (\"MFA\") limit the growth of imports from certain low-wage foreign suppliers such as China, India and Pakistan, thus limiting the price pressure on domestic manufacturers resulting from imports from these countries. However, import competition will continue to increase and accelerate as MFA quotas are phased out. Quotas will be completely eliminated on January 1, 2005.\nEMPLOYEES\nThe Company employs approximately 33,300 persons. Approximately 5,900 employees, principally international, are covered by collective bargaining agreements.\nITEM 1. BUSINESS -- (CONCLUDED) MISCELLANEOUS\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 periodically enters into futures contracts and call options as hedges for its purchases of cotton for inventory as a means of fixing its cotton costs. As of December 31, 1995 the Company has entered into contracts which cover a significant portion of its estimated cotton usage for 1996 and 1997.\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. PROPERTIES\nIn 1995, as part of the Company's review of manufacturing capacity and utilization, the Company commenced a plan which included the closure of certain domestic manufacturing facilities and the acceleration of offshore manufacturing capabilities. These actions were part of the Company's continuing effort to improve its manufacturing cost structure. See \"ITEM 1. BUSINESS\" and \"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\" for further discussion of the plan.\nThe Company's remaining properties and facilities aggregate approximately 18,782,000 square feet of usable space, of which approximately 6,856,000 square feet of facilities are under leases expiring through 2017. Management believes that the Company's remaining facilities and equipment are in good condition and that the Company's remaining properties, facilities and equipment are adequate for its current operations. Capital spending, primarily to enhance distribution and yarn manufacturing capabilities and to establish and support offshore assembly operations, is expected to approximate $75,000,000 in 1996. Management believes that these actions, together with planned capital expenditures, will allow the Company to accommodate current and anticipated sales growth and remain a low cost producer in the next several years.\nSet forth below is a summary of the principal facilities owned or leased by the Company:\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company and its subsidiaries are involved in certain legal proceedings and have retained liabilities, including certain environmental liabilities, such as those under the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended, its regulations and similar state statutes (\"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, 1995 related to discontinued operations consist primarily of certain environmental and product liability reserves of approximately $85,800,000. The Company has recorded receivables related to these liabilities of approximately $39,100,000 which, management believes, will be\nITEM 3. LEGAL PROCEEDINGS -- (CONTINUED) 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. Four sites and the total product liabilities individually represent more than 10% of the net reserve and, in the aggregate, represent approximately 95% 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 $5,600,000 to $28,300,000 annually between 1996 and 1999 and $19,300,000 in total subsequent to 1999. Only the long-term monitoring costs of approximately $11,300,000, primarily scheduled to be paid in 2000 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 $28,200,000. 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 1996 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.\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 filed its opening brief in the LMP appeal on September 27, 1995. The plaintiffs' responsive brief was filed in March 1996.\nITEM 3. LEGAL PROCEEDINGS -- (CONCLUDED) In 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.\nManagement believes, based on information currently available, that the ultimate resolution of the aforementioned matters will not have a material adverse effect on the financial condition or results of operations of the Company, but the ultimate resolution of certain of these matters, if unfavorable, could be material to the results of operations of a particular future period.\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 28 years. In October 1994 the United States Tax Court ruled in favor of the Company in the above case. On January 5, 1996, the United States Court of Appeals for the Seventh Circuit affirmed the decision of the United States Tax Court. The IRS has a period of 90 days from the date of the decision to petition for review by the United States Supreme Court. The Company believes, based on information currently available, that the IRS position is without merit and that the Company will prevail should the IRS appeal and the United States Supreme Court decide to hear 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 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 13, 1996, there were 2,188 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. The following table sets forth the high and low market prices of the Class A Common Stock for 1995 and 1994:\nNo dividends were declared on the Company's common stock issues during 1995 or 1994. The Company does not currently anticipate paying any dividends in 1996. 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)\n- ------------------------- (1) This information should be read in conjunction with \"ITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nExcept for historical information contained herein, certain matters set forth in this Annual Report on Form 10-K are forward looking statements that involve certain risks and uncertainties that could cause actual results to differ materially from those in the forward looking statements. Potential risks and uncertainties include such factors as the financial strength of the retail industry (particularly the mass merchant channel), the level of consumer spending for apparel, the amount of sales of the Company's activewear screenprint products, the competitive pricing environment within the basic apparel segment of the apparel industry, the ability of the Company to successfully move labor-intensive segments of the manufacturing process offshore and the success of planned advertising, marketing and promotional campaigns. Investors are also directed to consider other risks and uncertainties discussed in documents filed by the Company with the Securities and Exchange Commission.\nThe table below sets forth selected operating data (in millions of dollars and as percentages of net sales) of the Company:\nOPERATIONS\nIn the fourth quarter of 1995, management announced plans to close certain manufacturing operations and to take other actions to reduce costs and streamline operations. As a result, the Company recorded charges of approximately $372,900,000 ($287,400,000 after tax) related to impairment writedowns of goodwill, costs associated with the closing or realignment of certain domestic manufacturing facilities and attendant personnel reductions and charges related to inventory writedowns and valuations, foreign operations and other corporate issues. These charges were taken in an effort to substantially reduce the Company's cost structure, streamline operations and further improve customer service. See \"SPECIAL CHARGES\" in the Notes to Consolidated Financial Statements.\nThe above charges were recorded as $158,500,000 of impairment writedown of goodwill, $146,700,000 of increases to cost of goods sold, $47,000,000 of increases to selling, general and administrative costs and $20,700,000 of increases to other expense in the accompanying Consolidated Statement of Operations. These charges were based on management's best estimates of the potential costs related to the aforementioned actions. The amounts the Company will ultimately incur are dependent on certain risks and uncertainties and could differ materially from the amounts assumed in arriving at these charges. See \"SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- USE OF ESTIMATES\" in the Notes to Consolidated Financial Statements.\n1995 COMPARED TO 1994\nNet sales increased 4.6% in 1995 compared to 1994. The increase in net sales was primarily due to price increases in all of the Company's businesses. In addition, the inclusion of a full year of the results of Pro Player, which was acquired in August 1994, and the inclusion of a full year of the revenues of the Company's jeans and sportswear subsidiary, Gitano, the assets of which were acquired in late March 1994, also contributed to the increase in net sales. Gitano's revenues now reflect Gitano's transition to a traditional wholesale operation from a marketing service organization in late 1994. These increases were offset by lower unit volume of the Company's activewear and casualwear products as a result of the sluggish retail environment, a weak back-to-school selling season and competitive selling pressures. In addition, lower unit volume of certain products in the Company's licensed sports apparel business, which has been adversely\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED) OPERATIONS -- (CONTINUED) 1995 COMPARED TO 1994 -- (CONTINUED) affected by reduced consumer demand caused by labor issues in certain of the professional sports leagues, resulted in lower unit sales levels in the 1995 period compared to 1994.\nGross earnings decreased 20% in 1995 compared to 1994 due principally to the charges taken in the fourth quarter of 1995, the lower unit volume in activewear and casualwear, the unfavorable effects of operating certain facilities on reduced production schedules in response to lower than expected consumer demand and the effects of cost increases, all of which more than offset the effect of the price increases.\nThe gross margin was 21.5% in 1995 compared to 28.1% in 1994. The gross margin was negatively affected by the charges taken in the fourth quarter of 1995, higher raw material costs, other general cost increases and the unfavorable effects of operating certain facilities on reduced production schedules. Higher sales of closeouts and discontinued products, principally in the Company's casualwear and licensed sports apparel business as a result of the Company's decision to eliminate a number of product offerings, also had a negative impact on gross margin. In addition, a higher proportion of lower margin Gitano products contributed to the gross margin decline. The effect of these items on gross margin was partially offset by the effect of price increases.\nThe Company had an operating loss of $108,100,000 in 1995 compared to operating earnings of $235,000,000 in 1994. The operating margin decreased 14.7 percentage points to a negative 4.5% of net sales for 1995. The decrease in operating earnings in 1995 resulted from lower gross earnings combined with higher selling, general and administrative expenses and the recognition of an impairment writedown of goodwill in 1995. Higher selling, general and administrative costs arose principally from the charges taken in the fourth quarter of 1995 and the inclusion of a full year of the Pro Player operations acquired in 1994. The Pro Player operations include proportionally higher selling expenses for royalties as compared to the Company's consumer packaged goods and activewear operations. In addition, higher selling, general and administrative expenses resulted from higher shipping costs as a result of new distribution locations. The increase in selling, general and administrative expenses also includes higher advertising and promotion expenses, charges in the third quarter of 1995 related to severance costs and, in the first six months of 1995, charges related to the curtailment of selling and marketing activities in Mexico, the closing of Gitano's New York office and the consolidation of all Gitano related management functions into the Company's existing operations. Selling, general and administrative expenses were 17.9% of net sales in 1995 compared to 16.4% of net sales in 1994.\nInterest expense for 1995 increased 22.5% from 1994. The increase was primarily due to the effect of higher debt levels in 1995. Higher debt levels in 1995 were due principally to the acquisition of Pro Player in August 1994, higher working capital levels in 1995 and, in the first three months of 1995, the effect of higher debt levels resulting from the acquisition of Gitano in March 1994.\nIncluded in other expense-net in 1995 are charges of $20,700,000 related to certain obligations and other matters related to former subsidiaries and certain fees related to the modification of certain agreements. See \"SPECIAL CHARGES\" in the Notes to Consolidated Financial Statements. Included 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 did not recur after 1994 as Gitano reverted to a traditional apparel wholesaler. In 1994, this fee income 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 1995 and 1994 included approximately $5,700,000 and $8,100,000, respectively, of deferred debt amortization and bank fees. Other expense-net in 1995 includes $5,700,000 of gains as compared to $1,900,000 of expense in 1994 related to the settlement of certain foreign currency denominated transactions.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED) OPERATIONS -- (CONTINUED) 1995 COMPARED TO 1994 -- (CONCLUDED) The effective income tax rate for 1995 and 1994 differed from the Federal statutory rate of 35% primarily due to the impact of the impairment writedown of goodwill in 1995 and goodwill amortization, portions of which are not deductible for Federal income tax purposes, state income taxes, the provision for interest related to prior years' taxes and the impact of certain non-deductible foreign losses.\nEffective January 1, 1995 the Company recorded the cumulative effect of a change in accounting principle related to the Company's decision to adopt a more conservative position as a result of changes in its business and to expense pre-operating costs as incurred resulting in an after tax charge of $5,200,000 ($.07 per share).\nEarnings (loss) per share before extraordinary item and cumulative effect of change in accounting principles was a loss of $2.99 for 1995 compared to earnings of $.79 in 1994. The net loss per share in 1995 was $3.06 and included a $.07 charge related to the cumulative effect of a change in accounting for pre-operating costs.\nManagement believes that the moderate rate of inflation over the past few years has not had a significant impact on the Company's sales or profitability.\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.\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\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED) OPERATIONS -- (CONCLUDED) 1994 COMPARED TO 1993 -- (CONCLUDED) 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 did not recur after 1994 as Gitano reverted 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.\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.\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 bank facilities. In May 1995, the Company entered into a $155,000,000 short-term revolving commitment (the \"Short-Term Facility\") to supplement its existing revolving lines of credit. The Short-Term Facility was scheduled to expire in May 1996 and has been extended until May 1997. No borrowings are outstanding under this facility.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED) LIQUIDITY AND CAPITAL RESOURCES -- (CONTINUED) The Company has available for the funding of its operations approximately $1,066,600,000 of revolving lines of credit, including the Short-Term Facility. As of March 25, 1996 approximately $398,200,000 was available and unused under these facilities.\nNet cash provided by operating activities for the years ended December 31, 1995 and 1994 were $107,000,000 and $215,100,000, respectively. The primary components of cash provided by operating activities in 1995 were the net loss as adjusted for depreciation and amortization and impairment writedown of goodwill (totaling $95,000,000) plus $59,200,000 of special charges related to long-term items partially offset by deferred income tax benefits of $50,500,000. In 1995 working capital uses were a net $1,300,000 as an increase in inventory of $22,700,000 and a decrease in accounts payable of $53,200,000 were substantially offset by a decrease in notes and accounts receivable of $34,700,000 and other working capital declines of $39,900,000 (primarily the effect of the fourth quarter 1995 charges on other accounts payable and accrued expenses). The primary components of cash provided by operating activities in 1994 were net earnings plus depreciation and amortization (totaling $216,100,000) plus $18,000,000 of special charges related to Artex intangibles 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 increases in inventory in both 1995 and 1994 reflected the Company's ongoing efforts to improve customer service. In addition, in 1995, the sluggish retail environment which led to lower than anticipated sales volumes and, in 1994, the effect of the acquisitions of Artex, Gitano and Pro Player, resulted in higher inventory levels.\nNet cash used for investing activities in 1995 and 1994 were $103,300,000 and $430,800,000, respectively. Capital expenditures, net of amounts attributable to capital leases of $3,900,000 and $40,600,000 in 1995 and 1994, respectively, were $121,700,000 and $246,400,000 in 1995 and 1994, 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. Capital spending, primarily to enhance distribution and yarn manufacturing capabilities and to establish and support offshore assembly operations, is anticipated to approximate $75,000,000 in 1996.\nNet cash used for financing activities in 1995 was $26,600,000 and consisted primarily of principal payments on long-term debt and capital leases. Net cash provided by financing activities in 1994 was $190,900,000 and consisted principally of borrowings under the Company's bank credit agreements partially offset by principal payments on long-term debt and capital leases.\nIn September 1994 the Company entered into a five year operating lease agreement with two annual renewal options, primarily for certain machinery and equipment. The total cost of the assets to be covered by the lease is limited to $175,000,000. The total cost of assets under lease as of December 31, 1995 was approximately $132,000,000. 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.\nIn October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123 (\"Statement No. 123\"), \"Accounting for Stock-Based Compensation,\" which provides an alternative to Accounting Principles Board Opinion No. 25 (\"APB No. 25\"), \"Accounting for Stock Issued to Employees,\" in accounting for stock-based compensation issued to employees. Statement No. 123 allows for a fair value based method of accounting for employee stock options and similar equity instruments. However, for\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONCLUDED) LIQUIDITY AND CAPITAL RESOURCES -- (CONCLUDED) companies that continue to account for stock-based compensation arrangements under APB No. 25, Statement No. 123 requires disclosure of the pro forma effect on net earnings and earnings per share of its fair value based accounting for those arrangements. The disclosure requirements are effective for fiscal years beginning after December 15, 1995. Management continues to evaluate the provisions of Statement No. 123 and has not determined whether the Company will adopt the recognition and measurement provisions or pro forma disclosure provisions of Statement No. 123, which the Company expects would result in increased compensation expense in future periods.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA FRUIT OF THE LOOM, INC. AND SUBSIDIARIES\n- ------------------------- Note: 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, 1995 and 1994, and the related consolidated statements of operations and cash flows for each of the three years in the period ended December 31, 1995. 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, 1995 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, 1995, 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 pre-operating costs in 1995 and for income taxes in 1993.\nERNST & YOUNG LLP\nChicago, Illinois February 14, 1996\nFRUIT OF THE LOOM, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEET\nSee accompanying notes.\nFRUIT OF THE LOOM, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENT OF OPERATIONS\nSee accompanying notes.\nFRUIT OF THE LOOM, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENT OF CASH FLOWS\nSee accompanying notes.\nFRUIT OF THE LOOM, INC. AND SUBSIDIARIES\nNOTES 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.\nUSE OF ESTIMATES. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates depending upon certain risks and uncertainties. Potential risks and uncertainties include such factors as the financial strength of the retail industry (particularly the mass merchant channel), the level of consumer spending for apparel, the amount of sales of the Company's activewear screenprint products, the competitive pricing environment within the basic apparel segment of the apparel industry, the ability of the Company to successfully move labor-intensive segments of the manufacturing process offshore and the success of planned advertising, marketing and promotional campaigns.\nINVENTORIES. Inventory costs include material, labor and factory overhead. Inventories are stated at the lower of cost or market (net realizable value). Approximately 72% of year-end inventory amounts at December 31, 1995 and 1994 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 $88,500,000 and $41,500,000 higher than reported at December 31, 1995 and 1994, 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.\nIMPAIRMENT. In 1995 the Company adopted Statement of Financial Accounting Standards No. 121 \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of\" (\"Statement No. 121\"). Accordingly, when indicators of impairment are present, the Company periodically evaluates the carrying value of property, plant and equipment and intangibles in relation to the operating performance and future undiscounted cash flows of the underlying businesses. The Company adjusts the net book value of the underlying assets if the sum of expected future cash flows is less than book value.\nPRE-OPERATING COSTS. Prior to 1995 pre-operating costs associated with the start-up of significant new production facilities were deferred and amortized over three years. Effective January 1, 1995 the Company recorded the cumulative effect of a change in accounting principle related to the Company's decision to adopt a more conservative position as a result of changes in its business and to expense pre-operating costs as incurred resulting in an after tax charge of $5,200,000 ($.07 per share) in 1995.\nFUTURES CONTRACTS. The Company periodically enters into futures contracts and call options as hedges for its purchases of cotton for inventory as a means of fixing its cotton costs. Futures contracts are closed by either cash settlement or actual delivery of cotton. Gains and losses on these hedges are matched to inventory purchases and charged or credited to cost of sales as such inventory is sold. As of December 31, 1995 the Company has entered into contracts which cover a significant portion of its estimated cotton usage for 1996 and 1997.\nFORWARD CONTRACTS. Prior to 1995 the Company had entered into forward contracts to cover its principal and interest obligations on certain foreign currency denominated bank loans. The original discount on these contracts was amortized over the life of the contract and served to reduce the effective interest cost of these loans. In addition, the Company continues to enter into forward contracts to cover the future obligations of\nFRUIT OF THE LOOM, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nSUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONCLUDED) 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.\nDEFERRED GRANTS. The Company has negotiated grants from the governments of the Republic of Ireland, Northern Ireland and Germany. 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, 1995 and 1994 were $42,200,000 and $33,500,000, respectively. At December 31, 1995 and 1994, the Company has a contingent liability to repay, in whole or in part, grants received of approximately $70,900,000 and $54,300,000, respectively, in the event that the Company does not meet defined average employment levels or terminates operations in the Republic of Ireland, Northern Ireland or Germany.\nSTOCK-BASED COMPENSATION. The Company typically grants stock options for a fixed number of shares to employees with an exercise price equal to the fair value of the shares at the date of grant. The Company accounts for stock option grants in accordance with APB No. 25, and, accordingly, typically recognizes no compensation expense for these stock option grants.\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.\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.\nSPECIAL CHARGES\nIn the fourth quarter of 1995, management announced plans to close certain manufacturing operations and to take other actions to reduce costs and streamline operations. As a result, the Company recorded charges of approximately $372,900,000 ($287,400,000 after tax) related to impairment writedowns of goodwill, costs associated with the closing or realignment of certain domestic manufacturing facilities and attendant personnel reductions and charges related to inventory writedowns and valuations, foreign operations and other corporate issues. These charges were taken in an effort to substantially reduce the Company's cost structure, streamline operations and further improve customer service.\nDuring 1995, management reviewed the operations of Salem and Gitano and decided to discontinue the use of the SALEM brand and redeployed the other tangible assets relating to the Salem business to other brands within the Company's licensed sports apparel business. In addition, the Company determined that significant changes and investment would be necessary to restructure the Gitano business and implemented a plan to improve Gitano's profitability. The Company determined that the carrying value of the intangible assets related to the Salem and Gitano businesses were not expected to be recovered by their future undiscounted cash flows. Future cash flows were based on forecasted trends for the particular businesses and assumed capital spending in line with expected requirements. Accordingly, impairment writedowns of goodwill of $158,500,000 reflect the write-off of all goodwill related to the Salem and Gitano businesses. See \"ACQUISITIONS.\"\nFRUIT OF THE LOOM, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nSPECIAL CHARGES -- (CONCLUDED) During the fourth quarter of 1995, the Company recorded charges of approximately $82,800,000 related to the closing or realignment of certain domestic manufacturing operations, the closing of certain leased facilities, the write-off of fixed assets related to these facilities and changes in estimates of the cost of certain of the Company's insurance obligations. The Company recorded charges of approximately $5,800,000 related to the cost of providing severance and benefits to employees affected by the facility closings as well as certain administrative headcount reductions. The Company recorded charges of approximately $91,100,000 related to other asset writedowns, valuation reserves and other reserves as a result of reductions in its product offerings, changes in its operations and termination or modification of certain license and other agreements. In addition, the Company recorded charges of approximately $19,200,000 related to changes in estimates of certain retained liabilities in connection with the prior sale of certain discontinued operations. Also, the Company adopted a plan to realign certain of its corporate headquarters functions and to terminate its relationship for management services with Farley Industries, Inc. (\"FII\") and, accordingly, recorded charges of approximately $15,500,000 related to lease termination, severance benefits and other costs. See \"RELATED PARTY TRANSACTIONS.\"\nThe above charges were recorded as $158,500,000 of impairment writedown of goodwill, $146,700,000 of increases to cost of goods sold, $47,000,000 of increases to selling general and administrative costs and $20,700,000 of increases to other expense in the accompanying Consolidated Statement of Operations. These charges were based on management's best estimates of the potential costs related to the aforementioned actions. The amounts the Company will ultimately incur are dependent on certain risks and uncertainties and could differ materially from the amounts assumed in arriving at these charges. See \"SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- USE OF ESTIMATES.\"\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 was originally being amortized over periods ranging from 15 to 20 years. In 1995, the Company wrote-off the remaining balance of all goodwill related to the acquisitions of Salem and Gitano. See \"SPECIAL CHARGES.\" In 1994, the Company wrote-off the remaining intangibles related to the Acquisition of Artex.\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 $2,700,000 and $4,100,000 were included in cash and cash equivalents at December 31, 1995 and 1994, respectively. These investments were carried at cost, which approximated quoted market value.\nIncluded in short-term investments at December 31, 1995 and 1994 was $1,500,000 of restricted cash collateralizing domestic subsidiaries' letters of credit and insurance obligations.\nFRUIT OF THE LOOM, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nLONG-TERM DEBT (IN THOUSANDS OF DOLLARS)\n- ------------------------- (1) Represents the present value of future rentals on capitalized leases. The capitalized leases are secured by the related property under lease.\n(2) Interest ranged from 2.1% to 3.7% during 1995 and from 1.89% to 3.6% during 1994. (These rates are net of discount amortization. The Company entered into forward contracts that fixed the dollar amount of interest that had to be paid.)\n(3) Interest ranged from 4.43% to 11.54% during 1995 and from 5.68% to 7.1% during 1994. The weighted average interest rate for borrowings outstanding at December 31, 1995 was approximately 7.29%.\n(4) Interest ranged from 6.44% to 7.13% during 1995 and from 4% to 6.86% during 1994. The weighted average interest rate for borrowings outstanding under the New Term Loan at December 31, 1995 was approximately 6.77%.\n(5) Interest ranged from 5.49% to 9% during 1995 and from 3.41% to 8.5% during 1994.\n(6) Net of unamortized discount of $700 and $900 in 1995 and 1994, respectively (nominal rate 7.875%).\n(7) The obligations of the Company under the New Credit Agreement, the Canadian Note (as hereinafter defined) and the Foreign Credit Facilities are guaranteed by certain of the Company's subsidiaries and such debt effectively ranks ahead of this fixed rate debt with respect to such guarantees.\n(8) Net of unamortized discount of $1,000 and $1,100 in 1995 and 1994, respectively (nominal rate 6.5%).\n(9) Net of unamortized discount of $52,100 and $53,100 in 1995 and 1994, respectively (nominal rate 7%).\n(10) Net of unamortized discount of $1,900 and $2,000 in 1995 and 1994, respectively (nominal rate 7.375%).\nIn August 1993, the Company entered into the New Credit Agreement. Certain indebtedness of the Company under pre-existing secured domestic bank agreements (the \"Credit Agreements\") was refinanced with the proceeds of loans under the New Credit Agreement and the Credit Agreements were terminated at\nFRUIT OF THE LOOM, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nLONG-TERM DEBT -- (CONCLUDED) that time. The 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, 1995 and 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. Borrowings under the New Credit Agreement bear interest at a rate approximating the prime rate (8.5% at December 31, 1995) or, at the election of the Company, at rates approximating LIBOR (5.63% at December 31, 1995) 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, 1995 was approximately 6.31%. Borrowings under the New Credit Agreement are guaranteed by certain of the Company's subsidiaries.\nThe Company has $98,400,000 of standby letter of credit facilities from its bank lenders. At December 31, 1995 and 1994, approximately $79,600,000 and $83,300,000, respectively, 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 $110,000,000 of trade letter of credit facilities. At December 31, 1995 and 1994, the Company had $16,700,000 and $51,100,000, respectively, 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 in installments through 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.\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) restrictions 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 January 1, 1996 does not exceed the sum of approximately $80,000,000 and fifty percent of the Company's consolidated net earnings since January 1, 1996.\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: $14,600,000 in 1996; $41,700,000 in 1997; $63,500,000 in 1998; $783,100,000 in 1999; and $9,900,000 in 2000.\nCash payments of interest on debt were $114,600,000, $86,600,000 and $67,100,000 in 1995, 1994 and 1993, respectively. These amounts exclude amounts capitalized.\nFRUIT OF THE LOOM, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nFINANCIAL INSTRUMENTS\nPrior to December 31, 1995, certain of the Company's foreign subsidiaries had entered 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 sold European currencies and purchased United States dollars. At December 31, 1995 no foreign currency forward exchange contracts were outstanding. 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 served to reduce the effective interest cost of the drachma denominated loans and effectively made these loans the equivalent of United States dollar based loans. All of the aforementioned contracts matured in 1995.\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, 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 when available. At December 31, 1995 and 1994, the fair value of the Company's debt was approximately $1,505,000,000 and $1,369,000,000, 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 42.5% of net sales in 1995 and approximately 26.2% of gross accounts receivable at December 31, 1995. 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, 1995 related to discontinued operations consist primarily of certain environmental and product liability reserves of approximately $85,800,000. The Company has recorded receivables related to these environmental liabilities of approximately $39,100,000 which management believes will be recovered from insurance and\nFRUIT OF THE LOOM, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nCONTINGENT LIABILITIES -- (CONTINUED) 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. Four sites and the total product liabilities individually represent more than 10% of the net reserve and in the aggregate represent approximately 95% 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 $5,600,000 to $28,300,000 annually between 1996 and 1999 and $19,300,000 in total subsequent to 1999. Only the long-term monitoring costs of approximately $11,300,000, primarily scheduled to be paid in 2000 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 $28,200,000. 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 1996 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 judgment 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\nFRUIT OF THE LOOM, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nCONTINGENT LIABILITIES -- (CONTINUED) 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 filed its opening brief in the LMP appeal on September 27, 1995. The plaintiffs' responsive brief was filed in March 1996.\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 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.\nManagement believes, based on information currently available, that the ultimate resolution of the aforementioned matters will not have a material adverse effect on the financial condition or results of operations of the Company, but the ultimate resolution of certain of these matters, if unfavorable, could be material to the results of operations of a particular future period.\nFRUIT OF THE LOOM, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nCONTINGENT LIABILITIES -- (CONTINUED) In 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 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 receives 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 (the \"Acme Boot Credit Facility\"). FI owns 100% of the common stock of Acme Boot. William Farley, an executive officer and a director of the Company, holds 100% of the common stock of FI. See \"RELATED PARTY TRANSACTIONS.\" At December 31, 1995 the Acme Boot Credit Facility provides for up to $30,000,000 of loans and letters of credit. The Acme Boot Credit Facility is secured by first liens on substantially all of the assets of Acme Boot and its subsidiaries. At December 31, 1995 approximately $21,000,000 in loans and letters of credit were outstanding under the Acme Boot Credit Facility.\nAlso, in April 1995, Acme Boot entered into an additional secured credit facility with its bank lender (the \"New Acme Credit Agreement\"). The New Acme Credit Agreement provides for up to $37,000,000 in borrowings and expires in January 1997. In April 1995, Acme Boot used approximately $25,400,000 under this facility to repurchase certain of its debt, preferred stock and common stock. In November 1995, Acme Boot used approximately $11,300,000 under this facility to repurchase substantially all of the remaining portions of its publicly held debt, preferred stock and common stock issues. The New Acme Credit Agreement is secured by a second lien on substantially all of the assets of Acme Boot and its subsidiaries. In addition, the Company has guaranteed, on an unsecured basis, repayment of debt incurred or created under the New Acme Credit Agreement. In exchange for the additional guarantee, the Company received $6,000,000 of initial liquidation preference of Acme Boot's Series C 10% Redeemable Junior Preferred Stock (the \"Junior Preferred Stock\"). The Company has fully reserved for the amount of the Junior Preferred Stock. The Acme Boot Credit Facility and the New Acme Credit Agreement provide that no dividends may be paid in cash on the Junior Preferred Stock subject to certain tests. The Junior Preferred Stock carries voting rights representing 5% of the total voting power of Acme Boot so long as any of Acme Boot's 12 1\/2% Series B Preferred Stock (the \"Acme 12 1\/2% Preferred Stock\") is outstanding. The Acme 12 1\/2% Preferred Stock currently carries voting rights representing in the aggregate 25% of the total voting power of Acme Boot. If none of the Acme 12 1\/2% Preferred Stock is outstanding, the Junior Preferred Stock will carry voting rights representing 25% of the total voting power of Acme Boot.\nFRUIT OF THE LOOM, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nCONTINGENT LIABILITIES -- (CONCLUDED) Summarized unaudited financial information for Acme Boot follows (in thousands of dollars):\nCONDENSED BALANCE SHEET\nCONDENSED STATEMENT OF OPERATIONS\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 $175,000,000. The total cost of assets under lease as of December 31, 1995 was approximately $132,000,000. 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 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, 1995 the\nFRUIT OF THE LOOM, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nLEASE COMMITMENTS -- (CONCLUDED) maximum amount of the residual value guarantee relative to the assets under the lease at December 31, 1995 is approximately $88,400,000.\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, 1995 (in thousands of dollars):\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 $30,200,000, $20,200,000 and $11,600,000 in 1995, 1994 and 1993, respectively.\nSTOCK PLANS\nIn 1995, the Company's Board of Directors approved the repricing of certain of the Company's stock options which had exercise prices higher than the then market price of the Company's Class A Common Stock. The Company took this action as a means of reestablishing the long-term incentive benefits for which the stock option plans were originally designed. The Company exchanged previously granted stock options for fewer new stock options at an exercise price equal to the fair market value on the date of the exchange using a replacement formula based on the modified Black-Scholes Option Pricing Model.\nIn 1995, the Company established the 1995 Executive Incentive Compensation Plan (the \"1995 EICP\"). The 1995 EICP provides for the granting of non-qualified stock options, stock appreciation rights, restricted\nFRUIT OF THE LOOM, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nSTOCK PLANS -- (CONTINUED) stock, deferred stock, dividend equivalents, other stock related awards and performance or annual incentive awards that may be settled in cash, stock or other property. The 1995 EICP replaced the 1994 Plan, as hereinafter defined, and no further grants are allowable under the 1994 Plan. The 1995 EICP is administered by the Compensation Committee of the Board of Directors (the \"Compensation Committee\") and provides for the granting of up to 2,000,000 shares plus any shares of Class A Common Stock which are or become available under the 1994 Plan, the 1992 Plan (as hereinafter defined) and the 1987 Plan (as hereinafter defined), plus 5% of the number of shares of Class A Common Stock newly issued by the Company during the term of the 1995 EICP. Stock options may be granted under the 1995 EICP to eligible employees of the Company, its parent, its subsidiaries and certain entities who provide services to the Company, at a price not less than the market price on the date of grant. Options granted vest and may be exercised at such time as prescribed by the Compensation Committee. The Compensation Committee may, in its discretion, accelerate the exercisability, the lapsing of restrictions or the expiration of deferral or vesting periods of any award under the 1995 EICP, and such accelerated exercisability, lapse, expiration and vesting shall occur automatically in the case of a change of control of the Company as defined in the 1995 EICP. The Company granted 4,660,500 options in 1995, including 2,509,100 options which were exchanged in the repricing in 1995, to eligible employees at prices ranging from $17.75 to $26.13. The Company cancelled 2,051,400 options under the 1995 EICP during 1995. At December 31, 1995 approximately 6,580,500 shares, including shares which became available under the 1994 Plan, the 1992 Plan and the 1987 Plan, were reserved for issuance and 967,500 shares were exercisable under the 1995 EICP at prices ranging from $17.75 to $26.13.\nIn 1995 the Company granted 56,000 shares of performance units under the 1995 EICP. These units confer upon the participants in the 1995 EICP the right to receive one share of Class A Common Stock or the corresponding cash equivalent or a combination thereof for each unit earned at the end of a performance and service period.\nAt December 31, 1995 and 1994, approximately 707,400 and 1,494,700 shares, respectively, of Class A Common Stock were reserved for issuance under the Company's 1987 Stock Option Plan (the \"1987 Plan\"). Under the terms of the Plan, options were 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 at the time of grant but not later than ten years and one day from the date of grant. The 1987 Plan provides for the granting of qualified and nonqualified stock options.\nThe following summarizes the activity of the 1987 Plan for 1995:\nIn 1994 the Company established the Executive Incentive Compensation Plan (the \"1994 Plan\"). The 1994 Plan provided 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 and originally provided for the granting of up to 3,600,000 shares under the plan, which shares were reserved and available for purchase under the provisions of the plan. The 1994 Plan was replaced by the 1995 EICP. Stock options were granted under the 1994 Plan to eligible employees of the Company, its parent, its subsidiaries and certain entities who provide services to the Company at a price not less than the market price on the date of grant.\nFRUIT OF THE LOOM, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nSTOCK PLANS -- (CONTINUED) Options granted vested at such time as prescribed by the Compensation Committee, but in no event was any option exercisable prior to six months following its grant. No option granted was exercisable later than the tenth anniversary date of its grant.\nThe following summarizes the activity of the 1994 Plan for 1995:\nPerformance shares were granted under the 1994 Plan to eligible employees of the Company, its parent, its subsidiaries and certain entities who provide services to the Company. Each performance share has 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 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 at least 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. In September of 1995, the performance period was extended by two years to December 31, 1997. If the shares are not earned in 1996 under the original performance schedule, higher performance goals will be effective for 1997.\nIn 1995 the Company's stockholders approved the Company's 1995 Non-Employee Directors' Stock Plan (the \"1995 Directors' Plan\"). The 1995 Directors' Plan provides for the issuance of up to 200,000 shares of the Company's Class A Common Stock which shares are reserved and available for issuance under the plan. Only directors who are not employees of the Company, any parent or subsidiary of the Company or FII are eligible to participate in the 1995 Directors' Plan. The 1995 Directors' Plan provides for an initial grant to each non-employee director of a right to receive 2,500 shares of the Company's Class A Common Stock (each share representing one \"Restricted Stock Unit\"). In addition, the 1995 Directors' Plan provides for automatic annual grants of 1,250 Restricted Stock Units in 1995 and 1,850 Restricted Stock Units thereafter to each non-employee director at the close of business on the date 120 days after the annual meeting of stockholders. The right to receive shares of the Company's Class A Common Stock in settlement of a Restricted Stock Unit is subject to forfeiture in the event the recipient ceases to serve as a director prior to the second anniversary of the date of grant for any reason other than death, disability, retirement or upon the occurrence of a change of control as defined in the 1995 EICP. At December 31, 1995 22,500 Restricted Stock Units are outstanding under the 1995 Directors' Plan.\nIn 1993, the Company's stockholders approved the Company's Directors' Stock Option Plan (the \"Directors' Plan\"). The Directors' Plan provided for the issuance of options to purchase up to 175,000 shares of Class A Common Stock, which shares were reserved and available for purchase upon the exercise of options granted under the Directors' Plan. As of December 31, 1995 no additional shares can be granted under the Directors' Plan. Only directors who were not employees of the Company, any parent or subsidiary of the Company or FII were eligible to participate in the Directors' Plan. The Directors' Plan was administered by the Company's Board of Directors. Under the Directors' Plan each non-employee director was 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 was elected or after which the person continued as a non-employee director, such non-employee director was granted an option to purchase 2,500 shares of Class A Common Stock. The options were exercisable at a price per share equal to the fair market value per share of the Class A Common Stock on the\nFRUIT OF THE LOOM, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nSTOCK PLANS -- (CONCLUDED) 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. At December 31, 1995, 72,500 options are outstanding and exercisable at prices ranging from $30.88 to $42.\nIn 1992, the Company established the 1992 Executive Stock Option Plan (the \"1992 Plan\"). The 1992 Plan provided 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. 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 were 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 vested 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 ten 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 were exercisable and none of these options had been exercised or canceled. These 325,000 options were cancelled and a total of 227,500 options were issued in their place under the 1995 EICP in connection with the option repricing in 1995. The remaining options under the 1992 Plan were not repriced. In January 1996, 150,000 of these remaining options were cancelled.\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, 1995, none of these options have been exercised or canceled.\nAt December 31, 1995 and 1994, approximately 181,300 and 238,800 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 5,300 previously issued shares during 1995. The Company granted approximately 62,800 shares to eligible employees during 1995.\nAt December 31, 1995 and 1994, approximately 298,600 shares 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.\nFRUIT OF THE LOOM, INC. AND SUBSIDIARIES\nNOTES 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.\nIn March 1996 the Company adopted a stockholder rights plan (the \"Rights Plan\") by which preferred stock purchase rights were distributed for each outstanding share of the Company's Class A Common Stock and Class B Common Stock. The Rights Plan provides for Series A Rights and Series B Rights. Each Series A Right entitles holders of the Company's common stock to buy one one-hundredth of a share of a new series of preferred stock at an exercise price of $90. The Series A Rights will be exercisable only if a person or entity acquires 15% or more of the Company's common stock or announces a tender offer upon consummation of which such person or entity would own 15% or more of the common stock.\nGenerally, if any person or entity becomes the beneficial owner of 15% or more of the Company's common stock, each Series A Right not owned by such a person or entity will enable its holder both to (i) purchase Class A Common Stock of the Company having a value of $180 for a purchase price of $90 and (ii) receive a Series B Right. In addition, in such case, if the Company is thereafter involved in a merger or other business combination transaction with another entity or sells 50% or more of its assets or earning power to another person or entity, each Series B Right and each Series A Right that has not previously been exercised will entitle its holder to purchase, at $90 per Series A and Series B Right, common shares of such other entity having a value of twice that price.\nFRUIT OF THE LOOM, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nCONSOLIDATED STATEMENT OF COMMON STOCKHOLDERS' EQUITY -- (CONCLUDED) The Company generally will be entitled to amend the Rights Plan and redeem the Series A Rights at $.01 per Series A Right at any time prior to the time a person or group has acquired 15% of the Company's common stock. The Series B Rights cannot be redeemed after the time they are issued. The foregoing description of the Rights Plan does not purport to be complete and is qualified in its entirety by reference to the Rights Plan.\nApproximately 9.2% of the Company's common stock at December 31, 1995 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 and, 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, 1995 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 19.5%, 15.6% and 13.4% of consolidated net sales in 1995, 1994 and 1993, respectively. Additionally, sales to a second customer amounted to approximately 10.8%, 11.8% and 12.3% of consolidated net sales in 1995, 1994 and 1993, respectively.\nSales, operating earnings and identifiable assets are as follows (in thousands of dollars):\nFRUIT OF THE LOOM, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nBUSINESS SEGMENT AND MAJOR CUSTOMER INFORMATION -- (CONCLUDED)\nThe operating loss and identifiable assets for 1995 reflect the effect of special charges recorded in the fourth quarter of 1995. See \"SPECIAL CHARGES.\" Corporate assets presented above consist primarily of cash and other short-term investments, deferred financing costs and, in 1995 and 1994, a receivable related to anticipated environmental recoveries. Corporate assets in all periods also include Federal income taxes receivable.\nPENSION PLANS\nPension expense was $12,200,000, $11,700,000 and $5,500,000 in 1995, 1994 and 1993, respectively. The net pension expense is comprised of the following (in thousands of dollars):\nFRUIT OF THE LOOM, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nPENSION PLANS -- (CONCLUDED) The 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, 1995 and 1994 was 7.5% and 8.25%, respectively.\nPlan assets for the Company's funded plans, 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 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 70.6% and 69.3% of the Master Trust Allocated Assets at December 31, 1995 and 1994, respectively.\nIncluded in the Master Trust Allocated Assets at December 31, 1995 and 1994 were 647,852 shares (with a cost of $5,100,000 and a market value of $15,800,000 and $17,500,000, respectively) of the Company's Class A Common Stock.\nAs of December 31, 1995 and 1994, the Master Trust holds 348,012 shares (with a cost of $7,700,000 and a market value of $8,500,000 and $9,400,000, respectively) of the Company's Class A Common Stock that is specifically identified to the retirement plan of FI. Any change in market value associated with these shares is allocated entirely to the FI plan and does not effect the Master Trust Allocated Assets.\nStatement of Financial Accounting Standards No. 87 \"Employers' Accounting For Pensions\" (\"Statement No. 87\") requires recognition on the balance sheet of a minimum liability at least equal to the excess of the accumulated benefit obligation over plan assets. A corresponding amount is recognized as either an intangible asset or a reduction of equity. Accordingly, the Company, at December 31, 1995, has recorded an intangible asset of $2,100,000, an additional liability of $2,700,000 and a reduction in equity of $600,000 to reflect the balance sheet provisions of Statement No. 87 relative to certain unfunded nonqualified pension plans.\nFRUIT OF THE LOOM, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nDEPRECIATION EXPENSE\nDepreciation expense, including amortization of capital leases, approximated $125,500,000, $107,600,000 and $84,300,000 in 1995, 1994 and 1993, respectively.\nADVERTISING EXPENSE\nAdvertising, which is expensed as incurred, approximated $72,000,000, $70,800,000 and $52,800,000 in 1995, 1994 and 1993, respectively.\nINCOME TAXES\nIncome taxes are included in the Consolidated Statement of Operations as follows (in thousands of dollars):\nIncluded in earnings (loss) before extraordinary items and cumulative effect of change in accounting principles are foreign losses of $47,300,000 and $15,500,000 in 1995 and 1994, respectively, and foreign earnings of $17,000,000 in 1993.\nThe components of income tax (benefit) expense related to earnings (loss) before extraordinary item and cumulative effect of change in accounting principles were as follows (in thousands of dollars):\nFRUIT OF THE LOOM, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nINCOME TAXES -- (CONTINUED) The income tax rate on earnings (loss) before extraordinary item and cumulative effect of change in accounting principles differed from the Federal statutory rate as follows:\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\nFRUIT OF THE LOOM, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nINCOME TAXES -- (CONCLUDED) 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 the 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 28 years. In October 1994, the United States Tax Court ruled in favor of the Company in the above case. On January 5, 1996, the United States Court of Appeals for the Seventh Circuit affirmed the decision of the United States Tax Court. The IRS has a period of 90 days from the date of the decision to petition for a review by the United States Supreme Court. The Company believes, based on information currently available, that the IRS position is without merit and that the Company will prevail should the IRS appeal and the United States Supreme Court decide to hear the case.\nCash payments for income taxes were $32,700,000, $49,000,000 and $137,500,000 in 1995, 1994 and 1993, respectively.\nOTHER EXPENSE-NET\nOther expense-net in 1995 includes $20,700,000 of charges to provide for certain retained liabilities in connection with the prior sale of certain discontinued operations and fees related to the modification of certain agreements. See \"SPECIAL CHARGES.\" Included in other expense-net in 1995, 1994 and 1993 was deferred debt fee amortization and bank fees of approximately $5,700,000, $8,100,000 and $7,900,000, respectively. Other expense-net in 1995 includes $5,700,000 of gains as compared to $1,900,000 and $1,500,000 of expense in 1994 and 1993, respectively, related to the settlement of certain foreign currency denominated transactions. In addition, included 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 did not recur after 1994 as Gitano reverted to a traditional apparel wholesaler. In 1994, 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.\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 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 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.\nFRUIT OF THE LOOM, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONCLUDED)\nRELATED PARTY TRANSACTIONS -- (CONCLUDED) Fees for investment banking and financing services are generally payable to FII upon the closing of the subject transaction or agreement.\nEffective January 1995, 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 the 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 $8,100,000, $8,800,000 and $9,900,000 in 1995, 1994 and 1993, respectively. 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 to FII of approximately $2,000,000 and $2,500,000 in 1995 and 1994, respectively, for financing services related to 1994 and 1993, respectively, which costs were capitalized as deferred financing costs in 1995 and 1994, respectively.\nAs a part of the 1995 special charge, the Company decided to integrate into the Company's Bowling Green operations certain functions historically performed by FII personnel. In connection with this effort, the Board of Directors determined that the management agreement with FII should not be renewed for 1996 and that the general management functions previously performed by FII should be assumed directly by the Company. Accordingly, effective January 1, 1996, the Company severed its relationship with FII and by agreement with FII acquired substantially all of the assets (exclusive of a cash balance at December 31, 1995 of approximately $1,500,000) used by FII in providing management services to the Company and directly employed certain persons previously employed by FII who provide such services.\nPursuant to a determination by the non-management members of the Board of Directors, the Company agreed to pay $3,500,000 to FII in consideration of FII's transfer to the Company of such assets and personnel and its release of obligations to FII. The non-management members of the Board of Directors determined that such payment was fair and reasonable to the Company, basing their determination, in part, upon the anticipated cost savings to the Company in 1996 and beyond from the integration of FII functions into the Company, the cost of otherwise creating the workforce necessary to provide the management services previously provided by FII and the assistance of FII in effecting the transition of functions and personnel (including certain executive officers) to the Company. The Company agreed to pay up to approximately $4,000,000 to FII in 1996, all of which relates to the severance of certain FII employees who were not re-employed by the Company, including severance payments under certain employment agreements that were guaranteed by the Company. The Company also agreed to reimburse FII for any direct ordinary and reasonable costs and expenses associated with the transition of management functions from FII into the Company in 1996. The severance and asset purchase amounts were included in the Company's special charge accrued in the fourth quarter of 1995. See \"SPECIAL CHARGES.\"\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 receives 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. 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\nSUPPLEMENTARY DATA\nQUARTERLY FINANCIAL SUMMARY (UNAUDITED) (IN MILLIONS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)\n- -------------------------\n(1) Effective January 1, 1995, the Company recorded the cumulative effect of a change in accounting principle related to the Company's decision to adopt a more conservative position as a result of changes in its business and to expense pre-operating costs as incurred resulting in an after tax charge of $5.2 ($.07 per share).\n(2) Includes pretax charges of $372.9 ($287.4 after tax) related to impairment writedowns of goodwill, costs associated with the closing or realignment of certain domestic manufacturing facilities and attendant personnel reductions and charges related to inventory writedowns and valuations, foreign operations and other corporate issues.\n(3) Includes pretax charges of approximately $40 to write inventories down to net realizable value and a pretax charge of $18 related to the write-off of Artex intangibles.\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, 1995 were as follows:\n- ------------------------- (1) Mr. Holland retired as President and Chief Operating Officer at the end of January 1996.\n(2) Mr. Lappin was appointed to the additional posts of President and Chief Operating Officer at the end of January 1996.\nOfficers serve at the discretion of the Board of Directors. Messrs. Lappin, Cion, Switzer, Bogacki, Ridge and Shanks were employed by FII, which provided management services to companies owned or managed by Mr. Farley. Effective January 1, 1996, the FII Management Agreement was terminated and the functions previously performed by FII began to be performed directly by the Company. See \"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\" 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.\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 is also a director of Dollar General Corp. and Camping World, Inc.\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.\nITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT -- (CONCLUDED) RICHARD M. CION. Mr. Cion has been Senior Executive Vice President of the Company, FII and Acme Boot since before 1991 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.\nLARRY K. SWITZER. Mr. Switzer has been 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 distributor of paper products, 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 consumer home care and commercial chemical products, from before 1991 to August 1992.\nMICHAEL F. BOGACKI. Mr. Bogacki has served as Vice President and Corporate Controller of the Company, FII and FI since before 1991 and as a Vice President of Acme Boot since 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 1991 until October 1991. Mr. Ridge was appointed Vice President - -- Administration of FII and FI in August 1991 and of the Company in October 1991.\nEARL C. SHANKS. Mr. Shanks served as Vice President -- Taxes and Assistant Secretary of the Company, FII and FI from before 1991 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 a Vice President of Acme Boot. Mr. Shanks was Vice President -- Taxes of VBQ from before 1991 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 14, 1996 (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\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS -- (CONTINUED) 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 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 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 1995, 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 $8,100,000, $8,800,000 and $9,900,000 in 1995, 1994 and 1993, respectively. 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 to FII of approximately $2,000,000 and $2,500,000 in 1995 and 1994, respectively, for financing services related to 1994 and 1993, respectively, which costs were capitalized as deferred financing costs in 1995 and 1994, respectively.\nAs a part of the 1995 special charge, the Company decided to integrate into the Company's Bowling Green operations certain functions historically performed by FII personnel. In connection with this effort, the Board of Directors determined that the management agreement with FII should not be renewed for 1996 and that the general management functions previously performed by FII should be assumed directly by the Company. Accordingly, effective January 1, 1996, the Company severed its relationship with FII and by agreement with FII acquired substantially all of the assets (exclusive of a cash balance at December 31, 1995 of approximately $1,500,000) used by FII in providing management services to the Company and directly employed certain persons previously employed by FII who provide such services.\nPursuant to a determination by the non-management members of the Board of Directors, the Company agreed to pay $3,500,000 to FII in consideration of FII's transfer to the Company of such assets and personnel and its release of obligations to FII. The non-management members of the Board of Directors determined that such payment was fair and reasonable to the Company, basing their determination, in part, upon the anticipated cost savings to the Company in 1996 and beyond from the integration of FII functions into the Company, the cost of otherwise creating the workforce necessary to provide the management services previously provided by FII and the assistance of FII in effecting the transition of functions and personnel (including certain executive officers) to the Company. The Company has agreed to pay up to approximately $4,000,000 to FII in 1996, all of which relates to the severance of certain FII employees who were not re-employed by the Company, including severance payments under certain employment agreements that were guaranteed by the Company. The Company also agreed to reimburse FII for any direct ordinary and reasonable costs and expenses associated with the transition of management functions from FII into the Company in 1996. The severance and asset purchase amounts were included in the Company's special charge accrued in the fourth quarter of 1995.\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 receives 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\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS -- (CONCLUDED) lien on certain shares of the Company held by the bank for other loans made to Mr. Farley. See \"CONTINGENT LIABILITIES\" in the Notes to Consolidated Financial Statements.\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. 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\" in the Notes to Consolidated Financial Statements.\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 16 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 16 is filed as part of this Annual Report.\n3. Exhibits\nThe exhibits listed in the Index to Exhibits on pages 51 and 52 are filed as part of this Annual Report.\n(b) Reports on Form 8-K\nIn December 1995 the Company filed a Current Report on Form 8-K dated December 20, 1995 reporting the announcement of fourth quarter charges to operations.\nALTERNATE\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the 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, 1996.\nFRUIT OF THE LOOM, INC.\nBy: LARRY K. SWITZER\n-------------------------------------- (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, 1996.\nFRUIT OF THE LOOM, INC. AND SUBSIDIARIES\nSCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (IN THOUSANDS OF DOLLARS)\n- ------------------------- (1) Recoveries of bad debts and, in 1994 and 1993, the effect of the Acquisitions.\n(2) Bad debts written off and allowances and discounts taken by customers.\nFRUIT OF THE LOOM, INC. AND SUBSIDIARIES\nINDEX TO EXHIBITS (ITEM 14(A)(3) AND 14(C))\n- ------------------------- See footnote on following page.\nFRUIT OF THE LOOM, INC. AND SUBSIDIARIES\nINDEX TO EXHIBITS -- (CONCLUDED) (ITEM 14(A)(3) AND 14(C))\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":"715578_1995.txt","cik":"715578","year":"1995","section_1":"ITEM 1. BUSINESS\nReal Estate Associates Limited VI (\"REAL VI\" or the \"Partnership\") is a limited partnership which was formed under the laws of the State of California on October 12, 1982. On April 22, 1983, REAL VI offered 4,200 units consisting of 8,400 limited partnership interests and warrants to purchase a maximum of 8,400 additional limited partnership interests through a public offering managed by Lehman Brothers Inc.\nThe general partners of REAL VI are National Partnership Investments Corp. (\"NAPICO\"), a California corporation, (the \"Corporate General Partner\"), and Coast Housing Investment Associates (\"CHIA\"). CHIA is a limited partnership formed under the California Limited Partnership Act and consists of Messrs. Nicholas G. Ciriello, an unrelated individual, as general partner, and Mr. Charles H. Boxenbaum as limited partner. The business of REAL VI is conducted primarily by its general partners as REAL VI has no employees of its own.\nCasden Investment Corporation (\"CIC\") owns 100 percent of NAPICO's stock. The current members of NAPICO's Board of Directors are Charles H. Boxenbaum, Bruce E. Nelson, Alan I Casden, Henry C. Casden and Brian D. Goldberg.\nREAL VI holds limited partnership interests in 27 local limited partnerships and a general partner interest in one general partnership. REAL VI also holds a general partner interest in Real Estate Associates III (\"REA III\") which, in turn, holds a general partner interest in one local general partnership and limited partner interests in seven local limited partnerships. The other general partner of REA III is NAPICO. Therefore, REAL VI holds interests either directly or indirectly in 34 local limited partnerships and 2 local general partnerships which own a low income housing project which is subsidized and\/or has a mortgage note payable to or insured by agencies of the federal or local government.\nIn order to stimulate private investment in low income housing, the federal government and certain state and local agencies have provided significant ownership incentives, including among others, interest subsidies, rent supplements, and mortgage insurance, with the intent of reducing certain market risks and providing investors with certain tax benefits, plus limited cash distributions and the possibility of long-term capital gains. There remain, however, significant risks. The long-term nature of investments in government assisted housing limits the ability of REAL VI to vary its portfolio in response to changing economic, financial and investment conditions; such investments are also subject to changes in local economic circumstances and housing patterns, as well as rising operating costs, vacancies, rent collection difficulties, energy shortages and other factors which have an impact on real estate values. These projects also require greater management expertise and may have higher operating expenses than conventional housing projects.\nThe local partnerships in which REAL VI has invested were, at least initially, organized by private developers who acquired the sites, or options thereon, and applied for applicable mortgage insurance and subsidies. REAL VI became the principal limited or general partner in these local partnerships pursuant to arm's-length negotiations with these developers, or others, who normally act as general partners. As a limited partner, REAL VI's liability for obligations of the local limited partnership is limited to its investment. The local general partner of the local limited partnership retains responsibility for developing, constructing, maintaining, operating and managing the project. Under certain circumstances, REAL VI has the right to replace the general partner of the local limited partnerships. As discussed above, REAL VI is a general partner in certain of the local partnerships.\nAlthough each of the partnerships in which REAL VI has invested will generally own a project which must compete in the market place for tenants, interest subsidies and rent supplements from governmental agencies make it possible to offer these dwelling units to eligible \"low income\" tenants at a cost significantly below the market rate for comparable conventionally financed dwelling units in the area. During 1995, projects in which REAL VI had invested were substantially rented. The following is a schedule of the status, as of December 31, 1995, of the projects owned by local partnerships in which REAL VI, either directly or indirectly through REA III, has invested.\nSCHEDULE OF PROJECTS OWNED BY LOCAL LIMITED AND GENERAL PARTNERSHIPS IN WHICH REAL VI HAS AN INVESTMENT DECEMBER 31, 1995\nSCHEDULE OF PROJECTS OWNED BY LOCAL LIMITED AND GENERAL PARTNERSHIPS IN WHICH REAL VI HAS AN INVESTMENT DECEMBER 31, 1995 CONTINUED\nSCHEDULE OF PROJECTS OWNED BY LOCAL LIMITED AND GENERAL PARTNERSHIPS IN WHICH REAL VI HAS AN INVESTMENT DECEMBER 31, 1995 CONTINUED\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThrough its investment in local limited and general partnerships, REAL VI holds interests in real estate properties. See Item 1 and Schedule XI for information pertaining to these properties.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nAs of December 31, 1995, the Partnership's General Partner was a plaintiff or defendant in several suits. In addition, the Partnership is involved in the following lawsuits. In the opinion of management and the Corporate General Partner, these claims will not result in any material liability to the Partnership.\nReal Estate Associates Limited VI vs. Jansen Properties of Florida, Inc., Jeffrey Auslander and Peck, Shaffer & Williams, as Escrow Agents, Case No. 95-7005 AO, Circuit Court, 15th Judicial Circuit, Palm Beach County, Florida. On September 5, 1995, REAL VI filed a declaratory judgment action claiming that it is entitled to $376,500 of funds presently held in escrow which funds were realized from a refinancing of an apartment project in Boynton Beach, Florida in which REAL VI is the limited partner. The contestants to the escrow fund, in addition to REAL VI, are the general partners, Jeffrey Auslander and Jansen Properties of Florida, Inc., and Keith Rothchild, a judgment creditor of Auslander. The case is in its early stages and there is an appeal pending from an order which denied Auslander and Jansen's motion to compel arbitration of the dispute. There are settlement discussions pending between the parties.\nRhonda Harris v. HAPI Management Inc., The Carlton Arms Venture, Rosewood Apartments Corporation and Real Estate Associated Limited VI, Case No. CI90-7512, Circuit Court, 9th Judicial Circuit, Orange County, Florida. The Plaintiff is an acquaintance of a tenant. Plaintiff alleges that on August 13, 1990, while descending the outside wooden staircase one of the steps broke causing Plaintiff to fall down the remainder of the stairs. While the property has been foreclosed on, the alleged incident occurred prior to the foreclosure. Accordingly, this matter was turned over to the Partnership's insurer. Currently no dollar amount has been demanded by the Plaintiff and no medical report or supporting evidence validating this claim has been submitted.\nRosa Cunningham v. Drexel Park Apartments, Drexel Park Limited Partnership and (NAPICO), Case No. C-94-12276 OT, Circuit Court of Maryland, Anne Arundel County, Maryland. On May 2, 1994, the Plaintiff filed a lawsuit. Plaintiff alleges that on December 22, 1992, while exiting her apartment building, she slipped and fell on ice and\/or snow. As a result of the fall, the Plaintiff allegedly sustained personal injuries. This matter has been sent to the Partnership's insurer.\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 PARTNERSHIP INTERESTS AND RELATED SECURITY HOLDER MATTERS\nThe Limited Partnership Interests are not traded on a public exchange but were sold through a public offering managed by Lehman Brothers Inc. It is not anticipated that any public market will develop for the purchase and sale of any partnership interests. Limited Partnership Interests may be transferred only if certain requirements are satisfied. At December 31, 1995, there were 3,613 registered holders of units in REAL VI. Distributions have not been made from the inception of the Partnership to December 31, 1995. The Partnership has invested in certain government assisted projects under programs which in many instances restrict the cash return available to project owners. The Partnership was not designed to provide cash distributions to investors in circumstances other than refinancing or disposition of its investments in limited partnerships. 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\nLIQUIDITY\nThe Partnership's primary sources of funds include interest income on money market funds and certificates of deposit and distributions from local partnership in which the Partnership has invested. It is not expected that any of the local partnerships in which the Partnership has invested will generate cash flow sufficient to provide for distributions to the Partnership's limited partners in any material amount.\nThe financial statements of the three general partnerships in which REAL VI or REA III are the majority general partners, have been consolidated in the accompanying financial statements. Two of these partnerships are local operating partnerships which own and operate apartment buildings. The units are leased primarily on a month-to-month basis. These partnerships' primary source of funds are the rental payments from tenants. Expenditures primarily include normal operating expenses and debt service.\nCAPITAL RESOURCES\nREAL VI received $42,000,000 in subscriptions for units of limited partnership interests (at $5,000 per unit) during the period April 22, l983, to March 31, 1984, pursuant to a registration statement on Form S-11.\nThe Partnership has committed, as of December 31, 1995, to investments requiring additional capital contributions of $90,500. The Partnership normally makes its capital contributions to the local limited partnerships in stages, over a period of two to five years, with each contribution due on a specified date, provided that certain conditions regarding construction or operation of the project have been fulfilled. The Partnership has no significant commitments once the capital contributions have been made. The Partnership has no significant commitments for additional capital expenditures to the general partnerships which have been consolidated.\nRESULTS OF OPERATIONS\nThe Partnership was formed to provide various benefits to its partners as discussed in Item 1. It is anticipated that the local partnerships in which REAL VI has invested could produce tax losses for as long as 20 years. The Partnership will seek to defer limited partner income taxes from capital gains by not selling any projects or project interests within 10 years, except to qualified tenant cooperatives, or when proceeds of the sale would supply sufficient cash to distribute to limited partners to enable the partners to pay applicable taxes.\nTax benefits will decline over time as the advantages of accelerated depreciation are greatest in the earlier years, as deductions for interest expense decrease as mortgage principal is amortized, and as the Tax Reform Act of 1986 limits the deductions available.\nRental revenues remain steady over the past 3 years. Expenses incurred to operate the properties are consistent with prior years.\nOn February 2, 1996, one of the consolidated general partnerships (Drexel Park) sold its property for $6,300,000. The property as of December 31, 1995, had an outstanding loan of approximately $5,100,000 and a net book value of approximately $3,900,000. After payment of closings costs, the Partnership realized a gain of approximately $2,000,000 and cash of $837,000.\nThe Partnership ceased making mortgage payments in June 1991 on one its properties (Carlton Arms). Subsequently, a new management company was appointed by the lender and the Partnership entered into an agreement with the lender whereby the Partnership was given until January 1993 to cure any defaults on the mortgage. Failure to cure the defaults would result in the immediate transfer of title, which was placed in escrow, to the lender. The property continued to operate at a deficit and the Partnership was unable to cure the defaults. The assets and liabilities of the property were eliminated from the balance sheet at December 31, 1991 because the partnership no longer controlled the property. In addition, the related statements of operations reflect operations only through June 30, 1991. The deferred gain of $4,095,110 was recognized when title transferred to the mortgage holder in April 1993.\nThe Partnership accounts for its investments in the local limited partnerships on the equity method, thereby adjusting its investment balance by its proportionate share of the income or loss of the local limited partnerships. Losses incurred after the limited partnership investment account is reduced to zero are not recognized.\nDistributions received from limited partnerships are recognized as return of capital until the investment balance has been reduced to zero or to a negative amount equal to future capital contributions required. Subsequent distributions received are recognized as income.\nExcept for certificates of deposit and money market funds, the Partnership's investments are entirely interests in other limited and general partnerships owning government assisted projects. Funds temporarily not required for such investments in projects are invested providing interest income as reflected in the statement of operations. These funds can be converted to cash to meet obligations as they arise. The Partnership intends to continue investing available funds in this manner.\nA recurring partnership expense is the annual management fee. The fee is payable to the Corporate General Partner of the Partnership and is calculated as a percentage of the Partnership's invested assets. The management fee is paid to the Corporate General Partner for its continuing management of Partnership affairs. The fee is payable beginning with the month following the Partnership's initial investment in a local partnership.\nPartnership operating expenses, exclusive of management fees, consist substantially of professional fees for services rendered to the Partnership. Such expenses are consistent with prior years.\nThe Partnership, as a limited or general partner in the local partnerships in which it has invested, is subject to the risks incident to the construction, management, and ownership of improved real estate. The Partnership investments are also subject to adverse general economic conditions and accordingly, the status of the national economy, including substantial unemployment and concurrent inflation, could increase vacancy levels, rental payment defaults, and operating expenses, which in turn, could substantially increase the risk of operating losses for the projects.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe Financial Statements and Supplementary Data are listed under Item 14.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone. REAL ESTATE ASSOCIATES LIMITED VI AND SUBSIDIARIES (A California limited partnership)\nFINANCIAL STATEMENTS, FINANCIAL STATEMENT SCHEDULES AND INDEPENDENT PUBLIC ACCOUNTANTS' REPORT DECEMBER 31, 1995 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Partners of Real Estate Associates Limited VI (A California limited partnership)\nWe have audited the accompanying balance sheets of Real Estate Associates Limited VI (a California limited partnership) and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations, partners' deficiency and cash flows for each of the three years in the period ended December 31, 1995. Our audits also included the financial statement schedules listed in the index on item 14. These financial statements and financial statement schedules are the responsibility of the management of the Partnership. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits. We did not audit the financial statements of certain limited partnerships, the investments in which are reflected in the accompanying financial statements using the equity method of accounting. The investments in these limited partnerships represent 15 percent and 28 percent of total assets as of December 31, 1995 and 1994, respectively, and the equity in income (loss) of these limited partnerships represents 13 percent, 9 percent and 26 percent of the total net income (loss) of the Partnership for the years ended December 31, 1995, 1994 and 1993, respectively, and represent a substantial portion of the investee information in Note 2 and the financial statement schedules. The financial statements of these limited partnerships are audited by other auditors. Their reports have been furnished to us and our opinion, insofar as it relates to the amounts included for these limited 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 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 our audits and the reports of other auditors provide a reasonable basis for our opinion.\nIn our opinion, based on our audits and the reports of other auditors, the financial statements referred to above present fairly, in all material respects, the financial position of Real Estate Associates Limited VI and subsidiaries as of December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles. Also, in our opinion, based on our audits and the reports of other auditors, such financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nDELOITTE & TOUCHE LLP\nLos Angeles, California March 29, 1996 REAL ESTATE ASSOCIATES LIMITED VI (a California limited partnership)\nBALANCE SHEETS\nDECEMBER 31, 1995 AND 1994\nASSETS\nThe accompanying notes are an integral part of these consolidated financial statements. REAL ESTATE ASSOCIATES LIMITED VI (a California limited partnership)\nCONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nThe accompanying notes are an integral part of these consolidated financial statements. REAL ESTATE ASSOCIATES LIMITED VI AND SUBSIDIARIES (a California limited partnership)\nCONSOLIDATED STATEMENTS OF PARTNERS' DEFICIENCY FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nREAL ESTATE ASSOCIATES LIMITED VI AND SUBSIDIARIES (a California limited partnership)\nCONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nThe accompanying notes are an integral part of these consolidated financial statements. REAL ESTATE ASSOCIATES LIMITED VI AND SUBSIDIARIES (a California limited partnership)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1995\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nORGANIZATION\nReal Estate Associates Limited VI (the \"Partnership\"), was formed under the California Limited Partnership Act on October 12, 1982. The Partnership was formed to invest primarily in other limited partnerships or joint ventures which own and operate primarily federal, state or local government-assisted housing projects and to acquire, lease, sell or mortgage real or personal property. The general partners are Coast Housing Investments Associates (CHIA), a limited partnership, and National Partnership Investments Corp. (NAPICO), the corporate general partner. Casden Investment Corporation owns 100 percent of NAPICO's stock. The limited partner of CHIA is an officer of NAPICO.\nThe Partnership offered and issued 4,200 units of limited partner interests through a public offering. Each unit was comprised of two limited partner interests and a warrant granting the investor the right to purchase two additional limited partner interests. An additional 8,410 interests were issued from the exercise of warrants and the sale of interests associated with warrants not exercised. The general partners have a 1 percent interest in operating profits and losses of the Partnership. The limited partners have the remaining 99 percent interest in proportion to their respective investments.\nThe Partnership shall be dissolved only upon the expiration of 50 complete calendar years (December 31, 2032) from the date of the formation of the partnership or the occurrence of various other events as specified in the Partnership agreement.\nUpon total or partial liquidation of the Partnership or the disposition or partial disposition of a project or project interest and distribution of the proceeds, the general partners will be entitled to a liquidation fee as stipulated in the Partnership agreement. The limited partners will have a priority return equal to their invested capital attributable to the project(s) or project interest(s) sold and shall receive from the sale of the project(s) or project interest(s) an amount sufficient to pay state and federal income taxes, if any, calculated at the maximum rate then in effect. The general partner's liquidation fee may accrue but shall not be paid until the limited partners have received distributions equal to 100 percent of their capital contributions.\nUSE OF ESTIMATES\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the accounts of Real Estate Associates Limited VI and its majority-owned general partnerships. All significant intercompany accounts and transactions have been\nREAL ESTATE ASSOCIATES LIMITED VI AND SUBSIDIARIES (a California limited partnership)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1995\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)\neliminated in consolidation. Losses in excess of the minority interest is equity that would otherwise be attributed to the minority interest are being allocated to the Partnership.\nMETHOD OF ACCOUNTING FOR INVESTMENTS IN LIMITED PARTNERSHIPS\nThe investments in limited partnerships are accounted for on the equity method. Acquisition, selection and other costs related to the acquisition of the projects have been capitalized as part of the investment account and are being amortized on a straight line basis over the estimated lives of the underlying assets, which is generally 30 years.\nRENTAL PROPERTY AND DEPRECIATION\nRental property is stated at cost. Depreciation is provided on the straight-line and accelerated methods over the estimated useful lives of the buildings and equipment. Pursuant to a purchase agreement in which the Partnership acquired its interest from independent withdrawing general partners, certain rental property was revalued to reflect the purchase price.\nSubstantially all of the apartment units are leased on a month-to-month basis.\nThe costs of rental property and estimated useful lives for depreciation are as follows:\nOn February 2, 1996, one of the consolidated general partnerships (Drexel Park) sold its property for $6,300,000. The property as of December 31, 1995, had an outstanding loan of approximately $5,100,000 and a net book value of approximately $3,900,000. After payment of closings costs, the Partnership realized a gain of approximately $2,000,000 and cash of $837,000.\nThe Partnership ceased making mortgage payments in June 1991 on one of its properties (Carlton Arms). Subsequently, a new management company was appointed by the lender and the Partnership entered into an agreement with the lender whereby the Partnership was given until January 1993 to cure any defaults on the mortgage. Failure to cure the defaults would result in the immediate transfer of title, which was placed in escrow, to the lender. The property continued to operate at a deficit and the Partnership was unable to cure the defaults. The assets and liabilities of the property were eliminated\nREAL ESTATE ASSOCIATES LIMITED VI AND SUBSIDIARIES (a California limited partnership)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1995\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)\nfrom the balance sheet at December 31, 1991 because the partnership no longer controlled the property. In addition, the related statements of operations reflect operations only through June 30, 1991. The deferred gain of $4,095,110 was recognized when title transferred to the mortgage holder in April 1993.\nNET INCOME (LOSS) PER LIMITED PARTNERSHIP INTEREST\nNet income (loss) per limited partnership interest was computed by dividing the limited partners' share of net income (loss) by the number of limited partnership interests outstanding during the year. The number of limited partnership interests was 16,810 for all years presented.\nCASH AND CASH EQUIVALENTS\nCash and cash equivalents consist of unrestricted cash and bank certificates of deposit with maturities of three months or less.\nSHORT TERM INVESTMENTS\nShort term investments consist of bank certificates of deposit with original maturities ranging from more than three months to twelve months. The fair value of these securities, which have been classified as held for sale, approximates their carrying value.\n2. INVESTMENTS IN LIMITED PARTNERSHIPS\nThe Partnership holds limited partnership interests in 27 limited partnerships and a general partner interest in one general partnership. In addition, REAL VI holds a general partner interest in Real Estate Associates III (\"REA III\"), a California general partnership. NAPICO is also a general partner in REA III. REA III, in turn, holds a general partner interest in one general partnership and limited partner interests in seven limited partnerships. In total, therefore, the Partnership holds interests, either directly or indirectly through REA III, in 34 limited partnerships and 2 general partnerships which own residential low income rental projects consisting of 3,063 apartment units. The mortgage loans of these projects are payable to or insured by various governmental agencies.\nThe Partnership, as a limited partner, is entitled to between 90 percent and 99 percent of the profits and losses of the limited partnerships it has invested in directly. The Partnership is also entitled to 99.9 percent of the profits and losses of REA III. REA III holds a 99 percent interest in each of the limited partnerships in which it has invested.\nAs of December 31, 1995, the Partnership is obligated, if certain conditions are met, to invest an additional $90,500 in its investee partnerships at various times in the future. This amount has not been recorded as a liability in the accompanying financial statements.\nIn 1993, a limited partnership (Lincoln Mariner's Associates Limited) entered into a Loan Agreement with the City of San Diego to issue $15,700,000 of new Mortgage Revenue Funding Bonds to refinance the mortgage and refund the bonds. The annual interest rate on the mortgage was reduced from 10.85\nREAL ESTATE ASSOCIATES LIMITED VI AND SUBSIDIARIES (a California limited partnership)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1995\n2. INVESTMENTS IN LIMITED PARTNERSHIPS (CONTINUED)\npercent to 9.36 percent through August 1, 1995, and 5.575 percent thereafter through maturity on August 1, 2015. The Partnership and N.C. Lincoln Company (an affiliate of the general partner of Lincoln Mariner's Associates Limited) each loaned Lincoln Mariner's Associates Limited $382,500, to pay the costs and expenses in connection with the refunding and refinancing. These loans bear interest at 12 percent per annum and will be fully amortized and paid by August 1, 1995.\nIn 1995, two local limited partnerships refinanced their Taxable Mortgage Revenue Refunding Bonds. Fillmore Investors, Ltd. refunded the bond issue, consisting of $5,185,000 and $2,515,000 in Tax-Exempt Mortgage Revenue Refunding Bonds, Series 1995A and Series 1995A-1, respectively, and $160,000 in Taxable Mortgate Revenue Refunding Bonds, Series 1995B, for a total of $7,860,000. By completing the transaction, the local partnership benefits from a reduction of the mortgage interest rate, from 11.61% to a rate not to exceed 8.75%. Furthermore, all costs associated with the transaction were born by the U.S. Department of Housing and Urban Development (\"HUD\"). All debt service savings will be realized by the City of Phoenix and HUD until the expiration of the Housing Assistance Payments (\"HAP\") Contract in 2003; thereafter, the local partnership will realize all debt service savings from 2003 until the mortgage matures in 2024. Also, Boynton Associates, Ltd. refunded bond issue, consisting of $4,375,000 of Multifamily Housing Revenue Refunding Bonds, Series 1995A and $875,000 in Taxable Multifamily Housing Revenue Refunding Bonds, Series 1995B, for a total of $5,250,000.\nBy completing this transaction, the local partnership will benefit by sharing in the debt service savings resulting from a reduction in the mortgage interest rate. Ten percent (10%) of these savings will be deposited in the Replacement Reserve account, under the control of HUD, for the benefit of the property.\nEquity in losses of unconsolidated limited partnerships are recognized in the financial statements until the limited partnership investment account is reduced to a zero balance or to a negative amount equal to further capital contributions required. Losses incurred after the limited partnership investment account is reduced to zero are not recognized. The cumulative amount of the unrecognized equity in losses of unconsolidated limited partnerships was approximately $24,636,000 and $21,908,000 as of December 31, 1995 and 1994, respectively.\nDistributions from the unconsolidated limited partnerships are accounted for as a return of capital until the investment balance is reduced to zero. Subsequent distributions received are recognized as income.\nThe following is a summary of the investments in unconsolidated limited partnerships and reconciliation to the limited partnership accounts:\nREAL ESTATE ASSOCIATES LIMITED VI AND SUBSIDIARIES (a California limited partnership)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1995\n2. INVESTMENTS IN LIMITED PARTNERSHIPS (CONTINUED)\nThe difference between the investment per the accompanying balance sheets at December 31, 1995 and 1994, and the deficiency per the limited partnerships' combined financial statements is due primarily to cumulative unrecognized equity in losses of limited partnerships, additional basis and costs capitalized to the investment account and cumulative distributions recognized as income.\nSelected financial information from the combined financial statements at December 31, 1995 and 1994 and for each of the three years in the period ended December 31, 1995, of the limited partnerships in which the Partnership has invested directly or indirectly, is as follows:\nBalance Sheets\nStatements of Operations\nLand and buildings above have been adjusted for the amount by which the investments in the limited partnerships exceed the Partnership's share of the net book value of the underlying net assets of the\nREAL ESTATE ASSOCIATES LIMITED VI AND SUBSIDIARIES (a California limited partnership)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1995\n2. INVESTMENTS IN LIMITED PARTNERSHIPS (CONTINUED)\ninvestee which are recorded at historical costs. Depreciation on the adjustment is provided for over the estimated remaining useful lives of the properties.\nAn affiliate of NAPICO is the general partner in 10 of the limited partnerships included above, and another affiliate receives property management fees ranging from 5 percent to 7 percent of the revenue from six of these partnerships. The affiliate received property management fees of $178,106, $173,152 and $172,713 in 1995, 1994 and 1993 respectively. The following sets forth the significant data for the partnerships in which an affiliate of NAPICO was the general partner, reflected in the accompanying financial statements using the equity method of accounting:\n3. CASH, RESTRICTED\nRestricted cash at December 31, 1995 and 1994 consists of tenants' security deposits.\n4. MORTGAGE NOTES PAYABLE RELATED TO PROPERTIES\nMortgage notes bear interest at 9.5 percent per annum, with monthly principal and interest payments of $88,000, due from September 1996 to January 1997.\nA mortgage note for $4,838,169 is due on September 1, 1996. The Partnership is in the process of refinancing the loan and is of the opinion that it will obtain financing at comparable terms.\nThese notes are collateralized by the underlying rental properties.\nREAL ESTATE ASSOCIATES LIMITED VI AND SUBSIDIARIES (a California limited partnership)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1995\n4. MORTGAGE NOTES PAYABLE RELATED TO PROPERTIES (CONTINUED)\nPrincipal maturities on the above debt are as follows:\n5. NOTES PAYABLE AND AMOUNTS DUE FOR PARTNERSHIP INTERESTS\nCertain of the Partnership's investments involved purchases of partnership interests from partners who subsequently withdrew from the operating partnership. The purchase of these interests provides for additional cash payments of approximately $325,000, based upon specified events as outlined in the purchase agreements. Such amounts have been recorded as liabilities. In addition, the Partnership is obligated on non-recourse notes payable of $5,470,000 which bear interest at 9.5 percent per annum and have principal maturities ranging from December 1996 to December 2012. The notes and related interest are payable from cash flow generated from operations of the related rental properties as defined in the notes. These obligations are collateralized by the Partnership's investments in the limited partnerships. Unpaid interest is due at maturity of the notes.\nMaturity dates on the notes payable and amounts due are as follows:\n6. FEES AND EXPENSES DUE TO GENERAL PARTNER AND AFFILIATE\nUnder the terms of the Restated Certificate and Agreement of Limited Partnership, the Partnership is obligated to NAPICO for an annual management fee equal to .4 percent of the original invested assets of the partnerships. Invested assets is defined as the costs of acquiring project interests, including the proportionate amount of the mortgage loans related to the Partnership's interests in the capital accounts of the respective partnerships.\nREAL ESTATE ASSOCIATES LIMITED VI AND SUBSIDIARIES (a California limited partnership)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1995\n6. FEES AND EXPENSES DUE TO GENERAL PARTNER AND AFFILIATE\nFor one of the properties owned by the Partnership, an affiliate of NAPICO receives a management fee of 5 percent of its gross revenues plus reimbursement of certain expenses. The Partnership paid management fees to the affiliate of approximately $107,000, $106,000 and $92,000 in 1995, 1994 and 1993, respectively. An affiliate of the minority general partner of a general partnership that is consolidated, manages the property owned by that partnership. The fee is calculated based on five percent of gross collections plus reimbursement of certain expenses. The Partnership paid management fees to the affiliate of approximately $58,000, $63,000 and $60,000 in 1995, 1994 and 1993, respectively. In 1995 and 1993, NAPICO received mortgage brokerage fees of $131,000 and $157,000, respectively, for NAPICO's involvement with the refinancing of limited partnerships' mortgages (Note 2).\nThe Partnership reimburses NAPICO for certain expenses. The reimbursement to NAPICO was $43,729, $42,142 and $41,831 in 1995, 1994 and 1993, respectively, and is included in operating expenses.\n7. CONTINGENCIES\nThe corporate general partner of the Partnership is a plaintiff in various lawsuits and has also been named a defendant in other lawsuits arising from transactions in the ordinary course of business. In addition, the Partnership is involved in several lawsuits. In the opinion of management and the corporate general partner, the claims will not result in any material liability to the Partnership.\n8. INCOME TAXES\nNo provision has been made for income taxes in the accompanying financial statements since such taxes, if any, are the liability of the individual partners. The major differences in tax and financial reporting result from the use of different bases and depreciation methods for the properties held by the limited partnerships as well as the gain resulting from the foreclosure of the Carlton Arms property (Note 1). Differences in tax and financial reporting also arise as losses are not recognized for financial reporting purposes when the investment balance has been reduced to zero or to a negative amount equal to further capital contributions required.\n9. FAIR VALUE OF FINANCIAL INSTRUMENTS\nStatement of Financial Accounting Standards No. 107, \"Disclosure about Fair Value of Financial Instruments,\" requires disclosure of fair value information about financial instruments, when it is practicable to estimate that value. The mortgage notes payable are insured by HUD and are collateralized by the rental properties. The operations generated by the properties and investee limited\nREAL ESTATE ASSOCIATES LIMITED VI AND SUBSIDIARIES (a California limited partnership)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1995\n9. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)\npartnerships are subject to various government rules, regulations and restrictions which make it impracticable to estimate the fair value of the mortgage notes payable and related accrued interest. The carrying amount of other assets and liabilities reported on the balance sheets that require such disclosure approximates fair value due to their short-term maturity.\n10. FOURTH-QUARTER ADJUSTMENT\nThe Partnership's policy is to record its equity in the loss of limited partnerships on a quarterly basis using estimated financial information furnished by the various local operating general partners. The equity in income (loss) of limited partnerships reflected in the accompanying annual consolidated financial statements is based primarily upon audited financial statements of the investee limited partnerships. The increase, approximately $137,000, between the estimated nine-month equity in income and the actual 1995 year end equity in income has been recorded in the fourth quarter.\nSCHEDULE\nREAL ESTATE ASSOCIATES LIMITED VI INVESTMENTS IN LIMITED PARTNERSHIPS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSCHEDULE (CONTINUED)\nREAL ESTATE ASSOCIATES LIMITED VI INVESTMENTS IN LIMITED PARTNERSHIPS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSCHEDULE (CONTINUED)\nREAL ESTATE ASSOCIATES LIMITED VI INVESTMENTS IN LIMITED PARTNERSHIPS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSCHEDULE (CONTINUED)\nREAL ESTATE ASSOCIATES LIMITED VI INVESTMENTS IN LIMITED PARTNERSHIPS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSCHEDULE (CONTINUED)\nREAL ESTATE ASSOCIATES LIMITED VI INVESTMENTS IN LIMITED PARTNERSHIPS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSCHEDULE (CONTINUED)\nREAL ESTATE ASSOCIATES LIMITED VI INVESTMENTS IN LIMITED PARTNERSHIPS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSCHEDULE (Continued)\nREAL ESTATE ASSOCIATES LIMITED VI INVESTMENTS IN LIMITED PARTNERSHIPS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nNOTES: 1. Equity in losses represents the Partnership's allocable share of the net loss from the limited partnerships for the year. Equity in losses of the limited partnerships will be recognized until the investment balance is reduced to zero or below zero to an amount equal to future capital contributions to be made by the Partnership.\n2. Cash distributions from the limited partnerships will be treated as a return of the investment and will reduce the investment balance until such time as the investment is reduced to an amount equal to additional contributions. Distributions subsequently received will be recognized as income. REAL ESTATE ASSOCIATES LIMITED VI SCHEDULE III REAL ESTATE AND ACCUMULATED DEPRECIATION OF PROPERTY HELD BY LOCAL LIMITED PARTNERSHIPS IN WHICH REAL VI HAS INVESTMENTS DECEMBER 31, 1995\n(A) This project was completed when REAL VI entered the Partnership. SCHEDULE III (Continued) REAL ESTATE ASSOCIATES LIMITED VI REAL ESTATE AND ACCUMULATED DEPRECIATION OF PROPERTY HELD BY LOCAL LIMITED PARTNERSHIPS IN WHICH REAL VI HAS INVESTMENTS DECEMBER 31, 1995\nNOTES: 1. Each local partnership has developed, owns and operates the housing project. Substantially all project costs, including construction period interest expense, were capitalized by the local partnerships.\n2. Depreciation is provided for by various methods over the estimated useful lives of the projects. The estimated composite useful lives of the buildings are generally from 25 to 40 years.\n3. Investments in property and equipment - limited partnerships:\nSCHEDULE III (Continued)\nREAL ESTATE ASSOCIATES LIMITED VI REAL ESTATE AND ACCUMULATED DEPRECIATION OF PROPERTY HELD BY LOCAL LIMITED PARTNERSHIPS IN WHICH REAL VI HAS INVESTMENTS DECEMBER 31, 1995\nSCHEDULE III (CONTINUED)\nREAL ESTATE ASSOCIATES LIMITED VI REAL ESTATE AND ACCUMULATED DEPRECIATION OF PROPERTY HELD BY CONSOLIDATED LOCAL LIMITED PARTNERSHIPS IN WHICH REAL VI HAS INVESTMENTS DECEMBER 31, 1995\n(A). This project was completed when REAL VI entered the Partnership. SCHEDULE III (Continued)\nREAL ESTATE ASSOCIATES LIMITED VI REAL ESTATE AND ACCUMULATED DEPRECIATION OF PROPERTY HELD BY CONSOLIDATED LOCAL PARTNERSHIPS IN WHICH REAL VI HAS INVESTMENTS DECEMBER 31, 1995\nInvestments in property and equipment - general partnerships (continued):\nThe total cost of land, buildings, and equipment for federal income tax purposes at December 31, 1995 is approximately $12,026,975.\nSCHEDULE III (Continued)\nREAL ESTATE ASSOCIATES LIMITED VI REAL ESTATE AND ACCUMULATED DEPRECIATION OF PROPERTY HELD BY CONSOLIDATED LOCAL PARTNERSHIPS IN WHICH REAL VI HAS INVESTMENTS DECEMBER 31, 1995\nPART III.\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT:\nREAL ESTATE ASSOCIATES LIMITED VI (the \"Partnership\") has no directors or executive officers of its own.\nNational Partnership Investment Corp. (\"NAPICO\" or \"the Managing General Partner\") is a wholly-owned subsidiary of Casden Investment Corporation, an affiliate of The Casden Company. The following biographical information is presented for the directors and executive officers of NAPICO with principal responsibility for the Partnership's affairs.\nCHARLES H. BOXENBAUM, 66, Chairman of the Board of Directors and Chief Executive Officer of NAPICO.\nMr. Boxenbaum has been associated with NAPICO since its inception. He has been active in the real estate industry since 1960, and prior to joining NAPICO was a real estate broker with the Beverly Hills firm of Carl Rhodes Company.\nMr. Boxenbaum has been a guest lecturer at national and state realty conventions, certified properties exchanger's seminars, Los Angeles Town Hall, National Association of Home Builders, International Council of Shopping Centers, Society of Conventional Appraisers, California Real Estate Association, National Institute of Real Estate Brokers, Appraisal Institute, various mortgage banking seminars, and the North American Property Forum held in London, England. In 1963, he was the winner of the Snyder Award, the highest annual award offered by the National Association of Real Estate Boards for Best Exchange. He is one of the founders and a past director of the First Los Angeles Bank, organized in November 1974. Mr. Boxenbaum was a member of the Board of Directors of the National Housing Council. Mr. Boxenbaum received his Bachelor of Arts degree from the University of Chicago.\nBRUCE E. NELSON, 44, President and a director of NAPICO.\nMr. Nelson joined NAPICO in 1980 and became President in February 1989. He is responsible for the operations of all NAPICO sponsored limited partnerships. Prior to that he was primarily responsible for the securities aspects of the publicly offered real estate investment programs. Mr. Nelson is also involved in the identification, analysis, and negotiation of real estate investments.\nFrom February 1979 to October 1980, Mr. Nelson held the position of Associate General Counsel at Western Consulting Group, Inc., private residential and commercial real estate syndicators. Prior to that time, Mr. Nelson was engaged in the private practice of law in Los Angeles. Mr. Nelson received his Bachelor of Arts degree from the University of Wisconsin and is a graduate of the University of Colorado School of Law. He is a member of the State Bar of California and is a licensed real estate broker in California and Texas.\nALAN I. CASDEN, 50, Chairman of The Casden Company, an affiliate of Casden Properties (formerly CoastFed Properties), a director and member of the audit committee of NAPICO, and chairman of the Executive Committee of NAPICO.\nMr. Casden is Chairman of the Board, Chief Executive Officer and sole shareholder of The Casden Company and Casden Investment Company. Prior to that, he was the president and chairman of Mayer Group, Inc., which he joined in 1975. He is also chairman of Mayer Management, Inc., a real estate management firm. Mr. Casden has been involved in approximately $3 billion of real estate financings and sales and has been responsible for the development and construction of more than 12,000 apartment units and 5,000 single-family homes and condominiums. Mr. Casden is a member of the American Institute of Certified Public Accountants and of the California Society of Certified Public Accountants. Mr. Casden is a member of the advisory board of the National Multi-Family Housing Conference, the Multi-Family Housing Council, and the President's Council of the California Building Industry Association. He also serves on the advisory board to the School of Accounting of the University of Southern California. He holds a Bachelor of Science degree and a Masters in Business Administration degree from the University of Southern California.\nHENRY C. CASDEN, 52, President, Chief Operating Officer and Secretary of The Casden Company and a director and secretary of NAPICO.\nMr. Casden has been President and Chief Operating Officer of The Casden Company, as well as a director of NAPICO since February 1988. He became secretary of both companies in late 1994. From 1982 to 1988, Mr. Casden was of counsel and a partner in the Los Angeles law firm of Troy, Casden & Gould. From 1978 to 1981, he was of counsel and a partner in the Los Angeles law firm of Loeb & Loeb. From 1972 to 1978, Mr. Casden was a member of the Beverly Hills law firm of Fink & Casden, Professional Corporation.\nMr. Casden received his Bachelor of Arts degree from the University of California at Los Angeles, and is a graduate of the University of San Diego Law School. Mr. Casden is a member of the State Bar of California and has numerous professional affiliations.\nBRIAN D. GOLDBERG, 32, Chief Financial Officer of The Casden Company and a director of NAPICO.\nMr. Goldberg joined The Casden Company in 1990 as Vice President of Finance and became Chief Financial Officer in March 1991. Prior to joining The Casden Company, Mr. Goldberg was with Arthur Andersen & Co., an international public accounting firm, from August 1985 until July 1990 in their Los Angeles office. He received his bachelor of science degree in Accounting from the University of Denver. Mr. Goldberg is a member of the American Institute of Certified Public Accountants and the California Society of Certified Public Accountants.\nSHAWN HORWITZ, 36, Executive Vice President and Chief Financial Officer.\nMr. Horwitz joined NAPICO in 1990 and is responsible for the financial affairs of NAPICO and the limited partnerships sponsored by NAPICO. Prior to joining NAPICO, Mr. Horwitz was President for approximately one year of Star Sub Shops, Inc., a corporation engaged in the business of selling fast food franchises, for approximately one year, was an audit manager in the real estate industry group for Altschuler, Melvin & Glasser for six years, and was an auditor with Arthur Young & Co. for 3 years.\nMr. Horwitz received his Bachelor of Commerce degree in accounting from Rhodes University in South Africa and is a member of the Illinois Society of Certified Public Accountants, the American Institute of Certified Public Accountants and the South African Institute of Chartered Accountants.\nBOB SCHAFER, 54, Vice President and Corporate Controller.\nMr. Schafer joined NAPICO in 1984 and is the Corporate Controller responsible for the financial reporting function of the Company. Prior to this, he was a Group and Division Controller at Bergen Brunswig for over eight years, Controller at a Flintkote subsidiary for over four years, and Assistant Controller at an electronics subsidiary of General Electric for two years.\nMr. Schafer is a member of the California Society of Certified Public Accountants. He holds a Bachelor of Science degree in accounting from Woodbury University, Los Angeles. PATRICIA W. TOY, 66, Senior Vice President - Communications and Assistant Secretary.\nMrs. Toy joined NAPICO in 1977, following her receipt of an MBA from the Graduate School of Management, UCLA. From 1952 to 1956, Mrs. Toy served as a U.S. Naval Officer in communications and personnel assignments. She holds a Bachelor of Arts Degree from the University of Nebraska.\nMARK L. WALTHER, 35, Executive Vice President, General Counsel and Assistant Secretary.\nMr. Walther joined NAPICO in 1987 and is responsible for the legal affairs of the NAPICO sponsored limited partnerships. Prior to joining NAPICO, Mr. Walther worked in the San Francisco law firm of Browne and Kahn which specialized in construction litigation. Mr. Walther received his Bachelor of Arts Degree in Political Science from the University of California, Santa Barbara and is a graduate of the University of California, Davis, School of Law. He is a member of the State Bar of Hawaii. ITEM 11.","section_11":"ITEM 11. MANAGEMENT REMUNERATION AND TRANSACTIONS\nReal Estate Associates Limited VI has no officers, employees, or directors. However, under the terms of the Restated Certificate and Agreement of Limited Partnership, the Partnership is obligated to pay the Corporate General Partner an annual management fee. The annual management fee is approximately equal to .5 percent of the invested assets, including the Partnership's allocable share of the mortgages related to real estate properties held by local limited partnerships. The fee is earned beginning in the month the Partnership makes its initial contribution to the local partnership. In addition, the Partnership reimburses the Corporate General Partner for certain expenses.\nThe Corporate General Partner received mortgage brokerage fees in connection with the refinancing of certain limited partnerships' mortgages. In addition, an affiliate of the Corporate General Partner is responsible for the on-site property management for a property owned by the Partnership and for certain properties owned by the limited partnerships in which the Partnership has invested.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\n(a) Security Ownership of Certain Beneficial Owners\nThe general partners own all of the outstanding general partnership interests of REAL VI; no person is known to own beneficially in excess of 5% of the outstanding limited partnership interests.\n(b) With the exception of the initial limited partner, Bruce Nelson, who is an officer of the corporate general partner, none of the officers or directors of the corporate general partner own directly or beneficially any limited partnership interests in REAL VI.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe Partnership has no officers, directors or employees of its own. All of its affairs are managed by the Corporate General Partner, National Partnership Investments Corp. The transactions with the Corporate General Partner are primarily in the form of fees paid by the Partnership to the general partner for services rendered to the Partnership, as discussed in Item 11 and in the notes to the accompanying financial statements. ITEM 14.","section_14":"ITEM 14. FINANCIAL STATEMENTS, SCHEDULES, EXHIBITS AND REPORT ON FORM 8-K\nFINANCIAL STATEMENTS\nReport of Independent Public Accountants.\nConsolidated Balance Sheets as of December 31, 1995 and 1994.\nConsolidated Statements of Operations for the years ended December 31, 1995, 1994 and 1993.\nConsolidated Statements of Partners' Equity (Deficiency) for the years ended December 31, 1995, 1994 and 1993.\nConsolidated Statements of Cash Flows for the years ended December 31, 1995, 1994 and 1993.\nNotes to Consolidated Financial Statements.\nFINANCIAL STATEMENT SCHEDULES APPLICABLE TO REAL ESTATE ASSOCIATES LIMITED VI REAL ESTATE III AND THE LIMITED PARTNERSHIPS:\nSchedule - Investments in Limited Partnerships, December 31, 1995, 1994 and 1993.\nSchedule III - Real Estate and Accumulated Depreciation, December 31, 1995.\nThe remaining schedules are omitted because any required information is included in the financial statements and notes thereto.\nEXHIBITS\nREPORTS ON FORM 8-K\nNo reports on Form 8-K were filed during the year ended December 31, 1995.","section_15":""}
{"filename":"796486_1995.txt","cik":"796486","year":"1995","section_1":"ITEM 1. BUSINESS (Dollars in thousands)\nIntroduction\nAdelphia Communications Corporation (\"Adelphia\" and, collectively with its subsidiaries, the \"Company\") is the seventh largest cable television operator in the United States. As of March 31, 1995, cable systems owned or managed by the Company (the \"Systems\") in the aggregate passed 2,268,501 homes and served 1,579,437 basic subscribers who subscribed for 794,624 premium service units.\nThe Company's owned cable systems (the \"Company Systems\") are located in ten states and are organized into seven regional clusters: Western New York, Virginia, Western Pennsylvania, New England, Eastern Pennsylvania, Ohio and Coastal New Jersey. The Company Systems are located primarily in suburban areas of large and medium-sized cities within the 50 largest television markets (\"areas of dominant influence\" or \"ADIs,\" as measured by The Arbitron Company). At March 31, 1995, the Company Systems passed 1,340,808 homes and served 975,066 basic subscribers.\nThe Company owns a 50% voting interest and non-voting preferred limited partnership interests entitling the Company to a 16.5% priority return in Olympus Communications, L.P. (\"Olympus\"). Olympus is a joint venture which owns cable systems (the \"Olympus Systems\") primarily located in some of the fastest growing areas of Florida. The Olympus Systems in Florida form a substantial part of an eighth regional cluster, Southeastern Florida. The Company is the managing general partner of Olympus. As of March 31, 1995, the Olympus Systems passed 512,052 homes and served 306,317 basic subscribers. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Olympus.\"\nThe Company also provides, for a fee, management and consulting services to certain partnerships (the \"Managed Partnerships\"). John J. Rigas and certain members of his immediate family, including entities they own or control (collectively, the \"Rigas Family\") control or have substantial ownership interests in the Managed Partnerships. As of March 31, 1995, cable systems (the \"Managed Systems\") owned by the Managed Partnerships passed 415,641 homes and served 298,054 basic subscribers.\nUnless otherwise stated, the information contained in this Annual Report on Form 10-K is as of March 31, 1995.\nCable Television\nCable television systems receive a variety of television, radio and data signals transmitted to receiving sites (\"headends\") by way of off-air antennas, microwave relay systems and satellite earth stations. Signals are then modulated, amplified and distributed primarily through coaxial and fiber optic cable to subscribers, who pay fees for the service. Cable television systems are generally constructed and operated pursuant to non-exclusive franchises awarded by state or local government authorities for specified periods of time.\nCable television systems typically offer subscribers a package of basic video services consisting of local and distant television broadcast signals, satellite-delivered non-broadcast channels (which offer programming such as news, sports, family entertainment, music, weather, shopping, etc.) and public, governmental and educational access channels. Cable television systems may also offer certain non-video services, such as digital radio, data transmission and telephony.\nIn addition, premium service channels, which provide movies, live and taped concerts, sports events and other programming, are offered for an extra monthly charge. At March 31, 1995, over 97% of subscribers of the Company Systems were also offered pay-per-view programming, which allows the subscriber to order special events or movies and to pay on a per event basis. Local, regional and national advertising time is sold in the majority of the Systems, with commercial advertisements inserted on certain satellite-delivered non-broadcast channels.\nJohn J. Rigas, the Chairman, President, Chief Executive Officer and majority stockholder of Adelphia, is a pioneer in the cable television industry, having built his first system in 1952 in Coudersport, Pennsylvania. Adelphia was incorporated in Delaware on July 1, 1986 for the purpose of reorganizing five cable television companies, then principally owned by the Rigas Family, into a holding company structure in connection with the initial public offering of its Class A Common Stock, $.01 par value, and 13% Senior Subordinated Notes due 1996. Prior to 1982, the Company grew principally by obtaining municipal cable television franchises to construct new cable television systems. Since 1982, the Company has grown principally by acquiring and developing existing cable systems. The Company's business comprises one segment, the ownership, operation and management of cable television systems. The Company did not have any foreign operations or foreign sales in the year ended March 31, 1995.\nOperating Strategy\nThe Company's strategy has been to provide superior customer service while maximizing operating efficiencies. By acquiring and developing systems in geographic proximity, the Company has been able to realize significant operating efficiencies through the consolidation of many managerial, administrative and technical functions. The Systems have consolidated virtually all of their administrative operations, including customer service, service call dispatching, marketing, human resources, advertising sales and government relations into regional offices. Each regional office has a related technical center which contains the facilities necessary for the Systems' technical functions, including construction, installations and system maintenance and monitoring. Consolidating customer service functions into regional offices allows the Company to provide customer service through better training and staffing of customer service representatives, and by providing more advanced telecommunications and computer equipment and software to its customer service representatives than would otherwise be economically feasible in smaller systems.\nThe Company considers technological innovation to be an important component of cost-effective improvement of its product and customer satisfaction. Through the use of fiber optic cable and other technological improvements, the Company has increased system reliability, channel capacity and its ability to deliver advanced cable television services. These improvements have enhanced customer service, reduced operating expenses and allowed the Company to introduce additional services, such as impulse-ordered pay-per-view programming, which expand customer choices and increase Company revenues. The Company has developed new cable construction architecture which allows it to readily deploy fiber optic cable in its systems. The Company has replaced approximately 24% of the total installed trunk cable for the Systems with fiber optic cable and has used fiber optic cable in all of its rebuilding projects and principally all of the Systems' line extensions. In addition, the Company has installed over 690 miles of fiber optic plant for point-to-point applications such as connecting or eliminating headends or microwave link sites. Management believes that the Company is among the leaders of the cable industry in the deployment of fiber optic cable.\nDevelopment of the Systems\nThe Company has focused on acquiring and developing systems in markets which have favorable historical growth trends. The Company believes that the strong household growth trends in its Systems' market areas are a key factor in positioning itself for future growth in basic subscribers.\nSince 1982, the Company has grown principally by acquiring new cable systems and by developing existing cable systems. On June 16, 1994, Adelphia invested $34,000 for a majority equity position in TMC Holdings Corporation (\"THC\"), the parent of Tele-Media Company of Western Connecticut. THC owns cable television systems serving approximately 43,000 subscribers in Western Connecticut. On June 30, 1994, Adelphia acquired from Olympus 85% of the common stock of Northeast Cable, Inc. (\"Northeast Cable\") for a purchase price of $31,875. Northeast Cable owns cable television systems serving approximately 36,500 subscribers in Eastern Pennsylvania. On January 10, 1995, Adelphia issued 399,087 shares of Class A Common Stock in connection with the merger of a wholly-owned subsidiary of Adelphia into Oxford Cablevision, Inc. (\"Oxford\"), one of the Benjamin Terry family (the \"Terry Family\") cable systems. Oxford serves approximately 4,200 subscribers located in the North Carolina counties of Granville and Warren. On January 31, 1995, the Company acquired Tele-Media of Martha's Vineyard, L.P. for $11,775, a cable system serving approximately 7,000 subscribers in Martha's Vineyard, Massachusetts. On February 28, 1995, ACP Holdings, Inc., a wholly owned subsidiary and managing general partner of Olympus, certain shareholders of Adelphia, Olympus and various Telesat Entities (\"Telesat\"), wholly-owned subsidiaries of FP&L Group, Inc., entered into an investment agreement whereby Telesat agreed to contribute to Olympus substantially all of the assets associated with certain cable television systems, serving approximately 50,000 subscribers in southern Florida, in exchange for general and limited partner interests and newly issued preferred limited partner interests in Olympus.\nThe Company will continue to evaluate new opportunities that allow for the expansion of its business through the acquisition of additional cable television systems in geographic proximity to its existing regional market areas or in locations that can serve as the basis for new market areas, either directly or indirectly through joint ventures, where appropriate.\nThe following table indicates the growth of the Company Systems and Olympus Systems by summarizing the number of homes passed by cable and the number of basic subscribers for each of the five years in the period ended March 31, 1995. The table also indicates the numerical growth in subscribers attributable to acquisitions and the numerical and percentage growth attributable to internal growth. For the period April 1, 1990 through March 31, 1995, 67% of aggregate internal basic subscriber growth for both the Company Systems and the Olympus Systems was derived from internal growth in homes passed, while the remaining 33% of such aggregate growth was derived from penetration increases.\n(a) Data included for the South Dade System at March 31, 1993, 1994 and 1995 reflects actual homes passed and basic subscribers. At July 31, 1992, prior to Hurricane Andrew, the South Dade system had 157,992 homes passed by cable and 71,193 basic subscribers, respectively. At March 31, 1993, 1994 and 1995, the South Dade system served 40,999, 65,398 and 74,601 basic subscribers, respectively. See \"Management's Discussion and Analysis - Olympus.\"\nData for the Northeast System is included under Company Systems and excluded from the Olympus Systems for all periods presented.\n(b) A home is deemed to be \"passed\" by cable if it can be connected to the distribution system without any further extension of the cable distribution plant.\n(c) The number of additional homes passed or additional basic subscribers not attributable to acquisitions of new cable systems.\n(d) A home with one or more television sets connected to a cable system is counted as one basic subscriber. Bulk accounts (such as motels or apartments) are included on a \"subscriber equivalent\" basis in which the total monthly bill for the account is divided by the basic monthly charge for a single outlet in the area.\n(e) Basic subscribers as a percentage of homes passed by cable.\nMarket Areas\nThe Systems are \"clustered\" in eight market areas in the eastern portion of the United States as follows:\nMARKET AREA LOCATION OF SYSTEMS\nSoutheastern Florida Portions of southern Dade, Citrus, Orange, Hillsborough, Palm Beach, Martin and St. Lucie Counties and Hilton Head, South Carolina\nWestern New York Suburbs of Buffalo and the adjacent Niagara Falls area, and Syracuse and adjacent communities\nVirginia Winchester, Charlottesville, Staunton, Richland, Martinsville and surrounding communities in Virginia, and South Boston and Elizabeth City, North Carolina\nWestern Pennsylvania Suburbs of Pittsburgh and several small communities in western Pennsylvania\nMARKET AREA LOCATION OF SYSTEMS\nNew England Cape Cod communities, South Shore communities (the area between Boston and Cape Cod, Massachusetts), Martha's Vineyard, Massachusetts; and Bennington, Burlington, Rutland and Montpelier, Vermont and surrounding communities in Vermont and New York, and Seymour, Connecticut\nEastern Pennsylvania Suburbs of Philadelphia and suburbs of Scranton\nOhio Suburbs of Cleveland and the city of Mansfield and surrounding communities, Mt Vernon and portions of Kalamazoo County, Michigan\nCoastal New Jersey Ocean County, New Jersey\nThe following table summarizes by market area the homes passed by cable, basic subscribers and premium service units for the Systems as of March 31, 1995.\nFinancial Information\nThe financial data regarding the Company's revenues, results of operations and identifiable assets for each of the Company's last three fiscal years is set forth in, and incorporated herein by reference to, Item 8, Financial Statements and Supplementary Data of this Form 10-K.\nTechnological Developments\nThe Company has made a substantial commitment to the technological development of the Company Systems and has actively sought to upgrade the technical capabilities of its cable plant in order to increase channel capacity for the delivery of additional programming and new services. All of the Company Systems have a minimum of 35-channel capacity. By expanding channel capacity, the Company expects that it will be able to provide subscribers with a wider range of telecommunication services.\nOver 97% of the subscribers to the Company Systems are served by systems with \"addressable capable\" technology, which permits the cable operator to remotely activate the cable television services to be delivered to subscribers who are equipped with addressable converters. With addressable converters, the Company can immediately add to or reduce the services provided to a subscriber from the Company's headend site, without the need to dispatch a service technician to the subscriber's home. Addressable technology has allowed the Company to offer pay-per-view programming. This technology has assisted the Company in reducing pay service theft and, by allowing the Company to automatically cut off a subscriber's service, has been effective in collecting delinquent subscriber payments.\nIn all of its recent system upgrades, the Company has utilized fiber optic cable as an alternative to the coaxial cable that historically has been used to distribute cable signals to the subscriber's home. Fiber optic cable is capable of carrying hundreds of video, data and voice channels. The Company has developed an innovative \"fiber-to-feeder\" network design, consisting of a combination of fiber optic trunk and certain other distribution plant, which has proven to be economical for the construction, rebuilding, extension and upgrading of the Systems.\nThe Company expects that the continued use of the fiber-to-feeder network design strategy will give the Company the flexibility to exploit the expanded delivery capacity of fiber optic cable in a cost-effective manner. The construction of fiber-to-feeder networks will also position the Company to take advantage of alternative communications delivery systems made possible by fiber optic technology (such as mobile personal communications service (\"PCS\") and \"alternate access\" voice and data communications that bypass local exchange telephone carriers), to utilize the expanded bandwidth potential of digital compression technology and to meet the anticipated transmission requirements for high-definition television and digital television.\nThe Company is currently offering alternate access telecommunications services through a subsidiary, Hyperion Telecommunications, Inc. (\"Hyperion\"). Competitive access carriers can provide businesses and other large telecommunications consumers with local telecommunications services and access to long-distance service carriers via competitive networks that bypass the local telephone company. Hyperion's networks are constructed exclusively with fiber optics plant designed to provide increased quality service and data integrity compared to the existing local telephone company's network. As of March 31, 1995, Hyperion leased 460 route miles of fiber optic plant from Adelphia (which is included in fiber miles reflected in the preceding table) and 780 route miles from others. These competitive access networks also can complement existing networks by providing redundant telecommunications service backup and route diversity for their customers.\nAdelphia is a 49.9% owner of Page Call, Inc. which was a successful bidder in November 1994 on three regional narrowband PCS licenses, covering 62% of the country's population. Page Call, Inc. intends to use its narrowband PCS licenses as the basis for a planned nationwide paging service and expects to market its paging services to consumers through a series of marketing affiliation agreements with cable television operators.\nIn addition to the activities described above, the Company has made a substantial commitment to technological development as a member of Cable Television Laboratories, Inc., a not-for-profit research and development company serving the cable industry. The Company has also joined other industry members in a partnership venture in Digital Cable Radio, a satellite-delivered, multichannel music service featuring \"compact disc\" quality sound, which is marketed as a premium service. Subscriber Services and Rates\nThe Company's revenues are derived principally from monthly subscription fees for basic, satellite and premium services. Rates to subscribers vary from market to market and in accordance with the type of service selected. Although services vary from system to system because of differences in channel capacity and viewer interests, each of the Systems typically offers a basic service package ranging from $8.00 to $12.00 per month. As described herein, the Systems currently offer certain satellite services through CableSelect, at monthly per channel rates ranging from $.10 to $1.25 per channel, and in discounted packages. The Systems' monthly rates for premium services range from $7.00 to $13.00 per service. An installation fee, which the Company may wholly or partially waive during a promotional period, is usually charged to new subscribers. Subscribers are free to terminate cable service at any time without charge, but often are charged a fee for reconnection or change of service.\nThe Cable Communications Policy Act of 1984 (the \"1984 Cable Act,\" as amended by the 1992 Cable Act), deregulated basic service rates for systems in communities meeting the FCC's definition of effective competition. Pursuant to the FCC's definition of effective competition adopted following enactment of the 1984 Cable Act, substantially all of the Company's franchises were rate deregulated. However, in June 1991, the FCC amended its effective competition standard, which increased the number of cable systems which could be subject to local rate regulation. The 1992 Cable Act contains a new definition of effective competition under which nearly all cable systems in the United States are subject to regulation of basic service rates. Additionally, the legislation (i) eliminated the 5% annual basic rate increase allowed by the 1984 Cable Act without local approval; (ii) allows the FCC to adjudicate the reasonableness of rates for non-basic service tiers other than premium services for cable systems not subject to effective competition in response to complaints filed by franchising authorities and\/or cable subscribers; (iii) prohibits cable systems from requiring subscribers to purchase service tiers above basic service in order to purchase premium services if the system is technically capable of doing so; (iv) allows the FCC to impose restrictions on the retiering and rearrangement of cable services under certain circumstances; and (v) permits the FCC and franchising authorities more latitude in controlling rates and rejecting rate increase requests. See \"Legislation and Regulation\".\nFor a discussion of the changes in the Company's method of offering services to its subscribers implemented in September 1993 and recent FCC rate regulation and related developments, see \"Legislation and Regulation\" and \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Regulatory and Competitive Matters.\"\nFranchises\nThe 1984 Cable Act provides that cable operators may not offer cable service to a particular community without a franchise unless such operator was lawfully providing service to the community on July 1, 1984 and the franchising authority does not require a franchise. The Company Systems and the Olympus Systems operate pursuant to franchises or other authorizations issued by governmental authorities, substantially all of which are nonexclusive. Such franchises or authorizations awarded by a governmental authority generally are not transferable without the consent of the authority. Additionally, the 1992 Cable Act prohibits cable operators from selling or otherwise transferring the ownership of any cable system within 36 months after acquisition or initial construction, subject to certain limited exceptions. As of March 31, 1995, the Company held 439 franchises and Olympus held 82 franchises. Most of these franchises can be terminated prior to their stated expiration by the relevant governmental authority, after due process, for breach of material provisions of the franchise.\nUnder the terms of most of the Company's franchises, a franchise fee (ranging up to 5% of the gross revenues of the cable system) is payable to the governmental authority. For the past three years, franchise fee payments made by the Company have averaged approximately 2.6% of gross system revenues.\nThe franchises issued by the governmental authorities are subject to periodic renewal. In renewal hearings, the authorities generally consider, among other things, whether the franchise holder has provided adequate service and complied with the franchise terms. In connection with a renewal, the authority may impose different and more stringent terms, the impact of which cannot be predicted. To date, all of the Company's material franchises have been renewed or extended, at or effective upon their stated expiration, generally on modified terms. Such modified terms have not been materially adverse to the Company.\nThe Company believes that all of its material franchises are in good standing. From time to time, the Company notifies the franchising authorities of the Company's intent to seek renewal of the franchise in accordance with the procedures set forth in the 1984 Cable Act. The 1984 Cable Act process requires that the governmental authority consider the franchise holder's renewal proposal on its own merits in light of the franchise holder's past performance and the community's needs and interests, without regard to the presence of competing applications. See \"Legislation and Regulation.\" The 1992 Cable Act alters the administrative process by which operators utilize their 1984 Cable Act franchise renewal rights. Such changes could make it easier in some instances for a franchising authority to deny renewal of a franchise.\nCompetition\nAlthough the Company and the cable television industry have historically faced modest competition, the competitive landscape is changing, and competition will increase. The Company believes that the increase in competition within its communities will occur gradually over a period of time.\nAt the present time, cable television systems compete with other communications and entertainment media, including off-air television broadcast signals which a viewer is able to receive directly using the viewer's own television set and antenna. The extent to which a cable system competes with over-the-air broadcasting depends upon the quality and quantity of the broadcast signals available by direct antenna reception compared to the quality and quantity of such signals and alternative services offered by a cable system. In many areas, television signals which constitute a substantial part of basic service can be received by viewers who use their own antennas. Local television reception for residents of apartment buildings or other multi-unit dwelling complexes may be aided by use of private master antenna services. Cable systems also face competition from alternative methods of distributing and receiving television signals and from other sources of entertainment such as live sporting events, movie theaters and home video products, including videotape recorders and cassette players. In recent years, the FCC has adopted policies providing for authorization of new technologies and more favorable operating environment for certain existing technologies that provide, or may provide, substantial additional competition for cable television systems. The extent to which cable television service is competitive depends in significant part upon the cable televisions system's ability to provide an even greater variety of programming than that available off-air or through competitive alternative delivery sources. In addition, certain provisions of the 1992 Cable Act are expected to increase competition significantly in the cable industry. See \"Legislation and Regulation.\"\nThe 1992 Cable Act prohibits the award of exclusive franchises, prohibits franchising authorities from unreasonably refusing to award additional franchises and permits them to operate cable systems themselves without franchises.\nIndividuals presently have the option to purchase earth stations, which allow the direct reception of satellite- delivered program services formerly available only to cable television subscribers. Most satellite-distributed program signals are being electronically scrambled to permit reception only with authorized decoding equipment, generally at a cost to the viewer. From time to time, legislation has been introduced in Congress which, if enacted into law, would prohibit the scrambling of certain satellite-distributed programs or would make satellite services available to private earth stations on terms comparable to those offered to cable systems. Broadcast television signals are being made available to owners of earth stations under the Satellite Home View Copyright Act of 1988, which became effective January 1, 1989 for a six-year period. This Act establishes a statutory compulsory license for certain transmissions made by satellite owners to home satellite dishes for which carriers are required to pay a royalty fee to the Copyright Office. This Act has been extended by Congress until December 31, 1999. The 1992 Cable Act enhances the right of cable competitors to purchase nonbroadcast satellite-delivered programming. See \"Legislation and Regulation - Federal Regulation.\"\nIn late 1993, the first satellite providing high-power, direct broadcast satellite (\"DBS\") television service was launched, and this service became available to consumers during 1994. This technology has the capability of providing more than 100 channels of programming over a single DBS satellite. This capacity can be further increased by providing service from multiple satellites. DBS service can be received virtually anywhere in the United States through the installation of a small rooftop or side-mounted antenna, and it is more accessible than cable television service where cable plant has not been constructed or where it is not cost effective to construct cable television facilities. DBS service is being heavily marketed on a nation-wide basis. The extent to which DBS systems will be competitive with cable television systems will depend upon, among other things, the availability of reception equipment, and whether equipment and service can be made available to consumers at reasonable prices.\nMulti-channel multipoint distribution systems (\"MMDS\") deliver programming services over microwave channels licensed by the FCC which are received by subscribers with special antennas. MMDS systems are less capital intensive, are not required to obtain local franchises or to pay franchise fees and are subject to fewer regulatory requirements than cable television systems. To date, the ability of these so-called \"wireless\" cable services to compete with cable television systems has been limited by channel capacity constraints and the need for unobstructed line-of-sight over-the-air transmission. Although relatively few MMDS systems in the United States are currently in operation or under construction, virtually all markets have been licensed or tentatively licensed. The FCC has taken a series of actions intended to facilitate the development of MMDS and other wireless cable systems as alternative means of distributing video programming, including reallocating certain frequencies to these services and expanding the permissible use and eligibility requirements for certain channels reserved for educational purposes. The FCC's actions enable a single entity to develop an MMDS system with a potential of up to 35 channels that could compete effectively with cable television. MMDS systems qualify for the statutory compulsory copyright licenses for the retransmission of television and radio broadcast stations. FCC rules and the 1992 Cable Act prohibit the common ownership of cable systems and MMDS facilities serving the same area.\nAdditional competition may come from private cable television systems servicing condominiums, apartment complexes and certain other multiple unit residential developments. The operators of these private systems, known as satellite master antenna television (\"SMATV\") systems, often enter into exclusive agreements with apartment building owners or homeowners' associations which preclude franchised cable television operators from serving residents of such private complexes. Although a number of states have enacted laws to afford operators of franchised cable television systems access to such private complexes, the U.S. Supreme Court has held that cable companies cannot have such access without compensating the property owner. The access status of several statutes have been challenged successfully in the courts, and other such laws are under attack. However, the 1984 Cable Act gives franchised cable operators the right to use existing compatible easements within their franchise areas upon nondiscriminatory terms and conditions. Accordingly, where there are pre-existing compatible easements, cable operators may not be unfairly denied access or discriminated against with respect to the terms and conditions of access to those easements. There have been conflicting judicial decisions interpreting the scope of the access right granted by the 1984 Cable Act, particularly with respect to easements located entirely on private property.\nDue to the widespread availability of reasonably-priced earth stations, SMATV systems can offer both improved reception of local television stations and many of the same satellite- delivered program services which are offered by franchised cable television systems. Further, while a franchised cable television system typically is obligated to extend service to all areas of a community regardless of population density or economic risk, the SMATV system may confine its operation to small areas that are easy to serve and more likely to be profitable. The FCC recently issued a clarification of its rules interpreting the 1984 Cable Act which has the effect of making it easier for SMATV systems to interconnect non-commonly owned buildings without having to comply with certain local, state and federal regulatory requirements that are imposed upon cable systems providing similar services. The Supreme Court has upheld this decision. However, a SMATV system is subject to the 1984 Cable Act's franchise requirement if it uses physically closed transmission paths such as wires or cable to interconnect separately owned and managed buildings if its lines use or cross any public right-of-way. In a separate proceeding, the FCC has amended its rules to increase the number of microwave frequencies a SMATV operator may use to interconnect several buildings. The FCC's actions will make it easier for SMATV operators to compete with cable systems for subscribers located in multiple unit dwellings while allowing them to remain exempt from many burdensome government regulations which apply to cable systems. In some cases, SMATV operators may be able to charge a lower price than could a cable system providing comparable services and the FCC's new regulations implementing the 1992 Cable Act limit a cable operator's ability to reduce its rates to meet this competition. Furthermore, the U.S. Copyright Office has tentatively concluded that SMATV systems are \"cable systems\" for purposes of qualifying for the compulsory copyright license established for cable systems by federal law. This decision may help make SMATV systems more competitive with traditional cable systems. See \"Legislation and Regulation - Federal Regulation - Copyright.\" The 1992 Cable Act prohibits the common ownership of cable systems and SMATV facilities serving the same area. However, a cable operator can purchase a SMATV system serving the same area and technically integrate it into the cable system.\nThe FCC has authorized a new interactive television service which will permit non-video transmission of information between an individual's home and entertainment and information service providers. This service will provide an alternative means for DBS systems and other video programming distributors, including television stations, to initiate the new interactive television services. This service may also be used as well by the cable television industry.\nThe FCC also has initiated a new rulemaking proceeding looking toward the allocation of frequencies in the 28 Ghz range for a new multi-channel wireless video service which could make 98 video channels available in a single market. It cannot be predicted at this time whether competitors will emerge utilizing such frequencies or whether such competition would have a material impact on the operations of cable television systems.\nIn the past, federal cross-ownership restrictions have limited entry into the cable television business by potentially strong competitors such as telephone companies. Proposals recently adopted by the FCC, pending litigation and legislation, could make it possible for companies with considerable resources and consequently a potentially greater willingness or ability to overbuild, to enter the business. The FCC recently amended its rules to permit local telephone companies to offer \"video dialtone\" service for video programmers, including channel capacity for the carriage of video programming and certain non- common carrier activities such as video processing, billing and collection and joint marketing agreements. Furthermore, several federal district and two circuit courts have struck down as unconstitutional the provision in the 1984 Cable Act which prevents local telephone companies from offering video programming on a non-common carrier basis directly to subscribers in their local telephone service areas. Moreover, this cross-ownership restriction does not apply in communities with a population of less than 2,500 persons. Even in the absence of further changes in the cross-ownership restrictions, the expansion of telephone companies' fiber optic systems may facilitate entry by other video service providers in competition with cable systems. See \"Legislation and Regulation - Federal Regulation.\"\nFCC rules permit local telephone companies to offer \"video dialtone\" service for video programmers, including channel capacity for the carriage of video programming and certain non-common carrier activities such as video processing, billing and collection and joint marketing agreements. On December 15, 1992, New Jersey Bell Telephone Company filed an application with the FCC to operate a \"video dialtone\" service in portions of Dover County, New Jersey, in which the Company serves approximately 20,000 subscribers. The FCC approved the application on July 18, 1994. The Company has appealed this decision to the U.S. Court of Appeals for the District of Columbia. This case is presently pending.\nA number of telephone companies have filed suit seeking to void as unconstitutional the provisions in the 1984 Cable Act that prohibit telephone companies from owning cable television systems in their telephone service areas. The U.S. Courts of Appeal for the Fourth and Ninth Circuits have struck down the cross-ownership ban on First Amendment grounds. Several federal district courts have also struck down the cross- ownership ban on the same grounds. In addition, legislation which would alter or eliminate the cross-ownership ban is under active consideration in Congress.\nAdvances in communications technology, as well as changes in the marketplace and the regulatory and legislative environment, are constantly occurring. Thus, it is not possible to predict the effect that ongoing or future developments might have on the cable industry. The ability of cable systems to compete with present, emerging and future distribution media will depend to a great extent on obtaining attractive programming. The availability and exclusive use of a sufficient amount of quality programming may in turn be affected by developments in regulation or copyright law. See \"Legislation and Regulation.\"\nThe cable television industry competes with radio, television and print media for advertising revenues. As the cable television industry continues to develop programming designed specifically for distribution by cable, advertising revenues may increase. Premium programming provided by cable systems is subject to the same competitive factors which exist for other programming discussed above. The continued profitability of premium services may depend largely upon the continued availability of attractive programming at competitive prices.\nEmployees\nAt June 12, 1995, there were 2,564 full-time employees of the Company, of which 103 employees were covered by collective bargaining agreements at three locations. The Company considers its relations with its employees to be good.\nLEGISLATION AND REGULATION\nThe cable television industry is regulated by the FCC, some state governments and most local governments. In addition, various legislative and regulatory proposals under consideration from time to time by Congress and various federal agencies may materially affect the cable television industry. The following is a summary of federal laws and regulations affecting the growth and operation of the cable television industry and a description of certain state and local laws.\nCable Communications Policy Act of 1984\nThe 1984 Cable Act became effective on December 29, 1984. This federal statute, which amended the Communications Act of 1934 (the \"Communications Act\"), created uniform national standards and guidelines for the regulation of cable television systems. Violations by a cable television system operator of provisions of the Communications Act, as well as of FCC regulations, can subject the operator to substantial monetary penalties and other sanctions. Among other things, the 1984 Cable Act affirmed the right of franchising authorities (state or local, depending on the practice in individual states) to award one or more franchises within their jurisdictions. It also prohibited non-grandfathered cable television systems from operating without a franchise in such jurisdictions. In connection with new franchises, the 1984 Cable Act provides that in granting or renewing franchises, franchising authorities may establish requirements for cable-related facilities and equipment, but may not establish or enforce requirements for video programming or information services other than in broad categories. The 1984 Cable Act grandfathered, for the remaining term of existing franchises, many but not all of the provisions in existing franchises which would not be permitted in franchises entered into or renewed after the effective date of the 1984 Cable Act.\nCable Television Consumer Protection and Competition Act of 1992 (the \"1992 Cable Act\") On October 5, 1992, Congress enacted the 1992 Cable Act. This legislation effected significant changes to the legislative and regulatory environment in which the cable industry operates. It amends the 1984 Cable Act in many respects. The 1992 Cable Act became effective on December 4, 1992, although certain provisions, most notably those dealing with rate regulation and retransmission consent, became effective at later dates. The legislation also required the FCC to initiate a number of rulemaking proceedings to implement various provisions of the statute. The 1992 Cable Act allows for a greater degree of regulation on the cable industry with respect to, among other things: (i) cable system rates for both basic and certain nonbasic services; (ii) programming access and exclusivity arrangements; (iii) access to cable channels by unaffiliated programming services; (iv) leased access terms and conditions; (v) horizontal and vertical ownership of cable systems; (vi) customer service requirements; (vii) franchise renewals; (viii) television broadcast signal carriage and retransmission consent; (ix) technical standards; (x) subscriber privacy; (xi) consumer protection issues; (xii) cable equipment compatibility; (xiii) obscene or indecent programming; and (xiv) requiring subscribers to subscribe to tiers of service other than basic service as a condition of purchasing premium services. Additionally, the legislation encourages competition with existing cable systems by: allowing municipalities to own and operate their own cable systems without having to obtain a franchise; preventing franchising authorities from granting exclusive franchises or unreasonably refusing to award additional franchises covering an existing cable system's service area; and prohibiting the common ownership of cable systems and co-located MMDS or SMATV systems. The 1992 Cable Act also precludes video programmers affiliated with cable television companies from favoring cable operators over competitors and requires such programmers to sell their programming to other multichannel video distributors. This provision may limit the ability of cable program suppliers to offer exclusive programming arrangements to cable television companies. A number of provisions in the 1992 Cable Act relating to, among other things, rate regulation, have had a negative impact on the cable industry and the Company's business.\nVarious cable operators have filed actions in the United States District Court in the District of Columbia challenging the constitutionality of several sections of the 1992 Cable Act. Pursuant to special jurisdictional provisions in the 1992 Cable Act, a challenge to the must-carry provisions of the Act was heard by a three-judge panel of the District Court. On April 8, 1993, the three-judge court granted a summary judgment for the government upholding the constitutional validity of the must-carry provisions of the 1992 Cable Act. That decision was appealed directly to the U.S. Supreme Court. The plaintiffs in that case unsuccessfully sought an injunction pending appeal of the District Court's decision. On June 27, 1994, the Supreme Court vacated the District Court decision and remanded the case for further proceedings. Thus, the constitutionality of the must carry provision has yet to be finally decided.\nThe cable operators' constitutional challenge to the balance of the 1992 Cable Act provisions was heard by a single judge of the District Court. On September 16, 1993, the court rendered its decision upholding the constitutionality of all but three provisions of the statute (multiple ownership limits for cable operators, advance notice of free previews for certain programming services, and channel set-asides for DBS operators). This decision has been appealed to the U.S. Court of Appeals for the District of Columbia Circuit.\nAppeals were also filed in the U.S. Court of Appeals for the District of Columbia Circuit from the FCC's rate regulation rulemaking decisions. On June 6, 1995, the court upheld all aspects of the FCC's rate regulations except for certain minor matters.\nFederal Regulation\nThe FCC, the principal federal regulatory agency with jurisdiction over cable television, has promulgated regulations covering such areas as the registration of cable systems, cross-ownership between cable systems and other communications businesses, carriage of television broadcast programming, consumer education and lockbox enforcement, origination cablecasting and sponsorship identification, children's programming, the regulation of basic cable service rates in areas where cable systems are not subject to effective competition, signal leakage and frequency use, technical performance, maintenance of various records, equal employment opportunity, and antenna structure notification, marking and lighting. The FCC has the authority to enforce these regulations through the imposition of substantial fines, the issuance of cease and desist orders and\/or the imposition of other administrative sanctions, such as the revocation of FCC licenses needed to operate certain transmission facilities often used in connection with cable operations. Furthermore, the 1992 Cable Act required the FCC to adopt implementing regulations covering, among other things, cable rates, signal carriage, consumer protection and customer service, leased access, indecent programming, programmer access to cable television systems, programming agreements, technical standards, consumer electronics equipment compatibility, ownership of home wiring, program exclusivity, equal employment opportunity, and various aspects of direct broadcast satellite system ownership and operation. A brief summary of the most material federal regulations as adopted to date follows.\nRate Regulation. The 1984 Cable Act codified existing FCC preemption of rate regulation for premium channels and optional nonbasic program tiers. The 1984 Cable Act also deregulated basic cable rates for cable television systems determined by the FCC to be subject to effective competition. The 1992 Cable Act substantially changed the statutory and FCC rate regulation standards. The 1992 Cable Act replaced the FCC's old standard for determining effective competition, under which most cable systems were not subject to local rate regulation, with a statutory provision that has resulted in nearly all cable television systems becoming subject to local rate regulation of basic service. Additionally, the legislation eliminated the 5% annual rate increase for basic service previously allowed by the 1984 Cable Act without local approval; required the FCC to adopt a formula, for franchising authorities to enforce, to assure that basic cable rates are reasonable; allows the FCC to review rates for nonbasic service tiers (other than per-channel or per-program services) in response to complaints filed by franchising authorities and\/or cable customers; prohibits cable television systems from requiring customers to purchase service tiers above basic service in order to purchase premium services if the system is technically capable of doing so; required the FCC to adopt regulations to establish, on the basis of actual costs, the price for installation of cable service, remote controls, converter boxes and additional outlets; and allows the FCC to impose restrictions on the retiering and rearrangement of cable services under certain limited circumstances. The FCC adopted rules designed to implement these rate regulation provisions on April 1, 1993, and then significantly amended them on February 22, 1994, and November 10, 1994.\nThe FCC's regulations set standards for the regulation of basic and nonbasic cable service rates (other than per-channel or per-program services). The FCC initially ordered an interim 120-day freeze on these rates effective April 5, 1993, a freeze which was extended several times and finally expired on May 15, 1994. The FCC's original rules became effective on September 1, 1993. The amendments thereto became effective on May 15, 1994 and January 1, 1995, respectively. The rate regulations adopt a benchmark price cap system for measuring the reasonableness of existing basic and nonbasic service rates, and a formula for evaluating future rate increases. Alternatively, cable operators have the opportunity to make cost-of-service showings which, in some cases, may justify rates above the applicable benchmarks. The FCC has adopted interim rules to be utilized in such cost-of-service showings. The rules also require that charges for cable-related equipment (e.g., converter boxes and remote control devices) and installation services be unbundled from the provision of cable service and based upon actual costs plus a reasonable profit. Local franchising authorities and\/or the FCC are empowered to order a reduction of existing rates which exceed the benchmark level for either basic and\/or nonbasic cable services and associated equipment, and refunds could be required, measured from the date of a complaint to the FCC challenging an existing nonbasic cable service rate or from September 1, 1993, for existing basic cable service rates under the original rate regulations and from May 15, 1994, under the amended rate regulations. The retroactive refund period for basic cable service rates is limited to one year. In general, the reductions for basic and nonbasic cable service rates under the original rate regulations were to be to the greater of the applicable benchmark level or the rates in force as of September 30, 1992, minus 10 percent, adjusted forward for inflation. The amended regulations require an aggregate reduction of up to 17 percent, adjusted forward for inflation and certain other factors, from the rates in force as of September 30, 1992. The regulations also provide that future rate increases may not exceed an inflation-indexed amount, plus increases in certain costs beyond the cable operator's control, such as taxes, franchise fees and increased programming costs. Cost-based adjustments to these capped rates can also be made in the event a cable operator adds or deletes programming channels. The November 10, 1994 amendments incorporated an alternative method for adjusting the rate charged for a regulated nonbasic service tier when new services are added. This method will allow cable operators to increase rates by as much as $1.50 over a two year period to reflect the addition of up to seven new channels of service on regulated non basic tiers. In addition, new product tiers consisting of services new to the cable system can be created free of rate regulation as long as certain conditions are met such as not moving services from the existing tiers to the new tier. A significant number of franchising authorities have become certified by the FCC to regulate the rates charged by the Company for basic cable service and for associated equipment. Subscribers in some of the Company's cable systems have sought FCC review regarding the rates charged for non-basic cable service. The Company's ability to implement rate increases consistent with its past practices will likely be limited by the regulations that the FCC has adopted.\nCommencing in August 1993, in accordance with the 1992 Cable Act, the Company repackaged certain existing cable services and twice adjusted the basic service rates and related equipment and installation charges in substantially all of its Systems so as to bring these rates and charges into compliance with the then applicable benchmark or equipment and installation cost levels.\nEffective September 1, 1993, the Company also implemented a program in substantially all of its Systems under which a number of the Company's satellite-delivered and premium services were offered individually on a per channel (i.e., a la carte) basis, or as a group at a discounted price. A la carte services were not subject to the FCC's rate regulations under the rules originally issued to implement the 1992 Cable Act. The FCC, in its reconsideration of the original rate regulations, stated that it was going to review the regulatory treatment of such a la carte packages on an ad hoc basis. A la carte packages which are determined to be evasions of rate regulation rather than true enhancements of subscriber choice will be treated as regulated tiers, and therefore, subject to rate regulations. One of Olympus' Systems, along with numerous other cable operators, received a specific inquiry from the FCC regarding its implementation of this new method of offering cable services. The FCC's Cable Services Bureau has ruled that this system, and all other systems which moved more than six existing services to an a la carte tier, have engaged in an evasion of rate regulation and ordered this package to be treated as a regulated tier. The Company has appealed this decision to the full FCC. The November 10, 1994 amendments stated that, prospectively, any new a la carte package created after this date will be treated as a regulated tier, except for packages involving traditional premium services (e.g., HBO). Because of these developments and other factors, including the decisions of subscribers, the Company is currently unable to determine the effect that this a la carte method of offering cable services will have on its business and results of operations in future periods. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Regulatory and Competitive Matters\".\nThe FCC has adopted regulations pursuant to the 1992 Cable Act which require cable systems to permit customers to purchase video programming on a per channel or a per program basis without the necessity of subscribing to any tier of service, other than the basic service tier, unless the cable system is technically incapable of doing so. Generally, this exemption from compliance with the statute for cable systems that do not have such technical capability is available until a cable system obtains the capability, but not later than December, 2002.\nCarriage of Broadcast Television Signals. The 1992 Cable Act contains new mandatory carriage requirements. These new rules allow commercial television broadcast stations which are \"local\" to a cable system (i.e., the system is located in the station's Area of Dominant Influence), to elect every three years whether to require the cable system to carry the station, subject to certain exceptions, or whether the cable system will have to negotiate for \"retransmission consent\" to carry the station. The first such election was made on June 17, 1993. Local, non-commercial television stations are also given mandatory carriage rights, subject to certain exceptions, within the larger of (i) a 50 mile radius from the station's city of license or (ii) the station's Grade B contour (a measure of signal strength). Unlike commercial stations, noncommercial stations are not given the option to negotiate retransmission consent for the carriage of their signal. In addition, cable systems will have to obtain retransmission consent for the carriage of all \"distant\" commercial broadcast stations, except for certain \"superstations,\" i.e., commercial satellite-delivered independent stations such as WTBS. The 1992 Cable Act also eliminated, effective December 4, 1992, the FCC's regulations requiring the provision of input selector switches. The statutory must-carry provisions for non-commercial stations became effective on December 4, 1992. Must-carry rules for both commercial and non-commercial stations and retransmission consent rules for commercial stations were adopted by the FCC on March 11, 1993. The must-carry requirement for commercial stations went into effect on June 2, 1993, and any stations for which retransmission consent had not been obtained (other than must-carry stations, non-commercial stations and superstations) had to be dropped as of October 6, 1993. A number of stations previously carried by the Company's cable television systems elected retransmission consent. The Company has thus far been able to reach agreements with broadcasters who elected retransmission consent or to negotiate extensions to the October 6, 1993 deadline and has therefore not been required to pay cash compensation to broadcasters for retransmission consent or been required by broadcasters to remove broadcast stations from the cable television channel line-ups. The Company has, however, agreed to carry some services (e.g., ESPN2 and a new service by FOX) in specified markets pursuant to retransmission consent arrangements which it believes are comparable to those entered into by most other large cable operators.\nNonduplication of Network Programming. Cable systems that have 1,000 or more subscribers must, upon the appropriate request of a local television station, delete the simultaneous or nonsimultaneous network programming of a distant station when such programming has also been contracted for by the local station on an exclusive basis.\nDeletion of Syndicated Programming. FCC regulations enable television broadcast stations that have obtained exclusive distribution rights for syndicated programming in their market to require a cable system to delete or \"black out\" such programming from other television stations which are carried by the cable system. The extent of such deletions will vary from market to market and cannot be predicted with certainty. However, it is possible that such deletions could be substantial and could lead the cable operator to drop a distant signal in its entirety. The FCC also has commenced a proceeding to determine whether to relax or abolish the geographic limitations on program exclusivity contained in its rules, which would allow parties to set the geographic scope of exclusive distribution rights entirely by contract, and to determine whether such exclusivity rights should be extended to noncommercial educational stations. It is possible that the outcome of these proceedings will increase the amount of programming that cable operators are requested to black out. Finally, the FCC has declined to impose equivalent syndicated exclusivity rules on satellite carriers who provide services to the owners of home satellite dishes similar to those provided by cable systems.\nFranchise Fees. Although franchising authorities may impose franchise fees under the 1984 Cable Act, such payments cannot exceed 5% of a cable system's annual gross revenues. In those communities in which franchise fees are required, the Company currently pays franchise fees ranging up to 5% of gross revenues. Franchising authorities are also empowered in awarding new franchises or renewing existing franchises to require cable operators to provide cable-related facilities and equipment and to enforce compliance with voluntary commitments. In the case of franchises in effect prior to the effective date of the 1984 Cable Act, franchising authorities may enforce requirements contained in the franchise relating to facilities, equipment and services, whether or not cable-related. The 1984 Cable Act, under certain limited circumstances, permits a cable operator to obtain modifications of franchise obligations.\nRenewal of Franchises. The 1984 Cable Act established renewal procedures and criteria designed to protect incumbent franchises against arbitrary denials of renewal. While these formal procedures are not mandatory unless timely invoked by either the cable operator or the franchising authority, they can provide substantial protection to incumbent franchisees. Even after the formal renewal procedures are invoked, franchising authorities and cable operators remain free to negotiate a renewal outside the formal process. Nevertheless, renewal is by no means assured, as the franchisee must meet certain statutory standards. Even if a franchise is renewed, a franchising authority may impose new and more onerous requirements such as upgrading facilities and equipment, although the municipality must take into account the cost of meeting such requirements.\nThe 1992 Cable Act makes several changes to the process under which a cable operator seeks to enforce its renewal rights which could make it easier in some cases for a franchising authority to deny renewal. While a cable operator must still submit its request to commence renewal proceedings within thirty to thirty-six months prior to franchise expiration to invoke the formal renewal process, the request must be in writing and the franchising authority must commence renewal proceedings not later than six months after receipt of such notice. The four-month period for the franchising authority to grant or deny the renewal now runs from the submission of the renewal proposal, not the completion of the public proceeding. Franchising authorities may consider the \"level\" of programming service provided by a cable operator in deciding whether to renew. For alleged franchise violations occurring after December 29, 1984, franchising authorities are no longer precluded from denying renewal based on failure to comply substantially with the material terms of the franchise where the franchising authority has \"effectively acquiesced\" to such past violations. Rather, the franchising authority is estopped if, after giving the cable operator notice and opportunity to cure, it fails to respond to a written notice from the cable operator of its failure or inability to cure. Courts may not reverse a renewal denial based on procedural regulations found to be \"harmless error.\"\nChannel Set-Asides. The 1984 Cable Act permits local franchising authorities to require cable operators to set aside certain channels for public, educational and governmental access programming. The Company believes that none of the Systems' franchises contain unusually onerous access requirements. The 1984 Cable Act further requires cable systems with thirty-six or more activated channels to designate a portion of their channel capacity for commercial leased access by unaffiliated third parties. While the 1984 Cable Act presently allows cable operators substantial latitude in setting leased access rates, the 1992 Cable Act requires leased access rates to be set according to a formula determined by the FCC. It is possible that such leased access will result in competition to services offered by the Company on the other channels of its cable systems.\nCompeting Franchises. Questions concerning the ability of municipalities to award a single cable television franchise and to impose certain franchise restrictions upon cable television companies have been considered in several recent federal appellate and district court decisions. These decisions have been somewhat inconsistent and, until the U.S. Supreme Court rules definitively on the scope of cable television's First Amendment protections, the legality of the franchising process and of various specific franchise requirements is likely to be in a state of flux. It is not possible at the present time to predict the constitutionally permissible bounds of cable franchising and particular franchise requirements. However, the 1992 Cable Act, among other things, prohibits franchising authorities from unreasonably refusing to grant franchises to competing cable systems and permits franchising authorities to operate their own cable systems without franchises.\nOwnership. The 1984 Cable Act codified existing FCC crossownership regulations, which, in part, prohibit local exchange telephone companies (\"LECs\"), including the Bell Operating Companies (\"BOCs\"), from providing video programming directly to subscribers within their local exchange telephone service areas, except in rural areas or by specific waiver of FCC rules. The Fourth and Ninth Circuit Courts of Appeal and several district courts have struck down the 1984 Cable Act's cable\/telco cross-ownership prohibition as facially invalid and inconsistent with the First Amendment. Similar litigation has been commenced in several other district courts. The FCC has asked the Supreme Court to review the circuit court decisions. The Company cannot predict the outcome of this litigation, but believes that the provision of video programming by telephone companies with considerable financial resources in competition with the Company's existing operations could have an adverse effect on the Company's financial condition and results of operation; the magnitude of any such effect is not known or estimable. Separately, as part of a comprehensive proceeding examining whether and under what circumstances telephone companies should be allowed to provide cable television services, including video programming to their customers, the FCC has concluded that neither the 1984 Cable Act nor its rules apply to prohibit the interexchange carriers (i.e., long distance telephone companies such as AT&T) from providing such services to their customers. Additionally, the FCC has also concluded, as part of its \"video dialtone\" decision, that where a LEC makes its facilities available on a common carrier basis for the provision of video programming to the public, the 1984 Cable Act does not require either the LEC or its programmer customers to obtain a franchise to provide such service. Because cable operators are required to bear the costs of complying with local franchise requirements, the FCC's decision could place cable operators at a competitive disadvantage vis-a-vis local telephone companies seeking to offer competing services on a common carrier basis. Various parties have sought judicial review of the FCC's conclusion that neither a LEC or its programmer customers would be required to obtain a local franchise. This appeal is currently pending. As part of the same proceeding, the FCC recommended that Congress amend the 1984 Cable Act to allow LECs to provide their own video programming services over their facilities in competition with their customers' services. The FCC also decided to loosen ownership and affiliation restrictions currently applicable to telephone companies, and has proposed to increase the numerical limit on the population of areas qualifying as \"rural\" and in which LECs can provide cable service without FCC waiver.\nThe BOCs have been released by the United States District Court for the District of Columbia from restrictions on their ability to provide information services, including broadband video programming, which had been imposed as part of the 1984 AT&T divestiture decree. They are, of course, still subject to the 1984 Cable Act cross- ownership restriction discussed above.\nThe telephone industry has continued to lobby Congress for legislation that will permit LECs to provide video programming directly to consumers within their service areas. There are currently bills pending in both houses of Congress that would permit the LECs to provide cable television service over their own facilities conditioned on establishing a video programming affiliate that will maintain separate records to prevent cross-subsidization. These bills, among other provisions, would also prohibit telephone companies from purchasing existing cable television systems within their telephone service areas. The outcome of these FCC, legislative or court proceedings and proposals or the effect of such outcome on cable system operations cannot be predicted; however, adoption of such proposals could intensify the competition which the Systems might face from LECs in the areas in which the Systems operate.\nThe 1984 Cable Act and the FCC's rules also prohibit the common ownership, operation, control or interest in a cable system and a local television broadcast station whose predicted grade B contour (a measure of significant signal strength as defined by the FCC's rules) covers any portion of the community served by the cable system. As part of a wide ranging inquiry on competition in the video marketplace, the FCC has solicited comments to determine whether the policy prohibiting the common ownership or control of co-located broadcast and cable facilities continues to service the public interest. Common ownership or control has historically also been prohibited by the FCC (but not by the 1984 Cable Act) between a cable system and a national television network, although the FCC has recently adopted an order which substantially relaxes the network\/cable cross-ownership prohibitions subject to certain national and local ownership caps. In addition, the FCC's rules prohibit common ownership, affiliation, control or interest in cable systems and MMDS facilities having overlapping service areas, except in very limited circumstances. The 1992 Cable Act codified this restriction and also extended it to co-located SMATV systems. Permitted arrangements in effect as of October 5, 1992, were grandfathered. The FCC also allows cable operators to purchase co-located SMATV systems so long as they are then integrated into the cable system. Thus, the FCC's cross-ownership rules could preclude the Company, its general partners, the officers, directors of its general partners or holders of a cognizable equity interest in the Company (as defined by the FCC) from serving simultaneously as general partners, the officers or directors of, or from holding a substantial ownership interest in, these other businesses. The 1992 Cable Act permits states or local franchising authorities to adopt certain additional restrictions on the ownership of cable systems.\nPursuant to the 1992 Cable Act, the FCC has imposed limits on the number of cable systems which a single cable operator can own. In general, no cable operator can have an attributable interest in cable systems which pass more than 30 percent of all homes nationwide. Attributable interests for these purposes include voting interests of 5% or more (unless there is another single holder of more than 50% of the voting stock), officerships, directorships and general partnership interests. The FCC has stayed the effectiveness of these rules pending the outcome of the appeal from the U.S. District Court decision holding the multiple ownership limit provision of the 1992 Cable Act unconstitutional.\nThe FCC has also adopted rules which limit the number of channels on a cable system which can be occupied by programming in which the cable system's owner has an attributable interest. The limit is 40% of all activated channels.\nEEO. The 1984 Cable Act includes provisions to ensure that minorities and women are provided equal employment opportunities within the cable television industry. The statute requires the FCC to adopt reporting and certification rules that apply to all cable system operators with more than five full-time employees. Pursuant to the requirements of the 1992 Cable Act, the FCC has imposed more detailed annual EEO reporting requirements on cable operators and has expanded those requirements to all multichannel video service distributors. Failure to comply with the EEO requirements can result in the imposition of fines and\/or other administrative sanctions, or may, in certain circumstances, be cited by a franchising authority as a reason for denying a franchisee's renewal request.\nPrivacy. The 1984 Cable Act imposes a number of restrictions on the manner in which cable system operators can collect and disclose data about individual system subscribers. The statute also requires that the system operator periodically provide all subscribers with written information about its policies regarding the collection and handling of data about subscribers, their privacy rights under federal law and their enforcement rights. In the event that a cable operator is found to have violated the subscriber privacy provisions of the 1984 Cable Act, it could be required to pay damages, attorney's fees and other costs. Under the 1992 Cable Act, the privacy requirements are strengthened to require that cable operators take such actions as are necessary to prevent unauthorized access to personally identifiable information.\nAnti-Trafficking. The 1992 Cable Act precludes cable operators from selling or otherwise transferring ownership of a cable system within 36 months after acquisition or initial construction, except for: resales required by the terms of a contract covering the acquisition of multiple systems; tax free sales; governmentally required divestitures; or internal transfers to a commonly controlled entity. The anti-trafficking restriction applies to systems acquired prior to the effective date of the new law (i.e., December 4, 1992) as well as subsequent acquisitions. The FCC may waive the foregoing restrictions where generally consistent with the public interest, unless the franchising authority has refused to grant any required approval. The 1992 Cable Act also requires franchising authorities to act on any franchise transfer request submitted after December 4, 1992 within 120 days after receipt of all information required by FCC regulations and by the franchising authority. Approval is deemed to be granted if the franchising authority fails to act within such period.\nRegistration Procedure and Reporting Requirements. Prior to commencing operation in a particular community, all cable television systems must file a registration statement with the FCC listing the broadcast signals they will carry and certain other information. Additionally, cable operators periodically are required to file various informational reports with the FCC. Cable operators who operate in certain frequency bands are required on an annual basis to file the results of their periodic cumulative leakage testing measurements. Operators who fail to make this filing or who exceed the FCC's allowable cumulative leakage index risk being prohibited from operating in those frequency bands in addition to other sanctions.\nTechnical Requirements. Historically, the FCC has imposed technical standards applicable to the cable channels on which broadcast stations are carried, and has prohibited franchising authorities from adopting standards which were in conflict with or more restrictive than those established by the FCC. The FCC has recently revised such standards and made them applicable to all classes of channels which carry downstream NTSC video programming. Local franchising authorities are permitted to enforce the FCC's new technical standards. The FCC also has adopted additional standards applicable to cable television systems using frequencies in the 108-137 Mhz and 225-400 Mhz bands in order to prevent harmful interference with aeronautical navigation and safety radio services, and has also established limits on cable system signal leakage. Periodic testing by cable operators for compliance with these technical standards and signal leakage limits is required. The Company believes that the Systems are in compliance with these standards in all material respects. The 1992 Cable Act requires the FCC to update periodically its technical standards to take into account changes in technology and to entertain waiver requests from franchising authorities who would seek to impose more stringent technical standards upon their franchised cable systems. The FCC has adopted regulations to implement the requirements of the 1992 Cable Act designed to improve the compatibility of cable systems and consumer electronics equipment. These regulations, inter alia, generally prohibit cable operators from scrambling their basic service tier and from changing the infrared codes used in their existing customer premises equipment. This latter requirement could make it more difficult or costly for cable operators to upgrade their customer premises equipment and the FCC has been asked to reconsider its regulations. It is also anticipated that the FCC will seek comment on additional proposed regulations designed to promote equipment compatibility, including imposing further restrictions on the use of scrambling by cable operators. Such proposals, if ultimately adopted, could increase the capital and operating costs of providing cable service as well as limit the ability of cable operators to offer new unregulated services such as video on demand and multi-channel pay-per-view.\nPole Attachments. The FCC currently regulates the rates and conditions imposed by certain public utilities for use of their poles, unless under the Federal Pole Attachments Act state public service commissions are able to demonstrate that they regulate rates, terms and conditions of the cable television pole attachments. A number of states (including Massachusetts, Michigan, New Jersey, New York, Ohio and Vermont) and the District of Columbia have certified to the FCC that they regulate the rates, terms and conditions for pole attachments. In the absence of state regulation, the FCC administers such pole attachment rates through use of a formula which it has devised and from time to time revises.\nOther Matters. FCC regulation also includes matters regarding a cable system's carriage of local sports programming; restrictions on origination and cablecasting by cable system operators; application of the fairness doctrine and rules governing political broadcasts; customer service; home wiring; and limitations on advertising contained in nonbroadcast children's programming.\nCopyright. Cable television systems are subject to federal copyright licensing covering carriage of broadcast signals. In exchange for making semi-annual payments to a federal copyright royalty pool and meeting certain other obligations, cable operators obtain a statutory license to retransmit broadcast signals. The amount of this royalty payment varies, depending on the amount of system revenues from certain sources, the number of distant signals carried, and the location of the cable system with respect to over-the-air television stations. Originally, the Federal Copyright Royalty Tribunal was empowered to make and, in fact, did make several adjustments in copyright royalty rates. This tribunal was eliminated by Congress in 1993. Any future adjustment to the copyright royalty rates will be done through an arbitration process to be supervised by the U.S. Copyright office. Present rates remain in place until 1995 barring any changes in the FCC's signal carriage, syndicated exclusivity or sports blackout rules. Cable operators are liable for interest on underpaid and late paid royalty fees, but are not entitled to receive interest on refunds due to overpayment of royalty fees.\nThe Copyright Office has commenced a proceeding aimed at examining its policies governing the consolidated reporting of commonly owned and contiguous cable systems. The present policies governing the consolidated reporting of certain cable systems have often led to substantial increases in the amount of copyright fees owed by the systems affected. These situations have most frequently arisen in the context of cable system mergers and acquisitions. While it is not possible to predict the outcome of this proceeding, any changes adopted by the Copyright Office in its current policies may have the effect of reducing the copyright impact of certain transactions involving cable company mergers and cable system acquisitions.\nVarious bills have been introduced into Congress over the past several years that would eliminate or modify the cable television compulsory license. The FCC has recommended to Congress that it repeal the cable industry's compulsory copyright license. The FCC determined that the statutory compulsory copyright license for local and distant broadcast signals no longer serves the public interest and that private negotiations between the applicable parties would better serve the public. Without the compulsory license, cable operators might need to negotiate rights from the copyright owners for each program carried on each broadcast station in the channel lineup. Such negotiated agreements could increase the cost to cable operators of carrying broadcast signals. The 1992 Cable Act's retransmission consent provisions expressly provide that retransmission consent agreements between television broadcast stations and cable operators do not obviate the need for cable operators to obtain a copyright license for the programming carried on each broadcaster's signal.\nCopyrighted music performed in programming supplied to cable television systems by pay cable networks (such as HBO) and basic cable networks (such as USA Network) has generally been licensed by the networks through private agreements with the American Society of Composers and Publishers (\"ASCAP\") and BMI, Inc. (\"BMI\"), the two major performing rights organizations in the United States. As a result of extensive litigation, ASCAP and BMI are both now required to offer \"through to the viewer\" licenses to the cable networks which would cover the retransmission of the cable networks' programming by cable systems to their subscribers.\nState and Local Regulation\nBecause a cable television system uses local streets and rights-of-way, cable television systems are subject to state and local regulation, typically imposed through the franchising process. State and\/or local officials are usually involved in franchise selection, system design and construction, safety, service rates, consumer relations, billing practices and community related programming and services.\nCable television systems generally are operated pursuant to nonexclusive franchises, permits or licenses granted by a municipality or other state or local government entity. Franchises generally are granted for fixed terms and in many cases are terminable if the franchise operator fails to comply with material provisions. Although the 1984 Cable Act provides for certain procedural protections, there can be no assurance that renewals will be granted or that renewals will be made on similar terms and conditions. Franchises usually call for the payment of fees, often based on a percentage of the system's gross subscriber revenues, to the granting authority. Upon receipt of a franchise, the cable system owner usually is subject to a broad range of obligations to the issuing authority directly affecting the business of the system. The terms and conditions of franchises vary materially from jurisdiction to jurisdiction, and even from city to city within the same state, historically ranging from reasonable to highly restrictive or burdensome. The 1984 Cable Act places certain limitations on a franchising authority's ability to control the operation of a cable system operator and the courts have from time to time reviewed the constitutionality of several general franchise requirements, including franchise fees and access channel requirements, often with inconsistent results. On the other hand, the 1992 Cable Act prohibits exclusive franchises, and allows franchising authorities to exercise greater control over the operation of franchised cable systems, especially in the area of customer service and rate regulation. The 1992 Cable Act also allows franchising authorities to operate their own multichannel video distribution system without having to obtain a franchise and permits states or local franchising authorities to adopt certain restrictions on the ownership of cable systems. Moreover, franchising authorities are immunized from monetary damage awards arising from regulation of cable systems or decisions made on franchise grants, renewals, transfers and amendments.\nThe specific terms and conditions of a franchise and the laws and regulations under which it was granted directly affect the profitability of the cable television system. Cable franchises generally contain provisions governing charges for basic cable television services, fees to be paid to the franchising authority, length of the franchise term, renewal, sale or transfer of the franchise, territory of the franchise, design and technical performance of the system, use and occupancy of public streets and number and types of cable services provided.\nVarious proposals have been introduced at the state and local levels with regard to the regulation of cable television systems, and a number of states have adopted legislation subjecting cable television systems to the jurisdiction of centralized state governmental agencies, some of which impose regulation of a character similar to that of a public utility. Attempts in other states to regulate cable television systems are continuing and can be expected to increase. Such proposals and legislation may be preempted by federal statute and\/or FCC regulation. To date, the states in which the Company operates that have enacted such state level regulation are New York, New Jersey, Massachusetts and Vermont. The Company cannot predict whether other states in which it currently operates, or in which it may acquire systems, will engage in such regulation in the future.\nThe foregoing does not purport to describe all present and proposed federal, state and local regulations and legislation relating to the cable television industry. Other existing federal regulations, copyright licensing and, in many jurisdictions, state and local franchise requirements currently are the subject of a variety of judicial proceedings, legislative hearings and administrative and legislative proposals which could change, in varying degrees, the manner in which cable television systems operate. Neither the outcome of these proceedings nor their impact upon the cable television industry or the Systems can be predicted at this time.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's principal physical assets consist of cable television operating plant and equipment, including signal receiving, encoding and decoding devices, headends and distribution systems and subscriber house drop equipment for each of its cable television systems. The signal receiving apparatus typically includes a tower, antenna, ancillary electronic equipment and earth stations for reception of satellite signals. Headends, consisting of associated electronic equipment necessary for the reception, amplification and modulation of signals, are located near the receiving devices. The Company's distribution system consists primarily of coaxial and fiber optic cables and related electronic equipment. Subscriber devices consist of decoding converters. The physical components of cable television systems require maintenance and periodic upgrading to keep pace with technological advances.\nThe Company's cables and related equipment are generally attached to utility poles under pole rental agreements with local public utilities, although in some areas the distribution cable is buried in underground ducts or trenches. See \"Legislation and Regulation-Federal Regulation.\"\nThe Company owns or leases parcels of real property for signal reception sites (antenna towers and headends), microwave facilities and business offices in each of its market areas, and owns most of its service vehicles. The Company also leases certain cable, operating and support equipment from a corporation owned by members of the Rigas Family. All leasing transactions between the Company and its officers, directors or principal stockholders, or any of their affiliates, are, in the opinion of management, on terms no less favorable to the Company than could be obtained from unaffiliated third parties.\nSubstantially all of the assets of Adelphia's subsidiaries are subject to encumbrances as collateral in connection with the Company's credit arrangements, either directly with a security interest or indirectly through a pledge of the stock in the respective subsidiaries. See Note 3 to the Adelphia Communications Corporation Consolidated Financial Statements. The Company believes that its properties, both owned and leased, are in good operating condition and are suitable and adequate for the Company's business operations.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThere are no material pending legal proceedings, other than routine litigation incidental to the business, to which the Company or any of its subsidiaries is a part of 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 matters were submitted to a vote of security holders during the fourth quarter of the fiscal year 1995.\nExecutive Officers of the Registrant\nThe executive officers of the Company, first elected to hold their respective positions on July 1, 1986 following the reorganization of the Company as a holding company, serve at the discretion of the Board of Directors. The executive officers of the Company are:\nNAME AGE POSITION\nJohn J. Rigas 70 Chairman, Chief Executive Officer, President and Director Michael J. Rigas 41 Senior Vice President, Operations and Director Timothy J. Rigas 39 Senior Vice President, Chief Financial Chief Accounting Officer, Treasurer and Director James P. Rigas 37 Vice President, Strategic Planning and Director Daniel R. Milliard 47 Vice President, Secretary and Director\nJohn J. Rigas is the founder, Chairman, President and Chief Executive Officer of Adelphia and is President of its subsidiaries. Mr. Rigas has served as President or general partner of most of the constituent entities which became wholly-owned subsidiaries of Adelphia upon its formation in 1986, as well as the cable television operating companies acquired by the Company which were wholly or partially owned by members of the Rigas Family. Mr. Rigas has owned and operated cable television systems since 1952. Among his business and community service activities, Mr. Rigas is Chairman of the Board of Directors of Citizens Bancorp., Inc., Coudersport, Pennsylvania, and a member of the Board of Directors of Charles Cole Memorial Hospital. He is a director of the National Cable Television Association and a past President of the Pennsylvania Cable Television Association. He is also a member of the Board of Directors of C-SPAN and the Cable Advertising Bureau, and is a Trustee of St. Bonaventure University. He graduated from Rensselaer Polytechnic Institute with a B.S. in Management Engineering in 1950.\nJohn J. Rigas is the father of Michael J. Rigas, Timothy J. Rigas and James P. Rigas, each of whom currently serves as a director and executive officer of the Company.\nMichael J. Rigas is Senior Vice President, Operations of Adelphia and is a Vice President of its subsidiaries. Since 1981, Mr. Rigas has served as a Vice President, general partner or other officer of the constituent entities which became wholly-owned subsidiaries of Adelphia upon its formation in 1986, as well as the cable television operating companies acquired by the Company which were wholly or partially owned by members of the Rigas Family. From 1979 to 1981, he worked for Webster, Chamberlain & Bean, a Washington, D.C. law firm. Mr. Rigas graduated from Harvard University (magna cum laude) in 1976 and received his Juris Doctor degree from Harvard Law School in 1979.\nTimothy J. Rigas is Senior Vice President, Chief Financial Officer, Chief Accounting Officer and Treasurer of Adelphia and its subsidiaries. Since 1979, Mr. Rigas has served as Vice President, general partner or other officer of the constituent entities which became wholly-owned subsidiaries of Adelphia upon its formation in 1986, as well as the cable television operating companies acquired by the Company which were wholly or partially owned by members of the Rigas Family. Mr. Rigas graduated from the University of Pennsylvania, Wharton School, with a B.S. degree in Economics (cum laude) in 1978.\nJames P. Rigas is Vice President, Strategic Planning of Adelphia and is a Vice President of its subsidiaries. Since February 1986, Mr. Rigas has served as a Vice President or other officer of the constituent entities which became wholly-owned subsidiaries of Adelphia upon its formation in 1986, as well as the cable television operating companies acquired by the Company which were wholly or partially owned by members of the Rigas Family. Mr. Rigas graduated from Harvard University (magna cum laude) in 1980 and received a Juris Doctor degree and an M.A. degree in Economics from Stanford University in 1984. From June 1984 to February 1986, he was a consultant with Bain & Co., a management consulting firm.\nDaniel R. Milliard is Vice President and Secretary of Adelphia and its subsidiaries, and also serves as President of a subsidiary, Hyperion Telecommunications, Inc. From 1986 to 1992, Mr. Milliard served as Vice President, Secretary and\/or General Counsel of Adelphia and the constituent entities which became wholly-owned subsidiaries of Adelphia as well as the cable television operating companies acquired by the Company which were wholly or partially owned by members of the Rigas Family. He served as outside general counsel to the Company's predecessors from 1979 to 1982. Mr. Milliard graduated from American University in 1970 with a Bachelor of Science degree in Business Administration. He received an M.A. degree in Business from Central Missouri State University in 1971, where he was an Instructor in the Department of Finance, School of Business and Economics, from 1971-1973, and received a Juris Doctor degree from the University of Tulsa School of Law in 1976. He is a Director of Citizens Bancorp., Inc. in Coudersport, Pennsylvania and President of the Board of Directors of Charles Cole Memorial Hospital.\nOther Principal Employees\nOrby G. Kelley, 63, joined the Company in 1986 as Vice President of Human Resources. Since 1981, Mr. Kelley served as Vice President Human Resources-- Columbus Operations for Warner Amex Cable Communications, Inc. Prior to that time he served in a similar capacity for Colony Communications, Inc. and Landmark Communications, Inc. Mr. Kelley received his B.A. degree from Old Dominion University in 1958 and his M.B.A. from California Western University in 1980.\nDaniel Liberatore, 44, has been Vice President of Engineering since 1986. He is responsible for technical operations, engineering and related supervisory and management functions for the Company Systems. Mr. Liberatore received a B.S. degree in Electrical Engineering from West Virginia University and served as director of engineering for Warner Amex Cable Communications, Inc. from June 1982 until joining the Company. From December 1980 to June 1982, Mr. Liberatore served as a Project Administrator for Warner Amex Cable Communications, Inc.\nJames R. Brown, 32, joined the Company in 1984 and currently holds the position of Vice President of Finance. Mr. Brown graduated with a B.S. degree in\nIndustrial and Management Engineering from Rensselaer Polytechnic Institute in 1984.\nRandall D. Fisher, 43, joined the Company in 1991 and is Vice President, General Counsel and Assistant Corporate Secretary. Previously Mr. Fisher was in private practice with the Washington, D.C. law firm of Baraff, Koerner, Olender & Hochberg, P.C. Mr. Fisher earned his J.D. from Texas Tech University. He received a Masters Degree in Public Administration from Midwestern University in Wichita Falls, Texas, and a B.A. degree in Journalism from the University of Texas at Austin.\nLarry Brett, 42, joined the Company in May 1995 and currently holds the position of Corporate Director of Operations for the Florida cluster. Mr. Brett was employed by TeleCable Corporation, a cable television operator, from 1979 to 1995 and last served as Vice President, Regional Operations, from 1982 to 1995. Mr. Brett received a B.B.A. degree in finance and economics from Emory University in 1974 and an M.B.A. degree from the University of Virginia's Darden School in 1979.\nColin H. Higgin, 34, joined the Company in November 1992 as Deputy General Counsel and Assistant Secretary. Mr. Higgin was an associate at Proskauer Rose Goetz & Mendelsohn from 1991 to 1992 and Latham & Watkins from 1987 to 1991. Mr. Higgin graduated from the University of Pennsylvania, Wharton School, with a B.S. degree in Economics in 1983 and received his J.D. from Indiana University in 1987.\nWilliam C. Kent, 44, joined the Company in August 1994 as Corporate Director of Operations for the New England, Ohio and Virginia clusters. From 1993 to 1994, Mr. Kent served as a consultant to the Multi-Media Services Group of Southern New England Telephone. From 1991 to 1992, he served as Director of Operations for the Providence, Rhode Island cable system for Times Mirror. Mr. Kent was also employed by Viacom, Inc., a worldwide entertainment and media concern, for seven years and last served as General Manager of a cable system. He received a B.A. degree in English from Wittenberg University in 1973 and an M.B.A. degree from Cleveland State University in 1981.\nKathleen S. Mitchell, 47, joined the Company in 1989 and has held senior accounting and financial management positions. From 1979 to 1988, Ms. Mitchell was employed by American Television and Communications, Inc. Ms. Mitchell received her B.A. degree from Mount Holyoke College in 1969 and her M.B.A. degree from the University of Colorado in 1976.\nMichael C. Mulcahey, CPA, 37, has been the Director of Investor Relations since joining the Company in 1991. From 1987 to 1991, Mr. Mulcahey held accounting and tax positions with the Syracuse office of Coopers & Lybrand. Mr. Mulcahey received his B.A. in Political Science from State University of New York at Buffalo in 1980 and his M.B.A. from Eastern Washington University in 1985.\nJames M. Kane, CPA, 32, joined the Company in April 1992 and currently holds the position of Director of Finance. From 1989 to 1992, Mr. Kane served in accounting and consulting positions with Price Waterhouse in Pittsburgh. From 1984 to 1987, Mr. Kane served in accounting positions with Coopers & Lybrand in Pittsburgh. Mr. Kane received his B.S. degree in Accounting from Pennsylvania State University in 1984 and his M.B.A. from Carnegie Mellon's Graduate School of Industrial Administration in 1989.\nRobert G. Wahl, 53, joined the Company in May 1990 and was appointed to his present position of Corporate Director of Operations for the Western New York, Eastern Pennsylvania, Western Pennsylvania and New Jersey clusters in June 1994. From 1990 to 1994, Mr. Wahl served as General Manager of the Company's Northeast system and, from 1992 to 1994, he also acted as Pittsburgh Regional Manager. Prior to his employment with the Company, he served as Manager of the Horvitz Newspapers, Inc., in Troy, New York. Mr. Wahl graduated from John Carroll University in Cleveland with a B.S. degree in Business Administration in 1963.\nLeMoyne T. Zacherl, 42, joined the Company in November 1993 as Vice President Financial Operations and Administration. Since 1987, Mr. Zacherl was a Corporate Controller and member of senior management for Irvin Feld and Kenneth Feld Productions, Inc., a worldwide entertainment conglomerate. From 1975 to 1987, Mr. Zacherl was with Coopers & Lybrand and served in both the Pittsburgh, PA and Washington, D.C. offices.\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 for trading on the National Association of Securities Dealers Automated Quotations System National Market System (NASDAQ-NMS). Adelphia's NASDAQ- NMS symbol is \"ADLAC.\"\nThe following table sets forth the range of high and low closing bid prices of the Class A Common Stock on NASDAQ\/NMS. Such bid prices represent inter-dealer quotations, without retail mark-up, mark-down or commission, and may not necessarily represent actual transactions.\nAs of June 26, 1995, there were approximately 147 holders of record of Adelphia's Class A Common Stock. As of June 26, 1995, three record holders were registered clearing agencies holding Class A Common Stock on behalf of participants in such clearing agencies.\nNo established public trading market exists for Adelphia's Class B Common Stock. As of the date hereof, the Class B Common Stock was held of record by seven persons, principally members of the Rigas Family, including a Pennsylvania general partnership all of whose partners are members of the Rigas Family. The Class B Common Stock is convertible into shares of Class A Common Stock on a one-to-one basis. As of June 26, 1995 the Rigas Family owned 99.1% of the outstanding Class B Common Stock.\nAdelphia has never paid a cash dividend on its common stock and anticipates that for the foreseeable future any earnings will be retained for use in its business. The ability of Adelphia to pay cash dividends on its common stock is limited by the provisions of its indentures. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources\".\nITEM 6.","section_6":"ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA (Dollars in thousands, except per share amounts)\nThe selected consolidated financial data as of and for each of the five years in the period ended March 31, 1995 have been derived from the audited consolidated financial statements of the Company.\n(a) On February 28, 1995, Olympus entered into a Liquidation Agreement with the Gans Family (\"Gans\"), an Olympus limited partner, pursuant to which the Gans Limited Partner Interests in Olympus were liquidated. Concurrently, with the closing of the Liquidation Agreement, ACP Holdings, Inc., a wholly-owned subsidiary of the Company and managing general partner of Olympus, certain shareholders of Adelphia, Olympus and various Telesat Entities (\"Telesat\"), wholly-owned subsidiaries of FP & L Group, Inc. (\"FPL\"), entered into an Investment Agreement, whereby Telesat contributed to Olympus substantially all of the assets associated with certain cable television systems, serving approximately 50,000 subscribers in southern Florida, in exchange for general and limited partner interests and newly issued preferred limited partner interests (\"PLP interests\") in Olympus. At that time, Adelphia converted certain amounts owed to the Company by Olympus for advances, PLP interests and unpaid priority return on the PLP interests, to capital contributions. The Company's return on its priority investment in Olympus is based on a 16.5% return on its nonvoting PLP interests, although the Company recognizes priority investment income only to the extent received. At March 31, 1995 $2,997 accumulated priority return remained unpaid. Investment in and amounts due from Olympus at March 31, 1995 are comprised of the following:\nGross Investment in PLP Interests and General Partner's Equity.................................................$ 298,402 Excess of Ascribed Value of Contributed Property over Historical Cost.......................... (98,303)\nCumulative Equity in Net Loss of Olympus............... (318,707) Additional investment in Olympus....................... 69,920 Investments in Olympus................................. (48,688) Amounts due from Olympus............................... 60,631\nTotal.................................................. $ 11,943\n(b) \"Extraordinary loss\" relates to loss on the early retirement of debt. \"Cumulative Effect of Change in Accounting Principle\" refers to a change in accounting principle for Olympus and the Company. Effective January 1, 1993 and April 1, 1993, respectively, Olympus and the Company adopted the provisions of Statement of Financial Accounting Standards (\"SFAS\") No. 109, \"Accounting for Income Taxes\", which requires an asset and liability approach for financial accounting and reporting for income taxes. SFAS No. 109 resulted in the cumulative recognition of an additional liability by Olympus and the Company of $59,500 and $89,660,respectively.\n(c) Represents total debt less cash and cash equivalents.\n(d) Earnings before interest, income taxes, depreciation and amortization, equity in net loss of Olympus, other noncash charges, extraordinary loss and cumulative effect of change in accounting principle (\"EBITDA\"). EBITDA and similar measurements of cash flow are commonly used in the cable television industry to analyze and compare cable television companies on the basis of operating performance, leverage and liquidity. While EBITDA is not an alternative indicator of operating performance to operating income as defined by generally accepted accounting principles, the Company's management believes EBITDA is a meaningful measure of performance as substantially all of the Company's financing agreements contain financial covenants based on EBITDA.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Dollars in thousands)\nResults of Operations\nGeneral\nAdelphia Communications Corporation (\"Adelphia\" or the \"Company\") earned substantially all of its revenues in each of the last three fiscal years from monthly subscriber fees for basic, satellite, premium and ancillary services (such as installations and equipment rentals), local and national advertising sales, pay-per-view programming, home shopping networks and competitive access telecommunications services. Certain changes in the way the Company offers and charges for subscriber services were implemented as of September 1, 1993 under the 1992 Cable Act and under the Company's revised method of offering certain services. See \"Regulatory and Competitive Matters\" below.\nThe high level of depreciation and amortization associated with the significant number of acquisitions in recent years, the recent upgrading and expansion of systems and interest costs associated with financing activities will continue to have a negative impact on the reported results of operations. Also, significant charges for depreciation, amortization and interest are expected to be incurred in the future by the Olympus joint venture, which will also adversely impact Adelphia's future results of operations. Adelphia expects to report net losses for the next several years.\nThe Company currently offers competitive access telecommunications services through a subsidiary, Hyperion Telecommunications, Inc. (\"Hyperion\"). Since Hyperion's formation in October 1992, it has formed operating companies or entered into joint venture partnerships to develop and operate competitive access networks in twelve select metropolitan areas. The investment in Hyperion has resulted in a reduction in the Company's operating income before depreciation and amortization for fiscal years 1993, 1994 and 1995 of $900, $1,459 and $1,837, respectively. Included in these amounts are the equity in net loss of Hyperion's joint venture partnerships, which amounted to $0, $387 and $963 for the fiscal years 1993, 1994 and 1995, respectively.\nThe following table is derived from Adelphia Communications Corporation Consolidated Financial Statements for the years presented that are included in this Annual Report on Form 10-K and sets forth the historical percentage relationship of the components of operating income contained in such financial statements for the years indicated.\nPERCENTAGE OF REVENUES FOR YEAR ENDED MARCH 31, 1993 1994 1995 Revenues....................... 100.0% 100.0% 100.0% Operating expenses: Direct operating and programming................... 27.0 28.4 29.6 Selling, general and administrative................ 16.2 16.5 17.6\nOperating income before depreciation and amortization. 56.8 55.1 52.8 Depreciation and amortization.. 29.6 28.0 27.0\nOperating income............... 27.2% 27.1% 25.8%\nCOMPARISON OF THE YEARS MARCH 31, 1993, 1994 AND 1995\nRevenues. Revenues increased approximately 4.5% for the year ended March 31, 1994 compared with fiscal 1993. The majority of the increase was attributable to basic subscriber growth and rate increases, with the remainder primarily attributable to the expansion of advertising sales and services. Revenues increased approximately 13.3% for the year ended March 31, 1995 compared with fiscal 1994. The increase was attributable to the following:\nAcquisitions......................................................... 87% Basic subscriber growth.............................................. 10% Rate increases....................................................... 0% Advertising sales and other services................................. 3% 100%\nRevenues for the year ended March 31, 1994 and 1995 fully reflected the repackaging and adjustment of equipment and installation charges, effective in July 1993, and rates for basic services and certain other satellite programming services under CableSelect, the Company's method of offering services that was implemented effective September 1, 1993. In addition, fiscal 1994 and 1995 revenues were subject to the FCC rate freeze. Increases in total revenues for fiscal year 1994 are partially offset by a lower premium penetration rate, which caused premium service revenues to remain relatively constant compared to the respective prior year.\nDirect Operating and Programming Expenses. Direct operating and programming expenses, which are mainly basic and premium programming costs and technical expenses, increased 9.9% for the year ended March 31, 1994 compared with the prior year primarily due to increased costs of providing programming to subscribers and incremental costs associated with increased subscribers and revenues. Direct operating and programming expenses increased 18.2% for the year ended March 31, 1995 compared with fiscal 1994 primarily due to the increased operating expenses from acquired systems, increased programming costs and incremental costs associated with increased subscribers.\nSelling, General and Administrative Expenses. These expenses, which are mainly comprised of costs related to system offices, customer service representatives and sales and administrative employees, increased 6.7% and 20.2% the years ended March 31, 1994 and 1995, respectively, compared with the respective prior years. The increases were primarily due to incremental costs associated with acquisitions, subscriber growth and implementation of the 1992 Cable Act and regulations thereunder. As a percentage of revenues, such expenses remained relatively constant for fiscal 1994 compared with the prior year. Selling, general and administrative expenses increased as a percentage of revenues for fiscal 1995, as compared with fiscal 1994 primarily due to wage and benefit increases without a corresponding increase in revenues as a result of the rate freeze enacted by the 1992 Cable Act.\nOperating Income Before Depreciation and Amortization. Operating income before depreciation and amortization was $173,377, $175,697 and $191,025 for the years ended March 31, 1993, 1994 and 1995, respectively, representing operating margins of 56.8%, 55.1% and 52.8%, respectively. The increases in operating income before depreciation and amortization for the years ended March 31, 1994 and 1995 were due primarily to the impact of acquisitions, offset by cost increases at a rate greater than increases in revenue due largely to the above noted rate freeze.\nDepreciation and Amortization, Depreciation and amortization expense was higher for the years ended March 31, 1994 and 1995, compared with the respective prior year, primarily due to increased depreciation and amortization related to acquisitions consummated during fiscal 1994 and 1995 and capital expenditures made during fiscal 1993 and 1994.\nPriority Investment Income. Priority investment income is comprised of payments received from Olympus of accrued priority return on the Company's investment in PLP Interests in Olympus. The Company recognizes priority investment income only to the extent received. Priority investment income remained unchanged for the years ended March 31, 1993, 1994 and 1995.\nEBITDA. EBITDA (earnings before interest, income taxes, depreciation and amortization, equity in net loss of joint ventures, other non-cash charges, extraordinary loss and cumulative effect of change in accounting principle) amounted to $202,340, $207,936 and $225,890 for the years ended March 31, 1993, 1994 and 1995, respectively. The increase of 2.8% for the year ended March 31, 1994 compared with fiscal 1993 is primarily due to increased revenues, partially offset by increased operating expenses. The increase of 8.6% for the year ended March 31, 1995 compared with fiscal 1994 is primarily due to the acquisition of cable systems during fiscal 1995. Increased revenues and operating expenses during fiscal 1995 compared with the prior year primarily reflect the impact of acquisitions consummated during fiscal 1995. While EBITDA is not an alternative to operating income as defined by generally accepted accounting principles, the Company's management believes EBITDA is a meaningful measure of performance as substantially all of the Company's financing agreements contain financial covenants based on EBITDA.\nInterest Expense. Interest expense increased approximately 10.5% and 7.4% for the years ended March 31, 1994 and 1995, respectively, compared with the respective prior year. Approximately 56% of the increase for fiscal 1995 was due to additional interest cost associated with incremental debt related to acquisitions. Interest expense increased during fiscal 1994 compared with the prior year due primarily to higher levels of debt outstanding and the refinancing of short-term floating rate debt with long- term fixed rate debt during fiscal 1993 and 1994. In the 18 months ending March 31, 1994, the Company issued debt securities in four separate transactions (see \"Financing Activities\"). Each issue of these securities requires repayment of principal at maturity, the earliest of which is in July 2000. The interest rate on these securities ranged from 9 1\/2% to 11 7\/8%. Some of the proceeds from the securities were used to repay bank debt which had weighted average interest rates of 6.36% and 6.35% at March 31, 1993 and 1994, respectively. Interest expense includes $164, $1,680 and $14,756 for the years ended March 31, 1993, 1994 and 1995, respectively, of non-cash accretion of original issue discount and non-cash interest expense.\nEquity in Loss of Joint Ventures. The equity in loss of joint ventures represents primarily the Company's pro rata share of Olympus' losses and the accretion requirements of Olympus' redeemable limited partner interests. The decrease in fiscal 1994, compared with the prior year, is primarily attributable to a decrease in the loss of Olympus during such period, as compared with fiscal 1993, which operations were adversely impacted by Hurricane Andrew. The increase in fiscal 1995, compared with the prior year, is primarily attributable to the impact of the sale by Olympus of Northeast and lower business interruption revenue.\nNet Loss. The Company reported net losses of $176,795, $187,860, and $106,284 for the years ended March 31, 1993, 1994 and 1995, respectively. Included in net loss for fiscal 1993 is the cumulative effect of change in accounting for income taxes by Olympus of $59,500 and the extraordinary loss for the early extinguishment of debt of $14,386. Net loss for fiscal 1994 included the cumulative effect of the change in accounting of income taxes by the Company of $89,660. In addition to the effect of these items, net loss decreased by $5,461 from fiscal 1993 to 1994 and increased by $8,836 for fiscal 1994 to fiscal 1995. The decrease in net loss in fiscal 1994 when compared with the prior year was due primarily to the significant decrease in the equity in net losses of joint ventures (primarily Olympus), and higher operating income, offset by higher interest expense. The increase in net loss in fiscal 1995 when compared with fiscal 1994 was primarily due to an increase in the equity in net loss of joint venture (primarily Olympus) and higher non-cash interest expense, partially offset by higher operating income.\nLiquidity and Capital Resources\nThe cable television business is capital intensive and typically requires continual financing for the construction, modernization, maintenance, expansion and acquisition of cable systems. During the three fiscal years in the period ended March 31, 1995, the Company committed substantial capital resources for these purposes and for investments in Olympus and other affiliates and entities. These expenditures were funded through long-term borrowings and, to a lesser extent, internally generated funds. The Company's ability to generate cash to meet its future needs will depend generally on its results of operations and the continued availability of external financing.\nCapital Expenditures. The Company has developed an innovative fiber-to-feeder network architecture which is designed to increase channel capacity and minimize future capital expenditures, while positioning the Company to take advantage of future opportunities. Management believes its capital expenditures program has resulted in higher levels of channel capacity and addressability in comparison to other cable television operators.\nCapital expenditures for the years ended March 31, 1993, 1994 and 1995, were $70,975, $75,894 and $92,082, respectively. The increase in capital expenditures for fiscal 1993, 1994 and 1995, compared to each prior year, was primarily due to the acceleration of the rebuilding of plant using fiber-to-feeder technology, and expenditures related to faster than expected growth of the Company's competitive access telecommunications subsidiary, Hyperion Telecommunications, Inc. Management expects capital expenditures for fiscal 1996 to be approximately equal to fiscal 1995.\nFinancing Activities. The Company's financing strategy has been to maintain its public long-term debt at the parent holding company level while the Company's consolidated subsidiaries have their own senior and subordinated credit arrangements with banks and insurance companies. The Company's ability to generate cash adequate to meet its future needs will depend generally on its results of operations and the continued availability of external financing. During the three-year period ended March 31, 1995, the Company funded its working capital requirements, capital expenditures, investments in Olympus and other affiliates and entities and the redemption of the 16.5% Senior Discount Notes and 13% Senior Subordinated Notes through long-term borrowings primarily from banks and insurance companies, short-term borrowings, internally generated funds and the issuance of parent company public debt and equity. The Company generally has funded the principal and interest obligations on its long-term borrowings from banks and insurance companies by refinancing the principal with new loans or through the issuance of parent company debt securities, and by paying the interest out of internally generated funds. Adelphia has funded the interest obligations on its public borrowings from internally generated funds.\nMost of Adelphia's directly-owned subsidiaries have their own senior credit agreements with banks and\/or insurance companies. Typically, borrowings under these agreements are collateralized by the stock in and, in some cases, by the assets of the borrowing subsidiary and its subsidiaries and, in some cases, are guaranteed by such subsidiary's subsidiaries. At March 31, 1995, an aggregate of $942,350 in borrowings was outstanding under these agreements. These agreements contain certain provisions which, among other things, provide for limitations on borrowings of and investments by the borrowing subsidiaries, transactions between the borrowing subsidiaries and Adelphia and its other subsidiaries and affiliates, and the payment of dividends and fees by the borrowing subsidiaries. Several of these agreements also contain certain cross-default provisions relating to Adelphia or other subsidiaries. These agreements also require the maintenance of certain financial ratios by the borrowing subsidiaries. In addition, at March 31, 1995, an aggregate of $144,000 in subordinated and unsecured borrowings by Adelphia's subsidiaries was outstanding under credit agreements containing limitations and restrictions similar to those mentioned above. See Note 3 to the Adelphia Communications Corporation Consolidated Financial Statements. The Company is in compliance with the financial covenants and related financial ratio requirements contained in its various credit agreements, based on operating results for the period ended March 31, 1995.\nAt March 31, 1995, Adelphia's subsidiaries had an aggregate of $117,000 in unused credit lines with banks, part of which is subject to achieving certain levels of operating performance. In addition, the Company had an aggregate $5,045 in cash and cash equivalents at March 31, 1995 which combined with the Company's unused credit lines with banks aggregated to $122,045. The Company has the ability to pay interest on its 9 1\/2% PIK Notes by issuing additional notes totalling approximately $66,630 in lieu of cash interest payments through February 15, 1999. Based upon the results of operations of subsidiaries for the quarter ended March 31, 1995, approximately $141,000 of available assets could have been transferred to Adelphia at March 31, 1995, under the most restrictive covenants of the subsidiaries' credit agreements. The subsidiaries also have the ability to sell, dividend or distribute certain assets to other subsidiaries or Adelphia, which would have the net effect of increasing availability. At March 31, 1995, the Company's unused credit lines were provided by reducing revolving credit facilities whose revolver periods expire on April 1, 1995 through September 30, 2003. The Company's scheduled maturities of debt are currently expected to total $114,921 for fiscal 1996.\nAt March 31, 1995, the Company's total outstanding debt aggregated $2,021,610 which included $935,260 of parent debt and $1,086,350 of subsidiary debt. Bank debt interest rates are based upon one or more of the following rates at the option of ACC: prime rate plus 0% to 1.5%; certificate of deposit rate plus 1.25% to 2.75%; or Eurodollar (or London Interbank Offered) rate plus 1% to 2.5%. The Company's weighted average interest rate of notes payable to banks and institutions was approximately 9.33% at March 31, 1995, compared to 8.91% at March 31, 1994. At March 31, 1995, approximately 55% of such debt was subject to fixed interest rates for at least one year under the terms of such debt or applicable interest rate swap agreements. Approximately 76% of the Company's total indebtedness is at fixed interest rates as of March 31, 1995. Adelphia has entered into interest rate swap agreements to mitigate its exposure to interest rate fluctuations by attempting to achieve an appropriate balance between its fixed and variable rate debt.\nOn May 14, 1992, Adelphia completed offerings of $400,000 aggregate principal amount of unsecured 12 1\/2% Senior Notes Due 2002 and of 1,500,000 shares of its Class A Common Stock. The shares of Class A Common Stock were sold at a public offering price of $15.00 per share, including 750,000 of such shares which were purchased at the public offering price by certain members of the Rigas Family. The net proceeds from these offerings were approximately $389,000 for the offering of the 12 1\/2% Notes and $21,700 for the offering of the Class A Common Stock. On July 1, 1992, $260,000 of such net proceeds was used for the redemption of all outstanding 16 1\/2% Senior Discount Notes at 104% of par.\nOn September 10, 1992, Adelphia completed an offering of $125,000 aggregate principal amount of 11 7\/8% Senior Debentures Due 2004. The net proceeds from this offering were approximately $120,600.\nOn March 11, 1993, Adelphia completed the placement of $130,000 aggregate principal amount of 9 7\/8% Senior Debentures Due 2005. The net proceeds from this placement were approximately $125,307.\nOn July 28, 1993, Adelphia completed the placement of $110,000 aggregate principal amount of 10 1\/4% Senior Notes Due 2000, Series A. The net proceeds from this placement were approximately $106,961.\nOn January 14, 1994, Adelphia completed a public offering of 9,132,604 shares of Class A Common Stock (the \"Stock Offering\"). Of the 9,132,604 shares of Class A Common Stock sold in the Stock Offering, 3,300,000 shares were sold to the public at $18.00 per share and 5,832,604 shares were sold directly by Adelphia to partnerships controlled by members of the Rigas Family, at the public offering price less the underwriting discount. Highland Holdings and Syracuse Hilton Head Holdings, L.P., which purchased 4,374,453 and 1,458,151 of such 5,832,604 shares, respectively, hold and control the Managed Systems.\nOn February 22, 1994, the Company issued, in a private placement, $150,000 aggregate principal amount of 9 1\/2% Senior Pay-In-Kind (\"PIK\") Notes Due 2004, Series A. The net proceeds from the 9 1\/2% Notes of approximately $147,000 were used to repay outstanding bank debt of subsidiaries in order to extend the scheduled maturities of the Company's long-term debt. The Company has the ability to pay interest on its 9 1\/2 % PIK Notes by issuing additional notes totalling approximately $66,630 in lieu of cash interest payments through February 15, 1999.\nIn May 1994, Adelphia purchased on the open market $10,000 of its 10 1\/4% Senior Notes due in 2000 at a price of 94.5% of face value plus accrued interest.\nOn February 28, 1995, as a part of the Telesat Investment Agreement, FP&L Group Inc. purchased 1,000,000 shares of newly issued Class A Common Stock for $15,000.\nOn March 15, 1995, certain subsidiaries of the Company entered into a $200,000 revolving credit facility, maturing September 30, 2003. Initial borrowings under the revolving credit facility were used to repay existing indebtedness of the Borrowers. The maximum available under the agreement is reduced on June 30, 1997 by the lesser of $25,000 or 50% of the unused and available commitment. Thereafter, the credit facility provides for mandatory reductions in the revolving loan commitment, in increasing quarterly amounts, commencing June 30, 1997 through September 30, 2003.\nAcquisitions. On March 10, 1994, the Company purchased a 75% equity interest in Three Rivers Cable Associates, L.P. (\"TR\") for $6,000. TR serves approximately 15,000 subscribers in Ohio and approximately 3,000 subscribers in Pennsylvania, which are contiguous with existing Company owned systems. Adelphia has also committed to provide a fully collateralized $18,000 line of credit, similar to that which would be available to TR had it borrowed such monies from a commercial bank. At March 31, 1995, there were outstanding borrowings of $14,859 under this agreement.\nOn March 31, 1994, Adelphia acquired from Olympus the rights to provide alternate access in its respective franchise areas and an investment in the Sunshine Network, L.P. for a purchase price of $15,500. The purchase price of the assets resulted in a reduction of amounts due Adelphia of $15,500. Also, on March 31, 1994, Adelphia acquired from certain Managed Partnerships the rights to provide alternate access in their respective franchise areas for a purchase price of $14,000. Additionally, on March 31, 1994, Adelphia purchased real property from Dorellenic and Island Partners, L.P., partnerships owned by certain executive officers of the Company, for a total of $14,312.\nOn April 12, 1994, Adelphia purchased for $15,000 (i) convertible preferred units in Niagara Frontier Hockey, L.P., (the \"Sabres Partnership\") which owns the Buffalo Sabres National Hockey League Franchise, convertible to a 34% equity interest and (ii) warrants allowing Adelphia to increase its interest to 40%. Adelphia believes this investment will be competitively advantageous in the Buffalo cable television market. The Sabres Partnership will control, through a wholly-owned subsidiary, the Crossroads Arena, a new sports and entertainment facility expected to be completed in late 1996. Adelphia's convertible preferred units will earn a 4% cumulative preferred return beginning after the first National Hockey League game is played at the Crossroads Arena.\nOn May 12, 1994, Adelphia invested $3,000 for a 20% interest in SuperCable ALK International, a cable operator in Caracas, Venezuela. In April 1994, Adelphia invested $4,200 in Commonwealth Security Systems, Inc. in exchange for an 8.75% $4,200 convertible note and warrants. The note is convertible into a 33% fully-diluted common equity interest on demand. The warrants entitle Adelphia to acquire up to a 40% fully diluted common equity interest for an additional $670.\nOn June 16, 1994, Adelphia invested $34,000 in TMC Holdings Corporation (\"THC\"), the parent of Tele-Media Company of Western Connecticut. THC owns cable television systems serving approximately 43,000 subscribers in Western Connecticut. The investment in THC provides Adelphia with a $30,000 preferred equity interest in THC and a 75% non-voting common equity interest, with a liquidation preference to the remaining 25% common stock ownership interest in THC. Adelphia has the right to convert such interest to a 75% voting common equity interest, with a liquidation preference to the remaining shareholders' 25% common stock ownership interest, on demand subject to certain regulatory approvals. The acquisition of THC was accounted for using the purchase method of accounting. The consolidated statements of operations and cash flows include the operations of the acquired system from June 16, 1994. Debt assumed, included in notes payable of subsidiaries to banks and institutions, was $52,000 at closing.\nOn June 30, 1994, Adelphia acquired from Olympus 85% of the common stock of Northeast Cable, Inc. (\"Northeast\") for a purchase price of $31,875. Northeast owns cable television systems serving approximately 36,500 subscribers in eastern Pennsylvania. Of the purchase price, $16,000 was paid in cash and the remainder resulted in a decrease in Adelphia's receivable from Olympus. The acquisition of Northeast was accounted for using the purchase method of accounting. The consolidated statements of operations and cash flows include the operations of the acquired system since June 30, 1994. Debt assumed, included in notes payable of subsidiaries to banks and institutions, was $42,300 at closing.\nOn November 8, 1994, Page Call, Inc., a company 49.9% owned by Adelphia, was a successful bidder for three regional narrowband PCS licenses, covering 62% of the country's population. Page Call, Inc., was recently established to develop a nationwide paging service. Page Call, Inc.'s aggregate final bid for the three licenses was $52,900, an amount reduced to $31,800 due to its \"designated entity\" status.\nOn December 27, 1994, Adelphia exchanged its existing investment in TMIP with a Managed System for a note in the amount of $13,000.\nOn January 10, 1995, Adelphia issued 399,087 shares of Class A Common Stock in connection with the merger of a wholly-owned subsidiary of Adelphia into Oxford Cablevision, Inc. (\"Oxford\"), one of the Terry Family cable systems. Oxford serves approximately 4,200 subscribers located in the North Carolina counties of Granville and Warren. The acquisition of Oxford was accounted for using the purchase method of accounting. The consolidated statements of operations and cash flows include the operations of the acquired systems since January 10, 1995. Adelphia assigned the rights to purchase the stock of the other Terry Family cable systems to a Managed System.\nOn January 31, 1995, Adelphia acquired Tele-Media Company of Martha's Vineyard, L.P. (\"Martha's Vineyard\") for $11,775, a cable system serving approximately 7,000 subscribers located in Martha's Vineyard, Massachusetts. This system is part of Adelphia's New England cluster. The acquisition of Martha's Vineyard was accounted for using the purchase method of accounting. The consolidated statements of operations and cash flows include the operations of the acquired system since January 31, 1995.\nOn June 12, 1995, Adelphia announced the signing of definitive agreements for the purchase of all of the cable systems of Eastern Telecom Corporation, Robinson Cable TV, Inc. and First Carolina Cable TV, L.P. These systems together serve approximately 58,000 subscribers and are being purchased for an aggregate price of $92,000. On June 28, 1995, Adelphia and other relevant parties terminated their previously announced November 1994 letter of intent to increase by $63,000 to $75,000 the overall investment of Adelphia and the companies it manages (the \"Adelphia Group\") in cable systems held by Tele-Media Investment Partnership, L.P. and certain other Tele-Media controlled entities (collectively, \"Tele-Media\"). The Adelphia Group will continue to hold its existing investments in and recent acquisitions of Tele-Media cable systems, some of which are held by Adelphia as described herein.\nOlympus. During the years ended March 31, 1993 and 1994 the Company made advances of $49,061 and $16,554, respectively, to Olympus. Such advances provided funds for capital expenditures, the repayment of debt and working capital. In addition, the Company's investment in Olympus increased by $15,400 in fiscal 1994 in connection with the purchase by the Company from Olympus of rights to provide alternate access services in Olympus' franchise areas and an investment in an unaffiliated partnership. During each of the years ended March 31, 1993, 1994 and 1995, the Company received priority investment income from Olympus of $22,300.\nOn February 28, 1995, Olympus entered into a Liquidation Agreement with the Gans Family (\"Gans\"), an Olympus limited partner. Concurrently, with the closing of the Liquidation Agreement, ACP Holdings, Inc., a wholly-owned subsidiary of the Company and managing general partner of Olympus, certain shareholders of Adelphia, Olympus and various Telesat Entities (\"Telesat\"), wholly-owned subsidiaries of Florida Power and Light Company (\"FPL\"), entered into an Investment Agreement, whereby Telesat contributed to Olympus substantially all of the assets associated with certain cable television systems, serving approximately 50,000 subscribers in southern Florida, in exchange for general and limited partner interests and newly issued preferred limited partner interests (\"PLP interests\") in Olympus. At that time, Adelphia converted certain amounts owed the Company by Olympus for advances, PLP interests and unpaid priority return on the PLP interests, to capital contributions. This transaction, net of advances made to Olympus during the year ended March 31, 1995, resulted in a net reduction of the amount due from Olympus for advances of $25,307. After this transaction Adelphia's ownership in Olympus is 50% voting interest, with FPL as its only other partner in Olympus.\nManaged Partnerships. On September 29, 1993, the Board of Directors of the Company authorized the Company to make loans in the future to Highland Video Associates, L.P. (\"Highland\") and Syracuse Hilton Head Holdings, L.P. (\"SHHH\") up to an amount of $25,000 for each. During the years ended March 31, 1994 and 1995, the Company made advances in the net amount of $7,828 and $10,028, respectively, to these and other related parties, primarily for capital expenditures and working capital purposes.\nOn October 6, 1993, Adelphia purchased the 14% preferred Class B Limited Partnership Interest in SHHH for $18,338 from Robin Media Group, an unrelated party. SHHH is a joint venture of the Rigas Family and Tele- Communications, Inc., whose interests in SHHH are junior to Adelphia's.\nDuring the year ended March 31, 1994, the Company made loans in the net amount of $15,000 to SHHH, to facilitate the acquisition of cable television systems serving Palm Beach County, Florida from unrelated parties. During fiscal 1995, the Company sold its investment in TMIP to SHHH for $13,000. On January 31, 1995, a wholly owned subsidiary of Adelphia received a $20,000 preferred investment from SHHH to facilitate the acquisition of cable properties from Tele-Media of Delaware.\nResources. The Company plans to continue to explore and consider new commitments, arrangements or transactions to refinance existing debt, increase the Company's liquidity or decrease the Company's leverage. These could include, among other things, the future issuance by Adelphia of public or private equity or debt and the negotiation of new or amended credit facilities. These could also include entering into acquisitions, joint ventures or other investment or financing activities, although no assurance can be given that any such transactions will be consummated. The Company's ability to borrow under current credit facilities and to enter into refinancings and new financings is limited by covenants contained in Adelphia's indentures and its subsidiaries' credit agreements, including covenants under which the ability to incur indebtedness is in part a function of applicable ratios of total debt to cash flow.\nDuring the year ended March 31, 1995, the increase in capital expenditures and accounts payable was primarily attributed to the companies acquired and an increase in the level of expenditures for new technology and rebuild activity. The increase in accrued interest and other liabilities resulted from the timing of the payment of interest due on the Company's indebtedness. Deferred taxes increased as of March 31, 1995 compared with the balance as of March 31, 1994 primarily due to the impact of acquired companies.\nThe Company believes that cash and cash equivalents, internally generated funds, borrowings under existing credit facilities, and future financing sources will be sufficient to meet its short-term and long-term liquidity and capital requirements. Although in the past the Company has been able to refinance its indebtedness or obtain new financing, there can be no assurance that the Company will be able to do so in the future or that the terms of such financings would be favorable.\nManagement believes that the telecommunications industry, including the cable television and telephone industries, is in a period of consolidation characterized by mergers, joint ventures, acquisitions, sales of all or part of cable companies or their assets, and other partnering and investment transactions of various structures and sizes involving cable or other telecommunications companies. The Company continues to evaluate new opportunities that allow for the expansion of its business through the acquisition of additional cable television systems in geographic proximity to its existing regional markets or in locations that can serve as a basis for new market areas. The Company, like other cable television companies, has participated from time to time and is participating in preliminary discussions with third parties regarding a variety of potential transactions, and the Company has considered and expects to continue to consider and explore potential transactions of various types with other cable and telecommunications companies. However, except as otherwise stated herein, the Company has not reached any agreements, in principal or otherwise, with respect to any material transaction and no assurances can be given as to whether any such transaction may be consummated or, if so, when.\nRecent Accounting Pronouncements. Statement of Financial Accounting Standards (\"SFAS\") No. 109, \"Accounting for Income Taxes,\" requires an asset and liability approach for financial accounting and reporting for income taxes. Effective January 1, 1993 and April 1, 1993, respectively, Olympus and the Company adopted the provisions of SFAS No. 109. The adoption of SFAS No. 109 resulted in the cumulative recognition of an additional liability by Olympus and the Company of $59,500 and $89,660, respectively.\nSFAS No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,\" establishes accounting standards for assessing the impairment of long-lived assets, certain identifiable intangibles, and goodwill related to those assets to be held and used and for long-lived assets and certain identifiable intangibles to be disposed of. SFAS No. 121 is effective for financial statements for fiscal years beginning after December 15, 1995 although earlier application is encouraged. Effective January 1, 1994 and April 1, 1994, respectively, both Olympus and the Company early-adopted the provisions of SFAS No. 121. The adoption of SFAS No. 121 did not materially affect the financial statements of Olympus or the Company.\nInflation\nIn the three fiscal years ended March 31, 1995, inflation did not have a significant effect on the Company. Periods of high inflation could have an adverse effect to the extent that increased borrowing costs for floating-rate debt may not be offset by increases in subscriber rates. At March 31, 1995, after giving effect to interest rate hedging agreements, approximately $484,250 of the Company's total debt was subject to floating interest rates.\nOlympus\nThe Company serves as the managing general partner of Olympus and, as of December 31, 1994, held $10,000 of voting general partnership interests representing, in the aggregate, 50% of the voting interests of Olympus. The Company also held, as of December 31, 1994, $276,101 aggregate principal amount of nonvoting PLP Interests in Olympus, which entitle the Company to a 16.5% per annum priority return, and nonvoting special limited partnership interests. The remaining equity in Olympus consists of voting limited partnership interests held by unaffiliated third parties. At December 31, 1992, these interests included $10,000 of redeemable limited partnership interests held by certain members of the Joseph Gans family (\"Gans\"). On January 3, 1993, Olympus redeemed certain other limited partner interests for $9,795 and the Company converted $6,500 of its voting general partnership interests to nonvoting PLP Interests, thereby maintaining 50% of the outstanding general partner and limited partner voting units of Olympus.\nOn February 28, 1995, Olympus entered into a Liquidation Agreement with Gans. Under this Liquidation Agreement, Gans agreed to exchange their redeemable limited partner interests in Olympus for the remaining 15% of the common stock of Northeast held by Olympus. Concurrently with the closing of the Liquidation Agreement, ACP Holdings, Inc. (\"ACP\"), a wholly-owned subsidiary of the Company and managing general partner of Olympus, certain shareholders of Adelphia, Olympus and various Telesat entities entered into an Investment Agreement whereby Telesat contributed to Olympus substantially all of the assets associated with certain cable television systems, serving approximately 50,000 subscribers in southern Florida, in exchange for a general and limited partner interests and newly issued preferred limited partner interests (\"PLP interests\") in Olympus. As a result of the Telesat Investment Agreement, Telesat contributed its Florida cable systems and $20,000 and, in exchange, received $112,500 of 16.5% preferred limited partnership interests. Prior to the Telesat Investment Agreement, Olympus had obligations to Adelphia for intercompany advances, PLP interests and priority return on PLP interests. In conjunction with the Telesat Investment Agreement, Adelphia converted a portion of the intercompany advances, a portion of the existing PLP interests and all of the existing accrued priority return on the PLP interests, to capital contributions.\nThe Olympus limited partnership agreement requires approval by the holders of 85% of the voting interests for, among other things, significant acquisitions and dispositions of assets, and the issuance of certain partnership interests, and also requires approval by the holders of 75% of the voting interests for, among other things, material amendments to the Olympus partnership agreement, certain financings and refinancings, certain issuances of PLP interests, certain transactions with related parties and the adoption of annual budgets.\nOn August 24, 1992 service in Olympus' South Dade system in the southern portion of Florida's Dade County was interrupted by Hurricane Andrew. Other Olympus subscribers were unaffected by the storm. Prior to the hurricane, as of July 31, 1992, the South Dade system passed 157,922 homes and served 71,193 basic subscribers. The rebuilding of the cable plant has been completed with state-of-the-art fiber to feeder technology which has an 80 channel capacity. At March 31, 1995 the South Dade System served 74,601 basic subscribers.\nOn April 3, 1995, Olympus acquired all of the cable and security systems of WB Cable Associates, Ltd. (\"WB Cable\") serving approximately 44,000 subscribers for a purchase price of $82,000. WB Cable provides cable services from one headend and security monitoring services from one location in West Boca Raton, Florida. Of the purchase price, $77,000 was paid in cash and $5,000 was paid in Adelphia Class A Common Stock. The acquisition, was accounted for under the purchase method of accounting, was financed principally through borrowings under the ACP credit agreement.\nOn June 12, 1995, Olympus announced the signing of a definitive agreement for the purchase of all of the southeast Florida cable systems of the Leadership cable division of Fairbanks Communications, Inc. which serves approximately 50,000 subscribers for a purchase price of $94,000.\nThe following table is derived from the Olympus Communications, L.P. Consolidated Financial Statements included in this Form 10-K.\nSUPPLEMENTAL FINANCIAL DATA FOR OLYMPUS\nYEAR ENDED\nDECEMBER 31,\n1992 1993 1994\nSTATEMENT OF OPERATIONS DATA: Revenues................................... $ 86,255 $ 89,099 $ 93,421 Business Interruption Revenue.............. 7,146 9,547 1,037 Total...................................... 93,401 98,646 94,458\nOperating Income Before Depreciation and Amortization.............................. 47,280 55,195 47,079 Depreciation and Amortization.............................. 39,407 37,240 36,703\nOperating Income........................... 7,873 17,955 10,376\nInterest Expense........................... (30,272) (29,470) (32,262)\nNet Loss................................... (16,617) (70,744) (21,025)\nBALANCE SHEET DATA: Total Assets............................... $ 467,279 $ 458,663 $ 375,985\nTotal Long-Term Debt....................... 362,428 368,263 314,069\nPLP Interests.............................. 269,601 276,101 276,101\nOTHER FINANCIAL DATA: Capital Expenditures....................... $ 26,827 $ 23,164 $ 23,916\nOperating Margin (a)....................... 50.6% 56.0% 49.8%\n(a) Percentage representing operating income before depreciation and amortization divided by total revenues.\nComparison of Years Ended December 31, 1992, 1993 and 1994\nRevenues. Total revenues for the year ended December 31, 1993 increased 5.6% over the prior year. Total revenues for the year ended December 31, 1994 declined 4.2% from the prior year. The 1993 increase in revenues as compared with 1992 was primarily attributable to basic subscriber growth and rate increases, which were partially offset by the effects of Hurricane Andrew on the South Dade System, net of business interruption insurance proceeds. See Note 3 to the Olympus Communications, L.P. Consolidated Financial Statements. The 1994 decrease as compared with 1993 was due to the sale of Northeast in June 1994, partially offset by the positive impact of the South Dade rebuild from the effects of Hurricane Andrew and subscriber growth.\nOperating Income Before Depreciation and Amortization. For the year ended December 31, 1993, operating income before depreciation and amortization increased 16.7% as compared with the prior year. This increase was primarily attributable to higher levels of total revenues, including business interruption revenue related to the effects of Hurricane Andrew, that were not offset by corresponding increases in operating expenses. For the year ended December 31, 1994, operating income before depreciation and amortization decreased 14.7% as compared with the prior year. The decrease was due to increased operating costs with no corresponding increase in rates due to the FCC rate freeze, the impact of the sale of Northeast and the decline in business interruption insurance revenue.\nOperating Income. For the year ended December 31, 1993, operating income increased by $10,082 to $17,955. This increase was primarily due to the increase in total revenues, including business interruption revenue, and relatively constant depreciation and amortization and operating expenses. For the year ended December 31, 1994, operating income decreased by $7,579 to $10,376. The decrease was due to reduced business interruption insurance revenue in the current year, the above noted FCC rate freeze impact and the effect of the Northeast sale.\nInterest Expense. For the year ended December 31, 1993, interest expense decreased 2.6% primarily due to reduced interest rates. For the year ended December 31, 1994, interest expense increased 9.5% primarily due to higher average rates outstanding on debt offset somewhat by the reduction of debt from the sale of Northeast.\nNet Loss. Olympus reported net losses of $16,617, $70,744 and $21,025 for the years ended December 31, 1992, 1993 and 1994, respectively. The increase in 1993 was mainly due to the cumulative effect of a change in accounting for income taxes of $59,500 resulting from the adoption of SFAS No. 109 by Olympus, partially offset by increased operating income. The decrease in net loss in 1994 was attributable to the absence in 1994 of the impact of the change in accounting for income taxes, offset by lower operating income for the period.\nRegulatory and Competitive Matters\nThe cable television operations of the Company may be adversely affected by changes and developments in governmental regulation, competitive forces and technology. The cable television industry and the Company are subject to extensive regulation at the federal, state and local levels. Many aspects of such regulation are currently the subject of judicial proceedings and administrative or legislative proceedings or proposals. On October 5, 1992, Congress passed the 1992 Cable Act, which significantly expands the scope of regulation of certain subscriber rates and a number of other matters in the cable industry, such as mandatory carriage of local broadcast stations and retransmission consent, and which will increase the administrative costs of complying with such regulations. The FCC has adopted rate regulations that establish, on a system-by-system basis, maximum allowable rates for (i) basic and cable programming services (other than programming offered on a per-channel or per-program basis), based upon a benchmark methodology, and (ii) associated equipment and installation services based upon cost plus a reasonable profit. Under the FCC rules, franchising authorities are authorized to regulate rates for basic services and associated equipment and installation services, and the FCC will regulate rates for regulated cable programming services in response to complaints filed with the agency. The original rate regulations became effective on September 1, 1993. Amendments to the rate regulations became effective May 15, 1994. Further amendments were adopted on November 10, 1994. The FCC ordered an interim rate freeze effective April 5, 1993 which was extended through May 15, 1994.\nThe original rate regulations required a reduction of existing rates charged for basic services and regulated cable programming services to the greater of (i) the applicable benchmark level or (ii) the rates in force as of September 30, 1992, reduced by 10%, adjusted forward for inflation. The amended regulations generally require a reduction of up to 17 percent from the rates for regulated services in force as of September 30, 1992, adjusted forward for inflation and certain other factors. Rate reductions are not required to the extent that a cable operator at its option elects to use an alternative cost-of-service methodology and shows that rates for basic and cable programming services are reasonable. The FCC has adopted interim rules to govern cost-of-service showings by cable operators. Refunds with interest will be required to be paid by cable operators who are required to reduce regulated rates after September 1, 1993, calculated retroactively from the date of a local franchising authority's decision with regard to basic rates, and from the date a complaint is filed with the FCC with regard to the rates charged for regulated programming services. The FCC has reserved the right to reduce or increase the benchmarks it has established. The rate regulations will also limit future increases in regulated rates to an inflation indexed amount plus increases in certain costs such as taxes, franchise fees, costs associated with specific franchise requirements and increased programming costs. Cost-based adjustments to these capped rates can also be made in the event a cable operator adds or deletes channels. On November 10, 1994, the FCC adopted an alternative method for adjusting the rates charged for a cable programming services tier when new services are added. This will allow cable operators to increase rates by as much as $1.50 over a two year period to reflect the addition of up to six new channels of service on cable programming service tiers. In addition, a new programming tier can be created, the rate for which would not be regulated as long as certain conditions are met, such as not moving services from existing tiers to the new one. Because of the limitation on rate increases for regulated services, future revenue growth from cable services will rely to a much greater extent than has been true in the past on increased revenues from unregulated services and new subscribers than from increases in previously unregulated rates.\nThe FCC has adopted regulations implementing virtually all of the requirements of the 1992 Cable Act. As noted above, amendments to the rate regulations were recently announced and the FCC is also likely to continue to modify, clarify or refine the rate regulations. In addition, litigation has been instituted challenging various portions of the 1992 Cable Act and the rulemaking proceedings including the rate regulations. The Company cannot predict the effect or outcome of future rulemaking proceedings, changes to the rate regulations, or litigation. Further, because the FCC has only issued its interim rules and has not adopted final cost-of-service rules, the Company has not determined to what extent it will be able to utilize cost-of-service showings to justify rates.\nEffective as of September 1, 1993, in accordance with the 1992 Cable Act, the Company adjusted the basic service rates and related equipment and installation rates in all of its systems in order for such rates to be in compliance with the applicable benchmark or equipment and installation cost levels. The Company also implemented a program in all of its systems called \"CableSelect\" under which most of the Company's satellite-delivered programming services are now offered individually on a per channel basis, or as a group at a price of approximately 15% to 20% below the sum of the per channel prices of all such services. For subscribers who elect to customize their channel lineup, the Company will provide, for a monthly rental fee, an electronic device located on the cable line outside the home, enabling a subscriber's television to receive only those channels selected by the subscriber. These basic service rate adjustments and the CableSelect program have also been implemented in all systems managed by the Company. The Company believes CableSelect provides increased programming choices to the Company's subscribers while providing flexibility to the Company to respond to future changes in areas such as customer demand and programming.\nA letter of inquiry, one of at least 63 sent by the FCC to numerous cable operators, was received by an Olympus System regarding the implementation of this new method of offering services. Olympus responded in writing to the FCC's inquiry. On November 18, 1994, the Cable Services Bureau of the FCC issued a decision holding that the \"CableSelect\" program was an evasion of the rate regulations and ordered this package to be treated as a regulated tier. This decision, and all other letter of inquiry decisions, were principally decided on the number of programming services moved from regulated tiers to a la carte packages. Adelphia has appealed this decision to the full Commission. The Company cannot predict the outcome or effect of this proceeding.\nOn November 10, 1994 the FCC ruled that, prospectively, any a la carte package will be treated as a regulated tier, except for packages involving premium services. The Company is currently unable to predict the effect that the amended regulations, future FCC treatment of \"a la carte\" packages or other future FCC rulemaking proceedings will have on its business and results of operations in future periods. No assurance can be given at this time that such matters will not have a material negative financial impact on the Company's business and results of operations in the future. Also, no assurance can be given as to what other future actions Congress, the FCC or other regulatory authorities may take or the effects thereof on the Company.\nCable television companies operate under franchises granted by local authorities which are subject to renewal and renegotiation from time to time. Because such franchises are generally non-exclusive, there is a potential for competition with the Systems from other operators of cable television systems, including public systems operated by municipal franchising authorities themselves, and from other distribution systems capable of delivering television programming to homes. The 1992 Cable Act contains provisions which encourage competition from such other sources. Additionally, recent court and administrative decisions have removed certain of the restrictions that have limited entry into the cable television business by potential competitors such as telephone companies, and proposals now under consideration by the FCC, and which are being and from time to time have been considered by Congress, could result in the elimination of other such restrictions. The Company cannot predict the extent to which competition will materialize from other cable television operators, other distribution systems for delivering television programming to the home, or other potential competitors, or, if such competition materializes, the extent of its effect on the Company.\nFCC rules permit local telephone companies to offer \"video dialtone\" service for video programmers, including channel capacity for the carriage of video programming and certain non-common carrier activities such as video processing, billing and collection and joint marketing agreements. On December 15, 1992, New Jersey Bell Telephone Company filed an application with the FCC to operate a \"video dialtone\" service in portions of Dover County, New Jersey, in which the Company serves approximately 20,000 subscribers. The FCC approved the application on July 18, 1994. The Company has appealed this decision to the U.S. Court of Appeals for the District of Columbia. This case is presently pending.\nA number of telephone companies have filed suit seeking to void as unconstitutional the provisions in the 1984 Cable Act that prohibit telephone companies from owning cable television systems in their telephone service areas. The U.S. Courts of Appeal for the Fourth and Ninth Circuits have struck down the cross-ownership ban on first amendment grounds. Several federal district courts have also struck down the cross-ownership ban on the same grounds. In addition, legislation which would alter or eliminate the cross-ownership ban is under active consideration in Congress.\nDirect broadcast satellite (\"DBS\") service became available to consumers during 1994. A single DBS satellite can provide more than 100 channels of programming. DBS service can be received virtually anywhere in the United States through the installation of a small outdoor antenna. DBS service is being heavily marketed on a nation-wide basis. The extent to which DBS will be competitive with cable systems will depend on the continued availability of reception equipment and programming at reasonable prices to the consumer.\nThe Company cannot predict the ultimate outcome of the video dialtone proceeding or the cross-ownership ban litigation. However, the Company believes that the provision of video programming by telephone companies in competition with the Company's existing operations could have an adverse effect on the Company's financial condition and results of operations. At this time, the impact of any such effect is not known or estimable. See Item 1 - \"Business Competition\" and \"Legislation and Regulation\".\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe consolidated financial statements and related notes thereto and independent auditors report follow.\nADELPHIA COMMUNICATIONS CORPORATION AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS\nADELPHIA COMMUNICATIONS CORPORATION AND SUBSIDIARIES\nIndependent Auditors' Report..............................................\nConsolidated Balance Sheets, March 31, 1994 and 1995......................\nConsolidated Statements of Operations, Years Ended March 31, 1993, 1994 and 1995...............................\nConsolidated Statements of Stockholders' Equity (Deficiency), Years Ended March 31, 1993, 1994 and 1995...............................\nConsolidated Statements of Cash Flows, Years Ended March 31, 1993, 1994 and 1995...............................\nNotes to Consolidated Financial Statements................................\nOLYMPUS COMMUNICATIONS, L.P. AND SUBSIDIARIES\nIndependent Auditors' Report..............................................\nConsolidated Balance Sheets, December 31, 1993 and 1994...................\nConsolidated Statements of Operations, Years Ended December 31, 1992, 1993, and 1994...........................\nConsolidated Statements of General Partner's Equity (Deficiency), Years Ended December 31, 1992, 1993 and 1994............................\nConsolidated Statements of Cash Flows, Years Ended December 31, 1992, 1993 and 1994............................\nNotes to Consolidated Financial Statements................................\nINDEPENDENT AUDITORS' REPORT\nAdelphia Communications Corporation:\nWe have audited the accompanying consolidated balance sheets of Adelphia Communications Corporation and subsidiaries as of March 31, 1994 and 1995, and the related consolidated statements of operations, stockholders' equity (deficiency) and cash flows for each of the three years in the period ended March 31, 1995. 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 Adelphia Communications Corporation and subsidiaries at March 31, 1994 and 1995, and the results of their operations and their cash flows for each of the three years in the period ended March 31, 1995 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 7 to the consolidated financial statements, effective April 1, 1993, the Company changed its method of accounting for income taxes. Also, as discussed in Note 2 to the consolidated financial statements, as of January 1, 1993, an unconsolidated subsidiary accounted for on the equity method changed its method of accounting for income taxes.\nDELOITTE & TOUCHE LLP\nPittsburgh, Pennsylvania June 28, 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.\nADELPHIA COMMUNICATIONS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands)\n1. The Company and Summary of Significant Accounting Policies:\nThe Company and Basis for Consolidation\nAdelphia Communications Corporation and subsidiaries (\"ACC\") owns, operates and manages cable television systems. ACC's operations consist primarily of selling video programming which is distributed to subscribers for a monthly fee through a network of fiber optic and coaxial cables. These services are offered in the respective franchise areas under the name Adelphia Cable Communications.\nThe consolidated financial statements include the accounts of ACC and its more than 50% owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.\nDuring the year ended March 31, 1995, ACC consummated several acquisitions, each of which was accounted for using the purchase method. Accordingly, the financial results of each acquisition have been included in the consolidated results of ACC effective with the date acquired. A description of the acquisitions is provided below.\nOn June 16, 1994, ACC invested $34,000 in TMC Holdings Corporation (\"THC\"), the parent of Tele-Media Company of Western Connecticut. THC owns cable television systems serving approximately 43,000 subscribers in western Connecticut. The investment in THC provides ACC with a $30,000 preferred equity interest in THC and a 75% non-voting common equity interest, with a liquidation preference to the remaining 25% common stock ownership interest in THC. ACC has the right to convert such interest to a 75% voting common equity interest, with a liquidation preference to the remaining shareholders' 25% common stock ownership interest, on demand subject to certain regulatory approvals. Debt assumed, included in notes payable of subsidiaries to banks and institutions, was $52,000 at closing.\nOn June 30, 1994, ACC acquired from Olympus 85% of the common stock of Northeast Cable, Inc. (\"Northeast\") for a purchase price of $31,875. Northeast owns cable television systems serving approximately 36,500 subscribers in eastern Pennsylvania. Of the purchase price, $16,000 was paid in cash and the remainder resulted in a decrease in ACC's receivable from Olympus. Debt assumed, included in notes payable of subsidiaries to banks and institutions, was $42,300 at closing.\nOn January 10, 1995, ACC issued 399,087 shares of Class A Common Stock in connection with the merger of a wholly-owned subsidiary of Adelphia into Oxford Cablevision, Inc. (\"Oxford\"), one of the Terry Family cable systems. Oxford serves approximately 4,200 subscribers located in the North Carolina counties of Granville and Warren. On January 31, 1995, ACC acquired a majority equity position in Tele-Media Company of Martha's Vineyard, L.P. for $11,775, a cable system serving approximately 7,000 subscribers located in Martha's Vineyard, Massachusetts. This system will become part of ACC's New England cluster.\nInvestment in Olympus Joint Venture Partnership\nThe investment in the Olympus joint venture partnership comprises both limited and general partner interests. The general partner interest represents a 50% voting interest in Olympus Communications, L.P. (\"Olympus\") and is being accounted for using the equity method. Under this method, ACC's investment, initially recorded at the historical cost of contributed property, is adjusted for subsequent capital contributions and its share of the losses of the partnership as well as its share of the accretion requirements of the partnership's interests. The limited partner interest represents a preferred interest (\"PLP interests\") entitled to a 16.5% annual return. The PLP interests are nonvoting, are\nADELPHIA COMMUNICATIONS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands) (Continued)\n1. The Company and Summary of Significant Accounting Policies, continued:\nsenior to claims of certain other partner interests, and provide for an annual priority return of 16.5%. Olympus is not required to pay the entire 16.5% return currently and priority return on PLP interests is recognized as income by ACC when received. Correspondingly, equity in net loss of Olympus excludes accumulated unpaid priority return. (See Note 2)\nSubscriber Revenues\nSubscriber revenues are recorded in the month the service is provided.\nProperty, Plant and Equipment\nProperty, plant and equipment are comprised of the following:\nMarch 31, 1994 1995\nOperating plant and equipment........................$ 673,451 $ 786,917 Real estate and improvements......................... 41,150 46,453 Support equipment.................................... 25,132 28,242 Construction in progress............................. 48,118 77,026 787,851 938,638 Accumulated depreciation............................. (341,561) (420,233) $ 446,290 $ 518,405\nDepreciation is computed on the straight-line method using estimated useful lives of 5 to 12 years for operating plant and equipment and 3 to 20 years for support equipment and buildings. Additions to property, plant and equipment are recorded at cost which includes amounts for material, applicable labor and overhead, and interest. Capitalized interest amounted to $1,009, $1,345 and $1,736 for the years ended March 31, 1993, 1994 and 1995, respectively.\nIntangible Assets\nIntangible assets, net of accumulated amortization, are comprised of the following:\nMarch 31, 1994 1995\nPurchased franchises.....................................$368,938 $493,249 Purchased subscriber lists............................... 4,365 567 Goodwill................................................. 41,691 38,805 Non-compete agreements................................... 2,794 13,495 $417,788 $546,116\nA portion of the aggregate purchase price of cable television systems acquired has been allocated to purchased franchises, purchased subscriber lists, goodwill and non-compete agreements. Purchased franchises and goodwill are amortized on the straight-line method over 40 years. Purchased subscriber lists are amortized on the straight-line method over periods which range from 5 to 10 years. Non-compete agreements are amortized on the straight-line method over their contractual lives which range from 4 to 12 years. Accumulated amortization of intangible assets amounted to $76,812 and $107,914 at March 31, 1994 and 1995, respectively.\nADELPHIA COMMUNICATIONS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands) (Continued)\n1. The Company and Summary of Significant Accounting Policies, continued:\nCash and Cash Equivalents\nACC considers all highly liquid investments with original maturities of three months or less to be cash equivalents. Interest on liquid investments was $1,076, $2,020, and $1,230 for the years ended March 31, 1993, 1994, and 1995, respectively.\nInvestments\nThe equity method of accounting is generally used to account for investments in affiliates which are greater than 20% but not more than 50% owned. Under this method, ACC's initial investment is recorded at cost and subsequently adjusted for the amount of its equity in the net income or losses of its affiliates. Dividends or other distributions are recorded as a reduction of ACC's investment. Investments in affiliates accounted for using the equity method generally reflect ACC's equity in their underlying assets.\nInvestments in entities in which ACC's ownership is less than 20% and investments greater than 20% in which ACC does not influence the operating or financial decisions of the entity are accounted for using the cost method. Under the cost method, ACC's initial investment is recorded at cost and subsequently adjusted for the amount of its equity in net income or losses of the investee only to the extent distributed by the investee as dividends or other distributions. Dividends received in excess of earnings subsequent to the date the investment was made are recorded as reductions of the cost of the investment.\nThe balance of ACC's investments is as follows: March 31, 1994 1995 Investments accounted for using the equity method:\nGross investment: Alternate access ventures............................$ 9,068 $12,840 Page Call, Inc....................................... -- 6,915 Other................................................ -- 2,847 Cumulative equity in net losses.......................... (494) (1,458) Total.......................................... 8,574 21,144\nInvestments accounted for using the cost method:\nTele-Media Investment Partnership, L.P. (see Note 2)..... 13,000 -- Niagara Frontier Hockey, L.P............................. -- 15,000 Alternate access ventures................................ 1,379 2,924 Commonwealth Security, Inc............................... -- 4,200 SuperCable............................................... -- 3,000 Other.................................................... 969 2,700\nTotal.......................................... 15,348 27,824\nTotal investments........................................$23,922 $48,968\nOn April 12, 1994, ACC purchased (i) convertible preferred units in Niagara Frontier Hockey, L.P., (the \"Sabres Partnership\") which owns the Buffalo Sabres National Hockey League Franchise, convertible to a 34% equity interest and (ii) warrants allowing ACC to increase its interest to 40% for $15,000. ACC believes this investment will be competitively advantageous in the Buffalo cable television market. The Sabres Partnership will control, through a wholly-owned subsidiary, the Crossroads Arena, a new sports and entertainment facility expected to be completed\nADELPHIA COMMUNICATIONS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands) (Continued) 1. The Company and Summary of Significant Accounting Policies, continued:\nin late 1996. ACC's convertible preferred units will earn a 4% cumulative preferred return beginning after the first National Hockey League game is played at the Crossroads Arena.\nSubscriber Receivables\nAn allowance for doubtful accounts of $3,603 and $3,503 has been deducted from subscriber receivables at March 31, 1994 and 1995, respectively.\nAmortization of Other Assets and Debt Discounts\nDeferred debt financing costs, included in prepaid expenses and other assets, and debt discounts, a reduction of the carrying amount of the debt, are amortized over the term of the related debt. The unamortized amounts included in prepaid expenses and other assets were $22,328 and $23,355 at March 31, 1994 and 1995, respectively.\nAsset Impairments\nIn March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (\"SFAS\") No. 121 \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of.\" In accordance with SFAS No. 121, ACC periodically reviews the carrying value of its long-lived assets, identifiable intangibles and goodwill in relation to historical financial results, current business conditions and trends (including the impact of existing legislation and regulation) to identify potential situations in which the carrying value of assets may not be recoverable. If a review indicates that the carrying value of such assets may not be recoverable, the carrying value of such assets in excess of their fair value would be recorded as a reduction of the assets cost as if a permanent impairment has occurred. The adoption of SFAS No. 121 did not materially affect the financial statements of ACC.\nNoncash Financing and Investing Activities\nCapital leases entered into during years ended March 31, 1993 and 1994 totaled $8,742 and $7,186, respectively. There were no material capital leases entered into during fiscal 1995. Reference is made to Notes 1, 2 and 9 for descriptions of additional non-cash financing and investing activities.\nReclassification\nCertain 1993 and 1994 amounts have been reclassified for comparability with the 1995 presentation.\n2. Related Party Investments and Receivables:\nThe following table summarizes the investments in and receivables from Olympus and related parties: March 31, 1994 1995 Investment in Olympus..................................$(75,961) $(48,688) Amounts due from Olympus............................... 85,938 60,631 Amounts due from other related parties - net........... 26,663 49,691 $ 36,640 $ 61,634\nAmounts due from other related parties - net represent advances to (from) Managed Partnerships (see Note 9), the Rigas family (principal shareholders and officers of ACC) and Rigas family controlled entities. No related party advances are collateralized.\nADELPHIA COMMUNICATIONS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands) (Continued)\n2. Related Party Investments and Receivables, continued:\nDuring the year ended March 31, 1993, concurrent with Olympus's redemption of $6,500 in limited partner interests, ACC converted 6.5 general partner units to PLP interests, thereby maintaining 50% of the outstanding general partner and limited partner voting units of Olympus.\nOn February 28, 1995, ACP Holdings, Inc., a wholly-owned subsidiary of ACC, and the managing general partner of Olympus, certain shareholders of ACC, Olympus and various Telesat Entities (\"Telesat\"), wholly-owned subsidiaries of FP & L Group, Inc., entered into an investment agreement whereby Telesat contributed to Olympus substantially all of the assets associated with certain cable television systems, serving approximately 50,000 subscribers in southern Florida, in exchange for general and limited partner interests and newly issued preferred limited partner interests in Olympus. Prior to the Telesat Investment Agreement, Olympus had obligations to ACC for intercompany advances, preferred limited partner (\"PLP\") interests, and priority return on PLP interests. In conjunction with the Telesat Investment Agreement, ACC converted a portion of the intercompany advances, a portion of the existing PLP interests and all of the existing accrued priority return on the PLP interests, to capital contributions. At March 31, 1993, 1994 and 1995, ACC owned $276,101, $276,101 and $225,000 in Olympus PLP Interests, respectively.\nOn March 31, 1994, ACC acquired from Olympus the rights to provide alternate access in its respective franchise areas and an investment in an unaffiliated partnership for a purchase price of $15,500. The purchase price of the assets resulted in a corresponding reduction of amounts due ACC. The $15,400 excess of the purchase price over Olympus' book value has been recorded by ACC as an additional investment in Olympus.\nThe major components of the financial position of Olympus as of March 31, 1994 and 1995, and December 31, 1993 and 1994, and the results of operations for the three months ended March 31, 1994 and 1995, and the years ended December 31, 1993 and 1994 were as follows:\nADELPHIA COMMUNICATIONS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands) (Continued)\n2. Related Party Investments and Receivables, continued:\nThe following reconciles ACC's investment in Olympus to the related equity accounts of Olympus:\nMarch 31, 1994 1995\nInvestment in Olympus joint venture partnership......$ (75,961) $ (48,688) Accumulated unpaid priority return requirements...... (105,212) (2,997) Other................................................ -- 12,793 Olympus' combined PLP Interests and general partners' equity (deficiency)................................ $(181,173) $ (38,892)\nEffective January 1, 1993, Olympus adopted SFAS No. 109, \"Accounting for Income Taxes\" which requires an asset and liability approach for financial accounting and reporting for income taxes. SFAS No. 109 resulted in the cumulative recognition of an additional liability of approximately $59,500 on January 1, 1993. Olympus did not restate prior years' financial statements to reflect the provisions of SFAS No. 109.\nOn October 6, 1993, ACC purchased the preferred Class B Limited Partnership Interest in Syracuse Hilton Head Holdings, L.P. (\"SHHH\"), for a price of $18,338 from Robin Media Group, an unrelated party. SHHH is a joint venture of the Rigas Family and Tele-Communications, Inc. (\"TCI\") and owns systems managed by ACC. The Class B Limited Partnership Interest has a preferred return of 14% annually which is payable on a current basis at the option of SHHH, and is senior in priority to the partnership interests of the Rigas family and TCI. Priority return on the preferred Class B Limited Partner Interest in SHHH totaled $1,213 and $2,654 and is included in revenue for the years ended March 31, 1994 and 1995, respectively. SHHH is obligated to redeem the Class B Limited Partnership Interest between June 11, 1996 and December 31, 1996.\nIn September 1993, the Board of Directors of ACC authorized ACC to make loans in the future to two Managed Partnerships up to an amount of $25,000 for each. During the year ended March 31, 1994, ACC made loans in the net amount of $15,000 to SHHH, to facilitate the acquisition of cable television systems serving Palm Beach County, Florida from unrelated parties. During fiscal year 1995, ACC sold its investment in TMIP to SHHH for $13,000. On January 31, 1995, a wholly owned subsidiary of ACC received a $20,000 preferred investment from SHHH to facilitate the acquisition of cable properties from Tele-Media Company of Delaware.\nADELPHIA COMMUNICATIONS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands) (Continued)\n3. Debt:\nNotes Payable of Subsidiaries to Banks and Institutions\nNotes payable of subsidiaries to banks and institutions are comprised of the following: March 31, 1994 1995\nCredit agreements with banks payable through 2003 (weighted average interest rate 6.35% and 8.16% at March 31, 1994 and 1995, respectively)...............$ 354,375 $ 584,250 10.66% Senior Secured Notes due 1996 through 1999...... 250,000 250,000 9.95% Senior Secured Notes due through 1997............ 16,000 9,600 10.80% Senior Secured Notes due 1996 through 2000. ..... 45,000 45,000 10.50% Senior Secured Notes due 1997 through 2001. ..... 16,000 16,000 9.73% Senior Secured Notes due 1998 through 2001.. ..... 37,500 37,500 10.25% Senior Subordinated Notes due 1996 through 1998. 80,000 72,000 11.85% Senior Subordinated Notes due 1998 through 2000. 60,000 60,000 11.13% Senior Subordinated Notes due 1999 through 2002. 12,000 12,000 $ 870,875 $1,086,350\nThe amount of borrowings available to ACC under its revolving credit agreements is generally based upon the subsidiaries achieving certain levels of operating performance. ACC had commitments from banks for additional borrowings of up to $117,000 at March 31, 1995, which expire through 2003. At the expiration of the commitments, all outstanding borrowings are convertible into term loans. ACC pays commitment fees of up to .5% of unused principal.\nBorrowings under most of these credit arrangements of subsidiaries are collateralized by a pledge of the stock in their respective subsidiaries, and, in some cases, by assets. These agreements stipulate, among other things, limitations on additional borrowings, investments, transactions with affiliates and other subsidiaries, and the payment of dividends and fees by the subsidiaries. They also require maintenance of certain financial ratios by the subsidiaries. Several of the subsidiaries' agreements, along with the notes of the parent company, contain cross default provisions. At March 31, 1995, approximately $141,000 of the net assets of subsidiaries would be permitted to be transferred to the parent company in the form of dividends, priority return and loans without the prior approval of the lenders based upon the results of operations of such subsidiaries for the quarter ended March 31, 1995. The subsidiaries are permitted to pay fees to the parent company or other subsidiaries. Such fees are limited to a percentage of the subsidiaries' revenues.\nBank debt interest rates are based upon one or more of the following rates at the option of ACC: prime rate plus 0% to 1.5%; certificate of deposit rate plus 1.25% to 2.75%; or LIBOR rate plus 1% to 2.5%. At March 31, 1994 and 1995, the weighted average interest rate on notes payable to banks and institutions was 8.91% and 9.33%, respectively. The rates on 55% of ACC's notes payable to banks and institutions were fixed for at least one year through the terms of the notes or interest rate swap agreements.\nOn March 15, 1995, certain subsidiaries of the Company (collectively, the \"Borrowers\") entered into a $200,000 revolving credit facility, maturing September 30, 2003. Interest rates charged are based upon one or more of the following rates\nADELPHIA COMMUNICATIONS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands) (Continued) 3. Debt, continued:\nat the option of the Borrowers: the greater of the prime rate or the Federal funds rate plus 0% to .875%, certificate of deposit rate plus 1.125% to 2.125%, or LIBOR plus .875% to 1.875%. Interest on outstanding borrowings is generally payable on a quarterly basis. Initial borrowings under the revolving credit facility were used to repay existing indebtedness of the Borrowers. The Borrowers pay a commitment fee of .375% of unused commitments during the term of the agreement. The maximum available under this credit facility is reduced on June 30, 1997 by the lesser of $25,000 or 50% of the unused and available commitment. Thereafter, the credit facility provides for mandatory reductions in the revolving loan commitment, in increasing quarterly amounts, commencing June 30, 1997 through September 30, 1997.\nACC has entered into fixed and floating interest rate swap agreements with banks, Olympus and the Managed Partnerships (see Note 9) to mitigate its exposure to interest rate fluctuations by attempting to achieve an appropriate balance between its fixed and variable rate debt. At March 31, 1995, ACC had an aggregate notional principal amount of $802,000 outstanding under such agreements, which expire from 1996 through 2000. These agreements provide for a weighted average interest rate of 7.88% at March 31, 1995. ACC is exposed to credit loss in the event of nonperformance by the counterparties, although it does not expect any such nonperformance. Net settlement amounts under these swap agreements are recorded as adjustments to interest expense during the period incurred.\n12 1\/2% Senior Notes due 2002\nOn May 14, 1992, ACC issued at face value to the public $400,000 aggregate principal amount of unsecured 12 1\/2% Senior Notes due May 15, 2002. Interest is due on the notes semi-annually. The notes, which are effectively subordinated to all liabilities of the subsidiaries, contain restrictions on, among other things, the incurrence of indebtedness, mergers and sale of assets, certain restricted payments by ACC, investments in affiliates and certain other affiliate transactions. The notes further require that ACC maintain a debt to annualized operating cash flow ratio of not greater than 8.75 to 1.00, based on the latest fiscal quarter, exclusive of the incurrence of $50,000 in additional indebtedness which is not subject to the required ratio. ACC may redeem the notes in whole or in part on or after May 15, 1997, at 106% of principal, declining to 100% of principal on or after May 15, 1999.\n10 1\/4% Senior Notes due 2000\nOn July 28, 1993, ACC issued $110,000 aggregate principal amount of unsecured 10 1\/4% Senior Notes due July 2000. Interest is due on the notes semi-annually. The notes which are effectively subordinated to all liabilities of the subsidiaries, contain restrictions and covenants similar to the restrictions on the 12 1\/2% Senior Notes. The notes are not callable prior to the maturity date of July 15, 2000. During fiscal 1995 $10,000 of notes were retired through open market purchases.\n16 1\/2% Senior Discount Notes due 1999\nOn July 1, 1992, ACC redeemed all of the 16 1\/2% Senior Discount Notes, at 104% of principal. The $10,000 redemption premium together with $4,386 in unamortized deferred financing costs comprise the extraordinary loss on early retirement of debt recognized on ACC's consolidated financial statements for the year ended March 31, 1993.\nADELPHIA COMMUNICATIONS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands) (Continued)\n3. Debt, continued:\n11 7\/8% Senior Debentures due 2004\nOn September 10, 1992, ACC issued to the public $125,000 aggregate principal amount of unsecured 11 7\/8% Senior Debentures due September 2004. Interest is due on the debentures semi-annually. The debentures, which are effectively subordinated to all liabilities of the subsidiaries, contain restrictions and covenants similar to the restrictions on the 12 1\/2% Senior Notes. ACC may redeem the debentures in whole or in part on or after September 15, 1999, at 104.5% of principal, declining to 100% of principal on or after September 15, 2002.\n9 7\/8% Senior Debentures due 2005\nOn March 11, 1993, ACC issued 9 7\/8% Senior Debentures due March 2005 in the aggregate principal amount of $130,000. Interest on the debentures is payable semi-annually. The debentures, which are effectively subordinated to all liabilities of the subsidiaries, contain restrictions and covenants similar to the restrictions on the 12 1\/2% Senior Notes. The debentures are not redeemable prior to the maturity date of March 1, 2005.\n9 1\/2% Senior Pay-In-Kind Notes due 2004\nOn February 15, 1994, ACC issued $150,000 aggregate principal amount of unsecured 9 1\/2% Senior Pay-In-Kind Notes due February 2004. On or prior to February 1999, all interest on the notes, which is due semi-annually, may at the option of ACC be paid in cash or through the issuance of additional notes valued at 100% of their principal amount. The notes will bear cash interest from February 1999 through maturity. The notes which are effectively subordinate to all liabilities of the subsidiaries contain restrictions and covenants similar to the 12 1\/2% Senior Notes. ACC may redeem the notes in whole or in part on or after February 15, 1999, at 103.56% of principal, declining to 100% of principal on or after February 15, 2002. 13% Senior Subordinated Notes due 1996\nOn February 14, 1994, ACC redeemed all of the 13% Senior Subordinated Notes for 100% of the $100,000 aggregate principal amount.\nMaturities of Debt\nMaturities of debt for the five years after March 31, 1995 are as follows:\n1996...................................................... $ 114,921 1997...................................................... 216,099 1998...................................................... 274,701 1999...................................................... 264,427 2000...................................................... 113,014\nManagement intends to fund its requirements for maturities of debt through borrowings under new and existing credit arrangements and internally generated funds. Changing conditions in the financial markets may have an impact on how ACC will refinance its debt in the future.\nADELPHIA COMMUNICATIONS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands) (Continued)\n4. Commitments and Contingencies:\nACC rents office and studio space, tower sites, and space on utility poles under leases with terms which are generally less than one year or under agreements that are generally cancelable on short notice. Total rental expense under all operating leases aggregated $4,090, $3,988 and $4,356 for the years ended March 31, 1993, 1994 and 1995, respectively.\nIn connection with certain obligations under franchise agreements, ACC obtains surety bonds guaranteeing performance to municipalities and public utilities. Payment is required only in the event of nonperformance. ACC has fulfilled all of its obligations such that no payments under surety bonds have been required.\nAs of July 1, 1993, ACC adopted a program to self insure for casualty and business interruption insurance. This program is part of an agreement between ACC and each of its subsidiaries in which ACC will provide insurance for casualty and business interruption claims of up to $10,000 and $20,000 per claim, respectively, for each subsidiary of ACC. These risks were previously insured by outside parties with nominal deductible amounts.\nACC's cable television operations may be adversely affected by changes and developments in governmental regulation, competitive forces and technology. The cable television industry and ACC are subject to extensive regulation at the federal, state and local levels. Many aspects of such regulation are currently the subject of judicial proceedings and administrative or legislative proceedings or proposals. On October 5, 1992, Congress passed the 1992 Cable Act, which significantly expands the scope of regulation of certain subscriber rates and a number of other matters in the cable industry, such as mandatory carriage of local broadcast stations and retransmission consent, and which will increase the administrative costs of complying with such regulations. The FCC has adopted rate regulations that establish, on a system-by-system basis, maximum allowable rates for (i) basic and cable programming services (other than programming offered on a per-channel or per-program basis), based upon a benchmark methodology, and (ii) associated equipment and installation services based upon cost plus a reasonable profit. Under the FCC rules, franchising authorities are authorized to regulate rates for basic services and associated equipment and installation services, and the FCC will regulate rates for regulated cable programming services in response to complaints filed with the agency. The original rate regulations became effective on September 1, 1993. Amendments to the rate regulations became effective May 15, 1994. Further amendments were adopted on November 10, 1994. The FCC ordered an interim rate freeze effective April 5, 1993 which was extended through May 15, 1994.\nThe FCC had adopted regulations implementing virtually all of the requirements of the 1992 Cable Act. The FCC is also likely to continue to modify, clarify or refine the rate regulations. In addition, litigation has been instituted challenging various portions of the 1992 Cable Act and the rulemaking proceedings including the rate regulations. ACC cannot predict the effect or outcome of the future rulemaking proceedings, changes to the rate regulations, or litigation. Further, because the FCC has only issued its interim rules and has not adopted final cost-of-service rules, ACC has not determined to what extent it will be able to utilize cost-of-service showings to justify rates.\nEffective September 1, 1993, as a result of the 1992 Cable Act, ACC repackaged certain existing cable services by adjusting rates for basic service and introducing a new method of offering certain cable services. ACC adjusted the basic service rates and related equipment and installation rates in all of its systems in order for such rates to be in compliance with the applicable benchmark or equipment and installation cost levels. The amended rules may require further adjustments to ACC's rates. ACC also implemented a program in all of its systems called\nADELPHIA COMMUNICATIONS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands) (Continued)\n4. Commitments and Contingencies, continued:\n\"CableSelect\" under which most of ACC's satellite-delivered programming services are now offered individually on a per channel basis, or as a group at a price of approximately 15% to 20% below the sum of the per channel prices of all such services. For subscribers who elect to customize their channel lineup, ACC will provide, for a monthly rental fee, an electronic device located on the cable line outside the home, enabling a subscriber's television to receive only those channels selected by the subscriber. These basic service rate adjustments and the CableSelect program have also been implemented in all systems managed by ACC. ACC believes CableSelect provides increased programming choices to its subscribers while providing flexibility to ACC to respond to future changes in areas such as customer demand and programming.\nOn November 10, 1994 the FCC ruled that, prospectively, any \"a la carte\" package will be treated as a regulated tier, except for packages involving premium services. ACC is currently unable to predict the effect that the amended regulations, future FCC treatment of \"a la carte\" packages or other future FCC rulemaking proceedings will have on its business and results of operations in future periods. No assurance can be given at this time that such matters will not have a material negative financial impact on ACC's business and results of operations in the future. Also, no assurance can be given as to what other future actions Congress, the FCC or other regulatory authorities may take or the effects thereof on ACC.\nA letter of inquiry, one of at least 63 sent by the FCC to numerous cable operators, was received by ACC regarding the implementation of this new method of offering services. ACC responded in writing to the FCC's inquiry. On November 18, 1994, the Cable Services Bureau of the FCC issued a decision holding that the \"CableSelect\" program was an evasion of the rate regulations and ordered this package to be treated as a regulated tier. This decision, and all other letters of inquiry decisions, were principally decided on the number of programming services moved from regulated tiers to \"a la carte\" packages. ACC has appealed this decision to the full Commission. ACC cannot predict the outcome or effect of this proceeding.\n5. Stockholders' Equity (Deficiency):\nACC has no convertible securities or other common stock equivalent securities outstanding.\nPublic Offering of Class A Common Stock on May 14, 1992\nOn May 14, 1992, ACC sold to the public 1,500,000 shares of Class A Common Stock for $15.00 per share. The net proceeds of the sale, after offering costs, aggregated $21,725.\nPublic Offering of Class A Common Stock on January 14, 1994\nOn January 14, 1994, ACC sold 9,132,604 shares of Class A Common Stock. Of the 9,132,604 shares, 3,300,000 shares were sold to the public at $18.00 per share, with an underwriting discount of $.855 per share. Partnerships controlled by the family of John J. Rigas, President and Chief Executive Officer of ACC, purchased the other 5,832,604 shares at the public offering price less the underwriting discount. Net proceeds to ACC after offering expenses aggregated $155,963.\nStock Issued During Fiscal 1995\nOn January 10, 1995, ACC issued 399,087 shares of Class A Common Stock in connection with the acquisition of Oxford (see Note 1). On February 28, 1995, 1,000,000 shares of Class A Common Stock were sold to FP & L Group, Inc. for $15.00 per share.\nADELPHIA COMMUNICATIONS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands) (Continued)\n5. Stockholders' Equity (Deficiency), continued:\nPreferred Stock\nThe Certificate of Incorporation of ACC authorizes 5,000,000 shares of Preferred Stock, $.01 par value. None have been issued.\nCommon Stock\nThe Certificate of Incorporation of ACC authorizes two classes of common stock, Class A and Class B. Holders of Class A Common Stock and Class B Common Stock vote as a single class on all matters submitted to a vote of the stockholders, with each share of Class A Common Stock entitled to one vote and each share of Class B Common Stock entitled to ten votes, except (i) for the election of directors and (ii) as otherwise provided by law. In the annual election of directors, the holders of Class A Common Stock voting as a separate class, are entitled to elect one of ACC's directors. In addition, each share of Class B Common Stock is automatically convertible into a share of Class A Common Stock upon transfer, subject to certain limited exceptions. In the event a cash dividend is paid, the holders of Class A Common Stock will be paid 105% of the amount payable per share for each share of Class B Common Stock.\nUpon liquidation, dissolution or winding up of ACC, the holders of Class A Common Stock are entitled to a preference of $1.00 per share. After such amount is paid, holders of Class B Common Stock are entitled to receive $1.00 per share. Any remaining amount would then be shared ratably by both classes.\nRestricted Stock Bonus Plan\nACC has reserved 500,000 shares of Class A Common Stock for issuance to officers and other key employees at the discretion of the Compensation Committee of the Board of Directors. The bonus shares will be awarded without any cash payment by the recipient unless otherwise determined by the Compensation Committee. Shares awarded under the plan vest over a five year period. No awards have been made under the plan.\nStock Option Plan\nACC has a stock option plan, which provides for the granting of options to purchase up to 200,000 shares of ACC's Class A Common Stock to officers and other key employees of the Company and its subsidiaries. Options may be granted at an exercise price equal to the fair market value of the shares on the date of grant. The plan permits the granting of tax-qualified incentive stock options, in addition to non-qualified stock options. Options outstanding under the plan may be exercised by paying the exercise price per share through various alternative settlement methods. No stock options have been granted under the plan.\n6. Employee Benefit Plans:\nACC has a savings plan (401(k)) which provides that eligible full-time employees may contribute from 2% to 20% of their pre-tax compensation. ACC makes matching contributions not exceeding 1.5% of each participant's pre- tax compensation. ACC's matching contributions amounted to $241, $305 and $343 for the years ended March 31, 1993, 1994 and 1995, respectively.\nADELPHIA COMMUNICATIONS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands) (Continued)\n7. Taxes on Income:\nACC and its corporate subsidiaries file a consolidated federal income tax return, which includes its share of the subsidiary partnerships and joint venture partnership results. At March 31, 1995, ACC had net operating loss carryforwards for federal income tax purposes of approximately $1,000,000 expiring through 2010. Depreciation and amortization expense differs for tax and financial statement purposes due to the use of prescribed periods rather than useful lives for tax purposes and also as a result of differences between tax basis and book basis of certain acquisitions.\nACC adopted SFAS No. 109, \"Accounting for Income Taxes,\" effective April 1, 1993. Under SFAS No. 109, deferred tax assets and liabilities are recognized for differences between the financial statement amounts of assets and liabilities and their respective tax bases. The cumulative effect of adopting SFAS No. 109 at April 1, 1993 was to increase the net loss by $89,660 for the year ended March 31, 1994. The effect of adopting SFAS No. 109 on loss before extraordinary loss and cumulative effect of a change in accounting principle was not significant for the year ended March 31, 1994.\nAs a result of applying SFAS No. 109, $110,498 of previously unrecorded deferred tax benefits from operating loss carryforwards incurred by ACC were recognized at April 1, 1993 as part of the cumulative effect of adopting the statement. Under prior accounting, a portion of these benefits would have been recognized as a reduction of income tax expense from continuing operations in the year ended March 31, 1994.\nThe tax effects of significant items comprising ACC's net deferred tax liability are as follows:\nThe net change in the valuation allowance for the years ended March 31, 1994 and 1995 was an increase of $28,199 and $34,718, respectively. ADELPHIA COMMUNICATIONS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands) (Continued)\n7. Taxes on Income, continued:\nIncome tax (expense) benefit for the years ended March 31, 1993, 1994 and 1995 is as follows: March 31, 1993 1994 1995\nCurrent............................. $ (3,143) $ (681) $ (500) Deferred............................. -- (2,061) 5,975 Total................................$ (3,143) $ (2,742) $ 5,475\nA reconciliation of the statutory federal income tax rate and ACC's effective income tax rate is as follows: March 31, 1994 1995 Statutory federal income tax rate......... 35.0% 35.0% Change in valuation allowance............. (29.8) (31.1) State taxes, net of federal benefit....... (2.4) 3.7 Other..................................... (5.7) (2.7)\nIncome tax (expense) benefit.............. (2.9%) 4.9%\n8. Disclosures about Fair Value of Financial Instruments:\nIncluded in ACC's financial instrument portfolio are cash, notes payable, debentures and interest rate swaps. The carrying values of notes payable approximate their fair values at March 31, 1995. The fair value of the debentures totaled $938,589 at March 31, 1994, which exceeded the carrying value by approximately $27,500. The fair market value of debentures at March 31, 1995 totaled $820,378 which exceeded the carrying value by $95,468. At March 31, 1995, ACC would have been required to pay approximately $6,929 to settle its interest rate swap agreements, representing the excess carrying cost over fair value of these agreements. The fair values of the debt and interest rate swaps were based upon quoted market prices of similar instruments or on rates available to ACC for instruments of the same remaining maturities.\n9. Related Party Transactions:\nACC currently manages cable television systems which are principally owned by Olympus and limited partnerships of which certain of ACC's principal shareholders who are executive officers have equity interests (the \"Managed Partnerships\").\nACC has agreements with Olympus and the Managed Partnerships which provide for the payment of fees to ACC. The aggregate fee revenues from Olympus and the Managed Partnerships amounted to $4,659, $2,946 and $7,293 for the years ended March 31, 1993, 1994 and 1995, respectively. In addition, ACC was reimbursed by Olympus and Managed Partnerships for allocated corporate costs of $4,521, $4,021 and $4,521 for the years ended March 31, 1993, 1994 and 1995, respectively, which have been recorded as a reduction of selling, general and administrative expense.\nACC leases from a partnership and a corporation owned by principal shareholders who are executive officers support equipment under agreements which have been accounted for as capital leases. These obligations, which are included in other debt, amounted to $1,415 and $933 at March 31, 1994 and 1995, respectively. ACC also leases from this partnership certain buildings under operating leases. Rent expense under these operating leases aggregated $715, $391 and $97 for the years ended March 31, 1993, 1994 and 1995, respectively.\nADELPHIA COMMUNICATIONS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands) (Continued)\n9. Related Party Transactions, continued:\nNet settlement amounts under interest rate swap agreements with Olympus and the Managed Partnerships recorded as adjustments to interest expense during the period incurred, decreased ACC's interest expense by $1,698, $1,920 and $173 for the years ended March 31, 1993, 1994 and 1995, respectively.\nOn March 31, 1994, ACC acquired from certain Managed Partnerships the rights to provide alternate access in their respective franchise areas for a purchase price of $14,000. Additionally, on March 31, 1994, ACC purchased real property from certain partnerships owned by principal shareholders who are certain executive officers for a total of $14,312. The purchase of the assets resulted in a reduction of amounts due ACC of $28,312. Since these asset purchases are transactions among entities under common control, they have been recorded by ACC based upon the predecessor owners' book value. The $17,553 excess of the purchase price of these assets over the predecessor owners' book value has been recorded as a direct charge to ACC's additional paid-in capital.\n10. Quarterly Financial Data (Unaudited):\nThe following tables summarize the financial results of ACC for each of the quarters in the years ended March 31, 1994 and 1995:\n11. Subsequent Events\nOn June 12, 1995, ACC announced the signing of definitive agreements for the purchase of all of the cable systems of Eastern Telecom Corporation, Robinson Cable TV, Inc. and First Carolina Cable TV, L.P. These systems together serve approximately 58,000 subscribers and are being purchased for an aggregate price of $92,000. The acquisitions, which will be accounted for under the purchase method of accounting, are expected to close in the third quarter of fiscal 1996.\nOn June 28, 1995, Adelphia and other relevant parties terminated their previously announced November 1994 letter of intent to increase by $63,000 to $75,000 the overall investment of Adelphia and the companies it manages (the \"Adelphia Group\") in cable systems held by Tele-Media Investment Partnership, L.P. and certain other Tele-Media controlled entities (collectively, \"Tele-Media\"). The Adelphia Group will continue to hold its existing investments in and recent acquisitions of Tele-Media cable systems.\nINDEPENDENT AUDITORS' REPORT\nOlympus Communications, L.P.:\nWe have audited the accompanying consolidated balance sheets of Olympus Communications, L.P. and subsidiaries as of December 31, 1993 and 1994, and the related consolidated statements of operations, general partner's equity (deficiency), 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, such consolidated financial statements present fairly, in all material respects, the financial position of Olympus Communications, L.P. and subsidiaries at December 31, 1993 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles.\nAs discussed in Note 9 to the consolidated financial statements, effective January 1, 1993, the Partnership changed its method of accounting for income taxes.\nDELOITTE & TOUCHE LLP\nPittsburgh, Pennsylvania April 13, 1995 (June 8, 1995 as to Notes 4 and 12)\nSee notes to consolidated financial statements.\nOLYMPUS COMMUNICATIONS, L.P. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (Dollars in thousands)\nSee notes to consolidated financial statements.\nSee notes to consolidated financial statements.\nSee notes to consolidated financial statements.\nOLYMPUS COMMUNICATIONS, L.P. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands)\n1. The Partnership and Basis of Presentation:\nOlympus Communications, L.P. and Subsidiaries (\"Olympus\") is a joint venture limited partnership formed under the laws of Delaware with 50% of the outstanding voting interests controlled by Adelphia Communications Corporation (\"ACC\"). Olympus' operations consist primarily of selling video programming which is distributed to subscribers for a monthly fee through a network of fiber optic and coaxial cables.\nThe consolidated financial statements include the accounts of Olympus and its subsidiaries. All significant intercompany accounts and transactions have been eliminated.\nOn June 30, 1994, ACC acquired from Olympus 85% of the common stock of Northeast Cable, Inc. (\"Northeast\") for a purchase price of $31,875. Northeast owns cable television systems serving approximately 36,500 subscribers in eastern Pennsylvania. Of the purchase price, $16,000 was paid in cash and the remainder resulted in a decrease in Olympus' existing amount payable to ACC. The consolidated statements of operations and cash flows for Olympus include the operations of Northeast for the six months ended June 30, 1994.\nOn February 28, 1995, Olympus entered into a Liquidation Agreement with the Gans Family (\"Gans\"), an Olympus limited partner. Under this Liquidation Agreement, Gans agreed to exchange their redeemable limited partner interests in Olympus for the remaining 15% of the common stock of Northeast held by Olympus. Concurrently with the closing of the Liquidation Agreement, ACP Holdings, Inc., a wholly owned subsidiary of ACC and managing general partner of Olympus, certain shareholders of ACC, Olympus and various Telesat Entities (\"Telesat\"), wholly-owned subsidiaries of FP&L Group, Inc., entered into an investment agreement whereby Telesat contributed to Olympus substantially all of the assets associated with certain cable television systems, serving approximately 50,000 subscribers in southern Florida, in exchange for general and limited partner interests and newly issued preferred limited partner interests in Olympus (see Note 12).\nThe following unaudited pro forma consolidated statement of operations has been prepared assuming that the sale of the Northeast cable system had occurred on January 1, 1994. The effects of the sale of Northeast on the consolidated balance sheet are included in the accompanying consolidated balance sheet as of December 31, 1994. The pro forma data are not necessarily indicative of the results that actually would have occurred if Northeast had been sold on January 1, 1994, or what may be achieved in the future.\nOLYMPUS COMMUNICATIONS, L.P. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands)\n1. The Partnership and Basis of Presentation, continued:\nPRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS Year Ended December 31, 1994 (Dollars in thousands) (UNAUDITED)\nOLYMPUS COMMUNICATIONS, L.P. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands) (Continued)\n2. Summary of Significant Accounting Policies:\nSubscriber Receivables\nSubscriber revenues are recorded in the month the service is provided.\nAn allowance for doubtful accounts of $2,598 and $1,660 is recorded as a reduction of subscriber receivables at December 31, 1993 and 1994, respectively.\nProgramming Expense\nPrior to July 1, 1992, ACC charged programming expense to affiliates (including Olympus) based on the number of subscribers to each programming service in the affiliate. Effective July 1, 1992, programming expense charged by ACC to affiliates is based on cost reductions under programming contracts from incremental subscribers, as well as the number of subscribers. The effect of this change was to decrease programming expense by $814 and $2,888 and $3,250 for the years ended December 31, 1992, 1993 and 1994, respectively.\nProperty, Plant and Equipment\nProperty, plant and equipment are comprised of the following: December 31, 1993 1994\nOperating plant and equipment................... $197,604 $201,921 Real estate and improvements..................... 4,158 3,690 Support equipment................................ 3,440 3,513 Construction in progress......................... 15,258 14,302 220,460 223,426 Accumulated depreciation......................... (56,771) (69,128) $163,689 $154,298\nDepreciation is computed on the straight-line method using estimated useful lives of 5 to 12 years for operating plant and equipment and 3 to 20 years for support equipment and buildings. Additions to property, plant and equipment are recorded at cost which includes amounts for material, applicable labor, and interest. Olympus capitalized interest amounting to $436 and $391 for 1993 and 1994, respectively.\nIntangible Assets\nIntangible assets, net of accumulated amortization, are comprised of the following:\nDecember 31, 1993 1994\nPurchased franchises..............................$248,647 $206,441 Goodwill.......................................... 4,568 4,429 Non-compete agreements............................. 20,211 33 Purchased subscriber lists........................ 63 25 $273,489 $210,928\nA portion of the aggregate purchase price of cable television systems acquired has been allocated to purchased franchises, purchased subscriber lists, non-compete agreements and goodwill. Purchased franchises and goodwill are amortized on the straight-line method over periods, which range from 34 to 40 years. Purchased subscriber lists are amortized on the straight-line method over the average periods\nOLYMPUS COMMUNICATIONS, L.P. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands) (Continued)\n2. Summary of Significant Accounting Policies, continued:\nIntangible Assets, continued\nthat the listed subscribers are expected to receive service from the date of acquisition, which is 7 years. The non-compete agreements are amortized over their contractual lives, which range from 2 to 5 years. Accumulated amortization of intangible assets amounted to $81,668 and $76,642 at December 31, 1993 and 1994, respectively.\nAmortization of Other Assets\nDeferred debt financing costs are amortized over the term of the related debt. The unamortized amount included in prepaid expenses and other assets was $2,426 and $1,457 at December 31, 1993 and 1994, respectively.\nAsset Impairments\nIn March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (\"SFAS\") No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.\" In accordance with SFAS No. 121, Olympus periodically reviews the carrying value of its long-lived assets, identifiable intangibles and goodwill in relation to historical financial results, current business conditions and trends (including the impact of existing legislation and regulation) to identify potential situations in which the carrying value of assets may not be recoverable. If a review indicates that the carrying value of such assets may not be recoverable, the carrying value of such assets in excess of their fair value would be recorded as a reduction of the assets cost as if a permanent impairment has occurred. The adoption of SFAS No. 121 did not materially affect the financial statements of Olympus.\nNet Loss Per General Partner Unit After Priority Return and Accretion Requirements\nNet loss per general partner unit after priority return and accretion requirements is based upon the weighted average number of general partner units outstanding of 10.0 for 1993 and 1994.\nCash and Cash Equivalents\nOlympus considers all highly liquid investments with original maturities of three months or less to be cash equivalents.\n3. Business Interruption and Property Damage Related to Hurricane:\nOn August 24, 1992, service in Olympus' South Dade system was interrupted by Hurricane Andrew. The hurricane damaged property with a net book value of approximately $6,265. Olympus maintained insurance for property loss and for business interruption and transmission lines. Olympus received total net proceeds from the insurance carriers of which $20,225 and $4,305 were received in the years ended December 31, 1992 and 1993, respectively. There were no net proceeds received in 1994. Of the total insurance proceeds received, $7,146, $9,547, and $1,037 were allocated to business interruption in 1992, 1993 and 1994, respectively. Allocation of the business interruption proceeds between years was based upon estimated revenues lost as a result of the hurricane.\nOLYMPUS COMMUNICATIONS, L.P. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands) (Continued)\n4. Debt:\nNotes Payable to Banks\nNotes payable to banks of Olympus' subsidiaries are comprised of the following:\nNotes payable to banks are comprised of borrowings under a $350,000 credit agreement between ACP and several banks, which was refinanced on May 12, 1995 as discussed below. The ACP revolving credit agreement converted to a term note on December 30, 1992. Simultaneous with the conversion, ACP prepaid $25,000 of principal through March 31, 1994. Additional quarterly installments will be due through December 31, 1999. Borrowings under the ACP credit arrangement are collateralized by a pledge of the stock or partnership interests of the subsidiaries. The agreement stipulates, among other things, limitations on additional borrowings, investments, transactions with affiliates, payment of dividends, distributions and fees, and requires the maintenance of certain financial ratios. The indebtedness under these agreements is non-recourse to Olympus and ACC.\nInterest rates charged for the ACP bank debt are based upon one or more of the following options: prime rate plus 0% to 1.50%, certificate of deposit rate plus .88% to 2.63%, or Eurodollar rate plus .75% to 2.50%. The weighted average interest rate on notes payable of ACP to the banks, including the effect of interest rate hedging arrangements, was 8.90% at December 31, 1994. Interest on outstanding borrowings is generally payable on a quarterly basis.\nAs a result of the sale of 85% of the common stock of Northeast on June 30, 1994 (see Note 1), the $44,100 of notes payable to banks of Northeast is no longer an obligation of Olympus.\nOlympus has entered into interest rate swap agreements with banks and ACC to reduce the impact of changes in interest rates on its floating rate bank debt and its redeemable preferred limited partner interests. At December 31, 1994, Olympus had an aggregate notional principal amount of $255,000 outstanding under such agreements, which expire from 1995 through 2000. These agreements provide for a weighted average rate of 8.90%, at December 31, 1994. Olympus is exposed to credit loss in the event of nonperformance by the bank and ACC. Olympus does not expect any such nonperformance. Net settlement amounts under these swap agreements are recorded as adjustments to interest expense during the period incurred.\nPrior to March 31, 1992, Olympus, ACC and an affiliated partnership consummated a series of transactions which resulted in the repayment of amounts owed to Olympus by the affiliate, the release of the affiliate from the guarantee and the cancellation of the rights of the affiliate and ACC to contribute assets to Olympus in return for PLP Interest and the related return thereon, through an amendment to the Olympus partnership agreement. As a condition of the release of the affiliate's guarantee, ACP repaid $24,000 of its bank debt through funds provided by Olympus.\nOLYMPUS COMMUNICATIONS, L.P. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands) (Continued)\n4. Debt, continued:\nNotes Payable to Banks, continued\nOlympus obtained these funds through the repayment of the term note plus interest from the affiliate and advances from affiliates of ACC. In connection with the amendment, as of March 31, 1992, Olympus reversed $5,674 of the net priority return amounts previously accrued under the guarantee arrangement.\nRefinancing\nOn May 12, 1995, ACP and an affiliate, West Boca Acquisition, L.P. (collectively, the \"Borrowers\") entered into a $475,000 revolving credit facility with several banks, maturing December 31, 2003. Interest rates charged are based upon one or more of the following options: prime rate plus 0% to .75%, the Federal Funds rate plus .5% to 1.25%, or Eurodollar rate plus .625% to 1.75%.\nInitial borrowings under the revolving credit facility were used to repay the Borrowers' existing notes payable to banks and accrued interest.\nBorrowings under this credit arrangement are collateralized by substantially all of the assets of the Borrowers. The agreement limits, among other things, additional borrowings, investments, transactions with affiliates, payment of distributions and fees, and requires the maintenance of certain financial ratios by the Borrowers. The agreement also provides that advances and contributions from affiliates may be returned to the affiliate to the extent contributed or advanced from the closing date of the loan.\nThe amount of actual borrowings available under the facility is based upon achieving certain levels of operating performance. The Borrowers will pay commitment fees at the annual rate of .375% on unused principal. The credit facility provides for mandatory reductions in the revolving loan commitment, in increasing quarterly amounts, commencing June 30, 1997 through December 31, 2003. On the dates of such mandatory commitment reductions, the Borrowers are obligated to repay outstanding loans in excess of the remaining total commitment.\nThe following table sets forth the maximum principal outstanding under this revolving credit agreement at December 31 of each of the next five years:\nDecember 31, 1995 $475,000 December 31, 1996 475,000 December 31, 1997 446,500 December 31, 1998 394,250 December 31, 1999 337,250\nOther Debt\nOther debt, with interest at 9.0% to 11.3%, consists of purchase money indebtedness and capital leases incurred in connection with the acquisition of, and are collateralized by, certain equipment.\n5. 16.5% Redeemable PLP Interests and Special Limited Partner Interests:\nThe PLP Interests issued to ACC are nonvoting, senior to claims represented by other partner interests, provide for a priority return of 16.5% per annum (payable quarterly), and are to be repaid by 2004. In the event that any priority return is not paid when due, such unpaid amounts will accrue additional return at a rate of 18.5% per annum. The unpaid priority return amounted to $95,930 and $135,553 at\nOLYMPUS COMMUNICATIONS, L.P. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands) (Continued)\n5. 16.5% Redeemable PLP Interests and Special Limited Partner Interests, continued:\nDecember 31, 1993 and 1994, respectively. As a result of the February 28, 1995 investment agreement among ACC, Olympus and Telesat (see Notes 1 and 12), the unpaid priority return was eliminated.\nThe following summarizes the PLP Interests of ACC during the three years ended December 31, 1994:\nSpecial limited partner interests were issued to ACC in connection with the issuance of PLP Interests and general partner interests, without any contribution of assets by ACC. These interests provide for special allocations of Olympus' income (see Note 6).\n6. Redeemable Limited Partner Interests and General Partner's Equity (Deficiency):\nThe general partner and limited partners of Olympus will generally share in future net income and losses of Olympus based upon their respective percentage ownership of partnership voting units except for certain special allocation provisions set forth in the Olympus partnership agreement. As specified in the partnership agreement, after the holders of the PLP Interests have received a return of their capital plus 16.5% per annum priority return, distributions by Olympus will be made in the following order: (i) to partners holding voting units (other than ACC) until each partner receives an 18% compounded return on its investment; (ii) to ACC until it receives an 18% compounded return on its investment in the voting units; (iii) to ACC as managing general partner, to the special limited partners and to the partners holding voting units until each partner holding voting units receives a 24% compounded return on its investment; and (iv) to ACC as managing general partner, to the special limited partners and to the partners holding voting units.\nThe $16,500 in redeemable limited partner units issued to unrelated parties in connection with the 1990 cable television system acquisitions represent voting partnership interests which are subject to certain put and call rights. In the event that any such redemption or purchase of limited partner units results in ACC owning more than 50% of the Partnership's voting interests, ACC will be required under the Partnership Agreement to reduce its voting interests so as to maintain its voting interest at or below 50%. ACC may at its option convert voting partner units to PLP Interests or senior debt in order to maintain its voting interest at or below 50%.\nAfter giving notice to Olympus in July 1992, the holder of the $6,500 in limited partner interests exercised its right to require Olympus to redeem its units on or before January 30, 1993. On January 3, 1993, Olympus acquired the redeemable limited partner units from the holder for $9,795. Concurrently, ACC converted 6.5 general partner units to PLP interests, thereby maintaining its 50% partnership voting interest.\nThe holders (Gans) of redeemable limited partner units can, at various dates through January 1996, require Olympus to redeem all of its units at the fair market value of the units on the exercise date. In the event that Olympus does not\nOLYMPUS COMMUNICATIONS, L.P. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands) (Continued)\n6. Redeemable Limited Partner Interests and General Partner's Equity (Deficiency), continued:\nmake the required purchase or if such purchase would cause Olympus, ACC or any affiliate of ACC to be in default of the provisions of their respective loan agreements, then Olympus may sell the assets and liquidate the partnership. At various dates through January 1996, ACC may purchase the limited partner units at their fair market value at the exercise date.\nFor financial reporting purposes, the $9,900 redemption price on the $6,500 in limited partner units was being accreted using the interest method. Such accretion was charged proportionately to the remaining limited and general partners' capital accounts. The carrying value of the limited partner units were adjusted as the fair market value of the units changed. The difference between the carrying value and the fair market value was accreted ratably through January 1993 as a charge to the general partners' capital account.\nAs a result of the Liquidation Agreement entered into on February 28, 1995 between Gans and Olympus, Gans exchanged their redeemable limited partnership interest in Olympus for 15% of the common stock of Northeast (see Notes 1 and 12).\nThe following summarizes activity related to the redeemable limited partners for the three years ended December 31, 1994:\nBalance, December 31, 1991........................................$ 14,900\nNet loss allocated to redeemable limited partners............. (8,309) Accretion requirements to redeemable limited partners......... 12,924\nBalance, December 31, 1992......................................... 19,515\nRedemption of limited partnership interests on January 3, 1993. (9,795) Net loss allocated to redeemable limited partners.............. (9,720) Accretion requirements to redeemable limited partners......... 5,000\nBalance, December 31, 1993........................................ 5,000\nNet loss allocated to redeemable limited partners............ (5,000) Accretion requirements to redeemable limited partners........ 5,885\nBalance, December 31, 1994........................................$ 5,885\n7. Commitments and Contingencies:\nOlympus rents office space, tower sites, and space on utility poles under leases with terms which are generally less than one year or under agreements that are generally cancelable on short notice. Total rental expense under all operating leases aggregated $1,008, $1,148 and $1,036 for 1992, 1993 and 1994, respectively.\nIn connection with certain obligations under existing franchise agreements, Olympus obtains surety bonds guaranteeing performance to municipalities and public utilities. Payment is required only in the event of nonperformance. Olympus has fulfilled all of its obligations such that no payments under surety bonds have been required.\nAs of July 1, 1993, Olympus adopted a program to self insure for casualty and business interruption insurance. This program is part of an aggregate agreement\nOLYMPUS COMMUNICATIONS, L.P. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands) (Continued)\n7. Commitments and Contingencies, continued:\nbetween Olympus and its subsidiaries in which Olympus will provide insurance for casualty and business interruption claims of up to $10,000 and $20,000 per claim, respectively, for each subsidiary. These risks were previously insured by outside parties with nominal deductible amounts.\nOlympus' cable television operations may be adversely affected by changes and developments in governmental regulation, competitive forces and technology. The cable television industry and Olympus are subject to extensive regulation at the federal, state and local levels. Many aspects of such regulation are currently the subject of judicial proceedings and administrative or legislative proceedings or proposals. On October 5, 1992, Congress passed the 1992 Cable Act, which significantly expands the scope of regulation of certain subscriber rates and a number of other matters in the cable industry, such as mandatory carriage of local broadcast stations and retransmission consent, and which will increase the administrative costs of complying with such regulations. The FCC has adopted rate regulations that establish, on a system-by-system basis, maximum allowable rates for (i) basic and cable programming services (other than programming offered on a per-channel or per-program basis), based upon a benchmark methodology, and (ii) associated equipment and installation services based upon cost plus a reasonable profit. Under the FCC rules, franchising authorities are authorized to regulate rates for basic services and associated equipment and installation services, and the FCC will regulate rates for regulated cable programming services in response to complaints filed with the agency. The original rate regulations became effective on September 1, 1993. Amendments to the rate regulations became effective May 15, 1994. Further amendments were adopted on November 10, 1994. The FCC ordered an interim rate freeze effective April 5, 1993 which was extended through May 15, 1994.\nThe FCC had adopted regulations implementing virtually all of the requirements of the 1992 Cable Act. The FCC is also likely to continue to modify, clarify or refine the rate regulations. In addition, litigation has been instituted challenging various portions of the 1992 Cable Act and the rulemaking proceedings including the rate regulations. Olympus cannot predict the effect or outcome of the future rulemaking proceedings, changes to the rate regulations, or litigation. Further, because the FCC has only issued its interim rules and has not adopted final cost-of-service rules, Olympus has not determined to what extent it will be able to utilize cost-of-service showings to justify rates.\nEffective September 1, 1993, as a result of the 1992 Cable Act, Olympus repackaged certain existing cable services by adjusting rates for basic service and introducing a new method of offering certain cable services. Olympus adjusted the basic service rates and related equipment and installation rates in all of its systems in order for such rates to be in compliance with the applicable benchmark or equipment and installation cost levels. The amended rules may require further adjustments to Olympus' rates. Olympus also implemented a program in all of its systems called \"CableSelect\" under which most of Olympus' satellite- delivered programming services are now offered individually on a per channel basis, or as a group at a price of approximately 15% to 20% below the sum of the per channel prices of all such services. For subscribers who elect to customize their channel lineup, Olympus will provide, for a monthly rental fee, an electronic device located on the cable line outside the home, enabling a subscriber's television to receive only those channels selected by the subscriber. These basic service rate adjustments and the CableSelect program have also been implemented in all systems managed by Olympus. Olympus believes CableSelect provides increased programming choices to its subscribers while providing flexibility to Olympus to respond to future changes in areas such as customer demand and programming.\nOLYMPUS COMMUNICATIONS, L.P. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands) (Continued)\n7. Commitments and Contingencies, continued:\nOn November 10, 1994 the FCC ruled that, prospectively, any \"a la carte\" package will be treated as a regulated tier, except for packages involving premium services. Olympus is currently unable to predict the effect that the amended regulations, future FCC treatment of \"a la carte\" packages or other future FCC rulemaking proceedings will have on its business and results of operations in future periods. No assurance can be given at this time that such matters will not have a material negative financial impact on Olympus' business and results of operations in the future. Also, no assurance can be given as to what other future actions Congress, the FCC or other regulatory authorities may take or the effects thereof on Olympus.\nA letter of inquiry, one of at least 63 sent by the FCC to numerous cable operators, was received by Olympus regarding the implementation of this new method of offering services. Olympus responded in writing to the FCC's inquiry. On November 18, 1994, the Cable Services Bureau of the FCC issued a decision holding that the \"CableSelect\" program was an evasion of the rate regulations and ordered this package to be treated as a regulated tier. This decision, and all other letters of inquiry decisions, were principally decided on the number of programming services moved from regulated tiers to \"a la carte\" packages. Olympus has appealed this decision to the full Commission. Olympus cannot predict the outcome or effect of this proceeding.\n8. Employee Benefit Plans:\nOlympus participates in an ACC savings plan (401(k)) which provides that eligible full-time employees may contribute from 2% to 20% of their pre-tax compensation. Olympus matches contributions not exceeding 1.5% of each participant's pre-tax compensation. During 1992, 1993 and 1994, no significant matching contributions were made by Olympus.\n9. Taxes on Income:\nWholly-owned subsidiaries of Olympus are corporations that file separate federal and state income tax returns. At December 31, 1994, these subsidiaries had net operating loss carryforwards for federal income tax purposes of approximately $172,600 expiring through 2009.\nOlympus adopted SFAS No. 109, \"Accounting for Income Taxes,\" effective January 1, 1993. This Statement supersedes Accounting Principles Board Opinion No. 11, \"Accounting for Income Taxes,\" which Olympus had followed previously and under which Olympus recorded no deferred tax liability. The cumulative effect of adopting SFAS No. 109 at January 1, 1993 was to increase the net loss by $59,500 for the year ended December 31, 1993. As a result of applying SFAS No. 109, $47,130 of previously unrecorded deferred tax assets generated from previous operating loss carryforwards incurred by Olympus and $86,000 in deferred tax liabilities from differences between the book and tax basis of property were recognized at January 1, 1993 as part of the cumulative effect of adopting the Statement. Under prior accounting, a portion of these benefits would have been recognized as a reduction of income tax expense from continuing operations in the year ended December 31, 1993.\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 Olympus' net deferred tax liability as of December 31, 1993 and 1994 are as follows:\nOLYMPUS COMMUNICATIONS, L.P. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands) (Continued)\n9. Taxes on Income, continued:\nThe net change in the valuation allowance in 1994 was an increase of $5,314.\nThe provision for income taxes for years ended December 31, 1992, 1993 and 1994 is as follows:\nReconciliations between the statutory federal income tax rate and Olympus' effective income tax rate as a percentage of loss before income tax benefit and cumulative effect of change in accounting principle are as follows:\nYear Ended December 31,\n1993 1994\nStatutory federal income tax (benefit) rate......................................... (35%) (35%) Change in valuation allowance........................... 16% 25% Operating losses passed through to partners............. 19% 9% Effective income tax benefit rate....................... 0% 1%\n10. Disclosures about Fair Value of Financial Instruments:\nIncluded in Olympus' financial instrument portfolio are cash, notes payable, interest rate swaps, and redeemable limited partner interests (including redeemable preferred limited partner interests and the accrued priority return thereon). The carrying values of the notes payable and redeemable limited partnership interests approximate their fair values at December 31, 1994. At December 31, 1994, Olympus would have been required to pay approximately $3,455 to settle its interest rate swap agreements, representing the excess of carrying cost over fair value of these agreements. The fair values of the debt and interest rate swaps were based upon quoted market prices of similar instruments or on rates available to Olympus for instruments of the same remaining maturities.\nOLYMPUS COMMUNICATIONS, L.P. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands) (Continued)\n10. Disclosures about Fair Value of Financial Instruments, continued:\nThe aggregate of the redeemable limited partner and the redeemable preferred limited partner interests (collectively the \"Aggregate Redeemable Partner Interests\") had carrying values totalling $417,539 at December 31, 1994. The Aggregate Redeemable Partner Interests had an estimated fair value ranging from $250,000 to $350,000 at December 31, 1994. The fair value of the Aggregate Redeemable Partner Interests was based upon an investment bank market research report, computed using multiples of estimated cash flows. Considerable judgment is necessary to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that a holder 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.\n11. Transactions with Related Parties:\nOlympus has an agreement with a subsidiary of ACC (Managing Affiliate) which provides for payment of management fees by Olympus equal to 5% of Olympus' gross revenues. The amount and payment of these fees is subject to the restrictions contained in the credit agreements. Olympus also reimburses ACC for direct operating costs, which amounted to $1,245, $600 and $1,477 for 1992, 1993 and 1994, respectively. In 1992 Olympus assigned to ACC $750 of insurance proceeds for assistance provided with respect to the hurricane and the resulting insurance claims (see Note 3).\nAt December 31, 1991, Olympus held a 16.5% term note from an affiliated partnership of certain executive officers of ACC in the amount of $10,157. This note was repaid on March 27, 1992. Interest income from this affiliated partnership on the term note and other receivables amounted to $597 for 1992, which is included in revenues.\nOlympus has periodically received funds from and advanced funds to ACC and other affiliates. Olympus was charged $4,497, $4,955 and $9,373 of interest on such net payables for 1992, 1993 and 1994, respectively.\nNet settlement amounts under interest rate swap agreements with ACC are recorded as adjustments to interest expense during the period incurred. The effect of the interest rate swaps was to increase interest expense by $1,434 and $651 in 1992 and 1993, respectively.\nOlympus entered into an agreement with an affiliated partnership to provide for the payment of management fees to Olympus equal to 5% of the affiliated partnership's revenues. Such fees amounted to $397 and $1,356 for 1993 and 1994, respectively, which are included in revenues.\nOn March 31, 1994, Olympus sold to ACC, rights to provide alternate access in its franchised areas and an investment in an unaffiliated partnership for a purchase price of $15,500. The sale resulted in the reduction of a payable to ACC of $15,500. Due to the common control of these entities, the excess of the sale price over Olympus' carrying value has been credited directly in general partner's equity (deficiency).\nOn June 30, 1994, Olympus sold to ACC 85% of the common stock of Northeast Cable, Inc., a wholly-owned subsidiary, for a selling price of $31,875. Northeast owned cable television systems serving approximately 36,500 subscribers in eastern Pennsylvania. ACC paid $16,000 in cash and the remainder resulted in a decrease of ACC's existing receivable from Olympus. Due to the common control of these entities, the excess of the sale price over Olympus' carrying value has been credited directly in general partner's equity (deficiency).\nOLYMPUS COMMUNICATIONS, L.P. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands) (Continued)\n11. Transactions with Related Parties, continued:\nDuring 1994, Olympus entered into an agreement with an affiliate to provide the affiliate with alternate access rights to certain cable systems. Revenue generated from this agreement amounted to $162 for the year ended December 31, 1994.\n12. Subsequent Events:\nOn February 28, 1995, Olympus entered into both the Gans Liquidation Agreement and the Telesat Investment Agreement (see Note 1). As a result of the Gans Liquidation Agreement, Gans agreed to exchange their redeemable limited partnership interests in Olympus for 15% of the common stock of Northeast.\nAs a result of the Telesat Investment Agreement, Telesat contributed certain Florida cable systems serving approximately 50,000 subscribers. In exchange, Telesat received general and limited partner interests and $112,500 of 16.5% preferred limited partner interests and loaned Olympus $20,000.\nPrior to the Telesat Investment Agreement, Olympus had obligations to ACC for intercompany advances, preferred limited partner (\"PLP\") interests, and priority return on PLP interests. In conjunction with the Telesat Investment Agreement, ACC contributed a portion of the intercompany advances, a portion of the existing PLP interests and all of the existing accrued priority return on the PLP interests, to capital contributions.\nOn April 3, 1995, Olympus purchased all of the cable and security systems of WB Cable Associates, Ltd., (\"WB Cable\") serving approximately 44,000 subscribers for a purchase price of $82,000. WB Cable provides cable service from one headend and security monitoring services from one location in West Boca Raton, Florida. Of the purchase price, $77,000 was paid in cash and $5,000 was paid in ACC Class A Common Stock. The acquisition, which will be accounted for under the purchase method of accounting, was financed principally through additional borrowings under the ACP credit agreement (see Note 4).\nOn June 8, 1995, Olympus entered into a definitive agreement for the purchase of all the southeast Florida cable and electronic security monitoring systems of the Leadership Cable division of Fairbanks Communications, Inc. (\"Leadership Cable\") serving approximately 50,000 subscribers for a purchase price of approximately $94 million. Leadership Cable provides cable service and security monitoring services in and around West Palm Beach, Florida. The acquisition, which will be accounted for under the purchase method of accounting, is expected to close in the fourth quarter of 1995.\nThe following unaudited pro forma balance sheet, assumes that all transactions except Leadership Cable, which has not closed, had occurred on December 31, 1994. The unaudited pro forma statement of operations has been prepared assuming that the purchase of the Telesat and WB Cable systems and the sale of Northeast (see Note 1) had occurred on January 1, 1994. The pro forma data are not necessarily indicative of the results that actually would have occurred if the purchase of Telesat and WB Cable occurred on January 1, 1994 or what may be achieved in the future.\n(a) Exchange of the Gans redeemable limited partner interests for Olympus' investment in Northeast.\n(b) Historical cost basis of the assets of the cable systems contributed by Telesat.\n(c) Loan made by Telesat to Olympus. Under certain circumstances all or a portion of this loan will be converted to equity.\n(d) Telesat's 16.5% redeemable preferred limited partner interest.\n(e) Net assets of Telesat at acquisition date of $32,153 offset by the equity allocated to the 16.5% redeemable limited partner interests.\n(f) Conversion of the accrued priority return to general partner's equity.\n(g) Conversion of a portion of the affiliate payables to general partner's equity.\n(h) Conversion of a portion of the preferred limited partner units to general partner's equity.\n(i) Total effect of the items described in (f), (g), and (h).\n(j) Acquisition of the assets of WB Cable Associates, Ltd.\nPRO FORMA STATEMENT OF OPERATIONS YEAR ENDED DECEMBER 31, 1994 (Dollars in thousands) (UNAUDITED)\n(a) Reflects the operations for Telesat and WB Cable for the year ended December 31, 1994.\n(b) Represents the difference between the priority return calculated under the previous equity structure and the 16.5% return on the pro forma $337,500 in redeemable preferred limited partner interests.\n(c) Elimination of the net loss allocated to Gans.\n(d) Elimination of the accretion requirements of Gans.\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 set forth above in Part I under the caption \"Executive Officers of the Registrant\" is incorporated herein by reference. The other information required by this item is incorporated herein by reference to the information set forth under the caption \"Election of Directors - Description of Board of Directors\"; the information set forth under the caption \"Election of Directors - Nominee for Election by Holders of Class A Common Stock\"; the information set forth under the caption \"Election of Directors - Nominees for Election by Holders of Class A Common Stock and Class B Common Stock\"; and the information under the caption \"Certain Transactions - Certain Reports,\" in the Company's definitive proxy statement for the 1995 Annual Meeting of Stockholders filed pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended, or by reference to a filing amending 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 the information set forth under the caption \"Executive Compensation\" in the Company's definitive proxy statement for the 1995 Annual Meeting of Stockholders filed pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended, or by reference to a filing amending this Annual Report on Form 10-K.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required by this item is incorporated herein by reference to the information set forth under the caption \"Principal Stockholders\" in the Company's definitive proxy statement for the 1995 Annual Meeting of Stockholders filed pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended, or by reference to a filing amending this Annual Report of Form 10-K.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by this item is incorporated herein by reference to the information set forth under the caption \"Certain Transactions\" in the Company's definitive proxy statement for the 1995 Annual Meeting of Stockholders filed pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended, or by reference to a filing amending 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\nFinancial Statements, schedules and exhibits not listed have been omitted where the required information is included in the consolidated financial statements or notes thereto, or is not applicable or required.\n(a)(1)A listing of the consolidated financial statements, notes and independent auditors' report required by Item 8 are listed on page 46 of this Annual Report on Form 10-K.\n(2)Financial Statement Schedules: The following are included in this Report: Schedule I -- Condensed Financial Information of the Registrant Schedule II -- Valuation and Qualifying Accounts\n(3)Exhibits\nExhibit No.\nReference\f3.01 Certificate of Incorporation of Adelphia Communications Corporation Incorporated herein by reference is Exhibit 3.01 to Registration Statement No. 33-6974 on Form S-1.\n3.02 Bylaws of Adelphia Communications Corporation, as amended Incorporated herein by reference is Exhibit 3.02 to Registrant's Annual Report on Form 10-K for the fiscal year ended March 31, 1994.\n4.01 First Supplemental Indenture, dated as of May 4, 1994, with respect to Registrant's 91\/2% Senior Pay-In-Kind Notes Due\n4.02 Indenture, dated as of February 22, 1994, with respect to Registrant's 91\/2% Senior Pay-In-Kind Notes Due\n4.03 Indenture, dated as of July 28, 1993, with respect to Registrant's 101\/4% Senior Notes Due 2000\n4.04 Amended and Restated Indenture, dated as of May 11, 1993, with respect to Registrant's 9-7\/8% Senior Debentures Due 2005\nIncorporated herein by reference is Exhibit 4.01 to Registrant's Current Report on Form 8-K dated May 5, 1994.\nIncorporated herein by reference is Exhibit 4.05 to Registration Statement No. 33-52513 on Form S-4.\nIncorporated herein by reference is Exhibit 4.01 to Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1993.\nIncorporated herein by reference is Exhibit 4.01 to Registrant's Annual Report on Form 10-K for the fiscal year ended March 31, 1993. \f\f4.05 Indenture, dated as of September 2, 1992, with respect to the Registrant's 11-7\/8% Senior Debentures Due\n4.06 Indenture, dated as of May 7, 1992, with respect to the Registrant's 12-1\/2% Senior Notes Due 2002 Incorporated herein by reference is Exhibit 4.03 to Registration Statement No. 33-52630 on Form S-1.\nIncorporated herein by reference is Exhibit 4.03 to Registrant's Annual Report on Form 10-K for the fiscal year ended March 31, 1992. \f 10.01 Class B Common Stockholders Agreement\n10.02 Joinder to Class B Common Stockholders Agreement Incorporated herein by reference is Exhibit 10.01 to Registration Statement No. 33-6974 on Form S-1.\nIncorporated herein by reference is Exhibit 10.02 to Registrant's Annual Report on Form 10-K for the fiscal year ended March 31, 1994.\n10.03 Registration Rights Agreement and Amendment to Registration Rights Agreement Incorporated herein by reference are Exhibit 10.02 to Registration Statement No. 33-6974 on Form S-1 and Exhibit 10.35 to Registration Statement No. 33-25121 on Form S-1. 10.04 Management Agreement--Highland Video Associates, L.P. Incorporated herein by reference is Exhibit 10.06 to Registrant's Annual Report on Form 10-K for the fiscal year ended March 31, 1990. 10.05 Management Agreement-- Montgomery Cablevision Associates, L.P. Incorporated herein by reference is Exhibit 10.08 to Registration Statement No. 33-6974 on Form S-1. 10.06 Management Agreement--Adelphia Cablevision Associates of Radnor, L.P. Incorporated herein by reference is Exhibit 10.09 to Registration Statement No. 33-6974 on Form S-1.\n10.07 Form of Agreement Regarding Management Services for Olympus Communications, L.P.\nIncorporated herein by reference is Exhibit 10.06 to Registrant's Annual Report on Form 10-K for the fiscal year ended March 31, 1991. 10.08* Stock Option Plan of 1986, as amended Incorporated herein by reference is Exhibit 10.07 to Registration Statement No. 33-46551 on Form S-1. 10.09* Restricted Stock Bonus Plan, as amended Incorporated herein by reference is Exhibit 10.08 to Registration Statement No. 33-46551 on Form S-1. 10.10 Business Opportunity Agreement\nIncorporated herein by reference is Exhibit 10.13 to Registration Statement No. 33-3674 on Form S-1.\n10.11* Employment Agreement between the Company and John J. Rigas Incorporated herein by reference is Exhibit 10.14 to Registration Statement No. 33-6974 on Form S-1. 10.12* Employment Agreement between the Company and Daniel R. Milliard Incorporated herein by reference is Exhibit 10.15 to Registration Statement No. 33-6974 on Form S-1. 10.13* Employment Agreement between the Company and Timothy J. Rigas Incorporated herein by reference is Exhibit 10.16 to Registration Statement No. 33-6974 on Form S-1. 10.14* Employment Agreement between the Company and Michael J. Rigas Incorporated herein by reference is Exhibit 10.17 to Registration Statement No. 33-6974 on Form S-1. 10.15* Employment Agreement between the Company and James P. Rigas Incorporated herein by reference is Exhibit 10.18 to Registration Statement No. 33-6974 on Form S-1.\n10.16 Agreement Regarding Management Fees relating to the subsidiaries of Chauncey Communications Corporation\nIncorporated herein by reference is Exhibit 10.16 of Registrant's Annual Report on Form 10-K for the fiscal year ended March 31, 1991. 10.17 Loan Agreement among Chelsea Communications, Inc. and The Toronto-Dominion Bank Trust Company and NCNB Texas National Bank, as Agents, and the Banks named therein, dated as of September 25, 1989 Incorporated herein by reference is Exhibit 10.01 of Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1989.\n10.18 Agreement Regarding Management Fees relating to subsidiaries of Chelsea Communications, Inc. Incorporated herein by reference is Exhibit 10.31 of Registrant's Annual Report on Form 10-K for the fiscal year ended March 31, 1990. 10.19 Form of Note Agreement, dated as of August 1, 1990, relating to the 10.66% Senior Secured Notes due August 1, 1998 of Chauncey Communications Corporation Incorporated herein by reference is Exhibit 10.01 of Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1990. 10.20 Amendatory Agreement regarding Chauncey Communications Corporation 10.66% Senior Secured Note Agreement, dated as of August 6, 1991 Incorporated herein by reference is Exhibit 10.02 of Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1991. 10.21 $50,000 Term Note and Pledge Agreement between Adelphia Communications Corporation as lender and Daniel R. Milliard, dated October 1, 1988 Incorporated herein by reference is Exhibit 10.03 of Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1991. 10.22 $205,000 Revolving Term Note and Pledge Agreement among Adelphia Communications Corporation as lender, Daniel R. Milliard and David Acker Incorporated herein by reference is Exhibit 10.04 of Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1991. 10.23 First Amendment to Loan Agreement among Chelsea Communications, Inc. and The Toronto-Dominion Bank Trust Company and NCNB Texas National Bank, as Agents, and the Banks named therein, dated as of August 10, 1992 Incorporated herein by reference is Exhibit 10.39 to Registration Statement No. 33-52630 on Form S-1.\n10.24Purchase Agreement relating to 101\/4% Senior Notes Due 2000, Series A and B, by and between Adelphia Communications Corporation and the Purchaser, dated July 20, 1993 Incorporated herein by reference is Exhibit 10.01 to Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1993.\n10.25 Registration Rights Agreement relating to 101\/4% Senior Notes Due 2000, Series A and B, by and between Adelphia Communications Corporation and the Purchaser, dated July 28,\n10.26 Agreement for the Purchase of Class A Common Stock by the Rigas family, dated January 7,\n10.27 Underwriting Agreement between the Company and Salomon Brothers, Inc., dated January 7, 1994\n10.28 Registration Agreement between the Company and Salomon Brothers, Inc., dated January 7, 1994\n10.29 Second Amendment to Loan Agreement between Chelsea Communications, Inc. and The Toronto-Dominion Bank Trust Company and NationsBank of Texas, N.A, as Agents, dated December 31, 1993\n10.30 Purchase Agreement relating to 91\/2% Senior Pay-In-Kind Notes Due 2004, Series A, by and between Adelphia Communications Corporation and the Purchaser, dated February 14, 1994\n10.31 Registration Rights Agreement relating to 91\/2% Senior Pay- In-Kind Notes Due 2004, Series A, by and between Adelphia Communications Corporation and the Purchaser, dated February 22, 1994.\n10.32 Olympus Communications, L.P. Second Amended and Restated Limited Partnership Agreement, dated as of February 28, 1995.\n10.33 Credit, Security and Guaranty Agreement among UCA Corp. and certain of its Affiliates and First Union National Bank of North Carolina as Administrative Agent, dated as of March 15, 1995.\n10.34 Revolving Credit Facility among Adelphia Cable partners, L.P., Southwest Florida Cable, Inc., West Boca Acquisition Limited Partnership and Toronto-Dominion (Texas), Inc., as Administrative Agent, date May 12, 1995.\n21.01 List of Subsidiaries of Adelphia Communications Corporation Incorporated herein by reference is Exhibit 10.02 to Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1993.\nIncorporated herein by reference is Exhibit 10.01 to Registrant's Quarterly Report on Form 10-Q for the quarter ended December 31, 1993.\nIncorporated herein by reference is Exhibit 10.01 to Registrant's Current Report on Form 8-K dated January 14, 1994.\nIncorporated herein by reference is Exhibit 10.02 to Registrant's Current Report on Form 8-K dated January 14, 1994.\nIncorporated herein by reference is Exhibit 10.03 to Registrant's Current Report on Form 8-K dated January 14, 1994.\nIncorporated herein by reference is Exhibit 10.01 to Registration Statement No. 33-52513.\nIncorporated herein by reference is Exhibit 10.02 to Registration Statement No. 33-52513.\nFiled herewith.\nFiled herewith.\nFiled herewith.\nFiled herewith.\n23.01 Independent Auditors Consent\n27.01 Financial Data Schedule Filed herewith\nFiled herewith\nThe Registrant will furnish to the Commission upon request copies of instruments not filed herewith which authorize the issuance of long-term obligations of Registrant not in excess of 10% of the Registrant's total assets on a consolidated basis.\n(b)The Registrant filed the following Reports on Form 8-K during the three (3) months ended March 31, 1995.\nDate of Report Item Reported Financial Statements Filed\nFebruary 28, 1995 Items 5, 7 None\n(c)The Company hereby files as exhibits to this Form 10-K the exhibits set forth in Item 14(a)(3) hereof which are not incorporated by reference.\n(d)The Company hereby files as financial statement schedules to this Form 10-K the financial statement schedules set forth in Item 14(a)(2) hereof. _________________________ * Denotes management contracts and compensatory plans and arrangements required to be identified by Item 14(a)(3).\nSCHEDULE I Page 1 of\nADELPHIA COMMUNICATIONS CORPORATION AND SUBSIDIARIES Condensed Information as to the Financial Position of the Registrant (Dollars in thousands)\nSee notes to condensed financial information of the Registrant.\nSCHEDULE Iof 4\nADELPHIA COMMUNICATIONS CORPORATION AND SUBSIDIARIES Condensed Information as to the Operations of the Registrant (Dollars in thousands)\nSee notes to condensed financial information of the Registrant. SCHEDULE I Page 3 of 4\nADELPHIA COMMUNICATIONS CORPORATION AND SUBSIDIARIES Condensed Information as to the Cash Flows of the Registrant (Dollars in thousands)\nSee notes to condensed financial information of the Registrant.\nSCHEDULE Iof 4\nADELPHIA COMMUNICATIONS CORPORATION AND SUBSIDIARIES Notes to Condensed Financial Information of the Registrant (Dollars in thousands)\n1. Notes Payable to Subsidiaries:\nAdelphia Communications Corporation (\"ACC\") has partially funded its acquisitions and capital needs through borrowings and advances from subsidiaries. ACC had issued to certain of its subsidiaries unsecured demand notes payable in the principal amount of $128,382 at March 31, 1994 and 1995. The notes, which have been eliminated in consolidation, provide for interest at rates ranging from 4.83% to 16.5%, are due upon demand five years after March 31, 1995, and provide that non-payment of principal or interest is not an event of default.\nSCHEDULE II ADELPHIA COMMUNICATIONS CORPORATION AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS\n(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.\nADELPHIA COMMUNICATIONS CORPORATION\nJune 29, 1995 By: \/s\/ John J. Rigas John J. Rigas, 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.\nJune 29, 1995 \/s\/ John J. Rigas John J. Rigas, Director\nJune 29, 1995 \/s\/ Timothy J. Rigas Timothy J. Rigas, Senior Vice President, Chief Financial Officer, Treasurer, Director and Chief Accounting Officer\nJune 29, 1995 \/s\/ Michael J. Rigas Michael J. Rigas, Senior Vice President and Director\nJune 29, 1995 \/s\/ James P. Rigas James P. Rigas, Vice President and Director\nJune 29, 1995 \/s\/ Daniel R. Milliard Daniel R. Milliard, Vice President, Secretary and Director\nJune 29, 1995 \/s\/ Perry S. Patterson Perry S. Patterson, Director\nJune 29, 1995 \/s\/ Pete J. Metros Pete J. Metros, Director","section_15":""}
{"filename":"16104_1995.txt","cik":"16104","year":"1995","section_1":"Item 1: General Business\nCagle's, Inc. (the \"Company\"), which began business in 1945 and was first incorporated in Georgia in 1953, and its wholly owned subsidiary (Cagle's Farms ,Inc., formerly Strain Poultry Farms, Inc.) produce, market, and distribute a variety of fresh and frozen poultry products. The vertically integrated operations of the Company consist of breeding, hatching, and growing of chickens; feed milling; processing; further processing; and marketing. The Company's products are sold to national and regional independent and chain supermarkets, food distributors, food processing companies, national fast-food chains, and institutional users, such as restaurants, schools, and distributors, by the Company's sales staff located in Atlanta, Georgia, and through brokers selected by the Company.\nNarrative Description of Business\nFood Processing\nAll of the Company's business activities are conducted on a vertically integrated basis within one industry segment, poultry products. The Company's various poultry products are closely related, have similar purposes and uses, and, except for product sold under cost-plus arrangements, are similar in terms of profitability and types and degrees of risks. In addition, the production processes are similar to the extent that (a) production facilities are shared or are interchangeable and (b) the same types of raw materials, labor, and capital are used. Markets and marketing methods are comparable for all products (except cost-plus products) to the extent that they are generally sold to the same types of customers by a common sales force and are sensitive to changes in economic conditions to the same degree.\nThe Company currently processes approximately 2,035,000 birds per week in its three processing plants, including two plants which operate with two full shifts. Of the Company's total production, approximately 1,000,000 head per week are deboned. In March 1993, the Company placed one of its processing plants into a joint venture with a major customer, reducing the total company volume by 365,000 birds per week.\nThe complete cycle for growing broilers begins with the placement on a farm of a day-old breeder chick. This bird is reared for 25 weeks, at which time it begins to produce hatching eggs. The breeder produces eggs for approximately 40 weeks. These eggs are set in one of the Company's two hatcheries, and in three weeks, a baby chick is hatched.\nThe day-old broiler chick is placed on a farm where it will grow for six to eight weeks depending upon the size of bird desired, at which time it is transported to the processing plant for slaughter. To produce uniform size for customer demands, the Company grows the males and females separately. This is necessary because males and females grow at different rates and have different nutritional requirements for cost-effective growth. A significant investment in field inventories is required to support the Company's operating cycle.\nAll feed for all flocks is produced in feed mills owned by the Company.\nThe Company's goal is to add value to all of its birds, and the Company currently is accomplishing this on approximately 85% of all head slaughtered. This value-added product takes the form of deboned breast and thigh meat, cut-up marinated raw breaded chicken (including barbecue), government school lunch product, fast-food cuts, IQF (individually quick frozen) products, and mechanically deboned chicken meat.\nRaw Materials\nThe primary raw materials used by the Company are corn, soybean meal, and other ingredients; packaging materials; cryogenic materials; and breeder chicks. The Company believes that sources of supply for these materials are adequate and does not expect significant difficulty in acquiring required supplies. The major source of supply is the midwestern grain belt of the United States, although local supplies are utilized when available. Prices for the feed ingredients are sensitive to supply fluctuations worldwide, and weather conditions, especially drought, can cause significant price volatility. Since feed is the most significant factor in the cost of producing a broiler chicken, those fluctuations can have significant effects on margins. The Company also purchases product outside for further processing requirements.\nResearch and Development\nThe Company has made no material expenditures for research and development during the last three years.\nEmployees and Labor Relations\nThe Company employs approximately 3,250 persons of whom approximately 49% are covered by collective bargaining agreements which expire at various dates over the next three years. The Company believes its relationship with the bargaining groups and other employees is good.\nSeasonal Variations in Business\nThe seasonal demand for the Company's products is highest during the late spring and summer months and is normally lowest during the winter months.\nCustomers\nEquity Foods (\"Equity\") accounted for approximately 37% of the Company's sales for the year ended April 1, 1995. The Company has an agreement with Equity to supply chicken under a cost-plus arrangement, and approximately 50% of the Company's production is committed to Equity. Under the arrangement, production in excess of Equity's demands and by-products are sold to other customers and are credited against the cost-plus arrangement. The Company generally receives full margin on processed pounds regardless of the final customer.\nBacklog\nThe Company had no material backlog of orders existing as of April 1, 1995.\nCompetition\nThe Company is a leading regional integrated poultry processor, ranking eleventh nationally in pounds produced. The Company's products compete in the marketplace with comparable products of approximately ten national and regional producers in the areas of quality, service, and price. The Company believes its flexibility and accessibility are positive factors enhancing the Company's competitive position.\nRegulation\nThe Company'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 (\"FDA\"), the United States Department of Agriculture (\"USDA\"), the Environmental Protection Agency, the Occupational Safety and Health Administration, and the corresponding state agencies. The Company's processing plants are subject to continuous on-site inspection by the USDA, and the FDA inspects the production of the Company's feed mill. Management believes that the Company is in substantial compliance with applicable laws and regulations relating to the operation of its facilities.\nItem 2:","section_1A":"","section_1B":"","section_2":"Item 2: Properties\nProduction and Facilities\nBreeding and Hatching\nThe Company supplies its broiler chicks by producing all of its own hatching eggs from breeder flocks owned by the Company. These breeder flocks are maintained on 61 contract grower farms. In addition, the replacement breeder pullets are maintained on 32 contract grower farms where the breeders are reared from one day old to approximately 18 weeks old and then moved to the breeder farm where they begin to produce eggs at about 25 weeks of age. These farms are located in north Georgia.\nThe Company owns two hatcheries located in Dalton, Georgia, and Forsyth, Georgia, at which eggs are incubated and hatched. This is a continuous process and requires 21 days to complete. After the chicks are removed from the incubator, they are separated by sex, vaccinated against disease, and moved by a special-purpose vehicle, Chick Bus, to the Company's grow-out farms. The two hatcheries have an aggregate capacity of 2,100,000 chicks per week. Both of the hatcheries are company-owned.\nGrow-Out\nThe Company places its broiler chicks on approximately 283 contract grower farms. The birds are grown separately by sex to provide the exact size requirement of the Company's customers.\nThe independent contract growers provide the housing, equipment, utilities, and labor to grow the baby chicks to market age, which varies from six to eight weeks, depending on the market for which they are intended. The Company supplies the baby chicks, the feed, and all veterinary and technical services. Title to the birds remains with the Company at all times. The contract growers are paid on live weight and are guaranteed a minimum rate with various incentives based upon a grower's performance as compared to other growers whose birds are marketed during the same week. These contract farms are located in Georgia, Tennessee, and Alabama.\nFeed Mills\nThe Company owns one feed mill with a production capacity of approximately 520,000 tons per year. The mill is located in Dalton, Georgia. An additional feed mill in Camilla, Georgia, was completed in 1993 and contributed to Cagle's Foods in March 1993. A new feed mill is nearing completion in Forsyth, Georgia, which will have the capacity to produce approximately 300,000 tons annually.\nProcessing\nAs the broilers reach the desired processing weight, they are removed from the houses and transported by company trucks to a processing plant.\nThe processing plants are located in Pine Mountain, Georgia; Macon, Georgia; and Collinsville, Alabama. The Pine Mountain and Macon, Georgia, plants have the capacity to process 8,400 birds per hour, and the Collinsville plant can process up to 12,600 birds per hour. The Macon, Georgia, and Collinsville, Alabama, plants operate two full shifts.\nFurther Processing and Deboning\nThe Company has a stated goal of marketing the majority of its product as value-added product. This is accomplished by cutting the product into parts or fast-food cuts, deboning, marinating and breading, and converting into other convenience-type products.\nCurrently, further processing and deboning are conducted at the Collinsville, Alabama, plant (cutting, marinating, and breading) and the Pine Mountain and Macon, Georgia, plants (deboning). In addition, the Atlanta, Georgia, facility and the Lovejoy, Georgia, facility are totally devoted to further processing.\nFreezer Storage\nThe Company's facilities located in Atlanta, Georgia; Collinsville, Alabama; Pine Mountain, Georgia; and Lovejoy, Georgia, have freezer storage facilities with aggregate capacity of approximately 3,000,000 pounds of frozen product. The Company utilizes outside storage services as needed to supplement its own freezer capacity.\nLocal Distribution\nAs an extension of the company sales division, two local distribution divisions are operated from separate refrigerated warehouse facilities in Atlanta, Georgia, and Birmingham, Alabama. These units have sales representatives located in Macon, Georgia, as well as Atlanta, and are designed to provide storage and delivery service for those customers in their operating areas.\nSignificant Unconsolidated Subsidiaries\nThe Company owns a 50% interest in a joint venture, which is a fully integrated poultry company located in Camilla, Georgia. This company was created in March 1993 from the contributed assets of the Company's former south Georgia and north Florida operations. The joint venture is growing and processing approximately 525,000 birds per week in a processing plant that is capable of processing up to 1,400,000 broilers per week. A new hatchery was placed into service on March 28, 1994, and a new processing plant began operations in April 1995. The Company acquired a minority interest in a poultry by-product company in November 1994.\nExecutive Offices\nThe Company's executive offices are located in a renovated two-story (22,000-square-foot) building at 2000 Hills Avenue, NW, Atlanta, Georgia. The building is owned by the Company.\nSubstantially all of the Company's property, plant, and equipment are encumbered to secure long-term debt of the Company.\nAll of the properties described above are in good condition and are adequate for their stated uses.\nItem 3:","section_3":"Item 3: Legal Proceedings\nThe Company is involved in various lawsuits and legal matters on an ongoing basis as a result of its day-to-day operations; however, the Company does not believe that the ultimate resolution of these matters will have a material adverse effect on the Company or its business.\nItem 4:","section_4":"Item 4: Submission of Matters to a Vote of Security Holders\nNo matters were submitted to security holders for a vote during the fourth quarter of fiscal 1995.\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 Company's Annual Report to Stockholders for the year ended April 1, 1995 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 Company's Annual Report to Stockholders for the year ended April 1, 1995 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 Company's Annual Report to Stockholders for the year ended April 1, 1995 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 Company's Annual Report to Stockholders for the year ended April 1, 1995 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 is included in the Company's Proxy Statement for the Annual Meeting of Stockholders to be held July 14, 1995 and is incorporated herein by reference.\nItem 11:","section_11":"Item 11: Executive Compensation\nThe information required by this item is included in the Company's Proxy Statement for the Annual Meeting of Stockholders to be held July 14, 1995 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 Company's Proxy Statement for the Annual Meeting of Stockholders to be held July 14, 1995 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 in the Company's Proxy Statement for the Annual Meeting of Stockholders to be held July 14, 1995 and is incorporated herein by reference.\nPART IV\nItem 14:","section_14":"Item 14: Exhibits, Financial Statement Schedules, and Reports on Form 8-K\nThe following documents are filed as part of this report:\n(a)1. Financial Statements\nThe Company's 1995 Annual Report to Stockholders contains the consolidated balance sheets as of April 1, 1995 and April 2, 1994, the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended April 1, 1995, and the related report of Arthur Andersen LLP as to these financial statements. These financial statements and the report of Arthur Andersen LLP are incorporated herein by reference. The financial statements, incorporated by reference, include the following:\n\tConsolidated Balance Sheets--April 1, 1995 and April 2, 1994\n\tConsolidated Statements of Income for the Years Ended April 1, 1995, April 2, 1994, and April 3, 1993\n\tConsolidated Statements of Stockholders' Equity for the Years Ended April 1, 1995, April 2, 1994, and April 3, 1993\n\tConsolidated Statements of Cash Flows for the Years Ended April 1, 1995, April 2, 1994, and April 3, 1993\n\tNotes to Consolidated Financial Statements--April 1, 1995, April 2, 1994, and April 3, 1993\n(a)2. Financial Statement Schedules\nThe financial statement schedules have been omitted because they are not applicable or the required information is included in the consolidated financial statements or notes thereto. Reports on Form 8-KA report on Form 8-K was filed in April 1995 to disclose the Company's new unsecured revolving credit agreement.\nReports on Form 8-K\nA report on Form 8-k was filed in April 1995 to disclose the Company's new unsecured revolving credit agreement.\nSignatures\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nCagle's, Inc.\nBY: \/s\/ J. Douglas Cagle J. Douglas Cagle Chairman and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report is signed below by the following persons on behalf of the registrant and in capacities and on the date indicated:\n\/s\/ J.Douglas Cagle Chairman and Director and\tChief Executive Officer\n\/s\/ Kenneth R. Barkley Senior Vice President\tFinance\/Treasurer\/Chief Financial Officer\/Director\/\tPrinciple Financial and Accounting Officer\n\/s\/ Warner S. Currie Director\n\/s\/ George Douglas Cagle Vice President, New Product\tDevelopment and Director\n\/s\/ John J. Bruno Senior Vice President Sales\tMarketing and Director\n\/s\/ James David Cagle Vice President, New Product\tSales and Director\n\/s\/ Jerry D. Gattis President, Chief Operating\tOfficer and Director\n\/s\/ Mark M. Ham IV Vice President, Information\tSystems and Director\n\/s\/ Candace Chapman Director","section_15":""}
{"filename":"704051_1995.txt","cik":"704051","year":"1995","section_1":"Item 1. Business.\nGeneral\nLegg Mason, Inc. (the \"Company\") is a holding company which, through its subsidiaries, is engaged in securities brokerage and trading, investment management of Company-sponsored mutual funds and individual and institutional accounts, investment banking for corporations and municipalities, sale of insurance and annuity products, commercial mortgage banking and provision of other financial services.\nThe Company's principal broker-dealer subsidiary is Legg Mason Wood Walker, Incorporated (\"Legg Mason Wood Walker\"), a full service regional broker-dealer and investment banking firm operating primarily in the Eastern and Mid-South regions of the United States. Another broker-dealer subsidiary, Howard, Weil, Labouisse, Friedrichs Incorporated (\"Howard Weil\"), engages in public finance in the Mid-South region as well as energy-related investment banking and institutional brokerage.\nInvestment advisory subsidiaries of the Company, and their respective assets under management as of March 31, 1995, include Legg Mason Fund Adviser, Inc., which serves as investment adviser to or manager of Company-sponsored mutual funds, with assets of approximately $4.1 billion; Western Asset Management Company, which manages fixed-income assets for institutional accounts, with approximately $12.5 billion under management; Batterymarch Financial Management, Inc., which manages emerging markets, international and U.S. equity portfolios for institutional clients, with approximately $4.9 billion under management; Legg Mason Capital Management, Inc., which serves as investment adviser to individual and institutional accounts, with approximately $740 million under management; Gray, Seifert & Co., Inc., which serves as investment adviser to wealthy individual, family group, endowment and foundation accounts, with approximately $680 million under management; The Fairfield Group, Inc., which serves as investment adviser to mutual funds (with assets of approximately $310 million) structured to meet the investment needs of banks and bank trust departments.\nThe Company's principal real estate finance subsidiaries are Legg Mason Real Estate Services, Inc. (formerly named Latimer & Buck, Inc.) and Dorman & Wilson, Inc. which are primarily engaged in commercial mortgage banking and commercial loan servicing.\nIn the fiscal year ended March 31, 1995, the Company's total revenues were derived approximately 51% from individual investor brokerage accounts, including interest on margin accounts, 6% from institutional investor brokerage accounts, 24% from investment advisory services, and the balance from transactions as principal with\nother dealers, investment banking, mortgage banking and other activities.\nThe Company was incorporated in Maryland in 1981 to serve as a holding company for Legg Mason Wood Walker and other subsidiaries. The predecessor company to Legg Mason Wood Walker was formed in 1970 under the name Legg Mason & Co., Inc. to combine the operations of Legg & Co., a Maryland-based broker-dealer formed in 1899, and Mason & Company, Inc., a Virginia-based broker-dealer formed in 1962. The Company's subsequent growth has occurred through internal expansion as well as through its acquisitions of Wood Walker & Co., a New York broker-dealer, in 1973; Mason & Lee, Incorporated, a Virginia broker-dealer, in 1981; C. C. Collings and Company, Inc. and A. E. Masten & Co., Incorporated, two Pennsylvania broker-dealers, in 1984; Hill & Co., an Ohio broker-dealer, in 1985; Western Asset Management Company and Warren W. York & Co., a Pennsylvania broker-dealer, in 1986; Howard Weil in 1987; Latimer & Buck, Inc. in 1990; Dorman & Wilson, Inc. in 1991; The Fairfield Group, Inc. in April 1993; Gray, Seifert & Co., Inc. in April 1994; and Batterymarch Financial Management in January 1995.\nUnless the context otherwise requires, all references in this Report to the Company include Legg Mason, Inc. and its predecessors and subsidiaries.\nRegistrations and Exchange Memberships\nLegg Mason Wood Walker and Howard Weil are registered as broker-dealers with the Securities and Exchange Commission (\"SEC\"), are members of the New York Stock Exchange, Inc. (\"NYSE\"), the New York Futures Exchange, Inc., the National Association of Securities Dealers, Inc. (\"NASD\") and the Securities Investors Protection Corporation (\"SIPC\"), and are registered as futures commission merchants with the Commodity Futures Trading Commission. In addition, Legg Mason Wood Walker is a member of the Philadelphia Stock Exchange, Inc.\nBrokerage Offices\nThe following table reflects, as of March 31, 1995, certain information with respect to the Company's securities brokerage offices.\nRevenues by Source\nThe following table sets forth certain information regarding the revenues of the Company by source.\n(1) Principal transactions (securities transactions in which the Company buys for or sells from its own inventory) are classified as \"Customer Related\" when such transactions are effected with a customer of the Company (whether an individual or institutional investor) and as \"Dealer Related\" when such transactions are effected with another dealer. (2) Principally selling concessions from underwriting participations and fees from managed offerings. (3) Includes revenues from mortgage servicing and loan originations (1993: $12,198; 1994: $14,908; 1995: $14,603) and real estate appraisal and consulting fees (1993: $3,776; 1994: $3,094; 1995: $2,805); and retirement account fees (1993: $2,205; 1994: $1,922; 1995: $2,391).\nRetail Securities Business\nFor the fiscal years ended March 31, 1993, 1994 and 1995, revenues derived from securities transactions for individual investors (excluding interest on margin accounts) constituted approximately 82%, 84% and 88%, respectively, of total revenues from securities transactions and 50%, 50% and 45%, respectively, of the Company's total revenues. Management believes that such services will continue to be the Company's primary source of revenues in the foreseeable future, although the percentage of total revenues may decrease primarily as a result of increases in investment advisory revenues. Retail commissions are charged on both exchange and over-the-counter (\"OTC\") transactions in accordance with a schedule which the Company has formulated and may change from time to time. Discounts from the schedule are granted in certain cases. The Company also offers certain account arrangements under which a single fee is charged based on a percentage of the assets held in a customer's account and no commissions are charged on a transaction by transaction basis. When OTC transactions are executed by the Company as a dealer, the Company receives, in lieu of commissions, mark-ups or mark-downs that are included in \"Revenues by Source\" as customer-related principal transactions. The Company has dealer-sales agreements with several major distributors that offer mutual fund shares through broker-dealers. In addition, the Company sells shares of Company-sponsored mutual funds. See \"Company-Sponsored Mutual Funds.\"\nMargin Accounts, Interest Income and Free Credit Balances\nCustomers' securities transactions are effected on either a cash or a margin basis. In a margin account, the customer pays less than the full cost of the securities purchased and the broker-dealer makes a loan for the balance of the purchase price secured by the securities purchased or other securities owned by the investor. The amount of the loan is subject to the margin regulations (Regulation T) of the Board of Governors of the Federal Reserve System, NYSE margin requirements, and the Company's internal policies, which in some instances are more stringent than Regulation T or NYSE requirements. In permitting a customer to purchase securities on margin, the Company is subject to the risk that a market decline could reduce the value of its collateral below the amount of the customer's indebtedness and that the customer might be unable otherwise to repay the indebtedness.\nInterest is charged on amounts borrowed by customers (debit balances) to finance their margin transactions. The rate of interest charged to customers is the brokers' call money rate (the interest rate on bank loans to brokers collateralized by securities) plus an additional amount that varies depending upon the size of the customer's debit balance and level of account activity. For the fiscal years ended March 31, 1993, 1994 and 1995, interest income derived from these sources constituted approximately 3%, 3% and 5%, respectively, of the Company's total revenues. Interest is also\nearned on securities owned by the Company and on operating and segregated cash balances.\nFree credit balances (excess funds kept by customers in their brokerage accounts), equity capital and bank lines of credit are the primary sources of funds to finance customers' margin account borrowings. Legg Mason Wood Walker pays interest on certain free credit balances in customers' accounts when the customer has indicated that the funds will be used for reinvestment at a future date. The rate of interest on these customer balances has generally been below money market fund rates. In fiscal 1995, Legg Mason Wood Walker paid interest on approximately 76% of customer free credit balances.\nInstitutional Business\nThe Company is engaged in executing securities transactions for institutional investors such as banks, mutual funds, insurance companies and pension and profit-sharing plans. Such investors normally purchase and sell securities in large quantities which require special marketing and trading expertise. The Company believes that a significant portion of its institutional brokerage commissions is received as a consequence of provision to institutions of research opinions and services regarding specific corporations and industries and other matters affecting the securities markets. See \"Research.\"\nTransactions are executed by the Company acting as broker or as principal. The Company permits discounts from its commission schedule to its institutional customers. The size of such discounts varies with the size of particular transactions and other factors. For the fiscal years ended March 31, 1993, 1994 and 1995, revenues derived from securities transactions for institutional investors constituted approximately 18%, 16% and 12%, respectively, of total revenues from securities transactions and 11%, 10% and 6%, respectively, of the Company's total revenues.\nPrincipal Transactions\nThe Company is an active market maker and distributor of municipal bonds, particularly bonds issued by municipalities located in the Mid-Atlantic and Mid-South regions. The Company also makes primary markets in equity securities that are traded OTC, particularly securities of companies located in the Mid-Atlantic and Mid-South regions.\nAs of March 31, 1995, the Company made markets in equity securities of approximately 460 corporations, including corporations for which the Company has acted as a managing or co-managing underwriter. The Company has 23 traders involved in trading corporate equity and debt securities, 14 in trading municipal securities, and 9 in trading government securities.\nThe Company's market-making activities are also conducted with other dealers through a network of direct wires, and with institutional and individual customers of its branch office system. In making markets in equity and debt securities, the Company maintains positions in such securities to service its customers and accordingly exposes its own capital to the risk of fluctuations in market value. While the Company seeks to avoid substantial market risk, and may engage in hedging transactions to minimize risk, it does, nonetheless, realize profits and losses from market fluctuations. Trading profits (or losses) depend upon the skills of the employees engaged in market making, the amount of capital allocated to positions in securities and the general level of activity and trend of prices in the securities markets.\nInvestment Banking\nCorporate and Municipal Finance\nThe Company participates as an underwriter in public offerings of corporate debt and equity issues as well as municipal securities, generally as a member of underwriting syndicates managed by others. The Company also serves as manager or co-manager of corporate equity and municipal offerings, generally involving issuers located in the Mid-Atlantic and Mid-South regions.\nThe following tables set forth, for the periods indicated, (i) the total number and dollar amount of corporate stock and bond and municipal bond offerings managed or co-managed by the Company, and (ii) the total number and dollar amount of its underwriting participations in those offerings and in offerings managed by others.\nAs the above tables indicate, the number and size of corporate and municipal offerings managed or underwritten by the Company increased sharply in 1991, 1992 and 1993, largely because of favorable conditions in the equity and debt markets, and refinancings resulting from substantial declines in interest rates. The 1992 and 1993 increases included a substantial volume of closed-end fund offerings and the 1993 increase included a substantial volume of real estate investment trust offerings. In 1994, higher interest rate levels resulted in industry-wide declines in the volume and size of corporate and municipal securities offerings.\nUnderwriting involves both economic and regulatory risks. An underwriter may incur losses if it is unable to resell the securities it is committed to purchase, or if it is forced to liquidate its commitments at less than the agreed purchase price. In addition, an underwriter is subject to substantial potential liability for material misstatements or omissions in prospectuses and other communications with respect to underwritten offerings. See \"Item 3. Legal Proceedings.\" Furthermore, because underwriting commitments require a charge against net capital, the Company's broker-dealer subsidiaries could find it necessary to limit their underwriting participations to remain in compliance with regulatory net capital requirements. See \"Net Capital Requirements.\"\nOther Investment Banking Activities\nThe Company's investment banking activities also include private debt and equity placements and initiation and advice with respect to merger and acquisition transactions, as well as provision of financial advisory services to corporate and municipal clients.\nThe Company sells interests in both private and public limited partnership investments and in the past has originated real estate securities partnership offerings, although activities in this area have not been significant for several years. In self-originated offerings, subsidiaries of the Company serve as general partners of limited partnerships sponsored by the Company, which may subject the Company to the potential liabilities that can arise as a result of such service.\nAt March 31, 1995, the Company had 72 professionals engaged in investment banking activities, including 34 in municipal finance, 37 in corporate finance and 3 in limited partnership investment activities.\nCompany-Sponsored Mutual Funds\nThe Company sponsors and serves as distributor for fifteen Legg Mason mutual funds, including five equity funds, seven taxable and tax-exempt fixed-income funds and three taxable and tax-exempt money market funds. Legg Mason Fund Adviser, Inc., Western Asset Management Company, Batterymarch Financial Management, Inc. and Legg\nMason Capital Management, Inc., wholly-owned subsidiaries of the Company, serve as investment adviser to or manager of these funds. The Company anticipates that it will sponsor additional funds in the future and that such funds will be advised by investment advisory subsidiaries of the Company.\nAs of March 31, 1994 and 1995, the aggregate net assets of all Company-sponsored mutual funds were approximately $3.7 billion and $4.1 billion, respectively.\nFor the fiscal years ended March 31, 1993, 1994 and 1995, the Company received approximately $12.3 million, $16.8 million and $21.0 million, respectively, in asset-based sales charges from its sponsored mutual funds.\nInvestment Advisory Services\nLegg Mason Fund Adviser, Inc. serves as investment adviser to or manager of the Company-sponsored mutual funds as described above.\nWestern Asset Management Company specializes in the management of fixed-income assets for institutional clients. At March 31, 1994 and 1995, Western had approximately $10.5 billion and $12.5 billion, respectively, under management (not including assets in Company-sponsored mutual funds for which it serves as investment adviser).\nBatterymarch Financial Management, Inc., acquired in January 1995, manages emerging markets, international, and U.S. equity portfolios for institutional clients. At March 31, 1995, Batterymarch managed assets with a value of approximately $4.9 billion.\nGray, Seifert & Co., Inc., acquired in April 1994, manages securities portfolios for wealthy individuals and family groups, endowments, and foundations. At March 31, 1994 and 1995, Gray Seifert managed assets with a value of approximately $670 million and $680 million, respectively.\nThe Company has revenue sharing agreements with Western, Batterymarch, and Gray Seifert and certain of their key officers pursuant to which a specified percentage of the subsidiary's revenues is distributed to Legg Mason, Inc., and the balance of the revenues is retained by the subsidiary to pay its operating expenses, including salaries and bonuses, with specific expense and compensation allocations being determined by the subsidiary's management.\nLegg Mason Capital Management, Inc. manages securities portfolios of individual and institutional clients. At March 31, 1994 and 1995, this subsidiary managed assets with values of approximately $615 million and $740 million, respectively, including approximately $75 million and $55 million, respectively, of the Company's funds\ninvested in short-term securities (not including assets in Company-sponsored mutual funds for which it serves as investment adviser).\nThe Fairfield Group, Inc., acquired in April 1993, offers several investment vehicles structured to meet the specialized investment needs of banks and bank trust departments. These include the Navigator taxable and tax-free money market funds, with combined assets of approximately $560 million and $310 million at March 31, 1994 and 1995, respectively, and Navigator REPO\/LINE, a service which invested approximately $1.6 billion and $1.3 billion at March 31, 1994 and 1995, respectively, of short-term cash in repurchase agreements collateralized by U.S. government and government agency securities.\nThe Company's advisory activities also include wrap-fee programs in which the Company's customer pays a single asset-based fee that covers all execution and advisory services, including advisory services provided by the Company's investment advisory affiliates and selected independent advisory firms. In addition, the Company provides asset allocation and advisor performance and selection consultation services.\nMortgage Banking and Real Estate Services\nLegg Mason Real Estate Services, Inc. (\"LMRES\"), formerly named Latimer & Buck, Inc., is engaged in the commercial mortgage banking, loan servicing and pension fund advisory businesses. In its mortgage banking business, LMRES originates, structures, places and services commercial mortgages on income-producing properties for insurance companies, pension funds and other investors. In its pension fund advisory business, LMRES manages mortgage portfolios on behalf of two state pension funds. LMRES' headquarters are located in Philadelphia, Pennsylvania, and it has offices located in the Mid-Atlantic and Southeastern regions of the United States.\nDorman & Wilson, Inc. is a mortgage banking firm engaged in commercial mortgage banking and loan servicing. Headquartered in White Plains, New York, Dorman & Wilson has offices in New York and New Jersey.\nAs of March 31, 1994 and 1995, the combined commercial mortgage servicing portfolios of LMRES and Dorman & Wilson totaled approximately $12.0 and $10.8 billion, respectively.\nLegg Mason Realty Group, Inc., with offices in Baltimore, Washington, D.C. and Philadelphia, provides market feasibility, consulting and appraisal services regarding residential, retail, commercial and industrial real estate to a diverse clientele.\nInsurance and Financial Planning\nApproximately 725 of the Company's investment executives are licensed to sell insurance. Legg Mason Financial Services, Inc., a wholly-owned subsidiary of the Company, acts as general agent for several life insurance companies and sells fixed and variable annuities and insurance. The Company also offers comprehensive financial planning services to individuals.\nOther Services\nAt March 31, 1995, the Company served as a non-bank custodian for approximately 96,000 IRA's, 2,600 Keogh Plans, and 8,200 Simplified Employee Pension Plans.\nThe Company effects the purchase and sale of options and commodities contracts on behalf of clients.\nIn March 1993, the Company established the Legg Mason Trust Company, a state chartered, non-depository bank, to provide services as a trustee for trusts established by the Company's individual and employee benefit plan clients. The Company provides brokerage and advisory services for a significant portion of the assets held in the Trust Company's accounts.\nResearch\nThe Company employs 26 analysts who develop investment recommendations and market information with respect to companies and industries. Legg Mason Wood Walker's research emphasizes the identification of securities of financially sound, well managed companies that appear to be undervalued in relation to their long-term earning power or the value of underlying assets. Legg Mason refers to this investment strategy as the \"Value Approach\" to investing. Howard Weil's analysts concentrate on the oil and gas exploration, pipeline and service industries. The Company's research services are supplemented by research services purchased from outside consultants.\nThe Company's clients do not pay for research services directly, although the Company is often compensated for its research services by institutional clients through the direction of brokerage transactions to the Company for execution. The Company believes that its research activities are extremely important in attracting and retaining individual and institutional brokerage and investment advisory clients.\nOperations\nAdministrative and operations personnel are responsible for the processing of securities transactions; receipt, identification and delivery of funds and securities; internal financial controls; office services; custody of customers' securities and the handling of\nmargin accounts. At March 31, 1995, the Company had approximately 250 full-time employees performing such functions.\nThere is considerable fluctuation during any year and from year to year in the volume of transactions the Company must process. During the fiscal years ended March 31, 1993, 1994 and 1995, the Company processed approximately 1,721,000, 2,146,000 and 2,056,000 securities transactions, respectively. The Company records transactions and posts its books on a daily basis. Operations personnel monitor day-to-day operations to determine compliance with applicable laws, rules and regulations. Failure to keep current and accurate books and records can render the Company liable to disciplinary action by governmental and self-regulatory authorities.\nLegg Mason Wood Walker clears all of its own securities transactions as a participant in various depositories. It executes transactions in listed securities on the NYSE and other exchanges through the Pershing Division of Donaldson, Lufkin & Jenrette Securities Corporation. Pershing also processes orders and floor reports, matches trades and transmits execution reports and records data pertinent to trades in listed securities. All over-the-counter and foreign securities transactions are compared by Legg Mason Wood Walker through its participation in various clearing corporations.\nThe Company believes that its internal controls and safeguards are adequate, although fraud and misconduct by customers and employees and the possibility of theft of securities are risks inherent in the securities industry. As required by the NYSE and certain other authorities, the Company carries a fidelity bond covering loss or theft of securities as well as forgery of checks and drafts and embezzlement and misplacement of securities. The bond provides total coverage of $30,000,000 (subject to a $1,000,000 deductible per claim).\nEmployees\nAt March 31, 1995, the Company had approximately 2,900 employees. None of the Company's employees is covered by a collective bargaining agreement. The Company considers its relations with its employees to be satisfactory. However, competition for experienced financial services personnel, especially investment executives and investment management professionals, is keen and from time to time the Company may experience a loss of valuable personnel.\nThe Company recognizes the importance of hiring and training investment executives. The Company trains new investment executives who are required to take examinations given by the NYSE, the NASD and various states in order to be registered and qualified. The Company also requires ongoing training for investment executives.\nCompetition\nThe Company is engaged in an extremely competitive business. Its competition includes, with respect to one or more aspects of its business, numerous national, regional and local broker-dealer and investment advisory firms, and commercial banks and thrift institutions. Many of these organizations have substantially greater personnel and financial resources than the Company. Discount brokerage firms oriented to the retail market, including firms affiliated with commercial banks and thrift institutions, are devoting substantial funds to advertising and direct solicitation of customers in order to increase their share of commission dollars and other securities-related income. In many instances, the Company is competing directly with such organizations. The Company also competes for investment funds with banks, insurance companies and investment companies. The principal competitive factors relating to the Company's business are the quality of advice and services provided to investors and the price of those services.\nCompetition in the Company's business periodically has been affected by significant developments in the securities industry. See \"Factors Affecting the Company and the Securities Industry -- Industry Changes and Competitive Factors.\"\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. Much of the regulation of broker-dealers has been delegated to self-regulatory authorities, principally the NASD and the securities exchanges. These self-regulatory organizations conduct periodic examinations of member broker-dealers in accordance with rules they have adopted and amended from time to time, subject to approval by the SEC. Securities firms are also subject to regulation by state securities commissions in those states in which they do business.\nBroker-dealers are subject to regulations that cover all aspects of the securities business, including sales methods, trading practices among broker-dealers, uses and safekeeping of customers' funds and securities, capital structure and financial soundness of securities firms, recordkeeping and the conduct of directors, officers and employees. Additional legislation, changes in rules promulgated by the SEC and self-regulatory authorities, or changes in the interpretation or enforcement of existing laws and rules, may directly affect the mode of operation and profitability of broker-dealers. The SEC, self-regulatory authorities and state securities commissions may conduct administrative proceedings that can result in censure, fine, suspension or expulsion of a broker-dealer, its officers or employees. Such administrative proceedings, whether or not resulting in adverse findings, can require substantial expenditures and can have an adverse\nimpact on the reputation of a broker-dealer. The principal purpose of regulation and discipline of broker-dealers is the protection of customers and the securities markets, rather than protection of creditors and stockholders of the regulated entity.\nThe Company's investment advisory subsidiaries and the Company-sponsored mutual funds are also subject to extensive Federal and state regulation by the SEC and state securities commissions.\nThe Company's broker-dealer subsidiaries are required by Federal law to belong to the SIPC. When the SIPC fund falls below a certain amount, members are required to pay annual assessments. The Company's broker-dealer subsidiaries are currently contributing .00073% of their adjusted gross revenues to the fund. The SIPC fund provides protection for securities held in customer accounts up to $500,000 per customer, with a limitation of $100,000 on claims for cash balances. The Company purchases insurance that provides additional protection for securities of up to $24,500,000 per customer.\nNet Capital Requirements\nEvery registered broker-dealer doing business with the public is subject to the Uniform Net Capital Rule (Rule 15c3-1) promulgated by the SEC. The Rule, which is designed to measure the financial soundness and liquidity of broker-dealers, specifies minimum net capital requirements. Since the Company is not itself a registered broker-dealer, it is not directly subject to the Uniform Net Capital Rule. However, its broker-dealer subsidiaries are subject to the Rule, and a provision of the Rule requires that a broker-dealer notify the SEC prior to the withdrawal of equity capital by a parent company if the withdrawal would exceed the greater of $500,000 or 30 percent of the broker-dealer's excess net capital.\nRule 15c3-1 provides that a broker-dealer doing business with the public shall not permit its aggregate indebtedness to exceed 15 times its net capital (the \"primary method\") or, alternatively, that it not permit its net capital to be less than 2% of its aggregate debit items (primarily receivables from customers and broker-dealers) computed in accordance with such Rule (the \"alternative method\"). Legg Mason Wood Walker and Howard Weil use the alternative method of calculation. As of March 31, 1995, these broker-dealer subsidiaries had aggregate net capital of $89.6 million, which exceeded the minimum net capital requirements by $82.1 million.\nIn computing net capital under the Rule, various adjustments are made to net worth with a view to excluding assets not readily convertible into cash and to provide a conservative statement of other assets, such as a firm's position in securities. To that end, a deduction is made against the market value of securities to reflect the possibility of a market decline prior to their disposition. For every dollar that net capital is reduced, by means of such deductions\nor otherwise (for example, through operating losses or capital distributions), the maximum aggregate debit items which a firm may carry is reduced. Thus, net capital rules, which are unique to the securities industry, impose financial restrictions upon the Company's business that are more severe than those imposed on other types of businesses.\nUnder NYSE Rule 326, Legg Mason Wood Walker as a member organization that carries customer accounts, would be required to reduce its business activities if its net capital, as defined, was less than 4% of aggregate debit items, as defined, and would be precluded from expanding its business if its net capital was less than 5% of aggregate debit items.\nCompliance with applicable net capital rules could limit operations of the Company's broker-dealer subsidiaries, particularly operations such as underwriting and trading activities that require use of significant amounts of capital. A significant operating loss or an extraordinary charge against net capital could adversely affect the ability of the broker-dealers to expand or even maintain their present levels of business.\nOutstanding Subordinated Liabilities\nLegg Mason Wood Walker has incurred subordinated liabilities (\"Subordinated Liabilities\") which it is permitted to treat as capital for the purposes of the Uniform Net Capital Rule and NYSE Rules 325 and 326. The Subordinated Liabilities instruments issued by Legg Mason Wood Walker provide that such liabilities shall be subordinated in right of payment to the prior payment in full, or provision for such payment, of all obligations to all other present and future creditors of Legg Mason Wood Walker (except for other Subordinated Liabilities similarly subordinated). At March 31, 1995, Legg Mason Wood Walker had a $5.0 million Subordinated Liability outstanding, due to Legg Mason, Inc. The Subordinated Liability may, with the prior written consent of the NYSE, be prepaid in whole or in part at any time after such Subordinated Liability has been outstanding for more than one year. Legg Mason Wood Walker may not pay or permit the payment or withdrawal of any Subordinated Liability if, after giving effect to such payment or withdrawal, its net capital would be less than 5% (6% in the case of the Subordinated Liability due to Legg Mason, Inc.) of aggregate debit items. See Note 14 of Notes to Consolidated Financial Statements in Item 8 of this Report.\nFactors Affecting the Company and the Securities Industry\nThe securities industry is characterized by frequent change, the effects of which have been difficult to predict. In addition to an evolving regulatory environment, the industry has been subject to radical changes in pricing structure, alternating periods of contraction and expansion and intense competition from within and outside the industry.\nFluctuating Securities Volume and Prices\nThe securities industry is subject to substantial fluctuations in volume and price levels of securities transactions. These fluctuations can occur on a daily basis as well as over longer periods as a result of national and international economic and political events, and broad trends in business and finance. Reduced volume and prices generally result in lower brokerage and investment banking revenues, as well as losses from trading as principal and from underwriting. Profitability is adversely affected in periods of reduced volume because fixed costs remain relatively unchanged. To the extent that purchases of securities are permitted to be made on margin, securities firms also are subject to risks inherent in extending credit, especially during periods of rapidly declining markets, in that a market decline could reduce collateral value below the amount of a customer's indebtedness. In the past, heavy trading volume has caused clearance and processing problems for many securities firms, and this could occur in the future. In addition, there is risk of loss from errors that can occur in the execution and settlement process. See \"Operations.\"\nIndustry Changes and Competitive Factors\nConsiderable consolidation has occurred in the securities industry as numerous securities firms have either ceased operations or been acquired by other securities firms, in many cases resulting in firms with greater financial resources than firms such as the Company. In addition, a number of substantial companies not previously engaged in the securities business have made investments in and acquired securities firms. Increasing competitive pressures in the securities industry require regional securities firms to offer to their customers many of the financial services that are provided by much larger securities firms that have substantially greater resources than the Company. A sizeable number of new investment advisory firms and mutual funds have been established in recent years, increasing competition in that area of the Company's activities.\nFixed minimum commissions for securities transactions were eliminated in 1975, resulting in substantial discounts of commissions earned from institutional customers and in the establishment of an increasing number of firms, including affiliates of banks and thrift institutions, that offer discount brokerage services to retail customers. These firms generally effect transactions at lower commission rates on an \"execution only\" basis, without offering other services such as investment advice and research that are provided by \"full-service\" brokerage firms such as the Company. In addition, some discount brokerage firms have increased the range of services that they offer. Continued increases in the number of discount brokerage firms and services provided by such firms may adversely affect the Company.\nCertain institutions, notably commercial banks and thrift institutions, have become a competitive factor in the securities industry by offering certain investment banking and corporate and individual financial services traditionally provided only by securities firms. The Federal Reserve Board has approved applications of major commercial banks to underwrite and deal in certain types of securities that such banks had not been permitted to underwrite and deal in previously, subject to limitations on the resulting underwriting volume and market share. Commercial banks, generally, are expanding their securities activities, as well as their activities relating to the provision of financial services. Also, major corporations have acquired large securities firms. While it presently is not possible to predict the type and extent of competitive services that banks and other institutions ultimately may offer or the extent to which administrative or legislative barriers will be repealed or modified, to the extent that such services are offered on a large scale, securities firms such as the Company that are heavily oriented to individual retail customers may be adversely affected.\nRegulation\nThe business of the Company and its subsidiaries in the securities industry is subject to regulation by various regulatory authorities that are charged with protecting the interests of broker-dealers' customers. See \"Regulation.\"\nEffect of Net Capital Requirements\nThe SEC and the NYSE have stringent rules with respect to the net capital requirements of securities firms. A significant operating loss or extraordinary charge against net capital may adversely affect the ability of the Company's broker-dealer subsidiaries to expand or even maintain their present levels of business. See \"Net Capital Requirements.\"\nLitigation\nMany aspects of the Company's business involve substantial risks of liability. In the normal course of business, the Company's subsidiaries have been named as defendants or co-defendants in lawsuits seeking substantial damages. There has been an increased incidence of litigation in the securities industry in recent years, including customer claims as well as class action suits seeking substantial damages. See \"Item 3. Legal Proceedings.\"\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nThe Company leases a substantial portion of its office space. The Company's headquarters are located in an office building in which the Company is the major tenant. The Company currently occupies approximately 101,000 square feet in that building for a term expiring\nin February 1998. Annual base rent for the current leased space is approximately $2.4 million.\nThe Company's administrative and operations personnel are located in an office building owned by the Company. The building, located in Baltimore, consists of a total of 162,000 square feet, of which approximately 103,000 square feet is occupied by the Company and 48,000 square feet is leased to unrelated tenants.\nInformation concerning location of the Company's sales offices is contained in Item 1 of this Report. See Note 8 of Notes to Consolidated Financial Statements in Item 8 of this Report.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nTaxable Municipal Bond Litigation\nFrom April 1990 through January 1991, a number of purported class actions were filed in various federal courts naming Howard, Weil, Labouisse, Friedrichs Incorporated as one of the defendants in connection with seven different public offerings involving a total of $1.55 billion in taxable municipal bonds issued by six state financing authorities. The seven offerings were made in the period from July through November 1986. Howard Weil was one of the co-managing underwriters in the offerings, each of which had Drexel Burnham Lambert Incorporated as the senior managing underwriter. All of these actions, which generally are based on similar factual and legal allegations, as discussed below, were transferred by the Judicial Panel on Multidistrict Litigation to the United States District Court for the Eastern District of Louisiana (the \"MDL Court\") for coordinated and consolidated pre-trial proceedings under the caption In Re Taxable Municipal Bond Securities Litigation. Pursuant to a pre-trial order of the MDL Court, the various actions have been consolidated and a single complaint has been filed to cover all actions relating to each of the public offerings. In addition, a single complaint has been filed to cover the allegations made under RICO with respect to all of the offerings. The following schedule sets forth with respect to each offering the identification and amount of the offering, including the percentage underwritten by Howard Weil, and the title of the consolidated action in the MDL Court.\nGenerally, each action alleges, among other things, that the official statement by which the public offering was made contained misrepresentations and omissions in violation of federal and state securities laws, common law fraud, negligent misrepresentation and RICO. The complaints generally allege misstatements and omissions regarding, among other things, (i) the likelihood that the proceeds of each offering that were placed in a guaranteed investment contract (\"GIC\") issued by Executive Life Insurance Company would remain invested in the GIC rather than being used to purchase, and collateralize the bonds with, agricultural or multifamily housing loans; (ii) an alleged scheme between Drexel Burnham Lambert Incorporated, the senior managing underwriter of the offering, and Executive Life relating to retention of the proceeds in the GIC; (iii) Executive Life's substantial investment of its funds in junk bonds; and (iv) the possibility that the GICs would not be treated as\ninsurance products entitled to pro rata treatment with other Executive Life insurance products in the event of an Executive Life insolvency. In each action, the plaintiff class purportedly consists of all persons who purchased the bonds either in the initial offering or in the open market through April 1990. Following the deterioration of the junk bond market in early 1990, the ratings of both Executive Life and the bonds that had been issued in the seven offerings were downgraded and the bonds experienced substantial market price declines. In addition, the bonds have defaulted in interest payments as a result of Executive Life having been placed in conservatorship in April 1991 and ceasing payments on the GICs, and the amount of future payments of principal and interest is dependent upon successful resolution of the pending conservatorship. The various complaints seek actual and punitive damages in unspecified amounts, pre and post judgment interest, as well as costs and attorneys' fees. If any of these actions were determined adversely to Howard Weil, substantial liabilities could result, with a significant adverse effect on Howard Weil's financial condition and operations.\nDuring 1992, the MDL Court issued orders denying the motions to dismiss of Howard Weil and the other principal defendants with respect to virtually all counts of the complaint. In September 1993, all class plaintiffs except Washington National Life Insurance Company of New York, a putative class representative in the case relating to the Nebraska Investment Finance Authority bonds, voluntarily dismissed the plaintiffs' joint complaint covering allegations made under RICO. Howard Weil and other defendants filed a motion for summary judgment with respect to Washington National's RICO claim. This motion was granted. In August 1993, Howard Weil and other defendants filed motions for summary judgment with respect to the issue of whether plaintiffs' claims under Rule 10b-5 should be dismissed in any case in which plaintiffs did not actually rely on the official statements that are alleged to have been false and misleading. These motions are pending.\nIn February 1995, the MDL Court preliminarily approved the principal terms of a proposed settlement of the class actions as set forth in a settlement agreement among the defendants and the representatives of the putative plaintiff class. The settlement agreement will require Howard Weil, as one of the underwriter defendants, to contribute approximately $3.6 million toward a total settlement amount of $25.6 million. A settlement notice has been sent to putative class members and a settlement hearing before the MDL Court is scheduled for July 31, 1995.\nIn January 1991, an action captioned Magnolia Life Insurance Company v. Howard, Weil, Labouisse, Friedrichs Incorporated was commenced in the 14th Judicial District Court, Parish of Calcasieu, State of Louisiana, alleging misrepresentation by Howard Weil in the sale to Magnolia in April 1988 of approximately $830,000 of taxable municipal bonds issued by the Louisiana Agricultural Finance Authority\n(\"LAFA\"). These bonds had been part of the bonds issued in the 1986 LAFA public offering described above. The plaintiff alleges that Howard Weil misrepresented to it that the bonds were secured by government guaranteed loans. In September 1991, the plaintiff filed a motion for summary judgment. This motion is pending. A stay of this proceeding by the MDL Court was lifted in December 1994 permitting the case to proceed to discovery and ultimate resolution.\nNasdaq Market-Makers Antitrust Litigation\nLegg Mason Wood Walker and approximately thirty other broker-dealer firms have been named as defendants in a number of purported class actions filed in various federal courts alleging violation of federal antitrust laws. The first of these actions was filed in May 1994, and in October 1994 the actions were consolidated in the United States District Court for the Southern District of New York under the caption In re Nasdaq Market-Makers Antitrust Litigation. The consolidated complaint alleges that the defendants violated the antitrust laws by conspiring to raise, fix and maintain the \"spreads\" on certain securities traded on Nasdaq by refusing to quote bids and asks in so-called \"odd-eighths.\" The actions purport to be brought on behalf of all persons who purchased or sold these securities on Nasdaq during the approximately five year period preceding commencement of the litigation. The plaintiffs seek treble damages in an unspecified amount, injunctive relief, and attorneys' fees and costs. In February 1995, the defendants filed a motion to dismiss the actions. The decision on the motion is pending.\nFollowing the commencement of the antitrust litigation, the Antitrust Division of the United States Department of Justice and the Securities and Exchange Commission commenced investigations relating to the allegations in the litigation. Legg Mason Wood Walker, together with other broker-dealer firms, has received requests for information from both government agencies.\nIn addition to the matters described above, the Company's subsidiaries have been named as defendants or co-defendants in various other lawsuits alleging substantial damages. Some of these proceedings relate to public offerings of securities in which one or more subsidiaries of the Company participated as a member of the underwriting syndicate. The Company is also aware of litigation against certain underwriters of offerings in which one or more subsidiaries of the Company was a participant, but where the subsidiary is not now a defendant. In these latter cases, it is possible that a subsidiary may be called upon to contribute to settlements or judgments. While the ultimate resolution of pending litigation cannot be predicted with certainty, in the opinion of management, after consultation with legal counsel, pending litigation will not have a material adverse effect on the consolidated financial statements of the Company.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nNone.\nItem 4A. Executive Officers of the Company.\nInformation (not included in the Company's definitive proxy statement for the 1995 Annual Meeting of Stockholders) regarding certain executive officers of the Company is as follows:\nF. Barry Bilson, age 42, was elected Vice President-Finance of the Company in June 1984. He served as Controller of the Company from October 1983 until September 1988, and as Controller of Legg Mason Wood Walker from April 1981 to September 1988. From December 1978 to March 1981, he was Assistant Controller of the Coatings Division of Dutch Boy, Inc. Mr. Bilson is a certified public accountant.\nTheodore S. Kaplan, age 52, became Senior Vice President and General Counsel of the Company in April 1993. From 1970 until he joined the Company, he was engaged in the private practice of law with the firm of Weinberg and Green. Prior to 1970, Mr. Kaplan served as an attorney in the Office of the General Counsel and Division of Corporation Finance of the Securities and Exchange Commission.\nEileen M. O'Rourke, age 37, became Controller of the Company and of Legg Mason Wood Walker in September 1988 and was elected Vice President-Finance of the Company in March 1989, having served as Assistant Controller since December 1984. Mrs. O'Rourke is a certified public accountant and was an audit manager with Peat Marwick Main & Co. prior to joining the Company in 1984.\nTimothy C. Scheve, age 37, has been Treasurer of the Company and of Legg Mason Wood Walker since January 1992. He became a Vice President of the Company in August 1993 and a Senior Vice President of Legg Mason Wood Walker in August 1994. Mr. Scheve has served in various financial and administrative capacities since joining the Company in 1984. Mr. Scheve was a management consultant with Price Waterhouse & Co. prior to joining the Company.\nElisabeth N. Spector, age 47, became a Senior Vice President of the Company and Legg Mason Wood Walker in January 1994. She has general responsibilities in business and financial strategy. From November 1989 until she joined the Company, Ms. Spector was employed by the Resolution Trust Corporation, where, among other things, she served as the initial Director of the RTC's Capital Markets Division. From 1975 to November 1989 she was an investment banker with Merrill Lynch & Co., Inc.\nEdward A. Taber III, age 51, became an Executive Vice President of the Company in September 1992. He is responsible for supervising the Company's investment management activities. From 1973 until he joined the Company, Mr. Taber held various positions with T. Rowe Price Associates, Inc., an investment management firm, last\nserving as Director of that firm's taxable fixed income division. Prior to 1973, Mr. Taber served as the Treasurer and Chief Financial Officer of the Federal Home Loan Bank of Boston. Mr. Taber is a Director of the Legg Mason Value Trust, Inc., the Legg Mason Total Return Trust, Inc., the Legg Mason Special Investment Trust, Inc., a trustee of the Legg Mason Tax-Free Income Fund, President and a director of the Legg Mason Income Trust, Inc., the Legg Mason Global Trust, Inc., and the Legg Mason Investors Trust, Inc., and Vice President of the Worldwide Value Fund, Inc.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.\nShares of Legg Mason, Inc. common stock are listed and traded on the New York Stock Exchange (symbol LM). As of March 31, 1995, there were 1,385 shareholders of record of the Company's common stock. Information with respect to the Company's dividends and stock prices is as follows:\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.\nLegg Mason, Inc. and its subsidiaries (\"the Company\") are principally engaged in providing securities brokerage, investment advisory, investment banking and mortgage banking services to individuals, institutions, corporations and municipalities. The Company's profitability is sensitive to a variety of factors including the volume of trading in securities, the volatility and general level of market prices, and the demand for investment banking and mortgage banking services.\nDuring the fiscal year ended March 31, 1995, interest rate levels rose sharply, adversely impacting the Company's investment banking and securities brokerage revenues. In contrast, the prior year's results were the most successful in the Company's history and were achieved in a very favorable corporate and municipal finance environment.\nThe Company's investment advisory activities and their contribution to operating results have grown significantly, through both internal growth and acquisition, over the past ten years. During fiscal 1995, the Company acquired Batterymarch Financial Management, Inc. (\"Batterymarch\") and Gray, Seifert & Co. (\"Gray Seifert\"), as described in Note 2 of Notes to Consolidated Financial Statements. Batterymarch, acquired in January 1995, manages approximately $5 billion in emerging markets, international and U.S. equity portfolios for institutional clients. Gray Seifert, acquired in April 1994, manages $680 million in equity and balanced accounts for individuals and family groups, endowments and foundations. With these two additions, assets under management for institutions, Company-sponsored mutual funds and private accounts managed by the Company's subsidiaries were $24.6 billion at March 31, 1995, up 47% from $16.7 billion a year earlier and from $526 million ten years ago. Earnings from investment advisory services tend to be more stable than those from securities brokerage and investment banking activities because they are less affected by changes in securities market conditions.\nResults of any individual period should not be considered representative of future profitability. Many of the Company's activities have fixed operating costs which do not decline with reduced levels of volume. While the Company attempts to reduce costs, particularly during periods of low volume, it does not, as a general rule, attempt to do so through personnel reduction. Accordingly, sustained periods of unfavorable market conditions may adversely affect profitability.\nRESULTS OF OPERATIONS\nThe following table sets forth, for the periods indicated, items in the Consolidated Statements of Earnings as percentages of total revenues and the increase (decrease) by item as a percentage of the amount for the previous period:\nIn fiscal 1995, revenues, net earnings and earnings per share declined from record levels reached in the prior fiscal year. Revenues were $371.6 million, a 7% decrease from revenues of $397.5 million in fiscal 1994. Net earnings were $16.3 million, down 55% from net earnings of $36.0 million in the prior fiscal year. Primary earnings per share declined 56% to $1.30 from $2.98.\nRevenues derived from securities transactions for individual investors constituted approximately 50% of the Company's total revenues in fiscal 1995, and the Company believes this will continue to be the largest single source of its revenues in the foreseeable future.\nRevenues\nCommissions\nCommissions fell 15% to $120.7 million in fiscal 1995, principally as a result of lower sales of non-affiliated mutual funds and listed and over-the-counter securities. Commission revenues were adversely affected by rising interest rates and investor caution, particularly on the part of individual investors.\nIn fiscal 1994, commissions rose 21% to $141.4 million from levels in fiscal 1993, principally because of increases in sales of listed securities, non-affiliated mutual funds, variable annuities and over-the-counter securities. During most of fiscal 1994, commission revenues benefited from an active and rising stock market, attributable in part to investors seeking higher investment returns than those available on money market accounts and other short-term investments.\nPrincipal Transactions\nRevenues from principal transactions rose 10% to $59.5 million in fiscal 1995, principally as a result of increased sales of municipal and corporate debt securities, offset in part by lower sales of mortgage-backed securities. Higher sales of municipal securities in the secondary markets substantially offset sharp declines in municipal new issue volume. Sales of corporate debt securities benefited from the Company's expansion of its taxable fixed-income marketing capabilities.\nIn fiscal 1994, principal transactions fell 2% to $53.9 million because of lower sales of taxable fixed-income securities and a decline in profits on firm-owned securities positions, substantially offset by increased sales of over-the-counter securities.\nInvestment Advisory and Related Fees\nInvestment advisory and related fees rose 35% in fiscal 1995 to $88.3 million, principally as a result of the addition of fees earned by Batterymarch and Gray Seifert and growth in assets under management in Company-sponsored mutual funds and the Company's fixed-income advisory subsidiary. Excluding fees earned by Batterymarch and Gray Seifert, investment advisory and related fees rose 19% in fiscal 1995. Fees from assets under management and from fee-based brokerage accounts accounted for 24% of total revenues in fiscal 1995, up from 16% in the prior year.\nIn fiscal 1994, investment advisory and related fees rose 29% because of growth in assets under management in Company-sponsored mutual funds and the Company's fixed-income advisory subsidiary, as well as growth in various types of fee-based brokerage accounts.\nThe graph here depicts the growth in Investment Advisory and Related Fees Revenue and Assets Under Management for the five fiscal periods ended March 31, 1995.\nInvestment Banking\nInvestment banking revenues declined 56% to $34.7 million in fiscal 1995 from record levels achieved in the prior fiscal year as significantly higher interest rates led to industry-wide declines in corporate and municipal securities offerings.\nIn fiscal 1994, investment banking revenues rose 19% to $79.3 million as a result of selling concessions and management fees earned on a substantially higher level of corporate underwritings, particularly co-managed offerings of real estate investment trusts and closed-end fund issuances. Low interest rates and higher securities valuations were important factors in the growth of investment banking revenues during fiscal 1994.\nOther Revenues\nOther revenues rose 6% to $29.1 million, primarily because of increased account maintenance fees and rental income from an office building purchased in fiscal 1995.\nIn fiscal 1994, other revenues rose 21%, primarily because of increased mortgage banking loan origination fees and the addition of certain fees earned by The Fairfield Group subsequent to its acquisition in April 1993.\nExpenses\nCompensation and Benefits\nCompensation and benefits fell 5% to $217.0 million in fiscal 1995, as lower commission and profitability-based compensation was partially offset by personnel additions in certain\nproduct and support areas and in twelve new branch office locations.\nIn fiscal 1994, compensation and benefits rose 18% to $229.0 million, reflecting higher sales compensation on increased commission-based revenues, personnel additions, and higher profitability-based compensation.\nA substantial part of compensation expense fluctuates in proportion to the level of business activity. Other compensation costs, primarily salaries and benefits, are fixed and may not decline with reduced levels of volume. Therefore, profitability may be adversely affected by sustained periods of unfavorable market conditions or slow revenue growth in acquired businesses or new product areas.\nOccupancy and Equipment Rental\nOccupancy and equipment rental rose 11% to $29.8 million because of the inclusion of expenses of Batterymarch and Gray Seifert and higher depreciation and data processing expenses related to branch office and product area expansion.\nIn fiscal 1994, occupancy and equipment rental rose 15% to $26.9 million, principally because of increased transaction-related data processing costs and higher rental payments at corporate headquarters and certain branch office locations.\nCommunications\nCommunications costs rose 13% to $25.9 million in fiscal 1995, principally reflecting increased quote services for branch offices and product areas, and higher printing and paper expenses.\nIn fiscal 1994, communications costs rose 14%, reflecting increases in telephone and transaction-related variable expenses attributable to increased business activity.\nFloor Brokerage and Clearing Fees\nFloor brokerage and clearing fees fell 13% to $5.0 million in fiscal 1995, following a 4% increase in fiscal 1994, reflecting changes in securities transaction volume.\nOther Expense\nOther expense rose 28% and 17% in fiscal 1995 and 1994, respectively, because of increased litigation-related expenses (including a $2.0 million current year charge for the proposed settlement of a class action lawsuit discussed in Note 8 of Notes to Consolidated Financial Statements) and higher promotional and programming expense. In addition, fiscal 1995 includes the expenses of Batterymarch and Gray Seifert subsequent to their acquisitions.\nInterest Revenue and Expense\nInterest revenue increased 31% to $39.3 million in fiscal 1995, primarily as a result of higher interest rates earned on substantially larger customer margin account balances and stock loan conduit activity, offset in part by a reduction in interest earned on proprietary securities positions. Interest expense increased 11% to $17.1 million because of higher interest rates paid on customer credit and conduit stock loan balances, offset in part by a decline in interest paid on short-term borrowings.\nIn fiscal 1994, interest revenue increased 25% to $30.0 million, as a result of increased stock loan conduit activity, larger customer margin account balances and investment of proceeds of the Company's $68.0 million convertible subordinated debenture offering completed in April 1993. These increases were partially offset by lower interest earnings on proprietary fixed-income securities positions. Interest expense increased 32% to $15.4 million, primarily because of debt service on the convertible subordinated debentures and increased stock loan conduit activity.\nAs a result of substantially larger customer margin account balances and higher interest rates, the Company's net interest margin increased to 56.4% in fiscal 1995 from 48.7% in fiscal 1994.\nThe graph here depicts Interest Revenue and Interest Expense for the five fiscal periods ended March 31, 1995.\nIncome Taxes\nIncome taxes fell 51% to $11.4 million in fiscal 1995 because of lower pre-tax earnings. The Company's effective tax rate increased to 41.3% from 39.1% as a result of federal tax law changes and higher effective state income tax rates.\nIn fiscal 1994, income taxes increased 23% because of higher pre-tax earnings. The Company's effective tax rate increased to 39.1% from 38.3% as a result of higher corporate income tax rates following the enactment of the 1993 Omnibus Budget Reconciliation Act.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company's assets are primarily liquid, consisting mainly of cash and assets readily convertible into cash. These assets are financed primarily by free credit balances, equity capital, convertible debentures, bank lines of credit and other payables.\nDuring the year ended March 31, 1995, cash and cash equivalents increased $17.1 million. Cash flows from operating activities provided $62.3 million, primarily attributable to a reduction in regulatory deposits and to fiscal 1995 net earnings, adjusted for depreciation and amortization, offset in part by increased customer receivables. The Company invested cash of $26.7 million, principally related to the acquisition of Batterymarch, offset in part by a net decrease in resale agreements and investment securities. Cash flows from financing activities used $18.5 million primarily to repay short-term borrowings.\nDuring fiscal 1995, the Company acquired Batterymarch utilizing $54.1 million in cash. See Note 2 of Notes to Consolidated Financial Statements regarding future payments that may be required in the business combination.\nThe Company's broker-dealer subsidiaries are subject to the requirements of the SEC's net capital rule which is designed to measure the general financial soundness and liquidity of broker-dealers. At March 31, 1995, the brokerage subsidiaries had aggregate net capital of $90.7 million, which exceeded minimum net capital requirements by $82.9 million.\nThe principal sources of the Company's funds are its investment advisory and broker-dealer subsidiaries. The amount of the broker-dealers' net assets that may be distributed is subject to restrictions under applicable net capital rules. In addition, the Company has a revolving bank line of credit in the amount of $50.0 million, none of which is currently outstanding, and the Company's subsidiaries have lines of credit, aggregating $96.0 million, pursuant to which they may borrow on a short-term demand\nbasis generally at prevailing broker call rates. Management believes that funds available from operations and its lines of credit are sufficient to meet its present and reasonably foreseeable capital needs, although the Company may augment its capital funds for continued expansion by internal growth and acquisition.\nThe Company borrows and lends securities in the normal course of business to facilitate the settlement of its customer and proprietary transactions. In addition, the Company engages in conduit securities borrowing and lending activities in which it acts as an agent to facilitate settlement for other institutions. In both firm and conduit transactions, the Company deposits or receives cash, generally equal to 102% of the market value of securities exchanged, and monitors the adequacy of collateral levels on a daily basis.\nEFFECTS OF INFLATION\nThe Company's assets are not significantly affected by inflation because they are primarily monetary, consisting of cash, resale agreements, securities and receivables. However, the rate of inflation affects various expenses, including employee compensation, occupancy, and communications, which may not be readily recoverable in charges for services provided by the Company.\nRECENT ACCOUNTING DEVELOPMENT\nStatement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,\" was issued by the Financial Accounting Standards Board in March 1995. The Company expects to adopt the provisions of Statement No. 121 beginning in fiscal 1996. Based on the Company's current evaluation, the impact of adoption will not be material to the Company's financial position or results of operations.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Stockholders, Legg Mason, Inc.\nWe have audited the accompanying consolidated statements of financial condition of Legg Mason, Inc. and Subsidiaries as of March 31, 1995 and 1994, and the related consolidated statements of earnings, changes in stockholders' equity and cash flows for each of the three years in the period ended March 31, 1995. 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 Legg Mason, Inc. and Subsidiaries as of March 31, 1995 and 1994, and the consolidated results of their operations and their cash flows for each of the three years in the period ended March 31, 1995, in conformity with generally accepted accounting principles.\n\/s\/COOPERS & LYBRAND L.L.P.\nBaltimore, Maryland May 2, 1995\nCONSOLIDATED STATEMENTS OF EARNINGS (Dollars in thousands except per share amounts)\nCONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (Dollars in thousands except share amounts)\nCONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousand except per share amounts)\n1. Summary of Accounting Policies\nPrinciples of Consolidation\nThe consolidated financial statements include the accounts of Legg Mason, Inc. (\"Parent\") and its wholly-owned subsidiaries. All material intercompany balances and transactions have been eliminated. Where appropriate, prior years' financial statements have been reclassified to conform with the 1995 presentation.\nCash and Cash Equivalents\nCash equivalents are highly liquid investments with original maturities of less than 90 days, other than those held for sale in the ordinary course of business.\nResale Agreements\nThe Company invests in short-term resale agreements collateralized by U.S. government and agency securities. The market value of the underlying collateral as determined daily, plus accrued interest thereon, must exceed the face amount of the transaction. It is the Company's policy to have such underlying collateral deposited in the Company's accounts at its custodian banks. Resale agreements are carried at the amounts at which the securities will be subsequently resold as specified in the agreements, plus accrued interest.\nSecurities\nSecurities transactions are recorded on a settlement date basis which does not differ materially from a trade date basis. Commission revenues and related expenses for unsettled transactions are recorded on a trade date basis. Securities owned by the Company's broker-dealer subsidiaries, both for trading and investing, are valued at market and resulting unrealized gains and losses are reflected in earnings.\nThe Company adopted the provisions of Statement of Financial Accounting Standards (\"SFAS\") No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" in fiscal 1995. Accordingly, investment securities of the Parent and its non-broker-dealer subsidiaries held as available-for-sale are valued at market and resulting unrealized gains and losses are reflected in stockholders' equity.\nDepreciation and Amortization\nProperty and equipment are reported at cost, net of accumulated depreciation and amortization of $32,193 and $28,025 at March 31, 1995 and 1994, respectively.\nDepreciation and amortization are determined by use of the straight line method over the estimated useful life of the asset or the remaining life of the lease. Maintenance and repair costs are expensed as incurred.\nIntangible Assets\nIntangible assets consist principally of goodwill, asset management and mortgage servicing contracts, attributable to business combinations. Intangibles are amortized using straight line and accelerated methods over periods ranging from three to forty years. Accumulated amortization at March 31, 1995 and 1994 was $41,794 and $36,714, respectively.\nThe Company periodically reviews its accounting for goodwill and other intangible assets, considering such factors as historical profitability and projected operating cash flows, to determine that the assets are realizable and the amortization periods are appropriate.\nInvestment Advisory and Related Fees\nThe Company earns investment advisory fees on assets in accounts managed by its subsidiaries, distribution fees on assets in Company-sponsored equity and bond mutual funds, and asset based fees on various types of single-fee brokerage accounts.\nEarnings Per Share\nPrimary earnings per share are computed by dividing net earnings by the weighted average number of shares outstanding and dilutive common stock equivalents. The Company's common stock equivalents are shares of common stock issuable under various stock option plans.\nFully diluted earnings per share assumes both the exercise of dilutive common stock equivalents and conversion of subordinated debentures.\nThe weighted average number of shares is as follows:\n2. BUSINESS COMBINATIONS\nOn January 5, 1995, the Company acquired the assets of Batterymarch Financial Management (\"Batterymarch\"), an investment advisory firm that manages equity portfolios for institutional clients. The Company paid $54,141 cash at closing. A supplemental closing payment of $5,859 is due on or before January 1996 if Batterymarch reaches a specified annualized revenue level in any month during calendar 1995. An additional payment, due in early 1998 and based on Batterymarch's achievement of specified revenue levels for calendar 1997, could increase the total consideration up to $120,000. If the amount of the 1998 payment exceeds $40,000, the Company may pay all or any portion of the excess in the form of shares of the Company's common stock.\nThe acquisition was accounted for under the purchase method of accounting; accordingly, the total purchase price was allocated to the net assets acquired, principally goodwill and asset management contracts, based on estimated fair market values. The results of operations have been included in the consolidated financial statements from the date of acquisition.\nThe Company acquired Gray Seifert and Co. (\"Gray Seifert\") and The Fairfield Group (\"Fairfield\"), in April 1994 and 1993, respectively, through the issuance of common stock. Gray Seifert provides investment advisory services to individuals, endowments and foundations. Fairfield is a provider of mutual fund advisory and other services to banks and bank trust departments. The acquisitions were accounted for as poolings of interests, but were not material to the Company's results of operations and financial position. Accordingly, the results of operations of Gray Seifert and Fairfield have been included from the dates of acquisition.\n3. RECEIVABLE FROM AND PAYABLE TO CUSTOMERS\nReceivable from and payable to customers represent balances arising from cash and margin transactions. Securities owned by customers are held as collateral for the receivable balances. Included in payable to customers are free credit balances of approximately $269,825 as of March 31, 1995, and $261,803 as of March 31, 1994. The Company pays interest on certain customer free credit balances held for reinvestment purposes.\n4. SECURITIES, AT MARKET\nSecurities positions consist of the following at March 31:\n5. INVESTMENT SECURITIES\nThe Company's investment securities, including the type and maturity range for available-for-sale securities, are as follows:\nThe proceeds of debt securities held as available-for-sale which matured or were sold during fiscal 1995 were $35,882, with a gross realized loss of $124.\nAt March 31,1994, prior to adoption of SFAS 115, investment securities were carried at unamortized cost of $29,754 and had a market value of $30,368.\n6. SHORT-TERM BORROWINGS\nThe Company has a revolving credit agreement which permits it to borrow up to $50,000, repayable generally over five years, at floating rates. Under the terms of the agreement, the Company is required, among other things, to maintain consolidated net worth plus subordinated liabilities of not less than $252,011 plus 50% of consolidated annual net earnings subsequent to March 31, 1995. Together with certain subsidiaries, the Company has jointly entered into revolving credit agreements which permit it to borrow up to $40,000, repayable within 30 days. In addition, subsidiaries of the Company have bank lines of credit of $96,000, which are generally subject to termination at either party's discretion. No borrowings were outstanding under these agreements at March 31, 1995.\nShort-term borrowings at March 31, 1994, primarily loans from banks, totalled $15,546.\nInterest payments were $17,190 in 1995, $12,704 in 1994 and $10,941 in 1993.\n7. SUBORDINATED LIABILITIES\nThe Company's subordinated liabilities at March 31, 1995 and 1994 are as follows:\nThe 5.25% and 7% debentures are convertible at any time prior to maturity into common stock of the Company at per share conversion prices of $25.80 and $21.76, respectively. The conversion prices are subject to adjustment in certain events.\nThe Company may redeem the debentures prior to maturity, in whole or in part, subject to certain conditions. The 5.25% debentures are redeemable at 103.28% of the principal on May 1, 1996, and thereafter at prices declining annually to 100% on or after May 1, 2001. At March 31, 1995, the 7% debentures are redeemable at 101.4%, declining to 100% on or after June 15, 1996.\nThe 7% debentures require annual sinking fund payments of $1,500 beginning June 15, 1997 calculated to retire 61% of the debentures prior to maturity.\n8. COMMITMENTS AND CONTINGENCIES\nThe Company leases office facilities and equipment under non-cancellable operating leases which expire on varying dates through 2005. Certain leases provide for renewal options and contain escalation clauses providing for increased rentals. As of March 31, 1995, the minimum annual aggregate rentals are as follows:\nTotal rental expense, including cancellable equipment leases, was $23,510, $27,761 and $24,768 for 1995, 1994 and 1993, respectively.\nThe Company leased office space from a partnership in which the Company and some of its officers, stockholders and directors had a combined controlling interest through July 1994, at which time the Company acquired the property for $5,000. Rent expense includes payments of $240 in 1995, $811 in 1994, and $690 in 1993 to the aforementioned partnership.\nThe Company enters into when-issued and underwriting commitments. Had the open transactions relating to these commitments as of March 31, 1995 been closed, the effect on the consolidated financial statements of the Company would not have been material.\nThe Company and its subsidiaries have been named as defendants in various legal actions arising primarily from securities and investment banking activities, including certain class actions which primarily allege violations of securities laws and seek unspecified damages which could be substantial. While the ultimate resolution of these actions cannot be currently determined, in the opinion of management, after consultation with legal counsel, the actions will be resolved with no material adverse effect on the consolidated financial statements of the Company.\nFiscal 1995 earnings include a charge of $2,000 ($950 after tax) relating to the proposed settlement of class action litigation arising from taxable municipal bond offerings underwritten in 1986 by one of the Company's subsidiaries. The settlement is subject to final court approval, to be considered at\na hearing scheduled for July 1995. \"Item 3. Legal Proceedings\" of this Report contains additional information concerning this matter.\n9. EMPLOYEE BENEFITS\nThe Company, through its subsidiaries, maintains various defined contribution plans covering substantially all employees. Discretionary contributions charged to operations amounted to $3,417, $7,241 and $6,181 in 1995, 1994 and 1993, respectively. In addition, employees can make voluntary contributions under certain plans.\n10. INCOME TAXES\nThe Company and its subsidiaries file a consolidated federal income tax return. The provision for income taxes consists of:\nA reconciliation of the difference between the effective income tax rate and the statutory federal income tax rate follows:\nComponents of the Company's deferred tax assets and liabilities are as follows:\nAt March 31, 1995 and 1994, the deferred tax valuation allowance was primarily for benefits related to net operating losses which expire from 2000 to 2010.\nIncome tax payments were $12,047 in 1995, $26,114 in 1994, and $19,529 in 1993.\n11. CAPITAL STOCK\nAt March 31, 1995, the authorized numbers of common and preferred shares were 20,000,000 and 4,000,000, respectively, of which 4,220,540 common shares were reserved for issuance upon conversion of the Company's convertible subordinated debentures. In addition, at March 31, 1995 and 1994, there were 2,157,456 and 2,239,870 shares of common stock reserved for issuance under the Company's stock option plans.\nOn September 24, 1993, the Company paid a 5-for-4 stock split to shareholders of record on September 8, 1993. All references in the consolidated financial statements to the number of common shares and per share amounts have been adjusted retroactively to reflect the 5-for-4 stock split, except for the number of issued common shares presented in the consolidated financial statements.\n12. STOCK PLANS\nOptions under the Company's employee stock option plans have been granted at prices not less than 100% of the fair market\nvalue of the shares on the date of grant. Options granted are generally exercisable in cumulative 20% increments over five years and have a term of not more than ten years from the date of grant.\nTransactions under the plans during the three years ending March 31, 1995 are summarized below:\nThe Company has also adopted the \"Legg Mason 1988 Non-Employee Director Option Plan.\" Options granted under the plan are immediately exercisable at a price equal to the fair market value of the shares on the date of grant. Options issuable under the plan, limited to 175,000 shares in aggregate, have a term of not more than ten years from the date of grant. At March 31, 1995, options on 69,000 shares have been granted, of which 64,000 are currently outstanding. The Company makes no charge to income with respect to its stock option plans.\nThe Company has an Employee Stock Purchase Plan covering substantially all employees. Shares of common stock are purchased in the open market on behalf of participating employees, subject to a 625,000 total share limit under the plan. Purchases are made through payroll deductions with the Company matching 5% of the employees' contributions. Charges to earnings were not significant with respect to this plan.\n13. OFF-BALANCE SHEET RISK AND CONCENTRATION OF CREDIT\nIn the normal course of business, the Company executes, settles and finances customer and proprietary securities transactions. These activities expose the Company to off-balance sheet risk in the event that customers or other parties fail to satisfy their obligations.\nIn accordance with industry practice, securities transactions are recorded on settlement date, generally five business days after trade date. Should a customer or broker fail to deliver cash or securities as agreed, the Company may be required to purchase or sell securities at unfavorable market prices.\nThe Company extends credit to customers, collateralized by cash and securities, and subject to regulatory and internal requirements. Customer margin transactions include sales of securities not yet purchased, option contracts and commodity futures contracts. The Company continually monitors margin requirements and requests customers to deposit additional collateral or reduce positions when necessary. Such transactions expose the Company to risk in the event that margin requirements are insufficient to fully cover customer losses.\nThe Company borrows and lends securities to finance transactions and facilitate the settlement process, utilizing both firm proprietary positions and customer margin securities held as collateral. The Company deposits or receives cash generally equal to 102% of the market value of securities exchanged and monitors the adequacy of collateral levels on a daily basis. The Company periodically borrows from banks on a collateralized basis utilizing firm and customer margin securities in compliance with Securities and Exchange Commission rules. Should the counterparty fail to return customer securities pledged, the Company is subject to the risk of acquiring the securities at prevailing market prices in order to satisfy its customer obligations. The Company sells securities it does not currently own, and is obligated to subsequently purchase such securities at prevailing market prices. The Company is exposed to risk of loss if securities prices increase prior to closing the transactions.\n14. REGULATORY REQUIREMENTS\nThe Company's broker-dealer subsidiaries are subject to the Securities and Exchange Commission's Uniform Net Capital Rule. The rule provides that equity capital may not be withdrawn or cash dividends paid if resulting net capital would fall below specified levels. As of March 31, 1995, the broker-dealer subsidiaries had aggregate net capital, as defined, of $90,711 which exceeded required net capital by $82,949.\nThe Company's principal broker-dealer subsidiary must maintain a separate account for the exclusive benefit of customers in accordance with Securities and Exchange Commission Rule 15c3-3, as determined by periodic computations. The rule allows the broker-dealer to maintain the required amounts in cash or qualified securities.\n15. BUSINESS SEGMENT INFORMATION\nThe Company, through its subsidiaries, operates predominantly in a single business segment-the securities industry. Within this segment, the Company is primarily engaged in securities brokerage, investment advisory and investment banking activities.\nQUARTERLY FINANCIAL DATA* (Dollars in thousands except per share amounts) (Unaudited)\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.\nNone.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant.\nThe information required by this item is contained under the caption \"Election of Directors\" on pages 1 through 4 of the Company's definitive proxy statement for the 1995 Annual Meeting of Stockholders and the caption \"Compliance With Section 16(a) of the Securities Exchange Act of 1934\" on page 13 of such proxy statement. Such information is incorporated herein by reference to the proxy statement. See Part I, Item 4A of this Report for information regarding certain executive officers of the Company.\nItem 11.","section_11":"Item 11. Executive Compensation.\nThe information required by this item is contained under the caption \"Executive Compensation\" on pages 6 and 7 of the Company's definitive proxy statement for the 1995 Annual Meeting of Stockholders. Such information is incorporated herein by reference to the proxy statement.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nThe information required by this item is contained under the caption \"Security Ownership of Management and Principal Stockholders\" on page 5 of the Company's definitive proxy statement for the 1995 Annual Meeting of Stockholders. Such information is incorporated herein by reference to the proxy statement.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nThe information required by this item is contained under the caption \"Certain Transactions\" on page 10 of the Company's definitive proxy statement for the 1995 Annual Meeting of Stockholders. Such information is incorporated herein 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) Documents filed as a part of the report:\n1. The following consolidated financial statements are included in Item 8 of this Report:\n2. Financial Statement Schedules (included on pages S-1 to S-5 of this Report):\nReport of Independent Accountants on Financial Statement Schedules\nSchedule I - Condensed Financial Statement of Registrant\nAll other schedules to the consolidated financial statements for which provision is made in the accounting regulations of the Securities and Exchange Commission are not applicable or are not required and therefore have been omitted.\n*These exhibits are management contracts or compensatory plans or arrangements.\n(b) No reports on Form 8-K were filed during the quarter ended March 31, 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.\nLEGG MASON, INC.\nBy: \/s\/ Raymond A. Mason Raymond A. Mason, Chairman of the Board, President and Chief Executive Officer\nDate: June 28, 1995\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant in the capacities and on the dates indicated.","section_15":""}
{"filename":"835322_1995.txt","cik":"835322","year":"1995","section_1":"Item 1. Business\nThe Registrant, Inland Monthly Income Fund II, L.P. (the \"Partnership\"), was formed on June 20, 1988 pursuant to the Delaware Revised Uniform Limited Partnership Act, to invest in improved residential, retail, industrial and other income producing properties. On August 4, 1988, the Partnership commenced an Offering of 50,000 Limited Partnership Units (subject to an increase of up to 30,000 additional Units) pursuant to a Registration under the Securities Act of 1933. The Offering terminated on August 4, 1990, with total sales of 50,647.14 Units at $500 per Unit, resulting in gross offering proceeds of $25,323,569, not including the General Partner's contribution of $500. All of the holders of these Units were admitted to the Partnership. Inland Real Estate Investment Corporation is the General Partner. The Partnership has acquired five properties utilizing $21,224,542 of capital proceeds collected. On January 8, 1991, the Partnership sold one of its properties, The Wholesale Club. The Limited Partners of the Partnership share in their portion of benefits of ownership of the Partnership's real property investments according to the number of Units held. The Partnership has repurchased 551.64 Units for $260,285 from various Limited Partners through the Unit Repurchase Program. There are no funds remaining for the repurchase of Units through this program.\nThe Partnership is engaged in the business of real estate investment. A presentation of information about industry segments would not be material to an understanding of the Partnership's business taken as a whole.\nThe Partnership made the following real property investments:\nReference is made to Note 4 of the Notes to Financial Statements (Item 8 of this Annual Report) for additional descriptions of the Partnership's real property investments.\nThe Partnership's real property investments are subject to competition from similar types of properties in the vicinity in which each is located. Approximate occupancy levels for the properties are set forth on a year-end basis in the table in Item 2","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Partnership owns directly the properties referred to in Item 1 above and in Note 4 of the Notes to Financial Statements (Item 8 of this Annual Report) to which reference is hereby made for a description of said properties.\nThe following is a list of approximate occupancy levels for the Partnership's investment properties as of the end of each of the last five years:\nThe following tables set forth certain information with respect to the amount of and expiration of leases for the Partnership's investment properties:\n* This lease started 1\/1\/96.\n(1) No assumptions have been made regarding the releasing of expired leases. It is the opinion of the General Partner that the space will be released at market prices.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe Partnership is not subject to any material pending legal proceedings.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nThere were no matters submitted to a vote of security holders during 1995.\nPART II\nItem 5.","section_5":"Item 5. Market for the Partnership's Limited Partnership Units and Related Security Holder Matters\nAs of December 31, 1995, there were 2,206 holders of Units of the Partnership. There is no public market for Units nor is it anticipated that any public market for Units will develop. Reference is made to Item 6","section_6":"Item 6. Selected Financial Data\nINLAND MONTHLY INCOME FUND II, L.P. (a limited partnership)\nFor the years ended December 31, 1995, 1994, 1993, 1992 and 1991\n(not covered by Independent Auditors' Report)\nItem 6. Selected Financial Data, continued.\nINLAND MONTHLY INCOME FUND II, L.P. (a limited partnership)\nFor the years ended December 31, 1995, 1994, 1993, 1992 and 1991\n(not covered by Independent Auditors' Report)\n(a) The above selected financial data should be read in conjunction with the financial statements and related notes appearing elsewhere in this Annual Report.\n(b) The net income and distributions per Unit data are based upon the weighted average number of Units outstanding (50,095.50 for the years 1995 through 1992 and 50,195.60 for 1991).\n(c) The distributions from sales proceeds per Limited Partnership Unit in 1991 are from the sale of The Wholesale Club on January 8, 1991 and represents a return of Invested Capital, as defined in the Partnership Agreement.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nLiquidity and Capital Resources\nOn August 4, 1988, the Partnership commenced an Offering of 50,000 (subject to increase to 80,000) Limited Partnership Units pursuant to a Registration Statement on Form S-11 under the Securities Act of 1933. The Offering terminated on August 4, 1990, with total sales of 50,647.14 Units at $500 per Unit, resulting in gross offering proceeds of $25,323,569, not including the General Partner's contribution of $500. All of the holders of these Units have been admitted to the Partnership. The Partnership has acquired five properties utilizing $21,224,542 of capital proceeds collected. On January 8, 1991, the Partnership sold one of its properties, The Wholesale Club. As of December 31, 1995, cumulative distributions to Limited Partners totaled $16,279,471, of which $4,395,565 represents proceeds from the sale of The Wholesale Club and $11,883,906 represents distributable cash flow from the properties. The Partnership has repurchased 551.64 Units for $260,285 from various Limited Partners through the Unit Repurchase Program. There are no funds remaining for the repurchase of Units through this program.\nAs of December 31, 1995, the Partnership had cash and cash equivalents of $981,562, which includes approximately $311,000 held in an unrestricted escrow account for the payment of real estate taxes for Colonial Manor Living Center. The Partnership intends to use such remaining funds for distributions and for working capital requirements.\nThe properties owned by the Partnership are generating cash flow in excess of the 8% annualized distributions to the Limited Partners (paid monthly), in addition to covering all the operating expenses of the Partnership. In 1993, 1994 and 1995, the Partnership distributed $50,529, $103,339 and $50,000, respectively, in addition to the 8% annualized return to the Limited Partners from excess cash flow from the previous year. To the extent that these sources are insufficient to meet the Partnership's needs, the Partnership may rely on advances from Affiliates of the General Partner, other short-term financing, or may sell a property.\nDuring August 1995, Certified Grocers Midwest, Inc. (\"Certified\") vacated the anchor store of Water Tower Market Plaza in Palatine, Illinois. Eagle Foods had assigned the lease on February 4, 1994 to Certified, which occupied the store since March 1, 1994. Certified is currently performing approximately $500,000 in renovation of the space for Euro-Fresh Markets (\"Euro-Fresh\"), which is anticipated to occupy the space in April 1996. Under the original lease, as well as the assignment of the lease, Eagle Foods has guaranteed payments until November 1998. At December 31, 1995, there were three additional vacant units totaling 6,325 square feet at Water Tower Market Plaza. Subsequent to December 31, 1995, the Partnership executed two leases totaling 3,400 square feet of this space. Currently, Water Tower Market Plaza has a 95% financial occupancy rate.\nResults of Operations\nAt December 31, 1995, the Partnership owns four operating properties. Two out of the Partnership's four operating properties, Scandinavian Health Spa and Colonial Manor Living Center, are leased on a \"triple-net\" basis which means that all expenses of the property are passed through to the tenant. The leases of the other two properties owned by the Partnership, K mart and Water Tower Market Plaza, provide that the Partnership be responsible for maintenance of the structure and the parking lot and the tenants are required to reimburse the Partnership for portions of insurance, real estate taxes and common area maintenance. The Partnership sold one of its properties, The Wholesale Club, on January 8, 1991.\nRental income decreased slightly for the year ended December 31, 1995, as compared to the year ended December 31, 1994, due to a decrease in rental income at Water Tower Market Plaza. The shopping center continues to have three spaces vacant within the multi-tenant commercial building. These three spaces, with a total of 5,900 square feet, represent 11% of the total of 52,475 square feet of Water Tower Market Plaza. The General Partner is currently in the process of making improvements to the shopping center, such as painting and improved signage, in order to attract new tenants. The decrease in rental income was partially offset by a scheduled rental increase at Scandinavian Health Spa during 1995. Rental income decreased for the year ended December 31, 1994, as compared to the year ended December 31, 1993, due primarily to a non- recurring adjustment in rental income recorded for Colonial Manor Living Center in 1993 as a result of the settlement with Adventist Living Centers, Inc.\nInterest income increased for the years ended December 31, 1995 and 1994, as compared to the year ended December 31, 1993, due to increases in interest rates.\nThe other income recorded for the year ended December 31, 1994 is primarily a result of non-operating income relating to Water Tower Market Plaza.\nProfessional services to Affiliates were higher for the year ended December 31, 1994, as compared to the years ended December 31, 1995 and 1993, due to increases in in-house legal and accounting services required by the Partnership.\nGeneral and administrative expenses to Affiliates increased for the years ended December 31, 1995 and 1994, as compared to the year ended December 31, 1993, due to increases in postage, supplies and investor services expenses. This increase was partially offset by a decrease in data processing expense. General and administrative expenses to non-affiliates increased for the year ended December 31, 1994, as compared to the year ended December 31, 1993, due to an increase in the Illinois Replacement Tax paid in 1994.\nProperty operating expenses to Affiliates decreased for the years ended December 31, 1995 and 1994, as compared to the year ended December 31, 1993, due to a decrease in property maintenance performed by an Affiliate on the Partnership's investment properties. Property operating expenses to non- affiliates increased for the years ended December 31, 1995 and 1994, as compared to the year ended December 31, 1993, due to increases in real estate taxes, maintenance, painting and marketing at Water Tower Market Plaza.\nInflation\nIn general, rental income and operating expenses for those Partnership properties operated under triple-net leases, Scandinavian Health Spa and Colonial Manor Living Center, are not likely to be directly affected by future inflation, since rents are fixed under the leases and property expenses are the responsibility of tenants. The capital appreciation of triple-net-leased properties is likely to be influenced by interest rate fluctuations. To the extent that inflation affects interest rates, future inflation may have an effect on the capital appreciation of triple-net-leased properties.\nBoth the K mart and Water Tower Market Plaza properties are subject to net leases containing rental escalation clauses which take effect when specified sales volumes are achieved by the tenants. If inflation, over time, increases the prices of goods sold by these tenants, this may result in increased rental income for the Partnership. In addition to the grocery store which is its anchor tenant, Water Tower Market Plaza also includes smaller commercial spaces which are subject to renewal under short-term leases. For these spaces, inflation is likely to increase rental escalation income from leases to new tenants and lease renewals, subject to normal market conditions.\nImpact of Accounting Pronouncements Not Yet Adopted\nStatement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets to Be Disposed Of\" was issued in March 1995 and is effective for fiscal years beginning after December 15, 1995.\nThis pronouncement is not expected to have a material effect on the financial position or results of operations of the Partnership.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nINLAND MONTHLY INCOME FUND II, L.P. (a limited partnership)\nSchedules not filed:\nAll schedules other than those indicated in the index have been omitted as the required information is inapplicable or the information is presented in the financial statements or related notes.\nINDEPENDENT AUDITORS' REPORT\nTo the Partners of Inland Monthly Income Fund II, L.P.\nWe have audited the accompanying balance sheets of Inland Monthly Income Fund II, L.P. (a limited partnership) as of December 31, 1995 and 1994, and the related statements of operations, partners' capital, and cash flows for each of the three years in the period ended December 31, 1995. Our audits included the financial statement schedule listed in item 14(c). These statements and financial statement schedule are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, such financial statements present fairly, in all material respects, the financial position of Inland Monthly Income Fund II, L.P. as of December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles. Also, 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.\nDELOITTE & TOUCHE LLP\nChicago, Illinois February 2, 1996\nINLAND MONTHLY INCOME FUND II, L.P. (a limited partnership)\nBalance Sheets\nDecember 31, 1995 and 1994\nAssets ------\nSee accompanying notes to financial statements.\nINLAND MONTHLY INCOME FUND II, L.P. (a limited partnership)\nBalance Sheets (continued)\nDecember 31, 1995 and 1994\nLiabilities and Partners' Capital ---------------------------------\nSee accompanying notes to financial statements.\nINLAND MONTHLY INCOME FUND II, L.P. (a limited partnership)\nStatements of Operations\nFor the years ended December 31, 1995, 1994 and 1993\nSee accompanying notes to financial statements.\nINLAND MONTHLY INCOME FUND II, L.P. (a limited partnership)\nStatements of Partners' Capital\nFor the years ended December 31, 1995, 1994 and 1993\nSee accompanying notes to financial statements.\nINLAND MONTHLY INCOME FUND II, L.P. (a limited partnership)\nStatements of Cash Flows\nFor the years ended December 31, 1995, 1994 and 1993\nSee accompanying notes to financial statements.\nINLAND MONTHLY INCOME FUND II, L.P. (a limited partnership)\nNotes to Financial Statements\nFor the years ended December 31, 1995, 1994 and 1993\n(1) Organization and Basis of Accounting\nInland Monthly Income Fund II, L.P. (the \"Partnership\") was organized on June 20, 1988 by filing a Certificate of Limited Partnership under the Revised Uniform Limited Partnership Act of the State of Delaware. On August 4, 1988, the Partnership commenced an Offering of 50,000 (subject to increase to 80,000) Limited Partnership Units pursuant to a Registration under the Securities Act of 1933. The Offering terminated on August 4, 1990, with total sales of 50,647.14 Units at $500 per Unit, resulting in gross offering proceeds of $25,323,569, not including the General Partner's contribution for $500. All of the holders of these Units have been admitted to the Partnership. Inland Real Estate Investment Corporation is the General Partner. The Limited Partners of the Partnership share in the benefits of ownership of the Partnership's real property investments in proportion to the number of Units held. The Partnership had repurchased 551.64 Units for $260,285 from various Limited Partners through the Unit Repurchase Program. There are no funds remaining for the repurchase of Units through this program.\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.\nOffering costs have been offset against the Limited Partners' capital accounts.\nThe Partnership's policy is to reduce the cost basis of investment properties, including deferred leasing fees and deferred rent receivable, to its estimated net realizable value when the investment properties are judged to have suffered an impairment in value that is other than temporary. Estimated net realizable value is measured by the recoverability of the Partnership's investment through expected future cash flows on an undiscounted basis. Net realizable value is inherently subjective and is based on management's best estimate of current conditions and assumptions about expected future conditions, including lease-up periods, rental rates, interest rates and capitalization rates. As of December 31, 1995, no reduction to the cost basis of the investment properties has been recorded as the estimated net realizable value of the investment properties exceeds their cost basis.\nDepreciation expense is computed using the straight-line method. Buildings and improvements are based upon estimated useful lives of 30 to 40 years, while furniture and fixtures are based upon estimated useful lives of 5 to 12 years. Repair and maintenance expenses are charged to operations as incurred. Significant improvements are capitalized and depreciated over their estimated useful lives.\nINLAND MONTHLY INCOME FUND II, L.P. (a limited partnership)\nNotes to Financial Statements (continued)\nDeferred leasing fees are amortized on a straight-line basis over the term of the related lease.\nRental income is recognized on a straight-line basis over the term of each lease. The difference between rental income earned and the cash rent due under the provisions of the lease agreements is recorded as deferred rent receivable.\nThe Partnership considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents. For the years ended December 31, 1995 and 1994, included in cash and cash equivalents is approximately $311,000 and $341,000, respectively, held in an unrestricted escrow account for the payment of real estate taxes for Colonial Manor Living Center. The carrying amount of cash, cash equivalents and distributions payable approximates fair value because of the short maturity of those instruments.\nNo provision for Federal income taxes has been made as the liability for such taxes is that of the Partners rather than the Partnership.\nThe Partnership records are maintained on the accrual basis of accounting in accordance with generally accepted accounting principles (\"GAAP\"). The Federal income tax return has been prepared from such records after making appropriate adjustments, if any, to reflect the Partnership's accounts as adjusted for Federal income tax reporting purposes. Such adjustments are not recorded on the records of the Partnership. The net effect of these items is summarized as follows:\nStatement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets to Be Disposed Of\" was issued in March 1995 and is effective for fiscal years beginning after December 15, 1995. This pronouncement is not expected to have a material effect on the financial position or results of operations of the Partnership.\nINLAND MONTHLY INCOME FUND II, L.P. (a limited partnership)\nNotes to Financial Statements (continued)\n(2) Partnership Agreement\nThe Partnership Agreement defines the allocation of distributable available cash and profits and losses. Limited Partners will receive 100% of cash available for distribution until the Limited Partners have received a Cumulative Preferred Return of 8% per annum through August 4, 1993 and a Preferential Return of 10% of Cash Available for Distribution per annum for the period after August 4, 1993. Thereafter, the General Partner shall be allocated an amount equal to any Supplemental Capital Contributions outstanding at the time of the distribution and then 95% of cash available for distribution will be allocated to the Limited Partners and 5% will be allocated to the General Partner. Net Sale Proceeds will be distributed to the Limited Partners until they have received an amount equal to their Invested Capital and any deficiency in the 10% Preferential Return. Thereafter, any remaining Net Sale Proceeds will be distributed 85% to the Limited Partners and 15% to the General Partner. Distributions of Net Sale Proceeds to the Limited Partners represent a return of Invested Capital.\nPursuant to the terms of the Partnership Agreement, the profits and losses from operations are allocated as follows:\n(a) Depreciation deductions shall be allocated 99% to the taxable Limited Partners and 1% to the General Partner.\n(b) To the extent the minimum distribution of 8% per annum through August 4, 1993 to the Limited Partners is funded by Supplemental Capital Contributions, the distribution shall be treated as a guaranteed payment, and the resulting deduction shall be allocated to the General Partner.\n(c) The remaining net profits shall be allocated 100% to the Limited Partners until the Limited Partners have been allocated an amount equal to the distribution required to provide them a Cumulative Preferred Return of 8% per annum through August 4, 1993 and a Preferential Return of 10% per annum for the period after August 4, 1993.\n(d) The remainder, if any, shall be allocated 95% to the Limited Partners and 5% to the General Partner\nThe General Partner was required to make Supplemental Capital Contributions, if necessary, in sufficient amounts to allow the Partnership to make distributions to the Limited Partners to provide a non-compounded return on their invested capital equal to 8% per annum through August 4, 1993. The amount of such Supplemental Capital Contributions was $30,155. The entire amount was paid to the Partnership in April of 1990. The General Partner was repaid on August 4, 1993, after the Limited Partners received a Cumulative Preferred Return of 8% per annum through August 4, 1993.\nINLAND MONTHLY INCOME FUND II, L.P. (a limited partnership)\nNotes to Financial Statements (continued)\n(3) Transactions with Affiliates\nThe General Partner and its Affiliates are entitled to reimbursement for salaries and expenses of employees of the General Partner and its Affiliates relating to the administration of the Partnership. Such costs are included in professional services to Affiliates and general and administrative expenses to Affiliates, of which $7,398 and $680 was unpaid as of December 31, 1995 and 1994, respectively.\nAn Affiliate of the General Partner earned Property Management Fees of $31,068, $32,107 and $32,553 for the years ended December 31, 1995, 1994 and 1993, respectively, in connection with managing the Partnership's properties. Such costs are included in property operating expenses to Affiliates, all of which has been paid as of December 31, 1995. In addition, an Affiliate of the General Partner performed property maintenance on the Partnership's investment properties and was reimbursed (as set forth under terms of the Partnership Agreement) for direct costs. Such costs of $1,862 and $2,935 for the years ended December 31, 1994 and 1993, respectively, are included in property operating expenses to Affiliates, all of which has been paid. No such costs were incurred for the year ended December 31, 1995.\nIn connection with the sale of The Wholesale Club on January 8, 1991, the Partnership recorded $132,000 of sales commission payable to an Affiliate of the General Partner. Such commission has been deferred until the Limited Partners receive their Original Capital plus a return as specified in the Partnership Agreement. Due to the terms and the nature of the sales commission payable to the Affiliate, it is not practicable for the Partnership to estimate the fair value of such amount.\nThrough the Partnership's participation in an insurance program, claims from the Partnership's properties, as well as properties owned by other limited partnerships syndicated by Affiliates, were managed through a loss reserve trust. In June 1995, this program was terminated. The Partnership paid $428 and $599 to the loss reserve trust for K mart for the years ended December 31, 1995 and 1994, respectively.\n(4) Investments in Property\nScandinavian Health Spa, Inc., Broadview Heights, Ohio\nOn October 19, 1988, the Partnership took title to this property which an Affiliate of the General Partner purchased on behalf of the Partnership from an unaffiliated third party for $2,760,000. The property consists of a 26,040 net rentable square-foot, two-story masonry building including a pool, whirlpool, two saunas, suspended running track, two racquet ball courts, extensive locker room areas, a nursery and offices. The total cost of this property to the Partnership was $3,016,527, which includes acquisition fees of $241,500 and acquisition costs of $15,027. The lease expires in December 2004 and the tenant has the option to extend the lease for two additional five-year periods. The tenant has leased 100% of the rentable space on a triple-net basis for a current monthly amount of $29,925.\nINLAND MONTHLY INCOME FUND II, L.P. (a limited partnership)\nNotes to Financial Statements (continued)\nColonial Manor Living Center, LaGrange, Illinois\nOn June 7, 1989, the Partnership took title to this property which an Affiliate of the General Partner purchased on behalf of the Partnership from an unaffiliated third party for $6,787,232. The property consists of a 107,867 square-foot nursing care facility located in LaGrange, Illinois. The total cost of this property to the Partnership was $7,521,881, which includes acquisition fees of $601,675 and acquisition costs of $132,974. The center is currently 100% leased to Elite Care Corporation. The lease is a triple-net lease and expires January 2001. The tenant has the right to extend the lease for an additional ten-year term. The rent per annum is $850,586 and adjusts annually. In 1992, the current operator of this facility negotiated with a new operator to sublease the facility. The General Partner approved the transaction with no significant changes to the terms of the lease.\nK mart Retail Store, Chandler, Arizona\nOn December 29, 1989, the Partnership took title to this property which an Affiliate of the General Partner purchased on behalf of the Partnership from an unaffiliated third party for $4,568,000. The property consists of an 84,146 square-foot retail building. The total cost of this property to the Partnership was $5,072,473, which includes acquisition fees of $406,862 and related acquisition costs of $97,611. The tenant has a lease for 100% of the rentable space on a net basis and is responsible for payment of the real estate taxes, insurance and all utilities. The Partnership will be responsible for maintenance of the structure and the parking lot. The lease requires a base rent of $452,000 per annum and additional rent equal to 1% of gross sales in excess of $14,000,000. The lease expires in July 2013 and the tenant has the option to extend the lease for four additional five-year periods.\nWater Tower Market Plaza Shopping Center, Palatine, Illinois\nOn December 31, 1990, the Partnership took title to this property from an unaffiliated third party for $2,000,000. The property consists of two buildings aggregating 52,475 square feet. One of the buildings is a food store and the other is a multi-tenant building containing twelve commercial units. The total cost of this property to the Partnership was $2,186,383, which includes acquisition fees of $180,645 and related acquisition costs of $5,738. The property is 89% leased on a net basis with the tenants responsible for their portion of real estate taxes and common area maintenance. The Partnership is responsible for its share of real estate taxes and common area maintenance plus the maintenance of the structures and the parking lot. The anchor tenant, Eagle Food Store, had a lease through May 1997 with an annual rent of $78,600. The current tenants in the 12-unit building have leases ranging from one to five years at an average monthly rent of $1,445. On January 21, 1994, the anchor tenant at the shopping center, Eagle Foods, closed its store. On February 4, 1994, with the approval of the General Partner, Eagle Foods assigned its lease to Certified Grocers Midwest, Inc. (\"Certified\"). Certified occupied the store from March 1, 1994 until August 1995. Certified is currently improving the space for Euro-Fresh Markets (\"Euro-Fresh\"), which is anticipated to occupy the space in April 1996. Under the original lease, as well as the assignment of the lease, Eagle Foods has guaranteed payments until November 1998.\nINLAND MONTHLY INCOME FUND II, L.P. (a limited partnership)\nNotes to Financial Statements (continued)\nCost and accumulated depreciation of the above properties are summarized as follows:\n(5) Operating Leases\nCertain tenant leases contain provisions providing for stepped rent increases. Generally accepted accounting principles require that rental income be recorded for the period of occupancy using the straight-line basis. The accompanying financial statements include a decrease of $1,878, and increases of $12,901 and $27,651 in 1995, 1994 and 1993, respectively, of rental income for the period of occupancy for which stepped rent increases apply and $381,568 and $383,446 in related deferred rent receivable as of December 31, 1995 and 1994, respectively. These amounts will be collected over the terms of the related leases as scheduled rent payments are made.\nINLAND MONTHLY INCOME FUND II, L.P. (a limited partnership)\nNotes to Financial Statements (continued)\nMinimum lease payments to be received in the future from operating leases are as follows:\nPursuant to the lease agreements, tenants of Water Tower Market Plaza Shopping Center are required to reimburse the Partnership for their prorata share of the real estate taxes and operating expenses of the property. Such amounts are included in additional rental income.\nThe Partnership currently has significant net operating leases with Elite Care Corporation (\"Elite\"), K mart Corporation (\"K mart\") and Scandinavian Health Spa, Inc. (\"SHS\"). Revenues from the Elite lease for the Colonial Manor Nursing Home, the K mart lease for the K mart store and the SHS lease for the Scandinavian Health Spa represents approximately 41%, 22% and 17%, respectively, of the Partnership's income as of December 31, 1995.\n(6) Legal Proceedings\nOn March 10, 1995, the Partnership settled a claim with regards to the reorganization plan of Adventist Living Centers, Inc. (\"ALC\"), a former tenant of the Partnership's nursing home. The Partnership received $81,082 from ALC in connection with their lease termination agreement. The Partnership paid $36,941 as its portion of the settlement but received $5,906 from its share of a co- defendant's contribution.\n(7) Subsequent Events\nDuring January 1996, the Partnership paid a distribution of $140,426 to the Limited Partners.\nINLAND MONTHLY INCOME FUND II, L.P. (a limited partnership) Schedule III Real Estate and Accumulated Depreciation December 31, 1995\nNotes: (A) The initial cost to the Partnership represents the original purchase price of the properties, including amounts incurred subsequent to acquisition which were contemplated at the time the property was acquired. (B) The aggregate cost of real estate owned at December 31, 1995 for Federal income tax purposes was approximately $17,812,334, unaudited. (C) Reconciliation of real estate owned:\n(D) Reconciliation of accumulated depreciation:\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nThere were no disagreements on accounting or financial disclosures during 1995.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nThe General Partner of the Partnership, Inland Real Estate Investment Corporation, was organized in 1984 for the purpose of acting as general partner of limited partnerships formed to acquire, own and operate real properties. The General Partner is a wholly-owned subsidiary of The Inland Group, Inc. In 1990, Inland Real Estate Investment Corporation became the replacement General Partner for an additional 301 privately-owned real estate limited partnerships syndicated by Affiliates. The General Partner has responsibility for all aspects of the Partnership's operations. The relationship of the General Partner to its Affiliates is described under the caption \"Conflicts of Interest\" at pages 11 to 13 of the Prospectus, a copy of which description is hereby incorporated herein by reference.\nOfficers and Directors\nThe officers, directors, and key employees of The Inland Group, Inc. and its Affiliates (\"Inland\") that are likely to provide services to the Partnership are as follows:\nDANIEL L. GOODWIN (age 52) is Chairman of the Board of Directors of The Inland Group, Inc., a billion-dollar real estate and financial organization located in Oak Brook, Illinois. Among Inland's subsidiaries is the largest property management firm in Illinois and one of the largest commercial real estate and mortgage banking firms in the Midwest.\nMr. Goodwin has served as Director of the Avenue Bank of Oak Park and as a Director of the Continental Bank of Oakbrook Terrace. He was also Chairman of the Bank Holding Company of American National Bank of DuPage. Currently he is the President of Inland Mortgage Investment Corporation.\nMr. Goodwin has been in the housing industry for more than 25 years, and has demonstrated a lifelong interest in housing-related issues. He is a licensed real estate broker and a member of the National Association of Realtors. He has developed thousands of housing units in the Midwest, New England, Florida, and the Southwest. He is also the author of a nationally recognized reference book for the management of residential properties.\nMr. Goodwin serves on the Board of the Illinois State Affordable Housing Trust Fund for the past 6 years. He is an advisor for the Office of Housing Coordination Services of the State of Illinois, and a member of the Seniors Housing Committee of the National Multi-Housing Council. Recently, Governor Edgar appointed him Chairman of the Housing Production Committee for the Illinois State Affordable Housing Conference. He also served as a member of the Cook County Commissioner's Economic Housing Development Committee, and he was the Chairman of the DuPage County Affordable Housing Task Force. The 1992 Catholic Charities Award was presented to Mr. Goodwin for his work in addressing affordable housing needs. The City of Hope designated him as the 1980's Man of the Year for the Illinois construction industry. In 1989, the Chicago Metropolitan Coalition on Aging presented Mr. Goodwin with an award in recognition of his efforts in making housing more affordable to Chicago's Senior Citizens. On May 4, 1995, PADS, Inc. (Public Action to Deliver Shelter) presented Mr. Goodwin with an award, recognizing The Inland Group as the leading corporate provider of transitional housing for the homeless people of DuPage County.\nMr. Goodwin is a product of Chicago-area schools, and obtained his Bachelor's and Master's Degrees from Illinois Universities. Following graduation, he taught for five years in Chicago Public Schools. His commitment to education has continued through his work with the Better Boys Foundation's Pilot Elementary School in Chicago, and the development of the Inland Vocational Training Center for the Handicapped located at Little City in Palatine, Illinois. He personally established an endowment which funds a perpetual scholarship program for inner-city disadvantaged youth. In 1990 he received the Northeastern Illinois University President's Meritorious Service Award. Mr. Goodwin holds a Master's Degree in Education from Northern Illinois University, and in 1986, he was awarded an Honorary Doctorate from Northeastern Illinois University College of Education. He served as a member of the Board of Governors of Illinois State Colleges and Universities, and he is currently a trustee of Illinois Benedictine College. He was elected Chairman of Northeastern Illinois University Board of Trustees in January 1996.\nMr. Goodwin served as a member of Governor Jim Edgar's Transition Team. In 1988 he received the Outstanding Business Leader Award from the Oak Brook Jaycees. He also serves as the Chairman of the Illinois Speaker of the House of Representatives Club, and has been the General Chairman of the National Football League Players Association Mackey Awards for the benefit of inner-city youth. In March 1994, he won the Excellence in Business Award from the DuPage Area Association of Business and Industry. Additionally, he was honored by Little Friends on May 17, 1995 for rescuing their Parent-Handicapped Infant Program when they lost their lease last year, and on June 9, he received the 1995 March of Dimes Birth Defects Foundation Life Achievement Award.\nROBERT H. BAUM (age 52) has been with Inland since 1968 and is one of the four original principals. Mr. Baum is Vice Chairman and Executive Vice President-General Counsel of The Inland Group, Inc. In his capacity as General Counsel, Mr. Baum is responsible for the supervision of the legal activities of The Inland Group, Inc. and its affiliates. This responsibility includes the supervision of The Inland Law Department and serving as liaison with all outside counsel. Mr. Baum has served as a member of the North American Securities Administrators Association Real Estate Advisory Committee and as a member of the Securities Advisory Committee to the Secretary of State of Illinois. He is a member of the American Corporation Counsel Association, as well as a member of several bar associations. Mr. Baum has been admitted to practice before the Supreme Courts of the United States and the State of Illinois, as well as the bars of several federal courts of appeals and federal district courts. He received his B.S. Degree from the University of Wisconsin and his J.D. Degree from Northwestern University School of Law. Mr. Baum has served as a director of American National Bank of DuPage and is a member of the Governing Council of Wellness House, a charitable organization that provides emotional support for cancer patients and their families.\nG. JOSEPH COSENZA (age 52) joined Inland in 1968. Mr. Cosenza, is a director, Vice Chairman and Chief Executive Officer of the Inland Group Inc. Mr. Cosenza oversees, coordinates and directs Inland's many enterprises and, in addition, immediately supervises a staff of five persons who engage in property acquisition. Mr. Cosenza has been a consultant to other real estate entities and lending institutions on property appraisal methods. Mr. Cosenza received his B.A. degree from Northeastern Illinois University and his M.S. degree from Northern Illinois University. From 1967 to 1968, Mr. Cosenza taught at the LaGrange School District in Hodgkins, and from 1968 to 1972, he served as Assistant Principal and teacher in the Wheeling School District. He has been a licensed real estate broker since 1968 and an active member of various national and local real estate associations, including the National Association of Realtors and the Urban Land Institute. Mr. Cosenza has also been Chairman of the Board of American National Bank of DuPage and part owner of American National Bank of DuPage and Burbank State Bank, and has served on the Board of Directors of Continental Bank of Oakbrook Terrace.\nROBERT D. PARKS (age 52) joined Inland in 1968. He is Director of The Inland Group, Inc. and is President, Chairman and Chief Executive Officer of Inland Real Estate Investment Corporation and is Director of Inland Securities Corporation. Mr. Parks is responsible for the ongoing administration of existing partnerships, corporate budgeting and administration for Inland Real Estate Investment Corporation. He oversees and coordinates the marketing of all limited partnership interests nationwide and has overall responsibility for the portfolio management of all partnership investments and investor relations. Mr. Parks received his B.A. degree from Northeastern Illinois University and M.A. degree from the University of Chicago. He is a registered Direct Participation Program Principal with the National Association of Securities Dealers, Inc., and a licensed real estate broker. He is a member of the Real Estate Investment Association and a member of NAREIT.\nNORBERT J. TREONIS (age 45) joined Inland in 1975 and is currently a director of The Inland Group, Inc. and Chairman and Chief Executive Officer of Inland Property Management Group, Inc. He serves on the board of directors of all Inland subsidiaries involved in property management and construction, including Mid-America Property Management Corporation, Inland Commercial Property Management, Inc., Community Property Management, Inc. and Metropolitan Construction Services, Inc. Mr. Treonis is responsible for the overall management and leasing of all Inland apartment units. In addition, he is Executive Vice President of Inland Real Estate Acquisitions, Inc. and has been involved in the acquisition of thousands of apartment units. Mr. Treonis is a licensed real estate broker and has served as a board member of American National Bank of DuPage, the National Apartment Association, The Chicagoland Apartment Association and The Apartment Building Owners and Managers Association of Illinois.\nCATHERINE L. LYNCH (age 37) joined Inland in 1989 and is the Treasurer of Inland Real Estate Investment Corporation. Ms. Lynch is responsible for managing the Corporate Accounting Department. Prior to joining Inland, Ms. Lynch worked in the field of public accounting for KPMG Peat Marwick since 1980. She received her B.S. degree in Accounting from Illinois State University. Ms. Lynch is a Certified Public Accountant and a member of the American Institute of Certified Public Accountants. She is registered with the National Association of Securities Dealers as a Financial Operations Principal.\nPAUL J. WHEELER (age 43) joined Inland in 1982 and is currently the President of Inland Property Sales, Inc. and President of Inland Securities Corporation, Inland's broker\/dealer. Mr. Wheeler received his B.A. degree in Economics from DePauw University and an M.B.A. in Finance\/Accounting from Northwestern University. Mr. Wheeler is a Certified Public Accountant, a licensed real estate broker and is registered with the National Association of Securities Dealers, Inc. as a General Securities Principal. For three years prior to joining Inland, Mr. Wheeler was Vice President\/Finance at the real estate brokerage firm of Quinlan & Tyson, Inc.\nROBERTA S. MATLIN (age 51) joined Inland in 1984 as Director of Investor Administration and currently serves as Senior Vice President-Investments. Prior to that, Ms. Matlin spent 11 years with the Chicago Region of the Social Security Administration of the United States Department of Health and Human Services. As Senior Vice President-Investments, she directs the day-to-day internal operations of the General Partner. Ms. Matlin received her B.A. degree from the University of Illinois. She is registered with the National Association of Securities Dealers, Inc. as a General Securities Principal.\nMARK ZALATORIS (age 38) joined Inland in 1985 and currently serves as Vice President of Inland Real Estate Investment Corporation. His responsibilities include the coordination of due diligence activities by selling broker\/dealers and is also involved with limited partnership asset management including the mortgage funds. Mr. Zalatoris is a graduate of the University of Illinois where he received a Bachelors degree in Finance and a Masters degree in Accounting and Taxation. He is a Certified Public Accountant and holds a General Securities License with Inland Securities Corporation.\nPATRICIA A. CHALLENGER (age 43) joined Inland in 1985. Ms. Challenger serves as Senior Vice President of Inland Real Estate Investment Corporation in the area of Asset Management. As head of the Asset Management Department, she develops operating and disposition strategies for all investment-owned properties. Ms. Challenger received her bachelor's degree from George Washington University and her master's from Virginia Tech University. Ms. Challenger was selected and served from 1980-1984 as Presidential Management Intern, where she was part of a special government-wide task force to eliminate waste, fraud and abuse in government contracting and also served as Senior Contract Specialist responsible for capital improvements in 109 government properties. Ms. Challenger is a licensed real estate salesperson, NASD registered securities sales representative and is a member of the Urban Land Institute.\nCYNTHIA M. HASSETT (age 37) joined Inland in 1983 and is a Vice President of Inland Real Estate Investment Corporation. Ms. Hassett is responsible for the Investment Accounting Department which includes all public partnership accounting functions along with quarterly and annual SEC filings. Prior to joining Inland, Ms. Hassett was on the audit staff of Altschuler, Melvoin and Glasser since 1980. She received her B.S. degree in Accounting from Illinois State University. Ms. Hassett is a Certified Public Accountant and a member of the American Institute of Certified Public Accountants.\nVENTON J. CARLSTON (age 38) joined Inland in 1985 and is the Assistant Controller of Inland Real Estate Investment Corporation where he supervises the corporate bookkeeping staff and is responsible for financial statement preparation and budgeting for Inland Real Estate Investment Corporation and its subsidiaries. Prior to joining Inland, Mr. Carlston was a partnership accountant with JMB Realty. He received his B.S. degree in Accounting from Southern Illinois University. Mr. Carlston is a Certified Public Accountant and a member of the American Institute of Certified Public Accountants and the Illinois CPA Society. He is registered with the National Association of Securities Dealers, Inc. as a Financial Operations Principal.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe General Partner is entitled to receive a share of cash distributions when a Preferential Return of 10% of Cash Available for Distribution has been made to the Limited Partners, and a share of profits or losses as described under the caption \"Cash Distributions\" at page 42 and \"Allocation of Profits and Losses\" at pages 41 and 42 of the Prospectus, and at pages A-6 to A-10 of the Partnership Agreement, included as an exhibit to the Prospectus, which is incorporated herein by reference. Reference is also made to Note 2 of the Notes to Financial Statements (Item 8 of this Annual Report) for a description of such distributions and allocations for 1995.\nThe Partnership is permitted to engage in various transactions involving Affiliates of the General Partner of the Partnership, as described under the captions \"Compensation and Fees\" at pages 7-9 and \"Conflicts of Interest\" at pages 9-11 of the Prospectus, and at pages A-12 through A-20 of the Partnership Agreement, included as an exhibit to the Prospectus, which is incorporated herein by reference. The relationship of the General Partner (and its directors and officers) to its Affiliates is set forth above in Item 10.\nThe General Partner of the Partnership and its Affiliates may be reimbursed for their expenses or out-of-pocket expenses relating to administration of the Partnership and salaries and direct expenses of employees of the General Partner and its Affiliates for the administration of the Partnership. Such costs for 1995 were $54,492, of which $7,398 was unpaid as of December 31, 1995.\nDuring 1995, Affiliates of the General Partner earned $31,068 in management fees in connection with managing the Partnership's properties, all of which is paid as of December 31, 1995.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\n(a) No person or group is known by the Partnership to own beneficially more than 5% of the outstanding Units of the Partnership.\n(b) The officers and directors of the General Partner of the Partnership own as a group the following Units of the Partnership:\nAmount and Nature of Beneficial Percent Title of Class Ownership of Class -------------- ----------------- -------------- Limited Partnership 58.76 Units directly Less than 1\/2% Units\nNo officer or director of the General Partner of the Partnership possesses a right to acquire beneficial ownership of Units of the Partnership.\nAll of the outstanding shares of the General Partner of the Partnership are owned by an Affiliate or its officers and directors as set forth above in Item 10.\n(c) There exists no arrangement, known to the Partnership, the operation of which may, at a subsequent date, result in a change in control of the Partnership.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThere were no significant transactions or business relationships with the General Partner, Affiliates or their management other than those described in Items 10 and 11 above. Reference is made to Note 3 of the Notes to Financial Statements (Item 8 of this Annual Report) for information regarding related party transactions.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(a) The Financial Statements listed in the index at page 12 of this Annual Report are filed as part of this Annual Report.\n(b) Exhibits. The following documents are filed as part of this Report:\n3 Amended and Restated Agreement of Limited Partnership, and Certificate of Limited Partnership included as Exhibits A and B of the Prospectus dated August 4, 1988, as supplemented, are incorporated herein by reference thereto.\n4 Form of Certificate of Ownership representing interests in the registrant filed as Exhibit 4 to Registration Statement on Form S-11, File No. 33- 22513, is incorporated herein by reference thereto.\n28 Prospectus dated August 4, 1988, as supplemented, included in Post- effective Amendment No. 2 to Form S-11 Registration Statement, File No. 33- 22513, is incorporated herein by reference thereto.\n(c) Financial Statement Schedules.\nFinancial statement schedules for the years ended December 31, 1995, 1994 and 1993 are submitted herewith:\nPage ---- Real Estate and Accumulated Depreciation, (Schedule III)........ 26\nAll schedules other than those indicated in the index have been omitted as the required information is inapplicable or the information is presented in the financial statements or related notes.\n(d) Reports on Form 8-K.\nNone.\nNo Annual Report or proxy material for the year 1995 has been sent to the Partners of the Partnership. An Annual Report will be sent to the Partners subsequent to this filing and the Partnership will furnish copies of such report to the Commission when it is sent to the Partners.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nINLAND MONTHLY INCOME FUND II, L.P. Inland Real Estate Investment Corporation General Partner\nBy: Robert D. Parks Chairman of the Board and Chief Executive Officer Date: March 28, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, 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: Inland Real Estate Investment Corporation General Partner\nBy: Robert D. Parks Chairman of the Board and Chief Executive Officer Date: March 28, 1996\nBy: Patricia A. Challenger Senior Vice President Date: March 28, 1996\nBy: Cynthia M. Hassett Principal Financial Officer and Principal Accounting Officer Date: March 28, 1996\nBy: Daniel L. Goodwin Director Date: March 28, 1996\nBy: Robert H. Baum Director Date: March 28, 1996","section_15":""}
{"filename":"790498_1995.txt","cik":"790498","year":"1995","section_1":"ITEM 1. BUSINESS.\n(a) General Development of Business:\nData Transmission Network Corporation (the \"company\", \"DTN\") was incorporated on September 17, 1987 to change the name and state of incorporation of its predecessor company, Dataline, Inc. from Nebraska to Delaware pursuant to an Agreement and Plan of Merger dated October 8, 1987. The company was originally incorporated in Nebraska on April 9, 1984, as Scoular Information Services, Inc., a subsidiary of a regional grain company, later changing its name to Dataline, Inc.\nOn December 19, 1985 and January 31, 1986, in related transactions, certain employees of the company purchased all of the outstanding stock of the company from the regional grain company.\nIn January, 1987, the company completed an initial public offering of common stock selling 698,085 shares at $5.40 per share.\n(b) Financial Information About Industry Segments:\nNot Applicable\n(c) Narrative Description of Business:\nData Transmission Network Corporation (DTN) began operations in April, 1984. The company is in the business of providing information and communication services. During 1995, four new services were released: DTN Weather Center, DTN SPECTRUM, DTN GovRate and a joint venture DAT (Dial-a-Truck) Transportation Terminal. DTN's services reach 95,900 subscribers in the U.S. and Canada. All of these services are discussed in this report.\nThe company's subscription services are targeted at niche business markets and designed to be timely (NEWS...NOT HISTORY), simple to use, and convenient. The company's information distribution technology provides an efficient means of sending data and information from point to multi-point.\nThe development of a cost-effective electronic satellite delivery system, plus a total commitment to customer service and information quality, has enabled the company to become a major player in the communication industry. The company continues to make a large investment to develop and enhance its information distribution technology. This investment has allowed the company to take advantage of many engineering and software advancements in an exciting and growing industry.\nINFORMATION DISTRIBUTION TECHNOLOGY\nThe company is committed to research and to develop information distribution technologies to cost effectively deliver the timely information (NEWS...NOT HISTORY) that the company's subscribers demand. DTN supports several information distribution technologies allowing the distribution (transmission) and receiving (capture, manipulation and display) of information. These technologies include, FM radio side-band channels (FM), small dish Ku-band satellite (Ku), FAX, E-Mail, TV cable (VBI) (VBI-vertical blanking interval) and the Internet.\nThe first technology used by the company was FM. The Ku technology was added in 1989, providing the ability to reach customers outside the geographic territory of the signal of the FM stations. FAX, TV cable (VBI), E-Mail and the Internet have since been added to further expand our distribution network.\nThe company provides all of the equipment necessary for subscribers to receive their service based on FM, Ku, TV cable (VBI) and E-Mail technologies. This equipment includes a receiver, specifically built for the company, a video monitor, an FM antenna or a small 30\" Ku-band satellite dish. A keyboard, mouse and printer may be provided depending on the service. DTN is responsible for the normal maintenance and repair of the subscriber equipment.\nPrior to 1992, the company utilized a \"page-based\" receiver and monochrome system. The monochrome system translates the company's data stream into text and has the capability, depending on capacity, to receive and display from 126 to 246 different pages of information. The monochrome receiver has the capability to download information to a printer or computer.\nIn 1992, the company introduced the Advanced Communications EngineSM (ACE) receiver, a color graphics receiver system, that expanded the ability to provide information and communications services. This receiver has multiple processors that capture, manipulate and display high resolution color pictures, graphics, and text. A separate processor provides the ability to play audio clips such as weather forecasts, voice advertisements or audio alarms used when a futures contract reaches a pre-set price. In addition, this processor may send and retrieve information by using an internal modem.\nThe receiver has the ability to download information to a printer or computer. This receiver is equipped with an internal hard drive that allows processed information to be stored, archived (versus frequent rebroadcasting) and then displayed using the receivers built-in control panel, a keyboard or a mouse at the subscribers convenience.\nOne of the unique aspects of the company's information distribution technology is the computer software developed by the company specifically for use with the DTN receivers. This software manages information from a wide array of input sources, runs routines, sets priorities and then initiates transmissions to the satellite. The software provides the capability to individually address each receiver unit placed with a subscriber, permitting the company to transmit specific information to a specific subscriber(s).\nThe company leases FM radio side-band channels, satellite channels and TV cable (VBI) to deliver the information to the company's receivers used by its subscribers. All information is up-linked from Omaha to satellite (except FAX and other telephone delivery technology) and down-linked from the satellite to the subscriber based on the distribution technology.\nThe FM monochrome subscribers receive their information using an FM antenna that receives the information via the side-band signal transmitted from the radio stations.\nOn December 31, 1995, 19,000 subscribers were receiving the companies services via FM distribution technology.\nThe Ku subscribers utilize a 30\" satellite dish, a direct down-link, to receive their information. On December 31, 1995, 74,400 subscribers were receiving the companies services via Ku distribution technology.\nEarly in 1994, the company began using a new TV cable distribution technology involving vertical blanking intervals (VBI). The company has contracted with a major cable TV superstation to transmit information along with the station's TV signal. This technology eliminates the need for an FM antenna or satellite dish and is available to businesses or residences that are wired for cable TV and receive the superstation's service. On December 31, 1995, 2,500 subscribers were receiving the companies services by VBI distribution technology.\nThe company has approximately 8,000 FAX customers receiving information using FAX technology. The E-Mail business is primarily a subscriber (an E-Mail source) communicating specific messages to a group of subscribers. Currently, there are over 200 E-Mail sources delivering over 1,000 pages of information to subscribers. The company began to deliver services on the Internet in 1995 and plans to continue researching this information distribution technology.\nSERVICES OFFERED\nThe company's revenue is derived mainly from five categories: (1) monthly, quarterly or annual subscriptions, (2) optional service subscriptions, (3) communication services, (4) advertising and (5) service initiation fees.\nThe percentage of total revenue for each category over the last three fiscal years was:\nThe subscription revenue is monthly, quarterly or annual subscription fees for one of the company's services. A more detailed review of each service is found later in this report.\nOptional services are offered to subscribers on an \"a la carte basis\", similar to premium channels on cable TV. The information for these services is primarily provided by a third party with DTN receiving a share of the subscription revenue paid by the subscriber. Optional services revenue continues to grow but has decreased as a percentage of total revenue primarily due to the growth in subscriptions revenue.\nThe company sells communication services that allow companies to cost-effectively communicate a large amount of time-sensitive information (NEWS...NOT HISTORY) to their customers or field offices. This category includes revenue generated from FAX and E-Mail services.\nThe company sells advertising space interspersed among the pages of news and information, similar to a newspaper or magazine. The advantage of an electronic advertisement over typical print media is the time-sensitive (NEWS...NOT HISTORY) delivery of the ad, as well as the ability to change the advertising message quickly and as frequent as market conditions dictate. Advertising revenue continues to grow but has decreased as a percentage of total revenue primarily due to the growth in subscriptions revenue.\nService initiation fees are one-time charges to new subscribers depending on the service and the information distribution technology. DTN also charges an initiation fee for those subscribers who convert to another service (ie: from a monochrome FM to a Ku color service)\nDTN Agricultural Services\nThe DTN Agricultural related services include DTN AgDaily(R), DTNstant(R)\/Knight-Ridder, DTNironSM, DTN Pro Series, DTN PROduceSM and DTN Weather CenterSM.\nDTN AGDAILY SERVICE\nSERVICE REVIEW The company's first service, DTN AgDaily, is an agricultural market information and quotes service. Monochrome (FM and Ku) DTN AgDaily subscribers receive delayed commodity futures and options quotes; local cash grain and livestock prices; selected regional and world weather updates; and a variety of daily analysis, commentary and news that affects grain and livestock prices.\nThe DTN AgDaily color Ku graphics system includes an advanced weather segment with national and regional radar maps (updated every 15 minutes), satellite cloud cover maps, precipitation and temperature maps and much more. The subscriber can custom design high resolution charts and\/or select from a library that holds over 1,000 charts. Subscribers can custom program the futures quotes pages to display only the quotes they desire. The service also includes information segments for specific crop and livestock enterprises.\nSubscribers can select from more than 100 different optional services. The majority of these services have information provided by third parties and range from more advanced weather information to advisory services for specific commodities.\nApproximately 80% of the services subscribers are farmers or livestock producers with the balance consisting primarily of grain elevators, agribusinesses, and financial institutions. DTN AgDaily subscribers farm one quarter of the nation's total cropland and market 50% of the nation's cattle and hogs. This service has approximately 70% of the market for satellite-delivered agricultural news and information services. Subscribers can be found all across the U.S and Canada.\nThe biggest competitors to this service are considered to be the combination of printed advisory services, radio, television, telephone, other satellite information services, on-line services and the changing of old information gathering habits. The company believes it provides a superior service compared to the services available by its leading competitors.\nNew subscriptions are primarily sold by a sales force of employee district sales representatives as well as by independent, commission-only sales representatives. The company obtains leads for the sales force through telemarketing, direct mail, print media advertising and customer referrals. The price of the monochrome FM service is $25.99 per month, $32.99 per month for monochrome Ku service and $45.99 per month for color Ku service. The company offers a discount to subscribers who pre-pay their subscriptions annually.\nDTNSTANT\/KNIGHT-RIDDER SERVICE\nSERVICE REVIEW DTNstant\/Knight-Ridder(formerly DTNstant) is a color service that provides a selection of real-time futures and options quotes from the major commodity exchanges. The service also provides headline commodity news, market leading cash information, in-depth charting capabilities plus all the information available on the DTN AgDaily color service. The primary subscribers are commercial grain companies and elevators, feedlots, commodity brokers and commodity speculators. Due to the character of this industry, the company provides on-site service and installation by professional service technicians.\nDTNstant\/Knight-Ridder operates in a very competitive market with numerous national and regional providers of instant commodity quotes. This service is the leader in the satellite delivery of instant futures and options quotes.\nNew subscriptions are primarily sold by the district sales force which is supported by telemarketing and direct mail campaigns. This service is available only by color Ku-band satellite transmission and is priced at $160.00 a month.\nDTNIRON SERVICE\nSERVICE REVIEW DTNiron is a color service providing a cost-effective communication resource for the farm implement industry. DTNiron is an equipment locator and inventory management service providing a communication tool for the farm implement dealers throughout the U.S and Canada. The service allows dealers of all makes of farm implement equipment to work together to manage their inventory resulting in increased sales and profitability. This service provides valuable information on the national outlook for farm equipment sales.\nDTNiron provides detailed listings of farm implement equipment for sale by dealers as well as equipment needed by other dealers. Subscribers receive industry news, financial information, economic indicators and information from the DTN AgDaily color service.\nThis service is only available by color Ku-band satellite transmission and costs $94.50 a month.\nDTN PRO SERIES SERVICE\nSERVICE REVIEW The DTN Pro Series services are an advanced information source designed for agricultural subscribers who require more extensive information that can be customized for their specific needs and operations. The Pro Series includes five services: Weather Pro, News Pro, Chart Pro, Intraday Pro and Stock Pro.\nWeather Pro is the \"meteorological connection\" to the most complete array of current weather, forecast and satellite radar information. This service allows the subscriber to choose from over 70 new weather maps including detailed regional, state and zone forecasts. The Weather Pro service gives the subscriber 32 programmable pages to create their own unique weather information chapter.\nNews Pro is the \"broadcast connection\" to the most timely (NEWS...NOT HISTORY) business, sports, entertainment, financial, and general news of the day. The service also provides an audio summary of the day's agricultural news. New Pro subscribers receive AP Online, a service of the Associated Press, as a news source.\nChart Pro is the \"graphic connection\" bringing a variety of information to the screen in an organized format to allow the subscriber to analyze trends, patterns and cycles. This service includes 40 pages for programmable charts allowing the subscriber to create an extensive \"chart book\".\nIntraday Pro is the \"trading connection\" to the first low-cost system with the ability to chart market sessions minute-by-minute during the trading day. This service allows the subscriber to choose the time intervals they desire to chart and keep them abreast of the markets.\nStock Pro is the \"market connection\" providing access to prices for over 50,000 issues of stocks, bonds and funds. This service includes stock quotes using either the quick quote feature or the programmable quotes pages. Additional features are the personal library used to store news and information and the high interest windows that allows the subscriber to constantly monitor up to six futures, options, stock or bond quotes.\nThe individual Pro Series services are bundled with DTN Ag Daily. Each individual Pro Series service is $58.99 per month except the Stock Pro which is $66.00 a month. DTN Premier is the package of Weather Pro, News Pro, Chart Pro and Intraday Pro, priced at $73.99 per month. DTN Premier Plus is the package DTN Premier and Stock Pro, priced at $78.00 a month. This service is only available by color Ku-band satellite transmission.\nDTN PRODUCE SERVICE\nSERVICE REVIEW DTN PROduce is the authority in providing the produce industry with the most timely weather, prices, transportation and news information available. There are four major components to the DTN PROduce service. First is weather information, providing the single most important piece of information for anyone in the produce business. Second is pricing information, providing immediate updates upon release formatted by commodity, growing area and terminal market. Third is transportation information, providing freight rates and daily truck availability by the major growing areas. Finally, the service provides comprehensive industry specific and general news.\nThe market for the service is the entire produce food chain of growers, shippers, packers, brokers, retailers and institutions. This service is only available via color Ku-band satellite and is priced at $84.50 per month.\nDTN WEATHER CENTER (New Service)\nSERVICE REVIEW DTN Weather Center was unveiled at the corporation's annual meeting held in April 1995. This service combines many of DTN's most popular weather features with several new features that allow the service to be marketed to a variety of industries, such as golf course management, construction, emergency management, aviation and public works. This service can be sold to virtually any industry where timely (NEWS...NOT HISTORY), accurate, accessible weather information would cause a decision to be made concerning the deployment of manpower.\nDTN Weather Center provides 80 weather maps, 20 regional radar maps and four satellite maps. The service provides short-range (24-48 hours) forecasts, long-range (3-10 day) outlooks, and five-day city forecasts in three hour intervals for 223 different cities in the U.S. and Canada. DTN Weather Center features the new Insta-Rad radar maps that allow the company to send this information within five minutes to the subscriber.\nThis service is available only via color Ku-band satellite transmission and is priced at $68.00 per month.\nOPTIONAL SERVICES\nSERVICE REVIEW Optional Services include advisory, educational and other informational services offered to DTN subscribers on an \"a la carte\" basis. Additional Services are marketed by advertising on DTN services, direct mail, invoice stuffers and free trials. An Additional Service is featured on a regular basis providing all subscribers a three-day free trial. Subscribers can request and receive a two-week free trial of any Additional Service.\nNew Additional Services are developed and added to meet customer requests for information. Additional Services range in price from $6 to $300 per quarter depending on the service.\nDTN FINANCIAL SERVICES\nDTN Financial Services has grown from a single service in 1989, DTN Wall Street(R), to four services, DTN Wall Street, DTN SPECTRUMSM, DTN FirstRateSM and DTN GovRateSM. DTN Financial Services also includes a variety of optional advisory and fundamental market information services.\nThe financial services compounded revenue growth for the past five years was a very bullish 41%. The financial services objective is to provide a comprehensive in-depth service at an affordable cost to the subscriber. This objective will remain very important due to the highly competitive nature of this business. The \"a la carte\" optional services are offered to the subscriber to give them an even larger variety of information. The contents of all DTN Financial Services are broader in scope and cost less per month than the services offered by competitors. This combination allows the services to maintain a competitive advantage.\nDTN WALL STREET SERVICE\nSERVICE REVIEW DTN Wall Street provides exchange delayed quotes on stocks, bonds, mutual and money market funds, futures, interest rates, currencies and real-time index quotes. This service also provides in-depth economic, financial and business news and other time-sensitive (NEWS...NOT HISTORY) financial market information such as company-specific news and earnings. The service allows subscribers to custom program the system to track their selection of financial quotes.\nThe subscribers to DTN Wall Street have a variety of optional services from which to choose providing stock selection and timing advice, U.S. Treasury, Agency, mortgage-backed securities quotes and other financial related services.\nThe majority of subscribers are individual investors, independent brokers, financial advisors and financial institutions. The primary competition for DTN Wall Street are satellite, TV cable (VBI) and dial-up quote services. New subscribers to this service are obtained through direct response marketing, primarily print media, television advertising and telemarketing.\nThis service is available by monochrome Ku-band satellite and TV cable (VBI) and is priced at $41.95 per month.\nDTN SPECTRUM (New Service)\nSERVICE REVIEW DTN SPECTRUM was an important focus of the new service development team at DTN during 1995. This service was released during November, 1995, and is an enhanced version of DTN Wall Street utilizing the ACE technology. The service provides many additional features and functions that appeal to a wider market. This service provides advanced quote selection and custom programming along with alarms and charting capability. The service will continue to be enhanced during 1996.\nThis service was well received in the short time it was available during 1995. All indications are that subscription sales will be strong in 1996.\nAn extension of DTN SPECTRUM is the DTN SPECTRUM R-T service. This marks the entry by the DTN Financial Services into the real-time quotes market. The service will provide a mix of exchange-delayed quotes along with the subscriber's choice of real-time commodities and futures quotes. This service is expected to be well received by the market in 1996.\nThe DTN SPECTRUM and DTN SPECTRUM R-T services are only available by color Ku-band satellite and are priced at $68.00 and $118.00 per month, respectively. These services will become available by TV cable (VBI) during 1996.\nDTN FIRSTRATE SERVICE\nSERVICE REVIEW DTN FirstRate is a service for the mortgage industry providing wholesale price information in an easy-to-use standard format and intraday interest rate information to indicate the direction of wholesale prices. This service also provides subscribers with business, economic and financial news, analysis, and commentary including leading economic indicators, employment rates and government economic reports and trend analysis.\nSales for DTN FirstRate are slow. Company research suggests we should expect modest success with this service; however, the company is continuing the search for more cost effective sales and marketing programs.\nThis service is available by monochrome Ku-band satellite or TV cable (VBI) and is priced at $111.95 per month.\nDTN GOVRATE (New Service)\nSERVICE REVIEW DTN GovRate provides executable U.S. government security quotes from Zions First National Bank. The real-time prices are provided from a primary dealer, the former Discount Corporation of New York (DCNY), now operating as a division of Zions First National Bank.\nThe company views this service as an important development for financial institutions. The service will provide the ability for more than just large, money-center banks and institutions to have access to competitive pricing of U.S. government securities.\nDTN GovRate will open opportunities for smaller to mid-sized banks, public and corporate treasurers, and independent brokerage firms to participate in the trading of U.S. government securities. Zions First National Bank will facilitate this by offering odd lot trading and repurchase agreements.\nThis service is available by monochrome Ku-band satellite or TV cable (VBI) transmission for $34.95 per month. The service is also currently available on color Ku-band satellite for $68.00 per month.\nDTN ENERGY SERVICES\nThe energy related services include DTNergy(R) for the refined fuels and natural gas industries.\nDTNERGY SERVICE\nSERVICE REVIEW DTNergy is a service providing pricing information and communications services for the petroleum industry. This service consists of several pages of delayed energy futures and options quotes plus selected news and financial information. DTNergy is designed to connect refiners (producers of refined fuels) to wholesalers (distributor of refined fuels). The refiner sends refined fuel prices to wholesalers they have authorized to receive this information. The refiner also has the capability to send terminal alerts, electronic funds transfer notifications, invoices, and other communications to the wholesaler. DTNergy subscribers can select from a variety of optional services to give them even more prices or news related to the petroleum industry.\nThe strength of the DTNergy service is the ability to deliver, within seconds, accurate refiner terminal prices and other vital communications to the wholesalers. This service is more reliable, timely and less expensive than the competition, which utilize telephone delivered printer-only systems and FAX services.\nDTNergy generates revenue from two primary sources, the wholesaler and the refiner. The wholesaler pays a monthly subscription fee of $36.00 for the monochrome Ku-band satellite service. The refiner pays fees based upon the number and length of communications sent to wholesalers.\nDTNergy developed a service for the natural gas industry. Subscribers receive natural gas flow data, instant or delayed NYMEX energy options and futures quotes, weather and industry specific information. This service is marketed to natural gas producers, distributors and large consumers. The service is only available by color Ku-band satellite and is priced at $129 a month for 30-minute delayed quotes and $160 a month for real-time quotes.\nDTN AUTO SERVICES\nSERVICE REVIEW DTNautoSM is a communication and information service for the automobile industry. This service offers automobile dealers precision information to value trade-ins, locate used car inventory plus a host of other information and convenient features. Automobile auction companies and manufacturers are able to communicate directly with the dealers.\nDTNauto provides information on pre-auction automobile listings, results of past auctions, new and used car industry news, weather and other news. The service allows subscribers to perform searches of the auction listings, upcoming and past, for specific automobile information.\nThe service offers a variety of optional services providing information on credit reporting (CREDCO), vehicle histories (CARFAX), warranty information (The Warranty Guide) and residual value of leased vehicles (Lease Guide). The CARFAX and CREDCO optional services extensively utilize the internal modem to send and receive information. These services create a more comprehensive information service that puts the subscriber in the drivers seat.\nThis service is being marketed by the DTNauto sales force to automobile dealers across the United States. This service is only available by color Ku-band satellite transmission and is priced at $98.00 per month.\nJOINT VENTURE SERVICES\nDTN has joined forces with other companies to market their services using the company's technology. These services are TracElectric, a service for the electric equipment industry, and DAT Transportation Terminal, a service for the trucking industry.\nTRACELECTRIC SERVICE\nSERVICE REVIEW TracElectric is an equipment locator service for the electrical equipment industry. This service provides over 100 pages of new, remanufactured, surplus and used electrical equipment listings. The service connects buyers and sellers throughout the U.S. and Canada.\nThis service is available only by monochrome Ku-band satellite and DTN receives a percentage of the revenue.\nDAT Transportation Terminal (New Service)\nSERVICE REVIEW The DAT (Dial-A-Truck) Transportation Terminal (DAT) service was introduced in the fourth quarter of 1995 and is an information communication system for the trucking industry. This service is a joint venture with DAT in Beaverton, OR and DTN. The service provides load and truck matching performed on a database of 25,000 listings updated daily.\nDAT service allows subscribers to input their own listings into the ACE receiver and send this information to the database using the internal modem. This service provides the subscriber the ability to perform extensive searches to locate loads and trucks and set alarms to alert the user that a match has occurred. The service also provides regional radar maps of major highways and interstates, transportation news, diesel fuel prices and other financial information related to the trucking industry.\nThe target market includes all freight brokers and carriers throughout U.S. and Canada. This service is only available by color Ku-band satellite and DTN receives a monthly fee per receiver.\nEMPLOYEE DATA\nAt December 31, 1995 the company had approximately 725 full and part-time employees.\n(d) Financial Information about Foreign and Domestic Operations and Export Sales:\nNot applicable\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe company leases its executive and administrative offices in Omaha, Nebraska and has outside sales offices in Arizona, Colorado, Florida, Illinois and Utah. Approximately 75,000 square feet of office space is leased for these offices for various periods up through May 2005.\nIn addition, the company leases two distribution centers for the purpose of storing and distributing the electronic equipment needed by subscribers to receive the company's services. The main distribution center is located in Omaha, Nebraska and occupies approximately 28,000 square feet. The company also serves its Canadian subscribers with a 2,500 square foot distribution center located in Winnipeg, Manitoba. The leases related to these distribution centers are for various periods up through December, 2003.\nThe information set forth in Footnote 9 \"Leases\" on page 29-30 of the company's 1995 Annual Report to Stockholders is incorporated herein by reference.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThe company is not a party to nor is its property subject to any material pending legal proceedings, other than ordinary 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 security holders of the company during the fourth quarter of the fiscal year ended December 31, 1995.\n* * *\nThe executive officers serve annual terms, and are elected by the board of directors at their annual board of directors meeting in April of each year.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS.\nInformation concerning the market for the company's common stock, the number of stockholders of record and the company's dividend history is on pages 31 and 32 of the company's 1995 Annual Report to Stockholders and is incorporated herein by reference.\nOver-the-counter market quotations reflect inter-dealer prices, without retail mark-up, mark-down or commissions and may not necessarily represent actual transactions.\nThe company's most restrictive loan covenant restricts cash dividend payments to 25% of net income after taxes.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nSelected financial data for the company is on page 16 of the company's 1995 Annual Report to Stockholders and 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 is on pages 17 through 20 of the company's 1995 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 of the company, together with the Independent Auditors' Report, are on pages 21 through 30 of the company's 1995 Annual Report to Stockholders and are incorporated herein by reference.\nSupplementary quarterly financial information is on page 31 of the company's 1995 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 OF THE REGISTRANT.\nInformation concerning the present directors of the company and all persons nominated to become directors at the Annual Meeting of Stockholders of the company to be held April 24, 1996, is contained in the section captioned \"Election of Directors\" of the Proxy Statement for such annual meeting. Such section is on pages 2 through 3 of such Proxy Statement, and is incorporated herein by reference. Information concerning the registrant's executive officers is furnished in a separate item captioned \"Executive Officers of the Company\", included in Part I of this Form 10-K.\nCompliance With Section 16(a) Of The Exchange Act\nSection 16(a) of the Securities Exchange Act of 1934, as amended (the \"Exchange Act\"), requires the Company's directors, executive officers and holders of more than 10% of the Company's common stock to file with the Securities and Exchange Commission initial reports of ownership and reports of changes in ownership of common stock and other equity securities of the Company. The Company believes that during the fiscal year ended December 31, 1995, its officers, directors and holders of more than 10% of the Company's common stock complied with all Section 16(a) filing requirements, with the following exception. Jay E. Ricks, a director or the Company, filed late his initial report on Form 3 due upon his becomming a director of the Company. In making these statements, the Company has relied solely upon a review of Forms 3 and 4 furnished to the Company during its most recent fiscal year, Forms 5 furnished to the Company with respect to its most recent fiscal year, and written representations from reporting persons that no Form 5 was required.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nInformation concerning executive compensation paid by the company is contained in the sections captioned \"Executive Compensation\" and \"Compensation Committee Report on Executive Compensation\" on pages 6 through 10 of the Proxy Statement for the Annual Meeting of Stockholders of the company to be held April 24, 1996, and is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nInformation concerning the ownership of equity securities of the company by certain beneficial owners and management is contained in the sections captioned \"Ownership By Certain Beneficial Owners\" and \"Election of Directors\" on pages 2 through 6 of the Proxy Statement for the Annual Meeting of Stockholders of the company to be held April 24, 1996, and is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nInformation concerning transactions with management and others and indebtedness of management is contained in the section captioned \"Transactions with Management\" on page 11 of the Proxy Statement for the Annual Meeting of Stockholders of the company to be held April 24, 1996 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 Registrant's financial statements, together with the Independent Auditors' Report, are incorporated herein by reference to the 1995 Annual Report to Stockholders, pages 21 through 30. With the exception of the aforementioned information and the information incorporated by reference into Items 2,5,6,7 and 8 of this report, the Annual Report to Stockholders for the year ended December 31, 1995, is not to be deemed filed as a part of this report. The supplemental financial information listed below should be read in conjunction with the financial statements in the Annual Report to Stockholders for the year ended December 31, 1995.\n(a) 2. Financial Statement Schedules: Page ---- Auditors' Report on Financial Statement Schedules 26\nSchedule Number Description of Schedule --------- ---------------------------------- II Valuation and Qualifying Accounts 27\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.\n(a) 3. Exhibits:\n(3) (a) Certificate of Incorporation of Registrant.\n(b) By-Laws of Registrant. (These documents are filed as exhibits to the Registrant's Registration Statement on Form S-1 as filed December 4, 1987.)\n(4) (a) Specimen certificate representing shares of Common Stock $.001 par value, of Registrant. (This document is filed as an exhibit to the Registrant's Registration Statement on Form S-1 as filed November 4, 1988.)\n(b) Certificate of Incorporation of Registrant. (This document is filed as an exhibit to the Registrant's Registration Statement on Form S-1 as filed December 4, 1987.)\n(10) (a) Lease Agreement between the Registrant and Embassy Plaza Limited Partnership. (This document is filed as an exhibit to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1990.)\n(b) Registrant's Stock Option Plan of 1989. (This document is included as an exhibit to the Registrant's Proxy Statement for the Annual Meeting of Shareholders held on April 26, 1989.)\n(c) Registrant's Non-employee Directors Stock Option Plan. (This document is included as an exhibit to the Registrant's Proxy Statement for the Annual Meeting of Shareholders held on April 26, 1989.)\n(d) Form of indemnification agreement between the Registrant and the Officers and Directors of the Registrant. (This document is filed as an exhibit to the Registrant's Registration Statement on Form S-1 as filed May 22, 1989.)\n(e) First Amendment to Registrant's Employee Stock Option Plan of 1989 (amends Exhibit 10(b)).\n(f) First Amendment to Registrant's Non-employee Directors Stock Option Plan (amends Exhibit 10(c)). (These documents are included as exhibits to the Registrant's Proxy Statement for the Annual Meeting of Stockholders held on April 25, 1990.)\n(g) Second Amendment to Registrant's Employee Stock Option Plan of 1989 (amends Exhibit 10(b)).\n(h) Second Amendment to Registrant's Non-employee Directors Stock Option Plan (amends Exhibit 10(c)). (These documents are included as exhibits to the Registrant's Proxy Statement for the Annual Meeting of Stockholders held on April 24, 1991.)\n(i) Loan Agreement dated October 9, 1992 among the Registrant, First National Bank of Omaha, FirsTier Bank Lincoln and First National Bank of Wahoo.\n(j) First Amendment to Loan Agreement dated October 9, 1992 among the Registrant, First National Bank of Omaha, FirsTier Bank of Lincoln and First National Bank of Wahoo.\n(k) Independent Sales Representative Agreement dated March 28, 1990 between the Registrant and Phil Huston.\n(l) First Amendment dated March 1, 1991 to Independent Sales Representative Agreement dated March 28, 1990 between Registrant and Phil Huston.\n(m) Amendment to Independent Sales Representative Agreement dated March 28, 1990 between Registrant and Phil Huston.\n(These documents are included as exhibits to the Registrant's Annual Report on Form 10-K as filed March 24, 1993).\n(n) Third Amendment to Registrant's Stock Option Plan of 1989 (amends Exhibit 10(b)).\n(o) Third Amendment to Registrant's Non-Employee Directors Stock Option Plan (amends Exhibit 10(c)).\n(p) Fourth Amendment to Employee Stock Option Plan of 1989 (amends Exhibit 10(b)).\n(q) Fourth Amendment to Non-Employee Directors Stock Option Plan (amends Exhibit 10(c)). (These documents are included as exhibits to the Registrant's Proxy Statement for the Annual Meeting of Stockholders to be held April 27, 1994).\n(r) Restated Loan Agreement dated November 8, 1993 among the Registrant, First National Bank of Omaha, FirsTier Bank Lincoln, First National Bank of Wahoo, National Bank of Detroit, Norwest Bank Nebraska, NA and The Boatmen's Bank of St. Louis.\n(s) Restated Security Agreement dated November 8, 1993 among the Registrant, First National Bank of Omaha, FirsTier Bank Lincoln, First National Bank of Wahoo, National Bank of Detroit, Norwest Bank Nebraska, NA and The Boatmen's Bank of St. Louis.\n(These documents are included as exhibits to the Registrant's Annual Report on Form 10-K as filed March 14, 1994).\n(t) Restated and amended Non-Employee Directors Stock Option Plan.\n(This document is included as an exhibit to the Registrant's Proxy Statement for the annual meeting of stockholders to be held April 26, 1995).\n(u) First Amendment to the Restated Loan Agreement dated November 8, 1993 among the Registrant, First National Bank of Omaha, Firstier Bank Lincoln, First National Bank of Wahoo, National Bank of Detroit, Norwest Bank Nebraska, NA and The Boatmen's Bank of St. Louis.\n(v) Second Amendment to the Restated Loan Agreement dated November 8, 1993 among the Registrant, First National Bank of Omaha, Firstier Bank Lincoln, First National Bank of Wahoo, National Bank of Detroit, Norwest Bank Nebraska, NA and The Boatmen's Bank of St. Louis.\n(w) Third Amendment to the Restated Loan Agreement dated November 8, 1993 among the Registrant, First National Bank of Omaha, Firstier Bank Lincoln, First National Bank of Wahoo, National Bank of Detroit, Norwest Bank Nebraska, NA and The Boatmen's Bank of St. Louis.\n(x) Fourth Amendment to the Restated Loan Agreement dated November 8, 1993 among the Registrant, First National Bank of Omaha, Firstier Bank Lincoln, First National Bank of Wahoo, National Bank of Detroit, Norwest Bank Nebraska, NA and The Boatmen's Bank of St. Louis.\n(y) Lease agreement dated August 30, 1994 between Registrant and The Prudential Insurance Company of America.\n(z) First Amendment to lease agreement dated August 30, 1994 among the Registrant and The Prudential Insurance Company of America.\n(aa) Senior Subordinated Note dated June 30, 1994 between the Registrant and Equitable Capital Private Income and Equity Partnership II, L.P.\n(These documents are included as exhibits to the Registrant's Annual Report on Form 10-K as filed March 28, 1995).\n(ab) Fifth Amendment to the Restated Loan Agreement dated November 8, 1993 among the Registrant and six regional banks.\n(ac) Sixth Amendment to the Restated Loan Agreement dated November 8, 1993 among the Registrant and six regional banks.\n(ad) Lease agreement dated May 2, 1995 between the Registrant and The Prudential Insurance Company of America.\n(ae) First Amendment to lease agreement dated May 2, 1995 between the Registrant and The Prudential Insurance Company of America.\n(af) Restated Loan Agreement dated June 29, 1995 among the Registrant and seven regional banks.\n(ag) Purchase and service agreement dated July 13, 1995 between the Registrant and Knight-Ridder Financial.\n(ah) Adjustment to Independent Sales Representative Agreement dated March 28, 1990 between Registrant and Phil Houston.\n(ai) Senior Subordinated Notes and Warrant Purchase Agreement dated June 30, 1994 between Registrant and Equitable Capital Private Income and Equity Partnership II, L.P.\n(aj) First Amendment to Senior Subordinated Notes and Warrant Purchase Agreement dated June 30, 1994 between Registrant and Equitable Capital Private Income and Equity Partnership II, L.P.\n(11) Statement re computation of income per share. (12) Not applicable. (13) Registrant's 1995 Annual Report to Stockholders. (This document is hereby incorporated by reference.) (16) None. (18) None. (19) None. (22) None. (23) Consent of Deloitte & Touche LLP. (24) None. (25) None. (99) Proxy Statement for the Annual Meeting of Stockholders of the Registrant to be held April 24, 1996. (This document is hereby incorporated by reference.)\n(b) No reports on Form 8-K were filed by the Registrant during the fourth quarter of the year ended December 31, 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.\nData Transmission Network Corporation, a Delaware Corporation\nBy: \/s\/ Roger R. Brodersen ----------------------- Roger R. Brodersen Chief Executive Officer\nDated March 22, 1996.\nPursuant to the requirements of the Securities Exchange Act of 1934, 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\/ Roger R. Broderson March 22, 1996 ------------------------------ Roger R. Brodersen, Chairman of the Board, Chief Executive Officer and Director\nBy: \/s\/ Greg T. Sloma March 22, 1996 ------------------------------ Greg T. Sloma, President and Chief Operating Officer and Director\nBy: \/s\/ Roger W. Wallace March 22, 1996 ------------------------------ Roger W. Wallace, Senior Vice President, Co-President-Ag Services and Director\nBy: \/s\/ Robert S. Herman March 22, 1996 ------------------------------ Robert S. Herman, Senior Vice President and Director\nBy: \/s\/ Brian L. Larson March 22, 1996 ------------------------------ Brian L. Larson, Vice President, Chief Financial Officer, Secretary and Treasurer\nBy: \/s\/ David K. Karnes March 22, 1996 ------------------------------ David K. Karnes, Director\nBy: \/s\/ J. Michael Parks March 22, 1996 ------------------------------ J. Michael Parks, Director\nBy: \/s\/ Jay E. Ricks March 22, 1996 ------------------------------ Jay E. Ricks, Director\nINDEPENDENT AUDITORS' REPORT\nBoard of Directors and Stockholders Data Transmission Network Corporation Omaha, Nebraska\nWe have audited the financial statements of Data Transmission Network Corporation as of December 31, 1995 and 1994, and for each of the three years in the period ended December 31, 1995 and have issued our report thereon dated January 30, 1996; such financial statements and report are included in your 1995 Annual Report to Stockholders and are incorporated herein by reference. our audits also included the financial statement schedules of Data Transmission Network Corporation, listed in Item 14(a)2. These financial statement schedules are the responsibility of the company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.\n\/s\/ Deloitte & Touche LLP - ---------------------------\nDELOITTE & TOUCHE LLP\nOmaha, Nebraska January 30, 1996","section_15":""}
{"filename":"13390_1995.txt","cik":"13390","year":"1995","section_1":"ITEM 1. BUSINESS.\nGENERAL\nBoston Gas Company (the \"Company\"), is engaged in the transportation and sale of natural gas to over 515,000 residential, commercial and industrial customers in Boston, Massachusetts and 73 other communities in eastern and central Massachusetts. The Company also sells gas for resale in Massachusetts and other states. The Company has one subsidiary, Massachusetts LNG Incorporated (\"Mass LNG\"), which holds a long-term lease on two liquefied natural gas (\"LNG\") facilities. The Company is the largest natural gas distribution company in New England, has been in business for 173 years and is the second oldest gas company in the United States. Since 1929, all of the common stock of the Company has been owned by Eastern Enterprises (\"Eastern\"), which is headquartered in Weston, Massachusetts.\nFor definition of certain industry specific terms, see the Glossary at the end of Part I and appearing on page 5.\nThe Company provides both local transportation services and gas supply for all customer classes. All residential customers and most commercial\/industrial customers currently purchase combined or \"bundled\" supply and transportation services from the Company. Local transportation service is offered on an unbundled basis to large commercial\/industrial customers, who may purchase gas supply from the Company or other sources.\nThe Company's services are available on a firm and non-firm basis. Firm transportation services and sales are provided under rate tariffs filed with the Massachusetts Department of Public Utilities (the \"Department\") that typically obligate the Company to provide service without interruption throughout the year. Non-firm transportation services and sales are generally provided to large commercial\/industrial customers who can use gas and oil interchangeably. Non-firm services, including sales to other gas companies for resale, are provided through individually negotiated contracts and, in most cases, the price charged takes into account the price of the customer's alternative fuel. Beginning in November, 1993, margin on non-firm throughput and city gate sales in excess of a threshold based upon the prior year's non- firm margin is shared between firm customers and the Company, 75% and 25%, respectively. Under this sharing mechanism, the Company retained $353,000 and $1,040,000 in 1995 and 1994, respectively.\nMARKETS AND COMPETITION\nThe Company competes with other fuel distributors, primarily oil dealers, throughout its service territory. Over the last five years, the Company has increased its market share of the total stationary energy market from 28% to 35%. This market share compares to the national average of approximately 43% and may represent a growth opportunity for the Company. However, actual experience cannot be predicted with certainty, and will depend on such factors as the price of competitive energy sources and customer perceptions of relative value.\nResidential customers comprise 92% of its customer base, while commercial\/industrial establishments account for the remaining 8%. Volumetrically, residential customers account for 29% of total throughput and 42% of firm throughput, while commercial\/industrial customers account for 71% of total throughput and 58% of firm throughput. Approximately half of the commercial\/industrial customers' total throughput is local transportation.\nIn 1993, the Department approved the Company's proposal to unbundle local transportation service and gas sales service for its largest commercial\/industrial customers. Unbundling allows customers to purchase local transportation from the Company on a basis separate from the purchase of gas supply, which the customer may buy from the Company or third parties. This unbundling initiative extended to eligible customers direct access to gas supplies and interstate pipeline capacity, as authorized by the Federal Energy Regulatory Commission (\"FERC\") in Order 636. As a result of Order 636, the Company has seen increasing competition from other gas suppliers into its service territory. In 1995, 103 of the approximately 450 eligible customers purchased gas supplies from third parties. In response to such perceived trends, in 1994, the Company initiated a large-scale reengineering effort to reduce costs, increase productivity, and improve customer service.\nGAS THROUGHPUT\nThe following table, in billions of cubic feet of natural gas at 1,000 Btu per cubic foot (\"BCF\") provides information with respect to gas throughput of the Company for the three years 1993-1995.\nNo customer, or group of customers under common control, accounted for 3% or more of total firm revenues in 1995.\nGAS SUPPLY\nThe following table in BCF provides statistical information with respect to the Company's sources of supply for 1993-1995.\nThe Company purchases approximately 60% 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 Department. The Company purchases its remaining pipeline supplies from domestic sources pursuant to short-term, firm winter service agreements and on a spot basis. The Company 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 the Company's service territory pursuant to long-term contracts. FERC-approved tariffs provide for fixed demand charges for the firm capacity rights under these contracts. The interstate pipeline companies that provide firm transportation service to the Company's service territory, the peak daily and annual capacity and the contract expiration dates are as follows:\nIn addition, the Company has firm capacity contracts on interstate pipelines upstream of Algonquin and Tennessee pipelines to transport natural gas purchased by the Company from producing regions to the Algonquin and Tennessee pipelines. The expiration dates for these contracts are similar to those included in the above table.\nThe Company has contracted with pipeline companies and others for the storage of natural gas in underground storage fields located in Pennsylvania, New York, Maryland and West Virginia. These contracts provide for storage capacity of 17.3 BCF and peak day capacity of 0.16 BCF. The Company utilizes its existing capacity contracts to transport gas from the storage fields to its service territory. Supplemental supplies of LNG and propane are purchased and produced from foreign and domestic sources.\nPeak day throughput in BCF was 0.69, 0.65 and 0.64 in 1995, 1994 and 1993, respectively. The Company provides for peak period demand through a least cost portfolio of pipeline, storage and supplemental supplies. The Company considers its peak day sendout capacity, based on its total supply resources, to be adequate to meet the requirements of its firm customers.\nREGULATION\nThe Company's operations are subject to Massachusetts statutes applicable to gas utilities. Rates, the territorial limit of the Company's service area, purchase of gas, pipeline safety regulations, issuance of securities and affiliated party transactions are regulated by the Department. Rates for firm transportation and sales provided by the Company are subject to approval by, and are on file with, the Department. In addition, the Company 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, including the demand charges for capacity on the interstate pipeline system.\nIn February of 1995 the Department ordered all large gas and electric utilities to file incentive rate proposals as soon as possible. The order signaled a significant departure from established Department practice of setting rates to reflect all allowed costs of service. In the second quarter of 1996 the Company intends to file an incentive rate proposal consistent with the Department's directives. As part of its rate restructuring proposal, the Company will offer unbundled transportation and sales service to a broader range of customers.\nAs more customers elect to purchase gas from third parties, a greater amount of upstream pipeline capacity under contract may be idle, unless it can be remarketed or assigned. The recoverability of cost for any such idle capacity will be an issue for the Department to address for all utilities subject to its jurisdiction. While there can be no assurance, it is the Company's position that it should be afforded the opportunity to recover prudently incurred, non-mitigable stranded capacity cost.\nThe Company 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.\nSEASONALITY AND WORKING CAPITAL\nThe Company's revenues, earnings and cash flows are highly seasonal as the demand for most of its transportation services and sales is directly related to temperature conditions. The majority of the Company's 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, the Company bills its customers over the heating season for pipeline demand charges paid by the Company over the entire year. This difference, along with other costs of gas distributed but unbilled, is reflected as deferred gas costs and is financed through short-term borrowings. Short-term borrowings are also required from time to time to finance normal business operations. As a result, short-term borrowings are generally highest during the late fall and early winter.\nENVIRONMENTAL MATTERS\nThe Company may have to share responsibility under applicable environmental law for the remediation of certain former manufactured gas plant (\"MGP\") sites, as described in Note 11 of Notes to Financial Statements. A subsidiary of New England Electric System has assumed responsibility for remediating 11 of the 15 such sites owned by the Company, subject to a limited contribution by the latter. A 1990 regulatory settlement with the Department provides for recovery by the Company of environmental costs associated with such sites over separate, seven-year amortization periods without a return on the unamortized balance. The Company does not possess at this time sufficient information to reasonably determine the ultimate cost to it of such remediation and no assurance can be given with respect to the future recoverability of such costs. However, in light of the factors discussed above, the Company believes that it is not probable that such costs will materially affect its financial condition or results of operations.\nEMPLOYEES\nAs of December 31, 1995, the Company had approximately 1,550 employees, 73% of whom are organized in local unions with which the Company has collective bargaining agreements that expire in 1999. The approximate 10% reduction in staffing from the prior year was accomplished through attrition and early retirement and severance programs for both management and union employees associated with the Company's ongoing reengineering program.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company 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. The Company 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, the Company owns propane-air facilities at numerous locations throughout its service territory.\nOn December 31, 1995, the Company's distribution system included approximately 5,800 miles of gas mains, 397,000 services and 525,000 active customer meters.\nThe Company's gas mains and services are usually located on public ways or private property not owned by it. In general, the Company's occupation of such property is pursuant to easements, licenses, permits or grants of location. Except as stated above, the principal items of property of the Company are owned in fee.\nIn 1995, the Company's capital expenditures were $57.3 million. Capital expenditures were principally made for improvements to the distribution system, for system expansion to meet customer demand and for productivity enhancement initiatives. The Company plans to spend approximately $60.0 million for similar purposes in 1996.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nOther than routine litigation incidental to the Company's business, there are no material pending legal proceedings involving 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 in the fourth quarter of 1995.\nGLOSSARY\nBUNDLED SERVICE--Two or more services tied together as a single product. Services include gas sales at the city gate, interstate transportation, local transportation from the city gate to the customer's burner tip, balancing daily swings in customer loads, storage, and peak-shaving services.\nBURNER TIP--Ultimate point of consumption of natural gas at the customer's end-use equipment.\nCAPACITY--The maximum capability of pipelines and supplemental facilities to deliver and\/or store gas at a given time.\nCITY GATE--Physical interconnection between an interstate pipeline and the local distribution company.\nCORE CUSTOMER--Generally, customers with no readily available energy services alternative.\nFIRM SERVICE--Sales and\/or transportation service provided without interruption throughout the year. Uninterrupted seasonal services are also available for less than 365 days. Firm services are provided under either filed rate tariffs or through individually negotiated contracts.\nGAS MARKETER (BROKER)--A non-regulated buyer and seller of natural gas.\nLOCAL DISTRIBUTION COMPANY (LDC)--A utility that owns and operates a natural gas distribution system for the delivery of gas supplies from the city gate to end-user facilities.\nLOCAL TRANSPORTATION SERVICE--Transportation of gas by the LDC from the city gate to the customer's burner tip.\nMERCHANT BUSINESS--Business of purchasing and selling natural gas.\nNON-CORE CUSTOMERS--Generally, those customers with readily available, economically viable alternatives to natural gas, and\/or are of sufficient size to arrange for their own energy supplies.\nNON-FIRM SERVICE--Sales and transportation service that offers service at a lower cost and level of reliability. Under this service, the LDC can interrupt customers on short notice, typically during the winter season. Non-firm services are provided through individually negotiated contracts and, in most cases, the price charged takes into account the price of the customer's alternative fuel.\nTRANSITION COSTS--Pursuant to FERC Order 636, these are costs incurred by interstate pipelines as they unbundled their services and exited the merchant business. Transition costs include uncovered gas costs at the time the pipelines ceased the merchant function, stranded costs or unrecovered costs of assets that cannot be assigned to customers of unbundled services, and gas supply realignment costs or the costs of renegotiating existing gas supply contracts with producers.\nUNBUNDLED SERVICE--Service that is offered and priced separately, such as separating the cost of gas commodity delivered to the LDC's city gate from the cost of transporting the gas from the city gate to the end use. Unbundled services can also include daily or monthly balancing, back-up or stand-by services and pooling. With unbundled services, customers have the opportunity to select only the services they desire.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nEastern was the holder of record of all of the outstanding common equity securities of the Company throughout the year ended December 31, 1995. Dividends on such common equity amounted to $11.9 million and $12.8 million for 1995 and 1994, respectively. At December 31, 1995, under the most restrictive provision limiting dividend payments in the Company's financing indentures, there were no restrictions on retained earnings.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nNot required.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\n1995 COMPARED TO 1994\nNet earnings applicable to common stock for 1995 were $23.4 million, a decrease of $1.8 million or 7% from 1994. Increased throughput to new and existing customers, the recognition of lost margins associated with conservation programs and the reimbursement of previously incurred environmental expenses were offset primarily by lower customer consumption in the heating markets and to a lesser extent weather. While weather in both 1995 and 1994 was essentially normal for the year as a whole, temperatures within the year varied widely relative to normal and from year to year.\nHigher operating costs, primarily non-recurring charges associated with early retirement and severance programs for both management and union employees, were partially offset by related labor savings and reduced weather- related workload during the first half of the year. Work force reductions resulted from the Company's reengineering project which focused on improving customer service and lowering operating costs.\nAlso contributing to lower earnings were increased depreciation and property tax expenses related to continued investments in system replacement and expansion partially offset by a reduced provision for uncollectible accounts.\n1994 COMPARED TO 1993\nNet earnings applicable to common stock for 1994 were $25.2 million, an increase of $7.2 million or 40% from 1993. An annual rate increase of $37.7 million, effective November 1, 1993, increased 1994 net earnings by $18.2 million. Net earnings also benefited from increased sales to new and existing customers of 2.3 BCF. Despite record cold temperatures in early 1994, the year averaged only slightly colder than normal due to 18% warmer than normal fourth quarter weather. Weather for 1993 was essentially normal. In total, the weather decreased net earnings approximately $1.8 million after considering the higher workload related labor and operating costs associated with the unusually cold first quarter weather and the reduced sales margin attributable to the 18% warmer fourth quarter.\nIn addition, the above were partially offset by higher charges for property taxes, bad debts and employee benefits. Increased depreciation and amortization reflects higher allowed depreciation rates and continued investments in system replacement and expansion. Interest expense increased in 1994 primarily due to the issuance of long-term debt as well as higher rates on short-term borrowings.\nLIQUIDITY AND CAPITAL RESOURCES\nIn 1995, the Company maintained committed lines of credit totaling $40.0 million, which were not renewed when they expired on December 31, 1995. To meet cash requirements and support it's commercial paper program, the Company has available up to $75.0 million of Eastern's committed credit agreement and various uncommitted lines of credit. The Company also maintains a bank credit agreement which supports the issuance of up to $90.0 million of commercial paper to fund its inventory of gas supplies.\nDuring the fourth quarter of 1995, the Company issued $60.0 million of Medium-Term Notes, Series C pursuant to a shelf registration filed on June 13, 1995. These notes have an average maturity of 26 years and a weighted average interest rate of 7.08%. Proceeds from this issuance were used to complete an in-substance defeasance of all outstanding 8 3\/4% and 9% Debentures due 2001 with an aggregate principal amount of $60.0 million.\nIn connection with the defeasance, the Company has irrevocably requested that the 9% Debentures be called on May 15, 1996 and the 8 3\/4% Debentures be called on December 15, 1996. Under the terms of the applicable debt instruments, the Company has deposited U.S. Government Securities in an irrevocable trust to cover principal, call premiums and interest to the call dates.\nThe Company expects capital expenditures for 1996 to be approximately $60.0 million. Capital expenditures will be largely for improvements to the distribution system, for system expansion to meet customer demand and for productivity improvements.\nThe Company expects that projected cash flow from operations, in combination with currently available resources, is sufficient to meet 1996 capital expenditure and working capital requirements, normal debt repayments and dividends to its shareholders. The foregoing forward-looking statement involves risks and uncertainties. The Company's actual experience may differ materially from its current expectation for various reasons, including unexpected capital expenditures or working capital requirements. Moreover, there can be no assurance that the external capital resources which the Company believes are currently available to it will continue to be available or will be available on terms and conditions advantageous to the Company.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nInformation with respect to this item appears commencing on Page of this Report. Such information is incorporated herein by reference.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY.\nNot required.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nNot required.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nNot required.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nNot required.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\nLIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES.\nInformation with respect to these items appears on Page of this Report. Such information is incorporated herein by reference.\n(3) LIST OF EXHIBITS.\nThere were no reports on Form 8-K filed in the Fourth Quarter of 1995. - - -------- * Not filed herewith. In accordance with Rule 12(b)(32) of the General Rules and Regulations under the Securities Exchange Act of 1934, reference is made to the document previously filed with the Commission.\nSIGNATURES\nPURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES AND EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.\nBoston Gas Company Registrant\nBy: J.F. Bodanza --------------------------------- J.F. BODANZA SENIOR VICE PRESIDENT AND TREASURER (PRINCIPAL FINANCIAL AND ACCOUNTING OFFICER)\nDated: March 18, 1996\nPURSUANT TO THE REQUIREMENTS OF THE 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 18TH DAY OF MARCH 1996.\nSIGNATURE TITLE\nC. R. Messer Director and - - ------------------------------------- President C. R. MESSER\nA. J. DiGiovanni Director and Senior Vice - - ------------------------------------- President A. J. DIGIOVANNI\nJ. F. Bodanza Director and Senior Vice President - - ------------------------------------- and Treasurer (Principal Financial J. F. BODANZA and Accounting Officer)\nJ. A. Ives Director - - ------------------------------------- J. A. IVES\nR. R. Clayton Director - - ------------------------------------- R. R. CLAYTON\nW. J. Flaherty Director - - ------------------------------------- W. J. FLAHERTY\nBOSTON GAS COMPANY AND SUBSIDIARY\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES (INFORMATION REQUIRED BY ITEMS 8 AND 14 (A) OF FORM 10-K)\nSchedules other than those listed above have been omitted as the information has been included in the consolidated financial statements and related notes or is not applicable nor required.\nSeparate financial statements of the Company are omitted because the Company is primarily an operating company and its subsidiary is wholly-owned and is not indebted to any person in an amount that is in excess of 5% of total consolidated assets.\nBOSTON GAS COMPANY AND SUBSIDIARY\nCONSOLIDATED BALANCE SHEETS\nASSETS\nThe accompanying notes are an integral part of these consolidated financial statements.\nBOSTON GAS COMPANY AND SUBSIDIARY\nCONSOLIDATED BALANCE SHEETS\nLIABILITIES AND STOCKHOLDER'S INVESTMENT\nThe accompanying notes are an integral part of these consolidated financial statements.\nBOSTON GAS COMPANY AND SUBSIDIARY\nCONSOLIDATED STATEMENTS OF EARNINGS\nThe accompanying notes are an integral part of these consolidated financial statements.\nBOSTON GAS COMPANY AND SUBSIDIARY\nCONSOLIDATED STATEMENTS OF RETAINED EARNINGS\nThe accompanying notes are an integral part of these consolidated financial statements.\nBOSTON GAS COMPANY AND SUBSIDIARY\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nThe accompanying notes are an integral part of these consolidated financial statements.\nBOSTON GAS COMPANY AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(1) ACCOUNTING POLICIES\nThe accounting policies of Boston Gas Company (the \"Company\") conform to generally accepted accounting principles and reflect the effects of the ratemaking process in accordance with Statements of Financial Accounting Standards No. 71, \"Accounting for the Effects of Certain Types of Regulation\".\nThe significant accounting policies followed by the Company and its subsidiary are described below and in the following footnotes:\nNote 2--Cost of Gas Adjustment Clause and Deferred Gas Costs Note 3--Income Taxes Note 6--Pension Benefits Note 7--Postretirement Benefits Other Than Pensions Note 8--Leases\nPrinciples of Consolidation\nThe Company is a wholly-owned subsidiary of Eastern Enterprises (\"Eastern\"). The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, Massachusetts LNG Incorporated (\"Mass LNG\"). All material intercompany balances and transactions between the Company and its subsidiary have been eliminated in consolidation.\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nRegulation and Operations\nThe Company is a gas distribution company engaged in the transportation and sale of natural gas to residential, commercial and industrial customers. The Company's service territory includes Boston and 73 other communities in eastern and central Massachusetts.\nThe Company's operations are subject to Massachusetts statutes applicable to gas utilities. Its revenues, earnings and cash flows are highly seasonal as the demand for most of its transportation services and sales is directly related to temperature conditions. The Company purchases pipeline gas supplies from a variety of domestic and Canadian producers and marketers. Gas supplies are purchased using a combination of long-term commitments, firm winter service agreements and spot purchases. The Company has diversified its pipeline gas supplies across major North American producing regions, including western Canada.\nRegulatory Assets\nThe Company is subject to the provisions of Statement of Financial Accounting Standards 71, (\"SFAS 71\") \"Accounting for the Effects of Certain Types of Regulation\". Regulatory assets represent probable future revenue to the Company associated with certain costs which will be recovered from customers through the ratemaking process. Regulatory liabilities represent probable future reductions in revenues associated with amounts that are to be credited to customers through the ratemaking process. The following regulatory assets were reflected in the Consolidated Balance Sheets as of December 31:\nBOSTON GAS COMPANY AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(1) ACCOUNTING POLICIES (CONTINUED)\nRegulatory liabilities total $12,391,000 and $13,341,000 at December 31, 1995 and 1994 and relate primarily to income taxes.\nAs of December 31, 1995 all of the Company's regulatory assets and regulatory liabilities are being reflected in rates charged to customers over periods ranging from 1 to 24 years. For additional information regarding deferred income taxes, Order 636 transition costs, environmental costs and postretirement benefit costs, see footnotes 3, 12, 11, and 7 respectively.\nIf a portion of the Company's operations is no longer subject to the provisions of SFAS 71, a write off of related regulatory assets and liabilities would be required, unless some form of transition cost recovery (refund) continues through rates established and collected for the Company's remaining regulated operations.\nDepreciation\nDepreciation is provided at rates designed to amortize the cost of depreciable property, plant and equipment over their estimated remaining useful lives. The composite depreciation rate, expressed as a percentage of the average depreciable property in service, was 5.13% in 1995, 5.16% in 1994 and 3.98% in 1993.\nAccumulated depreciation is charged with the original cost and cost of removal, less salvage value, of units retired. Expenditures for repairs, upkeep of units of property and renewal of minor items of property replaced independently of the unit of which they are a part are charged to maintenance expense as incurred.\nGas Operating Revenues\nGas operating revenues are recorded when billed. Revenue is not recorded for the amount of gas distributed to customers, which is unbilled at the end of the period; however, the cost of this gas is deferred as discussed in Note 2.\n(2) COST OF GAS ADJUSTMENT CLAUSE AND DEFERRED GAS COSTS\nThe cost of gas adjustment clause requires the Company to adjust its rates semi-annually for firm gas sales in order to track changes in the cost of gas distributed with an annual adjustment of subsequent rates for any collection over or under actual costs incurred. As a result, the Company defers the cost of any firm gas that has been distributed, but is unbilled at the end of a period, to a period in which the gas is billed to customers. The cost of gas adjustment clause also recovers the amortization of all environmental response costs associated with former manufactured gas plant (\"MGP\") sites, FERC Order 636 transition costs and costs related to the Company's various conservation and load management programs.\nBOSTON GAS COMPANY AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(3) INCOME TAXES\nThe Company is a member of an affiliated group of companies that files a consolidated federal income tax return. The Company follows the policy, established for the group, of providing for income taxes which would be payable on a separate company basis. The Company's effective income tax rate was 39.1% in 1995, 39.5% in 1994, and 38.4% in 1993. State taxes represent the majority of the difference between the effective rate and the Federal income tax rate for 1995, 1994 and 1993.\nA summary of the provision for income taxes for the three years ended December 31 is as follows:\nEffective January 1, 1992, the Company adopted Statement of Financial Accounting Standards No. 109 (\"SFAS 109\"), \"Accounting for Income Taxes.\" SFAS 109 requires adjustment of deferred tax assets and liabilities to reflect the future tax consequences, at currently enacted rates, of items already reflected in the financial statements. A regulatory asset of $1,880,000 was established for the recovery of prepaid taxes established at the higher federal tax rates in effect prior to 1988. At December 31, 1995 the balance of the regulatory asset was $498,000. In its most recent rate request proceeding, the Company received permission to recover this amount over three years.\nA regulatory liability of $6,144,000 was established for the tax benefit of unamortized investment tax credits, which SFAS 109 requires to be treated as a temporary difference. This benefit will be passed on to customers over the lives of property giving rise to the investment credits, consistent with the 1986 Tax Reform Act. The balance at December 31, 1995 was $4,440,000. The regulatory liability for excess deferred taxes being returned to customers over a 30 year period pursuant to a 1988 rate order was similarly increased by $4,445,000 upon the adoption of SFAS 109. At December 31, 1995 the balance to be returned to customers was $7,951,000.\nFor income tax purposes, the Company uses accelerated depreciation and shorter depreciation lives permitted by the Internal Revenue Service. Deferred federal and state taxes are provided for the tax effects of all temporary differences between financial reporting and taxable income. Significant items making up deferred tax assets and deferred tax liabilities at December 31, 1995 and 1994, are as follows:\nBOSTON GAS COMPANY AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(3) INCOME TAXES (CONTINUED)\nInvestment tax credits are deferred and credited to income over the lives of the property giving rise to such credits. The credit to income was approximately $937,000 in 1995, $723,000 in 1994 and $689,000 in 1993.\n(4) COMMITMENTS\nLong-term Obligations\nThe following table provides information on long-term obligations as of December 31:\nIn 1995, the Company filed a shelf registration covering the issuance through 1997 of up to $100,000,000 of Medium-Term Notes. In October and November 1995, the Company issued $60,000,000 of Medium-Term Notes, Series C, with a weighted average maturity of 26 years and a coupon of 7.08%. The proceeds from this issuance were used to complete an in-substance defeasance of $60,000,000 principal amount of 8.75%--9.00% Debentures due 2001. In connection with the defeasance the Company has irrevocably requested that the Debenture Trustee call the Debentures on the first date that they can be redeemed with lower cost debt. In December 1995, the Company deposited $65,136,000 of U.S. government securities into an irrevocable trust to cover the principal amount called, the call premiums of $1,161,000 and interest to the date of call of $3,975,000. As a result of the in-substance defeasance, the debt has been considered extinguished; accordingly, the government securities and\nBOSTON GAS COMPANY AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(4) COMMITMENTS (CONTINUED)\n$60,000,000 principal amount of Debentures due 2001 were removed from the balance sheet at December 31, 1995. Pursuant to regulatory accounting, the in- substance defeasance transaction resulted in the deferral of $2,250,000 as debt issuance costs to be amortized over the lives of the newly issued Medium- Term Notes.\nOn September 1, 1995 the Company redeemed all of the outstanding principal amount of 8.375% First Mortgage Bonds due 1996 at a redemption price of 100%.\nIn 1994 the Company issued $50,000,000 of Medium-Term Notes, Series B, with a weighted average maturity of 21 years and a coupon of 7.20%. 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 issuance reduced current debt.\nThere are no sinking fund requirements for the next five years related to the $210,000,000 of Medium-Term Notes outstanding at December 31, 1995 and none are callable prior to maturity.\nAnnual maturities of capital lease obligations are $1,508,000, $1,029,000, $507,000, $561,000 and $620,000 for 1996 through 2000, respectively.\nThe terms of the various indentures referred to above, as supplemented, provide that dividends may not be paid on common stock of the Company under certain conditions. At December 31, 1995 there were no restrictions on retained earnings available for payment of dividends.\nGas Inventory Financing\nUnder the terms of the general rate order issued by the Massachusetts Department of Public Utilities (the \"Department\") effective October 1, 1988, the Company funds all of its inventory of gas supplies through external sources. All costs related to this funding are recoverable from its customers. The Company maintains a long-term 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. The Company had $45,600,000 and $53,578,000 of commercial paper outstanding to fund its inventory of gas supplies at December 31, 1995 and 1994, 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 364 day revolving credit which may be converted to a two-year term loan at the Company's option if the 364 day revolving credit is not renewed by the banks. The Company may select the agent bank's prime rate or, at the Company's option various alternatives. The agreement requires a facility fee of 1\/12 of 1% on the commitment. No borrowings were outstanding under this agreement during 1995 and 1994.\nEastern Borrowing Arrangement\nEastern maintains a credit agreement with a group of banks which provides for the borrowing by Eastern of up to $100,000,000 (of which up to $75,000,000 may be borrowed or used to back commercial paper issued by the Company) at any time through December 29, 2000. The interest rate for such borrowings is the agent bank's prime rate, or at Eastern's option, various alternatives.\nNotes Payable\nIn addition to the Eastern borrowing arrangement, the Company maintained committed lines of credit totaling $40,000,000 during 1995 and 1994 which were not renewed.\nBOSTON GAS COMPANY AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(4) COMMITMENTS--(CONTINUED)\nThe Company has various uncommitted lines of credit which provide for interest as a function of federal funds, money market or prime rates. These uncommitted lines of credit are used, in conjunction with commercial paper, for working capital needs. The Company had outstanding borrowings of $52,000,000 and $62,530,000 in commercial paper not related to gas inventory financing at December 31, 1995 and 1994, respectively. The weighted average interest rate on these borrowings at December 31, was 5.93% in both 1995 and 1994.\n(5) PREFERRED STOCK\nThe Company has outstanding 1,200,000 shares of 6.421% Cumulative Preferred Stock, which is non-voting and has a liquidation value of $25 per share. The preferred stock requires 5% annual sinking fund payments beginning on September 1, 1999 with a final redemption on September 1, 2018. The preferred stock is not callable prior to 2003.\n(6) PENSION BENEFITS\nThe Company, through retirement plans under collective bargaining agreements and participation in Eastern's pension plans, provides retirement benefits for substantially all of its employees. The benefits under these plans are based on stated amounts for years of service or employee's average compensation during the five years prior to retirement. The Company follows a policy of funding retirement and employee benefit plans in accordance with the requirements of the plans and agreements in sufficient amounts to satisfy the \"Minimum Funding Standards\" of the Employee Retirement Income Security Act of 1974 (\"ERISA\").\nNet pension cost included the following components:\nFor the periods 1995 and 1994, the expected long-term rate of return on assets was 8.5% and the discount rate used in determining the actuarial present value of the projected benefit obligation was 7.5%. The rate of increase in future compensation levels was 4.75%--5.0% for 1995 and 5% in 1994.\nThe following table sets forth the funded status of pension plans and amounts recognized in the Company's consolidated balance sheets based on a measurement date of October 1.\nBOSTON GAS COMPANY AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(7) POSTRETIREMENT BENEFITS OTHER THAN PENSIONS\nIn addition to providing pension benefits, the Company, through participation in Eastern administered plans and welfare plans under collective bargaining agreements, provides certain health care and life insurance benefits for retired employees.\nThe expected cost of postretirement benefits other than pensions is charged to expense during the period that the employee renders service. As of the date of adoption of Statement of Financial Accounting Standards No. 106 (\"SFAS106\"), \"Employees Accounting for Postretirement Benefits Other Than Pensions\" the cumulative effect of the accounting change (\"transition obligation\") was $89,120,000. With approval by the Department, the Company has deferred the cost of the transition obligation and the amount by which expense under SFAS 106 exceeds amounts currently included in rates. The 1993 rate order allows the Company to phase-in incremental costs associated with SFAS 106 over a four-year period. Each year during the phase-in, the Company will file for an increase in rates to reflect an additional increment of SFAS 106 costs. The difference between the incremental annual amount requested in rates during the phase-in period and the full SFAS 106 costs will be deferred as a regulatory asset with carrying costs.\nNet postretirement benefit costs included the following components:\nThe following table sets forth the funded status of the plans and amounts recognized in the Company's consolidated balance sheets based on a measurement date of October 1.\nThe Company established a 501(c) (9) Voluntary Employee Beneficiary Association (\"VEBA\") Trust in 1991 to begin funding its postretirement benefit obligation for collectively bargained employees. The Company contributed $2,600,000 to the VEBA in 1995. There were no contributions to the VEBA in 1994 or 1993. Plan assets are invested in equity securities, fixed-income investments and money market instruments.\nThe weighted average discount rate used in determining the accumulated post- retirement benefit obligation was 7.5% in 1995 and 1994. A 10% and 11% annual increase in the cost of covered health care benefits was\nBOSTON GAS COMPANY AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(7) POSTRETIREMENT BENEFITS OTHER THAN PENSIONS (CONTINUED)\nassumed for 1995 and 1994, respectively. This rate of increase is assumed to drop gradually to 5% after 5 years. A 1% increase in the assumed health care cost trend would have increased the postretirement benefit cost by $541,000 in 1995 and $529,000 in 1994, and the accumulated postretirement benefit obligation by $6,300,000 in 1995 and $6,302,000 in 1994.\n(8) LEASES\nThe Company and its subsidiary lease certain facilities and equipment under long-term leases which expire on various dates through the year 2001. Total rentals charged to income under all lease agreements were approximately $8,826,000 in 1995, $8,323,000 in 1994 and $7,663,000 in 1993.\nThe Company capitalizes its financing leases which include liquefied natural gas facilities and an operations center. A summary of property held under capital leases as of December 31 is as follows:\nUnder the terms of SFAS No. 71, the timing of expense recognition on capitalized leases should conform with regulatory rate treatment. The Company has included the rental payments on its financing leases in its cost of service for rate purposes. Therefore, the total depreciation and interest expense that was recorded on the leases was equal to the rental payments included in other operating and maintenance expense in the accompanying consolidated statements of earnings.\nThe Company also has various operating lease agreements for office facilities and other equipment. The remaining minimum rental commitment for these and all other noncancelable leases, including the financing leases, at December 31, 1995 is as follows:\nBOSTON GAS COMPANY AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(9) FAIR VALUES OF FINANCIAL INSTRUMENTS\nThe following methods and assumptions were used to estimate the fair value disclosures for financial instruments:\nCash\nThe carrying amounts approximate fair value.\nShort-term Debt\nThe carrying amounts of the Company's short-term debt, including notes payable and gas inventory financing, approximate their fair value.\nLong-term Debt\nThe fair value of long-term debt is estimated based on currently quoted market prices for similar types of borrowing arrangements.\nPreferred Stock\nThe fair value of the preferred stock for 1995 and 1994 is based on currently quoted market prices.\nThe carrying amounts and estimated fair values of the Company's financial instruments at December 31, 1995 and 1994 are as follows:\n(10) SUPPLEMENTARY INFORMATION\nThe Company paid Eastern $4,117,000 in 1995, $3,669,000 in 1994, and $3,096,000 in 1993 for various legal, tax and corporate services rendered.\n(11) ENVIRONMENTAL ISSUES\nThe Company, 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. The Company currently owns 15 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 site in Lynn, Massachusetts, pursuant to the decision of the First Circuit Court of Appeals in The 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 recent settlement agreement between MEC and the Company (the \"Settlement Agreement\"), MEC also assumed responsibility for remediating ten other sites owned by the Company, subject to limited contribution by the Company. The Company 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 the Company and not covered by the\nBOSTON GAS COMPANY AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(11) ENVIRONMENTAL ISSUES (CONTINUED)\nSettlement Agreement or the Boyd decision. The Company expects to spend approximately $1 million in 1996 for assessment and contribution costs associated with the Company's and MEC's site investigations. Since the DEP has not yet approved a remediation plan for any of these sites, the Company does not possess at this time sufficient information to reasonably determine the ultimate cost of remediation, and no assurance can be given with respect to the future recoverability of such costs. However, management believes that it is not probable that such costs will materially affect the Company's financial condition or results of operations, particularly given the Company's limited potential responsibility as a result of the Settlement Agreement and the rate order discussed below. Company experience to date indicates that assessment and remediation costs of approximately $15 million could be paid by the Company with respect to these ten sites covered by the Settlement Agreement and the four other currently owned sites.\nThe Company is aware of 25 other former MGP sites within the Company's service territory which the Company does not currently own. MEC has provided full indemnification of Boston Gas with respect to eight of these sites in the Settlement Agreement. At this time, there is substantial uncertainty as to whether the Company is responsible for remediating any of the other sites either because the Company does not have successor liability for contamination of these sites by earlier operators or site conditions do not require remediation by the Company. The DEP has not issued a Notice of Responsibility to the Company for any of these sites.\nBy a rate order issued on May 25, 1990, the Department approved the recovery through the cost of gas adjustment clause of all environmental response costs associated with former MGP sites over separate, seven-year amortization periods without a return on the unamortized balance. The rate order also provides for no further investigation of the prudency of any Massachusetts gas utility's past MGP operations.\n(12) PIPELINE TRANSITION COSTS\nPursuant to Federal Energy Regulatory Commission (\"FERC\") Order No. 636, pipelines are currently recovering prudently incurred transition costs, including (1) gas supply realignment costs or the costs of renegotiating existing gas supply contracts with producers; (2) unrecovered purchased gas adjustment costs or uncovered gas costs at the time the pipelines ceased the merchant function; (3) stranded costs or the unrecovered costs of assets that cannot be assigned to customers of unbundled services; and (4) new facilities costs or the costs of new facilities required to physically implement the order.\nThe Company's estimate of its obligation for transition costs is $44,520,000 at December 31, 1995 and it has recorded this amount less actual billings of $35,010,000 as a liability in the accompanying consolidated balance sheet. As pipelines continue to file for recovery of transition costs, the Company's obligation may increase.\nOn March 8, 1995 the Department issued an order allowing for the recovery of the Company's transition costs liability over one year. Accordingly, at December 31, 1995 the Company has recorded a regulatory asset of $9,510,000 and deferred gas costs of $19,363,000 which, taken together plus recoveries to date, is equivalent to the Company's total estimated obligation for transition costs.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo Boston Gas Company:\nWe have audited the accompanying consolidated balance sheets of Boston Gas Company (a Massachusetts Corporation and wholly-owned subsidiary of Eastern Enterprises) and subsidiary as of December 31, 1995 and 1994, and the related consolidated statements of earnings, retained earnings and cash flows for each of the three years in the period ended December 31, 1995. These consolidated financial statements and the schedules referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as 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 Boston Gas Company and subsidiary as of December 31, 1995 and 1994 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995, 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 schedules listed in the index to consolidated financial statements 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\nBoston, Massachusetts January 23, 1996\nBOSTON GAS COMPANY AND SUBSIDIARY\nINTERIM FINANCIAL INFORMATION FOR THE TWO YEARS ENDED DECEMBER 31, 1995 (UNAUDITED)\nThe following table summarizes the Company's reported quarterly information for the years ended December 31, 1995 and 1994:\nSCHEDULE II\nBOSTON GAS COMPANY AND SUBSIDIARY\nVALUATION AND QUALIFYING ACCOUNTS FOR THE YEAR ENDED DECEMBER 31, 1995 (IN THOUSANDS)\nSCHEDULE II\nBOSTON GAS COMPANY AND SUBSIDIARY\nVALUATION AND QUALIFYING ACCOUNTS FOR THE YEAR ENDED DECEMBER 31, 1994 (IN THOUSANDS)\nSCHEDULE II\nBOSTON GAS COMPANY AND SUBSIDIARY\nVALUATION AND QUALIFYING ACCOUNTS FOR THE YEAR ENDED DECEMBER 31, 1993 (IN THOUSANDS)","section_15":""}
{"filename":"92521_1995.txt","cik":"92521","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nThe Company\nSouthwestern Public Service Company (the Company) was incorporated in New Mexico in 1921. The Company's principal business is the generation, transmission, distribution and sale of electric energy. Substantially all of its operating revenues were so derived during each of the fiscal years ended August 31, 1995, 1994 and 1993. The Company has two wholly owned subsidiaries, Utility Engineering Corporation (UE) and Quixx Corporation (Quixx). See NONUTILITY BUSINESSES and Note (1) of NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.\nOn August 22, 1995, the Company and Denver-based Public Service Company of Colorado (PSCo) entered into a definitive agreement providing for a \"merger of equals\" of the two companies. Under the agreement, a registered public utility holding company would be the parent company of the Company and PSCo. See Note (2) of NOTES TO CONSOLIDATED FINANCIAL STATEMENTS for further information on this business combination. Reference is made to the Company's current report on Form 8-K filed with the Securities and Exchange Commission on August 23, 1995, including the Agreement and Plan of Reorganization and other documents filed as exhibits thereto. The information set forth in this Form 10-K (unless otherwise indicated) does not take into account changes that would result from the merger.\nThe Company has called for redemption on December 27, 1995, all of its outstanding Cumulative Preferred Stock which is redeemable by its terms. The Company will also purchase all 2,600 shares of its 14.50% Cumulative Preferred Stock (which is not redeemable by its terms). These 2,600 shares of preferred stock are held by Don Maddox, a director of the Company, as one of two co-personal representatives of the Estate of James M. Murray, Jr., in which Mr. Maddox shares voting and investment power. These shares were acquired by Mr. Murray in connection with the acquisition in 1982 by the Company of the electrical distribution system of Cochran Power and Light Company. This preferred stock purchase is being negotiated. As a consequence, upon the above redemptions and purchase, there will be no shares of Preferred Stock outstanding. However, the Company plans, subject to market conditions, to reissue Preferred Stock in 1996 subsequent to its Annual Meeting of Shareholders (scheduled to be held January 31, 1996) at which holders of its Common Stock will be requested to approve the amendment of the Company's Restated Articles of Incorporation (Articles) with respect to the Preferred Stock so as to modernize such provisions and eliminate covenants imposed thereby. The redemption and purchase of the outstanding Cumulative Preferred Stock is being undertaken for the purpose of facilitating obtaining shareholder approval of the merger of the Company and PSCo and modernizing the Preferred Stock provisions of the Articles. See MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS-Liquidity and Capital Resources.\nElectric service is provided through an interconnected system to a population of about one million in a 52,000-square-mile area of the Panhandle and south plains of Texas, eastern and southeastern New Mexico, the Oklahoma Panhandle and southwestern Kansas. The Company provides electric energy to forty-six communities with a population of 2,000 or more, thirty-five in Texas, nine in New Mexico, and one each in Oklahoma and Kansas. Approximately 56% of the Company's operating revenues during fiscal 1995, excluding sales to other utilities, were derived from operations in Texas.\nThe Company's sales are made to retail and wholesale customers. Retail sales to ultimate consumers include residential, commercial and industrial customers. Wholesale sales include sales for resale to rural electric cooperatives, and firm and non-firm sales to other utilities. These non-firm, or economy, wholesale sales to other utilities also include sales of interruptible power made under Federal Energy Regulatory Commission (FERC) approved contracts. Firm sales are made under contract to other adjoining utilities while non-firm sales are negotiated on the spot market or sold under the Western Systems Power Pool (WSPP) agreement. See INTERCONNECTIONS. Non-firm sales are made to adjoining and other utilities.\nThe production, transportation and processing of oil and natural gas, and chemical, mineral and light manufacturing industries are of prime importance in the area served. Agriculture and the processing of agricultural products, including wheat, cotton, corn, sugar beets and vegetables, and livestock raising and meat processing are industries of economic significance. The area also contains many other diversified industries and commercial enterprises. See STATISTICAL SUMMARY-ELECTRIC REVENUES.\nThe Company's largest sales of electric energy are during the summer months when demand reaches a peak. The Company's 1995 maximum hourly net peak system demand of 3,952 megawatts (MW) occurred on July 28, 1995 and was an all-time high peak. The previous maximum net peak of 3,682 MW occurred on July 6, 1994. See PEAK LOAD AND CAPABILITY.\nSee REGULATION-Competition and Note (8) of NOTES TO CONSOLIDATED FINANCIAL STATEMENTS for information on the changing utility environment.\nCONSTRUCTION PROGRAM\nCash expenditures for the Company's construction program were $94.7 million in fiscal 1995. These expenditures did not include any amounts for the construction of new base load generating facilities.\nThe following general discussion of the Company's construction program and related expenditures are for a stand-alone company; that is, without consideration to the proposed merger with PSCo. On that basis, the Company's estimated construction expenditures for the next five years are as follows:\nThe estimates in 1997, 1998 and 1999 for generating facilities include costs for the construction of approximately 400 MW of additional capacity. Such construction plans include a 200 MW natural-gas-fired cogeneration facility to be completed in 1998 at a Phillips Petroleum Company complex near Borger, Texas, and a 198 MW natural-gas-fired combustion turbine to be completed in 1999 at an existing Company plant site. The Company was recently granted a Notice of Intent by the Public Utility Commission of Texas (PUCT) to construct approximately 300 MW of the 400 MW of new capacity.\nPUCT regulations require that a solicitation be conducted before a utility seeks certification of a new generating unit. The goal of this solicitation process is to evaluate and select the most appropriate combination of resources. Pursuant to these regulations, on September 15, 1995, the Company issued a request for proposals (RFP) to seek alternatives to its proposed construction. The Company's solicitation encompasses alternative supply-side options, renewable resources, off-system transactions (primarily purchases), demand-side management programs, and existing customer interruptible load programs. Responses to this RFP are due to a third party evaluator in January 1996.\nThe estimates in 1998 and 1999 for transmission facilities include expenditures of $18 million for a 230 KV transmission line to be constructed from Amarillo, Texas to Clovis, New Mexico in order to improve the reliability of the Company's system. Expenditures are also planned to upgrade transmission and distribution lines and substations to preserve reliability and efficiency.\nThese estimated expenditures have been prepared for planning purposes as part of the Company's resource planning process (discussed below), and are subject to review and revision. Actual expenditures will vary from these estimates, as they have in the past, due to a number of factors, including regulatory requirements related to the planning and siting of facilities, changes in the rate of inflation, construction scheduling, environmental matters, the cost and availability of funds, the rate of kilowatt-hour (kwh) sales growth and other changes in business conditions, regulation and legislation. The completion of the merger with PSCo could significantly impact these estimates.\nThe Company's resource planning process is designed to determine the optimal mix of capacity resources that would reliably meet its load and reserve requirements at the least possible cost, while providing flexibility to respond to uncertainty in the forecasts of load, fuel prices, and financial and other conditions. The Company typically considers its load forecast, demand-side management programs, Southwest Power Pool (SPP) reserve requirements, and new generating unit alternatives, and after consideration of these and any other relevant factors, arrives at a capacity expansion plan which balances cost and system operations.\nDuring the five fiscal years ended August 31, 1995, the Company had property additions (including work in progress) to utility plant of $437 million and retirements of $43 million. At August 31, 1995, net utility plant was approximately $1.5 billion.\nSee MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS-Liquidity and Capital Resources for information on the Company's estimated capital expenditures and financing program. Also see NONUTILITY BUSINESSES-QUIXX for information on Quixx's investment expenditures.\nPEAK LOAD AND CAPABILITY\nPlant capability, peak load, capacity margin and load factor were as follows for the last three fiscal years:\nAs a member of the SPP, the Company's policy is to maintain a net capacity margin in accordance with SPP criteria. For steam-based utilities, the SPP guideline is a minimum capacity margin of 13%. Because of the high peak load experienced in 1995, the Company's capacity margin was 4.4% for that year. However, through the expansion of an existing interruptible program for irrigation load, the initiation of a new interruptible program for industrial load, purchased power and the consideration of additional capacity on the system, the Company expects to be within the SPP guideline through the remainder of the decade. See CONSTRUCTION PROGRAM.\nDuring the period 1996 through 2000, the Company currently estimates that its compound annual growth rates will be 2.5% for wholesale sales, excluding non-firm sales, and 2.0% for retail sales. Total kwh sales estimates show a compound annual growth rate of 1.3% for this forecast period. The Company periodically reviews expected growth patterns in its service area and these growth rate estimates are subject to change. See MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nINTERCONNECTIONS\nThe Company is connected with utilities west of its service territory through two high voltage direct current (HVDC) interconnections in New Mexico and has four interconnecting transmission lines with utilities of the SPP. These interconnections are described in the following table:\nTransactions with the SPP are handled through interties near Elk City and Guymon, Oklahoma, and Shamrock and Oklaunion, Texas. These interties allow the Company to sell or to purchase energy from the eastern electrical grid. Sales through eastern interties accounted for 2.0% of fiscal 1995 total sales.\nHVDC interconnections link the Company with the western electrical grid of the United States. The Company purchases and sells energy through HVDC interties near Artesia and Clovis, New Mexico. Sales through these interties accounted for 4.1% of fiscal 1995 total sales.\nThe Company participates in the bulk power market through the WSPP. In fiscal 1995, 2.0% of total sales were due to WSPP bulk power sales.\nUnder an agreement which expires in December 1996, the Company is selling 50 MW of firm power to El Paso Electric Company (EPE) through the HVDC interconnection near Artesia, New Mexico. The sale is scheduled to increase to 75 MW in January 1996. For the months of May through August 1995, EPE purchased an additional 70 MW to help meet increased weather-related demand. Additional firm power sales through this HVDC connection to Texas-New Mexico Power Company (TNP) are made under an agreement with an initial term that expires in 2004. TNP purchased 33 MW of service from September through December 1993, and 66 MW from January 1994 through December 1995. This sale is scheduled to decrease to 59 MW in January 1996. TNP may increase or decrease the contract amount by up to 10% with one year's notice.\nThe Company has an interconnection agreement with Public Service Company of New Mexico (PNM) to sell power through the HVDC interconnection near Clovis, New Mexico. Under this agreement PNM purchased 100 MW of interruptible power service through April 1995. Beginning in May 1995, PNM began purchasing 200 MW. The agreement provides that PNM will continue purchasing 200 MW annually thereafter through May 2011 except that they may reduce purchases by 25 MW increments upon written notice given at least three years in advance of each increment reduction. However, the purchase may not be reduced by more than one 25 MW increment in any twelve-month period. PNM has not provided any written notice of intent to reduce its purchases under this agreement.\nUnder a firm wholesale power agreement which expires in 2014, the Company has contracted to serve the full requirements load of Cap Rock Electric Cooperative (Cap Rock). Cap Rock began purchasing 15 MW of service on February 1, 1994, and increased to 100 MW in February 1995.\nThe Company has entered into an agreement with The Empire District Electric Company (EDE) to sell interruptible wholesale power through the interconnections near Elk City, Oklahoma and Oklaunion, Texas. Under this agreement, which expires in 2001, EDE may purchase available power through December 1995 and will purchase 35 MW in 1996 with such purchases to increase to 45 MW by 1999. Public Service Company of Oklahoma has agreed to wheel such service over its transmission system.\nInterconnection sales for fiscal 1995 through the eastern electrical grid totaled 395,490 MWH, including 303,037 MWH of WSPP sales. Sales through the western electrical grid totaled 820,445 MWH, consisting of 46,595 MWH of firm sales and 773,850 MWH of non-firm sales, including 90,807 MWH of WSPP sales.\nFUEL SUPPLY AND PURCHASED POWER\nFuel Supply\nApproximately 53% of the Company's present generating capacity is fueled by coal, 46% by gas and 1% by inert by-product gases, purchased steam and oil. See PROPERTIES for information about generating plants.\nThe Company's actual and anticipated fuel use, as reported in the table below, is based on MMBtu use for generation of electricity excluding non-firm sales. The unpredictability of the non-firm sales market precludes its inclusion as a factor in determining these fuel use projections. These projections do not consider the proposed merger with PSCo.\nFiscal Estimated for fiscal years ending August 31, Fuel 1995 1996 1997 1998 1999 2000 Coal 64.4% 65.4% 65.6% 63.0% 62.1% 61.3% Gas 34.8 33.8 33.6 36.2 37.2 37.9 Other 0.8 0.8 0.8 0.8 0.7 0.8\nAnticipated fuel use is based upon numerous assumptions with respect to, among other things, regulatory requirements relating to cogeneration and environmental protection, load growth, cost and availability of boiler fuels and the extent to which the Company receives and can utilize contracted-for gas, renegotiates present gas contracts and enters into new agreements. Actual fuel mix in future years may vary substantially from these estimates because these assumptions may not be realized.\nCoal\nThe Company purchases all of its coal requirements for Harrington and Tolk Stations from TUCO, Inc. (TUCO), a wholly owned subsidiary of Cabot Corporation, in the form of crushed, ready-to-burn coal delivered by coal-handling facilities owned by Wheelabrator Coal Services Co. to the Company's boiler bunkers located within the Company's coal-fueled stations where it is processed for burning. The coal is transported for TUCO by rail, primarily from mines located in Wyoming, to TUCO's stockpiles which are adjacent to the Company's coal-burning generating stations. At August 31, 1995, TUCO's coal inventories at the Harrington and Tolk sites were 723,091 tons and 652,978 tons (approximately 60 days supply), respectively. The Company has agreed to purchase all of the outstanding stock of TUCO from Cabot Corporation for $77 million, subject to certain regulatory approvals. This acquisition is scheduled to be completed in fiscal 1996. See Note (2) of NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.\nTUCO has long-term contracts with Atlantic Richfield Company (ARCO) for a supply of coal in sufficient quantities to meet all of the Company's needs for Harrington and Tolk Stations. See ITEM 3.","section_1A":"","section_1B":"","section_2":"","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThe Company has been named as a defendant in a case entitled Thunder Basin Coal Co. v. Southwestern Public Service Co., No. 93-CV-304B (D. Wyo.). The action was served on the Company on February 14, 1994 and it involves a dispute over the interpretation of a clause in a contract between Thunder Basin and TUCO for the supply of coal for use by the Company. The suit sought a determination that there has been a partial repudiation of the agreement by TUCO which has damaged Thunder Basin, and that the Company is liable for that damage as a result of its guarantee of TUCO's performance. Thunder Basin also claimed that the Company interfered with the contract between Thunder Basin and TUCO, causing Thunder Basin damage. The total alleged damages sought by Thunder Basin was in excess of $20 million. The Company denied any liability, and asked the court to determine that its interpretation of the contract was correct.\nThunder Basin's Wyoming lawsuit in federal court went to trial in late October 1994. On November 1, 1994 the jury returned a verdict in favor of Thunder Basin and against the Company finding that there had been a partial repudiation of the contract and that the Company had interfered with Thunder Basin's contract with TUCO. The jury awarded damages to Thunder Basin of approximately $18.8 million. The Company has appealed the judgement to the Tenth Circuit Court of Appeals and the appeal is progressing.\nThe Company, in conjunction with TUCO, has commenced a related case against Thunder Basin and its parent ARCO in state court in Amarillo, Texas (No. 80,280-E, TUCO, Inc. v. Thunder Basin Coal Company). This suit involves some of the same issues of contract interpretation raised in the Thunder Basin Wyoming suit, as well as the Company's claims that it has been overcharged approximately $40 million for coal during the course of the contract. This litigation is proceeding.\nTUCO requested an audit of Thunder Basin's and ARCO's costs and expenses used to calculate the cost escalation under the contracts which supply coal for the Company. Thunder Basin and ARCO filed suit in Wyoming state court (No. 20041, Thunder Basin Coal Company v. TUCO, Inc. and Southwestern Public Service Company) on June 26, 1995, seeking a declaratory judgment of the extent of the information which must be revealed to TUCO under the coal supply contracts. That suit was amended in September 1995 to request a declaratory judgment of the issues pending in the Texas state court litigation.\nManagement believes that if a payment must ultimately be made to Thunder Basin it would be recoverable from ratepayers, although any such recovery would be subject to regulatory review. The Company has applied to the FERC for approval to recover, subject to refund, the $18.8 million in potential damages. Intervention has been filed and the matter is pending before the FERC. Management believes that ultimate resolution will not have a material adverse effect on the Company's consolidated financial statements.\nThe Company is involved in ordinary routine litigation incidental to the business which litigation is not considered material. See REGULATION, ENVIRONMENTAL MATTERS and Notes (6), (8) and (9) of NOTES TO CONSOLIDATED FINANCIAL STATEMENTS for information on regulation, environmental and rate matters.\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 Company's 1995 fiscal year to a vote of its security holders.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nThe principal markets on which the Company's common stock is traded are the New York, Chicago and Pacific Stock Exchanges. The common stock has unlisted trading privileges on the Boston and Philadelphia Stock Exchanges. The table below presents the high and low market prices as reported by the National Quotations Bureau, Inc., and dividend information for the Company's common stock.\nMarket Price Dividends High Low Declared 1995 - Fiscal Quarter Ended: November 30, 1994 $27 $25-1\/8 $0.55 February 28, 1995 29-3\/8 25-7\/8 0.55 May 31, 1995 29 27-1\/4 0.55 August 31, 1995 30-3\/4 28-5\/8 0.55 1994 - Fiscal Quarter Ended: November 30, 1993 $32-1\/2 $29-3\/4 $0.55 February 28, 1994 31-1\/8 27-5\/8 0.55 May 31, 1994 29-1\/4 23-3\/4 0.55 August 31, 1994 27-1\/4 24-1\/8 0.55\nThe Company declared dividends on its common stock of $2.20 in 1995 and 1994. The Company has agreed with PSCo in the merger agreement that it will not raise its common stock dividend rate without the consent of PSCo. The Company's dividend payout on its common stock was 79% in 1995 and 93% in 1994. At August 31, 1995, the number of holders of record of the Company's common stock was 30,496.\nThe Company's Restated Articles of Incorporation (Articles) provide that the Company may not, without the consent of two-thirds in aggregate par value of the preferred stock outstanding, (1) declare any dividends (other than dividends payable in stock junior to the preferred stock) on, or acquire shares of such junior stock unless, after giving effect thereto, the common stock equity, as defined, is at least equal to the involuntary liquidation value of the preferred stock and any stock ranking on a parity therewith or prior thereto; or (2) make any distribution out of capital or capital surplus (other than dividends payable in junior stock) to holders of junior stock, or purchase any junior stock, if thereupon the common stock equity would be below 22% of total capitalization, as defined. If the common stock equity at the end of any fiscal year is less than 25% of total capitalization, the Company must, during the ensuing fiscal year, redeem shares of preferred stock of certain series having an aggregate par value equal to one-quarter of the amount of such deficiency. Dividends on and acquisition of common stock are prohibited during a failure to comply with such obligation. At August 31, 1995, the common stock equity represented approximately 52% of total capitalization.\nThe Company has called for redemption and is purchasing all of its currently outstanding Preferred Stock. The Company will seek approval of its Common Shareholders at the Annual Meeting scheduled for January 31, 1996, to amend its Articles to eliminate the current provisions with respect to Preferred Stock, including those described above, and adopt modern, flexible provisions pursuant to which new series would be issued. See MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS-Liquidity and Capital Resources.\nThe Company covenants, in the Mortgage pursuant to which First Mortgage Bonds are issued, that it will not declare any dividends (other than dividends payable in its stock) upon its common stock, or make any payment on account of the purchase, redemption or other retirement of, or make any distribution in respect of, any shares of its stock except to the extent that the sum of (1) $1,278,243.59, (2) net income of the Company, as defined, since June 1, 1946, and (3) net proceeds received by the Company from the issue since such date of any shares of its stock (but only up to an amount equal to the aggregate amount of all payments since such date on account of the acquisition of any shares of its stock) shall be (after giving effect to such dividends or distributions) greater than the aggregate amount of dividends declared on all classes of the Company's stock and of all payments made on account of the acquisition of, or distribution in respect of, any shares of its stock since such date. See Note (4) of NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.\nIn 1991 the Company adopted a Shareholder Rights Plan, which has been amended so that it is not applicable to the merger with PSCo. See Note (1) of NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.\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.\nReferences to \"years\" in this discussion pertain to the Company's fiscal years which begin September 1 and end August 31. References to \"Notes\" pertain to the Notes to Consolidated Financial Statements.\nRESULTS OF OPERATIONS\nOperating Revenues and Kilowatt-Hour Sales\nSubstantially all of the Company's operating revenues result from the sale of electric energy. The principal factors determining revenues are the amount and price per unit of energy sold. The following table describes the principal components of changes in revenues.\nVariations in Kwh Sales. The revenue increases in 1995 were due primarily to increased kwh sales to rural electric cooperatives (RECs) and retail (ultimate) customers. The increase in REC sales was due primarily to Cap Rock Electric Cooperative (Cap Rock). Sales began in February 1994 and increased to 100% of Cap Rock's West Texas requirements in February 1995. Accounting adjustments to the estimate of delivered not billed kwh sales also increased kwh revenues by approximately $8.3 million. These estimated kwh sales relate to energy used by customers but not billed until the subsequent month. Increases in 1994 were due largely to increased sales to all classes of customers, but principally RECs. These increases were due in large part to dry, hot weather that favorably impacted agriculture-related sales. The Company expects modest growth in kwh sales (excluding non-firm sales) in 1996, given normal weather conditions. Current estimates of the compound annual growth rates in kwh sales for the five-year period 1996-2000 are 2.5% for wholesale sales (excluding non-firm sales) and 2.0% for retail sales. Last year the Company estimated for the period 1995-1999 that its wholesale sales growth rate would be 3.9% and the retail sales growth rate would be 1.6%. Last year's wholesale growth rate estimate was higher because it included the increase in the Cap Rock load.\nActual kwh sales by class of customer are shown in the following table:\nVariations in Rates. Increased revenues for 1995 resulted primarily from additional demand charge revenues paid by certain wholesale customers. Additionally, a settlement of the 1985 Federal Energy Regulatory Commission (FERC) rate case with the Company's New Mexico wholesale REC customers contributed increased revenues of approximately $4.0 million (and interest of $3.0 million which is included in other income) (see Note 9). Revenues attributable to rate changes decreased for 1994 because of the effects of the retail rate reductions in Texas and New Mexico. In Texas reduced rates totaling approximately $13 million annually were implemented October 15, 1993. In New Mexico an approximate $4 million annual reduction, approved in September 1994, became effective April 1, 1994.\nVariations in Fuel and Purchased Power Cost Recovery. Revenues decreased in 1995 due to substantially lower natural gas prices. These revenues increased in 1994 due to greater per unit fuel cost as a result of higher coal costs.\nFuel and purchased power costs are recoverable in Texas under a Public Utility Commission of Texas (PUCT) rule that provides for a fixed factor (based on known or reasonably measurable fuel costs) to be used for fuel cost collection with final approval of the amount of recoverable fuel cost being determined at the time of a utility's fuel reconciliation proceeding. If reasonably unforeseeable circumstances result in a material under-recovery of fuel costs, the utility may file a petition with PUCT requesting an emergency interim fuel factor. The Company's current fixed factor, set by the PUCT in April 1990, is based on then reasonably predictable fuel and purchased power costs. In all other jurisdictions, the Company currently recovers substantially all increases and refunds substantially all decreases in fuel and purchased power costs pursuant to monthly adjustment clauses. Currently the Company has $5.5 million in total overrecovered costs that are comprised of fuel costs totaling $3.7 million and off-system sales margin credits totaling $1.8 million. The Company refunded to its Texas retail customers margin credits on non-firm sales totaling $4.6 million in 1995. The Company is currently in a fuel reconciliation with the PUCT (see Note 9).\nVariations in Non-Firm Kwh Sales. The amount of revenues arising from non-firm sales is dependent, in large part, upon the amount and cost of power available to the Company for sale, the demand for power, the availability of competing hydro-electric power from the Northwest and generation from major plants in the West. The decline in non-firm sales in 1995 was due primarily to available power from major western plants and excess hydroelectric power in the Northwest. Mild weather throughout the region, particularly in the winter, also contributed to the decline for the year. Greater non-firm sales in 1994 were due primarily to increased sales to other regional utilities. These sales were curtailed somewhat in the last quarter of 1994 and 1995 because hot weather in the Company's service territory limited the amount of power the Company had available for such sales.\nOperating Expenses and Other Income\nOperating Expenses. Fuel and purchased power expense comprised 55.2% of total operating expenses in 1995 and 58.0% in 1994. Such expenses, when compared to prior years, decreased 8.0% in 1995 and increased 6.5% in 1994. The decrease in 1995 is due primarily to decreased natural gas prices and decreased kwh generation. The primary reason for the rise in 1994 was increased kwh generation. The fuel cost per net kwh generated was 1.75 cents, 1.87 cents and 1.85 cents in 1995, 1994 and 1993, respectively. The decline in 1995 was due to decreased natural gas prices. The increase in 1994 was due to increased coal costs. Although fuel costs are expected to rise marginally throughout 1996, the Company plans to mitigate any such increases through the purchase of lower-priced gas on the open market and under short-term contracts, as well as using low-priced coal purchased on the spot market for generation of off-system sales.\nOperating expenses, excluding fuel and purchased power, increased 2.9% in 1995 and 3.4% in 1994. The increase in 1995 was due primarily to increased federal income taxes as a result of larger taxable income. The increase in 1994 was due primarily to the adoption of Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (see Note 7). Additionally, \"Taxes other than property and income taxes\" were higher in 1994 because a one-time Texas franchise tax refund lowered such taxes in 1993. This refund was a result of the Company amending its returns for 1988 through 1991 to utilize accelerated instead of straight-line depreciation to determine taxable capital. In 1995 and 1994 cost-reduction and cost-control measures were implemented throughout the Company in an effort to mitigate the financial impact of retail rate reductions that resulted in lowering the level of increases in certain operating expenses. Additionally, lower depreciation rates, approved in Texas and New Mexico retail jurisdictions in conjunction with the rate cases to lower base rates, caused depreciation expense to be approximately $2.9 million lower in 1994 than it would have been under the previous rates. Property additions caused increased property taxes in 1995 and school finance reform in Texas resulted in property tax increases in 1994. Although property taxes are expected to continue to increase in 1996, the rate of increase is expected to decline. The Company has a hiring freeze in effect during the merger process (see Note 2). The Company's expenses in 1995 and 1994 were not significantly impacted by inflation.\nOther Income. Other income increased 150.7% in 1995 and decreased 45.1% in 1994. The $4.3 million increase in 1995 is due primarily to approximately $3.0 million of interest on the rate case settlement with New Mexico wholesale customers and greater subsidiary earnings. The write-off in 1994 of nonrecurring items caused the decline in such income in 1994. These nonrecurring items included $2.8 million of engineering and design costs of a previously planned generating facility and contractual costs associated with other generation studies. Also included was $0.6 million of business development costs related to a generation project in the state of Missouri. Also contributing to the decrease in 1994 was a $1.4 million reduction in the equity portion of allowance for funds used during construction (AFUDC) due to reduced rates. Somewhat offsetting the effects of the nonrecurring expenses and lower AFUDC was a $1.5 million increase in subsidiary income. Subsidiary operations contributed approximately 13 cents per share to earnings in 1995 and 8 cents in 1994.\nEarnings\nOperating income and earnings applicable to common stock increased in 1995 due primarily to greater sales to RECs, the change in estimate of delivered not billed kwh ($5.4 million or 13 cents per share) and the rate settlement with wholesale customers in New Mexico ($4.5 million or 11 cents per share). Operating income and earnings declined in 1994 due to increased operating expenses. In 1994 the favorable effects of increased kwh sales and lower preferred stock dividends were mitigated by retail rate reductions, nonrecurring expenses, and lower AFUDC. Assuming normal weather conditions, earnings for the 1996 fiscal year are expected to remain relatively level. A favorable resolution of the 1985 FERC rate case with Texas wholesale REC customers could materially improve 1996 earnings. Quixx has entered into an agreement to sell certain water rights to the Canadian River Municipal Water Authority for $14.5 million which would result in an after-tax gain of approximately $7.6 million. The Company expects, but can give no assurance, that this sale would be completed in fiscal 1996.\nThe Company's average common equity for the years 1995, 1994 and 1993 was $708.5 million, $692.5 million and $684.2 million, respectively. The rate of return on average common equity for these years was 16.2%, 14.1% and 14.5%, respectively. The components of such return are presented as follows:\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company's demand for capital is normally related to the construction of utility plant and equipment. Cash construction expenditures excluding AFUDC were $94.7 million, $91.8 million and $92.3 million in 1995, 1994 and 1993, respectively. During 1995 the Company generated substantially all of its capital requirements for such purposes internally. Also in 1995, Quixx invested $28.3 million in independent power projects and expects to continue to make such investments in the future dependent upon suitable investment opportunities and the availability of capital. Estimated construction expenditures excluding AFUDC are $112.9 million for 1996 and $665 million for the five-year period 1996-2000. In 1996 the anticipated purchase of TUCO, Inc. (TUCO) from Cabot Corporation and certain Texas properties purchased from Texas New Mexico Power Company (TNP) will result in additional cash requirements of approximately $106 million (see Note 2). The portion of cash requirements to be provided by internally generated funds cannot be accurately forecast, but the Company expects that it will be approximately 40% in 1996 (including TNP and TUCO), and approximately 55% for the five-year period 1996-2000. The Company's estimates of capital needs, particularly those related to construction, and generation of internal funds are subject to review and revision, and may vary substantially from the foregoing. During the period 1996-2000, the Company will be required to retire $105 million of long-term debt, comprised of $15 million First Mortgage Bonds (Bonds), 5.70% Series due 1997 and $90 million Bonds 6.875% Series due 1999.\nIn addition, as discussed under BUSINESS-General, the Company has called for redemption as of December 27, 1995, all of its outstanding Preferred Stock which is redeemable by its terms and will purchase all of the outstanding 2,600 shares of its 14.50% Cumulative Preferred Stock which is not redeemable by its terms. As a consequence, following the redemptions and purchase, there will be no shares of Preferred Stock outstanding. The Company will seek approval of the holders of its Common Stock at its Annual Meeting to be held on January 31, 1996, to amend its Articles relating to the Preferred Stock in order to provide for updated provisions and eliminate covenants imposed by the current provisions. The aggregate redemption price of the outstanding shares of stock which are to be redeemed is approximately $75 million, including accrued dividends. The purchase price of the non-redeemable 14.50% Cumulative Preferred Stock is being negotiated. The Company plans to finance the redemption and purchase of the Preferred Stock with the use of short-term borrowings, which would be repaid subject to market conditions with the issuance of new Preferred Stock following the Annual Meeting in January 1996 or with the issuance of Bonds during 1996. The estimates set forth in the preceding paragraph do not include the issuance of securities to obtain the funds required for the Preferred Stock redemptions and purchase. The Company currently contemplates the sale of other Preferred Stock, Common Stock and Bonds during the five-year period 1996-2000 in connection with the financing of its construction program and retirement of Bonds.\nIn August 1994 the Company entered into a forward interest rate swap agreement in anticipation of redeeming its $25 million principal amount of 13-1\/2% pollution control revenue bonds with a new issuance of variable rate pollution control revenue bonds. Such bonds are not redeemable until October 1, 1996 (see Note 4).\nThe Company has effective a shelf registration under which a remaining aggregate of $130 million of First Mortgage Bonds and Cumulative Preferred Stock may be issued (a maximum of $40 million of Preferred Stock is issuable thereunder). At August 31, 1995, the Company maintained committed bank lines of credit aggregating $128 million, of which the Company had no borrowings outstanding at fiscal year-end.\nOTHER MATTERS\nElectric utilities have historically operated in a highly regulated environment in which they have an obligation to provide electric service to their customers in return for an exclusive franchise within their service territory with an opportunity to earn a regulated rate of return. This regulatory environment is changing. The generation sector has experienced competition from nonutility power producers, and the FERC is requiring utilities, including the Company, to provide wholesale transmission service to others and may order electric utilities to enlarge their transmission systems to facilitate transmission services. Some state regulatory authorities are in the process of changing utility regulations in response to federal and state statutory changes and evolving markets (see Note 8). In partial response to these changing conditions, the Company has entered into a definitive merger agreement with Public Service Company of Colorado (the Merger). Consummation of the Merger is subject to customary conditions including receiving shareholder and regulatory authority approvals. The two utilities are working toward a completion date in the fall of 1996 (see Item 1. BUSINESS-General and Note 2). The foregoing discussions of the Company's results of operations and liquidity and capital resources do not take into account any changes that could arise as a result of the Merger.\nThe foregoing discussion and analysis by management is intended to provide a summary of information relevant to an assessment of the financial condition and results of operations of the Company and should be read together with the Consolidated Financial Statements and Notes to Consolidated Financial Statements in order to arrive at a more complete understanding of such matters.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Shareholders Southwestern Public Service Company:\nWe have audited the accompanying consolidated balance sheets and statements of capitalization of Southwestern Public Service Company and subsidiaries as of August 31, 1995 and 1994, and the related consolidated statements of earnings, common shareholders' equity and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Southwestern Public Service Company and subsidiaries as of August 31, 1995 and 1994, and the results of their operations and their cash flows for the years then ended, in conformity with generally accepted accounting principles.\nAs discussed in Notes 1 and 7 to the consolidated financial statements, in 1994, the Company changed its method of accounting for income taxes and postretirement benefits other than pensions to conform with Statements of Financial Accounting Standards No. 109 and No. 106, respectively.\nDELOITTE & TOUCHE LLP\nDallas, Texas October 10, 1995\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Shareholders Southwestern Public Service Company:\nWe have audited the accompanying consolidated statements of earnings, common shareholders' equity and cash flows of Southwestern Public Service Company and subsidiaries for the year ended August 31, 1993. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the results of operations and cash flows of Southwestern Public Service Company and subsidiaries for the year ended August 31, 1993, in conformity with generally accepted accounting principles.\nKPMG Peat Marwick LLP\nAmarillo, Texas October 8, 1993\nSOUTHWESTERN PUBLIC SERVICE COMPANY\nNotes To Consolidated Financial Statements August 31, 1995\n(1) Nature of Operations and Summary of Significant Accounting Policies\nGENERAL\nSouthwestern Public Service Company (the Company) is principally engaged in the generation, transmission, distribution and sale of electric energy. The Company maintains its accounts in accordance with the Uniform System of Accounts prescribed by the Federal Energy Regulatory Commission (FERC) and as adopted by the Public Utility Commission of Texas (PUCT), the New Mexico Public Utility Commission (NMPUC), the Oklahoma Corporation Commission and the Kansas Corporation Commission.\nThe consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, Utility Engineering Corporation (UE) and Quixx Corporation and subsidiaries (Quixx). UE is primarily engaged in engineering, design and construction management. Quixx invests in cogeneration projects and holds water rights and certain other nonutility assets. The aggregate net earnings of UE and Quixx of $5,216,000, $3,335,000 and $1,868,000 in 1995, 1994 and 1993, respectively, are included in net other income in the Consolidated Statements of Earnings. All significant intercompany transactions and balances are eliminated in consolidation.\nUTILITY PLANT\nUtility plant is stated at the historical cost of construction, which includes labor, materials, an allowance for funds used during construction and indirect charges for such items as engineering, supervision and general administrative costs. Maintenance, repairs and minor replacements are charged to operating expense; major replacements and betterments are capitalized.\nThe cost of depreciable units of utility plant retired or disposed of in the normal course of business is eliminated from utility plant accounts and such cost plus removal expenses and less salvage value is charged to accumulated depreciation. When complete operating units are disposed of, appropriate adjustments are made to accumulated depreciation, and the resulting gains or losses, if any, are recognized.\nThe provision for depreciation is computed on a straight-line method at rates based on the estimated service lives and salvage values of the several classes of depreciable property as indicated by periodic depreciation studies. Depreciation as a percentage of average depreciable cost was 2.86% in 1995, 2.83% in 1994 and 2.96% in 1993.\nOPERATING REVENUES\nElectric rates include estimates of fuel costs incurred by the Company in the generation or purchase of electricity. Differences between amounts collected and allowable costs are recorded as over\/underrecovered fuel and purchased power costs in accordance with ratemaking policies of regulatory authorities. Such overrecovered fuel and purchased power costs are reflected as liability for refunds to customers in the accompanying consolidated financial statements.\nIncluded in operating revenues is an estimate of revenues for electric services provided but not billed. In 1995 the Company made accounting adjustments to the estimate of delivered not billed kwh sales which increased operating revenues by approximately $8,300,000 and net income by approximately $5,400,000, or 13 cents per share.\nDEFERRED DEBITS\nLosses on Early Retirements of Debt\nLosses on early retirements of debt refinanced by new lower coupon debt issues are amortized on a straight-line basis over the lives of the new issues. Losses on early debt retirements not refinanced by new issues are amortized on a straight-line basis over the remaining original lives of the retired debt. Amortization of such amounts is included in other interest charges in the Consolidated Statements of Earnings. The unamortized balances of losses on early retirements of debt are approximately $21,262,000 and $22,766,000 as of August 31, 1995 and 1994, respectively (see Note 4).\nDebt Premium, Discount and Expense\nExpenses incurred in connection with the issuance of long-term debt, and premiums and discounts relating to such debt, are being amortized or accreted on a straight-line basis over the lives of the respective issues.\nOther Assets\nIncluded in deferred debits are other assets that are expected to benefit future periods and certain costs that, for rate making purposes, are recorded as deferred charges and amortized over periods allowed by regulatory authorities.\nALLOWANCE FOR FUNDS USED DURING CONSTRUCTION\nThe allowance for funds used during construction (AFUDC) is designed to allow the Company to capitalize the net composite interest and equity costs of capital funds used to finance plant additions during construction periods and does not represent current cash income. Established regulatory rate practices permit the Company to recover these costs in future periods by fixing rates to include a fair return on, and a recovery of, these capital costs through their inclusion in the rate base and cost of service. The composite rates used for AFUDC were 6.5% in 1995, 6.2% in 1994 and 9.9% in 1993. Such rates reflect semiannual compounding.\nINCOME TAXES\nOn September 1, 1993, the Company adopted, on a prospective basis, as required by the FERC, Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (Statement 109). Statement 109 requires a change from the deferred method to the asset and liability method of accounting for income taxes. Under the asset and liability method, deferred income taxes are recognized for the tax consequences of \"temporary differences\" by applying enacted tax rates applicable to the differences between the financial statement amounts and the tax bases of existing assets and liabilities.\nStatement 109 requires the Company to recognize deferred income tax liabilities for the temporary differences including cumulative unrecognized timing differences as well as certain new items such as the equity portion of AFUDC and unamortized investment tax credits. Certain provisions of Statement 109 provide that regulated enterprises are permitted to recognize adjustments resulting from the adoption of Statement 109 as regulatory assets or liabilities if it is probable that such amounts will be recovered from or returned to customers through future rates. Accordingly, the Company recorded additional deferred income tax liabilities and corresponding regulatory assets of approximately $78,000,000 in 1994. The adoption of Statement 109 did not have a material effect on results of operations.\nInvestment tax credits have been deferred and are being amortized to income over the life of the related property.\nCASH FLOWS\nThe Company uses the direct method of presentation for cash flows from operating activities. For purposes of the Consolidated Statements of Cash Flows, the Company considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents. The Company records such investments at cost which approximates market value.\nEARNINGS PER COMMON SHARE\nEarnings per share of common stock is computed for each year based upon the weighted average number of common shares outstanding. The effect of stock awards and options outstanding under the Company's 1989 Stock Incentive Plan is not significant (see Note 7).\nThe Company has a Shareholder Rights Plan (the Rights Plan) designed to ensure that all shareholders receive fair and equal treatment in the event of any proposal to acquire control of the Company. Under the Rights Plan, each shareholder holds one right for each share of the Company's common stock held of record. Each right entitles the holder to purchase one share of the Company's common stock for $70 in the event a person or group acquires 10% or more of the Company's common stock. Under certain circumstances, the holders of the rights will be entitled to purchase common shares of the Company at one half of the current market price. In addition, any time after a person or group acquires 10% or more of the Company's outstanding common shares, the board of directors may, at its option, exchange part or all of the rights for shares of common stock of the Company. The Company will be entitled to redeem the rights for $0.01 per right at any time until the tenth day following a public announcement of the acquisition of 10% of its common shares. The rights expire in 2001, unless earlier redeemed or exchanged by the Company, and have no effect on operating results or earnings per share. This Rights Plan has been amended to provide that the merger agreement with Public Service Company of Colorado (PSCo) will not trigger the provisions of the Rights Plan.\nFAIR VALUES OF FINANCIAL INSTRUMENTS\nThe fair value amounts of certain financial instruments included in the accompanying Consolidated Balance Sheets as of August 31, 1995 and 1994 are as follows:\nThe fair values of cash and temporary investments approximate the carrying amount because of the short maturity of those instruments.\nThe estimated fair values of long-term debt and preferred stock are based on quoted market prices of the same or similar issues. The estimated fair values of long-term debt and preferred stock are as follows:\nThe fair values of other financial instruments for which estimated fair values have not been presented are not materially different than the related book values.\nThe fair value estimates presented herein are based on pertinent information available to management as of August 31, 1995 and 1994. These fair value estimates have not been comprehensively revalued for purposes of these financial statements since that date, and current estimates of fair values may differ significantly from the amounts presented herein.\nNEW ACCOUNTING STANDARDS\nIn March 1995 the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of\" (Statement 121). Statement 121 requires that long lived assets and certain identifiable intangibles to be held and used by an entity be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The statement also requires that rate-regulated enterprises recognize an impairment for the amount of costs excluded when a regulator excludes all or part of a cost from the enterprise's rate base. The adoption of Statement 121, which will be required in 1997, is not expected to have a material effect on the Company's consolidated financial position or results of operations.\n(2) Merger and Acquisitions\nMERGER WITH PUBLIC SERVICE COMPANY OF COLORADO\nThe Company and Denver-based PSCo entered into a definitive merger agreement (the Merger) on August 22, 1995, to form a registered public utility holding company, which will be the parent company for the Company and PSCo. The transaction is subject to various conditions, including receipt of the approval of the shareholders of the Company and PSCo, as well as the approval of or the taking of other action by the Securities and Exchange Commission, the Federal Trade Commission, the Department of Justice, the Nuclear Regulatory Commission, the Federal Energy Regulatory Commission, and the state public utility commissions in Texas, Colorado, New Mexico, Wyoming, and Kansas.\nThe Merger, with a targeted completion date in the fall of 1996, is conditioned on qualifying as a tax-free reorganization and being accounted for as a pooling of interests.\nUpon completion of the Merger, holders of the Company and PSCo common stock will receive 0.95 of one share and one share of the new holding company common stock, respectively, for each share of stock held. As of August 4, 1995, the Company and PSCo had 40,917,908 and 63,109,140 shares, respectively, of common stock outstanding. Based on that number of shares outstanding and the conversion ratios, the Company and PSCo shareholders would own 38.1 percent and 61.9 percent, respectively, of the common equity of the new holding company. The debt (including mortgage bonds) and preferred stock outstanding at the time of the effectiveness of the Merger will remain outstanding debt and preferred stock of the Company.\nThe board of directors of the new holding company will consist of six and eight current directors of the Company and PSCo, respectively.\nACQUISITION OF TNP PROPERTIES\nOn December 6, 1994, the Company signed a definitive agreement with Texas-New Mexico Power Company (TNP) for the purchase of certain Texas properties located in the Panhandle area for $29.2 million. These Panhandle area properties are located in the cities of Spearman, Perryton, Booker, Follett, Higgins and Darrouzett located in Hansford, Ochiltree and Lipscomb counties. The purchase was completed September 15, 1995, and added approximately 7,300 customers. Rates in the affected communities were immediately reduced by 10% and other rate decreases will follow over a ten-year period until the new customers are at the same rates as the Company's other customers in its Texas service area. In June 1995 the Company received approval from the PUCT to commence retail electric service to the Panhandle area properties. Cost recovery of the purchase amount in excess of book value of approximately $14,000,000 was allowed by FERC and the PUCT through a rate surcharge over a ten-year period. This purchase will not have a significant impact on results of operations of the Company.\nACQUISITION OF TUCO, INC.\nThe Company has agreed to purchase TUCO, Inc. (TUCO), a wholly owned subsidiary of Cabot Corporation, for $77,000,000 subject to regulatory approval and other conditions. TUCO owns the coal inventory maintained at the Company's Harrington and Tolk generating stations. It also administers contracts with coal mines, railroads and the coal-handling operator at the two coal-fueled power plants. This purchase is expected to lower fuel costs. Regulatory approval is expected in 1996.\n(3) Short-Term Debt\nUnsecured borrowings permitted under bank lines of credit were $128,000,000 in 1995 and $70,000,000 in 1994.\n(4) Capitalization\nCUMULATIVE PREFERRED STOCK\nThe Company is limited in the amount of preferred stock that it can issue by certain restrictions contained in the Restated Articles of Incorporation (Articles). As a condition to the issuance of additional shares of preferred stock, the Articles require that net earnings, as defined, for 12 consecutive calendar months within the 15 immediately preceding calendar months, must be at least 1.5 times the annual interest requirements on funded debt, as defined, plus annual dividend requirements on preferred stock (or any stock ranking on a parity). Such ratio for the year ended August 31, 1995, was 3.34. The Articles also limit the amount of restricted indebtedness, as defined, that may be issued or assumed by the Company without the consent of the holders of two-thirds of the aggregate par value of the preferred stock outstanding. Under this limitation approximately $379,000,000 of additional restricted indebtedness could have been issued or assumed as of August 31, 1995. Such limitation would also prevent the issuance of bonds against property additions unless, after giving effect to the use of the proceeds from such issuance, such restricted indebtedness limitation is met.\nIn the event of voluntary liquidation of the Company, holders of the cumulative preferred stock have a preference to the extent of amounts payable on redemption plus accrued dividends, and in the event of involuntary liquidation, to the extent of par value plus accrued dividends.\nThe 7-5\/8% and 9.68% series cumulative preferred stock were redeemed from the proceeds of the December 1992 issuance of First Mortgage Bonds (see LONG-TERM DEBT below).\nLONG-TERM DEBT\nFirst Mortgage Bonds (Bonds) issued under the Indenture of Mortgage and Deed of Trust dated August 1, 1946, as supplemented and amended (Mortgage), are secured by substantially all of the Company's utility plant. The Mortgage limits the maximum principal amount of Bonds that may be outstanding thereunder to $3,000,000,000 and contains provisions relating to the restriction of the payment of dividends on common stock. At August 31, 1995, approximately $949,000 of total retained earnings of $373,458,000 was so restricted.\nThe Company is limited in the amount of Bonds that it can issue by certain restrictions contained in the Mortgage. The Mortgage permits the issuance of Bonds against 60% of certain property additions, against certain retired Bonds or against deposited cash. Property additions and retired Bonds available for the issuance of Bonds were approximately $335,000,000 and $115,300,000, respectively, at August 31, 1995, which would permit issuance of $316,300,000 of additional Bonds. Substantial amounts of property additions are used by the Company to satisfy a maintenance fund covenant and improvement fund obligations under the Mortgage. The Mortgage also provides that, with certain exceptions, additional Bonds may not be issued unless net earnings, as defined, are at least twice the annual interest requirements on all Bonds outstanding and then to be issued and on all prior lien indebtedness. Such ratio for the year ended August 31, 1995, was 5.53.\nIn February 1995 the Company retired $16,000,000 of Bonds, 4-5\/8% Series due 1995 and in February 1994 retired $25,000,000 of Bonds, 4-1\/2% Series due 1994.\nIn February 1995 the Company issued $70,000,000 of additional Bonds of 8.50% Series due 2025. The proceeds from these Bonds were applied primarily to the retirement of short-term debt.\nIn December 1992 the Company issued $190,000,000 of additional Bonds consisting of $90,000,000 of 6.875% Series due 1999 and $100,000,000 of 8.20% Series due 2022. The proceeds from these Bonds were applied to the redemption of outstanding Bonds as follows: (i) 8.45% Series due 2001, (ii) 7-5\/8% Series due 2002, (iii) 8-3\/8% Series due 2007, and (iv) 9-1\/8% Series due 2016, and also cumulative preferred stock as follows: (i) 82,960 shares of 7-5\/8% preferred stock and (ii) 170,000 shares of 9.68% preferred stock. In connection with this redemption, the Company incurred a loss of approximately $10,575,000, including redemption premiums of $9,315,000; $10,192,000 of such loss was deferred and is being amortized over the lives of the new issues and $383,000 relating to the preferred stock was charged to retained earnings (see Note 1).\nThe Red River Authority of Texas has issued certain obligations, based on long-term installment sale agreements executed by the Company, that relate to the pollution control facilities installed at the Company's coal-fueled generating units. The Company's payments under the pollution control obligations are pledged to secure the Red River Authority Pollution Control Revenue Bonds.\nIn August 1994 the Company entered into a forward interest rate swap agreement in anticipation of redeeming its $25,000,000 principal amount of 13-1\/2% pollution control revenue bonds with a new issuance of variable rate pollution control revenue bonds. The 13-1\/2% bonds are not redeemable until October 1, 1996. The interest rate swap will commence in September 1996 on a $25,000,000 notional amount which, in effect, fixes the interest rate on the bonds to be issued at 6.435%. The swap agreement may be terminated by the Company at any time or by the other party, upon the occurrence of specified events. If terminated, the Company may be required to make a payment or may receive a payment to settle any gains or losses resulting from the termination. The amount of any settlement, which could be substantial, is dependent upon market interest rates at the time of settlement. If the forward interest rate agreement had been terminated at August 31, 1995, the Company would have been required to pay approximately $3,765,000; however, the Company would then have received the benefit of an interest rate lower than 6.435% on the bonds to be issued. The Company is exposed to interest rate risk in the event of nonperformance by the other party to the swap agreement; however, the Company does not anticipate nonperformance by the counter party.\nThe trust indenture for the 1991 Series of pollution control obligations permits the Company to choose between various interest rate options, including the option to convert to a fixed rate. Currently, the interest rate is adjusted weekly and as of August 31, 1995 and 1994, the interest rate was 3.45% and 3.15%, respectively.\nThe 1991 Series may be subject to tender for purchase at the option of the holder and will be subject to mandatory tender at certain times. The Company entered into a credit agreement with a bank to provide liquidity support in connection with the optional and mandatory tenders. The Company has also entered into a remarketing agreement to provide for the remarketing of any tendered bonds. The credit agreement is scheduled to expire on July 1, 1997. Based upon the Company's intent and ability to remarket such obligations, the 1991 Series obligations have been classified as long-term debt.\nAggregate maturities of long-term debt for each of the years in the five-year period subsequent to August 31, 1995, are as follows: 1996, $276,000; 1997, $15,176,000; 1998, $229,000; 1999, $0; and 2000, $90,000,000. Sinking fund and improvement fund requirements are not significant.\n(5) Income Taxes\nThe components of income tax expense (benefit) for the years ended August 31, 1995, 1994 and 1993 are as follows:\nThe provisions (credits) for deferred income taxes that arise from temporary differences between financial and tax reporting for the years ended August 31, 1995, 1994 and 1993, are as follows:\nTotal income tax expense for the years ended August 31, 1995, 1994, and 1993 differs from the amounts computed by applying the statutory federal tax rates (35% in 1995 and 1994, 34.67% in 1993) to earnings before income taxes for the following reasons:\nProperty-related differences increase income tax expense due primarily to the reversal of depreciation and basis differences.\nThe significant components of the Company's deferred tax assets and liabilities, which are reflected net in the accompanying Consolidated Balance Sheets at August 31, 1995 and 1994, are as follows:\n(6) Commitments, Contingencies and Financial Guarantees\nSYSTEM PURCHASE OPTION\nThe Company and the City of Las Cruces, New Mexico (the City) entered into a System Purchase Option and Rate Agreement in August 1994, which grants the City the option to sell to the Company the electric utility system serving the City (including distribution, subtransmission, and transmission facilities), which the City plans to acquire from El Paso Electric Company (EPE) by purchase or through condemnation proceedings. The agreement has a three-year term beginning at the time the City acquires the facilities and ending no later than January 1, 2002. The purchase price which would be paid by the Company would be equal to the amount required to retire all outstanding debt incurred by the City in acquiring the facilities plus the city's reasonable costs in acquiring the facilities. The Company has the right to terminate the agreement if, in the Company's sole discretion, it determines that any proposed condemnation award is excessive or upon the occurrence of certain other events. The agreement also provides that, if the City abandons or dismisses condemnation proceedings as a consequence of the Company's termination of the agreement, the Company will reimburse the City for one-half of its reasonable litigation expenses and for any of EPE's damages and litigation expenses that the City is obligated to pay by final court order.\nFUEL PURCHASE COMMITMENTS\nIn the ordinary course of business, the Company has made substantial commitments with respect to the purchase of coal and natural gas for use as fuel in its generating units. To provide fuel for its coal-fueled generating units, the Company has various long-term commitments with TUCO for the purchasing and processing of coal which is delivered to the Company's coal bunkers in the form of crushed, ready-to-burn coal. The commitments include the use of rail coal cars, unloading facilities and related services. Such commitments in 1995 dollars for the remaining term of the contract are approximately $1,756,000,000. The contracts for coal supply, transportation and other services expire in 2001, 2002 and 2016, respectively.\nIn May 1995 the Company agreed to purchase TUCO from Cabot Corporation for $77,000,000 (see Note 2).\nFINANCIAL GUARANTEES\nIn connection with an agreement for the sale of electric power, the Company guaranteed certain obligations of a customer totaling $48,000,000. These obligations relate to the construction of certain utility property, that in the event of default by the customer, would revert to the Company. In connection with a Quixx investment, Quixx has provided a financial guarantee totaling $8,900,000 to fund any construction cost overruns and other project contingencies. Should additional funds be provided, Quixx's ownership position in that project may be altered.\nENVIRONMENTAL MATTERS\nThe Company's facilities are regulated by federal and state environmental agencies. These agencies have jurisdiction over air emissions, water quality, wastewater discharges, solid wastes and hazardous substances. The Company has received all necessary authorizations for the construction and continued operation of its generation, transmission and distribution systems. Company facilities have been designed and constructed to operate in compliance with environmental standards.\nBeginning in the year 2000, the Clean Air Act Amendments of 1990 (CAAA) Phase II will require more stringent limits on SO2 emissions at the Company's existing fossil-fueled plants. However, current regulations permit compliance with sulfur emissions limitations in the year 2000 by using SO2 allowances allocated to plants by the Environmental Protection Agency (EPA), using allowances generated by reducing emissions at existing plants and by using allowances purchased from other companies. Based upon information from the Company's fuel suppliers, the SO2 allowances issued by the EPA approximate the Company's projected SO2 emissions. The Company monitors options to ensure that allowances will be sufficient to economically operate the Company's existing plants without significant emission reductions. The CAAA also requires the EPA to develop new oxides of nitrogen (NOx) emission standards for existing and new plants which may be more stringent than the current standards. The Company anticipates being able to comply with Phase II NOx emission standards with no additional material capital cost. The Company continues to monitor the impact that the CAAA may have on the Company.\nCapital expenditures for environmental protection facilities aggregated approximately $4,100,000, $11,600,000, and $4,500,000 for 1995, 1994 and 1993, respectively. Estimates of future capital expenditures for environmental protection facilities are subject to change but the Company has included approximately $11,700,000 in its construction program for these expenditures during the five years ending August 31, 2000, of which approximately $2,300,000 is for 1996.\nThe Company has not developed any specific site removal and exit plans for its fossil fuel plants or substation sites. Plant removal and exit plans are under development, and when such plans are developed in the future, the Company intends to treat removal and exit costs as a cost of retirement in utility plant and include them in depreciation accruals. An estimated removal cost (based on historical experience) is currently included in depreciation expense.\nTHUNDER BASIN LAWSUIT\nThe Company was named as a defendant in a case entitled Thunder Basin Coal Co. v. Southwestern Public Service Co., No. 93-CV-304B (D. Wyo.). Thunder Basin's Wyoming lawsuit in federal court went to trial in late October 1994. On November 1, 1994 the jury returned a verdict in favor of Thunder Basin and against the Company finding that there had been a partial repudiation of the contract and that the Company had interfered with Thunder Basin's contract with TUCO. The jury awarded damages to Thunder Basin of approximately $18,800,000. The Company has appealed the judgment to the Tenth Circuit Court of Appeals and the appeal is progressing.\nManagement believes that in the event a payment is ultimately required to be made to Thunder Basin it would be recoverable from ratepayers, although any such recovery would be subject to regulatory review. Management believes that the ultimate resolution will not have a material adverse effect on the Company's consolidated financial statements.\nOTHER\nThe Company is a defendant in various claims and legal actions, primarily workers' compensation, contractual matters and general liability lawsuits, all arising in the normal course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on the Company's consolidated financial statements.\n(7) Employee Benefit Plans\nDEFINED BENEFIT PLANS\nThe Company has a noncontributory defined benefit retirement plan (the Retirement Plan) which provides retirement and certain other benefits to its officers and employees. The Company's policy is to fund the accrued costs of the Retirement Plan. Assets of the Retirement Plan consist primarily of U.S. government and agency obligations, bonds and common stocks (including 586,236 shares of common stock of the Company with an estimated fair market value of $17,587,080 as of August 31, 1995).\nAdditionally, the Company has a noncontributory defined benefit supplemental retirement income plan (the Supplemental Plan) for qualifying executive personnel. The Supplemental Plan is unfunded, and benefits due under the plan are paid out of the Company's general funds.\nNet periodic pension cost for the Retirement and Supplemental Plans, as determined using the projected unit credit actuarial cost method for the years ended August 31, 1995, 1994 and 1993, is presented below:\nThe funded status of the Retirement and Supplemental Plans and amounts recognized in the Company's Consolidated Balance Sheets as of August 31, 1995 and 1994 is presented below:\nThe current and noncurrent portions of the accrued pension liability are included in other current liabilities and other deferred credits, respectively, in the accompanying Consolidated Balance Sheets.\nThe assumed discount rate and the rate of increase in compensation levels used in determining the actuarial present value of the projected benefit obligations were 8% and 6%, respectively. The expected long-term rate of return on plan assets was 8%. Plan assets and liabilities are valued each year using a measurement date of June 30.\nHEALTH AND WELFARE BENEFIT PLANS\nThe Company provides health care and life insurance benefits to its active and retired employees through various health and welfare benefit plans. In 1994 the Company adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (Statement 106). Statement 106 requires accrual of postretirement benefits other than pensions (primarily group term life insurance, medical and dental benefits provided to retired employees) during the years an employee provides services. Statement 106 also requires employers to recognize the costs of benefits already earned by active employees as of the date of adoption of Statement 106 (the Transition Obligation).\nThe accrual of postretirement costs was comprised of: (1) the portion of the expected postretirement benefit obligation attributable to employee service during the period, (2) amortization of the Transition Obligation and (3) interest costs associated with the unfunded accumulated obligation for future benefits. An assumed discount rate of 8% was used to develop the associated interest costs. The assumed health care cost trend rate used to measure the expected cost of benefits was 12% for 1995 and was assumed to diminish to a level of 5.5% in 2007 and thereafter. The Transition Obligation of approximately $58,000,000 is being amortized over a 20-year period. A one percentage point increase in the assumed health care cost trend rate in each future year would increase the accumulated postretirement benefit obligation (APBO) at August 31, 1995, by approximately $8,000,000 and other postretirement benefits cost for 1995 by approximately $900,000.\nThese postretirement costs have historically been included in rates when paid. Federal and state agencies that regulate the Company have issued guidelines permitting recovery of such additional costs on an accrual basis. In Texas and New Mexico, which represent approximately 72% of the Company's revenues, the Company was permitted in its rate settlements to recover the additional costs. The Company is required to deposit the amounts included in Texas and New Mexico rates in an irrevocable external trust dedicated to the payment of these postretirement benefits. In remaining jurisdictions, the Company is permitted to recognize regulatory assets for the difference between any amounts recorded currently and those required under Statement 106. At August 31, 1995 and 1994, deferred debits in the Consolidated Balance Sheets include $2,500,000 and $1,700,000, respectively, that represent the future revenues expected to be realized at the time the additional postretirement benefits are included in the Company's rates.\nThe Company's net periodic postretirement benefits cost other than pensions for the years ended August 31, 1995 and 1994, including amounts capitalized, were comprised of the following components:\nThe funded status for other postretirement benefits and amounts recognized by the Company at August 31, 1995 and 1994, is presented below:\nThe Company's cost of providing other postretirement benefits in 1993, which was recognized on a \"pay-as-you-go\" basis, was approximately $2,280,000.\nDEFINED CONTRIBUTION PLANS\nThe Company has an Employee Stock Ownership Plan and a 401(k) plan. Total contributions to the plans by the Company for the years ended August 31, 1995, 1994 and 1993 were approximately $1,469,000, $983,000 and $993,000, respectively. Effective March 1, 1995, the plan assets of the Employee Stock Ownership Plan and 401(k) plan were combined into one plan called the Employee Investment Plan.\nOTHER BENEFIT PLANS\nThe Company's 1989 Stock Incentive Plan provides for awards of share options and restricted shares, and delivery of shares in certain cases. The number of shares of common stock of the Company registered in connection with this plan is 800,000, the maximum amount that may be awarded prior to July 25, 1998.\nStock options have been awarded to key employees under the 1989 Stock Incentive Plan. Options granted under the plan have an exercise price equal to the fair market value of the common stock on its award date. At August 31, 1995, there were 22 participants in the plan. Options generally become exercisable evenly over nine years and expire ten years after the date of the grant.\nAt August 31, 1995, approximately 81,200 restricted shares of common stock have been awarded to employees, generally subject to a ten-year vesting requirement. The cost of shares awarded are charged to expense over a ten-year period based on the fair market value at date of award.\nThe Company has a Directors' Deferred Compensation Plan under which directors of the Company or its subsidiaries may elect to defer the distribution of all or a percentage of the annual retainer or meeting fees, or both, otherwise currently payable to such directors.\n(8) Competitive Environment and Regulatory Assets and Liabilities\nElectric utilities have historically operated in a highly regulated environment in which they have an obligation to provide electric service to their customers in return for an exclusive franchise within their service territory with an opportunity to earn a regulated rate of return. This regulatory environment is changing. The generation sector has experienced competition from nonutility power producers, and the FERC is requiring utilities, including the Company, to provide wholesale transmission service to others and may order electric utilities to enlarge their transmission systems to facilitate transmission services.\nThe changing regulatory environment has stimulated competition in the wholesale electric markets by creating a new class of independent power producers. Revisions to the Public Utility Holding Company Act of 1935 (PUHCA) have allowed both utilities and non-utilities to form independent power production companies called exempt wholesale generators (EWGs), which operate without the restrictions of the PUHCA. EWGs offer alternative sources of power supply to electric utilities across the country. Utilities are often required by state regulation to solicit to purchase power from nonutility power producers and other utilities before seeking approval to construct new generation of their own.\nSome state regulatory authorities are in the process of changing utility regulations in response to federal and state statutory changes and evolving markets. Texas legislation enacted in 1995 recognizes the movement to a more competitive marketplace by requiring the PUCT to issue new regulations including: allowance of less than fully costed rates in wholesale and retail markets; recognition of and essentially waiving all Texas utility regulation of EWGs and power marketers; and implementation of transmission access comparable to the owning utility's use of its transmission system for non-FERC regulated utilities. The Company believes that these statutory and conforming regulations may result in increased wholesale competition. However, due to the Company's low cost structure, increased wholesale competition is not expected to adversely affect it in the near term and may favorably impact it in the long term.\nThe New Mexico legislature rejected retail wheeling proposals; however, it continued post-session committee investigation of the matter. All of the Company's jurisdictions continue to evaluate utility regulations with respect to competition.\nThe Company currently applies accounting standards that recognize the economic effects of rate regulation. Regulatory assets represent probable future revenue associated with certain costs which will be recovered from customers through the ratemaking process. Regulatory liabilities represent costs previously collected that are refundable in future rates. If rate recovery of generation-related and other costs becomes unlikely or uncertain, whether due to competition or regulatory action, these accounting standards may no longer apply to the Company.\nRegulatory assets and liabilities reflected in the Consolidated Balance Sheets as of August 31, 1995 and 1994, are as follows:\nAs of August 31, 1995, the Company's regulatory assets are being recovered through rates charged to customers over periods ranging from ten to thirty years. Under current rates, the Company is recovering approximately $8,000,000 of regulatory costs per year. Based on prior and current rate treatment of such costs, management believes it is probable that the Company will continue to recover from ratepayers the regulatory assets described above.\nIn July 1995 the Company negotiated a settlement with the PUCT and various intervenors. As part of this agreement, the Company is required to perform certain demand side management activities and is allowed to defer the costs of these activities and include them in rate base and cost of service in future PUCT proceedings.\n(9) Rate Matters\nThe Company may effect changes in its rates only as approved by the regulatory authorities governing its jurisdictions. Amounts ultimately realized will differ from amounts approved because kilowatt-hour sales and other factors will vary from those approved in the rate proceedings.\nA PUCT substantive rule requires periodic examination of the Company's fuel and purchased power costs, the efficiency of the use of such fuel and purchased power, fuel acquisition and management policies and purchase power commitments (see Item 1. Business Fuel Supply and Purchased Power). On May 1, 1995, the Company filed with the PUCT a petition for a fuel reconciliation for the months of January 1992 through December 1994. A hearing was held in September 1995 and the Commission staff has recommended some disallowances which the Company opposes and which are subject to final ruling by the PUCT. The Company's management is unable to predict the ultimate outcome; however, they believe the final determination of this matter will not significantly affect consolidated financial results.\nOn December 19, 1989, the FERC issued its final order regarding the 1985 rate case. The Company appealed certain portions of the order that related to recognition in rates of the reduction of the federal income tax rate from 46% to 34%. The United States Court of Appeals for the District of Columbia Circuit remanded the case, directing the FERC to reconsider the Company's claim of an offsetting cost and limiting the FERC's actions. The FERC issued its Order on Remand in July 1992, required filings were made and a hearing was completed in February 1994. In October 1994 the administrative law judge issued a favorable initial decision that, if approved by the FERC, would result in a substantial recovery by the Company. Negotiated settlements with the Company's partial requirements customers and Texas- New Mexico Power Company were approved by the FERC in July 1993 and September 1993, respectively, and the Company received approximately $2,800,000. In a settlement with the Company's New Mexico cooperative customers the Company received approximately $7,000,000, including interest. The FERC approved this settlement in July 1995. Resolutions with the remaining wholesale customers, Golden Spread member cooperatives and Lyntegar Electric Cooperative have not been reached. The Company cannot reasonably estimate the remaining amount recoverable from these proceedings; however, a favorable resolution could materially improve 1996 consolidated earnings.\n10) Quarterly Operating Results (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 the Company's operating results for the periods indicated.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nAs previously reported on Form 8-K dated April 27, 1993, the Company notified its certifying accountants, KPMG Peat Marwick LLP (KPMG), that the client-auditor relationship between the Company and KPMG was terminated effective with the completion of the 1993 financial audit. Additionally, the Company announced its new certifying accountants, DELOITTE & TOUCHE LLP, to serve as independent accountants for the fiscal year 1994 and 1995. The decision to change accountants was recommended by the Audit Committee and approved by the Board of Directors.\nKPMG's report on the Company's financial statements for the 1993 fiscal year contained no adverse opinion or disclaimer of opinion, and was not qualified or modified as to uncertainty, audit scope, or accounting principles.\nDuring the 1993 fiscal year and up to the audit completion date, there were no disagreements between the Company and KPMG on any matters of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements, if not resolved to the satisfaction of KPMG, would have caused KPMG to make a reference to the subject matter of the disagreements in connection with its reports.\nNone of the \"reportable events\" described under Regulation S-K, Item 304(a)(1)(v), occurred within the Company's two most recent fiscal years.\nDuring the 1993 fiscal year, prior to their appointment as certifying accountants, the Company did not consult DELOITTE & TOUCHE LLP regarding any of the matters or events set forth in Item 304(a)(2)(i) and (ii) of Regulation S-K.\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.*\nTo the knowledge of the Company, no person is the beneficial owner of more than 5% of any class of the Company's voting securities.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.*\n*The information required by Items 10, 11, 12 and 13 with respect to directors and officers to the extent not set forth under Item 1 of Part I in this Form 10-K (pursuant to instruction 3 of paragraph (b) of Item 401 of Regulation S-K) under \"Executive Officers of the Registrant,\" is set forth in the Company's proxy statement for its Annual Meeting of Shareholders to be held January 31, 1996, which is incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.\nFINANCIAL STATEMENTS Independent Auditors' Reports Consolidated Balance Sheets as of August 31, 1995 and 1994 Consolidated Statements of Capitalization as of August 31, 1995 and 1994 Consolidated Statements of Earnings for the years ended August 31, 1995, 1994 and 1993 Consolidated Statements of Common Shareholders' Equity for the years ended August 31, 1995, 1994 and 1993 Consolidated Statements of Cash Flows for the years ended August 31, 1995, 1994 and 1993 Notes to Consolidated Financial Statements FINANCIAL STATEMENT SCHEDULES\nAll schedules are omitted because of the absence of conditions under which they are required or because the required information is included in the Consolidated Financial Statements or notes thereto.\nREPORTS ON FORM 8-K\nItems reported - Item 5. Other Events Financial Statements filed - None Dates of reports filed - August 22, 1995 and August 30, 1995\nEXHIBITS\nFiled with this Form 10-K:\n10a Form of Executive Employment Agreement, as amended 10b System Purchase Option and Rate Agreement with the City of Las Cruces 12 Statements re computation of ratio of earnings 21 Subsidiaries of the registrant 23a Consent of DELOITTE & TOUCHE LLP 23b Consent of KPMG Peat Marwick LLP 24 Power of attorney 27 Financial Data Schedule\nIncorporated in this Form 10-K by reference:\n2 Agreement and Plan of Reorganization dated as of August 22, 1995, among Southwestern Public Service Company, M-P New Co. and Public Service Company of Colorado, filed as exhibit 2, Form 8-K dated August 22, 1995.\n3(a) Restated Articles of Incorporation as amended through April 27, 1990, filed as exhibit 3, Form 10-Q for the quarter ended May 31, 1990.\n(b) Restated Bylaws as amended through July 23, 1991, filed as exhibit 3, Form 10-K for the fiscal year ended August 31,1991.\n4(a) First Mortgage Indenture dated August 1, 1946, filed as exhibit 7-A, Registration No. 2-6910.\n(b) Supplemental Indentures to the First Mortgage Indenture:\nDated File Reference Exhibit February 1, 1967 2-25983 2-S October 1, 1970 2-38566 2-T February 9, 1977 2-58209 2-Y March 1, 1979 2-64022 b(28) April 1, 1983 (two) Form 10-Q, May 1983 4(a) February 1, 1985 Form 10-K, August 1985 4(c) July 15, 1992 (two) Form 10-K, August 1992 4(a) December 1, 1992 (two) Form 10-Q, February 1993 4 February 15, 1995 Form 10-Q, May 1995 4\n(c) Standby Credit Agreement with Union Bank of Switzerland (Houston Agency) dated July 1, 1991, filed as exhibit 4(a), Form 10-K for the fiscal year ended August 31, 1991.\n(d) Red River Authority for Texas Indenture of Trust dated July 1, 1991, filed as exhibit 4(b), Form 10-K for the fiscal year ended August 31, 1991.\n(e) Rights Agreement between the Company and Society National Bank, dated July 23, 1991, filed as exhibit 2, Form 8-A dated July 23, 1991.\n(f) Amendment No. 1 dated August 22, 1995, to the Rights Agreement between the Company and Society National Bank, filed as exhibit 4, Form 8-K dated August 30, 1995.\n10(a) Coal Supply Agreement (Harrington Station) between Southwestern Public Service Company and TUCO, Inc., dated May 1, 1979, filed as exhibit 3, Form 8-K dated May 14, 1979.\n(b) Master Coal Service Agreement between Swindell-Dressler Energy Supply Company and TUCO, Inc., dated July 1, 1978, filed as exhibit 5A, Form 8-K dated May 14, 1979.\n(c) Guaranty of Master Coal Service Agreement between Swindell-Dressler Energy Supply Company and TUCO, Inc., filed as exhibit 5B, Form 8-K dated May 14, 1979.\n(d) Coal Supply Agreement (Tolk Station) between Southwestern Public Service Company and TUCO, Inc., dated April 30, 1979, as amended November 1, 1979 and December 30, 1981, filed as exhibit 10(b), Form 10-Q for the quarter ended February 28, 1982.\n(e) Master Coal Service Agreement between Wheelabrator Coal Services Co. and TUCO, Inc., dated December 30, 1981, filed as exhibit 10(c), Form 10-Q for the quarter ended February 28, 1982.\n(f) 1989 Stock Incentive Plan for Executive Management, filed as Exhibit A to the Company's Proxy Statement dated December 1,1988.\n(g) Directors' Plan for members of the Company's Board of Directors, filed as Exhibit B to the Company's Proxy Statement dated December 1, 1988.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nSOUTHWESTERN PUBLIC SERVICE COMPANY\nBy Bill D. Helton Chairman and Chief Executive Officer\nDATE: November 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 on the date indicated:\nSignature Title Date\nBill D. Helton Chairman and Chief November 20, 1995 Executive Officer (Principal Executive & Financial Officer & Director)\nDoyle R. Bunch II Executive Vice President, Accounting & Corporate Development (Principal Accounting Officer)\nC. Coney Burgess* Directors J. C. Chambers* Danny H. Conklin* Giles M. Forbess* Shirley Bird Perry* David M. Wilks*\nBy Doyle R. Bunch II* (Attorney-in-fact)","section_15":""}
{"filename":"715579_1995.txt","cik":"715579","year":"1995","section_1":"ITEM 1. BUSINESS The Registrant owns all the outstanding shares of Adams County National Bank (hereinafter the \"Bank\"). The Registrant and the Bank have the same Board of Directors. The Registrant, organized in 1983, presently has no significant operations other than serving as a holding company. The Bank engages in a full service commercial and consumer banking and trust business. With its main office at 675 Old Harrisburg Road, Gettysburg, Pa., the Bank provides services to its customers through its branch network of 12 full service offices located throughout Adams County, Pa. and 2 in York County, Pa.\nThe Bank's services include accepting time, demand, and savings deposits including NOW, supernow, money market, and regular savings accounts, a diversified array of certificates of deposit, IRA's, and club accounts. Its services also include making secured and unsecured commercial and consumer loans, financing commercial transactions, making construction and mortgage loans, and the renting of safe deposit facilities. Additional services include making residential mortgage loans, small business loans, and student loans. The Bank's business loans include seasonal credit, collateral loans and term loans.\nTrust services provided by the Bank include services as executor and trustee under wills and deeds, estate planning services, and custodian and agent for various investment companies. Trust services also include transfer agent, registrar of stock and bond issues, and escrow agent. The Bank has a relatively stable deposit base and no material amount of deposits is obtained from a single depositor or group of depositors (including federal, state, and local governments). See Management's Discussion and Analysis in the Annual Report. The Bank has not experienced any significant seasonal fluctuations in the amount of its deposits.\nAs of December 31, 1995, the Registrant had a total of 152 full-time and 73 part-time employees.\nSUPERVISION AND REGULATION\nThe Registrant and the Bank are considered \"affiliates\" for purposes of Section 23A of the Federal Reserve Act and as such are subject to certain limitations specified therein on the making of loans on, extensions of credit to, or investments in each other. The Federal Bank Holding Company Act of 1956 restricts the Registrant's activities, whether conducted directly or through subsidiary corporations, to specified activities functionally related to banking. Permissible activities under that Act include lending, certain leasing activities, fiduciary and investment advisory services, acting as insurance agent or broker in connection with loans by subsidiary or affiliated companies, and certain bookkeeping or data processing services.\nCOMPETITION\nAll phases of the Bank's business are highly competitive. The Bank's market area is the primary trade area of Adams County, Pa., a western portion of York County, Pa. and the northernmost portions of those counties in Maryland which are immediately adjacent to the southern border of Adams County, with concentration in the Gettysburg, Pa. area. The Bank competes with local commercial banks as well as other commercial banks with branches in the Bank's market area. The Bank considers its major competition to be PNC Corporation, Farmers Bank and Trust Company, a subsidiary of Dauphin Deposit Corporation, and Bank of Hanover and Trust Co.\nGOVERNMENT MONETARY POLICIES AND ECONOMIC CONTROLS\nThe earnings and growth of the Bank are affected by the policies of the regulatory authorities including the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, and the Federal Deposit Insurance Corporation. An important function of the Federal Reserve System is to\nregulate the money supply and interest rates. Among the instruments used to implement these objectives are open market operations in U.S. Government Securities and changes in reserve requirements against member bank deposits. These instruments are used in varying combinations to influence overall growth and distribution of Bank loans, investments, and deposits. Their use may also affect interest rates charged on loans or paid for deposits. The policies and regulations of the Federal Reserve Board have had and will probably continue to have a significant effect on the Bank's deposits, loans, and investment growth, as well as the rate of interest earned and paid. The effect of such policies and regulations upon the future business and earnings of the Bank cannot be accurately predicted.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nNAME AGE POSITION\nRonald L. Hankey 55 Director and President of the Corporation and the Bank\nJohn W. Krichten 49 Secretary\/Treasurer of the Corporation and Senior Vice President, Cashier, and Chief Financial Officer of the Bank\nLynda L. Glass 35 Assistant Secretary of the Corporation and Senior Vice President of the Bank\nCONSOLIDATED FINANCIAL AND STATISTICAL PROFILE\nThe following tables set forth statistical information relating to the Registrant and the Bank. The tables should be read in conjunction with the consolidated financial statements of the Registrant which are incorporated by reference hereinafter.\nINVESTMENT PORTFOLIO\nThe following tables show the year-end composition of the investment security portfolio for the three years ended December 31, 1995; the maturity distribution of the portfolio at December 31,1995; and the weighted average yield of the portfolio at December 31, 1995.\nBook Value December 31, HELD TO MATURITY 1995 1994 1993 (in thousands) U.S. Government and Federal Agency Obligations $101,400 $141,140 $142,769 State and Political Subdivision Obligations 962 1,509 1,296 Other Securities 2,480 2,256 3,737 -------- -------- -------- TOTAL $104,842 $144,905 $147,802\nMaturity Distribution Book Value After After 1 year 1 to 5 5 to 10 Over or less years years 10 years (in thousands) U.S. Government and Federal Agency Obligations $39,326 $62,074 $ 0 $ 0 State and Political Subdivision Obligations 37 253 423 249 Other Securities 0 0 0 2,480 ------- ------- ------- ------- TOTAL $39,363 $62,327 $ 423 $ 2,729\n* Federal Reserve Bank stock and Federal Home Loan Bank stock, having no stated maturity, have been included in \"Over 10 years\" in the above table.\nWeighted Average Yield After After 1 year 1 to 5 5 to 10 Over 10 or less years years years Total (in thousands) U.S. Government and Federal Agency Obligations 4.63% 6.12% 5.54% State and Political Subdivision Obligations 9.09% 9.09% 9.09% 9.09% 9.09% Other Securities 6.00% 6.00%\nThe weighted average yield of tax exempt obligations has been calculated on a tax equivalent basis. The amounts of the taxable equivalent adjustments are based on an effective tax rate of 34%.\nLOAN PORTFOLIO\nThe following summary shows the composition of the loan portfolio for the five years ended December 31, 1995:\n1995 1994 1993 1992 1991 Domestic Loans: Commercial, Financial, and Agricultural $ 9,268 $ 10,785 $ 14,100 $ 16,104 $ 17,038 Real Estate Loans 284,943 268,944 250,242 250,359 261,145 R\/E Construction 12,951 12,632 4,791 4,732 4,938 Consumer 18,150 17,444 17,950 20,867 23,387 -------- -------- -------- -------- -------- Total Loans $325,312 309,805 287,083 292,062 306,508 Unearned Discount 2.184 3,883 3,785 4,239 4,708 -------- -------- -------- -------- -------- Total $323,128 $305,922 $283,298 $287,823 $301,800\nThe following table shows the repricing opportunities for all loans outstanding as of December 31, 1995. Those loans with immediately adjustable rates (such as loans tied to prime) will be totaled in the thirty day column. Those loans with\nrates that are adjustable at some time over the life of the loan will be totaled under the time heading when they become adjustable. All fixed rate loans will be totaled under the heading which they mature.\nREPRICING From 30 After Thirty Days To 1 to 5 After Days 1 year Years 5 Years Total (in thousands) Commercial, Financial, and Agricultural $56,915 $ 14,103 $27,486 $2,866 $101,370 Consumer 5,565 14,519 18,512 38,596 Real Estate 7,922 145,961 30,288 1,175 185,346 ------- -------- ------- ------ -------- Total $70,402 $174,583 $76,286 $4,041 $325,312\nIncluded in the Real Estate total due within one year are $151,000,000 of Adjustable Rate Mortgages (ARM). The Bank's ARM has a 2% per year interest rate cap with a lifetime cap of 5%. The index used is the Federal Housing Finance Board's National Average Mortgage Contract Rate for Mortgage Lenders on the Purchase of Previously Occupied Homes.\nThe following table presents information concerning the aggregate amount of nonperforming assets. Nonperforming assets comprise (a) loans accounted for on a nonaccrual basis; (b) loans contractually past due ninety days or more but still accruing; (c) loans with deferral of interest or principal because of deterioration in the financial position of the borrower (exclusive of loans in (a) or (b)); (d) loans now current where there are serious doubts as to the ability of the borrower to comply with present loan repayment terms; and (e) other real estate owned.\nDecember 31 1995 1994 1993 1992 1991 (in thousands) Loans accounted for on a nonaccrual basis $1,093 $ 854 $ 977 $ 905 $1,093\nLoans contractually past due 90 days or more as to inte- rest or principal payments 2.780 2,219 2,614 3,900 3,800\nLoans whose terms have been renegotiated to provide a reduction or deferral of inte- rest or principal because of a deterioration in the financial position of the borrower 0 0 377 0 0\nLoans now current where there are serious doubts as to the ability of the borrower to comply with present loan repayment terms 0 0 0 0 0\nOther real estate owned 689 1,037 850 1,110 0\nThe Bank does not accrue interest on any loan when principal or interest are in default for 90 days or more unless the loan is well secured and in the process of collection. Consumer loans and residential real estate loans secured by 1 to 4 family dwellings shall ordinarily not be subject to these guidelines.\nWhen a loan is placed in a nonaccrual status all previously accrued but uncollected interest is charged against the interest income account. Previously accrued interest is not charged off if principal and interest are protected by sound collateral values.\nSUMMARY OF LOAN LOSS EXPERIENCES\nA detailed analysis of the Bank's Reserve for Loan Losses for the past five years is shown below:\nYear ended December 31 1995 1994 1993 1992 1991 Balance of reserve for loan losses at beginning of period $3,370 $3,581 $3,417 $2,815 $2,366 Loans charged off: Commercial, financial, and agricultural 0 8 37 90 77 Real estate-mortgage 44 178 35 75 102 Real estate-construction 0 0 0 0 34 Consumer 90 70 120 125 148 ------ ------ ------ ------ ------ Total loans charged off 134 256 192 290 361\nRecovery of charged off loans: Commercial, financial, and agricultural 12 5 8 22 3 Real estate-mortgage 1 13 1 1 22 Real estate-construction 0 0 0 0 17 Consumer 25 27 32 14 23 ------ ------ ------ ------ ------ Total recoveries 38 45 41 37 65\nNet loans charged off 96 211 151 253 296 Additions to reserve 0 0 315 855 745\nBalance at end of period $3,274 $3,370 $3,581 $3,417 $2,815\nThe amounts of additional provision to the reserve were based on management's judgment after considering an analysis of larger loans, all loans known to management to have unusual risk characteristics, non-performing or problem loans, historical patterns of charge-offs and recoveries, and actual net charge-offs. Further consideration was given to current economic and employment conditions both nationally and in the Bank's local service area. Loans secured by real estate comprise 92% of the Bank's total loan portfolio at December 31, 1995. The majority of loans in both the commercial,\nfinancial, and agricultural category and the consumer category are also secured by personal property, negotiable assets, or business assets. This conservative policy explains the low ratio of losses to loans experienced by the Bank over the last five years. This policy did not change during the year ending 1995. 1996 net losses for all loan categories are expected to approximate $150,000.\nThe following table reflects certain historical statistics of the Bank relative to the relationship among loans (net of unearned discount), net charge-offs, and the reserve:\nYear ended December 31 1995 1994 1993 1992 1991 (in thousands) Balances Average total loans $319,712 $289,350 $288,790 $293,075 $307,489 Total loans at yearend 323,128 305,922 283,298 287,823 301,800 Net charge-offs 96 211 151 253 296 Reserve for loan losses at yearend 3,274 3,370 3,581 3,417 2,815\nRatios\nNet charge-offs to: Average total loans .03% .07% .05% .09% .10% Total loans at yearend .03 .07 .05 .09 .10 Reserve for loan losses 2.93 6.26 4.22 7.40 10.52\nReserve for loan losses to: Average total loans 1.02 1.16 1.24 1.17 .92 Total loans at yearend 1.01 1.10 1.26 1.19 .93\nDEPOSITS The average daily amounts of deposits are summarized below:\nYear ended December 31 1995 1994 1993 (in thousands) Demand deposits $40,027 $ 38,772 $ 33,906 Interest-bearing demand deposits 48,805 56,420 50,563 Savings 116,660 137,910 127,785 Time deposits (excluding time cer- tificates of deposit of $100,000 or more) 169,276 162,366 173,880 Time certificates of $100,000 or more 11.720 13,856 18,255 -------- -------- -------- Total $386,488 $409,324 $404,389\nMaturities of time deposits of $100,000 or more outstanding at December 31, 1995 are summarized as follows (in thousands):\n3 months or less $ 4,324 Over 3 through 6 months 3,785 Over 6 through 12 months 5,276 Over 12 months 3,064 ------- Total $16,449\nFINANCIAL RATIOS\nThe following ratios are among those commonly used in analyzing bank holding company statements.\nYear ended December 31\n1995 1994 1993 1992 1991 Profitability ratios:\nRate of return on average: Earning assets 1.47% 1.49% 1.57% 1.66% 1.51% Total assets 1.41 1.43 1.51 1.59 1.45 Total stockholders equity 12.84 14.15 15.61 17.63 16.85\nLiquidity and capital ratios: Average primary (1) capital to average total assets 11.68 10.85 10.48 9.74 9.21 Average total stockholders eq- uity to average earning assets 11.41 10.54 10.07 9.40 8.95 Average total stockholders eq- uity to average total assets 10.96 10.12 9.70 9.04 8.62 Common dividend payout ratio (2) 54.30 50.45 44.73 40.68 42.74\n(1) includes total stockholders equity and reserve for loan losses. (2) Cash dividends paid on common stock as a percentage of net income.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe principal properties of the Registrant and its subsidiary are those held by the Bank. The Bank's main office and executive offices are located at 675 Old Harrisburg Road, Gettysburg, Adams County, Pa. Additionally, the Bank owns 13 other properties located at 2 Chambersburg St., 18-20 Chambersburg St., 22-22 1\/2 Chambersburg St., Gettysburg, Pa.; 17 S. Queen St., W. King St., Littlestown, Pa.; 369 Main St., McSherrystown; 1677 Abbottstown Pike, East Berlin, Pa.; 202 Main St., York Springs, Pa.; 101 Main St., Arendtsville, Pa.; U.S. Rte. 30, Cashtown, Pa.; 101 N. Main St., Bendersville, Pa.; Rte. 116 and Sanders Road, Fairfield, Pa.; and Eichelberger St. and Kennedy Ct., Hanover, Pa. The Bank also leases a full service office at South Main St., Biglerville, Pa.; and a supermarket office at 400 Eisenhower Drive, Hanover, Pa.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThere are no material legal proceedings pending against the Registrant or the Bank. Note K on page 33 of the Annual Report is herein incorporated 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 STOCK AND RELATED STOCKHOLDER MATTERS\nPage 37, entitled \"Common Stock Market Prices and Dividends\" and Note G on page 31 of the Annual Report to Shareholders for the year ended December 31, 1995, are herein incorporated by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nSelected Financial Data on page 36 of the Annual Report to Shareholders for the year ended December 31, 1995, is herein 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 on pages 15 through 21 of the Annual Report to Shareholders for the year ended December 31, 1995, is hereby incorporated by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPLEMENTARY DATA\nThe consolidated financial statements of the Registrant and the Bank, included in the Annual Report to Shareholders, on pages 22 through 34 for the year ended December 31, 1995, are incorporated herein 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\nThat portion of the Registrant's Proxy Statement dated April 10, 1996, entitled \"Election of Directors\", appearing on pages 5 through 9 thereof, is hereby incorporated by reference. Information regarding executive officers of the Registrant is included in PART I, ITEM I, BUSINESS.\nITEM 11.","section_11":"ITEM 11. MANAGEMENT REMUNERATION\nThose portions of the Registrant's Proxy Statement dated April 10, 1996, entitled \"Executive Compensation\" and \"Compensation of Directors\", appearing on page 9 through 14 thereof, are hereby incorporated by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nAs of February 29,1996, there were no persons known to the Registrant to be beneficial owners of more than 5% of the Registrant's common capital stock. Those portions of the Registrant's Proxy Statement dated April 10, 1996, entitled \"Beneficial Ownership by Officers, Directors and Nominees\", appearing on pages 3 through 5 are hereby incorporated by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information on page 15 through 16 of the Registrant's Proxy Statement dated April 10, 1996, is hereby incorporated by reference. Footnote M--Loans to Related Parties included in the Annual Report to Shareholders, on page 34, for the year ended December 31, 1995, is herein incorporated by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\nThe Report of Independent Certified Public Accountants is on page 14.\nItem 14(a)(1) Financial Statements: The following consolidated financial statements of the Registrant and its wholly-owned subsidiary included in the Annual Report to Shareholders, page 22 through 34, for the year ended December 31, 1995, are incorporated by reference in Item 8:\nConsolidated Balance Sheets - December 31, 1995 and 1994\nConsolidated Statements of Income - Years ended December 31, 1995, 1994, and\nConsolidated Statements of Cash Flows - December 31, 1995, 1994, and 1993\nConsolidated Statements of Changes in Equity Capital - Years ended December 31, 1995, 1994, and 1993\nCondensed Financial Information of Registrant - Years ended December 31, 1995 and 1994\nNotes to Consolidated Financial Statements - December 31, 1995 and 1994\nSchedules not listed above are omitted since the required information is either not applicable, not deemed material, or is shown in the respective financial statements or in the notes thereto.\nITEM 14(a)(3) EXHIBITS\nExhibit 3(a) Copy of Articles of Incorporation of ACNB Corporation is incorporated by reference to Exhibit 3(a), of the Annual Report on Form 10-K for the year ended December 31, 1992.\nExhibit 3(b) Copy of By-laws of ACNB Corporation is incorporated by\nreference to Exhibit 3(b) of the Annual Report on Form 10-K for the year ended December 31, 1992.\nExhibit 13 Annual Report to Shareholders.\nExhibit 21 Subsidiary of the Registrant.\nExhibit 23 Consent of Experts and Counsel.\nITEM 14(b) Reports on Form 8-K:\nNo reports on Form 8-K were filed during the fourth quarter of 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.\nACNB CORPORATION (Registrant)\nBy ----------------------------- Ronald L. Hankey, President\nBy -------------------------------------- John W. Krichten, Secretary\/Treasurer\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.\n- ------------------------ ----------------------- ------------------------\n- ------------------------ ----------------------- ------------------------\n- ------------------------ ----------------------- ------------------------\n- ------------------------ ----------------------- ------------------------\n- ------------------------ ----------------------- ------------------------\n- ------------------------ ----------------------- ------------------------\n- ------------------------ ----------------------- ------------------------","section_15":""}
{"filename":"819671_1995.txt","cik":"819671","year":"1995","section_1":"ITEM 1. BUSINESS (Continued)\nBusiness Plan (Continued)\nof $.07 per unit, the Partnership declared an extra distribution of $1.00 per unit which was paid January 2, 1996 to unitholders of record on December 15, 1995. The Partnership declared total distributions of $8.1 million in 1995. In March 1996, the Partnership announced an increase in its regular quarterly distribution from $.07 per unit to $.10 per unit. The Partnership also announced a special distribution of $.15 per unit. Both distributions are payable March 31, 1996 to unitholders of record March 15, 1996.\nAt the discretion of the Managing General Partner, the Partnership may, from time to time, sell properties or other assets, renovate or make improvements to properties, make additional investments or obtain additional or initial financing for its properties.\nThe establishment, implementation and modification of the business objectives and policies of the Partnership are the responsibility of the Managing General Partner, and, in general, the limited partners have no voting rights with respect to such matters. With respect to the GCLP properties, such business objectives and policies are the responsibility of GCMI. The Partnership's primary business purpose is the ownership of improved, income-producing real estate, but the Partnership may also conduct any business that may lawfully be conducted under the Delaware Revised Uniform Limited Partnership Act. As long as the Settlement Plan is in effect, Oversight Committee approval is required for the Partnership to enter into any new line of business. See \"Management and Operations\" below.\nManagement and Operations\nSince February 1, 1990, affiliates of the Managing General Partner have provided property management services to the Partnership. Currently, Carmel, Ltd. provides such property management services. Carmel, Ltd. subcontracts with other entities for the property-level management services to the Partnership. The general partner of Carmel, Ltd. is BCM. The limited partners of Carmel, Ltd. are (i) Syntek West, Inc. (\"SWI\") of which Mr. Phillips is the sole shareholder, (ii) Mr. Phillips and (iii) a trust for the benefit of the children of Mr. Phillips. Carmel, Ltd. subcontracts the property-level management and leasing of twelve of the Partnership's commercial properties to Carmel Realty, Inc. (\"Carmel Realty\"), which is a company owned by SWI. Carmel Realty is entitled to receive property and construction management fees and leasing commissions in accordance with the terms of its property-level management agreement with Carmel, Ltd. Effective November 25, 1992, Carmel, Ltd. ceased providing property management services for the apartment complexes transferred to GCLP.\nBCM performs administrative functions such as accounting services, mortgage servicing and portfolio review and analysis for the Partnership on a cost reimbursement basis. GCMI performs similar administrative functions for GCLP, also on a cost reimbursement basis. Affiliates of BCM also perform loan placement services, leasing services and real estate brokerage, and other services, for the Partnership for fees and commissions.\nITEM 1. BUSINESS (Continued)\nPending Withdrawal of General Partner\nAs described in ITEM 3. \"LEGAL PROCEEDINGS - Moorman Settlement,\" the Settlement Plan provided that, if certain aggressive, annually increasing Targets relating to the price of National Realty's units of limited partner interest and distributions to unitholders were not met for two successive years of the Settlement Plan or the fifth and final year of the Settlement Plan, the General Partner would be required to resign and the Partnership would be required to repurchase the General Partner's interest in the Partnership (the \"Redeemable General Partner Interest\") for its fair value, and to pay certain fees and other compensation, as provided in the Partnership Agreement and the Settlement Agreement.\nIf Targets are not met for any two successive years of the Settlement Plan or for the final year of the Settlement Plan, SAMLP must withdraw as General Partner effective at the time a successor general partner is selected. The Settlement Plan terminates upon the withdrawal of SAMLP as General Partner and the due election and taking office of a successor. Withdrawal of SAMLP as General Partner pursuant to the Settlement Agreement would be subject to the provisions of the Partnership Agreement, including the right of unitholders to elect a successor general partner by majority vote. Upon the withdrawal or removal of the General Partner without the election of a successor, the Partnership would be dissolved.\nThe Targets for the first and second anniversary dates were not met. Since the Targets were not met for two successive years, SAMLP expects to resign as General Partner, effective upon the election and qualification of its successor. On July 8, 1992, SAMLP notified the Oversight Committee of the failure to meet the Target for two successive years. See ITEM 3. \"LEGAL PROCEEDINGS - Moorman Settlement,\" for further information regarding the pending resignation of SAMLP as General Partner.\nCompetition\nThe real estate business is highly competitive and the Partnership competes with numerous entities engaged in real estate activities (including certain entities described in ITEM 13. \"CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - - Certain Business Relationships,\") some of which may have greater financial resources than the Partnership. The Partnership believes that success against such competition is dependent upon the geographic location of the property, the performance of the property managers in areas such as marketing, collection and the ability to control operating expenses, the amount of new construction in the area, and the maintenance and appearance of the property. Additional competitive factors with respect to commercial properties are the ease of access to the property, the adequacy of related facilities, such as parking, and sensitivity to market conditions in setting rent levels. With respect to apartments, competition is also based upon the design and mix of the units and the ability to provide a community atmosphere for the tenants. The Partnership believes that general economic\nITEM 1. BUSINESS (Continued)\nCompetition (Continued)\ncircumstances and trends and the rate at which properties are renovated or new properties are developed in the vicinity of each of the Partnership's properties are also competitive factors.\nAs discussed in \"Business Plan\" above, the Partnership does not anticipate making material property acquisitions at the present time. However, to the extent that the Partnership seeks to sell any of its properties, the sales prices for such properties may be affected by competition from other real estate entities and financial institutions also attempting to sell their properties located in areas in which the Partnership's properties are located.\nAs described in ITEM 13. \"CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - Certain Business Relationships,\" the executive officers of SAMI, the Managing General Partner of SAMLP, are also executive officers of certain other entities, each of which has business objectives similar to the Partnership's. These executive officers owe fiduciary duties to such other entities and the Partnership under applicable law.\nIn addition, the Partnership also competes with other entities which are affiliates of BCM or for which BCM acts as advisor, and which may have investment objectives similar to the Partnership's and that may compete with the Partnership in purchasing, selling, leasing and financing real estate and real estate related investments. In resolving any potential conflicts of interest which may arise, BCM has informed the Partnership that it intends to continue to exercise its best judgment as to what is fair and reasonable under the circumstances in accordance with applicable law.\nSpecial Considerations Relating to Investments in Real Estate\nThe Partnership is subject to all of the risks incident to the ownership of real estate and interests therein, many of which relate to the general illiquidity of real estate investments. These risks include, changes in general or local economic conditions, changes in interest rates and the availability of permanent mortgage financing which may render the sale or refinancing of a property difficult or unattractive and which may make debt service burdensome, changes in real estate and zoning laws, increases in real estate taxes, federal or local economic or rent controls, floods, earthquakes, hurricanes and other acts of God and other factors beyond the control of the Partnership. Also, the illiquidity of real estate investments may impair the ability of the Partnership to respond promptly to changing circumstances. The Partnership believes that such risks are partially mitigated by the diversification by geographic region and property type of the Partnership's real estate portfolio.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES (Continued)\nReal Estate (Continued)\nIn March 1995, the Partnership purchased the Chalet II Apartments, a 72 unit apartment complex in Topeka, Kansas, for $1.6 million. The Partnership paid $439,000 in cash and obtained new first mortgage financing of $1.2 million. The mortgage bears interest at a rate of prime plus 1% per annum (10% at December 31, 1995), requires monthly payments of principal and interest, currently $12,000, and matures in March 2002. The Partnership, in accordance with the Partnership Agreement, paid a real estate brokerage commission of $98,000 to Carmel Realty based on the $1.6 million purchase price of the property.\nIn December 1995, the Partnership sold the Harbour Pointe Apartments in Miami, Florida, for $5.2 million. The Partnership received $2.1 million in cash after the payoff of $3.0 million in existing mortgage debt and the payment of various closing costs associated with the sale. The Partnership, in accordance with the Partnership Agreement, paid a real estate sales commission of $155,000 to Carmel Realty based upon the $5.2 million sales price of the property. The Partnership recognized a gain of $2.8 million on the sale.\nAlso in December 1995, the Partnership sold the Vineyards Apartments in Broadview Heights, Ohio, for $10.7 million. The Partnership received net cash of $2.4 million after the payoff of $8.2 million in existing mortgage debt and the payment of various closing costs associated with the sale. The Partnership, in accordance with the Partnership Agreement, paid a real estate sales commission of $322,000 to Carmel Realty based upon the $10.7 million sales price of the property. The Partnership recognized a gain of $4.9 million on the sale.\nIn May 1995, the Partnership refinanced the mortgage debt secured by the Mallard Lake Apartments in Greensboro, North Carolina, in the amount of $8.2 million. The Partnership received net cash of $1.4 million after the payoff of $6.5 million in existing mortgage debt. The remainder of the refinancing proceeds were used to fund escrows for replacements and repairs and to pay various closing costs associated with the refinancing. The new mortgage bears interest at the rate of 8.75% per annum, requires monthly payments of principal and interest of $67,416 and matures June 1, 2005. The Partnership, in accordance with the Partnership Agreement, paid a mortgage brokerage and equity refinancing fee of $82,000 to BCM, based upon the new $8.2 million mortgage.\nIn September 1995, the Partnership refinanced the mortgage debt secured by the Four Seasons Apartments in Denver, Colorado, in the amount of $9.9 million. The Partnership received net cash of $4.4 million after the payoff of $5.2 million in existing mortgage debt, including a $147,000 prepayment penalty. The remainder of the refinancing proceeds were used to fund escrows for replacements and repairs and to pay various closing costs associated with the refinancing. The new mortgage bears interest at the rate of 8.25% per annum, requires monthly payments of principal and interest of $78,000 and matures in October 2005. The Partnership, in accordance with the Partnership Agreement, paid a\nITEM 2. PROPERTIES (Continued)\nReal Estate (Continued)\nmortgage brokerage and equity refinancing fee of $99,000 to BCM based upon the new $9.9 million mortgage.\nAlso in September 1995, the Partnership refinanced the mortgage debt secured by the Nora Pines Apartments in Indianapolis, Indiana, in the amount of $6.2 million. The Partnership received net cash of $952,000 after the payoff of $4.9 million in existing mortgage debt, including a $48,000 prepayment penalty. The remainder of the refinancing proceeds were used to fund escrows for replacements and repairs and to pay various closing costs associated with the refinancing. The new mortgage bears interest at the rate of 8.25% per annum, requires monthly payments of principal and interest of $48,000 and matures in October 2005. The Partnership, in accordance with the Partnership Agreement, paid a mortgage brokerage and equity refinancing fee of $62,000 to BCM based upon the new $6.2 million mortgage.\nIn October 1995, the Partnership refinanced the mortgage debt secured by the Covered Bridge Apartments in Gainesville, Florida, in the amount of $4.7 million. The Partnership received net cash of $907,000 after the payoff of $3.6 million in existing mortgage debt, including a $35,000 prepayment penalty. The remainder of the refinancing proceeds were used to pay various closing costs associated with the refinancing. The new mortgage bears interest at the rate of 8% per annum, requires monthly payments of principal and interest of $36,000 and matures in November 2005. The Partnership, in accordance with the Partnership Agreement, paid a mortgage brokerage and equity refinancing fee of $47,000 to BCM based upon the new $4.7 million mortgage.\nIn December 1995, the Partnership refinanced the mortgage debt secured by the Marina Playa Office Building in Santa Clara, California, in the amount of $8.3 million. The Partnership received net cash of $2.9 million after the payoff of $4.5 million in existing mortgage debt, including a $22,000 prepayment penalty. The remainder of the refinancing proceeds were used to fund a $625,000 escrow for tenant improvements and to pay various closing costs associated with the refinancing. The new mortgage bears interest at the rate of 8.25% per annum, requires monthly payments of principal and interest of $65,000 and matures in January 2006. The Partnership, in accordance with the Partnership Agreement, paid a mortgage brokerage and equity refinancing fee of $83,000 to BCM based upon the new $8.3 million mortgage.\nAlso in December 1995, the Partnership refinanced the mortgage debt secured by the Timbercreek Apartments in Omaha, Nebraska, in the amount of $5.0 million. The Partnership received net cash of $1.8 million after the payoff of $3.1 million in existing mortgage debt, including a $63,000 prepayment penalty. The remainder of the refinancing proceeds were used to pay various closing costs associated with the refinancing. The new mortgage bears interest at the rate of 7.75% per annum, requires monthly payments of principal and interest of $38,000 and matures in January 2006. The Partnership, in accordance with the Partnership Agreement, paid a mortgage brokerage and equity refinancing fee of $50,000 to BCM based upon the new $5.0 million mortgage.\nITEM 2. PROPERTIES (Continued)\nMortgage Loans\nIn addition to real estate, a portion of the Partnership's assets consists of mortgage notes receivable, principally those originating from the sale of Partnership properties and secured by income-producing properties. The Partnership's mortgage notes consist of first and wraparound mortgage loans.\nFirst Mortgage Loans. These loans generally provide for level periodic payments of principal and interest sufficient to substantially repay the loan prior to maturity, but may involve interest-only payments or moderate amortization of principal and a \"balloon\" principal payment at maturity. With respect to first mortgage loans, it is the Partnership's general policy to require that the borrower provide a mortgagee's title policy or an acceptable legal opinion of title as to the validity and the priority of the mortgage lien over all other obligations, except liens arising from unpaid property taxes and other exceptions normally allowed by first mortgage lenders in the relevant area.\nWraparound Mortgage Loans. A wraparound mortgage loan, sometimes called an all-inclusive loan, is a mortgage loan having an original principal amount equal to the outstanding balance under the prior existing mortgage loan(s) plus the amount actually advanced under the wraparound mortgage loan. Wraparound mortgage loans may provide for full, partial or no amortization of principal.\nAt December 31, 1995, the Partnership's mortgage notes had an aggregate face amount of $28.1 million and an aggregate net carrying value of $10.2 million, net of deferred gains ($15.8 million), discounts ($187,000) and allowance for estimated losses ($1.9 million).\nThe following table sets forth the percentage (based on the outstanding mortgage note balance at December 31, 1995), by property type and geographic region, of the properties that serve as collateral for the five mortgage notes receivable in the Partnership's mortgage notes receivable portfolio at December 31, 1995. See Schedule IV to the Consolidated Financial Statements included at ITEM 8. \"FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\" for further details of the Partnership's mortgage notes receivable portfolio.\nIn 1991, the Partnership and an insurance company entered into an Asset Sales Agreement to sell participations in certain of the Partnership's mortgage notes receivable in exchange for participations in other mortgage notes or assets and cash. The Partnership entered into the Asset Sales Agreement in an effort to develop a potential source for\nITEM 2. PROPERTIES (Continued)\nMortgage Loans\nfuture financing and to generate cash from otherwise illiquid assets. The assets transferred by the Partnership pursuant to the Asset Sales Agreement included a $2.5 million senior participation in a wraparound mortgage note receivable secured by a shopping center in Las Vegas, Nevada, a $1.0 million senior participation in a wraparound mortgage note receivable secured by a shopping center in La Crosse, Wisconsin, and a first lien mortgage note with a carrying value of $1.2 million prior to transfer. In return, the Partnership received a $447,000 senior participation in a note secured by land in Granby, Colorado, a $1.5 million participation in a note secured by a country club in the Ka'u District of Hawaii, a 10% limited partner interest in the partnership owning the country club, valued at $1.5 million, a $213,000 first lien mortgage note secured by land in Denver, Colorado and $1.0 million in cash. The Asset Sales Agreement included put and guaranty provisions.\nIn March 1992, the insurance company was placed in receivership. In June 1992, the Partnership provided notice to the insurance company, under the terms of the put and guaranty provisions, of its desire to divest itself of all the assets received. The Receiver refused to allow the enforcement of the terms of the Asset Sales Agreement.\nA settlement between the Partnership and the Receiver was approved by the court on February 15, 1995. Under the terms of the settlement, the insurance company returned to the Partnership the senior participations in the wraparound mortgage notes secured by the shopping centers in Las Vegas, Nevada and La Crosse, Wisconsin. In exchange, the Partnership returned all of the assets that it had received from the insurance company other than the first lien mortgage note secured by the land in Denver, Colorado, which had been foreclosed and sold by the Partnership, and $657,000 in cash. The Partnership also purchased from the insurance company the first lien note secured by the land in Granby, Colorado and a second lien note secured by commercial condominiums also in Granby, Colorado for a total of $550,000. The Partnership incurred no loss on the settlement.\nIn October 1995, the Partnership accepted a $3.7 million discounted payoff of three wraparound mortgage loans secured by the Hurstbourne Business Park in Louisville, Kentucky. The Partnership received $1.5 million in cash after the payoff of $2.2 million in first mortgage debt. No loss was recorded as the discounted note payoff was equal to the Partnership's net carrying value of the loans.\nInvestment in Marketable Equity Securities of ART\nAt December 31, 1995, the Partnership owned 97,866 shares of common stock of ART, a real estate investment company, representing approximately 1% of ART's outstanding shares. Mr. Phillips, a general partner of SAMLP, the General Partner of the Partnership, served as Chairman of the Board and as a director of ART until November 16, 1992. The executive officers of the Managing General Partner are also executive officers of ART. See ITEM 12. \"SECURITY OWNERSHIP OF CERTAIN\nITEM 2. PROPERTIES (Continued)\nMortgage Loans\nBENEFICIAL OWNERS AND MANAGEMENT.\" At December 31, 1995, the market value of the ART common stock owned by the Partnership was $722,000. ART owns a 76.8% limited partner interest in SAMLP. In addition, as of March 15, 1996 ART owned 3,340,522 of National Realty's units of limited partner interest, approximately 52% of the units then outstanding.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nMoorman Settlement\nThe Partnership is party to a Settlement Agreement, dated as of May 9, 1990, between plaintiffs Joseph B. Moorman, et al. and defendants Robert A. McNeil, National Realty, the Operating Partnership, SAMLP, Gene E. Phillips, William S. Friedman, and Shearson Lehman Hutton Inc., successor-in-interest to defendant E.F. Hutton & Company Inc., relating to the action entitled Moorman, et al. v. Southmark Corporation, et al. Such action was filed on September 2, 1987, in the Superior Court of the State of California, County of San Mateo. On May 9, 1990, the Partnership agreed to settle such action pursuant to the terms of a written agreement (the \"Moorman Settlement Agreement\"). On June 29, 1990, after a hearing as to its fairness, reasonableness and adequacy, the Moorman Settlement Agreement was granted final court approval.\nThe Moorman Settlement Agreement is complex and the following summary is qualified in its entirety by reference to the text thereof, which was previously included as an exhibit to the Partnership's Form 10-Q for the quarter ended March 31, 1990, as filed with the Securities and Exchange Commission. The Moorman Settlement Agreement provides for a plan (the \"Moorman Settlement Plan\") consisting of, among other things, the following: (i) the appointment and operation of a committee (the \"Oversight Committee\") to oversee the implementation of the Moorman Settlement Plan, (ii) the appointment and operation of an audit committee having a majority of members unaffiliated with Messrs. Phillips and Friedman or SAMLP, (iii) the establishment of specified annually increasing targets described below (each a \"Target\") for each of the next five years through May 1995, relating to the price of the units of limited partner interest as decreased for certain distributions to unitholders, (iv) an agreement by SAMLP not to seek reimbursement of greater than $500,000 per year for Messrs. Phillips' and Friedman's salaries for serving as general partners of SAMLP, (Mr. Friedman resigned as general partner of SAMLP effective March 4, 1994) and a deferral of such payments until such time as a Target may be met, and, if SAMLP resigns as General Partner, a waiver of any compensation so deferred, (v) a deferral until such time as a Target may be met of certain future annual General Partner compensation payable, pursuant to the Partnership's governing documents, to SAMLP or its affiliates, and, if SAMLP resigns as General Partner, a waiver of any compensation so deferred, (vi) the required distribution to unitholders of all the Partnership's operating cash flow in excess of certain renovation costs, unless the Oversight Committee approves alternative uses for such operating cash flow, (vii) the issuance of Warrants to purchase an\nITEM 3. LEGAL PROCEEDINGS (Continued)\nMoorman Settlement (Continued)\naggregate of up to 2,019,579 units (the \"Warrants\") to Class Members, (viii) the contribution by certain co-defendants of cash and notes payable to the Partnership aggregating $5.5 million (including $2.5 million contributed by SAMLP and its general partners over a four-year period), (ix) the amendment of the Partnership Agreement to reduce the vote required to remove the General Partner from a two-thirds vote to a majority vote of the units, (x) the Partnership's redemption of its unit purchase rights and an agreement not to adopt a similar rights plan without Oversight Committee approval and (xi) the Partnership's payment of certain settlement costs, including plaintiffs' attorneys' fees in the amount of $3.4 million. The Moorman Settlement Plan will remain in effect until SAMLP has resigned as General Partner and a successor general partner is elected and takes office, and the Warrants will remain exercisable for five years from the February 14, 1992 date of issuance or until earlier redemption.\nOn January 27, 1995, National Realty, SAMLP, the Oversight Committee and William H. Elliott executed an Implementation Agreement which provides for the nomination of an entity controlled by Mr. Elliott as successor general partner and for the resolution of all related matters under the Moorman Settlement. On February 20, 1996, the parties to the Implementation Agreement executed an Amended and Restated Implementation Agreement.\nProvided that the successor general partner is elected pursuant to the terms of the Amended and Restated Implementation Agreement, SAMLP shall receive $12,471,500 from the Partnership. This amount represents a compromise settlement of the net amounts owed by the Partnership to SAMLP upon SAMLP's withdrawal as General Partner and any amounts which SAMLP and its affiliates may owe to the Partnership. This amount shall be paid to SAMLP pursuant to a promissory note in accordance with the terms set forth in the Amended and Restated Implementation Agreement.\nThe Amended and Restated Implementation Agreement has been submitted to the Supervising Judge for tentative approval and approval of the notice to be sent to the original class members. Upon final approval by the Supervising Judge, the proposal to elect the successor general partner will be submitted to the unitholders of the Partnership for a vote. In addition, the unitholders will vote upon amendments to the Partnership Agreement which relate to the proposed compensation of the successor general partner and other related matters.\nUpon approval by the unitholders, SAMLP shall withdraw as General Partner and the successor general partner shall take office. If the required approvals are obtained, it is anticipated that the successor general partner will be elected and take office during the second or third quarter of 1996.\nThe Amended and Restated Implementation Agreement provides that SAMLP, and its affiliates owning units in the Partnership shall not vote to remove the successor general partner, except for removal with cause, for a period of 36 months from the date the successor general partner takes office.\nITEM 3. LEGAL PROCEEDINGS (Continued)\nMoorman Settlement (Continued)\nUpon the election and taking office of the successor general partner, the Moorman Settlement Plan and the Oversight Committee shall be terminated. If the successor general partner is not elected, the existing Moorman Settlement shall remain in full force and effect and all of the provisions of the Amended and Restated Implementation Agreement shall be voided.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNot applicable.\n_________________________________\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S UNITS OF LIMITED PARTNER INTEREST AND RELATED SECURITY HOLDER MATTERS\nNational Realty's units of limited partner interest are traded on the American Stock Exchange (\"AMEX\") using the symbol \"NLP.\" Although National Realty does not anticipate that the AMEX will seek to delist its units, there can be no assurance that the AMEX will not seek to do so.\nThe following table sets forth high and low sale prices of National Realty's units of limited partner interest as reported by the AMEX:\n* Restated for the three for one forward unit split effected January 2, 1996.\nAs of March 15, 1996, the closing price of National Realty's units of limited partner interest on the AMEX was $10.50 per unit.\nITEM 5. MARKET FOR THE REGISTRANT'S UNITS OF LIMITED PARTNER INTEREST AND RELATED SECURITY HOLDER MATTERS (Continued)\nAs of March 15, 1996, National Realty's units of limited partner interest were held by 7,380 holders of record.\nPursuant to the Moorman Settlement Agreement, on February 14, 1992, the Partnership issued 2,692,773 warrants (the \"Warrants\") to purchase an aggregate of 2,019,579 of National Realty's units of limited partner interest subject to adjustment. Each Warrant initially entitled the holder thereof to purchase three quarters of one unit at the exercise price ($11.00 per Warrant). The initial exercise price was equal to $14.67 per unit and increased to $16.00 per unit on February 14, 1993, subject to adjustment. The Warrants may be exercised for five years from their February 14, 1992 date of issuance, or until earlier redemption.\nPrior to 1989, the Partnership's policy was to distribute operating cash flow in excess of necessary reserves for property improvements and repairs. However, due to liquidity problems, on December 29, 1989 the Partnership announced a suspension of cash distributions. Pursuant to the terms of the Moorman Settlement Agreement, the Partnership has agreed to distribute to unitholders all of the Partnership's operating cash flow in excess of certain renovation costs, unless the Oversight Committee approves alternative uses for such operating cash flow. On October 7, 1993, the Partnership announced a resumption of regular quarterly distributions. During the first three quarters of 1995, the Partnership paid regular quarterly distributions of $.07 per unit. In the fourth quarter of 1995, in addition to the regular quarterly distribution of $.07 per unit, the Partnership declared an extra distribution of $1.00 per unit both payable January 2, 1996 to unitholders of record December 15, 1995. The Partnership declared total distributions of $8.1 million in 1995.\nThe distributions paid by the Partnership in 1995 and 1994 were are follows:\n__________________\n* Restated for the three for one forward unit split effected January 2, 1996.\nITEM 5. MARKET FOR THE REGISTRANT'S UNITS OF LIMITED PARTNER INTEREST AND RELATED SECURITY HOLDER MATTERS (Continued)\nIn November 1987, the Board of Directors of the Managing General Partner approved the Partnership's purchase of up to 10% of National Realty's units of limited partner interest and on December 15, 1992, the Board of Directors of the Managing General Partner approved the repurchase of up to 300,000 additional units in open-market transactions. Through December 31, 1995, the Partnership had purchased a total of 402,960 units at an total cost of $5.1 million. The Partnership has not repurchased any additional units under such repurchase program since January 1993.\n[THIS SPACE INTENTIONALLY LEFT BLANK.]\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nITEM 6. SELECTED FINANCIAL DATA (Continued)\nUnits and per unit data have been restated for the three for one forward unit split, effected January 2, 1996.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nIntroduction\nNational Realty, L.P. (\"National Realty\") is a Delaware limited partnership formed on January 29, 1987, the business of which consists primarily of owning and operating through National Operating, L.P., also a Delaware limited partnership (the \"Operating Partnership\"), a portfolio of real estate. Most of the Operating Partnership's properties were acquired in transactions consummated on September 18, 1987, pursuant to which National Realty acquired all of the assets, and assumed all of the liabilities, of 35 public and private limited partnerships. National Realty and the Operating Partnership operate as an economic unit and, unless the context otherwise requires, all references herein to the \"Partnership\" shall constitute references to National Realty and the Operating Partnership as a unit.\nIn November 1992, the Operating Partnership, in conjunction with a refinancing of 52 of its apartment complexes and a wraparound note receivable, transferred such assets to Garden Capital, L.P. (\"GCLP\"), a Delaware limited partnership in which the Operating Partnership holds a 99.3% limited partner interest. See NOTE 7. \"NOTES PAYABLE.\"\nLiquidity and Capital Resources\nThe Managing General Partner has discretion in determining methods of obtaining funds for the Partnership's operations. The Partnership's governing documents place no limitation on the amount of leverage that the Partnership may incur either in the aggregate or with respect to any particular property or other investment. At December 31, 1995, the aggregate loan-to-value ratio of the Partnership's real estate portfolio, computed on the basis of the ratio of total property-related debt to aggregate appraised values, was 47.3% compared to 47.9% at December 31, 1994.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nLiquidity and Capital Resources (Continued)\nCash and cash equivalents aggregated $20.7 million at December 31, 1995 as compared with $3.7 million at December 31, 1994.\nThe Partnership's principal sources of cash have been and will continue to be from property operations and externally generated funds. Externally generated funds include borrowings, proceeds from the sale of the Partnership's properties and other assets, proceeds from the issuance of debt secured by the Partnership's properties or mortgage notes receivable and in the future may include proceeds from the exercise of the Warrants which were issued to the class members included in the Moorman litigation settlement. The Partnership expects that cash flow from property operations together with externally generated funds will be sufficient to meet the Partnership's various cash needs in 1996, including, but not limited to, the payment of distributions, debt service obligations coming due and property maintenance and improvements, as more fully discussed in the paragraphs below.\nCurrently, all but six of the Partnership's properties are encumbered by mortgage debt. In 1996, mortgage debt totaling $9.7 million comes due, including a $2.3 million mortgage which matures in March 1996 and for which the Partnership has a commitment from the lender to refinance the mortgage. The Partnership intends to seek to refinance certain mortgages that mature in the next two years or where there is an interest rate advantage to the Partnership, and use excess refinancing proceeds for working capital purposes.\nDuring 1995, the Partnership received $39.6 million from mortgage refinancings secured by one commercial property and five apartment complexes, of which $27.8 million was used to payoff existing mortgage debt secured by the properties. In addition, the Partnership made scheduled principal paydowns on mortgage debt totaling $6.4 million.\nIn 1995, the Partnership sold two apartment complexes, the Harbour Pointe Apartments in Miami, Florida and the Vineyard Apartments in Broadview Heights, Ohio, for a total of $15.9 million. The Partnership received net cash of $4.5 million after the payoff or assumption by the purchaser of $11.2 million in existing mortgage debt and the payment of various closing costs associated with the sales.\nIn February 1995, the Partnership reached a settlement with the receiver for an insurance company. As part of the settlement, the Partnership paid the insurance company a total of $1.2 million in cash in exchange for the transfer of certain assets between the Partnership and the insurance company. See \"NOTE 4. NOTES RECEIVABLE.\"\nIn March 1995, the Partnership purchased the Chalet II Apartments, a 72 unit apartment complex in Topeka, Kansas, for $1.6 million. The Partnership paid $439,000 in cash, obtaining new mortgage financing of $1.2 million.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nLiquidity and Capital Resources (Continued)\nIn October 1995, the Partnership accepted a $3.7 million discounted payoff of three wraparound mortgage notes receivable secured by the Hurstbourne Business Park in Louisville, Kentucky. The Partnership received $1.5 million in cash after the payoff of $2.2 million in first mortgage debt.\nIn November 1992, in conjunction with the transfer of the net assets of 52 apartment complexes and a wraparound note receivable to GCLP, such assets were refinanced under a $223 million blanket mortgage loan. The blanket mortgage loan requires that cash flow from the GCLP properties be used to fund various escrow and reserve accounts and limits the payment of distributions to the Partnership. During 1995, the Partnership received distributions from GCLP totaling $2.9 million compared to $3.0 million in 1994. A total of $3.4 million of escrow deposits, excluding the tax and insurance reserve, are required to be funded by GCLP during 1996 in monthly installments. Such escrowed amounts are included in escrow deposits and other assets in the accompanying Consolidated Balance Sheets. GCLP is required to make monthly deposits, from the cash flow of its properties, for (i) a credit enhancement reserve and (ii) a tax and insurance reserve. As a result of the restrictions placed on GCLP's use of its cash flow, excess cash of approximately $3.4 million is expected to be remittable to the Partnership during 1996.\nThe Partnership has made regular quarterly distributions since the fourth quarter of 1993. During the first three quarters of 1995, the Partnership continued the payment of regular quarterly distributions of $.07 per unit. In the fourth quarter of 1995, in addition to the regular quarterly distribution of $.07 per unit, the Partnership declared an extra distribution of $1.00 per unit. The Partnership declared total distributions of $8.1 million in 1995. In March 1996, the Partnership announced an increase in its regular quarterly distribution from $.07 per unit to $.10 per unit. The Partnership also announced a special distribution of $.15 per unit. Both distributions are payable March 31, 1996 to unitholders of record on March 15, 1996.\nThe Partnership's rents collected increased from $105.4 million for 1994 to $107.9 million for 1995 due to the Partnership's successful effort of increasing and maintaining higher rental rates during 1995 as compared to 1994. Rental rates at the Partnership's apartment complexes, which account for over 80% of the Partnership's properties, increased an average of 3.2% as compared to 1994 rental rates. However, payments for property operating expenses increased from $63.4 million in 1994 to $64.8 million in 1995. This increase is primarily due to an increase in payments for repairs and maintenance.\nAs more fully discussed in NOTE 14. \"COMMITMENTS AND CONTINGENCIES - Moorman Settlement,\" the Moorman litigation settlement agreement (the \"Moorman Settlement Agreement\") set forth certain aggressive, annually increasing targets relating to the price of the Partnership's units of limited partner interest which were not achieved, resulting in, among\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nLiquidity and Capital Resources (Continued)\nother things, the required withdrawal of the Partnership's General Partner upon election of a successor and the resulting required purchase of the Redeemable General Partner Interest, as defined below.\nThe withdrawal of the General Partner requires the Partnership to acquire the General Partner's interest in the Partnership (the \"Redeemable General Partner Interest\") at its then fair value, and to pay certain fees and other compensation, as provided in the Partnership Agreement and the Moorman Settlement Agreement. The Moorman Settlement Agreement provides that any payment for such Redeemable General Partner Interest, fees and other compensation during the pendency of the Moorman Settlement Agreement may, at the option of the Oversight Committee (also established under the Moorman Settlement Agreement), be made over three years pursuant to a secured promissory note bearing interest at a financial institution's prime rate. The Managing General Partner has calculated the fair value of the Redeemable General Partner Interest at December 31, 1995 to be $36.2 million, and believes that there has been no material change in such value since that date. The Partnership would be entitled to offset against such payment the then outstanding principal balance of the note receivable ($4.2 million at December 31, 1995) plus all accrued and unpaid interest ($5.2 million at December 31, 1995) on the note receivable from the General Partner representing its capital contribution to the Partnership. When Syntek Asset Management, L.P. (\"SAMLP\") withdraws as General Partner of the Partnership, the fair value of the Redeemable General Partner Interest would depend on the value of the Partnership's assets at the time of calculation and there can be no assurance that the Redeemable General Partner Interest, fees and other compensation payable on any such withdrawal will not be substantially higher or lower than any current estimate or calculation.\nIn the accompanying Consolidated Financial Statements, the Redeemable General Partner Interest is shown as a reduction of Partners' Equity and the note receivable from the General Partner has been offset against the Redeemable General Partner Interest.\nOn January 27, 1995, National Realty, SAMLP and the Oversight Committee executed an Implementation Agreement which provides for the nomination of a successor general partner and for the resolution of all related matters under the Moorman Settlement. On February 20, 1996, the parties to the Implementation Agreement executed an Amended and Restated Implementation Agreement.\nProvided that the successor general partner is elected pursuant to the terms of the Amended and Restated Implementation Agreement, SAMLP shall receive $12,471,500 from the Partnership. This amount represents a compromise settlement of the net amounts owed by the Partnership to SAMLP upon SAMLP's withdrawal as General Partner and any amounts which SAMLP and its affiliates may owe to the Partnership. This amount shall be paid to SAMLP pursuant to a promissory note in accordance with the terms set forth in the Amended and Restated Implementation Agreement.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nLiquidity and Capital Resources (Continued)\nThe Amended and Restated Implementation Agreement has been submitted to the Supervising Judge for tentative approval and approval of the notice to be sent to the original class members. Upon final approval by the Supervising Judge, the proposal to elect the successor general partner will be submitted to the unitholders of National Realty for a vote. In addition, the unitholders will vote upon amendments to the National Realty Partnership Agreement which relate to the proposed compensation of the successor general partner and other related matters.\nUpon approval by the unitholders, SAMLP shall resign as General Partner and the successor general partner shall take office. If the required approvals are obtained, National Realty anticipates that the successor general partner may be elected and take office during the second or third quarter of 1996.\nThe Amended and Restated Implementation Agreement provides that SAMLP, and its affiliates owning units in National Realty, shall not vote to remove the successor general partner, except for removal with cause, for a period of 36 months from the date the successor general partner takes office.\nUpon the election and taking office of the successor general partner, the Moorman Settlement Plan and the Oversight Committee shall terminate. If the successor general partner is not elected, the existing Moorman Settlement Agreement shall remain in full force and effect and all of the provisions of the Amended and Restated Implementation Agreement shall be voided.\nIn November 1987, the Board of Directors of the Managing General Partner approved the Partnership's repurchase of up to 10% of National Realty's units of limited partner interest and on December 15, 1992, the Board of Directors of the Managing General Partner approved the repurchase of up to 300,000 additional units in open-market transactions. Through December 31, 1995, the Partnership had purchased a total of 402,960 units at a total cost of $5.1 million. The Partnership has not purchased any additional units under such repurchase program since January 1993.\nResults of Operations\n1995 COMPARED TO 1994. The Partnership reported net income of $3.8 million for 1995 as compared to net income of $5.0 million for 1994. Contributing to the Partnership's 1995 net income was a gain on sale of real estate of $7.7 million compared to a gain on real estate of $8.3 million in 1994. See NOTE 3. \"REAL ESTATE AND DEPRECIATION.\"\nRents increased from $105.0 million in 1994 to $108.0 million in 1995. This increase is primarily attributable to a 3.2% increase in average rental rates combined with a 1.8% increase in average occupancy rates at the\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nResults of Operations (Continued)\nPartnership's apartment complexes. In addition, an increase of $280,000 is attributable to the acquisition of the Chalet II Apartments in March 1995. These increases are partially offset by a decrease of $2.3 million due to the sale of the Brandywine and Raintree Apartments in October 1994. Rents are expected to decrease slightly in 1996 due to the sale of the Harbour Pointe and Vineyards Apartments in December 1995.\nInterest income increased from $2.4 million in 1994 to $2.9 million in 1995. Of this increase, $265,000 is due to interest earned on the Partnership's credit enhancement escrow deposit, which increased $3.3 million from December 31, 1994 to December 31, 1995. An additional $211,000 is attributable to interest earned on a $5.1 million note receivable, in which a senior participation previously sold by the Partnership was returned in July 1995. See NOTE 4. \"NOTES RECEIVABLE.\" Interest income is expected to continue to increase in 1996 due to interest earned on the Partnership's credit enhancement escrow account, which requires deposits totaling $3.5 million in 1996.\nInterest expense increased from $34.1 million in 1994 to $35.0 million in 1995. Of this increase, $331,000 is due to an increase in interest expense on the blanket mortgage secured by the GCLP properties as a result of the increase in the LIBOR interest rate. An additional increase of $1.0 million is due to mortgage debt which was refinanced in 1994 and 1995 and $89,000 is due to the acquisition of the Chalet II Apartments in March 1995. These increases are offset by a decrease of $713,000 due to the sale of Brandywine and Raintree Apartments in October 1994. Interest expense is expected to increase in 1996 due to a full year's interest on mortgages which were refinanced in 1995 and anticipated to be refinanced in 1996, offset in part by a decrease in interest expense due to the sale of the Harbour Pointe and Vineyards Apartments in December 1995.\nRepairs and maintenance expense increased from $21.9 million in 1994 to $23.9 million in 1995. This increase is attributable to the Partnership's effort to obtain higher rental rates, which increased an average of 3.2% in 1995, and to sustain occupancy levels in 1995. In addition, 1995 repairs and maintenance expenses include fire and storm damage repairs made in 1995.\nProperty taxes and insurance, utilities, property-level payroll costs, other property operation expenses and property management fees for 1995 approximated those of 1994.\nGeneral and administrative expenses increased from $5.8 million in 1994 to $6.3 million in 1995. This increase is primarily attributable to an increase in legal and consulting fees related to the Moorman litigation of $429,000 and an increase in the Partnership's overhead reimbursements to Basic Capital Management, Inc. (\"BCM\").\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nResults of Operations (Continued)\nIn 1995, the Partnership recognized gains on the sale of real estate totaling $7.7 million on the sale of the Harbour Pointe and Vineyards Apartments, compared to gains on sale of real estate in 1994 totaling $8.3 million on the sale of the Brandywine and Raintree Apartments. See NOTE 3. \"REAL ESTATE AND DEPRECIATION.\"\n1994 COMPARED TO 1993. The Partnership reported net income of $5.0 million for 1994 as compared to net income of $1.3 million for 1993. Contributing to the Partnership's 1994 net income was an increase in operating income of $4.6 million, as more fully discussed below, and a gain on sale of real estate of $8.3 million. See NOTE 3. \"REAL ESTATE AND DEPRECIATION.\" The Partnership's 1993 net income included an extraordinary gain of $9.0 million related to the acquisition at a discount of a mortgage obligation. See NOTE 8. \"ACCRUING MORTGAGE.\"\nRental income increased from $99.3 million in 1993 to $105.0 million in 1994. Of this increase, $1.4 million is due to the acquisition in June 1993 of the controlling partnership interest in Club Mar Realty Group, Ltd., which owns the Club Mar Apartments, and obtaining the Whispering Pines Apartments in Canoga Park, California through insubstance foreclosure in December 1993. This is offset by a decrease of $515,000 due to the sale of Brandywine and Raintree Apartments in October 1994. The remaining net increase of $4.8 million is primarily attributable to a 4.4% increase in average rental rates at the Partnership's apartment complexes.\nProperty operating expenses increased from $60.4 million in 1993 to $60.8 million in 1994. Of this increase, $764,000 is due to the acquisition in June 1993 of the controlling partnership interest in Club Mar Realty Group, Ltd., which owns the Club Mar Apartments, and obtaining the Whispering Pines Apartments through insubstance foreclosure in December 1993. This increase is offset by a decrease of $465,000 due to the sale of Brandywine and Raintree Apartments in October 1994.\nInterest income decreased from $3.1 million in 1993 to $2.4 million in 1994. This decrease is primarily attributable to the nonaccrual of interest income on the loan secured by the Whispering Pines Apartments in Canoga Park, California, which was foreclosed in December 1993 and to a decrease in cash receipts in 1994 on a mortgage note receivable on which interest is recognized on a cash receipts basis.\nInterest expense decreased from $34.7 million in 1993 to $34.1 million in 1994. Of this decrease, $265,000 is due to the December 1993 Southern Palms debt modification in which the interest rate was reduced from 11.7% per annum to 8.9% per annum and $350,000 is due to achievement escrows of $1.8 million applied against the principal balances of three of the Partnership's mortgage loans in 1993 and the payment of $228,000 in related prepayment penalties which were included in interest expense in 1993. An additional decrease of $144,000 is due\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nResults of Operations (Continued)\nto the sale of the Brandywine and Raintree Apartments in October 1994. These decreases are offset in part by an increase in interest expense of $252,000 related to the acquisition of the controlling partnership interest in Club Mar Apartments in June 1993.\nGeneral and administrative expenses increased from $5.6 million in 1993 to $5.8 million in 1994. The increase is attributable to an increase in the Partnership's overhead reimbursements to BCM.\nIn 1994, the Partnership recognized gains totaling $8.3 million on the sale of the Brandywine and Raintree Apartments. No gain on sale of real estate was recognized in 1993. See NOTE 3. \"REAL ESTATE AND DEPRECIATION.\"\nIn 1993, the Partnership recognized an extraordinary gain of $9.0 million from the acquisition at a discount of a mortgage obligation. No such gains were recognized in 1994. See NOTE 8. \"ACCRUING MORTGAGE.\"\nEnvironmental Matters\nUnder various federal, state and local environmental laws, ordinances and regulations, the Partnership, may be potentially liable for removal or remediation costs, as well as certain other potential costs relating to hazardous or toxic substances (including governmental fines and injuries to persons and property) where property-level managers have arranged for the removal, disposal or treatment of hazardous or toxic substances. In addition, certain environmental laws impose liability for release of asbestos-containing materials into the air, and third parties may seek recovery from the Partnership for personal injury associated with such materials.\nThe Managing General Partner is not aware of any environmental liability relating to the above matters that would have a material adverse effect on the Partnership's business, assets or results of operations.\nImpact of Inflation\nThe effects of inflation on the Partnership's operations are not quantifiable. Revenues from property operations fluctuate proportionately with inflationary increases and decreases in housing costs. Fluctuations in the rate of inflation also affect the sales values of the Partnership's properties and, correspondingly, the ultimate gains to be realized by the Partnership from property sales. Inflation also has an effect on the Partnership's earnings from short- term investments, and on its interest income and interest expense to the extent that such income and expense depend on floating interest rates.\nCurrent Value Reporting\nThe Partnership believes that the historical cost basis financial statements prepared in accordance with generally accepted accounting\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nCurrent Value Reporting (Continued)\nprinciples are not representative of the economic value of the Partnership's real estate assets because most of the properties have appreciated in value over their historical cost basis. Nevertheless, generally accepted accounting principles require periodic depreciation charges.\nIn conjunction with the exchange transaction, by which the Partnership was formed, the Partnership retained independent appraisers to estimate the Current Appraised Value of the Partnership's properties as of March 31, 1987, based in part upon certain financial, lease and other information provided by the general partners of the exchange transaction partnerships. The Current Appraised Value of the Partnership's properties at March 31, 1987 was $758.0 million, and Revaluation Equity was $410.0 million at such date. Revaluation Equity is defined as the difference between the appraised value of the Partnership's real estate, adjusted to reflect the Partnership's estimate of disposition costs, and the face amount of the mortgage notes payable and accrued interest, if any, encumbering such real estate. The Current Appraised Value of the Partnership's properties at December 31, 1994, was $644.3 million, and Revaluation Equity was $301.3 million at such date.\nIn 1995, the Partnership retained an independent appraiser to determine the Current Appraised Value of the Partnership's properties as of December 31, 1995, in a manner consistent with the methodology used to determine Current Appraised Value as of December 31, 1994 and March 31, 1987. The Current Appraised Value of the Partnership's properties at December 31, 1995 was $654.1 million and Revaluation Equity was $310.0 million at such date.\nTaxes\nNational Realty is a publicly traded limited partnership and, for federal income tax purposes, all income or loss generated by the Partnership is included in the income tax returns of the individual partners. In December 1987, Congress passed legislation requiring certain publicly traded partnerships to be taxed as corporations. National Realty qualifies for \"grandfather\" treatment and will be treated as a partnership until at least 1997, unless the Partnership adds a substantial new line of business, which would require approval of the Oversight Committee, and will continue to be so treated thereafter if 90% or more of its gross income consists of qualifying income from real estate activities. As presently operated, the Partnership meets these requirements. Under Internal Revenue Service guidelines generally applicable to publicly traded partnerships and thus to the Partnership, a limited partner's use of his or her share of partnership losses is subject to special limitations.\nRecent Accounting Pronouncements\nIn March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (\"SFAS\") No. 121 - \"Accounting for the\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nRecent Accounting Pronouncements (Continued)\nImpairment of Long-lived Assets and for Long-lived Assets to Be Disposed Of\". The statement requires that long-lived assets be considered impaired \"...if the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of the asset.\" If impairment exists, an impairment loss shall be recognized, by a charge against earnings, equal to \"...the amount by which the carrying amount of the asset exceeds the fair value of the asset.\" If impairment of a long-lived asset is recognized, the carrying amount of the asset shall be reduced by the amount of the impairment, shall be accounted for as the asset's \"new cost\" and such new cost shall be depreciated over the asset's remaining useful life.\nSFAS No. 121 further requires that long-lived assets held for sale \"be reported at the lower of carrying amount or fair value less cost to sell.\" If a reduction in a held for sale asset's carrying amount to fair value less cost to sell is required, a provision for loss shall be recognized by a charge against earnings. Subsequent revisions, either upward or downward, to a held for sale asset's fair value less cost to sell shall be recorded as an adjustment to the asset's carrying amount, but not in excess of the asset's carrying amount when originally classified as held for sale. A corresponding charge or credit to earnings is to be recognized. Long-lived assets held for sale are not to be depreciated. SFAS No. 121 is effective for fiscal years beginning after December 15, 1995.\nThe Managing General Partner estimates that if the Partnership had adopted SFAS No. 121 effective January 1, 1995 its depreciation and net income in the year ended December 31, 1995 would have been unchanged and that a provision for loss for impairment of its properties would not have been required.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS\nAll other schedules are omitted because they are not required, are not applicable or the information required is included in the Consolidated Financial Statements or the notes thereto.\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nThe Partners National Realty, L.P.\nWe have audited the accompanying consolidated balance sheets of National Realty, L.P., a limited partnership, as of December 31, 1995 and 1994, and the related consolidated statements of operations, partners' equity (deficit) and cash flows for each of the three years in the period ended December 31, 1995. We have also audited the schedules listed in the accompanying index. These financial statements and schedules are the responsibility of the Partnership's Managing General Partner. 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 and schedules. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements and schedules. We believe that our audits 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 National Realty, L.P. at December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\nAs described in Note 14. \"COMMITMENTS AND CONTINGENCIES - Moorman Settlement,\" the Moorman Settlement requires the Partnership to purchase the Redeemable General Partner Interest upon the election of a successor general partner. Although the parties have reached an agreement on the amount to be paid and the terms of payment, the agreement has not received the approval of the\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS - Continued\nSupervising Judge or the unitholders. The outcome of this matter cannot presently be determined and the consolidated financial statements do not include any adjustments that might result from the outcome of this matter.\nAlso, in our opinion, the schedules present fairly, in all material respects, the information set forth therein.\nBDO Seidman, LLP\nDallas, Texas March 21, 1996\nNATIONAL REALTY, L.P. CONSOLIDATED BALANCE SHEETS\nThe accompanying notes are an integral part of these Consolidated Financial Statements.\nNATIONAL REALTY, L.P. CONSOLIDATED BALANCE SHEETS (Continued)\nThe accompanying notes are an integral part of these Consolidated Financial Statements.\nNATIONAL REALTY, L.P. CONSOLIDATED STATEMENTS OF OPERATIONS\nThe accompanying notes are an integral part of these Consolidated Financial Statements.\nNATIONAL REALTY, L.P. CONSOLIDATED STATEMENTS OF PARTNERS' EQUITY (DEFICIT)\nThe accompanying notes are an integral part of these Consolidated Financial Statements.\nNATIONAL REALTY, L.P. CONSOLIDATED STATEMENTS OF CASH FLOWS\nThe accompanying notes are an integral part of these Consolidated Financial Statements.\nNATIONAL REALTY, L.P. CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)\nThe accompanying notes are an integral part of these Consolidated Financial Statements.\nNATIONAL REALTY, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nThe accompanying Consolidated Financial Statements of National Realty, L.P. and consolidated subsidiaries and partnerships (the \"Partnership\") have been prepared in conformity with generally accepted accounting principles, the most significant of which are described in NOTE 2. \"SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES.\" These, along with the remainder of the Notes to Consolidated Financial Statements, are an integral part of the Consolidated Financial Statements. The data presented in the Notes to Consolidated Financial Statements are as of December 31 of each year or for the year then ended, unless otherwise indicated. Dollar amounts in tables are in thousands, except per unit amounts.\nCertain balances for 1994 and 1993 have been reclassified to conform to the 1995 presentation. Units and per unit data have been restated for the three for one forward unit split effected January 2, 1996.\nNOTE 1. ORGANIZATION\nGeneral. National Realty, L.P. (\"National Realty\") is a Delaware limited partnership which commenced operations on September 18, 1987 when it acquired through National Operating, L.P. (the \"Operating Partnership\" or \"NOLP\") all of the assets, and assumed all of the liabilities, of 35 public and private limited partnerships.\nNational Realty is the sole limited partner of the Operating Partnership and owns 99% of the beneficial interest in the Operating Partnership. The general partner of, and owner of 1% of the beneficial interest in each of, National Realty and the Operating Partnership is Syntek Asset Management, L.P. (the \"General Partner\" or \"SAMLP\"). Gene E. Phillips is a general partner of SAMLP with a .95% general partner interest. Syntek Asset Management, Inc. (\"SAMI\") is the managing general partner of SAMLP, with a .10% general partner interest in SAMLP. SAMI, of which Mr. Phillips serves as a director, Chairman of the Board and Chief Executive Officer, is a company owned by Basic Capital Management, Inc. (\"BCM\"). American Realty Trust, Inc. (\"ART\"), a publicly held real estate investment company of which Mr. Phillips served as Chairman of the Board and director until November 16, 1992, owns a 76.8% limited partner interest in SAMLP. Southmark Corporation (\"Southmark\") owns a 19.2% limited partner interest in SAMLP. Mr. Phillips and William S. Friedman own the remaining 2.95% limited partner interest in SAMLP. Mr. Friedman was a general partner of SAMLP until March 4, 1994.\nSAMI, as Managing General Partner of SAMLP, manages the affairs of the Partnership. The executive officers of SAMI also serve as executive officers of BCM. BCM is a company owned by a trust for the benefit of the children of Mr. Phillips. Messrs. Phillips and Friedman served as directors of BCM until December 22, 1989 and as officers of BCM until September 1, 1992 and May 1, 1993, respectively.\nIn November 1992, the Partnership refinanced 52 of its apartment complexes and a wraparound mortgage note receivable with a financial institution. To facilitate the refinancing, the Operating Partnership\nNATIONAL REALTY, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 1. ORGANIZATION (Continued)\ntransferred those assets to Garden Capital, L.P. (\"GCLP\"), a Delaware limited partnership. The Operating Partnership is the sole limited partner with a 99.3% limited partner interest in GCLP. The Operating Partnership received its limited partner interest in exchange for the transfer of the net assets of the 52 apartment complexes and the wraparound mortgage note receivable to GCLP. Garden Capital Management Incorporated (\"GCMI\"), a Nevada corporation, is the .7% managing general partner of GCLP. See NOTE 8. \"ACCRUING MORTGAGE.\"\nGCLP transferred the acquired net apartment assets, in exchange for a 99% limited partner interest in each of 52 single asset limited partnerships which were formed for the purpose of operating, refinancing and holding title to the apartment complexes. The transfer of the 52 apartment complexes and the wraparound mortgage note receivable were effective November 25, 1992.\nEach of the single asset limited partnerships has no significant assets other than an apartment complex encumbered by mortgage debt. Garden Capital Incorporated (\"GCI\"), a Nevada corporation, is the 1% managing general partner in each of the single asset limited partnerships.\nExcept as described under NOTE 14. \"COMMITMENTS AND CONTINGENCIES - Moorman Settlement,\" all decisions relating to the Partnership, including all decisions with respect to the acquisition, disposition, improvement, financing or refinancing of the Partnership's properties or other investments, are made by the Managing General Partner. However, all decisions with respect to the acquisition, disposition, improvement, financing or refinancing of the GCLP properties are made by GCMI or GCI as managing general partner of GCLP or the single asset partnerships, respectively.\nBCM, SAMI's corporate parent, performs certain administrative functions for the Partnership, such as accounting services, mortgage servicing and portfolio review and analysis, on a cost reimbursement basis. Since February 1, 1990 BCM or affiliates of BCM have provided property management services for the Partnership. Currently, Carmel Realty Services, Ltd. (\"Carmel, Ltd.\"), an affiliate of BCM, performs such property management services for the Partnership. BCM or affiliates of BCM also perform loan placement services, leasing services and real estate brokerage and acquisition services and other services for the Partnership for fees and commissions. See NOTE 11. \"GENERAL PARTNER FEES AND COMPENSATION.\" GCMI performs administrative functions, similar to those performed for the Partnership by BCM, for GCLP on a cost reimbursement basis. The common stock of GCI and GCMI is owned by John A. Doyle (20%), Richard A. Green (40%) and Henry W. Simon (40%).\nParticipation in net income, net loss and distributions. The limited partners of National Realty have a 99% interest and the General Partner has 1% interest in the net income or net loss and distributions of National Realty. National Realty has a 99% and the General Partner has\nNATIONAL REALTY, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 1. ORGANIZATION (Continued)\na 1% interest in the net income or net loss of the Operating Partnership. The 1% General Partner interest in each of National Realty and the Operating Partnership is equal to a 1.99% interest on a combined basis. The Operating Partnership has a 99.3% limited partner interest and GCMI has a .7% general partner interest in the net income or net loss and distributions of GCLP. GCLP has a 99% interest and GCI has a 1% interest in the net income or net loss and distributions of the 52 single asset partnerships that hold title to the apartment complexes. GCMI's .7% general partner interest in GCLP and GCI's 1% general partner interest in the single asset partnerships is equal to a 1.68% interest on a combined basis. For tax purposes limited partners are allocated their proportionate share of net income or net loss commencing with the calendar month subsequent to their entry into the Partnership. During the pendency of the Moorman Settlement Plan (as defined in NOTE 14. \"COMMITMENTS AND CONTINGENCIES - Moorman Settlement\"), the General Partner's base compensation, equal to 10% of the distributions to unitholders from the Partnership's cash from operations, is waived.\nGeneral Partner's capital contribution. In return for its 1% interest in National Realty, the General Partner was required to make aggregate capital contributions to the Partnership in an amount equal to 1.01% of the total initial capital contributions to the Partnership. The General Partner contributed $500,000 in cash with the remaining contribution evidenced by a promissory note bearing interest at the rate of 10% per annum compounded semi-annually payable on the earlier of September 18, 2007, liquidation of the Partnership or termination of the General Partner's interest in the Partnership. The principal balance of such promissory note was $4.2 million at December 31, 1995 and 1994.\nIn the accompanying Consolidated Balance Sheets, the note receivable from the General Partner is offset against the Redeemable General Partner Interest as described in NOTE 14. \"COMMITMENTS AND CONTINGENCIES - Moorman Settlement.\" The General Partner received its 1% interest in the Operating Partnership in exchange for its agreement to serve as general partner of the Operating Partnership. If National Realty issues additional units of limited partner interest, the General Partner is entitled to maintain its aggregate 1% interest in each of National Realty and the Operating Partnership without payment of additional consideration.\nGCMI contributed 100% of its economic interest in an apartment complex in Flagstaff, Arizona, to GCLP as its initial general partner capital contribution. In March 1993, GCMI contributed the Accruing Mortgage (as defined in NOTE 8. \"ACCRUING MORTGAGE\") as a substitute capital contri- bution for its .7% general partner interest in GCLP. National Realty subsequently purchased the Accruing Mortgage for a $900,000 note payable. GCI received its 1% general partner interest in the single asset partnerships in exchange for agreeing to manage the property owned by each such partnership.\nNATIONAL REALTY, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBasis of consolidation. The Consolidated Financial Statements include the accounts of National Realty, the Operating Partnership, GCLP and consolidated entities. All significant intercompany balances and transactions have been eliminated. Minority interests (which are not significant) are included in other liabilities.\nAccounting estimates. In the preparation of the Partnership's Consolidated Financial Statements in conformity with generally accepted accounting principles it was necessary for the Managing General Partner 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 Consolidated Financial Statements and the reported amounts of revenues and expenses for the year then ended. Actual results could differ from these estimates.\nRevenue recognition on the sale of real estate. Sales of real estate are recognized when and to the extent permitted by Statement of Financial Accounting Standards No. 66, \"Accounting for Sales of Real Estate\" (\"SFAS No. 66\"). Until the requirements of SFAS No. 66 for full profit recognition have been met, transactions are accounted for using either the deposit, the installment, the cost recovery or the financing method, whichever is appropriate.\nReal estate and depreciation. Land, buildings and improvements are stated at the lower of cost or estimated net realizable value. Properties held for sale are depreciated in accordance with the Partnership's established depreciation policies. The subsequent classification of property previously held for sale to held for investment does not result in a restatement of previously reported revenues, expenses or net income .\nDepreciation is provided on buildings and improvements using the straight-line method over estimated useful lives of 40 years for buildings and 7 to 25 years for improvements. Expenditures for renewals and betterments are capitalized and repairs and maintenance are charged against operations as incurred.\nAllowance for estimated losses. A valuation allowance is provided for estimated losses on notes receivable to the extent that the Partnership's investment in the notes exceeds the Partnership's estimate of net realizable value of the collateral securing each such note, or fair value of the collateral if foreclosure is probable. In estimating net realizable value, consideration is given to the current estimated collateral value adjusted for costs to complete or improve, hold and dispose. The provision for losses on notes receivable is based on estimates, and actual losses may vary from current estimates. Such estimates are reviewed periodically and any additional provision determined to be necessary is charged against earnings in the period in which it becomes reasonably estimable.\nNATIONAL REALTY, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)\nInterest recognition on notes receivable. It is the Partnership's policy to cease recognizing interest income on notes receivable that have been delinquent for 60 days or more. In addition, accrued but unpaid interest income is only recognized to the extent that the net realizable value of underlying collateral exceeds the carrying value of the receivable.\nDeferred financing costs. Deferred financing costs are capitalized and amortized on the interest-rate method over the term of the related loans.\nPresent value discounts. The Partnership provides for present value discounts on notes receivable or payable that have interest rates that differ substantially from prevailing market rates and amortizes such discounts by the interest method over the lives of the related notes. The factors considered in determining a market rate for receivables include the borrower's credit standing, nature of the collateral and payment terms of the note.\nMarketable equity securities of affiliate. Marketable equity securities are considered to be available-for-sale and are carried at fair value, defined as period end closing market value. Net unrealized holding gains are reported as a separate component of partners' equity until realized.\nFair value of financial instruments. The Partnership used the following assumptions in estimating the fair value of its notes receivable, marketable equity securities and notes payable. For performing notes receivable, the fair value was estimated by discounting future cash flows using current interest rates for similar loans. For nonperforming notes receivable, the estimated fair value of the Partnership's interest in the collateral property was used. For marketable equity securities, fair value was the year end closing market price of each security. The estimated fair values presented do not purport to represent amounts to be ultimately realized by the Partnership. The amounts ultimately realized may vary significantly from the estimated fair values presented. For notes payable, the fair value was estimated using current rates for mortgages with similar terms and maturities, which, at December 31, 1995 and 1994, approximated carrying value.\nCash equivalents. For purposes of the Consolidated Statements of Cash Flows, the Partnership considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.\nEarnings per unit. Income per unit of limited partner interest is computed based upon the weighted average number of units outstanding during each year. Accordingly, net income per unit is derived by dividing 98.01% of the Partnership's net income by 6,418,104, 6,418,572 and 6,747,990 units for 1995, 1994 and 1993, respectively.\nNATIONAL REALTY, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 3. REAL ESTATE AND DEPRECIATION\nIn 1991, the General Partner of the Partnership selected a group of assets which it offered for sale in accordance with the terms of the Moorman Settlement Agreement classifying those properties as held for sale. The Partnership, among others, has entered into an agreement which provides for the nomination of a successor general partner and for the resolution of all matters under the Moorman Settlement Agreement. In contemplation of the election of such successor general partner and termination of the Moorman Settlement Plan, the Partnership has classified all of the Partnership's properties as held for investment at December 31, 1995. See NOTE 14. \"COMMITMENTS AND CONTINGENCIES - Moorman Settlement.\"\nIn March 1995, the Partnership purchased the Chalet II Apartments, a 72 unit apartment complex in Topeka, Kansas, for $1.6 million. The Partnership paid $439,000 in cash and obtained new mortgage financing of $1.2 million. The mortgage bears interest at a rate of prime plus 1% per annum (10% at December 31, 1995), requires monthly payments of principal and interest, currently $12,000, and matures in March 2002.\nIn December 1995, the Partnership sold the Harbour Pointe Apartments in Miami, Florida for $5.2 million. The Partnership received $2.1 million in cash after the payoff of $3.0 million in existing mortgage debt and the payment of various closing costs associated with the sale. The Partnership recognized a gain of $2.8 million on the sale.\nAlso in December 1995, the Partnership sold the Vineyards Apartments in Broadview Heights, Ohio for $10.7 million. The Partnership received net cash of $2.4 million after the payoff of $8.2 million in existing mortgage debt and the payment of various closing costs associated with the sale. The Partnership recognized a gain of $4.9 million on the sale.\nIn October 1994, the Partnership sold the Brandywine and Raintree Apartments, both located in Meridian Township, Michigan, to a single buyer for a total of $14.8 million. The Partnership received net cash of $4.5 million after the payoff of $9.4 million in existing mortgage debt, the payment of $82,000 in prepayment penalties and various closing costs associated with the sales. The Partnership recognized gains totaling $8.3 million on the sales.\n[THIS SPACE INTENTIONALLY LEFT BLANK.]\nNATIONAL REALTY, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 4. NOTES RECEIVABLE\nNotes and interest receivable consisted of the following:\nThe Partnership does not recognize interest income on nonperforming notes receivable. For 1995, 1994 and 1993, unrecognized interest income on nonperforming notes totaled $745,000, $372,000 and $924,000, respectively.\nThe notes receivable mature from 1996 through 2000 with interest rates ranging from 8.0% to 11.5% with a weighted average interest rate of 9.5%. Discounts were based on interest rates at the time of origination. Notes receivable are nonrecourse and are generally collateralized by real estate. The majority of the notes receivable require monthly payments of interest only with \"balloon\" principal payments at the end of their respective terms.\nDeferred gains result from property sales where the buyer has either made an inadequate down payment or has not met the continuing investment test of SFAS No. 66.\nIn 1991, the Partnership and an insurance company entered into an Asset Sales Agreement to sell participations in certain of the Partnership's mortgage notes receivable in exchange for participations in other mortgage notes or assets and cash. The Partnership entered into the Asset Sales Agreement in an effort to develop a potential source for future financing and to generate cash from otherwise illiquid assets. The assets transferred by the Partnership pursuant to the Asset Sales Agreement included a $2.5 million senior participation in a wraparound mortgage note receivable secured by a shopping center in Las Vegas, Nevada, a $1.0 million senior participation in a wraparound mortgage note receivable secured by a shopping center in La Crosse, Wisconsin, and a first lien mortgage note with a carrying value of $1.2 million prior to transfer. In return, the Partnership received a $447,000 senior participation in a note secured by land in Granby, Colorado, a $1.5 million participation in a note secured by a country club in the Ka'u District of Hawaii, a 10% limited partner interest in the partnership owning the country club, valued at $1.5 million, a $213,000\nNATIONAL REALTY, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 4. NOTES RECEIVABLE (Continued)\nfirst lien mortgage note secured by land in Denver, Colorado and $1.0 million in cash. The Asset Sales Agreement included put and guaranty provisions.\nIn March 1992, the insurance company was placed in receivership. In June 1992, the Partnership provided notice to the insurance company, under the terms of the put and guaranty provisions, of its desire to divest itself of all the assets received. The Receiver refused to allow the enforcement of the terms of the Asset Sales Agreement. A settlement between the Partnership and the Receiver was approved by the court on February 15, 1995. Under the terms of the settlement, the insurance company returned to the Partnership the senior participations in the wraparound mortgage notes secured by the shopping centers in Las Vegas, Nevada and La Crosse, Wisconsin. In exchange, the Partnership returned all of the assets that it received from the insurance company other than the first lien mortgage note secured by the land in Denver, Colorado, which had been foreclosed and sold by the Partnership, and $657,000 in cash. The Partnership also purchased from the insurance company the first lien note secured by the land in Granby, Colorado and a second lien note secured by commercial condominiums also in Granby, Colorado for a total of $550,000. The Partnership incurred no loss on the settlement.\nIn October 1995, the Partnership accepted a $3.7 million discounted payoff of three wraparound mortgage loans secured by the Hurstbourne Business Park in Louisville, Kentucky. The Partnership received $1.5 million in cash after the payoff of $2.2 million in first mortgage debt. No loss was recorded as the discounted note payoff was equal to the Partnership's net carrying value of the loans.\nNOTE 5. ALLOWANCE FOR ESTIMATED LOSSES\nActivity in the allowance for estimated losses was as follows:\nNOTE 6. INVESTMENTS IN MARKETABLE EQUITY SECURITIES OF AFFILIATE\nThe Partnership owns 97,866 shares of the common stock of ART, a publicly held real estate investment company, which the Partnership acquired in open market purchases in 1990 at an adjusted cost of $269,000. The Partnership considers the ART common stock to be available-for-sale and the shares are therefore carried at fair value (period end market value). The market value of the ART common stock was $722,000 at December 31, 1995 and $636,000 at December 31, 1994.\nNATIONAL REALTY, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 7. NOTES PAYABLE\nNotes payable at December 31, 1995 and 1994 are collateralized by land, buildings and improvements and are generally nonrecourse to the partnership. The GCLP mortgage debt, as discussed below, is cross-collateralized and cross- defaulted among the apartment complexes and wraparound note receivable that serve as collateral for such debt. The notes payable outstanding at December 31, 1995 bear interest at stated rates ranging from 5.0% to 11.5% with a weighted average rate of 8.9% and such notes have maturities or call dates ranging from one to 27 years.\nIn 1995, the Partnership refinanced the mortgage debt secured by the Mallard Lake Apartments in Greensboro, North Carolina in the amount of $8.2 million, the Four Seasons Apartments in Denver, Colorado in the amount of $9.9 million, the Nora Pines Apartments in Indianapolis, Indiana in the amount of $6.2 million, the Covered Bridge Apartments in Gainesville, Florida in the amount of $4.7 million, the Marina Playa Office Building in Santa Clara, California in the amount of $8.3 million and the Timbercreek Apartments in Omaha, Nebraska in the amount of $5.0 million. The Partnership received net cash of $10.7 million after the payoff of $27.8 million in existing mortgage debt including $315,000 in prepayment penalties. The remainder of the refinancing proceeds were used to fund escrows for replacements and repairs and to pay various closing costs associated with the refinancings. The new mortgages bear interest at the rates ranging from 7.75% to 8.75% per annum, require monthly payments of principal and interest and mature from June 2005 to January 2006.\nIn March 1994, the Partnership refinanced the mortgage debt secured by the Cross County Mall, a shopping center in Mattoon, Illinois. The Partnership borrowed $7.5 million under the loan to repay the then existing mortgage debt and to pay for the renovation of the shopping center as well as tenant improvements.\nIn September 1994, the Partnership sold the Creekwood Apartments in College Park, Georgia for $6.0 million. The Partnership has accounted for the sale as a financing transaction, due to the Partnership having provided financing of the purchaser's down payment. On the date of sale, the purchaser obtained new first mortgage financing from an independent lending institution in the amount of $3.0 million. The Partnership received $1.3 million in excess proceeds from the new financing, after the payoff of the existing mortgage in the amount of $1.1 million and the funding of required repair escrows and closing costs associated with the financing.\nIn November 1992, the Partnership transferred the net assets of 52 apartment complexes and a wraparound note receivable to GCLP, which then refinanced such assets with a financial institution through the issuance of a $223 million blanket mortgage. GCLP used the refinancing proceeds to pay off the mortgage debt of the 52 properties and the wraparound note receivable.\nNATIONAL REALTY, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 7. NOTES PAYABLE (Continued)\nIn conjunction with the refinancing, four escrow accounts were established and GCLP made an initial deposit totaling $3.8 million from the refinancing proceeds. The recurring replacement escrow required monthly deposits of $232,000 to be used for capital repairs, replacements and improvements. The capital replacement escrow required monthly deposits which totaled $1.7 million in 1994. No capital replacement escrow deposits were required in 1995. The credit enhancement escrow requires monthly deposits totaling $3.5 million in 1996 ($3.3 million in 1995 and $3.0 million in each of 1993 and 1994) and $2.0 million in each of 1997, 1998 and 1999 up to an aggregate maximum amount of $18.5 million. These funds will be used to fund any operating shortfalls. A tax and insurance escrow was also established which requires monthly payments based on projections of real estate taxes and insurance.\nAlso in conjunction with the GCLP refinancing, a letter of credit was provided by a financial institution for a term of not less than five years and in the amount of $12.5 million. The letter of credit may be drawn upon by GCLP to pay any operating shortfalls, provided such funds are not on deposit in the credit enhancement escrow, described above, which is to be used, first, to fund operating shortfalls. The letter of credit will be reduced by the amount of (i) each draw on the letter of credit, (ii) each credit enhancement escrow deposit and (iii) any additional deposits made to the credit enhancement escrow account in excess of the requirement. No amounts have been drawn under the letter of credit.\nScheduled notes payable principal payments (including pension notes) are due as follows:\nNOTE 8. ACCRUING MORTGAGE\nIn connection with its formation in January 1987, the Partnership restructured $12.7 million of obligations into an \"Accruing Mortgage\". The Accruing Mortgage had a maturity date of September 18, 1994 and was secured by Partnership properties. In November 1992, an affiliate of GCMI, the managing general partner of GCLP acquired the Accruing Mortgage. In connection with the GCLP refinancing, $8.5 million was paid against the principal balance and one of the Partnership's collateral apartment complexes was released and the recourse provisions of the Accruing Mortgage were canceled. In March 1993, the holder of the Accruing Mortgage merged into GCMI and GCMI contributed such\nNATIONAL REALTY, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 8. ACCRUING MORTGAGE (Continued)\nmortgage at an agreed value of $900,000 as a substitute capital contribution for its .7% general partner interest in GCLP. In March 1993, the Partnership acquired the Accruing Mortgage from GCLP in exchange for a $900,000 noninterest bearing unsecured demand note in full satisfaction of principal and accrued but unpaid interest. In 1993, the Partnership recognized an extraordinary gain of $9.0 million from the discounted acquisition of the Accruing Mortgage.\nNOTE 9. PENSION NOTES\nAlso in connection with its formation, the Partnership issued $4.7 million of 8% subordinated Pension Notes to certain investors in exchange for their interest in the net assets of certain of the \"rolled-up\" partnerships. The Pension Notes are issued under an Indenture between the Partnership and Bank of America Texas as successor Trustee. The Pension Notes are unsecured, subordinated obligations of the Partnership and bear interest at the rate of 8% compounded annually. Principal and interest are to be paid upon maturity on September 18, 1997 or earlier redemption. At December 31, 1995, such redemption amount was $12.0 million, including accrued but unpaid interest.\nThe Pension Notes are redeemable at the option of the Partnership at any time, in whole or in part, at 100% of the principal amount plus accrued and unpaid interest to the date of redemption. The Pension Notes are also subject to mandatory redemption if the Partnership's current value net worth (as defined in such Indenture) on the last day of each of any two consecutive fiscal quarters is less than 175% of the aggregate redemption price of Pension Notes then outstanding.\nThe 8% stated interest rate on the Pension Notes is different than the assumed market rate at the time of issuance. Such discount is being amortized over the term of the Pension Notes using the interest method. Interest expense of $1,289,000, $1,151,000 and $1,028,000 was recognized on the Pension Notes for the years 1995, 1994 and 1993, respectively.\nNOTE 10. WARRANTS\nPursuant to the Moorman Settlement Agreement, on February 14, 1992 the Partnership issued warrants to purchase an aggregate of 2,019,579 of its units of limited partner interest subject to adjustment. Each warrant initially entitled the holder thereof to purchase three quarters of one unit at the exercise price ($11.00 per warrant). The initial exercise price was equal to $14.67 per unit and increased to $16.00 per unit on February 14, 1993, subject to adjustment. The warrants are exercisable for five years from the February 14, 1992 date of issuance or until earlier redemption. See NOTE 14. \"COMMITMENTS AND CONTINGENCIES - Moorman Settlement.\"\nNATIONAL REALTY, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 11. GENERAL PARTNER FEES AND COMPENSATION\nGeneral. Gene E. Phillips is a general partner of SAMLP, the Partnership's General Partner. Mr. Phillips serves as a director, Chairman of the Board and Chief Executive Officer of SAMI, the Partnership's Managing General Partner. Mr. Phillips and the executive officers of SAMI also serve as officers or directors of various other real estate entities. These entities may have the same objectives and may be engaged in activities similar to those of the Partnership.\nProperty Management Fees. As compensation for providing property management services to the Partnership's properties, as provided in the Partnership Agreement, the General Partner or an affiliate of the General Partner is to receive a reasonable property management fee. Currently, Carmel Realty Services, Ltd. (\"Carmel, Ltd.\"), an affiliate of the General Partner, provides such property management services for a fee of 5% of the monthly gross rents collected on the properties under its management. Carmel, Ltd. subcontracts with other entities for the property-level management services to the Partnership at various rates. The general partner of Carmel, Ltd. is BCM. The limited partners of Carmel, Ltd. are (i) Syntek West, Inc. (\"SWI\"), of which Mr. Phillips is the sole shareholder, (ii) Mr. Phillips and (iii) a trust for the benefit of the children of Mr. Phillips. Carmel, Ltd. subcontracts the property-level management and leasing of twelve of the Partnership's commercial properties to Carmel Realty, Inc. (\"Carmel Realty\") which is a company owned by SWI. Carmel Realty is entitled to receive property and construction management fees and leasing commissions in accordance with the terms of its property-level management agreement with Carmel, Ltd. Carmel, Ltd. does not perform property management services for GCLP.\nLeasing Commissions. As compensation for providing leasing and rent-up services for a Partnership property, as provided in the Partnership Agreement, the General Partner or an affiliate of the General Partner shall be paid a reasonable leasing commission.\nReimbursement of Administrative Expenses. To the extent that officers or employees of the general partners or any of their affiliates participate in the operation or administration of the Partnership or GCLP, the general partners and their affiliates are to be reimbursed under the partnership agreements for salaries, travel, rent, depreciation, utilities and general overhead items incurred and properly allocable to such services. Such amounts are included in General and Administrative expense in the accompanying Consolidated Statements of Operations.\nGeneral Partner Compensation. As base compensation for providing administrative and management services under the Partnership Agreement, the General Partner is entitled to receive from the Partnership, an annual partnership management fee equal to 10% of distributions made in each calendar year of Cash from Operations, as defined in the Partnership Agreement, for the calendar year, payable within 90 days after the end of\nNATIONAL REALTY, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 11. GENERAL PARTNER FEES AND COMPENSATION (Continued)\nthat calendar year. As additional incentive compensation, the General Partner is entitled to receive in each calendar year an amount equal to 1% of the Average Unit Market Price, as defined in the Partnership Agreement, for that calendar year. Provided, however, that no incentive compensation is payable unless distributions of cash from operations exceed 6% of the Exchange Value of the original assets, also as defined in the Partnership Agreement. The General Partner has waived its base compensation during the pendency of the Moorman Settlement Agreement.\nReal Estate Brokerage Commissions. The General Partner or an affiliate of the General Partner may, pursuant to the Partnership Agreement, charge a reasonable real estate brokerage commission, payable at the time the Partnership acquires title to, or beneficial ownership in, an acquired property. Upon the sale of any Property by the Partnership, the General Partner or an affiliate of the General Partner may, pursuant to the Partnership Agreement, charge a reasonable real estate brokerage commission, payable at the time the Partnership transfers title to the property. In each case, such commissions are payable only if the General Partner or such affiliate actually performed brokerage services.\nIncentive Disposition Fee. Under the Partnership Agreement, the General Partner or an affiliate of the General Partner is paid a fee equal to 10% of the amount, if any, by which the Gross Sales Price, as defined in the Partnership Agreement, of any property sold by the Partnership exceeds 110% of the Adjusted Cost, also as defined in the Partnership Agreement, of such property.\nAcquisition Fees. As compensation under the Partnership Agreement for services rendered in structuring and negotiating the acquisition by the Partnership of any property, other than an Initial Property, as defined in the Partnership Agreement, the General Partner or an affiliate of the General Partner is paid a fee in an amount equal to 1% of the Original Cost, also as defined in the Partnership Agreement, of such property.\nFees For Additional Services. Under the Partnership Agreement the General Partner or an affiliate of the General Partner may provide services other than those set out above for the Partnership in return for reasonable compensation.\n[THIS SPACE INTENTIONALLY LEFT BLANK.]\nNATIONAL REALTY, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 11. GENERAL PARTNER FEES AND COMPENSATION (Continued)\nFees and cost reimbursement to SAMLP, the General Partner of the Partnership and its affiliates:\n- ---------------------\n* Net of property management fees paid to subcontractors, other than Carmel Realty.\nCost reimbursements to GCMI, the general partner of GCLP:\nNOTE 12. RENTS UNDER OPERATING LEASES\nThe Partnership's operations include the leasing of commercial properties (office buildings and shopping centers). The leases thereon expire at various dates through 2013. The following is a schedule of minimum future rents on non-cancelable operating leases as of December 31, 1995:\nNOTE 13. INCOME TAXES\nThe Partnership's partners include their share of partnership income or loss in their respective tax returns and, accordingly, no income taxes have been provided in the accompanying Consolidated Statements of Operations.\nIn December 1987, Congress passed legislation requiring certain publicly traded partnerships to be taxed as corporations. National Realty qualifies for \"grandfather\" treatment and will be treated as a partnership for federal tax purposes until at least 1997, unless the Partnership adds a substantial new line of business, which would require\nNATIONAL REALTY, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 13. INCOME TAXES (Continued)\napproval of the Oversight Committee (see NOTE 14. \"COMMITMENTS AND CONTINGENCIES - Moorman Settlement\") and will continue to be so treated thereafter if 90% or more of its gross income consists of qualifying income from real estate activities. As presently operated, the Partnership meets this qualification.\nUnder the legislation, Partnership losses are suspended for limited partners and carried forward to offset future income or gain from the Partnership's operations or gain upon a limited partner's disposition of all units held. Any remaining income will be taxed as portfolio income.\nNOTE 14. COMMITMENTS AND CONTINGENCIES\nMoorman Settlement\nThe Partnership is party to a settlement agreement, dated as of May 9, 1990, between plaintiffs Joseph B. Moorman, et al. and defendants Robert A. McNeil, National Realty, the Operating Partnership, SAMLP, Messrs. Phillips and Friedman, and Shearson Lehman Hutton Inc., successor-in-interest to defendant E.F. Hutton & Company Inc., relating to the action entitled Moorman, et al. v. Southmark Corporation, et al. Such action was filed on September 2, 1987, in the Superior Court of the State of California, County of San Mateo. On May 9, 1990, the Partnership agreed to settle such action pursuant to the terms of a written agreement (the \"Moorman Settlement Agreement\"). On June 29, 1990, after a hearing as to its fairness, reasonableness and adequacy, the Moorman Settlement Agreement was granted final court approval.\nThe Moorman Settlement Agreement is complex and the following summary is qualified in its entirety by reference to the text thereof, which was previously included as an exhibit to the Partnership's Form 10-Q for the quarter ended March 31, 1990, as filed with the Securities and Exchange Commission. The Moorman Settlement Agreement provides for a plan (the \"Moorman Settlement Plan\") consisting of, among other things, the following: (i) the appointment and operation of a committee (the \"Oversight Committee\"), to oversee the implementation of the Moorman Settlement Plan, (ii) the appointment and operation of an audit committee having a majority of members unaffiliated with Messrs. Phillips and Friedman or SAMLP, (iii) the establishment of specified annually increasing targets described below (each a \"Target\") for each of the next five years through May 1995, relating to the price of the units of limited partner interest as decreased for certain distributions to unitholders, (iv) an agreement by SAMLP not to seek reimbursement of greater than $500,000 per year for Messrs. Phillips' and Friedman's salaries for serving as general partners of SAMLP, (Mr. Friedman resigned as general partner of SAMLP effective March 4, 1994) and a deferral of such payments until such time as a Target may be met, and, if SAMLP resigns as General Partner, a waiver of any compensation so deferred, (v) a deferral until such time as a Target may be met of certain future annual General Partner compensation payable, pursuant to the Partner-\nNATIONAL REALTY, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 14. COMMITMENTS AND CONTINGENCIES (Continued)\nMoorman Settlement (Continued)\nship's governing documents, to SAMLP or its affiliates, and, if SAMLP resigns as General Partner, a waiver of any compensation so deferred, (vi) the required distribution to unitholders of all the Partnership's operating cash flow in excess of certain renovation costs, unless the Oversight Committee approves alternative uses for such operating cash flow, (vii) the issuance of Warrants to purchase an aggregate of up to 2,019,579 units (the \"Warrants\") to Class Members, (viii) the contribution by certain co-defendants of cash and notes payable to the Partnership aggregating $5.5 million (including $2.5 million to be contributed by SAMLP and its general partners over a four- year period), (ix) the amendment of the Partnership Agreement to reduce the vote required to remove the General Partner from a two-thirds vote to a majority vote of the units, (x) the Partnership's redemption of its unit purchase rights and an agreement not to adopt a similar rights plan without Oversight Committee approval and (xi) the Partnership's payment of certain settlement costs, including plaintiffs' attorneys' fees in the amount of $3.4 million. The Moorman Settlement Plan will remain in effect until SAMLP has resigned as General Partner and a successor general partner is elected and takes office, and the Warrants will remain exercisable for five years from the February 14, 1992 date of issuance or until earlier redemption.\nSAMLP, on behalf of itself and its general partners, has made the payments of $2.5 million (including accrued interest), to the Partnership, as required by the Moorman Settlement Agreement.\nIf Targets are not met for any two successive years of the Moorman Settlement Plan or for the final year of the Moorman Settlement Plan, SAMLP will be required to withdraw as General Partner effective at the time a successor general partner is elected. Upon, among other things, the withdrawal of SAMLP as General Partner and the due election and taking office of a successor, the Moorman Settlement Plan would terminate.\nThe Targets for the first and second anniversary dates were not met. Since the Targets were not met for two successive years, the Moorman Settlement Agreement requires that SAMLP resign as General Partner, effective upon the election and qualification of its successor. On July 8, 1992, SAMLP notified the Oversight Committee of the failure to meet the Target for two successive years.\nUpon, among other things, the withdrawal of SAMLP as General Partner and the due election and taking office of a successor, the Moorman Settlement Plan will terminate. Withdrawal of SAMLP as General Partner pursuant to the Moorman Settlement Agreement requires unitholders to elect a successor general partner by majority vote. Upon the withdrawal or removal of the General Partner without the selection of a successor, the Partnership would be dissolved.\nNATIONAL REALTY, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 14. COMMITMENTS AND CONTINGENCIES (Continued)\nMoorman Settlement (Continued)\nThe Moorman Settlement Agreement provides that between the date of the certification causing the General Partner's resignation and the date a successor general partner takes office, the resigning General Partner shall limit its activities, as General Partner, to the conduct of the business of the Partnership in the ordinary course, shall not, without consent of the Oversight Committee, purchase or sell any real estate or other assets of the Partnership not in progress on said date, shall cooperate in the election of a successor general partner and shall cooperate with its successor to facilitate a change in the office of General Partner of the Partnership. The resigning General Partner will continue to receive fees, expenses and distributions, if any, while the solicitation is prepared.\nThe withdrawal of the General Partner would require the Partnership to acquire the General Partner's interest in the Partnership (the \"Redeemable General Partner Interest\") at its then fair value, and to pay certain fees and other compensation, as provided in the Partnership Agreement and the Moorman Settlement Agreement. Under the Moorman Settlement Agreement, payment for such Redeemable General Partner Interest, fees and other compensation may, at the Oversight Committee's option, be paid over a three year period pursuant to a secured promissory note bearing interest at the prime rate and containing commercially reasonable terms and collateral. Under the Moorman Settlement Plan, the purchase price for Redeemable General Partner Interest would be calculated, as of the time SAMLP withdraws as General Partner under the Partnership's governing documents. The Managing General Partner has calculated the Redeemable General Partner Interest at December 31, 1995 to be $36.2 million, and believes there has been no material change in such value since such date. The Partnership would be entitled to offset against any such payment the then outstanding principal balance ($4.2 million at December 31, 1995) plus all accrued but unpaid interest ($5.2 million at December 31, 1995) on the note receivable from SAMLP described in NOTE 1. \"ORGANIZATION.\" In the accompanying Consolidated Financial Statements, the Redeemable General Partner Interest is shown as a reduction of Partners' Equity. The note receivable from the General Partner has been offset against the Redeemable General Partner Interest. The Oversight Committee previously has informed the Partnership that it calculated the amount of such Redeemable General Partner Interest to be less than the amount calculated by the Managing General Partner. When SAMLP withdraws as General Partner of the Partnership, the value of the Redeemable General Partner Interest would depend on the fair value of the Partnership's assets at the time of calculation and there can be no assurance that the Redeemable General Partner Interest, fees and other compensation payable on any such withdrawal will not be substantially higher or lower than any current estimate or calculation.\nOn January 27, 1995, National Realty, SAMLP and the Oversight Committee executed an Implementation Agreement which provides for the nomination of\nNATIONAL REALTY, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 14. COMMITMENTS AND CONTINGENCIES (Continued)\nMoorman Settlement (Continued)\na successor general partner and for the resolution of all related matters under the Moorman Settlement. On February 20, 1996, the parties to the Implementation Agreement executed an Amended and Restated Implementation Agreement.\nProvided that the successor general partner is elected pursuant to the terms of the Amended and Restated Implementation Agreement, SAMLP shall receive $12,471,500 from the Partnership. This amount represents a compromise settlement of the net amounts owed by the Partnership to SAMLP upon SAMLP's withdrawal as General Partner and any amounts which SAMLP and its affiliates may owe to the Partnership. This amount shall be paid to SAMLP pursuant to a promissory note in accordance with the terms set forth in the Amended and Restated Implementation Agreement.\nThe Amended and Restated Implementation Agreement has been submitted to the Supervising Judge for tentative approval and approval of the notice to be sent to the original class members. Upon final approval by the Supervising Judge, the proposal to elect the successor general partner will be submitted to the unitholders of National Realty for a vote. In addition, the unitholders will vote upon amendments to the National Realty Partnership Agreement which relate to the proposed compensation of the successor general partner and other related matters.\nUpon approval by the unitholders, SAMLP shall resign as General Partner and the successor general partner shall take office. If the required approvals are obtained, National Realty anticipates that the successor general partner may be elected and take office during the second or third quarter of 1996.\nThe Amended and Restated Implementation Agreement provides that SAMLP, and its affiliates owning units in National Realty, shall not vote to remove the successor general partner, except for removal with cause, for a period of 36 months from the date the successor general partner takes office.\nUpon the election and taking office of the successor general partner, the Moorman Settlement Plan and the Oversight Committee shall terminate. If the successor general partner nominee does not stand for election or is not elected, the existing Moorman Settlement Agreement shall remain in full force and effect and all of the provisions of the Amended and Restated Implementation Agreement shall be voided.\nOther Litigation\nThe Partnership is also involved in various other lawsuits arising in the ordinary course of business. In the opinion of the Managing General\nNATIONAL REALTY, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 14. COMMITMENTS AND CONTINGENCIES (Continued)\nOther Litigation (Continued)\nPartner, the outcome of these lawsuits will not have a material effect on the Partnership's financial condition, results of operations or liquidity.\nNOTE 15. QUARTERLY DATA\nThe following is a tabulation of the Partnership's quarterly results of operations for the years 1995 and 1994.\nIn fourth quarter 1995, the Partnership sold two of its apartment complexes for an aggregate gain of $7.7 million. See \"NOTE 3. REAL ESTATE AND DEPRECIATION.\"\nNATIONAL REALTY, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 15. QUARTERLY DATA (Continued)\nIn the third quarter of 1994, the Partnership sold two of its apartment complexes for an aggregate gain of $8.3 million. See \"NOTE 3. REAL ESTATE AND DEPRECIATION.\"\nSCHEDULE III\nNATIONAL REALTY, L.P.\nREAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1995\nSCHEDULE III (CONTINUED)\nNATIONAL REALTY, L.P.\nREAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1995\nSCHEDULE III (CONTINUED)\nNATIONAL REALTY, L.P.\nREAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1995\nSCHEDULE III (CONTINUED)\nNATIONAL REALTY, L.P.\nREAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1995\n- ---------------\n(1) The aggregate cost for financial statement purposes approximates that for federal tax purposes.\n(2) Does not include discounts and mortgages payable totaling $15,609 on real estate which has been sold but for which the Partnership remains liable on the underlying mortgage note.\n(3) Write-down of property to estimated net realizable value.\nSCHEDULE III (CONTINUED)\nNATIONAL REALTY, L.P.\nREAL ESTATE AND ACCUMULATED DEPRECIATION\nSCHEDULE IV\nNATIONAL REALTY, L.P.\nMORTGAGE LOANS ON REAL ESTATE DECEMBER 31, 1995\nSCHEDULE IV (CONTINUED)\nNATIONAL REALTY, L.P.\nMORTGAGE LOANS ON REAL ESTATE\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable.\n_________________________________\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. GENERAL PARTNER OF THE REGISTRANT AND EXECUTIVE OFFICERS OF THE REGISTRANT'S GENERAL PARTNER\nAs partnerships, neither National Realty, L.P. (\"National Realty\" or the \"Registrant\") nor National Operating, L.P. (the \"Operating Partnership\" or \"NOLP\") (collectively the \"Partnership\") has officers or directors. The General Partner of the Partnership is Syntek Asset Management, L.P. (\"SAMLP\"), whose general partners are Gene E. Phillips and Syntek Asset Management, Inc. (\"SAMI\"). SAMI serves as Managing General Partner. Mr. Phillips is associated with a number of entities which have business objectives that are similar in certain respects to those of the Partnership. The Managing General Partner manages the day-to-day affairs of the Partnership which includes all decisions with respect to the acquisition, disposition, improvement, financing or refinancing of the Partnership's properties, subject to the limitations of the Moorman Settlement Agreement. See ITEM 3. \"LEGAL PROCEEDINGS - Moorman Settlement.\" In addition, SAMI's corporate parent, Basic Capital Management, Inc. (\"BCM\"), performs certain administrative functions and other services for the Partnership for cost reimbursements and fees as described in ITEM 1. \"BUSINESS - Management and Operations.\" The individual general partner of SAMLP and the executive officers of SAMI are listed below, together with their ages, terms of service, their principal occupations, business experience, and directorships with other companies during the last five years or more.\n[THIS SPACE INTENTIONALLY LEFT BLANK.]\nITEM 10. GENERAL PARTNER OF THE REGISTRANT AND EXECUTIVE OFFICERS OF THE REGISTRANT'S GENERAL PARTNER (Continued)\nGENE E. PHILLIPS: Age 58, General Partner (since 1987) of SAMLP; and Chairman of the Board, Director and Chief Executive Officer (since March 1989) of SAMI, the Managing General Partner of SAMLP and a company owned by BCM.\nDirector and Secretary (since 1982) and the sole shareholder of Syntek West, Inc. (\"SWI\"); Chairman of the Board (since 1978) of Hungry Bull, Inc.; Limited Partner (since January 1991) of Carmel Realty Services, Ltd. (\"Carmel, Ltd.\"); Chief Executive Officer (February 1989 to September 1992) and Chairman of the Board and Director (February 1989 to December 1989) of BCM; Director and President (November 1989 to September 1992) of Carmel Realty Services, Inc. (\"CRSI\"); Chairman of the Board (1984 to November 1992), Director (1981 to November 1992), Chief Executive Officer (1982 to July 1991) and President (February 1989 to July 1991) of American Realty Trust, Inc. (\"ART\"); Trustee or Director (January 1989 to December 1992) of Transcontinental Realty Investors, Inc. (\"TCI\"), Vinland Property Trust (\"VPT\"), National Income Realty Trust (\"NIRT\"), Continental Mortgage and Equity Trust (\"CMET\") and Income Opportunity Realty Investors, Inc., formerly Income Opportunity Realty Trust (collectively \"IORI\").\nRANDALL M. PAULSON: Age 49, President and Director (since August 1995) and Executive Vice President (January 1995 to August 1995) of SAMI.\nPresident (since August 1995) and Executive Vice President (January 1995 to August 1995) of CMET, IORI and TCI and (October 1994 to August 1995) of BCM; Executive Vice President (since January 1995) of ART; Vice President (1993 to 1994) of GSSW, LP, a joint venture of Great Southern Life and Southwestern Life; Vice President (1990 to 1993) of Property Company of America Realty, Inc.; President (1990) of Paulson Realty Group; President (1983 to 1989) of Johnstown Management Company; and Vice President (1979 to 1982) of Lexton-Ancira.\nBRUCE A. ENDENDYK: Age 47, Executive Vice President (since January 1995) of SAMI.\nPresident (since January 1995) of Carmel Realty; Executive Vice President (since January 1995) of BCM, ART, CMET, IORI and TCI; Management Consultant (November 1990 to December 1994); Executive Vice President (January 1989 to November 1990) of Southmark Corporation (\"Southmark\"); President and Chief Executive Officer (March 1988 to January 1989) of Southmark Equities Corporation; and Vice President\/Resident Manager (December 1975 to March 1988) of Coldwell Banker Commercial\/Real Estate Services in Houston, Texas.\nITEM 10. GENERAL PARTNER OF THE REGISTRANT AND EXECUTIVE OFFICERS OF THE REGISTRANT'S GENERAL PARTNER (Continued)\nTHOMAS A. HOLLAND: Age 53, Executive Vice President and Chief Financial Officer (since August 1995) and Senior Vice President and Chief Accounting Officer (July 1990 to August 1995) of SAMI.\nExecutive Vice President and Chief Financial Officer (since August 1995) and Senior Vice President (July 1990 to August 1995) of BCM, ART, CMET, IORI and TCI; Senior Vice President and Chief Accounting Officer (July 1990 to February 1994) of NIRT and VPT; Vice President and Controller (December 1986 to June 1990) of Southmark; Vice President-Finance (January 1986 to December 1986) of Diamond Shamrock Chemical Company; Assistant Controller (May 1976 to January 1986) of Maxus Energy Corporation (formerly Diamond Shamrock Corporation); Trustee (August 1989 to June 1990) of Arlington Realty Investors; and Certified Public Accountant (since 1970).\nCompliance with Section 16(a) of the Securities Exchange Act of 1934\nUnder the securities laws of the United States, the directors and executive officers of the Partnership's Managing General Partner, and any persons holding more than 10% of the Partnership's units of limited partner interest are required to report their ownership of the Partnership's units and any changes in that ownership to the Securities and Exchange Commission (the \"Commission\"). Specific due dates for these reports have been established and the Partnership is required to report any failure to file by these dates during 1995. All of these filing requirements were satisfied by the directors and executive officers of the Partnership's Managing General Partner and 10% holders. In making these statements, the Partnership has relied on the written representations of the directors and executive officers of the Partnership's Managing General Partner and its ten percent holders and copies of the reports that they have filed with the Commission.\nAdministrative Agent. BCM, of which Mr. Phillips served as Chief Executive Officer until September 1, 1992, and of which Mr. Paulson serves as President, performs certain administrative functions such as accounting services, mortgage servicing and real estate portfolio review and analysis for the Partnership on a cost reimbursement basis.\nAffiliates of BCM perform property management, loan placement services, leasing services and real estate brokerage and acquisition services, and may perform other services, for the Partnership for fees and commissions. BCM's principal business activity is the providing of advisory services for real estate companies. See ITEM 13. \"CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\"\nThe directors and principal officers of BCM are set forth below.\nMICKEY N. PHILLIPS: Director\nRYAN T. PHILLIPS: Director\nITEM 10. GENERAL PARTNER OF THE REGISTRANT AND EXECUTIVE OFFICERS OF THE REGISTRANT'S GENERAL PARTNER (Continued)\nRANDALL M. PAULSON: President\nMARK W. BRANIGAN: Executive Vice President\nOSCAR W. CASHWELL: Executive Vice President\nBRUCE A. ENDENDYK: Executive Vice President\nTHOMAS A. HOLLAND: Executive Vice President and Chief Financial Officer\nCOOPER B. STUART: Executive Vice President\nCLIFFORD C. TOWNS, JR.: Executive Vice President, Finance\nROBERT A. WALDMAN: Senior Vice President, Secretary and General Counsel\nDREW D. POTERA: Vice President, Treasurer and Securities Manager\nMickey N. Phillips is Gene E. Phillips' brother and Ryan T. Phillips is Gene E. Phillips' son.\nOversight Committee. As more fully described under ITEM 3. \"LEGAL PROCEEDINGS - - Moorman Settlement,\" the Partnership is a party to the Moorman Settlement Agreement that, among other things, established an Oversight Committee which will exist only until termination of the Moorman Settlement Plan. The current members of the Oversight Committee are Kenneth R. Kelly, Ronald T. Baker and Joseph S. Radovsky. Mr. Kelly is the current Chairman and Secretary of the Oversight Committee.\nUnanimous consent of the Oversight Committee is required, during the term of the Moorman Settlement Plan, for the Partnership to adopt a new unit purchase rights plan, or for SAMLP, on behalf of the Partnership, to enter into or modify any transaction (other than certain transactions expressly permitted by the Partnership Agreement) with an affiliate (as defined below) of the Partnership, SAMLP, or Mr. Phillips or William S. Friedman, a general partner of SAMLP until March 4, 1994. Majority consent of the Oversight Committee is required, during the term of the Moorman Settlement Plan, for SAMLP, on behalf of the Partnership, to purchase securities of other issuers other than certain money market instruments and mortgages in the ordinary course of the Partnership's business, or to enter any new line of business. For purposes of the Moorman Settlement Agreement, an \"Affiliate\" of the Partnership, SAMLP, or Messrs. Phillips and Friedman (each, a \"Specified Party\") is any person or entity that (i) directly or indirectly through one or more intermediaries controls or is controlled by or is under common control with the Specified Party, (ii) owns or controls 10% or more of the outstanding voting securities of the Specified Party, or (iii) is an officer or director of, general partner in, or serves in a similar\nITEM 10. GENERAL PARTNER OF THE REGISTRANT AND EXECUTIVE OFFICERS OF THE REGISTRANT'S GENERAL PARTNER (Continued)\ncapacity to the Specified Party or of which the Specified Party is an officer, director, or general partner or with respect to which the Specified Party serves in a similar capacity.\nOn July 8, 1992, SAMLP notified the Oversight Committee of the failure to meet the Targets (as defined in ITEM 3. \"LEGAL PROCEEDINGS - Moorman Settlement\") for two successive years. The Moorman Settlement Agreement provides that between the date of the certification causing the General Partner's resignation and the date a successor general partner takes office, the resigning General Partner shall limit its activities, as General Partner, to the conduct of the business of the Partnership in the ordinary course, shall not, without consent of the Oversight Committee, purchase or sell any real property or other assets of the Partnership not in progress on said date, shall cooperate in the election of a successor general partner and shall cooperate with its successor to facilitate a change in the office of General Partner of the Partnership. The resigning General Partner will continue to receive fees, expenses and distributions, if any, while the solicitation is prepared. See ITEM 8. \"FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\"\nPursuant to the Moorman Settlement Agreement, the Partnership pays each member of the Oversight Committee $50,000 per year. The Partnership's obligation to pay such compensation ceased May 9, 1995. However, the Supervising Judge entered an order on May 19, 1995, providing that the obligation to pay such compensation shall continue until the Moorman Settlement Plan has been terminated and the Oversight Committee has been dissolved. The Partnership also pays the salary of an Oversight Committee employee, and reimburses certain of the Oversight Committee's expenses including legal fees.\nThe principal occupations and relevant affiliations of the Oversight Committee members, as furnished to the Partnership by such members, are as follows:\nKENNETH R. KELLY: Age 49, member (since July 1990), Chairman (since January 1995) and Secretary (since July 1990) of the Oversight Committee.\nPresident (since 1986) of Proximity Research Corporation, a real estate firm based in Auburn, California. Mr. Kelly has been involved in the real estate investment business throughout the United States for the past twenty years. Mr. Kelly is a member of the State Bar of California.\nRONALD T. BAKER: Age 48, member (since July 1990) and Chairman (July 1990 to January 1995) of the Oversight Committee.\nPresident of INVENEX (formerly known as Partnership Securities Exchange, Inc.) (\"INVENEX\") , a manufacturing company. INVENEX was one of the initial plaintiffs in the Moorman action discussed in ITEM 3. \"LEGAL PROCEEDINGS - Moorman Settlement.\"\nITEM 10. GENERAL PARTNER OF THE REGISTRANT AND EXECUTIVE OFFICERS OF THE REGISTRANT'S GENERAL PARTNER (Continued)\nJOSEPH S. RADOVSKY: Age 52, member (since July 1992) of the Oversight Committee.\nPartner with Greene, Radovsky, Maloney and Share, a law firm in San Francisco, California.\nFairness Committee. National Realty's Fairness Committee periodically reviewed certain transactions between the Partnership and its affiliates. The Partnership Agreement requires Fairness Committee approval of the interest rate to be paid on loans from the General Partner or its affiliates, the terms of any property sales to or purchases from the General Partner or its affiliates, the purchase of securities from the General Partner or its affiliates and, upon any withdrawal of the General Partner, the purchase price of the General Partner's interest in the Partnership and in the fees and other compensation to be paid under the Partnership Agreement.\nThe Partnership Agreement provides that the Fairness Committee shall consist of two or more natural persons, none of whom shall be affiliates (as defined in the Partnership Agreement) of the General Partner except as directors of the Managing General Partner.\nThe Fairness Committee consisted of two members until February 1995, when Raymond V. J. Schrag resigned. The remaining member of the Fairness Committee, Willie K. Davis, resigned in August 1995.\nAudit Committee. National Realty's Audit Committee, which reviews certain matters relating to the Partnership's auditors and annual and quarterly financial statements, was established effective August 3, 1990, pursuant to the Moorman Settlement Agreement. The chairman and only member of the Audit Committee is Harry J. Reidler, an attorney in private practice in Englewood, New Jersey.\nMr. Reidler has performed legal services for the Partnership.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nNeither National Realty nor the Operating Partnership has any employees, payroll or benefit plans and pays no salary or other cash compensation directly to any person other than (i) $50,000 per year to each member of the Oversight Committee plus $48,000 per year to an analyst engaged by the Oversight Committee, (ii) $4,000 per year to each member of the Fairness and Audit Committees and (iii) fees and expense reimbursements in accordance with the Partnership Agreement to the General Partner or its affiliates for services provided to the Partnership. See ITEM 8. \"FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\"\nSAMI has no employees, payroll or benefit plans and pays no compensation to its officers or directors.\nThe Moorman Settlement Agreement provides that effective May 1, 1990 the Partnership's future reimbursement of any salaries which may be paid to Messrs. Phillips and Friedman shall be limited to an aggregate of\nITEM 11. EXECUTIVE COMPENSATION (Continued)\n$500,000 per year, for any such reimbursement of salaries to be deferred until such time as a Target, as defined in the Moorman Settlement Agreement, may be met and, if SAMLP resigns as General Partner during the pendency of the Moorman Settlement Plan, for the waiver of any reimbursement of salary so deferred. Accordingly, no reimbursement for the salaries of Messrs. Phillips and Friedman was charged to or paid by the Partnership in the period January 1, 1991 through December 31, 1995. Mr. Friedman resigned as a general partner of SAMLP on March 4, 1994.\nMr. Phillips may indirectly benefit from other payments made by the Partnership to certain related parties.\nMr. Reidler received $4,000 in 1995 for serving on the Partnership's Audit Committee. Messrs. Kelly, Baker and Radovsky each received $50,000 in 1995 for serving on the Oversight Committee. See ITEM 10. \"GENERAL PARTNER OF THE REGISTRANT AND EXECUTIVE OFFICERS OF THE REGISTRANT'S GENERAL PARTNER.\"\n[THIS SPACE INTENTIONALLY LEFT BLANK.]\nITEM 11. EXECUTIVE COMPENSATION (Continued)\nPerformance Graph\nThe following performance graph compares the cumulative total unitholder return on the Partnership's units of limited partner interest with the Dow Jones Market Index (\"DJ Market Index\") and the Dow Jones Real Estate Index (\"DJ Real Estate Index\"). The comparison assumes that $100 was invested on December 31, 1990 in the Partnership's units of limited partner interest and in each of the indices and further assumes the reinvestment of all distributions. Past performance is not necessarily an indicator of future performance.\n[GRAPH]\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nSecurity Ownership of Certain Beneficial Owners. The following table sets forth the ownership of National Realty's units of limited partner interest, both beneficially and of record, both individually and in the aggregate, for those persons known by National Realty to be beneficial owners of more than 5% of its units of limited partner interest, as of the close of business on March 15, 1996.\n(1) Percentage is based upon 6,417,916 units of limited partner interest outstanding at March 15, 1996.\nSecurity Ownership of Management. The following table sets forth the ownership of National Realty's units of limited partner interest, both beneficially and of record, both individually and in the aggregate, by SAMLP, the general partners of SAMLP, and the executive officers and directors of SAMI, as of the close of business on March 15, 1996.\n(1) Percentage is based upon 6,417,916 units of limited partner interest outstanding as of March 15, 1996.\n(2) Includes 3,340,522 units owned by ART and 286,175 units owned by BCM, of which the general partners of SAMLP and the directors and executive officers of SAMI, ART and BCM may be deemed to be the beneficial owners by virtue of their positions as general partners of SAMLP and executive officers of SAMI, ART and BCM. SAMLP's general partners and the directors and executive officers of SAMI, ART and BCM disclaim beneficial ownership of such units.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nCertain Business Relationships\nNational Realty is the sole limited partner of the Operating Partnership and owns 99% of the beneficial interest in the Operating Partnership. SAMLP is the general partner of, and owner of a 1% beneficial interest\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS (Continued)\nCertain Business Relationships (Continued)\nin, each of National Realty and the Operating Partnership. Southmark Asset Management, Inc., a wholly-owned subsidiary of Southmark, was the managing general partner of SAMLP until January 17, 1989, when it transferred its 96% limited partnership interest to ART, a real estate investment company of which Messrs. Phillips and Friedman served as officers and directors until November 16, 1992 and December 31, 1992, respectively. As a result, Messrs. Phillips and Friedman became the sole general partners of SAMLP, and each owned 2% of the beneficial interest in SAMLP. On February 25, 1992, ART transferred a 19.2% limited partner interest in SAMLP to Southmark pursuant to a litigation settlement.\nOn July 18, 1989, Messrs. Phillips and Friedman each assigned .05% of their general partner interest in SAMLP to SAMI, a company of which Mr. Phillips serves as a director, Chairman of the Board and Chief Executive Officer and of which BCM is the sole shareholder. On March 4, 1994, Mr. Friedman resigned as a general partner of SAMLP. As a result, Mr. Phillips and SAMI are the general partners of SAMLP, with 1.95% and .10%, respectively, of the beneficial interest in SAMLP. Mr. Friedman's 1.95% interest in SAMLP is now a limited partner interest. SAMI was appointed Managing General Partner of SAMLP on June 18, 1990. Bruce A. Endendyk, Executive Vice President of SAMI, was Executive Vice President from January 1989 to November 1990 of Southmark and President and Chief Executive Officer of Southmark Equities Corporation from March 1988 to January 1989. Thomas A. Holland, Executive Vice President and Chief Financial Officer of SAMI, was Vice President and Controller of Southmark from December 1986 to June 1990.\nSince February 1, 1990, affiliates of the General Partner have provided property management services to the Partnership. Currently, Carmel, Ltd. provides property management services for a fee of 5% or less of the monthly gross rents collected on the properties under its management. Carmel, Ltd. subcontracts with other entities for the property-level management services to the Partnership at various rates. The general partner of Carmel, Ltd. is BCM. The limited partners of Carmel, Ltd. are (i) SWI, of which Mr. Phillips is the sole shareholder, (ii) Mr. Phillips and (iii) a trust for the benefit of Mr. Phillips' children. BCM is a company which is owned by a trust for the benefit of the children of Mr. Phillips. BCM performs certain administrative and other functions for the Partnership. See ITEM 1. \"BUSINESS - Management and Operations\" and ITEM 11. \"EXECUTIVE COMPENSATION.\"\nMessrs. Paulson, Endendyk and Holland serve as executive officers of BCM. Mr. Phillips served as a director until December 1989 and Chief Executive Officer until September 1, 1992, of BCM. Messrs. Paulson, Endendyk and Holland serve as executive officers of CMET, IORI, TCI and ART. BCM serves as advisor to CMET, IORI, TCI and ART.\nMr. Kelly, who serves as President of Proximity Research Corporation and who also serves as Chairman and Secretary of the Oversight Committee, has provided professional services to the Partnership.\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS (Continued)\nRelated Party Transactions\nThe Partnership has engaged in business transactions with certain related parties and may continue to do so, subject to unanimous approval of the Oversight Committee during the term of the Moorman Settlement Plan as discussed under ITEM 10. \"GENERAL PARTNER OF THE REGISTRANT AND EXECUTIVE OFFICERS OF THE REGISTRANT'S GENERAL PARTNER - Oversight Committee.\" The Partnership believes that all of the related party transactions were at least as advantageous to the Partnership as could have been obtained from unrelated third parties.\nThe Partnership has paid and pays cost reimbursements, property management fees or other cash compensation to the General Partner and its affiliates and other related parties as described in ITEM 11. \"EXECUTIVE COMPENSATION\" and ITEM 1. \"BUSINESS - Management and Operations.\" BCM, an affiliate of the General Partner, performs certain administrative functions for the Partnership on a cost reimbursement basis. The Fairness Committee has approved the formula for computing the Partnership's proportionate share of certain of BCM's reimbursable costs. GCMI performs administrative functions, similar to those performed for the Partnership by BCM, for GCLP on a cost reimbursement basis. Since February 1, 1990, affiliates of the General Partner have provided property management services to the Partnership. Currently, Carmel, Ltd., provides such property management services. Carmel, Ltd. subcontracts with other entities for the property-level management services to the Partnership. Carmel, Ltd. subcontracts the property-level management and leasing of twelve of the Partnership's commercial properties to Carmel Realty, which is a company owned by SWI. Carmel Realty is entitled to receive property and construction management fees and leasing commissions in accordance with the terms of its property-level management agreement with Carmel, Ltd. Carmel, Ltd. does not perform property management services to the properties of GCLP. Carmel, Ltd. and Carmel Realty also perform similar services for ART, CMET, IORI and TCI. See NOTE 11. \"GENERAL PARTNER FEES AND COMPENSATION\" included in Notes to Consolidated Financial Statements at ITEM 8. \"FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA,\" for a summary of fees paid and costs reimbursed by the Partnership.\nThe Partnership's Fairness Committee periodically reviewed certain transactions between the Partnership and its affiliates. See ITEM 1. \"BUSINESS - Management and Operations.\" The Fairness Committee approved the terms of the Partnership's contracts and terms for services and reimbursements with affiliates. Messrs. Schrag and Davis, the members of the Fairness Committee, resigned from the committee in February and August 1995, respectively.\nThe Partnership's Oversight Committee must approve certain types of transactions between the Partnership and SAMLP or its affiliates, as defined in the Moorman Settlement Agreement. See ITEM 3. \"LEGAL PROCEEDINGS - Moorman Settlement.\"\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS (Continued)\nIndebtedness of Management\nIn return for its 1% interest in National Realty, the General Partner was required to make aggregate capital contributions to National Realty in an amount equal to 1.01% of the total initial capital contributions to the Partnership. The General Partner contributed $500,000 cash with the remaining portion evidenced by a promissory note in the principal amount of $4.2 million, bearing interest at the rate of 10% per annum compounded semi-annually and payable on the earlier of September 18, 2007, liquidation of the Partnership or a termination of the General Partner's interest in the Partnership. As of December 31, 1995, no payments had been received on such note. At December 31, 1995, accrued and unpaid interest on the note totaled $5.2 million.\n_____________________________\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES, AND REPORTS ON FORM 8-K\n(a) The following documents are filed as part of this Report:\n1. Consolidated Financial Statements\nReport of Independent Certified Public Accountants\nConsolidated Balance Sheets - December 31, 1995 and 1994\nConsolidated Statements of Operations - Years Ended December 31, 1995, 1994 and 1993\nConsolidated Statements of Changes in Partners' Equity (Deficit) - Years Ended December 31, 1995, 1994 and 1993\nConsolidated Statements of Cash Flows - Years Ended December 31, 1995, 1994 and 1993\nNotes to Consolidated Financial Statements\n2. Financial Statement Schedules\nSchedule III - Real Estate and Accumulated Depreciation\nSchedule IV - Mortgage Loans on Real Estate\nAll other schedules are omitted because they are not applicable or because the required information is shown in the Consolidated Financial Statements or the Notes thereto.\nITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES, AND REPORTS ON FORM 8-K (Continued)\n3. Exhibits\nThe following documents are filed as Exhibits to this Report:\nExhibit Number Description - ------- ---------------------------------------------------------------------\n3.0 National Realty, L.P. Amended and Restated Certificate of Limited Partnership, dated March 4, 1987 (incorporated by reference to Exhibit 3.1 to the Registrant's Registration Statement No. 33-16215 on Form S- 4).\n3.1 National Realty, L.P. First Amended and Restated Agreement of Limited Partnership, dated as of January 29, 1987 (incorporated by reference to Exhibit 4.1 to the Registrant's Registration Statement No. 33-16215 on Form S-4).\n3.2 Certificate of Amendment of Limited Partnership Agreement of National Realty, L.P. dated as of May 14, 1990 (incorporated by reference to Exhibit 4.2 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1990).\n4.0 Indenture, dated as of September 18, 1987, by and between National Realty, L.P. and Mellon Bank, N.A. (incorporated by reference to Exhibit 4.2 to the Registrant's Registration Statement No. 33-16215 on Form S-4).\n4.1 Amendment No. 1, dated as of December 28, 1987, to Trust Indenture between National Realty, L.P. and Mellon Bank, N.A. (incorporated by reference to Exhibit 4.2 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1988).\n4.2 Form of Warrant Agreement between National Realty, L.P. and American Stock Transfer and Trust Company, as Warrant Agent (incorporated by reference to Exhibit 4.5 to the Registrant's Registration Statement No. 33- 38352 on Form S-11)\n10.0 Loan Agreement dated as of November 24, 1992 by and among First Commonwealth Realty Credit Corporation as Lender, and Garden Kimberly Woods L.P. et. al., as Borrower. (incorporated by reference to Exhibit 10.1 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1992).\n11.0 Computation of Earnings Per Unit, filed herewith.\n21.0 Subsidiaries of the Registrant, filed herewith.\n27.0 Financial Data Schedule, filed herewith.\nITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES, AND REPORTS ON FORM 8-K (Continued)\nExhibit Number Description - ------- ---------------------------------------------------------------------\n99.0 Agreement of Limited Partnership of National Operating, L.P. (incorporated by reference to Exhibit 4.3 to the Registrant's Registration Statement No. 33-16215 on Form S-4).\n99.1 Limited Partnership Agreement of Garden Capital, L.P. between Garden Capital Management Incorporated and National Operating, L.P. (incorporated by reference to Exhibit 28.2 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1992).\n99.2 Settlement Agreement, dated as of May 9, 1990, relating to the action entitled Moorman et. al v. Southmark Corporation et al. (incorporated by reference to Exhibit 5.1 to Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 1990).\n99.3 Amended and Restated Implementation Agreement, dated February 20, 1996, among National Realty, L.P., Syntek Asset Management, L.P., National Realty, L.P. Oversight Committee and William H. Elliott (incorporated by reference to Exhibit 99.2 to the Registrant's Current Report on Form 8-K, dated February 27, 1996).\n(b) Reports on Form 8-K\nA Current Report on Form 8-K, dated February 27, 1996, was filed with respect to Item 5, \"Other Events\", which reports the execution of the Amended and Restated Implementation Agreement.\nNATIONAL REALTY, L.P. Signature Page\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nNATIONAL REALTY, L.P.\nBy its General Partner:\nSYNTEK ASSET MANAGEMENT, L.P.\nBy its General Partners:\nSYNTEK ASSET MANAGEMENT, INC.\nBy: \/s\/ Randall M. Paulson --------------------------------- Randall M. Paulson President\n\/s\/ Gene E. Phillips --------------------------------- Gene E. Phillips\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of Syntek Asset Management, L.P., as General Partner of the Registrant and in the capacities and on the dates indicated.\nNATIONAL REALTY, L.P.\nEXHIBITS TO ANNUAL REPORT ON FORM 10-K\nFor the Year Ended December 31, 1995","section_15":""}
{"filename":"735349_1995.txt","cik":"735349","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"Item 2 - Properties - -------------------\nThe Company owns the office building and property located at 45 East Monterey Way, Phoenix, Arizona, where it conducts its licensing and franchising operations and its Phoenix claims adjusting and risk management-related services business. The office building currently contains approximately 13,000 square feet of office space.\nThe Company also owns a parcel of real property across the street from the Company's principal executive office, which is utilized for employee parking.\nItem 3","section_3":"Item 3 - Legal Proceedings - --------------------------\nA Declaratory Action was filed in May 1994 against the Company in the Superior Court of Los Angeles, California, regarding the interpretation of certain sections of the Company's license agreement with the plaintiff, a licensee. In June 1994, the Company removed the case to the U.S. District Court and raised certain counter claims for violation of the Company's license agreement. The Company terminated the licensee's agreement effective January 1, 1995. Subsequent to the termination, the plaintiff amended his complaint to include wrongful termination. On May 1, 1995, the U.S. District Court granted the Company's motion for Summary Judgement regarding all outstanding claims by the plaintiff. On June 19, 1995, the Court granted the Company's Summary Judgement motion regarding its claims against the former licensee including $204,144 in unpaid license fees and a yet to be determined amount for court costs. The Company does not believe that it is subject to any lawsuits or litigation or threatened lawsuits or litigation that will have a material adverse effect on the Company or its business.\nItem 4","section_4":"Item 4 - Submission of Matter 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 the Registrant's Common Stock and Related - ------------------------------------------------------------- Security Holders Matters ------------------------\nThe Company's Common Stock is listed on the American Stock Exchange (AMEX) under the symbol \"FAJ\". The Company's stock began trading on AMEX, March 24, 1994. Prior to being listed on AMEX, the Company's common stock was quoted on the National Association of Securities Dealers' Automated Quotations National Market System (\"NASDAQ-NMS\"). The following table sets forth the range of high and low prices, and the trading volume, during each quarterly period within the Company's two most recent fiscal years.\nPrice (1) Volume ----------------- -------- High Low ------ -------\nFiscal Year Ended June 30, 1994 First Quarter $3.125 $2.375 489,755 Second Quarter $3.625 $2.9375 634,200 Third Quarter $3.75 $3.00 600,803 Fourth Quarter $3.375 $2.5625 123,900\nFiscal Year Ended June 30, 1995 First Quarter $3.0625 $2.50 99,800 Second Quarter $3.125 $2.375 125,500 Third Quarter $2.875 $2.375 74,500 Fourth Quarter $3.125 $2.50 108,900\n(1) Through March 23, 1994 represents high and low bid quotations on NASDAQ-NMS. The bid quotations set above represent quotations by dealers, do not reflect applicable markups, markdowns or commissions, and do not necessarily represent actual transactions.\nThe following shows per share cash dividends declared for each quarter during the Company's two most recent fiscal years.\nCash Dividends Declared -----------------------\nFiscal Year Ended June 30, 1994 First Quarter ....................................... $.025 Second Quarter ...................................... $.025 Third Quarter ....................................... $.025 Fourth Quarter ...................................... $.035\nFiscal Year Ended June 30, 1995 First Quarter ....................................... $.0275 Second Quarter ...................................... $.0275 Thirst Quarter ...................................... $.03 Fourth Quarter ...................................... $.03\nAs of August 2, 1995, there were 281 shareholders of record (approximately 900 including beneficial owners) of the Company's Common Stock.\nItem 6","section_6":"Item 6 - Selected Financial Data - --------------------------------\nItem 7","section_7":"Item 7 - Management's Discussion and Analysis of Financial - ---------------------------------------------------------- Condition and Results of Operations -----------------------------------\nFINANCIAL CONDITION\nThe Company continues to finance its growth from funds generated by its current operations. The Company is also investing additional sums and increasing its cash dividends.\nIn 1995 the Company's continuing operations generated $537,831 in cash and this together with cash they had previously generated was used to pay $536,454 in cash dividends and acquire 50,000 shares of its common stock at a cost of $136,377. Additionally, the Company acquired approximately $129,000 in equipment and certain rights from two licensees for $92,000 in cash and monthly payments of $2,500 until August 1, 1999.\nThe Company intends to complete its authorized plan to purchase 100,000 shares of its common stock. As of June 30, 1995 the Company had purchased 91,112 of the authorized shares at a cost of $278,492. The Company intends to acquire the balance of 8,888 shares as market conditions permit. Based upon the market price of $2.38 on July 31, 1995 this would represent a cost of approximately $21,000. In addition to its authorized plan to acquire 100,000 shares, the Company acquired 50,000 shares at a cost of $136,377 in December 1994.\nEffective with its September 10, 1994 dividend, the Company increased its cash dividend to eleven cents per share annually from ten cents per share. The Company followed up this increase in January 1995 by increasing the dividend to twelve cents per share annually effective with its March 10, 1995 dividend. The combined increases represent a 20% increase in the annual dividend rate.\nThe Company anticipates that during fiscal 1996 it will generate sufficient cash to fund its operations, dividend payments and equipment purchases. The Company anticipates that its expenditures for equipment and furnishings will be approximately $150,000 to $200,000 during fiscal 1996.\nThe Company has always maintained a solid financial position. This policy is evidenced by the Company's ratio of current assets to current liabilities of 5.37 to 1 as of June 30, 1995 and 3.74 to 1 as of June 30, 1994.\nRESULTS OF OPERATIONS 1995 COMPARED TO 1994\nREVENUES\nThe Company's revenues increased to $5,241,000 from $4,590,000 in fiscal 1994, compared to the prior fiscal year, a 14.2% increase.\nThe increase consists of a $72,000 increase in adjusting revenues and a $579,000 increase in continuing licensee and franchisee fees. Continuing licensee and franchisee fees increased to $4,784,000 from $4,205,000 an increase of 14% from the prior fiscal year. This increase reflects the fact that the Company continues to benefit from an increase in claims, as insurers and self-insureds use the Company's licensees and franchisees to handle claims and the increase in Company licensees and franchisees.\nThe Company-owned offices' revenues increased $71,859 from the prior year. This increase is partially due to an increase in the number of claims being assigned to the offices as a result of a change in staff.\nThe Company's revenues are affected by many matters such as the work loads of other companies and claims presented by their clients. Therefore, it is impossible to project the Company's future revenues. The Company, however, has seen growth in the franchisee and licensee's fees paid, the most significant of which are from offices established in the preceding fiscal year. Approximately $374,000 of the $579,000 increase in continuing licensee and franchisee fees in fiscal year 1995 as compared to fiscal 1994 is the result of growth in the number of licensees and franchisees. The balance of the increase or $204,000 is the result of the judgement rendered on June 19, 1995 in the Company's lawsuit with a former licensee for unpaid licensee fees. Management believes that the Company will continue to realize growth in continuing licensing and franchising fees in the future as it adds qualified licensees and franchisees.\nCOMPENSATION AND FRINGE BENEFITS\nThe most significant of the Company's expenses are those related to the compensation of its employees. The Company's compensation expense increased $110,000 in fiscal 1995 when compared to fiscal 1994. This represents a 7% increase in overall cost due to the inflation and merit raises given to employees as well as an additional employee hired to handle the increased work load.\nEXPENSES OTHER THAN COMPENSATION AND FRINGE BENEFITS\nThe Company's expenses other than compensation and fringe benefits increased $549,000 from fiscal 1994 to fiscal 1995. The most significant items affecting these expenses were a $624,000 increase in legal fees, a $140,000 decrease in expenses related to the Company's London operations and a $50,000 advertising item that was not incurred in the current year. The $624,000 increase in legal fees is a result of the lawsuit filed by the now former licensee for which the Company received a Summary Judgement in it's favor on June 19, 1995. The $140,000 reduction in expenses related to the London franchise is a result of the expiration of the Company's agreement to subsidize the franchisee effective June 30, 1994. The $50,000 advertising item that was not incurred during 1995, is normally incurred in the fourth quarter of the fiscal year, however, the publisher of the Frontier Directory modified his scheduled printing date and the expenditure will be incurred in the second quarter of fiscal year ended June 30, 1996. No other item of expense had a significant affect on the increase in expenses other than compensation and fringe benefits.\nOTHER INCOME\nThe Company's other income increased $67,000 or 62% from fiscal 1994 to fiscal 1995. The most significant items related to this increase were a $36,000 increase in interest income, an $8,000 dividend income related to the Company's investments and a $19,000 gain on the sale of fixed assets. These increases were largely the result of increased interest rates as well as increase in funds for investment generated by its current operations.\nINCOME TAXES\nIncome taxes were 38.8% of the Company's income before taxes for the current fiscal year, an increase from 37.1% in fiscal 1994. The Company's income taxes have not been significantly affected by any changes in the federal or state tax laws. However, the Company could be affected by change in federal or state income tax rates at any time.\nNET INCOME\nThe Company's net income increased $9,000 from $1,018,000 in fiscal 1994 to $1,027,000 in the current fiscal year, an increase of .9%.\nRESULTS OF OPERATIONS 1994 COMPARED TO 1993\nREVENUES\nThe Company's revenues increased to $4,590,000 from $4,487,000 in fiscal 1993, compared to the prior fiscal year, a 2% increase.\nThe increase consists of a $122,000 decline in adjusting revenues and a $225,000 increase in continuing licensee and franchisee fees. Continuing licensee and franchisee fees increased to $4,205,000 in fiscal 1995 from $3,980,000 in fiscal 1994, an increase of 6%. This increase reflects the fact that the Company continues to benefit from an increase in claims, as insurers and self-insureds use the Company's licensees and franchisees to handle claims and the increase in Company licensees and franchisees.\nThe Company-owned offices' revenues declined $122,000 from fiscal 1994 to fiscal 1995. This decline is a result of fewer claims being assigned by insurance companies to the Company-owned offices as well as fewer self-insured claims being processed.\nThe Company's revenues are affected by natural and man caused events as well as other companies' work loads. Therefore, it is not possible to project the Company's future revenues. The Company has, however, seen growth in the fees paid to it by its licensees and franchisees, the most significant of which are from offices established in the preceding fiscal year. Management believes that the Company will continue to realize growth in licensing and franchising fees in the future as it adds qualified licensees and franchisees.\nCOMPENSATION AND FRINGE BENEFITS\nThe most significant of the Company's expenses are those related to the compensation of its employees. The Company's compensation expense increased $75,000 in fiscal 1994 when compared to fiscal 1993. This represents a 5% increase in overall cost due to the inflation and merit raises given to employees.\nEXPENSES OTHER THAN COMPENSATION AND FRINGE BENEFITS\nThe Company's expenses other than compensation and fringe benefits declined $123,000 from fiscal 1993 to fiscal 1994. The most significant item that affected these expenses was a $108,000 reduction in expenses related to its London franchisee. This is a result of the Company's effort to limit and reduce its annual expense related to London. The Company also has reduced its other expenses by being more selective in its advertising to obtain the most exposure for the least cost thereby reducing advertising costs by $44,000. No other item of expense had a significant affect on the decrease in expenses other than compensation and fringe benefits.\nOTHER INCOME\nThe Company's other income increased $26,000 from fiscal 1993 to fiscal 1994 or 31%. The most significant items related to this increase were a $23,000 increase in interest income and $6,000 in dividend income related to the Company's investments. These increases were the result of increased interest rates as well as the increase in funds for investment generated by its current operations.\nINCOME TAXES\nIncome taxes were 37.1% of the Company's income before taxes for the current fiscal year, an increase from 37% in fiscal 1993.\nNET INCOME\nThe Company's net income increased $109,000 from $909,000 in fiscal 1993 to $1,018,000 in the current fiscal year, an increase of 12%. This is the first time the Company's net income has exceeded $1,000,000 and is a milestone in the Company's continued growth.\nItem 8","section_7A":"","section_8":"Item 8 - Financial Statements and Supplementary Data - ----------------------------------------------------\nINDEPENDENT AUDITOR'S REPORT\nTo the Board of Directors Frontier Adjusters of America, Inc. Phoenix, Arizona\nWe have audited the accompanying consolidated balance sheets of Frontier Adjusters of America, Inc. and Subsidiaries as of June 30, 1995 and 1994, and the related consolidated statements of income, cash flows, and stockholders' equity for each of the three years in the period ended June 30, 1995. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. These standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Frontier Adjusters of America, Inc. and Subsidiaries as of June 30, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 1995, 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 I, V, VI and X for the years ended June 30, 1995, 1994 and 1993 included in pages 35 through 40 of this form 10-K are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic 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 herein in relation to the basic financial data taken as a whole.\nMcGLADREY & PULLEN, LLP\nPhoenix, Arizona August 3, 1995\nCONSOLIDATED BALANCE SHEETS\nFrontier Adjusters of America, Inc. and Subsidiaries\nJune 30, 1995 1994 - -------------------------------------------------------------------------------\nASSETS CURRENT ASSETS Cash and cash equivalents $ 358,960 $ 804,780 Short-term investments (Note 8) 1,255,627 1,275,223 Current portion of advances to licensees and franchisees (Note 4) 706,739 731,717 Receivables net (Note 3) 925,667 647,806 Unbilled adjusting fees 14,225 11,850 Prepaid expenses 258,165 227,057 Deferred income taxes (Note 11) 101,109 54,105 -------------------------- TOTAL CURRENT ASSETS 3,620,492 3,752,538 -------------------------- PROPERTY AND EQUIPMENT, at cost, less accumulated depreciation and amortization (Note 6) 1,484,545 1,460,601 --------------------------\nOTHER ASSETS Investments (Note 8) 764,090 742,224 Advances to licensees and franchisees, net of current portion (Note 4) 302,000 325,000 Licenses and franchises, net of accumulated amortization of $63,284 in 1995 and $19,750 in 1994 214,628 40,250 Cost of subsidiary in excess of net identifiable assets acquired, net of accumulated amortization of $172,196 in 1995 and $169,885 in 1994 41,621 43,932 Receivable from licensee (Note 5) 50,762 54,290 Other 118,912 72,171 -------------------------- 1,492,013 1,277,867 -------------------------- TOTAL ASSETS $ 6,597,050 $ 6,491,006 ==========================\nLIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES Accounts payable $ 12,669 $ 46,546 Accrued expenses 297,973 130,565 Income taxes payable 64,720 30,073 Licensees' and franchisees' remittance payable 221,620 719,355 Current portion of long term liability (Note 9) 22,951 -- Other 53,811 76,468 -------------------------- TOTAL CURRENT LIABILITIES 673,744 1,003,007 -------------------------- LONG TERM LIABILITY (Note 9) 84,655 -- -------------------------- COMMITMENTS (Note 15) -- -- STOCKHOLDERS' EQUITY Common stock, authorized 100,000,000 shares, par value $.01, issued 4,782,010 shares 47,820 47,820 Additional contributed capital 2,148,470 2,148,470 Retained earnings 4,042,588 3,552,194 -------------------------- 6,238,878 5,748,484 Add (deduct): Treasury stock 141,112 shares in 1995: 91,112 shares in 1994 (414,869) (278,492) Other 14,642 18,007 -------------------------- TOTAL STOCKHOLDERS' EQUITY 5,838,651 5,487,999 -------------------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 6,597,050 $ 6,491,006 ==========================\nThe accompanying notes are an integral part of these statements.\nCONSOLIDATED STATEMENTS OF INCOME\nFrontier Adjusters of America, Inc. and Subsidiaries\nYears Ended June 30, 1995 1994 1993 - -------------------------------------------------------------------------------\nREVENUES Continuing licensee and franchisee fees (Note 10) $4,783,941 $4,205,245 $3,979,794 Adjusting fees 456,884 385,025 507,297 -------------------------------------- 5,240,825 4,590,270 4,487,091 --------------------------------------\nCOST AND EXPENSES Compensation and fringe benefits 1,635,289 1,525,217 1,450,019 Office 308,783 266,030 289,923 Advertising and promotion 360,878 384,868 428,761 Depreciation and amortization 136,428 113,945 123,300 Provision for doubtful accounts 169,640 148,017 155,192 Other (Note 12 and 13) 1,127,138 641,434 679,704 -------------------------------------- 3,738,156 3,079,511 3,126,899 -------------------------------------- INCOME FROM OPERATIONS 1,502,669 1,510,759 1,360,192 --------------------------------------\nOTHER INCOME Interest income 134,136 98,150 74,484 Disposition of investments -- 1,700 -- Gain on disposition of equipment 19,416 525 67 Other 22,867 8,706 8,416 -------------------------------------- TOTAL OTHER INCOME 176,419 109,081 82,967 -------------------------------------- INCOME BEFORE INCOME TAXES 1,679,088 1,619,840 1,443,159\nINCOME TAXES (Note 11) 652,240 601,680 534,106 -------------------------------------- NET INCOME $1,026,848 $1,018,160 $ 909,053 ======================================\nEarnings per common share $ .22 $ .22 $ .19 ====================================== Weighted average number of shares of common stock outstanding 4,662,679 4,730,597 4,780,980 ======================================\nThe accompanying notes are an integral part of these statements.\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nFrontier Adjusters of America, Inc. and Subsidiaries\nYears Ended June 30, 1995 1994 1993 - -------------------------------------------------------------------------------\nCASH FLOWS FROM OPERATING ACTIVITIES Net Income $ 1,026,848 $ 1,018,160 $ 909,053 ----------------------------------------- Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 136,428 113,945 123,300 Gain on sale of investments -- (1,700) -- Gain on disposition of equipment (19,416) (525) (67) Allowance for doubtful accounts 168,222 (3,000) (205) Deferred income taxes (47,004) (11,120) (4,704) Change in assets and liabilities (Increase) decrease in: Receivables (282,028) (81,112) 85,442 Unbilled adjusting fees (2,375) 2,325 2,825 Prepaid expenses (31,108) 20,219 (48,663) Other (59,522) 139,750 (31,492) Increase (decrease) in: Accounts payable (33,877) 30,758 (1,726) Accrued expense 167,408 12,186 (149,511) Income taxes payable 34,647 (18,088) 105,765 Licensees' & franchisees' remittance payable (497,735) 233,387 193,241 Other (22,657) 13,604 (6,388) ----------------------------------------- Total adjustment (489,017) 450,629 267,817 ----------------------------------------- NET CASH PROVIDED BY OPERATING ACTIVITIES 537,831 1,468,789 1,176,870 ----------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES Capital expenditures (127,195) (12,083) (96,307) Investments purchased (3,968,431) (3,543,038) (3,333,541) Collection on receivable from licensee 3,154 16,622 4,322 Proceeds from disposition of equipment -- 600 16,281 Proceeds from maturity of investments 4,000,000 3,106,824 3,000,000 License acquisition (92,000) -- -- Payments on license acquisition (18,306) -- -- Advances to licensees and franchisees (3,358,235) (2,772,088) (3,950,434) Collections of advances to licensees & franchisees 3,241,491 2,672,815 3,681,819 ----------------------------------------- NET CASH USED IN INVESTING ACTIVITIES (319,522) (530,348) (677,860) ----------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES Cash dividends (536,454) (519,814) (418,166) Proceeds from issuance of common stock (net) -- -- 214,062 Common stock repurchased (136,377) (278,492) (76,424) ----------------------------------------- NET CASH USED IN FINANCING ACTIVITIES (672,831) (798,306) (280,528) EFFECT OF EXCHANGE RATE CHANGES ON CASH 8,702 18,007 -- ----------------------------------------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (445,820) 158,142 218,482 CASH AND CASH EQUIVALENTS AT BEGINNING OF THE PERIOD 804,780 646,638 428,156 ----------------------------------------- CASH AND CASH EQUIVALENTS AT END OF THE PERIOD $ 358,960 $ 804,780 $ 646,638 =========================================\nThe accompanying notes are an integral part of these statements.\nNOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPrinciples of consolidation -- These financial statements include the accounts of Frontier Adjusters of America, Inc. (Company) and its subsidiaries, all of which are wholly-owned. Intercompany accounts and transactions have been eliminated.\nBusiness -- The Company's operations consist of the licensing and franchising of independent adjusters throughout the United States, Puerto Rico, Canada and London, England and the operation of an independent adjusting business in Arizona and a risk management division out of its Phoenix, Arizona office. The Company grants credit to its licensees and franchisees, all of whom operate within the insurance industry. Revenues from claims adjusted by employees of the Company are recognized as the services are performed; revenues from claims adjusted by independent licensees and franchisees are recognized when they become due under the terms of the license and franchise agreements (Note ). Included in the revenues are collections received from one customer which provided the Company with approximately $1,044,000 or 21.8%, $968,000 or 23% and $774,000 or 19.5% of the continuing licensee and franchisee fees during the years ended June 30, 1995, 1994 and 1993 respectively. Outstanding licensee and franchisee fees receivable related to this customer were approximately $95,000 at June 30, 1995 and $93,000 at June 30, 1994.\nConsolidated statements of cash flow -- Short term investments which have original maturities of 90 days or less are considered cash equivalents.\nDepreciation and amortization -- Depreciation is computed using straight-line and accelerated methods over estimated useful lives, which range from three to ten years for all property and equipment except the building. The building is depreciated using the straight-line method over 30 years. The cost of a subsidiary in excess of net tangible assets acquired is being amortized over 40 years.\nLicenses and franchises -- Licenses and franchises are amortized on the straight-line basis over the period of the contract.\nIncome taxes -- Deferred income taxes result from temporary differences between book and tax bases of assets and liabilities. The principal sources of these differences are different depreciation rates for property and equipment, the difference between the book provision for doubtful accounts and the specific charge-off method used for income tax purposes, and the recognition of gain on sale of the Company's Tucson operations.\nInvestments in debt and marketable equity securities and accounting change -- The Company has investments in debt and marketable equity securities. Debt securities consist primarily of obligations of the U.S. and state governments. Marketable equity securities consist of mutual funds and preferred stocks that are traded or listed on national exchanges.\nThe Company adopted the provisions of FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities, as of July 1, 1994. Statement 115 requires that management determine the appropriate classification of securities at the date of adoption, and thereafter at the date individual investment securities are acquired, and that the appropriateness of such classification be reassessed at each balance sheet date. Since the Company does not buy investment securities in anticipation of short-term fluctuations in market price, none of its investments are considered trading securities. The Company purchases local government debt securities with the intent on holding them to maturity. All other securities are considered available-for-sale securities in accordance with Statement 115. Held to maturity securities are carried at amortized cost. Available-for-sale securities are stated at fair value, and unrealized holding gains and losses, net of the related deferred tax effect, are reported as a separate component of stockholders' equity.\nPrior to the adoption of Statement 115, the Company stated its debt securities at the lower of amortized cost or fair value. Under both the newly adopted accounting standard and the Company's former accounting practices, premiums and discounts on investments in debt securities are amortized over their contractual lives. The method of amortization results in a constant effective yield on those securities (the interest method). Interest on debt securities is recognized in income as earned, and dividends on marketable equity losses, including losses from declines in value of specific securities determined by management to be other-than-temporary, are included in income. Realized gains and losses are determined on the basis of the specific securities sold.\nNote 7 to the financial statements provides further information about the effect of adopting Statement 115.\nEarnings per common share -- Earnings per common share are based on the weighted average number of shares outstanding during the year. The effect of stock options (Note 14) as common stock equivalents is less than 3% dilutive and, therefore, is not included in the computation.\nForeign currency translation -- The functional currency of the Company's foreign operations is the applicable local currency. The foreign currencies are translated to U.S. dollars using applicable exchange rates. The gains or losses resulting from such translations are included in Stockholders' Equity.\nReclassification -- Certain items on the financial statements for the years ended June 30, 1994 and 1993 have been reclassified, with no effect on net income, to be consistent with the classifications adopted for the year ended June 30, 1995.\nNOTE 2: SUPPLEMENTAL CASH FLOW INFORMATION\n1995 1994 1993 ---------------------------------------- Cash paid during the year: Interest $ 6,745 $ 458 $ -- Income taxes $668,427 $ 631,141 $ 435,149\nNOTE 3: RECEIVABLES\nReceivables consist of: 1995 1994 --------------------------\nAccounts receivable trade $ 51,955 $ 38,472 Licensee and franchisee fees receivable 722,122 470,636 Errors and omissions insurance premium advanced 138,544 112,563 Other 40,546 50,135 -------------------------- Total receivables 953,167 671,806 Less allowance for doubtful accounts 27,500 24,000 -------------------------- $ 925,667 $ 647,806 ==========================\nNOTE 4: LONG-TERM RECEIVABLES\nLong-term receivables consist of advances to licensees and franchisees which are repayable in the amount equal to a percentage of the monthly licensee and franchisee revenue. Estimated current and long-term maturities are as follows:\n1995 1994 --------------------------\nAdvances to licensees and franchisees $1,204,239 $1,148,717 Less allowance for doubtful advances 195,000 92,000 -------------------------- 1,008,739 1,056,717 Less current portion 706,739 823,717 -------------------------- Long term portion $ 302,000 $ 325,000 ==========================\nNOTE 5: RECEIVABLE FROM LICENSEE\nThe Company sold its Tucson operation and related personal property in December, 1990 for $160,000. The Licensee has agreed to pay the Company 10% (in addition to the contractual license fee) of his gross collections until the balance is paid. This receivable is secured by the license rights. The balance is as follows:\n1995 1994 --------------------------\nBalance Due $ 80,552 $ 87,083 Imputed Interest 11.25% 22,926 26,303 -------------------------- 57,626 60,780 Current Portion 6,864 6,490 -------------------------- $ 50,762 $ 54,290 ==========================\nThe current portion of the receivable from Licensee is included in current receivables.\nOn August 1, 1995, the Company entered into an agreement with its Tucson licensee to acquire the Tucson operation. The agreed purchase price was $116,081 including the $57,626 outstanding receivable.\nNOTE 6: PROPERTY AND EQUIPMENT\nProperty and equipment consist of: 1995 1994 --------------------------\nBuilding and improvements $1,127,852 $1,121,926 Computers and software 300,380 282,726 Furniture and fixtures 251,933 237,795 Automobiles 88,802 66,335 -------------------------- 1,768,967 1,708,782 Less accumulated depreciation and amortization 784,565 748,324 -------------------------- 984,402 960,458 Land 500,143 500,143 -------------------------- $1,484,545 $1,460,601 ==========================\nNOTE 7: ACCOUNTING CHANGE\nAs discussed in Note 1, the Company adopted FASB Statement 115 as of July 1, 1994. In accordance with Statement 115, the 1994 comparative financial statements have not been restated for the change in accounting principle. The July 1, 1994 cumulative effect of adopting Statement 115 decreased the balance of stockholders' equity by $8,181 to recognize the net unrealized holding loss of securities at that date.\nNOTE 8: INVESTMENTS IN DEBT AND MARKETABLE EQUITY SECURITIES\nThe following is a summary of the Company's investment in debt and marketable equity securities as of June 30, 1995 and 1994:\nGross Gross Amortized Unrealized Unrealized Cost Gains Losses Fair Value ------------------------------------------------- ------------------------------------------------- U.S. government securities $ 981,197 $ -- $ -- $ 981,197 Local government securities 726,918 11,794 23,994 714,718 ------------------------------------------------- Total debt securities 1,708,115 11,794 23,994 1,695,915 Equity securities 286,496 10,967 23,033 274,430 ------------------------------------------------- $1,994,611 $ 22,761 $ 47,027 $1,970,345 =================================================\n------------------------------------------------- U.S. government securities $ 998,449 $ -- $ -- $ 998,449 Local government securities 742,224 8,204 58,424 692,004 ------------------------------------------------- Total debt securities 1,740,673 8,204 58,424 1,690,453 Equity securities 276,774 -- 13,285 263,489 ------------------------------------------------- $2,017,447 $ 8,204 $ 71,709 $1,953,942 =================================================\nThe Company's investment in local government securities is concentrated in Salt River Project Agricultural Improvement and Power District Municipal Bonds which mature between 2006 and 2031.\nNOTE 9: LONG TERM DEBT\nOn August 1, 1994, the Company acquired, from a licensee, certain rights under his license agreement. Those rights were acquired for $25,000 cash and sixty monthly payments of $2,500. The balance is as follows:\n---------- Balance Due $ 125,000 Imputed interest @ 7.25 17,394 ---------- 107,606 Less Current Portion 22,951 ---------- Long Term Portion $ 84,655 ==========\nInterest paid on outstanding debt amounted to $6,694. Aggregate payments for the next five years are as follows:\nYear Ending June 30, 1996 $ 22,951 1997 24,672 1998 26,521 1999 28,509 2000 4,953 --------- $ 107,606 =========\nNOTE 10: LICENSING AND FRANCHISING\nThe Company has entered into 437 license and franchise agreements with 390 entities, operating 590 offices with advertised locations, as of June 30, 1995, whereby the Company grants exclusive ten year licenses or franchises for the right to use the name \"Frontier Adjusters\" in a particular area. There is no initial license or franchise fee. The Company performs advertising, collection and remittance services, and provides the licensees and franchisees with supplies. As compensation for the above, the Company receives a fee based on a percentage of the licensees' or franchisees' gross billings. Gross billings by licensees and franchisees for the years ended June 30, 1995, 1994 and 1993 were approximately $42,690,000, $39,710,000 and $37,870,000, respectively.\nThe Company's main line of business is providing services to the insurance industry. The revenue and cost components along with identifiable assets and number of advertised locations are as follows:\nLicensing Corporate and and Franchising Adjusting Other Consolidated -------------------------------------------------------- - ---- Revenues $ 4,783,941 $ 456,884 $ -- $ 5,240,825 Costs and expenses 3,043,680 485,739 208,737 3,738,156 -------------------------------------------------------- Income (loss) from operations $ 1,740,261 $ (28,855) $ (208,737) $ 1,502,669 ========================================================\nIdentifiable assets $ 3,638,623 $ 457,380 $ 2,501,047 $ 6,597,050 ======================================================== Number of advertised locations Beginning of year 569 4 -- 573 Opened 47 -- -- 47 Closed (9) -- -- (9) Ownership changes (17) 17 -- -- -------------------------------------------------------- 590 21 -- 611 ======================================================== - ---- Revenues $ 4,205,245 $ 385,025 $ -- $ 4,590,270 Cost and expenses 2,359,352 492,512 227,647 3,079,511 -------------------------------------------------------- Income (loss) from operations $ 1,845,893 $ (107,487) $ (227,647) $ 1,510,759 ========================================================\nIdentifiable assets $ 3,831,994 $ 262,838 $ 2,396,174 $ 6,491,006 ======================================================== Number of advertised locations Beginning of year 541 4 -- 545 Opened 41 -- -- 41 Closed (13) -- -- (13) -------------------------------------------------------- 569 4 -- 573 ======================================================== - ---- Revenues $ 3,979,794 $ 507,297 $ -- $ 4,487,091 Costs and expenses 2,440,099 518,956 167,844 3,126,899 -------------------------------------------------------- Income (loss) from operations $ 1,539,695 $ (11,659) $ (167,844) $ 1,360,192 ======================================================== Identifiable assets $ 3,469,374 $ 405,476 $ 2,106,448 $ 5,981,298 ======================================================== Number of advertised locations Beginning of year 517 3 -- 520 Opened 45 -- -- 45 Closed (20) -- -- (20) Ownership changes (1) 1 -- -- -------------------------------------------------------- 541 4 -- 545 ========================================================\nNOTE 11: INCOME TAXES\nThe components of the provision for income taxes are as follows:\n1995 1994 1993 ------------------------------------------- Federal Current $ 544,580 $ 499,307 $ 455,810 Deferred (36,491) (9,195) (3,544) State Current $ 154,664 113,492 83,000 Deferred (10,513) (1,924) (1,160) ------------------------------------------- Income taxes $ 652,240 $ 601,680 $ 534,106 ===========================================\nA reconciliation of the statutory Federal income tax rate to the Company's effective tax rate follows:\n1995 1994 1993 ------------------------------------------- Statutory rate 35.0% 35.0% 34.0% Increase (decrease) resulting from: State income taxes, net 5.7 4.5 3.7 Non-deductible items 1.1 .7 .4 Non-taxable revenues (1.0) (.9) (.5) Other (1.9) (2.2) (.6) ------------------------------------------- Effective rate 38.9% 37.1% 37.0% ===========================================\nNet deferred tax assets consist of the following components at June 30, 1995 and 1994:\n1995 1994 -------------------------- Deferred tax assets Allowance for doubtful accounts $ 87,104 $ 43,797 Property and equipment 21,301 22,983 Other 12,735 8,105 Deferred tax liabilities Installment sale (20,031) (20,780) -------------------------- $ 101,109 $ 54,105 ==========================\nThe deferred tax amounts mentioned above have been classified as current assets in the accompanying balance sheets as of June 30, 1995 and 1994.\nNOTE 12: RELATED PARTY TRANSACTIONS\nA director\/officer of the Company is a partner in a law firm that renders legal services to the Company. The Company paid the law firm approximately $88,500 in fiscal 1995, $84,600 in fiscal 1994 and $82,200 in fiscal 1993 for legal services and reimbursement of expenses.\nNOTE 13: PROFIT SHARING PLAN\nOn June 14, 1984, the Company adopted a Profit Sharing Plan (Plan) covering substantially all employees of the Company who have completed one year of service and have reached age 20. The Plan provides for contributions at the discretion of management not to exceed the amount permitted under the Internal Revenue Code as a deductible expense. Participants' benefits vest at the rate of 20% per year. Contributions to the Plan are made to trust accounts for investment at the discretion of the individual participants. Profit sharing expense was $160,717, $165,980 and $155,504 for the years ended June 30, 1995, 1994 and 1993 respectively.\nNOTE 14: STOCK OPTIONS\nOn October 9, 1987, the shareholders approved an Incentive Stock Option Plan (Plan) which provides for the granting of options to acquire up to 300,000 shares of common stock to certain officers and key employees of the Company at no less than 100% of the fair market value of the stock on the date of the grant. Options under the Plan are intended to be Incentive Stock Options (ISOs) pursuant to Section 422A of the Internal Revenue Code. Such options may have a maximum term of ten years and are exercisable one year after they are granted.\nOptions become exercisable in varying amounts beginning one year after grant. Information regarding these option plans are as follows:\nNumber of Shares -------------------------------------------- 1995 1994 1993 -------------------------------------------- Outstanding July 1 113,130 -- 96,296 Granted 86,870 113,130 -- Exercised -- -- (96,296) --------------------------------------------\nOutstanding June 30 200,000 113,130 -- ============================================\nOptions were granted in fiscal 1995 at an average of $2.625 per share. Options were exercised in fiscal 1993 at an average of $2.223 per share. Options were outstanding at June 30, 1995 and 1994 at average prices per share of $3.1401 and $3.5357, respectively. At June 30, 1995, there are no remaining options available for issuance under the Plan.\nNOTE 15: COMMITMENTS\nThe Company entered into five-year employment agreements with three key executive officers which expire June 30, 2000. In addition to a base salary, the agreements provide for bonuses based upon the Company's pre-tax earnings and annual cost of living increases. Two of the key executive officers were covered by employment agreements which expired June 30, 1995. Total compensation under those employment agreements was $452,497, $435,711 and $412,144 for the years ended June 30, 1995, 1994 and 1993, respectively. The aggregate commitment for future salaries at June 30, 1995, excluding bonuses and cost of living increases, is $2,375,000 as follows:\nYear ended June 30, ------------------ 1996 $475,000 1997 475,000 1998 475,000 1999 475,000 2000 475,000\nThe Company has entered into an agreement with a customer to share a suite in the America West Arena in Phoenix, Arizona for client development purposes. The agreement provides that the Company is responsible for 50% of the costs and expenses of the suite. The Company's commitment began in June, 1992. The Company's minimum required payments are as follows:\nYear ended June 30, Amount ------------------------------------ 1996 $ 35,096 1997 36,500 1998 37,960 1999 39,477 ---------- $ 149,033 ==========\nFRONTIER ADJUSTERS OF AMERICA, INC. AND SUBSIDIARIES\nSUPPLEMENTARY DATA ------------------\nSelected Quarterly Financial Data\n(Information for all periods shown below is unaudited)\n------------------------------------------------- Three Months Ended ------------------------------------------------- Sept. 30 Dec. 31 Mar. 31 June 30 ---------- ---------- ---------- ---------- Revenues $1,270,785 $1,257,356 $1,232,935 $1,479,749 Income from operations 400,164 415,959 198,670 487,876 Income before income taxes 440,483 482,236 242,891 513,478 Net income 267,530 292,947 146,708 319,663 Net income per share .06 .06 .03 .07\nWeighted average shares outstanding 4,690,898 4,677,311 4,640,898 4,640,898\n------------------------------------------------- Three Months Ended ------------------------------------------------- Sept. 30 Dec. 31 Mar. 31 June 30 ---------- ---------- ---------- ---------- Revenues $1,155,528 $1,118,361 $1,146,805 $1,169,576 Income from operations 423,888 414,824 344,927 327,120 Income before income taxes 454,474 444,191 358,630 362,545 Net income 277,762 272,037 233,510 234,851 Net income per share .06 .06 .05 .05\nWeighted average shares outstanding 4,763,280 4,719,310 4,719,310 4,708,249\n------------------------------------------------- Three Months Ended ------------------------------------------------- Sept. 30 Dec. 31 Mar. 31 June 30 ---------- ---------- ---------- ---------- Revenues $1,125,701 $1,059,913 $1,131,167 $1,170,310 Income from operations 381,184 343,126 346,672 289,210 Income before income taxes 404,070 361,307 361,099 316,683 Net income 247,927 221,276 220,973 218,877 Net income per share .05 .05 .05 .04\nWeighted average shares outstanding 4,726,210 4,803,606 4,805,140 4,789,082\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 - ------------------------------------------------------------\nItem 11","section_11":"Item 11 - Executive Compensation - --------------------------------\nThe following table sets forth certain information concerning the compensation paid by the Company during its year ended June 30, 1994 to each executive officer whose aggregate compensation exceeded $100,000.\nAnnual Compensation ---------------------------------------------------- a b c d e i - --------------------------- ---- ---------- -------- ------------ ------------ Other Annual All Other Compensation Compensation Name and Principal Position Year Salary ($) Bonus ($) ($) (2) ($) (3) - --------------------------------------------------------------------------------\nWilliam J. Rocke, CEO, 1995 206,636 50,000 -- 23,670 Chairman, Director 1994 196,796 50,000 -- 32,250 1993 187,425 46,210 -- 33,750\nJean E. Ryberg, 1995 145,861 50,000 -- 29,168 President, Director 1994 138,915 50,000 -- 32,250 1993 132,300 46,210 -- 33,064\n(1) Columns f, g and h have been omitted as there has been no long term compensation awarded to, earned by or paid to any of the named executives in any fiscal year covered by these columns.\n(2) No perquisites were received by any person named above greater than the lesser of $50,000 or 10% of salary plus bonus.\n(3) \"All Other Compensation\" includes (i) directors fees of $3,000 in fiscal 1995, $2,250 in fiscal 1994 and $3,750 in fiscal 1993 for both Mr. Rocke and Mrs. Ryberg; (ii) profit sharing contributions of $20,670 for the year ended June 30, 1995 and $30,000 each year for the years ended June 30, 1994 and 1993 for Mr. Rocke and $26,168, $30,000 and $29,314 for Mrs. Ryberg for the years ended June 30, 1995, 1994 and 1993, respectively.\nOption\/SAR Exercises and Holdings - ---------------------------------\nThe following table is a summary of all Company stock options granted to the Named Executives during 1995. Individual grants are listed separately for each Named Executive. In addition, this table shows the potential gain that could be realized if the fair market value of the Company's common shares were to appreciate at either a 5% or 10% annual rate over the period of the option term (5 years for Mr. Rocke and 10 years of Mrs. Ryberg).\nThe following table shows Company stock options that were exercised during fiscal 1995 and the number of shares and value of grants outstanding as of June 30, 1995 for each Named Executive.\n(a) stock ofunexercised, in-the-money Company options based on a fair market value of the Company's common $2.6875 per share as of June 30, 1995.\nDirectors Compensation - ----------------------\nEach director, including employees of the Company, are paid $750 per Board meeting attended. During fiscal 1995, each director, except for Mr. Greer, received $3,000 for attendance at Board meetings. Mr. Greer was appointed to the Board of Directors on October 9, 1994 and received $2,250 for attendance at Board meetings during fiscal 1995.\nEmployment Agreements - ---------------------\nThe Company has entered into employment agreements with Mr. Rocke and Mrs. Ryberg, each for five-year terms, effective July 1, 1995 and expiring June 30, 2000.\nMr. Rocke's agreement provides for an annual salary of $225,000 with annual cost of living increases based upon the U.S. Department of Labor's cost of living index, plus a bonus of three percent (3%) of the Company's income before taxes and bonuses and 5% of the increase in the Company's income before taxes and bonuses from the prior year.\nMrs. Ryberg's agreement provides for an annual salary of $160,000 with annual cost of living increases based upon the U.S. Department of Labor's cost of living index, plus a bonus of three percent (3%) of the Company's income before taxes and bonuses and 5% of the increase in the Company's income before taxes and bonuses from the prior year.\nItem 12","section_12":"Item 12 - Security Ownership of Certain Beneficial Owners and Management - ------------------------------------------------------------------------\nName and Address Amount of Beneficial Ownership - --------------------------- ------------------------------ Common Stock $.01 Par Value ------------------------------ Number of Shares (1) Percent (2) -------------------- -----------\nWilliam W. Strawther, Jr. and Marjorie A. Strawther, his wife (3) 442,138 9.52% 7108 North 15th Street Phoenix, Arizona 85020\nWilliam J. Rocke and Garnet Rocke, his wife (4) 440,550 9.44% P. O. Box 7641 Phoenix, Arizona 85011\nGeorge M. Hill (5) 173,390 3.74%\nJean E. Ryberg (6) 138,871 2.97%\nLouis T. Mastos and Eva B. Mastos, his wife (7) 208,703 4.50%\nMerlin J. Schumann and Donna L. Schumann, his wife 20,114 *\nJames S. Rocke (8) 440,086 9.42%\nR. Scott Younker and Sandra L. Younker, his wife 93,469 2.01%\nPatric R. Greer and Nancy S. Greer, his wife (9) 44,599 *\nAll officers and directors as a group (nine persons) (10) 1,711,920 36.00% - ----------------------------------------- *Less than 1%\n(1) The number of shares shown in the table, including the notes thereto, have been rounded to the nearest whole share. Includes, when applicable, shares owned of record by such person's minor children and spouse and by other related individuals and entitiies over whose shares of Common Stock such person has custody, voting control or power of disposition. Also includes shares of Common Stock that the identified person had the right to acquire within 60 days of August 1, 1995 by the exercise of stock options.\n(2) The percentages shown include the shares of Common Stock which the person will have the right to acquire within 60 days of August 1, 1995. In calculating the percentage of ownership, all shares of Common Stock which the identified person will have the right to acquire within 60 days of August 1, 1995 upon the exercise of stock options are deemed to be outstanding for the purpose of computing the percentage of the shares of Common Stock owned by any other person.\n(3) Held as trustees under Trust Agreement, dated June 7, 1989, establishing the William W. Strawther, Jr. and Marjorie A. Strawther Living Trust, of which Mr. and Mrs. Strawther are beneficiaries. Excludes an aggregate of 200,000 shares beneficially owned by Mr. and Mrs. Strawther's son, in which shares Mr. and Mrs. Strawther disclaim any beneficial interest.\n(4) Includes 290,000 shares held by Old Frontier Investment, Inc., of Arizona, of which Mr. Rocke holds 51% of the outstanding stock. Includes 26,936 shares subject to a currently exercisable stock option at $3.7125 per share.\n(5) Excludes 50,000 shares held by Nell S. Hill, Mr. Hill's wife, and 112,243 shares held by Mr. Hill's children and grandchildren, in which shares he disclaims any beneficial interest.\n(6) Includes 29,629 shares subject to a currently exercisable stock option at $3.375 per share.\n(7) Includes 180,180 shares which are held in a trust under an agreement dated February 10, 1981, in which Mr. and Mrs. Mastos hold equal beneficial interests, and 25,523 shares which are held by the Louis T. Mastos & Associates, Profit Sharing Plan, of which he is a trustee and the majority beneficial owner.\n(8) Includes 290,000 shares held by Old Frontier Investment, Inc. of Arizona of which Mr. Rocke holds 49% of the outstanding stock. Includes 26,936 shares subject to a currently exercisable stock option at $3.7125 per share.\n(9) Includes 29,629 shares subject to a currently exercisable stock option at $3.375 per share.\n(10) Excludes all duplicate reporting of holdings.\nTo the best of knowledge of the Company, no person or groups of persons, other than officers and directors, beneficially own more than five percent of the Frontier Adjusters of America, Inc. Common Stock (based upon present records of the transfer agent).\nBased solely on a review of the copies of such forms received by the Company during the fiscal year ended June 30, 1995, and written representations that no other reports were required, the Company believes that each person who, at any time during such fiscal year, was a director, officer or beneficial owner of more than 10% of the Company's Common Stock complied with all Section 16(a) filing requirements during such fiscal year, except that (i) each of William J. Rocke, Jean E. Ryberg, James S. Rocke and Patric R. Greer filed late reports on Form 5 covering one grant of stock options to each person pursuant to the Company's 1987 Incentive Stock Option Plan and (ii) R. Scott Younker filed late one report on Form 5 covering one transaction.\nItem 13","section_13":"Item 13 - Certain Relationships and Related Transactions - --------------------------------------------------------\nOld Frontier Investment, Inc. of Arizona, of which William J. Rocke and Garnet Rocke, his wife, are owners of 51% of the issued and outstanding stock of said corporation and James S. Rocke owns the remaining 49%, has entered into a license agreement with the Company pursuant to which it operates, under standard terms and conditions, an insurance adjusting business located in Scottsdale, Arizona, and is paid a 5% royalty on gross revenues derived from services provided by others in certain other Arizona towns. The Company paid that corporation $20,255 during fiscal year 1995 in connection with such 5% royalty agreement.\nGeorge M. Hill, Vice President and Director of the Company, is a senior partner in the law firm which acts as General Counsel to the Company. During the fiscal year 1995, the Company paid such firm $88,544 for services rendered and disbursements. Such fees will continue to accrue, pursuant to a retainer agreement, at the rate of $6,650 per month effective September 1, 1995.\nThe Company paid its Vice Chairman, William W. Strawther, Jr., $20,000 during fiscal year 1995 for business and financial consulting services.\nThe Company believes that the cost to the Company for all of the foregoing were and are competitive with charges for similar services and facilities available from third parties.\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 included in Part II, Item 8:\nReport of Independent Certified Public Accountants\nConsolidated Balance Sheets - June 30, 1995 and 1994\nConsolidated Statements of Income for the Years Ended June 30, 1995, 1994 and 1993\nConsolidated Statements of Stockholders' Equity for the Years Ended June 30, 1995, 1994 and 1993\nConsolidated Statements of Cash Flows for the Years Ended June 30, 1995, 1994 and 1993\nNotes to Consolidated Financial Statements - June 30, 1995, 1994 and 1993\n(a) (2) Financial Statement Schedules\nSchedule Number\nI Marketable Securities and Other Security Investments June 30, 1995 and 1994\nV Property and Equipment for the Years Ended June 30, 1995, 1994 and 1993\nVI Accumulated Depreciation and Amortization of Property and Equipment for the Years Ended June 30, 1995, 1994 and 1993\nX Supplementary Income Statement Information for the Years Ended June 30, 1995, 1994 and 1993\nSchedules 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.\n(a) (3) Exhibits filed with this report.\nEXHIBIT LIST\nExhibit No. Description of Exhibit - ----------- ----------------------\n3(a) Articles of Incorporation of Frontier Adjusters of America, Inc.*\n3(b) By-Laws of Frontier Adjusters of America, Inc.**\n10(a) Frontier Adjusters of America, Inc. Incentive Stock Option Plan*\n10(b) Profit Sharing Plan, as amended\n10(c) Employment Agreement, dated August 10, 1995 between the Registrant and William J. Rocke\n10(d) Employment Agreement, dated August 10, 1995 between the Registrant and Jean E. Ryberg\n10(e) Incentive Stock Option Plan, dated October 10, 1987*\n10(f) Form of Franchise Agreement between the Registrant and franchisees*\n10(g) Form of License Agreement between the Registrant and licensees*\n10(h) Agreement, dated June 1, 1990, between the Registrant and Scottsdale Insurance Company*\n10(i) Form of Software Purchase Agreement and Order Form*\n10(j) Software Products License Agreements between the Registrant and MAI Systems, Inc. (formerly, MAI Basic Four, Inc.), each dated September 29, 1989*\n21 List of Subsidiaries of Frontier Adjusters of America, Inc.\n24 Consent of McGladrey & Pullen\n*Incorporated by reference to the Registrant's Form S-2 filed July 9, 1991\n**Incorporated by reference to the Registrant's Form 10-K for the year ended June 30, 1993\n(b) The Company filed no reports on Form 8-K with the Securities and Exchange Commission during the last quarter of the fiscal year June 30, 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.\nFRONTIER ADJUSTERS OF AMERICA, INC.\n\/s\/ William J. Rocke \/s\/ Jean E. Ryberg - ----------------------------------- ----------------------------------- William J. Rocke (Chief Executive Jean E. Ryberg, (President) Officer, Chairman of the Board, Principal Financial Officer)\nAugust 21, 1995 August 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 included:\n\/s\/ George M. Hill August 21, 1995 - ----------------------------------- ----------------------------------- George M. Hill, Director\n\/s\/ James S. Rocke August 21, 1995 - ----------------------------------- ----------------------------------- James S. Rocke, Secretary\/ Treasurer, Director\n\/s\/ William J. Rocke August 21, 1995 - ----------------------------------- ----------------------------------- William J. Rocke, Director\n\/s\/ Jean E. Ryberg August 21, 1995 - ----------------------------------- ----------------------------------- Jean E. Ryberg, Director\n\/s\/ Merlin J. Schumann August 21, 1995 - ----------------------------------- ----------------------------------- Merlin J. Schumann, Director\n- ----------------------------------- ----------------------------------- William W. Strawther, Jr., Director\n- ----------------------------------- ----------------------------------- Lou Mastos, Director\n- ----------------------------------- ----------------------------------- R. Scott Younker, Director\n\/s\/ Patric R. Greer August 21, 1995 - ----------------------------------- ----------------------------------- Patric R. Greer, Controller\nFRONTIER ADJUSTERS OF AMERICA, INC. AND SUBSIDIARIES\nSCHEDULE I\nMARKETABLE SECURITIES AND OTHER SECURITY INVESTMENTS\nFor Years Ended June 30, 1995 and 1994\nFRONTIER ADJUSTERS OF AMERICA, INC. AND SUBSIDIARIES\nSCHEDULE V\nPROPERTY AND EQUIPMENT\nFor Years Ended June 30, 1995, 1994 and 1993\nBalance Beginning Additions Retirement at End Classification of Period at Costs (1) or Sales or Period - -------------- ----------- ------------ ---------- ----------\n- ---- Computer $ 282,726 $ 18,829 $ (1,175) $ 300,380 Furniture and Fixtures 237,795 14,638 (500) 251,933 Building and Improvements 1,121,926 5,926 -- 1,127,933 Land (2) 500,143 -- -- 500,143 Automobiles 66,335 88,802 (66,335) 88,802 ----------- ----------- -------- ----------- $ 2,208,925 $ 128,195 $ 68,010 $ 2,269,110 =========== =========== ======== ===========\n- ----\nComputer $ 303,831 $ 5,280 $(26,385) $ 282,726 Furniture and Fixtures 236,670 1,125 -- 237,795 Building and Improvements 1,118,291 5,678 (2,043) 1,121,926 Land (2) 500,143 -- -- 500,143 Automobiles 66,335 -- -- 66,335 ----------- ----------- -------- ----------- $ 2,225,270 $ 12,083 $(28,428) $ 2,208,925 =========== =========== ======== ===========\n- ----\nComputer $ 304,159 $ 3,533 $ (3,861) $ 303,831 Furniture and Fixtures 236,445 4,818 (4,593) 236,670 Building and Improvements 1,095,861 25,456 (3,026) 1,118,291 Land 500,143 -- -- 500,143 Automobiles 66,335 -- -- 66,335 ----------- ----------- -------- ----------- $ 2,202,943 $ 33,807 $(11,480) $ 2,225,270 =========== =========== ======== ===========\n(1) Additions in 1994, 1993 and 1992 represent the purchase of computer equipment, furniture and fixtures, automobiles, and building improvements.\nFRONTIER ADJUSTERS OF AMERICA, INC. AND SUBSIDIARIES\nSCHEDULE VI\nACCUMULATED DEPRECIATION AND AMORTIZATION OF PROPERTY AND EQUIPMENT\nFor Years Ended June 30, 1995, 1994 and 1993\nAdditions Balance at Charged to Balance Beginning Costs and Retirements at End Classification of Period Expenses (1) or Sales or Period - -------------- ----------- ------------ ------------ ---------- - ----\nComputer $ 268,375 $ 13,013 $ (1,176) $ 280,212 Furniture and Fixtures 199,754 14,973 (500) 214,227 Building and Improvements 235,972 39,354 -- 275,326 Automobiles 44,223 20,328 (49,751) 14,800 ---------- ---------- ---------- ---------- $ 748,234 $ 87,668 $ (51,427) $ 784,565 ========== ========== ========== ==========\n- ----\nComputer $ 275,218 $ 19,468 $ (26,311) $ 268,375 Furniture and Fixtures 177,534 22,220 -- 199,754 Building and Improvements 195,652 42,362 (2,042) 235,972 Automobiles 27,639 16,584 -- 44,223 ---------- ---------- ---------- ---------- $ 676,043 $ 100,634 $ (28,353) $ 748,324 ========== ========== ========== ==========\n- ----\nComputer $ 253,165 $ 22,928 $ (875) $ 275,218 Furniture and Fixtures 149,579 31,319 (3,364) 177,534 Building and Improvements 153,153 45,526 (3,027) 195,652 Automobiles 11,055 16,584 -- 27,639 ---------- ---------- ---------- ---------- $ 566,952 $ 116,357 $ (7,266) $ 676,043 ========== ========== ========== ==========\n1995 1994 1993(1) -------- -------- -------- Depreciation per above $ 87,668 $100,634 $116,357 Amortization of intangible assets 48,760 13,311 6,943 -------- -------- --------\nTotal depreciation and amortization charged to expense $136,428 $113,945 $123,300 ======== ======== ========\n(2) Depreciation is computed using straight-line and accelerated methods over estimated useful lives, which range from 3 to 10 years for all assets except the building. The building is depreciated using the straight-line method over 30 years.\nFRONTIER ADJUSTERS OF AMERICA, INC. AND SUBSIDIARIES\nSCHEDULE X\nSUPPLEMENTARY INCOME STATEMENT INFORMATION\nFor Years Ended June 30, 1995, 1994 and 1993\nCharged to Costs Item and Expenses ------------------------ ---------------- 5. Advertising Costs\n1995 $360,878\n1994 $384,868\n1993 $428,761","section_15":""}
{"filename":"746425_1995.txt","cik":"746425","year":"1995","section_1":"ITEM 1. DESCRIPTION OF BUSINESS\nGENERAL\nJMC Group, Inc. (the \"Company\") is a Delaware corporation which was founded in 1983. Its executive offices are located at 9710 Scranton Road, Suite 100, San Diego, California 92121 and its telephone number is (619) 450-0055.\nThe Company operates its business in one industry segment--annuity, insurance and mutual fund sales through financial institutions and the related servicing of products previously sold. This business has historically been carried out through the Company's subsidiaries, James Mitchell & Co. and its subsidiaries (\"JMC\") and Priority Investment Services, Inc. (\"Priority\"). JMC and Priority are structured marketing organizations that sell tax-advantaged annuities, insurance products and mutual funds as investment vehicles to customers of financial institutions through relationships with banks and savings and loan associations and thrifts. The Company's products consist primarily of fixed and variable annuities underwritten by independent life insurance companies (rated A or higher by A.M. Best) and mutual fund shares. In January of 1996, the Company modified its relationship with First Tennessee Bank National Association (\"First Tennessee Bank\") and Priority, which offered and sold mutual funds and annuities exclusively to customers of First Tennessee Bank. See \"Material Customers.\" In addition, the Company terminated its relationship with Barnett Banks, Inc. (\"Barnett\")during 1995. See \"Material Customers.\"\nAlthough the termination or modification of contracts with financial institutions usually ends new sales activities, JMC continues, in most cases, to provide services to the customers of the institution and earns fees for these services based on the accumulated asset value of the accounts being serviced. The First Tennessee Bank modification will result in JMC receiving such asset fees as well as additional fees for services contracted for in the new agreement. Barnett selected the option of acquiring JMC's right to such future asset-based fees and made a one time payment to JMC during 1995 for such right. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations--Results of Operations--1995 compared to 1994.\"\nDuring 1995, the average monthly accumulated value of assets being serviced, for such clients (excluding First Tennessee Bank and Barnett), was over $273 million generating annual 1995 revenues of $1,019,000.\nDuring 1995, the Company's subsidiaries entered into selling agreements with numerous additional distributors of mutual fund shares.\nDuring 1995, the Company further restructured its operations by closing down its Florida operations upon the termination of its contract with Barnett and moved the servicing of its Tennessee customers to its corporate office upon the modification of its agreement with First Tennessee Bank. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations, -- Results of Operations--1995 Compared to 1994-- Restructuring.\"\nPRINCIPAL MARKETS AND METHODS OF DISTRIBUTION\nThe principal market for JMC's services is banks, savings and loan associations and thrifts. Management believes that these types of financial institutions perceive a need to provide their customers with a wider mix of financial products, yet often lack the infrastructure and corporate culture to market products which are not traditional to financial institutions. In addition, these institutions are focusing on developing fee income as a major source of revenue. An independent marketing organization such as JMC provides these institutions with the ability to make such products available to their customers and receive fee income. Specifically, the Company believes the primary market for such services, in the future, is the small to medium size financial institution which would have more difficulty offering the depth of services the Company provides in a cost effective manner.\nHistorically, the primary distribution method employed by the Company and its financial institution clients for the sale of annuities and insurance products has been a fully-managed alternative investment program. In most cases, this program is implemented by the establishment of a group trust at the institution, in which the client's customers may participate. The institution acts as trustee of the trust, and acquires annuities and insurance products for the benefit of the participants as they direct. The Company's subsidiaries act as the trustor and are appointed as the record keeping and servicing agent for the trust. Mutual fund products are generally sold directly by JMC's or Priority's employees to financial institution customers. In both cases, JMC's or Priority's structured retail marketing organization employs the retail sales force and thereby controls the point of sale.\nAs a result of the streamlining of administrative and sales management functions accomplished in the 1994 restructuring and further consolidation in 1995, the Company has positioned itself to expand the type and nature of services which it provides and the manner in which they are delivered. In addition to its fully-managed program, the Company will contract with financial institution clients to provide other programs such as the dual employee program where the financial institution rather than the Company employs the retail sales force, or the integrated support services program (\"ISS program\") where the bank internalizes all sales functions while the Company provides appointment tracking, business processing and customer account servicing. The ISS program would enable the Company to deliver a competitive package of services which would enhance the effectiveness and efficiency of non-deposit alternative investment programs instituted and managed by financial institutions themselves. These services include product selection and due diligence, sales and appointment management tracking and reporting, annuity and mutual fund transaction processing, commission accounting, customer service, sales personnel licensing, sales and marketing support, and training programs. The Company commenced its first ISS program at First Tennessee Bank as of February 1, 1996. See \"Material Customers\" below.\nOn January 28, 1996, the Company signed an exclusive marketing agreement with USBA Holdings, Ltd. (\"USBA\"), an Atlanta-based financial services company which provides financial institutions across the country with programs, products and financial expertise focused upon improving shareholder value. Under the agreement, JMC will gain exposure to nearly 4,000 financial institutions through the direct clients of US Banking Alliance, Diversified Consulting, Inc., PROACTIVE, Inc., and Financial Suppliers, Inc., all wholly- owned subsidiaries of USBA. JMC will become an integral part of USBA's package of products and services as the exclusive provider of mutual funds, insurance and annuity products to USBA's direct and indirect client financial institutions.\nManagement believes the agreement benefits JMC by providing an immediate avenue for substantial new client growth as part of a comprehensive financial institution performance package. It benefits USBA by enhancing its offerings to clients through the addition of alternative investment products and services for its distribution system. Both parties hope to benefit from sales- based fee income from these products.\nThis agreement is a result of JMC's strategic business plan to gain market share and increase revenues. USBA currently has approximately 1,000 diverse direct clients, most ranging in asset size from $100 million to $2 billion, with several clients ranging up to $5 billion in assets. In addition, USBA has exclusive agreements with data processors, trade associations and other industry product providers who serve approximately 3,000 financial institutions.\nThe terms of the marketing agreement offer JMC access to the USBA network as the exclusive alternative investments provider. For this access, JMC granted USBA one million common stock warrants exercisable after January 1, 1997, at $2.50 per share. Under certain circumstances, the warrants would be immediately exercisable at a lower price of $1.4375 per share.\nUSBA has established a program that offers banks a comprehensive analysis of their financial performance in key areas and compares them to peers with similar operating characteristics grouped by size, regions and markets. From this, USBA has generated an array of products and services intended to allow the institution to attract and retain customers, generate fee income and provide quality products and competitive positioning while enhancing efficiency and profitability. It is believed that the alliance with JMC augments these abilities since alternative investment programs are often an important avenue for banks to earn fee income while strengthening customer relationships.\nUnder a separate consulting agreement, JMC paid USBA $1.25 million in cash to provide a strategic plan, training and preparation to help JMC shift focus into the new market segment to significantly increase market share over the next five years.\nPRINCIPAL PRODUCTS\nThe principal non-deposit investment products offered by JMC and Priority to customers of their financial institution clients are annuities, both fixed and variable, and mutual funds, including equity funds, fixed income funds and tax exempt funds. Annuities are primarily used as tax-deferred retirement savings vehicles. There is a penalty if funds are withdrawn before age 59 1\/2 or within a specified period of time, usually 5 to 8 years. Unlike individual retirement accounts there is no maximum investment cap either annually or in total and contributions are not tax-deductible. Immediate annuities provide guaranteed income for a specified number of years or for an individual's lifetime.\nDuring 1995, the mix of annuities and insurance products sold by JMC was as follows: 65% fixed annuities and 35% variable and other annuities. The corresponding product mix percentages of annuities sold by the Company in 1994 and 1993 were 75% fixed\/25% variable and other and 74% fixed\/26% variable and other, respectively. Sales of annuities represented 65%, 90% and 94%, respectively, of total sales in each of 1995, 1994 and 1993. The gross revenue rate received by JMC on the sale of annuity products is significantly greater than the gross revenue rate received on mutual fund shares. In addition, the gross revenue rate received on fixed annuity products is greater than the gross revenue rate received on variable and other annuities. See \"Managements Discussion and Analysis of Financial Condition and Results of Operations-- Results of Operations--1995 Compared to 1994\" for further explanation of the impact of product mix on revenues and gross margin.\nThe Company's subsidiaries have negotiated relationships with numerous national insurance providers and, during 1995, such subsidiaries sold the products of Keyport Life Insurance Company, The Life Insurance Company of Virginia, Aetna Life Insurance and Annuity Company, Liberty Life Assurance Company, Allianz Life Insurance Company of North America, Western and Southern Life Assurance Company and Transamerica Life Insurance and Annuity Company, among others. All of these companies have A or higher ratings from A.M. Best.\nThe Company's subsidiaries' arrangements with each of its annuity and insurance provider companies are very similar. JMC or Priority, as the case may be, acts as an agent and sells the provider's products to customers of financial institution clients. In addition, the Company's subsidiaries handle certain administrative responsibilities and provide ongoing customer service. Both of these functions are often provided directly by the annuity and insurance provider in other agency relationships. The Company's subsidiaries earn commissions for the sale of the provider's products. In addition to the commission on the initial sale, they also earn a monthly asset-based fee on most products, based on the accumulated value of each contract for as long as the contract is in force and annuity payments have not started. Contracts with annuity and insurance providers are generally terminable by either party on thirty days' notice with regard to all of their provisions, except that the provider company continues to be obligated to pay the Company its monthly asset-based fee so long as there remains in force any accumulated value of contracts sold prior to termination of the contract. During 1995, the Company earned approximately $7.3 million in annuity commissions and $4.6 million in asset-based fee payments related to annuity contracts. Commissions are net of actual and projected chargebacks for surrenders. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations--Results of Operations--1995 Compared to 1994\" related to events impacting asset-based fee income during 1995 such as the net gain on the sale of rights to certain future asset-based fee revenue.\nManagement believes that the Company's subsidiaries have maintained strong relations with their current annuity and insurance provider companies. Many of the products are developed jointly by the Company with the annuity and insurance provider companies specifically for use in the Company's programs. During 1995, one of the Company's target provider companies, LICOVA, entered into an agreement to be acquired by Great Northern Annuity Company (GNA), a competitor of the Company. While this acquisition will not be consummated until mid 1996, the impact on product availability is uncertain at this time. However, the Company continues to work with current and prospective provider companies to insure the availability of competitive consumer products.\nIn connection with the sale of annuity and insurance products, neither JMC nor Priority assumes any of the underwriting risks or obligations of the insurance company itself. The Company conducts due diligence and has an established policy of selling only the products of insurance companies which it believes are highly-rated and financially sound.\nThe Company's subsidiaries have agreements to sell mutual fund shares for a large number of highly-regarded mutual fund families, including Putnam, Federated, Fidelity, Oppenheimer, Flagship, Franklin-Templeton and American Capital. JMC and Priority receive commissions for the sale of mutual fund shares and, in most instances, receive ongoing asset-based fees for providing continuing customer service. In connection with the sale of mutual fund shares, JMC's and Priority's representatives act strictly as agents and neither company underwrites securities. The Company reviews the mutual fund families it offers to ensure that they provide what the Company believes to be an appropriate range of quality products. JMC, through its subsidiary JMC Financial Corporation (\"JMC Financial\") acts as a self-clearing agent and a clearing agent for Priority and First Tennessee Brokerage, Inc.\nThe Company continues to work with and negotiate for new and more competitive products supplied by current and potential insurance carriers and thus believes that its business is not substantially dependent upon any one of these provider company contracts, and that if the products of any one of its suppliers were no longer available, they could be replaced by additional providers without a material adverse impact on the Company's results of operation or financial condition. As product competition increases, however, the Company may have to lower its compensation in order to generate higher rates of return to customers in order to increase or maintain production levels.\nMATERIAL CUSTOMERS\nDuring 1995, Barnett, Central Fidelity National Bank (\"Central Fidelity\") and First Tennessee Bank accounted for approximately 31%, 30% and 22%, respectively, of the Company's commission revenues. During 1995, the Company terminated its relationship with Barnett Bank and modified its relationship with First Tennessee Bank. JMC's current contract with Central Fidelity expires on December 31, 1996, but is subject to termination or may be renewed upon written notice prior to that time.\nOn January 31, 1996, the Company signed definitive agreements with First Tennessee Bank to provide for a transition of the Company's fully-managed alternative investment sales program to a newly-developed integrated support services program with an initial two-year term through 1997. The Company has developed this program to provide a variety of services to support alternative investment programs at banks utilizing an internal sales force to market mutual funds and annuities to its customers. The new services program enables First Tennessee Bank to internalize the sales functions of the Company's fully-managed program while maintaining the controls and efficiencies of the program's business processing and single-point customer service capabilities. Although the Company will no longer earn fees for the provision of a fully- managed sales program, the Company will generate revenues in the form of administration fees which provide for a minimum monthly payment of $25,000 through December 31, 1997. The fees will increase from such minimum level based on the success of the bank's internal sales program.\nCOMPETITION\nThe Company operates in a very competitive environment and competes for client bank relationships with other third-party marketing firms. Some of its competitors are subsidiaries of major insurance and mutual fund companies that operate marketing organizations similarly targeting sales of annuities, insurance products and mutual fund shares to customers of banks, savings and loan associations and thrifts. Many of the organizations affiliated with underwriters and distributors have the ability to offer very attractive pricing to potential client financial institutions. The largest and most recognized organizations competing in this general field are Great Northern Annuity (GNA), Essex, Liberty Securities, Marketing One and INVEST. Some financial institutions also elect to manage annuity, insurance and mutual fund sales programs internally, rather than use an outside\nmarketing firm. Generally it is the larger financial institutions who establish such internal programs. In addition, customers of financial institutions who might purchase products from the Company can obtain similar products from other licensed insurance agents, through stockbrokers and through financial institutions not affiliated with JMC.\nThe principal method of competition is price. Product and service are also important competitive factors.\nFrom a competitive standpoint, management believes that many of the Company's sales management and administrative procedures and systems set it apart from its competitors and make its programs more attractive to potential financial institution clients than its competitors' programs. These include its proprietary sales and appointment tracking and reporting systems, which support its regimented sales management approach and its comprehensive recruiting procedures as well as established administrative procedures which insure efficient business processing and high level customer service. Selling is not left to chance or the individual methods of salespeople. Defined operating procedures are implemented. Sales specialists account for their time on a daily basis by communicating with one of the Company's two service centers. Individual sales specialists are also directly supervised by sales managers.\nThe Company maintains an independence towards product distribution which it considers to be a competitive edge in terms of customer suitability and bank regulatory control. The independence is created through the Company's strong relationships with more than one insurance provider company as well as certain internal procedures, such as, product neutral incentive compensation for sales representatives. The result is the ability to offer a wide array of high- quality, attractive alternative non-deposit investment products to suit the needs of the customers of financial institutions. As banking regulators continue to emphasize the quality and suitability of non-deposit investment products sold through financial institutions, the ability of a marketing firm to provide a broad selection of suitable and attractive products to their customers will continue to be important to potential client financial institutions.\nREGISTRATION AND LICENSING\nJMC and certain of its subsidiaries and Priority are required to be licensed to do business in certain states where they transact business. In addition, JMC Financial Corporation and Priority are registered broker-dealers with the Securities and Exchange Commission (\"SEC\"), are members of the National Association of Securities Dealers, Inc. (\"NASD\") and are required to be licensed or registered as a securities broker-dealers in certain states where they transact business. Finally, certain of JMC's subsidiaries and Priority must be licensed or registered as an insurance agency or agent in order to engage in business in certain states. Each of JMC and its subsidiaries and Priority are duly qualified to transact business, and are duly registered or licensed or exempt from the registration or licensing requirements of broker- dealers and entities which engage in securities and insurance businesses, in every state where management believes such entities should be so qualified, registered or licensed.\nMaterial federal, state and local regulations affecting the business of JMC and its subsidiaries and Priority include the Securities Exchange Act of 1934, as amended, the Investment Company Act of 1940, as amended, the securities and insurance laws of each state in which JMC and Priority do business and the local ordinances of each city and county in which JMC and Priority maintain an office.\nREGULATION\nJMC and certain of its subsidiaries and Priority are subject to extensive state regulation in those states in which they are licensed to do insurance business. Each insurance department exercises jurisdiction over the licensing of agents, supervises the form and content of sales literature and other materials distributed to the public, and generally acts to protect consumers from misrepresentation and other unfair conduct. Legislation changing the substantive or procedural rules governing the insurance departments, insurers or agents may affect the mode of operation and profitability of insurance agencies. Insurance commissioners, to protect the public, may maintain administrative proceedings which could result in cease and desist orders, fines or the suspension or cancellation of an agent's license. (See \"Legal Proceedings.\")\nThe securities industry in the United States is also subject to extensive regulation under both federal and state law. The SEC is the federal agency responsible for the administration of federal securities laws. Much of the regulation of broker-dealers has been delegated to the self-regulatory organizations, principally the NASD and the securities exchanges. Certain of the Company's subsidiaries are subject to regulation by the SEC and the NASD. The NASD conducts periodic examinations of member broker-dealers in accordance with rules it has adopted and amended from time to time, subject to approval by the SEC. These subsidiaries are also subject to regulation by state securities authorities in those states in which they do business. Additional legislation, changes in the rules promulgated by the SEC and the NASD, or changes in the interpretation or enforcement of existing laws and rules, may directly affect the mode of operation and profitability of broker-dealers. In December, 1995, the NASD submitted for approval to the SEC proposed rules applicable to NASD members operating on the premises of financial institutions. These rules, if adopted, would be similar to the rules already adopted by bank regulators. See the discussion of the \"Interagency Guidelines\" below. These rules would allow the NASD to also regulate the physical location of sales within financial institutions, the signage necessary, customer disclosures, compensation of unregistered bank employees and public communications, among other aspects of the business. While the rules are substantially similar to those embodied in prior SEC communications on these issues, they are more comprehensive and cover areas not previously addressed by the SEC, but have been addressed and promulgated in the \"Interagency Guidelines,\" as discussed below. The SEC, the NASD and state securities commissions may conduct administrative proceedings which can result in censure, fine, suspension or expulsion of a broker-dealer, its officers or employees. The principal purpose of regulation and discipline of broker- dealers is the protection of customers and the securities markets rather than the protection of creditors and stockholders of broker-dealers.\nThe Company's client financial institutions also operate in a highly regulated environment. Existing federal rulings allow national banks and certain other federally-regulated financial institutions to sell annuities and mutual fund shares, but restrict the sale of many types of insurance products. See the discussions of NationsBank vs. Variable Annuity Life Insurance Company ------------------------------------------------------- below. In February, 1994, all of the primary federal banking regulators issued a single set of guidelines (the \"Interagency Guidelines\") regarding the retail sale of non-deposit investment products, such as annuities and mutual funds, through banks, savings and loan associations and thrifts. These guidelines and their manner of implementation could significantly affect the ability of, and the means by which, the Company's subsidiaries conduct business with federally-regulated banks, savings and loan associations and thrifts. Since issuance of the Interagency Guidelines, the federal banking agencies conducted audits of the non-deposit investment programs at numerous financial institutions. As a result of these audits, certain of the agencies have further clarified certain provisions of the Interagency Guidelines especially in regards to customer disclosures. In addition, state-chartered financial institutions are subject to regulation by state banking agencies. These agencies and state insurance regulators may limit the ability of the Company's financial institution clients and other banks, savings and loan associations and thrifts to engage in the annuity, insurance and mutual fund sales businesses through third-party marketing organizations or otherwise.\nOn January 18, 1995, the United States Supreme Court issued its decision in the case of NationsBank vs. Variable Annuity Life Insurance Company (the ------------------------------------------------------- \"VALIC case\"). The ruling upheld the Office of the Comptroller of the Currency's (\"OCC\") decision that national banks could sell annuities. The Comptroller had found that such products were not insurance within the meaning of the National Bank Act and that the sale of annuities by national banks was within the \"incidental powers\" granted to them under that act. The U. S. Supreme Court concurred with this judgment. The ruling in the VALIC case appears to open the door for federally-chartered financial institutions to sell annuities, even in states where state insurance laws would prohibit such sales. It also appears to create a similar opportunity for state banks in the majority of states where state law permits state-chartered financial institutions to engage in any business permitted for a national bank. In spite of the decision in the VALIC case, at the present time there are federal court proceedings and state and federal legislative proposals which could limit or alter the ability of banking institutions to sell annuities and insurance products. In particular, the United States Supreme Court recently heard oral argument in the case of Barnett Bank of Marion County, N.A. vs. Gallagher. -------------------------------------------------- This 11th Circuit Federal District Court case indicated that a state insurance agency could prevent a bank from selling insurance through an insurance agency located in a town of less than 5,000 people\nin the exercise of its power to regulate the business of insurance within a state. It is not possible to predict the outcome of any such proceeding or the likelihood that any particular proposal will be enacted or what effect such a change would have on the Company's continued ability to market annuities and insurance products and mutual funds through banking institutions. In light of the VALIC case, it is possible that banking institutions that currently utilize the Company's subsidiaries to market such products would market such products themselves, rather than through the Company. The same result might flow from any other change in regulatory landscape. In such an event, the Company's ability to continue its business as described herein would be impaired. However, the Company's subsidiaries currently market annuities, insurance products and mutual funds to customers of financial institutions that could legally sell such products themselves. These financial institutions prefer to use the Company's marketing services instead of developing their own. It is possible that a number of banking institutions will choose to utilize the Company's subsidiaries despite their ability to sell these products directly. In such an event, the Company's subsidiaries would be able to continue to sell annuities, insurance products and mutual funds through such institutions, although perhaps on a more limited basis. It is also possible that a change resulting from court proceedings or legislative initiatives could further restrict the ability of banking institutions to make annuities, insurance products and mutual funds available to their customers either directly through third-party marketing organizations or otherwise.\nLegislation or changes in tax regulations with regard to the tax-deferred status of earnings from annuities could also significantly affect the ability of the Company to market these products.\nEMPLOYEES\nAs of February 29, 1996, the Company had 78 full-time employees.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nDuring 1995, the Company closed its Florida office upon the termination of business with Barnett, and closed its Tennessee office on February 2, 1996, moving all customer service for Tennessee to the Company's corporate office. All facilities are suitable and adequate to meet the Company's requirements. The Company intends to either renegotiate new leases for the existing facilities or locate alternative suitable space upon expiration of these leases, as market conditions indicate. The following is a list of the leases for the principal facilities utilized in the Company's operations as of January 1, 1996.\nCorporate Headquarters 9710 Scranton Road Suites 100 and 120 San Diego, CA 92121 Exp. Date: March 1998 Square Footage: 18,451\nJMC TENNESSEE 850 Ridge Lake Blvd. Suite 207 Memphis, TN 38120 Exp. Date: February 2, 1996 Square Footage: 2,814\nJMC VIRGINIA 6800 Paragon Place Suite 526 Richmond, VA 23230 Exp. Date: July 1997 Square Footage: 3,171\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nOn July 7, 1995, the Florida Department of Insurance ( the \"Department\") issued a Final Order in its administrative proceeding against the Company's wholly-owned subsidiary, JMC, which was commenced on March 11, 1993. The enforcement of the majority of the Final Order has been stayed pending the outcome of its appeal and JMC has complied with all other aspects of the Final Order.\nThe Final Order is similar in many respects to the Recommended Order which was issued by an administrative hearing officer in August 1994. The Department found that JMC was not involved in an unlawful association with its Florida financial institution client with regard to the sale of annuities. JMC was ordered to cease and desist from certain advertising and sales practices which the Department found to be in violation of Florida insurance laws regarding deceptive advertising and sales practices. The Final Order also requires JMC to obtain an insurance agency license prior to engaging in any activity which by state law may be performed only by a licensed agent and revokes the Florida insurance license of James K. Mitchell, Chairman and Chief Executive Officer of the Company. No monetary damages or penalties were assessed against JMC or Mr. Mitchell.\nJMC has filed an appeal of the Final Order and intends vigorously to pursue the appeal. Until the Final Order was issued, JMC was limited to participating in an administrative proceeding before what management believes was a politically-motivated state agency. Management believes that many of its strongest arguments could not be raised in the administrative proceeding. These issues have been raised in the appeal before what management hopes is an impartial judicial panel.\nEffective October 31, 1995, JMC concluded its relationship with its Florida financial institution client and is not presently in business in the state of Florida. The Company has incurred most of the anticipated costs of the appeal and management believes that amounts accrued as of December 31, 1995 will be sufficient to cover any additional costs.\nThe Company's broker-dealer subsidiary, Priority (formerly Spear Rees & Co.), has been named as a defendant in lawsuits arising out of the sale of real estate limited partnerships to customers of Spear Rees & Co. and Rees Financial Group, Inc. and Rees Capital Group, Inc. (\"Rees\") prior to 1992. Spear Rees & Co. was a full service brokerage firm which acquired the assets of Rees in September 1991. Subsequent to year-end, the Company reached a settlement with certain of the Plaintiffs in this case, while other claims remain the subject of NASD arbitration. The amounts to be paid subject to Bankruptcy Court approval in the settlement were accrued in the Company's financial statements and are included in accrued expenses and other liabilities as of December 31, 1995. Management does not believe that resolution of the NASD arbitration will have a material adverse effect on the Company.\nIn addition, the Company and its subsidiaries are involved in various legal and regulatory proceedings from time to time in the ordinary course of business. Management does not believe that any such proceedings will have a material adverse effect on the Company's financial condition or results of operation.\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, 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nMARKET INFORMATION\nThe common stock of the Company is principally traded in the NASDAQ National Market System under the symbol JMCG and is owned as of February 29, 1996 by approximately 262 shareholders of record with approximately 1,200 beneficial owners. Approximately fifteen broker-dealers are market makers in the Company's stock on the NASDAQ National Market System.\nThe Company is also listed on the Pacific Stock Exchange under the symbol JMC, but the trading volume in the Company's common stock on the Pacific Stock Exchange is not material.\nThe following table reflects the high and low sales prices on the NASDAQ National Market System for the Company's common stock for the four quarters of each of 1995 and 1994.\nDIVIDENDS\nNo dividends were paid by the Company during fiscal 1995. Future dividends, if any, will be determined by the Company's Board of Directors, based upon the Company's profitability, its cash position and other considerations deemed appropriate.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nSELECTED ANNUAL FINANCIAL DATA\nNo cash dividends were paid during the period from January 1, 1991 through December 31, 1992. Cash dividends of $456,465 and $969,798 were paid during 1994 and 1993, respectively. No cash dividends were paid during 1995.\nSELECTED QUARTERLY FINANCIAL DATA\n- -------- * Non-recurring items included in the quarterly net income (loss) figures for 1995 include: (a) payment of $1,309,000 ($785,000 after-tax provision) for the right to hire certain personnel in the first quarter; and (b) after-tax net gain on sale of rights to certain future asset-based fees revenues of $1,987,000 in the third quarter and $361,000 in the fourth quarter. See further explanation of these items in \"Management's Discussion and Analysis of Financial Condition and Results of Operations--Results of Operations-- 1995 Compared to 1994.\" ** Includes a one-time charge for restructuring of $557,000 (or $345,000 after estimated tax benefit of $212,000) and a write-off of goodwill in the amount of $2,517,000 (with no corresponding tax benefit) in the third quarter. The fourth quarter includes revenue of approximately $1,000,000 (or $600,000 after estimated tax provision of $400,000) resulting from a payment from a financial institution client for the right to hire certain JMC employees.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\n1995 Compared to 1994 --------------------- General. Revenues and expenses include the accounts of the Company's subsidiaries, JMC and Priority.\nThe Company reported net income for the year ended December 31, 1995 of $1,741,000 (after providing for income taxes of $1,256,000) compared with a net loss of $2,370,000 (after providing for income taxes of $492,000) in 1994. Included in the 1995 and 1994 results were the following:\n1995: ----- . A net gain of $3,914,000 ($2,349,000 or $0.38 per share after estimated tax provision) on the sale of the rights to certain future asset-based fee revenues to a client financial institution.\n. Other revenue in the amount of approximately $1,309,000 ($785,000 or $0.13 per share after estimated tax provision) related to the final portion of that same client financial institution's payment for the right to hire certain employees and certain other services.\n1994: ----- . One-time pre-tax charges totaling $3,074,000. As explained in detail below, the charges consisted of a restructuring charge of $557,000 ($345,000 or $.05 per share after estimated tax benefit of $212,000) and a write-off of goodwill which amounted to $2,517,000 (or $.39 per share) with no corresponding tax benefit.\n. Revenue in the amount of approximately $1,000,000 ($600,000 or $.09 per share after estimated tax provision of $400,000) resulting from a payment from a financial institution client for the right to hire certain JMC employees.\nExcluding the above-mentioned items and amortization of goodwill in 1994, the Company would have reported an after tax loss of $1,393,000 (or $0.22 per share after an estimated tax benefit of $833,000) in 1995 compared to net income of $407,000 (or $0.06 per share after providing for income taxes of $304,000) in 1994.\nTotal revenues for 1995 were $20,372,000 compared to revenues of $33,357,000 in 1994, a decrease of $12,985,000 or 39%. Revenues for 1995 include the previously mentioned one-time payments from a client financial institution and the net gain on the sale of rights to certain asset-based fee revenues to that same client totaling $5,223,000 as well as transition fees of $538,000 which are included in other revenues:\n. The transition fees were intended to cover the cost of operating the Florida operations during a transitional period prior to termination of the Company's relationship with its Florida financial institution client. For purposes of analyzing revenues from operations, these transition fees have been included as they relate to services performed. As such, all expenses related to the same operational transition are included in total operating expenses.\n1994 revenues include the previously mentioned $1,000,000. Excluding the one-time payments for the right to hire certain JMC employees in 1994 and 1995 and the net gain on the sale of the rights to certain asset-based fee revenues in 1995, but including $538,000 for transition fees, revenues for 1995 would have been $15,149,000 compared to $32,357,000 in 1994 (a decrease of $17,208,000 or 53%). This reduction in revenues is primarily attributable to the following:\n. Lower gross sales volumes which declined $297 million or 62% due primarily to:\n* The reconfiguration and ultimate termination of the Company's Florida operations contributed to $241 million or 81% of the sales volume decline. The Company terminated its relationship with its Florida financial institution client in August, 1995.\n* The termination of another client relationship in the fourth quarter of 1994 due to that client being acquired by First Interstate Bank contributed to $18 million or 6% of the total gross sales decline in 1995 compared to 1994.\n* Declining interest rates and increased competition, primarily from Certificates of Deposits during 1995 also contributed to the sales decline.\n. A decrease of approximately 70 basis points or 12% in the gross revenue rate on products sold in 1995 compared to 1994 due to a shift in the product mix to mutual funds and variable annuities, both of which pay lower commissions than that of fixed annuities. Annuity sales as a percentage of total product sales were 65% in 1995 compared to 90% in 1994. In addition, fixed annuity sales as a percentage of total annuity sales were 65% in 1995 as compared to 75% in 1994.\n. A decrease of approximately $654,000 in asset-based fee revenue in 1995 compared to 1994. This decrease is a result of the sale of the rights to certain future asset-based fee revenues at the end of August for which the Company recognized a pre-tax net gain of approximately $3,914,000 during 1995. Because of the timing of this sale, the Company did not receive asset-based fee revenues for the last four months of 1995 which would have generated approximately $1.1 million in additional asset-based fee revenue for 1995.\nTotal expenses for 1995 were $17,375,000 compared to $35,235,000 in 1994. Excluding the previously described one-time charges of $3,074,000, total expenses for 1994 would have been $31,646,000 (which also excludes amortization of goodwill in 1994 of $515,000). Excluding the aforementioned charges in 1994, total expenses in 1995 decreased $14,271,000 or 45% when compared to 1994 expenses. This drop in total expenses is primarily attributable to the following:\n. A $6,744,000 or 51% reduction in fees to financial institutions due to lower sales volume.\n. A $783,000 or 48% reduction in salesperson's commissions also due to lower sales volume, and\n. An additional $6,745,000 or 40% reduction in base operating expenses as a result of the following:\n. The full impact of the Company's restructuring plan implemented in the latter part of 1994, coupled with additional cost reductions during 1995.\n. The reconfiguration and ultimate termination of the Company's Florida operations; and\n. A reduction in legal fees related to the Company's administrative proceeding with the Florida Department of Insurance. The Company incurred significant legal expenses in connection with the five-week administrative hearing which occurred in February and March of 1994.\nThe percentage decrease in fees to financial institutions in 1995 compared to 1994 is less than the percentage decrease in sales volume primarily due to the following:\n. The Company pays out to its financial institution clients a higher percentage of its asset-based fee revenue than it does on front commission revenue. Thus, as asset-based fee revenue becomes a larger percentage of total revenue (32% in 1995 vs. 17% in 1994) the total payout percentage to the financial institution will increase. The increased percentage of revenues paid out offset the decrease due to decreased revenues generated.\nThe Company's gross margin rate (gross revenue rate less payout rate to financial institutions and salesperson commissions) is sensitive to changes in product mix which is impacted by fluctuations in interest rates and other market conditions. The highest gross margin rate is achieved on the sale of fixed annuities, followed by variable annuities with mutual funds producing the lowest gross margin rate.\nFixed annuities achieve a higher gross margin rate because the Company receives a higher gross revenue rate on fixed annuities but makes payments to its financial institution clients and sales personnel at a constant. Mutual funds achieve the lowest gross margin rate due to the significantly lower gross revenue rate paid on\nthese products, even though the payout to the Company's financial institution clients is a fixed percentage of the gross revenue rate. During 1995, variable annuity and mutual fund sales comprised 58% of total sales compared to 33% of total sales in 1994, resulting in a decline in the gross margin rate on total product sales in 1995 from 1994.\nRESTRUCTURING. During the third quarter of 1994, the Company's Board of Directors approved a restructuring plan which was developed by management to enhance operating efficiencies by streamlining the Company's administrative and sales management functions. See explanation of restructuring in \"Results of Operations--1994 compared to 1993--Restructuring\". During 1995 the Company realized the benefits from this restructuring in terms of a reduced base operating overhead at the beginning of the year. In addition, with the centralization of support functions the Company was able to react quickly to effect further cost reductions as sales volumes continued to decline, primarily as a result of the reconfiguration and ultimate termination of its Florida operations.\nAs of December 31,1995 the balance remaining in the restructuring reserve was approximately $60,000 which is primarily to cover the remaining net obligation on leases of offices closed during restructuring. Management believes this reserve balance is adequate to cover its remaining obligations related to the restructuring.\n1994 COMPARED TO 1993 - --------------------- General. Revenues and expenses include the accounts of the Company's subsidiaries, JMC and Priority.\nThe Company reported a net loss for the year ended December 31, 1994 of $2,370,000 (after providing for income taxes of $492,000) compared with after- tax income from continuing operations of $4,368,000 (after providing for income taxes of $3,256,000) and net income of $4,883,000 (after providing for income taxes of $3,599,000) in 1993. Included in the 1994 results were the following:\n. One-time pre-tax charges totaling $3,074,000. As explained in detail below, the charges consisted of a restructuring charge of $557,000 (or $345,000 after estimated tax benefit of $212,000) and a write-off of goodwill which amounted to $2,517,000 with no corresponding tax benefit.\n. Revenue in the amount of approximately $1,000,000 (or $600,000 after estimated tax provision of $400,000) resulting from a payment from a financial institution client for the right to hire certain JMC employees.\nIncluded in 1993 after-tax income from continuing operations was a one-time pre-tax charge of $575,000 (or $352,000 after estimated tax benefit of $223,000) recorded in the third quarter arising out of an arbitration proceeding with a former bank client. Net income for 1993 included an after- tax gain from disposal of the Company's specialist and securities brokerage businesses of $515,000 (net of applicable income taxes of $343,000). Excluding the above-mentioned items and amortization of goodwill for both periods, the after-tax income from continuing operations would have been $407,000 (after providing for income taxes of $304,000) in 1994 compared to $5,406,000 (after providing for income taxes of $3,479,000) in 1993.\nTotal revenues for 1994 were $33,357,000 compared to revenues of $49,318,000 from continuing operations in 1993, a decrease of $15,961,000 or 32%. Included in 1994 revenues was the previously mentioned one-time payment from a client financial institution. Without this one-time payment, 1994 revenues would have been $32,357,000, a reduction of $16,961,000 or 34% from 1993. This reduction in revenues is primarily attributable to the following:\n. Lower sales volume which declined 37% principally as a result of the changing regulatory environment nationwide and surrounding negative news coverage, changing economic conditions in the financial markets and the reconfiguring of the Company's Florida operations. See \"Trends and Uncertainties--Declining Revenues\". Annuity sales volume decreased 40% while mutual fund sales remained relatively constant.\n.Offset, in part, by:\n. An approximately 3% increase in the gross revenue rate on annuities resulting from an increase in the front commission rate paid on variable annuities in the beginning of the second quarter of 1994. The increase was accomplished by increasing front commissions and reducing trail commissions on an actuarially-equivalent basis. The Company also obtained a slight increase in trail commissions from those previously paid; and\n. A $1,593,000 increase in asset-based fee revenues due to an increase over 1993 in the average accumulated value of assets generating fees.\nTotal expenses for 1994 were $35,235,000 compared to $41,694,000 in 1993. Excluding the previously described one-time charges of $3,074,000 and $575,000 in 1994 and 1993, respectively, total expenses for 1994 would have been $31,646,000 (excluding amortization of goodwill of $515,000) compared to total expenses of $40,433,000 (excluding amortization of goodwill of $686,000) in 1993, a decrease of $8,787,000 or 22%. This drop in total expenses is attributable to the following:\n. A $6,118,000, or 32%, reduction in fees to financial institutions due to lower sales volume;\n. A $2,149,000, or 57%, reduction in salespersons' commissions also due to lower sales volume; and\n. An additional $1,333,000 or 8% reduction in base operating expenses (excluding Florida legal fees) due to management of base operating expenses and the initial impact from the Company's restructuring. See \"Restructuring\".\n. Offset, in part, by an increase of approximately $813,000 in legal fees primarily related to the Florida Department of Insurance administrative proceedings.\nThe percentage decrease in fees to financial institutions in 1994 is less than the percentage decrease in sales volume due to the increase in asset- based fees paid to the financial institutions. Asset-based fees increased due to an increase over 1993 in the average accumulated value of assets generating fees.\nExcluding the one-time charges and non-recurring revenue in 1994, the one- time charge in 1993 and amortization of goodwill for both periods, the Company had pre-tax return on total revenues of 2.2% in 1994 compared to 18.0% in 1993. The principal reason for the reduction in pre-tax return was that the decline in sales volume experienced throughout 1994 occurred more rapidly than the Company was able to effectuate base operating expense reductions. This resulted in a sales production level which only marginally exceeded the minimum production level required to cover its base operating expenses. See \"Restructuring\" and \"Trends and Uncertainties--Declining Revenues\".\nThe Company's gross revenue rate is sensitive to changes in product mix which is impacted by fluctuations in interest rates. Fluctuations in gross revenue rates are not followed by a change in production-based expenses due to contractual obligations with financial institutions. Thus, changes in gross revenue rate will impact the Company's gross margin rate. As interest rates declined in 1993, the product mix moved toward a higher percentage of variable annuities and mutual funds with lower gross revenue rates. This resulted in a decrease in the gross revenue rate. Conversely, during 1994 interest rates increased and during the second half of the year, the amount of fixed annuities as a percentage of annuity sales also increased. As a result, the Company's gross revenue rate increased. If interest rates stabilize or increase further, management believes that the product mix will stabilize and potentially move towards an even higher percentage of fixed rate annuity products, but management is unable to predict interest rate movement and there can be no assurance that product mix will react as management anticipates. During 1994, management negotiated a change in the structure of commission payments it receives on variable annuities. As a result, beginning in the second quarter of 1994, the total compensation rate paid on variable annuities increased.\nRestructuring. During the third quarter of 1994, the Company's Board of Directors approved a restructuring plan which was developed by management to enhance operating efficiencies by streamlining the Company's administrative and sales management functions. The primary reason for the restructuring plan was to bring costs in line with the decline in sales volumes by taking advantage of operating efficiencies. See \"Trends and Uncertainties--Declining Revenues\". The restructuring, which was completed in the fourth quarter of 1994, involved the consolidation of five service centers in Florida into a single center in Tampa, the consolidation of the Company's northern California operations into its corporate offices in San Diego, the centralization of mutual fund processing in San Diego and a reduction in the number of sales managers in relation to active sales people. Approximately 31 administrative employees were terminated as a result of the restructuring.\nDuring the third quarter, the Company recorded one-time restructuring charges in the amount of $557,000. The restructuring charges included current and future cash requirements for severance costs and costs related to premature lease terminations of $64,000 and $280,000, respectively and non- cash expenses of $213,000 associated with the write-off of certain assets. As of December 31, 1994, there was a balance of $295,000 remaining in the restructuring accrual primarily related to premature lease termination costs. Management estimated the Company will incur an additional $200,000 of expenditures related to the revised structure of future operations which were not included in the restructuring charges recorded during the third quarter. These additional expenditures represent the cash outlays related to the expansion of the Tampa and San Diego facilities to accommodate the consolidated operations and the centralization of mutual fund processing. As of February 28, 1995, $150,000 of these additional expenses had been incurred. Management anticipates that most of these additional expenditures, which relate to the purchase of fixed assets and the construction of leasehold improvements, will be capitalized. The cash required to effect the restructuring was, and will continue to be, generated from operations.\nWrite-off of Goodwill. The Company acquired JMC in 1988. The purchase price was determined by an earn-out formula over a period which ended in 1992. The Company allocated to goodwill the excess purchase price over the fair value of the tangible assets acquired. The goodwill was being amortized over a ten-year period which was an estimate of the time during which JMC would have strong earnings potential from the financial institution clients it had at the time of the acquisition.\nDuring the third quarter of 1994, management was notified that JMC's contract with Sacramento Savings would be terminated in the fourth quarter. This contract was in fact terminated effective October 31, 1994. Sacramento Savings was the last significant JMC client remaining from those existing at the time of the 1988 acquisition. This event caused management to conclude that the original amortization period was too long. Accordingly, the Company accelerated its amortization and wrote off $2,517,000 representing the remaining unamortized book value of the goodwill.\nLIQUIDITY AND CAPITAL RESOURCES\nAs of December 31, 1995, the Company had cash and cash equivalents of approximately $5,833,000, an increase of $1,686,000 from $4,147,000 in cash and cash equivalents plus short-term investments at December 31, 1994.\nSignificant sources and uses of such amounts during 1995 included:\n. The net proceeds on the sale of rights to certain future asset-based fees generated approximately $2,348,000 (after providing for taxes of $1,566,000). This sale was effective as of the end of August, in 1995, thus the Company did not receive asset fee revenues related to this business sold for September through December, 1995, which for that period, would have generated approximately $177,000 in income after taxes for the year.\n. The Company recognized $1,309,000 (pre-tax) for the purchase of the right to hire certain JMC personnel. As of December 31,1995, all but $109,000 of this amount had been received (the remaining amount was received in January of 1996). Thus the Company generated $1,200,000 (or $720,000 after providing for taxes) in cash during 1995 related to this transaction.\n. Excluding the above two transactions and the tax effected non-cash expense reflected in the Company's Statement of Operations for 1995 the Company's operations used approximately $1,155,000 during 1995. As previously noted, the Company has reduced operating expenses, however, it was necessary to maintain the Company's Florida operations at a certain level through August, 1995 despite the low sales volumes in order for it to realize the previously noted revenues associated with the transition and termination of its relationship with its Florida financial institution client.\n. The remaining uses of cash of approximately $220,000 are primarily due to the reduction in liability balances from December 31, 1994 to December 31, 1995 and are not related to 1995 operating activities. Such liabilities consisted primarily of payroll related accruals which were paid down as personnel left the Company during the year.\nThe Company's cash needs are affected by its ongoing expenses. These expenses include fees to financial institutions and sales commissions, which fluctuate with sales production volumes (\"production-based expenses\") and other operating expenses, such as employee salaries and rent, which bear no precise correlation to sales volume (\"base operating expenses\"). The Company's base operating expenses were significantly reduced during 1995 due to cost containment and the impact from the Company's restructuring plan initiated in the later part of 1994. Base monthly operating expenses decreased from approximately $1,000,000 in January of 1995 to $600,000 in December of 1995.\nThe Company is actively pursuing new client financial institutions (see explanation of USBA agreement). Management believes that, as new client financial institutions are acquired, the Company will benefit from spreading its base operating expenses over a larger revenue base. However, the exact amount and nature of this benefit cannot be ascertained with any certainty and will depend, in large part, upon the nature of the services provided to new client financial institutions and sales volume generated. Depending upon the nature of these services and sales volume produced, the Company may need to increase base operating expenses from their current levels. In any event, under the new consolidated structure, the Company believes it has the ability to add new clients with significantly reduced start-up costs compared to historical amounts. In addition, the Company will service these new relationships on a more centralized basis to take full advantage of operating efficiencies. In the past, as the Company added new client financial institutions, it would incur between $125,000 to $250,000 in start-up costs to establish a new distribution center, which also resulted in ongoing increased base operating expenses. Management does not anticipate opening a new distribution center for each new client financial institution in the future.\nThe Company sells financial products, primarily annuities and mutual funds. Under its arrangements with the provider companies, the Company earns commissions on each sale and it's entitled to ongoing asset-based fees and 12 B-1 fees on the average accumulated value of assets. Under arrangements with most of its client financial institutions, the Company is also required to pay an asset-based fee which, although varying by product, amounts to approximately two-thirds of the fee earned from its provider companies for as long as the marketing relationship with the financial institution continues. The provisions for payment of asset-based fees to client financial institutions after the termination of the marketing relationship varies from institution to institution and depends upon the manner in which the relationship is terminated. Future fees, both those due from the provider company and those due to financial institution clients, are not reflected as an asset or a liability in the Consolidated Balance Sheets. At December 31,1995, the accumulated value of assets on which the Company receives asset- based fee payments was approximately $890 million (including mutual funds paying 12 B-1 fees). Asset-based fee income and asset-based fees paid to financial institutions amounted to approximately $4,866,000 and $3,068,000, respectively, in 1995. The reduction in these amounts as compared to 1994 is a result of the sale of the rights to asset-based fees generated by the Florida operation at the end of August, 1995. The fourth quarter asset-based fee income and asset-based fees paid to financial institutions amounted to approximately $654,000 and $363,000 respectively. This is reflective of the current levels of asset-based fee revenues and asset-based fees paid to financial institutions after the sale of asset-based fee revenues during the third quarter of 1995.\nDue to the reduction in the Company's base operating expenses as a result of the restructuring and other cost reductions, management expects the Company will meet its operating and capital expenditure needs over the next twelve months. The Company's cash flow from operations in 1996 is expected to approximate net income with the exception of the depreciation and amortization expense (estimated to be approximately $320,000 in 1996). However, in connection with an exclusive Marketing Agreement executed with USBA Holding, LTD., the Company paid out $1.25 million in the first quarter of 1996. This payment is not reflected on the balance sheet as of December 31, 1995.\nTRENDS AND UNCERTAINTIES\nREGULATORY ENVIRONMENT. The Company and its financial institution clients operate in a highly regulated environment. Both state and federal laws govern the manner in which insurance agencies, broker-dealers and financial institutions may make annuities, insurance products and mutual funds available to customers of financial institutions. Recently, federal banking regulators, the Securities and Exchange Commission and the National Association of Securities Dealers, Inc. have focused attention in this area. Changes in, or interpretations of, the laws and regulations governing these activities or changes in the implementation or enforcement of such laws and regulations could affect the ability of, and the means by which, the Company and its financial institution clients make annuities, insurance products and mutual funds available to customers of banks, savings and loan associations and thrifts.\nDECLINING REVENUES. During 1995, the Company experienced a continued decline in sales volume which generated a corresponding decrease in revenues. The primary reason for this decline was the transition and ultimate termination of the Company's relationship with Barnett. This accounted for 81% of the decrease in sales volume. See further explanation of revenue decline in \"Management's Discussion and Analysis of Financial Condition and Results of Operations--Results of Operations--1995 Compared to 1994\".\nManagement believes that interest rate competition also impacted sales volumes and revenues adversely. As long term interest rates declined, the Company's financial institution clients began aggressively pursuing deposit growth to meet loan demand by offering attractive interest rates on bank deposits which compete with the Company's products. Management believes that many conservative investors were attracted to the higher rates on FDIC insured deposits. In addition, as interest rates on fixed annuities came under increasing competition and the stock market rose, the product mix shifted to mutual funds and variable annuity products which provide the opportunity for customers to realize higher returns but pay lower commission rates to the Company. During the first quarter of 1995 the product mix was 65% fixed annuities, 15% variable annuities and 20% mutual funds compared to 17%, 31%, and 52%, respectively, for the fourth quarter of 1995.\nMost of these factors are outside the Company's control and, accordingly, management cannot predict when or if they will change or cease to affect sales volumes and revenues. In 1995, management responded to these events by developing an expanded choice of alternative investment programs for potential bank clients and intensifying its marketing efforts for new client acquisition. In addition, management reduced operating expenses to bring them in line with revenue. See explanation of reduction in expenses in the \"Management's Discussion and Analysis of Financial Condition and Results of Operation--Results of Operations--1995 Compared to 1994 and 1994 Compared to 1993--Restructuring\". In January 1996, the Company announced an exclusive marketing arrangement with USBA. See description of the USBA marketing agreement in Item 1 \"Description of Business--Principal Markets and Methods of Distribution\".\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS\nJMC GROUP, INC. AND SUBSIDIARIES\nCONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nCONTENTS\nINDEPENDENT AUDITORS' REPORT\nWe have audited the accompanying consolidated balance sheets of JMC Group, Inc. and subsidiaries as of December 31, 1995 and 1994 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, 1995. 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 JMC Group, Inc. and subsidiaries at December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles.\n\/s\/ Deloitte & Touche LLP\nSan Diego, California February 20, 1996\nJMC GROUP, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\nThe accompanying notes are an integral part of these financial statements.\nJMC GROUP, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF OPERATIONS\nThe accompanying notes are an integral part of these financial statements.\nJMC GROUP, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY\nThe Company's certificate of incorporation also authorizes 5,000,000 shares of no par value preferred stock, none of which have been issued.\nThe accompanying notes are an integral part of these financial statements.\nJMC GROUP, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nThe accompanying notes are an integral part of these financial statements.\nJMC GROUP, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1. ORGANIZATION AND ACQUISITIONS\nThe consolidated financial statements include the accounts of JMC Group, Inc. (\"JMCG\" or the \"Company\"), its wholly-owned subsidiaries, James Mitchell & Co. (\"JMC\"), and Priority Investment Services, Inc. (\"Priority\") (formerly known as Spear Rees & Co.). The Company is engaged in the business of selling annuities, insurance products, and mutual funds to the customers of banks, savings and loan associations and thrifts. Effective January 25, 1994, Spear Rees & Co. changed its name to Priority. Priority is registered with the Securities and Exchange Commission as a broker-dealer and during 1995 exclusively served customers of First Tennessee Bank National Association and its affiliates and correspondent banks. All significant intercompany transactions and balances have been eliminated in the consolidated financial statements.\nIn 1988, JMCG acquired all of the outstanding stock of JMC in a business combination accounted for by the purchase method of accounting. The total cost of the acquisition exceeded the fair value of the net assets acquired and the excess was allocated to the cost of goodwill which was originally being amortized over ten years. This amortization period was derived from the terms of the contracts that JMC had with its remaining financial institution clients at the time of the acquisition. During the third quarter of 1994, management was notified that JMC's contract with Sacramento Savings Bank (\"SSB\") would be terminated during the fourth quarter of that year. This contract was in fact terminated on October 31, 1994. SSB was the last significant JMC client remaining from those existing at the time of the 1988 acquisition. This event caused management to conclude that the original amortization period was too long. Accordingly, the Company accelerated its amortization and wrote-off $2,516,683 representing the remaining unamortized book value of goodwill during 1994.\nNOTE 2. SIGNIFICANT ACCOUNTING POLICIES\nCash and Cash Equivalents\nThe Company considers cash on hand, cash in banks, and all highly liquid investments purchased with a maturity of three months or less to be cash and cash equivalents.\nShort-Term Investments\nDuring 1994 the Company had a line of credit agreement which required it to maintain a collateral account which had a balance of $536,000 as of December 31, 1994. In December of 1995, the line of credit agreement was terminated; therefore, the collateral account is no longer required.\nCash Segregated Under Securities Regulations\nJMC Financial, a wholly owned subsidiary of JMC and a broker-dealer registered with the SEC and NASD, began self-clearing of mutual fund transactions for itself and Priority at the end of 1994. As such, JMC Financial carries cash balances for customers from the trade date of a mutual fund transaction through the settlement date of such transactions. These cash balances have been segregated in special bank accounts for the benefit of customers under Rule 15C3-3 of the Securities and Exchange Commission. Total deposits in these accounts as of December 31, 1995 are $894,269.\nRevenue Recognition\nThe Company recognizes and records commission revenue when a sale has been consummated. Annuity and insurance sales are deemed to be consummated when proof of premium payment, the completed application and supporting documentation have been received in the Company's distribution\/service center. Mutual fund\nJMC GROUP, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nsales are recorded on the trade date of such sale. Commission revenues for 1995, 1994 and 1993 were $9,447,074, $26,628,216 and $45,117,202, respectively. Annuity and insurance sales commission revenue is reported net of chargebacks. The Company recognizes and records asset-based fee revenues as they become due from the provider companies, based upon the average accumulated value of assets in force. Asset-based fee revenues for 1995, 1994 and 1993 were $4,865,633, $5,519,339 and $3,926,703, respectively.\nAllowance for Contract Cancellations\nThe Company reflects a liability on its balance sheet identified as \"Allowance for Contract Cancellations\". This allowance is a recognition that certain commissions earned by the Company on the sale of annuities and insurance products must be returned to the provider companies when policies are surrendered within the first year after purchase. A formula is used to calculate the returned commission exposure. This formula was developed based on the Company's policy surrender patterns, actual commissions received by month, \"known\" unprocessed surrenders, and the availability of recoveries of client fees and sales personnel commissions.\nNet Gain on Sale of Rights to Certain Future Asset-Based fee Revenue\nDuring the third quarter of 1995 the Company signed an agreement to terminate its Florida operations. As part of the termination agreement, the Florida based financial institution exercised its rights to purchase certain future asset-based revenues from the Company. The Company recorded a net gain of $3,914,350 from the sale. See discussion of Barnett Bank, Inc. at Note 5 and 10.\nOther Income\nFor 1995 and 1994, other income includes payments made by the Company's Florida based financial institution client, for the right to hire certain JMC employees of $1,308,500 and $1,000,000, respectively. In addition, 1995 other income includes fees of $538,200 paid to the Company by the same financial institution to transition the sales operation to the financial institution. Costs incurred by the Company to facilitate such transactions are included in Expenses for the year.\nFurniture, Equipment and Leasehold Improvements\nFurniture and equipment are recorded at cost. Depreciation is provided using the straight line method over the estimated useful lives of the property which range from three to five years. Leasehold improvements, also recorded at cost, are amortized over the lesser of the estimated life of the improvement or the term of the lease.\nAsset-Based Fees Purchased\nDuring 1993, the Company recorded $1,397,129 as a capital asset, which represented the discounted present value of the future asset-based fees acquired by the Company as a result of an arbitration proceeding involving a former bank client. The asset is being amortized over 13 years from the acquisition date which represents the estimated life of the asset-based fees purchased. The unamortized balance of this capital asset as of December 31, 1995 was $979,644.\nFinancial Statement Classification\nCertain reclassifications have been made to the 1994 and 1993 financial statements in order for them to conform to the presentation for 1995.\nJMC GROUP, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nRestructuring\nRestructuring expenses represent costs specifically associated with the Company's restructuring, which was approved in the third quarter of 1994, including employee severance, asset write-downs and lease write-offs for closed offices.\nNOTE 3. REVOLVING LINE OF CREDIT\nAs of December 31, 1994, the Company had available a $500,000 bank line of credit for short-term working capital requirements, which permitted borrowing at the bank's prime rate plus .5%. The line of credit required the Company to maintain a collateral account of $536,000 which was recorded as short-term investments as of December 31, 1994. The line of credit was terminated in December 1995.\nNOTE 4. DISCONTINUED OPERATIONS\nDuring 1993, the Company entered into two separate agreements for the disposition of its specialist and securities brokerage businesses. One agreement was for the sale of TCW, Inc., Spear Investment Services, Inc. and Spear Insurance Services, Inc. to a former officer\/stockholder of the Company for $1,554,017. An outstanding severance liability of $1,193,226 due to the former officer\/stockholder was offset against the sales price of these entities at the time of the disposition. The second agreement was for the sale of the customer accounts of Spear Rees & Co. to a major discount brokerage firm for $3,500,000.\nAmounts related to the dispositions, initially established as of December 31, 1992, were revised and a gain on disposal of securities businesses of $514,904, net of applicable taxes, was recorded during the year ended December 31, 1993.\nNOTE 5. COMMITMENTS AND CONTINGENCIES\nOperating Leases\nThe Company leases office facilities and equipment under the terms of operating leases which expire through 1998. At December 31, 1995 the aggregate minimum annual noncancelable lease commitments are as follows:\nThe above schedule of minimum aggregate rentals represents lease payments on all of the Company's offices as if rents were paid on all offices through their respective lease terms less amounts to be received by the Company for offices which have been subleased.\nAs of January 1, 1996 the Company had three offices which were being subleased. The net obligation on such offices, included in the above minimum aggregate rentals, is included in the remaining restructuring reserve and reserve for discontinued operations, included in accrued restructuring expenses and accrued expenses and other liabilities as of December 31, 1995.\nJMC GROUP, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nLEGAL MATTERS\nOn July 7, 1995, the Florida Department of Insurance (the \"Department\") issued a Final Order in its administrative proceeding against the Company's wholly-owned subsidiary, JMC, which was commenced on March 11, 1993. The enforcement of the majority of the Final Order has been stayed pending the outcome of its appeal and JMC has complied with all other aspects of the Final Order.\nThe Final Order is similar in many respects to the Recommended Order which was issued by an administrative hearing officer in August 1994. The Department found that JMC was not involved in an unlawful association with its Florida financial institution client with regard to the sale of annuities. JMC was ordered to cease and desist from certain advertising and sales practices which the Department found to be in violation of Florida insurance laws regarding deceptive advertising and sales practices. The Final Order also requires JMC to obtain an insurance agency license prior to engaging in any activity which by state law may be performed only by a licensed agent and revokes the Florida insurance license of James K. Mitchell, Chairman and Chief Executive Officer of the Company. No monetary damages or penalties were assessed against JMC or Mr. Mitchell.\nJMC has filed an appeal of the Final Order and intends vigorously to pursue the appeal. The Company has incurred most of the anticipated costs of the appeal and management believes that the amounts accrued as of December 31,1995 will be sufficient to cover any additional costs.\nEffective October 31, 1995, JMC concluded its relationship with its Florida financial institution client, Barnett Banks, Inc., and is not presently doing business in the State of Florida. As described in Note 10, Barnett Bank accounted for revenues of $10,239,630, $20,176,680 and $35,388,162 during 1995, 1994 and 1993, respectively.\nThe Company's broker-dealer subsidiary, Priority (formerly Spear Rees & Co.), has been named as a defendant in lawsuits arising out of the sale of real estate limited partnerships to customers of Spear Rees & Co. and Rees Financial Group, Inc. and Rees Capital Group, Inc. (\"Rees\") prior to 1992. Spear Rees & Co. was a full service brokerage firm which acquired the assets of Rees in September 1991. Subsequent to year-end, the Company reached a settlement with certain of the Plaintiffs in this case, while other claims remain the subject of NASD arbitration. The amounts to be paid subject to Bankruptcy Court approval in the settlement were accrued in the Company's financial statements and are included in accrued expenses and other liabilities as of December 31, 1995. Management does not believe that resolution of the NASD arbitration will have a material adverse effect on the Company.\nIn addition, the Company and its subsidiaries are involved in various legal and regulatory proceedings from time to time in the ordinary course of business. Management does not believe that any such proceedings will have a material adverse effect on the Company's financial condition or results of operation.\nJMC GROUP, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 6. FURNITURE, EQUIPMENT, AND LEASEHOLD IMPROVEMENTS\nFurniture, equipment and leasehold improvements consist of:\nNOTE 7. STOCKHOLDERS' EQUITY\nIn 1994, the Board of Directors authorized the purchase of up to 500,000 shares of the Company's common stock. During 1994, the Company repurchased 326,000 shares of common stock at a total cost of $643,310.\nDuring 1993, the Company repurchased 496,233 shares of common stock at a total cost of $4,646,553. During 1994, a final payment of $1,963,331 was made related to this repurchase of stock.\nIn 1983, the Company adopted a Stock Option Plan (the \"1983 Plan\") pursuant to which options to purchase an aggregate of 1,000,000 shares of common stock could be granted to directors, officers and key employees. The 1983 Plan expired by its terms in November 1993, although there are still options outstanding under the 1983 Plan. In 1993, the Company adopted the 1993 Executive Stock Option Plan (the \"Executive Plan\") pursuant to which options to purchase an aggregate of 750,000 shares of common stock may be granted to officers and directors of the Company and its subsidiaries and the 1993 Employee Stock Option Plan (the \"Employee Plan\") pursuant to which options to purchase an aggregate of 750,000 shares of common stock may be granted to employees of the Company and its subsidiaries (collectively, the \"1993 Plans\" and, together with the 1983 Plan, the \"Plans\"). Under the Plans, incentive stock options, as defined in section 422A of the Internal Revenue Code, or non-qualified stock options may be granted. Non-employee directors receive formula grants of options pursuant to the Executive Plan.\nA summary of changes in outstanding common stock options during 1995, 1994, and 1993 follows:\nJMC GROUP, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nOf the 218,000, 243,000 and 128,000 options granted in 1995, 1994 and 1993 respectively, options granted under the Executive Plan amounted to 152,000 for 1995, 170,000 for 1994 and 37,000 for 1993. Options granted under the Employee Plan amounted to 66,000 in 1995 and 73,000 in 1994. The remaining shares in each of these years were granted under the 1983 Plan. The 512,000 options outstanding at December 31, 1995 became or will become exercisable as follows: 207,500 shares in 1995 and prior; 193,166 in 1996; 82,666 in 1997 and 28,668 in 1998. As of December 31, 1995, options to purchase 546,834 shares had been exercised under the 1983 Plan and options for 101,000 shares were outstanding. As of December 31, 1995, 436,000 shares were available for future grants under the Executive Plan and 653,000 shares were available for future grants under the Employee Plan. As of December 31, 1995, a total of 1,601,000 shares were reserved for issuance under the Plans.\nNOTE 8. EARNINGS PER SHARE\nEarnings per share was computed based upon the weighted average number of shares of common stock and common stock equivalents outstanding during the periods. The weighted average number of shares outstanding was adjusted to reflect the dilutive effect of the assumed exercise of stock options using the treasury stock method.\nThe weighted average number of shares of common stock and common stock equivalents outstanding for the periods presented is as follows: 1995- 6,201,318; 1994-6,494,388; 1993-7,010,004.\nNOTE 9. INCOME TAXES\nThe provision (benefit) for income taxes is allocated as follows:\nThe provisions for income taxes for continuing operations differs from the amount computed using the statutory federal tax rate of 34% as a result of the following:\nJMC GROUP, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nAt December 31, 1995 and 1994, the components of the deferred income tax asset are as follows:\nNOTE 10. MAJOR CUSTOMERS\nDuring the years ended December 31, 1995, 1994 and 1993, the following client financial institutions individually accounted for 10% or more of the Company's total revenues:\nAs described in Note 5, the Company terminated its relationship with Barnett Banks, Inc. effective October 31, 1995.\nAs described in Note 12, effective February 1, 1996, the Company reduced its level of service provided to First Tennessee Bank from a fully-managed alternative investments program to an administrative support program.\nThe Company's current contract with Central Fidelity expires on December 31, 1996, but is subject to termination or may be renewed upon written notice prior to that time.\nNOTE 11. SHAREHOLDER RIGHTS PLAN\nIn 1990, the Company's Board of Directors adopted a Shareholder Rights Plan (the \"Plan\"). The Plan provided for the distribution of one common stock purchase right as a dividend for each outstanding share of common stock of the Company as of April 1, 1990. The right entitles stockholders to buy one share of the Company's common stock at thirty dollars per share, subject to adjustment per the Plan. All rights expire on February 23, 2000.\nGenerally, each right may be exercised ten days after any person or group (\"Acquirer\") acquires beneficial ownership of 20% of the outstanding shares of common stock, or ten days after an Acquirer announces a tender offer or other business combination, which would result in the Acquirer obtaining beneficial ownership of 20% or more of the voting power of the Company, unless such tender offer or acquisition is made with approval of the Board of Directors.\nJMC GROUP, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nUnder certain circumstances, including the acquisition of 25% of the Company's common stock and the occurrence of certain \"self-dealing transactions\" by an Acquirer or certain other 20% holders, all rights holders except the Acquirer may purchase the Company's common stock at approximately 50% of the prevailing market price. Similarly, if the Company is acquired in a merger after the acquisition of specified percentages of the voting power of the Company, and the Acquirer is the resultant corporation, the rights holders with the exception of the Acquirer, may purchase the Acquirer's shares at a similar discount.\nThe Board of Directors may effect the redemption of the rights at any time before the rights become exercisable at a nominal price payable in cash and\/or shares of common stock.\nNOTE 12. SUBSEQUENT EVENTS\nEffective February 1 1996, the Company entered into an agreement with First Tennessee Bank pursuant to which such client has internalized the distribution of annuities and mutual funds. Although the Company will no longer provide a fully-managed alternative investment program to this client, effective with the new agreement, the Company will provide this financial institution administrative support for which it will receive fees based on the number of customers serviced and the amount of transactions processed on a monthly basis. Regardless of the volume administered, the Company will receive a minimum monthly fee of $25,000 through December 31, 1997. For the period from February 1, 1996 through December 31, 1996 the Company and the client bank will share asset-based fees on the block of annuities and mutual funds generated as of January 31,1996 in the same proportion as before the new agreement. Subsequent to that date, the Company will earn a larger portion of the shared fees. Based on this new agreement, no material liabilities were created which would have required an accrual as of December 31, 1995.\nThe Company entered into an agreement with USBA Holdings, LTD (\"USBA\") on January 28, 1996. This agreement was established to provide JMC with access to financial institutions through the consulting and other relationships established by USBA and its subsidiaries. In connection with this transaction, the Company paid USBA $1.25 million on January 28, 1996 to assist in the preparation and implementation of a five year marketing plan focusing on the establishment of relationships with new financial institution clients. The Company has the right to recover $1 million of the amount paid under certain circumstances. In addition, USBA was given warrants to purchase up to 1 million shares of the Company's common stock at $2.50 per share which may be adjusted to approximately $1.44 per share under certain circumstances. The warrants, which are exercisable after January 29, 1997, have an estimated value of $315,000. Amounts associated with this transaction will be deferred and amortized over future benefit periods.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe following table sets forth names and certain other information concerning the Company's Directors and executive officers, as of February 29, 1996:\nInformation with respect to the principal occupation during the past five years of each nominee, each current Director and each executive officer is set forth below. There are no family relationships among Directors or executive officers of the Company.\nJames K. Mitchell became a Director in October 1988 and became Chairman and Chief Executive Officer of the Company on January 1, 1993. Mr. Mitchell is the founder of the Company's principal subsidiary, James Mitchell & Co. In 1973, Mr. Mitchell was a founding officer of Security First Group (now The Holden Group), a financial services firm which pioneered the concept of marketing insurance and annuity products through stock brokerage firms. Before joining that firm, Mr. Mitchell served as Vice President of Marketing for the Variable Annuity Life Insurance Company of Houston, Texas. He attended Portland State University and is a registered Principal with the National Association of Securities Dealers, Inc. (the \"NASD\").\nBrian J. Finneran became President and Chief Operating Officer and a Director of the Company on January 10, 1994. From May 1, 1993 to January 9, 1994, he served as Executive Vice President of the Company, with responsibility for sales and marketing. Mr. Finneran joined James Mitchell & Co. in 1984. Prior to that time, Mr. Finneran was an officer of Security First Group. He also held marketing and management positions with Allstate Insurance Company and Investors Diversified Services (IDS). Mr. Finneran received undergraduate and graduate degrees from Fairfield University and is a registered Principal with the NASD.\nD. Mark Carlson became Senior Vice President of the Company on January 10, 1994. Mr. Carlson joined James Mitchell & Co. in 1990 as Assistant Vice President--Accounting and became Chief Financial Officer of James Mitchell & Co. in January 1991. He became Vice President and Chief Financial Officer of the Company on May 1, 1993. Prior to joining James Mitchell & Co., Mr. Carlson was an audit manager with Steres, Alpert & Carne, a San Diego-based accounting firm, which he joined in 1988 after serving as an audit supervisor with the accounting firm of Arthur Young & Company. Mr. Carlson is a graduate of California Lutheran University, is a certified public accountant and is a registered Financial and Operations Principal with the NASD.\nWilliam L. Webster became Senior Vice President and Chief Administrative Officer of the Company on January 10, 1994. Mr. Webster joined James Mitchell & Co. in June 1993 as Vice President of Operations. Prior to that time, he was Vice President of New Business Administration and Vice President of Information Systems for The Holden Group. In such capacities, Mr. Webster was responsible for the administration of the company's annuity sales business which consisted of over 250,000 accounts representing approximately $4 billion in assets. Prior to joining The Holden Group, Mr. Webster was an Administrative Services Manager with Arthur Andersen & Co. Mr. Webster received his undergraduate degrees from Lehigh University.\nEdward J. Baran became a Director in August 1992. Mr. Baran, who has spent more than thirty years in the insurance business, is currently Chairman and Chief Executive Officer of BCS Financial Corporation, a financial services holding company. Prior to joining BCS in November 1987, Mr. Baran was Vice Chairman, President and Chief Executive Officer of Capitol Life Insurance Company of Denver, Colorado. He is a graduate of Georgetown University and a member of the Compensation Committee of the Board of Directors.\nBarton Beek became a Director in January 1984. Mr. Beek is a senior partner of O'Melveny & Myers, a law firm which he joined in 1955, with offices worldwide. Mr. Beek is a graduate of the California Institute of Technology, the Stanford University Graduate School of Business and Loyola College of Law. Mr. Beek is a director of Wynns International, Inc. He is a member of the Compensation Committee of the Board of Directors.\nCharles H. Black became a Director in June, 1993. Mr. Black is currently a private investor, having most recently served as Vice Chairman of Pertron Controls Corporation. From 1982 to 1985, Mr. Black served as Executive Vice President, Director and Chief Financial Officer of Kaiser Steel Corporation. He served as Executive Vice President and Chief Financial Officer of Great Western Financial Corporation and Great Western Savings and Loan from 1980 to 1982 after having spent over 20 years in various financial and management positions with Litton Industries, Inc., the most recent being Corporate Vice President and Treasurer. Mr. Black is a member of the Board of Governors of the Pacific Stock Exchange and serves as a director of Investment Company of America, AMCAP Fund, Inc., Fundamental Investors, Inc., American Variable Insurance Trust, and The Global Swap Fund, all mutual funds. He also serves as a director of Wilshire Technologies, Inc., in addition to several privately- held corporations. Mr. Black is a graduate of the University of Southern California. He is a member of the Audit Committee of the Board of Directors.\nRobert A. Cervoni became a Director in June 1987. Mr. Cervoni is the Managing Director of Finance and Compliance of Weeden & Co., L.P., a New York Stock Exchange member firm. Weeden & Co., L.P. makes a market in the Company's Common Stock on the NASDAQ National Market System. Mr. Cervoni served as Treasurer and Chief Financial Officer of the Company and its subsidiaries until July 1989. Prior to joining the Company, Mr. Cervoni was Controller of Trading Company of the West. Before joining Trading Company of the West in April 1982, Mr. Cervoni was audit manager with the public accounting firm of Spicer & Oppenheim, formerly Oppenheim, Appel, Dixon & Co., where he specialized in auditing securities brokerage firms and financial institutions. Mr. Cervoni is a certified public accountant and an allied member of and a Registered Financial Principal and Registered Compliance Officer with the New York Stock Exchange. Mr. Cervoni is Chairman of the Audit Committee of the Board of Directors.\nHerbert G. Kawahara became a Director in June 1989. Mr. Kawahara is the former President of the Pacific Stock Exchange, having served in that capacity from January 1988 to May 1989. Previously, Mr. Kawahara had a 29-year career with E.F. Hutton and Company Inc., starting as trainee in 1958 and filling various positions in the retail system. From 1982 to 1987, he served as an Executive Vice President and was the firm's top executive in Southern California. Mr. Kawahara was also a member of the Board of Directors of E.F. Hutton and Company, Inc. from 1982 to 1987. He is a graduate of the University of California at Los Angeles. Mr. Kawahara is Chairman of the Compensation Committee of the Board of Directors.\nRobert G. Sharp became a Director in May 1995. Mr. Sharp retired from his position as President and Chief Executive Officer of Keyport Life Insurance Company in February 1992 after having served in that position since 1979. Mr. Sharp is the past chairman of the National Association for Variable Annuities and a former director of the National Association of Life Companies. Mr. Sharp is a graduate of the California State University at Sacramento and is a registered Principal with the NASD.\nDonald E. Weeden became a Director in February 1987. Since January 1986, Mr. Weeden has been the Chief Executive Officer of Weeden & Co., L.P. Weeden & Co., L.P. makes a market in the Company's Common Stock on the NASDAQ National Market System. Prior to that time, he was Vice President of Moseley, Hallgarten, Estabrook & Weeden Inc. Mr. Weeden is a director of National Semiconductor, Inc. Mr. Weeden is a member of the Compensation Committee of the Board of Directors.\nCOMPLIANCE WITH SECTION 16(A) OF THE SECURITIES EXCHANGE ACT OF 1934\nSection 16(a) of the Securities Exchange Act of 1934 requires 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, NASDAQ and the Pacific Stock Exchange initial reports of ownership and reports of changes in ownership of Common Stock and other equity securities of the Company. Executive officers, Directors and greater than 10% stockholders are required by Securities and Exchange Commission regulations to furnish the Company with copies of all Section 16(a) reports they file.\nSpecific due dates for these reports have been established and the Company is required to identify those persons who failed to timely file these reports. To 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, during the fiscal year ended December 31, 1995 all Section 16(a) filing requirements applicable to its executive officers, Directors and greater than 10% beneficial owners were complied with, except for Donald A. Weeden, who filed his Form 4 on January 12, 1996, which was due on January 10, 1996.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nSUMMARY COMPENSATION TABLE\nThe following table sets forth certain information regarding compensation paid during each of the Company's last three fiscal years to the Company's Chief Executive Officer and the four highest paid executive officers of the Company (the \"named executive officers\"):\n- -------- (1) Disclosure of compensation for fiscal 1993 is not required for Messrs. Sippel and Webster, who were not executive officers of the Company at any time during 1993. Mr. Sippel's position as an executive officer was eliminated in February 1996. (2) Reflects bonuses earned for the respective fiscal year, which in some instances all or a portion of which was paid during the subsequent fiscal year. (3) The Company does not have any outstanding Stock Appreciation Rights (\"SARs\"). (4) Amounts reported for Mr. Mitchell in the \"All Other Compensation\" column include $4,620, $4,620, and $4,497, respectively, for 1995, 1994 and 1993, representing the Company's contributions to its 401(k) Savings Plan on his behalf and $4,829 for 1995 and $4,120 for 1994 and 1993, representing life insurance premiums advanced by the Company pursuant to a split dollar insurance agreement. (5) Salary amount for 1993 includes commission overrides of $171,650. Amounts reported for Mr. Finneran in the \"All Other Compensation\" column include $4,620, $4,620 and $4,497 representing the Company's contributions to its 401(k) Savings Plan on his behalf for 1995, 1994 and 1993, respectively, and $3,922 for 1995, and $3,350 for 1994 and 1993 representing life insurance premiums advanced by the Company pursuant to a split dollar insurance agreement. (6) Represents the Company's contributions to its 401(k) Savings Plan on behalf of the named executive officer. (7) Salary amount includes commission overrides of $25,506 for 1995 and $24,486 for 1994. Amounts reported for Mr. Sippel in the \"All Other Compensation\" column represent the Company's contribution to its 401(k) Savings Plan on his behalf.\nOPTION GRANTS\nThe following table provides information related to grants of options to purchase Common Stock to the named executive officers during the 1995 fiscal year:\n- -------- (1) The Company does not have any outstanding SARs. Each of the options shown vest in two equal installments on December 31, 1995 and June 14, 1996, or all shares may vest immediately under certain circumstances. (2) The 5% and 10% assumed rates of appreciation are mandated by rules of the Securities and Exchange Commission and do not represent the Company's estimate or projection of the future Common Stock price. The potential realizable value was calculated using the closing price of the Common Stock on June 14, 1995, the date of grant, of $1.00 per share. The exercise price was also determined by using the closing price of the Common Stock on that date.\nOPTION EXERCISES AND FISCAL YEAR-END OPTION VALUES\nThe following table provides information related to options exercised by the named executive officers during the 1995 fiscal year and the number and value of options held at fiscal year-end.\n- -------- (1) The Company does not have any outstanding SARs. (2) The closing price for the Common Stock on December 29, 1995, as reported by the NASDAQ National Market System, was $0.906. All of the named executive officers' outstanding options were exercisable for a price greater than $0.906 at fiscal year end.\nCOMPENSATION OF DIRECTORS\nThe members of the Board of Directors who are not full-time employees of the Company are entitled to receive reimbursement for out-of-pocket expenses they incur in attending Board meetings and otherwise performing their duties and receive fees of $1,000 for each meeting of the Board of Directors which they attend. Members of committees additionally receive $500 per committee meeting held on the same day as a Board of Directors' meeting, or $1,000 per committee meeting if held on a different day. Committee chairpersons receive an additional $500 per committee meeting. Non-employee Directors receive formula grants of non-qualified\nstock options under the Company's 1993 Executive Stock Option Plan. Options to acquire 12,000 shares of Common Stock are to be granted within six months after an individual takes office as a Director and options to acquire an additional 12,000 shares are to be granted within six months after every third anniversary of such Director's taking office. Officers of the Company are not compensated for their services as Directors or committee members.\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\nNo member of the Compensation Committee of the Board of Directors served as an officer or employee of the Company or its subsidiaries. No executive officers of the Company served during fiscal 1995 on the board of directors of any company which had a representative on the Company's Board of Directors. No member of the Company's Board of Directors served during 1995 as an executive officer of a company whose board of directors had a representative from the Company or the Company's Board of Directors.\nBOARD COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION\nThe Company's Compensation Committee (the \"Committee\") is composed entirely of independent members of the Board of Directors. During fiscal year 1995, this Committee met three times, February 13, April 18 and June 6,1995. The Committee recommends executive compensation policy and practice to the Board of Directors and administers the Company's 1993 Executive Stock Option Plan. The Board of Directors did not modify or reject in any material way any action or recommendation of the Committee during fiscal year 1995.\nThe Committees compensation policy with regards to the Company's executive officers has been to provide these officers, in aggregate, with salary and incentive compensation competitive with the marketplace. Compensation has primarily consisted of salaries, stock options and cash bonuses based upon the Company's pre-tax earnings. No executive is currently a party to an employment contract. For the first three months of 1995 the salary of the Chief Executive Officer remained fixed at $284,427 by a past employment agreement which expired on January 1, 1996, but from April 1, he voluntarily reduced his salary by 20% to an annual rate of $225,000. The President similarly reduced his salary by 20%.\nThe Committee at its February 6, 1996 meeting considered the reporting operating results for 1995 and recognized that when the net gain on sale of rights to certain future asset fee revenue were not included, there was a net operating loss for that year. Therefore, although the Committee felt that management during the year had acted appropriately in attempting to maintain revenues and reducing costs in a very difficult industry environment, it decided not to award any cash bonuses to the Chief Executive Officer or the other executive officers. However, the committee did reinstate the salaries of the Chief Executive Officer as well as the President to the annual salary rates earned prior to the 1995 salary reductions as of February 1, 1996.\nWhile there is no established policy with respect to the frequency or amount of options grants, the Committee desires that the executive officers own Company stock to both provide incentive compensation based on performance factors deemed important to the Company's stockholders and to provide an element of downside risk to more closely align the interests of executives with the interests of the stockholders. The Committee considers the granting of stock options annually and, in reviewing the Chief Executive Officers recommendation, considers the individual executive officers contributions to the Company and the amount and terms of existing options. The grants of options made by the Committee on June 6, 1995 covering approximately 80,000 shares at an average exercise price of $1.00 were based solely upon the recommendations of the Chief Executive Officer who desired to continue to provide key executives with stock options to encourage retention in light of a reduction in their salaries from mid year and to reinforce the objectives of the Committee as articulated above. The options granted were to four executives other than the Chief Executive Officer and President and represented less than two percent of the outstanding Common Stock.\nAs noted above, Mr. Mitchell's compensation as Chairman and Chief Executive Officer of the Company was governed by the terms of a written Employment Agreement for the first three months of 1995. Mr. Mitchell, who became Chief Executive Officer of the Company effective January 1, 1993, received a total of $248,664 in salary for fiscal 1995. This compares to a $280,500 salary and a $42,075 bonus for a total of $322,575, exclusive of standard benefits in 1994. This also compares to $275,000 salary and $267,027 bonus for a total of $542,027 in 1993. At the close of 1995, Mr. Mitchell was the largest stockholder of the Company with a total of 703,607 shares.\nThe report of the Committee shall not be deemed incorporated by reference by any general statement incorporating by reference this Proxy Statement into filing under the Securities Act of 1993 or under the Securities Exchange Act of 1934, except to the extent that the Company specifically incorporates this information by reference, and shall not otherwise be deemed filed under such Acts.\nHerbert G. Kawahara, Chairman of the Compensation Committee Edward J. Baran Barton Beek Donald E. Weeden\nPERFORMANCE GRAPH\nThe following chart compares the yearly percentage change in the cumulative total stockholder return on the Company's Common Stock during the five fiscal years ended December 31, 1995 with the cumulative total return on the S&P 500 Index and the NASDAQ Financial Stocks Industry Index.\n[GRAPH APPEARS HERE]\nThe foregoing information shall not be deemed incorporated by reference by any general statement incorporating by reference this Form 10-K into any filing under the Securities Act of 1933 or under the Securities Exchange Act of 1934, except to the extent the Company specifically incorporates this information by reference, and shall not otherwise be deemed filed under such Acts.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nUnless otherwise noted below, the following table presents certain information with respect to the ownership of the Common Stock as of February 29, 1996 by each person known by the Company to own beneficially more than 5% of the Common Stock, by each person who is a Director or nominee for Director of the Company, by each named executive officer and by all executive officers and Directors of the Company as a group:\n- -------- * Less than 1% (1) All ownership figures include options to purchase shares of Common Stock exercisable within 60 days of February 29, 1996, as set forth below. Except as otherwise noted below, each individual, directly or indirectly, has sole or shared voting and investment power with respect to the shares listed. (2) Includes 8,600, 8,549, 6,304, 7,222, 1,836 and 32,511 vested shares of Common Stock contributed by the Company to the Company's 401(k) Savings Plan for Messrs. Mitchell, Finneran, Carlson, Sippel, Webster and for all executive officers and Directors as a group, respectively. (3) Includes options to purchase 25,000, 30,000, 25,000, 15,000, 13,334, 12,000, 16,000, 8,000, 16,000, 12,000, 12,000 and 184,334 shares of Common Stock for Messrs. Mitchell, Finneran, Carlson, Sippel, Webster, Baran, Beek, Black, Cervoni, Kawahara, Weeden and for all executive officers and Directors as a group, respectively. (4) Information is as of March 13,1996. Each of Messrs. Smith, McAree and Tryforos beneficially own the shares shown in his capacity as investment manager for three private investment limited partnerships of which he is a general partner. (5) Includes 22,800 shares held by the Charles H. Black Pension Trust and 14,000 shares held by Mr. Black as trustee for the benefit of Richard S. Black, Charles H. Black, Jr., and Mr. Black in which Mr. Black has a 1\/3 beneficial ownership interest. Also includes 36,200 shares owned individually by Mr. Black's wife as to which he disclaims beneficial ownership. (6) Includes 3,000 shares held by Weeden & Co., L.P., of which Mr. Weeden is Chief Executive Officer. (7) Includes 184,334 shares issuable upon exercise of stock options.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nNot applicable.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES, AND REPORTS ON FORM 8-K\n(a)(1)The following documents are filed herewith:\nIndependent Auditors' Report\nConsolidated Balance Sheets as of December 31, 1995 and 1994\nConsolidated Statements of Operations For the Years Ended December 31, 1995, 1994 and 1993\nConsolidated Statements of Changes in Stockholders' Equity For the Years Ended December 31, 1995, 1994 and 1993\nConsolidated Statements of Cash Flows For the Years Ended December 31, 1995, 1994 and 1993 Notes to Consolidated Financial Statements\n(a)(2)Not applicable.\n(a)(3)The following exhibits are filed herewith:\n(b) No current reports on Form 8-K were filed by the Company during the fourth quarter of fiscal year 1995. - -------- * Filed as an exhibit to the Registrant's Form 10-k for the Fiscal Year ended December 31, 1993. ** Filed as an exhibit to the Registrant's Form S-8 Registration Statement No. 33-74842 filed with the SEC on February 7, 1994. *** Filed as an exhibit to the Registrant's Form S-8 Registration Statement No. 33-74840 filed with the SEC on February 7, 1994. **** Filed as an exhibit to the Registrant's Form 10-k for the Fiscal Year ended December 31, 1994. m Management Contract or Compensatory Plan or Arrangement.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in Los Angeles, California, on the 25th day of March, 1996\nJMC GROUP, INC.\nBy: \/s\/ James K. Mitchell ---------------------------------- James K. 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 dates indicated.\nSIGNATURE TITLE DATE\n\/s\/ James K. Mitchell Chairman and Chief Executive March 25, 1996 - --------------------- Officer James K. Mitchell\n\/s\/ D. Mark Carlson Chief Financial Officer and March 25, 1996 - --------------------- Principal Accounting Officer D. Mark Carlson\n\/s\/ Edward J. Baran Director March 25, 1996 - --------------------- Edward J. Baran\n\/s\/ Charles H. Black Director March 25, 1996 - --------------------- Charles H. Black\n\/s\/ Robert Cervoni Director March 25, 1996 - --------------------- Robert Cervoni\n\/s\/ Brian J. Finneran Director March 25, 1996 - --------------------- Brian J. Finneran\n\/s\/ Herbert Kawahara Director March 25, 1996 - --------------------- Herbert Kawahara\n\/s\/ Robert G. Sharp Director March 25, 1996 - --------------------- Robert G. Sharp\n\/s\/ Donald E. Weeden Director March 25, 1996 - --------------------- Donald E. Weeden","section_15":""}
{"filename":"44570_1995.txt","cik":"44570","year":"1995","section_1":"Item 1. Business\nBUSINESS OF ENTERGY\nGeneral\nEntergy Corporation was originally incorporated under the laws of the State of Florida on May 27, 1949. On December 31, 1993, Entergy Corporation merged with and into Entergy-GSU Holdings, Inc., a Delaware corporation, which then changed its name to Entergy Corporation. Entergy Corporation is a public utility holding company registered under PUHCA and does not own or operate any significant assets other than the stock of its subsidiaries. Entergy Corporation owns all of the outstanding common stock of five domestic retail operating electric utility subsidiaries, AP&L, GSU, LP&L, MP&L, and NOPSI. AP&L was incorporated under the laws of the State of Arkansas in 1926; GSU was incorporated under the laws of the State of Texas in 1925; LP&L and NOPSI were incorporated under the laws of the State of Louisiana in 1974 and 1926, respectively; and MP&L was incorporated under the laws of the State of Mississippi in 1963. As of December 31, 1995, the Operating Companies provided electric service to approximately 2.4 million customers in the States of Arkansas, Louisiana, Mississippi, Tennessee, and Texas. In addition, GSU furnishes natural gas utility service in the Baton Rouge, Louisiana area, and NOPSI furnishes natural gas utility service in the New Orleans, Louisiana area. GSU produces and sells, on a nonregulated basis, process steam and by-product electricity supplied from its steam electric extraction plant to a large industrial customer. The business of the Operating Companies is subject to seasonal fluctuations with the peak period occurring during the third quarter. During 1995, the System's electric sales as a percentage of total System electric sales were: residential - - - - - 26.8%; commercial - 20%; and industrial - 40.8%. Electric revenues from these sectors as a percentage of total System electric revenues were: 35.6% - residential; 24.4% - commercial; and 29.6% - industrial. Sales to governmental and municipal sectors and to nonaffiliated utilities accounted for the balance of energy sales. The System's major industrial customers are in the chemical processing, petroleum refining, paper products, and food products industries.\nEntergy Corporation also owns directly all of the outstanding common stock of the following subsidiary companies: System Energy, Entergy Services, Entergy Operations, Entergy Power, Entergy Enterprises, Entergy S.A., Entergy Argentina S.A., Entergy Argentina S.A., Ltd., Entergy Power Development Corporation, Entergy Transener S.A., Entergy Power Marketing Corporation, Entergy Power Development International Holdings, Inc., and Entergy Power Development International Corporation. System Energy is a nuclear generating company that was incorporated under the laws of the State of Arkansas in 1974. System Energy sells at wholesale the capacity and energy from its 90% interest in Grand Gulf 1 to its only customers, AP&L, LP&L, MP&L, and NOPSI (see \"CAPITAL REQUIREMENTS AND FUTURE FINANCING - Certain System Financial and Support Agreements - Unit Power Sales Agreement,\" below). System Energy has approximately a 78.5% ownership interest and an 11.5% leasehold interest in Grand Gulf 1. Entergy Services, a Delaware corporation, provides general executive, advisory, administrative, accounting, legal, engineering, and other services to the Operating Companies, generally at cost. Entergy Operations, a Delaware corporation, is a nuclear management company that operates ANO, River Bend, Waterford 3, and Grand Gulf 1, subject to the owner oversight of AP&L, GSU, LP&L, and System Energy, respectively. Entergy Power, a Delaware corporation, is an independent power producer that owns 809 MW of generating capacity and markets its capacity and energy in the wholesale market and in other markets not otherwise presently served by the System. (For further information on regulatory proceedings related to Entergy Power, see \"RATE MATTERS AND REGULATION - - - - - Rate Matters - Wholesale Rate Matters - Entergy Power,\" below). Entergy Enterprises is a nonutility company incorporated under Delaware law that invests in and develops energy-related projects and other businesses that are or may be of benefit to the System's utility business (see \"Domestic and Foreign Energy-Related Investments,\" below). Entergy Enterprises also markets outside the System technical expertise, products, and services developed by the Operating Companies that have commercial value beyond their use in the System's operations and provides services to certain nonutility companies in the System. Entergy Corporation also has subsidiaries that participate in utility projects located outside the System's retail service territory, both domestically and internationally. See \"Domestic and Foreign Energy- Related Investments\" and \"CitiPower Acquisition,\" below) for a discussion of these subsidiaries.\nAP&L, LP&L, MP&L, and NOPSI own 35%, 33%, 19%, and 13%, respectively, of all the common stock of System Fuels, a non-profit subsidiary incorporated in Louisiana that implements and\/or maintains certain programs to procure, deliver, and store fuel supplies for the Operating Companies.\nGSU has four wholly owned subsidiaries: Varibus Corporation, GSG&T, Inc., Southern Gulf Railway Company, and Prudential Oil & Gas, Inc. Varibus Corporation operates intrastate gas pipelines in Louisiana, which are used primarily to transport fuel to two of GSU's generating stations. GSG&T, Inc. owns the Lewis Creek Station, a gas- fired generating plant, which is leased to and operated by GSU. Southern Gulf Railway Company owns and will operate several miles of rail track being constructed in Louisiana for the purpose of transporting coal for use as a boiler fuel at Nelson Unit 6. Prudential Oil & Gas, Inc., which was formerly in the business of exploring, developing, and operating oil and gas properties in Texas and Louisiana, is presently inactive.\nEntergy Corporation-GSU Merger\nOn December 31, 1993, GSU became a wholly owned subsidiary of Entergy Corporation. As consideration to GSU's shareholders, Entergy Corporation paid $250 million in cash and issued 56,695,724 shares of its common stock, based upon a valuation of $35.8417 per share, in exchange for outstanding shares of GSU common stock.\nUnless otherwise noted, consolidated financial position and statistical information contained in this report for the years ended December 31, 1995, 1994, and 1993 (such as assets, liabilities, and property) includes the associated GSU amounts. Consolidated financial results and statistical information (such as revenues, sales, and expenses) for the years ended December 31, 1995 and 1994 includes such GSU amounts, while periods ending before January 1, 1994, do not include GSU amounts; those amounts are presented separately for GSU in this report.\nCertain Industry and System Challenges\nThe System's business is affected by various challenges and issues, many of which confront the electric utility industry generally. These issues and challenges include:\n- responding to an increasingly competitive environment (see \"MANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS - SIGNIFICANT FACTORS AND KNOWN TRENDS\");\n- addressing current and proposed structural changes in the electric utility industry and changes in the regulation of generation and transmission of electricity (see \"MANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS - SIGNIFICANT FACTORS AND KNOWN TRENDS\");\n- achieving cost savings anticipated with the Merger;\n- complying with regulatory requirements with respect to nuclear operations (see \"RATE MATTERS AND REGULATION - Regulation - Regulation of the Nuclear Power Industry,\" below) and environmental matters (see \"RATE MATTERS AND REGULATION - Regulation - Environmental Regulation,\" below);\n- resolving GSU's major contingencies, including potential write-offs and refunds related to River Bend (see \"RATE MATTERS AND REGULATION - Rate Matters - Retail Rate Matters - GSU,\" below), litigation with Cajun relating to its ownership interest in River Bend, and Cajun's bankruptcy proceedings (see \"RATE MATTERS AND REGULATION - Regulation - Other Regulation and Litigation - Cajun - River Bend Litigation,\" below); and\n- implementing a new accounting standard that describes the circumstances in which assets are determined to be impaired, which may eventually be applied to \"stranded costs\" (costs not recoverable from those customers for whose benefit the costs were incurred) resulting from increased competition (see \"MANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS - SIGNIFICANT FACTORS AND KNOWN TRENDS,\");\n- achieving high levels of operating efficiencies, cost control, and returns on investments in Entergy Corporation's growing portfolio of non utility and overseas business ventures (see \"Domestic and Foreign Energy-Related Investments\" and \"CitiPower Acquisition,\" below).\nDomestic and Foreign Energy-Related Investments\nEntergy Corporation seeks opportunities to expand its energy- related businesses that are not regulated by state and local regulatory authorities (nonregulated businesses). These nonregulated businesses currently include power development and new technology related to the utility business. Entergy Corporation's strategy is to identify and pursue nonregulated business opportunities that have the potential to earn a greater return than its regulated utility operations. Entergy Corporation has expanded its investments in nonregulated business opportunities overseas as well as in the United States. Through the end of 1995, Entergy Corporation had participated in foreign non- regulated electric ventures in Pakistan, Argentina, and Peru. As of December 31, 1995, Entergy Corporation had invested $555.5 million in equity capital (reduced by accumulated losses of $169 million) in nonregulated businesses. See the discussion below of Entergy Corporation's acquisition of CitiPower on January 5, 1996.\nDuring 1995, Entergy Corporation's nonregulated businesses activities included the following:\n(1) Entergy Power's $246.7 million debt obligation to Entergy Corporation was converted into equity in April 1995. Entergy Power sells capacity and energy from its 100% and 31.5% interest in Ritchie 2 and Independence 2, respectively. Entergy Power purchased an interest in these plants from AP&L in 1990. Entergy Corporation originally financed Entergy Power principally with a loan to Entergy Power. Entergy Power was formed to compete with other utilities and independent power producers in the bulk power market.\n(2) In April 1995, Entergy Systems and Service, Inc. (Entergy SASI) and Systems and Service International, Inc. (SASI), amended their existing distribution agreement. As a result, Entergy SASI liquidated its equity interest in SASI. Previously, Entergy SASI, a subsidiary of Entergy Enterprises, held a 9.95% equity interest in SASI, a manufacturer of efficient lighting products. Entergy SASI distributes such products purchased under a distribution agreement with SASI, in conjunction with providing various energy management services to its customers. The amended distribution agreement discussed above provided for a reduction in SASI's profit margin on its sale of products to Entergy SASI and transferred the rights to certain of SASI's energy efficient technologies to Entergy SASI. In exchange, among other things, Entergy SASI transferred to SASI all of its equity ownership in SASI.\n(3) In June 1995, Entergy Corporation contributed $125 million in equity capital to Entergy SASI through Entergy Enterprises, Inc., thus allowing Entergy SASI to retire its debt obligation to Entergy Corporation. Entergy Corporation had previously provided loans to Entergy SASI to fund Entergy SASI's business expansion.\n(4) As of December 31, 1995, Entergy Enterprises wrote down its equity interest in First Pacific Networks (FPN), a communications company, by $9.3 million to reflect what management believes is a permanent decline in market value. Entergy Enterprises holds a 7.9% equity interest in FPN. The total cost of Entergy Enterprises' investment in FPN as of December 31, 1995, was approximately $1.2 million.\n(5) In June 1995, Entergy Corporation received SEC authorization to invest up to $350 million through December 31, 1997, in Entergy Enterprises. Such investments may take the form of purchases of common stock, capital contributions, loans, and\/or guarantees of indebtedness or other obligations of Entergy Enterprises or certain of its affiliated companies. In January 1995 Entergy Corporation guaranteed $65 million of EP Edegel, Inc., a subsidiary of Entergy Corporation, obligations.\n(6) In 1995, Entergy Corporation has requested approval from the SEC to form a new nonregulated subsidiary named Entergy Technologies Company (ETC). ETC would offer bulk interstate telecommunications service to telecommunications carriers which in turn would market that service to third parties. The recently enacted Telecommunications Reform Act of 1996 permits Entergy to market such a service, pending state and local regulatory approval. See MANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS - SIGNIFICANT FACTORS AND KNOWN TRENDS for a discussion of the Telecommunications Act of 1996 and its impact on Entergy.\n(7) During the third quarter of 1995, Entergy Corporation's subsidiary, Entergy S.A., purchased 3.9% of the outstanding stock of the Central Buenos Aires Project (CBA Project) for $1.7 million. Entergy S.A., owns a 10% interest in a consortium with other nonaffiliated companies that acquired a 60% interest in Central Costanera, S.A. (Costanera), a steam electric generating facility located in Argentina. Through Entergy S.A.'s interest in Costanera, Entergy S.A. indirectly purchased an additional 3% of the outstanding stock of the CBA Project. In October 1995, Entergy Power Holding Limited, a wholly owned subsidiary of Entergy Corporation, purchased Entergy S.A.'s interest in the CBA Project and purchased an additional 3.9% of the outstanding stock of the CBA Project for $1.9 million. The CBA Project includes the addition of a 220 MW combustion turbine and heat recovery boiler to a generating unit at the Costanera steam electric generating facility. This addition will provide electricity to the Argentina transmission grid and steam to the Costanera generating unit. The open cycle portion of the CBA Project, providing electricity to the Argentina grid, was placed into operation at the end of October 1995. The steam recovery portion, which will provide steam to the Costanera generating unit, is expected to be in operation in October 1996.\n(8) On November 30, 1995, Entergy Corporation's subsidiary, Entergy Power Development Corporation, purchased through a consortium 20.8% of Edegel, S.A. for $100 million in equity and $65 million of debt guaranteed by Entergy Corporation. Edegel S.A. is a privatization project in Lima, Peru consisting of 5 hydroelectric generation stations (totaling 539 MW) and one thermal station (154 MW) supporting 345 miles of transmission lines. An additional 100 MW of thermal load capacity is required to be installed within one year. The additional plant is expected to be financed by Edegel S.A.\n(9) In early October 1995, FERC issued an order granting exempt wholesale generator status to Entergy Power Marketing Corporation (EPM), a wholly owned subsidiary of Entergy Corporation. EPM was created during 1995 to become a buyer and seller of electrical energy and its generating fuels. In February 1996, FERC approved market-based rate sales of electricity by EPM. Such approval will allow EPM to begin providing wholesale customers with a variety of products including physical and financial trading. Pending approval from the SEC, EPM expects to begin financial trading by the summer of 1996.\nEntergy Corporation's net investment in nonregulated subsidiaries, reduced by accumulated losses, as of December 31, 1995 and 1994, is as follows:\nNet Investment Nonregulated Subsidiary 1995* 1994 ----------------------- --------- -------- (In Millions)\nEntergy Power Development $ 180.6 $ 80.8 Corporation Entergy Power, Inc. 173.1 154.4 Entergy Enterprises, Inc. 112.0 22.2 Entergy Argentina S.A., Ltd. 42.0 41.1 Entergy Transener 19.0 22.7 Entergy Argentina 17.4 17.1 Entergy S.A. 11.4 13.3 -------- -------- Total $ 555.5 $351.6 ======== =======\n* Excludes Entergy Corporation's equity investment in CitiPower completed on January 5, 1996. See \"CitiPower Acquisition\" below.\nIn 1995, Entergy Corporation's nonregulated investments reduced consolidated net income by approximately $64.8 million. In the near term, these investments are unlikely to have a positive effect on Entergy Corporation's earnings, but management believes that these investments will contribute to future earnings growth. Certain of these investments may involve a higher degree of risk than domestic regulated utility enterprises.\nInternational operations are subject to the risks inherent in conducting business abroad, including possible nationalization or expropriation, price and currency exchange controls, limitations on foreign participation in local energy-related enterprises, and other restrictions. Changes in the relative value of currencies occur from time to time and their effects may be favorable or unfavorable on results of operations. In addition, there are exchange control restrictions in certain countries relating to repatriation of earnings.\nCitiPower Acquisition\nOn January 5, 1996, Entergy Corporation finalized its acquisition of CitiPower, an electric distribution company serving Melbourne, Australia, and surrounding suburbs. The purchase price of CitiPower was approximately $1.2 billion, of which $294 million represented an equity investment by Entergy Corporation, and the remainder represented debt. Entergy Corporation funded the majority of the equity portion of the investment by using $230 million of its $300 million line of credit. CitiPower serves approximately 234,500 customers, the majority of which are commercial customers. At the time of the acquisition, CitiPower had 846 employees.\nSelected Data\nSelected domestic customer and sales data for 1995 are summarized in the following tables:\n1995 - Selected Electric Energy Sales Data\nNOPSI sold 16,782,805 MCF of natural gas to retail customers in 1995. Revenues from natural gas operations for each of the three years in the period ended December 31, 1995, were material for NOPSI, but not material for the System (see \"INDUSTRY SEGMENTS\" below for a description of NOPSI's business segments).\nGSU sold 6,476,496 MCF of natural gas to retail customers in 1995. Revenues from natural gas operations for each of the three years in the period ended December 31, 1995, were not material for GSU.\nSee \"ENTERGY CORPORATION AND SUBSIDIARIES SELECTED FINANCIAL DATA - - - - - FIVE-YEAR COMPARISON,\" and \"SELECTED FINANCIAL DATA - FIVE-YEAR COMPARISON OF AP&L, GSU, LP&L, MP&L, NOPSI, and SYSTEM ENERGY,\" (which follow each company's financial statements in this report) for further information with respect to operating statistics.\nEmployees\nAs of December 31, 1995, Entergy had 13,521 employees as follows:\nFull-time: Entergy Corporation - AP&L 1,647 GSU 1,833 LP&L 1,082 MP&L 892 NOPSI 489 System Energy - Entergy Operations 4,102 Entergy Services 2,529 Other Subsidiaries 869 ------ Total Full-time 13,443 Part-time 78 ------ Total Entergy System 13,521 ====== Competition\nRefer to \"MANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS - SIGNIFICANT FACTORS AND KNOWN TRENDS\" for a detailed discussion of competitive challenges Entergy faces in the utility industry.\nCAPITAL REQUIREMENTS AND FUTURE FINANCING\nConstruction expenditures by company (including environmental expenditures, which are immaterial, and AFUDC, but excluding nuclear fuel) for the period 1996-1998 are estimated as follows:\nNo significant construction costs are expected in connection with the System's generating facilities. Actual construction costs may vary from these estimates because of a number of factors, including changes in load growth estimates, changes in environmental regulations, modifications to nuclear units to meet regulatory requirements, increasing costs of labor, equipment and materials, and cost of capital. In addition to construction expenditure requirements, the System must meet scheduled long-term debt and preferred stock maturities and cash sinking fund requirements. See Notes 4, 5, and 6 to the financial statements for further capital requirements and financing information.\nEntergy Corporation's primary capital requirements are to invest periodically in, or make loans to, its subsidiaries and to invest in new energy-related enterprises. See \"MANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS - LIQUIDITY AND CAPITAL RESOURCES,\" for additional discussion of Entergy Corporation's current and future planned investments in its subsidiaries and financial sources for such investments. One source of funds for Entergy is dividend distributions from its subsidiaries. Certain events could limit the amount of these distributions. Such events include River Bend rate appeals and pending litigation with Cajun. Substantial write-offs or charges resulting from adverse rulings in these matters could adversely affect GSU's ability to continue to pay dividends. See Notes 2 and 8 to the financial statements regarding River Bend rate appeals and pending litigation with Cajun.\nCertain System Financial and Support Agreements\nUnit Power Sales Agreement (AP&L, LP&L, MP&L, NOPSI, and System Energy)\nThe Unit Power Sales Agreement allocates capacity and energy from System Energy's 90% ownership and leasehold interests in Grand Gulf 1 (and the related costs) to AP&L (36%), LP&L (14%), MP&L (33%), and NOPSI (17%). AP&L, LP&L, MP&L, and NOPSI make payments to System Energy for their respective entitlements of capacity and energy on a full cost-of-service basis regardless of the quantity of energy delivered, so long as Grand Gulf 1 remains in commercial operation. Payments under the Unit Power Sales Agreement are System Energy's only source of operating revenues. The financial condition of System Energy depends upon the continued commercial operation of Grand Gulf 1 and the receipt of payments from AP&L, LP&L, MP&L, and NOPSI. Payments made by AP&L, LP&L, MP&L, and NOPSI under the Unit Power Sales Agreement are generally recovered through rates. In the case of AP&L and LP&L, payments are also recovered through sales of electricity from their respective retained shares of Grand Gulf 1. See Note 1 to the financial statements for further information regarding retained shares.\nAvailability Agreement (AP&L, LP&L, MP&L, NOPSI, and System Energy)\nThe Availability Agreement among System Energy and AP&L, LP&L, MP&L, and NOPSI was entered into in 1974 in connection with the financing by System Energy of Grand Gulf. The agreement provided that System Energy would join in the agreement among AP&L, LP&L, MP&L, and NOPSI for the sharing of generating capacity and other capacity and energy resources on or before the date on which Grand Gulf 1 was placed in commercial operation. It also provided that System Energy would make available to AP&L, LP&L, MP&L, and NOPSI all capacity and energy available from System Energy's share of Grand Gulf.\nAP&L, LP&L, MP&L, and NOPSI also agreed severally to pay System Energy monthly for the right to receive capacity and energy available from Grand Gulf in amounts that (when added to any amounts received by System Energy under the Unit Power Sales Agreement, or otherwise) would at least equal System Energy's total operating expenses for Grand Gulf (including depreciation at a specified rate) and interest charges.\nAs amended to date, the Availability Agreement provides that:\n- the obligations of AP&L, LP&L, MP&L, and NOPSI for payments for Grand Gulf 1 become effective upon commercial operation of Grand Gulf 1 on July 1, 1985;\n- the sale of capacity and energy generated by Grand Gulf may be governed by a separate power purchase agreement among System Energy and AP&L, LP&L, MP&L, and NOPSI;\n- the September 1989 write-off of System Energy's investment in Grand Gulf 2, amounting to approximately $900 million, will be amortized for Availability Agreement purposes over 27 years rather than in the month the write-off was recognized on System Energy's books; and\n- the allocation percentages under the Availability Agreement are fixed as follows: AP&L - 17.1%; LP&L - 26.9%; MP&L - 31.3%; and NOPSI - 24.7%.\nAs noted above, the Unit Power Sales Agreement provides for different allocation percentages for sales of capacity and energy from Grand Gulf 1. However, the allocation percentages under the Availability Agreement remain in effect and would govern payments made under such agreement in the event of a shortfall of funds available to System Energy from other sources, including payments by AP&L, LP&L, MP&L, and NOPSI to System Energy under the Unit Power Sales Agreement.\nSystem Energy has assigned its rights to payments and advances from AP&L, LP&L, MP&L, and NOPSI under the Availability Agreement as security for its first mortgage bonds and reimbursement obligations to certain banks providing the letters of credit in connection with the equity funding of the sale and leaseback transactions described in Note 9 to the financial statements under \"Sale and Leaseback Transactions - Grand Gulf 1 Lease Obligations (System Energy).\" In these assignments, AP&L, LP&L, MP&L, and NOPSI further agreed that, in the event they were prohibited by governmental action from making payments under the Availability Agreement (if, for example, FERC reduced or disallowed such payments as constituting excessive rates), they would then make subordinated advances to System Energy in the same amounts and at the same times as the prohibited payments. System Energy would not be allowed to repay these subordinated advances so long as it remained in default under the related indebtedness or in other similar circumstances.\nEach of the assignment agreements relating to the Availability Agreement provides that AP&L, LP&L, MP&L, and NOPSI shall make payments directly to System Energy. However, if there is an event of default, AP&L, LP&L, MP&L, and NOPSI must make those payments directly to the holders of indebtedness that are the beneficiaries of such assignment agreements. The payments must be made pro rata according to the amount of the respective obligations secured.\nThe obligations of AP&L, LP&L, MP&L, and NOPSI to make payments under the Availability Agreement are subject to the receipt and continued effectiveness of all necessary regulatory approvals. Sales of capacity and energy under the Availability Agreement would require that the Availability Agreement be submitted to FERC for approval with respect to the terms of such sale. No such filing with FERC has been made because sales of capacity and energy from Grand Gulf are being made pursuant to the Unit Power Sales Agreement. Other aspects of the Availability Agreement, including the obligations of AP&L, LP&L, MP&L, and NOPSI to make subordinated advances, are subject to the jurisdiction of the SEC under PUHCA, whose approval has been obtained. If, for any reason, sales of capacity and energy are made in the future pursuant to the Availability Agreement, the jurisdictional portions of the Availability Agreement would be submitted to FERC for approval.\nSince commercial operation of Grand Gulf 1 began, payments under the Unit Power Sales Agreement to System Energy have exceeded the amounts payable under the Availability Agreement. Accordingly, no payments under the Availability Agreement by AP&L, LP&L, MP&L, and NOPSI have ever been required. In the event such payments were required, the ability of AP&L, LP&L, MP&L, and NOPSI to recover from their customers amounts paid under the Availability Agreement, or under the assignments thereof, would depend upon the outcome of rate proceedings before state and local regulatory authorities. In view of the controversies that arose over the allocation of capacity and energy from Grand Gulf 1 pursuant to the Unit Power Sales Agreement, opposition to full recovery would be likely and the outcome of such proceedings, should they occur, is not predictable.\nCapital Funds Agreement (Entergy Corporation and System Energy)\nSystem Energy and Entergy Corporation have entered into the Capital Funds Agreement whereby Entergy Corporation has agreed to supply System Energy with sufficient capital to (1) maintain System Energy's equity capital at an amount equal to a minimum of 35% of its total capitalization (excluding short-term debt) and (2) permit the continued commercial operation of Grand Gulf 1 and pay in full all indebtedness for borrowed money of System Energy when due under any circumstances.\nEntergy Corporation has entered into various supplements to the Capital Funds Agreement, and System Energy has assigned its rights under such supplements as security for its first mortgage bonds and for reimbursement obligations to certain banks providing letters of credit in connection with the equity funding of the sale and leaseback transactions described in Note 9 to the financial statements under \"Sale and Leaseback Transactions - Grand Gulf 1 Lease Obligations (System Energy).\" Each such supplement provides that permitted indebtedness for borrowed money incurred by System Energy in connection with the financing of Grand Gulf may be secured by System Energy's rights under the Capital Funds Agreement on a pro rata basis (except for the Specific Payments, as defined below). In addition, in the supplements to the Capital Funds Agreement relating to the specific indebtedness being secured, Entergy Corporation has agreed to make cash capital contributions directly to System Energy sufficient to enable System Energy to make payments when due on such indebtedness (Specific Payments). However, if there is an event of default, Entergy Corporation must make those payments directly to the holders of indebtedness benefiting from the supplemental agreements. The payments (other than the Specific Payments) must be made pro rata according to the amount of the respective obligations benefiting from the supplemental agreements.\nRATE MATTERS AND REGULATION\nRate Matters\nThe Operating Companies' retail rates are regulated by state and\/or local regulatory authorities, as described below. FERC regulates their wholesale rates (including intrasystem sales pursuant to the System Agreement) and interstate transmission of electricity, as well as rates for System Energy's sales of capacity and energy from Grand Gulf 1 to AP&L, LP&L, MP&L, and NOPSI pursuant to the Unit Power Sales Agreement.\nWholesale Rate Matters\nSystem Energy\nAs described above under \"Certain System Financial and Support Agreements,\" System Energy recovers costs related to its interest in Grand Gulf 1 through rates charged to AP&L, LP&L, MP&L, and NOPSI for capacity and energy under the Unit Power Sales Agreement.\nOn December 12, 1995, System Energy implemented a $65.5 million rate increase, subject to refund. Refer to Note 2 for a discussion of the rate increase filed by System Energy with FERC.\nEntergy Power\nIn 1990, authorizations were obtained from the SEC, FERC, the APSC, and the Public Service Commission of Missouri for Entergy Power to purchase AP&L's interest in Independence 2 and Ritchie 2, and to begin marketing the capacity and energy from the units in certain wholesale markets. The SEC order was appealed to the D.C. Circuit by various intervenors. The D.C. Circuit reversed a portion of the SEC order and remanded the case to the SEC for consideration of the effect of the transfers on the System's future costs of replacement generating capacity and fuel. On September 9, 1993, the City of New Orleans and the LPSC each requested a hearing. However, on January 5, 1994, the City of New Orleans withdrew from the proceeding, pursuant to its settlement with NOPSI of various issues related to the Merger. In November 1995, the SEC issued an order in which the SEC reaffirmed its prior order authorizing the acquisition and formation of Entergy Power and denying the LPSC's request for a hearing. The November 1995 order was not appealed, and the statutory period for such an appeal has expired.\nIn a related matter, on August 20, l990, the City of New Orleans filed a complaint against Entergy Corporation, AP&L, LP&L, MP&L, NOPSI, and System Energy, requesting that FERC investigate AP&L's transfer of its interest in Independence 2 and Ritchie 2 to Entergy Power and the effect of the transfer on AP&L, LP&L, MP&L, NOPSI, and their ratepayers. On October 20, 1995, the D.C. Circuit affirmed FERC's original orders that the transfer and its effect on current rates was prudent. However, a determination of the prudency of the transfer on future replacement costs was deferred until a time when the need for such replacement capacity occurs.\nSystem Agreement (Energy Corporation, AP&L, GSU, LP&L, MP&L, NOPSI, and System Energy)\nAP&L, GSU, LP&L, MP&L, and NOPSI engage in the coordinated planning, construction, and operation of generation and transmission facilities pursuant to the terms of the System Agreement as described under \"PROPERTY - Generating Stations,\" below.\nIn connection with the Merger, FERC approved certain rate schedule changes to integrate GSU into the System Agreement. Certain commitments were also adopted to assure that the ratepayers of AP&L, LP&L, MP&L, and NOPSI will not be allocated higher costs. Such commitments included: (1) a tracking mechanism to protect these companies from certain unexpected increases in fuel costs; (2) the exclusion of GSU from the distribution of profits from power sales contracts entered into prior to the Merger; (3) a methodology to estimate the cost of capital in future FERC proceedings; and (4) a stipulation that these companies be insulated from certain direct effects on capacity equalization payments if GSU should acquire Cajun's 30% share in River Bend. See \"Regulation - Other Regulation and Litigation,\" for information on appeals of FERC Merger orders and related pending rate schedule changes.\nIn the December 15, 1993, order approving the Merger, FERC also initiated a new proceeding to consider whether the System Agreement permits certain out-of-service generating units to be included in reserve equalization calculations under Service Schedule MSS-1 of that agreement. In connection with this proceeding, the LPSC and the MPSC submitted testimony seeking retroactive refunds for LP&L and MP&L (estimated at $22.6 million and $13.2 million, respectively). The FERC staff subsequently submitted testimony concluding that Entergy's treatment was reasonable. However, because it concluded that Entergy's treatment violated the tariff, FERC staff maintained that refunds of approximately $7.2 million should be ordered. Entergy submitted testimony on September 23, 1994, describing the potential impacts (not including interest) on Service Schedule MSS-1 calculations if extended reserve shutdown units were not included in the MSS-1 calculations during the period 1987 through 1993. Under such a theory, LP&L and MP&L would have been overbilled by $10.6 and $8.8 million respectively, and AP&L and NOPSI would have been underbilled by $6.3 and $13.1 million respectively. The amounts potentially subject to refund will continue to accrue while the case is pending.\nOn March 3, 1995, a FERC ALJ issued an opinion holding that the practice of including the out-of-service units in the reserve equalization calculations during the period 1987 through 1993 was not permitted by Service Schedule MSS-1 and, therefore, constituted a violation of the System Agreement. However, the ALJ found that the violation was in good faith and had benefited the customers of the System as a whole. Accordingly, the ALJ recommended that no retroactive refunds should be ordered. The ALJ also held that the System Agreement should be amended to allow out-of-service units to be included in reserve equalization as proposed in an offer of settlement filed by Entergy on February 16, 1994. The ALJ's opinion is subject to review by FERC. If FERC concurs with the finding that the System Agreement was violated, it would have the discretion to order that refunds be made. If that were to occur, certain Operating Companies may be required to refund some or all of the amount by which they were underbilled pursuant to the System Agreement. The Operating Companies cannot determine at this time whether they would be authorized to recover through retail rates any amounts associated with refunds that might be ordered by FERC in this proceeding. The matter remains pending before FERC.\nOn March 14, 1995, the LPSC filed a complaint with FERC alleging that the System Agreement results in unjust and unreasonable rates and requested that FERC order a hearing on this matter. The LPSC contends that the failure of the System Agreement to exclude curtailable load from the determination of an Operating Company's responsibility for reserve equalization and transmission equalization costs results in an unjust and unreasonable cost allocation to the Operating Companies that does not cause these costs to be incurred, and also results in cross- subsidization among the Operating Companies. Further, the LPSC alleges that the mechanism by which the Operating Companies purchase energy under the System Agreement results in unjust and unreasonable rates because it does not permit Operating Companies that engage in real time pricing to be charged the marginal cost of the energy generated for the real time pricing customer. In May 1995, the LPSC amended its original complaint and Entergy subsequently filed an answer to the LPSC's amended complaint. The LPSC's amended complaint asserts that the System Agreement should be revised to exclude curtailable load from the cost allocation determination due to conflicts with federal policies under PURPA and with Entergy's system planning philosophy. Entergy's response asserts that both the provisions under PURPA and the Entergy system planning philosophy referred to in the LPSC's amended complaint are applicable only to retail sales.\nIn June 1995, the APSC filed a complaint with FERC alleging that, because of changed circumstances, FERC's allocation of nuclear decommissioning costs in the System is no longer just and reasonable. The APSC proposes that the System Agreement be amended to provide a new schedule that would equalize nuclear decommissioning costs according to load responsibility among the pre-merger operating companies.\nOpen Access Transmission (Entergy Corporation, AP&L, GSU, LP&L, MP&L, and NOPSI)\nOn August 2, 1991, Entergy Services, as agent for AP&L, LP&L, MP&L, NOPSI, and Entergy Power, submitted to FERC (1) proposed tariffs that, subject to certain conditions, would provide to electric utilities \"open access\" to the System's integrated transmission system, and (2) rate schedules providing for sales of wholesale power at market- based rates. FERC approved the filing in August 1992, and various parties filed appeals with the D.C. Circuit. The case was remanded to FERC in July 1994 for further proceedings. On October 31, 1994, Entergy Services as agent for AP&L, GSU, LP&L, MP&L, and NOPSI filed revised transmission tariffs. On January 6, 1995, FERC issued an order accepting the tariffs for filing and made them effective, subject to refund. These tariffs provide both point-to-point and network transmission service, and are intended to provide \"comparability of service\" over the Entergy transmission network. In that order FERC also ordered that Entergy Power's market pricing authority be investigated, thereby making Entergy Power's market price rate schedules subject to refund. An order in the market price rate investigation is expected to be issued by January 1997. Entergy expects that no refunds relating to market price rates will be required.\nOn March 29, 1995, FERC issued a supplemental notice of proposed rulemaking (Mega-NOPR) which would require public utilities to provide non-discriminatory open access transmission service to wholesale customers, and which would also provide guidance on the recovery of wholesale and retail stranded costs. Under the proposal, public utilities would be required to file transmission tariffs for both point- to-point and network service. Model transmission tariffs were included in the proposal. With regard to pending proceedings, including Entergy's tariff proceeding, FERC directed the parties to proceed with their cases while taking into account FERC's views expressed in the proposed rule. Hearings relating to Entergy Services' open access tariffs concluded on February 22, 1996.\nIn September 1995 and January 1996, Entergy Services filed offers of partial settlement accepting certain provisions of the transmission tariffs contained in the Mega-NOPR and resolving certain rate issues. The remaining rate and tariff issues will be resolved as part of the FERC's rulemaking in the Mega-NOPR, or after scheduled hearings. In August 1995, EPM filed an application for permission to make market- based sales, but subsequently asked that action not be taken on that request until the open access transmission service proceeding discussed above is resolved. On December 13, 1995, Entergy Services filed revised transmission tariffs in a separate proceeding proposing terms and conditions for open access transmission service that are substantially identical to the terms and conditions contained in the Mega-NOPR transmission tariffs with rates to be the same as those determined in the pending proceeding. On February 14, 1996, FERC accepted for filing the revised transmission tariffs making rates subject to the outcome of the pending proceeding and conditionally accepted EPM's application for market based sales.\nWholesale Contract (AP&L)\nIn March 1994, North Little Rock, Arkansas awarded to AP&L a wholesale power contract that will provide estimated revenues of $347 million over 11 years. Under the contract, the price per KWh was reduced 18% with increases in price through the year 2004. AP&L, which has been serving North Little Rock for over 40 years, was awarded the contract after intense bidding with several competitors. On May 22, 1994, FERC accepted the contract. Rehearings were requested by one of AP&L's competitors. In September 1995, FERC denied the petition for rehearing.\nRetail Rate Matters\nGeneral (AP&L, GSU, LP&L, MP&L, and NOPSI)\nCertain costs related to Grand Gulf 1, Waterford 3, and River Bend were phased into retail rates over a period of years in order to avoid the \"rate shock\" associated with increasing rates to reflect all such costs at once. The deferral period in which costs are incurred but not currently recovered has expired for all of these programs, and AP&L, GSU, LP&L, MP&L, and NOPSI are now recovering those costs that were previously deferred.\nGSU is involved in several rate proceedings involving, among other things, recovery of costs associated with River Bend. Some rate relief has been received, but GSU has been unable to obtain recognition in rates for a substantial portion of its River Bend investment. Recovery of certain costs was disallowed while other costs were deferred for future recovery, held in abeyance pending further regulatory action, or treated as investments in deregulated assets. Rate proceedings and appeals relating to these issues are ongoing as discussed in \"GSU\" below.\nAs a means of minimizing the need for retail rate increases, the System is committed to containing costs to the greatest degree practicable. In accordance with this retail rate policy, the Operating Companies have agreed to retail rate caps and\/or rate freezes for specified periods of time.\nThe retail regulatory philosophy is shifting in some jurisdictions from traditional cost of service regulation to incentive rate regulation. System management believes incentive and performance-based rate plans encourage efficiencies and productivity while permitting utilities and their customers to share in the resulting benefits. MP&L implemented an incentive-rate plan in March 1994, and, in June 1995, LP&L implemented a performance-based formula rate plan. Recognizing that many industrial customers have energy alternatives, Entergy continues to work with these customers to address their needs. In certain cases, competitive prices are negotiated using variable-rate designs.\nLeast Cost Integrated Resource Planning (AP&L, GSU, LP&L, MP&L, and NOPSI)\nThe System continues to utilize integrated resource planning (IRP), also known as least cost planning, in order to compete more effectively in both retail and wholesale markets. IRP is the development of integrated supply and demand side strategies to meet future electricity demands reliably, at the lowest possible cost, and in a more competitive manner.\nIn 1992, AP&L, LP&L, MP&L, and NOPSI each filed a Least Cost Integrated Resource Plan (LCIRP) with its respective regulator. However, in 1994 the System substantially revised its approach to IRP, and AP&L, LP&L, MP&L, and NOPSI requested that their retail regulators allow for significant changes in the IRP process. At MP&L's request, the MPSC dismissed MP&L's LCIRP filing. Due to the increasingly competitive nature of the electric service market, the System believes that changes in the IRP process are required. Entergy has adopted a streamlined process that focuses on minimizing the cost of incremental resources and maximizing the System's flexibility to adapt its resource plans to the changing environment in which electric utilities now operate.\nOn October 10, 1995, despite Entergy's request, the APSC issued an order requiring that Arkansas utilities file current integrated resource plans at least every three years. In this order, the APSC emphasized that planning processes must continue to evolve and publicly available information on utility resource plans must be maintained. The LPSC has established generic hearings to address IRP issues for all electric utilities within its jurisdiction. These proceedings are currently ongoing. The Council has suspended the requirement to file an LCIRP with the Council and has received testimony and held public hearings regarding the revision of its IRP Ordinance. LP&L and NOPSI are awaiting an order from the Council that would resolve the matter of IRP. Currently, the PUCT does not have formal IRP rules in place. Legislation passed in 1995 requires that the PUCT have IRP rules in place by September of 1996. This rulemaking process has been initiated by the PUCT, and GSU is actively participating in this process.\nIn the fourth quarter of 1995, the System provided to its retail regulators (the APSC, the Council, the LPSC, the MPSC, and the PUCT) a new IRP for informational purposes only. The new IRP provides for a flexible resource strategy to meet the System's additional resource requirements over the next ten years. The IRP provides for the utilization of capacity currently in extended reserve shutdown to meet additional load growth, but also provides the flexibility to rely on short-term power purchases, upgrades to existing nuclear capacity, or cogeneration when these resources are more economical.\nAP&L\nRate Freeze\nIn connection with the settlement of various issues related to the Merger, AP&L agreed that it will not request any general retail rate increase that would take effect before November 3, 1998, except for certain instances. See Note 2 for a discussion of the rate freeze as well as other aspects of the settlement agreement between AP&L and the APSC.\nRecovery of Grand Gulf 1 Costs\nUnder the settlement agreement entered into with the APSC in 1985 and amended in 1988, AP&L agreed to retain a portion of its Grand Gulf l-related costs, recover a portion of such costs currently, and defer a portion of such costs for future recovery. In 1995 and subsequent years, AP&L retains 22% of its 36% interest in Grand Gulf 1 costs and recovers the remaining 78%. Deferrals ceased in l990, and AP&L is recovering a portion of the previously deferred costs each year through l998. As of December 31, l995, the balance of deferred costs was $360 million. AP&L is permitted to recover on a current basis the incremental costs of financing the unrecovered deferrals.\nAP&L has the right to sell capacity and energy from its retained share of Grand Gulf 1 to third parties and to sell such energy to its retail customers at a price equal to AP&L's avoided energy cost. Proceeds of sales to third parties of AP&L's retained share of Grand Gulf l capacity and energy accrue to the benefit of AP&L's stockholder.\nFuel Adjustment Clause\nAP&L's retail rate schedules include a fuel adjustment clause to recover the excess cost of fuel and purchased power incurred in the second prior month. The fuel adjustment clause also contains a nuclear reserve fund designed to cover the cost of replacement energy during scheduled maintenance and refueling outages at ANO, and an incentive provision that permits over- or under-recovery of the excess cost of replacement energy when ANO is operating or down for reasons other than refueling.\nGSU\nRate Cap and Other Merger-Related Rate Agreements\nIn 1993, the LPSC and the PUCT approved separate regulatory proposals, which included the implementation of a five-year Rate Cap on GSU's retail electric base rates in the respective states and provisions for passing fuel and nonfuel savings created by the Merger on to the customers. See Note 2 for a discussion of the Rate Cap as well as other aspects of the settlement agreement between GSU and the LPSC and the PUCT.\nRecovery of River Bend Costs\nGSU deferred approximately $369 million of River Bend operating costs, purchased power costs, and accrued carrying charges pursuant to a 1986 PUCT accounting order. Approximately $182 million of these costs are being amortized over a 20-year period ending in the year 2009, and the remaining $187 million are not being amortized pending the ultimate outcome of the Rate Appeal as discussed in \"Texas Jurisdiction - River Bend,\" below. As of December 31, 1995, the unamortized balance of these costs was $312 million. Further, GSU deferred approximately $400.4 million of similar costs pursuant to a 1986 LPSC accounting order. These costs, of which approximately $83 million are unamortized as of December 31, 1995, are being amortized over a 10-year period ending in 1998.\nIn accordance with a phase-in plan approved by the LPSC, GSU deferred $294 million of its River Bend costs related to the period February 1988 through February 1991. GSU has amortized $172 million through December 31, 1995, and the remaining $122 million will be recovered over approximately 2.2 years.\nTexas Jurisdiction - River Bend\nIn May 1988, the PUCT granted GSU a permanent increase in annual revenues of $59.9 million resulting from the inclusion in rate base of approximately $1.6 billion of company-wide River Bend plant investment and approximately $182 million of related Texas retail jurisdiction deferred River Bend costs (Allowed Deferrals). In addition, the PUCT disallowed as imprudent $63.5 million of company-wide River Bend plant costs and placed in abeyance, with no finding as to prudence, approximately $1.4 billion of company-wide River Bend plant investment and approximately $157 million of Texas retail jurisdiction deferred River Bend operating and carrying costs.\nAs discussed in Note 2, various appeals of the PUCT's order have been filed. GSU has filed an appeal with the Texas Supreme Court. On February 9, 1996, the Texas Supreme Court agreed to hear the appeal. Oral arguments are scheduled for March 19, 1996.\nAs of December 31, 1995, the River Bend plant costs disallowed for retail ratemaking purposes in Texas, the River Bend plant costs held in abeyance, and the related operating and carrying cost deferrals totaled (net of taxes) approximately $13 million, $276 million (both net of depreciation), and $169 million, respectively. Allowed Deferrals were approximately $83 million, net of taxes and amortization, as of December 31, 1995. GSU estimates it has recorded approximately $182 million of revenues as of December 31, 1995, as a result of the originally ordered rate treatment by the PUCT of these deferred costs. If recovery of the Allowed Deferrals is not upheld, future revenues based upon those allowed deferrals could be lost, and no assurance can be given as to whether or not refunds to customers of revenue received based upon such deferred costs will be required.\nAs discussed in Note 2, as of December 31, 1995, GSU has made no write-offs or reserves for the River Bend-related costs. See below for a discussion of the write-off of deferred operating and carrying costs required under SFAS 121 in 1996. Based on advice from Clark, Thomas & Winters, A Professional Corporation, legal counsel of record in the Rate Appeal, management believes that it is reasonably possible that the case will be remanded to the PUCT, and that the PUCT will be allowed to rule on the prudence of the abeyed River Bend plant costs. Management and legal counsel are unable to predict the amount, if any, of abeyed and previously disallowed River Bend plant costs that ultimately may be disallowed by the PUCT. As of December 31, 1995, a net of tax write-off of up to $289 million could be required if the PUCT ultimately issues an adverse ruling on the abeyed and disallowed plant costs.\nThe following factors support management's position that a loss contingency requiring accrual has not occurred, and that all, or substantially all, of the abeyed plant costs will ultimately be recovered:\n1. The $1.4 billion of abeyed River Bend plant costs have never been ruled imprudent and disallowed by the PUCT; 2. Analysis by Sandlin Associates, management consultants with expertise in the cost of nuclear power plants, which supports the prudence of substantially all of the abeyed construction costs; 3. Historical inclusion by the PUCT of prudent construction costs in rate base; and 4. The analysis of GSU's legal staff, which has considerable experience in Texas rate case litigation.\nAdditionally, based on advice from Clark, Thomas & Winters, A Professional Corporation, legal counsel of record in the Rate Appeal, management believes that it is reasonably possible that the Allowed Deferrals will continue to be recovered in rates, and that it is reasonably possible that the deferred costs related to the $1.4 billion of abeyed River Bend plant costs will be recovered in rates to the extent that the $1.4 billion of abeyed River Bend plant is recovered.\nThe adoption of SFAS 121, \"Accounting for the Impairment of Long- Lived Assets and for Long-Lived Assets to Be Disposed Of\" (SFAS 121), became effective January 1, 1996. SFAS 121 changes the standard for continued recognition of regulatory assets, and as a result in 1996 GSU will be required to write-off $169 million of rate deferrals discussed above. The standard also describes circumstances that may result in assets being impaired and provides criteria for recognition and measurement of asset impairment. See Note 1 for further information regarding SFAS 121.\nNISCO Unrecovered Costs\nIn 1986, the PUCT ordered that the purchased power costs from NISCO in excess of GSU's avoided costs be disallowed. The PUCT disallowance resulted in approximately $12 million to $15 million of unrecovered purchased power costs on an annual basis, which GSU continued to expense as the costs were incurred. In April 1991, the Texas Supreme Court, on the appeal of such order, ordered the PUCT to allow GSU to recover purchased power payments in excess of its avoided cost in future proceedings if GSU established to the PUCT's satisfaction that the payments were reasonable and necessary expenses.\nIn January 1992, GSU applied to the PUCT for a new fixed fuel factor and requested a final reconciliation of fuel and purchased power costs incurred between December 1, 1986 and September 30, 1991. GSU proposed to recover net under-recoveries and interest (including under- recoveries related to NISCO) over a twelve-month period. In June 1993, the PUCT concluded that the purchased power payments made to NISCO in excess of GSU's avoided cost were not reasonably incurred. In October 1993, GSU appealed the PUCT's order to the Travis County District Court where the matter is still pending. As of December 31, 1995, GSU has expensed $119.4 million of unrecovered purchased power costs and deferred revenue pending the appeal of the District Court. No assurance can be given as to the timing or outcome of the appeal.\nPUCT Fuel Cost Review\nOn January 9, 1995, GSU and various parties reached an agreement for the reconciliation of over- and under-recovery of fuel and purchased power expenses for the period October 1, 1991, through December 31, 1993. On April 17, 1995, the PUCT issued a final order approving the settlement. As a result of the PUCT order, $7.6 million of prior period fuel costs were refunded to customers through the fuel adjustment clause.\nRetail Rate Proceedings\nRefer to Note 2 for a discussion of additional retail rate proceedings which have been resolved during the current year and\/or are currently outstanding in the regulatory jurisdictions in which GSU operates.\nFuel Recovery\nGSU's Texas rate schedules include a fixed fuel factor to recover fuel and purchased power costs not recovered in base rates. The fixed factor may be revised every six months in accordance with a schedule set by the PUCT for each utility. To the extent actual costs vary from the fixed factor, refunds or surcharges are required or permitted, respectively. Fuel costs are also subject to reconciliation proceedings every three years. GSU's Louisiana electric rate schedules include a fuel adjustment clause to reflect the cost of fuel and purchased power costs in the second prior month, adjusted by a surcharge for deferred fuel expense arising from the monthly reconciliation of actual fuel cost incurred with fuel revenues billed to customers.\nGSU's Louisiana gas rates include a purchased gas adjustment to recover the cost of purchased gas.\nSteam Customer Contract\nGSU is currently negotiating with its only steam customer whose contract is scheduled to expire in 1997. It is anticipated that GSU will be successful in such negotiations and the contract will be renewed. During 1995 sales to this customer contributed $44.5 million in base revenues to GSU.\nLP&L\nRecovery of Waterford 3 and Grand Gulf 1 Costs\nIn a series of LPSC orders, court decisions, and agreements from late 1985 to mid-1988, LP&L was granted rate relief with respect to costs associated with Waterford 3 and LP&L's share of capacity and energy from Grand Gulf l, subject to certain terms and conditions. With respect to Waterford 3, LP&L was granted an increase aggregating $170.9 million over the period 1985-1988, and LP&L agreed to permanently absorb, and not recover from retail ratepayers, $284 million of its investment in the unit and to defer $266 million of its costs related to the years 1985-1988 to be recovered over approximately 8.6 years beginning in April 1988. As of December 31, 1995, LP&L's unrecovered deferral balance was $26 million.\nWith respect to Grand Gulf l, LP&L agreed to retain, and not recover from retail ratepayers, 18% of its 14% share or, approximately 2.52% of the costs of Grand Gulf l's capacity and energy. LP&L is allowed to recover, through the fuel adjustment clause, 4.6 cents per KWh for the energy related to its retained portion of these costs. Alternatively, LP&L may sell such energy to nonaffiliated parties at prices above the fuel adjustment clause recovery amount, subject to the LPSC's approval.\nPerformance-Based Formula Rate Plan\nIn June 1995, in conjunction with the LPSC's rate review, a performance-based formula rate plan previously proposed by LP&L was approved with certain modifications. At the same time, the LPSC ordered a $49.4 million reduction in base rates. For a discussion of LP&L's approved performance-based formula rate plan, LP&L's subsequent appeal of the LPSC's June 1995 rate order, and the final settlement of this appeal, see Note 2.\nFuel Adjustment Clause\nLP&L's rate schedules include a fuel adjustment clause to reflect the cost of fuel and purchased power in the second prior month. The fuel adjustment also reflects a surcharge for deferred fuel expense arising from the monthly reconciliation of actual fuel cost incurred with fuel revenues billed to customers.\nMP&L\nRetail Rate Proceedings\nRefer to Note 2 for a discussion of the retail rate proceedings which have been resolved during the current year and\/or are currently outstanding in the regulatory jurisdictions in which MP&L operates.\nRate Freeze\nIn connection with the settlement of various issues related to the Merger, MP&L agreed that it will not request any general retail rate increase to take effect before November 3, 1998, except for certain instances. See Note 2 for a discussion of the rate freeze as well as other aspects of the settlement agreement between MP&L and the MPSC.\nRecovery of Grand Gulf 1 Costs\nIn 1988 the MPSC granted MP&L an annual base rate increase of approximately $326.5 million in connection with its allocated share of Grand Gulf 1 costs. The MPSC also provided for the deferral of a portion of such costs that were incurred each year through 1992, and recovery of these deferrals over a period of six years ending in 1998. As of December 31, 1995, the uncollected balance of MP&L's deferred costs was approximately $378 million. MP&L is permitted to recover the carrying charges on all deferred amounts on a current basis.\nFormula Rate Plan\nUnder a formulary incentive rate plan (Formula Rate Plan) effective March 25, 1994, MP&L's earned rate of return is calculated automatically every 12 months and compared to and adjusted against a benchmark rate of return (calculated under a separate formula within the Formula Rate Plan). The Formula Rate Plan allows for periodic small adjustments in rates based on a comparison of actual earned returns to benchmark returns and upon certain performance factors. Pursuant to a stipulation with the MPSC's Public Utilities Staff, MP&L did not request an adjustment in rates based on its earned rate of return for the 12-months ended December 31, 1994.\nFuel Adjustment Clause\nMP&L's rate schedules include a fuel adjustment clause that recovers changes in cost of fuel and purchased power. The monthly fuel adjustment rate is based on projected sales and costs for the month, adjusted for differences between actual and estimated costs and KWh sales for the second prior month.\nNOPSI\nRecovery of Grand Gulf 1 Costs\nUnder NOPSI's various Rate Settlements with the Council in 1986, 1988, and 1991, NOPSI agreed to absorb and not recover from ratepayers a total of $96.2 million of its Grand Gulf 1 costs. NOPSI was permitted to implement annual rate increases in decreasing amounts each year through 1995, and to defer certain costs and related carrying charges, for recovery on a schedule extending from 1991 through 2001. As of December 31, 1995, the uncollected balance of NOPSI's deferred costs was $171 million. The 1994 NOPSI Settlement did not affect the scheduled Grand Gulf 1 phase-in rate increases.\n1994 NOPSI Settlement\nIn a settlement with the Council that was approved on December 29, 1994, NOPSI agreed to reduce electric and gas rates and issue credits and refunds to customers. Effective January 1, 1995, NOPSI implemented a $31.8 million permanent reduction in electric base rates and a $3.1 million permanent reduction in gas base rates. The 1994 NOPSI Settlement also required NOPSI to credit its customers $25 million over a 21-month period, beginning January 1, 1995, in order to resolve disputes with the Council regarding the interpretation of the 1991 NOPSI Settlement. See Note 2 for additional discussion of the rate reductions and refunds ordered by the Council in the 1994 NOPSI settlement, as well as the 1995 and 1996 annual earnings reviews required by the Council.\nFuel Adjustment Clause\nNOPSI's electric rate schedules include a fuel adjustment clause to reflect the cost of fuel in the second prior month, adjusted by a surcharge for deferred fuel expense arising from the monthly reconciliation of actual fuel incurred with fuel cost revenues billed to customers. The adjustment, on a monthly basis, also reflects the difference between nonfuel Grand Gulf 1 costs paid by NOPSI and the estimate of such costs provided in NOPSI's Grand Gulf 1 Rate Settlements. NOPSI's gas rate schedules include an adjustment to reflect gas costs in excess of those collected in base rates, adjusted by a surcharge similar to that included in the electric fuel adjustment clause.\nRegulation\nFederal Regulation (Entergy Corporation, AP&L, GSU, LP&L, MP&L, NOPSI, and System Energy)\nPUHCA\nEntergy Corporation is a public utility holding company registered under PUHCA. As such, Entergy Corporation and its various direct and indirect subsidiaries (with the exception of its EWG and foreign utility subsidiaries) are subject to the broad regulatory provisions of that Act. Except with respect to investments in certain domestic power projects, foreign utility company projects, and telecommunication projects, PUHCA limits the operations of a registered holding company system to a single, integrated public utility system, plus additional systems and businesses as provided by that section. See \"MANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS - SIGNIFICANT FACTORS AND KNOWN TRENDS,\" for a discussion of the Telecommunications Act.\nEntergy Corporation and other electric utility holding companies, have supported legislation in the United States Congress which would repeal PUHCA, which requires detailed oversight by the SEC of many business practices and activities of utility holding companies and their subsidiaries. The proposed legislation would transfer certain aspects of the oversight of public utility holding companies from the SEC to FERC.\nEntergy believes that PUHCA inhibits its ability to compete in the evolving electric energy marketplace and largely duplicates the oversight activities already performed by FERC and state and local regulators. In June 1995, the SEC adopted a report proposing options for the repeal or significant modification of PUHCA and proposed rule changes that would reduce the regulations governing utility holding companies. One rule change adopted as a result of such proposals eliminated the requirement to receive prior authorization for capital contributions made by a parent company to its nonutility subsidiary companies and for financing its non utility subsidiary companies. Such rule was appealed to the D.C. Circuit by the City of New Orleans where the appeal was denied in January 1996.\nFederal Power Act\nThe Operating Companies, System Energy, and Entergy Power are subject to the Federal Power Act as administered by FERC and the DOE. The Federal Power Act provides for regulatory jurisdiction over the licensing of certain hydroelectric projects, the transmission and wholesale sale of electric energy in interstate commerce, and certain other activities, including accounting policies and practices. Such regulation includes jurisdiction over the rates charged by System Energy for capacity and energy provided to AP&L, LP&L, MP&L, and NOPSI from Grand Gulf 1.\nAP&L holds a license for two hydroelectric projects (70 MW) that was renewed on July 2, 1980. This license, granted by FERC, will expire in February 2003.\nRegulation of the Nuclear Power Industry (Entergy Corporation, AP&L, GSU, LP&L, and System Energy)\nGeneral\nUnder the Atomic Energy Act of 1954 and the Energy Reorganization Act of 1974, operation of nuclear plants is intensively regulated by the NRC, which has broad power to impose licensing and safety-related requirements. In the event of non-compliance, the NRC has the authority to impose fines or shut down a unit, or both, depending upon its assessment of the severity of the situation, until compliance is achieved. AP&L, GSU, LP&L, and System Energy, as owners of all or a portion of ANO, River Bend, Waterford 3, and Grand Gulf 1, respectively, and Entergy Operations, as the operator of these units, are subject to the jurisdiction of the NRC. Revised safety requirements promulgated by the NRC have, in the past, necessitated substantial capital expenditures at these nuclear plants, and additional such expenditures could be required in the future.\nThe nuclear power industry faces uncertainties with respect to the cost and long-term availability of sites for disposal of spent nuclear fuel and other radioactive waste, nuclear plant operations, the technological and financial aspects of decommissioning plants at the end of their licensed lives, and requirements relating to nuclear insurance. These matters are briefly discussed below.\nSpent Fuel and Other High-Level Radioactive Waste\nUnder the Nuclear Waste Policy Act of 1982, the DOE is required, for a specified fee, to construct storage facilities for, and to dispose of, all spent nuclear fuel and other high-level radioactive waste generated by domestic nuclear power reactors. However, the DOE has not yet identified a permanent storage repository and, as a result, future expenditures may be required to increase spent fuel storage capacity at the plant sites. For further information concerning spent fuel disposal contracts with the DOE, schedules for initial shipments of spent nuclear fuel, current on-site storage capacity, and costs of providing additional on-site storage, see Note 8.\nLow-Level Radioactive Waste\nThe availability and cost of disposal facilities for low-level radioactive waste resulting from normal nuclear plant operations are subject to a number of uncertainties. Under the Low-Level Radioactive Waste Policy Act of 1980, as amended, each state is responsible for disposal of its own waste, and states may participate in regional compacts to fulfill their responsibilities jointly. The States of Arkansas and Louisiana participate in the Central States Compact, and the State of Mississippi participates in the Southeast Compact. Two disposal sites are currently operating in the United States, and until recently both were closed to out-of-region generators. The Barnwell Disposal Facility (Barnwell), located in South Carolina and operated by the Southeast Compact, reopened to out-of-region generators in July 1995. The South Carolina State legislative action reopening Barnwell must be renewed annually. The availability of Barnwell provides only temporary relief from low-level radioactive waste storage and does not alleviate the need to develop new disposal capacity.\nBoth the Central States Compact and the Southeast Compact are working to establish additional disposal sites. The System, along with other waste generators, funds the development costs for new disposal facilities. As of December 1995, the System's cumulative expenditures for the development of new disposal facilities totaled approximately $38 million. Future levels of expenditures cannot be predicted. Until long-term disposal facilities are established, the System will seek continued access to existing facilities. If such access is unavailable, the System will store low-level waste at its nuclear plant sites.\nDecommissioning\nAP&L, GSU, LP&L, and System Energy are recovering from ratepayers portions of their estimated decommissioning costs for ANO, River Bend, Waterford 3, and Grand Gulf 1, respectively. These amounts are deposited in trust funds that, together with the related earnings, can only be used for future decommissioning costs. Estimated decommissioning costs are periodically reviewed and updated to reflect inflation and changes in regulatory requirements and technology, and applications are periodically made to appropriate regulatory authorities to reflect in rates any future changes in projected decommissioning costs. For additional information with respect to decommissioning costs for ANO, River Bend, Waterford 3, and Grand Gulf 1, see Note 8.\nUranium Enrichment Decontamination and Decommissioning Fees\nThe EPAct requires all electric utilities (including AP&L, GSU, LP&L, and System Energy) that have purchased uranium enrichment services from the DOE to contribute up to a total of $150 million annually, adjusted for inflation, up to a total of $2.25 billion over approximately 15 years, for decontamination and decommissioning of enrichment facilities. In accordance with the EPAct, contributions to decontamination and decommissioning funds are recovered through rates in the same manner as other fuel costs. See Note 8 for the estimated annual contributions by the System companies for decontamination and decommissioning fees.\nNuclear Insurance\nThe Price-Anderson Act limits public liability for a single nuclear incident to approximately $8.92 billion. AP&L, GSU, LP&L, and System Energy have protection with respect to this liability through a combination of private insurance and an industry assessment program, and also have insurance for property damage, costs of replacement power, and other risks relating to nuclear generating units. For a discussion of insurance applicable to the nuclear programs of AP&L, GSU, LP&L, and System Energy, see Note 8.\nNuclear Operations\nGeneral (Entergy Corporation, AP&L, GSU, LP&L, and System Energy)\nEntergy Operations operates ANO, River Bend, Waterford 3, and Grand Gulf 1, subject to the owner oversight of AP&L, GSU, LP&L, and System Energy, respectively. AP&L, GSU, LP&L, and System Energy, and the other Grand Gulf 1 and River Bend co-owners, have retained their ownership interests in their respective nuclear generating units. AP&L, GSU, LP&L, and System Energy have also retained their associated capacity and energy entitlements, and pay directly or reimburse Entergy Operations at cost for its operation of the units.\nANO Matters (Entergy Corporation and AP&L)\nEntergy Operations has made inspections and repairs from time to time on ANO 2's steam generators. During the October 1995 inspection, additional cracks in the tubes were discovered. Currently, Entergy Operations is monitoring the development of the cracks and assessing various options for the repair or the replacement of ANO 2's steam generators. See Note 8 for additional information.\nRiver Bend (Entergy Corporation and GSU)\nIn connection with the Merger, GSU filed two applications with the NRC in January 1993 to amend the River Bend operating license. The applications sought the NRC's consent to the Merger and to a change in the licensed operator of the facility from GSU to Entergy Operations. In August 1993 Cajun filed a petition to intervene and a request for a hearing in the proceeding. In January 1994, the presiding NRC Atomic Safety and Licensing Board (ASLB) issued an order granting Cajun's petition to intervene and ordering a hearing on one of Cajun's contentions. In 1994, subsequent to Cajun's intervention in such proceedings, the NRC Staff issued the two license amendments for River Bend, which were effective immediately upon consummation of the Merger. A hearing on the proceeding before the ASLB has been postponed, pending approval of a petition by Cajun to withdraw such a proceeding. On February 14, 1994, Cajun filed with the D.C. Circuit petitions for review of the two license amendments for River Bend. In March 1995, the D.C. Circuit ordered the original NRC order and license amendments be set aside, and remanded the case to the NRC for further consideration. Subsequently, the NRC affirmed its original findings and reissued the two license amendments approving the Merger and the change in the licensed operator of River Bend. Cajun has filed a petition for review with the D. C. Circuit, and oral arguments are expected to be heard in May 1996. These two amendments are in full force and effect, but are subject to the outcome of the two proceedings.\nState Regulation (AP&L, GSU, LP&L, MP&L, and NOPSI)\nGeneral\nEach of the Operating Companies is subject to regulation by state and\/or local regulatory authorities having jurisdiction over the areas in which it operates. Such regulation includes authority to set rates for retail electric and gas service. (See \"RATE MATTERS AND REGULATION - - - - - Rate Matters - Retail Rate Matters,\" above.)\nAP&L is subject to regulation by the APSC and the Tennessee Public Service Commission (TPSC). APSC regulation includes the authority to set rates, determine reasonable and adequate service, fix the value of property used and useful, require proper accounting, control leasing, control the acquisition or sale of any public utility plant or property constituting an operating unit or system, set rates of depreciation, issue certificates of convenience and necessity and certificates of environmental compatibility and public need, and control the issuance and sale of securities. Regulation by the TPSC includes the authority to set standards of service and rates for service to customers in the state, require proper accounting, control the issuance and sale of securities, and issue certificates of convenience and necessity.\nGSU is subject to the jurisdiction of the municipal authorities of incorporated cities in Texas as to retail rates and services within their boundaries, with appellate jurisdiction over such matters residing in the PUCT. GSU is also subject to regulation by the PUCT as to retail rates and services in rural areas, certification of new generating plants, and extensions of service into new areas. GSU is subject to regulation by the LPSC as to electric and gas service, rates and charges, certification of generating facilities and power or capacity purchase contracts, depreciation, accounting, and other matters.\nLP&L is subject to regulation by the LPSC as to electric service, rates and charges, certification of generating facilities and power or capacity purchase contracts, depreciation, accounting, and other matters. LP&L is also subject to the jurisdiction of the Council with respect to such matters within Algiers.\nMP&L is subject to regulation as to service, service areas, facilities, and retail rates by the MPSC. MP&L is also subject to regulation by the APSC as to the certificate of environmental compatibility and public need for the Independence Station.\nNOPSI is subject to regulation by the Council as to electric and gas service, rates and charges, standards of service, depreciation, accounting, issuance of certain securities, and other matters.\nFranchises\nAP&L holds exclusive franchises to provide electric service in 300 incorporated cities and towns in Arkansas. These franchises are unlimited in duration and continue until such a time when the municipalities purchase the utility property. In Arkansas, franchises are considered to be contracts and, therefore, are terminable upon breach of the contract.\nGSU holds non-exclusive franchises, permits, or certificates of convenience and necessity to provide electric and gas service in 55 incorporated villages, cities, and towns in Louisiana and 64 incorporated cities and towns in Texas. GSU ordinarily holds 50-year franchises in Texas and 60-year franchises in Louisiana. GSU's current electric franchises will expire in 2007 - 2036 in Texas and in 2015 - 2046 in Louisiana. The natural gas franchise in the City of Baton Rouge will expire in 2015. In addition, GSU has received from the PUCT a certificate of convenience and necessity to provide electric service to areas within 21 counties in eastern Texas.\nLP&L holds non-exclusive franchises to provide electric service in 116 incorporated villages, cities, and towns. Most of these municipal franchises have 25-year terms, although six municipalities have granted LP&L 60-year franchises. LP&L also supplies electric service in 353 unincorporated communities, all of which are located in parishes in which LP&L holds non-exclusive franchises.\nMP&L has received from the MPSC certificates of public convenience and necessity to provide electric service to areas within 45 counties in western Mississippi, which include a number of municipalities. Under Mississippi statutory law, such certificates are exclusive. MP&L may continue to serve in such municipalities upon payment of a statutory franchise fee, regardless of whether an original municipal franchise is still in existence.\nNOPSI provides electric and gas service in the City of New Orleans pursuant to city ordinances, which state, among other things, that the City has a continuing option to purchase NOPSI's electric and gas utility properties.\nSystem Energy has no distribution franchises. Its business is currently limited to wholesale power sales.\nEnvironmental Regulation\nGeneral\nIn the areas of air quality, water quality, control of toxic substances and hazardous and solid wastes, and other environmental matters, the facilities and operations of the System companies are subject to regulation by various federal, state, and local authorities. The System companies believe they are in substantial compliance with environmental regulations currently applicable to their respective facilities and operations. They have incurred significant costs in meeting environmental protection standards. Because environmental regulations are continually changing, the ultimate compliance costs to the System companies cannot be precisely estimated. However, management currently estimates that ultimate capital expenditures for environmental compliance purposes, including those discussed in \"Clean Air Legislation,\" below, will not be material for the System as a whole.\nClean Air Legislation\nThe Clean Air Act Amendments of 1990 (the Act) set up three programs that affect the System companies: an acid rain program for control of sulfur dioxide (SO2) and nitrogen oxides (NOx), an ozone nonattainment area program for control of NOx and volatile organic compounds, and an operating permits program for administration and enforcement of these and other Clean Air Act programs.\nUnder the acid rain program, no additional control equipment is expected to be required by the System to control SO2. The Act provides \"allowances\" to most of the affected System companies' generating units for emissions based upon past emission levels and operating characteristics. Each allowance is an entitlement to emit one ton of SO2 per year. Under the Act, utilities will be required to possess allowances for SO2 emissions from affected generating units. All of the Entergy company generating units are classified as \"Phase II\" units under the Act and are subject to SO2 allowance requirements beginning in the year 2000. Based on operating history, the System companies are considered \"clean\" utilities and have been allocated more allowances than are currently necessary for normal operations. Management believes that it will be able to operate its units efficiently without installing scrubbers or purchasing allowances from outside sources, and that one or more of the System companies may have excess allowances available for sale.\nThe System companies have installed continuous emission monitoring (CEM) equipment at their fossil generating units to comply with EPA regulations under the Act, and CEM software and computer equipment is currently being updated at AP&L, MP&L, LP&L, and NOPSI generating units. Such CEM equipment resulted in approximately $5.2 million of capital costs during 1995. No material costs for CEM equipment are expected in 1996.\nControl equipment may eventually be required for NOx reductions due to the ozone nonattainment status of the areas served by GSU in and around Beaumont and Houston, Texas. Texas environmental authorities are studying the causes of ozone pollution and will decide during 1996 whether to require controls. If Texas decides to regulate NOx, the cost of such control equipment for the affected GSU plants is estimated at $10.4 million through the year 2000.\nIn accordance with the Act, the EPA promulgated operating permit regulations in 1994 that may set new operating criteria for fossil plants relating to fuels, emissions, and equipment maintenance practices. Some or all Entergy Companies may also have to install additional CEM equipment as a result of these regulations. The cost will be determined on a state-by-state basis as the plants are granted permits during 1996 and 1997. Related capital and operation and maintenance costs are expected to begin in 1996, but are not expected to be material. The authority to impose permit fees under this program has been delegated to the states by the EPA and, depending on the outcomes of various decisions of each state regulatory authority, total permit fees for the System could range from $1.6 to $5.0 million annually.\nOther Environmental Matters\nThe 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 or operators of any such site, to clean-up the site or reimburse such clean-up costs. CERCLA has been interpreted to impose joint and several liability on responsible parties. The System companies sent waste materials to various disposal sites over the years. Also, certain operating procedures and maintenance practices, that historically were not subject to regulation, are now regulated by environmental laws. Some of these sites have been the subject of governmental action under CERCLA, as a result of which the System companies have become involved with site clean-up activities. The System companies have participated to various degrees in accordance with their potential liability in such site clean-ups and have developed experience with clean-up costs. The System companies have established reserves for such environmental clean-up\/restoration activities. In the aggregate, the cost of such remediation is not considered material to the System.\nAP&L\nAP&L has received notices from time to time from the EPA, the Arkansas Department of Pollution Control and Ecology (ADPC&E), and others alleging that it, along with others, may be a PRP for clean-up costs associated with various sites in Arkansas. Most of these sites are neither owned nor operated by any System company. Contaminants at the sites include polychlorinated biphenyls (PCBs), lead, and other hazardous substances.\nIn response to such notices from the EPA and the ADPC&E, the sites discussed below have been remediated:\nAt the EPA's request, AP&L voluntarily performed stabilization activities at the Benton Salvage site in Saline County, Arkansas. While the EPA has not named PRPs for this site, AP&L has negotiated an agreement with the EPA to remove waste stored at the site. AP&L will spend approximately $250,000 to remove and dispose of waste material at the Benton Salvage site. Although GSU and LP&L have had minor involvement in the Benton Salvage site, no remediation action is anticipated by these companies.\nAs a result of an internal investigation, AP&L has identified soil contamination at AP&L-owned sites located in Blytheville and Pine Bluff, Arkansas. The contamination appears to be a result of operating procedures that were performed prior to any applicable environmental regulation. Remediation of the Blytheville and Pine Bluff sites was completed in 1995 at a total cost of approximately $2.25 million.\nReynolds Metals Company (Reynolds) and AP&L notified the EPA in 1989 of possible PCB contamination at two former Reynolds plant sites (Jones Mill and Patterson) in Arkansas to which AP&L had supplied power. Subsequently, AP&L completed remediation at the substations serving the plant sites at a cost of $1.7 million. Additional PCB contamination was found in a portion of a drainage ditch that flows from the Patterson facility to the Ouachita River. Reynolds demanded that AP&L participate in remediation efforts with respect to the ditch. AP&L and independent contractors engaged by AP&L conducted an investigation of the ditch contamination and the possible migration of PCBs from the electrical equipment that AP&L maintained at the plant. The investigation concluded that little, if any, of the contamination was caused by AP&L. AP&L has thus far expended approximately $150,000 on investigation of the ditch. In May 1995, AP&L was named as a defendant in a suit by Reynolds seeking to recover a share of its costs associated with the clean-up of hazardous substances at the Patterson site. Reynolds alleges that it has spent $11.2 million to clean-up the site, and that AP&L bears some responsibility for PCB contamination at the site. AP&L believes that it has no liability for contamination at the Patterson site and is contesting the lawsuit.\nAP&L entered into a Consent Administrative Order, dated February 21, 1991, with the ADPC&E that named AP&L as a PRP for the initial stabilization associated with contamination at the Utilities Services, Inc. state Superfund site located near Rison, Arkansas. This site was found to have soil contaminated by PCBs and pentachlorophenol (a wood preservative). Containers and drums that contained PCBs and other hazardous substances were found at the site. AP&L's share of total remediation costs is estimated to range between $3.0 and $5.0 million. AP&L is attempting to identify and notify other PRPs with respect to this site. AP&L has received assurances that the ADPC&E will use its enforcement authority to allocate remediation expenses among AP&L and any other PRPs that can be identified. Approximately 20 PRPs have been identified to date. AP&L has performed the activities necessary to stabilize the site, at a cost of approximately $350,000. AP&L believes that its potential liability for this site will not be material.\nGSU\nGSU has been designated by the EPA as a PRP for the clean-up of certain hazardous waste disposal sites. GSU is currently negotiating with the EPA and state authorities regarding the clean-up of these sites. Several class action and other suits have been filed in state and federal courts seeking relief from GSU and others for damages caused by the disposal of hazardous waste and for asbestos-related disease allegedly resulting from exposure on GSU premises (see \"Other Regulation and Litigation\" below). While the amounts at issue may be substantial, GSU believes that its results of operations and financial condition will not be materially adversely affected by the outcome of the suits. Through December 31, 1995, $7.9 million has been expended on clean-up activities. As of December 31, 1995, a remaining recorded liability of $21.7 million existed relating to the clean-up of five sites at which GSU has been designated a PRP.\nIn 1971, GSU purchased property near its Sabine generating station, known as the Bailey site, for possible expansion of cooling water facilities. Although it was not known to GSU at the time, the property was utilized by area industries in the 1950's and 1960's as an industrial waste dump. GSU sold the property in 1984. In October 1984, an abandoned waste site on the property was included on the Superfund National Priorities List (NPL) by the EPA. GSU has pursued negotiations with the EPA and is a member of a task force with other PRPs for the voluntary clean-up of the waste site. A Consent Decree has been signed by all PRPs for the voluntary clean-up of the Bailey site. Additional wastes have been discovered at the site since the original clean-up costs were estimated. Remediation of the Bailey site is being redesigned and costs are currently expected to be approximately $33 million. GSU is expected to be responsible for 2.26% of the estimated clean-up cost. Federal and state agencies are presently examining potential liabilities associated with natural resource damages. This matter is currently under negotiation with the other PRPs and the agencies. GSU does not believe that its ultimate responsibility with respect to this site will be material after allowance for the existing clean-up reserve in the amount of $760,000.\nGSU is currently involved in a multi-phased remedial investigation of an abandoned manufactured gas plant (MGP) site, known as the Lake Charles Service Center, located in Lake Charles, Louisiana. The property was the site of an MGP that is believed to have operated from approximately 1916 to 1931. Coal tar, a by-product of the distillation process employed at MGPs, was apparently routed to a portion of the property for disposal. The same area has also been used as a landfill. Under an order issued by the Louisiana Department of Environmental Quality (LDEQ), which is currently stayed, GSU was required to investigate and, if necessary, take remedial action at the site. Preliminary estimates of remediation costs are approximately $20 million. On February 13, 1995, the EPA published a proposed rule adding the Lake Charles Service Center to the NPL. Another PRP has been identified and is believed to have had a role in the ownership and operation of the MGP. Negotiations with that company for joint participation and possible remedial action have been held and are expected to continue. GSU currently is awaiting notification from the EPA before initiating additional clean-up negotiations or actions. GSU does not presently believe that its ultimate responsibility with respect to this site will be material, after allowance for the existing clean-up reserve of $19.8 million.\nGSU along with LP&L has been named as a PRP for an abandoned waste oil recycling plant site in Livingston Parish, Louisiana, known as Combustion, Inc., which is included on the NPL. Although most surface remediation has been completed, additional studies related to residual groundwater contamination are expected to continue in 1996. GSU and LP&L have been named as defendants in a class action lawsuit lodged against a group of PRPs associated with the site. (For information regarding litigation in connection with the Combustion, Inc. site, see \"Other Regulation and Litigation\" below.) GSU does not presently believe that its ultimate responsibility with respect to this site will be material.\nGSU received notification in 1992 from the EPA of potential liability at a site located in Iota, Louisiana. This site was the depository of a variety of wastes, including medical and chemical wastes. In addition to GSU, over 200 parties have been named as PRPs. The EPA has completed remediation at the Iota site. However, it is continuing its investigation of the site and has notified the PRPs of the possibility of this site being linked to other sites. GSU does not believe it is implicated in these other sites. GSU has not received notification of liability or location with regard to the other sites, and does not believe that its ultimate responsibility with respect to these other sites will be material.\nGSU, along with AP&L and LP&L, has been notified of its potential liability with respect to the Benton Salvage site located in Saline County, Arkansas. Although GSU and LP&L have had minor involvement in the Benton Salvage site, no remediation action is anticipated by these companies. See \"AP&L\" above for a discussion of the Benton Salvage site.\nLP&L, NOPSI, and System Energy\nLP&L, NOPSI, and System Energy have received notices from the EPA and\/or the states of Louisiana and Mississippi that one or more than one company may be a PRP for disposal sites that are neither owned nor operated by any System company. In response to such notices the sites discussed below have been remediated:\nLP&L and NOPSI have completed remediation at the Rose Chemical site located in Missouri and the aggregate remaining costs are considered immaterial.\nLP&L, along with AP&L and GSU, was notified in 1990 of its potential liability at the Benton Salvage site located in Saline County, Arkansas. Although GSU and LP&L have been involved in the Benton Salvage site, their contributions are considered minor; and therefore, no remediation action is required by these companies. See \"AP&L\" above for a discussion of the Benton Salvage site.\nThe EPA named LP&L and System Energy as two of the 44 PRPs for the Disposal Systems, Inc. site in Mississippi. The State of Mississippi has indicated that it intends to have the PRPs conduct a clean-up of the Disposal Systems, Inc. site but has not yet taken formal action. LP&L has settled this matter with the EPA. The State of Mississippi is continuing to evaluate whether additional remediation measures are necessary. However, further remediation costs at the Disposal Systems, Inc. site are not expected to be material.\nNOPSI received notice from the EPA with respect to a Mississippi site, known as Pike County, in the fall of 1994. The EPA alleged that NOPSI sold and shipped hazardous waste to the Pike County site during 1983 and 1984. NOPSI has negotiated a final settlement with the EPA for remediation of the site and no further costs are expected.\nFrom 1992 to 1994, LP&L performed site assessments and remedial activities at three retired power plants, known as the Homer, Jonesboro, and Thibodaux municipal sites, previously owned and operated by Louisiana municipalities. LP&L purchased the power plants as part of the acquisition of municipal electric systems after operating them for the last few years of their useful lives. The site assessments indicated some subsurface contamination from fuel oil. LP&L has completed all remediation work to the LDEQ's satisfaction for these three former generating plants, and follow-up sampling has been completed at the Homer site. Sampling at the Jonesboro and Thibodaux sites is expected to be completed in 1996. The costs incurred through December 31, 1995 for the Homer, Jonesboro, and Thibodaux sites are $22,000, $156,000, and $34,000, respectively. Any remaining costs are considered immaterial.\nThere are certain disposal sites in which LP&L and NOPSI have been named by the EPA as PRPs for associated clean-up costs, but management believes no liability exists in connection with these sites for LP&L and NOPSI. Such Louisiana sites include Combustion Inc., an abandoned waste oil recycling plant site located in Livingston Parish (involving at least 70 PRPs, including GSU), and the Dutchtown site (also included on the NPL and involving 57 PRPs). LP&L has found no evidence of its involvement in the Combustion Inc. site. (For information regarding litigation in connection with the Livingston Parish site, see \"Other Regulation and Litigation,\" below). With respect to the Dutchtown site, NOPSI believes it has no liability because the material it sent to this site was not a hazardous substance.\nDuring 1993, the LDEQ issued new rules for solid waste regulation, including regulation of waste water impoundments. LP&L has determined that certain of its power plant waste water impoundments were affected by these regulations and has chosen to upgrade or close them. As a result, a remaining recorded liability in the amount of $10.6 million existed at December 31, 1995, for waste water upgrades and closures to be completed by the end of 1996. Cumulative expenditures relating to the upgrades and closures of waste water impoundments were $5.6 million as of December 31, 1995.\nOther Regulation and Litigation\nMerger (Entergy Corporation and GSU)\nIn July and August 1992, Entergy Corporation and GSU filed applications with FERC, the LPSC, and the PUCT, and Entergy Corporation, Entergy Operations, and Entergy Services filed an application with the SEC under PUHCA, seeking authorization of various aspects of the Merger. In January 1993, GSU filed two applications with the NRC seeking approval of the change in ownership of GSU and an amendment to the operating license for River Bend to reflect its operation by Entergy Operations. All regulatory approvals were obtained in 1993 and the Merger was consummated on December 31, 1993.\nFERC's December 15, 1993, and May 17, 1994, orders approving the Merger were appealed to the D.C. Circuit by Entergy Services, the City, the Arkansas Electric Energy Consumers (AEEC), the APSC, Cajun, the MPSC, the American Forest and Paper Association, the State of Mississippi, the City of Benton and other cities, and Occidental Chemical Corporation (Occidental). Entergy seeks review of FERC's deletion of a 40% cap on the amount of fuel savings GSU may be required to transfer to other Entergy operating companies under a tracking mechanism designed to protect the other companies from certain unexpected increases in fuel costs. The other parties are seeking to overturn FERC's decisions on various grounds, including the issues of whether FERC appropriately conditioned the Merger to protect various interested parties from alleged harm and FERC's reliance on Entergy's transmission tariff to mitigate any potential anticompetitive impacts of the Merger.\nOn November 18, 1994, the D. C. Circuit denied motions filed by Cajun, Occidental, and AEEC for a remand to FERC and a partial summary grant of the petitions for review. At the same time, the D.C. Circuit ordered that the cases be held in abeyance pending FERC's issuance of (1) a final order on remand in the proceedings on Entergy's transmission tariff, see discussion of tariff case in \"RATE MATTERS AND REGULATION - Rate Matters - Wholesale Rate Matters - Open Access Transmission\" above, and (2) a final order on competition issues in the proceedings on the Merger.\nOn December 30, 1993, Entergy Services submitted to FERC tariff revisions to comply with FERC's order dated December 15, 1993, approving the Merger. On February 4, 1994, the APSC and AEEC filed with FERC a joint protest to the compliance filing. They alleged that Entergy must insulate the ratepayers of AP&L, LP&L, MP&L, and NOPSI from all litigation liabilities related to GSU's River Bend nuclear facility. In its May 17, 1994, order on rehearing, FERC addressed Entergy's commitment to insulate the customers of AP&L, LP&L, MP&L, and NOPSI against liability resulting from certain litigation involving River Bend. In response to FERC's clarification of Entergy's commitment, Entergy Services filed a compliance filing on June 16, 1994, which amended certain System Agreement language submitted with the December 30, 1993, filing. APSC and AEEC subsequently filed protests questioning the adequacy of Entergy's June 16, 1994, compliance filing. Entergy filed an answer to the protest reiterating its full compliance with the requirements of FERC's May 17, 1994, order on rehearing. FERC has not yet acted on the compliance filings.\nRequests for rehearing of the SEC order were filed with the SEC by Houston Industries Incorporated and Houston Lighting & Power Company on December 28, 1993, and petitions for review seeking to set aside the SEC order were filed with the D.C. Circuit by these parties and by Cajun in February 1994. The matter has been remanded by the D.C. Circuit to the SEC for further consideration in light of developments at FERC relating to Entergy's transmission tariffs.\nAppeals seeking to set aside the LPSC order related to the Merger were filed in the 19th Judicial District Court for the Parish of East Baton Rouge, Louisiana, by Houston Lighting & Power Company on August 13, 1993, and by the Alliance for Affordable Energy, Inc. on August 20, 1993. Subsequently, on February 9, 1994, Houston Lighting & Power Company filed a motion voluntarily dismissing its appeal. In judgments issued in February and November 1995, the 19th Judicial District Court dismissed the appeals of the Alliance for Affordable Energy, Inc.\nFlowage Easement Suits (AP&L)\nThree lawsuits (subsequently consolidated into one) were filed in the Arkansas District Court by numerous plaintiffs against AP&L and Entergy Services in connection with the operation of two dams during a period of heavy rainfall and flooding in May 1990. The consolidated lawsuits sought approximately $14.4 million in property losses and other compensatory damages, and $500 million in punitive damages. In their responses to these complaints, AP&L and Entergy Services asserted, among other things, that AP&L owns flowage easements giving it the permanent right to inundate the lands owned or occupied by the plaintiffs in connection with the operation of the dams. Rulings issued by the Arkansas District Court in June and November 1991 found that AP&L had the right to enforce its flowage easements and that Entergy Services was entitled to the benefit of AP&L's flowage easements. Such rulings removed from consideration damages in the approximate amount of $13.5 million alleged to have occurred within the areas covered by the easements. As a result, over 300 plaintiffs claiming damage within the easements were dismissed from the consolidated case in December 1991. Certain plaintiffs appealed the Arkansas District Court rulings to the Eighth Circuit, and these appeals were ultimately denied in December 1993. The remaining plaintiffs, to whom the flowage easements did not apply, had obtained a stay and an administrative termination of their claims, pending the outcome of the appeal. On February 10, 1995, such plaintiffs petitioned the Arkansas District Court to reopen the proceedings as to their claims. In March 1995, the Arkansas District Court ordered the reopening of the proceedings relating to the plaintiffs' claims which were previously stayed and administratively terminated, and the claims were subsequently tried. On November 9, 1995, the Arkansas District Court dismissed all remaining plaintiffs' claims, resolving the case in favor of AP&L.\nAsbestos and Hazardous Waste Suits\n(GSU and LP&L)\nA number of plaintiffs who allegedly suffered damage or injury, or are survivors of persons who allegedly died, as a result of exposure to \"hazardous toxic waste\" that emanated from a site in Livingston Parish, sued GSU and approximately 70 other defendants, including LP&L, in 17 suits filed in the Livingston Parish, Louisiana District Court (State District Court). The plaintiffs alleged that the defendants generated, transported, or participated in the storage of such wastes at the facility, which was previously operated as a waste oil recycling facility. These State District Court suits, which seek damages in total amounts ranging from $1 million to $10 billion and are now consolidated in a class action, and three federal suits in three states other than Louisiana involving issues arising from the same facility, have been removed and transferred, respectively, to the U.S. District Court for the Middle District of Louisiana. No assurances can be given to the timing or outcome of these suits.\n(GSU)\nA total of six suits have been filed on behalf of approximately 3,415 plantiffs in state and federal courts in Jefferson County, Texas. These suits seek relief from GSU as well as numerous other defendants for damages caused by the alleged exposure to hazardous waste and asbestos on the defendants' premises. At least five other individual suits have been filed in Beaumont against GSU and others, seeking damages for alleged asbestos exposure. All of the plaintiffs in such suits are also suing GSU and all other defendants on a conspiracy count. It is not yet known how many of the plantiffs in the suits discussed above worked on GSU's premises. There have been approximately 55 asbestos-related law suits filed in the District Court of Calcasieu Parish in Lake Charles, Louisiana, on behalf of an aggregate of 119 plaintiffs naming numerous defendants including GSU, and GSU expects additional cases to be filed. The suits allege that each plaintiff contracted an asbestos-related disease from exposure to asbestos insulation products on the premises of such defendants. Settlements of the two largest of the Jefferson County suits (involving about 1,660 groups of claimants) and 38 suits in Calcasieu Parish (involving approximately 91 plantiffs) have been consummated. GSU was named as one of a number of defendants in nearly all of the suits. GSU's share of the settlements of these cases was not material to its financial position or results of operations.\nCajun - River Bend Litigation (Entergy Corporation and GSU)\nGSU has significant business relationships with Cajun, including co-ownership of River Bend (operated by GSU) and Big Cajun 2, Unit 3 (operated by Cajun). GSU and Cajun, respectively, own 70% and 30% undivided interests in River Bend and 42% and 58% undivided interests in Big Cajun 2, Unit 3. Cajun is currently in reorganization proceedings under the United States Bankruptcy Code.\nIn June 1989, Cajun filed a civil action against GSU in the United States District Court for the Middle District of Louisiana (District Court). Cajun's complaint seeks to annul, rescind, terminate and\/or dissolve the Joint Ownership Participation and Operating Agreement (Operating Agreement) entered into on August 28, 1979 relating to River Bend. Cajun alleges fraud and error by GSU, breach of its fiduciary duties owed to Cajun and\/or GSU's repudiation, renunciation, abandonment or dissolution of its core obligations under the Operating Agreement, as well as the lack or failure of cause and\/or consideration for Cajun's performance under the Operating Agreement. The suit also seeks to recover Cajun's alleged $1.6 billion investment in the unit as damages, plus attorneys' fees, interest, and costs. Two member cooperatives of Cajun have brought an independent action to declare the Operating Agreement void, based upon failure to get prior LPSC approval alleged to be necessary. GSU believes the suits are without merit and is contesting them vigorously.\nA trial on the portion of the suit by Cajun to rescind the Operating Agreement began in April 1994 and was completed in March 1995. On October 24, 1995, the District Court issued a memorandum opinion ruling in favor of GSU. The District Court found that Cajun did not prove that GSU fraudulently induced it to execute the Operating Agreement and that Cajun failed to timely assert its claim. A final judgment on this portion of the suit is not expected to be entered until all claims asserted by Cajun have been heard. The trial of the second portion of the suit currently is scheduled to begin on July 2, 1996. If GSU is ultimately unsuccessful in this litigation and is required to pay substantial damages, GSU would probably be unable to make such payments and could be forced to seek relief from its creditors under the United States Bankruptcy Code. If GSU prevails in this litigation, there can be no assurance that the United States Bankruptcy Court will allow funding by Cajun of all required costs of ownership in River Bend.\nIn the bankruptcy proceedings, Cajun filed a motion to reject the Operating Agreement as a burdensome executory contract. GSU responded on January 10, 1995, with a memorandum opposing Cajun's motion. If the District Court were to grant Cajun's motion to reject the Operating Agreement, Cajun would be relieved of its financial obligations under the contract, while GSU would likely have a substantial damage claim arising from any such rejection. Although GSU believes that Cajun's motion to reject the Operating Agreement is without merit, it is not possible to predict the outcome or ultimate impact of these proceedings.\nSee Note 8 for additional information regarding the Cajun litigation, Cajun's bankruptcy filing, related filings, and the ongoing potential effects of these matters upon GSU.\nAs the result of an order issued by the District Court in August 1995, a former federal bankruptcy judge, Ralph Mabey, was appointed as trustee to oversee Cajun in bankruptcy. The LPSC and Cajun appealed the appointment of a trustee to the Fifth Circuit where the action of the District Court was reversed and remanded for further proceedings. However, in January 1996, the Fifth Circuit reversed its original position and affirmed the appointment of the trustee.\nIn October 1995, the appeals court affirmed the District Court's preliminary injunction in the Cajun litigation. The preliminary injunction stipulated that GSU should make payments for its portion of expenses for Big Cajun 2, Unit 3 into the registry of the District Court. As of December 31, 1995, $38 million had been paid by GSU into the registry of the District Court.\nCajun has not paid its full share of capital costs, operating and maintenance expenses and other costs for repairs and improvements to River Bend since 1992. However, Cajun continues to pay its share of decommissioning costs for River Bend. Cajun's unpaid portion of River Bend operating and maintenance expenses (including nuclear fuel) and capital costs for 1995 was approximately $58.7 million. The cumulative cost (excluding nuclear fuel) to GSU resulting from Cajun's failure to pay its full share of River Bend-related costs, reduced by the proceeds from the sale by GSU of Cajun's share of River Bend power and payments for GSU's portion of expenses for Big Cajun 2, Unit 3 into the registry of the District Court, was $31.1 million as of December 31, 1995. These amounts are reflected in long-term receivables with an offsetting reserve in other deferred credits. Cajun's bankruptcy may affect the ultimate collectibility of the amounts owed to GSU, including any amounts that may be awarded in litigation.\nCajun - Transmission Service (Entergy Corporation and GSU)\nGSU and Cajun are parties to FERC proceedings relating to transmission service charge disputes. See Note 8 for additional information regarding these FERC proceedings, FERC orders issued as a result of such proceedings and the potential effects of these proceedings upon GSU.\nOn December 7, 1993, Cajun filed a complaint in the Middle District of Louisiana alleging that GSU failed to provide Cajun an opportunity to construct certain facilities that allegedly would have reduced its rates under Service Schedule CTOC, and is seeking an order compelling the conveyance of certain facilities and awarding unspecified damages. GSU has moved to dismiss the complaint on the basis, among others, that FERC has already addressed the matter in the proceedings described in Note 8.\nService Area Dispute\n(Entergy Corporation and GSU)\nGSU was requested by Cajun and Jefferson Davis Electric Cooperative, Inc. (Jefferson Davis), to provide the transmission of power over GSU's system for delivery to an area near Lake Charles, Louisiana. GSU provides electric service to industrial and other customers in this area, and Cajun and Jefferson Davis do not. In October 1989, Cajun filed a complaint at FERC contending that GSU wrongfully refused to provide Cajun certain transmission services so that its member, Jefferson Davis, could provide service to certain industrial customers, and it requested FERC to order GSU to provide the service. Subsequently, the FERC summarily dismissed Cajun's complaint, but the D.C. Circuit reversed FERC's summary determination and remanded the case to FERC for a hearing. Ultimately, in March 1994, the FERC issued an order dismissing Cajun's complaint and finding that GSU properly exercised its contractual right to refuse to provide transmission service to Cajun. In August 1994, the FERC denied a rehearing. Subsequently, Cajun filed a petition for review of the FERC's orders in the D.C. Circuit. In October 1995, the D.C. Circuit affirmed the FERC's previous opinion in its entirety.\nCajun and Jefferson Davis also brought a related action in federal court in the Western District of Louisiana alleging that GSU breached its obligations under the parties' contract and violated the antitrust laws by refusing to provide the transmission service described above. Cajun and Jefferson Davis seek an injunction requiring GSU to provide the requested service and unspecified treble damages for GSU's refusal to provide the service. In November 1989, the district court denied Cajun's and Jefferson Davis' motion for a preliminary injunction. In May 1991, the judge stayed the proceeding pending final resolution of the matters still pending before FERC.\n(Entergy Corporation and MP&L)\nOn October 11, 1994, twelve Mississippi cities filed a complaint in state court against MP&L and eight electric power associations seeking a judgment from the court declaring unconstitutional certain Mississippi statutes that establish the procedure that must be followed before a municipality can acquire the facilities and certificate rights of a utility serving in the municipality. Specifically, the suit requests that the court declare unconstitutional certain 1987 amendments to the Mississippi Public Utilities Act that require that the MPSC cancel a utility's certificate to serve in the municipality before a municipality may acquire a utility's facilities located in the municipality. The suit also requests that the court find that Mississippi municipalities can serve any consumer in the boundaries of the municipality and within one mile thereof. On January 6, 1995, MP&L and the other defendants filed motions to dismiss. In October 1995, the state court dismissed the complaint. The plaintiffs have appealed the dismissal to the Mississippi Supreme Court.\nCajun\/River Bend Repairs (Entergy Corporation and GSU)\nIn December 1991, Cajun filed a complaint seeking declaratory and injunctive relief from the U. S. District Court for the Middle District of Louisiana. The complaint concerns GSU's position that Cajun has defaulted on the payment of its share of certain expenditures to repair corrosion damage in the service water system, to repair a feedwater nozzle crack and to repair a turbine rotor. Cajun alleges that it has no obligation to pay its share of such costs and seeks a declaration that it may elect not to participate in the funding of such costs and that GSU may not demand payment or attempt to implement default provisions in the Operating Agreement. Cajun alleges that if it is required to pay its share of such costs it would be forced to default on other obligations. See \"Cajun - River Bend\" above for information regarding Cajun's bankruptcy filing. GSU believes that Cajun is in default under the provisions of the Operating Agreement. No assurance can be given as to the outcome or timing of this action brought by Cajun.\nTaxes Paid Under Protest (Entergy Corporation and LP&L)\nSince the mid-1980's, LP&L and the tax authorities of St. Charles Parish, Louisiana (Parish), the parish in which Waterford 3 is located, have disputed use taxes paid on nuclear fuel ($4.9 million through 1989) under protest by LP&L. LP&L continues to be successful in lawsuits in the Parish with regard to recovering these taxes, plus interest, and also with regard to Parish lease tax issues pertaining to fuel financing arrangements. In October 1994, Parish tax authorities sued LP&L and Entergy Corporation in the Civil District Court of Orleans Parish, Louisiana, claiming that $1.4 million of sales and use and lease taxes paid under protest by LP&L with respect to newly acquired nuclear fuel were not, in fact, paid under protest, and that unspecified additional taxes, interest, and penalties are due. Subsequently, the suit filed by the Parish tax authorities was dismissed. In September 1995, LP&L similarly paid use tax under protest in the amount of $209,000 with regard to the delivery of a new batch of fuel. In June 1995, LP&L received a favorable decision from the Louisiana Fifth Circuit Court of Appeals that confirmed that no such use taxes are due. The Parish and LP&L are currently discussing a possible settlement of all pending tax-related litigation including the likely return of the amounts paid under protest in October 1994 and September 1995. The suits by LP&L with regard to state use tax paid under protest on nuclear fuel are still pending.\nFederal Income Tax Audit (Entergy Corporation, LP&L, and System Energy)\nIn August 1994, Entergy received an IRS report covering the federal income tax audit of Entergy Corporation and subsidiaries for the years 1988 - 1990. The report asserts an $80 million tax deficiency for the 1990 consolidated federal income tax returns related primarily to the application of accelerated investment tax credits associated with Waterford 3 and Grand Gulf nuclear plants. Entergy Corporation believes there is no material tax deficiency and is vigorously contesting the proposed assessment.\nPanda Energy Corporation Complaint (Entergy Corporation)\nPanda Energy Corporation (Panda) has commenced litigation in the Dallas District Court naming Entergy Corporation, Energy Enterprises, Entergy Power, Entergy Power Asia, Ltd., and Entergy Power Development Corporation as defendants. The allegations against the defendants include, among others, tortious interference with contractual relations, conspiracy, misappropriation of corporate opportunity, unfair competition and fraud, and constructive trust issues. Panda seeks damages of approximately $4.8 billion, of which $3.6 billion is claimed in punitive damages. Entergy believes that this lawsuit is without merit, that the damages claimed are insupportable, and that some or all of the claims against Entergy will be dismissed. However, no assurance can be given as to the timing or outcome of this matter.\nCatalyst Technologies, Inc. (Entergy Corporation)\nIn June 1993 Catalyst Technologies, Inc. (CTI) filed a petition against Electec, Inc. (Electec), the predecessor to Entergy Enterprises. Prior to the filing of the petition, CTI and Electec entered into an agreement whereby CTI was required to raise a specified amount of funding in exchange for the right to acquire Electec's computer software technology marketing rights. CTI alleges that due to actions of Electec, it was unable to secure the necessary funding, and therefore, was not able to meet the terms of the agreement. The petition alleges breach of contract, breach of the obligation of good- faith and fair dealing, and bad-faith breach of contract against Electec. Subsequent to the filing of the petition, CTI indicated that it is seeking to recover approximately $36 million from Entergy Enterprises. No trial date has been set at this time. No assurance can be given as to the timing or outcome of this matter.\nEARNINGS RATIOS OF OPERATING COMPANIES AND SYSTEM ENERGY\nThe Operating Companies and System Energy's ratios of earnings to fixed charges and ratios of earnings to fixed charges and preferred dividends pursuant to Item 503 of SEC Regulation S-K are as follows:\n(a) \"Preferred Dividends\" in the case of GSU also include dividends on preference stock.\n(b) Earnings for the year ended December 31, 1991, include the $90 million effect of the 1991 NOPSI Settlement.\n(c) Earnings for the year ended December 31, 1993, include approximately $81 million, $52 million, and $18 million for AP&L, MP&L, and NOPSI, respectively, related to the change in accounting principle to provide for the accrual of estimated unbilled revenues.\n(d) Earnings for the year ended December 31, 1994, for GSU were not adequate to cover fixed charges and combined fixed charges and preferred dividends by $144.8 million and $197.1 million, respectively.\nINDUSTRY SEGMENTS\nNOPSI\nNarrative Description of NOPSI Industry Segments\nElectric Service\nNOPSI supplied retail electric service to 190,332 customers as of December 31, 1995. During 1995, 39% of electric operating revenues was derived from residential sales, 40% from commercial sales, 6% from industrial sales, and 15% from sales to governmental and municipal customers.\nNatural Gas Service\nNOPSI supplied retail natural gas service to 153,370 customers as of December 31, 1995. During 1995, 56% of gas operating revenues was derived from residential sales, 19% from commercial sales, 9% from industrial sales, and 16% from sales to governmental and municipal customers. (See \"FUEL SUPPLY - Natural Gas Purchased for Resale.\")\nSelected Financial Information Relating to Industry Segments\nFor selected financial information relating to NOPSI's industry segments, see NOPSI's financial statements and Note 14.\nEmployees by Segment\nNOPSI's full-time employees by industry segment as of December 31, 1995, were as follows:\nElectric 378 Natural Gas 111 --- Total 489 ===\n(For further information with respect to NOPSI's segments, see \"PROPERTY.\")\nGSU\nFor the year ended December 31, 1995, 96% of GSU's operating revenues was derived from the electric utility business. Of the remaining operating revenues 3% was derived from the steam business and 1% from the natural gas business.\nPROPERTY\nGenerating Stations\nThe total capability of the System's owned and leased generating stations as of December 31, 1995, by company and by fuel type, is indicated below:\n(1) \"Owned and Leased Capability\" is the dependable load carrying capability as demonstrated under actual operating conditions based on the primary fuel (assuming no curtailments) that each station was designed to utilize.\n(2) Excludes the capacity of fossil-fueled generating stations placed on extended reserve as follows: AP&L - 506 MW; GSU - 405 MW; LP&L - 157 MW; MP&L - 73 MW; and NOPSI - 143 MW. Generating stations that are not expected to be utilized in the near-term to meet load requirements are placed in extended reserve shutdown in order to minimize operating expenses.\n(3) Excludes net capability of generating facilities owned by Entergy Power, which owns 809 MW of fossil-fueled capacity.\n(4) Includes 188 MW of capacity leased by AP&L through 1999.\nLoad and capacity projections are regularly reviewed in order to coordinate and recommend the location and time of installation of additional generating capacity and of interconnections in light of the availability of power, the location of new loads, and maximum economy to the System. Based on load and capability projections and bulk power availability, the System has no current need to install additional generating capacity. When new generation resources are needed, the System plans to meet this need with a variety of sources other than construction of new base load generating capacity. In the meantime, the System will meet capacity needs by, among other things, purchasing power in the wholesale power market and\/or removing generating stations from extended reserve shutdown.\nUnder the terms of the System Agreement, certain generating capacity and other power resources are shared among the Operating Companies. Among other things, the System Agreement provides that parties having generating capacity greater than their load requirements (long companies) shall sell receive payments from those parties having deficiencies in generating capacity (short companies) and an amount sufficient to cover certain of the long companies' costs, including operating expenses, fixed charges on debt, dividend requirements on preferred and preference stock, and a fair rate of return on common equity investment. Under the System Agreement, these charges are based on costs associated with the long companies' steam electric generating units fueled by oil or gas. In addition, for all energy exchanged among the Operating Companies under the System Agreement, the short companies are required to pay the cost of fuel consumed in generating such energy plus a charge to cover other associated costs (see \"RATE MATTERS AND REGULATION - Rate Matters - Wholesale Rate Matters - System Agreement,\" above, for a discussion of FERC proceedings relating to the System Agreement).\nThe System's business is subject to seasonal fluctuations, with the peak period occurring in the summer months. The System's 1995 (and all-time) peak demand of 19,590 MW occurred on August 16, 1995. The net System capability at the time of peak was 21,100 MW, net of off- system firm sales of 302 MW. The capacity margin at the time of the peak was approximately 7.2%, excluding units placed on extended reserve and capacity owned by Entergy Power.\nInterconnections\nThe electric power supply facilities of Entergy consist principally of steam-electric production facilities strategically located with reference to availability of fuel, protection of local loads, and other controlling economic factors. These are interconnected by a transmission system operating at various voltages up to 500 kilovolts. Generally, with the exception of Grand Gulf 1, Entergy Power's capacity and a small portion of MP&L's capacity, operating facilities or interests therein are owned by the System operating company serving the area in which the facilities are located. However, all of the System's generating facilities are centrally dispatched and operated in order to obtain the lowest cost sources of energy with a minimum of investment and the most efficient use of plant.\nIn addition to the many neighboring utilities with which the Operating Companies interconnect, the Operating Companies are members of the Southwest Power Pool, the primary purpose of which is to ensure the reliability and adequacy of the electric bulk power supply in the southwest region of the United States. The Southwest Power Pool is a member of the North American Electric Reliability Council. The Operating Companies are also members of the Western Systems Power Pool.\nGas Property\nAs of December 31, 1995, NOPSI distributed and transported natural gas for distribution solely within the limits of the City of New Orleans through a total of 1,421 miles of gas distribution mains and 40 miles of gas transmission lines. Koch Gateway Pipeline Company is a principal supplier of natural gas to NOPSI, delivering to 6 of NOPSI's 14 delivery points.\nAs of December 31, 1995, the gas properties of GSU were not material to GSU.\nTitles\nThe System's generating stations are generally located on properties owned in fee simple. The greater portion of the transmission and distribution lines of the Operating Companies has been constructed over property of private owners pursuant to easements or on public highways and streets pursuant to appropriate franchises. The rights of each Operating Company in the realty on which its facilities are located are considered by it to be adequate for its use in the conduct of its business. Minor defects and irregularities customarily found in properties of like size and character exist, but such defects and irregularities do not materially impair the use of the properties affected thereby. The Operating Companies generally have the right of eminent domain, whereby they may, if necessary, perfect or secure titles to, or easements or servitudes on, privately-held lands used or to be used in their utility operations.\nSubstantially all the physical properties owned by each Operating Company and System Energy, respectively, are subject to the lien of a mortgage and deed of trust securing the first mortgage bonds of such company. The Lewis Creek generating station is owned by GSG&T, Inc., and is not subject to the lien of the GSU mortgage securing the first mortgage bonds of GSU, but is leased to and operated by GSU. In the case of LP&L, certain properties are also subject to the liens of second mortgages securing other obligations of LP&L. In the case of MP&L and NOPSI, substantially all of their properties and assets are also subject to the second mortgage lien of their respective general and refunding mortgage bond indentures.\nFUEL SUPPLY\nEntergy's sources of generation and average fuel cost per KWh, excluding Entergy Power, for the years 1993-1995 were:\nThe System's actual 1995 and projected 1996 sources of generation, excluding Entergy Power, are:\n(a)Capacity and energy from System Energy's interest in Grand Gulf 1 is allocated as follows: AP&L - 36%; LP&L - 14%; MP&L - 33%; and NOPSI - 17%.\nThe balance of generation, which was immaterial, was provided by hydroelectric power.\nNatural Gas\nThe Operating Companies have long-term firm and short-term interruptible gas contracts. Long-term firm contracts comprise less than 40% of total System requirements but can be called upon, if necessary, to satisfy a significant percentage of the System's needs. Additional gas requirements are satisfied by short-term contracts and spot-market purchases. GSU has a transportation service agreement with a gas supplier that provides flexible natural gas service to certain generating stations by using such supplier's pipeline and gas storage facility.\nMany factors, including wellhead deliverability, storage and pipeline capacity, and demand requirements of end users influence the availability and price of natural gas supplies for power plants. Demand is tied to regional weather conditions as well as to the prices of other energy sources. Supplies of natural gas are expected to be adequate in 1996. However, pursuant to federal and state regulations, gas supplies to power plants may be interrupted during periods of shortage. To the extent natural gas supplies may be disrupted, the Operating Companies will use alternate fuels, such as oil, or rely on coal and nuclear generation.\nCoal\nAP&L has long-term contracts with mines in the State of Wyoming for the supply of low-sulfur coal for the White Bluff Steam Electric Generating Station and Independence. These contracts, which expire in 2002 and 2011, provide for approximately 85% of AP&L's expected annual coal requirements. Additional requirements are satisfied by annual spot market purchases. GSU has a contract for a supply of low-sulfur Wyoming coal for Nelson Unit 6, which should be sufficient to satisfy the fuel requirements at Nelson Unit 6 through 2004. Cajun has advised GSU that it has contracts that should provide an adequate supply of coal until 1999 for the operation of Big Cajun 2, Unit 3.\nNuclear Fuel\nThe nuclear fuel cycle involves the mining and milling of uranium ore to produce a concentrate, the conversion of uranium concentrate to uranium hexafluoride gas, enrichment of that gas, fabrication of nuclear fuel assemblies for use in fueling nuclear reactors, and disposal of the spent fuel.\nSystem Fuels is responsible for contracts to acquire nuclear material to be used in fueling AP&L's, LP&L's, and System Energy's nuclear units and maintaining inventories of such materials during the various stages of processing. Each of these companies contracts for the fabrication of its own nuclear fuel and purchases the required enriched uranium hexafluoride from System Fuels. The requirements for GSU's River Bend plant are covered by contracts made by GSU. Entergy Operations acts as agent for System Fuels and GSU in negotiating and\/or administering nuclear fuel contracts.\nIn October 1989, System Fuels entered into a revolving credit agreement with a bank that provides up to $45 million in borrowings to finance its nuclear materials and services inventory. Should System Fuels default on its obligations under its credit agreement, AP&L, LP&L, and System Energy have agreed to purchase nuclear materials and services under the agreement.\nBased upon the planned fuel cycles for the System's nuclear units, the following tabulation shows the years through which existing contracts and inventory will provide materials and services:\n(1) Current contracts will provide a significant percentage of these materials and services through termination dates ranging from 1996-1999. Additional materials and services required beyond these dates are estimated to be available for the foreseeable future.\n(2) Current contracts will provide a significant percentage of these materials and services through approximately 2000.\n(3) The Nuclear Waste Policy Act of 1982 provides for the disposal of spent nuclear fuel or high level waste by the DOE.\nThe System will enter into additional arrangements to acquire nuclear fuel beyond the dates shown above. Except as noted above, Entergy cannot predict the ultimate availability or cost of such arrangements at this time.\nAP&L, GSU, LP&L, and System Energy currently have arrangements to lease nuclear fuel and related equipment and services in aggregate amounts up to $130 million, $70 million, $80 million, and $80 million, respectively. As of December 31, 1995, the unrecovered cost base of AP&L's, GSU's, LP&L's, and System Energy's nuclear fuel leases amounted to approximately $98.7 million, $69.9 million, $72.9 million, and $71.4 million, respectively. The lessors finance the acquisition and ownership of nuclear fuel through credit agreements and the issuance of notes. These agreements are subject to annual renewal with, in LP&L's and GSU's case, the consent of the lenders. The credit agreements for AP&L, GSU, LP&L, and System Energy have been extended and now have termination dates of December 1998, December 1998, January 1999, and February 1999, respectively. The debt securities issued pursuant to these fuel lease arrangements have varying maturities through January 31, 1999. It is expected that the credit agreements will be extended or alternative financing will be secured by each lessor upon the maturity of the current arrangements. If extensions or alternative financing cannot be arranged, the lessee in each case must purchase sufficient nuclear fuel to allow the lessor to retire such borrowings.\nNatural Gas Purchased for Resale\nNOPSI has several suppliers of natural gas for resale. Its system is interconnected with three interstate and three intrastate pipelines. Presently, NOPSI's primary suppliers are Koch Gas Services Company (KGS), an interstate gas marketer, and Bridgeline and Pontchartrain, intrastate pipelines. NOPSI has a firm gas purchase contract with KGS. The KGS gas supply is transported to NOPSI pursuant to a \"No-Notice\" transportation service agreement with Koch Gateway Pipeline Company (KGPC). This service is subject to FERC-approved rates. NOPSI has firm contracts with its two intrastate suppliers and also makes interruptible spot market purchases. In recent years, natural gas deliveries have been subject primarily to weather-related curtailments. However, NOPSI has experienced no such curtailments.\nAfter the implementation of FERC-mandated interstate pipeline restructuring in 1993, curtailments of interstate gas supply could occur if NOPSI's suppliers failed to perform their obligations to deliver gas under their supply agreements. KGPC could curtail transportation capacity only in the event of pipeline system constraints. Based on the current supply of natural gas, and absent extreme weather-related curtailments, NOPSI does not anticipate any interruptions in natural gas deliveries to its customers.\nGSU purchases natural gas for resale under a \"No-Notice\" type of agreement from Mid Louisiana Gas Company. Abandonment of service by the present supplier would be subject to abandonment proceedings by FERC.\nResearch\nAP&L, GSU, LP&L, MP&L, and NOPSI are members of the Electric Power Research Institute (EPRI). EPRI conducts a broad range of research in major technical fields related to the electric utility industry. Entergy participates in various EPRI projects based on Entergy's needs and available resources. During 1995, 1994, and 1993, the System contributed approximately $9 million, $18 million, and $17 million, respectively, for the various research programs in which Entergy was involved.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nRefer to Item 1. \"Business - PROPERTY,\" for information regarding the properties of the registrants.\nItem 3.","section_3":"Item 3. Legal Proceedings\nRefer to Item 1. \"Business - RATE MATTERS AND REGULATION,\" for details of the registrants' material rate proceedings and other regulatory proceedings and litigation that are pending or that terminated in the fourth quarter of 1995.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nDuring the fourth quarter of 1995, no matters were submitted to a vote of the security holders of Entergy Corporation, AP&L, GSU, LP&L, MP&L, NOPSI, or System Energy.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrants' Common Equity and Related Stockholder Matters\nEntergy Corporation\nThe shares of Entergy Corporation's common stock are listed on the New York, Chicago, and Pacific Stock Exchanges.\nThe high and low prices of Entergy Corporation's common stock for each quarterly period in 1995 and 1994 were as follows:\nDividends of 45 cents per share were paid on Entergy Corporation's common stock in each of the quarters of 1995 and 1994.\nAs of February 29, 1996, there were 98,911 stockholders of record of Entergy Corporation.\nFor information with respect to Entergy Corporation's future ability to pay dividends, refer to Note 7, \"DIVIDEND RESTRICTIONS.\" In addition to the restrictions described in Note 7, PUHCA provides that, without approval of the SEC, the unrestricted, undistributed retained earnings of any Entergy Corporation subsidiary are not available for distribution to Entergy Corporation's common stockholders until such earnings are made available to Entergy Corporation through the declaration of dividends by such subsidiaries.\nAP&L, GSU, LP&L, MP&L, NOPSI, and System Energy\nThere is no market for the common stock of Entergy Corporation's subsidiaries as all shares are owned by Entergy Corporation. Cash dividends on common stock paid by the subsidiaries to Entergy Corporation during 1995 and 1994, were as follows:\nIn February 1996, Entergy Corporation received common stock dividend payments from its subsidiaries totaling $48.7 million. For information with respect to restrictions that limit the ability of System Energy and the Operating Companies to pay dividends, see Note 7.\nItem 6.","section_6":"Item 6. Selected Financial Data\nEntergy Corporation. Refer to information under the heading \"ENTERGY CORPORATION AND SUBSIDIARIES SELECTED FINANCIAL DATA - FIVE- YEAR COMPARISON.\"\nAP&L. Refer to information under the heading \"ARKANSAS POWER & LIGHT COMPANY SELECTED FINANCIAL DATA - FIVE-YEAR COMPARISON.\"\nGSU. Refer to information under the heading \"GULF STATES UTILITIES COMPANY SELECTED FINANCIAL DATA - FIVE-YEAR COMPARISON.\"\nLP&L. Refer to information under the heading \"LOUISIANA POWER & LIGHT COMPANY SELECTED FINANCIAL DATA - FIVE-YEAR COMPARISON.\"\nMP&L. Refer to information under the heading \"MISSISSIPPI POWER & LIGHT COMPANY SELECTED FINANCIAL DATA - FIVE-YEAR COMPARISON.\"\nNOPSI. Refer to information under the heading \"NEW ORLEANS PUBLIC SERVICE INC. SELECTED FINANCIAL DATA - FIVE-YEAR COMPARISON.\"\nSystem Energy. Refer to information under the heading \"SYSTEM ENERGY RESOURCES, INC. SELECTED FINANCIAL DATA - FIVE-YEAR COMPARISON.\"\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nEntergy Corporation and Subsidiaries. Refer to information under the heading \"ENTERGY CORPORATION AND SUBSIDIARIES MANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS - LIQUIDITY AND CAPITAL RESOURCES,\" \" - - - - - SIGNIFICANT FACTORS AND KNOWN TRENDS,\" and \"- RESULTS OF OPERATIONS.\"\nAP&L. Refer to information under the heading \"ARKANSAS POWER & LIGHT COMPANY MANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS - RESULTS OF OPERATIONS.\"\nGSU. Refer to information under the heading \"GULF STATES UTILITIES COMPANY MANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS - RESULTS OF OPERATIONS.\"\nLP&L. Refer to information under the heading \"LOUISIANA POWER & LIGHT COMPANY MANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS - RESULTS OF OPERATIONS.\"\nMP&L. Refer to information under the heading \"MISSISSIPPI POWER & LIGHT COMPANY MANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS - RESULTS OF OPERATIONS.\"\nNOPSI. Refer to information under the heading \"NEW ORLEANS PUBLIC SERVICE INC. MANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS - RESULTS OF OPERATIONS.\"\nSystem Energy. Refer to information under the heading \"SYSTEM ENERGY RESOURCES, INC. MANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS - RESULTS OF OPERATIONS.\"\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nEntergy Corporation and Subsidiaries: Report of Management 44 Audit Committee Chairperson's Letter 45 Management's Financial Discussion and Analysis for Entergy 46 Corporation and Subsidiaries Report of Independent Accountants for Entergy Corporation 55 and Subsidiaries Independent Auditors' Report for Entergy Corporation and 56 Subsidiaries Management's Financial Discussion and Analysis for Entergy 57 Corporation and Subsidiaries Statements of Consolidated Income For the Years Ended December 31, 1995, 1994, and 1993 for Entergy Corporation and 59 Subsidiaries Statements of Consolidated Cash Flows For the Years Ended December 31, 1995, 1994, and 1993 for Entergy Corporation and 60 Subsidiaries Balance Sheets, December 31, 1995 and 1994 for Entergy 62 Corporation and Subsidiaries Statements of Consolidated Retained Earnings and Paid-In Capital for the Years Ended December 31, 1995, 1994, and 1993 64 for Entergy Corporation and Subsidiaries Selected Financial Data - Five-Year Comparison for Entergy 65 Corporation and Subsidiaries Report of Independent Accountants for Arkansas Power & Light 66 Company Independent Auditors' Report for Arkansas Power & Light 67 Company Management's Financial Discussion and Analysis for Arkansas 68 Power & Light Company Statements of Income For the Years Ended December 31, 1995, 1994, and 1993 for Arkansas Power & Light Company 70 Statements of Cash Flows For the Years Ended December 31, 1995, 1994, and 1993 for Arkansas Power & Light Company 71 Balance Sheets, December 31, 1995 and 1994 for Arkansas 72 Power & Light Company Statements of Retained Earnings for the Years Ended December 31, 1995, 1994, and 1993 for Arkansas Power & Light Company 74 Selected Financial Data - Five-Year Comparison for Arkansas 75 Power & Light Company Report of Independent Accountants for Gulf States Utilities 76 Company Management's Financial Discussion and Analysis for Gulf 78 States Utilities Company Statements of Income For the Years Ended December 31, 1995, 1994, and 1993 for Gulf States Utilities Company 80 Statements of Cash Flows For the Years Ended December 31, 1995, 1994, and 1993 for Gulf States Utilities Company 81 Balance Sheets, December 31, 1995 and 1994 for Gulf States 82 Utilities Company Statements of Retained Earnings and Paid-In Capital for the Years Ended December 31, 1995, 1994, and 1993 for Gulf States 84 Utilities Company Selected Financial Data - Five-Year Comparison for Gulf 85 States Utilities Company Report of Independent Accountants for Louisiana Power & 86 Light Company Independent Auditors' Report for Louisiana Power & Light 87 Company Management's Financial Discussion and Analysis for Louisiana 88 Power & Light Company Statements of Income For the Years Ended December 31, 1995, 1994, and 1993 for Louisiana Power & Light Company 90 Statements of Cash Flows For the Years Ended December 31, 1995, 1994, and 1993 for Louisiana Power & Light Company 91 Balance Sheets, December 31, 1995 and 1994 for Louisiana 92 Power & Light Company Statements of Retained Earnings for the Years Ended December 31, 1995, 1994, and 1993 for Louisiana Power & Light Company 94 Selected Financial Data - Five-Year Comparison for Louisiana 95 Power & Light Company Report of Independent Accountants for Mississippi Power & 96 Light Company Independent Auditors' Report for Mississippi Power & Light 97 Company Management's Financial Discussion and Analysis for 98 Mississippi Power & Light Company Statements of Income For the Years Ended December 31, 1995, 1994, and 1993 for Mississippi Power & Light Company 100 Statements of Cash Flows For the Years Ended December 31, 1995, 1994, and 1993 for Mississippi Power & Light Company 101 Balance Sheets, December 31, 1995 and 1994 for Mississippi 102 Power & Light Company Statements of Retained Earnings for the Years Ended December 31, 1995, 1994, and 1993 for Mississippi Power & Light Company 104 Selected Financial Data - Five-Year Comparison for 105 Mississippi Power & Light Company Report of Independent Accountants for New Orleans Public 106 Service Inc. Independent Auditors' Report for New Orleans Public Service 107 Inc. Management's Financial Discussion and Analysis for New 108 Orleans Public Service Inc. Statements of Income For the Years Ended December 31, 1995, 1994, and 1993 for New Orleans Public Service Inc. 110 Statements of Cash Flows For the Years Ended December 31, 1995, 1994, and 1993 for New Orleans Public Service Inc. 111 Balance Sheets, December 31, 1995 and 1994 for New Orleans 112 Public Service Inc. Statements of Retained Earnings for the Years Ended December 31, 1995, 1994, and 1993 for New Orleans Public Service Inc. 114 Selected Financial Data - Five-Year Comparison for New 115 Orleans Public Service Inc. Report of Independent Accountants for System Energy 116 Resources, Inc. Independent Auditors' Report for System Energy Resources, 117 Inc. Management's Financial Discussion and Analysis for System 119 Energy Resources, Inc. Statements of Income For the Years Ended December 31, 1995, 1994, and 1993 for System Energy Resources, Inc. 120 Statements of Cash Flows For the Years Ended December 31, 1995, 1994, and 1993 for System Energy Resources, Inc. 121 Balance Sheets, December 31, 1995 and 1994 for System Energy 122 Resources, Inc. Statements of Retained Earnings for the Years Ended December 31, 1995, 1994, and 1993 for System Energy Resources, Inc. 124 Selected Financial Data - Five-Year Comparison for System 125 Energy Resources, Inc.. Notes to Financial Statements for Entergy Corporation and 126 Subsidiaries\nENTERGY CORPORATION AND SUBSIDIARIES\nREPORT OF MANAGEMENT\nThe management of Entergy Corporation and Subsidiaries has prepared and is responsible for the financial statements and related financial information included herein. The financial statements are based on generally accepted accounting principles. Financial information included elsewhere in this report is consistent with the financial statements.\nTo meet its responsibilities with respect to financial information, management maintains and enforces a system of internal accounting controls that is designed to provide reasonable assurance, on a cost-effective basis, as to the integrity, objectivity, and reliability of the financial records, and as to the protection of assets. This system includes communication through written policies and procedures, an employee Code of Conduct, and an organizational structure that provides for appropriate division of responsibility and the training of personnel. This system is also tested by a comprehensive internal audit program.\nThe independent public accountants provide an objective assessment of the degree to which management meets its responsibility for fairness of financial reporting. They regularly evaluate the system of internal accounting controls and perform such tests and other procedures as they deem necessary to reach and express an opinion on the fairness of the financial statements.\nManagement believes that these policies and procedures provide reasonable assurance that its operations are carried out with a high standard of business conduct.\n\/s\/Ed Lupberger \/s\/Gerald D. McInvale ED LUPBERGER GERALD D. MCINVALE Chairman, President, and Chief Executive Vice President and Executive Officer of Entergy Chief Financial Officer Corporation, AP&L, GSU, LP&L, MP&L and NOPSI\n\/s\/Donald C. Hintz DONALD C. HINTZ President and Chief Executive Officer of System Energy\nENTERGY CORPORATION AND SUBSIDIARIES\nAUDIT COMMITTEE CHAIRPERSON'S LETTER\nThe Entergy Corporation Board of Directors' Audit Committee is comprised of four directors who are not officers of Entergy Corporation: Lucie J. Fjeldstad, Chairperson, Dr. Norman C. Francis, James R. Nichols, and H. Duke Shackelford. The committee held four meetings during 1995.\nThe Audit Committee oversees Entergy Corporation's financial reporting process on behalf of the Board of Directors and provides reasonable assurance to the Board that sufficient operating, accounting, and financial controls are in existence and are adequately reviewed by programs of internal and external audits.\nThe Audit Committee discussed with Entergy's internal auditors and the independent public accountants (Coopers & Lybrand L.L.P.) the overall scope and specific plans for their respective audits, as well as Entergy Corporation's financial statements and the adequacy of Entergy Corporation's internal controls. The committee met, together and separately, with Entergy's internal auditors and independent public accountants, without management present, to discuss the results of their audits, their evaluation of Entergy Corporation's internal controls, and the overall quality of Entergy Corporation's financial reporting. The meetings also were designed to facilitate and encourage private communication between the committee and the internal auditors and independent public accountants.\n\/s\/Lucie J. Fjeldstad LUCIE J. FJELDSTAD Chairperson, Audit Committee\nENTERGY CORPORATION AND SUBSIDIARIES\nMANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS\nLIQUIDITY AND CAPITAL RESOURCES\nEntergy, AP&L, GSU, LP&L, MP&L, NOPSI, and System Energy\nCash Flows\nEntergy is involved in capital-intensive businesses, which require large investments in long-lived assets. While capital expenditures for the construction of new generating capacity are not currently planned, the System does require significant capital resources for the periodic maturity of debt and preferred stock, ongoing construction expenditures, and increasing investments in domestic and foreign energy- related businesses. Net cash flow from operations totaled $1.397 billion, $1.538 billion, and $1.074 billion in 1995, 1994, and 1993, respectively. Net cash flow from operations for the Operating Companies and System Energy was as follows:\nIn 1995, AP&L's net cash flow from operations decreased because of increases in customer accounts receivables due to increased 1995 sales and the replenishment of coal inventory which was depleted in 1994. This decrease was partially offset by lower other operation and maintenance expense. GSU's net cash flow from operations increased in 1995 due to higher revenues and lower operation and maintenance expenses. This increase was partially offset by a Texas retail rate refund, recorded in 1994 and paid in 1995. LP&L's net cash flow from operations increased in 1995 as a result of lower operation and maintenance expenses partially offset by a rate reduction in April 1995. MP&L's net cash flow from operations decreased in 1995 because of increased accounts receivable balances due to increased 1995 sales, partially offset by lower other operation and maintenance expenses. NOPSI's net cash flow from operations was higher in 1995 than 1994 because refunds that were made in 1994 as a result of the NOPSI settlement did not impact 1995 cash flow. Lower operation and maintenance expenses in 1995 for NOPSI also contributed to the increase. System Energy's net cash flow from operations decreased in 1995 due to refunds made to associated companies in 1995 as the result of a 1994 FERC audit settlement, and higher income tax payments in 1995.\nFinancing Sources\nIn recent years, cash flows of the Operating Companies, supplemented by cash on hand, have been sufficient to meet substantially all investing and financing requirements, including capital expenditures, dividends and debt\/preferred stock maturities. Entergy's ability to fund these capital requirements with cash from operations results, in part, from continued efforts to streamline operations and reduce costs, as well as from collections under rate phase-in plans that exceed current cash requirements for the related costs. (In the income statement, these revenue collections are offset by the amortization of previously deferred costs; therefore, there is no effect on net income.) These phase-in plans will continue to contribute to Entergy's cash position for the next several years. Specifically, the Grand Gulf 1 phase-in plans will expire in 1998 for AP&L and MP&L, and in 2001 for NOPSI.\nENTERGY CORPORATION AND SUBSIDIARIES\nMANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS\nLIQUIDITY AND CAPITAL RESOURCES\nGSU's phase-in plan for River Bend will expire in 1998, and LP&L's phase-in plan for Waterford 3 expires in 1996. In addition, the Operating Companies and System Energy have the ability to meet future capital requirements through future debt or preferred stock issuances, as discussed below. Also, to the extent current market interest and dividend rates allow, the Operating Companies and System Energy may continue to refinance high-cost debt and preferred stock prior to maturity. See Notes 5, 6, and 8 for additional information on the System's capital and refinancing requirements in 1996 - 2000.\nEntergy Corporation periodically reviews its capital structure to determine its future needs for debt and equity financing. Certain agreements and restrictions limit the amount of mortgage bonds and preferred stock that can be issued by the Operating Companies and System Energy. Based on the most restrictive applicable tests as of December 31, 1995, and assumed annual interest or dividend rates of 8.25% for bonds and 8.50% for preferred stock, each of the Operating Companies and System Energy could have issued mortgage bonds or preferred stock in the following amounts:\n(a) GSU was precluded from issuing preferred stock at December 31, 1995. (b) System Energy's charter does not presently provide for the issuance of preferred stock.\nIn addition to these amounts, the Operating Companies and System Energy have the ability, subject to certain conditions, to issue bonds against retired bonds. Such amounts may be significant in some instances, and, in some cases, no earnings coverage test is required. AP&L may also issue preferred stock to refund outstanding preferred stock without meeting an earnings coverage test. GSU has no earnings coverage limitations on the issuance of preference stock. In January of 1996, the Boards of Directors of AP&L and LP&L authorized the officers of those companies to deposit cash with the trustees under their respective first mortgage indentures to satisfy the annual maintenance and replacement fund requirements thereunder, and to require the trustees to use such cash to redeem all or a part of certain series of first mortgage bonds at par as permitted by the respective first mortgage indentures. See Notes 5 and 6 for long-term debt and preferred stock issuances and retirements. See Note 4 for information on the System's short-term borrowings.\nENTERGY CORPORATION AND SUBSIDIARIES\nMANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS\nLIQUIDITY AND CAPITAL RESOURCES\nFinancing Requirements\nProductive investment by Entergy Corporation is necessary to enhance the long-term value of its common stock. Entergy Corporation has been expanding its investments in nonregulated business opportunities overseas as well as in the United States. Through the end of 1995, Entergy Corporation had participated in foreign non regulated electric ventures in Pakistan, Argentina, and Peru. As of December 31, 1995, Entergy Corporation had invested $555.5 million in equity capital (reduced by $169 million of accumulated losses) in nonregulated businesses. See Note 15 for a discussion of Entergy Corporation's acquisition of CitiPower on January 5, 1996.\nIn addition to investing in nonregulated businesses, Entergy Corporation's capital requirements include periodically investing in, or making loans to, its subsidiaries, and sustaining its dividends. To meet such capital requirements, Entergy Corporation will utilize internally generated funds, cash on hand, and the $70 million remaining on its $300 million credit facility ($230 million of this credit facility was used for the CitiPower acquisition). Entergy Corporation receives funds through dividend payments from its subsidiaries. During 1995, such common stock dividend payments from subsidiaries totaled $565.6 million, none of which was contributed by GSU. Entergy Corporation, in turn, paid $408.6 million of dividends on its common stock. Declarations of dividends on common stock are made at the discretion of Entergy Corporation's Board of Directors. It is anticipated that management will not recommend future dividend increases to the Board unless such increases are justified by sustained earnings growth of Entergy Corporation and its subsidiaries. See Note 7 for information on dividend restrictions.\nEntergy Corporation and GSU\nSee Notes 2 and 8 regarding River Bend rate appeals and litigation with Cajun. Adverse rulings in the River Bend rate appeal could result in approximately $289 million of potential write-offs (net of tax) and $182 million in refunds of previously collected revenue. Such write- offs and charges, as well as the application of SFAS 121 (see Note 1), could result in substantial net losses being reported in the future by Entergy Corporation and GSU, with resulting adverse adjustments to common equity of Entergy Corporation and GSU. Adverse resolution of these matters could adversely affect GSU's ability to obtain financing, which could in turn affect GSU's liquidity and ability to pay dividends. Although Entergy Corporation's common shareholders experienced some dilution in earnings as a result of the Merger, Entergy believes that the Merger will ultimately be beneficial to common shareholders in terms of strategic benefits as well as economies and efficiencies produced.\nEntergy Corporation and System Energy\nUnder the Capital Funds Agreement, Entergy Corporation has agreed to supply to System Energy sufficient capital to maintain System Energy's equity capital at a minimum of 35% of its total capitalization (excluding short-term debt), to permit the continued commercial operation of Grand Gulf 1, and to pay in full all indebtedness for borrowed money of System Energy when due under any circumstances. In addition, under supplements to the Capital Funds Agreement assigning System Energy's rights as security for specific debt of System Energy, Entergy Corporation has agreed to make cash capital contributions, if required, to enable System Energy to make payments on such debt when due. The Capital Funds Agreement can be terminated by the parties thereto, subject to consent of certain creditors.\nENTERGY CORPORATION AND SUBSIDIARIES\nMANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS\nSIGNIFICANT FACTORS AND KNOWN TRENDS\nCompetition and Industry Challenges\nElectric utilities traditionally have operated as regulated monopolies in which there was little opportunity for direct competition in the provision of electric service. In return for the ability to receive a reasonable return on and of their investments, utilities were obligated to provide service and meet future customer requirements. However, the electric utility industry is now undergoing a transition to an environment of increased retail and wholesale competition.\nPressures that underlie the movement toward increasing competition are numerous and complex. They include legislative and regulatory changes, technological advances, consumer demands, greater availability of natural gas, environmental needs, and other factors. The increasingly competitive environment presents opportunities to compete for new customers, as well as the risk of loss of existing customers. Competition presents Entergy with many challenges. The following have been identified by Entergy as its major competitive challenges.\nThe Energy Policy Act of 1992\nThe EPAct addresses a wide range of energy issues and is being implemented by both FERC and state regulators. The EPAct is designed to promote competition among utility and non utility generators by amending PUHCA to exempt from regulation a class of EWGs, among others, consisting of utility affiliates and non utilities that own and operate facilities for the generation and transmission of power for sale at wholesale. The EPAct also gave FERC the authority to order investor- owned utilities to transmit power and energy to or for wholesale purchasers and sellers. This creates potential for electric utilities and other power producers to gain increased access to the transmission systems of other utilities to facilitate wholesale sales.\nIn response to the EPAct, FERC issued a notice of proposed rulemaking in mid-1994. This rulemaking concerns a regulatory framework for dealing with recovery of costs that were prudently incurred by electric utilities to serve customers under the traditional regulatory framework. These costs may become \"stranded\" as a result of increased competition. On March 29, 1995, FERC issued a supplemental notice of proposed rulemaking in this proceeding that would require public utilities to provide nondiscriminatory open access transmission service to wholesale customers and would also provide guidance on the recovery of wholesale and retail stranded costs. The risk of exposure to stranded costs that may result from competition in the industry will depend on the extent and timing of retail competition, the resolution of jurisdictional issues concerning stranded cost recovery, and the extent to which such costs are recovered from departing or remaining customers.\nWith regard to pending proceedings, including Entergy's open access transmission tariff proceedings originally filed in 1991 and amended in 1994 and 1995, FERC directed the parties to proceed with their cases while taking into account FERC's proposed rule. Comments and reply comments on the proposed rulemaking have now been filed with FERC by interested parties. Certain of the parties filing comments have proposed that FERC should order the immediate unbundling of all retail services as part of the final rulemaking in this proceeding, which is expected in the second quarter of 1996. In its comments in the proposed rulemaking, Entergy urged FERC to exercise its authority and responsibility to serve as a \"backstop\" in the event a state is unable or unwilling to provide for stranded-cost recovery -- particularly in the case of multi state utilities (such as the System), where cost shifting among jurisdictions might otherwise occur.\nENTERGY CORPORATION AND SUBSIDIARIES\nMANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS\nSIGNIFICANT FACTORS AND KNOWN TRENDS\nRetail and Wholesale Rate Issues\nThe retail regulatory philosophy is shifting in some jurisdictions from traditional cost-of-service regulation to incentive-rate regulation. Incentive and performance-based rate plans encourage efficiencies and productivity while permitting utilities and their customers to share in the results. MP&L implemented an incentive-rate plan in March 1994 and, in June 1995, the LPSC implemented a performance-based formula rate plan for LP&L. The continuing pattern of rate reductions is a characteristic of the competitive environment in which Entergy operates.\nSeveral of the Operating Companies have recently been ordered to grant base rate reductions and have refunded or credited customers for previous overcollections of rates. See Note 2 for additional discussion of rate reductions and incentive-rate regulation.\nIn connection with the Merger, AP&L and MP&L agreed with their respective retail regulators not to request any general retail rate increases that would take effect before November 1998, with certain exceptions. MP&L also agreed that during this period retail base rates under its formula rate plan would not be increased above the level of rates in effect on November 1, 1993. In connection with the Merger, NOPSI agreed with the Council to reduce its annual electric base rates by $4.8 million, effective for bills rendered on or after November 1, 1993. GSU agreed with the LPSC and PUCT to a five-year Rate Cap on retail electric rates, and to pass through to retail customers the fuel savings and a certain percentage of the nonfuel savings created by the Merger. Under the terms of their respective Merger agreements, the LPSC and PUCT have reviewed GSU's base rates during the first post-Merger earnings analysis and ordered rate reductions. See Note 2 for additional discussion of GSU's post-Merger filings with the LPSC and the PUCT.\nSystem Energy implemented a $65.5 million rate increase, subject to refund, in December 1995.\nPotential Changes in the Electric Utility Industry\nRetail wheeling, the transmission by an electric utility of energy produced by another entity over the utility's transmission and distribution system to a retail customer in the electric utility's area of service, continues to evolve. Approximately 40 states have initiated studies of the concept of retail competition or are considering it as part of industry restructuring. Within the area served by the Operating Companies, the City of New Orleans, Louisiana, and Texas are conducting such studies.\nIn January 1996, the Council voted to investigate retail utility service competition. Although no date has been set, the investigation will focus on the impact of competition, service unbundling, and utility restructuring on consumers of retail electric and gas utility service in New Orleans. Earlier in 1995, a newly incorporated entity, Crescent City Utilities, Inc., submitted to the Council a draft resolution intended to permit the use of NOPSI's gas and electric transmission and distribution facilities by any other franchised utility to supply electricity and gas to retail customers in New Orleans. The Council has not scheduled hearings relating to this resolution.\nENTERGY CORPORATION AND SUBSIDIARIES\nMANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS\nSIGNIFICANT FACTORS AND KNOWN TRENDS\nThe PUCT is currently developing rules that will permit greater wholesale electric competition in Texas, as mandated by the Texas legislature in its 1995 session. These wholesale transmission access rules are expected to be in place by the first quarter of 1996. In addition, the PUCT is developing information to be contained in reports that will be submitted to the 1997 legislature concerning broader competitive issues such as the unbundling of electric utility operations, market-based pricing, performance-based ratemaking, and the identification and recovery of potential stranded costs as part of the transition to a more competitive electric industry environment. This information will be developed through a series of workshops and comments by interested parties throughout 1996. In addition, during 1995, the Texas legislature revised the Public Utility Regulatory Act, the law regulating electric utilities in Texas. The revised law permits utility and non utility EWGs and power marketers to sell wholesale power in the state. The revised law also permits the discounting of rates with certain conditions, but does not change the current law governing retail wheeling or the treatment of federal income taxes.\nDuring the second quarter of 1995, the Louisiana legislature considered a bill permitting local retail wheeling. The bill was defeated, but similar bills are likely to be introduced in the future. During the same time period, the LPSC initiated a generic docket to investigate retail, wholesale, and affiliate wheeling of electricity. Currently, no procedural schedule has been set for this docket.\nDuring January 1996, a bill entitled the \"Electric Power Competition Act of 1996\" was introduced into the United States House of Representatives. The bill proposes to amend certain provisions under PURPA for the purpose of facilitating future deregulation of the electric power industry.\nIn some areas of the country, municipalities (or comparable entities) whose residents are served at retail by an investor-owned utility pursuant to a franchise, are exploring the possibility of establishing new electric distribution systems, or extending existing ones. In some cases, municipalities are also seeking new delivery points in order to serve retail customers, especially large industrial customers, which currently receive service from an investor-owned utility. Where successful, however, the establishment of a municipal system or the acquisition by a municipal system of a utility's customers could result in the utility's inability to recover costs that it has incurred for the purpose of serving those customers.\nSignificant Industrial Cogeneration Effects\nMany of Entergy's industrial customers, whose costs structures are energy-sensitive, have energy alternatives available to them such as fuel switching, cogeneration, and production shifting. Cogeneration is generally defined as the combined production of electricity and some other useful form of heat, typically steam. Cogenerated power may either be sold by its producer to the local utility at its avoided cost under PURPA, and\/or utilized by the cogenerator to displace purchases from the utility. To the extent that cogeneration is used by industrial customers to meet their own power requirements, the System may suffer loss of industrial load. It is the practice of the Operating Companies to negotiate the renewal of contracts with large industrial customers prior to their expiration. In certain cases (particularly for GSU and LP&L), contracts or special tariffs that use flexible pricing have been negotiated with industrial customers to keep these customers on the System. The pricing agreements are not at full cost of service. Such rates may fully recover all related costs, but provide only a minimal return, if any, on investment. In 1995, KWh sales to GSU's and LP&L's industrial customers at less than full cost- of-service rates made up approximately 27% and 39% of GSU's and LP&L's total industrial class sales, respectively.\nENTERGY CORPORATION AND SUBSIDIARIES\nMANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS\nSIGNIFICANT FACTORS AND KNOWN TRENDS\nSince PURPA was enacted in 1978, the Operating Companies have been largely successful in retaining industrial load. The Operating Companies anticipate they will be successful in renegotiating such contracts with large industrial customers. However, this competitive challenge will likely increase. There can be no assurance that the Operating Companies will be successful or that future revenues will not be lost to other forms of generation.\nThe Council has recently approved a resolution requiring its prior approval of regulatory treatment of any lost contribution to fixed costs as a result of incentive-rate agreements with large industrial or commercial customers entered into for the purposes of retaining those customers. The resolution also requires prior approval by the Council of the regulatory treatment of stranded costs resulting from the loss of large customers.\nDuring 1995, LP&L received separate notices from two large industrial customers that will proceed with proposed cogeneration projects for the purpose of fulfilling their future electric energy needs. These customers will continue to purchase their energy requirements from LP&L until their cogeneration facilities are completed and operational, which is expected to occur between the years 1997 and 1998. After that time these customers will still purchase energy from LP&L, but at a reduced level. During 1995, these two customers represented an aggregate of approximately 18% of total LP&L industrial sales, and provided 12% of total industrial base revenues.\nDomestic and Foreign Energy-Related Investments\nEntergy Corporation seeks opportunities to expand its domestic energy-related businesses that are not regulated by state and local regulatory authorities, as well as foreign power investments that provide returns in excess of similar domestic investments. Such business ventures currently include power development and new technology related to the utility business. Entergy Corporation's strategy is to identify and pursue business opportunities that have the potential to earn a greater return than its regulated utility operations. Refer to \"MANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS - LIQUIDITY AND CAPITAL RESOURCES\" for a discussion of Entergy Corporation's 1995 investment in domestic and foreign energy-related businesses. These investments may involve a greater risk than domestically regulated utility enterprises. In 1995, Entergy Corporation's investments in domestic and foreign energy-related investments reduced consolidated net income by approximately $64.8 million. While such investments did not have a positive effect on 1995 earnings, management believes they will show profits in the near term.\nIn an effort to expand into new energy-related businesses, Entergy plans to commercialize its fiber optic telecommunications network that connects system facilities and supports its internal business needs. Entergy will provide long-haul fiber optic capacity to major telecommunications carriers, which in turn will market that service to third parties. The recently enacted Telecommunications Act of 1996 permits Entergy to market such a service, pending state and local regulatory approval. On February 8, 1996, the President of the United States signed the Telecommunications Act into law. This new law contains an exemption from PUHCA that will permit registered utility holding companies to form and capitalize subsidiaries to engage in telephone, telecommunications, and information service businesses without SEC approval. However, the law requires that such telecommunications subsidiaries file for exemption with the Federal Communications Commission, and that they not engage in transactions with utility affiliates within their holding company systems or acquire utility affiliates' property without state or local regulatory approval. Entergy Corporation has requested approval from the SEC to form a new nonregulated subsidiary named Entergy Technologies Company to commercialize the Entergy telecommunications network.\nENTERGY CORPORATION AND SUBSIDIARIES\nMANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS\nSIGNIFICANT FACTORS AND KNOWN TRENDS\nIn early October 1995, FERC issued an order granting EWG status to Entergy Power Marketing Corporation (EPM), a wholly owned subsidiary of Entergy Corporation. EPM was created during 1995 to become a buyer and seller of electrical energy and its generating fuels. In February 1996, FERC approved market-based rate sales of electricity by EPM. Such approval will allow EPM to begin providing wholesale customers with a variety of services including physical and financial trading. Pending approval from the SEC, EPM expects to begin financial trading by the summer of 1996.\nOn January 5, 1996, Entergy Corporation finalized its acquisition of CitiPower, an electric distribution company serving Melbourne, Australia, and surrounding suburbs. The purchase price of CitiPower was approximately $1.2 billion, of which $294 million represented an equity investment by Entergy Corporation, and the remainder represented debt. Entergy Corporation funded the majority of the equity portion of the investment by using $230 million of its $300 million line of credit. CitiPower serves approximately 234,500 customers, the majority of which are commercial customers. At the time of the acquisition, CitiPower had 846 employees.\nANO Matters\nEntergy Operations has made inspections and repairs from time to time on ANO 2's steam generators. During the October 1995 inspection, additional cracks in the tubes were discovered. Currently, Entergy Operations is in the process of gathering information and assessing various options for the repair or replacement of ANO 2's steam generators. See Note 8 for additional information.\nDeregulated Utility Operations\nGSU discontinued regulatory accounting principles for its wholesale jurisdiction and steam department and the Louisiana deregulated portion of River Bend during 1989 and 1991, respectively. The operating income (loss) from these operations was $7.2 million in 1995, $(5.2) million in 1994, and $(2.9) million in 1993.\nThe increase in 1995 net income from deregulated operations was due to increased revenues and reduced operation and maintenance expenses, partially offset by increased depreciation. The larger net loss from deregulated operations in 1994 was principally due to a smaller income tax benefit. The future impact of the deregulated utility operations on Entergy and GSU's results of operations and financial position will depend on future operating costs, the efficiency and availability of generating units, and the future market for energy over the remaining life of the assets. Entergy expects the performance of its deregulated utility operations to improve, due to continued reductions in operation and maintenance expenses. The deregulated operations will be subject to the requirements of SFAS 121, as discussed in Note 1, in determining the recognition of any asset impairment.\nProperty Tax Exemptions\nLP&L and GSU are working with tax authorities to determine the method for calculating the amount of property taxes to be paid once Waterford 3 and River Bend's local property tax exemptions expire. Waterford 3's exemption expired in December 1995 and River Bend's exemption expires in December 1996. LP&L expects that the LPSC will address the accounting treatment and recovery of Waterford 3's property taxes in April 1996, in conjunction with the annual filing required under its performance-based formula rate plan.\nENTERGY CORPORATION AND SUBSIDIARIES\nMANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS\nSIGNIFICANT FACTORS AND KNOWN TRENDS\nEnvironmental Issues\nGSU has been notified by the U. S. Environmental Protection Agency (EPA) that it has been designated as a PRP for the clean-up of certain hazardous waste disposal sites. See Note 8 for additional information.\nAs a consequence of rules for solid waste regulation issued by the Louisiana Department of Environmental Quality in 1993, LP&L has determined that certain of its power plant wastewater impoundments must be upgraded or closed. See Note 8 for additional information.\nAccounting Issues\nNew Accounting Standard - In March 1995, the FASB issued SFAS 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of\" (SFAS 121), effective January 1, 1996. This standard describes circumstances that may result in assets being impaired and provides criteria for recognition and measurement of asset impairment. See Notes 1 and 2 for information regarding the potential impacts of the new accounting standard on Entergy.\nContinued Application of SFAS 71 - As a result of the EPAct and actions of regulatory commissions, the electric utility industry is moving toward a combination of competition and a modified regulatory environment. The System's financial statements currently reflect, for the most part, assets and costs based on current cost-based ratemaking regulations in accordance with SFAS 71, \"Accounting for the Effects of Certain Types of Regulation\" (SFAS 71). Continued applicability of SFAS 71 to the System's financial statements requires that rates set by an independent regulator on a cost-of-service basis can actually be charged to and collected from customers.\nIn the event that all or a portion of a utility's operations cease to meet those criteria for various reasons, including deregulation, a change in the method of regulation, or a change in the competitive environment for the utility's regulated services, the utility should discontinue application of SFAS 71 for the relevant portion. That discontinuation should be reported by elimination from the balance sheet of the effects of any actions of regulators recorded as regulatory assets and liabilities.\nAs of December 31, 1995, and for the foreseeable future, the System's financial statements continue to follow SFAS 71, except for certain portions of GSU's business. See Note 1 for additional discussion of Entergy's application of SFAS 71.\nAccounting for Decommissioning Costs - The staff of the SEC has been reviewing the financial accounting practices of the electric utility industry regarding the recognition, measurement, and classification of nuclear decommissioning costs for nuclear generating stations in the financial statements of electric utilities. In February 1996 the FASB issued an exposure draft of the proposed SFAS addressing the accounting for decommissioning costs as well as liabilities related to the closure and removal of all long-lived assets. See Note 8 for a discussion of proposed changes in the accounting for decommissioning\/closure costs and the potential impact of these changes on Entergy.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholders of Entergy Corporation\nWe have audited the accompanying consolidated balance sheets of Entergy Corporation and Subsidiaries as of December 31, 1995 and 1994, and the related statements of consolidated income, retained earnings and paid-in-capital and cash flows for the years then ended. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audits. The consolidated financial statements of Entergy Corporation and Subsidiaries for the year ended December 31, 1993, were audited by other auditors, whose report, dated February 11, 1994, included explanatory paragraphs that (i) described changes in 1993 in the method of accounting for revenues by certain of the Corporation's subsidiaries (Note 1); (ii) uncertainties regarding costs capitalized by Gulf States Utilities Company for its River Bend Unit I Nuclear Generating Plant (River Bend) and other rate-related contingencies which may result in a refund of revenues previously collected (Note 2); and, (iii) an uncertainty regarding civil actions against Gulf States Utilities Company (Note 8).\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as 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 Entergy Corporation and Subsidiaries as of December 31, 1995 and 1994, and the results of their operations and their cash flows for the years then ended in conformity with generally accepted accounting principles.\nAs discussed in Note 2 to the consolidated financial statements, the net amount of capitalized costs for River Bend exceed those costs currently being recovered through rates. At December 31, 1995, approximately $482 million is not currently being recovered through rates. If current regulatory and court orders are not modified, a write-off of all or a portion of such costs may be required. Additionally, other rate-related contingencies exist which may result in refunds of revenues previously collected. The extent of such write- off of capitalized River Bend costs or refunds of revenues previously collected, if any, will not be determined until appropriate rate proceedings and court appeals have been concluded. Accordingly, the accompanying consolidated financial statements do not include any adjustments or provision for write-off or refund that might result from the outcome of these uncertainties. As also discussed in Note 2, approximately $187 million of additional deferred River Bend operating costs which exceed those costs currently being recovered through rates are expected to be written-off upon the adoption of Statement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.\" Adoption of this Statement is required on January 1, 1996.\nAs discussed in Note 8 to the consolidated financial statements, civil actions have been initiated against Gulf States Utilities Company to, among other things, recover the co-owner's investment in River Bend and to annul the River Bend Joint Ownership Participation and Operating Agreement. The ultimate outcome of these proceedings cannot presently be determined.\nAs discussed in Note 1 to the consolidated financial statements, in 1995 one of the Corporation's subsidiaries changed its method of accounting for incremental nuclear plant outage maintenance costs.\nCOOPERS & LYBRAND L.L.P. New Orleans, Louisiana February 14, 1996\nINDEPENDENT AUDITORS' REPORT\nTo the Board of the Directors and the Shareholders of Entergy Corporation:\nWe have audited the accompanying statements of consolidated income, retained earnings and paid-in capital, and cash flows of Entergy Corporation and subsidiaries for the year ended December 31, 1993. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audit. We did not audit the financial statements of Gulf States Utilities Company (a consolidated subsidiary acquired on December 31, 1993), which statements reflect total assets constituting 31% of consolidated total assets at December 31, 1993. Those statements were audited by other auditors whose report (which included explanatory paragraphs regarding the uncertainties discussed in the fourth and fifth paragraphs below) has been furnished to us, and our opinion, insofar as it relates to the amounts included for Gulf States Utilities Company, is based solely on the report of such auditors.\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 and the report of the other auditors provide a reasonable basis for our opinion.\nIn our opinion, based on our audit and the report of the other auditors, such consolidated financial statements present fairly, in all material respects, the results of Entergy Corporation and subsidiaries' operations and their cash flows for the year ended December 31, 1993 in conformity with generally accepted accounting principles.\nThe Corporation acquired a 70% interest in River Bend Unit 1 Nuclear Generating Plant (River Bend) through its acquisition of Gulf States Utilities Company on December 31, 1993. As discussed in Note 2 to the consolidated financial statements, the net amount of capitalized costs for River Bend exceed those costs currently being recovered through rates. If current regulatory and court orders are not modified, a write-off of all or a portion of such costs may be required. Additionally, as discussed in Note 2 to the consolidated financial statements, other rate-related contingencies exist which may result in a refund of revenues previously collected. The extent of such write-off of capitalized River Bend costs or refund of revenue previously collected, if any, will not be determined until appropriate rate proceedings and court appeals have been concluded. Accordingly, the accompanying 1993 consolidated financial statements do not include any adjustments that might result from the outcome of these uncertainties.\nAs discussed in Note 8 to the consolidated financial statements, civil actions have been initiated against Gulf States Utilities Company to, among other things, recover the co-owner's investment in River Bend and to annul the related joint ownership participation and operating agreement. The ultimate outcome of these proceedings, including their impact on Gulf States Utilities Company, cannot presently be determined. Accordingly, the accompanying 1993 consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.\nAs discussed in Note 1 to the consolidated financial statements, certain of the Corporation's subsidiaries changed their method of accounting for revenues in 1993.\nDELOITTE & TOUCHE LLP New Orleans, Louisiana February 11, 1994\nENTERGY CORPORATION AND SUBSIDIARIES\nMANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS\nRESULTS OF OPERATIONS\nOn December 31, 1993, GSU became a subsidiary of Entergy Corporation. In accordance with the purchase method of accounting, the results of operations for the twelve months ended December 31, 1993, of Entergy Corporation and Subsidiaries reported in its Statements of Consolidated Income and Cash Flows do not include GSU's results of operations. However, the following discussion is presented with GSU's 1993 results of operations included for comparative purposes.\nNet Income\nConsolidated net income increased in 1995 due primarily to increased electric operating revenues, decreased other operation and maintenance expenses, the onetime recording of the cumulative effect of the change in accounting method for incremental nuclear refueling outage maintenance costs at AP&L, and decreased interest expense, partially offset by increased income taxes and decreased miscellaneous income - net.\nConsolidated net income decreased in 1994 due primarily to the one time recording in 1993 of the cumulative effect of the change in accounting principle for unbilled revenues for AP&L, GSU, MP&L, and NOPSI, and a base-rate reduction ordered by the PUCT. In addition, net income was impacted by a decrease in revenues, increased Merger- related costs, certain restructuring costs, and decreased miscellaneous income - net, partially offset by a decrease in interest on long-term debt and preferred dividend requirements.\nSignificant factors affecting the results of operations and causing variances between the years 1995 and 1994, and 1994 and 1993, are discussed under \"Revenues and Sales,\" \"Expenses,\" and \"Other\" below.\nRevenues and Sales\nSee \"SELECTED FINANCIAL DATA - FIVE-YEAR COMPARISON,\" following the notes, for information on operating revenues by source and KWh sales.\nThe changes in electric operating revenues for the twelve months ended December 31, 1995, are as follows:\nIncrease\/ Description (Decrease) ----------------------- ------------ (In Millions)\nChange in base revenues $6.6 Rate riders 15.3 Fuel cost recovery (28.0) Sales volume\/weather 141.3 Other revenue (including 4.3 unbilled) Sales for resale 49.5 System Energy-FERC Settlement 120.5 ------- Total $309.5 =======\nENTERGY CORPORATION AND SUBSIDIARIES\nMANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS\nRESULTS OF OPERATIONS\nElectric operating revenues increased in 1995 as a result of an increase in retail energy sales, the effects of the 1994 FERC Settlement, and increased wholesale revenues, partially offset by rate reductions at GSU, LP&L, and NOPSI and lower fuel adjustment revenues. Warmer weather and non-weather related volume growth contributed equally to the increase in retail electric energy sales. The increase in sales for resale was primarily from increased energy sales outside of Entergy's service area. The increase in other revenues was due to the effects of the 1994 FERC Settlement and the 1994 NOPSI Settlement.\nElectric operating revenues decreased in 1994 due primarily to rate reductions at GSU, MP&L, and NOPSI, the effects of the 1994 NOPSI Settlement and the FERC Settlement, and decreased fuel adjustment revenues, partially offset by increased retail energy sales and increased collections of previously deferred Grand Gulf 1-related costs.\nGas operating revenues decreased in 1995 because of a milder winter than in 1994, gas rate reductions agreed to in the 1994 NOPSI Settlement, and a lower unit price for gas purchased for resale. Gas operating revenues decreased slightly in 1994 as a result of lower weather-related sales.\nExpenses\nOperating expenses increased in 1995 due to increased income taxes related to higher pre-tax book income and the effects of the 1994 FERC Settlement. In addition, nuclear refueling outage expenses increased due to a 1995 refueling outage at Grand Gulf 1 and the adoption of the change in accounting method at AP&L. The increase in operating expenses was partially offset by a reduction in other operation and maintenance expenses. Other operation and maintenance expenses decreased primarily because of lower payroll-related expenses resulting from the restructuring program discussed in Note 11 and 1994 Merger-related costs.\nOperating expenses decreased in 1994 due primarily to decreased power purchases from nonassociated utilities and to changes in generation requirements for the Operating Companies, decreased nuclear refueling outage expenses as the result of Grand Gulf 1 outage expenses incurred in 1993, decreased income taxes due primarily to lower pre-tax book income, and the effects of the FERC Settlement.\nInterest charges decreased in 1995 and 1994 as a result of the retirement and refinancing of higher cost long-term debt.\nPreferred dividend requirements decreased in 1995 and 1994 due to stock redemption activities.\nOther\nMiscellaneous other income - net decreased in 1995 due primarily to expansion activities in nonregulated businesses.\nMiscellaneous other income - net decreased in 1994 due primarily to the amortization of the plant acquisition adjustment related to the GSU Merger, the adoption of SFAS 116, \"Accounting for Contributions Made and Contributions Received,\" and reduced Grand Gulf 1 carrying charges at AP&L.\nENTERGY CORPORATION AND SUBSIDIARIES STATEMENTS OF CONSOLIDATED INCOME\nENTERGY CORPORATION AND SUBSIDIARIES STATEMENTS OF CONSOLIDATED CASH FLOWS\nENTERGY CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS ASSETS\nENTERGY CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS CAPITALIZATION AND LIABILITIES\nENTERGY CORPORATION AND SUBSIDIARIES STATEMENTS OF CONSOLIDATED RETAINED EARNINGS AND PAID-IN CAPITAL\nENTERGY CORPORATION AND SUBSIDIARIES\nSELECTED FINANCIAL DATA - FIVE-YEAR COMPARISON\n(1) Includes long-term debt (excluding currently maturing debt), preferred and preference stock with sinking fund, and noncurrent capital lease obligations.\n(2) 1993 amounts include the effects of the Merger in accordance with the purchase method of accounting for combinations.\n(1)1994 includes the effects of the FERC Settlement, the 1994 NOPSI Settlement, and a GSU reserve for rate refund.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholders of Arkansas Power & Light Company\nWe have audited the accompanying balance sheets of Arkansas Power & Light Company as of December 31, 1995 and 1994, and the related statements of income, retained earnings and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. The financial statements of the Company for the year ended December 31, 1993, were audited by other auditors, whose report, dated February 11, 1994, included an explanatory paragraph that described a change in the method of accounting for revenues, which is discussed in Note 1 to these financial 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 financial position of the Company as of December 31, 1995 and 1994, and the results of its operations and its cash flows for the years then ended in conformity with generally accepted accounting principles.\nAs discussed in Note 1 to the financial statements, in 1995 the Company changed its method of accounting for incremental nuclear plant outage maintenance costs.\nCOOPERS & LYBRAND L.L.P. New Orleans, Louisiana February 14, 1996\nINDEPENDENT AUDITORS' REPORT\nTo the Shareholders and the Board of Directors of Arkansas Power & Light Company:\nWe have audited the accompanying statements of income, retained earnings, and cash flows of Arkansas Power & Light Company (AP&L) for the year ended December 31, 1993. These financial statements are the responsibility of AP&L's management. Our responsibility is to express an opinion on these financial statements based on our audit.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, such financial statements present fairly, in all material respects, the results of AP&L's operations and its cash flows for the year ended December 31, 1993 in conformity with generally accepted accounting principles.\nAs discussed in Note 1 to the financial statements, AP&L changed its method of accounting for revenues in 1993.\nDELOITTE & TOUCHE LLP New Orleans, Louisiana February 11, 1994\nARKANSAS POWER & LIGHT COMPANY\nMANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS\nRESULTS OF OPERATIONS\nNet Income\nNet income increased in 1995 due primarily to the onetime recording of the cumulative effect of the change in accounting method for incremental nuclear refueling outage maintenance costs as discussed in Note 1. Excluding the above mentioned item, net income for 1995 decreased due to an increase in depreciation, amortization, and decommissioning expenses and income tax expense offset by an increase in revenues from retail energy sales and a decrease in other operation and maintenance expenses.\nNet income decreased in 1994 due primarily to the onetime recording in the first quarter of 1993 of the cumulative effect of the change in accounting principle for unbilled revenues and its ongoing effects, and to increased other operation and maintenance expenses resulting from restructuring and storm damage costs during 1994.\nSignificant factors affecting the results of operations and causing variances between the years 1995 and 1994, and 1994 and 1993, are discussed under \"Revenues and Sales,\" \"Expenses,\" and \"Other\" below.\nRevenues and Sales\nSee \"SELECTED FINANCIAL DATA - FIVE-YEAR COMPARISON,\" following the notes to financial statements, for information on operating revenues by source and KWh sales.\nThe changes in electric operating revenues for the twelve months ended December 31, 1995, are as follows:\nIncrease\/ Description (Decrease) ------------------------- ------------- (In Millions)\nChange in base revenues $(3.4) Rate riders 15.9 Fuel cost recovery 25.1 Sales volume\/weather 38.2 Other revenue (including unbilled) 9.7 Sales for resale (28.0) ------- Total $57.5 ======\nElectric operating revenues increased for 1995 due primarily to increased retail energy sales and fuel adjustment revenues partially offset by a decrease in sales for resale to associated companies. The increase in sales volume\/weather resulted from increased customers and associated usage, while the remainder resulted from warmer weather in the summer months. The decrease in sales for resale to associated companies was caused by changes in generation availability and requirements among the Operating Companies.\nTotal revenues remained relatively unchanged in 1994. Retail revenues decreased primarily due to lower recovery of fuel revenues during the year offset by increased sales for resale to associated companies in 1994, caused by changes in generation availability and requirements among the Operating Companies.\nARKANSAS POWER & LIGHT COMPANY\nMANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS\nRESULTS OF OPERATIONS\nExpenses\nOperating expenses increased in 1995 because of an increase in depreciation, amortization, and decommissioning expenses and income tax expense, offset by a decrease in other operation and maintenance expenses. Depreciation, amortization, and decommissioning expenses increased primarily due to additions and upgrades at ANO and additions to transmission lines, substations, and other equipment. Also, decommissioning expense increased due to the implementation of the decommissioning rate rider which resulted from the decommissioning study performed in 1994. Income tax expense increased primarily due to the write-off in 1994 of investment tax credits in accordance with the FERC Settlement, as discussed below. Income tax expense also increased due to higher pre-tax income in 1995. The decrease in other operation and maintenance expenses is largely due to restructuring costs and storm damage costs recorded in 1994 .\nOperating expenses increased in 1994 due primarily to increased other operation and maintenance expenses and increased amortization of rate deferrals partially offset by lower purchased power expenses. Other operation and maintenance expenses increased in 1994 primarily due to the storm damage and restructuring costs as discussed in Note 11. The decrease in 1994 purchased power expenses is primarily due to the decrease in the price of purchased power. Total income taxes decreased during 1994 primarily due to the write-off of unamortized deferred investment tax credit of $27.3 million due to a FERC settlement and due to lower pretax income in 1994. This decrease was partially offset by an increase in tax expense due to the true-up of actual income tax expense for 1993 determined during 1994.\nOther\nMiscellaneous other income - net decreased in 1994 due primarily to reduced Grand Gulf 1 carrying charges. Other income taxes decreased in 1994 primarily due to a lower pretax income as discussed above. Interest on long-term debt decreased in 1994 due primarily to the continued retirement and refinancing of high-cost debt.\nARKANSAS POWER & LIGHT COMPANY STATEMENTS OF INCOME\nARKANSAS POWER & LIGHT COMPANY STATEMENTS OF CASH FLOWS\nARKANSAS POWER & LIGHT COMPANY BALANCE SHEETS ASSETS\nARKANSAS POWER & LIGHT COMPANY BALANCE SHEETS CAPITALIZATION AND LIABILITIES\nARKANSAS POWER & LIGHT COMPANY STATEMENTS OF RETAINED EARNINGS\nARKANSAS POWER & LIGHT COMPANY\nSELECTED FINANCIAL DATA - FIVE-YEAR COMPARISON\n(1) Includes long-term debt (excluding currently maturing debt), preferred stock with sinking fund, and noncurrent capital lease obligations.\nSee Notes 1, 3, and 10 for the effect of accounting changes in 1995 and 1993 .\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholders of Gulf States Utilities Company\nWe have audited the accompanying balance sheets of Gulf States Utilities Company as of December 31, 1995 and 1994 and the related statements of income (loss), retained earnings and paid-in-capital and cash flows for each of the three years in the period ended December 31, 1995. 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 as of December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles.\nAs discussed in Note 2 to the financial statements, the net amount of capitalized costs for its River Bend Unit I Nuclear Generating Plant (River Bend) exceed those costs currently being recovered through rates. At December 31, 1995, approximately $482 million is not currently being recovered through rates. If current regulatory and court orders are not modified, a write-off of all or a portion of such costs may be required. Additionally, other rate-related contingencies exist which may result in refunds of revenues previously collected. The extent of such write-off of capitalized River Bend costs or refunds of revenues previously collected, if any, will not be determined until appropriate rate proceedings and court appeals have been concluded. Accordingly, the accompanying financial statements do not include any adjustments or provision for write-off or refund that might result from the outcome of these uncertainties. As also discussed in Note 2, approximately $187 million of additional deferred River Bend operating costs which exceed those costs currently being recovered through rates are expected to be written-off upon the adoption of Statement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.\" Adoption of this Statement is required on January 1, 1996.\nAs discussed in Note 8 to the financial statements, civil actions have been initiated against Gulf States Utilities Company to, among other things, recover the co-owner's investment in River Bend and to annul the River Bend Joint Ownership Participation and Operating Agreement. The ultimate outcome of these proceedings cannot presently be determined.\nAs discussed in Note 13 to the financial statements, the common stock of the Company was acquired on December 31, 1993.\nAs discussed in Note 3 to the financial statements, in 1993, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\" As discussed in Note 10 to the financial statements, the Company adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" as of January 1, 1993. As discussed in Note 1 to the financial statements, as of January 1, 1993, the Company began accruing revenues for energy delivered to customers but not yet billed.\nCOOPERS & LYBRAND L.L.P. New Orleans, Louisiana February 14, 1996\nGULF STATES UTILITIES COMPANY\nMANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS\nRESULTS OF OPERATIONS\nNet Income\nNet income increased in 1995 principally as the result of an increase in electric operating revenues, a decrease in other operation and maintenance expenses, and an increase in other income. These changes were partially offset by higher income taxes.\nNet income decreased in 1994 due primarily to write-offs and charges associated with the resolution of contingencies and additional Merger-related costs aggregating $137 million, a base rate reduction ordered by the PUCT applied retroactively to March 1994, and restructuring costs. See Note 2 and Note 11 for additional information.\nSignificant factors affecting the results of operations and causing variances between the years 1995 and 1994, and 1994 and 1993, are discussed under \"Revenues and Sales,\" \"Expenses,\" and \"Other\" below.\nRevenues and Sales\nSee \"SELECTED FINANCIAL DATA - FIVE-YEAR COMPARISON,\" following the notes to financial statements, for information on operating revenues by source and KWh sales.\nThe changes in electric operating revenues for the twelve months ended December 31, 1995, are as follows:\nIncrease\/ Description (Decrease) ------------------------- --------- (In Millions)\nChange in base revenues $32.0 Fuel cost recovery (29.6) Sales volume\/weather 35.0 Other revenue (including unbilled) 1.1 Sales for resale 31.3 ------- Total $69.8 =======\nElectric operating revenues increased in 1995 primarily due to increased sales volume\/weather and higher sales for resale. These increases were partially offset by lower fuel adjustment revenues, which do not affect net income. Base revenues also increased in 1995 as a result of rate refund reserves established in 1994, as discussed below, which were subsequently reduced as a result of an amended PUCT order. The increase in base revenues was partially offset by rate reductions in effect for Texas and Louisiana. Sales volume\/weather increased because of warmer than normal weather and an increase in usage by all customer classes. Sales for resale increased as a result of changes in generation availability and requirements among the Operating Companies.\nElectric operating revenues decreased in 1994 due primarily to a base rate reduction ordered by the PUCT applied retroactively to March 1994, see Note 2 for additional information, and lower retail fuel revenues partially offset by increased wholesale revenues associated with higher sales for resale and increased retail base revenue. The decrease in retail revenues is primarily due to a decrease in fuel recovery revenue and a November 1993 rate reduction in Texas. Energy sales increased due primarily to higher sales for resale as a result of GSU's participation in the System power pool.\nGULF STATES UTILITIES COMPANY\nMANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS\nRESULTS OF OPERATIONS\nGas operating revenues decreased for 1995 primarily due to a decrease in residential sales. This decrease was the result of a milder winter than in 1994.\nExpenses\nOperating expenses decreased in 1995 as a result of lower other operation and maintenance expenses and purchased power expenses, partially offset by higher income taxes. Other operation and maintenance expenses decreased primarily due to charges made in 1994 for Merger-related costs, restructuring costs, and certain pre- acquisition contingencies including unfunded Cajun-River Bend costs and environmental clean-up costs. Purchased power expenses decreased because of the availability of less expensive gas and nuclear fuel for use in electric generation as well as changes in the generation requirements among the Operating Companies. In addition, the decrease in purchased power expenses in 1995 was the result of the recording of a provision for refund of disallowed purchased power expenses in 1994. Income taxes increased primarily due to higher pre-tax income in 1995.\nOperating expenses increased in 1994 due primarily to higher purchased power and other operation and maintenance expenses, partially offset by lower fuel for electric generation and fuel-related expense and lower income tax expense. Purchased power expenses increased in 1994 due to GSU's participation in joint dispatch through the System power pool resulting from increased energy sales as discussed above. The increase in purchased power expenses in 1994 was also due to the recording of a provision for refund of disallowed purchased power costs resulting from a Louisiana Supreme Court ruling. Fuel, fuel-related expenses, and gas purchased for resale decreased in 1994 primarily due to lower gas prices.\nOther operation and maintenance expenses increased in 1994 due primarily to charges associated with certain pre-acquisition contingencies, additional Merger-related costs and restructuring costs as discussed in Note 11.\nIncome taxes decreased in 1994 due primarily to lower pretax income resulting from the charges discussed above.\nOther\nOther miscellaneous income increased in 1995 as the result of certain adjustments made in 1994 related to pre-acquisition contingencies including Cajun-River Bend litigation (see Note 8 for additional information) the write-off of previously disallowed rate deferrals, and plant held for future use. As a result of these charges, income taxes on other income were significantly higher in 1995 compared to 1994.\nOther miscellaneous income decreased in 1994 due to the write-off of plant held for future use, establishment of a reserve related to the Cajun-River Bend litigation, the write-off of previously disallowed rate deferrals, and obsolete spare parts. These charges were partially offset by lower interest expense as a result of the continued refinancing of high-cost debt.\nIncome taxes decreased in 1994 due primarily to the charges discussed above.\nGULF STATES UTILITIES COMPANY STATEMENTS OF INCOME (LOSS)\nGULF STATES UTILITIES COMPANY STATEMENTS OF CASH FLOWS\nGULF STATES UTILITIES COMPANY BALANCE SHEETS ASSETS\nGULF STATES UTILITIES COMPANY BALANCE SHEETS CAPITALIZATION AND LIABILITIES\nGULF STATES UTILITIES COMPANY STATEMENTS OF RETAINED EARNINGS AND PAID-IN CAPITAL\nGULF STATES UTILITIES COMPANY\nSELECTED FINANCIAL DATA - FIVE-YEAR COMPARISON\n(1) Includes long-term debt (excluding currently maturing debt), preferred and preference stock with sinking fund, and noncurrent capital lease obligations.\nSee Notes 1 and 10 for the effect of accounting changes in 1993 and Notes 2 and 8 regarding River Bend rate appeals and litigation with Cajun.\n(1) 1994 includes the effects of a GSU reserve for rate refund.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholders of Louisiana Power & Light Company\nWe have audited the accompanying balance sheets of Louisiana Power & Light Company as of December 31, 1995 and 1994, and the related statements of income, retained earnings and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. The financial statements of the Company for the year ended December 31, 1993, were audited by other auditors, whose report, dated February 11, 1994, expressed an unqualified opinion on these financial 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 financial position of the Company as of December 31, 1995 and 1994, and the results of its operations and its cash flows for the years then ended in conformity with generally accepted accounting principles.\nCOOPERS & LYBRAND L.L.P. New Orleans, Louisiana February 14, 1996\nINDEPENDENT AUDITORS' REPORT\nTo the Shareholders and the Board of Directors of Louisiana Power & Light Company:\nWe have audited the accompanying statements of income, retained earnings, and cash flows of Louisiana Power & Light Company (LP&L) for the year ended December 31, 1993. These financial statements are the responsibility of LP&L's management. Our responsibility is to express an opinion on these financial statements based on our audit.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, such financial statements present fairly, in all material respects, the results of LP&L's operations and its cash flows for the year ended December 31, 1993 in conformity with generally accepted accounting principles.\nDELOITTE & TOUCHE LLP New Orleans, Louisiana February 11, 1994\nLOUISIANA POWER & LIGHT COMPANY\nMANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS\nRESULTS OF OPERATIONS\nNet Income\nNet income decreased in 1995 due to an April 1995 rate reduction and higher income taxes, partially offset by lower other operation and maintenance expenses. Net income increased in 1994 due primarily to the fourth quarter write-off of unamortized balances of deferred investment tax credits, partially offset by lower operating revenues and higher other operation and maintenance expenses.\nSignificant factors affecting the results of operations and causing variances between the years 1995 and 1994, and 1994 and 1993, are discussed under \"Revenues and Sales\" and \"Expenses\" below.\nRevenues and Sales\nSee \"SELECTED FINANCIAL DATA - FIVE-YEAR COMPARISON,\" following the notes to financial statements, for information on operating revenues by source and KWh sales.\nThe changes in operating revenues for the twelve months ended December 31, 1995, are as follows:\nIncrease\/ Description (Decrease) ------------------------ -------------- (In Millions)\nChange in base revenues $(29.9) Fuel cost recovery (35.9) Sales volume\/weather 40.7 Other revenue (including unbilled) (23.3) Sales for resale 12.9 ------- Total $(35.5) =======\nOperating revenues were lower in 1995 due primarily to a base rate reduction in the second quarter of 1995 and to lower fuel adjustment revenues, which do not affect net income. This decrease was partially offset by increased customer usage, principally caused by warmer summer weather. The completion of the amortization of proceeds from litigation with a gas supplier in the second quarter of 1994 also contributed to the decrease in other revenue, partially offset by higher sales to non-associated utilities.\nOperating revenues were lower in 1994 due primarily to the completion of the amortization of the proceeds resulting from litigation with a gas supplier in the second quarter and lower wholesale revenues partially offset by higher retail revenues. Wholesale revenues decreased due primarily to lower sales to non- associated utilities. Retail revenues increased due primarily to increases in sales to industrial and commercial customers.\nLOUISIANA POWER & LIGHT COMPANY\nMANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS\nRESULTS OF OPERATIONS\nExpenses\nOperating expenses decreased in 1995 due to decreases in fuel expenses, including purchased power, and other operation and maintenance expenses, partially offset by an increase in depreciation and income taxes. The decrease in fuel expenses is due to lower fuel prices partially offset by an increase in generation. Other operation and maintenance expenses decreased because of lower payroll-related expenses as a result of the restructuring program discussed in Note 11, power plant waste water site closures in 1994, and a court settlement reducing legal expense. Depreciation expense increased due to capital improvements to distribution lines and substations and to an increase in the depreciation rate associated with Waterford 3. Income taxes increased due to the write-off in 1994 of deferred investment tax credits in accordance with the 1994 FERC Settlement, a decrease in tax depreciation associated with Waterford 3, and higher pre-tax income.\nOperating expenses decreased in 1994 due primarily to a decrease in income tax expense as a result of the write-off of deferred investment tax credits pursuant to a FERC settlement and lower fuel expenses partially offset by higher other operation and maintenance expenses. The decrease in fuel and purchased power expenses is due primarily to lower fuel and purchased power prices. The increase in other operation and maintenance expenses is due primarily to restructuring costs and power plant waste water site closures. Interest expense decreased in 1994 as a result of the retirement and refinancing of high-cost debt.\nLOUISIANA POWER & LIGHT COMPANY STATEMENTS OF INCOME\nLOUISIANA POWER & LIGHT COMPANY STATEMENTS OF CASH FLOWS\nLOUISIANA POWER & LIGHT COMPANY BALANCE SHEETS ASSETS\nLOUISIANA POWER & LIGHT COMPANY BALANCE SHEETS CAPITALIZATION AND LIABILITIES\nLOUISIANA POWER & LIGHT COMPANY STATEMENTS OF RETAINED EARNINGS\nLOUISIANA POWER & LIGHT COMPANY\nSELECTED FINANCIAL DATA - FIVE-YEAR COMPARISON\n(1) Includes long-term debt (excluding currently maturing debt), preferred stock with sinking fund, and noncurrent capital lease obligations.\nSee Notes 3 and 10 for the effect of accounting changes in 1993.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholders of Mississippi Power & Light Company\nWe have audited the accompanying balance sheets of Mississippi Power & Light Company as of December 31, 1995 and 1994, and the related statements of income, retained earnings and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. The financial statements of the Company for the year ended December 31, 1993, were audited by other auditors, whose report, dated February 11, 1994, included an explanatory paragraph that described a change in the method of accounting for revenues, which is discussed in Note 1 to these financial 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 financial position of the Company as of December 31, 1995 and 1994, and the results of its operations and its cash flows for the years then ended in conformity with generally accepted accounting principles.\nCOOPERS & LYBRAND L.L.P. New Orleans, Louisiana February 14, 1996\nINDEPENDENT AUDITORS' REPORT\nTo the Shareholders and the Board of Directors of Mississippi Power & Light Company:\nWe have audited the accompanying statements of income, retained earnings, and cash flows of Mississippi Power & Light Company (MP&L) for the year ended December 31, 1993. These financial statements are the responsibility of MP&L's management. Our responsibility is to express an opinion on these financial statements based on our audit.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, such financial statements present fairly, in all material respects, the results of MP&L's operations and its cash flows for the year ended December 31, 1993 in conformity with generally accepted accounting principles.\nAs discussed in Note 1 to the financial statements, MP&L changed its method of accounting for revenues in 1993.\nDELOITTE & TOUCHE LLP New Orleans, Louisiana February 11, 1994\nMISSISSIPPI POWER & LIGHT COMPANY\nMANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS\nRESULTS OF OPERATIONS\nNet Income\nNet income increased in 1995 primarily due to increased revenues and a decrease in other operation and maintenance expenses partially offset by an increase in income tax expense. Net income decreased in 1994 due primarily to the onetime recording in the first quarter of 1993 of the cumulative effect of the change in accounting principle for unbilled revenues. In addition, net income was reduced by the rate reduction in connection with the formula incentive-rate plan, partially offset by a FERC settlement.\nSignificant factors affecting the results of operations and causing variances between the years 1995 and 1994, and 1994 and 1993, are discussed under \"Revenues and Sales,\" \"Expenses,\" and \"Other\" below.\nRevenues and Sales\nSee \"SELECTED FINANCIAL DATA - FIVE-YEAR COMPARISON,\" following the notes to financial statements, for information on operating revenues by source and KWh sales.\nThe changes in electric operating revenues for the twelve months ended December 31, 1995, are as follows:\nIncrease\/ Description (Decrease) ------------------------ ------------- (In Millions)\nChange in base revenues $(6.1) Grand Gulf Rate Rider (0.6) Fuel cost recovery 12.8 Sales volume\/weather 14.9 Other revenue (including unbilled) 5.6 Sales for resale 3.4 ------ Total $30.0 ======\nOperating revenues increased in 1995 primarily due to an increase in retail and wholesale energy sales and higher fuel adjustment revenues, partially offset by rate reductions. Retail energy sales increased primarily due to the impact of weather and increased customer usage. Fuel adjustment revenues increased in response to higher fuel costs and do not impact net income. Operating revenues decreased in 1994 due to the impact of the rate reduction in connection with the incentive-rate plan that went into effect in March 1994, partially offset by higher energy sales. In addition to the factors cited above for revenues, accrued unbilled revenues decreased due to a change in the cycle billing dates offset by an increase in billed revenues. This decrease was partially offset by increased commercial and industrial retail sales.\nExpenses\nOperating expenses increased in 1995 due primarily to an increase in income tax expense partially offset by a decrease in other operation and maintenance expenses. Operating expenses increased in 1994 due primarily to increased amortization of rate deferrals partially offset by lower fuel\/purchased power and income tax expenses.\nMISSISSIPPI POWER & LIGHT COMPANY\nMANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS\nRESULTS OF OPERATIONS\nIncome tax expense increased in 1995 due primarily to the 1994 write-off of unamortized deferred investment tax credits and higher pretax income in 1995. Income taxes decreased in 1994 due primary to lower pretax income, and the write-off of unamortized deferred investment tax credits in accordance with a FERC settlement.\nOther operation and maintenance expense decreased in 1995 due primarily to 1994 Merger-related costs allocated to MP&L and payroll expenses. No significant Merger-related costs were allocated to MP&L during the current year. Payroll expenses decreased as a result of the restructuring program announced and accrued for during the third quarter of 1994. The restructuring program included a reduction in the number of MP&L employees during 1995. In addition, maintenance expenses decreased at various power plants.\nPurchased power expense decreased in 1994 due primarily to changes in generation availability and requirements among the Operating Companies and a lower per unit price for power purchased.\nThe amortization of rate deferrals increased in 1994 reflecting the fact that MP&L, based on the Revised Plan, collected more Grand Gulf 1-related costs from its customers in 1994 than in 1993.\nOther\nInterest expense decreased in 1994 due primarily to the retirement and refinancing of high-cost debt.\nMISSISSIPPI POWER & LIGHT COMPANY STATEMENTS OF INCOME\nMISSISSIPPI POWER & LIGHT COMPANY STATEMENTS OF CASH FLOWS\nMISSISSIPPI POWER & LIGHT COMPANY BALANCE SHEETS ASSETS\nMISSISSIPPI POWER & LIGHT COMPANY BALANCE SHEETS CAPITALIZATION AND LIABILITIES\nMISSISSIPPI POWER & LIGHT COMPANY STATEMENTS OF RETAINED EARNINGS\nMISSISSIPPI POWER & LIGHT COMPANY\nSELECTED FINANCIAL DATA - FIVE-YEAR COMPARISON\n(1) Includes long-term debt (excluding currently maturing debt), preferred stock with sinking fund, and noncurrent capital lease obligations.\nSee Notes 1, 3, and 9 for the effect of accounting changes in 1993.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholders of New Orleans Public Service Inc.\nWe have audited the accompanying balance sheets of New Orleans Public Service Inc. as of December 31, 1995 and 1994, and the related statements of income, retained earnings and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. The financial statements of the Company for the year ended December 31, 1993, were audited by other auditors, whose report, dated February 11, 1994, included an explanatory paragraph that described a change in the method of accounting for revenues, which is discussed in Note 1 to these financial 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 financial position of the Company as of December 31, 1995 and 1994, and the results of its operations and its cash flows for the years then ended in conformity with generally accepted accounting principles.\nCOOPERS & LYBRAND L.L.P. New Orleans, Louisiana February 14, 1996\nINDEPENDENT AUDITORS' REPORT\nTo the Shareholders and the Board of Directors of New Orleans Public Service Inc.\nWe have audited the accompanying statements of income, retained earnings, and cash flows of New Orleans Public Service Inc. (NOPSI) for the year ended December 31, 1993. These financial statements are the responsibility of NOPSI's management. Our responsibility is to express an opinion on these financial statements based on our audit.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, such financial statements present fairly, in all material respects, the results of NOPSI's operations and its cash flows for the year ended December 31, 1993 in conformity with generally accepted accounting principles.\nAs discussed in Note 1 to the financial statements, NOPSI changed its method of accounting for revenues in 1993.\nDELOITTE & TOUCHE LLP New Orleans, Louisiana February 11, 1994\nNEW ORLEANS PUBLIC SERVICE INC.\nMANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS\nRESULTS OF OPERATIONS\nNet Income\nNet income increased in 1995 principally due to 1994 refunds associated with the 1994 NOPSI Settlement and a decrease in other operation and maintenance expense, partially offset by a permanent rate reduction that took place January 1, 1995. Net income decreased in 1994 due to the effects of the 1994 NOPSI Settlement and the one- time recording of the cumulative effect of the change in accounting principle for unbilled revenues in 1993, partially offset by lower operating expenses. See Note 2 for a discussion of the 1994 NOPSI Settlement.\nSignificant factors affecting the results of operations and causing variances between the years 1995 and 1994, and 1994 and 1993, are discussed under \"Revenues and Sales\" and \"Expenses\" below.\nRevenues and Sales\nSee \"SELECTED FINANCIAL DATA-FIVE-YEAR COMPARISON,\" following the notes to financial statements, for information on electric operating revenues by source and KWh sales.\nThe changes in electric operating revenues for the twelve months ended December 31, 1995, are as follows:\nIncrease\/ Description (Decrease) -------------------- ------------- (In Millions)\nChange in base revenues $12.2 Fuel cost recovery (0.3) Sales volume\/weather 12.5 Other revenue (including 6.1 unbilled) Sales for resale 3.5 ------ Total $34.0 ======\nElectric operating revenues increased in 1995 as a result of refunds in 1994 associated with the 1994 NOPSI Settlement and an increase in energy sales. The increase in energy sales is primarily due to weather effects on retail sales and an increase in sales for resale. Electric operating revenues decreased in 1994 due primarily to the effects of the 1994 NOPSI Settlement as discussed in Note 2. Electric energy sales increased slightly in 1994.\nGas operating revenues decreased in 1995 primarily due to the rate reduction agreed to in the NOPSI Settlement effective January 1, 1995, and a lower unit purchase price for gas purchased for resale. Gas operating revenues decreased slightly in 1994 as a result of lower gas sales.\nExpenses\nOperating expenses increased in 1995 due primarily to an increase in income taxes and the increased amortization of rate deferrals, partially offset by a decrease in fuel and other operation and maintenance expenses. Fuel expenses decreased in 1995 primarily due to a decrease in fuel prices. Other operation and maintenance expenses decreased primarily due to a decrease in maintenance activity and lower payroll expenses. The decrease in payroll expenses is the result of the 1994 restructuring and the related decrease in employees. Operating expenses decreased in 1994 due primarily to lower purchased power expenses and lower income tax expenses.\nNEW ORLEANS PUBLIC SERVICE INC.\nMANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS\nRESULTS OF OPERATIONS\nPurchased power expenses decreased in 1994 due primarily to changes in generation availability and requirements among the Operating Companies and lower costs.\nGas purchased for resale decreased in 1995 due lower gas prices. Gas purchased for resale decreased in 1994 due to decreased gas sales.\nIncome taxes increased in 1995 as a result of lower pretax income in 1994 due to the 1994 NOPSI Settlement and the write-off of the unamortized balances of deferred investment tax credits pursuant to the FERC Settlement in 1994. Income taxes decreased in 1994 due primarily to lower pretax income, resulting from the 1994 NOPSI Settlement, and the write-off of the unamortized balances of deferred investment tax credits pursuant to the FERC Settlement.\nThe increases in the amortization of rate deferrals in 1995 and 1994 are primarily a result of the collection of larger amounts of previously deferred costs under the 1991 NOPSI Settlement, which allowed NOPSI to record an additional $90 million of previously incurred Grand Gulf 1-related costs.\nNEW ORLEANS PUBLIC SERVICE INC. STATEMENTS OF INCOME\nNEW ORLEANS PUBLIC SERVICE INC. STATEMENTS OF CASH FLOWS\nNEW ORLEANS PUBLIC SERVICE INC. BALANCE SHEETS ASSETS\nNEW ORLEANS PUBLIC SERVICE INC. BALANCE SHEETS CAPITALIZATION AND LIABILITIES\nNEW ORLEANS PUBLIC SERVICE INC. STATEMENTS OF RETAINED EARNINGS\nNEW ORLEANS PUBLIC SERVICE INC.\nSELECTED FINANCIAL DATA - FIVE-YEAR COMPARISON\n(1) Includes long-term debt (excluding currently maturing debt) and preferred stock with sinking fund.\nSee Notes 1, 3, and 9 for the effect of accounting changes in 1993.\n(1) 1994 includes the effects of the 1994 NOPSI Settlement.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholder of System Energy Resources, Inc.\nWe have audited the accompanying balance sheets of System Energy Resources, Inc. as of December 31, 1995 and 1994, and the related statements of income, retained earnings and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. The financial statements of the Company for the year ended December 31, 1993, were audited by other auditors, whose report, dated February 11, 1994, expressed an unqualified opinion on these financial 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 financial position of the Company as of December 31, 1995 and 1994, and the results of its operations and its cash flows for the years then ended in conformity with generally accepted accounting principles.\nCOOPERS & LYBRAND L.L.P. New Orleans, Louisiana February 14, 1996\nINDEPENDENT AUDITORS' REPORT\nTo the Shareholders and the Board of Directors of System Energy Resources, Inc.\nWe have audited the accompanying statements of income, retained earnings, and cash flows of System Energy Resources, Inc. (System Energy) for the year ended December 31, 1993. These financial statements are the responsibility of System Energy's management. Our responsibility is to express an opinion on these financial statements based on our audit.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, such financial statements present fairly, in all material respects, the results of System Energy's operations and its cash flows for the year ended December 31, 1993 in conformity with generally accepted accounting principles.\nDELOITTE & TOUCHE LLP New Orleans, Louisiana February 11, 1994 (November 30, 1994 as to Note 2, \"Rate and Regulatory Matters - FERC Settlement\")\nSYSTEM ENERGY RESOURCES, INC.\nMANAGEMENT'S FINANCIAL DISCUSSION AND ANALYSIS\nRESULTS OF OPERATIONS\nNet Income\nNet income increased in 1995 primarily due to the effect of the FERC Settlement which reduced 1994 net income by $80.2 million. See Note 2 for a discussion of the FERC Settlement. This was partially offset by revenues being adversely impacted by a lower return on System Energy's decreasing investment in Grand Gulf 1. These factors also resulted in the decrease in 1994 net income.\nSignificant factors affecting the results of operations and causing variances between the years 1995 and 1994, and 1994 and 1993, are discussed under \"Revenues\" and \"Expenses\" below.\nRevenues\nOperating revenues increased in 1995 due primarily to the effect of the FERC Settlement on 1994 revenues as discussed in \"Net Income\" above and the recovery of increased expenses in connection with a Grand Gulf 1 refueling outage offset by a lower return on System Energy's decreasing investment in Grand Gulf 1. Revenues attributable to the return on investment are expected to continue to decline each year as a result of the depreciation of System Energy's investment in Grand Gulf 1.\nOperating revenues decreased in 1994 due primarily to the effect of the FERC Settlement as discussed in \"Net Income\" above, a lower return on System Energy's decreasing investment in Grand Gulf 1, and decreased operation and maintenance expenses. See Note 1 for a description of the components of System Energy's operating revenues.\nExpenses\nOperating expenses increased in 1995 due primarily to higher nuclear refueling outage expenses, higher depreciation, amortization, and decommissioning, and higher income taxes, partially offset by lower fuel expenses as a result of the refueling outage. Grand Gulf 1 was on-line for 285 days in 1995 as compared with 345 days in 1994. The difference in the on-line days was primarily due to the unit's seventh refueling outage that lasted from April 15, 1995, to June 21, 1995 (68 days), and, to a lesser extent, unplanned outages in 1995 totaling 12 days, compared to 20 days in 1994. Depreciation, amortization, and decommissioning increased due to a $4 million increase in amortization (as a result of the reclassification of $81 million of Grand Gulf 1 costs and the accelerated amortization of the reclassified costs over a ten-year period in accordance with the 1994 FERC Settlement) and $1 million in decommissioning. Total income taxes increased in 1995 due primarily to higher pretax book income.\nOperating expenses decreased in 1994 due primarily to lower other operation and maintenance expenses and lower income taxes. The lower level of outages for 1994 increased fuel for electric generation, but was partially offset by less expensive nuclear fuel and increased operating efficiency. Nonfuel operation and maintenance expenses decreased significantly in 1994 due to declines in contract work expenses, employee benefits, and materials and supplies expenses. Total income taxes decreased in 1994 due primarily to lower pretax book income\nInterest charges decreased in both 1995 and 1994 due primarily to the retirement and refinancing of high-cost long-term debt partially offset by interest associated with the FERC Settlement refunds.\nSYSTEM ENERGY RESOURCES, INC. STATEMENTS OF INCOME\nSYSTEM ENERGY RESOURCES, INC. STATEMENTS OF CASH FLOWS\nSYSTEM ENERGY RESOURCES, INC. BALANCE SHEETS ASSETS\nSYSTEM ENERGY RESOURCES, INC. BALANCE SHEETS CAPITALIZATION AND LIABILITIES\nSYSTEM ENERGY RESOURCES, INC. STATEMENTS OF RETAINED EARNINGS\nSYSTEM ENERGY RESOURCES, INC.\nSELECTED FINANCIAL DATA - FIVE-YEAR COMPARISON\n(1) Includes long-term debt (excluding current maturities) and noncurrent capital lease obligations.\nSee Note 2 for information with respect to refunds and charges resulting from the FERC Settlement in 1994 and Note 3 for the effect of the accounting change for income taxes in 1993.\nENTERGY CORPORATION AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Entergy Corporation, AP&L, GSU, LP&L, MP&L, NOPSI, and System Energy)\nThe accompanying consolidated financial statements include the accounts of Entergy Corporation and its direct subsidiaries: AP&L, GSU, LP&L, MP&L, NOPSI, System Energy, Entergy Services, Entergy Operations, Entergy Power, Entergy Enterprises, System Fuels, Entergy S.A., Entergy Argentina S.A., Entergy Power Marketing Corporation, Entergy Power Development Corporation, Entergy Argentina S.A., Ltd., Entergy Transener S.A., Entergy Power Development International Holdings, Inc., and Entergy Power Development International Holdings. A number of these subsidiaries have additional subsidiaries.\nBecause the acquisition of GSU was consummated on December 31, 1993, under the purchase method of accounting, GSU's operations were not included in the consolidated amounts for the year ended December 31, 1993. GSU is included in all of the consolidated financial statements for 1994 and 1995. All references made to Entergy or the System as of, and subsequent to, the Merger closing date include amounts and information pertaining to GSU as an Entergy company. All significant intercompany transactions have been eliminated. Entergy Corporation's utility subsidiaries maintain accounts in accordance with FERC and other regulatory guidelines. Certain previously reported amounts have been reclassified to conform to current classifications with no effect on net income or shareholders' equity.\nUse of Estimates in the Preparation of Financial Statements - - - - -----------------------------------------------------------\nThe preparation of Entergy Corporation and its subsidiaries' financial statements, in conformity with generally accepted accounting principles, requires management to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of December 31, 1995 and 1994, and the reported amounts of revenues and expenses during fiscal years 1995, 1994, and 1993. Adjustments to the reported amounts of assets and liabilities may be necessary in the future to the extent that future estimates or actual results are different from the estimates used in 1995 financial statements.\nRevenues and Fuel Costs - - - - -----------------------\nAP&L, LP&L, and MP&L generate, transmit, and distribute electricity (primarily to retail customers) in the States of Arkansas, Louisiana, and Mississippi, respectively. GSU generates, transmits, and distributes electricity primarily to retail customers in the States of Texas and Louisiana; distributes gas at retail in the City of Baton Rouge, Louisiana, and vicinity; and also sells steam to a large refinery complex in Baton Rouge. NOPSI sells both electricity and gas to retail customers in the city of New Orleans (except for Algiers where LP&L is the electricity supplier).\nSystem Energy's operating revenues recover operating expenses, depreciation, and capital costs attributable to Grand Gulf 1 from AP&L, LP&L, MP&L, and NOPSI. Capital costs are computed by allowing a return on System Energy's common equity funds allocable to its net investment in Grand Gulf 1, plus System Energy's effective interest cost for its debt allocable to its investment in Grand Gulf 1. See Note 2 for a discussion of System Energy's proposed rate increase.\nA portion of AP&L's and LP&L's purchase of power from Grand Gulf has not been included in the determination of the cost of service to retail customers by the APSC and LPSC, respectively, as described in Note 2.\nThe Operating Companies accrue estimated revenues for energy delivered since the latest billings. However, prior to January 1, 1993, AP&L, GSU, MP&L, and NOPSI recognized electric and gas revenues when billed. To provide a better matching of revenues and expenses, effective January 1, 1993, AP&L, GSU, MP&L, and NOPSI adopted a change in accounting principle to provide for the accrual of estimated unbilled revenues. The cumulative effect (excluding GSU) of this accounting change as of January 1, 1993, increased System 1993 net income by $93.8 million (net of income taxes of $57.2 million), or $0.54 per share. The impacts on the individual operating companies are shown below:\nNet of Tax Total Tax Effect ------------ ---------- --------- (In Thousands)\nAP&L $81,327 $31,140 $50,187 MP&L 52,162 19,456 32,706 NOPSI 17,540 6,592 10,948 ------------ ---------- --------- System $151,029 $57,188 $93,841 ============= =========== ==========\nIn accordance with a LPSC rate order, GSU recorded a deferred credit of $16.6 million for the January 1, 1993, amount of unbilled revenues. See Note 2 regarding GSU's subsequent appeals of the LPSC order regarding deferred unbilled revenues.\nThe Operating Companies' rate schedules (except GSU's Texas retail rate schedules) include fuel adjustment clauses that allow either current recovery or deferrals of fuel costs until such costs are reflected in the related revenues. GSU's Texas retail rate schedules include a fixed fuel factor approved by the PUCT, which remains in effect until changed as part of a general rate case, fuel reconciliation, or fixed fuel factor filing.\nUtility Plant - - - - -------------\nUtility plant is stated at original cost. The original cost of utility plant retired or removed, plus the applicable removal costs, less salvage, is charged to accumulated depreciation. Maintenance, repairs, and minor replacement costs are charged to operating expenses. Substantially all of the utility plant is subject to liens of the subsidiaries' mortgage bond indentures.\nUtility plant includes the portions of Grand Gulf 1 and Waterford 3 that were sold and currently are leased back. For financial reporting purposes, these sale and leaseback transactions are reflected as financing transactions.\nNet electric utility plant in service, by company and functional category, as of December 31, 1995 (excluding owned and leased nuclear fuel and the plant acquisition adjustment related to the Merger), is shown below:\nDepreciation is computed on the straight-line basis at rates based on the estimated service lives and costs of removal of the various classes of property. Depreciation rates on average depreciable property are shown below:\nAFUDC represents the approximate net composite interest cost of borrowed funds and a reasonable return on the equity funds used for construction. Although AFUDC increases both utility plant and earnings, it is only realized in cash through depreciation provisions included in rates.\nJointly-Owned Generating Stations - - - - ---------------------------------\nCertain Entergy Corporation subsidiaries own undivided interests in several jointly-owned electric generating facilities and record the investments and expenses associated with these generating stations to the extent of their respective ownership interests. As of December 31, 1995, the subsidiaries' investment and accumulated depreciation in each of these generating stations were as follows:\nIncome Taxes - - - - ------------\nEntergy Corporation and its subsidiaries file a consolidated federal income tax return. Income taxes are allocated to the System companies in proportion to their contribution to consolidated taxable income. SEC regulations require that no Entergy Corporation subsidiary pay more taxes than it would have paid if a separate income tax return had been filed. Deferred income taxes are recorded for all temporary differences between the book and tax basis of assets and liabilities and for certain credits available for carryforward.\nDeferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.\nInvestment tax credits are deferred and amortized based upon the average useful life of the related property in accordance with rate treatment. As discussed in Note 3, in 1993 Entergy changed its accounting for income taxes to conform with SFAS 109, \"Accounting for Income Taxes.\"\nAcquisition Adjustment - - - - ----------------------\nEntergy Corporation, upon completion of the Merger in December 1993, recorded an acquisition adjustment in utility plant in the amount of $380 million, representing the excess of the purchase price over the historical cost of the GSU net assets acquired. During 1994, Entergy recorded an additional $124 million of acquisition adjustment related to the resolution of certain preacquisition contingencies and appropriate allocation of purchase price.\nThe acquisition adjustment is being amortized on a straight-line basis over a 31-year period beginning January 1, 1994, which approximates the remaining average book life of the plant acquired as a result of the Merger. As of December 31, 1995, the unamortized balance of the acquisition adjustment was $472 million. The System anticipates that its future net cash flows will be sufficient to recover such amortization.\nReacquired Debt - - - - ---------------\nThe premiums and costs associated with reacquired debt are being amortized over the life of the related new issuances, in accordance with ratemaking treatment.\nCash and Cash Equivalents - - - - -------------------------\nEntergy considers all unrestricted highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents.\nContinued Application of SFAS 71 - - - - --------------------------------\nAs a result of the EPAct, other Federal laws, and actions of regulatory commissions, the electric utility industry is moving toward a combination of competition and a modified regulatory environment. The Operating Companies' and System Energy's financial statements currently reflect, for the most part, assets and costs based on cost- based ratemaking regulation, in accordance with SFAS 71, \"Accounting for the Effects of Certain Types of Regulation.\" Continued applicability of SFAS 71 to the System's financial statements requires that rates set by an independent regulator on a cost-of-service basis (including a reasonable rate of return on invested capital) can actually be charged to and collected from customers.\nIn the event either all or a portion of a utility's operations cease to meet those criteria for various reasons, including deregulation, a change in the method of regulation or a change in the competitive environment for the utility's regulated services, the utility should discontinue application of SFAS 71 for the relevant portion. That discontinuation would be reported by elimination from the balance sheet of the effects of any actions of regulators recorded as regulatory assets and liabilities.\nAs of December 31, 1995, and for the foreseeable future, the System's financial statements continue to follow SFAS 71, with the exceptions noted below.\nSFAS 101 - - - - --------\nSFAS 101, \"Accounting for the Discontinuation of Application of FASB Statement No. 71,\" specifies how an enterprise that ceases to meet the criteria for application of SFAS 71 to all or part of its operations should report that event in its financial statements. GSU discontinued regulatory accounting principles for its wholesale jurisdiction and its steam department during 1989 and for the Louisiana retail deregulated portion of River Bend in 1991. The results of Entergy's deregulated operations (before interest charges) for the years ended December 31, 1995, 1994, and 1993 are as follows:\nSFAS 121 - - - - --------\nIn March 1995, the FASB issued SFAS 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of\" (SFAS 121), which became effective January 1, 1996. This statement describes circumstances that may result in assets (including goodwill such as the Merger acquisition adjustment, discussed above) being impaired. The statement also provides criteria for recognition and measurement of asset impairment. Note 2 describes regulatory assets of $169 million (net of tax) related to Texas retail deferred River Bend operating and carrying costs. These deferred costs will be required to be written off upon the adoption of SFAS 121.\nCertain other assets and operations of the Operating Companies totaling approximately $1.7 billion (pre-tax) could be affected by SFAS 121 in the future. Those assets include AP&L's and LP&L's retained shares of Grand Gulf 1, GSU's Louisiana deregulated asset plan, and its Texas jurisdiction abeyed portion of the River Bend plant, in addition to the wholesale jurisdiction and steam department operations of GSU. As discussed above, GSU has previously discontinued the application of SFAS 71 for the Louisiana deregulated asset plan, operations under the wholesale jurisdiction, and the steam department.\nEntergy periodically reviews these assets and operations in order to determine if the carrying value of such assets will be recovered. Generally, this determination is based on the net cash flows expected to result from such operations and assets. Projected net cash flows depend on the future operating costs associated with the assets, the efficiency and availability of the assets and generating units, and the future market and price for energy over the remaining life of the assets. Based on current estimates of future cash flows as prescribed under SFAS 121, management anticipates that future revenues from such assets and operations of Entergy will fully recover all related costs.\nChange in Accounting for Nuclear Refueling Outage Costs (Entergy - - - - ------------------------------------------------------- Corporation and AP&L)\nIn December 1995, at the recommendation of FERC, AP&L changed its method of accounting for nuclear refueling outage costs. The change, effective January 1, 1995, results in AP&L deferring incremental maintenance costs incurred during an outage and amortizing those costs over the operating period immediately following the nuclear refueling outage, which is the period that the charges are billed to customers. Previously, estimated costs of refueling outages were accrued over the period (generally 18 months) preceding each scheduled outage. The effect of the change for the year ended December 31, 1995, was to decrease net income by $5.1 million (net of income taxes of $3.3 million) or $.02 per share. The cumulative effect of the change was to increase net income $35.4 million (net of income taxes of $22.9 million) or $.15 per share. The pro forma effects of the change in accounting for nuclear refueling outages in 1994 and 1993, assuming the new method was applied retroactively to those years, would have been to decrease net income $3.2 million (net of income taxes of $2.1 million) and $6.5 million (net of income taxes of $4.2 million), respectively, or $.01 per share and $.04 per share, respectively.\nFair Value Disclosures - - - - ----------------------\nThe estimated fair value of financial instruments was determined using bid prices reported by dealer markets and by nationally recognized investment banking firms. Considerable judgment is required in developing the estimates of fair value. Therefore, estimates are not necessarily indicative of the amounts that Entergy could realize in a current market exchange. In addition, gains or losses realized on financial instruments may be reflected in future rates and not accrue to the benefit of stockholders.\nEntergy considers the carrying amounts of financial instruments classified as current assets and liabilities to be a reasonable estimate of their fair value because of the short maturity of these instruments. In addition, Entergy does not expect that performance of its obligations will be required in connection with certain off-balance sheet commitments and guarantees considered financial instruments. Due to this factor, and because of the related-party nature of these commitments and guarantees, determination of fair value is not considered practicable. See Notes 5, 6, and 8 for additional disclosure concerning fair value methodologies.\nNOTE 2. RATE AND REGULATORY MATTERS\nMerger-Related Rate Agreements (Entergy Corporation, AP&L, GSU, LP&L, - - - - ------------------------------ MP&L, and NOPSI)\nIn November 1993, Entergy Corporation, AP&L, MP&L, and NOPSI entered into separate settlement agreements whereby the APSC, MPSC, and Council agreed to withdraw from the SEC proceeding related to the Merger. In return AP&L, MP&L, and NOPSI agreed, among other things, that their retail ratepayers would be protected from (1) increases in the cost of capital resulting from risks associated with the Merger, (2) recovery of any portion of the acquisition premium or transactional costs associated with the Merger, (3) certain direct allocations of costs associated with GSU's River Bend nuclear unit, and (4) any losses of GSU resulting from resolution of litigation in connection with its ownership of River Bend. AP&L and MP&L agreed not to request any general retail rate increase that would take effect before November 1998, except for, among other things, increases associated with the recovery of certain Grand Gulf 1-related costs, recovery of certain taxes, and catastrophic events, and in the case of AP&L, excess capacity costs and costs related to the adoption of SFAS 106 that were previously deferred. MP&L agreed that retail base rates under the formula rate plan would not be increased above November 1, 1993, levels for a period of five years beginning November 9, 1993.\nIn 1993, the LPSC and the PUCT approved separate regulatory proposals for GSU that include the following elements: (1) a five-year Rate Cap on GSU's retail electric base rates in the respective states, except for force majeure (defined to include, among other things, war, natural catastrophes, and high inflation); (2) a provision for passing through to retail customers the jurisdictional portion of the fuel savings created by the Merger; and (3) a mechanism for tracking nonfuel operation and maintenance savings created by the Merger. The LPSC regulatory plan provides that such nonfuel savings will be shared 60% by shareholders and 40% by ratepayers during the eight years following the Merger. The LPSC plan requires annual regulatory filings by the end of May through the year 2001. The PUCT regulatory plan provides that such savings will be shared equally by shareholders and ratepayers, except that the shareholders' portion will be reduced by $2.6 million per year on a total company basis in years four through eight. The PUCT plan also requires a series of future regulatory filings in November 1996, 1998, and 2001 to ensure that the ratepayers' share of such savings be reflected in rates on a timely basis. In addition, the plan requires Entergy Corporation to hold GSU's Texas retail customers harmless from the effects of the removal by FERC of a 40% cap on the amount of fuel savings GSU may be required to transfer to other Operating Companies under the FERC tracking mechanism (see below). On January 14, 1994, Entergy Corporation filed a petition for review before the D.C. Circuit seeking review of FERC's deletion of the 40% cap provision in the fuel cost protection mechanism. The matter is currently being held in abeyance.\nFERC approved GSU's inclusion in the System Agreement. Commitments were adopted to provide reasonable assurance that the ratepayers of AP&L, LP&L, MP&L, and NOPSI will not be allocated higher costs including, among other things, (1) a tracking mechanism to protect AP&L, LP&L, MP&L, and NOPSI from certain unexpected increases in fuel costs, (2) the distribution of profits from power sales contracts entered into prior to the Merger, (3) a methodology to estimate the cost of capital in future FERC proceedings, and (4) a stipulation that AP&L, LP&L, MP&L, and NOPSI will be insulated from certain direct effects on capacity equalization payments if GSU were to acquire Cajun's 30% share in River Bend. The Operating Companies' regulatory authorities can elect to \"opt out\" of the fuel tracker, but are not required to make such an election until FERC has approved the respective Operating Company's compliance filing. The City and the MPSC have made such an election.\nRiver Bend (Entergy Corporation and GSU) - - - - -----------\nIn May 1988, the PUCT granted GSU a permanent increase in annual revenues of $59.9 million resulting from the inclusion in rate base of approximately $1.6 billion of company-wide River Bend plant investment and approximately $182 million of related Texas retail jurisdiction deferred River Bend costs (Allowed Deferrals). In addition, the PUCT disallowed as imprudent $63.5 million of company-wide River Bend plant costs and placed in abeyance, with no finding of prudence, approximately $1.4 billion of company-wide River Bend plant investment and approximately $157 million of Texas retail jurisdiction deferred River Bend operating and carrying costs. The PUCT affirmed that the rate treatment of such amounts would be subject to future demonstration of the prudence of such costs. GSU and intervening parties appealed this order (Rate Appeal) and GSU filed a separate rate case asking, among other things, that the abeyed River Bend plant costs be found prudent (Separate Rate Case). Intervening parties filed suit in a Texas district court to prohibit the Separate Rate Case and prevailed. The district court's decision in favor of the intervenors was ultimately appealed to the Texas Supreme Court, which ruled in 1990 that the prudence of the purported abeyed costs could not be relitigated in a separate rate proceeding. The Texas Supreme Court's decision stated that all issues relating to the merits of the original PUCT order, including the prudence of all River Bend-related costs, should be addressed in the Rate Appeal.\nIn October 1991, the Texas district court in the Rate Appeal issued an order holding that, while it was clear the PUCT made an error in assuming it could set aside $1.4 billion of the total costs of River Bend and consider them in a later proceeding, the PUCT, nevertheless, found that GSU had not met its burden of proof related to the amounts placed in abeyance. The court also ruled that the Allowed Deferrals should not be included in rate base. The court further stated that the PUCT had erred in reducing GSU's deferred costs by $1.50 for each $1.00 of revenue collected under the interim rate increases authorized in 1987 and 1988. The court remanded the case to the PUCT with instructions as to the proper handling of the Allowed Deferrals. GSU's motion for rehearing was denied and, in December 1991, GSU filed an appeal of the October 1991 district court order. The PUCT also appealed the October 1991 district court order, which served to supersede the district court's judgment, rendering it unenforceable under Texas law.\nIn August 1994, the Texas Third District Court of Appeals (the Appellate Court) affirmed the district court's decision that there was substantial evidence to support the PUCT's 1988 decision not to include the abeyed construction costs in GSU's rate base. While acknowledging that the PUCT had exceeded its authority in attempting to defer a decision on the inclusion of those costs in rate base in order to allow GSU a further opportunity to demonstrate the prudence of those costs in a subsequent proceeding, the Appellate Court found that GSU had suffered no harm or lack of due process as a result of the PUCT's error. Accordingly, the Appellate Court held that the PUCT's action had the effect of disallowing the company-wide $1.4 billion of River Bend construction costs for ratemaking purposes. In its August 1994 opinion, the Appellate Court also held that GSU's deferred operating and maintenance costs associated with the allowed portion of River Bend, as well as GSU's deferred River Bend carrying costs included in the Allowed Deferrals, should be included in rate base. The Appellate Court's August 1994 opinion affirmed the PUCT's original order in this case.\nThe Appellate Court's August 1994 opinion was entered by two judges, with a third judge dissenting. The dissenting opinion stated that the result of the majority opinion was, among other things, to deprive GSU of due process at the PUCT because the PUCT never reached a finding on the $1.4 billion of construction costs.\nIn October 1994, the Appellate Court denied GSU's motion for rehearing on the August 1994 opinion as to the $1.4 billion in River Bend construction costs and other matters. GSU appealed the Appellate Court's decision to the Texas Supreme Court. On February 9, 1996, the Texas Supreme Court agreed to hear the appeal. Oral arguments are scheduled for March 19, 1996.\nAs of December 31, 1995, the River Bend plant costs disallowed for retail ratemaking purposes in Texas, the River Bend plant costs held in abeyance, and the related operating and carrying cost deferrals totaled (net of taxes) approximately $13 million, $276 million (both net of depreciation), and $169 million, respectively. Allowed Deferrals were approximately $83 million, net of taxes and amortization, as of December 31, 1995. GSU estimates it has collected approximately $182 million of revenues as of December 31, 1995, as a result of the originally ordered rate treatment by the PUCT of these deferred costs. If recovery of the Allowed Deferrals is not upheld, future revenues based upon those allowed deferrals could also be lost, and no assurance can be given as to whether or not refunds to customers of revenue received based upon such deferred costs will be required.\nNo assurance can be given as to the timing or outcome of the remands or appeals described above. Pending further developments in these cases, GSU has made no write-offs or reserves for the River Bend- related costs. See below for a discussion of the write-off of deferred operating and carrying cost required under SFAS 121 in 1996. Based on advice from Clark, Thomas & Winters, A Professional Corporation, legal counsel of record in the Rate Appeal, management believes that it is reasonably possible that the case will be remanded to the PUCT, and the PUCT will be allowed to rule on the prudence of the abeyed River Bend plant costs. At this time, management and legal counsel are unable to predict the amount, if any, of the abeyed and previously disallowed River Bend plant costs that ultimately may be disallowed by the PUCT. A net of tax write-off as of December 31, 1995, of up to $289 million could be required based on an ultimate adverse ruling by the PUCT on the abeyed and disallowed costs.\nIn prior proceedings, the PUCT has held that the original cost of nuclear power plants will be included in rates to the extent those costs were prudently incurred. Based upon the PUCT's prior decisions, management believes that River Bend construction costs were prudently incurred and that it is reasonably possible that it will recover in rate base, or otherwise through means such as a deregulated asset plan, all or substantially all of the abeyed River Bend plant costs. However, management also recognizes that it is reasonably possible that not all of the abeyed River Bend plant costs may ultimately be recovered.\nAs part of its direct case in the Separate Rate Case, GSU filed a cost reconciliation study prepared by Sandlin Associates, management consultants with expertise in the cost analysis of nuclear power plants, which supports the reasonableness of the River Bend costs held in abeyance by the PUCT. This reconciliation study determined that approximately 82% of the River Bend cost increase above the amount included by the PUCT in rate base was a result of changes in federal nuclear safety requirements, and provided other support for the remainder of the abeyed amounts.\nThere have been four other rate proceedings in Texas involving nuclear power plants. Disallowed investment in the plants ranged from 0% to 15%. Each case was unique, and the disallowances in each were made for different reasons. Appeals of two of these PUCT decisions are currently pending.\nThe following factors support management's position that a loss contingency requiring accrual has not occurred, and its belief that all, or substantially all, of the abeyed plant costs will ultimately be recovered:\n1. The $1.4 billion of abeyed River Bend plant costs have never been ruled imprudent and disallowed by the PUCT; 2. Analysis by Sandlin Associates, which supports the prudence of substantially all of the abeyed construction costs; 3. Historical inclusion by the PUCT of prudent construction costs in rate base; and 4. The analysis of GSU's legal staff, which has considerable experience in Texas rate case litigation.\nBased on advice from Clark, Thomas & Winters, A Professional Corporation, legal counsel of record in the Rate Appeal, management believes that it is reasonably possible that the Allowed Deferrals will continue to be recovered in rates, and that it is reasonably possible that the deferred costs related to the $1.4 billion of abeyed River Bend plant costs will be recovered in rates to the extent that the $1.4 billion of abeyed River Bend plant is recovered.\nThe adoption of SFAS 121 became effective January 1, 1996. SFAS 121 changes the standard for continued recognition of regulatory assets and, as a result GSU will be required to write-off $169 million of rate deferrals in 1996. The standard also describes circumstances that may result in assets being impaired and provides criteria for recognition and measurement of asset impairment. See Note 1 for further information regarding SFAS 121.\nFilings with the PUCT and Texas Cities (Entergy Corporation and GSU) - - - - --------------------------------------\nIn March 1994, the Texas Office of Public Utility Counsel and certain cities served by GSU instituted an investigation of the reasonableness of GSU's rates. On March 20, 1995, the PUCT ordered a $72.9 million annual base rate reduction for the period March 31, 1994, through September 1, 1994, decreasing to an annual base rate reduction of $52.9 million after September 1, 1994. In accordance with the Merger agreement, the rate reduction was applied retroactively to March 31, 1994.\nOn May 26, 1995, the PUCT amended its previously issued March 20, 1995 rate order, reducing the $52.9 million annual base rate reduction to an annual level of $36.5 million. The PUCT's action was based, in part, upon a Texas Supreme Court decision not to require a utility to use the prospective tax benefits generated by disallowed expenses to reduce rates. The PUCT's May 26, 1995, amended order no longer required GSU to pass such prospective tax benefits onto its customers. The rate refund, retroactive to March 31, 1994, was approximately $61.8 million (including interest) and was refunded to customers in September, October, and November 1995. GSU and other parties have appealed the PUCT order, but no assurance can be given as to the timing or outcome of the appeal.\nFilings with the LPSC - - - - --------------------- (Entergy Corporation and GSU)\nIn May 1994, GSU filed a required earnings analysis with the LPSC for the test year preceding the Merger (1993). On December 14, 1994, the LPSC ordered a $12.7 million annual rate reduction for GSU, effective January 1995. GSU received a preliminary injunction from the District Court regarding $8.3 million of the reduction relating to the earnings effect of a 1994 change in accounting for unbilled revenues. On January 1, 1995, GSU reduced rates by $4.4 million. GSU filed an appeal of the entire $12.7 million rate reduction with the District Court, which denied the appeal in July 1995. GSU has appealed the order to the Louisiana Supreme Court. The preliminary injunction relating to $8.3 million of the reduction will remain in effect during the appeal.\nOn May 31, 1995, GSU filed its second required post-Merger earnings analysis with the LPSC. Hearings on this review were held and a decision is expected in mid-1996.\n(Entergy Corporation and LP&L)\nIn August 1994, LP&L filed a performance-based formula rate plan with the LPSC. The proposed formula rate plan would continue existing LP&L rates at current levels, while providing a financial incentive to reduce costs and maintain high levels of customer satisfaction and system reliability. The plan would allow LP&L the opportunity to earn a higher rate of return if it improves performance over time. Conversely, if performance declines, the rate of return LP&L could earn would be lowered. This would provide a financial incentive for LP&L to continuously improve in all three performance categories (price, customer satisfaction, and service reliability).\nOn June 2, 1995, as a result of the LPSC's earnings review of LP&L's performance-based formula rate plan, a $49.4 million reduction in base rates was ordered. This included $10.5 million of rate reductions previously made through the fuel adjustment clause. The net effect of the LPSC order was to reduce rates by $38.9 million. The LPSC approved LP&L's proposed formula rate plan with the following modifications. An earnings band was established with a range from 10.4% to 12% for return on equity. If LP&L's earnings fall within the bandwidth, no adjustment in rates occurs. However, if LP&L's earnings are above or below the established earnings band, prospective rate decreases or increases will occur. The LPSC also reduced LP&L's authorized rate of return from 12.76% to 11.2%. The LPSC rate order was retroactive to April 27, 1995.\nOn June 9, 1995, LP&L appealed the $49.4 million rate reduction and filed a petition for injunctive relief from implementation of $14.7 million of the reduction. The $14.7 million portion of the rate reduction represents revenue imputed to LP&L as a result of the LPSC's conclusion that LP&L charged unreasonably low rates to three industrial customers. Subsequently, a request for a $14.7 million rate increase was filed by LP&L. On July 13, 1995, LP&L was granted a preliminary injunction by the District Court on $14.7 million of the rate reduction pending a final LPSC order. Exclusive of the $14.7 million stayed under the preliminary injunction, the rate refund was retroactive to April 27, 1995, and amounted to approximately $8.2 million. Customers received the refunds in the months of September and October 1995.\nIn an order issued on January 31, 1996, the LPSC approved a settlement reducing the $14.7 million portion of the rate reduction to $12.35 million. Rate refunds subject to this settlement were retroactive to April 27, 1995, and were made in the months of January and February 1996. The refunds and related interest resulting from the settlement amounted to $8.9 million. The District Court case discussed above was dismissed as part of the settlement.\nLPSC Fuel Cost Review (Entergy Corporation and GSU) - - - - ---------------------\nIn November 1993, the LPSC ordered a review of GSU's fuel costs for the period October 1988 through September 1991 (Phase 1) based on the number of outages at River Bend and the findings in the June 1993 PUCT fuel reconciliation case. In July 1994, the LPSC ruled in the Phase 1 fuel review case and ordered GSU to refund approximately $27 million to its customers. Under the order, a refund of $13.1 million was made through a billing credit on August 1994 bills. In August 1994, GSU appealed the remaining $13.9 million of the LPSC-ordered refund to the district court. GSU has made no reserve for the remaining portion, pending outcome of the district court appeal, and no assurance can be given as to the timing or outcome of the appeal.\nThe LPSC is currently conducting the second phase of its review of GSU's fuel costs for the period October 1991 through December 1994. On June 30, 1995, the LPSC consultants filed testimony recommending a disallowance of $38.7 million of fuel costs. Hearings began in December 1995 and are expected to be completed in early March 1996.\nDeregulated Asset Plan (Entergy Corporation and GSU) - - - - ----------------------\nA deregulated asset plan representing an unregulated portion (approximately 24%) of River Bend (plant costs, generation, revenues, and expenses) was established pursuant to a January 1992 LPSC order. The plan allows GSU to sell such generation to Louisiana retail customers at 4.6 cents per KWh or off-system at higher prices, with certain sharing provisions for sharing such incremental revenue above 4.6 cents per KWh between ratepayers and shareholders.\nRiver Bend Cost Deferrals (Entergy Corporation and GSU) - - - - -------------------------\nGSU deferred approximately $369 million of River Bend operating and purchased power costs, and accrued carrying charges, pursuant to a 1986 PUCT accounting order. Approximately $182 million of these costs are being amortized over a 20-year period, and the remaining $187 million are not being amortized pending the outcome of the Rate Appeal. As of December 31, 1995, the unamortized balance of these costs was $312 million. GSU deferred approximately $400.4 million of similar costs pursuant to a 1986 LPSC accounting order, of which approximately $83 million were unamortized as of December 31, 1995, and are being amortized over a 10-year period ending in 1998.\nIn accordance with a phase-in plan approved by the LPSC, GSU deferred $294 million of its River Bend costs related to the period February 1988 through February 1991. GSU has amortized $172 million through December 31, 1995. The remainder of $122 million will be recovered over approximately 2.2 years.\nGrand Gulf 1 and Waterford 3 Deferrals - - - - -------------------------------------- (Entergy Corporation and AP&L)\nUnder the settlement agreement entered into with the APSC in 1985 and amended in 1988, AP&L agreed to retain a portion of its Grand Gulf 1-related costs, recover a portion of such costs currently, and defer a portion of such costs for future recovery. In 1995 and subsequent years, AP&L retains 22% of its 36% interest in Grand Gulf 1 costs and recovers the remaining 78%. The deferrals ceased in l990, and AP&L is recovering a portion of the previously deferred costs each year through l998. As of December 31, l995, the balance of deferred costs was $360 million. AP&L is permitted to recover on a current basis the incremental costs of financing the unrecovered deferrals. In the event AP&L is not able to sell its retained share to third parties, it may sell such energy to its retail customers at a price equal to its avoided energy cost, which is currently less than AP&L's cost of energy from its retained share.\n(Entergy Corporation and LP&L)\nIn a series of LPSC orders, court decisions, and agreements from late 1985 to mid-1988, LP&L was granted rate relief with respect to costs associated with Waterford 3 and LP&L's share of capacity and energy from Grand Gulf 1, subject to certain terms and conditions. With respect to Waterford 3, LP&L was granted an increase aggregating $170.9 million over the period 1985-1988, and agreed to permanently absorb, and not recover from retail ratepayers, $284 million of its investment in the unit and to defer $266 million of its costs related to the years 1985-1988 to be recovered over approximately 8.6 years beginning in April 1988. As of December 31, 1995, LP&L's unrecovered deferral balance was $26 million.\nWith respect to Grand Gulf 1, in November 1988, LP&L agreed to retain and not recover from retail ratepayers, 18% of its 14% share (approximately 2.52%) of the costs of Grand Gulf 1 capacity and energy. LP&L is allowed to recover through the fuel adjustment clause 4.6 cents per KWh for the energy related to its retained portion of these costs. Alternatively, LP&L may sell such energy to nonaffiliated parties at prices above the fuel adjustment clause recovery amount, subject to the LPSC's approval.\n(Entergy Corporation and MP&L)\nMP&L entered into a revised plan with the MPSC that provides, among other things, for the recovery by MP&L, in equal annual installments over ten years beginning October 1, 1988, of all Grand Gulf 1-related costs deferred through September 30, 1988, pursuant to a final order by the MPSC. Additionally, the plan provides that MP&L defer, in decreasing amounts, a portion of its Grand Gulf 1-related costs over four years beginning October 1, 1988. These deferrals are being recovered by MP&L over a six-year period beginning in October 1992 and ending in September 1998. As of December 31, 1995, the uncollected balance of MP&L's deferred costs was approximately $378 million. The plan also allows for the current recovery of carrying charges on all deferred amounts.\n(Entergy Corporation and NOPSI)\nUnder NOPSI's various Rate Settlements with the Council in 1986, 1988, and 1991, NOPSI agreed to absorb and not recover from ratepayers a total of $96.2 million of its Grand Gulf 1 costs. NOPSI was permitted to implement annual rate increases in decreasing amounts each year through 1995, and to defer certain costs and related carrying charges for recovery on a schedule extending from 1991 through 2001. As of December 31, 1995, the uncollected balance of NOPSI's deferred costs was $171 million.\nFebruary 1994 Ice Storm\/Rate Rider (Entergy Corporation and MP&L) - - - - ---------------------------------- In early February 1994, an ice storm left more than 80,000 MP&L customers without electric power across the service area. The storm was the most severe natural disaster ever to affect the System, causing damage to transmission and distribution lines, equipment, poles, and facilities in certain areas, primarily in Mississippi. Repair costs totaled approximately $77.2 million, with $64.6 million of these amounts capitalized as plant-related costs. The remaining balances were recorded as a deferred debit.\nSubsequent to a request by MP&L for rate recovery, the MPSC approved a stipulation in September 1994, with respect to the recovery of ice storm costs recorded through April 30, 1994. Under the stipulation, MP&L implemented an ice storm rate rider, which increased rates approximately $8 million for a period of five years beginning on September 29, 1994. This stipulation also stated that at the end of the five-year period, the revenue requirement associated with the undepreciated ice storm capitalized costs will be included in MP&L's base rates to the extent that this revenue requirement does not result in MP&L's rate of return on rate base being above the benchmark rate of return under MP&L's Formula Rate Plan.\nIn September 1995, the MPSC approved a second stipulation which allows for a $2.5 million rate increase for a period of four years beginning September 28, 1995, to recover costs related to the ice storm that were recorded after April 30, 1994. The stipulation also allows for undepreciated ice storm capital costs recorded after April 30, 1994, to be treated as described above.\n1994 NOPSI Settlement (Entergy Corporation and NOPSI) - - - - --------------------- In a settlement with the Council that was approved on December 29, 1994, NOPSI agreed to reduce electric and gas rates and issue credits and refunds to customers. Effective January 1, 1995, NOPSI implemented a $31.8 million permanent reduction in electric base rates and a $3.1 million permanent reduction in gas base rates. These adjustments resolved issues associated with NOPSI's return on equity exceeding 13.76% for the test year ended September 30, 1994. Under the 1991 NOPSI Settlement, NOPSI is recovering from its retail customers its allocable share of certain costs related to Grand Gulf 1. NOPSI's base rates to recover those costs were derived from estimates of those costs made at that time. Any overrecovery of costs is required to be returned to customers. Grand Gulf 1 has experienced lower operating costs than previously estimated, and NOPSI accordingly is reducing its base rates in two steps to match more accurately the current costs related to Grand Gulf 1. On January 1, 1995, NOPSI implemented a $10 million permanent reduction in base electric rates to reflect the reduced costs related to Grand Gulf 1, which was followed by an additional $4.4 million rate reduction on October 31, 1995. These Grand Gulf rate reductions, which are expected to be largely offset by lower operating costs, may reduce NOPSI's after-tax net income by approximately $1.4 million per year beginning November 1, 1995. The Grand Gulf 1 phase-in rate increase in the amount of $4.4 million on October 31, 1995, was not affected by the 1994 NOPSI Settlement.\nThe 1994 NOPSI Settlement also required NOPSI to credit its customers $25 million over a 21-month period beginning January 1, 1995, in order to resolve disputes with the Council regarding the interpretation of the 1991 NOPSI Settlement. NOPSI reduced its revenues by $25 million and recorded a $15.4 million net-of-tax reserve associated with the credit in the fourth quarter of 1994. The 1994 NOPSI Settlement further required NOPSI to refund, in December 1994, $13.3 million of credits previously scheduled to be made to customers during the period January 1995 through July 1995. These credits were associated with a July 7, 1994, Council resolution that ordered a $24.95 million rate reduction based on NOPSI's overearnings during the test year ended September 30, 1993. Accordingly, NOPSI recorded an $8 million net-of-tax charge in the fourth quarter of 1994.\nThe 1994 NOPSI Settlement also required NOPSI to refund $9.3 million of overcollections associated with Grand Gulf 1 operating costs, and $10.5 million of refunds associated with the settlement by System Energy of a FERC tax audit. The settlement of the FERC tax audit by System Energy required refunds to be passed on to NOPSI and to other Entergy subsidiaries and then on to customers. These refunds have no effect on current period net income.\nPursuant to the 1994 NOPSI Settlement, NOPSI is required to make earnings filings with the Council for the 1995 and 1996 rate years. A review of NOPSI's earnings for the test year ending September 30, 1995, will require NOPSI to credit customers $6.2 million over a 12-month period beginning March 11, 1996. Hearings with the Council as to the reasonableness and prudence of NOPSI's deferred Least Cost Intergrated Resource Planning expenses for cost recovery purposes are scheduled for April 1996.\nProposed Rate Increase - - - - ---------------------- (System Energy)\nSystem Energy filed an application with FERC on May 12, 1995, for a $65.5 million rate increase. The request seeks changes to System Energy's rate schedule, including increases in the revenue requirement associated with decommissioning costs, the depreciation rate, and the rate of return on common equity. On December 12, 1995, System Energy implemented a $65.5 million rate increase, subject to refund. Hearings on System Energy's request began in January 1996 and were completed in February 1996. The ALJ's initial decision is expected in 1996.\n(MP&L)\nMP&L's allocation of the proposed System Energy wholesale rate increase is $21.6 million. In July 1995, MP&L filed a schedule with the MPSC that will defer the ultimate amount of the System Energy rate increase. The deferral plan, which was approved by the MPSC, began in December 1995, the effective date of the System Energy rate increase, and will end after the issuance of a final order by FERC. The deferred rate increase is to be amortized over 48 months beginning October 1998.\n(NOPSI)\nNOPSI's allocation of the proposed System Energy wholesale rate increase is $11.1 million. In February 1996, NOPSI filed a plan with the City to defer 50% of the amount of the System Energy rate increase. The deferral began with the February 1996 bill to NOPSI from System Energy and will end after the issuance of a final order by FERC.\nFERC Settlement (Entergy Corporation and System Energy)\nIn November 1994, FERC approved an agreement settling a long- standing dispute involving income tax allocation procedures of System Energy. In accordance with the agreement, System Energy refunded approximately $61.7 million to AP&L, LP&L, MP&L, and NOPSI, each of which in turn has made refunds or credits to its customers (except for those portions attributable to AP&L's and LP&L's retained share of Grand Gulf 1 costs). Additionally, System Energy will refund a total of approximately $62 million, plus interest, to AP&L, LP&L, MP&L, and NOPSI over the period through June 2004. The settlement also required the write-off of certain related unamortized balances of deferred investment tax credits by AP&L, LP&L, MP&L, and NOPSI. The settlement reduced Entergy Corporation's consolidated net income for the year ended December 31, 1994, by approximately $68.2 million, offset by the write-off of the unamortized balances of related deferred investment tax credits of approximately $69.4 million ($2.9 million for Entergy Corporation; $27.3 million for AP&L; $31.5 million for LP&L; $6 million for MP&L; and $1.7 million for NOPSI). System Energy also reclassified from utility plant to other deferred debits approximately $81 million of other Grand Gulf 1 costs. Although such costs are excluded from rate base, System Energy is recovering them over a 10-year period. Interest on the $62 million refund and the loss of the return on the $81 million of other Grand Gulf 1 costs will reduce Entergy's and System Energy's net income by approximately $10 million annually over the next 10 years.\nFERC Return on Equity Case - - - - -------------------------- In August 1992, FERC instituted an investigation of the return on equity (ROE) component of all formula wholesale rates for System Energy as well as AP&L, LP&L, MP&L, and NOPSI. Rates under the Unit Power Sales Agreement are based on System Energy's cost of service, including a return on common equity which had been set at 13%.\nIn August 1993, Entergy and the state regulatory agencies that intervened in the proceeding reached an agreement (Settlement Agreement) in this matter. The Settlement Agreement, which was approved by FERC on October 25, 1993, provides that an 11.0% ROE will be included in the formula rates under the Unit Power Sales Agreement. System Energy's refunds payable to AP&L, LP&L, MP&L, and NOPSI, which were due prospectively from November 3, 1992, were reflected as a credit to their bills in October 1993. These refunds decreased System Energy's 1993 revenues and net income by approximately $29.4 million and $18.2 million, respectively. The Unit Power Sales Agreement formula rate, including the 11.0% ROE component, currently remains in effect. However, in December 1995, System Energy implemented a rate increase subject to refund, which included an increased return on common equity. Refer to above for a discussion of the proposed System Energy rate increase.\nNOTE 3. INCOME TAXES\nEntergy Corporation - - - - ------------------- Entergy Corporation's income tax expense consists of the following:\nEntergy Corporation's total income taxes differ from the amounts computed by applying the statutory Federal income tax rate to income before taxes. The reasons for the differences are:\nSignificant components of Entergy Corporation's net deferred tax liabilities as of December 31, 1995 and 1994, are as follows:\nArkansas Power & Light Company - - - - ------------------------------\nAP&L's income tax expense consists of the following:\nAP&L's total income taxes differ from the amounts computed by applying the statutory Federal income tax rate to income before taxes. The reasons for the differences are:\nSignificant components of AP&L's net deferred tax liabilities as of December 31, 1995 and 1994,are as follows:\nGulf States Utilities Company - - - - -----------------------------\nGSU's income tax expense consists of the following:\nGSU's total income taxes differ from the amounts computed by applying the statutory Federal income tax rate to income before taxes. The reasons for the differences are:\nSignificant components of GSU's net deferred tax liabilities as of December 31, 1995 and 1994, are as follows:\nLouisiana Power & Light Company - - - - -------------------------------\nLP&L's income tax expense consists of the following:\nLP&L's total income taxes differ from the amounts computed by applying the statutory Federal income tax rate to income before taxes. The reasons for the differences are:\nSignificant components of LP&L's net deferred tax liabilities as of December 31, 1995 and 1994, are as follows:\nMississippi Power & Light Company - - - - ---------------------------------\nMP&L's income tax expense consists of the following:\nMP&L's total income taxes differ from the amounts computed by applying the statutory federal income tax rate to income before taxes. The reasons for the differences are:\nSignificant components of MP&L's net deferred tax liabilities as of December 31, 1995 and 1994, are as follows:\nNew Orleans Public Service Inc. - - - - -------------------------------\nNOPSI's income tax expense consists of the following:\nNOPSI's total income taxes differ from the amounts computed by applying the statutory Federal income tax rate to income before taxes. The reasons for the differences are:\nSignificant components of NOPSI's net deferred tax liabilities as of December 31, 1995 and 1994, are as follows:\nSystem Energy Resources, Inc. - - - - -----------------------------\nSystem Energy's income tax expense consists of the following:\nSystem Energy's total income taxes differ from the amounts computed by applying the statutory Federal income tax rate to income before taxes. The reasons for the differences are:\nSignificant components of System Energy's net deferred tax liabilities as of December 31, 1995 and 1994, are as follows:\nAs of December 31, 1995, Entergy had investment tax credit (ITC) carryforwards of $167.7 million, federal net operating loss (NOL) carryforwards of $384.6 million and state NOL carryforwards of $355.0 million, all related to GSU operations. The ITC carryforwards include the 35% reduction required by the Tax Reform Act of 1986 and may be applied against federal income tax liability of only GSU and, if not utilized, will expire between 1996 and 2002. It is currently anticipated that approximately $44.6 million of ITC carryforward will expire unutilized. A valuation allowance has been provided for deferred tax assets relating to that amount. The alternative minimum tax (AMT) credit carryforwards as of December 31, 1995, were $130.7 million, including $39.7 million at GSU, $27.4 million at LP&L, and $63.6 million at SERI. This AMT credit can be carried forward indefinitely and will reduce the System's federal income tax liability in the future.\nIn accordance with the System Energy-FERC Settlement, the System wrote off $66.5 million of unamortized deferred investment tax credits in 1994, including $27.3 million at AP&L, $31.5 million at LP&L, $6.0 million at MP&L, and $1.7 million at NOPSI.\nIn 1993, the System adopted SFAS 109. SFAS 109 required that deferred income taxes be recorded for all carryforwards and temporary differences between the book and tax basis of assets and liabilities, and that deferred tax balances be based on enacted tax laws at tax rates that are expected to be in effect when the temporary differences reverse. SFAS 109 required that regulated enterprises recognize adjustments resulting from implementation as regulatory assets or liabilities if it is probable that such amounts will be recovered from or returned to customers in future rates. A substantial majority of the adjustments required by SFAS 109 was recorded to deferred tax balance sheet accounts with offsetting adjustments to regulatory assets and liabilities. As a result of the adoption of SFAS 109, Entergy's 1993 net income and earnings per share were decreased by $13.2 million and $0.08 per share, respectively, and assets and liabilities were increased by $822.7 million and $835.9 million, respectively. The cumulative effect of the adoption of SFAS 109 is included in income tax expense charged to operations. The following table shows the effect of the adoption of SFAS 109 on 1993 net income, assets and liabilities for AP&L, LP&L, MP&L, NOPSI, and SERI.\nGSU recorded the adoption of SFAS 109 by restating 1990, 1991, and 1992 financial statements and including a charge of $96.5 million for the cumulative effect of the adoption of SFAS 109 in 1990 primarily for that portion of the operations on which GSU has discontinued regulatory accounting principles.\nIn August 1994, Entergy received an IRS report covering the federal income tax audit of Entergy Corporation and subsidiaries for the years 1988 - 1990. The report asserts an $80 million tax deficiency for the 1990 consolidated federal income tax returns related primarily to the application of accelerated investment tax credits associated with Waterford 3 and Grand Gulf nuclear plants. Entergy believes there is no material tax deficiency and is vigorously contesting the proposed assessment.\nNOTE 4. LINES OF CREDIT AND RELATED BORROWINGS (Entergy Corporation, AP&L, GSU, LP&L, MP&L, NOPSI, and System Energy)\nThe SEC has authorized AP&L, GSU, LP&L, MP&L, NOPSI, and System Energy to effect short-term borrowings up to $125 million, $125 million, $150 million, $100 million, $39 million, and $125 million, respectively (for a total of $664 million). These limits may be increased to as much as $1.216 billion in total (subject to individual authorizations for each company) after further SEC approval. These authorizations are effective through November 30, 1996. Of these companies, only LP&L and System Energy had borrowings outstanding as of December 31, 1995. LP&L had $76.5 million of borrowings outstanding, including $61.5 million under the money pool, an intra-System borrowing arrangement designed to reduce the System's dependence on external short-term borrowings. LP&L had unused bank lines of credit in the amount of $2.7 million. System Energy had money pool borrowings outstanding of approximately $3 million at December 31, 1995. AP&L and MP&L had undrawn lines of credit as of December 31, 1995, of $34 million and $30 million, respectively.\nOn July 27, 1995, Entergy Corporation received SEC authorization for a $300 million bank credit facility. Thereafter, a three-year credit agreement was signed with a group of banks on October 10, 1995, to provide up to $300 million of loans to Entergy Corporation. As of December 31, 1995, no amounts were outstanding against this credit facility. However, on January 4, 1996, $230 million was borrowed against the facility for use in the acquisition of CitiPower. See Note 15 for a discussion of the acquisition.\nOther Entergy companies have financing agreements and facilities permitting them to borrow up to $135 million, of which $30 million was outstanding as of December 31, 1995. Some of these borrowings are restricted as to use, and are secured by certain assets.\nIn total, the System had commitments in the amount of $516.7 million at December 31, 1995, of which $471.7 million was unused. The weighted average interest rate on the outstanding borrowings at December 31, 1995, and December 31, 1994, was 6.35% and 7.18%, respectively. Commitment fees on the lines of credit for AP&L, LP&L, and MP&L are 0.125% of the undrawn amounts. The commitment fee for Entergy Corporation's $300 million credit facility is currently 0.17%, but can fluctuate depending on the senior debt ratings of the Operating Companies.\nNOTE 5. PREFERRED, PREFERENCE, AND COMMON STOCK (Entergy Corporation, AP&L, GSU, LP&L, MP&L, and NOPSI)\nThe number of shares, authorized and outstanding, and dollar value of preferred and preference stock for Entergy, AP&L, GSU, LP&L, MP&L, and NOPSI as of December 31, 1995, and 1994 were:\n(a) The total dollar value represents the involuntary liquidation value of $25 per share. (b) These series are not redeemable as of December 31, 1995. (c) Rates are as of December 31, 1995. (d) Fair values were determined using bid prices reported by dealer markets and by nationally recognized investment banking firms. See Note 1 for additional disclosure of fair value of financial instruments.\nChanges in the preferred stock, with and without sinking fund, preference stock, and common stock of AP&L, GSU, LP&L, MP&L, and NOPSI during the last three years were:\nCash sinking fund requirements for the next five years for preferred stock, outstanding as of December 31, 1995 are:\n(a) AP&L, GSU, LP&L, and MP&L have the annual noncumulative option to redeem, at par, additional amounts of certain series of their outstanding preferred stock.\nOn December 31, 1993, Entergy Corporation issued 56,695,724 shares of common stock in connection with the Merger. In addition, Entergy Corporation redeemed 174,552,011 shares of $5 par value common stock and reissued 174,552,011 shares of $0.01 par value common stock resulting in an increase in paid-in capital of $871 million.\nEntergy Corporation had a program in which it repurchased and retired (returned to authorized but unissued status) 1,230,000 shares of common stock at a cost of $30.7 million in 1994. In addition, 627,000 shares of treasury stock were purchased for cash during 1993 at a cost of $20.6 million. A portion of the treasury shares purchased in 1993 was subsequently reissued, and in connection with the Merger on December 31, 1993, the remaining balance of 579,274 shares of treasury stock was canceled.\nEntergy Corporation from time to time acquires shares of its common stock to be held as treasury shares and to be reissued to meet the requirements of the Stock Plan for Outside Directors (Directors' Plan), the Equity Ownership Plan of Entergy Corporation and Subsidiaries (Equity Plan), and certain other stock benefit plans. Under this program, 2,805,000 of treasury shares were purchased in 1994 at a cost of $88.8 million. The Directors' Plan awards nonemployee directors a portion of their compensation in the form of a fixed number of shares of Entergy Corporation common stock. Shares awarded under the Directors' Plan were 9,251, 18,757, and 12,550 during 1995, 1994, and 1993, respectively. The Equity Plan grants stock options, restricted shares, and equity awards to key employees of the System companies. The costs of awards are charged to income over the period of the grant or restricted period, as appropriate. Amounts charged to compensation expense in 1995 were immaterial. Stock options, which comprise 50% of the shares targeted for distribution under the Equity Plan, are granted at exercise prices not less than market value on the date of grant. The options are generally exercisable no less than six months nor more than 10 years after the date of grant.\nNonstatutory stock option transactions are summarized as follows:\n(a) Options were not exercisable as of December 31, 1995.\nThe Employee Stock Investment Plan (ESIP) is authorized to issue or acquire, through March 31, 1997, up to 2,000,000 shares of its common stock to be held as treasury shares and reissued to meet the requirements of the ESIP. Under the ESIP, employees may be granted the opportunity to purchase (for up to 10% of their regular annual salary, but not more than $25,000) common stock at 85% of the market value on the first or last business day of the plan year, whichever is lower. Through this program, employees purchased 329,863 shares for the 1994 plan year. The 1995 plan year runs from April 1, 1995, to March 31, 1996.\nNOTE 6. LONG - TERM DEBT (Entergy Corporation, AP&L, GSU, LP&L, MP&L, NOPSI, and System Energy)\nThe long-term debt of Entergy Corporation's subsidiaries, AP&L, GSU, LP&L, MP&L, NOPSI, and System Energy, as of December 31, 1995, was:\nThe long-term debt of Entergy Corporation's subsidiaries, AP&L, GSU, LP&L, MP&L, NOPSI, and System Energy, as of December 31, 1994, was:\n(a) $20 million of MP&L's 14.95% Series G&R Bonds and $9.2 million of NOPSI's 13.9% Series G&R Bonds were due 2\/1\/95. All other series are at interest rates within the range of 6.95% - 11.2%.\n(b) Consists of pollution control bonds, certain series of which are secured by non-interest bearing first mortgage bonds.\n(c) The fair value excludes lease obligations, long-term DOE obligations, and other long-term debt and was determined using bid prices reported by dealer markets and by nationally recognized investment banking firms. See Note 1 for additional information on disclosure of fair value of financial instruments.\nThe annual long-term debt maturities (excluding lease obligations) and annual cash sinking fund requirements for the next five years follow:\nSystem Entergy (a) AP&L (b) GSU (c) LP&L (d) MP&L (e) NOPSI Energy (Dollars In Thousands)\n1996 558,650 28,700 145,425 35,260 61,015 38,250 250,000 1997 361,270 33,065 160,865 34,325 96,015 27,000 10,000 1998 314,920 18,710 190,890 35,300 20 - 70,000 1999 172,391 1,225 100,915 231 20 - 70,000 2000 143,015 1,825 945 100,225 20 - 40,000\n(a) Not included are other sinking fund requirements of approximately $20.4 million annually which may be satisfied by cash or by certification of property additions at the rate of 167% of such requirements.\n(b) Not included are other sinking fund requirements of approximately $1.1 million annually which may be satisfied by cash or by certification of property additions at the rate of 167% of such requirements.\n(c) Not included are other sinking fund requirements of approximately $13.8 million annually which may be satisfied by cash or by certification of property additions at the rate of 167% of such requirements.\n(d) Not included are other sinking fund requirements of approximately $5.5 million annually which may be satisfied by cash or by certification of property additions at the rate of 167% of such requirements.\n(e) Not included are other sinking fund requirements of approximately $0.1 million for 1996 which may be satisfied by cash or by certification of property additions at the rate of 167% of such requirements.\nGSU has two outstanding series of pollution control bonds collateralized by irrevocable letters of credit, which are scheduled to expire before the scheduled maturity of the bonds. The letter of credit collateralizing the $28.4 million variable rate series, due December 1, 2015, expires in September 1996 and the letter of credit collateralizing the $20 million variable rate series, due April 1, 2016, expires in April 1996. GSU plans to refinance these series or renew the letters of credit.\nUnder MP&L's G&R Mortgage, G&R Bonds are issuable based upon 70% of bondable property additions, based upon 50% of accumulated deferred Grand Gulf 1 related costs, based upon the retirement of certain bonds previously outstanding, or based upon the deposit of cash with the trustee. MP&L's G&R Mortgage prohibits the issuance of additional first mortgage bonds (including for refunding purposes) under MP&L's first mortgage indenture, except such first mortgage bonds as may hereafter be issued from time to time at MP&L's option to the corporate trustee under the G&R Mortgage to provide additional security for MP&L's G&R Bonds.\nUnder NOPSI's G&R Mortgage, G&R Bonds are issuable based upon 70% of bondable property additions or based upon 50% of accumulated deferred Grand Gulf 1-related costs. The G&R Mortgage precludes the issuance of any additional bonds based upon property additions if the total amount of outstanding Rate Recovery Mortgage Bonds issued on the basis of the uncollected balance of deferred Grand Gulf 1-related costs exceeds 66 2\/3% of the balance of such deferred costs. As of December 31, 1995, the total amount of Rate Recovery Mortgage Bonds outstanding aggregated $30.0 million, or 17.3% of NOPSI's accumulated deferred Grand Gulf 1-related costs.\nNOTE 7. DIVIDEND RESTRICTIONS - (Entergy Corporation, AP&L, GSU, LP&L, MP&L, NOPSI, and System Energy)\nProvisions within the Articles of Incorporation or pertinent Indentures and various other agreements related to the long-term debt and preferred stock of Entergy Corporation's subsidiaries restrict the payment of cash dividends or other distributions on their common and preferred stock. Additionally, PUHCA prohibits Entergy Corporation's subsidiaries from making loans or advances to Entergy Corporation. Detailed below are the restricted common equity and restricted retained earnings unavailable for distribution to Entergy Corporation by subsidiary.\nRestricted Restricted Company Equity Earnings (In Millions)\nAP&L $ 882.6 $ 291.3 GSU 1,266.5 - LP&L 1,084.1 - MP&L 334.8 135.7 NOPSI 85.2 15.2 System Energy 808.1 18.7 ----------- ---------- Entergy $ 4,461.3 $ 460.9 =========== ==========\nNOTE 8. COMMITMENTS AND CONTINGENCIES\nCajun - River Bend Litigation (Entergy Corporation and GSU)\nGSU has significant business relationships with Cajun, including co-ownership of River Bend (operated by GSU) and Big Cajun 2, Unit 3 (operated by Cajun). GSU and Cajun, respectively, own 70% and 30% undivided interests in River Bend and 42% and 58% undivided interests in Big Cajun 2, Unit 3.\nIn June 1989, Cajun filed a civil action against GSU in the United States District Court for the Middle District of Louisiana (District Court). Cajun's complaint seeks to annul, rescind, terminate, and\/or dissolve the Joint Ownership Participation and Operating Agreement (Operating Agreement) entered into on August 28, 1979, relating to River Bend. Cajun alleges fraud and error by GSU, breach of its fiduciary duties owed to Cajun, and\/or GSU's repudiation, renunciation, abandonment, or dissolution of its core obligations under the Operating Agreement, as well as the lack or failure of cause and\/or consideration for Cajun's performance under the Operating Agreement. The suit also seeks to recover Cajun's alleged $1.6 billion investment in the unit as damages, plus attorneys' fees, interest, and costs. Two member cooperatives of Cajun have brought an independent action to declare the Operating Agreement void, based upon failure to get prior LPSC approval alleged to be necessary. GSU believes the suits are without merit and is contesting them vigorously.\nA trial on the portion of the suit by Cajun to rescind the Operating Agreement began in April 1994 and was completed in March 1995. On October 24, 1995, the District Court issued a memorandum opinion ruling in favor of GSU. The District Court found that Cajun did not prove that GSU fraudulently induced it to execute the Operating Agreement and that Cajun failed to timely assert its claim. A final judgment on this portion of the suit will not be entered until all claims asserted by Cajun have been heard. The second portion of the suit is scheduled to begin on July 2, 1996. If GSU is ultimately unsuccessful in this litigation and is required to pay substantial damages, GSU would probably be unable to make such payments and could be forced to seek relief from its creditors under the United States Bankruptcy Code. If GSU prevails in this litigation, there can be no assurance that the United States Bankruptcy Court will allow funding of all required costs of Cajun's ownership in River Bend.\nCajun has not paid its full share of capital costs, operating and maintenance expenses, or other costs for repairs and improvements to River Bend since 1992. In addition, certain costs and expenses paid by Cajun were paid under protest. These actions were taken by Cajun based on its contention, with which GSU disagrees, that River Bend's operating and maintenance expenses were excessive. Cajun's unpaid portion of River Bend operating and maintenance expenses (including nuclear fuel) and capital costs for 1995 was approximately $58.7 million. Cajun continues to pay its share of decommissioning costs for River Bend.\nDuring the period in which Cajun is not paying its share of River Bend costs, GSU intends to fund all costs necessary for the safe, continuing operation of the unit. The responsibilities of Entergy Operations as the licensed operator of River Bend, for safely operating and maintaining the unit, are not affected by Cajun's actions.\nIn view of Cajun's failure to fund its share of River Bend-related operating, maintenance, and capital costs, GSU has (i) credited GSU's share of expenses for Big Cajun 2, Unit 3 against amounts due from Cajun to GSU, and (ii) sought to market Cajun's share of the power from River Bend and apply the proceeds to the amounts due from Cajun to GSU. As a result, on November 2, 1994, Cajun discontinued supplying GSU with its share of power from Big Cajun 2, Unit 3. GSU requested an order from the District Court requiring Cajun to supply GSU with this energy and allowing GSU to credit amounts due to Cajun for Big Cajun 2, Unit 3 energy against amounts Cajun owed to GSU for River Bend. In December 1994, by means of a preliminary injunction, the District Court ordered Cajun to supply GSU with its share of energy from Big Cajun 2, Unit 3 and ordered GSU to make payments for its share of Big Cajun 2, Unit 3 expenses to the registry of the District Court. In October 1995, the Fifth Circuit affirmed the District Court's preliminary injunction. As of December 31, 1995, $38 million had been paid by GSU into the registry of the District Court.\nOn December 21, 1994, Cajun filed a petition in the United States Bankruptcy Court for the Middle District of Louisiana seeking bankruptcy relief under Chapter 11 of the Bankruptcy Code. Cajun's bankruptcy could have a material adverse effect on GSU. However, GSU is taking appropriate steps to protect its interests and its claims against Cajun arising from the co-ownership in River Bend and Big Cajun 2, Unit 3. On December 31, 1994, the District Court issued an order lifting an automatic stay as to certain proceedings, with the result that the preliminary injunction granted by the Court in December 1994 remains in effect. Cajun filed a Notice of Appeal on January 18, 1995, to the Fifth Circuit seeking a reversal of the District Court's grant of the preliminary injunction. No hearing date has been set on Cajun's appeal.\nIn the bankruptcy proceedings, Cajun filed on January 10, 1995, a motion to reject the Operating Agreement as a burdensome executory contract. GSU responded on January 10, 1995, with a memorandum opposing Cajun's motion. Should the court grant Cajun's motion to reject the Operating Agreement, Cajun would be relieved of its financial obligations under the contract, while GSU would likely have a substantial damage claim arising from any such rejection. Although GSU believes that Cajun's motion to reject the Operating Agreement is without merit, it is not possible to predict the outcome or ultimate impact of these proceedings.\nThe cumulative cost (excluding nuclear fuel) to GSU resulting from Cajun's failure to pay its full share of River Bend-related costs, reduced by the proceeds from the sale by GSU of Cajun's share of River Bend power and payments for GSU's portion of expenses for Big Cajun 2, Unit 3 into the registry of the District Court, was $31.1 million as of December 31, 1995. These amounts are reflected in long-term receivables with an offsetting reserve in other deferred credits. Cajun's bankruptcy may affect the ultimate collectibility of the amounts owed to GSU, including any amounts that may be awarded in litigation.\nCajun - Transmission Service (Entergy Corporation and GSU)\nGSU and Cajun are parties to FERC proceedings relating to transmission service charge disputes. In April 1992, FERC issued a final order in these disputes. In May 1992, GSU and Cajun filed motions for rehearings on certain portions of the order, which are still pending at FERC. In June 1992, GSU filed a petition for review in the United States Court of Appeals regarding certain of the other issues decided by FERC. In August 1993, the United States Court of Appeals rendered an opinion reversing FERC's order regarding the portion of such disputes relating to the calculations of certain credits and equalization charges under GSU's service schedules with Cajun. The opinion remanded the issues to FERC for further proceedings consistent with its opinion. In February 1995, FERC eliminated an issue from the remand that GSU believes the Court of Appeals directed FERC to reconsider. In orders issued on August 3, 1995, and October 2, 1995, FERC affirmed an April 1995 ruling by an ALJ in the remanded portion of GSU's and Cajun's ongoing transmission service charge disputes before FERC. Both GSU and Cajun have petitioned for appeal. No hearing dates have been set in the appeals.\nUnder GSU's interpretation of the 1992 FERC order, as modified by its August 3, 1995, and October 2, 1995, orders, Cajun would owe GSU approximately $64.9 million as of December 31, 1995. GSU further estimates that if it were to prevail in its May 1992 motion for rehearing and on certain other issues decided adversely to GSU in the February 1995, August 1995, and October 1995 FERC orders, which GSU has appealed, Cajun would owe GSU approximately $143.5 million, as of December 31, 1995. If Cajun were to prevail in its May 1992 motion for rehearing to FERC, and if GSU were not to prevail in its May 1992 motion for rehearing to FERC, and if Cajun were to prevail in appealing FERC's August and October 1995 orders, GSU estimates it would owe Cajun approximately $96.4 million as of December 31, 1995. The above amounts are exclusive of a $7.3 million payment by Cajun on December 31, 1990, which the parties agreed to apply to the disputed transmission service charges. Pending FERC's ruling on the May 1992 motions for rehearing, GSU has continued to bill Cajun, utilizing the historical billing methodology, and has recorded underpaid transmission charges, including interest, in the amount of $137.2 million as of December 31, 1995. This amount is reflected in long-term receivables, with an offsetting reserve in other deferred credits. Cajun's bankruptcy may affect GSU's collection of the above amounts. FERC has determined that the collection of the pre-petition debt of Cajun is an issue properly decided in the bankruptcy proceeding.\nCapital Requirements and Financing (Entergy Corporation, AP&L, GSU, LP&L, MP&L, NOPSI, and System Energy)\nConstruction expenditures (excluding nuclear fuel) for the years 1996, 1997, and 1998 are estimated to total $571 million, $510 million, and $507 million, respectively. The System will also require $1.3 billion during the period 1996-1998 to meet long-term debt and preferred stock maturities and cash sinking fund requirements. The System plans to meet the above requirements primarily with internally generated funds and cash on hand, supplemented by the issuance of debt and preferred stock and the use of its outstanding credit facility. Certain System companies may also continue with the acquisition or refinancing of all or a portion of certain outstanding series of preferred stock and long-term debt. See Notes 5 and 6 for further information.\nGrand Gulf 1-Related Agreements\nCapital Funds Agreement (Entergy Corporation and System Energy)\nEntergy Corporation has agreed to supply System Energy with sufficient capital to (1) maintain System Energy's equity capital at an amount equal to a minimum of 35% of its total capitalization (excluding short-term debt), and (2) permit the continued commercial operation of Grand Gulf 1 and pay in full all indebtedness for borrowed money of System Energy when due under any circumstances. In addition, under supplements to the Capital Funds Agreement assigning System Energy's rights as security for specific debt of System Energy, Entergy Corporation has agreed to make cash capital contributions to enable System Energy to make payments on such debt when due.\nSystem Energy has entered into various agreements with AP&L, LP&L, MP&L, and NOPSI whereby they are obligated to purchase their respective entitlements of capacity and energy from System Energy's 90% ownership and leasehold interest in Grand Gulf 1, and to make payments that, together with other available funds, are adequate to cover System Energy's operating expenses. System Energy would have to secure funds from other sources, including Entergy Corporation's obligations under the Capital Funds Agreement, to cover any shortfalls from payments received from AP&L, LP&L, MP&L, and NOPSI under these agreements.\nUnit Power Sales Agreement (AP&L, LP&L, MP&L, NOPSI, and System Energy)\nSystem Energy has agreed to sell all of its 90% owned and leased share of capacity and energy from Grand Gulf 1 to AP&L, LP&L, MP&L, and NOPSI in accordance with specified percentages (AP&L-36%, LP&L-14%, MP&L-33% and NOPSI-17%) as ordered by FERC. Charges under this agreement are paid in consideration for the purchasing companies' respective entitlement to receive capacity and energy and are payable irrespective of the quantity of energy delivered so long as the unit remains in commercial operation. The agreement will remain in effect until terminated by the parties and approved by FERC, most likely upon Grand Gulf 1's retirement from service. Monthly obligations for payments, including the rate increase which was placed into effect in December 1995, subject to refund, under the agreement are approximately $21 million, $8 million, $19 million, and $10 million for AP&L, LP&L, MP&L, and NOPSI, respectively.\nAvailability Agreement (AP&L, LP&L, MP&L, NOPSI, and System Energy)\nAP&L, LP&L, MP&L, and NOPSI are individually obligated to make payments or subordinated advances to System Energy in accordance with stated percentages (AP&L-17.1%, LP&L-26.9%, MP&L-31.3%, and NOPSI- 24.7%) in amounts that when added to amounts received under the Unit Power Sales Agreement or otherwise, are adequate to cover all of System Energy's operating expenses as defined, including an amount sufficient to amortize Grand Gulf 2 over 27 years. (See Reallocation Agreement terms below.) System Energy has assigned its rights to payments and advances to certain creditors as security for certain obligations. Since commercial operation of Grand Gulf 1, payments under the Unit Power Sales Agreement have exceeded the amounts payable under the Availability Agreement. Accordingly, no payments have ever been required. If AP&L or MP&L fails to make its Unit Power Sales Agreement payments, and System Energy is unable to obtain funds from other sources, LP&L and NOPSI could become subject to claims or demands by System Energy or its creditors for payments or advances under the Availability Agreement (or the assignments thereof) equal to the difference between their required Unit Power Sales Agreement payments and their required Availability Agreement payments.\nReallocation Agreement (AP&L, LP&L, MP&L, NOPSI, and System Energy)\nSystem Energy and AP&L, LP&L, MP&L, and NOPSI entered into the Reallocation Agreement relating to the sale of capacity and energy from the Grand Gulf and the related costs, in which LP&L, MP&L, and NOPSI agreed to assume all of AP&L's responsibilities and obligations with respect to the Grand Gulf under the Availability Agreement. FERC's decision allocating a portion of Grand Gulf 1 capacity and energy to AP&L supersedes the Reallocation Agreement as it relates to Grand Gulf 1. Responsibility for any Grand Gulf 2 amortization amounts has been individually allocated (LP&L-26.23%, MP&L-43.97%, and NOPSI-29.80%) under the terms of the Reallocation Agreement. However, the Reallocation Agreement does not affect AP&L's obligation to System Energy's lenders under the assignments referred to in the preceding paragraph. AP&L would be liable for its share of such amounts if LP&L, MP&L, and NOPSI were unable to meet their contractual obligations. No payments of any amortization amounts will be required as long as amounts paid to System Energy under the Unit Power Sales Agreement, including other funds available to System Energy, exceed amounts required under the Availability Agreement, which is expected to be the case for the foreseeable future.\nReimbursement Agreement (System Energy)\nIn December 1988, System Energy entered into two entirely separate, but identical, arrangements for the sales and leasebacks of an approximate aggregate 11.5% ownership interest in Grand Gulf 1 (see Note 9). In connection with the equity funding of the sale and leaseback arrangements, letters of credit are required to be maintained to secure certain amounts payable for the benefit of the equity investors by System Energy under the leases. The current letters of credit are effective until January 15, 1997.\nUnder the provisions of a bank letter of credit reimbursement agreement, System Energy has agreed to a number of covenants relating to the maintenance of certain capitalization and fixed charge coverage ratios. System Energy agreed, during the term of the reimbursement agreement, to maintain its equity at not less than 33% of its adjusted capitalization (defined in the reimbursement agreement to include certain amounts not included in capitalization for financial statement purposes). In addition, System Energy must maintain, with respect to each fiscal quarter during the term of the reimbursement agreement, a ratio of adjusted net income to interest expense (calculated, in each case, as specified in the reimbursement agreement) of at least 1.60 times earnings. As of December 31, 1995, System Energy's equity approximated 34.8% of its adjusted capitalization, and its fixed charge coverage ratio was 2.11.\nFuel Purchase Agreements\n(AP&L and MP&L)\nAP&L has long-term contracts with mines in the State of Wyoming for the supply of low-sulfur coal for the White Bluff Steam Electric Generating Station and Independence (which is 25% owned by MP&L). These contracts, which expire in 2002 and 2011, provide for approximately 85% of AP&L's expected annual coal requirements. Additional requirements are satisfied by annual spot market purchases.\n(GSU)\nGSU has a contract for a supply of low-sulfur Wyoming coal for Nelson Unit 6, which should be sufficient to satisfy the fuel requirements at Nelson Unit 6 through 2004. Cajun has advised GSU that it has contracts that should provide an adequate supply of coal until 1999 for the operation of Big Cajun 2, Unit 3.\nGSU has long-term gas contracts, which will satisfy approximately 75% of its annual requirements. Such contracts generally require GSU to purchase in the range of 40% of expected total gas needs. Additional gas requirements are satisfied under less expensive short- term contracts. GSU has a transportation service agreement with a gas supplier that provides flexible natural gas service to the Sabine and Lewis Creek generating stations. This service is provided by the supplier's pipeline and salt dome gas storage facility, which has a present capacity of 5.3 billion cubic feet of natural gas.\n(LP&L)\nIn June 1992, LP&L agreed to a renegotiated 20-year natural gas supply contract. LP&L agreed to purchase natural gas in annual amounts equal to approximately one-third of its projected annual fuel requirements for certain generating units. Annual demand charges associated with this contract are estimated to be $8.6 million through 1997, and a total of $116.6 million for the years 1998 through 2012. LP&L recovers the cost of fuel consumed during the generation of electricity through its fuel adjustment clause.\nPower Purchases\/Sales Agreements\n(GSU)\nIn 1988, GSU entered into a joint venture with a primary term of 20 years with Conoco, Inc., Citgo Petroleum Corporation, and Vista Chemical Company (Industrial Participants) whereby GSU's Nelson Units 1 and 2 were sold to a partnership (NISCO) consisting of the Industrial Participants and GSU. The Industrial Participants supply the fuel for the units, while GSU operates the units at the discretion of the Industrial Participants and purchases the electricity produced by the units. GSU is continuing to sell electricity to the Industrial Participants. For the years ended December 31, 1995, 1994, and 1993, the purchases by GSU of electricity from the joint venture totaled $59.7 million, $58.3 million, and $62.6 million, respectively.\n(LP&L)\nLP&L has a long-term agreement through the year 2031 to purchase energy generated by a hydroelectric facility. During 1995, 1994, and 1993, LP&L made payments under the contract of approximately $55.7 million, $56.3 million, and $66.9 million, respectively. If the maximum percentage (94%) of the energy is made available to LP&L, current production projections would require estimated payments of approximately $47 million in 1996, $54 million in 1997, and a total of $3.5 billion for the years 1998 through 2031. LP&L recovers the costs of purchased energy through its fuel adjustment clause.\nSystem Fuels (AP&L, LP&L, MP&L, NOPSI, and System Energy)\nAP&L, LP&L, MP&L, and NOPSI have interests in System Fuels of 35%, 33%, 19%, and 13%, respectively. The parent companies of System Fuels agreed to make loans to System Fuels to finance its fuel procurement, delivery, and storage activities. As of December 31, 1995, AP&L, LP&L, MP&L, and NOPSI had, respectively, approximately $11 million, $14.2 million, $5.5 million, and $3.3 million in loans outstanding to System Fuels which mature in 2008.\nIn addition, System Fuels entered into a revolving credit agreement with a bank that provides $45 million in borrowings to finance System Fuels' nuclear materials and services inventory. Should System Fuels default on its obligations under its credit agreement, AP&L, LP&L, and System Energy have agreed to purchase nuclear materials and services financed under the agreement.\nNuclear Insurance (Entergy Corporation, AP&L, GSU, LP&L, MP&L, NOPSI, and System Energy)\nThe Price-Anderson Act limits public liability for a single nuclear incident to approximately $8.92 billion. The System has protection for this liability through a combination of private insurance (currently $200 million each for AP&L, GSU, LP&L, and System Energy) and an industry assessment program. Under the assessment program, the maximum payment requirement for each nuclear incident would be $79.3 million per reactor, payable at a rate of $10 million per licensed reactor per incident per year. The System has five licensed reactors. As a co-licensee of Grand Gulf 1 with System Energy, SMEPA would share 10% of this obligation. With respect to River Bend, any assessments pertaining to this program are allocated in accordance with the respective ownership interests of GSU and Cajun. In addition, the System participates in a private insurance program which provides coverage for worker tort claims filed for bodily injury caused by radiation exposure. The program provides for a maximum assessment of approximately $16 million for the System's five nuclear units in the event losses exceed accumulated reserve funds.\nAP&L, GSU, LP&L, and System Energy are also members of certain insurance programs that provide coverage for property damage, including decontamination and premature decommissioning expense, to members' nuclear generating plants. As of December 31, 1995, AP&L, GSU, LP&L, and System Energy each was insured against such losses up to $2.75 billion. In addition, AP&L, GSU, LP&L, MP&L, and NOPSI are members of an insurance program that covers certain replacement power and business interruption costs incurred due to prolonged nuclear unit outages. Under the property damage and replacement power\/business interruption insurance programs, these System companies could be subject to assessments if losses exceed the accumulated funds available to the insurers. As of December 31, 1995, the maximum amounts of such possible assessments were: AP&L - $36.3 million; GSU - $22.0 million; LP&L - $33.2 million; MP&L - $0.8 million; NOPSI - $0.5 million; and System Energy - $29.0 million. Under its agreement with System Energy, SMEPA would share in System Energy's obligation. Cajun shares approximately $4.6 million of GSU's obligation.\nThe amount of property insurance presently carried by the System exceeds the NRC's minimum requirement for nuclear power plant licensees of $1.06 billion per site. NRC regulations provide that the proceeds of this insurance must be used, first, to place and maintain the reactor in a safe and stable condition and, second, to complete decontamination operations. Only after proceeds are dedicated for such use and regulatory approval is secured would any remaining proceeds be made available for the benefit of plant owners or their creditors.\nSpent Nuclear Fuel and Decommissioning Costs (Entergy Corporation, AP&L, GSU, LP&L, and System Energy)\nAP&L, GSU, LP&L, and System Energy provide for estimated future disposal costs for spent nuclear fuel in accordance with the Nuclear Waste Policy Act of 1982. The affected System companies entered into contracts with the DOE, whereby the DOE will furnish disposal service at a cost of one mill per net KWh generated and sold after April 7, 1983, plus a onetime fee for generation prior to that date. AP&L, the only System company that generated electricity with nuclear fuel prior to that date, elected to pay the onetime fee plus accrued interest, no earlier than 1998, and has recorded a liability as of December 31, 1995, of approximately $111 million for generation subsequent to 1983. The fees payable to the DOE may be adjusted in the future to assure full recovery. The System considers all costs incurred or to be incurred, except accrued interest, for the disposal of spent nuclear fuel to be proper components of nuclear fuel expense, and provisions to recover such costs have been or will be made in applications to regulatory authorities.\nDelays have occurred in the DOE's program for the acceptance and disposal of spent nuclear fuel at a permanent repository. In a statement released February 17, 1993, the DOE asserted that it does not have a legal obligation to accept spent nuclear fuel without an operational repository for which it has not yet arranged. Currently, the DOE projects it will begin to accept spent fuel no earlier than 2015. In the meantime, all System companies are responsible for spent fuel storage. Current on-site spent fuel storage capacity at River Bend, Waterford 3, and Grand Gulf 1 is estimated to be sufficient until 2003, 2000, and 2004, respectively. Thereafter, the affected companies will provide additional storage. Current on-site spent fuel storage capacity at ANO is estimated to be sufficient until mid-1998, at which time an ANO storage facility using dry casks will begin operation. This facility is estimated to provide sufficient storage until 2000, with the capability of being expanded further as required. The initial cost of providing the additional on-site spent fuel storage capability required at ANO, River Bend, Waterford 3, and Grand Gulf 1 is expected to be approximately $5 million to $10 million per unit. In addition, about $3 million to $5 million per unit will be required every two to three years subsequent to 2000 for ANO and every four to five years subsequent to 2003, 2000, and 2004 for River Bend, Waterford 3, and Grand Gulf 1, respectively, until the DOE's repository begins accepting such units' spent fuel.\nEntergy Operations and System Fuels joined in lawsuits against the DOE, seeking clarification of the DOE's responsibility to receive spent nuclear fuel beginning in 1998. The original suits, filed June 20, 1994, asked for a ruling stating that the Nuclear Waste Policy Act require the DOE to begin taking title to the spent fuel and to start removing it from nuclear power plants in 1998, a mandate for the DOE's nuclear waste management program to begin accepting fuel in 1998 and court monitoring of the program, and the potential for escrow of payments to a nuclear waste fund instead of directly to the DOE.\nTotal decommissioning costs at December 31, 1995, for the System nuclear power plants, excluding co-owner shares, have been estimated as follows:\nAP&L and LP&L are authorized to recover in rates amounts that, when added to estimated investment income, should be sufficient to meet the above estimated decommissioning costs for ANO and Waterford 3, respectively. In the Texas retail jurisdiction, GSU is recovering in rates decommissioning costs (based on the 1991 cost study) that, with adjustments, total $204.9 million. In the Louisiana retail jurisdiction, GSU is currently recovering in rates decommissioning costs (based on a 1985 cost study) which total $141 million. GSU included decommissioning costs (based on the 1991 study) in the LPSC rate review filed in May 1995 which has not yet been concluded. System Energy was previously recovering in rates amounts sufficient to fund $198 million (in 1989 dollars) of its decommissioning costs. System Energy included decommissioning costs (based on the 1994 study) in its rate increase filing with FERC. Rates in this proceeding were placed into effect in December 1995, subject to refund. AP&L, GSU, LP&L, and System Energy periodically review and update estimated decommissioning costs. Although the System is presently underrecovering based on the above estimates, applications are periodically made to the appropriate regulatory authorities to reflect in rates any future change in projected decommissioning costs. The amounts recovered in rates are deposited in trust funds and reported at market value as quoted on nationally traded markets. These trust fund assets largely offset the accumulated decommissioning liability that is recorded as accumulated depreciation for AP&L, GSU, and LP&L, and as other deferred credits for System Energy.\nThe cumulative liabilities and actual decommissioning expenses recorded in 1995 by the System companies were as follows:\nCumulative 1995 1995 Cumulative Liabilities as of Trust Decommissioning Liabilities as of December 31, 1994 Earnings Expenses December 31, 1995 (In Millions)\nANO 1 and ANO 2 $137.4 $13.9 $17.7 $169.0 River Bend 22.2 1.4 8.1 31.7 Waterford 3 28.2 1.7 7.5 37.4 Grand Gulf 1 31.9 2.1 5.4 39.4 ------ ----- ----- ------ $219.7 $19.1 $38.7 $277.5 ====== ===== ===== ======\nIn 1994 and 1993, ANO's decommissioning expense was $12.2 million and $11.0 million, respectively; River Bend's decommissioning expense was $3.0 million, respectively; Waterford 3's decommissioning expense was $4.8 million and $4.0 million, respectively; and Grand Gulf 1's decommissioning expense was $5.2 million and $4.9 million, respectively. The actual decommissioning costs may vary from the estimates because of regulatory requirements, changes in technology, and increased costs of labor, materials, and equipment. Management believes that actual decommissioning costs are likely to be higher than the estimated amounts presented above.\nThe staff of the SEC has questioned certain of the financial accounting practices of the electric utility industry regarding the recognition, measurement, and classification of decommissioning costs for nuclear generating stations in the financial statements of electric utilities. In response to these questions, the FASB has been reviewing the accounting for decommissioning and has expanded the scope of its review to include liabilities related to the closure and removal of all long-lived assets. An exposure draft of the proposed SFAS was issued in February 1996 would be effective in 1997. The proposed SFAS would require measurement of the liability for closure and removal of long- lived assets (including decommissioning) based on discounted future cash flows. Those future cash flows should be determined by estimating current costs and adjusting for inflation, efficiencies that may be gained from experience with similar activities, and consideration of reasonable future advances in technology. It also would require that changes in the decommissioning\/closure cost liability resulting from changes in assumptions should be recognized with a corresponding adjustment to the plant asset, and depreciation should be revised prospectively. The proposed SFAS stated that the initial recognition of the decommissioning\/closure cost liability would result in an asset that should be presented with other plant costs on the financial statements because the cost of decommissioning\/closing the plant is recognized as part of the total cost of the plant asset. In addition there would be a regulatory asset recognized on the financial statements to the extent the initial decommissioning\/closure liability has increased due to the passage of time, and such costs are probable of future recovery.\nIf current electric utility industry accounting practices with respect to nuclear decommissioning and other closure costs are changed, annual provisions for such costs could increase, the estimated cost for decommissioning\/closure could be recorded as a liability rather than as accumulated depreciation, and trust fund income from decommissioning trusts could be reported as investment income rather than as a reduction to decommissioning expense.\nThe EPAct has a provision that assesses domestic nuclear utilities with fees for the decontamination and decommissioning of the DOE's past uranium enrichment operations. The decontamination and decommissioning assessments will be used to set up a fund into which contributions from utilities and the federal government will be placed. AP&L, GSU, LP&L, and System Energy's annual assessments, which will be adjusted annually for inflation, are approximately $3.4 million, $0.9 million, $1.3 million, and $1.4 million (in 1995 dollars), respectively, for approximately 15 years. At December 31, 1995, AP&L, GSU, LP&L, and System Energy had recorded liabilities of $35.3 million, $6.0 million, $13.2 million, and $12.8 million, respectively, for decontamination and decommissioning fees in other current liabilities and other noncurrent liabilities, and these liabilities were offset in the consolidated financial statements by regulatory assets. FERC requires that utilities treat these assessments as costs of fuel as they are amortized and are recovered through rates in the same manner as other fuel costs.\nANO Matters (Entergy Corporation and AP&L)\nCracks in steam generator tubes at ANO 2 were discovered and repaired during an outage in March 1992. Further inspections and repairs were conducted at subsequent refueling and mid-cycle outages, including the most recent refueling outage in October 1995. Beginning in January 1995, ANO 2's output was reduced 15 megawatts or 1.6% due to secondary side fouling, tube plugging, and reduction of primary temperature. During the October 1995 inspection, additional cracks in the tubes were discovered. The unit may be approaching the limit for the number of steam generator tubes that can be plugged with the unit in operation. If the currently established limit is reached, Entergy Operations could be required during future outages to insert sleeves in some of the steam generator tubes that were previously plugged. Entergy Operations is monitoring the development of the cracks and assessing various options for the repair or the replacement of ANO 2's steam generators. Certain of these options could, in the future, require significant capital expenditures and result in additional outages. However, a decision as to the repair or replacement of ANO 2's steam generators is not expected prior to 1997. Entergy Operations periodically meets with the NRC to discuss the results of inspections of the generator tubes, as well as the timing of future inspections.\nEnvironmental Issues\n(AP&L)\nIn May 1995, AP&L was named as a defendant in a suit by Reynolds Metals Company (Reynolds), seeking to recover a share of the costs associated with the clean-up of hazardous substances at a site south of Arkadelphia, Arkansas. Reynolds alleges that it has spent $11.2 million to clean-up the site, and that the site was contaminated in part with PCBs for which AP&L bears some responsibility. AP&L, voluntarily, at its expense, has already completed remediation at a nearby substation site and believes that it has no liability for contamination at the site that is subject to the Reynolds suit and is contesting the lawsuit. Regardless of the outcome, AP&L does not believe this matter would have a materially adverse effect on its financial condition or results of operations.\n(GSU)\nGSU has been designated as a PRP for the clean-up of certain hazardous waste disposal sites. GSU is currently negotiating with the EPA and state authorities regarding the clean-up of these sites. Several class action and other suits have been filed in state and federal courts seeking relief from GSU and others for damages caused by the disposal of hazardous waste and for asbestos-related disease allegedly resulting from exposure on GSU premises. While the amounts at issue in the clean-up efforts and suits may be substantial, GSU believes that its results of operations and financial condition will not be materially adversely affected by the outcome of the suits. Through December 31, 1995, $7.9 million has been expended on the clean-up. As of December 31, 1995, a remaining recorded liability of $21.7 million existed relating to the clean-up of five sites at which GSU has been designated a PRP.\n(LP&L)\nDuring 1993, the LDEQ issued new rules for solid waste regulation, including regulation of wastewater impoundments. LP&L has determined that certain of its power plant wastewater impoundments were affected by these regulations and has chosen to upgrade or close them. As a result, a remaining recorded liability in the amount of $10.6 million existed at December 31, 1995, for wastewater upgrades and closures to be completed in 1996. Cumulative expenditures relating to the upgrades and closures of wastewater impoundments were $5.6 million as of December 31, 1995.\nCity Franchise Ordinances (NOPSI)\nNOPSI provides electric and gas service in the City of New Orleans pursuant to City franchise ordinances that state, among other things, that the City has a continuing option to purchase NOPSI's electric and gas utility properties.\nNOTE 9. LEASES\nGeneral\nAs of December 31, 1995, the System had capital leases and noncancelable operating leases for equipment, buildings, vehicles, and fuel storage facilities (excluding nuclear fuel leases and the sale and leaseback transactions) with minimum lease payments as follows:\nCapital Leases\nYear Entergy AP&L GSU (In Thousands)\n1996 $ 29,054 $ 11,126 $ 12,475 1997 24,653 8,293 12,475 1998 24,634 8,293 12,475 1999 24,610 8,294 12,475 2000 22,872 6,987 12,049 Years thereafter 113,421 41,708 69,331 Minimum lease payments 239,244 84,701 131,280 Less: Amount representing interest 87,284 34,360 47,921 --------- ---------- ---------- Present value of net minimum lease payments $ 151,960 $ 50,341 $ 83,359 ========= ========== ==========\nOperating Leases\nYear Entergy AP&L GSU LP&L (In Thousands)\n1996 $ 76,866 $ 36,498 $ 12,871 $ 4,820 1997 66,009 29,460 12,566 4,369 1998 65,914 29,047 16,499 4,256 1999 63,198 27,304 16,499 3,990 2000 59,760 25,722 16,326 3,846 Years thereafter 214,577 71,272 60,518 1,905 --------- --------- --------- ---------- Minimum lease payments $ 546,324 $ 219,303 $ 135,279 $ 23,186 ========= ========= ========= ==========\nRental expense for the System leases (excluding nuclear fuel leases and the sale and leaseback transactions) amounted to approximately $67.8 million, $64.8 million, and $62.7 million in 1995, 1994, and 1993, respectively. These amounts include $27.7 million, $26.4 million, and $23.2 million, respectively, for AP&L, $15.1 million, $15.3 million, and $31.9 million, respectively for GSU, and $14.8 million, $12.1 million, and $6.6 million, respectively, for LP&L.\nNuclear Fuel Leases\nAP&L, GSU, LP&L, and System Energy each has arrangements to lease nuclear fuel in an aggregate amount up to $395 million as of December 31, 1995. The lessors finance the acquisition and ownership of nuclear fuel through credit agreements and the issuance of notes. These agreements are subject to annual renewal with, in LP&L's and GSU's case, the consent of the lenders. The credit agreements for AP&L, GSU, LP&L, and System Energy have been extended and now have termination dates of December 1998, December 1998, January 1999, and February 1999, respectively. The debt securities issued pursuant to these fuel lease arrangements have varying maturities through January 31, 1999. It is expected that the credit agreements will be extended or alternative financing will be secured by each lessor upon the maturity of the current arrangements. If extensions or alternative financing cannot be arranged, the lessee in each case must purchase sufficient nuclear fuel to allow the lessor to retire such borrowings.\nLease payments are based on nuclear fuel use. Nuclear fuel lease expense charged to operations by the System in 1995, 1994, and 1993 was $153.5 million (including interest of $22.1 million), $163.4 million (including interest of $27.3 million), and $145.8 million (excluding GSU and including interest of $20.5 million), respectively. Specifically, in 1995, 1994, and 1993, AP&L's expense was $46.8 million, $56.2 million, and $69.7 million (including interest of $6.7 million, $7.5 million, and $10.6 million), respectively; GSU's expense was $41.4 million, $37.2 million, and $43.6 million (including interest of $6.0 million, $8.7 million, and $10.2 million), respectively; LP&L's expense was $30.8 million, $32.2 million, and $39.9 million (including interest of $3.7 million, $4.3 million, and $4.9 million), respectively; System Energy's expense was $34.5 million, $37.8 million, and $36.2 million (including interest of $5.7 million, $6.8 million, and $5.1 million), respectively.\nSale and Leaseback Transactions\nWaterford 3 Lease Obligations (LP&L)\nOn September 28, 1989, LP&L entered into three transactions for the sale (for an aggregate cash consideration of $353.6 million) and leaseback of three undivided portions of its 100% ownership interest in Waterford 3. The three undivided interests in Waterford 3 sold and leased back exclude certain transmission, pollution control, and other facilities that are part of Waterford 3. The interests sold and leased back are equivalent on an aggregate cost basis to approximately a 9.3% undivided interest in Waterford 3. LP&L is leasing back the interests on a net lease basis over an approximate 28-year basic lease term. LP&L has options to terminate the lease and to repurchase the interests in Waterford 3 at certain intervals during the basic lease term. Further, at the end of the basic lease term, LP&L has an option to renew the lease or to repurchase the undivided interests in Waterford 3.\nInterests were acquired from LP&L with funds obtained from the issuance and sale by the purchasers of intermediate-term and long-term secured lease obligation bonds. The lease payments to be made by LP&L will be sufficient to service such debt.\nLP&L did not exercise its option to repurchase the undivided interests in Waterford 3 in September 1994. As a result, LP&L was required to provide collateral for the equity portion of certain amounts payable by LP&L under the leases. Such collateral was in the form of a new series of non interest-bearing first mortgage bonds in the aggregate principal amount of $208.2 million issued by LP&L in September 1994.\nUpon the occurrence of certain adverse events (including lease events of default, events of loss, deemed loss events or certain adverse \"Financial Events\" with respect to LP&L), LP&L may be obligated to pay amounts sufficient to permit the termination of the lease transactions and may be required to assume the outstanding indebtedness issued to finance the acquisition of the undivided interests in Waterford 3. \"Financial Events\" include, among other things, failure by LP&L, following the expiration of any applicable grace or cure periods, to maintain (1) as of the end of any fiscal quarter, total equity capital (including preferred stock) at least equal to 30% of adjusted capitalization, or (2) in respect of the 12-month period ending on the last day of any fiscal quarter, a fixed charge coverage ratio of at least 1.50. As of December 31, 1995, LP&L's total equity capital (including preferred stock) was 48.7% of adjusted capitalization and its fixed charge coverage ratio was 3.29.\nAs of December 31, 1995, LP&L had future minimum lease payments (reflecting an overall implicit rate of 8.76%) in connection with the Waterford 3 sale and leaseback transactions as follows (in thousands):\n1996 $ 35,165 1997 39,805 1998 41,447 1999 50,530 2000 47,510 Years thereafter 628,704 ----------- Total 843,161 Less: Amount representing interest 489,561 ----------- Present value of net minimum lease payments $ 353,600 ===========\nGrand Gulf 1 Lease Obligations (System Energy)\nOn December 28, 1988, System Energy entered into two arrangements for the sale and leaseback of an aggregate 11.5% undivided ownership interest in Grand Gulf 1 for an aggregate cash consideration of $500 million. System Energy is leasing back the undivided interest on a net lease basis over a 26 1\/2-year basic lease term. System Energy has options to terminate the leases and to repurchase the undivided interest in Grand Gulf 1 at certain intervals during the basic lease term. Further, at the end of the basic lease term, System Energy has an option to renew the leases or to repurchase the undivided interest in Grand Gulf 1. See Note 8 with respect to certain other terms of the transactions.\nIn accordance with SFAS 98, \"Accounting for Leases,\" due to \"continuing involvement\" by System Energy, the sale and leaseback arrangements of the undivided portions of Grand Gulf 1, as described above, are required to be reflected for financial reporting purposes as financing transactions in System Energy's financial statements. The amounts charged to expense for financial reporting purposes include the interest portion of the lease obligations and depreciation of the plant. However, operating revenues include the recovery of the lease payments because the transactions are accounted for as sales and leasebacks for rate-making purposes. The total of interest and depreciation expense exceeds the corresponding revenues realized during the early part of the lease term. Consistent with a recommendation contained in a FERC audit report, System Energy recorded as a deferred asset the difference between the recovery of the lease payments and the amounts expensed for interest and depreciation and is recording such difference as a deferred asset on an ongoing basis. The amount of this deferred asset was $85.8 million and $78.5 million as of December 31, 1995, and 1994, respectively.\nAs of December 31, 1995, System Energy had future minimum lease payments (reflecting an implicit rate of 7.02% after the above refinancing) as follows (in thousands):\n1996 $ 42,753 1997 42,753 1998 42,753 1999 42,753 2000 42,753 Years thereafter 760,067 ----------- Total 973,832 Less: Amount representing interest 473,832 ----------- Present value of net minimum lease payments $ 500,000 ===========\nNOTE 10. POSTRETIREMENT BENEFITS (Entergy Corporation, AP&L, GSU, LP&L, MP&L, NOPSI, and System Energy)\nPension Plans\nThe System companies have various postretirement benefit plans covering substantially all of their employees. The pension plans are noncontributory and provide pension benefits that are based on employees' credited service and compensation during the final years before retirement. Entergy Corporation and its subsidiaries fund pension costs in accordance with contribution guidelines established by the Employee Retirement Income Security Act of 1974, as amended, and the Internal Revenue Code of 1986, as amended. The assets of the plans include common and preferred stocks, fixed income securities, interest in a money market fund, and insurance contracts. Prior to January 1, 1995, all System Companies' non-bargaining employees were generally included in a plan sponsored by the System company where they were employed. However, NOPSI was a participating employer in a plan sponsored by LP&L. Effective January 1, 1995, these employees became participants in a new plan with provisions substantially identical to their previous plan.\nTotal 1995, 1994, and 1993 pension cost of Entergy Corporation and its subsidiaries (excluding GSU for 1993 for the Entergy Corporation total), including amounts capitalized, included the following components (in thousands):\nThe funded status of Entergy's various pension plans as of December 31, 1995 and 1994 was (in thousands):\nThe significant actuarial assumptions used in computing the information above for 1995, 1994, and 1993 (only 1995 and 1994 with respect to GSU being included in the Entergy Corporation total), were as follows: weighted average discount rate, 7.5% for 1995, 8.5% for 1994, and 7.5% for 1993, weighted average rate of increase in future compensation levels, 4.6% for 1995, 5.1% for 1994 and 5.6% (5% for GSU) for 1993; and expected long-term rate of return on plan assets, 8.5% . Transition assets of the System are being amortized over the greater of the remaining service period of active participants or 15 years.\nIn 1994, GSU recorded an $18.0 million charge related to early retirement programs in connection with the Merger, of which $15.2 million was expensed.\nOther Postretirement Benefits\nThe System companies also provide certain health care and life insurance benefits for retired employees. Substantially all employees may become eligible for these benefits if they reach retirement age while still working for the System companies.\nEffective January 1, 1993, Entergy adopted SFAS 106. The new standard required a change from a cash method to an accrual method of accounting for postretirement benefits other than pensions. The Operating Companies, other than MP&L and NOPSI, continue to fund these benefits on a pay-as-you-go basis. During 1994, pursuant to regulatory directives, MP&L and NOPSI began to fund their postretirement benefit obligation. These assets are invested in a money market fund. At January 1, 1993, the actuarially determined accumulated postretirement benefit obligation (APBO) earned by retirees and active employees was estimated to be approximately $241.4 million and $128 million for Entergy (other than GSU) and for GSU, respectively. Such obligations are being amortized over a 20-year period beginning in 1993.\nThe Operating Companies have sought approval, in their respective regulatory jurisdictions, to implement the appropriate accounting requirements related to SFAS 106 for ratemaking purposes. AP&L has received an order permitting deferral, as a regulatory asset, of the difference between its annual cash expenditures for postretirement benefits other than pensions and the SFAS 106 accrual, for up to a five- year period commencing January 1, 1993. MP&L is expensing its SFAS 106 costs, which are reflected in rates pursuant to an order from the MPSC in connection with MP&L's formulary incentive-rate plan (see Note 2). The LPSC ordered GSU and LP&L to continue the use of the pay-as-you-go method for ratemaking purposes for postretirement benefits other than pensions, but the LPSC retains the flexibility to examine individual companies' accounting for postretirement benefits to determine if special exceptions to this order are warranted. NOPSI is expensing its SFAS 106 costs. Pursuant to resolutions adopted in November 1993 by the Council related to the Merger, NOPSI's SFAS 106 expenses through October 31, 1996, will be allowed by the Council for purposes of evaluating the appropriateness of NOPSI's rates. Pursuant to the PUCT's May 26, 1995, amended order, GSU is currently collecting its SFAS 106 costs in rates.\nTotal 1995, 1994 and 1993 postretirement benefit cost of Entergy Corporation and its subsidiaries (excluding GSU for the Entergy Corporation total for 1993), including amounts capitalized and deferred, included the following components (in thousands):\nThe funded status of Entergy's postretirement plans as of December 31, 1995 and 1994, was (in thousands):\nThe assumed health care cost trend rate used in measuring the APBO of the System companies was 8.4% for 1996, gradually decreasing each successive year until it reaches 5.0% in 2005. A one percentage-point increase in the assumed health care cost trend rate for each year would have increased the APBO of the System companies, as of December 31, 1995, by 11.3% (AP&L-11.8%, GSU-10.4%, LP&L-11.8%, MP&L-12.2% and NOPSI- 10.0%), and the sum of the service cost and interest cost by approximately 14.1% (AP&L-15.0%, GSU-12.8%, LP&L-14.4%, MP&L-14.4% and NOPSI-12.8%). The assumed discount rate and rate of increase in future compensation used in determining the APBO were 7.5% for 1995, 8.5% for 1994 and 7.5% for 1993, and 4.6% for 1995, 5.1% for 1994 and 5.5% (5% for GSU) for 1993, respectively. The expected long-term rate of return on plan assets was 8.5% for 1995.\nNOTE 11. RESTRUCTURING COSTS (Entergy Corporation, AP&L, GSU, LP&L, MP&L, and NOPSI)\nThe restructuring programs announced by Entergy in 1994 and 1995 included anticipated reductions in the number of employees and the consolidation of offices and facilities. The programs are designed to reduce costs, improve operating efficiencies, and increase shareholder value in order to enable Entergy to become a low-cost producer. The balances as of December 31, 1994, and 1995, for restructuring liabilities associated with these programs are shown below by company along with the actual termination benefits paid under the programs.\nRestructuring Restructuring Liability as of Additional Payments Liability as of December 31, 1995 Made in December 31, Company 1994 Charges 1995 1995 (In Millions)\nAP&L $12.2 $16.2 ($20.1) $8.3 GSU 6.5 13.1 (14.2) $5.4 LP&L 6.8 6.4 (11.0) $2.2 MP&L 6.2 2.9 (6.6) $2.5 NOPSI 3.4 0.2 (3.0) $0.6 Other - 9.6 (4.4) $5.2 ----- ----- ------ ----- Total $35.1 $48.4 ($59.3) $24.2 ===== ===== ====== =====\nThe restructuring charges shown above primarily included employee severance costs related to the expected termination of approximately 2,750 employees in various groups. As of December 31, 1995, 2,100 employees had either been terminated or accepted voluntary separation packages under the restructuring plan.\nAdditionally, the System recorded $24.3 million in 1994 (of which $23.8 million was recorded by GSU) for remaining severance and augmented retirement benefits related to the Merger. Actual termination benefits paid under the program during 1995 amounted to $21.6 million. During that same period, adjustments to the allocation of the total liability were made among the System companies. At December 31, 1995, the total remaining System liability for expected future Merger-related outlays was $2.8 million, comprised principally of GSU's liability of $2.3 million.\nNOTE 12. TRANSACTIONS WITH AFFILIATES (AP&L, GSU, LP&L, MP&L, NOPSI, and System Energy)\nThe various Operating Companies purchase electricity from and\/or sell electricity to other Operating Companies, System Energy, and Entergy Power (in the case of AP&L) under rate schedules filed with FERC. In addition, the Operating Companies and System Energy purchase fuel from System Fuels, receive technical, advisory, and administrative services from Entergy Services, and receive management and operating services from Entergy Operations.\nAs described in Note 1, all of System Energy's operating revenues consist of billings to AP&L, LP&L, MP&L, and NOPSI.\nThe tables below contain the various affiliate transactions among the Operating Companies and System Entergy (in millions).\nIntercompany Revenues\nSystem AP&L GSU LP&L MP&L NOPSI Energy\n1995 $ 195.5 $62.7 $ 1.6 $ 43.3 $ 3.2 $ 605.6 1994 $ 232.6 $44.4 $ 1.0 $ 45.8 $ 2.1 $ 475.0 1993 $ 175.8 $ - $ 4.8 $ 40.7 $ 2.5 $ 650.8\nIntercompany Operating Expenses\nSystem AP&L(1) GSU LP&L MP&L NOPSI Energy\n1995 $ 316.0 $ 266.5 $ 335.5 $ 262.6 $ 164.4 $ 6.5 1994 $ 310.7 $ 296.9 $ 365.8 $ 280.2 $ 170.1 $ 10.5 1993 $ 323.2 $ 25.5 $ 322.0 $ 360.5 $ 176.3 $ 12.3\n(1) Includes $31.0 million in 1995, $25.7 million in 1994, and $16.8 million in 1993 for power purchased from Entergy Power.\nOperating Expenses Paid or Reimbursed to Entergy Operations\nSystem AP&L GSU LP&L Energy\n1995 $ 189.8 $ 129.1 $ 122.6 $ 116.9 1994 $ 221.2 $ 210.2 $ 152.5 $ 179.6 1993 $ 226.3 $ - $ 118.9 $ 151.3\nIn addition, certain materials and services required for fabrication of nuclear fuel are acquired and financed by System Fuels and then sold to System Energy as needed. Charges for these materials and services, which represent additions to nuclear fuel, amounted to approximately $51.5 million in 1995, $26.4 million in 1994, and $32.8 million in 1993.\nNOTE 13. ENTERGY CORPORATION-GSU MERGER\nOn December 31, 1993, Entergy Corporation and GSU consummated the Merger. GSU became a wholly owned subsidiary of Entergy Corporation and continues to operate as an electric utility corporation under the regulation of FERC, the SEC, the PUCT, and the LPSC. As consideration to GSU's shareholders, Entergy Corporation paid $250 million and issued 56,695,724 shares of its common stock in exchange for the 114,055,065 outstanding shares of GSU common stock. In addition, $33.5 million of transaction costs were capitalized in connection with the Merger. Note 1 describes the accounting for the acquisition adjustment recorded in connection with the Merger.\nThe pro forma combined revenues, net income, earnings per common share before extraordinary items, cumulative effect of accounting changes, and earnings per common share of Entergy Corporation presented below give effect to the Merger as if it had occurred at January 1, 1992. This unaudited pro forma information is not necessarily indicative of the results of operations that would have occurred had the Merger been consummated for the period for which it is being given effect.\nYears Ended December 31 1993 1992 (In Thousands, Except Per Share Amounts)\nRevenues $6,286,999 $5,850,973 Net income $ 595,211 $ 521,783 Earnings per average common share before extraordinary items and cumulative effect of accounting changes $ 2.10 $ 2.26 Earnings per average common share $ 2.57 $ 2.24\nNOTE 14. BUSINESS SEGMENT INFORMATION\nNOPSI supplies electric and natural gas services in the City. NOPSI's segment information follows:\n(1) NOPSI's intersegment transactions are not material (less than 1% of sales to unaffiliated customers).\nNOTE 15. SUBSEQUENT EVENT (UNAUDITED)\nAcquisition of CitiPower (Entergy Corporation)\nOn January 5, 1996, Entergy Corporation finalized its acquisition of CitiPower, an electric distribution utility serving Melbourne, Australia. Entergy Corporation made an equity investment of $294 million in CitiPower and the remainder of the total purchase price of approximately $1.2 billion was made up of new CitiPower debt. CitiPower has 234,500 customers, the majority of which are commercial customers.\nNOTE 16. QUARTERLY FINANCIAL DATA (UNAUDITED) (Entergy Corporation, AP&L, GSU, LP&L, MP&L, NOPSI, and System Energy)\nThe business of the System is subject to seasonal fluctuations with the peak period occurring during the third quarter. Operating results for the four quarters of 1995 and 1994 were:\n(a)See Note 2 for information regarding the recording of a reserve for rate refund in December 1994. (b)See Note 11 for information regarding the recording of certain restructuring costs in 1994 and 1995. (c)See Note 3 for information regarding the write-off of certain unamortized deferred investment tax credits in the fourth quarter of 1994. (d)See Note 2 for information regarding credits and refunds recorded in 1994 as a result of the 1994 NOPSI Settlement. (e)See Note 2 for information regarding the recording of refunds in connection with the FERC Settlement in November 1994. (f)The fourth quarter of 1995 reflects an increase in net income of $35.4 million (net of income taxes of $22.9 million) and an increase in earnings per share of $.15 due to the recording of the cumulative effect of the change in accounting method for incremental nuclear refueling outage maintenance costs. See Note 1 for a discussion of the change in accounting method.\nEarnings (Loss) per Average Common Share (Entergy Corporation)\n1995 1994\nFirst Quarter $0.40 $ 0.31 Second Quarter $0.71 $ 0.63 Third Quarter $1.16 $ 0.63 Fourth Quarter (f) $0.02 $(0.07)\nItem 9.","section_9":"Item 9. Changes In and Disagreements With Accountants On Accounting and Financial Disclosure.\nNo event that would be described in response to this item has occurred with respect to Entergy, System Energy, AP&L, GSU, LP&L, MP&L, or NOPSI.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrants.\nAll officers and directors listed below held the specified positions with their respective companies as of the date of filing this report.\nENTERGY CORPORATION\nDirectors\nInformation required by this item concerning directors of Entergy Corporation is set forth under the heading \"Election of Directors\" contained in the Proxy Statement of Entergy Corporation to be filed in connection with its Annual Meeting of Stockholders to be held May 17, 1996, and is incorporated herein by reference.\n(a) Mr. Lupberger is a director of First Commerce Corporation, New Orleans, LA, International Shipholding Corporation, New Orleans, LA, and First National Bank of Commerce, New Orleans, LA.\n(b) Mr. Bemis is a director of Deposit Guaranty National Bank, Jackson, MS and Deposit Guaranty Corporation, Jackson, MS.\n(c) Mr. Meiners is a director of Trustmark National Bank, Jackson, MS, and Trustmark Corporation, Jackson, MS.\nEach director and officer of the applicable System company is elected yearly to serve until the first Board Meeting following the Annual Meeting of Stockholders or until a successor is elected and qualified. Annual meetings are currently expected to be held as follows:\nEntergy Corporation - May 17, 1996 AP&L - May 13, 1996 GSU - May 13, 1996 LP&L - May 13, 1996 MP&L - May 13, 1996 NOPSI - May 13, 1996 System Energy - May 13, 1996\nDirectorships shown above are generally limited to entities subject to Section 12 or 15(d) of the Securities and Exchange Act of 1934 or to the Investment Company Act of 1940.\nSection 16(a) of the Exchange Act and Section 17(a) of the Public Utility Holding Company Act of 1935, as amended, require the Corporation's officers, directors and persons who own more than 10% of a registered class of the Corporation's equity securities to file reports of ownership and changes in ownership concerning the securities of the Corporation and its subsidiaries with the SEC and to furnish the Corporation with copies of all Section 16(a) and 17(a) forms they file. Terry L. Ogletree, an officer of Entergy Enterprises, Inc., filed a Form 3 in March of 1995, which inadvertently failed to report ownership of 5,000 restricted shares of the Corporation's stock. This has now been correctly reported.\nItem 11.","section_11":"Item 11. Executive Compensation\nENTERGY CORPORATION\nInformation called for by this item concerning the directors and officers of Entergy Corporation and the Personnel Committee of Entergy Corporation's Board of Directors is set forth under the headings \"Executive Compensation\" and \"Personnel Committee Interlocks and Insider Participation\" contained in the Proxy Statement of Entergy Corporation to be filed in connection with its Annual Meeting of Stockholders to be held on May 17, 1996, which information is incorporated herein by reference.\nAP&L, GSU, LP&L, MP&L, NOPSI, AND SYSTEM ENERGY\nSummary Compensation Table\nThe following table includes the Chief Executive Officers and the four other most highly compensated executive officers in office as of December 31, 1995 at AP&L, GSU, LP&L, MP&L, NOPSI, and System Energy. This determination was based on total annual base salary and bonuses (including bonuses of an extraordinary and nonrecurring nature) from all System sources earned by each officer during the year 1995. See Item 10, \"Directors and Executive Officers of the Registrants,\" incorporated herein by reference, for information on the principal positions of the executive officers named in the table below.\nAP&L, GSU, LP&L, MP&L, NOPSI, and System Energy\nAs shown in Item 10, most executive officers named below are employed by several System companies. Because it would be impracticable to allocate such officers' salaries among the various companies, the table below includes aggregate compensation paid by all System companies.\n* Chief Executive Officer of System Energy.\n** Chief Executive Officer of AP&L, GSU, LP&L, MP&L, and NOPSI.\n(a) Includes bonuses earned pursuant to the Annual Incentive Plan.\n(b) Amounts include the value of restricted shares that vested in 1995, 1994, and 1993 (see note (d) below) under Entergy's Equity Ownership Plan.\n(c) Includes the following:\n(1) 1995 employer payments for Executive Medical Plan premiums as follows: Mr. Bemis $3,019; Mr. Blount $3,019; Mr. Hintz $3,019; Mr. Jackson $3,019; Mr. Lupberger $3,019; Mr. Maulden $3,019; Mr. McInvale $3,019; Mr. Regan $2,013.\n(2) 1995 benefit accruals under the Defined Contribution Restoration Plan as follows: Mr. Bemis $4,200; Mr. Hintz $5,250; Mr. Jackson $5,250; Mr. Lupberger $16,500; Mr. Maulden $8,550; Mr. McInvale $3,164.\n(3) 1995 employer contributions to the System Savings Plan as follows: Mr. Bemis $4,500; Mr. Blount $3,576; Mr. Hintz $4,500; Mr. Jackson $4,500; Mr. Lupberger $4,500; Mr. Maulden $4,500; Mr. McInvale $4,500; Mr. Regan $877.\n(4) 1995 reimbursements under the Executive Financial Counseling Program as follows: Mr. Bemis $2,625; Mr. Jackson $1,225; Mr. Lupberger $3,100; Mr. Maulden $2,715; Mr. McInvale $680.\n(5) 1995 payments for personal use under the Private Ownership Vehicle Plan as follows: Mr. Bemis $9,900; Mr. Blount $7,200; Mr. Hintz $10,800; Mr. Jackson $10,800; Mr. Lupberger $6,023; Mr. Maulden $9,720; Mr. McInvale $9,900; Mr. Regan $4,800.\n(6) 1995 earnings under the Entergy Stock Investment Plan as follows: Mr. Bemis $3,363; Mr. Blount $1,910.\n(7) 1995 reimbursements for moving expenses paid to Mr. Regan in the amount of $6,943.\n(d) There were no restricted stock awards in 1995 under the Equity Ownership Plan. At December 31, 1995, the number and value of the aggregate restricted stock holdings were as follows: Mr. Bemis: 4,000 shares, $117,000; Mr. Hintz: 5,429 shares, $158,798; Mr. Jackson: 5,500 shares, $160,875; Mr. Lupberger: 10,900 shares, $318,825; Mr. Maulden: 5,500 shares, $160,875; and Mr. McInvale: 4,000 shares, $117,000. Accumulated dividends are paid on restricted stock when vested. The value of stock for which restrictions were lifted in 1995, and the applicable portion of accumulated cash dividends, are reported in the LTIP Payouts column in the above table. The value of restricted stock awards as of December 31, 1995 are determined by multiplying the total number of shares awarded by the closing market price of Entergy Corporation common stock on the New York Stock Exchange Composite Transactions on December 29, 1995 ($29.25 per share).\nOption Grants in 1995\nThe following table summarizes option grants during 1995 to the executive officers named in the Summary Compensation Table above. The absence, in the table below, of any named officer indicates that no options were granted to such officer.\nAP&L, GSU, LP&L, MP&L, NOPSI, and System Entergy\n(a) Options were granted on January 26, 1995, pursuant to the Equity Ownership Plan. All options granted on this date have an exercise price equal to the closing price of Entergy Corporation common stock on the New York Stock Exchange Composite Transactions on January 26, 1995. These options became exercisable on July 26, 1995.\n(b) Options were granted on March 31, 1995, pursuant to the Equity Ownership Plan. All options granted on this date have an exercise price equal to the closing price of Entergy Corporation common stock on the New York Stock Exchange Composite Transactions on March 31, 1995. These options will become exercisable on March 31, 1998.\n(c) Calculation based on the market price of the underlying securities over a ten-year period assuming annual compounding. The column presents estimates of potential values based on simple mathematical assumptions. The actual value, if any, an executive officer may realize is dependent upon the market price on the date of option exercise.\nAggregated Option Exercises in 1995 and December 31, 1995 Option Values\nThe following table summarizes the number and value of options exercised during 1995, as well as the number and value of unexercised options, as of December 31, 1995, held by the executive officers named in the Summary Compensation Table above.\n(a) Based on the difference between the closing price of the Corporation's Common Stock on the New York Stock Exchange Composite Transactions on the exercise date of November 17, 1995, and the option exercise price.\n(b) Based on the difference between the closing price of the Corporation's Common Stock on the New York Stock Exchange Composite Transactions on December 29, 1995, and the option exercise price.\nPension Plan Tables\nAP&L, GSU, LP&L, MP&L, NOPSI, and System Energy\nRetirement Income Plan Table\nAnnual Covered Years of Service Compensation 15 20 25 30 35 $100,000 $22,500 $30,000 $37,500 $45,000 $ 52,000 200,000 45,500 60,000 75,000 90,000 105,000 300,000 67,500 90,000 112,500 135,000 157,500 400,000 90,000 120,000 150,000 180,000 210,000 500,000 112,500 150,000 187,500 225,000 262,500 850,000 191,250 255,000 318,750 382,500 446,250\nAll of the named officers of AP&L, GSU, LP&L, MP&L, NOPSI and System Energy participate in a Retirement Income Plan (a defined benefit plan) that provides a benefit for employees at retirement from the System based upon (1) generally all years of service beginning at age 21 through termination, with a forty-year maximum, multiplied by (2) 1.5%, multiplied by (3) the final average compensation. Final average compensation is based on the highest consecutive 60 months of covered compensation in the last 120 months of service. The normal form of benefit for a single employee is a lifetime annuity and for a married employee is a 50% joint and survivor annuity. Other actuarially equivalent options are available to each retiree. Retirement benefits are not subject to any deduction for Social Security or other offset amounts. The amount of the named executive officers' annual compensation covered by the plan as of December 31, 1995, is represented by the salary column in the Summary Compensation Table above.\nThe maximum benefit under each Retirement Income Plan is limited by Sections 401 and 415 of the Internal Revenue Code of 1986, as amended; however, AP&L, GSU, LP&L, MP&L, NOPSI, and System Energy have elected to participate in the Pension Equalization Plan sponsored by Entergy Corporation. Under this plan, certain executives, including the named executive officers, would receive an amount equal to the benefit payable under the Retirement Income Plans, without regard to the limitations, less the amount actually payable under the Retirement Income Plans.\nEffective January 1, 1995, the System Companies Retirement Income Plans were amended to transfer assets and related liabilities to a single Entergy Corporation Retirement Plan for all non- bargaining unit employees. Each Retirement Income Plan (except GSU) was amended effective February 1, 1991, to provide a minimum accrued benefit as of that date to any employee who was vested as of that date. For purposes of calculating such minimum accrued benefit, each eligible employee was deemed to have had an additional five years of service and age as of that date. The additional years of age did not count toward eligibility for early retirement, but served only to reduce the early retirement discount factor for those employees who were at least age 50 as of that date.\nThe credited years of service under the Retirement Income Plan (without giving effect to the five additional years of service credited pursuant to the February 1, 1991 amendment as discussed above) as of December 31, 1995, for the following executive officers named in the Summary Compensation Table above were: Mr. Bemis 13; Mr. Blount 11; and Mr. Maulden 30.\nThe credited years of service under the respective Retirement Income Plan, as amended, as of December 31, 1995 for the following executive officers named in the Summary Compensation Table, as a result of entering into supplemental retirement agreements, were as follows: Mr. Hintz 24; Mr. Jackson 16; Mr. Lupberger 32; and Mr. McInvale 23.\nIn addition to the Retirement Income Plan discussed above, AP&L, LP&L, MP&L, NOPSI, and System Energy participate in the Supplemental Retirement Plan of Entergy Corporation and Subsidiaries (SRP) and the Post-Retirement Plan of Entergy Corporation and Subsidiaries (PRP). Participation is limited to one of these two plans and is at the invitation of AP&L, LP&L, MP&L, NOPSI, and System Energy. The participant may receive from the appropriate System company a monthly benefit payment not in excess of .025 (under the SRP) or .0333 (under the PRP) times the participant's average basic annual salary (as defined in the plans) for a maximum of 120 months. Mr. Hintz has entered into a SRP participation contract, and all of the other executive officers of AP&L, LP&L, MP&L, NOPSI, and System Energy named in the Summary Compensation Table (except for Mr. Blount, Mr. McInvale and Mr. Regan) have entered into PRP participation contracts. Current estimates indicate that the annual payments to a named executive officer under the above plans would be less than the payments to that officer under the System Executive Retirement Plan.\nSystem Executive Retirement Plan Table (1)\nAnnual Covered Years of Service Compensation 15 20 25 30+ $ 200,000 $ 90,000 $100,000 $110,000 $120,000 300,000 135,000 150,000 165,000 180,000 400,000 180,000 200,000 220,000 240,000 500,000 225,000 250,000 275,000 300,000 600,000 270,000 300,000 330,000 360,000 700,000 315,000 350,000 385,000 420,000 1,000,000 450,000 500,000 550,000 600,000 ___________\n(1)Benefits shown are based on a target replacement ratio of 50% based on the years of service and covered compensation shown. The benefits for 10, 15, and 20 or more years of service at the 45% and 55% replacement levels would decrease (in the case of 45%) or increase (in the case of 55%) by the following percentages: 3.0%, 4.5%, and 5.0%, respectively.\nIn 1993, Entergy Corporation adopted the System Executive Retirement Plan (SERP). AP&L, GSU, LP&L, MP&L, NOPSI, and System Energy are participating employers in the SERP. The SERP is an unfunded defined benefit plan offered at retirement to certain senior executives, which would currently include all the executive officers (except Mr. Blount) named in the Summary Compensation Table above. Participating executives choose, at retirement, between the retirement benefits paid under provisions of the SERP or those payable under the executive retirement benefit plans discussed above. Covered pay under the SERP includes final annual base salary (see the Summary Compensation Table above, for the base salary covered by the SERP as of December 31, 1995) plus the Target Incentive Award (i.e., a percentage of final annual base salary) for the participant in effect at retirement. Benefits paid under the SERP are calculated by multiplying the covered pay times target pay replacement ratios (45%, 50%, or 55%, dependent on job rating at retirement) that are attained, according to plan design, at 20 years of credited service. The target ratios are increased by 1% for each year of service over 20 years, up to a maximum of 30 years of service. In accordance with the SERP formula, the target ratios are reduced for each year of service below 20 years. The credited years of service under this plan are identical to the years of service for named executive officers (other than Mr. Bemis, Mr. Jackson, and Mr. McInvale) disclosed above in the \"Pension Plan Tables-Retirement Income Plan Table\" section. Mr. Bemis, Mr. Jackson, and Mr. McInvale have 23 years, 22 years, and 14 years, respectively, of credited service under this plan.\nThe normal form of benefit for a single employee is a lifetime annuity and for a married employee is a 50% joint and survivor annuity. All SERP payments are guaranteed for ten years. Other actuarially equivalent options are available to each retiree. SERP benefits are offset by any and all defined benefit plan payments from the System and from prior employers. SERP benefits are not subject to Social Security offsets.\nEligibility for and receipt of benefits under any of the executive plans described above are contingent upon several factors. The participant must agree that, without the specific consent of the System company for which such participant was last employed, he may take no employment after retirement with any entity that is in competition with, or similar in nature to, AP&L, GSU, LP&L, MP&L, NOPSI, and System Energy or any affiliate thereof. Eligibility for benefits is forfeitable for various reasons, including violation of an agreement with AP&L, GSU, LP&L, MP&L, NOPSI, and System Energy, resignation of employment, or termination for cause.\nIn addition to the non-bargaining unit employees Retirement Income Plan discussed above, GSU provides, among other benefits to officers, an Executive Income Security Plan for key managerial personnel. The plan provides participants with certain retirement, disability, termination, and survivors' benefits. To the extent that such benefits are not funded by the employee benefit plans of GSU or by vested benefits payable by the participants' former employers, GSU is obligated to make supplemental payments to participants or their survivors. The plan provides that upon the death or disability of a participant during his employment, he or his designated survivors will receive (i) during the first year following his death or disability an amount not to exceed his annual base salary, and (ii) thereafter for a number of years until the participant attains or would have attained age 65, but not less than nine years, an amount equal to one-half of the participant's annual base salary. The plan also provides supplemental retirement benefits for life for participants retiring after reaching age 65 equal to 1\/2 of the participant's average final compensation rate, with 1\/2 of such benefit upon the death of the participant being payable to a surviving spouse for life.\nGSU amended and restated the plan effective March 1, 1991, to provide such benefits for life upon termination of employment of a participating officer or key managerial employee without cause (as defined in the plan) or if the participant separates from employment for good reason (as defined in the plan), with 1\/2 of such benefits to be payable to a surviving spouse for life. Further, the plan was amended to provide medical benefits for a participant and his family when the participant separates from service. These medical benefits generally continue until the participant is eligible to receive medical benefits from a subsequent employer; but in the case of a participant who is over 50 at the time of separation and was participating in the plan on March 1, 1991, medical benefits continue for life. By virtue of the 1991 amendment and restatement, benefits for a participant under such plan cannot be modified once he becomes eligible to participate in the plan.\nCompensation of Directors\nAP&L, GSU, LP&L, MP&L, NOPSI, and System Energy currently have no non-employee directors, and none of the current directors is compensated for his responsibilities as director.\nRetired non-employee directors of AP&L, LP&L, MP&L, and NOPSI with a minimum of five years of service on the respective Boards of Directors are paid $200 a month for a term of years corresponding to the number of years of active service as directors. Retired non- employee directors with over ten years of service receive a lifetime benefit of $200 a month. Years of service as an advisory director are included in calculating this benefit. System Energy has no retired non-employee directors.\nRetired non-employee directors of GSU receive retirement benefits under a plan in which all directors who served continuously for a period of years will receive a percentage of their retainer fee in effect at the time of their retirement for life. The retirement benefit is 30 percent of the retainer fee for service of not less than five nor more than nine years, 40 percent for service of not less than ten nor more than fourteen years, and 50 percent for fifteen or more years of service. For those directors who retired prior to the retirement age, their benefits will be reduced. The plan also provides disability retirement and optional hospital and medical coverage if the director has served at least five years prior to the disability. The retired director pays one-third of the premium for such optional hospital and medical coverage and GSU pays the remaining two-thirds. Years of service as an advisory director are included in calculating these benefits.\nEmployment Contracts and Termination of Employment and Change-in- Control Arrangements\nGSU\nOn January 18, 1991, GSU established an Executive Continuity Plan for elected and appointed officers providing for severance benefits equal to 2.99 times the officer's annual compensation upon termination of employment for reasons other than cause or upon a resignation of employment for good reason within two years after a change in control of GSU. Benefits are prorated if the officer is within three years of normal retirement age (65) at termination of employment. The plan further provides for continued participation in medical, dental, and life insurance programs for three years following termination unless such benefits are available from a subsequent employer. The plan provides for outplacement assistance to aid a terminated officer in securing another position. Upon consummation of the Merger on December 31, 1993, GSU made a one time contribution of $16,330,693 to a trust equivalent to the then present value of the maximum benefits which might be payable under the plan. As of December 31, 1995, the balance in the trust had been reduced to $7,678,628. If and to the extent outstanding benefits are not paid to the participants, the balance in the trust will be returned to GSU.\nAs a result of the Merger, GSU is obligated to pay benefits under the Executive Income Security Plan to those persons who were participants at the time of the Merger and who later terminated their employment under circumstances described in the plan. For additional description of the benefits under the Executive Income Security Plan, see the \"Pension Plan Tables-System Executive Retirement Plan Table\" section noted above.\nPersonnel Committee Interlocks and Insider Participation\nThe compensation of AP&L, GSU, LP&L, MP&L, NOPSI, and System Energy executive officers was set by the Personnel Committee of Entergy Corporation's Board of Directors for 1995. No officers or employees of such companies participated in deliberations concerning compensation during 1995. The Personnel Committee of Entergy Corporation's Board of Directors is set forth under the heading \"Report of Personnel Committee on Executive Compensation\" contained in the Proxy Statement of Entergy Corporation to be filed in connection with its Annual Meeting of Stockholders to be held May 17, 1996, and is incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nEntergy Corporation owns 100% of the outstanding common stock of registrants AP&L, GSU, LP&L, MP&L, NOPSI, and System Energy. The information with respect to persons known by Entergy Corporation to be beneficial owners of more than 5% of Entergy Corporation's common stock is included under the heading \"Voting Securities Outstanding\" in the Proxy Statement of Entergy Corporation to be filed in connection with its Annual Meeting of Stockholders to be held May 17, 1996, which information is incorporated herein by reference. The registrants know of no contractual arrangements that may, at a subsequent date, result in a change in control of any of the registrants.\nThe directors, the executive officers named in the Summary Compensation Table above, and the directors and officers as a group for Entergy Corporation, AP&L, GSU, LP&L, MP&L, NOPSI, and System Energy, respectively, beneficially owned directly or indirectly the cumulative preferred stock of an Operating Company and common stock of Entergy Corporation as indicated:\n* Director of the respective Company ** Named Executive Officer of the respective Company *** Officer and Director of the respective Company\n(a) Stock ownership amounts refer to 6,000 shares of AP&L's $0.01 Par Value ($25 liquidation value) Preferred Stock held by the John A. Cooper Trust, and 3,500 shares of AP&L's $0.01 Par Value ($25 liquidation value) Preferred Stock held by Eugene H. Owen. Mr. Cooper disclaims any personal interest in these shares.\n(b) Based on information furnished by the respective individuals. The ownership amounts shown for each individual and for all directors and executive officers as a group do not exceed one percent of the outstanding securities of any class of security so owned.\n(c) Includes all shares as to which the individual has the sole voting power and powers of disposition, or power to direct the voting and disposition.\n(d) Includes, for the named persons, shares of Entergy Corporation common stock held in the Employee Stock Ownership Plan of the registrants as follows: Michael B. Bemis, 767 shares; Joseph L. Blount, 810 shares; John J. Cordaro, 1,082 shares; Frank F. Gallaher, 1,011 shares; William D. Hamilton, 617 shares; Donald C. Hintz, 810 shares; Jerry D. Jackson, 810 shares; R. Drake Keith, 810 shares; Edwin Lupberger, 886 shares; Jerry L. Maulden, 856 shares; Gerald D. McInvale, 118 shares; and Donald E. Meiners, 594 shares.\n(e) Includes, for the named persons, shares of Entergy Corporation common stock held in the System Savings Plan company account as follows: Michael B. Bemis, 5,140 shares; Joseph L. Blount, 1,809 shares; John J. Cordaro, 2,003 shares; Frank F. Gallaher, 3,930 shares; William D. Hamilton, 1,591 shares; Donald C. Hintz, 1,412 shares; Jerry D. Jackson, 2,427 shares; R. Drake Keith, 4,336 shares; Edwin Lupberger, 6,771 shares; Jerry L. Maulden, 10,460 shares; Gerald D. McInvale, 802 shares; Donald E. Meiners, 4,950 shares; William J. Regan, 15 shares.\n(f) Includes, for the named persons, unvested restricted shares of Entergy Corporation common stock held in the Equity Ownership Plan as follows: Michael B. Bemis, 4,000 shares; John J. Cordaro, 1,200 shares; Frank F. Gallaher, 5,175 shares; Donald C. Hintz, 5,429 shares; Jerry D. Jackson, 5,500 shares; R. Drake Keith, 250 shares; Edwin Lupberger, 10,900 shares; Jerry L. Maulden, 5,500 shares; Gerald D. McInvale, 4,000 shares; and Donald E. Meiners, 250 shares.\n(g) Includes, for the named persons, shares of Entergy Corporation common stock in the form of unexercised stock options awarded pursuant to the Equity Ownership Plan as follows: Michael B. Bemis, 35,000 shares; John J. Cordaro 7,500 shares; Frank F. Gallaher, 32,500 shares; Donald C. Hintz, 42,500 shares; Jerry D. Jackson, 39,411 shares; R. Drake Keith, 7,174 shares; Edwin Lupberger, 88,824 shares; Jerry L. Maulden, 45,000 shares; Gerald D. McInvale, 35,000 shares; and Donald E. Meiners, 10,000 shares.\n(h) Includes 1,500 shares of Entergy Corporation common stock held jointly between Edwin Lupberger and Ms. E. H. Lupberger.\n(i) Includes, for the named persons, shares of Entergy Corporation common stock held by their spouses. The named persons disclaim any personal interest in these shares as follows: Edwin Lupberger, 2,500 shares; Robert D. Pugh, 10,000 shares; and H. Duke Shackelford, 3,950 shares.\n(j) Includes 752 shares of Entergy Corporation common stock held jointly with spouse.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nInformation called for by this item concerning the directors and officers of Entergy Corporation is set forth under the heading \"Certain Transactions\" in the Proxy Statement of Entergy Corporation to be filed in connection with its Annual Meeting of Stockholders to be held on May 17, 1996, which information is incorporated herein by reference.\nSee Item 10, \"Directors and Executive Officers of the Registrants,\" for information on certain relationships and transactions required to be reported under this item.\nOther than as provided under applicable corporate laws, the System companies do not have policies whereby transactions involving executive officers and directors of the System are approved by a majority of disinterested directors. However, pursuant to the Entergy Corporation Code of Conduct, transactions involving a System company and its executive officers must have prior approval by the next higher reporting level of that individual, and transactions involving a System company and its directors must be reported to the secretary of the appropriate System company.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.\n(a)1. Financial Statements and Independent Auditors' Reports for Entergy, AP&L, GSU, LP&L, MP&L, NOPSI, and System Energy are listed in the Index to Financial Statements (see pages 42 and 43)\n(a)2. Financial Statement Schedules\nReports of Independent Accountants on Financial Statement Schedules (see pages 218 and 219)\nFinancial Statement Schedules are listed in the Index to Financial Statement Schedules (see page S-1)\n(a)3. Exhibits\nExhibits for Entergy, AP&L, GSU, LP&L, MP&L, NOPSI, and System Energy are listed in the Exhibit Index (see page E-1). Each management contract or compensatory plan or arrangement required to be filed as an exhibit hereto is identified as such by footnote in the Exhibit Index.\n(b) Reports on Form 8-K\nEntergy and NOPSI\nA current report on Form 8-K, dated April 20, 1995, was filed with the SEC on April 26, 1995, reporting information under Item 5. \"Other Events\".\nEntergy and GSU\nA current report on Form 8-K, dated July 26, 1995, was filed with the SEC on July 26, 1995, reporting information under Item 5. \"Other Events\".\nA current report on Form 8-K, dated October 25, 1995, was filed with the SEC on October 25, 1995, reporting information under Item 5. \"Other Events\".\nEXPERTS\nThe statements attributed to Clark, Thomas & Winters, a professional corporation, as to legal conclusions with respect to GSU's rate regulation in Texas under Item 1. \"Rate Matters and Regulation - Rate Matters - Retail Rate Matters - GSU\" and in Note 2 to Entergy Corporation and Subsidiaries Consolidated Financial Statements and GSU's Financial Statements, \"Rate and Regulatory Matters,\" have been reviewed by such firm and are included herein upon the authority of such firm as experts.\nThe statements attributed to Sandlin Associates regarding the analysis of River Bend Construction costs of GSU under Item 1. \"Rate Matters and Regulation - Rate Matters - Retail Rate Matters - GSU\" and in Note 2 to Entergy Corporation and Subsidiaries Consolidated Financial Statements and GSU's Financial Statements, \"Rate and Regulatory Matters,\" have been reviewed by such firm and are included herein upon the authority of such firm as experts.\nENTERGY CORPORATION\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company and any subsidiaries thereof.\nENTERGY CORPORATION\nBy \/s\/ Louis E. Buck, Jr. Louis E. Buck, Jr., Vice President and Chief Accounting Officer\nDate: March 11, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. The signature of each of the undersigned shall be deemed to relate only to matters having reference to the above-named company and any subsidiaries thereof.\nSignature Title Date\n\/s\/ Louis E. Buck, Jr. Louis E. Buck, Jr. Vice President and March 11, 1996 Chief Accounting Officer (Principal Accounting Officer)\nEdwin Lupberger (Chairman of the Board, Chief Executive Officer and Director; Principal Executive Officer); Gerald D. McInvale (Executive Vice President and Chief Financial Officer; Principal Financial Officer); W. Frank Blount, John A. Cooper, Jr., Lucie J. Fjeldstad, N. C. Francis, Kaneaster Hodges, Jr., Robert v.d. Luft, Kinnaird R. McKee, Paul W. Murrill, James R. Nichols, Eugene H. Owen, John N. Palmer, Sr., Robert D. Pugh, H. Duke Shackelford, Wm. Clifford Smith, and Bismark A. Steinhagen (Directors).\nBy: \/s\/ Louis E. Buck, Jr. March 11, 1996 (Louis E. Buck, Jr., Attorney-in-fact)\nARKANSAS POWER & LIGHT COMPANY\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company and any subsidiaries thereof.\nARKANSAS POWER & LIGHT COMPANY\nBy \/s\/ Louis E. Buck, Jr. Louis E. Buck, Jr., Vice President, Chief Accounting Officer and Assistant Secretary\nDate: March 11, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. The signature of each of the undersigned shall be deemed to relate only to matters having reference to the above-named company and any subsidiaries thereof.\nSignature Title Date\n\/s\/ Louis E. Buck, Jr. Louis E. Buck, Jr. Vice President, Chief Accounting March 11, 1996 Officer and Assistant Secretary (Principal Accounting Officer)\nEdwin Lupberger (Chairman of the Board, Chief Executive Officer and Director; Principal Executive Officer); Gerald D. McInvale (Executive Vice President, Chief Financial Officer, and Director; Principal Financial Officer); Michael B. Bemis, Donald C. Hintz, Jerry D. Jackson, R. Drake Keith, and Jerry L. Maulden (Directors).\nBy: \/s\/ Louis E. Buck, Jr. March 11, 1996 (Louis E. Buck, Jr., Attorney-in-fact)\nGULF STATES UTILITIES COMPANY\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company and any subsidiaries thereof.\nGULF STATES UTILITIES COMPANY\nBy \/s\/ Louis E. Buck, Jr. Louis E. Buck, Jr., Vice President, Chief Accounting Officer and Assistant Secretary\nDate: March 11, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. The signature of each of the undersigned shall be deemed to relate only to matters having reference to the above-named company and any subsidiaries thereof.\nSignature Title Date\n\/s\/ Louis E. Buck, Jr. Louis E. Buck, Jr. Vice President, Chief Accounting March 11, 1996 Officer and Assistant Secretary (Principal Accounting Officer)\nEdwin Lupberger (Chairman of the Board, Chief Executive Officer and Director; Principal Executive Officer); Gerald D. McInvale (Executive Vice President, Chief Financial Officer, and Director; Principal Financial Officer); Michael B. Bemis, Frank F. Gallaher, Donald C. Hintz, Jerry D. Jackson, and Jerry L. Maulden (Directors).\nBy: \/s\/ Louis E. Buck, Jr. March 11, 1996 (Louis E. Buck, Jr., Attorney-in-fact)\nLOUISIANA POWER & LIGHT COMPANY\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company and any subsidiaries thereof.\nLOUISIANA POWER & LIGHT COMPANY\nBy \/s\/ Louis E. Buck, Jr. Louis E. Buck, Jr., Vice President, Chief Accounting Officer and Assistant Secretary\nDate: March 11, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. The signature of each of the undersigned shall be deemed to relate only to matters having reference to the above-named company and any subsidiaries thereof.\nSignature Title Date\n\/s\/ Louis E. Buck, Jr. Louis E. Buck, Jr. Vice President, Chief Accounting March 11, 1996 Officer and Assistant Secretary (Principal Accounting Officer)\nEdwin Lupberger (Chairman of the Board, Chief Executive Officer and Director; Principal Executive Officer); Gerald D. McInvale (Executive Vice President, Chief Financial Officer, and Director; Principal Financial Officer); Michael B. Bemis, John J. Cordaro, Donald C. Hintz, Jerry D. Jackson, and Jerry L. Maulden (Directors).\nBy: \/s\/ Louis E. Buck, Jr. March 11, 1996 (Louis E. Buck, Jr., Attorney-in-fact)\nMISSISSIPPI POWER & LIGHT COMPANY\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company and any subsidiaries thereof.\nMISSISSIPPI POWER & LIGHT COMPANY\nBy \/s\/ Louis E. Buck, Jr. Louis E. Buck, Jr., Vice President, Chief Accounting Officer and Assistant Secretary\nDate: March 11, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. The signature of each of the undersigned shall be deemed to relate only to matters having reference to the above-named company and any subsidiaries thereof.\nSignature Title Date\n\/s\/ Louis E. Buck, Jr. Louis E. Buck, Jr. Vice President, Chief Accounting March 11, 1996 Officer and Assistant Secretary (Principal Accounting Officer)\nEdwin Lupberger (Chairman of the Board, Chief Executive Officer and Director; Principal Executive Officer); Gerald D. McInvale (Executive Vice President, Chief Financial Officer, and Director; Principal Financial Officer); Michael B. Bemis, Donald C. Hintz, Jerry D. Jackson, Jerry L. Maulden, and Donald E. Meiners (Directors).\nBy: \/s\/ Louis E. Buck, Jr. March 11, 1996 (Louis E. Buck, Jr., Attorney-in-fact)\nNEW ORLEANS PUBLIC SERVICE 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. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company and any subsidiaries thereof.\nNEW ORLEANS PUBLIC SERVICE INC.\nBy \/s\/ Louis E. Buck, Jr. Louis E. Buck, Jr., Vice President, Chief Accounting Officer and Assistant Secretary\nDate: March 11, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. The signature of each of the undersigned shall be deemed to relate only to matters having reference to the above-named company and any subsidiaries thereof.\nSignature Title Date\n\/s\/ Louis E. Buck, Jr. Louis E. Buck, Jr. Vice President, Chief Accounting March 11, 1996 Officer and Assistant Secretary (Principal Accounting Officer)\nEdwin Lupberger (Chairman of the Board, Chief Executive Officer and Director; Principal Executive Officer); Gerald D. McInvale (Executive Vice President, Chief Financial Officer, and Director; Principal Financial Officer); John J. Cordaro, Jerry D. Jackson, and Jerry L. Maulden (Directors).\nBy: \/s\/ Louis E. Buck, Jr. March 11, 1996 (Louis E. Buck, Jr., Attorney-in-fact)\nSYSTEM ENERGY RESOURCES, 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. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company and any subsidiaries thereof.\nSYSTEM ENERGY RESOURCES, INC.\nBy \/s\/ Louis E. Buck, Jr. Louis E. Buck, Jr., Vice President and Chief Accounting Officer\nDate: March 11, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. The signature of each of the undersigned shall be deemed to relate only to matters having reference to the above-named company and any subsidiaries thereof.\nSignature Title Date\n\/s\/ Louis E. Buck, Jr. Louis E. Buck, Jr. Vice President and March 11, 1996 Chief Accounting Officer (Principal Accounting Officer)\nDonald C. Hintz (President, Chief Executive Officer and Director; Principal Executive Officer); Gerald D. McInvale (Executive Vice President, Chief Financial Officer, and Director; Principal Financial Officer); Edwin Lupberger (Chairman of the Board), and Jerry L. Maulden (Directors).\nBy: \/s\/ Louis E. Buck, Jr. March 11, 1996 (Louis E. Buck, Jr., Attorney-in-fact)\nEXHIBIT 23(a) CONSENT OF INDEPENDENT ACCOUNTANTS\nWe consent to the incorporation by reference in Post-Effective Amendment Nos. 2, 3, 4A, and 5A on Form S-8 and the related Prospectuses to registration statement of Entergy Corporation on Form S- 4 (File Number 33-54298), of our reports dated February 14, 1996, on our audits of the financial statements and financial statement schedules of Entergy Corporation as of and for the years ended December 31, 1995 and 1994, which reports include emphasis paragraphs related to rate-related contingencies and legal proceedings and a 1995 change of accounting method for incremental nuclear plant outage maintenance costs by one of the Corporation's subsidiaries, and are included in this Annual Report on Form 10-K.\nWe consent to the incorporation by reference in the registration statements and the related Prospectuses of Arkansas Power & Light Company on Form S-3 (File Numbers 33-36149, 33-48356, 33-50289 and 333- 00103) of our reports dated February 14, 1996, on our audits of the financial statements and financial statement schedule of Arkansas Power & Light Company as of and for the years ended December 31, 1995 and 1994, which reports include an emphasis paragraph related to the Company's 1995 change in its method of accounting for incremental nuclear plant outage maintenance costs, and are included in this Annual Report on Form 10-K.\nWe consent to the incorporation by reference in registration statements and the related Prospectuses of Gulf States Utilities Company on Form S-3 (File Numbers 33-49739 and 33-51181) and Form S-8 (File Numbers 2-76551 and 2-98011) of our reports dated February 14, 1996, on our audits of the financial statements and financial statement schedule of Gulf States Utilities Company as of December 31, 1995 and 1994 and for the three years ended December 31, 1995, which reports include emphasis paragraphs related to rate-related contingencies, legal proceedings and changes in accounting for income taxes, postretirement benefits and unbilled revenue, and are included in this Annual Report on Form 10-K.\nWe consent to the incorporation by reference in the registration statements and the related Prospectuses of Louisiana Power & Light Company on Form S-3 (File Numbers 33-46085, 33-39221, 33-50937, 333- 00105, and 333-01329) of our reports dated February 14, 1996, on our audits of the financial statements and financial statement schedule of Louisiana Power & Light Company as of and for the years ended December 31, 1995 and 1994, which are included in this Annual Report on Form 10- K.\nWe consent to the incorporation by reference in the registration statements and the related Prospectuses of Mississippi Power & Light Company on Form S-3 (File Numbers 33-53004, 33-55826 and 33-50507) of our reports dated February 14, 1996, on our audits of the financial statements and financial statement schedule of Mississippi Power & Light Company as of and for the years ended December 31, 1995 and 1994, which are included in this Annual Report on Form 10-K.\nWe consent to the incorporation by reference in the registration statements and the related Prospectuses of New Orleans Public Service Inc. on Form S-3 (File Numbers 33-57926 and 333-00255) of our reports dated February 14, 1996, on our audits of the financial statement and financial statement schedules of New Orleans Public Service Inc. as of and for the years ended December 31, 1995 and 1994, which are included in this Annual Report on Form 10-K.\nWe consent to the incorporation by reference in the registration statements and the related Prospectuses of System Energy Resources, Inc. on Form S-3 (File Numbers 33-47662 and 33-61189) of our reports dated February 14, 1996, on our audits of the financial statements of System Energy Resources, Inc. as of and for the years ended December 31, 1995 and 1994, which are included in this Annual Report on Form 10- K.\nCOOPERS & LYBRAND L.L.P. New Orleans, Louisiana March 8, 1996\nEXHIBIT 23(b) INDEPENDENT AUDITORS' CONSENT\nWe consent to the incorporation by reference in Post-Effective Amendments Nos. 2, 3, 4A, and 5A on Form S-8 to Registration Statement No. 33-54298 of Entergy Corporation on Form S-4, and the related Prospectuses, of our reports dated February 11, 1994, appearing in this Annual Report on Form 10-K of Entergy Corporation.\nWe also consent to the incorporation by reference in Registration Statements Nos. 333-00103, 33-36149, 33-48356 and 33-50289 of Arkansas Power & Light Company on Form S-3, and the related Prospectuses, of our reports dated February 11, 1994, appearing in this Annual Report on Form 10-K of Arkansas Power & Light Company.\nWe also consent to the incorporation by reference in Registration Statements Nos. 333-01329, 333-00105, 33-46085, 33-39221 and 33-50937 of Louisiana Power & Light Company on Form S-3, and the related Prospectuses, of our reports dated February 11, 1994, appearing in this Annual Report on Form 10-K of Louisiana Power & Light Company.\nWe also consent to the incorporation by reference in Registration Statements Nos. 33-53004, 33-55826 and 33-50507 of Mississippi Power & Light Company on Form S-3, and the related Prospectuses, of our reports dated February 11, 1994, appearing in this Annual Report on Form 10-K of Mississippi Power & Light Company.\nWe also consent to the incorporation by reference in Registration Statement Nos. 333-00255 and 33-57926 of New Orleans Public Service Inc. on Form S-3, and the related Prospectuses, of our reports dated February 11, 1994, appearing in this Annual Report on Form 10-K of New Orleans Public Service Inc.\nWe also consent to the incorporation by reference in Registration Statement Nos. 33-61189 and 33-47662 of System Energy Resources, Inc. on Form S-3, and the related Prospectuses, of our reports dated February 11, 1994 (November 30, 1994 as to Note 2, \"Rate and Regulatory Matters - FERC Settlement\"), appearing in this Annual Report on Form 10-K of System Energy Resources, Inc.\nDELOITTE & TOUCHE LLP New Orleans, Louisiana March 8, 1996\nEXHIBIT 23(c)\nCONSENT\nWe consent to the reference to our firm under the heading \"Experts\", and to the inclusion in this Annual Report on Form 10-K of Gulf States Utilities Company (\"GSU\") of the statements of legal conclusions attributed to us herein (the Statements of Legal Conclusions) under Part I, Item 1. Business - \"Rate Matters and Regulation\" and in the discussion of Texas jurisdictional matters set forth in Note 2 to GSU's Financial Statements and Note 2 to Entergy Corporation and Subsidiaries Consolidated Financial Statements appearing as Item 8. of Part II of this Form 10-K, which Statements of Legal Conclusions have been prepared or reviewed by us (Clark, Thomas & Winters, a Professional Corporation). We also consent to the incorporation by reference in the registration statements of GSU on Form S-3 and Form S-8 (File Numbers 2-76551, 2-98011, 33-49739, and 33-51181) of such reference and Statements of Legal Conclusions.]\nCLARK, THOMAS & WINTERS A Professional Corporation\nAustin, Texas March 11, 1996\nEXHIBIT 23(d)\nCONSENT\nWe consent to the reference to our firm under the heading \"Experts\" and to the inclusion in this Annual Report on Form 10-K of Gulf States Utilities Company (\"GSU\") of the statements (Statements) regarding the analysis by our Firm of River Bend construction costs which are made herein under Part I, Item 1. Business - \"Rate Matters and Regulation\" and in the discussion of Texas jurisdictional matters set forth in Note 2 to GSU's Financial Statements and Note 2 to Entergy Corporation and Subsidiaries' Consolidated Financial Statements appearing as Item 8. of Part II of this Form 10-K, which Statements have been prepared or reviewed by us (Sandlin Associates). We also consent to the incorporation by reference in the registration statements of GSU on Form S-3 and Form S-8 (File Numbers 2-76551, 2- 98011, 33-49739 and 33-51181) of such reference and Statements.\nSANDLIN ASSOCIATES Management Consultants\nPasco, Washington March 11, 1996\nREPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULES\nTo the Board of Directors and Shareholders of Entergy Corporation\nWe have audited the consolidated financial statements of Entergy Corporation and Subsidiaries and the financial statements of Arkansas Power & Light Company, Louisiana Power & Light Company, Mississippi Power & Light Company, New Orleans Public Service Inc., and System Energy Resources, Inc. as of and for the years ended December 31, 1995 and 1994, and the financial statements of Gulf States Utilities Company as of December 31, 1995 and 1994, and for each of the three years in the period ended December 31, 1995, and have issued our reports, included elsewhere in this Form 10-K, thereon dated February 14, 1996, which reports as to Entergy Corporation and Gulf States Utilities Company include emphasis paragraphs related to rate-related contingencies and legal proceedings, and which report as to Gulf States Utilities Company includes an emphasis paragraph related to changes in accounting for income taxes, postretirement benefits and unbilled revenue, and which reports as to Entergy Corporation and Arkansas Power & Light Company include an emphasis paragraph related to changes in accounting for incremental nuclear plant outage maintenance expenses. In connection with our audits of such financial statements, we have also audited the related financial statement schedules included 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 L.L.P.\nNew Orleans, Louisiana February 14, 1996\nINDEPENDENT AUDITORS' REPORT ON FINANCIAL STATEMENT SCHEDULES\nTo the Shareholders and the Board of Directors of Entergy Corporation\nWe have audited the consolidated financial statements of Entergy Corporation and subsidiaries and the financial statements of Arkansas Power & Light Company, Louisiana Power & Light Company, Mississippi Power & Light Company, New Orleans Public Service Inc., and System Energy Resources, Inc. for the year ended December 31, 1993, and have issued our reports thereon dated February 11, 1994, which report as to Entergy Corporation includes explanatory paragraphs as to uncertainties because of certain regulatory and litigation matters, and which report as to System Energy Resources, Inc. is dated November 30, 1994 as to Note 2, \"Rate and Regulatory Matters - FERC Settlement\"; such reports are included elsewhere in this Form 10-K. Our audit also included the 1993 financial statement schedules of these companies, listed in Item 14(a)2. These financial statement schedules are the responsibility of the companies' managements. Our responsibility is to express an opinion based on our audit. We did not audit the financial statements of Gulf States Utilities Company (a consolidated subsidiary of Entergy Corporation acquired on December 31, 1993), which statements reflect total assets constituting 31% of consolidated total assets at December 31, 1993. Those statements were audited by other auditors whose report (which included explanatory paragraphs regarding uncertainties because of certain regulatory and litigation matters) has been furnished to us, and our opinion, insofar as it relates to the amounts included for Gulf States Utilities Company, is based solely on the report of such other auditors. In our opinion, based on our audit and the report of the other auditors, such financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nDELOITTE & TOUCHE LLP New Orleans, Louisiana February 11, 1994\nINDEX TO FINANCIAL STATEMENT SCHEDULES\nSchedule Page\nI Financial Statements of Entergy Corporation: Statements of Income - For the Years Ended December 31, 1995, 1994, and 1993 S-2 Statements of Cash Flows - For the Years Ended December 31, 1995, 1994, and 1993 S-3 Balance Sheets, December 31, 1995 and 1994 S-4 Statements of Retained Earnings and Paid-In Capital - For the Years Ended December 31, 1995, 1994, and 1993 S-5 II Valuation and Qualifying Accounts 1995, 1994, and 1993: Entergy Corporation and Subsidiaries S-6 Arkansas Power & Light Company S-7 Gulf States Utilities Company S-8 Louisiana Power & Light Company S-9 Mississippi Power & Light Company S-10 New Orleans Public Service Inc. S-11\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.\nColumns have been omitted from schedules filed because the information is not applicable.\nENTERGY CORPORATION SCHEDULE I-FINANCIAL STATEMENTS OF ENTERGY CORPORATION STATEMENTS OF INCOME\nFor the Years Ended December 31, 1995 1994 1993 (In Thousands)\nIncome: Equity in income of subsidiaries $549,144 $369,701 $557,681 Interest on temporary investments 20,641 25,496 18,520 -------- -------- -------- Total 569,785 395,197 576,201 -------- -------- -------- Expenses and Other Deductions: Administrative and general expenses 53,872 57,846 25,129 Income taxes (credit) (5,383) (6,350) 3,587 Taxes other than income (credit) 1,102 465 (696) Interest (credit) 214 1,395 (3,749) -------- -------- -------- Total 49,805 53,356 24,271 -------- -------- -------- Net Income $519,980 $341,841 $551,930 ======== ======== ========\nSee Entergy Corporation and Subsidiaries Notes to Financial Statements in Part II, Item 8.\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. The exhibits marked with a (+) are management contracts or compensatory plans or arrangements required to be filed herewith and required to be identified as such by Item 14 of Form 10-K. Reference is made to a duplicate list of exhibits being filed as a part of this Form 10-K, which list, prepared in accordance with Item 102 of Regulation S-T of the SEC, immediately precedes the exhibits being physically filed with this Form 10-K.\n(3) (i) Articles of Incorporation\nEntergy Corporation\n(a) 1 -- Certificate of Incorporation of Entergy Corporation dated December 31, 1993 (A-1(a) to Rule 24 Certificate in 70-8059).\nSystem Energy\n(b) 1 -- Amended and Restated Articles of Incorporation of System Energy and amendments thereto through April 28, 1989 (A-1(a) to Form U-1 in 70-5399).\nAP&L\n(c) 1 -- Amended and Restated Articles of Incorporation of AP&L and amendments thereto through May 27, 1992 (4(c) in 33-50289).\nGSU\n(d) 1 -- Restated Articles of Incorporation of GSU and amendments thereto through May 28, 1993 (A-11 in 70- 8059).\n(d) 2 -- Statement of Resolution amending Restated Articles of Incorporation, as amended, of GSU (A-11(a) in 70- 8059).\nLP&L\n(e) 1 -- Restated Articles of Incorporation of LP&L and amendments thereto through July 21, 1994 (3(a) to Form 10- Q for the quarter ended June 30, 1994 in 1-8474).\nMP&L\n*(f) 1 -- Restated Articles of Incorporation of MP&L and amendments thereto through January 19, 1996.\nNOPSI\n(g) 1 -- Restatement of Articles of Incorporation of NOPSI and amendments thereto through July 21, 1994 (3(c) to Form 10-Q for the quarter ended June 30, 1994 in 0-5807).\n(3) (ii) By-Laws\n(a) -- By-Laws of Entergy Corporation effective August 25, 1992, and as presently in effect (A-2(a) to Rule 24 Certificate in 70-8059).\n(b) -- By-Laws of System Energy effective May 4, 1989, and as presently in effect (A-2(a) in 70-5399).\n(c) -- By-Laws of AP&L as amended effective May 5, 1994, and as presently in effect (4(f) in 33-50289).\n(d) -- By-Laws of GSU as amended effective May 5, 1994, and as presently in effect (A-12 in 70-8059).\n(e) -- By-Laws of LP&L effective January 23, 1984, and as presently in effect (A-4 in 70-6962).\n*(f) -- By-Laws of MP&L effective April 5, 1995, and as presently in effect.\n(g) -- By-Laws of NOPSI effective May 5, 1994, and as presently in effect (3(b) to Form 10-Q for the quarter ended September 30, 1989 in 0-5807).\n(4) Instruments Defining Rights of Security Holders, Including Indentures\nEntergy Corporation\n(a) 1 -- See (4)(b) through (4)(g) below for instruments defining the rights of holders of long-term debt of System Energy, AP&L, GSU, LP&L, MP&L and NOPSI.\n(a) 2 -- Credit Agreement, dated as of October 3, 1989, between System Fuels and The Yasuda Trust and Banking Co., Ltd., New York Branch, as agent (B-1(c) to Rule 24 Certificate, dated October 6, 1989, in 70-7668).\n(a) 3 -- First Amendment, dated as of March 1, 1992, to Credit Agreement, dated as of October 3, 1989, between System Fuels and The Yasuda Trust and Banking Co., Ltd., New York Branch, as agent (4(a)5 to Form 10-K for the year ended December 31, 1991 in 1-3517).\n(a) 4 -- Second Amendment, dated as of September 30, 1992, to Credit Agreement dated as of October 3, 1989, between System Fuels and The Yasuda Trust and Banking Co., Ltd., New York Branch, as agent (4(a)6 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n(a) 5 -- Security Agreement, dated as of October 3, 1989, as amended, between System Fuels and The Yasuda Trust and Banking Co., Ltd., New York Branch, as agent (B-3(c) to Rule 24 Certificate, dated October 6, 1989, in 70-7668), as amended by First Amendment to Security Agreement, dated as of March 14, 1990 (A to Rule 24 Certificate, dated March 7, 1990, in 70-7668).\n(a) 6 -- Consent and Agreement, dated as of October 3, 1989, among System Fuels, The Yasuda Trust and Banking Co., Ltd., New York Branch, as agent, AP&L, LP&L, and System Energy (B-5(c) to Rule 24 Certificate, dated October 6, 1989, in 70-7668).\n(a) 7 -- Credit Agreement, dated as of October 10, 1995, among Entergy, the Banks (Bank of America National Trust & Savings Association, The Bank of New York, Chemical Bank, Citibank, N.A., Union Bank of Switzerland, ABN AMRO Bank N.V., the Bank of Nova Scotia, Canadian Imperial Bank of Commerce, Bank N.A., First National Bank of Commerce and Whitney National Bank) and Citibank, N.A., as Agent (Exhibit B to Rule 24 Certificate dated October 20, 1995 in File No. 70-8149).\nSystem Energy\n(b) 1 -- Mortgage and Deed of Trust, dated as of June 15, 1977, as amended by nineteen Supplemental Indentures (A-1 in 70-5890 (Mortgage); B and C to Rule 24 Certificate in 70-5890 (First); B to Rule 24 Certificate in 70-6259 (Second); 20(a)-5 to Form 10-Q for the quarter ended June 30, 1981, in 1-3517 (Third); A-1(e)-1 to Rule 24 Certificate in 70-6985 (Fourth); B to Rule 24 Certificate in 70-7021 (Fifth); B to Rule 24 Certificate in 70-7021 (Sixth); A-3(b) to Rule 24 Certificate in 70-7026 (Seventh); A-3(b) to Rule 24 Certificate in 70-7158 (Eighth); B to Rule 24 Certificate in 70-7123 (Ninth); B-1 to Rule 24 Certificate in 70-7272 (Tenth); B-2 to Rule 24 Certificate in 70-7272 (Eleventh); B-3 to Rule 24 Certificate in 70-7272 (Twelfth); B-1 to Rule 24 Certificate in 70-7382 (Thirteenth); B-2 to Rule 24 Certificate in 70-7382 (Fourteenth); A-2(c) to Rule 24 Certificate in 70-7946 (Fifteenth); A-2(c) to Rule 24 Certificate in 70-7946 (Sixteenth); A-2(d) to Rule 24 Certificate in 70-7946 (Seventeenth); A-2(e) to Rule 24 Certificate dated May 4, 1993 in 70-7946 (Eighteenth); and A-2(g) to Rule 24 Certificate dated May 6, 1994, in 70-7946 (Nineteenth)).\n(b) 2 -- Facility Lease No. 1, dated as of December 1, 1988, between Meridian Trust Company and Stephen M. Carta (Steven Kaba, successor), as Owner Trustees, and System Energy (B-2(c)(1) to Rule 24 Certificate dated January 9, 1989 in 70-7561), as supplemented by Lease Supplement No. 1 dated as of April 1, 1989 (B-22(b) (1) to Rule 24 Certificate dated April 21, 1989 in 70-7561) and Lease Supplement No. 2 dated as of January 1, 1994 (B- 3(d) to Rule 24 Certificate dated January 31, 1994 in 70- 8215).\n(b) 3 -- Facility Lease No. 2, dated as of December 1, 1988 between Meridian Trust Company and Stephen M. Carta (Steven Kaba, successor), as Owner Trustees, and System Energy (B-2(c)(2) to Rule 24 Certificate dated January 9, 1989 in 70-7561), as supplemented by Lease Supplement No. 1 dated as of April 1, 1989 (B-22(b) (2) to Rule 24 Certificate dated April 21, 1989 in 70-7561) and Lease Supplement No. 2 dated as of January 1, 1994 (B-4(d) Rule 24 Certificate dated January 31, 1994 in 70-8215).\n(b) 4 -- Indenture (for Unsecured Debt Securities), dated as of September 1, 1995, between System Energy Resources, Inc., and Chemical Bank (B-10(a) to Rule 24 Certificate in 70-8511).\nAP&L\n(c) 1 -- Mortgage and Deed of Trust, dated as of October 1, 1944, as amended by fifty-two Supplemental Indentures (7(d) in 2-5463 (Mortgage); 7(b) in 2-7121 (First); 7(c) in 2-7605 (Second); 7(d) in 2-8100 (Third); 7(a)-4 in 2-8482 (Fourth); 7(a)-5 in 2-9149 (Fifth); 4(a)-6 in 2-9789 (Sixth); 4(a)-7 in 2-10261 (Seventh); 4(a)-8 in 2-11043 (Eighth); 2(b)-9 in 2-11468 (Ninth); 2(b)-10 in 2-15767 (Tenth); D in 70-3952 (Eleventh); D in 70-4099 (Twelfth); 4(d) in 2-23185 (Thirteenth); 2(c) in 2-24414 (Fourteenth); 2(c) in 2-25913 (Fifteenth); 2(c) in 2-28869 (Sixteenth); 2(d) in 2-28869 (Seventeenth); 2(c) in 2-35107 (Eighteenth); 2(d) in 2-36646 (Nineteenth); 2(c) in 2-39253 (Twentieth); 2(c) in 2-41080 (Twenty-first); C-1 to Rule 24 Certificate in 70-5151 (Twenty-second); C-1 to Rule 24 Certificate in 70-5257 (Twenty-third); C to Rule 24 Certificate in 70-5343 (Twenty-fourth); C-1 to Rule 24 Certificate in 70-5404 (Twenty-fifth); C to Rule 24 Certificate in 70-5502 (Twenty-sixth); C-1 to Rule 24 Certificate in 70-5556 (Twenty-seventh); C-1 to Rule 24 Certificate in 70-5693 (Twenty-eighth); C-1 to Rule 24 Certificate in 70-6078 (Twenty-ninth); C-1 to Rule 24 Certificate in 70-6174 (Thirtieth); C-1 to Rule 24 Certificate in 70-6246 (Thirty-first); C-1 to Rule 24 Certificate in 70-6498 (Thirty-second); A-4b-2 to Rule 24 Certificate in 70-6326 (Thirty-third); C-1 to Rule 24 Certificate in 70-6607 (Thirty-fourth); C-1 to Rule 24 Certificate in 70-6650 (Thirty-fifth); C-1 to Rule 24 Certificate, dated December 1, 1982, in 70-6774 (Thirty-sixth); C-1 to Rule 24 Certificate, dated February 17, 1983, in 70-6774 (Thirty-seventh); A-2(a) to Rule 24 Certificate, dated December 5, 1984, in 70-6858 (Thirty-eighth); A-3(a) to Rule 24 Certificate in 70-7127 (Thirty-ninth); A-7 to Rule 24 Certificate in 70-7068 (Fortieth); A-8(b) to Rule 24 Certificate dated July 6, 1989 in 70-7346 (Forty-first); A-8(c) to Rule 24 Certificate, dated February 1, 1990 in 70-7346 (Forty-second); 4 to Form 10-Q for the quarter ended September 30, 1990 in 1-10764 (Forty-third); A-2(a) to Rule 24 Certificate, dated November 30, 1990, in 70-7802 (Forty-fourth); A-2(b) to Rule 24 Certificate, dated January 24, 1991, in 70-7802 (Forty-fifth); 4(d)(2) in 33-54298 (Forty-sixth); 4(c)(2) to Form 10-K for the year ended December 31, 1992 in 1- 10764 (Forty-seventh); 4(b) to Form 10-Q for the quarter ended June 30, 1993 in 1-10764 (Forty-eighth); 4(c) to Form 10-Q for the quarter ended June 30, 1993 in 1-10764 (Forty-ninth); 4(b) to Form 10-Q for the quarter ended September 30, 1993 in 1-10764 (Fiftieth); 4(c) to Form 10- Q for the quarter ended September 30, 1993 in 1-10764 (Fifty-first); and 4(a) to Form 10-Q for the quarter ended June 30, 1994 (Fifty-second)).\nGSU\n(d) 1 -- Indenture of Mortgage, dated September 1, 1926, as amended by certain Supplemental Indentures (B-a-I-1 in Registration No. 2-2449 (Mortgage); 7-A-9 in Registration No. 2-6893 (Seventh); B to Form 8-K dated September 1, 1959 (Eighteenth); B to Form 8-K dated February 1, 1966 (Twenty-second); B to Form 8-K dated March 1, 1967 (Twenty-third); C to Form 8-K dated March 1, 1968 (Twenty- fourth); B to Form 8-K dated November 1, 1968 (Twenty- fifth); B to Form 8-K dated April 1, 1969 (Twenty-sixth); 2-A-8 in Registration No. 2-66612 (Thirty-eighth); 4-2 to Form 10-K for the year ended December 31, 1984 in 1-2703 (Forty-eighth); 4-2 to Form 10-K for the year ended December 31, 1988 in 1-2703 (Fifty-second); 4 to Form 10- K for the year ended December 31, 1991 in 1-2703 (Fifty- third); 4 to Form 8-K dated July 29, 1992 in 1-2703 (Fifth-fourth); 4 to Form 10-K dated December 31, 1992 in 1-2703 (Fifty-fifth); 4 to Form 10-Q for the quarter ended March 31, 1993 in 1-2703 (Fifty-sixth); and 4-2 to Amendment No. 9 to Registration No. 2-76551 (Fifty- seventh)).\n(d) 2 -- Indenture, dated March 21, 1939, accepting resignation of The Chase National Bank of the City of New York as trustee and appointing Central Hanover Bank and Trust Company as successor trustee (B-a-1-6 in Registration No. 2-4076).\n(d) 3 -- Trust Indenture for 9.72% Debentures due July 1, 1998 (4 in Registration No. 33-40113).\nLP&L\n(e) 1 -- Mortgage and Deed of Trust, dated as of April 1, 1944, as amended by fifty Supplemental Indentures (7(d) in 2-5317 (Mortgage); 7(b) in 2-7408 (First); 7(c) in 2-8636 (Second); 4(b)-3 in 2-10412 (Third); 4(b)-4 in 2-12264 (Fourth); 2(b)-5 in 2-12936 (Fifth); D in 70-3862 (Sixth); 2(b)-7 in 2-22340 (Seventh); 2(c) in 2-24429 (Eighth); 4(c)-9 in 2-25801 (Ninth); 4(c)-10 in 2-26911 (Tenth); 2(c) in 2-28123 (Eleventh); 2(c) in 2-34659 (Twelfth); C to Rule 24 Certificate in 70-4793 (Thirteenth); 2(b)-2 in 2-38378 (Fourteenth); 2(b)-2 in 2-39437 (Fifteenth); 2(b)-2 in 2-42523 (Sixteenth); C to Rule 24 Certificate in 70-5242 (Seventeenth); C to Rule 24 Certificate in 70-5330 (Eighteenth); C-1 to Rule 24 Certificate in 70-5449 (Nineteenth); C-1 to Rule 24 Certificate in 70-5550 (Twentieth); A-6(a) to Rule 24 Certificate in 70-5598 (Twenty-first); C-1 to Rule 24 Certificate in 70-5711 (Twenty-second); C-1 to Rule 24 Certificate in 70-5919 (Twenty-third); C-1 to Rule 24 Certificate in 70-6102 (Twenty-fourth); C-1 to Rule 24 Certificate in 70-6169 (Twenty-fifth); C-1 to Rule 24 Certificate in 70-6278 (Twenty-sixth); C-1 to Rule 24 Certificate in 70-6355 (Twenty-seventh); C-1 to Rule 24 Certificate in 70-6508 (Twenty-eighth); C-1 to Rule 24 Certificate in 70-6556 (Twenty-ninth); C-1 to Rule 24 Certificate in 70-6635 (Thirtieth); C-1 to Rule 24 Certificate in 70-6834 (Thirty-first); C-1 to Rule 24 Certificate in 70-6886 (Thirty-second); C-1 to Rule 24 Certificate in 70-6993 (Thirty-third); C-2 to Rule 24 Certificate in 70-6993 (Thirty-fourth); C-3 to Rule 24 Certificate in 70-6993 (Thirty-fifth); A-2(a) to Rule 24 Certificate in 70-7166 (Thirty-sixth); A-2(a) in 70-7226 (Thirty-seventh); C-1 to Rule 24 Certificate in 70-7270 (Thirty-eighth); 4(a) to Quarterly Report on Form 10-Q for the quarter ended June 30, 1988, in 1-8474 (Thirty-ninth); A-2(b) to Rule 24 Certificate in 70-7553 (Fortieth); A-2(d) to Rule 24 Certificate in 70-7553 (Forty-first); A-3(a) to Rule 24 Certificate in 70-7822 (Forty-second); A-3(b) to Rule 24 Certificate in 70-7822 (Forty-third); A-2(b) to Rule 24 Certificate in File No. 70-7822 (Forty-fourth); A-3(c) to Rule 24 Certificate in 70-7822 (Forty-fifth); A-2(c) to Rule 24 Certificate dated April 7, 1993 in 70-7822 (Forty-sixth); A-3(d) to Rule 24 Certificate dated June 4, 1993 in 70-7822 (Forth- seventh); A-3(e) to Rule 24 Certificate dated December 21, 1993 in 70-7822 (Forty-eighth); A-3(f) to Rule 24 Certificate dated August 1, 1994 in 70-7822 (Forty-ninth) and A-4(c) to Rule 24 Certificate dated September 28, 1994 in 70-7653 (Fiftieth)).\n(e) 2 -- Facility Lease No. 1, dated as of September 1, 1989, between First National Bank of Commerce, as Owner Trustee, and LP&L (4(c)-1 in Registration No. 33-30660).\n(e) 3 -- Facility Lease No. 2, dated as of September 1, 1989, between First National Bank of Commerce, as Owner Trustee, and LP&L (4(c)-2 in Registration No. 33-30660).\n(e) 4 -- Facility Lease No. 3, dated as of September 1, 1989, between First National Bank of Commerce, as Owner Trustee, and LP&L (4(c)-3 in Registration No. 33-30660).\nMP&L\n(f) 1 -- Mortgage and Deed of Trust, dated as of September 1, 1944, as amended by twenty-five Supplemental Indentures (7(d) in 2-5437 (Mortgage); 7(b) in 2-7051 (First); 7(c) in 2-7763 (Second); 7(d) in 2-8484 (Third); 4(b)-4 in 2-10059 (Fourth); 2(b)-5 in 2-13942 (Fifth); A-11 to Form U-1 in 70-4116 (Sixth); 2(b)-7 in 2-23084 (Seventh); 4(c)-9 in 2-24234 (Eighth); 2(b)-9(a) in 2-25502 (Ninth); A-11(a) to Form U-1 in 70-4803 (Tenth); A-12(a) to Form U-1 in 70-4892 (Eleventh); A-13(a) to Form U-1 in 70-5165 (Twelfth); A-14(a) to Form U-1 in 70-5286 (Thirteenth); A-15(a) to Form U-1 in 70-5371 (Fourteenth); A-16(a) to Form U-1 in 70-5417 (Fifteenth); A-17 to Form U-1 in 70-5484 (Sixteenth); 2(a)-19 in 2-54234 (Seventeenth); C-1 to Rule 24 Certificate in 70-6619 (Eighteenth); A-2(c) to Rule 24 Certificate in 70-6672 (Nineteenth); A-2(d) to Rule 24 Certificate in 70-6672 (Twentieth); C-1(a) to Rule 24 Certificate in 70-6816 (Twenty-first); C-1(a) to Rule 24 Certificate in 70-7020 (Twenty-second); C-1(b) to Rule 24 Certificate in 70-7020 (Twenty-third); C-1(a) to Rule 24 Certificate in 70-7230 (Twenty-fourth); and A-2(a) to Rule 24 Certificate in 70-7419 (Twenty-fifth)).\n(f) 2 -- Mortgage and Deed of Trust, dated as of February 1, 1988, as amended by tenth Supplemental Indentures (A-2(a)-2 to Rule 24 Certificate in 70-7461 (Mortgage); A-2(b)-2 in 70-7461 (First); A-5(b) to Rule 24 Certificate in 70-7419 (Second); A-4(b) to Rule 24 Certificate in 70-7554 (Third); A-1(b)-1 to Rule 24 Certificate in 70-7737 (Fourth); A-2(b) to Rule 24 Certificate dated November 24, 1992 in 70-7914 (Fifth); A-2(e) to Rule 24 Certificate dated January 22, 1993 in 70-7914 (Sixth); A-2(g) to Form U-1 in 70-7914 (Seventh); A-2(i) to Rule 24 Certificate dated November 10, 1993 in 70-7914 (Eighth); A-2(j) to Rule 24 Certificate dated July 22, 1994 in 70-7914 (Ninth); and (A-2(l) to Rule 24 Certificate dated April 21, 1995 in File 70-7914 (Tenth)).\nNOPSI\n(g) 1 -- Mortgage and Deed of Trust, dated as of July 1, 1944, as amended by eleven Supplemental Indentures (B-3 in 2-5411 (Mortgage); 7(b) in 2-7674 (First); 4(a)-2 in 2-10126 (Second); 4(b) in 2-12136 (Third); 2(b)-4 in 2-17959 (Fourth); 2(b)-5 in 2-19807 (Fifth); D to Rule 24 Certificate in 70-4023 (Sixth); 2(c) in 2-24523 (Seventh); 4(c)-9 in 2-26031 (Eighth); 2(a)-3 in 2-50438 (Ninth); 2(a)-3 in 2-62575 (Tenth); and A-2(b) to Rule 24 Certificate in 70-7262 (Eleventh)).\n(g) 2 -- Mortgage and Deed of Trust, dated as of May 1, 1987, as amended by four Supplemental Indentures (A-2(c) to Rule 24 Certificate in 70-7350 (Mortgage); A-5(b) to Rule 24 Certificate in 70-7350 (First); A-4(b) to Rule 24 Certificate in 70-7448 (Second); 4(f)4 to Form 10-K for the year ended December 31, 1992 in 0-5807 (Third); 4(a) to Form 10-Q for the quarter ended September 30, 1993 in 0-5807 (Fourth); and 4(a) to Form 8-K dated April 26, 1995 in File No. 0-5807 (Fifth)).\n(10) Material Contracts\nEntergy Corporation\n(a) 1 -- Agreement, dated April 23, 1982, among certain System companies, relating to System Planning and Development and Intra-System Transactions (10(a)1 to Form 10-K for the year ended December 31, 1982, in 1-3517).\n(a) 2 -- Middle South Utilities System Agency Agreement, dated December 11, 1970 (5(a)-2 in 2-41080).\n(a) 3 -- Amendment, dated February 10, 1971, to Middle South Utilities System Agency Agreement, dated December 11, 1970 (5(a)-4 in 2-41080).\n(a) 4 -- Amendment, dated May 12, 1988, to Middle South Utilities System Agency Agreement, dated December 11, 1970 (5(a)-4 in 2-41080).\n(a) 5 -- Middle South Utilities System Agency Coordination Agreement, dated December 11, 1970 (5(a)-3 in 2-41080).\n(a) 6 -- Service Agreement with Entergy Services, dated as of April 1, 1963 (5(a)-5 in 2-41080).\n(a) 7 -- Amendment, dated January 1, 1972, to Service Agreement with Entergy Services (5(a)-6 in 2-43175).\n(a) 8 -- Amendment, dated April 27, 1984, to Service Agreement with Entergy Services (10(a)-7 to Form 10-K for the year ended December 31, 1984, in 1-3517).\n(a) 9 -- Amendment, dated August 1, 1988, to Service Agreement with Entergy Services (10(a)-8 to Form 10-K for the year ended December 31, 1988, in 1-3517).\n(a) 10-- Amendment, dated January 1, 1991, to Service Agreement with Entergy Services (10(a)-9 to Form 10-K for the year ended December 31, 1990, in 1-3517).\n(a) 11-- Amendment, dated January 1, 1992, to Service Agreement with Entergy Services (10(a)-11 for the year ended December 31, 1994 in 1-3517).\n(a) 12-- Availability Agreement, dated June 21, 1974, among System Energy and certain other System companies (B to Rule 24 Certificate, dated June 24, 1974, in 70-5399).\n(a) 13-- First Amendment to Availability Agreement, dated as of June 30, 1977 (B to Rule 24 Certificate, dated June 24, 1977, in 70-5399).\n(a) 14-- Second Amendment to Availability Agreement, dated as of June 15, 1981 (E to Rule 24 Certificate, dated July 1, 1981, in 70-6592).\n(a) 15-- Third Amendment to Availability Agreement, dated as of June 28, 1984 (B-13(a) to Rule 24 Certificate, dated July 6, 1984, in 70-6985).\n(a) 16-- Fourth Amendment to Availability Agreement, dated as of June 1, 1989 (A to Rule 24 Certificate, dated June 8, 1989, in 70-5399).\n(a) 17-- Fifteenth Assignment of Availability Agreement, Consent and Agreement, dated as of May 1, 1986, with Deposit Guaranty National Bank, United States Trust Company of New York and Malcolm J. Hood, as Trustees (B-3(b) to Rule 24 Certificate, dated June 5, 1986, in 70-7158).\n(a) 18-- Eighteenth Assignment of Availability Agreement, Consent and Agreement, dated as of September 1, 1986, with United States Trust Company of New York and Gerard F. Ganey, as Trustees (C-2 to Rule 24 Certificate, dated October 1, 1986, in 70-7272).\n(a) 19-- Nineteenth Assignment of Availability Agreement, Consent and Agreement, dated as of September 1, 1986, with United States Trust Company of New York and Gerard F. Ganey, as Trustees (C-3 to Rule 24 Certificate, dated October 1, 1986, in 70-7272).\n(a) 20-- Twenty-sixth Assignment of Availability Agreement, Consent and Agreement, dated as of October 1, 1992, with United States Trust Company of New York and Gerard F. Ganey, as Trustees (B-2(c) to Rule 24 Certificate, dated November 2, 1992, in 70-7946).\n(a) 21-- Twenty-seventh Assignment of Availability Agreement, Consent and Agreement, dated as of April 1, 1993, with United States Trust Company of New York and Gerard F. Ganey as Trustees (B-2(d) to Rule 24 Certificate dated May 4, 1993 in 70-7946).\n(a) 22-- Twenty-eighth Assignment of Availability Agreement, Consent and Agreement, dated as of December 17, 1993, with Chemical Bank, as Agent (B-2(a) to Rule 24 Certificate dated December 22, 1993 in 70-7561).\n(a) 23-- Twenty-ninth Assignment of Availability Agreement, Consent and Agreement, dated as of April 1, 1994, with United States Trust Company of New York and Gerard F. Ganey as Trustees (B-2(f) to Rule 24 Certificate dated May 6, 1994, in 70-7946).\n(a) 24-- Capital Funds Agreement, dated June 21, 1974, between Entergy Corporation and System Energy (C to Rule 24 Certificate, dated June 24, 1974, in 70-5399).\n(a) 25-- First Amendment to Capital Funds Agreement, dated as of June 1, 1989 (B to Rule 24 Certificate, dated June 8, 1989, in 70-5399).\n(a) 26-- Fifteenth Supplementary Capital Funds Agreement and Assignment, dated as of May 1, 1986, with Deposit Guaranty National Bank, United States Trust Company of New York and Malcolm J. Hood, as Trustees (B-4(b) to Rule 24 Certificate, dated June 5, 1986, in 70-7158).\n(a) 27-- Eighteenth Supplementary Capital Funds Agreement and Assignment, dated as of September 1, 1986, with United States Trust Company of New York and Gerard F. Ganey, as Trustees (D-2 to Rule 24 Certificate, dated October 1, 1986, in 70-7272).\n(a) 28-- Nineteenth Supplementary Capital Funds Agreement and Assignment, dated as of September 1, 1986, with United States Trust Company of New York and Gerard F. Ganey, as Trustees (D-3 to Rule 24 Certificate, dated October 1, 1986, in 70-7272).\n(a) 29-- Twenty-sixth Supplementary Capital Funds Agreement and Assignment, dated as of October 1, 1992, with United States Trust Company of New York and Gerard F. Ganey, as Trustees (B-3(c) to Rule 24 Certificate dated November 2, 1992 in 70-7946).\n(a) 30-- Twenty-seventh Supplementary Capital Funds Agreement and Assignment, dated as of April 1, 1993, with United States Trust Company of New York and Gerard F. Ganey, as Trustees (B-3(d) to Rule 24 Certificate dated May 4, 1993 in 70-7946).\n(a) 31-- Twenty-eighth Supplementary Capital Funds Agreement and Assignment, dated as of December 17, 1993, with Chemical Bank, as Agent (B-3(a) to Rule 24 Certificate dated December 22, 1993 in 70-7561).\n(a) 32-- Twenty-ninth Supplementary Capital Funds Agreement and Assignment, dated as of April 1, 1994, with United States Trust Company of New York and Gerard F. Ganey, as Trustees (B-3(f) to Rule 24 Certificate dated May 6, 1994, in 70-7946).\n(a) 33-- First Amendment to Supplementary Capital Funds Agreements and Assignments, dated as of June 1, 1989, by and between Entergy Corporation, System Energy, Deposit Guaranty National Bank, United States Trust Company of New York and Gerard F. Ganey (C to Rule 24 Certificate, dated June 8, 1989, in 70-7026).\n(a) 34-- First Amendment to Supplementary Capital Funds Agreements and Assignments, dated as of June 1, 1989, by and between Entergy Corporation, System Energy, United States Trust Company of New York and Gerard F. Ganey (C to Rule 24 Certificate, dated June 8, 1989, in 70-7123).\n(a) 35-- First Amendment to Supplementary Capital Funds Agreement and Assignment, dated as of June 1, 1989, by and between Entergy Corporation, System Energy and Chemical Bank (C to Rule 24 Certificate, dated June 8, 1989, in 70-7561).\n+(a) 36-- Agreement between Entergy Corporation and Edwin Lupberger (10(a)-42 to Form 10-K for the year ended December 31, 1985, in 1-3517).\n(a) 37-- Reallocation Agreement, dated as of July 28, 1981, among System Energy and certain other System companies (B-1(a) in 70-6624).\n(a) 38-- Joint Construction, Acquisition and Ownership Agreement, dated as of May 1, 1980, between System Energy and SMEPA (B-1(a) in 70-6337), as amended by Amendment No. 1, dated as of May 1, 1980 (B-1(c) in 70-6337) and Amendment No. 2, dated as of October 31, 1980 (1 to Rule 24 Certificate, dated October 30, 1981, in 70-6337).\n(a) 39-- Operating Agreement dated as of May 1, 1980, between System Energy and SMEPA (B(2)(a) in 70-6337).\n(a) 40-- Assignment, Assumption and Further Agreement No. 1, dated as of December 1, 1988, among System Energy, Meridian Trust Company and Stephen M. Carta, and SMEPA (B-7(c)(1) to Rule 24 Certificate, dated January 9, 1989, in 70-7561).\n(a) 41-- Assignment, Assumption and Further Agreement No. 2, dated as of December 1, 1988, among System Energy, Meridian Trust Company and Stephen M. Carta, and SMEPA (B-7(c)(2) to Rule 24 Certificate, dated January 9, 1989, in 70-7561).\n(a) 42-- Substitute Power Agreement, dated as of May 1, 1980, among MP&L, System Energy and SMEPA (B(3)(a) in 70-6337).\n(a) 43-- Grand Gulf Unit No. 2 Supplementary Agreement, dated as of February 7, 1986, between System Energy and SMEPA (10(aaa) in 33-4033).\n(a) 44-- Compromise and Settlement Agreement, dated June 4, 1982, between Texaco, Inc. and LP&L (28(a) to Form 8-K, dated June 4, 1982, in 1-3517).\n+(a) 45-- Post-Retirement Plan (10(a)37 to Form 10-K for the year ended December 31, 1983, in 1-3517).\n(a) 46-- Unit Power Sales Agreement, dated as of June 10, 1982, between System Energy and AP&L, LP&L, MP&L and NOPSI (10(a)-39 to Form 10-K for the year ended December 31, 1982, in 1-3517).\n(a) 47-- First Amendment to Unit Power Sales Agreement, dated as of June 28, 1984, between System Energy and AP&L, LP&L, MP&L and NOPSI (19 to Form 10-Q for the quarter ended September 30, 1984, in 1-3517).\n(a) 48-- Revised Unit Power Sales Agreement (10(ss) in 33-4033).\n(a) 49-- Middle South Utilities Inc. and Subsidiary Companies Intercompany Income Tax Allocation Agreement, dated April 28, 1988 (Exhibit D-1 to Form U5S for the year ended December 31, 1987).\n(a) 50-- First Amendment, dated January 1, 1990, to the Middle South Utilities Inc. and Subsidiary Companies Intercompany Income Tax Allocation Agreement (D-2 to Form U5S for the year ended December 31, 1989).\n(a) 51-- Second Amendment dated January 1, 1992, to the Entergy Corporation and Subsidiary Companies Intercompany Income Tax Allocation Agreement (D-3 to Form U5S for the year ended December 31, 1992).\n(a) 52-- Third Amendment dated January 1, 1994 to Entergy Corporation and Subsidiary Companies Intercompany Income Tax Allocation Agreement (D-3(a) to Form U5S for the year ended December 31, 1993).\n(a) 53-- Guaranty Agreement between Entergy Corporation and AP&L, dated as of September 20, 1990 (B-1(a) to Rule 24 Certificate, dated September 27, 1990, in 70-7757).\n(a) 54-- Guarantee Agreement between Entergy Corporation and LP&L, dated as of September 20, 1990 (B-2(a) to Rule 24 Certificate, dated September 27, 1990, in 70-7757).\n(a) 55-- Guarantee Agreement between Entergy Corporation and System Energy, dated as of September 20, 1990 (B-3(a) to Rule 24 Certificate, dated September 27, 1990, in 70- 7757).\n(a) 56-- Loan Agreement between Entergy Operations and Entergy Corporation, dated as of September 20, 1990 (B-12(b) to Rule 24 Certificate, dated June 15, 1990, in 70-7679).\n(a) 57-- Loan Agreement between Entergy Power and Entergy Corporation, dated as of August 28, 1990 (A-4(b) to Rule 24 Certificate, dated September 6, 1990, in 70-7684).\n(a) 58-- Loan Agreement between Entergy Corporation and Entergy Systems and Service, Inc., dated as of December 29, 1992 (A-4(b) to Rule 24 Certificate in 70-7947).\n+(a) 59-- Executive Financial Counseling Program of Entergy Corporation and Subsidiaries (10(a) 52 to Form 10-K for the year ended December 31, 1989, in 1-3517).\n+(a) 60-- Entergy Corporation Annual Incentive Plan (10(a) 54 to Form 10-K for the year ended December 31, 1989, in 1-3517).\n+(a) 61-- Equity Ownership Plan of Entergy Corporation and Subsidiaries (A-4(a) to Rule 24 Certificate, dated May 24, 1991, in 70-7831).\n+(a) 62-- Retired Outside Director Benefit Plan (10(a)63 to Form 10-K for the year ended December 31, 1991, in 1-3517).\n+(a) 63-- Agreement between Entergy Corporation and Jerry D. Jackson. (10(a) 67 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(a) 64-- Agreement between Entergy Services, Inc., a subsidiary of Entergy Corporation, and Gerald D. McInvale (10(a) 68 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(a) 65-- Supplemental Retirement Plan (10(a) 69 to Form 10- K for the year ended December 31, 1992 in 1-3517).\n+(a) 66-- Defined Contribution Restoration Plan of Entergy Corporation and Subsidiaries (10(a)53 to Form 10-K for the year ended December 31, 1989 in 1-3517).\n+(a) 67-- Amendment No. 1 to the Equity Ownership Plan of Entergy Corporation and Subsidiaries (10(a) 71 to Form 10- K for the year ended December 31, 1992 in 1-3517).\n+(a) 68-- Executive Disability Plan of Entergy Corporation and Subsidiaries (10(a) 72 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(a) 69-- Executive Medical Plan of Entergy Corporation and Subsidiaries (10(a) 73 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(a) 70-- Stock Plan for Outside Directors of Entergy Corporation and Subsidiaries, as amended (10(a) 74 to Form 10-K for the year ended December 31, 1992 in 1- 3517).\n+(a) 71-- Summary Description of Private Ownership Vehicle Plan of Entergy Corporation and Subsidiaries (10(a) 75 to Form 10-K for the year ended December 31, 1992 in 1- 3517).\n(a) 72-- Agreement and Plan of Reorganization Between Entergy Corporation and Gulf States Utilities Company, dated June 5, 1992 (1 to Current Report on Form 8-K dated June 5, 1992 in 1-3517).\n+(a) 73-- Amendment to Defined Contribution Restoration Plan of Entergy Corporation and Subsidiaries (10(a) 81 to Form 10-K for the year ended December 31, 1993 in 1-11299).\n+(a) 74-- System Executive Retirement Plan (10(a) 82 to Form 10-K for the year ended December 31, 1993 in 1-11299).\nSystem Energy\n(b) 1 through (b) 12-- See 10(a)-12 through 10(a)-23 above.\n(b) 13 through (b) 24-- See 10(a)-24 through 10(a)-35 above.\n(b) 25-- Reallocation Agreement, dated as of July 28, 1981, among System Energy and certain other System companies (B-1(a) in 70-6624).\n(b) 26-- Joint Construction, Acquisition and Ownership Agreement, dated as of May 1, 1980, between System Energy and SMEPA (B-1(a) in 70-6337), as amended by Amendment No. 1, dated as of May 1, 1980 (B-1(c) in 70-6337) and Amendment No. 2, dated as of October 31, 1980 (1 to Rule 24 Certificate, dated October 30, 1981, in 70-6337).\n(b) 27-- Operating Agreement, dated as of May 1, 1980, between System Energy and SMEPA (B(2)(a) in 70-6337).\n(b) 28-- Installment Sale Agreement, dated as of December 1, 1983 between System Energy and Claiborne County, Mississippi (B-1 to First Rule 24 Certificate in 70-6913).\n(b) 29-- Installment Sale Agreement, dated as of June 1, 1984, between System Energy and Claiborne County, Mississippi (B-2 to Second Rule 24 Certificate in 70-6913).\n(b) 30-- Installment Sale Agreement, dated as of December 1, 1984, between System Energy and Claiborne County, Mississippi (B-1 to First Rule 24 Certificate in 70-7026).\n(b) 31-- Installment Sale Agreement, dated as of May 1, 1986, between System Energy and Claiborne County, Mississippi (B-1(b) to Rule 24 Certificate in 70-7158).\n(b) 32-- Amended and Restated Installment Sale Agreement, dated as of May 1, 1995, between System Energy and Claiborne County, Mississippi (B-6(a) to Rule 24 Certificate in 70-8511).\n(b) 33-- Facility Lease No. 1, dated as of December 1, 1988, between Meridian Trust Company and Stephen M. Carta (Stephen J. Kaba, successor), as Owner Trustees, and System Energy (B-2(c)(1) to Rule 24 Certificate dated January 9, 1989 in 70-7561), as supplemented by Lease Supplement No. 1 dated as of April 1, 1989 (B-22(b) (1) to Rule 24 Certificate dated April 21, 1989 in 70-7561) and Lease Supplement No. 2 dated as of January 1, 1994 (B- 3(d) to Rule 24 Certificate dated January 31, 1994 in 70- 8215).\n(b) 34-- Facility Lease No. 2, dated as of December 1, 1988 between Meridian Trust Company and Stephen M. Carta (Stephen J. Kaba, successor), as Owner Trustees, and System Energy (B-2(c)(2) to Rule 24 Certificate dated January 9, 1989 in 70-7561), as supplemented by Lease Supplement No. 1 dated as of April 1, 1989 (B-22(b) (2) to Rule 24 Certificate dated April 21, 1989 in 70-7561) and Lease Supplement No. 2 dated as of January 1, 1994 (B- 4(d) Rule 24 Certificate dated January 31, 1994 in 70- 8215).\n(b) 35-- Assignment, Assumption and Further Agreement No. 1, dated as of December 1, 1988, among System Energy, Meridian Trust Company and Stephen M. Carta, and SMEPA (B-7(c)(1) to Rule 24 Certificate, dated January 9, 1989, in 70-7561).\n(b) 36-- Assignment, Assumption and Further Agreement No. 2, dated as of December 1, 1988, among System Energy, Meridian Trust Company and Stephen M. Carta, and SMEPA (B-7(c)(2) to Rule 24 Certificate, dated January 9, 1989, in 70-7561).\n(b) 37-- Collateral Trust Indenture, dated as of January 1, 1994, among System Energy, GG1B Funding Corporation and Bankers Trust Company, as Trustee (A-3(e) to Rule 24 Certificate dated January 31, 1994, in 70-8215), as supplemented by Supplemental Indenture No. 1 dated January 1, 1994, (A-3(f) to Rule 24 Certificate dated January 31, 1994, in 70-8215).\n(b) 38-- Substitute Power Agreement, dated as of May 1, 1980, among MP&L, System Energy and SMEPA (B(3)(a) in 70-6337).\n(b) 39-- Grand Gulf Unit No. 2 Supplementary Agreement, dated as of February 7, 1986, between System Energy and SMEPA (10(aaa) in 33-4033).\n(b) 40-- Unit Power Sales Agreement, dated as of June 10, 1982, between System Energy and AP&L, LP&L, MP&L and NOPSI (10(a)-39 to Form 10-K for the year ended December 31, 1982, in 1-3517).\n(b) 41-- First Amendment to the Unit Power Sales Agreement, dated as of June 28, 1984, between System Energy and AP&L, LP&L, MP&L and NOPSI (19 to Form 10-Q for the quarter ended September 30, 1984, in 1-3517).\n(b) 42-- Revised Unit Power Sales Agreement (10(ss) in 33-4033).\n(b) 43-- Fuel Lease, dated as of February 24, 1989, between River Fuel Funding Company #3, Inc. and System Energy (B-1(b) to Rule 24 Certificate, dated March 3, 1989, in 70-7604).\n(b) 44-- System Energy's Consent, dated January 31, 1995, pursuant to Fuel Lease, dated as of February 24, 1989, between River Fuel Funding Company #3, Inc. and System Energy (B-1(c) to Rule 24 Certificate, dated February 13, 1995 in 70-7604).\n(b) 45-- Sales Agreement, dated as of June 21, 1974, between System Energy and MP&L (D to Rule 24 Certificate, dated June 26, 1974, in 70-5399).\n(b) 46-- Service Agreement, dated as of June 21, 1974, between System Energy and MP&L (E to Rule 24 Certificate, dated June 26, 1974, in 70-5399).\n(b) 47-- Partial Termination Agreement, dated as of December 1, 1986, between System Energy and MP&L (A-2 to Rule 24 Certificate, dated January 8, 1987, in 70-5399).\n(b) 48-- Middle South Utilities, Inc. and Subsidiary Companies Intercompany Income Tax Allocation Agreement, dated April 28, 1988 (D-1 to Form U5S for the year ended December 31, 1987).\n(b) 49-- First Amendment, dated January 1, 1990 to the Middle South Utilities Inc. and Subsidiary Companies Intercompany Income Tax Allocation Agreement (D-2 to Form U5S for the year ended December 31, 1989).\n(b) 50-- Second Amendment dated January 1, 1992, to the Entergy Corporation and Subsidiary Companies Intercompany Income Tax Allocation Agreement (D-3 to Form U5S for the year ended December 31, 1992).\n(b) 51-- Third Amendment dated January 1, 1994 to Entergy Corporation and Subsidiary Companies Intercompany Income Tax Allocation Agreement (D-3(a) to Form U5S for the year ended December 31, 1993).\n(b) 52-- Service Agreement with Entergy Services, dated as of July 16, 1974, as amended (10(b)-43 to Form 10-K for the year ended December 31, 1988, in 1-9067).\n(b) 53-- Amendment, dated January 1, 1991, to Service Agreement with Entergy Services (10(b)-45 to Form 10-K for the year ended December 31, 1990, in 1-9067).\n(b) 54-- Amendment, dated January 1, 1992, to Service Agreement with Entergy Services (10(a) -11 to Form 10-K for the year ended December 31, 1994 in 1-3517).\n(b) 55-- Operating Agreement between Entergy Operations and System Energy, dated as of June 6, 1990 (B-3(b) to Rule 24 Certificate, dated June 15, 1990, in 70-7679).\n(b) 56-- Guarantee Agreement between Entergy Corporation and System Energy, dated as of September 20, 1990 (B-3(a) to Rule 24 Certificate, dated September 27, 1990, in 70-7757).\n+(b) 57-- Agreement between System Energy and Donald C. Hintz (10(b)47 to Form 10-K for the year ended December 31, 1991, in 1-9067).\n+(b) 58-- Agreement between Entergy Corporation and Edwin Lupberger (10(a)-42 to Form 10-K for the year ended December 31, 1985 in 1-3517).\n+(b) 59-- Agreement between Entergy Services and Gerald D. McInvale (10(a)-69 to Form 10-K for the year ended December 31, 1992 in 1-3517).\nAP&L\n(c) 1 -- Agreement, dated April 23, 1982, among AP&L and certain other System companies, relating to System Planning and Development and Intra-System Transactions (10(a) 1 to Form 10-K for the year ended December 31, 1982, in 1-3517).\n(c) 2 -- Middle South Utilities System Agency Agreement, dated December 11, 1970 (5(a)2 in 2-41080).\n(c) 3 -- Amendment, dated February 10, 1971, to Middle South Utilities System Agency Agreement, dated December 11, 1970 (5(a)-4 in 2-41080).\n(c) 4 -- Amendment, dated May 12, 1988, to Middle South Utilities System Agency Agreement, dated December 11, 1970 (5(a) 4 in 2-41080).\n(c) 5 -- Middle South Utilities System Agency Coordination Agreement, dated December 11, 1970 (5(a)-3 in 2-41080).\n(c) 6 -- Service Agreement with Entergy Services, dated as of April 1, 1963 (5(a)-5 in 2-41080).\n(c) 7 -- Amendment, dated January 1, 1972, to Service Agreement with Entergy Services (5(a)- 6 in 2-43175).\n(c) 8 -- Amendment, dated April 27, 1984, to Service Agreement, with Entergy Services (10(a)- 7 to Form 10-K for the year ended December 31, 1984, in 1-3517).\n(c) 9 -- Amendment, dated August 1, 1988, to Service Agreement with Entergy Services (10(c)- 8 to Form 10-K for the year ended December 31, 1988, in 1-10764).\n(c) 10-- Amendment, dated January 1, 1991, to Service Agreement with Entergy Services (10(c)-9 to Form 10-K for the year ended December 31, 1990, in 1-10764).\n(c) 11-- Amendment, dated January 1, 1992, to Service Agreement with Entergy Services (10(a)-11 to Form 10-K for the year ended December 31, 1994 in 1-3517).\n(c) 12 through (c) 23-- See 10(a)-12 through 10(a)-23 above.\n(c) 24-- Agreement, dated August 20, 1954, between AP&L and the United States of America (SPA)(13(h) in 2-11467).\n(c) 25-- Amendment, dated April 19, 1955, to the United States of America (SPA) Contract, dated August 20, 1954 (5(d)-2 in 2-41080).\n(c) 26-- Amendment, dated January 3, 1964, to the United States of America (SPA) Contract, dated August 20, 1954 (5(d)-3 in 2-41080).\n(c) 27-- Amendment, dated September 5, 1968, to the United States of America (SPA) Contract, dated August 20, 1954 (5(d)-4 in 2-41080).\n(c) 28-- Amendment, dated November 19, 1970, to the United States of America (SPA) Contract, dated August 20, 1954 (5(d)-5 in 2-41080).\n(c) 29-- Amendment, dated July 18, 1961, to the United States of America (SPA) Contract, dated August 20, 1954 (5(d)-6 in 2-41080).\n(c) 30-- Amendment, dated December 27, 1961, to the United States of America (SPA) Contract, dated August 20, 1954 (5(d)-7 in 2-41080).\n(c) 31-- Amendment, dated January 25, 1968, to the United States of America (SPA) Contract, dated August 20, 1954 (5(d)-8 in 2-41080).\n(c) 32-- Amendment, dated October 14, 1971, to the United States of America (SPA) Contract, dated August 20, 1954 (5(d)-9 in 2-43175).\n(c) 33-- Amendment, dated January 10, 1977, to the United States of America (SPA) Contract, dated August 20, 1954 (5(d)-10 in 2-60233).\n(c) 34-- Agreement, dated May 14, 1971, between AP&L and the United States of America (SPA) (5(e) in 2-41080).\n(c) 35-- Amendment, dated January 10, 1977, to the United States of America (SPA) Contract, dated May 14, 1971 (5(e)-1 in 2-60233).\n(c) 36-- Contract, dated May 28, 1943, Amendment to Contract, dated July 21, 1949, and Supplement to Amendment to Contract, dated December 30, 1949, between AP&L and McKamie Gas Cleaning Company; Agreements, dated as of September 30, 1965, between AP&L and former stockholders of McKamie Gas Cleaning Company; and Letter Agreement, dated June 22, 1966, by Humble Oil & Refining Company accepted by AP&L on June 24, 1966 (5(k)-7 in 2-41080).\n(c) 37-- Agreement, dated April 3, 1972, between Entergy Services and Gulf United Nuclear Fuels Corporation (5(l)-3 in 2-46152).\n(c) 38-- Fuel Lease, dated as of December 22, 1988, between River Fuel Trust #1 and AP&L (B-1(b) to Rule 24 Certificate in 70-7571).\n(c) 39-- White Bluff Operating Agreement, dated June 27, 1977, among AP&L and Arkansas Electric Cooperative Corporation and City Water and Light Plant of the City of Jonesboro, Arkansas (B-2(a) to Rule 24 Certificate, dated June 30, 1977, in 70-6009).\n(c) 40-- White Bluff Ownership Agreement, dated June 27, 1977, among AP&L and Arkansas Electric Cooperative Corporation and City Water and Light Plant of the City of Jonesboro, Arkansas (B-1(a) to Rule 24 Certificate, dated June 30, 1977, in 70-6009).\n(c) 41-- Agreement, dated June 29, 1979, between AP&L and City of Conway, Arkansas (5(r)-3 in 2-66235).\n(c) 42-- Transmission Agreement, dated August 2, 1977, between AP&L and City Water and Light Plant of the City of Jonesboro, Arkansas (5(r)-3 in 2-60233).\n(c) 43-- Power Coordination, Interchange and Transmission Service Agreement, dated as of June 27, 1977, between Arkansas Electric Cooperative Corporation and AP&L (5(r)-4 in 2-60233).\n(c) 44-- Independence Steam Electric Station Operating Agreement, dated July 31, 1979, among AP&L and Arkansas Electric Cooperative Corporation and City Water and Light Plant of the City of Jonesboro, Arkansas and City of Conway, Arkansas (5(r)-6 in 2-66235).\n(c) 45-- Amendment, dated December 4, 1984, to the Independence Steam Electric Station Operating Agreement (10(c) 51 to Form 10-K for the year ended December 31, 1984, in 1-10764).\n(c) 46-- Independence Steam Electric Station Ownership Agreement, dated July 31, 1979, among AP&L and Arkansas Electric Cooperative Corporation and City Water and Light Plant of the City of Jonesboro, Arkansas and City of Conway, Arkansas (5(r)-7 in 2-66235).\n(c) 47-- Amendment, dated December 28, 1979, to the Independence Steam Electric Station Ownership Agreement (5(r)-7(a) in 2-66235).\n(c) 48-- Amendment, dated December 4, 1984, to the Independence Steam Electric Station Ownership Agreement (10(c) 54 to Form 10-K for the year ended December 31, 1984, in 1-10764).\n(c) 49-- Owner's Agreement, dated November 28, 1984, among AP&L, MP&L, other co-owners of the Independence Station (10(c) 55 to Form 10-K for the year ended December 31, 1984, in 1-10764).\n(c) 50-- Consent, Agreement and Assumption, dated December 4, 1984, among AP&L, MP&L, other co-owners of the Independence Station and United States Trust Company of New York, as Trustee (10(c) 56 to Form 10-K for the year ended December 31, 1984, in 1-10764).\n(c) 51-- Power Coordination, Interchange and Transmission Service Agreement, dated as of July 31, 1979, between AP&L and City Water and Light Plant of the City of Jonesboro, Arkansas (5(r)-8 in 2-66235).\n(c) 52-- Power Coordination, Interchange and Transmission Agreement, dated as of June 29, 1979, between City of Conway, Arkansas and AP&L (5(r)-9 in 2-66235).\n(c) 53-- Agreement, dated June 21, 1979, between AP&L and Reeves E. Ritchie ((10)(b)-90 to Form 10-K for the year ended December 31, 1980, in 1-10764).\n(c) 54-- Reallocation Agreement, dated as of July 28, 1981, among System Energy and certain other System companies (B-1(a) in 70-6624).\n+(c) 55-- Post-Retirement Plan (10(b) 55 to Form 10-K for the year ended December 31, 1983, in 1-10764).\n(c) 56-- Unit Power Sales Agreement, dated as of June 10, 1982, between System Energy and AP&L, LP&L, MP&L, and NOPSI (10(a) 39 to Form 10-K for the year ended December 31, 1982, in 1-3517).\n(c) 57-- First Amendment to Unit Power Sales Agreement, dated as of June 28, 1984, between System Energy, AP&L, LP&L, MP&L, and NOPSI (19 to Form 10-Q for the quarter ended September 30, 1984, in 1-3517).\n(c) 58-- Revised Unit Power Sales Agreement (10(ss) in 33-4033).\n(c) 59-- Contract For Disposal of Spent Nuclear Fuel and\/or High-Level Radioactive Waste, dated June 30, 1983, among the DOE, System Fuels and AP&L (10(b)-57 to Form 10-K for the year ended December 31, 1983, in 1-10764).\n(c) 60-- Middle South Utilities, Inc. and Subsidiary Companies Intercompany Income Tax Allocation Agreement, dated April 28, 1988 (D-1 to Form U5S for the year ended December 31, 1987).\n(c) 61-- First Amendment, dated January 1, 1990, to the Middle South Utilities, Inc. and Subsidiary Companies Intercompany Income Tax Allocation Agreement (D-2 to Form U5S for the year ended December 31, 1989).\n(c) 62-- Second Amendment dated January 1, 1992, to the Entergy Corporation and Subsidiary Companies Intercompany Income Tax Allocation Agreement (D-3 to Form U5S for the year ended December 31, 1992).\n(c) 63-- Third Amendment dated January 1, 1994, to Entergy Corporation and Subsidiary Companies Intercompany Income Tax Allocation Agreement (D-3(a) to Form U5S for the year ended December 31, 1993).\n(c) 64-- Assignment of Coal Supply Agreement, dated December 1, 1987, between System Fuels and AP&L (B to Rule 24 letter filing, dated November 10, 1987, in 70-5964).\n(c) 65-- Coal Supply Agreement, dated December 22, 1976, between System Fuels and Antelope Coal Company (B-1 in 70-5964), as amended by First Amendment (A to Rule 24 Certificate in 70-5964); Second Amendment (A to Rule 24 letter filing, dated December 16, 1983, in 70-5964); and Third Amendment (A to Rule 24 letter filing, dated November 10, 1987 in 70-5964).\n(c) 66-- Operating Agreement between Entergy Operations and AP&L, dated as of June 6, 1990 (B-1(b) to Rule 24 Certificate, dated June 15, 1990, in 70-7679).\n(c) 67-- Guaranty Agreement between Entergy Corporation and AP&L, dated as of September 20, 1990 (B-1(a) to Rule 24 Certificate, dated September 27, 1990, in 70-7757).\n(c) 68-- Agreement for Purchase and Sale of Independence Unit 2 between AP&L and Entergy Power, dated as of August 28, 1990 (B-3(c) to Rule 24 Certificate, dated September 6, 1990, in 70-7684).\n(c) 69-- Agreement for Purchase and Sale of Ritchie Unit 2 between AP&L and Entergy Power, dated as of August 28, 1990 (B-4(d) to Rule 24 Certificate, dated September 6, 1990, in 70-7684).\n(c) 70-- Ritchie Steam Electric Station Unit No. 2 Operating Agreement between AP&L and Entergy Power, dated as of August 28, 1990 (B-5(a) to Rule 24 Certificate, dated September 6, 1990, in 70-7684).\n(c) 71-- Ritchie Steam Electric Station Unit No. 2 Ownership Agreement between AP&L and Entergy Power, dated as of August 28, 1990 (B-6(a) to Rule 24 Certificate, dated September 6, 1990, in 70-7684).\n(c) 72-- Power Coordination, Interchange and Transmission Service Agreement between Entergy Power and AP&L, dated as of August 28, 1990 (10(c)-71 to Form 10-K for the year ended December 31, 1990, in 1-10764).\n+(c) 73-- Executive Financial Counseling Program of Entergy Corporation and Subsidiaries (10(a)52 to Form 10-K for the year ended December 31, 1989, in 1-3517).\n+(c) 74-- Entergy Corporation Annual Incentive Plan (10(a)54 to Form 10-K for the year ended December 31, 1989, in 1-3517).\n+(c) 75-- Equity Ownership Plan of Entergy Corporation and Subsidiaries (A-4(a) to Rule 24 Certificate, dated May 24, 1991, in 70-7831).\n+(c) 76-- Agreement between Arkansas Power & Light Company and R. Drake Keith. (10(c) 78 to Form 10-K for the year ended December 31, 1992 in 1-10764).\n+(c) 77-- Supplemental Retirement Plan (10(a)69 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(c) 78-- Defined Contribution Restoration Plan of Entergy Corporation and Subsidiaries (10(a)53 to Form 10-K for the year ended December 31, 1989 in 1-3517).\n+(c) 79-- Amendment No. 1 to the Equity Ownership Plan of Entergy Corporation and Subsidiaries (10(a)71 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(c) 80-- Executive Disability Plan of Entergy Corporation and Subsidiaries (10(a)72 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(c) 81-- Executive Medical Plan of Entergy Corporation and Subsidiaries (10(a)73 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(c) 82-- Stock Plan for Outside Directors of Entergy Corporation and Subsidiaries, as amended (10(a)74 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(c) 83-- Summary Description of Private Ownership Vehicle Plan of Entergy Corporation and Subsidiaries (10(a)75 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(c) 84-- Agreement between Entergy Corporation and Edwin Lupberger (10(a)-42 to Form 10-K for the year ended December 31, 1985 in 1-3517).\n+(c) 85-- Agreement between Entergy Corporation and Jerry D. Jackson (10(a)-68 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(c) 86-- Agreement between Entergy Services and Gerald D. McInvale (10(a)-69 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(c) 87-- Agreement between System Energy and Donald C. Hintz (10(b)-47 to Form 10-K for the year ended December 31, 1991 in 1-9067).\n+(c) 88-- Summary Description of Retired Outside Director Benefit Plan. (10(c) 90 to Form 10-K for the year ended December 31, 1992 in 1-10764).\n+(c) 89-- Amendment to Defined Contribution Restoration Plan of Entergy Corporation and Subsidiaries (10(a) 81 to Form 10-K for the year ended December 31, 1993 in 1-11299).\n+(c) 90-- System Executive Retirement Plan (10(a) 82 to Form 10-K for the year ended December 31, 1993 in 1-11299).\n(c) 91-- Loan Agreement dated June 15, 1993, between AP&L and Independence Country, Arkansas (B-1 (a) to Rule 24 Certificate dated July 9, 1993 in 70-8171).\n(c) 92-- Installment Sale Agreement dated January 1, 1991, between AP&L and Pope Country, Arkansas (B-1 (b) to Rule 24 Certificate dated January 24, 1991 in 70-7802).\n(c) 93-- Installment Sale Agreement dated November 1, 1990, between AP&L and Pope Country, Arkansas (B-1 (a) to Rule 24 Certificate dated November 30, 1990 in70-7802).\n(c) 94-- Loan Agreement dated June 15, 1994, between AP&L and Jefferson County, Arkansas (B-1(a) to Rule 24 Certificate dated June 30, 1994 in 70-8405).\n(c) 95-- Loan Agreement dated June 15, 1994, between AP&L and Pope County, Arkansas (B-1(b) to Rule 24 Certificate in 70-8405).\n*(c) 96-- Loan Agreement dated November 15, 1995, between AP&L and Pope County, Arkansas.\nGSU\n(d) 1 -- Guaranty Agreement, dated July 1, 1976, between GSU and American Bank and Trust Company (C and D to Form 8-K, dated August 6, 1976 in 1-2703).\n(d) 2 -- Lease of Railroad Equipment, dated as of December 1, 1981, between The Connecticut Bank and Trust Company as Lessor and GSU as Lessee and First Supplement, dated as of December 31, 1981, relating to 605 One Hundred-Ton Unit Train Steel Coal Porter Cars (4-12 to Form 10-K for the year ended December 31, 1981 in 1-2703).\n(d) 3 -- Guaranty Agreement, dated August 1, 1992, between GSU and Hibernia National Bank, relating to Pollution Control Revenue Refunding Bonds of the Industrial Development Board of the Parish of Calcasieu, Inc. (Louisiana) (10-1 to Form 10-K for the year ended December 31, 1992 in 1-2703).\n(d) 4 -- Guaranty Agreement, dated January 1, 1993, between GSU and Hancock Bank of Louisiana, relating to Pollution Control Revenue Refunding Bonds of the Parish of Pointe Coupee (Louisiana) (10-2 to Form 10-K for the year ended December 31, 1992 in 1-2703).\n(d) 5 -- Deposit Agreement, dated as of December 1, 1983 between GSU, Morgan Guaranty Trust Co. as Depositary and the Holders of Despositary Receipts, relating to the Issue of 900,000 Depositary Preferred Shares, each representing 1\/2 share of Adjustable Rate Cumulative Preferred Stock, Series E-$100 Par Value (4-17 to Form 10- K for the year ended December 31, 1983 in 1-2703).\n(d) 6 -- Letter of Credit and Reimbursement Agreement, dated December 27, 1985, between GSU and Westpack Banking Corporation relating to Variable Rate Demand Pollution Control Revenue Bonds of the Parish of West Feliciana, State of Louisiana, Series 1985-D (4-26 to Form 10-K for the year ended December 31, 1985 in 1-2703) and Letter Agreement amending same dated October 20, 1992 (10-3 to Form 10-K for the year ended December 31, 1992 in 1- 2703).\n(d) 7 -- Reimbursement and Loan Agreement, dated as of April 23, 1986, by and between GSU and The Long-Term Credit Bank of Japan, Ltd., relating to Multiple Rate Demand Pollution Control Revenue Bonds of the Parish of West Feliciana, State of Louisiana, Series 1985 (4-26 to Form 10-K, for the year ended December 31, 1986 in 1- 2703) and Letter Agreement amending same, dated February 19, 1993 (10 to Form 10-K for the year ended December 31, 1992 in 1-2703).\n(d) 8 -- Agreement effective February 1, 1964, between Sabine River Authority, State of Louisiana, and Sabine River Authority of Texas, and GSU, Central Louisiana Electric Company, Inc., and Louisiana Power & Light Company, as supplemented (B to Form 8-K, dated May 6, 1964, A to Form 8-K, dated October 5, 1967, A to Form 8- K, dated May 5, 1969, and A to Form 8-K, dated December 1, 1969, in 1-2708).\n(d) 9 -- Joint Ownership Participation and Operating Agreement regarding River Bend Unit 1 Nuclear Plant, dated August 20, 1979, between GSU, Cajun, and SRG&T; Power Interconnection Agreement with Cajun, dated June 26, 1978, and approved by the REA on August 16, 1979, between GSU and Cajun; and Letter Agreement regarding CEPCO buybacks, dated August 28, 1979, between GSU and Cajun (2, 3, and 4, respectively, to Form 8-K, dated September 7, 1979, in 1-2703).\n(d) 10-- Ground Lease, dated August 15, 1980, between Statmont Associates Limited Partnership (Statmont) and GSU, as amended (3 to Form 8-K, dated August 19, 1980, and A-3-b to Form 10-Q for the quarter ended September 30, 1983 in 1-2703).\n(d) 11-- Lease and Sublease Agreement, dated August 15, 1980, between Statmont and GSU, as amended (4 to Form 8- K, dated August 19, 1980, and A-3-c to Form 10-Q for the quarter ended September 30, 1983 in 1-2703).\n(d) 12-- Lease Agreement, dated September 18, 1980, between BLC Corporation and GSU (1 to Form 8-K, dated October 6, 1980 in 1-2703).\n(d) 13-- Joint Ownership Participation and Operating Agreement for Big Cajun, between GSU, Cajun Electric Power Cooperative, Inc., and Sam Rayburn G&T, Inc, dated November 14, 1980 (6 to Form 8-K, dated January 29, 1981 in 1-2703); Amendment No. 1, dated December 12, 1980 (7 to Form 8-K, dated January 29, 1981 in 1-2703); Amendment No. 2, dated December 29, 1980 (8 to Form 8-K, dated January 29, 1981 in 1-2703).\n(d) 14-- Agreement of Joint Ownership Participation between SRMPA, SRG&T and GSU, dated June 6, 1980, for Nelson Station, Coal Unit #6, as amended (8 to Form 8-K, dated June 11, 1980, A-2-b to Form 10-Q For the quarter ended June 30, 1982; and 10-1 to Form 8-K, dated February 19, 1988 in 1-2703).\n(d) 15-- Agreements between Southern Company and GSU, dated February 25, 1982, which cover the construction of a 140- mile transmission line to connect the two systems, purchase of power and use of transmission facilities (10- 31 to Form 10-K, for the year ended December 31, 1981 in 1-2703).\n+(d) 16-- Executive Income Security Plan, effective October 1, 1980, as amended, continued and completely restated effective as of March 1, 1991 (10-2 to Form 10-K for the year ended December 31, 1991 in 1-2703).\n(d) 17-- Transmission Facilities Agreement between GSU and Mississippi Power Company, dated February 28, 1982, and Amendment, dated May 12, 1982 (A-2-c to Form 10-Q for the quarter ended March 31, 1982 in 1-2703) and Amendment, dated December 6, 1983 (10-43 to Form 10-K, for the year ended December 31, 1983 in 1-2703).\n(d) 18-- Lease Agreement dated as of June 29, 1983, between GSU and City National Bank of Baton Rouge, as Owner Trustee, in connection with the leasing of a Simulator and Training Center for River Bend Unit 1 (A-2-a to Form 10-Q for the quarter ended June 30, 1983 in 1-2703) and Amendment, dated December 14, 1984 (10-55 to Form 10-K, for the year ended December 31, 1984 in 1-2703).\n(d) 19-- Participation Agreement, dated as of June 29, 1983, among GSU, City National Bank of Baton Rouge, PruFunding, Inc. Bank of the Southwest National Association, Houston and Bankers Life Company, in connection with the leasing of a Simulator and Training Center of River Bend Unit 1 (A-2-b to Form 10-Q for the quarter ended June 30, 1983 in 1-2703).\n(d) 20-- Tax Indemnity Agreement, dated as of June 29, 1983, between GSU and Prufunding, Inc., in connection with the leasing of a Simulator and Training Center for River Bend Unit I (A-2-c to Form 10-Q for the quarter ended June 30, 1993 in 1-2703).\n(d) 21-- Agreement to Lease, dated as of August 28, 1985, among GSU, City National Bank of Baton Rouge, as Owner Trustee, and Prudential Interfunding Corp., as Trustor, in connection with the leasing of improvement to a Simulator and Training Facility for River Bend Unit I (10- 69 to Form 10-K, for the year ended December 31, 1985 in 1-2703).\n(d) 22-- First Amended Power Sales Agreement, dated December 1, 1985 between Sabine River Authority, State of Louisiana, and Sabine River Authority, State of Texas, and GSU, Central Louisiana Electric Co., Inc., and Louisiana Power and Light Company (10-72 to Form 10-K for the year ended December 31, 1985 in 1-2703).\n+(d) 23-- Deferred Compensation Plan for Directors of GSU and Varibus Corporation, as amended January 8, 1987, and effective January 1, 1987 (10-77 to Form 10-K for the year ended December 31, 1986 in 1-2703). Amendment dated December 4, 1991 (10-3 to Amendment No. 8 in Registration No. 2-76551).\n+(d) 24-- Trust Agreement for Deferred Payments to be made by GSU pursuant to the Executive Income Security Plan, by and between GSU and Bankers Trust Company, effective November 1, 1986 (10-78 to Form 10-K for the year ended December 31, 1986 in 1-2703).\n+(d) 25-- Trust Agreement for Deferred Installments under GSU's Management Incentive Compensation Plan and Administrative Guidelines by and between GSU and Bankers Trust Company, effective June 1, 1986 (10-79 to Form 10-K for the year ended December 31, 1986 in 1-2703).\n+(d) 26-- Nonqualified Deferred Compensation Plan for Officers, Nonemployee Directors and Designated Key Employees, effective December 1, 1985, as amended, continued and completely restated effective as of March 1, 1991 (10-3 to Amendment No. 8 in Registration No. 2- 76551).\n+(d) 27-- Trust Agreement for GSU's Nonqualified Directors and Designated Key Employees by and between GSU and First City Bank, Texas-Beaumont, N.A. (now Texas Commerce Bank), effective July 1, 1991 (10-4 to Form 10-K for the year ended December 31, 1992 in 1-2703).\n(d) 28-- Lease Agreement, dated as of June 29, 1987, among GSG&T, Inc., and GSU related to the leaseback of the Lewis Creek generating station (10-83 to Form 10-K for the year ended December 31, 1988 in 1-2703).\n(d) 29-- Nuclear Fuel Lease Agreement between GSU and River Bend Fuel Services, Inc. to lease the fuel for River Bend Unit 1, dated February 7, 1989 (10-64 to Form 10-K for the year ended December 31, 1988 in 1-2703).\n(d) 30-- Trust and Investment Management Agreement between GSU and Morgan Guaranty and Trust Company of New York (the \"Decommissioning Trust Agreement) with respect to decommissioning funds authorized to be collected by GSU, dated March 15, 1989 (10-66 to Form 10-K for the year ended December 31, 1988 in 1-2703).\n*(d) 31-- Amendment No. 2 dated November 1, 1995 between GSU and Mellon Bank to Decommissioning Trust Agreement.\n(d) 32-- Credit Agreement, dated as of December 29, 1993, among River Bend Fuel Services, Inc. and Certain Commercial Lending Institutions and CIBC Inc. as Agent for the Lenders ((d) 34 to Form 10-K for year ended December 31, 1994).\n*(d) 33-- Amendment No. 1 dated as of January 31, 1996 to Credit Agreement, dated as of December 31, 1993, among River Bend Fuel Services, Inc. and certain commercial lending institutions and CIBC Inc. as agent for Lenders.\n(d) 34-- Partnership Agreement by and among Conoco Inc., and GSU, CITGO Petroleum Corporation and Vista Chemical Company, dated April 28, 1988 (10-67 to Form 10-K for the year ended December 31, 1988 in 1-2703).\n+(d) 35-- Gulf States Utilities Company Executive Continuity Plan, dated January 18, 1991 (10-6 to Form 10-K for the year ended December 31, 1990 in 1-2703).\n+(d) 36-- Trust Agreement for GSU's Executive Continuity Plan, by and between GSU and First City Bank, Texas- Beaumont, N.A. (now Texas Commerce Bank), effective May 20, 1991 (10-5 to Form 10-K for the year ended December 31, 1992 in 1-2703).\n+(d) 37-- Gulf States Utilities Board of Directors' Retirement Plan, dated February 15, 1991 (10-8 to Form 10- K for the year ended December 31, 1990 in 1-2703).\n+(d) 38-- Gulf States Utilities Company Employees' Trustee Retirement Plan effective July 1, 1955 as amended, continued and completely restated effective January 1, 1989; and Amendment No.1 effective January 1, 1993 (10-6 to Form 10-K for the year ended December 31, 1992 in 1- 2703).\n(d) 39-- Agreement and Plan of Reorganization, dated June 5, 1992, between GSU and Entergy Corporation (2 to Form 8- K, dated June 8, 1992 in 1-2703).\n+(d) 40-- Gulf States Utilities Company Employee Stock Ownership Plan, as amended, continued, and completely restated effective January 1, 1984, and January 1, 1985 (A to Form 11-K, dated December 31, 1985 in 1-2703).\n+(d) 41-- Trust Agreement under the Gulf States Utilities Company Employee Stock Ownership Plan, dated December 30, 1976, between GSU and the Louisiana National Bank, as Trustee (2-A to Registration No. 2-62395).\n+(d) 42-- Letter Agreement dated September 7, 1977 between GSU and the Trustee, delegating certain of the Trustee's functions to the ESOP Committee (2-B to Registration Statement No. 2-62395).\n+(d) 43-- Gulf States Utilities Company Employees Thrift Plan as amended, continued and completely restated effective as of January 1, 1992 (28-1 to Amendment No. 8 to Registration No. 2-76551).\n+(d) 44-- Restatement of Trust Agreement under the Gulf States Utilities Company Employees Thrift Plan, reflecting changes made through January 1, 1989, between GSU and First City Bank, Texas-Beaumont, N.A., (now Texas Commerce Bank ), as Trustee (2-A to Form 8-K dated October 20, 1989 in 1-2703).\n(d) 45-- Operating Agreement between Entergy Operations and GSU, dated as of December 31, 1993 (B-2(f) to Rule 24 Certificate in 70-8059).\n(d) 46-- Guarantee Agreement between Entergy Corporation and GSU, dated as of December 31, 1993 (B-5(a) to Rule 24 Certificate in 70-8059).\n(d) 47-- Service Agreement with Entergy Services, dated as of December 31, 1993 (B-6(c) to Rule 24 Certificate in 70-8059).\n+(d) 48-- Amendment to Employment Agreement between J. L. Donnelly and GSU, dated December 22, 1993 (10(d) 57 to Form 10-K for the year ended December 31, 1993 in 1- 2703).\n(d) 49-- Assignment, Assumption and Amendment Agreement to Letter of Credit and Reimbursement Agreement between GSU, Canadian Imperial Bank of Commerce and Westpac Banking Corporation (10(d) 58 to Form 10-K for the year ended December 31, 1993 in 1-2703).\n(d) 50-- Third Amendment, dated January 1, 1994, to Entergy Corporation and Subsidiary Companies Intercompany Income Tax Allocation Agreement (D-3(a) to Form U5S for the year ended December 31, 1993).\n(d) 51-- Refunding Agreement between GSU and West Feliciana Parish (dated December 20, 1994 (B-12(a) to Rule 24 Certificate dated December 30, 1994 in 70-8375).\nLP&L\n(e) 1 -- Agreement, dated April 23, 1982, among LP&L and certain other System companies, relating to System Planning and Development and Intra-System Transactions (10(a) 1 to Form 10-K for the year ended December 31, 1982, in 1-3517).\n(e) 2 -- Middle South Utilities System Agency Agreement, dated December 11, 1970 (5(a)-2 in 2-41080).\n(e) 3 -- Amendment, dated as of February 10, 1971, to Middle South Utilities System Agency Agreement, dated December 11, 1970 (5(a)-4 in 2-41080).\n(e) 4 -- Amendment, dated May 12, 1988, to Middle South Utilities System Agency Agreement, dated December 11, 1970 (5(a) 4 in 2-41080).\n(e) 5 -- Middle South Utilities System Agency Coordination Agreement, dated December 11, 1970 (5(a)-3 in 2-41080).\n(e) 6 -- Service Agreement with Entergy Services, dated as of April 1, 1963 (5(a)-5 in 2-42523).\n(e) 7 -- Amendment, dated as of January 1, 1972, to Service Agreement with Entergy Services (4(a)-6 in 2-45916).\n(e) 8 -- Amendment, dated as of April 27, 1984, to Service Agreement with Entergy Services (10(a) 7 to Form 10-K for the year ended December 31, 1984, in 1-3517).\n(e) 9 -- Amendment, dated as of August 1, 1988, to Service Agreement with Entergy Services (10(d)-8 to Form 10-K for the year ended December 31, 1988, in 1-8474).\n(e) 10-- Amendment, dated January 1, 1991, to Service Agreement with Entergy Services (10(d)-9 to Form 10-K for the year ended December 31, 1990, in 1-8474).\n(e) 11-- Amendment, dated January 1, 1992, to Service Agreement with Entergy Services (10(a)-11 to Form 10-K for the year ended December 31, 1994 in 1-3517).\n(e) 12 through (e) 23-- See 10(a)-12 through 10(a)-23 above.\n(e) 24-- Fuel Lease, dated as of January 31, 1989, between River Fuel Company #2, Inc., and LP&L (B-1(b) to Rule 24 Certificate in 70-7580).\n(e) 25-- Reallocation Agreement, dated as of July 28, 1981, among System Energy and certain other System companies (B-1(a) in 70-6624).\n(e) 26-- Compromise and Settlement Agreement, dated June 4, 1982, between Texaco, Inc. and LP&L (28(a) to Form 8-K, dated June 4, 1982, in 1-8474).\n+(e) 27-- Post-Retirement Plan (10(c)23 to Form 10-K for the year ended December 31, 1983, in 1-8474).\n(e) 28-- Unit Power Sales Agreement, dated as of June 10, 1982, between System Energy and AP&L, LP&L, MP&L and NOPSI (10(a) 39 to Form 10-K for the year ended December 31, 1982, in 1-3517).\n(e) 29-- First Amendment to the Unit Power Sales Agreement, dated as of June 28, 1984, between System Energy and AP&L, LP&L, MP&L and NOPSI (19 to Form 10-Q for the quarter ended September 30, 1984, in 1-3517).\n(e) 30-- Revised Unit Power Sales Agreement (10(ss) in 33-4033).\n(e) 31-- Middle South Utilities, Inc. and Subsidiary Companies Intercompany Tax Allocation Agreement, dated April 28, 1988 (D-1 to Form U5S for the year ended December 31, 1987).\n(e) 32-- First Amendment, dated January 1, 1990, to the Middle South Utilities, Inc. and Subsidiary Companies Intercompany Income Tax Allocation Agreement, dated January 1, 1990 (D-2 to Form U5S for the year ended December 31, 1989).\n(e) 33-- Second Amendment dated January 1, 1992, to the Entergy Corporation and Subsidiary Companies Intercompany Income Tax Allocation Agreement (D-3 to Form U5S for the year ended December 31, 1992).\n(e) 34-- Third Amendment dated January 1, 1994 to Entergy Corporation and Subsidiary Companies Intercompany Income Tax Allocation Agreement (D-3(a) to Form U5S for the year ended December 31, 1993).\n(e) 35-- Contract for Disposal of Spent Nuclear Fuel and\/or High-Level Radioactive Waste, dated February 2, 1984, among DOE, System Fuels and LP&L (10(d)33 to Form 10-K for the year ended December 31, 1984, in 1-8474).\n(e) 36-- Operating Agreement between Entergy Operations and LP&L, dated as of June 6, 1990 (B-2(c) to Rule 24 Certificate, dated June 15, 1990, in 70-7679).\n(e) 37-- Guarantee Agreement between Entergy Corporation and LP&L, dated as of September 20, 1990 (B-2(a), to Rule 24 Certificate, dated September 27, 1990, in 70-7757).\n+(e) 38-- Executive Financial Counseling Program of Entergy Corporation and Subsidiaries (10(a) 52 to Form 10-K for the year ended December 31, 1989, in 1-3517).\n+(e) 39-- Entergy Corporation Annual Incentive Plan (10(a) 54 to Form 10-K for the year ended December 31, 1989, in 1-3517).\n+(e) 40-- Equity Ownership Plan of Entergy Corporation and Subsidiaries (A-4(a) to Rule 24 Certificate, dated May 24, 1991, in 70-7831).\n+(e) 41-- Supplemental Retirement Plan (10(a) 69 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(e) 42-- Defined Contribution Restoration Plan of Entergy Corporation and Subsidiaries (10(a) 53 to Form 10-K for the year ended December 31, 1989 in 1-3517).\n+(e) 43-- Amendment No. 1 to the Equity Ownership Plan of Entergy Corporation and Subsidiaries (10(a) 71 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(e) 44-- Executive Disability Plan of Entergy Corporation and Subsidiaries (10(a) 72 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(e) 45-- Executive Medical Plan of Entergy Corporation and Subsidiaries (10(a) 73 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(e) 46-- Stock Plan for Outside Directors of Entergy Corporation and Subsidiaries (10(a) 74 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(e) 47-- Summary Description of Private Ownership Vehicle Plan of Entergy Corporation and Subsidiaries (10(a) 75 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(e) 48-- Agreement between Entergy Corporation and Edwin Lupberger (10(a) 42 to Form 10-K for the year ended December 31, 1985 in 1-3517).\n+(e) 49-- Agreement between Entergy Corporation and Jerry D. Jackson (10(a) 68 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(e) 50-- Agreement between Entergy Services and Gerald D. McInvale (10(a) 69 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(e) 51-- Agreement between System Energy and Donald C. Hintz (10(b) 47 to Form 10-K for the year ended December 31, 1991 in 1-9067).\n+(e) 52-- Summary Description of Retired Outside Director Benefit Plan (10(c)90 to Form 10-K for the year ended December 31, 1992 in 1-10764).\n+(e) 53-- Amendment to Defined Contribution Restoration Plan of Entergy Corporation and Subsidiaries (10(a) 81 to Form 10-K for the year ended December 31, 1993 in 1-11299).\n+(e) 54-- System Executive Retirement Plan (10(a) 82 to Form 10-K for the year ended December 31, 1993 in 1-11299).\n(e) 55-- Installment Sale Agreement, dated July 20, 1994, between LP&L and St. Charles Parish, Louisiana (B-6(e) to Rule 24 Certificate dated August 1, 1994 in 70-7822).\n(e) 56-- Installment Sale Agreement, dated November 1, 1995, between LP&L and St. Charles Parish, Louisiana (B- 6(a) to Rule 24 Certificate dated December 19, 1995 in 70- 8487).\nMP&L\n(f) 1 -- Agreement dated April 23, 1982, among MP&L and certain other System companies, relating to System Planning and Development and Intra-System Transactions (10(a) 1 to Form 10-K for the year ended December 31, 1982, in 1-3517).\n(f) 2 -- Middle South Utilities System Agency Agreement, dated December 11, 1970 (5(a)-2 in 2-41080).\n(f) 3 -- Amendment, dated February 10, 1971, to Middle South Utilities System Agency Agreement, dated December 11, 1970 (5(a) 4 in 2-41080).\n(f) 4 -- Amendment, dated May 12, 1988, to Middle South Utilities System Agency Agreement, dated December 11, 1970 (5(a) 4 in 2-41080).\n(f) 5 -- Middle South Utilities System Agency Coordination Agreement, dated December 11, 1970 (5(a)-3 in 2-41080).\n(f) 6 -- Service Agreement with Entergy Services, dated as of April 1, 1963 (D in 37-63).\n(f) 7 -- Amendment, dated January 1, 1972, to Service Agreement with Entergy Services (A to Notice, dated October 14, 1971, in 37-63).\n(f) 8 -- Amendment, dated April 27, 1984, to Service Agreement with Entergy Services (10(a) 7 to Form 10-K for the year ended December 31, 1984, in 1-3517).\n(f) 9 -- Amendment, dated as of August 1, 1988, to Service Agreement with Entergy Services (10(e) 8 to Form 10-K for the year ended December 31, 1988, in 0-320).\n(f) 10-- Amendment, dated January 1, 1991, to Service Agreement with Entergy Services (10(e) 9 to Form 10-K for the year ended December 31, 1990, in 0-320).\n(f) 11-- Amendment, dated January 1, 1992, to Service Agreement with Entergy Services (10(a)-11 to Form 10-K for the year ended December 31, 1994 in 1-3517).\n(f) 12 though (f) 23-- See 10(a)-12 - 10(a)-23 above.\n(f) 24-- Installment Sale Agreement, dated as of June 1, 1974, between MP&L and Washington County, Mississippi (B- 2(a) to Rule 24 Certificate, dated August 1, 1974, in 70- 5504).\n(f) 25-- Installment Sale Agreement, dated as of July 1, 1982, between MP&L and Independence County, Arkansas, (B- 1(c) to Rule 24 Certificate dated July 21, 1982, in 70- 6672).\n(f) 26-- Installment Sale Agreement, dated as of December 1, 1982, between MP&L and Independence County, Arkansas, (B-1(d) to Rule 24 Certificate dated December 7, 1982, in 70-6672).\n(f) 27-- Amended and Restated Installment Sale Agreement, dated as of April 1, 1994, between MP&L and Warren County, Mississippi, (B-6(a) to Rule 24 Certificate dated May 4, 1994, in 70-7914).\n(f) 28-- Amended and Restated Installment Sale Agreement, dated as of April 1, 1994, between MP&L and Washington County, Mississippi, (B-6(b) to Rule 24 Certificate dated May 4, 1994, in 70-7914).\n(f) 29-- Substitute Power Agreement, dated as of May 1, 1980, among MP&L, System Energy and SMEPA (B-3(a) in 70-6337).\n(f) 30-- Amendment, dated December 4, 1984, to the Independence Steam Electric Station Operating Agreement (10(c) 51 to Form 10-K for the year ended December 31, 1984, in 0-375).\n(f) 31-- Amendment, dated December 4, 1984, to the Independence Steam Electric Station Ownership Agreement (10(c) 54 to Form 10-K for the year ended December 31, 1984, in 0-375).\n(f) 32-- Owners Agreement, dated November 28, 1984, among AP&L, MP&L and other co- owners of the Independence Station (10(c) 55 to Form 10-K for the year ended December 31, 1984, in 0-375).\n(f) 33-- Consent, Agreement and Assumption, dated December 4, 1984, among AP&L, MP&L, other co-owners of the Independence Station and United States Trust Company of New York, as Trustee (10(c) 56 to Form 10-K for the year ended December 31, 1984, in 0-375).\n(f) 34-- Reallocation Agreement, dated as of July 28, 1981, among System Energy and certain other System companies (B-1(a) in 70-6624).\n+(f) 35-- Post-Retirement Plan (10(d) 24 to Form 10-K for the year ended December 31, 1983, in 0-320).\n(f) 36-- Unit Power Sales Agreement, dated as of June 10, 1982, between System Energy and AP&L, LP&L, MP&L, and NOPSI (10(a) 39 to Form 10-K for the year ended December 31, 1982, in 1-3517).\n(f) 37-- First Amendment to the Unit Power Sales Agreement, dated as of June 28, 1984, between System Energy and AP&L, LP&L, MP&L, and NOPSI (19 to Form 10-Q for the quarter ended September 30, 1984, in 1-3517).\n(f) 38-- Revised Unit Power Sales Agreement (10(ss) in 33-4033).\n(f) 39-- Sales Agreement, dated as of June 21, 1974, between System Energy and MP&L (D to Rule 24 Certificate, dated June 26, 1974, in 70-5399).\n(f) 40-- Service Agreement, dated as of June 21, 1974, between System Energy and MP&L (E to Rule 24 Certificate, dated June 26, 1974, in 70-5399).\n(f) 41-- Partial Termination Agreement, dated as of December 1, 1986, between System Energy and MP&L (A-2 to Rule 24 Certificate dated January 8, 1987, in 70-5399).\n(f) 42-- Middle South Utilities, Inc. and Subsidiary Companies Intercompany Income Tax Allocation Agreement, dated April 28, 1988 (D-1 to Form U5S for the year ended December 31, 1987).\n(f) 43-- First Amendment dated January 1, 1990 to the Middle South Utilities Inc. and Subsidiary Companies Intercompany Tax Allocation Agreement (D-2 to Form U5S for the year ended December 31, 1989).\n(f) 44-- Second Amendment dated January 1, 1992, to the Entergy Corporation and Subsidiary Companies Intercompany Income Tax Allocation Agreement (D-3 to Form U5S for the year ended December 31, 1992).\n(f) 45-- Third Amendment dated January 1, 1994 to Entergy Corporation and Subsidiary Companies Intercompany Income Tax Allocation Agreement (D-3(a) to Form U5S for the year ended December 31, 1993).\n+(f) 46-- Executive Financial Counseling Program of Entergy Corporation and Subsidiaries (10(a) 52 to Form 10-K for the year ended December 31, 1989, in 1-3517).\n+(f) 47-- Entergy Corporation Annual Incentive Plan (10(a) 54 to Form 10-K for the year ended December 31, 1989, in 1-3517).\n+(f) 48-- Equity Ownership Plan of Entergy Corporation and Subsidiaries (A-4(a) to Rule 24 Certificate, dated May 24, 1991, in 70-7831).\n+(f) 49-- Supplemental Retirement Plan (10(a)69 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(f) 50-- Defined Contribution Restoration Plan of Entergy Corporation and Subsidiaries (10(a)53 to Form 10-K for the year ended December 31, 1989 in 1-3517).\n+(f) 51-- Amendment No. 1 to the Equity Ownership Plan of Entergy Corporation and Subsidiaries (10(a)71 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(f) 52-- Executive Disability Plan of Entergy Corporation and Subsidiaries (10(a)72 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(f) 53-- Executive Medical Plan of Entergy Corporation and Subsidiaries (10(a)73 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(f) 54-- Stock Plan for Outside Directors of Entergy Corporation and Subsidiaries, as amended (10(a)74 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(f) 55-- Summary Description of Private Ownership Vehicle Plan of Entergy Corporation and Subsidiaries (10(a)75 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(f) 56-- Agreement between Entergy Corporation and Edwin Lupberger (10(a)-42 to Form 10-K for the year ended December 31, 1985 in 1-3517).\n+(f) 57-- Agreement between Entergy Corporation and Jerry D. Jackson (10(a)-68 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(f) 58-- Agreement between Entergy Services and Gerald D. McInvale (10(a)-69 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(f) 59-- Agreement between System Energy and Donald C. Hintz (10(b)-47 to Form 10-K for the year ended December 31, 1991 in 1-9067).\n+(f) 60-- Summary Description of Retired Outside Director Benefit Plan (10(c)-90 to Form 10-K for the year ended December 31, 1992 in 1-10764).\n+(f) 61-- Amendment to Defined Contribution Restoration Plan of Entergy Corporation and Subsidiaries (10(a) 81 to Form 10-K for the year ended December 31, 1993 in 1-11299).\n+(f) 62-- System Executive Retirement Plan (10(a) 82 to Form 10-K for the year ended December 31, 1993 in 1-11299).\nNOPSI\n(g) 1 -- Agreement, dated April 23, 1982, among NOPSI and certain other System companies, relating to System Planning and Development and Intra-System Transactions (10(a)-1 to Form 10-K for the year ended December 31, 1982, in 1-3517).\n(g) 2 -- Middle South Utilities System Agency Agreement, dated December 11, 1970 (5(a)-2 in 2-41080).\n(g) 3 -- Amendment dated as of February 10, 1971, to Middle South Utilities System Agency Agreement, dated December 11, 1970 (5(a)-4 in 2-41080).\n(g) 4 -- Amendment, dated May 12, 1988, to Middle South Utilities System Agency Agreement, dated December 11, 1970 (5(a) 4 in 2-41080).\n(g) 5 -- Middle South Utilities System Agency Coordination Agreement, dated December 11, 1970 (5(a)-3 in 2-41080).\n(g) 6 -- Service Agreement with Entergy Services dated as of April 1, 1963 (5(a)-5 in 2-42523).\n(g) 7 -- Amendment, dated as of January 1, 1972, to Service Agreement with Entergy Services (4(a)-6 in 2-45916).\n(g) 8 -- Amendment, dated as of April 27, 1984, to Service Agreement with Entergy Services (10(a)7 to Form 10-K for the year ended December 31, 1984, in 1-3517).\n(g) 9 -- Amendment, dated as of August 1, 1988, to Service Agreement with Entergy Services (10(f)-8 to Form 10-K for the year ended December 31, 1988, in 0-5807).\n(g) 10-- Amendment, dated January 1, 1991, to Service Agreement with Entergy Services (10(f)-9 to Form 10-K for the year ended December 31, 1990, in 0-5807).\n(g) 11-- Amendment, dated January 1, 1992, to Service Agreement with Entergy Services (10(a)-11 to Form 10-K for year ended December 31, 1994 in 1-3517).\n(g) 12 (g) 23-- See 10(a)-12 - 10(a)-23 above.\n(g) 24-- Reallocation Agreement, dated as of July 28, 1981, among System Energy and certain other System companies (B-1(a) in 70-6624).\n+(g) 25-- Post-Retirement Plan (10(e) 22 to Form 10-K for the year ended December 31, 1983, in 1-1319).\n(g) 26-- Unit Power Sales Agreement, dated as of June 10, 1982, between System Energy and AP&L, LP&L, MP&L and NOPSI (10(a) 39 to Form 10-K for the year ended December 31, 1982, in 1-3517).\n(g) 27-- First Amendment to the Unit Power Sales Agreement, dated as of June 28, 1984, between System Energy and AP&L, LP&L, MP&L and NOPSI (19 to Form 10-Q for the quarter ended September 30, 1984, in 1-3517).\n(g) 28-- Revised Unit Power Sales Agreement (10(ss) in 33-4033).\n(g) 29-- Transfer Agreement, dated as of June 28, 1983, among the City of New Orleans, NOPSI and Regional Transit Authority (2(a) to Form 8-K, dated June 24, 1983, in 1-1319).\n(g) 30-- Middle South Utilities, Inc. and Subsidiary Companies Intercompany Income Tax Allocation Agreement, dated April 28, 1988 (D-1 to Form U5S for the year ended December 31, 1987).\n(g) 31-- First Amendment, dated January 1, 1990, to the Middle South Utilities, Inc. and Subsidiary Companies Intercompany Income Tax Allocation Agreement (D-2 to Form U5S for the year ended December 31, 1989).\n(g) 32-- Second Amendment dated January 1, 1992, to the Entergy Corporation and Subsidiary Companies Intercompany Income Tax Allocation Agreement (D-3 to Form U5S for the year ended December 31, 1992).\n(g) 33-- Third Amendment dated January 1, 1994 to Entergy Corporation and Subsidiary Companies Intercompany Income Tax Allocation Agreement (D-3(a) to Form U5S for the year ended December 31, 1993).\n+(g) 34-- Executive Financial Counseling Program of Entergy Corporation and Subsidiaries (10(a)52 to Form 10-K for the year ended December 31, 1989, in 1-3517).\n+(g) 35-- Entergy Corporation Annual Incentive Plan (10(a)54 to Form 10-K for the year ended December 31, 1989, in 1-3517).\n+(g) 36-- Equity Ownership Plan of Entergy Corporation and Subsidiaries (A-4(a) to Rule 24 Certificate, dated May 24, 1991, in 70-7831).\n+(g) 37-- Supplemental Retirement Plan (10(a)69 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(g) 38-- Defined Contribution Restoration Plan of Entergy Corporation and Subsidiaries (10(a)53 to Form 10-K for the year ended December 31, 1989 in 1-3517).\n+(g) 39-- Amendment No. 1 to the Equity Ownership Plan of Entergy Corporation and Subsidiaries (10(a)71 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(g) 40-- Executive Disability Plan of Entergy Corporation and Subsidiaries (10(a)72 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(g) 41-- Executive Medical Plan of Entergy Corporation and Subsidiaries (10(a)73 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(g) 42-- Stock Plan for Outside Directors of Entergy Corporation and Subsidiaries, as amended (10(a)74 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(g) 43-- Summary Description of Private Ownership Vehicle Plan of Entergy Corporation and Subsidiaries (10(a)75 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(g) 44-- Agreement between Entergy Corporation and Edwin Lupberger (10(a)-42 to Form 10-K for the year ended December 31, 1985 in 1-3517).\n+(g) 45-- Agreement between Entergy Corporation and Jerry D. Jackson (10(a)-68 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(g) 46-- Agreement between Entergy Services and Gerald D. McInvale (10(a)-69 to Form 10-K for the year ended December 31, 1992 in 1-3517).\n+(g) 47-- Agreement between System Energy and Donald C. Hintz (10(b)-47 to Form 10-K for the year ended December 31, 1991 in 1-9067).\n+(g) 48-- Summary Description of Retired Outside Director Benefit Plan (10(c)-90 to Form 10-K for the year ended December 31, 1992 in 1-10764).\n+(g) 49-- Amendment to Defined Contribution Restoration Plan of Entergy Corporation and Subsidiaries (10(a) 81 to Form 10-K for the year ended December 31, 1993 in 1-11299).\n+(g) 50-- System Executive Retirement Plan (10(a) 82 to Form 10-K for the year ended December 31, 1993 in 1-11299).\n(12) Statement Re Computation of Ratios\n*(a) AP&L's Computation of Ratios of Earnings to Fixed Charges and of Earnings to Fixed Charges and Preferred Dividends, as defined.\n*(b) GSU's Computation of Ratios of Earnings to Fixed Charges and of Earnings to Fixed Charges and Preferred Dividends, as defined.\n*(c) LP&L's Computation of Ratios of Earnings to Fixed Charges and of Earnings to Fixed Charges and Preferred Dividends, as defined.\n*(d) MP&L's Computation of Ratios of Earnings to Fixed Charges and of Earnings to Fixed Charges and Preferred Dividends, as defined.\n*(e) NOPSI's Computation of Ratios of Earnings to Fixed Charges and of Earnings to Fixed Charges and Preferred Dividends, as defined.\n*(f) System Energy's Computation of Ratios of Earnings to Fixed Charges, as defined.\n(18) Letter Re Change in Accounting Principles\n*(a) Letter from Coopers & Lybrand L.L.P. regarding change in accounting principles for AP&L.\n*(b) Letter from Coopers & Lybrand L.L.P. regarding change in accounting principles for Entergy.\n*(21) Subsidiaries of the Registrants\n(23) Consents of Experts and Counsel\n*(a) The consent of Coopers & Lybrand L.L.P. is contained herein at page 214.\n*(b) The consent of Deloitte & Touche LLP is contained herein at page 215.\n*(c) The consent of Clark, Thomas & Winters is contained herein at page 216.\n*(d) The consent of Sandlin Associates is contained herein at page 217.\n*(24) Powers of Attorney\n(27) Financial Data Schedule\n*(a) Financial Data Schedule for Entergy Corporation and Subsidiaries as of December 31, 1995.\n*(b) Financial Data Schedule for AP&L as of December 31, 1995.\n*(c) Financial Data Schedule for GSU as of December 31, 1995.\n*(d) Financial Data Schedule for LP&L as of December 31, 1995.\n*(e) Financial Data Schedule for MP&L as of December 31, 1995.\n*(f) Financial Data Schedule for NOPSI as of December 31, 1995.\n*(g) Financial Data Schedule for System Energy as of December 31, 1995.\n(99) Additional Exhibits\nGSU\n(a) 1 Opinion of Clark, Thomas & Winters, a professional corporation, dated September 30, 1992 regarding the effect of the October 1, 1991 judgment in GSU v. PUCT in the District Court of Travis County, Texas (99-1 in Registration No. 33-48889).\n(a) 2 Opinion of Clark, Thomas & Winters, a professional corporation, dated August 8, 1994 regarding recovery of costs deferred purusant to PUCT order in Docket 6525 (99 (j) to Quarterly Report on Form 10-Q for the quarter ended June 30, 1994 in No. 1-2703).\n*(a) 3 Opinion of Clark, Thomas & Winters, a professional corporation, confirming its opinions dated September 30, 1992 and August 8, 1994.\n_________________\n* Filed herewith. + Management contracts or compensatory plans or arrangements.","section_15":""}
{"filename":"793280_1995.txt","cik":"793280","year":"1995","section_1":"ITEM 1. DESCRIPTION OF BUSINESS\nGENERAL\nRyan, Beck & Co., Inc. (the \"Company\" or \"Ryan, Beck\") was organized in 1946 and is principally engaged in the underwriting, distribution and trading of tax-exempt, bank equity and debt securities. The Company provides consulting, research and financial services to the banking and thrift industries, with a focus on corporate finance and merger related services. The Company offers a general securities brokerage business with investment products for retail and institutional clients, as well as life insurance and annuity products. The Company's brokerage customers consist primarily of high net worth individuals (primarily residents of New Jersey, other Mid-Atlantic and Northeastern states and Florida), banking institutions (primarily located in New Jersey and Florida) and, to a lesser extent, insurance companies and bond funds.\nThe Company was organized in New Jersey in 1965 under the name of John J. Ryan & Co., Incorporated, as a successor to various entities dating from 1946. The Company changed its name to Ryan, Beck & Co., Inc. in 1981. Unless the context otherwise requires, all references herein to the \"Company\" include Ryan, Beck & Co., Inc. and its predecessors and subsidiaries.\nThe principal executive office of the Company is located at 80 Main Street, West Orange, New Jersey 07052-5414 and its telephone number is 201-325-3000. The Company is registered as a broker-dealer with the Securities and Exchange Commission (\"SEC\") and is a member of the National Association of Securities Dealers, Inc. (\"NASD\") and the Securities Investor Protection Corporation (\"SIPC\"). The Company is not a member of any securities exchange.\nThe Company, like other securities firms, is directly affected by national and international economic and political conditions, broad trends in industry and finance, changes in and uncertainty regarding tax laws and substantial fluctuations in the volume and price levels of securities transactions (such as occurred in October 1987 and the fourth quarter of 1989). A substantial portion of the Company's business is particularly sensitive to developments, including political developments, affecting municipal finance and financial institutions.\nReduced volume and prices generally result in lower investment banking revenues and commissions and may result in losses from declines in the market value of securities held in trading, investment and underwriting positions. In periods of low business activity for the Company, profitability may be adversely affected because a significant portion of the Company's expenses are fixed.\nOn the other hand, as in the past, heavy trading volume has caused clearance and processing problems for many securities firms, and this could occur in the future. In addition, there is a risk of loss from errors which can occur in the execution and settlement process. See \"Accounting, Administration and Operations.\"\nTAX-EXEMPT BOND DIVISION\nThe Company maintains primary and secondary markets in tax-exempt securities issued primarily by the State of New Jersey and its political subdivisions. To a lesser extent, the Company also maintains primary and secondary markets for tax-exempt securities issued by municipalities located outside of New Jersey. Principal transactions in tax-exempt securities accounted for 19.8% of the Company's revenues during 1995, 17.3% of the Company's revenues during 1994 and 18.8% during 1993.\nThe Company provides investment banking advice to, and raises capital for, many types of issuers of tax-exempt securities, including counties, cities, transportation authorities, sewer and water authorities and housing, health and higher education agencies. Most of these issuers are located in New Jersey. The Company arranges public offerings of municipal securities and distributes these securities to individual and institutional investors. In addition, the Company is often included in national and regional syndications which underwrite tax-exempt issues. Increasingly, underwritings of tax-exempt issues are being conducted on a competitive, rather than negotiated, basis. The impact of this on future revenue is unclear.\nNew issues of municipal bonds have declined as a result of the adoption of the Tax Reform Act of 1986 (the \"TRA\"). The TRA limits the types of municipal bonds eligible for tax-exempt status to \"essential purpose\" bonds. It also includes certain municipal bond interest as an item of tax preference in calculating the \"alternative minimum tax\" and denies interest deductions to financial institutions on the debt they incur to carry certain tax-exempt bonds.\nThe following tables set forth, for the periods indicated, (i) the total number and dollar amount of municipal bond offerings managed or co- managed by the Company and (ii) the total number and dollar amount of the Company's underwriting participations in those offerings and in offerings managed by others.\nRevenues from all municipal bond transactions were $4,940,000, $5,046,000 and $5,249,000 for 1995, 1994 and 1993, respectively. The decrease from 1994 to 1995 primarily reflects reduced product availability and lower yields and the decrease from 1993 to 1994 reflected greater demand during 1993 for exchanging securities in a lower interest rate environment as compared to a weak market for most of 1994.\nTAXABLE BOND DIVISION\nThe Company maintains secondary markets in corporate bonds, mortgage backed securities and unit investment trusts. Ryan, Beck also executes trades in Treasury Bonds, Treasury Notes, Treasury Bills and makes markets in U.S. Government Guaranteed Securities. Revenues relating to such transactions increased in 1995 to $2,302,000 from $1,729,000 in 1994. Revenues in 1993 were $2,818,000. Principal transactions in taxable securities accounted for 9.2% of the Company's revenues during 1995, 5.9% of revenues during 1994 and 10.2% of revenues during 1993.\nFINANCIAL INSTITUTIONS DIVISION\nThe Company provides market-making, underwriting, financial advisory, consulting and research for bank and thrift institutions throughout the country.\nThe Company has participated as an underwriter in public offerings of bank and thrift equity and debt issues as a sole underwriter without a syndicate, as a manager or co-manager of underwriting syndicates, as a member of underwriting syndicates managed by others and as a selling group member in issues of others. Revenues from underwriting bank and thrift securities for 1995 were $1,988,000, revenues for 1994 were $809,000 and revenues for 1993 were $1,898,000.\nThe following tables set forth, for the periods indicated, (i) the total number and dollar amount of bank\/thrift related equity and debt offerings managed or co-managed by the Company and (ii) the total number and dollar amount of the Company's underwriting participations in those offerings and in offerings managed by others. The table below also includes offerings, including thrift conversion and mutual holding Company formations whereby the Company acted as selling agent.\nThe decreased level of activity in the Financial Institutions Division reflected a reduced number of mutual to stock thrift conversions, including mutual holding companies which closed in 1995 as compared to 1994, the smaller size of the transactions which closed in 1995 and decreased fee income from merger and acquisition advisory work. The Company has played a significant role in the introduction of the thrift mutual holding company to the marketplace and raised $75,282,000 in 1995, $422,215,000 in 1994 and $316,047,000 in 1993 in equity for thrifts in mutual holding company-related transactions.\nUnderwriting involves both economic and regulatory risks. An underwriter may incur losses if it is unable to resell the securities it is committed to purchase, or if it is forced to liquidate its commitments at less than the agreed purchase price. In addition, an underwriter is subject to substantial potential liability for material misstatements or omissions in prospectuses and other communications with respect to underwritten offerings. In the last several years, investment banking firms, including the Company, have increasingly participated in underwritten offerings with fewer syndicate participants or without a syndicate. In such cases, the underwriter assumes a larger part, or all, of the risk of an underwriting transaction. Furthermore, because underwriting commitments constitute a charge against net capital, the Company, as a broker-dealer, could find it necessary to limit its underwriting activities to remain in compliance with net capital requirements. See \"Regulation.\"\nDevelopments in the banking and thrift industries, including regulatory policies with respect to thrift conversions and the trend toward consolidation of banking institutions, have caused banks and thrift institutions to seek advice from investment banking firms such as the Company. The Company provides financial advisory services in connection with capital formation and planning, branch sales, mergers and acquisitions (including appraisals and fairness opinions), shareholder\/investor issues and financial management issues. Consulting, valuations and placement fees decreased to $4,494,000 in 1995 from $11,902,000 in 1994 and accounted for 18.0% of the Company's revenues during 1995 and 40.9% during 1994. Consulting, valuation and placement fees amounted to $4,354,000 in 1993 or 15.6% of the Company's revenues.\nRyan, Beck & Co. serves the capital needs of community-oriented financial institutions by managing \"best-efforts\" public offerings, including thrift conversions, mutual holding company formations (a partial conversion of a thrift) and secondary offerings by banks and thrifts. The objective is to provide on-site administrative support and subscription enhancement for public offerings conducted by banks and thrifts. This has been, and is anticipated to be, a significant source of revenue for the Company. Revenue, however, is subject to political and regulatory developments related to the thrift industry, especially as they impact thrift conversions and mutual holding formations. These activities generated gross revenues of $3,369,000 in 1995 as compared to $8,586,000 in 1994 and $2,874,000 in 1993. Such revenue is reflected in investment banking revenue as consulting, placement and valuation fees.\nThe Company's Research Department is dedicated principally to bank and thrift securities. Its publications include Bank Stock Annuals for New Jersey, Florida, New York, Maryland, Delaware and Pennsylvania, periodic updates on the outlook for financial equities, reports on specific financial institutions, and reports and analyses on general banking developments.\nSALES AND TRADING\nSales and trading activities are conducted both as principal and as agent on behalf of individual and institutional investor clients. Transactions as principal involve making markets in securities which are held in inventory to facilitate sales to and purchases from customers in an attempt to realize trading gains. When over-the-counter (\"OTC\") transactions are executed by the Company as a dealer, the Company receives, in lieu of commissions, mark-ups or mark-downs which are included in revenues as principal transactions. As agent, the Company effects brokerage transactions which generate commission revenues. These commissions are charged on both exchange and OTC transactions in accordance with a schedule which the Company has formulated and may change from time to time. Discounts from the schedule may be granted in certain cases. Total principal transactions accounted for 52.9% of the Company's revenues during 1995, 40.4% during 1994 and 50.7% during 1993, while total commissions accounted for 11.2% of revenues during 1995, 8.1% of revenues during 1994 and 12.4% of revenues during 1993.\nThe Company is an active market maker and distributor of equity securities issued by financial institutions throughout the country and tax-exempt bonds, particularly bonds issued by entities located in the Mid-Atlantic region. As of December 31, 1995, the Company made markets in 204 bank and thrift stocks quoted on the NASDAQ system. The Company also maintains quotations in 362 additional bank and thrift stocks and distributes and makes markets in certain issues of bank debt securities.\nIn making markets in equity and debt securities, the Company maintains positions in such securities to service its customers and, accordingly, has at risk its own capital in the event of a decline in the market price of such securities or of a decrease in the liquidity of markets (especially in the area of risk arbitrage, as described below), which can limit the Company's ability to sell securities purchased or to purchase securities sold in such transactions. Trading and investing in corporate and municipal securities as principal and underwriting the issuance of such securities represent an important part of the Company's business and subjects the Company's capital to significant risk. While the Company seeks to avoid market risk, it may, nonetheless, realize profits and losses from market fluctuations. Trading profits (or losses) depend upon the skills of the employees engaged in market making, the amount of capital allocated to positions in securities and the general level of activity and trend of prices in the securities markets.\nThe Company also offers other financial instruments to its clients which include U.S. Government and Agency obligations, zero coupon bonds, collateralized mortgage obligations, utility and industrial bonds, mutual funds and unit investment trusts.\nAlthough the Company presently maintains no discretionary accounts for customers, it may do so in the future. The Company introduced margin accounts during early 1991. Margin transactions are subject to credit risks. To the extent that funds are advanced in a securities transaction, payment may not be received. If the securities decline in value, the Company may not recover the amounts advanced. As of December 31, 1995, the Company had approximately $22.2 million in customer margin debits with its clearing broker.\nDuring 1995, the Company continued to maintain its salesforce by recruiting and training both new and experienced sales personnel to replace those who left during the period. The Company had 72 sales account executives as of December 31, 1995. As part of its trading activities, the Company may engage in risk arbitrage, which involves investing for the Company's own account in securities of companies engaged in publicly announced corporate transactions. Such transactions include, mergers, acquisitions, changes in capital structure and dividend payments. Risk arbitrage requires the commitment of capital and involves substantial risk.\nThe following table shows, (i) for the year ended December 31, 1995, the highest, lowest and average month-end inventories by type of securities in which the Company trades as principal and (ii) the inventories for these types of securities as of December 31, 1995.\nOTHER SERVICES\nThe Company offers IRA and other retirement plans to its customers. In 1987, the Company began functioning as custodian and trustee for newly opened IRA's and effective January 1, 1991 transferred these accounts to its independent clearing broker as successor custodian and trustee. Clients retain control over their own funds and may direct the purchase and sale of a variety of investment instruments.\nThe Company has an arrangement with an independent investment manager pursuant to which it offers various money market funds to its customers. On a periodic basis, the Company's clearing broker sweeps participating customers' free credit balances into a designated fund and also withdraws funds to satisfy debit balances.\nACCOUNTING, ADMINISTRATION AND OPERATIONS\nAccounting, administration and operations personnel are responsible for internal financial control, accounting functions, office services, personnel services, and compliance with regulatory and legal requirements. The Company clears all securities transactions through another broker\/dealer on a fully-disclosed basis.\nThere is a considerable fluctuation in the volume of transactions which a securities firm must process. In the past, when the volume of trading in securities reached record levels, the securities industry has experienced operating problems. The Company has not experienced any material operating difficulties during periods of heavy volume.\nThe Company believes that its internal controls and safeguards against securities theft are adequate. The Company carries fidelity bonds covering any loss or theft of securities, employee dishonesty, forgery and alteration of checks and similar items, and securities forgery. The amounts of coverage provided by the bonds are believed to be adequate.\nThe Company generally posts its books and records daily. Periodic reviews of certain controls are conducted to assure compliance with applicable laws, rules and regulations.\nCOMPETITION\nThe Company is engaged in an extremely competitive business. Competitors include, with respect to one or more aspects of its business, all of the member organizations of the New York Stock Exchange and other registered securities exchanges, all members of the NASD, commercial banks, thrift institutions and financial consultants. As related to the Company's investment banking and consulting merger- related services, the Company also competes with many of the larger Wall Street investment banking firms. Many of these organizations have substantially more employees and greater financial resources than the Company. The Company also competes for investment funds with banks, insurance companies and investment companies. Discount brokerage firms oriented to the retail market, including firms affiliated with commercial banks and thrift institutions, are devoting substantial funds to advertising and direct solicitation of customers in order to increase their share of commission dollars and other securities-related income. The Company typically has not engaged in extensive advertising programs for this type of business. The Company believes that the principal competitive factors relating to the Company's business are the quality of advice and service provided to investors and financial institutions and the competitive pricing of their products.\nThe securities industry has become considerably more concentrated and more competitive since the late 1960's as numerous securities firms have either ceased operation or have been acquired by or merged into other firms. In addition, companies not engaging primarily in the securities business, but having substantial financial resources, have acquired leading securities firms. These developments have increased competition from firms with greater capital resources than those of the Company. Furthermore, many commercial banks offer various securities related activities and investment vehicles. While it is presently not possible to predict the type and extent of competitive services which other financial institutions may offer or the extent to which administrative or legal barriers are repealed or modified, ultimately these developments may lead to the creation of integrated financial services firms that may be able to compete more effectively than the Company for investment funds by offering a greater range of financial services.\nFixed minimum commissions for securities transactions were eliminated in 1975. The elimination of fixed minimum commission rates has resulted in substantial commission discounting by broker-dealers competing for institutional and individual brokerage business. The Company believes its commission structure compares favorably with firms with which it competes. Nevertheless, the anticipated continuation of such discounting and an increase in the number of new and existing firms offering discounts could adversely affect the Company.\nThe SEC's Rule 415 permits the registration of certain securities that are to be offered on a delayed or continuous basis in the future. This procedure provides a competitive advantage to securities firms with substantial capital and large in-house distribution networks and may reduce opportunities for brokerage firms such as the Company to participate in major underwritings.\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. Much of the regulation of broker-dealers has been delegated to self- regulatory authorities, principally the NASD and, in the case of broker- dealers that are members of a securities exchange, the securities exchanges. These self-regulatory organizations conduct periodic examinations of member broker-dealers in accordance with rules they have adopted and amended from time to time, subject to approval by the SEC.\nSecurities firms are also subject to regulation by state securities commissions in those states in which they do business. As of December 31, 1995, the Company was registered as a broker-dealer in 49 states and the District of Columbia.\nBroker-dealers are subject to regulations which cover all aspects of the securities business, including sales methods, trade practices among broker-dealers, uses and safekeeping of customers funds and securities, capital structure of securities firms, record keeping and the conduct of directors, officers and employees. Additional legislation, changes in rules promulgated by the SEC and self-regulatory authorities, or changes in the interpretation or enforcement of existing laws and rules, may directly affect the mode of operation and profitability of broker- dealers. The SEC, self-regulatory authorities and state securities commissions may conduct administrative proceedings which can result in censure, fine, suspension or expulsion of a broker-dealer, its officers or employees. Such administrative proceedings, whether or not resulting in adverse findings, can require substantial expenditures. The principal purpose of regulation and discipline of broker\/dealers is the protection of customers and the securities market, rather than protection of creditors and shareholders of broker-dealers.\nAs a broker-dealer, the Company is required by federal law to belong to the Securities Investors Protection Corp. (\"SIPC\"). When the SIPC fund falls below a certain minimum amount, as it did in 1983, members are required to pay annual assessments in amounts (based upon adjusted gross revenues) necessary to restore the fund. Accounts are insured up to $25,000,000, and Pro Cash Plus accounts are insured up to $50,000,000. The first $500,000 of protection is provided by SIPC and the balance is provided by a separate policy from a private insurer. There is a limitation of $100,000 on claims for cash balances.\nAs a registered broker-dealer, the Company is also subject to the SEC's Net Capital Rule (the \"Rule\"). The Rule specifies minimum net capital requirements for registered brokers and dealers and is designed to maintain the general financial integrity and liquidity of a broker- dealer.\nThe Rule provides that a broker-dealer doing business with the public shall not permit its aggregate indebtedness to exceed 15 times its net capital or, alternatively, that it not permit its net capital to be less than 2% of its aggregate debit balances (primarily receivables from customers and broker-dealers) computed in accordance with Rule 15c3-3. As of December 31, 1995, the Company had aggregate net capital of $5,663,000, which exceeded minimum net capital requirements by $4,663,000.\nCompliance with the Net Capital Rule could limit the Company's operations, such as underwriting and trading activities which require the use of significant amounts of capital. A significant operating loss or an extraordinary charge against net capital could adversely affect the ability of the Company to expand or even maintain its present levels of business.\nEMPLOYEES\nAt December 31, 1995, the Company had 172 full-time employees. None of the Company's employees are covered by a collective bargaining agreement. The Company considers its relations with its employees to be satisfactory. However, competition for experienced financial services personnel, especially account executives, is intense in the securities industry. Accordingly, from time to time the Company may experience the loss of valuable personnel which could adversely impact revenues.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. DESCRIPTION OF PROPERTIES\nThe Company's offices, including its trading operations, occupy an aggregate of approximately 22,000 square feet in West Orange, New Jersey. Such space is leased pursuant to a seven-year lease term which commenced January 19, 1992. The Company has a five-year renewal option at the conclusion of the original term. In addition, the Company occupies approximately 3,600 square feet of office space in Bala Cynwyd, Pennsylvania under a five-year lease which commenced April 12, 1994. The Company has a five-year renewal option at the conclusion of the original term. The Company also occupies approximately 8,500 square feet of office space in West Palm Beach, Florida under a four-year lease which commenced May 1, 1995. While such space is suitable and sufficient for the Company's present needs, the Company anticipates that, based on its present operations and its anticipated future growth, additional space will be required in the foreseeable future. The Company believes that its current fire and casualty insurance policies provide sufficient coverage to allow it to replace any of its properties that might be damaged or destroyed.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nSet forth below is information concerning certain litigation matters to which the Company is a party and in which there have been developments of a material nature during the year ended December 31, 1995.\nOn December 13, 1991, an action was filed in the United States District Court for the District of New Jersey under the caption Schiffli Embroidery Workers Pension Fund v. Ryan, Beck & Co., Inc., et al (Civ. Act. No. 91-5433) (\"Schiffli\") alleging that the Company and one of its former account executives had engaged in violations of federal securities laws, the Employee Retirement Income Security Act (\"ERISA\"), the Racketeering Influenced and Corrupt Practices Act (\"RICO\"), and various common law claims in connection with the purchase of securities. The plaintiff seeks compensatory damages in excess of $1,400,000, punitive damages, treble damages, interest, attorneys' fees and expenses and have submitted a preliminary expert's report alleging damages in excess of $2,000,000. On February 20, 1992, the Company filed a Motion to Dismiss and on September 25, 1992, the Court dismissed the plaintiff's RICO claims. All other claims remain pending. The Company has also filed crossclaims against the trustees of the Pension Fund. On December 29, 1994, a status conference was held before the Magistrate Judge assigned to this matter. On May 5, 1995, the Magistrate Judge entered a scheduling order and discovery, which was stayed pending a motion to disqualify plaintiff's counsel, recommenced. In addition, certain defendants, other than the Company, have joined the former legal counsel to the Pension Fund as a third-party defendant to the action. Discovery in this matter is continuing. Although the outcome of this litigation is inherently uncertain, and no assurances regarding the final outcome of this matter can be given, the Company intends vigorously to defend this matter and pursue its crossclaims and believes it has meritorious defenses in this action.\nOn September 27, 1995, an action was filed in the United States District Court for the District of New Jersey under the caption Luis Lozada, Trustee of Local 211 Staff Employees' Pension Plan and Luis Lozada, Individually v. Ryan, Beck & Co., Inc. and Douglas A. MacWright Civ. Act. No. 95-4743 (AMW) (U.S.D.C.D.N.J.). The allegations asserted by the plaintiffs in this action are substantially similar to the allegations made by the plaintiffs in the Schiffli matter above. The claims asserted against the Company are for violations of ERISA and various state-law claims including breach of trust agreement, negligence and breach of contract. On November 1, 1995, the Company filed a motion to dismiss for failure to state a claim upon which relief can be granted. On January 2, 1996, the Court granted the Company's motion in part and denied it in part. The Court dismissed the breach of trust agreement claim on the grounds that the Company was not a party to the trust agreement for the Local 211 Plan. The remainder of the Company's motion to dismiss was denied. On or about January 24, 1996, the Company filed its answer to the complaint and asserted a counterclaim against the plaintiff, Luis Lozada. Although the outcome of litigation is inherently uncertain, and no assurances regarding the final outcome of this matter can be given, the Company intends vigorously to defend this matter and pursue its crossclaim and believes it has meritorious defenses in this action.\nThe Company, Ryan Beck Financial Corp., a wholly-owned subsidiary of the Company, and a former account executive of the Company have been named as third-party defendants in Inrevco Associates v. BDO Seidman, et al., v. Ryan, Beck & Co., et al., Superior Court of New Jersey, Law Division, No. MRS-L-2961-94. Inrevco is a New Jersey limited partnership. Ryan, Beck Financial Corp. (\"RBFC\") is a special limited partner in the partnership and such former account executive is a limited partner. The third-party complaint alleges that certain duties were owed to the partnership by the Company and RBFC. The third-party plaintiffs allege that the Company and RBFC breached these duties and are liable to the third-party plaintiffs for contribution in the event the plaintiff prevails at trial.\nOn February 17, 1995, a motion to dismiss filed by the defendants was granted in favor of RBFC and the former account executive. On March 9, 1995, RBFC and the Company's former account executive were dismissed by order of the Court. Discovery in this case is proceeding. On September 5, 1995, certain defendants filed a new third-party complaint seeking contribution from the Company, RBFC and certain present and former employees and officers of the Company as additional third-party defendants. All of the claims asserted against the Company are for contribution. On October 15, 1995, the Company, RBFC and all individual defendants named as third-party defendants in the litigation entered into a settlement agreement with Inrevco. The terms of the settlement agreement include a provision for an automatic judgment reduction in the event any liability is apportioned against the Company, RBFC or any individual third-party defendant on the contribution claims. Subsequently, the third-party defendants filed a motion to dismiss on the grounds that the claims against the third-party defendants were moot as a result of the entering into of the settlement agreement. On January 19, 1996 the Court heard argument on the motion to dismiss and denied such motion. The third-party defendants have filed a motion for permission to file an interlocutory appeal with respect to the motion to dismiss with the Superior Court of New Jersey, Appellate Division.\nOn or about December 13, 1994, a complaint under the caption Robert J. Buckley, et al. v. Northwest Savings Bank (\"Northwest\"), et. al., C.A. No 94-340-E (U.S.D.C. W.D. Pa.), was filed in the United States District Court of the Western District of Pennsylvania. The complaint alleges violations of the Securities Act of 1933, the Securities Act of 1934, as well as various state law securities and common law claims in connection with Northwest Savings Bank's reorganization from a mutual state savings bank to a stock mutual holding company.\nThe complaint alleges that the Company was retained as a consultant and advisor to Northwest in connection with such transaction and engaged in the promotion and sale of Northwest stock. The complaint further alleges that the Offering Circular prepared in connection with the initial public offering contained misstatements of material facts and omitted to state material facts necessary to make the statements contained in the Offering Circular not misleading, including false statements representing the appraised valuation and number of shares to be issued in the initial offering would be increased only if market and economic conditions warranted such increase. The complaint alleges that after the offering was concluded, the appraised value of Northwest was increased and the offering was diluted by the sale of additional shares and that such increase in appraised value was not warranted by market or economic conditions.\nThe complaint seeks unspecified monetary damages against the defendants, including the Company, on behalf of all persons who subscribed for and purchased shares of common stock in Northwest's initial public offering. In connection with the offering, Northwest executed an agency and underwriting agreement with the Company whereby Northwest agreed among other things to indemnify and contribute sums to the Company for losses and legal fees in connection with the offerings. Pursuant to the Agency Agreement, Northwest has agreed to indemnify the Company and to advance reasonable expenses incurred by the Company in connection with the lawsuit.\nOn March 13, 1995, the plaintiffs filed a Motion for Class Certification. On March 24, 1995, the Company, as well as all other defendants, filed a motion to dismiss the plaintiff's complaint. By order dated November 17, 1995, the Court dismissed the complaint with prejudice against all defendants on the ground that plaintiff failed to identify affirmative misrepresentations and material omissions of fact in the Offering Circular. On December 14, 1995, plaintiff filed an appeal with the United States Court of Appeals for the Third Circuit. The parties have not yet filed legal briefs on the appeal, and no date for oral argument has been set. While the outcome of the appeal is uncertain, the Company believes that the decision of the District Court will be affirmed.\nOn January 11, 1996, the Company gave notice to Municipal Square Associates (\"Municipal Square\"), its landlord at 80 Main Street, West Orange, New Jersey that it had been constructively evicted as a result of Municipal Square's breaches of the lease in failing to provide adequate heating, air conditioning, security, janitorial and other services.\nOn February 29, 1996 Municipal Square filed an action in the Superior Court of New Jersey, Essex County, Law Division, under the caption Municipal Square Associates v. Ryan, Beck & Co., Docket No. L 2751-96 in which Municipal Square seeks a declaratory judgment that the lease is not terminated and alternatively, that the Company's January 11th notice had terminated the lease and triggered an early termination penalty of $375,000.\nThe Company has filed a counter-claim alleging that Municipal Square breached the lease by failing to provide services which Municipal Square was required to provide under the lease and alleging that Municipal Square's conduct constituted a constructive eviction of the Company.\nSince the suit has just been instituted, no discovery has been taken in the matter. Although the outcome of this litigation is inherently uncertain and no assurances regarding the final outcome of this matter can be given, the Company intends to defend vigorously this matter and to pursue its counterclaim for damages. The Company believes that it has a meritorious defense, that it has sustained substantial damages as a result of breaches of the lease by Municipal Square, and that those damages significantly exceed the damages claimed by Municipal Square.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SHAREHOLDERS\nNone. PART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS\nThe Company's Common Stock is traded in the OTC market and quoted on the National Market segment of the NASDAQ Stock Market under the symbol \"RBCO.\" The following table sets forth the high and low closing sales prices of the common stock, as quoted by the NASDAQ Stock Market, and dividends declared by the Company during the quarterly periods indicated.\nDue to the volatile nature of the Company's business, it has been the policy of the Board of Directors to determine dividends individually for each quarter. No assurance can be given as to the amount or frequency of future dividend payments, if any. The Board currently intends to continue to make future dividend payment decisions on a quarterly basis. Special dividends will no longer be declared on a quarterly basis. In the future, the Board of Directors will determine on an annual basis if a special dividend will be paid and the amount of the dividend. In evaluating the possible distribution of special dividends, the Board considers, among other things, the level of the Company's earnings, its operating capital requirements, the current and prospective business and operating environment and alternative uses of any excess operating capital. The policy is subject to change at any time.\nThe number of common shareholders of record as of March 21, 1995, was 535. The number of preferred shareholders of record as of March 21, 1995, was 49.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe information contained under the caption \"Five Year Financial Comparison\" on page 10 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 information contained under the caption \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" on pages 11 through 14 of the 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 and Notes to Consolidated Financial Statements and Independent Auditors' report on pages 15 through 23 of the Annual Report is incorporated herein by reference.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nOn February 16, 1996, the Company engaged Deloitte & Touche LLP as its certifying accountant for the 1996 fiscal year, thereby replacing Trien, Rosenberg, Felix, Rosenberg, Barr & Weinberg LLP (\"Trien Rosenberg\"). The change was approved by the Company's Board of Directors.\nNo report on the financial statements of the Company issued by Trien Rosenberg during the last two fiscal years contained an adverse opinion or disclaimer of opinion, or was qualified or modified as to uncertainty, audit scope or accounting principles, nor were there any disagreements during the last two fiscal years and through February 16, 1996, between Trien Rosenberg and the Company concerning any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements if not resolved would have required Trien Rosenberg to make reference to the subject matter thereof in connection with its report. During the last two fiscal years and through February 16, 1996, none of the events listed in items (A) through (D) of Item 304(a)(1)(b) of Regulation S-K have occurred; and during such period the Company has not consulted with Deloitte & Touche LLP regarding any matter referred to under paragraphs (i) or (ii) of Item 304(a)(2) of Regulation S-K.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information required herein is incorporated by reference to the Company's Proxy Statement (\"Proxy Statement\") as filed with the Securities and Exchange Commission.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required herein is incorporated by reference to the Company's Proxy Statement.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required herein is incorporated by reference to the Company's Proxy Statement.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required herein is incorporated by reference to the Company's Proxy Statement.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8- K\nEXHIBITS\n3.1Restated Certificate of Incorporation, as amended (incorporated by reference to Exhibit 3.1 of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994 (the \"1994 Form 10-K\")).\n3.2Bylaws, as amended (incorporated herein by reference to Exhibit 3.2 of the Registrant's Registration Statement on Form S-1 (No. 33-5543) filed with the SEC on June 27, 1986).\n9.1Amended and Restated Stock Pooling Agreement by and among Fenwick H. Garvey, Matthew R. Naula and Bruce M. Chodash dated as of March 15, 1994 (incorporated by reference to Exhibit 9.1 of the 1994 Form 10-K).\n10.1Stock Option Plan, as amended (incorporated by reference to Exhibit 10. 1 to the Company's Annual Report on Form 10-K for the year ended December 31, 1991).\n10.2Employee Stock Ownership Plan dated May 15, 1994 (incorporated by reference to Exhibit 10.2 of the 1994 Form 10-K).\n10.3Term Loan Agreement by and among the Company, the Ryan, Beck & Co., Inc. Employee Stock Ownership Plan and Northwest as of June 23, 1995\n10.4Employee Stock Ownership Plan Trust Agreement by and between the Company and Matthew Naula as Trustee dated May 15, 1994 (incorporated by reference to Exhibit 10.3 of the 1994 Form 10-K).\n10.5Lease pertaining to the Company's West Orange, New Jersey offices effective as of January 1, 1992, (incorporated by reference to Exhibit 10.2 to the Company's Annual Report on Form 10-KSB for the year ended December 31, 1992).\n10.6Lease pertaining to the Company's Bala Cynwyd, Pennsylvania offices effective as of April 12, 1994.\n10.7Lease pertaining to the Company's West Palm Beach, Florida offices effective as of February 28, 1995.\n10.8Employment Agreement, dated November 14, 1990, by and between Jack R. Rosenthal and Ryan, Beck & Co., Inc. (incorporated by reference to Exhibit 10.7 to the Company's Annual Report on Form 10-K for the year ended December 31, 1990).\n10.9Amended and Restated Employment Agreement dated December 14, 1995 by and between Allen S. Greene and Ryan, Beck & Co., Inc.\n10.10Employment Agreement dated September 26, 1994 by and between Fenwick H. Garvey and Ryan, Beck & Co., Inc. (the \"Garvey Employment Agreement\") (incorporated by reference to Exhibit 10.8 of the 1994 Form 10-K).\n10.11Amendment to the Garvey Employment Agreement, dated December 14, 1995.\n10.12Employment Agreement dated September 26, 1994, by and between Matthew R. Naula and Ryan, Beck & Co., Inc. (the \"Naula Employment Agreement\") (incorporated by reference to Exhibit 10.9 of the 1994 Form 10-K).\n10.13Amendment to the Naula Employment Agreement, dated December 14, 1995.\n10.14Employment Agreement dated September 26, 1994 by and between Bruce M. Chodash and Ryan, Beck & Co., Inc. (the \"Chodash Employment Agreement\") (incorporated by reference to Exhibit 10.10 of the 1994 Form 10-K).\n10.15Amendment to the Chodash Employment Agreement, dated December 14, 1995.\n10.16Amended and Restated Employment Agreement, dated December 14, 1995 by and between Ben A. Plotkin and Ryan, Beck & Co., Inc.\n10.17Amended and Restated Restricted Stock Grant Plan dated July 16, 1993 (incorporated by reference to Exhibit 10.12 of the 1994 Form 10-K).\n11.Statement regarding computation of per share earnings is omitted pursuant to SEC regulations.\n12.Statement re: computation of ratios.\n13.Annual Report for the fiscal year ended December 31, 1995.\n16.Letter re: Change in Certifying Accountants (incorporated by reference from the current Report on Form 8-K filed with the SEC on February 23, 1996.).\n21.Subsidiaries (incorporated by reference to Exhibit 21 of the 1994 Form 10-K).\n23.Consent of Trien, Rosenberg, Felix, Rosenberg, Barr & Weinberg\n27.Financial Data Schedule\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nRYAN, BECK & CO., INC.\nBy: \/S\/ FENWICK H. GARVEY March 21, 1996 Fenwick H. Garvey 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.","section_15":""}
{"filename":"790988_1995.txt","cik":"790988","year":"1995","section_1":"Item 1. BUSINESS\nPennRock Financial Services Corp. (the Company) is a Pennsylvania business corporation which was organized on March 5, 1986 and became a bank holding company when it acquired all of the issued and outstanding common stock of Blue Ball National Bank (sometimes hereinafter referred to as \"the Bank\") on August 1, 1986.\nPennRock Financial Services Corp. was organized as a financial holding company which operates through its subsidiary to deliver financial and related services to its customers. The Company's primary function is to direct the policies and coordinate the financial resources of its bank subsidiary as well as provide various advisory services. Dividends paid to stockholders are obtained by the Company from dividends paid to it by its subsidiary and through funds received under its dividend reinvestment plan.\nThe Company is a registered bank holding company under the Bank Holding Company Act of 1956, as amended, and is subject to regulation by the Federal Reserve Board and by the Pennsylvania Department of Banking.\nBlue Ball National Bank - ----------------------- Blue Ball National Bank, organized in 1906, provides a full range of general commercial and retail banking services to its customers, including several types of checking and savings accounts, certificates of deposit, and commercial, consumer and mortgage loans. Additionally, the Bank also provides personal and corporate trust and agency services to individuals, corporations and others, including trust investment accounts, investment advisory services, estate planning, and management of pension and profit sharing plans.\nOn January 27, 1995, the Bank acquired three branch offices of PNC Bank, NA (PNC). In connection with the transaction, the Bank assumed $38.1 million in deposits and purchased $6.7 million in assets including consumer loans, vault cash, furniture and equipment and real estate and improvements. In consideration for the assumption of the deposit liabilities, the Bank paid PNC a deposit premium of $1.1 million or 2.8%. With the acquisition of these three offices, the Bank now operates 12 full service branches in Berks, Chester and Lancaster Counties.\nBusiness is not considered seasonal, although normal increases in deposit totals occur following the end of a quarter and near year-end.\nEmployees - --------- The approximate number of persons employed by the Bank is 243. The Company has no employees.\nCompetition - ----------- The banking industry in the Company's service area continues to be extremely competitive, both among commercial banks and with other financial service providers such as consumer finance companies, thrifts, investment companies, mutual funds and credit unions. The increased competition has resulted from a changing legal and regulatory climate as well as changes in the economy.\nPENNROCK FINANCIAL SERVICES CORP.\nMortgage banking firms, real estate investment trusts, insurance companies brokerage companies, financial affiliates of commercial companies, and government agencies also provide additional competition for loans and other financial services.\nThe Company is not dependent upon a single customer or a small number of customers, the loss of which would have a materially adverse effect upon the Company or the Bank.\nSupervision and Regulation - -------------------------- General\nThe Company is registered as a bank holding company and is subject to supervision and regulation by the Board of Governors of the Federal Reserve System (the \"Federal Reserve Board\") under the Bank Holding Act of 1956, as amended (the \"BHCA\"). As a bank holding company, the Company's activities and those of its bank subsidiary are limited to the business of banking and activities closely related or incidental to banking. Bank holding companies are required to file periodic reports with and are subject to examination by the Federal Reserve Board. The Federal Reserve Board has issued regulations under the BHCA that require a bank holding company to serve as a source of financial and managerial strength to its subsidiary banks. As a result, the Federal Reserve Board, pursuant to such regulations may require the Company to stand ready to use its resources to provide adequate capital funds to its bank subsidiary during periods of financial stress or adversity.\nThe BHCA prohibits the Company from acquiring direct or indirect control of more than 5% of the outstanding shares of any class of voting stock or substantially all of the assets of any bank or merging or consolidating with another bank holding company without prior approval of the Federal Reserve Board. Additionally, the BHCA prohibits the Company from engaging in or from acquiring ownership or control of more than 5% of the outstanding shares of any class of voting stock of any company engaged in a non-banking business, unless such business is determined by the Federal Reserve Board to be so closely related to banking as to be a proper incident thereto.\nAs a \"bank holding company\" for purposes of the Pennsylvania Banking Code, the Company is also subject to regulation and examination by the Pennsylvania Department of Banking.\nThe Bank is a national bank and a member of the Federal Reserve System and its deposits are insured (up to applicable limits) by the Federal Deposit Insurance Corporation (the \"FDIC\"). Accordingly, the Bank is subject to regulation and examination by the Office of the Comptroller of the Currency (the \"OCC\"), by the Federal Reserve Board, and by the FDIC. Although the Bank is subject to examination by the Federal Reserve Board and by the FDIC, in practice examinations are only rarely undertaken by these agencies in view of the regular examination policies of the OCC. The Bank is 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. Various consumer laws and regulations also affect the operations of\nPENNROCK FINANCIAL SERVICES CORP.\nthe Bank. 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.\nCapital Adequacy Guidelines\nBank holding companies are required to comply with the Federal Reserve Board's risk-based capital guidelines. The required minimum ratio of total capital to risk-weighted assets (including certain off-balance sheet activities, such as standby letters of credit) is 8%. At least half of the total capital is required to be \"Tier 1 capital,\" consisting principally of common shareholders' equity, non-cumulative perpetual preferred stock and minority interests in the equity accounts of consolidated subsidiaries, less certain intangible assets (as discussed below). The remainder (\"Tier 2 capital\") may consist of a limited amount of subordinated debt and intermediate-term preferred stock, certain hybrid capital instruments and other debt securities, perpetual preferred stock, and a limited amount of the general allowance for loan loss. In addition to the risk-based capital guidelines, the Federal Reserve Board requires a bank holding company to comply with the so-called \"leverage ratio\" under which a bank holding company must maintain a minimum level of Tier 1 capital (as determined under the risk-based capital guidelines) equal to 3% of average total consolidated assets for those bank holding companies which have the highest regulatory examination ratings and are not contemplating or experiencing significant growth or expansion. All other bank holding companies are required to maintain a ratio of at least 1% to 2% above the stated minimum. The Bank is subject to similar capital requirements adopted by the OCC.\nThe risk-based capital guidelines are required to take adequate account of interest rate risk, concentration of credit risk, and risks of nontraditional activities. In August of 1995, the Federal banking agencies, including the Federal Reserve Board and the OCC, issued a rule modifying their existing risk- based capital standards to provide for consideration of interest rate risk when assessing the capital adequacy of an institution. This new rule implements the first step of a two-step process by explicitly including a bank's exposure to declines in the value of its capital due to changes in interest rates as one factor that the banking agencies will consider in evaluating a bank's capital adequacy. The new rule does not establish a measurement framework for assessing a bank's interest rate risk exposure level. Examiners will use data collected by the banking agencies to determine the adequacy of an individual bank's capital in light of interest rate risk. Examiners will also consider historical financial performance, earnings exposure to interest rate movements and the adequacy of internal interest rate risk management, among other things. This case-by-case approach for assessing a bank's capital adequacy for interest rate risk is transitional. The second step of the banking agencies' interest rate risk regulation will be to establish an explicit minimum capital charge for interest rate risk, based on measured levels of interest rate risk exposure. The banking agencies will implement this second step at some future date. The Company is unable to predict the form in which these future regulations will ultimately be adopted or the effect the new or anticipated regulations would have on the operations and capital adequacy of the Bank.\nThe federal bank regulators also adopted final rules relating to concentration of credit risk and risks of non-traditional activities effective on January 17,\nPENNROCK FINANCIAL SERVICES CORP.\n1995. The agencies declined to adopt a quantitative test for concentrations of credit risk and, instead, provided that such risk would be considered in addition to other risks in assessing an institution's overall capital adequacy. Institutions with higher concentration of credit risk will be required to maintain greater levels of capital. Similarly, the federal banking agencies incorporated the evaluation of the risks of non-traditional activities into the overall assessment of capital adequacy. The agencies also indicated that rules regarding specific types of non-traditional activities will be promulgated from time to time.\nPrompt Corrective Action Rule\nThe Federal banking agencies have issued uniform final regulations defining the levels at which an insured institution would be considered \"well capitalized,\" \"adequately capitalized,\" \"undercapitalized,\" \"significantly undercapitalized\" and \"critically undercapitalized.\" Under these regulations, a bank is considered \"well capitalized\" if it has: (i) a total risk-based capital ratio of 10% or greater, (ii) a Tier 1 risk-based capital ratio of 6% or greater, (iii) a leverage ratio of 5% or greater, and (iv) is not subject to any order or written directive to meet and maintain a specific capital level. An \"adequately capitalized\" bank is defined under the regulations as one that has: (i) a total risk-based capital ratio of 8% or greater, (ii) a Tier 1 risk-based capital ratio of 4% or greater, (iii) a leverage ratio of 4% or greater (or 3% or greater in the case of a bank with the highest composite regulatory examination rating), and (iv) does not meet the definition of a well-capitalized bank. A bank would be considered (A) \"undercapitalized\" if it has (i) a total risk-based capital ratio of less than 8%, (ii) a Tier 1 risk-based capital ratio of less than 4%, or (iii) a leverage ratio of less than 4% (or 3% in the case of a bank with the highest regulatory examination rating); (B) \"significantly undercapitalized\" if the bank has: (i) a total risk-based capital ratio of less than 6%, (ii) a Tier 1 risk-based capital ratio of less than 3%, or (iii) a leverage ratio of less than 3%; and (C) \"critically undercapitalized\" if the bank has a ratio of tangible equity to total assets of equal to or less than 2%. The applicable Federal bank regulator for a depository institution could, under certain circumstances, reclassify a \"well capitalized\" institution as \"adequately capitalized\" or require an \"adequately capitalized\" or \"undercapitalized\" institution to comply with supervisory actions as if it were in the next lower category. Such a reclassification could be made if the regulatory agency determines that the institution is in an unsafe or unsound condition (which could include unsatisfactory examination ratings). The Company and the Bank each satisfy the criteria to be classified \"well capitalized\" within the meaning of applicable regulations.\nRegulatory Restrictions on Dividends\nThe Bank may not, under the National Bank Act, declare a dividend without approval of the Comptroller of the Currency, unless the dividend to be declared by the Bank's Board of Directors does not exceed the total of: (i) the Bank's net profits (as defined and interpreted by regulation) for the current year to date, plus (ii) its retained net profits (as defined and interpreted by regulation) for the preceding two current years, less any required transfers to surplus. In addition, the Bank can only pay dividends to the extent that its retained net profits (including the portion transferred to surplus) exceed its bad debts (as defined by regulation). The Federal Reserve Board, the OCC and\nPENNROCK FINANCIAL SERVICES CORP.\nthe FDIC have formal and informal policies which provide that insured banks and bank holding companies should generally pay dividends out of current operating earnings, with some exceptions. The Prompt Corrective Action Rules, described above, further limit the ability of banks to pay dividends, because banks which are not classified as well capitalized or adequately capitalized may not pay dividends.\nUnder these policies and subject to the restrictions applicable to the Bank, the Bank could declare, during 1996, without prior regulatory approval, aggregate dividends of approximately $13.8 million, plus net profits earned to the date of such dividend declaration in 1996.\nFDIC Insurance Assessments\nThe FDIC has implemented a risk-related premium schedule for all insured depository institutions that results in the assessment of premiums based on capital and supervisory measures. Under the risk-related premium schedule, the FDIC assigns, on a semiannual basis, each depository institution to one of three capital groups (well-capitalized, adequately capitalized or undercapitalized) and further assign such institution to one of three subgroups within a capital group. The institution's subgroup assignment is based upon the FDIC's judgment of the institution's strength in light of supervisory evaluation, including examination reports, statistical analyses and other information relevant to measuring the risk posed by the institution. Only institutions with a total capital to risk-adjusted assets ratio of 10% or greater, a Tier 1 capital to risk-adjusted assets ratio of 6% or greater and a Tier 1 leverage ratio of 5% or greater, are assigned to the well-capitalized group. As of December 31, 1995, the Bank was well capitalized for purposes of calculating insurance assessments.\nIn August, 1995 the FDIC adopted an amendment to the Bank Insurance Fund (the \"BIF\") risk-based assessment schedule that lowers the deposit insurance assessment rate for most (90% or more) commercial banks and other depository institutions with deposits insured by the BIF to $.04 per $100 of insured deposits. On November 14, 1995 the FDIC further reduced the BIF assessment rates to a range of $.00 per $100 of insured deposits (subject to a minimum annual premium of $2,000) for those institutions with the least risk, to $.27 for every $100 of insured deposits for institutions deemed to have the highest risk, beginning January 1, 1996. At the same time, the FDIC voted to retain the existing assessment rates of $.23 for every $100 of insured deposits for the members of the Savings Association Insurance Fund (the \"SAIF\"), in the lowest risk-based premium category and $.31 for every $100 of insured deposits for members of the SAIF in the highest risk-based premium category. The Bank is a member of the BIF.\nInterstate Banking\nPrior to the passage of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the \"Interstate Banking Act\"), the BHCA prohibited a bank holding company located in one state from acquiring a bank located in another state, unless such an acquisition by an out-of-state bank holding company was specifically authorized by the law of the state where the bank to be acquired was located. Similarly, interstate branching was generally prohibited by the McFadden Act. The Interstate Banking Act permits an adequately capitalized and adequately managed bank holding company to acquire a bank in\nPENNROCK FINANCIAL SERVICES CORP.\nanother state as of September 29, 1995, whether or not the law of that other state permits the acquisition, subject to certain deposit concentration caps and approval by the Federal Reserve Board. In addition, beginning on June 1, 1997, under the Interstate Banking Act, a bank can engage in interstate expansion by merging with a bank in another state or acquiring the assets and liabilities of a bank in another state and also may consolidate the acquired bank into new branch offices of the acquiring bank, unless the other state affirmatively opts out of the legislation before that date. A state may also opt into the legislation earlier than June 1, 1997 if it wishes to do so. The Interstate Banking Act also permits de novo interstate branching as of June 1, 1997, but only if a state affirmatively opts in by adopting appropriate legislation. In July of 1995, Pennsylvania adopted \"opt in\" legislation which allows such transactions to take place prior to the June 1, 1997 federal effective date.\nForeign Operations\nThe Company does not depend on foreign sources for funds, nor does the Company make foreign loans.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nPennRock Financial Services Corp. - --------------------------------- The Company's headquarters are located at the main office of Blue Ball National Bank located at 1060 Main Street, Blue Ball, Pennsylvania. The Company owns no real estate.\nBlue Ball National Bank - ----------------------- The principal executive office and main banking office is located in Blue Ball, Pennsylvania. This and the other 11 branch offices are owned by Blue Ball National Bank free and clear of any indebtedness. The land on which two of the branch offices are located is leased.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nVarious legal actions or proceedings are pending involving the Company or the Bank. Management believes that the aggregate liability or loss, if any, will not be material.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matter was submitted during the fourth quarter of 1995 to a vote of security holders, through the solicitation of proxies or otherwise.\nPENNROCK FINANCIAL SERVICES CORP.\nItem 4A. EXECUTIVE OFFICERS OF THE REGISTRANT\nThe names, ages and positions of all of the executive officers of the Company as of March 1, 1996 are listed below, along with the positions with the Company and the Bank held by each of them during the past five years. Officers are elected annually by the Board of Directors.\nPOSITION AND BUSINESS EXPERIENCE NAME AGE DURING PAST 5 YEARS - --------------- ---- --------------------------------------------------------- Norman Hahn 59 PennRock Financial Services Corp.: Chairman of the Board (January 1991 to date) Blue Ball National Bank: Chairman of the Board (January 1991 to date) Vice-Chairman of the Board (April 1988 to January 1991)\nGlenn H. Weaver 61 PennRock Financial Services Corp.: President (April 1989 to date)\nRobert K. Weaver 47 PennRock Financial Services Corp.: Secretary (March 1986 to date) Blue Ball National Bank: Secretary (1977 to date)\nMelvin Pankuch 56 PennRock Financial Services Corp.: Executive Vice President and Chief Executive Officer (April 1989 to date) Blue Ball National Bank: President and Chief Executive Officer (April 1988 to date)\nGeorge B. Crisp 48 PennRock Financial Services Corp.: Vice President and Treasurer (April 1989 to date) Blue Ball National Bank: Senior Vice President - Operations (July 1993 to date) Chief Financial Officer (July 1987 to date)\nJoseph C. Spada 45 Blue Ball National Bank: Senior Vice President - Banking Sales\/Service (July 1993 to date)\nMichael H. Peuler 45 Blue Ball National Bank: Senior Vice President - Trust Sales\/Service (April 1995 to date) Vice President - Trust Sales\/Service (June 1993 to April 1995)\nPENNROCK FINANCIAL SERVICES CORP.\nPART II\nItem 5.","section_5":"Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe price on the Company's common stock ranged from $16 to $25 1\/4 in 1995 and from $16 to $25 1\/4 in 1994. The book value per share was $8.52 at December 31, 1995 and $6.64 at December 31, 1994. The prices listed below have been adjusted to reflect the 3-for-2 stock split on November 27, 1994 and represent the high, low and quarter ending prices for stock trades as reported on the OTC Bulletin Board (r) during the quarter.\nPENNROCK FINANCIAL SERVICES CORP.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA\nIn thousands, except per share data\nPENNROCK FINANCIAL SERVICES CORP.\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe following section presents management's discussion and analysis of the financial condition and results of operations of PennRock Financial Services Corp., a bank holding company (the Company), and its wholly owned subsidiary, Blue Ball National Bank (the Bank) and should be read in conjunction with the financial statements and other financial data presented elsewhere in this Annual Report. This discussion and analysis is intended to focus on certain financial data which might not otherwise be readily apparent.\nOn September 27, 1994, the Company's Board of Directors declared a 3-for-2 stock split in the form of a 50% stock dividend, payable on November 22, 1994 to shareholders of record on October 25, 1994. All per share data have been restated to reflect the stock split.\nEffective January 1, 1994, the Company adopted the provisions of Statement of Financial Accounting Standard No. 115 (SFAS 115), \"Accounting for Certain Investments in Debt and Equity Securities\" which requires that securities be classified in one of three categories: debt securities for which a company has 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 purchased and held for the purpose of selling them in the near term are classified as trading securities and reported at fair value, with unrealized gains and losses included in earnings; debt and equity securities not classified as either held-to-maturity or trading securities are classified as available-for - -sale and reported at fair value with unrealized gains and losses reported as a separate component of stockholders' equity, net of deferred taxes. Upon adoption of SFAS 115, all securities were transferred to the available-for-sale category at fair value. Subsequent to adoption of SFAS 115, certain debt securities were purchased as investment securities and classified as held-to- maturity. On November 15, 1995, the Financial Accounting Standards Board (FASB) issued a Special Report, \"A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities.\" In this report, the FASB permitted a one-time reassessment of the appropriateness of the designations of all securities held at the time of the issuance of the Special Report. Debt securities transferred from the investment security portfolio to the available for sale portfolio under the guidance of the Special Report would not call into question intent to hold other debt securities to maturity. Accordingly, in the fourth quarter of 1995, the Company transferred all of the investment security portfolio consisting of debt securities with an amortized cost of $15.4 million and a net unrealized gain of $302,000 to the available for sale portfolio. At December 31, 1995, the Company had no investment securities classified as held to maturity.\nOn January 27, 1995, the Bank acquired three branch offices of PNC Bank, NA (PNC). In connection with the transaction, the Bank assumed $38.1 million in deposits and purchased $6.7 million in assets including consumer loans, vault cash, furniture and equipment and real estate and improvements. In consideration for the assumption of the deposit liabilities, the Bank paid PNC a deposit premium of $1.1 million or 2.8%.\nOn January 1, 1995, the Company adopted Statement of Financial Accounting Standard No. 114 (SFAS 114), \"Accounting by Creditors for Impairment of a Loan\"\nPENNROCK FINANCIAL SERVICES CORP.\nand Statement of Financial Accounting Standard No. 118 (SFAS 118), \"Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures.\" SFAS 114 addresses the accounting by creditors for impairment of certain loans. SFAS 114 requires that impaired loans that are within the scope of the Statement be measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or, at the loan's market price or the fair value of the collateral if the loan is collateral dependent. SFAS 118 amends SFAS 114 to allow a creditor to use existing methods for recognizing interest income on an impaired loan and to require additional disclosures on interest income recognition related to impaired loans.\nDuring the first quarter of 1996, the Company formed Atlantic Regional Mortgage Corporation (\"Atlantic\"), a Pennsylvania business corporation which was organized as a wholly-owned subsidiary of the Bank. In accordance with its business plan, Atlantic has hired experienced mortgage bankers who will be responsible for the conduct of Atlantic's operations and will open four offices by year-end in the Baltimore, Washington and Philadelphia metropolitan areas. Atlantic will operate as a mortgage banker originating and selling residential mortgage loans, service released. The business plan calls for Atlantic to increase the Company's level of fee income and diversify its income stream.\nAlthough, there is no assurance that Atlantic will achieve its goal of profitability, the business is expected to be a generator of fee income and could contribute significantly to the Company's income Additionally, Atlantic will incur start-up expenses that may result in a loss for the subsidiary during 1996.\nRESULTS OF OPERATIONS\nOVERVIEW:\nPennRock Financial Services Corp. recorded net income of $6.2 million in 1995, an increase of 5.9% from the net income of $5.8 million recorded in 1994. Net income was $6.4 million in 1993. Net income per share was $1.02 in 1995, $.98 in 1994 and $1.08 in 1993.\nReturn on average total assets was 1.21% in 1995 compared with 1.32% in 1994 and 1.55% in 1993. Return on average equity for 1995 was 13.41% compared with 13.95% in 1994 and 16.74% in 1993.\nAverage earning assets increased $67.3 million or 16.1% during 1995, while average interest bearing liabilities grew $62.6 million or 18.1%. The yield on earning assets increased from 7.35% in 1994 to 8.08% in 1995, while the average yield on paying liabilities increased from 3.70% in 1994 to 4.75% in 1995. The Company's net interest income on a fully taxable equivalent basis increased $1.9 million or 10.6% during 1995. The net interest margin declined from 4.29% in 1994 to 4.09% in 1995.\nNon-interest income other than gains and losses on security and mortgage loan transactions increased $199,000 or 8.8% in 1995 compared with a $130,000 or 6.1% increase in 1994 and a $537,000 or 33.6% increase in 1993. The increase in 1995 is due primarily to increases in fiduciary fees and service charge fee income while the increase in 1994 was a result of higher mortgage servicing fee income.\nPENNROCK FINANCIAL SERVICES CORP.\nNon-interest expenses increased $1.3 million or 10.4% in 1995. Most of the increase is related to increased personnel, equipment, and occupancy expenses due to the expansion of new offices, offset partially by a decrease in FDIC insurance of $323,000 due to a reduction in the fund assessment rate. Other overhead increases included costs associated with data processing and normal increases in other overhead expenses. Non-interest expenses in 1994 increased $433,000 over 1993 due to increases in personnel, FDIC insurance and data processing costs.\nNET INTEREST INCOME:\nNet interest income is the amount by which interest income on loans, investments and other earning assets exceeds interest paid on deposits and other interest bearing liabilities. Net interest income is the primary source of revenue for the Company. The amount of net interest income is affected by changes in interest rates and the balances of the various types of earning assets and interest bearing liabilities. For comparative purposes, and throughout this discussion unless otherwise noted, net interest income and corresponding yields are shown on a taxable equivalent basis. This adjustment will give effect to the interest earned on tax-exempt loans and investments by an amount equivalent to the federal income taxes which would have been paid if the income received on these assets was taxable at the statutory rate of 34% for 1995, 1994, and 1993.\nNet interest income is the product of the volume of average earning assets and the average rates earned on them, less the volume of average interest bearing liabilities and the average rates paid on them. Table 1 presents average balances, taxable equivalent interest income and expense and rates for the Company's assets and liabilities.\nPENNROCK FINANCIAL SERVICES CORP.\nTable 1 - Average Balances, Rates and Interest Income and Expense Summary\n(Taxable equivalent basis)\nPENNROCK FINANCIAL SERVICES CORP.\nTable 2 presents the net interest income on a fully taxable equivalent basis for the three years ended December 31, 1995.\nTable 2 - Net Interest Income\nNet interest income on a fully taxable equivalent basis was $19.8 million in 1995, an increase of $1.9 million or 10.6% from the $17.9 million earned in 1994. Net interest income in 1994 decreased 5.0% from $18.8 million in 1993.\nThe rate and volume components of earning assets and paying liabilities can be isolated in order to analyze the separate effects of each on changes in interest income. Table 3 analyzes the changes in the volume and rate components of net interest income. During 1995, net interest income increased $3.0 million due to changes in volume and decreased $1.1 million due to changes in interest rates. In 1994, net interest income increased by $1.4 million due to changes in volume and declined by $2.3 million due to changes in interest rates. During 1993, net interest income increased $1.8 million due to changes in volume and declined by $.6 million due to changes in interest rates.\nPENNROCK FINANCIAL SERVICES CORP.\nTable 3 - Volume and Rate Analysis of Changes in Interest Income\n(Taxable equivalent basis)\nThe changes in the Company's net interest margin can be understood by analyzing the interest rate spread and the net interest margin on earning assets. The interest rate spread as shown in Table 4 is the difference between the average rate earned on earning assets and the average rate paid on interest bearing liabilities. The net interest margin takes into account the benefit derived from assets funded by interest free sources such as non-interest bearing demand deposits and capital.\nPENNROCK FINANCIAL SERVICES CORP.\nTable 4 - Interest Rate Spread and Net Interest Margin on Earning Assets\n(Taxable equivalent basis)\nAs indicated in Table 4, average earning assets increased to $485.1 million in 1995 from $417.7 million in 1994 and $388.9 million in 1993. Interest rate spread was 3.33%, 3.65% and 4.27% in 1995, 1994 and 1993, respectively. Net interest margins were 4.09% in 1995 compared with 4.29% in 1994 and 4.85% in 1993.\nInterest rate spreads declined 32 basis points during 1995. Earning asset yields increased 73 basis points while funding costs increased 105 basis points. Loan yields increased 69 basis points from 8.64% in 1994 to 9.33% in 1995 . The prime rate was 8.5% at both the beginning and end of 1995 but was higher than 8.5% for most of the year. On February 1, 1995, the prime increased 50 basis points, then dropped 25 basis points on July 7, 1995 and again on December 20, 1995. Yields on securities increased 52 basis points due to higher yields on adjustable rate securities and due to a larger investment in higher yielding tax free municipal bonds. Rates on interest bearing deposits rose from 3.49% in 1994 to 4.51% in 1995. Most of this increase is attributable to higher rates on time deposits which increased 131 basis points from 4.20% in 1994 to 5.51% in 1995. Short-term borrowing costs were 161 basis points higher in 1995 while the cost of long-term debt increased 79 basis points.\nInterest rate spreads declined 62 basis points during 1994. Earning asset yields dropped 70 basis points while funding costs declined only 8 basis points. Loan yields declined 58 basis points despite the fact that the prime rate was increased five times in 1994 from 6.0% to 8.5%. The lower yields were due to lower fees on mortgages originated as higher rates ended the heavy refinancing activity experienced in 1992 and 1993. Total fees recognized on mortgage loans declined $1.8 million or 71.7% from $2.5 million in 1993 to only $700,000 in 1994. Yields on investment securities fell 77 basis points from 1993 as higher\nPENNROCK FINANCIAL SERVICES CORP.\nyielding securities matured and were replaced primarily by lower yielding adjustable rate mortgage-backed securities. Rates on deposits also declined during 1994. The average cost of interest bearing deposits dropped 32 basis points from 3.81% in 1993 to 3.49% in 1994. The cost of borrowings increased in 1994. Short-term borrowing rates increased 148 basis points while the average cost of long-term debt increased 19 basis points.\nPROVISION FOR LOAN LOSSES:\nThe provision for loan losses charged against earnings was $360,000 in 1995 compared with $352,000 in 1994 and $958,000 in 1993. The amount of the provision is based, among other factors, on the amount of net credit losses which totaled $181,000 in 1995, $331,000 in 1994 and $902,000 in 1993. Adequacy of the allowance will continue to be examined in light of past loan loss experience, current economic conditions, size and characteristics of the loan portfolio, volume of non-performing and delinquent loans and other relevant information.\nThe ratio of net charge-offs to average loans decreased from .15% in 1994 to .07% in 1995 while the ratio of net charge-offs to the allowance for loan losses decreased from 9.51% to 4.94%. Non-performing loans increased slightly from $1.1 million at the end of 1994 to $1.2 million at the end of 1995 but decreased as a percentage of total loans from .44% in 1994 to.41% of total loans in 1995.\nNON-INTEREST INCOME:\nTotal non-interest income declined $189,000 or 5.6% in 1995 compared with a $597,000 or 21.4% increase in 1994. Excluding security and mortgage transactions, non-interest income increased $199,000 or 8.8% in 1995 compared with a $130,000 or 6.1% increase in 1994 and a $537,000 or 33.6% increase in 1993. Income from fiduciary activities increased $113,000 or 23.7% in 1995 compared with an increase of $15,000 or 3.3% in 1994. Table 5 indicates changes in the major categories of non-interest income.\nPENNROCK FINANCIAL SERVICES CORP.\nTable 5 - Non-interest Income\nSecurity gains totaled $647,000 in 1995 and $1,173,000 in 1994. Securities gains and losses in 1995 and 1994 were attributable to the sale of securities for the purpose of adding liquidity or to manage interest rate risk. In addition some gains were realized in 1994 with respect to several pre-refunded municipal bonds in the Company's available-for-sale portfolio which were scheduled to be called within one to two years. The Company continuously monitors its interest rate sensitivity position and periodically restructures its security portfolio as conditions warrant to hedge changes in funding sources or projected changes in future interest rates.\nThe Company realized a net gain of $90,000 on sales of $26.2 million of mortgage loans in 1995 compared with a loss of $48,000 on sales of $40.4 million of mortgage loans in 1994. Mortgages held for sale are carried at the lower of cost or market. Market value for mortgages held for sale is determined on the basis of open commitments for committed loans. For uncommitted loans, market is determined on the basis of current delivery prices in the secondary mortgage market.\nEffective January 1, 1996, the Company plans to adopt Statement of Financial Accounting Standard No. 122, \"Accounting for Mortgage Servicing Rights, an Amendment of FASB Statement No. 65\" (SFAS 122). SFAS 122 amended Statement 65 to require an institution to recognize as separate assets the rights to service mortgage loans for others when a mortgage loan is sold or securitized and servicing rights retained. When capitalizing originated mortgage servicing rights (\"OMSR's\"), an institution allocates the total cost of the mortgage loans (the recorded investment in the mortgage loans including net deferred fees or costs and any purchase premium or discount) to the OMSR's and the loans (without the OMSR's) based on their relative fair values. OMSR's are amortized in proportion to, and over the period of, estimated net servicing income.\nPENNROCK FINANCIAL SERVICES CORP.\nSFAS 122 also requires that all capitalized mortgage servicing rights be evaluated for impairment based on the difference between the carrying amount of the servicing rights and their current fair value. Impairment of OMSR's is recognized through a valuation allowance. The amount of impairment recognized is the amount by which the capitalized OMSR's exceed their fair value. Subsequent to the initial measurement of impairment, the valuation allowance is adjusted to reflect changes in the measurement of impairment. Fair value in excess of the amount capitalized as OMSR's (net of amortization) is not recognized.\nManagement is currently evaluating the potential impact of the adoption of SFAS 122 on the financial statements. Factors such as volume of mortgage loans which will be originated in 1996 will have a significant effect on the amount of OMSR's recognized and consequently the effect on the 1996 financial statements cannot be determined at this time. The Company has no purchased mortgage servicing rights.\nNON-INTEREST EXPENSE:\nTotal non-interest expense for 1995 increased $1,278,000 or 10.4% compared with a $433,000 or 3.7% increase in 1994. Salaries and employee benefits increased $544,000 or 7.9% in 1995 and $263,000 or 4.0% in 1994. Total full-time equivalent employees did not change from 1993 to 1994 holding steady at 184 but increased to 217 in 1995 due primarily to the addition of four new branch offices. The ratio of average assets (millions) per employee was $2.24 in 1993, $2.40 in 1994 and $2.36 in 1995. The average salary per employee was $28,000 in 1993, 1994 and 1995.\nOther non-interest expenses increased $734,000 or 13.7% in 1995. The higher overhead is partially attributable to the new branch offices added in 1995 and to the opening of a new operations center in early 1995. Equipment depreciation also increased due to a substantial investment in additional furniture and equipment including the Company's new check imaging system. The Bank Insurance Fund reached its statutory goal of 1.25% of all insured deposits in the second quarter of 1995. As a result, the FDIC insurance assessment rate decreased dramatically for all banks beginning June 1, 1995 through the remainder of the year. In addition, all insured banks received a FDIC premium rebate in September 1995. As a result, total deposit insurance costs for the Company declined by $323,000 or 41.8% in 1995. The FDIC insurance assessment in 1996 is anticipated to be $2,000 which will have a favorable impact on earnings in 1996. Increases in other non-interest expenses are the result of normal inflationary increases or due to additional volume from growth in numbers of accounts processed. Table 6 summarizes the changes in the major categories of non- interest expense.\nPENNROCK FINANCIAL SERVICES CORP.\nTable 6 - Non-interest Expense\nPROVISION FOR INCOME TAXES:\nIncome tax expense totaled $2.1 million in 1995 compared with $2.3 million in 1994 and 1993. The statutory federal tax rate was 34% each year. The Company's effective tax rate was 25.8% in 1995 compared with 27.9% in 1994 and 1993. The primary reason for the decline in the effective tax rate is due to an increase in tax exempt income. For a more comprehensive analysis of income tax expense, refer to Note 12 of the Notes to Consolidated Financial Statements.\nIn February 1992, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard No. 109 (SFAS 109), \"Accounting for Income Taxes.\" The Company adopted the provisions of SFAS 109 effective January 1, 1993 (see Note 1 of the Notes to Consolidated Financial Statements). As permitted under the Statement, the Company has elected not to restate the financial statements of prior years. There was no effect from the adoption of SFAS 109 on pretax income from continuing operations. The cumulative effect as of January 1, 1993 of adopting SFAS 109 increased net income by $410,000 or $.07 per share.\nUnder SFAS 109, the liability method is used in accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. Prior to the adoption of the Statement, 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.\nPENNROCK FINANCIAL SERVICES CORP.\nFINANCIAL CONDITION\nSOURCES AND USES OF FUNDS:\nTable 7 examines the Company's financial condition in terms of its sources and uses of funds. Average funding uses increased $67.3 million or 16.1% in 1995 compared with an increase of $28.8 million or 7.4% in 1994.\nTable 7 - Sources and Uses of Funds\nSECURITIES AND SHORT-TERM INVESTMENTS:\nAs of January 1, 1994, with the adoption of SFAS 115, the entire security portfolio was transferred to the securities available-for-sale (AFS) category on the balance sheet at fair value to reflect the Company's active management of the portfolio in response to changes in interest rates, liquidity needs, expectation of changes in the prepayment speeds on mortgage-backed securities and the exercise of call options on municipal and agency bonds and other asset- liability management decisions. As a result, AFS securities increased by $4.4 million to reflect the net unrealized appreciation in the portfolio. The net unrealized gain, net of tax, of $2.9 million was recorded as a separate component of Stockholders' Equity. By December 31, 1994, after a rapid rise in market rates during the year, the fair value of the AFS portfolio had declined\nPENNROCK FINANCIAL SERVICES CORP.\nto a net unrealized loss of $9.1 million. As discussed in Note 3 of the Notes to Consolidated Financial Statements, the FASB has permitted a one-time reassessment of the appropriateness of the designations between the AFS and held - -to-maturity (HTM) portfolios without calling into question the intent to hold other debt securities to maturity. Accordingly, in the fourth quarter of 1995, the Company transferred all of the investment security portfolio which had been classified as HTM consisting of debt securities with an amortized cost of $15.4 million and a net unrealized gain of $302,000 to the AFS portfolio. At December 31, 1995, the Company had no securities classified HTM. The AFS portfolio had a net unrealized gain of $1.2 million. Table 8 indicates the composition and maturity of the securities available for sale portfolio at December 31, 1995. For mortgage-backed securities, maturity is based on expected average lives rather than contractual maturity.\nTable 8 - Analysis of Securities Available for Sale\nMeasured on an amortized cost basis, average securities and short-term investments in the aggregate, increased $9.9 million or 5.0% during 1995 and by $28.7 million or 17.1% in 1994. As of December 31, 1995, AFS securities at fair value totaled $196.0 million compared with $191.9 million at the end of 1994. Investment securities classified as HTM totaled $16.1 million at the end of 1994. There were no investment securities classified as HTM at the end of 1995. During 1995, the Company sold $65.0 million in securities and purchased $57.7 million. In addition, $15.3 million was received from maturities of securities and principal repayments on mortgage-backed securities.\nAt December 31, 1995, the AFS portfolio had a net unrealized gain of $1.2 million consisting of gross unrealized gains of $2.3 million and gross unrealized losses of $1.1 million. At December 31, 1994, the total portfolio had a net unrealized loss of $9.7 million consisting of gross unrealized gains of $.4 million and gross unrealized losses of $10.1 million. Market values of\nPENNROCK FINANCIAL SERVICES CORP.\nthe portfolio increased during 1995 as market interest rates on investments fell for most of the year. The portfolio has an average life of approximately seven years. As a reference, treasury yields in the seven-year maturity range declined 236 basis points from 7.83% at the beginning of 1995 to 5.47% by year end. This caused the total portfolio market value, which moves in the opposite direction as interest rates, to increase a total of $10.9 million. Included in the portfolio are state and municipal securities, mortgage-backed securities (including adjustable rate mortgage-backed securities) and collateralized mortgage obligations (CMO's) which may be called, prepaid or reprice before final maturity. The average life to call or repricing of the portfolio was 3.7 years at December 31, 1995.\nAt December 31, 1995, the Company had $134.0 million invested in mortgage-backed pass-through securities and CMO's compared with $154.0 million at December 31, 1994. A mortgage-backed pass-through security depends on an underlying pool of mortgage loans to provide a cash flow pass-through of principal and interest. The Company had $51.3 million in mortgage-backed pass-through securities at December 31, 1995 of which $40.8 million were adjustable rate and $10.5 million were fixed rate securities. A CMO is a mortgage-backed security that is comprised of classes of bonds created by prioritizing the cash flows from the underlying mortgage pool in order to meet different objectives of investors. The Company had $82.7 million in CMO securities at December 31, 1995 all of which were fixed rate securities. The CMO securities held by the Company are shorter-maturity class bonds which have relatively low levels of prepayment risk. In addition, none of the CMO's in the portfolio were considered \"high risk CMO's\" as defined by banking regulations. All CMO's and mortgage-backed pass-through securities were issued or backed by Federal agencies.\nLOANS:\nTable 9 presents loans outstanding, by type of loan, for the past five years. Loans increased from year-end 1994 to year-end 1995 by $58.1 million or 24.2%, compared with a $31.5 million or 15.1% increase from year-end 1993 to year-end 1994. Most of this growth was realized in commercial real estate loans which grew $20.5 million or 23.8% and residential mortgage loans, primarily home equity loans, which grew $18.6 million or 21.8% in 1995. Also during 1995, the Company originated $27.3 million in salable residential mortgage loans and sold $26.2 million The Company's policy is to retain servicing on all mortgages sold.\nPENNROCK FINANCIAL SERVICES CORP.\nTable 9 - Loans Outstanding, Net of Unearned Income\nTable 10 - Loan Maturities and Interest Sensitivity (1)\nNON-PERFORMING ASSETS:\nTable 11 shows the Company's non-performing loans for the five years ended December 31, 1995. The Company's policy is to discontinue the accrual of interest on loans for which the principal or interest is past due 90 days or more unless the loan is well secured and corrective action has begun or the loan is in the process of collection. When a loan is placed on non-accrual status, any unpaid interest is charged against income.\nPENNROCK FINANCIAL SERVICES CORP.\nTable 11 - Non-Performing Assets\nLoans which are not considered non-performing and are current as to payments of principal and interest but have a somewhat higher than normal risk of becoming non-performing in the future are estimated to total $4.7 million at December 31, 1995, compared with $6.2 million at December 31, 1994 and $6.9 million at December 31, 1993.\nAt December 31, 1994, the Company did not have any loan concentrations exceeding 10% of total loans to any particular economic group or industry. The loan portfolio is well diversified as to industry and companies within each industry which helps minimize risk. Loan quality is maintained through diversification of risk, strict credit control practices and continued monitoring of the loan portfolio. At December 31, 1995, the Company did not have any loans outstanding to any foreign entity or government.\nOther real estate owned (OREO) amounted to $276,000 at December 31, 1995 and was included in other assets on the Consolidated Balance Sheets. At December 31, 1994, OREO totaled $1,431,000 with a valuation reserve of $383,000. Valuation reserves are established for OREO properties whenever estimated current realizable values fall below the original fair value recorded.\nALLOWANCE FOR LOAN LOSSES:\nThe allowance for loan losses (Table 12) is based on Management's evaluation of historical and anticipated loan loss expense, analysis of non-performing and delinquent loans, prevailing and anticipated economic conditions, and banking industry standards. The allowance is established at a level considered by Management to be adequate to absorb potential future losses contained in the portfolio and is monitored on a continuous basis with independent formal reviews conducted semiannually. The allowance is increased by provisions charged to operating expense and reduced by net charge-offs.\nPENNROCK FINANCIAL SERVICES CORP.\nTable 12 - Allowance for Loan Losses\nThe allowance for loan losses totaled $3.7 million at December 31, 1995, an increase of 5.1% from 1994. The allowance for loan losses as a percentage of year-end loans was 1.23% at December 31, 1995 and 1.45% at December 31, 1994. The provision for loan losses exceeded net charge-offs by $179,000 in 1995, by $21,000 in 1994 and by $56,000 in 1993. The allowance for loan losses as a percentage of non-performing loans was 295.96% at December 31, 1995 and 329.11% at December 31, 1994.\nCharge-offs decreased from $1,052,000 in 1993 to $461,000 in 1994 to $225,000 in 1995. Recoveries of loans previously charged-off decreased from $150,000 in 1993 to $130,000 in 1994 to $44,000 in 1995. The ratio of net charge-offs to average loans decreased from .43% in 1993 to .15% in 1994 to .07% in 1995.\nPENNROCK FINANCIAL SERVICES CORP.\nTable 13 presents the allocation of the allowance for loan losses by major loan category for the past five years. The specific allocations in any particular category may prove to be excessive or inadequate to absorb future charge-offs and may be reallocated in the future to reflect changing conditions. Accordingly, the entire allowance is considered available to absorb losses in any category.\nTable 13 - Allocation of Allowance for Loan Losses\nIn May 1993, the FASB issued Statement of Financial Accounting Standard No. 114 (SFAS 114), \"Accounting by Creditors for the Impairment of a Loan.\" In October 1994, the FASB issued Statement of Financial Accounting Standard No. 118 (SFAS 118) \"Accounting by Creditors for the Impairment of a Loan - Income Recognition and Disclosures\" which amended SFAS 114. SFAS 114 and SFAS 118 are effective for years beginning after December 15, 1994. Accordingly, the Company adopted the provisions of SFAS 114 and SFAS 118 as of January 1, 1995. These statements are applicable to all creditors and to all loans, uncollateralized as well as collateralized, except for large groups of smaller balance homogenous loans that are collectively evaluated for impairment (e.g., credit card, residential mortgage and consumer installment loans), loans measured at fair value or at the lower of cost or fair value, leases and debt securities.\nUnder SFAS 114, a loan is impaired when it is probable that a creditor will be unable to collect all amounts due (including interest and principal) according to the contractual terms of the loan agreement. When a loan is impaired, a creditor must measure the extent of that impairment by determining the present value of the expected future cash flows on the loan discounted at the loan's effective interest rate or by using either the loan's observable market price or the fair value of the loan's collateral if the loan is collateral dependent. If the value of the impaired loan, measured in accordance with these methods, is less than the recorded balance of the loan, a creditor must recognize the impairment by creating a valuation allowance for the difference and recording a corresponding bad debt expense.\nPENNROCK FINANCIAL SERVICES CORP.\nAs of December 31, 1995, the balance of impaired loans was $758,000 and the allowance for loan losses on those loans was $217,000.\nLIQUIDITY:\nThe purpose of liquidity management is to ensure that there are sufficient cash flows available to meet a variety of needs. These include financial commitments such as satisfying the credit needs of our borrowers and withdrawals by our depositors, the ability to capitalize on investment and business opportunities as they occur, and the funding of the Company's own operations. Liquidity is measured by the Company's ability to convert assets to cash at a reasonable cost or a minimum loss. Liquidity is provided by maturities and sales of investment securities (Table 8), loan payments and maturities (Table 10), liquidating money market investments such as federal funds sold, and the Company's dividend reinvestment plan. In addition, the Company is a member of the Federal Home Loan Bank of Pittsburgh which provides a reliable source of long and short-term funds. However, the Company's primary source of liquidity lies in the Company's ability to renew, replace and expand its base of core deposits (consisting of demand, NOW, money market and cash management accounts, savings accounts, certificates of deposit, and other time deposits less than $100,000).\nTotal deposits increased $75.5 million or 22.0% in 1995 compared with $.8 million or .2% in 1994. $38.1 million of the increase in 1995 is attributable to the acquisition of three PNC offices. Table 14 reflects the changes in the major classifications of deposits by comparing the year-end balances for the past five years. Table 15 reflects the maturity of large dollar deposits.\nTable 14 - Deposits by Major Classification\nPENNROCK FINANCIAL SERVICES CORP.\nTable 15 - Maturity of Time Deposits of $100,000 or More\nThe Bank maintains lines of credit with various correspondent banks to use as sources of short-term funds in addition to repurchase agreements with bank customers. Federal funds purchased and securities sold under agreements to repurchase increased from $13.0 million at December 31, 1994 to $40.6 million at December 31, 1995. The Bank also maintains a line of credit with the Federal Home Loan Bank of Pittsburgh. Advances on this line of credit totaled $39.1 million at December 31, 1994. There were no line advances outstanding at December 31, 1995. The Bank also had $6.5 million in short-term adjustable rate borrowings at December 31, 1995. The level of short-term borrowings depends on loan growth, deposit growth, current market rates and other factors. The average cost of short-term borrowings increased from 3.07% in 1993 to 4.55% in 1994 to 6.09% in 1995. Table 16 shows the Company's short-term borrowings for the five years ended December 31, 1995.\nTable 16 - Short-Term Borrowings\nThe cash proceeds of $30.4 million from the assumption of the deposit liabilities net of assets acquired and deposit premium paid for the PNC branch purchase discussed above were applied against short-term borrowings.\nPENNROCK FINANCIAL SERVICES CORP.\nCAPITAL RESOURCES:\nTotal stockholders' equity increased $11.8 million or 29.5% from 1994. $6.8 million of the increase is attributable to the effect of SFAS 115 on equity. At December 31, 1994, the unrealized loss on AFS securities net of tax effect totaled $6.0 million. At December 31, 1995, there was an unrealized gain on AFS securities, net of tax effect, of $769,000.\nOn June 27, 1995, the Company announced that the Board of Directors had authorized the purchase of up to 200,000 shares of its outstanding common stock. The shares are to be used for general corporate purposes including employee benefit and executive compensation plans or for the dividend reinvestment plan. During 1995, the Company repurchased 20,000 shares for $374,000. Of these shares, 19,421 were reissued in connection with the Company's dividend reinvestment plan and 579 remained as treasury shares on December 31, 1995 at the Company's cost.\nThe ratio of average equity to average assets was 9.00% in 1995, compared with 9.49% in 1994, and 9.26% in 1993. The ratio of average equity to average assets net of the SFAS 115 adjustment in 1995 was 9.62% and 9.83% in 1994. Internal capital generation is calculated by multiplying return on average equity by the percentage of earnings retained. Internal capital generation amounted to 8.03% in 1995, 8.43% in 1994 and 11.3% in 1993.\nBank and bank holding company minimum regulatory capital requirements have been revised to make regulatory capital more sensitive to individual differences in credit risk profiles (including off-balance-sheet risks). Risk based capital is segregated into two components, Tier 1 capital which includes stockholders' equity reduced by goodwill, and Tier 2 capital which includes the allowance for loan losses (subject to limitations) and qualifying debt obligations. In December 1994, federal banking regulators issued rulings which excluded the net unrealized holding gains and losses on AFS securities from the calculation of Tier 1 capital. Net unrealized losses on marketable equity securities will continue to deducted from Tier 1 capital. The rule has the effect of valuing AFS securities at amortized cost rather than fair value for purposes of calculating risk-based and leverage capital ratios. The minimum leverage capital requirement is 3% and is determined by dividing Tier 1 capital by average assets. Banking organizations must adjust their assets and off-balance sheet exposures by assigning risk-weighted percentages depending on regulatory defined credit risks. Off-balance-sheet assets must be converted to credit equivalents before being risk weighted. These balances are then added to determine total risk weighted assets. Table 17 shows the Company's capital resources for the past three years. The Company and the Bank exceed all minimum capital guidelines and are considered \"well capitalized.\"\nPENNROCK FINANCIAL SERVICES CORP.\nTable 17 - Capital Resources\nOn October 23, 1995, the FASB issued Statement of Financial Accounting Standard No. 123 (SFAS 123), \"Accounting for Stock-Based Compensation.\" This Statement provides accounting and reporting standards for stock-based employee compensation plans and also applies to transactions in which the Company acquires goods and services from non-employees in exchange for the Company's equity instruments. SFAS 123 defines a fair value based method of accounting for an employee stock option or similar equity instrument and encourages all entities to adopt that method of accounting for all employee stock compensation plans. Entities electing to remain with the accounting treatment outlined in APB Opinion No. 25, \"Accounting for Stock Issued to Employees\" are required to make pro forma disclosures of net income and earnings per share, as if the fair value method had been adopted. The accounting and disclosure requirements of this Statement are effective for transactions entered into in fiscal years beginning after December 15, 1995. The Company plans to adopt the provisions of SFAS 123 on January 1, 1996. The adoption of this statement is not expected to have a material impact on the consolidated financial statements.\nINTEREST RATE RISK:\nInterest rate risk refers to the Company's degree of exposure to loss of earnings and market value of equity resulting from changes in market interest rates. The magnitude of this exposure depends on the severity and timing of the market rate changes and on Management's ability to adjust.\nEffective interest rate risk management protects the Company's earnings and the market value of equity from large and unexpected interest rate changes. However, management may sometimes structure the balance sheet to take advantage of expected interest rate movements. Mismatches of maturities of assets and liabilities within a specific time frame is referred to as a rate sensitivity gap. If more assets than liabilities mature or reprice within the time frame, the Company is asset sensitive. If more liabilities mature or reprice, the Company is liability sensitive. An asset sensitive gap will benefit the Company in a period of rising rates while a liability sensitive gap will benefit the Company during declining rates. Gap analysis has certain limitations because it does not take into consideration the varying degrees of interest rate\nPENNROCK FINANCIAL SERVICES CORP.\nsensitivity or speed at which different assets and liabilities can reprice. While management continuously monitors and adjusts the gap position to maximize profitability, the primary objective is to maintain net interest income and market value of equity within self-imposed parameters for a wide range of possible changes in interest rates. Table 18 presents an interest sensitivity analysis of the Company's assets and liabilities at December 31, 1995. Although interest bearing demand and savings deposits have been relatively rate insensitive and have maintained stable balances through several interest rate cycles, because they are subject to immediate withdrawal, they have been presented as repricing in the earliest period.\nTable 18 - Interest Sensitivity Analysis\nPENNROCK FINANCIAL SERVICES CORP.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe following audited consolidated financial statements are set forth in this Annual Report of Form 10-K on the following pages:\nPennRock Financial Services Corp. and Subsidiary Independent Auditors' Report Consolidated Balance Sheets Consolidated Statements of Income Consolidated Statements of Stockholders' Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Stockholders PennRock Financial Services Corp.\nWe have audited the accompanying consolidated balance sheets of PennRock Financial Services Corp. and subsidiary as of December 31, 1995 and 1994, and the related consolidated statements of income, stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 1995. 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 consolidated financial position of PennRock Financial Services Corp. and subsidiary as of December 31, 1995 and 1994, and the consolidated results of their operations and their consolidated cash flows for each of the years in the three-year period ended December 31, 1995 in conformity with generally accepted accounting principles.\n\/S\/ SIMON LEVER & COMPANY\nJanuary 26, 1996 Lancaster, Pennsylvania\nPENNROCK FINANCIAL SERVICES CORP. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS\nPENNROCK FINANCIAL SERVICES CORP. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF INCOME\nPENNROCK FINANCIAL SERVICES CORP. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY\nPENNROCK FINANCIAL SERVICES CORP. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS\nPENNROCK FINANCIAL SERVICES CORP.\nNOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPennRock Financial Services Corp. and Subsidiary provide banking services to domestic markets. The accounting and reporting policies of PennRock Financial Services Corp. and Subsidiary conform to generally accepted accounting principles and to general practices within the banking industry. The following is a description of the more significant of those policies:\nPrinciples of Consolidation: The consolidated financial statements include the accounts of PennRock Financial Services Corp. and its subsidiary, Blue Ball National Bank. All significant intercompany balances and transactions have been eliminated.\nEstimates: 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 during the reporting period. Actual results could differ significantly from those estimates.\nCash Equivalents: Cash equivalents include amounts due from banks, federal funds sold and other short-term investments. Generally, federal funds are purchased and sold for one - -day periods.\nMortgages Held for Sale: Mortgages held for sale are carried at the lower of aggregate cost or market value with market determined on the basis of open commitments for committed loans. For uncommitted loans, market is determined on the basis of current delivery prices in the secondary mortgage market. Resulting unrealized losses are included in other income.\nSecurities: Securities are classified in one of three categories and are accounted for as follows:\nInvestment securities: Securities classified as held to maturity are those debt securities the Company has both the intent and ability to hold to maturity regardless of changes in market conditions, liquidity needs or changes in general economic conditions. These securities are carried at cost adjusted for amortization of premium and accretion of discount, computed by the interest method over their contractual lives.\nSecurities available for sale: Securities classified as available for sale are those debt securities that the Company intends to hold for an indefinite period of time but not necessarily to maturity and all equity securities. Any decision to sell a security classified as available for sale would be based on various factors, including significant movements in interest rates, changes in maturity mix of the Company's assets and liabilities, liquidity needs, regulatory capital considerations, and other similar factors. Securities available for sale are carried at fair value. Unrealized gains or losses are reported as increases or decreases in stockholders' equity, net of the related deferred tax effect.\nPENNROCK FINANCIAL SERVICES CORP.\nTrading securities: Trading securities, which are generally held for the short term, usually under 30 days, in anticipation of market gains, are carried at fair value. Realized and unrealized gains and losses on trading account assets are included in non- interest income on trading account securities. The Company has no securities classified as trading securities.\nA decline in the market value of any security available for sale or investment security below cost that is deemed to be other than temporary is charged to income resulting in the establishment of a new cost basis for the security.\nPurchase premiums and discounts on securities are amortized and accreted to interest income using a method which approximates a level yield over the period to maturity of the related securities. Purchase premiums and discounts on mortgage-backed securities are amortized and accreted to interest income using a method which approximates a level yield over the remaining lives of the securities, taking into consideration assumed prepayment patterns. Interest and dividend income are recognized when earned. Realized gains and losses for securities are included in income and are derived using the specific identification method for determining the costs of securities sold.\nLoans: Loans are carried at the principal amount outstanding, net of unearned income reduced by any charge-offs or specific valuation accounts. Interest income is accounted for on an accrual basis. Loan fees, net of certain origination costs are deferred and amortized over the lives of the underlying loans using a method which approximates a level yield. Interest income is generally not accrued when, in the opinion of management, its full collectibility is doubtful or when the loan becomes past due 90 days as to principal or interest. When a loan is designated as non-accrual, any accrued interest receivable is charged against current earnings.\nAllowance for Loan Losses: As discussed in Note 3 to the consolidated financial statements, the Company adopted Statement of Financial Accounting Standard No. 114 (SFAS 114), \"Accounting by Creditors for Impairment of a Loan,\" as amended by Statement of Financial Accounting Standard No. 118 (SFAS 118), \"Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures.\" Under these standards, the Company estimates losses on impaired loans based on the present value of expected cash flows or the fair value of the underlying collateral if the loan repayment is expected to come from the sale of such collateral. Prior to 1995, credit losses related to these loans were estimated based on undiscounted cash flows or the fair value of the underlying collateral. The adoption of these standards did not have a material impact on the consolidated financial statements.\nThe allowance for loan losses is maintained at a level believed adequate by Management to absorb potential losses in the loan portfolio. Management's determination of the adequacy of the allowance is based on an evaluation of the portfolio, past loan loss experience, current domestic economic conditions, volume, growth and composition of the loan portfolio, and other relevant factors. This evaluation is inherently subjective as it requires material estimates, including the amounts and timing of expected future cash flows on impaired loans, which may be susceptible to significant change. The allowance\nPENNROCK FINANCIAL SERVICES CORP.\nfor loan losses on impaired loans pursuant to SFAS 114 is one component of the methodology for determining the allowance for loan losses. Loan losses are charged directly against the allowance for loan losses, and recoveries on previously charged off loans are added to the allowance. The allowance is increased by provisions for loan losses charged against income.\nOther Real Estate Owned: Other real estate owned represents properties acquired through customers' loan defaults. When properties are acquired through foreclosure, any excess of the loan balance at the time of foreclosure over the fair value of the real estate held as collateral is recognized as a loss and charged to the allowance for loan losses. After foreclosure, other real estate is reported at the lower of fair value at acquisition date or fair value less estimated disposal costs. Fair value is determined on the basis of current appraisals obtained from independent sources. Subsequent write-downs are charged to an allowance for other real estate established through provisions for other real estate expenses. Costs of improvements to other real estate are capitalized while costs associated with holding other real estate are charged to operations. Other real estate owned is recorded as other assets in the consolidated balance sheet.\nBank Premises and Equipment: Bank premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed on straight line and accelerated methods based on the estimated useful lives of the assets. When assets are retired or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts and any resulting gain or loss is reflected in income for the period. Maintenance, repairs, and minor improvements are expensed as incurred. Significant renewals and betterments are capitalized.\nDeposit Premium: The deposit premium is the excess of the value of deposit liabilities assumed over cash received for the assumption of those liabilities for branch offices acquired through business combinations that are recorded using the purchase method of accounting. Included in other assets is $1.0 million of deposit premiums at December 31, 1995. There was no recorded deposit premiums at December 31, 1994. The deposit premium is being amortized using the straight- line method over 10 years.\nTrust Assets: Assets held by the Bank in a fiduciary or agency capacity are not included in the consolidated financial statements since such assets are not assets of the Bank. In accordance with banking industry practice, income from fiduciary activities is generally recognized on a cash basis which is not significantly different from amounts that would have been recognized on the accrual basis.\nFederal Income Taxes: In February 1992, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 109, \"Accounting for Income Taxes\". The Statement requires a change from the deferred method of accounting for income taxes of Accounting Principles Board (APB) Opinion 11 to the asset and liability method in computing income tax expense for financial reporting purposes. 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\nPENNROCK FINANCIAL SERVICES CORP.\ntheir 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. 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 Company adopted Statement No. 109 in 1993 and has applied those provisions as of January 1, 1993.\nAt December 31, 1995, management has determined the deferred tax assets are fully realizable due to sufficient income taxes paid in 1993, 1994 and 1995. Accordingly, no valuation allowance has been established against the deferred tax assets.\nTreasury Stock: The purchase of Company's treasury stock is recorded at cost. At the date of subsequent reissue, the treasury stock account is reduced by the cost of such stock on a first-in, first-out method.\nProfit Sharing Plan: Profit sharing contributions are calculated by a formula approved by the Board of Directors and is based on the Bank's return on equity. Costs are funded as accrued.\nNet Income per Share: Net income per share is computed based on the weighted average number of shares of stock outstanding during the year. Retroactive effect is given to stock dividends and stock splits.\nMortgage Banking Activities: Fees for servicing loans for investors are based on the outstanding principal balance on the loans serviced. Fees are recognized as earned and are included in the consolidated statements of income under other income.\nReclassifications: Certain reclassifications have been made to the 1993 consolidated financial statements to conform with the 1994 presentation. Such reclassifications had no effect on net income or stockholders' equity.\nNOTE 2: ACQUISITIONS\nOn January 27, 1995, the Bank acquired three branch offices of PNC Bank, NA (PNC). In connection with the transaction, the Bank assumed $38.1 million in deposits and purchased $6.7 million in assets including consumer loans, vault cash, furniture and equipment and real estate and improvements. In consideration for the assumption of the deposit liabilities, the Bank paid PNC a deposit premium of $1.1 million or 2.8%.\nPENNROCK FINANCIAL SERVICES CORP.\nNOTE 3: ACCOUNTING CHANGES\nThe Company adopted the provisions of Statement of Financial Accounting Standard No. 115 (SFAS 115) effective January 1, 1994. The entire investment portfolio was transferred to the available for sale category on the balance sheet. As a result, available for sale securities increased by $4.4 million to reflect the net unrealized appreciation in the portfolio. The net unrealized gain, net of tax, of $2.9 million was recorded as a separate component of Stockholders' Equity.\nOn November 15, 1995, the Financial Accounting Standards Board (FASB) issued a Special Report, \"A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities.\" In this report, the FASB permitted a one-time reassessment of the appropriateness of the designations of all securities held at the time of the issuance of the Special Report. Debt securities transferred from the investment security portfolio to the available for sale portfolio under the guidance of the Special Report would not call into question intent to hold other debt securities to maturity. Accordingly, in the fourth quarter of 1995, the Company transferred all of the investment security portfolio consisting of debt securities with an amortized cost of $15.4 million and a net unrealized gain of $302,000 to the available for sale portfolio. At December 31, 1995, the Company had no securities classified as held to maturity.\nOn January 1, 1995, the Company adopted Statement of Financial Accounting Standard No. 114 (SFAS 114), \"Accounting by Creditors for Impairment of a Loan\" and Statement of Financial Accounting Standard No. 118 (SFAS 118), \"Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures.\" SFAS 114 addresses the accounting by creditors for impairment of certain loans. SFAS 114 requires that impaired loans that are within the scope of the Statement be measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or, at the loan's market price or the fair value of the collateral if the loan is collateral dependent. SFAS 118 amends SFAS 114 to allow a creditor to use existing methods for recognizing interest income on an impaired loan and to require additional disclosures on interest income recognition related to impaired loans.\nAll impaired loans have a related allowance for loan losses balance associated with the loan. The impaired loans consist of loans where it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Interest income for impaired loans that are on non-accrual status is recognized using the cash basis, while interest income on impaired loans that are still accruing is recognized using the accrual method. On December 31, 1995 the balance of impaired loans was $758,000 and the allowance for loan losses on those loans was $217,000.\nNOTE 4: RESTRICTIONS ON CASH AND DUE FROM BANKS\nThe Bank is required to maintain average balances of reserves on deposit with the Federal Reserve Bank based on deposits outstanding. The average amount of those required reserve balances at December 31, 1995 was approximately $4,537,000. Balances maintained at the Federal Reserve Bank are included in cash and due from banks.\nPENNROCK FINANCIAL SERVICES CORP.\nNOTE 5: SECURITIES AVAILABLE FOR SALE\nThe amortized cost and estimated market value of securities available for sale are as follows:\nThe amortized cost and fair value of debt securities as of December 31, 1995, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because issuers may have the right to call obligations and mortgages underlying the mortgage-backed securities may be prepaid without any penalties.\nPENNROCK FINANCIAL SERVICES CORP.\nGains and losses from sales of securities available for sale are as follows:\nProceeds from sales of securities available for sale are as follows:\nPENNROCK FINANCIAL SERVICES CORP.\nNOTE 6: INVESTMENT SECURITIES\nThe amortized cost and estimated market value of investment securities are as follows:\nThere were no securities classified as held to maturity at December 31, 1995.\nNo securities classified as held to maturity were sold during 1995 or 1994 or 1993.\nInvestment and available for sale securities with a carrying value of $23,213,000 and $28,032,000 at December 31, 1995 and 1994 were pledged to secure public and trust deposits, repurchase agreements as well as other purposes.\nNOTE 7: LOANS\nThe loan portfolio net of unearned income, at December 31, 1995 and 1994 is as follows:\nPENNROCK FINANCIAL SERVICES CORP.\nIn the ordinary course of business, the Bank has loan, deposit, and other transactions with its directors, their affiliated companies, executive management and their associates (as defined), collectively referred to as related parties. Such transactions are on substantially the same terms, including interest rates and collateral (with regard to loans), as those prevailing at the time for comparable transactions with others. Activity for the related party loans for the year ended December 31, 1995, was as follows:\nIncluded in the loan portfolio are loans on which the Bank has ceased the accrual of interest. Such loans amounted to $862,000 and $624,000 at December 31, 1995 and December 31, 1994, respectively. If interest income had been recorded on all non-accrual loans outstanding during the years 1995, 1994 and 1993, interest income would have been increased as shown in the following table:\nNOTE 8: LOAN SERVICING\nMortgage loans serviced for Federal National Mortgage Association and Federal Home Loan Mortgage Corporation are not included in the accompanying consolidated balance sheets. The unpaid principal balances of those loans at December 31, 1995 and 1994 were $201.0 million and $205.7 million, respectively.\nPENNROCK FINANCIAL SERVICES CORP.\nNOTE 9: ALLOWANCE FOR LOAN LOSSES\nChanges in the allowance for loan losses were as follows:\nAs discussed in Note 3 to the consolidated financial statements, the Company adopted SFAS 114 as of January 1, 1995. As of December 31, 1995, the Company had recognized impaired loans with a recorded investment of $758,000 in conformity with SFAS 114 as amended by SFAS 118. The average recorded investment in impaired loans during 1995 was $793,000. The total allowance for loan losses related to these loans was $217,000 at December 31, 1995. Interest income on impaired loans of $27,000 was recognized for cash payments received in 1995.\nNOTE 10: BANK PREMISES AND EQUIPMENT\nDetails of bank premises and equipment at December 31 are as follows:\nDepreciation and amortization expense was $861,000 in 1995, $620,000 in 1994 and $537,000 in 1993.\nPENNROCK FINANCIAL SERVICES CORP.\nAt December 31, 1995, the Bank was obligated under non-cancelable leases at two of its office locations. Future minimum rental payments remaining on these leases are:\nTotal lease payments were $74,000 in 1995, $108,000 in 1994 and $79,000 in 1993.\nNOTE 11: SHORT-TERM BORROWINGS\nFederal funds purchased, securities sold under agreements to repurchase and the treasury tax and loan note generally mature within one to ninety days from the transaction date. Advances from the Federal Home Loan Bank include short-term fixed and variable rate advances and advances from an established line of credit with no specific maturity date. The line of credit is equal to approximately 10% of the Bank's assets. These advances are collateralized by a security agreement covering qualifying mortgage loans and unpledged treasury, agency and mortgage-backed securities which at December 31, 1995 had a combined carrying value of $277 million.\nA summary of aggregate short-term borrowings is as follows for the years ended December 31, 1995, 1994 and 1993.\nNOTE 12: LONG-TERM DEBT\nLong-term debt consists of fixed and variable rate term advances from the Federal Home Loan Bank of Pittsburgh with maturity dates ranging from August, 1996 to January, 1999. All are collateralized by the security agreement described in Note 11.\nPENNROCK FINANCIAL SERVICES CORP.\nNOTE 13: DIVIDEND RESTRICTIONS AND OTHER CAPITAL TRANSACTIONS\nCertain restrictions exist regarding the ability of the bank subsidiary to transfer funds to the Company in the form of cash dividends. The approval of the Comptroller of the Currency is required if the total dividends declared by a national bank in any calendar year exceeds the bank's net profits (as defined) for that year combined with its retained net profits for the preceding two calendar years. Under this formula, the Bank can declare dividends in 1996 without approval of the Comptroller of the Currency of approximately $13,834,000 plus an additional amount equal to the Bank's net profit (as defined) for 1996 up to the date of any such dividend declaration.\nOn September 27, 1994, the Board of Directors declared a 3-for-2 stock split in the form of a 50% stock dividend which totaled 2,001,659 additional shares issued on November 22, 1994 to shareholders of record on October 25,1994. A cash dividend in lieu of additional shares of $10,896 was issued for fractional shares outstanding. On September 14, 1993, the Board of Directors declared a 3- for-2 stock split in the form of a 50% stock dividend which totaled 1,311,317 additional shares issued on November 22, 1993 to shareholders of record on October 25,1993. A cash dividend in lieu of additional shares of $10,069 was issued for fractional shares outstanding. All per share data have been retroactively restated to reflect the stock splits in 1994 and 1993.\nOn June 27, 1995, the Company announced that the Board of Directors had authorized the purchase of up to 200,000 shares of the outstanding common stock. The shares are to be used for general corporate purposes including employee benefit and executive compensation plans or for the dividend reinvestment plan. During 1995, the Company repurchased 20,000 shares for $374,000. On October 10, 1995, 19,421 of these shares were reissued for the company's dividend reinvestment plan.\nNOTE 14: INCOME TAXES\nAn analysis of the provision for income taxes included in the Statements of Income is as follows:\nPENNROCK FINANCIAL SERVICES CORP.\nA reconciliation between the provision for income taxes and the amount computed by applying the statutory federal income tax rate to income before provision for income taxes are as follows:\nDeferred taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax liabilities and assets as of December 31, 1995 and 1994 are as follows:\nIncluded in the table above is the recognition of unrealized gains and losses on certain investments in debt and equity securities accounted for under SFAS 115 for which no deferred tax expense or benefit was recognized in the consolidated statements of income.\nPENNROCK FINANCIAL SERVICES CORP.\nManagement believes that it is more likely than not that the net deferred tax asset of $505,000 will be realized since the Company has a long history of earnings and has a carryback potential greater than the deferred tax asset and is unaware of any reason that the Company would not ultimately realize this asset.\nNOTE 15: EMPLOYEE BENEFIT PLAN\nThe Bank has a noncontributory profit sharing plan covering substantially all full time employees. Contributions to the plan were $491,000 in 1995, $521,000 in 1994 and $569,000 in 1993.\nNOTE 16: STOCK OPTION PLAN\nThe Company has an Omnibus Stock Option Plan the terms of which permit the granting of non-qualified stock options, incentive stock options, stock appreciation rights, performance shares, performance units, and restricted stock to senior executives of the Company. The Board of Directors have granted the following incentive stock options at an exercise price equal to the market price at the date of the grant. Each of the incentive stock options vests and becomes exercisable one-half after three years and the balance after five years of date granted. All options have been adjusted to reflect stock splits since the date of grant.\nNone of these options were exercisable at December 31, 1995. A maximum of 1,125 shares will be exercisable at a share price of $11.67 in 1996.\nNOTE 17: COMMITMENTS AND CONTINGENT LIABILITIES AND CONCENTRATIONS OF CREDIT RISK\nThe Company's financial statements do not reflect various commitments and contingent liabilities which arise in the normal course of business and which involve elements of credit risk, interest rate risk and liquidity risk. These\nPENNROCK FINANCIAL SERVICES CORP.\nfinancial instruments include commitments to extend credit, standby letters of credit, guarantees, and liability for assets held in trust, which arise in the normal course of business. The Company uses the same credit policies in commitments and conditional obligations as it does for on-balance sheet instruments.\nA summary of the Company's commitments and contingent liabilities at December 31, 1995 and 1994 are as follows:\nCommitments to extend credit are agreements to lend to a customer to the extent that there is no violation of any condition established in the contract.\nCommitments 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 represent future cash requirements. Management evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained if deemed necessary by management upon extension of credit is based on a credit evaluation of the customer. Collateral held varies but may include accounts receivable; inventory; property, plant and equipment; and income producing commercial properties.\nStand-by letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The term of the letters of credit varies from one month to 24 months and may have renewal features. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. The Company holds collateral supporting those commitments for which collateral is deemed necessary.\nThe Company's exposure to possible loss in the event of non-performance by the other party to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual amount of the instruments.\nMost of the Company's business activity is with customers located within the Company's defined market area. Investments in state and municipal securities may also involve government entities within the Company's market area. The concentrations by loan type are set forth in Note 7. The distribution of commitments to extend credit approximates the distribution of loans outstanding. The Bank, as a matter of policy, does not extend credit to any single borrower or group of related borrowers in excess of 65% of its legal lending limit. At December 31, 1995, this limit was $4,773,000.\nPENNROCK FINANCIAL SERVICES CORP.\nNOTE 18: FAIR VALUE OF FINANCIAL INSTRUMENTS\nStatement of Financial Accounting Standard No. 107 (SFAS 107), \"Disclosures about Fair Value of Financial Instruments,\" requires disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions would significantly affect the estimates. Statement 107 excludes certain financial instruments and all non-financial instruments from its disclosure requirements.\nFair value estimates are based on existing on and off-balance sheet financial instruments without attempting to estimate the value of future business. The value of significant sources of income such as trust or mortgage banking operations have not been estimated. In addition, the tax effect relative to the recognition of unrealized gains and losses can have a significant impact on fair value estimates and have not been considered in any of the estimates. Accordingly, the aggregate fair value amounts do not represent the underlying value of the Company.\nThe following methods and assumptions were used by the Company in estimating the fair value of its financial instruments:\nCash and cash equivalents: The carrying amounts reported in the consolidated balance sheets for cash and short-term investments approximate their fair values.\nMortgages held for sale: The fair value of mortgages held for sale is estimated using current secondary market rates.\nSecurities: Fair values for securities are based on quoted prices, where available. If quoted prices are not available, fair values are based on quoted prices of comparable instruments.\nLoans: For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. The fair values of other loans are determined using estimated future cash flows, discounted at the interest rates currently being offered for loans with similar terms to borrowers with similar credit quality. The carrying amount of accrued interest receivable approximates its fair value.\nOff-balance-sheet instruments: For the Company's off-balance-sheet instruments consisting of commitments to extend credit and financial and performance standby letters of credit, the estimated fair value is the same as the instrument's contract or notional values since they are priced at market at the time of funding.\nPENNROCK FINANCIAL SERVICES CORP.\nDeposit liabilities: The fair values of deposits with no stated maturities, such as demand deposits, savings accounts, NOW and money market deposits equal their carrying amounts which represent the amount payable on demand. Fair values for fixed- rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.\nShort-term borrowings: The carrying amounts of federal funds purchased and securities sold under agreements to repurchase, advances from the Federal Home Loan Bank and other short-term borrowings approximate their fair values.\nLong-term debt: The fair values of the Company's long-term debt are estimated using discounted cash flow analyses, based on the Company's incremental borrowing rates for similar types of borrowing arrangements.\nAccrued interest payable: The fair value of accrued interest payable is estimated to be the current book value.\nPENNROCK FINANCIAL SERVICES CORP.\nAt December 31, 1995 and 1994, the estimated fair values of financial instruments based on disclosed assumptions are as follows:\nPENNROCK FINANCIAL SERVICES CORP.\nNOTE 19: PARENT COMPANY ONLY FINANCIAL INFORMATION\nThe following represents parent only condensed financial information of the Company:\nPennRock Financial Services Corp. (Parent Company Only) Condensed Balance Sheets\nPENNROCK FINANCIAL SERVICES CORP.\nPennRock Financial Services Corp. (Parent Company Only) Condensed Statements of Income\nPENNROCK FINANCIAL SERVICES CORP.\nPennRock Financial Services Corp. (Parent Company Only) Condensed Statements of Cash Flows\nPENNROCK FINANCIAL SERVICES CORP.\nNOTE 20: CONSOLIDATED QUARTERLY FINANCIAL DATA (Unaudited)\nPENNROCK FINANCIAL SERVICES CORP.\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\nInformation concerning directors and nominees for election to the Board of Directors is incorporated herein by reference to the Registrant's Proxy Statement for its annual meeting to be held on April 23, 1996 under the caption \"Information about Nominees and Continuing Directors\", and information concerning executive officers is included under Part I, Item 4A, \"Executive Officers of the Registrant\" of this report on Form 10-K.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION\nInformation concerning director compensation is incorporated herein by reference to the Registrant's Proxy Statement for its annual meeting to be held on April 23, 1996 under the caption \"Compensation of Directors\" and concerning executive compensation under the caption \"Executive Compensation and Related Matters,\" except that information appearing under the caption \"Board Report on Executive Compensation\" and information appearing under the caption \"Stock Performance Graph\" is not 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 is incorporated herein by reference to the Registrant's Proxy Statement for its annual meeting to be held on April 23, 1996, under the caption \"Voting of Shares and Principal Holders Thereof\" and concerning security ownership of management under the caption \"Information about Nominees and Continuing Directors.\"\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation under the caption \"Transactions with Directors and Executive Officers\" is incorporated herein by reference to the Registrant's Proxy Statement for its annual meeting to be held on April 23, 1996.\nPENNROCK FINANCIAL SERVICES CORP.\nPART IV\nItem 14.","section_14":"Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) 1. Financial Statements\nThe consolidated financial statements listed on the index to Item 8 of this Annual Report on Form 10-K are filed as a part of this Annual Report.\n(a) 2. Financial Statement Schedules\nAll schedules applicable to the Registrant are shown in the respective consolidated financial statements or in the notes thereto included in this Annual Report.\n(a) 3. Exhibits\n(3)(a) Article of Incorporation of the Corporation are filed as Exhibit 3(a) to Registration Statement Number 33-4328 on Form S-4 dated March 25, 1986 and are incorporated herein by reference.\n(3)(b) Bylaws of the Corporation are incorporated by reference to Exhibit 3(b) to Form 10-K for the year ended December 31, 1993.\n(10)(a) Omnibus Stock Plan is incorporated by reference to Exhibit A to Form 10-Q for the quarter ended March 31, 1992.\n(10)(b) Executive Compensation Bonus Plan is incorporated by reference to Exhibit 10(a) to Form 10-K for the year ended December 31, 1991.\n(10)(c) Executive Incentive Compensation Plan is incorporated by reference to Exhibit 10(c) to Form 10-K for the year ended December 31, 1994.\n(10)(d) Melvin Pankuch Deferred Compensation Plan Agreement\n(21) Subsidiaries of the Registrant\n(23) Independent Auditors' Consent\n(27) Financial Data Schedule\n(b) Reports on Form 8-K\nThere were no reports on Form 8-K filed in the fourth quarter of 1995.\nPENNROCK FINANCIAL SERVICES CORP. 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.\nPENNROCK FINANCIAL SERVICES CORP. (Registrant)\nDated: February 27, 1996 By \/s\/ Glenn H. Weaver ----------------------------------------- Glenn H. Weaver, President\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities indicated on the 27th of February, 1996.\nSignatures Title ----------- ------\n\/s\/ Norman Hahn Chairman and Director - ------------------------------- Norman Hahn\n\/s\/ Glenn H. Weaver President and Director - ------------------------------- Glenn H. Weaver\n\/s\/ Robert K. Weaver Secretary and Director - ------------------------------- Robert K. Weaver\n\/s\/ Melvin Pankuch Executive Vice President, - ------------------------------- Chief Executive Officer and Director Melvin Pankuch\n\/s\/ George B. Crisp Vice President and Treasurer - ------------------------------- (Principal Financial and Accounting George B. Crisp Officer)\n\/s\/ Dale M. Weaver Director - ------------------------------- Dale M. Weaver\n\/s\/ Aaron S. Kurtz Director - ------------------------------- Aaron S. Kurtz\n\/s\/ Robert L. Spotts Director - ------------------------------- Robert L. Spotts\n\/s\/ Elton Horning Director - ------------------------------- Elton Horning\n\/s\/ Lewis M. Good Director - ------------------------------- Lewis M. Good\nPENNROCK FINANCIAL SERVICES CORP.\nANNUAL REPORT ON FORM 10-K EXHIBIT INDEX YEAR ENDED DECEMBER 31, 1995\nPENNROCK FINANCIAL SERVICES CORP. BLUE BALL, PENNSYLVANIA\nSequentially Item Description Numbered Page ----- ----------- ------------- 3(a) Articles of Incorporation - filed as exhibit 3(a) to Registration Statement Number 33-4328 on Form S-4 dated March 25, 1986, and are incorporated herein by reference.\n3(b) Bylaws - filed as exhibit 3(b) to Form 10-K dated March 28, 1994, and are incorporated herein by reference.\n10(a) Omnibus Stock Plan - incorporated by reference to Exhibit A to Form 10-Q for the quarter ended March 31, 1992\n10(b) Executive Compensation Bonus Plan - incorporated by reference to Exhibit 10(a) to Form 10-K for the year ended December 31, 1991\n10(c) Executive Incentive Compensation Plan - incorporated by reference to Exhibit 10(c) to Form 10-K for the year ended December 31, 1994\n10(d) Melvin Pankuch Deferred Compensation Plan Agreement 68\n21 Subsidiaries of Registrant 80\n23 Independent Auditors' Consent 81\n27 Financial Data Schedules 82","section_15":""}
{"filename":"793733_1995.txt","cik":"793733","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nSkyWest, Inc. (the \"Company\"), through its wholly-owned subsidiary, SkyWest Airlines, Inc. (\"SkyWest\"), operates one of the larger regional airlines in the United States. SkyWest provides passenger and air freight service and completes over 550 daily flights to 48 cities in eleven western states. Pursuant to a joint marketing and code sharing agreement with Delta, SkyWest operates as The Delta Connection in SkyWest's markets. Management believes that during calendar year 1994, approximately 48% of SkyWest's passengers were interline passengers connecting with flights offered by Delta. With principal hubs located at the Los Angeles and Salt Lake City International Airports, SkyWest offers a convenient and frequent flight schedule designed to maximize connecting and origin-destination traffic. SkyWest currently operates a fleet of 54 turbo-prop aircraft and 8 regional jet aircraft.\nFounded in 1972, the Company has experienced significant growth and profitability since 1984. During the past five fiscal years, consolidated operating revenues have increased from $113.3 million in fiscal 1991 to $225.4 million in fiscal 1995. Total passengers carried by SkyWest have increased from approximately 1,169,000 to approximately 2,074,000 over the same period. In fiscal 1995, the Company achieved record levels of passengers carried, and record consolidated operating revenues of $225.4 million, net income was $13.7 million.\nThe Company, through two wholly-owned subsidiaries, is also engaged in various other transportation related businesses. Scenic Airlines, Inc. (formerly Aviation Services West, Inc.) (\"Scenic\") provides air tours and general aviation services to the scenic regions of northern Arizona and southern Utah and operates 57 aircraft. National Parks Transportation, Inc. (\"NPT\") provides car rental services through a fleet of Avis vehicles located at five airports served by SkyWest. In fiscal 1995, Scenic and NPT together accounted for approximately 18.5% and 11.9% of the Company's consolidated operating revenues and net income, respectively. Effective June 15, 1993, the Company through its wholly-owned subsidiary, Aviation Services West, Inc. (\"ASW\") consummated an agreement to acquire from an entity then known as Scenic Airlines, Inc. (\"Scenic Airlines\") the flight tour operations of Scenic Airlines. (See Acquisition of Scenic Airlines)\nJOINT MARKETING AND CODE SHARING AGREEMENT\nSince April 1987, SkyWest has operated as \"The Delta Connection\" in SkyWest's markets pursuant to the terms of a joint marketing and code sharing agreement with Delta Air Lines, Inc. (\"Delta\"). On July 1, 1990, the Company and Delta entered into a revised Delta Connection Agreement (the \"Delta Connection Agreement\") under which the Company coordinates with Delta to facilitate interline connections at the Los Angeles and Salt Lake City International Airports. At these two airports combined, Delta presently has more passenger enplanements and flight departures than any other carrier. The primary benefit of this affiliation is the use of the Delta designation code (DL) in listing flights in the Official Airline Guide and in the computerized reservation systems used throughout the industry. The Company's code sharing arrangement allocates to the Company a portion of the passenger fare on a formula or other basis, subject to periodic adjustments. The Company also participates in cooperative advertising and marketing activities with Delta, including Delta's Frequent Flyer Program, the Delta Meeting Network and Delta Dream Vacations.\nThe Company believes the arrangement created between SkyWest and Delta is similar to those which exist between other major and regional airlines. The Delta Connection Agreement is subject to termination in various circumstances, including upon 180 days' advance notice by either party for any or no reason. Delta currently owns 15.1% of the Company's outstanding common stock. Pursuant to a Stock Option Agreement between Delta and the Company, Delta holds preemptive rights and registration rights (two demand rights and unlimited \"piggy-back\" rights) with respect to the Common Stock owned by Delta, as well as the right to designate one nominee for the Company's Board of Directors, so long as Delta owns at least ten percent of all Common Stock.\nROUTES\nThe Company's flight schedules are structured to facilitate the connection of its passengers with flights of Delta at the airports it serves. The following table shows selected information about the cities served by SkyWest as of June 21, 1995.\n(1) Refers to the calendar year service was initiated. (2) Service is provided on a seasonal basis.\nSEASONALITY\nThe Company's operations are favorably affected by increased travel usually occurring in the summer months and are unfavorably affected by inclement weather which occasionally results in cancelled flights principally during the winter months. The business related to the flight tour operations of Scenic is seasonal in nature. A large percentage of Scenic's passengers are tourists visiting the Las Vegas and Grand Canyon areas during the summer months. During the first calendar quarter, the operations of Scenic are generally reduced as a result of decreased traffic.\nRECENT PUBLIC OFFERINGS\nOn June 21, 1993, the Company completed a public offering of 1,875,000 shares of common stock which generated net proceeds of $28,802,000 after deducting underwriting commissions and other expenses. On July 7, 1993, the underwriters executed an over allotment option for 219,250 shares of common stock which generated net proceeds of $3,412,000 after deducting underwriting commissions. On February 16, 1994, the Company completed another public offering of 1,150,000 shares of common stock which generated net proceeds of $33,456,000 after deducting underwriting commissions and other expenses. A portion of the proceeds were used to fund the acquisition of Scenic Airlines, to pay off certain long-term debt and to facilitate the acquisition of the Canadair Regional Jets. The balance is being used for general corporate purposes.\nGOVERNMENT REGULATION\nAll interstate air carriers, including SkyWest and Scenic, are subject to regulation by the FAA. The FAA requires operating, air worthiness and other certificates; FAA approval of personnel who may engage in flight, maintenance or operation activities; record keeping procedures in accordance with FAA requirements; and FAA approval of flight training and retraining programs.\nThe Company believes it is operating in material compliance with FAA regulations and holds all necessary operating and air worthiness certificates and licenses. The Company's flight operations, maintenance programs, record keeping\nand training programs are conducted under FAA approved procedures. The Company does not operate at any airports where landing slots are restricted.\nAll air carriers are required to comply with federal law and regulations pertaining to noise abatement and engine emissions. All air carriers are also subject to certain provisions of the Federal Communications Act of 1934, as amended, because of their extensive use of radio and other communication facilities. Management believes that the Company is in compliance in all material respects with these laws and regulations.\nCOMPETITION\nThe airline industry is highly competitive. The Company not only competes with other regional airlines, some of which are owned by or are operated as code sharing partners of major airlines, but also faces competition from major airlines on certain routes. SkyWest is the dominant regional airline operating out of the Salt Lake City International Airport. Competition in the southern California markets, which are serviced by SkyWest from its hub in Los Angeles, is particularly intense, with a large number of carriers in these markets. In its markets served from the Los Angeles International Airport, SkyWest's principal competitors include Mesa Airlines, Inc. (operating as \"Mesa Airlines\" and \"United Express\"), Wings West, Inc. (operating as \"American Eagle\"), and Trans States, Inc. (operating as \"USAir Express\"). The Company also faces indirect low-fare competition from carriers such as Southwest Airlines and Shuttle by United.\nThe Company believes that the principal competitive factors affecting decisions by travelers in SkyWest's markets are the frequency, convenience and reliability of flights and, to a lesser extent, the level of fares.\nEMPLOYEES\nAs of June 21, 1995, the Company employed 2,369 employees consisting of 771 pilots and flight attendants, 283 maintenance personnel, 1,065 customer service personnel, 61 reservation and marketing personnel, and 189 employees engaged in accounting, administration and other functions. The increase was primarily due to hiring pilots, flight attendants and customer service personnel for regional jet operations. The Company's employees are not represented by any union. The Company is aware, however, that collective bargaining group organization efforts among its employees occur from time to time and are expected to continue in the future. The Company has never experienced any work stoppages and considers its relationship with its employees to be very good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nFLIGHT EQUIPMENT\nAs of June 21, 1995, SkyWest owned or leased the following types of aircraft:\nSkyWest's aircraft are primarily turbo-prop, pressurized aircraft designed to operate more economically over short-haul routes with lower passenger load factors than larger jet aircraft. These factors make it economically feasible for SkyWest to provide high frequency service in markets with relatively low volumes of passenger traffic. Although the Metroliner aircraft has been a principal factor in the Company's historical growth, it does not provide the operating efficiencies and customer acceptance offered by the Brasilia aircraft. Management has effected a plan to eliminate these Metroliner aircraft by the end of fiscal 1997. As a result, the Company's turboprop fleet will consist entirely of Brasilia aircraft. Passenger comfort features of the Brasilia aircraft include stand-up headroom, a lavatory, overhead baggage compartments and flight attendant service. Fiscal year 1995 marked the introduction of the Canadair Regional Jet. As noted above, the Company operates eight of these aircraft and on stage lengths up to 800 miles. During fiscal 1995, the Company acquired five Brasilia aircraft and terminated two Metroliner long-term operating leases. The Company took delivery of one new Brasilia in June 1995. As part of the effort to upgrade its fleet of aircraft, the Company has agreed to acquire 21 Brasilia aircraft and related parts inventory and support equipment at an aggregate cost of approximately $158.0 million, including cost escalation provisions as of June 21, 1995. The Company is scheduled to take delivery of six of these aircraft in the remainder of fiscal 1996, and the remaining 15 in fiscal 1997.\nAs of June 21, 1995, the Company has also agreed to acquire two Canadair Regional Jets and related spare parts inventory and support equipment at an aggregate cost of approximately $36 million, including estimated cost escalations. Two Canadair Regional Jets were delivered during the fourth quarter of fiscal 1995 and two were delivered subsequent to March 31, 1995, and have been financed under long-term lease arrangements. The remaining two Canadair Regional Jets are scheduled for delivery in fiscal 1996.\nThe Company has also secured options to purchase an additional 10 Brasilia aircraft at fixed prices (subject to cost escalation and delivery schedules). These options are exercisable through fiscal 1999. Options to acquire an additional ten Canadair Regional Jets have been secured; five are exercisable through September 1995 and five are exercisable through July 1996. Any decision to acquire additional aircraft in the long-term will depend upon the Company's future operations, competitive forces, financial resources and other factors.\nGROUND FACILITIES\nEmployees of the Company perform substantially all routine airframe and engine maintenance and periodic inspection of equipment. Maintenance is performed primarily at facilities in Palm Springs, California and Salt Lake City, Utah. The Company owns a 56,600 square foot maintenance facility in Palm Springs, California and leases a 90,000 square foot aircraft maintenance and training facility at the Salt Lake International Airport. The facility consists of a 40,000 square foot maintenance hangar and 50,000 square feet of training and other facilities to support the Company's growing hub operations. The facility was constructed and is owned by the Salt Lake City Airport Authority. The Company is leasing the facility under an operating lease arrangement over a 36-year term.\nThe Company leases ticket counters, check-in, and boarding and other facilities in the passenger terminal areas in the majority of the airports it serves and staffs these facilities with Company personnel. Delta provides ticket handling and\/or ground support services for the Company in eight of the 48 airports it serves.\nThe Company's corporate headquarters are located in a newly constructed 63,000 square foot building in St. George, Utah. Management deems the Company's facilities as being suitable and necessary to support exisiting operations and facilities are adequate for the forseeable future.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is a party to routine legal proceedings incident to its business. In the opinion of management, none of such proceedings are 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\nNo matters were submitted to a vote of security holders during the fourth quarter of fiscal year 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nThe Company's Common Stock is traded over-the-counter and quoted in the NASDAQ National Market System under the symbol \"SKYW.\" At June 21, 1995, there were approximately 1,138 stockholders of record. Securities held of record do not include shares held in securities position listings. The following table sets forth the range of high and low closing sales prices for the Company's Common Stock.\nThe transfer agent for the Company's Common Stock is Zions First National Bank, Salt Lake City, Utah.\nIn fiscal 1995, the Board of Directors declared an annual dividend of $.08 per share and a special dividend of $.20 per share. In fiscal 1994, the Board of Directors declared an annual dividend of $.05 per share and a special dividend of $.010 per share.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe information required by this item is incorporated herein by reference to page 1 of the Company's Annual Report to Shareholders for the fiscal year ended March 31, 1995, furnished herewith to the Commission as Exhibit 13.1 to this report on Form 10-K.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION\nThe information required by this item is incorporated herein by reference to pages 10 through 14 of the Company's Annual Report to Shareholders for the fiscal year ended March 31, 1995, furnished herewith to the Commission as Exhibit 13.1 to this report on Form 10-K.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe consolidated financial statements of the Company included on pages 15 through 27 of the Company's Annual Report to Shareholders for the fiscal year ended March 31, 1995, furnished herewith to the Commission as Exhibit 13.1 to this report on Form 10-K, are incorporated by reference.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nAll items in Part III are incorporated by reference to the Company's Proxy Statement for its 1995 annual stockholders meeting to be held August 8, 1995, to be filed with the 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\n(a) Documents Filed:\n1. Financial Statements. The following consolidated financial statements of SkyWest, Inc., included in the Annual Report to Shareholders for the year ended March 31, 1995, are incorporated herein by reference in Item 8 of the Form 10-K.\n- Report of independent public accountants\n- Consolidated balance sheets as of March 31, 1995 and 1994\n- Consolidated statements of income for the years ended March 31, 1995, 1994 and 1993\n- Consolidated statements of stockholders' equity for the years ended March 31, 1995, 1994 and 1993\n- Consolidated statements of cash flows for the years ended March 31, 1995, 1994 and 1993\n- Notes to consolidated financial statements\n2. Financial Statement Schedules. The following consolidated financial statement schedule of SkyWest, Inc. is included in Item 14(d) hereof.\n- Report of independent public accountants on financial statement schedule\n- Schedule II -- Valuation and qualifying accounts\nAll other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are not applicable, and therefore have been omitted.\n(b) Reports on Form 8-K.\nThe Company did not file a report on Form 8-K during the quarter ended March 31, 1995.\n(c) Exhibits.\n- ----------------------\n(1) Incorporated by reference to Registration Statement on Form S-1, File No. 33-5823. (2) Incorporated by reference to Registrant's 10-Q filed for the quarter ended December 31, 1986. (3) Incorporated by reference to Registrant's Form 10-K filed for the year ended March 31, 1987. (4) Incorporated by reference to Registrant's Form 10-K filed for the year ended March 31, 1989. (5) Incorporated by reference to Registrant's Form 10-K filed for the year ended March 31, 1990. (6) Incorporated by reference to Registration Statement on Form S-8, File No. 33-41285. (7) Incorporated by reference to Registrant's Form 10-K filed for the year ended March 31, 1992. (8) Incorporated by reference to Registration Statement on Form S-2, File No. 33-61958. (9) Incorporated by reference to Registrant's For 10-K filed for the year ended March 31, 1994.\n(d) Financial Statement Schedule.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE\nTo SkyWest, Inc.:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in SkyWest, Inc.'s Annual Report to Shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated May 26, 1995. Our audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule listed in Item 14 (a)(2) is the responsibility of the Company's management and is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. 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 May 26, 1995\nSKYWEST, INC. AND SUBSIDIARIES\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS\nFOR THE YEARS ENDED MARCH 31, 1995, 1994 AND 1993\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.\nSKYWEST, INC.\nBy \/s\/ Jerry C. Atkin ------------------------------------------ Jerry C. Atkin Chairman, President and Chief Executive Officer\nPursuant to the requirement of the Securities Act of 1934, this report has been signed below by the following persons in the capacities and on the dates indicated.\nExhibit Index\nEx 10.16 Purchase agreement No. DSP\/AJV-042\/95 dated June 9, 1995 between Embraer - Empressa Brasileria de Aeronautica S.A. and SkyWest Airlines, Inc. (Confidential treatment requested)\nEx 10.17 SkyWest, Inc. 1995 Employee Stock Purchase Plan\nEx 11.0 Computation of earnings per share\nEx 13.1 Certain portions of the Annual Report to Shareholders for the year ended March 31, 1995, are incorporated by reference into this report on Form 10-K\nEx 24.1 Consent of independent public accountants\nEx 27 Financial Data Schedule","section_15":""}
{"filename":"352363_1995.txt","cik":"352363","year":"1995","section_1":"Item 1. Business.\nOverview\nLiz Claiborne, Inc. designs and markets an extensive range of women's fashion apparel and accessories, with versatile collections appropriate for wearing occasions ranging from casual to dressy. The Company also designs and markets men's apparel and furnishings, as well as fragrances for women and men. A portfolio of products licensed to carry the Company's LIZ CLAIBORNE or CLAIBORNE brand includes women's shoes, home furnishings, optics, sunglasses and men's suits. Products are manufactured to the Company's specifications in the United States and abroad and are marketed through leading department and specialty stores and other channels in the United States, Canada, Europe, Asia, and Central and South America. The Company's products are also marketed through the Company's own retail stores, which operate under a variety of formats in the United States. Although they offer a wide array of styles, all of Liz Claiborne's lines share the common characteristics of innovative fashion and exceptionally high quality and value. The Company believes that it is the largest \"better\" women's sportswear and dress company in the United States. Generally, the Company's sportswear products are conceived and marketed as \"designer\" items, but are priced in the \"better\" apparel range.\nAt March 1, 1996, the Company's order book reflected unfilled customer orders for approximately $536 million of merchandise, as compared to approximately $443 million at March 1, 1995. Order book data at any given date is materially affected by the timing of recording orders and of shipments. Accordingly, order book data should not be taken as indicative of eventual actual shipments or net sales, or as providing meaningful period-to-period comparisons.\nAs used herein, the term the \"Company\" refers to Liz Claiborne, Inc., a Delaware corporation, together with its consolidated subsidiaries, and its predecessor New York corporation (incorporated in 1976).\nNarrative Description of Business\nThe Company's business is operated through separate divisions which each have responsibility for sales, production and product development.\nIn the first quarter of 1996, the Company reorganized several of its divisions into four new groupings: Liz Claiborne Casual, which includes the \"misses\" lines of the LIZSPORT, LIZWEAR and LIZ & CO. casual sportswear divisions; COLLECTION, which includes the STUDIO line; Special Sizes, which includes the ELISABETH (large size) division and the above sportswear divisions' petite lines; and Special Markets Group, which includes the Moderate Division.\nThe Company seeks in its product offerings to offer versatility to its consumers, both in terms of individual items and overall collections. Substantially all items in each sportswear collection are sold as \"separates\" rather than as ensembles, such as suits. Collections are structured, however, through the use of related styles, color schemes and fabrics, to enable the consumer to assemble outfits consisting of separate items which are designed to be worn together. By offering similar or related styles, color schemes and fabrics over an extended period, the Company intends to provide the consumer with a wardrobe which can be coordinated with other Company items from season to season.\n- 2 - The following is a comparison of net sales by product\/division for each of the five fiscal years ended December 30, 1995.\n- ---------- * Partial Year Sales\n- 3 - Liz Claiborne Casual offers casual sportswear under three of the Company's trademarks. The LIZSPORT Division offers all-American sportswear for less formal work settings and casual occasions. The LIZWEAR Division offers denim and denim-related sportswear, including twills and fashion coordinates. The LIZ & CO. Division offers versatile career and casual knitwear.\nThe COLLECTION Division offers professional careerwear under the LIZ CLAIBORNE trademark with desk-to-dinner versatility. A line of casual careerwear under the STUDIO trademark, initially shipped in January 1996, is now offered by the COLLECTION Division. The COLLECTION Division's products offer the consumer coordinated designs and integrated groupings.\nThe DANA BUCHMAN Division offers collections for the women's \"bridge\" market, the price range between better sportswear and designer clothing under the Company's DANA BUCHMAN trademark. The Division offers products with elegant styling in distinctive fabrics, in \"misses\", large and petite sizes. In February 1996, the Division commenced shipment of a new line of sophisticated casual wear under the Company's new DANA B. AND KAREN trademark.\nThe ELISABETH Division offers large-sized classic careerwear, weekend casual, and wardrobe basics in both \"misses\" and petite proportions under the Company's ELISABETH trademark.\nThe Dress Division offers dresses and suits providing day-into- evening versatility and special occasion dresses under the Company's LIZ CLAIBORNE trademarks in both the \"misses\" and petite size ranges, as well as special occasion dresses under the LIZ NIGHT trademark.\nThe Menswear Division offers men's business-casual wear, sportswear and furnishings (dress shirts and ties) under the CLAIBORNE trademark.\nDuring 1995, each of the above Divisions presented three to six seasonal collections. The Company has announced that commencing in 1996, its major sportswear divisions will present four seasonal collections each year.\nThe Accessories Division offers handbags, small leather goods, hats, belts, scarves, socks, tights and bodywear -- primarily under the LIZ CLAIBORNE trademark -- which mirror major fashion trends and complement many of the Company's other product lines.\nThe Company's Cosmetic and Jewelry Divisions operate under a single management. Cosmetic offerings include fragrance and bath and body-care products under the LIZ CLAIBORNE, REALITIES, VIVID and CLAIBORNE FOR MEN trademarks. In March 1996, the Company introduced new women's and men's fragrance and bath and body product lines under its new CURVE trademark, with shipping to commence in the third quarter of 1996. Jewelry offerings include collections of fashion jewelry, such as earrings, necklaces, bracelets and pins, to complement the Company's women's apparel and accessories lines.\nIn late 1994, the Company announced plans to phase out its First Issue retail store business and to close or convert its 77 First Issue locations to other Company-operated retail formats. As of March 1, 1996, the phase out has been completed. (See \"Item 7. -- Management's Discussion and Analysis of Financial Condition and Results of Operations.\")\n- 4 - The Moderate Sportswear Division offers updated career and casual clothing under the Company's RUSS trademark; traditional mainstream sportswear under the Company's THE VILLAGER trademark; and fashion related separates with a jeanswear attitude under the Company's CRAZY HORSE trademark. These product lines are sold in department stores, national chains and specialty stores. See \"Competition and Certain Other Risks.\"\nEffective June 30, 1995, the business formerly operated by the Company's Shoe Division was licensed to a third party. (See \"Item 7. -- Management's Discussion and Analysis of Financial Condition and Results of Operations.\")\nSales and Marketing\nThe Company's wholesale sales are made primarily to department and specialty store customers throughout the United States. Retail sales are also made through the Company's own retail stores and outlet stores, as well as to international customers, direct-mail catalog companies, military exchanges and other outlets. The Company is currently evaluating its methods of doing business internationally. At 1995 year end, LIZ CLAIBORNE products were being sold in over 50 markets outside the United States. The Company expects to continue expansion to additional markets.\nThe Company currently operates a total of 117 prototype and presentational specialty retail stores located throughout the United States which carry exclusively Company products: 46 LIZ CLAIBORNE stores, 64 ELISABETH large- size apparel stores, 6 CLAIBORNE mens' stores and one DANA BUCHMAN store. These stores typically range in size from 2,000 square feet to 12,000 square feet. In 1995, the LIZ CLAIBORNE flagship store, an approximately 17,000 square foot store which carries the full line of Liz Claiborne women's apparel and related items, opened on Fifth Avenue in New York City. The Company's retail stores enable it to closely track sales and other product data, obtain market information and experiment with new products, visual presentation and new ideas for enhancing customer service. This information is used to help the Company's wholesale customers more quickly respond to consumer preferences.\nIn Canada, the Company operates a wholesale business which sells primarily to major department store chains. In addition, during 1995, the Company began its expansion into the Canadian specialty store market. In Western Europe, the Company operates leased or licensed departments, or concessions, at leading specialty stores. These departments are currently the Company's primary method of doing business in Europe. Although the Company plans to add additional concessions in Europe, it is also evaluating options to service European retailers on a wholesale basis. In other international markets, the Company has granted retail licenses to third parties under which they operate LIZ CLAIBORNE stores and shops. During 1995, 22 additional licensed stores and shops were opened in a total of 16 countries. During 1996, the Company plans to grant additional store licenses, as well as open wholesale accounts in new markets.\n- 5 - Approximately 83% of 1995 sales were made to the Company's 100 largest customers. Except for Dillard's Department Stores, Inc., which accounted for approximately 11% of 1995 and 1994 sales, no single customer accounted for more than 6% of 1995 or 1994 sales. However, certain of the Company's customers are under common ownership; when considered together as a group under common ownership, sales to the eight department store customers which were owned at year-end 1995 by The May Department Stores Company accounted for approximately 18% of 1995 and 17% of 1994 sales. Sales to the eleven department store customers which were owned at year-end 1995 by Federated Stores, Inc. accounted for approximately 17% of 1995 and 16% of 1994 sales. See Note 8 of Notes to Consolidated Financial Statements. Many major department store groups make centralized buying decisions; accordingly, any material change in the Company's relationship with any such group could have a material adverse effect on the Company's operations. The Company expects that its largest customers will continue to account for a significant percentage of its sales.\nSales to the Company's department and specialty store customers are made primarily through the Company's New York City showrooms.\nOrders from the Company's customers generally precede the related shipping periods by several months. The Company's largest customers discuss with the Company retail trends and their plans regarding their anticipated levels of total purchases of Company products for future seasons. These discussions are intended to assist the Company in planning the production and timely delivery of its products. The Company continually monitors retail sales in order to assess directly consumer response to its products.\nThe Company has implemented and continues to expand in-stock reorder programs in several divisions to enable customers to reorder certain items for quick delivery. See \"Manufacturing.\" In 1995, as part of these programs, the Company began implementation of LizRim, an inventory replenishment system, which has been installed at a number of its retail customers.\nEffective January 1, 1996, the Company lowered the trade discount offered by its LIZWEAR, LIZSPORT, LIZ & CO., ELISABETH, Dress and LIZ CLAIBORNE COLLECTION Divisions from the previous 10% level to 8% (the prevailing standard in the industry). The Company is redeploying the additional funds received as a result of this change towards a national advertising campaign, an expanded in-store presentation program and similar brand-enhancing activities, in an effort to stimulate full price sales at retail. In January 1996, the Company introduced LIZEDGE, an in-store servicing and maintenance program designed to enhance the way the Company's products appear on the selling floor, and in March 1996, introduced LIZVIEW, a special presentation program designed to create a more effective retail presence at department stores. (See \"Item 7. - -- Management's Discussion and Analysis of Financial Condition and Results of Operations.\")\nThe Company maintains cooperative advertising programs under which it will generally share the costs of each customer's advertising and promotional expenditures, up to a stated percentage of the customer's purchases. The Company incurred costs under these cooperative advertising programs of approximately $39 million in respect of 1995 sales. The Company spent approximately $4 million in 1995 on national advertising. The Company plans to expend significantly greater amounts on national advertising in 1996.\nThe Company currently operates 76 outlet stores, virtually all of which are located in \"outlet centers\" comprised primarily of manufacturer- operated stores.\n- 6 - Manufacturing\nThe Company does not own any product manufacturing facilities; all of its products are manufactured in accordance with its specifications through arrangements with independent suppliers.\nA very substantial portion of the Company's sales is represented by products produced abroad, mainly in the Far East, the Caribbean and Central America. The Company also sources in the United States and other regions. The Company does not itself own quota and therefore must obtain quota from its suppliers and vendors. During 1995, the Company's products were manufactured by several hundred suppliers. The Company's products are currently manufactured in approximately 35 different countries, including China, Sri Lanka, South Korea, the Dominican Republic, Indonesia and Hong Kong. The Company continually seeks additional suppliers throughout the world for its sourcing needs. The Company's largest supplier of finished products manufactured less than 6% of the Company's purchases of finished products during 1995. Approximately 28% of the Company's 1995 purchases of finished products were manufactured by its ten largest suppliers, as compared to 24% of 1994 purchases. The percentage of the Company's production represented by its ten largest suppliers increased in 1995 as compared to 1994, and the Company is planning to allocate even larger portions of its production requirements to suppliers which appear to have superior capacity, quality (of product and operations) and financial resources, thus increasing the percent of purchases accounted for by the Company's leading suppliers. The Company's purchases from its suppliers are effected through individual purchase orders specifying the price and quantity of the items to be produced. Generally, 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 such suppliers to be satisfactory.\nThe Company's fabrics, trimmings and other materials are obtained in bulk from various foreign and domestic suppliers. During 1995, the raw materials used in Company products were purchased from several hundred suppliers, located primarily in South Korea, Japan, Taiwan, Hong Kong and Italy. Approximately 25% of the Company's expenditures for raw materials during 1995 and 1994 were accounted for by its five largest raw material suppliers, with no single raw material supplier accounting for more than 7% of 1995 raw material expenditures. Generally, the Company does not have any long-term, formal arrangements with any supplier of raw materials. The Company has a 50% interest in a joint venture which supplies certain types of domestically dyed and finished fabrics for use in certain Company products; the Company is currently analyzing its options with respect to this venture. To date, the Company has experienced little difficulty in satisfying its raw material requirements and considers its sources of supply adequate.\nThe Company operates under substantial time constraints in producing each of its collections. See \"Sales and Marketing.\" In order to deliver, in a timely manner, merchandise which reflects current tastes, the Company attempts to schedule a substantial portion of its materials and manufacturing commitments relatively late in the production cycle, thereby favoring suppliers able to make quick adjustments in response to changing production needs. However, in order to secure necessary materials and manufacturing facilities, the Company must make substantial advance commitments, often as much as seven months prior to the receipt of firm orders from customers for the items to be produced. The Company has and continues to implement a number of initiatives designed to reduce the time required to move a product from design to the sales floor.\n- 7 - If the Company should misjudge its ability to sell its products, it could be faced with substantial outstanding fabric and\/or manufacturing commitments, resulting in excess merchandise inventories. See \"Competition; Certain Risks\". The Company was left with significant excess merchandise inventory positions during 1993 and into the first half of 1994 due to the Company's increased 1993 commitments compared to 1992 and the decreased demand for certain of the Company's apparel at retail.\nThe Company's arrangements with foreign suppliers are subject to the risks of doing business abroad, including currency fluctuations and revaluations, restrictions on the transfer of funds and in certain parts of the world, political instability. The Company's operations have not been materially affected by any of such factors to date. However, due to the large portion of the Company's products which are produced abroad, any substantial disruption of its relationships with its foreign suppliers could adversely affect the Company's operations.\nImport and Import Restrictions\nVirtually all of the Company's merchandise imported into the United States is subject to United States duties. In addition, bilateral agreements between the major exporting countries and the United States impose quotas that limit the amount of certain categories of merchandise that may be imported into the United States. The majority of such agreements contain \"consultation\" clauses which allow the United States, under certain circumstances, to impose unilateral restrictions on the importation of certain categories of merchandise that are not subject to specified limits under the terms of an agreement. These bilateral agreements have been negotiated under the framework of the Multi Fiber Arrangement (\"MFA\"), which has been in effect since 1974. The United States, a participant in international negotiations known as the \"Uruguay Round\", ratified legislation enacting and implementing the various agreements of the Uruguay Round, effective January 1, 1995, including the Uruguay Round Agreement on Textiles and Clothing which requires World Trade Organization Member countries to phase out textile and apparel quotas in three stages over a ten year period. In addition, it regulates trade in non-integrated textile and apparel quotas during the ten year transition period. However, even with respect to integrated textile and apparel quota categories, the United States remains free to establish numerical restraints in response to a particular product being imported in such increased quantities as to cause (or threaten) serious damage to the relevant domestic industry. The U. S. legislation implementing the Uruguay Round also changes the rule of origin for many textiles and apparel products effective July 1, 1996, with certain minor exceptions. This change would determine country of origin based on \"assembly\" for most textile and apparel products. The Uruguay Round also incorporates modest duty reductions for textile and apparel products over a ten year staging schedule. This will likely result in a modification of current patterns of international trade with respect to apparel and textiles. In addition, there are various United States initiatives pending concerning the trading status of certain countries, which, if enacted, would likely increase the cost of doing business in such countries. (See \"Item 7. -- Management's Discussion and Analysis of Financial Condition and Results of Operations\".)\n- 8 - In addition, each of the countries in which the Company's products are sold have laws and regulations regarding import restrictions and quotas. Because the United States and other countries in which the Company's products are manufactured and sold may, from time to time, impose new quotas, duties, tariffs, surcharges or other import controls or restrictions, or adjust presently prevailing quota allocations or duty or tariff rates or levels, the Company maintains a program of intensive monitoring of import and quota-related developments. The Company seeks continually to minimize its potential exposure to import and quota-related risks through, among other measures, allocation of production to merchandise categories that are not subject to quota pressures, adjustments in product design and fabrication, shifts of production among countries and manufacturers, and otherwise, as well as through geographical diversification of its sources of supply.\nIn light of the very substantial portion of the Company's products which are manufactured by foreign suppliers, the enactment of new legislation or the administration of current international trade regulations, or executive action affecting textile agreements, could adversely affect the Company's operations.\nTrademarks\nThe Company utilizes a variety of trademarks on its products, including LIZ CLAIBORNE, LIZ, CLAIBORNE, LIZWEAR, LIZSPORT, LIZ CLAIBORNE COLLECTION, LIZ NOW, LIZ NIGHT, LIZ CLAIBORNE STUDIO, its triangular logomark, DANA BUCHMAN, dana b. and karen, ELISABETH, LIZ & CO., LEATHER CO., RUSS, THE VILLAGER, CRAZY HORSE, REALITIES, VIVID and CURVE. The Company has registered or applied for registration of a multitude of trademarks for use on apparel and apparel-related products, including accessories, cosmetics and jewelry in the United States as well as numerous foreign territories. The Company also has a number of design patents. 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. The Company vigorously protects its trademarks and other intellectual property rights against infringement.\nLicensing\nThe Company has five license agreements pursuant to which third party licensees produce merchandise under the Company's trademarks in accordance with designs furnished or approved by the Company. The present terms of these agreements (exclusive of renewal terms) expire at various dates through 2010. Current licenses cover women's and men's sunglasses and readers; women's and men's ophthalmic frames for prescription eyewear; home furnishing products (with the first collections shipped in the first quarter of 1995), men's tailored clothing (with the first collections shipped in the third quarter of 1995), and women's career, career-casual, casual and sport shoes (with the first licensed collections shipped in the third quarter of 1995). Each of the licenses provides for the payment to the Company of a percentage of the licensee's sales of the licensed products against a guaranteed minimum royalty which generally increases over the term of the agreement.\n- 9 - Competition; Certain Risks\nThe apparel and related product markets are highly competitive, both within the United States and abroad.\nThe Company's ability to effectively compete depends on a number of factors, including the Company's ability to effectively anticipate, gauge and respond to changing consumer demands and tastes, to effectively translate these market trends into appropriate, saleable product offerings relatively far in advance, and to operate within substantial production and delivery constraints. In addition, consumer and customer acceptance and support (especially by the Company's largest customers), depend upon, among other things, product, value and services.\nThe Company believes that, based on sales, it is among the largest apparel companies operating in the United States. Although the Company is unaware of any comprehensive trade statistics, it believes, based on its knowledge of the market and available trade information, that measured by sales, it is the largest \"better\" women's sportswear and dress company in the United States. A number of apparel companies have announced plans to distribute new collections of women's \"better\" sportswear through the department store channel of distribution, commencing in 1996.\nIn addition to the competitive factors described above, the Company's business, including its revenues and profitability, is influenced by and subject to a number of factors which are inherently uncertain and therefore difficult to predict, including the general retail environment and general economic conditions; the Company's relationships with its customers, especially its major department store customers; the Company's ability to correctly judge the level of its fabric and\/or merchandise commitments; the Company's ability to effectively distribute its products within its targeted markets (including distribution through wholesale accounts and Company operated retail stores and concession locations); and the chance of substantial disruption of the Company's relationships with its suppliers and manufacturers. See \"Sales and Marketing.\" and \"Manufacturing.\"\nThe Company from time to time reviews its possible entry into new markets. The entry into new markets, such as the Company's entry into the moderate market, is accompanied by risks inherent in any new business. New businesses may require methods of operations and marketing strategies different from those employed in the Company's other businesses. Certain new businesses may be lower margin businesses and will require the Company to achieve significant cost efficiencies, in part by using sources of supply different from the Company's sources for other products. In addition, new markets may involve buyers, store customers and\/or competitors different from the Company's historical buyers, customers and competitors.\n- 10 - Employees\nAt December 30, 1995, the Company had more than 7,400 full-time employees, as compared with approximately 8,000 full-time employees at December 31, 1994.\nAs a member of a manufacturers' association, the Company is bound by collective bargaining agreements with affiliates of UNITE, the successor to the International Ladies' Garment Workers' Union and the Amalgamated Clothing and Textile Workers of America, covering, at December 30, 1995, approximately 1,750 of the Company's full-time apparel, accessories and cosmetics employees in the United States and Canada. These collective bargaining agreements expire on various dates through 1997.\nThe Company considers its relations with its employees to be satisfactory and has not experienced any interruption of operations due to labor disputes.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nThe Company's showrooms, sales, merchandising and design staffs, as well as its executive offices, are located at 1441 Broadway, New York, New York, where the Company leases approximately 276,000 square feet under a master lease which expires at the end of 2001 and contains certain renewal options and rights of first refusal for additional space. The Company currently leases office space at two other buildings in New York City covering approximately 60,000 and 24,000 square feet (with terms expiring in 1996 and 2003, respectively).\nThe Company owns its approximately 450,000 square foot principal New Jersey warehouse and distribution facility located at One Claiborne Avenue, North Bergen, New Jersey. This facility also houses the Company's production and certain other administrative personnel. The Company also owns an approximately 300,000 square foot office facility at this location which was completed in 1994. The Company presently leases approximately 969,000 square feet in 6 other New Jersey warehouse facilities, the current terms of which expire through 2008. The Company also owns an approximately 313,000 square foot warehouse and distribution facility located on approximately 80 acres in Mt. Pocono, Pennsylvania. The Company's approximately 270,000 square foot facility in Augusta, Georgia (located on a 98-acre site), has been leased to a joint venture comprised of a wholly-owned subsidiary of the Company and an unrelated third party. This facility is used as a dyeing and finishing operation. The Company occupies an approximately 290,000 square foot warehouse and distribution facility located on an approximately 124 acre site in Montgomery, Alabama. The Company has options to purchase an additional 80 acres adjacent to the facility. The Company currently is planning to expand its operations at this location. The Company is the lessee of the Georgia and Alabama facilities pursuant to industrial development financing. The Company also leases showroom, warehouse and office space in various other domestic and international locations.\nThe Company leases space for its 117 retail specialty stores (aggregating approximately 518,000 square feet in various malls) and for 75 of its outlet stores (aggregating approximately 740,000 square feet).\nThe Company believes that its existing facilities are well maintained, in good operating condition and are adequate for its present level of operations. (See Note 8 of Notes to Consolidated Financial Statements.)\n- 11 - Item 3.","section_3":"Item 3. Legal Proceedings.\nThe Company and certain of its present and former officers and directors are parties to several pending legal proceedings and claims, including an action styled Ressler et al. vs. Liz Claiborne, Inc., et al., pending in the United States District Court for the Eastern District of New York. The plaintiffs seek compensatory damages on behalf of a class of purchasers of the Company's Common Stock during the period commencing September 21, 1992 through and including July 16, 1993, and allege that the defendants violated the federal securities laws by, among other things, making misrepresentations or omissions of material facts that artificially inflated the market price of the Common Stock during the class period. An earlier-filed lawsuit before the same court as Ressler, styled Fishbaum vs. Chazen, et. al., made allegations similar to the Ressler complaint and sought damages on behalf of a class of purchasers of the company's Common Stock for the period commencing March 30, 1993, through and including July 16, 1993. An amended complaint was filed in the Ressler action in May 1994 to add Fishbaum as a plaintiff. In June 1994, the court granted the defendants' motion to dismiss the Fishbaum complaint, with leave to amend, on the grounds that the complaint did not adequately set forth the requisite element of scienter. In July 1994, the Company moved to dismiss the Ressler complaint. In August 1995, the Court granted that motion, again with leave to amend, on the grounds that the Ressler complaint failed to comply with pleading requirements of the Federal Rules of Civil Procedure. However, the Court rejected the contention that scienter had not been adequately pled. In response to the defendants' motion for reconsideration of that latter point, the Court indicated that the Company could present the scienter issue again in moving to dismiss a new amended complaint. In October 1995, a second amended complaint was filed in the Ressler action. In December 1995, the defendants moved to dismiss that complaint.\nIn April 1994, two stockholder derivative actions, which contain substantially similar allegations, styled Goldberg Family Trust vs. Chazen, et al. and Liz Claiborne, Inc., nominal defendant, and Laz Schneider vs. Chazen, et al. and Liz Claiborne, Inc., nominal defendant, were brought in the Court of Chancery of the State of Delaware against certain of the Company's directors and two of its former Vice Chairmen. The complaints contain allegations that the individual defendants breached their fiduciary obligations to the Company and its shareholders committed corporate mismanagement and wasted corporate assets in connection with the Company's stock repurchase program and the defense of pending legal proceedings, and were unjustly enriched in connection with the sale of shares of the Company's Common Stock between September 1992 and July 1993 by certain of its present and former officers and directors. In July 1994, the Laz Schneider action was consolidated with the Goldberg action. In August 1994, the defendants moved to dismiss the consolidated complaint. The motion is pending.\nThe Company believes that the litigations described in this Item are without merit and intends to vigorously defend these actions. Although the outcome of any such litigation or claim cannot be determined with certainty, management is of the opinion that the final outcome of these litigations should not have a material adverse effect on the Company's results of operations or financial position.\n- 12 - Item 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.\nExecutive Officers of the Registrant.\nInformation as to the executive officers of the Company is set forth below:\nName Age Position(s) - ---- --- -----------\nJerome A. Chazen 69 Chairman of the Board\nPaul R. Charron 53 President and Chief Executive Officer\nJorge L. Figueredo 35 Senior Vice President - Human Resources\nSamuel M. Miller 58 Senior Vice President - Finance, Chief Financial Officer\nJohn R. Thompson 44 Senior Vice President - Service, Systems and Reengineering, Chief Information Officer\nRobert J. Zane 56 Senior Vice President - Manufacturing and Sourcing\n- 13 - Executive officers serve at the discretion of the Board of Directors.\nMr. Chazen has served in various senior executive positions and as a Director of the Company since 1977. In 1985, he was elected Co-Chairman of the Board of the Company, and became Vice Chairman of the Board in 1987. In 1989, Mr. Chazen became Chairman of the Board. Mr. Chazen also serves on the board of directors of Taubman Centers, Inc., an owner and operator of regional shopping centers.\nMr. Charron joined the Company as Vice Chairman and Chief Operating Officer, and became a Director, in May 1994. Effective May 1995, he became President and Chief Executive Officer. Prior to joining the Company, he served as Executive Vice President of VF Corporation, an apparel manufacturer, from 1993, and as a Group Vice President of VF Corporation from 1988 to 1993.\nMr. Figueredo joined the Company in 1984 as Administrator, Warehouse Employee Relations and served in various management positions thereafter. In 1992, he was promoted to Vice President, Human Resources Operations. In 1994, he was promoted to Senior Vice President - Human Resources.\nMr. Miller, a certified public accountant, joined the Company in 1988 as Senior Vice President - Finance (Chief Financial and Accounting Officer) after more than sixteen years in various senior financial positions within the apparel industry.\nMr. Thompson joined the Company in February 1995 as Senior Vice President of Service, Systems and Reengineering and Chief Information Officer. Prior to joining the Company, Mr. Thompson served as Executive Vice President for Business Systems\/Logistics and Chief Information Officer of Goody's Family Clothing, Inc., an apparel retailer, from 1993 to 1995. From 1991 to 1993, Mr. Thompson was Vice President Business Systems and Management Information Systems for Lee Apparel Company, an apparel manufacturer. Mr. Thompson also served as Executive Vice President and Chief Information Officer of Quick Response Services, Inc., an information management services company, from 1987 to 1991.\nMr. Zane joined the Company in September 1995 as Senior Vice President - Manufacturing and Sourcing. Prior to joining the Company, Mr. Zane owned and operated Medallion Tekstil, a private label manufacturing company he founded in 1989. Prior to that, Mr. Zane was Vice President, Sourcing at Bernard Chaus, Inc. and Executive Vice President at Murjani International, Inc.\n- 14 - PART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.\nThe Company's Common Stock trades on the New York Stock Exchange (\"NYSE\") under the symbol LIZ. The table below sets forth the high and low closing sale prices of the Common Stock (based on the NYSE composite tape) for the periods indicated.\nOn March 5 1996, the closing sale price of the Common Stock on the NYSE was $35 5\/8. As of March 5, 1996, the approximate number of record holders of Common Stock was 11,160.\nThe Company has paid regular quarterly cash dividends since May 1984. Quarterly dividends for the last two fiscal years were paid as follows:\nThe Company plans to continue paying quarterly cash dividends on its Common Stock. The amount of any such dividend will depend on the Company's earnings, financial position, capital requirements and other relevant factors.\n- 15 - In December 1989, the Board of Directors first authorized the repurchase, as market and business conditions warranted, of the Company's Common Stock for cash in open market purchases and privately negotiated transactions. From time to time thereafter, the Board has authorized additional repurchases. As of March 4, 1996, the Company had expended or had commitments to expend, through the sale of put warrants, (see Note 8 of Notes to Consolidated Financial Statements) approximately $499 million of the $550 million authorized under its stock repurchase program, covering an aggregate of 18.9 million shares.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nThe following table sets forth certain information regarding the Company's operating results and financial position and is qualified in its entirety by the consolidated financial statements and notes thereto which appear elsewhere herein:\n(All dollar amounts in thousands except per common share data)\n- -------------------------------------------------------------------------------- * Includes the after tax effect of a restructuring charge of $18,900 ($30,000 pretax) or $.24 per common share in 1994.\n** Includes a credit representing the cumulative effect of a change in the method of accounting for income taxes of $1,643 or $.02 per common share in 1993.\n- 16 - Item 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 items in the Consolidated Statements of Income as a percent of net sales and the percentage change of those items as compared to the prior year.\n- 17 - RESULTS OF OPERATIONS\ncontinued\nThe Company's net sales for 1995 (52 weeks) were $2.08 billion, compared to $2.16 billion in 1994 (53 weeks) and $2.20 billion in 1993 (52 weeks). The 1995 net sales decline of 3.8% reflected a 9% decrease in domestic net sales of Misses and Petite COLLECTION, LIZSPORT and LIZWEAR (collectively, \"Sportswear\"), to $861 million, and a 32% decrease in domestic net sales of the Moderate Division to $71 million. The Sportswear net sales decrease reflected planned unit volume declines and slightly lower average unit selling prices due to product mix. The Moderate Division's net sales decline reflected a planned unit volume decrease. Also contributing to the net sales result was a decrease in the net sales of accessories (6%, to $175 million), due primarily to lower average unit selling prices, reflecting lower initial selling prices and changes in product mix, and ELISABETH (4%, to $131 million), principally reflecting lower off-price sales volume, offset by increased sales to the Company's new ELISABETH stores. Effective June 30, 1995, the business formerly operated by the Company's Shoe Division was licensed to a third party. The Shoe Division accounted for $39 million of 1995 net sales (six months), compared to $63 million in 1994 (twelve months) (see Note 3 of Notes to Consolidated Financial Statements). These declines were offset in part by a 30% sales increase within the Company's LIZ CLAIBORNE, ELISABETH, DANA BUCHMAN, CLAIBORNE, First Issue and international retail stores and leased departments (collectively, the \"Retail Operations\"), to $195 million, reflecting higher average numbers of domestic retail stores and European retail leased departments. In late 1994, the Company announced plans to phase out the First Issue retail store business and to close or convert its 77 First Issue locations to other Company-operated retail formats. As of March 1, 1996, the phase out has been completed; First Issue accounted for $53 million of 1995 net sales, compared to $64 million in 1994 (see Note 2 of Notes to Consolidated Financial Statements). Net sales gains were also posted by DANA BUCHMAN (21%, to $136 million), menswear (11%, to $113 million) and LIZ & CO. (11%, to $84 million). The DANA BUCHMAN net sales increase primarily reflected higher unit volume, as well as slightly higher average unit selling prices. The menswear and LIZ & CO. net sales increases were due to higher unit volume. Net sales of the outlet operations increased 11%, to $155 million, principally reflecting the opening of new stores (76 at 1995 year end compared with 70 at 1994 year end). The 1994 net sales decrease reflected a 12% decline in the net sales of Sportswear, to $1 billion, primarily resulting from substantially lower average unit prices due to weakness in demand, the liquidation during the first half of 1994 of significant prior year excess inventory at distressed prices, and changes in product mix. The net sales result also reflected an 18% decline in LIZ & CO. sales, to $76 million, due primarily to lower unit volume. These decreases were partially offset by increases in sales of the Moderate Division (42%, to $112 million), menswear (26%, to $102 million), and DANA BUCHMAN (25%, to $113 million). These increases primarily reflected higher unit volume, although more than half of the menswear increase was due to higher average unit prices as a result of a higher proportion of regular price sales. In addition, sales of the Retail Operations increased 31%, to $150 million, due to the opening of new domestic retail stores (113 at 1994 year end compared with 78 at 1993 year end) as well as the conversion of most of the Company's European business from a wholesale to a leased department operation. First Issue accounted for $64 million of the Retail Operations' 1994 sales, compared to $51 million in 1993. Sales of the Company's outlet stores increased 14%, to $140 million, in 1994, due\n- 18 - RESULTS OF OPERATIONS continued\nto the opening of new stores (70 at 1994 year end compared with 61 at 1993 year end). The 1994 and 1993 results also reflected the delay of certain shipments of 1994 Spring season merchandise into 1994.\nGross profit dollars increased $35 million, or 4.7%, in 1995. Gross profit margins were 38.0% in 1995, compared to 34.9% in 1994 and 34.1% in 1993. The margin improvement in 1995 generally reflected lower markdowns resulting from lower excess inventory positions, an increase in average unit selling prices realized on close-out merchandise, and slightly lower average unit costs across substantially all of the wholesale apparel divisions. Significant margin gains were realized by the ELISABETH and LIZ & CO. Divisions, as well as the outlet operations. Although Sportswear margins improved, gross profit dollars declined somewhat, reflecting the lower sales base. Moderate margins remained at depressed levels notwithstanding significant improvement over 1994. Overall margins were favorably impacted by the larger percentage of sales represented by the Retail Operations and the DANA BUCHMAN Division (which are generally higher margin businesses) and the lower percentage of sales represented by the Moderate Division (which is a lower margin business). Margins within the Retail Operations declined slightly from 1994 levels, and DANA BUCHMAN margins improved. Margin improvements were partially offset by margin declines within the menswear and jewelry businesses due to a lower proportion of regular price sales, reflecting weakness in demand. Gross profit dollars increased slightly in 1994, reflecting an improvement in the overall gross profit percentage from the depressed level of 1993, on a slightly lower sales base. Margins were negatively impacted throughout 1994 by the highly promotional retail environment. While Sportswear gross margins showed some improvement, notwithstanding the liquidation during the first half of significant excess prior year inventory, volume declines resulted in lower gross profit dollars. Margin percentages of the Menswear and Dress Divisions improved from depressed 1993 levels, due to a higher proportion of regular price sales. Also contributing to the margin improvement was the higher proportion of the Company's net sales represented by the Retail Operations and the DANA BUCHMAN and Accessories Divisions (which are all generally higher margin businesses). These increases were offset by severely depressed margins within the Moderate Division (which is a lower margin business) due to a very low proportion of regular price sales, and the higher proportion of the Company's sales represented by this Division. In addition, margins declined in the Cosmetics Division, reflecting weak demand and changes in product mix, and in the ELISABETH Division, reflecting a lower proportion of regular price sales due primarily to the liquidation of excess prior year inventory.\nLegislation which would further restrict the importation and\/or increase the cost of textiles and apparel produced abroad has periodically been introduced in Congress. Although it is unclear whether any new legislation will be enacted into law, it appears likely that various new legislative or executive initiatives will be proposed. These initiatives may include a reevaluation of the trading status of certain countries, including Most Favored Nation (\"MFN\") treatment for the People's Republic of China (\"PRC\"), which, if enacted, would increase the cost of products purchased from suppliers in such countries. The PRC's MFN treatment was renewed in July 1995 for an additional year. In light of the very substantial portion of the Company's products which are manufactured by foreign suppliers, the enactment of new legislation or the administration of current international trade regulations, or executive action affecting international textile agreements, could adversely affect the Company's operations.\n- 19 - RESULTS OF OPERATIONS continued\nSelling, general and administrative (\"SG&A\") expenses decreased $4 million (0.7%) in 1995 over 1994, compared with an increase of $36 million (6.4%) in 1994 over 1993. These expenses represented 28.8% of net sales in 1995 compared to 27.9% in 1994 and 25.8% in 1993. The 1995 SG&A results reflect lower expense levels as expense reduction initiatives continue; however, the percentage decrease in the sales of certain divisions slightly outpaced their percentage decreases in expense levels. The 1995 results also reflect increases resulting from the continued expansion of the Company's outlets and Retail Operations ($21.8 million increase in 1995), as well as expansion of the DANA BUCHMAN Division and the expansion of in-store retail shop programs at a number of divisions. These results reflect $6 million of direct expenses related to the Shoe Division in 1995 (six months), compared with $12 million in 1994 (twelve months). The 1994 results reflected the continued expansion of the Retail Operations, which accounted for approximately three-quarters of the dollar increase. Also reflected in the 1994 dollar increase was the expansion of the Moderate and DANA BUCHMAN Divisions and outlet operations, partially offset by an overall expense reduction within the wholesale better-apparel businesses; however, the overall percentage decrease in the sales of these businesses slightly outpaced their percentage decrease in expense levels.\nInvestment and other income-net increased on a year-to-year basis by $2 million in 1995, compared with a year-to-year decrease of $5 million in 1994. The 1995 increase reflected an increase in the Company's investment portfolio of cash equivalents and marketable securities, notwithstanding the ongoing stock repurchase program, as well as slightly higher interest rates. The 1994 decrease was due to lower rates of return realized on the investment portfolio, as well as a decrease in the average portfolio, reflecting in part the stock repurchase program.\nAs a result of the factors described above, the Company's income before provision for income taxes and cumulative effect of a change in accounting principle expressed as a percentage of net sales was 9.8% in 1995, compared to 6.1% in 1994 and 9.0% in 1993. The 1995 results included continuing operating losses within the Retail Operations and the Moderate Division. The 1994 results reflected a $30 million charge which was provided to cover the estimated costs associated with the restructuring of the Retail Operations and Moderate Division, as well as the Company's strategic efforts to streamline operating and administrative functions. This charge included estimated losses on the phase out of the First Issue retail business, contract termination costs, severance and the write-off of certain assets (see Note 2 of Notes to Consolidated Financial Statements). 1994 operating income was also reduced by continuing losses within the Company's Moderate Division, Retail Operations and outlets. The provision for income taxes expressed as a percentage of net sales was 3.7% in 1995, 2.3% in 1994 and 3.3% in 1993, reflecting changes in pre-tax income, and in 1995 an increase in the effective income tax rate.\nThe Company adopted the Financial Accounting Standards Board Statement No. 109 \"Accounting for Income Taxes\" and changed its method of accounting for income taxes as of the beginning of fiscal year 1993. The cumulative effect on prior years of this accounting change is reflected in the consolidated statements of income as a one-time increase in 1993 net income of $1.6 million, or $.02 per common share (see Note 1 of Notes to Consolidated Financial Statements).\n- 20 - RESULTS OF OPERATIONS continued\nThe earnings per common share computations reflected a lower number of outstanding shares on a period-to-period basis as a result of the Company's stock repurchase program.\nNet income expressed as a percentage of net sales was 6.1% in 1995, compared with 3.8% in 1994 and 5.8% in 1993. The 1995 increase was principally due to higher operating margins and higher investment and other income-net, offset in part by a higher provision for income taxes. The 1994 decrease was primarily due to lower operating margins and lower investment and other income-net, offset in part by a lower provision for income taxes. The 1995 and 1994 year-to-year results also reflected the restructuring charge discussed above, which reduced 1994 after-tax net income by $19 million.\nThe retail environment remains highly promotional, and the tone of business continues to be difficult. The Company continues the process of implementing a comprehensive business transformation effort which includes process reengineering and profit improvement programs, and is progressing towards a number of previously announced three-year goals for this initiative. The Company continues to expect that earnings for the first half of 1996 will show improvement over 1995 levels although any such improvement will be moderated by continuing losses within certain operations. As part of its ongoing strategic review process, the Company continues to evaluate certain business operations.\nEffective January 1, 1996, the Company lowered the trade discount offered by its Sportswear, Dress, LIZ & CO. and ELISABETH Divisions from the previous 10% level to 8% (the prevailing standard in the industry). The Company is redeploying the additional funds received as a result of this change towards a national advertising campaign, an expanded in-store presentation program and similar brand-enhancing activities, in an effort to stimulate full price sales at retail. As a result of this change, the net sales of the affected divisions will increase by approximately 2% over the results they would have reported without the change in trade discount, with corresponding dollar increases in gross margin and SG&A expenses.\nFINANCIAL POSITION, CAPITAL RESOURCES AND LIQUIDITY\nNet cash provided by operating activities was $222 million in 1995, compared to $173 million in 1994 and $120 million in 1993. The year-to-year increase in 1995 primarily reflects higher net income, a larger decrease in accounts receivable ($34 million in 1995 compared to $15 million in 1994), a smaller increase in deferred income tax benefits ($0.4 million in 1995 compared to $15 million in 1994) and a $5 million increase in income taxes payable compared to an $8 million decrease in 1994, offset by a decrease in accrued expenses of $1 million compared to an increase in 1994 (including accruals associated with the restructuring charge) of $59 million. The 1994 increase was due primarily to a decrease in inventory levels in 1994 compared to an increase in 1993 and a larger increase in accrued expenses in 1994 (including accruals associated with the restructuring charge), offset in part by lower net income. Net cash used in investing activities was $134 million in 1995, compared to $131 million in 1994 and net cash provided by investing activities of $1 million in 1993. The year-to-year fluctuations in net cash used in or provided by investing activities is related to the increase or decrease in marketable securities and capital expenditures, as well as the cash proceeds from the sale of certain Shoe Division assets realized in 1995. Net cash used in financing activities was $104 million in 1995, compared to $75 million in 1994 and $148 million in 1993. The\n- 21 - RESULTS OF OPERATIONS continued\nchanges in net cash used in financing activities principally reflects amounts expended in the Company's stock repurchase program. As of March 4, 1996, the Company had expended or had commitments to expend, through the sale of put warrants (see Note 8 of Notes to Consolidated Financial Statements), approximately $499 million of the $550 million authorized under its stock repurchase program, covering an aggregate of 18.9 million shares.\nThe decrease in 1995 year end inventory levels over the prior year end reflected the sale of inventory related to the Company's former Shoe Division and the reduction of ongoing inventory levels within the outlet operations, offset in part by planned earlier receipt of spring merchandise across substantially all of the Company's wholesale apparel divisions and the expansion of in-stock reorder programs in several divisions. The higher inventory levels required by the expanded in-stock reorder programs and, to a lesser degree the expansion of the Retail Operations, had a negative impact on the Company's 1995 inventory turnover rate. The existence of excess inventory (which takes additional time to liquidate) during the first half of 1994 had a negative impact on the Company's 1994 inventory turnover rate and gross profit margin.\nThe Company's anticipated capital expenditures for 1996 currently approximate $45 million. These expenditures consist primarily of certain building and equipment expenses, including expansion of the Company's Alabama distribution facility and the upgrading of management information systems. These expenditures will be financed through available capital and future earnings. Any increased working capital needs will be met by current funds. Bank lines of credit, which are available to finance import transactions and direct borrowings, were decreased by the Company from $282 million at December 31, 1994 to $270 million at December 30, 1995 to reduce excess lines. The Company expects to be able to adjust these lines as required.\nINFLATION\nThe moderate rate of inflation over the past few years has not had a significant impact on the Company's sales and profitability.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nInformation called for by this Item 8 is included following the \"Index to Consolidated Financial Statement Schedules\" appearing at the end 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.\n- 22- PART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant.\nInformation with respect to Executive Officers of the Company is set forth in Part I of this Annual Report on Form 10-K.\nInformation with respect to Directors of the Company which is called for by this Item 10 is incorporated by reference to the information set forth under the heading \"Election of Directors\" in the Company's Proxy Statement relating to its 1996 Annual Meeting of Stockholders to be filed pursuant to Regulation 14A (the \"Company's 1996 Proxy Statement\").\nItem 11.","section_11":"Item 11. Executive Compensation.\nInformation called for by this Item 11 is incorporated by reference to the information set forth under the heading \"Executive Compensation\" in the Company's 1996 Proxy Statement.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nInformation called for by this Item 12 is incorporated by reference to the information set forth under the headings \"Security Ownership of Certain Beneficial Owners\" and \"Security Ownership of Management\" in the Company's 1996 Proxy Statement.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nInformation called for by this Item 13 is incorporated by reference to the information set forth under the headings \"Election of Directors\" and \"Employment Arrangements\" in the Company's 1996 Proxy Statement.\n- 23 - PART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.\n(a) 1. Financial Statements.\nNOTE: Schedules other than those referred to above and parent company condensed financial statements have been omitted as inapplicable or not required under the instructions contained in Regulation S-X or the information is included elsewhere in the financial statements or the notes thereto.\n- 24 - 3. Exhibits.\nExhibit No. Description - ------- -----------\n3(a) - Restated Certificate of Incorporation of Registrant (incorporated herein by reference from Exhibit 3(a) to Registrant's Quarterly Report on Form 10-Q for the quarter ended June 26, 1993).\n3(b) - By-laws of Registrant, as amended (incorporated herein by reference from Exhibit 3(b) to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 26, 1992 [the \"1992 Annual Report\"]).\n4(a) - Specimen certificate for Registrant's Common Stock, par value $1.00 per share (incorporated herein by reference from Exhibit 4(a) to the 1992 Annual Report).\n4(b) - Rights Agreement, dated December 7, 1988, as amended, between Registrant and First Chicago Trust Company of New York, as Rights Agent (successor to The Chase Manhattan Bank, N.A.) (incorporated herein by reference from Exhibit 4(d) to Registrant's Report on Form 8-A dated January 29, 1991).\n4(b)(i) - Amendment to Rights Agreement, dated March 1990, between Registrant and First Chicago Trust Company of New York, as Rights Agent (successor to The Chase Manhattan Bank, N.A.) (incorporated herein by reference from Exhibit 4(d)(i) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 30, 1989 [the \"1989 Annual Report\"]).\n4(b)(ii) - Amendment to Rights Agreement, dated as of January 24, 1992, between Registrant and First Chicago Trust Company of New York, as Rights Agent (incorporated herein by reference from Exhibit 4(b)(ii) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 28, 1991 [the \"1991 Annual Report\"]).\n10(a) - Reference is made to Exhibits 4(b) - 4(b)(ii) filed hereunder, which are incorporated herein by this reference.\n10(b)+ - Liz Claiborne, Inc. 1984 Stock Option Plan (incorporated herein by reference from Exhibit 10(hh) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1983 [the \"1983 Annual Report\"]).\n10(b)(i)+ - Amendment to the 1984 Stock Option Plan (incorporated herein by reference from Exhibit 10(d)(i) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1988 [the \"1988 Annual Report\"]).\n- --------------------------------------------------------------------- + Compensation plan or arrangement required to be noted as provided in Item 14(a)(3).\n- 25 - Exhibit No. Description - ------- -----------\n10(c)+ - Form of Option Agreement under Liz Claiborne, Inc. 1984 Stock Option Plan (the \"1984 Option Plan\") (incorporated herein by reference from Exhibit 10(nn) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 29, 1984).\n10(c)(i)+ - Amended Form of Option Agreement under the 1984 Option Plan (incorporated herein by reference from Exhibit 10(e)(i) to the 1992 Annual Report).\n10(d)+ - Liz Claiborne Savings Plan (the \"Savings Plan\"), as amended and restated (incorporated herein by reference from Exhibit 10(f) to the 1989 Annual Report).\n10(d)(i)+ - Trust Agreement dated as of July 1, 1994, between Liz Claiborne, Inc. and IDS Trust Company (incorporated herein by reference from Exhibit 10(b) to Registrant's Quarterly Report on Form 10-Q for the period ended July 2, 1994).\n10(e)+ - Amendment Nos. 1 and 2 to the Savings Plan (incorporated herein by reference from Exhibit 10(g) to the 1992 Annual Report).\n10(e)(i)+ - Amendment Nos. 3 and 4 to the Savings Plan (incorporated herein by reference from Exhibit 10(g) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 26, 1993 [the \"1993 Annual Report\"]).\n10(e)(ii)+ - Amendment No. 5 to the Savings Plan (incorporated herein by reference from Exhibit 10(a) to Registrant's Quarterly Report on Form 10-Q for the period ended July 2, 1994).\n10(f)+ - Amended and Restated Liz Claiborne Profit-Sharing Retirement Plan (the \"Profit-Sharing Plan\") (incorporated herein by reference from Exhibit 10(h) to the 1992 Annual Report).\n10(g) - Trust Agreement related to the Profit-Sharing Plan (incorporated herein by reference from Exhibit 10(jj) to the 1983 Annual Report).\n10(g)(i)+ - Amendment Nos. 1 and 2 to the Profit-Sharing Plan (incorporated herein by reference from Exhibit 10(i)(i) to the 1993 Annual Report).\n10(g)(ii)+ - Amendment No. 3 to the Profit-Sharing Plan (incorporated herein by reference from Exhibit 10(a) to Registrant's Quarterly Report on Form 10-Q for the period ended October 1, 1994).\n10(g)(iii)+ - Amendment No. 4 to the Profit-Sharing Plan (incorporated herein by reference from Exhibit 10(a) to Registrant's Quarterly Report on Form 10-Q for the period ended July 1, 1995).\n- --------------------------------------------------------------------- + Compensation plan or arrangement required to be noted as provided in Item 14(a)(3).\n- 26 - Exhibit No. Description - ------- -----------\n10(h)* - Collective Bargaining Agreement, dated June 1, 1994, between New York Skirt and Sportswear Association, Inc. (of which Registrant is a member) and Amalgamated Ladies' Garment Cutters' Union, Local 10, I.L.G.W.U. and Blouse, Skirt, Sportswear, Children's Wear & Allied Workers' Union, Local 23-25, I.L.G.W.U.\n10(i) - Executive Liability and Indemnification Policy No. 81035379F, with Chubb Group of Insurance Companies (the \"Insurance Policy\") (incorporated herein by reference from Exhibit 10(l) to Registrant's Annual Report on Form 10-K for Fiscal Year ended December 31, 1994 [the \"1994 Annual Report\"].\n10(i)(i)* - Summary of Extension of the Insurance Policy.\n10(j)* - Excess Coverage Directors and Officers Liability Insurance Policy No. ZKA9400406, with Lloyds of London (the \"Excess Insurance Policy\").\n10(j)(i)* - Summary of Extension of the Excess Insurance Policy.\n10(k)+* - Description of 1995 Salaried Employee Incentive Bonus Plan.\n10(l) - Lease, dated as of January 1, 1990 for premises located at 1441 Broadway, New York, New York between Registrant and Lechar Realty Corp. (incorporated herein by reference from Exhibit 10(n) to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 29, 1990).\n10(m)+* - Liz Claiborne, Inc. Amended and Restated Outside Directors' 1991 Stock Ownership Plan.\n10(n)+ - Liz Claiborne, Inc. 1992 Stock Incentive Plan (the \"1992 Plan\") (incorporated herein by reference from Exhibit 10(p) to the 1991 Annual Report).\n10(n)(i)+ - Amendment No. 1 to the 1992 Plan (incorporated herein by reference from Exhibit 10(p)(i) to the 1993 Annual Report).\n10(o)+ - Form of Option Agreement under the 1992 Plan for premium-priced options (incorporated herein by reference from Exhibit 10(q) to the 1992 Annual Report).\n10(p)+ - Form of Option Agreement under the 1992 Plan (incorporated herein by reference from Exhibit 10(r) to the 1992 Annual Report).\n10(q)+ - Form of Restricted Career Share Agreement under the 1992 Plan (incorporated herein by reference from Exhibit 10(a) to Registrant's Quarterly Report of Form 10-Q for the period ended September 30, 1995).\n- --------------------------------------------------------------------- * Filed herewith.\n+ Compensation plan or arrangement required to be noted as provided in Item 14(a)(3).\n- 27 - Exhibit No. Description - ------- -----------\n10(r)+ - Description of unfunded deferred compensation arrangement for Jerome A. Chazen (incorporated herein by reference from Exhibit 10(s) to the 1992 Annual Report).\n10(s)+* - Description of Supplemental Life Insurance Plans.\n10(t)+ - Description of unfunded death\/disability benefits for certain executives (incorporated herein by reference from Exhibit 10(u) to the 1992 Annual Report).\n10(u)+ - Form of the Liz Claiborne Section 162(m) Cash Bonus Plan (incorporated herein by reference from Exhibit 10(v) to the 1994 Annual Report).\n10(v)+ - Liz Claiborne Supplemental Executive Retirement Plan (the \"SERP\") (incorporated by reference from Exhibit 10(w) to the 1994 Annual Report).\n10(w)+* - Description of the Liz Claiborne, Inc. Bonus Deferral Plan.\n10(x)+ - Employment Agreement dated as of May 9, 1994, between Registrant and Paul R. Charron (the \"Employment Agreement\") (incorporated herein by reference from Exhibit 10(a) to Registrant's Quarterly Report on Form 10-Q for the period ended April 2, 1994).\n10(x)(i)+* - Amendment to the Employment Agreement, dated as of November 20, 1995, between Registrant and Paul R. Charron.\n10(y) - Agreement dated as of January 2, 1995, between Registrant and Harvey Falk (incorporated herein by reference from Exhibit 10(y) to the 1994 Annual Report).\n21* - List of Registrant's Subsidiaries.\n23* - Consent of Independent Public Accountants.\n27* - Financial Data Schedule.\n29* - Undertakings.\n(b) Reports on Form 8-K.\nNot applicable.\n- --------------------------------------------------------------------- * Filed herewith.\n+ Compensation plan or arrangement required to be noted as provided in Item 14(a)(3).\n- 28 - SIGNATURES\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 March 28, 1996.\nLIZ CLAIBORNE, INC.\nBy \/s\/Samuel M. Miller ---------------------- Samuel M. Miller, Senior Vice President-Finance\/ Principal Financial and Accounting 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 March 28, 1996.\nSignature Title --------- -----\n\/s\/Paul R. Charron Chief Executive Officer, Principal Executive - ------------------------ Paul R. Charron Officer, President and Director\n\/s\/Jerome A. Chazen - ------------------------ Jerome A. Chazen Chairman of the Board and Director\n\/s\/Lee Abraham - ------------------------ Lee Abraham Director\n- ------------------------ Eileen H. Bedell Director\n\/s\/Ann M. Fudge - ------------------------ Ann M. Fudge Director\n\/s\/J. James Gordon - ------------------------ J. James Gordon Director\n\/s\/Sherwin Kamin - ------------------------ Sherwin Kamin Director\n\/s\/Kay Koplovitz - ------------------------ Kay Koplovitz Director\n\/s\/Louis Lowenstein - ------------------------ Louis Lowenstein Director\n\/s\/Paul E. Tierney, Jr. - ------------------------ Paul E. Tierney, Jr. Director\n- 29 - INDEX\nLIZ CLAIBORNE, INC. AND SUBSIDIARIES\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES\nNOTE: Schedules other than those referred to above and parent company condensed financial statements have been omitted as inapplicable or not required under the instructions contained in Regulation S-X or the information is included elsewhere in the financial statements or the notes thereto.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Board of Directors and Stockholders of Liz Claiborne, Inc.:\nWe have audited the accompanying consolidated balance sheets of Liz Claiborne, Inc. (a Delaware corporation) and subsidiaries as of December 30, 1995 and December 31, 1994, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three fiscal years in the period ended December 30, 1995. 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 Liz Claiborne, Inc. and subsidiaries as of December 30, 1995 and December 31, 1994, and the results of their operations and their cash flows for each of the three fiscal years in the period ended December 30, 1995 in conformity with generally accepted accounting principles.\nAs explained in Note 1 to the consolidated financial statements, effective December 27, 1992, the Company changed its method of accounting for income taxes.\n\/s\/ Arthur Andersen New York, New York February 19, 1996\nCONSOLIDATED BALANCE SHEETS LIZ CLAIBORNE, INC. AND SUBSIDIARIES\nTHE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ARE AN INTEGRAL PART OF THESE STATEMENTS. CONSOLIDATED STATEMENTS OF INCOME\nTHE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ARE AN INTEGRAL PART OF THESE STATEMENTS. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY\nLIZ CLAIBORNE, INC. AND SUBSIDIARIES\nTHE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ARE AN INTEGRAL PART OF THESE STATEMENTS.\nTHE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ARE AN INTEGRAL PART OF THESE STATEMENTS. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS LIZ CLAIBORNE, INC. AND SUBSIDIARIES - --------------------------------------------------------------------------------\nNOTE 1 SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the accounts of Liz Claiborne, Inc. and its wholly-owned subsidiaries (the \"Company\"). All intercompany balances and transactions have been eliminated in consolidation. The consolidated financial statements are prepared in accordance with generally accepted accounting principles which require management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent gains and losses at the date of the financial statements and the reported amounts of revenues and expenses during the period. Actual results could differ from those estimates. The Company is primarily engaged in the design and marketing of a broad range of apparel, as well as accessories and fragrances. The principal market for the products is the United States.\nCASH EQUIVALENTS\nAll highly liquid investments with a remaining maturity of three months or less at the date of acquisition are classified as cash equivalents.\nMARKETABLE SECURITIES\nInvestments are stated at market in accordance with Statement of Financial Accounting Standards (\"SFAS\") No. 115 \"Accounting for Certain Investments in Debt and Equity Securities\" which was adopted by the Company at the beginning of the 1994 fiscal year. Gains and losses on investment transactions are recognized in income based on settlement dates. Unrealized gains and losses are included in retained earnings until realized. Dividends on equity securities are recorded in income based on payment dates. Interest is recognized when earned.\nINVENTORIES\nInventories are stated at the lower of cost (first-in, first-out for wholesale operations and retail method for retail and outlet operations) or market.\nPROPERTY AND EQUIPMENT - NET\nProperty and equipment is stated at cost less accumulated depreciation and amortization. Buildings and building improvements are depreciated using the straight-line method over their estimated useful lives of 20 to 39 years. Machinery and equipment and furniture and fixtures are depreciated using the straight-line method over their estimated useful lives of five to seven years. Leasehold improvements are amortized over the shorter of the lease term or the estimated useful lives of the assets.\nFOREIGN CURRENCY TRANSLATION\nAssets and liabilities of non-U.S. subsidiaries have been translated at year-end exchange rates. Revenues and expenses have been translated at average rates of exchange in effect during the year. Resulting translation adjustments have been recorded as a separate component of stockholders' equity. Gains and losses on translation of intercompany transactions with foreign subsidiaries of a long-term investment nature are also included in this component of stockholders' equity. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) LIZ CLAIBORNE, INC. AND SUBSIDIARIES - --------------------------------------------------------------------------------\nFOREIGN EXCHANGE CONTRACTS\nThe Company enters into foreign exchange contracts to hedge transactions denominated in foreign currencies for periods up to 12 months and to hedge expected payment of intercompany transactions with its non-U.S. subsidiaries. Gains and losses on contracts which hedge specific foreign currency denominated commitments are recognized in the period in which the transaction is completed. Transaction gains and losses included in income were not significant in fiscal 1995, 1994 and 1993. As of December 30, 1995, the Company had contracts maturing through December 1996 to purchase at contracted forward rates 42,427,000 Japanese yen and to sell 37,000,000 Canadian dollars and 4,600,000 British pounds sterling. The aggregate U.S. dollar value of all foreign exchange contracts is approximately $35,000,000 at year end 1995, as compared with approximately $50,000,000 at year end 1994. Unrealized gains and losses for outstanding foreign exchange contracts were not material at December 30, 1995 and December 31, 1994.\nREVENUE RECOGNITION\nRevenue within wholesale operations is recognized at the time merchandise is shipped from the Company's distribution centers. Retail and outlet store revenues are recognized at the time of sale.\nCHANGE IN ACCOUNTING PRINCIPLES - INCOME TAXES\nThe Company adopted the provisions of SFAS No. 109 \"Accounting for Income Taxes\" as of the beginning of fiscal 1993. The effect of this accounting change in fiscal 1993 was an increase in net income of $1,643,000, or $.02 per common share.\nEARNINGS PER COMMON SHARE\nEarnings per common share have been computed using the weighted average number of shares outstanding during each period. The inclusion of shares subject to unexercised stock options would not have a material dilutive effect.\nFISCAL YEAR\nIn 1994, the Company changed its fiscal year to the Saturday closest to December 31 from the last Saturday in December. This change had no effect on the 1995 or 1994 year end date. The 1994 fiscal year reflects a 53-week period, while the 1995 and 1993 fiscal years each reflect a 52-week period.\nNOTE 2\nRESTRUCTURING CHARGE\nIn December 1994, the Company recorded a $30.0 million restructuring charge. The amount included $16.8 million related to the phase out of its First Issue business, $10.2 million for the streamlining of operating and administrative functions and $3.0 million for the restructuring of its Moderate Division. Principal items included in the charge are estimated contract termination costs, severance and related benefits for staff reductions, losses on contracts and the write-off of certain assets. This charge reduced net income by $18.9 million, or $.24 per common share, in the fourth quarter of 1994. The remaining balance of the restructuring charge as of December 30, 1995 was $13.3 million. Of the $16.7 million expended for restructuring costs, $7.1 million was related to severance costs, $5.5 million to losses on contracts and write-off of certain assets and $4.1 million to other miscellaneous costs. The majority of the remaining liabilities should be paid or settled during 1996. First Issue accounted for $53.3 million of fiscal 1995 net sales, as compared with $63.9 million in 1994, and incurred operating losses of $8.9 million in fiscal 1995, as compared with $17.3 million in 1994. The 26 First Issue locations remaining at December 30, 1995 will be converted to other Company-operated retail formats or closed during the first quarter of 1996. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) LIZ CLAIBORNE, INC. AND SUBSIDIARIES - --------------------------------------------------------------------------------\nNOTE 3\nLICENSE AGREEMENT\nEffective June 30, 1995, the Company entered into an agreement with a third party to operate under license the shoe business formerly operated by the Company's Shoe Division. As part of the transaction, the Company received $18.0 million in cash, plus other consideration valued at $4.9 million, in exchange for inventory and other assets. The Shoe Division had net sales of $38.9 million in the first half of fiscal 1995 and $62.7 million in fiscal 1994. The operating results of the shoe business for each period were not material to the Company's overall operating results.\nNOTE 4\nMARKETABLE SECURITIES\nThe Company adopted the provisions of SFAS No. 115 \"Accounting for Certain Investments in Debt and Equity Securities\" as of the beginning of fiscal 1994. In accordance with SFAS No. 115, prior period financial statements have not been restated to reflect the change in accounting principle. The effect as of December 26, 1993 of adopting SFAS No. 115 was an increase in the opening balance of stockholders' equity of $2,848,000 (net of $1,673,000 in deferred income taxes) to reflect the net unrealized gains on securities classified as available-for-sale, which were previously carried at amortized cost. This increase in stockholders' equity was included in retained earnings.\nThe following are summaries of available-for-sale marketable securities and maturities:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) LIZ CLAIBORNE, INC. AND SUBSIDIARIES - --------------------------------------------------------------------------------\nThese investments include $46,903,000 in 1995 and $64,422,000 in 1994 of tax exempt notes and bonds which are classified as cash and cash equivalents and equity securities which are included in other long-term assets in the consolidated balance sheets.\nFor the fiscal years 1995 and 1994, gross realized gains of available-for-sale securities totaled $956,000 and $674,000, respectively, and gross realized losses totaled $1,167,000 and $412,000, respectively. The adjustment to unrealized gains and losses on available-for-sale securities which was included in retained earnings was a credit of $4,549,000 (net of $2,729,000 in deferred income taxes) and a charge of $6,787,000 (net of $3,986,000 in deferred income taxes) in fiscal 1995 and 1994, respectively.\nNOTE 5 INVENTORIES\nInventories are summarized as follows:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) LIZ CLAIBORNE, INC. AND SUBSIDIARIES - --------------------------------------------------------------------------------\nNOTE 6 PROPERTY AND EQUIPMENT\nProperty and equipment consists of the following:\nThe Company's land and building located in Mount Pocono, Pennsylvania is pledged as collateral against long-term debt of $1,115,000.\nNOTE 7\nINCOME TAXES\nLiz Claiborne, Inc. and its U.S. subsidiaries file a consolidated federal income tax return. Deferred income tax benefits and deferred income taxes represent the tax effects of revenues, costs and expenses which are recognized for tax purposes in different periods from those used for financial statement purposes. The current income tax provisions have not been reduced by $27,000 in 1995, $15,000 in 1994 and $1,171,000 in 1993, of tax benefits arising from the exercise of nonqualified stock options. These amounts have been credited to capital in excess of par value. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) LIZ CLAIBORNE, INC. AND SUBSIDIARIES - --------------------------------------------------------------------------------\nThe effective income tax rate differs from the statutory federal income tax rate as follows:\nThe components of net deferred taxes arising from temporary differences as of December 30, 1995 and December 31, 1994 are as follows:\nManagement believes that the deferred tax benefits will be fully realized through future taxable income and reversals of deferred tax liabilities. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) LIZ CLAIBORNE, INC. AND SUBSIDIARIES - --------------------------------------------------------------------------------\nNOTE 8 COMMITMENTS, CONTINGENCIES AND OTHER MATTERS\nThe Company leases office, showroom, warehouse\/distribution and retail space, computers and other equipment under various noncancellable operating lease agreements which expire through December 2013. Rental expense for 1995, 1994 and 1993 was approximately $74,902,000, $67,208,000 and $56,664,000, respectively.\nAt December 30, 1995, the minimum aggregate rental commitments are as follows:\nCertain rental commitments have renewal options extending through the year 2029. Some of these renewals are subject to adjustments in future periods. Many of the leases call for additional charges, some of which are based upon various escalations, and, in the case of outlet and retail leases, the gross sales of the individual stores above base levels.\nAt December 30, 1995, the Company had entered into commitments for the purchase of raw materials and for the production of finished goods totaling approximately $565,681,000.\nIn 1995, in connection with its stock repurchase program, the Company sold put warrants on 2.0 million shares of common stock in privately negotiated transactions based on the then-current market price of the common stock. The warrants give the holders the right at maturity to require the Company to repurchase shares of its common stock at specified prices. As of December 30, 1995, warrants on 1.0 million shares of common stock had expired unexercised and warrants on an additional 1.0 million shares remained outstanding, which, if exercised, will require the Company to purchase up to 1.0 million shares of its common stock at various dates in 1996. The proceeds of $3.6 million from the sale of put warrants have been recorded in capital in excess of par value. The Company's potential $25.3 million obligation to buy back 1.0 million shares of common stock has been charged to capital in excess of par value and is reflected as put warrants on the consolidated balance sheets as of December 30, 1995.\nIn the normal course of business, the Company extends credit, on open account, to its retail store customers, after a credit analysis based on a number of financial and other criteria. In recent years, a number of corporate groups which include certain of the Company's largest department store customers have been involved in highly leveraged financial transactions and certain of these customers have filed for protection under Chapter 11 of the Federal Bankruptcy Code. Subsequently, certain customers have emerged from protection under Chapter 11. In 1995, three corporate groups of department store customers accounted for 18%, 17% and 11%, respectively, of net sales. In 1994, two corporate groups of department store customers accounted for 17% and 11%, respectively, of net sales. In 1993, two corporate groups of department store customers accounted for 18% and 11%, respectively, of net sales. The Company does not believe that this concentration of sales and credit risk represents a material risk of loss with respect to its financial position as of December 30, 1995.\nThe Company is a party to several pending legal proceedings and claims. Although the outcome of such actions cannot be determined with certainty, management is of the opinion that the final outcome should not have a material adverse effect on the Company's results of operations or financial position. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) LIZ CLAIBORNE, INC. AND SUBSIDIARIES - --------------------------------------------------------------------------------\nNOTE 9 LINES OF CREDIT\nAs of December 30, 1995, the Company had bank lines of credit aggregating $270,000,000 which were available to cover letters of credit issued by the banks and direct borrowings. The Company has not used these facilities for direct borrowings.\nAt December 30, 1995 and December 31, 1994, the Company had outstanding letters of credit of $210,145,000 and $204,113,000, respectively.\nNOTE 10\nSTOCK PLANS\nIn February 1984 and March 1992, the Company adopted plans under which nonqualified options to acquire shares of common stock may be granted to officers, other key employees and directors selected by the plans' administrative committee. Payment by option holders upon exercise of an option may be made in cash or, with the consent of the committee, by delivering previously acquired shares of Company common stock. Stock appreciation rights may be granted in connection with all or any part of any option granted under the plans, and may also be granted without a grant of a stock option. The grantee of a stock appreciation right has the right, with the consent of the committee, to receive either in cash or in shares of common stock, an amount equal to the appreciation in the fair market value of the covered shares from the date of grant to the date of exercise. Options and rights are exercisable over a period of time designated by the committee (but not prior to one year from the date of grant) and are subject to such other terms and conditions as the committee determines. Vesting schedules will be accelerated upon merger of the Company or the happening of certain other events. Options and rights may not be transferred during the lifetime of a holder.\nAwards under the 1992 plan may also be made in the form of stock appreciation rights, incentive stock options, dividend equivalent rights, restricted stock, unrestricted stock and performance shares. To date, no stock appreciation rights, incentive stock options, dividend equivalent rights, unrestricted stock or performance shares have been granted under the plan. Exercise prices for awards under the plans are determined by the committee; to date, all stock options have been granted at an exercise price not less than the fair market value of the underlying shares on the date of grant.\nThe 1992 plan provides initially for the issuance of up to 2,500,000 shares of common stock with respect to options, stock appreciation rights and other awards granted under the plan, and provides that the Board of Directors may increase such number by an amount equal to 1% of the common stock outstanding as of January 1, 1994 and each January 1st thereafter. At December 30, 1995, there were available for future grant 1,632,892 shares under the 1992 plan. The 1992 plan expires in 2002. The 1984 plan has expired; awards made thereunder prior to its termination remain in effect in accordance with their terms.\nSince January 1990, the Company has delivered treasury shares upon the exercise of stock options. The difference between the cost of the treasury shares, on a first-in, first-out basis, and the exercise price of the options has been reflected in retained earnings. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) LIZ CLAIBORNE, INC. AND SUBSIDIARIES - --------------------------------------------------------------------------------\nChanges in common shares under option for the three fiscal years in the period ended December 30, 1995 are summarized as follows:\nIn October 1995, the Financial Accounting Standards Board issued SFAS No. 123 \"Accounting for Stock-Based Compensation.\" This Statement is effective beginning in 1996. Adoption of SFAS No. 123 will require the Company to disclose additional information relating to the stock option plans and the Company's pro forma net income and earnings per share, as if the options granted were expensed at their fair value at the time of grant.\nOn January 11, 1996, 660,750 nonqualified options to acquire shares of common stock were granted to officers and other key employees with an exercise price of $26.88.\nIn June 1995, the committee granted 416,000 shares of common stock to a group of key executives in connection with a \"Career Share Program\" under the 1992 Plan. These shares are subject to restrictions on transfer and subject to risk of forfeiture until earned by continued employment. The restrictions expire on December 20, 2004. The expiration of the restrictions may be accelerated if the total return of the common stock exceeds that of a predetermined group of competitors or upon the happening of certain other events. The unearned compensation related to this restricted stock grant as of December 30, 1995 was $5,373,000 and is included in retained earnings on the consolidated balance sheets. The unearned compensation amount is currently being amortized over a period of three years in anticipation of the accelerated expiration of the restrictions.\nIn May 1994, the committee granted 85,000 shares of common stock in connection with the hiring of a key executive. These shares are subject to restrictions on transfer and subject to risk of forfeiture until earned by continued employment. The restrictions expire on the last day of each of the Company's fiscal years 1994 through 2001, at the rate of 10,000 shares of common stock per year through the year 2000 and 15,000 shares in the year 2001. The expiration of the restrictions may be accelerated if the market value of the common stock attains certain predetermined levels or upon the happening of certain other events. The unearned compensation related to this restricted stock grant as of December 30, 1995 was $1,560,000 and is included in retained earnings on the consolidated balance sheets. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) LIZ CLAIBORNE, INC. AND SUBSIDIARIES - --------------------------------------------------------------------------------\nIn 1992, options were granted to certain of the Company's senior officers at a price of $58.50 per share, representing 150% of the market price at the date of grant. At December 30, 1995, 50,000 of these options remained outstanding; they will become exercisable on October 21, 1998 and expire on October 21, 2000, subject to certain exceptions.\nIn November 1991, the Company adopted an outside directors' stock ownership plan under which non-employee directors automatically receive, as part of their annual retainer, shares of common stock with a value of $10,000 on each January 1. The shares so issued are nontransferable for a period of three years following the grant date, subject to certain exceptions. In 1995, 4,116 shares of common stock were issued under this plan. Not more than one twentieth of one percent (0.05%) of the shares of common stock outstanding from time to time may be issued under the plan, which will expire in 2002.\nNOTE 11 PROFIT-SHARING RETIREMENT, SAVINGS AND DEFERRED COMPENSATION PLANS\nThe Company adopted a noncontributory, defined contribution profit-sharing retirement plan in January 1983. The plan covers all eligible U.S. employees who are 21 years of age with one or more years of service and who are not covered by collective bargaining agreements. The plan pays benefits based on an employee's vested account balance in accordance with qualification rules set out in the plan. Vesting begins at 20% after two years of service, and from the 3rd through 6th years, vesting increases by 20% each year until full vesting occurs. Each year, profit-sharing contributions, if any, are determined by the Board of Directors. The Company's 1995, 1994 and 1993 plan contribution expenses, which are included in selling, general and administrative expenses, were $5,572,000, $6,166,000 and $5,646,000, respectively.\nThe Company adopted a 401(k) savings plan effective January 1985. The plan covers all eligible US employees who are 21 years of age with one or more years of service and who are not covered by collective bargaining agreements. The plan pays benefits based on an employee's vested account balance. Subject to Internal Revenue Code limitations, participants may contribute from 1% to 15% of their salary on a before-tax basis. Such contributions are fully and immediately vested. Vesting of the Company's matching contribution is on the same basis as the profit sharing retirement plan. The Company's 1995, 1994 and 1993 plan contribution expenses, which are included in selling, general and administrative expenses, were $2,044,000, $2,082,000 and $2,015,000, respectively.\nThe Company has established an unfunded deferred compensation arrangement for a senior executive which accrues for four years at the rate of $375,000 per year commencing on January 1, 1993. The accrued amount, plus interest, will be payable upon retirement.\nIn 1993, the Company adopted a supplemental retirement plan for executives whose benefits under the profit-sharing retirement plan and the savings plan are constrained by the operation of certain Internal Revenue Code limitations. The supplemental plan provides a benefit equal to the difference between the contribution that would be made for an executive under the two tax-qualified plans absent such limitations and the actual contribution under those plans. Supplemental benefits vest on the same schedule applicable under the tax-qualified plans. The supplemental plan is not funded. The plan as amended also allows participants to contribute up to 100% of their annual bonus and up to 15% of their salary. Eligible executives employed on August 5, 1993 were credited with a retroactive supplemental plan benefit for the prior years in which the legal limitations had affected their tax-qualified plan benefits. The Company's plan expenses, which are included in selling, general and administrative expenses, were $405,000, $362,000 and $773,000 in 1995, 1994 and 1993, respectively. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) LIZ CLAIBORNE, INC. AND SUBSIDIARIES - --------------------------------------------------------------------------------\nNOTE 12 STOCKHOLDER RIGHTS PLAN\nThe Company has adopted a Stockholder Rights Plan under which one preferred stock purchase right is attached to each share of common stock outstanding. Pursuant to the Rights Agreement covering the Stockholder Rights Plan, the rights become exercisable ten days, subject to extension, after a party or group acquires or makes a tender offer for 20% or more of the Company's common stock. Each right entitles its holder, under certain circumstances, to buy 1\/100 share of a newly created Series A Junior Participating Preferred Stock for $85. If 20% of the Company's common stock is acquired by a party or group, each right not owned by a 20%-or-more stockholder will entitle the holder to purchase Company common stock having a market value of twice the exercise price of the right. In addition, if the Company is involved in a merger or certain other business combinations in which it is not the surviving corporation, each right not owned by a 20%-or-more stockholder will entitle the holder to purchase common stock of the surviving corporation having a market value of twice the exercise price of the right. The rights, which expire on December 21, 1998 and do not have voting rights, may be redeemed by the Company at $.01 per right prior to their becoming exercisable.\nNOTE 13\nCONSOLIDATED STATEMENTS OF CASH FLOWS SUPPLEMENTARY DISCLOSURES\nDuring fiscal 1995, 1994 and 1993, the Company made income tax payments of $65,590,000, $72,415,000 and $84,689,000, respectively. Non-cash investing activities which are not included in the cash flow statements for 1995 and 1994 include a direct financing lease receivable with a disposition of property and equipment of $1,120,000 and $1,177,000, respectively, and in 1995, a reversal of the remaining direct financing lease receivable and acquisition of property and equipment of $9,738,000.\nNOTE 14 ACCRUED EXPENSES\nAccrued expenses at December 30, 1995 and December 31, 1994 consisted of the following:\nUNAUDITED QUARTERLY RESULTS\nUnaudited quarterly financial information for 1995 and 1994 is set forth in the table below:\n* Includes the after tax effect of a restructuring charge of $18,900 ($30,000 pretax) or $.24 per common share in 1994. INDEX TO EXHIBITS\nExhibit No. Description - ------- -----------\n3(a) - Restated Certificate of Incorporation of Registrant (incorporated herein by reference from Exhibit 3(a) to Registrant's Quarterly Report on Form 10-Q for the quarter ended June 26, 1993).\n3(b) - By-laws of Registrant, as amended (incorporated herein by reference from Exhibit 3(b) to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 26, 1992 [the \"1992 Annual Report\"]).\n4(a) - Specimen certificate for Registrant's Common Stock, par value $1.00 per share (incorporated herein by reference from Exhibit 4(a) to the 1992 Annual Report).\n4(b) - Rights Agreement, dated December 7, 1988, as amended, between Registrant and First Chicago Trust Company of New York, as Rights Agent (successor to The Chase Manhattan Bank, N.A.) (incorporated herein by reference from Exhibit 4(d) to Registrant's Report on Form 8-A dated January 29, 1991).\n4(b)(i) - Amendment to Rights Agreement, dated March 1990, between Registrant and First Chicago Trust Company of New York, as Rights Agent (successor to The Chase Manhattan Bank, N.A.) (incorporated herein by reference from Exhibit 4(d)(i) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 30, 1989 [the \"1989 Annual Report\"]).\n4(b)(ii) - Amendment to Rights Agreement, dated as of January 24, 1992, between Registrant and First Chicago Trust Company of New York, as Rights Agent (incorporated herein by reference from Exhibit 4(b)(ii) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 28, 1991 [the \"1991 Annual Report\"]).\n10(a) - Reference is made to Exhibits 4(b) - 4(b)(ii) filed hereunder, which are incorporated herein by this reference.\n10(b)+ - Liz Claiborne, Inc. 1984 Stock Option Plan (incorporated herein by reference from Exhibit 10(hh) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1983 [the \"1983 Annual Report\"]).\n10(b)(i)+ - Amendment to the 1984 Stock Option Plan (incorporated herein by reference from Exhibit 10(d)(i) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1988 [the \"1988 Annual Report\"]).\n- -------------------------------------------------------------------------------- + Compensation plan or arrangement required to be noted as provided in Item 14(a)(3). Exhibit No. Description - ------- -----------\n10(c)+ - Form of Option Agreement under Liz Claiborne, Inc. 1984 Stock Option Plan (the \"1984 Option Plan\") (incorporated herein by reference from Exhibit 10(nn) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 29, 1984).\n10(c)(i)+ - Amended Form of Option Agreement under the 1984 Option Plan (incorporated herein by reference from Exhibit 10(e)(i) to the 1992 Annual Report).\n10(d)+ - Liz Claiborne Savings Plan (the \"Savings Plan\"), as amended and restated (incorporated herein by reference from Exhibit 10(f) to the 1989 Annual Report).\n10(d)(i)+ - Trust Agreement dated as of July 1, 1994, between Liz Claiborne, Inc. and IDS Trust Company (incorporated herein by reference from Exhibit 10(b) to Registrant's Quarterly Report on Form 10-Q for the period ended July 2, 1994).\n10(e)+ - Amendment Nos. 1 and 2 to the Savings Plan (incorporated herein by reference from Exhibit 10(g) to the 1992 Annual Report).\n10(e)(i)+ - Amendment Nos. 3 and 4 to the Savings Plan (incorporated herein by reference from Exhibit 10(g) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 26, 1993 [the \"1993 Annual Report\"]).\n10(e)(ii)+ - Amendment No. 5 to the Savings Plan (incorporated herein by reference from Exhibit 10(a) to Registrant's Quarterly Report on Form 10-Q for the period ended July 2, 1994).\n10(f)+ - Amended and Restated Liz Claiborne Profit-Sharing Retirement Plan (the \"Profit-Sharing Plan\") (incorporated herein by reference from Exhibit 10(h) to the 1992 Annual Report).\n10(g) - Trust Agreement related to the Profit-Sharing Plan (incorporated herein by reference from Exhibit 10(jj) to the 1983 Annual Report).\n10(g)(i)+ - Amendment Nos. 1 and 2 to the Profit-Sharing Plan (incorporated herein by reference from Exhibit 10(i)(i) to the 1993 Annual Report).\n10(g)(ii)+ - Amendment No. 3 to the Profit-Sharing Plan (incorporated herein by reference from Exhibit 10(a) to Registrant's Quarterly Report on Form 10-Q for the period ended October 1, 1994).\n10(g)(iii)+ - Amendment No. 4 to the Profit-Sharing Plan (incorporated herein by reference from Exhibit 10(a) to Registrant's Quarterly Report on Form 10-Q for the period ended July 1, 1995).\n- -------------------------------------------------------------------------------- + Compensation plan or arrangement required to be noted as provided in Item 14(a)(3). Exhibit No. Description - ------- ----------- 10(h)* - Collective Bargaining Agreement, dated June 1, 1994, between New York Skirt and Sportswear Association, Inc. (of which Registrant is a member) and Amalgamated Ladies' Garment Cutters' Union, Local 10, I.L.G.W.U. and Blouse, Skirt, Sportswear, Children's Wear & Allied Workers' Union, Local 23-25, I.L.G.W.U.\n10(i) - Executive Liability and Indemnification Policy No. 81035379F, with Chubb Group of Insurance Companies (the \"Insurance Policy\") (incorporated herein by reference from Exhibit 10(l) to Registrant's Annual Report on Form 10-K for Fiscal Year ended December 31, 1994 [the \"1994 Annual Report\"].\n10(i)(i)* - Summary of Extension of the Insurance Policy.\n10(j)* - Excess Coverage Directors and Officers Liability Insurance Policy No. ZKA9400406, with Lloyds of London (the \"Excess Insurance Policy\").\n10(j)(i)* - Summary of Extension of the Excess Insurance Policy.\n10(k)+* - Description of 1995 Salaried Employee Incentive Bonus Plan.\n10(l) - Lease, dated as of January 1, 1990 for premises located at 1441 Broadway, New York, New York between Registrant and Lechar Realty Corp. (incorporated herein by reference from Exhibit 10(n) to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 29, 1990).\n10(m)+* - Liz Claiborne, Inc. Amended and Restated Outside Directors' 1991 Stock Ownership Plan.\n10(n)+ - Liz Claiborne, Inc. 1992 Stock Incentive Plan (the \"1992 Plan\") (incorporated herein by reference from Exhibit 10(p) to the 1991 Annual Report).\n10(n)(i)+ - Amendment No. 1 to the 1992 Plan (incorporated herein by reference from Exhibit 10(p)(i) to the 1993 Annual Report).\n10(o)+ - Form of Option Agreement under the 1992 Plan for premium-priced options (incorporated herein by reference from Exhibit 10(q) to the 1992 Annual Report).\n10(p)+ - Form of Option Agreement under the 1992 Plan (incorporated herein by reference from Exhibit 10(r) to the 1992 Annual Report).\n10(q)+ - Form of Restricted Career Share Agreement under the 1992 Plan (incorporated herein by reference from Exhibit 10(a) to Registrant's Quarterly Report of Form 10-Q for the period ended September 30, 1995).\n- -------------------------------------------------------------------------------- * Filed herewith.\n+ Compensation plan or arrangement required to be noted as provided in Item 14(a)(3). Exhibit No. Description - ------- -----------\n10(r)+ - Description of unfunded deferred compensation arrangement for Jerome A. Chazen (incorporated herein by reference from Exhibit 10(s) to the 1992 Annual Report).\n10(s)+* - Description of Supplemental Life Insurance Plans.\n10(t)+ - Description of unfunded death\/disability benefits for certain executives (incorporated herein by reference from Exhibit 10(u) to the 1992 Annual Report).\n10(u)+ - Form of the Liz Claiborne Section 162(m) Cash Bonus Plan (incorporated herein by reference from Exhibit 10(v) to the 1994 Annual Report).\n10(v)+ - Liz Claiborne Supplemental Executive Retirement Plan (the \"SERP\") (incorporated by reference from Exhibit 10(w) to the 1994 Annual Report).\n10(w)+* - Description of the Liz Claiborne, Inc. Bonus Deferral Plan.\n10(x)+ - Employment Agreement dated as of May 9, 1994, between Registrant and Paul R. Charron (the \"Employment Agreement\") (incorporated herein by reference from Exhibit 10(a) to Registrant's Quarterly Report on Form 10-Q for the period ended April 2, 1994).\n10(x)(i)+* - Amendment to the Employment Agreement, dated as of November 20, 1995, between Registrant and Paul R. Charron.\n10(y) - Agreement dated as of January 2, 1995, between Registrant and Harvey Falk (incorporated herein by reference from Exhibit 10(y) to the 1994 Annual Report).\n21* - List of Registrant's Subsidiaries.\n23* - Consent of Independent Public Accountants.\n27* - Financial Data Schedule.\n29* - Undertakings.\n(b) Reports on Form 8-K.\nNot applicable.\n- -------------------------------------------------------------------------------- * Filed herewith.\n+ Compensation plan or arrangement required to be noted as provided in Item 14(a)(3).","section_15":""}
{"filename":"931494_1995.txt","cik":"931494","year":"1995","section_1":"Item 1. Business.\nOn November 21, 1995 The CIT Group Securitization Corporation II (the \"Company\") issued its Manufactured Housing Contract Senior\/Subordinate Pass-Through Certificates, Series 1995-2, Class A-1, Class A-2, Class A-3, Class A-4, Class A-5 and Class B Certificates (collectively, the \"Offered Certificates\") and Class R Certificates, such Series representing interests in the CIT Manufactured Housing Contract Senior\/Subordinate Pass-Through Certificates Trust, Series 1995-2 (the \"Trust\"). The Offered Certificates were offered pursuant to Company's prospectus dated February 10, 1995 as supplemented by the prospectus supplement dated November 14, 1995 (collectively referred to herein as the \"Prospectus\").\nThe Class A-1 Certificates evidence an initial (approximate) 18.20% ownership interest in the Trust. The Class A-2 Certificates evidence an initial (approximate) 17.80% ownership interest in the Trust. The Class A-3 Certificates evidence an initial (approximate) 12.27% ownership interest in the Trust. The Class A-4 Certificates evidence an initial (approximate) 32.73% ownership interest in the Trust. The Class A-5 Certificates evidence an initial (approximate) 8.00% ownership interest in the Trust. The Class B Certificates evidence an initial (approximate) 11.00% ownership interest in the Trust. The Class R Certificates evidence a 100% interest in the residual of the Trust.\nThe Class A-5, Class B and Class R Certificates are subordinated to the rights of the Class A-1, Class A-2, Class A-3 and Class A-4 Certificates to the extent described in the Prospectus. The Class B Certificates have the benefit of a Limited Guarantee provided by The CIT Group Holdings, Inc. as described in the Prospectus. The Class R Certificates represent the right to receive certain residual cashflows.\nThe Trust's only business is to act as a passive conduit to permit investment in a pool of retail consumer receivables.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nThe property of the Trust consists of a pool of manufactured housing installment sales contracts and installment loan agreements (collectively, the \"Contracts\").\nAll of the Contracts were acquired by the Company from The CIT Group\/Sales Financing, Inc. (\"CITSF\") pursuant to the terms of a Sale and Purchase Agreement between the Company and CITSF dated as of November 1, 1995, and sold to the Trust pursuant to a Pooling and Servicing Agreement dated as of November 1, 1995, among the Company, CITSF and Harris Trust and Savings Bank, as trustee (the \"Trustee\").\nInformation related to the payment on the Contracts by the obligors under the Contracts is set forth in the 1995 Annual Statement of Trust filed as Exhibit 99 to this Annual Report on Form 10-K.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nIn June, 1995, a suit, Harvey Travis et al. v. The CIT Group Sales Financing, Inc., et al., Civil Action No. CV-95-P-1544-S, was filed in the United States District Court for the Northern District of Alabama, against CITSF, its force-placed insurance carrier and another lender. Plaintiffs in this action allege primarily that force-placed insurance coverage on manufactured homes was placed by defendants in a manner which caused plaintiffs and other borrowers to be charged or assessed for excessive premiums and that there was inadequate disclosure regarding certain fees charged and commissions earned in connection therewith. In their complaint, plaintiffs ask that a class action be certified, with the class to be comprised of individuals against whom monetary charges alleged to be excessive have been assessed and\/or collected by CITSF and\/or the other defendants for the purchase of force-placed insurance in connection with consumer installment transactions with CITSF and\/or the other defendants. It cannot at this time be determined whether there is any basis for a class action. The allegations of the complaint are very general and discovery has only recently commenced. However, based on what it knows at this time, the management of CITSF has no reason to believe that this case will have a material effect upon CITSF's financial condition or results of operations.\nThe registrant knows of no other material pending legal proceedings with respect to the Trust or involving the Trust, the Owner Trustee, the Indenture Trustee, the Company or CITSF.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nNo matter was submitted to a vote of Certificateholders during 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 Offered Certificates are held and delivered in book-entry form through the facilities of The Depository Trust Company (\"DTC\"), a \"clearing agency\" registered pursuant to the provisions of Section 17A of the Securities Exchange Act of 1934, as amended.\nAs of January 2, 1996, 100% of the Offered Certificates were held in the nominee name of Cede & Co. for 11 beneficial owners. As of January 2, 1996, the Company owned the Class R Certificate which was not offered for sale, which represented beneficial ownership of a residual interest in the assets of the Trust as provided in the Pooling and Servicing Agreement\nItem 9.","section_6":"","section_7":"","section_7A":"","section_8":"","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.\nNone.\nPART 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) Exhibits:\nExhibit Number Description - -------------- ----------- 19 Annual Report of Accountants with respect to the servicing of the contracts by the Servicer, pursuant to the Pooling and Servicing Agreement.\n99 1995 Annual Statement of Trust.\n(b) Reports on Form 8-K:\nCurrent Reports on Form 8-K are filed each month. The reports include as an exhibit, the Monthly Reports to Certificateholders. Current Reports on Form 8-K dated December 15,1995 and January 16, 1996 were filed with the Securities and Exchange Commission.\n(c), (d) 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.\nMANUFACTURED HOUSING CONTRACT SENIOR\/SUBORDINATE PASS-THROUGH CERTIFICATES, SERIES 1995-2 (Registrant)\nBy: The CIT Group Securitization Corporation II, as Originator of the Trust\nDated: March 29, 1996 By: \/s\/ Frank Garcia ------------------------- Name: Frank Garcia Title: Vice President","section_15":""}
{"filename":"779338_1995.txt","cik":"779338","year":"1995","section_1":"Item 1. Business\nA. General\nDelta Computec Inc. and its subsidiaries\/divisions (the \"Registrant\" or the \"Company\"), provide a wide array of Computer System, Data Communication and Lan\/Wan technical services and products to a customer base which encompasses many industries and many geographic locations. Its customer base includes large brokerage houses, banks, pharmaceutical companies, major hospitals and long distance carriers, located principally in the Northeast but reaching as far as Florida and the West Coast. Technical services offered include but are not limited to design, product procurement, installation, service, maintenance and on-site technical management and consulting.\nWhile the Company maintains its corporate headquarters in Rochester, New York, its main operation center is located in Teterboro, New Jersey. The Northeast and Mid-Atlantic regions are both serviced from Teterboro while other areas of the country are supported by branch locations in: Atlanta, Georgia; Escandido, California; Altamonte Spring, Florida; Mt. Laurel, Maryland; Philadelphia, Pennsylvania; Sunrise, Florida; Syracuse, New York; Waltham, Massachusetts and Wilmington, Delaware. The Company, a New York Corporation, is qualified to do business in California, Connecticut, Georgia, Illinois, Louisiana, Maryland, Massachusetts, Ohio, Pennsylvania, Texas and New Jersey.\nIn November, 1992, the Company completed the acquisition of the assets of Data Net, Inc. (\"Data Net\") and Dataspan Systems, Inc. (\"Dataspan\") from Willcox & Gibbs through the Company's wholly-owned subsidiary, Delta Data Net, Inc. (the \"Data Net Subsidiary\"). Data Net's historical focus had been the sale of Data Communications hardware and test equipment. Dataspan had focused exclusively on the sale and assembly of cables used in Data Communication applications. Dataspan sells directly to end users and original equipment manufacturers (OEM), custom manufactured and bulk cable products. In 1990, Data Net established an engineering team to support the sale of their core products in the form of integrated network systems. this effort included the design, specifications, project management, installation and (to a lesser extent) trouble shooting support of complete cable plants and data centers using digital switching, hubbing, bridging, and routing hardware. The Company relocated its Data Net Subsidiary to its main operations facility in Teterboro, New Jersey in March, 1993 and combined its operations with its Computer Hardware maintenance organization.\nIn November, 1994, the Company completed the acquisition of the assets of Intronet, Inc. (\"Intronet, Inc.\"), which assets formed the basis of the Company's Intronet Division (\"Intronet\"). Intronet designs, installs and supports advanced computer networks in such specialty markets as large campuses and industrial facilities which require network hubbing integrated with fiber and copper cabling. Following the acquisition, the Company assumed the lease on the Waltham, Massachusetts office of Intronet.\nIn December, 1994, the Company acquired the balance of ownership in its joint venture technical services company, SAI\/Delta, Inc. (\"SAI\/Delta\") and operated from SAI\/Delta's two Florida offices in Altamonte Spring and Sunrise.\nSignificant events which occurred in the Fiscal year ending October 31, 1995, (\"Fiscal 1995\") included:\n1. Changes in the Company's senior management.\nOn March 24, 1995, the Company filed Form 8-K concerning the resignation of Mr. L. Rodger Loomis, President and Chief Executive Officer and Mr. Peter D. Smith, Chief Financial Officer. Following these resignations, Mr. John T. DeVito was named President and Chief Operating Officer. The Board of Directors performed services as an Executive Management Committee. The position of Chief Accounting Officer was filled by Mr. Walter Struble who sadly and unexpectedly died at the early age of 41 years in December of 1995. The position has not yet been filled.\n2. A return to the Company's core business.\nIn the beginning of April, 1995, management and the Board of Directors determined to strategically shift the Company's direction back toward its prior core business of providing technical integration services to customers while de-emphasizing the product and system engineering aspects of its Data Net Subsidiary. The decision was based on the large overhead costs necessary to support the business of the Data Net Subsidiary as well as anticipated changes to market conditions leading to increased competition and lower gross margins.\nConsistent with this shift in strategic direction, management immediately instituted approximately $1,200,000 in payroll reduction and approximately $300,000 to $400,000 of additional cost savings through expense reduction. The impact of these cost reductions was partially recognized in the third quarter of Fiscal 1995, with most of the cost reductions being fully recognized in the fourth quarter of Fiscal 1995.\nBased on this strategic shift in direction, the Company signed a letter of intent in June, 1995, to sell certain of its business units to a private investment group. This specific transaction was not successfully completed. However, management continues to negotiate with other potential qualified acquirers for similar transactions.\n3. Changes in financing.\nOn May 4, 1995, the Company filed a Form 8-K concerning an agreement with its commercial lender and with Joseph M. Lobozzo, II, an officer, Director and the Company's controlling shareholder (\"Lobozzo\") to provide for an additional $700,000 Over Advance Lending Facility. The Company also agreed to issue an option to Lobozzo exercisable through May 20, 1999, to purchase an additional 11,440,475 of the Company's common shares. This Over Advance Lending Facility was critical in providing increased working capital to help bridge the Company through its critical restructuring phase.\n4. Project overruns.\nAt the time of the Company's acquisition of the assets of Intronet, Inc. in November, 1994, the Company entered into a major contract in excess of $4,000,000 from a well known eastern college to provide extensive on-campus computer access to all of the college's buildings. The contract, to be performed by the Company's Intronet Division, was essentially completed prior to the end of Fiscal 1995. Actual costs incurred by the Company significantly exceeded contractual estimates. Most of these cost overruns have been recognized in the Fiscal 1995\nfinancial statements which accompany this Form 10-K. As described in paragraph 6 below, Intronet has since been down-sized and is operating under a new management team.\n5. Relocation of Functions\nFollowing the changes in senior management referred to above, the Company closed its Syracuse, New York executive\/administrative office in July, 1995. The Company's principal executive offices were moved to Rochester, New York and the remainder of the administrative functions previously performed in the Syracuse office were either terminated or moved to the Company's Teterboro, New Jersey facility. The remaining employees associated with the Syracuse office were either terminated or moved to Teterboro, New Jersey.\n6. Downsizing of the Intronet division\nIn the fall of 1995, the Company reduced the size of its operating staff of the Waltham, Massachusetts office of Intronet. The Company and two of its employees who had also been principal executives of Intronet, Inc. prior to the acquisition reached agreement terminating employment agreements with those employees. One employee has since become a consultant to the Company assisting in Intronet's Connecticut operations.\nThe Board of Directors and management believe that the decision to downsize the Company and to refocus its emphasis on its core business has provided the Company with the means to return to profitability.\nB. Services, Products and Markets\nThe Company operates in an extraordinarily large market. While the Company's total sales and revenues are but a fractional percent of the dollars spent each year for services and products related to Computer Systems Data Communications and Lan\/Wan Networks, nevertheless the Company does have long standing relationships with major brokerage firms, banks and pharmaceutical companies. By refocusing on its core business, the Company hopes to be able to expand those relationships.\nThe Company's customers are not committed to fulfilling their Computer System and Data Communication needs through a single manufacturer. Performance differences as well as constant changes in technology make such a commitment nearly\nimpossible. As a result, service and integration needs have become far more complex requiring knowledge of multiple manufacturers' products, how they interact with each other and how they must be serviced\/maintained. This complexity has become significant enough that many customers are now considering\nor already outsourcing complete management of their Computer System and Data Communication needs. By doing so, they are no longer compelled to maintain internal resources to perform the same or similar functions. The Company hopes to be able to take advantage of these market opportunities.\nConsequences of this trend are likely to include increased margin pressure on third party maintenance providers that are not able to provide higher level technical services and continued margin pressure on companies that are exclusively product\/distribution oriented.\n1. Technical Services\nThe Company's core business is based in providing technical and maintenance services in direct support of its customers' Computer Systems, Data Communication Systems and Lan\/Wan Networks. Broadly, these services include:\n* Network systems design * Network analysis and performance testing * Network management * Project management * Premise wiring * Installation services * Technical consulting services * Maintenance Services * Help desk support * Complete outsourcing responsibility for all or most of the above\nTechnical services are either charged at a predetermined contractual price or on the basis of labor and materials used. Maintenance services are generally performed at a customer's site on an \"on-call\" basis, either pursuant to a contract of a specified term and coverage (\"Service Agreement\") or, as in the case of technical services, on a time and materials basis.\nIn Fiscal year 1995, approximately 66% of the Company's service revenue was generated from contractual Service Agreements. This compares to 72% in Fiscal year 1994 and 81% in Fiscal year 1993. Technical services and maintenance are performed either at the customer's site or at one of the Company's regional offices or the Teterboro, New Jersey depot facility. Project related technical services are most often initiated through an authorization to proceed given by the customer following a competitive bid process. A Service Agreement related repair service is initiated by the customer, usually by telephoning the Company's National Response Center which then dispatches a Field Engineer to diagnose the source of the problem and repair or replace the malfunctioning component or equipment. Frequently, the Company's service personnel are permanently located at the customer's site in order to ensure optimum response time to the customer's mission critical needs.\nIn the broader context of technical services offered by the Company, a number of customers, actual and potential, are currently considering complete outsourcing of the ongoing management of their Computer System\/Data Communications systems. Where such a commitment is made, the nature of the agreement between the Company and its customer is similar to that of a Service Agreement including a defined period of time (usually at least one year) as well as predetermined billing rates for specific functions performed or technical positions filled.\nCustomer Service Agreements generally have an initial term of one year and continue thereafter until terminated by either the customer or the Company, usually upon 90 days prior written notice. After the first year, the Company may increase or decrease the prices related to this service, typically with 90 days advance written notice to the customer. In some cases the Company provides service at customer sites as part of a subcontracting agreement with another provider, usually a manufacturer or reseller of equipment that has taken responsibility as prime contractor for all maintenance services. In these cases, the provider (prime contractor) is responsible for payment of all services rendered by the Company to the end user. The Company currently is engaged in this type of sub-contractor relationship with several large organizations.\nThe Company maintains a significant inventory of spare parts in order to ensure prompt servicing of its customers' requirements. This inventory is replenished on a regular basis based on the number of different systems being supported, past parts usage and anticipated future requirements.\nMarketing The Company markets its technical services by direct development of customers through its sales force and senior management and by initiating and responding with technical and price proposals when customer needs are specifically identified. Unique to the Company's approach is its emphasis on custom crafted solutions which focus on creating the resources to meet a customer's specific needs instead of attempting to modify customer needs to fit specific resources.\nCompetition The Company competes both with third party service providers that are either nationally based or have strong regional presence and with manufacturers and\/or large distributors which have their own technical service organizations. It is management's belief that the Company competes with third party providers on the basis of technical competence, customer satisfaction, responsiveness and effectiveness of services as well as the price at which such services are provided, and with manufacturers on the basis of its breadth of product availability\nas well as its ability to service these multiple product lines. The Company also believes that its scope of services, its presence in the industry and its specific expertise in computer systems and networks gives it an advantage over traditional maintenance companies and enables it to compete on a regional\/national basis.\nBacklog As of October 31, 1995, the Company had service maintenance contracts and technical service contracts in force with an annual volume of approximately $5,772,000, subject to renewal on contract anniversary dates, compared with approximately $6,558,000 at October 31, 1994.\n2. Products\nIn addition to the technical services provided, the Company distributes a wide variety of Computer System, Data Communication and Networking products from over 40 manufacturers. Included are modems, multiplexers, channel banks, CSU\/DSU's, workstations, terminal servers, hubs, bridges, routers, gateways, cable assemblies, bulk cable and cabinets. The Company also offers a line of high quality cables and accessories manufactured by the Company through its Data Span division to service the extensive premise wiring requirements of Data Communications installations. This division, located at the Teterboro facility, fabricates custom cable assemblies and molded cables for end users as well as OEM manufacturers.\nMarketing The Company's marketing strategy is to offer a full line of Data Communication and Computer System Networking products to its customers, linked as often as possible to its broad range of technical services. This strategy facilitates the development of long term relationships with customers and provides market differentiation both from manufacturers and distributors.\nThe products sold by the Company are marketed through direct solicitation of customers by the Company's sales staff and its senior management as well as by initiating and responding with technical and price proposals to specific customer requirements.\nCompetition The Company competes directly with manufacturers, distributors and even retailers. Its principal disadvantage with these competitors is its lack of volume driven buying power. This disadvantage is offset somewhat by long term relationships with customers and integrated value added services.\nBacklog As of October 31, 1995, the Company had a backlog for network products of approximately $800,000 compared to a backlog of $2,900,000 on October 31, 1994. The prior year amount reflected the contract with a well known eastern college.\n3. Other aspects of the Company's business\nIt is not believed that the Company's business is seasonal; however, several large service and maintenance contracts are usually renewed near the calendar year end and at calendar mid-year. The Company does not believe its business is 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 the Company's business. No customer accounts for sales of more than ten percent (10%) of the Company's consolidated revenues. No significant portion of the Company's business is subject to renegotiation of profits or termination of contracts or subcontracts at the election of the government. Research and development activities are not considered to be material to the Company's operations.\n4. Government Regulation\nTo the best of the Company's knowledge, it is presently in compliance with environmental statues and regulations.\n5. Executive Officers Who Are Not Directors\nMr. John DeVito, President and Chief Operating Officer joined the Company as a result of the acquisition by the Company of R&M Associates, Electronic Data Products Service, Inc. in June, 1990.\n6. Employees\nAs of October 31, 1995, the Company had approximately 232 full and part time employees. Except as noted below, the employees of the Company are not covered by any collective bargaining agreement and the Company has never experienced a strike or work-stoppage. The Company does have an agreement with IBEW local 164 in New Jersey to provide cable installers as needed. The number of employees subject to this agreement fluctuates between 2 and 20 and includes career managers of that division. The Company considers its relations with its employees to be good. As a result of the November 1994 acquisition of the assets of Intronet, Inc., the Company has agreements with Massachusetts IBEW Local 1499 and currently employs 12 union employees in the Northeast.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nOffices\nThe Company maintains offices in many cities. In addition to the locations listed below, customers provide, at no cost to the Company, facilities at their premises in:\nBedminster, New Jersey Pompton Plains, New Jersey King of Prussia, Pennsylvania Toms River, New Jersey Miami, Florida White Plains, New Jersey Morristown, New Jersey Wilmington, Delaware New York City, New York\nThe following summarizes the Company's current leased facilities:\nManagement considers its present leased space to be adequate for current operations. The Company relocated its Data Net subsidiary in March of 1993 to its facility in Teterboro, New Jersey and its Syracuse offices\/service center to the same location in May, 1995. The Company has closed its Syracuse location but has not yet reached agreement with the landlord of this facility regarding a termination of the Lease.\nItem 3.","section_3":"Item 3. Legal Proceedings\nNo material litigation is pending or is known to be contemplated against 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\nDuring the period reported ending October 31, 1995, the common stock of the Registrant was traded on the over-the-counter NASDAQ market under the symbol DCIS. As of November 10, 1995, the common stock of the Registrant fell below the NASDAQ minimum bid price guidelines and since then has traded only on local OTC markets. At the end of Fiscal 1995, there were approximately 450 holders of record of the Company's common stock. The high and low bid prices of the common stock during each quarter of Fiscal 1995 and Fiscal 1994 were as follows:\n1994 Bid Prices High Low\n1st Quarter 7\/8 3\/4 2nd Quarter 3\/4 1\/2 3rd Quarter 1\/2 1\/2 4th Quarter 5\/8 1\/2\n1995 Bid Prices\n1st Quarter 3\/4 3\/4 2nd Quarter 1\/4 1\/4 3rd Quarter 1\/8 1\/8 4th Quarter 1\/16 1\/16\nThe over-the-counter market quotations described above reflect inter-dealer prices, without retail mark-up, mark-down or commission, and may not necessarily represent actual transactions.\nNo cash dividends have been declared on the common stock of the Company for Fiscal 1995 or Fiscal 1994. The Company anticipates that, for the foreseeable future, any earnings which may be generated from its operations will be used to reduce debt and provide working capital. Payment of dividends are prohibited under the terms of the Company's long-term credit facility. In any event, the payment of dividends in the future will depend upon the Company's financial condition, capital requirements and earnings and such other factors as\nthe Board of Directors may deem relevant.\nItem 6.","section_6":"Item 6. Selected Financial Data Delta Computec Inc.\nThe selected data presented below for and as of the end of the four years ended October 31, 1994, 1993, 1992 and 1991 is derived from the financial statements of the Company which have been audited by Deloitte & Touche, independent certified public accountants. Data for and as of the end of the year ended October 31, 1995 is per the Company's unaudited internal financial statements. This data should be read in conjunction with the related financial statements and notes included elsewhere in the Form 10-K.\n(1) Operating results include the results of Intronet Inc. from the date of acquisition of assets in November, 1994.\n(2) Operating results include the results of Delta Data Net, Inc. a wholly owned subsidiary which acquired the assets of Data Net, Inc. and Dataspan Systems, Inc. in November, 1992.\n(3) The Company adopted the Statement of Financial Accounting Standards No. 109 (FAS 109) \"Accounting for Income Taxes\" effective November 1, 1992. This statement supersedes FAS No. 96 \"Accounting for Income Taxes\". The cumulative effect of adopting FAS No. 109 on the Company's financial statements was to increase income by $775,000 ($.11 per share) for the year ended October 31, 1993.\n(4) Utilization of Tax Loss Carryforwards.\n(5) Includes full dilution for convertible debenture and for option issued to Lobozzo in the year ended October 31, 1995 to acquire 11,440,475 common shares.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation\nResults of Operations\nOperating results for the year ended October 31, 1995 (Fiscal 1995) reflected a net loss of $1,550,842 or $.08 per share compared with a net loss of $643,426 or $.09 per share for the year ended October 31, 1994 (Fiscal 1994) and net earnings of $205,990 or $.03 per share (after reflecting the cumulative effect of a change in accounting for income taxes of $775,000 or $.11 per share) for the year ending October 31, 1993 (Fiscal 1993). Operating results for Fiscal 1994 and Fiscal 1993 were negatively impacted by unusual charges for obsolete inventory, litigation and relocation expenses, as well as declining revenues at its Data Net subsidiary. Operating results for Fiscal 1995 were negatively impacted by cost overruns on a major contract in the Company's Intronet division and by a continued decline in revenues in the Data Net subsidiary.\nRevenues\nTotal revenues for Fiscal 1995, Fiscal 1994 and Fiscal 1993 were $30,801,156, $25,361,745 and $30,901,744 respectively. Revenues increased $5,439,411 or 21.5% in Fiscal 1995 compared to Fiscal 1994. This increase was primarily due to the acquisition of the assets of Intronet, Inc. in November 1994. Revenues decreased $5,539,999 or 17.9% in Fiscal 1994 compared to Fiscal 1993. This decrease was primarily due to the integration of the Company's Data Net subsidiary which was acquired in November, 1992.\nCosts and Expenses\nService costs for Fiscal 1995, Fiscal 1994 and Fiscal 1993 were $10,969,323, $7,654,062 and $7,341,708 respectively. Service costs increased $3,315,261 or 43.3% in Fiscal 1995 compared to Fiscal 1994.\nService costs in Fiscal 1994 increased $312,354 or 4.3% compared to Fiscal 1993. These increases were primarily due to the incremental costs associated with the increase in service revenue from period to period.\nService costs as a percentage of service revenue increased from 70.0% in Fiscal 1993 to 72.4% in Fiscal 1994 and increased to 81.3% in Fiscal 1995. The 1994 increase is reflective of a decline in service contracts in the Company's branch offices and high start-up costs associated with the Company's entry into high volume laser printer maintenance. The 1995 increase was due to the front loaded costs associated with the Company's entry into the \"high end\" technical consulting business.\nCost of equipment sold for Fiscal 1995, Fiscal 1994 and Fiscal 1993 was $13,689,506, $11,645,855 and $15,937,346. Cost of equipment sold increased $2,043,651 or 17.5% in Fiscal 1995 compared to Fiscal 1994. This increase was primarily due to a proportionate increase in equipment sales. Cost of equipment sold decreased $4,291,491 or 26.9% in Fiscal 1994 compared with Fiscal 1993. This decrease was due to a proportionate decrease in equipment sales. Cost of equipment sold as a percentage of sales increased from 78.1% in Fiscal 1993 to 78.7% in Fiscal 1994 to 78.5% in 1995. These increases reflect lower margins on sales of Data Communication equipment sold due to price pressure in the marketplace, offset partially by a few higher margin customers.\nSelling, General and Administrative Expenses\nSelling, general and administrative expenses for Fiscal 1995, Fiscal 1994 and Fiscal 1993 were $6,615,896, $5,682,678 and $7,283,166 respectively. Selling, general and administrative expenses increased $933,207 or 16.4% in Fiscal 1995 compared with Fiscal 1994. This increase was primarily due to the acquisition of Intronet. Selling, general and administrative expenses decreased $1,600,488 or 22.0% in Fiscal 1994 compared with Fiscal 1993. This decrease was primarily due to the continued integration of its Data Net subsidiary.\nInventory and Product Obsolescence\nDuring Fiscal 1995, the Company accounted for normal product obsolescence through inventory reserves. During the quarter ended October 31, 1994, management made a decision to eliminate its stocking position of certain data communication equipment in its Data Net subsidiary. As a result, the Company provided $846,527 as an unusual charge to write down certain data communication equipment to net realizable value. During the quarter and year ended October 31, 1993, an unusual charge was made in the amount of $700,866 to write down certain inventories of data communication equipment of the Data Net subsidiary, which were assumed at the time of the acquisition of Data Net in November, 1992. While Company personnel review obsolescence on a regular basis by reference to historical movement and market\nconditions, the Fiscal 1993 charges were recognized principally during the Company's fourth quarter of Fiscal 1993.\nInterest Expense\nInterest expense for Fiscal 1995, Fiscal 1994 and Fiscal 1993 was $462,485, $390,343 and $460,649 respectively. Interest expense increased by $72,142 or 18.5% in Fiscal 1995 compared with Fiscal 1994. This increase was primarily due to increased borrowing from the prior year. Interest expense decreased by $70,306 or 15.3% in Fiscal 1994 compared with Fiscal 1993. This decrease was primarily due to reduced borrowing from the prior year.\nIncome Taxes\nIncome tax (benefit) expense for Fiscal 1995, Fiscal 1994 and Fiscal 1993 was $642,764, $(260,000) and $(249,000) respectively. Income taxes are recognized for the amount of taxes payable or refundable for the current tax year, and deferred tax liabilities and assets for the future tax consequence of events that have been recognized in the Company's consolidated financial statements or tax returns.\nThe Company adopted the Statement of Financial Accounting Standards No. 109, (FAS 109) \"Accounting for Income Taxes\" effective November 1, 1992. This statement supersedes FAS No. 96 \"Accounting for Income Taxes\": The cumulative effect of adopted FAS No. 109 on the Company's financial statements was to increase income by $775,000 ($.11 per share) for the year ended October 31, 1993.\nAt July 31, 1995 the Company had accumulated approximately $2,500,000 of operating loss carryforward for tax purposes which was primarily the result of losses generated by its newly acquired business units over the\nprior two years. The Company had recognized the tax benefit of these losses, in the form of deferred tax assets on its balance sheet, through April 30, 1995. Generally accepted accounting principles (FAS 109) establish guidelines to be used in valuing deferred tax assets. The Company incorporated in the financial statements at July 31, 1995 reserves for the valuation of previously recorded deferred tax assets in the amount of $400,000 and additional reserves in the amount of $400,000 at October 31, 1995. It continues to be the Company's intention to divest itself of certain non-strategic business units and the Company will continue to assess, in future periods, the value of these deferred tax assets which expire in varying amounts between the years 2001 and 2009. This assessment will include, but not be limited to, the Company's ability to divest of non-strategic business units\nand the ability to project adequate profits to utilize the operating loss carryforward.\nLiquidity and Capital Resources\nThe Company has financed its working capital requirements, capital expenditures and debt service from cash flow provided from the operations and borrowing. Cash provided by operations in Fiscal 1995, Fiscal 1994 and Fiscal 1993 totalled $1,028,570, $1,232,188 and $1,803,185 respectively. Working capital at October 31, 1995 decreased by approximately $4,922,905 from October 31, 1994 primarily due to classifying the bank line of credit as a current obligation as of October 31, 1995. Working capital at October 31, 1994 improved by approximately $2,601,120 over October 31, 1993 primarily due to bank debt refinancing. It is possible that in Fiscal 1996, the Company may require supplemental sources of capital at least on a short term basis, to support seasonal cash needs.\nOn May 4, 1995, the Company filed Form 8-K concerning an agreement with its commercial lender and Lobozzo to provide for an additional $700,000 overdraft lending facility, and to issue an option to Lobozzo to purchase an additional 11,440,475 common shares. This modified lending arrangement was critical to providing central working capital to help bridge the Company through its critical restructuring phase.\nOn April 1, 1994, The Company executed a credit agreement to provide a long-term credit facility. This facility will expire on April 30, 1997 and bears interest at 2.0% above the bank's prime lending rate. Proceeds from this facility were utilized to refinance existing credit facilities and provide on-going working capital requirements. This facility was amended in November 1994, to complete the acquisition of the assets of Intronet, Inc. Availability of funds under this facility is limited to the lesser of $4,500,000 or a percentage of eligible accounts receivable and inventory.\nCapital expenditures for field spare parts and property and equipment were $1,282,678 in Fiscal 1995 compared with $964,822 in Fiscal 1994 and $1,167,669 in Fiscal 1993. Capital expenditures are expected to be approximately $1,000,000 in Fiscal 1996.\nDepreciation and amortization expense in Fiscal 1995, Fiscal 1994 and Fiscal 1993 was $1,366,484, $1,262,478 and $1,174,356 respectively. Depreciation and amortization expense is expected to be approximately $1,300,000 in Fiscal 1996.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Schedule\nCONSOLIDATED FINANCIAL STATEMENTS DELTA COMPUTER INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS\nForm 10-K Ref.\nConsolidated Financial Statements:\nConsolidated Balance Sheets, October 31, 1995 and 1994 17\nConsolidated Statements of Operations for the Years Ended October 31, 1995, 1994 and 1993 19\nConsolidated Statements of Cash Flows for the Years Ended October 31, 1995, 1994 and 1993 20\nNotes to Consolidated Financial Statements 21\nAll other schedules are not submitted because they are not applicable, are not required or because the required information is included in the financial statements or notes thereto.\nDELTA COMPUTEC INC.\nCONSOLIDATED BALANCE SHEETS\nOCTOBER 31, 1995 AND 1994\nASSETS\nSee notes to consolidated financial statements.\nDELTA COMPUTEC INC.\nCONSOLIDATED BALANCE SHEETS\nOCTOBER 31, 1995 AND 1994\nLIABILITIES AND STOCKHOLDERS' INVESTMENT\nSee notes to consolidated financial statements.\nDELTA COMPUTEC INC.\nCONSOLIDATED STATEMENTS OF OPERATIONS\nFOR THE YEARS ENDED OCTOBER 31, 1995, 1994 AND 1993\nDELTA COMPUTEC INC.\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nFOR THE YEARS ENDED OCTOBER 31, 1995, 1994 AND 1993\nSee notes to consolidated financial statements.\nDELTA COMPUTEC INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nFOR THE YEARS ENDED OCTOBER 31, 1995, 1994 AND 1993\n(1) Summary of Significant Accounting Policies\nPrinciples of Consolidation\nThe consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries R&M Associates Electronic Data Products Service Inc., Computer Support, Inc., Delta Data Net Inc., Intronet Inc. All significant intercompany accounts and transactions have been eliminated in consolidation. The unaudited financial statements included herein reflect all normal and recurring adjustments that are in the opinion of management, necessary for fair presentation of the results for the period.\nBasis of Presentation\nThe accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern. The Company incurred an operating loss in Fiscal 1994 and 1995 and was in default under certain loan agreements as of October 31, 1995 (Note 3). In Fiscal 1994, the Company executed a credit agreement to provide a long-term credit facility which will expire April 30, 1997. On January 24, 1995, certain debt covenants were amended based on the Company's business plan for Fiscal 1995. If certain measures that management has recently implemented prove unsuccessful and defaults occur under the amended credit agreement, then the Company may need to seek additional financing from outside sources.\nProperty and Equipment\nProperty and equipment are stated at cost and are depreciated using the straight-line method over the following estimated useful lives:\nEstimated Description Useful Lives\nTechnical equipment 5 - 7 years Office furniture and equipment 5 - 7 years Vehicles 2 - 3 years Leasehold improvements 5 - 10 years\nMaintenance and repairs are charged to expense as incurred. The cost of renewals or betterments that increase the useful lives of the assets is capitalized in the appropriate asset account. The gain or loss on property retired or otherwise disposed of is credited or charged to operations and the cost and accumulated depreciation are removed from the accounts.\nInventories\nInventories represent computer equipment and peripherals held for resale in the normal course of business and consumable field spare parts. These inventories are recorded at the lower of cost (first-in, first-out) or market.\nField Spare Parts\nField spare parts are stated at cost and are amortized using the straight-line method over an estimated useful life of 5 years, beginning in the year after acquisition.\nGoodwill\nGoodwill, representing the excess of the cost of acquired businesses over the fair value of net assets acquired, is being amortized on a straight-line basis over periods ranging from ten to twenty years.\nCustomer Lists\nCustomer lists, representing the fair market value of customer lists for businesses acquired, are being amortized on a straight-line basis over a ten-year period.\nDeferred Service Revenue\nService revenue is recognized ratably over the contract period. Deferred service revenue represents billings in advance of the service period.\nRevenue Recognition\nService revenues: Contract service revenue is recognized ratably over the contractual period or as services are provided. Revenue from service rendered on a \"time and materials\" basis is recognized in the period the work is performed.\nEquipment sales: Revenue from equipment sales and the related cost of sales are recognized when title to the equipment passes. Component repair revenue and related costs are recognized upon completion of the repair.\nIncome Taxes\nIncome taxes are recognized for the amount of taxes payable or refundable for the current year, and deferred tax liabilities and assets for the future tax consequence of events that have been recognized in the Company's consolidated financial statements or tax returns.\nAt July 31, 1995 the Company had accumulated approximately $2,500,000 of operating loss carryforward for tax purposes which was primarily the result of losses generated by its newly acquired business units over the prior two years. The Company had recognized the tax benefit of these losses, in the form of deferred tax assets on its balance sheet, through April 30, 1996. Generally accepted accounting\nprincipals (FAS 109) establishes guidelines to be used in valuing deferred tax assets. The Company had incorporated in the financial statements at July 31, 1995 reserves for the valuation of previously recorded deferred tax assets in the amount of $400,000. The financial statements at October 31, 1995 incorporate valuation reserves of $800,000. As discussed in Note 5, it is the Company's intention to divest itself of certain non-strategic business units. The Company will continue to assess, in future periods, the value of the deferred tax assets. This assessment will include, but will not be limited to, the Company's ability to divest of non-strategic business units and the ability to project adequate profits to utilize the operating loss carryforward including that portion that has been reserved during the period being reported.\nEarnings Per Share\nEarnings per common and common equivalent share are computed based upon the weighted average of common shares outstanding during each year adjusted for dilutive outstanding stock options using the Treasury Stock Method. Earnings per common and common equivalent share assuming full dilution are computed on the assumption that all outstanding convertible debentures were exercised on the issue date.\n(2) Acquisitions\nOn November 17, 1994, the Company acquired substantially all of the operating assets of Intronet, Inc. Intronet designs, installs, and supports advanced computer networks with emphasis on large campus and industrial facilities requiring network hubbing integrated with fiber and copper cabling. These assets were acquired in exchange for $337,000 in cash and assumption of approximately $588,000 in liabilities of the seller. The Company accounted for the acquisition as a purchase and the operating results of the acquisition from November 17, 1994 have been included in the consolidated financial statements.\nOn December 1, 1994, the Company exercised an option to acquire the remaining shares of SAI\/Delta, Inc. The Company accounted for the acquisition as a purchase and the operating results of the acquisition from December 1, 1994 have been included in the consolidated financial statements.\n(3) Long-Term Debt\nOn April 1, 1994, the Company executed a credit agreement to provide a long-term credit facility. This facility will expire on April 30, 1997 and bears interest at 2.0% above the bank's prime lending rate (8.75% at October 31, 1995). Proceeds from this facility were utilized to refinance existing credit facilities and provide ongoing working capital. This facility was amended in November 1994 to complete the acquisition of the assets of Intronet, Inc. (see note 2). Availability of funds under this facility is limited to the lesser of $4,500,000 or a percentage of eligible accounts receivable and inventory. The credit agreement contains restrictive covenants, the more significant of which require maintenance of minimum net working capital, minimum tangible net worth, maximum debt-to-tangible net worth, pre-tax income and a restriction on capital expenditures and prohibition of dividend payments. The Company was not in compliance with certain of these restrictive covenants due to lower than projected earnings for the period. The Company plans to request a waiver of non-compliance from the bank and has classified this debt as current until it receives the waiver.\nOn May 1, 1995, Delta Computec Inc. reached an agreement with its commercial lender for an additional $700,000 lending facility. Mr. Joseph M. Lobozzo II, Delta's controlling shareholder, Secretary and a director, agreed with Delta to provide funding for $400,000 of the $700,000 additional lending facility. In return, Delta agreed to issue to Mr. Lobozzo an option to purchase 11,440,475 common shares, the balance of its available authorized but unissued common shares for a four year period between May 20, 1995 and May 20, 1999 for nominal consideration. If Mr. Lobozzo exercises the option, Mr. Lobozzo and affiliated parties will hold or control 78 percent of the authorized common shares of Delta. The option is cancelable under certain circumstances if Delta's computer service business is sold within 1 year.\n(4) Subordinated Debentures\nAs of October 31, 1995, the Company had issued an 8% subordinated debenture in the face amount of $475,000 due November 4, 1997 to the seller of Data Net.\nAs of October 31, 1995, the Company had issued an 8% subordinated debenture in the face amount of $600,001 due to Mr. Lobozzo, a director of Delta Computec Inc. Principal payments are due in three annual installments of $200,000 commencing January 31, 1996 subject to meeting bank loan covenants.\n(5) Other Matters\nThe Company is continuing discussions with certain parties in order to divest itself of non-performing operations.\nPART III\nItem 10.","section_9":"","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Company\nThe information required by this Item is (i) incorporated herein by reference to the Company's proxy statement under \"Election of Directors\", which proxy statement will be filed within 120 days after the end of the Company's Fiscal year.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe information required by this Item is incorporated herein by reference to the Company's proxy statement under \"Executive Compensation\", which proxy statement will be filed 120 days after the end of the Company's Fiscal year.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThe information required by this Item is incorporated herein by reference to the Company's proxy statement under \"Principal Stockholders\", which proxy statement will be filed within 120 days after the end of the Company's Fiscal year.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThe information required by this Item is incorporated herein by reference to the Company's proxy statement under \"Certain Transactions\", which proxy statement will be filed within 120 days after the end of the Company's Fiscal year.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\nItems 14(a)(1), 14(a)(2) and 14(d): The following financial statements and financial statement schedules will be filed pursuant to a Form 8 Amendment to this report as part of Item 8 of this report upon receipt of the audited financial statements for the fiscal year ended October 31, 1995:\nIndependent Auditors' Report\nConsolidated Balance Sheets - October 31, 1995 and 1994\nConsolidated Statements of Operations for the years ended October 31, 1995, 1994, and 1993\nConsolidated Statements of Changes in Stockholders' Investment for the years ended October 31, 1995, 1994, and 1993\nConsolidated Statements of Cash Flows for the years ended October 1995, 1994, and 1993\nNotes to Consolidated Financial Statements\nFinancial Statements Schedule - Schedule VIII - Valuation and Qualifying Accounts for the years ended October 31, 1995, 1994 and 1993.\nSee Index to Exhibits for a list of exhibits to this Annual Report.\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 Company have been omitted because the Company 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 Company in excess of 5% of total consolidated assets.\nItem 14(a)(3) 14(b) and 14(c): Not Applicable, incorporated by reference or referred to in Exhibits 10.48 through 10.51.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1933, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nDated: February 13, 1996 DELTA COMPUTEC INC.\nBy: \/s\/ John DeVito John DeVito 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.\nDated: February 13, 1996 By: \/s\/ Alfred Engelfried Alfred Engelfried Director\nDated: February 13, 1996 By: \/s\/ Michael Julian Michael Julian Director and Secretary\nDated: February 13, 1996 By: \/s\/ Joseph M. Lobozzo II Joseph M. Lobozzo II Director and Chairman of the Board of Directors\nDated: February 13, 1996 By: \/s\/ Michael McCusker Michael McCusker Director\nINDEX TO EXHIBITS\nThe Exhibits denominated by (1) were previously filed as part of, and are hereby incorporated herein by reference to, the Exhibits in the Registrant's Registration Statement on Form S-18 (File No. 33-389NY) as amended by Amendment No. 1. the number contained in parentheses set forth opposite the Exhibit hereunder refers to the Exhibit number in the Registrant's Registration Statement on Form S-18 and amendments thereto.\nThe Exhibits denominated by (2) were previously filed as part of, and are hereby incorporated herein, by reference to the Exhibits in the Registrant's Annual Report on Form 10-K for the Fiscal year ended October 31, 1986. The number contained in parentheses set forth opposite the Exhibit hereunder refers to the Exhibit number in that Annual Report on Form 10-K.\nThe Exhibits denominated by (3) were previously filed as part of, and are hereby incorporated by reference herein, the Exhibits in the Registrant's Annual Report on Form 10-K for the Fiscal year ended October 31, 1987. The number contained in the parentheses set forth opposite the Exhibit hereunder refers to the Exhibit number in that Annual Report on Form 10-K.\nThe Exhibits denominated by (4) were previously filed as part of, and are hereby incorporated by reference herein, the Exhibits in the Registrant's Annual Report on Form 10-K for the Fiscal year ended October 31, 1988.\nThe Exhibits denominated by (5) were previously filed as part of, and are hereby incorporated by reference herein, the Exhibits in the Registrant's Annual Report on Form 10-K for the Fiscal year ended October 31, 1989.\nThe Exhibits denominated by (6) were previously filed as part of, and are hereby incorporated by reference herein, the Exhibits in the Registrant's Annual Report on Form 10-K for the Fiscal year ended October 31, 1990.\nThe Exhibits denominated by (7) were previously filed as part of, and are hereby incorporated by reference herein, the Exhibits in the Registrant's Annual Report on Form 10-K for the Fiscal year ended October 31, 1991.\nThe Exhibits denominated by (8) were previously filed as part of, and are hereby incorporated by reference herein, the Exhibits in the Registrant's Form 8-K dated November 13, 1992.\nThe Exhibits denominated by (9) were previously filed as part of, and are hereby incorporated by reference herein, the Exhibits in the Registrant's Annual Report on Form 10-K for the Fiscal year ended October 31, 1992.\nThe Exhibits denominated by (10) were previously filed as part of, and are hereby incorporated by reference herein, the Exhibits in the Registrant's Annual Report on Form 10-K for the Fiscal year ended October 31, 1993.\nThe Exhibits denominated by (11) were previously filed as part of, and are hereby incorporated by reference herein, the Exhibits in the Registrant's Annual Report on Form 10-K for the Fiscal year ended October 31, 1994.\n(3) Certificate of Incorporation and By-Laws\n(3.1) Restated Certificate of Incorporation.\n(3.2) Amended and Restated By-Laws of the Registrant.(3)\n(3.3) Certificate of Change, changing Registrant's address.\n(4.1) Specimen Stock Certificates representing shares of the Registrant's $.01 par value Common Stock.(1)\n(4.2) Restated Incentive Stock Option Plan.(4)\n(4.3) Non-Qualified Stock Option Plan.(1)\n(10.15) Asset Purchase Agreement with JWP.(5)\n(10.20) Stock purchase agreement R&M Associates.(6)\n(10.21) Asset purchase agreement RTK Computer Services.(6)\n(10.24) Building Lease Teterboro, New Jersey (7)\n(10.26) Building Lease Syracuse, New York (7)\n(10.27) Equipment Lease Bell Atlantic Systems (7)\n(10.28) Purchase agreement CSI (7)\n(10.29) Purchase agreement Market Line (7)\n(10.31) Sale and Purchase Agreement dated as of September 29, 1992 (8)\n(10.32) Amendment to Sale and Purchase Agreement dated as of October 31, 1992 (8)\n(10.33) 8% Subordinated Debenture due October 31, 1997 (8)\n(10.34) 8% Subordinated Short-Term Note, $1,150,000 (Subject to Adjustment) dated October 31, 1992 (8)\n(10.35) Assignment and Assumption Agreement dated October 31, 1992 (8)\n(10.36) Registration Rights Agreement dated as of October 31, 1992 (8)\n(10.37) 8% Subordinated Debenture due October 28, 1995 (8)\n(10.38) Option Agreement dated October 28, 1992 (8)\n(10.39) Registration Rights Agreement dated October 28, 1992 (8)\n(10.40) Letter from Richard J. Mackey, President and Chief Financial Officer of Willcox & Gibbs, Inc., to Peter D. Smith, Chief Financial Officer of Delta Computec Inc., dated October 13, 1992. (8)\n(10.41) Loan Agreement, Fleet Bank of New York to Delta Data Net, Inc. (9)\n(10.42) Credit Agreement, Norstar Bank of Upstate NY to Delta Computec Inc. and R&M Associates Electronic Data Products Services, Inc. (9)\n(10.43) Employment Agreement between Delta Computec Inc., and L. Rodger Loomis dated September 1, 1992. (9)\n(10.44) Joint venture Agreement between SAI\/Delta, Inc., and Systems Automation, Inc., dated March 10, 1992. (9)\n(10.45) Amendment Number 1 to Loan Agreement. (10)\n(10.46) Amendment Number 1 to Credit Agreement. (10)\n(10.47) Amendment Number 2 to Loan Agreement. (10)\n(10.48) Credit Agreement, National Canada Finance Corporation. (11)\n(10.49) Credit Agreement, National Canada Finance Corporation, Amendment No. 1. (11)\n(10.50) Asset Purchase Agreement dated October 17, 1994. (11)\n(10.51) Amendment No. 1 to Asset Purchase Agreement. (11)\n(10.52) Credit Agreement, National Canada Finance Corporation, Amendment No. 2. (11)\n(10.53) Credit Agreement, National Canada Finance Corporation, Amendment No. 3.\n(10.54) Credit Agreement, National Canada Finance Corporation, Amendment No. 4.\n(10.55) Credit Agreement, National Canada Finance Corporation, Amendment No. 5.\n(10.56) Letter agreements dated, respectively, May 1, 1995, May 1, 1995, and May 4, 1995, with Joseph M. Lobozzo II, a Director, Chairman of the Board of Directors and controlling person of the Registrant, relative to providing a commitment to advance up to $400,000 of the Overadvance Facility provided by National Canada Finance Corporation, and granting a stock option to Joseph M. Lobozzo II.\n(11) Statement re: computation of per share earnings. (This document will be filed pursuant to a Form 8 Amendment to this report along with the audited financial statements for the fiscal year ended October 31, 1995.\n(12) Statement re: computation of ratios. Not Applicable\n(13) Annual report to security holders, Form 10-Q or quarterly report to security holders. Not Applicable\n(16) Letter re: change in certifying accountant. Not Applicable\n(18) Letter re: change in accounting principles. Not Applicable\n(19) Report furnished to security holders. Not applicable\n(21) Subsidiaries of the Registrant.\n(22) Published report regarding matters submitted to vote of security holders. Not applicable\n(23) Consents of experts and counsel. Not applicable\n(24) Power of Attorney.\nNot applicable\n(28) Information from reports furnished to state insurance regulatory authorities. Not applicable\n(99) Additional Exhibits. None","section_15":""}
{"filename":"723889_1995.txt","cik":"723889","year":"1995","section_1":"ITEM 1. BUSINESS:\nCOMPANY OVERVIEW: - ----------------\nMicrofluidics International Corporation (\"Microfluidics\" or the \"Company\"), through its wholly-owned subsidiaries, Microfluidics Corporation (\"MFC\") and MediControl Corporation (\"MediControl\"), which is currently inactive, specializes in producing and marketing proprietary Microfluidizer\/(R)\/ devices used for the creation of micro droplets and dispersions in liquid streams for very fine mixing and blending applications. Microfluidizer devices have wide- spread applications in the chemical processing, pharmaceutical, biotechnology, cosmetics and food processing industries.\nMicrofluidizer equipment is used to formulate emulsions, dispersions and liposomes, and is used in cell rupture. Emulsions are intimate mixtures of oil and water (or other normally immiscible components). They are found in a broad variety of common products, including processed foods, medicines and photographic films. Dispersions are mixtures of fine solids suspended in liquids and are often employed in products such as inks, pigments and coatings. The Company believes that the processing technique of the Microfluidizer equipment enhances the stability and consistency of emulsions and dispersions due to the equipment's unique ability to consistently produce uniform micron scale particles in many applications. Liposomes are biodegradable, cell-like structures used to entrap medications or nutrients, and are typically used in cosmetics or pharmaceutical products. In addition, Microfluidizer equipment may be used in biotechnology applications to harvest, through cell rupture, the desired product contents of plant and animal cells.\nThe Company was incorporated in Delaware in 1983. The Company, formerly named Biotechnology Development Corporation, changed its name effective June 8, 1993 to Microfluidics International Corporation. Its principal executive offices are located at 30 Ossipee Road, in Newton, Massachusetts, and its telephone number is (617) 969-5452.\nTHE TECHNOLOGY: - --------------\nThe Company's Microfluidizer devices are based on a patent and related technology that was licensed by MFC from Arthur D. Little & Co. in 1983 and subsequently purchased by MFC in 1985. The Company holds two United States patents related to the apparatus and process used to intimately mix liquids and disperse particulate solids in microemulsions.\nThe Company's Microfluidizer is used in the processing industries to mix materials that are normally very difficult to mix. The Microfluidizer allows manufacturers in such industries as chemicals, pharmaceuticals, cosmetics, biotechnology and food processing, to produce higher quality products with better characteristics on a more consistent basis than with other blending and mixing techniques.\nIn the Microfluidizer, two or more ingredients are pumped into the device under high pressure. The fluid streams are then injected at very high speeds into the proprietary interaction chamber where the particles collide and interact. This collision of fluids causes the thorough mixing and integration of the component ingredients. The result is a uniform, consistent, lump-free product which can be anything from paint to a vaccine. The process can also be used in biotechnology cell-rupture applications. The precision with which the Microfluidizer can be used to break up materials allows the encapsulating cell wall to be ruptured without damage to or contamination of the cell contents. The advantage of Microfluidics' equipment is its ability to: (i) reduce the particle size of ingredients to minute levels using extremely high pressures (up to 40,000 pounds per square inch (\"psi\"); and (ii) precisely control the process so all component ingredients are uniformly affected by interaction.\nThe Company believes its patented Microfluidizer device, with its unique ability to consistently produce micron and sub-micron-size particles, allows users to manufacture new and improved formulations with enhanced\nproduct stability and formulation consistency. The Company's technology is distinguished by its ability to provide uniform treatment of all elements of a formulation. A fixed geometry mixing chamber and consistent pressure pump technology result in high intensity forces of shear (flow), impact and cavitation (vapor bubble implosion) in the interaction chamber. The process stream can operate at near constant pressures of up to 40,000 psi. In contrast, the Company believes that other mixing technologies are limited by non-uniform pressure and variable geometry processes, which generally have much lower practical operating pressures and result in less uniform formulations that are inferior to those produced with the Microfluidizer.\nThe Company believes that its proprietary interaction chamber differentiates its equipment from the equipment of its competitors. In the Company's equipment, all processed material must flow through fixed channels under constant pressure to a confined liquid collision zone. The resulting shear, impact and cavitation forces uniformly affect all materials in the zone, reducing the size of droplets or particles in the material flow to a uniform micron-size scale. Smaller and more uniform particles result in increased surface area that can substantially improve the compatibility of formulation ingredients, allowing a much higher level of intimate mixing and homogeneity.\nAmong the many benefits provided by the Microfluidizer process for various industries are:\n* extended shelf life * enhanced flavor and texture * consistent color and fragrance * improved delivery of drugs and cosmetics * elimination of additives and solvents * more uniform product appearance * more effective (higher yield) cell rupture\nIn February 1995, the Company introduced the Diamond Interaction Chamber as a product enhancement to the Microfluidizer. This chamber uses diamond surfaces in the high wear regions of the chamber, rather than the Company's proprietary ceramic materials. While the standard ceramic interaction chamber is generally acceptable for most applications, the Diamond Interaction Chamber was designed to reduce wear in the chamber from applications that introduce abrasive materials into the process stream, such as metal oxides, and cause significant wear to areas of high energy transfer. Proprietary material preparation, machining and assembly methodologies for the Company's Diamond Interaction Chamber were developed during 1993 and 1994.\nThe Company believes that the equipment of its competitors generally incorporate mechanical components in the mixing valves that move continually during processing, allowing variable size particles to pass through and resulting in non-uniform, inconsistent products. In contrast, the Company's equipment contains no in-line moving parts in the high energy mixing zone. In addition, while the Company believes that competing equipment frequently needs to repeat a mixing process cycle (pass), Microfluidics' equipment can achieve results that are similar to its competitor's results with fewer mixing processes. An additional advantage of the Microfluidizer equipment is that it can be scaled up to larger, higher volume product requirements in a reliable manner.\nCOMMERCIAL APPLICATIONS: - -----------------------\nThe Microfluidizer equipment can be used to mix and formulate emulsions, dispersions and liposomes, and for cell rupture.\nEmulsions are homogenous mixtures of oil and water components (or other normally immiscible components), which, if mixed properly, do not readily separate. Emulsions make up many products, such as processed foods, medicines, photographic films, hydraulic fluids and polymers. The Company believes that, generally, an emulsion processed with a Microfluidizer unit will exhibit improved stability and require reduced concentrations of costly emulsifying agents that are needed to enhance product stability.\nDispersions are mixtures of fine solids suspended in liquid so that the two do not separate readily after processing. Similar to emulsions, dispersions are used in a variety of consumer and industrial products, including pigments for paints and inks, iron oxide for magnetic tapes and mascara, phosphorescent coatings for TV screens and fluorescent lamps, barium titanate for capacitors, toners and inks, aluminum hydroxide (antacid) and ketchup.\nLiposomes are biodegradable cell-like structures, formed from materials such as cholesterol and lecithin, that can be used to entrap medications or nutrients. Pharmaceutical and cosmetic manufacturers use liposomes as a delivery system to target active ingredients for specific anatomical sites and to prolong their efficacy. To date, liposomes have been used commercially primarily in the area of medical diagnostic agents and cosmetics. Applications include the encapsulation of dye to be used as a marker in medical diagnostic tests and the encapsulation of ingredients for deeper skin penetration, as well as pharmaceutical, food and specialized agricultural applications.\nIn the biotechnology industry, Microfluidizer equipment is currently used to harvest, by cell rupture, the contents of plant or animal cells. The precision with which the Microfluidizer can be used to break up materials allows the encapsulating cell wall to be ruptured without damage to or contamination of the cell contents. As a result, the Microfluidizer equipment minimizes the amount and presence of cell wall debris, thus resulting in maximum yields.\nWith the introduction of the Diamond Interaction Chamber, the Company has targeted the markets for processing abrasive materials by wet milling and wet grinding, which cause the deagglomeration and dispersion of these materials into slurries.\nThe Company continually seeks to expand the applications for which the Microfluidizer technology can be used. The Company is exploring other applications for the Microfluidizer technology in research and licensing arrangements with Worcester Polytechnic Institute (\"WPI\") and Catalytica, Inc. (\"Catalytica\"). See \"Research and Development\".\nTHE PRODUCTS: - ------------\nMicrofluidics currently manufactures and markets the following lines of equipment that range in price from $9,000 to $500,000:\nThe HC Series: The HC Series, also known as \"Homogenizers,\" is a ------------- laboratory-scale series of equipment that is intended to impart moderate levels of energy into a customer's product with greater flow rates than the more energy intensive Microfluidizers. Operating pressures of products in the Company's HC Series can range from under 500 psi to as high as 8,000 psi, and will process as much as two liters of fluids per minute.\nThe 110 Series: The 110 Series, a laboratory product line, is designed -------------- primarily for research and development applications. The original pneumatically driven laboratory-scale Microfluidizer has been supplemented by a newer, more costly, electrically driven unit. Standard models can operate at pressures as high as 25,000 psi and have a flow rate that exceeds one-half of a liter of product per minute.\nThe M-140K: The M-140K, introduced in June of 1994, is a laboratory- ---------- scale unit developed for customers in chemical, biotechnology, pharmaceutical, cosmetic and food processing industries who require elevated operating pressures to achieve better performance. The M-140K can achieve operating pressures up to 40,000 psi. The M-140K has a built-in hydraulic system and utilizes a double ended intensifier pump that provides a highly uniform pressure profile. It has been designed with important safety features such as an explosion proof motor, starter and electrical controls.\nThe 210 Series: The 210 Series is primarily marketed to manufacturers who -------------- have created a successful new or improved formulation on a 110 series unit and would like to increase their productive capacity. The 210 Series\nunit is typically used for testing formulations at greater volume levels before initiating full scale production. For some customers (such as pharmaceutical product manufacturers), the 210 series may have the capacity to function as a production unit.\nThe 610 Series: The 610 Series consists of custom built models used for -------------- large-scale manufacturing. These units have flow rates of up to 50 gallons per minute and generate operating pressures up to 40,000 psi.\nMARKETING AND SALES: - -------------------\nThe Company's strategy is to sell laboratory Microfluidizer systems such as the 110 Series or the M-140K into customers' research and development departments where chemists, formulators, scientists and process engineers are searching for new and better formulations of their products. If the laboratory Microfluidizer systems are accepted, Microfluidizer systems such as the 210 Series or the 610 Series are introduced into a customer's operations department where a customer may use Microfluidizer technology for production levels of its new or improved products.\nMarketing is conducted through advertising, direct mail, seminars, trade shows and telemarketing. In addition, the Company has an active program of field demonstrations, as well as demonstrations to potential users in the Company's applications laboratory. International distributors and sales agents are supported with trade advertising, collateral literature and trade show materials. The distributors also advertise directly on their own behalf and attend regional and international trade shows. As an aid to the marketing and sales activity for the equipment, the Company provides a complete applications testing laboratory service. This service includes free processing and analysis of a prospective customer's sample formulation. Additionally, a prospective customer may pay for subsequent laboratory time and services on a fee for services basis, which includes equipment rentals.\nForeign sales, in general, contributed approximately $2,498,000, representing approximately 47% of total revenues in 1995. Sales in Asia contributed approximately $1,514,000, or 29%, of revenue in 1995. Sales in Europe contributed approximately $984,000, or 19%, of revenue in 1995.\nCUSTOMERS: - ---------\nThe Company's customers are companies with processing needs in the chemical, pharmaceuticals, food, cosmetic and biotechnology industries, including E.I. DuPont, Polaroid, Kodak, 3M, Burroughs-Wellcome, Chiron, PPG, Amgen, Genentech and Hershey. Mizuho Industrial Co., a distributor, accounted for 21% of revenues in 1995. One other customer (PPG) accounted for 10% of revenues in 1995. A reduction or delay in orders from Mizuho or other significant customers could have a material adverse effect on the Company's results of operations.\nCOMPETITION: - -----------\nThe Company believes that its Microfluidizer equipment competes with high and low pressure homogenizers and high energy mechanical dispersing equipment. Homogenizers are directly descended from the first milk homogenizer, introduced around 1900. Mechanical dispersers employ high shear technology, which consists of blades rotating in a vessel containing the material to be dispersed. The Company believes that machines produced by other manufacturers have, in general, more moving parts and operate at lower pressures and at less intense energy. Colloid mills are also used to produce emulsions and dispersions. Other types of rotor-stator mixing equipment, which are sometimes referred to as low-shear mixers, are generally not competitive in function with the Company's equipment, but may be useful in pre-mixing product for subsequent processing by other means.\nWith respect to emulsions, the Company believes that, generally, an emulsion processed with a Microfluidizer unit will exhibit improved stability characteristics and require reduced concentrations of costly emulsifying agents. Competing homogenizer equipment operates by impacting the pressurized ejection of a\nformulation upon a ring of metal. The Company believes that these devices have several operational disadvantages, including variable treatment of formulation elements, particle size reduction limitations, cleaning difficulty, energy inefficiency and imprecise temperature control.\nWith respect to dispersions, the available competing equipment (\"media mills\") uses milling media (beads of ceramic, metal, etc.) to facilitate dispersion of the solid component in the liquid. This technology, however, often results in crushed formulation particles. In contrast, the Microfluidizer process does not damage the primary solid. In addition, when using a media mill, the media used is often fragmented in the mixing process, thus contaminating the final dispersion. Using its fluid stream mixing process, the Microfluidizer unit avoids the need for an additional processing step to remove such impurities.\nThe Company believes that most competing technologies in cell rupture processing frequently contaminate the cell contents with membrane debris and\/or by introducing contamination from media breakdown, requiring additional downstream separation and purification and resulting in lower yield. Further, such technologies usually require multiple passes to adequately process cells.\nThere are several competing technologies that can be used to manufacture liposomes. However, the Company believes that these production methods suffer from their lot size limitations, lack of consistency, requisite use of detergents or emulsifiers and an inability to operate in a continuous process mode. In addition, to the Company's knowledge, only the Microfluidizer system has demonstrated the ability to produce small, uniform, unilamellar (single membrane) liposomes on a commercial production scale.\nRESEARCH AND DEVELOPMENT: - ------------------------\nThe Company's research and development efforts are focused on developing new mixing techniques for the process industries and further enhancing the functionality, reliability and performance of existing products. Research and development costs were $691,446 in 1995.\nCOOPERATIVE RESEARCH ARRANGEMENTS: - ---------------------------------\nThe Company subsidizes research and development activities centered around Microfluidizer technology at a number of research universities. Currently, the Company is subsidizing research and development in the following fields at the following universities: The University of Massachusetts, Lowell - biotechnology; Lehigh University - polymer chemistry; University of Lavaal (Quebec) - food science; Worcester Polytechnic Institute (\"WPI\") - catalytic chemistry; Rutgers University - ceramics; and Purdue University - pharmaceuticals. In addition to their research activities, these universities provide the Company with contacts at industrial companies that may utilize the Microfluidizer technology.\nWorcester Polytechnic Institute (WPI) -------------------------------------\nThe Company has supported research and development at WPI since 1988. In 1992, the Company entered into a cooperative venture with WPI to develop, patent and license for commercial applications the Microfluidizer process technology in the following fields: (i) the production of catalysts used in chemical and petroleum processing; (ii) the manufacture of advance ceramic materials; and (iii) the destruction of volatile organic contaminants in process waste water. The Company and WPI applied for United States and foreign patents in 1992 and 1993, respectively, which cite the Microfluidizer technology as enabling the above process technologies. The two applied-for United States patents were both granted and issued in the United States in 1995. Patent issuance for these process technologies is either pending or in the latter stages of prosecution in several foreign jurisdictions.\nBased upon market research and technical evaluation to date, the Company is focusing its activities on the synthesis of advanced zeolite and metal oxide catalysts using the WPI process technology. A catalyst is a substance that initiates, accelerates and determines the course of a chemical reaction. The Company believes that properties\nof proprietary catalysts may improve industrial process economics by making more efficient use of raw materials, reducing energy requirements and increasing product yields. The Company believes that the catalytic materials produced by the Microfluidizer process may result in improved efficiency and extended life, compared with conventional catalysts.\nCatalytica, Inc. ----------------\nIn 1993, the Company entered into a licensing agreement with Catalytica, Inc. and WPI, and concurrently formed a collaboration with Catalytica. WPI granted to Microfluidics and Catalytica, jointly, an exclusive, worldwide license to develop and commercialize the Microfluidizer process technology developed at WPI for the synthesis of nanometer size, high purity, solid state metal oxide materials. Microfluidics and Catalytica are currently focusing on technically refining this process with the objectives of producing advanced catalyst for resale or licensing the process to catalysts manufacturers.\nIn November of 1994, the Company and Catalytica were jointly awarded a $2 million matching funds grant under the Advanced Technology Program of the United States Department of Commerce's National Institute of Standards and Technology. The Advanced Technology Program is designed to assist in funding emerging, economically important projects with well defined research and development, technology and business objectives. The grant was awarded to the Company and Catalytica to develop and demonstrate the ability, using patented Microfluidizer equipment, to synthesize nanometer size catalysts providing enhanced performance for use in the chemical and petroleum refining industries. The project targets three types of nanometer-size catalysts: mixed metal oxides used in chemical manufacturing, non-crystalline zeolites used for petrochemical production and colloidal catalysts used for processing by the petroleum refining industry. During the remaining two years of the project, the Company has budgeted expenditures of approximately $320,000 and $350,000, respectively. Under this grant, the Company will be reimbursed 48% of its expenditures. The first year of the project sought to demonstrate technical aspects such as synthesis techniques and catalyst performance, followed by prototyping proof of principle and scale up for pilot production in year two, and customer evaluation in year three. There can be no assurances that this project will result in technology useful for the chemical and petroleum refining industries or that any revenue will be generated from the results of this project.\nIn connection with the Catalytica cooperative venture, the Company has provided its equipment to the University of Illinois (Champagne Urbana) for research in the area of cavitational processing.\nPATENTS AND PROPRIETARY RIGHTS PROTECTION: - -----------------------------------------\nTo protect its proprietary rights, the Company relies on a combination of U.S. patent laws, trademark laws, trade secrets, confidentiality agreements, contractual provisions and technical measures, including x-ray transparent components and a tamper-resistant, self-contained interaction chamber. In the event of patent infringement or breach of confidentiality, there can be no assurance that these measures will be adequate or that the Company will have sufficient resources to prosecute or prevail in an action against a third party. In addition, the Company has not sought patent or trademark protection for its interaction chamber in any country other than the United States and, as such, its proprietary rights are not subject to the protection of patent or trademark laws of foreign countries where the Company's equipment is sold. The Company's process patent expires March 13, 2007 and its equipment patent expires August 6, 2002.\nMANUFACTURING - -------------\nAt present, the Company subcontracts the manufacture of many of the components of its equipment to many third parties, with the Company undertaking the remaining fabrication, assembly and performance testing. The Company has selected certain primary suppliers based upon pricing terms and the quality of their products. The Company believes that there are adequate available alternate manufacturing sources and suppliers for the Company's components and raw materials.\nGOVERNMENT REGULATION: - ---------------------\nCertain of the Company's customers utilize the Microfluidizer equipment in processes and production that are subject to governmental regulation. For example, the manufacturing and marketing of pharmaceutical products requires the approval of the Food and Drug Administration (\"FDA\") within the United States and of comparable agencies in foreign countries. The FDA has established mandatory procedures, safety standards and protocols that apply to the manufacture, clinical testing and marketing of new pharmaceutical products in the United States. The process of seeking and obtaining FDA approval of a new product often takes a number of years and often involves the expenditure of substantial resources. The FDA approval process contributes to the extremely long lead times that are attendant to manufacturing equipment orders for these applications.\nFurther, in addition to product approvals, the FDA imposes requirements as to manufacturing practices, record keeping and reporting (\"Good Manufacturing Practices\" or \"GMP\"). GMP-regulated companies are subject to inspections by the FDA (inclusive of Microfluidizer equipment) and product approvals may be withdrawn if GMP are not met.\nAt present, the Company's customers include several companies who are making FDA approved drugs and preparations for external use and a few companies who utilize Microfluidizer equipment for the formulation or production of FDA approved parenteral (injectable) drugs or compounds.\nVarious laws, regulations and recommendations relating to safe working conditions, laboratory practices and the purchase, storage, movement, import and export, use and disposal of harmful or potentially harmful substances that may be used in connection with the Company's research work are or may be applicable to its activities. These laws include, among others, the United States Atomic Energy Act, the Clean Air Act, the Clean Water Act, the Occupational Safety and Health Act, the National Environmental Policy Act, the Toxic Substances Control Act, the Resource Conservation and Recovery Act, national restrictions on technology transfer, import, export and customs regulations and other present and possible future local, state or Federal regulation. The extent of adverse governmental regulation which might result from future legislation or administrative action cannot be accurately predicted. Certain agreements that may be entered into by the Company involving exclusive license rights may also be subject to national or supranational antitrust regulatory control, the effect of which cannot be predicted.\nBACKLOG: - -------\nThe Company's backlog of accepted and unfilled orders at March 26, 1996 and March 20, 1995 was $635,697 and $435,627, respectively. Revenue is not recognized until equipment is shipped. Backlog as of any particular date should not be relied upon as indicative of the Company's net revenues for any future period.\nEMPLOYEES: - ---------\nThe Company has approximately 35 full-time employees. None of the Company's employees are covered by a collective bargaining agreement, and the Company considers its relations with its employees to be excellent. The Company believes that its future success will depend in large part on its ability to attract and retain highly skilled employees.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company rents approximately 32,000 square feet of offices, production and research and development facilities in Newton, Massachusetts for administrative, development and production activities at an annual expense of approximately $150,000. The lease term expires on May 31, 1998. The Company believes that this facility will be adequate for operations for the next three years.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nNot applicable.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS\nNot applicable.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nUntil January 17, 1994, the Company's Common Stock was traded on the Nasdaq Small Cap Market. Thereafter, the Company's Common Stock was traded on the Nasdaq Stock Market under the symbol MFIC. The following table sets forth the range of quarterly high and low bid quotations for the period from January 1, 1994 to December 31, 1995, as furnished by the National Association of Securities Dealers Automated Quotation System. The quotations represent interdealer quotations without adjustment for retail markups, markdowns, or commissions, and may not necessarily represent actual transactions.\nAs of March 26, 1996 there were approximately 486 holders of record of the Company's Common Stock.\nThe Company has never paid any cash dividends on its capital stock and presently anticipates that no dividends on its Common Stock will be declared in the foreseeable future. The Company's current policy is to retain all of its earnings to finance future growth. In addition, the Company's arrangement with its commercial lender prohibits the payment of dividends without prior approval.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe selected financial information presented below is derived from the consolidated financial statements of the Company for the five years ended December 31, 1995. The information set forth below should be read in conjunction with \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" included as Item 7","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nOVERVIEW --------\n1995 was a year of conscientious change in strategy and in the way that the Company conducts its business. What was expected to be a year of both growth and profitability, based upon investments made in 1994, did not materialize.\nThe most significant factor that affected 1995 results from operations was a 28% decline in revenue from the previous year level. This revenue decline was primarily in North America and was reflected in lower system shipments in most product line categories. Fourth quarter sales rose to higher levels than those posted in the third quarter.\nSignificant management changes took place in 1995. In July, the Company's President resigned. Michael A. Lento was appointed President in September 1995. Mr. Lento had been Vice President of Marketing at the Company since September 1994 and prior to that had managed the Company's cooperative venture with Catalytica, Inc. Subsequent management changes have included the resignation of the Company's Vice President of Engineering, Vice President of Sales, and Controller. The Controller position has been filled and the Company is currently interviewing candidates for the other positions.\nWithin the Unites States in 1995, the Company shifted from a predominantly direct sales force to the appointment and use of manufacturers representatives and sales agents with previous experience in the sale of materials processing equipment. Sales activity and performance in the Company's overseas markets remain stable and in Europe are showing signs of growth. The Company has strengthened its relationships with its existing distributors in Asia. In Europe, the Company has replaced a number of sales agents that were not performing at acceptable levels, while also appointing several additional sales agents. The Company's new sales agents, together with the efforts of the Company's resident European manager in Frankfurt, have increased the Company's activities in Europe and the Company believes that it can achieve significant growth in this market.\nThe Company's cash and cash equivalent position rose in 1995 by almost $230,000 to over $1,900,000. In light of the Company's debt-free balance sheet, the Company believes that it has adequate resources and reserves to allow it to accomplish its business plan.\nThe Company has adopted a customer-focused approach to reaching a broader market base with its message of \"Innovation through Microfluidizer\/(R)\/ technology\".\nRESULTS OF OPERATIONS\nFISCAL 1995 COMPARED TO FISCAL 1994 -----------------------------------\nTotal revenue for fiscal 1995 was $5,273,399, as compared to $7,298,416 in fiscal 1994, a decrease of $2,025,017, or approximately 28%. This decline was primarily the result of a decrease in North American revenues from approximately $4,753,000 in 1994 to $2,775,000 in 1995.\nSales of both the 110 Series and 210 Series decreased by approximately $857,000 from 1994 to 1995. In addition, the Company's sale of large volume production units in fiscal 1995 was two units, down from five units in fiscal 1994, and represented a decrease of approximately $840,000. Foreign revenue for the year was $2,497,248, representing approximately 47% of total revenue, as compared to $2,543,566 or 35% of total revenue in fiscal 1994. The increase in foreign revenues as a percentage of sales was significantly impacted by a corresponding decrease in North American sales.\nCost of goods sold for fiscal 1995 was $2,813,801, or 53% of revenue, as compared to $2,968,030, or 41% of revenue, in fiscal 1994. This increase was primarily the result of an increase in material costs and direct labor as a percentage of sales, and the write off of obsolete inventory. The Company's product lines each have different profit margins, as well as multiple profit margins within each product line. In year-to-year comparisons, there may be significant changes in the cost of goods sold as a percentage of revenue, depending on the mix of products sold. Generally, full scale production units yield lower profit margins than laboratory or pilot production units and electric hydraulic units yield lower profit margins than air driven units.\nOperating expenses for fiscal 1995 were $3,742,946 as compared to $3,828,367 for fiscal 1994, a decrease of $85,421, or 2%. Research and development expenses decreased to $691,466 in fiscal 1995 from $762,620 in fiscal 1994, primarily due to a grant reimbursement from the United States Department of Commerce in the amount of $118,638 for 1995 in connection with the Company's continued research efforts with Worcester Polytechnic Institute and Catalytica, Inc. Sales and Marketing expenses increased to $1,895,274, or 36% of revenue, from $1,764,060, or 24% of revenue, in fiscal 1994 as a result of the Company's continued efforts to expand and strengthen its sales force. General and administrative expenses deceased to $1,156,206 in fiscal 1995 from $1,301,687 in fiscal 1994.\nInterest income increased 115% to $98,675 in fiscal 1995 from $43,608 in fiscal 1994, reflecting the amount of cash available for investment due to the collection of accounts receivable in 1995. There were no interest expenses incurred in either fiscal 1995 or fiscal 1994.\nIn fiscal 1995, the Company recognized a gain of $93,239 on the sale of a portion of its holdings in PolyMedica Industries, Inc. The market value for the remaining 13,940 shares owned by the Company at December 31, 1995 was $83,640.\nOn December 27, 1995, the Company sold to ChemMark Development, Inc. (\"ChemMark\") its business of manufacturing and distributing proprietary cosmetic liposomal formulations, sold under the trade name Dermasome\/(R)\/. In return for ChemMark's payment of $50,000, the Company transferred to ChemMark its Dermasome\/(R)\/ trademark, its customer list, its products list, all unfilled Dermasome\/(R)\/ orders, and all products and product literature. Additionally, the Company granted to ChemMark a two year, world-wide, exclusive license to use the Company's proprietary technology and know-how to manufacture and\ndistribute Dermasome products. In exchange, the Company received a one-time, non-refundable $50,000 rights grant acquisition fee, and the payment over the license term of a percentage royalty equal to ten percent (10%) of the net sales realized by ChemMark on the sale of products derived from the Company's technology. Notwithstanding the amount of such percentage royalty, ChemMark is obligated to pay a minimum royalty payment in the amount of $100,000, payable in 22 equal monthly installments of $4,167.67, with a final payment of $8,333.34 due upon the second anniversary of the agreement. As security for ChemMark's performance of its obligations to the Company, the Company retains a security interest in the Trademark. The Company recognized a gain of $81,537 upon the sale of the Dermasome\/(R)\/ business.\nThe tax provision of $1,107,422 principally results from the recording of a valuation allowance for net operating loss carryforwards, tax credit carryforwards, and other deferred tax assets, which may not be realized.\nLIQUIDITY AND CAPITAL RESOURCES\nThe cash and cash equivalents balance at December 31, 1995 was $1,903,418, an increase of $229,607 from the December 31, 1994 balance of $1,673,811. This increase was the result of a reduction in accounts receivables (from $2,991,184 at December 31, 1994 to $1,751,199 at December 31, 1995, a decrease of 41%) of over $1,197,000, as well as proceeds of $100,000 related to the sale and license transaction related to the Dermasome\/(R)\/ business and a $93,239 gain on the sale of 10,000 shares of PolyMedica Industries, Inc. stock. The Company continues to maintain a line of credit with the Bank of Boston equal to the lesser of $750,000 or 80% of the domestic accounts receivable that are less than 60 days old. The available line, as of March 26, 1996, was $276,796. The accounts receivable balance as of March 26, 1996 was $1,222,973. Inventory decreased by 14% due to a decrease in sales and improved controls over inventory levels. Accounts payable decreased by 48% primarily due to a decrease in inventory.\nThe Company may, from time to time, consider acquisition of complementary businesses, products or technologies, although it has no present understandings, commitments or agreements with respect to any such acquisitions. The Company believes that anticipated cash flows from operations and current sources of liquidity will be adequate to fund operations for at least the next year.\nFISCAL 1994 COMPARED TO FISCAL 1993 -----------------------------------\nTotal revenue increased $520,318, or approximately 8%, to $7,298,416 in fiscal 1994 from $6,778,098 in fiscal 1993. This increase was primarily the result of a 27% increase in the sale of electric hydraulic laboratory and pilot production units and related spare parts over fiscal 1993 levels. The Company's sale of five full production units in fiscal 1994 was down from eight such sales in fiscal 1993. Foreign revenue for the year was $2,543,566, representing approximately 35% of total revenue, as compared to $2,286,994, or 34% of total revenue, in fiscal 1993. The increase in foreign revenues was significantly impacted by one additional sale of a full scale production unit.\nCost of goods sold for fiscal 1994 was $2,968,030, or 41% of revenue, as compared to $2,922,298, or 43% of revenue, in fiscal 1993. Operating expenses for fiscal 1994 were $3,828,367, as compared to $2,975,271 for fiscal 1993, an increase of $853,096, or 29%. Research and development expenses increased 78% to $762,620 in fiscal 1994 from $427,568 in fiscal 1993, primarily due to a $180,000 expenditure in connection with the Company's continued research efforts with Worcester Polytechnic Institute and Catalytica, Inc. and the Company's internal developments, including the Diamond Interaction Chamber and a number of design enhancements to its existing products. Sales and marketing expenses increased 39% to $1,764,060 (24% of revenue) in fiscal 1994 from $1,268,804 (19% of revenue) in fiscal 1993. This increase resulted from the Company's efforts in 1994 to expand and strengthen its sales force. General and administrative expenses increased 2% to $1,301,687 in fiscal 1994 from $1,278,899 in fiscal 1993.\nInterest income increased 84% to $43,608 in fiscal 1994 from $23,705 in fiscal 1993, reflecting the amount of cash available for investment due to the private placement the Company completed in fiscal 1993. There were no interest expenses incurred in either fiscal 1994 or fiscal 1993.\nIn fiscal 1993, the Company recognized a gain of $34,096 on the sale of a portion of its holdings in PolyMedica Industries, Inc. There were no sales of these shares in fiscal 1994. The market value for the remaining 23,940 shares owned by the Company at December 31, 1994 was $104,738.\nIn 1993 the Company adopted the liability method of accounting for income taxes in accordance with Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\" SFAS 109 requires the recognition of deferred tax assets (net of any valuation allowance) and liabilities based on 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 upon the difference between the financial statement and tax basis of assets and liabilities using the expected tax rates in effect for the year in which the differences are expected to reverse. The effect of adopting SFAS 109 resulted in a cumulative increase in book income of $290,609 for 1993.\nThe Company's provision\/(benefit) for income taxes was due mainly to its continued profitability through 1994. Therefore, the majority of prior years valuation allowance under SFAS 109 was no longer required. The deferred benefit related to the release of the valuation allowance for 1995 was $728,151.\nThe accounts receivable balance at December 31, 1994 was $2,991,184, an 85% increase over the balance of $1,616,208 at December 31, 1993. The majority of this increase was due to sales for full scale production units in the latter half of the fourth quarter of 1994, which are on different payment terms. The accounts receivable balance as of March 20, 1995 was $1,208,092. Inventory increased by 57% due to anticipated fourth quarter orders that did not materialize. Accounts payable increased by 32%, primarily due to the increase in inventory. Customer advances decreased by approximately 40% primarily because advance payments received in 1993 were offset against final invoices issued when full scale production units were shipped in 1994. The customer advance represented an overpayment on behalf of a customer.\nNEW ACCOUNTING PRONOUNCEMENTS\nStatement of Financial Accounting Standards No. 123 \"Accounting for Stock- Based Compensation\" (SFAS 123), will require the Company to either elect expense recognition or the disclosure-only alternative for stock-based employee compensation. SFAS 123 must be adopted in the\nCompany's 1996 financial statements with comparable disclosures for the prior year. While the Company is reviewing the adoption and impact of SFAS 123, it expects to adopt the disclosure-only alternative and, accordingly, this standard will have no impact on the Company's results of operations or its financial position.\nBUSINESS OUTLOOK\nThis report contains forward-looking statements within the meaning of the \"safe-harbor\" provisions of the Private Securities Litigation Reform Act of 1995. Such statements are based on management's current expectations and are subject to a number of factors and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. Such factors and uncertainties include, but are not limited to, the uncertainty that the performance advantages of the Microfluidizer equipment will be realized commercially or that a commercial market for Microfluidizer equipment will continue to develop; the dependence by the Company on key customers; the loss of the services of one or more of the Company's key employees, which could have a material adverse impact on the Company; the development of competing or superior technologies and products from manufacturers, many of which have substantially greater financial, technical and other resources than the Company; the cyclical nature of the materials processing industry, which has historically negatively affected the Company's sales of Microfluidizer equipment during industry downturns and which could do so in the future; the availability of additional capital to fund expansion on acceptable terms, if at all; and general economic conditions.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe following consolidated financial statements of the Company and its subsidiaries appear on the following pages of this 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\nDIRECTORS - ---------\nThe information concerning directors of the Company required under this item is incorporated herein by reference to the Company's definitive proxy statement pursuant to Regulation 14A, to be filed with the Commission not later than 120 days after the close of the Company's fiscal year ended December 31, 1995.\nEXECUTIVE OFFICERS - ------------------\nThe information concerning executive officers of the Company required under this item is incorporated herein by reference to the Company's definitive proxy statement pursuant to Regulation 14A, to be filed with the Commission no later than 120 days after the close of the Company's fiscal year ended December 31, 1995.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required under this item is incorporated herein by reference to the Company's definitive proxy statement pursuant to Regulation 14A, to be filed with the Commission not later than 120 days after the close of the Company's fiscal year ended December 31, 1995.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required under this item is incorporated herein by reference to the Company's definitive proxy statement pursuant to Regulation 14A, to be filed with the Commission not later than 120 days after the close of the Company's fiscal year ended December 31, 1995.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required under this item is incorporated herein by reference to the Company's definitive proxy statement pursuant to Regulation 14A, to be filed with the Commission within 120 days after the close of the Company's fiscal year ended December 31, 1995.\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 financial statements are included in Item 8:\nConsolidated Balance Sheets as of December 31, 1995 and 1994\nConsolidated Statements of Operations for the years ended December 31, 1995, 1994 and 1993\nConsolidated Statements of Cash Flows for the years ended December 31, 1995, 1994 and 1993\nConsolidated Statements of Changes in Stockholders' Equity for the years ended December 31, 1995, 1994 and 1993\nNotes to Consolidated Financial Statements\nReport of Independent Accountants\n(a)2. FINANCIAL STATEMENT SCHEDULES.\nAll schedules are omitted because they are not applicable or the required information is shown in the financial statements or the notes thereto.\n(a)3. LIST OF EXHIBITS.\nExhibit Number Description of Exhibit ------ ----------------------\n3.3(a) Certificate of Incorporation for the Company, as amended (filed as Exhibit 2A to Registration Statement No. 0-11625 on Form 8-A and incorporated herein by reference).\n3.3(b) By-Laws for the Company, as amended (filed as Exhibit 3(b) to Registration Statement No. 2-85290 on Form S-1 and Incorporated herein by reference).\n3.10(a) 1987 Stock Plan (filed as Exhibit 10(g) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1987 and incorporated herein by reference).\n3.10(b) 1988 Stock Plan (filed as Exhibit 10(g) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1988 and incorporated herein by reference).\n3.10(c) 1989 Non-Employee Directors Stock Option Plan (filed as Exhibit 10(h) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1988 and incorporated herein by reference).\n3.10(d) Loan Agreement between The First National Bank of Boston and Microfluidics International Corporation dated as of December 10, 1993 (filed as Exhibit 10.1 to Form 8-K filed on December 27, 1993 and incorporated herein by reference).\n3.10(e) Lease for 30 Ossipee Road, Newton, Massachusetts dated April 22, 1993 between Microfluidics International Corporation and J. Frank Garrity, Trustee of 1238 Chestnut Street Trust under Declaration of Trust dated May 23, 1969, recorded with Middlesex South Registry of Deeds in Book 11682, Page 384 (filed as Exhibit 3.10(e) to the\nCompany's Form 10-K for the fiscal year ended December 31, 1993 and incorporated herein by reference).\n3.10(f) Letter of Understanding between Microfluidics International Corporation and Worcester Polytechnic Institute dated as of April 3, 1993 (filed as Exhibit 3.10(f) to the Company's Form 10-K for the fiscal year ended December 31, 1993 and incorporated herein by reference).\n3.10(g) Agreement between Microfluidics International Corporation and Catalytica, Inc. dated as of October 18, 1993 (filed as Exhibit 3.10(g) to the Company's Form 10-K for the fiscal year ended December 31, 1993 and incorporated herein by reference).\n3.10(h) License Agreement among Microfluidics International Corporation, Worcester Polytechnic Institute and Catalytica, Inc. dated as of October 18, 1993 (filed as Exhibit 3.10(h) to the Company's Form 10- K for the fiscal year ended December 31, 1993 and incorporated herein by reference).\n*3.10(i) Agreement, dated July 27, 1995, between Microfluidics International Corporation and Michael T. Rumley.\n*3.10(j) Letter, dated August 16, 1995, from Microfluidics International Corporation to Michael T. Rumley.\n*3.10(k) Letter, dated December 31, 1995, from Microfluidics International Corporation to Irwin J. Gruverman.\n*3.10(l) Warrant for the Purchase of Shares of Common Stock, dated July 15, 1993, in favor of Ladenburg, Thalman & Co. Inc.\n*3.21 Subsidiaries of the Registrant.\n*3.24 Consent of Coopers & Lybrand L.L.P.\n*3.27 Financial Data Schedule _____________________ * Filed herewith\n(b) REPORTS ON FORM 8-K.\nNot applicable.\n(c) EXHIBITS.\nThe Company hereby files as part of this Form 10-K the Exhibits listed in Item 14(a)(3) as set forth above.\n(d) FINANCIAL STATEMENT SCHEDULES.\nSee (a)(2) above.\nREPORT OF INDEPENDENT ACCOUNTANTS ---------------------------------\nTo the Board of Directors and Stockholders of Microfluidics International Corporation:\nWe have audited the accompanying consolidated balance sheets of Microfluidics International Corporation and Subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1995. 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 Microfluidics International Corporation and Subsidiaries as of December 31, 1995 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, 1995, in conformity with generally accepted accounting principles.\nCOOPERS & LYBRAND L.L.P.\nBoston, Massachusetts February 23, 1996\nMICROFLUIDICS INTERNATIONAL CORPORATION CONSOLIDATED BALANCE SHEETS\nThe accompanying notes are an integral part of the financial statements.\nMICROFLUIDICS INTERNATIONAL CORPORATION CONSOLIDATED BALANCE SHEETS (CONTINUED)\nThe accompanying notes are an integral part of the financial statements.\nMICROFLUIDICS INTERNATIONAL CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS\nThe accompanying notes are an integral part of the financial statements.\nMICROFLUIDICS INTERNATIONAL CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS\nThe accompanying notes are an integral part of the financial statements.\nMICROFLUIDICS INTERNATIONAL CORPORATION CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY\nfor the years ended December 31, 1995, 1994 and 1993\nThe accompanying notes are an integral part of the financial statements.\nA. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:\n1. CONSOLIDATION\nThe consolidated financial statements of the Company include the accounts of the Company and its wholly owned subsidiaries, Microfluidics Corporation (\"MFC\") and MediControl Corporation (\"MediControl\").\nAll significant intercompany transactions have been eliminated.\n2. CASH EQUIVALENTS\nThe Company considers securities with maturities of three months or less, when purchased, to be cash equivalents.\n3. MARKETABLE SECURITIES\nDuring 1994, the Company adopted Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" (SFAS 115). The adoption of SFAS 115 resulted in an increase in stockholders' equity of $20,797 and $62,843 in 1995 and 1994, respectively. In accordance with this statement, prior years' financial statements have not been restated to reflect the change in accounting method.\nAt December 31, 1995 and 1994, marketable equity securities have been categorized as available for sale and, as a result, are stated at fair value. Unrealized holding gains and losses, net of tax, are included as a component of stockholders' equity until realized.\n4. INVENTORIES\nInventories are stated at the lower of cost or market. Approximate cost is determined on a first-in, first-out basis. Certain inventories are held on customer premises on a trial basis preparatory to sale.\n5. EQUIPMENT AND LEASEHOLD IMPROVEMENTS\nThe Company's equipment and leasehold improvements are recorded at cost. Depreciation is computed on the straight-line method, based upon useful lives of three to five years. Leasehold improvements are amortized on the straight-line method based upon the lesser of the estimated useful lives or term of the lease. Expenditures for maintenance and repairs are expensed as incurred. Upon retirement or sale of property and equipment, the cost of the disposed asset and the related accumulated depreciation are removed from the accounts and any resulting gain or loss is credited or charged to operations.\n6. INTANGIBLES\nPatents, patent applications and rights are stated at acquisition cost. Amortization of patents is recorded using the straight-line method over the legal lives of the patents. The excess of cost over fair value of net assets acquired is amortized over 5 years. The Company periodically reviews the carrying value of intangible assets and impairments are recognized when the expected future operating cash flows derived from such intangible assets is less than their carrying value.\n7. INCOME TAXES\nThe Company provides for income taxes based on the provisions of Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes,\" which requires recognition of deferred tax assets and liabilities based on 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 upon 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 be reversed. Under SFAS No. 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized as income or loss in the period that includes the enactment date.\n8. REVENUE RECOGNITION\nProduct sales and related cost of sales are reflected in income when goods are shipped for final sale.\n9. NEW ACCOUNTING PRONOUNCEMENTS\nStatement of Financial Accounting Standards No. 123 \"Accounting for Stock-Based Compensation\" (SFAS 123), will require the Company to either elect expense recognition or the disclosure-only alternative for stock-based employee compensation. SFAS 123 must be adopted in the Company's 1996 financial\nstatements with comparable disclosures for the prior year. While the Company is reviewing the adoption and impact of SFAS 123, it expects to adopt the disclosure only alternative and accordingly this standard will have no impact on the Company's results of operations or its financial position.\n10. EARNINGS (LOSS) PER SHARE\nPrimary and fully diluted earnings per common and common equivalent share are computed by dividing net income by the weighted average number of shares of common stock and common stock equivalents outstanding during the year. The calculation of fully diluted income (loss) per common share uses a different market price assumption than primary earnings (loss) per common share for the reacquisition of common shares.\nNet income (loss) per common share is calculated by dividing net income (loss) by the weighted average number of shares of common stock and common stock equivalents outstanding during the year. Options and warrants are not reflected in the calculation of net income (loss) per common share when their inclusion would be anti-dilutive.\n11. USE OF ESTIMATES\nThe process of preparing financial statements in conformity with generally accepted accounting principles requires the use of estimates and assumptions that affect the reported amounts of 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 these estimates.\nB. INDUSTRY SEGMENT AND MAJOR CUSTOMERS:\nThe Company has one business segment: the development, manufacture, marketing and sale of process and formulation equipment. The Company's sales are primarily to companies with processing needs in the chemical, pharmaceutical, food, cosmetic, and biotechnology industries.\nMizuho Industrial Co. (a distributor) accounted for 21% of revenues in 1995, 20% of revenues in 1994 and 19% of revenues in 1993. Sales in Europe were approximately $984,000, $625,000 and $395,000, and sales in Asia were approximately $1,514,000, $1,919,000 and $1,892,000 in 1995, 1994 and 1993, respectively, of the total revenues. One other customer (PPG) accounted for 10% of revenues in 1995. A reduction or delay in orders from Mizuho or other significant customers could have a material adverse effect on the Company's results of operations.\nC. INVESTMENTS:\nAt December 31, 1995 and 1994, the Company held 13,940 and 23,940 shares, respectively, of PolyMedica Industries, Inc. at zero cost through its wholly owned subsidiary MediControl. The market value of these shares at December 31, 1995 and 1994 was $83,640 and $104,738, respectively.\nDuring 1995, the Company sold 10,000 shares of PolyMedica Industries, Inc. at a gain of $93,239. On October 28, 1994 the Company received from PolyMedica Industries, Inc. a stock dividend of 1,140 shares. During 1993, the Company sold 2,000 shares of PolyMedica Industries, Inc. at a gain of $34,906.\nD. INVENTORY\nThe components of inventories at the respective dates are as follows:\nE. INTANGIBLE ASSETS:\nThe Company purchased the rights and title of certain liposome and microemulsion technology devices from Arthur D. Little in 1985. The unamortized license fee and patent are included in intangible assets and are being amortized using the straight line method over the useful life of the patent, 17 years. Patents and other intangible assets were purchased in 1991 as a result of a share exchange by MediControl stockholders. These patents and other intangible assets are being amortized using the straight line method over five years. In addition, the Company capitalized $96,680 of patent costs related to the cooperative-venture described in Note M. Amortization charged to expense was $53,412 in 1995 and $54,276, in 1994 and 1993, respectively.\nF. LINE OF CREDIT\nIn December 1993, the Company entered into a loan and security agreement (the \"Agreement\") for a line of credit with a local bank. The available line or borrowing base is equal to the lesser of $750,000 or 80% of net outstanding amount of base accounts, as defined in the agreement.\nThe line is collateralized by all inventory, accounts receivable, general intangibles, machinery and equipment and all other property of the Company, excluding leased inventory and certain intangible assets. There were no borrowings under this line of credit arrangement during 1995 or 1994.\nG. DEBT\nEffective September 30, 1989, the Company issued to G.D. Searle & Company (\"Searle\") a 9% Debenture due September 30, 1994 in the original principal amount of $750,000 (the \"Searle Debenture\"). Interest under the Searle Debenture was payable in one installment on the unpaid balance at the due date. The Company also granted to Searle an irrevocable, immediately exercisable option to purchase up to 600,000 shares of the Company's Common Stock at a purchase price of $1.50 per share (the \"Searle Option\") and certain rights to market the Company's products.\nEffective March 9, 1992 and June 30, 1993, Searle exercised the Searle Option and purchased 600,000 shares of the Company's Common Stock. Searle paid the aggregate exercise price by surrendering the Searle Debenture.\nH. EMPLOYEE BENEFITS:\nEffective January 1, 1990, the Company offered a 401(k) profit-sharing plan (the \"Plan\"), to its employees. All Company and related entity employees who are eighteen years of age and have completed one hour of service are eligible to participate in the Plan. Employees may contribute from 1% to 20% of their compensation. The Company's contribution is discretionary, with contributions made from time to time as management deems advisable. The Company made no matching contributions during 1995, 1994 or 1993. Plan administration expenses of $2,755, $2,110 and $1,660 were incurred by the Company in 1995, 1994 and 1993, respectively. The Company instituted a cafeteria plan in 1992, giving the employees certain pre-tax advantages on specific payroll deductions, at an administrative cost of $500 each in each of 1995, 1994 and 1993.\nI. INCOME TAXES\nIn 1993, the Company adopted SFAS 109, \"Accounting for Income Taxes.\" The cumulative effect of this change of $290,609 was determined at January 1, 1993, and reported in the Company's prior year financial statement.\nThe provision\/(benefit) for income taxes for the current year is as follows:\nThe current year income tax provision of $6,643 represents state tax. The deferred income tax expense of $1,100,779 results from net operating loss carryforwards, tax credit carryforwards and other deferred tax assets, which may not be realized.\nThe approximate tax effect of each type of temporary difference and carryforward before and after allocation of the valuation allowance is as follows:\nThe Company has a net operating loss tax carryforward of approximately $3,273,000 and research and development tax credit carryforwards of approximately $175,000, expiring at various dates beginning in 1999 through 2010. Ownership changes may result in future limitations on the utilization of net operating losses and research and development tax credit carryforwards.\nBased on the financial results known at December 31, 1995, the Company has established a complete valuation allowance against the deferred tax asset due to the uncertainty of earning sufficient taxable income to realize the benefit of these assets. Therefore the Company has increased the valuation allowance by $1,382,834 in 1995 to reflect this uncertainty.\nThe following schedule reconciles the difference between the federal income tax rate and the effective income tax rate:\nJ. OPTIONS:\nThe Company adopted the 1988 Stock Plan as the successor plan to the 1987 Stock Plan, which authorizes the grant of Stock Rights for up to 1,750,000 shares of Common Stock and the 1989 Non-Employee Director Stock Option Plan which, as amended at the 1991 shareholders' meeting, authorizes the grant of nonqualified stock options for up to 240,000 shares of Common Stock. Information concerning stock options are as follows:\nThere were 495,563 shares of Common Stock subject to exercisable options at December 31, 1995, with a price range of $1.16-$7.44. In 1995, options to purchase 27,875 shares were exercised at prices ranging from $1.16-$2.32. In 1994, options to purchase 143,925 shares were exercised at prices ranging from $1.16-$4.625 per share. In 1993, options to purchase 290,725 shares were exercised at prices ranging from $1.16 to $3.13 per share.\nOn January 3, 1995, the Company issued options for an additional 22,500 shares at a price of $3.88 per share under the 1989 Non-Employee Director Stock Plan.\nDuring 1995, 1994 and 1993, employees delivered shares to the Company in payment for shares they were purchasing upon exercise of the stock options they held. The aggregate amount of shares received during 1995, 1994, and 1993 were 5,180, 10,000, and 82,644 shares respectively.\nK. STOCKHOLDER'S EQUITY:\nIn 1993, the Company raised additional capital through a private sale of 633,000 shares of its common stock. The shares were sold at $4.20 per share, less expenses of approximately $360,000, resulting in net proceeds to the Company of approximately $2,300,000. The financial advisors who facilitated the financing were awarded warrants for the purchase of 44,681 shares of restricted common stock. The warrants were exercisable from November 5, 1993 through April 28, 1995 at $6 per share.\nAs partial compensation for financial advisory services rendered to the Company by Ladenburg Thalmann & Co., Inc., an investment banking firm (\"Ladenburg\"), the Company on July 15, 1993 granted to Ladenburg a warrant to purchase up to 75,000 shares at a per share purchase price of $4.50 commencing on July 14, 1994 and exercisable until July 14, 1998.\nL. COMMITMENTS AND CONTINGENCIES:\nAt December 31, 1995 the Company had an operating lease for the rental of its facilities which requires the following minimum payments during the following years:\nRent expense for 1995, 1994 and 1993 was approximately $150,000, $162,000 and 122,000, respectively. The current lease is due to terminate on May 31, 1998.\nM. COOPERATIVE VENTURE:\nIn 1992, the Company formed a cooperative venture with Worcester Polytechnic Institute to develop, patent, and license for commercial application the Microfluidizer processing technology in certain fields. Expenditures for this venture were approximately $48,000 in 1995 and $180,000 in 1994. The costs in connection with patent applications of $96,680 have been included in intangible assets at December 31, 1995. Amortization began in December, 1995.\nIn September of 1993, the Company signed a license and research and development agreement with Catalytica, Inc., as joint licensee, to further the studies of the venture with Worcester Polytechnic Institute, as licensor. In 1995, the Company spent $247,162 related to this venture, of which the Company was reimbursed $118,638 from a government grant awarded jointly to Catalytica, Inc. and the Company in relation to this project. The remainder of the expenditures were included in research and development expense.\nN. SALE OF ASSETS:\nOn December 27, 1995, the Company sold to ChemMark Development, Inc. (\"ChemMark\") its business of manufacturing and distributing proprietary cosmetic\nliposomal formulations, sold under the trade name Dermasome\/(R)\/. In return for ChemMark's payment of $50,000, the Company transferred to ChemMark its Dermasome\/(R)\/ trademark, its customer list, its products list, all unfilled Dermasome\/(R)\/ orders, and all products and product literature. Additionally, the Company granted to ChemMark a two year, world-wide, exclusive license to use the Company's proprietary technology and know-how and to manufacture and distribute Dermasome products. In exchange, the Company received a one-time, non-refundable $50,000 rights grant acquisition fee, and the payment over the license term of a percentage royalty equal to ten percent (10%) of the net sales realized by ChemMark on the sale of products derived from the Company's technology. Notwithstanding the amount of such percentage royalty, ChemMark is obligated to pay a minimum royalty payment in the amount of $100,000, payable in 22 equal monthly installments of $4,167.67, with a final payment of $8,333.34 due upon the second anniversary of the agreement. As security for ChemMark's performance of its obligations to the Company, the Company retains a security interest in the trademark. The Company recognized a gain of $81,537 upon the sale of the Dermasome\/(R)\/ business.\nO. RELATED PARTY TRANSACTIONS:\nDuring 1995, 1994 and 1993, the Company and an entity controlled by Mr. Gruverman, the Company's Chairman, entered into an arrangement whereby such entity reimbursed the Company for a portion of certain administrative expenses. The Company was reimbursed approximately $31,155, $21,800 and $16,400 by such entity during 1995, 1994 and 1993, respectively. The Company reimbursed the entity controlled by Mr. Gruverman $53,478, $32,898 and $56,580 for consulting services (other than those of Mr. Gruverman) paid by such entity on behalf of the Company in 1995, 1994 and 1993, respectively.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized, in the city of Newton, Commonwealth of Massachusetts, on the 26th day of March, 1996.\nMICROFLUIDICS INTERNATIONAL CORPORATION\nBy: \/s\/ Michael A. Lento -------------------- Michael A. Lento President\nPursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nEXHIBIT INDEX\nExhibit Number Description of Exhibit - ------- ----------------------\n3.3(a) Certificate of Incorporation for the Company, as amended (filed as Exhibit 2A to Registration Statement No. 0-11625 on Form 8-A and incorporated herein by reference).\n3.3(b) By-Laws for the Company, as amended (filed as Exhibit 3(b) to Registration Statement No. 2-85290 on Form S-1 and Incorporated herein by reference).\n3.10(a) 1987 Stock Plan (filed as Exhibit 10(g) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1987 and incorporated herein by reference).\n3.10(b) 1988 Stock Plan (filed as Exhibit 10(g) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1988 and incorporated herein by reference).\n3.10(c) 1989 Non-Employee Directors Stock Option Plan (filed as Exhibit 10(h) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1988 and incorporated herein by reference).\n3.10(d) Loan Agreement between The First National Bank of Boston and Microfluidics International Corporation dated as of December 10, 1993 (filed as Exhibit 10.1 to Form 8-K filed on December 27, 1993 and incorporated herein by reference).\n3.10(e) Lease for 30 Ossipee Road, Newton, Massachusetts dated April 22, 1993 between Microfluidics International Corporation and J. Frank Garrity, Trustee of 1238 Chestnut Street Trust under Declaration of Trust dated May 23, 1969, recorded with Middlesex South Registry of Deeds in Book 11682, Page 384 (filed as Exhibit 3.10(e) to the Company's Form 10-K for the fiscal year ended December 31, 1993 and incorporated herein by reference).\n3.10(f) Letter of Understanding between Microfluidics International Corporation and Worcester Polytechnic Institute dated as of April 3, 1993 (filed as Exhibit 3.10(f) to the Company's Form 10-K for the fiscal year ended December 31, 1993 and incorporated herein by reference).\n3.10(g) Agreement between Microfluidics International Corporation and Catalytica, Inc. dated as of October 18, 1993 (filed as Exhibit 3.10(g) to the Company's Form 10-K for the fiscal year ended December 31, 1993 and incorporated herein by reference).\n3.10(h) License Agreement among Microfluidics International Corporation, Worcester Polytechnic Institute and Catalytica, Inc. dated as of October 18, 1993 (filed as Exhibit 3.10(h) to the Company's Form 10-K for the fiscal year ended December 31, 1993 and incorporated herein by reference).\n*3.10(i) Agreement, dated July 27, 1995, between Microfluidics International Corporation and Michael T. Rumley.\nExhibit Number Description of Exhibit - ------- ----------------------\n*3.10(j) Letter, dated August 16, 1995, from Microfluidics International Corporation to Michael T. Rumley.\n*3.10(k) Letter, dated December 31, 1995, from Microfluidics International Corporation to Irwin J. Gruverman.\n*3.10(l) Warrant for the Purchase of Shares of Common Stock, dated July 15, 1993, in favor of Ledenburg, Thalmann & Co. Inc.\n*3.21 Subsidiaries of the Registrant.\n*3.24 Consent of Coopers & Lybrand L.L.P.\n*3.27 Financial Data Schedule\n_____________________ *Filed herewith","section_15":""}
{"filename":"818764_1995.txt","cik":"818764","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL DEVELOPMENT OF BUSINESS\nCentex is incorporated in the State of Nevada. The Company's common stock, par value $.25 per share (\"Centex Common Stock\") began trading publicly in 1969. As of May 30, 1995, 28,147,011 shares of Centex Common Stock, which are traded on the New York Stock Exchange (NYSE) and The International Stock Exchange of the United Kingdom and the Republic of Ireland, Ltd., were outstanding.\nSince its founding in 1950 as a Dallas, Texas-based residential and commercial construction company, Centex has evolved into a multi-industry company. Centex currently operates in three business segments: Home Building, Financial Services and Contracting and Construction Services. Centex also has a 49% interest in Centex Construction Products, Inc., a NYSE listed company in the construction products business.\nCentex is the nation's largest home builder (having built and delivered, through its wholly-owned subsidiary Centex Real Estate Corporation d\/b\/a Centex Homes (\"CREC\" or \"Centex Homes\"), 12,964 homes in its fiscal year ended March 31, 1995). Centex's Home Building operations currently involve the construction and sale of residential housing in 289 neighborhoods in 44 different markets. These activities also include the purchase and development of land. Centex has participated in the home building business since 1950.\nCentex's Financial Services operations in fiscal 1995 included mortgage origination and other related services on homes sold by Centex subsidiaries and by third parties as well as the operation of a savings and loan. Centex has been in the mortgage banking business since 1973. Centex is a leading retail mortgage originator (originating approximately $4.2 billion of residential mortgages in fiscal 1995). In 1988 the Company acquired a savings and loan operation with eight branch offices in central Texas. The savings and loan deposits and branch operations were sold and the savings and loan was liquidated in December 1994.\nCentex entered the contracting and construction services business in 1966 with the acquisition of J.W. Bateson Company, Inc. (now known as Centex Bateson Construction Company, Inc.), a Dallas-based contractor which has been in business since 1936. Additional significant acquisitions of construction companies were made in 1978, 1982 and 1990. Centex currently ranks as the nation's largest general building contractor. The contracting and construction activities of the Company involve the construction of buildings for both private and government interests, including office, commercial and industrial buildings, hospitals, hotels, museums, libraries, airport facilities, condominiums and educational institutions.\nCentex's involvement in the construction products business started in 1963 when it began construction of its first cement plant. Since that time, this segment has expanded to include additional cement production and distribution facilities and the production, distribution and sale of aggregates, readymix concrete and gypsum wallboard. In April 1994, the\nCompany's formerly wholly-owned Construction Products group, Centex Construction Products, Inc. (CXP), completed an initial public offering of 51% of its stock, which shares are now traded on the New York Stock Exchange. CXP is the 6th largest U.S. owned cement producer and the nation's 13th largest cement producer. Centex retained a 49% interest in this group.\nIn fiscal 1988, Centex established CDC. Reference is made to PART B of this Report for a discussion of the business of CDC.\nFINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS\nNotes (B) and (I) of the Notes to Consolidated Financial Statements of Centex on pages - and - of Exhibit 99 to this Report contain additional information about the savings and loan and the Company's business segments for years ended March 31, 1995, 1994 and 1993 and are incorporated herein by reference.\nNARRATIVE DESCRIPTION OF BUSINESS\nHOME BUILDING\nThe Company's Home Building operations primarily involve the construction and sale of residential housing, including the purchase and development of land. The Company's Home Building operations have ranked, by the number of units produced in a calendar year, as the largest U.S. builder of single-family homes since 1989. Centex is also the only company to rank among Professional Builder's top 10 home builders for each of the past 26 years. Centex sells to both first time and move-up buyers. Approximately 95% of the houses Centex sells are single-family detached homes and the remainder are townhomes and low-rise condominiums.\nMarkets\nCentex follows a strategy of reducing exposure to local market volatility by spreading operations across geographically and economically diverse markets. Centex presently builds in 44 market areas in 20 states and the United Kingdom. The markets are listed below by geographic areas.\nIn fiscal 1995, Centex closed 12,964 houses, including first time, move-up and, in some markets, custom homes, ranging in price from approximately $65,000 to about $650,000, with the average sale price being approximately $159,000. In the Dallas and San Antonio locations Centex has custom home divisions which offer higher-end homes.\nSummarized below are Centex's home closings, sales (orders) backlog and sales (orders) by geographic area for each of the five fiscal years ended March 31, 1995.\nInventory Turnover\nThe Company's policy has been to acquire land with the intent to complete the sale of housing units within 24-36 months from the date of acquisition. Generally, this involves land that is properly zoned and is either ready for development or, to a much lesser degree, already developed.\nThe Company has acquired a substantial amount of its finished and partially improved lots and land under option agreements which are exercised over specified time periods, or in certain cases, as the lots are needed. The purchase of finished lots generally allows the Company to shorten the lead time to commence construction and reduces the risks of unforeseen improvement costs and volatile market conditions.\nCompetition and Other Factors\nThe residential housing industry is essentially a \"local\" business and is highly competitive. Centex competes in each of its market areas with numerous other home builders. The Company's Home Building operations account for less than 2% of the total housing starts in the United States. The main competitive factors affecting Centex's Home Building operations are location, price, cost of providing mortgage financing for customers, construction costs, design and quality of homes, marketing expertise, availability of land and a builder's reputation. Management believes the Company competes effectively by maintaining geographic diversity, being responsive to the specific demands of each market and managing the operations at a local level.\nThe home building industry is cyclical and is particularly affected by changes in local economic conditions and in long-term and short-term interest rates and, to a lesser extent, changes in property taxes and energy costs, federal income tax laws, federal mortgage financing programs and various demographic factors. The political and economic environment affects both the demand for housing constructed by the Company and the Company's cost of financing. Unexpected climatic conditions, such as unusually heavy or prolonged rain or snow, may affect operations in certain areas.\nThe housing industry is subject to extensive and complex regulations. The Company and its subcontractors must comply with various federal, state and local laws and regulations including zoning, building, environmental, advertising and consumer credit rules and regulations. The Company is also subject to other rules and regulations in connection with its manufacturing and sales activities, including requirements as to building materials to be used and building designs. The Company's homes are inspected by local authorities.\nThe Company's Home Building operations are subject to numerous federal, state and local regulatory schemes concerning, among other things, worker health and safety, zoning, building design, construction materials, and the extensive and changing federal, state and local laws, regulations and ordinances governing the protection of the environment (\"Environmental Laws\"), including protection of endangered species. All of the foregoing regulatory requirements are applicable to all home building companies, and to date, compliance with the foregoing requirements has not had a material impact on the Company. The Company believes that it is in material compliance with all such requirements.\nCentex has numerous suppliers of all the materials and services and sources of lots and land used in home building and believes that it can deal effectively with any problems it may experience relating to the supply of materials and services as well as lots and land.\nVista Acquisition\nIn December 1994, Centex International, Inc., a wholly-owned subsidiary of Centex Corporation, entered into an agreement with Dallas-based Vista Properties, Inc. under which it would acquire equity interests in Vista and in its affiliated partnership, Vista Partners, as part of a proposed prepackaged bankruptcy structuring by Vista. For an investment of approximately $70 million, Centex would acquire an ownership in a portfolio\nof properties, comprising over 4,000 acres in seven states. The land is zoned, planned or developed for: single- and multi-family residential, office and industrial, and retail and commercial. The acquisition would provide Centex with future residential sites in several of its existing markets as well as opportunities in retail, industrial and office segments. The transaction is expected to be completed during the summer of 1995, subject to the satisfaction of the condition stated in the agreement, including approval from Vista's securityholders and bankruptcy court approval.\nUnited Kingdom Joint Venture\nIn February 1995, Centex announced its wholly-owned subsidiary, Centex Homes (UK) Limited, had entered into a joint venture agreement with a London-area home builder, The Charles Church Group Limited (\"Charles Church\"), to build homes in the United Kingdom. The venture is the first entry into the international home building marketplace for Centex Homes. Centex Homes (UK) Limited and Charles Church each are contributing $3 million in cash, with the remaining $9 million financed by a United Kingdom bank, which is guaranteed by Centex Homes. In addition, Centex Homes will transfer some personnel to the United Kingdom to work with the venture.\nThe new operation, Charles Church Homes Limited, acquired its first parcel of undeveloped land in Berkshire County, west of London. Located in Sunningdale, the parcel consists of 2.1 acres. Homes in the 3,500-4,000 square foot range, which will sell for approximately $750,000, should be ready for occupancy late in calendar 1995. Several other potential sites in the London area are currently being evaluated.\nFINANCIAL SERVICES\nFinancial Services consist of mortgage banking and, until December 1994, the savings and loan operations. The Company's mortgage banking activities are conducted through Centex's wholly-owned subsidiary, CTX Mortgage Company (\"CTX\"), which offers mortgage origination and other related services on homes sold by Centex Homes and by third parties. The savings and loan activities which were conducted through Texas Trust Savings Bank, FSB were sold in December 1994.\nCTX Mortgage Company\nCTX was created in 1973 to provide mortgage financing for homes built by Centex Homes, Centex's home building operation. The establishment by CTX of mortgage offices in substantially all of Centex Homes' housing markets has enabled it to consistently provide mortgage financing for an average of 73% of the homes built by Centex Homes (\"Builder Loans\") over the past five years. In 1985, CTX expanded its operations to include third-party loans (\"Spot Loans\") that are not associated with the sale of homes built by Centex. At March 31, 1995, CTX had 110 offices located in 23 states. The offices vary in size depending on volume in each locality.\nDuring the 1995 fiscal year, due to the increase in mortgage rates and the related decline in refinancings, CTX downsized its operations. The division's operating locations and personnel were reduced by approximately 40%. CTX is updating and expanding its mortgage banking systems, including reautomating its accounting and loan delivery functions. This process will continue during fiscal 1996.\nThe unit breakdown of Builder and Spot Loans for the five years ended March 31, 1995 are set forth in the following table:\nCTX provides mortgage origination and other mortgage related services for Federal Housing Administration (\"FHA\"), Veterans Administration (\"VA\") and conventional loans on homes built and sold by the Company or by others. The Company's mortgage loans are first-lien mortgages secured by 1-4 family residences. A majority of the conventional loans are conforming loans which qualify for inclusion in guaranteed programs sponsored by Fannie Mae (\"FNMA\") or Freddie Mac (\"FHLMC\"). The remainder of the conventional loans are pre-approved and individually underwritten by private investors who purchase such loans on a whole-loan basis for their investment portfolios.\nThe principal sources of income from CTX's mortgage banking business are: loan origination fees; revenues from sale of servicing rights; positive carry (discussed below); and marketing gains and losses. Generally, CTX sells its right to service the mortgage loans to various loan servicing companies, therefore, it retains no mortgage servicing rights. Accordingly, CTX avoids the risk of early payoffs and foreclosures. CTX enters into various financial agreements, in the normal course of business, in order to manage the exposure to changing interest rates as a result of having issued loan commitments to its customers at a specified price and period, committing to sell mortgage loans to various investors. By immediately selling the mortgages for future delivery, substantially all interest rate risk is removed at the time of closing.\nCTX borrows money at short-term rates to fund its mortgage loans. During the 30-to-60 day period between the closing of a loan and delivery of such loan to the purchaser, CTX earns the interest accrued on the mortgage, which is normally a higher interest rate than the rate paid on the short-term loans used to fund the mortgage during this 30-to-60 day holding period. This positive spread between the long-term interest rate earned and the short-term interest rate paid is referred to as \"positive carry\", and generally represents a major source of income.\nCompetition and Other Factors\nThe mortgage banking industry in the United States is highly competitive. CTX competes with other mortgage banking companies as well as financial institutions to supply mortgage financing at attractive rates to purchasers of Centex homes as well as to the general public. Mortgage Banking results in fiscal 1995 were negatively impacted by an increasingly competitive environment. Rapidly rising interest rates commencing in February 1994, virtually stopped refinancing activity and caused consumers to shift from more profitable fixed-rate mortgages to lower-margin adjustable rate products.\nCTX is subject to the rules and regulations of, and examinations by, the Federal National Mortgage Association (\"FNMA\"), the Federal Home Loan Mortgage Corporation (\"FHLMC\"), the Department of Veterans' Affairs (\"VA\"), the Federal Housing Administration (\"FHA\"), the Government National Mortgage Association (\"GNMA\") and state regulatory authorities with respect to originating, processing, underwriting, making, selling, securitizing and servicing residential mortgage loans. In addition, there are other federal and state statutes and regulations affecting such activities. These rules and regulations, among other things, impose licensing obligations on CTX, establish eligibility criteria for mortgage loans, provide for inspection and appraisals of properties, regulate payment features and, in some cases, fix maximum interest rates, fees and loan amounts. CTX is required to maintain specified net worth levels by, and submit annual audited financial statements to FHA, VA, FNMA, FHLMC and GNMA and certain state regulators. CTX's affairs are also subject to examination by the Federal Housing Commissioner at all times to assure compliance with FHA regulations, policies and procedures. Among other federal and state consumer credit laws, mortgage origination and servicing activities are subject to the Equal Credit Opportunity Act, the Federal Truth-In-Lending Act, the Real Estate Settlement Procedures Act (\"RESPA\") and the regulations promulgated under such statutes which prohibit discrimination and unlawful kickbacks and referral fees and require the disclosure of certain information to borrowers concerning credit and settlement costs. Many of these regulatory requirements are designed to protect the interest of consumers, while others protect the owners or insurers of mortgage loans. Failure to comply with these requirements can lead to loss of approved status, demands for indemnification or loan repurchases from investors, class action lawsuits by borrowers, administrative enforcement actions and, in some cases, rescission or voiding of the mortgage loan by the mortgagor.\nOther financial-related services provided by CTX affiliates include acting as an agent for the issuance of homeowners' insurance policies, title insurance policies and escrow services. CTX Insurance Agency provides hazard insurance to home buyers in Texas and Florida through third party insurance companies. During fiscal 1994, CTX opened its first commercial loan operation. In the current fiscal year, CTX entered into a joint venture agreement with another homebuilder to provide mortgage origination for homes built by this homebuilder. In addition, during fiscal 1995, an affiliate of CTX entered the second lien market whereby this CTX affiliate will originate second mortgages for home improvements and home equity lines of credit. The affiliate utilizes CTX's branch network and telemarketing to solicit potential customers.\nSavings and Loan\nIn December 1988, Centex purchased certain assets and assumed certain liabilities of four Texas savings and loan associations under the Federal Savings and Loan Insurance Corporation's assisted transactions process commonly known as the \"Southwest Plan\". The acquisition was made by Texas Trust Savings Bank, FSB (\"Texas Trust\"), a federal stock savings bank and subsidiary of CTX Holding Company (\"CTX Holding\"), a wholly-owned subsidiary of Centex. The acquisition was made pursuant to acquisition agreements and an assistance agreement (the \"Assistance Agreement\") with the Federal Savings and Loan Insurance Corporation (the \"FSLIC\").\nDuring December 1994, Texas Trust negotiated an early termination of the Assistance Agreement with the Federal Deposit Insurance Corporation (\"FDIC\") (as successor to the FSLIC). On December 30, 1994 Texas Trust's eight branch facilities were sold to a financial institution and all deposit liabilities were assumed by the purchaser. On the same day, immediately following the branch sale, Texas Trust was dissolved, thereby completing Centex's exit from the savings and loan industry.\nCONTRACTING AND CONSTRUCTION SERVICES\nCentex's contracting and construction services work is performed nationwide. As a group, Centex's Contracting and Construction Services subsidiaries rank as one of the largest building contractors in the country as well as one of the largest U.S. - owned construction groups. The Construction Group is made up of seven firms with various geographic locations and project niches. The overall group is heavily weighted towards health care facility construction which represents nearly 40% of its mix. New contracts for fiscal 1995 totaled $1.15 billion versus $1.03 billion for fiscal 1994. The backlog of uncompleted contracts at March 31, 1995 was $1.33 billion, compared to $1.24 billion at March 31, 1994. The group's principal subsidiaries are as follows:\nCENTEX BATESON CONSTRUCTION COMPANY, INC. - This Dallas-based contractor (acquired in 1966) has become one of the nation's larger general contractors specializing in government and competitively bid jobs. Its projects are nationwide.\nCENTEX-ROONEY CONSTRUCTION COMPANY, INC. - This Ft. Lauderdale-based subsidiary was acquired in 1978 and is one of the largest general contractors in the state of Florida. It operates primarily in Florida and handles predominantly negotiated work for private owners.\nCENTEX GOLDEN CONSTRUCTION COMPANY - This company (acquired in fiscal 1982) operates in the San Diego, Los Angeles and Northern California markets, handling both negotiated and competitively bid work.\nCENTEX-SIMPSON CONSTRUCTION COMPANY - This contractor (organized in 1966) is based in the Washington D. C. area and is engaged primarily in competitive bid work for the public sector.\nCENTEX-RODGERS CONSTRUCTION COMPANY - This company (organized in 1987) is headquartered in Nashville, Tennessee, and is active nationally in the private medical construction services market.\nCENTEX GREAT SOUTHWEST CORPORATION - This subsidiary (acquired in 1978) builds principally in the Tampa and Orlando areas and is a leading builder of airport terminals.\nCENTEX FORCUM LANNOM, INC. - This industrial contracting company (acquired in 1990) is located in Dyersburg, Tennessee and operates in Tennessee and surrounding states.\nAs a general contractor or construction manager, Centex provides the supervisory personnel for the construction of the building or facility. In addition, Centex may perform varying amounts of the actual construction work on a project, but will generally hire subcontractors to perform the majority of the work. As a result, the Company's Contracting and Construction Services operation requires a relatively small asset base.\nConstruction contracts are primarily entered into under two formats: competitively bid and negotiated jobs. In a competitively bid format, Centex will bid a fixed amount for which it will agree to construct the project based on an evaluation of detailed plans and specifications. In a negotiated job, the contractor bids on a fixed fee over the cost of the project and, in many instances, agrees that the final cost will not exceed a designated amount. Such contracts may include a provision whereby the owner will pay a part of any savings from the guaranteed amount to the contractor. The Company's highest margins in contracting operations have historically been on competitively bid jobs. Currently, the margins on competitive bid and negotiated jobs are about equal. On average, about half of Centex's projects are competitively bid, public jobs and the other half are negotiated contracts with private owners. The Company's public work for federal, state and local governments includes hospitals, jails, airports, parking garages, office buildings, military facilities, post offices and convention and performing arts centers. Most of Centex's private owner contracts are for hotels, medical facilities and office buildings, plus some shopping centers and condominiums.\nCompetition and Other Factors\nThe construction industry has become increasingly competitive, and Centex competes with numerous other companies. With respect to competitively bid projects, Centex generally competes for projects throughout the United States and with local, regional or national contractors, depending upon the nature of the project. For negotiated projects, Centex's subsidiaries compete primarily in the general geographical area where they are located and with other local, regional and national contractors. Centex solicits new projects by attending project bid meetings and meeting with builders and owners and through existing customers. Centex competes successfully on the basis of its reputation and financial strength.\nThe Company's Contracting and Construction Services operations are affected by federal, state and local laws and regulations relating to worker health and workplace safety as well as Environmental Laws. With respect to health and safety matters, the Company believes that appropriate precautions are taken to protect employees and others from\nworkplace hazards. Current Environmental Laws may require the Company's operating subsidiaries to work in concert with project owners to acquire the necessary permits or other authorizations for certain activities, including the construction of projects located in or near wetland areas. The Company's Contracting and Construction Services operations are also affected by Environmental Laws regulating the use and disposal of hazardous materials encountered during demolition operations.\nThe Company believes that the Contracting and Construction Services group's current procedures and practices are consistent with industry standards and that compliance by the Construction Group with the health and safety laws and Environmental Laws does not constitute a material burden or expense for the Company.\nThe Company's Contracting and Construction Services operations obtain materials and services from numerous sources. The Company believes that its construction companies can deal effectively with any problems they may experience in the supply of materials and services.\nEMPLOYEES\nThe breakdown of employees by line of business as of March 31, 1995 is presented in the following table:\nThe following is a summary of average balances and average interest rates for the periods ended December 31, 1994, March 31, 1994 and 1993.\nTEXAS TRUST SAVINGS BANK, FSB AVERAGE BALANCES AND INTEREST RATES ($ IN THOUSANDS)\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\n(a) Holding\nDue to the nature of its business, Holding does not own or hold for investment any real or personal properties other than cash, receivables and other similar assets, and the securities relating to its subsidiary, Development.\n(b) CDC\nThe remaining Original Properties and the Additional Properties consist of properties located in Illinois, Texas, New Jersey, Florida and California. Such properties predominantly consist of undeveloped sites zoned for light industrial, agricultural, general retail, office industrial, business park, research and development and single- and multi-family residential property purposes.\nAt March 31, 1995, there were four remaining Original Properties and one Additional Property owned by CDC of material value. Set forth below is a brief description, including the present zoning therefor, of such properties.\nColony South Planning Unit. Colony South Planning Unit is an Original Property and is located in suburban Dallas, Texas in the cities of The Colony (approximately 520 acres) and Lewisville (approximately 152 acres). The Colony acreage is zoned office, general retail, business park and residential. The Lewisville acreage is zoned light industrial.\nEast Windsor. East Windsor is an Original Property comprising approximately 600 acres with four separate residential tracts, 13 farm parcels and 100 acres of office industrial zoned property in East Windsor, New Jersey, a township located in the vicinity of Princeton. The residential tracts have final plan approval for a total of 75 half-acre lots and 174 quarter-acre lots and preliminary plan approval for 426 multi-family units. Forty-eight of the quarter-acre lots have been sold to CREC, which has a contract with CDC to purchase the remaining 126. The farm parcels vary in size from 11 to 35 acres and total 313 acres.\nBryan Place. Bryan Place is an Original Property and is located in Dallas, Texas just east of downtown and Central Expressway. It is comprised of 28 non-contiguous parcels zoned office, commercial, retail and residential ranging from approximately 2,000 square feet to 80,000 square feet. The total area of the property is approximately 622,000 square feet.\nCarrollton Property. The Carrollton Property is an Original Property located in the City of Carrollton, a suburb of Dallas, Texas. This property consists of one office and five fabrication-warehouse buildings on approximately 17 acres, zoned industrial, with a rail spur.\nForster Ranch. Forster Ranch, located in San Clemente, California, is an Additional Property that included 1,077 acres when it was purchased in March 1989. CDC's Development Agreement with the City of San Clemente allows a series of residential villages containing a total of approximately 2,200 lots and 78 acres of mixed use property. As of March 31, 1995, 580 of these lots had been sold to CREC and 21 acres of mixed use property had been sold to other entities. CDC has entered an agreement with the holder of the Forster Ranch non-recourse purchase money notes that may result in the transfer of the real estate to it in satisfaction of the debt, a portion of which is past due. The lender in turn may sell the real estate to CREC pursuant to an agreement between them.\nRecent Write-Down of Properties. In March 1995, CDC recorded a pre-tax adjustment to reduce the book value of certain properties in the amount of approximately $15,500,000 to reflect CDC's view that development activity has not reached anticipated levels during the current economic cycle in order to continue to support the historical carrying value of such properties. This adjustment results in carrying values that will facilitate a nearer-term disposition or development of these properties. A substantial portion of the adjustment related to the book values of the Colony South Planning Unit and Bryan Place properties.\nCDC's principal assets consist of the Original Properties and the Additional Properties remaining unsold.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nHolding is not a party to, and its assets are not the subject of, any material pending legal proceedings. CDC may be involved from time to time in litigation matters incident to its day-to-day business; however, management of Development believes that such litigation, if determined unfavorably to CDC, would not have a material adverse effect on the financial condition or operations of CDC.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\nEXECUTIVE OFFICERS OF HOLDING AND DEVELOPMENT\nInformation concerning the present executive officers of Holding is set forth below. All of such officers have served in their capacities since the organization of Holding, except as indicated. CDC has no executive officers. The executive officers of Holding set forth below hold the same offices in Development, the general partner of CDC, as disclosed in \"Item 10. Directors and Executive Officers of the Registrant-Directors and Executive Officers of Development\".\n(1) Mr. Bilheimer is an employee of Centex Development Management Company (\"CDMC\"), a wholly-owned subsidiary of Centex, and served as Executive Vice President of CREC from April 1987 until March 31, 1988. Mr. Bilheimer was a director of Development from its date of incorporation until his resignation as of June 1, 1987 and was re-elected to the Board of Directors of Development on May 24, 1989. Since April 1, 1988, Mr. Bilheimer has devoted a majority of his time to the business and affairs of Holding and Development.\n(2) Mr. Sefzik is an employee of CDMC and was a Vice President of CTX Mortgage Company from May 1987 to March 1988 and Executive Vice President of Centex Title Company from July 1986 to March 1988. Prior thereto\nhe held various offices with various Centex subsidiaries since March 1983. Mr. Sefzik was elected to his present positions with Holding as of April 1, 1988. Since April 1, 1988, Mr. Sefzik has devoted a majority of his time to the business and affairs of Holding and Development.\n(3) Mr. Arcisz is an employee of CDMC and was a Division President of CREC, a wholly-owned subsidiary of Centex, from October 1985 until February 28, 1995. Prior thereto he held various offices with CREC since April 1983. Mr. Arcisz was elected to his present position with Holding as of March 10, 1995. Since March 1, 1995, Mr. Arcisz has devoted a majority of his time to the business and affairs of Holding and Development.\nAll executive officers of Holding are elected annually by the Board of Directors to serve until the next annual meeting of the Board of Directors or until their successors have been duly elected. There are no family relationships among or between such executive officers or the directors. Holding's executive officers hold the same positions with its subsidiary, Development.\nHolding has no full time employees. The directors and executive officers perform all executive management functions; all other services necessary to the conduct of Holding's business are performed by employees of a subsidiary of Centex or its designee under a services agreement. See \"Item 10. Directors and Executive Officers of the Registrant--Services Agreement\".\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANTS' COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\n(a) Holding\nExcept as additionally provided below, the information called for by this Item 5 with respect to Holding is incorporated herein by reference to (1) the Joint Explanatory Statement on page 2 of this Report, (2) the information included and referenced under the caption \"Stock Prices and Dividends\" on page of Exhibit 99 to this Report and (3) the information included in Notes (F) and (G) of the Notes to the Holding\/CDC Combining Financial Statements on pages - of Exhibit 99 to this Report.\nPrior to the date of the distribution, Centex owned all of the issued and outstanding shares of Holding Common Stock and, accordingly, there was no public market for such shares. Following the distribution by Centex, shares of Holding Common Stock have been tradeable only in tandem with, and as a part of, shares of Centex Common Stock, and may not be separately sold or otherwise transferred. Therefore, except with respect to the trading market established for the tandem traded securities, there is no separate market for shares of Holding Common Stock. Because of the tandem trading arrangement, it is not possible to identify precisely the portion of the market price of the tandem traded securities allocable to shares of Holding Common Stock.\nThe restrictions on the transfer of the Holding Common Stock and the Stockholder Warrants separate from Centex Common Stock are imposed by the terms of a nominee agreement (the \"Nominee Agreement\") among Centex, Holding, CDC and the Nominee. Centex Common Stock certificates issued after the date of the Nominee Agreement bear a legend referring to the restrictions on transfer imposed thereby.\nNo dividends have been paid on shares of Holding Common Stock since the incorporation of Holding. Future cash dividends on Holding Common Stock will depend on the earnings, financial condition, capital requirements and other factors affecting Holding and Development.\nThe provisions of the loan agreement and pledge and security agreement relating to Holding's $7,700,000 note to Centex (the \"Holding Note\"), which had a balance of $7,600,000 at March 31, 1995, include certain restrictive covenants that limit the extent to which Holding and its subsidiaries (including Development but not CDC or any Operating Partnership) may create, assume or guarantee additional indebtedness, pledge or encumber certain of their assets or otherwise take certain corporate actions. These covenants include limitations on (a) incurring, assuming or guaranteeing any other indebtedness, except indebtedness which provides for all payments of principal to be made after April 1, 1994, indebtedness that is fully and completely subordinated on terms satisfactory to Centex, and certain trade debt, (b) creating any additional liens other than statutory liens for taxes, certain mechanics' and materialmen's liens and other similar liens, (c) effecting a merger or consolidation, (d) selling property and (e) declaring any dividends or making certain other shareholder payments, as defined. Holding's obligations under the Holding Note are secured by a pledge of all of the issued and outstanding shares of the common stock of Development pursuant to a pledge and security agreement under which a default by Holding in the performance of its obligations could give Centex the right to vote such shares, to seek the registration under the Securities Act of 1933, as amended, of all or a portion thereof, and to sell such shares to satisfy Holding's obligations. See \"Item 13. Certain Relationships and Related Transactions\" and Note (G) of the Notes to the Holding\/CDC Combining Financial Statements included on page of Exhibit 99 to this Report, which is incorporated herein by reference.\n(b) CDC\nExcept as additionally provided below, the information called for by this Item 5 with respect to CDC is included herein in (1) the Joint Explanatory Statement on page 2 of this Report, (2) the information included and referenced under the caption \"Stock Prices And Dividends\" on page of Exhibit 99 to this Report and (3) the information included in Notes (F) and (G) of the Notes to the Holding\/CDC Combining Financial Statements on pages - of Exhibit 99 to this Report.\nThe Stockholder Warrants were issued to Centex immediately prior to the November 30, 1987 distribution to Centex Stockholders and, accordingly, there was no public market for the Stockholder Warrants prior to the distribution. Following the distribution by Centex, the Stockholder Warrants have been tradeable only in tandem with, and as part of, shares of Centex Common Stock, and may not be separately sold or otherwise transferred. Therefore, except with respect to the trading market established for the tandem traded securities, there is no separate market for the Stockholder Warrants. Because of the tandem trading arrangement, it is not possible to identify precisely the portion of the market price of the tandem traded securities allocable to the Stockholder Warrants.\nThe restrictions on the transfer of the Stockholder Warrants and the Holding Common Stock separate from Centex Common Stock are imposed by the terms of a nominee agreement (the \"Nominee Agreement\") among Centex, Holding, CDC and the Nominee. Centex Common Stock certificates issued after the date of the Nominee Agreement bear a legend referring to the restrictions on transfer imposed thereby.\nNo dividends or distributions have been made on the Stockholder Warrants since their issuance.\nCREC, a subsidiary of Centex, is the present holder of all of the Class A Units, and accordingly, at this time there is no public market for such securities. See \"Item 1. Business--General Development of Business\". CDC has not made any payment to the holder of the Class A Units with respect to the Preferred Return during the last four fiscal years. Preference payments in arrears at March 31, 1995 amounted to $35,818,000.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\n(a) Holding\nThe information called for by this Item 6 with respect to Holding is incorporated herein by reference to the Combining Balance Sheets and the Combining Statements of Operations included in the Holding\/CDC Combining Financial Statements on pages - of Exhibit 99 to this report.\n(b) CDC\nThe information called for by this Item 6 with respect to CDC is incorporated herein by reference to the Combining Balance Sheets and the Combining Statements of Operations included in the Holding\/CDC Combining Financial Statements on pages - of Exhibit 99 to this report.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\n(a) Holding\nThe information called for by this Item 7 with respect to Holding is incorporated herein by reference to the information included and referenced under the caption \"Management's Discussion and Analysis of Results of Operations and Financial Condition\" on page of Exhibit 99 to this report.\n(b) CDC\nThe information called for by this Item 7 with respect to CDC is incorporated herein by reference to the information included and referenced under the caption \"Management's Discussion and Analysis of Results of Operations and Financial Condition\" on page of Exhibit 99 to this report.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe information called for by this Item 8 is incorporated herein by reference to Exhibit 99 to this report as set forth in the Index to Financial Statements on page 35 to this Report (see Item 14).\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\n(a) Holding\nDIRECTORS AND EXECUTIVE OFFICERS OF HOLDING\nExcept as additionally provided below, the information called for by this Item 10 with respect to Holding is incorporated herein by reference to the information included under the caption \"Election of Directors\" on page 25 and the information included under the caption \"Section 16(a) Compliance\" on page 29 of Holding's proxy statement dated June 15, 1995 for the 1995 Annual Meeting of Stockholders of Holding to be held on July 27, 1995 (the \"1995 Holding Proxy Statement\"); however, as required by Instruction 3 to Item 401(b) of Regulation S-K, information regarding executive officers of Holding is included under the caption \"Executive Officers of Holding\" included in Part B of this Report following Item 4.\nSERVICES AGREEMENT\nHolding has no full time employees. The directors and executive officers of Holding, who hold the same directorships and offices in Development, perform all executive management functions. See \"Item 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nHolding and CDC\nThe information called for by this Item 11 with respect to Holding and CDC is incorporated herein by reference to the information included and referenced under the caption \"Executive Compensation\" in the 1995 Holding Proxy Statement on pages 27-28 thereof.\nCDC does not have any directors, officers or employees, and is managed by its sole general partner, Development. Except for the allocations of profit and loss and distributions of cash and other property to which Development is entitled under the Partnership Agreement, and except for the right to be reimbursed for certain expenses, Development does not receive any compensation from CDC in respect of its duties and obligations as general partner for CDC. As general partner, Development is entitled to be allocated certain items of income and loss of CDC and to receive certain distributions of cash from CDC depending upon the level of income and cash available for distribution and whether Payout has occurred. The terms and conditions upon which Development will be allocated items of income and loss and will receive distributions are set forth in the Partnership Agreement. For a summary of these rights and benefits, see Note (F) of the Notes to the Holding\/CDC Combining Financial Statements included on page of Exhibit 99 to this report, which is incorporated herein by this reference.\nThe directors and executive officers of Development perform all executive management functions for CDC. See \"Item 10. Directors and Executive Officers of the Registrant\". Services required by CDC in its operations are also provided pursuant to a Management Agreement with Holding pursuant to which Holding operates, manages and develops the properties of CDC for and on behalf of CDC. See \"Item 11 - -Directors and Executive Officers of the Registrant--Management Agreement\". The executive officers of Development did not receive any remuneration from Development or CDC for the year ended March 31, 1995. Directors of Development who are neither officers nor employees of Development, Centex or Centex's subsidiaries received compensation from Development in the form of directors' and committee members' fees. During the 1995 fiscal year, each executive officer of Development received remuneration from Centex or one of its subsidiaries in his capacity as a director, officer or employee thereof. None of the directors or executive officers of Development received any additional compensation from Centex or any of its subsidiaries\nfor services rendered on behalf of Development or CDC during the 1995 fiscal year.\nDuring fiscal 1995, J. Stephen Bilheimer, a Director and the President of Development, and Roger D. Sefzik, Vice President and Treasurer of Development, both of whom are employees of subsidiaries of Centex, have devoted a majority of their time and attention to the management of Development and Holding. Messrs. Bilheimer and Sefzik provided such services to Development on behalf of and in their capacities as officers of Holding pursuant to the Management Agreement. Each current executive officer of Development continues to receive remuneration from Centex or one of its subsidiaries in his capacity as an officer or employee thereof and is not compensated by Development or CDC. As of March 10, 1995, Joseph J. Arcisz joined Holding as a Vice President. It is expected that during fiscal year 1996, he will devote a majority of his time to Development and Holding.\nThe directors of Development, who also hold the same directorships in Holding and are neither officers nor employees of Development, Centex or Centex's subsidiaries, each receive approximately $8,000 annually in the form of directors' and committee members' fees in their capacities as directors and\/or committee members of Development. In addition, Development reimburses these directors for the reasonable expenses incurred in attending directors' and committee meetings.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\n(a) Holding\nThe information called for by this Item 12 with respect to Holding is incorporated herein by reference to the information included and referenced under the caption \"Security Ownership of Management and Certain Beneficial Owners\" in the 1995 Holding Proxy Statement on pages 26-27.\n(b) CDC\nThe following table sets forth certain information with respect to the ownership of the equity securities of CDC as of December 31, 1994 by Development, the directors of Development, individually itemized, all directors and executive officers of Development as a group, and any person known to CDC to be the beneficial owner of more than 5% of any class of CDC's equity securities. Except as otherwise indicated, all securities are owned directly, and the beneficial owner of such securities has the sole voting and investment power with respect thereto.\n- -------------------- *Under the terms of the Partnership Agreement, CDC is managed by a sole corporate general partner and none of the present classes of CDC's securities are \"voting securities\" within the meaning of the rules and regulations of the Commission promulgated pursuant to the Exchange Act. Nonetheless, information with respect to each class of CDC's equity securities has been set forth in accordance with such rules and regulations.\n**The address of any person who is the beneficial owner of more than five percent of a class of CDC's securities is also included.\n***Less than 1%.\n(1) In connection with the formation of CDC, Development made a capital contribution to CDC of $767,182, in exchange for Development's general partner interest in CDC. As general partner, Development is entitled to receive allocations\nof income and loss and distributions of property from CDC. See \"Item 11. Executive Compensation\".\n(2) The Class A Units were issued to the Original Limited Partners in exchange for the contribution to CDC of the Original Properties. Record title to the Class A Units presently is held by CREC, a subsidiary of Centex. See \"Item 1. Business--General Development of Business\". As of the date or dates when the Stockholder Warrants are deemed to have been exercised, the Class A Units will be automatically converted into (i) a number of Class B Units equal to 20% of the total number of Class B Units that would be outstanding after conversion based on the actual exercise of the Stockholder Warrants and the assumed exercise of all the then exercisable Centex Class B Unit Warrants (see footnote (3)) and (ii) a like number of Class A Units. The Class A Units will be automatically cancelled upon Payout and the exercise and\/or expiration of all of the Stockholder Warrants and the Centex Class B Unit Warrants.\n(3) The Nominee holds record title to the Stockholder Warrants, which are exercisable for Class B Units, for the benefit of Centex Stockholders pursuant to the Nominee Agreement. See \"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters\". However, the Nominee has no power to vote the Class B Units issuable upon exercise of the Stockholder Warrants or to direct the investment of the Stockholder Warrants or such Class B Units. Beneficial ownership of the Stockholder Warrants is, by virtue of the Nominee arrangement, indirect and undivided. The number of Stockholder Warrants listed as beneficially owned has been rounded to the nearest whole warrant and is based on the assumption that options to purchase Centex Common Stock, presently exercisable, or exercisable within 60 days, have been exercised. The Class B Units issuable upon exercise of the Stockholder Warrants have not been shown as \"beneficially owned\" under the rules and regulations of the Commission promulgated pursuant to the Exchange Act because the beneficial owners of the Stockholder Warrants have no present right to exercise the Stockholder Warrants and acquire Class B Units.\n(4) Centex has received information from FMR Corp. (\"FMR\") stating that, as of December 31, 1994, FMR may be deemed to beneficially own 4,611,272 shares of Centex Common Stock, (and therefore to own a beneficial interest in 161 Stockholder Warrants) acquired solely for investment purposes, as a parent holding company with respect to holdings of wholly-owned investment adviser subsidiaries of FMR or other entities affiliated with FMR. FMR stated that it held 145,684 shares of Centex Common Stock with sole voting power (and therefore held a beneficial interest in 5 Stockholder Warrants with sole voting power), 156,284 shares of Centex Common Stock with sole dispositive power (and therefore held a beneficial interest in 5 Stockholder Warrants with sole dispositive power), 10,600 shares of Centex Common Stock with no power to vote (and therefore held a beneficial interest in 0 Stockholder Warrants with no power to vote), and no shares with shared voting power. The remaining shares (and therefore Stockholder Warrants) that FMR may beneficially own may be voted by (i) the Board of Trustees of certain Fidelity Funds, or (ii) certain institutions whose funds are managed by Fidelity Management Trust Company, a wholly-owned subsidiary of FMR.\n(5) Centex has received information from The Prudential Insurance Company of America (\"Prudential\") stating that, as a result of shares of Centex Common Stock held by Prudential for the benefit of its clients by its separate accounts, externally managed accounts, registered investment companies, subsidiaries and\/or other affiliates, as of December 31, 1994, Prudential may be deemed to beneficially own 1,789,100 shares of Centex Common Stock (and therefore to own a beneficial interest in 62 Stockholder Warrants). Prudential stated that it held 331,300 shares of Centex Common Stock with sole voting and dispositive power (and therefore held a beneficial interest in 12 Stockholder Warrants with sole voting and dispositive power, 1,456,900 shares of Centex Common Stock with shared voting power (and therefore held a beneficial interest in 51 Stockholder Warrants with shared voting power), and 1,457,800 shares of Centex Common Stock with shared dispositive power (and therefore held a beneficial interest in 51 Stockholder Warrants with shared dispositive power).\n(6) On November 30, 1987, Centex acquired from CDC 100 warrants (the \"Centex Class B Unit Warrants\") to purchase a like number of Class B Units, subject to adjustment, pursuant to an agreement for purchase of warrants. The Centex Class B Unit Warrants are generally in the same form as, and contain the same terms as, the Stockholder Warrants, except for the manner in which they may be subdivided (and the corresponding exercise price) and the applicable exercise period. See Note (F) of the Notes to the Holding\/CDC Combining Financial Statements included on page of Exhibit 99 to this report, which is herein incorporated by this reference.\n(7) Presently, there are no Class B Units issued or outstanding.\n(8) When issued, record title to 200 of these Class B Units will be held by the owners of the Class A Units. See footnote (2).\n(9) The Class B Units that may be acquired upon conversion of outstanding Class A Units as of the date of the exercise of\nthe Stockholder Warrants, which date Centex may indirectly determine by virtue of its ability, in its sole and absolute discretion, to determine the date of detachment of the Stockholder Warrants from Centex Common Stock, and the Class B Units that may be acquired upon exercise of the Centex Class B Unit Warrants are included as \"beneficially owned\" pursuant to the rules and regulations of the Commission promulgated pursuant to the Exchange Act. See footnotes (2) and (3). The number of Class B Units and the percentage of class listed assume that the Stockholder Warrants and the Centex Class B Unit Warrants have been exercised in full for Class B Units but that no subdivision of any of the warrants has occurred; however, both the Stockholder Warrants and the Centex Class B Unit Warrants may be subdivided or combined and any such subdivision or combination would necessarily change the number of Class B Units beneficially owned and the percent of class represented thereby.\nAll of the issued and outstanding shares of Development have been pledged to secure the Holding Note. See \"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters\".\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\n(a) Holding\nThe information called for by this Item 13 with respect to Holding is incorporated herein by reference to the information included under the caption \"Certain Transactions\" in the 1995 Holding Proxy Statement on pages 29-30.\n(b) CDC\nHolding entered into a services agreement in May, 1987 with Centex Service Company (\"CSC\"), whereby CSC will provide certain tax, accounting and other similar services for Holding at a fee of $2,500 per month. Service fees of $30,000 were paid pursuant to this agreement for fiscal year 1995.\nCDC has entered into an agreement with Holding for it to provide management services to CDC in connection with the development and operation of properties acquired by CDC, maintenance of CDC property, and accounting and clerical services. Management fees and development costs totaling $922,000 were incurred in fiscal 1995.\nIn connection with Holding's acquisition of additional shares of common stock of Development in 1987, Holding borrowed $7,700,000 from Centex pursuant to a secured promissory note (the \"Holding Note\"). The Holding Note, which had a fluctuating balance during 1995, bears interest, payable quarterly, at the prime rate of interest of NationsBank of Texas, N.A. (\"NationsBank\") plus 1% (10% at May 30, 1995). As of May 30, 1995, the outstanding principal balance of the Holding Note was $5,927,000. The Holding Note is secured by a pledge of all of the issued and outstanding shares of Development. The Holding Note, as amended, matures on the earlier to occur of April 1, 1996 or the last detachment of Holding Common Stock and the Stockholder Warrants from Centex Common Stock pursuant to the Nominee Agreement. There was interest expense of $611,000 related to the Holding Note for the year ended March 31, 1995.\nIn fiscal year 1995, CDC sold to CREC 254 lots for $5,423,000. CREC has contracts to purchase an additional 364 lots from CDC.\nIn 1987, Development loaned $7,700,000 to CREC, pursuant to an unsecured note (the \"CREC Note\") and related loan agreement. The CREC Note bears interest, payable quarterly, at the prime rate of interest of NationsBank plus 7\/8% (9 7\/8% at May 30, 1995). As of May 30, 1995, the outstanding principal balance on the CREC Note was $7,700,000. The CREC Note matures on April 30, 1996. There was interest income of $680,000 related to the CREC Note for the year ended March 31,1995.\nIn July 1992, on behalf of CDC, CREC guaranteed a $10,000,000 bank line of credit for CDC to utilize in conjunction with development of lots to be sold to CREC. In July 1993, the amount of such line of credit was reduced to $5,000,000. This line of credit, which had an outstanding balance of $1,539,000 at May 30, 1995, bears interest at LIBOR plus 3\/4% (6 13\/16% at May 30, 1995), is unsecured and matures in July 1995.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) The following documents are filed as part of this Report:\n(1) and (2) See the Index to Financial Statements below for a list of the Financial Statements filed herewith.\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\n(A) Holding\nThe information on exhibits required by this Item 14 is set forth in the Holding Index to Exhibits appearing on pages 42-43 of this Report.\n(B) CDC\nThe information on exhibits required by this Item 14 is set forth in the CDC Index to Exhibits appearing on pages 44-46 of this Report.\n(b) Reports on Form 8-K:\nNeither Holding nor CDC filed any reports on Form 8-K during the quarter ended March 31, 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.\nPursuant to 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- -------------------- *Pursuant to authority granted by powers of attorney, copies of which are filed herewith, except for Mr. Low's Power of Attorney which will be filed upon execution.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, 3333 Development Corporation, as general partner of, and on behalf of, 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 3333 Development Corporation, as general partner of, and on behalf of, the registrant in the capacities and on the dates indicated.\n- -------------------- *Pursuant to authority granted by powers of attorney, copies of which are filed herewith, except for Mr. Low's Power of Attorney which will be filed upon execution.\nINDEX TO EXHIBITS\nCENTEX CORPORATION AND SUBSIDIARIES\nINDEX TO EXHIBITS\nCENTEX CORPORATION AND SUBSIDIARIES--CONTINUED\nINDEX TO EXHIBITS\nCENTEX CORPORATION AND SUBSIDIARIES--CONTINUED\nINDEX TO EXHIBITS\nCENTEX CORPORATION AND SUBSIDIARIES--CONTINUED\n- -------------------- * Required to be filed as an exhibit pursuant to Item 14(c).\nINDEX TO EXHIBITS\n3333 HOLDING CORPORATION AND SUBSIDIARY\nINDEX TO EXHIBITS\n3333 HOLDING CORPORATION AND SUBSIDIARY--CONTINUED\n- --------------------\nINDEX TO EXHIBITS\nCENTEX DEVELOPMENT COMPANY, L.P.\nINDEX TO EXHIBITS\nCENTEX DEVELOPMENT COMPANY, L.P.\nINDEX TO EXHIBITS\nCENTEX DEVELOPMENT COMPANY, L.P.--CONTINUED\n- --------------------","section_15":""}
{"filename":"46043_1995.txt","cik":"46043","year":"1995","section_1":"ITEM 1. BUSINESS\nRETAIL ELECTRONICS\nThe Company, through its Retail Electronics Business, Harvey Electronics ( Harvey Electronics ), is engaged in the retail sale, service and custom installation of high quality home audio and video equipment. This equipment includes high fidelity components and systems, video cassette recorders, camcorders, direct view and projection TV sets, digital satellite systems, cellular and conventional phones, fax machines as well as accessories for this equipment.\nThe Company maintains strong relationships with many of the finest consumer electronics manufacturers in the world. Audio and video products and custom installation account for virtually all of Harvey Electronics business. The Company targets upscale shoppers who base their purchase decisions on quality, features and reliability along with value.\nPrior to fiscal 1990, the Company operated 3 stores (Midtown Manhattan, New York, White Plains, New York, Paramus, New Jersey). In May of 1989, the Company purchased the assets of the Audio Exchange Company and began operating its two existing stores (Westbury, New York and Greenwich Village, New York) under the Harvey Electronics name. In March of 1990, the Company opened an outlet store in Secaucus, New Jersey. In fiscal 1994, the Company opened a retail store located within ABC Carpet and Home, a New York City based specialty retailer of high quality home furnishings and carpeting. In fiscal 1995 the Company opened a new retail store located on prestigious 57th Street in Manhattan, bringing the total stores operated by the Company to eight. In February 1990, Harvey Electronics administrative offices and main warehouse facility were relocated from New York City to Secaucus, New Jersey. In fiscal 1993, the Corporate offices were also relocated to Secaucus, New Jersey from Roslyn Heights, New York.\nThe business is seasonal, with greater sales and income being achieved in the fourth quarter of the fiscal year.\nEMPLOYEES\nThe Company employs approximately 110 full-time employees. Approximately 65 hourly employees are covered by one labor union contract expiring on July 31, 1996. Employee relations are considered to be good and there have been no work stoppages in the history of the Company. The Company is an Equal Opportunity Employer.\nCOMPETITION\nHarvey Electronics competes in the Metropolitan New York area with department stores, mail order houses, discount stores and numerous other electronic specialty stores. Many of such competitors sell other lines of merchandise and many have substantially larger total sales and greater total financial resources. Management believes that Harvey Electronics competes on the basis of the high quality of the national brands of audio and video products which it carries and on its ability to give customers personalized service, quality home or office installation and extensive product knowledge.\nDISCONTINUED OPERATIONS\nOn March 31, 1992, the Company completed the sale of certain assets and the business of its food brokerage division, The Boerner Company (\"Boerner Division\"), to Merkert Enterprises, Inc., a Massachusetts corporation (\"Merkert\"). Pursuant to the terms of the Asset Purchase Agreement (the \"Agreement\"), dated as of January 17, 1992, and amended as of January 23, 1992, the Company sold certain tangible and intangible assets and the business of the Boerner Division, agreed not to compete with Merkert in the food brokerage business and also agreed to provide certain consulting services to Merkert.\nPursuant to the Agreement, the purchase price was unsecured and the Company was to receive an aggregate consideration, payable by Merkert over five and one-quarter years, equal to approximately $7,237,000 (which amount includes interest payments, at 12.5% per annum, and payment of $1,037,000 for substantially all of the fixed assets of the Boerner Division, which amount was received by the Company on April 1, 1992). However, the purchase price was subject to adjustment for, among other things, modification, resignation or termination by existing principals of the Boerner Division (including the failure of principals to appoint Merkert as food broker) during the one year period following the closing of the transaction. During the period ending March 31, 1993, the Boerner Division experienced the resignation of certain principals decreasing the aggregate purchase price to be received by $610,951. As a result, the present value of the aforementioned purchase price was reduced, and $238,955 was charged to loss on Disposal of Discontinued Operations during fiscal 1993.\nIn conjunction with the successful refinancing effort completed on May 2, 1994, (see Notes 2 and 4 to the consolidated financial statements) the Company agreed to the discounting and prepayment of certain remaining scheduled payments due from Merkert. At closing, the Company received $2,150,000 from Merkert, of which $2,100,000 was used to substantially reduce the amount due to National Westminster Bank USA (the Bank ) (from $2,600,000 to $500,000). As a result of the discounting and prepayment agreement with Merkert, the Company recorded a provision to continuing operations of $320,266 at January 29, 1994.\nIn accordance with the prepayment agreement, the remaining installments to be received from Merkert, are as follows:\nFISCAL INSTALLMENT YEAR DATE PAYMENT INTEREST PRINCIPAL\n1996 1\/1\/96 $100,000 $12,901 $87,099\n1997 1\/1\/97 74,000 5,670 68,330 Totals $174,000 $18,571 $155,429\nSuch remaining installments will be used to pay outstanding obligations under a lease termination agreement (see Note 8 to the consolidated financial statements).\nMerkert generally did not assume any of the liabilities of the Company relating to the Boerner Division except for certain motor vehicle leases, equipment leases and service contracts. The Company has agreed to indemnify Merkert against any loss, damage or expense arising out of any liability or any tax of the Company in respect of the Boerner Division which was not expressly assumed by Merkert pursuant to the terms of the Agreement.\nIn accordance with the Agreement, therefore, the Company retained all remaining liabilities pertaining to the Boerner Division. In particular, the Company agreed to retain the obligation to pay a consultant $21,133 per quarter for consulting services provided with respect to certain principals of Boerner. The agreement with such consultant commenced on February 2, 1991 and will terminate according to its terms on November 2, 1995.\nEXISTING CREDIT ARRANGEMENTS\nOn May 2, 1994 the Company successfully completed a refinancing which included the prepayment and discounting of the receivable due from Merkert (see Note 2 to the consolidated financial statements). At closing, the Company received $2,150,000 from Merkert of which $2,100,000 was used to substantially reduce the amount due to the Bank (from $2,600,000 to $500,000). The remaining $500,000 obligation, due to the Bank was converted to a two year term loan bearing interest at the Bank s prime rate plus 5% per annum and the existing credit facility with the Bank was cancelled.\nThe Bank and InterEquity Capital Partners L.P. ( I.E.C.P. ), an entity which has provided term loans to the Company (see Note 4 to the consolidated financial statements), have entered into an intercreditor agreement whereby both will share equally in a subordinated second position to the Company s new lender, Congress Financial Corporation ( Congress ). The term loan with the Bank also provides for rights of acceleration upon the occurrence of certain customary events of default and includes restrictive covenants similar to those existing with the term loans from I.E.C.P.\nPursuant to the refinancing effort, the Company entered into a three year revolving line of credit facility with Congress, dated May 2, 1994 whereby the Company may borrow up to $3,000,000, based upon a lending formula (as defined) calculated on eligible inventory. The interest rate per annum on this credit facility is 2% over the prime rate of Philadelphia National Bank. An unused line fee of one quarter of one percent per annum and prescribed early termination fees also exist under the line of credit.\nCongress has a senior security interest in all of the Company s assets and assets of its subsidiary and the stock of its subsidiary. The line of credit facility provides Congress with rights of acceleration upon the occurrence of certain customary events of default including, among others, the event of bankruptcy. The Company is also restricted from paying dividends, retiring or repurchasing its common stock and entering into additional indebtedness. As described above, an intercreditor agreement exists between Congress, and the subordinated lenders, I.E.C.P. and the Bank.\nAt closing, $200,000 was required to be placed in escrow in a certificate of deposit as additional collateral for Congress.\nPROPOSED PRIVATE PLACEMENT AND RELATED RESTRUCTURING OF CERTAIN DEBT\nAs a result of continued losses and negative cash flows from operations, on March 13, 1995 the Company announced that it would seek to raise up to $4,200,000, prior to the payment of fees and expenses, of new equity with the issuance of up to 12,000,000 shares of common stock pursuant to the terms of a Placement Agreement (the Placement ) entered into between the Company and Janssen-Meyers Associates, L.P. ( Janssen-Meyers ). The Placement will be on a best efforts all or none basis for 7,500,000 shares and on a best efforts basis as to an additional 4,500,000 shares. It is anticipated that the price per common share to be sold in the Placement will be between $.35 and $.38 (the market value of the Company's common stock on May 8, 1995 is below such amounts). In connection with the Placement, the Company will issue to Janssen-Meyers, seven-year warrants to acquire up to 2,750,000 shares of the Company s common stock at an exercise price of 120% of the price that the shares are sold in the Placement.\nThe Company also entered into a letter agreement with Capital Vision Group, Inc. (\"CVG\") pursuant to which the Company has agreed, among other things, to retain CVG as its financial and business advisor upon completion of the Placement. As compensation for CVG's services, the Company agreed, contingent upon and following the completion of the Placement, to pay CVG a cash fee equal to $6,000 per month and to grant CVG seven-year warrants to purchase 5,000,000 shares of common stock at an exercise price of $.50 per share.\nThe proposed Placement is subject to certain conditions including shareholder approval and the restructuring of certain existing subordinated convertible and nonconvertible debentures. This restructuring will require that such debentures (aggregating $1,057,405) either (1) convert to common stock of the Company at an exchange rate equal to the price that shares of common stock are sold in the Placement or (2) exchange such debentures for a new series of convertible subordinated debentures bearing an interest rate of 11% per annum, maturing on July 1, 2000 and convertible into shares of common stock at a conversion price of $1.15 per share.\nIn conjunction with the approval of the Placement, and as a condition of the Placement, the shareholders will also be required to approve an Amendment to the Company s Restated Certificate of Incorporation, which will increase the amount of authorized common stock from 5,000,000 shares to 50,000,000 shares, reduce the par value of the common stock from $1.00 per share to $.01 per share and increase the authorized preferred stock from 100,000 shares to 2,500,000 shares.\nAs soon as practicable following the successful completion of the Placement, and subject to shareholders approval, the Company will effect a reverse stock split whereby each four shares of common stock will be combined into one share of common stock. The amended par value will remain at $.01 per share. The Company shall have the option of paying cash in lieu of fractional shares resulting from the reverse stock split or rounding up fractional shares to the nearest whole number of shares.\nFollowing the closing of the Placement, the Board of Directors will fix the number of directors at not less than five and not more than nine. In accordance with the letter agreement entered into between the Company and CVG, the members of the Company s Board of Directors must be reasonably satisfactory to CVG.\nProceeds from the proposed Placement, after related expenses, will be used: (1) to reduce trade accounts payable, (2) to reduce amounts outstanding under the revolving line of credit facility and (3) as additional working capital, as deemed appropriate by the Company (see Note 11 to the consolidated financial statements).\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nAll of the premises which the Company occupies are leased. The Company's facilities are adequate and suitable for its business as such business is presently conducted. Information with respect to the Company's leased premises is as follows:\nAPPROXIMATE SELLING SQUARE PRINCIPAL ANNUAL LOCATION TERM FOOTAGE OPERATION RENT\n600 Secaucus Road Leased Retail offices, Secaucus, through warehouse New Jersey 12\/31\/1999 27,000 facility and outlet store $180,000\n2 West 45th Street Leased New York, through New York 6\/30\/2005 7,500 Retail store $498,000\n556 Route 17 North Leased Paramus, through New Jersey 6\/30\/2003 7,000 Retail store $238,000\n485 Old Country Rd Leased Westbury, through New York 12\/31\/1996 3,000 Retail store $148,000\n236 East Post Road Leased White Plains, through New York 2\/28\/1996 6,000 Retail store $63,000\nWithin ABC Leased Carpet and Home through 888 Broadway and 9\/4\/1998 4,000 Retail store $150,000 19th Street minimum New York, New York per annum\n119 West 57th St. Leased New York, New York through 10019 8\/14\/2004 3,300 Retail store $275,000\n28 West 8th Street Month New York, to $5,500 New York Month 750 Retail store per month\nIn addition, the Company had leased premises for the Boerner Division offices in Roslyn Heights, New York. Lease commitments remaining under this lease through March 31, 1999 approximated $6,000,000. In connection with the sale of the Boerner Division, the Company had entered into a sublease arrangement with Merkert for this facility.\nOn July 8, 1992, the Company entered into termination agreements with the landlord and Merkert relating to the original prime lease and sublease as noted above. Pursuant to the agreement with the landlord, the Company was released from all obligations under the prime lease in exchange for consideration approximating $885,000 (including $79,000 for legal, commission and administrative fees which were paid in July 1992). Prepaid rent and a security deposit aggregating $137,000 were used to partially satisfy the above noted consideration. Approximately $345,000 of the above mentioned consideration has been paid by the Company through January 28, 1995. The remaining consideration of $324,000 is to be paid over a period of time annually as follows: $115,000 annually on January 1, 1996 and January 1, 1997 and $94,000 on January 1, 1998. In conjunction with the termination agreements and with the consent of the Bank, all remaining amounts due from Merkert have been assigned to the landlord. The Company's corporate offices, which were also located in Roslyn Heights, New York have been relocated to Secaucus, New Jersey, the headquarters of Harvey Electronics.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company or its subsidiaries are defendants in certain legal actions which arose in the normal course of business, the outcome of which, in the opinion of management, will not have a material effect on the Company's financial position or operations.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThere were no matters submitted for 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 traded on the American Stock Exchange (ticker symbol HRA). The approximate number of record holders of the Company's Common Stock at January 28, 1995 was 900.\nThe Company is currently not in compliance with the financial guidelines for continued listing on the American Stock Exchange and there can be no assurances that the listing will be continued (see Note 11 to the consolidated financial statements regarding the proposed Placement).\nThe following table indicates the quarterly high and low stock prices for the last two fiscal years:\nQUARTER 1995 QUARTER 1994 ENDED FIFTH LOW ENDED HIGH LOW\nApril 30, 1994 3\/4 3\/8 May 1, 1993 1 1\/8 7\/16 July 30, 1994 1\/2 5\/16 July 31, 1993 1 1\/16 1\/2 October 29, 1994 1\/2 5\/16 October 30, 1993 13\/16 1\/2 January 28, 1995 1\/2 5\/16 January 29, 1994 15\/16 5\/16\nThe Company has paid no dividends on its Common Stock for the last two years. The Company's revolving line of credit facility, term loans, subordinated debentures and convertible subordinated debentures contain certain restrictions on the payment of dividends.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nSee Note 1 to the accompanying consolidated financial statements as to the Basis of Presentation.\nNOTES TO CONSOLIDATED FINANCIAL DATA\n(1) Revenues for fiscal 1995, 1994 and 1993 include $135,059, $489,076 and $557,004, respectively, of interest, consulting and other income relating to the proceeds from the sale of the Boerner Division. Additionally, revenues include a gain on the sale of stock held for investment of $110,733 in fiscal 1993.\n(2) Includes a provision relating to the prepayment discount ($320,266) of the amount due from Merkert Enterprises in conjunction with the Company's refinancing effort which was completed in fiscal 1994.\n(3) Fiscal 1994 includes a $50,000 interest accrual for a New York State tax audit assessment relating to fiscal years 1988 through 1991. Fiscal 1993 includes interest paid to a judgment creditor of approximately $60,000 and loan origination and administrative fees of $61,000 paid to the Company's bank.\n(4) The loss from continuing operations includes a provision for unfavorable outcome of lawsuit of $2,138,076 and $400,000 for fiscal 1992 and 1991, respectively. Such amounts include legal fees associated with the defense of this lawsuit aggregating $535,000 and $400,000 for fiscal 1992 and 1991, respectively.\n(5) The loss from continuing operations for fiscal 1991 includes: net interest income of $367,297 relating to the completion of an examination by the Internal Revenue Service and the write-off of $137,711 of certain recoverable income taxes.\n(6) The loss per share for all fiscal years presented was computed on the weighted average number of common shares outstanding; common equivalent shares were not considered since their inclusion would have been antidilutive.\n(7) There were no cash dividends declared during the five fiscal years ended January 28, 1995.\n(8) Certain items in the fiscal 1991 consolidated financial statements have been reclassified to reflect the discontinued operations of the Boerner Division.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\nNet (Loss)\nThe net loss from continuing operations for fiscal 1995 was $906,442 ($.29 per share) as compared to a net loss of $1,733,110 ($.55 per share) and $298,349 ($.11 per share) for fiscal 1994 and 1993, respectively. The net loss for fiscal 1994 includes a provision of $320,266 ($.10 per share) relating to the prepayment discount of the amount due from Merkert in conjunction with the Company's successful refinancing, completed May 2, 1994. Fiscal 1994 also includes $210,000 ($.07 per share) of expenses relating to additional nonrecurring advertising and various production costs from the Company's advertising campaign. Additionally, the loss for fiscal 1994 includes nonrecurring interest expense of $50,000 ($.02 per share) relating to a New York State tax assessment for fiscals 1988 through 1991. Fiscal 1993 includes a gain on the sale of stock held for investment of $110,733 ($.04 per share).\nThe net loss for fiscal 1995, 1994 and 1993 includes interest, consulting and other income aggregating $135,059 ($.04 per share), $489,076 ($.15 per share) and $557,004 ($.20 per share), respectively, relating to the sale of the Boerner Division.\nRevenues\nTotal store sales for fiscal 1995 (inclusive of sales from the Company's retail store opened in September 1993 and also from the new retail store opened in November 1994) increased 6.9% from fiscal 1994, which decreased 11.5% from fiscal 1993.\nComparable store sales for fiscal 1995 increased less than 1% from fiscal 1994, which decreased 14% from fiscal 1993. The increase in comparable store sales for fiscal 1995 is due primarily to the Company's advertising campaign, merchandising changes emphasizing home theater presentations and increased custom home installation, offset by a decrease in lower margin corporate sales. The decrease in comparable store sales for fiscal 1994 as compared to fiscal 1993 is due primarily to reduced corporate sales, extremely adverse weather conditions experienced in the first and fourth quarters and from soft market conditions experienced throughout the New York Metropolitan area. This decrease was offset slightly by revenues from the Company's first audio\/video show and sale held in April 1993.\nCosts and Expenses\nCost of sales for fiscal 1995 increased 5.8% from fiscal 1994 and decreased 11.1% in fiscal 1994 from 1993. The increase in fiscal 1995 is due to increased sales as a result of the new store openings as previously mentioned, offset by higher gross margins experienced in fiscal 1995 from 1994. The decrease in fiscal 1994 from 1993 is principally from the aforementioned sales decreases.\nGross profit margins in fiscal 1995 increased to 33.1% from 32.3% in fiscal 1994 which in turn decreased slightly from 32.7% in fiscal 1993. The gross profit margin increased for fiscal 1995 (despite certain new and extended promotional events which reduced margins) primarily from further reductions in lower margin corporate sales and to a lesser extent, continued improvement in inventory shrinkage which has consistently been much lower than industry average. Higher store margins in fiscal 1994 were offset by a reduction of purchase discounts primarily from lower inventory purchases and reduced average inventories, thus resulting in the overall decrease in gross margins from fiscal 1993.\nConsolidated selling, general and administrative expenses (\"S,G&A expenses\") for fiscal 1995 decreased 1.6% from fiscal 1994 despite additional operating expenses relating to the new retail stores as discussed above. S,G&A expenses remained consistent in fiscal 1994 compared to fiscal 1993 despite increased advertising costs as mentioned above, additional operating expenses relating to the new retail store opened in September 1993 and costs associated with the Company's first audio\/video show and sale held in April 1993. Excluding these additional expenses (aggregating approximately $500,000 in fiscal 1994), comparable S,G&A expenses decreased 5.9% in fiscal 1994 from fiscal 1993. Comparable S,G&A expenses for fiscal 1995 also decreased 1.3% from fiscal 1994. The decrease in S,G&A expenses is a result of the Company's ongoing and effective expense reduction program which was implemented by management in the second quarter of fiscal 1994.\nConsolidated interest expense for fiscal 1995 remained consistent with fiscal 1994. Excluding interest of $50,000 in fiscal 1994 relating to the New York State tax audit assessment, interest expense increased 11.7% for fiscal 1995. This increase was due primarily from interest relating to the new term loans and increased interest rates during fiscal 1995. Consolidated interest expense for fiscal 1994 decreased 14.1 % as compared to fiscal 1993. This is primarily the result of reduced bank borrowings and non-recurring interest payments made to the judgment creditor in fiscal 1993 offset by additional interest on the term loan which financed the opening of the new retail store in September 1993, and interest expense relating to the New York State tax audit assessment, as discussed above.\nLiquidity and Capital Resources\nThe Company's ratio of current assets to current liabilities was 1.14 at January 28, 1995 as compared to 1.24 at January 29, 1994 and .90 at January 30, 1993. The decrease in the current ratio for fiscal 1995 is primarily due to the use of cash to fund the Company's net loss, offset by the classification to long-term debt of the entire amount outstanding under the Congress revolving line of credit facility at January 28, 1995. The increase in the current ratio for fiscal 1994 is primarily the result of the successful refinancing which was concluded May 2, 1994.\nThe Company successfully completed a refinancing on May 2, 1994. The refinancing included the discounted prepayment of a significant portion ($2,150,000) of the remaining amount due from Merkert Enterprises. Proceeds of the prepayment aggregating $2,100,000, were used to substantially reduce the current obligation due to the Company's predecessor bank, National Westminster Bank USA (from $2,600,000 to $500,000). The remaining obligation with this bank was refinanced into a two year term loan ($455,000 outstanding at January 28, 1995).\nThe Company simultaneously obtained new financing under a three year revolving line of credit facility with Congress Financial Corporation and may now borrow up to $3,000,000 based on a lending formula (as defined) calculated on eligible inventory. The amount outstanding under the revolving line of credit facility ($1,341,020 at January 28, 1995) is classified as long- term debt. Effective April 5, 1995 Congress has agreed to provide additional availability of $200,000 to the Company through the revolving line of credit facility. This additional amount will be available for working capital needs until the proposed Placement (see below) is completed.\nOn October 30, 1994 the Company opened a new retail store located on prestigious 57th Street in Manhattan. Accordingly, the Company entered into a ten year lease for this new store and also entered into a Term Loan with I.E.C.P. to finance $200,000 for necessary capital improvements, a security deposit and inventory. The Term Loan bears interest at 13% per annum, and requires payment of $200,000 on August 30, 1999. I.E.C.P. also received Warrants for the right to immediately purchase 150,000 shares of the Company's common stock at $1.00 per share. The Term Loan may be redeemed in its entirety at the election of the Company at any time after February 1, 1995, at a prescribed premium. The remainder of the financing necessary for the opening of the new store (approximately $300,000) was provided by borrowings from the Company's revolving line of credit facility with Congress.\nIn July 1994, the Company requested an extension of the maturity on its remaining ($398,000) 10% Subordinated Debentures (\"Debentures\"), originally due July 1, 1995. Holders of $276,155 of these Debentures consented to a two year extension of maturity (due July 1, 1997) with an increase in the interest rate to 11% per annum, effective January 1, 1995. Holders of $121,845 of the remaining Debentures agreed to extend the maturity for 10 years through July 1, 2005 with the interest rate remaining at 10%. Additionally, these Debenture holders also forgave $6,845 of the outstanding principal balance, leaving $115,000 to be repaid in ten equal annual installments of $11,500 beginning July 1, 1996. As a result, $391,155 of the Debentures remain outstanding and are classified as long-term debt as of January 28, 1995.\nThe loss of liquidity has caused the Company to delay payments to many of its suppliers of inventory. As a result, the Company is currently experiencing some difficulty in stocking certain inventory at desired levels, resulting in an adverse effect on current sales.\nAs a result of continued losses and negative cash flows from operations, on March 13, 1995 the Company announced that it would seek to raise up to $4,200,000, prior to the payment of fees and expenses, of new equity with the issuance of up to 12,000,000 shares of common stock pursuant to the terms of a Placement Agreement (the \"Placement\") entered into between the Company and Janssen-Meyers Associates, L.P. (\"Janssen-Meyers\"). The Placement will be on a \"best efforts all or none basis\" for 7,500,000 shares and on a \"best efforts basis\" as to an additional 4,500,000 shares. It is anticipated that the price per share sold in the Placement will be between $.35 and $.38 (the market value of the Company's common stock on May 8, 1995 is below such amounts). In connection with the Placement, the Company will issue to Janssen-Meyers, seven-year warrants to acquire up to 2,750,000 shares of the Company's common stock at an exercise price of 120% of the price that shares are sold in the Placement.\nThe proposed Placement is subject to certain conditions including shareholder approval and the restructuring of certain existing subordinated convertible and nonconvertible debentures. This restructuring will require that such debentures (aggregating $1,057,405) either (1) convert to common stock of the Company at an exchange rate equal to the price that shares of common stock are sold in the Placement or (2) exchange such debentures for a new series of convertible subordinated debentures bearing an interest rate of 11% per annum, maturing on July 1, 2000 and convertible into shares of common stock at a conversion price of $1.15 per share.\nProceeds from the proposed Placement, after related expenses, will be used: (1) to reduce trade accounts payable, (2) to reduce amounts outstanding under the revolving line of credit facility and (3) as additional working capital, as deemed appropriate by the Company (see Note 11 to the consolidated financial statements).\nThe Company believes that the net cash provided by this proposed placement, assuming the minimum 7,500,000 shares are sold, in conjunction with the Company's efforts to further reduce expenses, (including the expected reduction in interest expense from the proposed conversion of certain debentures), lower inventory levels and increase its sales base through merchandising and marketing changes, will be adequate to meet its working capital needs for fiscal 1996.\nThere can be no assurance that this proposed Placement will be completed. Unless the above Placement or other appropriate equity offering is consummated, the Company may be forced to informally restructure its obligations with its creditors or formally reorganize or liquidate under the United States Bankruptcy Code.\nDuring the period, the Company was not significantly impacted by the effects of inflation.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA\nThe response to the Item is submitted in the financial statements set forth below:\nAnnual Report on Form 10 K Item 8, Item 14(a) (1) and (2), (c) and (d)\nList of Financial Statements and Financial Statement Schedules\nFinancial Statements Certain Exhibits Financial Statement Schedules Fiscal year ended January 28, 1995\nThe Harvey Group Inc. and Subsidiaries Secaucus, New Jersey\nFORM 10 K ITEM 14(a)(1) AND (2)\nTHE HARVEY GROUP INC. AND SUBSIDIARIES\nLIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE\nThe following consolidated financial statements of The Harvey Group Inc. and subsidiaries are included in Item 8:\nConsolidated balance sheets January 28, 1995 and January 29, 1994 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . II 13\nConsolidated statements of operations Fiscal years ended January 28, 1995, January 29,1994 and January 30, 1993 . . . . . . . . . . . . . . . . . . . . . . . . . II 15\nConsolidated statements of shareholders (deficit) equity Fiscal years ended January 28, 1995, January 29, 1994 and January 30, 1993 . . . . . . . . . . . . . . . . . II 16\nConsolidated statements of cash flows Fiscal years ended January 28, 1995, January 29, 1994 and January 30, 1993 . . . . . . . . . . . . . . . . . . . II 17\nNotes to consolidated financial statements January 28, 1995 . . . . . . . . . . . . . . . . . . . . . . . . . II 19\nThe following consolidated financial statement schedule of The Harvey Group Inc. and subsidiaries are included in Item 14(d):\nSchedule II Valuation and qualifying accounts . . . . . . II 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.\nReport of Independent Auditors\nShareholders and Board of Directors The Harvey Group Inc.\nWe have audited the accompanying consolidated balance sheets of The Harvey Group Inc. as of January 28, 1995 and January 29, 1994, and the related consolidated statements of operations, shareholders (deficit) equity, and cash flows for each of the three fiscal years in the period ended January 28, 1995. 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 schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of The Harvey Group Inc. at January 28, 1995 and January 29, 1994, and the consolidated results of its operations and its cash flows for each of the three fiscal years in the period ended January 28, 1995, 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.\nThe accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As more fully described in Note 1, the Company has incurred recurring losses and negative cash flows from operations and anticipates that negative cash flows from operations will continue. These conditions raise substantial doubt about the Company s ability to continue as a going concern. Management s plans in regard to these matters are described in Notes 1 and 11. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.\nERNST & YOUNG LLP\nMarch 24, 1995, except for Note 4, as to which the date is April 6, 1995\nTHE HARVEY GROUP INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\nJANUARY 28 JANUARY 29 1995 1994\nASSETS (Notes 1 and 4) Current assets: Cash and cash equivalents $75,243 $ 226,119 Trade receivables, less allowance of $25,000-1995 and $12,500 - 1994 (Note 1) 608,295 523,172 Inventories 3,694,415 3,546,004 Amount due from Merkert Enterprises, including interest receivable of $1,075-1995 and $245,922- 1994 (Notes 2 and 4) 88,175 2,199,591 Amount due from AIMS Corporation, including interest receivable of $981 - 1994 - 39,533 Prepaid expenses and other current assets 217,022 197,327 Total current assets 4,683,150 6,731,746\nProperty, plant, and equipment, at cost: Leasehold improvements 1,941,130 1,858,020 Furniture, fixtures and equipment 1,926,845 1,743,038 3,867,975 3,601,058\nLess accumulated depreciation and amortization (2,697,864) (2,365,465) 1,170,111 1,235,593 Certificate of deposit, including interest receivable of $7,130 (Note 4) 207,130 - Equipment under capital leases, less accumulated depreciation of $272,065-1995 and $345,409-1994 (Note 8) 122,662 99,635 Amount due from Merkert Enterprises (Notes 2 and 4) 68,329 155,428 Other, less accumulated amortization of $574,095-1995 and $412,614-1994 823,394 651,085 Total assets $7,074,776 $8,873,487\nSee notes to consolidated financial statements.\nTHE HARVEY GROUP INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS (CONTINUED)\nJANUARY 28 JANUARY 29 1995 1994\nLIABILITIES AND SHAREHOLDERS' (DEFICIT) (Note 1) Current liabilities: Trade accounts payable $2,536,288 $2,511,303 Accrued expenses and other current liabilities (Note 9) 811,455 847,234 Note payable to bank (Notes 2 and 4) - 1,450,000 Income taxes 10,471 34,342 Accrued costs related to discontinued operations (Note 2) 136,193 138,630 Current portion of long-term liabilities (Notes 4 and 9) 530,028 361,517 Current portion of capital lease obligations (Note 8) 73,778 76,205 Total current liabilities 4,098,213 5,419,231\nLong-term liabilities: Long-term debt (Notes 2 and 4) 3,313,425 2,744,370 Accrued costs related to discontinued operations (Note 2) 257,033 398,227 Other liabilities (Note 9) 580,946 582,894 4,151,404 3,725,491\nCapital lease obligations (Note 8) 43,320 40,484\nShareholders' (deficit) (Notes 4, 5 and 11): Preferred stock, par value $20 per share; authorized 100,000 shares; none issued Common stock, par value $1 per share; authorized 5,000,000 shares; issued 3,498,968-1995 and 1994 3,498,968 3,498,968 Capital in excess of par 5,899,010 5,899,010 Retained (deficit) (9,750,538) (8,844,096) (352,560) 553,882 Less treasury stock, at cost (334,081 shares - 1995 and 1994) (865,601) (865,601) Total shareholders' (deficit) (1,218,161) (311,719) Commitments and contingencies (Note 8)\nTotal liabilities and shareholders' (deficit) $7,074,776 $8,873,487\nSee notes to consolidated financial statements.\nTHE HARVEY GROUP INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF OPERATIONS\n52 WEEKS 52 WEEKS 52 WEEKS ENDED ENDED ENDED JANUARY 28 JANUARY 29 JANUARY 30 1995 1994 1993 REVENUES Net sales $22,814,279 $21,348,066 $24,136,172 Interest and other income (Note 9) 233,780 499,457 692,147 23,048,059 21,847,523 24,828,319 COST AND EXPENSES Cost of sales 15,274,991 14,442,169 16,239,401 Selling, general and administrative expenses 8,211,060 8,348,632 8,340,599 Interest expense (Notes 2 and 4) 468,450 469,566 546,668 Provision for prepayment discount of Merkert receivable (Notes 2 and 4) - 320,266 - 23,954,501 23,580,633 25,126,668 (Loss) from continuing operations before income taxes (906,442) (1,733,110) (298,349) Income taxes (Note 6) - - - (Loss) from continuing operations (906,442) (1,733,110) (298,349)\n(Loss) on disposal of discontinued operations (Note 2) - - (259,390) Net (loss) $ (906,442) $(1,733,110) $(557,739)\nNet (loss) per common and common equivalent share: (Loss) from continuing operations $(.29) $(.55) $(.11) (Loss) from discontinued operations - - (.09) Net (loss) $(.29) $(.55) $(.20) Weighted average number of common shares and common equivalent shares outstanding during the year 3,164,887 3,163,637 2,773,207\nSee notes to consolidated financial statements.\nTHE HARVEY GROUP INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF SHAREHOLDERS' (DEFICIT) EQUITY\nSEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nTHE HARVEY GROUP INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\n52 WEEKS 52 WEEKS 52 WEEKS ENDED ENDED ENDED JANUARY 28 JANUARY 29 JANUARY 30 1995 1994 1993 OPERATING ACTIVITIES Net (loss) $ (906,442) $(1,733,110) $ (557,739) Adjustments to reconcile net (loss) to net cash (used in) operating activities: Provision for prepayment discount of Merkert receivable - 320,266 - Loss on disposal of discontinued operations - - 217,798 Depreciation and amortization 604,697 511,358 473,759 Loss (gain) on sale\/disposal of property, plant equipment and other assets - 782 (124,907) Provision for losses on accounts receivable 12,500 2,500 - Increase in cash surrender value of officers' life insurance - (35,788) (25,696) Provision for deferred compensation plan 12,918 11,299 10,105 Payments on covenant not to compete, consulting and deferred compensation agreements (94,175) (194,869) (223,699) Net payments relating to discontinued operations (132,508) (289,002) (1,446,243) Payments of restructured legal costs (79,687) (142,000) (82,000) Straight-line impact of rent escalations 64,298 17,714 27,982 Reversal of sales tax and other liabilities (50,343) - - Payments to judgment creditor - - (1,963,557) Changes in operating assets and liabilities: Accounts receivable (97,623) (35,433) 2,081,789 Inventories (132,441) 19,288 479,964 Accrued interest receivable (7,224) 55,573 (248,383) Prepaid expenses and other current assets 40,305 34,457 (17,268) Accounts payable 24,985 904,771 (44,593) Accrued expenses and other current liabilities and income taxes payable (59,650) (32,980) (1,058,711) Net cash (used in) operating activities (800,390) (585,174) (2,501,399)\nThe Harvey Group Inc. and Subsidiaries\nConsolidated Statements of Cash Flows (continued)\n52 WEEKS 52 WEEKS 52 WEEKS ENDED ENDED ENDED JANUARY 28 JANUARY 29 JANUARY 30 1995 1994 1993\nINVESTING ACTIVITIES Proceeds from Merkert Enterprises $ 2,199,590 689,611 1,954,669 Purchase of certificate of deposit (200,000) - - Proceeds from Aims Corporation 38,552 57,052 - Purchases of property, plant and equipment (271,135) (259,710) (174,320) Proceeds from sale of property, plant, equipment and other assets - 5,163 87,802 Purchase of other assets (250,643) (117,162) (18,564) Net cash provided by investing activities 1,516,364 374,954 1,849,587\nFINANCING ACTIVITIES Proceeds from Revolving line of credit facility 19,783,964 - - Repayments of Revolving line of credit facility (18,442,944) - - Debt payments forgiven by creditors (20,812) - - Proceeds from sale of 10% convertible subordinated debentures - - 781,250 Proceeds from borrowings of cash surrender value of officer's life insurance - - 100,000 Proceeds from note payable to bank - 800,000 661,000 Proceeds from term loans 200,000 400,000 - Principal payments on long-term debt (133,316) (268,110) (191,882) Principal payments on note payable to bank and term loan (2,145,000) (500,000) (1,486,000) Reclassification of accrued expenses to long-term debt 10,000 71,000 96,000 Principal payments on capital lease obligations (118,742) (108,597) (72,659) Proceeds from sale of common stock - - 468,750 Net cash (used in) provided by financing activities (866,850) 394,293 356,459 (Decrease) increase in cash and cash equivalents (150,876) 184,073 (295,353) Cash and cash equivalents at beginning of year 226,119 42,046 337,399 Cash and cash equivalents at end of year $ 75,243 $ 226,119 $ 42,046\nSee notes to consolidated financial statements.\nTHE HARVEY GROUP INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nJANUARY 28 1995\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND BASIS OF PRESENTATION\nBASIS OF PRESENTATION\nThe accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. The Company has incurred recurring losses and negative cash flows from operations for each of the three fiscal years in the period ending January 28, 1995, and anticipates that negative cash flows from operations will continue. These conditions raise substantial doubt about the Company s ability to continue as a going concern. Management s plans in regard to these matters principally include raising additional equity through a private placement, which will require converting or extending the maturity of certain Debentures (see Note 11). Additionally, the Company will look to increase its sales through merchandising and marketing changes and further reduce expenses and lower inventory levels. If the Company is unable to accomplish these objectives or otherwise generate sufficient levels of cash flows from operations and\/or alternative financing sources, as necessary, the Company may not be able to continue as a going concern and may be forced to informally restructure its obligations with its creditors or formally reorganize or liquidate under the United States Bankruptcy Code. The financial statements do not include any adjustments that may result from the possible inability of the Company to continue as a going concern.\nDESCRIPTION OF BUSINESS\nHarvey Electronics, the operating entity of The Harvey Group Inc. and subsidiaries (the \"Company\"), is a specialty retailer of high quality audio\/video consumer electronics and home theater products with eight stores in the Metropolitan New York area.\nPRINCIPLES OF CONSOLIDATION\nThe 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 in consolidation.\nINVENTORIES\nInventories are stated at the lower of cost (average cost method, which approximates the first in, first out method) or market.\nDEPRECIATION AND AMORTIZATION\nDepreciation of property, plant and equipment, including equipment acquired under capital leases, is provided for by the straight line method over the estimated useful lives of the related equipment. Leasehold improvements are amortized over the lease term or estimated useful life of the improvements, whichever is shorter.\nLOSS PER SHARE\nThe loss per common share for fiscal years 1995, 1994 and 1993 was computed on the weighted average number of common shares outstanding; common equivalent shares were not considered since their inclusion would have been antidilutive. Per share data for all years presented, on a fully diluted basis, is the same as amounts shown.\nSTATEMENT OF CASH FLOWS\nThe Company considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents.\nTotal interest paid during fiscal 1995, 1994 and 1993 was $486,000, $430,000 and $563,000, respectively. Total income taxes paid during fiscal 1995, 1994 and 1993 was $29,000, $3,000, and $18,000 respectively.\nCONCENTRATION OF CREDIT RISK\nThe Company s operations consist of the retail sale, service and custom installation of advanced consumer electronic equipment, specifically home audio and custom video equipment. The Company performs ongoing credit evaluations of its customers financial condition and payment history but does not require collateral. Generally, accounts receivable are due within 30 days and credit losses have historically been minimal.\n2. DISCONTINUED OPERATIONS AND PREPAYMENT OF AMOUNT DUE FROM MERKERT ENTERPRISES\nOn March 31, 1992, the Company completed the sale of certain assets and the business of its food brokerage division, The Boerner Company (\"Boerner Division\"), to Merkert Enterprises, Inc., a Massachusetts corporation (\"Merkert\"). Pursuant to the terms of the Asset Purchase Agreement (the Agreement ), the Company sold certain tangible and intangible assets including the business of the Boerner Division, agreed not to compete with Merkert in the food brokerage business and also agreed to provide certain consulting services to Merkert.\nPursuant to the Agreement, the purchase price was unsecured and the Company was to receive an aggregate consideration, payable by Merkert over five and one quarter years, equal to approximately $7,237,000 (which amount includes interest payments, at 12.5% per annum, and payment of $1,037,000 for substantially all of the fixed assets of the Boerner Division, which amount was received by the Company on April 1, 1992). However, the purchase price was subject to adjustment for, among other things, modification, resignation or termination by existing principals of the Boerner Division (including the failure of principals to appoint Merkert as food broker) during the one year period following the closing of the transaction. During this period, ending March 31, 1993, the Boerner Division experienced the resignation of certain principals decreasing the aggregate purchase price to be received by $610,951. As a result, the present value of the aforementioned purchase price was reduced, and $238,955 was charged to loss on Disposal of Discontinued Operations in fiscal 1993.\nIn conjunction with the refinancing (see Note 4) completed May 2, 1994, the Company agreed to the discounting and prepayment of certain remaining scheduled payments due from Merkert. At closing, the Company received $2,150,000 from Merkert of which $2,100,000 was used to substantially reduce the outstanding amount (from $2,600,000 to $500,000) due to National Westminster Bank USA (the \"Bank\"). As a result of this agreement, in fiscal 1994 the Company recorded a provision to continuing operations relating to the resulting discount of $320,266.\nIn accordance with the prepayment agreement, the remaining installments to be received from Merkert are as follows: Installment Fiscal Year Date Payment Interest Principal\n1996 1\/1\/96 $100,000 $12,901 $87,099 1997 1\/1\/97 74,000 5,670 68,330 Totals $174,000 $18,571 $155,429\nRemaining installment payments to be received will be used to pay outstanding obligations under a lease termination agreement (see Note 8).\nAccrued costs relating to discontinued operations at January 28, 1995 and January 29, 1994 aggregate $393,226 and $536,856, respectively. The long term portions of $257,033 and $398,227 for fiscal 1995 and 1994, respectively, are comprised primarily of lease commitments (see Note 8) and legal fees.\n3. COMPLETION OF PRIVATE PLACEMENT AND EXCHANGE AGREEMENT\nIn August 1992, the Company completed a private placement aggregating $1,250,000, comprised of 468,750 shares of common stock, and $781,250 aggregate principal amount of 10% convertible subordinated Debentures (\"Convertible Debentures\"). The shares of common stock were sold at a price of $1.00 per share, (which exceeded market value at the time of sale) (see Note 4).\nOn September 1,1992, the Company used the proceeds noted above and other available cash to satisfy the remaining obligations to a judgment creditor. Investors in the private placement included certain members of the Company s Board of Directors and certain members of management.\nOn August 6, 1992, the Company also issued an additional 304,611 shares of common stock pursuant to an Exchange Agreement (the \"Exchange Agreement\") dated as of June 8, 1992, between the Company and Windcrest Partners (\"Windcrest\"). Pursuant to the Exchange Agreement, Windcrest acquired such shares of common stock, at $1.00 par value in exchange for $304,611 principal amount of the Company s existing 10% subordinated Debentures due July 1, 1993 held by Windcrest (see Note 4). Windcrest is the largest shareholder of the Company and a partner thereof is a member of the Company s Board of Directors.\n4. REFINANCING OF NOTE PAYABLE TO BANK, NEW REVOLVING LINE OF CREDIT FACILITY AND LONG TERM DEBT\nREFINANCING OF NOTE PAYABLE TO BANK\nOn May 2, 1994 the Company completed the refinancing which included the prepayment and discounting of the receivable due from Merkert (see Note 2). At closing, the Company received $2,150,000 from Merkert of which $2,100,000 was used to substantially reduce the amount due to the Bank (from $2,600,000 to $500,000). The remaining $500,000 obligation was converted to a two year term loan bearing interest at the Bank's prime rate plus 5% per annum and the existing credit facility was cancelled.\nThe Bank and InterEquity Capital Partners L.P. (\"I.E.C.P.\"), an entity which in 1995 and 1994 provided term loans to the Company (see below), have entered into an intercreditor agreement whereby both will share equally in a subordinate second position to the Company s new lender, Congress Financial Corporation (\"Congress\"). The term loan with the Bank also provides for rights of acceleration upon the occurrence of certain customary events of default and includes restrictive covenants similar to those existing with the term loan from I.E.C.P.\nNEW REVOLVING LINE OF CREDIT FACILITY\nPursuant to the refinancing effort, the Company entered into a three year revolving line of credit facility with Congress, dated May 2, 1994 whereby the Company may borrow up to $3,000,000, based upon a lending formula (as defined), calculated on eligible inventory. The interest rate per annum on this revolving line of credit facility is 2% over the prime rate of Philadelphia National Bank. An unused line fee of one quarter of one percent per annum and prescribed early termination fees also exist under the line of credit. At closing, $200,000 was required to be placed in escrow in a certificate of deposit as additional collateral for Congress.\nCongress has a senior security interest in all of the Company s assets and assets of a subsidiary and the stock of such subsidiary. The line of credit facility provides Congress with rights of acceleration upon the occurrence of certain customary events of default including, among others, the event of bankruptcy. The Company is also restricted from paying dividends, retiring or repurchasing its common stock and entering into additional indebtedness. As discussed above, an intercreditor agreement exists between Congress, and the subordinated lenders, I.E.C.P. and the Bank.\nEffective April 6, 1995, Congress has agreed to provide additional availability of $200,000 to the Company through the revolving line of credit facility. This additional amount will be available for working capital needs until the proposed Placement (see Note 11) is completed.\nLONG TERM DEBT January 28 January 29 1995 1994\nLong-term portion of Congress revolving $1,341,020 $700,000 line of credit facility (a) Term loan due to National Westminster Bank USA 455,000 500,000 (b) 10% Subordinated debentures 391,155 398,000 (c) 10% Convertible subordinated debentures 781,250 781,250\n(d) Notes payable Audio Exchange - 50,000 (e) Notes payable truck financing 15,120 44,001 (f) 13% Convertible term loan - InterEquity Capital Partners, L.P. 400,000 400,000 (g) 13% Term loan-InterEquity Capital Partners, L.P. 200,000 - 3,583,545 2,873,251 Less current portion 270,120 128,881 $3,313,425 $2,744,370\n(a) Payable at $5,000 January 31, 1995, $100,000 February 1, 1995, $12,500 in monthly installments from February 1995 to January 1996 and $200,000 due February 1, 1996.\n(b) The 10% subordinated debentures (\"Debentures\") (which are principally due to shareholders of the Company), under which interest is payable semiannually on January 1 and July 1, are subordinate to all senior indebtedness (as defined therein) of the Company and are redeemable at face value at the option of the Company at any time prior to maturity.\nIn July 1994, the Company requested extension of the maturity on its remaining ($398,000) 10% Debentures, due July 1, 1995. Holders of $276,155 of these Debentures consented to a two year extension of maturity (through July 1, 1997) with an increase in the interest rate to 11% per annum, effective January 1, 1995. Holders of $121,845 of the remaining Debentures agreed to extend the maturity for 10 years through July 1, 2005 with the interest rate remaining at 10%.\nAdditionally, these Debentures holders also forgave $6,845 of the outstanding principal balance, leaving $115,000 to be repaid in ten equal installments of $11,500 beginning July 1, 1996. As a result, $391,155 of the Debentures remain outstanding and are classified as long-term debt as of January 28, 1995.\nThe Company is required to make annual payments to the Debenture holders in amounts equal to 20% of the Company s net income in excess of $500,000, up to a maximum annual payment of $150,000. The Debentures contain certain restrictions, as defined, on the payment of dividends. (See Note 11 regarding proposed conversion or extension of $276,155 of such Debentures).\n(c) In connection with the completed private placement (see Note 3), the Company issued $781,250 aggregate principal amount of 10% Convertible Debentures. The Convertible Debentures are convertible into shares of common stock after July 1, 1993 at a conversion price of $1.15 per share and may be redeemed in their entirety at the election of the Company at any time after July 1, 1994 at a prescribed premium. The Convertible Debentures mature July 1, 1997 and are subordinate to all senior indebtedness (as defined therein) and contain certain restrictions, as defined, on the payment of dividends. Interest is payable semi annually on January 1, and July 1 at 10% per annum on the outstanding principal balance. Convertible Debentures in the aggregate amount of $265,625 are held by members of the Company s Board of Directors and certain members of management. The Company is required to make a sinking fund payment of $390,625 on July 1, 1996. (See Note 11 regarding proposed conversion or extension of these Convertible Debentures).\n(d) The 10% notes to Audio Exchange were paid in full in fiscal 1995.\n(e) The notes payable relate to the financing of two trucks ($10,943) and a van ($4,177), with a cost basis aggregating approximately $82,000. Payments for thirty six months approximate $2,703 per month and include interest at rates of 13% and 6%, respectively.\n(f) On August 31, 1993, in connection with the opening of a retail store in fiscal 1994 (see Note 10), the Company entered into a Store Financing and Term Loan Agreement (\"Term Loan\") with I.E.C.P. to finance $400,000 for all necessary leasehold improvements, equipment and inventory. The Term Loan bears interest at 13% per annum, and requires a payment of $400,000 on August 31, 1998. The Term Loan is also convertible into shares of common stock at a conversion price of $1.15 per share and may be redeemed in its entirety at the election of the Company at a prescribed premium. The Term Loan, which is subordinate to Congress (see Note 3), provides I.E.C.P. with rights of acceleration upon the occurrence of certain customary events of default including, among others, payment defaults and the event of bankruptcy. The Company is also restricted from paying dividends, retiring or repurchasing its common stock and entering into additional indebtedness.\n(g) On August 30, 1994, in connection with the opening of a new retail store in fiscal 1995 (see Note 10), the Company entered into a second Term Loan with I.E.C.P. for $200,000. The loan bears interest at 13% per annum, and requires a balloon principal payment of $200,000 on August 30, 1999. I.E.C.P. also received Warrants for the right to immediately purchase 150,000 shares of the Company s common stock at $1.00 per share. The loan may be redeemed in its entirety at the election of the Company at any time after February 1, 1995, at a prescribed premium. The loan, which is subordinate to Congress (see Note 3), contains the same rights and restrictions as the term loan set forth in (f) above.\nThe aggregate maturities of long term debt are:\n1996 $270,120\n1997 602,125\n1998 2,019,300\n1999 411,500\n2000 211,500\nThereafter 69,000 $3,583,545\n5. CAPITAL STOCK\nCOMMON STOCK\nDuring 1988, the shareholders of the Company approved the 1988 Stock Option Plan which provides for the grant of incentive and nonqualified stock options to certain directors, officers and key employees. The Company has reserved 200,000 shares for issuance under this plan. The stock options are exercisable at prices not less than the fair market value of the Company s common stock on the date of grant. All options must be exercised within five years from the date of grant.\nAt January 28, 1995 and January 29, 1994 the Company had reserved 200,000 and 215,000 shares of common stock, respectively, for issuance in connection with stock options.\nTransactions during the three fiscal years ended January 28, 1995 were as follows:\nShares Shares Under Option Available Option Price Number for Granting Per Share of Shares\nBalance at February 1, 1992 32,975 188,500 Cancelled 167,025 $1.125 to $1.375 (167,025) Granted (178,000) $1.00 178,000 Expired - $1.125 to $1.375 (6,475) Balance at January 30, 1993 22,000 193,000 Cancelled 10,000 $1.00 (10,000) Granted - - Expired - - Balance at January 29, 1994 32,000 183,000 Cancelled 5,000 $1.00 (5,000) Granted - - Expired - $2.125 (15,000) Balance at January 28, 1995 37,000 163,000\nOf the options outstanding at January 28, 1995, 163,000 options are exercisable in three equal annual installments commencing one year from the date of grant. At January 28, 1995 and January 29, 1994, options for 108,667 and 71,000 shares, respectively, were exercisable.\n6. INCOME TAXES\nAt January 28, 1995, the Company has available net operating loss carryforwards of approximately $9,000,000 which expire in various years through fiscal 2010. Alternative minimum taxes of approximately $53,000 can be carried forward indefinitely and may be utilized to reduce the regular tax liability in a future year. The Company also has available investment tax credits of approximately $90,000 expiring in various years through fiscal 2001, and a capital loss carryover of approximately $1,458,000 expiring in fiscal 1998. Under the Company s proposed private placement (see Note 11) the net operating loss carryforward and other tax attributes would be severely restricted.\nAt January 28, 1995, deferred tax assets approximating $4,400,000 arising primarily from the future availability of the above tax attributes have been offset in full by a valuation allowance.\nThe reconciliation of the difference between income tax (benefit) and the amount computed by applying the statutory Federal income tax rate of 34% to income from continuing operations is as follows:\n1995 1994 1993 Income tax (benefit at statuory rate on (loss) before income taxes $(285,940) $(572,257) $(189,631)\nBenefit not recoreded due to net carryforward Position 285,940 572,257 189,631\nIncome tax expense $ - $ - $ -\n7. PENSION AND PROFIT SHARING PLAN\nThe Harvey Group Inc. Savings and Investment Plan (the \"Plan\") includes profit sharing, defined contribution and 401(k) provisions and is available to all eligible employees of the Company. Contributions (primarily based on salaries of eligible employees and matching of employee contributions under the 401(k) provisions) to the Plan for fiscal years 1995, 1994 and 1993 approximated $25,000, $47,000 and $50,000, respectively. Effective January 1, 1995 the Company s Board of Directors temporarily elected to eliminate the employer 401(k) match on employee contributions.\n8. COMMITMENTS AND CONTINGENCIES\nCOMMITMENTS\nThe Company s financial statements reflect the accounting for equipment leases as capital leases recording the asset and liability for the lease obligation. Capital lease acquisitions amounted to $133,000 in fiscal 1995. Future minimum rental commitments, by year and in the aggregate, under the capital lease and noncancelable operating leases with initial or remaining terms of one year or more consisted of the following at January 28, 1995:\nOperating Capital Leases Leases\nFiscal 1996 $1,433,000 $84,000 Fiscal 1997 1,403,000 24,000 Fiscal 1998 1,203,000 24,000 Fiscal 1999 1,212,000 Fiscal 2000 1,221,000 Thereafter 5,003,000 Total minimum lease payments $11,475,000 132,000 Less amount representing interest 15,000 Present value of net minimum lease payments 117,000 Less current portion 74,000 $43,000\nThe Company s minimum annual commitment of $150,000 through August 31, 1998 relating to the retail store opened in fiscal 1994 and located within ABC Carpet and Home has not been presented in the above total minimum lease payments as this lease is contingent on the attainment of specified sales levels (see Note 10).\nOn July 8, 1992, the Company entered into termination agreements with the landlord of its previous headquarters located in Roslyn Heights, and Merkert, relating to the original prime lease and sublease agreements. Pursuant to the agreement with the landlord, the Company was released from all obligations under the prime lease for consideration approximating $885,000 (including $79,000 for legal, commission and administrative fees which were paid in July 1992). Prepaid rent and a security deposit aggregating $137,000 were used to partially satisfy the above noted consideration. Approximately $345,000 has been paid by the Company through January 28, 1995. The remaining consideration of $324,000 is to be paid as follows: $115,000 annually on January 1, 1996 and 1997 and $94,000 on January 1, 1998. In conjunction with the termination agreements and with the consent of the Bank, the Company assigned the remaining amounts to be received from Merkert to the landlord (see Note 2). Remaining amounts due to the landlord under the settlement are included in the balance sheet caption \"Accrued Costs Related to Discontinued Operations\".\nTotal rental expense for operating leases was $1,180,000, $1,038,000, and $999,000 in fiscals 1995, 1994 and 1993, respectively. Certain leases provide for the payment of insurance, maintenance charges and taxes and contain renewal options.\nCONTINGENCIES\nThe Company or its subsidiaries are defendants in certain legal actions which arose in the normal course of business, the outcome of which, in the opinion of management, will not have a material effect on the Company s financial position or operations.\nThe Company had available standby letters of credit outstanding at January 28, 1995, aggregating $185,000.\n9. OTHER INFORMATION\nACCRUED EXPENSES AND OTHER CURRENT LIABILITIES\nIncluded in accrued expenses and other current liabilities at January 28, 1995 and January 29, 1994 were the following:\n1995 1994 Salaries, severance, vacation and incentives $167,349 $189,963 Accrued professional fees 35,575 54,631 401(k)\/defined contribution and employee benefits 12,079 23,049 Customer layaways 288,393 283,273 Sales tax 134,504 115,092 New York State audit accrued interest 35,000 50,000 Other 138,555 131,226 $811,455 $847,234\nCURRENT PORTION OF LONG TERM LIABILITIES 1995 1994 Current portion of term loan to Bank $255,000 $ - Deferred compensation agreement 60,481 74,949 Notes payable Audio Exchange (Note 4) 50,000 Notes payable truck financing (Note 4) 15,120 28,881 Accrued expenses restructured\/ reclassified (legal fees) 183,083 207,687 Miscellaneous 16,344 - $530,028 $361,517\nOTHER LONG TERM LIABILITIES 1995 1994 Deferred compensation agreements $113,996 $180,785 Straight line impact of lease escalations 282,720 172,796 Accrued expenses restructured\/reclassified (legal fees) 184,230 179,313 Other - 50,000 $580,946 $582,894\nOTHER MATTERS\nIn connection with the refinancing on May 2, 1994 (see Note 4), the Company s chief executive officer\/chairman ( officer ) purchased from the Company certain life insurance policies and their related cash surrender values ($153,371). In consideration, the Company received a promissory note bearing interest at 6% from such officer, which is included in other long-term assets, to be repaid in six equal installments beginning January 1, 1997. Interest and principal payments on the note were pledged to Congress by the Company and, in addition, the officer provided a limited guarantee of up to $150,000 to Congress relating to the revolving credit facility.\nLegal fees payable to a law firm, a partner of which is a director\/shareholder\/Debenture holder of the Company were $239,000 and $210,000, at January 28, 1995 and January 29, 1994, respectively.\nThe financial statement caption, \"Interest and Other Income\" includes $135,059, $489,076 and $557,004 of interest, consulting and other income relating to proceeds of the sale of the Boerner Division, for fiscal 1995, 1994 and 1993, respectively.\n10. NEW STORE OPENINGS\nOn September 4, 1993, the Company opened a new retail store located within ABC Carpet and Home (\"ABC\"), a New York City based specialty retailer of high quality home furnishings and carpets. This new merchandising alliance was completed pursuant to a five year License Agreement (\"License Agreement\") between the Company and C&W Furniture, Inc., a subsidiary of ABC (see Note 4).\nAt anytime after the first year, the Company has the right to terminate the License Agreement if net sales for the new store (as defined) are less that $1,500,000 for any year. ABC has the right to terminate the License Agreement after the second year if a default of any substantial performance provision (as defined) occurs.\nOn October 30, 1994 the Company opened a new retail store located on 57th Street in Manhattan. Accordingly, the Company entered into a ten year lease for this new store (see Note 4).\n11. PROPOSED PRIVATE PLACEMENT AND RELATED RESTRUCTING OF CERTAIN DEBT\nOn March 13, 1995 the Company announced that it would seek to raise up to $4,200,000, prior to the payment of fees and expenses, of new equity with the issuance of up to 12,000,000 shares of common stock pursuant to the terms of a Placement Agreement (the \"Placement\") entered into between the Company and Janssen-Meyers Associates, L.P. (\"Janssen-Meyers\"). The Placement will be on a best efforts all or none basis as to 7,500,000 shares and a best efforts basis as to an additional 4,500,000 shares. It is anticipated that the price per share sold in the Placement will be between $.35 and $.38. In connection with the Placement, the Company will issue to Janssen-Meyers, seven-year warrants to acquire up to 2,750,000 shares of the Company s common stock at an exercise price of 120% of the price that shares are sold in the Placement.\nIn connection with the Placement, the Company also entered into a letter agreement with Capital Vision Group, Inc. (\"CVG\") pursuant to which the Company has agreed, among other things, to retain CVG as its financial and business advisor upon completion of the Placement. As compensation for CVG's services, the Company agreed, contingent upon and following the completion of the Placement, to pay CVG a cash fee equal to $6,000 per month and to grant CVG seven-year warrants to purchase 5,000,000 shares of common stock at an exercise price of $.50 per share. The Company would also pay to CVG a bonus equal to 10% of the Company s pre-tax earnings exceeding $500,000 in any given fiscal year (subject to adjustment for any fiscal year which is for a period of less than twelve months).\nThe proposed Placement is subject to certain conditions including shareholder approval and the restructuring of certain existing subordinated convertible and nonconvertible Debentures. This restructuring will require that such Debentures (aggregating $1,057,405) either (1) convert to common stock of the Company at an exchange rate equal to the price that shares of common stock are sold in the Placement or (2) exchange such Debentures for a new series of convertible subordinated Debentures bearing an interest rate of 11% per annum, maturing on July 1, 2000 and convertible into shares of common stock at a conversion price of $1.15 per share. To the extent that Convertible Subordinated Debenture holders elect to convert their debt into Common Stock, the Company would be required to recognize a charge equal to the value of the Common Stock issued in the conversion in excess of the value of the Common Stock that would have been currently received under the original conversion terms.\nIn conjunction with the approval of the Placement, and as a condition of the Placement, the shareholders will also be required to approve an Amendment to the Company s Restated Certificate of Incorporation, which will increase the amount of authorized common stock from 5,000,000 shares to 50,000,000 shares, reduce the par value of the common stock from $1.00 per share to $.01 per share and increase the authorized preferred stock from 100,000 shares to 2,500,000 shares.\nAs soon as practicable following the successful completion of the Placement, and subject to shareholders approval, the Company will effect a reverse stock split whereby each four shares of common stock will be combined into one share of common stock. The amended par value will remain at $.01 per share.\nProceeds from the proposed Placement, after related expenses, will be used: (1) to reduce trade accounts payable, (2) to reduce amounts outstanding under the revolving line of credit facility and (3) as additional working capital, as deemed appropriate by the Company.\nSCHEDULE II VALUATION AND QUALIFYING ACCOUNTS\nTHE HARVEY GROUP INC. AND SUBSIDIARIES\nCOL. A COL. B COL. C COL. D COL. E ADDITIONS\nAdditions Charged to Other Balance charged to other changes - Balance at beginning costs and accounts add (deduct) at end Description of period expenses - describe - describe of period\nFISCAL YEAR ENDED JANUARY 28, 1995 Reserves and allowances deducted from assets accounts:\nAllowance for doubtful $12,500 $13,000 $(500)(1) $25,000 accounts\nFISCAL YEAR ENDED JANUARY 29, 1994 Reserves and allowances deducted from asset accounts: Allowance for doubtful accounts $10,000 $11,488 $(8,988)(1) $12,500\nFISCAL YEAR ENDED JANUARY 30, 1993 Reserves and allowances deducted from asset accounts: Allowance for doubtful accounts $95,000 $43,717 (2) $(128,717)(1) $10,000 4% reserve for reduced commission base 180,850 (180,850) 0\n(1) Uncollectible accounts written off, net of recoveries. (2) Uncollectible accounts written off and charged to accrued costs relating to discontinued operations.\nITEM 9.","section_9":"ITEM 9. CHANGES AND DISAGREEMENTS WITH AUDITORS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nInformation with respect to directors and executive officers of the Company will be included in the Company s Proxy Statement (the \"Proxy Statement\") for its annual meeting of shareholders which is expected to be filed within 120 days from the end of the fiscal year and such information is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation with respect to executive compensation is incorporated herein by reference to the Proxy Statement.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation with respect to security ownership of certain beneficial owners and management is incorporated herein by reference to the Proxy Statement.\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 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) LISTING OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nThe response to this portion of Item 14 is submitted under Item 8 - \"Financial Statements and Supplemental Data\" of this report.\n(3) LISTING OF EXHIBITS* INCORPORATED BY REFERENCE SEC File No. I-4626, Filing and Filed Description Exhibit No. Herewith\n(3) (a) Restated Certificate of December 1967 Incorporation of the Registrant 8-K Exhibit 3 (b) Certificate of Amendment to Restated September 1968 Certificate of Incorporation of the 8-K Exhibit 1 Registrant (c) Certificate of Amendment to Restated June 1969 Certificate of Incorporation of the 8-K Exhibit I Registrant (d) Certificate of Amendment to Restated May 1971 Certificate of Incorporation of the 8-K Exhibit I Registrant (e) Certificate of Amendment to Restated August 1971 Certificate of Incorporation of the 8-K Exhibit I Registrant (f) Certificate of Amendment of the July 30, 1988 Certificate of Incorporation of The 10-Q Exhibit 3h Harvey Group Inc. (g) By-laws of The Harvey Group Inc. July 30, 1988 10-Q Exhibit 3f (4) (a) Form of 10% Subordinated Debentures due January 31, 1981 July 1, 1993 10-K Exhibit 4 (b) Form of Waiver and Consent given by February 1, 1992 the holders of the 10% Subordinated 10-K Exhibit Debentures due July 1, 1993 4(b)\n* Exhibits are not contained herein except as noted. The Company will furnish any exhibits upon the payment of a fee equivalent to the expenses in furnishing such exhibits upon written request directed to Joseph J. Calabrese, Jr., Secretary.\n(10) (a) Agreement of lease dated October 17, January 31, 1981 1980, between Joseph P. Day Realty 10-K Exhibit 10o Corp., as agent for landlord and The Harvey Group Inc. as tenant relating to the premises at 2 West 45th Street utilized by the Registrant as a retail store. Period of lease July 1, 1983 to June 30, 1995. (b) Agreement of lease dated October 18, February 1, 1986 1985, between Sprout Development 10-K Exhibit 10g Co. as landlord and Harvey Electronics of Paramus, Inc., as tenant relating to the premises at 556 Route 17 North, Paramus, New Jersey 07652, utilized by the Registrant as a retail store. Period of lease November 1, 1985 to October 31, 1995. (c) Agreement of lease dated October 5, January 28, 1989 1988, between Puntillo Limited 10-K Exhibit 10o Partnership, landlord and The Harvey Group, Inc., as tenant relating to the premises at 3 Expressway Plaza, Roslyn, New York. Period of lease April 1, 1989 to March 31, 1999. (d) Lease Modification Agreement made January 28, 1989 this 24th day of January 1989 by 10-K Exhibit 10p and between The Harvey Group Inc., a tenant; and Puntillo Limited Partnership, a landlord to modify agreement of lease dated October 5, 1988. (e) The Harvey Group Inc., 1988 Stock July 30, 1988 Option Plan 10-Q Exhibit 4b (f) Agreement of lease dated November 2, January 27, 1990 1989, between Venture 600. A Joint 10-K Exhibit 10s Venture General Partnership, as landlord and Harvey Sound Inc. as tenant related to the premises at 600 Secaucus Road, Secaucus, New Jersey, utilized by the Registrant as a warehouse, outlet store and administrative office. Period of lease January 1, 1990 to March 31, 1999. (g) Assignment and Assumption Agreement January 27, 1990 dated May 4, 1989 by and between 10-K Exhibit 10t Audio Exchange of Westbury, Inc. (the assignor) and The Harvey Group, Inc. (the assignee) and Agreement of lease dated January 1, 1985 between Century Investors Corporation, as landlord and Audio Exchange o Westbury, Inc., as tenant relating to premises at 485 Old Country Road, Westbury, utilized by the Registrant as a retail store. (h) Asset Purchase Agreement, dated as January 30, 1992 of January 17, 1992, as amended as Form 8-K of January 23, 1992, by and between Exhibit 28.5 The Harvey Group, Inc. and Merkert Enterprises, Inc. (i) Continuing general security Form 10-Q for agreement for The Harvey Group, the Quarter ended Inc. dated August 16, 1991 August 3, 1991 Exhibit 2 (j) Continuing general security Form 10-Q for agreement for Harvey Sound, Inc. the Quarter ended dated August 16, 1991. August 3, 1991 Exhibit 3 (k) Continuing general security Form 10-Q for agreement for Harvey Electronics of the Quarter ended Paramus, Inc., dated August 16, August 3, 1991 1991. Exhibit 4 (l) Guarantee agreement by Harvey Sound, Form 10-Q for Inc. dated August 16, 1991. the Quarter ended August 3, 1991 Exhibit 5 (m) Guarantee agreement by Harvey Form 10-Q for Electronics of Paramus, Inc., dated the Quarter ended August 16, 1991. August 3, 1991 Exhibit 6 (n) Lessor's Consent, Certificate and February 1, 1992 Lease Modification Agreement by and 10-K Exhibit (gg) between LKM Expressway Plaza Limited Partnership (formerly known as Puntillo Limited Partnership), The Harvey Group Inc. and Merkert Enterprises. (o) Promissory Note dated May 15, 1992 February 1, 1992 issued by The Harvey Group, Inc. to 10-K Exhibit (hh) Kelly Drye and Warren in the principal amount of $360,000. (p) Form of Common Stock and Form 8-K dated Subordinated Convertible Debenture August 7, 1992 Subscription and Registration Exhibit 28(b) Rights Agreement. (q) Form of Convertible Subordinated Form 8-K dated Debenture due July 1, 1997 issued August 7, 1992 by The Harvey Group. Exhibit 28(c) (r) Amendment to Prime Lease and Form 10-Q for Termination Agreement dated the Quarter ended July 8, 1992. August 1, 1992 Exhibit 1 (s) Sublease Amendment and Termination Form 10-Q for Agreement dated July 8, 1992. the Quarter ended August 1, 1992 Exhibit 2 (t) Assignment Agreement dated July 8, Form 10-Q for 1992. the Quarter ended August 1, 1992 Exhibit 3 (u) Consent and Release Agreement with Form 10-Q for National Westminster Bank USA dated the Quarter ended July 1, 1992. August 1, 1992 Exhibit 4 (v) Exchange Agreement between The Form 10-K Harvey Group and Windcrest Partners January 30, 1993 Exhibit (kk) (w) Employment Agreement between The Form 10-K Harvey Group and Arthur Shulman. January 30, 1993 Exhibit (ll) (x) Letter Agreement, dated April 16, Form 10-K 1993, between The Harvey Group and January 30, Merkert Enterprises, Inc. 1993 Exhibit (mm) (y) Consent to Extension of Maturity and Form 10-K letter of Transmittal dated July January 30, 28, 1992. 1993 Exhibit (nn) (z) Store Financing Loan Agreement dated Form 10-Q for August 31, 1993. the Quarter ended July 31, 1993 (aa) Subordinated Convertible Promissory Form 10-Q for Note dated August 31, 1993. the Quarter ended July 31, 1993 (bb) Security Agreement between The Harvey Form 10-Q for Group Inc. the Quarter ended and Interequity Capital Partners, L.P. July 31, 1993 dated August 31, 1993. (cc) Security Agreement between Harvey Sound Form 10-Q for Inc. and Interequity Capital Partners, the Quarter ended L.P. dated August 31, 1993. July 31, 1993 (dd) Unlimited Continuing Guaranty by Harvey Form 10-Q for Sound Inc. dated August 31, 1993. the Quarter ended July 31, 1993 (ee) Third Party Pledge Agreement Form 10-Q for (intercreditor agreement between The the Quarter ended Harvey Group Inc., Interequity Capital July 31, 1993 Partners, L.P. and National Westminster Bank U.S.A. dated August 31, 1993 (ff) License Agreement dated July 30, 1993. Form 10-Q for Quarter ended July 31, 1993 (gg) Loan and Security Agreement between Form 10-K Congress Financial Corporation and January 30, The Harvey Group Inc. and Harvey Sound 1994 Exhibit Inc. dated May 2, 1994. (qq) (hh) Guarantee to Congress Financial Form 10-K Corporation by The Harvey Group Inc. January 30, dated May 2, 1994 1994 Exhibit (rr) (ii) Guarantee to Congress Financial Form 10-K Corporation by Harvey Sound Inc. January 30, dated May 2, 1994 1994 Exhibit (ss) (jj) Subordination and Intercreditor Form 10-K Agreement between Congress Financial January 30, Corporation, National Westminster 1994 Exhibit (tt) Bank U.S.A. and Interequity Capital Partners, L.P., dated May 2, 1994. (kk) Amendment Agreement to Interest Bearing Form 10-K Grid Not dated August 16, 1991 with January 30, National Westminster Bank U.S.A. 1994 Exhibit (uu) dated May 2, 1994. (ll) Waiver and Amendment Agreement to Store Form 10-K Financing Loan Agreement dated January 30, August 31, 1993, dated May 2, 1994. 1994 Exhibit (vv) (mm) Amendment to Asset Purchase Agreement Form 10-K dated January 17, 1992 between Merkert January 30, Enterprises Inc. and The Harvey Group 1994 Exhibit (ww) Inc., dated May 2, 1994. (nn) Promissory Note issued by Harvey E. Form 10-K Sampson to T Harvey Group Inc. dated January 30, May 2, 1994. 1994 Exhibit (xx) (oo) Limited Guarantee by Harvey E. Sampson Form 10-K to Congress Financial Corporation January 30, dated May 2, 1994. 1994 Exhibit (yy) (pp) Stock Pledge Agreement between The Form 10-K Harvey Group Inc. and Congress January 30, Financial Corporation dated May 2, 1994 Exhibit (zz) 1994. (qq) Supplemental Store Financing Loan Form 10-Q for the Agreement date August 30, 1994. Quarter ended July 30, 1994 Exhibit 1 (rr) Subordinated Promissory Note dated Form 10-Q for the August 30, 1994. Quarter ended July 30, 1994 Exhibit 2 (ss) Amendment No. 1 to the Subordination Form 10-Q for the and Intercreditor Agreement between Quarter ended The Harvey Group Inc., Congress July 30, 1994 Financial Corporation InterEquity Exhibit 3 Capital Partners, L.P. and National Westminster Bank U.S.A. dated August 30, 1994. (tt) Warrant Agreement dated August 30, Form 10-Q for the 1994 between The Harvey Group Inc. Quarter ended and InterEquity Capital Partners, L.P. July 30, 1994 Exhibit 4 (uu) Lease Agreement dated September 2, Form 10-Q for the 1994 between Musart Associates and Quarter ended The Harvey Group Inc. July 30, 1994 Exhibit 5 (vv) Letter Agreement dated March 10, 1995, March 10, 1995 by and between The Harvey Group Inc. Form 8-K and Janssen-Meyers Associates, L.P. Exhibit 99.1 (ww) Letter Agreement dated March 9, 1995, March 10, 1995 by and between The Harvey Group Inc. Form 8-K and Capital Vision Group. Exhibit 99.2 (xx) Press Release dated March 13, 1995, March 10, 1995 issued by The Harvey Group Inc. Form 8-K Exhibit 99.3 (yy) Lease Modification and Extension x Agreement dated January 26, 1995 between Joseph P. Day Realty Corp. and The Harvey Group Inc.\n(21) Subsidiaries of the Registrant as required by Regulation S-K of Item 601.\n(23) Consent of Ernst & Young LLP, Independent Auditors.\n(b) Reports on Form 8-K filed in the Fourth Quarter of Fiscal Year Ended January 28, 1995\nNo reports on Form 8-K were filed during the fourth quarter of the fiscal year ended January 28, 1995\n(c) Exhibits\nExhibits as required by Item 601 of the Regulation S-K are listed in Section (a)(3) above.\n(d) Financial Statement Schedules\nThe response to this portion of Item 14 is submitted under Item 8 - \"Financial Statements and Supplemental Data\" 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.\nThe Harvey Group Inc. _____________________________________ (Registrant)\n\/s\/ Arthur Shulman May 8, 1995 ______________________________________ Arthur Shulman, President (Date) and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\n\/s\/ Joseph J. Calabrese, Jr. May 8, 1995 __________________________________________ __________________________ Joseph J. Calabrese, Jr., Vice President, (Date) Secretary, Chief Financial Officer, Chief Accounting Officer\n\/s\/ Michael E. Gellert May 8, 1995 ____________________________________________ ___________________________ Michael E. Gellert, Director (Date)\n\/s\/ Mark N. Kaplan May 8, 1995 ____________________________________________ ___________________________ Mark N. Kaplan, Director (Date)\n\/s\/ William F. Kenny III May 8, 1995 ____________________________________________ ___________________________ William F. Kenny, III, Director (Date)\n\/s\/ Harvey E. Sampson May 8, 1995 ____________________________________________ ___________________________ Harvey E. Sampson, Chairman of the Board (Date)\n\/s\/ Arthur Shulman May 8, 1995 ____________________________________________ ___________________________ Arthur Shulman, Director (Date)\nEXHIBIT INDEX\nExhibit No. Description\n10 (yy) Lease Modification and Extension Agreement dated January 26, 1995 between Joseph P. Day Realty Corp. and The Harvey Group Inc.\n21 Subsidiaries of the Registrant as required by Regulation S-K Item 601.\n23 Consent of Ernst & Young LLP, Independent Auditors","section_15":""}
{"filename":"782975_1995.txt","cik":"782975","year":"1995","section_1":"ITEM 1. BUSINESS\nTHE PARTNERSHIP. Cable TV Fund 12-C, Ltd. (the \"Partnership\") is a Colorado limited partnership that was formed pursuant to the public offering of limited partnership interests in the Cable TV Fund 12 Limited Partnership Program (the \"Program\"), which was sponsored by Jones Intercable, Inc. (the \"General Partner\"). Cable TV Fund 12-A, Ltd. (\"Fund 12-A\"), Cable TV Fund 12-B, Ltd. (\"Fund 12-C\") and Cable TV Fund 12-D, Ltd. (\"Fund 12-D\") are the other partnerships that were formed pursuant to that Program. In 1986, the Partnership, Fund 12-B and Fund 12-D formed a general partnership known as Cable TV Fund 12-BCD Venture (the \"Venture\"), in which the Partnership owns a 15 percent interest, Fund 12-B owns a 9 percent interest and Fund 12-D owns a 76 percent interest. The Partnership and the Venture were formed for the purpose of acquiring and operating cable television systems.\nThe Partnership does not directly own any cable television systems. The Partnership's sole asset is its 15 percent interest in the Venture. The Venture recently sold one of its cable television systems as described below and now owns the cable television systems serving Palmdale, Lancaster and Rancho Vista and the military installation of Edwards Air Force Base, all in California (the \"Palmdale\/Lancaster System\") and Albuquerque, New Mexico (the \"Albuquerque System\"). See Item 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe cable television systems owned by the Venture are described below:\nThe following sets forth (i) the monthly basic plus service rates charged to subscribers and (ii) the number of basic subscribers and pay units 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. 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, 1995, the Palmdale\/Lancaster System operated cable plant passing approximately 90,800 homes, representing an approximate 68% penetration rate, and the Albuquerque System operated cable plant passing approximately 223,800 homes, representing an approximate 49% penetration rate. Figures for numbers of subscribers and homes passed are compiled from the General Partner's records and may be subject to adjustments.\n* The decrease in pay units between 1993 and 1994 was primarily due to the conversion of The Disney Channel from a premium service to a basic plus service.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nOn September 20, 1995, a civil action entitled David Hirsch, on behalf of himself and all others similarly situated, Plaintiff, vs. Jones Intercable, Inc., Defendant, was filed in the District Court, County of Arapahoe,\nState of Colorado (Case No. 95-CV-1800). The plaintiff has brought the action as a purported class action on behalf of himself and all other limited partners of Fund 12-D against the General Partner seeking to recover damages caused by the General Partner's alleged breaches of its fiduciary duties to the limited partners of Fund 12-D in connection with the sale of the Tampa System and the subsequent exchange of the Tampa System with an unaffiliated cable television system operator in return for systems owned by that operator. The plaintiff also seeks certain equitable and injunctive relief. On January 25, 1996, the plaintiff filed an amended complaint and request for a jury trial. On February 20, 1996, the General Partner filed a Motion to Dismiss the Amended Complaint on the ground that it fails to state a claim upon which relief can be granted as a matter of law. The General Partner believes that it has meritorious defenses, and the General Partner intends to defend this lawsuit vigorously.\nOn November 17, 1995, a civil action entitled Martin Ury, derivatively on behalf of Cable TV Fund 12-B, Ltd., Cable TV Fund 12-C, Ltd. and Cable TV Fund 12-D, Ltd., Plaintiff vs. Jones Intercable, Inc., Defendant and Cable TV Fund 12-BCD Venture, Cable TV Fund 12-B, Ltd., Cable TV Fund 12-C, Ltd. and Cable TV Fund 12-D, Ltd., Nominal Defendants, was filed in the District Court, County of Arapahoe, State of Colorado (Case No. 95-CV-2212). The plaintiff, a limited partner of Fund 12-D, has brought the action as a derivative action on behalf of the three partnerships that comprise the Venture against the General Partner seeking to recover damages caused by the General Partner's alleged breaches of its fiduciary duties to the Venture and to the three partnerships that comprise the Venture (and their respective limited partners) in connection with the sale of the Tampa System and the subsequent exchange of the Tampa System with an unaffiliated cable television system operator in return for systems owned by that operator. On February 1, 1996, the General Partner filed a Motion to Dismiss the Complaint on the ground that it fails to state a claim upon which relief can be granted as a matter of law. The Motion also asserts that the plaintiff does not have standing to bring a claim on behalf of Fund 12-B and Fund 12-C and their respective limited partners. The General Partner believes that it has meritorious defenses, and the General Partner intends to defend this lawsuit vigorously.\nPursuant to the indemnification provisions of Section 9.6 of the Partnership's limited partnership agreement, the General Partner may be entitled to indemnification from the Partnership for its legal fees and expenses, and for any amounts paid in settlement, in defending the above-described lawsuits. The General Partner cannot determine at this time whether such amounts 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 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, 1996, the number of equity security holders in the Partnership was 3,620.\nItem 6.","section_6":"Item 6. Selected Financial Data\n* Activity in Cable TV Fund 12-C, Ltd. is limited to its equity interest in Cable TV Fund 12-BCD Venture.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nCABLE TV FUND 12-C, LTD.\nRESULTS OF OPERATIONS\nAll of Cable TV Fund 12-C, Ltd.'s (\"Fund 12-C's\") operations are represented by its 15 percent interest in Cable TV Fund 12-BCD Venture (the \"Venture\"). Thus, Management's Discussion and Analysis of the Venture should be consulted for pertinent comments regarding Fund 12-C's performance.\nFINANCIAL CONDITION\nFund 12-C's investment in the Venture has decreased by $1,699,611 when compared to the December 31, 1994 balance, representing a deficit of $4,702,099. This deficit is due to Fund 12-C's share of Venture losses, which are principally the result of depreciation and amortization charges being greater than equity invested. These losses are expected to be recovered upon liquidation of the Venture.\nOn February 28, 1996, the Venture sold the cable television system serving areas in and around Tampa, Florida (the \"Tampa System\") to Jones Cable Holdings, Inc. (\"JCH\"), a wholly owned subsidiary of the General Partner, for the sales price of $110,395,667, subject to normal working capital closing adjustments. This price represented the average of three separate, independent appraisals of the fair market value of the Tampa System. Because the Venture's debt arrangements did not allow the Venture to make distributions on the sale of Venture assets, in February 1996 the Venture's existing debt arrangements were amended to permit a $55,000,000 distribution to the Venture's partners from the sale proceeds, and the balance of the sale proceeds were used to reduce Venture indebtedness. The Partnership's portion of this distribution is $8,404,000. Because the limited partners have not yet received distributions in an amount equal to 100 percent of the capital initially contributed to the Partnership by them, the entire portion of the Partnership's distribution will be distributed to the limited partners in April 1996. This distribution will give the Partnership's limited partners an approximate return of $346 for each $1,000 invested in the Partnership. Because the Tampa System did not constitute all or substantially all of the Venture's assets, no vote of the limited partners of the Partnership was required in connection with this transaction.\nCABLE TV FUND 12-BCD VENTURE\nRESULTS OF OPERATIONS\n1995 compared to 1994\nRevenues of Cable TV Fund 12-BCD Venture (the \"Venture\") increased $8,576,621, or approximately 9 percent, to $101,399,697 in 1995 from $92,823,076 in 1994. At December 31, 1995, the Venture's systems had 236,866 basic subscribers compared to 227,950 basic subscribers at December 31, 1994, an increase of approximately 4 percent. This increase in basic subscribers accounted for approximately 39 percent of the increase in revenues. Basic service rate increases accounted for approximately 37 percent of the increase in revenues. No other single factor significantly affected the increase in revenues.\nOperating expenses consist primarily of costs associated with the administration of the Venture's cable television systems. The principal cost components are salaries paid to system personnel, programming expenses, professional fees, subscriber billing costs, rent for leased facilities, cable system maintenance expenses and consumer marketing expenses.\nOperating expenses in the Venture's systems increased $2,220,438, or approximately 4 percent, to $58,351,692 in 1995 from $56,131,254 in 1994. Operating expenses represented approximately 57 percent and approximately 60 percent of revenues in 1995 and in 1994, respectively. The increase in operating expenses was due to increases in subscriber related costs, programming fees, property tax expenses and advertising related costs, which were partially offset by decreases in personnel related costs. No other single factor significantly affected the increase in operating expenses.\nManagement fees and allocated overhead from Jones Intercable, Inc. increased $661,384, or approximately 6 percent, to $12,253,648 in 1995 from $11,592,264 in 1994 due to the increase in revenues, upon which such fees and allocations are based.\nDepreciation and amortization expense increased $1,857,081, or approximately 7 percent, to $26,666,735 in 1995 from $24,809,654 in 1994. This increase was due to the increase in the Venture's depreciable asset base.\nThe Venture's operating income increased $3,837,718 to $4,127,622 in 1995 from $289,904 in 1994. This increase was the result of increases in revenues exceeding the increases in operating expenses, management fees and allocated overhead from Jones Intercable, Inc. and depreciation and amortization expenses.\nThe cable television industry generally measures the financial performance of a cable television system in terms of cash flow or operating income before depreciation and amortization. The value of a cable television system is often determined using multiples of cash flow. This measure is not intended to be a substitute or improvement upon the items disclosed on the financial statements, rather it is included because it is an industry standard. Operating income before depreciation and amortization increased $5,694,799, or approximately 23 percent, to $30,794,357 in 1995 from $25,099,558 in 1994. This increase was due to the increase in revenues exceeding the increase in operating expenses and management fees and allocated overhead from Jones Intercable, Inc.\nInterest expense increased $2,190,557, or approximately 17 percent, to $15,347,250 in 1995 from $13,156,693 in 1994 due to higher interest rates and higher outstanding balances on interest bearing obligations in 1995.\nNet loss decreased $1,751,675, or approximately 14 percent, to $11,124,567 in 1995 from $12,876,242 in 1994 due to the factors discussed above.\n1994 compared to 1993\nRevenues of the Venture increased $3,691,546, or approximately 4 percent, to $92,823,076 in 1994 from $89,131,530 in 1993. At December 31, 1994, the Venture's systems had 227,950 basic subscribers compared to 213,072 basic subscribers at December 31, 1993, an increase of approximately 7 percent. This increase in basic subscribers accounted for approximately 37 percent of the increase in revenues. Increases in advertising sales activity accounted for approximately 28 percent of the increase in revenues. Increases in premium service and pay-per-view revenues accounted for approximately 27 percent of the increase. The increase in revenues would have been greater but for the reduction in\nbasic rates due to new basic rate regulations issued by the FCC in May 1993 with which the Venture complied effective September 1, 1993. No other single factor significantly affected the increase in revenues.\nOperating expenses in the Venture's systems increased $4,057,270, or approximately 8 percent, to $56,131,254 in 1994 from $52,073,984 in 1993. Operating expenses represented approximately 60 percent and approximately 58 percent of revenues in 1994 and in 1993, respectively. The increase in operating expenses was due to increases in subscriber related costs, programming fees and marketing related costs. No other single factor significantly affected the increase in operating expenses.\nManagement fees and allocated overhead from Jones Intercable, Inc. increased $1,086,904, or approximately 10 percent, to $11,592,264 in 1994 from $10,505,360 in 1993 due to the increase in revenues, upon which such fees and allocations are based, and an increase in allocated expenses from Jones Intercable, Inc. Jones Intercable, Inc. experienced increases in expenses in 1994.\nDepreciation and amortization expense decreased $962,645, or approximately 4 percent, to $24,809,654 in 1994 from $25,772,299 in 1993. This decrease was due to the maturation of the Venture's asset base.\nThe Venture's operating income decreased $489,983, or approximately 63 percent, to $289,904 in 1994 from $779,887 in 1993. This decrease was the result of increases in operating expenses and management fees and allocated overhead from Jones Intercable, Inc. exceeding the increases in revenues and was offset by the decreases in depreciation and amortization expenses.\nOperating income before depreciation and amortization decreased $1,452,628, or approximately 5 percent, to $25,099,558 in 1994 from $26,552,186 in 1993. This decrease was due to the increase in operating expenses and management fees and allocated overhead from Jones Intercable, Inc. exceeding the increase in revenues.\nInterest expense increased $1,288,625, or approximately 11 percent, to $13,156,693 in 1994 from $11,868,068 in 1993 due to higher interest rates and higher outstanding balances on interest bearing obligations in 1994.\nNet loss increased $1,291,826, or approximately 11 percent, to $12,876,242 in 1994 from $11,584,416 in 1993 due to the factors discussed above.\nFINANCIAL CONDITION\nFor the twelve months ended December 31, 1995, the Venture generated net cash from operating activities totaling approximately $18,100,250, which was available to fund capital expenditures and non-operating costs. Capital expenditures for the Venture totaled approximately $21,500,000 during 1995. Service drops to homes accounted for approximately 41 percent of the capital expenditures. New plant construction accounted for approximately 19 percent of the capital expenditures. Approximately 10 percent of capital expenditures was for converters. The remaining expenditures related to various system enhancements. These capital expenditures were funded primarily from cash generated from operations and borrowings from the General Partner. Expected capital expenditures for 1996 are approximately $15,200,000. Service drops to homes are anticipated to account for approximately 43 percent. Approximately 31 percent of budgeted capital expenditures is for new plant construction. The remainder of the expenditures are for various system enhancements in all of the Venture's systems. Funding for these expenditures is expected to be provided by cash on hand, cash generated from operations and borrowings from the Venture's amended credit facility. The Venture has sufficient sources of capital available in its ability to generate cash from operations and to borrow under its credit facility to meet its presently anticipated needs.\nOn August 11, 1995, the Venture entered into a purchase and sale agreement pursuant to which it agreed to sell its Tampa, Florida system (the \"Tampa System\") to the General Partner for a sales price of $110,395,667, subject to working capital adjustments. The General Partner assigned its rights and obligations under the purchase and sale agreement to Jones Cable Holdings, Inc., a wholly owned subsidiary of the General Partner. Closing of this sale occurred on February 28, 1996. The sales price represented the average of three separate, independent appraisals of the fair market value of the Tampa System. The net sales proceeds were used to make a $55,000,000 distribution to the Venture's partners, with the remainder of the proceeds used to reduce the Venture's debt. The net sales proceeds were distributed as follows: Fund 12-B received $5,049,000; Fund 12-C received $8,404,000 and Fund 12-D received $41,547,000.\nThe Venture's debt arrangements at December 31, 1995 consisted of $93,000,000 of Senior Notes placed with a group of institutional lenders and an $87,000,000 credit facility with a group of commercial bank lenders.\nThe Senior Notes have a fixed interest rate of 8.64 percent and a final maturity date of March 31, 2000. The Senior Notes call for payments of interest only through March 1996, with interest and accelerating amortization of principal payments required for the four years thereafter. In February 1996, the Venture was required to make a principal repayment of approximately $33,650,000 from proceeds received from the sale of the Tampa System. The Senior Notes carry a \"make-whole\" payment, which is a prepayment penalty, in the event the notes are prepaid prior to maturity. The make-whole payment protects the lenders in the event that prepaid funds are reinvested at a rate below 8.64 percent. The Venture was required to pay a make-whole payment in February 1996 of approximately $2,217,000. Principal and interest payments due in 1996 are expected to be funded from cash on hand, cash generated from operations and borrowings under the Venture's new credit facility, as discussed below. Installments due on the Senior Notes, subsequent to the February 1996 repayment, each year for the five year period ended December 31, 2000 are: $3,956,656, $7,913,313, $11,869,968, $15,826,624 and $19,783,282, respectively.\nThe balance outstanding on the Venture's credit agreement at December 31, 1995 was $87,000,000. However, upon the sale of the Tampa System and, as required under the Venture's credit facility, $22,000,000 of the sale proceeds were used to reduce amounts outstanding under its credit facility, leaving $65,000,000 outstanding. In February 1996, the Venture increased the amount available to $120,000,000 to meet the Venture's long-term financing requirements. The amended credit facility matures on December 31, 1999 or, at the Venture's option, on December 31, 2004. In the event the Venture elects the latter maturity date, the credit facility shall amortize in consecutive quarterly amounts. Interest on the amended credit facility is at the Venture's option of the London Interbank Offered Rate plus .625 percent to 1.375 percent, the Base Rate plus 0 percent to .375 percent or the Certificate of Deposit Rate plus .75 percent to 1.50 percent.\nBoth lending facilities are equal in standing with the other, and both are equally secured by the assets of the Venture.\nAt December 31, 1995, amounts payable to the General Partner totaled $4,198,739. By February 1996, this balance had increased to approximately $5,100,000, which amount was repaid to the General Partner with borrowings from the Venture's amended credit facility.\nThe General Partner believes that cash generated from operations and borrowings from the Venture's amended credit facility will be sufficient to fund capital expenditures and other liquidity needs of the Venture.\nREGULATION AND LEGISLATION\nThe Venture has filed cost-of-service showings in response to rulemakings concerning the 1992 Cable Act for its systems and thus anticipates no further reductions in rates in these systems. The cost-of-service showings have not yet received final approvals from regulatory authorities, however, and there can be no assurance that the Venture's cost-of- service showings will prevent further rate reductions in these systems until such final approvals are received.\nThe Telecommunications Act of 1996 (the \"1996 Act\"), which became law on February 8, 1996, substantially revised the Communications Act of 1934, as amended, including the 1984 Cable Act and the 1992 Cable Act, and has been described as one of the most significant changes in communications regulation since the original Communications Act of 1934. The 1996 Act is intended, in part, to promote substantial competition in the telephone local exchange and in the delivery of video and other services. As a result of the 1996 Act, local telephone companies (also known as local exchange carriers or \"LECs\") and other service providers are permitted to provide video programming, and cable television operators are permitted entry into the telephone local exchange market. The FCC is required to conduct rulemaking proceedings over the next several months to implement various provisions of the 1996 Act.\nAmong other provisions, the 1996 Act modified the 1992 Cable Act by deregulating the cable programming service tier of large cable operators including the Partnership and Venture effective March 31, 1999 and the cable programming service tier of \"small\" cable operators in systems providing service to 50,000 or fewer subscribers effective immediately. The 1996 Act also revised the procedures for filing cable programming service tier rate complaints and adds a new effective competition test.\nIt is premature to predict the specific effects of the 1996 Act on the cable industry in general or the Venture in particular. The FCC will be undertaking numerous rulemaking proceedings to interpret and implement the 1996 Act. It is not possible at this time to predict the outcome of those proceedings or their effect on the Venture. See Item 1.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements\nCABLE TV FUND 12-C, LTD. AND CABLE TV FUND 12-BCD VENTURE\nFINANCIAL STATEMENTS\nAS OF DECEMBER 31, 1995 AND 1994\nINDEX\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Partners of Cable TV Fund 12-C, Ltd.:\nWe have audited the accompanying balance sheets of CABLE TV FUND 12-C, LTD. (a Colorado limited partnership) as of December 31, 1995 and 1994, and the related statements of operations, partners' deficit and cash flows for each of the three years in the period ended December 31, 1995. These financial statements are the responsibility of the General Partner's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Cable TV Fund 12-C, Ltd. as of December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\n\/s\/ ARTHUR ANDERSEN LLP ARTHUR ANDERSEN LLP\nDenver, Colorado, March 8, 1996.\nCABLE TV FUND 12-C, LTD. (A Limited Partnership)\nBALANCE SHEETS\nThe accompanying notes to financial statements are an integral part of these balance sheets.\nCABLE TV FUND 12-C, LTD. (A Limited Partnership)\nSTATEMENTS OF OPERATIONS\nThe accompanying notes to financial statements are an integral part of these statements.\nCABLE TV FUND 12-C, LTD. (A Limited Partnership)\nSTATEMENTS OF PARTNERS' DEFICIT\nThe accompanying notes to financial statements are an integral part of these statements.\nCABLE TV FUND 12-C, LTD. (A Limited Partnership)\nSTATEMENTS OF CASH FLOWS\nThe accompanying notes to financial statements are an integral part of these statements.\nCABLE TV FUND 12-C, LTD. (A Limited Partnership)\nNOTES TO FINANCIAL STATEMENTS\n(1) ORGANIZATION AND PARTNERS' INTERESTS\nFormation and Business\nCable TV Fund 12-C, Ltd. (\"Fund 12-C\"), a Colorado limited partnership, was formed on October 9, 1985, under a public program sponsored by Jones Intercable, Inc. Fund 12-C was formed to acquire, construct, develop and operate cable television systems. Jones Intercable, Inc. is the \"General Partner\" and manager of Fund 12-C. The General Partner and its subsidiaries also own and operate cable television systems. In addition, the General Partner manages cable television systems for other limited partnerships for which it is general partner and, also, for affiliated entities.\nFund 12-C owns an interest of 15 percent in Cable TV Fund 12-BCD Venture (the \"Venture\"), through capital contributions made in 1986 of $20,700,000. The Venture acquired certain cable television systems in New Mexico, California, and Florida during 1986. The Venture incurred losses of $11,124,567, $12,876,242 and $11,584,416 in 1995, 1994 and 1993, respectively, of which $1,699,611, $1,967,232 and $1,769,867, respectively, were allocated to Fund 12-C.\nSale of Cable Television System\nOn February 28, 1996, the Venture sold the cable television system serving areas in and around Tampa, Florida (the \"Tampa System\") to Jones Cable Holdings, Inc., a wholly owned subsidiary of the General Partner, for the sales price of $110,395,667, subject to normal working capital closing adjustments. This price represented the average of three separate, independent appraisals of the fair market value of the Tampa System. Because the Venture's debt arrangements did not allow the Venture to make distributions on the sale of Venture assets, in February 1996 the Venture's existing debt arrangements were amended to permit a $55,000,000 distribution to the Venture's partners from the sale proceeds, and the balance of the sale proceeds were used to reduce Venture indebtedness. The Partnership's portion of this distribution is $8,404,000. Because the limited partners have not yet received distributions in an amount equal to 100 percent of the capital initially contributed to the Partnership by them, the entire portion of the Partnership's distribution will be distributed to the limited partners in April 1996. This distribution will give the Partnership's limited partners an approximate return of $346 for each $1,000 invested in the Partnership. Because the Tampa System did not constitute all or substantially all of the Venture's assets, no vote of the limited partners of the Partnership was required in connection with this transaction.\nContributed Capital\nThe capitalization of Fund 12-C is set forth in the accompanying statements of partners' deficit. No limited partner is obligated to make any additional contributions to partnership capital.\nThe General Partner purchased its interest in Fund 12-C by contributing $1,000 to partnership capital.\nAll profits and losses of Fund 12-C are allocated 99 percent to the limited partners and 1 percent to the General Partner, except for income or gain from the sale or disposition of cable television properties, which will be allocated to the partners based upon the formula set forth in the Partnership Agreement, and interest income earned prior to the first acquisition by Fund 12-C 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. Fund 12-C's tax returns are also prepared on the accrual basis.\nThe preparation of financial statements in conformity with generally accepted accounting principles requires the General Partner's 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.\nInvestment in Cable Television Joint Venture\nThe investment in the Venture is accounted for under the equity method due to Fund 12-C's influence on the Venture as a general partner. The operations of the Venture are significant to Fund 12-C and should be reviewed in conjunction with these financial statements. Reference is made to the accompanying financial statements of the Venture on pages 25 to 34.\n(3) TRANSACTIONS WITH THE GENERAL PARTNER AND AFFILIATES\nManagement Fees and Distribution Ratios\nThe General Partner manages Fund 12-C and the Venture and receives a fee for its services equal to 5 percent of the gross revenues of the Venture, excluding revenues from the sale of cable television systems or franchises.\nAny partnership distributions made from cash flow (defined as cash receipts derived from routine operations, less debt principal and interest payments and cash expenses) are allocated 99 percent to the limited partners and 1 percent to the General Partner. Any distributions other than interest income on limited partnership subscriptions earned prior to the acquisition of Fund 12-C's first cable television system or from cash flow, such as from the sale or refinancing of a system or upon dissolution of Fund 12-C, will be made as follows: first, to the limited partners in an amount which, together with all prior distributions, will equal the amount initially contributed by the limited partners; the balance, 75 percent to the limited partners and 25 percent to the General Partner.\n(4) INCOME TAXES\nIncome taxes have not been recorded in the accompanying financial statements because they accrue directly to the partners. The Federal and state income tax returns of Fund 12-C are prepared and filed by the General Partner.\nFund 12-C's tax returns, the qualification of the Partnership as such for tax purposes, and the amount of distributable partnership income or loss are subject to examination by federal and state taxing authorities. If such examinations result in changes with respect to the Partnership's qualification as such, or in changes with respect to Fund 12-C's recorded income or loss, the tax liability of the general and limited partners would likely be changed accordingly.\nTaxable loss reported to the partners is different from that reported in the statements of operations due to the difference in depreciation recognized under generally accepted accounting principles and the expense allowed for tax purposes under the Modified Accelerated Cost Recovery System (MACRS). There are no other significant differences between taxable loss and the net loss reported in the statements of operations.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Partners of Cable TV Fund 12-BCD Venture:\nWe have audited the accompanying balance sheets of CABLE TV FUND 12-BCD VENTURE (a Colorado general partnership) as of December 31, 1995 and 1994, and the related statements of operations, partners' deficit and cash flows for each of the three years in the period ended December 31, 1995. 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 Fund 12-BCD Venture as of December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\n\/s\/ ARTHUR ANDERSEN LLP ARTHUR ANDERSEN LLP\nDenver, Colorado, March 8, 1996.\nCABLE TV FUND 12-BCD VENTURE (A General Partnership)\nBALANCE SHEETS\nThe accompanying notes to financial statements are an integral part of these balance sheets.\nCABLE TV FUND 12-BCD VENTURE (A General Partnership)\nBALANCE SHEETS\nThe accompanying notes to financial statements are an integral part of these balance sheets.\nCABLE TV FUND 12-BCD VENTURE (A General Partnership)\nSTATEMENTS OF OPERATIONS\nThe accompanying notes to financial statements are an integral part of these statements.\nCABLE TV FUND 12-BCD VENTURE (A General Partnership)\nSTATEMENTS OF PARTNERS' DEFICIT\nThe accompanying notes to financial statements are an integral part of these statements.\nCABLE TV FUND 12-BCD VENTURE (A General Partnership)\nSTATEMENTS OF CASH FLOWS\nThe accompanying notes to financial statements are an integral part of these statements.\nCABLE TV FUND 12-BCD VENTURE (A General Partnership)\nNOTES TO FINANCIAL STATEMENTS\n(1) ORGANIZATION AND PARTNERS' INTERESTS\nFormation and Business\nOn March 17, 1986, Cable TV Fund 12-B, Ltd., Cable TV Fund 12-C, Ltd. and Cable TV Fund 12-D, Ltd. (the \"Venture Partners\") formed Cable TV Fund 12-BCD Venture (the \"Venture\"). The Venture was formed for the purpose of acquiring certain cable television systems serving Tampa, Florida; Albuquerque, New Mexico; and Palmdale, California. Jones Intercable, Inc. (\"Intercable\"), the \"General Partner\" of each of the Venture Partners, manages the Venture. Intercable and its subsidiaries also own and operate cable television systems. In addition, Intercable manages cable television systems for other limited partnerships for which it is general partner and, also, for affiliated entities.\nContributed Capital\nThe capitalization of the Venture is set forth in the accompanying statements of partners' deficit.\nAll Venture distributions, including those made from cash flow, from the sale or refinancing of Partnership property and on dissolution of the Venture, shall be made to the Venture Partners in proportion to their approximate respective interests in the Venture as follows:\nVenture Sale of Cable Television System\nAs of December 31, 1995, the Venture owned and operated the cable television systems serving certain areas in and around Tampa, Florida, Albuquerque, New Mexico and Palmdale, California.\nThe Venture's acquisitions were accounted for as purchases with the individual purchase prices allocated to tangible and intangible assets based upon an independent appraisal. The method of allocation of purchase price was as follows: first, to the fair value of the net tangible assets acquired; second, to the value of subscriber lists; third, to franchise costs; and fourth, to costs in excess of interests in net assets purchased. Brokerage fees paid to an affiliate of Intercable and other system acquisition costs were capitalized and included in the cost of intangible assets.\nOn August 11, 1995, the Venture entered into a purchase and sale agreement pursuant to which it agreed to sell its Tampa, Florida system (the \"Tampa System\") to the General Partner for a sales price of $110,395,667, subject to working capital adjustments. The General Partner assigned its rights and obligations under the purchase and sale agreement to Jones Cable Holdings, Inc., a wholly owned subsidiary of the General Partner. Closing of this sale occurred on February 28, 1996. The sales price represented the average of three separate, independent appraisals of the fair market value of the Tampa System. The net sales proceeds were used to make a $55,000,000 distribution to the Venture's partners, with the remainder of the proceeds used to reduce the Venture's debt. The net sales proceeds were distributed as follows: Fund 12-B received $5,049,000; Fund 12-C received $8,404,000 and Fund 12-D received $41,547,000\nThe pro forma effect of the sale of the Tampa System on the results of the Venture's operations for the years ended December 31, 1995 and 1994, assuming the transaction had occurred at the beginning of the years, is presented in the following unaudited tabulation:\n(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nAccounting Records\nThe accompanying financial statements have been prepared on the accrual basis of accounting in accordance with generally accepted accounting principles. The Venture's tax returns are also prepared on the accrual basis.\nThe preparation of financial statements in conformity with generally accepted accounting principles requires the General Partner's 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.\nProperty, Plant and Equipment\nDepreciation is provided using the straight-line method over the following estimated service lives:\nReplacements, renewals and improvements are capitalized and maintenance and repairs are charged to expense as incurred.\nIntangible Assets\nCosts assigned to franchises and costs in excess of interests in net assets purchased are amortized using the straight-line method over the following remaining estimated useful lives:\nRevenue Recognition\nSubscriber prepayments are initially deferred and recognized as revenue when earned.\nCash and Cash Equivalents\nFor purposes of the Statements of Cash Flows, the Venture considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents.\nReclassifications\nCertain prior year amounts have been reclassified to conform to the 1995 presentation.\n(3) TRANSACTIONS WITH JONES INTERCABLE, INC. AND AFFILIATES\nManagement Fees and Reimbursements\nIntercable manages the Venture and receives a fee for its services equal to 5 percent of the gross revenues of the Venture, excluding revenues from the sale of cable television systems or franchises. Management fees paid to Intercable for the years ended December 31, 1995, 1994 and 1993 were $5,069,985, $4,641,154 and $4,456,577, respectively.\nThe Venture 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 Venture. Allocations of personnel costs are based primarily on actual time spent by employees of Intercable with respect to each entity managed. Remaining expenses are allocated based on the pro rata relationship of the Venture's revenues to the total revenues of all systems owned or managed by Intercable and certain of its subsidiaries. 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. Overhead and administrative expenses allocated to the Venture by Intercable during the years ended December 31, 1995, 1994 and 1993 were $7,183,663, $6,951,110 and $6,048,783, respectively.\nThe Venture was charged interest during 1995 at an average interest rate of 10.51 percent on the amounts due Intercable, which approximated Intercable's cost of borrowing. Total interest charged to the Venture by Intercable was $220,743, $33,627 and $15,477 during 1995, 1994 and 1993, respectively.\nPayments to\/from Affiliates for Programming Services\nThe Venture receives programming from Superaudio, Mind Extension University, Jones Computer Network and Product Information Network, all of which are affiliates of Intercable.\nPayments to Superaudio totaled $135,861, $135,346 and $134,179 in 1995, 1994, and 1993, respectively. Payments to Mind Extension University totaled $145,598, $124,043 and $79,002 in 1995, 1994 and 1993, respectively. Payments to Jones Computer Network, which initiated service in 1994, totaled $283,339 and $71,961 in 1995 and 1994, respectively.\nThe Venture receives a commission from Product Information Network based on a percentage of advertising sales and number of subscribers. Product Information Network, which initiated service in 1994, paid commissions to the Venture totaling $212,844 and $81,592 in 1995 and 1994, respectively.\n(4) PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment as of December 31, 1995 and 1994, consisted of the following:\n(5) DEBT\nDebt consists of the following:\nThe Venture's debt arrangements at December 31, 1995 consisted of $93,000,000 of Senior Notes placed with a group of institutional lenders and an $87,000,000 credit facility with a group of commercial bank lenders.\nThe Senior Notes have a fixed interest rate of 8.64 percent and a final maturity date of March 31, 2000. The Senior Notes call for payments of interest only through March 1996, with interest and accelerating amortization of principal payments required for the four years thereafter. In February 1996, the Venture was required to make a principal repayment of approximately $33,650,000 from proceeds received from the sale of the Tampa System. The Senior Notes carry a \"make-whole\" payment, which is a prepayment penalty, in the event the notes are prepaid prior to maturity. The make-whole payment protects the lenders in the event that prepaid funds are reinvested at a rate below 8.64 percent. The Venture was required to pay a make-whole payment in February 1996 of approximately $2,217,000. Principal and interest payments due in 1996 are expected to be funded from cash on hand, cash generated from operations and borrowings under the Venture's new credit facility, as discussed below. Installments due on the Senior Notes, subsequent to the February 1996 repayment, each year for the five year period ended December 31, 2000 are: $3,956,656, $7,913,313, $11,869,968, $15,826,624 and $19,783,282, respectively.\nThe balance outstanding on the Venture's credit agreement at December 31, 1995 was $87,000,000. However, upon the sale of the Tampa System and, as required under the Venture's credit facility, $22,000,000 of the sale proceeds were used to reduce amounts outstanding under its credit facility, leaving $65,000,000 outstanding. In February 1996, the Venture increased the amount available to $120,000,000 to meet the Venture's long-term financing requirements. The amended credit facility matures on December 31, 1999 or, at the Venture's option, on December 31, 2004. In the event\nthe Venture elects the latter maturity date, the credit facility shall amortize in consecutive quarterly amounts. Interest on the amended credit facility is at the Venture's option of the London Interbank Offered Rate plus .625 percent to 1.375 percent, the Base Rate plus 0 percent to .375 percent or the Certificate of Deposit Rate plus .75 percent to 1.50 percent.\nBoth lending facilities are equal in standing with the other, and both are equally secured by the assets of the Venture.\nDuring 1992 and 1994, the Venture incurred costs associated with renegotiating its debt arrangements. These costs were capitalized and are being amortized using the straight-line method over the life of the debt agreements.\nInstallments due on debt principal for each of the five years in the period ending December 31, 2000 and thereafter, respectively, are: $14,261,080, $18,721,080, $25,356,080, $31,837,027, $90,595,000 and $-0-, respectively.\nAt December 31, 1995, the carrying amount of the Venture's long-term debt did not differ significantly from the estimated fair value of the financial instruments. The fair value of the Venture's long-term debt is estimated based on the discounted amount of future debt service payments using rates of borrowing for a liability of similar risk.\n(6) INCOME TAXES\nIncome taxes have not been recorded in the accompanying financial statements because they accrue directly to the partners of Cable TV Fund 12-B, Ltd., Cable TV Fund 12-C, Ltd. and Cable TV Fund 12-D, Ltd.\nThe Venture's tax returns, the qualification of the Venture 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 Venture's qualification as such, or in changes with respect to the Venture's recorded loss, the tax liability of the Venture's general partners would likely be changed accordingly.\nTaxable losses 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 losses reported in the statements of operations.\n(7) COMMITMENTS AND CONTINGENCIES\nOn September 20, 1995, a civil action entitled David Hirsch, on behalf of himself and all others similarly situated, Plaintiff vs. Jones Intercable, Inc., Defendant, was filed in the District Court, County of Arapahoe, State of Colorado (Case No. 95-CV-1800). The plaintiff has brought the action as a purported class action on behalf of himself and all other limited partners of Cable TV Fund 12-D, Ltd. against the General Partner seeking to recover damages caused by the General Partner's alleged breaches of its fiduciary duties to the limited partners of Cable TV Fund 12-D, Ltd. in connection with the sale of the Tampa System and the subsequent exchange of the Tampa System with an unaffiliated cable television system operator in return for systems owned by that operator. The plaintiff also seeks certain equitable and injunctive relief. On January 25, 1996, the Plaintiff filed an amended complaint and request for a jury trial. On February 20, 1996, the General Partner filed a Motion to Dismiss the Amended Complaint on the ground that it fails to state a claim upon which relief can be granted as a matter of law. The General Partner believes that it has meritorious defenses, and the General Partner intends to defend this lawsuit vigorously.\nOn November 17, 1995, a civil action entitled Martin Ury, derivatively on behalf of Cable TV Fund 12-B, Ltd., Cable TV Fund 12-C, Ltd. and Cable TV Fund 12-D, Ltd., Plaintiff vs. Jones Intercable, Inc., Defendant and Cable TV Fund 12-BCD Venture, Cable TV Fund 12-B, Ltd., Cable TV Fund 12-C, Ltd. and Cable TV Fund 12-D, Ltd. Nominal Defendants, was filed in the District Court, County of Arapahoe, State of Colorado (Case No. 95-CV-2212). The plaintiff, a limited partner of Cable TV Fund 12-D, Ltd., has brought the action as a derivative action on behalf of the three partnerships that comprise the Venture against the General Partner seeking to recover damages caused by the General Partner's alleged breaches of its fiduciary duties to the Venture and to the three partnerships that comprise the Venture (and their respective limited partners) in connection with the sale to the General Partner of the Tampa System and the subsequent exchange of the Tampa System with an unaffiliated cable television system operator in return for systems owned by that operator. On February 1, 1996, the General Partner filed a Motion to Dismiss the Complaint on the ground that it fails to state a claim upon which relief can be granted as a matter of law. The Motion also asserts that the plaintiff\ndoes not have standing to bring a claim on behalf of Cable TV Fund 12-B, Ltd. and Cable TV Fund 12-C, Ltd. and their respective limited partners. The General Partner believes that it has meritorious defenses, and the General Partner intends to defend this lawsuit vigorously.\nPursuant to the indemnification provisions of Section 9.6 of the limited partnership agreements of each of the three partnerships that comprise the Venture, the General Partner may be entitled to indemnification from the partnerships for its legal fees and expenses, and for any amounts paid in settlement, in defending the above-described lawsuits. The General Partner cannot determine at this time whether such amounts will be material.\nThe Venture has filed cost-of-service showings in response to rulemakings concerning the 1992 Cable Act for its systems and thus anticipates no further reductions in rates in these systems. The cost-of-service showings have not yet received final approvals from regulatory authorities, however, and there can be no assurance that the Venture's cost-of- service showings will prevent further rate reductions in these systems until such final approvals are received.\nOffice and other facilities are rented under various long-term lease arrangements. Rent paid under such lease arrangements totaled $331,963, $345,531 and $454,229, respectively, for the years ended December 31, 1995, 1994 and 1993. Minimum commitments under operating leases for the five years in the period ending December 31, 2000 and thereafter are as follows:\n(8) SUPPLEMENTARY PROFIT AND LOSS INFORMATION\nSupplementary profit and loss information for the respective years is presented below:\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III.\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe Partnership itself has no officers or directors. Certain information concerning the directors and executive officers of the General Partner is set forth below.\nMr. Glenn R. Jones has served as Chairman of the Board of Directors and Chief Executive Officer of the General Partner since its formation in 1970, and he was President from June 1984 until April 1988. Mr. Jones 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 and the Executive Committee of the National Cable Television Association. He also is on the Executive Committee of Cable in the Classroom, an organization dedicated to education via cable. Additionally, in March 1991, Mr. Jones was appointed to the Board of Governors for the American Society for Training and Development, and in November 1992 to the Board of Education Council of the National Alliance of Business. Mr. Jones is also a founding member of the James Madison Council of the Library of Congress. 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; the Women in Cable Accolade in 1990 in recognition of support of this organization; the Most Outstanding Corporate Individual Achievement award from the International Distance Learning Conference; the Golden Plate Award\nfrom the American Academy of Achievement for his advances in distance education; the Man of the Year named by the Denver chapter of the Achievement Rewards for College Scientists; and in 1994 Mr. Jones was inducted into Broadcasting and Cable's Hall of Fame.\nMr. Derek H. Burney was appointed a Director of the General Partner on December 20, 1994 and Vice Chairman of the Board of Directors on January 31, 1995. 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 subsidiary 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 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 ethnic minority groups 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. George H. Newton joined the General Partner in January 1996 as Group Vice President\/Telecommunications. Prior to joining the General Partner, Mr. Newton was President of his own consulting business, Clear Solutions, and since 1994 Mr. Newton has served as a Senior Advisor to Bell Canada International. From 1990 to 1993, Mr. Newton served as the founding Chief Executive Officer and Managing Director of Clear Communications, New Zealand, where he established an alternative telephone company in New Zealand. From 1964 to 1990, Mr. Newton held a wide variety of operational and business assignments with Bell Canada International.\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\nUSWest. 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. Robert E. Cole was appointed a Director of the General Partner in March 1996. Mr. Cole is currently self-employed as a partner of First Variable Insurance Marketing and is responsible for marketing to National Association of Securities Dealers, Inc. firms in northern California, Oregon, Washington and Alaska. From 1993 to 1995, Mr. Cole was the Director of Marketing for Lamar Life Insurance Company; from 1992 to 1993, Mr. Cole was Senior Vice President of PMI Inc., a third party lender serving the special needs of Corporate Owned Life Insurance (COLI) and from 1988 to 1992, Mr. Cole was the principal and co-founder of a specialty investment banking firm that provided services to finance the ownership and growth of emerging companies, productive assets and real property. Mr. Cole is a Certified Financial Planner and a former United States Naval Aviator.\nMr. William E. Frenzel was appointed a Director of the General Partner on April 11, 1995. Mr. Frenzel has been a Guest Scholar since 1991 with the Brookings Institution, a research organization located in Washington D. C. Until his retirement in January 1991, Mr. Frenzel served for twenty years in the United States House of Representatives, representing the State of Minnesota, where he was a member of the House Ways and Means Committee and its Trade Subcommittee, the Congressional Representative to the General Agreement on Tariffs and Trade (GATT), the Ranking Minority Member on the House Budget Committee and a member of the National Economic Commission. Mr. Frenzel also served in the Minnesota Legislature for eight years. He is a Distinguished Fellow of the Tax Foundation, Vice Chairman of the Eurasia Foundation, a Board Member of the U.S.-Japan Foundation, the Close-Up Foundation, Sit Mutual Funds and Chairman of the Japan-America Society of Washington.\nMr. Donald L. Jacobs was appointed a Director of the General Partner on April 11, 1995. Mr. Jacobs is a retired executive officer of TRW. Prior to his retirement, he was Vice President and Deputy Manager of the Space and Defense Sector; prior to that appointment, he was the Vice President and General Manager of the Defense Systems Group and prior to his appointment as Group General Manager, he was President of ESL, Inc., a wholly owned subsidiary of TRW. During his career, Mr. Jacobs served on several corporate, professional and civic boards.\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 was Group Vice President of the General Partner. He also served as an officer of Jones Futurex, Inc., a subsidiary 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, and several of its subsidiaries engaged in the provision of telecommunications\nservices until leaving the General Partner in May 1994. Mr. Krejci has been a Director of the General Partner since August 1987.\nMr. John A. MacDonald was appointed a Director of the General Partner on November 8, 1995. Mr. MacDonald is Executive Vice President of Business Development and Chief Technology Officer of Bell Canada International Inc. Prior to joining Bell Canada in November 1994, Mr. MacDonald was President and Chief Executive Officer of The New Brunswick Telephone Company, Limited, a post he had held since March of that year. Prior to March 1994, Mr. MacDonald was with NBTel for 17 years serving in various capacities, including Market Planning Manager, Corporate Planning Manager, Manager of Systems Planning and Development and General Manager, Chief Engineer and General Manager of Engineering and Information Systems and Vice President of Planning. Mr. MacDonald was the former Chairman of the New Brunswick section of the Institute of Electrical and Electronic Engineers and also served on the Federal Government's Information Highway Advisory Council. Mr. MacDonald is Chairman of MediaLinx Interactive Inc. and Stentor Canadian Network Management and is presently a Governor of the Montreal Exchange. He also serves on the Board of Directors of Tele-Direct (Publications) Inc., Bell-Northern Research, Ltd., SRCI, Bell Sygma, Canarie Inc., and is a member of the University of New Brunswick Venture Campaign Cabinet.\nMr. Raphael M. Solot was appointed a Director of the General Partner in March 1996. Mr. Solot is an attorney licensed to practice law in the State of Colorado. Mr. Solot has practiced law in the State of Colorado as a sole practitioner since obtaining his Juris Doctor degree from the University of Colorado in 1964.\nMr. Daniel E. Somers was initially appointed a Director of the General Partner on December 20, 1994. Mr. Somers resigned as a Director on December 31, 1995, at the time he was elected Chief Executive Officer of Bell Cablemedia. Mr. Somers was reinstated as a Director of the General Partner on February 2, 1996. 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. Mr. Somers currently serves as Chief Executive Officer of Bell Cablemedia. 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. Howard O. Thrall was appointed a Director of the General Partner on March 6, 1996. Mr. Thrall had previously served as a Director of the General Partner from December 1988 to December 1994. Since September 1993, Mr. Thrall has served as Vice President of Sales, Asian Region, for World Airways, Inc. From 1984 until August 1993, Mr. Thrall was with the McDonnell Douglas Corporation, where he concluded as a Regional Vice President, Commercial Marketing with the Douglas Aircraft Company subsidiary. Mr. Thrall is also a management and international marketing consultant, having completed assignments with First National Net, Inc., Cheong Kang Associated (Korea), Aero Investment Alliance, Inc. and Western Real Estate Partners.\nMr. Robert B. Zoellick was appointed a Director of the General Partner on April 11, 1995. Mr. Zoellick is Executive Vice President, General Counsel and Corporate Secretary of Fannie Mae, a federally chartered and stockholder-owned corporation that is the largest housing finance investor in the United States. From August 1992 to January 1993, Mr. Zoellick served as Deputy Chief of Staff of the White House and Assistant to the President. From May 1991 to August 1992, Mr. Zoellick served concurrently as the Under Secretary of State for Economic and Agricultural Affairs and as Counselor of the Department of State, a post he assumed in March 1989. From 1985 to 1988, Mr. Zoellick served at the Department of Treasury in a number of capacities, including Counselor to the Secretary. Mr. Zoellick received the Alexander Hamilton and Distinguished Service Awards, highest honors of the Departments of Treasury and State, respectively. The German Government awarded him the Knight Commanders Cross for his work on Germany unification. Mr. Zoellick currently serves on the boards of the Council on Foreign Relations, the Congressional Institute, the German Marshall Fund of the U.S., the European Institute, the National Bureau of Asian Research, the American Council on Germany and the Overseas Development Council.\nChristopher J. Bowick, Cynthia A. Winning and Larry W. Kaschinske are executive officers of the General Partner; Raymond L. Vigil is an executive officer and a director of the General Partner; and John A. MacDonald is a director of the General Partner. Reports by these persons with respect to the ownership of limited partnership interests in the Partnership required by Section 16(a) of the Securities Exchange Act of 1934, as amended, were not filed within the required time. None of these individuals own any limited partnership interests in the Partnership.\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 Venture. Such personnel are employed by the General Partner and, the cost of such employment is charged by the General Partner to the Venture as a direct reimbursement item. See Item 13.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGERS\nNo person or entity owns more than 5 percent of the limited partnership interests of the Partnership.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe General Partner and its affiliates engage in certain transactions with the Venture. The General Partner believes that the terms of such transactions are generally as favorable as could be obtained by the Venture from unaffiliated parties. This determination has been made by the General Partner in good faith, but none of the terms were or will be negotiated at arm's-length and there can be no assurance that the terms of such transactions have been or will be as favorable as those that could have been obtained by the Venture from unaffiliated parties.\nThe General Partner charges a management fee, and the General Partner is reimbursed for certain allocated overhead and administrative expenses. These expenses represent the salaries and benefits paid to corporate personnel, rent, data processing services and other corporate facilities costs. Such personnel provide engineering, marketing, administrative, accounting, legal and investor relations services to the Venture. Allocations of personnel costs are based primarily on actual time spent by employees of the General Partner with respect to each partnership managed. Remaining expenses are allocated based on the pro rata relationship of the Partnership's revenues to the total revenues of all systems owned or managed by the General Partner and certain of its subsidiaries. Systems owned by the General Partner and all other systems owned by partnerships for which Jones Intercable, Inc. is the general partner, are also allocated a proportionate share of these expenses.\nThe General Partner also advances funds and charges interest on the balance payable. The interest rate charged approximates the General Partner's weighted average cost of borrowing.\nThe Systems receives stereo audio programming from Superaudio, a joint venture owned 50% by an affiliate of the General Partner and 50% by an unaffiliated party, educational video programming from Mind Extension University, Inc., an affiliate of the General Partner, and computer video programming from Jones Computer Network, Ltd., an affiliate of the General Partner, for fees based upon the number of subscribers receiving the programming.\nProduct Information Network (\"PIN\"), an affiliate of the General Partner, provides advertising time for third parties on the Systems. In consideration, the revenues generated from the third parties are shared between PIN and the Venture. During the year ended December 31, 1995, the Venture received revenues from PIN of $212,844.\nThe charges to Venture for related party transactions are as follows for the periods indicated:\nPART IV.\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a)1. See index to financial statements for list of financial statements and exhibits thereto filed as a part of this report.\n3. The following exhibits are filed herewith.\n4.1 Limited Partnership Agreement for Cable TV Fund 12-C, Ltd. (1)\n4.2 Joint Venture Agreement of Cable TV Fund 12-BCD Venture dated as of March 17, 1986, among Cable TV Fund 12-B, Ltd., Cable TV Fund 12-C, Ltd. and Cable TV Fund 12-D, Ltd. (2)\n10.1.1 Copy of a franchise and related documents thereto granting a community antenna television system franchise for Edwards Air Force Base, California (Fund 12-BCD). (3)\n10.1.2 Copy of a franchise and related documents thereto granting a community antenna television system franchise for the City of Lancaster, California (Fund 12-BCD). (4)\n10.1.3 Copy of a franchise and related documents thereto granting a community antenna television system franchise for Unincorporated portions of Los Angeles County, California (Fund 12-BCD). (4)\n10.1.4 Copy of Los Angeles County Code regarding cable tv system franchises (Fund 12-BCD). (5)\n10.1.5 Copy of Ordinance 90-0118F dated 10\/29\/90 granting a cable television franchise to Fund 12-BCD (Fund 12-BCD). (5)\n10.1.6 Copy of a franchise and related documents thereto granting a community antenna television system franchise for the Green Valley\/Elizabeth Lake\/Leona Valley unincorporated areas of Los Angeles County, California (Fund 12-BCD). (2)\n10.1.7 Ordinance 88-0166F dated 10\/4\/88 amending the franchise described in 10.1.5 (Fund 12-BCD). (5)\n10.1.8 Copy of a franchise and related documents thereto granting a community antenna television system franchise for the City of Palmdale, California (Fund 12-BCD). (5)\n10.1.9 Copy of a franchise and related documents thereto granting a community antenna television system franchise for the City of Albuquerque, New Mexico (Fund 12-BCD). (4)\n10.1.15 Copy of a franchise and related documents thereto granting a community antenna television system franchise for the County of Bernalillo, New Mexico (Fund 12-BCD). (4)\n10.1.10 Copy of a franchise and related documents thereto granting a community antenna television system franchise for the Town of Bernalillo, New Mexico (Fund 12-BCD). (4)\n10.1.11 Resolution No. 12-14-87 dated 12\/14\/87 authorizing the assignment of the franchise to Fund 12-BCD. (5)\n10.1.12 Copy of a franchise and related documents thereto granting a community antenna television system franchise for the Village of Bosque Farms, New Mexico (Fund 12-BCD). (4)\n10.1.13 Copy of a franchise and related documents thereto granting a community antenna television system franchise for the Village of Corrales, New Mexico (Fund 12-BCD). (4)\n10.1.14 Copy of a franchise and related documents thereto granting a community antenna television system franchise for the Kirtland Air Force Base, New Mexico (Fund 12-BCD). (5)\n10.1.15 Copy of a franchise and related documents thereto granting a community antenna television system franchise for the Village of Los Ranchos, New Mexico (Fund 12-BCD). (4)\n10.1.16 Copy of a franchise and related documents thereto granting a community antenna television system franchise for the County of Sandoval, New Mexico (Fund 12-BCD). (4)\n10.1.17 Copy of a franchise and related documents thereto granting a community antenna television system franchise for the County of Valencia, New Mexico (Fund 12-BCD). (4)\n10.1.18 Resolution No. 88-23 dated 2\/14\/88 authorizing assignment of the franchise to Fund 12-BCD. (5)\n10.2.1 Note Purchase Agreement dated as of March 31, 1992 between Cable TV Fund 12-BCD Venture and the Noteholders\n10.2.2 Amendment No. 1 dated as of March 31, 1994 to the Note Purchase Agreement dated as of March 31, 1992 between Cable TV Fund 12-BCD Venture and the Noteholders\n10.2.3 Amendment No. 2 dated as of September 30, 1994 to the Note Purchase Agreement dated as of March 31, 1992 between Cable TV Fund 12-BCD Venture and the Noteholders\n10.2.4 Amendment No. 3 dated as of February 12, 1996 to the Note Purchase Agreement dated as of March 31, 1992 between Cable TV Fund 12-BCD Venture and the Noteholders\n10.2.5 Second Amended and Restated Credit Agreement by and among Cable TV Fund 12-BCD Venture, various banks, Corestates Bank, N.A. and Societe Generale, as Managing Agents and Corestates Bank, N.A., as Administrative Agent dated February 12, 1996.\n10.3.1 Purchase and Sale Agreement dated as of March 29, 1988 by and between Cable TV Fund 12-BCD Venture as Buyer and Video Company as Seller. (6)\n10.3.2 Purchase and Sale Agreement dated 9\/20\/91 and amendments thereto between Cable TV Fund 12-BCD Venture as Seller and Falcon Classic Cable Income Properties, L.P. (Fund 12-BCD). (7)\n10.3.3 Purchase and Sale Agreement dated as of August 11, 1995 between Cable TV Fund 12-BCD Venture and Jones Intercable, Inc. (9)\n10.3.4 Assignment and Assumption Agreement dated as of October 20, 1995 between Jones Intercable, Inc. and Jones Cable Holdings, Inc. (10)\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 (Commission File Nos. 0-13193, 0-13807, 0-13964 and 0-14206).\n(2) Incorporated by reference from Registrant's Report on Form 10-K for the fiscal year ended December 31, 1987 (Commission File Nos. 0-13193, 0-13807, 0-13964 and 0-14206).\n(3) Incorporated by reference from Registrant's Report on Form 10-K for the fiscal year ended December 31, 1994 (Commission File No. 0-13193).\n(4) Incorporated by reference from Registrant's Report on Form 10-K for the fiscal year ended December 31, 1986 (Commission File Nos. 0-13193, 0-13807, 0-13964 and 0-14206).\n(5) Incorporated by reference from Registrant's Report on Form 10-K for the fiscal year ended December 31, 1992 (Commission File Nos. 0-13193, 0-13807, 0-13964 and 0-14206).\n(6) Incorporated by reference from Registrant's Report on Form 10-K for the fiscal year ended December 31, 1988 (Commission File Nos. 0-13193, 0-13807, 0-13964 and 0-14206).\n(7) Incorporated by reference from the Forms 8-K of Fund 12-B, Fund 12-C and Fund 12-D dated 4\/6\/92 (Commission File Nos. 0-13193, 0-13964 and 0-14206, respectively).\n(8) Incorporated by reference from the Form 8-K of Cable TV Fund 12-B, Ltd. dated 3\/10\/95 (Commission File No. 0-13193).\n(9) Incorporated by reference from the Annual Report on Form 10-K for fiscal year ended May 31, 1995 of Jones Intercable, Inc. (Commission File No. 1-9953)\n(10) Incorporated by reference from the Form 8-K of Cable TV Fund 12-B, Ltd. dated 11\/1\/95 (Commission File No. 0-13193).\n(b) Reports on Form 8-K.\nA Current Report on Form 8-K (Commission File No. 0-13193), dated December 4, 1995, describing certain litigation regarding the proposed sale of the Tampa System was filed with the Securities and Exchange Commission on December 5, 1995.\nA Current Report on Form 8-K (Commission File No. 0-13193), dated December 4, 1995, describing certain litigation regarding the proposed sale of the Tampa System was filed with the Securities and Exchange Commission on December 5, 1995.\nA Current Report on Form 8-K (Commission File No. 0-13193), dated March 13. 1996. describing the sale of the Tampa System was filed with the Securities and Exchange Commission on March 14, 1996.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nCABLE TV FUND 12-C, LTD. a Colorado limited partnership By: Jones Intercable, Inc.\nBy: \/s\/ Glenn R. Jones ------------------------------- Glenn R. Jones Chairman of the Board and Chief Dated: March 25, 1996 Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nBy: \/s\/ Glenn R. Jones ------------------------------- Glenn R. Jones Chairman of the Board and Chief Executive Officer Dated: March 25, 1996 (Principal Executive Officer)\nBy: \/s\/ Kevin P. Coyle ------------------------------- Kevin P. Coyle Group Vice President\/Finance Dated: March 25, 1996 (Principal Financial Officer)\nBy: \/s\/ Larry Kaschinske ------------------------------- Larry Kaschinske Controller Dated: March 25, 1996 (Principal Accounting Officer)\nBy: \/s\/ James B. O'Brien ------------------------------- James B. O'Brien Dated: March 25, 1996 President and Director\nBy: \/s\/ Raymond L. Vigil ------------------------------- Raymond L. Vigil Dated: March 25, 1996 Group Vice President and Director\nBy: \/s\/ Derek H. Burney ------------------------------- Derek H. Burney Dated: March 25, 1996 Director\nBy: ------------------------------- Robert E. Cole Dated: Director\nBy: \/s\/ William E. Frenzel ------------------------------- William E. Frenzel Dated: March 25, 1996 Director\nBy: \/s\/ Donald L. Jacobs ------------------------------- Donald L. Jacobs Dated: March 25, 1996 Director\nBy: \/s\/ James J. Krejci ------------------------------- James J. Krejci Dated: March 25, 1996 Director\nBy: \/s\/ John A. MacDonald ------------------------------- John A. MacDonald Dated: March 25, 1996 Director\nBy: ------------------------------- Raphael M. Solot Dated: Director\nBy: \/s\/ Daniel E. Somers ------------------------------- Daniel E. Somers Dated: March 25, 1996 Director\nBy: \/s\/ Howard O. Thrall ------------------------------- Howard O. Thrall Dated: March 25, 1996 Director\nBy: \/s\/ Robert B. Zoellick ------------------------------- Robert B. Zoellick Dated: March 25, 1996 Director\n(21507)\nEXHIBIT INDEX\nEXHIBIT INDEX\nEXHIBIT INDEX","section_15":""}
{"filename":"716039_1995.txt","cik":"716039","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"ITEM 3 - LEGAL PROCEEDINGS\nThere is incorporated by reference the information regarding environmental remediation reserves in Note 17 to the consolidated financial statements on page 50, the discussion thereof in the Environmental Matters section of Management's Discussion and Analysis, on pages 25 through 27 and the information regarding contingent liabilities in Note 18 to the consolidated financial statements on pages 50 and 51 of this report.\n(1) The matter previously reported regarding claimed violations concerning hazardous waste management at the company's Parachute Creek Oil Shale facility in Colorado has been settled.\n(2) The matters previously reported regarding claimed NPDES permit violations in Cook Inlet have been settled. The company paid $140,000 to EPA; $499,000 to Greenpeace; and $36,524 to the Trustees for the State of Alaska.\n(3) The matter previously reported regarding the complaint filed by the Ventura County District Attorney for several alleged violations related to discharges of crude oil into state waters has been settled for a total payment of $27,000.\n(4) In December 1994, the company received notice of alleged violations from the EPA, Region IX, relating to New Source Performance Standards at its Los Angeles Refinery - Carson Plant. Civil penalties in excess of $100,000 could be imposed. Proceedings and negotiations are continuing.\n(5) In the litigation previously reported as Forty-Niner Truck Plaza Inc., et -------------------------------- al. v. Unocal Corporation, et al. in Superior Court for Sacramento County, ------------------------------- the trial court granted the company's motion for a new trial. That order is now on appeal. This matter does not appear to have a potentially material effect on the company's financial condition or results of operations, and no further reports will be made.\n(6) On April 13, 1995, Atlantic Richfield Company, Chevron U.S.A., Inc., Exxon Corporation, Mobil Oil Corporation, Shell Oil Products Company and Texaco Refining and Marketing, Inc. filed a lawsuit against the company regarding U.S. Letters Patent No. 5,288,393 issued to the company in 1994 and covering several patent claims for the composition of reformulated gasoline. (Atlantic Richfield Company, et al. v. Unocal Corporation, et ------------------------------------------------------------ al., U.S.D.C., C.D. California, No. CV-95-2379-RG). The plaintiffs allege ---- that the company's patent is invalid and unenforceable, and they seek declaratory relief for equitable estoppel and an injunction against enforcement. The company has filed its answer as well as a counterclaim for patent infringement, lost royalties and further injunctive relief. Discovery and pretrial proceedings are continuing.\n(7) Between August 22 and September 6, 1994, a chemical known as \"Catacarb\" was released into the environment at the company's San Francisco Refinery near Rodeo, California. Persons in the surrounding area have claimed that they were exposed to the chemical in varying degrees. Since September 22, 1994, 42 lawsuits have been filed by or on behalf of all persons, alleged to be several thousand, claiming that they or their property were adversely affected by the releases. Thirty-nine of the lawsuits have been consolidated in the Superior Court for Contra Costa County under the caption In Re Unocal Refinery Litigation (Santos, et al. v. Unocal ---------------------------------------------------------- Corporation), Case No. 94-04141. The First Amended Model Complaint in this ------------ consolidated action, filed on February 1, 1996, on behalf of individual plaintiffs and purported classes of plaintiffs, alleges personal injury, emotional distress, and increased risk of future illness on behalf of the named plaintiffs and all persons present in and around or downwind from the San Francisco Refinery, and property damage and loss or diminution of property value on behalf of all owners of real and personal property in the vicinity of the Refinery, resulting from the release of Catacarb by the Refinery. Certain individual plaintiffs allege injury from alleged subsequent releases at the Refinery of hydrogen sulfide and other chemicals. The Model Complaint seeks compensatory and punitive damages in unspecified amounts, equitable relief including the creation of a fund for medical monitoring and treatment of plaintiffs and members of the purported classes, statutory penalties and other relief.\nThe company is also presently in discussions with the EPA to settle an administrative Complaint issued on November 28, 1995, seeking approximately $490,000 in civil penalties for failure to report timely the Catacarb release and a subsequent release of hydrogen sulfide. All state civil and criminal governmental investigations, claims and charges have been settled.\n(8) Citizens for a Better Environment, et al. v. Union Oil Company of ----------------------------------------------------------------- California, No. C94-0712, U.S. D.C., N.D. California, filed on March 2, ---------- 1994, alleges that as of February 28, 1994, the company's San Francisco Refinery was in violation of the selenium limit in its NPDES permit. The company denies that any violations have occurred. By a prior Cease and Desist Order issued after notice and hearing, the permitting agency, the California Regional Water Quality Control Board, deferred to July 1998, the effective date of the selenium limitation in question. The company's motion to dismiss the Citizens action was denied by the trial court. The -------- company believes that the court's ruling is in error and that it conflicts\nwith precedent from two different federal circuits. The Ninth Circuit Court of Appeals has accepted the appeal of the trial court decision. That appeal is now pending and oral arguments are scheduled for April 8, 1996.\n(9) In September 1994, the California Regional Water Quality Control Board issued a Cleanup or Abatement Order relating to prior underground petroleum leaks along Front Street and vicinity in the town of Avila Beach, California. In October 1994, the company initiated an administrative appeal proceeding and a related civil suit in the Superior Court for San Luis Obispo County for declaratory and injunctive relief and writ of mandate with respect to the soil and shallow ground water standard to be applied to the remediation. The company has been working with local agencies and property owners for several years regarding the hydrocarbon presence in this location. Various related civil suits have been filed or threatened.\n(10) On March 23, 1994, a civil suit seeking various forms of penalties, restitution and remediation regarding contamination at the Guadalupe oil field was filed against the company by the California Attorney General on behalf of the Department of Fish and Game, the Regional Water Quality Control Board and the Department of Toxic Substances Control (People v. --------- Union Oil Company of California, Superior Court for San Luis Obispo County, -------------------------------- Civil No. 75194). The complaint alleges several categories of violations, namely, discharge into marine and state waters, failure to report discharge, destruction of natural resources, failure to warn, exposure to known carcinogens, public nuisance, unauthorized disposal of hazardous waste, and labeling violations for \"recycled\" diluent material. Injunctive relief and civil penalties are demanded for the various claimed violations, as well as prejudgment and postjudgment interest, costs and reasonable attorney fees. Several related follow-on private civil actions have been filed, including a purported class action, or threatened, each seeking damages and various other forms of relief similar to those sought by the Attorney General.\nTrial settings have been vacated on motion of the California Attorney General. The next status conference is scheduled for July 19, 1996.\n(11) In September 1994, the U.S. Minerals Management Service (MMS) issued an administrative compliance order assessing the company approximately $21 million in royalty fees and interest associated with FERC Order No. 94. The company is presently negotiating with the MMS for a settlement of outstanding issues which could include this MMS assessment.\n(12) In June 1994, the EPA filed an administrative complaint against the company seeking $252,000 in civil penalties for alleged late filing of certain reports regarding gas processing plant inventories under the Toxic Substances Control Act (TSCA) Inventory Update Rule. The company notified the EPA that no reports for the gas processing facilities had been filed in 1991. Reports, due every four years, were filed in March 1994. No public safety or environmental harm could be associated with these delayed reports or any alleged technical violation of the reporting rules, even if the rules are applicable. The Gas Processors Association has urged an amnesty for past alleged violations and is seeking EPA clarification of application of these rules to natural gas streams for the next TSCA Inventory Update due later this year. The company has appealed this complaint.\n(13) On February 9, 1996, Bridas Corporation filed a petition in the District Court of Fort Bend County, Texas alleging that the company and other defendants conspired to and did tortiously interfere with certain agreements and prospective business relations between Bridas and the government of Turkmenistan (Bridas Corporation v. Unocal Corporation, ----------------------------------------- et al., Case No. 94144, 268th Judicial District). The Plaintiff alleges ------ that as a result of the defendants' conduct, it has lost the ability to timely and reasonably develop, produce, transport, export and sell its interest in the Yashlar area of Turkmenistan, an area that includes the Yashlar field. The plaintiff also claims it has lost the opportunity to participate in a Turkmenistan-Pakistan pipeline project. The plaintiff seeks unspecified actual damages as well as punitive damages, plus interest at the highest lawful rate. On March 11, 1996, the defendants filed a notice of removal of the case to U.S. District Court, Southern District of Texas, Houston Division (Civ. No. H-906-0824).\nITEM 4","section_4":"ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - NONE.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nSet forth below are the executive officers of Unocal Corporation as of March 1, 1996.\nThe bylaws of the company provide that each executive officer shall hold office until the annual organizational meeting of the Board of Directors held June 3, 1996 and until his successor shall be elected and qualified, unless he shall resign or shall be removed or otherwise disqualified to serve.\nPART II\nITEM 5","section_5":"ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nPrices in the foregoing table are from the New York Stock Exchange Composite Transactions listing. On March 15, 1996, the high price per share was $32 and the low price per share was $31-5\/8.\nUnocal common stock is listed for trading on the New York, Pacific and Chicago Stock Exchanges in the United States, on the Stock Exchange of Singapore and on the Basel, Geneva and Zurich Stock Exchanges in Switzerland.\nAs of March 15, 1996, the approximate number of holders of record of Unocal common stock was 35,051 and the number of shares outstanding was 247,860,562.\nUnocal's quarterly dividend declared has been $.20 per common share since the third quarter of 1993. The previous quarterly dividend rate was $.175 per share since the third quarter of 1989. The company has paid a quarterly dividend for 80 consecutive years.\nITEM 6","section_6":"ITEM 6 - SELECTED FINANCIAL DATA - SEE PAGE 67\nITEM 7","section_7":"ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe 1995 earnings excluding special items reflected lower margins for refined petroleum products due primarily to lower refinery production, lower worldwide crude oil production, lower average sales prices for natural gas and lower geothermal steam production. Partially offsetting these negative factors were higher worldwide average crude oil sales prices and higher average sales prices for agricultural products.\nComparing the 1994 operating results with 1993, the reduction in earnings reflected the adverse effects of lower average crude oil and natural gas prices and lower margins in West Coast refining and marketing operations. These negative factors were partially offset by higher natural gas production, higher foreign crude oil production, stronger agricultural products earnings, and lower domestic oil and gas operating and depreciation expenses.\nIn the above special items table, the Other category for 1995 included benefits of $34 million from a bankruptcy settlement with Columbia Gas Transmission Corporation (Columbia settlement) and $18 million from a settlement to recover lease bonus and rentals relating to Outer Continental Shelf leases offshore Florida and Alaska (OCS Settlement). Partially offsetting these benefits were charges of $18 million for a deferred tax adjustment and $14 million for a receivable write-down. For 1994, the amount included a $24 million gain from the settlement of a lawsuit against Mesa Petroleum and a $9 million benefit related to the cancellation of the lease on the Unocal headquarters building in downtown Los Angeles. For 1993, the amount included a $14 million charge for the effect of the federal tax rate change on deferred taxes and a $4 million provision for the closure of the company's credit card center.\nREVENUES\nConsolidated revenues in 1995 were $8.4 billion, up $460 million from year- end 1994 and up $81 million from 1993. The increase from 1994 was primarily due to higher petroleum product sales volumes, agricultural products average sales prices and gains on sales of assets. The decrease in 1994 from 1993 was mainly due to lower refined product prices and volumes.\nCOSTS AND OTHER DEDUCTIONS\nAdjusted to exclude special items, crude oil and product purchases, operating expense, and selling, administrative and general expense totaled $5.3 billion in 1995, compared with $5.0 billion in 1994 and $5.3 billion in 1993. The increase in 1995 was primarily due to increased expense for crude oil and product purchases resulting from higher average crude oil prices and increased purchases of refined products for resale due to extended maintenance activities at the refineries.\nThe higher depreciation, depletion and amortization expense in 1995 was due to an $87 million charge resulting from the adoption of Statement of Financial Accounting Standards (SFAS) No. 121, \"Accounting for the Impairment of Long- Lived Assets and for Long-Lived Assets to Be Disposed Of,\" as described in Note 2 to the consolidated financial statements.\nThe company's interest expense increased in 1995 due primarily to higher debt.\nOIL AND GAS EXPLORATION AND PRODUCTION\nThis segment is engaged in the exploration for, and the production and marketing of crude oil, condensate, natural gas and natural gas liquids.\nThe 1995 earnings excluding special items reflected lower worldwide crude oil production and lower average domestic natural gas sales prices. Worldwide crude oil production in 1995 averaged 240,400 barrels per day, down from 259,800 in 1994 and 246,000 in 1993. The decrease was mainly due to natural production declines and the sale of nonstrategic domestic properties. The company's average domestic sales price for natural gas was $1.56 per thousand cubic feet, down from $1.78 in 1994 and $1.97 in 1993.\nPositive factors in 1995 were higher average worldwide crude oil sales prices, lower effective foreign income tax rates and lower domestic operating expense. Unocal's average worldwide sales price for crude oil was $15.40 per barrel in 1995, up from $13.63 in 1994 and $14.21 in 1993. The decrease in domestic operating expense was primarily due to sales of nonstrategic domestic properties and cost reductions. In 1995, the company reduced its worldwide average production costs per barrel of oil equivalent to $2.94, compared with $3.00 for 1994 and $3.40 for 1993. Domestic natural gas production averaged 1,103 million cubic feet per day in 1995, up from 1,095 in 1994 and 952 in 1993. The accelerated development program initiated in 1993, primarily in the Gulf of Mexico, has allowed Unocal to keep its domestic natural gas production stable despite the continuing sales of oil and gas properties.\nComparing the adjusted 1994 results with 1993, the decrease reflected lower worldwide natural gas and crude oil sales prices and lower domestic crude oil production. The decrease in production was mainly due to asset sales and natural declines. Positive factors in 1994 were higher natural gas production, higher foreign crude oil production and lower domestic operating expense. The increase in foreign crude oil production was due to new production in Indonesia and the Netherlands. The 1994 results also benefited from a $38 million reduction in depreciation and depletion expense as a result of the change in accounting policy for recognizing the reduction in value of the company's producing properties, as described in Note 2. The pro forma effect of this accounting change on 1993 results would have been an increase in net earnings of $31 million.\nREFINING, MARKETING AND TRANSPORTATION -- 76 PRODUCTS COMPANY\nThis business segment is principally responsible for the company's West Coast petroleum refining operations, marketing and transportation of refined petroleum products, and the manufacturing and marketing of petroleum coke.\nThe lower 1995 earnings excluding special items reflected lower refined product margins and lower refinery production volumes due to extended maintenance and modification activities early in the year. These negative factors were partially offset by California business tax credits of $18 million (net of federal tax effect) related to refinery modifications to produce reformulated fuels and by lower operating and selling expenses.\nPetroleum product sales volumes were 269,000 barrels per day in 1995, up from 252,000 barrels per day in 1994. Due to scheduled refinery maintenance in 1995, the increased sales volumes and lower margins were principally related to the outside purchase and resale of refined petroleum products to other than retail customers.\nComparing 1994 results with 1993, the decrease was principally due to lower margins resulting from weak selling prices for refined products, which were partially offset by lower crude oil and product purchase costs.\nGEOTHERMAL AND POWER OPERATIONS\nThis segment is involved in the exploration for, and the production and sale of geothermal resources for the generation of electricity.\nThe decreased 1995 earnings excluding special items resulted from lower steam production and prices at The Geysers in Northern California and lower steam production in the Philippines primarily due to damage to the Tiwi facilities caused by a November typhoon. The lower production at The Geysers was due to seven months of discretionary curtailments by the public utility company that purchases the steam to generate electricity. The curtailments were the product of abundant supplies of inexpensive hydro-power available from record rainfall in the western U.S. and depressed natural gas prices. These negative factors were partially offset by increased production and prices for Indonesian operations. The increased production resulted from a full year of supplying steam from the Gunung Salak field to power two 55-megawatt power plants that began commercial operation during the third quarter of 1994. The power plants are located on the island of Java and are operated by Indonesia's state utility company.\nComparing the 1994 operating results with 1993, the increase reflected higher domestic earnings, primarily due to reduced depreciation expense at The Geysers, and the start-up of Indonesian operations.\nDIVERSIFIED BUSINESSES\nAgricultural Products manufactures and markets nitrogen-based fertilizers for wholesale markets to the western United States and to the Pacific Rim. Carbon and Minerals produces and markets petroleum coke (other than on the West Coast), graphites, solvents and specialty minerals. Pipelines principally includes the company's equity interests in affiliated pipeline companies. Other includes the development and sale of real estate assets and the company's equity interest in The UNO-VEN Company, a refining and marketing partnership in the midwestern United States.\nIn 1995, Agricultural Products continued to benefit from significant increases in ammonia and urea product sales prices primarily due to high demand in international markets. This was partially offset by higher raw materials costs and higher manufacturing costs due to start-up expenses associated with an ammonia plant located in Finley, Washington. Plant improvements were completed and production began in December 1995. Production from the Finley plant is targeted for domestic markets. This will allow more of the Kenai, Alaska facility's marketable production of ammonia and urea to target international markets.\nComparing the 1994 Agricultural Products earnings with 1993, the increase reflected considerably higher margins on sales of ammonia and urea products, particularly in Asian markets.\nIn 1995, Carbon and Minerals benefited from higher petroleum coke and lanthanide earnings. The increase in 1994 from 1993 was primarily due to higher lanthanide earnings.\nThe higher Administrative and General expense in 1995 was primarily due to the income tax effect of allocable expenses to foreign operations for tax purposes and lower pension income.\nNet interest expense represents interest income and expense, net of capitalized interest. The increase in 1995 was primarily due to higher debt, while the decrease in 1994 reflected the benefit of refinancing debt at lower interest rates.\nThe Other category includes all unallocated corporate items and miscellaneous operations. In addition, this category, especially in prior years, includes the earnings effects and close-down expenses of businesses that were sold or being phased-out, such as the company's Process, Technology and Licensing business (sold in 1995), national auto\/truckstop system (sold in 1993), Imperial Valley geothermal operations (sold in 1993), PureGro chemical operations (sold in 1993), and Southeast marketing operations (phased-out beginning in 1992). This category also includes corporate items such as tax adjustments and certain special items noted in the above table.\nCash flow from operating activities, including working capital and other changes, was $1,277 million in 1995, $1,299 million in 1994 and $1,100 million in 1993. The 1995 amount included $200 million of proceeds from the sale of trade receivables (see Note 23 to the consolidated financial statements), $71 million from the Columbia settlement and $34 million from the OCS settlement. These benefits were more than offset by temporary working capital changes. The 1994 cash flow reflected decreased working capital requirements and significant income tax refunds received during the year. These benefits were partially offset by lower operational earnings. The 1993 amount reflected significant payments for legal and tax settlements and an adjustment for a 1992 crude oil forward sale.\nDuring 1995, the company generated $204 million in pretax proceeds from sales of assets, primarily nonstrategic oil and gas properties and the company's Process, Technology and Licensing business. Proceeds from sales of assets in 1994 totaled $156 million, primarily from the sale of nonstrategic oil and gas properties. Proceeds of $586 million in 1993 included $218 million from the sale of the Imperial Valley and other geothermal assets, $172 million from the sale of the company's national auto\/truckstop system and $106 million from the sale of various nonstrategic oil and gas properties.\nIn 1995 and 1994, the company also generated approximately $55 million and $54 million, respectively, in cash from the sale of its common stock, primarily through the Dividend Reinvestment and Common Stock Purchase Plan.\nThe company's total debt at year-end 1995 increased by $240 million from a year ago to $3,706 million. The increase was primarily due to the carrying values of debt-related currency swaps in the amount of $137 million being classified as long-term receivables at December 31, 1995. As a result, the principal amounts of the company's foreign-currency debt, when stated at the current exchange rates, totaled $350 million, an increase of $130 million from year-end 1994. The difference between the carrying values of the currency swaps and the increase in the principal amounts of the related foreign-currency debt represents the net gain that would have occurred if the currency swaps and debt had been settled at the end of December 1995. This classification has no effect on the consolidated cash flow statement.\nFor 1996, the company expects cash generated from operational earnings and asset sales to be adequate to meet its operating requirements, capital spending and dividend payments. In addition, the company has substantial borrowing capacity to meet unanticipated cash requirements. At December 31, 1995, the company had approximately $1.5 billion of undrawn commitments under various credit facilities with major banks.\nThe company's foreign operations have limited exposures to foreign currency risks. In most countries, energy products are valued and sold in U.S. dollars, and foreign currency operating cost exposures have not been significant. In the Philippines and Thailand, the company is paid for product deliveries in the local currencies, but at prices indexed to U.S. dollar valuations. Such funds, less amounts required for local currency-denominated obligations, are converted to U.S. dollars as soon as practicable and periodically remitted to the U.S. parent. The company's Canadian subsidiary is paid in Canadian dollars for its crude oil and natural gas sales. Excess Canadian funds generally have been invested in other Unocal foreign operations rather than remitted to the U.S. parent.\nThe company has only limited involvement with derivative financial instruments. The majority are debt-related and are used to manage interest rate and foreign currency exchange rate risks. The company also uses futures contracts to hedge its exposure to fluctuations in petroleum commodity prices. Such contracts covered less than one percent of the company's annual oil and gas production at year-end 1995. Authorization from the Board of Directors is needed before the company hedges more than 15% of its production of oil and gas, refined products, and of crude oil purchased for refinery supply.\nCapital spending in 1995 on foreign oil and gas exploration and production was up 14 percent compared with 1994, primarily reflecting increased expenditures in Myanmar, Indonesia, the Netherlands and Azerbaijan. The $422 million spent by 76 Products Company during 1995 primarily reflected refinery upgrades to complete environmental requirements for reformulated gasoline required by the California Air Resources Board, and the addition of refinery units to increase production of higher value products. Capital spending on geothermal energy projects in 1995 primarily focused on development work at the Salak field on the island of Java and exploration drilling on the island of Sumatra, in Indonesia.\nThe forecasted 1996 capital expenditures will focus on development of overseas oil and gas projects, particularly in Myanmar, Thailand, Indonesia and Azerbaijan. This capital plan reflects Unocal's continued emphasis on energy development projects overseas with higher potential rates of return.\nThe foreign petroleum exploration and production capital spending plan is up 49 percent from the 1995 amount. A major focus of this spending will be the Yadana field development and pipeline project offshore Myanmar. This natural gas project is expected to be in operation by mid-1998. In Thailand, the company plans to develop its existing fields in order to increase natural gas production capacity, as a second pipeline from the Gulf of Thailand to shore is being constructed by the Thai government. In Indonesia, the company plans to further develop new oil and gas reserves offshore East Kalimantan and accelerate its successful exploratory drilling program by drilling 15 to 25 exploratory wells in known producing basins as the first phase of a 65-well, multi-year program. Another important overseas project is in the Caspian Sea, offshore Azerbaijan. Unocal is a member of an international consortium that is moving forward with a development program to begin initial oil production by mid-1997.\nThe Louisiana\/Gulf of Mexico area accounts for 64 percent of the 1996 domestic capital budget, as the company moves ahead with development of key natural gas projects.\nThe capital spending plan for petroleum exploration and production includes $230 million for worldwide exploration. Of this, $170 million, or 74 percent, is planned for projects near existing operations that have a high potential for success.\nPlanned capital expenditures for 76 Products Company in 1996 are down 48 percent from 1995. The allocated capital for this segment has been significantly reduced since refinery modifications have been completed to manufacture California-mandated reformulated gasoline. Of the 1996 amount, about $95 million is planned for marketing operations, mostly for the addition of new profit centers to existing locations, such as convenience stores, car washes, quick- service restaurants and car maintenance services. Another $85 million is planned for the company's California refineries on projects to enhance profitability and meet environmental regulations.\nCapital expenditures for Geothermal and Power Operations are expected to more than double in 1996, focusing on projects in Indonesia. The company expects to accelerate development of resource production facilities at the Salak field and conduct additional exploration at the Sarulla contract area on the island of Sumatra. The company also expects to be a 50 percent owner in a venture that expects to build and operate power plants at the Salak field that will utilize its steam production.\nThe decrease in Agricultural Products capital spending in 1996 reflects reduced expenditures for the startup of the Finley, Washington, ammonia manufacturing plant. The planned increase in capital spending for Carbon and Minerals reflects anticipated projects at the Mountain Pass, Chicago Carbon and Poco Graphite facilities.\nENVIRONMENTAL MATTERS\nUnocal continues to make substantial capital and operating expenditures for environmental protection and to comply with federal, state and local laws and provisions regulating the discharge of materials into the environment. In many cases, investigatory or remedial work is now required at various sites even though past operations followed practices and procedures that were considered acceptable under environmental laws and regulations, if any, existing at the time.\nIn 1995, the company recorded approximately $230 million in environment- related capital expenditures, compared with an average of approximately $160 million per year for the prior three years. Estimated 1996 capital expenditures for environment-related costs are $90 million. The capital expenditures for 1994 and 1995 included significant amounts for refinery modifications to manufacture reformulated gasoline for the California market. No significant capital expenditures related to reformulated gasoline are anticipated in 1996.\nThe amount charged to 1995 earnings for remediation costs and for operating, maintenance and administrative costs to maintain environmental compliance was approximately $170 million, and such costs averaged approximately $270 million per year for the prior three years, including $370 million in 1994. The amount charged to 1994 earnings included provisions of $187 million for certain known future environmental remediation costs, of which $152 million was recorded in the fourth quarter of 1994. The 1994 fourth quarter provision was primarily the result of an extensive and ongoing review by the company of its reserves for environmental assessment\/remediation costs and its procedures for monitoring such reserves. In 1995, the company's continuing review identified additional future remediation costs which resulted in provisions of $45 million that were included in the amount charged to 1995 earnings.\nAt December 31, 1995, the company's reserves for environmental remediation obligations totaled $214 million, of which $83 million was included in other current liabilities. The total reserve amount is grouped into five categories and discussed below.\nSUPERFUND AND SIMILAR SITES. At year-end 1995, Unocal had received notification from the federal Environmental Protection Agency that the company may be a potentially responsible party (PRP) at 40 sites and may share certain liabilities at these sites. In addition, various state agencies and private parties had identified 30 other similar PRP sites that may require investigation and remediation. Of the total, the company has denied responsibility at 2 sites and at another 13 sites the company's liability, although unquantified, appears to be de minimis. The total also includes 25 sites which are under investigation or in litigation, for which the company's potential liability is not presently determinable. Of the remaining 30 sites, where probable costs can be reasonably estimated, reserves of $32 million had been established for future remediation and settlement costs. These 70 sites are exclusive of 44 sites where the company's liability has been settled or where the company has no evidence of liability and there has been no further indication of liability by government agencies or third parties for at least a 12-month period.\nUnocal does not consider the number of sites for which it has been named a PRP as a relevant measure of liability. Although the liability of a PRP is generally joint and several, the company is usually just one of several companies designated as a PRP. The company's ultimate share of the remediation costs at those sites often is not determinable due to many unknown factors as discussed in Note 18 to the consolidated financial statements. The solvency of other responsible parties and disputes regarding responsibilities may also impact the company's ultimate costs.\nFORMER COMPANY-OPERATED SITES. Reserves of $35 million had been established for this category of sites. Of the total, $14 million was for approximately 190 service station sites on leased properties at which operations have ceased and which the company is obligated to remediate before returning them to the owners. Also included was $12 million for approximately 230 service station sites that the company previously owned or leased. The current owners of such properties are holding the company responsible for environmental remediation costs.\nCOMPANY FACILITIES SOLD WITH RETAINED LIABILITIES. This category had reserves of $71 million for accrued environmental liabilities related to major company assets that were sold in prior years. Included are the company's former auto\/truckstop facilities, a former mine site in Wyoming, industrial chemical and polymer sites and agricultural chemical sites. In each sale, the company retained a contractual remediation or indemnification obligation and is responsible only for certain environmental problems associated with its past operations. The reserves represent presently estimated future costs for investigation\/feasibility studies and identified remediation work as a result of claims made by buyers of the properties.\nAlso included are reserves for the remediation of certain facilities which were transferred to The UNO-VEN Company in 1989 in connection with its formation. The facilities included the Chicago Refinery and related product terminals and service stations. Under the UNO-VEN Asset Purchase and Contribution Agreement, the company retained certain environmental liabilities that would require Unocal to either manage remediation work or reimburse UNO-VEN for remediation costs resulting from valid environmental claims. The agreement required all claims to be filed by November 30, 1995. The company has not completely evaluated the additional claims made by UNO-VEN near or on the November 30, 1995 deadline; however, it does not anticipate that any additional material liabilities beyond the current reserves will be incurred for these claims.\nINACTIVE OR CLOSED COMPANY FACILITIES. Reserves of $57 million had been established for these types of facilities. Major sites included in this category are the former Beaumont refinery in Texas and the shale oil project and a chemical facility in Colorado. Also included in this category is the Questa molybdenum mine in New Mexico. In the second quarter of 1995, an additional $9 million was added to the reserve for the estimated costs of investigations and remedial activities for the Questa site.\nThis category also includes the cleanup at the Guadalupe oil field on the central California coast of underground releases of a diesel-like additive formerly used to produce the field's heavy crude oil. During 1995, an additional reserve of $8 million was provided for estimated costs to complete the beach cleanup and for assessing and investigating the inland portion of the field. At year-end 1995, the reserve that had been established for the above activities had been fully utilized. The company expects to incur additional, but indeterminate, costs for continuing assessment, investigation and remediation of the inland portion of the field.\nAlso included in this category is the Avila Beach, California site. In 1988, petroleum hydrocarbon contamination under the Front Street section of the town was discovered. It was determined that the source of the contamination had been leaking pipelines that ran between a tank farm and wharf operated by the company. The company has installed interim systems as an initial remediation measure until a final remedial action plan is completed and implemented. The company is currently developing a plan that will be submitted by mid-1996 to the Regional Water Quality Control Board for approval. The plan will outline the procedures that will be used to determine the desired alternatives for the site's final remediation. The future costs related to the final remediation will not be determined until these alternatives are identified. The year-end reserve included the estimated remaining cost for the excavation of one section of the beach where contaminants were detected close to the surface of the sand during the company's third quarter 1995 testing and monitoring of the site. The company completed the cleanup of this area in January 1996 as required by a state order.\nACTIVE COMPANY FACILITIES. The company had provided $19 million for estimated future costs of remedial orders, corrective actions and other investigation, remediation and monitoring obligations at certain operating facilities and producing oil and gas fields. The operating facilities primarily consist of refineries, marketing terminals and bulk plants.\nThe total environmental remediation reserves recorded on the consolidated balance sheet represent the company's estimate of assessment and remediation costs based on currently available facts, existing technology, and presently enacted laws and regulations. The remediation cost estimates, in many cases, are based on plans recommended to the regulatory agencies for approval and are subject to future revisions. The ultimate costs to be incurred will likely exceed the total amounts reserved, since many of the sites are relatively early in the remedial investigation or feasibility study phase. Additional liabilities may be accrued as the assessment work is completed and formal remedial plans are formulated.\nThe company estimated, to the extent it was able to do so, that it could incur approximately $180 million of additional costs in excess of the $214 million accrued at December 31, 1995. The amount of such possible additional costs reflects, in most cases, the high end of the range of costs of feasible alternatives identified by the company for those sites with respect to which investigation or feasibility studies have advanced to the stage of analyzing such alternatives. However, such estimated possible additional costs are not an estimate of the total remediation costs beyond the amounts reserved, since at a large number of sites the company is not yet in a position to estimate such possible additional costs.\nBoth the amounts reserved and estimates of possible additional costs may change in the near term, in some cases, substantially, as additional information becomes available regarding the nature and extent of site contamination, required or agreed upon remediation methods, and other actions by governmental agencies and private parties.\nSee Notes 17 and 18 to the consolidated financial statements for additional information.\nFUTURE ACCOUNTING CHANGE\nThe Financial Accounting Standards Board recently issued Statement of Financial Accounting Standards (SFAS) No. 123, \"Accounting for Stock-Based Compensation.\" The new requirements under SFAS No. 123 are generally effective for 1996 financial statements. Companies must either expense the value of stock-based compensation or disclose in a footnote what the earnings and earnings per share would be had the value been expensed. The company expects to adopt the disclosure method. At adoption, the effect on earnings and earnings per share is not expected to be material.\nOUTLOOK\nCertain of the statements in this discussion, as well as other forward-looking statements within this document, contain estimates and projections of amounts of or increases in future revenues, earnings, cash flows, capital expenditures, assets, liabilities and other financial items and of future levels of or increases in reserves, production, sales including related costs and prices, and other statistical items; plans and objectives of management regarding the company's future operations, products and services; and certain assumptions underlying such estimates, projection plans and objectives. While these forward-looking statements are made in good faith, future operating, market, competitive, legal, economic, political, environmental, and other conditions and events could cause actual results to differ materially from those in the forward-looking statements.\nCrude oil prices are expected to be unstable in 1996 because of the uncertain effect of the United Nations' seeming willingness to allow a partial resumption of oil exports from Iraq. However, domestic natural gas prices are expected to remain strong in early 1996, at least until the winter selling season is over and natural gas inventories within the industry are replenished.\nThe sale of the company's California oil and gas producing properties is expected to be completed in April 1996. The proceeds are expected to be used to reduce debt and fund capital projects overseas. The sale includes Unocal's interests in 68 oil and gas fields, including 11 producing platforms off the California coast in state and federal waters. Unocal's average net daily production from the properties in the proposed sale was 27,000 barrels of oil and 59 million cubic feet (mmcf) of natural gas during 1995, and proven reserves of 184 million barrels of oil equivalent at year-end 1995. For 1995, Unocal's California oil and gas producing properties generated pretax operating earnings and cash flow of approximately $14 million and $64 million, respectively. Unocal has approximately 600 employees involved in its California oil and gas operations. While many of those employees will be offered positions with the buyer or at other Unocal operations, some layoffs are expected (see Note 25 for additional information). The sale of these producing properties is not expected to have a material effect on Unocal's future operating results.\nOn a worldwide basis, 1996 daily natural gas production is expected to average nearly 1.8 billion cubic feet, up slightly from 1995. Crude oil and condensate production is expected to average 210,000 barrels per day, down from 240,000 last year.\nThe company anticipates an approximate 15 percent increase in foreign natural gas production in 1996. This improvement is expected mainly from a significant increase in the company's Gulf of Thailand production beginning in the second quarter of 1996, when the Petroleum Authority of Thailand's new pipeline comes on stream. Also, oil and gas production should continue to improve in Indonesia as a result of successful exploration and development programs that have revitalized operations.\nFor 1996, the company expects domestic crude oil and natural gas production to be lower, reflecting the expected completion of the sale of its California producing oil and gas properties and continued natural production declines. The company will continue to focus on domestic natural gas production in the Louisiana\/Gulf Coast area.\nThe company is in the process of retaining an advisor to assist in the disposal of its oil and gas interests in the Netherlands sector of the North Sea as it continues to shift its strategic focus to Southeast Asia and other areas that offer greater opportunities for growth. Unocal's net daily production from its Netherlands operations in 1995 was 11,000 barrels of crude oil and condensate and 9 mmcf of natural gas.\nIn Thailand, the company expects to spend approximately $160 million on development projects that should allow the company to sustain gross production at 950 mmcf of natural gas per day once a second pipeline becomes operational in 1996. The planned production for 1996 is expected to average 825 mmcf per day (gross). Natural gas demand in Thailand is expected to continue its active growth over the next 10 to 15 years, providing a market for the increased production from the Gulf of Thailand.\nUnocal is currently pursuing growth opportunities in Central and Southeast Asia. The main areas of oil and gas exploration and development opportunities are in Azerbaijan, Myanmar, Turkmenistan, Pakistan, China and Vietnam.\nIn Azerbaijan, Unocal is part of an international consortium participating in the development of three oil fields in the Caspian Sea offshore Azerbaijan. Unocal has a 9.5 percent interest in the project. Initial production is expected to begin in mid-1997. This is a major, long-term commitment for Unocal. There are still difficult issues to resolve as to the route and construction of permanent export pipelines for the oil.\nA major focus of 1996 capital spending will be the Yadana project offshore Myanmar. This natural gas project, which is to include four offshore platforms, should be in operation by mid-1998. When fully developed, estimated gross production in 1999 is expected to reach 650 mmcf of natural gas per day. The majority of the production is to be sold under a 30-year gas sales contract and a pipeline agreement calling for natural gas deliveries of 525 mmcf per day to Thailand beginning in mid-1998. A separate sales agreement calls for 125 mmcf per day of natural gas to be supplied to Myanmar for its domestic use. Unocal has a 28.26 percent interest in the Yadana project.\nIn March 1996, Unocal announced the discovery of a potentially significant new gas field located about six miles south of the Yadana field in the Andaman Sea. Further studies are under way to prove the commerciality of this new offshore discovery. The field could be produced through the Yadana platform complex. Unocal has the same percentage ownership and partners in this discovery as it has in the Yadana project.\nThe United States Congress is currently considering legislation that could ban United States companies from all business activities associated with Myanmar. This action, if passed, would adversely effect the company's future prospects in that country.\nThe company will continue to expand its marketing operations at retail outlets with the addition of new businesses to certain existing locations, such as convenience stores, car washes, quick-service restaurants and car maintenance services. The company is also working to increase gasoline retail sales volumes by installing credit card readers at the dispensers and reconfiguring the service islands. In February 1996, Unocal entered into a strategic alliance with Fleetman, Inc. to market Fuelman Fleet Cards. Also, Unocal signed a Memorandum of Understanding with Southern Counties Oil Company\/Cardlock Fuels System which could lead to joint construction, development and operation of unattended commercial fueling facilities throughout California. These agreements position the company as a leader in the West Coast commercial fleet fuel business.\nTo improve the company's standing in markets outside California and Hawaii, Unocal is actively pursuing joint ventures and alliances. In October 1995, Unocal and Circle K Corporation (Circle K), one of the nation's leading convenience store operators, signed a branding\/licensing agreement for more than 400 Circle K sites in the Phoenix and Tucson, Arizona markets. In addition, the company plans to brand and supply 20 existing Circle K sites in Las Vegas, Nevada, and the two companies plan to co-develop new service station\/convenience store sites in the Las Vegas area. In February 1996, Tosco Corporation, a petroleum refiner and marketer, announced that it had entered into a merger agreement with Circle K.\nThe upgrades to the company's refineries are now complete and higher valued products are being produced along with the new reformulated gasolines that meet California standards. On the retail marketing side, the company foresees improved margins on the California reformulated gasolines that must be sold at retail sites by June 1, 1996. In addition, the increased gasoline throughput and returns from its reformatted service stations are meeting or exceeding the company's forecasts. However, the ultimate effect on product margins of the new gasolines cannot be accurately predicted.\nIn February 1994, the company was granted a United States patent for reformulated gasolines that meet the 1996 California standards. Six refining companies filed suit against Unocal in April 1995 to invalidate the patent or declare it unenforceable. The company intends to aggressively defend its rights under this patent.\nIn Indonesia, the Geothermal and Power Operations segment expects to accelerate development of resource production facilities at the Salak field on the island of Java. The company also expects to be a 50 percent owner in a venture that expects to build and operate new power plants at this field. Unocal will supply steam for the power plants. The company also plans to conduct additional exploration in the Sarulla block on the island of Sumatra, after a discovery well indicated a highly productive geothermal resource. The company had previously negotiated a power sales agreement that allows it to develop up to 1,000 megawatts of generating capacity in the Sarulla block. The first of the Unocal power plants is expected to begin operation in 1999, assuming the commerciality of the field. The company is also pursuing other geothermal development and power generation opportunities throughout Indonesia.\nThe geothermal segment expects to benefit from improved earnings in 1996 from operations at The Geysers in Northern California. The 1995 earnings were adversely affected by seven months of discretionary curtailments by the public utility that purchases the steam. Such curtailments are not expected in 1996. In 1996, the company is scheduled to begin a project to inject waste water from municipal treatment plants to recharge the reservoir. This injection project should increase the productivity of the field.\nIn 1996, the Agricultural Products segment expects continued high sales volumes of ammonia and urea. Approximately 200,000 additional tons per year of ammonia is expected to be available for sale due to new production from the Finley, Washington plant and higher production from the Kenai, Alaska facility. The segment plans to expand sales efforts in its existing markets in South Korea, Japan, China and Vietnam. The company also plans to develop new markets in India.\nThe Carbon and Minerals segment will continue to expand specialty graphite products and will begin production of higher margin minerals. Also, primarily due to increased molybdenum prices, the Questa mine is expected to resume operations in late 1996, after being idle for approximately ten years. This mine is expected to produce about 14 million pounds of molybdenum per year when it reaches full production. Carbon and Minerals will continue to look for new products and expansion opportunities in order to provide earnings growth.\nITEM 8","section_7A":"","section_8":"ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nAll other financial statement schedules have been omitted as they are not applicable, not material or the required information is included in the financial statements or notes thereto.\nREPORT ON MANAGEMENT'S RESPONSIBILITIES ----------------------------------------\nTO THE STOCKHOLDERS OF UNOCAL CORPORATION:\nUnocal's management is responsible for the integrity and objectivity of the financial information contained in this Annual Report. The financial statements included in this report have been prepared in accordance with generally accepted accounting principles and, where necessary, reflect the informed judgments and estimates of management.\nThe financial statements have been audited by the independent accounting firm of Coopers & Lybrand L.L.P. Management has made available to Coopers & Lybrand L.L.P. all the company's financial records and related data, minutes of the company's executive and management committee meetings and directors' meetings and all internal audit reports. The independent accountants conduct a review of internal accounting controls to the extent required by generally accepted auditing standards and perform such tests and procedures as they deem necessary to arrive at an opinion on the fairness of the financial statements presented herein.\nManagement maintains and is responsible for systems of internal accounting controls designed to provide reasonable assurance that the company's assets are properly safeguarded, transactions are executed in accordance with management's authorization and the books and records of the company accurately reflect all transactions. The systems of internal accounting controls are supported by written policies and procedures and by an appropriate segregation of responsibilities and duties. The company maintains an extensive internal auditing program that independently assesses the effectiveness of these internal controls with written reports and recommendations issued to the appropriate levels of management. Management believes that the existing systems of internal controls are achieving the objectives discussed herein.\nUnocal assessed its internal control systems in relation to criteria for effective internal control over financial reporting following the Treadway Commission's Committee of Sponsoring Organizations \"Internal Control - Integrated Framework.\" Based on this assessment, Unocal believes that, as of December 31, 1995, its systems of internal controls over financial reporting met those criteria.\nUnocal's Accounting, Auditing and Ethics Committee, consisting solely of directors who are not employees of Unocal, is responsible for: reviewing the company's financial reporting, accounting and internal control practices; recommending the selection of independent accountants (which in turn are approved by the Board of Directors and annually ratified by the stockholders); monitoring compliance with applicable laws and company policies; and initiating special investigations as deemed necessary. The independent accountants and the internal auditors have full and free access to the Accounting, Auditing and Ethics Committee and meet with it, with and without the presence of management, to discuss all appropriate matters.\nRoger C. Beach John F. Imle, Jr. Neal E. Schmale Charles S. McDowell Chief Executive President Chief Financial Vice President Officer Officer and Comptroller\nFebruary 14, 1996\nREPORT OF INDEPENDENT ACCOUNTANTS ---------------------------------\nTO THE STOCKHOLDERS OF UNOCAL CORPORATION:\nWe have audited the accompanying consolidated balance sheets of Unocal Corporation and its subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of earnings, cash flows and stockholders' equity for each of the three years in the period ended December 31, 1995 and the related financial statement schedule. These financial statements are the responsibility of Unocal Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above, which appear on pages 33 through 61 of this Annual Report on Form 10-K, present fairly, in all material respects, the consolidated financial position of Unocal Corporation and its subsidiaries as of December 31, 1995 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, 1995, 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 Note 2 to the consolidated financial statements, Unocal Corporation and its subsidiaries changed their method of accounting for the impairment of long-lived assets and long-lived assets to be disposed of in 1995; for recognizing the reduction in value of its producing oil and gas properties in 1994; and for postretirement benefits other than pensions and for postemployment benefits in 1993.\nCoopers & Lybrand L.L.P. February 14, 1996, except for Note 25, as to which the date is February 16, 1996 Los Angeles, California\nCONSOLIDATED EARNINGS UNOCAL CORPORATION\nSee Notes to Consolidated Financial Statements.\nCONSOLIDATED BALANCE SHEET UNOCAL CORPORATION\nThe company follows the successful efforts method of accounting for its oil and gas activities.\nSee Notes to Consolidated Financial Statements.\nCONSOLIDATED CASH FLOWS UNOCAL CORPORATION\nSee Notes to Consolidated Financial Statements.\nCONSOLIDATED STOCKHOLDERS' EQUITY UNOCAL CORPORATION\nSee Notes to Consolidated Financial Statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION\nFor the purpose of this report, Unocal Corporation (Unocal) and its consolidated subsidiary, Union Oil Company of California (Union Oil) and its consolidated subsidiaries, will be referred to as the company.\nThe consolidated financial statements of the company include the accounts of subsidiaries more than 50 percent owned. Investments in affiliates owned 50 percent or less are accounted for by the equity method. Under the equity method, the investments are stated at cost plus the company's equity in undistributed earnings after acquisition. Income taxes estimated to be payable when earnings are distributed are included in deferred income taxes.\nUSE OF ESTIMATES\nThe consolidated financial statements are prepared in conformity with generally accepted accounting principles, which require management to make estimates and assumptions that affect the amounts of assets and liabilities and the disclosures of contingent liabilities as of the financial statement date and the amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nINVENTORIES\nInventories are valued at lower of cost or market. The costs of crude oil, refined products and agricultural products inventories are determined using the last-in, first-out (LIFO) method. The costs of other inventories are determined by using various methods. Cost elements primarily consist of raw materials and production expenses.\nIMPAIRMENT OF ASSETS\nOil and gas producing properties are regularly assessed for possible impairment on a field-by-field basis using the estimated undiscounted future cash flows of each field. Impairment loss is charged to depreciation, depletion and amortization expense when the estimated discounted future cash flows are less than the current net book values of the properties in a field. See Note 2 for additional information.\nImpairment charges are also made for the write-down of other long-lived assets when it is determined that the carrying values of the assets may not be recoverable. A long-lived asset is reviewed for impairment whenever events or changes in circumstances indicate that the carrying value of the asset may not be recoverable.\nOIL AND GAS EXPLORATION AND DEVELOPMENT COSTS\nThe company follows the successful-efforts method of accounting for its oil and gas activities.\nAcquisition costs of exploratory acreage are capitalized. Full amortization of such costs related to the portion of unproved properties is provided over the shorter of the exploratory period or the lease holding period. Costs of successful leases are transferred to proved properties. Exploratory drilling costs are initially capitalized. If exploratory wells are determined to be commercially unsuccessful, the related costs are expensed. Geological and geophysical costs for exploration and leasehold rentals for unproved properties are expensed.\nDevelopment costs of proved properties, including unsuccessful development wells, are capitalized.\nDEPRECIATION, DEPLETION AND AMORTIZATION\nDepreciation, depletion and amortization related to proved oil and gas properties and estimated future abandonment and removal costs for offshore production platforms are calculated at unit-of-production rates based upon estimated proved recoverable reserves. Depreciation of other properties is generally on a straight-line method using various rates based on estimated useful lives.\nMAINTENANCE AND REPAIRS\nExpenditures for maintenance and repairs are expensed. In general, improvements are charged to the respective property accounts and such accounts are relieved of the original cost of property replaced.\nRETIREMENT AND DISPOSAL OF PROPERTIES\nUpon retirement of facilities depreciated on an individual basis, remaining book values are charged to depreciation expense. For facilities depreciated on a group basis, remaining book values are charged to accumulated allowances. Gains or losses on sales of properties are included in current earnings.\nINCOME TAXES\nThe company uses the liability method for reporting income taxes in which current or deferred tax liabilities or assets are recorded in accordance with enacted tax laws and rates. Under this method, the amount of deferred tax liabilities or assets at the end of each period is determined using the tax rate expected to be in effect when taxes are actually paid or recovered. Future tax benefits are recognized to the extent that realization of such benefits is more likely than not.\nDeferred income taxes are provided for the estimated income tax effect of temporary differences between financial and tax bases in assets and liabilities. Deferred tax assets are also provided for certain tax credit carryforwards. A valuation allowance to reduce deferred tax assets is established when deemed appropriate. See Note 9 for the principal temporary differences and unused tax credits.\nFOREIGN CURRENCY TRANSLATION\nForeign exchange gains and losses as a result of translating a foreign entity's financial statements from its functional currency into U.S. dollars are included as a separate component of stockholders' equity. The functional currency for all foreign operations, except Canada, is the U.S. dollar. Gains or losses incurred on currency transactions in other than a country's functional currency are included in net earnings.\nENVIRONMENTAL EXPENDITURES\nEnvironmental expenditures that create future benefits or contribute to future revenue generation are capitalized. Expenditures that relate to existing conditions caused by past operations are expensed.\nLiabilities related to environmental assessment and future remediation costs are recorded when such liabilities are probable and the amounts can be reasonably estimated. The company considers a site to present a probable liability when an investigation has identified environmental remediation requirements for which the company is responsible. The timing of accruing for remediation costs generally coincides with the company's completion of investigation or feasibility work and its recommendation of a remedy or commitment to an appropriate plan of action.\nEnvironmental liabilities are not discounted or reduced by possible recoveries from third parties. However, accrued liabilities for Superfund and similar sites reflect anticipated allocations of liabilities among settling participants.\nEnvironmental remediation expenditures required for properties held for sale are capitalized. A valuation allowance is established when the aggregate book values of the properties, including capitalized remediation costs, exceed net aggregate realizable values.\nSee Notes 17 and 18 for additional information.\nFINANCIAL INSTRUMENTS\nThe company has only limited involvement with derivative financial instruments and does not use them for trading purposes. They are used to manage well-defined interest rate, foreign currency exchange rate and commodity price risks. Gains and losses arising from currency swap agreements are recognized in income and offset the foreign exchange gains and losses on the underlying transactions. Gains and losses arising from commodity future contracts are deferred and included in the basis of the underlying transactions. Income or expense associated with interest rate swap agreements is recognized on the accrual basis over the life of the swap agreement as a component of interest income or interest expense.\nSee Note 16 for additional information.\nOTHER\nEarnings per share of common stock are based on net earnings less preferred stock dividend requirements, divided by the weighted average shares of common stock outstanding during each period.\nInterest is capitalized on major construction and development projects as part of the costs of the assets.\nCertain items in prior year financial statements have been reclassified to conform to the 1995 presentation.\nNOTE 2 - ACCOUNTING CHANGES\nEffective in the fourth quarter of 1995, the company adopted Statement of Financial Accounting Standards (SFAS) No. 121, \"Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of.\" The new accounting standard sets guidelines to be used for determining and measuring impairment of certain assets. As a result, the company recorded a charge to earnings of $87 million pretax ($53 million after tax or 22 cents per common share) for the write-down of several oil and gas producing properties where recent downward revisions in reserve estimates indicated future net cash flows would be insufficient to fully recover the carrying value of these properties. The carrying values were written down to estimated future discounted cash flows or fully written off in the case of negative future cash flows. The charge was recorded in depreciation, depletion and amortization expense and reflected the reduction in value of various properties located in the United States ($44 million), the Netherlands ($37 million) and Canada ($6 million).\nEffective January 1, 1994, the company changed its accounting policy for recognizing the reduction in value of its producing oil and gas properties and commenced to evaluate properties for impairment on a field-by-field basis instead of a country-by-country basis which was previously used. The cumulative effect of the accounting change resulted in a charge to earnings of $447 million pretax ($277 million after tax or $1.14 per common share) in the first quarter of 1994. The charge reflected the reduction in value of certain oil and gas properties in the U.S. from which the estimated undiscounted future cash flows were less than the current net book values of the properties. As a result of the property write-downs, the company's depreciation and depletion expense in 1994 was reduced by approximately $61 million ($38 million after tax). On a pro forma basis, net earnings for 1993 would have increased by $31 million to $244 million or 86 cents per common share as a result of the accounting change.\nEffective January 1, 1993, the company adopted SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" This new accounting standard requires the company to recognize its obligation to provide postretirement health care benefits and to accrue such costs rather than recording them on a cash basis. The actuarial present value of the accumulated postretirement health care obligation existing at January 1, 1993 was recognized in the consolidated earnings statement as a cumulative effect of an accounting change, resulting in a charge to the first quarter 1993 earnings of $192 million before tax ($121 million after tax or 50 cents per common share).\nThe company also adopted SFAS No. 112, \"Employers' Accounting For Postemployment Benefits,\" effective January 1, 1993. This statement requires the company to recognize its obligation to provide benefits, such as workers' compensation and disabled employees' medical care, to former or inactive employees after employment but before retirement. The charge to earnings for the cumulative effect of the company's unfunded obligation prior to 1993 was $14 million before tax ($9 million after tax or 4 cents per common share).\nNOTE 3 - RESTRUCTURING COSTS\nDuring the fourth quarter of 1994, as a result of an overhead study, the company began a two-year program to reduce its 1,540-person corporate staff by 630 positions and to eliminate another 126 positions in the operating groups. A pretax charge of $25 million was recorded in administrative and general expense for net costs associated with the staff reductions. This charge included $34 million of estimated benefits to be paid to ex-employees over a period of time. Partially offsetting this charge was an estimated credit of $9 million for reduced pension obligations. At December 31, 1995, approximately 541 employees had been terminated as a result of the program. The amount of unpaid benefits remaining on the consolidated balance sheet was $14 million.\nNOTE 4 - WRITE-DOWNS OF ASSETS\nIn 1995, prior to the adoption of SFAS No. 121 in the fourth quarter, the company recorded a pretax charge of $13 million to write down the carrying values of certain domestic oil and gas properties and $5 million for miscellaneous asset write-downs.\nDuring 1994, the company recorded a pretax charge of $25 million to write down the carrying value of the Guadalupe oil field due to its decision to shut down the field for environmental reasons. The company also closed certain facilities used in refining and marketing operations and research activities, which resulted in write-downs of $39 million. Due to project modifications, the company wrote off an additional $7 million in 1994 for costs related to the reformulated fuels program at the company's Los Angeles Refinery.\nThe 1993 earnings included a pretax charge of $19 million for the write-off of refining projects, primarily due to the cancellation of a portion of work associated with the reformulated fuels program at the company's Los Angeles Refinery.\nNOTE 5 - DISPOSITIONS OF ASSETS\nDuring 1995, the company received total proceeds from sales of assets of $204 million and recorded a pretax gain of $117 million. Of the total, $134 million was from the sale of nonstrategic oil and gas properties with a pretax gain of $52 million. In addition, the company recorded a pretax gain of $26 million on proceeds of $32 million from the sale of its Process, Technology and Licensing business.\nIn 1994, asset sales generated total proceeds of $156 million with a pretax loss of $2 million. Of the total proceeds, $118 million was from the sale of oil and gas properties.\nIn 1993, the sale of the company's geothermal assets in the Imperial Valley of California and other geothermal exploration leases resulted in a $40 million pretax gain on proceeds of $218 million. An $11 million pretax gain on proceeds of $172 million was recorded from the sale of the company's national auto\/truckstop system. In addition, various oil and gas properties were sold which generated total proceeds of $106 million with a pretax gain of $42 million. The company also sold its retail agricultural businesses with a pretax loss of $1 million on proceeds of $31 million.\nNOTE 6 - CASH FLOW INFORMATION\nThe company considers cash equivalents to be all highly liquid investments purchased with a maturity of three months or less. All income taxes paid are included in determining cash flows from operating activities. As a result, income taxes paid on taxable income from sales of assets are not included in cash flows from investing activities.\nThe 1995 and 1994 cash flow statements excluded $30 million and $23 million, respectively, in non-cash transactions. These amounts primarily relate to the purchase of Unocal common stock by the trustee of the Unocal Savings Plan (the \"Plan\") from Unocal. The trustee used the company's matching contributions to the Plan, which were expensed in the company's consolidated earnings statements, to purchase the shares. In the consolidated cash flow statements, the issuance of Unocal common stock and the matching contribution expense were treated as non-cash transactions since the resulting effect on cash flow was zero.\nIn the consolidated statement of cash flows for 1994, the $217 million adjustment to reconcile the net loss to net cash provided by operating activities principally included non-cash charges to earnings of $170 million for future environmental remediation costs.\nIn the consolidated statement of cash flows for 1993, other changes related to operations principally included $106 million of payments for Alaska tax and geothermal energy sales contract settlements. Also included was a cash flow reduction of $125 million relating to the settlement of crude oil forward sales contracts, for which revenue was recognized in 1993, but cash was received in 1992.\nNOTE 7 - OTHER FINANCIAL INFORMATION\nCONSOLIDATED EARNINGS INCLUDE THE FOLLOWING:\nThe consolidated balance sheet at December 31 includes the following:\nNOTE 8 - EXCISE, PROPERTY AND OTHER OPERATING TAXES\nIn addition, social security and unemployment insurance taxes, which are charged to earnings and included with salaries and wages, totaled $45 million in 1995 and $44 million in 1994 and 1993.\nNOTE 9 - INCOME TAXES\nUnocal files a consolidated federal income tax return that includes essentially all U.S. subsidiaries. The components of pretax earnings and the provision for income taxes are as follows:\nThe following table is a reconciliation of income taxes at the federal statutory income tax rates to income taxes as reported in the consolidated earnings statement.\nNOTE 9 - INCOME TAXES (CONTINUED)\nThe significant components of deferred income tax assets and liabilities included in the consolidated balance sheet at December 31, 1995 and 1994 are as follows:\nNo deferred U.S. income tax liability has been recognized on the undistributed earnings of foreign subsidiaries that have been retained for reinvestment. If distributed, no additional U.S. tax is expected due to the availability of foreign tax credits. Such undistributed earnings for tax purposes, excluding previously taxed earnings, are estimated at $759 million as of December 31, 1995.\nAt year-end 1995, the company had $66 million of unused foreign tax credits with various expiration dates through the year 2000. No deferred tax asset for these foreign tax credits is recognized for financial statement purposes.\nThe federal alternative minimum tax credits are available to offset future U.S. federal income taxes on an indefinite basis. In addition, the company has approximately $15 million of federal business tax credit carryforwards and $28 million of California business tax credit carryforwards that will expire between the years 2001 and 2009. The 1995 federal net operating loss carryforward is expected to be fully utilized in 1996.\nThe current replacement cost of inventories exceeded the LIFO inventory value included above by $149 million and $142 million at December 31, 1995 and 1994, respectively.\nNOTE 11 - PROPERTIES AND CAPITAL LEASES\nInvestments in owned and capitalized leased properties at December 31, 1995 and 1994 are set forth below. Total accumulated depreciation, depletion and amortization was $11,431 million and $11,096 million at December 31, 1995 and 1994, respectively.\nNOTE 12 - RETIREMENT PLANS\nThe company and its subsidiaries have several non-contributory retirement plans covering substantially all employees. Plan benefits are primarily based on years of service and employees' compensation near retirement.\nAll U.S. plans are administered by corporate trustees. There was no company contribution to any of the U.S. plans during the years 1993 through 1995 as plan assets substantially exceeded the pension obligations. At year-end 1995, plan assets principally consisted of equity securities, U.S. government and agency issues, corporate bonds and cash.\nEmployees of certain foreign subsidiaries of the company are covered by separate plans. Total obligations for all foreign plans are not material.\nNOTE 12 - RETIREMENT PLANS (CONTINUED)\nPension costs for the funded U.S. plans include the following components:\nThe following table sets forth the plans' funded status and amounts recognized in the consolidated balance sheet at December 31, 1995 and 1994:\nThe assumed rates used to measure the projected benefit obligation and the expected earnings on plan assets were as follows:\nThe amount of benefits which can be covered by the funded plans described above are limited by the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code. Therefore, the company has a supplemental retirement plan designed to maintain benefits for all employees at the plan formula level. The amounts expensed for this plan were $5 million, $5 million and $2 million in 1995, 1994 and 1993, respectively. The accumulated obligation recognized in the consolidated balance sheet at December 31, 1995 was $21 million.\nThe company has established a grantor trust to provide funding for the benefits payable under the supplemental retirement plan. Total assets held in the trust at December 31, 1995 and 1994 amounted to $14 million and $8 million, respectively.\nNOTE 13 - POSTRETIREMENT AND POSTEMPLOYMENT BENEFIT PLANS\nThe company's medical plan provides health care benefits for eligible employees and retired employees. Employees may become eligible for postretirement benefits if they reach the normal retirement age while working for the company. The plan is contributory and the benefits are subject to deductibles and co-payments.\nThe following table sets forth the postretirement benefit obligation recognized in the consolidated balance sheet at December 31, 1995 and 1994:\nNet periodic postretirement benefits cost is comprised of the following components:\nThe accumulated postretirement benefit obligation at December 31, 1995 was determined using a discount rate of 7.25 percent. The health care cost trend rates used in measuring the 1995 benefit obligations were 7.0 percent for under age 65 and 6.2 percent for age 65 and over, gradually decreasing to 5.0 percent by the year 2001 and remaining at that level thereafter. The rates are subject to change in the future. The health care cost trend rate assumption has a significant effect on the amounts reported. For example, an increase in the assumed health care cost trend rate of one percentage point in each year would increase the accumulated postretirement benefit obligation as of December 31, 1995 by $24 million and net periodic benefits cost by $3 million.\nThe company also provides benefits such as workers' compensation and disabled employees' medical care to former or inactive employees after employment but before retirement. The accumulated postemployment benefit obligation was $16 million as of December 31, 1995 and $17 million as of December 31, 1994.\nNOTE 14 - LONG-TERM DEBT AND CREDIT AGREEMENTS\nThe following table summarizes the company's long-term debt:\nAt December 31, 1995, the commercial paper, the Swiss Franc Bonds, $5 million of medium-term notes due in 1996 and short-term borrowings under various credit facilities due in 1996 were classified as long-term debt and included with the maturity amount due in the year 2000, listed below. The company has the intent to refinance these borrowings on a long-term basis and has the ability to do so, if necessary, through existing lines of credit extending to the year 2000. The amounts of long-term debt maturing in 1997, 1998, 1999 and 2000 are $118 million, $415 million, $171 million and $1,336 million, respectively.\nIn 1995, the company's new borrowings consisted of: (1) $350 million in medium-term notes with interest rates ranging from 6.70% to 8.15% and maturity dates ranging from March 2002 to April 2015; (2) $200 million of 7.20% Notes due 2005; (3) and $50 million under a $50 million revolving credit facility. The proceeds were used principally to retire the Eurodollar Notes and refinance other maturing debt.\nThe company also borrowed an additional $50 million under a $250 million revolving credit facility that was established in 1993 for the purpose of funding its oil and gas development program in Thailand. This credit facility, which had $80 million outstanding at December 31, 1995, terminates December 15, 2000. For the same purpose, the company has a $45 million revolving credit facility through April 19, 2000 in the Netherlands. The entire commitment amount was unborrowed at year-end 1995. During 1994, the company arranged an $85 million revolving credit facility with a Canadian Bank. This facility, which has a perpetual 364-day maturity date, was reduced to $25 million in 1995. The entire amount was available at year-end 1995. During 1995, the company arranged a $200 million 364-day credit facility, which matures March 1997 and is subject to annual renewal. The entire commitment amount was undrawn at year-end 1995. Borrowings under these four credit facilities bear interest at different margins above London Interbank Offered Rates (LIBOR) and the agreements call for facility fees on either the total or undrawn commitment.\nThe Bank Credit Agreement provides a revolving credit of $1.2 billion through June of the year 2000 at interest rates based on LIBOR and requires a facility fee on the total commitments. Of the total, $105 million had been drawn at December 31, 1995. This agreement is available for general corporate purposes, including the support of commercial paper. The company has other undrawn letters of credit for approximately $183 million. The majority are maintained for operational needs.\nNOTE 14 - LONG-TERM DEBT AND CREDIT AGREEMENTS (CONTINUED)\nThe Bank Credit Agreement and certain of the other revolving credit facilities described above provide for the termination of the commitments and require the prepayment of all outstanding borrowings in the event (a) any person or group becomes the beneficial owner of more than 30 percent of the then outstanding voting stock of Unocal, otherwise than in a transaction having the approval of the Board of Directors of Unocal (the Board), at least a majority of which are continuing directors (as defined therein), or (b) continuing directors shall cease to constitute at least a majority of the Board.\nNOTE 15 - LEASE RENTAL OBLIGATIONS\nFuture minimum rental payments for operating leases having initial or remaining noncancelable lease terms in excess of one year are as follows:\nNet operating rental expense included in consolidated earnings is as follows:\nNOTE 16 - FINANCIAL INSTRUMENTS\nUnocal does not hold or issue financial instruments for trading purposes.\nNotional amounts are not included in the consolidated balance sheet and generally exceed the future cash requirements relating to the instruments.\nThe counterparties to the company's financial instruments are regulated exchanges or major international financial institutions with high credit ratings. Even though the company may be exposed to losses in the event of non- performance by these counterparties, it does not anticipate losses due to non- performance by the counterparties. In the opinion of management, the off- balance-sheet risk associated with these instruments is minimal and immaterial.\nFOREIGN CURRENCY FORWARD AND SWAP CONTRACTS\nUnocal enters into various foreign currency forward and swap contracts to manage its exposures to adverse impacts of foreign currency fluctuations under both debt and other obligations. Foreign currency gains or losses on the outstanding contracts essentially offset the foreign currency gains or losses of the underlying obligations.\nNOTE 16 - FINANCIAL INSTRUMENTS (CONTINUED)\nDuring 1986, the company entered into two currency swap agreements to hedge foreign currency exchange exposures related to the interest and principal payments on the company's Swiss Franc bonds due in 1996 and Deutsche Mark bonds due in 1998. These instruments have the same maturities as the related underlying debt. At year-end 1995 and 1994, the aggregate notional principal amounts of these agreements were $220 million. At year-end 1995, these currency swap agreements had an aggregate fair value of approximately $137 million, based on dealer quotes, which is included in long-term receivables on the consolidated balance sheet.\nIn addition, the company had two currency swap agreements outstanding on borrowings of its Canadian subsidiary, with notional amounts totaling $250 million at year end 1995, and three currency swap agreements outstanding with national amounts totaling $310 million at year-end 1994. The agreements, entered into by the subsidiary, have the effect of changing the subsidiary's U.S. dollar denominated borrowings into its functional Canadian currency. The objective of these agreements is to limit the subsidiary's exposure to currency exchange gains and losses. The parent company also has two currency swap agreements to offset the subsidiary's currency swaps with the objective of maintaining the underlying debt in U.S. dollars for reporting in the consolidated financial statements. The maturities of the agreements range from 1996 to 1999, which generally correspond to the related debt obligations. The net fair value of the currency swap agreements at year-end 1995 and 1994, based on dealer quotes, was approximately zero.\nAs of December 31, 1995, the company had 20 currency forward contracts outstanding to purchase 32 million Pounds Sterling for $48 million. At December 31, 1994, the company had eight currency forward contracts outstanding to purchase 17 million Pounds Sterling for $25 million. The objective is to hedge a series of known obligations denominated in Pounds Sterling which will come due during the period from January 1996 to July 2000. The fair value of these currency forward contracts at December 31, 1995 and 1994, based upon quoted market prices of comparable instruments, was approximately $0.4 million and $1.4 million, respectively, in assets.\nINTEREST RATE SWAPS\nUnocal enters into interest rate swap agreements to manage its debt with the objective of minimizing the company's borrowing costs. Net payments or receipts under the agreements are recorded in interest expense on a current basis. The related amounts payable to, or receivable from, the counterparties are included in interest payable on the balance sheet. At year-end 1995 and 1994, the interest rate swap agreements had aggregate fair values of approximately $12 million and $15 million, respectively, in liabilities, based on quoted market prices of comparable instruments.\nIn 1986, the company entered into a 10-year interest rate swap agreement with a notional amount of $200 million. This swap was entered into to hedge $200 million floating-rate Eurodollar notes, which were redeemed early in March 1995. From March 1995 until its termination in March 1996, the agreement was used to hedge floating-rate debt consisting of $150 million of outstanding commercial paper and borrowing under the $50 million credit facility as discussed in Note 14. The company paid interest at a fixed rate of 9.28 percent and received interest at a floating rate based on LIBOR. At year-end 1995 and 1994, the floating-interest rates were 5.8 percent and 5.6 percent, respectively.\nIn 1994, the company entered into a three-year interest rate swap with a notional amount of $25 million. This swap was entered into to hedge $25 million in medium-term notes. The company pays interest at a floating rate based on LIBOR and receives interest at a fixed rate of 6.7 percent. At year-end 1995 and 1994, the floating interest rates were 5.8 percent and 6.0 percent, respectively.\nOTHER\nThe company uses commodity futures contracts with maturities of one year or less to hedge the impact of fluctuations in prices of crude oil, natural gas and refined products. Realized and unrealized changes in the market value of futures contracts are deferred until the hedged transaction is recognized. At December 31, 1995, contracts covering 225 thousand barrels of crude oil, 4.2 million gallons of heating oil and 1.02 billion cubic feet of natural gas with notional amounts totaling $4 million for crude oil, $3 million for heating oil and $2 million for natural gas were outstanding. At December 31, 1994, the company had outstanding contracts covering 419 thousand barrels of crude oil and 9 billion cubic feet of natural gas with notional amounts totaling $7 million for crude oil and $16 million for natural gas. The fair values of the contracts, based on quoted market prices, were insignificant at year-end 1995 and 1994.\nNOTE 16 - FINANCIAL INSTRUMENTS (CONTINUED)\nAs of December 31, 1995 and 1994, the carrying amounts of certain financial instruments employed by the company, including cash, cash equivalents, and trade receivables and payables are representative of fair value because of the short- term maturity of these instruments.\nThe estimated fair value of the company's long-term debt was $3,983 million and $3,541 million at year-end 1995 and 1994, respectively. The fair values of debt instruments were based on the discounted amount of future cash outflows using the rates offered to the company for debt of the same remaining maturities.\nCONCENTRATIONS OF CREDIT RISK\nFinancial instruments that potentially subject the company to concentrations of credit risk consist primarily of temporary cash investments and trade receivables. The company places its temporary cash investments with high credit quality financial institutions and, by policy, limits the amount of credit exposure to any one financial institution. Concentrations of credit risk with respect to trade receivables are limited because there is a large number of customers in the company's customer base spread across many industries and geographic areas. As of December 31, 1995 and 1994, the company had no significant concentrations of credit risk.\nNOTE 17 - ACCRUED ABANDONMENT, RESTORATION AND ENVIRONMENTAL LIABILITIES\nAt December 31, 1995, the company had accrued $476 million for the estimated future costs to abandon and remove wells and production facilities, primarily related to worldwide offshore operations. The total costs for abandonments are estimated to be $640 million to $780 million, of which the lower end of the range is used to calculate the amount to be amortized. These estimates are lower than those reported last year as a result of recent abandonment cost studies performed by an outside firm.\nAt December 31, 1995, the company's reserves for environmental remediation obligations totaled $214 million, of which $83 million was included in other current liabilities. The reserve includes estimated probable future costs of $32 million for federal Superfund and comparable state-managed multiparty disposal sites; $35 million for formerly-operated sites for which the company has remediation obligations; $71 million for sites related to businesses or operations that have been sold with contractual remediation or indemnification obligations; $57 million for company-owned or controlled sites where facilities have been closed or operations shut down; and $19 million for sites owned and\/or controlled by the company and utilized in its ongoing operations.\nNOTE 18 - CONTINGENT LIABILITIES\nThe company has certain contingent liabilities with respect to material existing or potential claims, lawsuits and other proceedings, including those involving environmental, tax and other matters, certain of which are discussed more specifically below. The company accrues liabilities when it is probable that future costs will be incurred and such costs can be reasonably estimated. Such accruals are based on developments to date, the company's estimates of the outcomes of these matters and its experience in contesting, litigating and settling other matters. As the scope of the liabilities becomes better defined, there will be changes in the estimates of future costs, which could have a material effect on the company's future results of operations and financial condition or liquidity.\nENVIRONMENTAL MATTERS\nThe company is subject to loss contingencies pursuant to federal, state and local environmental laws and regulations. These include existing and possible future obligations to investigate the effects of the release or disposal of certain petroleum, chemical and mineral substances at various sites; to remediate or restore these sites; to compensate others for damage to property and natural resources, for remediation and restoration costs and for personal injuries; and to pay civil penalties and, in some cases, criminal penalties and punitive damages. These obligations relate to sites owned by the company or others and associated with past and present operations, including sites at which the company has been identified as a potentially responsible party (PRP) under the federal Superfund laws and comparable state laws. Liabilities are accrued when it is probable that future costs will be incurred and such costs can be reasonably estimated. However, in many cases, investigations are not yet at a stage where the company is able to determine whether it is liable or, if liability is probable, to quantify the liability or estimate a range of possible exposure. In such cases, the amounts of the company's liabilities are indeterminate due to the potentially large number of claimants for any given site or exposure, the unknown\nmagnitude of possible contamination, the imprecise and conflicting engineering evaluations and estimates of proper cleanup methods and costs, the unknown timing and extent of the corrective actions that may be required, the uncertainty attendant to the possible award of punitive damages, the recent judicial recognition of new causes of action, the present state of the law, which often imposes joint and several and retroactive liabilities on PRPs, and the fact that the company is usually just one of a number of companies identified as a PRP.\nAs disclosed in Note 17, at year-end 1995 the company had accrued $214 million for estimated future environmental assessment and remediation costs at various sites where liabilities for such costs are probable. At those sites where investigations or feasibility studies have advanced to the stage of analyzing feasible alternative remedies and\/or ranges of costs, the company estimates that it could incur additional remediation costs aggregating approximately $180 million.\nBetween August 22 and September 6, 1994, a chemical known as \"Catacarb\" was released into the environment at the company's San Francisco Refinery near Rodeo, California. Persons in the surrounding area have claimed that they were exposed to the chemical in varying degrees. Since September 22, 1994, forty two lawsuits have been filed by or on behalf of all persons, alleged to be several thousand, claiming that they or their property were adversely affected by the releases. Thirty nine of the lawsuits have been consolidated in the Superior Court for Contra Costa County. The First Amended Model Complaint in this consolidated action, filed on February 1, 1995, on behalf of individual plaintiffs and purported classes of plaintiffs, alleges personal injury, emotional distress and increased risk of future illness on behalf of the named plaintiffs and all persons present in and around or downwind from the San Francisco Refinery, and property damage and loss or diminution of property value on behalf of all owners of real and personal property in the vicinity of the Refinery, resulting from the release of Catacarb by the Refinery. Certain individual plaintiffs allege injury from alleged subsequent releases at the Refinery of hydrogen sulfide and other chemicals. The Model Complaint seeks compensatory and punitive damages in unspecified amounts, equitable relief including the creation of a fund for medical monitoring and treatment of plaintiffs and members of the purported classes, statutory penalties and other relief.\nTAX MATTERS\nIn December 1994, the company received a Notice of Proposed Deficiency from the Internal Revenue Service (IRS) related to the years 1985 through 1987. In February 1995, the company filed a protest of the proposed tax deficiency with the appeals section of the IRS. Discussions with the Appeals Officer are ongoing, but it appears that two substantial issues will proceed to litigation.\nThe most significant issue relates to an IRS challenge of a $341 million deduction taken by the company in its 1985 tax return for amounts paid under a settlement agreement with Mesa Petroleum, T. Boone Pickens and Drexel Burnham Lambert, Incorporated and certain others which ended a hostile takeover attempt by that group. The IRS contends that the deduction is not allowable because the payment was related solely to the purchase of the company's common stock. Although the company did purchase shares under the settlement agreement, it properly reflected the purchase in its records at the fair market value of the shares purchased. The deduction at issue relates to that portion of the payment made under the settlement agreement that exceeded the value of the shares purchased. The company intends to vigorously dispute the IRS' assertions in court. If the IRS were ultimately to prevail, the company would owe $157 million of tax for 1985 plus tax deductible interest estimated at $235 million as of December 31, 1995. As this matter is not yet before a court, final resolution of this matter is likely to be several years away.\nThe second issue relates to an IRS challenge of a continued deferral of intercompany gains which arose from sales of property between subsidiaries in 1982 and 1983. The IRS contends that the $201 million balance of deferred gain must be recognized in the company's taxable income for 1985 when the subsidiaries contributed the property to a wholly owned master limited partnership. The company intends to vigorously dispute the IRS' assertions in court. If the IRS were ultimately to prevail, the company would owe $92 million in tax for 1985, but would receive credits or refunds for offsetting deductions in later years. For 1986 and 1987 the credits or refunds would total $35 million. In addition to tax, the company would owe tax deductible interest estimated at $96 million as of December 31, 1995. As this matter is not yet before a court, final resolution of this matter is likely to be several years away.\nThe company believes it has adequately provided in its accounts for items and issues not yet resolved. In the opinion of management, a successful outcome of the litigation is reasonably likely. However, substantial adverse\ndecisions could have a material effect on the company's financial condition, operating results and liquidity in a given quarter and year when such matters are resolved.\nOTHER MATTERS\nThe company also has certain other contingent liabilities with respect to litigation, claims and contractual agreements arising in the ordinary course of business. Although these contingencies could result in expenses or judgments that could be material to the company's results of operations for a given reporting period, on the basis of management's best assessment of the ultimate amount and timing of these events, such expenses or judgments are not expected to have a material adverse effect on the company's consolidated financial condition or liquidity.\nNOTE 19 - CAPITAL STOCK\nAt December 31, 1995, there were approximately 16.7 million shares reserved for the conversion of preferred stock, 14.2 million shares for the company's employee benefit plans and Directors' Restricted Stock Plan and 5.7 million shares for the company's Dividend Reinvestment and Common Stock Purchase Plan.\nPREFERRED STOCK\nThe company has authorized 100,000,000 shares of preferred stock with a par value of $0.10 per share. In July 1992, the company issued 10,250,000 shares of $3.50 convertible preferred stock. The convertible preferred stock is redeemable on and after July 15, 1996, in whole or in part, at the option of the company, at a redemption price of $52.10 per share declining to $50 per share on and after July 15, 2002, together with accumulated but unpaid dividends. The convertible preferred stock has a liquidation value of $50 per share and is convertible at the option of the holder into common stock of the company at a conversion price of $30.75 per share, subject to adjustment in certain events. Dividends on the preferred stock at an annual rate of $3.50 per share are cumulative and are payable quarterly in arrears, when and as declared by Unocal's Board of Directors (the Board). Holders of the preferred stock have no voting rights. However, there are certain exceptions including the right to elect two additional directors if the equivalent of six quarterly dividends payable on the preferred stock are in default.\nSTOCKHOLDER RIGHTS PLAN\nIn January 1990, the Board adopted a stockholder rights plan (Rights Plan) and declared a dividend of one preferred stock purchase right (Right) for each share of common stock outstanding. The Board also authorized the issuance of one Right for each common share issued after February 12, 1990, and prior to the earlier of the date on which the rights become exercisable, the redemption date, or the expiration date.\nThe Board has designated 3,000,000 shares of preferred stock as Series A Junior Participating Cumulative Preferred Stock (Series A Preferred Stock) in connection with the Rights Plan. The Rights Plan provides that in the event any person, or group of affiliated persons, becomes, or commences a tender offer or exchange offer pursuant to which such person or group would become, the beneficial owner of 15 percent or more of the outstanding common shares, each Right (other than Rights held by the 15 percent stockholder) will be exercisable, on and after the close of business on the tenth business day following such event, unless the Rights are redeemed by the Board of Directors of the company, to purchase units of Series A Preferred Stock (each consisting of one one-hundredth of a share) having a market value equal to two times the then-current exercise price (initially $75). The Rights Plan further provides that if, on or after the occurrence of such event, the company is merged into any other corporation or 50 percent or more of the company's assets or earning power are sold, each Right (other than\nRights held by the 15 percent stockholder) will be exercised to purchase shares of the acquiring corporation having a market value equal to two times the exercise price.\nThe Rights expire on January 29, 2000, unless previously redeemed by the Board. The Rights do not have voting or dividend rights and, until they become exercisable, have no diluting effect on the earnings of the company. As of December 31, 1995, none of the Series A Preferred Stock had been issued nor had the Rights become exercisable.\nNOTE 20 - STOCK OPTION PLANS\nUnder the company's Long-Term Incentive Plans of 1991 and 1985, stock options are granted to executives and key employees to purchase shares of the company's common stock. The option price per share will not be less than the fair market value of a share of common stock on the date granted. No options will be exercisable more than 10 years after the date of grant. Restrictions may be imposed for a period of five years on certain shares acquired through exercise of options granted after 1990.\nThe following is a summary of stock option transactions for 1993, 1994 and 1995:\nUnder the Long-Term Incentive Plan of 1991, there were 5,303,044 shares available at year-end 1995 for stock option awards as well as other awards. No additional shares will be granted under the 1985 Plan.\nNOTE 21 - SUMMARIZED FINANCIAL DATA OF UNION OIL\nUnocal Corporation is the parent of Union Oil Company of California, a fully integrated energy resources company. Virtually all operations are conducted by Union Oil and its subsidiaries. Summarized financial information for Union Oil and its consolidated subsidiaries is presented below:\nNOTE 22 - INVESTMENTS IN AFFILIATES\nInvestments in affiliated companies accounted for by the equity method were $407 million, $391 million and $389 million at December 31, 1995, 1994 and 1993, respectively. Dividends or cash distributions received from these affiliates were $92 million, $88 million and $80 million for the same years, respectively. These affiliated companies are primarily engaged in pipeline ventures, refining and marketing operations, and the manufacture of needle coke.\nThe excess of the company's investments in Colonial Pipeline Company and West Texas Gulf Pipeline Company over its share in the related underlying equity in net assets is being amortized on a straight-line basis over a period of 40 years. The remaining unamortized balance at December 31, 1995 was $107 million.\nThe company has a 50% interest in The UNO-VEN Company (UNO-VEN), a refining and marketing partnership in the midwestern United States. The company's share of the underlying equity in the net assets of UNO-VEN over the carrying value of its investment is being amortized on a straight-line basis over a period of 25 years. The remaining unamortized balance at December 31, 1995 was $57 million.\nSummarized financial information for these equity investees is shown below.\nNOTE 23 - SALE OF ACCOUNTS RECEIVABLE\nOn December 15, 1995, the company entered into an agreement to sell, on a revolving basis, an undivided interest in a defined pool of the company's trade receivables. As collections reduce the amount of receivables included in the pool, the company sells new receivables to bring the amount sold up to the $200 million maximum permitted by the agreement. Under the terms of the agreement, the company retains the risk of credit loss and the collection and administrative responsibilities for the receivables sold.\nThe $200 million proceeds from the sale were used to reduce borrowings and is reflected as a reduction of accounts receivable in the consolidated balance sheet and as operating cash flows in the consolidated statement of cash flows. The total cost of the program from December 15, 1995 through the end of the year was $0.8 million, which included a one-time charge of $0.3 million. The total amount was included in operating expense in the consolidated earnings statement.\nNOTE 24 - SEGMENT AND GEOGRAPHIC DATA\nThe company's businesses include petroleum, geothermal, agricultural products, carbon and minerals. Petroleum involves the exploration for, and the production, transportation, purchase and sale of, crude oil and natural gas; and the manufacture, purchase, transportation and marketing of petroleum products and the manufacturing and marketing of petroleum coke. Geothermal involves the exploration for, and the production and sale of, geothermal resources and the construction and eventual operation of electrical generating plants served by the resources. Agricultural Products involves the manufacture, transportation and marketing of nitrogen-based fertilizers for agricultural uses. Carbon and Minerals operations involves the production and marketing of petroleum coke, graphites, solvents and specialty minerals. The company is also involved in other miscellaneous businesses.\nUnocal has domestic oil and gas operations in the Louisiana\/Gulf, California, Alaska and Central U.S. regions. The sale of California oil and gas producing properties is expected to be completed in April 1996 (see Note 25 for additional information). Most of the company's crude oil produced in the United States is sold to third parties. A substantial portion of the natural gas produced domestically is sold to third parties under contracts having terms of less than two years. The remainder is sold to third parties in the spot market, used in the company's agricultural products operations or as fuel in its refineries.\nUnocal has oil and gas production in six foreign countries: Thailand, Indonesia, Canada, the Netherlands, United Kingdom and Zaire. The company sells most of its foreign natural gas production overseas to third parties under long-term contracts. The crude oil and condensate produced overseas are primarily sold to third parties at spot market prices.\nUnocal pursues exploration opportunities and business development projects worldwide to sustain the long-term growth of the company. Currently, the main areas of oil and gas exploration and development opportunities are in Azerbaijan, Myanmar, Turkmenistan, Pakistan, China and Vietnam.\nThe company owns three refineries in California that are operated by the 76 Products Company business segment, which carries out the company's refining and marketing activities. The company manufactures a complete line of high-quality petroleum products, including automotive gasoline, jet and turbine fuels, kerosene, diesel oils, automotive and industrial lubricating oils and petroleum coke.\nThe company principally markets gasoline and other refined petroleum products in the western United States under the \"Unocal 76\" trade name. Gasoline is marketed to consumers at retail service stations, while jet fuels, diesel fuel, lube oil, and heavy fuel oil are marketed to commercial users.\nThe Geothermal and Power Operations segment supplies geothermal steam for power generation, with major operations in California, the Philippines and Indonesia. This segment is constructing power plants in Indonesia to be served by the geothermal resources it provides.\nAgricultural Products manufactures and markets nitrogen-based fertilizers for wholesale markets to the western United States and to the Pacific Rim. Carbon and Minerals produces and markets petroleum coke (other than on the West Coast), graphites, solvents and specialty minerals. Pipelines principally includes the company's equity interests in affiliated pipeline companies. Other includes the development and sale of real estate assets and the company's equity interest in UNO-VEN.\nThe Corporate and Unallocated category includes all unallocated corporate items and miscellaneous operations. In addition, this category, especially in prior years, includes the financial data related to businesses that were sold or being phased-out.\nFinancial data by business segments and geographic areas of operation are shown below. Intersegment revenue eliminations in business segment data are mainly transfers from exploration and production operations to refining, marketing and transportation operations, and in geographic areas of operations essentially represent transfers from foreign countries to the United States. Intersegment sales prices approximate market prices.\nBUSINESS SEGMENT DATA\nBUSINESS SEGMENT DATA (continued)\n(a) 1991 includes the write-down of the Los Angeles Refinery for $73 million. (b) 1994 includes a $161 million provision for environmental remediation costs. (c) The decline in 1994 is primarily due to the write-down of impaired producing oil and gas properties as discussed in Note 2.\nBUSINESS SEGMENT DATA (continued)\nGEOGRAPHIC AREAS OF OPERATIONS\nNOTE 25 - SUBSEQUENT EVENT\nOn February 16, 1996, Unocal and Nuevo Energy Company (Nuevo) signed an asset purchase agreement for the sale of nearly all of Unocal's crude oil and natural gas producing properties in California. Torch Energy Advisors, Inc. (Torch) negotiated the sale and will operate the properties on behalf of Nuevo, a company Torch formed in 1990. The sales agreement is subject to certain regulatory consents, approvals and waiting periods.\nUnder the terms of the agreement, Unocal will receive approximately $500 million from the sale of the properties. The final cash settlement will be set at the closing, which is expected in April 1996. In addition, beginning in 1998, the company could receive further payments that are contingent upon the price per barrel from the properties' future oil production. The company expects to use the proceeds from the sale to reduce debt and fund projects in Central and Southeast Asia.\nSUPPLEMENTAL INFORMATION ON OIL AND GAS EXPLORATION AND PRODUCTION ACTIVITIES\nResults of Operations\nResults of operations of oil and gas exploration and production activities are shown below. Sales revenues are net of royalty payments, net profits interests and marketing related purchases. Other revenues primarily include gains or losses on sales of oil and gas properties and miscellaneous rental income.\nProduction costs include lifting costs and taxes other than income. Exploration expenses consist of geological and geophysical costs, leasehold rentals and dry hole costs. Other operating expenses primarily include administrative and general expense. Income tax expense is based on the tax effects arising from the operations. Results of operations do not include general corporate overhead and interest costs.\nCOSTS INCURRED\nCosts incurred in oil and gas property acquisition, exploration and development activities, either capitalized or charged to expense, are shown below. Data for the company's capitalized costs related to petroleum production and exploration activities are presented in Note 11.\nAVERAGE SALES PRICE AND PRODUCTION COSTS PER UNIT (UNAUDITED)\nThe average sales price is based on sales revenues and volumes attributable to net working interest production. The average production costs per barrel presented below are based on equivalent petroleum barrels, including natural gas converted at a ratio of 6.0 MCF to one barrel of oil which represents the energy content of the wet gas.\nOIL AND GAS RESERVE DATA (UNAUDITED)\nEstimates of physical quantities of oil and gas reserves, determined by company engineers, for the years 1995, 1994 and 1993 are shown below. As defined by the Securities and Exchange Commission, proved oil and gas reserves are the estimated quantities of crude oil, natural gas and natural gas liquids that geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic and operating conditions. Accordingly, these estimates do not include probable or possible reserves. Estimated oil and gas reserves are based on available reservoir data and are subject to future revision. Proved reserve quantities exclude royalties owned by others, however, foreign reserves held under certain production sharing agreements, principally with Indonesia, are reported on a gross basis. The gross basis includes the company's net working interest and host country's interest. Unocal's estimated net worldwide reserves, excluding the host country's share under these production sharing agreements, would have been 596 million barrels of crude oil and 6,308 billion cubic feet of natural gas at December 31, 1995.\nNatural gas reserves are reported on a wet-gas basis, which include natural gas liquids reserves. For informational purposes, natural gas liquids reserves in the U.S. were 83, 91 and 95 million barrels at December 31, 1995, 1994 and 1993, respectively. They are derived from the natural gas reserves by applying a national average shrinkage factor obtained from the Department of Energy published statistics. Foreign natural gas liquids reserves were insignificant for the above periods.\nESTIMATED PROVED RESERVES OF CRUDE OIL AND CONDENSATE\n(a) Excludes 7 million barrels produced in 1993 but sold under forward contracts in 1992.\nOIL AND GAS RESERVE DATA (UNAUDITED) (CONTINUED)\nESTIMATED PROVED RESERVES OF NATURAL GAS\n(a) Includes 115 billion cubic feet due to property exchanges. (b) Includes 105 billion cubic feet due to property exchanges.\nPRESENT VALUE OF FUTURE NET CASH FLOW (UNAUDITED)\nThe present value of future net cash flows from proved oil and gas reserves for the years 1995, 1994 and 1993 are presented below. Revenues are based on estimated production of proved reserves from existing and planned facilities and on average prices of oil and gas at year-end. Development and production costs related to future production are based on year-end cost levels and assume continuation of existing economic conditions. Income tax expense is computed by applying the appropriate year-end statutory tax rates to pretax future cash flows less recovery of the tax basis of proved properties, and reduced by applicable tax credits.\nThe company cautions readers that the data on the present value of future net cash flow of oil and gas reserves are based on many subjective judgments and assumptions. Different, but equally valid, assumptions and judgments could lead to significantly different results. Additionally, estimates of physical quantities of oil and gas reserves, future rates of production and related prices and costs for such production are subject to extensive revisions and a high degree of variability as a result of economic and political changes. Any subsequent price changes will alter the results and the indicated present value of oil and gas reserves. It is the opinion of the company that this data can be highly misleading and may not be indicative of the value of underground oil and gas reserves.\n(b) Includes dismantlement and abandonment costs.\nCHANGES IN PRESENT VALUE OF FUTURE NET CASH FLOW (UNAUDITED) (CONTINUED)\n(a) Purchases of reserves were valued at $23 million, $26 million and $39 million in 1995, 1994 and 1993, respectively. Sales of reserves, including the sale of future production, were valued at $74 million, $48 million and $91 million for the same years, respectively.\n(b) Excludes the 1992 sale of future production for which income was recognized in 1993 but cash was received in 1992.\nQUARTERLY FINANCIAL AND MARKET PRICE DATA (Unaudited) - -----------------------------------------------------\nThe net loss for the fourth quarter of 1994 included charges of $94 million ($152 million pretax) for environmental remediation costs, $22 million ($35 million pretax) for litigation expenses, $22 million ($35 million pretax) for asset write-downs and $15 million ($25 million pretax) for restructuring costs. Fourth quarter charges for environmental remediation and litigation are principally due to changes in estimates. Included in the $94 million for environmental remediation costs was $16 million ($26 million pretax) which relates to incremental obligations incurred over a number of prior periods but which would not have been material to any such period.\nSELECTED FINANCIAL DATA\n(a) Net earnings (loss) included the cumulative effect of accounting changes which consisted of a charge of $277 million ($1.14 per common share) in 1994, a charge of $130 million ($.54 per common share) in 1993 and a gain of $24 million ($.10 per common share) in 1992.\n(b) Employee benefits are net of pension income recognized in accordance with current accounting standards for pension costs. For years 1995, 1994 and 1993, such benefits also include the accrued postretirement medical benefits cost.\nITEM 9","section_9":"ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE: None.\n-----------------\nPART III\nThe information required by Items 10 through 12 (except for information regarding the company's executive officers) is incorporated by reference to Unocal's Proxy Statement for its 1996 Annual Meeting of Stockholders (the \"1996 Proxy Statement\") (File No. 1-8483), as indicated below. The 1996 Proxy Statement is expected to be filed with the Securities and Exchange Commission on or about April 22, 1996.\nITEM 10","section_9A":"","section_9B":"","section_10":"ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nSee the information regarding Unocal's directors and nominees for election as directors to appear under the caption \"Item 1. Election of Directors\" in the 1996 Proxy Statement. Also, see the list of Unocal's executive officers and related information under the caption \"Executive Officers of the Registrant\" in Part I of this report on page 17.\nITEM 11","section_11":"ITEM 11 - EXECUTIVE COMPENSATION\nSee the 1996 Proxy Statement for information regarding executive compensation to appear under the captions \"Summary Compensation Table,\" \"Option Grants in 1995,\" \"Aggregated Option\/SAR Exercises in 1995 and December 31, 1995 Option Values,\" \"Long-Term Incentive Plans - Awards in 1995,\" \"Pension Plan Benefits - Estimated Annual Retirement Benefits,\" \"Employment and Change of Control Agreements\" and for information regarding directors' compensation to appear under the caption \"Directors' Compensation.\"\nITEM 12","section_12":"ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nSee the 1996 Proxy Statement for information regarding security ownership to appear under the captions \"Security Ownership of Certain Beneficial Owners\" and \"Security Ownership of Management.\"\nITEM 13","section_13":"ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS: Not required.\n-----------------\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 filed as part of this annual report:\n(1) Financial Statements: See the Index to Consolidated Financial Statements and Financial Statement Schedules under Item 8 on page 30 of this report.\n(2) Financial Statement Schedules: See the Index to Consolidated Financial Statements and Financial Statement Schedules under Item 8 on page 30 of this report.\n(3) Exhibits: The Exhibit Index on pages 73 and 74 of this report lists the exhibits that are filed as part of this report.\nITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (continued)\n(b) Reports filed on Form 8-K:\nDuring the fourth quarter of 1995:\n(1) Current Report on Form 8-K dated and filed October 26, 1995, for the purpose of reporting, under item 5, third quarter and year-to-date earnings.\nDuring the first quarter of 1996 to the date hereof:\n(1) Current Report on Form 8-K dated and filed January 25, 1996, for the purpose of reporting, under item 5, the company's fourth quarter and full-year 1995 earnings.\n(2) Current Report on Form 8-K dated and filed February 20, 1996 for the purpose of reporting, under item 5, the company's sale of its California oil and gas producing properties.\n(3) Current Report on Form 8-K dated and filed February 23, 1996 for the purpose of reporting, under item 5, the company's crude oil and natural gas reserve data.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nUNOCAL CORPORATION (Registrant)\nDate: March 25, 1996 By \/s\/ NEAL E. SCHMALE ---------------------------------- Neal E. Schmale Chief Financial Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on March 25, 1996.\nUNOCAL CORPORATION AND CONSOLIDATED SUBSIDIARIES\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS (MILLIONS OF DOLLARS)\n(a) Represents receivables written off, net of recoveries, reinstatements, and losses sustained.\nUNOCAL CORPORATION\nEXHIBIT INDEX\nUNOCAL CORPORATION\nEXHIBIT INDEX (CONTINUED)","section_15":""}
{"filename":"806029_1995.txt","cik":"806029","year":"1995","section_1":"Item 1. Business\n(a) General Development of Business\nMidwest Real Estate Shopping Center L.P. (formerly Equitable Real Estate Shopping Centers, L.P.), a Delaware limited partnership (the \"Partnership\"), was formed on October 28, 1986. Midwest Centers Inc. (formerly Shearson ESC\/GP Inc.), a Delaware corporation, is the general partner of the Partnership (the \"General Partner\"). Midwest Centers Depositary Inc. (the \"Assignor Limited Partner\", formerly Shearson ESC Corp.) is the sole limited partner of the Partnership. The General Partner and the Assignor Limited Partner are affiliates of Lehman Brothers Holdings, Inc.\nOn December 30, 1986, the Partnership completed an offering of $107,000,000 of limited partnership securities (\"Units,\" the holders of which are referred to herein as \"Unitholders\") representing assignments of limited partnership interests from the Assignor Limited Partner. The net proceeds of the offering after payment of syndication and organizational costs aggregated $97,925,000.\nThe Partnership was formed to acquire from The Equitable Life Assurance Society of the United States (\"Equitable\") two regional shopping malls which Equitable had owned since 1978: Brookdale Center, located in Brooklyn Center (Hennepin County), Minnesota (\"Brookdale\"), and Northland Center, located in Southfield (Oakland County), Michigan (\"Northland\") (together the \"Properties\"). On December 30, 1986 the Partnership acquired the lease fee interest in the land and improvements constituting the Properties for a total purchase price of $130,025,000 ($49,000,000 for Brookdale and $81,025,000 for Northland).\nTwo mortgage notes from Equitable were issued on December 30, 1986 in the initial principal amounts of $15,175,000 (the \"Brookdale Note\") and $25,675,000 (the \"Northland Note\") (together, the \"Notes\"). The Partnership had deferred payment of principal and interest on the Northland Note until its scheduled maturity on June 30, 1995. In connection with the impending maturity of the Northland Note, the Partnership executed a contract with Equitable on March 28, 1994 for the sale of Northland at the price of $6,600,000 in excess of the balance of the Northland Note (the \"Northland Sales Contract\"). On July 22, 1994, the sale was completed and the Northland Note paid. The effective date of the sale of Northland was January 1, 1994 and any positive cash flow generated by Northland Center from January 1, 1994 to the closing belonged to Equitable. The Partnership also deferred payment of principal and interest on the Brookdale Note until its maturity date on June 30, 1995. The General Partner attempted, but was unable, to sell Brookdale and pay off the Brookdale Note prior to its maturity date. On July 5, 1995, Equitable notified the Partnership of its default under the terms of the Brookdale Note and that it would pursue all remedies available to it, including, without limitation, foreclosure of the lien of the Mortgage by power of sale or judicial foreclosure and the appointment of the receiver. Further to its July 5, 1995 notice of default to the Partnership, Equitable commenced advertising Brookdale for a public nonjudicial foreclosure sale to be held on September 12, 1995. The date of this foreclosure sale was subsequently postponed to April 5, 1996. Please refer to Item 7 for a detailed discussion of the Partnership's default on the Brookdale Note and events subsequent to such default.\nThe Unitholders were solicited on June 7, 1994 in connection with the sale of Northland. This solicitation informed the Unitholders that the sale of Northland would be the first step in the disposition of the assets of the Partnership with a view to the orderly dissolution and liquidation of the Partnership. Information involving the plan to dispose of all the assets of the Partnership with a view to its liquidation is contained under the caption \"The Plan to Liquidate\" in the Partnership's definitive proxy statement filed on May 27, 1994 pursuant to Regulation 14A and is incorporated herein by reference.\nOn December 31, 1986 the Partnership entered into an agreement with Equitable Real Estate Investment Management, Inc. (\"EREIM\"), an indirect wholly-owned subsidiary of Equitable, to retain EREIM as asset manager (the \"Asset Manager\") to the Partnership. In association with the sale of Northland and intention to dispose of Brookdale, the asset management agreement with EREIM for both malls was terminated effective December 31, 1993, thereby releasing the Partnership from its obligation to pay EREIM an asset management fee of $1,060,000 per year.\nOn November 21, 1994, the Partnership changed its name from Equitable Real Estate Shopping Centers, L.P. to Midwest Real Estate Shopping Center L.P. The name change was in conjunction with the termination of the former asset management agreement with EREIM, pursuant to which the Partnership agreed to cease using the words \"Equitable\" and \"Equitable Real Estate\" in its name.\n(b) Financial Information About Industry Segments\nThe Partnership's sole business is the ownership and operation of its remaining property, Brookdale Center. All of the Partnership's revenues, operating profit or loss and assets relate solely to such industry segment.\n(c) Narrative Description of Business\nThe Registrant's principal business is to own and operate its remaining property. The Partnership's principal objective is to produce distributions to Unitholders on sale. Please refer to Item 5 for a description of the Partnership's policy concerning distributions.\nThere is no assurance that this objective will be achieved.\nCompetition\nSee Item 2","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Partnership's remaining property, Brookdale Center, is a regional shopping mall located in Brooklyn Center (Hennepin County), Minnesota, approximately five miles northwest of the central business district of Minneapolis. Brookdale is anchored by five major department stores - Sears, Roebuck and Co. (\"Sears\"), J.C. Penney, Inc. (\"J.C. Penney\"), Dayton-Hudson Corporation, doing business as Dayton's (\"Dayton's\"), Mervyn's, a California corporation doing business as Mervyn's (\"Mervyn's\"), which acquired Carson Pirie Scott & Co., doing business as Carson's (\"Carson's\") on March 6, 1995, and Kohl's Department Stores, Inc., doing business as Kohl's (\"Kohl's\") in a freestanding building, all located on a site of approximately 81 acres. Brookdale contains approximately 980,000 gross leasable square feet, of which approximately 780,000 square feet is owned or leased by the anchor tenants and not by the Partnership. Brookdale has parking for approximately 5,000 automobiles. During 1988, a freestanding Kohl's department store consisting of approximately 75,000 square feet was completed on the east end of the mall site. Kohl's commenced operations on August 1, 1988. Brookdale was constructed in 1962, underwent major expansion in 1966, and was refurbished in 1970 and again in 1983.\nThe total building area of Brookdale is allocated as shown in the table below.\nSquare Feet Square Feet Total Leasable to Owned by Square Tenants Anchors(1) Feet Anchor Stores: Mervyn's (2) - 140,336 140,336 Dayton's - 195,368 195,368 J.C. Penney - 140,320 140,320 Kohl's - 75,000 75,000 Sears - 180,669 180,669 Outparcel Stores (3) - 48,858 48,858 Enclosed Mall Tenants(4) 199,922 - 199,922 199,922 780,551 980,473 Common Area - - 119,113\nTotal 199,922 780,551 1,099,586\n(1) Includes square footage leased by anchors from independent third parties.\n(2) On March 2, 1995, Carson's ceased operations at Brookdale Center. On March 6, 1995, Mervyn's, a California Corporation, took possession of the space. See description below under \"Anchor tenants.\"\n(3) The four outparcel stores at Brookdale are owned by the tenants and consist primarily of automotive accessory stores.\n(4) Storage area of 3,104 square feet is included in the mall stores' square footage.\nAnchor Tenants Sears, which owns its own buildings and land, pays its own real estate taxes and utilities. Sears has an operating agreement and a purchase agreement that require it to operate a Sears store in its main building until May 1997. Sears is required to pay a proportionate share of the costs incurred by Brookdale in maintaining the common areas, which is in proportion to the Sears building area to the aggregate of all building area in Brookdale. Sears may not sublease its space except to carry on portions of its business through licensees, lessees, concessionaires or corporations in which a majority of the voting stock is owned by Sears. The operating agreement and purchase agreement and all rights and obligations thereunder, including Sears' obligation to pay common area expenses, expire in May 1997.\nJ.C. Penney leases its building and the land on which its building is constructed from a third party which leases the land from the Partnership until July 27, 2015; however, it has the option to terminate the lease on either July 27, 1995 or July 27, 2005. J.C. Penney pays its own real estate taxes and utilities. J.C. Penney was required to operate a J.C. Penney-type department store until July 27, 1995. J.C. Penney did not exercise the option to terminate the lease on July 27, 1995 and has not informed the Partnership of any intention to sublease the premises. J.C. Penney may sublet the entire premise or assign the lease to any corporation which may take over the business of J.C. Penney in Minnesota as a result of an assignment or merger. J.C. Penney is also subject to an operating agreement that requires it to pay a portion of the common area expenses, including real estate taxes and assessments of the common area, in proportion to 75% of the gross building area in its store to the total gross building area.\nMervyn's, a California corporation, finalized an agreement on March 6, 1995, pursuant to which Mervyn's agreed to purchase all of the outstanding shares of stock of a wholly-owned subsidiary of CPS Department Stores, Inc., a Delaware corporation (\"Carson's\"), thereby acquiring the 140,336 square foot Carson's store in the Mall and assuming Carson's lease. Carson's ceased operations at the store on March 2, 1995 and Mervyn's took possession of this space on March 6, 1995. Mervyn's remodeled the store, which reopened during the third quarter of 1995.\nDayton's land and building are owned by Dayton Development Company (\"DDC\"), an affiliate of Dayton's which leases Dayton's land and building to Dayton's. DDC's lease to Dayton's runs through July 31, 1996. DDC and Dayton's are subject to an operating agreement that generally requires Dayton's to operate a Dayton's store in the Dayton's building until July 31, 1996. DDC pays its own real estate taxes and for the water, gas and electricity used by Dayton's. In addition, DDC also pays a proportionate share of the costs incurred by Brookdale in supplying climate conditioning services to the entire shopping center, plus a $2,442.10 monthly standby charge. DDC is also required to pay a proportionate share of the costs incurred by Brookdale in maintaining the common areas. DDC has the right to approve any purchaser of the Brookdale Center, and if such approval is not granted and the purchaser subsequently defaults in its common area maintenance obligations, DDC shall have the right to take over common area maintenance. The Dayton's operating agreement terminates on July 31, 1996, except that it shall continue thereafter so long as Brookdale is a shopping center and Dayton's shall continue to operate a Dayton's department store therein. Dayton's has not informed the Partnership of any intention to leave the Mall.\nKohl's owns its building and leases land from the Partnership. Kohl's lease runs for a period of 22 years through January 31, 2010 with two five-year renewals. The minimum rent is $175,000 per year with percentage rent of 1.5% of all net sales in excess of $16,000,000 per year. The leases are net ground leases with the tenant responsible for all costs such as real estate taxes and utilities. Kohl's pays a fixed common area maintenance charge. Kohl's did not renew its operating agreement which expired on August 1, 1993, but has not informed the Partnership of any intention to leave the Mall.\nMall and Outparcel Tenants As of December 31, 1995, Brookdale had 199,922 square feet of gross leasable area (excluding anchor stores and outparcel stores), of which 40,652 square feet (representing kiosks and mall stores totalling 37,548 square feet and 3,104 square feet of storage area) was vacant. During 1995, nine leases totalling 14,616 square feet terminated and space totalling 10,442 square feet was leased. Two leases totalling 4,954 square feet were signed with existing tenants and 5 leases totalling 5,488 square feet were signed with new tenants.\nAs of December 31, 1995, six tenants, or their parent corporations, at Brookdale have filed for protection under the U.S. Federal Bankruptcy Code. These tenants currently occupy approximately 9.1% of the Mall's leasable area (exclusive of anchor tenants), and at this point their plans to remain at Brookdale remain uncertain, although Merry Go 'Round closed its store in 1996. Please refer to Item 7 for a listing of Brookdale tenants which have filed for bankruptcy protection.\nHistorical Occupancy The following table shows the historical occupancy percentage at Brookdale at December 31 of the indicated years.\n1995 1994 1993 1992 1991\nIncluding Anchor Stores 96.0% 94.0% 96.0% 99.0% 99.4%\nExcluding Anchor Stores 80.0% 79.0% 85.0% 95.0% 98.0%\nCompetition The Minneapolis-St. Paul metropolitan area contains 17 regional shopping centers containing a total of 14 million square feet of retail space. Brookdale, which is located in a northern suburb of Minneapolis, competes directly with three shopping centers - Northtown Mall, Rosedale Center and Ridgedale Center. Brookdale also competes for customers with a variety of local shops and merchants.\nNorthtown Mall is a smaller regional center located five miles north of Brookdale and is anchored by Mervyn's, Montgomery Ward and Kohl's. Northtown Mall contains gross leasable area of approximately 800,000 square feet. Rosedale Center, which is owned by an affiliate of Equitable, is a two-level, enclosed mall located ten miles southeast of Brookdale and is anchored by Dayton's, Mervyn's, J.C. Penney and Montgomery Ward. This center contains a gross leasable area of 1,400,000 square feet and underwent an expansion in 1991, including a new 250,000 square foot Dayton's store. Ridgedale Center is located eight miles southeast of Brookdale and is anchored by Sears, J.C. Penney and Dayton's. Ridgedale contains gross leasable area of 1,035,000 square feet. All three centers compete against Brookdale for customers with a variety of local shops and national retailers.\nOn August 11, 1992, a super-regional center, Mall of America, opened in Bloomington, approximately 8.25 miles from downtown Minneapolis and approximately 14.25 miles southeast of Brookdale. The 4.2 million square foot center is anchored by Nordstrom's, Bloomingdale's, Sears and R.H. Macy & Co., Inc., among others, and includes an amusement park. Although occupancy has declined over the past few years, the General Partner attributes this decline to general competition from other shopping centers, of which the Mall of America is only a part. Mall of America has had an impact on consumer traffic at Brookdale.\nItem 3.","section_3":"Item 3. Legal Proceedings\nOn January 17, 1995, the Partnership announced that an action had been filed against the General Partner, the Partnership and other defendants in the United States District Court for the Southern District of New York on behalf of all persons who owned Limited Partnership Units of the Partnership on June 7, 1994. The complaint alleges, among other things, that the solicitation statement used by the Partnership to solicit the consent of the Limited Partners to the July 1994 sale of the Northland Shopping Center (the \"Solicitation Statement\") contained material misrepresentations and omissions in violation of Section 14(a) of the Securities and Exchange Act of 1934 and Rule 14a-9 promulgated thereunder. The complaint also alleges claims for breach of fiduciary duty, negligent misrepresentation and breach of the limited partnership agreement related to the Northland sale and the partial liquidation of the assets. Plaintiffs seek, among other things, compensatory damages and to have their action certified as a class action under the Federal Rules of Civil Procedure. On May 12, 1995, the Partnership announced that two similar actions had been filed in the District Court for the Southern District of New York. On November 16, 1995, the complaint in one of these three actions was amended to add a derivative claim for breach of fiduciary duty on behalf of the Partnership. The amended complaint also alleges that the General Partner, assisted by the other defendants, breached its fiduciary duties by failing to take steps to maximize the value of Brookdale Center. The General Partner believes that the allegations in these complaints are without merit and will defend these lawsuits vigorously.\nOn May 12, 1995, the Partnership also announced that an action had been filed against the General Partner and other defendants in the Federal District Court for the Central District of California on behalf of all persons who owned Limited Partnership Units during the period June 7, 1994 to the present. The complaint alleges that the Solicitation Statement contained material misrepresentations and omissions in violation of Section 14(a) of the Securities and Exchange Act of 1934 and Rule 14a-9 promulgated thereunder. Plaintiffs seek, among other things, compensatory damages and to have their action certified as a class action under the Federal Rules of Civil Procedure. This action has been transferred to the District Court for the Southern District of New York to be coordinated with the New York actions for pre-trial proceedings. The General Partner believes that the allegations in this complaint are without merit and will defend this lawsuit vigorously.\nThe Partnership also announced on May 12, 1995, that an action had recently been filed against the General Partner and other defendants in the Superior Court for Los Angeles County and removed to the District Court for the Central District Court of California. This action is brought on behalf of all persons who purchased Limited Partnership Units of the Partnership during the period from December 26, 1986 to the present. The complaint alleges, among other things, that the General Partner, assisted by the other defendants, breached its fiduciary duty to the plaintiffs in connection with the offer and sale of Limited Partnership Units, the operation of the Partnership and the Northland sale. Plaintiffs seek, among other things, compensatory damages, punitive damages, and to have their action certified as a class action under the Federal Rules of Civil Procedure. This action also has been transferred to the District Court for the Southern District of New York to be coordinated with the pre-trial proceedings. The General Partner believes that the allegations in the complaint are without merit and will defend the lawsuit vigorously.\nOn August 2, 1995, at the request of Equitable, the District Court for the Fourth Judicial District of Minnesota appointed General Growth Management, Inc. (\"General Growth\") as the receiver of Brookdale. In such capacity, General Growth collects the rent proceeds from Brookdale's tenants and applies the proceeds to payment of, among other things, Brookdale's operating expenses, maintenance costs, real estate taxes, tenant improvements and leasing commissions, with any remaining funds to be paid to Equitable on account of its mortgage on Brookdale (the \"Mortgage\"). During December 1995, $700,000 was forwarded to Equitable and applied against the Mortgage under the terms of the receivership. As of December 31, 1995, the cash flow generated by Brookdale, less the cash forwarded to Equitable during December 1995, is reflected on the Partnership's balance sheet as \"Restricted cash\" in the amount of $1,012,296. The restricted cash will be used to pay, at Equitable's discretion, property operating expenses and real estate taxes for Brookdale. During January and February 1996, an additional $550,000 was forwarded to Equitable under the terms of the receivership, and applied against the Mortgage. Shortfalls in cash flow generated by Brookdale, if any, may be advanced by Equitable and added to the principal amount of the Mortgage. General Growth is paid a receiver's fee equal to 4.45% of all fixed minimum rents and percentage or overage rents collected. General Growth had previously been the Partnership's property manager for Brookdale and received management fees at the same rate as receiver fees in its role as property manager.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNo matters were submitted to a vote of the Unitholders at a meeting or otherwise during the three months ended December 31, 1995.\nPART II \t \t Item 5.","section_5":"Item 5. Market for the Registrant's Limited Partnership Units and Related Security Holder Matters\n(a) Market Information\nThe Units are listed on the New York Stock Exchange and trade under the symbol \"EQM\". The high and low sales price of the Units on the New York Stock Exchange as reported on the consolidated transaction reporting system, during the periods January 1, 1994 to December 31, 1994 and January 1, 1995 to December 31, 1995 were as follows:\nHigh Low \t First Quarter $ 2.38 $ 2.00 Second Quarter 2.13 1.13 Third Quarter 1.75 .69 Fourth Quarter .88 .50\nFirst Quarter $ .88 $ .38 Second Quarter .75 .50 Third Quarter .85 .31 Fourth Quarter .50 .17\n(b) Holders\nAs of December 31, 1995, there were 6,193 Unit Holders.\n(c) Distribution of Operating Cash Flow\nThe Partnership's policy is to distribute to the Unitholders their allocable portion of Operating Cash Flow (as defined below) in respect of each fiscal year in substantially equal quarterly installments based on estimated Operating Cash Flow for the current year.\nDistributions of Operating Cash Flow are paid on a quarterly basis to registered holders of Units on record dates established by the Partnership, which generally will be the last day of each quarter. If a Unitholder transfers a Unit prior to a record date for a quarterly distribution of Operating Cash Flow, the transferor Unitholder may be subject to tax on part or all of the Net Income from operations, if any, for such quarter (since Net Income from operations is allocated on a monthly basis, rather than quarterly), but will not be entitled to receive any portion of the Operating Cash Flow to be distributed with respect to such quarter.\nThe amount of Operating Cash Flow available for distribution is determined by the General Partner after taking into account the cash requirements of the Partnership, including operating expenses and reserves for future commitments and contingencies.\nFor the specific terms of the distribution of operating cash flow, reference is made to pages 84 and 85 in the Partnership Agreement which is incorporated herein by reference.\nQuarterly Cash Distributions Per Limited Partnership Unit\nDistribution amounts are reflected in the period for which they are declared. The record date is the last day of the respective quarter and the actual cash distributions are paid approximately 45 days after the record date.\n1995 1994 First Quarter $ .07 $ .07 Second Quarter .07 .07 Third Quarter .07 .935* Fourth Quarter** - .07\nTOTAL $ .21 $1.145\n* This amount includes the Partnership's third quarter cash distribution of $.07 per Unit as well as a special cash distribution of $.865 per Unit paid on August 31, 1994, to unitholders of record as of August 12, 1994. This distribution represented the net proceeds from the sale of Northland Center and included a disbursement of $4,484,000 from the Partnership's cash reserves. See Item 7 for a discussion of the sale of Northland Center.\n** Distributions were suspended effective during the fourth quarter of 1995 pending a resolution of the situation with respect to the Partnership's default on the Brookdale Note. See Item 7.\n(d) Distribution of Net Proceeds of Capital Transactions:\nThe Net Proceeds of a Capital Transaction, which would include the sale of Brookdale, are distributable to the Unitholders and the General Partner in the manner described in the Partnership Agreement which is incorporated herein by reference. See also Note 4 to the Financial Statements.\nRelated Security Holder Matters\nThe Partnership is a \"publicly traded partnership\" for purposes of Federal income taxation. The Revenue Act of 1987 (the \"Act\") changed the Federal income tax treatment of \"publicly traded partnerships.\" Under the Act, the Partnership could be taxed as a corporation for Federal income tax purposes beginning in 1998 if the Partnership does not satisfy an income test under the Act. While the Partnership currently expects to meet this income test, it is unclear whether the Partnership will always meet the income requirements for an exception to the rule treating a publicly traded partnership as a corporation. Publicly traded partnerships are subject to a modified version of the passive loss rules if they are not taxed as corporations. Under the modified rules applicable to publicly traded partnerships, the passive loss rules are applied separately for the items attributable to each publicly traded partnership.\nAny Tax-Exempt Entity acquiring Units after December 17, 1987 (including any acquired pursuant to a reinvestment plan) realizes unrelated business income (\"UBI\"), with respect to such Units for periods during which the Partnership is a \"publicly traded partnership\", and such UBI may cause the Tax-Exempt Entity to incur a federal income tax liability. It should be noted that the Partnership agreement stated that \"An investment in the Units is not suitable for Tax-Exempt Entities, including Individual Retirement Accounts (\"IRA's\") and Keogh and other retirement plans, because such investment would give rise to unrelated business taxable income.\"\nItem 6.","section_6":"Item 6. Selected Financial Data\n(dollars in thousands except per Unit data)\nAs of and for the years ended December 31,\n1995 1994 1993 1992 1991\nTotal Income $ 11,772 $12,695 $ 30,312 $ 31,404 $ 30,383 Net Income (Loss) $(10,764)(3) $(7,567)(2) $(18,377)(1) $ (7,834)(1) $ 389 Net Income (Loss) per Limited Partnership Unit (10,700,000 outstanding) $ (1.00)(3) $ (.79)(2) $ (1.70)(1) $ (.73)(1) $ .04 Real Estate $ 24,500 $35,072 $100,264 $118,416 $127,101 Mortgage Notes Payable $ 38,029 $33,652 $ 82,011 $ 77,245 $ 70,215 Total Assets $ 32,341 $42,302 $113,448 $131,082 $136,879 Cash Distributions per Limited Partnership Unit (10,700,000 outstanding) $ .21 $ 1.145(4) $ .50 $ .50 $ .50\n(1) Includes write-downs in carrying value of the Northland property in 1992 and 1993. See Item 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nLiquidity and Capital Resources\nThe General Partner has been attempting to sell the Partnership's remaining property, Brookdale Center (the \"Property\" or \"Brookdale\"), and pay off the Mortgage, which is held by The Equitable Life Assurance Society of the United States (\"Equitable\") and secured by the Property. The General Partner was unable to consummate a sale of the Property and repay the Mortgage prior to June 30, 1995, the maturity date of the Mortgage. As a result, on July 5, 1995, Equitable issued a notice of default to the Partnership and commenced advertising Brookdale for a public nonjudicial foreclosure sale to be held on September 12, 1995. Such date was subsequently postponed until April 5, 1996.\nOn August 2, 1995, at the request of Equitable, the District Court for the Fourth Judicial District of Minnesota appointed General Growth as the receiver of Brookdale. In such capacity, General Growth collects the rent proceeds from Brookdale's tenants and applies the proceeds to payment of, among other things, Brookdale's operating expenses, maintenance costs, real estate taxes, tenant improvements and leasing commissions, with any remaining funds to be paid to Equitable on account of its mortgage on Brookdale (the \"Mortgage\"). During December 1995, $700,000 was forwarded to Equitable and applied against the Mortgage per the terms of the receivership. As of December 31, 1995, the cash flow generated by Brookdale, less the cash forwarded to Equitable during December 1995, is reflected on the Partnership's balance sheet as \"Restricted cash\" in the amount of $1,012,296. The restricted cash will be used to pay, at Equitable's discretion, property operating expenses and real estate taxes for Brookdale. During January and February 1996, an additional $550,000 was forwarded to Equitable, per the terms of the receivership, and applied against the Mortgage. Shortfalls in cash flow generated by Brookdale, if any, may be advanced by Equitable and added to the principal amount of the Mortgage. General Growth is paid a receiver's fee equal to 4.45% of all fixed minimum rents and percentage or overage rents collected. General Growth had previously been the Partnership's property manager for Brookdale and received management fees at the same rate as receiver fees in its role as property manager.\nThe Partnership continues to hold negotiations with Equitable concerning the Mortgage. In addition to such negotiations, the Partnership is considering all alternatives available to it with respect to such potential foreclosure sale. There is no assurance that the parties will reach an agreement that will prevent the foreclosure sale or that a buyer can be found for Brookdale prior to the foreclosure sale.\nAs of the filing date of this report, the following tenants, or their parent corporations, at the Mall have filed for protection under the U.S. Federal Bankruptcy Code.\nTenant Square Footage Leased Gordon's Jewelers 992 Merry Go 'Round 3,378 Mr. Bulky 1,566 Stuarts 8,069 J Riggings 2,815 JW 1,410\nThese tenants occupy 18,230 square feet, or approximately 9.1% of Brookdale's leasable area (exclusive of anchor tenants), and at this time their plans to remain at Brookdale remain uncertain. Pursuant to the provisions of the U.S. Federal Bankruptcy Code, these tenants may, with court approval, choose to reject or accept the terms of their leases. Should any of these tenants exercise the right to reject their leases, this could have an adverse impact on cash flow generated by Brookdale and revenues received by the Partnership and the Partnership's negotiations with Equitable with respect to the default on the Mortgage. Merry Go 'Round closed its store in 1996.\nAt December 31, 1995, the Partnership had unrestricted cash totalling $5,971,023 compared to $6,693,502 at December 31, 1994. The decrease is due to the receipt by Equitable of all net cash flow from Brookdale, which commenced upon appointment of a receiver on August 2, 1995 as described above.\nAccounts receivable totalled $537,561 at December 31, 1995 compared with $181,358 at December 31, 1994. The increase reflects the accrual for 1995 percentage rent and property tax income.\nAccounts payable and accrued expenses decreased from $1,170,453 at December 31, 1994 to $623,499 at December 31, 1995. The decrease is primarily due to expenditures made for (i) renovations in 1995 of space at Brookdale recaptured upon the departure of Carson's, a former anchor tenant (ii) the 1994 Michigan business tax related to the 1994 sale of Northland and (iii) the 1994 annual audit fee and the Minnesota partnership tax.\nZero coupon mortgage note payable increased from $33,652,305 at December 31, 1994 to $38,028,587 at December 31, 1995 due to the accretion of interest on the Mortgage which matured on June 30, 1995. Pursuant to its terms, the Mortgage accrues interest at a default rate of 19% per annum commencing July 1, 1995. See \"Liquidity and Capital Resources\" above for a discussion of the default.\nDistributions payable decreased from $756,565 at December 31, 1994 to $0 at December 31, 1995. The Partnership suspended cash distributions beginning with the fourth quarter of 1995 pending a resolution of the situation surrounding the Mortgage.\nDayton's land and building are owned by DDC, an affiliate of Dayton's, which leases Dayton's land and building to Dayton's. DDC's lease to Dayton's runs through July 31, 1996. DDC and Dayton's are subject to an operating agreement that generally requires Dayton's to operate a Dayton's store in the Dayton's building until July 31, 1996. Dayton's has not informed the Partnership of any intention to leave the Mall. Please refer to Item 2 for additional discussion regarding Dayton's lease.\nResults of Operations\n1995 versus 1994 Cash provided by operating activities totalled $2,817,025 for the year ended December 31, 1995 compared with $4,483,503 during 1994. The reduced cash flow is primarily due to the funding of all net cash flow from Brookdale to Equitable, which commenced on August 2, 1995 (see \"Liquidity and Capital Resources\" above).\nThe Partnership recognized a net loss of $10,763,695 for the year ended December 31, 1995 compared to $7,567,268 during 1994. The increase in net loss during 1995 primarily reflects the gain recognized on the sale of Northland in 1994 and a greater loss on the write-down of Brookdale to its estimated fair market value in 1995 compared to 1994. The carrying value of Brookdale was reduced during the fourth quarter of 1995 and 1994 based upon management's assessment of the estimated fair market value of the property. The determination of the estimated fair market value of the property was based upon the most recent appraisal of the property, which is conducted annually.\nRental income totalled $4,691,179 for the year ended December 31, 1995 compared with $4,895,956 in 1994. The decrease reflects lower average rental rates on new leases and a decrease in percentage rent due to the decrease in tenant sales. Interest income for the year ended December 31, 1995 totalled $421,179 compared to $326,493 in 1994. The increase is mainly due to higher interest rates earned on the Partnership's invested cash. Miscellaneous income totalled $606,678 for the year ended December 31, 1995 compared to $1,508,212 during 1994. Miscellaneous income during 1995 primarily consisted of lease buyout settlements for three Brookdale tenants totaling $444,000 and a $105,728 adjustment for an overaccrual of the Michigan Single Business Tax as a result of the sale of Northland Center, whereas the balance for the 1994 period primarily consisted of lease settlements for one former Brookdale in-line tenant and Carson's, a former Brookdale anchor store, totaling $1,450,000.\nTotal expenses for the year ended December 31, 1995 totalled $22,535,891 compared to $24,872,636 during 1994. The decrease reflects the absence of interest expense and depreciation and amortization associated with Northland, which was sold in 1994, which was partially offset by an increased write-down of Brookdale in 1995 compared to 1994. Property operating expenses increased from $2,657,042 for the year ended December 31, 1994 to $2,897,546 during 1995. The increase is due to the collection of past due Carson's receivables in 1994.\nReal estate taxes decreased from $3,528,943 for the year ended December 31, 1994 to $3,205,621 during 1994 primarily due to a reduction in the assessed value of Brookdale in January 1995. General and administrative expense decreased for the year ended December 31, 1995 compared to 1994 reflecting lower transfer agent fees in 1995 and costs associated with the proxy solicitation incurred in 1994.\nSales for tenants (exclusive of anchor tenants) who operated at Brookdale for each of the last two years were approximately $35,959,700 and $38,032,700 for the years ended December 31, 1995 and 1994, respectively. The General Partner attributes the decrease in sales to increased competition from nearby regional shopping centers which have been renovated or upgraded and a decline in consumer spending on softgoods, particularly apparel, a trend experienced by retailers across the country. As of December 31, 1995, Brookdale was 80% occupied (exclusive of anchor and outparcel stores), compared with 79% at December 31, 1994.\n1994 versus 1993 Cash provided by operating activities totalled $4,483,503 for the year ended December 31,1994, compared with $12,701,730 for the year ended December 31, 1993. The reduced cash flow is primarily due to the assignment of positive cash flow from Northland to Equitable, pursuant to the terms of the sale contract which provided for all operating income of Northland commencing January 1, 1994 to be paid to Equitable upon closing of the sale. The Partnership recognized a net loss of $7,567,268 for the year ended December 31, 1994 compared to a net loss of $18,376,967 for 1993. The decrease in net loss is due to the fact that the write-down of Brookdale to its estimated value in 1994 was less than the write-down in value of Northland in 1993, as well as the sale of Northland which resulted in a gain of $4,610,550 in 1994.\nThe carrying value of Brookdale was reduced during the fourth quarter of 1994, based upon management's assessment of the estimated fair market value of the property. The determination of the estimated fair market value of the property was based upon the most recent appraisal of the property , which is conducted annually, and the impending maturity of the first mortgage note.\nRental income totalled $4,895,956 in 1994, as compared to $12,622,285 in 1993. The decrease reflects the absence of Northland activity as well as lower average occupancy at Brookdale in 1994. Escalation income decreased $11,262,664 from 1993 to $5,964,157 in 1994. Escalation income represents billings to tenants for their proportionate share of common area maintenance, insurance and real estate tax expenses, HVAC and other miscellaneous expenses. The decrease in escalation income is primarily due to the absence of Northland activity. Miscellaneous income increased $1,303,568 from 1993, primarily due to the recognition of the $1,250,000 termination and restructuring fee paid by Carson's in connection with its lease settlement and the receipt of $200,000 in connection with the Herman's lease buyout at Brookdale.\nTotal expenses decreased $23,815,857 from $48,688,493 in 1993 to $24,872,636 in 1994 primarily due to the write-down of Brookdale to its estimated value being less than the write-down of Northland in 1993, and due to the absence of Northland activity resulting from the sale of Northland in 1994. Property operating expenses decreased due primarily to the absence of Northland activity and a decrease in bad debt expense at Brookdale resulting from the collection of past due Carson's receivables. This was slightly offset by an increase in CAM and promotion expenses at Brookdale. Real estate tax expense decreased due to the absence of Northland activity offset by an increase at Brookdale due to an increased assessed value of the Mall. Interest expense totaled $6,145,897 compared with $7,857,584 in 1993. The decrease is due to the payment of the Northland zero coupon note upon closing of the Northland sale on July 22, 1994. General and administrative expenses decreased in 1994, primarily due to the termination of the EREIM asset management agreement as of December 31, 1993 (see Note 8 to the Notes to the Financial Statements).\nSales for tenants (exclusive of anchor tenants) who operated at Brookdale for each of the last two years were approximately $38,032,000 and $38,288,000 for the years ending December 31, 1994 and 1993, respectively. As of December 31, 1994, Brookdale was 79% occupied (exclusive of anchor and outparcel stores) as compared to 85% on December 31, 1993. The decline in occupancy is largely attributable to the reconfiguration of approximately 40,000 square feet of previously leased space, which was recently renovated. These renovations were completed in November 1994 and a portion of the space has been re-leased as of year-end 1994.\nProperty Appraisal\nThe Partnership Agreement and the Mortgage Note require the Partnership to retain an independent, third-party appraisal firm to appraise the Partnership's property each year. The Partnership is required to provide an appraisal of the property to the Unit Holders within 90 days after the end of the Partnership's fiscal year. Cushman & Wakefield, Inc., an independent appraisal firm retained by the Partnership to appraise Brookdale in 1995, has appraised fair market value of Brookdale at $25,000,000 as of January 1, 1996.\nIt should be noted that appraisals are only estimates of current value and actual values realizable upon a 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 remaining property and the limited market for such properties, there can be no assurance that the other properties reviewed by the appraiser are comparable. Additionally, the low level of liquidity as a result of the current restrictive capital environment has had the effect of limiting the number of transactions in real estate markets and the availability of financing to potential purchasers, which may have a negative impact on the value of an asset. Further, the appraised value does not reflect the actual costs which would be incurred in selling the property, including brokerage fees.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nSee Item 14a for a listing of the Financial Statements and Supplementary data filed in this report.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone.\nPART III\n\t Item 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nThe Partnership has no officers or directors. The General Partner manages and controls substantially all of the Partnership's affairs and has general responsibility and ultimate authority in all matters affecting the Partnership's business. Certain officers and directors of the General Partner are now serving (or in the past have served) as officers and directors of entities which act as general partners of a number of real estate limited partnerships which have sought protection under the provisions of the federal Bankruptcy Code. The partnerships which have filed 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 protection of the bankruptcy laws to protect the partnerships' assets from loss through foreclosure.\nOn July 31, 1993, Shearson Lehman Brothers, Inc. (\"Shearson\") sold certain of its domestic retail brokerage and asset management businesses to Smith Barney, Harris Upham & Co. Incorporated (\"Smith Barney\"). Subsequent to this sale, Shearson changed its name to Lehman Brothers Inc. The transaction did not affect the ownership of the Partnership or the Partnership's General Partner. However, the assets acquired by Smith Barney included the name \"Shearson.\" Consequently, the general partner changed its name to Midwest Centers Inc. to delete any references to \"Shearson.\"\nThe directors and executive officers of the General Partner are as follows: \t Name Office\n\tPaul L. Abbott\t\tDirector, President and Chairman of the Board \tStevan N. Bach\t\tDirector \tKathleen Carey\t\tDirector Raymond C. Mikulich Director Robert J. Hellman Vice President, Director and Chief Financial Officer Joan B. Berkowitz Vice President \tElizabeth Rubin\t\tVice President Robert Sternlieb Vice President\nPaul L. Abbott, 50, is a Managing Director of Lehman Brothers. Mr. Abbott joined Lehman Brothers in August 1988, and is responsible for investment management of residential, commercial and retail real estate. Prior to joining Lehman Brothers, Mr. Abbott was a real estate consultant and a senior officer of a privately held company specializing in the syndication of private real estate limited partnerships. From 1974 through 1983, Mr. Abbott was an officer of two life insurance companies and a director of an insurance agency subsidiary. Mr. Abbott received his formal education in the undergraduate and graduate schools of Washington University in St. Louis.\nStevan N. Bach, 56, is Executive Vice President of Bach, Thoreen, McDermott Inc., a real estate valuation and consulting firm based in Houston, Texas. Mr. Bach has over 32 years of experience in the real estate business. From December 1980 through July 1984, Mr. Bach was a Senior Vice President, National Director and General Manager of the Southwestern Region for Landauer Associates, Inc. From December 1975 through December 1980, Mr. Bach was the Vice President and Manager of Coldwell Banker Appraisal Services. Mr. Bach is a graduate of the University of Southern California.\nKathleen B. Carey, 42, is an attorney specializing in commercial real estate. She is a graduate of the State University of New York at Albany and St. John's University Law School. In 1987, she joined the Connecticut law firm of Cummings & Lockwood and served as a partner in the firm from 1989 until mid-1994. Kathleen's practice has involved all facets of acquisitions, sales and financing of commercial properties, including multifamily housing, office buildings and shopping centers. She is admitted to practice in New York, Connecticut and California and currently works as an independent commercial real estate consultant.\nRaymond C. Mikulich, 42, is a Managing Director of Lehman, and since January 1988, has been head of the Real Estate Investment Banking Group. Prior to joining Lehman Brothers Kuhn Loeb in 1982, Mr. Mikulich was a Vice President with LaSalle National Bank, Chicago, in the Real Estate Advisory Group, where he was responsible for the acquisition of equity interests in commercial real estate. Over his fifteen years in the real estate business, Mr. Mikulich has arranged acquisitions and dispositions on behalf of both individuals and institutional investors. Mr. Mikulich holds a BA degree from Knox College and a JD degree from Kent College of Law.\nRobert J. Hellman, 41, is a Senior Vice President of Lehman Brothers and is responsible for investment management of retail, commercial and residential real estate. Since joining Lehman Brothers in 1983, Mr. Hellman has been involved in a wide range of activities involving real estate and direct investments including origination of new investment products, restructurings, asset management and the sale of commercial, retail and residential properties. Prior to joining Lehman Brothers, Mr. Hellman worked in strategic planning for Mobil Oil Corporation and was an associate with an international consulting firm. Mr. Hellman received a bachelor's degree from Cornell University, a master's degree from Columbia University, and a law degree from Fordham University.\nJoan B. Berkowitz, 36, is a Vice President of Lehman Brothers, responsible for asset management within the Diversified Asset Group. Ms. Berkowitz joined Lehman Brothers in May 1986 as an accountant in the Realty Investment Group. From October 1984 to May 1986, she was an Assistant Controller to the Patrician Group. From November 1983 to October 1984, she was employed by Diversified Holdings Corporation. From September 1981 to November 1983, she was employed by Deloitte Haskins & Sells. Ms. Berkowitz, a Certified Public Accountant, received a B.S. degree from Syracuse University in 1981.\nElizabeth Rubin, 29, is a Vice President of Lehman Brothers in the Diversified Asset Group. Ms. Rubin joined Lehman Brothers in April 1992. Prior to joining Lehman Brothers, she was employed from September 1988 to April 1992 by the accounting firm of Kenneth Leventhal and Co. Ms. Rubin is a Certified Public Accountant and received a B.S. degree from the State University of New York at Binghamton in 1988.\nRobert Sternlieb, 31, is an Assistant Vice President of Lehman Brothers and is responsible for asset management within the Diversified Asset Group. Mr. Sternlieb joined Lehman Brothers in April 1989 as an asset manager. From May 1986 to April 1989, he was a systems analyst at Drexel Burnham Lambert. Mr. Sternlieb received a B.S. degree in Finance from Lehigh University in 1986.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe Directors and Officers of the General Partner do not receive any salaries or other compensation from the Partnership, except that Mr. Bach and Ms. Carey receive $12,000 per year for serving as Directors of the General Partner. Prior to September 1, 1993 Mr. Bach received $10,000, and $2,400 for attendance in person at any meeting of the Board of Directors of the General Partner or of the Audit Committee. During 1995, Mr. Bach was paid $21,600 in director fees and Ms. Carey was paid $19,600 in director fees.\nThe General Partner is entitled to receive 1% of Operating Cash Flow distributed in any fiscal year and to varying percentages of the Net Proceeds of capital transactions. See pages 84 and 85 of the Partnership Agreement for a description of such arrangements which description is incorporated by reference thereto.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\n(a) Security Ownership of Certain Beneficial Owners - To the knowledge of the Partnership, no person owns more than 5% of the outstanding Units as of December 31, 1995.\n(b) Security Ownership of Management - Various employees of Lehman Brothers that perform services on behalf of the General Partner own no units of the Partnership as of December 31, 1995.\n(c)\tChanges in Control - None\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThe General Partner, an affiliate of Lehman Brothers, is entitled to receive a portion of Operating Cash Flow and Net Proceeds from Capital Transactions (see Item 5). During 1995, the General Partner received $22,698 as its share of Operating Cash Flow for 1995.\nDuring 1993, the Partnership engaged Lehman Brothers, an affiliate of the General Partner, in conjunction with the possible sales of Brookdale and Northland. Pursuant to such agreement, Lehman Brothers was entitled to a fee equal to 0.875% of the gross proceeds of a transaction, as defined in the Letter Agreement (incorporated by reference to Exhibit 10.13). Pursuant to this agreement, the Partnership paid Lehman Brothers $508,774 in 1994 for advisory services related to the sale of Northland Center. Such agreement was terminated in 1995.\nAffiliates of the General Partner are or have been responsible for certain administrative functions of the Partnership. For amounts paid to such affiliates, see Note 7 of the Notes to Financial Statements.\nPART IV \t \t Item 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(a) (1) and (2). \tMIDWEST REAL ESTATE SHOPPING CENTER L.P. \t(a Delaware limited partnership) \t \tIndex to Financial Statements and Schedules Page Number\nIndependent Auditors' Report\n\tBalance Sheets At December 31, 1995 and 1994\n\tStatements of Partners' Capital (Deficit) \tFor the years ended December 31, 1995, 1994 and 1993\n\tStatements of Operations \tFor the years ended December 31, 1995, 1994 and 1993\n\tStatements of Cash Flows \tFor the years ended December 31, 1995, 1994 and 1993\nNotes to the Financial Statements\n\tSchedule II - Valuation and Qualifying Accounts\n\tSchedule III - Real Estate and Accumulated Depreciation \t\t\t\t\n(b) Exhibits.\nSubject to Rule 12b-32 of the Securities Act of 1934 regarding incorporation by reference, listed below are the exhibits which are filed as part of this report:\n3.* Registrant's Agreement of Limited Partnership, dated December 1, 1986, is hereby incorporated by reference to Exhibit A to the Prospectus contained in Registration Statement No. 33-9937, which Registration Statement (the \"Registration Statement\") was declared effective by the SEC on December 23, 1986.\n4.1* The form of Certificate of Limited Partnership Interest is hereby incorporated by reference to Exhibit 4.1 to the Registration Statement.\n4.2* The form of Unit Certificate is hereby incorporated by reference to Exhibit 4.2 to the Registration Statement.\n10.1* The form of Property Management Agreement between Registrant and Center Management Venture is hereby incorporated by reference to Exhibit 2 to the Registration Statement.\n10.2* The form of Transfer Agent Agreement is hereby incorporated by reference to Exhibit 10.7 to the Registration Statement.\n10.3* The form of Promissory Note (Brookdale) is hereby incorporated by reference to Exhibit 10.8.1 to the Registration Statement.\n10.4* The form of Promissory Note (Northland) is hereby incorporated by reference to Exhibit 10.8.2 to the Registration Statement.\n10.5* The form of Mortgage is hereby incorporated by reference to Exhibit 10.9 to the Registration Statement.\n10.6* The form of Assignments of Leases and Rents is hereby incorporated by reference to Exhibit 10.10 to the Registration Statement.\n10.7* The Indemnification Agreement is hereby incorporated by reference to Exhibit 10.11 to the Registration Statement.\n10.8* The Agreement of Indemnification is hereby incorporated by reference to Exhibit 10.11 to the Registration Statement. \t 10.9* The Second Mortgage Loan Agreement from Equitable to the Partnership dated June 25, 1991 is hereby incorporated by reference to Exhibit 10.13 to the Registrant's Form 10-K for the year ended December 31, 1991.\n10.10* Letter of Intent to Purchase Northland Center by Equitable Life Assurance Society of the United States is hereby incorporated by reference to Exhibit A to the Partnership's Current Report on Form 8-K filed with the Securities and Exchange Commission on January 19, 1994.\n10.11* The Engagement Letter between the Partnership and Lehman Brothers securing Lehman Brothers services as exclusive financial advisor with respect to the sale of Northland Center and Brookdale Center, dated October 25, 1993 is hereby incorporated by reference to Exhibit 10.13 to the Partnership's Annual Report on Form 10-K for the year ended December 31, 1993.\n10.12* Termination and Release Agreement between the Partnership and Equitable Real Estate Investment Management, Inc. dated March 28, 1994 is hereby incorporated by reference to Exhibit 10.14 to the Partnership's Annual Report on Form 10-K for the year ended December 31, 1993.\n27\tFinancial Data Schedule.\n* Previously filed\n(c) Reports on Form 8-K during the three months ended December 31, 1995:\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.\nDated: March 29, 1996\nMIDWEST REAL ESTATE SHOPPING CENTER L.P.\nBY: Midwest Centers Inc. General Partner\nBY: \/s\/Paul L. Abbott Name: Paul L. Abbott Title: Director, President and Chairman of the Board\nBY: \/s\/Robert J. Hellman Name: Robert J. Hellman Title: Director, Vice President and Chief Financial Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant in the capacities and on the dates indicated.\nMIDWEST CENTERS INC. General Partner\nDate: March 29, 1996\nBY: \/s\/Paul L. Abbott Paul L. Abbott Director, Chairman of the Board and President\nDate: March 29, 1996\nBY: \/s\/Raymond Mikulich Raymond Mikulich Director\nDate: March 29, 1996\nBY: \/s\/Stevan N. Bach Stevan N. Bach Director\nDate: March 29, 1996\nBY: \/s\/Kathleen Carey Kathleen Carey Director\nDate: March 29, 1996\nBY: \/s\/Robert J. Hellman Robert J. Hellman Director, Vice President and Chief Financial Officer\nDate: March 29, 1996\nBY: \/s\/Joan Berkowitz Joan Berkowitz Vice President\nDate: March 29, 1996\nBY: \/s\/Elizabeth Rubin Elizabeth Rubin Vice President\nDate: March 29, 1996\nBY: \/s\/Robert J. Sternlieb Robert J. Sternlieb Vice President\nIndependent Auditors' Report\nThe Partners Midwest Real Estate Shopping Center L.P.:\nWe have audited the financial statements of Midwest Real Estate Shopping Center L.P. (a Delaware limited partnership) as listed in the accompanying index. In connection with our audits of the financial statements, we also have audited the financial statement schedules as listed in the accompanying index. These financial statements and financial statement schedules are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Midwest Real Estate Shopping Center L.P. as of December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 1995 in conformity with generally accepted accounting principles. Also in our opinion, the related financial statement schedules, when considered in relation to the financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.\nThe accompanying financial statements and financial statement schedules have been prepared assuming that the Partnership will continue as a going concern. As discussed in Note 5 to the financial statements, the Partnership's mortgage note payable, secured by its remaining property, matured on June 30, 1995. Market conditions have prevented the Partnership from obtaining sufficient proceeds from a sale or refinancing to satisfy the mortgage obligation. The mortgage lender has notified the Partnership of its default and is attempting a non judicial foreclosure sale scheduled for April 5, 1996. These conditions raise substantial doubt about the Partnership's ability to continue as a going concern. These financial statements and financial statement schedules do not include any adjustments that might result from the outcome of this uncertainty.\nKPMG Peat Marwick LLP\nBoston, Massachusetts March 27, 1996\nBalance Sheets December 31, 1995 and 1994\nAssets 1995 1994\nProperty held for disposition (notes 3 and 5) $24,500,000 $35,072,000 Cash and cash equivalents 5,971,023 6,693,502 Restricted cash (note 5) 1,012,296 - Accounts receivable, net of allowance of $174,600 in 1995 and $95,229 in 1994 537,561 181,358 Deferred rent receivable 112,931 90,969 Due from affiliates, net (note 7) 115,062 88,278 Deferred charges, net of accumulated amortization of $246,676 in 1994 - 33,324 Prepaid assets 92,607 142,679\nTotal Assets $32,341,480 $42,302,110\nLiabilities and Partners' Capital (Deficit)\nLiabilities: Accounts payable and accrued expenses $ 623,499 $ 1,170,453 Zero coupon mortgage note payable (note 5) 38,028,587 33,652,305 Distribution payable (note 10) - 756,565\nTotal Liabilities 38,652,086 35,579,323\nPartners' Capital (Deficit) (note 4): General Partner (111,270) 19,065 Limited Partners (10,700,000 securities outstanding) (6,199,336) 6,703,722\nTotal Partners' Capital (Deficit) (6,310,606) 6,722,787\nTotal Liabilities and Partners' Capital (Deficit) $32,341,480 $42,302,110\nStatements of Partners' Capital (Deficit) For the years ended December 31, 1995, 1994 and 1993\nLimited General Partners Partner Total\nBalance at December 31, 1992 $ 50,928,358 $(482,044) $ 50,446,314 Net loss (18,193,197) (183,770) (18,376,967) Distributions (note 10) (5,350,000) (54,040) (5,404,040)\nBalance at December 31, 1993 27,385,161 (719,854) 26,665,307 Net income (loss) (8,429,939) 862,671 (7,567,268) Distributions (note 10) (12,251,500) (123,752) (12,375,252)\nBalance at December 31, 1994 6,703,722 19,065 6,722,787 Net loss (10,656,058) (107,637) (10,763,695) Distributions (note 10) (2,247,000) (22,698) (2,269,698)\nBalance at December 31, 1995 $ (6,199,336) $(111,270) $ (6,310,606)\nStatements of Operations For the years ended December 31, 1995, 1994 and 1993\nIncome 1995 1994 1993\nRental income (note 3) $ 4,691,179 $ 4,895,956 $ 12,622,285 Escalation income (note 3) 6,053,160 5,964,157 17,226,821 Interest income 421,179 326,493 257,776 Miscellaneous income (note 2) 606,678 1,508,212 204,644\nTotal Income 11,772,196 12,694,818 30,311,526\nExpenses\nProperty operating expenses 2,897,546 2,657,042 13,025,506 Loss on write-down of real estate (note 3) 9,498,921 9,068,553 16,163,153 Real estate taxes 3,205,621 3,528,943 5,705,170 Interest expense 5,076,282 6,145,897 7,857,584 Depreciation and amortization 1,196,967 2,677,432 3,854,330 General and administrative 236,175 311,639 1,289,480 Management fee (note 9) 215,365 230,565 563,654 Professional fees 209,014 252,565 229,616\nTotal Expenses 22,535,891 24,872,636 48,688,493\nLoss from Operations (10,763,695) (12,177,818) (18,376,967)\nGain on sale of property (note 3) - 4,610,550 -\nNet Loss $(10,763,695) $ (7,567,268) $(18,376,967)\nNet Loss Allocated:\nTo the General Partner $ (107,637) $ 862,671 $ (183,770) To the Limited Partners (10,656,058) (8,429,939) (18,193,197)\n$(10,763,695) $ (7,567,268) $(18,376,967)\nPer Limited Partnership Security (10,700,000 securities outstanding) $ (1.00) $ (.79) $ (1.70)\nStatements of Cash Flows For the years ended December 31, 1995, 1994 and 1993\nCash Flows from Operating Activities:\n1995 1994 1993\nNet loss $(10,763,695) $ (7,567,268) $(18,376,967) Adjustments to reconcile net loss to net cash provided by operating activities: Depreciation and amortization 1,196,967 2,677,432 3,854,330 Loss on write-down of real estate 9,498,921 9,068,553 16,163,153 Increase in interest on zero coupon mortgage note payable 4,376,282 6,145,897 7,766,104 Gain on sale of property - (4,610,550) - Increase (decrease) in cash arising from changes in operating assets and liabilities: Restricted cash (1,012,296) - - Accounts receivable (356,203) 304,519 1,552,961 Deferred rent receivable (21,962) (62,341) (118,152) Due from affiliates, net (26,784) 36,067 (41,723) Prepaid assets 50,072 1,533,654 (96,338) Accounts payable and accrued expenses (124,277) (1,792,460) 748,362 Deferred income - (1,250,000) 1,250,000\nNet cash provided by operating activities 2,817,025 4,483,503 12,701,730\nCash Flows from Investing Activities:\nNet proceeds from sale of property - 5,625,304 - Additions to real estate (513,241) (1,114,049) (2,322,045) Construction escrow - - 84,425\nNet cash (used for) provided by investing activities (513,241) 4,511,255 (2,237,620)\nCash Flows from Financing Activities:\nPayoff of note payable - - (3,000,000) Construction escrow - - 486,280 Distributions paid (3,026,263) (12,969,697) (5,417,550)\nNet cash used for financing activities (3,026,263) (12,969,697) (7,931,270)\nNet (decrease) increase in cash and cash equivalents (722,479) (3,974,939) 2,532,840 Cash and cash equivalents at beginning of period 6,693,502 10,668,441 8,135,601\nCash and cash equivalents at end of period $ 5,971,023 $ 6,693,502 $ 10,668,441\nSupplemental Disclosure of Cash Flow Information:\nCash paid during the period for interest $ 700,000 $ - $ 91,480\nSupplemental Disclosure of Noncash Investing Activities:\nClosing costs of $370,000 and capital expenditures of $422,677 were funded through accounts payable in 1994.\nSupplemental Disclosure of Noncash Financing Activities:\nIn connection with the sale of Northland Center, Equitable released the Partnership from the related $54,504,713 mortgage obligation.\nNotes to the Financial Statements December 31, 1995, 1994 and 1993\n1. Organization Midwest Real Estate Shopping Center L.P., formerly Equitable Real Estate Shopping Center L.P. (the \"Partnership\") was formed as a limited partnership on October 28, 1986, under the laws of the State of Delaware. The Partnership was formed to acquire two regional shopping malls, Brookdale Center and Northland Center.\nIn conjunction with the termination of the former asset management agreement with Equitable Real Estate Investment Management, Inc. (Note 8), the Partnership was required to cease using \"Equitable\" and \"Equitable Real Estate\" in its name. Consequently, effective November 21, 1994, the Partnership changed its name to Midwest Real Estate Shopping Center, L.P.\nThe general partner of the Partnership is Midwest Centers Inc., (the \"General Partner\"), formerly Shearson ESC\/GP Inc. (see below), an affiliate of Lehman Brothers Inc., formerly Shearson Lehman Brothers Inc.\nThe initial capital was $1,000, representing a capital contribution by the General Partner. The Partnership commenced investment operations on December 30, 1986, with the acceptance of subscriptions for 10,700,000 limited partnership securities from unitholders, the maximum authorized by the agreement of limited partnership (the \"Partnership Agreement\").\nOn July 31, 1993, Shearson Lehman Brothers Inc. (\"Shearson\") sold certain of its domestic retail brokerage and asset management businesses to Smith Barney, Harris Upham & Co. Incorporated (\"Smith Barney\"). Subsequent to the sale, Shearson changed its name to Lehman Brothers Inc. (\"Lehman Brothers\"). The transaction did not affect the ownership of the General Partner. However, the assets acquired by Smith Barney included the name \"Shearson\". Consequently, effective November 12, 1993, the general partner changed its name to Midwest Centers Inc. to delete any reference to \"Shearson\".\nThe General Partner believes it is in the best interests of the Partnership and the Unitholders for the Partnership to dispose of its assets and dissolve and liquidate the Partnership in an orderly manner. During 1993, the Partnership engaged Lehman Brothers, an affiliate of the General Partner, to assist in this effort with respect to the sale of the Properties. On March 28, 1994, the Partnership executed a contract with Equitable for the sale of Northland Center subject to agreement by the parties to certain additional documentation. On July 22, 1994, the Partnership sold Northland Center.\nThe General Partner has been attempting to sell the Partnership's remaining property, Brookdale Center (the \"Property\" or \"Brookdale\"), and pay off the Zero Coupon Mortgage Note Payable (the \"Mortgage\"), which is held by The Equitable Life Assurance Society of the United States (\"Equitable\") and secured by the Property. The General Partner was unable to consummate a sale of the Property and repay the Mortgage prior to June 30, 1995, the maturity date of the Mortgage. As a result, on July 5, 1995, Equitable issued a notice of default to the Partnership and commenced advertising Brookdale for a public nonjudicial foreclosure sale to be held on September 12, 1995. Such date was subsequently postponed until April 5, 1996.\n2. Summary of Significant Accounting Policies Basis of Accounting. The financial statements of the Partnership have been prepared on the accrual basis of accounting.\nProperty Held for Disposition. Property held for disposition, which consist of buildings, land and personal property, is recorded at its fair market value less costs to sell. Effective January 1, 1996, Brookdale will no longer be depreciated. Prior to 1993, the Brookdale real estate investment was recorded at cost less accumulated depreciation. As further discussed in Note 3, it was determined that the decline in appraised value of Northland Center as of December 31, 1993 and the decline in the appraised value of Brookdale as of December 31, 1994, the decline in national real estate market trends and continuing decreases in occupancy were not abating and the carrying values should be reduced to their appraised value. After adjustment for write downs, depreciation of the buildings was computed using the straight-line method over an estimated useful life of 40 years. Depreciation of personal property was computed using the straight-line method over an estimated useful life of 12 yea s. Amortization of tenant leasehold improvements was computed using the straight-line method over the lease term.\nAccounting for Impairment. In March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121 Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of (\"FAS 121\"), which requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amount. FAS 121 also addresses the accounting for long-lived assets that are expected to be disposed of. The Partnership has adopted FAS 121 in the fourth quarter of 1995.\nFair Value of Financial Instruments. Statement of Financial Accounting Standards No. 107, \"Disclosures about Fair Value of Financial Instruments\" (\"FAS 107\"), requires that the Partnership disclose the estimated fair values of its financial instruments. Fair values generally represent estimates of amounts at which a financial instrument could be exchanged between willing parties in a current transaction other than in forced liquidation.\nFair value estimates are subjective and are dependent on a number of significant assumptions based on management's judgment regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. In addition, FAS 107 allows a wide range of valuation techniques, therefore, comparisons between entities, however similar, may be difficult.\nDeferred Charges. The following fees and charges were amortized using the straight-line method over the following periods:\nPeriod\n\tFee for negotiating the mortgage notes\t8.5 years \tFee for placement of mortgage notes\t8.5 years\nOffering Costs. Offering costs are nonamortizable and have been deducted from partners' capital.\nTransfer of Units and Distributions. Upon the transfer of a unit, net income and net loss from operations attributable to such unit generally will be allocated between the transferor and the transferee based on the number of days during the year of transfer that each is deemed to have owned the unit. The unitholder of record on the last day of a calendar month will be deemed to have owned the unit for the entire month. Distributions of operating cash flow, as defined in the Partnership Agreement, will be paid on a quarterly basis to registered holders of units on record dates established by the Partnership, which generally will be the last day of each quarter.\nIncome Taxes. No provision is made for income taxes since such liability is the liability of the individual partners.\nNet Loss Per Limited Partnership Unit. Net loss per limited partnership unit is based upon the limited partnership interests outstanding at year-end and the net income allocated to the limited partners.\nRental Income and Deferred Rent. The Partnership rents its property to tenants under operating leases with various terms. Deferred rent receivable consists of rental income which is recognized on the straight-line basis over the lease terms, but will not be received until later periods as a result of scheduled rent increases.\nCash and Cash Equivalents. Cash equivalents consists of short-term highly liquid investments which have maturities of three months or less from the date of issuance. The carrying amount approximates fair value because of the short maturity of the instruments.\nRestricted Cash. Restricted cash represents net cash flow generated by Brookdale subsequent to the date of receivership.\nConcentration of Credit Risk. Financial instruments which potentially subject the Partnership to a concentration of credit risk principally consist of cash and cash equivalents in excess of the financial institutions' insurance limits. the Partnership invests available cash with high credit quality financial institutions.\nUse of Estimates. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\n3. Real Estate The Partnership's real estate, which was purchased on December 30, 1986 from Equitable, originally consisted of two regional shopping malls known as Brookdale Center, located in Brooklyn Center, Hennepin County, Minnesota; and Northland Center, located in Southfield, Oakland County, Michigan (\"Northland\"), collectively, the \"Properties.\"\nBrookdale is a regional shopping mall anchored by five major department stores - - Sears, Roebuck and Co. (\"Sears\"), J.C. Penney, Inc. (\"J.C. Penney\"), Dayton-Hudson Corporation (\"Dayton's\"), Mervyn's (\"Mervyn's\") and Kohl's Department Stores, Inc. (\"Kohl's\"), all located on a site of approximately 81 acres. Brookdale contains approximately 985,000 gross leasable square feet, of which approximately 780,000 square feet is owned or leased by the anchor tenants and not by the Partnership.\nJ.C. Penney leases its building and the land on which its building is constructed from a third party which leases the land from the Partnership until July 27, 2015; however, it has the option to terminate the lease on either July 27, 1995 or July 27, 2005. J.C. Penney was required to operate a J.C. Penney type department store until July 27, 1995; however J.C. Penney may sublet the entire premise or assign the lease to any corporation which may take over the business of J.C. Penney in Minnesota as a result of an assignment or merger. J.C. Penney did not exercise the option to terminate the lease on July 27, 1995 and has not informed the Partnership of any intention to sublease the premises.\nSears, which owns its own building and land, has an operating agreement and a purchase agreement that require it to operate a Sears store in its main building until its expiration in May 1997. Mervyn's, which opened in 1995, has a lease which expires in August 2003. Dayton's, which leases its building and land from a third party, has an operating agreement which terminates on July 31, 1996. Kohl's own's its building and leases the land from the Partnership. Kohl's land lease terminates on January 31, 2010 with two five-year renewals. Kohl's did not renew its operating agreement, which expired on August 1, 1993. None of the above anchors have informed the Partnership of any intention to leave Brookdale.\nDuring 1995 and 1994, the Partnership wrote down the net book value of Brookdale by $9,498,921 and $9,068,553, respectively, to its estimated fair market value less costs to sell. The determination of the estimated fair market value of the property was based upon the most recent appraisal of the property, which is conducted annually.\nThe following is a schedule of the remaining minimum lease payments for Brookdale as called for under the lease agreements:\n\tYear ending \tDecember 31,\t\t\n1996 $ 3,962,275 1997 3,741,906 1998 3,447,194 1999 3,243,802 2000 2,693,023 Thereafter 9,789,334\n$26,877,534\nIn addition to the minimum lease amounts, the leases provide for escalation charges to tenants for common area maintenance, real estate taxes and percentage rents. For the years ended December 31, 1995, 1994 and 1993, percentage rents amounted to $282,843, $233,639, and $855,488 respectively, which amounts are included in rental income.\nOn July 22, 1994, the Partnership executed an agreement with Equitable for the sale of Northland for the price of $6,600,000 in excess of the balance of the first mortgage loan. The carrying value was reduced by $16,163,153 to its estimated fair market value at December 31, 1993, which reflected the terms of the sale. The price was determined as if the sale had closed on December 31, 1993 and any positive cash flow generated by Northland from January 1, 1994 to the closing belonged to Equitable. The Partnership received net proceeds of $5,625,304. The transaction resulted in a gain on sale of $4,610,550 in 1994. Pursuant to the Partnership agreement (see note 4), the gain was allocated $984,449 to the general partner and $3,626,101 to the limited partners.\n4. Partnership Agreement Pursuant to the terms of the Partnership Agreement, profits and losses from operations shall be allocated 99% to the unitholders and 1% to the General Partner. Distributions of net cash flow from operations, as defined in the Partnership Agreement, shall be made in the following amounts and order of priority: (i) first, 99% to the unitholders and 1% to the General Partner, until the unitholders receive an amount equal to a cumulative annual return of 11%, compounded quarterly, on their Adjusted Capital Contributions; and (ii) second, 99% to the unitholders and 1% to the General Partner.\nWith respect to capital transactions, income and losses will be allocated to the General Partner and the unitholders in the same proportions as net proceeds from capital transactions are distributed, except to the extent necessary to reflect prior capital account adjustments. Distributions of net proceeds from capital transactions shall be distributed as follows: (i) first, 99% to the unitholders and 1% to the General Partner, until the unitholders have received, from aggregate distributions of operating cash flow and net proceeds from capital transactions, an amount equal to a cumulative annual return of 11% compounded quarterly on their adjusted capital contributions; (ii) second, 99% to unitholders and 1% to the General Partner, until the unitholders have received, from aggregate distributions of operating cash flow and net proceeds from capital transactions, less distributions constituting the cumulative priority return, as defined in the Partnership Agreement, an amount equal to their adjusted capital contributions; and (iii) third, 88.24% to the unitholders and 11.76% to the General Partner.\n5. Zero Coupon Mortgage Note Payable Financing for the purchase of the Malls was provided by two nonrecourse mortgage notes from Equitable in the initial principal amounts of $15,175,000 (the \"Brookdale Note\") and $25,675,000 (the \"Northland Note\"). Upon the sale of the Northland Center on July 22, 1994, Equitable released and discharged the Partnership from the Northland Note and all interest accrued on the principal as specified in the mortgage note agreement. The Brookdale Note has an interest rate of 10.2% per annum, compounded semiannually. The note provides that the Partnership must maintain at all times a \"Loan-to-Value Ratio\" of not greater than 90%. Loan-to-Value Ratio is defined generally as the then outstanding accreted amount of the Brookdale Note divided by the most recent appraised value of the property, as updated on an annual basis. The Brookdale Note is secured by a first mortgage on Brookdale Mall and an assignment of rents and leases.\nOn May 10, 1995, the Partnership received a notice from Equitable requesting that the Partnership deposit eligible collateral having a present value of $3,312,199 by June 3, 1995. The Partnership did not deposit the eligible collateral.\nOn July 5, 1995, the Partnership received notice from Equitable that the Partnership failed to pay all principal and accrued interest due under the Mortgage on June 30, 1995, the maturity date of the Mortgage. The notice stated that in the event such amount is not paid within ten days after receipt of the notice, an Event of Default under the Mortgage will exist and Equitable will pursue all remedies available to it, including without limitation, foreclosure of the lien of the Mortgage by power of sale or judicial foreclosure and the appointment of a receiver. Further to its July 5, 1995 notice of default to the Partnership, Equitable, which holds the mortgage on Brookdale, commenced advertising Brookdale for a public nonjudicial foreclosure sale to be held initially on September 12, 1995, and which was postponed to April 5, 1996.\nOn August 2, 1995, at the request of Equitable, the District Court for the Fourth Judicial District of Minnesota appointed General Growth Management, Inc. (\"General Growth\") as the receiver of Brookdale. In such capacity, General Growth will collect the rent proceeds from Brookdale's tenants and apply the proceeds to payment of, among other things, Brookdale's operating expenses, maintenance costs, real estate taxes, tenant improvements and leasing commissions, with any remaining funds to be paid to Equitable on account of its mortgage on Brookdale. From the date of receivership through December 31, 1995, the net cash flow generated by Brookdale, which is reflected on the Partnership's balance sheet as \"Restricted cash\" in the amount of $1,012,296, will be used to pay property operating expenses and real estate taxes for Brookdale. As of December 31, 1995, $700,000 of restricted cash was forwarded to Equitable to be applied against accrued interest, per the terms of the receivership . Debt service shortfalls, if any, may be advanced by Equitable and added to the principal amount of the Mortgage. The Partnership continues to hold negotiations with Equitable concerning the mortgage in default. In addition to such negotiations, the Partnership is considering all alternatives available to it with respect to such potential foreclosure sale.\nBeginning on July 1, 1995, the Partnership started to accrue interest on the Mortgage at the default rate of 19%, in accordance with the Brookdale Note. As of December 31, 1995, the Partnership accrued $3,360,015 in default interest, of which $2,600,015 remained unpaid.\nIt is not practicable for the Partnership to estimate the fair value of the Brookdale Note as no quoted market price exists and the cost of obtaining an independent valuation appears excessive to the Partnership. However, the Partnership believes the fair value of the Brookdale Note is no more than the estimated fair market value of Brookdale.\n6. Note Payable On June 25, 1991, the Partnership obtained a $3,000,000 loan from Equitable Life Assurance Society of the U.S. The note bore interest at 1% above prime and was secured by a second mortgage lien on Northland Center. Monthly payments of interest only were required. On June 6, 1993, the Partnership repaid the note payable from cash reserves.\n7. Transactions with Related Parties The General Partner or its affiliates earned fees and compensation in connection with the syndication, acquisition and administrative services rendered to the Partnership of $11,342,000 and incurred unreimbursed costs on behalf of the Partnership of $570,352. The aggregate amount of the aforementioned fees and compensation earned and unreimbursed costs was composed of $7,490,000 included in offering costs and $4,422,352 included in deferred charges. During 1993, the Partnership engaged Lehman Brothers, an affiliate of the General Partner, in conjunction with exploring the possible sales of Brookdale and Northland. Pursuant to such agreement which was terminated in 1995, Lehman Brothers was entitled to a fee equal to .875% of the gross proceeds of a transaction, as defined in the Letter Agreement. Pursuant to this agreement, Lehman Brothers received $508,774, in 1994, from the Partnership for advisory services related to the sale of Northland.\nAs of December 31, 1995 and 1994, $115,062 and $88,278, respectively, is the net amount due from affiliates. For the years ended December 31, 1995, 1994 and 1993, $167,032, $665,155, and $151,243, respectively, was earned by affiliates.\nCash and Cash Equivalents. Cash and cash equivalents reflected on the Partnership's balance sheets at December 31, 1995 and 1994 were on deposit with an affiliate of the General Partner.\n8. Asset Management Agreement On December 31, 1986, the Partnership entered into an agreement with Equitable Real Estate Investment Management, Inc. (\"EREIM\") for the management of the Properties. The agreement provided for an annual fee equal to $1,060,000 per annum (included in operating expenses) through December 30, 2001. Effective December 31, 1993, the Asset Management Agreement with EREIM was terminated.\n9. Management Agreement The Partnership entered into a management agreement with General Growth for the day-to-day operations of the Properties. General Growth received a monthly fee of 4.45% (increased from 4% commencing February 1, 1989) of the net rents as defined in the management agreement. The agreement expired January 31, 1989 and was extended for two years. The Properties were managed pursuant to the terms of the agreement through August 2, 1995. Pursuant to the default of the Mortgage and the appointment of General Growth as the receiver of Brookdale, General Growth is entitled to receiver's fees equal to 4.45% of all fixed minimum rents and percentage or overage rents collected. For the year ended December 31, 1995, General Growth earned receiver fees of approximately $78,000.\n10. Distributions to Limited Partners Distributions to limited partners for 1995, 1994 and 1993 were $2,247,000 ($.21 per limited partnership security), $12,251,500 ($1.15 per limited partnership security), and $5,350,000 ($.50 per limited partnership security), respectively. Cash distributions declared payable to limited partners at December 31, 1994 were $749,000 ($.07 per limited partnership security). Cash distributions to limited partners were suspended, beginning in the fourth quarter of 1995.\n11. Reconciliation of Financial Statement Net Loss and Partners' Capital (Deficit) to Federal Income Tax Basis Net Loss and Partners' Capital\nReconciliations of financial statement net loss and partners' capital (deficit) to federal income tax basis net loss and partners' capital follow:\n1995 1994 1993\nFinancial statement net loss $(10,763,695) $ (7,567,268) $(18,376,967) Tax basis depreciation over financial statement depreciation (1,539,664) (169,715) (2,565,258) Tax basis rental income over (under) financial statement rental income (54,816) (2,187,492) 1,899,207 Tax basis loss on sale of property over financial statement gain on sale of property - (12,630,880) - Financial statement loss on write-down of real estate 9,498,921 9,068,553 16,163,153 Other 74,568 (194,409) (31,791)\nFederal income tax basis net loss $ (2,784,686) $(13,681,211) $ (2,911,656)\nFinancial statement partners' capital (deficit) $ (6,310,606) $ 6,722,787 $ 26,665,307 Current year financial statement net loss over (under) federal income tax basis net loss 7,979,009 (6,113,943) 15,465,311 Cumulative financial statement net income (loss) over (under) federal income tax basis net income (loss) (485,600) 5,628,343 (9,836,968)\nFederal income tax basis partners' capital $ 1,182,803 $ 6,237,187 $ 32,293,650\nBecause many types of transactions are susceptible to varying interpretations under Federal and State income tax laws and regulations, the amounts reported above may be subject to change at a later date upon final determination by the taxing authorities.\n12. Litigation On January 17, 1995, the Partnership announced that an action had been filed against the General Partner, the Partnership and other defendants in the United States District Court for the Southern District of New York on behalf of all persons who owned Limited Partnership Units of the Partnership on June 7, 1994. The complaint alleges, among other things, that the solicitation statement used by the Partnership to solicit the consent of the Limited Partners to the July 1994 sale of the Northland Shopping Center (the \"Solicitation Statement\") contained material misrepresentations and omissions in violation of Section 14(a) of the Securities and Exchange Act of 1934 and Rule 14a-9 promulgated thereunder. The complaint also alleges claims for breach of fiduciary duty, negligent misrepresentation and breach of the limited partnership agreement related to the Northland sale and the partial liquidation of the assets. Plaintiffs seek, among other things, compensatory damages and to have their action certified as a class action under the Federal Rules of Civil Procedure. On May 12, 1995, the Partnership announced that two similar actions had been filed in the District Court for the Southern District of New York. On November 16, 1995, the complaints in one of these three actions was amended to add a derivative claim for breach of fiduciary duty on behalf of the Partnership. The amended complaint also alleges that the General Partner, assisted by the other defendants, breached its fiduciary duties by failing to take steps to maximize the value of the Brookdale Shopping Center. The General Partner believes that the allegations in these complaints are without merit and will defend these lawsuits vigorously.\nOn May 12, 1995, the Partnership also announced that an action had been filed against the General Partner and other defendants in the Federal District Court for the Central District of California on behalf of all persons who owned Limited Partnership Units during the period June 7, 1994 to the present. The complaint alleges that the Solicitation Statement contained material misrepresentations and omissions in violation of Section 14(a) of the Securities and Exchange Act of 1934 and Rule 14a-9 promulgated thereunder. Plaintiffs seek, among other things, compensatory damages, and to have their action certified as a class action under the Federal Rules of Civil Procedure. This action has been transferred to the District Court for the Southern District of New York to be coordinated with the New York actions for pre-trial proceedings. The General Partner believes that the allegations in this complaint are without merit and will defend this lawsuit vigorously.\nThe Partnership also announced on May 12, 1995, that an action had recently been filed against the General Partner and other defendants in the Superior Court for Los Angeles County and removed to the District Court for the Central District Court of California. This action is brought on behalf of all persons who purchased Limited Partnership Units of the Partnership during the period from December 26, 1986 to the present. The complaint alleges, among other things, that the General Partner, assisted by the other defendants, breached its fiduciary duty to the plaintiffs in connection with the offer and sale of Limited Partnership Units, the operation of the Partnership and the Northland sale. Plaintiffs seek, among other things, compensatory damages, punitive damages, and to have their action certified as a class action under the Federal Rules of Civil Procedure. This action also has been transferred to the District Court for the Southern District of New York to be coordinated with the pre-trial proceedings. The General Partner believes that the allegations in the complaint are without merit and will defend the lawsuit vigorously.\nSchedule II Valuation and Qualifying Accounts\nBalance at Charged to Balance at Beginning Costs and End of of Period Expenses Deductions Period\nAllowance for doubtful accounts:\nYear ended December 31, 1993: $ 1,152,546 $ 544,951 $445,692 $1,251,805\nYear ended December 31, 1994: $ 1,251,805 $(184,872) $971,704 $ 95,229\nYear ended December 31, 1995: $ 95,229 $ 87,621 $ 8,250 $ 174,600\nMIDWEST REAL ESTATE SHOPPING CENTER, L.P. Schedule III - Real Estate and Accumulated Depreciation\nDecember 31, 1995\nCosts Capitalized Subsequent Initial Cost to Partnership (A) To ------------------------------------- Acquisition\nLand, Buildings and Buildings and Write-down Description Encumbrances Land Improvements Improvements Adjustment\nBrookdale Shopping Center, Hennepin County, MN $38,028,587 $5,413,594 $42,816,568 $5,611,188 $29,341,350\n$38,028,587 $5,413,594 $42,816,568 $5,611,188 $29,341,350\n(CONT.)----------------------------------------------------------------------\nGross Amount at Which Carried at Close of Period (B)----------------------\nBuildings and Accumulated Description Land Improvements Total Depreciation\nBrookdale Shopping Center, Hennepin County, MN $2,551,918 $21,948,082 $24,500,000 $ -\n$2,551,918 $21,948,082 $24,500,000 $ -\n(CONT.)------------------------------------------------------------------\nLife on which Depreciation in Latest Date of Date Income Statements Description Construction Acquired is Computed\nBrookdale Shopping Center, Hennepin County, MN 1962 12\/30\/86 10-40 years \t\t\t\t\n(A) The initial cost of the Partnership represents the original purchase price of the property, including amounts incurred subsequent to the acquisition which were contemplated. The initial costs included the purchase price paid by the Partnership and acquisition fees and expenses.\n(B) The aggregate costs of real estate at December 31, 1995 and 1994 for Federal income tax purposes is $53,862,752 and $53,602,750, respectively.\n(C) During 1995 and 1994, the Partnership recognized a write-down in the book value of the Brookdale Center of $9,498,921 and $9,068,553, respectively. The net book value adjusted for the write-down, becomes the new carrying value for the property.\nA reconciliation of the carrying amount of real estate and accumulated depreciation for the years ended December 31, 1995, 1994 and 1993 follows:\nReal Estate Investments: 1995 1994 1993\nBeginning of year $ 35,072,000 $108,498,993 $125,363,943 Additions 90,564 1,536,726 1,716,870 Write-down (10,662,564) (18,678,786) (18,581,820) Dispositions - (56,284,933) -\nEnd of year $ 24,500,000 $ 35,072,000 $108,498,993\nAccumulated Depreciation:\nBeginning of year $ - $ 8,234,897 $ 6,948,395 Depreciation expense 1,163,643 2,510,802 3,705,169 Write-down (1,163,643) (9,610,233) (2,418,667) Dispositions - (1,135,466) -\nEnd of year $ - $ - $ 8,234,897","section_15":""}
{"filename":"320333_1995.txt","cik":"320333","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nHanover Direct, Inc. (the \"Company\") is a leading direct specialty retailer that markets via a portfolio of branded specialty catalogs offering home fashions, general merchandise and apparel. The Company's home fashion catalogs include Domestications(R), a leading specialty home textile catalog, and The Company Store(R), an upscale direct marketer of down comforters and other down and related products for the home. The Company also markets Gump's(R), a leading upscale catalog of exclusive gifts, which opened its new retail store in downtown San Francisco in March 1995. The Company also markets via catalogs in the kitchenware market with Colonial Garden Kitchens(R), a specialty catalog featuring work saving and lifestyle enhancing items for the kitchen and home, and Kitchen & Home(R), an upscale kitchen and home product catalog. The Company's apparel catalogs include Tweeds(R), the European inspired women's fashion catalog, and International Male(R), offering unique men's fashions with an international flair.\nIn 1995, the Company acquired Improvements(R), a leading do-it-yourself home improvement catalog featuring home aid accessories, the remaining interest in The Safety Zone(R), a direct marketer of safety, prevention and protection products, and Austad's(R), a direct marketer of golf equipment, related apparel and accessories.\nThe Company, in connection with its venture with Sears, Roebuck and Co. (\"Sears\"), mails several versions of its catalogs to the more than 20 million mail order and credit card customers of Sears.\nDuring 1995, the Company mailed approximately 370 million catalogs. The Company maintains a proprietary customer list currently containing approximately 18 million names of customers (down from 19 million names in 1994) who have made purchases from at least one of the Company's catalogs within the past 36 months. Over 7 million of the names on the list represent customers who have made purchases from at least one of the Company's catalogs within the last 12 months.\nThe Company is incorporated in Delaware with its principal executive office at 1500 Harbor Boulevard, Weehawken, New Jersey 07087. The Company's telephone number is (201) 863-7300. NAR Group Limited, a British Virgin Islands corporation (together with its affiliates, \"NAR\"), owns approximately 53% of the Company's common stock. NAR, a private investment holding company, is a joint venture between the family of Alan G. Quasha, a Director and the Chairman of the Board of the Company, and Compagnie Financiere Richemont A.G., a Swiss public company engaged in luxury goods, tobacco and other businesses. The Company is a successor in interest to The Horn & Hardart Company, a restaurant company founded in 1911, and Hanover House Industries, Inc., founded in 1934.\nTHE COMPANY'S CATALOGS\nEach of the Company's specialty catalogs targets distinct market segments offering a focused assortment of merchandise designed to meet the needs and preferences of its target customers. Through market research and ongoing testing of new products and concepts, each catalog determines its own merchandise strategy, including the appropriate price points, mailing plans and presentation of its products. The Company is continuing its development of exclusive or private label products for a number of its catalogs, including Domestications, Tweeds, Austad's and The Company Store, to further enhance the brand identity of the catalogs.\nThe Company's specialty catalogs typically range in size from 32 to 100 pages with four to six new editions per year depending on the seasonality and fashion content of the products offered. Each edition may be mailed several times each season with variations in format and content. Each catalog employs the services of an outside creative agency or has its own creative staff which is responsible for the design, layout, copy, feel and theme of the book. Generally, the initial sourcing of new merchandise for a catalog begins two to six months before the catalog is mailed.\nThe Company's operations are divided into two groups, Non-Apparel and Apparel. Revenues and the percent of total revenues for 1994 and 1995 for each group are set forth below; all revenues are net of returns:\nAs a result of significant losses incurred in 1995 and the future prospects for these catalogs, the Company discontinued six catalogs which generated revenues of $66.0 million and $21.8 million in 1995, and $77.7 million and $40.2 million in 1994 for the Non-Apparel and Apparel groups, respectively. These catalogs lost $10.1 million and $9.9 million in 1995 and $1.3 million and $3.4 million in 1994 for the Non-Apparel and Apparel groups, respectively.\nNon-Apparel Catalogs\nDomestications is a leading specialty home textile catalog and a fashion decorating source book for today's value-oriented and style-conscious consumer. Domestications features sheets, towels, comforters, tablecloths, draperies and other items for the home, and offers coordinated decorating ideas for the home at value prices. Domestications is also mailed to Sears customers under the name Show Place.\nThe Company Store is an upscale direct marketer of down comforters and other down and related products for the home. The Company Store also features designer brand name sheets, towels and other bedding accessories.\nColonial Garden Kitchens features work saving and lifestyle enhancing items for the kitchen and home. Colonial Garden Kitchens is also mailed to Sears customers under the name Great Kitchens.\nKitchen & Home features upscale kitchen and home products.\nGump's is the well-known San Francisco retailer and a leading upscale catalog marketer of exclusive gifts, specialized housewares and other unique items. In March 1995, the Company completed construction and moved to its new store located in a landmark building in downtown San Francisco.\nImprovements, acquired in January 1995, is a leading do-it-yourself home improvement catalog featuring home improvement accessories. Improvements is also mailed to Sears customers under the name Sears Improvements.\nThe Safety Zone, the remaining interest in which was acquired in February 1995, is a direct marketer of safety, protection and prevention products.\nAustad's, acquired in May 1995, is a direct marketer of golf equipment and related apparel and accessories.\nApparel Catalogs\nTweeds is a European inspired women's fashion catalog featuring relaxed, cosmopolitan fashions uniquely designed by its in-house staff.\nSilhouettes is a women's fashion catalog featuring every day, workout, special occasion and career fashions for larger sized women.\nInternational Male is an authority for unique men's fashion with an international flair.\nUndergear is a leader in activewear, workout wear and fashion underwear for men.\nIn 1995, the Company discontinued six catalogs, One 212(R), Simply Tops(R), Essence By Mail, Hanover House(R), Mature Wisdom(R) and Tapestry(R).\nSEARS\nIn January 1994, the Company entered into a licensing agreement with the direct marketing subsidiary of Sears to produce specialty catalogs for the more than 20 million mail order and credit card customers of Sears. The catalogs currently being mailed under the program are based on existing Company catalogs and contain a title page with the Sears name and logo. The specialty catalogs include: Show Place, based on the Domestications catalog, Great Kitchens, based on the Colonial Garden Kitchens catalog, and Sears Improvements, based on the Improvements catalog. From time to time, the Company and Sears will add or delete catalogs to its offerings. In 1995, Beautiful Style, based on Silhouettes, and Right Touch, based on Tapestry, were discontinued. The Sears agreement has an initial three-year term and continues thereafter unless terminated by either party on various grounds, including the Company's failure to meet various operational performance standards. Profits and losses from this licensing agreement are shared between the parties on an equal basis. The Company also issued to Sears a performance warrant to purchase up to 7 million shares of the Company's Common Stock in 1999, at an exercise price of $10.57 per share, subject to certain revenue and profit thresholds. In fiscal 1995, the Company generated revenues of $81 million and operating income of $3 million from this venture.\nMARKETING AND DATABASE MANAGEMENT\nThe Company maintains one of the largest proprietary customer lists in the industry currently containing approximately 18 million names of customers (down from 19 million names in 1994) who have purchased from one of the Company's catalogs within the past 36 months. The list contains name, gender, residence and historical transaction data. This database is selectively enhanced with demographic, socioeconomic, lifestyle and purchase behavior overlays from other sources.\nThe Company utilizes proprietary modeling and sophisticated segmentation analysis, on a catalog by catalog basis, to devise catalog marketing and circulation strategies that are intended to maximize customer contribution by catalog. This analysis is the basis for the Company's determination of which of the Company's catalogs will be mailed and how frequently to a particular customer, as well as the promotional incentive content of the catalog(s) such customer receives.\nThe primary source of new customers for the Company's catalogs is lists rented from other mailers and compilers. Prior to mailing to these non-proprietary lists, the lists are edited using statistical segmentation tools to enhance their probable performance. Other sources of new customers include space advertisements and promotional inserts in outbound merchandise packages.\nTELEMARKETING\nThe Company receives approximately 80% of its orders through its toll-free telephone service which offers customer access seven days per week, 24 hours per day. The Company has created a telephone network to link its three primary telemarketing facilities in Hanover, Pennsylvania, Roanoke, Virginia and LaCrosse, Wisconsin. The Company's telemarketing facilities utilize state-of-the-art telephone switching equipment which enables the Company to route calls between telemarketing centers and thus provide prompt customer service. A satellite telemarketing center is also located in San Diego, California. The Company handled approximately 18 million telephone order calls in 1995.\nThe Company trains its telemarketing service representatives to be courteous, efficient and knowledgeable about the Company's products. Telemarketing service representatives generally receive 40 hours of training in selling products, services, systems and communication skills through simulated as well as actual phone calls. A substantial portion of the evaluation of telemarketing service representatives' performance is based on how well the representative meets customer service standards. While primarily trained with product knowledge to serve customers of one or more specific catalogs, telemarketing service representatives also receive cross-training that enables them to take overflow calls from other catalogs. The Company utilizes customer surveys as an important measure of customer satisfaction.\nDISTRIBUTION\nThe Company operates four distribution centers in three principal locations: two in Roanoke, Virginia for home fashions and apparel, one in Hanover, Pennsylvania for general merchandise including giftware and other hardgoods, and one in LaCrosse, Wisconsin for home fashions. The Company's facilities processed approximately 14 million packages in 1995. The Company's plan to maximize efficiencies in merchandise handling and distribution by consolidating its warehouse and fulfillment centers. In 1995, the Company completed construction of its 530,000 square foot facility site in Roanoke which completed the consolidation of all of Domestications' warehouse and fulfillment operations from several locations into one facility. The Company also concluded the consolidation of its apparel catalogs in 1995 into the Company's Roanoke apparel facility. The consolidation of the fulfillment operations of Gump's from DeSoto, Texas and Improvements' from Cleveland, Ohio to other Company facilities, was also completed in 1995. The relocation of Austad's fulfillment operations from Sioux Falls, South Dakota to other Company facilities will be completed by early 1996. In 1995, the Company incurred operating inefficiencies in the new facilities and operating expenses related to maintaining duplicate facilities.\nThe Company mails its catalogs through the United States Postal Service (\"USPS\") utilizing pre-sort, bulk mail and other discounts. Most of the Company's packages are shipped through the USPS. In January 1995, the USPS increased postage rates by approximately 14% to\n18%. Overall, catalog mailing and package shipping costs approximated 18% of the Company's net revenues in 1995. The Company obtains rate discounts from the USPS by automatically weighing each parcel and sorting and trucking packages to a number of USPS drop points throughout the country. Some packages are shipped using a consolidator for less frequently used drop points. The Company utilizes the United Parcel Service, Federal Express and other delivery services.\nPURCHASING\nThe Company's large sales volume permits it to achieve a variety of purchasing efficiencies, including the ability to obtain prices and terms that are more favorable than those available to smaller companies. Major goods and services used by the Company are purchased or leased from selected suppliers by its central buying staff. These goods and services include: paper, catalog printing and printing related services such as order forms and color separations, communication systems including telephone time and switching devices, packaging materials, expedited delivery services, computers and associated network software and hardware.\nThe Company's telephone telemarketing costs (both inbound and outbound calls) are typically contracted for a three-year period. The Company generally enters into annual agreements for paper and printing with a limited number of suppliers. These agreements permit periodic price increases or decreases based on prevailing market conditions, changes in supplier costs and continuous productivity improvements. For 1995, paper costs approximated 8% of the Company's net revenues.\nMANAGEMENT INFORMATION SYSTEMS\nThe Company is continuing to upgrade its management information systems by implementing new integrated software and migrating from a centralized mainframe to mid-range mini-computers. The migration of the Company's business applications to mid-range mini-computers is an important part of the Company's overall systems plan which defines the mid and long-term systems and computing strategy for the Company. The Company is continuing to modify and install, on a catalog by catalog basis, these new integrated systems for use in managing all phases of the Company's operations. These systems have been designed to meet the Company's requirements as a high volume publisher of multiple catalogs.\nThe new software system is an on-line, real-time system which includes order processing, fulfillment, inventory management, list management and reporting. The software, where implemented, provides the Company with a flexible system that offers data manipulation and in-depth reporting capabilities. The new management information systems are designed to permit the Company to achieve substantial improvements in the way its financial, merchandising, inventory, telemarketing, fulfillment and accounting functions are performed. Until the new system is installed Company-wide, the Company will not achieve the full benefits of the new system. Two catalogs were brought on-line in 1994. The Company brought eight additional\ncatalogs on-line in 1995, and expects to bring the remaining catalogs on-line in 1996. As of December 30, 1995, the Company invested approximately $16 million in such systems. The Company currently estimates that the total cost to install and implement the new systems will be approximately $19 million.\nCREDIT MANAGEMENT\nSeveral of the Company's catalogs, including Domestications, International Male and Gump's, offer their own credit cards. The Company also offers, for use with almost all catalogs, the use of the Hanover Shop At Home credit card. The Company has a five year $75 million credit facility with General Electric Credit Corporation (\"GECC\") expiring in the year 2000, which provides for the sale and servicing of accounts receivable originating from the Company's revolving credit cards. GECC's servicing responsibilities include credit processing, collections, billing\/payment processing, reporting and credit card issuance.\nINVENTORY MANAGEMENT\nThe Company's inventory management strategy is designed to maintain inventory levels that provide optimum in-stock positions while maximizing inventory turnover rates and minimizing the amount of unsold merchandise at the end of each season. The Company manages inventory levels by monitoring sales and fashion trends, making purchasing adjustments as necessary and by promotional sales. Additionally, the Company sells excess inventory in its special sale catalogs, its outlet stores and to jobbers. Due in part to the transition to new management information systems, the Company is currently operating with different systems which increases the difficulty of optimizing inventory levels.\nThe Company acquires products for resale in its catalogs from numerous domestic and foreign vendors. No single source supplied more than 5% of the Company's products in 1995. The Company's vendors are selected based on their ability to reliably meet the Company's production and quality requirements, as well as their financial strength and willingness to meet the Company's needs on an ongoing basis.\nRECENT ACQUISITIONS\nImprovements. In January 1995, the Company acquired substantially all of the assets of Leichtung, Inc., the publisher of Improvements, a leading do-it-yourself home improvement catalog, for a total cash purchase price of approximately $12 million and the assumption of certain liabilities. Also included in the purchase were the assets of Leichtung Workshops, a woodworking and hobby catalog, which the Company is currently negotiating to sell.\nThe Safety Zone. In February 1995, the Company acquired the remaining 80% of the outstanding common stock it did not already own of Aegis Safety Holdings, Inc., a direct marketer of safety, prevention and protection products through The Safety Zone catalog. The purchase\nprice was approximately $6.3 million, stated value, of the Company's Series B Convertible Additional Preferred Stock.\nAustad's. In May 1995, the Company acquired 67.5% of the outstanding common stock of Austad Holdings, Inc. (\"AHI\"), a direct marketer of golf equipment and related apparel and accessories, for a purchase price of $1.8 million in cash. The Company lent $2.2 million to The Austad Company (\"TAC\"), a wholly owned subsidiary of AHI, which bears interest at the rate of 10% per annum, is due by May 2000 and subordinated to certain of AHI's existing bank indebtedness. The Company also provided a $.4 million loan to TAC which bears interest at a fluctuating rate and is secured by a second mortgage on TAC's office and warehouse. In February 1996, David Austad and certain family members surrendered to AHI their AHI shares, amounting to 32.5% of the outstanding shares, and paid approximately $1.2 million (subject to certain post-closing adjustments) in exchange for all the outstanding shares of AGS, Inc. (\"AGS\"), a South Dakota corporation newly formed by TAC to hold the existing retail assets and liabilities of TAC. As a result of the reorganization, AHI became a wholly owned subsidiary of the Company. AGS will operate the four existing retail stores acquired from TAC, located in Illinois, Minnesota and South Dakota, as Austad's stores under license from AHI. The license grants Mr. Austad exclusive retail rights to the Austad's name in 37 states and Canada. AHI retains all direct marketing and other rights.\nFor further information with respect to \"Recent Acquisitions\", see Note 2 of Notes to Consolidated Financial Statements.\nFINANCING\nIn November 1995, the Company obtained a new $75 million secured credit facility from Congress Financial Corporation (\"Congress\") to replace its former $80 million credit facility with another lender. The Congress facility provides for a three-year revolving line of credit of up to $65 million and two-year term loans aggregating $10 million. The revolving facility carries an interest rate of 1.25% above prime and the term loan carries an interest rate of 1.5% above prime. The facility is secured by all of the assets of the Company.\nFor further information with respect to \"Financing\", see Note 7 of Notes to Consolidated Financial Statements.\nEMPLOYEES\nThe Company currently employs approximately 2,200 persons on a full time basis and approximately 1,300 persons on a part time basis. Approximately 150 employees at one of the Company's subsidiaries are represented by a union. The Company believes its relations with its employees are good.\nSEASONALITY\nThe Company has experienced substantially increased sales in the fourth quarter of each year as compared to the first three quarters, due in part to the Company mailing more catalogs in the second part of the year and decreasing apparel sales as a percentage of total sales.\nCOMPETITION\nThe mail order catalog business is highly competitive. The Company believes that the principal basis upon which it competes are quality, value, service, product offerings, catalog design, convenience and efficiency. The Company's catalogs compete with other mail order catalogs, both specialty and general, and retail stores, including department stores, specialty stores and discount stores. Competitors also exist in each of the Company's catalog specialty areas of women's apparel, home fashions, general merchandise, and men's apparel. A number of the Company's competitors have substantially greater financial, distribution and marketing resources than the Company.\nTRADEMARKS\nEach of the Company's catalogs has its own federally registered trademark. The Company also owns numerous trademarks, copyrights and service marks on its logos, products and catalog offerings. The Company has also protected various trademarks internationally. The Company vigorously protects such marks and believes there is substantial goodwill associated with them. Show Place and Great Kitchens are trademarks of Sears.\nGOVERNMENT REGULATION\nThe Company is subject to Federal Trade Commission regulations governing its advertising and trade practices, Consumer Product Safety Commission and Food and Drug Administration regulations governing the safety of the products it sells in its catalogs and other regulations relating to the sale of merchandise to its customers. The Company is also subject to the Department of Treasury-Customs regulations with respect to any goods it directly imports.\nThe imposition of a sales and use tax collection obligation on out-of-state catalog companies in states to which they ship products was the subject of a case decided in 1994 by the United States Supreme Court. While the Court reaffirmed an earlier decision that allowed direct marketers to make sales into states where they do not have a physical presence without collecting sales taxes with respect to such sales, the Court further noted that Congress has the power to change this law. The Company believes that it collects sales tax in all jurisdictions where it is currently required to do so.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's corporate headquarters are located in a modern 85,000-square-foot facility in Weehawken, New Jersey. The facility houses merchandising and marketing personnel, catalog production personnel and corporate and administrative offices. The Weehawken facility is leased for a 15-year term expiring in 2005. The Company operates four warehouses and fulfillment facilities in three principal locations: two in Roanoke, Virginia for home fashions and apparel, one in Hanover, Pennsylvania for general merchandise, including giftware and other hardgoods, and one in LaCrosse, Wisconsin for upscale home fashions.\nIn Roanoke, the Company owns a newly completed 530,000 square-foot home fashions distribution center. The facility became operational in the second half of 1995 and handles all of Domestications' fulfillment processing. Also in Roanoke, the Company leases a 175,000 square- foot apparel distribution and telemarketing center from a partnership in which it owns a 50% interest.\nIn Hanover, the Company owns a distribution center of approximately 265,000 square feet and leases a telemarketing and administrative office facility of 123,000 square feet and a warehouse facility of 433,000 square feet. Renewal terms on the telemarketing center extend through 2009. The warehouse lease expires November 30, 1996 with two short term renewal periods.\nIn LaCrosse, Wisconsin, the Company also owns a 150,000 square-foot home fashions manufacturing and assembly facility and a 58,000 square-foot telemarketing and customer service facility, and leases a warehouse and fulfillment center of 185,000 square feet under a short-term lease.\nIn addition to these principal facilities, the Company leases administrative facilities for men's apparel in San Diego, California. The San Diego facility also serves as a telemarketing and customer service facility.\nThe Company's principal retail operations consist of the Gump's retail store, which occupies approximately 30,000 square feet in a building in downtown San Francisco, California. The Gump's facility, which is leased pursuant to a 15-year lease, also includes approximately 15,000 square feet of administrative offices for retail and mail order functions. The Company also operates and leases 7 other retail and outlet stores at various locations.\nThe Company leases or owns premises in Cleveland, Ohio, Sioux Falls, South Dakota and Edgewater, New Jersey as part of its discontinued operations or consolidated facilities plan. The Company is actively seeking to sub-lease or sell, as applicable, all such properties.\nThe following chart provides certain information concerning each of the Company's principal properties:\n(a) Does not include the Sioux Falls, South Dakota (closed 1996), Cleveland, Ohio (closed 1995 ), Beachwood, Ohio (closed in 1996), or Edgewater, New Jersey (closed in 1995), in conjunction with the consolidation of the Company's warehouse facilities.\n(b) Telemarketing and warehouse\/fulfillment functions are all located and performed at the one facility. Square footage stated represents the entire facility.\n(c) The building is owned by the Company and the property is subject to a ground lease.\n(d) Telemarketing and corporate\/administrative functions are all located and performed at the one facility. Square footage stated represents the entire facility.\n(e) Retail and office space are all located at the one facility. Square footage stated represents allocations to corporate\/administrative and retail and retail storage space.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is involved in various routine lawsuits of a nature which is deemed customary and incidental to its businesses. In the opinion of management, the ultimate disposition of such actions will not have a material adverse effect on the Company's financial position or results of operations.\nOn or about September 2, 1994, a complaint was filed in the United States District Court for the District of New Jersey by Veronica Zucker, an individual who allegedly purchased shares of Common Stock of the Company in the public offering completed on April 7, 1994, against the Company, all of its directors, certain of its officers, Sun Life Insurance Company of America, Merrill Lynch, Pierce, Fenner & Smith Incorporated and Alex. Brown & Sons, Incorporated. The complaint, which purports to be filed on behalf of a class of all persons who purchased the Common Stock of the Company in the public offering or thereafter through and including August 14, 1994, seeks to recover monetary damages the class has allegedly suffered as a result of certain alleged false and materially misleading statements contained in the Company's public offering prospectus dated March 30, 1994. In lieu of an answer, defendants filed a motion to dismiss the complaint in its entirety for failure to state a claim upon which relief can be granted. On May 23, 1995, the United States District Court for the District of New Jersey dismissed the plaintiff's claim, with prejudice, for failure to state a claim upon which relief could be granted. On June 22, 1995, plaintiff filed a notice of appeal of the May 23, 1995 decision to the United States Court of Appeal for the Third Circuit. The appeal was submitted on the briefs on March 11, 1996. On March 26, 1996, the Court rendered its decision affirming the District Court's decision.\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 is traded on the American Stock Exchange (Symbol: HNV). The following table sets forth, for the periods shown, the high and low sale prices of the Common Stock reported on the American Stock Exchange Composite Tape.\nThe Company is restricted from paying dividends on its Common Stock or from acquiring its capital stock by certain debt covenants contained in agreements to which the Company is a party.\nAs of March 21, 1996, there were approximately 4,826 holders of record of Common Stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following table presents selected financial data for each of the years indicated:\nThere were no cash dividends declared on the Common Stock in any of the periods. See Notes to Consolidated Financial Statements.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe following table sets forth, for the fiscal years indicated, the percentage relationship to revenues of certain items in the Company's Consolidated Statements of Income:\nRESULTS OF OPERATIONS\n1995 COMPARED WITH 1994\nNet Income (loss). The Company reported a net loss before extraordinary items of $28.2 million or $(.30) per share for the year ended December 30, 1995 compared to net income of $14.8 million or $.16 per share in 1994. Including the effect of the extraordinary loss of $1.8 million for the early extinguishment of debt, the Company reported a net loss of $30 million or $(.32) per share for the year ended December 30, 1995. Per share amounts are expressed after deducting preferred dividends of $.2 million in 1995 and $.1 million in 1994. The weighted average number of shares outstanding was 93,029,816 for the year ended December 30, 1995 compared to 93,285,190 in 1994.\nThe net loss in 1995 was primarily the result of the cumulative impact of the significant increase in postage and paper prices and weak consumer demand. As a result of these factors, the Company discontinued six poorly performing catalogs in 1995 which have incurred substantial losses which the Company believed could not overcome these obstacles. Including a provision for the costs associated with discontinuing these catalogs of $8.6 million, these catalogs lost $20 million in 1995 compared to $4.7 million in the prior year. In addition, the Company also incurred costs, aggregating $2.7 million, in connection with the consolidation of facilities into its new Roanoke, VA fulfillment center. These costs included operating expenses related to maintaining duplicate facilities, start-up problems, operating down-time and inefficiencies in the new facility. Due to these cost pressures, the Company implemented a cost reduction program in 1995 whereby the Company instituted a salary freeze, reduced its workforce by approximately 10%, closed 5 facilities and reduced other administrative and overhead expenses. In connection with this program, the Company incurred non-recurring costs of $1.5 million and one-time severance and employee separation expenses of $2.0 million.\nRevenues. Revenues decreased 2.5% in 1995 to $750 million from $769 million in 1994. Revenues of continuing catalogs increased approximately 2% from $651 million in 1994 to $662 million in 1995, which was offset by a 26% decline to $88 million in revenues from discontinued catalogs. The Company circulated 370 million catalogs in 1995, a 2% reduction from the prior year.\nNon-Apparel continuing catalog revenues increased 1% to $528 million, due to a 14% increase in revenues from the Company's venture with Sears to $81 million and $68 million of revenues from the 1995 acquisitions of Improvements, Safety Zone and Austad's which offset revenue reductions in the other Non-Apparel catalogs, principally Domestications and Colonial Garden Kitchens. Domestications revenues were down 28% as improved customer response rates partially offset a decline in the average order and a 31% reduction in circulation. Revenues from discontinued catalogs decreased $11.7 million from $77.7 million in 1994 to $66 million in 1995. The Company discontinued the Mature Wisdom catalog in mid-1995 and the Tapestry and Hanover House catalogs in the fourth quarter of 1995.\nApparel continuing catalog revenues increased $5 million, or approximately 4%, from $129 million in 1994 to $134 million in 1995, as all continuing catalogs, International Male, Undergear, Silhouettes and Tweeds reported higher sales than the prior year. Revenues from discontinued Apparel catalogs declined 46% from $40 million in 1994 to $22 million in 1995, including the effect of discontinuing Essence by Mail, One 212 and Simply Tops.\nOperating Costs and Expenses. Cost of sales and operating expenses as a percentage of revenues increased from 62.9% in 1994 to 64.5% in 1995. This increase is primarily attributable to lower overall product margins due to greater promotional expenses as a result of the generally weak consumer demand and the impact of markdowns for the discontinued catalogs. In addition, fulfillment costs were higher in 1995 due to the start up of the new facility in Roanoke and higher outbound freight expenses of approximately $7 million or 15% as a result of the increase in USPS rates.\nDuring 1995, the Company recorded a Provision for Catalog and Facility Closings totalling $10.1 million. The provision for the discontinuance of six of the Company's catalogs of $8.6 million primarily consisted of incremental inventory mark-downs in excess of normal seasonal mark-downs and severance expenses. The $1.5 million provision for facility closings consisted primarily of moving expenses, lease termination fees and severance expenses, substantially all of which were paid in 1995. No such charges were recorded in 1994.\nSelling expenses increased from 25.7% of revenues in 1994 to 27.4% of revenues for the current year, primarily due to a 43% increase in average paper costs and a 15% increase in the average cost of mailing a catalog which more than offset the 2.0% reduction in catalog circulation and higher customer response rates. As a result of these price increases, the Company incurred approximately $18.0 million of higher costs to prepare and deliver its catalogs in 1995.\nGeneral and administrative expenses declined $1.1 million or 2% in 1995 although they remained constant as a percentage of revenues at 8.5% in both years. Excluding the impact of one-time severance expenses of $2.0 million, these expenses declined as a percentage of sales to 8.3% due to the Company's cost reduction program instituted in early 1995. This reduction was partially offset by higher bad debt expenses, reflecting increased losses on major credit cards and the Company's private label credit card.\nDepreciation and amortization increased $2.8 million from $6.2 million in 1994 to $9.0 million in 1995. The increase was attributable to new amortization charges associated with the Roanoke, Virginia fulfillment facility, the management information system, the new Gump's retail store and the goodwill and mailing lists associated with the 1995 acquisitions.\nIncome (Loss) from Operations. Income from operations declined from $16.0 million in 1994 to a loss of $22.6 million in 1995. Losses from discontinued catalogs increased from $4.7 million in 1994 to $20 million in 1995.\nNon-Apparel income from operations decreased from $20.5 million in 1994 to a loss of $7.8 million in 1995. The most significant contributor to the decrease in profitability was Domestications, which in addition to being significantly impacted by the higher postage and paper costs also incurred additional costs in connection with the move of its operations into the new Roanoke facility. These costs included start-up costs, down time due to equipment problems, temporary labor costs, higher shipping , damages and replacement costs. Additionally, Domestications' product margin was adversely impacted by product mix changes, increased promotional activities and higher obsolescence charges. The loss from discontinued Non-Apparel catalogs increased from $1.3 million in 1994 to $10.1 million in 1995. Profitability from the Sears venture increased by $.1 million to $3 million in 1995 and the 1995 acquisitions contributed income of $2.5 million. The Company Store and Gump's also had higher operating profits in 1995 compared to 1994.\nApparel results of operations declined $7.7 million from a loss of $.5 million in 1994 to a loss of $8.2 million in 1995. This decrease is mainly attributable to the discontinued Apparel catalogs whose losses increased $6.5 million from $3.4 million in 1994 to $9.9 million in 1995. Mens Apparel operating income increased 35% to $2.6 million which offset lower earnings at Tweeds and an operating loss at Silhouettes, where credit problems in the fourth quarter of 1995 contributed to its loss.\nInterest Income(Expense). Interest expense increased approximately $1.5 million from $3.5 million in 1994 to $5.0 million in 1995. This increase was due to higher average borrowings outstanding under the Company's revolving credit facility in 1995 as well as an increase in the basis point of approximately 3% in the Company's borrowing rate which is attributable to the Company's deteriorating financial performance in 1995. Interest income declined by $.2 million to $.5 million in 1995 because the Company had less cash available for investment.\nOther Income (Expense). Other expenses in 1994 totaled a net $1.8 million while there were no similar expenses in 1995. The loss in 1994 was comprised of $2.5 million in charges due to losses on certain investments offset by other income of $.7 million.\nIncome Taxes. The Company did not record a Federal income tax provision in 1995 based on the current year net operating loss. The Federal income tax provision of $5.9 million in 1994 was offset by the utilization of net operating loss carry forwards. The Company's state tax provision was $1.0 million and $.9 million in 1995 and 1994, respectively.\nShareholders' Equity. The number of shares of Common Stock outstanding increased by 714,928 in 1995 due to shares issued in connection with the Company's equity and incentive plans, the exchange of the 6% Series A Convertible Preferred Stock and other activities. At December 30, 1995 there were 93,452,768 shares of Common Stock outstanding compared to 92,737,840 shares of Common Stock outstanding at December 31, 1994.\n1994 COMPARED WITH 1993\nNet Income. The Company reported net income of $14.8 million or $.16 per share for the year ended December 31, 1994, compared to net income of $17.3 million or $.17 per share for the same period in 1993. Per share amounts are expressed after deducting preferred dividends of $.1 million in 1994 and $4.1 million in 1993. The weighted average number of shares outstanding increased approximately 21% to 93,285,190 shares for the year ended December 31, 1994, compared to 77,064,131 shares for the same period in 1993, primarily due to the public offering and the conversion of certain preferred stocks.\nRevenues. Revenues increased $126 million, or 20%, from $643 million in 1993 to $769 million in 1994. This significant increase in revenues was primarily a result of an increase of $48 million from the Company's venture with Sears and increased revenues of $88 million from Gump's, The Company Store and Tweeds which were acquired in the second half of 1993 (\"1993 acquisitions\"). Revenues from catalogs discontinued in 1993 were $20 million in 1993 and $1 million in 1994.\nRevenues were negatively impacted in 1994 by an increase in customer returns from approximately 13.1% of shipped sales in 1993 to 14.9% of shipped sales in 1994. The increased returns were generated by new product categories and the Company implemented measures that reduced the rate of returns in the second half of 1994.\nNon-Apparel continuing catalog revenues increased $122 million, or 26%, from $477 million in 1993 to $599 million in 1994. The Company's venture with Sears generated increased Non-Apparel revenues of $46 million from 1993 to 1994, while revenues generated by Gump's and The Company Store increased $57 million from 1993 to 1994. The remainder of the Non-Apparel revenue increase was primarily due to increased revenues related to Domestications, and the new Kitchen & Home catalog. Revenues from discontinued catalogs were $7 million and $.2 million in 1993 and 1994, respectively.\nApparel continuing catalog revenues increased $23 million, or approximately 16%, from $146 million in 1993 to $169 million in 1994. This increase was primarily due to a $31 million increase in the revenues of Tweeds which was acquired in the fourth quarter of 1993. Women's Apparel continuing catalog revenues increased 6% which is mainly attributable to Silhouettes and One 212, while Men's Apparel revenues decreased 16% as the group discontinued an under performing catalog in 1993 thus focusing on its profitable segments. Revenues from discontinued apparel catalogs were $13 million and $.5 million in 1993 and 1994, respectively.\nOperating Costs and Expenses. Cost of sales and operating expenses as a percentage of revenues decreased from 63.4% in 1993 to 62.9% in 1994. The decrease was primarily attributable to higher overall profit margins and lower fulfillment costs, as partially offset by higher delivery costs in 1994 based on sales mix.\nSelling expenses increased from 24.6% of revenues for the year ended January 1, 1994 to 25.7% of revenues for the year ended December 31, 1994 as the Company increased catalog circulation 17% in an effort to increase the number of active customers on its mailing lists in anticipation of the 1995 postal rate increase. The response to this prospecting program was less than anticipated which resulted in higher selling expense. Overall demand from the new customer acquisition program was soft principally in the Non-Apparel catalogs, particularly in Domestications, where prospecting was heaviest. The Company mailed approximately 377 million catalogs in 1994.\nGeneral and administrative expenses remained flat as a percentage of revenues at 8.5% in both years. General and administrative expenses increased $10.0 million or 18.1% from 1993 to 1994 due primarily to the 1993 acquisitions.\nDepreciation and amortization increased $2.9 million from $3.3 million in 1993 to $6.2 million in 1994. The increase was attributable to a full year of charges for goodwill, mailing lists and depreciation associated with the 1993 acquisitions of Gump's, The Company Store and Tweeds.\nIncome from Operations. Income from operations decreased from $19.1 million in 1993, or 3.0% of revenues, to $16.0 million in 1994, or 2.1% of revenues. Losses from discontinued catalogs were $3.9 million in 1993 compared to $.1 million in 1994.\nNon-Apparel income from operations decreased $5.7 million from $25.9 million in 1993 to $20.2 million in 1994. This decrease was mainly due to the previously-mentioned lower response rates to the Company's customer acquisition program. Non-Apparel income from operations was also impacted by a loss of $2.1 million in 1994 compared to break even results in 1993 related to the Gump's retail operations due to the temporary relocation of its retail store prior to the move to its new location in March 1995.\nApparel income from operations increased $3.1 million from a $3.6 million loss in 1993 to a $.5 million loss in 1994. The Men's Apparel income from operations increased $3.3 million from a loss of $1.4 million in 1993 to income of $1.9 million in 1994 as a result of overhead reductions and increased response rates. The Women's Apparel income from operations increased $1.0 million excluding losses of $.5 million and $1.6 million in 1993 and 1994, respectively, from the start-up of a new catalog. Apparel income from operations for discontinued catalogs was a loss of $4.3 million in 1993 and income of $.2 million in 1994.\nThe Company's venture with Sears generated $1.4 million of income from operations in 1993 versus $2.9 million in 1994.\nInterest Income (Expense). Interest expense decreased approximately $1.4 million from $4.9 million in 1993 to $3.5 million in 1994. This decrease was the result of the Company using the proceeds of the public offering to pay down its revolving line of credit in April 1994, thus reducing borrowing requirements throughout the remainder of 1994. In addition, the Company experienced lower interest rates upon entering into a new credit agreement in October 1994. The Company's long-term debt increased $2.5 million from 1993 to 1994. Interest income decreased $1.5 million from $2.2 million in 1993 to $.7 million in 1994, due to interest income related to a Federal income tax refund received in 1993.\nOther Income (Expense). Other income decreased $2.7 million from income of $.9 million in 1993 to a loss of $1.8 million in 1994. The income of $.9 million in 1993 represents a settlement of a claim in bankruptcy. The loss in 1994 was comprised of $2.5 million of charges due to losses on investments and advances as partially offset by other income of $.7 million.\nIncome Taxes. The Company recorded a Federal income tax benefit of $4.4 million in 1994 based on its estimate of the amount of net operating loss carryfowards (\"NOLs\") that can be utilized in the future. Federal income tax provisions of $5.9 million and $4.2 million, respectively, were offset by the utilization of NOLs in 1993 and 1994. The Company's state tax provision was $.5 million and $.9 million in 1993 and 1994, respectively.\nShareholders' Equity. The number of shares of Common Stock outstanding increased by 9,804,663 in 1994 due to: i) 8,045,296 shares issued in connection with the Public Offering, ii) 1,309,207 shares issued in connection with a cashless exchange upon the exercise of certain warrants and iii) 450,160 shares issued in connection with the Company's equity and incentive plans, the exchange of the 6% Series A Convertible Preferred Stock (the \"6% Preferred Stock\") and other activities. At December 31, 1994, there were 92,737,840 shares of Common Stock outstanding compared to 82,933,177 shares of Common Stock outstanding at January 1, 1994.\nThe dividends of $.1 million in 1994 represent dividend requirements on the 6% Preferred Stock issued in September 1993 while the dividends of $4.1 million in 1993 represent dividend requirements on the 7.5% Preferred Stock and the Class B Preferred Stock, both of which were converted into Common Stock in the fourth quarter of 1993.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company had $24.1 million and $2.7 million in cash and cash equivalents at December 31, 1994 and December 30, 1995 respectively. Working capital and the current ratio were $58.5 million and 1.51 to 1 at December 31, 1994 versus $28.8 million and 1.22 to 1 at December 30, 1995.\nThe primary sources of cash in 1995 were the $20.7 million of proceeds from the issuance of long-term debt and $8.7 million due to a reduction in inventories. Cash was used primarily to fund: (i) the Company's 1995 operating loss, (ii) $13.7 million of capital expenditures, (iii) $13.0 million for the purchase of businesses, (iv) $8.7 million for the reduction of accounts payable, and (v) $3.6 million for payments of long-term debt and debt issuance costs.\nAs a result of the operating losses incurred in 1995, the Company's financial condition deteriorated which reduced its working capital position and resulted in an increase in long-term debt. In addition, as a result of these operating losses, the Company was not in compliance at various times during 1995 with certain financial covenants that had been contained in its $80 million credit facility that it had entered into in 1994 (\"Credit Facility\"). The Company obtained waivers for these covenant violations, but was required to agree to more restrictive terms with respect to availability (reduced to $55 million), financial covenants and a higher interest rate. The disclosure of these covenant violations in the Company's 1995 interim financial statements, coupled with a very difficult year for retailers with numerous Chapter 11 filings occurring, caused a tightening of vendor credit in the fourth quarter of 1995. This resulted in higher backorder levels and increased fulfillment costs which negatively impacted the Company's operating results in that quarter, even though credit restrictions eased when the Company closed its new three year $75 million credit facility with Congress Financial Corp. (\"Congress Facility\") on November 15, 1995. The Company had determined that it was necessary to replace the original Credit Facility because the terms of the proposed amendment were too restrictive. Although the Congress Facility is secured by all of the Company's assets, it provides the Company with greater liquidity and less restrictive financial covenants, and was competitive in terms of cost with the proposed amendment.\nAt the time the Company closed the Congress Facility, the Company believed that the facility would provide the Company with adequate capital to fund its operations. The Company had made this determination based upon the relaxing of the trade credit restrictions, the accompanying increased flow of merchandise, and expectations for its fourth quarter operating results it had at that time. In early 1996, after several additional retail companies filed Chapter 11, the Company again began to experience tightening of vendor credit. Despite this, backorder levels have increased only marginally, and the Company has managed to receive merchandise shipments in most cases on a timely basis and in sufficient quantities to satisfy its customer demand. However, it has had to utilize more working capital to accomplish this than had previously been anticipated, due to a tightening in trade terms. In addition, when the final results of 1995 became known to the Company, it concluded that such results would have a further negative impact on the Company's ability to conduct business on normal trade terms. Therefore, the Company decided that it was necessary to obtain an equity infusion which would: (i) restore the Company's equity base that had deteriorated due to the operating loss in 1995, (ii) reduce long-term debt, and (iii) provide the Company with additional liquidity. As a result, the Company announced that it would conduct a $40 million rights offering after the first quarter to be underwritten by NAR, the Company's largest shareholder. The Company will utilize $14 million of the net proceeds to repay its 9.25% Senior Subordinated Notes due 1998. At such time, the Company will record an extraordinary expense related to the early extinguishment of debt, representing the write-off of the unamortized debt issuance costs of approximately $1.4 million. The balance of the proceeds will be used for general corporate purposes, including the repayment of outstanding revolver indebtedness under the Congress Facility.\nThe announcement of this rights offering has eased vendor\/creditor concerns about the Company's viability, and the Company believes that upon the conclusion of the rights offering, the Company will return to normal trade terms with all suppliers and will be able to obtain sufficient merchandise on a timely basis to satisfy customer demand, as well as have adequate capital to support its operations.\nThe Company experiences seasonality in its working capital requirements and fluctuations in the revolving credit facility will occur usually within the first and fourth quarters of the year.\nInfrastructure Investments. In early 1995, the Company completed the construction of a new fulfillment facility on a 53 acre site in Roanoke, Virginia to support the Domestications catalog. The total cost of the facility was $18.3 million. The Company began partial shipping and receiving activities in the first quarter of 1995 and the facility was fully operational in September 1995. The Company experienced operating inefficiencies and start-up problems in conjunction with bringing this facility into service. The Company's operating margins were negatively impacted by approximately $2.7 million of costs in 1995. The Company believes it will continue to experience inefficiencies in early 1996. However, the Company has taken and is taking actions which it believes will lead to more efficient operations.\nThe Company also completed the construction and opened its new Gump's retail store in San Francisco in March 1995. The total cost of the construction was $7.8 million, of which $1.7 million was spent in 1995.\nThe Company continued its management information systems up-grade in 1995. The new system, which began operation in two of the Company's catalogs in 1994, was operational in ten catalogs at the end of 1995. The Company expects to complete the roll-out of the system to the remaining catalogs in 1996. The Company will incur higher MIS costs in 1996 due to the completion of the transition to the new system. As of December 30, 1995, the Company had incurred costs of approximately $15.9 million as part of this plan, including $6.8 million in 1995. Such costs included hardware and software costs aggregating $10.3 million and internal costs of $5.6 million related to production of this new system that have been capitalized. The Company began to amortize these costs over 5 years in 1995. The Company's level of capital spending will be reduced in 1996 and will focus on the completion of the systems project.\nEffects of Inflation and Cost Increases. The Company normally experiences increased costs of sales and operating expenses as a result of the general rate of inflation in the economy. Operating margins are generally maintained through internal cost reductions and operating efficiencies and then through selective price increases where market conditions permit. The Company's inventory is mailorder merchandise which undergoes sufficiently high turnover so that the costs of goods sold approximates replacement cost. Because sales are not dependent upon a particular supplier or product brand, the Company can adjust product mix to mitigate the effects of inflation on its overall merchandise base.\nPaper and Postage. The Company mails its catalogs and ships most of its merchandise through the United States Postal Service (\"USPS\"), with catalog mailing and product shipment expenses representing approximately 18% of revenues in 1995. In January 1995, the USPS increased postage rates by approximately 14% to 18%. The Company also experienced record price increases in 1995 for the paper that is used in the production of its catalogs as the paper industry announced a series of significant price increases that increased the Company's average cost for paper by over 43% from 1994. Paper costs represented approximately 8% of revenues in 1995. These cost increases which totaled $25 million, and the duplicate costs associated with the consolidation of the distribution facilities and the transition to the new system discussed earlier, adversely impacted the Company's margins and earnings in 1995. In 1996, the USPS announced a reclassification of postal rates that will become effective on July 1, 1996. It is anticipated that this will favorably impact the Company's postage expenses by approximately 2% - 3% on an annualized basis. Paper prices may continue at current levels during 1996.\nCautionary Statements.\nThe following statements constitute forward looking statements which involve risks and uncertainties:\n- \"...the Company believes that upon the conclusion of the rights offering, the Company will return to normal trade terms with all suppliers and will be able to obtain sufficient merchandise on a timely basis to satisfy customer demand, as well as have adequate capital to support its operations.\" - \"...the Company has taken and is taking actions which it believes will lead to more efficient operations.\" - \"In 1996, the USPS announced a reclassification of postal rates that will become effective on July 1, 1996. It is anticipated that this will favorably impact the Company's postage expenses by approximately 2%-3% on an annualized basis. Paper prices may continue at current levels during 1996.\"\nThe following are important factors, among others, that could cause the Company's actual results to differ materially from those expressed in any forward-looking statements made by, or on behalf of, the Company.\n- a general deterioration in the economic conditions in the United States leading to increased competitive activity including a business failure; a business failure of a substantial size company in the retail industry, a reduction in consumer spending generally or specifically with reference to the types of merchandise that the Company offers in its catalogs; - an increase in the failure rate of consumer indebtedness generally; an increase in credit sales by the Company accompanied by an increase in its bad debt experience with respect to consumer debt; - a delay in the implementation of the actions to be taken by the Company to increase the efficiency of operations; rapid increases and decreases in the volume of merchandise that passes through the Company's warehouse facilities; - and a delay or reversal in the implementation of postal rate increase or an increase in paper costs;\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Shareholders of Hanover Direct, Inc.:\nWe have audited the accompanying consolidated balance sheets of Hanover Direct, Inc. (a Delaware corporation) (successor to The Horn & Hardart Company, see Note 1 to the Consolidated Financial Statements) and subsidiaries as of December 30, 1995 and December 31, 1994, and the related consolidated statements of income, shareholders' (deficit) equity and cash flows for each of the three fiscal years in the period ended December 30, 1995. These consolidated 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 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 financial statements referred to above present fairly, in all material respects, the financial position of Hanover Direct, Inc. and subsidiaries as of December 30, 1995 and December 31, 1994, and the results of their operations and their cash flows for each of the three fiscal years in the period ended December 30, 1995 in conformity with generally accepted accounting principles.\nOur audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule listed in the index to financial statement 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.\nARTHUR ANDERSEN LLP\nFebruary 26, 1996 (except with respect to the matters discussed in Note 14, as to which the date is March 7, 1996)\nHANOVER DIRECT, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS As of December 31, 1994 and December 30, 1995\nSee Notes to Consolidated Financial Statements.\nHANOVER DIRECT, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (CONTINUED) As of December 31, 1994 and December 30, 1995\nSee Notes to Consolidated Financial Statements.\nHANOVER DIRECT, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (LOSS)\nFor the years ended January 1, 1994, December 31, 1994 and December 30, 1995\nSee Notes to Consolidated Financial Statements.\nHANOVER DIRECT, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS\nFor the years ended January 1, 1994, December 31, 1994 and December 30, 1995\nSee Notes to Consolidated Financial Statements.\nHANOVER DIRECT, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) Years ended January 1, 1994, December 31, 1994 and December 30, 1995\nSee Notes to Consolidated Financial Statements.\nSee notes to consolidated financial statements\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED JANUARY 1, 1994, DECEMBER 31, 1994 AND DECEMBER 30, 1995\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nNature of Operations - Hanover Direct, Inc. (\"HDI\") is a direct specialty retailer in the United States that publishes a portfolio of branded specialty catalogs offering home fashions, general merchandise and apparel. HDI also operates several retail operations in the United States which comprised approximately 3% of HDI's net revenues for the year ended December 30, 1995.\nMerger - Hanover Direct, Inc. (\"HDI\") was formed in connection with the September 8, 1993 merger (the \"Merger\") involving HDI, The Horn & Hardart Company (\"H&H\") and The Hanover Companies (\"THC\"), a wholly-owned subsidiary of H&H. The Merger consisted of the merger of H&H into HDI, followed by the merger of THC into HDI. The financial statements of THC had previously been included in the consolidated financial statements of H&H.\nThe Merger was consummated by (i) the exchange of shares of H&H Common Stock for shares of HDI Common Stock, (ii) the exchange of shares of THC 7.5% Preferred Stock for shares of HDI's 7.5% Preferred Stock, and (iii) the exchange of shares of THC Class B Preferred Stock for shares of HDI's Class B Preferred Stock, each such distribution being on a one-for-one-basis.\nThe Merger was accounted for similarly to a pooling-of-interests and, accordingly, HDI's Consolidated Financial Statements include the results of H&H and THC for all applicable periods presented.\nPrinciples of Consolidation - The Consolidated Financial Statements include the accounts of HDI and all subsidiaries (the \"Company\"). Intercompany transactions and balances have been eliminated. Certain prior year amounts have been reclassified to conform to the current year presentation.\nFiscal Year - The Company operates on a 52\/53 - week fiscal year. The years ended December 31, 1994 and December 30, 1995 were 52 - week years. The year ended January 1, 1994 was a 53 - week year.\nUse of Estimates - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the 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.\nInventories - Inventories consist principally of merchandise held for resale and are stated at the lower of cost or market. Cost is determined using the first-in, first-out (FIFO) method.\nPrepaid Catalog Costs - Costs related to mail order catalogs and promotional material are amortized over their estimated productive lives, not exceeding six months.\nDepreciation and Amortization - Depreciation and amortization of property and equipment are provided on the straight-line method over the following lives: buildings and building improvements, 30-40 years; furniture, fixtures and equipment, 3-10 years; and leasehold improvements, over the lower of the estimated useful lives or the terms of the related leases. Expenditures for maintenance and repairs are charged to operations as incurred; major improvements are capitalized.\nCapitalized development costs for the Company's new management information systems aggregated $6.4 million and $5.5 million at December 30, 1995 and December 31, 1994, respectively. Such costs are included in other assets and are being amortized over a five year period commencing July 1995.\nGoodwill - Excess of cost over the net assets of acquired businesses is being amortized on a straight-line basis over periods up to forty years. Accumulated amortization was $4.5 million and $5.6 million at December 31, 1994 and December 30, 1995, respectively. On an on-going basis, the Company assesses the carrying value and the economic useful life of the goodwill based on the acquired business' prior and future operating income and estimated net cash flows.\nMailing Lists - The costs of acquired mailing lists are amortized over a five year period. Mailing lists, included in Other assets, amounted to $1.8 million and $3.5 million at December 31, 1994 and December 30, 1995, respectively, and are carried net of accumulated amortization of $.7 million and $1.6 million, respectively. On an ongoing basis, the Company assesses the carrying value and the economic useful life of the mailing lists based on the acquired business' potential future operating income and estimated net cash flows.\nAccounting for Income Taxes - The Company accounts for income taxes in accordance with Statement of Financial Accounting Standards No. 109 - Accounting for Income Taxes (\"SFAS 109\").\nAccounting for the Impairment of Long-Lived Assets: In March, 1995, the Financial Accounting Standards Board (\"FASB\") issued SFAS No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of.\" This Statement is effective beginning in 1996 and requires long-lived assets as well as identifiable intangibles be reviewed for impairment whenever events or changes in circumstances indicate the carrying amount of the assets may not be recoverable. The Company does not expect a material impact on their financial position upon implementation of this Statement in 1996.\nCash and Cash Equivalents - For purposes of the Consolidated Statements of Cash Flows, the Company considers all highly liquid temporary investments with an original maturity of less than ninety days as cash equivalents.\nNet Income Per Share - Net income per share was computed using the weighted average number of common shares outstanding. The weighted average number of shares used in the calculation for both primary and fully diluted net income per share in 1994 and 1995 was 93,285,190 and 93,029,816 shares, respectively. For 1993 the weighted average number of shares for primary and fully diluted net income per share was 75,625,330 and 77,064,131 shares, respectively. Common share equivalents for purposes of net income per share consist of stock options and warrants.\nSupplemental Earnings Per Share - Assuming that the conversion of the 7.5% Preferred Stock and the exchange of the Class B 8% Preferred Stock and the Class B Common Stock discussed in Note 8 had been consummated at the beginning of fiscal year 1993, the weighted average number of shares outstanding for primary and fully diluted earnings per share for 1993 would have been 84,408,807 and 85,847,608 and earnings per share for 1993 would have been $.21 and $.20, respectively.\nSupplemental Disclosure of Noncash Activities\n2. ACQUISITIONS AND INVESTMENTS\nACQUISITIONS - The Company made the following acquisitions in 1995:\nLeichtung, Inc. In January 1995, the Company acquired substantially all of the assets of Leichtung, Inc., a direct marketer of wood-working and home improvement tools and related products sold under the Improvements and Leichtung Workshops names, for a purchase price of approximately $12.8 million in cash and the assumption of certain liabilities. This acquisition has been accounted for using the purchase method of accounting based on the fair market values of the assets and liabilities acquired and has resulted in the recording of approximately $7.3 million of goodwill and $1.4 million of customer mailing list intangible assets. In connection with this acquisition the Company plans to sell the assets of the Leichtung Workshops catalog and has relocated all telemarketing and fulfillment operations to the Company's Hanover, PA facility. The distribution facility in Ohio and the Leichtung Workshops assets, which are being held for sale are being carried at their estimated net realizable value of $1.7 million, as of December 30, 1995.\nThe Safety Zone. In February 1995, the Company acquired the remaining 80% of the outstanding common stock it did not already own of Aegis Safety Holdings, Inc. (\"Aegis\"), publisher of The Safety Zone catalog, through the issuance of 634,900 shares of a newly-created Series B Convertible Additional Preferred Stock (\"Series B Stock\") of the Company with a stated value of $10 per share. Previously, in September 1993, the Company had acquired 20% of the outstanding common stock of Aegis. Dividends can be payable on the Series B Stock at various rates and times and are contingent on specific earnings targets. The Series B Stock is also convertible, subject to antidilution, as discussed in Note 8. Dividends were not paid in 1995 based on The Safety Zone catalog's 1995 operating results.\nThis investment has been accounted for using the purchase method of accounting based on the fair market values of Aegis' assets and liabilities and the Series B Stock, and has resulted in the recording of approximately $7.1 million of goodwill. The fair value of the Series B Stock, which is based on an independent appraisal, is $.9 million less than the stated value and the discount is being amortized over a five-year period. This amortization is included in preferred stock dividends in the statement of income from the date of acquisition.\nAustad's. In May 1995, the Company acquired 67.5% of the outstanding shares of Austad's Holdings, Inc. (\"Austad's\"), which owned The Austad Company (\"TAC\"), the publisher of the Austad's catalog featuring golf equipment, apparel and gifts, for a purchase price of $1.8 million in cash. The Company also lent TAC, on a subordinated basis, $2.2 million which bears interest at the rate of 10% per annum and is due by May 2000. The Company also provided a $.4 million loan to TAC which bears interest at a fluctuating rate (8.75% through April 1996) and is secured by a second mortgage on TAC's office and warehouse. The acquisition has been accounted for using the purchase method of accounting based on the estimated fair market values of the assets and liabilities acquired and has resulted in the recording of approximately $4.5 million of goodwill and approximately $1.2 million of customer mailing list intangible assets.\nOn February 16, 1996, David Austad and certain family members surrendered to Austad's their Austad's shares, amounting to 32.5% of the outstanding shares, and paid approximately $1.2 million (subject to certain post-closing adjustments) in exchange for all the outstanding shares of AGS, Inc. (\"AGS\"), a South Dakota corporation newly formed by TAC to hold the existing retail assets and liabilities of TAC. The transaction assumed a value for Austad's and TAC based on the Company's purchase price in the May 1995 acquisition, as adjusted by adding the net income of Austad's and TAC from May 25, 1995 through February 16, 1996.\nAs a result of the reorganization, Austad's became a wholly owned subsidiary of the Company. In connection with the reorganization, TAC was released from all future obligations under three of four store leases. The Company expects that a similar release will be obtained in the near future regarding the fourth lease. AGS will operate the four existing retail stores acquired from TAC as Austad's stores under license from Austad's. The license grants Mr. Austad exclusive retail rights to the Austad's name in 37 states and Canada. Austad's retains all direct marketing rights and all other rights. Mr. Austad will continue to work together with TAC on joint buying and other cooperative efforts. The customer service and fulfillment operations of Austad's will be transferred to other Company facilities in the first quarter of 1996. The Company plans on selling the Austad's South Dakota warehouse and distribution facility. To the extent that the proceeds from both the sale of such facility and certain computer equipment produces any gain or loss, Mr. Austad will share therein to the extent of his previous 32.5% interest in Austad's.\nTAC had a revolving credit facility that was secured by substantially all of TAC's assets that was to expire on February 26, 1996. Such facility was paid off at the February 16th closing with the proceeds from the sale of the retail operations and from the Company's revolving credit facility.\nAccounting for Acquisitions - The acquisitions of Improvements, Leichtung Workshops, The Safety Zone and Austad's have been accounted for using the purchase method of accounting with goodwill of approximately $18.9 million in the aggregate initially recorded based upon the fair values of the net assets acquired and liabilities assumed. In addition, the Company recorded $3.1 million representing the fair value of acquired mailing lists. The operating results of the acquired companies are included in Consolidated Net Income (Loss) from their respective dates of acquisition.\nThe following represents the unaudited pro forma results of operations for the years ended January 1, 1994, December 31, 1994 and December 30, 1995 as if these three acquisitions had occurred at the beginning of fiscal year 1993.\nThe pro forma information does not purport to be indicative of the results that actually would have been obtained if the operations were combined during the periods presented and is not intended to be a projection of future results or trends. Per share amounts are expressed after deducting preferred stock dividends of $4.1, $.1 and $.2 , million in 1993, 1994 and 1995, respectively.\nOTHER INVESTMENTS - Other Investments include the following:\nBlue Ridge Associates - In January 1994, the Company purchased for $1.1 million a 50% interest in Blue Ridge Associates (\"Blue Ridge\"), a partnership which owns the apparel distribution center in Roanoke, Virginia. This investment is accounted for by the equity method of accounting. The Company made annual rent payments to the partnership totaling $.7 million and $.6 million in 1994 and 1995, respectively, as part of a 15 year lease through 2008. The Company recorded $.1 million in income for its portion of the partnership income in 1994, and 1995, respectively. The Company's investment in Blue Ridge was $1.1 million and $1.0 million at December 31, 1994 and December 30, 1995, respectively.\nBoston Publishing Company - In February 1994, the Company acquired a 20% equity interest in Boston Publishing Company (\"BPC\") and provided secured and unsecured loans to BPC. In August 1994, BPC filed for protection under Chapter 11 of the United States Code. In 1995, the Company received inventory and the customer mailing list of BPC in payment of its $1.2 million loan and subsequently realized $.3 million upon disposition of these assets and wrote off the remaining assets.\nRegal Communications, Inc. - During 1994, the Company invested approximately $2.7 million in convertible debt securities of Regal Communications, Inc. (\"Regal\"). In September 1994, Regal filed for protection under Chapter 11 of the United States Code. As a result, during 1994, the Company established a valuation allowance against the securities reflecting their estimated fair value of $1.7 million. In December 1995, a plan of reorganization was confirmed by the Bankruptcy Court and the Company expects to recover the $1.7 million carrying value of its investment. The Company received its first distribution of $.5 million in February 1996.\nTiger Direct. - In February 1995, the Company entered into an agreement to acquire certain securities of Tiger Direct, Inc. (\"Tiger\"), a direct marketer of computer software, peripherals and CD-ROM hardware and software. In February 1995, the Company entered into a loan and security agreement with Tiger pursuant to which the Company provided a secured working capital line of credit to Tiger, up to a maximum of $3.0 million, which was loaned under such agreement. In September 1995, due to the continued deterioration of Tiger's financial condition, the Company terminated the securities purchase agreement. The Company sold the loan to a third party and received payment in full for the principal of the loan and interest to the date of sale.\nDuring the period from February 1995 to September 1995, the Company provided certain services to Tiger and also incurred certain costs related to entering into the loan and security agreements aggregating $.5 million. Under the terms of the agreement, Tiger is required to reimburse the Company for such costs and services rendered. To date, Tiger has refused to reimburse the Company for these costs. The Company has instituted an action to recover such costs, which are carried at their realizable value.\n3. PROVISION FOR CATALOG AND FACILITY CLOSINGS\nIn 1995, the Company made a decision to discontinue six catalogs. The six discontinued catalogs generated an operating loss of $20 million in 1995 which included a provision of approximately $8.6 million. This provision was recorded in 1995 primarily to write-down the inventory associated with these catalogs to their liquidation value. The $8.6 million is included in the Provision for Catalog and Facility Closings in the Consolidated Statements of Income (Loss) and, at December 30, 1995, approximately $4.9 million remained in the inventory obsolescence reserve. There were no such charges incurred by the Company in 1993 or 1994.\nIn 1995, the Company incurred costs, aggregating approximately $1.5 million, in connection with the consolidation of its fulfillment facilities. These cost included moving expenses, lease termination fees and severence expenses, substantially all of which were paid in 1995. There were no such charges incurred by the Company in 1993 and 1994.\n4. SEARS LICENSING AGREEMENT\nIn January 1994, the Company entered into a licensing agreement (the \"Sears Agreement\") with the direct marketing subsidiary of Sears Roebuck and Co. (\"Sears\") to produce specialty catalogs for customers of the recently discontinued Sears catalog. The specialty catalogs include: Show Place, based on the Domestications catalog, Great Kitchens, based on the Colonial Garden Kitchens catalog and Sears Improvements, based on the Improvements catalog. The Sears Agreement has an initial three-year term and continues thereafter unless terminated by either party. Profits and losses from the venture are shared between the parties on an equal basis. The Sears specialty catalogs generated revenues of $81 million and $71 million and earnings before interest and taxes (\"EBIT\") of $3.0 million and $2.9 million in 1995 and 1994, respectively.\nThe Company also issued to Sears a performance warrant to purchase 3.5 million shares of Common Stock in 1999 if the licensed business with Sears has revenues of at least $250 million and EBIT of at least $30 million in 1998. Alternately, Sears will be entitled to purchase 7 million shares of Common Stock in 1999 if the licensed business with Sears has revenues of at least $500 million and EBIT of at least $60 million in 1998. The warrant exercise price is $10.57 per share. If neither of these goals is achieved, the performance warrant will expire unexercised in 1999. Through 1995, no charges have been required to be recorded in connection with the warrants. The Company is obligated to meet various operational performance standards and if the Company is unable to meet these standards, Sears is entitled to terminate the agreement. The Company also has the right to terminate the agreement in certain circumstances, including if Sears fails to comply with any material provision of the Sears Agreement.\n5. ACCOUNTS RECEIVABLE, NET\nThe Company currently maintains an agreement with an unrelated third party which provides for the sale and servicing of accounts receivable originating from the Company's revolving credit card. The agreement expires in December 2000. The Company remains obligated to repurchase uncollectible accounts pursuant to the recourse provisions of the agreement and is required to maintain a specified percentage of all outstanding receivables sold under the program as a deposit with the third party to secure its obligations under the agreement.\nAt December 31, 1994 and December 30, 1995, the uncollected balances under this program were $45.9 million and $38.6 million, respectively, of which $11.5 million and $5.5 million, respectively, represent deposits under the agreement which are included in Accounts receivable, net. The total reserve balance maintained for the repurchase of uncollectible accounts was $2.3 million and $2.4 million at December 31, 1994 and December 30, 1995, respectively, of which $1.2 million and $1.4 million, respectively, are included in Accrued liabilities and the remaining balance is included in the allowance for doubtful accounts.\nReceivables sold under this agreement are considered financial instruments with off-balance sheet risk as defined in Statement of Financial Accounting Standards No. 105. Because the Company's sales are primarily made to individual customers located throughout the United States, the Company believes there are no concentrations of credit risks.\n6. ACCRUED LIABILITIES\nAccrued liabilities consists of the following (in thousands):\n7. LONG-TERM DEBT\nLong-term debt consists of the following (in thousands):\nRevolving Credit Facility - As a result of the operating losses incurred during 1995, the Company was not in compliance with certain financial covenants under its revolving credit facility that it had entered into in 1994. In order to obtain waivers to this facility for these covenant violations, the Company agreed to more restrictive terms with respect to availability (reduced from $80 million to $55 million), rate and financial covenants. The Company determined that the terms of these proposed amendments were too restrictive and agreed to a waiver through November 15, 1995, when the Company replaced this facility with a new $75 million secured credit facility with Congress Financial Corporation (\"Congress Facility\").\nThe Congress Facility is comprised of a revolving line of credit of up to $65 million with a three year term and two year term loans aggregating $10 million (\"Revolving Term Notes\"). The amount that can be borrowed under the Congress Facility is based on percentages of eligible inventory and accounts receivable from time to time. The revolving line of credit carries an interest rate of 1.25% above CoresSates' prime rate and the Revolving Term Notes carry an interest rate of 1.5% above CoreStates' prime rate. The Congress Facility is secured by all assets of the Company including customer mailing lists, and the Company is required to maintain a minimum net worth of $80 million, as well as working capital of $26 million. In addition, the Congress Facility places limitations on the incurrence of additional indebtedness.\nIn October 1994, the Company consummated a five-year $80 million unsecured revolving credit facility with a syndicate of banks (the \"Credit Facility\") led by NationsBank of North Carolina, N.A. The Credit Facility provided for a $40 million revolving credit facility, a $20 million acquisition line and $20 million of 15 year Term Financing for certain capital expenditures (\"Term Financing Facility\"). There was a $35 million sub-limit for letters of credit under the Credit Facility.\nThe Company borrowed $10 million in each of 1994 and 1995 under the Term Financing Facility. The rate of interest on the Term Financing Facility is based on the equivalent rate of A-1 commercial paper existing at the time of each borrowing. The face rate ranged from 5.85% to 6.30% and 5.73% to 6.02% at December 31, 1994 and December 30, 1995. The Term Financing Facility requires annual sinking fund payments of $1.0 million beginning October 1996 though October 1999 and increasing to $1.6 million for each of the ten years thereafter.\nThe Credit Facility was terminated and amounts outstanding under the revolving credit facility were repaid with the closing of the Congress Facility in November 1995. The Term Financing Facility continues to be outstanding and in effect under its original terms. All standby letters of credit issued under the Credit Facility were replaced with letters of credit issued by Congress.\nAt December 30, 1995, the Company had no outstanding borrowings under the revolving line of credit and $9.9 million outstanding under the Revolving Term Notes. The rates of interest related to the revolving line of credit and Term Notes were 9.50% and 9.75%, respectively, at December 30, 1995.\nThe face amount of unexpired documentary letters of credit at December 31, 1994 and December 30, 1995, were $7.2 million and $4.2 million, respectively. In addition, the Company had issued $31.2 million and $28.5 million of standby letters of credit at December 30, 1995 and December 31, 1994, respectively, which in 1995 included $8.6 million related to the Industrial Revenue Bonds due 2003 and $20.3 million related to the Term Financing Facility.\nThe TAC Revolving Credit Facility was paid off with the proceeds from the Congress Facility on February 16, 1996 and accordingly has been classified as a long-term obligation.\n8.75% Mortgage Note Payable due 2003 - TAC's 8.75% Mortgage Note Payable is reflected as an obligation of the Company and its subsidiaries as a result of the corporate reorganization, completed in February 1996. The 8.75% Mortgage Note Payable is secured by the TAC warehouse and distribution facility in South Dakota. That facility's operations have been largely transferred to other Company facilities and the Company plans to sell the South Dakota property. Monthly principal payments amount to approximately $.1 million per year with a final payment of $1.4 million due in March 2003.\nIndustrial Revenue Bonds due 2003 - The Industrial Revenue Bonds are due on December 1, 2003 and are secured by the related assets purchased from the proceeds of the bonds and by an irrevocable letter of credit in the amount of $8.6 million. The obligations are guaranteed by the Company.\n6% Mortgage Notes Payable due 1998 - In connection with The Company Store acquisition, subsidiaries of the Company executed and delivered two secured notes in the aggregate amount of $3.5 million with interest at 6% per annum with principal and interest payments payable monthly on a fifteen-year amortization schedule with the remaining balance due in August 1998. The mortgage notes payable are non-recourse notes and are not guaranteed by the Company. The mortgage notes payable are secured by the manufacturing and office facilities of The Company Store.\n9.25% Senior Subordinated Notes due 1998 - At December 30, 1995, the Company has $14 million of 9.25% Senior Subordinated Notes due 1998 (\"9.25% Notes\") outstanding.\nIn November 1995 Intercontinental Mining & Resources Incorporated (\"IMR\"), an affiliate of NAR, purchased the 9.25% Notes from a third party in connection with the refinancing of the indebtedness under the Congress Facility. The Company paid NAR a commitment fee of $105,000 upon the signing of a repurchase and option agreement and a fee of $210,000 (1.5% of the outstanding principal amount of the 9.25% Notes acquired by IMR) upon the funding, as well as all expenses incurred by NAR in performing its obligation. The Company also extended by two years the terms of the warrants to purchase 5,033,735 shares held by NAR and IMR to August 1, 1998. The Company recorded as debt issuance costs, approximately $1.2 million, representing the fair value of the warrant extensions. Such costs are being amortized over the life of the 9.25% Notes. The Company has also agreed to indemnify NAR against any and all claims or losses asserted against it or incurred by it relating to the transactions contemplated by the repurchase and option agreement.\nIn connection with IMR's purchase of the 9.25% Notes, the Company and IMR agreed to amend the financial covenants contained in the Indenture relating to the 9.25% Notes and to grant to the Trustee for such 9.25% Notes a second priority security interest in the Company's customer and mailing lists. The Company is required to maintain certain financial covenants with which it was in compliance at December 30, 1995.\nGeneral - As a result of the replacement of the Credit Facility and the purchase by IMR of the 9.25% Notes, the Company wrote off approximately $1.8 million of unamortized debt issuance costs as an extraordinary item due to the early extinguishment of debt.\nAt December 30, 1995, the aggregate annual principal and sinking fund payments required on all long-term debt were as follows (in thousands): 1996 - $2,286; 1997 - $10,176; 1998 - $19,868; 1999 - $1,076; 2000 - $1,649 and thereafter - $24,514.\n8. CAPITAL STOCK\nPublic Offering - In April 1994, the Company completed a public offering (the \"Public Offering\") of 8,045,296 shares of Common Stock for proceeds of approximately $47.5 million, net of expenses.\n6% Series A Convertible Additional Preferred Stock - In December 1993, in connection with the Company's acquisition of Tweeds Inc., (\"Tweeds\"), the Company entered into an exchange agreement with a major vendor of Tweeds. Under the exchange agreement, the Company issued 234,900 shares of its 6% Series A Convertible Additional Preferred Stock (\"6% Preferred Stock\") for an installment note, dated March 29, 1993, as amended, in the amount of approximately $2.4 million previously issued by Tweeds. Dividends began accruing on September 30, 1993.\nThe 6% Preferred Stock is convertible into Common Stock of the Company over a three year period in equal amounts on September 30, 1994, 1995 and 1996. The conversion price is an amount equal to the average of the per share closing prices for the five trading days preceding the conversion dates. The Company converted the first and second equal portions of the 234,900 issued shares of the 6% Preferred Stock into 189,818 and 427,785 shares of Common Stock on September 30, 1994 and September 29, 1995, respectively. The Company elected to pay cash dividends of $.1 million related to the September 1994 conversion.\nSeries B Convertible Additional Preferred Stock - In February 1995, the Company issued 634,900 shares of its Class B Convertible Additional Preferred Stock (\"Series B Stock\") to acquire the remaining 80% of the outstanding common stock of Aegis Safety Holdings, Inc. (\"Aegis\"), publisher of The Safety Zone catalog. The Series B Stock has a stated value of $10 per share. Non-cumulative dividends will accrue and be paid at 5% per annum during each of the first three years if Aegis attains at least $1 million in earnings before interest and taxes each year. In years four and five, dividends are cumulative and will accrue and be paid at 7% per annum and are not contingent on the achievement of any earnings target. Dividends will not be paid in 1995 based on The Safety Zone catalog's 1995 operating results.\nThe Series B Stock is convertible at any time, at $6.66 per share, subject to antidilution, at the option of the holder and is convertible at the Company's option if the market value of the Company's Common Stock is greater than $6.66 per share, subject to antidilution, for 20 trading days in any consecutive 30 day trading period or at the holder's option from time to time. If, after five years, the Series B Stock is not converted, it is mandatorily redeemable, at the Company's option, in cash or for 952,359 shares of the Company's Common Stock provided the\nmarket value of the stock is at least $6.33 per share, subject to antidilution. If the market value of the Company's Common Stock does not meet this minimum, the redemption rate is subject to adjustment which would increase the number of shares for which the Series B Stock is redeemed.\nThe fair value of the Series B Stock, which is based on an independent appraisal, is $.9 million less than the stated value. This discount is being amortized over a five year period and resulted in a charge of $.2 million to preferred stock dividends in the statement of income for 1995.\nWarrants - The warrants outstanding at December 30, 1995 are as follows:\nAll of the above issued warrants are held by NAR and its affiliates.\nAs previously discussed, the Company issued to Sears a performance warrant to purchase up to 7 million shares of Common Stock in 1999. This performance warrant is not reflected in the above table.\nGeneral - At December 30, 1995, there were 93,452,768 shares of Common Stock, 78,300 shares of 6% Preferred Stock and 634,900 shares of Series B Stock outstanding. Additionally, an aggregate of 15,087,471 shares of Common Stock were reserved for issuance pursuant to (i) the exercise of outstanding options (265,000), (ii) the exercise of outstanding warrants (12,033,735), (iii) the Executive Equity Incentive Plan (1,021,170), (iv) the Restricted Stock Award Plan (275,700), and (v) the All Employee Equity Investment Plan (1,491,866).\nIn October 1995, the FASB issued SFAS No. 123, \"Accounting for Stock-Based Compensation\", which is effective in 1996. The statement encourages entities to adopt the fair value based method of accounting for employee stock options, as opposed to the Company's current method, which measures compensation cost for those plans using the intrinsic value based method of accounting prescribed by APB Opinion No. 25, \"Accounting for Stock Issued to Employees.\" The Company has not as yet decided whether it will adopt SFAS No. 123 for financial statement purposes, however at a minimum it will be required to disclose in its footnotes to the financial statements, additional information relating to the Company's various stock-based employee benefit plans and the Company's pro forma net income and earnings per share, as if the options granted were expensed at their estimated fair values at the time of grant. If the Company decides to adopt SFAS No. 123 for financial statement purposes, an additional expense will be recorded, however the Company has not as yet calculated the impact of the adoption.\nDividend Restrictions - The Company is restricted from paying dividends on its Common Stock or from acquiring its capital stock by certain debt covenants contained in agreements to which the Company is a party.\n9. EMPLOYEE BENEFIT PLANS\nStock Option Plan - Pursuant to the Company's Stock Option Plan (the \"Plan\"), an aggregate of 2,830,519 shares were approved for issuance to employees and consultants of the Company. The option price and the periods over which an option is exercisable are specified by the Compensation Committee of the Board of Directors.\nOptions expire five years from the date of grant and generally vest over three to four years. Payment for shares purchased upon the exercise of an option shall be in cash or stock of the Company. If paid in cash, a partial payment may be made with the remainder in installments evidenced by promissory notes at the discretion of the Compensation Committee.\nChanges in options outstanding and options available for grant, expressed in numbers of shares, are as follows:\nThe option prices and amounts are: $1.75 - 20,000 shares, $2.25 - 50,000 shares and $3.50 - 20,000 shares.\nIn June 1994, one director was granted non-qualified options to purchase 55,000 shares at an exercise price of $6.125 per share which expire in 2000. In September 1992, six directors were granted options to purchase 20,000 shares each, at the market price, which at the time was $1.75 per share. These option grants were approved at the 1993 Annual Meeting of Shareholders and the options expire in 1997. The table above does not include these option grants.\nHanover Direct, Inc. Savings Plan - The 401(k) Savings and Retirement Plan (the \"401(k) Plan\") allows eligible employees to contribute a percentage of their annual compensation to the 401(k) Plan. The Company makes matching contributions of one-third of the employees' pre-tax contributions. Participants may invest contributions in various investment funds, in addition to a guaranteed investment fund or in the Company's Common Stock.\nThe Company's contributions charged to expense for 1993, 1994 and 1995 were approximately $431,000, $608,000 and $556,000, respectively.\nSupplemental Retirement Plan - The Supplemental Retirement Plan (the \"Retirement Plan\") allows eligible employees to make contributions to a trust where the contributions are invested by the trust for each participant in a tax free money market fund. The Company makes matching contributions. Company contributions charged to expense in 1993, 1994 and 1995 amounted to approximately $130,000, $192,000 and $222,000, respectively.\nThe Retirement Plan permits eligible employees to contribute up to 4% of their salary. The Company matches all participant contributions, up to 50% of their contributions with a cap of 2%. The Retirement Plan is not tax-qualified under the applicable provisions of the Internal Revenue Code of 1986, as amended.\nIncentive Compensation Plan - Bonus arrangements with certain executives and key employees generally provide for additional compensation based upon the attainment of certain profit levels, as well as other performance measures. These bonuses approximated an aggregate of $.4 million, $1.1 million and $1.5 million in 1993, 1994 and 1995, respectively. Under the bonus plan, 25% of the bonus is deferred and payable in cash or restricted stock that vests over a three year period.\nExecutive Equity Incentive Plan - In December 1992, the Board of Directors adopted the 1993 Executive Equity Incentive Plan (the \"Incentive Plan\"). The Incentive Plan was approved by shareholders at the 1993 Annual Meeting. Pursuant to the Incentive Plan, options to purchase shares of the Company's Common Stock will be granted from time to time by the Compensation Committee of the Board of Directors to selected executives of the Company or its affiliates. For each such option granted, the selected executive will receive the right to purchase on a specified date (the \"Tandem Investment Date\") a number of shares of the Company's Common Stock (\"Tandem Shares\") equal to one-half the maximum number of shares of the Company's Common Stock covered by such option. An aggregate of 2,400,000 shares of the Company's Common Stock have been reserved for issuance under the Incentive Plan. Company financing is available under the Incentive Plan to pay for the purchase price of the Tandem Shares.\nChanges in shares, options outstanding and options available for grant, expressed in numbers of shares, for the Incentive Plan are as follows:\nThe purchase prices per share of the Company's Common Stock upon exercise of stock options are as follows: $1.75 - 30,000 shares, $2.25 - 33,333 shares, $2.50 - 676,505 shares, $2.63 -50,000 shares, $2.75 - 133,332 shares, $3.00 - 20,000 shares, $3.89 - 20,000 shares and $4.50 - 58,000 shares. Options granted under the Incentive Plan become exercisable three years after the dates of grant and expire six years from the dates of grant. The purchase price shall be paid in full at the time of purchase in cash or shares of the Company's Common Stock valued at their fair market value or in a combination thereof. The difference between the Option Price and the fair market value of the Common Stock on the Tandem Investment Dates is being amortized over the three-year period in which the options become exercisable. The amount of amortization charged to expense was approximately $170,000, $137,000 and $72,000 for 1993, 1994 and 1995, respectively, net of forfeitures.\nChanges to the notes receivable related to the Incentive Plan are as follows:\nThe Incentive Plan participants purchased shares at prices ranging from $1.75 to $4.50 with the Company accepting notes bearing interest at rates ranging from 5.35% to 7.75%.\nRestricted Stock Award Plan - In December 1992, the Board of Directors adopted the 1993 Restricted Stock Award Plan (the \"Restricted Stock Plan\"). Each full-time or permanent part-time employee of the Company or its affiliates selected by the Compensation Committee who holds a key position that the Compensation Committee shall have been designated for eligibility in the Restricted Stock Plan, has attained the age of 18, has performed at least 12 months of continuous service with the Company or an affiliate of the Company and is not covered by a collective bargaining agreement may participate in the Restricted Stock Plan. Pursuant to the Restricted Stock Plan, the Compensation Committee from time to time may award shares of the Company's Common Stock (\"Award Shares\") to such participants. The Award Shares received by such participants are not transferable (other than by will or the laws of descent and distribution) until the vesting date or when such participant attains the age of 65, dies or becomes permanently disabled, and are subject to forfeiture in the event the participant ceases to be an employee prior to that date. An aggregate of 500,000 shares of the Company's Common Stock have been reserved for issuance under the Restricted Stock Plan. During 1993, 224,300 shares were awarded to participants aggregating $785,000. Such amount is being amortized over a three-year vesting period. The amount of amortization charged to expense was approximately $188,000 in 1993, $292,000 in 1994 and $219,000 in 1995, net of forfeitures.\nAll Employee Equity Investment Plan - In December 1992, the Board of Directors adopted the 1993 All Employee Equity Investment Plan (the \"Investment Plan\"). Such plan was approved by the shareholders at the 1993 Annual Meeting. Each full-time or permanent part-time employee of the Company or its affiliates who has attained the age of 18, has met certain standards of continuous service with the Company or an affiliate of the Company and is not covered by a collective bargaining agreement may participate in the Investment Plan.\nAn eligible employee will be granted a right to purchase a specific number of shares of the Company's Common Stock by the Compensation Committee, based on the eligible employee's salary level. The purchase price of the Company's Common Stock in the Investment Plan shall be the average market value of a share of the Company's Common Stock during the 20 days prior to the first day of the subscription period, less a 40% discount. The shares received by such participants are not transferable (other than by will or the laws of descent and distribution) until the vesting date or when such participant attains the age of 65, dies or becomes permanently disabled, and are subject to forfeiture in the event the participant ceases to be an employee prior to that date. The employees who choose to participate in the Investment Plan vest in their shares equally over a three-year period beginning with the first anniversary of the day subsequent to the final day of the subscription period or when they reach the age of 65, die or become permanently disabled. An aggregate of 2,000,000 shares of the Company's Common Stock have been reserved for issuance under the Investment Plan.\nChanges in shares outstanding and available for grant, expressed in numbers of shares for the Investment Plan are as follows:\nThe difference between the market price and the discounted price aggregated approximately $.4 million, $.4 million and $.2 million in 1993, 1994 and 1995, respectively. These amounts have been reduced by approximately $46,000 in 1993, $226,000 in 1994 and $181,000 in 1995 which have been charged to amortization expense.\n10. INCOME TAXES\nAt December 30, 1995, the Company had net operating loss carryforwards (\"NOLs\") totalling $162.5 million, which expire as follows: In the year 2001 - $17.3 million, 2003 - $14.6 million, 2004 - $14.3 million, 2005 - $20.6 million, 2006 - $46.9 million, 2007 - $27.7 million and 2010 - $21.1 million. The Company also has $1 million of general business tax credit carryforwards that expire in 2000 through 2009. The Company's available NOLs for tax purposes consists of $91.4 million of NOLs subject to a $4 million annual limitation under Section 382 of the Internal Revenue Code of 1986 and $71.2 million of NOLs not subject to a limitation.\nThe unused portion of the $4 million annual limitation for any year may be carried forward to succeeding years to increase the annual limitation for those succeeding years. In addition, the Company's entire $91.4 million of NOLs, subject to the limitation, may be used to offset future taxable income generated by July 1996 from built-in gains (generally, taxable income from the sale of appreciated assets held by the Company at the date of its change in ownership in July 1991) without reference to the limitation.\nSFAS 109 requires that the future tax benefit of such NOLs be recorded as an asset to the extent that management assesses the utilization of such NOLs to be \"more likely than not\". In 1992 management determined that, based upon the conversion of interest-bearing debentures to equity, the issuance of additional Common Stock, the disposal of unprofitable discontinued restaurant operations, the Company's history of prior operating earnings in the direct marketing business and its expectations for the future, the operating income of the Company will, more likely than not, be sufficient to utilize $30 million of deductible temporary differences and NOLs prior to their expiration. In making such determination, the Company adjusted 1992 income by eliminating interest expense related to retired debt and assumed that such adjusted 1992 income level could be obtained in each of the next three years. The Company maintained a consistent adjusted income level in 1993. In 1994, the Company continued the practice of estimating the NOLs that it could utilize over the subsequent three years and estimated that it would be able to utilize up to $43 million of NOLs over the next three years based on the pre-tax income of the most recent two years. Despite incurring an additional $21.1 million NOL in 1995, management believes that the Company will\nbe able to utilize up to $43 million of NOLs over the next three years based upon the Company's assessment of numerous factors, including its future operating plans and its pre-tax income in 1993 and 1994 and its 1995 NOL.\nFor the year ended January 1, 1994, the Company recognized an additional deferred tax asset of $.6 million, reflecting the effect of the increase in the Federal corporate income tax rate (from 34% to 35%). For the year ended December 31, 1994, the Company reduced its valuation allowance by $4.4 million, reflecting the increase in management's assessment of the future utilization of the Company's NOLs and deductible temporary differences. For the year ended December 30, 1995, the Company maintained its deferred tax asset of $15 million (net of a valuation allowance of $48.5 million). Management believes that the $15 million net deferred tax asset represents a reasonable estimate of the future utilization of the NOLs and will continue to routinely evaluate the likelihood of future profits and the necessity of future adjustments to the deferred tax asset valuation allowance.\nRealization of the future tax benefits is dependent on the Company's ability to generate taxable income within the carryforward period and the periods in which net temporary differences reverse. Future levels of operating income and taxable income are dependent upon general economic conditions, competitive pressures on sales and margins, postal and other delivery rates, and other factors beyond the Company's control. Accordingly, no assurance can be given that sufficient taxable income will be generated for utilization of NOLs and reversals of temporary differences.\nThe Company's Federal income tax provision was $5.9 million in 1993, $4.2 million in 1994 and zero in 1995. The 1994 provision was offset by utilization of the NOLs. In addition, the Company recognized the $4.4 million benefit in 1994 discussed above. The Company's provision for state income taxes was $.5 million in 1993, $.9 million in 1994 and $1.0 million in 1995.\nThe following is reconciliation of the Company's net income for financial statement purposes to taxable income (loss) for the years ended January 1, 1994, December 31, 1994 and December 30, 1995 (in thousands):\nThe components of the net deferred tax asset at December 30, 1995 are as follows (in millions):\nThe Company has established a valuation allowance for a portion of the deferred tax asset, due to the limitation on the utilization of the NOLs and its estimate of the future utilization of the NOL's.\nThe Company's tax returns for years subsequent to 1984 have not been examined by the Internal Revenue Service (\"IRS\"). Availability of the NOLs might be challenged by the IRS upon examination of such returns which could affect the availability of the NOLs. The Company believes, however, that IRS challenges that would limit the utilization of the NOLs will not have a material adverse effect on the Company's financial position.\nTotal tax expense for each of the three fiscal years presented differ from the amount computed by applying the Federal statutory tax rate due to the following:\n11. LEASES\nCertain leases to which the Company is a party provide for payment of real estate taxes and other expenses. Most leases are operating leases and include various renewal options with specified minimum rentals. Rental expense for operating leases related to continuing operations were as follows (in thousands):\nFuture minimum lease payments under noncancellable operating and capital leases relating to continuing operations that have initial or remaining terms in excess of one year, together with the present value of the net minimum lease payments as of December 30, 1995, are as follows (in thousands):\n(a) Amount necessary to reduce net minimum lease payments to present value calculated at the Company's incremental borrowing rate at the inception of the leases.\n(b) Reflected in the balance sheet as current and noncurrent capital lease obligations of $628,000 and $1,196,000 at December 31, 1994 and $1,260,000 and $1,973,000 at December 30, 1995, respectively.\nThe future minimum lease payments under noncancellable leases that remain from the discontinued restaurant operations as of December 30, 1995 are as follows: 1996 - $1.3 million; 1997 - $1.3 million; 1998 - $1.3 million; 1999 - $1.3 million; 2000 - $1.3 million; and thereafter $11.7 million. The above amounts exclude annual sublease income of $1.2 million from subleases which have the same expiration as the underlying leases.\nIn connection with the Company's investment in Blue Ridge, a subsidiary of the Company is contingently liable with respect to the lease obligation related to the apparel distribution center in Roanoke, Virginia.\n12. RELATED PARTY TRANSACTIONS\nAt December 30, 1995, current and former officers and executives of the Company owed the Company approximately $2.2 million of which approximately $1.7 million relates to receivables under the Executive Equity Incentive Plan. These amounts due to the Company bear interest at rates ranging from 5.35% to 7.75% and are due from 1999 to 2001. The remaining $.5 million is due on demand from two officers of the Company and bears interest at rates ranging from 6.0% to 7.96%.\nSince January 1993, pursuant to a consulting arrangement, a subsidiary of NAR renders management consulting, business advisory and investment banking services to the Company for an annual fee of $750,000. NAR will not collect such a fee in 1996.\nAt December 30, 1995, NAR owned approximately 50% of the Company's outstanding Common Stock and would own 53% upon excercising all of their outstanding warrants.\n13. COMMITMENTS AND CONTINGENCIES\nOn or about September 2, 1994, a complaint was filed in the United States District Court for the District of New Jersey by Veronica Zucker, an individual who allegedly purchased shares of Common Stock of the Company in the public offering completed on April 7, 1994, against the Company, all of its directors, certain of its officers, Sun Life Insurance Company of America, Merrill Lynch, Pierce, Fenner & Smith Incorporated and Alex. Brown & Sons, Incorporated. The complaint, which purports to be filed on behalf of a class of all persons who purchased the Common Stock of the Company in the public offering or thereafter through and including August 14, 1994, seeks to recover monetary damages the class has allegedly suffered as a result of certain alleged false and materially misleading statements contained in the Company's public offering prospectus dated March 30, 1994. In lieu of an answer, defendants filed a motion to dismiss the complaint in its entirety for failure to state a claim upon which relief can be granted. On May 23, 1995, the United States District Court for the District of New Jersey dismissed the plaintiff's claim, with prejudice, for failure to state a claim upon which relief could be granted. On June 22, 1995, plaintiff filed a notice of appeal of the May 23, 1995 decision to the United States Court of Appeal for the Third Circuit. The appeal was submitted on the briefs on March 11, 1996. On March 26, 1996, the Court rendered its decision affirming the District Court's decision.\nThe Company is involved in other various routine lawsuits of a nature which are deemed customary and incidental to its business. In the opinion of management, the ultimate disposition of such actions will not have a material adverse effect on the Company's financial position or results of operations.\nThe imposition of a sales and use tax collection obligation on out-of-state catalog companies in states to which they ship products was the subject of a case decided in 1994 by the United States Supreme Court. While the court reaffirmed an earlier decision that allowed direct marketers to make sales into states where they do not have a physical presence without collecting sales taxes with respect to such sales, the Court further noted that Congress has the power to change this law. The Company believes that it collects sales tax in all jurisdictions where it is currently required to do so.\nIn connection with certain discontinued restaurant transactions, the Company remains contingently liable with respect to lease obligations for 9 restaurant properties, should the buyers fail to perform under the agreements. The future minimum lease payments as of December 30, 1995 are as follows (in thousands): 1996 - $336; 1997 - $278; 1998 - $192; 1999 - $192; 2000 - $143; and thereafter $403.\n14. SUBSEQUENT EVENTS:\nIn March 1996 the Company announced that the Board of Directors had voted to conduct a rights offering for $40 million of the Company's Common Stock after completion of the first quarter. The rights will be exercisable at a price to be determined at the time of commencement of the rights offering equal to 75% of the then-current market price, but not less than $1.00 nor more than $1.50 per share. NAR Group Limited, the Company's majority shareholder, will receive rights entitling it to purchase approximately 50% of the shares to be offered in the rights offering and has agreed to exercise such rights. In addition, NAR has agreed to standby and purchase all shares not subscribed by common shareholders and will receive a fee as a result. The proceeds of the rights offering will be used by the Company to repay the 9.25% Senior Subordinated Notes due on August 1, 1998 held by an affiliate of NAR, and for other general corporate purposes, including repaying outstanding indebtedness under its revolving credit facility. At such time the Company will record an extraordinary expense related to the early extinquishment of this debt, representing the write-off of the unamortized debt issuance costs of approximately $1.4 million.\nIn February 1996, the Company announced that Rakesh K. Kaul was named President and Chief Executive Officer and elected to the Board of Directors effective March 7, 1996. Mr. Kaul has most recently served as Vice Chairman and Chief Operating Officer of Fingerhut Companies, Inc.\n15. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\n(a) Identification of Directors.\nThe information required by this item is incorporated by reference from the Company's definitive proxy statement to be filed by the Company pursuant to Regulation 14A.\n(b) Identification of Executive Officers.\nJack E. Rosenfeld resigned as President and Chief Executive Officer and as a Director effective December 30, 1995. Alan G. Quasha, the Company's Chairman of the Board, served as acting President and Chief Executive Officer from January 1, 1996 until March 7, 1996.\n- --------------- (a) All references to dates and positions held by such executive officers prior to September 1993 refer to the Company's predecessor, The Horn & Hardart Company (\"H&H\"). H&H merged with and into the Company in September 1993, with the Company surviving.\nPursuant to the Company's By-Laws, its officers are chosen annually by the Board of Directors and hold office until their respective successors are chosen and qualified.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by this item is incorporated by reference from the Company's definitive proxy statement to be filed by the Company 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 by reference from the Company's definitive proxy statement to be filed by the Company pursuant to Regulation 14A.\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 definitive proxy statement to be filed by the Company pursuant to Regulation 14A.\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.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nHANOVER DIRECT, INC. (registrant)\nDate: March 29, 1996 By: s\/Rakesh K. Kaul ------------------------ Rakesh K. Kaul, Director President and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated and on the date indicated below.\nSchedule II\nHANOVER DIRECT VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED DECEMBER 30, 1995, DECEMBER 31,1994 AND JANUARY 1,1994\n(1) Accounts written -off. (2) Utilization of reserves. (3) Utilization of valuation allowance. (4) Represents acquired allowance for doubtful accounts receivable. (5) Represents available NOL's and the effect of the increase in corporate tax rates from 34% to 35%. (6) Represents decrease due to: utilization of valuation allowance and recognition of NOL's estimated to be utilized by future operating results. (7) Represents the increase in the valuation allowance offset by an increase in the gross deferred tax asset.\nEXHIBIT INDEX\nE-1\nE-2\nE-3\nE-4\nE-5\nE-6\n- ------------- * Hanover Direct, Inc., a Delaware corporation, is the successor by merger to The Horn & Hardart Company and The Hanover Companies.\n** EDGAR filing only.\nE-7","section_15":""}
{"filename":"12245_1995.txt","cik":"12245","year":"1995","section_1":"ITEM 1. DESCRIPTION OF BUSINESS\nAs a result of the sale of its vinyl building products business, window fabrication business and San Leon hydrocarbon waste recycling center (see \"Recent Business Developments\" below), Bird Corporation's current manufacturing operation consists of one primary business unit - roofing manufacturing and sales and marketing. Products currently manufactured at Bird Corporation's roofing facility include asphalt shingles and roll roofing for commercial and residential use. These products are marketed through independent wholesalers, including wholesalers whose primary customers are roofing contractors. All references herein to the \"Company\" or \"Bird\" refer to Bird Corporation and its subsidiaries unless otherwise indicated by the context.\nRECENT BUSINESS DEVELOPMENTS\nThere have been a number of significant developments in the business of the Company since December 31, 1994, including the following:\n_ On March 14, 1996, the Company signed a definitive agreement with CertainTeed Corporation, a subsidiary of Saint-Gobain Corporation, providing for CertainTeed to acquire in a merger transaction all of the Company's outstanding common, preferred and preference shares.\nCertainTeed will pay $7.50 per share for the common stock. As of March 1, 1996 there were approximately 4.1 million shares of Bird common stock outstanding.\nThe Bird\/CertainTeed merger provides for the acquisition or redemption of all outstanding 5% cumulative preferred stock at their liquidation preference of $110.00 per share and all outstanding $1.85 cumulative convertible preference stock for $20.00 per share. Payment for preferred and preference stock will include any previously accrued but unpaid dividends. The total consideration for the transaction exceeds $50 million, including common and preferred equity plus debt.\nCompletion of the transaction is subject to approval by Bird's shareholders, appropriate governmental approvals and other customary conditions.\n_ On November 29, 1995, the Company sold all of the outstanding capital stock of Bird Environmental Gulf Coast, Inc. (\"BEGCI\") which owned the Company's interest in the San Leon, Texas based hydrocarbon waste recycling center, to GTS Duratek, Inc. (\"Purchaser\") for a purchase price of $1.00. In addition, BETI agreed to pay the Purchaser the amount by\nwhich BEGCI's current liabilities exceeded its current assets at August 31, 1995, which was approximately $1.3 million. The sale of the recycling center completes the Company's withdrawal from the environmental remediation and recycling industry. The resulting loss of $11,252,000 is reflected as discontinued operations in the Company's consolidated statements of operations.\n_ On September 26, 1994, the Company announced that it had signed a definitive agreement to sell the assets of its vinyl building products manufacturing operation located in Bardstown, Kentucky to Jannock, Inc. (\"Jannock\"). This transaction also included an option to purchase the Company's interest in Kensington Partners (\"Kensington\"), a window fabrication business. At a special meeting of the shareholders held in Dedham, Massachusetts on March 7, 1995, the shareholders of the Company voted to sell the assets of the Company's vinyl building products operation to Jannock essentially in accordance with the terms and conditions as outlined in the definitive agreement between the Company and Jannock dated September 23, 1994. On March 8, 1995, the sale was closed for a gross purchase price of $47.5 million which was reduced to approximately $42.5 million by post-closing working capital adjustments. The sale included the assumption by the purchaser of certain specified liabilities of the vinyl business. Proceeds from the sale were used to reduce bank debt. Net of adjustments, the Company's gain on this sale totaled $20,579,000 million and is reflected as discontinued business activity income in the consolidated statements of operations.\n_ On June 2, 1995, the Company sold all of the outstanding capital stock of Bird-Kensington Holding Corp. (\"Bird-Kensington\"), which owned the Company's interest in Kensington to Jannock, Inc. The sale was consummated pursuant to the exercise by Jannock of an option granted under the Asset Purchase Agreement dated as of September 23, 1994 (as amended by amendments dated as of January 24, 1995, January 31, 1995, and April 27, 1995). The purchase price consisted of cash in the amount of $2,780,000 and the assumption of certain liabilities related to the Kensington business. Cash proceeds of $1 million were used to acquire the minority partner's interest in Kensington. In addition, $4,090,000 was invested by the Company in Bird-Kensington, as a condition of the sale, to enable Kensington to pay certain liabilities and to meet equity requirements as stipulated in the Asset Purchase Agreement. The sale resulted in a loss of $1,959,000 and is reflected as discontinued business activity expense in the Company's consolidated statements of operations.\nHOUSING GROUP\nAsphalt roofing products are manufactured and sold at the Company's facilities in Norwood, Massachusetts. Asphalt shingles and roll roofing are produced by coating a fiberglass mat with a mixture of hot asphalt and crushed rock filler and covering the coated mat with Company-manufactured roofing granules. The Company's facilities include a roofing manufacturing facility, a granule plant, a quarry, an asphalt plant and a private landfill for the Company's use.\nThe Company's Housing Group produced vinyl siding products at its plant in Bardstown, Kentucky prior to the sale of such facility in March 1995. Additionally, the Company sold its interest in Kensington, its joint venture in the replacement window fabrication business in June 1995. The Housing Group also carried on a distribution business through wholesale building materials distributors based in New England, New York, Kentucky, Texas, Louisiana, and Arizona until such businesses were sold in August and November 1994.\nNet sales of the components of the Housing Group as a percentage of consolidated net sales of the Company were as follows: sales of asphalt roofing products, 80% in 1995, 31% in 1994 and 23% in 1993; sales of vinyl products, 20% in 1995, 24% in 1994 and 20% in 1993; and sales through building materials distribution centers (including roofing and vinyl products manufactured by the Company), 45% in 1994 and 57% in 1993.\nThe principal geographic markets for the Company's manufactured roofing products, due to limitations imposed by freight costs, are the northeastern United States. The building materials business is seasonal to the extent that outside repair and remodeling and new construction decline during the winter months. To reduce the impact of this seasonal factor, the Company generally employs what it believes to be an industry-wide practice of \"winter dating\", pursuant to which extended or discounted payment terms are offered to credit-worthy customers who order and accept delivery of roofing products during specified periods of time in the slow season.\nRAW MATERIALS\nThe principal raw materials used in the manufacture of asphalt roofing products are fiberglass mat, asphalt saturants and coatings and crushed granules. The Company's requirements for fiberglass mat are met primarily under a Glass Mat Supply Agreement with one vendor which expires on December 31, 1996. Fiberglass mat is also generally available in adequate quantities from a number of outside suppliers. Asphalt saturants and coatings were, until recently, purchased from a major oil refinery. These materials are also available from other sources at a higher delivered cost. After the refinery's discontinuation of its production of asphalt in April 1994, the Company relied on a number of alternative sources for this raw material. Since completion of construction of an asphalt plant in January 1995, the Company has been able to process asphalt at its\nroofing facility, thereby reducing its costs and decreasing the potential for temporary interruptions in its manufacturing operations. The Company believes that it can produce all of its current granule requirements at its granule plant and quarry.\nBACKLOG\nOrder backlog is not a meaningful measure of the Company's building materials business because there are fewer sales during the last quarter of the fiscal year and the order-to-shipment cycle is relatively short. Additionally, it is very rare, at any time, to require more than 30 days from the receipt of a product order to delivery of the product.\nCOMPETITION\nThe building materials business is, to a large degree, a commodities-type business and is highly competitive with respect to price, delivery terms and consistent product quality. Many of the Company's competitors are larger and financially stronger than the Company, but none is dominant in any of its markets.\nThe strengths of the Company's asphalt roofing business arise, in part, from the unique marketing programs the Company directs toward its indirect customer base, professional roofing contractors, combined with an industry-wide reputation for providing quality products with a high level of service. The Company's comprehensive contractor marketing program is designed to support the position of the Company's contractors in the industry. Such marketing programs include a special system for in-home sales promotions. Pursuant to its exclusive certification program, the Company also certifies contractors who have recorded three (3) successful years in business, who provide the Company with names of customers for quality checks, sign a letter of ethics, have a good credit history, warrant their workmanship for two (2) years and attend annual training meetings. Contractors must be recertified every two years. Certified contractors are supplied with a wide array of marketing materials, including customized sample cases, special mailers and custom job site signs.\nINTELLECTUAL PROPERTY\nThe Company owns a number of trademarks, as well as significant technology and know-how, which it utilizes in connection with its asphalt roofing business. The Company believes that its trademarks are strong and well recognized in the industry.\nCOMPLIANCE WITH CERTAIN ENVIRONMENTAL LAWS\nThe Company has expended, and expects to continue to expend, funds to comply with federal, state and local provisions and orders which\nrelate to the environment. Based on the information available to the Company at this time, the Company believes that the effect of compliance with these provisions on the capital expenditures, earnings and competitive position of the Company is not material. Litigation and other proceedings involving environmental matters are described under the heading \"Environmental Matters\" in Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and in Item 3, \"Legal Proceedings\".\nFINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS\nWhile the Company formerly operated in two major business segments, its housing segment and its environmental segment, the Company no longer operates its environmental segment. Financial information about the industrial segments in which the Company operates, for the three years ended December 31, 1995, appear in Note 12 of the Notes to Consolidated Financial Statements which are included herein.\nEMPLOYEES\nAt December 31, 1995, the Company employed 174 people.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's executive offices are located at its plant in Norwood, Massachusetts. The Company believes that its plant and facilities, as described below, are suitable and adequate for its current and anticipated business. Operating capacity can be increased by additional man hours, changing product mix, and\/or minimal capital investment should the need arise. The Company's facilities are well maintained, in sound operating condition, and in regular use.\nROOFING MANUFACTURING FACILITY\nThe Company owns its asphalt roofing manufacturing facility in Norwood, Massachusetts. The Norwood plant includes the roofing manufacturing facility, a granule plant and an asphalt plant. The Company's quarry is located in Wrentham, Massachusetts, and its private landfill is located in Walpole, Massachusetts. The Company leases an industrial laminator and certain other equipment which were fabricated for use in its roofing plant. The laminator lease expires in 1998. The Company completed the construction of an asphalt oxidizer plant at the Norwood premises in January 1995 to ensure a continuous supply of asphalt. The Company also leases an asphalt storage tank and terminal facilities in Providence, Rhode Island.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company monitors its compliance with environmental regulations on an ongoing basis. The Company's general counsel receives environmental site assessments from the operating managers responsible for site environmental compliance. Appropriate action is undertaken where needed. When environmental claims are asserted against the Company, the claims are evaluated by the Company's general counsel and operating management in conjunction with external legal counsel and environmental engineers as necessary, and action is taken with respect to all known sites, as appropriate. The Company is currently engaged in proceedings relating to or has received notice of the following environmental matters:\nOn March 15, 1994 the Company received a draft of an Administrative Consent Order and Notice of Noncompliance from the Massachusetts Department of Environmental Protection (\"DEP\") concerning operations at its Norwood, Massachusetts manufacturing facility and associated rock granule processing facility. The draft alleges that the Company was not in compliance with regulations of the DEP relating to air emissions, granule plant operation, and labeling, handling and storage of certain hazardous waste. The draft proposes certain corrective action on the part of the Company as well as payment of civil administrative penalties. On June 10, 1994, the Company's roofing division entered into an administrative consent order and notice of noncompliance with respect to the alleged violations. The consent order requires the Company to undertake certain modifications and corrective actions with respect to certain hazardous waste handling and storage facilities at the Norwood facility, to conduct an environmental audit of its operations at such facility and to undertake various modifications of air pollution control equipment. On May 13, 1994, the Company paid an administrative penalty of $30,000. The Company estimated that the cost of corrective action to be taken by it in accordance with the consent order would be approximately $100,000. The majority of the corrective actions were completed in 1995.\nOn March 25, 1994, the Company received a notice from the United States Environmental Protection Agency (the \"EPA\") regarding a site inspection prioritization report prepared by the DEP. The notice alleges a potential release of hazardous substances into the environment at the Company's former mill site in East Walpole, Massachusetts. The EPA has reserved the right to conduct further site tests on the location. A site assessment performed on the mill site for the Company by its environmental consultants, GZA GeoEnvironmental Inc. (\"GZA\"), showed no environmental cleanup was necessary. This report was submitted to the DEP in July 1995. In the opinion of management and based on management's and GZA's understanding that the alleged releases are in de minimis quantities, this matter should not have a material adverse effect on the Company's financial position or on the results of its operations.\nOn June 21, 1994, the Arizona Department of Environmental Quality (\"ADEQ\") issued a notice of violation (\"NV\") to Southwest Roofing\nSupply, a previously owned division of the Company (\"Southwest\"), which directed Southwest to conduct a site investigation of property formerly leased by Southwest. A consent order between the ADEQ and the Company was issued on September 23, 1994. Pursuant to the consent order, the Company agreed to submit a work plan with a view to remediating the soil and groundwater that may have been contaminated by leaks from an underground storage tank previously removed by the Company. The Company's management believes that the remediation cost to the Company will be in the range of $200,000 to $700,000. As of December 31, 1995, the Company has provided a reserve of $450,000 for the estimated cost of cleanup. The Company anticipates that $200,000 will be reimbursed to the Company by the ADEQ in accordance with Arizona law and regulation.\nIn 1986, the Company, along with numerous other companies, was named by the EPA and other governmental agencies responsible for regulation of the environment as a Potentially Responsible Person (\"PRP\") pursuant to the Comprehensive Environmental Response, Compensation and Liability Act, as amended, 42 U.S.C. Paragraph 9601, et seq. (\"CERCLA\") in connection with hazardous substances at a site known as the Fulton Terminal Superfund site located in Fulton, Oswego County, New York. On September 28, 1990, the Company and a number of other PRPs reached a negotiated settlement with the EPA pursuant to which the settling PRPs agreed to pay the costs of certain expenses in connection with the proceedings and to pay certain other expenses, including the costs and expenses of administering a trust fund to be established by the settling PRPs. The settlement agreement is embodied in a consent decree lodged with the United States District Court for the Western District of New York and fixed the Company's proportionate share of the total expenses. The ultimate cost to the Company of the remedial work and other expenses covered by the settlement agreement is estimated to be between $1 million to $2 million payable over a period of 3 to 15 years (depending upon the duration of remediation efforts). At December 31, 1995, the Company has provided a reserve of approximately $1 million to cover the estimated cost of the Company's remaining proportionate share (i.e., 17%) of the ultimate total cost of cleanup. Under a cost-sharing arrangement set forth in a consent decree with the EPA, the other PRPs have agreed to incur 83% of the aggregate cost of remediation of this site.\nThe Company has been named as a PRP with respect to certain other sites which are being investigated by federal or state agencies responsible for regulation of the environment. As a consequence of its status as a PRP, the Company may be jointly and severally liable for all of the potential monetary sanctions and remediation costs applicable to each site. In assessing the potential liability of the Company at each site, management has considered, among other things, the aggregate potential cleanup costs of each site; the apparent involvement of the Company at each site and its prospective share of the remediation costs attributable thereto; the number of PRPs identified with respect to each site and their financial ability to contribute their proportionate shares of the remediation costs for such site; the availability of insurance coverage for the Company's\ninvolvement at each site and the likelihood that such coverage may be contested; and whether and to what extent potential sources of contribution from other PRPs or indemnification by insurance companies constitute reliable sources of recovery for the Company. Similar consideration has been given in determining the exposure and potential liability of the Company in connection with other significant legal proceedings to which the Company is a party. On the basis of such consideration, management has determined that such environmental matters will not have a material adverse effect on the Company's financial position or results of operations. The Company has provided an aggregate reserve amounting to approximately $300,000 for its estimated share of the ultimate cost of clean-up for claims arising from other such sites (without taking into account any potential indemnification or recovery from third parties).\nThe Company's roofing facility at Norwood, Massachusetts is one of 4,000 sites on the DEP List of Confirmed Disposal Sites. The DEP significantly revised the regulations that govern the reporting, assessment and remediation of hazardous waste sites in Massachusetts. The new Massachusetts Contingency Plan (\"MCP\") however, does not alter the ultimate liability for any remediation that may be necessary at the Norwood facility. Under the new MCP, the roofing facility was listed on the August 1993 \"Transition List of Confirmed Disposal Sites and Locations to be Investigated.\"\nA site assessment of the Norwood facility was performed for the Company by its environmental consultants GZA GeoEnvironmental, Inc. because the Company was on the DEP List of Confirmed Disposal Sites. The Company was required to complete certain additional remedial activities described in the new MCP on or before August 2, 1996. The Phase I and Phase II plan was completed in 1995 and submitted to the DEP in January 1996. In the opinion of management, no additional material costs will be incurred.\nSince 1981 Bird has been named as a defendant in approximately 550 product liability cases throughout the United States by persons claiming to have suffered asbestos-related diseases as a result of alleged exposure to asbestos used in products manufactured and sold by Bird. Approximately 140 of these cases are currently pending and costs of approximately $2 million in the aggregate have been incurred in the defense of these claims since 1981. Employers Insurance of Wausau (\"Wausau\") has accepted the defense of these cases under an agreement for sharing of the costs of defense, settlements and judgments, if any. At December 31, 1995, the Company has recorded a reserve of $950,000 to cover the estimated cost of these claims. In light of the nature and merits of the claims alleged, in the opinion of management, the resolution of these remaining claims will not have a material adverse effect on the results of operations or financial condition of the Company.\nIn 1992, a subsidiary of the Company, Bird Atlantic Corporation, formerly Atlantic Building Products Corporation (\"ABPCO\"), commenced an action against a former vendor, alleging violation of an exclusive distributorship without adequate and fair compensation to ABPCO. A jury trial was held in November 1995 in the Superior Court of Plymouth\nCounty, Massachusetts. The jury found in favor of ABPCO and judgement was entered on January 26, 1996 in the principal amount of approximately $1.8 million. The award, with interest accruing at 12% per annum, is expected to be in excess of $3 million and will not be reported as income until collected. The defendant has appealed the judgement.\nINSURANCE AND PRODUCT LIABILITY CLAIMS\nOn June 1, 1993, Wausau commenced action in the Superior Court for Norfolk County, Massachusetts, against Bird seeking a declaratory judgment that certain built-up roofing and glass shingle claims made against Bird were not covered by liability insurance policies issued by Wausau. Bird asserts that the claims are covered and has answered the complaint. A trial is scheduled for 1997. In the opinion of management, the above matter will not have a material adverse effect on the Company's financial position or results of operations.\nThe Company is also exposed to a number of other asserted and unasserted potential claims encountered in the normal course of business. In the opinion of management, the resolution of such claims will not have a material adverse effect on the Company's financial position or results of operations.\nThe Company is a defendant in a number of suits alleging product defects, the outcome of which management believes will not in the aggregate have a material impact 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\nThere were no matters submitted to a vote of security holders during the quarter ended December 31, 1995.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe names and ages of the executive officers of the Company as of\nMarch 8, 1996, the date from which they have served as officers and their present positions with the Company are as follows:\nRichard C. Maloof 50 January 1985 President and Chief Operating Officer\nFrank S. Anthony 49 May 1984 Vice President, General Counsel and Corporate Secretary\nMr. Maloof joined the Company in October 1971. He has held various positions such as Senior Roofing Engineer, Manufacturing Manager - Pacific Division, Vice President of Manufacturing and President of the Roofing Division. Mr. Maloof holds an engineering degree. He was elected President and COO in May 1995 and was also elected to the Board of Directors in 1995. Mr. Anthony is an attorney and prior to joining Bird served in the law department of Westinghouse Electric Corporation from 1976 to 1983.\nThese officers are appointed annually at an organizational meeting of the Board of Directors immediately following the annual meeting of stockholders. There are no family relationships among any of the officers of the Company nor are any of the officers related to any member of the Board of Directors.\nThe Company had an employment agreement with George Haufler, the former CEO, which was terminated on January 25, 1994. In December 1993, the Company entered into an employment contract and a severance agreement with Joseph Vecchiolla, successor to Mr. Haufler. The Company has also entered into agreements with its two executive officers. Mr. Anthony's agreement superseded his earlier severance agreement and provides that severance benefits are payable to him on March 31, 1996. The agreement automatically converts to an oral agreement on the same terms and conditions terminable by either party on 60 days notice. Mr. Maloof's agreement provides severance benefits to him after a change in control of the Company. These agreements are described in the Company's definitive proxy statement for its 1996 Annual Meeting which is to be filed with the Commission by April 30, 1996 and is incorporated herein by reference.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS COMMON STOCK INFORMATION\nThe Company had 2,123 common shareholders of record at December 31, 1995.\nThe common stock is quoted in the National Market System under the NASDAQ symbol BIRD. The range of high and low prices for the common stock as reported by NASDAQ for the periods indicated is set forth below.\nThe Company paid no cash dividends on its common stock during 1995 or 1994.\nUnder the terms of the Loan Agreement between the Company and Fleet Capital, the Company has agreed that it will refrain from paying cash dividends on its common stock or its $1.85 cumulative preference stock, without prior approval from the Bank.\nThe Company is in arrears in the payment of four dividends on its preference stock. The Articles of Organization of the Company provide that as long as any arrearage on the payment of dividends on the Company's 5% preferred stock exists, no dividends may be declared or paid on any other class of stock of the Company and further provides that in the event that full cumulative dividends on the preference stock have not been declared and paid, the Company may not declare or pay any dividends or make any distributions on, or purchase, redeem, or otherwise acquire, its common stock until full cumulative dividends on the preference stock have been declared and paid or set aside for payment.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following tables set forth certain financial data and are qualified in their entirety by the more detailed Consolidated Financial Statements and information included elsewhere herein:\nSELECTED CONSOLIDATED STATEMENT OF OPERATIONS DATA\nSELECTED CONSOLIDATED BALANCE SHEET DATA\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nPROPOSED MERGER\nOn March 14, 1996, the Company signed a definitive agreement with CertainTeed Corporation, a subsidiary of Saint-Gobain Corporation, providing for CertainTeed to acquire in a merger transaction all of the Company's outstanding common, preferred and preference shares.\nUpon the effective date of the merger, each share of the Company's outstanding common stock, par value $1 per share, will be converted into the right to receive an amount in cash equal to $7.50. The Company's outstanding 5% cumulative preferred stock, par value $100 per share, will remain issued and outstanding upon the effective date of the merger and will be called for redemption and retirement as soon as practicable thereafter at a price equal to $110, plus all accrued and unpaid dividends thereon as of the date of redemption and retirement. Each share of the Company's outstanding $1.85 cumulative convertible preference stock, par value $1 per share, will be converted into the right to receive $20 plus all accrued and unpaid dividends thereon as of the effective date of the merger.\nCompletion of the merger is subject to approval by the Company's shareholders and appropriate governmental authorities. The merger is not subject to a financing contingency. The Company's Board of Directors has received a fairness opinion from its investment bankers regarding the merger. The closing of the merger is anticipated at the end of the second quarter, following distribution of proxy materials to the Company's shareholders and approval at a special meeting.\nFINANCIAL CONDITION\nPrior to November 30, 1994, the Company's external financial needs were satisfied by borrowing under the Second and Third Amended Credit Agreements with The First National Bank of Boston, Philadelphia National Bank incorporated as Corestates Bank, N.A. and The Bank of Tokyo Trust Company.\nOn November 30, 1994, Bird Incorporated entered into a three year $39 million Loan Agreement with Fleet Capital Corporation (\"Fleet Capital\"), previously Barclays Business Credit, Inc. and Shawmut Capital Corporation. At the end of the three year period, the Loan Agreement will be automatically renewed for successive one year periods unless terminated specifically in writing. The Loan Agreement consisted of a $24 million revolving credit commitment and two equal term loans (Term loan A and Term loan B, as defined in the Loan Agreement) totaling $15 million. On March 8, 1995 the Company sold the assets of its vinyl siding operation to Jannock, Inc. for $47.5 million\nwhich was reduced to approximately $42.5 million by post-closing working capital adjustments. The proceeds from the sale were used to reduce bank debt. Concurrent with the sale, Fleet Capital executed the First Amendment to the Loan Agreement amending the amount of the facility to $20 million consisting of a $15 million revolving credit commitment and a $5 million term loan. At December 31, 1995, $5 million of debt was outstanding. On January 10, 1996, the Company paid down the term loan so that the outstanding principal balance equaled $2.5 million. Up to $5 million of the revolving credit facility can be used for letters of credit. Letters of credit outstanding as of December 31, 1995 totaled $2,233,000 compared to $2,927,000 as of December 31, 1994.\nBorrowings by Bird Incorporated under the Loan Agreement are guaranteed by the Company and the Company's other subsidiaries and are secured by substantially all of the assets of the Company and its subsidiaries. The revolving credit line availability is determined with reference to a percentage of accounts receivable and inventory which are pledged to the lender. During the period January 1 through April 30, the Loan Agreement provides a $2 million over advance on accounts receivable and inventories in order to assist the Company in assuring adequate funding of any seasonal build up of accounts receivable which may occur under sales programs offered during the winter months. Currently, the availability calculation does not allow borrowings to the full extent of the revolving credit commitment, due to the seasonality of the building materials manufacturing business. As of March 15, 1996, an aggregate of $7,683,000 was available to the Company under the terms of the revolving credit facility under the Loan Agreement.\nThe Loan Agreement contains financial and operating covenants which, among other things, (i) require the Company to maintain prescribed levels of tangible net worth, net cash flow and working capital and (ii) place limits on the Company's capital expenditures. The Loan Agreement also contains restrictions on indebtedness, liens, investments, distributions (including payment of common and preference dividends), mergers, acquisitions and disposition of assets. As of September 30, 1995, the Company was in default under Section 8.3.3 of the Loan Agreement as a result of failing to achieve a stated level of cash flow for the third quarter of 1995. As a result of the weak remodeling market during 1995, sales volume and earnings were less than anticipated, negatively impacting cash flow. At the request of the Company, Fleet Capital waived the cash flow requirements for the third quarter without penalty and amended this and other financial covenants for subsequent periods based on a review of the Company's financial condition and future projections. As of December 31, 1995, the Company was in compliance with all covenants.\nInterest on the revolving credit commitment under the First Amended Loan Agreement accrues at the Fleet Capital base rate (as specified in such Agreement) or the London Interbank Offering Rate (\"LIBOR\") plus 2 3\/4% at the Company's election on all borrowings plus the greater of $25,000 per annum or 1\/4% on any unused portion of the commitment payable monthly in arrears. The interest on the term loan accrues at the base rate or the LIBOR rate plus 2 3\/4% at the Company's election. The interest rate on outstanding borrowings at December 31, 1995 was\n8.69%. The repayment of the principal on the term loan is at the rate of $62,500 per month through November 1996 and $71,417 per month thereafter with a final principal payment of $3,455,800 due on November 30, 1997. Proceeds in excess of $100,000 from the sale of fixed assets may, at Fleet Capital's discretion, be applied to the outstanding principal payments of the term loan.\nIn order to control its cost and supply of asphalt, the Company constructed an asphalt oxidizer plant at its roofing facility in Norwood, Massachusetts. Construction was completed during January 1995. The Company's decision to build the oxidizer was triggered by the decision of Exxon (the only remaining supplier of asphalt in New England) to exit the New England market. The cost of this plant expansion was approximately $5.5 million.\nOn March 8, 1995, the Company sold substantially all of the assets of its vinyl siding operation to Jannock, Inc. for $47.5 million in cash subject to certain downward adjustments which totaled $4,962,000. Net of adjustments, the gain on the sale of the vinyl business totaled $20,579,000.\nOn June 2, 1995, the Company sold all of the outstanding capital stock of Bird-Kensington Holding Corp. (\"Bird-Kensington\"), which owned the Company's interest in Kensington Partners (\"Kensington\"), to Jannock, Inc. (\"Jannock\"). The sale was consummated pursuant to the exercise by Jannock of an option granted under an Asset Purchase Agreement related to the sale of the Company's vinyl business dated as of September 23, 1994 (as amended by amendments dated as of January 24, 1995, January 31, 1995, and April 27, 1995, the \"Asset Purchase Agreement\"). The purchase price consisted of cash in the amount of $2,780,000 and the assumption of certain liabilities related to the Kensington business. Cash proceeds of $1 million were used to acquire the minority partner's interest in Kensington. In addition, $3,692,000 was invested by the Company in Bird-Kensington, as a condition of the sale, to enable Kensington to pay certain liabilities and to assure that the equity of Kensington was not less than $1,150,000 at the time of closing as stipulated in the Asset Purchase Agreement.\nFollowing the closing date, Jannock presented to the Company financial statements of Kensington as of June 2, 1995, indicating that net equity was $471,000 less than the amount required by the Asset Purchase Agreement. The Company had established a reserve for the full amount of the shortfall at June 30, 1995 and subsequently paid to Jannock $398,000 in full settlement of the terms of the Asset Purchase Agreement. Net of certain purchase price adjustments, the loss on the sale of Kensington was $1,959,000.\nOne June 18, 1994, the Company agreed to cause the sale of its 80% interest in Bird Environmental Gulf Coast, Inc. (\"BEGCI\") to the minority shareholders thereof, subject to financing, resulting in the complete withdrawal from the environmental business. During 1995, the minority partner became unable to finance the purchase of the facility and efforts to attract another purchaser were unsuccessful. In July 1995, the Company's Board of Directors suspended further funding of the facility. As a result of this action, during the second quarter of\n1995, the Company's remaining investment of $8.6 million was written-off and a $3 million reserve was established for the costs associated with the closure of the facility. On November 29, 1995, the Company caused the sale all of the outstanding capital stock of BEGCI to GTS Duratek, Inc. for a purchase price of $1.00. In addition, the Company agreed to pay the purchaser the amount by which BEGCI's current liabilities exceeded its current assets at August 31, 1995 which was approximately $1.3 million. Of the $3 million reserve established in the second quarter of 1995, $2,050,000 was utilized, while $650,000 remains at December 31, 1995 for future claims against discontinued operations.\nNet cash and cash equivalents increased during fiscal 1995 by $3.4 million primarily due to cash received from the sale of the vinyl business. The cash used by continuing operations for the fiscal period ended December 31, 1995 increased $6.7 million, from $11.6 million to $18.3 million. In 1995, the Company recorded a gain of $20.6 million on the sale of its vinyl business. This gain was offset by charges of $11.3 million and $2 million related to the disposal of the environmental and window fabrication businesses, respectively. Cash used by operations in 1995 was also attributable to several significant changes in the balance sheet such as a reversal of future tax benefits of $11.3 million, a decrease of $3.1 million in trade accounts receivable, a decrease of $14.3 million in liabilities not relating to financing activities and an increase of $2.7 million relating to inventories.\nAdditionally, the vinyl and window fabrication business activities which were discontinued in 1995 had a significant impact on the changes in the balance sheet accounts between December 31, 1994 and December 31, 1995. As a result of these sales, inventory decreased $6.3 million, accounts and notes receivable decreased $11 million, and current liabilities decreased $9 million. In addition, assets held for sale decreased $7.5 million due to the write-off of the Company's interest in Bird Environmental Gulf Coast, Inc. (\"BEGCI\").\nThe Company had approximately $47.3 million of net cash provided from investing activities for the period ended December 31, 1995 as compared to a total of approximately $19.4 million for the period ended December 31, 1994. The change is primarily the result of $50.7 million of cash receipts from the proceeds of the sale of certain of the Company's assets (primarily, the sale of the assets of the vinyl and window fabrication businesses to Jannock, Inc. in March and June 1995, respectively), offset by cash used for capital expenditures of the roofing business and additional investments in discontinued operations. In the prior comparable period, net cash provided by investing activities resulted primarily from the proceeds of the sale of the Company's distribution business to Wm. Cameron & Co., offset by cash used for capital expenditures.\nThe net cash resulting from financing activities changed by $11 million from the prior year. Cash used in financing activities during 1995 resulted from the net repayment of debt of $24 million and $1.6 million of dividend payments, as compared to 1994 when the Company had net\nrepayments of debt of approximately $16 million and made minimal dividend payments.\nENVIRONMENTAL MATTERS\nThe Company monitors its compliance with environmental regulations on an ongoing basis. The Company's general counsel receives environmental site assessments from the operating managers responsible for site environmental compliance. Appropriate action is undertaken where needed. When environmental claims are asserted against the Company, the claims are evaluated by the Company's general counsel and operating management in conjunction with external legal counsel and environmental engineers as necessary, and action is taken with respect to all known sites, as appropriate. The Company is currently engaged in proceedings relating to or has received notice of the following environmental matters:\nOn March 15, 1994 the Company received a draft of an Administrative Consent Order and Notice of Noncompliance from the Massachusetts Department of Environmental Protection (\"DEP\") concerning operations at its Norwood, Massachusetts manufacturing facility and associated rock granule processing facility. The draft alleges that the Company was not in compliance with regulations of the DEP relating to air emissions, granule plant operation, and labeling, handling and storage of certain hazardous waste. The draft proposes certain corrective action on the part of the Company as well as payment of civil administrative penalties. On June 10, 1994, the Company's roofing division entered into an administrative consent order and notice of noncompliance with respect to the alleged violations. The consent order requires the Company to undertake certain modifications and corrective actions with respect to certain hazardous waste handling and storage facilities at the Norwood facility, to conduct an environmental audit of its operations at such facility and to undertake various modifications of air pollution control equipment. On May 13, 1994, the Company paid an administrative penalty of $30,000. The Company estimated that the cost of corrective action to be taken by it in accordance with the consent order would be approximately $100,000. The majority of the corrective actions were completed in 1995.\nOn March 25, 1994, the Company received a notice from the United States Environmental Protection Agency (the \"EPA\") regarding a site inspection prioritization report prepared by the DEP. The notice alleges a potential release of hazardous substances into the environment at the Company's former mill site in East Walpole, Massachusetts. The EPA has reserved the right to conduct further site tests on the location. A site assessment performed on the mill site in East Walpole for the Company by its environmental consultants, GZA, showed no environmental cleanup was necessary. This report was submitted to the DEP in July 1995. In the opinion of management and based on management's and GZA's understanding that the alleged releases are in de minimis quantities, this matter should not have a material adverse effect on the Company's financial position or on the results of its operations.\nOn June 21, 1994, the Arizona Department of Environmental Quality (\"ADEQ\") issued a notice of violation (\"NV\") to Southwest Roofing Supply, a previously owned division of the Company (\"Southwest\"), which directed Southwest to conduct a site investigation of property formerly leased by Southwest. A consent order between the ADEQ and the Company was issued on September 23, 1994. Pursuant to the consent order, the Company agreed to submit a work plan with a view to remediating the soil and groundwater that may have been contaminated by leaks from an underground storage tank previously removed by the Company. The Company's management believes that the remediation cost to the Company will be in the range of $200,000 to $700,000. As of December 31, 1995, the Company has provided a reserve of $450,000 for the estimated cost of cleanup. The Company anticipates that $200,000 will be reimbursed to the Company by the ADEQ in accordance with Arizona law and regulation.\nIn 1986, the Company, along with numerous other companies, was named by the EPA and other governmental agencies responsible for regulation of the environment as a Potentially Responsible Person (\"PRP\") pursuant to the Comprehensive Environmental Response, Compensation and Liability Act, as amended, 42 U.S.C. Paragraph 9601, et seq. (\"CERCLA\") in connection with hazardous substances at a site known as the Fulton Terminal Superfund site located in Fulton, Oswego County, New York. On September 28, 1990, the Company and a number of other PRPs reached a negotiated settlement with the EPA pursuant to which the settling PRPs agreed to pay the costs of certain expenses in connection with the proceedings and to pay certain other expenses, including the costs and expenses of administering a trust fund to be established by the settling PRPs. The settlement agreement is embodied in a consent decree lodged with the United States District Court for the Western District of New York and fixed the Company's proportionate share of the total expenses. The ultimate cost to the Company of the remedial work and other expenses covered by the settlement agreement is estimated to be between $1 million to $2 million payable over a period of 3 to 15 years (depending upon the duration of remediation efforts). At December 31, 1995, the Company has provided a reserve of approximately $1 million to cover the estimated cost of the Company's remaining proportionate share (i.e., 17%) of the ultimate total cost of cleanup. Under a cost-sharing arrangement set forth in a consent decree with the EPA, the other PRPs have agreed to incur 83% of the aggregate cost of remediation of this site.\nThe Company has been named as a PRP with respect to certain other sites which are being investigated by federal or state agencies responsible for regulation of the environment. As a consequence of its status as a PRP, the Company may be jointly and severally liable for all of the potential monetary sanctions and remediation costs applicable to each site. In assessing the potential liability of the Company at each site, management has considered, among other things, the aggregate potential cleanup costs of each site; the apparent involvement of the\nCompany at each site and its prospective share of the remediation costs attributable thereto; the number of PRPs identified with respect to each site and their financial ability to contribute their proportionate shares of the remediation costs for such site; the availability of\ninsurance coverage for the Company's involvement at each site and the likelihood that such coverage may be contested; and whether and to what extent potential sources of contribution from other PRPs or indemnification by insurance companies constitute reliable sources of recovery for the Company. Similar consideration has been given in determining the exposure and potential liability of the Company in connection with other significant legal proceedings to which the Company is a party. On the basis of such consideration, management has determined that such environmental matters will not have a material adverse effect on the Company's financial position or results of operations. The Company has provided an aggregate reserve amounting to approximately $300,000 for its estimated share of the ultimate cost of clean-up for claims arising from other such sites (without taking into account any potential indemnification or recovery from third parties).\nThe Company's roofing facility at Norwood, Massachusetts is one of 4,000 sites on the DEP List of Confirmed Disposal Sites. The DEP significantly revised the regulations that govern the reporting, assessment and remediation of hazardous waste sites in Massachusetts. The new Massachusetts Contingency Plan (\"MCP\") however, does not alter the ultimate liability for any remediation that may be necessary at the Norwood facility. Under the new MCP, the roofing facility was listed on the August 1993 \"Transition List of Confirmed Disposal Sites and Locations to be Investigated.\"\nA site assessment of the Norwood facility was performed for the Company by its environmental consultants GZA GeoEnvironmental, Inc. because the Company was on the DEP List of Confirmed Disposal Sites. The Company must complete certain additional remedial activities described in the new MCP on or before August 2, 1996. The Phase I and Phase II plan was completed and submitted to the DEP in January 1996. In the opinion of management, no additional material costs will be incurred.\nSince 1981 Bird has been named as a defendant in approximately 550 product liability cases throughout the United States by persons claiming to have suffered asbestos-related diseases as a result of alleged exposure to asbestos used in products manufactured and sold by Bird. Approximately 140 of these cases are currently pending and costs of approximately $2 million in the aggregate have been incurred in the defense of these claims since 1981. Employers Insurance of Wausau (\"Wausau\") has accepted the defense of these cases under an agreement for sharing of the costs of defense, settlements and judgments, if any. At December 31, 1995, the Company has recorded a reserve of $950,000 to cover the estimated cost of these claims. In light of the nature and merits of the claims alleged, in the opinion of management, the resolution of these remaining claims will not have a material adverse effect on the results of operations or financial condition of the Company.\nINSURANCE AND PRODUCT LIABILITY CLAIMS\nOn June 1, 1993, Wausau commenced action in the Superior Court for Norfolk County, Massachusetts, against Bird seeking a declaratory judgment that certain built-up roofing and glass shingle claims made\nagainst Bird were not covered by liability insurance policies issued by Wausau. Bird asserts that the claims are covered and has answered the complaint. A trial is scheduled for 1997. In the opinion of management, the above matter will not have a material adverse effect on the Company's financial position or results of operations.\nThe Company is also exposed to a number of other asserted and unasserted potential claims encountered in the normal course of business. In the opinion of management, the resolution of such claims will not have a material adverse effect on the Company's financial position or results of operations.\nThe Company is a defendant in a number of suits alleging product defects, the outcome of which management believes will not in the aggregate have a material impact on the Company's financial position or results of operations.\nLEGAL MATTERS\nIn 1992, a subsidiary of the company, Bird Atlantic Corporation, formerly Atlantic Building Products Corporation (\"ABPCO\"), commenced an action against a former vendor, alleging violation of an exclusive distributorship without adequate and fair compensation to ABPCO. A jury trial was held in November 1995 in the Superior Court of Plymouth County, Massachusetts. The jury found in favor of ABPCO and judgement was entered on January 26, 1996 in the principal amount of approximately $1.8 million. The award, with interest accruing at 12% per annum, is expected to be in excess of $3 million and will not be reported as income until collected. The defendant has appealed the judgement.\nRESULTS OF OPERATIONS\nThe Company's future prospects and sales are tied solely to one line of business (roofing manufacturing) which is dependent upon the economy in the northeastern United States. The Company produces all of its output at a single plant which relies on one major supplier for glass mat, a critical raw material. Nevertheless, the Company believes it has significant competitive advantages in this business. These advantages stem from, and are expected to continue in light of the Company's leading market share, its low cost production abilities resulting from a state-of-the-art plant, its internal supply of granules from its own quarry and granule plant and its asphalt oxidizing plant.\n1995 COMPARED WITH 1994\nEarnings from continuing operations before income taxes in fiscal 1995 were $10,627,000 compared to losses of $5,927,000 in fiscal 1994. Net sales from continuing operations decreased 67.7% from $167,886,000 to $54,180,000 as compared to 1994, primarily due to the sale of the Company's distribution and vinyl products business units. Sales from the roofing manufacturing business decreased $10,857,000 or 19.9% due\nto price weakness and a decline in volume. The decreased volume was attributable to a weak re-roofing market in the northeast caused by a mild 1994\/1995 winter followed by a hot, dry summer. The Company is expanding its sales territories to include areas bordering the northeastern United States in an effort to replace lost volume.\nCost of sales in 1995 was $48,007,000 as compared to $136,878,000 in 1994, constituting a decrease of 64.9%. The decline was primarily a result of the sale of the Company's distribution and vinyl products business units. Cost of sales for the roofing business decreased 18.4% or $8,662,000 due primarily to decreased manufacturing costs related to a decrease in sales volume. Although the Company experienced raw material price increases in glass mat and dry felt, the cost of asphalt, along with related freight, was reduced significantly as a result of the newly constructed asphalt oxidizer, which produces asphalt saturant and coatings. The oxidizer became operational in February 1995. From November 1995 through mid-February 1996, the oxidizer was temporarily shut down for repairs as a result of a fire within the tank farm area of the plant.\nCost of sales, stated as a percentage of net sales, was 88.6% in fiscal 1995 as compared to 81.5% in fiscal 1994. Roofing manufacturing cost of sales, as a percentage of sales, increased 1.6% from 86.2% to 87.8% in 1995. Increases in raw material costs and decreases in sales prices contributed to the percentage increase.\nSelling, general and administrative (\"SG&A\") expenses for fiscal 1995 decreased 59% from $28,786,000 to $11,817,000. The decrease was primarily attributable to the sale of the Company's distribution and vinyl products business units. However, SG&A expenses, as a percentage of sales, increased approximately 5% from year-to-year. The increase was due primarily to the amortized refinancing costs associated with the 1994 refinancing of an earlier credit agreement, additional charges related to environmental remediation and costs associated with closing the Company's corporate office. The decrease in sales in the roofing business without a corresponding decline in certain fixed costs also contributed to the increase as a percentage of sales.\nInterest expense was $927,000 in 1995 as compared to $4,782,000 in 1994, an 80.6% decrease. The decrease resulted from the reduction of debt which occurred through the use of proceeds from the sale of the vinyl products and distribution business units.\nDiscontinued business activities income in 1995 reflects primarily the gain of $20,579,000 on the sale of the vinyl manufacturing business, the loss of $1,959,000 on the sale of the window fabrication business and a charge of $1,500,000 for costs associated with the Company's employee benefit plans and future product liability claims, both related to former roofing operations. Fiscal 1994 discontinued business activities income reflects primarily the gain of $2,727,000 on the sale of all of the Company's building materials distribution businesses reduced by the loss of $1,261,000 on the sale of the Company's 40% interest in Mid-South Building Supply, Inc.\nEquity losses from the Company's partnership in the Kensington window\nfabrication business amounted to $372,000 for the period January 1, through February 28, 1995 as compared to $4,680,000 for the twelve month period ended December 31, 1994.\nA provision for income taxes from continuing operations amounting to $11,424,000 was recorded in 1995 compared to a benefit of $7,010,000 in 1994. The Company's decision to reverse $4 million of the valuation reserve in 1994 and subsequent decision to increase the reserve to $15.1 million in 1995 is the primary reason the effective tax rates differ from the statutory rate. At December 31, 1995 the Company's net deferred tax asset is approximately $19.1 million less a valuation reserve of $15.1 million. As required under FAS 109, this valuation reserve was determined based upon the Company's review of all available evidence including projections of future taxable income. During 1995, the Company disposed of Bird-Kensington Holding Corporation and Bird Environmental Gulf Coast, Inc. resulting in losses not anticipated at the end of the previous year. In addition, the lower overall demand and price weakness in the northeast caused by a mild 1994\/1995 winter followed by a hot, dry summer negatively impacted profits of the roofing operations.\nDuring the second quarter of 1995, the Company's remaining investment in BEGCI of $8.6 million was written-off to discontinued operations and a $3 million reserve was established for additional costs associated with the closure and disposition of the facility (see Note 9 to Consolidated Financial Statements). In November 1995, the Company caused the sale of all the outstanding capital stock of BEGCI to GTS Duratek, Inc.. for a purchase price of $1.00. Of the $3 million reserve established in the second quarter of 1995, $2,050,000 was utilized, while $650,000 remains at December 31, 1995 for future claims against discontinued operations.\nIn connection with the Board of Director's 1994 decision to withdraw from the off-site environmental business and the Company's agreement on June 18, 1994 to cause the sale of its shares in BEGCI to the minority stockholders on or before February 28, 1995, subject to financing, the Company reclassified the environmental business results as discontinued operations as of June 30, 1994 and adjusted the book value associated with BEGCI, resulting in an aggregate charge for the twelve months ended December 31, 1994 of $11,586,000.\nIn 1993, in connection with its decision to withdraw from the \"on-site\" environmental remediation business, the Company charged the results of operations for the write-down of assets, the expected loss from operations and general expenses related to closing of such \"on-site\" remediation business (see notes to Consolidated Financial Statements). Based upon the actual outcome of the sale of assets and results of operations, excess costs of $3,861,000 charged in 1993 were reversed and recorded as discontinued operations in the consolidated statement of operations for the year ending December 31, 1994.\n1994 COMPARED WITH 1993\nLosses from continuing operations before income taxes in 1994 were\napproximately $5.9 million compared to losses of approximately $5.3 million in 1993. Net sales from continuing operations decreased 10.6% from $187,745,000 in 1993 to $167,886,000 in 1994. Sales from the Company's roofing manufacturing business and its vinyl business increased 14.9% and 5.9%, respectively. Improved weather conditions and renewed strength in the remodeling market caused by low interest rates and a generally favorable economy contributed to the improvement in these businesses. However, a decrease in sales volume due to the sale of substantially all of the Company's building materials distribution businesses in August and November of 1994 significantly offset the improvement attained by the roofing and vinyl businesses.\nThe Company's cost of sales from continuing operations in 1994 as compared to 1993 decreased 9.7% from $151,664,000 to $136,878,000. Cost of sales from continuing operations in the roofing and vinyl manufacturing businesses increased 15.4% and 7.9%, respectively, due to increased manufacturing costs related to volume, higher raw material costs related to the increase in resin prices for the vinyl business and higher asphalt prices for the roofing manufacturing business. The increase was more than offset by the decline in cost of sales due to the August and November 1994 sales of the Company's building materials distribution businesses.\nCost of sales stated as a percentage of net sales was 81.5% in 1994 as compared to 80.8% in 1993. The roofing manufacturing business cost of sales as a percentage of sales increased .3% from 85.9% to 86.2% in 1994. The vinyl business cost of sales as a percentage of sales for fiscal 1994 increased from 76.0% to 77.5% or 1.5% over fiscal 1993. The major factor in such percentage increase was the increased cost of raw materials.\nSelling, general and administrative (\"SG&A\") expenses for fiscal 1994 decreased 12.0% from $32,716,000 in 1993 to $28,786,000 in 1994. The decrease was primarily attributable to the sale of the Company's building materials distribution businesses. The SG&A expenses of the Company's roofing and vinyl manufacturing businesses, on a combined basis, decreased 7.2% from year-to-year. However, SG&A expenses, as a percentage of sales remained relatively constant at approximately 17%.\nInterest expense was $4,782,000 in 1994 as compared to $2,472,000 in 1993, constituting a 93% increase. The increased interest expense reflects the nearly $10 million increased debt level and higher overall interest costs in 1994. Between April 11, 1994 and November 30, 1994 the Company was required to pay a default interest rate of 4% above the rate otherwise applicable to the revolving credit and term loans, compared to an approximate rate of 4.5% to 5% for 1993. Default interest expense totaled $1,032,000 during fiscal 1994.\nDiscontinued business activities income in 1994 reflects primarily the gain of $2,727,000 on the sale of all of the Company's building materials distribution businesses reduced by the loss of $1,261,000 on the sale of the Company's 40% interest in Mid-South Building Supply, Inc.\nOther non-recurring expenses totalled $4,680,000 in 1994 as compared to $5,903,000 in 1993. Kensington continued to experience operations problems and incurred losses of $4,680,000 and $2,625,000 in 1994 and 1993, respectively.\nA higher tax benefit from continuing operations was recorded in 1994 compared to the benefit booked in 1993. The Company's decision to record a $9 million valuation reserve in 1993 and subsequent decision to reverse $4 million in 1994 is the primary reason the effective tax rates differ from the statutory rate.\nIn connection with the Board of Director's decision to withdraw from the environmental business and the Company's agreement on June 18, 1994 to cause the sale of its shares in BEGCI to the minority stockholders on or before February 28, 1995, subject to financing, the Company reclassified BEGCI results as a discontinued operation as of June 30, 1994 and adjusted its book value, resulting in an aggregate charge for the twelve months ended December 31, 1994 of $11,586,000. The Company intended to operate the San Leon Facility until the sale of its interest in BEGCI was consummated.\nDue to the Company's decision to exit the off-site environmental business by selling its interest in the San Leon Facility as described above, the Company completely withdrew from the environmental business. As a result, historical results of operations for all of the environmental businesses have been classified as discontinued operations. In 1993, in connection with its decision to withdraw from the \"on-site\" environmental remediation business, the Company recorded a charge for the write-down of assets, the expected loss from operations and general expenses related to the closing of such \"on-site\" remediation business (see notes to Consolidated Financial Statements). Based upon the outcome of the sales of assets and results of operations, excess costs of $3,861,000 charged in 1993 were reversed and recorded as discontinued operations in the consolidated statement of operations for the year ending December 31, 1994.\nINFLATION\nThe Company is continually seeking ways to deal with raw material cost increases by productivity improvements and cost reduction programs. In recent years, the Company has not always been able to pass on increased raw material costs to customers by increasing selling prices because of intense competitive pressures. The Company has an ongoing program of updating productive capacity to take advantage of improved technology, and although the cumulative impact of inflation has resulted in higher costs for replacement of plant and equipment, these costs have been offset, in part, by productivity savings.\nNEW ACCOUNTING PRONOUNCEMENTS\nDuring 1995, the Financial Accounting Standards Board issued \"Statement of Financial Accounting Standards No. 123 Accounting For Stock Based\nCompensation\" (\"FAS 123\"). The Company intends to adopt FAS 123 through disclosure only in 1996.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe consolidated financial statements and schedules of the Company are included in a separate section of this report and 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\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by Items 10, 11, 12 and 13 (except the information on executive officers) is included in the Company's definitive proxy statement for its 1996 Annual Meeting of Stockholders which will be filed with the Commission by April 30, 1996 and which is incorporated herein by reference. Information on executive officers, required by Item 10, is included in PART I of this report under the heading \"Executive Officers of the Registrant\".\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) An Index of Financial Statements and Schedules is on page of this report. The Exhibit Index is on pages 28 through 33 of this report.\n(b) Reports on Form 8-K - No reports on Form 8-K were filed during the last quarter of the year ended December 31, 1995.\n(d) Financial Statements of Kensington Partners are on Page through of this report.\nItems 14 (a) (3) and (c) Exhibits Bird Corporation Norwood, Massachusetts\nEXHIBIT INDEX\nSequential Exhibit No. Page No. - ----------- ----------\n3(a) Articles of Organization (Filed as Appendix B to the Company's Registration Statement on Form S-4, Registration No 33-34440 and incorporated herein by reference.)\n3(b) By-laws of the Company as amended to date. (Filed as Exhibit 3(b) to the Company's report on Form 10-K for the year ended December 31, 1990 and incorporated herein by reference.)\n4(a)(1) Forbearance Agreement dated as of February 14, 1994 with regard to the Revolving Credit Agreement dated as of December 17, 1990, as amended. (Filed as Exhibit 4 (a)(3) to the Company's Form 10-K for the year ended December 31, 1993 and incorporated herein by reference.)\n4(a)(2) Third Amended and Restated Revolving Credit and Term Loan Agreement dated as of March 4, 1994 (Filed as Exhibit 4(a)(1) to the Company's Form 8-K dated March 14, 1994 and incorporated herein by reference.)\n4(a)(3) Loan and Security Agreement dated as of November 30, 1994 (the \"Loan Agreement\") between Barclays Business Credit, Inc. (now known as Fleet Capital Corporation) and Bird Incorporated. (Filed as Exhibit 4(a)(3) to the Company's Form 10-K for the year ended December 31, 1994 and incorporated herein by reference.)\n4(a)(4) First Amendment dated as of March 8, 1995 to the Loan Agreement between Shawmut Capital Corporation (now known as Fleet Capital Corporation) and Bird Incorporated. (Filed as Exhibit 4(a)(4) to the Company's Form 10-K for the year ended December 31, 1994 and incorporated herein by reference.)\nSequential Exhibit No. Page No. - ----------- ----------\n4(a)(5) Rights Agreement dated as of November 25, 1986 between the Company and the First National Bank of Boston, as Rights Agent. (Filed as Exhibit 1 to Registration Statement on Form 8-A dated December 5, 1986 and incorporated herein by reference.)\n4(a)(6) First Amendment dated May 24, 1990 to Rights Agreement dated as of November 25, 1986. (Filed as Exhibit 4(b)(2) to the Company's report on Form 10-K for the year ended December 31, 1990 and incorporated herein by reference.)\n10(a)* Plan for Assistance to Key Employees in Financing Purchases of Company Stock (Filed as Exhibit 10(b) to the Company's report on Form 10-K for the year ended December 31, 1980 and incorporated herein by reference.)\n10(b)* Plan for Deferring Payment of Senior Officer's Compensation (Adopted December 22, 1975). (Filed as Exhibit 10(c) to the Company's report on Form 10-K for the year ended December 31, 1980 and incorporated herein by reference.)\n10(c)* 1975 Plan for Deferring Payment of Director's Compensation (Adopted June 23, 1975). (Filed as Exhibit 10(d) to the Company's report on Form 10-K for the year ended December 31, 1980 and incorporated herein by reference.)\n10(d)* Settlement Agreement dated as of July 7, 1994 between Bird Corporation and George J. Haufler. (Filed as Exhibit 10(d) to the Company's Form 10-K for the year ended December 31, 1994 and incorporated herein by reference.)\n10(e)* Management Incentive Compensation Program adopted January 25, 1983. (Filed as Exhibit 10(m) to the Company's report on Form 10-K for the year ended December 31, 1982 and incorporated herein by reference.)\nSequential Exhibit No. Page No. - ----------- ----------\n10(f)* Bird Corporation 1982 Stock Option Plan as amended through January 29, 1992. (Filed as Exhibit 10(f) to the Company's report on Form 10-K for the year ended December 31, 1991 and incorporated herein by reference.)\n10(g)* Bird Corporation 1992 Stock Option Plan. (Filed as Exhibit 10(g) to the Company's report on Form 10-K for the year ended December 31, 1992 incorporated herein by reference.)\n10(h)* Bird Corporation Non-Employee Director Stock Option Plan. (Filed as Exhibit 10(h) to the Company's report on Form 10-K for the year ended December 31, 1992 incorporated herein by reference.)\n10(i)(1)* Form of severance agreement with eight key executive employees of the Company. (Filed as Exhibit 10(n) to the Company's report on Form 10-K for the year ended December 31, 1984 and incorporated herein by reference.)\n10(i)(2)* Form of Amendment dated May 24, 1990 to form of severance agreement. (Filed as Exhibit 10(g)(2) to the Company's report on Form 10-K for the year ended December 31, 1990 and incorporated herein by reference.)\n10(k) Glass Mat Supply Agreement dated as of February 20, 1985 between the Company, The Flintkote Company and Genstar Roofing Company, Inc. (Filed as Exhibit 10(s) to Amendment No. 1 to the Company's report on Form 10-K for the year ended December 31, 1984 and incorporated herein by reference.)\n10(l) Equipment Acquisition Agreement dated May 25, 1990 between BancBoston Leasing Inc. and Bird Incorporated. (Filed as Exhibit 10(j) to the Company's report on Form 10-K for the year ended December 31, 1990 and incorporated herein by reference.)\nSequential Exhibit No. Page No. - ----------- ----------\n10(m) Equipment Acquisition Agreement dated July 23, 1986 between BancBoston Leasing Inc. and Bird Incorporated. (Filed as Exhibit 10(s) to the Company's report on Form 10-K for the year ended December 31, 1986 and incorporated herein by reference.)\n10(n)(1)* Long Term Incentive Compensation Plan dated June 28, 1988. (Filed as Exhibit 10(v) to the Company's report on Form 10-Q for the quarter ended September 30, 1988 and incorporated herein by reference.)\n10(n)(2)* Amendment dated May 24, 1990 to Long Term Incentive Compensation Plan. (Filed as Exhibit 10(o)(2) to the Company's report on Form 10-K for the year ended December 31, 1990 and incorporated herein by reference.)\n10(o) Amendment dated February 1, 1994 to the First Amended and Restated Partnership Agreement between Bird Vinyl Products, Inc. and Kensington Manufacturing Company. (Filed as Exhibit 10(o)(2) to the Company's report on Form 10-K for the year ended December 31, 1993 and incorporated herein by reference.)\n10(p)* Employment Agreement dated as of December 1, 1993 between the Company and Joseph D. Vecchiolla. (Filed as Exhibit 10(p) to the Company's report on Form 10-K for the year ended December 31, 1993 and incorporated herein by reference.)\n10(q)* Severance Agreement dated as of December 21, 1993 between the Company and Joseph D. Vecchiolla. (Filed as Exhibit 10(q) to the Company's report on Form 10-K for the year ended December 31, 1993 and incorporated herein by reference.)\n10(r)* Settlement Agreement dated as of November 25, 1994 between Bird Corporation and William A. Krivsky. (Filed as Exhibit 10(r) to the Company's Form 10-K for the year ended December 31, 1994 and incorporated herein by reference.)\nSequential Exhibit No. Page No. - ----------- ----------\n10(s) Asset Purchase Agreement dated as of August 19, 1994 between Bird Incorporated, Atlantic Building Products Corporation, Greater Louisville Aluminum, Inc., Southwest Roofing Supply, Inc., Southwest Express, Inc., New York Building Products, Inc., and Wm. Cameron & Co. (Filed as Exhibit (1) to the Company's Form 8-K dated August 31, 1994 and incorporated herein by reference.)\n10(t) Asset Purchase Agreement dated as of September 23, 1994 among Bird Corporation, Bird Incorporated, and Jannock, Inc. (as amended by amendments dated as of January 27, 1995 and January 31, 1995). (Filed as Exhibit B to the Company's proxy statement dated February 10, 1995 for the special meeting of the stockholders to be held on March 7, 1995 and incorporated herein by reference.)\n10(u)* Employment Agreement dated as of July 31, 1995 between the Company and Frank S. Anthony. (Filed as Exhibit 10(u) to the Company's Form 10-Q for the quarter ended September 30, 1995 and incorporated herein by reference).\n10(v)* Amended Employment Agreement dated August 21, 1995 between the Company and Richard C. Maloof. (Filed as Exhibit 10(v) to the Company's Form 10-Q for the quarter ended September 30, 1995 and incorporated herein by reference).\n10(w) Stock Purchase Agreement dated as of November 29, 1995 by and among Bird Environmental Gulf Coast, Inc., Bird Environmental Technologies, Inc., Bird Corporation, GTS Duratek,Inc. and GTSD Sub II, Inc.\n10(x) Amended Glass Mat Supply Agreement dated as of December 1, 1995 between the Company, Flintkote Company and Genstar Roofing Company, Inc.\n10(y) Agreement and Plan of Merger by and among CertainTeed Corporation, BI Expansion Corporation and Bird Corporation dated as of March 14, 1996.\nSequential Exhibit No. Page No. - ----------- ----------\n11 Statement regarding computation of per share earnings(loss).\n22 Significant subsidiaries.\n23(a) Consent of Price Waterhouse LLP.\n23(b) Consent of Alpern, Rosenthal and Company, independent accountants for Kensington Partners.\n24 Power of Attorney. (Immediately preceding the signature page hereof.)\n28 Annual report on Form 11-K of the Bird Employees' Savings and Profit Sharing Plan for the fiscal year ended December 31, 1995. (To be filed by amendment.)\n* Indicates management contract or compensatory plan or arrangement\nPOWER OF ATTORNEY\nWe, the undersigned officers and Directors of Bird Corporation, hereby severally constitute and appoint Richard C. Maloof and Frank S. Anthony, and each of them severally, our true and lawful attorneys or attorney, with full power to them and each of them to execute for us, and in our names in the capacities indicated below, and to file with the Securities and Exchange Commission the Annual Report on Form 10-K of Bird Corporation, for the fiscal year ended December 31, 1995, and any and all amendments thereto.\nIN WITNESS WHEREOF, we have signed this Power of Attorney in the capacities indicated on March 21, 1996.\nPrincipal Executive Officer:\n____________________________ President, Director and Richard C. Maloof Chief Operating Officer\nPrincipal Accounting Officer:\n____________________________ Corporate Controller Donald L. Sloper, Jr.\nDirectors\n____________________________ ____________________________ Robert P. Bass, Jr. Francis J. Dunleavy\n____________________________ ____________________________ Charles S. Bird, Jr. John T. Dunlop\n____________________________ ____________________________ Guy W. Fiske Joseph D. Vecchiolla\n____________________________ Loren R. Watts\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nBIRD CORPORATION (Registrant)\nBy_____________________ Richard C. Maloof President, COO\nMarch 27, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, 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________________________ President, Director, March 27, 1996 RICHARD C. MALOOF and COO (Principal Executive Officer)\n________________________ Corporate Controller March 27, 1996 DONALD L. SLOPER, JR. (Principal Accounting Officer)\n* ________________________ Director March 27, 1996 JOSEPH D. VECCHIOLLA\nSIGNATURES (continued)\n* ________________________ Director March 27, 1996 ROBERT P. BASS, JR.\n* ________________________ Director March 27, 1996 CHARLES S. BIRD, JR.\n* ________________________ Director March 27, 1996 FRANCIS J. DUNLEAVY\n* ________________________ Director March 27, 1996 JOHN T. DUNLOP\n* ________________________ Director March 27, 1996 GUY W. FISKE\n* ________________________ Director March 27, 1996 LOREN R. WATTS\n* By _________________________________________ Frank S. Anthony as Attorney-in-fact\nANNUAL REPORT ON FORM 10-K\nITEM 14 (A) (1) AND (2)\nLIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nYEAR ENDED DECEMBER 31, 1995\nBIRD CORPORATION NORWOOD, MASSACHUSETTS\nBird Corporation and Subsidiaries\nForm 10-K\nItems 14(a)(1) and (2)\nINDEX OF FINANCIAL STATEMENTS AND SCHEDULES\nThe following consolidated financial statements of the registrant and its subsidiaries required to be included in Item 8 are listed below.\nConsolidated Financial Statements: Page ---- Reports of independent accountants\nBalance sheets at December 31, 1995 and 1994\nStatements of operations for each of the three years in the period ended December 31, 1995\nStatements of stockholders' equity for each of the three years in the period ended December 31, 1995\nStatements of cash flows for each of the three years in the period ended December 31, 1995\nNotes to consolidated financial statements\nThe following consolidated financial statement schedules of Bird Corporation and its subsidiaries are included in Item 14(a)(2) and should be read in conjunction with the financial statements included herein:\nSchedule II - Valuation and qualifying accounts\nAll other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission have been omitted because they are not applicable or the required information is shown in the financial statements or the notes thereto.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Stockholders of Bird Corporation\nWe have audited the consolidated balance sheets of Bird Corporation and its subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations, of stockholders' equity and of cash flows for each of the three years in the period ended December 31, 1995. 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 Kensington Partners, which statements reflect total assets of $8.9 million at December 31, 1994, and total net sales of $24.2 million and $21.2 million and net losses of $5.3 million and $5.2 million for the years ended December 31, 1994 and 1993, respectively. Those 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 Kensington Partners, 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 and the report of the other auditors provide a reasonable basis for our opinion.\nIn our opinion, based on our audits and the report of the other auditors, 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 Bird Corporation and its subsidiaries as of December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles.\nAs discussed in Note 4 to the consolidated financial statements, the Company changed its method of accounting for income taxes in 1993 to comply with a new pronouncement issued by the Financial Accounting Standards Board.\nPrice Waterhouse LLP Boston, Massachusetts\nMarch 15, 1996\nINDEPENDENT AUDITORS' REPORT\nTO THE PARTNERS KENSINGTON PARTNERS AND AFFILIATE Leechburg, Pennsylvania\nWe have audited the accompanying combined balance sheet of Kensington Partners and Affiliate (Joint Venture Partnerships) as of December 31, 1994 and the related combined statements of operations and changes in partners' capital (deficit), and cash flows for the years ended December 31, 1994 and 1993. These financial statements are the responsibility of the Partnerships' 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 combined financial statements referred to above present fairly, in all material respects, the financial position of Kensington Partners and Affiliate as of December 31, 1994, and the results of their operations and their cash flows for the years ended December 31, 1994 and 1993, in conformity with generally accepted accounting principles.\nThe accompanying financial statements have been prepared assuming that Kensington Partners and Affiliate will continue as going concerns. As discussed in Note 2 to the financial statements, the Companies have incurred significant operating losses and current liabilities exceed current assets. Those conditions, among others, raise substantial doubt about the Companies' ability to continue as going concerns. Management's plans regarding those matters are also described in Note 2. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.\nAlpern, Rosenthal & Company Pittsburgh, Pennsylvania\nFebruary 10, 1995\nBIRD CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE, PAR VALUE, AND LIQUIDATION VALUE DATA)\nSee accompanying notes to consolidated financial statements.\nBIRD CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE, PAR VALUE, AND LIQUIDATION VALUE DATA)\nSee accompanying notes to consolidated financial statements.\nBIRD CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)\nSee accompanying notes to consolidated financial statements.\nBIRD CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (In thousands, except share and per share amounts)\nSee accompanying notes to consolidated financial statements.\nBIRD CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)\nSee accompanying notes to consolidated financial statements.\nBIRD CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. ACCOUNTING POLICIES\nNATURE OF OPERATIONS\nBird Corporation is a manufacturer of asphalt roofing products. Currently, asphalt shingles and roll roofing are produced at the Company's plant in Norwood, Massachusetts for commercial and residential use. These products are marketed in the northeastern United States through independent wholesalers and building material retailers whose primary customers are roofing contractors.\nBASIS OF CONSOLIDATION\nThe accompanying consolidated financial statements include the accounts of Bird Corporation and its majority-owned subsidiaries (the \"Company\"). All material intercompany activity has been eliminated from the financial statements. Investments in less than majority-owned companies are accounted for by the equity method. Certain prior year amounts have been reclassified to conform with the 1995 presentation.\nPERVASIVENESS OF ESTIMATES\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nCONCENTRATION OF RISK AND MAJOR CUSTOMERS\nThe Company is dependent upon the economy in the northeastern United States and sells its products primarily to independent wholesalers and building material retailers for resale primarily to roofing contractors. One customer accounted for slightly more than 10% of the Company's sales during 1995 and accounts receivable at December 31, 1995.\nThe principal raw materials used in the manufacture of asphalt roofing products are fiberglass mat, asphalt saturants and coatings and crushed granules. The Company's requirements for fiberglass mat are met primarily under a Glass Mat Supply Agreement with one vendor which expires on December 31, 1996. Fiberglass mat is also generally available in adequate quantities from a number of outside suppliers.\nREVENUE RECOGNITION\nThe Company recognizes revenue when products are shipped or services are performed.\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.\nINVENTORIES\nInventories are valued at the lower of cost or market. Cost is determined for a large portion of the inventories by the last-in, first-out (LIFO) method computed using the dollar value method for natural business unit pools. The cost of the remaining inventories is determined generally on a first-in, first-out (FIFO) basis.\nPROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment is stated at cost. Depreciation has been provided in the financial statements primarily on the straight-line method at rates, based on reasonable estimates of useful lives, which fall within the following ranges for major asset classifications:\nLand improvements 10 to 20 years Buildings 20 to 40 years Machinery and equipment 5 to 20 years\nDeprecation expense for continuing operations for 1995, 1994 and 1993 amounted to $2,831,000, $3,644,000 and $3,757,000, respectively. Maintenance, repairs and minor renewals are charged to earnings in the year in which the expense is incurred. Additions, improvements and major renewals are capitalized. The cost of assets retired or sold, together with the related accumulated depreciation, are removed from the accounts, and any gain or loss on disposition is credited or charged to earnings. The Company capitalizes interest cost on construction projects while in progress. The capitalized interest is recorded as part of the asset to which it is related and is amortized over the asset's estimated useful life.\nRETIREMENT PLANS\nThe Company has a defined contribution plan covering substantially all eligible non-union salaried and non-union hourly employees. Annual contributions are made to the plan based on rates identified in the plan agreement.\nADVERTISING\nAdvertising costs are charged to operations when incurred. The Company did not incur any costs associated with direct response advertising in 1995, 1994 and 1993, and there were no capitalized advertising costs at December 31, 1995 and 1994. Advertising expense for 1995, 1994 and 1993 was $503,000, $1,023,000 and $1,230,000, respectively.\nEARNINGS(LOSS) PER COMMON SHARE\nPrimary earnings(loss) per common share is determined after deducting the dividend requirements of the preferred and preference shares and is based on the weighted average number of common shares outstanding during each period increased by the effect of dilutive stock options. Fully diluted earnings(loss) per common share also give effect to the reduction in earnings per share, if any, which would result from the conversion of the $1.85 cumulative convertible preference stock at the beginning of each period if the effect is dilutive.\nENVIRONMENTAL MATTERS\nThe Company records a liability for environmental matters when it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated based on the available evidence and site assessments. If an amount is likely to fall within a range and no single amount within that range can be determined to be a better estimate, the minimum amount of the range is recorded. If there are other participants and the liability is joint and several, the financial stability of the other participants is considered in determining the Company's accrual. In addition, the liability excludes claims for recoveries from insurance companies and other third parties until such claims for recoveries are probable of realization at which point they would be classified separately as a receivable.\nWARRANTY COSTS\nThe Company warrants under certain circumstances that its building material products meet certain manufacturing and material specifications. The warranty policy is unique to each product, ranges from twenty to forty years, is generally for the material cost and requires the owner to meet specific criteria such as proof of purchase. The Company offers the original manufacturer's warranty only as part of the original sale and at no additional cost to the customer. In addition, for marketing considerations, the Company makes elective settlements in response to customer complaints. The Company records the liability for warranty claims and elective customer settlements when it determines that a specific liability exists or a payment will be made.\n2. INVENTORIES\nThe percentages of inventories valued on the LIFO method were 100% and 86% at December 31, 1995 and 1994, respectively. It is not practical to separate LIFO inventories by raw materials and finished goods components; however, the following table (in thousands) presents these components on a current cost basis with the LIFO reserve shown as a reduction.\n3. DEBT\nAt December 31, the Company's borrowings and debt obligations are summarized as follows (in thousands):\nPrior to November 30, 1994, the Company's external financial needs were satisfied by borrowing under the Second and Third Amended Credit Agreements with The First National Bank of Boston, Philadelphia National Bank incorporated as Corestates Bank, N.A. and The Bank of Tokyo Trust Company.\nOn November 30, 1994, Bird Incorporated entered into a three year $39 million Loan Agreement with Fleet Capital Corporation (\"Fleet Capital\"), previously Barclays Business Credit, Inc. and Shawmut Capital Corporation. At the end of the three year period, the Loan Agreement will be automatically renewed for successive one year periods unless terminated specifically in writing. The Loan Agreement consisted of a $24 million revolving credit commitment and two equal term loans (Term loan A and Term loan B, as defined in the Loan Agreement) totaling $15 million. On March 8, 1995 the Company sold the assets of its vinyl siding operation to Jannock, Inc. for $47.5 million which was reduced to approximately $42.5 million by post-closing working capital adjustments (see Note 7). The proceeds from the sale were used to reduce bank debt. Concurrent with the sale, Fleet Capital executed the First Amendment to the Loan Agreement amending the amount of the facility to $20 million consisting of a $15\nmillion revolving credit commitment and a $5 million term loan. On January 10, 1996, the Company paid down the term loan so that the outstanding principal balance equaled $2.5 million. Up to $5 million of the revolving credit facility can be used for letters of credit. Letters of credit outstanding as of December 31, 1995 totaled $2,233,000 compared to $2,927,000 as of December 31, 1994.\nBorrowings by Bird Incorporated under the Loan Agreement are guaranteed by the Company and the Company's other subsidiaries and are secured by substantially all of the assets of the Company and its subsidiaries. The revolving credit line availability is determined with reference to a percentage of accounts receivable and inventory which are pledged to the lender. During the period January 1 through April 30, the Loan Agreement provides a $2 million over advance on accounts receivable and inventories in order to assist the Company in assuring adequate funding of any seasonal build up of accounts receivable which may occur under sales programs offered during the winter months. Currently, the availability calculation does not allow borrowings to the full extent of the revolving credit commitment, due to the seasonality of the building materials manufacturing business. As of March 15, 1996, an aggregate of $7,683,000 was available to the Company under the terms of the revolving credit facility under the Loan Agreement.\nThe Loan Agreement contains financial and operating covenants which, among other things, (i) require the Company to maintain prescribed levels of tangible net worth, net cash flow and working capital and (ii) place limits on the Company's capital expenditures. The Loan Agreement also contains restrictions on indebtedness, liens, investments, distributions (including payment of common and preference dividends), mergers, acquisitions and disposition of assets. As of September 30, 1995, the Company was in default under Section 8.3.3 of the Loan Agreement as a result of failing to achieve a stated level of cash flow for the third quarter of 1995. As a result of the weak remodeling market during 1995, sales volume and earnings were less than anticipated, negatively impacting cash flow. At the request of the Company, Fleet Capital waived the cash flow requirements for the third quarter without penalty and amended this and other financial covenants for subsequent periods based on a review of the Company's financial condition and future projections. As of December 31, 1995, the Company was in compliance with all covenants.\nInterest on the revolving credit commitment under the First Amended Loan Agreement accrues at the Fleet Capital base rate (as specified in such Agreement) or the London Interbank Offering Rate (\"LIBOR\") plus 2 3\/4% at the Company's election on all borrowings plus the greater of $25,000 per annum or 1\/4% on any unused portion of the commitment payable monthly in arrears. The interest on the term loan accrues at the base rate or the LIBOR rate plus 2 3\/4% at the Company's election. The interest rate on outstanding borrowings at December 31, 1995 was 8.69%. The repayment of the principal on the term loan is at the rate of $62,500 per month through November 1996 and $71,417 per month thereafter with a final principal payment of $3,455,800 due on November 30, 1997. Proceeds in excess of $100,000 from the sale of fixed assets may, at Fleet Capital's discretion, be applied to the outstanding principal payments of the term loan.\nThe weighted average interest rates on short term borrowings at December 31, 1995 and December 31, 1994 were 9.74% and 9.53%, respectively. The fair value of the Company's total debt approximated the carrying value at December 31, 1995 and 1994, respectively. The fair value is based on management's estimate of current rates available to the Company for similar debt with the same remaining maturity.\nMaturities of long-term debt for each of the five years subsequent to December 31, 1995 are as follows:\n1996 - $1,113,000; 1997 - $4,614,000; 1998 - $255,000; 1999 - $0; 2000 - $0. The Company incurred net interest expense of $927,000 in 1995, $4,782,000 in 1994 (net of $257,000 capitalized interest), and $2,472,000 in 1993 (net of $345,000 capitalized interest).\n4. INCOME TAXES\nEarnings (loss) from continuing operations before income taxes and the provision(benefit) for income taxes are shown below (in thousands):\nThe provision (benefit) for income taxes on continuing operations varied from the U.S. federal statutory rate for the following reasons:\nThe net provision (benefit) for income taxes related to discontinued operations amounted to $(2,962,000) and $304,000 for 1994 and 1993, respectively.\nThe deferred income tax asset recorded in the consolidated balance sheet results from differences between financial statement and tax\nreporting of income and deductions. A summary of the composition of the deferred income tax asset at December 31, 1995 and 1994 is as follows (in thousands):\nThe Company has available for federal income tax purposes unused net operating loss and investment tax credit carryforwards, which may provide future tax benefits, expiring as follows (in thousands):\nAdditionally, for federal income tax purposes, at December 31, 1995 the Company had available for carryforward minimum tax credits with no expiration aggregating $1,091,000. If certain substantial changes in the Company's ownership should occur, there would be an annual limitation on the amount of the carryforwards, including certain unrealized built-in losses, which can be utilized for regular and alternative minimum tax purposes. (See Note 14 regarding proposed merger with CertainTeed Corporation.)\nThe Company adopted FAS 109 in 1993 and recorded the cumulative effect of the change in accounting principle of approximately $2.7 million as a benefit in the results of operations for the first quarter of 1993. This accounting change also requires the recognition of a valuation reserve if it is more likely than not that the Company may not be able to realize the benefits of recorded deferred tax assets. At December 31, 1995 the Company's net deferred tax asset is approximately $19.1 million less a valuation reserve of $15.1 million. As required under FAS 109, this valuation reserve was determined based upon the Company's review of all available evidence including projections of future taxable income. During 1995, the company disposed of Bird-Kensington Holding Corporation and Bird Environmental Gulf Coast, Inc. (as disclosed in Notes 7 and 9, respectively) resulting in losses not anticipated at the end of the previous year. In addition, the lower overall demand and price weakness in the northeast caused by a mild 1994\/1995 winter followed by a hot, dry summer negatively impacted profits of the roofing operations. Based on the above factors, the Company increased the valuation reserve by $10.1 million.\nThe Company expects to be profitable and with other tax planning strategies expects to generate future taxable income. Realization of the $4,066,000 net deferred tax asset is dependent on generating sufficient taxable income prior to expiration of the loss carryforwards. Although realization is not assured, management believes that it is more likely than not that the net deferred tax asset will be realized. The amount of the net deferred tax asset considered realizable, however, could be reduced in the near term if estimates of future taxable income during the carryforward period are reduced.\n5. STOCKHOLDERS' EQUITY\nThe $1.85 cumulative convertible preference stock is redeemable, in whole or in part, at the option of the Company, at a redemption price of $20.00 per share on and after May 15, 1993. The convertible preference stock has a liquidation value of $20.00 per share and is convertible at the option of the holder into common stock of the Company at a conversion price of $22.25 per share, subject to adjustment in certain events. Dividends are cumulative from the date of issue and are payable quarterly. There are four preference dividends in arrears. The Company has the option to redeem the convertible preference stock. The Company's 5% cumulative preferred stock ranks senior to the convertible preference stock as to dividends and upon liquidation.\nOn June 18, 1992 the Company announced that its Board of Directors authorized it to buy back, on the open market or in privately negotiated transactions, up to 400,000 of its outstanding shares of common stock at prices available from time to time that the Company deems attractive. Since this announcement the Company has repurchased 248 shares in 1994, 5,364 shares in 1993 and 92,007 shares in 1992.\nThe Company is prohibited from purchasing its common stock as long as dividends on the convertible preference stock are in arrears. Under the 1992 Stock Option Plan described in Note 6, 931,325 shares of\ncommon stock are reserved for issuance upon exercise of options and stock appreciation rights at December 31, 1995.\nRestrictions on the payment of dividends on common and preference stock are imposed by the terms of the Loan Agreement dated November 30, 1994. Payment of dividends on the preferred stock are permitted under the Loan Agreement. As of December 31, 1995, all dividends current and in arrears on the preferred stock in the amount of $29,000 and $22,000 respectively, have been declared and paid in full. Dividends are in arrears on the preference stock in the aggregate amount of $1,506,000 for the four quarterly periods ended February 15, 1995 and must be paid in full before any dividends could be declared and paid on the common stock. The quarterly dividends on the preference stock due May 15, August 15, and November 15, 1995 in the aggregate amount of $1,130,000, along with one dividend in arrears in the amount of $377,000, have with the consent of Fleet Capital, been declared and paid in full.\nThe Company has a Rights Agreement which, as amended, entitles certain common stockholders to purchase shares of common stock of the Company or securities of an acquiring entity in the event of certain efforts to acquire control of the Company. The proposed merger with CertainTeed Corporation (Note 14) will not trigger the exercisability of these rights.\n6. EMPLOYEE BENEFIT PLANS\nRETIREMENT PLANS\nThe Company's \"Bird Employees' Savings and Profit Sharing Plan\" provides for a defined base contribution and profit sharing and savings contributions.\nDEFINED BASE CONTRIBUTION\nThe Company contributes annually 2-7% of plan participants' basic compensation depending upon their age and employment status as of December 31, 1984. Vesting accrues at 20% per year of service. Contributions for continuing operations for the years ended December 31, 1995, 1994, and 1993 amounted to $72,000, $203,000, and $352,000, respectively.\nPROFIT SHARING CONTRIBUTION\nProfit sharing contributions are made annually, if earned, based upon certain defined levels of return on equity by the Company and its business units. The distribution of the contribution to the plan's participants is based upon annual basic compensation. Contributions for continuing operations for the year ended December 31, 1993 amounted to $145,000. No profit sharing contributions were earned for 1995 or 1994.\nSAVINGS CONTRIBUTION\nThe Company's savings plan provides that eligible employees may contribute to the plan any whole percentage of their basic\ncompensation varying from 2 to 15%. The Company may make discretionary matching contributions not exceeding 6% of the participant's basic compensation during the plan year. Such matching Company contributions are invested in shares of the Company's common stock. The Company's contributions for continuing operations for the years ended December 31, 1995, 1994, and 1993 amounted to $124,000, $142,000, and $155,000, respectively.\nPOST RETIREMENT BENEFITS\nCertain health care and life insurance benefits are provided for substantially all of the Company's retired employees, except those covered under union plans. Benefits are provided by the payment of premiums for life insurance benefits and the reimbursement for eligible employees of a portion of their health care premiums. The Company's cost for the years 1995, 1994, and 1993 amounted to $66,000, $79,000, and $71,000, respectively.\nEMPLOYEE INCENTIVE PLANS\nUnder the 1982 Stock Option Plan, as amended, options to purchase up to 900,000 shares of the Company's common stock may be granted to officers, directors and key employees upon terms and conditions determined by a committee of the Board of Directors which administers the plan. In 1993, the Company adopted a new stock option plan which allows the issuance of up to 450,000 stock options in addition to the unissued shares approved for issuance under the 1982 plan. The new plan will expire in 2002 and no further options will be granted under the former plan. A Non-Employee Directors' Stock Option Plan was also adopted in 1993 which will automatically provide grants of options to each non-employee director serving on the Board of Directors at the time of such grant. Each annual grant will cover 2,500 shares of common stock and any recipient may not receive option grants exceeding a total of 30,000 shares. An aggregate of 100,000 shares of common stock are available for grants under the Non-Employee Directors' Stock Option Plan.\nOptions granted by the committee may be designated as either incentive stock options, as defined under the current tax laws, or non-qualified options. The committee may also grant stock appreciation rights, either singly or in tandem with stock options. A right entitles the holder to benefit from market appreciation in the Company's common stock subject to the right between the date of the grant and the date of exercise without any payment on the part of the holder. Upon exercise of a right, the holder surrenders the option and receives an amount of common stock (or, at the election of the committee, cash) equal in value to the amount of such appreciation.\nThe exercise price of options specified by the committee must be at least 100% of the fair market value of the Company's common stock as of the date of grant. All options and rights granted become exercisable at the rate of 20 to 25% per year, on a cumulative basis, beginning with the first anniversary of the date of grant for options granted under the Stock Option Plan and in full one year after grant for option granted under the Non-Employee Directors' Stock Option Plan. In case of termination of employment, options and grants\nvested, but not yet exercised, are subject to forfeiture under the Stock Option Plan and are exercisable up to 90 days after termination for the Non-Employee Directors' Stock Option Plan.\nTransactions involving the Stock Option Plan are summarized as follows for the year ended December 31, 1995:\nIn tandem with the stock options there are 9,500 stock appreciation rights at December 31, 1995.\nDuring 1995, the Financial Accounting Standards Board issued \"Statement of Financial Accounting Standards No. 123 Accounting for Stock Based Compensation\" (\"FAS 123\"). The Company intends to adopt FAS 123 through disclosure only in 1996.\nLONG TERM INCENTIVE COMPENSATION\nUnder the terms of a Long Term Incentive Compensation Plan, certain officers and key management employees received common stock of the Company on a restricted time lapse grant basis. These shares were to be released from escrow and delivered to the plan's participants when the market price of the Company's common stock achieved certain designated levels between $12 and $24 per share for 30 consecutive days prior to June 28, 1994 or in any event if the participant has remained in the continuous employ of the Company through June 2003. Certain market prices were achieved and maintained for the required 30-day period during 1994 and 1993. Therefore, 40,670 and 45,630 shares of the Company's common stock were released in June of 1994 and 1993, respectively, to the plan's participants. Additionally, 30,000 shares were released to the former Chief Executive Officer in 1994 as part of his Termination Agreement. As a result of his termination and the termination of certain other officer and key management personnel during 1994, 125,145 shares of restricted stock valued at $910,000 were forfeited and returned to treasury stock. Upon consummation of the vinyl sale, all restrictions on the remaining 23,560 shares of common stock held under the plan automatically lapsed and such shares were distributed to the intended recipients.\nAmortization of unearned compensation under this agreement for the years 1995 and 1993 amounted to $157,000 and $595,000, respectively. In 1994 amortization was reduced by $113,000 associated with the forfeiture of shares.\n7. DISCONTINUED BUSINESS ACTIVITIES\nThe Company records income and expenses associated with former business activities on the Consolidated Statement of Operations under the caption \"Discontinued Business Activities\".\nOn March 8, 1995, the Company sold substantially all of the assets of its vinyl business to Jannock, Inc. for $47.5 million in cash subject to certain downward adjustments which totaled $4,962,000. Net of adjustments, the gain on the sale of the vinyl business totaled $20,579,000. Sales of $6,365,000 were recorded for the now discontinued vinyl business for the period ending March 7, 1995.\nOn June 2, 1995 the Company sold all of the outstanding capital stock of Bird-Kensington Holding Corp., which owned the Company's interest in Kensington Partners, to Jannock, Inc. The purchase price consisted of cash in the gross amount of $2,780,000 and the assumption of certain liabilities related to the Kensington window business. The sale resulted in a loss of $1,959,000. Sales of $4,265,000 were recorded for this business for the period March 1, 1995 through June 2, 1995.\nOn June 10, 1994, the Company's 40% interest in Mid-South Building Supply, Inc. was redeemed for $1 million in cash resulting in a loss of $1,261,000.\nOn August 22, 1994, the Company sold the assets of substantially all of its distribution businesses to Wm. Cameron & Co. for a purchase price consisting of cash in the amount of $26,142,000, including $1 million held in escrow to pay any indemnification claims arising under the purchase and sale agreement. The sale resulted in a gain of $2,677,000. Sales of $67,089,000 were recorded for these businesses for the period ending August, 22, 1994.\nOn November 28, 1994, the Company sold its last remaining building materials distribution business, Southland Building Products, Inc., to Ashley Aluminum, Inc. for a purchase price of $2,134,000. The sale resulted in a modest gain. Sales of $9,092,000 were recorded for this business for the period ending November 27, 1994.\nThe Company recorded other expenses related to discontinued business activities of $1,050,000, $153,000, and $268,000, for the years 1995, 1994, and 1993, respectively. These charges against earnings include warranty claims and other costs directly related to discontinued business activities. Expenses incurred in 1995 also included $1.5 million in provisions relating to employee benefit plans and product liability claims associated with former roofing operations which were offset by a $602,000 crude oil refund from the Department of Energy.\n8. OTHER EXPENSE\nOther expense was $3.3 million in 1993. A series of non-recurring items developed at the end of 1993 that required a number of charges to results of operations. The majority of these are outlined in the following paragraphs:\nAccounting requirements associated with the responsible parties on an environmental cleanup require the Company to maintain a reserve sufficient to absorb the full cost of the Company's portion of the cleanup. Based on recent site assessments, the Company increased the cleanup reserve by $500,000 based on the Company's estimated share of the proportionate costs.\nThe Company had been considering the development of certain real property. As a result of cash flow and bank covenant constraints, no further development was possible. Based on the estimated net realizable value of the property, the Company wrote-off its $1.3 million investment.\nTo satisfy the remaining portion of an outstanding receivable, the Company previously accepted a $1.3 million note, collateralized by a secondary interest in a mortgage portfolio. Because assessment of the portfolio and the bankruptcy of the debtor indicated the note to be of no value it was written off.\nThe termination of the former Chief Executive Officer of the Company resulted in a $850,000 reserve to cover a settlement under an employment agreement which was paid in 1994.\nThe remainder of \"Other Expense\" is comprised of other miscellaneous adjustments of a more typical nature and income of approximately $1.3 million from a settlement with an insurance provider relating to product liability claims.\n9. DISCONTINUED OPERATIONS\nENVIRONMENTAL BUSINESSES\nOn June 18, 1994, the Company agreed to cause the sale of its 80% interest in its \"off-site\" environmental business, Bird Environmental Gulf Coast,Inc. (\"BEGCI\") to the minority shareholders thereof, subject to financing, resulting in the complete withdrawal from the environmental business. Accordingly, the Company, as of June 30, 1994, recorded the operating results of BEGCI as a discontinued operation for all years presented. In conjunction with this decision, the Company recorded an aggregate charge of approximately $9 million, to adjust its book value to approximate the net realizable value of $7.5 million at June 30, 1994. In June 1994, the Company estimated that the results of operations from the \"off-site\" environmental business would be breakeven through the disposal date and, accordingly, no liability for anticipated losses from the measurement date to the disposal date was recorded. However, at December 31, 1994, the Company had invested an additional $1,270,000 in BEGCI\nwhich, based on the Company's assessment, would not be recoverable and was accordingly written-off, thus maintaining the Company's investment at $7.5 million.\nDuring 1995, the minority partner became unable to finance the purchase of the facility and efforts to attract another purchaser were unsuccessful. In July 1995, the Company's Board of Directors suspended further funding of the facility. As a result of this action, during the second quarter of 1995, the Company's remaining investment of $8.6 million was written off and a $3 million reserve was established for additional expenses associated with the closure of the facility. On November 29, 1995, the Company caused the sale of all of the outstanding capital stock of BEGCI to GTS Duratek, Inc. for a purchase price of $1.00. Of the $3 million reserve established in the second quarter of 1995, $2,050,000 was utilized, while $650,000 remains at December 31, 1995 for future claims against discontinued operations.\nIn 1993 the Company decided to close the \"on-site\" environmental remediation business. This business involved environmental remediation projects such as the processing of oily waste sites at a refinery, operations and management of waste processing sites and the removal and remediation of sludge. The contracts with customers were generally fixed price and usually for periods less than one year. As a result of the decision to exit this business, the Company recorded a provision totaling approximately $11 million. Included in this provision was a $5.8 million write-down of certain assets to net realizable value, $2.1 million for certain contracts including any additional amounts due to stipulated buyouts, $635,000 for severance-related payments, $740,000 for inventory and other assets, $1 million for the write-off of intangible assets and $700,000 for other expenses due to lease buyouts, fees and other general expenses.\nIncluded in the 1993 environmental results is a restructuring reserve of $2 million relating primarily to the environmental business. Included in this provision is $300,000 for severance and benefit payments, $700,000 for lease buyouts, $650,000 for expected losses on exiting certain contracts, and $350,000 of other costs. This charge was offset by a $858,000 gain on the sale of the municipal sludge business. These amounts, including the operating results, are recorded as discontinued operations. Based upon the actual results of the environmental \"on-site\" remediation operations and the sale of its assets, excess costs of $3,861,000 charged in 1993 were reversed and recorded as discontinued operations in the consolidated statement of operations for the twelve months ended December 31, 1994.\nNet sales relating to these environmental businesses amounted to $2,848,000, $3,715,000 and $24,681,000 for 1995, 1994 and 1993, respectively.\n10. ACQUISITIONS\nOn July 1, 1992 the Company entered into a 50% joint venture with Kensington Manufacturing Company to manufacture vinyl replacement windows through Kensington Partners (\"Kensington\"). In 1993,\nKensington experienced serious cash needs which hampered production requirements. As a result of continuing losses and the inability of Kensington to properly finance its operation, Kensington's independent accountants issued \"going concern\" opinions at December 31, 1994 and December 31, 1993. After negotiating with its partner, Bird Corporation agreed to invest additional cash in return for temporarily increasing its ownership in Kensington to 90%. The terms of the new agreement allowed Kensington to return to an equal partnership if, before the later of December 31, 1994 or six months following the Company's last investment (made in August, 1994), its partner matched the additional investment made by the Company. As of February 28, 1995, the minority partner did not match the additional investment made by the Company. As a result, the Company's ownership in the joint venture was permanently fixed at 90%, resulting in a change in financial reporting from the equity method to consolidation beginning March 1, 1995 through June 2, 1995 when the operation was sold (see Note 7).\nThe Company recorded 50% of the joint venture's loss from operations under the equity method from inception through January 31, 1994 and 90% for the period February 1, 1994 through February 28, 1995. Equity losses from Kensington are shown separately on the consolidated statements of operations.\nThe following table represents summarized financial information for Kensington Partners for the year ended December 31, 1994 (in thousands):\nThe following table represents summarized financial information for the years ended December 31, 1994 and December 31, 1993 and the two month period ended February 28, 1995 (in thousands):\n11. COMMITMENTS AND CONTINGENCIES\nLEASE COMMITMENTS\nThe Company leases certain manufacturing, administrative, warehousing,\ntransportation equipment and other facilities. The leases generally provide that the Company pay the taxes, insurance and maintenance expenses related to the leased assets.\nAt December 31, 1995 minimum lease commitments under noncancelable operating leases are as follows (in thousands):\nTotal rental expense for continuing operations, exclusive of taxes, insurance and other expenses paid by the lessee related to all operating leases (including those with terms of less than one year) was as follows (in thousands):\nThe following represents property under capital leases (in thousands):\nAt December 31, 1995 minimum lease commitments under capital leases are as follows (in thousands):\nLITIGATION\nSince 1981, the Company has been named as a defendant in approximately\n550 product liability cases throughout the United States by persons claiming to have suffered asbestos-related diseases as a result of alleged exposure to asbestos in products manufactured and sold by the Company. Approximately 140 of these cases are currently pending and costs of approximately $2 million in the aggregate have been incurred in the defense of these claims since 1981. The Company's insurance provider has accepted the defense of these cases under an agreement for sharing of the costs of defense, settlements and judgements, if any. The Company has provided a reserve amounting to $950,000 at December 31, 1995 for its estimated share of losses related to these claims. In light of the nature and merits of the claims alleged, in the opinion of management, the resolution of these remaining claims will not have a material adverse effect on the results of operations or financial condition of the Company.\nIn 1986, the Company, along with numerous other companies, was named by the United States Environmental Protection Agency (\"EPA\") as a Potentially Responsible Party (\"PRP\") under the Comprehensive Environmental Response, Compensation, and Liability Act, as amended, 42 U.S.C. Paragraph 9601, et seq. (\"CERCLA\"), in connection with the existence of hazardous substances at a site known as the Fulton Terminal Superfund site located in Fulton, Oswego County, New York. On September 28, 1990 the Company and a number of other PRPs reached a negotiated settlement with the EPA pursuant to which the settling PRPs agreed to pay the costs of certain expenses in connection with the proceedings, and to pay certain other expenses including the costs and expenses of administering a trust fund to be established by the settling PRPs. The settlement agreement is embodied in a consent decree lodged with the United States District Court for the Western District of New York. The ultimate cost to the Company of the remedial work and other expenses covered by the settlement agreement is estimated to be between $1 million to $2 million. This range is based, in part, on an allocation of certain sites' costs which, due to the joint and several nature of the liability, could increase if the other PRP's are unable to bear their allocated share. The Company has provided a reserve of approximately $1 million at December 31, 1995 to cover the remaining proportionate share of the estimated total remaining cost of cleanup, most of which will be paid in 1996. Based on information currently available to the Company, management believes that it is probable that the major responsible parties will fully pay the cost apportioned to them. Management believes that, based on its financial position and the estimated accrual recorded, its remediation expense with respect to this site is not likely to have a material adverse effect on its consolidated financial position or results of operations of the Company.\nThe Company has been named as a PRP with respect to certain other sites which are being investigated by federal or state agencies responsible for regulation of the environment. Status as a PRP means that the Company may be jointly and severally liable for all of the potential monetary sanctions and remediation costs applicable to each site. In assessing the potential liability of the Company at each site, management has considered, among other things, the aggregate potential cleanup costs of each site; the apparent involvement of the Company at each site and its prospective share of the remediation costs attributable thereto; the number of the PRPs identified with\nrespect to each site and their financial ability to contribute their proportionate shares of the remediation costs for such site; the availability of insurance coverage for the Company's involvement at each site and the likelihood that such coverage may be contested; and whether and to what extent potential sources of contribution from other PRPs or indemnification by insurance companies constitute reliable sources of recovery for the Company. On the basis of such consideration, management has determined that such environmental matters will not have a material affect on the Company's financial position or results of operations. The Company has provided an aggregate reserve amounting to approximately $300,000 at December 31, 1995 for its estimated share of the ultimate cost of cleanup for such claims excluding any potential sources of indemnification or recovery from third parties.\nIn 1992, a subsidiary of the Company, Bird Atlantic Corporation, formerly Atlantic Building Products Corporation (\"ABPCO\"), commenced an action against a former vendor, alleging violation of an exclusive distributorship without adequate and fair compensation to ABPCO. A jury trial was held in November 1995 in the Superior Court of Plymouth County, Massachusetts. The jury found in favor of ABPCO and judgement was entered on January 26, 1996 in the principal amount of approximately $1.8 million. The award, with interest accruing at 12% per annum, is expected to be in excess of $3 million and will not be reported as income until collected. The defendant has appealed the judgement.\nThe Company is also exposed to a number of other asserted and unasserted potential claims encountered in the normal course of business and unrelated to environmental matters. In the opinion of management, the resolution of such claims will not have a material adverse effect on the Company's financial position or results of operations.\nWARRANTY OBLIGATIONS\nThe Company warrants under certain circumstances that its Housing Group's products meet certain manufacturing and material specifications. In addition, for marketing considerations, the Company makes elective settlements in response to customer complaints. The Company records the liability for warranty claims and elective customer settlements when it determines that a specific liability exists or a payment will be made. During 1995, 1994 and 1993, the Company recorded (exclusive of those claims included in discontinued business activities) approximately $2,262,000, $2,687,000, and $3,196,000, respectively, in warranty expenses and elective customer settlements. The warranty related expense included in discontinued business activities for 1995, 1994 and 1993 amounted to approximately $94,000, $100,000 and $104,000, respectively. Based upon analyses performed by the Company's management, a reasonably possible range of potential liability from unasserted warranty obligations for all products sold prior to December 31, 1995 is estimated to be between $3.5 million and $16.5 million. However, the Company has not recorded any liability for these future unasserted claims or complaints because management has concluded, based on such analyses, that no particular estimate within this range is probable.\n12. OPERATIONS IN DIFFERENT INDUSTRIES\nThe Company has had two business segments which it defined as the Housing Group and the Environmental Group.\nThe Housing Group manufactures and markets residential and commercial roofing products in the northeastern United States, including a full line of fiberglass based asphalt shingles and roll roofing. The Group also manufactured vinyl siding, window profiles, trim and accessories which were distributed nationwide. In prior years, the Group operated distribution centers primarily in the southeastern and southwestern markets for vinyl siding and in the Arizona and northeastern markets for roofing and other building materials products.\nThe Company's Environmental Group provided recycling, remediation, and beneficial re-use services for applications as diverse as food processing waste streams, oily waste recovery and the treatment of municipal wastes. Generally, these on-site services recovered valuable constituents, removed wastes and reduced the volume of materials which must be disposed of by other means. In December 1993, the Company decided to close this portion of the environmental segment and dedicate this group to operating BEGCI, the fixed site facility in Texas. As discussed in Note 9, the Company sold its interest in BEGCI in November 1995 to GTS Duratek, Inc.\nNet sales represent sales to unaffiliated customers. Identifiable assets are those that are used in the Company's operations in each industry segment. Corporate assets are principally cash investments and equivalents and property maintained for general corporate purposes. As discussed in Note 9, the results of operations for the environmental group for the three years ended December 31, 1995 have been recorded as discontinued operations. Accordingly, net sales, cost of sales and SG&A relating to this segment are not shown below.\n12. OPERATIONS IN DIFFERENT INDUSTRIES (CONTINUED)\n13. QUARTERLY FINANCIAL DATA (UNAUDITED)\nSummarized quarterly financial data for 1995 and 1994 is shown below:\n(1) Decrease in gross profit in the fourth quarter compared to the previous quarter is due to sales price weakness and the decline in sales volume attributable to a weak re-roofing market caused by a dry, hot summer.\n(2) Decrease in gross profit in the fourth quarter compared to the previous quarter is due primarily to increased raw material costs that could not be passed on via price increases.\n14. MERGER WITH CERTAINTEED CORPORATION\nOn March 14, 1996, the Company signed a definitive agreement with CertainTeed Corporation, a subsidiary of Saint-Gobain Corporation, providing for CertainTeed to acquire in a merger transaction all of the Company's outstanding common, preferred and preference shares.\nUpon the effective date of the merger, each share of the Company's outstanding common stock, par value $1 per share, will be converted into the right to receive an amount in cash equal to $7.50. The Company's outstanding 5% cumulative preferred stock, par value $100 per share, will remain issued and outstanding upon the effective date of the merger and will be called for redemption and retirement as soon as practicable thereafter at a price equal to $110, plus all accrued and unpaid dividends thereon as of the date of redemption and retirement. Each share of the Company's outstanding $1.85 cumulative convertible preference stock, par value $1 per share, will be converted into the right to receive $20 plus all accrued and unpaid dividends thereon as of the effective date of the merger. All outstanding options to purchase common stock under the 1982 Stock Option Plan, the 1992 Stock Option Plan, and the 1992 Non-Employee Directors' Stock Option Plan will be converted into the right to receive an amount in cash equal to $7.50 per share less the exercise price per share. Any option with an exercise price equal to or greater than $7.50 will be cancelled on the effective date of the merger without any payment to the option holder.\nCompletion of the merger is subject to approval by the Company's shareholders and appropriate governmental authorities. The merger is not subject to a financing contingency. The Company's Board of Directors has received a fairness opinion from its investment bankers regarding the merger. The closing of the merger is anticipated at the end of the second quarter, following distribution of proxy materials to the Company's shareholders and approval at a special meeting.\nBIRD CORPORATION and Subsidiaries\nSCHEDULE II\nVALUATION AND QUALIFYING ACCOUNTS\nYears Ended December 31, 1995, 1994 and 1993 (In thousands)\n(a) Represents recovery of balances previously written off.\n(b) Uncollectible accounts written off by a charge to reserve.\n(c) Represents the allowance for doubtful accounts of vinyl business sold of $517 and the uncollectible accounts written off by a charge to reserve of $2,549.\nKENSINGTON PARTNERS AND AFFILIATE (JOINT VENTURE PARTNERSHIPS)\nCOMBINED FINANCIAL STATEMENTS AND SUPPLEMENTAL INFORMATION ITEM 14(d)\nDECEMBER 31, 1994\nKENSINGTON PARTNERS AND AFFILIATE (JOINT VENTURE PARTNERSHIPS)\nCOMBINED FINANCIAL STATEMENTS\n- -------------------------------------------------------------------------------- DECEMBER 31, 1994 - --------------------------------------------------------------------------------\nPAGE ----\nFINANCIAL STATEMENTS\nIndependent Auditors' Report\nCombined Balance Sheet\nCombined Statements of Operations and Partners' Capital (Deficit)\nCombined Statements of Cash Flows\nNotes to the Combined Financial Statements\nSUPPLEMENTAL INFORMATION\nIndependent Auditors' Report on Financial Statement Schedule\nFinancial Statement Schedule II\nINDEPENDENT AUDITORS' REPORT\nTO THE PARTNERS KENSINGTON PARTNERS AND AFFILIATE Leechburg, Pennsylvania\nWe have audited the accompanying combined balance sheet of Kensington Partners and Affiliate (Joint Venture Partnerships) as of December 31, 1994 and the related combined statements of operations and changes in partners' capital (deficit), and cash flows for the years ended December 31, 1994 and 1993. These financial statements are the responsibility of the Partnerships' 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 combined financial statements referred to above present fairly, in all material respects, the financial position of Kensington Partners and Affiliate as of December 31, 1994, and the results of their operations and their cash flows for the years ended December 31, 1994 and 1993, in conformity with generally accepted accounting principles.\nThe accompanying financial statements have been prepared assuming that Kensington Partners and Affiliate will continue as going concerns. As discussed in Note 2 to the financial statements, the Companies have incurred significant operating losses and current liabilities exceed current assets. Those conditions, among others, raise substantial doubt about the Companies' ability to continue as going concerns. Management's plans regarding those matters are also described in Note 2. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.\n\/s\/Alpern, Rosenthal & Company Pittsburgh, Pennsylvania\nFebruary 10, 1995\nKENSINGTON PARTNERS AND AFFILIATE (JOINT VENTURE PARTNERSHIPS)\nCOMBINED BALANCE SHEET\nThe accompanying notes are an integral part of these combined financial statements.\nKENSINGTON PARTNERS AND AFFILIATE (JOINT VENTURE PARTNERSHIPS)\nCOMBINED STATEMENTS OF OPERATIONS AND PARTNERS' CAPITAL (DEFICIT)\nThe accompanying notes are an integral part of these combined financial statements.\nKENSINGTON PARTNERS AND AFFILIATE (JOINT VENTURE PARTNERSHIPS)\nCOMBINED STATEMENTS OF CASH FLOWS\nThe accompanying notes are an integral part of these combined financial statements.\nKENSINGTON PARTNERS AND AFFILIATE (JOINT VENTURE PARTNERSHIPS)\nCOMBINED STATEMENTS OF CASH FLOWS (CONTINUED)\nThe accompanying notes are an integral part of these combined financial statements.\nKENSINGTON PARTNERS AND AFFILIATE (JOINT VENTURE PARTNERSHIPS) NOTES TO THE COMBINED FINANCIAL STATEMENTS\nNOTE 1-SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nA. PRINCIPLES OF COMBINATION\nThe accompanying combined financial statements include the accounts of Kensington Partners (KP), combined with the accounts of North American Installations Company (NAICO). NAICO is owned 100% by common owners of KP. All significant intercompany balances and transactions have been eliminated in the preparation of the combined financial statements. The combined group is herein referred to as \"the Companies\".\nKP is a joint venture partnership formed by ZES, Inc. (formerly Kensington Manufacturing Company) (ZES) and Bird-Kensington Holding Corp., an indirect subsidiary of Bird Corporation (Bird). NAICO was formed in May 1993, as a joint venture partnership, and ceased operations in 1994.\nB. NATURE OF BUSINESS\nKensington Partners operates in one principal industry segment: the manufacture of vinyl replacement windows for wholesalers and home remodelers. The Partnership grants credit to its customers, substantially all of which are retail and wholesale resellers of windows located in the eastern half of the United States.\nNAICO was an exclusive installer of KP windows for a significant customer of KP, a retail seller of windows to end users, which has sales throughout the United States. The installation of the windows has been transferred to the customer that purchases the windows.\nC. CASH AND CASH EQUIVALENTS\nInterest-bearing deposits and other investments with original maturities of three months or less are considered cash equivalents.\nD. ACCOUNTS RECEIVABLE\nThe Companies provide for estimated losses on uncollectible accounts receivable based on historical data and management's evaluation of individual accounts receivable balances at the end of the year.\nKENSINGTON PARTNERS AND AFFILIATE (JOINT VENTURE PARTNERSHIPS) NOTES TO THE COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)\nE. INVENTORIES\nThe Companies value all of its inventories at the lower of cost or market. Raw materials are determined on the last-in, first-out (LIFO) method. Work-in-process and finished goods inventories are determined on a first-in, first-out (FIFO) method.\nF. DEPRECIATION\nDepreciation is computed by the straight-line method at rates intended to distribute the cost of the assets over their estimated useful lives. Property under capital lease is being amortized over the life of the lease in accordance with generally accepted accounting principles. Rates used by principal classifications are as follows:\nRate (Years) -------\nWarehouse and manufacturing equipment 3-10 Furniture and fixtures 5-10 Leasehold improvements 3-15 Transportation equipment 3- 6\nMaintenance and repairs which are not considered to extend the useful lives of assets are charged to operations as incurred. Upon sale or retirement, the cost of assets and related allowances are removed from the accounts and any resulting gains or losses are included in other income (expense) for the year.\nG. INVESTMENT IN AFFILIATED COMPANY\nThe Companies' investment in a joint venture partnership is carried on the equity basis, which approximates the Companies' equity in the underlying net book value.\nH. PRODUCT WARRANTIES\nThe Companies provide an accrual for future warranty costs based upon actual claims experience. The warranties are limited and provide for parts and\/or labor based upon the type of window sold.\nI. INCOME TAXES\nThe Companies are being treated as partnerships for Federal and state income tax purposes. Under the Internal Revenue Code provisions for partnerships, the partners reflect their proportionate share of the Companies' taxable income or loss on their respective income tax returns, and the Companies are not liable for income taxes.\nKENSINGTON PARTNERS AND AFFILIATE (JOINT VENTURE PARTNERSHIPS)\nNOTES TO THE COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 1-SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)\nJ. RECLASSIFICATION\nCertain reclassifications were made to the amounts previously reported for December 31, 1993 to conform with the 1994 classifications.\nNOTE 2 - OPERATIONS AND LIQUIDITY\nThe Companies' combined financial statements have been presented on the basis that they are going concerns, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The Companies incurred net losses of approximately $5,310,000 and negative cash flows from operations of $1,731,000 for 1994. At December 31, 1994, the balance sheet reflects an excess of current liabilities over current assets of $4,682,000, and a net capital deficiency of $2,155,000.\nIn addition, a lease agreement (Note 12A) is in default as a result of late payments being made and certain payroll and sales taxes are delinquent. (Note 9)\nManagement believes the above mentioned losses and the associated balance sheet deficiencies are a result of adding new products in 1993 which required different manufacturing processes and a significant increase in orders, which put strain on the existing systems. The combination of the above resulted in manufacturing inefficiencies, low asset performance, excessive delivery costs and inadequate management information.\nDuring 1993, the Companies embarked on a program to correct the problems associated with operations. Management believes that the major components of the plan have been achieved in 1994 and that the effect of addressing and correcting these problems during 1994 will have a positive impact on 1995 operating results.\nDuring the first quarter of 1995, KP has secured price increases from a majority of its customers and negotiated a price reduction from a major vendor. In addition, KP continues on a program to increase productivity, which includes: simplifying product lines, improving plant layout, management training and investing in labor saving equipment. KP has also begun a sales program to broaden its customer base.\nThe outcome of the uncertainties discussed above cannot be predicted at this time. The financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts and classification of liabilities that might be necessary should the Companies be unable to continue in existence.\nKENSINGTON PARTNERS AND AFFILIATE (JOINT VENTURE PARTNERSHIPS)\nNOTES TO THE COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 3 - ACCOUNTS RECEIVABLE\nAt December 31, 1994, accounts receivable - trade from three customers were approximately 67% of trade receivables. Sales to these unrelated customers comprised 67% of total sales for the years ended December 31, 1994. Sales to these customers comprised 51% of total sales for the year ended December 31, 1993.\nNOTE 4-INVENTORIES\nInventories at December 31, 1994 are as follows:\nKENSINGTON PARTNERS AND AFFILIATE (JOINT VENTURE PARTNERSHIPS)\nNOTES TO THE COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 6 - OTHER ASSETS\nOther assets at December 31, 1994 is as follows:\nNOTE 7 - DEMAND NOTES\nOn June 15, 1994, KP entered into a financing\/factoring agreement with a lending institution to sell, on an ongoing basis, up to 80% or $2,500,000, whichever is less, of acceptable trade accounts receivable. All accounts receivable that remain unpaid after 90 days of the purchase by the lender are subject to recourse at the lender's discretion. KP may, at any time, repurchase the accounts receivable sold. The agreement, which expires on June15, 1995, is subject to automatic renewal for a six month period, unless notice of nonrenewal is given by either party. The loan was funded with $1,000,000, at which time the Companies' line of credit was paid in full (see below).\nUnder the terms of this agreement, fees ranging from 1% to 3 1\/2% are based on the number of days to collect the trade receivable, with a guaranteed minimum monthly fee of $5,000. In addition, interest is charged on any amounts advanced under the agreement, at the rate of prime (8 1\/2% at December 31, 1994) plus 1 1\/2%. Under the terms of this agreement, Bird has guaranteed $1,250,000 of this debt.\nThe amount outstanding under this agreement, included in the accompanying balance sheet at December 31, 1994, is net of a $150,000 cash reserve held by the lending institution.\nPrior to June 15, 1994, the Companies had a line-of-credit, with maximum borrowings of $2,500,000. Interest was payable monthly at the bank's basic rate plus 1% (see below). The borrowings on the line were collateralized by substantially all the assets of the Companies. The line was guaranteed by the partners of the Companies.\nIn early 1994, the bank cited defaults under the line of credit agreement and made demand for payment. Based on agreements between the Companies and the bank in February and April, 1994, the bank agreed to forebear collection and set a final due date of August 31, 1994. In addition, the interest rate was changed to the bank's basic rate plus 3%. Bird was required to put up $750,000 as additional collateral, which was later applied to the line. Bird was also required to make additional payments totaling $1,200,000. The payments by Bird were recorded as capital contributions to the partnership.\nKENSINGTON PARTNERS AND AFFILIATE (JOINT VENTURE PARTNERSHIPS)\nNOTES TO THE COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 8-CAPITAL LEASE OBLIGATIONS AND LONG-TERM DEBT\nThe following is a schedule by years of future minimum lease payments under capital leases and installment notes together with the present value of the net minimum lease payments and note payments as of December 31, 1994:\nKENSINGTON PARTNERS AND AFFILIATE (JOINT VENTURE PARTNERSHIPS)\nNOTES TO THE COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 9 - ACCRUED EXPENSES\nAccrued expenses at December 31, 1994 are as follows:\nNOTE 10 - PARTNERS' CAPITAL\nEffective July 1, 1992, ZES entered into an agreement with Bird through one of Bird's indirect subsidiaries to form a joint venture partnership, Kensington Partners (KP), for the purpose of manufacturing and selling custom windows, a business previously conducted by ZES. ZES' capital contribution to KP consisted of all of its assets subject to certain of its liabilities, including $2,800,000 owed to Jones and Brown, Inc. (J&B), a related party. Bird's capital contribution consisted of $2,800,000, in cash, which was used to pay off the amount owed by KP to J&B, subsequent to the inception of the Partnership. The net assets contributed by ZES were $1,689,000.\nDuring 1994, the partners entered into an agreement to restructure the partnership agreement of KP and to make capital contributions. Each partner's ownership percentage is to be adjusted plus or minus 2% for each $50,000 of capital contributed or collateral provided on the bank loan, but in no event should a partner be diluted below 10%. A diluted partner is entitled to cure any shortfall between its capital account and the other partner's capital account by contributing the capital necessary to equalize each partner's capital account by the later of December 31, 1994 or six months from the date of the last capital contribution (August 1994) made on or before December 31, 1994.\nPursuant to the agreement, Bird contributed $2,700,000 in cash, including payments on debt (Note 7), and $150,000 of inventory. ZES has contributed $250,000 in cash and $250,000 of inventory. Accordingly, the ownership percentages for Bird and ZES at December 31, 1994 are 90% and 10%, respectively.\nIn addition to the capital contributed, the partners have advanced various amounts of working capital during 1994 (Note 13).\nKENSINGTON PARTNERS AND AFFILIATE (JOINT VENTURE PARTNERSHIPS)\nNOTES TO THE COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 10 - PARTNERS' CAPITAL (CONTINUED)\nIn September 1994, Bird entered into a sales agreement with Jannock, Inc. to sell all of the assets of a wholly owned subsidiary, Bird Incorporated. The sales agreement contains an option for Jannock to purchase Bird's interest in Kensington Partners for $2,780,000. In addition to the purchase price, Jannock would assume all of Bird's obligations under various security agreements. The option, which expires on April 7, 1995, is subject to Bird fulfilling its obligations under the partnership agreement.\nSubsequent to December 31, 1994, Bird advanced KP approximately $524,000.\nNOTE 11 - RETIREMENT PLANS\nKP participates in a multi-employer defined benefit pension plan for the electrician's union employees. Plan contributions are determined by the union labor agreement. Management has not expressed any intent to terminate its participation in this plan. KP contributed approximately $191,000 and $163,000 to this plan during the years ended December 31, 1994 and 1993, respectively.\nThe Companies also sponsors an executive retirement plan. Under the provisions of the plan certain key employees may elect, at their discretion, to contribute to the plan. The Companies provide a matching contribution of one half of all employee contributions up to a maximum of 3% of gross compensation. Contributions are used to purchase variable rate annuities.\nAdditional benefits under this plan include proceeds from life insurance policies owned by KP or the cash value upon termination of employment. The Companies' contributions to this plan were not material for the years ended December 31, 1994 and 1993.\nNOTE 12 - COMMITMENTS AND CONTINGENCIES\nA. OPERATING LEASES\nThe Companies lease various operating facilities from related and unrelated parties and transportation equipment from unrelated parties under various operating leases. Rent expense for the years ended December 31, 1994 and 1993 are as follows:\nKENSINGTON PARTNERS AND AFFILIATE (JOINT VENTURE PARTNERSHIPS)\nNOTES TO THE COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 12 - COMMITMENTS AND CONTINGENCIES (CONTINUED)\nThe following are the approximate future minimum operating lease payments at December31, 1994, substantially all of which are due to a related party:\nKP is currently in default on its lease for its primary operating facility as a result of not making the required rent payments as they became due. Rent of approximately $237,000, due a related party, has been accrued in the accompanying balance sheets at December 31, 1994. Based upon the current payment plan, approximately $61,000 of the accrued rent at December31, 1994 is included in other long-term liabilities - related parties.\nB. PURCHASE COMMITMENTS\nKP and Bird have entered into a supply agreement which requires KP to purchase specified quantities of raw materials from Bird beginning in 1993 and ending in the year 2002. Minimum purchases for the next five years are 1995, $900,000; 1996, $1,100,000; 1997, $1,300,000; and 1998 and 1999, the greater of $1,300,000 or actual amounts purchased in 1997. The agreement includes penalties for shortfalls in purchases on a per year basis. Shortfalls can be offset with credits from years when excess volume is purchased.\nKP and Domken Plastics (Note 13A) have entered into a supply agreement which requires KP to purchase $2,500,000 of raw materials, annually, through 1999. The agreement includes penalties for shortfalls in total purchases over the term of the agreement.\nC. SUPPLY AGREEMENTS\nKP has entered into a supply agreement with a customer that primarily purchases through Quantum II Partners (Notes 12D and 13E). The agreement requires KP to provide not less than 90% of the customer's total requirement of Quantum II vinyl replacement windows (Note 12D).\nKENSINGTON PARTNERS AND AFFILIATE (JOINT VENTURE PARTNERSHIPS)\nNOTES TO THE COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 12 - COMMITMENTS AND CONTINGENCIES (CONTINUED)\nD. LITIGATION\nOn September 13, 1994, a complaint was filed in Middlesex Superior Court by the other 50% owner of Quantum II Partners (Note 13E) and others, including Quantum II Partners (collectively, the plaintiffs), against Kensington Partners and Quantum II Partners (collectively, the defendants). The plaintiffs allege various breaches of contract on the part of the defendants including breach of a partnership agreement, a supply agreement (Note 12C) and an employment agreement along with other complaints under the Massachusetts Unfair Trade Practices Act. The plaintiffs are seeking relief of actual damages in an unspecified amount and a doubling or trebling of such damages as provided in the Unfair Trade Practices Act. KP believes that the claims filed by the plaintiffs have no merit and denies any liability.\nOn October 4, 1994, the defendants filed a complaint in Federal Court alleging various breaches of contract by the plaintiffs and seeking collection of outstanding balances due to the Company from the plaintiffs of approximately $560,000, included in accounts receivable - trade.\nNo answers have been filed in these actions because the parties are involved in settlement negotiations. With respect to the litigation filed by KP for the collection of the 1994 balances receivable, management estimates that some loss may occur and has recorded its estimate of possible loss as an allowance for doubtful accounts.\nThe Company anticipates that a settlement agreement will be achieved, as currently contemplated. If the matter is not settled, and goes to trial, management believes that the ultimate loss, if any, will not exceed the amounts recorded.\nKENSINGTON PARTNERS AND AFFILIATE (JOINT VENTURE PARTNERSHIPS)\nNOTES TO THE COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 13 - RELATED PARTY TRANSACTIONS\nThe Companies have entered into various transactions with related parties during the years ended December 31, 1994 and 1993. The transactions are as follows:\nA. PURCHASES AND PAYABLES\nThe Companies have purchases for raw materials, advertising services, and commissions from the following related parties as of and for the years ended December 31, 1994 and 1993:\nDMI and DPL are related through common ownership with ZES.\nA stockholder of ZES was compensated approximately $143,000 during the year ended December 31, 1993 for services rendered in assisting with the acquisition of raw materials from DPL. In addition, J&B was also compensated $86,000 during 1993 for similar services.\nAny compensation for services discussed above was reimbursed directly by DPL to ZES for the year ended December 31, 1994.\nFees from J&B for computer software support of approximately $144,000 were charged to operations for the year ended December 31, 1994.\nKENSINGTON PARTNERS AND AFFILIATE (JOINT VENTURE PARTNERSHIPS)\nNOTES TO THE COMBINED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 13-RELATED PARTY TRANSACTIONS (CONTINUED)\nB. SALES AND RECEIVABLES\nThe Companies had sales to Jones & Brown, Inc. (J&B), a related party through common ownership with ZES, of approximately $5,890,000 and $7,255,000 for 1994 and 1993, respectively. In addition, the Companies had sales to other related parties of approximately $471,000 for 1994. Accounts receivable from related parties are as follows as of December31, 1994:\nC. RENTS\nKP rents facilities from related parties (Note 12).\nD. MANAGEMENT FEES\nManagement fees of approximately $488,000 were paid to J&B under a management contract for the year ended December 31, 1993. The management agreement was terminated effective December 31, 1993.\nE. OTHER\nKensington Partners owns a 50% equity investment in Quantum II Partners (Note 12D). Quantum II was formed during 1993 to be the exclusive marketing representative to sell Quantum II replacement windows manufactured by KP. Quantum II Partners reported a net partnership deficit of approximately $130,000 and $138,000 for 1994 and 1993, respectively. KP has reflected its share of Quantum's excess of liabilities over assets in other long-term liabilities.\nAt December 31, 1994, approximately $306,000 due from Quantum II is included in other receivables - related parties. This amount is net of an allowance for doubtful accounts of $65,000.\nKENSINGTON PARTNERS AND AFFILIATE (JOINT VENTURE PARTNERSHIPS)\nNOTES TO THE COMBINED FINANCIAL STATEMENTS (CONTINUED)\nEVENT (UNAUDITED) SUBSEQUENT TO THE DATE OF THE INDEPENDENT AUDITORS' REPORT\nIn 1995, Jannock, Inc. exercised its option to purchase Bird's interest, owned by its wholly-owned subsidiary Bird-Kensington Holding Corporation, in KP. Immediately preceding the sale, Bird purchased ZES' interest in KP for $1,000,000. In addition, Bird invested in KP $4,090,000 prior to the sale to fulfill provisions in the asset purchase agreement.\nOn June 2, 1995, the stock of Bird-Kensington Holding Corporation, which owned the assets and liabilties of KP was sold by Bird to Jannock, Inc. in exchange for cash of $2,780,000 and assumption of certain liabilities.\nSUPPLEMENTAL INFORMATION\nINDEPENDENT AUDITORS' REPORT ON FINANCIAL STATEMENT SCHEDULE\nTO THE PARTNERS KENSINGTON PARTNERS AND AFFILIATE Leechburg, Pennsylvania\nWe have audited the combined financial statements of Kensington Partners and Affiliate as of December 31, 1994 and for each of the two years in the period then ended, and have issued our report thereon dated February 10, 1995. In connection with our audits of these financial statements, we audited financial statement schedule II. In our opinion, such a 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\/Alpern, Rosenthal & Company Pittsburgh, Pennsylvania February 10, 1995\nKENSINGTON PARTNERS AND AFFILIATE\nSCHEDULE II\nVALUATION AND QUALIFYING ACCOUNTS\nYEAR ENDED DECEMBER 31, 1994\n(1) Uncollectible accounts written off.","section_15":""}
{"filename":"311780_1995.txt","cik":"311780","year":"1995","section_1":"Item 1 - Business Prospectus of IEA Marine Container Fund, dated August 27, 1979 included as part of Registration Statement on Form S-1 (No. 2-64700)\nCertificate of Limited Partnership of IEA Marine Container Fund, filed as Exhibit 3.4 to the Registration Statement on Form S-1 (No. 2-64700) PART I\nItem 1. Business\n(a) General Development of Business\nThe Registrant is a California limited partnership formed on April 26, 1979 to engage in the business of leasing marine dry cargo containers to unaffiliated third-party lessees. The Registrant was initially capitalized with $100, and commenced offering its limited partnership interests to the public during the week of August 27, 1979, pursuant to its Registration Statement on Form S-1 (File No. 2-64700). The offering terminated on March 31, 1980.\nThe Registrant raised $8,201,600 in subscription proceeds. The following table sets forth the use of said subscription proceeds:\nOn June 9, 1980, the Registrant borrowed $3,693,250 to finance the purchase of additional containers. The loan was repaid on March 31, 1988.\nThe managing general partner of the Registrant is Cronos Capital Corp. (\"CCC\"), a wholly-owned subsidiary of Cronos Holdings\/Investments (U.S.), Inc., a Delaware corporation. Cronos Holdings\/Investments (U.S.), Inc. is a wholly-owned subsidiary of Cronos Investments B.V., a Dutch company. These and other affiliated companies are ultimately wholly-owned by The Cronos Group, a holding company registered in Luxembourg (\"Holding Company\") and are collectively referred to as the \"Group\". The activities of the container division of the Group are managed through the Group's subsidiary in the United Kingdom, Cronos Containers Limited (\"the Leasing Company\"). The Leasing Company manages the leasing operations of all equipment owned or managed by the Group on its own behalf or on behalf of other third-party container owners, including all other programs organized by CCC. The associate general partner is Smith Barney Shearson, Inc., a successor to The F&M Corporation.\nPursuant to the Limited Partnership Agreement of the Registrant, all authority to administer the business of the Registrant is vested in CCC. CCC has entered into a Leasing Agent Agreement whereby the Leasing Company has the responsibility for the container leasing activities of CCC's managed programs.\nFor information concerning the containers acquired by the Registrant, see Item 2, \"Properties.\"\n(b) Financial Information About Industry Segments\nInapplicable.\n(c) Narrative Description of Business\n(c)(1)(i) A marine cargo container is a reusable metal container designed for the efficient carriage of cargo with a minimum of exposure to loss from damage or theft. Containers are manufactured to conform to worldwide standards of container dimensions and container ship fittings adopted by the International Standards Organization (\"ISO\") in 1968. The standard container is either 20' long x 8' wide x 8'6\" high (one twenty-foot equivalent unit (\"TEU\"), the standard unit of physical measurement in the container industry) or 40' long x 8' wide x 8'6\" high (two TEU). Standardization of the construction, maintenance and handling of containers allows containers to be picked up, dropped off, stored and repaired effectively throughout the world. This standardization is the foundation on which the container industry has developed.\nStandard dry cargo containers are rectangular boxes with no moving parts, other than doors, and are typically made of steel. They are constructed to carry a wide variety of cargos ranging from heavy industrial raw materials to light-weight finished goods. Specialized containers include, among others, refrigerated containers for the transport of temperature-sensitive goods and tank containers for the carriage of liquid cargo. Dry cargo containers constitute approximately 85% of the worldwide container fleet. Refrigerated and tank containers constitute approximately 7% of the worldwide container fleet, with open-tops and other specialized containers constituting the remainder.\nOne of the primary benefits of containerization has been the ability of the shipping industry to effectively lower freight rates due to the efficiencies created by standardized intermodal containers. Containers can be handled much more efficiently than loose cargo and are typically shipped via several modes of transportation, including truck, railway and ship. Containers require loading and unloading only once and remain sealed until arrival at the final destination, significantly reducing transport time, labor and handling costs and losses due to damage and theft. Efficient movement of containerized cargo between ship and shore reduces the amount of time that a ship must spend in port and reduces the transit time of freight moves.\nThe logistical advantages and reduced freight rates brought about by containerization have been a major catalyst for world trade growth during the last twenty-five years, which in turn has generated increased demand for containerization. The world container fleet has grown from an estimated 270,000 TEU in 1969 to 9,198,000 TEU at the end of 1995, and according to recent industry data, growth of containerized shipping since 1987 has generally averaged two to three times that of average GDP growth in industrialized countries.\nThe container leasing industry has been a significant contributor to the growth of containerization, and, in 1995, had an approximately 47% share of the total world container fleet with ocean carriers holding most of the remainder. To an ocean carrier, the primary benefits of leasing rather than owning containers are the following:\n- Reduced Capital Expenditures. Leasing is an attractive option to ocean carriers because ownership of containers requires significant capital expenditures. Carriers constantly evaluate their investment strategy, with container purchasing competing directly with other expenditure requirements, such as ship purchases, ship conversions and terminal improvements. Container leasing allows ocean carriers to invest capital in assets that are more central to their business.\n- Improved Asset Management. Trade flow imbalances and seasonal demands frequently leave ocean carriers with regional surpluses or shortages of containers, requiring costly repositioning of empty containers. Leasing companies help ocean carriers manage these trade imbalances by providing the inventory to service demand, reducing the costs of maintaining local inventories and minimizing repositioning expenses. By matching different carriers' container needs, leasing companies can reduce their own risks of container inventory imbalances and seasonality through a portfolio of lessees as well as variations in lease terms.\n- Increased Container Fleet Flexibility. Ocean carriers benefit from the variety of lease types offered by leasing companies such as the master lease, long-term and short-term lease and direct financing lease. These various leases give ocean carriers flexibility in sizing their fleets while minimizing capital costs. For example, master lease agreements give ocean carriers the option of adjusting the size of their fleets, with the flexibility to pick-up and drop-off containers at various locations around the world.\nDuring 1995, the Registrant's 17th year of operations, the Registrant's remaining containers were disposed. As a result of the declining cash flows from operations and sales proceeds, CCC and the Leasing Company determined that disposing of the remaining containers would be in the best interest of the limited partners. The Registrant's original fleet consisted of dry cargo containers, the most commonly used type in the shipping industry. Over 90% of the Registrant's dry cargo container fleet was constructed of all Corten(R) steel (Corten(R) roofs, walls, doors and undercarriage), a high-tensile steel yielding greater damage and corrosion resistance than mild steel.\nThe Registrant's containers were leased primarily to ocean-going steamship companies operating in major trade routes (see Item 1(d)). Most if not all of the Registrant's marine dry cargo containers were leased pursuant to operating leases, primarily master leases, where the containers were leased to the ocean carrier on a daily basis for any desired length of time, with the flexibility of picking up and dropping off containers at various agreed upon locations around the world and, secondarily, term leases (1-5 years) and one-way or round-trip leases.\nMaster lease agreements. A master lease is designed to provide greater flexibility by allowing customers to pick-up and drop-off containers where and when needed, subject to restrictions and availability, on pre-agreed terms. The commercial terms of master leases are generally negotiated annually. Master leases also define the number of containers that may be returned within each calendar month and the return locations and applicable drop-off charges. Because of the increased flexibility they offer, master leases usually command higher per-diem rates and generate more ancillary fees (including pick-up, drop-off, handling and off-hire fees) than term leases.\nTerm lease agreements. Term lease agreements include short-term and long-term leases. Long-term lease agreements define the number of containers to be leased, the pick-up and drop-off locations, the applicable per-diem rental rate for the duration of the lease and the early termination penalties that may apply in the event of early redelivery. Ocean carriers use long-term leases when they have a need for identified containers for a specified term. Long-term leases usually are not terminated early by the customer and provide stable and relatively predictable sources of revenue, although per-diem rates and ancillary charges are lower under long-term leases than under master lease agreements. Short-term lease agreements have a duration of less than one year and include one-way, repositioning and round-trip leases. They differ from master leases in that they define the number and the term of containers to be leased. Ocean carriers use one-way leases to manage trade imbalances (where more containerized cargo moves in one direction than another) by picking up a container in one port and dropping it off at another after one or more legs of a voyage. Except for direct financing leases, lease rates typically are highest for short-term leases.\nUnder these leases, customers were responsible for paying all taxes and service charges arising from container use, maintaining the containers in good and safe operating condition while on lease and paying for repairs upon redelivery, other than ordinary wear and tear. Some leases provided for a \"damage protection plan\" whereby lessees, for an additional payment (which may have been in the form of a higher per-diem rate), were relieved of the responsibility of paying some of the repair costs upon redelivery of the containers. The Leasing Company has historically provided this service on a limited basis to selected customers. Repairs provided under such plans were carried out by the same depots, under the same procedures, as were repairs to containers not covered by such plans. Customers also were required to insure leased containers against physical damage and loss, and against third party liability for loss, damage, bodily injury or death.\nAll containers were inspected and repaired when redelivered by a customer, and customers were obligated to pay for all damage repair, excluding wear and tear, according to standardized industry guidelines. Depots in major port areas performed repair and maintenance which was verified by independent surveyors or the Leasing Company's technical and operations staff.\nBefore any repair or refurbishment was authorized on containers in the Registrant's fleet, the Leasing Company's technical and operations staff reviewed the age, condition and type of container and its suitability for continued leasing. The Leasing Company compared the cost of such repair or refurbishment with the prevailing market resale price that was obtained for that container and made the appropriate decision whether to repair or sell the container.\nThe Leasing Company made payments to the Registrant based upon rentals collected from ocean carriers after deducting certain operating expenses associated with the containers, such as the base management fee payable to CCC, certain expense reimbursements to CCC, the costs of maintenance and repairs not performed by lessees, independent agent fees and expenses, depot expenses for handling, inspection and storage, and additional insurance.\nThe Registrant's sales and marketing operations were conducted through the Leasing Company, in the United Kingdom, with support provided by area offices and dedicated agents located in San Francisco, California; Iselin, New Jersey; Windsor, England; Hamburg; Antwerp; Auckland; Genoa; Singapore; Hong Kong; Sydney; Tokyo; Taipei; Seoul; Rio de Janeiro; and Shanghai. Each of the Leasing Company's area offices and dedicated agents is staffed with local people familiar with the customers and language of the region. The Leasing Company's marketing directors have been employed in the container industry in their respective regions for an average of 15 years, building direct personal relationships with the local ocean carriers and locally based representatives of other ocean carriers.\nThe Leasing Company also maintains agency relationships with over 20 independent agents around the world, who are generally paid a commission based upon the amount of revenues they generate in the region or the number of containers that are leased from their area on behalf of the Registrant. They are located in jurisdictions where the volume of the Leasing Company's business necessitates a presence in the area but is not sufficient to justify a fully-functioning Leasing Company office or dedicated agent. These agents provide marketing support to the area offices covering the region, together with limited operational support.\nIn addition, the Leasing Company relies on the services of over 300 independently-owned and operated depots around the world to inspect, repair, maintain and store containers while off-hire. The Leasing Company's area offices authorize all container movements into and out of the depot and supervise all repair and maintenance performed by the depot. The Leasing Company's technical staff sets the standards for repair of its owned and managed fleet throughout the world and monitors the quality of depot repair work. The depots provide a vital link to the Leasing Company's operations, as the redelivery of a container into a depot is the point at which the container is off-hired from one customer and repaired in preparation for re-leasing to the next, and the point when the Leasing Company's area offices report the container's movements onto the Leasing Company's equipment tracking system. The Leasing Company's computer system has the capability to accommodate future developments, such as allowing depots access to record directly on the system the on-hire and off-hire activity of containers delivered into the depot. It also has the capability of verifying the terms of redelivery authorized by the area offices. These functions are currently being performed by the Leasing Company's area offices.\n(c)(1)(ii) Inapplicable.\n(c)(1)(iii) Inapplicable.\n(c)(1)(iv) Inapplicable.\n(c)(1)(v) The Registrant's containers were leased globally, therefore, seasonal fluctuations were minimal. Other economic and business factors to which the transportation industry in general and the container leasing industry in particular are subject, include inflation and fluctuations in general business conditions and fluctuations in supply and demand for equipment resulting from, among other things, obsolescence, changes in the methods or economics of a particular mode of transportation or changes in governmental regulations or safety standards.\n(c)(1)(vi) The Registrant established an initial working capital reserve of approximately $42,000 (0.5% of subscription proceeds raised). The Registrant has reserved the remaining cash balances at December 31, 1995 from cash distributions to its partners in order to maintain sufficient cash reserves for expenses relating to its final liquidation and subsequent dissolution. The Registrant anticipates that after the remaining net lease receivables and liabilities are collected and discharged during 1996, or as soon as practicable, the Registrant will then undertake a final distribution to its partners. The Partnership will then be dissolved.\nAmounts due under master leases were calculated at the end of each month and billed approximately six to eight days thereafter. Amounts due under short-term and long-term leases were set forth in the respective lease agreements and were generally payable monthly. However, payment was normally received within 45-100 days of receipt. Past due penalties are not customarily collected from lessees, and accordingly were not generally levied by the Leasing Company against lessees of the Registrant's containers.\n(c)(1)(vii) One lessee contributed approximately 19% of the Registrant's rental revenue earned during 1995. The remaining containers in the Registrant's fleet were disposed of during 1995. Accordingly, the Registrant's container operations ceased during the fourth quarter of 1995.\n(c)(1)(viii) Inapplicable.\n(c)(1)(ix) Inapplicable.\n(c)(1)(x) Competition among container leasing companies is based upon several factors, including the location and availability of inventory, lease rates, the type, quality and condition of the containers, the quality and flexibility of the service offered and the confidence in and professional relationship with the lessor. Other factors include the speed with which a leasing company can prepare its containers for lease and the ease with which a lessee believes it can do business with a lessor or its local area office. The Leasing Company believes that it, on behalf of the Registrant, competed favorably on all of these factors.\nThe Leasing Company, on behalf of the Registrant, competed with various container leasing companies in the markets in which it conducted business, including Genstar Container Corp., Transamerica Leasing, Triton Container International Ltd., Trans Ocean Ltd., Textainer Corp. and others. In a series of recent consolidations, one of the major leasing companies, as well as some smaller ones, have been acquired by competitors. It is estimated that at the end of 1995, the ten largest leasing companies (including the Leasing Company) represented 94% of the global leased fleet. Genstar Container Corp. and Transamerica Leasing, the two largest container leasing companies, had approximately 50% of the worldwide leased container fleet at the end of 1995. Some of the Leasing Company's competitors have greater financial resources than the Leasing Company and may be more capable of offering lower per-diem rates on a larger fleet. In the Leasing Company's experience, however, ocean carriers will generally lease containers from more than one leasing company in order to minimize dependence on a single supplier. In addition, not all container leasing companies compete in the same market, as some supply only dry cargo containers and not specialized containers, while others offer only long-term leasing.\n(c)(1)(xi) Inapplicable.\n(c)(1)(xii) Inapplicable.\n(c)(1)(xiii) The Registrant, as a limited partnership, is managed by CCC, the managing general partner, and accordingly does not itself have any employees. CCC has 27 employees, consisting of 5 officers, 4 other managers and 18 clerical and staff personnel.\n(d) Financial Information About Foreign and Domestic Operations and Export Sales\nThe Registrant's business was not divided between foreign and domestic operations. The Registrant's business was the leasing of containers worldwide to ocean-going steamship companies. To this extent, the Registrant's operations were subject to the fluctuations of worldwide economic and political conditions that affected the pattern and levels of world trade.\nRental income from leases to foreign customers constituted approximately 90% of the Registrant's total rental income for the years 1995, 1994 and 1993. The Registrant believes that the profitability of, and risks associated with, leases to foreign customers were generally the same as those of leases to domestic customers. The Registrant's leases generally required all payments to be made in United States currency.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Registrant's remaining 261 twenty-foot and 64 forty-foot marine dry cargo containers were disposed of during 1995, at an average book gain of $57 per container. Of this amount, 178 containers were sold during the second quarter of 1995, pursuant to an agreement with an unrelated party. The purchase price of these 178 containers totaled $130,789, which equaled approximately 105% of the containers' net book value.\nUtilization by lessees of the Registrant's containers fluctuated over time depending on the supply of and demand for containers in the Registrant's inventory locations. During 1995, utilization averaged 64%.\nItem 3.","section_3":"Item 3. Legal Proceedings\nInapplicable.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nInapplicable.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters\n(a) Market Information\n(a)(1)(i) The Registrant's outstanding units of limited partnership interests are not traded on any market nor does an established public trading market exist for such purposes.\n(a)(1)(ii) Inapplicable.\n(a)(1)(iii) Inapplicable.\n(a)(1)(iv) Inapplicable.\n(a)(1)(v) Inapplicable.\n(a)(2) Inapplicable.\n(b) Holders\n(c) Dividends\nInapplicable. For the distributions made by the Registrant to its limited partners, see Item 6, \"Selected Financial 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 Result of Operations\nLiquidity and Capital Resources\nDuring the Registrant's first ten years of operations, the Registrant's primary objective was to generate cash flow from operations for distribution to its limited partners. Aside from the initial working capital reserve retained from the gross subscription proceeds (equal to approximately 0.5% of such proceeds), the Registrant relied primarily on container rental receipts to meet this objective, as well as to finance current operating needs. No credit lines are maintained to finance working capital. Commencing in 1989, the Registrant's 11th year of operations, the Registrant began focusing its attention on the disposition of its fleet in accordance with another of its original investment objectives, realizing the residual value of its containers after the expiration of their economic useful lives, estimated to be between 10 to 15 years after placement in leased service. During this phase, the Registrant began actively disposing of its container fleet, while cash proceeds from equipment disposals, in addition to cash from operations, provided the cash flow for distributions to the limited partners. The remaining 325 containers of the Registrant's fleet were disposed of during 1995. The Registrant is currently in the final phase of the liquidation and wind up stage of operations, focusing on the collection of its lease receivables, a component of net lease receivables. The Registrant anticipates that after the remaining net lease receivables and liabilities are collected and discharged during 1996, or as soon as practicable, the Registrant will undertake a final distribution to its partners and proceed to cancel the Certificate of Limited Partnership, thus terminating the Partnership. The Partnership will then be dissolved. The Registrant has reserved the remaining cash balances at December 31, 1995 from cash distributions to its partners, in order to maintain sufficient cash reserves for expenses relating to its final liquidation and subsequent dissolution.\nDistributions from operations are allocated 1% to the general partners and 99% to the limited partners, until the limited partners have received a 3% cumulative quarterly return on their adjusted capital contributions. Thereafter, the distributions are allocated 50% to the general partners and 50% to the limited partners. Distributions from sales proceeds are allocated 1% to the general partners and 99% to the limited partners, as the limited partners have received cumulative distributions equal to their original capital contributions.\nFrom inception through February 29, 1996, the Registrant has distributed $9,651,882 in cash from operations and $4,859,448 in cash from sales proceeds to its limited partners. This represents a total distribution of $14,511,330 or 177% of the Registrant's original limited partners' investment. Cash generated from sales proceeds totaled $270,981, $252,081 and $381,447 for the years ended December 31, 1995, 1994 and 1993, respectively, and represented approximately 80%, 60% and 52% of the Registrant's cash generated from operating and investing activities, respectively.\nResults of Operations\n1995 - 1994\nDuring 1995, the Registrant's 17th year of operations, the remaining 325 containers in the Registrant's fleet were disposed. Accordingly, the Registrant's container operations ceased during the fourth quarter of 1995. Approximately 17% of the Registrant's 1995 net earnings were from gain on disposal of equipment, as compared to 25% for the year ended December 31, 1994.\nThe Registrant's net lease revenue is determined by deducting direct operating expenses, management fees and reimbursed administrative expenses, from rental revenues billed by the Leasing Company from the leasing of the Registrant's containers. The Registrant's net lease revenue is directly related to the size of its fleet and the utilization and per-diem rental rates of the equipment owned by the Registrant. Net lease revenue declined by approximately 38%, when compared to 1994. Gross rental revenue and rental equipment operating expenses, components of net lease revenue, declined 46% and 51%, respectively, when compared to the prior year. These declines were primarily attributable to the disposal of the Registrant's fleet. Rental equipment operating expenses consisted of, but were not limited to, costs associated with the recovery actions against the doubtful accounts of certain lessees, including legal and container recovery expenses, as well as the provision for doubtful accounts.\nThe Registrant's average utilization and per-diem rental rates fluctuated throughout the year. Utilization averaged 64% during 1995, as compared to 77% during 1994. The Registrant's average per-diem rental rates during 1995 remained virtually unchanged when compared to the prior year. The Registrant's average fleet size (as measured in twenty-foot equivalent units (\"TEU\")) during 1995, was 210 TEU, as compared to 1994's average of 530 TEU.\nDuring the remaining period in the wind up phase of operations, the Registrant expects to incur net losses, as certain other and general administrative expenses including investor processing, tax, legal and audit expenses, should be in excess of any other income generated by the Registrant. The Registrant has increased its cash reserves in anticipation of these expected losses.\n1994 - 1993\nThe container leasing industry began to benefit from a global economic recovery during the latter half of 1994, experiencing an improvement in conditions that existed during 1993, including an upward trend in utilization rates, a reduction in container inventories, and a stabilization of declining per-diem rental rates during the fourth quarter of 1994. However, the age and condition of the Registrant's fleet, combined with the efforts to dispose of the remaining fleet and lower average per-diem rental rates during 1994, resulted in a reduction of net lease revenue by approximately 42%, when compared to 1993. The Registrant's average per-diem rental rates during 1994 were 4% lower than 1993 levels. Utilization averaged 77% during 1994, a decline from the average rate of 81% experienced during 1993.\nThe Registrant continued the disposal of its fleet during 1994, disposing of 215 twenty-foot and 52 forty-foot dry cargo containers, as compared to disposals of 391 twenty-foot and 69 forty-foot dry cargo containers during 1993. By the end of 1994, the Registrant had disposed of 93% of its original fleet. Factors such as age, condition, and geographical location influenced the amount of sales proceeds received and the related gain on container disposals. During 1994, approximately 25% of the Registrant's net earnings were from gains on disposal of equipment, as compared to 19% during the prior year.\nAt December 31, 1994, the Registrant's fleet was comprised of the following:\nThe Registrant's fleet became fully depreciated during 1993 and, accordingly, no depreciation expense was recognized during 1994. The Leasing Company made payments to the Registrant based upon rentals collected from ocean carriers after deducting certain operating expenses associated with the containers, such as the base management fee payable to the managing general partner, the costs of maintenance and repairs not performed by lessees, independent agent fees and expenses, depot expenses for handling, inspection and storage, and additional insurance. During 1994, these rental equipment direct operating expenses and base management fees declined directly as a result of the diminishing fleet size.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nThe Partners IEA Marine Container Fund (A California Limited Partnership):\nWe have audited the accompanying balance sheets of IEA Marine Container Fund (A California Limited Partnership) as of December 31, 1995 and 1994, and the related statements of operations, partners' capital and cash flows for each of the three years in the period ended December 31, 1995. 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 IEA Marine Container Fund (A California Limited Partnership) as of December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\nArthur Andersen LLP\nSan Francisco, California, March 15, 1996\nIEA MARINE CONTAINER FUND (A CALIFORNIA LIMITED PARTNERSHIP)\nBALANCE SHEETS\nDECEMBER 31, 1995 AND 1994\nThe accompanying notes are an integral part of these statements.\nIEA MARINE CONTAINER FUND (A CALIFORNIA LIMITED PARTNERSHIP)\nSTATEMENTS OF OPERATIONS\nFOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nThe accompanying notes are an integral part of these statements.\nIEA MARINE CONTAINER FUND (A CALIFORNIA LIMITED PARTNERSHIP)\nSTATEMENTS OF PARTNERS' CAPITAL\nFOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nThe accompanying notes are an integral part of these statements.\nIEA MARINE CONTAINER FUND (A CALIFORNIA LIMITED PARTNERSHIP)\nSTATEMENTS OF CASH FLOWS\nFOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nThe accompanying notes are an integral part of these statements.\nIEA MARINE CONTAINER FUND (A CALIFORNIA LIMITED PARTNERSHIP)\nNOTES TO FINANCIAL STATEMENTS\nDECEMBER 31, 1995, 1994 AND 1993\n(1) Summary of Significant Accounting Policies\n(a) Nature of Operations\nIEA Marine Container Fund (A California Limited Partnership) (the \"Partnership\"), was organized under the laws of the State of California on April 26, 1979 for the purpose of owning and leasing marine dry cargo containers. The managing general partner is Cronos Capital Corp. (\"CCC\"); the associate general partner is Smith Barney Shearson, Inc. CCC, with its affiliate, Cronos Containers Limited (the \"Leasing Company\"), manages and controls the business of the Partnership.\nThe Partnership commenced operations on September 19, 1979, when the minimum subscription proceeds of $500,000 were obtained. The Partnership offered 20,000 units of limited partnership interest at $500 per unit, or $10,000,000. The offering terminated on March 31, 1980, at which time 16,403 limited partnership units had been purchased.\nDuring 1995, the Partnership's 17th year of operations, the remaining containers in the Partnership's fleet were disposed. The Partnership anticipates that after the remaining net lease receivables and liabilities are collected and discharged during 1996, or as soon as practicable, the Partnership will undertake a final distribution to its partners. The Partnership will then be dissolved.\n(b) Leasing Company and Leasing Agent Agreement\nPursuant to the Limited Partnership Agreement of the Partnership, all authority to administer the business of the Partnership is vested in CCC. CCC entered into a Leasing Agent Agreement whereby the Leasing Company had the responsibility to manage the leasing operations of all equipment owned by the Partnership. Pursuant to the Agreement, the Leasing Company was responsible for leasing, managing and re-leasing the Partnership's containers to ocean carriers and has full discretion over which ocean carriers and suppliers of goods and services it dealt with. The Leasing Agent Agreement permitted the Leasing Company to use containers owned by the Partnership, together with other containers owned or managed by the Leasing Company and its affiliates, as part of a single fleet operated without regard to ownership. Since the Leasing Agent Agreement meets the definition of an operating lease in Statement of Financial Accounting Standards (SFAS) No. 13, it has been accounted for as a lease under which the Partnership is the lessor and the Leasing Company is the lessee.\nThe Leasing Agent Agreement generally provided that the Leasing Company make payments to the Partnership based upon rentals collected from ocean carriers after deducting direct operating expenses and management fees to CCC. The Leasing Company leases containers to ocean carriers, generally under operating leases which are either master leases or term leases (mostly two to five years). Master leases do not specify the exact number of containers to be leased or the term that each container will remain on hire but allow the ocean carrier to pick up and drop off containers at various locations; rentals are based upon the number of containers used and the applicable per-diem rate. Accordingly, rentals under master leases are all variable and contingent upon the number of containers used. Most of the Registrant's containers were leased to ocean carriers under master leases; leasing agreements with fixed payment terms are not material to the financial statements. Since there are no material minimum lease rentals, no disclosure of minimum lease rentals is provided in these financial statements.\nIEA MARINE CONTAINER FUND (A CALIFORNIA LIMITED PARTNERSHIP)\nNOTES TO FINANCIAL STATEMENTS\n(c) Basis of Accounting\nThe Partnership utilizes the accrual method of accounting. Revenue is recorded when earned.\nThe preparation of financial statements in conformity with generally accepted accounting principles (GAAP) requires the Partnership 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 reported period.\n(d) Allocation of Net Earnings and Partnership Distributions\nNet earnings have been allocated between general and limited partners in accordance with the Partnership Agreement.\nActual cash distributions differ from the allocations of net earnings between the general and limited partners as presented in these financial statements. Partnership distributions are based on \"distributable cash\" and are paid to the general and limited partners on a quarterly basis. Cash generated from operations are allocated 1% thereof to the general partners and 99% thereof to the limited partners until the limited partners have received a 3% cumulative quarterly return on their adjusted capital contributions and thereafter 50% to the limited partners and 50% to the general partners.\nDistributions of proceeds from container sales are also made quarterly; first to the limited partners until they have received cumulative distributions equal to their capital contributions; thereafter 99% to the limited partners and 1% to the general partners until the limited partners have received cumulative distributions equal to 8% per annum on their adjusted capital contributions and thereafter 75% to the limited partners and 25% to the general partners.\n(e) Depreciation of Containers\nRental equipment was depreciated over a twelve-year life on a straight-line basis to its estimated salvage value.\n(f) Income Taxes\nThe Partnership is not subject to income taxes, consequently no provision for income taxes has been made. The Partnership files an annual information tax return, prepared on the accrual basis of accounting. At December 31, 1995, the tax basis of total partners' capital was $1,157,682.\n(g) Foreign Operations\nThe Partnership's business was not divided between foreign or domestic operations. The Partnership's business was the leasing of containers worldwide to ocean-going steamship companies and did not fit the definition of reportable foreign operations within Financial Accounting Standards Board Statement No. 14 \"Financial Reporting for Segments of a Business Enterprise.\" Any attempt to separate \"foreign\" operations from \"domestic\" operations would have been dependent on definitions and assumptions that were so subjective as to render the information meaningless and potentially misleading.\nIEA MARINE CONTAINER FUND (A CALIFORNIA LIMITED PARTNERSHIP)\nNOTES TO FINANCIAL STATEMENTS\n(h) Financial Statement Presentation\nThe Partnership has determined that for accounting purposes the Leasing Agent Agreement has been a lease, and the receivables, payables, gross revenues and operating expenses attributable to the containers managed by the Leasing Company are, for accounting purposes, those of the Leasing Company and not of the Partnership. Consequently, the Partnership's balance sheets and statement of operations display the payments to be received by the Partnership from the Leasing Company as the Partnership's receivables and revenues.\n(2) Short-term Investments\nShort-term investments are carried at cost which approximates market value. Short-term investments with an original maturity of less than three months are considered cash equivalents.\n(3) Net Lease Receivables Due from Leasing Company\nNet lease receivables due from the Leasing Company are determined by deducting direct operating payables and accrued expenses, and base management fees payable to CCC and its affiliates from the rental billings payable by the Leasing Company to the Partnership under operating leases to ocean carriers for the containers owned by the Partnership. Net lease receivables at December 31, 1995 and December 31, 1994 were as follows:\n(4) Damage Protection Plan\nThe Leasing Company offered a repair service to several lessees of the Partnership's containers, whereby the lessee paid an additional rental fee for the convenience of having the Partnership incur the repair expense for its containers damaged while on lease. This revenue was recorded when earned according to the terms of the rental contract. A reserve was established to provide for the estimated costs incurred by this service. This reserve is a component of net lease receivables due from the Leasing Company (see note 3). The Partnership was not responsible in the event repair costs exceeded predetermined limits, or for repairs that were required for damages not defined by the damage protection plan agreement.\nIEA MARINE CONTAINER FUND (A CALIFORNIA LIMITED PARTNERSHIP)\nNOTES TO FINANCIAL STATEMENTS\n(5) Net Lease Revenue\nNet lease revenue is determined by deducting direct rental equipment operating expenses and management fees to CCC from the rental revenue billed by the Leasing Company under operating leases to ocean carriers for the containers owned by the Partnership. Net lease revenue for the years ended December 31, 1995, 1994 and 1993, was as follows:\n(6) Compensation to Managing General Partner\nCompensation paid by the Partnership to CCC consisted solely of base management fees. Base management fees were equal to $0.25 per day per twenty-foot and $0.43 per day per forty-foot container owned by the Partnership pursuant to Section 4.3 of the Partnership Agreement.\n(7) Limited Partners' Capital\nCash distributions made to the limited partners included distributions of proceeds from equipment sales in the amount of $184,536 in 1995, $246,048 in 1994 and $430,584 in 1993. These distributions are treated as a reduction of \"Adjusted Capital Contributions\" as defined by the Partnership Agreement.\nThe limited partners' per unit share of capital at December 31, 1995, 1994 and 1993 was $15, $24 and $44, respectively. This is calculated by dividing the limited partners' capital at the end of the year by 16,403, the total number of limited partnership units.\n(8) Major Lessees\nOne lessee contributed approximately 19% of the Partnership's rental revenue earned during 1995. No single lessee contributed more than 10% of the rental revenue earned in 1994 and 1993.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nInapplicable.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nThe Registrant, as such, has no officers or directors, but is managed by CCC, the managing general partner. The officers and directors of CCC at January 31, 1996, are as follows:\nDENNIS J. TIETZ Mr. Tietz, 43, as President and Chief Executive Officer, is responsible for the general management of CCC. From 1986 until August 1992, Mr. Tietz was responsible for the organization, marketing and after-market support of CCC's investment programs. Mr. Tietz is also President and a director of Cronos Securities Corp. and a director of The Cronos Group. Mr. Tietz was a regional manager for CCC, responsible for various container leasing activities in the U.S. and Europe from 1981 to 1986. Prior to joining CCC in December 1981, Mr. Tietz was employed by Trans Ocean Leasing Corporation as Regional Manager based in Houston, with responsibility for all leasing and operational activities in the U.S. Gulf.\nMr. Tietz holds a B.S. degree in Business Administration from San Jose State University and is a Registered Securities Principal with the NASD.\nJOHN P. MCDONALD Mr. McDonald, 34, was elected Vice President - National Sales Manager of CCC in August 1992, with responsibility for marketing CCC's investment programs. Since 1988, Mr. McDonald had been Regional Marketing Manager for the Southwestern U.S. From 1983 to 1988, Mr. McDonald held a number of container leasing positions with CCC, the most recent of which was as Area Manager for Belgium and the Netherlands, based in Antwerp.\nMr. McDonald holds a B.S. degree in Business Administration from Bryant College, Rhode Island. Mr. McDonald is also a Vice President of Cronos Securities Corp.\nELINOR A. WEXLER Ms. Wexler, 47, was elected Vice President - Administration and Secretary of CCC in August 1992. Ms. Wexler has been employed by the General Partner since 1987, and is responsible for investor services, compliance and securities registration. From 1983 to 1987, Ms. Wexler was Manager of Investor Services for The Robert A. McNeil Corporation, a real estate syndication company, in San Mateo, California. From 1971 to 1983, Ms. Wexler held various positions, including securities trader and international research editor, with Nikko Securities Co., International, based in San Francisco.\nMs. Wexler attended the University of Oregon, Portland State University and the Hebrew University of Jerusalem, Israel. Ms. Wexler is also Vice President and Secretary of Cronos Securities Corp. and a Registered Principal with the NASD.\nJOHN KALLAS Mr. Kallas, 33, was elected Vice President\/Treasurer and Chief Financial Officer of CCC in December 1993 and is directly responsible for CCC's accounting operations and reporting activities. Mr. Kallas has held various accounting positions since joining CCC in 1989, including Controller, Director of Accounting and Corporate Accounting Manager. From 1985 to 1989, Mr. Kallas was an accountant with KPMG Peat Marwick, San Francisco, California.\nMr. Kallas holds a B.S. degree in Business Administration from the University of San Francisco and is a certified public accountant. Mr. Kallas is also Treasurer of Cronos Securities Corp.\nLAURENCE P. SARGENT Mr. Sargent, 66, joined the Board of Directors of CCC in 1991. Mr. Sargent was a founder of Leasing Partners International (\"LPI\") and served as its Managing Director from 1983 until 1991. From 1977 to 1983, Mr. Sargent held a number of positions with Trans Ocean Leasing Corporation, the last of which was as a director of its refrigerated container leasing activities. From 1971 to 1977, Mr. Sargent was employed by SSI Container Corporation (later Itel Container International), ultimately serving as Vice President \/ Far East. Prior to that, Mr. Sargent was a Vice President of Pacific Intermountain Express, a major U.S. motor carrier, responsible for its bulk container division. Mr. Sargent holds a B.A. degree from Stanford University. Mr. Sargent also serves as a director of the Institute of International Container Lessors (\"IICL\"), an industry trade association. Mr. Sargent is also a director of Cronos Securities Corp.\nMr. Sargent retired as Deputy Chairman of the Group as of January 1, 1996 . He remains a director of CCC, The Cronos Group, as well as other various subsidiaries of The Cronos Group.\nSTEFAN M. PALATIN Mr. Palatin, 42, joined the Board of Directors of CCC in January 1993. Mr. Palatin is Chairman and CEO of The Cronos Group, and was a founder of LPI in 1983. From 1980 to 1991, Mr. Palatin was an executive director of the Contrin Group, which has provided financing to the container leasing industry, as well as other business ventures, and has sponsored limited partnerships organized in Austria. From 1977 to 1980, Mr. Palatin was a consultant to a number of companies in Austria, including Contrin. From 1973 to 1977, Mr. Palatin was a sales manager for Generali AG, the largest insurance group in Austria.\nMr. Palatin, who is based in Austria, holds a Doctorate in Business Administration from the University of Economics and World Trade in Vienna. Mr. Palatin is also a director of The Cronos Group.\nA. DARRELL PONNIAH Mr. Ponniah, 46, was elected to the Board of Directors of CCC in January 1993. Mr. Ponniah is Chief Financial Officer of The Cronos Group and is based in the United Kingdom. Prior to joining Cronos in 1991, Mr. Ponniah was employed by the Barclays Bank Group and served as Chief Operating Officer of Barclays European Equipment Finance. From 1973 to 1988, Mr. Ponniah was employed by Rank Xerox, the European-based subsidiary of Xerox Corporation of the U.S.A., in a number of positions, the most recent of which was as Group Controller and Chief Financial Officer of the International Equipment Financing Division of Rank Xerox Limited.\nMr. Ponniah is an honors graduate of Manchester University in England and holds post graduate degrees in operational research from Brunel University and in Business Administration from the Manchester Business School. Mr. Ponniah is also a director of The Cronos Group and Cronos Securities Corp.\nThe key management personnel of the Leasing Company at January 31, 1996, were as follows:\nNIGEL J. STRIBLEY Mr. Stribley, 42, has been responsible for the general management of the Leasing Company since September 1991. From 1985 to 1991, Mr. Stribley was a director of LPI, based in the United Kingdom and responsible for worldwide lease marketing and operations of refrigerated containers. From 1978 to 1985, Mr. Stribley was employed by Sea Containers Limited, London, where he was involved in refrigerated container leasing, ultimately as Manager of Refrigerated Containers with responsibility for world-wide activities. From 1975 to 1978, Mr. Stribley was employed by Sealand Containerships, Ltd., the United Kingdom subsidiary of a major U.S. container shipping company, as a management trainee and later as Operations Manager and a Container Terminal Manager.\nMr. Stribley holds a BA degree with honors from Bristol University in England. Mr. Stribley is a director of The Cronos Group.\nJOHN M. FOY Mr. Foy, 50, is directly responsible for the Leasing Company's lease marketing and operations in North America, Central America, and South America, and is based in San Francisco. From 1985 to 1993, Mr. Foy was Vice President\/Pacific with responsibility for dry cargo container lease marketing and operations in the Pacific Basin. From 1977 to 1985 Mr. Foy was Vice President of Marketing for Nautilus Leasing Services in San Francisco with responsibility for worldwide leasing activities. From 1974 to 1977, Mr. Foy was Regional Manager for Flexi-Van Leasing, a container lessor, with responsibility for container leasing activities in the Western United States. Mr. Foy holds a B.A. degree in Political Science from University of the Pacific, and a Bachelor of Foreign Trade from Thunderbird Graduate School of International Management.\nGEOFFREY J. MORNARD Mr. Mornard, 36, is directly responsible for the Leasing Company's lease marketing and operations in Europe, the Middle East and Africa. From 1991 to 1993, Mr. Mornard was Director of Marketing for refrigerated containers in Australia and New Zealand. From 1989 to 1991, Mr. Mornard held the same position with LPI. From 1979 to 1989, Mr. Mornard was employed by Cooltainer Services, Ltd., a refrigerated container carrier company, initially as Melbourne Branch Manager, later as Sydney Branch Manager, and ultimately as Australian Trade Manager, responsible for marketing and operations of all container traffic to and from Australia.\nDANNY WONG Mr. Wong, 42, is responsible for the Leasing Company's lease marketing and operations in Asia, Australia and the Indian sub-continent, and is based in Singapore. From 1991 to 1993, Mr. Wong was Vice President\/Refrigerated Containers, responsible for the marketing of refrigerated containers worldwide for the Leasing Company. From 1988 to 1991, Mr. Wong was employed by LPI, as Director of Marketing for the Far East and Southeast Asia based in Singapore. From 1987 to 1988, Mr. Wong was a district manager in Singapore covering leasing activities in Southeast Asia for Gelco CTI, a major container leasing company. From 1979 to 1987, Mr. Wong was employed by Flexi-Van Leasing in Singapore as a sales manager and later as Regional Manager for Southeast Asia and the Indian sub-continent. Mr. Wong holds a Diploma in Marketing Management from the Singapore Institute of Management.\nDAVID HEATHER Mr. Heather, 48, is responsible for all technical and engineering activities of the fleet managed by the Leasing Company. Mr. Heather was Technical Director for LPI, based in the United Kingdom, from 1986 to 1991. From 1980 to 1986, Mr. Heather was employed by ABC Containerline NV as Technical Manager with technical responsibility for the shipping line's fleet of dry cargo, refrigerated and other specialized container equipment. From 1974 to 1980, Mr. Heather was Technical Supervisor for ACT Services Ltd., a shipping line, with responsibility for technical activities related to refrigerated containers. Mr. Heather holds a Marine Engineering Certificate from Riversdale Marine Technical College in England.\nJOHN C. KIRBY Mr. Kirby, 42, is responsible for container purchasing, contract and billing administration, container repairs and leasing-related systems, and is based in the United Kingdom. Mr. Kirby joined CCC in 1985 as European Technical Manager and advanced to Director of European Operations in 1986, a position he held with CCC, and later the Leasing Company, until his promotion to Vice President\/Operations of the Leasing Company in 1992. From 1982 to 1985, Mr. Kirby was employed by CLOU Containers a container leasing company, as Technical Manager based in Hamburg, Germany. Mr. Kirby acquired a professional engineering qualification from the Mid-Essex Technical College in England.\nJ. GORDON STEEL Mr. Steel, 63, is directly responsible for the overall lease marketing activity for the Leasing Company's Tank Container Division. From 1990 to 1992, Mr. Steel held the position of Director\/General Manager for Tiphook Container's Tank Division. From 1977 to 1990, Mr. Steel held various managerial positions, involving manufacturing and transportation of hazardous materials, with Laporte Industries and ICI, major chemical distribution companies. Mr. Steel is a qualified Chemical Engineer and attended the Associate Royal Technical College in Scotland.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe Registrant paid a base management fee to the managing general partner as set forth in the table below.\nThe Registrant also makes quarterly distributions to its partners (general and limited) from cash generated from operations which are allocated 1% thereof to the general partners and 99% thereof to the limited partners until the limited partners have received a 3% cumulative quarterly return on their adjusted capital contributions and, thereafter, 50% to the limited partners and 50% to the general partners.\nProceeds from container sales are also made quarterly; first to the limited partners until the limited partners have received cumulative distributions equal to their capital contributions; thereafter, 99% to the limited partners and 1% to the general partners until the limited partners have received cumulative distributions equal to 8% per annum on their adjusted capital contributions and thereafter 75% to the limited partners and 25% to the general partners. (See Partnership Agreement for a complete discussion of the sharing arrangement for the sale proceeds.)\nThe Registrant does not pay or reimburse CCC or the associate general partner for any remuneration payable by them to their officers, directors or employees. All remuneration payable by CCC to its officers, directors and employees, and all of CCC's corporate overhead incurred in connection with the operation of the Registrant, is borne by CCC from the fees payable to it by the Registrant and from other income earned by CCC.\nThe following table sets forth the fees the Registrant paid (on a cash basis) to CCC and Smith Barney Shearson, Inc., the associate general partner of the Registrant, for the fiscal year 1995.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\n(a) Security Ownership of Certain Beneficial Owners\nThere is no person or \"group\" of persons known to the management of CCC, the managing general partner of the Registrant, to be the beneficial owner of more than five percent of the outstanding units of limited partnership interests of the Registrant.\n(b) Security Ownership of Management\nThe Registrant has no directors or officers. It is managed by CCC, the managing general partner. With the exception of Dennis J. Tietz, President and a director of CCC, no other director or officer owns any units of limited partnership interest of the Registrant. Mr. Tietz owns 5 units, representing 0.031% of the total amount of units outstanding.\n(c) Changes in Control\nInapplicable.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\n(a) Transactions with Management and Others\nThe Registrant's only transactions with management and other related parties during 1995 were limited to those fees paid or amounts committed to be paid (on an annual basis) to CCC, the managing general partner, and Smith Barney Shearson, Inc., the associate general partner. See Item 11, \"Executive Compensation,\" herein.\n(b) Certain Business Relationships\nInapplicable.\n(c) Indebtedness of Management\nInapplicable.\n(d) Transactions with Promoters\nInapplicable.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\n(a)1. Financial Statements\nAll other schedules are omitted as the information is not required or the information is included in the financial statements or notes thereto.\n(a)3. Exhibits\n(b) Reports on Form 8-K\nNo reports on Form 8-K were filed by the Registrant during the quarter ended December 31, 1995\n- ---------- * Incorporated by reference to the Prospectus of the Registrant dated August 27, 1979, included as part of Registration Statement on Form S-1 (No. 2-64700)\n** Incorporated by reference to Exhibit 3.4 to the Registration Statement on Form S-1 (No. 2-64700)\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nIEA MARINE CONTAINER FUND (A California Limited Partnership)\nBy Cronos Capital Corp. The Managing General Partner\nBy \/s\/ John Kallas ---------------------------------------------------- John Kallas Vice President\/Treasurer and Chief Financial Officer Principal Accounting Officer\nDate: March 28, 1996\nPursuant to the requirement of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of Cronos Capital Corp., the managing general partner of the Registrant, in the capacities and on the dates indicated:\nSUPPLEMENTAL INFORMATION\nThe Registrant's annual report will be furnished to its limited partners on or about April 30, 1996. Copies of the annual report will be concurrently furnished to the Commission for information purposes only, and shall not be deemed to be filed with the Commission. EXHIBIT INDEX\n- ---------- * Incorporated by reference to the Prospectus of the Registrant dated August 27, 1979, included as part of Registration Statement on Form S-1 (No. 2-64700)\n** Incorporated by reference to Exhibit 3.4 to the Registration Statement on Form S-1 (No. 2-64700)","section_15":""}
{"filename":"106135_1995.txt","cik":"106135","year":"1995","section_1":"ITEM 1. BUSINESS.\n(a) GENERAL DEVELOPMENT OF BUSINESS.\nWestern Investment Real Estate Trust (\"The Trust\") is a real estate investment trust (\"REIT\") and qualifies as such under Sections 856 and 960 of the Internal Revenue Code. The Trust was organized under the laws of the State of California in 1962 and commenced real estate operations in 1964.\nIn order that the Trust may continue to qualify as a real estate investment trust: (i) more than 75% of the Trust's total assets must be invested in real estate, cash, cash items or government securities, (ii) at least 75% of the Trust's gross income must be derived from real estate assets, (iii) the Trust can hold no property primarily for sale to customers in the ordinary course of business, (iv) beneficial ownership of the Trust must be held by more than 100 persons during at least 335 days of each taxable year, and (v) the Trust must distribute annually to its shareholders an amount equal to or exceeding 95% of its real estate investment trust taxable income. Under the terms of its Declaration of Trust, the Trust is permitted to invest its funds in ownership of real estate, mortgages, deeds of trust and certain financial instruments as permitted by law. Substantially all of the Trust's funds have been invested in the ownership of real estate.\n(b) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS.\nThe Trust is not engaged in different segments of a business nor is the Trust engaged in more than one line of business.\n(c) NARRATIVE DESCRIPTION OF BUSINESS.\nThe Trust, which at December 31, 1995 employed 51 people, is in the business of acquiring, managing, leasing and developing retail, commercial and industrial properties. At December 31, 1995, the Trust owned 50 retail properties, 10 commercial properties and 2 industrial properties with a combined gross leasable area of 4.8 million square feet.\nThe Trust has its executive office at 3450 California Street, San Francisco, California, 94118, and can be reached at (415) 929-0211. Additionally, the Trust maintains two regional offices in California.\nThe Trust's portfolio of 62 properties at December 31, 1995 is summarized as follows:\nAt December 31, 1995, occupancy for each property type is as follows:\nProperty Type Occupancy Rate (1) ------------- ------------------ Shopping Center and Retail 93.8% Commercial 93.1% Industrial 100.0%\nAverage Occupancy for All Property Types 93.9%\n(1) Once a space is subject to an executed lease, the space is then included in occupied space. A space continues to be incorporated in our occupancy percentage until: (1) the related lease expires and the tenant is no longer in legal possession, or (2) the related lease is formally terminated and the tenant is no longer in legal possession.\nThe following table summarizes the composition of the Trust's real estate investments as of December 31, 1995 by type based on amounts invested by the Trust.\nPORTFOLIO SUMMARY DECEMBER 31, 1995\nThe Trust owns 23 unimproved pads located within or adjacent to the property lines of its shopping centers that are available for development and leasing. Additionally, the Trust owns a total of 25 acres of undeveloped land adjacent to its North Hills and Elko Shopping Centers in Nevada.\nThe weighted average age of the Trust's 62 properties is 12.5 years. The weighted average age of the Trust's commercial, industrial and retail properties is 21.5 years, 15.4 years and 12.05 years, respectively. This calculation is weighted by Gross Leasable Area and is based on the original construction date of the property. As such, construction or renovation occurring subsequent to the original construction date is not reflected in this calculation.\nCURRENT ECONOMIC CLIMATE\nAfter a number of false starts in recent years, California's economy has experienced solid improvement. Additionally, many economists believe California's future is brighter. According to the Center for Continuing Study of the California Economy (Palo Alto, California), total personal income rose 7.2 percent during the first half of 1995. This, in conjunction with a 1.8 percent increase in consumer prices, produced the first substantial boost in real spending power since 1990. Some economists believe that California is once again ready to take its place as an engine of growth for the U.S. economy. California's strengths of foreign trade, entertainment and business services are producing gains in jobs, income and spending that will likely continue into 1996 and the decade ahead. While the strength of the California economic recovery is uncertain, improvement in economic conditions should help improve the Trust's operating results in 1996. Recent property acquisitions and improvements have been completely or partially funded with advances under the Trust's variable rate line of credit. If interest rates were to increase substantially the interest rate under the line of credit could approach, or exceed the yield on the property acquisitions. However, improving economic conditions, which could lead to higher interest rates, should also lead to improved occupancy and rental rates.\nCOMPETITION\nDuring the past several years, volume discount retailers, such as Wal-Mart and Costco, have entered certain areas of California and Nevada where Trust community shopping center properties are located. The Trust expects that these discounters may positively or negatively affect certain of the Trust's shopping center tenants. The Trust believes that its tenants could benefit if these discounters attract additional customers to nearby Trust properties and thereby generate increased sales for Trust tenants. Conversely, the Trust's tenants could be negatively affected if discounters draw customers away from the Trust's properties. The Trust believes that to date the trend has had no significant impact on the Trust's results of operations.\nThe Trust competes for quality properties with other investors and engages in a continuing effort to identify desirable properties for acquisition. As the number of prospective buyers of the types of properties the Trust considers for purchase increases, the prices of such properties may increase and the yield decrease. The Trust believes it can continue to compete effectively in the current real estate environment because of its experienced staff and management team.\nThe Trust competes for tenants primarily on the basis of location, rental rates, services provided and the design and condition of the properties. In some of the geographic areas in which the Trust owns properties, the available supply of space for lease exceeds the demand by prospective tenants. In order to compete effectively, the Trust employs experienced property managers and leasing agents.\nTENANTS\nThe Trust's principal shopping center and retail tenants include substantial, well-recognized businesses such as Food-4-Less, Nob Hill Foods, PayLess Drugs, Pak N Save, Raley's, Safeway, Save Mart Supermarket and Thrifty Drug. The Trust's commercial tenants include Coast Federal Bank and Fireman's Fund Insurance Company. In addition, the Trust has other major retail tenants such as Lucky Stores and J.C. Penney.\nNo single property investment accounted for more than 5% of total revenues in 1995. At December 31, 1995, Raley's, the Trust's most significant tenant, a supermarket and super drug retailer, was a lessee in nineteen of the Trust's properties and accounted for 20% of the Trust's 1995 total revenues. Raley's, a privately owned company, currently operates 81 stores in Northern California and Nevada. The Raley's organization has released information indicating that its sales exceeded $1.8 billion in its most recently reported fiscal year ended June 24, 1995. The Trust receives audited financial statements annually from Raley's and uses them to monitor Raley's financial position and results of operations.\nThe following table provides the location, size and expiration of the Raley's leases:\nNOTE (1): Although Raley's no longer occupies this Fallon, Nevada, property, it guarantees the J. C. Penney and Hub leases and makes supplemental lease payments to the Trust.\nMAJOR PRODUCERS OF 1995 TOTAL REVENUE\nThe Trust receives sales and other information on a monthly, quarterly or annual basis from its retail tenants, including Raley's, under leases which provide for such reports. The Trust uses this information to monitor the payment of percentage rents where leases so provide. The Trust recognized $559,000 and $537,000 of percentage rents during 1995 and 1994, respectively. Virtually all of the Trust's existing leases include at least one of the following provisions for payment of additional rent: (1) scheduled fixed increases, (2) percentage rent based on tenants' gross sales, or (3) CPI-based escalation clauses. The Trust endeavors to structure leases on a triple-net basis with the lessees being responsible for most operating expenses, such as real estate taxes, certain types of insurance, utilities, normal repairs and maintenance. To the extent such provisions cannot be negotiated and incorporated into a lease and in regard to vacant space, the Trust pays such expenses from current operating income. Most of the Trust's leases require the tenant to carry liability insurance coverage on their leased premises. The Trust monitors tenant compliance with insurance coverage requirements. While the Trust believes its properties are adequately insured, the Trust does not carry earthquake or flood coverage. Most of the Trust's properties are located in areas of California and Nevada where earthquakes have been known to occur. The Trust periodically considers the merits of purchasing earthquake insurance. To date the Trust has not purchased earthquake insurance because of (i) the high premiums and deductibles and (ii) the geographically diversified portfolio that reduces the likelihood of an earthquake resulting in a material loss to the Trust. Furthermore, the majority of properties in the portfolio principally comprise single-story, relatively new buildings.\nTENANT LEASE EXPIRATIONS AND RENEWALS\nThe following table shows lease expirations for the leases in effect as of December 31, 1995, for the next ten years, assuming none of the tenants exercise renewal options:\nASSET MANAGEMENT\nThe Trust is a fully integrated REIT which provides full asset management services to all but two of its properties. Asset management includes property management, leasing, marketing and accounting support. Internal management provides for regular interaction between the Trust and its tenants and close supervision of properties.\nThe Trust directly manages 60 of its 62 properties. In order to facilitate its present and future asset management activities, the Trust maintains two branch offices which are centrally located to the properties. The offices are located at the Trust's Country Gables shopping center in Granite Bay, California and at the Victorian Walk shopping center in Fresno, California.\nInternal management permits the Trust to provide value added services to its tenants. For example, the Trust's marketing staff works with the Trust's tenants on promotional and advertising activities to draw consumers to the shopping centers. These activities help the Trust attract and retain the national, regional and local retail tenants which serve the Northern California and Nevada markets. The Trust believes the cost of internal property management and leasing is generally less expensive than employing independent property management, marketing and leasing firms due to lower commissions and fees and certain economies of scale.\nTwo of the Trust's 62 properties are managed by independent property managers. G & W Management Co. provides management services for the property leased to Fireman's Fund Insurance Company, in Petaluma, California, for fees equal to 3.5% of gross receipts. The Trust's property is part of a larger office park which is managed by G & W Management Co. Commercial Real Estate Service (CRES) provides management services with respect to Serra Center, located in Colma, California, for fees equal to 4% of gross rents plus tenant administrative and management fees paid by the tenants attributable to the Trust's 30% interest in the center. CRES is an affiliate of the co-owner of the Serra Center and has been managing the property for approximately 20 years. Neither one of the above-named property managers are affiliated with the Trust, its trustees, officers or any shareholder owning 5% or more of the Trust's shares. Repairs and maintenance of the Trust's properties not undertaken by tenants under the terms of the Trust's triple-net leases are performed by independent contractors not affiliated with the Trust, its trustees or officers, or any shareholder owning 5% or more of the Trust's shares.\nPOTENTIAL ENVIRONMENTAL RISKS\nInvestments in real property create a potential for environmental liability on the part of the owner of such real property. If hazardous substances are discovered on or emanating from any of the Trust's properties, the Trust and\/or others may be held strictly liable for all costs and liabilities relating to the clean-up of such hazardous substances.\nIn order to mitigate environmental risks, in 1989 the Trust adopted a policy of obtaining at least a Phase I environmental study (a preliminary site assessment which does not include environmental sampling, monitoring or laboratory analysis) on each property it seeks to acquire. From time to time, when the Trust deems it appropriate, we have acquired independent environmental analyses on properties acquired prior to 1989. Although the Trust has no knowledge that any material environmental contamination has occurred, no assurance can be given that hazardous substances are not located under any of the properties. The Trust carries no express insurance coverage for the type of environmental risk described above.\nThe trust assesses on an ongoing basis measures necessary to comply with environmental laws and regulations. In conducting its assessments, the Trust has identified the following matters:\nOAKLAND, CALIFORNIA\nDuring 1994, the Trust concluded the sale of its industrial property in Oakland, California. Under the terms of the sale agreement, the Trust is responsible for environmental clean-up costs that exceed the sum of (i) $658,000, and (ii) any amounts recovered by the buyer from third parties. On the basis of the current facts and circumstances, the Trust has not recorded a provision for any future environmental liability resulting from this property because the Trust believes the likelihood of incurring any liability is remote. The Trust will continue to monitor the environmental remediation activity and status of this property.\nVALLEJO, CALIFORNIA\nThe Trust has agreed to guarantee the performance of the restoration work related to disturbance of wetlands by, and to provide certain financial accommodations to, the developer of the Trust's Park Place Shopping Center in Vallejo, California. During July 1995, the developer declared Chapter 11 bankruptcy. The Trust received an initial estimate for the wetlands restoration from an environmental consulting firm, which projected total costs of as much as $250,000. Approximately $200,000 has already been funded by the Trust.\nUNDERGROUND STORAGE TANKS\nThe Trust, as far as it is aware, owns only three properties which presently contain underground storage tanks. The Trust has no knowledge of any leakage or contamination resulting from these tanks that will have a material impact on its financial position or results of operations. There are, however, reported low levels of soil contamination from underground storage tanks removed from the Heritage Place Shopping Center in Tulare, California, prior to its acquisition by the Trust. The prior owner has been ordered by the Tulare County environmental officials to clean up suspected soil contamination and has been approved for and received funding from the California Leaking Underground Storage Tank Fund. Should the prior owner fail to complete remediation, the Trust's exposure could be as much as $230,000 per the initial estimate by an environmental consultant. In addition, there is a potential for contamination from reported off-site leaking petroleum underground storage tanks located on properties adjacent to certain Trust properties.\nThe probable overall costs of these measures cannot be determined at this time due to uncertainty about the extent of environmental risks and the Trust's responsibility, the complexity of environmental laws and regulations, and the selection of alternative compliance approaches. However, the Trust is not aware of any environmental conditions that it believes will have a material impact on its financial position or results of operations.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nProperty information is presented on the following pages.\nITEM 2: PROPERTIES\ncontinued on next page\nITEM 2: PROPERTIES\ncontinued on next page\nITEM 2: PROPERTIES\ncontinued on next page\nITEM 2: PROPERTIES\n(1) Once a space is subject to an executed lease, the space is then included in occupied space. A space continues to be incorporated in our occupied percentage until: 1) the related lease expires and the tenant is no longer in legal possession, or 2) the related lease is formally terminated and the tenant is no longer in legal possession. (2) Sold in 1994. (3) Acquired in 1994. (4) Acquired in 1995. (5) Investment converted to equity ownership through a deed in lieu of foreclosure in 1993. (6) Included in Other Income.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThe Trust is involved in various legal actions arising in the normal course of business. After taking into consideration legal counsel's evaluation of such actions, management is of the opinion that their outcome will not have a material adverse effect on the Trust'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 REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nPrincipal Market:\nThe shares of beneficial interest of the Trust, without par value, are listed on the American Stock Exchange under the symbol \"WIR\". The following table sets forth the high and low sales prices of the shares as reported by the American Stock Exchange:\n(1) Paid March 15, 1996.\nApproximate number of equity security holders:\nTitle of Class Number of Record Holders -------------- ------------------------- (as of December 31, 1995)\nShares of Beneficial Interest, without par value 2,428\nThe Trust estimates that there were over 18,000 beneficial owners of shares, including owners whose shares were held in brokerage and trust accounts.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\n(1) Revenues comprise minimum rents, percentage rents, recoveries from tenants and other income.\n(2) The Trust, along with most industry analysts, considers Funds From Operations (FFO) to be an appropriate supplemental measure of the operating performance of an equity REIT. Funds From Operations, as defined in 1991 by the National Association of Real Estate Investment Trusts (NAREIT), is: net income excluding gains or losses from debt restructuring and sales of property, plus depreciation and amortization, and after adjustments for unconsolidated joint ventures. Funds From Operations does not replace net income as a measure of performance or net cash provided by operating activities as a measure of liquidity.\nFunds From Operations presented in the Selected Financial Data schedule is calculated in accordance with the 1991 NAREIT definition of FFO. In 1995, NAREIT interpreted its definition of Funds From Operations. The effect of the 1995 interpretation on the Trust's calculation of FFO is to require exclusion from the add-backs to net income of: (i) amortization of deferred financing costs and (ii) depreciation of personal property. When calculated in accordance with NAREIT'S 1995 interpretation, FFO would be $21,017,000, $20,084,000, $20,522,000, $20,017,000 and $22,566,000 for the year ended December 31, 1995, 1994, 1993, 1992 and 1991, respectively. The Trust will adopt the 1995 interpretation in 1996.\n(3) Real estate owned reflects acquisition costs and capitalized costs of improvements before deduction of depreciation and amortization.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nLIQUIDITY AND CAPITAL RESOURCES\nThe Trust anticipates that cash flows provided by operating activities will continue to provide adequate funds for all current principal and interest payments as well as dividend payments in accordance with REIT requirements. Cash on hand and borrowings under its existing bank line of credit, as well as other debt and equity alternatives, will provide the necessary funds to achieve future growth. The Trust has only one loan secured by one of its properties. Additionally, the Trust jointly owns two properties where a co-owner is obligated under a note that is secured by the property.\nAny incurrence of additional debt by the Trust would be subject to limitations imposed by the Indenture Agreement executed in connection with the Trust's senior notes and the bank line of credit.\nAs of December 31, 1995, the Trust had approximately $30.8 million available under its $60 million bank line of credit. This facility, which has certain covenants (including minimum shareholders' equity, maximum ratio of debt to net worth and income coverage requirements), could be used to fund acquisitions, improvements to real estate and other cash requirements. The interest rate on the bank line of credit is either LIBOR plus 1.6% or the participating banks' reference rate, at the Trust's election. The weighted average interest rate on the bank line of credit at December 31, 1995, was 7.57%. This facility expires May 31, 1996, at which time the Trust intends to renew it.\nRESULTS OF OPERATIONS\nCOMPARISON OF YEARS ENDED DECEMBER 31, 1995 AND 1994\nNet income decreased $5 million to $10.3 million, or $0.61 per share, in 1995, from $15.3 million, or $0.92 per share, in 1994. This 33% decrease is principally due to the 1994 gains realized from the sales of real estate investments. Additionally, the decrease is due to increased interest expense, depreciation and amortization, and property operating costs, as well as decreased other income, partially offset by the absence of the 1994 provision for loss on real estate investment.\nFunds From Operations (NAREIT 1991 definition) increased $969,000 to $21.5 million in 1995, an increase of more than 4% over the 1994 figure of $20.6 million. The major components of this increase are increased minimum rents, increased recoveries from tenants and the absence of a 1994 provision for environmental costs relating to the Oakland, California, property, offset in part by increased interest expense, property operating costs and decreased other income. The Trust, along with most industry analysts, considers Funds From Operations to be an appropriate supplemental measure of the operating performance of an equity REIT. Funds From Operations does not replace net income as a measure of performance or net cash provided by operating activities as a measure of liquidity.\nMinimum rents increased $3.5 million in 1995 to $37.6 million, a 10% increase over $34.1 million in 1994. This increase resulted from (i) the Trust's seven acquisitions during 1994 and 1995, partially offset by five dispositions in 1994 and (ii) occupancy gains.\nRecoveries from tenants increased by 12%, or $738,000, to $6.8 million in 1995 as compared to $6.1 million in 1994. This increase is primarily the result of the Trust's seven acquisitions and occupancy gains referred to above.\nOther income decreased $1.4 million to $584,000 from the 1994 amount of $2,017,000. The contributing factors to this decrease are the absence in 1995 of (i) a $600,000 lease termination fee recorded in 1994, (ii) investment income earned in 1994 from the senior notes net proceeds prior to the use of these proceeds for several 1994 acquisitions and (iii) mortgage interest income earned on a note retired during the second quarter of 1994.\nInterest expense increased $1.4 million, or 14%, in 1995 to $11.5 million from $10.1 million in 1994. This increase primarily results from increased borrowings and higher interest rates under the Trust's bank line of credit. Additionally, interest expense increased as a result of twelve months of interest on the senior notes in 1995, compared to 10-1\/2 months in 1994.\nProperty operating costs were $8.3 million in 1995 compared to $7.4 million in 1994. This $899,000, or 12% increase from the prior year, is primarily due to the 1994 and 1995 acquisitions. Ownership of the majority of these properties commenced mid-year 1994.\nDepreciation and amortization expense increased $1 million to $10.9 million for the year ended December 31, 1995, from $9.9 million in 1994. This 10% increase results from a net increase in the depreciable basis of the Trust's portfolio of real estate investments due to additions made by the Trust beginning in mid-year 1994, net of dispositions.\nIncome from operations was $10.3 million, or $0.61 per share, for the twelve months ended December 31, 1995, a $650,000 decrease from the comparable 1994 figure of $10.9 million, or $0.65 per share. The primary reasons for this decrease are increased interest expense, depreciation and amortization, property operating costs, and decreased other income, partially offset by increased minimum rents and increased recoveries from tenants.\nCOMPARISON OF YEARS ENDED DECEMBER 31, 1994 AND 1993\nNet income increased $3.7 million, or 32%, to $15.3 million, or $0.92 per share, in 1994 from $11.6 million, or $0.70 per share, in 1993. This increase reflects the gains realized from the sales of real estate investments and increases achieved in revenues from the Trust's six 1994 acquisitions, offset by increased interest expense and reduced revenues due to property dispositions.\nFunds From Operations decreased $282,000, or 1%, to $20.6 million from $20.9 million. The major components of this decrease are the provision for environmental costs related to the Oakland, California, property and increased interest expense partially offset by increased minimum rents.\nMinimum rents increased $1.9 million to $34.1 million, a 6% increase over the 1993 total of $32.2 million. This growth reflects rental revenues from the acquisition of six properties, offset by reduced rental revenues due to the dispositions of two retail properties, a commercial building, an industrial building and a parcel of land. The 1994 acquisitions and dispositions resulted in a net increase of 324,000 square feet to the portfolio.\nOther income increased $937,000 to $2,017,000 in 1994 from $1,080,000 for the comparable period in 1993. Most of this increase is due to (i) a lease termination fee of $600,000 and (ii) investment income from the senior notes proceeds earned prior to the use of these proceeds for several 1994 acquisitions.\nInterest expense increased by $2.3 million in 1994 to $10.1 million from $7.8 million in 1993. This 29% increase is due to the Trust's increased borrowings to fund property acquisitions and higher interest rates. On February 24, 1994, the Trust issued $50 million of 7 7\/8% senior notes due February 15, 2004. Proceeds from the sale of the senior notes were used in part to pay the outstanding balance on the previous bank line of credit of $17.6 million. The remaining proceeds were used to acquire additional properties. On May 31, 1994, the Trust obtained a two-year unsecured $60 million bank line of credit (replacing the previous $35 million bank line of credit), which the Trust has drawn upon to fund additional acquisitions.\nIncome from operations was $10.9 million, or $0.65 per share, for the year ended December 31, 1994, as compared to $11.6 million, or $0.70 per share, for the same period in 1993. This 6% decrease results from increased interest expense, depreciation and amortization, and property operating costs partially offset by increased minimum rents and other income.\nIMPACT OF THE ECONOMY\nSubstantially all of the Trust's properties are leased on a triple-net basis, which reduces the Trust's exposure to increases in property operating expenses resulting from inflation. Future increases in inflation would likely increase revenues and thereby further protect the Trust from the impact of inflation. Revenue increases could be realized through CPI-based escalation of rents, percentage rents based on tenants' gross sales and inflation-adjusted base rents on new leases.\nIncreases in interest rates could increase the Trust's borrowing costs. As of December 31, 1995, the Trust had $29.3 million outstanding under its unsecured variable-rate bank line of credit. This amount represents approximately 20% of the Trust's total liabilities and approximately 7% of the Trust's historical cost of real estate owned.\nThe continuing recovery of the California economy should lead to increases in employment, personal income and retail spending. Improving economic conditions should help strengthen the Trust's operating results in 1996 as occupancy continues to increase and rental rates continue to stabilize and improve.\nACCOUNTING DEVELOPMENTS\nThe Financial Accounting Standards Board has issued Financial Accounting Standards (FAS) 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of\" and FAS 123, \"Accounting for Stock-Based Compensation.\"\nThe Trust has adopted FAS 121 effective January 1, 1996, and believes that adoption will not have a material impact on the Trust's 1996 financial statements. The Trust will adopt the disclosure requirements of FAS 123 in 1996, but continue to account for its stock option plan under Accounting Principles Board Opinion 25, \"Accounting for Stock Issued to Employees,\" as permitted under FAS 123.\nWESTERN INVESTMENT REAL ESTATE TRUST\nFinancial Statements\nForm 10-K Item 8","section_7A":"","section_8":"","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.\nInformation with respect to the trustees and executive officers of the Trust is incorporated by reference to the section entitled \"Trustees and Executive Officers\" of the Trust's definitive Proxy Statement in connection with the annual Meeting of Shareholders to be held May 9, 1996, which will be filed with the Commission not later than 120 days after the end of the fiscal year covered by this Form 10-K, pursuant to General Instruction G to this Form 10-K.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nInformation with respect to executive compensation is incorporated by reference to the sections entitled \"Compensation of Trustees\", \"Compensation of Executive Officers\", \"Compensation Pursuant to Plans\", \"Trustee Emeritus Program and Death and Disability Program\", \"Stock Option Grants and Exercises\" and \"Report of Compensation Committee on Executive Compensation\" of the Trust's definitive Proxy Statement in connection with the annual Meeting of Shareholders to be held May 9, 1996, which will be filed with the Commission not later than 120 days after the end of the fiscal year covered by this Form 10-K, pursuant to General Instruction G to this Form 10-K.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nInformation with respect to security ownership of certain beneficial owners and management is incorporated by reference to the section entitled \"Trustees and Executive Officers\" of the Trust's definitive Proxy Statement in connection with the annual Meeting of Shareholders to be held May 9, 1996, which will be filed with the Commission not later than 120 days after the end of the fiscal year covered by this Form 10-K, pursuant to General Instruction G to this Form 10-K.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe Trust, its employees, officers or trustees are not engaged in any related transactions with the Trust. Additionally, the Trust has never made any loans to its management.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\nPage ---- (a) 1. Financial Statements - Included in Item 8 Report of Independent Certified Public Accountants 21 Balance Sheets - December 31, 1995 and 1994 22 Financial Statements for the Years Ended December 31, 1995, 1994 and 1993: Statements of Income 23 Statements of Shareholders' Equity 24 Statements of Cash Flows 25 Notes to Financial Statements 26 to 34\n2. Financial Statement Schedule III: Real Estate and Accumulated Depreciation 35 to 36\n3. Additional Information: 1995 Building Improvement and Leasing Commission Additions (unaudited) 37\n(b) 1. Reports on Form 8-K.\nNone.\nPage ---- (c) Exhibits.\n(3) Declaration of Trust, as amended (filed as Exhibit 3.1 to Registration Statement on Form S-3 No. 33-22893 and incorporated herein by reference).\n(4.1) Form of Indenture relating to the 8% Convertible Debentures (filed as Exhibit 4.1 to Registration Statement on Form S-3 No. 33-22893 and incorporated herein by reference).\n(4.2) Form of Indenture relating to the Senior Notes (filed as Exhibit 4.1 to registration Statement on Form S-3 No. 33-71270 and incorporated herein by reference).\n(4.3) Form of Senior Notes (filed as Exhibit 4.2 to Registration Statement on Form S-3 No. 33-71270 and incorporated herein by reference).\n(10.1)**Trust's Nonqualified Stock Option Plan (filed as Exhibit 4.2 to Registration Statement on Form S-8 No. 33-27016 and incorporated herein by reference).\n(10.2)**Trust's Trustee Emeritus Plan (filed as an Exhibit to Proxy Statement dated March 25, 1986, and incorporated herein by reference.\n(23)* Consent of Independent Certified Public Accountants 41 __________\n* Filed with this report. ** Management contract or compensatory plan or arrangement.\nConsent of Independent Certified Public Accountants\nThe Trustees Western Investment Real Estate Trust:\nWe consent to incorporation by reference in the registration statement (No. 33-27016) on Form S-8 of Western Investment Real Estate Trust of our report dated January 29, 1996, relating to the balance sheets of Western Investment Real Estate Trust as of December 31, 1995 and 1994, and the related statements of income, shareholders' equity and cash flows for each of the years in the three-year period ended December 31, 1995, and the related schedule, which report appears in the December 31, 1995, annual report on Form 10-K of Western Investment Real Estate Trust.\nSan Francisco, California KPMG PEAT MARWICK LLP March 21, 1996\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned there unto duly authorized.\nWESTERN INVESTMENT REAL ESTATE TRUST - ------------------------------------ (Registrant)\nBy: s\/ DENNIS D. RYAN ------------------------------------- Dennis D. Ryan Executive Vice President, Chief Financial Officer Dated: March 21, 1996 and Trustee --------------\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nSignature Title Date - --------- ----- ----\ns\/ O. A. Talmage Chairman of the Board, March 21, 1996 - ------------------------------ Chief Executive -------------- O. A. Talmage Officer and Trustee\ns\/ William A. Talmage President, March 21, 1996 - ------------------------------ Chief Operating Officer -------------- William A. Talmage and Trustee\ns\/ Dennis D. Ryan Executive Vice President, March 21, 1996 - ------------------------------ Chief Financial Officer -------------- Dennis D. Ryan and Trustee\ns\/ Chester R. MacPhee, Jr. Trustee March 21, 1996 - ------------------------------ -------------- Chester R. MacPhee, Jr.\ns\/ Reginald B. Oliver Trustee March 21, 1996 - ------------------------------ -------------- Reginald B. Oliver\ns\/ James L. Stell Trustee March 21, 1996 - ------------------------------ -------------- James L. Stell","section_15":""}
{"filename":"793613_1995.txt","cik":"793613","year":"1995","section_1":"ITEM 1. BUSINESS\nThe following discussion contains forward-looking statements that involve risks and uncertainties. The Company's actual results may differ significantly from the results discussed in the forward-looking statements.\nGENERAL\nJones Medical Industries, Inc. (\"JMI\" or the \"Company\") is engaged in the manufacture, marketing and sale of pharmaceuticals and nutritional supplements. Founded in 1981, the Company markets a wide variety of pharmaceuticals and branded nutritional supplements under its own trademarks and tradenames. All of the Company's product lines have been acquired through a series of 13 acquisitions which have complemented or expanded its existing lines of business. The Company intends to leverage its existing marketing and sales capabilities through additional strategic acquisitions of complementary products and businesses, by expanding and increasing the penetration of its existing customer base, and through the introduction of new formats for pharmaceuticals and new formulations for nutritional supplements. During 1995, sales of pharmaceuticals and nutritional supplements accounted for approximately 46% and 54% of the Company's total sales, respectively.\nThrombin-JMI(TM), Thrombinar(R), Brevital(R) Sodium, Bronson(TM), Bronson Pharmaceutical(TM), MD Pharmaceutical(TM), Liqui-Char(R), Therevac(R), Derma-Scrub(R), Thyroid Strong(TM), and Westhroid(TM) are trademarks owned by or under license to the Company. All other trademarks and registered trademarks used in this Form 10-K are the property of their respective owner.\nBUSINESS STRATEGY\nThe Company's business strategy is to acquire specialty product lines or operations that complement or expand the marketing or distribution of existing product lines and to develop and apply marketing initiatives to such products. The key elements of the Company's strategy include:\nAcquire and Build Market Share in Specialty Pharmaceuticals. Since inception, the Company has purchased domestic rights to certain specialty pharmaceuticals addressing markets such as hemostasis and anesthesia. JMI intends to continue to seek the rights to products that it believes can benefit from a focused marketing effort.\nLeverage Established Pharmaceutical Marketing and Sales Efforts. JMI intends to maximize productivity of its sales force through replacement of existing, lower-volume products with new products with larger market opportunities. In addition, the Company intends to raise the awareness of selected products through targeted sales efforts focused on the hospital pharmacists and health care professionals in the United States.\nExpand Marketing Initiatives for Nutritional Supplements to Health Care Professionals. Since the Company acquired Bronson Pharmaceuticals in early 1993, monthly orders of nutritional supplements have grown from 27,000 to over 30,000 as of January 1996, and the average order has grown from $43 to $62 as of January 1996. JMI intends to continue to expand its marketing efforts for nutritional supplements by focusing on developing recommendations and referrals to consumers through health care professionals and introducing new products to its existing customer base.\nImprove Margins Through Focus on High-Margin Products and Cost Control. JMI intends to increase gross and operating margins by using sales personnel efficiently, minimizing corporate overhead and focusing on high margin products. The Company believes that by focusing on a limited number of products, the Company can increase sales by maximizing the productivity of its sales force and controlling overhead costs.\nPRINCIPAL PRODUCTS AND PRODUCT LINES\nPharmaceuticals. The Company markets and distributes a variety of branded pharmaceuticals, which accounted for approximately 36% of the Company's sales in 1995. The Company's principal branded pharmaceuticals primarily serve the critical care segment of the health care industry and are as follows:\nThrombin-JMI and Thrombinar. During invasive surgical procedures, surgeons typically limit bleeding in order to control blood loss and maintain visibility of the surgical site. Surgeons may apply pressure bandages, suture severed vessels and\/or use a topical hemostatic agent to maintain the surgical site. In most cases, collagen, cellulose or thrombin-based hemostatic agents are used because of their ability to rapidly begin the clotting process. The Company's products, Thrombin-JMI and Thrombinar, are thrombin-based topical hemostatic agents derived from bovine blood. The Company's thrombin products offer advantages over collagen and cellulose products because of faster activity in the surgical site. Additionally, because of their physical characteristics, JMI's thrombin products do not need to be removed from the surgical site prior to closure, whereas non-thrombin competing products need to be removed, often leading to recurrence of bleeding. Thrombin-JMI was introduced in 1995 and differs from Thrombinar in that Thrombin-JMI does not require refrigeration, and is therefore more convenient in the operating room. The topical hemostat market was estimated to be greater than $80 million in the United States in 1995. The Company's branded thrombin products accounted for 13.8% of the United States topical hemostat market and 50.4% of the United States topical bovine thrombin market in 1995. Thrombin-JMI and Thrombinar accounted for 19.7% of total Company sales in 1995. The Company's first thrombin product, Thrombinar, was acquired by JMI from Armour Pharmaceuticals (\"Armour\") in 1989. Thrombin-JMI is manufactured at the Company's wholly-owned subsidiary GenTrac, Inc. (\"GenTrac\"). Thrombinar was manufactured by Armour for JMI until September 1995 when it was replaced by Thrombin-JMI.\nBrevital Sodium. The intravenous (\"I.V.\") anesthetic market is split into segments based on type and length of therapeutic, diagnostic or surgical procedures. Short-term general\nanesthesia is required when performing minor surgical procedures such as dental surgery, cardioversion and other brief ambulatory surgeries. Long-term general anesthesia is required when more complex and invasive surgical procedures are performed. In order to administer long-term general anesthesia, induction agents are used to begin the anesthetic event and are subsequently followed by another drug or gas to maintain the anesthesia. The Company's product, Brevital Sodium (\"Brevital\"), is a general I.V. anesthetic agent that addresses both the short-term and long-term anesthesia markets. Brevital is used in short-term procedures because of its rapid onset of action and minimal recovery time. Brevital's rapid onset of action also makes it a useful induction agent for long-term general anesthesia prior to the administration of another agent to maintain the anesthesia. The I.V. anesthetic market in the United States is estimated to be $500 million. Brevital accounted for 4.2% of JMI's sales in 1995 and 10.9% of the Company's sales during the last four months of 1995. Brevital was introduced by Eli Lilly & Company (\"Lilly\") in 1961 and exclusively licensed in perpetuity to JMI on August 31, 1995 for sale in the United States.\nOther Pharmaceuticals. The Company also manufactures and distributes other critical care products and other branded pharmaceuticals under numerous trademarks and tradenames, the most prominent of which are Liqui-Char, a toxin antidote, Therevac, a mini-enema for rehabilitation therapy, Derma-Scrub, a surgical scrub, and Thyroid Strong and Westhroid, natural thyroid supplements. Combined, all other branded pharmaceutical products accounted for 12% of the Company's total sales in 1995.\nNutritional Supplements. The Company markets and distributes a full line of branded nutritional supplements, which accounted for approximately 42% of the Company's total sales in 1995. The Company's branded nutritional supplements are marketed under the Bronson Pharmaceutical and MD Pharmaceutical tradenames.\nBronson Pharmaceutical. The Bronson Pharmaceutical product line consists of over 260 branded vitamin, mineral and herbal extract formulations. The products include multi-vitamins, mineral formulations, individual vitamins, antioxidants, herbal formulations and personal care products. The Bronson Pharmaceutical product line accounted for approximately 36% of the Company's total sales in 1995.\nMD Pharmaceutical. These products are sold exclusively through military base retail outlets and consist of a broad line of branded nutritional supplements which compete with national brands. The products include multi-vitamins, mineral formulations, individual vitamins and antioxidants. The MD Pharmaceutical product line accounted for approximately 6% of the Company's total sales in 1995.\nMARKETING AND SALES\nThe Company markets and promotes its products primarily through a direct sales force, direct mail, telemarketing and trade publication advertising. The Company also attends major medical conventions and symposia. The Company maintains a sales and marketing staff of approximately\n40 people, and employs an additional 10 people devoted to customer service and marketing support. The Company also utilizes independent sales representatives for marketing certain products.\nPharmaceuticals. The Company has a 24-person marketing and sales staff for pharmaceuticals and critical care products which includes 18 field sales personnel (including three regional managers and 15 hospital territory managers), four marketing support specialists, a hospital group contract coordinator and a product manager, all reporting to the Company's Vice President-Sales. Sales activities are focused on major hospital buying groups which, in the aggregate, manage and contract for a majority of the purchasing of pharmaceuticals for private sector hospitals through bid and contract agreements. Although the Company's marketing efforts focus upon individual hospitals' Directors of Pharmacy as the ultimate decision-maker, the Company presently has contracts for one or more product lines with substantially all of the approximately 120 major hospital buying groups and distributes pharmaceuticals nationally through approximately 320 wholesale distributors.\nNutritional Supplements. The Company markets the Bronson Pharmaceutical product line directly to consumers and health care and nutritional professionals through catalogs and direct mailings to a database that, as of December 31, 1995, included approximately 18,000 health care and nutritional professionals and 530,000 mail order and retail customers, of whom approximately 135,000 purchased products directly from the Company in 1995. The Company does not rent or utilize mailing lists from other sources, preferring to focus upon generating customers through professional recommendations and referrals from current customers. The Company maintains a telemarketing sales force of 16 persons which processes approximately 29,000 orders per month with an average order of approximately $60 during 1995. Prepaid orders are received through mail order, toll-free telephone numbers or by facsimile, and are filled at the Company's distribution center in St. Louis, Missouri, usually within 24 hours of receipt, and are shipped by United Parcel Service or parcel post. In addition to direct mail sales, the Bronson Pharmaceutical product line is marketed to approximately 5,000 retail accounts. The MD Pharmaceutical product line is marketed exclusively through military outlets by approximately 30 independent sales representatives.\nMANUFACTURING\nThe Company manufactures pharmaceuticals at its facilities in Canton, Ohio, Middleton, Wisconsin and St. Louis, Missouri, and manufactures and formulates nutritional supplements at its facilities in Tempe, Arizona.\nThe Company has manufactured pharmaceuticals at its United States Food and Drug Administration (\"FDA\") registered Canton, Ohio, facility since March 1984. The Company processes raw materials purchased from outside sources and produces products in tablet form. Content, shape and color of such products are produced within the guidelines of FDA regulations pertaining to over-the-counter drugs or prescription drugs that were marketed prior to 1938.\nIn 1991, in connection with the Company's acquisition of GenTrac, the Company assumed operations of the GenTrac facility located in Middleton, Wisconsin which is licensed by The Center for Biologics Evaluation and Research (\"CBER\"), a Division of the FDA, for the production of therapeutic and diagnostic thrombin products. Biological products such as Thrombin-JMI must be produced at a licensed biologic facility specifically licensed to manufacture that product. The Company's GenTrac facility, which produces Thrombin-JMI, is licensed for the production of thrombin United States Pharmacopoeia (\"U.S.P.\") products and also acts as a contract manufacturer of Thrombogen, a line of proprietary thrombin products manufactured for Johnson & Johnson Medical, Inc. (\"Johnson & Johnson\") under distribution and development agreements.\nPackaging, as well as warehousing and distribution, for certain pharmaceuticals and for nutritional supplements, is primarily conducted at the Company's distribution center and headquarters located in St. Louis, Missouri. The Company also formulates and produces liquid products such as Liqui-Char and the Derma-Scrub line at its St. Louis, Missouri facility.\nThe Company has manufactured nutritional supplements at its facilities in Tempe, Arizona, since 1984. As in the case of pharmaceuticals, the Company processes raw materials purchased from outside sources and formulates them into final dosage form. Although, prior to the acquisition of Bronson Pharmaceuticals (\"Bronson\") by the Company in March 1993, Bronson functioned solely as a marketer and distributor of its product line, the Company now manufactures the majority of its Bronson products at its Tempe, Arizona facilities.\nThe Company utilizes available excess capacity at its manufacturing facilities to produce pharmaceuticals and nutritional supplements for other branded and generic distributors, in bulk or packaged (private label) form. The Company's marketing efforts with respect to contract manufactured products are conducted both internally and through independent commissioned sales representatives.\nWith the exception of GenTrac's agreement with Johnson & Johnson, the Company does not have long-term manufacturing contracts with its customers for contract manufacturing but instead manufactures products pursuant to purchase orders as they are received. Contract manufacturing is performed primarily for generic and private label product distributors which are not involved in manufacturing and whose products primarily consist of basic generic ethical drugs, generic over-the-counter drugs and vitamins, and private formulations of vitamins, prescription and over-the-counter drugs. Notwithstanding the absence of long-term manufacturing agreements with its contract manufacturing customers, JMI has long-standing relationships with the majority of its customers for such products. There can be no assurance, however, that such relationships will continue in the future.\nIn 1995, the Company manufactured approximately 80% of its total products sold and approximately 60% of its branded products sold. However, the Company anticipates that these historical percentages will change since all production of thrombin products has been integrated at the GenTrac facility while Brevital is produced under contract by Lilly.\nThe Company has historically relied on third-party manufacturers to produce certain of its products. The Company typically does not enter into long-term manufacturing contracts with such third-party manufacturers, however, even when such contracts exist there can be no assurance that the Company will be able to obtain adequate supplies of such products in a timely fashion, or at all. For example, the Company's thrombin products were manufactured for the Company under a contract with Armour from whom the Thrombinar product line was acquired in 1989. During the fourth quarter of 1994 and first quarter of 1995, Armour was unable to fully meet the Company's requirements for thrombin products, resulting in the Company's inability to fill product orders from customers and the loss of sales and income. The Company also faces the risk that upon expiration of the term of any third-party manufacturing agreement it may not be able to renew or extend the agreement with the third-party manufacturer, to obtain an alternative manufacturing source from other third parties or develop internal manufacturing capabilities on commercially viable terms, if at all. In such circumstances the Company may be unable to continue to market its products as planned and could be required to abandon or divest itself of a product line on terms which would materially adversely affect the Company's business, financial condition and results of operations.\nBrevital is manufactured for the Company by Lilly from whom the product line was acquired as of August 31, 1995. Pursuant to such acquisition, the Company obtained a perpetual, exclusive license to market and distribute Brevital in the United States. The Company has entered into a 10-year manufacturing agreement with Lilly, which may be terminated by Lilly at any time after the first five years by giving at least five years notice to the Company prior to ceasing the manufacture of Brevital. In the event of such termination, Lilly must use reasonable efforts to assist the Company in obtaining all the necessary licenses and approvals to enable the Company or an alternative manufacturer to manufacture Brevital. There can be no assurance that Lilly will continue to meet FDA or product specification standards for Brevital or that the Company's Brevital product demand can be met in a consistent and timely manner. Lilly is the sole manufacturer of Brevital and any alternative manufacturer would require regulatory change-in-site qualification to manufacture the product. In the event of any interruption in the supply of Brevital from Lilly due to regulatory or other causes, there can be no assurance that the Company could make alternative manufacturing arrangements on a timely basis, if at all. Such an interruption would have a material adverse effect on the Company's business, financial condition and results of operations.\nPRINCIPAL CUSTOMERS AND SUPPLIERS\nNo one customer accounted for 10% or more of the Company's sales in 1995. GenTrac's sales of thrombin products to Johnson & Johnson were $3.5 million or 6.1% of the Company's total sales in 1995.\nThe Company has not experienced to date any significant shortages in supplies of raw materials. The raw materials utilized by the Company in its manufacturing operations are purchased from a variety of suppliers. The Company endeavors to maintain multiple suppliers in order to minimize delays or cost disparities in the event of supplier shortages. For the most part the\nCompany's ability to manufacture products is not dependent on any particular raw material supplier except as to thyroid raw materials.\nThe Company relies on certain suppliers of key raw materials to provide an adequate supply of such materials for production of finished products. Certain materials are purchased from single sources. In particular, the manufacture of Brevital is dependent upon Lilly's ability to procure certain raw materials used in the manufacture of Brevital. Although the Company has no reason to believe that Lilly will be unable to procure adequate supplies of such raw materials on a timely basis, disruptions in supplies of Brevital, including delays due to Lilly's inability to procure raw materials, would have a material adverse effect on the Company's business, financial condition and results of operations.\nCOMPETITION\nThe manufacture and sale of pharmaceuticals is highly competitive. Many of the Company's competitors are large well-known pharmaceutical, chemical and health care companies which have considerably greater financial, sales, marketing and technical resources than those of the Company. Additionally, many of the Company's present and potential competitors have research and development capabilities that may allow such competitors to develop new or improved products that may compete with the Company's product lines. The pharmaceutical industry is characterized by rapid product development and technological change. The Company's pharmaceuticals could be rendered obsolete or uneconomical by the development of new pharmaceuticals to treat the conditions addressed by the Company's products or as the result of technological advances affecting the cost of production, or as a result of marketing or pricing action by one or more of the Company's competitors. The Company's business, financial condition and results of operations could be materially and adversely affected by any one or more of such developments.\nThe Company's thrombin product lines compete with those produced for and marketed by Johnson & Johnson and with thrombin products distributed by Parke-Davis, a division of the Warner-Lambert Company. The Company's thrombin products also compete with other hemostatic agents, including Gelfoam, manufactured by Pharmacia & Upjohn, Inc., and Surgicel, manufactured by Johnson & Johnson. Brevital faces competition in the I.V. anesthetic market from other I.V. anesthetic products, including Diprivan, which is produced by Stuart Pharmaceuticals, a business unit of Zeneca, Inc., and Versed, produced and marketed by Roche Labs, a division of Hoffmann-LaRoche, Inc. Each of these competitors has substantially greater marketing, sales and financial resources than the Company.\nThe market for nutritional supplements is characterized by extensive competition, frequent new product introductions, short product life cycles and changing customer preferences. The Company is subject to competition from the retail market, as well as the mass-market, direct-mail market, for nutritional supplements, and there can be no assurance that the Company's targeted direct-market approach will remain a viable alternative within the industry or that other competitors may not enter the targeted direct-mail market and offer products similar to those offered by the\nCompany. Many of the Company's existing and potential competitors in the nutritional supplements market have greater financial, marketing and research capabilities than the Company.\nTRADEMARKS\nThe branded products sold by the Company are sold under a variety of trademarks. While the Company believes that it has valid proprietary interests in all currently used trademarks, only certain of the trademarks are registered with the United States government. The Company's license to the Brevital trademark is limited to the United States and its right to utilize the MD Pharmaceutical brand name is restricted to the United States military and its outlets.\nGOVERNMENT REGULATION\nThe manufacturing, processing, formulation, packaging, labeling, storage, promotion, distribution and advertising of the Company's products are subject to extensive regulation by one of or more federal agencies including the FDA, the Drug Enforcement Administration (\"DEA\"), the Environmental Protection Agency (\"EPA\"), the Federal Trade Commission (\"FTC\"), the Occupational Safety and Health Administration (\"OSHA\"), the Department of Agriculture (\"USDA\"), the Consumer Product Safety Commission (\"CPC\"), the United States Customs Service, and the United States Postal Service. These activities are also regulated by various agencies of the states and localities in which the Company's products are sold.\nPharmaceuticals. All pharmaceutical manufacturers, including the Company, are subject to regulation by the FDA. New drugs must be approved by the FDA before they may be marketed, except for those prescription drugs about which the FDA has knowledge but for which the FDA is not requiring applications either because of 'grandfather status' under 1938 legislation, 'grandfather status' under 1962 legislation, or for other reasons. The FDA has the authority to revoke existing approvals, or to review the status of currently exempt pharmaceuticals and require application and approval, of prescription drugs if new information reveals that they are not safe or effective and also regulates the advertising of prescription drugs. The Company's marketing of OTC drugs is affected by the establishment of FDA monographs, a regulatory system arising under 1962 legislation. FDA monographs effectively exempt from FDA approval OTC drugs which are produced and labeled in accordance with the standards set forth in FDA regulations. The rulemaking process to establish or revise an FDA monograph allows a 12 month grace period to make appropriate formulation or label changes following publication of the final monograph. The FTC regulates advertising of OTC drug products. Drug products must be manufactured, packaged, and labeled in accordance with their approvals and in conformity with current good manufacturing practice (\"CGMP\"). The Company is subject to periodic inspection by the FDA to assure such compliance. Drugs must be distributed, sampled and promoted in accordance with FDA requirements. The FDA has extensive enforcement powers over the activities of pharmaceutical manufacturers, including authority to seize and prohibit the sale of unapproved or non-complying products, to halt manufacturing operations that are not in compliance with CGMP, and to impose civil penalties and seek criminal penalties. The restriction or prohibition on sales of products\nmarketed by the Company could materially adversely affect the Company's business, financial condition, and results of operation.\nThe Company manufactures and distributes biological drugs, including thrombin, which are also regulated by the FDA. The Company's Thrombin-JMI line of products has been approved by the FDA, and the Company's GenTrac facility is licensed by the FDA to produce Thrombin-JMI and Thrombogen, a line of proprietary thrombin products manufactured for Johnson & Johnson. The Company has a pending application for a new pre-mixed liquid thrombin formulation product line. Although the Company believes that this application is in the final approval phase, additional clinical testing of the product may be required and there can be no assurance as to when or if favorable FDA action will be forthcoming. While the Company intends to pursue completion of the application process, development of the product will depend in part upon the Company's assessment of market demand for the product and upon satisfactory resolution of claims by Johnson & Johnson to certain rights in the product. See \"Item 3. Legal Proceedings.\"\nThe Company also manufactures and sells drugs which are \"controlled substances\" as defined in the Controlled Substances Act, which establishes certain security and record keeping requirements administered by the Drug Enforcement Administration (\"DEA\") of the Department of Justice. The Company has experienced regulatory challenges with respect to compliance with the foregoing regulations which have been resolved, but no assurance can be given that restrictions or fines which could have a material adverse effect upon the Company's business, financial condition and results of operations will not be imposed upon the Company.\nNutritional Supplements. Although the manufacturing and production of nutritional supplements has historically been subject to less intensive regulation than pharmaceutical products, government oversight in this area is currently increasing. Under the Dietary Supplement Health & Education Act of 1994, the FDA may exercise increased authority over the labeling and sales of vitamin and mineral supplements. In addition, the United States Postal Service and the FTC regulate advertising claims with respect to the Company's products sold by solicitation through the mail.\nRecent proposed regulations issued by the FDA require the relabeling of dietary supplements with regard to nutrition labeling ingredient information and nutrient content claims. The proposed rules are not due to become effective until January 1997 and may be modified prior to final adoption. The FDA and other federal authorities are also reviewing alternative approaches to assure the safety of vitamins, minerals, herbal extracts and other products sold as nutritional supplements. Although no current regulatory approval is required prior to or after the introduction of a new nutritional supplement, the FDA must be notified regarding the use of new dietary ingredients and future regulation could result in a recall or discontinuance of certain products.\nThe Company believes that it is in material compliance with applicable laws and regulations concerning nutritional supplements. Moreover, the Company believes that its experience in the manufacture and sale of pharmaceuticals, and its use of certain manufacturing processes and controls uniformly across all product lines, will enable the Company to comply with regulations, record\nkeeping, testing and manufacturing standards which may be applied to nutritional supplements. Nevertheless, increased regulatory oversight could subject the Company and other manufacturers of nutritional supplements to increased production and compliance costs and possibly require capital expenditures.\nENVIRONMENTAL STANDARDS\nThe Company uses certain hazardous substances which require special handling and disposal as dictated by the EPA. The Company believes that its manufacturing operations are in compliance with environmental protection and other government regulations.\nEMPLOYEES\nAt February 1, 1996, the Company had 334 full-time employees: 191 in manufacturing, 50 in sales, 40 in finance and administration, 29 in quality assurance, and 24 in distribution. The Company believes that its relationship with its employees is good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's distribution operations, including warehousing and shipping for the Company's branded products, are located in a 150,000 square foot facility on a 15 acre site in St. Louis, Missouri which was acquired by the Company in mid-1993. The 24,000 square feet of office space within the facility permit it to serve as corporate headquarters and to house the Company's administration, sales and marketing, and telemarketing operations. The Company has centralized packaging operations for its branded nutritional supplements at this location in addition to certain laboratory and quality assurance facilities. Liquid products, including Liqui-Char and the Derma-Scrub line, are also manufactured and packaged at this facility.\nThe Company owns a facility at Canton, Ohio where its subsidiary, JMI-Canton Pharmaceuticals, Inc. (\"JMI-Canton\"), manufactures and packages pharmaceuticals. The facility is a 25,000 square foot building containing manufacturing, laboratory and administrative space.\nThe Company manufactures hemostatic thrombin products in a 40,000 square foot FDA-licensed sterile fill facility owned by the Company which is located on an eight acre site in Middleton, Wisconsin.\nThe Company's subsidiary, JMI Phoenix Laboratories, Inc. (\"JMI Phoenix\"), manufactures the Company's nutritional supplements in two adjacent buildings owned by the Company consisting of approximately 30,000 total square feet, located in Tempe, Arizona.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is not presently involved in any litigation in which it believes an adverse outcome would materially adversely affect the Company's business, financial condition or results of operations. However, the Company has been involved in litigation and is subject to certain claims as set forth below.\nL-Tryptophan Claims. Many distributors and marketers of nutritional supplements have been subjected to claims relating to the manufacture or distribution of L-Tryptophan. The Company is, and has in the past been, a defendant in such lawsuits filed throughout the United States.\nThe plaintiffs in these lawsuits generally allege damages resulting from the ingestion of a product known as L-Tryptophan. In suits involving the Company, the Company has been one of many defendants, and the manufacturer of L-Tryptophan, Showa Denko, has agreed to indemnify the Company (including Bronson) from all costs and damages with respect thereto to the extent that the product distributed by the Company was produced by Showa Denko. Any such lawsuits involving Bronson have been tendered to Bronson's insurance carrier under a policy which does not exclude L-Tryptophan claims. As a result of the indemnity provided by Showa Denko with respect to these types of lawsuits, and the product liability insurance maintained by Bronson prior to its acquisition by the Company, it is not anticipated that the Company will have any material liability with respect to these types of lawsuits. However, in the event that Showa Denko is unable to satisfy or fulfill its obligations under the indemnity, the Company would have to defend such lawsuits and be responsible for damages, if any, which are awarded against it or for amounts in excess of Bronson's insurance coverage of $1.0 million per claim and $1.0 million in the aggregate.\nJohnson & Johnson Claims. Under development and distribution agreements between GenTrac and Johnson & Johnson entered into prior to the Company's acquisition of GenTrac, Johnson & Johnson acquired certain rights to new thrombin products and thrombin product improvements developed by GenTrac. Johnson & Johnson has notified the Company that it believes that it is entitled to exclusive distribution rights for Thrombin-JMI and a liquid thrombin product for which FDA approval is currently pending. Although the Company strongly disagrees with and will vigorously contest such claims by Johnson & Johnson, any resolution of the claims in favor of Johnson & Johnson could have a materially adverse effect on the Company's business, financial condition or results of operations, notwithstanding provisions in the product development agreement which would (i) require Johnson & Johnson to reimburse GenTrac for all development costs associated with such products, and (ii) provide the Company's GenTrac facility with the right to manufacture such products for Johnson & Johnson. Even if the Company is successful in contesting Johnson & Johnson's claim and manufactures and markets the liquid thrombin product, the Company would be obligated to pay a royalty to Johnson & Johnson equal to five percent of the Company's net sales of such product, up to an aggregate maximum royalty payment of $240,000. The Company and Johnson & Johnson are currently attempting to negotiate an amicable resolution of such claims.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matters were submitted during the 4th quarter of 1995 to a vote of security holders of the Company through the solicitation of proxies or otherwise.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Company's common stock (\"Common Stock\") is traded on the Nasdaq National Market under the symbol \"JMED\". The following table sets forth the quarterly high and low sales prices for the Common Stock reported by Nasdaq for the periods indicated (as adjusted to the nearest 1\/16 to reflect the three-for-two stock split effected in the form of a 50% stock dividend to be paid on March 1, 1996 to holders of record as of February 23, 1996):\nAs of February 15, 1996, there were approximately 1,000 holders of record and the Company believes approximately 5,000 non-record beneficial owners of the Common Stock.\nDuring 1994 and 1995, cash dividends of $0.06 2\/3 and $0.07 1\/3 per share, respectively, were declared with respect to the Common Stock. On February 7, 1996, in connection with the three-for-two split of the outstanding shares of Common Stock, the Company declared a dividend of $0.025 per share payable on April 1, 1996.\nThe future declaration and payment of cash dividends is subject to the discretion of the Board of Directors and will be dependent on many factors, including the Company's earnings, financial condition and capital needs of the Company and such other factors as are deemed relevant by the Company's Board of Directors. The Company anticipates that it will continue to pay a dividend each quarter; however, the Company's Board of Directors intends to review this policy from time to time.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following selected financial data of the Company for each of the prior five fiscal years has been derived from the consolidated financial statements of the Company. The selected financial data should be read in conjunction with the consolidated financial statements and related notes thereto contained herein. The selected financial data set forth below has been adjusted to reflect the three-for-two stock split effected in the form of a 50% stock dividend to be paid on March 1, 1996 to holders of record on February 23, 1996.\n_______________ (1) Net income and earnings per share in 1993 do not reflect cumulative effect of change in accounting principle of $207,100.\n_______________ (2) Per share book value is computed assuming conversion of the outstanding preferred stock.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe following discussion contains forward-looking statements that involve risks and uncertainties. The Company's actual results may differ significantly from the results discussed in the forward-looking statements.\nOVERVIEW\nThe Company was founded in 1981 to market and distribute specialty pharmaceuticals and nutritional supplements. To date, the Company has completed 13 acquisitions of products and businesses which complement or expand the Company's business, while adding selected manufacturing capacity to support certain product lines. The Company has achieved significant increases in sales and net income through such acquisition activity and through related internal growth initiatives to develop marketing opportunities with respect to the acquired product lines. Sales and net income have increased from $19.7 million and $2.8 million in 1990, respectively, to $56.4 million and $9.3 million in 1995, respectively, representing five-year compounded annual growth rates of approximately 23.4% in sales and 27.0% in net income.\nSales are reported net of returns during the period in which product is shipped. These sales are subsequently adjusted for reserves incurred due to volume or other contractual discounts on certain pharmaceuticals under contracts with hospitals and hospital buying groups. As of December 31, 1995, the Company maintained a reserve of $1.5 million for such anticipated discounts. The reserve was increased from $1.1 million as of year-end 1994 due to higher sales levels of the products involved. Product returns, both of unused pharmaceuticals and of nutritional supplements sold to consumers subject to a limited money-back refund policy, are less than 1% of gross annual sales. Sales are reflected prior to royalties due on sales of certain pharmaceuticals arising from product line acquisitions. Such royalties are recorded as a selling expense. Royalty arrangements typically extend for a fixed period from the date of acquisition and do not require minimum payments to maintain ownership or any rights to products.\nDuring the year ending December 31, 1995, sales were $56.4 million comprised of $25.9 million of pharmaceutical sales and $30.5 million of nutritional supplement sales. The relative contributions of pharmaceuticals and nutritional supplements to the Company's sales can be influenced by acquisition activity in each product category as well as by marketing activity and customer demand. In 1993 the Company increased its presence in the marketing of nutritional supplements as a result of its acquisition of the operations of Bronson. In the fourth quarter of 1994 and first quarter of 1995, sales of certain of its thrombin-based hemostats were adversely impacted by supply difficulties. In August 1995 the Company acquired domestic rights to the Brevital pharmaceutical line for $14 million and a 10-year royalty of 5% on net sales of Brevital. During the last four months of 1995, sales of Brevital represented approximately 10.9% of total Company sales.\nThe Company intends to seek additional acquisitions of product lines of niche-market pharmaceuticals to leverage its existing distribution channels and marketing infrastructure and to market aggressively new formats or formulations of existing products. The success of the Company's efforts is subject to a number of risks and uncertainties including its dependence upon key pharmaceuticals and integration of new product acquisitions, its reliance upon third-party manufacturers to produce certain key products, its ability to effectively manage a changing business, uncertainties related to pharmaceutical pricing and reimbursement and on the uncertainty of competitive forces within the pharmaceutical and nutritional supplement industries which affect both the market for its products and the availability of suitable product lines of acquisition. The future results of operations, both annually and from quarter-to-quarter, are subject to a variety of factors applicable to the Company and to the industries and markets in which it operates.\nRESULTS OF OPERATIONS\nThe following discussion and analysis should be read in conjunction with the Consolidated Financial Statements and Notes to Consolidated Financial Statements contained elsewhere herein. The following table sets forth certain data as a percentage of net sales for the periods indicated.\n- --------------- * Before cumulative effect of change in accounting principle of $207,100 in 1993.\nSales\nThe following summarizes approximate sales activity by product categories:\nSales for the year ended December 31, 1995 increased 18.6% to $56.4 million from $47.5 million for the year ended December 31, 1994 and 10.0% to $47.5 million from $43.2 million for the year ended December 31, 1993. The Company's sales increased in 1995 as the result of unit and dollar growth in both pharmaceuticals and nutritional supplements and increased in 1994 as the result of unit and dollar growth in nutritional supplements.\nSales of pharmaceuticals in 1995 grew 18.5% to $25.9 million from $21.9 million in 1994 due primarily to increases in sales of the Company's critical care pharmaceutical products, including four months of Brevital sales. Sales of nutritional supplements in 1995 grew 18.9% to $30.5 million from $25.6 million in 1994 due to a 14.5% increase in Bronson Pharmaceutical product sales and a 102.2% increase in sales of contract manufactured products, offset in part by a 27.5% decline in sales of the MD Pharmaceutical products.\nSales of pharmaceuticals in 1994 grew 3.6% to $21.9 million from $21.1 million in 1993 due primarily to increases in sales of Therevac and Liqui-Char. Sales of Thrombinar were essentially flat due to the inability of the Company's supplier to meet fully the Company's requirements. Sales of nutritional supplements in 1994 increased 16.2% to $25.6 million from $22.0 million in 1993 resulting from the inclusion of a full 12 months of sales of the Bronson Pharmaceutical product line which was acquired in March 1993.\nGross Profit\nGross profit during 1995 increased 27.9% or $6.4 million to $29.2 million from $22.9 million in 1994. As a percentage of sales, margins grew to 51.8% in 1995 from 48.1% in 1994 as a result of greater manufacturing efficiencies and sales increases in higher margin products.\nGross profit during 1994 increased 7.3% or $1.6 million to $22.9 million from $21.3 million in 1993. As a percentage of sales, margins declined to 48.1% in 1994 from 49.3% in 1993 as a result of increases in labor and overhead components in cost of goods.\nSelling, General and Administrative Expenses\nSelling expenses increased 4.8% or $388,000 to $8.4 million in 1995 from $8.0 million in 1994 primarily as a result of adding five hospital territory managers in the fourth quarter of 1995 and due to higher direct marketing expenses associated with larger and more frequent mailings of the Bronson Pharmaceutical catalogue. As a percentage of sales, these expenses decreased to 15.0% in 1995 from 16.9% in 1994.\nSelling expenses increased 25.0% or $1.6 million to $8.0 million in 1994 from $6.4 million in 1993 as a result of the inclusion of a full 12 months of Bronson Pharmaceutical selling expenses and greater shipping and direct marketing expenses associated with sales of Bronson Pharmaceutical products. Additionally, the Company added one major market hospital representative during 1994. Selling expenses as a percentage of sales in 1994 increased to 16.9% from 14.9% in 1993.\nGeneral and administrative expenses in 1995 remained essentially unchanged at approximately $4.0 million, but declined as a percentage of sales to 7.2% in 1995 from 8.4% in 1994.\nGeneral and administrative expenses in 1994 increased 18.3% or $619,000 to $4.0 million from $3.4 million in 1993 primarily due to the inclusion of a full 12 months of Bronson Pharmaceutical expenses and to a lesser extent due to increases in overhead. As a percentage of sales, these expenses increased to 8.4% in 1994 from 7.8% in 1993 for the same reasons.\nResearch and development expenses were eliminated in 1995 after declining to $101,000 in 1994 from $377,000 in 1993 due to the reduction of ongoing expenses by GenTrac associated with the development of pre-mixed liquid thrombin formulations.\nAmortization expenses associated with intangible assets and included in selling, general and administrative expenses remained essentially unchanged in 1995 at approximately $1.4 million, as the impact of the Brevital product line acquisition was substantially offset by declining amortization on other products. As a percentage of sales these expenses decreased to 2.5% in 1995 from 2.9% in 1994.\nAmortization expenses increased 20.8% or $234,000 to $1.4 million in 1994 from $1.1 million in 1993 as a result of the Bronson Pharmaceutical and Derma System product acquisitions and the corresponding full 12 months of amortization of the associated intangible assets acquired. Also, as a percent of sales, amortization expenses increased 2.9% in 1994 from 2.6% in 1993.\nOperating Income\nOperating income during 1995 increased 63.6% or $6.0 million to $15.3 million from $9.4 million in 1994, and increased as a percentage of sales to 27.1% from 19.7% in 1994, as the result of higher overall gross profits and marginal increases in operating expenses.\nOperating income during 1994 decreased 6.3% or $627,000 to $9.4 million from $10.0 million in 1993, and decreased as a percentage of sales to 19.7% from 23.1% in 1993, as a result of an increase in cost of sales and in selling, general and administrative expenses.\nOther Income (Expense)\nOther income during 1995 reflects a one time loss of $126,000 associated with the sale of certain real property which the Company was unable to use and the reduction in the associated rental income.\nInterest and dividends from investing activities decreased to $101,000 in 1994 from $189,000 in 1993 due to lower cash balances resulting from the uses of cash in 1993 associated with the Company's acquisition program and the purchase of a 150,000 square foot distribution and headquarters facility. Interest expense increased to $516,000 in 1994 from $354,000 in 1993 due to borrowings associated with the acquisitions and facility purchase.\nIncome Taxes\nThe provision for income taxes increased to 37.5% of pre-tax income in 1995 compared to 36.5% of pre-tax income in 1994, primarily as the result of a 1% higher federal tax rate on annual profits exceeding $10 million.\nThe provision for income taxes decreased to 36.5% of pre-tax income in 1994 compared to 37.6% of pre-tax income in 1993. The lower rate was due to lower effective state income tax rates.\nNet Income\nNet income increased 62.5% or $3.6 million to $9.3 million in 1995 from $5.7 million in 1994, and increased as a percentage of sales to 16.5% in 1995 from 12.1% in 1994.\nNet income decreased 7.5% or $464,000 to $5.7 million in 1994 from $6.2 million in 1993, and decreased as a percentage of sales to 12.1% in 1994 from 14.4% in 1993 as a result of lower operating and interest income and higher interest expense.\nFourth Quarter\nSales during the fourth quarter of 1995 increased $4.7 million, or 40.6%, to $16.4 million from $11.7 million during the fourth quarter of 1994. Net income during the fourth quarter of 1995 increased $1.5 million, or 112%, to $2.8 million from $1.3 million during the fourth quarter of 1994. Earnings per share during the fourth quarter of 1995 were $.19, with 14.6 million shares outstanding, compared to $.09 per share earnings, with 14.4 million average shares outstanding during the fourth quarter of 1994. The 1995 increases resulted from improvements in operations throughout 1995 and a full quarter of Brevital sales.\nSales during the fourth quarter of 1994 decreased $445,000, or 3.7% to $11.7 million from $12.1 million during the fourth quarter of 1993. Net income during the fourth quarter of 1994 decreased $547,000, or 29.2% to $1.3 million from $1.8 million during the fourth quarter of 1993. Earnings per share during the fourth quarter of 1994 were $.09, compared to $.13 during the fourth quarter of 1993, with an average of 14.4 million shares outstanding during both periods. Decreases in sales and net income during the fourth quarter of 1994 were in large part the result of a product shortage of $1.1 million of Thrombinar which was produced for the Company under contract by Armour.\nFINANCIAL CONDITION\nBalance Sheet Information\nThe Company's current ratio declined to 2.2:1 as of December 31, 1995 from 3.6:1 as of December 31, 1994, working capital decreased to $13.4 million as of December 31, 1995 from $15.0 million as of December 31, 1994, and debt as a percentage of equity increased to 29.6% as of December 31, 1995 from 13.0% as of December 31, 1994, primarily as a result of the August 31, 1995 acquisition of the Brevital product line and the associated debt incurred in connection therewith.\nLiquidity and Capital Resources\nSince inception the Company has financed its operations primarily through cash flow from operations, public and private sales of equity securities and borrowings under revolving credit facilities. At December 31, 1995 and 1994, respectively, the Company had cash and cash equivalents of $5.4 million and $7.0 million, respectively.\nTotal assets increased $19.8 million to $74.7 million at December 31, 1995 from $54.9 million at December 31, 1994 and total liabilities increased $11.4 million to $24.8 million at December 31, 1995 from $13.4 million at December 31, 1994. Inventories increased to $10.7 million at December 31, 1995 from $8.3 million at December 31, 1994 principally from higher thrombin product inventories and the acquired Brevital inventories. Accounts receivable increased\nto $7.1 million at December 31, 1995 from $4.2 million at December 31, 1994 due to higher year end sales in 1995. For the same reason, in days outstanding, accounts receivable increased to 46 days at December 31, 1995 from 33 days at December 31, 1994. Net property, plant and equipment increased by $2.8 million to $15.4 million at December 31, 1995, from $12.6 million at December 31, 1994, primarily due to the expansion of the Company's GenTrac facility.\nIn August 1995, the Company borrowed $8.7 million to fund its cash requirements in connection with its acquisition of the exclusive United States license to sell Brevital and to refinance existing term loan indebtedness of $1.7 million, with interest thereon at the rate of 0.5% below prime, payable in equal monthly installments until paid in full in September 2000. Such indebtedness is secured by substantially all of the Company's assets. The Company may prepay such indebtedness without penalty. As of December 31, 1995, the outstanding balance of this term loan was $7.8 million. In addition, the Company is indebted to Lilly in the principal amount of $7.0 million bearing interest at 7.0% and due in installments of $4.0 million in August 1996 and $3.0 million in August 1997.\nUnder revolving credit and other borrowing lines available to the Company at January 31, 1996, the Company had an unused line of credit aggregating $4.0 million. Such line of credit is secured by substantially all of the Company's assets and contains certain restrictive provisions, including maintaining a maximum tangible net worth ratio, maintaining a minimum current ratio, obtaining prior approval of acquisition financings in excess of $3.0 million and limiting the amount of additional borrowings. The Company will be in default under its revolving credit and borrowing lines if (i) Dennis Jones ceases to be the Company's Chairman of the Board and Chief Executive Officer, or (ii) Dennis Jones and Judith Jones, collectively, own less than 15% of the outstanding shares of Common Stock of the Company, or (iii) a third party acquires 50% or more of the shares of the Company's capital stock without the lender's prior approval.\nThe Company has experienced only moderate raw material and labor price increases in recent years. While the Company has passed some price increases along to customers, the Company has primarily benefitted from rapid sales growth, negating most inflationary pressures.\nThe Company's manufacturing operations are not capital intensive and, as such, the impact of inflation on the property, plant and equipment and associated depreciation expense of the Company has been minimal.\nRecent Accounting Pronouncements\nAdoption of FASB Statement No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of\", and the adoption of FASB Statement No. 123, \"Accounting for Stock Based Compensation\", which are effective for the Company in 1996, are not anticipated to have a material effect on the Company's consolidated financial statements.\nEffective January 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, \"Accounting for Income Taxes.\" The cumulative effect of adopting Statement No. 109 as of January 1, 1993 was to increase net income by $207,100. Application of the new income tax rules for 1993 did not have a significant effect on net income before cumulative effect of the accounting change.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA\nReference is made to the Financial Statements contained in Part IV hereof.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThere were no disagreements with the Company's auditors, Ernst & Young LLP, on any matters 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 OFFICERS OF THE REGISTRANT\nDIRECTORS AND OFFICERS\nThe following table sets forth certain information as of March 1, 1996 with respect to the directors and executive officers of the Company.\nName Age Position - ---- --- --------\nDennis M. Jones 57 Chairman of the Board, President and Chief Executive Officer\nJudith A. Jones(1) 55 Executive Vice President, Secretary, Treasurer and Director\nMichael T. Bramblett 53 Executive Vice President and Director\nG. Andrew Franz 43 Senior Vice President-Operations- Pharmaceuticals and Director\nDavid A. McLaughlin 48 Senior Vice President-Operations- Nutritionals and Director\nEdward A. Chod(2) 42 Director\nStanley L. Lopata(1)(2) 81 Director\nThomas F. Patton(1) 47 Director\nL. John Polite, Jr.(1)(2) 74 Director\n- ---------------\n(1) Member of the Audit Committee of the Board of Directors.\n(2) Member of the Compensation Committee of the Board of Directors.\nDennis M. Jones, the founder of the Company, has been JMI's Chairman of the Board, President and Chief Executive Officer since its inception in March 1981. Mr. Jones has been involved primarily in the pharmaceutical industry since 1964 in various marketing, management and administrative positions. He was a co-founder of O'Neal, Jones and Feldman Pharmaceuticals, which was acquired by Chromalloy American Pharmaceuticals, Inc. in 1978 and subsequently acquired by Forest Laboratories, Inc., a specialty pharmaceutical company, in 1984. Mr. Jones has been a director of Mark Twain State Bank, a subsidiary of Mark Twain Bancshares, Inc., since 1988.\nJudith A. Jones joined the Company in October 1981 and has been in charge of the financial affairs and books of the Company since that time. Mrs. Jones has been a Director of the Company since December 1981, and the Secretary and Treasurer since April 1982. Mrs. Jones served as Vice President of the Company from March 1985 to February 1994 and has been Executive Vice President of the Company since February 1994.\nMichael T. Bramblett, a Director of the Company since 1987, served as Vice President - Marketing of the Company from January 1991 to February 1994 and has served as Executive Vice President since February 1994. From May 1988 through December 1990, Mr. Bramblett served as Marketing Director of Carlson Marketing Group, and from June 1987 until May 1988, he served as Corporate Vice President of S&H Motivation Company.\nG. Andrew Franz, a Director of the Company since 1994, became Senior Vice President-Operations-Pharmaceuticals for the Company in February 1994. He served as the Vice President-Operations of JMI-Canton since the facility was acquired by JMI-Canton from Bowman Pharmaceuticals, Inc. in March 1984 until February 1994. Prior to March 1984, Mr. Franz held various management positions for 14 years within Bowman Pharmaceuticals, Inc., including Chief Chemist and Vice President-Operations.\nDavid A. McLaughlin, a Director of the Company since 1994, became Senior Vice President-Operations-Nutritionals in February 1994. He served as the Vice President-Operations of JMI's subsidiary, American Vitamin Company from May 1988 until that company's merger into JMI Phoenix in 1993. From April 1986 to May 1988, Mr. McLaughlin was the Vice President-Sales and Marketing of JMI Phoenix. Prior to that time, Mr. McLaughlin served as an independent consultant to a number of health food, chemical and pharmaceutical companies, including JMI Phoenix. From May 1978 to January 1982 he was a supervisor of packaging and processing for the Searle Consumer Products Division of G.D. Searle & Company, a chemical company.\nEdward A. Chod has been a Director since 1991. Mr. Chod is an officer and shareholder in the law firm of Greensfelder, Hemker & Gale, P.C. which he joined in 1978 and which has served as counsel to the Company since 1982.\nStanley L. Lopata, a Director since 1988, is the President of Lopata Research and Development Corp. and has served in that capacity since 1988. Prior to 1988, Mr. Lopata was the Chairman of the Board of Directors and Chief Executive Officer of Carboline Corporation, a\nmanufacturer of specialty paint and coating products, from 1960 through 1988. Mr. Lopata has been a director of Boatmen's Trust Company, a subsidiary of Boatmen's Bancshares, Inc., since 1983.\nThomas F. Patton, Ph.D., a Director since 1995, is President of the St. Louis College of Pharmacy and has served in that capacity since June 1994. From April 1993 until January 1994 and from January 1994 until May 1994, Dr. Patton served as Executive Director of Pharmaceutical Research and Development and as Vice President of Pharmaceutical Research and Development, respectively, at Dupont-Merck Pharmaceutical Co., a pharmaceutical company. From March 1990 through March 1993, Dr. Patton served as Director and Senior Director of Pharmaceutical Research and Development at Merck and Co., Inc., a pharmaceutical company. In 1993, Dr. Patton was President of the American Association of Pharmaceutical Scientists. Dr. Patton's 20 year career also includes tenures as Professor of Pharmaceutical Chemistry and Pharmacy Practice at the University of Kansas, Associate Director Control Development at the Upjohn Co., a pharmaceutical company, and Vice President of Operations at Oread Laboratories, Inc., a pharmaceutical company.\nL. John Polite, Jr., a Director since 1989, is Chairman of Peridot (New Jersey) Chemicals, Inc., and has served in that capacity since December 1989. He was the Chairman of the Board, President and Chief Executive Officer of Essex Chemical Corporation (\"Essex\") from April 1978 to October 1988 when Essex merged into Dow Chemical Company, a chemical company. Mr. Polite also serves as a director of Witco Corporation, a manufacturer and marketer of a wide range of specialty chemicals, petroleum products and engineered materials.\nDennis M. Jones and Judith A. Jones are husband and wife. G. Andrew Franz is the son-in-law of Dennis M. and Judith A. Jones.\nDirectors of the Company are elected by the Company's stockholders and hold office until the next annual meeting of stockholders and until their successors are elected and qualified, or until their earlier resignation or removal. All executive officers are appointed by and serve at the discretion of the Board of Directors.\nNo employee who is a director receives a director's fee for services rendered as a director. However, each non-employee director receives reimbursement for any expenses incurred in his capacity as a director of the Company and $2,500 per meeting of the Board of Directors attended by such non-employee director, subject to a minimum (as of December 31, 1995) of $5,000 per year. In addition, non-employee directors who are members of the Company's compensation committee receive $500 per meeting of the compensation committee attended by such non-employee directors. Finally, the present non-employee directors of the Company have been granted stock options pursuant to the Company's 1994 Formula Stock Option Plan for Non-Management Directors, as set forth in the table below:\n- --------------- (1) Adjusted to reflect the three-for-two split effected in the form of a 50% stock dividend to be paid on March 1, 1996 to holders of record on February 23, 1996.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nCompensation of Executive Officers\nSummary Compensation Table. The table below sets forth all compensation received in each of the three fiscal years ended December 31, 1993, 1994 and 1995 for services rendered in all capacities to the Company and its subsidiaries by the Chief Executive Officer and the other four (4) highest-compensated Executive Officers of the Company during the fiscal year ended December 31, 1995 (the \"Named Executives\").\n- --------------- (1) None of the Named Executives received Other Annual Compensation which is required to be reported in this column.\n(2) Consists of a Company contribution to a 401(k) plan ($9,240 in 1995, $6,264 in 1994 and $8,004 in 1993) and the dollar value of premiums paid by the Company for a split-dollar life insurance policy on Mr. Jones, of which $8,161, $7,707 and $7,200 constituted his entire economic benefit in the years 1995, 1994 and 1993, respectively.\n(3) Consists of a Company contribution to a 401(k) plan ($6,771 in 1995, $7,239 in 1994 and $6,160 in 1993) and the dollar value of premiums paid by the Company for a split-dollar life insurance policy on Mrs. Jones, of which $2,948, $2,784 and $2,760 constituted her entire economic benefit in the years 1995, 1994 and 1993, respectively.\n(4) Consists of a Company contribution to a 401(k) plan.\n(5) As adjusted to reflect the three-for-two stock split effected in the form of a 50% stock dividend to be paid on March 1, 1996 to holders of record on February 23, 1996.\nStock Option\/SAR Grants. The Company granted no stock options and no stock appreciation rights (\"SARs\") to the Named Executives during the fiscal year ended December 31, 1995.\nAggregated Option Exercises in Last Fiscal Year and FY-end Option Values. The following table provides information with respect to the stock options exercised during the fiscal year ended December 31, 1995 and the value as of December 31, 1995 of unexercised in-the-money options held by the Named Executives. The value realized on the exercise of options is calculated using the difference between the option exercise price and the fair market value of the Company's stock on the date of the exercise. The value of unexercised in-the-money options at fiscal year end is calculated using the difference between the option exercise price and the fair market value of the Company's stock at fiscal year end, December 31, 1995. The Named Executives exercised no SARs during the fiscal year ended December 31, 1995 and held no SARs as of December 31, 1995. The information in the following table is adjusted to reflect the three-for-two stock split effected in the form of a 50% stock dividend, to be paid on March 1, 1996 to holders of record on February 23, 1996.\nCash or Deferred Profit-Sharing Plan and Trust. Effective as of January 1, 1987, the Company adopted a Cash or Deferred Profit-Sharing Plan and Trust known as JMI's Employee Retirement 401(k) Plan (\"401(k) Plan\"). The 401(k) Plan has been amended from time-to-time and was amended and restated as of January 1, 1995. The 401(k) Plan provides employees with a convenient way to save on a regular and long-term basis and encourages employees to make and continue careers with the Company. During 1995, the Company made matching contributions to the 401(k) Plan of $33,032 to the Named Executives.\nTo become eligible to participate in the 401(k) Plan, an employee must have completed six months of service and have reached his or her eighteenth birthday (\"Eligible Employee\"). As of January 1, 1996, the Company had approximately 275 Eligible Employees, including the directors who are also Named Executives (Dennis M. Jones, Judith A. Jones, Michael T. Bramblett, G. Andrew Franz and David A. McLaughlin). Pursuant to the 401(k) Plan, an Eligible Employee who participates (\"Participant\") may direct that a portion of his or her compensation be contributed to the 401(k) Plan (\"Elective Contributions\"). The Company will contribute a matching amount determined by the Company each year (five percent in each of 1993, 1994 and 1995) of the Participant's compensation (\"Company Contributions\"). In addition to matching contributions, the Company may make a discretionary contribution which is allocated among Participants in proportion to compensation. The Participants are not allowed to make any voluntary contributions to the 401(k) Plan, other than their Elective Contributions. The Company Contributions are subject to a vesting schedule described below and may not be withdrawn from the 401(k) Plan until age 59 1\/2, retirement, termination of employment, or other condition specified in the 401(k) Plan. In addition, Participants may withdraw their Elective Contributions to the 401(k) Plan at any time after they are made for reasons of hardship as described in the 401(k) Plan. Elective Contributions are always 100% vested. Company Contributions become vested according to the following schedule:\nForfeitures of discretionary Company Contributions will be allocated to the accounts of other Participants. Forfeitures of matching contributions are allocated in proportion to matching contributions.\nThe 401(k) Plan Trustee may invest in investments as described in the 401(k) Plan, including stocks, bonds, notes and other property. Participants may not obtain loans from their accounts under any circumstances. Company Contributions have, at times, been invested in shares of the Company's Common Stock acquired in the open market. On February 15, 1996, the 401(k) Plan held 90,000 shares of Common Stock (as adjusted for the three-for-two stock split effected in the form of a 50% stock dividend to be paid March 1, 1996 to holders of record as of February 23, 1996).\nThe Company is the 401(k) Plan Administrator and currently pays all expenses of the 401(k) Plan other than audit fees, which are paid by the 401(k) Plan. The Company has appointed Dennis M. Jones and Judith A. Jones as Trustees of the 401(k) Plan. The 401(k) Plan may be modified by the Board at any time, provided that no modification shall adversely affect the rights of the Participants or divert any of the trust fund to purposes other than the benefit of the Participants.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following table sets forth certain information regarding the record and beneficial ownership of the Common Stock of the Company on the indicated date (as adjusted to reflect the three-for-two stock split effected in the form of a 50% stock dividend to be paid on March 1, 1996 to holders of record on February 23, 1996) by (i) each director and Named Executive (as such term is defined in \"Executive Compensation -- Summary Compensation Table\", above) of the Company, (ii) all directors and executive officers of the Company as a group, and (iii) each shareholder owning of record or beneficially five percent (5%) or more of the outstanding Common Stock:\n- --------------- * Less than one percent.\n(1) Except as otherwise indicated, the officers and directors of the Company named in the above table have sole voting and investment power with respect to all shares of Common Stock\nshown as beneficially owned by them and their respective addresses are 1945 Craig Road, St. Louis, Missouri 63146.\n(2) Includes shares deemed owned as a result of options to purchase 96,000 shares which are presently or will become exercisable within 60 days of February 15, 1996.\n(3) The number of shares of Common Stock deemed outstanding as of February 15, 1996 includes (i) 14,310,663 shares of Common Stock outstanding, (ii) an aggregate of 737 shares of Common Stock issuable upon conversion of all of the shares of the Company's Preferred Stock, Series A outstanding at February 15, 1996 (which conversion is presently in progress), and (iii) shares of Common Stock issuable pursuant to options held by the directors and executive officers that are currently exercisable or will become exercisable within 60 days of February 15, 1996 by the person or group in question.\n(4) Excludes 90,000 shares owned by the Company's 401(k) Plan (of which Dennis and Judith Jones are co-trustees) and with respect to which Dennis and Judith Jones disclaim beneficial ownership.\n(5) Only includes shares owned directly by Mr. Jones. Does not include 680,625 shares owned by his spouse, with respect to which he disclaims beneficial ownership.\n(6) Only includes shares owned directly by Mrs. Jones. Does not include 2,781,840 shares owned by her spouse, with respect to which she disclaims beneficial ownership.\n(7) Includes 83,250 shares owned directly by Mr. Bramblett, 2,400 by his IRA, 1,926 shares held by his spouse's IRA and with respect to which he disclaims beneficial ownership, and vested and unexercised options to purchase 75,000 shares of Common Stock pursuant to the Company's 1989 Incentive Stock Option Plan.\n(8) Includes 114,007 shares owned directly by Mr. Franz, 154,110 shares owned by his spouse and with respect to which he disclaims beneficial ownership, 34,560 shares held by his spouse as custodian for his children and with respect to which he disclaims beneficial ownership, 15,006 shares held by his spouse as trustee for his children and with respect to which he disclaims beneficial ownership and vested and unexercised options to purchase 7,500 shares of common stock pursuant to the Company's 1989 Incentive Stock Option Plan.\n(9) Includes 75,000 shares owned directly by Mr. McLaughlin and vested and unexercised options to purchase 7,500 shares of Common Stock pursuant to the Company's 1989 Incentive Stock Option Plan.\n(10) Includes 109,500 shares owned directly by Mr. Lopata, 40,500 shares owned by Mr. Lopata through his spouse's revocable trust and with respect to which he disclaims beneficial\nownership, and vested and unexercised options to purchase 1,500 shares of Common Stock pursuant to the Company's 1994 Formula Stock Option Plan for Non-Management Directors.\n(11) Includes 22,500 shares owned directly by Mr. Polite and vested and unexercised options to purchase 3,000 shares of Common Stock pursuant to the Company's 1994 Formula Stock Option Plan for Non-Management Directors.\n(12) Includes 15,750 shares owned directly by Mr. Chod and vested and unexercised options to purchase 1,500 shares of Common Stock pursuant to the Company's 1994 Formula Stock Option Plan for Non-Management Directors.\nBased upon filings with the Securities and Exchange Commission, the Company is advised that as of December 31, 1995, each of the following investment advisors held discretionary authority over accounts holding, in the aggregate, the indicated numbers of shares of the Common Stock (as adjusted to reflect the three-for-two stock split), in each case representing approximately 5% of the then outstanding shares of Common Stock (as adjusted to reflect the three-for-two stock split):\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nEdward A. Chod, director of the Company, is a principal in the law firm of Greensfelder, Hemker & Gale, P.C., which firm has served as counsel to the Company since 1982. The amount of legal fees paid by the Company to Greensfelder, Hemker & Gale, P.C. during the fiscal year ended December 31, 1995 did not exceed five percent (5%) of such firm's gross revenues for its applicable fiscal year.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) 1. The consolidated financial statements filed as part of this report on Form 10-K are listed on the accompanying Index to Consolidated Financial Statements and Consolidated Financial Statement Schedule on page.\n2. The consolidated financial statement schedule filed as part of this report on Form 10-K is listed on the accompanying Index to Consolidated Financial Statements and Consolidated Financial Statement Schedule on page.\n3. Exhibits:\n(3.1) Restated Certificate of Incorporation of the Company dated June 21, 1988.\n(3.2) Certificate of Amendment of the Certificate of Incorporation of the Company dated May 14, 1990.\n(3.3) Certificate of Amendment of the Certificate of Incorporation of the Company dated May 30, 1991.\n(3.4) Certificate of Designation of Convertible Preferred Stock, Series A, as filed with the Secretary of State of Delaware on May 15, 1991, is incorporated by reference from Form 8-K dated May 29, 1991.\n(3.5) Amended By-Laws of the Company as of June 14, 1988.\n(3.6) Amendment to Section 3.02 of By-Laws of the Company as of April 1, 1992.\n(10.1) The Company's 1989 Incentive Stock Option Plan.\n(10.2) The Company's Cash or Deferred Profit Sharing Plan and Trust amended and restated as of January 1, 1995 (to be filed by amendment).\n(10.3) Agreement and Plan of Reorganization dated as of December 27, 1990, as Amended and Restated as of March 15, 1991, between the Company and GenTrac, Inc., is incorporated by reference from Form 8-K dated May 29, 1991.\n(10.4) Asset Purchase Agreement dated as of February 12, 1993, between the Company and Tsumura International, Inc., is incorporated by reference from Form 8-K dated February 18, 1993.\n(10.5) Stock Purchase Agreement dated as of March 22, 1993, among the Company and each of the stockholders of Bronson Pharmaceuticals, is incorporated by reference from Form 8-K dated April 7, 1993.\n(10.6) The Company's 1994 Incentive Stock Plan effective June 1, 1994, is incorporated by reference from the Company's Proxy Statement dated April 21, 1995 for the Annual Meeting of Stockholders held May 15, 1995.\n(10.7) The Company's 1994 Formula Stock Option Plan for Non-Management Directors effective May 25, 1994, is incorporated by reference from the Company's Proxy Statement dated April 21, 1995 for the Annual Meeting of Stockholders held May 15, 1995.\n(10.8) Licensing Agreement dated August 31, 1995 between the Company and Eli Lilly & Company is incorporated by reference from Form 8-K dated September 15, 1995.\n(10.9) Manufacturing Agreement dated August 31, 1995 between the Company and Eli Lilly & Company, is incorporated by reference from Form 8-K dated September 15, 1996.\n(11.1) Statement re: computation of per share earnings.\n(21.1) Subsidiaries of the Registrant.\n(23.1) Consent of Ernst & Young LLP.\n(27.1) Financial Data Schedule.\n(b) No reports on Form 8-K were filed by the Company 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.\nJONES MEDICAL INDUSTRIES, INC.\nBy: \/s\/ Dennis M. Jones ----------------------------------- Dennis M. Jones, President\nDate: March 1, 1996 ---------------------------------\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.\nSIGNATURES TITLE DATE - --------------------------- -------------------- --------------------\n\/s\/ Dennis M. Jones President, Chief March 1, 1996 - ------------------------- Executive Officer -------------- Dennis M. Jones and Director\n\/s\/ Judith A. Jones Principal Financial March 1, 1996 - ------------------------- and Accounting -------------- Judith A. Jones Officer, Executive Vice President, Secretary, Treasurer and Director\n\/s\/ Michael T. Bramblett Executive Vice March 1, 1996 - ------------------------ President and -------------- Michael T. Bramblett Director\n\/s\/ G. Andrew Franz Senior Vice March 1, 1996 - -------------------------- President - G. Andrew Franz Operations - Pharmaceuticals and Director\n\/s\/ David A. McLaughlin Senior Vice March 1, 1996 - -------------------------- President - David A. McLaughlin Operations - Nutritionals and Director\n\/s\/ Edward A. Chod Director March 1, 1996 - -------------------------- Edward A. Chod\n\/s\/ Stanley Lopata Director March 1, 1996 - -------------------------- Stanley Lopata\n\/s\/ L. John Polite, Jr. Director March 1, 1996 - -------------------------- L. John Polite, Jr.\n\/s\/ Thomas F. Patton, Ph.D. Director March 1, 1996 - --------------------------- Thomas F. Patton, Ph.D.\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND CONSOLIDATED FINANCIAL STATEMENT SCHEDULE\nPage ----\nReport of Ernst & Young LLP, independent auditors\nConsolidated balance sheets as of December 31, 1994 and 1995\nConsolidated statements of income for the years ended December 31, 1993, 1994 and 1995\nConsolidated statements of stockholders' equity for the years ended December 31, 1993, 1994 and\nConsolidated statements of cash flows for the years ended December 31, 1993, 1994 and 1995\nNotes to consolidated financial statements\nConsolidated schedule for the years ended December 31, 1993, 1994 and 1995:\nII. Valuation and qualifying accounts\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.\nREPORT OF INDEPENDENT AUDITORS\nThe Board of Directors and Stockholders Jones Medical Industries, Inc.\nWe have audited the accompanying consolidated balance sheets of Jones Medical Industries, Inc. as of December 31, 1995 and 1994, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1995. 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 Jones Medical Industries, Inc. at December 31, 1995 and 1994, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, 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 10 to the consolidated financial statements, in 1993, the Company changed its method of accounting for income taxes.\nERNST & YOUNG LLP\nSt. Louis, Missouri February 12, 1996, except for Note 16 as to which the date is February 26, 1996\nJONES MEDICAL INDUSTRIES, INC.\nCONSOLIDATED BALANCE SHEETS\nSee accompanying notes.\nJONES MEDICAL INDUSTRIES, INC.\nCONSOLIDATED STATEMENTS OF INCOME\nSee accompanying notes.\nJONES MEDICAL INDUSTRIES, INC.\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY\nYEARS ENDED DECEMBER 31, 1993, 1994, AND 1995\nSee accompanying notes.\nJONES MEDICAL INDUSTRIES, INC.\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nSee accompanying notes.\nJONES MEDICAL INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1995\n1. NATURE OF OPERATIONS AND CUSTOMER CONCENTRATION\nThe Company is engaged in the manufacturing, marketing, and sale of pharmaceuticals and nutritional supplements. The Company's principal customers include consumers, retail pharmacies, hospitals (through wholesale drug distributors), physicians, and the United States government, of which sales to the United States government totaled approximately $4,600,000, $4,500,000, and $3,250,000 in 1993, 1994, and 1995, respectively. No one customer accounted for more than 10% of the Company's consolidated sales in 1993, 1994, or 1995. The Company's most significant product line is a topical hemostat with sales totaling approximately $13,126,000, $12,681,000, and $14,573,000 in 1993, 1994, and 1995, respectively. The Company's only source of supply for this product line is from GenTrac, Inc. (\"GenTrac\"), a wholly-owned subsidiary of the Company.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the accounts of Jones Medical Industries, Inc. and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.\nCASH AND CASH EQUIVALENTS\nCash equivalents in short-term money market accounts and other investments with original maturities of less than three months are stated at cost plus accrued interest and are considered to be cash equivalents.\nINVENTORIES\nInventories are valued at the lower of cost or market with cost determined on the first-in, first-out basis.\nPROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment is recorded at cost. Depreciation is computed by the straight-line method over the useful life of the assets as follows:\nINTANGIBLE ASSETS\nThe cost of product line or business acquisitions is allocated first to identifiable assets and liabilities based on estimated fair values. The excess of cost over identifiable assets and liabilities is\nJONES MEDICAL INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nrecorded as goodwill. Amortization is provided using the straight-line method over the estimated useful life of the assets as follows:\nThe Company continually reevaluates the propriety of the carrying amount of goodwill and other intangibles as well as the related amortization period to determine whether current events and circumstances warrant adjustments to the carrying values and\/or revised estimates of useful lives. This evaluation is based on the Company's projection of the undiscounted operating income before depreciation, amortization, and interest over the remaining lives of the amortization periods of related goodwill and intangible assets. The projections are based on the historical trend line of actual results since the commencement of operations and adjusted for expected changes in operating results. To the extent such projections indicate that the undiscounted operating income (as defined above) is not expected to be adequate to recover the carrying amounts of related intangibles, such carrying amounts are written down by charges to expense in amounts equal to the excess of the carrying amount of intangible assets over the respective fair values. At this time, the Company believes that no significant impairment of the goodwill and other intangibles has occurred and that no reduction of the estimated useful lives is warranted.\nREVENUE RECOGNITION\nSales are reported net of returns during the period in which product is shipped. These sales are subsequently adjusted for reserves incurred due to volume or other contractual discounts on certain pharmaceuticals under contracts with hospitals and hospital buying groups. At December 31, 1995 and 1994, the Company maintained a reserve of $1,500,000 and $1,050,000, respectively, for such anticipated discounts.\nEARNINGS PER COMMON AND COMMON EQUIVALENT SHARE\nEarnings per common and common equivalent share are based on the weighted average number of shares of Common Stock and Common Stock equivalents outstanding during each year (14,256,640 in 1993, 14,391,084 in 1994, and 14,589,150 in 1995) after giving retroactive effect to a three-for-two stock split declared February 7, 1996. The computation assumes that outstanding stock options were exercised and the proceeds used to purchase common shares. Outstanding Preferred Stock was assumed to have been converted to Common Stock at the issuance date.\nSTOCK OPTIONS\nThe Company has elected to follow Accounting Principles Board Opinion No. 25, \"Accounting for Stock Issued to Employees,\" (APB 25) and related interpretations in accounting for its employee stock options because the alternative fair value accounting provided under FASB Statement No. 123, \"Accounting for Stock-Based Compensation,\" requires use of option valuation models that were not developed for use in valuing employee stock options. Under APB 25, because the exercise price of the Company's incentive stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized.\nIn connection with various nonqualified stock option plans, certain options have been granted at exercise prices below the fair market value of the Common Stock at the grant date. Differences\nJONES MEDICAL INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nbetween the option prices and fair market values at the dates of grant are charged to compensation expense ratably over the future service vesting periods.\nDIRECT-RESPONSE ADVERTISING\nCosts associated with the production of the Company's direct-response mail order catalog are capitalized and amortized over the expected period of future benefit, which typically does not extend beyond six months. At December 31, 1994 and 1995, approximately $181,000 and $392,000, respectively, of capitalized catalog costs are included in the accompanying balance sheets. Advertising expense associated with the catalog in 1993, 1994, and 1995 totalled $584,000, $902,000, and $1,223,000, respectively.\nUSE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nRECLASSIFICATIONS\nCertain reclassifications have been made to the 1993 and 1994 financial statements to conform to the 1995 presentation.\n3. COMMON STOCK SPLIT\nOn February 7, 1996, the Board of Directors declared a three-for-two stock split effected in the form of a stock dividend to be paid on March 1, 1996 to holders of record on February 23, 1996. The financial statements, including stock option, share, per share data, and market prices, have been retroactively adjusted to reflect the split.\n4. ACQUISITIONS\nBrevital\nOn August 31, 1995, the Company entered into a perpetual licensing agreement with Eli Lilly & Company (\"Lilly\") for the exclusive United States marketing rights to the Brevital product line. The purchase price of approximately $14.0 million was financed with bank debt of $7.0 million and Lilly financing of $7.0 million. Approximately $13.0 million was allocated to the perpetual license with an amortizable life of 30 years, and $1.0 million was allocated to a restrictive covenant with an amortizable life of 10 years.\nBronson Pharmaceuticals\nOn March 24, 1993, the Company acquired the outstanding stock of Bronson Pharmaceuticals (\"Bronson\"), a California subchapter S corporation. The cost of the acquisition of $10,500,000 has been recorded using the purchase method of accounting, and the results of Bronson's operations, since the date of acquisition, have been included in the Company's consolidated financial statements. The excess of the purchase price over the estimated fair market value of the net assets acquired of approximately $2,700,000 is being amortized over 40 years using the straight-line method.\nThe following summarized unaudited pro forma results of operations for the year ended December 31, 1993 assume the acquisition occurred as of the beginning of the respective period. The pro forma results have been prepared for comparative purposes only and do not purport to be\nJONES MEDICAL INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nindicative of the results of operations which actually would have resulted had the acquisition occurred on the date indicated, or which may result in the future.\nDerma System Professional Skin Care\nOn February 12, 1993, the Company acquired the Derma System Professional Skin Care product line for approximately $3,500,000 which was paid in cash. The entire purchase price was allocated to intangible assets, the majority of which are being amortized over a useful life of 20 years.\n5. SUPPLEMENTAL CASH FLOW INFORMATION\nThe Company paid the following amounts for interest and income taxes:\n6. INVENTORIES\nInventories at December 31, 1994 and 1995 are comprised of the following:\n7. PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment at December 31, 1994 and 1995 are as follows:\nJONES MEDICAL INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n8. ACCOUNTS PAYABLE AND ACCRUED EXPENSES\nAccounts payable and accrued expenses at December 31, 1994 and 1995 are comprised of the following:\n9. LONG-TERM DEBT\nLong-term debt at December 31, 1994 and 1995 consists of the following:\nApproximately $1,167,000 of the $5,399,986 of long-term debt outstanding at December 31, 1994 was refinanced in connection with the 1995 bank note payable.\nMaturities of long-term debt at December 31, 1995 are as follows:\nJONES MEDICAL INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nOn March 16, 1995, the Company increased its available borrowings under the March 16, 1993 credit arrangement from $2.0 million to $4.0 million. Interest on outstanding borrowings is based on the bank base rate and is payable monthly. Borrowings on the line of credit are secured by substantially all of the assets of the Company. There were no borrowings under the line of credit agreement in 1994 and 1995.\nThe bank credit agreement including the note payable to bank and the line of credit arrangement contain certain restrictive provisions including maintaining a maximum tangible net worth ratio, maintaining a minimum current ratio, obtaining prior approval of acquisition financings in excess of $3.0 million and limiting the amount of additional borrowings. The Company will be in default under its revolving credit and borrowing lines if (i) Dennis Jones ceases to be the Company's Chairman of the Board and Chief Executive Officer, or (ii) Dennis Jones and Judith Jones, collectively, own less than 15% of the outstanding shares of Common Stock of the Company, or (iii) a third party acquires 50% or more of the shares of the Company's capital stock without the lender's prior approval.\n10. INCOME TAXES\nEffective January 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, \"Accounting for Income Taxes.\" The cumulative effect of adopting Statement No. 109 as of January 1, 1993 was to increase net income by $207,100.\nDeferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax assets and liabilities as of December 31, 1995 and 1994 are as follows:\nSignificant components of the provision for income taxes are as follows:\nJONES MEDICAL INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nA reconciliation of the difference between the United States federal statutory tax rates and the effective income tax rate as a percentage of net income before cumulative effect of change in accounting principle is as follows:\n11. PREFERRED STOCK\nThe Company's Convertible Cumulative Preferred Stock, Series A, bears dividends at an annual dividend rate of $0.16 per share. Each preferred share has voting rights equal to one share of Common Stock and is convertible into 1.75 shares (2.625 shares after giving retroactive effect to the three-for-two stock split declared February 7, 1996) of the Company's Common Stock.\nDuring 1995, the Company reached a settlement regarding a portion of the contingent purchase price payable to the former stockholders of GenTrac. In connection with the settlement, 44,004 shares of the Company's Preferred Stock held in an escrow account, pending final dispute resolution, were released from escrow and returned to the Company. These shares of Preferred Stock with an original cost of $381,277 have been canceled by the Company. The accompanying 1995 financial statements reflect the resulting $381,277 reduction of goodwill associated with the contingent purchase price and reduction in Preferred Stock.\n12. STOCK OPTION PLANS\nThe Company has various incentive stock option (\"ISO\") plans for executives and employees. In connection with the ISO plans, options to purchase Common Stock are granted at option prices not less than the fair market values of the Common Stock at the time the options are granted and vest ratably over a five-year period from the grant dates. At December 31, 1995, options for 170,499 shares of Common Stock are available for future grant. There were 479,850 options granted but unexercised under the ISO plans at December 31, 1995, of which 55,500 were exercised subsequent to December 31, 1995.\nIn addition, the Company has various nonqualified stock option (\"NSO\") plans for certain officers and independent directors. Certain of these options offer exercise prices below the fair market value of the Common Stock at the date of grant. In accordance with APB 25, differences between the option prices and the fair market values at the dates of grant have been accrued ratably over the five-year vesting periods. Total compensation expense in 1993, 1994, and 1995 related to the NSO plans was $67,000, $122,000, and $123,500, respectively. At December 31, 1995, there were 103,500 options granted but unexercised under the NSO plans, of which 75,000 shares were exercised subsequent to December 31, 1995.\nJONES MEDICAL INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nOption activity for 1993, 1994, and 1995 was as follows:\nOutstanding options at December 31, 1995 are exercisable as follows:\nSubsequent to December 31, 1995, options to purchase 70,500 shares of Common Stock were granted to certain employees of the Company under the ISO plan. The option price of $16 per share represents the fair market value of the stock on the date the options were granted. The options vest over periods of five to seven years from the grant date.\nIn addition, subsequent to December 31, 1995, options to purchase 450,000 shares of Common Stock were granted to certain officers of the Company under time accelerated stock option agreements pursuant the Company's 1994 Incentive Stock Plan. The option price of $16 per share represents the fair market value of the stock on the date the options were granted. The options become exercisable at the end of eight years from the grant date; however, the options may become exercisable if certain targeted Common Stock prices are attained as follows: $20 for the 1997 installment, $26.67 for the 1998 installment, $32 for the 1999 installment, $40 for the 2000 installment, and $50 for the 2001 installment.\n13. EMPLOYEE BENEFIT PLAN\nThe Company has a defined contribution plan covering substantially all employees. The plan provides the Company match 100 percent of the employee voluntary contributions up to a maximum matching contribution of 5 percent of the employee's compensation. Company contributions in 1993, 1994, and 1995 were approximately $172,000, $184,000, and $204,000, respectively.\nJONES MEDICAL INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n14. CONTINGENCIES AND COMMITMENTS\nThe Company currently carries product liability coverage of $10,000,000 per occurrence and $10,000,000 in the aggregate on a \"claims made\" basis. There is no assurance that the Company's present insurance will cover any potential claims that may be asserted in the future. In addition, the Company is subject to legal proceedings and claims which arise in the ordinary course of its business.\nUnder development and distribution agreements between GenTrac and Johnson & Johnson entered into prior to the Company's acquisition of GenTrac, Johnson & Johnson acquired certain rights to new thrombin products and thrombin product improvements developed by GenTrac. Johnson & Johnson has notified the Company that it believes that it is entitled to exclusive distribution rights for Thrombin-JMI and a liquid thrombin product for which FDA approval is currently pending. Although the Company strongly disagrees with and will vigorously contest such claims by Johnson & Johnson, any resolution of the claims in favor of Johnson & Johnson could have a materially adverse effect upon the Company's business, financial condition and results of operations.\nThe Company currently relies on Lilly for the manufacture of Brevital. The Company has entered into a 10-year manufacturing agreement with Lilly, which may be terminated by Lilly at any time after the first five years by giving at least five years notice to the Company prior to ceasing the manufacture of Brevital. In the event of such termination, Lilly must use reasonable efforts to assist the Company in obtaining all the necessary licenses and approvals to enable the Company or an alternative manufacturer to manufacture Brevital. Lilly is the sole manufacturer of Brevital and any alternative manufacturer would require regulatory change-in-site qualification to manufacture the product. In the event of any interruption in the supply of Brevital from Lilly due to regulatory or other causes, there can be no assurance that the Company could make alternative manufacturing arrangements on a timely basis, if at all. Such an interruption would have a material adverse effect on the Company's business, financial condition and results of operations.\nIn connection with certain product line acquisitions, the Company is obligated to pay royalties of up to 10 percent of certain product sales through 2005. Total royalty expense in 1993, 1994, and 1995 was approximately $621,000, $636,000, and $593,000, respectively.\n15. QUARTERLY FINANCIAL DATA (UNAUDITED)\n- ------------ * Adjusted to reflect the three-for-two stock split declared February 7, 1996.\n16. SUBSEQUENT EVENTS\nOn February 26, 1996, the Company filed with the Securities and Exchange Commission a Registration Statement on Form S-3 relating to the offering of 2,300,000 shares of its Common Stock. The proceeds from the equity offering will be used for repayment of certain indebtedness and for general corporate purposes, including the possible acquisition of product lines or businesses.\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS\nJONES MEDICAL INDUSTRIES, INC.\n*Write off of fully amortized intangibles in 1995, and 1994.\nCommission File No: 0-15098\n- --------------------------------------------------------------------------------\nSECURITIES AND EXCHANGE COMMISSION\nWashington, D.C. 20549\n-------------------------------------------\nEXHIBITS\nTO\nFORM 10-K\nANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1995\n-------------------------------------------\nJONES MEDICAL INDUSTRIES, INC.\n(Exact name of Registrant as specified in its charter)\n1945 Craig Road St. Louis, MO 63146 (Address of Registrant's principal offices)","section_15":""}
{"filename":"740112_1995.txt","cik":"740112","year":"1995","section_1":"Item 1. Business Concord EFS, Inc. and its subsidiaries (the Company) provide electronic transaction processing, authorization and settlement services and ATM processing and ATM driving services to retailers, grocery stores, financial institutions and trucking companies nationwide. The related electronic terminal equipment used in transaction processing is sold and\/or maintained by the Company .\nOn February 20, 1992, Concord Computing Corporation changed its name to Concord EFS,Inc.(the Parent) and became a holding company.Subsequently, Concord Computing Corporation (Concord) incorporated as a Delaware corporation and acquired the operational assets and liabilities of the Parent. Concord is a wholly owned subsidiary of the Parent. The Parent was originally incorporated as a Massachusetts company on January 23, 1970 and has operated continuously since that time. During 1990, the Parent reincorporated in Delaware. The Parent became a one- bank holding company on December 1, 1992, in connection with the formation of EFS National Bank (EFSNB) described below.\nThe Parent acquired a 100% interest in EFS, Inc. (EFS), a Delaware corporation, on March 15, 1985. EFS National Bank (formerly EFS, Inc.) (EFSNB), sells credit, debit, and electronic benefits transfer (EBT) card authorization, data capture and settlement services to retailers and grocery stores. It also sells cash card and cash forwarding services to trucking companies through agreements with a network of truck stops. On December 1, 1992, EFSNB was formed. Simultaneous to its formation, the Bank issued 1,000,000 outstanding shares of common stock to the Parent in exchange for all of the outstanding shares of common stock of EFS, Inc., a wholly owned subsidiary of the Parent. EFS, Inc. was subsequently dissolved.\nEFSNB's formation occurred so the Company could provide a full spectrum of electronic transaction processing and settlement services to its customers. Previously, EFS had to contract settlement services and sponsorship into bankcard associations with unrelated financial institutions. As a bank, EFSNB can provide its existing services in a more efficient and cost effective manner as well as new services such as debit card processing to retailers, convenience stores and supermarkets and banking services to trucking companies and truck drivers.\nThe services of EFSNB do not consist of material amounts of traditional banking activities (i.e., consumer and commercial loans, demand and time deposits, real estate, etc.). Therefore, the Company did not change to the reporting format and related disclosures normally required for bank holding companies.\nConcord Computing Corporation's (Concord) primary activity is check authorization and POS terminal driving, servicing and maintenance for grocery store chains. It also owns and operates cash dispensing machines (ATMs) at truck stops and grocery stores nationwide. Additionally, Concord provides certain processing services for its affiliated companies.\nThe Parent acquired a majority interest in Network EFT, Inc.(NEFTI ), a Delaware corporation located in Chicago, Illinois, on June 14, 1981. NEFTI sells electronic funds transfer services to financial institutions in grocery stores. Depositors of financial institutions may make deposits and withdrawals and perform electronic banking\ntransactions at these terminals. The Parent sold a 37% interest in NEFTI to a customer in April of 1983. The Parent currently retains a 57% interest in NEFTI.\nThe Parent incorporated a wholly-owned Tennessee subsidiary, Concord Equipment Sales, Inc. (formerly VMT, Inc.) on September 5, 1991. Concord Equipment Sales, Inc. purchases from manufacturers point-of- sale (POS) terminal products and communications equipment for use by the Company's customers in connection with the Company's transaction processing services.\nConcord Computing Corporation incorporated a wholly-owned Delaware subsidiary, Concord Retail Services, Inc. (CRS). CRS provides POS terminal driving, servicing and maintenance to the Company's customers in the northeast United States.\nDescription of Business The Company operates exclusively in the payment services industry. The primary components of the services are:\nBank Card Services consist of credit, debit, and EBT card authorization, data capture and settlement services provided to retail and grocery store merchants.\nTrucking Services consist of cash card, cash forwarding services, ATM operations and banking services for trucking companies and truck drivers.\nCheck Services consist of check authorization services sold to retail and grocery store merchants.\nIn addition, the Company provides Electronic Funds Transfer (EFT) services and sells electronic terminal equipment to customers who are users of the services.\nAll of these services are sold directly to the end-user on a nationwide basis.\nThe following table is a listing of revenues by service type for the three years ended December 31: 1995 1994 1993 -------- ------- ------- (in thousands) Bank Card Services $ 92,223 $66,959 $47,482 Trucking Services 16,687 12,853 12,022 Check Services 12,168 9,954 9,279 EFT and Terminal Services 6,684 6,447 6,660 -------- ------- ------- $127,762 $96,213 $75,443 ======== ======= =======\nAs transaction service revenues are similar in nature, total operating expenses are not directly attributable to any individual revenue type.\nData Processing and Field Service Support The Company maintains a data processing facility in Elk Grove,Illinois, primarily for the Company's Check Services and EFT Services, and a data processing facility in Memphis, Tennessee for Trucking Services and Bank Card Services. These facilities utilize fully redundant computers\nwhich provide the high levels of availability and the transaction speed necessary for processing large numbers of financial transactions. Backup power is available to provide service in the event of power failure at a computer center. The Company maintains dedicated telephone networks, packet switching networks and In-Watts networks connecting data processing centers to retail stores where transaction and electronic funds transfer terminals are located.\nThe Company also provides field support and repair services for POS terminal installations. The Company maintains field support and repair facilities in Elk Grove, Illinois, Aurora, Colorado and West Chester, Pennsylvania.\nMarketing and Customers The Company markets its services and products on a nationwide basis directly to retail merchant companies, electronic funds transfer networks, financial institutions and trucking companies through sales offices located in suburbs of Chicago and Memphis. The Company's executive officers participate in the Company's marketing efforts.\nThe Company's principal services are designed and programed by the Company, and, in general, utilize commonly available system hardware and components and are not dependent upon scarce materials, patents or trademarks for continued viability.\nCompetition The Company competes with a large number of suppliers of services and products, many of which are large companies with substantially greater financial and marketing resources than those of the Company. The Company's competition includes other providers of data processing and switching services including several banks and\/or bank holding companies, electronic funds transfer networks and equipment vendors. The markets for the services and products which are offered by the Company are highly fragmented, and no supplier has a dominant share of the market for Check Services, EFT Services, Terminal Products or Bank Card Services. One supplier, ComData Network, a wholly-owned sub- sidiary of Ceridian Corporation, has a dominant share of the Trucking Services market. Another competitor, First Data Corporation, has a large share of the Bank Card Services market.\nThe Company competes in its markets in terms of price, quality, speed and flexibility in customizing systems to meet the particular needs of customers. The Company believes that it is one of the few integrated suppliers of both services and hardware for use in transaction services at retail locations.\nSupervision and Regulation Concord EFS, Inc. and its subsidiaries are subject to a number of federal and state laws. As a bank holding company, the Parent is subject to regulation under the Bank Holding Company Act of 1956, as amended (the \"Act\") which is administered by the Federal Reserve Board (the \"Board\"). Under the Act, the Company is generally prohibited from directly engaging in any activities other than banking, managing or controlling banks, and bank-related activities. Also, the Act prohibits a bank holding company, with certain exceptions, from acquiring, directly or indirectly, ownership or control of 5% or more of the voting shares of any company which is not a bank or bank holding company. The primary exception to this prohibition involves activities which the Board determines are closely related to banking. A bank is\nalso generally prohibited from engaging in certain tie-in arrangements with its bank holding company or affiliates with respect to the lease or sale of property, furnishing of services, or the extension of credit. The Act contains certain restrictions concerning future mergers with other bank holding companies and banks. The Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA) contains certain merger restrictions with Savings and Loan Associations.\nUnder the Act, a bank holding company is required to file with the Board an annual report and such additional information which the Board may require. The Board may examine the Company's and each of its subsidiaries' records, including a review of capital adequacy in relation to guidelines issued by the Board. If the level of capital is deemed to be inadequate, the board may restrict the future expansion and operations of the Company. The Board possesses cease and desist powers over a bank holding company if its actions or actions of any of its subsidiaries represent unsafe or unsound practices or violations of law.\nFederal law also regulates transactions among the Company and its affiliates, including the amount of a banking affiliate's loan to, or investments in non-bank affiliates and the amount of advances to third parties collateralized by securities of an affiliate. In addition, various requirements and restrictions under federal and state laws regulate the operations of the Company's banking affiliates, requiring the maintenance of reserves against deposits, limiting the nature of loans and the interest that may be charged thereon, restricting investments and other activities. The Company's bank affiliates are also limited in the amount of dividends that they may declare. Prior regulatory approval must be obtained before declaring any dividends if the amount of capital, surplus and retained earnings is below certain statutory limits.\nAs a national bank, EFSNB operates under the rules and regulations of the Comptroller of the Currency and is also a member of the Federal Reserve System, subject to provisions of the Federal Reserve Act. The FDIC insures the domestic deposits of all the Banks. Periodic audits and regularly scheduled reports of financial information are required by all regulatory agencies. Federal laws also regulate certain transactions among EFSNB and its affiliates, including Concord EFS,Inc.\nThe Company's EFT Services sold to financial institutions are regulated by certain State and Federal banking laws. Material changes in federal or state regulation could increase the cost to the Company of providing EFT Services, change the competitive environment or otherwise adversely affect the Company. The Company is not aware of any such change which is pending.\nEmployees As of December 31, 1995, the Company employed 474 full and part-time personnel, including 51 data processing and technical employees, 257 in operations, and 166 in sales and administration. Many of the Company's employees are highly skilled, and the Company believes its future success will depend in a large part on its ability to attract and retain such employees. The Company does not have employment contracts with any of its personnel. None of the Company's employees are represented by a labor union and the Company has experienced no work stoppages. The Company considers its employee relations to be\nexcellent.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES The following table sets forth certain information concerning the principal facilities of the Company, all of which are leased: APPROXIMATE AREA IN LEASE LOCATION SQUARE FEET PRIMARY USES EXPIRATION . Memphis, TN 34,125 Corporate Offices July 31, 1997 & EFSNB Operations\nElk Grove, IL 18,300 Data Processing, May 31, 1996 Field Service, NEFTI and Concord Operations\nAurora, Co 2,800 Field Service month to month\nWest Chester, Pennsylvania 1,300 Field Service month to month The Company believes all facilities are adequate.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS The Company is a party to various routine lawsuits arising out of the conduct of its business, none of which are expected to have a material adverse effect upon the Company.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS There were no matters submitted to a vote of stockholders in the fourth quarter of fiscal 1995. PART II\nItem 5.","section_5":"Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS This information is included under the caption \"Market Value For the Registrant's Common Stock and Related Stockholders Matters\" on page 5 of the Company's Annual Report (the \"Annual Report\"), and is herein incorporated by reference.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA This information is included under the caption \"Selected Consolidated Financial Data\" on page 1 of the Annual Report and is herein incorporated by reference.\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This information is included under the captions \"Management's Discus- sion and Analysis of Financial Condition and Results of Operations\" on pages 3, 4 and 5 of the Annual Report and is herein incorporated by reference.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The report of independent auditors and consolidated financial state- ments set forth below are included on pages 6 - 16 of the Annual Report, and are incorporated herein by reference.\nReport of Independent Auditors.\nConsolidated Balance Sheets as of December 31, 1995 and 1994.\nConsolidated Statements of Income for the years ended December 31, 1995, 1994 and 1993.\nConsolidated Statements of Stockholders' Equity for the years ended December 31, 1995, 1994, and 1993.\nConsolidated Statements of Cash Flows for the years ended December 31, 1995, 1994, and 1993.\nNotes to Consolidated Financial Statements as of December 31, 1995.\nQuarterly results of operations for the years ended December 31, 1995 and 1994 on page 5 of the Annual Report are incorporated herein by reference.\nSchedule II, Valuation and Qualifying Accounts, is listed below. All schedules for which provision is made in the applicable accounting regulations of the Securities & Exchange Commission are not required under the related instructions and, therefore, have been omitted.\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNT\nCONCORD EFS, INC.\nBalance Charged to Balance Beginning Costs and * End of Period Expenses Deductions of Period --------- ---------- ---------- --------- Year ended December 31, 1995 Allowance for uncollectible accounts $750,206 $500,000 $490,771 $759,435 ======== ======== ======== ========\nYear ended December 31, 1994 Allowance for uncollectible accounts $605,247 $480,000 $355,041 $750,206 ======== ======== ======== ========\nYear ended December 31, 1993 Allowance for uncollectible accounts $891,210 $525,000 $810,963 $605,247 ======== ======== ======== ========\n* Uncollectible accounts written off, net of recoveries.\nItem 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES None. PART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT See Item 13 below.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION See Item 13 below.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT See Item 13","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Information with respect to Items 10, 11, 12, and 13 is included in the Company's Proxy Statement for the Annual Meeting of Shareholders to be held on May 2, 1996 under the captions \"Election of Directors\", \"Executive Compensation\", \"Stock Options\", Beneficial Ownership of Common Stock\", and \"Certain Transactions\" and is herein incorporated by reference. PART IV\nItem 14.","section_14":"Item 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES AND REPORTS ON FORM 8-K (a) (1) and (2) -- The response to this portion of Item 14 is submitted as a separate section of this report.\n(3) Listing of Exhibits Exhibit Numbers 2 Agreement and Plan of Merger dated January 12, 1990 by and between Concord Computing Corporation, a Massachusetts corporation , and Concord Computing Corporation, a Delaware corporation *\n3(A) Certificate of Incorporation of Concord Computing Corporation, a Delaware corporation *\n3(B) Bylaws of Concord Computing Corporation, a Delaware corporation *\n3(C) Certificate of Merger of Concord Computing Corporation, a Massachusetts corporation, with and into Concord Computing Corporation, a Delaware corporation, filed with the Secretary of State of Delaware March 22, 1990 *\n3(D) Articles of Merger of Concord Computing Corporation, a Massachusetts corporation, with and into Concord Computing Corporation, a Delaware corporation, filed with the Secretary of State of Massachusetts March 22, 1990 *\n10 1993 Incentive Stock Option Plan (incorporated by reference from exhibit to the Registrant's Proxy Statement for the Annual Meeting of Shareholders held on May 12, 1993.)\n11 Statement Re: Computation of Per-share Earnings.\n22 List of Subsidiaries Jurisdiction of Company Organization Ownership Concord Computing Corp. Delaware 100% EFS National Bank National Bank Charter 100% Network EFT, Inc. Delaware 57% Concord Equipment Sales Tennessee 100%\n23 Consent of Independent Auditors\n* Incorporated by reference from exhibits to the Registrant's Amendment No. 1 to Form 10-Q for quarter ended March 31, 1990.\n(b) Reports on Form 8-K -- No reports on Form 8-K were filed during the quarter ended December 31, 1995.\n(c) Exhibits -- The response to this portion of Item 14 is submitted as a separate section of this report. (d) Financial Statement Schedules -- The response to this portion of Item 14 is submitted as a separate section of this report. ************************************************************************* For the purposes of complying with the amendments to the rules governing the 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 No's. 33-60871.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has fully caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nConcord EFS, Inc.\nBy:\/s\/ Dan M. Palmer Dan M. Palmer Chief Executive Officer Date: March 29, 1996\n\/s\/ Thomas J. Dowling Thomas J. Dowling 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.\nSignature Title Date - ---------------------------------------------------------------------- \/s\/ Dan M. Palmer Chairman of the Board and CEO March 29, 1996 Dan M. Palmer of the Company and EFS National Bank\n\/s\/ Edward A. Labry President of the Company and March 29, 1996 Edward A. Labry III EFS National Bank\n\/s\/ Richard M. Harter Director and Secretary of March 29, 1996 Richard M. Harter the Company\n\/s\/ David C. Anderson Director of the Company March 29, 1996 David C. Anderson\n\/s\/J. Richard Buchignani Director of the Company and March 29, 1996 J. Richard Buchignani EFS National Bank\n\/s\/ Joyce Kelso Director of the Company and March 29, 1996 Joyce Kelso EFS National Bank\n\/s\/ Jerry D. Mooney Director of the Company March 29, 1996 Jerry D. Mooney\n\/s\/Paul L. Whittington Director of the Company March 29, 1996 Paul L. Whittington","section_15":""}
{"filename":"701286_1995.txt","cik":"701286","year":"1995","section_1":"Item 1. BUSINESS (a) General Development of Business. Columbia Futures Fund (the \"Partnership\") is a New York limited partnership formed on December 24, 1981, to engage in the speculative trading of commodity futures contracts and other commodity interests. The Partnership commenced trading on July 15, 1983. The Partnership's net asset value per unit, as of December 31, 1995, was $1,938.89, representing an increase of 28.21 percent from the net asset value per unit of $1,512.26 at December 31, 1994. (b) Financial Information about Industry Segments. The Partnership's business comprises only one segment for financial reporting purposes, speculative trading of commodity futures contracts and other commodity interests. The relevant financial information is presented in Items 6 and 8. (c) Narrative Description of Business. The Partnership was formed to engage in speculative trading of futures contracts on domestic exchanges (including futures contracts in foreign currencies and financial instruments). (d) Financial Information About Foreign and Domestic Operations and Export Sales. The Partnership has not engaged in any operations in foreign countries; however, the Partnership (through the commodity broker) enters into forward contract transactions where foreign banks are the contracting party and futures contracts on foreign exchanges. Item 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES The executive and administrative offices are located within the offices of Dean Witter Reynolds Inc. (\"DWR\"). The DWR offices utilized by the Partnership are located at Two World Trade Center, 62nd Floor, New York, NY 10048.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS The general partner, Demeter Management Corporation (\"Demeter\"), is not aware of any material pending legal proceedings to which the Partnership is a party or to which any of its assets are subject. Item 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 PARTNERSHIP UNITS AND RELATED SECURITY HOLDER MATTERS\nThere is no established public trading market for the Units of Limited Partnership Interest in the Partnership. The number of holders of Units at December 31, 1995 was approximately 778. No distributions have been made by the Partnership since it commenced trading operations on July 15, 1983. Demeter has sole discretion to decide what distributions, if any, shall be made to investors in the Partnership. No determination has yet been made as to future distributions.\nItem 7.","section_6":"","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nLiquidity. The Partnership's assets are deposited in separate commodity trading accounts with DWR, the commodity broker, and are used by the Partnership as margin to engage in commodity futures contract trading. DWR holds such assets in either designated depositories or in securities approved by the Commodity Futures Trading Commission (\"CFTC\") for investment of customer funds. The Partnership's assets held by DWR may be used as margin solely for the Partnership's trading. Since the Partnership's sole purpose is to trade in commodity futures contracts and other commodity interests, it is expected that the Partnership will continue to own such liquid assets for margin purposes. The Partnership's investment in commodity futures contracts and other commodity interests may be illiquid. If the price for a futures contract for a particular commodity has increased or decreased by an amount equal to the \"daily limit\", positions in the commodity can neither be taken nor liquidated unless traders are willing to effect trades at or within the limit. Commodity futures prices have occasionally moved the daily limit for several consecutive days with little or no trading. Such market conditions could prevent the Partnership from promptly liquidating its commodity futures positions. There is no limitation on daily price moves in trading forward contracts on foreign currencies. The markets for some world currencies have low trading volume and are illiquid, which may prevent the Partnership from trading in potentially profitable markets or prevent the Partnership from promptly liquidating unfavorable positions in such markets and subjecting it to substantial losses. Either of these market conditions could result in restrictions on redemptions.\nMarket Risk. The Partnership trades futures, options and forward contracts in interest rates, stock indices, commodities and currencies. In entering into these contracts there exists a risk to the Partnership (market risk) that such contracts may be significantly influenced by market conditions, such as interest rate volatility, resulting in such contracts being less valuable. If the markets should move against all of the commodity interest positions held by the Partnership at the same time, and if the Trading Advisor was unable to offset commodity interest positions of the Partnership, the Partnership could lose all of its assets. The Partnership has established Trading Policies for liquidity and leverage which help control market risk. Both the Trading Advisor and Demeter monitor the Partnership's trading activities on a daily basis to ensure compliance with the Trading Policies. Demeter may (under terms of the Management Agreement) override the trading instructions of the Trading Advisor to the extent necessary to comply with the Partnership's Trading Policies. Credit Risk. In addition to market risk, the Partnership is subject to credit risk in that a counterparty may not be able to meet its obligations to the Partnership. The counterparty of the Partnership for futures contracts traded in the United States and most foreign exchanges on which the Partnership trades is the clearinghouse associated with such exchange. In general, clearinghouses are backed by the membership of the exchange and will act in the event of non-performance by one of its members or one of its members' customers, and as such, should significantly reduce this credit risk. In cases where the Partnership trades on exchanges where the clearinghouse is not backed by the membership or when the Partnership enters into off-exchange contracts with a counterparty, the sole recourse of the Partnership will be the\nclearinghouse or the counterparty as the case may be. With respect to futures contracts, DWR, in its business as an international commodity broker, constantly monitors the credit-worthiness of the exchanges and clearing members of the foreign exchanges with which it does business for clients, including the Partnership. If DWR believes that there was a problem with the credit-worthiness of an exchange on which the Partnership deals, it would so advise Demeter. With respect to forward contract trading, the Partnership trades with only those counterparties which Demeter, together with DWR, have determined to be creditworthy. As set forth in the Partnership's Trading Policies, in determining credit- worthiness, Demeter and DWR consult with the Corporate Credit Department of DWR. Currently, the Partnership deals solely with DWR as its counterparty on forward contracts. While DWR and Demeter monitor credit- worthiness and risk involved in dealing on the various exchanges and with counterparties, there can be no assurance that an exchange or counterparty will be able to meet its obligations to the Partnership. Capital Resources. The Partnership does not have, nor does it expect to have, any capital assets. Redemptions of additional Units in the future will impact the amount of funds available for investments in commodity futures, forward contracts on foreign currencies and other commodity interests in subsequent periods. As redemptions are at the discretion of Limited Partners, it is not possible to estimate the amount and therefore, the impact of future redemptions. Results of Operations. As of December 31, 1995, the Partnership's total capital was $7,687,670, an increase of $1,107,723 from the Partnership's total capital of $6,579,947 at December 31, 1994. For the year ended December 31, 1995, the Partnership generated net income of $1,815,259 and total redemptions aggregated $707,536.\nFor the year ended December 31, 1995, the Partnership's total trading revenues including interest income were $2,756,685. The Partnership's total expenses for the year were $941,426, resulting in net income of $1,815,259. The value of an individual unit in the Partnership increased from $1,512.26 at December 31, 1994 to $1,938.89 at December 31, 1995. As of December 31, 1994, the Partnership's total capital was $6,579,947, a decrease of $1,218,600 from the Partnership's total capital of $7,798,547 at December 31, 1993. For the year ended December 31, 1994, the Partnership generated a net loss of $404,752 and total redemptions aggregated $813,848. For the year ended December 31, 1994, the Partnership's total trading revenues including interest income were $482,814. The Partnership's total expenses for the year were $887,566, resulting in a net loss of $404,752. The value of an individual unit in the Partnership decreased from $1,604.44 at December 31, 1993 to $1,512.26 at December 31, 1994.\nAs of December 31, 1993, the Partnership's total capital was $7,798,547, an increase of $331,648 from the Partnership's total capital of $7,466,899 at December 31, 1992. For the year ended December 31, 1993, the Partnership generated net income of $1,024,820 and total redemptions aggregated $693,172. For the year ended December 31, 1993, the Partnership's total trading revenues including interest income were $1,994,437. The Partnership's total expenses for the period were $969,617, resulting in net income of $1,024,820. The value of an individual unit in the Partnership increased from $1,403.01 at December 31, 1992 to $1,604.44 at December 31, 1993.\nThe Partnership's overall performance record represents varied results of trading in different commodity markets. For a further description of trading results, refer to the letter to the Limited Partners in the accompanying 1995 Annual Report to Partners, incorporated by reference in this Form 10-K. The Partnership's gains and losses are allocated among its Limited Partners for income tax purposes.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The information required by this Item appears in the attached 1995 Annual Report to Partners and is incorporated by reference in this Annual Report on Form 10-K. Item 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS OF THE REGISTRANT\nGeneral Partner Demeter, a Delaware corporation, was formed on August 18, 1977 to act as a commodity pool operator and is registered with the CFTC as a commodity pool operator and currently is a member of the National Futures Association (\"NFA\") in such capacity. Demeter is wholly-owned by Dean Witter, Discover & Co. (\"DWD\") and is an affiliate of DWR. DWD, DWR and Demeter may each be deemed to be \"promoters\" and\/or a \"parent\" of the Partnership within the meaning of the federal securities laws. Dean Witter Reynolds Inc. DWR is a financial services company which provides to its individual, corporate and institutional clients services as a broker in securities and commodity interest contracts, a dealer in corporate, municipal and government securities, an investment banker, an investment adviser and an agent in the sale of life insurance and various other products and services. DWR is a member firm of the New York Stock Exchange, the American Stock Exchange, the Chicago Board Options Exchange, and other major securities exchanges, and is a clearing member of the Chicago Board of Trade, the Chicago Mercantile Exchange, the Commodity Exchange Inc., and other major commodities exchanges. DWR is registered with the CFTC as a futures commission merchant and is a member of the NFA in such capacity. DWR is currently servicing its clients through a network of 350 branch offices with approximately 8,500 account executives servicing individual and institutional client accounts.\nDirectors and Officers of the General Partner The directors and officers of Demeter as of December 31, 1995 are as follows: Richard M. DeMartini, age 43, is the Chairman of the Board and a Director of Demeter. Mr. DeMartini is also the Chairman of the Board and a Director of Dean Witter Futures & Currency Management Inc. (\"DWFCM\"), a registered commodity trading advisor. Mr. DeMartini has served as President and Chief Operating Officer of Dean Witter Capital, a division of DWR since January 1989. From January 1988 until January 1989, Mr. DeMartini served as President and Chief Operating Officer of the Consumer Banking Division of DWD, and from May 1985 until January 1988 was President and Chief Executive Officer of the Consumer Markets Division of DWD. Mr. DeMartini currently serves as a Director of DWD and DWR, and has served as an officer of DWR for the past five years. Mr. DeMartini has been with DWD and its affiliates for 18 years. While Mr. DeMartini has extensive experience in the securities industry, he has no experience in commodity interests trading. Mark J. Hawley, age 52, is President and a Director of Demeter. Mr. Hawley joined DWR in February 1989 as Senior Vice President and Director of DWR's Managed Futures and Precious Metals Department. Mr. Hawley also serves as President of DWFCM. From 1978 to 1989, Mr. Hawley was a member of the senior management team at Heinold Asset Management, Inc., a commodity pool operator, and was responsible for a variety of projects in public futures funds. From 1972 to 1978, Mr. Hawley was a Vice President in charge of institutional block trading for the Mid-West at Kuhn Loeb & Co. Lawrence Volpe, age 48, is a Director of Demeter and DWFCM. Mr. Volpe joined DWR as a Senior Vice President and Controller in September\n1983, and currently holds those positions. From July 1979 to September 1983, he was associated with E.F. Hutton & Company Inc. and prior to his departure, held the positions of First Vice President and Assistant Controller. From 1970 to July 1979, he was associated with Arthur Anderson & Co. and prior to his departure he served as audit manager in the financial services division. Joseph G. Siniscalchi, age 50, is a Director of Demeter. Mr. Siniscalchi joined DWR in July 1984 as a First Vice President, Director of General Accounting. He is currently Senior Vice President and Controller of the Financial Markets Division of DWR. From February 1980 to July 1984, Mr. Siniscalchi was Director of Internal Audit at Lehman Brothers Kuhn Loeb, Inc. Laurence E. Mollner, age 54, is a Director of Demeter. Mr. Mollner joined DWR in May 1979 as Vice President and Director of Commercial Sales. He is currently Executive Vice President and Deputy Director of the Futures Markets Division of DWR. Edward C. Oelsner III, age 53, is a Director of Demeter. Mr. Oelsner joined DWR in March 1981 as a Managing Director in the Corporate Finance Department. He currently manages DWR's Retail Products Group within the Corporate Finance Department. While Mr. Oelsner has extensive experience in the securities industry, he has no experience in commodity interests trading. Robert E. Murray, age 35, is a Director of Demeter. Mr. Murray is currently a First Vice President of the DWR Managed Futures Division and is a Director and the Senior Administrative Officer of DWFCM. Mr. Murray graduated from Geneseo State University in May 1983 with a B.A. degree in Finance. Mr. Murray began at DWR in 1984 and is currently the Director of Product Development for the Managed Futures Division and is responsible\nfor the development and maintenance of the proprietary Fund Management System utilized by Demeter and DWFCM for organizing information and producing reports for monitoring investors' accounts. Patti L. Behnke, age 35, is Vice President and Chief Financial Officer of Demeter. Ms. Behnke joined DWR in 1991 as Assistant Vice President of Financial Reporting and is currently First Vice President and Director of Financial Reporting and Managed Futures Accounting in the Capital Markets division of DWR. From August 1988 to September 1990, Ms. Behnke was Assistant Controller of L.F. Rothschild & Co. and from September 1986 to August 1988, she was associated with Carteret Savings Bank as Assistant Vice President - Financial Analysis. From April 1982 to September 1986, Ms. Behnke was an auditor at Arthur Andersen & Co. Item 11.","section_11":"Item 11. EXECUTIVE COMPENSATION The Partnership has no directors and executive officers. As a limited partnership, the business of the Partnership is managed by Demeter which is responsible for the administration of the business affairs of the Partnership but receives no compensation for such services. Item 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT (a) Security Ownership of Certain Beneficial Owners - As of December 31, 1995 there were no persons as beneficial owners of more than 5 percent of the Units of Limited Partnership Interest in the Partnership. (b) Security Ownership of Management - At December 31, 1995, Demeter owned 100 Units of General Partnership Interest in the Partnership representing a 2.52 percent interest in the Partnership. (c) Changes in Control - None\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Refer to Note 2 - \"Related Party Transactions\" of \"Notes to Financial Statements\", in the accompanying 1995 Annual Report to Partners, incorporated by reference in this Form 10-K. In its capacity as the Partnership's retail commodity broker, DWR received commodity brokerage commissions (paid and accrued by the Partnership) of $361,179 for the year\nended December 31, 1995.\nPART IV Item 14.","section_14":"Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORT ON FORM 8-K (a) 1. Listing of Financial Statements The following financial statements and reports of independent accountants, all appearing in the accompanying 1995 Annual Report to Partners, are incorporated by reference in this Form 10-K: - Report of Deloitte & Touche LLP, independent auditors, for the years ended December 31, 1995, 1994 and 1993.\n- Statements of Financial Condition as of December 31, 1995 and 1994.\n- Statements of Operations, Changes in Partners' Capital, and Cash Flows for the years ended December 31, 1995, 1994 and 1993.\n- Notes to Financial Statements. With exception of the aforementioned information and the information incorporated in Items 7, 8, and 13, the 1995 Annual Report to Partners is not deemed to be filed with this report. 2. Listing of Financial Statement Schedules No financial statement schedules are required to be filed with this report. (b) Reports on Form 8-K No reports on Form 8-K have been filed by the Partnership during the last quarter of the period covered by this report. (c) Exhibits Refer to Exhibit Index on Page E-1.\nSIGNATURES\nPursuant to the requirement 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.\nCOLUMBIA FUTURES FUND (Registrant)\nBY: Demeter Management Corporation, General Partner\nMarch 21, 1996 BY: \/s\/ Mark J. Hawley Mark J. Hawley, 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.\nDemeter Management Corporation.\nBY: \/s\/ Mark J. Hawley March 21, 1996 Mark J. Hawley, Director and President\n\/s\/ Richard M. DeMartini March 21, 1996 Richard M. DeMartini, Director and Chairman of the Board\n\/s\/ Lawrence Volpe March 21, 1996 Lawrence Volpe, Director\n\/s\/ Laurence E. Mollner March 21, 1996 Laurence E. Mollner, Director\n\/s\/ Joseph G. Siniscalchi March 21, 1996 Joseph G. Siniscalchi, Director\n\/s\/ Edward C. Oelsner III March 21, 1996 Edward C. Oelsner III, Director\n\/s\/ Robert E. Murray March 21, 1996 Robert E. Murray, Director\n\/s\/ Patti L. Behnke March 21, 1996 Patti L. Behnke, Chief Financial Officer\nEXHIBIT INDEX\nItem METHOD OF FILING\n- - 3. Amendment to Limited Partnership (1) Agreement of Columbia Futures Fund, dated as of February 14, 1985.\n- -10. Advisory Agreement among the Partnership, (2) Demeter Management Corporation, and John W. Henry & Co., Inc. dated as of January 20, 1987.\n- -10. December 31, 1995 Annual Report to Limited Partners. (3)\n(1) Incorporated by reference to Exhibit 3.01 of the Partnership's Annual Report on Form 10-K for the fiscal year ended December 31, 1985.\n(2) Incorporated by reference to Exhibit 10.03 of the Partnership's Annual Report on Form 10-K for the fiscal year ended December 31, 1986.\n(3) Filed herewith.\nE-1\nColumbia Futures Fund\nDecember 31, 1995 Annual Report\n[LOGO] DEAN WITTER\nDEAN WITTER Two World Trade Center 62nd Floor New York, NY 10048 Telephone (212) 392-8899\nCOLUMBIA FUTURES FUND ANNUAL REPORT\nDear Limited Partner:\nThis marks the thirteenth annual report for the Columbia Futures Fund (the \"Fund\"). This is the eleventh report filed by Demeter Management Corporation, the Fund's General Partner since February 1985. The Fund began the year trading at a Net Asset Value per Unit of $1,512.26 and finished 1995 at a Net Asset Value per Unit of $1,938.89, an increase of 28.2%. Since its inception in 1983, the Fund has increased by 98.2% (a compound annualized return of 5.6%).\nThe Fund recorded gains during the first quarter as a result of a strong upward trend in the value of the Japanese yen relative to the U.S. dollar during February and March. Additionally, trading in the financial futures and energy markets during February and March resulted in profit from the Fund's long positions in U.S. interest rate futures, as well as in long positions in crude oil futures. Smaller trading gains were recorded in soft commodities from cotton futures trading. Trading losses recorded during January as a result of trend reversals in the currency markets, coupled with erratic price movement in a majority of the other markets traded, offset a small portion of the overall Fund gains recorded during the first quarter.\nThe second quarter began with trading gains in April as a result of a continued upward move in the value of the Japanese yen relative to the U.S. dollar. Continued strengthening in global bond futures also contributed to gains recorded in April. The value of the U.S. dollar, which had been declining versus the Japanese yen and other\nworld currencies, moved higher causing losses for the Fund's previously established Japanese yen and European currency positions during May. Small trading losses were recorded in June as losses experienced in the financial futures markets, coupled with losses in the currency, agricultural and metals markets, more than offset trading gains in the energy and soft commodities markets.\nThe Fund's only negative performance quarter during 1995 was the result of trendless and volatile price movement in a majority of the markets traded by the Fund. The majority of the losses in July were recorded in global stock index futures and U.S. interest rate futures. Trading losses in the soft commodities and base metals markets during August resulted in losses for the Fund. A portion of these losses was offset by gains in the currency markets as the value of the Japanese yen decreased relative to the U.S. dollar. During September, losses were the result of a dramatic downward move in crude oil prices late in the month after moving higher during the first half of the month, and a sharp and extremely significant reversal in the upward trend of the U.S. dollar relative to major European currencies on September 20 and 21.\nUpward price trends in the financial futures and agricultural markets resulted in profits for the Fund's long positions in U.S. Treasury bond and Treasury note futures as well as in corn and soybean futures. Additional gains were recorded in the energy markets during the final quarter as a result of trading crude oil, unleaded gas and gas oil futures. Trading losses in the currency and metals markets offset a portion of the overall gains recorded during the fourth quarter.\nThe diversification of multiple John W. Henry & Co., Inc. trading portfolios and significant price trends in a number of the markets traded resulted in an overall strong\nyear for the Columbia Futures Fund. This diversity has benefited the Fund since John W. Henry & Co., Inc. took over as the Fund's sole Trading Advisor in 1988 and we believe it will continue to do so, given the opportunity of trending market conditions.\nShould you have any questions concerning this report, please feel free to contact Demeter Management Corporation at Two World Trade Center, 62nd Floor, New York, NY 10048, or your Dean Witter Account Executive.\nI hereby affirm, that to the best of my knowledge and belief, the information contained in this report is accurate and complete. Past performance is not a guarantee of future results.\nSincerely,\n\/s\/ Mark J. Hawley\nMark J. Hawley President Demeter Management Corporation General Partner\nCOLUMBIA FUTURES FUND INDEPENDENT AUDITORS' REPORT\nThe Limited Partners and the General Partner:\nWe have audited the accompanying statements of financial condition of Columbia Futures Fund (the \"Partnership\") as of December 31, 1995 and 1994 and the related statements of operations, changes in partners' capital, and cash flows for each of the three years in the period ended December 31, 1995. These financial statements are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, such financial statements present fairly, in all material respects, the financial position of Columbia Futures Fund as of December 31, 1995 and 1994 and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles.\n\/s\/ Deloitte & Touche LLP\nFebruary 21, 1996 New York, New York\nCOLUMBIA FUTURES FUND STATEMENTS OF FINANCIAL CONDITION\nThe accompanying notes are an integral part of these financial statements.\nCOLUMBIA FUTURES FUND STATEMENTS OF OPERATIONS\nSTATEMENT OF CHANGES IN PARTNERS' CAPITAL FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nThe accompanying notes are an integral part of these financial statements.\nCOLUMBIA FUTURES FUND STATEMENTS OF CASH FLOWS\nThe accompanying notes are an integral part of these financial statements.\nCOLUMBIA FUTURES FUND NOTES TO FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nORGANIZATION--Columbia Futures Fund (the \"Partnership\") is a limited partnership organized to engage in the speculative trading of commodity futures contracts and forward contracts on foreign currencies. The general partner for the Partnership is Demeter Management Corporation (the \"General Partner\"). The commodity broker is Dean Witter Reynolds Inc. (\"DWR\"). Both DWR and the General Partner are wholly-owned subsidiaries of Dean Witter, Discover & Co.\nThe General Partner is required to maintain a 1% minimum interest in the equity of the Partnership and income (losses) are shared by the General and Limited Partners based upon their proportional ownership interests.\nBASIS OF ACCOUNTING--The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts in the financial statements.\nREVENUE RECOGNITION--Commodity futures contracts and forward contracts on foreign currencies are open commitments until settlement date. They are valued at market and the resulting unrealized gains and losses are reflected in income. Monthly, DWR pays the Partnership interest income based upon 80% of the average equity at a rate equal to the average yield on 13-Week U.S. Treasury Bills issued during such month.\nNET INCOME (LOSS) PER UNIT--Net income (loss) per Unit is computed using the weighted average number of units outstanding during the period.\nEQUITY IN COMMODITY FUTURES TRADING ACCOUNTS--The Partnership's asset \"Equity in Commodity futures trading accounts\" consists of cash on deposit at DWR to be used as margin for trading and the net asset or liability related to unrealized gains or losses on open contracts. The asset or liability related to the unrealized gains or losses on forward contracts is presented as a net amount because the Partnership has a master netting agreement with DWR.\nBROKERAGE COMMISSIONS AND RELATED TRANSACTION FEES AND COSTS--Brokerage commissions are accrued at 80% of DWR's published non-member rates on a half- turn basis.\nThrough March 31, 1995, brokerage commissions were capped at 1% per month of the adjusted Net Assets allocated to each trading program employed by the Trading Manager.\nEffective April 1, 1995, the cap was reduced to 3\/4 of 1%.\nCOLUMBIA FUTURES FUND NOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nTransaction fees and costs are accrued on a half-turn basis.\nOPERATING EXPENSES--The Partnership bears all operating expenses related to its trading activities. These include filing fees, clerical, administrative, auditing, accounting, mailing, printing, and other incidental operating expenses as permitted by the Limited Partnership Agreement. In addition, the Partnership incurs a monthly management fee and may incur an incentive fee. The General Partner bears all other operating expenses.\nINCOME TAXES--No provision for income taxes has been made in the accompanying financial statements, as partners are individually responsible for reporting income or loss based upon their respective share of the Partnership's revenues and expenses for income tax purposes.\nDISTRIBUTIONS--Distributions, other than on redemptions of Units, are made on a pro-rata basis at the sole discretion of the General Partner. No distributions have been made to date.\nREDEMPTIONS--Limited Partners may redeem their Units as of the end of any calendar month upon ten days advance notice by redemption form to the General Partner.\nDISSOLUTION OF THE PARTNERSHIP--The Partnership will terminate on December 31, 2002 regardless of its financial condition at such time, unless the term is extended in accordance with the Limited Partnership Agreement, upon a decline in Net Assets to less than $250,000, a decline in the Net Asset Value Per Unit to less than $343.22, or under certain other circumstances as defined in the Limited Partnership Agreement.\n2. RELATED PARTY TRANSACTIONS\nThe Partnership pays brokerage commissions to DWR on trades executed on its behalf as described in Note 1. The Partnership's cash is on deposit with DWR in commodity trading accounts to meet margin requirements as needed. DWR pays interest on these funds as described in Note 1. For general administrative services performed for the Partnership, the General Partner receives a monthly administration fee which equals $1.50 per limited partner outstanding. For the years ended December 31, 1995, 1994 and 1993 the General Partner received $14,483, $15,888 and $17,288, respectively for such administrative services.\n3. TRADING MANAGER\nThe General Partner, on behalf of the Partnership, retains a commodity trading manager to make all\nCOLUMBIA FUTURES FUND NOTES TO FINANCIAL STATEMENTS--(CONTINUED)\ntrading decisions for the Partnership. Since January 22, 1988, John W. Henry & Co., Inc. has served as the sole trading manager.\nCompensation to the trading manager consists of a management fee and an incentive fee as follows:\nMANAGEMENT FEE--The management fee is accrued daily at the rate of 1\/3 of 1% per month of the Partnership's managed Net Assets at each month-end.\nINCENTIVE FEE--At the end of each quarter or upon redemption of a Partnership Unit, an incentive fee is assessed each Unit equal to 15 percent of the excess of the Unit value, excluding interest earned during the period, over the Unit value at the time immediately following the last incentive payment. Such incentive fee is accrued in each month in which new appreciation occurs. In those months in which new appreciation is negative, previous accruals, if any, during each fiscal quarter will be reduced.\n4. FINANCIAL INSTRUMENTS\nThe Partnership trades futures and forward contracts in interest rates, stock indices, commodities, currencies, petroleum, and precious metals. Futures and forwards represent contracts for delayed delivery of an instrument at a specified date and price. Risk arises from changes in the value of these contracts and the potential inability of counterparties to perform under the terms of the contracts. There are numerous factors which may significantly influence the market value of these contracts, including interest rate volatility. At December 31, 1995 and 1994 open contracts were:\nCOLUMBIA FUTURES FUND NOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nA portion of the amounts indicated as off-balance-sheet risk in forward foreign currency contracts is due to offsetting forward commitments to purchase and to sell the same currency on the same date in the future. These commitments are economically offsetting, but are not offset in the forward market until the settlement date.\nThe unrealized gains on open contracts are reported as a component of \"Equity in Commodity futures trading accounts\" on the Statements of Financial Condition and totaled $836,228 and $1,033,911 at December 31, 1995 and 1994, respectively.\nOf the $836,228 net unrealized gain on open contracts at December 31, 1995, $858,691 related to exchange-traded futures contracts and $(22,463) related to off-exchange-traded forward currency contracts. Of the $1,033,911 net unrealized gain on open contracts at December 31, 1994, $1,018,465 related to exchange-traded futures contracts and $15,446 related to off-exchange-traded forward currency contracts.\nExchange-traded futures contracts held by the Partnership at December 31, 1995 and 1994 mature through December 1996 and September 1995, respectively. Off- exchange-traded forward currency contracts held by the Partnership at December 31, 1995 and 1994 mature through January 1996 and March 1995, respectively. The contract amounts in the above table represent the Partnership's extent of involvement in the particular class of financial instrument, but not the credit risk associated with counterparty nonperformance. The credit risk associated with these instruments is limited to the amounts reflected in the Partnership's Statements of Financial Condition.\nThe Partnership also has credit risk because the sole counterparty, with respect to most of the Partnership's assets, is DWR. Exchange-traded futures contracts are marked to market on a daily basis, with variations in value settled on a daily basis. DWR, as the futures commission merchant for all of the Partnership's exchange-traded futures contracts, is required pursuant to regulations of the Commodity Futures Trading Commission to segregate from its own assets, and for the sole benefit of its commodity customers, all funds held by DWR with respect to exchange-traded futures contracts including an amount equal to the net unrealized gain on all open futures contracts, which funds totaled $7,887,165 and $6,652,308 at December 31, 1995 and 1994, respectively. With respect to the Partnership's off-exchange-traded forward currency contracts, there are no daily settlements of variations in value nor is there any requirement that an amount equal to the net unrealized gain on open\nCOLUMBIA FUTURES FUND NOTES TO FINANCIAL STATEMENTS--(CONCLUDED)\nforward contracts be segregated. With respect to those off-exchange-traded forward currency contracts, the Partnership is at risk to the ability of DWR, the counterparty on all of such contracts, to perform.\nFor the year ended December 31, 1995, the average fair value of financial instruments held for trading purposes was as follows:\nDEAN WITTER REYNOLDS INC. Two World Trade Center 62nd Floor New York, NY 10048\nFIRST-CLASS MAIL ZIP + 4 PRESORT U.S. POSTAGE PAID BROOKLYN, NY PERMIT NO. 148","section_15":""}
{"filename":"1002669_1995.txt","cik":"1002669","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"Item 2.\t\tProperties\n\tThe Issuer has no physical properties. The Equicon Mortgage Loan Trust, Series 1995-2 securities represent in the aggregate the entire beneficial ownership interest in a trust consisting primarily of a pool of fixed rate, amortizing mortgage loans and adjustable rate, amortizing mortgage loans which are secured by first or second liens on residential properties. We will furnish an Annual Statement of Compliance delivered by the Mortgage Servicer to the Trustee with respect to each Mortgage Servicer in t\nAnnual Statement of Compliance............................................ .............Not available currently. \t\t\t\t\t\tWill be subsequently filed on Form 10K\/A.\nItem 3.","section_3":"Item 3.\t\tLegal Proceedings\n\tNONE.\nItem 4.","section_4":"Item 4.\t\tSubmission of Matters to a Vote of Security Holders\n\tNo matters were submitted to a vote of holders of equity interest during the period covered by this report through the solicitation of proxies or otherwise.\nPART II\nItem 5.","section_5":"Item 5.\t\tMarket for the Registrant's Common Equity and Related Stockholder Matters.\n\tThe Issuer does not issue stock. Presently, there is no established trading market for the Trust's securities. The holders of the Equicon Mortgage Loan Trust, Series 1995-2 will be subquently filed on Form 10K\/A.\nItem 8.","section_6":"","section_7":"","section_7A":"","section_8":"Item 8.\t\tFinancial Statements and Supplementary Data.\nAnnual Statement of Compliance............................................. ...........Not available currently. \t\t\t\t\t\tWill be subsequently filed on Form 10K\/A.\nIndependent Accountant's Report on Servicer's \tServicing Activities..................................................... ...........Not available currently. \t\t\t\t\t\tWill be subsequently filed on Form 10K\/A.\nItem 9.","section_9":"Item 9.\t \tChanges In and Disagreement with Accountants on Accounting and Financial \t\t\t\tDisclosure.\n\t\tNONE\nPART III\nItem 12.","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"Item 12.\tSecurity Ownership of Certain Beneficial Owners and Management.\nSecurity Ownership of Certain Beneficial Owners............................ ............... Will be filed \t\t\t\t\t\t\t\t subsequently on Form 10K\/A.\nPART IV\nItem 14.","section_13":"","section_14":"Item 14.\tExhibits, Financial Statement Schedules and Reports on Form 8K\n\t(a) (1)\tFinancial Statements...............Annual Statement of Compliance and Independent \t\t\t\t\t\tAccountant's Report on Servicer's Servicing Activities are\t\t\t\t\t\tnot currrently available. Will be filed subsequently on \t\t\t\t\t\tForm 10K\/A.\n\t(a) (2)\tFinancial Statement Schedules\n\t\tNOT APPLICABLE\n\t(a) (3)\tExhibits \t \t\t*\tFiled with the SEC on the indicated dates.","section_15":""}
{"filename":"807862_1995.txt","cik":"807862","year":"1995","section_1":"ITEM 1. BUSINESS INTRODUCTION Flagstar Corporation (\"Flagstar\"), is one of the largest restaurant companies in the United States, operating (directly and through franchisees) more than 2,500 moderately priced restaurants. Flagstar's restaurant operations are conducted through four chains or concepts. Denny's is the nation's largest chain of family-oriented full service restaurants, with over 1,500 units in 49 states, Puerto Rico, and four foreign countries, including 508 in California and Florida. According to an independent survey conducted in 1995, Denny's has the leading share of the national market in the family segment. Hardee's is a chain of quick-service restaurants of which Flagstar, with 593 units located primarily in the Southeast, is the largest franchisee. Although specializing in sandwiches, Flagstar's Hardee's restaurants serve fresh fried chicken and offer a breakfast menu that accounts for approximately 42% of total sales and features the chain's famous \"made-from-scratch\" biscuits. Quincy's, with more than 200 locations, is one of the largest chains of family steakhouse restaurants in the southeastern United States, offering steak, chicken and seafood entrees as well as a buffet food bar, called the \"Country Sideboard.\" A weekend breakfast buffet is available at most Quincy's locations. Flagstar also operates El Pollo Loco, a chain of 217 quick-service restaurants featuring flame-broiled chicken and steak products and related Mexican food items, with a strong regional presence in California. Although operating in two distinct segments of the restaurant industry -- full-service and quick-service -- the Company's restaurants benefit from a single management strategy that emphasizes superior value and quality, friendly and attentive service and appealing facilities. During the past year, Flagstar remodeled 333 of its Company-owned restaurants and added a net of seven (both franchised and Company-owned) new restaurants to its chains (reflecting an increase of 82 franchised and international units offsetting a 75 unit decline in Company-owned restaurants). Incorporated in 1980, Flagstar is a wholly-owned subsidiary of Flagstar Companies, Inc. (\"FCI\"). FCI is a holding company that was organized in Delaware in 1988 in order to effect the acquisition of Flagstar in 1989. On November 16, 1992, FCI and Flagstar consummated the principal elements of a recapitalization (the \"Recapitalization\"), which included, among other things, an equity investment by TW Associates, L.P. (\"TW Associates\") and KKR Partners II, L.P. (\"KKR Partners II\") (collectively, \"Associates\"), partnerships affiliated with Kohlberg Kravis Roberts & Co. (\"KKR\"). As a result of such transactions, Associates acquired control of FCI and Flagstar. Prior to June 16, 1993, FCI and Flagstar had been known, respectively, as TW Holdings, Inc. and TW Services, Inc. As used herein, the term \"Company\" includes Flagstar and its subsidiaries, except as the context otherwise requires. As a result of the 1989 acquisition of Flagstar, the Company became and remains very highly leveraged. While the Company's cash flows have been, and are expected to continue to be, sufficient to cover interest costs, operating results since the acquisition in 1989 have fallen short of expectations. Such shortfalls have resulted from negative operating trends which are due to increased competition, intensive pressure on pricing due to discounting, declining customer traffic, adverse economic conditions, and relatively limited capital resources to respond to these changes. In the fourth quarter of 1993, management determined that the most likely projections of future results were those based on the assumption that these historical operating trends of each of the Company's restaurant concepts and of its now sold food and vending business would continue, and that such projected financial results of the Company would not support the carrying value of the remaining balance of goodwill and certain other intangible assets. Accordingly, such balances were written-off during 1993. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and Notes 1 and 3 to the Consolidated Financial Statements for additional information. These operating trends have generally continued through 1995. RESTAURANTS The Company believes its restaurant operations benefit from the diversity of the restaurant concepts represented by its four chains, the strong market positions and consumer recognition enjoyed by each of these chains, the benefits of a centralized support system for purchasing, menu development, human resources, management information systems, site selection, restaurant design and construction, and an aggressive new management team. The Company owns or has rights in all trademarks it believes are material to its restaurant operations. Denny's and Quincy's may benefit from the demographic trend of aging baby boomers and the growing population of elderly persons. The largest percentage of \"family style\" customers comes from the 35 and up age group. The Company expects its chain of Hardee's restaurants to maintain a strong market position in the Southeast.\nDuring the fourth quarter of 1993, the Company approved a restructuring plan for its restaurant concepts which included the following key features: (1) the identification of units for sale, closure or conversion to another concept; (2) changes to the field management structure to eliminate a layer of management and increase the regional managers' \"span of control\"; and (3) consolidation of certain Company operations and elimination of overhead positions in the field and in certain of its corporate functions. The restructuring charge reflected in the Company's 1993 Consolidated Financial Statements consisted primarily of the write-down in the carrying value of assets referred to in (1) above and severance and relocation costs associated with (2) and (3) above. As of December 31, 1995, the Company had closed or sold 69 restaurant units referred to in (1) above and intends to close or dispose of an additional 17 units generally in 1996. Management intends to operate the remaining units. As of December 31, 1995, substantially all of the incremental changes relating to (2) and (3) above had been completed. During 1995, the Company identified 36 underperforming units for sale or closure generally during 1996. The carrying value of these units have been written-down to estimated fair value based on sales of similar units or other estimates of selling price, less cost to sell. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and Notes 1, 2, and 3 to the Consolidated Financial Statements for additional information. DENNY'S\n(1) Includes distribution and processing operations. The distribution operations were sold September 8, 1995. (2) Operating income reflects the write-off of goodwill and certain other intangible assets and the provision for restructuring charges of $716 million for the year ended December 31, 1993. For a discussion of the write-off and restructuring and the reasons therefor, see \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and Notes 1 and 3 to the Consolidated Financial Statements. (3) Operating income reflects a provision for restructuring of $5 million and a charge for impaired assets of $24 million for the year ended December 31, 1995. For a discussion of the provision for restructuring and charge for impaired assets, see \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and Notes 1 and 2 to the Consolidated Financial Statements. (4) Amount is calculated on an average unit sales basis for owned\/operated units. Denny's is the largest full-service family restaurant chain in the United States in terms of both number of units and total revenues and, according to an independent survey conducted in 1995 by Consumer Reports on Eating Share Trends (CREST), an industry market research firm, Denny's has the leading share of the national market in the family segment. Denny's restaurants currently operate in 49 states, Puerto Rico, and four foreign countries, with principal concentrations in California, Florida, Texas, Arizona, Washington, Ohio, Illinois, and Pennsylvania. Denny's restaurants are designed to provide a casual dining atmosphere with moderately priced food and quick, efficient service to a broad spectrum of customers. The restaurants generally are open 24 hours a day, seven days a week. All Denny's restaurants have uniform menus (with some regional and seasonal variations) offering traditional family fare (including breakfast, steaks, seafood, hamburgers, chicken and sandwiches) and provide both counter and table service for breakfast, lunch and dinner as well as a \"late night\" menu. The Company acquired the Denny's chain in September 1987. Since the acquisition, the Company has reduced corporate level overhead (including through the relocation of key operating personnel to the Company's Spartanburg, South Carolina headquarters), accelerated Denny's remodeling program, added point-of-sale (\"POS\") systems to the chain's restaurants, simplified the menu and created new advertising and marketing programs. In 1994, the Company began to implement a \"reimaging\" strategy intended to result in a fundamental change in the competitive positioning of Denny's. This reimaging strategy involved all restaurants within a market area and included an updated exterior look, new signage, an improved interior layout with more comfortable seating and enhanced lighting. Reimaging also included a new menu, new menu offerings, new uniforms, and enhanced dessert offerings, including in\nsome markets Baskin-Robbins(Register mark) ice cream. The Company completed the reimaging of 306 restaurant units during 1994 and 1995. During 1995 management curtailed the efforts of its reimaging program in order to focus its attention on programs specifically designed at improving customer service, restaurant efficiency, and value positioning. In 1996, the Company plans to complete limited exterior refurbishments to enhance the curb appeal of the remaining 627 Company-owned restaurants. To achieve improvements in customer service and restaurant efficiency, Denny's introduced the \"Managing Partners Program\" during the fourth quarter of 1995. Under this program, a managing partner will typically have full accountability for three to five restaurants and report directly to the president of Denny's. Managing partners will be compensated for improving customer service and running their restaurants efficiently. This program is expected to provide additional support to the restaurants by flattening the organizational structure and creating more open communications between the restaurants and Denny's senior management. The Company's POS system provides hourly sales reports, cash control and marketing data and information regarding product volumes. POS systems provide guest traffic information for labor scheduling, provide information to evaluate more effectively the impact of menu changes on sales, and reduce the paperwork of managers. Marketing initiatives in 1996 will focus on the positioning of Denny's as the price value leader within its segment, offering value menus at breakfast and lunch through its tiered menu items priced at $1.99, $2.99, $3.99, and $4.99. The Company rolled-out its value menu system-wide in January 1996. These promotions are designed to capitalize on the strong public recognition of the Denny's name. The Company intends to open relatively few Company-owned Denny's restaurants and to expand its franchising efforts in 1996 in order to increase its market share, establish a presence in new areas and further penetrate existing markets. To accelerate the franchise expansion, the Company will identify units to sell to franchisees which are not part of its growth strategy for Company-owned Denny's units. As of December 31, 1995, 15 units have been identified for sale or closure generally during 1996. The field management infrastructures established to serve the existing Denny's system are expected to provide sufficient support for additional units with moderate incremental expense. Expanded franchising also will permit the Company to exploit smaller markets where a franchisee's ties to the local community are advantageous. During 1995, the Company added a net of 84 new Denny's franchises, of which 36 units were previously owned by the Company, bringing total franchised units to 596, or 38% of all Denny's restaurants. The initial fee for a single Denny's franchise is $35,000, and the current royalty payment is 4% of gross sales. In 1995, Denny's realized $47.7 million of revenues from franchising. Franchisees also purchase food and supplies from a Company subsidiary. HARDEE'S\n(1) Operating income reflects the write-off of goodwill and certain other intangible assets and the provision for restructuring charges of $260 million for the year ended December 31, 1993. For a discussion of the write-off and restructuring and the reasons therefor, see \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and Notes 1 and 3 to the Consolidated Financial Statements. (2) Operating income reflects a provision for restructuring of $8 million and a charge for impaired assets of $24 million for the year ended December 31, 1995. For a discussion of the provision for restructuring and charge for impaired assets see \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and Notes 1 and 2 to the Consolidated Financial Statements. (3) Amount is calculated on an average unit sales basis. The Company's Hardee's restaurants are operated under licenses from Hardee's Food Systems, Inc. (\"HFS\"). The Company is HFS' largest franchisee, operating 17% of Hardee's restaurants nationwide. HFS is the fifth largest sandwich chain in the United States based on national systemwide sales. Of the 593 Hardee's restaurants operated by the Company at December 31, 1995, 572 were located in ten southeastern states. The Company's Hardee's restaurants provide uniform menus in a quick-service format targeted to a broad spectrum of customers. The restaurants offer hamburgers, chicken,\nroast beef and fish sandwiches, hot dogs, salads and low-fat yogurt, as well as a breakfast menu featuring Hardee's popular \"made-from-scratch\" biscuits. To add variety to its menu, further differentiate its restaurants from those of its major competitors and increase customer traffic during the traditionally slower late afternoon and evening periods, HFS added fresh fried chicken as a menu item in a number of its restaurants beginning in 1991. The Company accelerated the introduction of fresh fried chicken as a regular menu item during 1992 and completed the rollout in 1993. Substantially all of the Company's Hardee's restaurants have drive-thru facilities, which provided 52% of the chain's revenues in 1995. Most of the restaurants are open 18 hours a day, seven days a week. Operating hours of selected units have been extended to 24 hours a day, primarily on weekends. Hardee's breakfast menu, featuring the chain's signature \"made-from-scratch\" biscuits, accounts for approximately 42% of total sales at the Company's Hardee's restaurants. Each Hardee's restaurant is operated under a separate license from HFS. Each license grants the exclusive right, in exchange for a franchise fee, royalty payments and certain covenants, to operate a Hardee's restaurant in a described territory, generally a town or an area measured by a radius from the restaurant site. Each license has a term of 20 years from the date the restaurant is first opened for business and is non-cancellable by HFS, except for the Company's failure to abide by its covenants. Earlier issued license agreements are renewable under HFS' renewal policy; more recent license agreements provide for successive five-year renewals upon expiration, generally at rates then in effect for new licenses. A number of the Company's licenses are scheduled for renewal. The Company has historically experienced no difficulty in obtaining such renewals and does not anticipate any problems in the future. The Company's territorial development agreement with HFS which called for the Company to open a specified number of Hardee's restaurants in a development territory in the Southeast (and certain adjacent areas) by the end of 1996 was terminated during the fourth quarter of 1995. Termination of such agreement makes the Company's development rights non-exclusive in the development territory. As a result, other Hardee's franchisees along with the Company are permitted to open Hardee's restaurants in such territory. During 1995, the Company experienced an 8.6% decline in comparable store sales at its Hardee's restaurants due to continued promotions and discounting by quick-service competitors. In an effort to reverse these negative trends, the Company has taken a variety of steps, including the introduction of the new $0.79 Big Value Menu, as well as, the engagement of a new advertising agency to create and enhance advertising for the value pricing and other Hardee's programs. In addition, the Company is currently working together with HFS and other large franchisees to develop a brand positioning which will better differentiate Hardee's in the marketplace. As of December 31, 1995, 26 units have been identified for sale or closure generally during 1996. QUINCY'S\n(1) Operating income reflects the write-off of goodwill and certain other intangible assets and the provision for restructuring charges of $164 million for the year ended December 31, 1993. For a discussion of the write-off and restructuring and the reasons therefor, see \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and Notes 1 and 3 to the Consolidated Financial Statements. (2) Operating income reflects a charge for impaired assets of $3 million for the year ended December 31, 1995. For a discussion of the charge for impaired assets see \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and Notes 1 and 2 to the Consolidatd Financial Statements. (3) Amount is calculated on an average unit sales basis. Ranked by 1995 sales, Quincy's is the sixth largest family steakhouse (grill buffet) chain in the country and one of the largest such chains in the southeastern United States. The Quincy's chain consists of 203 Company-owned restaurants at December 31, 1995 which are designed to provide families with limited-service dining at moderate prices. All Quincy's are open seven days a week for lunch and dinner. The restaurants serve steak, chicken and seafood entrees along with a buffet-style food bar, called the \"Country Sideboard,\" offering hot foods, soups, salads and desserts. In addition, weekend breakfast service, which is available at most locations, allows Quincy's to utilize its asset base more efficiently.\nDuring 1995, the Company continued its reimaging program at Quincy's with a total of 35 restaurant units reimaged. After experimenting with a number of formats at Quincy's during the years 1993 through 1995, including enhancements to the scatter bar buffet and a few buffet only restaurants, the Company has concluded that it can achieve its greatest success with Quincy's by moving away from the low margin buffet concept and repositioning itself with a simpler menu which emphasizes \"value-steak.\" As of December 31, 1995, 4 units have been identified for sale or closure generally during 1996. EL POLLO LOCO\n(1) Operating income reflects the write-off of goodwill and certain other intangible assets and the provision for restructuring charges of $126 million for the year ended December 31, 1993. For a discussion of the write-off and restructuring and reasons therefor, see \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and Notes 1 and 3 to the Consolidated Financial Statements. (2) Amount is based on an average unit sales basis for owned\/operated units. El Pollo Loco is the leading chain in the quick-service segment of the restaurant industry to specialize in flame-broiled chicken. Approximately 91% of these restaurants are located in Southern California. El Pollo Loco directs its marketing at customers desiring an alternative to other fast food products. The Company's El Pollo Loco restaurants are designed to facilitate customer viewing of the preparation of the flame-broiled chicken. El Pollo Loco restaurants generally are open 12 hours a day, seven days per week. El Pollo Loco restaurants feature a limited, but expanding menu highlighted by marinated flame-broiled chicken and steak products and related Mexican food items. Since 1993, the Company has been able to increase average annual unit sales at its El Pollo Loco restaurants by over 10%. Much of its recent progress can be attributed to the remodels of units, successful menu positioning, and dual branding of the Foster's Freeze dessert line. During 1995, the Company remodeled 57 of its Company-owned El Pollo Loco units. As of December 31, 1995, 8 units have been identified for sale or closure generally during 1996. Based on El Pollo Loco's recent success, the Company is optimistic about future expansion of the El Pollo Loco concept, principally through franchising in Texas and in other California markets. By the year 2000, the Company hopes to add as many as 250 additional El Pollo Loco restaurant units. In the first quarter of 1996, the Company secured the international rights to the El Pollo Loco brand to facilitate expansion opportunities in Mexico and other countries. OPERATIONS The Company believes that successful execution of basic restaurant operations in each of its restaurant chains is critical to its success. Accordingly, significant effort is devoted to ensuring that all restaurants offer quality food and service. Through a network of division leaders, region leaders, district leaders and restaurant managers, the Company standardizes specifications for the preparation and efficient service of quality food, the maintenance and repair of its premises and the appearance and conduct of its employees. Major emphasis is placed on the proper preparation and delivery of the product to the consumer and on the cost-effective procurement and distribution of quality products. A principal feature of the Company's restaurant operations is the constant focus on improving operations at the unit level. Unit managers are especially hands-on and versatile in their supervisory activities. Region and district leaders have no offices and spend substantially all of their time in the restaurants. A significant majority of restaurant management personnel began as hourly employees in the restaurants and therefore perform restaurant functions and train by example. The Company benefits from an experienced management team.\nEach of the Company's restaurant chains maintains training programs for employees and restaurant managers. Restaurant managers and assistant managers receive training at specially designated training units. Areas of training for managers include customer interaction, kitchen management and food preparation, data processing and cost control techniques, equipment and building maintenance and leadership skills. Video training tapes demonstrating various restaurant job functions are located at each restaurant location and are viewed by employees prior to a change in job function or utilizing new equipment or procedures. Each of the Company's restaurant chains continuously evaluates its menu. New products are developed in Company test kitchens and then introduced in selected restaurants to determine customer response and to ensure that consistency, quality standards and profitability are maintained. If a new item proves successful at the research and development level, it is usually tested in selected markets, both with and without market support. A successful menu item is then incorporated into the restaurant system. In the case of the Hardee's restaurants, menu development is coordinated through HFS. Financial and management control of the Company's restaurants is facilitated by the use of POS systems. Detailed sales reports, payroll data and periodic inventory information are transmitted to the Company for management review. These systems economically collect accounting data and enhance the Company's ability to control and manage these restaurant operations. Such systems are in use in all of the Company's Denny's, Hardee's, Quincy's and El Pollo Loco restaurants. The Company also operates a food-processing facility in Texas which supplies beef, pork sausage, soup and many other food products currently used by the Company's restaurants. Food and packaging products for the Company's Hardee's restaurants are purchased from HFS and independent suppliers approved by HFS. A substantial portion of the products for the Company's Hardee's and Quincy's restaurants is obtained from MBM Corporation (\"MBM\"), an independent supplier\/distributor. In connection with the 1995 sale of its distribution subsidiary, Proficient Food Company (\"PFC\"), to MBM, the Company entered into new long-term supply contracts with MBM for the supply of products to its Hardee's and Quincy's units and with PFC for the supply of products to Denny's and El Pollo Loco. Adequate alternative sources of supply for required items are believed to be available. ADVERTISING Denny's primarily relies upon national and regional television and radio advertising. Advertising expenses for Denny's restaurants were $49.2 million for 1995, representing approximately 2.6% of Denny's system-wide restaurant sales. Individual restaurants are also given the discretion to conduct local advertising campaigns. In accordance with HFS licensing agreements, the Company spent approximately 6.8% of Hardee's total gross sales on marketing and advertising during 1995. Of this amount, approximately 2.1% of total gross sales is contributed to media cooperatives and HFS' national advertising fund. The balance is directed by the Company on local levels. HFS engages in substantial advertising and promotional activities to maintain and enhance the Hardee's system and image. The Company participates with HFS in planning promotions and television support for the Company's primary markets and engages in local radio, outdoor and print advertising for its Hardee's operations. The Company, together with a regional advertising agency, advertises its Quincy's restaurants primarily through television, print, radio and billboards. In addition, Quincy's has focused on in-store promotions. The Company spent approximately 5.1% of Quincy's gross sales on Quincy's marketing in 1995. During 1995, El Pollo Loco spent approximately 5.1% of its system-wide restaurant sales on advertising, primarily through regional television, radio, and print media in its market areas. SITE SELECTION The success of any restaurant depends, to a large extent, on its location. The site selection process for Company-owned restaurants consists of three main phases: strategic planning, site identification and detailed site review. The planning phase ensures that restaurants are located in strategic markets. In the site identification phase, the major trade areas within a market area are analyzed and a potential site identified. The final and most time consuming phase is the detailed site review. In this phase, the site's demographics, traffic and pedestrian counts, visibility, building constraints and competition are studied in detail. A detailed budget and return on investment analysis are also completed. The Company considers its site selection standards and procedures to be rigorous and will not compromise those standards or procedures in order to achieve accelerated growth.\nCOMPETITION According to the National Restaurant Association, in the past five years, the total food service industry experienced annual real growth of approximately 1.8%. The restaurant industry not only competes within the food consumed away from home segment of the food industry, but also with sources of food consumed at home. In order to grow at a real growth rate in excess of 1.8%, the Company's restaurant concepts must take market share from other competing restaurant and non-restaurant food sources. The restaurant industry can be divided into three main categories: full-service restaurants, quick-service restaurants, and other miscellaneous establishments. Since the early 1970s, growth in eating places has been driven primarily by quick-service restaurants. On a segment-wide basis, the full-service and quick-service restaurants currently have approximately the same revenues and an equal share of the market. Full-service restaurants include the mid-scale (family-style and family-steak), casual dining and upscale (fine dining) segments. The mid-scale segment, which includes Denny's and Quincy's, is characterized by complete meals, menu variety and moderate prices ($4-$7 average check), and includes a small number of national chains, many local and regional chains, and thousands of independent operators. The casual dining segment, which typically has higher menu prices ($8-$16 average check) and availability of alcoholic beverages, primarily consists of regional chains and small independents. The quick-service segment, which includes Hardee's and El Pollo Loco, is characterized by low prices ($3-$5 average check), finger foods, fast service, and convenience. Large sandwich, pizza, and chicken chains overwhelmingly dominate the quick-service segment. The restaurant industry is highly competitive and affected by many factors, including changes in economic conditions affecting consumer spending, changes in socio-demographic characteristics of areas in which restaurants are located, changes in customer tastes and preferences and increases in the number of restaurants generally and in particular areas. Competition among a few major companies that own or operate quick-service restaurant chains is especially intense. Restaurants, particularly those in the quick-service segment, compete on the basis of name recognition and advertising, the quality and perceived value of their food offerings, the quality and speed of their service, the attractiveness of their facilities and, to a large degree in a recessionary environment, price and perceived value. Denny's, which has a strong national presence, competes primarily with regional family chains such as Big Boy, Shoney's, Friendly's, Perkins and Cracker Barrel -- all of which are ranked among the top six midscale restaurant chains. According to an independent survey conducted during 1995, Denny's had a 14.5% share of the national market in the family segment. Hardee's restaurants compete principally with four other national fast-food chains: McDonald's, Burger King, Wendy's and Taco Bell. In addition, Hardee's restaurants compete with quick-service restaurants serving other kinds of foods, such as chicken outlets (e.g., KFC and Bojangles), family restaurants (e.g., Shoney's and Friendly's) and dinner houses. Management believes that Hardee's has the highest breakfast sales per unit of any major quick-service restaurant chain. According to an independent survey conducted during 1995, Hardee's had a 17.1% share of the Southeast market in the hamburger segment. Quincy's primary competitors include Ryan's and Golden Corral, both of which are based in the Southeast. Quincy's also competes with other family restaurants and with casual dining and quick-service outlets. Nationwide, the top five chains are Sizzler, Ponderosa, Golden Corral, Ryan's, and Western Sizzlin'. According to NATION'S RESTAURANT NEWS (published August 7, 1995), Quincy's ranked sixth nationwide in system-wide sales and third in sales per unit among the family steakhouse (grill buffet) chains. According to an independent survey conducted during 1995, Quincy's had a 19.3% share of the Southeast market in the family steakhouse segment. El Pollo Loco's business is split approximately evenly between the lunch daypart and the dinner daypart. During the lunch daypart, El Pollo Loco competes primarily with McDonald's, Burger King, Taco Bell and Carl's Jr. During the dinner daypart, El Pollo Loco's menu mix is more heavily oriented towards bone-in chicken in large meal combinations (8 or 12 pieces), the majority of which is taken home by consumers. El Pollo Loco's major competitors during the dinner daypart are KFC, Popeyes, Boston Market, and the take-out and delivery pizza restaurants (e.g., Pizza Hut and Domino's). According to an independent survey conducted during 1995, El Pollo Loco had a 35.8% share of the Los Angeles DMA (over 5 million households) in the chicken segment, and had a 4.6% share of the total of all of the quick-service restaurants segment.\nEXECUTIVE OFFICERS OF THE REGISTRANT The following table sets forth information with respect to each executive officer of FCI, along with certain executive officers of Flagstar.\nEMPLOYEES At December 31, 1995, the Company had approximately 88,000 employees of which less than 1% are union members. Many of the Company's restaurant employees work part-time, and many are paid at or slightly above minimum wage levels. The Company has experienced no significant work stoppages and considers its relations with its employees to be satisfactory. ITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES Most of the Company's restaurants are free-standing facilities. An average Denny's restaurant ranges from 3,900 to 5,800 square feet and seats 100 to 175 customers. Denny's restaurants generally occupy 35,000 to 45,000 square feet of land. An average Hardee's restaurant operated by the Company has approximately 3,300 square feet and provides seating for 94 persons, and most have drive-thru facilities. Each of the Company's Hardee's restaurants occupies approximately 50,000 square feet of land. The average Quincy's restaurant has approximately 7,100 square feet and provides seating for 250 persons. Each Quincy's restaurant occupies approximately 63,000 square feet of land. A typical El Pollo Loco restaurant has 2,250 square feet and seats 66 customers. The following table sets forth certain information regarding the Company's restaurant properties as of December 31, 1995:\nThe number and location of the Company's restaurants in each chain as of December 31, 1995 are presented below:\nAt December 31, 1995, the Company owned one manufacturing facility in Texas. The Company also owns a 19-story, 187,000 square foot office tower, which serves as its corporate headquarters, located in Spartanburg, South Carolina. The Company's corporate offices currently occupy approximately 14 floors of the tower, with the balance leased to others. See \"Certain Relationships and Related Transactions -- Description of Indebtedness\" and Note 4 to the accompanying Consolidated Financial Statements for information concerning encumbrances on certain properties of the Company. ITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS FCI, Flagstar, El Pollo Loco and Denny's, along with several former officers and directors of those companies, are named as defendants in an action filed on August 28, 1991 in the Superior Court of Orange County, California. The plaintiffs, who are current and former El Pollo Loco franchisees allege that the defendants, among other things, failed or caused a failure to promote, develop and expand the El Pollo Loco franchise system in breach of contractual obligations to the plaintiff franchisees and made certain misrepresentations to the plaintiffs concerning the El Pollo Loco system.\nAsserting various legal theories, the plaintiffs seek actual and punitive damages in excess of $90 million, together with declaratory and certain other equitable relief. The defendants have denied all material allegations, and certain defendants have filed cross-complaints against various plaintiffs in the action for breach of contract and other claims. Since the filing of the action the defendants have entered into settlements with five of the plaintiffs leaving three remaining in the lawsuit. The cost of the settlements, which included the purchase of 15 operating EPL franchises, was in the aggregate amount of $20.6 million. With respect to the remaining plaintiffs, the litigation is in the final stages of discovery, with a trial date to hear the outstanding issues in the case, anticipated sometime during 1996. The Company has received proposed deficiencies from the Internal Revenue Service (the \"IRS\") for federal income taxes and penalties totalling approximately $12.7 million. The proposed deficiencies relate to examinations of certain income tax returns filed by the Company for the seven fiscal periods ended December 31, 1992. The deficiencies primarily involve the proposed disallowance of deductions associated with borrowings and other costs incurred prior to, at and just following the time of the acquisition of Flagstar in 1989. The Company intends to vigorously contest the proposed deficiencies because it believes the proposed deficiencies are substantially incorrect. The Company is also the subject of pending and threatened employment discrimination claims principally in California and Alabama. In certain of these claims, the plaintiffs have threatened to seek to represent a class alleging racial discrimination in employment practices at Company restaurants and to seek actual, compensatory and punitive damages, and injunctive relief. The Company believes that these claims also lack merit and, unless there is an early resolution thereof, intends to defend them vigorously. On June 15, 1994, a derivative action was filed in the Alameda County Superior Court for the State of California by Mr. Adam Lazar, purporting to act on behalf of the Company, against the Company's directors and certain of its current and former officers alleging breach of fiduciary duty and waste of corporate assets by the defendants relating to alleged acts of mismanagement or the alleged failure to act with due care, resulting in policies and practices at Denny's that allegedly gave rise to certain public accommodations class action lawsuits against the Company that were settled in 1994. The action seeks unspecified damages against the defendants on behalf of the Company and its stockholders, including punitive damages, and injunctive relief. There has been only limited discovery in this action to date. Accordingly, it is premature to express a judgment herein as to the likely outcome of the action. Other proceedings are pending against the Company, in many cases involving ordinary and routine claims incidental to the business of the Company, and in others presenting allegations that are nonroutine and include compensatory or punitive damage claims. The ultimate legal and financial liability of the Company with respect to the matters mentioned above and these other proceedings cannot be estimated with certainty. However, the Company believes, based on its examination of these matters and its experience to date, that sufficient accruals have been established by the Company to provide for known contingencies. 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 Flagstar is a wholly-owned subsidiary of FCI. As a result, there is no established public trading market for the common stock of Flagstar and all per share data is omitted. As of March 26, 1996, 440 shares of common stock of Flagstar were outstanding, all of which are owned by FCI. Dividends were not paid by Flagstar during 1994 or 1995. See \"Management's Discussion and Analysis of Financial Condition and Result of Operations -- Liquidity and Capital Resources\" and, Note 4 to the accompanying Consolidated Financial Statements of Flagstar regarding certain restrictions on the payment of dividends. ITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA Set forth below are certain selected financial data concerning the Company for each of the five years ended December 31, 1995. Such data generally have been derived from the Consolidated Financial Statements of the Company for such periods which have been audited. The following information should be read in conjunction with the Consolidated Financial Statements of the Company and Notes thereto presented elsewhere herein and \"Management's Discussion and Analysis of Financial Condition and Results of Operations\".\n(1) Certain amounts for the four years ended December 31, 1994 have been reclassified to conform to the 1995 presentation. (2) Operating loss for the year ended December 31, 1993 reflects charges for the write-off of goodwill and certain other intangible assets of $1,104.6 million and the provision for restructuring charges of $158.6 million. (3) Operating income for the year ended December 31, 1994 reflects a recovery of restructuring charges of $7.2 million. (4) Operating income for the year ended December 31, 1995 reflects a provision for restructuring charges of $15.9 million and a charge for impaired assets of $51.4 million. (5) The Company has reclassified as discontinued operations Preferred Meal Systems, Inc., which was sold in 1991, Canteen Corporation, a food and vending subsidiary, sold in 1994, TW Recreational Services, Inc. (\"TWRS\"), a recreation services subsidiary, and Volume Services (\"VS\"), Inc., a stadium concessions subsidiary. TWRS and VS were sold during 1995. (6) The ratio of earnings to fixed charges has been calculated by dividing pre-tax earnings by fixed charges. Earnings, as used to compute the ratio, equal the sum of income from continuing operations before income taxes and fixed charges excluding capitalized interest. Fixed charges are the total interest expense including capitalized interest, amortization of debt expenses and a rental factor that is representative of an interest factor (estimated to be one third) on operating leases. (7) The current assets and working capital deficiency amounts presented exclude assets held for sale of $503.0 million, $480.8 million, $103.2 million, and $77.3 million as of December 31, 1991 through 1994, respectively. Such assets held for sale relate to the Company's food and vending and concessions and recreation services subsidiaries. (8) A negative working capital position is not unusual for a restaurant operating company. At December 31, 1992, the decrease in the working capital deficiency from December 31, 1991 is due primarily to decreased current maturities of the Company's bank debt as a result of the Recapitalization. The increase in the working capital deficiency from December 31, 1992 to December 31, 1993 is attributable primarily to an increase in restructuring and other liabilities.\nThe decrease in the working capital deficiency from December 31, 1993 to December 31, 1994 is due primarily to an increase in cash following the sale of the Company's food and vending subsidiary during 1994. The decrease in the working capital deficiency from December 31, 1994 to December 31, 1995 is due primarily to an increase in cash following the 1995 sales of the Company's (i) distribution subsidiary, Proficient Food Company, net of current assets and liabilities of such subsidiary, and (ii) the concession and recreation services subsidiaries. ITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with \"Selected Financial Data and the Consolidated Financial Statements\" and other more detailed financial information appearing elsewhere herein. 1995 COMPARED TO 1994 OPERATING TRENDS: During 1995, the Company experienced comparable store sales increases at Denny's, Quincy's, and El Pollo Loco, due to the success of the Denny's value menu strategy, the impact of remodelings at Quincy's, and El Pollo Loco's successful menu positioning, dual-branding of Foster's Freeze, and favorable results from remodeled restaurants. However, the Company experienced a significant decline in comparable store sales at Hardee's due to continued competitive promotions and discounting by quick-service competitors. Primarily as a result of lower revenues at Hardee's, the Company experienced a reduction in operating income (before considering the provision for (recovery of) restructuring charges and charge for impaired assets) of $38.8 million. As a result, the trends experienced since the 1989 acquisition generally have continued through 1995; operating income has been insufficient to cover the interest and debt expense (although operating cash flows have been sufficient to cover interest costs), resulting in continued losses from continuing operations. The external factors that have contributed to such trends, including increased competition and intensive pressure on pricing due to discounting, are expected to continue. In response to these factors, during 1995, management instituted the changes described above that have contributed to improving sales on a comparable store basis at Denny's, Quincy's, and El Pollo Loco. Management continues to explore alternatives in an attempt to reverse the negative sales trends at Hardee's. During 1995 the Company began the upgrading of all marketing programs by hiring new marketing agencies for all its restaurant concepts and completed the analytical stage of a comprehensive business transformation program which is intended to result in better customer support at the restaurant level, increased operational efficiencies, and a more streamlined organizational structure. In addition, the proceeds from the sale of certain operations have partially been used to reduce the Company's long-term debt; however, the majority of such proceeds have been retained in short-term liquidity or have been used to fund capital expenditures. OPERATING REVENUES: Operating revenues from continuing operations for 1995 decreased by approximately $94.5 million (3.5%) as compared with 1994 primarily reflecting the sale of non-core assets coupled with continued weakness at Hardee's. Denny's revenues decreased by $57.3 million (3.7%), of which $53.0 million was attributable to a decrease in outside revenues at the Company's food processing and distribution subsidiaries. Such revenue decrease reflects the sale of the Company's distribution subsidiary during the third quarter of 1995. The remaining decrease of $4.3 million is primarily due to a 45-unit net decrease in the number of Company-owned restaurants at December 31, 1995 as compared to December 31, 1994 which was partially offset by an 84-unit increase in the number of franchised restaurants. Comparable store sales at Denny's increased 2.4% during 1995 as compared with 1994 reflecting increases in average check of 2.3% and 0.2% in traffic. During 1995, Denny's completed remodels on 182 Company-owned restaurants. Hardee's revenues decreased during 1995 by $40.6 million to $659.9 million from $700.5 million during 1994 principally due to a decline of 8.6% in comparable store sales. The decrease in comparable store sales resulted from a 10.0% decline in traffic which was mitigated by a 1.6% increase in average check. Although Hardee's traffic continues to be impacted by continued aggressive promotions and discounting by quick service competitors, active involvement by the Company with Hardee's Food Systems, Inc. and a continued focus on a value menu strategy is planned to address this issue. During 1995, the Company remodeled 59 Hardee's restaurants. Quincy's revenues increased by $9.9 million (3.5%) during 1995 as compared with 1994 despite a 4-unit decrease in the number of restaurants operated at December 31, 1995 as compared to December 31, 1994. Such increase in revenues is primarily due to a 4.8% increase in comparable store sales as a result of increases of 3.3% in traffic and 1.5% in average check. During 1995, the increased traffic is partially attributable to the remodeling of 35 of its Quincy's restaurants.\nRevenues at El Pollo Loco decreased $6.4 million (4.8%) to $126.7 million during 1995 from $133.1 million during 1994 primarily due to a 24-unit net decrease in the number of Company-owned restaurants following the sales of units to franchisees. Comparable store sales at Company-owned El Pollo Loco units increased by 2.0% reflecting an increase in average check of 2.4% which was partially offset by a 0.4% decrease in traffic. During 1995, El Pollo Loco completed remodels on 57 of its Company-owned restaurants. OPERATING EXPENSES: The Company's operating expenses from continuing operations, before considering the effects of the provision for (recovery of) restructuring charges and charge for impaired assets, decreased by $55.7 million (2.3%) in 1995 as compared with 1994. Operating expenses before the provision for restructuring charges and charge for impaired assets at Denny's decreased $59.9 million principally due to decreases in product costs including $43.6 million attributable to Denny's distribution subsidiary which was sold in September 1995. Operating expenses for 1994 include twelve months of charges for the food distribution subsidiary; whereas, 1995 includes approximately nine months of such charges. Denny's operating expenses before the provision for restructuring charges and charge for impaired assets were also reduced during 1995 by gains on the sale of restaurants to franchisees of $20.7 million, including a gain on the sale of Denny's joint venture in Mexico for $6.0 million. This compares to gains in 1994 of $8.8 million. Such decreases in operating expenses were offset, in part, by an increase in advertising expense of $6.0 million. At Hardee's, operating expenses before considering the effects of the provision for restructuring charges and charge for impaired assets decreased by $0.8 million. This reflects increased expenses during 1995 of $12.8 million for general and administrative, payroll and benefits, restructuring of field management, workers' compensation charges, and expenses related to promotional programs. Such increases were more than offset by a $13.6 million decrease in product costs directly associated with decreased revenues in 1995. An increase in operating expenses before considering the effects of the provision for restructuring charges and charge for impaired assets of $9.8 million at Quincy's is principally attributable to increases in payroll and benefits expense of $4.4 million, product costs of $3.3 million associated with an increase in revenues during 1995, and advertising expense of $2.7 million. Operating expenses before considering the effects of the provision for restructuring charges and charge for impaired assets at El Pollo Loco decreased by $9.6 million during 1995 due primarily to a 24-unit net decrease at December 31, 1995 as compared with December 31, 1994 in the number of Company-operated restaurants following the sale of restaurants to franchisees. El Pollo Loco's operating expenses before considering the effects of the provision for restructuring charges and charge for impaired assets during 1995 included gains on the sale of restaurants of $3.8 million as compared with $1.2 million during 1994. Corporate and other expenses before considering the effects of the provision for (recovery of) restructuring charges and charge for impaired assets increased by $4.8 million during 1995 as compared with 1994 due primarily to increased charges of $4.2 million related to various management recruiting, training, and information services initiatives. RESTRUCTURING: Effective in the fourth quarter of 1995, as a result of a comprehensive financial and operational review, the Company approved a restructuring plan. The plan generally involves the reduction in personnel and a decision to outsource the Company's information systems function. Operating expenses for 1995 reflect a provision for restructuring of $15.9 million including charges for severance of $5.4 million, $7.6 million for the write-down of computer hardware and other assets, and $2.9 million for various other charges. Approximately $7.5 million of the restructuring charges represent cash charges of which approximately $0.6 million was incurred and paid in 1995. ACCOUNTING CHANGE: During 1995 the Company adopted Statement of Financial Accounting Standards No. 121 which resulted in a charge to operating expenses of $51.4 million for the write-down of Denny's, Hardee's, and Quincy's restaurant properties. This charge reflects the write-down of 99 units which the Company will continue to operate and an additional 36 units which will be closed or sold generally in 1996. See Note 2 to the Consolidated Financial Statements for further details. As a result of this write-down, the Company estimates that its depreciation expense in future years will be reduced by an average of $6.0 million annually over the estimated remaining useful life of such assets. INTEREST AND DEBT EXPENSE: Total interest and debt expense from continuing and discontinued operations decreased by $18.1 million in 1995 as compared to 1994 ($18.5 million decrease attributable to discontinued operations offset by a $0.4 million increase in continuing operations) principally as a result of a reduction in interest expense of $7.0 million following the payment during June 1994 of the principal amount ($170.2 million) outstanding under the term\nfacility of the Company's Restated Credit Agreement then outstanding and certain other indebtedness upon the sale of the Company's food and vending subsidiary, a reduction in interest expense of $4.0 million during 1995 for other indebtedness which was related to such subsidiaries which have been sold, and a decrease in interest expense of $6.1 million during 1995 related to interest rate exchange agreements. DISCONTINUED OPERATIONS: The Company's concession and recreation services businesses were sold during 1995 and resulted in a net gain of $77.9 million. These businesses are accounted for as discontinued operations and recorded operating revenues of $322.3 million during 1995, a decrease of $3.1 million (0.9%) from 1994. Revenues related to the stadium concession subsidiary increased $9.2 million during 1995 to $190.8 million from $181.6 million in 1994. Operating income and depreciation and amortization expense of the concession subsidiary were $2.4 million and $10.9 million, respectively, during 1995 as compared with $6.5 million and $9.8 million, respectively in 1994. Such decrease in operating income during 1995 is due principally to a decrease in average attendance at major league baseball games during the 1995 season. Revenues related to the recreation services subsidiary decreased by $12.3 million during 1995 to $131.5 million from $143.8 million during 1994. Operating income and depreciation and amortization expense of the recreation services subsidiary for 1995 were $14.7 million and $3.8 million, respectively, as compared with $16.3 million and $4.7 million, respectively, during 1994. Such decrease in revenues and operating income of the recreation services subsidiary is due principally to the loss of the service contract at the Kennedy Space Center during 1995. EXTRAORDINARY ITEMS: The Company recognized an extraordinary gain totaling $0.5 million, net of income taxes, during 1995 which represents a gain on the repurchase of $24,975,000 principal amount of certain indebtedness, net of the charge-off of the related unamortized deferred financing costs. During 1994, the Company also recognized an extraordinary loss totaling $11.7 million, net of income tax benefits of $0.2 million representing the charge-off of unamortized deferred financing costs associated with the prepayment in June 1994 of senior bank debt. 1994 COMPARED TO 1993 OPERATING REVENUES: Operating revenues from continuing operations for 1994 increased by approximately $50.8 million (1.9%) as compared with 1993. Denny's revenues increased $1.9 million (0.1%) due to increased outside revenues of $36.3 million from its food distribution operations offset in part by a reduction of restaurant revenues of $34.4 million, principally as a result of a net decrease of 46 units in the number of Company-owned units. This decrease in the number of Company-owned units was partially offset by a net increase of 81 units in the number of franchise-owned restaurants and by a 0.3% increase in comparable store sales during 1994 as compared to 1993. The increase in comparable store sales resulted from a 0.6% increase in customer traffic offset, in part, by a decrease in average check of 0.4%. Management believes that the positive trend in customer traffic, primarily during the third and fourth quarters of 1994, was the result of the Company-wide $1.99 Original Grand Slam Breakfast promotion. Hardee's revenues increased $18.8 million (2.8%) during 1994 as compared to the prior year due to a net increase of 31 units. Although Hardee's total revenues increased, comparable store sales decreased 3.6% as a result of a 3.9% decrease in customer traffic mitigated, in part, by a 0.3% increase in average check. The decline in customer traffic at Hardee's during 1994 was principally the result of aggressive discounting by the Company's quick-service competitors. Quincy's revenues increased by $5.6 million (2.0%) in 1994 as compared with 1993, primarily due to successful product promotions and the impact of remodeled restaurants resulting in a 2.9% increase in comparable store sales which more than offset a net decrease of 6 units. The increase in comparable store sales at Qunicy's reflects an increase of 3.2% in average check and a 0.3% decrease in customer traffic. Revenues at El Pollo Loco increased by $24.6 million (22.7%) during 1994 over 1993 due primarily to new products and combination meals, including barbeque chicken, additional taco and burrito entrees, and new side orders such as french fries, black beans, corn, and potatoes, introduced during 1994, and the acquisition of high-volume franchise restaurants in late 1993. Comparable store sales increased 6.5% and reflect increases in customer traffic of 6.0% and in average check of 0.5%. OPERATING EXPENSE: The Company's overall operating expenses before considering the effects of the write-off of goodwill and certain other intangible assets and the provisions for restructuring charges in 1993 increased by $0.5 million in 1994 as compared with 1993.\nAt Denny's, operating expenses before considering the effects of the write-off of goodwill and certain other intangible assets and the provision for restructuring charges in 1993 decreased by $29.9 million in 1994 as compared with 1993. A significant portion of the decrease ($20.7 million) was attributable to a reduction in depreciation and amortization expense related to the year-end 1993 write-off of assets and a reduction of $18.5 million in payroll and benefits expense. Such decreases were partially offset by a $3.9 million increase in occupancy expense and a $2.1 million increase in advertising. In addition, Denny's operating expenses for 1994 reflect a gain of approximately $8.8 million related to the sale of Company-owned restaurants. At Hardee's, an increase in operating expenses of $24.4 million was mainly attributable to the increase in the number of restaurants in operation and reflects increases in payroll and benefits expenses of $14.6 million, product costs of $7.4 million, occupancy and maintenance expenses of $2.6 million, and utilities expense of $1.8 million. Such increases were partially offset by reduced depreciation and amortization charges of $1.2 million related to the year-end 1993 write-off of assets. A decrease in operating expenses of $7.6 million at Quincy's was principally attributable to a decrease in depreciation and amortization charges of $9.6 million related to the year-end 1993 write-off of assets which was offset, in part, by increased payroll and benefits expense of $2.3 million. General corporate overhead expense (before allocation to specific operating companies) decreased by $5.2 million in 1994 as compared to 1993 primarily as a result of the effect of the Company's 1993 restructuring plan. INTEREST AND DEBT EXPENSE: Interest and debt expense increased by $13.9 million in 1994 as compared to 1993. During 1993, $45.6 million was allocated to discontinued operations; however, the allocation decreased to $33.7 million as a result of the sale of the Company's food and vending subsidiary in June 1994. Cash interest increased by $6.9 million during 1994 as compared with 1993 due to the higher fixed interest rates on the $400.0 million of the 10 3\/4% Senior Notes due 2001 (the \"10 3\/4% Notes\") and 11 3\/8% Senior Subordinated Debentures due 2003 (the \"11 3\/8% Debentures\") issued during the third quarter of 1993, the proceeds of which were used to refinance a portion of the Company's bank facility that during 1993 had interest at lower variable rates. Interest expense for 1994 included charges of $9.2 million related to interest rate exchange agreements compared to charges of $12.2 million during 1993. See Notes 1 and 4 to the Consolidated Financial Statement for additional information relating to the interest rate exchange agreements. DISCONTINUED OPERATIONS: The Company's concession and recreation services businesses, which are accounted for as discontinued operations, recorded a revenue increase of $3.3 million (1.0%) to $325.4 million during 1994 as compared to 1993. During April 1994, the Company announced its intent to dispose of these businesses. See Note 13 to the accompanying Consolidated Financial Statements for additional information. WRITE-OFF OF GOODWILL AND CERTAIN OTHER INTANGIBLES AND RESTRUCTURING CHARGES IN During the fourth quarter of 1993, management determined that the most likely projections of future operating results would be based on the assumption that historical operating trends of the Company derived from the prior four years (1990-1993) would continue, and that such projections indicated an inability to recover the recorded balance of goodwill and certain other intangible assets. The Company's operating results since the 1989 acquisition of Flagstar had fallen short of projections prepared at the date of such acquisition due to increased competition, intensive pressure on pricing due to discounting, declining customer traffic, adverse economic conditions, and relatively limited capital resources to respond to these changes. Accordingly, such assets were written off in 1993, resulting in non-cash charges of $1,475 million ($1,104.6 million to continuing operations and $370.2 million to discontinued operations). Also in response to such trends, the Company adopted a plan of restructuring that resulted in a separate charge in 1993 of $192.0 million ($158.6 million to continuing operations and $33.4 million to discontinued operations). While total operating revenues increased 2.8% in 1992 and 6.7% in 1993, operating income for each of the four full years from the Company's 1989 acquisition of Flagstar through 1993 were insufficient to cover the Company's interest and debt expense as discussed under \"Operating Trends\", and this trend has continued through 1995. Operating cash flows have been sufficient to cover interest costs. The primary factor affecting the Company's ability to generate operating income sufficient to cover interest and debt expenses and amortization of goodwill and other intangibles has been the comparable store sales at the restaurant concepts and the sales volume at the Company's contract food and vending operation. At the time of the Company's 1989 acquisition of Flagstar, projections of future operations assumed annual growth rates in comparable store sales at all concepts and corresponding increases in operating income. Such projections and those prepared since the 1989 acquisition and prior to the fourth quarter of 1993, indicated that the Company would\nbecome profitable within several years. However, since the 1989 acquisition through the end of 1993, and despite increases in comparable store sales at Hardee's, comparable store sales at Denny's and Quincy's increased only slightly and food and vending sales volume declined through 1993. (Since 1993, comparable store sales have increased at Denny's and Quincy's, however, Hardee's comparable store sales have declined during that time.) Projections prepared during the fourth quarter of 1993 indicated that, if the four years trends in customer traffic and other operating factors were to continue future operating income less interest and debt expenses would continue to be insufficient to recover the carrying value of goodwill and other intangible assets. The projections assumed that comparable store sales at each of the restaurants concepts and food and vending sales volume would increase or decrease consistent with the four year historical trends described above. These fourth quarter 1993 projections assumed no additional borrowings to fund new unit growth (because even if new units continued to be developed at historical levels, it would not have a material impact on projected net income) and no reversal of the historical trends that may result from successful restructuring and reimaging programs instituted by management in 1993, since management determined, based on all information then available, that historical trends provided the best estimate of future operating results. Also as a result of the historical operating trends described above and in an attempt to reverse them, effective in the fourth quarter of 1993, the Company approved a restructuring plan that included the sale, closure, or conversion of restaurants, a reduction in personnel, and a reorganization of certain management structures. The restructuring charge (for continuing operations) included primarily a non-cash charge of $130.7 million (including $15 million related to reserves for operating leases) to write-down assets, and incremental charges of $27.9 million for severance, relocation, and other costs. The restructuring charge for discontinued operations was $33.4 million. In conjunction with this plan, 240 units were identified for sale, closure, or conversion to another concept. As of December 31, 1995, 69 units had been closed, sold, or converted to another concept, and 17 units are intended to be disposed of generally during 1996. Management intends to operate the remaining units. As of December 31, 1995, substantially all of the other incremental charges identified in conjunction with the 1993 restructuring have been incurred. LIQUIDITY AND CAPITAL RESOURCES Historically, the Company has met its liquidity requirements with internally generated funds and external borrowings. The Company expects to continue to rely on internally generated funds, supplemented by available working capital advances under its Amended and Restated Credit Agreement, dated as of October 26, 1992, among Flagstar and TWS Funding, Inc., as borrowers, certain lenders and co-agents named therein, and Citibank, N.A., as managing agent (as amended, from time to time, including by means of a second amended and restated credit agreement (the \"New Facility\") anticipated to be consummated in early 1996, the \"Restated Credit Agreement\"), and other external borrowings, as its primary sources of liquidity. The Company believes that funds from these sources will be sufficient for the next twelve months to meet the Company's working capital, debt service, and capital expenditure requirements. The Company reported a net loss in 1995 attributable in major part to non-cash charges, including a provision for restructuring charges and a charge for impaired assets related to certain restaurants properties. The following table sets forth, for each of the years indicated, a calculation of the Company's cash from operations available for debt repayment and capital expenditures:\nThe Restated Credit Agreement currently consists of a working capital and letter of credit facility of up to $160.1 million with a working capital sublimit of $78.6 million and a letter of credit sublimit of $125.0 million. By its terms, the Restated Credit Agreement expires in June 1996. The Company is currently in the process of renewing its bank credit agreement. It is anticipated that the New Facility will consist of a $150 million working capital and letter of credit facility secured by a pledge of the stock of the Company's operating subsidiaries and all of its and their respective trademarks, tradenames, copyrights, hedge agreements, tax sharing agreements and bank accounts. The New Facility, as presently contemplated, would terminate March 31, 1999, subject to mandatory prepayments and commitment reductions under certain circumstances upon the Company's sale of assets or incurrence of additional debt. The New Facility would also include certain financial and other operating covenants generally consistent with those provided in the Restated Credit Agreement currently in effect. The Restated Credit Agreement and the indentures governing the Company's outstanding public debt contain negative covenants that restrict, among other things, the Company's ability to pay dividends, incur additional indebtedness, further encumber its assets and purchase or sell assets. In addition, the Restated Credit Agreement includes provisions for the maintenance of a minimum level of interest coverage, limitations on ratios of indebtedness to earnings before interest, taxes, depreciation and amortization (EBITDA) and limitations on annual capital expenditures. At December 31, 1995 scheduled debt maturities of long-term debt for the years 1996 through 2000 are as follows:\nIn addition to scheduled maturities of principal, approximately $240 million of cash will be required in 1996 to meet interest payments on long-term debt and dividends on FCI's $2.25 Series A Cumulative Convertible Exchangeable Preferred Stock, par value $0.10 per share (\"the Preferred Stock\"). The projections of future operating results prepared in the fourth quarter of 1993, which resulted in the conclusion that goodwill and certain other intangibles were impaired (see \"Write-off of Goodwill and Certain Other Intangibles and Restructuring Charges in 1993\"), assumed that the historical operating trends experienced by the Company since the 1989 acquisition will continue in the future. Such trends have generally continued through 1995. If historical trends are not reversed, the Company may need to refinance or renegotiate the terms of existing debt prior to their maturities. While management believes that the Company will be able, if necessary, to refinance or renegotiate the terms of its existing debt prior to maturity, no assurance can be given that it will be able to do so on acceptable terms. The Company's principal capital requirements are those associated with opening new restaurants and remodeling and maintaining its existing restaurants and facilities. During 1995, total capital expenditures were approximately $129.2 million, of which approximately $71.7 million was used to reimage existing restaurants, $7.2 million was used to open new restaurants, and $50.3 million was used to maintain existing facilities. Of these expenditures, approximately $5.5 million were financed through capital leases. Capital expenditures during 1996 are expected to total approximately $60 million to $80 million. The Company currently expects to finance such capital expenditures internally through continuing operations and asset sales. The Company is able to operate with a substantial working capital deficiency because (i) restaurant operations and most food service operations are conducted primarily on a cash (and cash equivalent) basis with a low level of accounts receivable, (ii) rapid turnover allows a limited investment in inventories, and (iii) accounts payable for food, beverages, and supplies usually become due after the receipt of cash from the related sales. At December 31, 1995, the Company's working capital deficiency was $122.2 million as compared with $128.3 million at the end of 1994. Such decrease is attributable primarily to an increase in cash of approximately $130.2 million as a result of the sale of the Company's distribution and concession and recreation services businesses during 1995, net of the current assets and liabilities of the distribution subsidiary and the net assets of the concession and recreation services businesses which had been included in working capital. On February 22, 1996, the Company entered into an agreement with Integrated Systems Solutions Corporation (ISSC). The ten year agreement for $323 million provides for ISSC to manage and operate the Company's information\nsystems, as well as develop and implement new systems and applications to enhance information technology for the Company's corporate headquarters, restaurants, and field management. ISSC will oversee data center operations, applications development and maintenance, voice and data networking, help desk operations, and point-of-sale technology. On March 1, 1995, the Company entered into an agreement to acquire the Coco's and Carrows restaurant chains, consisting of approximately 350 units operating in the family dining segment. The purchase is subject to the signing of certain ancillary agreements and other customary terms and conditions. If consummated, the purchase price (including estimated expenses) would consist of $131 million of cash ($56 million of which will be financed by bank term loans), the issuance of notes payable to the seller of $150 million, and the assumption of certain capital lease obligations of approximately $31.5 million. ITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA See Index to Financial Statements which appears on page herein. FORM 11-K INFORMATION Flagstar, pursuant to Rule 15d-21 promulgated under the Securities Exchange Act of 1934, as applicable, will file as an amendment to this Annual Report of Form 10-K the information, financial statements and exhibits required by Form 11-K with respect to the Flagstar Thrift Plan and the Denny's Inc. Profit Sharing Retirement Plan. ITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this item is omitted pursuant to General Instruction (J)(2)(c) of Form 10-K. ITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION The information required by this item is omitted pursuant to General Instruction (J)(2)(c) of Form 10-K. ITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this item is omitted pursuant to General Instruction (J)(2)(c) of Form 10-K. ITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS CERTAIN TRANSACTIONS The information required by this item is omitted pursuant to General Instruction (J)(2)(c) of Form 10-K. DESCRIPTION OF INDEBTEDNESS The following summary of the principal terms of the current indebtedness of the Company does not purport to be complete and is qualified in its entirety by reference to the documents governing such indebtedness, including the definitions of certain terms therein, copies of which have been filed as exhibits to this Annual Report on Form 10-K. Whenever particular provisions of such documents are referred to herein, such provisions are incorporated herein by reference, and the statements are qualified in their entirety by such reference. THE RESTATED CREDIT AGREEMENT In connection with the Recapitalization, Flagstar entered into the Restated Credit Agreement, pursuant to which senior debt facilities were established consisting (after certain adjustments and prepayments subsequent to the closing of the Recapitalization) of (i) a $171.3 million senior term loan (the \"Term Facility\"), and (ii) a $350 million senior revolving credit facility (the \"Revolving Credit Facility\" and, together with the Term Facility, the \"Bank Facilities\"), with sublimits for working capital advances and standby letters of credit, and a swing line facility of up to $30 million. The proceeds of the Term Facility were used principally to refinance comparable facilities under a prior credit agreement and the balance\nwas used to finance the redemption of certain debt securities pursuant to the Recapitalization and to pay certain transaction costs. Proceeds of the Revolving Credit Facility may be used solely to provide working capital to the Company. In connection with the sale of its food and vending operation on June 17, 1994 the Term Facility was repaid in full and the Revolving Credit Facility was reduced to $250 million. The sale of PFC, TWRS, and VS during 1995 further reduced the Revolving Credit Facility to $160 million at December 31, 1995. Under the Restated Credit Agreement, the Revolving Credit Facility is scheduled to terminate on June 17, 1996 (the \"Termination Date\"), the second anniversary of the repayment of the Term Facility. The Company is currently negotiating the terms of a new working capital and letter of credit facility. For additional information concerning such New Facility see \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources\". Flagstar has obtained the waivers and consents necessary under the Restated Credit Agreement to permit it to enter into and perform its obligations under the Coco's and Carrows transactions described elsewhere herein. See \"Management's Discussion and Analysis of Financial Condition -- Liquidity and Capital Resources.\" The Restated Credit Agreement as currently in effect provides generally that the working capital advances under the Revolving Credit Facility must be repaid in full and not reborrowed for at least 30 consecutive days during any thirteen-month period but at least once during each fiscal year. Under the Restated Credit Agreement, Flagstar is required to permanently reduce the Revolving Credit Facility by the aggregate amount of Net Cash Proceeds (as defined therein) received from (i) the sale, lease, transfer or other disposition of assets of the Company (other than dispositions of assets permitted by the terms of the Restated Credit Agreement and other dispositions of assets not exceeding $5,000,000 in any fiscal year or $1,000,000 in any transaction or series of related transactions) and (ii) the sale or issuance by FCI or any of its subsidiaries of any Debt (as defined therein) (other than Debt permitted by the terms of the Restated Credit Agreement and to the extent the Net Cash Proceeds are applied to refinance certain existing Subordinated Debt (as defined therein)). The Restated Credit Agreement contains covenants customarily found in credit agreements for leveraged financings that restrict, among other things, (i) liens and security interests other than liens securing the obligations under the Restated Credit Agreement, certain liens existing as of the date of effectiveness of the Restated Credit Agreement, certain liens in connection with the financing of capital expenditures, certain liens arising in the ordinary course of business, including certain liens in connection with intercompany transactions and certain other exceptions; (ii) the incurrence of Debt, other than Debt in respect of the Recapitalization, Debt under the Loan Documents (as defined therein), the 10 3\/4% Notes, the 11 3\/8% Debentures, certain capital lease obligations, certain Debt in existence on the date of the Restated Credit Agreement, certain Debt in connection with the financing of capital expenditures, certain Debt in connection with Investments (as defined therein) in new operations, properties and franchises, certain trade letters of credit, certain unsecured borrowings in the ordinary course of business, certain intercompany indebtedness and certain other exceptions; (iii) lease obligations, other than obligations in existence as of the effectiveness of the Restated Credit Agreement, certain leases entered into in the ordinary course of business, certain capital leases, certain intercompany leases and certain other exceptions; (iv) mergers or consolidations, except for certain intercompany mergers or consolidations and certain mergers to effect certain transactions otherwise permitted under the Restated Credit Agreement; (v) sales of assets, other than certain dispositions of inventory and obsolete or surplus equipment in the ordinary course of business, certain dispositions in the ordinary course of business of properties no longer used or useful to the business of the Company, certain intercompany transactions, certain dispositions in connection with the sale and leaseback transactions, and certain exchanges of real property, fixtures and improvements for other real property, fixtures and improvements; (vi) investments, other than certain intercompany indebtedness, certain investments made in connection with joint venture or franchise arrangements, certain loans to employees, investments in new operations, properties or franchises subject to certain limitations and certain other exceptions; (vii) payment of dividends or other distributions with respect to capital stock of Flagstar, other than dividends from Flagstar to FCI to enable FCI to repurchase Common Stock and FCI stock options from employees in certain circumstances, payments to FCI with respect to fees and expenses incurred in the ordinary course of business by FCI in its capacity as a holding company for Flagstar, payments under a tax sharing agreement among FCI, Flagstar and its subsidiaries and certain other exceptions; (viii) sales or dispositions of the capital stock of subsidiaries other than sales by certain subsidiaries of Flagstar to Flagstar or certain other subsidiaries and certain other exceptions; (ix) the conduct by Flagstar or certain of its subsidiaries of business inconsistent with its status as a holding company or single purpose subsidiary, as the case may be, or entering into transactions inconsistent with such status; and (x) the prepayment of Debt, other than certain payments of Debt in existence on the date of the Restated Credit Agreement, certain payments to retire Debt in connection with permitted dispositions of assets, certain prepayments of advances under the Restated Credit Agreement and certain other exceptions.\nThe Restated Credit Agreement also contains covenants that require Flagstar and its subsidiaries on a consolidated basis to meet certain financial ratios and tests described below: TOTAL DEBT TO EBITDA RATIO. Flagstar and its subsidiaries on a consolidated basis are required not to permit the ratio of (a) Adjusted Total Debt (as defined below) outstanding on the last day of any fiscal quarter to (b) EBITDA (as defined below) for the Rolling Period (as defined below) ending on such day to be more than a specified ratio, ranging from a ratio of 5.70:1.00 applicable upon the effectiveness of the Restated Credit Agreement to a ratio of 6.50:1.00 applicable on or after December 31, 1995. SENIOR DEBT TO EBITDA RATIO. Flagstar and its subsidiaries on a consolidated basis are required not to permit the ratio of (a) Adjusted Senior Debt (as defined below) outstanding on the last day of any fiscal quarter to (b) EBITDA for the Rolling Period ending on such day to be more than a specified ratio, ranging from a ratio of 3.50:1.00 applicable upon the effectiveness of the Restated Credit Agreement to a ratio of 2.50:1.00 on or after December 31, 1999 (3.30:1.00 as of the Termination Date). INTEREST COVERAGE RATIO. Flagstar and its subsidiaries on a consolidated basis are required not to permit the ratio, determined on the last day of each fiscal quarter for the Rolling Period then ended, of (a) EBITDA less Adjusted Cash Capital Expenditures (as defined below) to (b) Adjusted Cash Interest Expense (as defined below) to be less than a specified ratio, ranging from a ratio of 1.20:1.00 applicable upon the effectiveness of the Restated Credit Agreement to a ratio of 1.60:1.00 on or after December 31, 1997 (1.25:1.00 as of the Termination Date). CAPITAL EXPENDITURES TEST. Flagstar and its subsidiaries are prohibited from making capital expenditures in excess of $195,000,000, $210,000,000, and $200,000,000 in the aggregate for the fiscal years ending December 31, 1992 through 1994, respectively. For the fiscal year ending December 31, 1995 Flagstar and its subsidiaries are prohibited from making capital expenditures in excess of the sum of $175,000,000 plus the available cash proceeds received during such period from the PFC and TWRS sales transactions, subject to certain restrictions, including, without limitation, a reduction equal to the amount of certain prepayments of funded debt during such period. Subsequent to 1995, capital expenditures in excess of $275,000,000 in the aggregate are prohibited for each fiscal year thereafter. \"Adjusted Cash Capital Expenditures\" is defined in the Restated Credit Agreement to mean, for any period, Cash Capital Expenditures (as defined below) less, for each of the Rolling Periods (as defined below) ending September 30, 1995 through March 31, 1996, an amount equal to the sum of (i) a specified amount, ranging from $125,000,000 for the Rolling Period ending September 30, 1995 to $65,000,000 for the Rolling Period ending March 31, 1996, plus (ii) the available cash proceeds received during such rolling period from the PFC and TWRS sales transactions, subject to certain restrictions, including, without limitation, a reduction equal to the amount of certain prepayments of funded debt during such period. \"Adjusted Cash Interest Expense\" is defined in the Restated Credit Agreement to mean, for any Rolling Period (as defined below), Cash Interest Expense (as defined below) for such Rolling Period. \"Adjusted Senior Debt\" is defined in the Restated Credit Agreement to mean Senior Debt (as defined therein) outstanding on the last day of any fiscal quarter. \"Adjusted Total Debt\" is defined in the Restated Credit Agreement to mean Total Debt (as defined below) outstanding on the last day of any fiscal quarter. \"Capex Financing\" is defined in the Restated Credit Agreement to mean, with respect to any capital expenditure, the incurrence by certain subsidiaries of Flagstar of any Debt (including capitalized leases) secured by a mortgage or other lien on the asset that is the subject of such capital expenditure, to the extent that the Net Cash Proceeds of such Debt do not exceed the amount of such capital expenditure. \"Cash Capital Expenditures\" is defined in the Restated Credit Agreement to mean, for any period, without duplication, capital expenditures of the Company for such period, LESS (without duplication) (i) the Net Cash Proceeds of all Capex Financings during such period and (ii) the aggregate amount of the principal component of all obligations of the Company in respect of capitalized leases entered into during such period. \"Cash Interest Expense\" is defined in the Restated Credit Agreement to mean, for any Rolling Period, without duplication, interest expense net of interest income, whether paid or accrued during such Rolling Period (including the interest component of capitalized lease obligations) on all Debt, INCLUDING, without limitation, (a) interest expense in respect of advances under the Restated Credit Agreement, the 10 7\/8% Notes (as defined below) and the Subordinated Debt (as\ndefined therein), (b) commissions and other fees and charges payable in connection with letters of credit, (c) the net payment, if any, payable in connection with all interest rate protection contracts and (d) interest capitalized during construction, but EXCLUDING, in each case, interest not payable in cash (including amortization of discount and deferred debt expenses), all as determined in accordance with generally accepted accounting principles as in effect on December 31, 1991. \"EBITDA\" of any person is defined in the Restated Credit Agreement to mean, for any period, on a consolidated basis, net income (or net loss) PLUS the sum of (a) interest expense net of interest income, (b) income tax expense, (c) depreciation expense, (d) amortization expense and (e) extraordinary or unusual losses included in net income (net of taxes to the extent not already deducted in determining such losses) LESS extraordinary or unusual gains included in net income (net of taxes to the extent not already deducted in determining such gains), in each case determined in accordance with generally accepted accounting principles as in effect on December 31, 1991. \"Funded Debt\" is defined in the Restated Credit Agreement to mean the principal amount of Debt in respect of advances under the Bank Facilities and the principal amount of all Debt that should, in accordance with generally accepted accounting principles as in effect on December 31, 1991, be recorded as a liability on a balance sheet and matures more than one year from the date of creation or matures within one year from such date but is renewable or extendible, at the option of the debtor, to a date more than one year from such date or arises under a revolving credit or similar agreement that obligates the lender or lenders to extend credit during period of more than one year from such date, including, without limitation, all amounts of Funded Debt required to be paid or prepaid within one year from the date of determination. \"Rolling Period\" is defined in the Restated Credit Agreement to mean, for any fiscal quarter, such quarter and the three preceding fiscal quarters. \"Total Debt\" outstanding on any date is defined in the Restated Credit Agreement to mean the sum, without duplication, of (a) the aggregate principal amount of all Debt of Flagstar and its subsidiaries, on a consolidated basis, outstanding on such date to the extent such Debt constitutes indebtedness for borrowed money, obligations evidenced by notes, bonds, debentures or other similar instruments, obligations created or arising under any conditional sale or other title retention agreement with respect to property acquired or obligations as lessee under leases that have been or should be, in accordance with generally accepted accounting principles, recorded as capital leases, (b) the aggregate principal amount of all Debt of Flagstar and its subsidiaries , on a consolidated basis, outstanding on such date constituting direct or indirect guarantees of certain Debt of others and (c) the aggregate principal amount of all Funded Debt of Flagstar and its subsidiaries on a consolidated basis consisting of obligations, contingent or otherwise, under acceptance, letter of credit or similar facilities; PROVIDED that advances under the Revolving Credit Facility shall be included in Total Debt only to the extent of the average outstanding principal amount thereof outstanding during the 12-month period ending on the date of determination. Under the Restated Credit Agreement, an event of default will occur if, among other thing, (i) any person or group of two or more persons acting in concert (other than KKR, Gollust Tierney & Oliver and their respective affiliates) acquires, directly or indirectly, beneficial ownership of securities of FCI representing, in the aggregate, more of the votes entitled to be cast by all voting stock of FCI than the votes entitled to be cast by all voting stock of FCI beneficially owned, directly or indirectly, by KKR and its affiliates, (ii) any person or group of two or more persons acting in concert (other than KKR and its affiliates) acquires by contract or otherwise, or enters into a contract or arrangement that results in its or their acquisition of the power to exercise, directly or indirectly, a controlling influence over the management or policies of Flagstar or FCI or (iii) Flagstar shall cease at any time to be a wholly-owned subsidiary of FCI. If such an event of default were to occur, the lenders under the Related Credit Agreement would be entitled to exercise a number of remedies, including acceleration of all amounts owed under the Restated Credit Agreement. PUBLIC DEBT As part of the Recapitalization, Flagstar consummated on November 16, 1992 the sale of $300 million aggregate principal amount of 10 7\/8% Senior Notes Due 2002 (the \"10 7\/8% Notes\") and issued pursuant to an exchange offer for previously outstanding debt issues $722.4 million principal amount of 11.25% Senior Subordinated Debentures Due 2004 (the \"11.25% Debentures\"). On September 23, 1993, Flagstar consummated the sale of $275 million aggregate principal amount of 10 3\/4% Senior Notes Due 2001 (the \"10 3\/4% Notes\") and $125 million aggregate principal amount of 11 3\/8% Senior Subordinated Debentures Due 2003 (the \"11 3\/8% Debentures\"). The 10 7\/8% Notes and the 10 3\/4% Notes are general unsecured obligations of Flagstar and rank PARI PASSU in right of payment with Flagstar's obligations under the\nRestated Credit Agreement. The 11.25% Debentures are general unsecured obligations of Flagstar and are subordinate in right of payment to the obligations of Flagstar under the Restated Credit Agreement, the 10 7\/8% Notes and the 10 3\/4% Notes. The 11.25% Debentures rank PARI PASSU in right of payment with the 11 3\/8% Debentures. All such debt is senior in right of payment to the 10% Debentures. THE SENIOR NOTES. Interest on the 10 7\/8% Notes is payable semi-annually in arrears on each June 1 and December 1. They will mature on December 1, 2002. The 10 7\/8% Notes will be redeemable, in whole or in part, at the option of Flagstar, at any time on or after December 1, 1997, initially at a redemption price equal to 105.4375% of the principal amount thereof to and including November 30, 1998, at a decreased price thereafter to and including November 30, 1999 and thereof at 100% of the principal amount thereof, together in each case with accrued interest. Interest on the 10 3\/4% Notes is payable semi-annually in arrears on each March 15 and September 15. They will mature on September 15, 2001. The 10 3\/4% Notes may not be redeemed prior to maturity, except that prior to September 15, 1996, the Company may redeem up to 35% of the original aggregate principal amount of the 10 3\/4% Notes, at 110% of their principal amount, plus accrued interest, with that portion, if any, of the net proceeds of any public offering for cash of the Common Stock that is used by FCI to acquire from the Company shares of common stock of the Company. THE SENIOR SUBORDINATED DEBENTURES. Interest on the 11.25% Debentures is payable semi-annually in arrears on each May 1 and November 1. They will mature on November 1, 2004. The 11.25% Debentures will be redeemable, in whole or in part, at the option of Flagstar, at any time on or after November 1, 1997, initially at a redemption price equal to 105.625% of the principal amount thereof to and including October 31, 1998, at decreasing prices thereafter to and including October 31, 2002 and thereafter at 100% of the principal amount thereof, together in each case with accrued interest. Interest on the 11 3\/8% Debentures is payable semi-annually in arrears on each March 15 and September 15. They will mature on September 15, 2003. The 11 3\/8% Debentures will be redeemable, in whole or in part, at the option of the Flagstar, at any time on or after September 15, 1998, initially at a redemption price equal to 105.688% of the principal amount thereof to and including September 14, 1999, at 102.844% of the principal amount thereof to and including September 14, 2000 and thereafter at 100% of the principal amount thereof, together in each case with accrued interest. THE 10% DEBENTURES. Interest on the 10% Debentures is payable semi-annually in arrears on each May 1 and November 1. The 10% Debentures mature on November 1, 2014. Unless previously redeemed, the 10% Debentures are convertible at any time at the option of the holders thereof by exchange into shares of Common Stock at a conversion price of $24.00 per share, subject to adjustment. The 10% Debentures are redeemable, in whole or in part, at the option of the Company upon payment of a premium. The Company is required to call for redemption on November 1, 2002 and on November 1 of each year thereafter, through and including November 1, 2013, $7,000,000 principal amount of the 10% Debentures. A \"Change of Control\" having occurred on November 16, 1992, holders of the 10% Debentures had the right, under the indenture relating thereto, to require the Company, subject to certain conditions, to repurchase such securities at 101% of their principal amount together with interest accrued to the date of purchase. On February 19, 1993, FCI made such an offer to repurchase the $100 million of 10% Debentures then outstanding. On March 24, 1993 the Company repurchased $741,000 principal amount of the 10% Debentures validly tendered and accepted pursuant to such offer. MORTGAGE FINANCINGS A subsidiary of Flagstar had issued and outstanding, at December 31, 1995, $202.7 million in aggregate principal amount of 10 1\/4% Guaranteed Secured Bonds due 2000. Interest is payable semi-annually in arrears on each November 15 and May 15. As a result of the downgrade of Flagstar's outstanding debt securities during 1994, certain payments by the Company which fund such interest payments are due and payable on a monthly basis. Principal payments total $12.5 million annually for the years 1996 through 1999; and $152.7 million in 2000. The bonds are secured by a financial guaranty insurance policy issued by Financial Security Assurance, Inc. and by collateral assignment of mortgage loans on 238 Hardee's and 148 Quincy's restaurants. Another subsidiary of Flagstar had outstanding $160 million aggregate principal amount of 11.03% Notes due 2000. Interest is payable quarterly in arrears, with the principal maturing in a single installment payable in July 2000. These notes are redeemable, in whole, at the subsidiary's option, upon payment of a premium. They are secured by a pool of cross-collateralized mortgages on approximately 240 Denny's restaurant properties.\nPART IV ITEM 14.","section_14":"ITEM 14. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. (a)(1) -- Financial Statements: See the Index to Financial Statements which appears on page hereof. (2) -- Financial Statement Schedules: No schedules are filed herewith because of the absence of conditions under which they are required or because the information called for is in the Consolidated Financial Statements or Notes thereto. (3) -- Exhibits: Certain of the exhibits to this Report, indicated by an asterisk, are hereby incorporated by reference to other documents on file with the Commission with which they are physically filed, to be a part hereof as of their respective dates.\n* Certain of the exhibits to this Annual Report on Form 10-K, indicated by an asterisk, are hereby incorporated by reference to other documents on file with the Commission with which they are physically filed, to be part hereof as of their respective dates. (b) The Company filed a report of Form 8-K on December 28, 1995 providing certain information in Item 2. Acquisition or Disposition of Assets of such report. This filing reported the consummation of sales of the Company's subsidiaries engaged in the recreation services business and in the concessions business. An unaudited pro forma condensed consolidated balance sheet for September 30, 1995 and unaudited pro forma condensed consolidated statements of operations for the year ended December 31, 1994 and the nine months ended September 30, 1995 were included in such filing.\nFLAGSTAR CORPORATION\nINDEPENDENT AUDITORS' REPORT FLAGSTAR COMPANIES, INC. We have audited the accompanying consolidated balance sheets of Flagstar Corporation and subsidiaries (the Company) as of December 31, 1994 and 1995, and the related statements of consolidated operations and consolidated cash flows for each of the three years in the period ended December 31, 1995. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 1994 and 1995 and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles. As discussed in Note 1 to the consolidated financial statements, in 1995 the Company changed its method of accounting for the impairment of long-lived assets. DELOITTE & TOUCHE LLP Greenville, South Carolina February 14, 1996\nFLAGSTAR CORPORATION STATEMENTS OF CONSOLIDATED OPERATIONS (IN THOUSANDS EXCEPT PER SHARE AMOUNTS)\nSee notes to consolidated financial statements.\nFLAGSTAR CORPORATION CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)\nSee notes to consolidated financial statements.\nFLAGSTAR CORPORATION STATEMENTS OF CONSOLIDATED CASH FLOWS (IN THOUSANDS)\nSee notes to consolidated financial statements.\nFLAGSTAR CORPORATION STATEMENTS OF CONSOLIDATED CASH FLOWS (CONTINUED) (IN THOUSANDS)\nSee notes to consolidated financial statements.\nFLAGSTAR CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS INTRODUCTION Flagstar Corporation (Company) was acquired by Flagstar Companies, Inc. (FCI) as of July 20, 1989. Prior to June 16, 1993 the Company and FCI had been known, respectively, as TW Services, Inc. and TW Holdngs, Inc. The acquisition was accounted for under the purchase method of accounting as of July 20, 1989. Accordingly, the Company has allocated its total purchase cost of approximately $1.7 billion to the assets and liabilities of Flagstar based upon their respective fair values, which were determined by valuations and other studies. As discussed in Note 3, during 1993 the Company determined that goodwill and certain intangible assets arising principally from the acquisition were impaired resulting in a write-off of such assets. The Company conducts business through its Denny's, Hardee's, Quincy's, and El Pollo Loco restaurant concepts. Denny's, a full service family restaurant chain, operates in forty-nine states, Puerto Rico, and four foreign countries, with principal concentrations in California, Florida, Texas, Washington, Arizona, Pennsylvania, Illinois, and Ohio. Hardee's competes in the quick-service sandwich segment and Quincy's operates in the steakhouse segment. The Company's Hardee's and Quincy's restaurant chains are located primarily in the southeastern United States; El Pollo Loco is a quick-service flame-broiled chicken concept which operates primarily in southern California. NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Accounting policies and methods of their application that significantly affect the determination of financial position, cash flows and results of operations are as follows: (a) CONSOLIDATED FINANCIAL STATEMENTS. The Consolidated Financial Statements include the accounts of the Company, and its subsidiaries. See also Note 13, related to subsidiaries held for sale as of December 31, 1994. Certain 1993 and 1994 amounts have been reclassified to conform to the 1995 presentation. (b) FINANCIAL STATEMENT ESTIMATES. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures 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. (c) CASH AND CASH EQUIVALENTS. For purposes of the Statements of Consolidated Cash Flows, the Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents. (d) INVENTORIES. Merchandise and supply inventories are valued primarily at the lower of average cost or market. (e) PROPERTY AND DEPRECIATION. Property and equipment owned are depreciated on the straight-line method over its estimated useful life. Property held under capital leases (at capitalized value) is amortized over its estimated useful life, limited generally by the lease period. The following estimated useful service lives were in effect during all periods presented in the financial statements: Merchandising equipment -- Principally five to ten years Buildings -- Fifteen to forty years Other equipment -- Two to ten years Leasehold improvements -- Estimated useful life limited by the lease period. (f) GOODWILL AND OTHER INTANGIBLE ASSETS. The excess of cost over the fair value of net assets of companies acquired had been amortized over a 40-year period on the straight-line method prior to being written-off at December 31, 1993. Other intangible assets consist primarily of costs allocated in the acquisition to tradenames, franchise and other operating agreements. Such assets are being amortized on the straight-line basis over the useful lives of the franchise or the contract period of the operating agreements. Certain tradenames, franchise and other operating agreements were amortized over periods up to 40 years on the straight-line basis prior to being written-off at\nFLAGSTAR CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- Continued December 31, 1993. The Company assesses the recoverability of goodwill and other intangible assets by projecting future net income, before the effect of amortization of intangible assets, over the remaining amortization period of such assets. Management believes that the projected future results are the most likely scenario assuming historical trends continue. See Note 3 for further discussion of the write-off of goodwill and certain other intangible assets. (g) IMPAIRMENT OF LONG-LIVED ASSETS. During 1995, the Company adopted the provisions of Statement of Financial Accounting Standards No. 121 (SFAS No. 121) \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of \". Pursuant to this statement, the Company reviews long-lived assets and certain identifiable intangibles to be held and used for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. In addition, long-lived assets and certain identifiable intangibles to be disposed of are reported at the lower of carrying amount or estimated fair value less costs to sell. See Note 2 for further discussion of the impairment of long-lived assets. (h) DEFERRED FINANCING COSTS. Costs related to the issuance of debt are deferred and amortized as a component of interest and debt expense over the terms of the respective debt issues using the interest method. (i) PREOPENING COSTS. The Company capitalizes certain costs incurred in conjunction with the opening of restaurants and amortizes such costs over a twelve month period from the date of opening. (j) INCOME TAXES. Income taxes are accounted for under the provisions of Statement of Financial Accounting Standards No. 109 \"Accounting for Income Taxes.\" (k) INSURANCE. The Company is primarily self insured for workers compensation, general liability, and automobile risks which are supplemented by stop loss type insurance policies. The liabilities for estimated incurred losses are discounted to their present value based on expected loss payment patterns determined by independent actuaries or experience. During 1993, the Company changed its method of determining the discount rate applied to insurance liabilities, retroactive to January 1, 1993, pursuant to Staff Accounting Bulletin (SAB) No. 92 issued by the staff of the Securities and Exchange Commission in June 1993 concerning the accounting for environmental and other contingent liabilities. The SAB requires, among other things, that a risk free rate be used to discount such liabilities rather than a rate based on average cost of borrowing, which had been the Company's practice. As a result of this change, the Company recognized an additional liability, measured as of January 1, 1993, through a one-time pre-tax charge of $12,100,000. The effect of this accounting change on 1993 operating results, in addition to recording the cumulative effect for years prior to 1993, was to increase insurance expense and decrease interest expense by approximately $5,900,000. The total discounted self-insurance liabilities recorded at December 31, 1994 and 1995 were $90,800,000 and $91,000,000 respectively, reflecting a 4% discount rate. The related undiscounted amounts at such dates were $98,800,000 and $98,000,000, respectively. (l) INTEREST RATE EXCHANGE AGREEMENTS. As a hedge against fluctuations in interest rates, the Company has entered into interest rate exchange agreements to swap a portion of its fixed rate interest payment obligations for floating rates without the exchange of the underlying principal amounts. The Company does not speculate on the future direction of interest rates nor does the Company use these derivative financial instruments for trading purposes. Since such agreements are not entered into on a speculative basis, the Company uses the settlement basis of accounting. See Note 4 for further discussion of the interest rate exchange agreements. (m) ADVERTISING COSTS. The Company expenses advertising costs as incurred. Advertising expense for the years ended December 31, 1993, 1994 and 1995 was $89,365,000, $85,799,000, and $93,012,000, respectively. (n) DISCONTINUED OPERATIONS. The Company has allocated to discontinued operations a pro-rata portion of interest and debt expense related to its acquisition debt based on a ratio of the net assets of its discontinued operations to its total consolidated net assets as of the 1989 acquisition date. Interest included in discontinued operations for the years ended December 31, 1993, 1994, and 1995 was $53.0 million, $37.4 million, and $18.9 million, respectively.\nFLAGSTAR CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- Continued (o) POSTEMPLOYMENT BENEFITS. During 1994, the Company adopted the provisions of Statement of Financial Accounting Standards No. 112 \"Employers' Accounting for Postemployment Benefits\" which requires that benefits provided to former or inactive employees prior to retirement be recognized as an obligation when earned, subject to certain conditions, rather than when paid. The impact of Statement No. 112 on the Company's statement of consolidated operations for 1994 and 1995 is not material. (p) DEFERRED GAIN. In September 1995, the Company sold its distribution subsidiary, Proficient Food Company (PFC), for approximately $128.0 million including receipt of cash of approximately $122.5 million. In conjunction with the sale, the Company entered into an eight year distribution contract with the acquirer of PFC. This transaction resulted in a deferred gain of approximately $72.0 million that is being amortized over the life of the distribution contract as a reduction of product cost. The portion of the deferred gain recognized as a reduction in product costs in 1995 was approximately $2.8 million. (q) CASH OVERDRAFTS. The Company has included in accounts payable on the accompanying consolidated balance sheets cash overdrafts totalling $59.8 million and $54.4 million at December 31, 1994 and 1995, respectively. NOTE 2 RESTRUCTURING AND IMPAIRMENT OF LONG-LIVED ASSETS Effective in the fourth quarter of 1995, as a result of a comprehensive financial and operational review, the Company approved a restructuring plan. The plan generally involved the reduction in personnel and a decision to outsource the Company's information systems function. In addition, the Company adopted SFAS No. 121 during 1995 (see Note 1(g)). In connection with such adoption, 99 restaurant units, which will continue to be operated, were identified as impaired as the future undiscounted cash flows of each of these units is estimated to be insufficient to recover the related carrying value. As such, the carrying values of these units were written down to the Company's estimate of fair value based on sales of similar units or other estimates of selling price. During 1995, the Company also identified 36 underperforming units for sale or closure generally during 1996. The carrying value of these units have been written-down to estimated fair value, based on sales of similar units or other estimates of selling price, less costs to sell. Charges attributable to the restructuring plan and the adoption of SFAS No. 121 during the year ended December 31, 1995 are comprised of the following:\nApproximately $7.5 million of the restructuring charges represent cash charges of which approximately $600,000 was incurred and paid in 1995. Unpaid amounts are included in other current liabilities on the accompanying consolidated balance sheet. The Company anticipates completion of its restructuring plan generally in 1996.\nFLAGSTAR CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 2 RESTRUCTURING AND IMPAIRMENT OF LONG-LIVED ASSETS -- Continued The 36 units identified in 1995 for disposal had aggregate operating revenues of approximately $26.1 million and negative operating income of approximately $2.9 million during 1995, and an aggregate carrying value of approximately $5.8 million as of December 31, 1995. Effective in the fourth quarter of 1993 the Company approved a restructuring plan. The plan involved the sale or closure of restaurants, a reduction in personnel, a reorganization of certain management structures and a decision to fundamentally change the competitive positioning of Denny's, El Pollo Loco and Quincy's. The plan resulted in a restructuring charge during the year ended December 31, 1993 comprised of the following:\nThe write-down of assets represented predominantly non-cash adjustments made to reduce to net realizable value approximately 240 of the Company's 1,376 Denny's, Quincy's and El Pollo Loco restaurants. These 240 restaurants were identified for sale, conversion to another concept, or closure. As of December 31, 1995, 69 units had been sold, closed or converted to another concept and 17 are intended to be disposed of generally during 1996, with an additional charge of approximately $744,000 recorded in 1995 for such units. Management intends to operate the remaining units. The 17 units to be disposed generally during 1996 had aggregate operating revenues of approximately $11.8 million and negative operating income of approximately $1.3 million during 1995 and an aggregate carrying value of approximately $1.0 million as of December 31, 1995. NOTE 3 WRITE-OFF OF GOODWILL AND CERTAIN OTHER INTANGIBLE ASSETS For the year ended December 31, 1993, the Company's consolidated statement of operations reflects charges totaling $1,474.8 million ($1,104.6 million in continuing operations and $370.2 million in discontinued operations) for the write-off of goodwill and certain other intangible assets, primarily tradenames and franchise agreements. Since the acquisition of Flagstar in 1989, the Company has not achieved the revenue and earnings projections prepared at the time of the acquisition. In assessing the recoverability of goodwill and other intangible assets prior to 1993, the Company developed projections of future operations which indicated the Company would become profitable within several years and fully recover the carrying value of the goodwill and certain other intangible assets. However, actual results have fallen short of these projections primarily due to increased competition, intensive pressure on pricing due to discounting, declining customer traffic, adverse economic conditions, and relatively limited capital resources to respond to these changes. During the fourth quarter of 1993, management determined that the most likely projections of future operating results would be based on the assumption that historical operating trends would continue. Thus, the Company determined that the projected financial results would not support the future amortization of the remaining goodwill balance and certain other intangible assets at December 31, 1993. The methodology employed to assess the recoverability of the Company's goodwill and certain other intangible assets involved a detailed six year projection of operating results extrapolated forward 30 years, which approximated the maximum remaining amortization period for such assets as of December 31, 1993. The Company then evaluated the recoverability of goodwill and certain other intangibles on the basis of this projection of future operations. Based on this projection over the next six years, the Company would have a net loss each year before income taxes and amortization of goodwill and certain other intangibles. Extension of these trends to include the entire 36 year amortization period indicated that there would be losses each year, unless the restructuring plan or other activities were successful in reversing the present operating trends; thus, the analysis indicated that there was insufficient net income to recover the goodwill and\nFLAGSTAR CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 3 WRITE-OFF OF GOODWILL AND CERTAIN OTHER INTANGIBLE ASSETS -- Continued certain other intangible asset balances at December 31, 1993. Accordingly, the Company wrote off the goodwill balance and certain other intangible asset balances including tradename and franchise agreements for its Denny's, Quincy's, and El Pollo Loco restaurant operations and tradename and location contracts for its former contract food and vending services operations. The projections generally assumed that historical trends experienced by the Company over the previous four years would continue. The current mix between company-owned and franchised restaurants was assumed to continue, customer traffic for Denny's, Quincy's, and El Pollo Loco was assumed to decline at historical rates, average check amounts for Denny's, Hardee's, Quincy's, and El Pollo Loco were assumed to increase indefinitely at historical rates due to inflation and changes in product mix, volume for Canteen (see Note 13) was assumed to decline at historical rates, and pricing for Canteen was assumed to increase at historical rates, as a result of inflation. Capital expenditures were assumed to continue at a level necessary to repair and maintain current facilities and systems. No new unit growth was assumed. Variable costs for food and labor were assumed to remain at their historical percentage of revenues. Other costs were assumed to increase at the historical inflation rate consistent with revenue pricing increases. Through the year 1999, the Company's projections indicated that interest expense would exceed operating income, which was determined after deducting annual depreciation expense; however, operating income before depreciation would be adequate to cover interest expense. A continuation of this trend for the next 30 years did not generate cash to repay the current debt and management assumes it will be refinanced at constant interest rates. NOTE 4 DEBT At December 31, 1995, the Restated Credit Agreement includes a working capital and letter of credit facility of up to a total of $160.1 million which includes a working capital sublimit of $78.6 million and a letter of credit sublimit of $125.0 million. At such date, the Company had no working capital borrowings; however, letters of credit outstanding were $93.4 million. All outstanding amounts under the Restated Credit Agreement must be repaid by June 17, 1996. See also discussion below. Long-term debt consists of the following:\nFLAGSTAR CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 4 DEBT -- Continued (a) Collateralized by restaurant and other properties with a net book value of $22.8 million at December 31, 1995. (b) Collateralized by equipment with a net book value of $14.7 million at December 31, 1995. (c) Aggregate annual maturities during the next five years of long-term debt are as follows (in thousands): 1996 -- $38,835; 1997 -- $38,470; 1998 -- $32,660; 1999 -- $26,267, and 2000 -- $322,188. The borrowings under the Restated Credit Agreement are secured by the stock of certain operating subsidiaries and the Company's trade and service marks and are guaranteed by certain operating subsidiaries. Such guarantees are further secured by certain operating subsidiary assets. The Restated Credit Agreement and indentures under which the debt securities have been issued contain a number of restrictive covenants. Such covenants restrict, among other things, the ability of Flagstar and its subsidiaries to incur indebtedness, create liens, engage in business activities which are not in the same field as that in which the Company currently operates, mergers and acquisitions, sales of assets, transactions with affiliates and the payment of dividends. In addition, the Restated Credit Agreement contains affirmative and negative financial covenants including provisions for the maintenance of a minimum level of interest coverage (as defined), limitations on ratios of indebtedness (as defined) to earnings before interest, taxes, depreciation and amortization (EBITDA), and limitations on annual capital expenditures. The Company was in compliance with the terms of the Restated Credit Agreement at December 31, 1995. Under the most restrictive provision of the Restated Credit Agreement (ratio of senior debt to EBITDA, as defined), at December 31, 1995, the Company could incur approximately $31 million of additional indebtedness. The Company is currently in the process of renewing its bank credit agreement. It is anticipated that the new agreement will consist of a $150 million working capital and letter of credit facility secured by a pledge of the stock of the Company's operating subsidiaries and all of its and their respective trademarks, tradenames, copyrights, hedge agreements, tax sharing agreements and bank accounts. The new agreement, as presently contemplated, would terminate March 31, 1999, subject to mandatory prepayments and commitment reductions under certain circumstances upon the Company's sale of assets or incurrence of additional debt. The new agreement would also include certain financial and other operating covenants generally consistent with those provided in the Restated Credit Agreement currently in effect. At December 31, 1995, the 10.25% guaranteed bonds were secured by, among other things, mortgage loans on 386 restaurants, a lien on the related restaurant equipment, assignment of intercompany lease agreements, and the stock of the issuing subsidiaries. At December 31, 1995, the restaurant properties and equipment had a net book value of $327.2 million. In addition, the bonds are insured with a financial guaranty insurance policy written by a company that engages exclusively in such coverage. Principal and interest on the bonds is payable semiannually; certain payments are made by the Company on a monthly basis. Principal payments total $12.5 million annually through 1999 and $152.7 million in 2000. The Company through its operating subsidiaries covenants that it will maintain the properties in good repair and expend annually to maintain the properties at least $18.1 million in 1996 and increasing each year to $23.7 million in 2000. In 1992, FCI loaned $150.0 million to the Company, on a subordinated basis, in exchange for a note payable. Such borrowing matures on July 28, 2017 and accrues interest at a rate which will yield the amount of cash dividends to be paid by FCI to holders of its preferred stock (approximately 9.45%, assuming no redemption or conversion of the preferred stock). The 11.03% mortgage notes are secured by a pool of cross collateralized mortgages on 240 restaurants with a net book value at December 31, 1995 of $225.5 million. In addition, the notes are collateralized by, among other things, a security interest in the restaurant equipment, the assignment of intercompany lease agreements and the stock of the issuing subsidiary. Interest on the notes is payable quarterly with the entire principal due at maturity in 2000. The notes are redeemable, in whole, at the issuer's option. The Company through its operating subsidiary covenants that it will use each property as a food service facility, maintain the properties in good repair and expend at least $5.3 million per annum and not less than $33 million, in the aggregate, in any five year period to maintain the properties.\nFLAGSTAR CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 4 DEBT -- Continued At December 31, 1995, the Company has $775 million aggregate notional amount in effect of reverse interest rate exchange agreements with maturities ranging from twelve to forty-eight months. These notional amounts reflect only the extent of the Company's involvement in these financial instruments and do not represent the Company's exposure to market risk. The Company receives interest at fixed rates calculated on such notional amounts and pays interest at floating rates based on six months LIBOR in arrears calculated on like notional amounts. The net expense from such agreements is reflected in interest and debt expense and totalled $12.2 million, $9.2 million, and $3.1 million for the years ended December 31, 1993, 1994, and 1995, respectively. Subsequent to year end, the Company terminated interest rate exchange agreements with notional aggregate amounts totalling $200 million that were scheduled to mature in 1997. Management intends to maintain its remaining exchange agreements until maturity, unless there is a material change in the underlying hedged instruments of the Company. The counterparties to the Company's interest rate exchange agreements are major financial institutions who participate in the Company's senior bank credit facility. Such financial institutions are leading market-makers in the financial derivatives markets, are well capitalized, and are expected to fully perform under the terms of such exchange agreements, thereby mitigating the credit risk to the Company. The Company is exposed to market risk for such exchange agreements due to the interest rate differentials described above. The Company monitors its market risk by periodically preparing sensitivity analyses of various interest rate fluctuation scenarios and the results of such scenarios on the Company's cash flows on a nominal and discounted basis. In addition, the Company obtains portfolio mark-to-market valuations from market-makers of financial derivatives products. Information regarding the Company's reverse interest rate exchange agreements at December 31, 1995 is as follows:\nThe estimated fair value of the Company's long-term debt (excluding capital lease obligations) is approximately $1.90 billion at December 31, 1995. Such computations are based on market quotations for the same or similar debt issues or the estimated borrowing rates available to the Company. At December 31, 1995, the estimated fair value of the $775 million notional amount of reverse interest rate swaps was a net payable of approximately $2.7 million and represents the estimated amount that the Company would be required to pay to terminate the swap agreements at December 31, 1995. This estimate is based upon a mark-to-market valuation of the Company's swap portfolio obtained from a major financial institution which is one of the counterparties to the exchange agreements. NOTE 5 LEASES AND RELATED GUARANTEES The Company's operations utilize property, facilities, equipment and vehicles leased from others. In addition, certain owned and leased property, facilities and equipment are leased to others. Buildings and facilities leased from others primarily are for restaurants and support facilities. At December 31, 1995, 899 restaurants were operated under lease arrangements which generally provide for a fixed basic rent, and, in some instances, contingent rental based on a percentage of gross operating profit or gross revenues. Initial terms of land and restaurant building leases generally are not less than twenty years exclusive of options to renew. Leases of other equipment primarily consist of merchandising equipment, computer systems and vehicles, etc.\nFLAGSTAR CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 5 LEASES AND RELATED GUARANTEES -- Continued Information regarding the Company's leasing activities at December 31, 1995 is as follows:\nThe total rental expense included in the determination of operating income for the years ended December 31, 1993, 1994 and 1995 is as follows:\nTotal rental expense does not reflect sublease rental income of $8,998,000, $9,975,000, and $14,426,000 for the years ended December 31, 1993, 1994, and 1995, respectively.\nFLAGSTAR CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 6 INCOME TAXES A summary of the provision for (benefit from) income taxes attributable to the loss before discontinued operations, extraordinary items, and cumulative effect of change in accounting principles is as follows:\nFor the year ended December 31, 1993, the Company utilized regular tax net operating loss carryforwards of approximately $9.5 million. For the years ended December 31, 1994 and 1995, the provision for income taxes relating to discontinued operations was reduced due to the utilization of regular tax net operating loss carryforwards of approximately $89 million in 1994 and $75 million in 1995. In addition, the deferred federal tax benefit for the year ended December 31, 1993, has been offset by approximately $2.7 million due to the 1% corporate tax rate increase included in the Omnibus Budget Reconciliation Act of 1993.\nFLAGSTAR CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 6 INCOME TAXES -- Continued The following represents the approximate tax effect of each significant type of temporary difference and carryforward giving rise to the deferred income tax liability or asset:\nThe Company has provided a valuation allowance for the portion of the deferred tax asset for which it is more likely than not that a tax benefit will not be realized. The difference between the statutory federal income tax rate and the effective tax rate on loss from continuing operations before discontinued operations, extraordinary items and cumulative effect of accounting change is as follows:\nAt December 31, 1995, the Company has available, to reduce income taxes that become payable in the future, general business credit carryforwards of approximately $22 million, most of which expire in 2002 through 2007, and alternative minimum tax (AMT) credits of approximately $18 million. The AMT credits may be carried forward indefinitely. In addition, the Company has available regular income tax net operating loss carryforwards of approximately $28 million which expire in 2007. Due to the Recapitalization of the Company which occurred during 1992, the Company's ability to utilize general business credits, and AMT credits which arose prior to 1992 will be limited to a specified annual amount. The annual limitation for the utilization of the tax credit carryforwards is approximately $8 million. The remaining amount of net operating loss carryforward which arose in 1992 of approximately $28 million is presently not subject to any annual limitation.\nFLAGSTAR CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 7 EMPLOYEE BENEFIT PLANS The Company maintains several defined benefit plans which cover a substantial number of employees. Benefits are based upon each employee's years of service and average salary. The Company's funding policy is based on the minimum amount required under the Employee Retirement Income Security Act of 1974. The Company also maintains defined contribution plans. Total net pension cost of defined benefit plans for the years ended December 31, 1993, 1994, and 1995 amounted to $3,724,000, $3,995,000 and $5,594,000, respectively, of which $2,802,000, $3,270,000 and $3,260,000 related to funded defined benefit plans and $922,000, $725,000 and $2,334,000 related to nonqualified unfunded supplemental defined benefit plans for executives. The components of net pension cost of the funded and unfunded defined benefit plans for the years ended December 31, 1993, 1994, and 1995 determined under SFAS No. 87 follow:\nThe following table sets forth the funded status and amounts recognized in the Company's balance sheet for its funded defined benefit plans:\nAssets held by the Company's plans are invested in money market and other fixed income funds as well as equity funds.\nFLAGSTAR CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 7 EMPLOYEE BENEFIT PLANS -- Continued The following sets forth the funded status and amounts recognized in the Company's balance sheet for its unfunded defined benefit plans:\nSignificant assumptions used in determining net pension cost and funded status information for all the periods shown above are as follows:\nIn addition, the Company has defined contribution plans whereby eligible employees can elect to contribute from 1%-15% of their compensation to the plans. These plans include profit sharing and savings plans under which the Company makes matching contributions, with certain limitations. Amounts charged to income under these plans were $3,767,000, $3,932,000, and $3,911,000 for the years ended December 31, 1993, 1994, and 1995, respectively. Incentive compensation plans provide for awards to management employees based on meeting or exceeding certain levels of income as defined by such plans The amounts charged to income under the plans for the years ended December 31, 1993, 1994, and 1995 were as follows: zero, $4,212,000, and $610,000. In addition to these incentive compensation plans, certain operations have incentive plans in place under which regional, divisional and local management participate. NOTE 8 COMMITMENTS AND CONTINGENCIES There are various claims and pending legal actions against or indirectly involving the Company, including actions concerned with civil rights of employees and customers, other employment related matters, taxes, sales of franchise rights, and other matters. Certain of these are seeking damages in substantial amounts. The amounts of liability, if any, on these direct or indirect claims and actions at December 31, 1995, over and above any insurance coverage in respect to certain of them, are not specifically determinable at this time. Flagstar has received proposed deficiencies from the Internal Revenue Service (IRS) for federal income taxes totalling approximately $12.7 million. The proposed deficiencies relate to examinations of certain income tax returns filed by the Company and Flagstar for the seven fiscal periods ended December 31, 1992. The deficiencies primarily involve the proposed disallowance of deductions associated with borrowings and other costs incurred prior to, at and just following the time of the acquisition of Flagstar in 1989. The Company intends to vigorously contest the proposed deficiencies because it believes the proposed deficiencies are substantially incorrect.\nFLAGSTAR CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 8 COMMITMENTS AND CONTINGENCIES -- Continued The Company is also the subject of pending and threatened employment discrimination claims principally in California and Alabama. In certain of these claims, the plaintiffs have threatened to seek to represent a class alleging racial discrimination in employment practices at Company restaurants and to seek actual, compensatory and punitive damages, and injunctive relief. It is the opinion of Management (including General Counsel), after considering a number of factors, including but not limited to the current status of the litigation (including any settlement discussions), the views of retained counsel, the nature of the litigation or proposed tax deficiencies, the prior experience of the consolidated companies, and the amounts which the Company has accrued for known contingencies that the ultimate disposition of these matters will not materially affect the consolidated financial position or results of operations of the Company. The Company is guarantor on capital lease obligations of approximately $5.7 million at December 31, 1995 from the sale of PFC. See Note 1(p). NOTE 9 SHAREHOLDER'S EQUITY (DEFICIT)\nNOTE 10 EARNINGS (LOSS) PER SHARE As described in the introduction, the Company is a wholly-owned subsidiary of FCI; accordingly, per share data is not meaningful and has been omited for all years.\nFLAGSTAR CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 11 EXTRAORDINARY ITEMS The Company recorded losses from extraordinary items as follows:\nDuring the third quarter of 1993, the prepayment of $387.5 million of the Company's term loan under the Restated Credit Agreement resulted in a charge-off of $26.5 million of unamortized deferred financing costs. During the first quarter of 1993, the Company purchased $741,000 in principal amount of 10% Convertible Debentures at 101% of their principal amount plus unpaid accrued interest, pursuant to change in control provisions of the indenture. The repurchase of the 10% Convertible Debentures resulted in a charge of $132,000. During the second quarter of 1994, the Company sold Canteen Corporation, a wholly-owned subsidiary. A portion of the proceeds from the sale was used to prepay $170.2 million of term and $126.1 million of working capital advances which were outstanding under the Company's Restated Credit Agreement resulting in a charge-off of $11.9 million of unamortized deferred financing costs. During the third quarter of 1995, the Company recognized an extraordinary gain totaling $0.5 million, net of income taxes, which represents the repurchase of $24,975,000 principal amount of certain senior indebtedness, net of the charge-off of the related unamortized deferred financing costs of $0.9 million. NOTE 12 RELATED PARTY TRANSACTIONS The Company expensed annual advisory fees of $250,000 for the years ended December 31, 1993 and 1994, respectively, for Gollust, Tierney & Oliver, Incorporated (GTO), a stockholder of the Company.\nFLAGSTAR CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 12 RELATED PARTY TRANSACTIONS -- Continued Donaldson, Lufkin & Jenrette Securities Corporation (DLJ), a stockholder of the Company, received $4,059,000 during the year ended December 31, 1993 for investment banking services related to the issuance of indebtedness by the Company. KKR received annual financial advisory fees of $1,250,000 for the years ended December 31, 1993, 1994, and 1995. The Company has a loan receivable at December 31, 1995 from its former chairman totaling $16,454,000. The proceeds of the loan were used during 1992 by the former chairman to repay a 1989 loan obtained for the purchase of Company common stock. The loan is due in November 1997 and is secured by 812,000 shares of common stock and certain other collateral. The Company earned for the years ended December 31, 1993, 1994, and 1995 $789,000, $842,000, and $886,000, respectively, on such loan which accrues interest at 5.6% per annum and is payable at maturity. NOTE 13 DISCONTINUED OPERATIONS During April 1994, the Company announced the signing of a definitive agreement to sell the food and vending business and its intent to dispose of the remaining concession and recreation services businesses of its subsidiary, Canteen Holdings, Inc. The Company sold Canteen Corporation, a food and vending subsidiary, for $447.1 million during June 1994, and recognized a net gain of approximately $399.2 million, net of income taxes, during the year ended December 31, 1994. During December 1995, the Company sold TW Recreational Services, Inc., a concession and recreation services subsidiary, for $98.7 million and Volume Services, Inc., a stadium concession services subsidiary for $73.4 million, both subject to certain adjustments, and recognized gains totaling $77.9 million, net of income taxes. The financial statements and related notes presented herein classify Canteen Holdings, Inc. and its subsidiaries as discontinued operations in accordance with Accounting Principles Board Opinion No. 30. Revenues and operating income (loss) of the discontinued operations for the years ended December 31, 1993, 1994, and 1995 were $1.37 billion, $859.7 million, and $322.3 million and $(313.3) million, $32.6 million, and $17.1 million, respectively.\nFLAGSTAR CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 14 QUARTERLY DATA (UNAUDITED) The results for each quarter include all adjustments which are, in the opinion of management, necessary for a fair presentation of the results for interim periods. The consolidated financial results on an interim basis are not necessarily indicative of future financial results on either an interim or an annual basis. Selected consolidated financial data for each quarter within 1994 and 1995 are as follows:\nDuring the second quarter of 1994, the Company sold its food and vending subsidiary (see Note 13) and recorded a $383.9 million net gain on the sale of the discontinued operation. During the fourth quarter of 1994, the Company increased its gain by $15.3 million to reflect the final settlement of such sale. During the fourth quarter of 1994, the Company recognized a reduction in operating expenses of approximately $15.0 million principally due to favorable claims trends associated with the Company's self-insurance liabilities. During the fourth quarter of 1995, the Company sold its concession and recreation services subsidiaries and recorded a $77.9 million net gain on the sales of such discontinued operations. NOTE 15 SUBSEQUENT EVENTS (UNAUDITED) On February 22, 1996, the Company entered into an agreement with Integrated Systems Solutions Corporation (ISSC). The ten year agreement for $323 million provides for ISSC to manage and operate the Company's information systems, as well as, develop and implement new systems and applications to enhance information technology for the Company's corporate headquarters, restaurants, and field management. ISSC will oversee data center operations, applications development and maintenance, voice and data networking, help desk operations and point-of-sale technology.\nFLAGSTAR CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 15 SUBSEQUENT EVENTS (UNAUDITED) -- Continued On March 1, 1996, the Company entered into an agreement to acquire the Coco's and Carrows restaurant chains, consisting of approximately 350 units operating in the family dining segment. The purchase is subject to the signing of certain ancillary agreements and other customary terms and conditions. If consummated, the purchase price (including estimated expenses) would consist of $131 million of cash ($56 million of which will be financed by bank term loans), the issuance of notes payable to the seller of $150 million, and the assumption of certain capital lease obligations of approximately $31.5 million.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nFLAGSTAR CORPORATION\nBy: \/s\/ RHONDA J. PARISH Rhonda J. Parish (Senior Vice President, General Counsel and Secretary)\nDate: March 29, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, 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":"814037_1995.txt","cik":"814037","year":"1995","section_1":"ITEM 1. BUSINESS.\n(a) GENERAL DEVELOPMENT OF BUSINESS.\nEssef Corporation was incorporated in Ohio in 1954 as Structural Fibers, Inc. and commenced operations by focusing on an emerging technology: the use of fiberglass reinforced plastics (FRP) as an alternative to metal in cast, forged, and other formed or fabricated parts. The Company, having a strong engineering oriented emphasis, pioneered the production of such products for use in Polaris and Hercules missiles, jet engines, electrical components, and other national defense related items.\nThis experience helped the Company successfully develop a proprietary molding technology that radically changed its direction. Perfection of the internal bag-molding process enabled mass production of seamless pressure vessels with fiberglass-reinforced plastic, and in 1959, the Company began to specialize in the manufacture of these products.\nBy the early 1970's, with the Company's basic product well established in the pressure vessel market, the Company acquired Pac-Fab, Inc. (Pac-Fab) a manufacturer of iron, brass and steel pump and filter products. As a result of product conversion to polymeric materials, Pac-Fab today is a manufacturer of swimming pool filters, pumps, underwater lights, and other swimming pool equipment produced from engineered plastics.\nIn 1976, sa SFC nv was formed in Herentals, Belgium. This company manufactures and distributes FRP pressure vessels, polyglass wound vessels, and swimming pool filters for the European market.\nIn October 1991, sa SFC nv formed a new subsidiary, Structural Iberica S.A. (Structural Iberica), located in Barcelona, Spain. This subsidiary distributes water treatment, well system, and swimming pool products, primarily in Spain.\nIn 1981, the Company acquired QPI and thus entered into the blow molding business. QPI transferred its manufacturing operations to the Company's Chardon facility in 1985 to support the Company's manufacturing capabilities for its proprietary pressure vessels. During the period 1989 through early 1991, QPI entered the market as a custom blow molder specializing in the production of structural flat panel systems. Today, as an integral part of Structural Fibers, and no longer recognized as a separate business unit, the capabilities of QPI are almost entirely focused on the Company's proprietary product lines. The Company also has blow molding capabilities in Europe to support its proprietary products which are manufactured there.\nAs part of the plan to sustain growth and to finance working capital needs, the Company made an initial public offering of common shares in June, 1987. The offering enabled the Company to expand manufacturing capacity in all operating segments in the period 1987 through 1990, although some facilities and equipment have since been sold.\nENPAC Corporation (ENPAC) was formed in 1988. It designs, manufactures, and markets proprietary engineered plastic vessels and related accessory products for secondary containment and regulated transport of industrial and environmentally hazardous waste materials.\nPage 3 of 68 sequentially numbered pages In the Fall of 1988, the Company acquired Hobson Brothers Aluminum Foundry & Mould Works, Inc. (Hobson Brothers) a blow mold and injection mold toolmaker operating in Shell Rock, Iowa.\nContaminant Recovery Systems, Inc. (ConRec) was formed in March, 1989 as a joint venture to develop and market proprietary equipment for the minimization of hazardous waste generation and recycling of process water in plating, metal finishing, and other chemical process industries where hazardous waste management is of growing concern.\nIn 1981, the Company acquired FAME Plastics, Inc. (FAME), a custom injection molder specializing in engineered plastic parts for the business machine and computer industry. During the fourth quarter of fiscal year 1990, the Company adopted a plan to dispose of FAME and substantially all of the net assets of FAME were sold in fiscal year 1991.\nIn September 1992, Structural Fibers Division and its sister company in Europe, SFC, agreed to a simultaneous name change. Structural Fibers became Structural North America, and SFC became Structural Europe N.V. (Structural Europe).\nIn March of 1994, Pac-Fab acquired Purex Pool Systems, Inc., (Purex Pool Systems) a manufacturer of pumps, filters and heaters for the swimming pool market.\nIn December of 1994, the Company signed a joint venture agreement with a German manufacturer and distributor of metal hydropneumatic pressure vessels. The joint venture, Reflex-WellMate GmbH is developing a composite hydropneumatic pressure vessel to be manufactured and sold in Europe.\nIn July 1995, the Company acquired Advanced Structures, Inc. of Escondido, California, a manufacturer of composite pressure vessel housings for industrial and municipal reverse osmosis membrane systems.\nIn August of 1995, the Company acquired Euroimpex Srl, in Milan, Italy, a manufacturer of pressure vessels and other components for the water treatment industry.\nIn September of 1995, the company acquired Compool Corporation of Mountain View, California, a manufacturer of electronic controls and valves for swimming pools and spas.\n(b) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS.\n[For financial information about industry segments in which the Company is engaged in business see Item 8 Financial Statements and Supplementary Data; Note 10: Business Segment Information under Notes to Consolidated Financial statements.]\n(c) NARRATIVE DESCRIPTION OF BUSINESS.\n- in general\nEssef Corporation designs, manufactures and markets products made from engineered plastics and specialized polymers combined with fiberglass and other reinforcing materials. Principal products in the water treatment and systems equipment segment include pressure vessels used in the treatment,\nPage 4 of 68 sequentially numbered pages. storage and delivery of water. Principal products in the swimming pool and spa equipment segment include filters, heaters, pumps, underwater lights, and accessories for swimming pools and spas. The Company draws on its ability to adapt emerging technologies in plastic materials and plastic processing equipment to design and manufacture products requiring special performance characteristics such as high strength-to-weight ratios, resistance to corrosion, precise dimensional tolerances, and particular surface appearance.\nThe Company operates in two industry segments: 1) water treatment and systems equipment, and 2) swimming pool and spa equipment. The water treatment and systems equipment segment manufactures and markets fiberglass reinforced plastic pressure vessels and related components used in the treatment, filtration and storage of water in residential, commercial and industrial water supply systems. Additionally this segment manufactures engineered plastic vessels and accessory products for secondary containment and regulated transport of industrial and environmentally hazardous waste materials. Structural North America, Advanced Structures, ENPAC, ConRec, Hobson Brothers, Structural Europe, Euroimpex, Reflex-WellMate GmbH and Structural Iberica operate in this segment.\nThe swimming pool and spa equipment segment manufactures and markets filters, heaters, pumps, underwater lights, white goods, electronic controls and valves and other components for swimming pools and spas. Pac-Fab, Purex Pool Systems, Compool and Structural Europe operate in this segment.\nStructural North America, Advanced Structures, ENPAC, Pac-Fab, Compool and Purex Pool Systems serve primarily the domestic and Canadian markets. Hobson Brothers serves both the domestic and international markets. Structural Europe, Euroimpex, Reflex-WellMate and Structural Iberica serve the European and other International markets. ConRec serves principally the domestic market.\n-by industry segment\nWATER TREATMENT AND SYSTEMS EQUIPMENT INDUSTRY SEGMENT\nPrincipal Products\nStructural North America and the Company's European subsidiaries manufacture and distribute fiberglass reinforced plastic pressure vessels for the treatment, storage and delivery of water for residential, commercial and industrial use. The Company produces two companion lines of vessels, distinguishable by design and method of construction but not by purpose or function, for sale to both the water treatment equipment and water systems equipment markets of this industry segment. The vessels comprising what has become known as the FRP product line (an acronym for fiberglass reinforced plastic) are integrally cast of a matrix of thermosetting resin and randomly laid chopped fiberglass reinforcing filaments. By contrast, the vessels comprising the newer polyglass (PolyGlass(TM)) product line are either blow-molded or rotationally cast of thermoplastic resins and then reinforced by a patterned winding of continuous fiberglass filaments.\nENPAC manufactures engineered plastic vessels and related accessory products for secondary containment and regulated transport of industrial and environmentally hazardous waste materials.\nConRec, a majority-owned joint venture of Essef Corporation, designs and markets proprietary contaminant filtration and recovery systems and hazardous\nPage 5 of 68 sequentially numbered pages waste minimization systems to the electroplating, metal finishing and circuit board manufacturing industries. Operations of this company are included in the water treatment and systems equipment segment.\nHobson Brothers designs and manufactures custom blow molds which are used by its customers for processing engineered plastics in various industries. The molds are sold by inside salesmen and commissioned sales representatives. Hobson Brothers believes that it receives a significant portion of its business through referrals from plastics material suppliers.\nReflex-Wellmate GmbH is developing a composite hydropneumatic pressure vessel to be manufactured and sold in Europe.\nAdvanced Structures manufactures composite pressure vessel housings for industrial and municipal reverse osmosis membrane systems.\n[For information relating to the amount of sales of the water treatment and systems equipment segment, see Item 8 Financial Statements and Supplementary Data; NOTE 10: BUSINESS SEGMENT INFORMATION UNDER NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.]\nCustomers and Distribution\nThe Company sells water treatment products to major original equipment manufacturers (OEMs) in the United States, Canada, Europe and other International markets through salaried sales personnel. It sells water systems products through both salaried sales personnel and commissioned sales representatives to plumbing wholesalers and well system supply houses, primarily in the United States and Canada. The Company sells environmental containers and related plastic products primarily through distributors located primarily in the United States.\nCompetition\nThe Company's only major competitor in water treatment products in the United States is Park International, Inc. The Company has several competitors in Europe. The Company competes both domestically and in Europe on the basis of its more extensive product line, quality and service.\nManufacturers of steel tanks currently hold approximately 88% of the water systems market. The largest producer of steel tanks and the Company's primary competitor in these products is Amtrol, Inc. The Company believes that it competes in this market by providing its customers with better features, responsive distribution practices, and competitive pricing.\nThe Company is one of several manufacturers supplying vessels, the majority of which in this industry are steel, for secondary containment of environmentally hazardous waste materials. The Company competes on the basis of quality and an innovative product line.\nThe Company competes in the mold business with several manufacturers. The Company believes it has one of the largest blow mold manufacturing facilities in the U.S. The Company offers a full range of capabilities with a mold shop, foundry, pattern shop, engraving, CAD\/CAM, and complete engineering design services, as well as the capability to sample many blow molds. The Company believes that it competes by producing high quality custom molds with technologically advanced machinery, and with on-time delivery. Page 6 of 68 sequentially numbered pages SWIMMING POOL AND SPA EQUIPMENT INDUSTRY SEGMENT\nPrincipal Products\nThe Company manufactures and sells a complete line of filters, heaters, pumps, underwater lights, white goods, electronic controls, valves and other accessories for swimming pools and spas through Pac-Fab, Purex Pool Systems, Compool and through the Company's European subsidiary, Structural Europe. The Company sells its products under the Purex-Triton(TM) and Compool(TM) names.\nThe filters come in a range of sizes and materials to satisfy consumer needs. The filter media is sand, diatomaceous earth, or cartridge. Pumps are made in a range of sizes from 1\/2 to 20 horsepower and configured for high flow or high pressure. Lights are made in a variety of wattages as well as bulb type and cord length. The heaters are gas and are available with electronic or pilot light ignition. White goods consist of skimmers, main drains, and fittings and come in a variety of configurations and sizes.\n[For information relating to the amount of sales of the swimming pool and spa equipment segment, see Item 8 Financial Statements and Supplementary Data; NOTE 10: BUSINESS SEGMENT INFORMATION UNDER NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.]\nCustomers and Distribution\nIn the swimming pool market, the Company sells its products primarily to distributors. Sales of spa products and jetted tub pumps are primarily to OEMs and the balance to distributors. The Company maintains a field sales organization made up of salaried territory managers, each of whom is assigned to and based in a geographic region to service customer accounts and develop business within that particular region. The Company also has two commissioned sales groups geographically disbursed in the United States and Canada.\nCompetition\nThere are eight significant competitors in the swimming pool and spa equipment market, two of which are considered by the Company to be its major competitors. The Company is a market leader in sales of in-ground pool filters and estimates that it currently sells about 9.5% of all such pool filters. The Company believes that it competes in the filter market by offering high quality products which are priced competitively.\nHistorically, the Company's sales of pumps have been less than its sales of filters. With the growing family of Challenger(TM) and WhisperFlo(TM) pumps, the Company now competes effectively in the pump market. In particular, the Company believes that its market presence, existing distribution channels and reputation for quality in the filter market is contributing to market penetration and increasing sales of its pumps.\nSOURCES AND AVAILABILITY OF RAW MATERIALS - ALL INDUSTRY SEGMENTS\nThe principal material used in all segments of the Company's business, except mold making and certain of ConRec's products, is plastic resins. The Company has alternate sources for these resins and is not dependent on any single supplier. The supply of materials for making molds and the ConRec products is readily available from a number of suppliers. The Company\nPage 7 of 68 sequentially numbered pages believes that it has alternate sources for substantially all other materials required for the production of its products.\nBACKLOG - BUSINESS IN GENERAL\nAs of September 30, 1995 and September 30, 1994, the Company had a backlog of orders believed by it to be firm of approximately $7,511,000 and $7,871,000 respectively. The Company expects the backlog as of September 30, 1995 to be delivered in fiscal 1996.\nSEASONALITY AND WORKING CAPITAL - BY INDUSTRY SEGMENT\nSwimming pool and spa equipment experiences the greatest demand for their products during the second and third quarters of each fiscal year, when Pac-Fab, Purex Pool Systems, Compool and the Company's European subsidiaries fill approximately 60% of their orders to distributors who are increasing their inventories to meet the peak demand for swimming pool equipment in the spring and early summer months.\nBecause of the seasonality described above, the Company's peak demand for working capital occurs during the second and third quarters. In addition, Pac-Fab, Purex Pool Systems, Compool and Structural Europe offer their customers extended terms during this period and thereby decrease the cash flow from operations available to the Company during these quarters. The Company has historically met these needs from its revolving credit facility and income from operations. The Company expects its working capital requirements to continue to fluctuate on a seasonal basis and to be financed both from its revolving credit facility and from cash flow from operations.\nENGINEERING AND DEVELOPMENT - BUSINESS IN GENERAL\nThe Company believes its success is dependent upon its ability to adapt materials, machines, processes and other emerging technologies to the design and manufacture of new products and to the improvement of the performance, quality and manufactured cost of existing products. For this reason, expenditures of the Company in engineering and development have been primarily directed to the development of devices and processes and not to fundamental research.\n[For expenditures on engineering and development see Item 8 Financial Statements and Supplementary Data; CONSOLIDATED STATEMENTS OF INCOME - ESSEF AND SUBSIDIARIES FOR THE YEARS ENDED SEPTEMBER 30, 1995, 1994, AND 1993; line item ENGINEERING AND DEVELOPMENT.]\nPATENTS AND TRADEMARKS - BUSINESS IN GENERAL\nThe Company owns various trademarks, trade names and logos, the most important of which are Triton(R), Challenger(TM), Purex-Triton(TM), Codeline(TM), Purex(TM), Hatteras(R), Nautilus(R), WhisperFlo(TM), MiniMax(TM), Poly Glass(TM), and WellMate(TM). The Company owns a number of patents covering various aspects of the Company's products and manufacturing processes. Although the Company believes its patents, trademarks, trade names and logos enhance its competitive position and the name recognition of its products, the Company relies more on its reputation for quality and its relationship with customers for the maintenance and growth of its business.\nPage 8 of 68 sequentially numbered pages ENVIRONMENTAL MATTERS - BUSINESS IN GENERAL\nThe Company's manufacturing processes, like those of the plastics industry generally, result in the generation of hazardous and other plant waste and emissions. Consequently, the Company is subject to various federal, state and local laws and regulations relating to environmental protection. The Company routinely monitors and maintains installed equipment as necessary to assure operation continuously in substantial compliance with the environmental regulations to which they are subject. All operating facilities file reports with and obtain current operating permits from appropriate governmental oversight agencies.\nEMPLOYEES - BUSINESS IN GENERAL\nAt September 30, 1995, the Company employed 1096 persons, of whom 338 are salaried managerial, administrative and supervisory personnel. The balance are hourly personnel. Hourly employees at the Purex Pool Systems subsidiary are covered by a collective bargaining agreement. The Company has not experienced work stoppages and considers its relations with its employees to be good.\n(d) FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND EXPORT SALES.\n[For financial information about foreign and domestic operations and export sales see item 8 Financial Statements and Supplementary Data; NOTE 10: BUSINESS SEGMENT INFORMATION under NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.]\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company's headquarters are in Chardon, Ohio, in offices contiguous to the division operating there.\nThe Company conducts its manufacturing, accounting, purchasing, marketing and engineering operations at eleven facilities in the United States, one in Belgium, two in Italy and one in Wales, U.K. The Company has rented additional facilities near its Chardon, Ohio operations for use as temporary storage or operations. The table below summarizes certain information with respect to the principal facilities. The table does not include the administrative\/sales office which is leased by the Company's joint venture, ConRec.\nPage 9 of 68 sequentially numbered pages\nPage 10 of 68 sequentially numbered pages The Company considers all of its properties, both owned and leased, together with the related machinery and equipment contained therein to be well maintained, in good operating condition, and suitable and adequate for its present and forseeable future needs.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nCertain claims, suits and complaints arising in the ordinary course of business have been filed or are pending against the Company. In the opinion of management, all such matters are adequately covered by insurance, or if not so covered are without merit or are of such a nature, or involve such sums, as not to have a significant adverse effect on the financial position of the Company or the results of its operations were they to be disposed of unfavorably.\nThe Company is a participating defendant under a 1985 consent decree issued in United States of America v. Chem-Dyne Corporation. This consent decree attempts to resolve conflicting claims of responsibility and provide for the cleanup of a toxic waste disposal site in Hamilton, Ohio. The Company contributed approximately $29,000 of the $23,000,000 trust established by the consent decree and paid approximately $12,000 in administrative costs associated with the suit. Although the Company remains contingently liable for any and all additional amounts that may be necessary for the cleanup of the disposal site, the Company does not believe that any significant additional expense will be incurred.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNo matters were submitted to a vote of security holders, through the solicitation of proxies or otherwise, during the fourth quarter of the year covered by this report.\nPage 11 of 68 sequentially numbered pages PART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDERS' MATTERS.\nEssef Corporation Common Shares are listed in THE NASDAQ Stock Market under the symbol ESSF. At November 17, 1995 the outstanding common shares were held by 419 shareholders of record. There were no cash dividends declared or paid for the year ended September 30, 1995 as the company continued its policy of retaining earnings and cash for future expansion of the business. [For information in respect of the market price range see Item 8 Financial Statements and Supplementary Data; Note 13: Quarterly Information (unaudited) of Notes to Consolidated Financial statements.]\nPage 12 of 68 sequentially numbered pages ITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe following data has been selected from the Consolidated Financial Statements of the Company and its Subsidiaries for the periods and dates indicated:\nINCOME STATEMENT DATA: (Dollars in Thousands Except Per Share Data)\nPage 13 of 68 sequentially numbered pages BALANCE SHEET DATA: (AT SEPTEMBER 30) (Dollars in Thousands)\n(1) Average shares outstanding represents common shares outstanding plus equivalents (stock options).\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nRESULTS OF OPERATIONS 1995 COMPARED WITH 1994\nNET SALES\nNet sales of $157,507,000 increased 17.5 percent from 1994 net sales of $134,020,000. Water treatment and systems equipment segment sales increased 9.9 percent to $71,556,000 from $65,134,000 recorded in 1994. The acquisitions of Advanced Structures and Euroimpex contributed approximately 60 percent of this increase. Other contributors to the sales increase in this segment were commercial and industrial water treatment products and the Company's Hobson Brothers subsidiary. This growth was partially offset by reduced sales in the secondary containment business (ENPAC). The Company's business generated from its European subsidiary in this segment increased 19.3 percent compared with last year. Sales of the swimming pool and spa equipment segment of $85,951,000 increased 24.8 percent from $68,886,000 reported in 1994. Domestic swimming pool and spa equipment sales increased 25.3 percent over 1994, while swimming pool and spa equipment sales generated from the Company's European subsidiary increased 17.6 percent from the prior year. Purex Pool Systems (acquired in March, 1994) was the major contributor to the domestic increase. As of September 30, 1995 and 1994, the Company had a backlog of orders of approximately $7,511,000 and $7,871,000 respectively. The Company expects that the September 30, 1995 backlog will be delivered in fiscal 1996.\nCOSTS AND EXPENSES\nCost of sales increased from 69.6 percent to 72.5 percent. All divisions experienced increases except Structural Europe which was flat. The cost of sales increase was primarily the result of an increase in material cost and changes in product mix. Operating expenses, consisting of engineering and development, selling, and administrative expenses increased $2,751,000, but\nPage 14 of 68 sequentially numbered pages as a percentage of sales decreased from 21.4 percent to 20.0 percent. The percentage of sales decrease is a result of better management of operating expenses and increased sales.\nINTEREST EXPENSE\nInterest expense increased by $800,000 to $2,075,000. This was primarily the result of an approximate 15 percent increase in average outstanding borrowings of the Company (for acquisition purposes) and an increase in the effective interest rate of approximately 170 basis points.\nOTHER INCOME\nOther income in 1995 and 1994 consists primarily of interest income received pursuant to a receivable under an Agreement for Deed.\nINCOME TAXES\nThe Company recorded a $3,710,000 tax provision in fiscal 1995, which reflects an effective tax rate of 36.0 percent. In fiscal 1994 the Company recorded a $4,379,000 provision which represents an effective tax rate of 38.5 percent.\nINCOME BEFORE EXTRAORDINARY ITEM\nThe Company reported income before extraordinary item of $6,591,000 compared to $6,995,000 in 1994. The change between years is a result of the addition of Purex offset by decreased income at ENPAC and increased interest expense.\nNET INCOME\nThe Company reported net income of $7,511,000 compared to 1994 net income of $6,995,000. In addition to the items listed above, the change between years is a result of the fire in Hobson Brothers' foundry building. The excess of $1,437,000 (less related income tax of $517,000) of the insurance claim over the net book value of the Company's assets has been reflected as an extraordinary gain.\nRESULTS OF OPERATIONS 1994 COMPARED WITH 1993\nNET SALES\nNet sales of $134,020,000 increased 28.3 percent from 1993 net sales of $104,466,000. Water treatment and systems equipment segment sales increased 10.9 percent to $65,134,000 from $58,723,000 recorded in 1993. Major contributors to the sales increase in this segment were commercial and industrial water treatment products, WellMate sales and the Company's Hobson Brothers subsidiary. This growth was partially offset by reduced sales in the secondary containment business (ENPAC). The Company's business generated from its European subsidiary in this segment was flat compared with 1993. Sales of the swimming pool and spa equipment segment of $68,886,000 increased 50.6 percent from $45,743,000 reported in 1993. Domestic swimming pool and spa equipment sales increased 54.6 percent over\nPage 15 of 68 sequentially numbered pages 1993, while swimming pool and spa equipment sales generated from the Company's European subsidiary increased 10.8 percent from the prior year. In March, 1994, the Company acquired the assets and assumed certain liabilities of Purex Pool Systems, Inc. (Purex). Without the impact of the Purex sales, the swimming pool and spa equipment segment sales would have increased 16.4 percent. As of September 30, 1994 and 1993, the Company had a backlog of orders believed by it to be firm of approximately $7,871,000 and $5,090,000 respectively.\nCOSTS AND EXPENSES\nCost of sales decreased from 69.9 percent to 69.6 percent. Improvements occurred at Pac-Fab and Hobson due to increased sales which resulted in better utilization of fixed costs. This was partially offset by a shift in product mix with a higher cost of sales for products sold at Structural North America and Purex. Operating expenses, consisting of engineering and development, selling and administrative expenses, increased $4,296,000, but as a percentage of sales decreased from 23.4 percent to 21.4 percent. In fiscal 1993 a non-recurring charge was incurred for an arbitration award and a severance package for the Company's European managing director. While no such non-recurring charge was incurred in fiscal 1994, additional engineering and development expenses related to new product development and a new marketing program in the domestic swimming pool business, and the addition of Purex expenses exceeded the 1993 non-recurring charge.\nINTEREST EXPENSE\nInterest expense increased by $111,000 to $1,275,000. This was primarily the result of an approximate 9.3 percent increase in average outstanding borrowings of the Company, caused by the acquisition of Purex, and a slight increase in the effective interest rate.\nOTHER INCOME\nOther income in 1994 and 1993 consists primarily of interest income received pursuant to a receivable under an Agreement for Deed.\nINCOME TAXES\nThe Company recorded a $4,379,000 tax provision in fiscal 1994, which reflects an effective tax rate of 38.5 percent. In fiscal 1993 the Company recorded a $527,000 provision. This provision reflected tax expense in the Company's international operations and state tax provisions related to certain of the Company's domestic operations. Net book operating loss carryforwards of approximately $5.4 million were used during fiscal 1993 to offset approximately $1.8 million of U.S. tax provision.\nNET INCOME\nThe Company reported net income of $6,995,000 as compared to a 1993 net income of $6,173,000. The change between years is a result of increased sales and income from operations offset by an increase in the effective tax rate.\nPage 16 of 68 sequentially numbered pages\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company had working capital of $21,423,000 at September 30, 1995 compared to $18,212,000 at September 30, 1994, and the ratio of current assets to current liabilities decreased to 1.76 to 1.00 from 2.00 to 1.00. The increase in working capital is due primarily to an increase in accounts receivable, inventories and prepayments offset by an increase in notes payable, accounts payable and accrued expenses. These increases are primarily due to the acquisitions of Advanced Structures, Inc., Euroimpex and Compool. Capital expenditures for fiscal 1995 totaled $8,387,000 compared to $4,906,000 in fiscal 1994, and were funded from net income, depreciation and borrowing. The difference in capital expenditures relates to building renovations, investment in tooling for new and existing products and capital expenditures associated with Purex which was acquired in March, 1994. The Company has a revolving loan, acquisition-related line of credit and term loan facility providing a maximum availability of $53 million through its bank group. In addition, the Company's Belgium subsidiary has a line of credit available of $8.5 million. As of September 30, 1995, approximately $39.4 million is available under these facilities. Management expects that cash generated from operating activities and its borrowing capacity will be sufficient to meet its current obligations, to fund current operating and capital requirements and finance future growth.\nThe Company is involved in various claims and lawsuits incidental to its business, including product liability claims which are covered by insurance and for which the self-insured deductible per claim has over the past several years ranged from a low of $75,000 to its current level of $275,000. Although the Company believes that its' reserves, approximately $748,000 as of September 30, 1995, are adequate, a significant increase in the aggregate amount of claims could have an adverse effect on the deductible level or upon the Company's ability to obtain product liability coverage for certain product lines. Management is addressing this issue in various ways and is reasonably confident, but cannot guarantee, that the situation will be managed with no material adverse impact on the Company. As of the end of September 1995, the Company had foreign assets of approximately $18 million principally located in Belgium and Italy. The assets were converted at year end using a U.S. dollar exchange rate that was 8.6% lower than at September 30, 1994.\nDIVIDENDS\nThe Company intends to continue its policy of retaining earnings and cash for the future expansion of the business.\nPage 17 of 68 sequentially numbered pages ITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nCONSOLIDATED STATEMENTS OF INCOME ESSEF CORPORATION AND SUBSIDIARIES For the Years Ended September 30, 1995, 1994, and 1993 (Dollars in Thousands Except Per Share Data)\nSee Notes to Consolidated Financial Statements\nPage 18 of 68 sequentially numbered pages CONSOLIDATED BALANCE SHEETS ESSEF CORPORATION AND SUBSIDIARIES September 30, 1995 and 1994 (Dollars in Thousands)\nSee Notes to Consolidated Financial Statements\nPage 19 of 68 sequentially numbered pages CONSOLIDATED BALANCE SHEETS ESSEF CORPORATION AND SUBSIDIARIES (CONTINUED) September 30, 1995 and 1994 (Dollars in Thousands)\nSee Notes to Consolidated Financial Statements\nPage 20 of 68 sequentially numbered pages CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY ESSEF CORPORATION AND SUBSIDIARIES For the Years Ended September 30, 1995, 1994, and 1993 (Dollars in Thousands except for number of shares)\nSee Notes to Consolidated Financial Statements\nPage 21 of 68 sequentially numbered pages CONSOLIDATED STATEMENTS OF CASH FLOWS ESSEF CORPORATION AND SUBSIDIARIES For the Years Ended September 30, 1995, 1994, and 1993 (Dollars in Thousands)\nSee Notes to Consolidated Financial Statements\nPage 22 of 68 sequentially numbered pages CONSOLIDATED STATEMENTS OF CASH FLOWS ESSEF CORPORATION AND SUBSIDIARIES (CONTINUED) For the Years Ended September 30, 1995, 1994, and 1993 (Dollars in Thousands)\nSee Notes to Consolidated Financial Statements\nPage 23 of 68 sequentially numbered pages NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ESSEF CORPORATION AND SUBSIDIARIES SEPTEMBER 30, 1995, 1994, AND 1993 NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBUSINESS\nEssef Corporation is the leading worldwide supplier of composite components and subsystems for the movement, storage and treatment of water. Residential, commercial, industrial, and municipal end-users rely on the Company's high-performance products for consistent and reliable results. Essef's technology produces products that are basic to almost any water treatment, filtration, or storage system. The Company reports its business in two segments: Swimming Pool and Spa Equipment, and Water Treatment and Systems Equipment.\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the accounts of Essef Corporation and subsidiaries (the Company). All significant intercompany items have been eliminated. Certain reclassifications have been made to prior year amounts in order to be consistent with the presentation for the current year.\nREVENUE RECOGNITION\nThe Company recognizes revenue when products are shipped.\nCASH AND CASH EQUIVALENTS\nThe Company considers all highly liquid short term investments with initial maturities of three months or less to be cash equivalents.\nDEPRECIATION AND AMORTIZATION\nDepreciation is computed on the straight-line method for financial reporting purposes while accelerated methods are used for tax reporting purposes. Goodwill arising from business acquisitions is amortized on the straight-line method over forty years. The Company continually evaluates goodwill to assess recoverability.\nINCOME TAXES\nEffective October 1, 1993, the Company adopted the provisions of the Financial Accounting Standards Board Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes\", which requires the use of the liability method of accounting for deferred taxes. SFAS No. 109 supersedes SFAS No. 96, \"Accounting for Income Taxes\", which the Company had adopted in the first quarter of 1992. The consolidated\nPage 24 of 68 sequentially numbered pages NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ESSEF CORPORATION AND SUBSIDIARIES SEPTEMBER 30, 1995, 1994, AND 1993\nfinancial statements for prior years have not been restated and the cumulative effect of the accounting change was not material. The provision for income taxes includes federal, foreign, state and local taxes currently payable and those deferred because of temporary differences between financial statement and tax bases of assets and liabilities.\nEARNINGS PER SHARE\nThe computation of earnings per share is based on the weighted average number of outstanding common shares and equivalents (stock options) during the periods. Average shares outstanding for the purpose of calculating earnings per share were 5,831,098 in 1995, 5,742,705 in 1994, and 5,713,763 in 1993.\nFOREIGN CURRENCY TRANSLATION\nAssets and liabilities of the Company's foreign subsidiaries are translated at current exchange rates and the results of operations are translated at the average exchange rates during the periods. Adjustments resulting from these translations are recorded as a separate component of Shareholders' Equity.\nNOTE 2: INVENTORIES\nInventories are stated at the lower of cost or market. The majority of domestic inventories are valued using the last-in, first-out (LIFO) method and the balance of the Company's inventories are valued using the first-in, first-out (FIFO) method.\nInventories are valued as follows:\n(dollars in thousands)\nPage 25 of 68 sequentially numbered pages NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ESSEF CORPORATION AND SUBSIDIARIES SEPTEMBER 30, 1995, 1994, AND 1993\nNOTE 2: INVENTORIES (CONTINUED)\nNOTE 3: ACCRUED EXPENSES\nThe following components of accrued expenses were in excess of 5% of total current liabilities: (dollars in thousands)\nNOTE 4: NOTE RECEIVABLE UNDER AGREEMENT FOR DEED\nThe Company has restructured the original Agreement for Deed which was for the sale of the remaining assets of Fame Plastics, Inc., now known as Sanford Technology Corporation, to Apogee Plastics. Subsequent to the sale of Fame, Apogee Plastics was acquired by Apogee Acquisition Corporation which acquired and assumed all rights and obligations of Apogee Plastics under the Agreement for Deed. Simultaneously with the assumption, the face value of the note was reduced to $4.6 million, a payment for $.75 million was then made to reduce the receivable to $3.85 million. The receivable bears interest at 10% and requires interest payments from April 1, 1995 through March 1, 1996, at which time a $.25 million principal payment is due. Interest and principal payments, based on a 15 year amortization, are required monthly beginning April 1, 1996 through and including February 1, 2000. On March 1, 2000 there shall be due and payable a final payment in an amount equal to the entire unpaid principal balance and all unpaid accrued interest. Under the Agreement for Deed, conveyance of title to the buyer will occur upon full payment of the $3.85 million receivable. Until such time, title remains with the Company.\nPage 26 of 68 sequentially numbered pages NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ESSEF CORPORATION AND SUBSIDIARIES SEPTEMBER 30, 1995, 1994, AND 1993\nNOTE 5: FINANCIAL INSTRUMENTS\nThe Company has financial instruments which consist primarily of cash and cash equivalents, accounts receivable, a receivable under an agreement for deed, notes payable and long-term debt. The Company has determined that the estimated fair value of its financial instruments approximates carrying value. At September 30, 1995 the Company held no derivative financial instruments.\nNOTE 6: LONG-TERM DEBT\nThe Company and its bank group have an unsecured $33,000,000 revolving loan, an acquisition-related line of credit in the maximum aggregate amount of $10,000,000, and an additional term loan facility in the maximum aggregate amount of $10,000,000. There are no outstanding borrowings on the acquisition-related line of credit at September 30, 1995. The revolving loan extends through January 31, 1997 and may be extended in one year increments with the approval of the bank group. The term loan is payable in equal quarterly installments using a seven year amortization schedule with the unpaid principal balance outstanding due January 31, 1997. Interest rates for the revolving loan, acquisition-related line of credit, and term loan are based on increments over the lead bank's base lending rate or LIBOR rate at the Company's option. A 3\/8 percent commitment fee is payable on the unused portion of the revolving loan and the acquisition-related line of credit.\nThe Company's Belgium subsidiary has a line of credit available of approximately $8.5 million. There are no outstanding borrowings as of September 30, 1995. In addition, a note payable of $3.75 million is outstanding related to the acquisition of a subsidiary and is due January 31, 1996. Interest is charged at a rate of 8% annually.\nThe Company is in compliance with all of its covenants under the credit facility. As of September 30, 1995, interest rates for the revolving debt and the term loan ranged from 7.25% to 8.75%. The long term debt balances are as follows: (dollars in thousands)\nSeptember 30, 1995 1994 -------------------------- Term loan $ 8,214 $ 9,643 Revolving credit agreement 13,900 8,000 Other loans 5,579 39 -------------------------- 27,693 17,682 Less current maturities 5,272 1,436 -------------------------- $22,421 $16,246 ==========================\nPage 27 of 68 sequentially numbered pages NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ESSEF CORPORATION AND SUBSIDIARIES SEPTEMBER 30, 1995, 1994, AND 1993\nFuture maturities of long-term debt at September 30, 1995 are $5,272 in 1996 and $22,421 in 1997.\nNOTE 7: INCOME TAXES\nDuring 1994, the Company adopted the provisions of the Financial Accounting Standards Board Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes.\" SFAS No. 109 supersedes SFAS No. 96, \"Accounting for Income Taxes,\" which the Company adopted in the first quarter of 1992. The consolidated financial statements for prior years have not been restated and the cumulative effect of the accounting change was not material. The provision for income taxes is calculated based upon the following components of income before taxes:\n(dollars in thousands) September 30, 1995 1994 1993 ----------------------------------------------- Domestic $ 8,393 $10,225 $6,056 Foreign 1,908 1,149 644 ----------------------------------------------- $10,301 $11,374 $6,700 ===============================================\nThe significant components of the provision for income taxes are as follows: (dollars in thousands) September 30, 1995 1994 1993 --------------------------------------- Current Federal $2,485 $3,369 $ 37 Foreign (311) 313 322 State 226 603 198 --------------------------------------- Total Current $2,400 $4,285 $ 557 ---------------------------------------\nDeferred Federal $1,199 $ 96 $ -- Foreign (116) (18) (30) State 227 16 -- --------------------------------------- Total Deferred 1,310 94 (30) --------------------------------------- $3,710 $4,379 $ 527 =======================================\nPage 28 of 68 sequentially numbered pages NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ESSEF CORPORATION AND SUBSIDIARIES SEPTEMBER 30, 1995, 1994, AND 1993 Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial\nreporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax assets and liabilities are as follows: (dollars in thousands)\nThe consolidated tax provision differs from the tax provision computed at statutory United States tax rates for the following reasons: (dollars in thousands)\nPage 29 of 68 sequentially numbered pages NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ESSEF CORPORATION AND SUBSIDIARIES SEPTEMBER 30, 1995, 1994, AND 1993\nNOTE 8: LEASES\nThe Company leases some of its facilities and equipment. Total rental expenses were $982,000, $945,000, and $801,000 in 1995, 1994, and 1993, respectively.\nMinimum annual rental commitments for the next five years under non-cancelable operating leases at September 30, 1995, are as follows: (dollars in thousands) 1996 $1,585 1997 1,146 1998 817 1999 261 2000 220\nNOTE 9: RETIREMENT AND DEFERRED COMPENSATION PLANS\nThe Company has a qualified defined contribution retirement plan covering substantially all of its employees. The plan provides for an annual basic contribution by the Company equal to 2% of each participant's compensation (which is fully vested), a discretionary contribution (which is fully vested after seven years), and a matching contribution (which is fully vested). Total Company contributions were approximately $1,211,000, $1,070,000, and $892,000 for the years ended September 30, 1995, 1994, and 1993, respectively.\nThe Company has a deferred compensation plan for executive officers. At September 30, 1995 and 1994, liabilities of approximately $576,000 and $501,000, respectively, have been recorded in other long-term liabilities. The Company has a non qualified retirement plan for its Board of Directors. At September 30, 1995 and 1994, liabilities of approximately $375,000 and $420,000, respectively, have been recorded in other long-term liabilities.\nNOTE 10: BUSINESS SEGMENT INFORMATION\nBy Industry--The Company operates in two industry segments: water treatment and systems equipment, and swimming pool and spa equipment. The water treatment and systems equipment segment manufactures products for moving, storing and treating water in residential, commercial, industrial and municipal water supply systems. This segment also manufactures products for the transport and containment of hazardous and industrial waste materials, as well as molds and tools used in the plastic blow molding industries. Swimming pool and spa equipment operations include pumps, filters, heaters, lights, and components for swimming pools and spas.\nPage 30 of 68 sequentially numbered pages NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ESSEF CORPORATION AND SUBSIDIARIES SEPTEMBER 30, 1995, 1994, AND 1993\nNOTE 10: BUSINESS SEGMENTS (CONTINUED)\nThe following table contains a summary of information of each industry segment. The principal corporate assets are cash and cash equivalents, and a receivable under agreement for deed, neither of which is included as an asset in an industry segment. (dollars in thousands)\nPage 31 of 68 sequentially numbered pages NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ESSEF CORPORATION AND SUBSIDIARIES SEPTEMBER 30, 1995, 1994, AND 1993\nNOTE 10: BUSINESS SEGMENTS (CONTINUED)\nPage 32 of 68 sequentially numbered pages NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ESSEF CORPORATION AND SUBSIDIARIES SEPTEMBER 30, 1995, 1994, AND 1993\nNOTE 10: BUSINESS SEGMENT INFORMATION (CONTINUED)\nBy Geographic Area--Operations of the Company are located in the United States and Europe. The following table contains a summary of activity by geographic area. (dollars in thousands)\nPage 33 of 68 sequentially numbered pages NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ESSEF CORPORATION AND SUBSIDIARIES SEPTEMBER 30, 1995, 1994, AND 1993\nNOTE 11: CAPITAL STOCK AND STOCK OPTION PLAN\nThe Company has 1,000,000 Serial Preferred Shares authorized, none of which have been issued. When issued, each of such shares would have one vote, and in special situations the Serial Preferred Shares would vote in a class separate from the Company's common shares. The Board of Directors is authorized to establish the dividend rates, cumulative rights, redemption prices, sinking fund provisions and conversion rights of the Serial Preferred Shares.\nThe Company has a stock option plan for employees granting ten year options for the purchase of up to 500,000 common shares of the Company and the granting of stock appreciation rights. Options may be exercised partially during the first three to five years from the date of grant, and in whole or in part thereafter. The outstanding options expire at various dates through the year 2005. Activity in the stock option plan is as follows:\nIn addition to the options shown above, in 1990, the company granted options to purchase 971,800 common shares at $2.00 per share. These options expire ten years from the date of grant and are fully vested. None of these options have been exercised. Additionally, in 1994 and 1995, the Company granted certain officers options to purchase 150,000 and 25,000 common shares. These options shall vest based on attainment of specified financial ratios and expire 10 years from the date of grant.\nPage 34 of 68 sequentially numbered pages NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ESSEF CORPORATION AND SUBSIDIARIES SEPTEMBER 30, 1995, 1994, AND 1993\nNOTE 11: CAPITAL STOCK AND STOCK OPTION PLAN (Continued)\nIn October 1995, the Financial Accounting Standards Board issued Statement of Financial Standards No. 123, \"Accounting for Stock-Based Compensation,\" which requires adoption no later than fiscal years beginning after December 15, 1995. The new standard defines a fair value method of accounting for stock options and similar equity instruments. Companies are also permitted to continue to account for such transactions under Accounting Principles Board Opinion No. 25, \"Accounting for Stock Issued to Employees,\" with certain other disclosures.\nThe accounting requirements of the new method are effective for all employee awards granted after the beginning of the fiscal year of adoption. The Company has not yet determined if it will elect to change to the fair value method, nor has it determined the effect the new standard will have on net income and earnings per share should it elect to make such a change. Adoption of the new standard will have no effect on the Company's cash flows.\nPage 35 of 68 sequentially numbered pages NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ESSEF CORPORATION AND SUBSIDIARIES SEPTEMBER 30, 1995, 1994, AND 1993\nNOTE 12: QUARTERLY INFORMATION (UNAUDITED) (Dollars in Thousands Except Share Data)\n(a) The prices in this table, representing the high and low \"Bid\" prices, have been supplied to the Company by The National Association of Securities Dealers, Inc. These prices reflect quotations between dealers which do not include mark-ups, mark-downs, or commissions, and may not be actual transactions.\n(b) The total of the earnings per share for each quarter does not equal the earnings per share for the full year, either because the calculations are based on the weighted average shares outstanding during each of the individual periods, or due to rounding.\nNote: The quoted market price of the Company's common share was $17.875 at the close of business on November 17, 1995.\nPage 36 of 68 sequentially numbered pages NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ESSEF CORPORATION AND SUBSIDIARIES SEPTEMBER 30, 1995, 1994, AND 1993\nNOTE 13: BUSINESS ACQUISITIONS\nOn July 21, 1995, Advanced Structures, Inc. of Escondido, California, a manufacturer of composite pressure vessel housings for industrial and municipal reverse osmosis membrane systems, was merged into a wholly-owned subsidiary of the Company. On August 4, 1995, the Company acquired certain assets and assumed certain liabilities of Euroimpex Srl, in Milan, Italy, a manufacturer of pressure vessels and other components for the water treatment industry. On September 1, 1995, the Company acquired certain assets and liabilities of Compool Corporation of Mountain View, California, a manufacturer of electronic controls and valves for swimming pools and spas. The Company paid approximately $13 million in cash, Essef Common Stock, and notes payable for these companies. The purchase price was allocated to the assets and liabili-ties based on their estimated fair values as of the date of acquisition. Under earn-out agreements related to these acquisitions, additional amounts are contingent on the acquired companies reaching certain profitability goals through September 30, 2000. Any such payments will be accounted for as additional cost in excess of net assets acquired in the year earned.\nOn March 7, 1994 the Company acquired certain assets and assumed certain liabilities of the Purex Pool Products Division of Hydrotech Chemical Corporation, a subsidiary of Great Lakes Chemical Company for approximately $13.6 million. Purex is a manufacturer of filters, pumps, lights, and heaters for swimming pools and spas.\nAll of the acquisitions were accounted for as purchases and the results of operations have been included in the Company's results since acquisition. The cost in excess of net assets acquired is amortized on a straight line basis over forty years.\nThe following unaudited proforma consolidated results of operations give effect to the above acquisitions as though they were acquired at the beginning of each period shown. The proforma information has been presented for comparative purposes only and does not purport to be indicative of what would have occurred had the acquisitions been made at the beginning of the earliest period presented, or of results which may occur in the future.\nPage 37 of 68 sequentially numbered pages NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ESSEF CORPORATION AND SUBSIDIARIES SEPTEMBER 30, 1995, 1994, AND 1993\nNOTE 13: BUSINESS ACQUSITIONS (CONTINUED)\n(Unaudited) (Dollars in Thousands Except Per Share Data)\nOn December 1, 1994, the Company signed a joint venture agreement with a German manufacturer and distributor of metal hydropneumatic pressure vessels. The joint venture, Reflex-WellMate GmbH is developing a composite hydropneumatic pressure vessel to be manufactured and sold in Europe. The Company's interest in the joint venture is being accounted for using the equity method of accounting. At September 30, 1995 the Company had made investments and advances of approximately $1.57 million to the joint venture, $.66 million of which are included in other current assets. During 1995, the Company had no equity income from the investment.\nNOTE 14: EXTRAORDINARY ITEM\nIn February, 1995, Hobson Brothers, a subsidiary of the Company, suffered a major fire in their foundry building. All assets destroyed were insured and the Company has settled its claim with the carrier. The excess of $1,437,000 (less related income tax of $517,000) of the insurance claim over the net book value of the Company's assets has been reflected as an extraordinary gain. Additionally, proceeds of $200,000 were included in operating income to offset fire-related business interruption costs.\nPage 38 of 68 sequentially numbered pages INDEPENDENT AUDITORS' REPORT\nTO THE BOARD OF DIRECTORS,\nWe have audited the accompanying consolidated balance sheet of Essef Corporation and Subsidiaries as of September 30, 1995, and the related consolidated statements of income, shareholders' equity, and cash flows for the year then ended. Our audit also included the Financial Statement Schedule listed in the index at Item 14(a)(2). These financial statements and the financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audit. The financial statements of the Company for the years ended September 30, 1994 and 1993 were audited by other auditors whose report, dated November 4, 1994, expressed an unqualified opinion on those statements.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements and financial statement schedule. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above, present fairly, in all material respects, the financial position of the Company at September 30, 1995, and the results of its operations and its cash flows for the year then ended 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.\nDeloitte & Touche LLP\nCleveland Ohio November 10, 1995\nPage 39 of 68 sequentially numbered pages REPORT OF MANAGEMENT\nThe Management of Essef Corporation is responsible for the preparation and accuracy of the financial statements and other information included in this report. The financial statements have been prepared in accordance with generally accepted accounting principles using, where appropriate, management's best estimates and judgement.\nIn meeting its responsibility for the reliability of the financial statements, the Company depends upon its system of internal accounting controls. The system is designed to provide reasonable assurance that assets are safeguarded and that transactions are properly authorized and recorded. The system is supported by policies and guidelines, and by careful selection and training of financial management personnel.\nThe Company's independent public accountants, Deloitte & Touche LLP, are retained to audit Essef Corporation's financial statements. Their audit is conducted in accordance with generally accepted auditing standards and provides an independent assessment that helps ensure fair presentation of the Company's financial statements.\nThe Board of Directors meets its responsibility for overview of the Company's financial statements through its Audit Committee which is composed entirely of Directors who are neither officers nor employees of the Company.\nThe Audit Committee meets periodically with Management and with the independent public accountants to review and assess the activities of each in meeting their respective responsibilities. The independent public accountants have full access to the Audit Committee to discuss the results of their audit work, the adequacy of internal accounting controls, and the quality of financial reporting.\nThomas B. Waldin President and Chief Executive Officer\nTheodore A. Havens Vice President, Chief Financial Officer and Treasurer\nPage 40 of 68 sequentially numbered pages ITEM 9.","section_9":"ITEM 9.DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNone\nPage 41 of 68 sequentially numbered pages\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[For identity of directors and director-nominees including age, business experience, positions held and other relevant information see Essef Corporation - Proxy Statement - December 22, 1995; (definitive proxy statement filed with the Commission pursuant to Regulation 14A) under the headings NOMINATION AND ELECTION OF DIRECTORS, NOMINEE AND DIRECTORS, on pages 2-4 and DIRECTORS' COMMITTEES, MEETINGS AND FEES on page 5; incorporated herein by this reference].\n(b) Identification of Executive Officers\nThe persons named below are the executive officers of the Company at the date hereof. Messrs. Waldin, Ross, Hornick and Havens were elected to their current positions at the Annual Meeting of Directors held January 25, 1995. All serve at the pleasure of the Board of Directors; otherwise all terms expire with the Annual Meeting of Directors to be held January 23, 1996. Mr Britelle was elected to his current position by the Board of Directors of Pac-Fab, Inc. at a meeting held on January 25, 1995.\nPage 42 of 68 sequentially numbered pages Thomas B. Waldin has been Chief Executive Officer of the Company since his appointment on October 26, 1990, and President and a Director since his appointment and election January 31, 1991. Since 1977, Mr. Waldin has been active as an investor in and director of a number of small businesses. He retired in 1987 as Chief Operating Officer of USG Interiors, Inc., and Chief Executive Officer of Donn, Inc. The former is a unit of USG Corporation, a worldwide manufacturer and distributor of building products, created in connection with the acquisition of Donn, Inc. in 1986.\nElliot B. Ross has been Executive Vice President and Chief Operating Officer of the Company since January 31, 1994. Prior to joining the Company, Mr. Ross was the co-chairman of Inverness Partners and Inverness Casting Group. Prior to founding Inverness, he spent 14 years as a member and partner in the Cleveland office of McKinsey & Company.\nTheodore A. Havens has been Vice President, Chief Financial Officer and Treasurer of the Company since September 1994. Prior to that, Mr. Havens had served in various positions since joining the Company in 1977. Most recently, he was the Vice President of Purex Pool Systems and the Assistant Treasurer and Controller of Pac-Fab, Inc.\nGerald C Hornick has been a Vice President of the Company since 1970 and has served as Chief Operating Officer of Structural North America since 1985, and as President since January, 1991. He has been Assistant Treasurer of Essef Corporation since 1988.\nDouglas J. Britelle came to Pac-Fab from General Electric where he served in a variety of assignments since 1971. Most recently, he served as General Manager of G.E's Apparatus Service Business headquartered in Schenetady, New York. Prior to that, he was General Manager of G.E's Transformer Business headquartered in Hickory, North Carolina from 1983 to 1992.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\n[For information relating to compensation of executive officers and directors see Essef Corporation - Proxy Statement - December 22, 1995; under the headings DIRECTORS' COMMITTEES, MEETINGS AND FEES on page 5, and EXECUTIVE COMPENSATION on page 6; incorporated herein by this reference].\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\n[For information relating to security ownership of certain beneficial owners and management see Essef Corporation - Proxy Statement - December 22, 1995; under the heading BENEFICIAL OWNERSHIP OF SHARES appearing on pages 12-14; incorporated herein by this reference].\nPage 43 of 68 sequentially numbered pages ITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\n[For information regarding related transactions see Essef Corporation - Proxy Statement - December 22, 1995; under the heading BENEFICIAL OWNERSHIP OF SHARES on pages 12-14; incorporated herein by this reference].\nPage 44 of 68 sequentially numbered pages PART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.\na) 2. Financial Statement Schedules\nSCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED SEPTEMBER 30, 1995, 1994 AND 1993 (Dollars in Thousands)\n(A) Uncollectible accounts charged off, less recoveries, foreign currency translation adjustments and acquisition costs.\nAll other schedules are omitted either because they are not applicable or the required disclosure information is included in the consolidated financial statements or notes thereto.\nPage 45 of 68 sequentially numbered pages a) 3. Exhibit List\nPage 46 of 68 sequentially numbered pages\nPage 47 of 68 sequentially numbered pages\n(b) There were no reports filed on Form 8-K during the last quarter of fiscal year ended 1995.\nPage 48 of 68 sequentially numbered pages 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.\nEssef Corporation\nBy THEODORE A. HAVENS -----------------------\nTheodore A. Havens Vice President, Chief Financial Officer and Treasurer\nDecember 22, 1995\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the date indicated.\nSignature Title - --------- -----\nTHOMAS B. WALDIN Chief Executive Officer - ------------------- (Principal Executive Officer) Thomas B. Waldin\nTHEODORE A. HAVENS Vice President, Chief Financial Officer - ------------------- and Treasurer Theodore A. Havens (Principal Financial Officer)\nPage 49 of 68 sequentially number pages\nSignature Title - --------- -----\nGORDON D. HARNETT Director - ------------------------- Gordon D. Harnett\nCHARLES W. W. HORNER Director - ------------------------- Charles W. W. Horner\nGEORGE M. HUMPHREY, II Director - ------------------------- George M. Humphrey, II\nMARY ANN JORGENSON Director - ------------------------ Mary Ann Jorgenson\nRALPH T. KING Director - ------------------------ Ralph T. King\nELLIOT B. ROSS Director - ------------------------ Elliot B. Ross\nDate: December 22, 1995\nPage 50 of 68 sequentially numbered pages\nSECURITIES AND EXCHANGE COMMISSION\nWashington, D.C. 20549\n_____________\nFORM 10-K\nANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934\nFor the fiscal year ended September 30, 1995 Commission File No. 0-15902\n_____________\nEssef Corporation\nEXHIBIT VOLUME\nPage 51 of 68 sequentially numbered pages\nEssef Corporation 1995 Form 10-K Annual Report\nExhibit Volume - Table of Contents\nExhibits filed with and sequentially numbered as part of the report\nPage 52 of 68 sequentially numbered pages","section_15":""}
{"filename":"832175_1995.txt","cik":"832175","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nTelescan, Inc., (\"Telescan\" or the \"Company\") provides innovative solutions for online technology, sophisticated data retrieval tools and state-of-the-art Internet services. The Company develops, markets, and operates major online networks and Internet sites serving the financial, publishing, home design and building, entertainment and technology transfer industries. The Company's products and services, which are based upon its proprietary online operating system and user software, allow its customers to electronically access and analyze information through their personal computer systems.\nThe Company's primary product lines are the (1) Telescan system of online financial services and products (\"Telescan Financial\"), which allow sophisticated investors to obtain financial news and information, perform fundamental and technical analyses and design personalized searches using current and historical information on more than 350,000 global equities, indices and currencies; (2) Computer Sports Network division (\"CSN\"), which offers online computer sports games to golf and baseball enthusiasts; (3) numerous third party online services which are developed and operated via alliances with third parties in the publishing, entertainment, and home design and building industries; and (4) Knowledge Express Data Systems, L.C. (\"KEDS\"), which is an online database system for the commercialization and transfer of technology which serves corporations, government agencies, universities, and research institutions.\nThe Company's online service products contain proprietary software technologies, developed or acquired by the Company, which increase the speed, power and user friendliness of information retrieval in information applications while lowering costs to users. The Company's proprietary technology employs a host hardware configuration connected to an intelligent terminal, which is typically a personal computer. The Company's software enables the user to accomplish a full text search of databases for complex queries, without requiring the use of Boolean logic found in traditional database search technologies. It also employs a proprietary optimal search algorithm to accomplish quantitative analysis. In addition, the Company has developed graphical interfaces for Windows and Internet affiliates.\nRevenue is generated in the form of online service fees, product sales and contract revenue. The Company has experienced a significant increase in revenue over the past three years. The higher revenue is primarily attributable to increases in the Company's subscriber base. This subscriber growth, in turn, has resulted from an increase in the online services market, the diversification of the Company's offerings, and the Company's continued investment in customer acquisition through technology development and marketing.\nThe Company's online revenue is generated from individual subscribers paying annual subscription fees plus recurring monthly usage fees. Product revenue is generated from the sale of online system software, software and service enhancements, major product upgrades and related educational and training products such as books and videotapes. The Company's software products generally reflect a common base technology to which additional features can be added to satisfy the various needs of the sophisticated user. Accordingly, product revenue primarily consists of revenue from product enhancements or major upgrades. The Company's contract revenue is generated from providing contract services to other companies. These contract services include developing, operating and maintaining online database systems as well as providing administrative and marketing services.\nThe following table summarizes the Company's revenue by product line and type of revenue (dollars in thousands).\n(1) Net of elimination of intercompany sales subsequent to March 31, 1993, when the Company began consolidating Knowledge Express Data Systems, L.C. as the result of increasing its ownership from 50% to 55.58%\nThe business of the Company has been operated by the Company or its predecessors since 1983. The Company, which is a Delaware corporation, was incorporated in 1988 under the name \"Max Ret, Inc.\" for the purpose of acquiring or participating in a business opportunity. In 1989 the Company issued 75% of its outstanding common stock (\"Common Stock\") to acquire all of the outstanding common stock of D.B. Technology, Inc. (dba Telescan, Inc.) (\"DB\"), and DB's wholly owned subsidiary, CSN. After the acquisition of DB and CSN by the Company, DB was merged into the Company and the Company changed its name from Max Ret, Inc. to Telescan, Inc. In December 1991, CSN was merged into the Company.\nSince its formation, the Company has expanded its on-line service offerings through a series of strategic acquisitions, joint ventures and partnerships. In June 1990, the Company issued 420,000 shares of its Common Stock to T.I.C. Software, Inc. in exchange for assets consisting of license and contract rights,\nproprietary software, several full-text, technology-oriented databases, computers, computer-related equipment and furniture.\nIn December 1990, the Company entered into a corporate joint venture (as a 50% owner) in Technology Resource Company, for the purpose of marketing and operating the Knowledge Express online database system. During 1991, the corporate joint venture was dissolved and its interests were assigned to Telescan, L.C., a Texas limited liability company, which has since been renamed Knowledge Express Data Systems, L.C.. The Company acquired an additional 5.58% ownership interest in March 1993. Telescan acts under contract as the exclusive system operator of the KEDS database system and provides development, maintenance and operation of the system including the uploading of the databases; programming and development of the systems and end-user software; system operations; and certain other contract services, all of which are charged to KEDS on a \"cost plus\" basis.\nIn 1992, in exchange for 100,000 shares of Common Stock, the Company acquired the 15% minority interest of the Screening Technologies partnership (\"Screening Tech\"), and became the sole owner. Screening Tech developed the Telescan Edge, Prosearch and Mutual Fund Search software programs. The partnership was subsequently merged into the Company.\nThe Company has a 21.25% equity interest in Telebuild, L.C. (\"Telebuild\"), a limited liability company formed in 1990 to develop and market online information systems serving the building and construction industry. Telescan provides maintenance and operation of the Telebuild information systems, including the uploading of information; programming and development of the systems and end-user software; system operations; and certain marketing, general and administrative services, all of which it charges to Telebuild on a \"cost plus\" basis.\nINDUSTRY\nOnline services allow personal computer users to access outside sources of information and interact with other users via telephone line connections channeled through a central host computer. The online services industry includes commercial services targeted exclusively to businesses, such as medical, legal, financial, credit reporting, marketing, and technical databases, and consumer-oriented databases offering a wide range of informational, educational, consumer and entertainment services. The consumer online services market emerged in the early 1980's when business-oriented, online services market began to offer limited services to owners of personal computers. Since that time, both the consumer and business online services markets have grown dramatically in breadth of services offered and in market penetration.\nOnline services typically include information databases and specialized search and retrieval software maintained by the service provider on a host computer. Interface software, which is used on the customer's computer, permits users to access information through the online system. The service provider usually rents or purchases databases on a non-exclusive basis from third parties and then further develops such databases for use within the provider's online system. Customers typically subscribe to an online system for an initial base charge for which they are granted a license for the interface software needed to access the online services. Following their subscription, customers are typically charged in one of two ways. The most common method used by consumer based services is a periodic subscription fee for which users receive a fixed allotment of time on the online system, after which they are charged on a per-minute basis. The second method bills users at varying per minute rates, according to time actually spent online on the databases. Under both of these methods there are often additional charges for specific services used within the databases.\nThe industry's dramatic growth in recent years has resulted from a number of key factors which are expected to contribute to continued growth throughout this decade. Some of these key factors include the increasing market awareness of online services and the Internet; growth in the availability, quality and marketing of online products and services; growth in the home and personal computer markets including mobile \"laptop\" computing; increased use of modems for telecommunications; and the development of alternative access devices such as dedicated communications terminals. The Company believes that as the market continues to expand, important competitive factors will be system performance, product differentiation, quality and quantity of content, user friendliness, price, customer support and effective marketing techniques.\nBUSINESS STRATEGY\nThe Company's mission is to be a worldwide leader in the development of sophisticated interactive online information systems and Internet sites among businesses, individuals, associations and government agencies through the delivery of superior, cost effective data retrieval technology, customer user interface programs and communications services. To achieve this mission, the Company's business strategy is (i) to increase Telescan's customer base and recurring revenue; (ii) to continue investing in the development of new technology; and (iii) to increase current customer usage. There can be no assurance that this strategy will be effective.\nManagement believes that the continued investment in customer acquisition and the resulting increase in recurring revenue is crucial to the future growth of the Company. This is achieved by creatively marketing its services and exploiting the Company's existing proprietary software technologies in the development of new online systems and Internet sites. Joint marketing relationships with companies selling related products or services and having large, preexisting customer bases are a major source of growth for the Company. Additional growth is achieved by entering into mutually beneficial alliances with associations, publishers and other third parties to jointly develop and market online systems and Internet sites to service their members' or customers' specific needs. Typically the Company is responsible for software design, development and programming services; the partner is responsible for supplying the data and marketing the service; and the net revenues of the project are split.\nDeveloping state-of-the-art technology is key to establishing the Company as a leader in the industry and is important to the long-term growth of the Company. The Company is continually investing its resources in the development of new products and services which provide powerful online capabilities to sophisticated users in a wide range of industries.\nCurrent customers are a valuable Company asset and are a key component in the Company's overall business strategy. With customer acquisition costs so high, increasing current customer usage is the most cost-beneficial method of maximizing internal growth. Increasing usage is accomplished by (i) providing access to an increasing array of comprehensive, high-quality data coupled with powerful and easy to use search and analytical tools; (ii) providing free customer training and support to educate existing customers on the capabilities of the system; and (iii) conducting reactivation campaigns to encourage inactive subscribers to log back onto the system.\nPRODUCTS AND SERVICES\nThe Company has attempted to penetrate the market for online services by developing and marketing products that build and expand upon the Company's base technology of proprietary operating systems and user software for database applications. The Company's major product lines include the Telescan system of online financial databases and software programs, CSN, the KEDS service and its numerous third party online services.\nTELESCAN FINANCIAL\nTELESCAN INVESTORS PLATFORM (TIP) 1.1. Telescan Investors Platform (\"TIP\") is the MS Windows version of the Company's popular financial research, screening and analysis software. Introduced in June 1995, TIP offers numerous enhancements over the Analyzer 3.0 software. Some of the new features are improved charting capabilities, a unique portfolio-based control for greater flexibility and faster data retrieval, additional database information such as current quotes for all major international exchanges, full-text analysts' reports, a Market Snapshot of major indexes, improved communications options including TCP\/IP access and interactive roundtables, a TOP PICKS screening feature, and expanded automation tools. Features such as multi-tasking and graphic toolbars that are inherent in the Windows operating environment make TIP more user-friendly and lead to its improved data presentation options.\nTELESCAN ANALYZER 3.0. This is the most recent version of the original Telescan Analyzer product with the capability of accessing other Telescan products, such as Prosearch and Mutual Fund Search. This DOS product features a graphical user interface similar to the Microsoft Windows and Apple Macintosh operating environments. The software allows the user to access the Telescan Database of over 14,000 stocks, 5,600 mutual funds, 60,000 options, 1,000 market indexes and more than 1,200 futures and commodities contracts. Telescan Analyzer 3.0 helps the investor evaluate stock portfolios and mutual fund holdings. Over 80 fundamental and technical indicators such as price, volume, insider trading, key company facts, volume indexes, trend lines, news releases, MACD and relative strength are available for analyzing securities. Users can retrieve historical price and volume charts of up to 23 years of data in less than 8 seconds. They can utilize the Company's powerful relevant text searching technology to screen the news and Securities and Exchange Commission filings databases using simple words and sentences to retrieve desired information ranked in the order of relevance. Additional features include multiple graphs per screen, higher graphics resolution, 9600 baud modem support, mouse interface and pull down menus, and enhanced system integration and visual presentation.\nTELESCAN PROSEARCH. Prosearch is a powerful search program that allows the user to develop customer screening routines to select securities that best meet the individual's specific investment goals. The program was designed for serious investors as a tool for identifying stocks to meet virtually any investment objective as defined by a wide variety of fundamental and technical indicators. ProSearch allows the user to select up to 40 parameters from a list of 207 criteria for building a search strategy. The program is shipped with several pre-defined search strategies that can also be used for narrowing the list of potentially profitable investments.\nTELESCAN MUTUAL FUND SEARCH. This product is a mutual fund screening program that allows an investor to sort through more than 5,600 mutual funds using the Company's unique scoring system to pick the funds that best fit the user's investment objectives. The selection criteria are grouped into three main categories: purchase requirements, performance and consistency characteristics, and portfolio composition. The investor\nthen chooses up to 30 of the 80 individual criteria contained within the categories to produce a list of the mutual funds best suited to their needs.\nTELESCAN ESEARCH. Built as a complement to the ProSearch program, Esearch adds the ability to screen for investment candidates based on earnings estimate information. Earnings estimates are very important to investors in that they are often a preview of Wall Street's positive or negative perception of a particular stock.\nQUOTELINK. The Company released the QuoteLink quote and news utility during 1992. This product permits users of competing financial analysis software and spreadsheet programs to download information from the Telescan Database into such programs. QuoteLink is compatible with all the major competitive programs such as AIQ, Metastock, Super Charts, Quicken, Lotus and Excel\nOPTIONS SEARCH. This product is a screening program that allows an investor to sort through more than 60,000 options using the Company's unique scoring system to pick the options that best fit the user's investment objectives. The investor chooses up to 30 of the 122 screening criteria to produce a list of the options best suited to their needs.\nTELESCAN GATEWAY. Telescan Gateway is an electronic library that brings information to computer terminals. This online library includes domestic and international magazines, newspapers, published papers, indexes, scholarly journals, directories, statistics, and more, from over 800 databases.\nWALL STREET CITY. Wall Street City is a comprehensive financial supersite on the Internet designed to provide a central gathering place for financial service providers, advertisers, and the individual investor. The site was launched in February 1996 and is located at http:\/\/www.wallstreetcity.com. The site gives Internet users access to a broad array of both free and subscription-based services including real-time quotes, financial market information, product news and data, plus search and analytical tools. The site features a revolutionary \"live\" stock ticker which allows Internet users to customize a rolling ticker of up to 50 stocks and continuously monitor the price movement of their portfolio. For content providers, such as brokers, banks and public companies, Wall Street City offers a highly targeted medium for reaching the Internet's investment-oriented audience. To develop corporate and product awareness, commercial sponsors of the site can maintain a virtual office or display space in the appropriate building or district with hyper-links to their home pages. Wall Street City graphically resembles lower Manhattan, and is configured into more than twenty information and advertising districts including Corporate Headquarters, the Exchange and the Research District.\nTIPNET. TIPnet is one of the two financial Internet web sites created by the Company, and was launched in October 1995. The site, located at http:\/\/www.tipnet.com, offers Internet users the ability to access the Company's comprehensive financial database and to analyze the data through a downloadable graph viewer application. TIPnet is the Company's first major Internet effort and is targeted to slightly less sophisticated investors. The site gives them access to most of the research and analysis tools available in the Company's proprietary software, but eliminates the upfront software price which can be a barrier to entry for the lower level investor. TIPnet is a fee-based service and users are charged a flat monthly rate based on the breadth of information they want to access. The site is built on the World Wide Web platform which allows for its graphical navigation, and is designed to appeal to the younger audience typically found on the Internet.\nTELESCAN PORTFOLIO MANAGER. Telescan Portfolio Manager is a securities portfolio management program which was developed as a joint venture between the Company and The Pilot Group, Inc. The program offers\na wide variety of report options and was designed to provide speed and power in a user friendly manner that forgives many common user mistakes and accepts corrections with ease.\nSUNFLOWER. This software development tool, released during 1995, allows the Company to establish proprietary online communication networks for third parties without a substantial investment in hardware or software.\nCOMPUTER SPORTS NETWORK\nTHE LINKS TOUR. The Links Tour gaming program allows members to participate in nationally held computer golf tournaments, which closely follow the pro tour. In September 1992, the Company entered into a joint agreement with Access Software, Inc. (\"Access\") to develop and market an online tournament play interface for the Links 386 Pro golf game produced by Access. Links 386 Pro is one of the top rated golf simulation games on the market and has sold in excess of 1 million copies. The Company provides Access with the data structure and format necessary to upload scores and statistics to the CSN Host Computer; conducts online tournaments; and provides customer support. Access includes Links Tour subscription information in all Links 386 Pro software sold, markets the Links Tour to its existing customers and provides its software to CSN at a distributor discount.\nLinks users, who are also CSN subscribers, can compete in CSN \"sponsored\" golf tournaments on both a regional and national level using the CSN interface. CSN members are also able to organize and\/or join their own private \"clubs.\" Access' Links 386 Pro provides the graphic golf simulation game and CSN provides the online national tournament format.\nGENERAL MANAGER. This program enables fans of APBA major league baseball, a simulated baseball game which has been in existence since 1951, to compete nationally on a network of home computers. The Company's product acts as an online interface to disk-based baseball software, published by APBA, enabling customers to play interactively. The program includes the ability to draft a team of major leaguers, trade players, maintain active reserve rosters, and guide the team through a season of scheduled games.\nKNOWLEDGE EXPRESS DATA SYSTEMS\nKEDS service is an online database system serving the federal government, universities, and private sector corporations. KEDS serves the needs of business developers, licensing professionals, strategic planners, competitive intelligence directors, research and development managers, scientists and others by allowing access to information about collaborative research and technology licensing opportunities. KEDS produces databases from information gathered from government labs and agencies, universities, non-profit research centers and private sector companies. KEDS not only hosts the databases it produces, but other commercially available databases such as, Corptech, Bioscan, Business News, and Federal Research in Progress. In addition to providing the industry with greater access to information coming from universities and federal laboratories, KEDS proprietary software and search capabilities facilitate better matching of technology sources with industrial partners. This capability is also used by intellectual property and technology transfer managers at universities and federal laboratories to locate and qualify prospects for collaborative research and technology licensing opportunities. The Company is the system operator and joint owner of KEDS.\nDuring 1993, KEDS initiated the LES Online Information Service offering database services to the more than 7,000 individual and organization members of the Licensing Executives Society, an association of technology transfer professionals.\nIn April 1994, KEDS was awarded a one-year contract from the Department of Energy (the \"DOE Contract\") under its Technology Reinvestment Program which was subsequently renewed for an additional one year term. Under the terms of the DOE Contract, the Company markets its services in order to obtain subscribers, develops and maintains the required databases, and provides training and customer service to the subscribers. In exchange, the Department of Energy subsidizes online services for up to 1,200 subscribers. The DOE Contract expires March 31, 1996. KEDS has been actively working to convert its subsidized subscribers to paying customers and to expand its non-subsidized subscriber base in order to minimize the impact of the DOE Contract expiration.\nTHIRD PARTY ONLINE SERVICES\nThe Company has continued to expand its business outside the Telescan financial and sports online services by forming business alliances with institutions, associations, publishers and other third parties to develop and operate online databases which have been tailored to meet their members' or customers' needs. The Company is responsible for the development and operation of the online database systems and the partners are responsible for providing data and marketing the services. Revenues are split after deducting certain costs as defined in the individual agreements. The Company usually does not receive any revenue from a project until after the service is launched. Costs incurred prior to launch are charged to expense as incurred.\nBILLBOARD ONLINE. Billboard OnLine, which is a joint effort of the Company and BPI Communications, L.P. (\"BPI\"), is a global online network originally launched as a non-Internet service during April 1994 and then launched on the World Wide Web during December 1995. The site, located at http:\/\/www.billboard-online.com, offers articles and charts from the current issue of Billboard magazine, along with exclusive editorial features and the opportunity to download Billboard OnLine software. The online service offers its users full access to Billboard magazine's vast electronic library of more than 20,000 charts in all music genres back to 1983, and full text articles dating back to 1991.\nHOLLYWOOD REPORTER ONLINE. Hollywood Reporter Online, is a joint effort between the Company and BPI, to develop and operate databases serving the entertainment industry. It will offer users access to the current and archived issues of Hollywood Reporter magazine. In addition, the users will have access to film reviews and news articles relating to TV, film, and music, as well as information on current events and industry developments. The Hollywood Reporter Online service will be launched during 1996.\nADWEEK ONLINE. Adweek Online, which is a joint effort between the Company and BPI, was launched during September 1995 to provide easily accessible information to the advertising industry. It offers users access to full text news and articles from Brandweek, Mediaweek and all six regional editions of Adweek magazine plus instant access to other advertising industry information such as Accounts in Review, Accounts Awarded, the Adweek Client\/Brand Directory and details on breaking campaigns. The full searchable database includes archives dating back to January 1992, and is updated weekly.\nEDITOR AND PUBLISHER'S AMPERSAND. In August 1993, the Company and The Editor and Publisher Company (\"E&P\") signed a 10-year agreement for the development and operation of databases servicing the newspaper and advertising industries. It will offer users access to the current issue of E&P magazine, and archived issues dating back to 1988. In addition, users will have access to proprietary E&P databases, and\nwill be able to utilize the ProSearch technology to identify demographic regions, and newspapers servicing those regions to facilitate the targeting of advertising campaigns. The E&P Online service is scheduled to be launched during 1996.\nARTISTS ONLINE. Artists OnLine, which is a joint effort of the Company and Artists OnLine, Ltd., is a global online network launched during March 1996, linking artists and art buyers on the World Wide Web at http:\/\/www.onlineart.com. This unique Internet service enables users to obtain complete information on a particular artist or gallery, view their works of art, and contact the artist. The powerful search engine allows users to quickly search for artwork and artists based on a wide range of criteria including the type of art, style, media, price, dimension, color and subject matter.\nCONSULTANTS ONLINE. In February 1995, the Company and Consultants-On-Line, Inc. entered into an agreement to develop and operate an online service providing health, safety and environmental information to consultants and users of consulting services in the environmental and occupational health and safety industries. The service will provide users access to business news, Commerce Business Daily, NASA Tech Briefs, and resumes of consultants. In addition, users will be able to access databases including Corptech and Federal Research in Progress. The service is expected to be launched during 1996.\nHOME & DESIGN ONLINE. In March 1995, the Company and Home & Design OnLine entered into an agreement to jointly develop the Home & Design Online network which is expected to be launched during 1996. The service will provide a nationwide information and communications platform linking consumers, realtors, builders and all others involved in the buying, selling, building or remodeling of a home. The service will provide access to real estate listings, fine art, home furnishings, product suppliers and manufacturers, codes and regulations and technical data. See Item 13 - \"CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\".\nAIA ONLINE. In August 1992, The Company entered into an agreement with the American Institute of Architects to develop and operate AIA Online, an information and communications network using the proprietary technology of Telebuild. AIA Online, a global electronic network launched during 1993, provides time sensitive access to information used by architects and those associated with the design and construction industry. The network also includes large searchable databases, electronic communications and online ordering of publications, products and services. In addition, architects have access to more than 850 databases which cover a wide range of business needs. See Item 13 - \"CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\".\nPUBLIC INFORMATION ONLINE. In April 1994, the Company and Public Information Online, Inc. entered into an agreement for the development and operation of an online database system to facilitate the distribution of news stories. The service will allow users to deliver unedited press releases via fax, Telescan e-mail, and Internet e-mail. The press releases will be archived in the database and accessible using Telescan's proprietary keyword and relevance search engine. The Public Information service will be launched during 1996.\nENTREPRENEURS ONLINE. In September 1993, the Company and Entrepreneurs OnLine, Inc. (\"EOL\") entered into an arrangement to develop and operate Entrepreneurs Online network, an online database linking entrepreneurs and providers of services, capital and other resources. The service was launched during 1995. EOL was acquired by the Company during 1995.\nOTHER\nIn addition to its online database services, the Company also performs software design, development, and programming under contract for third parties and for related parties. The Company also offers video training tapes, financial books, and monthly newsletters in conjunction with its Telescan financial products.\nThe Company's online services employ databases that consist of information typically obtained from public and private third-party sources, usually on a non-exclusive basis. Therefore, the Company's business is dependent upon its ability to obtain and maintain, on an ongoing basis, information for inclusion in the Company's databases. Acquisition of databases typically involves the payment by the Company of a one-time fee and\/or royalties based on some combination of user subscriptions and actual database usage. Information suppliers typically license access to data on a yearly renewable basis, subject to termination by either party upon 90 to 180 days notice. Government contracts may often be terminated or renegotiated at the option of the government entities. The Company also obtains information pursuant to non-exclusive licenses from private sector information compilers, some of which currently are or in the future may be direct or indirect competitors of the Company. There can be no assurance that the Company will be able to renew its current contracts with data sources, maintain comparable price levels for information acquired, or negotiate additional contracts with data sources as necessary to maintain existing products or introduce new products. Termination of the Company's relationship with one or more of the Company's information suppliers could have a material adverse effect on the Company's operations if the data became available through one of the Company's competitors and if the Company was unable to obtain comparable data through other sources. The Company considers continued access to databases as a critical factor in the competitiveness of its existing products and believes that future product development will depend on the availability of data in specific markets targeted by the Company. However, the Company does not believe at this time that the loss of any single source of data would be detrimental to its business.\nMARKETING\nThe Company's online services are sold to customers for an initial licensing fee followed by monthly charges under either a monthly fixed fee package or on a per minute basis based upon actual online usage. To attract new subscribers for Telescan, CSN and KEDS, the Company typically offers low cost initial trial subscriptions, the cost of which is credited against the normal fee schedule if the customer continues to subscribe after the trial period.\nThe Company's major marketing objectives for its online services are to increase the number of subscribers, to sell additional products to existing subscribers and to increase average monthly online use per subscriber. The channels for increasing the number of subscribers to Telescan Financial include joint marketing agreements, trade shows and seminars, advertising and direct sales and word-of-mouth.\nThe Company's primary market has historically been the sophisticated individual investor. The Company has significantly increased its individual investor subscriber base through joint advertising and marketing arrangements with major discount brokerage firms including Fidelity Investments Retail Services, Quick & Reilly, Accutrade, and Charles Schwab & Co., Inc. These marketing arrangements typically call for the brokerage firm to incorporate and package the Telescan Financial software and a gateway to the Telescan database into their software products, or to incorporate an application interface in their software products that allows access to the Telescan database.\nThe Company and Notable Technologies, Inc. a wholly owned subsidiary of McCaw Cellular Communications, Inc. have entered into an agreement calling for the co-marketing of products and services to each other's customer base, the development of an investment research product and the establishment of a wireless network to deliver the Company's financial data to McCaw's cellular phone and pager customers. See Item 13 - \"CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\".\nBecause of the breadth and cost effectiveness of the Company's financial online systems, the Company targets users of competitors' financial analysis software packages as a source of online revenue. During 1993, the Company released an application interface product facilitating the downloading of information from the Telescan Database to users of competitors' analysis software. The company has continued to leverage the opportunity to tap the large data downloading market through cooperative alliances with several major charting software publishers including Metastock, Supercharts and AIQ.\nMATERIAL CUSTOMERS\nRevenue earned under the DOE Contract amounted to 15.1% and 13.7% of consolidated revenue during the year ended December 31, 1995 and 1994, respectively. The DOE Contract expires March 31, 1996. KEDS has been actively working to convert its subsidized subscribers to paying customers and to expand its non-subsidized subscriber base in order to minimize the impact of the contract expiration.\nPRODUCT DEVELOPMENT\nThe Company has developed and acquired proprietary software technologies to make its products easy to use and to achieve efficient searching of extensive databases using simple, non-Boolean logic search queries. Consequently, the Company believes that using its proprietary technologies it can deliver superior online database services. The Company intends to employ its proven software technologies in developing additional products serving new markets and customers.\nTelescan's software development staff includes 37 staff programmers who develop new products and provide maintenance support for existing products. During the years ended December 31, 1995, 1994 and 1993, the Company spent approximately $1,600,000, $1,200,000 and $900,000, respectively, for software development activities, all of which was capitalized. All software development costs are charged to expense until technological feasibility is established, after which remaining software production costs are capitalized and amortized over periods ranging from three to five years. The Company also continuously evaluates opportunities to obtain new products through acquisition.\nPROPRIETARY RIGHTS\nThe Company relies upon a combination of contract provisions and copyrights, trademarks, and trade secret laws to protect its proprietary rights in its products. The Company attempts to protect its trade secrets and other proprietary information through software licenses, nondisclosure agreements with product development partners, employees and consultants. Although the Company intends to protect and defend its proprietary rights vigorously, there can be no assurance that these measures will be successful.\nWith respect to software technologies which the Company has licensed to third parties for use in specific applications, the Company has entered into licensing agreements which are intended to protect the proprietary rights of the Company in such technologies. The Company seeks to protect the source code of its products as a trade secret and as an unpublished copyright work. The Company has also obtained federal trademark registration of the name \"Telescan\" and for the names of many of its leading services.\nThe Company has filed a patent application with the U.S. Patent and Trademark Office for its new technology, code-named Sunflower and has filed patent applications in certain foreign countries. The Company believes that its products, trademarks and other proprietary rights do not infringe on the proprietary rights of third parties, and the Company is not aware of any current infringement claims from third parties. There can be no assurance that third parties will not assert infringement claims against the Company in the future with respect to current or future features or contents of services or that any such assertion may not require the Company to enter into royalty arrangements or result in litigation.\nCOMPUTER AND NETWORK OPERATIONS\nThe Company's data center computer system consists of commonly available PC processors, disk storage devices and telecommunications equipment, operated by a common operating system which is proprietary to the Company. The Company typically screens and filters incoming data feeds from third parties, using specific software routines, in order to detect errors and certain detectable viruses.\nThe Company's data center is located at the Company's headquarters facility. The data center has separate air conditioning units and the equipment room has a raised floor. The power system includes power conditioning, backup battery, and full \"zero downtime\" emergency generator support on site, which is supplied by the facility owner. Data is regularly backed up and stored off-site, and certain data is duplicated on separate storage devices within the data center. The building in which the data center is located has off-hours card key access, card key access to the Company's offices, separate card key access to the data center and 24 hour on site security personnel. The Company believes that data center system redundancy is afforded by the Company's ability to use commonly available computer processors, storage devices, and communications equipment, including the Company's non-data center computer systems, in its data center in case of equipment failure or other emergency. The Company's telecommunications network consists of the public packet switching networks provided by US Sprint and ADP Autonet. Through these networks, subscribers in hundreds of cities in the U.S. and Canada can dial a local number to connect to the Company's online services.\nAlthough the Company believes that its computer and communications hardware systems are adequate for existing operations, the Company has recently purchased additional hardware required in order to accommodate any significant increases in the customer base for the Company's existing products and services, and to accommodate additional products or services.\nThe Company continually upgrades its computers and peripheral hardware to take advantage of technological advances. Further, the Company believes that future hardware and software advances will serve to improve the performance of the Company's systems. While the Company does not believe that it faces a material risk due to technological changes, there can be no assurance that the Company's existing technology will remain viable or that the Company will be able to achieve technological advances that may be necessary in order to remain viable.\nCOMPETITION\nThe Company competes with many companies, who operate proprietary and\/or online systems, many of which have significantly greater financial, technical, and marketing resources than the Company. In addition, a substantial number of new competitors are entering the online services market as a result of the recent growth and the perceived future opportunities in this market. The Company believes the principal competitive factors in the online services market include system performance, product differentiation, quality and quantity of content, user friendliness, price, customer support and effective marketing techniques. The Company believes that it competes effectively in these areas. Competitive pressures could result in reduced market share, price reductions and increased spending on marketing and product development, which could adversely affect the Company's financial condition and operating results. However, the Company believes that its business strategy of building marketing relationships with larger partners and expanding the range of its online offerings by entering into alliances with associations, publishers and other third parties may serve to lessen the impact of future competitive pressures on the Company.\nEMPLOYEES\nAs of December 31, 1995, the Company had 153 full-time employees, with 29 employed in sales and marketing; 37 in customer service; 14 in computer operations; 37 in product development and maintenance; and 36 in general management and administration. None of the Company's employees is represented by a labor union, and the Company has never experienced a work stoppage.\nGOVERNMENTAL REGULATION\nThe Company is not subject to direct regulation other than regulation generally applicable to businesses. However, changes in the regulatory environment relating to the telecommunications and media industries could have an effect on the Company's business, including regulatory changes which directly or indirectly affect telecommunication costs or increase the likelihood or scope of competition from regional telephone and cable television companies. See \"Competition.\" In addition, although the Federal government research data available through the Company's KEDS online database is intended to be non-confidential, the Company could be liable if data later determined to be confidential was disseminated by the Company through its database. The Company cannot predict the impact, if any, future regulation may have on its business.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's principal executive offices, as well as its principal marketing, computer operations, and product development activities, are located in leased facilities in Houston, Texas, consisting of a total of approximately 51,500 square feet. The Knowledge Express Data Systems, L.C. subsidiary maintains a marketing and administrative office of approximately 7,400 square feet in Berwyn, Pennsylvania, which is leased. The current aggregate monthly rental for these facilities is approximately $45,000. The leases for Houston and Berwyn facilities will expire in 2007 and 1999, respectively. The Company believes that its facilities are adequate for its present needs and that suitable space will be available to accommodate its anticipated future needs. The Company has a five year option for 15,179 square feet of contiguous office space plus the right of first refusal for an additional 20,103 square feet of contiguous office space.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIn 1986, a stockholder of Telescan, Inc. (predecessor business to D.B. Technology, Inc.) filed suit in the 269th District Court in Texas against the Company, certain stockholders of the Company, and others. The suit sought to set aside the 1986 merger of D.B. Technology and Telescan, Inc., money damages from all defendants, and sums due under alleged promissory notes. The case went to trial in October 1989 and judgment was rendered in favor of the defendants on a directed verdict including an order for the plaintiff to pay certain court costs and certain attorney's fees of Telescan, Inc. Subsequent to an appeal by the stockholder in the Texas Court of Appeals 14th Judicial District, the appellate court remanded the case to trial court. At the conclusion of presentation of evidence, the case was submitted to the jury by means of questions in order to determine issues of liability and damages. Based on a lack of evidence which would impose liability upon Telescan, Inc., no questions were submitted which asked the jury to determine whether or not the Company bears any liability to any plaintiff. A hearing on pending matters, including entry of Judgment, was held April 10, 1995. At the hearing the court ruled that plaintiffs take nothing other than the payment, with interest, of $40,000 in promissory notes in favor of plaintiff Investa, Inc. and Hoggett, which notes preceded the merger. The defendants were awarded attorney's fees and court costs. The Judgment has been entered; however, it is subject to appeal. Management does not believe that any material adverse outcome is reasonably possible nor probable and thus, no qualified disclosure as to a range of reasonable possible loss or accrual in the financial statements of probable loss have been made.\nDuring 1993, the Company replaced a leased telephone system prior to the expiration of the existing rental agreement and ceased further rental payments under such agreement. In April 1994, the lessor filed suit against the Company in the District Court of Harris County, Texas 270th Judicial District, seeking accelerated rental payments of approximately $106,000, together with interest, court costs and legal fees. The Company answered the lawsuit, asserted the defense of failure of consideration and counterclaimed for breach of contract, fraud and Deceptive Trade Practices Act violations by the lessor. On May 26, 1995, the parties entered into an Agreement of Settlement and Mutual Release pursuant to which the Company paid $47,500 to the lessor. The lawsuit was then dismissed without prejudice.\nFrom time to time the Company may be involved in certain other legal actions arising in the ordinary course of business.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nDuring the fourth quarter of 1995, there were no matters submitted to a vote of the security holders, through solicitation of proxies or otherwise.\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 quoted on the NASDAQ Small-Cap Market under the symbol \"TSCN.\" The following table sets forth, for the periods indicated, the high and low closing bid prices for the Common Stock as reported by the NASDAQ Small-Cap Market. The bid prices reflect inter-dealer quotations, do not include retail markups, markdowns or commissions and do not necessarily represent actual transactions.\nCOMMON STOCK PRICES -------------------------- HIGH LOW ------------ ---------- 1994: Quarter ended March 31 .............. $ 8.87 $ 7.50 Quarter ended June 30 ............... 7.75 5.00 Quarter ended September 30 .......... 6.50 4.75 Quarter ended December 31 ........... 6.00 3.75\n1995: Quarter ended March 31 .............. $ 6.25 $ 4.00 Quarter ended June 30 ............... 5.87 4.37 Quarter ended September 30 .......... 7.25 5.75 Quarter ended December 31 ........... 8.75 5.75\nOn March 25, 1996, the last closing price of the Company's Common Stock as reported by the NASDAQ Small-Cap Market was $7.13. As of March 25, 1996, the Company had approximately 300 stockholders of record.\nDIVIDEND POLICY\nThe Company has never declared a cash dividend on its Common Stock. The Board of Directors presently intends to retain all earnings for use in the Company's business, and therefore, does not anticipate paying any cash dividends in the foreseeable future. The declaration of dividends, if any, in the future would be subject to the discretion of the Board of Directors, which may consider factors such as the Company's results of operations, financial condition, capital needs and acquisition strategy, among others. See \"Item 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\".\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe selected consolidated financial data presented below for the five-year period ended December 31, 1995, have been derived from the audited historical consolidated financial statements of the Company. The historical consolidated financial data include the results of operations of acquired businesses from their dates of acquisition. The selected 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 the notes thereto.\n(1) Nonrecurring charges for 1991 consist of approximately $16,000 in tax penalties paid to the Internal Revenue Service, $19,000 representing the recognition of a previously unrecorded liability, approximately $26,000 related to current period payments to a contract employee for services rendered in prior years, and certain other expenses.\n(2) Reflects minority interest in Knowledge Express Data Systems, L.C. in 1994 and 1993 and Screening Technologies partnership in 1991.\n(3) Reflects recognition of losses of Knowledge Express Data Systems, L.C. of which the Company is currently a 55.58% owner.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe following discussion should be read in conjunction with the Company's consolidated financial statements and related notes, and \"Item 6 - SELECTED FINANCIAL DATA\" included elsewhere in this Annual Report.\nRESULTS OF OPERATIONS\nOVERVIEW\nTelescan is an industry leader in providing innovative solutions for online technology, sophisticated data retrieval tools and Internet services. The Company develops, markets, and operates major online networks and Internet sites serving the financial, publishing, home design and building, entertainment and technology transfer industries. The Company's products and services, which are based upon its proprietary online operating system and user software, allow its customers to electronically access and analyze information through their personal computer systems.\nThe Company's primary product lines are the (1) Telescan system of online financial databases and software tools which allow sophisticated investors to obtain financial news and information and to design a variety of sophisticated searches and perform fundamental and technical analyses using current and historical financial information on more than 350,000 global equities, indices and currencies; (2) CSN, which offers online computer sports games to golf and baseball enthusiasts; (3) numerous third party online services which are developed and operated via alliances with third parties in the publishing, entertainment, and home design and building industries; and (4) KEDS, which is an online database system for the commercialization and transfer of technology serving corporations, government agencies, universities, and research institutions. The Company owns 55.58% of KEDS and acts under contract as the exclusive system operator.\nRevenue is generated in the form of online service fees, product sales and contract revenue. The Company has experienced a significant increase in revenue over the past three years. The higher revenue is primarily attributable to increases in the Company's subscriber base and the DOE Contract. The subscriber growth, is a result of the growth in the online services industry, the diversification of the Company's offerings, and the Company's continued investment in customer acquisition through technology development and marketing.\nThe Company's online revenue is generated primarily from individual subscribers paying annual subscription fees plus recurring monthly usage fees. Until recently, the monthly usage fees for the Company's financial online service were based upon actual hours of prime time and non-prime time usage, with prime-time hours charged at a premium. In December 1995, after negotiating more favorable contracts with several of its communications providers and data vendors, the Company implemented a new fixed rate pricing plan for the Telescan Financial online service, whereby all customers are charged a flat monthly fee for a specified number of hours, with no stipulations as to time of day access. Under the terms of the plan, financial customers will now have free access to several services which were previously available only for a surcharge. The Company will benefit from having a predictable base of recurring monthly revenue and should see future reductions in its incremental communications costs. The Company's other online services should also benefit from future reductions in incremental communication costs under the new telecommunications contract.\nThe Company's incremental online operating expenses primarily include telecommunications costs, royalties and customer service expenses, while fixed online operating costs include data costs, amortization of software development and amortization of capitalized data. On a going forward basis, telecommunications cost will become semi-variable due to new \"per port\" contract. As a result of this mixed cost structure, the online gross margin rate will typically increase as online revenue increases and will decrease as online revenue decreases.\nProduct revenue is primarily generated from the sale of online access software, software and service enhancements, major product upgrades and related educational and training products such as books and videotapes. The Company's software products generally reflect a common base technology to which additional features can be added to satisfy the needs of the more sophisticated user. Accordingly, product revenue principally represents revenue from product enhancements or major upgrades. During 1995, the first version of Telescan Investor's Platform for Windows (\"TIP\") software was released and generated a significant increase in product revenue.\nProduct costs are variable in nature and include production, duplication, royalties and distribution costs. Due to the variable nature of these costs, increases or decreases in product revenue typically do not impact the gross margin rate. In 1994 however, the Company made a strategic decision to lower the price of its Analyzer software product below cost in order to increase its online subscriber base. While this campaign resulted in an increase in customers and an increase in recurring online revenue for future periods, it significantly lowered the product sales gross margin rate for 1994.\nThe Company's contract revenue is generated from providing contract services to other companies which include developing, operating and maintaining online database systems as well as providing administrative and marketing services. Contract revenue has increased primarily due to the Department of Energy (\"DOE\") contract awarded to KEDS in April 1994. Under the terms of the contract, the Company is responsible for the development, marketing and operation of an online service enabling technology transfer among universities, federal laboratories, and small to medium sized businesses. In exchange, DOE subsidizes online services for up to 1,200 subscribers, pursuant to which $2,114,000 and $1,434,000 of contract revenue and $934,000 and $659,000 of gross margin was recognized by the Company during 1995 and 1994, respectively. The DOE Contract expires in March 1996. To counter the impact of the expiration of the Contract, KEDS has been actively working to expand its unsubsidized subscriber base. Since the beginning of 1995, the number of unsubsidized subscribers has increased 270% from 683 to 1,853. This represents an increase in monthly revenue from unsubsidized subscribers of $13,000 per month during the first quarter of 1995 to $39,000 per month during the first quarter of 1996. Management will continue to closely monitor the operating results of KEDS, and will make modifications, if necessary, to optimize KEDS' operating results subsequent to the expiration of this contract. See Item 13 - \"CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\" 1995 COMPARED TO 1994\nTotal revenue increased $3,512,000, or 34%, from $10,477,000 for the year ended December 31, 1994, to $13,989,000 for the year ended December 31, 1995. Online revenue, which consists primarily of recurring revenue, increased $2,263,000, or 35%, from $6,564,000 for fiscal 1994 to $8,827,000 for fiscal 1995, primarily due to continued growth in the number of online customers. Product revenue increased $606,000, or 34%, from $1,779,000 in 1994 to $2,385,000 in fiscal 1995, primarily due to the 1995 release of Telescan Investor's Platform for Windows. Contract and license revenue increased $635,000, or 30%, from $2,099,000 to $2,734,000, primarily due to the DOE Contract, which commenced April 1, 1994, and a $200,000 license fee earned pursuant to an agreement with a major financial services institution, whereby the Company's financial software will be included in a new software bundle due to be released during 1996. Under the terms of this agreement, the Company has been guaranteed a minimum of $500,000 of online revenue within 12 months after the software bundle is released, although the actual amounts could be higher.\nFor the year ended December 31, 1995, total cost of revenue increased from $6,489,000 in fiscal 1994 to $7,769,000 in fiscal 1995, a $1,280,000, or 20% increase. This increase is primarily attributable to the increase in revenue discussed above. As a percentage of total revenue, cost of revenue decreased from 62% to 56% primarily due to the higher margin TIP software released in 1995 coupled with the below cost pricing of the 1994 Analyzer sales.\nFor the year ended December 31, 1995, the Company earned a gross margin on its online service revenue of $3,854,000 compared to $2,972,000 for the comparable period of 1994. Online gross margin as a percentage of online revenue remained relatively constant at 44% and 45% for the year ended December 31, 1995 and 1994.\nFor the year ended December 31, 1995, the Company earned a gross margin on its product revenue of $1,128,000 compared to $175,000 for the comparable period of 1994. Product gross margin as a percentage of product revenue increased from 10% to 47% primarily due to the higher margin TIP software released in 1995 coupled with the below cost pricing of the 1994 Analyzer sales.\nMarketing expenses increased 4% from $3,169,000 for the year ended December 31, 1994 to $3,284,000 for the year ended December 31, 1995 primarily as a result of the Company's continuing commitment to customer acquisition. The increase includes an additional $213,000 in marketing personnel salaries and $118,000 of additional commission expense directly related to the 34% increase in product sales discussed above. These increases were offset by a decrease in advertising and sales promotion expenses of $342,000, which is a result of the postponement of major 1995 advertising activities until the release of TIP at the end of the second quarter.\nGeneral and administrative expenses increased 19% from $3,256,000 for the year ended December 31, 1994 to $3,859,000 for the year ended December 31, 1995, primarily due to increased salary expense of approximately $394,000 and increased depreciation and amortization expense of approximately $168,000.\nThe net loss during the fourth quarter of 1995 was $939,000, or $0.09 per share verses $873,000, or $0.09 per share during the same period of the prior year.\n1994 COMPARED TO 1993\nFor the year ended December 31, 1994, total revenues of $10,477,000 were $3,527,000, or 51%, higher than the same period 1993 total revenues of $6,950,000, principally due to a $2,205,000, or 51%, increase in online service revenue together with a $1,148,000, or 121%, increase in contract revenue principally as the result of the DOE Contract acquired by KEDS in the first quarter of 1994. The online service revenue increase was principally the result of increased online volume primarily resulting from growth in the number of the Company's online customers. This increase is attributable to the higher level of advertising employed by the Company during the year ended December 31, 1994 as compared to the same period of 1993. In conjunction with increased advertising in 1994, the Company sharply reduced the price of its Analyzer product on January 1, 1994, which resulted in the shipment of approximately 39,000 Analyzer units during the year ended December 31, 1994, compared to approximately 6,400 units shipped in the same 1993 period.\nFor the year ended December 31, 1994, the Company's gross margin was $3,988,000, representing an increase of $760,000 compared to the corresponding 1993 period's gross margin of $3,228,000. The overall increase in gross margin primarily reflects increases of $992,000 and $616,000, respectively, in the online and contract gross margins offset by a decline of $867,000 in gross margin from the product revenues. For the year ended December 31, 1994 and 1993, the online service gross margins remained constant at 45% of their respective online revenues. Product gross margins were 10% and 64% for the respective years ended December 31, 1994 and 1993, with the margin decline primarily reflecting the lowered price of the Analyzer product below cost, together with a lower margin sales mix of other products. Gross margin earned on contracts for the year ended December 31, 1994 improved to 38% from 20% for the same period of the prior year, primarily as the result of the DOE Contract.\nMarketing expense increased $1,763,000 to $3,169,000 during the year ended December 31, 1994 from $1,406,000 in the same 1993 period, due primarily to higher advertising expenses of approximately $1,000,000 and higher salary expense of approximately $490,000 principally related to the hiring of additional personnel. At December 31, 1994, the number of employees involved in selling-related functions was 30, compared to 22 at December 31, 1993.\nPrior to the third quarter of 1994, the Company capitalized direct-response advertising costs and amortized such costs on the straight-line method over 12 months. Beginning in the third quarter of 1994, direct-response advertising costs are expensed in the year in which they were incurred to preclude carrying such costs over from one year to the next. Although the foregoing had no material effect on the Company's historical 1994 results of operations for the first three quarters of the year, advertising expense in the fourth quarter of 1994 was approximately $350,000 higher than otherwise would have been reported.\nGeneral and administrative expense increased $1,397,000 from $1,859,000 in the year ended December 31, 1993 to $3,256,000 in the year ended December 31, 1994, due primarily to increased legal expense, approximately $580,000 of increased salary and related fringe benefit expenses, approximately $255,000 of increased depreciation expense and approximately $130,000 of higher building rent expense. At December 31, 1994 and 1993, the numbers of administrative employees totaled 72 and 50, respectively. Legal expense, which included a $28,000 settlement of a lawsuit, increased approximately $240,000, reflecting unusually high corporate development activity and litigation matters principally involving the Hoggett Litigation, as discussed in Note 9 to the Company's Consolidated Financial Statements.\nFor the year ended December 31, 1994, the Company incurred a net loss of $2,631,000 compared to a net loss of $31,000 for the corresponding 1993 period principally as the result of higher selling, general and administrative expenses together with a decrease in the product revenue margin partially offset by increased gross margins associated with online and contract revenue.\nLIQUIDITY AND CAPITAL RESOURCES\nAt December 31, 1995, the Company had cash and cash equivalents aggregating $1,796,000, which represents an $840,000 increase over the prior year. Net cash provided by operating activities was $551,000 for the year ended December 31, 1995 compared to cash used by operations of $1,562,000 for the year ended December 31, 1994. This $2,113,000 increase in cash provided by operations was primarily due to improved operating results adjusted for non-cash items, including $1,552,000 of depreciation and amortization during 1995.\nThe Company's primary capital needs are for (1) the continued investment in technology through its software development activities, (2) the purchase of capitalized data and (3) the purchase of computers and communications equipment. During the year ended December 31, 1995, the Company invested $1,566,000 in software development costs and acquired property and equipment totaling $450,000, of which $292,000 was financed. The Company estimates that it may invest an additional $2 million in capital expenditures over the next twelve months. The Company intends to fund these capital additions through existing cash on hand, cash generated from operations, long-term capital leasing and proceeds from borrowings.\nIn June 1995, the Company entered into a Stock Purchase Agreement with TransTerra Company (\"TransTerra\"), whereby TransTerra agreed to purchase $5 million of the Company's common stock (\"Common Stock\") in four equal installments over a nine month period. The number of restricted shares of Common Stock to be issued for each installment is calculated based upon the average market price of the Common Stock over the preceding quarter. In connection with this agreement, the Company granted certain registration rights to TransTerra and allowed TransTerra to appoint a representative to the Board of Directors. Net proceeds of approximately $4,900,000 from this series of transactions are being used by the Company for technology development, working capital and other general corporate requirements. During 1995, pursuant to the terms of this agreement, 427,998 shares of restricted Common Stock were issued for total consideration of $2.5 million. An additional 173,459 shares were issued in January 1996 in exchange for the third installment of $1,250,000.\nThe Company believes that the existing cash on hand, cash generated from operations, proceeds from borrowings and the proceeds from the TransTerra Common Stock purchase will be adequate to fund its working capital and other cash requirements over the next twelve months.\nAggregate revenue from the Company's online financial database and related product sales accounted for approximately 72% and 74% of the Company's total revenue for the year ended December 31, 1995 and 1994, respectively. A downturn in the equity markets could cause a reduction in this revenue, which could have an adverse effect on the Company's financial position and results of operations. However, the Company believes that the effect of such adverse market conditions would be lessened by its fixed rate billing structure. To counter the potential impact, if any, of such a downturn, the Company is broadening its revenue base through its alliances with third parties to develop and operate online databases and Internet sites outside the Company's primary market. Also, during the fourth quarter of 1995, the Company began utilizing its new technology, code-\nnamed Sunflower, which will allow the Company to efficiently establish additional third party online communication networks without a substantial investment in hardware or software development.\nThe Financial Accounting Standards Board (the \"FASB\") issued Statement of Financial Accounting Standards (\"SFAS\") No. 121 \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of\". This statement is effective for fiscal years beginning after December 15, 1995. Management does not believe that adoption of this pronouncement in 1996 will have a material impact on its financial statements.\nThe FASB also issued SFAS No. 123, \"Accounting for Stock Based Compensation\", effective for fiscal years beginning after December 15, 1995. This statement allows companies to choose to adopt the statement's new rules for accounting for employee stock-based compensation plans. For those companies who choose not to adopt the new rules, the statement requires disclosures as to what earnings and earnings per share would have been if the new rules had been adopted. Management intends to adopt the disclosure requirements of this statement in 1996.\nSEASONALITY\nThe Company does not believe that seasonality has a discernible effect on the Company's aggregate results of operations, which is influenced by an array of other diverse factors, including general economic and stock market conditions, new product releases, and the existence or absence of significant contracts.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe financial statements are filed pursuant to Item 14 (a)1.\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\nEXECUTIVE OFFICERS AND DIRECTORS\nThe Company's directors and executive officers are as follows:\nNAME AGE POSITION - ----------------------- ---------- ------------------------------------ David L. Brown 55 Director, Chairman and Chief Executive Officer\nRichard K. Carlin 40 Director, Vice Chairman and Senior Vice President\nRoger C. Wadsworth 48 Director and Senior Vice President\nKaren R. Fohn 35 Chief Financial Officer\nLuiz V. Alvim 65 Executive Vice President and \"Acting\" Chief Operating Officer\nWilliam T. Melton 59 Vice President\nNeil S. Waldman 39 Vice President\nTracy N. Curry 31 Vice President\nJoseph F. Frantz II 32 Vice President\nJ. Joseph Ricketts 54 Director\nRonald W. Hart, Ph.D. 54 Director\nBurt H. Keenan 57 Director\nWilliam D. Savoy 31 Director\nStephen C. Wood 44 Director\nEach director holds office until the next annual meeting of stockholders or until his successor has been elected and qualified. The Compensation Committee and Audit Committee of the Board of Directors is composed of Messrs. Ricketts, Hart, Keenan, Savoy, and Wood.\nDavid L. Brown, Chairman of the Board and CEO, has served as a director of the Company since 1989. Mr. Brown is co-author of CYBER-INVESTING: CRACKING WALL STREET WITH YOUR PERSONAL COMPUTER, a book on computerized investing, published by John Wiley & Sons, Inc. From 1978 to 1986, Mr. Brown was president and, from 1978 to 1986 and from 1992 to 1993, a director of Time Energy Systems, Inc., a public company, which changed its name to ACR Group, Inc. He has served as chairman of the U.S. Science and Technology Commission for the Emerging Leaders Summit Conference series with the USSR. For the past nine years, he has served as a director of the Alliance for Aging Research, based in Washington, D.C. He has also served as chairman of the New Millennium Committee of the Planetary Society, a group based in Pasadena, California, which supports space exploration. He has served as chairman of the Advisory Board of the Southwest Council of Public CEOs and on the boards of several banks and financial institutions. Mr. Brown began his career in the space program at NASA, where he headed the team of engineers who designed the landing gear for the first lunar module. Mr. Brown holds a B.S. degree in mechanical engineering from the University of Pittsburgh and an M.B.A. from the University of Houston.\nDr. Richard K. Carlin, Vice Chairman of the Board and Senior Vice President, was one of the founders of Telescan and has served as a director of the Company since 1989. From 1988 to April 1990, Dr. Carlin served as the director of Technology Information Center, a subsidiary of Maxwell Communications, where he managed the development and maintenance of a technology transfer online database. From 1983 to 1988, he was with D.B. Technology, Inc., the predecessor to the Company. From 1981 to 1983, Dr. Carlin was assistant professor at Rockefeller University. Dr. Carlin holds a B.S. degree in biophysical sciences from the University of Houston and a Ph.D. in biochemistry, also from the University of Houston.\nRoger C. Wadsworth, Senior Vice President, has served as a director since 1989. From 1988 to 1990, Mr. Wadsworth served as President of the Company. From 1983 to 1988, Mr. Wadsworth was employed as vice-president of Information Management Services, Inc., in Houston, Texas, where he provided management services to investment vehicles such as limited partnerships and joint ventures. From 1979 to 1983 he served as co-owner of D. Russell Smith Associates, a restaurant and tenant finish general contractor. Mr. Wadsworth holds a B.B.A. from the University of Houston.\nKaren R. Fohn, Chief Financial Officer, came to Telescan in September 1995 from TransAmerican Waste Industries, Inc., where she served as Corporate Controller since 1992. From 1990 to 1992, Ms. Fohn was employed as External Reporting Manager for Sanifill, Inc.. From 1985 to 1990, she was an Audit Manager for Ernst & Young. Ms. Fohn is a Certified Public Accountant and holds a B.S. in accounting from Louisiana State University.\nLuiz V. Alvim was appointed Executive Vice President and \"Acting\" Chief Operating Officer of Telescan in March 1996, after having served as the Company's Director of Financial Research and Chairman of the International Committee since 1994. From 1988 to 1994, Mr. Alvim held the position of Executive Vice President and Chief Operating Officer of PanAtlantica SA.\nWilliam T. Melton, Vice President of the Company since January 1995, previously held the position of Manager of Project Development. Before joining the Company in October 1993, Mr. Melton served as a Project Manager with International Business Machines, Inc., having previously served in other sales positions as a 30-year employee of that company. Mr. Melton holds both a B.S. in Business Administration and an M.B.A. from the University of Arkansas.\nNeil S. Waldman, Vice President of the Company since May 1995, previously held the position of Director of Institutional Sales. Before joining the Company in 1993, Mr. Waldman was employed as Manager Business Development for IDD Information Services, Inc. where he was instrumental in the introduction of three new products for the investment management and brokerage communities. From 1989 to 1991 Mr. Waldman served as Vice President of Sales and Marketing for Vista Computer, Inc. where he directed sales and marketing for the developer of integrated software solution targeted at international commodities traders. Mr. Waldman holds a B.S. in Business Administration from Northeastern University.\nTracy N. Curry, Vice President of the Company since February 1996, previously held the positions of Director of Marketing and Marketing Manager. Ms. Curry came to Telescan from Utopia Spring Water, Inc. where she was instrumental in the successful positioning of a product which fueled significant growth. From 1989 to 1991 Ms. Curry served as a Marketing Coordinator for Blue Bell Creameries, Inc. where she spearheaded a marketing campaign for the nation's first dietary ice cream. Ms. Curry holds a B.B.A in Marketing from the University of Texas at Austin.\nJoseph F. Frantz II, Vice President of the Company since May 1995, previously held the positions of Computer Operations Manager, End-User Software Product Manager and Senior Programmer. Mr. Frantz joined the Company in 1987 as a Technical Support Representative. Mr. Frantz holds a B.S. in Applied Mathematics from the University of Houston and a M.S. in Management Computing and Systems from Houston Baptist University.\nDr. Ronald W. Hart has been a Distinguished Scientist in Residence for the Food and Drug Administration, Public Health Service, since 1992. From 1980 to 1992, he was the Director for the National Center for Toxicological Research, Food and Drug Administration, Public Health Service, Department of Health and Human Services in Jefferson, Arkansas. From 1987 to 1993, Dr. Hart served on the Board of Directors of First Commercial Bank Corporation of Little Rock, Arkansas. Dr. Hart has received over 30 awards and recognition for his research and administrative accomplishments and is an internationally recognized scientist and science manager holding the position of distinguished professor at a number of universities and colleges, including Cairo University, Cairo, Egypt; Gangzou University, Gangzou, China; Moscow State University, Moscow, Russia. Dr. Hart also serves as a professor at the University of Arkansas for Medical Sciences and the University of Tennessee Center for Health Sciences. Dr. Hart has published over 500 manuscripts on various topics, including research management and administration and is a fellow of the American College of Toxicology, American Association for the Advancement of Science, and the Gerontology Society of America. Dr. Hart received his B.A. in 1967 from Syracuse University, an M.S. in 1970, and a Ph.D. in 1971 at the University of Illinois, Urbana. Dr. Hart has been a director since 1990.\nJ. Joseph Ricketts currently serves as Chairman and Chief Executive Officer of TransTerra Co., a financial services holding company. TransTerra was purchased by Mr. Ricketts in 1975, and he continues to manage the Company and is the principal stockholder. Mr. Ricketts also serves on the Board of CSS, Inc., a software development consortium, and is on the Advisory Committee of Roundtable Partners, L.L.C., a securities trading firm. He is also a newly elected member of the District Committee of the National Association of Securities Dealers, Inc. Mr. Ricketts is a resident of Omaha, Nebraska, and is a graduate of Creighton University with a major in economics. Mr. Ricketts has been a director since July 1995.\nBurt H. Keenan has been an associate with Chaffe & Associates, Inc., an investment banking firm located in New Orleans, Louisiana, since 1987. Prior to 1987, Mr. Keenan was the Chairman and Chief Executive Officer of Offshore Logistics, Inc., a publicly held oil and gas service company operating a fleet of marine service vessels and helicopters worldwide. Mr. Keenan received his bachelor and masters degrees in business administration from Tulane University. Mr. Keenan has been a director since 1989.\nWilliam D. Savoy currently serves as Vice President of Vulcan Ventures Incorporated, a venture capital fund controlled by Paul G. Allen, co-founder of Microsoft Corporation. Vulcan is a significant stockholder of the Company. From 1987 until November 1990, Mr. Savoy was employed by Layered, Inc., a company controlled by Mr. Allen, and became its President in 1988. Mr. Savoy has served as President for Vulcan Northwest Inc., a company wholly-owned by Mr. Allen, from November 1990 until the present. He also represents Mr. Allen in a wide variety of other personal financial transactions. Mr. Savoy holds a B.S. in Computer Science, Accounting and Finance from Atlantic Union College. Mr. Savoy was appointed as a director of the Company in March 1993.\nStephen C. Wood is currently Chief Executive Officer of Notable Technologies, Inc. based in Kirkland, Washington. Until December 1994 Mr. Wood was Vice President of Information Broadcasting for McCaw Development Corporation, located in Kirkland, Washington. From February 1993 to December 1993, Mr. Wood was a consultant providing advisory services to the computer industry. Until February 1993 he was President of Starwave Corporation, a company he formed in 1992 with Microsoft Corporation co-founder Paul G. Allen to develop and market data and information products. Mr. Wood is a member of the Board of Directors of Raima Corporation, a database software company in Bellevue, Washington. From 1986 through 1991, Mr. Wood served as Vice President of Marketing, Vice President of Marketing and Development, Vice President of Marketing and Sales and Vice President of Business Development at Asymetrix Corporation, a software development and marketing firm. From 1980 until 1985, Mr. Wood was in charge of building a microcomputer software development organization for Datapoint Corporation in Austin, Texas, after serving in R & D and marketing positions. Mr. Wood began his career in 1976 when he became the sixth employee of Microsoft Corporation, where he was General Manager from 1977 to 1980. Mr. Wood holds a B.S. in Computer Engineering from Case Western Reserve University, and an M.S. in Electrical Engineering from Stanford University.\nMr. Wood was appointed as a director of the Company in August 1993 in accordance with the agreement entered into between the Company and Vulcan. Pursuant to the terms of the agreement, Vulcan has the right to designate one director to the Company's Board of Directors for as long as Vulcan (or its affiliate) owns, or has the right to acquire through the exercise of their warrants, at least 540,000 shares of Common Stock of the Company. In addition, the Company has agreed not to take any corporate action to increase its number of directors without the unanimous written consent of all directors for as long as Vulcan (or its affiliate) owns, or has the right to acquire through the exercise of their warrants, at least 540,000 shares of Common Stock of the Company.\nIn March 1993, upon unanimous consent of all directors and with the assent of Vulcan, the number of directors was expanded by one to a total of eight. Vulcan determined to change its designate as its representative to the Company's Board of Directors from Mr. Stephen C. Wood, who continues to serve as a director of the Company, to William D. Savoy. Mr. Savoy was elected by unanimous consent of the directors to a seat on the Company's board\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by this item appears in the section entitled \"Executive Compensation\" in the Company's Proxy Statement relating to the 1996 Annual Meeting of Shareholders, which information is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required by this item appears in the section entitled \"Security Ownership of Certain Beneficial Owners and Management\" in the Company's Proxy Statement relating to the 1996 Annual Meeting of Shareholders, which information is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by this item appears in the section entitled \"Certain Relationships and Related Transactions\" in the Company's Proxy Statement relating to the 1996 Annual Meeting of Shareholders, which information is incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES AND REPORTS ON FORM 8-K\n(A) The following documents are filed as a part of this Annual Report: PAGE\n1. FINANCIAL STATEMENTS. Independent Auditor's Report.................................... 35 Consolidated Balance Sheets as of December 31, 1995 and 1994.... 36 Consolidated Statements of Operations for the years ended December 31, 1995, 1994 and 1993............................ 37 Consolidated Statements of Stockholders' Equity for the years ended December 31, 1995, 1994 and 1993...................... 38 Consolidated Statements of Cash Flows for the years ended December 31, 1995, 1994 and 1993.............................. 39 Notes to Consolidated Financial Statements...................... 40\n2. FINANCIAL STATEMENT SCHEDULES. Independent Auditor's Report on Schedules....................... 51 Schedule II - Valuation and Qualifying Accounts................. 52\nAll other schedules have been omitted since the required information is not present or is not present in amounts sufficient to require submission of the schedule, or because the information required is included in the consolidated financial statements or notes thereto.\n3. EXHIBITS\nEXHIBIT NUMBER DESCRIPTION\n3.1** Restated Certificate of Incorporation of Registrant. (Incorporated by reference to the Company's Form S-1 dated September 14, 1993 (Registration No. 33-52182)).\n3.2** Certificate of Amendment of Restated Certificate of Incorporation of the Registrant. (Incorporated by reference to the Company's Form S-1 dated September 14, 1993 (Registration No. 33-52182)).\n3.3** By-laws of the Registrant. (Incorporated by reference to the Company's Form S-1 dated September 14, 1993 (Registration No. 33-52182)).\n4.1** See Exhibits 3.1 through 3.4 for provisions of the Certificate of Incorporation and By-laws of the Registrant defining rights of holders of Common Stock of the Registrant. (Incorporated by reference to the Company's Form S-1 dated September 14, 1993 (Registration No. 33-52182)).\n4.2** Asset Purchase Agreement dated June 30, 1990, between TIC Software, Inc. and the Registrant which sets forth certain registration rights of TIC Software, Inc. (Incorporated by reference to the Company's Form S-1 dated September 14, 1993 (Registration No. 33-52182)).\n4.3** Exhibits to Asset Purchase Agreement dated June 30, 1990, between TIC Software, Inc. and the Registrant which set forth certain registration rights of TIC Software, Inc. (Incorporated by reference to the Company's Form S-1 dated September 14, 1993 (Registration No. 33-52182)).\n4.4** Assignment of Agreement between Jacob Sobotka, Marvin Deuell, Raymond C. Wicker and the Registrant which sets forth certain registration rights of those parties, effective as of January 1, 1992. (Incorporated by reference to the Company's Form S-1 dated September 14, 1993 (Registration No. 33-52182)).\n4.5** Assignment of General Partnership interest between New World Technologies, a Texas general partnership, and the Registrant which sets forth certain registration rights effective as of January 1, 1992. (Incorporated by reference to the Company's Form S-1 dated September 14, 1993 (Registration No. 33-52182)).\n4.6** Registration Rights Agreement between Vulcan Ventures Incorporated and the Registrant dated May 20, 1992. (Incorporated by reference to the Company's Form S-1 dated September 14, 1993 (Registration No. 33-52182)).\n4.7** Form of Redeemable Warrant Certificate issued by the Registrant to Vulcan Ventures Incorporated to purchase 600,000 shares of Common Stock of the Registrant at $3.25 per share dated May 20, 1992. (Incorporated by reference to the Company's Form S-1 dated September 14, 1993 (Registration No. 33-52182)).\n4.8** Form of Registration Rights Agreement between Sanders Morris Mundy Inc. and the Registrant dated May 20, 1992. (Incorporated by reference to the Company's Form S-1 dated September 14, 1993 (Registration No. 33-52182)).\n4.9** Form of Warrant Certificate issued by the Registrant to Sanders Morris Mundy Inc. to purchase 60,000 shares of Common Stock of the Registrant at $1.75 per share dated May 20, 1992. (Incorporated by reference to the Company's Form S-1 dated September 14, 1993 (Registration No. 33-52182)).\n4.10** Form of Warrant Certificate issued by Registrant to Sanders Morris Mundy Inc. to purchase 60,000 shares of Common Stock of Registrant at $3.25 per share dated May 20, 1992. (Incorporated by reference to the Company's Form S-1 dated September 14, 1993 (Registration No. 33-52182)).\n4.11** Form of Registration Rights Agreement between the Registrant and 47 private investors dated August 5, 1992. (Incorporated by reference to the Company's Form S-1 dated September 14, 1993 (Registration No. 33-52182)).\n4.12** Form of Redeemable Warrant Certificate issued by the Registrant to 47 private investors to purchase, in the aggregate, 1,200,000 shares of Common Stock of the Registrant at $3.25 per share dated August 5, 1992. (Incorporated by reference to the Company's Form S-1 dated September 14, 1993 (Registration No. 33-52182)).\n4.13** Form of Registration Rights Agreement between the Registrant and Sanders Morris Mundy Inc. dated August 5, 1992. (Incorporated by reference to the Company's Form S-1 dated September 14, 1993 (Registration No. 33-52182)).\n4.14** Form of Warrant Certificate issued by the Registrant to Sanders Morris Mundy Inc. to purchase 120,000 shares of Common Stock of the Registrant at $1.75 per share dated August 5, 1992. (Incorporated by reference to the Company's Form S-1 dated September 14, 1993 (Registration No. 33-52182)).\n4.15** Form of Warrant Certificate issued by the Registrant to Sanders Morris Mundy Inc. to purchase 120,000 shares of Common Stock of the Registrant at $3.25 per share dated August 5, 1992. (Incorporated by reference to the Company's Form S-1 dated September 14, 1993 (Registration No. 33-52182)).\n4.16** Form of Registration Rights Agreement between the Registrant and G. Robert Friedman dated May 24, 1990. (Incorporated by reference to the Company's Form S-1 dated September 14, 1993 (Registration No. 33-52182)).\n4.17** Registration Rights Agreement between TransTerra Company and the Registrant dated June 28, 1995. (Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1995.)\n10.1** Independent Contractor Agreement by and between Knowledge Express, L.C. and the Registrant dated December 31, 1990. (Incorporated by reference to the Company's Form S-1 dated September 14, 1993 (Registration No. 33-52182)).\n10.2** Assignment of General Partnership interest dated as of January 1, 1992 by and between the Registrant and New World Technologies, a Texas general partnership (see Exhibit 4.5). (Incorporated by reference to the Company's Form S-1 dated September 14, 1993 (Registration No. 33-52182)).\n10.3** Assignment of Agreement effective as of January 1, 1992 by and among the Registrant and Jacob C. Sobotka, Marvin J. Deuell and Raymond C. Wicker. (see Exhibit 4.4). (Incorporated by reference to the Company's Form S-1 dated September 14, 1993 (Registration No. 33-52182)).\n10.4** Stock Purchase Agreement between the Registrant and Vulcan Ventures, Incorporated dated May 20, 1992. (Incorporated by reference to the Company's Form S-1 dated September 14, 1993 (Registration No. 33-52182)).\n10.5** Asset Purchase Agreement between the Registrant and TIC Software, Inc. dated June 30, 1990 (see Exhibit 4.2). (Incorporated by reference to the Company's Form S-1 dated September 14, 1993 (Registration No. 33-52182)).\n10.6** Agreement between the Registrant and the Brown\/Friedman Partnership dated July 31, 1991. (Incorporated by reference to the Company's Form S-1 dated September 14, 1993 (Registration No. 33-52182)).\n10.7** Employee Stock Option Plan. (Incorporated by reference to the Company's Form S-1 dated September 14, 1993 (Registration No. 33-52182)). (1)\n10.8** Amended Stock Option Plan. Incorporated by reference to Exhibit 4.1 to the Company's Post-Effective Amendment No. 1 to Form S-8 (File No. 33-63172) as filed with the Commission on February 2, 1994. (1)\n10.9** Exchange Agreement among the Registrant, Resurgence Systems, Inc. and certain persons or entities whose names appear on the signature page thereof dated as of December 7, 1992. (Incorporated by reference to the Company's Form S-1 dated September 14, 1993 (Registration No. 33-52182)).\n10.10** Regulations of Telescan (TRC), L.C. effective January 1, 1992 by and between the Registrant and The Radnor-Houston Joint Venture. (Incorporated by reference to the Company's Form S-1 dated September 14, 1993 (Registration No. 33-52182)).\n10.11** First Amendment to Regulations of Knowledge Express, L.C. (formally now Telescan (TRC), L.C.) entered into effective July 23, 1992, by and between the Registrant and The Radnor-Houston Joint Venture. (Incorporated by reference to Amendment No. 1 to the Company's Form S-1 dated January 8, 1993).\n10.12** Regulations of Telebuild, L.C. entered into effective July 31, 1992, by and among the Registrant, JST Technology Center, Inc. and Friedman Interests, Inc. (Incorporated by reference to Amendment No. 2 to the Company's Form S-1 dated February 1, 1993).\n10.13** Agreement by and between Fidelity Investments Retail Services and Telescan, Inc. dated as of March 15, 1991. (Incorporated by reference to Amendment No. 2 to the Company's Form S-1 dated February 1, 1993).\n10.14** Database License Agreement between SEC Online, Inc. and Telescan, Inc. dated as of November 25, 1992. (Incorporated by reference to Amendment No. 2 to the Company's Form S-1 dated February 1, 1993).\n10.15** Agreement between the Registrant and Access Software, Inc. dated January 23, 1992. (Incorporated by reference to Amendment No. 3 to the Company's Form S-1 dated March 29, 1993).\n10.16** Contribution Agreement between The Radnor-Houston Joint Venture and Telescan, Inc. dated March 25, 1993. (Incorporated by reference to Amendment No. 3 to the Company's Form S-1 dated March 29, 1993).\n10.17** Fourth Amendment to Regulations of Knowledge Express, L.C. made and entered into effective March 25, 1993, by and between The Radnor-Houston Joint Venture and Telescan, Inc. (Incorporated by reference to Amendment No. 3 to the Company's Form S-1 dated March 29, 1993).\n10.18** Agreement by and between American Institute of Architects and Telebuild, L.C. dated August 7, 1992. (Incorporated by reference to Amendment No. 4 to the Company's Form S-1 dated May 5, 1993).\n10.19** Employment Agreement by and between the Company and David L. Brown dated March 10, 1994. (Incorporated by reference to Post-Effective Amendment No. 1 to the Company's Form S-1dated August 11, 1994). (1)\n10.20** Stock Purchase Agreement between the Company and TransTerra Company dated June 28, 1995. (Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1995.)\n10.21* Office Lease Agreement between the Registrant and Chevron U.S.A., Inc. dated November 8, 1995.\n11* Statement regarding computation of per share earnings.\n21* Subsidiaries of the Registrant.\n23* Consent of Independent Public Accountants.\n27* Financial Data Schedule.\n* Indicates documents filed herewith.\n** Indicated documents incorporated by reference from the prior filing indicated.\n(1) Management contracts or compensation plans or arrangements.\n(B) REPORTS ON FORM 8-K\nNo reports on Form 8-K were filed during the last quarter of fiscal\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 IN THE CITY OF HOUSTON, STATE OF TEXAS, ON MARCH 28, 1996.\nTELESCAN, INC. BY: \/S\/ DAVID L. BROWN David L. Brown, Chief Executive Officer\nPURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1934, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS IN THE CAPACITIES AND ON THE DATE INDICATED.\nINDEPENDENT AUDITOR'S REPORT\nBoard of Directors and Stockholders Telescan Inc. Houston, Texas\nWe have audited the accompanying consolidated balance sheets of Telescan, Inc. and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1995. 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 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 financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as 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 Telescan, Inc. and subsidiaries as of December 31, 1995 and 1994, and the results of their operations and cash flows for each of the years in the three-year period ended December 31, 1995, in conformity with generally accepted accounting principles.\nHEIN + ASSOCIATES LLP HOUSTON, TEXAS FEBRUARY 13, 1996\nTELESCAN, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AMOUNTS)\nThe accompanying notes are an integral part of these financial statements.\nTELESCAN, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\nThe accompanying notes are an integral part of these financial statements.\nTELESCAN, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (IN THOUSANDS)\nThe accompanying notes are an integral part of these financial statements.\nTELESCAN, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)\nThe accompanying notes are an integral part of these financial statements.\nTELESCAN, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBASIS OF PRESENTATION. The consolidated financial statements include the accounts of Telescan, Inc., and its majority owned subsidiaries (\"Telescan\" or the \"Company\"). All significant intercompany accounts and transactions have been eliminated in consolidation. The Company's consolidated statement of operations includes the results of Knowledge Express Data Systems, L.C. (\"KEDS\") beginning April 1, 1993. KEDS results of operations were accounted for on the equity method of accounting prior to the Company acquiring a majority interest on April 1, 1993.\nNATURE OF BUSINESS. The Company is an industry leader in providing innovative solutions for on-line technology, data retrieval and Internet services. The Company develops, markets, and operates major online networks serving the financial, publishing, home design and building, entertainment and technology transfer industries. The Company's products and services, which are based upon its proprietary online operating system and user software, allow its customers to electronically access and analyze information through their personal computer systems.\nThe Company's primary products are the Telescan system of on-line financial databases and software tools, which offer current and historical financial news and information as well as search and analytical tools; Computer Sports Network (\"CSN\"), which offers on-line computer sports games; third party on-line services which are developed and operated via alliances with third parties in the publishing, entertainment, and home design and building industries; and KEDS, which is an on-line database system for the commercialization and transfer of technology serving corporations, government agencies, universities, and research institutions. The Company owns 55.58% of KEDS and acts under contract as the exclusive system operator.\nSIGNIFICANT RISKS AND UNCERTAINTIES. 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, the disclosed amounts of contingent assets and liabilities, and the reported amounts of revenues and expenses. Actual results could differ from those estimates.\nCONCENTRATION OF CREDIT RISK. The Company markets its products to a diverse customer base, and as such does not have any significant concentrations of credit risk. The Company maintains deposits in banks which may exceed the amount of federal deposit insurance available. Management periodically assesses the financial condition of the institutions and believes that any possible deposit loss is minimal.\nINVENTORIES. Inventories are carried at the lower-of-cost or market, determined on the specific identification method.\nEQUIPMENT. Equipment is recorded at cost and depreciated over the estimated useful life of the related assets. Equipment under capital lease is amortized over the shorter of the lease term or its estimated useful life. Depreciation and amortization expense is determined principally on the straight-line method. The estimated useful lives of the Company's equipment is as follows: Computer equipment 5 years Furniture 7 years Automobiles 5 years\nSOFTWARE DEVELOPMENT COSTS. Costs incurred in the research, design and development of software are charged to expense until technological feasibility is established, after which remaining software production costs are capitalized and amortized on a product-by-product basis based upon the greater of the ratio of current gross revenues for such product to total anticipated revenues or the straight-line basis over periods of three to five years. The Company has interpreted \"technological feasibility\" as the completion of a working model. Amortization of software development costs is included in cost of products in the accompanying consolidated statements of operations and totaled $505,000, $371,000, and $266,000 for the years ended December 31, 1995, 1994 and 1993, respectively. Accumulated amortization totaled $2,121,000 and $1,617,000 at December 31, 1995 and 1994, respectively. Amortization of capitalized software development costs begin when the related product is available for general release to customers. The Company periodically reviews software development costs to assess impairment. Amounts impaired are charged to expense as identified.\nSOFTWARE TECHNOLOGY RIGHTS. The Company has acquired rights to certain core software technologies. These rights are recorded at cost and are amortized over a period of five years. Amortization of software technology rights is included in cost of products in the accompanying consolidated statements of operations and totaled $55,000, $55,000 and $46,000 for the years ended December 31, 1995, 1994 and 1993, respectively. Accumulated amortization totaled $178,000 and $123,000 at December 31, 1995 and 1994, respectively.\nCAPITALIZED DATA COSTS. Costs incurred to acquire data are capitalized and amortized on a straight-line basis over three to five years. Capitalized data costs include actual costs to acquire the data plus personnel costs specifically related to loading the purchased data and performing the required programming. Amortization of capitalized data costs is included in cost of products in the accompanying consolidated statements of operations and totaled $266,000, $195,000 and $152,000 for the years ended December 31, 1995, 1994 and 1993, respectively. Accumulated amortization totaled $823,000 and $540,000 at December 31, 1995 and 1994, respectively. The Company periodically reviews capitalized data costs to assess impairment. Amounts impaired are charged to expense as identified.\nDIRECT-RESPONSE ADVERTISING COSTS. Prior to 1994, the Company capitalized direct-response advertising costs and amortized such costs on the straight-line method over 12 months. Beginning in 1994, the Company changed its policy to expense such costs in the year in which they were incurred in order to preclude carrying such costs over from one year to the next. For purposes of interim financial reporting, the Company has historically expensed direct-response advertising on a campaign by campaign basis based upon the ratio of actual revenue derived from a specific campaign compared to the expected revenue for that fiscal year. On a going forward basis, the Company will expense such costs in the interim period in which the costs are incurred.\nGOODWILL. Goodwill, totaling $277,000 and $29,000 at December 31, 1995 and 1994, respectively, represents the cost in excess of the fair value of the net assets of companies acquired and is being amortized on the straight-line basis over periods ranging from five to fifteen years. Accumulated amortization totaled $29,000 and $15,000 at December 31, 1995 and 1994, respectively. Goodwill amortization totaled approximately $14,000 and $2,000 for the years ended December 31, 1995 and 1994, respectively.\nEQUITY INVESTMENTS. The Company accounts for its investments in less than majority-owned entities, using the equity method of accounting. The Company discontinues recognition of losses on corporate joint\nventures once the Company's investment has been reduced to zero, provided the Company is not committed to fund the operations of the joint venture and is not contingently liable for obligations of such joint ventures.\nFAIR VALUE OF FINANCIAL INSTRUMENTS. The Company's financial instruments consist of trade receivables and liabilities, notes receivable due from officers, and various notes payable to banks. The Company believes the carrying value of these financial instruments approximate their estimated fair value.\nREVENUE RECOGNITION.. The Company recognizes online revenue when the service is provided. Software license fee revenue is recognized at the time of shipment unless significant future obligations remain. In these instances, revenue is not recognized until obligations have been satisfied or are no longer significant. Product revenue is recognized when the product is shipped. Revenue and costs related to the Company's \"cost plus\" contracts are recognized as the services are performed or the expenses incurred. Revenue and costs related to the Company's fixed price contract are recognized on the percentage-of-completion method. At December 31, 1995 cost and profits in excess of amounts billed on uncompleted contracts totaled $31,000 and is included in other current assets.\nINCOME TAXES. The Company accounts for income taxes on the liability method as prescribed by Statement of Financial Accounting Standards No. 109.\nEARNINGS PER SHARE. Earnings per share is computed based on the weighted average number of common and common equivalent shares outstanding. For periods in which a net loss occurred, common equivalent shares are not included in the weighted average number of common and common equivalent shares outstanding, as their inclusion would be anti-dilutive. During the periods presented, common equivalent shares consisted of warrants and options to acquire common stock.\nCONSOLIDATED STATEMENTS OF CASH FLOWS. For purposes of the consolidated statements of cash flows, the Company considers all highly liquid debt instruments with a remaining maturity of three months or less at the date of purchase and mutual funds readily convertible to cash, to be cash equivalents. The effects of non-cash transactions related to the acquisition discussed in Note 3 and certain other non-cash transactions are excluded from the statement of cash flows. Supplemental disclosures of cash flow information are as follows: YEAR ENDED DECEMBER 31, ---------------------------------- 1995 1994 1993 -------- --------- -------- Interest paid ........................... $ 66,000 $ 42,000 $ 25,000 Income taxes paid ....................... -- -- -- Property and equipment financed by debt or long-term capital leases .......... $256,000 $545,000 $362,000\nRECENT ACCOUNTING PRONOUNCEMENTS. The Financial Accounting Standards Board (the \"FASB\") issued Statement of Financial Accounting Standards (\"SFAS\") No. 121 \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of\". This statement is effective for fiscal years\nbeginning after December 15, 1995. Management does not believe that adoption of this pronouncement in 1996 will have a material impact on its financial statements.\nThe FASB also issued SFAS No. 123, \"Accounting for Stock Based Compensation\", effective for fiscal years beginning after December 15, 1995. This statement allows companies to choose to adopt the statement's new rules for accounting for employee stock-based compensation plans. For those companies who choose not to adopt the new rules, the statement requires disclosures as to what earnings and earnings per share would have been if the new rules had been adopted. Management intends to adopt the disclosure requirements of this statement in 1996.\nMAJOR CUSTOMERS. Revenue earned under the KEDS contract with the Department of Energy (the \"DOE Contract\") amounted to 15.1% and 13.7% of consolidated revenue during years ended December 31, 1995 and 1994, respectively. The DOE Contract expires March 31, 1996. KEDS has been actively working to convert its subsidized subscribers to paying customers and to expand its non-subsidized subscriber base in order to minimize the impact of the contract expiration.\nRECLASSIFICATIONS. Amounts in prior years' consolidated financial statements have been reclassified whenever necessary to conform with the current year's presentation.\n2. EQUIPMENT\nA summary of property and equipment at December 31, 1995 and 1994 is as follows: 1995 1994 ----------- ----------- Property and equipment ............... $ 3,519,000 $ 2,818,000 Furniture and fixtures ............... 370,000 345,000 Autos ................................ 53,000 106,000 ----------- ----------- 3,942,000 3,269,000 Accumulated depreciation ............. (1,682,000) (1,036,000) ----------- ----------- $ 2,260,000 $ 2,233,000 =========== ===========\nDepreciation and amortization expense was approximately $679,000, $511,000 and $244,000 for the years ended December 31, 1995, 1994 and 1993, respectively.\n3. ACQUISITIONS\nDuring September 1995, the Company acquired all of the outstanding capital stock of Entrepreneurs On-line, Inc. (\"EOL\"), for total consideration of $230,000, consisting of 43,774 restricted shares of the Company's common stock (\"Common Stock\"). This transaction has been accounted for under the purchase method of\naccounting and has been treated as a non-cash transaction in the Consolidated Statement of Cash Flows. The operating results of EOL have been included in the Company's consolidated financial statements since the date of acquisition. Pro Forma statements are not presented, as the impact of the 1995 EOL operating results on the consolidated total is immaterial. EOL operates an online database which links entrepreneurs and providers of services, capital and other resources.\n4. RELATED PARTY TRANSACTIONS\nThe Company has receivables from and payables to officers, stockholders, joint ventures and affiliates. The balances are generally due on demand and are noninterest bearing. At December 31, 1995 and 1994, the net amounts due from officers, stockholders, joint ventures and affiliates amounted to $315,000 and $312,000 respectively. Included in these amounts at December 31, 1995 is $44,000 in legal expenses paid by the Company on behalf of certain officers\/stockholders in connection with litigation discussed in Note 10. These advances are expected to be repaid during 1996.\nThe Company has provided computer hardware, programming, systems maintenance, data loading, telecommunications and certain administrative services to KEDS, Telebuild, and the Brown\/Friedman Partnership. The Company owns 55.58% of KEDS and 21.25% of Telebuild. GRF Interests, Inc., a company controlled by G. Robert Friedman (\"Friedman\"), a significant stockholder of the Company, owns 30% of KEDS. Friedman Interest, Inc., also controlled by Friedman, and JST Technology Center, Inc. (\"JST\"), own 38.1625% and 40.875% respectively of Telebuild. JST is owned 93.98% by the Brown Family Partnership and 6.02% by an unrelated party. The Brown Family Partnership is owned by David L. Brown, the Company's Chairman and Chief Executive Officer, Scott L. Brown, the former Vice President of Operations, and other members of the Brown family. The Brown\/Friedman Partnership is owned by David L. Brown and Friedman.\nContract service revenue earned from affiliates for the years ended December 31, 1995, 1994 and 1993 are as follows:\n1995 1994 1993 -------- -------- -------- Telebuild, L.C .......................... $408,000 $514,000 $616,000 Brown\/Friedman Partnership .............. -- 29,000 131,000 Knowledge Express Data Systems, L.C ..... -- -- 22,000 -------- -------- -------- $408,000 $543,000 $769,000 ======== ======== ========\n5. LONG -TERM OBLIGATIONS\nCAPITAL LEASES. Future minimum lease payments under capital leases at December 31, 1995, together with the present value of the minimum lease payments, are as follows:\nYEAR ENDING DECEMBER 31\n1996 ........................................... $ 206,000 1997 ........................................... 162,000 1998 ........................................... 138,000 1999 ........................................... 55,000 --------- Total minimum lease payments ............................... 561,000 Amount representing interest ............................... (85,000) --------- Present value of minimum lease payments ................ 476,000 Current portion capital lease obligations .................. (163,000) --------- Long-term capital lease obligations .................... $ 313,000 =========\nProperty and Equipment under capital lease at December 31, 1995 and 1994 totaled $765,000 and $690,000, with related accumulated depreciation of $283,000 and $164,000, respectively.\nLINE OF CREDIT. The Company has a $500,000 revolving line of credit with a bank to fund equipment purchases. Borrowings under this line bear interest at Wall Street Prime, are collateralized by the equipment purchased, and are due in 36 equal monthly installments following the draw. As of December 31, 1995, $310,000 was outstanding under this equipment line. The line of credit expired during 1996. The Company is in the process of renewing it for an additional one year term.\nEQUIPMENT NOTE. At December 31, 1995, the Company has a $17,000 note payable to a bank The note bears interest at 7.8%, is collateralized by equipment , and is payable in monthly installments of principal and interest through April 1997.\nFuture payments under the line of credit and bank note are as follows:\nYEAR ENDING DECEMBER 31,\n1996 ..................... $ 152,000 1997 ..................... 149,000 1998 ..................... 26,000 --------- 327,000 Current portion of long-term debt ........ (152,000) --------- $ 175,000 =========\nOPERATING LEASES. The Company has commitments to lease office space and equipment under noncancelable operating leases. During the fourth quarter of 1995, the Company entered into a long-term lease agreement pursuant to which the Company is leasing approximately 51,500 square feet of office space in Houston, Texas to house its principal executive offices as well as its marketing, computer operations and product development activities. The agreement is for an initial term of 11 years with a one-time cancellation option at the end of the sixth year.\nRent expense under operating leases totaled $581,000, $373,000 and $214,000 for the years ended December 31, 1995, 1994 and 1993, respectively. Future minimum lease payments are as follows:\nYEAR ENDING DECEMBER 31, 1996 $ 526,000 1997 851,000 1998 833,000 1999 797,000 2000 663,000 Thereafter 4,350,000 =========== $ 8,020,000 =========== 6. STOCKHOLDERS' EQUITY\nTRANSTERRA TRANSACTION. In June 1995, the Company entered into a Stock Purchase Agreement with TransTerra Company (\"TransTerra\"), whereby TransTerra agreed to purchase $5 million of restricted Common Stock in four equal installments over a nine month period. The number of shares of Common Stock to be issued for each installment is calculated based upon the average market price of the Common Stock over the preceding quarter. In connection with this agreement, the Company granted certain registration rights to TransTerra and allowed TransTerra to appoint a representative to the Board of Directors. Net proceeds of approximately $4,900,000 from this series of transactions are being used by the Company for product development, working capital and other general corporate requirements. During 1995, pursuant to the terms of this agreement, 427,998 shares of restricted Common Stock were issued for total consideration of $2.5 million. An additional 173,459 shares were issued in January 1996 in exchange for the third installment of $1,250,000.\nWARRANTS. During 1993, the Company issued 1,935,000 shares of Common Stock upon exercise of various stock purchase warrants at exercise prices ranging from $1.75 to $3.00, per share. During 1995, the Company issued 157,500 shares of Common Stock upon the exercise of various stock purchase warrants at exercise prices ranging from $1.75 to $3.00 per share. As of December 31, 1995, warrants to acquire 67,500 shares of Common Stock at an exercise price of $3.00 per share were outstanding. These warrants expire in August 1997.\nThe predecessor cost adjustment reflected in the accompanying Consolidated Statement of Stockholders' Equity arose in 1991 in connection with the acquisition of software technology by KEDS from the Company. It did not appear in the Company's financial statements prior to 1993 because the accounts of KEDS were not consolidated with those of the Company until 1993.\nThe holders of any preferred stock which might be issued shall have such rights, preferences and privileges as may be determined by the Company's Board of Directors.\n7. INCOME TAXES\nAt December 31, 1995, the Company had net operating loss carryforwards for tax reporting purposes of approximately $8,600,000 which expire in years 2000 through 2010.\nDeferred tax assets and liabilities as of December 31, 1995 consisted of the following:\nDeferred tax assets: Net operating loss carryforwards ............................ $ 3,268,000 Other, net .................................................. 19,000 ----------- Total deferred tax asset ................................ 3,287,000 Less: Valuation allowance ........................................ (1,675,000) ----------- Deferred tax asset, net .......................................... 1,612,000 ----------- Deferred tax liability - accumulated depreciation and amortization (1,612,000) ----------- $ --- =========== 8. STOCK OPTION PLAN\nThe Company's stock option plan ( the \"Plan\") for officers, directors and key employees authorizes the grant of options to purchase a maximum of 1,000,000 shares of Common Stock. The Plan provides for the issuance of incentive stock options or nonstatutory stock options, as defined by the Internal Revenue Code. Pursuant to the terms of the Plan, the exercise price of incentive stock options must equal the greater of $1.50 or the fair market value of the Common Stock on the date of grant. The exercise price of nonstatutory options may be any amount equal to or greater than $1.50 per share. The vesting period of each grant is determined by the Compensation Committee of the Board of Directors.\nNo non-statutory options have been granted as of December 31, 1995. Transactions with regard to incentive options issued pursuant to the Plan are as follows: SHARES AVERAGE UNDER PRICE OPTION PER SHARE --------- --------\nBalance - January 1, 1993 .................. 618,250 $ 1.63 Granted .................................. 99,500 $ 2.81 Canceled ................................. (24,725) $ 1.73 Exercised ................................ (89,125) $ 1.53 --------- Balance - December 31, 1993 ................ 603,900 $ 1.84 Granted .................................. 183,373 $ 7.96 Canceled ................................. (12,108) $ 6.03 Exercised ................................ (56,725) $ 1.61 --------- Balance - December 31, 1994 ................ 718,440 $ 3.35 Granted .................................. 148,395 $ 4.91 Canceled ................................. (39,148) $ 5.27 Exercised ................................ (122,763) $ 1.67 --------- Balance - December 31, 1995 ................ 704,924 $ 3.87 =========\nAt December 31, 1995, options to purchase a total of 353,481 shares of Common Stock were exercisable at prices ranging from $1.50 to $8.44 per share. Subsequent to December 31, 1995, an additional 131,035 options were granted at an exercise price of $7.44 per share, the market price at the date of grant.\n9. CONTINGENCIES\nIn 1986, a stockholder of Telescan, Inc. (predecessor business to D.B. Technology, Inc.) filed suit in the 269th District Court in Texas against the Company, certain stockholders of the Company, and others. The suit sought to set aside the 1986 merger of D.B. Technology and Telescan, Inc., money damages from all defendants, and sums due under alleged promissory notes. The case went to trial in October 1989 and judgment was rendered in favor of the defendants on a directed verdict including an order for the plaintiff to pay certain court costs and certain attorney's fees of Telescan, Inc. Subsequent to an appeal by the stockholder in the Texas Court of Appeals 14th Judicial District, the appellate court remanded the case to trial court. At the conclusion of presentation of evidence, the case was submitted to the jury by means of questions in order to determine issues of liability and damages. Based on a lack of evidence which would impose liability upon Telescan, Inc., no questions were submitted which asked the jury to determine whether or not the Company bears any liability to any plaintiff. A hearing on pending matters including entry of Judgment, was held April 10, 1995. At the hearing the court ruled that plaintiffs take nothing other than the payment, with interest, of $40,000 in promissory notes in favor of plaintiff Investa, Inc. and Hoggett which notes preceded the merger. The defendants were awarded attorney's fees and court costs. The Judgment has been entered; however, it is subject to appeal. Management does not believe that any material adverse outcome is reasonably possible nor probable and thus, no qualified disclosure as to a range of reasonable possible loss or accrual in the financial statements of probable loss have been made.\nFrom time to time the Company is involved in certain other legal actions arising in the ordinary course of business. It is the opinion of management that such litigation will be resolved without a material effect on the Company's financial position or results of operations\n10. JOINT VENTURES\nKNOWLEDGE EXPRESS DATA SYSTEMS, L.C. At the end of the first quarter of 1993, the Company acquired an additional 5.58% ownership interest in KEDS, which increased its total ownership to 55.58%. As a result of this additional equity purchase, KEDS became a majority owned subsidiary of the Company, and accordingly, beginning with the second quarter of 1993, the financial statements of KEDS were consolidated with those of the Company. Prior to that time, KEDS operating results were reflected on the equity method.\nTELEBUILD L.C. The Company has a 21.25% equity interest in Telebuild L.C., a limited liability company formed in 1990 to develop and market the Telebuild on-line data base service for which the Company has served as a contract software developer. During the years ended December 31, 1995, 1994 and 1993, the Company performed services under contract for Telebuild totaling approximately $408,000, $514,000 and $616,000 respectively. As of December 31, 1995 and 1994, corresponding amounts due the Company totaled $307,000 and $271,000, including costs and profits in excess of amounts billed of $40,000 and $30,000, respectively.\nSelected condensed balance sheet and operations data for Telebuild is summarized as follows:\nBALANCE SHEET DATA: DECEMBER 31, ---------------------------- 1995 1994 --------- --------- (unaudited) Current assets ........................... $ 131,000 $ 36,000 Other assets, net ........................ 360,000 487,000 --------- --------- $ 491,000 $ 523,000 ========= =========\nNotes and advances due owners ............ $ 865,000 $ 435,000 Other liabilities ........................ 312,000 277,000 Owners' equity (deficit) ................. (686,000) (189,000) --------- --------- $ 491,000 $ 523,000 ========= =========\nSUMMARY OPERATIONS DATA: YEAR ENDED DECEMBER 31, ------------------------------------- 1995 1994 1993 --------- --------- --------- (unaudited) Revenue ............................. $ 98,000 $ 86,000 $ 28,000 Cost of Revenue ..................... 273,000 276,000 74,000 Marketing, general and administrative 322,000 266,000 356,000 --------- --------- --------- Net loss ............................ $(497,000) $(456,000) $(402,000) ========= ========= =========\nINDEPENDENT AUDITOR'S REPORT ON SCHEDULES\nStockholders and Board of Directors Telescan, Inc. Houston, Texas\nWe have audited the consolidated financial statements of Telescan, Inc. and subsidiaries as of December 31, 1995 and 1994, and for each of the years in the three-year period ended December 31, 1995. Our audits for such years also included the financial statement schedules of Telescan, Inc. and subsidiaries, listed in Item 16(2), for each of the years in the three-year period ended December 31, 1995. These financial statement schedules are the responsibility of the Company's management. Our responsibility is to report on these schedules based on our audits. In our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth herein.\nHEIN + ASSOCIATES LLP HOUSTON, TEXAS FEBRUARY 13, 1996\nTELESCAN, INC. SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS (IN THOUSANDS)","section_15":""}
{"filename":"790609_1995.txt","cik":"790609","year":"1995","section_1":"Item 1. Business\nGeneral Development of Business\nMoore's Lane Properties, Ltd. (\"Registrant\"), is a Tennessee limited partnership organized in December 1985, pursuant to the provisions of the Tennessee Uniform Limited Partnership Act, Chapter 2, Title 61, Tennessee Code Annotated, as amended. The General Partners of Registrant are W. Gerald Ezell and 222 Partners, Inc. The Partnership is a venturer in Moore's Lane Venture Associates (the \"Joint Venture\") and has controlling interest in this Joint Venture.\nRegistrant's primary business, as a consolidated entity with the Joint Venture, is to hold for investment certain undeveloped real property located in Franklin, Williamson County, Tennessee (the \"Property\"). Registrant's investment objectives are preservation of investment capital and appreciation of the value of the Property due to development of the immediately surrounding areas and the growth of the community generally.\nFinancial Information About Industry Segments\nThe Registrant's activity, investment in land, is within one industry segment and geographical area. Therefore, financial data relating to the industry segment and geographical area is included in Item 6 - Selected Financial Data.\nNarrative Description of Business\nAs of December 31, 1995, the Joint Venture owned approximately 61 saleable acres of partially developed land in Franklin, Tennessee. The Property is held for resale. The Property is included in the 1,150 acre Cool Springs Corporate and Retail Center.\nThe majority of the Property development work was completed in 1991. This work included construction of the Cool Springs Interchange and Mallory Lane north of Cool Springs Boulevard. Mallory Lane North was relocated and improved from a two lane to a four-lane boulevard. South Springs Drive, which runs through the property, was constructed as a four-lane boulevard. During 1995, the General Partner began a new phase of development on the Property. This development, which was initiated by a sale in December 1995, includes (i) finishing Mallory Station Road through the Property with utilities and (ii) constructing two detention ponds. This development is expected to cost approximately $700,000, of which $358,000 was retained from the December sale.\nCompetition:\nThe Cool Springs Corporate and Retail Center is in various stages of development and is being developed for retail, office and mixed commercial uses similar to those considered suitable for the Property. Cool Springs Real Estate Associates, L.P. (\"CSREA\") owns much of the undeveloped land in the immediate vicinity of the Property. CSREA is an institutional real estate investor. Their asking prices are currently comparable to the Registrant's. There are several other competitive retail sites at the I-65 and Moore's Lane intersection, one mile north of the Cool Springs Boulevard intersection. However, the General Partner feels that the market can ultimately absorb all these sites and that the Registrant's low cost in its land will allow it to compete effectively.\nAn affiliate of the General Partner owns 65 acres in the immediate vicinity of the Property and therefore may have objectives similar to those of the Registrant. As a result, the Registrant is likely to be in competition for potential buyers of the Property with this affiliate. The General Partner believes that potential purchasers will survey all available property in making their decision, and their choice of location is generally made without regard to the ownership of the land.\nThe Registrant has no employees. Partnership management services are being provided under a contractual agreement with Landmark Realty Services Corporation, an affiliate of the General Partner.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nAs of December 31, 1995, the Joint Venture of which the Registrant has a controlling interest owned 61 acres of land in Franklin, Williamson County, Tennessee. The Property is included in the Cool Springs Retail and Corporate Center. The Property is located along Mallory Lane, west and south of the Cool Springs Galleria mall.\nItem 3.","section_3":"Item 3. Legal Proceedings\nRegistrant is not a party to, nor is any of Registrant's property the subject of any material legal proceedings.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nThe security holders of Registrant did not vote on any matters during the fiscal year covered by this report.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Units of Limited Partnership Interest and Related Security Holder Matters\nThere is no established market for the Units, and it is not anticipated that any will exist in the future. The Registrant commenced an offering to the public on April 22, 1986 of 7,500 Units of limited partnership interests. The offering of $7,500,000 was fully subscribed and closed on May 30, 1986. As of February 29, 1996, there were 565 holders of record of the 7,500 Units of limited partnership interests.\nThere are no material restrictions upon Registrant's present or future ability to make distributions in accordance with the provisions of Registrant's Limited Partnership Agreement.\nItem 6.","section_6":"Item 6. Selected Financial Data For the Year Ending December 31,\n1995 1994 1993 1992 1991 Total Income $1,437,479 $ 258,112 $ 902,322 $ 664,567 $ 560,651 Net Income 1,364,037 131,947 786,068 126,319 608,072 Net Income Per Unit 181.87 17.59 104.81 16.84 81.08 Total Assets 2,964,702 3,469,752 3,593,804 4,255,290 4,415,067 Notes Payable - 0 - 175,000 500,251 982,125 1,200,000 Cash Distributions 220 - 0 - -0- -0- -0- per unit\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nResults of Operations\n1995 Sales In February, the Registrant sold approximately 2.2 acres for approximately $682,000 in gross proceeds to a medical office user. In March, 3.3 acres were sold to a hotel developer for approximately $1,071,000. In November, 2.2 acres were sold to another hotel developer for approximately $583,000. In December, 6.8 acres were sold to a manufacturer for $445,000. From these sale proceeds, $1,650,000 was distributed to the partners, the $175,000 Note payable - private was retired and the remaining proceeds were retained for development and operating expenses.\n1994 Sales\nThe Registrant sold approximately two acres for $428,000 to Saturn Corporation, who was expanding their original site purchased from the Registrant in 1992. Proceeds were used to reduce the Note Payable-Private.\n1993 Sales\nThe Registrant sold 7.72 acres for $1,200,000 and reduced a $722,591 development obligation to a purchaser by transferring title to 1.7 acres. Sale proceeds were used to retire the Note payable to bank, to pay property taxes, and to fund certain site improvement on the sale site. The remaining proceeds were reserved to meet future operational needs.\nOperations\nAlthough there has been some variance between accounts, overall operations of the Registrant have not fluctuated significantly, except for the change in sales explained by the number of acres sold (14.5, 2 and 9.42 in 1995, 1994 and 1993, respectively). Interest expense has declined through the years due to lower principal balances. Property tax payments have declined through the years due to reductions in land. The 1994 property tax expense included a $6,000 credit received from a 1993 sale. The increase in 1994 architect and engineering fees is due to the fees incurred in preparation for the car dealership sale in 1994 and the two 1995 sales.\nFinancial Condition\nDevelopment\nDuring 1995, the General Partner began a new phase of development on the Property. This development was initiated by the sale to the manufacturer in 1995 but also benefits the surrounding area. This development includes finishing Mallory Station Road through the Property with utilities and constructing two detention ponds. This development is expected to costs approximately $700,000, of which $358,000 was retained from the sale in December 1995. The General Partner expects to fund the remaining development costs with proceeds from future sales.\nLiquidity & Capital Resources\nAs of February 29, 1996, the Registrant has cash of approximately $60,000, which the General Partner believes is sufficient to meet operating needs for 1996.\nThroughout 1995, W. Gerald Ezell, the Registrant's general partner, continued to operate under Chapter 11 of the United States Bankruptcy Code. The Bankruptcy court has approved Mr. Ezell's plan to liquidate his assets and satisfy his creditors. The plan includes the sale of Mr. Ezell's partnership interests, including his general partnership interest in the Registrant. In accordance with the partnership agreement, Mr. Ezell can sell his interest in profits, losses and distributions, but the purchaser does not assume his responsibilities as Managing General Partner. Therefore, upon the sale of Mr. Ezell's partnership interest, the general partner's interest will be converted into a special limited partner interest and his general partner responsibilities will be transferred to the remaining general partner.\nIn March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121 Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed of (Statement 121). It requires that long-lived assets that are to be disposed of be reported at the lower of carrying amount or fair value less costs to sell. If quoted prices are not available, the estimated fair value is determined using the best information available. After implementation, any material impairments must be recorded to reflect an excess of the carrying amount over the estimated fair value.\nStatement 121 is applicable for fiscal years beginning after December 15, 1995, and it will be implemented by the Registrant effective January 1, 1996. Implementation of Statement 121 is not expected to have a material impact on the financial statements of the Registrant.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statement and Supplementary Data\nThe Financial Statements required by Item 8 are filed at the end of this Report.\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\nRegistrant does not have any directors or officers. W. Gerald Ezell and 222 Partners, Inc. are the General Partners of the Registrant and as such have general responsibility and ultimate authority in matters affecting Registrant's business.\nThe general partners are as follows:\nW. Gerald Ezell\nW. Gerald Ezell, age 65, is the Managing General Partner of the Partnership. Mr. Ezell is also a general partner of affiliated limited partnerships which own various real estate properties. Until November 15, 1985, Mr. Ezell had been for over 20 years an agency manager for Fidelity Mutual Life Insurance Company and a registered securities principal of Capital Analysts Incorporated, a wholly owned subsidiary of Fidelity Mutual Life Insurance Company.\nThroughout 1995, W. Gerald Ezell continued to operate under Chapter 11 of the United States Bankruptcy Code. The Bankruptcy court has approved Mr. Ezell's plan to liquidate his assets and satisfy his creditors. The plan includes the sale of Mr. Ezell's partnership interests, including his general partnership interest in the Registrant. In accordance with the partnership agreement, Mr. Ezell can sell his interest in profits, losses and distributions but the purchaser does not assume his responsibilities as Managing General Partner. Upon sale of Mr. Ezell's partnership interest, the general partner's interest will be converted into a special limited partner interest and his general partner responsibilities will be transferred to the remaining general partner.\n222 Partners Inc.\n222 Partners, Inc. was formed in September, 1986 and serves as general partner for several other real estate investment limited partnerships.\nThe executive officers and directors of 222 Partners, Inc. are as follows:\nSteven D. Ezell, age 43, serves as a director, president and sole shareholder of the corporate general partner. He has been an officer of 222 Partners, Inc. from September 17, 1986 through the current period. Mr. Ezell is President and 50% owner of Landmark Realty Service Corporation. He was active for the four years prior to joining Landmark in property acquisitions for Dean Witter Realty Inc. in New York City, most recently as Senior Vice President. He is the son of W. Gerald Ezell.\nMichael A. Hartley, age 36, is Secretary\/Treasurer and Vice President of the corporate general partner. He has been an officer of 222 Partners, Inc. from September 17, 1986 through the current period. He also serves as Vice President and 50% owner of Landmark Realty Services Corporation. For the three years prior to joining Landmark, Mr. Hartley was a Vice President of Dean Witter Realty Inc., a New York-based real estate investment company.\nItem 11.","section_11":"Item 11. Executive Compensation\nDuring 1995, the Registrant was not required to and did not pay remuneration to any partners of the General Partner or any affiliates, except as set forth in Item 13 of this report, \"Certain Relationships and Related Transactions.\" The General Partner does participate in the Profits, Losses, and Distributions of the Partnership as set forth in the Partnership Agreement.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nAs of February 29, 1996, no person or \"group\" (as that term is used in Section 3 (d)(3) of the Securities Exchange Act of 1934) was known by the Registrant to beneficially own more than five percent of the Units of Registrant. Also as of the above date, no director of 222 Partners, Inc. was known by the Registrant to beneficially own any of the units of the Registrant. There are no arrangements known by the Registrant, the operation of 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\nNo affiliated entities have, for the year ending December 31, 1995, earned or received compensation or payments for services from the Registrant in excess of $60,000. For a listing of miscellaneous transactions with affiliates refer to Note 4 of the notes to consolidated Financial Statements herein.\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 are included herein:\nIndependent Auditors' Report\nFinancial Statements Consolidated Balance Sheets Consolidated Statements of Earnings Consolidated Statements of Changes in Partners' Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements\n(2) Financial Statement Schedule Independent Auditors's Report on Schedule S-1\nSchedule XI - Real Estate and Accumulated Depreciation S-2\nAll other Schedules have been omitted because they are inapplicable, not required or the information is included in the Consolidated Financial Statements or notes thereto.\n(3) Exhibits\n3 Amended and Restated Certificate and Agreement of Limited Partnership, incorporated by reference to Exhibit A to the Prospectus of Registrant dated April 22, 1986 filed pursuant to Rule 424(b) of the Securities and Exchange Commission.\n22 Subsidiaries\n27 Financial Data Schedule\n(b) No reports on Form 8-K have been filed during the last quarter of 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.\nMOORE'S LANE PROPERTIES,LTD.\nDATE: March 29, 1996 By: \/s\/W.Gerald Ezell W. Gerald Ezell General Partner\nBy: 222 Partners, Inc. General Partner\nDATE: March 29, 1996 By:\/s\/ Steven D. Ezell Steven D. Ezell President and Director\nDATE: March 29, 1996 By:\/s\/ Michael A. Hartley Michael A. Hartley Vice President and Director\nSIGNATURES (Cont'd.)\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nMOORE'S LANE PROPERTIES, LTD.\nDATE: March 29, 1996 By:\/s\/W. Gerald Ezell W. Gerald Ezell General Partner\nBy:222 Partners, Inc. General Partner\nDATE: March 29, 1996 By:\/s\/ Steven D. Ezell Steven D. Ezell President and Director\nDATE: March 29, 1996 By:\/s\/ Michael A. Hartley Michael A. Hartley Vice President and Director\nSupplemental Information to be Furnished with Reports filed Pursuant to Section 15(d) of the Act by Registrant Which Have Not Registered Securities Pursuant to Section 12 of the Act:\nNo annual report or proxy material has been sent to security holders.\nIndependent Auditors' Report\nThe Partners Moore's Lane Properties, Ltd.:\nWe have audited the accompanying consolidated balance sheets of Moore's Lane Properties, Ltd. (a limited partnership) and subsidiary as of December 31, 1995 and 1994, 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, 1995. These consolidated financial statements are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Moore's Lane Properties, Ltd. and subsidiary at December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1995, in conformity with generally accepted accounting principles.\nAs discussed in Note 9, the Partnership adopted in 1995 the provisions of Statement of Financial Accounting Standards No. 107, Disclosures about Fair Value of Financial Instruments.\nKPMG Peat Marwick LLP\nNashville, Tennessee January 19, 1996\nMOORE'S LANE PROPERTIES, LTD. AND SUBSIDIARY (A Limited Partnership)\nConsolidated Balance Sheets\nDecember 31, 1995 and 1994\n[FN]\nSee accompanying notes to financial statements.\nMOORE'S LANE PROPERTIES, LTD. AND SUBSIDIARY (A Limited Partnership)\nConsolidated Statements of Partners' Equity\nYears ended December 31, 1995, 1994 and 1993\nMOORE'S LANE PROPERTIES, LTD. AND SUBSIDIARY (A Limited Partnership)\nConsolidated Statements of Cash Flows\nYears ended December 31, 1995, 1994 and 1993\nMOORE'S LANE PROPERTIES, LTD. AND SUBSIDIARY (A Limited Partnership)\nConsolidated Statements of Cash Flows, Continued\nYears ended December 31, 1995, 1994 and 1993\nMOORE'S LANE PROPERTIES, LTD. AND SUBSIDIARY (A Limited Partnership)\nNotes to Consolidated Financial Statements\nDecember 31, 1995 and 1994\n(1) Summary of Significant Accounting Policies\n(a) Organization\nMoore's Lane Properties, Ltd. (the Partnership) was organized on December 10, 1985 as a Tennessee limited partnership to acquire and hold for investment approximately 174 acres of unimproved real property in Williamson County, Tennessee. On May 30, 1986, a public offering of limited partnership units closed whereby the Partnership issued 7,500 limited partnership units and the original limited partner withdrew. The General Partners are W. Gerald Ezell (see note 8) and 222 Partners, Inc.\n(b) Principles of Consolidation\nThe consolidated financial statements include the accounts of Moore's Lane Properties, Ltd. and the accounts of a majority-owned joint venture. All significant intercompany accounts and transactions have been eliminated.\n(c) Income Taxes\nThe Partnership prepares financial statements and Federal income tax returns on the accrual method and includes only those assets, liabilities and results of operations which relate to the business of the Partnership. No provision has or will be made for Federal or state income taxes since such taxes are the personal responsibility of the partners.\n(d) Land Held for Investment\nLand held for investment is recorded at cost and includes approximately 72 and 93 acres at December 31, 1995 and 1994, respectively. Of these amounts, management believes that 61 and 76 acres are sellable at December 31, 1995 and 1994, respectively. Land costs include amounts to acquire and hold land, including interest and property taxes during the development period. Costs to hold land, including insurance and property taxes are charged to expense once development is substantially complete. Land improvement costs include development costs expended subsequent to the acquisition of the tract.\n(Continued)\nMOORE'S LANE PROPERTIES, LTD. AND SUBSIDIARY (A Limited Partnership)\nNotes to Consolidated Financial Statements\n(e) Revenue Recognition\nSales are recorded at the time of closing. A portion of sales proceeds is deferred if additional construction is required and is recognized on the percentage of completion method as the construction is completed.\n(f) Partnership Allocations\nNet earnings, losses, and distributions of cash flow of the Partnership are allocated among the limited partners and general partners, in accordance with the agreement of the limited partnership.\n(g) Cash and Cash Equivalents\nThe Partnership considers all short-term investments with original maturities of three months or less at the date of purchase to be cash equivalents.\nCash belonging to the Partnership is combined in an account with funds from other partnerships related to the general partner.\n(h) Estimates\nManagement of the Partnership has made estimates and assumptions to prepare these financial statements. Actual results could differ from those estimates.\n(2) Restricted Cash\nAt December 31, 1995, the Partnership has restricted cash balances of $358,320 to be used to fund property improvements, consisting of road and utility work, and property taxes.\n(3) Moore's Lane Venture Associates\nOn May 29, 1986, Moore's Lane Venture Associates (the Joint Venture) was formed with the Partnership and Southeast Venture Companies (Southeast) as joint venturers. On March 4, 1987, the Partnership contributed its land held for investment to the Joint Venture. The contribution of land was accounted for at book value.\n(Continued)\nMOORE'S LANE PROPERTIES, LTD. AND SUBSIDIARY (A Limited Partnership)\nNotes to Consolidated Financial Statements\nSoutheast will contribute services for overseeing the implementation of the master land use plan and ensuring that any improvements proceed on schedule. The joint venture agreement provides that Southeast will receive 17% of the proceeds of any disposition of the property after the limited partners have received an amount equal to their capital contributions plus their preferred return as defined in the partnership agreement.\n(4) Related Party Transactions\nThe General Partner and its affiliates have been actively involved in managing the property. Affiliates of the General Partner receive fees and commissions as consideration for performing certain services. Expenses incurred for these services during 1995, 1994 and 1993 are as follows:\n(5) Land Held for Investment\nThe components of land held for investment at December 31, are as follows:\nAggregate cost for federal income tax purposes for this property was $2,673,705 and $3,634,383 at December 31, 1995 and 1994, respectively.\n(Continued)\nMOORE'S LANE PROPERTIES, LTD. AND SUBSIDIARY (A Limited Partnership)\nNotes to Consolidated Financial Statements\n(6) Note Payable\nOn April 28, 1994, the Partnership entered into a $825,000 term loan agreement with a private lending source. At December 31, 1994, the balance outstanding was $175,000 which was paid in full in 1995. The note accrues simple interest at an annual rate of 4% over a local bank's prime lending rate (12.5% at December 31, 1994). The note is secured by a mortgage on the land held for investment. Semi-annual interest payments are due on April 28 and October 28. The note matures on April 28, 1996. At December 31, 1995, the Partnership can make additional draws under the loan agreement in the amount of $300,000.\nIn addition, the term loan agreement entitles the lender to receive a profit participation equal to 25% of profits, as defined in the loan agreement. At December 31, 1995, the Partnership has accrued $4,594 under this agreement.\n(7) Note Payable - Other\nOn February 3, 1993, the Joint Venture conveyed to a purchaser approximately 1.7 acres of land held for investment. Such conveyance satisfied $722,591 of amounts due to the purchaser of $856,530 for infrastructure improvements. In addition to the conveyance of land, the consideration included a cash payment of $33,939 and the issuance of a note payable to the purchaser of $100,000. The note payable was due on February 3, 1995, and had no stated rate of interest. The note was secured by a deed of trust on certain of the Joint Venture's property. On May 3, 1994, the note was retired in full with proceeds from the note payable discussed in note 6.\nMOORE'S LANE PROPERTIES, LTD. AND SUBSIDIARY (A Limited Partnership)\nNotes to Consolidated Financial Statements\n(8) General Partner Bankruptcy\nOn February 25, 1991, W. Gerald Ezell, a general partner of the Partnership, elected to file for reorganization under Chapter 11 of the United States Bankruptcy Code. This election is designed to allow Mr. Ezell to satisfy his personal creditors in an orderly manner. The filing has no impact on the legal standing of the Partnership. Mr. Ezell has retained his role as an active general partner and continues to fulfill his general partner responsibilities.\n(9) Distributions\nFor the year ended December 31, 1995, the Partnership made a distribution of $1,656,335. Of this amount, $1,650,000 ($220 per unit) was allocated to the limited partners and $6,335 was allocated to the general partner. There were no distributions in 1994 or 1993.\n(10) Fair Value of Financial Instruments\nAt December 31, 1995, the Partnership had financial instruments including cash and cash equivalents of $156,971,restricted cash of $358,320, and accrued liabilities of $55,767. The carrying amounts of cash and cash equivalents, restricted cash, and accrued liabilities approximate fair value because of the short maturity of those financial instruments.\nIndependent Auditors' Report __________________________\nThe Partners Moore's Lane Properties, Ltd.:\nUnder date of January 19, 1996, we reported on the consolidated balance sheets of Moore's Lane Properties, Ltd. and subsidiary as of December 31, 1995 and 1994, 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, 1995. The consolidated financial statements and our reports thereon are included elsewhere herein. In connection with our audits of the aforementioned consolidated financial statements, we have also audited the related financial statement schedule as listed in the accompanying index. This financial statement schedule is the responsibility of the Partnership's management. Our responsibility is to express an opinion on this financial statement schedule based on our audits.\nIn our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.\nKPMG Peat Marwick LLP\nNashville, Tennessee January 19, 1996\nS-1\nSchedule XI MOORE'S LANE PROPERTIES, LTD. AND SUBSIDIARY (A Limited Partnership)\nReal Estate and Accumulated Depreciation\nDecember 31, 1995\nSee accompanying independent auditors' report. S-2 Schedule XI\nSchedule XI\nExhibits filed pursuant to Item 14(a)(3):\nMOORE'S LANE PROPERTIES, LTD. (A Tennessee Limited Partnership)\nExhibit Index\nExhibit\n3 Amended and Restated Certificate and Agreement of Limited Partnership, incorporated by reference to Exhibit to a Prospectus of Registrant dated April 22, 1986 (Registration No. 33-3395-A)\n22 Subsidiaries\n27 Financial Data Schedule","section_15":""}
{"filename":"783747_1995.txt","cik":"783747","year":"1995","section_1":"Item 1. Business.\nCoastal 1986 Drilling Program, Ltd. (\"Partnership\") was a limited partnership organized under the laws of the State of Texas on October 18, 1985. Its General Partner is Coastal Limited Ventures, Inc. (\"CLV\"), a Texas corporation and a wholly-owned subsidiary of The Coastal Corporation (\"Coastal\"). The Partnership commenced operations on October 8, 1986.\nThe operations of the Partnership consisted of operating, through a joint venture (\"Joint Venture\") described below, gas and oil wells located in several regions of the United States, which resulted from the Partnership's exploration and development drilling program (\"Program\") completed in 1987.\nThe Partnership and CLV have no employees. None of the officers of CLV devotes full time to the activities of the Partnership.\nUnder the terms of the Agreement of Limited Partnership dated as of September 1, 1986 (the \"Partnership Agreement\") and the Joint Venture Agreement dated as of October 8, 1986 (the \"Joint Venture Agreement\"), both the Partnership and the Joint Venture terminated on January 1, 1996. In accordance with the terms and conditions of the Joint Venture Agreement, upon dissolution, each gas and oil property will be sold or transferred to the Other Joint Venturer which assigned the property to the Joint Venture at a value determined by independent appraisal. After all Joint Venture assets have been liquidated and all Joint Venture obligations have been paid, the remaining cash in the Joint Venture will be distributed among the Joint Venturers. As among the Partners in the Partnership, the liquidating distribution will be distributed 99% to the Limited Partners and 1% to the General Partner. Final dissolution proceeds will be distributed to the Limited Partners in May 1996. During the dissolution phase of the Partnership, the General Partner shall act as liquidator and may be paid a reasonable fee for acting as such. The amounts determined by the independent appraisal which will be realized from the disposition of the remaining assets may differ materially from the amounts in the accompanying financial statements.\nJoint Venture\nThe Joint Venture which conducted the operations of the Partnership was a Texas general partnership between the Partnership and three wholly-owned subsidiaries of Coastal. The Partnership was the managing partner of the Joint Venture. Coastal Oil & Gas Corporation, ANR Production Company and CIG Exploration, Inc. were the Other Joint Venturers, each of which is a direct or indirect, wholly-owned subsidiary of Coastal engaged primarily in gas and oil exploration and production activities.\nThe Other Joint Venturers contributed leasehold acreage having an agreed value of $6,300,000 to the Joint Venture to provide the drilling blocks (\"Drilling Blocks\") upon which the exploratory and development wells were drilled. The Partnership contributed $12,121,000 to the Joint Venture, including $12,000,000 from the public offering of 12,000 units of limited partnership interests (\"Units\"), which was expended for drilling, completing and equipping Program wells.\nCrude oil and other liquid hydrocarbon production from Joint Venture wells was generally subject to a preferential right and option of the Other Joint Venturer to purchase such production at the higher of its posted field price or the average of the highest three prices being paid for similar production in the field. Production not sold to one of the Other Joint Venturers was sold at negotiated prices.\nMost of the natural gas from Joint Venture wells was committed under contracts with pipeline companies. Contract prices for natural gas are subject to limitations under the Natural Gas Policy Act of 1978. Gas production not committed was sold at negotiated prices.\n- 1 -\nDuring 1995, natural gas and crude oil, condensate and natural gas liquids sales to Coastal subsidiaries and crude oil sales to Texaco Trading & Transportation and Koch Oil Company accounted for 57%, 21% and 12% of the Joint Venture's oil and gas sales.\nParticipation in Costs and Revenues\nInformation as to participation by the Partnership and Joint Venture in costs and revenues is set forth in Note 2 of Notes to Financial Statements included herein.\nPursuant to the Partnership Agreement, CLV received administrative fee payments from the Partnership in lieu of allocating its administrative expenses as discussed in Note 4 of Notes to Financial Statements included herein.\nPartnership Payout was achieved in October 1992. After payout, the Partnership's share of Joint Venture revenues and expenses was reduced to 40% from 90% and the Other Joint Venturers' share was increased to 60% from 10%.\nProduction Operations\nThe following table presents production and sales price information for 1995, 1994 and 1993.\nFor a discussion of \"Operations,\" see \"Management's Review,\" presented on pages and, included herein.\n- 2 -\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nThe following table sets forth information with respect to the producing gas and oil properties in which the Partnership had an interest as of December 31, 1995.\nState\/Field\/County Oil Gas ------------------ --- --- California Grimes, Colusa County - 1 Montana Crane, Richland County 1 - Oklahoma East Lookeba, Caddo County 2 - Southwest Hinton, Caddo County 1 - Texas Caramel, Terry County 1 - West Jeffress, Hidalgo County - 1 Utah Bitter Creek, Uintah County - 11 Wyoming South Powell, Converse County 1 - --- ---\nTotal 6 13 === ===\nFor information on proved reserves of the Partnership, see \"Supplemental Information on Exploration, Development and Production Activities,\" pages -, included herein.\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.\n- 3 -\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters.\nThe registrant had no common stock. Its ownership was represented by Units. There were 428 holders of Units as of December 31, 1995. There was no market for the Units as transfer of Units was restricted. Under the Partnership Agreement, Units were transferable only in the event of death, by operation of law, or by a natural person by gift to family members, i.e., parents, spouses, children and grandchildren or to a trust for the benefit of such family members. The General Partner was required to offer, by May 1st of each year, commencing in 1988 and ending in 1995, to repurchase Units as discussed in Note 5 of Notes to Financial Statements included herein.\nCash distributions to Limited Partners, which are paid quarterly, totaled $8.45 per $1,000 Unit for 1995, $30.95 for 1994 and $22.30 for 1993.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nThe following selected financial data (in thousands of dollars except per Unit amounts) is derived from the Financial Statements included herein and Item 6 of the Partnership's Annual Report on Form 10-K for the fiscal year ended December 31, 1994. The Notes to Financial Statements included herein contain other information relating to this 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 Financial Condition and Results of Operations is presented on pages and herein.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nThe Financial Statements and Supplementary Data required hereunder are included in this Annual Report as set forth in Item 14(a) herein.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.\nNone.\n- 4 -\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant.\nThe Partnership does not have any directors or executive officers. Its General Partner is CLV. The following presents information with respect to the directors and executive officers of CLV as of March 13, 1996:\nName (Age), Year First Elected Director and\/or Officer of CLV Positions and Offices with CLV\nDavid A. Arledge (51), 1981 Chairman of the Board and Chief Executive Officer Jerry D. Bullock (66), 1992 President and Director Carl A. Corrallo (52), 1993 Senior Vice President and Director Rodney D. Erskine (51), 1994 Senior Vice President Coby C. Hesse (48), 1986 Senior Vice President Harvey R. Klingensmith (43), 1993 Senior Vice President and Director Austin M. O'Toole (60), 1980 Senior Vice President, Secretary and Director Charles R. Carpenter (47), 1990 Vice President Fred H. Hallman (55), 1980 Vice President and Controller Wilson Humphrey (60), 1983 Vice President Gregory W. Hutson (44), 1989 Vice President Ronald D. Matthews (48), 1994 Vice President and Treasurer B. P. McCarley (60), 1980 Vice President John C. McKay (47), 1996 Vice President Betty J. Nelson (64), 1988 Vice President Dale V. Shultz (61), 1981 Vice President\nThe above named persons bear no family relationship to each other. Their respective terms of office expire coincident with CLV's Annual Meeting of the sole stockholder and Annual Meeting of the Board of Directors to be held in May 1996. Each of the officers named above have been officers of CLV and\/or Coastal for five years or more with the following exceptions:\nMr. Bullock was elected Senior Vice President, exploration and production, of Coastal in August 1992. From 1987 to 1990, he was an Executive Vice President of British Petroleum's BP Exploration Company and a director and a member of the management committee of BP Exploration USA. From 1990 to 1992, he was an independent petroleum consultant for several major exploration companies.\nMr. Corrallo was elected Senior Vice President and General Counsel of Coastal in March 1993. He has served as a Senior Vice President of Coastal States Management Corporation, a subsidiary of Coastal, since August 1991 and prior thereto as Vice President since December 1986.\nMr. Erskine was elected Senior Vice President, Production, of Coastal Oil & Gas Corporation in February 1994. Prior to joining Coastal Oil & Gas, he had been president and chief executive officer of Nerco Oil & Gas Inc., a subsidiary of Kennecott, since 1991. From 1975 to 1991, he held a series of engineering and executive positions with Union Texas Petroleum.\nMr. Klingensmith was elected Senior Vice President of Coastal Oil & Gas Corporation in October 1993. Prior to joining Coastal Oil & Gas, he was Vice President - Exploration at Maxus Energy since 1989. From 1977 to 1989, he held a series of engineering and executive positions with Maxus.\nMr. Matthews was elected Vice President and Treasurer in September 1994. He has held various positions in financial management with Coastal and its affiliates since 1981, and was elected Treasurer of Coastal in September 1994.\n- 5 -\nMr. McKay was elected Vice President, Operations Administration, of ANR Production Company, CIG Exploration, Inc., CoastalDril, Inc. and Coastal Oil & Gas Corporation in February 1996. He has served as Assistant Controller of CLV since 1986.\nItem 11.","section_11":"Item 11. Executive Compensation.\nThe Registrant has no executive officers or directors. It is managed by CLV which receives an annual administrative fee pursuant to the Partnership Agreement as discussed in Note 4 of Notes to Financial Statements included herein.\nCLV is an indirect, wholly-owned subsidiary of Coastal. Information concerning the cash compensation and certain other compensation of the directors and officers of Coastal is contained in this section.\nSummary of Cash and Certain Other Compensation\nThe following table sets forth information for the fiscal years ended December 31, 1995, 1994 and 1993 as to cash compensation paid by Coastal and its subsidiaries, as well as certain other compensation paid or accrued for those years, to Coastal's Chief Executive Officer (\"CEO\") and its four other most highly compensated executive officers (the \"Named Executive Officers\").\nCoastal is negotiating an employment contract with James L. Van Lanen, Senior Vice President of Coastal responsible for coal operations, at his current annual rate of salary which will become effective upon the completion of the previously announced prospective sale of Coastal's coal subsidiaries, and which will extend through January 26, 2000. In addition, Coastal anticipates an agreement with Mr. Van Lanen under which he will receive a bonus based on the proceeds of the sale of such subsidiaries.\nStock Options\nThe following table sets forth information with respect to stock options granted on March 1, 1995 for the fiscal year ended December 31, 1995 to the Named Executive Officers.\nOption\/SAR Exercises and Holdings\nThe following table sets forth information with respect to the Named Executive Officers, concerning the exercise of options during the last fiscal year and unexercised options and SARs held as of the fiscal year (\"FY\") ended December 31, 1995.\nCOMPENSATION AND EXECUTIVE DEVELOPMENT COMMITTEE REPORT ON EXECUTIVE COMPENSATION\nThe following report has been provided by The Coastal Corporation's Compensation and Executive Development Committee (the \"Committee\") of the Board of Directors in accordance with current S.E.C. proxy statement disclosure\n- 8 -\nrequirements. The members of the Committee include John M. Bissell (Chairman), Roy D. Chapin, Jr., and Jerome S. Katzin.\nThis material states Coastal's current overall compensation philosophy and program objectives. Detailed descriptions of Coastal's compensation programs are provided as well as the information on Coastal's 1995 pay levels for the CEO.\nOverall Objectives of the Executive Compensation Program\nCoastal's compensation philosophy and program objectives are directed by two primary guiding principles. First, the program is intended to provide fully competitive levels of compensation - at expected levels of performance - in order to attract, motivate and retain talented executives. Second, the program is intended to create an alignment of interests between Coastal's executives and stockholders such that a significant portion of each executive's compensation is directly linked to maximizing stockholder value.\nIn support of this philosophy, the executive compensation program is designed to reward performance that is directly relevant to Coastal's short-term and long-term success. As such, Coastal attempts to provide both short-term and long-term incentive pay that varies based on corporate and individual performance.\nTo accomplish these objectives, the Committee has structured the executive compensation program with three primary underlying components: base salary, annual incentives, and long-term incentives (i.e., stock options). The following sections describe Coastal's plans by element of compensation and discuss how each component relates to Coastal's overall compensation philosophy.\nIn reviewing this information, reference is often made to the use of competitive market data as criteria for establishing targeted compensation levels. Coastal targets the market 50th percentile for its total compensation program and actual total compensation rates in 1995 were at or below the targeted level. (However, Coastal's competitive pay posture varies by pay element, as described below.) Several market data sources are used by Coastal, including energy industry norms for the publicly traded peer companies included in Coastal's shareholder return performance graph, as reflected in these companies' proxy statements. In addition, we utilize published survey data and data obtained from independent consultants that are for general industry companies similar in size (i.e., revenues) to Coastal. The published surveys include data on over 50 companies of comparable size to Coastal, as measured by revenues. Greater emphasis is placed on the published data and data obtained from consultants than on the data for proxy peers, since the published data and consulting data are reflective of company size.\nBase Salary Program\nCoastal's base salary program is based on a philosophy of providing base pay levels that fall between the market 50th and 75th percentiles. Coastal periodically reviews its executive pay levels to assure consistency with the external market. Generally, Coastal's actual base salary levels for 1995 for executives as a group were consistent with the targeted percentiles. We believe it is crucial to provide strongly competitive salaries over time in order to attract and retain executives who are highly talented.\nAnnual salary adjustments for Coastal are based on several factors: general levels of market salary increases, individual performance, competitive base salary levels, and Coastal's overall financial results. Coastal reviews performance qualitatively considering total shareholder returns, the level of earnings, return on equity, return on total capital and individual business unit performance. These criteria are assessed qualitatively and are not weighted. All base salary increases are based on a philosophy of pay-for-performance and perceptions of an individual's long-term value to Coastal. As a result, employees with higher levels of performance sustained over time will be paid correspondingly higher salaries.\n- 9 -\nThe Annual Bonus Plan\nCoastal's Annual Bonus Plan is intended to (1) reward key employees based on company\/business unit and individual performance; (2) motivate key employees; and (3) provide competitive cash compensation opportunities to plan participants. Under the plan, target award opportunities vary by individual position and are expressed as a percent of base salary. The individual target award opportunities, which are slightly below market median levels, are then aggregated into a total target pool which is adjusted as described below. The amount a particular executive may earn is directly dependent on the individual's position, responsibility, and ability to impact our financial success.\nThe actual bonus pool is established each year by modifying the target pool based on Coastal's overall performance against measures established by the Committee. In fiscal year 1995, the key performance measure considered was earnings before interest and taxes (\"EBIT\") against plan. This measure was weighted 50% of the total bonus program. In 1995 Coastal's EBIT performance was above threshold standards (minimum performance level for bonus payment) but below a very aggressive plan, resulting in the EBIT portion of the bonus paid being below target. The remaining 50% of the annual bonus opportunity in 1995 is a discretionary annual bonus pool. As a result, no formula performance measures were used in establishing the size of awards under this portion of the plan. However, in establishing the size of the discretionary bonus pool, the Committee considered Coastal's Return on Equity relative to industry peers (using the same peers included in the shareholder return graph), Return on Total Capital compared to industry peers, the EBIT performance of each business unit, progress made toward improving Coastal's operational and financial performance, and the need to reward unique individual contributions. These measures were not formally weighted by the Committee. The size of the discretionary bonus pool element was established above threshold but below target based on the qualitative performance assessment described above. As a result, actual bonus payments for 1995 were below target and median market levels.\nIndividual awards from the established bonus pool are recommended by senior management, with advice and consent from the Committee. Individual awards from the pool are based on business unit and individual employee performance, future potential, and competitive considerations. All individual performance assessments are conducted in a non-formula fashion without specific goal weightings. The total bonus awards made may not exceed the amount of funds in the bonus pool.\nLong-Term Incentive Plan\nCoastal's Long-Term Incentive Plan (\"LTIP\") is designed to focus executive efforts on the long-term goals of Coastal and to maximize total return to our shareholders. While Coastal's LTIP allows the Committee to use a variety of long-term incentive devices, the Committee has relied solely on stock option awards to provide long-term incentive opportunities in recent years.\nStock options align the interests of employees and shareholders by providing value to the executive through stock price appreciation only. All stock options have a ten-year term before expiration and are fully exercisable within 7 years of the grant date.\nStock options were granted to the Named Executive Officers in 1995 and it is anticipated that stock option awards will be made periodically at the discretion of the Committee in the future. As in past years, the number of shares actually granted to a particular participant is also based on Coastal's financial success, its future business plans, and the individual's position and level of responsibility within Coastal. All of these factors are assessed subjectively and are not weighted.\n1995 Chief Executive Officer Pay\nAs previously described, the Committee considers several factors in developing an executive's compensation package. For the CEO, these include competitive market practices (consistent with the philosophy described for other executives), experience, achievement of strategic goals, and the financial success of Coastal (considering the factors described under the annual bonus plan above).\n- 10 -\nO. S. Wyatt, Jr.\nMr. Wyatt served as CEO through October 4, 1995 when, at his recommendation, the Board of Directors elected Mr. Arledge to the CEO position.\nMr. Wyatt received no salary increase in 1995. The Committee took no action regarding Mr. Wyatt's base salary, in spite of significantly improved Coastal performance during the year. This lack of any adjustment is not a reflection of performance; rather, it is based on considering strong input from the Chairman, who wants to see continued improvement in shareholder returns before receiving any base salary increase.\nMr. Wyatt's bonus for 1995 performance was $300,000 payable in 1996. This bonus award was below targeted levels (and below market median levels) since Coastal's aggregate performance on the measures described in the annual bonus section of this report was below the aggressive Coastal targets.\nThe Committee granted no stock options to Mr. Wyatt in 1995 (consistent with past practices), considering his strongly expressed and longstanding opinion on this issue. Mr. Wyatt and the Committee considered Mr. Wyatt's current level of stock ownership in reaching this decision.\nDavid A. Arledge\nMr. Arledge was elected CEO on October 5, 1995. During 1995, his base annual salary was increased to $625,000.\nMr. Arledge's bonus for 1995 was $300,000 payable in 1996. This award was below targeted levels (and below market median levels) since Coastal's aggregate performance on the measures described in the annual bonus section of this report were below the aggressive Coastal targets.\nThe Committee granted stock options for 50,000 shares to Mr. Arledge in 1995 in recognition of his performance and as an incentive to continue his efforts to increase shareholder value. These awards are tied to performance in that the executive only realizes income from stock options if the stock price rises. The grant is below market levels for the executive positions held by him.\n$1 Million Pay Deductibility Cap\nUnder Section 162(m) of the Internal Revenue Code, public companies are precluded from receiving a tax deduction on compensation paid to executive officers in excess of $1 million. To address the $1 million pay deductibility cap issue, Coastal's 1995 LTIP is structured so that stock option awards (which are intended to be the primary long-term incentive vehicle for the present time) qualify for an exemption from the $1 million pay deductibility limit.\nAlso, at the present time, the Chairman of the Board of Directors and the CEO are the only executives whose base salary plus target bonus exceeds $1 million. In order to preserve Coastal's tax deduction for base salary plus bonus for these individuals, Coastal has established a nonqualified deferred compensation program. Under this program, any annual incentive awards that bring cash compensation to a level over $1 million may be deferred so that payments occur after the individual is no longer a Named Executive Officer, thus preserving the deductibility of the pay for Coastal.\nCompensation and Executive Development Committee\nJohn M. Bissell, Chairman Roy D. Chapin, Jr. Jerome S. Katzin\n- 11 -\nPension Plan\nThe following table shows for illustration purposes the estimated annual benefits payable currently under the Pension Plan and Coastal's Replacement Pension Plan described below upon retirement at age 65 based on the compensation and years of credited service indicated.\nThe Employee Retirement Income Security Act of 1974, as amended by subsequent legislation, limits the retirement benefits payable under the tax-qualified Pension Plan. Where this occurs, Coastal will provide to certain executives, including persons named in the Summary Compensation Table, additional nonqualified retirement benefits under a Coastal Replacement Pension Plan. These benefits, plus payments under the Pension Plan, will not exceed the maximum amount which Coastal would have been required to provide under the Pension Plan before application of the legislative limitations, and are reflected in the above table and footnote (B).\n- 12 -\nPERFORMANCE GRAPH - SHAREHOLDER RETURN ON COMMON STOCK\n[GRAPH]\nTransaction with Management and Others\nIn 1987, Coastal Mart, Inc. (\"Coastal Mart\"), a subsidiary of Coastal, entered into a ten-year lease\/purchase agreement with Pester Marketing Company (\"Pester Marketing\") for 220 gasoline service stations (subsequently reduced to 182 stations through disposition of assets) located in the midwestern region of the United States. Jack Pester, a principal stockholder and Chief Executive Officer of Pester Marketing, subsequently became an employee, officer and director of Coastal Mart and was elected a Senior Vice President of Coastal. Mr. Pester is no longer active in the management of Pester Marketing, and his stock interest in that company has been placed in trust. In 1994, the lease transaction was terminated pursuant to an agreement under which Coastal Mart acquired ownership of and title to 175 of the gasoline service stations and Pester Marketing retained the seven remaining stations.\nDuring 1995 Coastal and\/or its subsidiaries sold approximately 13,447,600 gallons of gasoline to Pester Marketing at prevailing market prices totaling approximately $8,352,300.\n- 13 -\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\n(a) Security Ownership of Certain Beneficial Owners.\nHolders of Units are entitled to vote only as to certain specific matters. The following table sets forth information, as of December 31, 1995, with respect to CLV and to each person known or believed by CLV to be the beneficial owner of five percent or more of the Units, the only class of securities of the Registrant outstanding.\n(b) Security Ownership of Management.\nCLV is an indirect, wholly-owned subsidiary of Coastal. Information concerning the security ownership of certain beneficial owners and management of Coastal is contained in this section.\nThe total number of shares of stock of Coastal outstanding as of March 13, 1996 is 113,480,598: consisting of 61,056 shares of $1.19 Cumulative Convertible Preferred Stock, Series A (the \"Series A Preferred Stock\"); 77,495 shares of $1.83 Cumulative Convertible Preferred Stock, Series B (the \"Series B Preferred Stock\"; 32,663 shares of $5.00 Cumulative Convertible Preferred Stock, Series C (the \"Series C Preferred Stock\"); 8,000,000 non-voting shares of $2.125 Cumulative Preferred Stock, Series H; 104,918,785 shares of Common Stock, and 390,599 shares of Class A Common Stock.\nEach voting share of Common Stock or Preferred Stock entitles the holder to one vote with respect to all matters to come before a shareholders' meeting while each share of Class A Common Stock entitles the holder to 100 votes. However, 25% of Coastal's directors standing for election at each annual meeting will be determined solely by holders of the Common Stock and voting Preferred Stock voting as a class.\n- 14 -\nThe following table sets forth information, as of March 13, 1996, with respect to each person known or believed by Coastal to be the beneficial owner, who has or shares voting and\/or investment power (other than as set forth below), of more than five percent (5%) of any class of its voting securities.\n- 15 -\nThe following table sets forth information, as of March 13, 1996, regarding each of the current directors, including Class I directors standing for election, and all directors and executive officers as a group. Each director has furnished the information with respect to age, principal occupation and ownership of shares of stock of Coastal Messrs. Bissell, Burrow, Chapin and Katzin are Class I directors whose terms expire in 1996; Messrs. Arledge, Brundrett, Wooddy and Wyatt are Class II directors whose terms expire in 1997 and Messrs. Cordes, Gates, Johnson and McDade are Class III directors whose terms expire in 1998.\nNo incumbent director is related by blood, marriage or adoption to another director or to any executive officer of Coastal or its subsidiaries or affiliates.\nExcept as hereafter indicated, the above table includes the principal occupation of each of the directors during the past five years. The listed executive officers have held various executive positions with Coastal, American Natural Resources Company, ANR Pipeline Company and\/or Colorado Interstate Gas Company during the five-year period.\nMr. Bissell is a member of the Boards of Directors of Old Kent Financial Corporation and Batts Inc.\nMr. Cordes is a member of the Board of Directors of Comerica Inc.\nMr. Katzin is a member of the Board of Directors of Qualcomm Incorporated.\nMr. McDade is a trial lawyer and the founding senior partner of the Houston law firm of McDade & Fogler L.L.P. Prior to forming McDade & Fogler L.L.P., he was a senior partner in the Houston law firm of Fulbright & Jaworski. He is a member of the Board of Directors of Equity Corporation International.\nMessrs. Arledge, Burrow, Cordes and Wyatt are directors of Colorado Interstate Gas Company and ANR Pipeline Company. Messrs. Bissell and Chapin are directors of ANR Pipeline Company. Both of these subsidiaries of Coastal are subject to the reporting requirements of the Securities Exchange Act of 1934, as amended (the \"Exchange Act\").\n- 17 -\nThe following table sets forth information, as of December 31, 1995, concerning ownership of units of limited partnership interests in the Coastal 1986 Drilling Program, Ltd. and Coastal 1987 Drilling Program, Ltd., by directors and all directors and executive officers as a group.\n(c) Changes in Control.\nCoastal knows of no arrangement which may, at a subsequent date, result in a change in control of Coastal or CLV.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nThe General Partner and the Other Joint Venturers are Coastal subsidiaries, as discussed in Item 1 herein, and the directors of CLV are officers and\/or directors of one or more Coastal subsidiaries, or of Coastal, as indicated in Item 10 herein. CLV receives payments from the Partnership of administrative fees and the Partnership has account balances with the Other Joint Venturers, as described in Note 4 of Notes to Financial Statements included herein. Certain production, in which the Partnership has an interest, is being sold to Coastal subsidiaries, as discussed in Item 1 herein. During 1995, sales of natural gas amounting to $196,000 and sales of crude oil, condensate and natural gas liquids amounting to $69,000 were made to Coastal subsidiaries at market value.\nAdditional information called for by this item is set forth under Item 11, \"Executive Compensation,\" and Note 4 of Notes to Financial Statements included herein.\n(b) Certain business relationships.\nNone.\n(c) Indebetedness of management.\nNone.\n(d) Transactions with promoters.\nNot applicable.\n- 18 -\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 or incorporated herein by reference.\n1. Financial Statements of Registrant and supplemental information included in response to Item 8 herein.\nPage\nIndependent Auditors' Report ..................................\nBalance Sheet - December 31, 1995 and 1994 ....................\nStatement of Partners' Capital for the years ended December 31, 1995, 1994 and 1993 .......................................\nStatement of Operations for the years ended December 31, 1995, 1994 and 1993 .............................................\nStatement of Cash Flows for the years ended December 31, 1995, 1994 and 1993 .............................................\nNotes to Financial Statements .................................\nSupplemental Information on Exploration, Development and Production Activities (unaudited) .........................\n2. Financial statement schedules.\nSchedules are omitted as not applicable or not required, or the required information is shown in the Financial Statements or Notes thereto.\n3. Exhibits.\n3.1+ Agreement of Limited Partnership.\n3.2+ Certificate of Limited Partnership.\n10.1+ Joint Venture Agreement among Coastal 1986 Drilling Program, Ltd., Coastal Oil & Gas Corporation, ANR Production Company and CIG Exploration, Inc.\n24* Powers of Attorney (included on signature page herein).\n27* Financial Data Schedule\n+Incorporated by reference from Registration Statement No. 33-1658. *Indicates filed herewith.\n(b) Reports on Form 8-K.\nNo reports on Form 8-K were filed during the last quarter of 1995.\n- 19 -\nPOWERS OF ATTORNEY\nEach person whose signature appears below hereby appoints David A. Arledge, Coby C. Hesse and Austin M. O'Toole and each of them, any one of whom may act without the joinder of the others, as his attorney-in-fact to sign on his behalf and in the capacity stated below and to file all amendments to this Annual Report on Form 10-K, which amendment or amendments may make such changes and additions thereto as such attorney-in-fact may deem necessary or appropriate.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nCOASTAL 1986 DRILLING PROGRAM, LTD. (Registrant)\nBy Its General Partner, Coastal Limited Ventures, Inc.\nBy: JERRY D. BULLOCK -------------------------------- Jerry D. Bullock President March 28, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, 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: DAVID A. ARLEDGE -------------------------------- David A. Arledge Principal Financial Officer and Director March 28, 1996\nBy: JERRY D. BULLOCK -------------------------------- Jerry D. Bullock Director March 28, 1996\nBy: CARL A. CORRALLO -------------------------------- Carl A. Corrallo Director March 28, 1996\nBy: HARVEY R. KLINGENSMITH -------------------------------- Harvey R. Klingensmith Director March 28, 1996\nBy: AUSTIN M. O'TOOLE -------------------------------- Austin M. O'Toole Director March 28, 1996\n- 20 -\nMANAGEMENT'S REVIEW\nManagement's Discussion and Analysis of Financial Condition and Results of Operations\nLIQUIDITY AND CAPITAL RESOURCES\nEffective January 1, 1996, the Partnership terminated in accordance with the provisions for dissolution set forth in the Partnership Agreement as summarized in Note 1 of Notes to Financial Statements. Final dissolution proceeds will be distributed in May 1996.\nRESULTS OF OPERATIONS\nAnnual changes shown in this discussion are in comparison with the year immediately preceding.\nProduction\nNatural gas production decreased 139 million cubic feet (43%) in 1995 and increased 170 million cubic feet (111%) in 1994. The decrease in 1995 was primarily attributable to decreased production from the Bitter Creek Field in Utah due to market conditions in the area. The 1994 increase was primarily due to an increase from the Bitter Creek Field in Utah due to improved marketing alternatives in the area and to prior maintenance activities in the field.\nProduction of crude oil, condensate and natural gas liquids decreased 1,353 barrels (9%) in 1995 and 2,237 barrels (12%) in 1994. The reductions in 1995 and 1994 were primarily due to normal production declines.\nRevenues\nRevenues from the sale of production decreased $350,000 (43%) in 1995 and increased $202,000 (33%) in 1994.\nNatural gas revenues decreased $347,000 (59%) in 1995 and increased $280,000 (92%) in 1994. The reduction in 1995 was attributable to a decrease in production volumes and a lower net weighted average price. The 1994 increase was due to increased production volumes, partially offset by a lower net weighted average price.\nCrude oil, condensate and natural gas liquids revenues decreased $3,000 (1%) in 1995 and $78,000 (25%) in 1994. The 1995 decrease was due to a decrease in production volumes, partially offset by a higher net weighted average price. The decrease in 1994 was due to a decrease in production volumes and a lower net weighted average price.\nInterest income decreased $8,000 (100%) in 1995 and $1,000 (11%) in 1994 due primarily to varying levels of cash available for investment purposes.\nOperating Expenses\nLease operating expenses decreased $88,000 (26%) in 1995 and increased $94,000 (38%) in 1994. The decrease in 1995 was primarily attributable to decreased production taxes. The increase in 1994 was primarily due to increased production taxes and maintenance expenses.\nDepreciation and Amortization\nDepreciation and amortization decreased $191,000 (37%) in 1995 and $198,000 (27%) in 1994. The decrease in 1995 was primarily due to decreased equivalent production volumes, a decreased rate and reduced carrying value charges. The 1994 decrease was primarily a result of decreased carrying value charges and a decreased rate, partially offset by increased production volumes. Non-cash charges of $165,000, $231,000 and $489,000 in 1995, 1994 and 1993, respectively, were recorded so that the net investment in gas and oil properties would not exceed the estimated\nfuture net revenues from proved reserves, computed at prices at the end of the reported period, and discounted at 10% as required under the full-cost method of accounting for gas and oil properties.\nCash Distributions\nCash distributions to Limited Partners since commencement of operations were (December distribution is made in the subsequent February):\nThe 1991 fourth quarter distribution includes proceeds attributable to the sale of Program wells in the Roaring Fork Field in Virginia and Kentucky.\nINDEPENDENT AUDITORS' REPORT\nTo the Partners of Coastal 1986 Drilling Program, Ltd. Houston, Texas\nWe have audited the accompanying balance sheets of Coastal 1986 Drilling Program, Ltd. (a Texas limited partnership) as of December 31, 1995 and 1994, and the related statements of partners' capital, operations and cash flows for each of the three years in the period ended December 31, 1995. These financial statements are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, such financial statements present fairly, in all material respects, the financial position of Coastal 1986 Drilling Program, Ltd. as of December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\nAs discussed in Note 1 to the Financial Statements, both the Partnership and the Joint Venture terminated on January 1, 1996, under the terms of the Partnership Agreement and the Joint Venture Agreement. The amounts determined by the independent engineer which will be realized from the disposition of the remaining assets may differ materially from the amounts in the accompanying financial statements.\nDELOITTE & TOUCHE LLP\nHouston, Texas March 4, 1996\nSee Notes to Financial Statements\nSee Notes to Financial Statements\nNOTES TO FINANCIAL STATEMENTS\nNote 1. Summary of Significant Accounting Policies\nOrganization and Basis of Presentation\nCoastal 1986 Drilling Program, Ltd. (the \"Partnership\") commenced operations on October 8, 1986, as a Texas limited partnership to participate in drilling development and exploratory wells located in the United States on leasehold acreage held by subsidiaries of The Coastal Corporation (\"Coastal\"). The Partnership was funded primarily through the sale of 12,000 Limited Partnership Units providing $12,000,000. Under the terms of the Partnership Agreement, the General Partner, Coastal Limited Ventures, Inc., a wholly-owned subsidiary of Coastal, incurred all costs of organizing the Partnership and contributed 1% of the total capital, or $121,000, as general partner capital.\nThe drilling operations were conducted through a joint venture in the form of a Texas general partnership (the \"Joint Venture\") between the Partnership and three wholly-owned subsidiaries of Coastal (\"Other Joint Venturers\"). For financial reporting purposes, the Partnership's investment in such venture was accounted for by consolidating its share of the operating results of the venture.\nAll costs and revenues of the Partnership were allocated 1% to the General Partner and 99% to the Limited Partners. Net loss per Limited Partnership Unit was calculated by dividing the net loss attributable to Limited Partners by the 12,000 units outstanding.\nUnder the terms of the Partnership Agreement and the Joint Venture Agreement, both the Partnership and the Joint Venture terminated effective January 1, 1996. In accordance with the terms and conditions of the dissolution, each gas and oil property will be sold or transferred to the Other Joint Venturer which assigned the property to the Joint Venture at a value determined by independent appraisal (see \"Partnership Interest in Proved Reserves\" on page). After all Joint Venture assets have been liquidated and all Joint Venture obligations have been paid, the remaining cash in the Joint Venture will be distributed among the Joint Venturers. As among the Partners in the Partnership, the liquidating distribution will be distributed 99% to the Limited Partners and 1% to the General Partner in May 1996. The amounts determined by the independent appraisal which will be realized from the disposition of the remaining assets may differ materially from the amounts in the accompanying financial statements.\nStatement of Cash Flows\nCash equivalents include time deposits, certificates of deposit and all highly liquid instruments with original maturities of three months or less.\nGas and Oil Properties\nThe Partnership followed the full-cost method of accounting for gas and oil properties. Under this method, all costs incurred in the exploration and development of gas and oil properties, including unproductive wells, were capitalized. Depreciation and amortization of gas and oil properties was provided on the unit-of-production basis whereby the unit rate was determined by dividing the total unrecovered carrying value of all gas and oil properties by the estimated proved reserves included therein, as estimated by an independent engineer, adjusted so that the net investment in gas and oil properties did not exceed the estimated future net revenues from proved reserves, computed at prices at the end of the reported period, discounted at 10%. In 1995, 1994 and 1993, such additional depreciation and amortization expense of $165,000, $231,000 and $489,000, respectively, was recorded. The depreciation and amortization rates, excluding the adjustments, amounted to $0.56, $0.70 and $0.89 per equivalent unit of a thousand cubic feet of natural gas production during 1995, 1994 and 1993, respectively.\nNo property acquisition costs were recorded by the Partnership since all drilling blocks were contributed to the Joint Venture by the Other Joint Venturers. Development costs incurred by the Partnership during 1995, 1994 and 1993 were $38,000, $12,000 and $12,000, respectively. These development costs were attributable to capitalized well maintenance activities and abandonments, net of salvage.\nTaxes\nNo provision for income tax expense is reflected in the financial statements since the income and deductions of the Partnership are reported on the separate tax returns of the individual partners. State severance taxes are classified as lease operating expenses.\nNote 2. Participation in Costs And Revenues\nUnder the terms of the Partnership and Joint Venture Agreements, revenues, costs and expenses were allocated on the following basis:\nAll costs and revenues of the Partnership were allocated 1% to the General Partner and 99% to the Limited Partners.\nNote 3. Partnership Payout\nPartnership Payout is defined in the Partnership Agreement as the close of business on the last day of the calendar month during which revenues from the sale of production less operating costs of the Joint Venture allocated to the Partnership and less amounts applied to pay in full the principal of, and interest on, the Joint Venture Note plus gains on the sale or other disposition of Joint Venture assets credited to the capital account of the Partnership plus interest earned after October 8, 1986 (effective date of operations), by the Partnership plus any contributions distributed pro rata to the Partners as a return of capital, first equal the sum of $12,121,000 plus Permitted Excess Drilling Costs. Partnership Payout was achieved in October 1992.\nNote 4. Transactions With Related Parties\nAccounts with Affiliated Companies\nThe accounts receivable - affiliates and accounts payable - affiliates balances are with the General Partner and Other Joint Venturers, and result from provisions of the Partnership Agreement, Joint Venture Agreement and transactions in the ordinary course of business as more fully explained in the following paragraphs.\nFee to General Partner\nUnder terms of the Partnership Agreement, the General Partner was entitled to an annual fee (paid in quarterly installments) of $400,000 in 1986, $300,000 in 1987 and $200,000 in each year from 1988 through 1995 in lieu of general and administrative overhead costs. The cumulative amount of such fee paid at any point in time could not exceed 15% of the Partnership's cumulative revenues received up to and including that point in time, with any remaining balance due carried forward and paid in subsequent quarters. However, the General Partner reduced the management fee to $81,000 for each of the years 1995, 1994 and 1993, respectively, as a result of a restructuring of the fee by the\nGeneral Partner. Fees paid to the General Partner totaled $58,000, $82,000 and $80,000 in 1995, 1994 and 1993, respectively. As of December 31, 1995, there was a remaining balance of $44,000 payable to the General Partner.\nBalances with Other Joint Venturers\nSuch balances arose in the normal course of business from advance payments or billings for development and exploratory drilling activities, the sale of gas and oil production, and the operating costs of producing wells. In 1995, 1994 and 1993, two unrelated companies accounted for more than 10% of gas and oil sales from the Joint Venture. The Partnership's share of these sales was $154,000, $290,000 and $229,000 in 1995, 1994 and 1993, respectively. All costs and revenues were allocated to the respective parties as indicated in Note 2.\nSales to Affiliated Companies\nDuring 1995, 1994 and 1993, sales of natural gas amounting to $196,000, $289,000 and $223,000, respectively, and sales of crude oil, condensate and natural gas liquids amounting to $69,000, $67,000 and $76,000, respectively, were made to Coastal subsidiaries at market value.\nNote 5. Repurchase of Partnership Units\nDuring the 1995 repurchase period, 415 of the 10,152 eligible units were tendered by Limited Partners and were purchased by the General Partner. In 1994, 516 units were tendered and purchased. As of December 31, 1995, the General Partner held 2,263 of the 12,000 units outstanding.\nSUPPLEMENTAL INFORMATION ON EXPLORATION, DEVELOPMENT AND PRODUCTION ACTIVITIES (Unaudited)\nIntroduction\nThis section presents information on Partnership and Joint Venture costs, revenues, reserves and estimates of future gas and oil operations. The estimates of gas and oil reserves and future net cash flows from gas and oil production were prepared by independent engineers, Huddleston & Co., Inc., Houston, Texas.\nTotal Costs\nTotal costs shown in the following tables were allocated as indicated in Note 2 to the accompanying financial statements. (Thousands of Dollars)\nTotal Revenues\nTotal revenues for the cumulative period October 8, 1986 (effective date of operations), to December 31, 1995, and for the year ended December 31, 1995, are shown in the following tables. Revenues were allocated as indicated in Note 2 to the accompanying financial statements. (Thousands of Dollars).\nPartnership Interest in Proved Reserves\nPresented below are the quantities associated with the Partnership's interest in estimated proved reserves as of December 31, 1992, 1993, 1994 and 1995. Also included are the changes in net quantities for the years ended December 31, 1993, 1994 and 1995. Natural gas is stated in millions of cubic feet. Oil includes condensate and natural gas liquids and is stated in barrels.\nPresented below is an estimate of the Partnership's interest at December 31, 1995, 1994 and 1993, in future net cash flows from the Joint Venture proved reserves, a standardized measure of discounted future net cash flows, and the commensurate standardized measure per Limited Partnership Unit. (Thousands of Dollars except per Limited Partnership Unit)\nThe standardized measure of discounted future net cash flows per Limited Partnership Unit is calculated in accordance with Securities and Exchange Commission regulations and should not be construed as the liquidation price of units as described in Note 1 of Notes to Financial Statements included herein.\nThe Partnership's interest in the net quantities of gas and oil reserves and the Partnership's interest in the standardized measure of discounted future net cash flows for 1995, 1994 and 1993, were calculated by the independent engineers using a discount factor of 10%. The upward revision attributed to oil in 1995 was primarily due to the production of various wells exceeding previously recognized quantity estimates.\nIn the opinion of the General Partner, the above estimates do not necessarily represent the current value of the reserves or of future net cash flows which may reasonably be expected to be realized from future production.\nEXHIBIT INDEX\nExhibit Number Document - ------- -------- 3.1+ Agreement of Limited Partnership.\n3.2+ Certificate of Limited Partnership.\n10.1+ Joint Venture Agreement among Coastal 1986 Drilling Program, Ltd., Coastal Oil & Gas Corporation, ANR Production Company and CIG Exploration, Inc.\n24* Powers of Attorney (included on signature page herein).\n27* Financial Data Schedule.\n+Incorporated by reference from Registration Statement No. 33-1658. *Indicates filed herewith.","section_15":""}
{"filename":"216324_1995.txt","cik":"216324","year":"1995","section_1":"ITEM 1. BUSINESS. --------\nGENERAL\nImage Entertainment, Inc. (the \"Company\") was incorporated in Colorado in April 1975 as Key International Film Distributors, Inc. The Company's present name was adopted in June 1983. The Company reincorporated in California in November 1989. Its principal executive offices are located at 9333 Oso Avenue, Chatsworth, California 91311, and its telephone number is (818) 407-9100.\nThe Company has distributed programming on laserdisc since 1983, and is the largest laserdisc licensee and distributor in North America with an estimated 35% market share. It distributes thousands of titles ranging from feature films and music videos to family, documentary and special interest programming, directly or through subdistributors. Titles are obtained from major motion picture studios and other suppliers under exclusive and nonexclusive license and wholesale distribution agreements.\nTo obtain exclusive titles, the Company generally enters into license agreements whereby it acquires the exclusive right to manufacture and distribute laserdisc programming in exchange for royalties. The Company releases exclusive titles from licensors such as Disney's Buena Vista Home Video, Hallmark Home Entertainment, New Line Home Video, Orion Home Video, Playboy Home Video and Turner Home Entertainment. Some of the exclusive titles currently available from the Company include: Aladdin, Snow White and the Seven Dwarfs, Quiz Show, The Jungle Book, Terminal Velocity, Hoop Dreams, The Mask, and Blue Sky. Some of the exclusive titles the Company expects to release during fiscal 1996 include: The Lion King, Cinderella, While You Were Sleeping, Pulp Fiction, Crimson Tide, Judge Dredd, The Santa Clause, The Madness of King George, Dumb and Dumber, Don Juan DeMarco, Special Collector's Editions of The Howling, The Fog, Tron, Alice in Wonderland and Three Caballeros.\nWhen the Company acts as a wholesale distributor, it generally acquires laserdisc programming in finished, prepackaged form for resale to retail accounts. The Company is the exclusive wholesale distributor of laserdisc programming from Twentieth Century Fox Home Entertainment and The Voyager Company (including Voyager's prestigious \"Criterion Collection\" line). Some of the Twentieth Century Fox and Voyager titles currently available from the Company include: Speed, True Lies, the THX Special Edition of Mrs. Doubtfire, the Collector's Edition of Powell and Pressburger's The Red Shoes, A Night To Remember and THX Special Editions of Robocop and Silence Of The Lambs. Some of the Twentieth Century Fox and Voyager titles the Company expects to release during fiscal 1996 include: Die Hard With A Vengeance, Kiss of Death, Nell, Mighty Morphin Power Rangers, Miracle on 34th Street, French Kiss, the Collector's Edition of Schindler's List, the Collector's Edition of The Day The Earth Stood Still, the THX Edition of The Towering Inferno and the Special Collector's Edition of The Rocky Horror Picture Show. In addition, the Company is a nonexclusive wholesale distributor of laserdisc programming from motion picture studios such as Columbia, MCA\/Universal, MGM\/UA, TriStar and Warner Bros. Some of the nonexclusive studio titles currently distributed by the Company include: Interview With The Vampire, Legends of the Fall, Four Weddings and a Funeral, The Shawshank Redemption, Jurassic Park, Junior, Disclosure and Eric Clapton Unplugged. Some of the nonexclusive studio titles the Company expects to distribute during fiscal 1996 include: Batman Forever, The Bridges of Madison County, Casper, Waterworld and Apollo 13.\nIn preparing titles for laserdisc replication, the Company uses its in- house, state-of-the-art digital post-production facility to create laserdisc masters. It then delivers the masters to manufacturers such as Digital Audio Disc Corporation (Sony), Kuraray, Mitsubishi, Pioneer Video Manufacturing, Technidisc and 3M for the replication of laserdiscs. The Company's in-house, full-service creative services\/computer\n- -------------------------------------------------------------------------------- Image Entertainment, Inc. 1\ngraphics department designs laserdisc jackets and creative materials for advertising and merchandising. The Company's in-house marketing department implements marketing programs, issues publicity and publishes Image Laserdisc Preview magazine, a consumer-oriented monthly featuring new releases and containing articles and information of current interest to the laserdisc\/multimedia consumer.\nRECENT DEVELOPMENTS\nOn November 15, 1994, to refinance its existing long-term debt and gain borrowing flexibility to maintain growth, the Company entered into a Loan and Security Agreement with Foothill Capital Corporation, an asset-based lender. The agreement provides for revolving advances and the issuance of and guaranty of standby letters of credit under a $14,250,000 revolving credit facility and a series of term loans under a $750,000 capital expenditure term loan facility. The term of the agreement is three years, renewable automatically thereafter for successive one-year periods. Concurrent with funding of the revolving credit facility, the Company immediately retired $11,500,000 of long-term debt representing the outstanding balance of the Company's November 18, 1991 private placement financing. See \"Item 7. Management's Discussion and Analysis of --- Financial Condition and Results of Operations -- Liquidity and Capital Resources.\"\nOn January 16, 1995, the Company instituted a stock repurchase program to buy up to one million shares of its outstanding common stock. Purchases will be made from time to time in open market and\/or privately negotiated transactions based on current market conditions and other factors. As of March 31, 1995, the Company had repurchased 254,800 shares of common stock for approximately $1.9 million. See \"Item 7. Management's Discussion and Analysis of Financial --- Condition and Results of Operations -- Liquidity and Capital Resources.\"\nOn March 30, 1995, the Company received an $880,000 business interruption insurance claim settlement arising from losses sustained in the January 17, 1994 Northridge earthquake. See \"Item 7. Management's Discussion and Analysis of --- Financial Condition and Results of Operations -- Insurance Settlements - Business Interruption and Property Damage.\"\nOn June 21, 1995, the Company, acquired V.T. Laser, Inc., a privately held New Jersey based corporation doing business as \"U.S. Laser Video Distributors,\" for approximately $3.1 million. U.S. Laser is a nonexclusive distributor of optical disc programming and the publisher of LASERVIEWS: America's Laser Disc Magazine, a bimonthly consumer periodical focusing on product announcements, software reviews and articles of general interest to the laserdisc consumer, and D.I.S.C.: Dealer's Interactive Software Companion, a dealer-oriented multimedia publication. U.S. Laser has been in the laserdisc distribution business since 1985 and will continue to operate on a business as usual basis out of its New Jersey offices. Prior to the acquisition, U.S. Laser was a competitor of the Company and one of the Company's largest customers. See \"Item 7. Management's --- Discussion and Analysis of Financial Condition and Results of Operations -- Recent Acquisition.\"\nLASERDISC BASICS\nThe laserdisc, a larger, optical version of the compact disc (CD), is encoded with both audio and visual information. Just as CDS offer distinct advantages over records and audiotapes, laserdiscs offer distinct advantages over videocassettes: higher resolution video, full-fidelity digital audio, instant access to any scene, frame-by-frame viewing, greater durability and superior interactive capability. The laserdisc is not to be confused with the short-lived capacitance electronic disc (CED), which was introduced by RCA in the early 1980s and abandoned by it in 1986. The CED (or \"videodisc\") was read by a stylus and did not utilize optical laser technology.\nLaserdisc (software) demand is primarily driven by the installed base of laserdisc players (hardware). When introduced over a decade ago, laserdisc players met with only moderate success because of their cost compared to VCRs, their inability to record, limited software availability and\n- -------------------------------------------------------------------------------- 2 Image Entertainment, Inc.\nconsumers' unfamiliarity with the laserdisc format. However, the format has since benefitted from consumer acceptance of CD technology and increasing consumer interest in the \"home theater\" concept, including THX sound equipment, big-screen televisions and wide-screen televisions. Player prices continue to decline and a wide variety of models are available at retail.\nToday, a large number of hardware manufacturers, including Denon, Kenwood, Magnavox, Mitsubishi, Panasonic, Pioneer, Quasar, RCA, Runco, Samsung, Sharp, Sony, Theta and Yamaha, offer a variety of laserdisc player models. Major retailers of audio and video components such as Circuit City, Frys, Lechmere, Montgomery Ward, Radio Shack, Sears and The Good Guys carry laserdisc players.\nVirtually all laserdisc players are combination players (\"Combi-players\"), which play both CDS and laserdiscs. The average selling price of an entry-level player is between $299 and $379. Pioneer Electronics, a leading manufacturer of laserdisc hardware, introduced an entry-level player listing at $299 in early 1995. Denon, Pioneer, Panasonic, Runco and Theta have introduced several high- end laserdisc player models which retail between $1,000 and $4,500. Depending upon the make and model, laserdisc players may also offer karaoke and game add- ons and an assortment of other special features. Newly introduced by Pioneer in calendar 1995, in all new models of players retailing for $399 and above, is \"Dolby Digital Surround\" also known as \"AC-3.\" This new audio feature, currently available only with laserdisc technology, allows for six discrete channels of audio to be played back in home theatre applications, giving the viewer a closer approximation of the original theatrical experience and a more true-to-life placement of sound.\nThe Company believes that growth in the installed player base will boost laserdisc sales. Paul Kagan Associates, Inc. estimates the number of laserdisc- player households, the percentage of television households with laserdisc players and the number of laserdiscs sold in the United States as follows:\n(C) 1995 Paul Kagan Associates, Inc. estimates.\nThe Company anticipates the laserdisc market will remain primarily a sell- through rather than a rental market. Most titles currently have a suggested retail price of $24.99 to $39.99, low enough for consumers to build a personal library. If a large laserdisc rental market develops, the Company expects disc sales per household to drop as the price per disc increases, but total disc sales and the number of outlets renting or selling discs to multiply.\nPROGRAM ACQUISITION\nGENERAL. As the Company does not produce its own programming, its success ------- depends upon entering into new and renewing existing licenses and wholesale distribution agreements for feature films and other programming. There is no assurance that suppliers of programming will continue to enter into or renew licenses or distribution agreements on terms acceptable to the Company; however, the Company believes that its production, creative services, marketing and distribution expertise will continue to make it an attractive partner for such suppliers.\nTwentieth Century Fox and Disney's Buena Vista retain the right to terminate their respective agreements with the Company if specified events of default occur, such as a \"change in control\" (as\n- -------------------------------------------------------------------------------- Image Entertainment, Inc. 3\ndefined in the agreements) of the Company. Future licenses and distribution agreements may contain similar termination provisions.\nLICENSES. The Company enters into licenses whereby it acquires from -------- suppliers of programming the right to manufacture and distribute their titles on laserdisc. Licenses are for specific titles or for a licensor's existing library and future releases over a designated term (\"output licenses\"), and generally give the Company exclusive rights. The Company releases exclusive titles from licensors such as Buena Vista Home Video, Hallmark Home Entertainment, Geffen Records, New Line Home Video, Orion Home Video, Playboy Home Video and Turner Home Entertainment. Under a November 26, 1991 agreement with Buena Vista Home Video, a subsidiary of The Walt Disney Company, the Company has the exclusive right to replicate, market and distribute all Disney, Touchstone, Buena Vista and Hollywood Pictures programming on laserdisc in the United States and Canada and their respective territories (although Disney may distribute to certain accounts if it so elects) until December 1995 or June 1996 depending on the title. In connection with the agreement, Buena Vista's parent company was issued a warrant to purchase 1,671,760 shares of Common Stock at $6.00 per share. The warrant has certain registration rights. See Item 8. --- Financial Statements and Supplementary Data -- Note 10 to Financial Statements. Under a December 22, 1992 agreement with New Line Home Video, Inc., a division of New Line Cinema, the Company has the exclusive right to replicate, market and distribute all New Line, Fine Line and other programming acquired by New Line on laserdisc in the United States (and Canada for certain titles) until December 1997 or December 1998 if New Line elects. In connection with the agreement, New Line was issued a warrant to purchase 500,000 shares of the Company's Common Stock at $6.30 per share. The warrant has certain registration rights. See --- Item 8. Financial Statements and Supplementary Data -- Note 10 to Financial Statements.\nIn return for the grant of rights, the Company pays royalties to its licensors. Royalties are expressed as a percentage of the Company's revenues from laserdisc sales. In many cases, the Company pays licensors advances or minimum guarantees on a title, which are recouped against any royalties earned from that title and (if cross-collateralized) other titles under the license. Advances under most output licenses are paid according to predetermined schedules, regardless of the number and marketability of the titles subsequently available. In entering into licenses, the Company depends, to a large extent, on its ability to anticipate the public's changing taste in laserdisc programming, foresee (as to output licenses) licensors' future releases, and pay for any advances, minimum guarantees and other licensee obligations.\nIn general, licenses have terms of two to seven years and are limited to the United States, Canada and their respective territories and possessions. Under most output licenses, the Company has one to five years to select titles and two to five years to distribute a title after its release on laserdisc.\nDistribution of licensed titles accounted for approximately 55% of fiscal 1995 net sales, 50% of fiscal 1994 net sales and 48% of fiscal 1993 net sales. Exclusive titles from the following licensors accounted for the largest percentages of fiscal 1995 net sales (the only percentage in excess of 10% is indicated): Buena Vista Home Video (29.2%), New Line Home Video, Orion Home Video, Sultan Entertainment, and Turner Home Entertainment. Exclusive titles from the following licensors accounted for the largest percentages of fiscal 1994 net sales (the only percentage in excess of 10% is indicated): Buena Vista Home Video (18.4%), New Line Home Video, Orion Home Video, Academy Entertainment, Inc. and Prism Entertainment. Exclusive titles from the following licensors accounted for the largest percentages of the Company's fiscal 1993 net sales (the only percentage in excess of 10% is indicated): Buena Vista Home Video (20.0%), Playboy Video Entertainment, Orion Home Video, L.I.V.E Home Video, Turner Home Entertainment and New Line Home Video (sales commenced in the fourth quarter).\nThe selection periods under the five licenses which accounted for the largest percentages of fiscal 1995 net sales will expire on various dates between December 1995 and December 1999 and the distribution periods with respect to individual titles under such licenses have expired or will expire on various dates through approximately September 2003. While efforts are made to renegotiate and renew\n- -------------------------------------------------------------------------------- 4 Image Entertainment, Inc.\nlicenses prior to expiration, there can be no assurance that licenses or distribution agreements will be renegotiated or renewed.\nHistorically, the Company has not attempted to obtain foreign (with the exception of Canadian) laserdisc distribution rights, since foreign sales, outside of Canada and certain Pacific Rim countries where such rights are generally unavailable to non-domestic entities, have been minimal. Under a special arrangement, Image sells laserdiscs of Disney titles to Disney, for a specified fulfillment fee, for distribution to designated Disney licensees and distributors in the Philippines, Taiwan, Hong Kong, Malaysia, Singapore and Thailand. From time to time the Company similarly acts as a fulfillment center servicing foreign territories for other licensors.\nAlthough the Company does not produce its own motion picture programming, the Company often creates and releases Special Edition laserdiscs, an increasingly important source of revenue, publicity and prestige for the Company. Special Editions usually consist of a feature film (obtained under license) and a variety of ancillary materials such as out-takes, restored footage or a director's cut, interviews with the director, cast or other participants in the film-making process, separate audio track narratives, scripts and\/or treatments, press clippings, compact discs of the soundtrack, production photos, and other materials of interest. Recently, the Company began releasing limited, numbered Special Editions personally autographed by the film's director or other talent. The Voyager Company also creates and releases Special Editions which the Company distributes on an exclusive basis. In response to growing consumer demand, the Company will be releasing increasingly more titles in THX, wide-screen (letterboxed) and\/or AC-3 surround sound versions.\nWHOLESALE DISTRIBUTION. In addition to its licensing activities, the ---------------------- Company is a wholesale distributor of laserdisc programming which it acquires from certain major motion picture studios and other suppliers.\nOn July 1, 1992, the Company and Twentieth Century Fox Home Entertainment (formerly known as FoxVideo, Inc.) entered into an exclusive four-year laserdisc distribution agreement which superseded the exclusive laserdisc distribution agreement between the parties which had been in effect since September 1, 1990. Under the agreement, the Company has the right to acquire existing and future Fox titles until June 30, 1996 for distribution in the United States, Canada and Puerto Rico (although Fox may distribute to certain accounts if it so elects). In connection with the agreement, Twentieth Century Fox Film Corporation, Twentieth Century Fox Home Entertainment's parent company, was issued a warrant to purchase 1,671,760 shares of Common Stock at $6.00 per share. The warrant has certain registration rights. See Item 8. Financial Statements and Supplementary --- Data -- Note 10 to Financial Statements. Under a November 10, 1992 agreement, the Company has the exclusive right to purchase and distribute Voyager programming in the United States, and additional territories, under certain circumstances. The Company's rights with respect to Voyager titles are exclusive until the end of the term specified in the agreement and non-exclusive thereafter.\nThe Company is also a nonexclusive wholesale distributor of laserdisc programming from Warner Home Video, MGM\/UA Home Video, MCA\/Universal Home Video, Columbia TriStar Home Video, Lumivision, Republic, BMG and Polygram.\nIn general, the Company acquires laserdisc programming for wholesale distribution in finished, prepackaged form, and thus does not provide any creative services with respect to such programming; however, in connection with the Fox and Voyager exclusive distribution agreements, the Company finishes and packages the product for a fee. The Company is generally not required to pay advances, although the Voyager agreement requires an advance and the Fox and Voyager agreements contain minimum guarantees. In a typical nonexclusive wholesale distribution arrangement, the program supplier notifies the Company of its upcoming releases and the Company then solicits its customers and places orders for the releases. In acquiring laserdiscs for nonexclusive wholesale distribution, the Company is generally required to pay within 60 days of delivery.\n- -------------------------------------------------------------------------------- Image Entertainment, Inc. 5\nWholesale (exclusive and nonexclusive) distribution of laserdiscs accounted for approximately 45% of fiscal 1995 net sales, 50% of fiscal 1994 net sales and 52% of fiscal 1993 net sales. Exclusive wholesale distribution of Fox product accounted for approximately 27% of fiscal 1995 net sales, 31% of fiscal 1994 net sales and 27.3% of fiscal 1993 net sales. Generally, the Company's profit margin on exclusive licensed product and exclusive distributed product has been greater than its profit margin on nonexclusive product it distributes wholesale. The Company's commitment to nonexclusive wholesale distribution has varied from time to time, depending principally upon the availability of capital to carry inventory and receivables. With the securing of financing in November 1991, the Company expanded its nonexclusive wholesale distribution of studio titles, thus strengthening its ability to provide a full range of laserdisc titles.\nSALES AND CREDIT POLICIES\nThe Company sells product directly or through subdistributors subject to the terms of the Company's dealer sales policies. Laserdisc sales to the following customers accounted for the largest percentage of the Company's fiscal 1995 net sales (none equaled or exceeded 10%): Musicland, U.S. Laser, MTS\/Tower Records and Video, Camelot Music and Ken Crane's. Laserdisc sales to the following customers accounted for the largest percentages of the Company's fiscal 1994 net sales (none equalled or exceeded 10%): U.S. Laser, Norwalk Record Distributors, Ken Crane's, Musicland and MTS\/Tower Records and Video. Laserdisc sales to the following customers accounted for the largest percentages of the Company's fiscal 1993 net sales (the only percentage equal to or greater than 10% is indicated): Camelot Music (10%), Musicland, U.S. Laser, Ken Crane's, and MTS\/Tower Records and Video.\nThe Company's prospective customers generally submit a credit application followed by a minimum opening order for laserdiscs. If the application is accepted, credit terms are assigned. Open account terms generally require payment within 45 to 60 days of delivery. The Company may also require a purchaser to provide a purchase money security interest, a personal guarantee, a letter of credit and\/or other collateral. Due largely to extensive controls instituted by the Company and the efforts of its experienced credit department, bad debt expense was less than 0.1% of net sales during fiscal 1995, 1994 and 1993. The amount of bad debt actually written off in fiscal 1995, 1994 and 1993 was approximately $47,000, $39,000 and $56,000, respectively.\nSales of laserdiscs are generally considered final, however, the Company allows customers to return a portion of their stock on a quarterly basis. This allowance is noncumulative and is based on the customer's prior quarter purchases. Stock returns, other than for defective laserdiscs, amounted to approximately 8.6% of all laserdiscs sold in fiscal 1995, 9.5% of all laserdiscs sold in fiscal 1994 and 9.4% of all laserdiscs sold in fiscal 1993. Returns of defective laserdiscs have been minimal and are generally covered by manufacturers' warranties.\nAs part of its ongoing campaign to expand the laserdisc market, the Company aggressively solicits new retail accounts, enticing them with a broad range of titles. Although the Company generally sells directly to retailers it also sells to certain major music and laserdisc subdistributors boasting a sizeable sales force and an extensive retail network. To stay competitive with subdistributors, the Company has offered improved pricing, faster delivery, expanded sales, customer service and marketing departments and increased inventory of high- demand titles.\nMARKETING\nThe Company's strategy is to promote its product and the laserdisc format in general. The Company's marketing efforts are directed toward consumers and video software and hardware dealers, and involve point-of-sale advertising, advertising in trade and consumer publications, dealer incentive programs, trade show exhibits, bulletins featuring new releases and in-stock catalogue titles and the publication of the Image Laserdisc Preview magazine, a monthly consumer- oriented magazine with an estimated 100,000 unit circulation.\n- -------------------------------------------------------------------------------- 6 Image Entertainment, Inc.\nPromotion of each new title generally begins eight to sixteen weeks before the scheduled in-store release with the mailing of the Image Laserdisc Preview magazine and bulletins to retailers. An active telemarketing campaign follows. The Company attempts to release a title on laserdisc as close in time as possible to its videocassette release date to capitalize on videocassette advertising and publicity campaigns.\nSince the installed base of laserdisc players and the demand for laserdiscs are interrelated, the Company has worked closely with major player manufacturers to promote the laserdisc format. For example, manufacturers of selected laserdisc players sometimes make available to purchasers free or substantially discounted laserdiscs.\nLASERDISC PRODUCTION\nUnder a typical license, the licensor of a title delivers a program master and art work to the Company for quality evaluation. If the Company deems the master acceptable, its postproduction facility creates a submaster with specifications for laserdisc format. This submaster is delivered to the manufacturer for the replication of laserdiscs. The laserdisc jacket is designed and produced by the Company's creative services staff and sent to a printer for replication. The laserdisc manufacturer will either package and shrink-wrap the laserdiscs and ship the completed product to the Company or ship the laserdiscs in bulk to the Company and the Company will package and shrink-wrap the laserdiscs at its own facility.\nTo reduce production costs and expedite the production process, in November 1990 the Company installed an in-house, state-of-the-art digital postproduction facility. To further increase efficiencies and reduce costs, in January 1995 the Company purchased a digital pre-press for high resolution, four color separations. These unique facilities allow the Company to format over 90% of the laserdisc masters it would otherwise contract out to post production facilities and deliver final, color separated film to printers it would otherwise contract out to graphics houses.\nMANUFACTURING OF LASERDISCS\nThe Company currently uses six laserdisc manufacturers, four of which press discs in the United States. In fiscal 1994, the following manufacturers supplied the largest percentages of the laserdiscs pressed for the Company (percentages in excess of 10% are indicated): Mitsubishi (32.0%), Technidisc (31.3%), Kuraray (21.4%), Pioneer Video Manufacturing (12.7%), Sony's Digital Audio Disc Corporation and 3M.\nThe Company attempts to solicit orders from its customers for laserdiscs prior to submitting orders for the manufacture of such discs. Under its manufacturing purchase orders, the Company generally must pay for finished laserdiscs within 30 to 90 days of invoicing. The Company's goal is to order for manufacture that number of units of each title which will enable the Company to ship the bulk of the order within 60 days of delivery. Attainment of this goal depends largely upon the Company's ability to predict the popularity of a title.\nWhile the Company believes that manufacturing facilities currently have the aggregate capacity to fulfill its orders, if any manufacturer used by the Company were unable to supply the Company with laserdiscs, the Company believes it could place its orders for such laserdiscs with other manufacturers (subject to such manufacturers' willingness to re-prioritize their laserdisc pressing schedules).\nSEASONALITY\nThe Company has generally experienced higher sales of laserdiscs in the quarters ended December 31 and March 31 due to increased consumer spending associated with the year-end holidays;\n- -------------------------------------------------------------------------------- Image Entertainment, Inc. 7\nhowever, since most sales of a title occur in the first few months after its release, seasonal sales also vary with the popularity of titles in release.\nCOMPETITION\nThe Company believes that it is the largest laserdisc licensee and distributor in the United States; however, the Company also faces competition from Pioneer LDCA, which also licenses and distributes laserdiscs, laserdisc subdistributors, and Columbia TriStar Home Video, MCA\/Universal Home Video, MGM\/UA Home Video and Warner Home Video, who sell their own programming directly to retailers, as well as to the Company and other distributors.\nLaserdiscs also face competition from other forms of home video entertainment, e.g., videocassettes and network, syndicated, pay\/cable --- television and DSS (direct satellite system). New technologies in the entertainment industry also offer alternate forms of leisure-time entertainment or alter the way in which existing forms are delivered, thereby increasing competition.\nOTHER APPLICATIONS FOR OPTICAL LASER TECHNOLOGY\nThe Company, consistent with its commitment to innovative programming, is continually looking to exploit other applications for optical laser technology, ranging from CD-ROM interactive programming to high definition television to video games. In 1990, the Company introduced laserdiscs with interactive programming which enables the consumer to view ancillary materials such as story boards, portions of screenplays, still photographs and behind-the-scenes footage. Future interactive programming may consist of a menu of options, either on screen or in print, enabling the consumer to access and rearrange sequences. The extent to which the Company releases interactive programming will depend upon several factors, including market acceptance and availability of ancillary materials. The Company distributes CD-ROM programming released by The Voyager Company. The Company is aggressively pursuing license rights which, if granted, will enable it to release additional programming in the CD-ROM format.\nThe Company's exploitation of other applications for optical laser technology will depend upon many factors, including the success of its current business and the availability of financing. No assurance exists that other applications of optical laser technology will be exploited by the Company or, if exploited, contribute to profitability.\nTRADEMARKS\nThe Company has received federal registration of the trademark \"IMAGE\" in the United States Patent and Trademark Office. The Company also uses the trademarks \"Vocal Images,\" \"The Music Disc\" and \"The Finest in Laserdiscs\" and the service marks \"Image Post\" and \"Image Creative Group.\"\nEMPLOYEES\nAs of June 1, 1995, the Company had 94 full-time employees. The Company considers its employee relations to be satisfactory.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES. ----------\nThe lease for the company's office space (30,080 square feet) provides for monthly rent of $13,726 (subject to annual adjustment based upon increases in the consumer price index) and will expire on March 31, 2000.\n- -------------------------------------------------------------------------------- 8 Image Entertainment, Inc.\nThe lease for the company's warehouse space (48,300 square feet) provides for monthly rent of $22,039 (subject to annual adjustment based upon increases in the consumer price index) and will expire on March 31, 2000.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS. -----------------\nThe Company is not currently a party to any material legal action.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. ---------------------------------------------------\nNone.\n- -------------------------------------------------------------------------------- Image Entertainment, Inc. 9\nTHE COMPANY'S EXECUTIVE OFFICERS\nExecutive officers serve at the pleasure of the Company's board of directors (the \"Board\"). There are no family relationships between any executive officer or director. The following information sets forth the position and age of the Company's executive officers at June 1, 1995 and their business experience for at least the prior five years:\nEXECUTIVE OFFICER AGE POSITION & BACKGROUND - --------------------------------------------------------------------------------\nMartin W. Greenwald 53 Chairman of the Board, Chief Executive Officer and President since April 1981, and Treasurer since January 1988. Mr. Greenwald's prior experience includes film production services and investment management. Mr. Greenwald is a 1964 graduate of Fairleigh Dickinson University. Since July 1990, Mr. Greenwald has been a director of the Permanent Charities Committee of the Entertainment Industries, an umbrella organization which coordinates charitable contributions from the entertainment industries. Mr. Greenwald is also the 1995 Chairperson of the Laserdisc Association of America.\nCheryl L. Lee 36 Chief Administrative Officer since April 1993 and General Counsel since April 1992; Vice President of Business Affairs from February 1989 to March 1992; prior thereto, Counsel, Theatrical Distribution & Acquisition, Twentieth Century Fox Film Corporation. Ms. Lee received her A.B. degree from Stanford University in 1980 and her J.D. degree from New York University Law School in 1984. Ms. Lee is a member of the California Bar.\nJeff M. Framer 34 Chief Financial Officer since April 1993; Controller from September 1990 to March 1993; Senior Manager, KPMG Peat Marwick, from July 1989 to September 1990; and, Manager, KPMG Peat Marwick, from July 1988 to June 1989. Mr. Framer is a certified public accountant.\nDavid Borshell 30 Senior Vice President, Operations, Sales and Marketing from December 1994; Senior Vice President, Operations, from April 1993 to December 1994; Vice President, Operations, from January 1991 to March 1993; Director of Operations from July 1990 to December 1990; Director of Sales from November 1988 to June 1990; and, Account Executive from February 1986 to November 1988.\n- -------------------------------------------------------------------------------- 10 Image Entertainment, Inc.\n- -------------------------------------------------------------------------------- PART II - --------------------------------------------------------------------------------\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. ---------------------------------------------------------------------\nThe Common Stock is traded over-the-counter (OTC), has been quoted on the National Association of Securities Dealers, Inc. Automated Quotation System (NASDAQ) under the symbol \"DISK\" since February 1988, and has been included on the NASDAQ National Market System (\"NASDAQ\/NMS\") since February 19, 1991. The table below presents the high and low closing prices on the NASDAQ\/NMS. All prices reflect a 1-for-14 6\/7 reverse stock split effected February 8, 1991.\nAs of June 1, 1995 there were 2,064 holders of record of Common Stock. The closing price on that date was $7.22.\nThe Company has never paid a cash dividend on the Common Stock and presently intends to retain any future earnings for business development and debt retirement. In addition, the Company is party to a loan agreement which imposes restrictions on its payment of dividends. See Note 9 to Financial --- Statements.\n- -------------------------------------------------------------------------------- Image Entertainment, Inc. 11\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA. -----------------------\nThe selected financial data presented below was derived from the financial statements of the Company and should be read in conjunction with such financial statements, the notes thereto and the other financial information included herein.\n* Extraordinary item - costs associated with early retirement of debt, net of related taxes of $33,800 and $10,476 for fiscal 1995 and 1994, respectively. ** Includes a nonrecurring pre-tax charge of $10,366,000 equal to $.88 per share, related to the Company's restructuring of its operations.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS ----------------------------------------------------------------------- OF OPERATIONS. -------------\nINSURANCE SETTLEMENTS - BUSINESS INTERRUPTION AND PROPERTY DAMAGE\nOn March 30, 1995, the Company received an $880,000 insurance settlement from its claim of business interruption losses sustained in the January 17, 1994 Northridge earthquake. The settlement resulted in a net gain of $742,390 after the accrual of related expenses and reimbursement of incurred costs. The net gain was reported as other income in the accompanying statement of operations for the year ended March 31, 1995.\nIn June 1994, the Company, under its commercial property insurance policy, received a $7,543,000 insurance settlement from its claim to recover damage and losses to personal property including fixtures, property, inventory and equipment sustained in the Northridge earthquake. The settlement resulted in a net gain of $959,511 after the write-off of the net book value of damaged inventory, fixtures, property and equipment, accrual of related royalties and expenses and reimbursement of incurred costs. The net gain was reported as other income in the accompanying statement of operations for the year ended March 31, 1994.\nThe Company has no further claim with respect to damage and losses sustained in the January 17, 1994 Northridge earthquake.\nMARCH 18, 1993 RESTRUCTURING PLAN\nOn March 18, 1993, the Company's Board of Directors unanimously approved a comprehensive restructuring of the Company's operations. The restructuring plan provided for changes in operational, sales, marketing and production strategies, the prepayment of long-term debt (in part by accelerating the sale of certain inventory at significantly reduced prices) and an overall work force reduction. In fiscal 1995 and 1994, the restructuring positively impacted the Company's cash flow through inventory reductions, reduced operating and interest expense and improved gross margins.\nPursuant to the plan, the Company materially changed its sales strategies, emphasizing the initial release\/growth phase of a title's life cycle in order to take advantage of the marketing dollars often spent by major program suppliers to promote the videocassette release of a title and, in general, the excitement generated by anticipation of a new release. Marketing strategies were similarly refocused on the initial release\/growth phase to further increase awareness of new releases.\nPursuant to the plan, the Company materially changed its production strategies. Prior to the restructuring, the Company's initial manufacturing order for a title generally reflected a supply intended to satisfy demand over the title's full distribution period. After the restructuring, manufacturing orders reflect only that supply which is reasonably necessary to fill demand during the initial release\/growth phase, with incremental, smaller-quantity reorders submitted throughout the remaining maturity\/decline phase of the distribution term on an as needed basis. As a result, on-hand inventory more closely tracks actual sales experience (i.e., explosive initial demand which ---- slowly decreases over time as the title competes with new releases). Although demand for the average title still exists throughout the distribution term, the manufacturing and inventory strategies implemented in the restructuring were intended to result in supply matching near-term demand, thus reducing inventory carrying costs and reducing instances where sales made near the end of a distribution term must be effected at a lower price.\nPursuant to the plan, the Company voluntarily prepaid long-term debt. The Company made voluntary long-term debt prepayments of $2,000,000 during fiscal 1995 (through the date of its November 15, 1994 refinancing - See \"Liquidity and --- Capital Resources\") and scheduled mandatory and voluntary prepayments of $1,000,000 and $5,500,000, respectively, during fiscal 1994. Approximately $650,000 and $2,777,000 of the prepayments during fiscal 1995 and 1994, respectively, were funded by deliberate liquidation of certain inventory. Certain exclusively distributed titles, from all genres, for which inventory\n- -------------------------------------------------------------------------------- Image Entertainment, Inc. 13\nexisted to satisfy demand over the duration of their distribution terms, were targeted for sale over a twelve-month period commencing shortly after the restructuring plan was implemented. The price of the targeted inventory was set at or, in certain cases, below the then-current carrying cost, which such price was intended to result in the sale of substantially all of the inventory by the expiration of the self-imposed twelve-month period. The remaining balance of the targeted inventory at March 31, 1995 is 10,000 units versus 506,000 units at the date the restructuring plan was instituted.\nThe Company's decision to significantly reduce the selling prices of the targeted inventory to encourage sales over a twelve-month period (a shorter time period compared to the Company's typical distribution period) resulted in the write-down of the then-current carrying cost of the targeted inventory and related unamortized production costs and royalty advances to a carrying cost equal to the reduced selling price of such inventory, resulting in an approximate zero gross margin upon future sale. Additionally, royalty advances relating to titles which would not be released or reordered in accordance with the Company's restructured operational strategies were also written-down. The write-downs were accrued as a restructuring charge in the accompanying statement of operations for fiscal 1993.\nThe Company recorded a $10,366,000 pre-tax charge, or $.88 per share, for restructuring costs during the fourth quarter of fiscal 1993. The restructuring charge, by component, is summarized as follows:\nRESULTS OF OPERATIONS\nThe Company recorded all-time high net sales, up 30.5% in fiscal 1995 from fiscal 1994, as well as all-time highs in operating income, income before extraordinary item and net income for the year ended March 31, 1995. Net sales have increased each year in the three-year period ended March 31, 1995 from $59,813,867 in fiscal 1993 to $65,577,813 in fiscal 1994 to $85,590,730 in fiscal 1995. Operating income was up 54.7% to $7,739,799 in fiscal 1995 from $5,002,215 in fiscal 1994. Fiscal 1993 had an operating loss of $14,566,988. Higher net sales, significantly reduced interest expense and net gains on insurance settlements contributed to income before extraordinary item of $7,529,495, or $.51 per share, and $3,738,599, or $.30 per share, for the years ended March 31, 1995 and 1994, respectively, compared to a loss before extraordinary item of $16,975,667, or $1.44 per share, which included a $10,366,000 restructuring charge, for fiscal 1993. Net income increased to $6,310,664, or $.44 per share, for fiscal 1995 from $3,361,064, or $.27 per share, for fiscal 1994, as compared to a net loss of $16,975,667, or $1.44 per share, for fiscal 1993.\nFISCAL YEAR ENDED MARCH 31, 1995 COMPARED TO FISCAL YEAR ENDED MARCH 31, 1994\nNet sales for fiscal 1995 increased 30.5% to $85,590,730 from $65,577,813 for fiscal 1994. Fiscal 1995 net sales benefitted from a strong release schedule which included the aggregate net sales of approximately $17,000,000 from the exclusive release of SNOW WHITE AND THE SEVEN DWARFS, SPEED, ALADDIN, and TRUE LIES and the continued sale of STAR WARS TRILOGY: THE DEFINITIVE COLLECTION. During fiscal 1994, the exclusive release of STAR WARS TRILOGY: THE DEFINITIVE COLLECTION and BEAUTY AND THE BEAST, accounted for approximately $8,000,000 of net sales. Net sales are affected by the popularity of new releases and the current economic environment.\nCost of laserdisc sales for fiscal 1995 increased to $66,773,017 from $50,985,390 for fiscal 1994. As a percentage of net sales, cost of laserdisc sales for fiscal 1995 increased to 78.0% from 77.7% in fiscal 1994. The sales mix of higher-margin exclusive product and lower-margin nonexclusive product and\n- -------------------------------------------------------------------------------- 14 Image Entertainment, Inc.\nthe margins within each category have a direct effect on these percentages and vary with the availability and popularity of titles and the Company's marketing emphasis. Lower margin nonexclusive product sales accounted for 9.4% and 10.5% of net sales for fiscal 1995 and 1994, respectively. During fiscal 1995, sales of salvaged inventory, retained as part of the June 1994 insurance settlement relating to the January 17, 1994 Northridge earthquake, decreased cost of laserdisc sales as a percentage of net sales to 78.0% from 79.0%. Cost of laserdisc sales as a percentage of net sales for fiscal 1995 was also impacted by selling certain slower moving inventory at reduced prices, in the ordinary course of business, not specifically targeted in the Company's March 1993 restructuring. Fiscal 1995 restructuring-targeted inventory sales had an immaterial effect on cost of laserdisc sales as a percentage of net sales.\nSelling expenses increased to $4,002,482 for fiscal 1995 from $3,113,131 for fiscal 1994; however, as a percentage of net sales, selling expenses were 4.7% in fiscal 1995 and 1994. Fiscal 1995 saw improvements in and expanded circulation of the Company's monthly Image Laserdisc Preview magazine, increased advertising in trade magazines, and the Company's introduction of a 2-day air shipping program.\nGeneral and administrative expenses increased 10.1% to $4,025,822 for fiscal 1995 from $3,657,082 for fiscal 1994; however, as a percentage of net sales, general and administrative expenses decreased to 4.7% for fiscal 1995 from 5.6% for fiscal 1994. Fiscal 1995 saw an increase in the allowance for doubtful accounts, higher depreciation expense related to the addition of the creative services\/ computer graphics department's digital pre-press system and higher employee and executive performance-based bonuses.\nAmortization of production costs increased 8.1% to $3,049,610 for fiscal 1995 from $2,819,995 for fiscal 1994; however, as a percentage of net sales, amortization of production costs decreased to 3.6% for fiscal 1995 from 4.3% for fiscal 1994. Amortization of production costs is a function of the timing and number of Image exclusive titles placed into production. The Company has not seen a trend toward higher per title production costs.\nInterest expense and amortization of deferred financing costs together decreased 50.3% to $1,295,649 for fiscal 1995 from $2,606,145 for fiscal 1994. The reduction in interest expense and amortization of deferred financing costs resulted from the fiscal 1995 and 1994 prepayments of debt and the November 1994 refinancing described in \"Liquidity and Capital Resources.\"\nExtraordinary item - costs associated with early retirement of debt of $1,218,831, net of related taxes of $33,800 for fiscal 1995, resulted from the July 1994 prepayment and the November 1994 refinancing described in \"Liquidity and Capital Resources\" and is composed of prepayment penalties and amortization of deferred financing costs and discount of debt issuance, accelerated as a result of the early retirement ($759,138 of the extraordinary charge represents noncash charges). The extraordinary charge of $377,535, net of related taxes of $10,476, for fiscal 1994 resulted from voluntary prepayments of debt and is composed of prepayment penalties and noncash charges of $263,011 in accelerated amortization of deferred financing costs.\nFISCAL YEAR ENDED MARCH 31, 1994 COMPARED TO FISCAL YEAR ENDED MARCH 31, 1993\nNet sales for fiscal 1994 increased 9.6% to $65,577,813 from $59,813,867 for fiscal 1993. Fiscal 1994 net sales benefitted from a strong release schedule of higher-margin exclusive programming including the exclusive release of two blockbuster titles: STAR WARS TRILOGY: THE DEFINITIVE COLLECTION and BEAUTY AND THE BEAST. Net sales are affected by the popularity of new releases and the current economic environment.\nCost of laserdisc sales for fiscal 1994 decreased to $50,985,390 from $52,036,255 for fiscal 1993. As a percentage of net sales, cost of laserdisc sales for fiscal 1994 decreased to 77.7% from 87.0% in fiscal 1993. Lower- margin nonexclusive product sales accounted for 10.5% of net sales in fiscal 1994,\n- -------------------------------------------------------------------------------- Image Entertainment, Inc. 15\nsubstantially down from 18.9% in fiscal 1993. The sales mix of higher-margin exclusive product and lower-margin nonexclusive product varies with the availability and popularity of titles and the Company's marketing emphasis. Fiscal 1993 included a fourth quarter accrual of $3,400,000 for estimated unrecouped minimum royalty guarantees payable through the term of an exclusive license agreement.\nFiscal 1994 cost of sales as a percentage of net sales was negatively affected by sales of inventory targeted for liquidation in accordance with the March 18, 1993 restructuring plan. The targeted inventory was sold at a price approximating its written-down cost, effectively at a gross profit margin equal to zero. The following table reflects the Company's fiscal 1994 quarterly and annual net sales of the targeted inventory and cost of laserdisc sales as a percentage of net sales with and without the effect of selling the targeted inventory at a price equal to its written-down cost (all other measurable effects of the restructuring on the gross profit margin are not material):\nThe reduction in quarterly gross margins ranged from .5% to 2.0% depending upon the level of quarterly restructuring targeted inventory net sales.\nThe March 1994 quarter included net returns of the targeted inventory. Due to damage sustained in the January 17, 1994 Northridge earthquake, the Company was unable to access and sell the targeted inventory from January 17, 1994 to March 31, 1994. At March 31, 1994, the Company had approximately 70,000 units of undamaged, targeted inventory. See aforementioned \"Insurance --- Settlements - Business Interruption and Property Damage.\"\nSelling expenses for fiscal 1994 decreased to $3,113,131 from $5,125,916 for fiscal 1993, due to reduction in work force levels, related payroll costs, advertising and other sales and marketing expenditures in accordance with the March 18, 1993 restructuring plan. As a percentage of net sales, selling expenses decreased to 4.7% for fiscal 1994 from 8.6% for fiscal 1993.\nGeneral and administrative expenses for fiscal 1994 decreased 4.5% to $3,657,082 from $3,828,103 for fiscal 1993, due to reductions in work force levels, related payroll costs and professional fees in accordance with the March 18, 1993 restructuring plan offset, in part, by payment and accrual of fiscal 1994 employee and executive performance bonuses totaling $413,000 (employee and executive bonuses for fiscal 1993 were minimal). As a percentage of net sales, general and administrative expenses decreased to 5.6% in fiscal 1994 from 6.4% in fiscal 1993.\nAmortization of production costs for fiscal 1994 decreased 6.8% to $2,819,995 from $3,024,581 for fiscal 1993. Amortization of production costs is a function of the timing and number of Image exclusive titles placed into production. The decrease in amortization results from the reduction in unamortized production costs effected in the restructuring, partially offset by accelerated amortization rates set in accordance with the restructuring plan.\nInterest expense for fiscal 1994 decreased 7.7% to $2,335,894 from $2,531,729 for fiscal 1993. The reduction in interest expense resulted from the fiscal 1994 prepayments of debt described in \"Liquidity and Capital Resources.\"\n- -------------------------------------------------------------------------------- 16 Image Entertainment, Inc.\nAmortization of deferred financing costs of $270,251 and $315,631 for fiscal 1994 and 1993, respectively, is attributable to the warrants and costs relating to the Company's November 1991 financing. The reduction in amortization resulted from the fiscal 1994 prepayments of debt described in \"Liquidity and Capital Resources.\"\nExtraordinary item - costs associated with early retirement of debt of $377,535, net of related taxes of $10,476, resulted from the fiscal 1994 voluntary prepayments of debt described in \"Liquidity and Capital Resources\" and is composed of $125,000 in prepayment penalties and noncash charges of $263,011 in accelerated amortization of deferred financing costs.\nACCOUNTING POLICIES\nThe Company's earnings are significantly affected by accounting policies required for the entertainment industry. The costs to produce licensed laserdisc programming (the \"Production Costs\") are capitalized as incurred. Pursuant to the income forecast method, as discussed in Financial Accounting Standards Board Statement No. 53, a percentage of the Production Costs is charged to expense each month based upon (i) a projected revenue stream resulting from distribution of new and previously released laserdisc programming related to the Production Costs and (ii) management's estimate of the ultimate net realizable value of the Production Costs. Production Costs include the cost of converting film prints or tapes into the laserdisc format, jacket artwork costs and the overhead of the Company's creative services\/computer graphics and production departments. Estimates of future revenues are reviewed periodically and amortization of Production Costs is adjusted accordingly. If estimated future revenues are not sufficient to recover the unamortized balance of Production Costs, such costs are reduced to estimated net realizable value.\nRoyalty and distribution fee advances represent fixed minimum payments made to licensors for laserdisc programming distribution rights. A licensor's share of program distribution revenues is retained by the Company until the share equals the advance(s) paid to the licensor. Thereafter, any excess is paid to the licensor. In the event of an excess, the Company records, as a cost of laserdisc sales, an amount equal to the licensor's share of the distribution revenues. Royalty and distribution fee advances are charged to operations as revenues are earned, and are stated at the lower of unamortized cost or estimated net realizable value on an individual-title or license-agreement basis.\nINFLATION\nManagement believes that inflation is not a material factor in the operation of the Company's business at this time.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company's working capital requirements vary primarily with the level of its licensing, production and distribution activities. The principal uses of working capital are for program licensing costs (i.e., royalty payments, ---- including advances, to program suppliers), distribution fee advances, manufacturing and production costs, costs of acquiring finished product for wholesale distribution, principal and interest payments on long-term debt and selling, general and administrative expenses. Working capital requirements increase as licensing and distribution activities increase. Working capital has historically been provided by private sales of common stock, notes representing long-term debt, bank borrowings and cash flow from operations. For fiscal 1995, operating activities provided cash of $11,015,346, investing activities provided cash of $3,632,857 and financing activities used cash of $14,816,789, resulting in a net decrease in cash and cash equivalents of $168,586.\nTo refinance its existing long-term debt and gain borrowing flexibility to maintain growth, on November 15, 1994, the Company entered into a Loan and Security Agreement with Foothill Capital Corporation, an asset-based lender. The agreement provides for revolving advances and the issuance of\n- -------------------------------------------------------------------------------- Image Entertainment, Inc. 17\nand guaranty of standby letters of credit under a $14,250,000 revolving credit facility and a series of term loans under a $750,000 capital expenditure term loan facility. The term of the agreement is three years, renewable automatically thereafter for successive one-year periods.\nBorrowings under the agreement are secured by substantially all of the Company's assets and bear interest at the highest prime rate of three reference banks plus 1.5% (10.5% at March 31, 1995), payable monthly. Funds available for borrowing under the credit facility may not exceed the borrowing base specified in the agreement. At March 31, 1995, the Company had no borrowings outstanding under the revolving credit and term loan facilities and had borrowing availability of $7,172,000 and $750,000, respectively. The agreement requires the Company to comply with certain financial and operating covenants. At March 31, 1995, the Company was in compliance with all covenants.\nConcurrent with funding of the revolving credit facility, the Company immediately retired $11,500,000 of long-term debt representing the outstanding balance of the November 18, 1991 private placement.\nOn January 16, 1995, the Company's Board of Directors announced approval of a stock repurchase program authorizing the Company to buy up to one million shares of its outstanding common stock. Purchases will be made from time to time in open market and\/or privately negotiated transactions based on current market conditions and other factors. Since the announcement and through March 31, 1995, the Company has repurchased 254,800 shares of its common stock for $1,868,481.\nAt March 31, 1995, the Company had license obligations for royalty advances and minimum guarantees and exclusive distribution fee obligations for minimum guarantees of approximately $6,325,000 during fiscal 1996, $4,033,000 during fiscal 1997, $4,422,000 during fiscal 1998, $4,678,000 during fiscal 1999 and $2,627,000 during fiscal 2000. These advances and guarantees are recoupable against royalties and distribution fees earned by the licensors and program suppliers, respectively. Depending upon the competition for license and exclusive distribution rights, the Company may have to pay increased advances, guarantees and\/or royalty rates in order to acquire or retain such rights in the future.\nAt March 31, 1995, the Company had $2,990,000 of outstanding letters of credit of which $990,000 and $2,000,000 were issued and guaranteed, respectively, by the Company's lender and expire on November 15, 1995. These letters of credit secure balances due to program suppliers.\nManagement believes its internal and external sources of funding are adequate to meet anticipated needs.\nRECENT ACQUISITION\nEffective June 8, 1995, the Company, through its newly created wholly owned subsidiary, acquired and assumed substantially all of the assets and liabilities, respectively, of V.T. Laser, Inc., a privately held New Jersey based corporation doing business as \"U.S. Laser Video Distributors\" (\"U.S. Laser\"), for a purchase price of approximately $3.1 million in cash. The transaction was funded through operating cash flow and borrowings under the Company's revolving credit facility. This acquisition will be accounted for as a purchase in the Company's first quarter ending June 30, 1995. U.S. Laser is a nonexclusive distributor of optical disc programming and the publisher of LASERVIEWS: America's Laser Disc Magazine, a bimonthly consumer periodical focusing on product announcements, software reviews and articles of general interest to the laserdisc consumer, and D.I.S.C.: Dealer's Interactive Software Companion, a dealer-oriented multimedia publication. U.S. Laser has been in the laserdisc distribution business since 1985 and will continue to operate on a business as usual basis out of its New Jersey offices.\n- -------------------------------------------------------------------------------- 18 Image Entertainment, Inc.\nSUMMARY AND OUTLOOK\nThe financial condition of the Company has strengthened considerably since the March 18, 1993 Restructuring Plan was implemented. In the two years following implementation, Company operations have provided strong positive cashflow, which along with approximately $3.4 million from sales of restructuring-targeted inventory, have afforded the Company the ability to retire $20 million in long-term debt and embark on a stock buy back program. At March 31, 1995, the Company was debt free excluding accounts payable and accrued royalties and expenses.\nThe Company continues to aggressively license new programming for laserdisc distribution as well as renew and extend relationships with existing studios as distribution and or license agreements mature. The Company believes the laserdisc industry will continue its growth through the turn of the century.\nIn addition to its laserdisc licensing and distribution, the Company continues to seek investment opportunities in growth oriented companies which would be complementary to the Company's existing operations such as proprietary content production or software distribution businesses. Should additional suitable investment opportunities arise that would require funds in excess of those provided by operations and availability under the Company's revolving credit facility, additional financing sources may be sought.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. -------------------------------------------\n- -------------------------------------------------------------------------------- Image Entertainment, Inc. 19\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Shareholders Image Entertainment, Inc.:\nWe have audited the accompanying financial statements of Image Entertainment, Inc., as listed in the accompanying index. In connection with our audits of the financial statements, we also have audited the accompanying 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 Image Entertainment, Inc. as of March 31, 1995 and 1994 and the results of its operations and its cash flows for each of the years in the three-year period ended March 31, 1995 in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.\nKPMG PEAT MARWICK LLP\nLos Angeles, California June 6, 1995, except for Note 14, which is as of June 8, 1995.\n- -------------------------------------------------------------------------------- 20 Image Entertainment, Inc.\nBALANCE SHEETS\nMARCH 31, 1995 AND 1994\n================================================================================\nASSETS\nSee accompanying notes to financial statements.\n- -------------------------------------------------------------------------------- Image Entertainment, Inc. 21\nBALANCE SHEETS\nMARCH 31, 1995 AND 1994\n================================================================================\nLIABILITIES AND SHAREHOLDERS' EQUITY\nSee accompanying notes to financial statements.\n- -------------------------------------------------------------------------------- 22 Image Entertainment, Inc.\nSTATEMENTS OF OPERATIONS\nFOR THE YEARS ENDED MARCH 31, 1995, 1994 AND 1993\n================================================================================\nSee accompanying notes to financial statements.\n- -------------------------------------------------------------------------------- Image Entertainment, Inc. 23\nSTATEMENTS OF SHAREHOLDERS' EQUITY (NOTES 10 AND 11)\nFOR THE YEARS ENDED MARCH 31, 1995, 1994 AND 1993\n================================================================================\nSee accompanying notes to financial statements.\nSTATEMENTS OF CASH FLOWS\nFOR THE YEARS ENDED MARCH 31, 1995, 1994 AND 1993\n================================================================================\nSee accompanying notes to financial statements.\n- -------------------------------------------------------------------------------- Image Entertainment, Inc. 25\nSTATEMENTS OF CASH FLOWS (CONT'D.)\nFOR THE YEARS ENDED MARCH 31, 1995, 1994 AND 1993\n================================================================================\nSee accompanying notes to financial statements.\n- -------------------------------------------------------------------------------- 26 Image Entertainment, Inc.\nSTATEMENTS OF CASH FLOWS (CONT'D.)\nFOR THE YEARS ENDED MARCH 31, 1995, 1994 AND 1993\n================================================================================\nSUPPLEMENTAL DISCLOSURES OF NONCASH OPERATING, INVESTING AND FINANCING ACTIVITIES:\nFully amortized production costs removed from production costs totaled $3,208,593 and $2,985,897 at March 31, 1995 and 1994, respectively.\nCapital expenditures for the year ended March 31, 1994 excludes $204,053 of property and equipment destroyed in the January 17, 1994 Northridge earthquake and reimbursed under the insurance settlement. See Note 3 to the financial --- statements for additional information.\nCapital lease obligations totaling approximately $394,000 were incurred during the fiscal year ended March 31, 1993. There were no capital lease obligations incurred during fiscal years ended March 31, 1995 and 1994.\nSee accompanying notes to financial statements.\n- -------------------------------------------------------------------------------- Image Entertainment, Inc. 27\nNOTES TO FINANCIAL STATEMENTS - --------------------------------------------------------------------------------\nNOTE 1. ORGANIZATION AND BUSINESS.\nImage Entertainment, Inc. (the \"Company\") was incorporated in Colorado on April 1, 1975. In November 1989, the Company reincorporated in California. The Company's primary business is the distribution of programming on laserdisc under exclusive and nonexclusive license and wholesale distribution agreements.\nNOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES.\nCash and Cash Equivalents - -------------------------\nThe Company considers all highly liquid investments purchased with maturities of three months or less to be cash equivalents.\nShort-Term Investments - ----------------------\nShort-term investments at March 31, 1994 consist of liquid investments purchased with original maturities between three and twelve months. Certain short-term investments secured outstanding letters of credit at March 31, 1994.\nEffective April 1, 1994, the Company adopted the provisions of Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" Under Statement No. 115, the Company has classified its short-term investments as available-for-sale. Available-for-sale securities are stated at market value and unrealized holding gains and losses, net of the related tax effect, are excluded from earnings and are reported as a separate component of shareholders' equity until realized. A decline in the market value of the security below cost that is deemed other than temporary is charged to earnings resulting in the establishment of a new cost basis for the security.\nSince the market value of short-term investments approximates cost as of April 1, 1994 the application of Statement No. 115 did not have material effect on the Company's financial statements. Net unrealized gains and losses on available- for-sale securities for fiscal 1995 were not material.\nAccounts Receivable - -------------------\nAt March 31, 1995 and 1994, the allowance for doubtful accounts was $200,000 and $168,570, respectively, and the allowance for sales returns was $2,500,000 and $4,075,000, respectively.\nThe Company discontinued selling product to a video tape distributor at the close of fiscal 1994 to maintain better control over distribution of product and eliminate any duplication of efforts. As a result, the allowance for sales returns at March 31, 1994 includes approximately $1,300,000, representing the Company's buy back of the distributor's inventory of Company product at wholesale sales value, less a restocking fee.\nRevenue Recognition - -------------------\nRevenue is recognized upon shipment. The Company's return policy allows customers to return a percentage of laserdiscs purchased on a quarterly basis. This allowance is non-cumulative and is based on the customer's prior-quarter purchases and is limited on an individual-title basis. The Company provides for estimated returns when product is shipped to customers.\n- -------------------------------------------------------------------------------- 28 Image Entertainment, Inc.\nNOTES TO FINANCIAL STATEMENTS - --------------------------------------------------------------------------------\nMajor Customers - ---------------\nNo customers individually accounted for 10% or more of fiscal 1995 and 1994 net sales. One customer accounted for 10% of 1993 net sales.\nDepreciation and Amortization of Property, Equipment and Improvements - ---------------------------------------------------------------------\nDepreciation of property and equipment is provided for using the straight-line method over the estimated useful lives of the related assets, generally five years. Leasehold improvements are amortized over the shorter of the estimated useful life of the improvements or the remaining lease term. Assets acquired under capitalized leases are amortized over the life of the lease. The cost of repairs and maintenance is charged to operations when incurred.\nIncome Taxes - ------------\nThe Company accounts for income taxes pursuant to the provisions of Financial Accounting Standards Board Statement No. 109. Under the asset and liability method of Statement No. 109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and the future tax benefits derived from operating loss and tax credit carryforwards.\nFourth Quarter Adjustments - --------------------------\nDuring the fourth quarter of fiscal 1995 and 1994, the Company recorded a net gain on insurance settlement of claims of business interruption and property damage, respectively, related to the January 17, 1994 Northridge earthquake of $742,390 and $959,511, respectively. See Note 3 to the financial statements. ---\nDuring the fourth quarter of fiscal 1993, the Company recorded adjustments aggregating approximately $13,766,000 as a charge to operations. The adjustments are composed of a $3,400,000 accrual for estimated unrecouped minimum royalty guarantees payable through the term of an exclusive license agreement and $10,366,000 in restructuring charges described in Note 4 to the financial statements.\nReclassifications - -----------------\nCertain fiscal 1994 and 1993 balances have been reclassified to conform with the fiscal 1995 presentation.\nFair Value of Financial Instruments - -----------------------------------\nCarrying amounts approximate fair value due to the relatively short maturity of such instruments.\nNOTE 3. INSURANCE SETTLEMENTS - BUSINESS INTERRUPTION AND PROPERTY DAMAGE.\nOn March 30, 1995, the Company received an $880,000 insurance settlement from its claim of business interruption losses sustained in the January 17, 1994 Northridge earthquake. The settlement resulted in a net gain of $742,390 after the accrual of related expenses and reimbursement of incurred costs. The net gain was reported as other income in the accompanying statement of operations for the year ended March 31, 1995.\nIn June 1994, the Company received a $7,543,000 insurance settlement from its claim to recover damage and losses to personal property including fixtures, property, inventory and equipment sustained in the\n- -------------------------------------------------------------------------------- Image Entertainment, Inc. 29\nNOTES TO FINANCIAL STATEMENTS - --------------------------------------------------------------------------------\nNorthridge earthquake. Of the settlement, $1,000,000 was received in February 1994 and the remaining $6,543,000 was received in June 1994. The settlement resulted in a net gain of $959,511 after the write-off of the net book value of damaged inventory, fixtures, property and equipment, accrual of related royalties and expenses and reimbursement of incurred costs. The net gain was reported as other income in the accompanying statement of operations for the year ended March 31, 1994.\nThe Company has no further claim with respect to damage and losses sustained in the January 17, 1994 Northridge earthquake.\nNOTE 4. MARCH 18, 1993 RESTRUCTURING PLAN.\nOn March 18, 1993, the Company's Board of Directors unanimously approved a comprehensive restructuring of the Company's operations. The restructuring plan provided for changes in operational, sales, marketing and production strategies, the prepayment of long-term debt (in part by accelerating the sale of certain inventory at significantly reduced prices) and an overall work force reduction.\nPursuant to the plan, the Company voluntarily prepaid long-term debt. The Company made voluntary long-term debt prepayments of $2,000,000 during fiscal 1995 (through the date of its November 15, 1994 refinancing - See Note 9 to the --- financial statements) and scheduled mandatory and voluntary prepayments of $1,000,000 and $5,500,000, respectively, during fiscal 1994. Approximately $650,000 and $2,777,000 of the prepayments during fiscal 1995 and 1994, respectively, were funded by deliberate liquidation of certain inventory. Certain exclusively distributed titles, from all genres, for which inventory existed to satisfy demand over the duration of their distribution terms, were targeted for sale over a twelve-month period commencing shortly after the restructuring plan was implemented. The Company's decision to significantly reduce the selling prices resulted in the write-down of the then-current carrying cost of the targeted inventory and related unamortized production costs and royalty advances to a carrying cost equal to the reduced selling price of such inventory, resulting in an approximate zero gross margin upon future sale. Additionally, royalty advances relating to titles which would not be released or reordered in accordance with the Company's restructured operational strategies were also written-down. The write-downs were accrued as a restructuring charge in the accompanying statement of operations for fiscal 1993.\nThe Company recorded a $10,366,000 pre-tax charge, or $.88 per share, for restructuring costs during the fourth quarter of fiscal 1993. The restructuring charge, by component, is summarized as follows:\nThe remaining balance of the targeted inventory at March 31, 1995 was 10,000 units versus 506,000 units at the date the restructuring plan was instituted.\nNOTE 5. NET INCOME (LOSS) PER SHARE.\nNet income per share was based on the weighted average number of common shares and common share equivalents (e.g., options and warrants), if dilutive, outstanding for each of the periods presented. The amount of dilution to be reflected in net income per share was computed by application of the treasury stock method. In periods where the amount of common stock issuable if all options and warrants are deemed exercised exceeds 20% of the total shares outstanding at the end of the period, the treasury\n- -------------------------------------------------------------------------------- 30 Image Entertainment, Inc.\nNOTES TO FINANCIAL STATEMENTS - --------------------------------------------------------------------------------\nstock method was modified, as required by Accounting Principles Board Opinion No. 15, to adequately reflect the dilutive effect of options and warrants on net income per share. Under the modified treasury stock method, net income per share data were computed as if all outstanding options and warrants were exercised at the beginning of the period (or on the issuance date, if issued during the period) and as if the funds obtained thereby were applied as follows: first to repurchase up to 20% of the outstanding shares at the average market price during the period, then any remaining proceeds are applied to reduce long-term debt and, if any proceeds remain thereafter, such proceeds are applied to invest in U.S. government securities. If the result of the foregoing application of proceeds has an aggregate dilutive effect on net income per share, the net income per share calculation must reflect the shares issuable upon the assumed exercise of options and warrants, net of the assumed repurchase of shares, and adjustments to net income resulting from the assumed application of proceeds. If, on the other hand, the aggregate effect is anti-dilutive, common share equivalents and adjustments to net income resulting from the assumed application of proceeds are excluded from the calculation of net income per share.\nThe effects of the application of the modified treasury stock method were included in determining net income per share for the year ended March 31, 1995 and were excluded from the per share amounts for the years ended March 31, 1994 and 1993.\nFully diluted net income per share was not presented since the amounts do not differ significantly from the primary net income per share.\nThe following table sets forth the calculation of net income (loss) per share for the years ended March 31, 1995, 1994 and 1993:\n- -------------------------------------------------------------------------------- Image Entertainment, Inc. 31\nNOTES TO FINANCIAL STATEMENTS - --------------------------------------------------------------------------------\nNOTE 6. INVENTORIES.\nInventories at March 31, 1995 and 1994 are summarized as follows:\nLaserdisc inventory consists of finished laserdiscs for sale and is stated at the lower of average cost or market.\nRoyalty and distribution fee advances represent fixed minimum payments made to licensors for laserdisc programming distribution rights. A licensor's share of program distribution revenues is retained by the Company until the share equals the advance(s) paid to the licensor. Thereafter, any excess is paid to the licensor. In the event of an excess, the Company records, as a cost of laserdisc sales, an amount equal to the licensor's share of the distribution revenues. Royalty and distribution fee advances are charged to operations as revenues are earned and are stated at the lower of unamortized cost or estimated net realizable value on an individual-title or license-agreement basis.\nThe costs to produce licensed laserdisc programming include the cost of converting film prints or tapes into the laserdisc format, jacket artwork costs and the overhead of the Company's creative services\/computer graphics and production departments. The Company amortizes its capitalized production costs in accordance with the provisions of Statement of Financial Accounting Standards No. 53. Pursuant to the income forecast method, a percentage of the production costs is charged to expense each month based upon (i) a projected revenue stream resulting from distribution of new and previously released laserdisc programming related to the production costs and (ii) management's estimate of the ultimate net realizable value of the production costs. Estimates of future revenues are reviewed periodically and amortization of production costs is adjusted accordingly. If estimated future revenues are not sufficient to recover the unamortized balance of production costs, such costs are reduced to the estimated net realizable value. Production costs are net of accumulated amortization of $4,838,547 and $5,030,756 at March 31, 1995 and 1994, respectively. The Company expects to amortize substantially all of the March 31, 1995 production costs through fiscal 1997.\nNOTE 7. NOTES RECEIVABLE - SALE OF CERTAIN ASSETS.\nOn December 31, 1990, the Company sold assets relating to its licensing and distribution of adult programming on laserdisc (the \"Assets\") for $3,828,600. The Assets included inventory, jackets, artwork, laserdisc masters and submasters, copyrights and contract rights, but excluded accounts receivable. The buyer agreed to assume certain obligations related to the Assets.\nPayment for the Assets consisted of $300,000 cash, a $1,328,600 note (\"Note A\") and a $2,200,000 note (\"Note B\").\nNote A bears annual interest of 10%, payable monthly. Two principal payments of $82,700 each were received in February and March 1991. Two final principal payments of $581,600 each are due in December 1995 and December 1996. Principal prepayments may be required pursuant to a formula set forth in the note. The note is secured by the Assets and certain other assets of the buyer acquired after December 31, 1990.\n- -------------------------------------------------------------------------------- 32 Image Entertainment, Inc.\nNOTES TO FINANCIAL STATEMENTS - --------------------------------------------------------------------------------\nPrincipal and interest on Note B, which is unsecured, are payable as follows: until the principal is repaid, the buyer will pay the Company, by the 60th day following December 31, 1991 and each subsequent six-month period ending June 30 and December 31, an amount, if any, pursuant to a formula set forth in the note. Each amount paid, discounted to its present value at an annual rate of 11% compounded monthly from the date of payment to December 31, 1990, is credited against principal and the remainder is credited as interest. The buyer made principal payments totaling $202,351 and $108,549 during fiscal years ended March 31, 1995 and 1994, respectively. Currently, only one company manufactures adult programming on laserdisc. If that company ceases to manufacture such programming under certain circumstances, and the buyer is unable to secure replacement manufacturing within a specified period, Notes A and B will be canceled and the buyer will assign to the Company the Assets and other assets then owned by the buyer (except for cash, inventory and accounts receivable).\nThe sale resulted in a gain, before applicable income taxes (if any), of $2,626,450. Recognition of the gain is deferred until the net book value of the Assets is recovered through principal repayment under Notes A and B and the $300,000 down payment. Once the net book value of the Assets is recovered, the gain will be recognized as cash payments under Notes A and B are received. In the accompanying balance sheets at March 31, 1995 and 1994, the Notes A and B plus a note receivable from a related party are presented as follows:\nNOTE 8. PROPERTY, EQUIPMENT AND IMPROVEMENTS.\nProperty, equipment and improvements, stated at cost, at March 31, 1995 and 1994 are summarized as follows:\nDepreciation and amortization of property, equipment and improvements was $795,580, $623,777, and $523,303 for fiscal 1995, 1994, and 1993, respectively.\n- -------------------------------------------------------------------------------- Image Entertainment, Inc. 33\nNOTES TO FINANCIAL STATEMENTS - --------------------------------------------------------------------------------\nNOTE 9. REVOLVING CREDIT AND TERM LOAN FACILITY.\nOn November 15, 1994, the Company entered into a Loan and Security Agreement with Foothill Capital Corporation, an asset-based lender. The agreement provides for revolving advances and the issuance of and guaranty of standby letters of credit under a $14,250,000 revolving credit facility and a series of term loans under a $750,000 capital expenditure term loan facility. The term of the agreement is three years, renewable automatically thereafter for successive one-year periods.\nBorrowings under the agreement are secured by substantially all of the Company's assets and bear interest at the highest prime rate of three reference banks plus 1.5% (10.5% at March 31, 1995), payable monthly. Funds available for borrowing under the credit facility may not exceed the borrowing base specified in the agreement. At March 31, 1995, the Company had no borrowings outstanding under the revolving credit and term loan facilities and had borrowing availability of $7,172,000 and $750,000, respectively. The Agreement requires the Company to comply with certain financial and operational covenants. At March 31, 1995, the Company was in compliance with all covenants.\nConcurrent with funding of the revolving credit facility, the Company immediately retired $11,500,000 of long-term debt representing the outstanding balance of the November 18, 1991 private placement. The accelerated amortization of deferred financing costs and discount on debt issuance and penalties resulting from the early retirement of debt totaled $1,218,831 and $377,535 for the fiscal years ending March 31, 1995 and 1994, respectively, of which $759,138 and $263,011, respectively, represent noncash charges. The extraordinary charges are recorded net of taxes of $33,800 and $10,476 for fiscal 1995 and 1994, respectively.\nFor the years ended March 31, 1995, 1994 and 1993, amortization of the lender's and investment banker's warrants issued in connection with the 1991 private placement, excluding amortization accelerated as a result of the early retirement of this debt, totaled $82,799, $144,283 and $156,870, respectively. Amortization of the lender's and investment banker's warrants were recorded as interest expense and amortization of deferred financing costs, respectively, in the accompanying statements of operations.\nNOTE 10. PROGRAM ACQUISITION AGREEMENTS AND ASSOCIATED WARRANTS.\nOn December 22, 1992, the Company entered into a five-year license agreement with New Line Home Video, Inc. (\"New Line\") for the replication, marketing and exclusive distribution of programming on laserdisc in the United States and Canada. In connection with the agreement, New Line was issued a warrant to purchase 500,000 shares of the Company's common stock at $6.30 per share. The warrant is exercisable until December 31, 1997. The estimated fair market value of the warrant at the date of issuance and associated costs, aggregating $487,500, have been recorded in shareholders' equity as stock warrants.\nOn July 1, 1992, the Company entered into a four-year videodisc purchase and distribution agreement with Twentieth Century Fox Home Entertainment (formerly FoxVideo, Inc.) for the marketing and exclusive distribution of programming on laserdisc in the United States and Canada. In connection with the agreement, Twentieth Century Fox Film Corporation, parent of Twentieth Century Fox Home Entertainment, was issued a warrant to purchase 1,671,760 shares of the Company's common stock at $6.00 per share. The warrant vested as to 25% of the shares on July 1, 1992 and the balance vests equally over the next three years, subject to deferral and\/or acceleration of vesting under certain circumstances. The warrant is exercisable until June 30, 1996; however, as to any deferred- vested shares, the warrant is exercisable only from January 1, 2000 to January 5, 2000. The estimated fair market value of the warrant at the date of issuance and associated costs, aggregating $315,917, have been recorded in shareholders' equity as stock warrants.\n- -------------------------------------------------------------------------------- 34 Image Entertainment, Inc.\nNOTES TO FINANCIAL STATEMENTS - --------------------------------------------------------------------------------\nOn November 26, 1991, the Company entered into a four-year license agreement with Buena Vista Home Video for the replication, marketing and exclusive distribution of Walt Disney, Touchstone, Hollywood Pictures and Buena Vista Home Video programming on laserdisc in the United States and Canada. In connection with the agreement, The Walt Disney Company, parent of Buena Vista Home Video, was issued a warrant to purchase 1,671,760 shares of the Company's common stock at $6.00 per share. The warrant vested as to 25% of the shares on January 1, 1992 and the balance vests equally over the next three years, subject to deferral and\/or acceleration of vesting under certain circumstances. The warrant is exercisable until December 31, 1996; however, as to any deferred- vested shares, the warrant is exercisable only from January 1, 2000 to January 5, 2000. The estimated fair market value of the warrant at the date of issuance and associated costs, aggregating $774,566, have been recorded in shareholders' equity as stock warrants.\nThe value of all of the aforementioned warrants and issuance costs are amortized ratably over the term of the agreements. Amortization for the years ended March 31, 1995 and 1994 totaled $348,605 each, and $255,735 for the year ended March 31, 1993, and was recorded as cost of laserdisc sales in the accompanying statements of operations.\nNOTE 11. STOCK OPTIONS AND WARRANTS.\nThe Company has three employee stock option plans. Incentive stock options may be granted under one plan, and incentive stock options and nonstatutory options under the other two. Under the plans, the exercise price of an incentive stock option may not be less than the fair market value of the common stock on the date of grant. The exercise price of a nonstatutory option generally may not be less than 85% of the fair market value on the date of grant. The term of an option may be no more than 10 years from the date of grant. In addition to options under the three employee plans, the Company has granted options (including the antidilution rights described below and the warrants described in Notes 9 and 10) to officers, shareholders, creditors and others for various business purposes.\nStock option transactions for the three years ended March 31, 1995 are as follows:\n- -------------------------------------------------------------------------------- Image Entertainment, Inc. 35\nNOTES TO FINANCIAL STATEMENTS - --------------------------------------------------------------------------------\nOf the options reflected as outstanding on March 31, 1995 and 1994, options to purchase 6,602,611 and 6,850,254 shares of common stock were exercisable, respectively.\nA December 29, 1987 stock purchase agreement (the \"Agreement\") provides for the grant of antidilution rights (the \"Rights\") to various persons (the \"Investors\"). Each Investor is entitled to Rights in connection with certain issuances of common stock.\nUpon the exercise of certain options outstanding as of December 29, 1987 (the \"Management Options\"), each Investor will be granted Rights to purchase shares of common stock pursuant to a formula based in part on the percentage of the outstanding shares of common stock owned by the Investor on December 29, 1987. Rights to purchase an aggregate of 522,135 shares of common stock may be granted to the Investors if all the Management Options are exercised. As of March 31, 1995, Rights to purchase 449,878 shares had been granted, Rights to purchase 223,115 shares had been exercised (as to 12,299 shares in fiscal 1995, 36,933 shares in fiscal 1994, and 6,343 shares in fiscal 1993, at per-share exercise prices ranging from $.74 to $1.07) and Rights to purchase 226,763 shares were outstanding. The above table includes as outstanding on March 31, 1995 additional Rights to purchase 72,257 shares, which Rights would be granted only upon subsequent exercises of Management Options.\nRights granted in connection with the exercise of a Management Option are exercisable for two years from the date of grant and have a per-share exercise price equal to the greater of (a) $.74 or (b) the exercise price of the Management Option.\nUpon certain issuances of shares of common stock other than pursuant to the exercise of Management Options, each Investor will be granted a Right (the \"Other Right\") so that the equity interest represented by the Agreement shares held by the Investor (excluding the shares purchased upon the exercise of Rights issued in connection with the exercise of Management Options) will not be diluted. As of March 31, 1995, Other Rights to purchase 848,463 shares of common stock had been exercised (as to 87,771 shares in fiscal 1995, none in fiscal 1994, and 9,405 shares in fiscal 1993, at per-share exercise prices ranging from $.59 to $9.29).\n- -------------------------------------------------------------------------------- 36 Image Entertainment, Inc.\nNOTES TO FINANCIAL STATEMENTS - --------------------------------------------------------------------------------\nNOTE 12. INCOME TAXES.\nIncome taxes for the three years ended March 31, 1995, all current, are summarized as follows:\nThe tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at March 31, 1995 and 1994 are presented below:\nIncome taxes for the years ended March 31, 1995 and 1994 is net of credits of approximately $7,362,000 and $3,583,000, respectively, which resulted from the utilization of net operating loss carryforwards to offset taxable income for Federal and state income tax purposes.\nNOTE 13. COMMITMENTS AND CONTINGENCIES.\nThe Company entered into renegotiated leases for its office and warehouse space on December 1, 1993. The new leases commenced on April 1, 1994 and expire on March 31, 2000.\nThe lease for the Company's office provides for monthly rent of $13,726 (subject to annual adjustment based upon increases in the consumer price index). The lease for the Company's warehouse space provides for monthly rent of $22,039 (subject to annual adjustment based upon increases in the consumer price index).\n- -------------------------------------------------------------------------------- Image Entertainment, Inc. 37\nNOTES TO FINANCIAL STATEMENTS - --------------------------------------------------------------------------------\nFuture minimum annual rental payments at March 31, 1995 are approximately as follows:\nRent expense was $458,819, $296,190, and $341,305 for fiscal 1995, 1994, and 1993, respectively.\nAt March 31, 1995, the Company had $2,990,000 of outstanding letters of credit of which $990,000 and $2,000,000 were issued and guaranteed, respectively, by the Company's lender and expire on November 15, 1995. These letters of credit secure balances due to program suppliers.\nThe Company's future obligations for royalty advances and minimum guarantees and exclusive distribution fee guarantees under the terms of existing licenses and an exclusive distribution agreement, respectively, are as follows:\nNOTE 14. SUBSEQUENT EVENT.\nEffective June 8, 1995, the Company, through its newly created wholly owned subsidiary, acquired and assumed substantially all of the assets and liabilities, respectively, of V.T. Laser, Inc., a privately held New Jersey based corporation doing business as \"U.S. Laser Video Distributors\" (\"U.S. Laser\"), for a purchase price of approximately $3.1 million in cash. The transaction was funded through operating cash flow and borrowings under the Company's revolving credit facility. This acquisition will be accounted for as a purchase in the Company's first quarter ending June 30, 1995. U.S. Laser is a nonexclusive distributor of optical disc programming and the publisher of LASERVIEWS: America's Laser Disc Magazine, a bimonthly consumer periodical focusing on product announcements, software reviews and articles of general interest to the laserdisc consumer, and D.I.S.C.: Dealer's Interactive Software Companion, a dealer-oriented multimedia publication.\n- -------------------------------------------------------------------------------- 38 Image Entertainment, Inc.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND --------------------------------------------------------------- FINANCIAL DISCLOSURE. --------------------\nNone.\n- -------------------------------------------------------------------------------- PART 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 to be set forth in this Part III (except for the list of Executive Officers set forth in Part I hereof) is included in a definitive Proxy Statement pursuant to Regulation 14A, incorporated herein by reference, to be filed with the Securities and Exchange Commission not later than 120 days after the close of the Company's fiscal year ended March 31, 1995.\n- -------------------------------------------------------------------------------- PART IV - --------------------------------------------------------------------------------\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K. ---------------------------------------------------------------\n- -------------------------------------------------------------------------------- Image Entertainment, Inc. 39\nSCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS - FOR THE YEARS ENDED MARCH 31, 1995, 1994 AND 1993\n================================================================================\nAllowance for Doubtful Accounts -------------------------------\nAllowance for Sales Returns ---------------------------\n- -------------------------------------------------------------------------------- 40 Image Entertainment, Inc.\n- -------------------------------------------------------------------------------- SIGNATURES - --------------------------------------------------------------------------------\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nIMAGE ENTERTAINMENT, INC., a California corporation\nDated: June 26, 1995 By: \/s\/ Martin W. Greenwald ------------------------------------------- MARTIN W. GREENWALD, Chairman of the Board, Chief Executive Officer, President & 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.\n\/s\/ Martin W. Greenwald ------------------------------------------- Dated: June 26, 1995 MARTIN W. GREENWALD, Chairman of the Board, Chief Executive Officer, President & Treasurer\n\/s\/ Jeff M. Framer ------------------------------------------- Dated: June 26, 1995 JEFF M. FRAMER, Chief Financial Officer (Principal Financial and Accounting Officer)\n\/s\/ Stuart Segall ------------------------------------------- Dated: June 26, 1995 STUART SEGALL, Vice President & Director\n\/s\/ Ira Epstein ------------------------------------------- Dated: June 26, 1995 IRA EPSTEIN, Director\n\/s\/ Russell Harris ------------------------------------------- Dated: June 26, 1995 RUSSELL HARRIS, Director\n\/s\/ Kyle Kirkland ------------------------------------------- Dated: June 26, 1995 KYLE KIRKLAND, Director\n- -------------------------------------------------------------------------------- Image Entertainment, Inc. 41\n- -------------------------------------------------------------------------------- EXHIBIT INDEX - --------------------------------------------------------------------------------\nEXHIBIT NO. DESCRIPTION - ----------- -----------\n3.1 * Restated Articles of Incorporation.\n3.2 * Bylaws.\n10.1 + The Company's Restated 1989 Incentive Stock Option Plan, as amended. Filed as Exhibit 10.1 of the Company's Form 10-K for the year ended March 31, 1992, and incorporated by reference herein.\n10.2 + The Company's 1990 Stock Option Plan. Filed as Exhibit A of the Company's Proxy Statement dated December 27, 1990, and incorporated by reference herein.\n10.3 + The Company's Restated 1992 Stock Option Plan. Filed as Exhibit A of the Company's Proxy Statement dated September 9, 1994, and incorporated by reference herein.\n10.4 * The Company's 1994 Eligible Directors Stock Option Plan and Form of Eligible Director Non-Qualified Stock Option Agreement.\n10.5 + Form of Option Agreement dated October 15, 1991 between the Company and Martin W. Greenwald. Filed as Exhibit 10.3 of the Company's 10-Q for the quarter ended September 30, 1991, and incorporated by reference herein.\n10.6 + Option granted August 13, 1992 by the Company to Cheryl Lee.\n10.7 + Form of Option granted May 19, 1994 to Jeff Framer, Cheryl Lee and David Borshell.\n10.8 * + Employment Agreement of Martin W. Greenwald dated July 1, 1994.\n10.9 * + Employment Agreement of Cheryl Lee dated July 1, 1994.\n10.10 * + Employment Agreement of Jeff Framer dated July 1, 1994.\n10.11 * + Employment Agreement of David Borshell dated July 1, 1994.\n10.11.A * + Amendment No. 1 dated and effective as of September 1, 1994 to Employment Agreement of David Borshell dated July 1, 1994.\n10.12 + Form of Indemnity Agreement between the Company and its directors and officers. Filed as Exhibit F of the Company's Proxy Statement dated September 5, 1989, and incorporated by reference herein.\n10.13 Stock Purchase Agreement among the Company, Directors of the Company and various Buyers dated December 29, 1987. Filed as Exhibit 4.3 of the Company's Form 8-K dated December 29, 1987, and incorporated by reference herein.\n10.13.A Form of First Amendment dated July 7, 1992 to the Stock Purchase Agreement referenced in Exhibit 10.19 above. Filed as Exhibit 10.5 of the Company's Form 10-Q for the quarter ended September 30, 1992, and incorporated by reference herein.\n- -------------------------------------------------------------------------------- Image Entertainment, Inc.\n10.14 Stock Purchase Agreement among the Company, Directors of the Company and Image Investors Co. dated June 27, 1990. Filed as Exhibit 10.53 of the Company's Form 10-K for the year ended March 31, 1990. The Company and Image Investors Co. are parties to Stock Purchase Agreements dated July 14, 1988, November 30, 1988, January 11, 1989, February 14, 1989, May 10, 1989 and June 20, 1990, which are virtually identical to this Exhibit except for the number of shares of Common Stock purchased, and incorporated by reference herein.\n10.15 Stock Purchase Agreement between the Company and Image Investors Co. dated December 30, 1992, including Warrant. Filed as Exhibit 10.6 of the Company's Form 10-Q for the quarter ended December 31, 1992, and incorporated by reference herein.\n10.16 Purchase and Sale Agreement between the Company and LEI Partners, L.P. dated December 31, 1990. Filed as Exhibit 10.1 of the Company's Form 10-Q for the quarter ended December 31, 1990, and incorporated by reference herein.\n10.17 Standard Industrial Lease for 9333 Oso Avenue, Chatsworth, California, dated December 1, 1993 and effective April 1, 1994, between the Company and P&R Investment Company. Filed as Exhibit 10.1 of the Company's Form 10-Q for the quarter ended December 31, 1993.\n10.18 Standard Industrial Lease for 20350 Prairie Street, Chatsworth, California, dated December 1, 1993 and effective April 1, 1994, between the Company and P&R Investment Company. Filed as Exhibit 10.2 of the Company's Form 10-Q for the quarter ended December 31, 1993.\n10.19 Loan and Security Agreement between the Company and Foothill Capital Corporation dated as of November 15, 1994, including Capital Expenditure Loan Note and Trademark Security Agreement. Filed as Exhibit 4 of the Company's Form 10-Q for the quarter ended September 30, 1994.\n10.20 * Stock Purchase Agreement between the Company and Kyle Kirkland dated as of January 26, 1995.\n21 * Subsidiaries of the Registrant.\n23 * Consent Letter of KPMG Peat Marwick LLP.\n27 * Financial Data Schedule. _______________________________________________________________\n* Exhibit(s) not previously filed with the Securities and Exchange Commission. + Management Contracts, Compensatory Plans or Arrangements\n- -------------------------------------------------------------------------------- Image Entertainment, Inc.","section_15":""}
{"filename":"5657_1995.txt","cik":"5657","year":"1995","section_1":"ITEM 1. BUSINESS --------\na. PRODUCTS AND MARKETING\nThe registrant and its subsidiaries (the \"Company\" or \"API\") conduct operations in three major industrial classifications, namely, Heat Transfer, Motion Technologies, and Electronic Components.\nThe Company continues to direct its efforts towards major sales drives for current products in its served markets and target markets. In addition, the Company continues to aggressively seek profitable growth by enhancing and complementing its existing technology base.\nHEAT TRANSFER -------------\nThe Heat Transfer Group, comprised of the Basco and Air Technologies Divisions, designs, engineers, and manufactures a broad range of heat transfer products which are used in a variety of applications, including the cooling of oil, air, and other gases; steam condensing; vapor recovery; and many other processing requirements. The Group's products are sold for use on various types of industrial machinery and for use in power, chemical, petrochemical, and refining operations.\nThe Basco Division manufacturers a full line of standard and custom shell and tube heat exchangers, plate fin intercoolers and aftercoolers, and Centraflow steam surface condensers. The Air Technologies Division produces a full line of aluminum air-to-air and air-to-liquid heat exchangers for use on air compressors, construction equipment, and industrial machines.\nThe Group generates its bookings and sales through a network of sales representatives whose territories are geographically defined. The majority of sales are made to original equipment manufacturers, with the balance of sales made to end users, usually for use in a plant or processing application.\nDuring 1995, the Group upgraded its computer hardware and software systems to support the upcoming growth objectives. In addition to the capability to support additional sales volume, significant benefits are expected in inventory management, scheduling, and cost control.\nThroughout the year the Basco Division reorganized departmental responsibilities into a format that fits its future business operating strategy and upgraded management positions in Engineering, Manufacturing, and Marketing. This action, combined with upgrades in machinery and equipment, has positioned this Division to become an even larger force in the heat exchanger industry. In addition, Basco has secured overseas representation, and as a result obtained significant business in Germany.\nThe Air Technologies Division experienced over 30% growth during 1995, and this, combined with healthy projections for 1996, has created the need for a larger facility. We expect to complete a new 80,000 square foot manufacturing facility in 1996. This\nmove will approximately double the floor space currently in use and will allow for both more efficient production of current backlog, as well as the required space for expected future growth. This new facility, coupled with planned heavy investments in capital equipment will enable this Division to pursue a leadership role in its industry. High quality, flexibility, and strength of design, along with serviceability to our customers at a competitive price, continues to drive the Air Technologies Division to new heights.\nThe Group will continue to pursue new products and new markets and strive for further productivity gains and processing improvement to enhance value to its customers.\nMOTION TECHNOLOGIES -------------------\nThe Motion Technologies Group is comprised of the Controls, Deltran, Harowe, and Rapidsyn Divisions. In addition, on January 1, 1995, the Group assumed the management of the day-to-day operations of Gettys Corporation, a manufacturer of precision industrial motors located in Racine, Wisconsin.\nDuring 1995, the number of facilities occupied by the Group was reduced from six to four. The Rapidsyn Division was relocated from Oceanside, California and merged into the Gettys facilities in Wisconsin. The Controls and Deltran facilities were also relocated into one larger, state-of-the-art facility in Amherst, New York.\nCONTROLS The Controls Division offers a complete line of drives, controls, power-supplies, and applications support for motion control systems, including factory automation, semi-conductor equipment, printing, packaging, and winding equipment, positioning tables, fluid metering, and electronics assembly applications. During 1995, the Division continued to focus its efforts on developing the Intelligent Drive family of products. This product line provides the user with an integrated microstep controller and drive unit with built-in network communications. In 1996, plans are to continue development of the Intelligent Drive family, including a new brushless servo unit that will be directed to specific market opportunities in semi-conductor and medical applications.\nDELTRAN The Deltran Division manufactures high quality electro-magnetic clutches and brakes used in sophisticated rotary control applications. During 1995, the Division developed a new line of spring-set brakes for servo motors. This highly tooled product line will allow Deltran to become a leader within this market, just as they are today in the office copier market. The Division recently formed an alliance with Xerox Corporation, being only the second company in the United States to do so, which assures Deltran a long-term, profitable relationship as the major supplier of clutches to Xerox world-wide. Significant cost reductions are planned for 1996, such as the start-up of a new manufacturing plant in St. Kitts, West Indies, and further off-shore sourcing of key components. These efforts will further enhance the Division's position within the highly competitive markets in which it focuses.\nHAROWE SERVO CONTROLS, INC. Harowe produces precision motors and feedback devices for medical, factory automation, and aerospace markets. The motors are fractional horsepower AC, DC brushless, and stepper types. The feedback devices\nconsist of tachometers, synchros, and resolvers which provide velocity or position feedback. Harowe plans to develop and introduce new feedback components in 1996. These will include resolver-to-digital electronic packages and optical encoders. Harowe will continue implementing cellular manufacturing that was initiated in 1995. These efforts have already resulted in shorter lead time and improved quality, productivity, and on-time delivery.\nRAPIDSYN The Rapidsyn Division offers a full line of step motors, ranging from 2.3 inches to 4.2 inches in diameter. The Division also manufactures AC synchronous motors, linear actuators, and high performance brushless DC motors.\nThe Division also began an aggressive new product development program that has resulted in a new high performance line of hybrid step motors that meet or exceed the microstepping accuracy and torque output of any products currently on the market. Patents for the new motors have been applied for.\nELECTRONIC COMPONENTS ---------------------\nThe Electronic Components Group is comprised of the Delevan and Surface Mounted Devices Divisions. These divisions design, manufacture, and market an extensive line of quality inductors, chokes, and coils to satisfy various electrical and electronic filtering requirements. The Group concentrates on producing high performance inductive devices to meet stringent government and customer specifications relating to high product quality, reliability, and dependability. The Delevan and SMD Divisions are world-class suppliers to the telecommunication, aerospace, avionics, lighting, computer, medical, and military markets.\nGlobal competitive forces continue to push the market towards improved product quality and lower product costs. This competition from off-shore manufacturing is being neutralized through major improvements in our manufacturing capabilities. Productivity continues to increase due to the success of our ISO-9001 certification, Total Quality Management practices, recently introduced Statistical Process Control, and High Performance teams. Aggressive automation and process streamlining contributes to reducing our overall costs and cycle time and to providing improved customer service.\nThe Group continues an assault on winning new markets and new customers. The Group introduced both new product series and expanded existing series to enhance our presence in the high frequency and power markets. Two additional series are in the final stages of development that will allow us to further penetrate these growing markets. Custom designed products to meet specific and unique customer requirements is an additional area that the Group continues to grow. The net effort of our new and custom products in 1995 resulted in increasing our business base by 10% and is giving us the opportunity to service over 50 new customers.\nOne of the key initiatives identified in our Five Year Strategic Business Plan was strengthening our customer base at both Divisions. Today, our customer base is diverse, including customers from the lighting, automotive, medical, and industrial segments along with our traditional markets. This diversity has both strengthened our backlog and reduced sales fluctuations that commonly occur with a narrow customer\nbase. To properly support this larger customer base, the Group has developed a complete presence on the World Wide Web where customers around the world can view our product offerings, contact our field sales forces and distributors, request additional information, and generally learn about our Company. Likewise, each internal sales representative, has been \"computerized\" with the latest sales management software to quickly respond to customer needs.\nThe outlook in the coming years looks promising and full of growth opportunities. Detailed plans, all focused on customer satisfaction, are being implemented to develop new products, enter new markets, and reduce our costs. Internal training, both formal and on the job, continues to strengthen the capabilities and skills of our workforce. This investment in training and our new EVA-based incentive system are key factors that will enable the Electronic Components Group to drive and accelerate our commitment to excellence in meeting both customer requirements and our strategic growth objectives.\nTo learn more about the Group, throughout the year, please visit our homepage on the Internet...HTTP:\/\/WWW.DELEVAN.COM or E-mail us at APISALES@DELEVAN.COM or APIENG@DELEVAN.COM and communicate via the Internet directly with our sales or engineering team members.\nb. COMPETITION -----------\nIn each of its segments the Company faces substantial competition from a number of companies, some of which have off-shore manufacturing facilities, and many of which are larger and have greater resources. In the electronic components market, several of our domestic competitors have become part of a single organization through a series of acquisitions. The inductor market continues to be faced with strong global competition and trends towards product miniaturization and lower costs. The Company relies primarily on the quality of its products and service to meet competition. Although the Company is not aware of definitive industry statistics by manufacturer for the products it makes, in the opinion of management, the Registrant is a significant competitive factor in the high quality micro-miniature electronic coil, electro-magnetic components, and compressor cooler markets.\nc. BACKLOG -------\nThe Company's backlog of unfilled orders believed to be firm at December 29, 1995 was approximately $30,441,000. All backlog orders are expected to be completed in the current fiscal year. The following table shows the backlog of orders for products associated with the three business segments:\nBacklogs have increased for the Heat Transfer and Motion Technologies segments primarily due to a focused strategic account sales program and the general business climate. While the Electronic Components segment sales have increased, the backlog has remained steady and is the result of reduced lead times for delivery required by our customers.\nd. SUPPLIERS ---------\nThe Company is not dependent upon any single supplier for any of the raw materials used in manufacturing its products and has not encountered significant difficulties in purchasing sufficient quantities of raw materials on the open market.\ne. PATENTS AND LICENSES --------------------\nThe Company has patents covering the design and certain manufacturing processes for some of its surface mounted inductors which management believes may be material to the Electronic Components segment over the next several years. These patents have a remaining duration in excess of ten years. Otherwise, no single patent or group of patents is material to the operations of any industry segment or to the business as a whole.\nf. CUSTOMERS ---------\nDuring 1995, no single customer accounted for more than 10% of consolidated sales.\ng. RESEARCH AND PRODUCT DEVELOPMENT --------------------------------\nThe Company charges earnings directly for research and product development expenses. Costs for Company-sponsored programs, excluding capital expenditures, were approximately $1,111,000, $888,000, and $602,000, in 1995, 1994, and 1993, respectively.\nh. ENVIRONMENTAL MATTERS ---------------------\nIn 1990, the U.S. Environmental Protection Agency (EPA) named the Company a potentially responsible party (PRP) with respect to hazardous substances disposed of at the Envirotek II Site (the Site) in Tonawanda, New York. The Company is a member of a steering committee which was formed to facilitate discussions with the EPA. The Company was named a de minimis participant with respect to the first phase of the clean-up action and was relieved of any potential liability for the first phase clean-up with the payment of a minor fee. The EPA has since advised the Company that its name had been removed from the PRP list. The State of New York has also indicated to the Envirotek II PRP Group its intention to pursue additional remedial measures at a site which surrounds the Site. It is not possible at this time to determine, whether and to what extent, the Company will incur additional liability as a result of any future government or private action.\ni. EMPLOYEES ---------\nAt December 29, 1995, 1,019 persons were employed by the Company.\nj. LINES OF BUSINESS AND INDUSTRY SEGMENT INFORMATION --------------------------------------------------\nThe Company's operations in 1995 were carried on through seven divisions and two subsidiaries. Operations are classified into three industry segments based upon the characteristics of manufacturing processes and the nature of markets served. The operating units which currently comprise the segments and their principal products are as follows:\nAmounts of revenue from sales to unaffiliated customers, operating profit or loss, and identifiable assets for the three years ended December 29, 1995, are included in Note M of the notes to consolidated financial statements on page(s) 34-35 of this document.\nk. FOREIGN OPERATIONS ------------------\nExport sales, principally to Europe, Canada, and Asia, were approximately 14% of consolidated sales for 1995. In 1994 and 1993, export sales were 17% of consolidated sales and were principally to Europe and Canada. The foreign sales are not believed to be subject to any risks other than those normally associated with the conduct of business in friendly nations having stable governments.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES ----------\nThe location of the Company's facilities and their approximate size in terms of floor area are as follows:\nThe Walden Avenue, Quaker Road, and North Street facilities are owned by the Company.\nThe facilities leased by the Company are as follows:\nThe Company believes all of its existing properties are well maintained, are suitable for the operation of its business, and are capable of handling production for the coming year.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS -----------------\nSee Item 1(h).\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 1995.\nPART II -------\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY ------------------------------------- AND RELATED SHAREHOLDER MATTERS -------------------------------\nCOMMON STOCK PRICES\nAmerican Precision Industries common stock is listed on the New York Stock Exchange and traded principally in that market. The following table shows the Company's high and low prices on the New York Stock Exchange, as reported in the Wall Street Journal.\nAs of December 29, 1995, there were 1,076 shareholders of record.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA -----------------------\nFIVE YEAR SELECTED FINANCIAL DATA\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND --------------------------------------------------------------- RESULTS OF OPERATIONS --------------------- FINANCIAL REVIEW - OPERATIONS\nREVENUES Consolidated revenues increased 26.7% as compared to the prior year. Sales within the Heat Transfer segment increased 22.6% in 1995 and is attributable to increased sales of traditional water cooled heat exchangers to existing customers, as well as significant growth in the air cooled heat exchanger product line. The Electronic Components segment sales increased 8.7% due to a higher sales volume in a specific axial-leaded product, offset by the completion of a major sales order to one customer in 1994 which has not reoccurred in 1995. The increase of 45.4% in sales of the Motion Technologies segment is the result of the acquisition of Harowe Servo Controls Inc. (\"Harowe\") in June 1994, as well as a slightly higher sales volume of our previously existing motion control products.\nIn 1994, consolidated revenues increased 27.1% as compared to 1993. Sales within the Heat Transfer segment increased 22.7% in 1994 reflecting continued demand for both air cooled and water cooled heat exchangers, as well as sales to new customers and new product offerings. Sales for the Electronic Components segment increased 18.8% in 1994 reflecting a broad-based increase in demand and a major order from one customer. The increased sales in the Motion Technologies segment of 43.7% reflect a strong market demand for motion control products. The 1994 results of the Motion Technologies segment were also favorably impacted by sales of approximately $5.0 million from Harowe, which was acquired by the Company June 30, 1994.\nThe Company's consolidated backlog of firm orders at December 29, 1995 was $30,441,000, up 35.6% from the prior year. This reflects a 49.7% increase in the Heat Transfer segment, a minor increase in the Electronic Components segment, and a 31.3% increase in the Motion Technologies segment. A focused strategic account sales program and the general business climate have all contributed to these increases.\nInvestment income declined $112,000, or 30.4% in 1995 as compared to 1994 and $107,000, or 22.5% in 1994 as compared to 1993. The decline for both periods reflects lower average investment asset balances resulting from the sale of various bonds to fund both current operations and the purchase of Harowe in June 1994 combined with lower average interest rates.\nSELLING AND ADMINISTRATIVE EXPENSES Selling and administrative expenses increased $3,219,000, or 20.7% in 1995 as compared to 1994 and $2,646,000 or 20.5% in 1994 as compared to 1993. The majority of the increase in both periods relates to: 1) increased commissions as a result of the increase in sales revenue; 2) the inclusion of Harowe's selling and administrative expenses for the six months in 1994 and for the full year in 1995; and 3) the provision for bonuses under the Company's current incentive plans. In spite of these increases, selling and administrative expenses continue to decline when expressed as a percent of net sales, and this is consistent with management's efforts to hold the growth of overhead costs below the growth in sales.\nRESEARCH AND PRODUCT DEVELOPMENT Research and development expenses increased $223,000, or 25.1% in 1995 as compared to 1994 and $286,000, or 47.5% in 1994 as compared to 1993. The increases for both periods reflects management's continued commitment to the design of new products and improvement of existing products.\nINTEREST AND DEBT EXPENSE Interest and debt expense increased $18,000 or 8.2% in 1995 as compared to 1994. The increase is due to slightly higher interest rates offset by lower average principal balances in 1995. While total debt increased in 1995 due to the industrial revenue bond financing of $6,660,000, there was only a minor impact on interest and debt expense since this financing was obtained on December 22, 1995. Another contributing factor is the increased activity in short-term borrowings in 1995 as compared to 1994.\nThe decrease in interest and debt expense for 1994 as compared to 1993 is attributable to lower principal balances on the industrial revenue bonds. Offsetting the effect of the lower principal balances was a slight increase in interest rates from 1993.\nINCOME TAXES Income taxes expressed as a percent of earnings before taxes were 34.5%, 35.3%, and 34.9%, in 1995, 1994, and 1993, respectively. The lower rate in 1995 can be attributed to the undistributed earnings of the Company's foreign subsidiary for which no federal tax has been provided since it is the intention of the Company to indefinitely reinvest those earnings back into the operations of that entity.\nThe increased rate in 1994 is primarily the result of lower tax-exempt investment income as compared to 1993.\nNET EARNINGS Net earnings increased 37.9% in 1995 as compared to 1994. This increase is primarily the result of the increased level of net sales combined with lower operating costs, when expressed as a percentage of revenues.\nNet earnings increased 67.4% in 1994 as compared to 1993. A substantial part of this increase can be attributed to the increased net sales discussed previously, offset by higher selling and administrative and research and product development costs. The Company also recorded a fourth quarter charge of $217,000, after tax, to provide for the closing of the Rapidsyn Division plant in California and the movement of Rapidsyn's motor production to the Gettys Corporation facility in Racine, Wisconsin.\nPursuant to a Management Contract, the Company assumed responsibility for the day-to-day management of Gettys as of January 1, 1995.\nFINANCIAL POSITION The Company's liquidity is primarily generated from operations. In addition, short-term lines of credit totaling $7,398,000 were available at December 29, 1995. Information on the Company's liquidity position for the past three years is as follows:\nThe reduction in the current ratio for 1994 as compared to 1993 can be attributed to the combination of the lower marketable securities balance in 1994 as a result of the purchase of Harowe, the inclusion of Harowe's net current assets in API's net working capital, and the increase in short-term borrowings which were outstanding for only two business days.\nThe increase in cash flow from operations in 1995 as compared to 1994 is principally the result of increased sales and net income.\nThe decline in cash flow from operations in 1994 as compared to 1993 reflects increases in accounts receivable and inventories as a result of the increased sales and bookings in 1994.\nCash, cash equivalents, and marketable securities for 1995 includes $2,114,000 of restricted funds held in an escrow account as part of the Management Agreement between the Company and Gettys Corporation. These funds will be applied to the purchase price of the net assets of Gettys Corporation at the time the Company acquires those net assets pursuant to the exercise of the put or call option provisions of the Management Agreement.\nThe increase in capital expenditures in 1995 as compared to 1994 reflects the Company's investment in new machinery and equipment and computer systems at both the Heat Transfer and Motion Technologies Groups.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA -------------------------------------------\nREPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Shareholders of American Precision Industries Inc.\nIn our opinion, the accompanying consolidated balance sheet and the related consolidated statements of earnings and shareholders' equity and of cash flows present fairly, in all material respects, the financial position of American Precision Industries Inc. and its subsidiaries at December 29, 1995 and December 30, 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 29, 1995, 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.\nBuffalo, New York February 12, 1996\nCONSOLIDATED BALANCE SHEET\nSee notes to consolidated financial statements\nLIABILITIES AND SHAREHOLDERS' EQUITY\nSee notes to consolidated financial statements\nCONSOLIDATED STATEMENT OF EARNINGS\nSee notes to consolidated financial statements\nCONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY\nSee notes to consolidated financial statements\nCONSOLIDATED STATEMENT OF CASH FLOWS\nSee notes to consolidated financial statements\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nFor the years ended December 29, 1995, December 30, 1994, and December 31, 1993.\nA. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\n(1) NATURE OF OPERATIONS American Precision Industries Inc. (the \"Company\") is a diversified manufacturing company whose principal lines of business include the production and sale of heat transfer products, motion control devices, and electronic components. Sales of these products are primarily to customers in industrialized nations both domestic and foreign.\n(2) CONSOLIDATION The accounts of all subsidiaries are included in the consolidated financial statements. The fiscal years consisted of 52 weeks. The Consolidated Balance Sheet, Statement of Earnings, and Statement of Cash Flows include the results of Harowe Servo Controls, Inc. since June 30, 1994, the date of acquisition.\n(3) INVENTORIES Inventories are valued at the lower of cost or market, net of progress payments. At December 29, 1995 and December 30, 1994 inventories comprising approximately 50% and 52%, respectively, of total inventories were valued using the last-in, first-out (LIFO) method. Other inventories are priced using the first-in, first-out (FIFO) method.\n(4) PROPERTY, PLANT AND EQUIPMENT These assets are stated at cost and are depreciated over their estimated useful lives; building and improvements - 10 to 45 years; machinery, equipment, and furniture - 2 to 15 years.\nExpenditures for maintenance and repairs are charged to expense; renewals and betterments are capitalized and depreciated. Properties are removed from the accounts when they are disposed of, and the related cost and accumulated depreciation are eliminated from the accounts. Associated gains and losses, if any, are included in consolidated net earnings.\n(5) GOODWILL The excess of the purchase cost over the fair value of net assets acquired in an acquisition (goodwill) is separately disclosed, net of accumulated amortization, and is being amortized over 25 years on a straight-line basis. Amortization expense amounted to $102,000 in 1995 and $44,000 in 1994. Accumulated amortization of goodwill at December 29, 1995 was $146,000.\n(6) INCOME TAXES The Company provides for deferred income taxes under the asset and liability approach. This method requires the recognition of deferred tax liabilities and assets for the expected future tax consequences of temporary differences between the carrying amounts and tax basis of assets and liabilities. No provision has been made for United States income taxes applicable to undistributed earnings of a foreign subsidiary as it is the intention of the Company to indefinitely reinvest those earnings in the operations of that entity.\n(7) EMPLOYEE BENEFIT PLANS Benefits under the Company's salaried defined benefit and supplemental benefit plans are based upon years of service and average compensation during an individual's last years of employment for the defined benefit plan and final pay for the supplemental benefit plan.\nBenefits under the salaried defined benefit plan are funded annually based upon the maximum contribution deductible for federal income tax purposes. The supplemental benefit program is funded through company-owned life insurance contracts on the lives of the participants, but the benefit obligation to certain participants will be offset by the participant's interest in a split-dollar insurance contract.\nBenefits under the hourly defined benefit plan of Harowe are based upon years of service, not to exceed 35, times a fixed rate specified in the union contract. Benefits under this plan are funded annually based upon funding recommendations of the plan actuaries.\nAll union employees are covered under defined contribution plans. The Company's contribution to these plans are set forth under the provisions of the specific union contracts.\n(8) STOCK OPTIONS Proceeds from the sale of common stock issued under employee stock option plans are credited to capital accounts. There are no charges to income with respect to the plans; however, compensation expense is recorded with respect to the increase in value of stock appreciation rights.\n(9) EARNINGS PER SHARE Earnings per share are based on the weighted average number of shares outstanding during each year.\n(10) ADVERTISING The Company expenses the production costs of advertising in the year in which the advertising takes place. Total advertising expense in 1995, 1994, and 1993 was $873,000, $664,000, and $514,000, respectively.\n(11) ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.\nB. BUSINESS ACQUISITION AND STRATEGIC ALLIANCE\n(1) BUSINESS ACQUISITION On June 30, 1994, the Company acquired 100% of the stock of Harowe Servo Controls, Inc. (\"HSC\"), a Delaware corporation and Harowe Servo Controls (St. Kitts) Limited (\"HSC Limited\"), a corporation organized under the laws of the Island of St. Christopher and Nevis, from Hawker Siddeley Holdings Inc., a Delaware corporation, at a cost of approximately $5,200,000. HSC and HSC Limited are engaged in the business of designing, manufacturing, and marketing precision motors, feedback devices, and related products for motion control applications.\nThe acquisition has been accounted for by the purchase method of accounting, and accordingly, the purchase price has been allocated to the assets acquired and the liabilities assumed based on the estimated fair values at the date of acquisition. The resulting goodwill is being amortized on a straight-line basis over 25 years.\nThe following table presents unaudited pro forma results of operations as if the acquisition had occurred on January 1, 1994 and 1993, respectively, after giving effect to certain adjustments, including amortization of goodwill, loss of interest income on tax-exempt municipal bonds sold to fund the purchase cost, adjusted depreciation on fair value of assets acquired, and the related income tax effects. The pro forma results have been prepared for comparative purposes only and do not purport to be indicative of what would have occurred had the acquisition been made at the beginning of 1993 or of results which may occur in the future. Furthermore, no effect has been given in the pro forma information for operating and synergistic benefits that are expected to be realized through the combination of the entities because precise estimates of such benefits cannot be quantified.\n(2) STRATEGIC ALLIANCE On December 23, 1994, the Company entered into a strategic alliance with AEG Daimler-Benz Industrie of Frankfurt, Germany, which provided that on January 1, 1995, the Company would assume responsibility for the day-to-day management of Gettys Corporation, a manufacturer of high performance servo-motors and controls in Racine, Wisconsin. As part of the Management Agreement between the Company and Gettys Corporation, cash in the amount of $333,000 and marketable\nsecurities in the amount of $1,781,000 are held in an escrow account to be applied to the purchase price of the net assets of Gettys Corporation at the time the Company acquires those net assets pursuant to the exercise of the put or call option provisions of the Management Agreement. In conjunction with this strategic alliance, the Company moved the production of the industrial stepper motor line of the Rapidsyn Division into the Gettys facility during the first half of 1995. In anticipation of this move, the Company recorded a fourth quarter reserve in 1994 of $350,000 ($217,000 net of tax) relating to the estimated cost of the relocation of the production facility. This reserve consisted primarily of nonemployee related costs. Final relocation costs incurred in 1995 approximated $350,000.\nC. CASH EQUIVALENTS, MARKETABLE SECURITIES, AND INVESTMENTS\n(1) Cash equivalents consist of money market funds, commercial paper, and certificates of deposit with original maturities of three months or less. Marketable securities, consisting of municipal securities, are carried at market. Included in marketable securities is $1,781,000 of municipal bonds which is restricted as to use under the provisions of the Gettys Management Agreement. Investments primarily consist of marketable municipal bonds, which are carried at market. Included in Investments is $6,233,000 of funds obtained under industrial revenue bond financing. Use of these funds is restricted and can only be applied to the purchase of capital assets for the related expansion program.\nFor the purpose of determining gross realized gains and losses, the cost of securities sold is based upon specific identification.\nDuring 1994, the Company adopted Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities. This Statement requires that debt and equity securities not classified as either held-to-maturity or trading be classified as \"available for sale\" and reported at market value, with unrealized gains and losses reported as a separate component of shareholders' equity.\n(2) Additional information pertaining to the Consolidated Statement of Cash Flows is as follows:\nD. INVENTORIES\nThe major classes of inventories are as follows:\nHad the cost of all inventories at December 29, 1995 and December 30, 1994 been determined by the FIFO method, the amounts thereof would have been greater by $1,187,000 and $1,043,000, respectively.\nE. OTHER NONCURRENT LIABILITIES\nIn 1995, other noncurrent liabilities consist of the noncurrent portion of bonus obligations under the Company's incentive plans, deferred compensation associated with the stock appreciation rights granted to the Chief Executive Officer on June 16, 1992, and options granted to certain members of the Board of Directors of the Company in lieu of certain directors' fees.\nIn 1994, other noncurrent liabilities consisted of the noncurrent portion of bonuses under the Company's incentive plans.\nF. SHORT AND LONG-TERM OBLIGATIONS\n(1) SHORT-TERM OBLIGATIONS As of December 29, 1995 and December 30, 1994, the Company had $2,602,000 and $2,000,000, respectively outstanding on its line of credit. These amounts were outstanding for four and two business days, respectively. The Company had available unsecured, short-term lines of credit totalling $7,398,000 and $8,000,000 at the prime rate on December 29, 1995 and December 30, 1994, respectively. During 1994, the Company borrowed $4,000,000 on its unsecured short-term line of credit to fund the purchase of Harowe Servo Controls, Inc. which was acquired on June 30, 1994. This borrowing was repaid within six business days after the closing through the sale of certain municipal bonds.\n(2) LONG-TERM OBLIGATIONS CONSIST OF THE FOLLOWING:\nDuring the fourth quarter of 1995, the Company obtained adjustable rate industrial revenue bond (\"IRB\") capital lease financing of $6,660,000 for asset purchases associated with its Air Technologies expansion program. The interest rate on these bonds, which approximates 60% of the prime rate, is adjustable every seven days in order for the Remarketing Agent to sell the bonds at par value. The bonds are subject to a mandatory sinking fund repayment schedule through 2015. Unexpended revenue bond proceeds of $6,233,000 were invested and held by a trustee at the end of 1995 and are included in Investments in the accompanying consolidated balance sheet. Such amount is restricted and can only be applied to the purchase of capital assets for the related expansion program, and such assets will be pledged as collateral for the bonds.\nPreviously obtained adjustable rate IRB capital lease financing is collateralized by assets with a depreciated value of $1,501,000 at December 29, 1995. The bonds are subject to a mandatory sinking fund repayment schedule through 2008 and had an average interest rate of 4.1% in 1995. During 1994, the Company also repaid other IRB financing obtained in prior years.\nAll of the IRB's are subject to various restrictive covenants, with respect to which the Company is in compliance.\nUnder the supplemental benefit program, the Company provides retirement or death benefits to directors and certain officers meeting specified service requirements. Directors are entitled to an annual benefit of $10,000 per year for ten years. Generally, participating officers are provided an annual benefit equal to 20% of their current salary payable over fifteen years. In the case of several executives, these benefits will be partially or totally funded through split-dollar life insurance contracts. The estimated future benefits to be paid directly by the Company under this program are accrued over the participants' service lives by estimating the present value of such future benefits assuming a 9% rate of interest. The Company has also invested in company-owned life insurance contracts on the lives of the participants, the cash surrender values of which are recorded in Other Assets. It is actuarially assumed that over the term of this program all costs will be offset by benefits provided from the underlying contracts.\nOver the next five years, the Company will make long-term obligation payments of approximately $628,000 in 1996, $724,000 in 1997, $742,000 in 1998,\n$768,000 in 1999, and $778,000 in 2000.\nG. OPERATING LEASES\nThe Company leases certain office and manufacturing facilities and automotive and other equipment through operating leases. Certain of these provide for the payment of taxes, insurance and maintenance costs and most contain renewal options. Net future minimum lease commitments do not have a material impact on the consolidated financial statements. Total rental expense for 1995, 1994, and 1993, was $587,000, $568,000, and $436,000, respectively.\nH. EMPLOYEE BENEFITS\nRetirement Plans - In addition to the aforementioned supplemental benefit program, the Company has a defined benefit retirement plan covering all nonunion employees (\"Salaried Plan\") and makes contributions to union-sponsored plans. Harowe has a defined benefit retirement plan covering all hourly employees in its West Chester, Pennsylvania location (\"HSC Hourly Plan\"). The total expense for such plans, net of the recognition of net periodic pension income was $227,000, $44,000, and $230,000, in 1995, 1994, and 1993, respectively.\nThe following summarizes the funded status of the Company's and Harowe's defined benefit retirement plans:\nNet periodic pension income (cost) associated with the salaried plan and the HSC Hourly Plan for 1995 and 1994 included the following components:\nAn assumed discount rate of 7.75%, a rate increase in future compensation of 4.0%, and an expected long-term rate of return of 9.0% have been used in determining the actuarial present value of projected benefit obligations of the Salaried Plan for 1995 and 1994. The HSC Hourly Plan includes an assumed discount rate and expected long-term rate of return of 7.5% for 1995 and 1994.\nI. SHAREHOLDERS' EQUITY\n(1) PREFERRED STOCK - None of the Company's authorized 20,000 shares of preferred stock (par value $50 a share) have been issued.\n(2) STOCK OPTIONS - The Company has granted options to employees under four employee stock option plans and pursuant to the 1992 employment of the Company's Chief Executive Officer. Changes in outstanding options are as follows:\nOptions outstanding at December 29, 1995 were granted at the fair market value on the date of grant and expire at various dates from April, 1996 to December, 2005. In 1995, 125,920 options became exercisable, and, in 1994, 109,255 options became exercisable. At December 29, 1995, 470,970 of the outstanding options were exercisable and 519,150 shares of common stock were available for future grants under the 1993 and 1995 stock option plans. All options become exercisable over a five year period at the rate of 20% each year.\nOn June 16, 1992, the Company's new Chief Executive Officer was granted options to acquire 200,000 shares of the Company's common stock, along with 50,000 stock appreciation rights (\"SARs\") which must be exercised in tandem with the exercise of the options at the rate of one SAR for each four stock options exercised. The options and SARs have a term of ten years, are exercisable at $7.75 per share or right, the fair market value at date of grant, and become exercisable over a five year period at the rate of 20% per year. Data relating to the CEO options are included in the table above. In 1995, the Company recorded compensation expenses in the amount of $148,000 in connection with the increase in value of these stock appreciation rights.\nBeginning on July 1,1995, the Company has granted stock options to each of five directors of the Company on the first day of each calendar quarter under the 1995 Directors Stock Option Plan. Under this plan, a director may elect to receive options in lieu of his cash annual retainer and meeting fees. The option exercise price is 30% of the fair market value of a share on the date of grant, and the cash fees foregone by the director are equivalent to 70% of the fair market value. Options become exercisable six months after date of grant and expire ten years from date of grant. Options outstanding on December 29, 1995 totaled 4,989 shares. None of the options were exercisable on that date and 45,011 shares were available for future grants of options under the plan.\nJ. INVESTMENT INCOME\nInvestment income consists of the following:\nK. INCOME TAXES\nThe provision for income taxes includes the following:\nDeferred tax liabilities (assets) at December 29, 1995 and December 30, 1994 are comprised of the following:\nThe provision for income tax differs from the federal statutory rate of 34% due to the following:\nThe Company has not recorded deferred income taxes applicable to undistributed earnings of a foreign subsidiary that are indefinitely reinvested in foreign operations. Undistributed earnings amounted to approximately $525,000 at December 29, 1995. If the earnings of such foreign subsidiary were not reinvested, a deferred tax liability of approximately $217,000 would have been required.\nL. LITIGATION\nIn 1990, the U.S. Environmental Protection Agency (EPA) named the Company a potentially responsible party (PRP) with respect to hazardous substances disposed of at the Envirotek II Site (the Site) in Tonawanda, New York. The Company is a member of a steering committee which was formed to facilitate discussions with the EPA. The Company was named a de minimis participant with respect to the first phase of the clean-up action and was relieved of any potential liability for the first phase clean-up with the payment of a minor fee. The EPA has since advised the Company that its name had been removed from the PRP list. The State of New York has also indicated to the Envirotek II PRP Group its intention to pursue additional remedial measures at a site which surrounds the Site. It is not possible at this time to determine whether, and to what extent, the Company will incur additional liability as a result of any future government or private action.\nM. BUSINESS SEGMENT DATA\nThe Company conducts operations in three major industrial classifications: Heat Transfer, Motion Technologies, and Electronic Components. The operations of the Heat Transfer segment include the production and sale of water and air-cooled heat transfer equipment to industrial customers. Operations of the Motion Technologies segment comprises production and sale of electro-magnetic clutches and brakes, high performance motors, step motors, controllers, and resolvers. Operations of the Electronic Components segment involve production and sale of inductors and coils.\nTotal revenues by segment consist entirely of sales to unaffiliated customers. Operating profit is total revenue less operating expenses. Operating profit does not include the following items: general corporate income and expense, investment income, interest expense, other income and expense, or income taxes. Identifiable assets by segment consist of those assets that are, or will be, used in the segmental operations. Corporate assets are principally cash, cash equivalents, marketable securities, investments, and other assets.\nExport sales, principally to Europe, Canada, and Asia, were approximately 14% of consolidated sales for 1995. In 1994 and 1993, export sales were 17% of consolidated sales and were principally to Europe and Canada.\nInformation about the Company's operations in different industries, stated in thousands of dollars, are as follows:\nN. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)\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 Price Waterhouse on accounting or financial 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 concerning the directors and executive officers of the Company, appearing on pages 2 through 7 and page 11 of the Company's definitive Proxy Statement, which has been filed with the Commission pursuant to Regulation 14A, is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION ----------------------\nThe information required by this item concerning executive compensation appearing on pages 12 through 17 of the company's definitive Proxy Statement, which has been filed with the Commission pursuant to Regulation 14A, is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT --------------------------------------------------------------\na) & b) SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT --------------------------------------------------------------\nThe information required by this item, appearing on pages 8 and 9 of the Company's definitive Proxy Statement which has been filed with the Commission pursuant to Regulation 14A, is incorporated herein by reference.\nc) CHANGES IN CONTROL ------------------\nThe 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 ----------------------------------------------\na) TRANSACTIONS WITH MANAGEMENT AND OTHERS ---------------------------------------\nNone.\nb) BUSINESS RELATIONSHIPS ----------------------\nNone.\nc) INDEBTEDNESS OF MANAGEMENT --------------------------\nNone.\nd) TRANSACTIONS WITH PROMOTERS ---------------------------\nNone.\nPART IV -------\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K ---------------------------------------------------------------\n2. FINANCIAL STATEMENT SCHEDULES -----------------------------\nAll schedules are omitted because they are inapplicable, immaterial, or not required under the instructions, or the information is included in the financial statements or notes thereto.\nb) REPORTS ON FORM 8-K -------------------\nThere were no reports on Form 8-K for the three months ended December 29, 1995.\nc) 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.\nAMERICAN PRECISION INDUSTRIES INC.\nMarch 27, 1996 By: \/s\/ Kurt Wiedenhaupt ------------------------------------------- Kurt Wiedenhaupt President and Director\nMarch 27, 1996 By: \/s\/ John M. Murray ------------------------------------------- John M. Murray Vice President-Finance and Treasurer\nMarch 27, 1996 By: \/s\/ Thomas M. Huebsch ------------------------------------------- Thomas M. Huebsch Corporate Controller\nSIGNATURES ----------\nPursuant to the requirement of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nCONSENT OF INDEPENDENT ACCOUNTANTS ----------------------------------\nWe hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (Nos. 2-85320, 33-31315, 33-61734, and 33-71839) of American Precision Industries Inc. of our report dated February 12, 1996 appearing on page 16 of this Form 10-K.\nPRICE WATERHOUSE LLP\nBuffalo, New York March 27, 1996\nEXHIBIT INDEX -------------\n21 List of Subsidiaries\n23 Page 43 of Form 10-K\n27 FDS","section_15":""}
{"filename":"731244_1995.txt","cik":"731244","year":"1995","section_1":"Item 1. Business.\nGeneral\nBMJ\nB.M.J. Financial Corp. (\"BMJ\") is a bank holding company incorporated in New Jersey and registered under the Bank Holding Company Act of 1956, as amended. As of December 31, 1995, BMJ, on a consolidated basis, had total assets of $588.7 million, total deposits of $485.0 million and total shareholders' equity of $65.6 million. BMJ commenced business in 1984 when it acquired The Bank of Mid-Jersey (\"Mid-Jersey\"), a New Jersey banking corporation organized in 1851. BMJ acquired Mount Holly State Bank (\"Mount Holly\") in 1984 and Southern Ocean State Bank (\"Southern Ocean\") in 1988. On July 29, 1994, BMJ sold substantially all of the assets and liabilities of Southern Ocean to Sun National Bank of Medford, New Jersey (\"Sun\"). On June 23, 1994, BMJ merged Mount Holly into Mid-Jersey with Mid-Jersey as the surviving institution. Unless specified otherwise, the term \"BMJ\" as used herein refers to the consolidated B.M.J. Financial Corp. and The Bank of Mid- Jersey entity. BMJ's principal business offices are located at 243 Route 130, Bordentown, New Jersey and its telephone number is (609) 298-5500.\nBMJ conducts its operations through 20 banking offices located in the central and southern New Jersey counties of Burlington, Mercer and Ocean. Mid-Jersey is a full service commercial bank offering individual and commercial banking services and trust services. As of December 31, 1995, BMJ employed 329 part-time and full-time employees.\nMid-Jersey\nMid-Jersey is a New Jersey banking corporation. It was organized in 1851 as the Bordentown Banking Company and began operations in the same year. In 1964, Mid-Jersey merged with First National Bank and Trust Company of Roebling, New Jersey and in 1970 it merged with First National Bank of New Egypt, New Jersey and changed its name to \"The Bank of Mid-Jersey.\" In 1978, Mid-Jersey acquired the assets and assumed the liabilities of Hamilton Bank, which then operated in Mercer County, New Jersey. In July 1989, Mid-Jersey acquired the Hamilton Township, Mercer County, New Jersey branch of Howard Savings Bank. On June 23, 1994, BMJ merged Mount Holly into Mid-Jersey with Mid-Jersey as the surviving institution.\nMid-Jersey conducts a general banking and trust business embracing the customary deposit, lending and trust functions of a commercial bank in the State of New Jersey. Commercial banking involves accepting demand, time and savings deposits and making business, consumer, personal, construction and permanent mortgage loans. Through its trust department, Mid-Jersey renders services as trustee, executor, administrator, guardian, managing agent, custodian and investment advisor and it engages in other personal and corporate fiduciary activities authorized by law. As of December 31, 1995, Mid-Jersey had total consolidated assets of $576.3 million, including net loans of $389.3 million, total deposits of $485.1 million and total consolidated shareholders' equity of $58.0 million.\nSubsidiaries\nMid-Jersey has a wholly-owned subsidiary, Hopkinson Corp., a New Jersey corporation, which was formed for the purpose of holding and marketing repossessed properties. This corporation had total assets of $16 thousand as of December 31, 1995.\nMarket Area\nMid-Jersey maintains its principal executive office at 243 Route 130 in Bordentown, New Jersey, and operates 20 banking offices in Burlington, Ocean and Mercer Counties, New Jersey.\nCapital\nThe Federal Reserve Board (\"FRB\") has issued risk-based capital guidelines applicable to member banks and bank holding companies, and the FDIC has issued comparable guidelines applicable to state nonmember banks. The guidelines, which establish a risk-adjusted ratio relating to the total amount of assets and off-balance sheet exposures, (as such assets and off-balance sheet items are weighted to reflect the risk inherent therein), require a minimum total risk-based capital ratio of 8.00%, with at least half of the total capital in the form of Tier 1 capital. See \"Regulation and Supervision - Risk-Weighted Capital Requirements.\"\nThe risk-based capital ratios of BMJ and Mid-Jersey were as follows on the dates shown:\nThe FRB and FDIC have also adopted leverage capital requirements specifying the minimum acceptable ratios of Tier 1 capital to total assets. Under these requirements, the most sound, well-run institutions engaged in the least risky operations are required to maintain minimum ratios of Tier 1 capital to total assets of 3%; all other institutions are required to maintain higher levels of capital depending on their condition. The leverage ratios of BMJ and Mid-Jersey were as follows on the dates shown:\nFailure to satisfy any minimum capital requirements applicable to BMJ or Mid-Jersey could subject BMJ or Mid-Jersey, as the case may be, to further regulatory actions by the FRB.\nRegulation and Supervision\nBank holding companies and banks are extensively regulated under both federal and state law. To the extent that the following information describes statutory and regulatory provisions, it is qualified in its entirety by reference to those particular statutory and regulatory provisions. Any change in applicable law or regulation may have a material effect on the business and prospects of BMJ and Mid-Jersey.\nThe Bank of Mid-Jersey\nMid-Jersey's operations are subject to state and federal laws applicable to banks chartered by the State of New Jersey, to members of the Federal Reserve System, and to banks insured by the FDIC. The FRB is Mid- Jersey's primary federal supervisory authority; the FDIC is Mid-Jersey's secondary federal supervisory authority. The New Jersey Commissioner is Mid-Jersey's state supervisory authority.\nMid-Jersey may not enter into certain transactions (such as the establishment or relocation of an office at which banking business is conducted, or a merger or consolidation with another bank) unless certain regulatory criteria are satisfied and the transactions are met and the transactions are approved by the appropriate bank regulatory authorities. These authorities regularly examine Mid-Jersey's loans, investments, management practices and other aspects of its operations. These examinations are for the protection of depositors and not for the protection of BMJ, Mid-Jersey or their shareholders or other creditors. In addition to these regular examinations, Mid-Jersey must furnish periodic reports to its supervisory authorities.\nRisk-Weighted Capital Requirements\nThe FRB has issued regulations that require banking organizations such as BMJ and Mid-Jersey to maintain minimum levels of capital. Failure to satisfy any minimum capital requirement applicable to BMJ or Mid-Jersey could subject BMJ or Mid-Jersey, as the case may be, to regulatory action by appropriate supervisory authorities.\nBanking organizations are required to meet a minimum ratio of total capital to total risk-weighted assets of 8%, of which at least 4% must be in the form of Tier 1 Capital. A banking organization's qualifying total capital consists of two components: Tier 1 Capital (core capital) and Tier 2 Capital (supplementary capital). Tier 1 Capital is an amount equal to the sum of: (i) common shareholders' equity (including adjustments for any surplus or deficit); (ii) qualifying noncumulative perpetual preferred stock (plus, for bank holding companies, qualifying cumulative perpetual preferred stock in an amount up to 25% of Tier 1 Capital); and (iii) the company's minority interests in the equity accounts of consolidated subsidiaries. At least 50% of the banking organization's total regulatory capital must consist of Tier 1 Capital.\nTier 2 Capital is an amount equal to the sum of (i) the allowance for possible 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 instruments (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 are subject to certain further requirements and limitations of the federal bank regulatory agencies.\nInvestments in unconsolidated banking and finance subsidiaries, investments in securities subsidiaries and reciprocal holdings of capital instruments must be deducted from capital. The federal banking regulators may require other deductions on a case-by-case basis.\nUnder the risk-weighted capital guidelines, balance sheet assets and certain off-balance sheet items, such as standby letters of credit, are assigned to one of four risk weight categories (0%, 20%, 50%, or 100%) according to the nature of the asset and its collateral or the identity of any obligor or guarantor. For example, cash is assigned to the 0% risk category, while loans secured by one-to-four family residences are assigned to the 50% risk category. The aggregate amount of such assets and off-balance sheet items in each risk category is adjusted by the risk weight assigned to that category to determine weighted values, which are added together to determine the total risk-weighted assets for the banking organization. Accordingly, an asset such as a commercial loan, which is assigned to a 100% risk category, is included in risk-weighted assets at its nominal face value, whereas a loan secured by a single-family home mortgage is included at only 50% of its nominal face value. The applicable ratios reflect capital, as determined, divided by risk-weighted assets, as determined.\nCapital Ratios\nThe information presented in \"Business - Capital\" sets forth the regulatory capital ratios of BMJ and Mid-Jersey as of December 31, 1995, as compared to the required minimum levels established in regulations promulgated by the FRB under its risk-based capital guidelines. Failure to satisfy any minimum capital requirement applicable to BMJ or Mid-Jersey could subject BMJ or Mid-Jersey, as the case may be, to regulatory actions by the FRBP.\nPrompt Corrective Action\nThe Federal Deposit Insurance Corporation Improvement Act of 1991 (\"FDICIA\") created five capital- based supervisory categories for banks and required the federal bank regulatory agencies to broaden the scope of regulatory corrective action taken with respect to depository institutions that do not meet minimum capital and related requirements, as well as to take actions promptly in order to minimize any losses to the FDIC. These five capital categories are: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized.\nThe federal bank regulatory agencies, including the FRB, have adopted regulations establishing capital measures and relevant capital levels pursuant to FDICIA for each of the five capital categories. The relevant capital measures are the total risk-based capital ratio, Tier 1 risk-based capital ratio, and the leverage ratio. Under the regulations, a bank is (i) well capitalized if it has a total risk-based capital ratio of 10% or greater, a Tier 1 risk-based capital ratio of 6% or greater, and a leverage ratio of 5% or greater, and is not subject to any order, written agreement, capital directive or prompt corrective action directive to meet and maintain a specific capital level for any capital measure; (ii) adequately capitalized if it has a total risk-based ratio of 8% or greater, a Tier 1 risk-based capital ratio of 4% or greater, a leverage ratio of 4% or greater (3% or greater if the bank is rated composite 1 in its most recent report of examination and is not experiencing or anticipating significant growth), and does not meet the definition of a well capitalized bank; (iii) undercapitalized if it has a total risk- based capital ratio of less than 8%, a Tier 1 risk-based capital ratio of less than 4% or a leverage ratio of less than 4% (or a leverage ratio of less than 3% if the institution is rated composite 1 in its most recent report of examination and is not experiencing or anticipating significant growth); (iv) significantly undercapitalized if it has a total risk-based capital ratio of less than 6%, a Tier 1 risk-based capital ratio of less than 3% or a leverage ratio of less than 3%; and (v) critically undercapitalized if the bank has a ratio of tangible equity to total assets that is equal to or less than 2%.\nAs of December 31, 1995, Mid-Jersey was considered well capitalized under the FRB's regulations.\nDividend Restrictions\nCertain bank regulatory limitations exist on the availability of a subsidiary bank's undistributed net assets for the payment of dividends to the parent company without the prior approval of the bank regulatory authorities.\nThe Federal Reserve Act restricts the payment of dividends in any calendar year to the net profit of the current year combined with retained net profits of the preceding two years. Mid-Jersey may declare a dividend to the parent company only if, after payment thereof, its capital would be unimpaired and its remaining surplus would equal 50 percent of its capital. At January 1, 1996, Mid-Jersey had $19.0 million of undistributed net assets available for the payment of dividends to BMJ.\nRecent Legislative and Regulatory Developments\nInterstate Banking and Branching Act\nThe Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (\"Interstate Act\"), enacted on September 23, 1994, permits bank holding companies, effective September 23, 1995, to acquire banks located in any state without regard to whether the transaction is prohibited under any state law (except that states may establish the minimum age of their local banks, up to a maximum of 5 years, subject to interstate acquisition by out-of-state bank holding companies). Another provision of the Interstate Act allows interstate merger transactions beginning June 1, 1997. States are permitted, however, to adopt 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 Interstate Act provides that such interstate merger transactions will thereafter become the exclusive means for bank holding companies to obtain interstate branches.\nThe Interstate Act permits banks to establish and operate a de novo branch in any state that elects to permit de novo branching. 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. The Interstate Act also requires each federal bank regulatory agency to prescribe uniform regulations including guidelines ensuring that interstate branches operated by out-of-state banks are reasonable, helping to meet the credit needs of communities where they operate. These agencies are required to conduct evaluations of Community Reinvestment Act performance of institutions with interstate branches.\nInsurance Premiums\nFDICIA mandated that the FDIC set semi-annual assessment rates for Bank Insurance Fund (\"BIF\") members sufficient to increase the BIF's reserve ratio to a designated level within a prescribed period of time. In addition, FDICIA directed the FDIC to develop and implement a system of risk-based premiums for federal deposit insurance pursuant to which the semi-annual rates will be assessed on a depository institution based on the probability that the appropriate depository institution fund will incur a loss with respect to the institution.\nPursuant to FDICIA, the FDIC has developed and implemented a risk-based insurance premium system, under which an insured depository institution's deposit insurance assessment rate varies according to the level of risk incurred in its activities. An institution's risk category is based upon whether the institution is well capitalized, adequately capitalized or undercapitalized, as defined by the FDIC. A well capitalized institution is one with a total risk-based ratio of 10.0% or greater, a Tier 1 risk-based ratio of 6.0% or greater, and a Tier 1 leverage ratio of 5.0% or greater. An adequately capitalized institution is one that does not meet the standards of a well capitalized institution, but has a total risk-based ratio of 8% or greater, a Tier 1 risk-based ratio of 4% or greater, and a Tier 1 leverage ratio of 4% or greater. An undercapitalized institution is one that does not meet the requirements of a well capitalized or adequately capitalized institution. Classification depends on an institution's capital ratios as determined by the institution's Report of Income and Condition as of a date determined by the FDIC with respect to each semi-annual assessment period.\nOn August 16, 1995, the FDIC adopted a rate schedule for its risk-based insurance premium system that reduces deposit insurance rates for well-managed and well-capitalized banks. Under the new rate schedule, each BIF member institution is assigned, based on its capital and supervisory subgroups, an annual FDIC assessment rate varying from 4 cents (for well capitalized Subgroup A institutions) to 31 cents (for undercapitalized Subgroup C institutions) per $100 of domestic deposits.\nSeparately, FDICIA also authorized one or more \"special assessments,\" if necessary, (i) to repay funds borrowed from the Secretary of the Treasury pursuant to Section 14(a) of the Federal Deposit Insurance Act, (ii) to repay obligations issued to or borrowed from the BIF or (iii) for any other purpose the FDIC deems necessary. An additional special assessment could have an adverse impact on the financial condition of BMJ and Mid-Jersey.\nCapital Effect of Interest Rate Risk\nOn August 2, 1995, the FRB adopted regulations that permit it to take into account in determining an institution's capital adequacy the institution's levels of interest rate. Under the regulation, a finding that an insured institution has significant levels of such risk could result in the FRB requiring that the institution maintain its capital ratios at levels above the minimum otherwise prescribed by the FRB. Such a finding with respect to BMJ or Mid-Jersey could result in a requirement that BMJ or Mid-Jersey raise their levels of capital.\nSafety and Soundness Standards\nFDICIA required that each of the federal bank regulatory agencies prescribe by regulation depository institution and depository institution holding company standards relating to operations and management, as well as specific quantitative standards for ratios of asset quality, earnings, and stock valuation. FDICIA mandated that a holding company or institution failing to comply with such standards would be required to submit a plan designed to achieve such compliance.\nSubsequently, CDRIA made several significant changes to FDICIA's safety and soundness provisions. Specifically, CDRIA allows the federal bank regulatory agencies the option to prescribe the standards as guidelines rather than as regulations. The procedures for submitting compliance plans must still be prescribed by regulation, but the actual submission of a plan no longer is mandatory; rather, the submission of a plan now is at the agency's option. In addition, CDRIA also excluded holding companies from the scope of the safety and soundness standards. Moreover, CDRIA provided that the standards for asset quality, earnings and stock valuation must be qualitative as opposed to quantitative. On July 10, 1995, the FRB adopted final regulations implementing FDICIA's safety and soundness standards, as amended by CDRIA.\nThe FRB also has adopted guidelines setting out the safety and soundness standards that the FRB will use to identify and address problems at insured institutions before capital becomes impaired. The guidelines are general in nature and focus on the objectives to be achieved by management, while leaving the precise methods for achieving those objectives to each institution. The FRB also adopted a final rule establishing deadlines for submission and review of safety and soundness compliance plans.\nCommunity Reinvestment Act\nOn May 4, 1995, the FRB and the other federal bank regulatory agencies adopted new regulations pursuant to the Community Reinvestment Act (\"CRA\").\nThe new regulations eliminate the agencies' former system of 12 assessment factors for evaluating CRA performance and instead adopt a new system based on performance measures. For larger institutions (generally those over $250 million in assets), the regulations utilize three tests as measures of performance -- a Lending Test, an Investment Test, and a Service Test. Alternative methods of CRA evaluation are available for institutions that elect to use a CRA strategic plan, as well as for wholesale and limited-purpose banks, and for small banks. The new regulations also require all large institutions to collect and report data by geographic area for three categories of loans to be considered in connection with the Lending Test. The new CRA evaluation approach is effective for examinations commencing on or after July 1, 1997; the new loan data collection requirements took effect on January 1, 1996.\nProposed Legislation\nCertain proposals affecting the banking industry have been discussed from time to time. Such proposals include: consolidation of some or all of the federal agencies regulating insured depository institutions; relaxation of the prohibitions on affiliation of entities engaged in commercial banking and investment banking; permitting the affiliation of insurance companies and banks; enhancement of banks' ability to underwrite debt instruments and securitize assets; restrictions on the ability of bank holding companies and their subsidiaries to invest in derivative instruments; and limitation of the applicability of certain provisions of the Community Reinvestment Act to small banks. It is uncertain which, if any, of the above proposals may become law and what effect they would have on BMJ and Mid-Jersey.\nCompetition\nMid-Jersey's principal market is within Burlington, Ocean and Mercer Counties, New Jersey, the three counties in which Mid-Jersey's offices are located.\nAll phases of Mid-Jersey's businesses are highly competitive. Mid-Jersey competes primarily with other commercial banks, saving and loan associations, savings banks and credit unions, many of which are larger than Mid-Jersey. Mid-Jersey is generally competitive with financial institutions in its respective service area with respect to interest rates paid on time and savings deposits, service charges on deposit accounts and interest rates charged on loans.\nCompetition in the banking industry has experienced and will continue to experience rapid changes. Banks are now faced with competition from large business corporations which previously concentrated in stock brokerage, life insurance and other non-banking activities.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nThe principal properties of BMJ and its subsidiaries are those owned or leased by Mid-Jersey.\nBMJ does not own any properties in its name at this time. BMJ leases its Operations Center located on Route 206 in Columbus, New Jersey. The lease is a five-year lease with 206 Commerce Center, a partnership in which Mr. William C. Gray, a director of BMJ, is a partner, for 24,000 square feet of space used by it as its Operations Center. The lease will terminate in November 1999 unless BMJ exercises its option to extend the term of the lease for an additional five-year period. The rental during 1994 was $12.00 per square foot. In future years, the rental will be adjusted based on increases or decreases (subject to certain limitations) in the Consumer Price Index. BMJ believes that the lease is on terms no more favorable to the lessor than would be the case for a lease between unrelated parties.\nMid-Jersey owns the building in which its main banking, trust department and administrative offices are located, at 243 Route 130, Bordentown, New Jersey.\nMid-Jersey operates 19 additional branch offices at the following locations in New Jersey: the corner of Farnsworth Avenue and Walnut Street, Bordentown; 5th Avenue and Main Street, Roebling; 73 Main Street, New Egypt; 10 Browns Mills\/Juliustown Road, Browns Mills; 10 Homestead Plaza, Columbus; 1981 N. Olden Avenue, Ewing Township; 450 Route 33, Mercerville; South Broad Street and Sunnybrae Boulevard, Yardville; South Broad Street, Hamilton; Route 528, Chesterfield; 3800 Quakerbridge Road, Mercerville Township; 160 Lawrenceville-Pennington Road, Lawrenceville; Church Street and Academy Drive, Mount Laurel; Route 38 and Ark Road, Mount Laurel; 239 Taunton Boulevard, Medford; Burlington Center Mall, Burlington Township; 10 Rancocas Road, Mount Holly; 1225 Route 33, Hamilton Square; and 2555 Pennington Road, Pennington. Mid- Jersey owns the buildings in which, and the land on which, all of its branches are located except that the land and buildings for the Yardville, Quakerbridge Road, Hamilton Township, Lawrenceville, Ark Road, Burlington Center, Hamilton Square and Pennington branches are leased and the land for the Columbus and the N. Olden Avenue, Ewing Township branches are leased. Mid-Jersey owns a lot located at the intersection of Route 541 and the Route 541 Bypass in Lumberton, New Jersey but has indefinitely deferred the establishment of a branch facility at that location. Mid-Jersey also owns undeveloped land on Route 541 in Burlington Township, New Jersey which was originally purchased as a future branch location but which it has been attempting to sell for some time.\nIn the opinion of management, all properties are well maintained and suitable to their respective present needs and operations.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nThe nature of BMJ's business generates a certain amount of litigation involving matters arising in the ordinary course of business. However, BMJ believes that there are no proceedings pending to which BMJ or Mid-Jersey is a party or to which any of their property is subject which, if determined adversely to them, would be material in relation to their net worth or financial condition, nor are there any proceedings pending other than ordinary routine litigation incident to their business. No material proceedings are pending, or known to be threatened or contemplated, against BMJ or Mid-Jersey by the governmental authorities or others.\nBMJ is not a party to any pending material litigation, and to its knowledge, is not the subject of any threatened material 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 Registrant's Common Equity and Related Stockholder Matters.\nSee \"Management's Discussion and Analysis of Financial Condition and Results of Operations Common Stock\" for market and dividend information with respect to BMJ's Common Stock.\nItem 6.","section_6":"Item 6. Selected Financial Data\nSee \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Earnings Performance - Table 1.\"\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Conditions and Results of Operations\nOverview\nB.M.J. Financial Corp. (\"BMJ\") is a bank holding company incorporated in New Jersey and registered under the Bank Holding Company Act of 1956, as amended. As of December 31, 1995, BMJ, on a consolidated basis, had total assets of $588.7 million, total deposits of $485.0 million and total shareholders' equity of $65.6 million. BMJ commenced business in 1984 when it acquired The Bank of Mid-Jersey (\"Mid- Jersey\"), a New Jersey banking corporation organized in 1851. BMJ acquired Mount Holly State Bank (\"Mount Holly\") in 1984 and Southern Ocean State Bank (\"Southern Ocean\") in 1988. On July 29, 1994, BMJ sold substantially all of the assets and liabilities of Southern Ocean to Sun National Bank of Medford, New Jersey (\"Sun\"). On June 23, 1994, BMJ merged Mount Holly into Mid-Jersey with Mid-Jersey as the surviving institution. Unless specified otherwise, the term \"BMJ\" as used herein refers to the consolidated B.M.J. Financial Corp. and The Bank of Mid-Jersey entity. BMJ's principal business offices are located at 243 Route 130, Bordentown, New Jersey and its telephone number is (609) 298-5500.\nBMJ conducts its operations through 20 banking offices located in the central and southern New Jersey counties of Burlington, Mercer and Ocean. Mid-Jersey is a full service commercial bank offering individual and commercial banking services and trust services. As of December 31, 1995, BMJ employed 329 part-time and full-time employees.\nEarnings Performance\nB.M.J. Financial Corp. reported net income of $8.3 million for the year ended December 31, 1995 compared to net income of $12.5 million for the year ended December 31, 1994, which included a credit of $4.9 million described below. For the year ended December 31, 1993, BMJ reported a net loss of $890 thousand, which included a net charge of $1.5 million due to a change in accounting principle.\nOn a fully diluted per share basis, earnings for the year ended December 31, 1995 were $1.07, compared to per share earnings of $1.60 for 1994, of which $0.62 represented the effect of the credit. For the year ended December 31, 1993, the net loss was $0.13 per share.\nBMJ reported pre-tax income of $11.5 million for the year ended December 31, 1995 which represented a 48% increase compared to pre-tax income of $7.7 million for the year ended December 31, 1994. Pre-tax income for the year ended December 31, 1993 was $670 thousand.\nEffective January 1, 1993, BMJ adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"FAS 109\") and recorded, as the cumulative effect of a change in accounting principle, a charge to 1993 operating results of $1.5 million.\nDuring 1994, management considered the positive and negative evidence in evaluating the need for the deferred tax asset valuation allowance established upon adoption of FAS 109 and concluded that it was no longer necessary. Accordingly, operating results for the year ended December 31, 1994 include a $4.9 million credit to income representing the reversal of the previously established valuation allowance plus recognition of state deferred tax assets and alternative minimum tax credits.\nNet income for 1995 was negatively affected by income tax expense of $3.1 million. As of December 31, 1994, BMJ had fully recognized all of its available tax credits. Therefore, income tax expense for the year ended December 31, 1995 represents the tax provision associated with BMJ's results of operations for 1995.\nBMJ recorded a negative provision for loan losses of $2.0 million in 1995. No provision for loan losses was recorded in 1994 and a provision of $840,000 was recorded in 1993.\nThe negative provision of $2.0 million recorded in 1995 was driven by the continuing improvement of BMJ's asset quality, including reduced levels of nonperforming assets and net loan charge-offs. Specifically, since December 31, 1992, nonperforming loans declined from $31.4 million to $6.0 million at December 31, 1995, and net charge-offs declined from $6.7 million during 1993 to $1.5 million during 1994 and $386 thousand during 1995. In addition, BMJ has adhered to a procedural discipline in determining both the necessary provision for loan losses to be taken from earnings and the adequacy of the allowance for loan losses. Based upon management's judgement and evaluation of this methodology, BMJ has recorded no quarterly provision for loan losses since the second quarter of 1993. As a result of BMJ's increasingly diversified loan mix, stabilized and improving regional economies, and the continuing adequacy of the reserve for loan losses subsequent to the non-recurring negative provision, it was management's and the Board of Director's judgement that the interest of BMJ's shareholders was best served by this immediate, one-time negative provision.\nBMJ continued to pursue its aggressive program to reduce the level of total noninterest expenses while increasing operating efficiency. As a result, total noninterest expenses for the year ended December 31, 1995 amounted to $23.1 million, a reduction of 11.7% from total noninterest expenses of $26.1 million for the year ended December 31, 1994. Total noninterest expenses for 1994 represented a reduction of 20.9% from 1993.\nFor the year ended December 31, 1995, BMJ's core efficiency ratio (total noninterest expenses exclusive of other real estate expenses and certain nonrecurring charges as a percent of taxable-equivalent net interest income plus adjusted noninterest income) improved to 65.7% from 72.6% and 84.8% for the years ended December 31, 1994 and 1993, respectively.\nOperating results for 1994 and 1993 include those of BMJ's Southern Ocean State Bank subsidiary and the Willingboro branch of The Bank of Mid-Jersey. Southern Ocean State Bank was sold in July 1994, and the Willingboro branch was sold in November 1994.\nN\/M Not Meaningful. (1) Average equity divided by average total assets. (2) Tax equivalent based on a 34% federal tax rate for all periods represented (FTE=federal tax-equivalent basis). (3) Noninterest expense minus noninterest income to average earning assets. (4) Leverage ratio is Tier 1 capital to period end total assets less intangible assets. (5) Nonperforming loans include nonaccrual loans, impaired loans, loans 90 days past due or greater and still accruing, and restructured loans.\nNet Interest Income\nNet interest income is interest earned on loans and other interest-earning assets minus interest paid on deposits and other borrowed funds. Interest rate fluctuations as well as changes in the volume and mix of interest-earning assets and interest-bearing liabilities combine to affect net interest income.\nBMJ's net interest income was $28.2 million in 1995, matching the $28.2 million reported in 1994. Net interest income in 1994 increased marginally from the $27.8 million reported in 1993.\nThe financial summary presented in Table 3 details yields and rates of major interest-earning assets and interest-bearing liabilities over the past five years. Among other things, Table 3 shows that the net interest margin between yields on average interest-earning assets and costs of average funding sources was 5.53% in 1995 versus 5.28% in 1994 and 4.71% in 1993. The increase in BMJ's net interest margin is primarily the combined result of (a) growth in the loan portfolio; (b) a greater percentage of earning assets being funded by noninterest-bearing funding sources; and (c) a reduced level of nonperforming assets. The average balance of BMJ's loan portfolio increased to 72.3% of total interest-earning assets for 1995 compared to 67.1% for 1994 and 64.6% for 1993. For 1995, 21.3% of total interest-earning assets were funded by noninterest-bearing funding sources versus 18.1% for 1994 and 13.4% for 1993. In addition, total nonperforming assets at December 31, 1995 were reduced to $7.7 million compared to $14.2 million and $27.8 million at December 31, 1994 and 1993, respectively.\nBMJ's nonaccrual loans decreased to $6.0 million at December 31, 1995 compared to $8.7 million at December 31, 1994. Had year-end nonaccrual loans been paid in the manner and at the rate and time contracted at the time the loans were made, BMJ would have recognized additional interest income of $643 thousand in 1995, $845 thousand in 1994 and $1.4 million in 1993. Moreover, BMJ's net interest margin would have been .12% higher in 1995, .11% higher in 1994 and .14% higher in 1993.\nNet interest income also may be analyzed by segregating the volume and rate components of interest income and interest expense. Table 2 demonstrates the impact on net interest income of changes in the volume of interest-earning assets and interest-bearing liabilities and changes in interest rates earned and paid.\nThe interest-earning assets averages used in the calculation of the changes in Table 2 include nonaccrual loans and, therefore, their impact on net interest income is reflected in the change due to rate and not the change due to volume. Table 2 indicates that the modest increases in taxable equivalent net interest income for 1995 and 1994 resulted from the positive impact of changes in rate which were, to varying degrees, tempered by the negative impact of changes in volume.\nMost of BMJ's assets and liabilities do not reprice instantaneously with changes in market rates. During 1995, rates on every major category of interest-earning assets and interest-bearing liabilities increased from the prior year, reflecting increases in market interest rates. Table 14 illustrates BMJ's periodic and cumulative interest rate sensitivity positions as of December 31, 1995. BMJ is liability sensitive in the three month and six month periods whereas BMJ is asset sensitive in the one year, five year and after five year periods. A similar position existed throughout most of 1994.\nFor several years, BMJ has had a greater level of interest-earning assets than interest-bearing liabilities, with a difference of $80.7 million in 1993, $98.3 million in 1994, and $111.1 million in 1995. The ratio of average interest-bearing liabilities to average interest-earning assets has decreased from 86.6% in 1993 to 81.9% in 1994 and 78.7% in 1995. As noted above, decreases in this ratio result in a growing net interest margin as a result of a larger portion of interest-earning assets being funded by noninterest-bearing funding sources.\nNote: Interest income on tax-exempt loans and investments was computed by dividing the tax-exempt income by one minus the federal corporate income tax rate to reflect the tax equivalent income. Variances which were not specifically attributable to volume or rate were allocated proportionately between each, based on the overall effect on interest income and interest expense.\nNotes:\n(1) In the calculation of average loan rates, loan fees have been included in interest income as follows: $34,062 (or .01%) in 1995; $175,994 (or .05%) in 1994; $696,037 (or .18%) in 1993; $969,404 (or .20%) in 1992; $662,040 (or .12%) in 1991. Nonaccrual loans have been included in average balances.\n(2) Tax equivalent yield - Interest income on tax-exempt loans and securities was computed by dividing the tax-exempt income by one minus the federal corporate income tax rate of 34% to reflect the tax equivalent income.\n(3) Noninterest-bearing funding sources - Computed by subtracting interest-bearing liabilities from interest-earning assets.\nNoninterest Income\nBMJ's revenues include noninterest income, which consists primarily of service charges on deposit accounts and trust services income. In 1995, total noninterest income was $4.3 million and represented 13.3% of operating income (net interest income plus noninterest income) compared to $5.7 million, or 16.7%, in 1994 and $6.7 million, or 19.4%, in 1993.\nService charges, commissions and fees for 1995 decreased to $3.9 million from $5.2 million in 1994. Service charges, commissions and fees amounted to $5.0 million for 1993. The decrease in revenues from service charges, commissions and fees for the year ended December 31, 1995 compared to 1994 is due to the lower level of deposit accounts subject to service charges and other fees primarily as a result of the sale of BMJ's former Southern Ocean State Bank subsidiary on July 29, 1994.\nThere were no net gains or losses from securities transactions for the years ended December 31, 1995 and 1994 compared to securities gains of $690 thousand for the year ended December 31, 1993.\nNoninterest Expense\nNoninterest expense for 1995 was $23.1 million, a decrease of 11.7% from the $26.1 million reported for 1994. Noninterest expense for 1994 declined 20.9% from the $33.0 million reported for 1993. This decrease in noninterest expense is a result of the corporate-wide restructuring program begun in 1993, the objectives of which were to increase operating efficiency, further consolidate management functions, enhance the level of service provided to customers and increase shareholder value. Two significant initiatives completed during 1994 which have had an ongoing positive impact on the level of BMJ's noninterest expenses consistent with the restructuring program's objectives were the merger of BMJ's The Bank of Mid-Jersey and Mount Holly State Bank subsidiaries and the sale of BMJ's former Southern Ocean State Bank subsidiary. As previously discussed, Southern Ocean State Bank's 1994 operating results through June 30, 1994 are included in BMJ's operating results for the year ended December 31, 1994. BMJ's operating results for 1993 include those of Southern Ocean State Bank.\nSalaries and employee benefits amounted to $9.6 million for 1995 compared to $10.7 million for 1994 and $13.3 million for 1993. Salaries expense, which is the largest component of this noninterest expense category, amounted to $8.1 million for 1995, decreasing by 9.7% from the $9.0 million for 1994. Salaries expense for 1993 was $11.2 million. BMJ has reduced the number of full-time equivalent employees at December 31, 1995 to 277 employees compared to 289 employees and 371 employees, at December 31, 1994 and 1993, respectively. Salaries and employee benefits as a percentage of average assets decreased to 1.74% for 1995 compared to 1.83% for 1994 and 2.05% for 1993.\nNet occupancy expense decreased by 11.5% to $2.9 million for 1995 compared to $3.2 million for 1994. Net occupancy expense for 1993 totaled $3.7 million. This category of noninterest expense has decreased as a percentage of average assets to .51% for 1995 compared to .55% for 1994 and .57% for 1993.\nOther real estate expenses decreased to $641 thousand for 1995 from $1.5 million for 1994. Other real estate expenses decreased to $1.5 million for 1994 from $3.9 million for 1993. These expenses include the costs to maintain repossessed properties, such as insurance, property taxes and general maintenance expenses. The significant decrease in the level of other real estate expenses for 1995 is a result of BMJ's success in effectively liquidating the property portfolio. Other real estate expenses also include a provision to increase the valuation reserve used to adjust the carrying value of foreclosed properties to their fair value. Provisions of $150 thousand, $863 thousand and $1.7 million were recorded during 1995, 1994 and 1993, respectively.\nThe other noninterest expense category totaled $10.0 million for 1995 compared to $10.7 million for 1994 and $12.1 million for 1993. Included among the components in this noninterest expense category are FDIC insurance premiums and legal fees. Refer to Note 12 to the Consolidated Financial Statements for the primary components of this category.\nIn August 1995, the Federal Deposit Insurance Corporation (\"FDIC\") approved a reduction in the premium banks pay for deposit insurance. For well-capitalized institutions, the premium is reduced by 83%, from $0.23 for every $100 of deposits to $0.04 for every $100 of deposits. BMJ's The Bank of Mid-Jersey subsidiary is qualified as a well-capitalized institution. On September 15, 1995, The Bank of Mid-Jersey received a refund of $281 thousand from the FDIC representing a refund of prepaid deposit insurance premiums. As a result, FDIC insurance expense for the year ended December 31, 1995 was $539 thousand, which reflects a 60% decrease from the $1.3 million for 1994. FDIC insurance premiums amounted to $1.8 million for 1993.\nLegal fees for 1995 amounted to $1.1 million compared to $1.6 million for 1994 and $2.0 million for 1993. The current year decrease reflects lower costs associated with obtaining title to properties through the foreclosure process and in pursuing collection of delinquent loans.\nIncome Tax Expense\nIncome tax expense for the year ended December 31, 1995 amounted to $3.1 million, increasing from the income tax expense amounts reported for each of the years ended December 31, 1994 and 1993.\nAs a result of significant tax loss carryback refund claims previously filed by the Company, BMJ has been under examination by the Internal Revenue Service (\"IRS\") for the taxable years 1989 through 1993. During the third quarter of 1995, BMJ received the Revenue Agent's Report (\"RAR\") for the years under audit and has agreed to the examiner's findings. Although the agent's report and the related refund claims are subject to review by the Joint Committee on Taxation of the U.S. Congress, BMJ has evaluated its reserves for income taxes based on acceptance of the RAR. As a result of this review, income tax expense for the year ended December 31, 1995 has been reduced by $1.0 million, representing the reversal of previously accrued income taxes. BMJ believes that the remaining income tax reserves are adequate to cover tax liabilities for all open years.\nEffective January 1, 1993, BMJ adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\". During 1994, sufficient positive evidence had accumulated to warrant the reversal of the valuation allowance originally established upon adoption of the Statement. Therefore, income tax expense for the year ended December 31, 1994 was reduced by $4.9 million, representing a reversal of a portion of the valuation allowance.\nBalance Sheet Analysis\nTotal assets of BMJ amounted to $588.7 million at December 31, 1995, increasing from $538.4 million at December 31, 1994. This increase is primarily attributable to an increase in the level of total deposits at December 31, 1995 versus December 31, 1994. Total deposits of $485.0 million at December 31, 1995 represents a 5% increase from the $463.6 million of total deposits at December 31, 1994. This increase was achieved despite the high level of competition that exists among financial institutions in BMJ's market for retail deposits. Through renewed marketing programs and competitively priced deposit products, it is BMJ's intention to increase its share of the retail deposits market.\nDuring 1995, BMJ continued to improve its capital ratios and its balance sheet condition. Shareholders' equity increased from $58.3 million at December 31, 1994 to $65.6 million at December 31, 1995. The ratio of shareholders' equity to total assets at December 31, 1995 remained strong at 11.1% compared to 10.8% at December 31, 1994.\nIn addition, asset quality continued to improve as total nonperforming assets at December 31, 1995 were reduced by $6.5 million to $7.7 million compared to $14.2 million at December 31, 1994. The following discussion deals with the major components of the balance sheet.\nSecurities Available for Sale\nSecurities which may be sold in response to changing market and interest rate conditions or as part of BMJ's asset\/liability strategy have been classified as securities available for sale. The securities available for sale portfolio amounted to $64.6 million at December 31, 1995 compared to $2.9 million at December 31, 1994. On an average basis, the portfolio represented 4.3% of average interest-earning assets for the year ended December 31, 1995 compared to 2.3% of average interest-earning assets for the year ended December 31, 1994. BMJ's practice had been to classify all securities purchased during 1995 as securities available for sale as management responded to changes in the interest rate environment and as part of the asset\/liability management strategy. Following an analysis of the securities available for sale portfolio during 1993, management transferred certain securities for which it was determined BMJ had the intent and ability to hold to maturity, to the securities held to maturity portfolio.\nNote 3 to the Consolidated Financial Statements details the composition of the securities available for sale portfolio at December 31, 1995, 1994 and 1993. Table 3 provides information concerning average yields and balances of the securities available for sale portfolio over the past five years. Table 4 provides the maturities and weighted average yields for the securities available for sale portfolio at December 31, 1995. Yields on tax-exempt securities are presented on a fully taxable equivalent basis assuming a 34% federal tax rate.\nNote: Tax equivalent yield-interest income on tax exempt securities was computed by dividing the tax exempt income by one minus the federal corporate income tax rate (34%) to reflect the tax equivalent income.\nSecurities Held to Maturity\nBMJ's securities held to maturity portfolio amounted to $82.5 million at December 31, 1995 compared to $119.0 million at December 31, 1994. Note 4 to the Consolidated Financial Statements details the composition of the securities held to maturity portfolio at December 31, 1995, 1994 and 1993. As previously stated, BMJ's practice had generally been to classify all securities purchased during 1995 as securities available for sale as management responded to changes in the interest rate environment and as part of the asset\/liability strategy. During 1995 BMJ transferred $23.1 million from the securities held to maturity portfolio to the available for sale portfolio in accordance with the one-time reassessment opportunity permitted by the Financial Accounting Standards Board special report entitled \"A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities\". Table 3 provides information concerning average yields and balances of the securities held to maturity portfolio over the past five years. Table 5 provides the maturities and weighted average yields for the securities held to maturity portfolio at December 31, 1995. Yields on tax-exempt securities are presented on a fully taxable equivalent basis assuming a 34% federal tax rate.\nNote: Tax equivalent yield-interest income on tax exempt securities was computed by dividing the tax exempt income by one minus the federal corporate income tax rate (34%) to reflect the tax equivalent income.\nLoan Portfolio\nBMJ's loan portfolio totaled $399.4 million at December 31, 1995, increasing by 11.7% from $357.4 million at December 31, 1994. Total loans averaged $377.4 million during 1995, an increase of $12.6 million compared to $364.8 million for 1994. The yield on the total loan portfolio was 8.94% in 1995 compared to 8.35% in 1994. A five-year comparative schedule of the components of BMJ's loan portfolio is presented in Table 6.\nSubstantially all of BMJ's lending activity is to customers, or secured by property, located within Mercer, Burlington and Ocean counties in New Jersey. Of the portfolio as a whole, at December 31, 1995, approximately 82.1% of BMJ's loans are secured by real estate.\nFor purposes of monitoring credit exposure and concentration of risk, BMJ tracks its loans to related individuals and entities of which one person may be associated as a principal or a common enterprise exists. As of December 31, 1995, BMJ had 8 relationships with outstanding loan balances in excess of $4.5 million, the largest of which was $8.6 million. All of these relationships were current in meeting scheduled payment terms and were considered performing, except for one relationship which included a $960 thousand loan which was 30 - 59 days past due.\nThe real estate mortgage portfolio of $295.5 million at December 31, 1995 represented 74.0% of the total loan portfolio and includes $116.6 million in residential mortgage loans, $36.2 million in home equity credit-lines, and $142.7 million in commercial real estate loans. The residential and home equity credit-line portions of this portfolio represent a core business for BMJ which management intends to expand.\nAt December 31, 1995 real estate construction loans totaled $32.4 million, representing 8.1% of the total loan portfolio. These loans are monitored with advances made generally after work is completed and independently inspected and verified by qualified professionals. It is BMJ's policy to provide construction financing to qualified customers within its marketplace only when commitments for permanent financing are in place.\nBMJ's consumer loan portfolio of $46.5 million has experienced minimal delinquency or credit losses. Management believes that this portion of the loan portfolio can continue to be profitably expanded without lessening credit standards. It is management's intention to continue aggressively marketing these products to the communities which BMJ serves.\nThe degree of risk inherent in all of BMJ's lending activities is heavily influenced by the economic conditions of BMJ's primary market areas. Changes in regional and local real estate values, employment levels, and income levels are among the factors affecting the risk in the loan portfolio.\nConsumer loan portfolio risk is affected by the value of collateral such as residential property and personal automobiles. This portfolio includes both traditional installment type lending and traditional residential first and second mortgages.\nCommercial real estate\/construction loan risk is influenced by the same general factors as indicated above but, in addition, risk is influenced by the specific borrower's financial condition, demand for retail and office space, and the long-term viability of manufacturing and distribution businesses within BMJ's marketplace.\nAt December 31, 1995, BMJ had no loans concentrated to borrowers engaged in the same or similar industries that exceeded 10% of total loans other than the loan categories presented in Table 6. There was no leveraged buy-out (\"LBO\") loan exposure at December 31, 1995. In addition, at December 31, 1995, BMJ had no cross-border outstandings to borrowers in foreign countries. Cross-border outstandings are defined as loans, acceptances, interest-bearing assets with other banks and other interest-bearing investments.\nTable 7 provides information concerning the interest rate sensitivity of BMJ's commercial, financial and agricultural, and real estate-construction loans at December 31, 1995.\nNonperforming Assets\nNonperforming assets consist of nonperforming loans, impaired loans and other real estate owned. Table 8 sets forth a five-year comparative schedule of nonperforming assets and risk elements in BMJ's loan portfolio by type for the periods indicated.\nNonperforming loans include nonaccrual loans, impaired loans, loans 90 days or greater past due and still accruing, and restructured loans. Loans are generally reported as nonaccrual if they are past due as to maturity or payment of principal or interest for a period of more than 90 days, unless such loans are well-secured and in the process of collection. If a loan or a portion of a loan is partially charged off, the loan is classified as nonaccrual. Loans that are on a current payment status or past due less than 90 days may also be classified as nonaccrual if repayment in full of principal and\/or interest is determined to be in jeopardy. Loans, with the exception of partially charged off loans or loans with any portion classified as doubtful, may be placed back on accrual status when they become current as to both principal and interest and when concern as to future collectibility in full no longer exists. The remaining recorded balance of a partially charged off loan, however, may be returned to accrual status if the entire contractual loan balance, together with all unpaid contractual interest, is determined to be fully collectible. Nonperforming loans as a percentage of total loans were 1.5% as of December 31, 1995, and 2.8% as of December 31, 1994. The decline in nonaccrual loans is attributable to increased collections, transfers to other real estate, and charge-offs.\nInterest recognized as income during 1995 on nonaccrual loans totaled $75 thousand, compared to $384 thousand in 1994, and $38 thousand in 1993. While a loan is classified as nonaccrual and the future collectibility of the recorded loan balance is doubtful, collections of interest and principal are generally applied as a reduction to principal outstanding. When the future collectibility of the recorded loan balance is expected, interest income may be recognized on a cash basis. In the case where a nonaccrual loan had been partially charged off, recognition of interest on a cash basis is limited to that which would have been recognized on the recorded loan balance at the contractual interest rate. Additional interest income amounting to approximately $643 thousand for 1995, $845 thousand in 1994, and $1.4 million in 1993 would have been recognized if interest on all such loans had been recorded based upon original terms.\nRestructured loans are those whose contractual interest rates have been reduced to below current market rates or other concessions made due to the borrowers' financial difficulties. Interest on these loans is subject to the nonaccrual policy. At December 31, 1995 and December 31, 1994, BMJ had no restructured loans.\nThe following table illustrates the activity in BMJ's nonaccrual loans during the year ended December 31, 1995. Payments received on these loans continue to provide significant reductions in the outstanding balances.\n(in thousands) Balance, January 1, 1995 $ 5,769 New defaults 3,403 Transfer of insubstance foreclosures upon adoption of FAS 114 2,935 Assets foreclosed upon (2,208) Payoff, cures and sales (2,703) Charge-offs and writedowns (1,155) ------- Balance, December 31, 1995 $ 6,041 =======\nPotential problem loans consist of loans which are included in performing loans at December 31, 1995, but for which potential credit problems of the borrowers have caused management to have concerns as to the ability of such borrowers to comply with present repayment terms. At December 31, 1995 and 1994, such potential problem loans amounted to approximately $3.5 million and $5.9 million, respectively. Depending on the state of the economy and the impact thereof on BMJ's borrowers, as well as other future events, these loans and others not currently so identified could be classified as nonperforming loans in the future.\nOn January 1, 1995, BMJ adopted 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 Disclosure\". FAS No. 114 provides guidelines for measuring impairment losses on loans. A loan is considered to be impaired, based on current information and events, if it is probable that BMJ will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement. The measurement of impaired loans is generally based upon the present value of expected future cash flows discounted at the loan's historical effective interest rate except that all collateral- dependent loans are measured for impairment based on the fair value of the collateral. If the loan valuation is less than the recorded value of the loan, an impairment reserve must be established for the difference. The impairment reserve is established by either an allocation of the reserve for loan losses or by a provision for loan losses, depending on the adequacy of the reserve for loan losses.\nAt December 31, 1995, BMJ's recorded investment in loans for which impairment has been recognized in accordance with FAS 114 amounted to $7.3 million. The reserve for loan losses at December 31, 1995 includes reserves of $1.2 million applicable to such impaired loans. All of these loans were valued using the fair value of collateral method. Based on this method, $1.2 million of the $10.1 million reserve for loan losses at December 31, 1995 was allocated against all of the impaired loans. The remaining reserve for loan losses, totalling $8.9 million at December 31, 1995, is available to absorb losses in BMJ's entire loan portfolio. During 1995, the average recorded investment in impaired loans was approximately $7.1 million. Interest income recognized on total impaired loans during 1995 was approximately $447 thousand.\nFAS No. 114 also provides for the reclassification of all outstanding insubstance foreclosure loans (\"ISF\") from Other Real Estate to the loan portfolio as nonaccrual loans at their current carrying value. The reclassification of ISFs to loans has been made upon adoption of FAS No. 114 and this reclassification is reflected in the schedule of BMJ's nonperforming assets in Table 8. BMJ will no longer be required to identify and isolate future loans that may meet the former criteria for ISF classification.\nThe following table illustrates the activity in BMJ's other real estate during the year ended December 31, 1995.\n(in thousands) Balance, January 1, 1995 $ 8,172 Assets foreclosed upon 2,882 Sales and other reductions (5,037) Writedowns to fair value\/charge-offs (1,119) Transfer of insubstance foreclosures to loans upon adoption of FAS 114 (2,935) -------- Subtotal 1,963 Less loss reserve (277) -------- Balance, December 31, 1995 $ 1,686 ========\nOther real estate consists of properties acquired through foreclosure or acceptance of a deed in lieu of foreclosure. A reserve for other real estate has been established to maintain the portfolio at the lower of cost or fair value less estimated disposition costs. At December 31, 1995, the balance of other real estate, net of the reserve, amounted to $1.7 million, a reduction of 77% from the combined balance of $7.2 million at December 31, 1994.\nThe 45.8% decline in nonperforming assets during 1995 is the result of workout and collection activity, write-offs in recognition of lesser collateral value, disposal of other real estate owned and the effects of the economic recovery.\nReserve For Loan Losses\nAt December 31, 1995 the reserve for loan losses totaled $10.1 million compared to $12.5 million at December 31, 1994. The ratio of the reserve for loan losses to total loans at December 31, 1995 was 2.53% versus 3.52% at December 31, 1994.\nManagement has adopted a reserve methodology consistent with the provisions of FAS 114 for the assessment of all loans including residential real estate mortgages and consumer loans. This methodology assigns reserves based upon credit risk ratings for specific loans and general reserves for all other loans. The general reserves are based on historical charge-off experience but are subject to certain minimums based upon BMJ's assessment of the current economic environment. Table 9 provides a five year summary of the changes in the reserve for loan losses and Table 10 provides a five year summary of the distribution of the loan loss reserve to loan categories.\nAs with any financial institution, poor economic conditions, high inflation, high interest rates, or high unemployment may lead to increased losses in the loan portfolio. Conversely, improvements in economic conditions tend to reduce the amounts charged off against the reserve. BMJ's gross charge-offs in 1995 totaled $2.1 million, compared with $3.1 million in 1994 and $8.1 million in 1993. Loans other than certain consumer loans not secured by real estate are charged off if management judges the loans to be uncollectible or the loan has been classified as a loss by either the Federal Reserve, FDIC, or New Jersey state examiners. Certain closed-end and open-end consumer loans not secured by real estate are automatically charged off after they are contractually delinquent 90 days.\nSubsequent to the charge-off of a loan, it is BMJ's policy to continue to vigorously pursue the collection of principal outstanding as well as past due interest. During 1995, collection efforts resulted in recoveries of $1.7 million on previously charged-off loans compared with $1.6 million in 1994 and $1.4 million in 1993. Net loan charge-offs in 1995 represented .10% of average loans outstanding compared to .42% in 1994 and 1.72% in 1993.\nThe provision for loan losses represents BMJ's assessment of the amount to be provided to the reserve for loan losses in order to maintain the reserve at a level considered adequate in relation to the risks and uncertainties inherent in the loan portfolio. Amounts charged against current income are based on such factors as past loan loss experience as related to current loan portfolio mix, evaluation of actual and potential losses in the loan portfolio, prevailing regional and national economic conditions that might have an impact on the portfolio, regular reviews and examinations of the loan portfolio by internal loan reviewers and reviews and examinations by bank regulatory authorities.\nBMJ recorded a negative provision for loan losses of $2.0 million in 1995. No provision for loan losses was recorded in 1994 and a provision of $840 thousand was recorded in 1993.\nThe negative provision of $2.0 million recorded in 1995 was driven by the continuing improvements of BMJ's asset quality, including reduced levels of nonperforming assets and net loan charge-offs. Specifically, since December 31, 1992, nonperforming loans have declined from $31.4 million to $6.0 million at December 31, 1995, and net charge-offs declined from $6.7 million during 1993 to $1.5 million during 1994 and $386 thousand during 1995. In addition, BMJ has adhered to the previously discussed methodology in determining both the necessary provision for loan losses to be taken from earnings and the adequacy of the allowance for loan losses. Based upon management's judgement and evaluation of this methodology, BMJ has recorded no quarterly provision for loan losses since the second quarter of 1993. As a result of BMJ's increasingly diversified loan mix, stabilized and improving regional economies, and the continuing adequacy of the reserve for loan losses subsequent to the non-recurring negative provision, it was management's and the Board of Director's judgement that the interest of BMJ's shareholders was best served by this immediate, one-time negative provision.\nManagement also determined that the fourth quarter of 1995 was the appropriate period in which to record the negative provision for loan losses for the following reasons:\no Trends in BMJ's criticized assets have stabilized over the last three quarters of 1995;\no Recoveries on previously charged-off loans over the past eight quarters have been strong and, accordingly, charge-offs have not reduced the reserve for loan losses as originally anticipated;\no All litigation associated with the loans reserved for during the period of 1991 through 1994 had essentially been settled by the third quarter of 1995; and\no The adoption of FAS 114 during 1995 has increased the unallocated portion of the reserve because \"substandard\" loans which have been identified as impaired generally do not require specific reserves as a result of collateral which supports the recorded investment in the loan.\nSubsequent to the non-recurring negative provision, management believes BMJ's reserve for loan losses is adequate for losses inherent in the loan portfolio, and its reserve coverage is generally comparable with BMJ's peer institutions. The reserve for loan losses at December 31, 1995 was 2.53% of total loans. According to the most recent Uniform Bank Performance Report issued by the Federal Reserve Bank, the peer average for banks throughout the country between $500 million and $1.0 billion in assets is a reserve for loan losses to total loan portfolio ratio of 1.59%. Consistent with BMJ's practice of maintaining an adequate reserve for loan losses, the general portion of the loan loss reserve was $8.9 million, or 88% of the total reserve at December 31, 1995. There can be no assurance that if asset quality deteriorates in future periods material additions to the reserve for loan losses will not be required.\nTable 10 provides a five-year summary of the distribution of the loan loss reserve to loan categories. The unallocated reserve includes both the specific reserve as calculated under FAS 114 and the general reserve as calculated under Statement of Financial Accounting Standards No. 5, \"Accounting for Contingencies\".\nTable 11 sets forth information concerning other real estate owned reserve activity for the periods indicated:\nOff-Balance Sheet Risk\nIn the normal course of business, BMJ enters into various financial instruments which are properly not recorded in the consolidated financial statements. BMJ's risk of accounting loss due to the credit risks and market risks associated with these off-balance sheet instruments varies with the type of financial instrument. Principal or notional amounts may not necessarily indicate the degree of exposure involved. Credit risk represents the possibility of a loss occurring from the failure of another party to perform in accordance with the terms of the contract. BMJ's maximum exposure to accounting loss, based upon the credit risk associated with unfunded loan commitments and letters of credit outstanding, is represented by the contractual amount of these items as of the dates indicated in the following table:\n(in millions) Contractual Amount ------------------ 12\/31\/95 12\/31\/94 -------- --------\nCommitments to extend credit $76.4 $57.0\nPerformance standby letters of credit and similar arrangements $ 2.7 $ 3.1\nFinancial standby letters of credit and similar arrangements $ 0.9 $ 1.1\nMany of such commitments to extend credit may expire without being drawn upon and, therefore, the total commitment amounts do not necessarily represent future cash flow requirements. In making the commitments, BMJ applies the same credit policy standards used in the lending process and periodically reassesses the customers' creditworthiness through ongoing credit reviews. BMJ also holds various forms of collateral, including cash deposits and mortgage liens on real estate, to support those commitments for which collateral is deemed necessary. Substantially all of BMJ's lending is secured by property located within Mercer, Burlington and Ocean counties in New Jersey. The risks associated with making these commitments are also included in BMJ's evaluation of the overall credit risk in determining the reserve for loan losses.\nFinancial standby letters of credit and similar arrangements are commitments issued by BMJ which irrevocably obligate BMJ to pay a third-party beneficiary when a customer fails to repay an outstanding loan or debt instrument.\nPerformance standby letters of credit are commitments issued by BMJ which irrevocably obligate BMJ to pay a third-party beneficiary when a customer fails to perform some contractual non-financial obligation.\nAt December 31, 1995 and 1994, BMJ had identified approximately $745 thousand and $972 thousand, respectively, of the reserve for loan losses as a general allocation of the reserve for potential losses, including losses due to off-balance sheet credit risk. No material amount of currently outstanding commitments are to borrowers having prior outstanding balances which are classified as nonperforming or potential problem assets.\nDeposits\nBMJ's deposit base is the principal source of funds supporting interest-earning assets. Maintaining a strong core deposit base is key to the development of long-term customer relationships, which, in turn, present opportunities for BMJ to cross-sell its services. To meet the requirements of its diverse customer base, BMJ offers a full range of deposit products, including interest-bearing and noninterest-bearing demand deposits, savings deposits, insured retail money market accounts and certificates of deposit.\nTotal deposits amounted to $485.0 million at year-end 1995 compared to $463.6 million at the end of 1994. Average total deposits during the year were $466.7 million compared to $516.0 million during 1994. The sale of BMJ's Southern Ocean State Bank subsidiary and the sale of Mid-Jersey's Willingboro branch office during 1994 resulted in a decline in total deposits when comparing 1995 average total deposits with 1994 amounts.\nTable 12 details average deposit balances and rates over the past three years. As indicated in the table, the average total of noninterest-bearing demand deposits and savings deposits for the year ended December 31, 1995 decreased by 6.3% and 3.1%, respectively, from their 1994 average balances. The average total of other time deposits for the year ended December 31, 1995 increased by 9.7%, while interest bearing demand deposits decreased by 26.7% from the 1994 average balances. As a result of this shift in BMJ's deposit mix, the average rate paid on BMJ's deposit balances for 1995 was 2.65%, a 41.0% increase from the 1.88% average rate for 1994.\nThe balance of certificates of deposit of $100,000 or more increased by $9.4 million at year-end 1995 compared to year-end 1994. The balance also increased as a percentage of total deposits from .97% of deposits at year-end 1994 to 2.9% of deposits at year-end 1995. The ratio of time deposits greater than $100,000 to total assets at year-end 1995 was 2.4%. The higher interest rate levels during 1995 allowed BMJ to attract and retain deposits in this product which was more attractive to BMJ's customer base than other investment vehicles. The maturity characteristics and dollar amount of these deposits are reflected in Table 13. BMJ does not purchase deposits through wholesale deposit brokers, preferring to rely on more stable retail deposits to support growth.\nCapital Adequacy\nBMJ's level of shareholders' equity continued to improve during 1995, primarily as the result of improved operating results and earnings retention. The following table provides selected shareholders' equity data at December 31, 1995 and 1994.\nThe Federal Reserve Board (\"FRB\") has issued risk-based capital guidelines applicable to member banks and bank holding companies, and the FDIC has issued comparable guidelines applicable to state nonmember banks. The guidelines, which establish a risk-adjusted ratio relating to the total amount of assets and off-balance sheet exposures, (as such assets and off-balance sheet items are weighted to reflect the risk inherent therein,) require a minimum total risk-based capital ratio of 8.00%, with at least half of the total capital in the form of Tier 1 capital. The risk-based capital ratios of BMJ and Mid-Jersey were as follows on the dates shown:\nThe FRB and FDIC have also adopted leverage capital requirements specifying the minimum acceptable ratios of Tier 1 capital to total assets. Under these requirements, the most sound, well-run institutions engaged in the least risky operations are required to maintain minimum leverage ratios of at least 3%; all other institutions are required to maintain higher levels of capital depending on their condition. The leverage ratios of BMJ and Mid-Jersey were as follows on the dates shown:\nFailure to satisfy any minimum capital requirements applicable to BMJ or Mid-Jersey could subject BMJ or Mid-Jersey, as the case may be, to further regulatory actions by the FRB.\nAs a result of BMJ's improved capital ratios and continued earnings progress, the payment of quarterly dividends to shareholders was resumed during 1995 at the level of $.05 per share. During the fourth quarter of 1995, BMJ announced a 50% increase in the amount of the quarterly cash dividend to $.075 per share. These shareholder dividends represent the first to be paid by BMJ since dividends were suspended in 1991.\nThe primary source of funds for payment of dividends by BMJ is dividends received from Mid-Jersey. The amount of dividends that Mid-Jersey may declare in any year is subject to certain regulatory limitations. Mid-Jersey may not declare dividends if such declaration would leave it inadequately capitalized. Generally, dividends declared by a bank are limited to its net profit, as defined by the regulatory agencies, for that year combined with its retained net income from the preceding two years. At January 1, 1996, the amount of retained earnings of Mid-Jersey available for declaration of dividends to BMJ was $19.0 million.\nLiquidity and Asset\/Liability Management\nLiquidity refers to BMJ's ability to maintain cash flow adequate to fund operations and meet obligations on a timely and cost effective basis. Asset liquidity is represented by the ease with which assets can be converted into cash. BMJ continually evaluates its funding needs and manages its liquidity position by maintaining adequate levels of liquid assets, such as cash and cash equivalents and securities available for sale. BMJ's funding needs change as loans grow, deposits mature and payments on obligations are made. Because the characteristics of BMJ's assets and liabilities change, liquidity management is a dynamic process. Among those factors affecting liquidity management are pricing and maturity of loans, deposits and other assets and liabilities. In addition, liquidity management is affected by changes in the relationship between short-term and long-term interest rates.\nAt December 31, 1995, BMJ had a total of $90.2 million or 15.3% of total assets in cash and cash equivalents and securities available for sale, representing its primary sources of liquidity, as compared to $47.7 million or 8.9% of assets at December 31, 1994. Another source of asset liquidity is the cash flows provided by maturities and periodic repayments of principal of both the securities held to maturity portfolio and the loan portfolio.\nLiabilities also provide a source of liquidity for BMJ. Wholesale certificates of deposit (none of which were brokered deposits) and repurchase agreements comprised 5.1% of total liabilities at December 31, 1995 and 2.8% at December 31, 1994. Management believes there is substantial room to increase these funding sources if necessary to meet its liquidity needs. The Bank of Mid-Jersey joined the Federal Home Loan Bank system during 1995 and has established a line of credit of approximately $71.9 million with the Federal Home Loan Bank of New York to further support and enhance liquidity. At December 31, 1995 approximately $13.4 million was outstanding against this line of credit. In addition, Mid-Jersey currently has a $2.0 million line of credit with a correspondent bank to cover short term funding needs in the federal funds market.\nAs shown in the Consolidated Statement of Cash Flows, cash and cash equivalents decreased by $19.2 million to $25.6 million at December 31, 1995. This decrease reflected net cash of $9.7 million provided by operating activities and $37.1 million of net cash provided by financing activities offset by $66.0 million of net cash used in investing activities. Cash generated by operating activities reflected BMJ's net income of $8.3 million adjusted for noncash charges and credits. Cash provided by financing activities primarily reflected the net increases in certificates of deposit and in other borrowed funds, partly offset by the net decrease in demand deposits, savings and interest checking accounts. Cash used in investing activities was primarily for the purchase of the securities available for sale and the net increase in loans, offset in part by the proceeds from sales of securities available for sale and the proceeds from maturities of securities held to maturity.\nAt December 31, 1995, the parent company had a total of $2.2 million in cash and cash equivalents and $8.5 million in available for sale securities, which serve as the parent company's primary sources of liquidity. The parent company does not maintain lines of credit or other borrowing arrangements. BMJ has the capacity to borrow funds from the Federal Reserve discount window to meet liquidity needs that are not funded through subsidiary dividends or income.\nBMJ's principal asset\/liability management objectives are to manage the sensitivity of net interest spreads to potential changes in interest rates and to enhance profitability in ways that should provide sufficient reward for understood and controlled risk. Specific asset\/liability strategies are chosen to achieve an appropriate trade-off between average spreads and the variability of spreads. The BMJ Asset\/Liability Management Committee meets weekly to monitor consolidated risk at the corporate level and to monitor compliance with established liquidity and interest rate sensitivity policy parameters on a consolidated and subsidiary bank basis. Funding positions are kept within established policy limits designed to maintain reasonable risk levels and adequate liquidity.\nTable 14 represents BMJ's interest rate gap position at December 31, 1995. This is a one-day position which is continually changing and is not necessarily indicative of BMJ's position at any other time. Additionally, Table 14 indicates only the contractual or anticipated repricing of assets and liabilities and does not consider the many factors that accompany interest rate movements. BMJ's negative period interest rate gap position through six months reflects its historically strong customer deposit-gathering franchise which provides a relatively stable core deposit base. These available funds have been deployed in longer-term interest-earning assets including certain loans and securities.\nIn order to measure the effects of interest rate fluctuations on BMJ's net interest margin, management simulates the potential effects of changing interest rates through computer modeling. These simulations determine the impact on net interest income of various interest rate scenarios and balance sheet trends and strategies. These simulations incorporate the dynamics of the balance sheet as well as the interrelationships between various categories of short-term interest rates and the impact the yield curve level has on asset and liability pricing. Net interest income sensitivity to balance sheet trends and interest rate movements is quantified, and appropriate strategies are developed and implemented.\nAs a financial institution, BMJ entails a degree of interest rate risk as a provider of banking services to its customers. BMJ does not use derivative interest rate contracts, such as interest rate swaps, caps or floors to manage interest rate risk. In the event BMJ's computer model indicates an unacceptable level of risk, BMJ could undertake a number of actions that would reduce this risk, including the sale of a portion of its available for sale securities portfolio.\nQuarterly Results of Operations\nA summary of the quarterly results of operations for the years ended December 31, 1995 and 1994 is presented in Table 15. Cumulative data for the same period is found in the consolidated statement of operations.\nThe following discussion addresses those quarter-to-quarter fluctuations determined by management to be material items requiring additional disclosure.\nProvision for Loan Losses\nBMJ's continued improvement in asset quality resulted in a negative provision for loan losses for the year ended December 31, 1995 of $2.0 million compared to no provision in 1994. The negative provision of $2.0 million is a one-time non-recurring event recognized in the fourth quarter of 1995. This negative provision was driven by the continuing improvement in asset quality including reduced levels of nonperforming assets and net loan charge-offs. Specifically, since 1992, BMJ has adhered to a procedural discipline in determining both the necessary provision for loan losses to be taken from earnings and the adequacy of the allowance for loan losses. Based upon management's judgement and evaluation of this methodology, BMJ has recorded no quarterly provision for loan losses since the second quarter of 1993. As a result of BMJ's increasingly diversified loan mix, stabilized and improving regional economies, and the continuing adequacy of the reserve for loan losses, subsequent to the non-recurring negative provision, it is management's and the Board of Directors' judgement that the interest of BMJ's shareholders is best served by this immediate, one-time negative provision.\nManagement also determined that the fourth quarter of 1995 was the appropriate period in which to record the negative provision for loan losses for the following reasons:\no Trends in BMJ's criticized assets have stabilized over the last three quarters of 1995;\no Recoveries on previously charged-off loans over the past eight quarters have been strong and, accordingly, charge-offs have not reduced the reserve for loan losses as originally anticipated;\no All litigation associated with the loans reserved for during the period of 1991 through 1994 had essentially been settled by the third quarter of 1995; and\no The adoption of FAS 114 during 1995 has increased the unallocated portion of the reserve because \"substandard\" loans which have been identified as impaired generally do not require specific reserves as a result of collateral which supports the recorded investment in the loan.\nManagement has determined that as a result of the negative loan loss provision, quarterly provisions will be required during 1996 to maintain an adequate reserve for loan losses.\nIncome Tax Expense\nAs a result of significant tax loss carryback refund claims previously filed by the Company, BMJ has been under examination by the Internal Revenue Service (\"IRS\") for the taxable years 1989 through 1993. During the third quarter of 1995, BMJ received the Revenue Agent's Report (\"RAR\") for the years under audit and has agreed to the examiner's findings. Although the agent's report and the related refund claims are subject to review by the Joint Committee on Taxation of the U.S. Congress, BMJ has evaluated its reserves for income taxes based on acceptance of the RAR. As a result of this review, income tax expense for the third quarter of 1995 was reduced by $1.0 million, representing the reversal of previously accrued income taxes. BMJ believes that the remaining income tax reserves are adequate to cover tax liabilities for all open years.\nCommon Stock\nBMJ's common stock is traded over-the-counter and quoted by the National Association of Securities Dealers through the NASDAQ National Market System. The NASDAQ symbol for BMJ's common stock is BMJF. During 1995, monthly trading volume averaged approximately 215,710 shares. As of December 31, 1995, there were 1,970 registered holders of BMJ's common stock.\nTable 16 presents the sale price range and dividends per share for the eight quarters ended December 31, 1995. These prices reflect actual transactions and do not include commissions.\nAs a result of BMJ's improved capital ratios and continued earnings progress, the payment of quarterly dividends to shareholders was resumed during 1995 at the level of $.05 per share. During the fourth quarter of 1995, BMJ announced a 50% increase in the amount of the quarterly cash dividend to $.075 per share. These shareholder dividends represent the first to be paid by BMJ since dividends were suspended in 1991.\nA dividend reinvestment and stock purchase plan is available for shareholders who wish to increase their holdings. Under the plan, quarterly dividends may be reinvested in BMJ common stock at a discount from market value of between 0% and 10% inclusive (as determined from time to time by BMJ's Board of Directors). In addition, optional cash investments of not less than $100 nor more than a specified amount per quarterly investment period (as determined by BMJ's Board of Directors from time to time) may be made in BMJ common stock at a discount from market value of between 0% and 10% inclusive without incurring any commission or fee. BMJ has reserved the right, however, to eliminate and\/or reinstate the optional cash investment feature at any time, which shall be indicated to shareholders by written notice. At present, BMJ provides no discount on dividend reinvestments and optional cash investments. BMJ permits optional cash investments by a participating shareholder of up to $5,000 per calendar quarter per account.\nOn January 22, 1996, BMJ announced a stock buy-back program for calendar year 1996. The program, approved by the Board of Directors, allows for the repurchase of up to five percent of BMJ stock at management's discretion, either on a privately negotiated basis or on the open market.\nRecent Accounting Pronouncements\nIn March 1995, the Financial Accounting Standards Board (\"FASB\") released FAS No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of\". FAS No. 121 established guidelines for recognition of impairment losses related to long-lived assets and certain intangibles related to goodwill for both assets to be held and used as well as assets held for disposition. This statement excludes financial instruments, long-term customer relationships of financial institutions, mortgage and other servicing rights and deferred tax assets. This standard becomes effective on January 1, 1996. BMJ has determined that adoption of FAS No. 121 will not have a material impact on its financial position or results of operations and, at this time, does not plan early adoption.\nIn May 1995, the FASB released FAS No. 122, \"Accounting for Mortgage Servicing Rights\". FAS No. 122 requires recognition of mortgage servicing rights as separate assets, whether those rights are purchased or relate to loans originated for sale. This standard becomes effective on January 1, 1996. BMJ has determined that adoption of FAS No. 122 will not materially impact BMJ's financial position or results of operations and, at this time, does not plan early adoption.\nIn October 1995, the FASB released FAS No. 123, \"Accounting for Stock-Based Compensation,\" which is effective for fiscal years beginning after December 15, 1995. FAS No. 123 establishes a fair value-based method of accounting for stock-based compensation plans which measures compensation cost as the value of the award at the grant date and recognizes such cost over the service period. Under Accounting Principles Board Opinion (\"APBO\") No. 25 \"Accounting for Stock Issued to Employees,\" compensation cost as the excess of quoted market price at the grant date or other measurement date over the exercise price. FAS No. 123 allows for either method to be used; however, if a company elects to continue to account for stock-based compensation under APBO No. 25, pro forma disclosures of net income and earnings per share must be presented as if the fair value-based method had been adopted. BMJ has not determined which method will be used or the effect of adoption of FAS No. 123 and does not plan to elect early adoption of either the accounting or disclosure requirements.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nSee Financial Summary, attached hereto.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.\nNone\nPART III\nPursuant to General Instruction G(3), the information required by Part III (Items 10, 11, 12 and 13) are incorporated by reference from BMJ's definitive proxy statement which will be filed pursuant to Regulation 14A not later than 120 days after the end of BMJ's fiscal year ended December 31, 1995.\nPART VI\nItem 14.","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"Item 14. Exhibits, Financial Statements Schedules, and Reports on Form 8-K.\n(a) 1. Financial Statements\nIndependent Auditor's Report\nConsolidated Balance Sheet\nConsolidated Statement of Operations\nConsolidated Statement of Changes in Shareholders' Equity\nConsolidated Statement of Cash Flows\nNotes to Consolidated Financial Statements\n2. Financial Statement Schedules\nAll Schedules have been omitted as inapplicable, or not required, or because the required information is included in the Consolidated Financial Statements of the Notes thereto.\n3. Exhibits\n3(a) Certificate of Incorporation of B.M.J. Financial Corp., as amended, incorporated by reference to Exhibit 3(a) to the Registrant's Registration Statement on Form S-2, previously filed with the Securities and Exchange Commission on December 23, 1992, File No. 33-56266.\n3(b) Bylaws of B.M.J. Financial Corp., as amended, incorporated by reference to Exhibit 3.1 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1987. previously filed with the Securities and Exchange Commission, File No. 0-13440.\n4(a) Form of Common Stock Certificate of B.M.J. Financial Corp., incorporated by reference to Exhibit 4 to the Registrant's Registration Statement on Form S-1, previously filed with the Securities and Exchange Commission on September 4, 1984, File No. 2-93099.\n4(b) Form of Indenture between B.M.J. Financial Corp. and The Bank of Mid-Jersey, dated as of June 1, 1986, incorporated by reference to Exhibit 4.2(a) to the Registrant's Registration Statement on Form S-1, previously filed with the Securities and Exchange Commission on June 24, 1986, File No. 33-5264.\n4(c) Form of Indenture between B.M.J. Financial Corp. and The Bank of Mid-Jersey, dated as of June 1, 1990, incorporated by reference to Exhibit 4(b) to Amendment No. 2 to the Registrant's Registration Statement on Form S-2, previously filed with the Securities and Exchange Commission on February 9, 1993, File No. 33-56266.\n10(a) Lease for The Bank of Mid-Jersey Operations Center, incorporated by reference to Exhibit 10.5 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1984, previously filed with the Securities and Exchange Commission, File No. 2-87343.\n10(b) Lease for Mount Holly Executive Offices, incorporated by reference to Exhibit 10.11 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1987, previously filed with the Securities and Exchange Commission, File No. 2-87343.\n10(c) Assignment of Lease, dated as of July 24, 1990, between B.M.J. Financial Corp. and Bank of Delaware Valley, incorporated by reference to Exhibit 10(c) to the Registrant's Registration Statement on Form S-2, previously filed with the Securities and Exchange Commission on December 23, 1992, File No. 33-56266.\n10(d) Lease, dated as of November 7, 1988, between the Nickerson Development Corporation and B.M.J. Financial Corp., incorporated by reference to Exhibit 10-4 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1989, previously filed with the Securities and Exchange Commission, File No. 2- 87343.\n10(e) Certified resolutions of The Bank of Mid-Jersey describing guaranty of employment and severance pay in the event of a merger or sale of Mid-Jersey, incorporated by reference to Exhibit 10.7 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1984, previously filed with the Securities and Exchange Commission, File No. 2-87343.\n10(f) Certified resolutions of B.M.J. Financial Corp. describing guaranty of employment and severance pay in the event of a merger or sale of BMJ, incorporated by reference to Exhibit 10.13 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1986, previously filed with the Securities and Exchange Commission, File No. 2-87343.\n10(g) B.M.J. Financial Corp. Profit-Sharing and Deferred Savings Plan (as amended, 1987), incorporated by reference to Exhibit 10.14 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1989, previously filed with the Securities and Exchange Commission, File No. 2-87343.\n10(h) B.M.J. Financial Corp. Pension Plan (as amended, 1989), incorporated by reference to Exhibit 10.15 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1989, previously filed with the Securities and Exchange Commission, File No. 2-87343.\n10(i) B.M.J. Financial Corp. Executive Long-Term Incentive Plan, incorporated by reference to Exhibit 10.16 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1990, previously filed with the Securities and Exchange Commission, File No. 0-13440.\n10(j) B.M.J. Financial Corp. Director Stock Option Plan incorporated by reference to Exhibit 10.18 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1990, previously filed with the Securities and Exchange Commission, File No. 0-13440.\n10(k) Non-Qualified Option Agreement, dated as of June 15, 1992, between B.M.J. Financial Corp. and John H. Walther, incorporated by reference to Exhibit 10(k) to the Registrant's Registration Statement on Form S-2, previously filed with the Securities and Exchange Commission on December 23, 1992, File No. 33-56266.\n10(l) Written Agreement, dated as of December 24, 1991, between B.M.J. Financial Corp. and the Federal Reserve Bank of Philadelphia, incorporated by reference to Exhibit 28.2 to the Registrant's Report on Form 8-K, previously filed with the Securities and Exchange Commission on December 24, 1991, File No. 0-13440.\n10(m) Written Agreement, dated as of December 24, 1991, between The Bank of Mid- Jersey, the Federal Reserve Bank of Philadelphia, and the New Jersey State Commissioner of Banking, incorporated by reference to Exhibit 28.3 to the Registrant's Report on Form 8-K, previously filed with the Securities and Exchange Commission on December 24, 1991, File No. 0-13440.\n10(n) Facilities Management Data Processing Agreement, dated as of May 6, 1992, between B.M.J. Financial Corp. and Systematics Financial Services, Inc., incorporated by reference to Exhibit 28.2 to the Registrant's Report on Form 10-Q for the quarter ended March 31, 1992, previously filed with the Securities and Exchange Commission, File No. 0-13440.\n10(o) Amendment to the Memorandum of Understanding, dated as of January 11, 1989, between B.M.J. Financial Corp. and Robert H. Deacon, incorporated by reference to Exhibit 10.23 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1988, previously filed with the Securities and Exchange Commission, File No. 2-87343.\n10(p) Financial Advisory Agreement with Bear, Stearns & Co., Inc., incorporated by reference to Exhibit 10(r) to the Registrant's Registration Statement on Amendment No. 1 to Form S-2, previously filed with the Securities and Exchange Commission on January 25, 1993, File No. 33-56266.\n10(q) Agreement, dated February 17, 1993, between John H. Walther and B.M.J. Financial Corp., incorporated by reference to Exhibit 10(u) to the Registrant's Annual Report on Form 10-K, filed with the Securities and Exchange Commission on March 31, 1993, File No. 0-13440.\n10(r) Agreement and Plan of Merger between Citizens Investments, Inc. and B.M.J. Financial Corp. joined in by Sun National Bank and Southern Ocean State Bank, dated as of February 3 , 1994, incorporated by reference to Exhibit 10(a) to the Registrant's Current Report on Form 8-K, filed with the Securities and Exchange Commission on March 9, 1994, File No. 0-13440.\n10(s) Short Term Incentive Plan, incorporated by reference to Exhibit 10 (s) to the Registrant's Annual Report on Form 10-K, filed with the Securities and Exchange Commission on March 31, 1995, File No. 0-13440.\n11 Statement Regarding Computation of Per Share Income (Loss).*\/\n16 Letter regarding change in certifying accountant from KPMG Peat Marwick to B.M.J. Financial Corp. (March 24, 1993), incorporated by reference to Exhibit 16 to the Registrant's Current Report on Form 8-K, filed with the Securities and Exchange Commission on March 24, 1993, as amended by Amendment No. 1 on Form 8, filed with the Securities and Exchange Commission on March 29, 1993, File No. 0-13440.\n22 Subsidiaries of the Registrant\n24.1 Consent of Coopers & Lybrand L.L.P..*\/\n28(a) Form of Stipulation and Consent to the Issuance of an Order to Cease and Desist and Order to Cease and Desist in the Matter of Mount Holly State Bank, Mount Holly, New Jersey, incorporated by reference to Exhibit 28.1 to the Registrant's Report on Form 10-Q for the quarter ended March 31, 1992, previously filed with the Securities and Exchange Commission, File No. 0-13440.\n28(b) Form of B.M.J. Dividend Reinvestment and Stock Purchase Plan incorporated by reference to Exhibit 4.4 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1990, previously filed with the Securities and Exchange Commission, File No. 0-13440.\n*\/ Filed herewith.\n(b) Exhibits and Reports on Form 8-K\nNone\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.\nB.M.J. FINANCIAL CORP.\nBy: \/s\/ Edwin W. Townsend ---------------------------------------- Edwin W. Townsend Chairman of the Board\nDate: March 25, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nIndependent Accountant's Report\nThe Board of Directors and Shareholders of B.M.J. Financial Corp.:\nWe have audited the accompanying consolidated balance sheets of B.M.J. Financial Corp. and subsidiaries (the \"Company\") as of December 31, 1995 and 1994, 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, 1995. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of B.M.J. Financial Corp. and subsidiaries as of December 31, 1995 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, 1995 in conformity with generally accepted accounting principles.\nAs discussed in Note 1 and Note 13 of notes to consolidated financial statements, the Company changed its method of accounting for loan loss reserves effective January 1, 1995, changed its method of accounting for securities effective January 1, 1994 and changed its method of accounting for income taxes effective January 1, 1993.\n\/s\/Coopers & Lybrand L.L.P.\nNew York, New York January 22, 1996\nB.M.J. Financial Corp. and Subsidiaries\nNotes to Consolidated Financial Statements\n1. Summary of Significant Accounting Policies\nThe accounting policies of B.M.J. Financial Corp. (\"BMJ\") and its wholly-owned subsidiary, The Bank of Mid-Jersey (\"Mid-Jersey\"), conform with generally accepted accounting principles and prevailing practices within the banking industry. Unless the context otherwise indicates, the term \"BMJ\" as used herein refers to the consolidated B.M.J. Financial Corp. and The Bank of Mid-Jersey entity.\nBUSINESS BMJ provides a full range of banking services to individual and corporate customers through its subsidiary bank in New Jersey. The Bank of Mid-Jersey is subject to competition from other financial institutions. In addition, BMJ is subject to the regulations of certain federal and state agencies and undergoes periodic examinations by those regulatory authorities.\nBASIS FOR FINANCIAL STATEMENT PRESENTATION The consolidated financial statements include the accounts of BMJ and its wholly-owned subsidiary. All significant intercompany accounts and transactions have been eliminated. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of 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. Material estimates that are particularly susceptible to significant change in the near-term relate to the determination of the reserve for loan losses, the valuation of other real estate acquired in connection with foreclosures or in satisfaction of loans, and the valuation of the deferred tax asset. In connection with the determination of the reserves for loan losses and other real estate, management periodically obtains independent appraisals for significant properties. Management believes that the reserves for losses on loans and other real estate are adequate in relation to the risks and uncertainties inherent in those portfolios. While management uses available information to determine the appropriate recognition of losses on loans and other real estate, future additions to the reserves may be necessary based on, among other things, changes in economic conditions, particularly in New Jersey, and the changing circumstances of the borrowers. In addition, various regulatory agencies, as an integral part of their examinations, periodically review BMJ's reserves for loan losses. Such agencies may request BMJ to consider recognizing additions to the reserves based on the regulators' judgements about information available to them at the time of their examination.\nRECLASSIFICATIONS Certain amounts in the financial statements presented for prior periods have been reclassified to conform with the 1995 presentation. Effective January 1, 1995 and for all prior periods presented, BMJ reclassified insubstance foreclosures (\"ISFs\") from other real estate (\"ORE\") to loans. Charges to other real estate expense to cover writedowns and charge-offs on ISFs have been reclassified to the provision for loan losses. Such reclassifications were done to reflect a change in accounting principle; however, there was no effect on previously recorded net income (see \"Income Recognition on Impaired and Nonaccrual Loans\").\nCASH AND CASH EQUIVALENTS Cash and cash equivalents include cash on hand, amounts due from banks, and money market investments with an original maturity of three months or less.\nSECURITIES On January 1, 1994, BMJ adopted Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" (\"FAS 115\"). FAS 115 establishes the accounting and reporting for investments in equity securities that have readily determinable fair values and for all investments in debt securities. In accordance with FAS 115, investments are classified into three categories: (1) held to maturity securities, which are reported at amortized cost (debt securities only); (2) trading securities, which are reported at fair value with unrealized gains and losses included in earnings; and (3) available for sale securities, which are reported at fair value with unrealized gains and losses reported as a separate component of shareholders' equity net of taxes and excluded from earnings. BMJ currently has no securities classified as trading securities. Securities classified as available for sale may be sold prior to their contractual maturity in response to changing market and interest rate conditions or as part of an overall asset\/liability strategy. These securities are carried at their fair value with unrealized gains and losses carried, net of tax, as adjustments to shareholders' equity. Gains and losses on disposition are included in earnings using the specific identification method. Securities held to maturity are comprised of securities that BMJ has the positive intent and ability to hold to maturity. These securities are carried at cost, adjusted for amortization of premium or accretion of discount. The premium or discount adjustments are recognized as adjustments to interest income, on a level yield basis. Unrealized losses due to fluctuations in fair value are recognized as security losses when a decline in value is assessed as being other than temporary.\nLOANS Loans are reported at their principal outstanding balance net of charge-offs, deferred loan fees and costs on originated loans, and unearned income. Interest income is generally recognized when income is earned using the interest method. Loan origination fees and certain direct loan origination costs are deferred and the net amounts are amortized as adjustments of the loans' yields.\nRESERVE FOR LOAN LOSSES On January 1, 1995, BMJ adopted 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 Disclosure\". FAS No. 114 provides guidelines for measuring impairment losses on loans. A loan is considered to be impaired, based on current information and events, if it is probable that BMJ will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement. The measurement of impaired loans is generally based upon the present value of expected future cash flows discounted at the loan's historical effective interest rate except that all collateral- dependent loans are measured for impairment based on the fair value of the collateral. The adequacy of the reserve for loan losses is periodically evaluated by BMJ in order to maintain the reserve at a level that is sufficient to absorb probable loan losses. Management's evaluation of the adequacy of the reserve is based on a review of BMJ's historical loss experience, known and inherent risks in the loan portfolio, including adverse circumstances that may affect the ability of the borrower to repay interest and\/or principal, the estimated value of collateral, and an analysis of the levels and trends of delinquencies, charge-offs, and the risk ratings of the various loan categories. Such factors as the level and trend of interest rates and the condition of the national and local economies are also considered. The reserve for loan losses is established through charges to earnings in the form of a provision for loan losses. Increases and decreases in the reserve due to changes in the measurement of the impaired loans are included in the provision for loan losses. Loans continue to be classified as impaired unless they are brought fully current and the collection of scheduled interest and principal is considered probable. When a loan or portion of a loan is determined to be uncollectible, the portion deemed uncollectible is charged against the reserve and subsequent recoveries, if any, are credited to the reserve.\nINCOME RECOGNITION ON IMPAIRED AND NONACCRUAL LOANS Loans, including impaired loans, are generally reported as nonaccrual if they are past due as to maturity or payment of principal or interest for a period of more than 90 days, unless such loans are well-secured and in the process of collection. If a loan or a portion of a loan is partially charged off, the loan is classified as nonaccrual. Loans that are on a current payment status or past due less than 90 days may also be classified as nonaccrual if repayment in full of principal and\/or interest is in doubt. Loans, with the exception of partially charged off loans or loans with any portion classified as doubtful, may be placed back on accrual status when they become current as to both principal and interest and when concern as to future collectibility in full no longer exists. The remaining recorded balance of a partially charged off loan, however, may be returned to accrual status if the entire contractual loan balance, together with all unpaid contractual interest, is determined to be fully collectible. While a loan is classified as nonaccrual and the future collectibility of the recorded loan balance is doubtful, collections of interest and principal are generally applied as a reduction to principal outstanding. When the future collectibility of the recorded loan balance is expected, interest income may be recognized on a cash basis. In the case where a nonaccrual loan had been partially charged off, recognition of interest on a cash basis is limited to that which would have been recognized on the recorded loan balance at the contractual interest rate. Cash interest receipts in excess of that amount are recorded as recoveries to the reserve for loan losses until prior charge-offs have been fully recovered.\nPREMISES AND EQUIPMENT Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the straight line method. Estimated useful lives range up to 40 years for buildings and 3 - 10 years for furniture and equipment.\nOTHER REAL ESTATE Other real estate acquired through foreclosure or acceptance of a deed in lieu of foreclosure is carried at the lower of the recorded investment in the loan or the fair value less estimated costs of disposal. When a property is acquired, the excess of the loan balance over the estimated fair value is charged to the reserve for loan losses. A reserve for other real estate has been established to provide for subsequent write-downs that may be required to the carrying value of the property or losses on the sales of properties. The reserve is established through charges to other real estate expense. Operating results of other real estate owned, including rental income and operating expenses, are recorded in other real estate expense. Gains and losses realized from the sales of other real estate are included in noninterest income. Specific dates of disposal cannot realistically be projected without the existence of firm contracts for sale. At this time contracts for sale exist on certain foreclosed assets representing an insignificant portion of the carrying value on the balance sheet. In prior years, BMJ classified certain loans meeting the insubstance foreclosure criteria as other real estate. Upon the adoption of FAS 114, BMJ reclassified insubstance foreclosed assets that were not in its possession to loans. Prior periods have been reclassified for comparative purposes.\nINTANGIBLE ASSETS The portion of the cost allocated to values associated with the future earnings potential of acquired deposits and the excess of cost over fair value of net assets acquired resulting from bank and branch acquisitions is being amortized on a straight line basis over the estimated useful lives of the assets, which lives range from three to 40 years.\nOFF-BALANCE SHEET FINANCIAL INSTRUMENTS In the ordinary course of business, BMJ has entered into off-balance sheet financial instruments including commitments to extend credit, and standby and commercial letters of credit. Amounts due or payable on such instruments are recorded on the balance sheet.\nINCOME TAXES BMJ files a consolidated Federal income tax return, and the amount of income tax expense or benefit is computed and allocated among subsidiaries on a separate return basis. BMJ utilizes the asset and liability method of accounting for income taxes as required by Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"FAS 109\"). Under this 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 temporary differences, which are inherent in the tax filing process, are expected to be recovered or settled. Under FAS 109, the effect on deferred tax assets and liabilities of a change in the tax rates is recognized in income in the period that includes the enacted date.\nINCOME PER SHARE Income per share is based on the weighted average number of shares outstanding during the period after consideration of the dilutive effect of the convertible subordinated capital notes (see Note 8) and stock options (see Note 10).\n2. Divestitures and Merger\nEffective June 24, 1994, having received the required regulatory and shareholder approvals, BMJ completed the merger of its Mount Holly State Bank subsidiary into its lead bank subsidiary, The Bank of Mid- Jersey. This merger was consistent with the corporate-wide restructuring program initiated in 1993, with the objectives being to increase operating efficiency and enhance the level of service provided to customers.\nOn July 29, 1994, BMJ completed the sale of its Southern Ocean State Bank subsidiary located in Tuckerton, New Jersey to Sun National Bank of Medford, New Jersey for a total consideration of $6.8 million in cash. At June 30, 1994, Southern Ocean State Bank had total assets of $69.1 million and had net income of $591 thousand for the six-month period ended June 30, 1994.\nOn November 18, 1994, BMJ's Mid-Jersey subsidiary sold the furnishings and equipment of its Willingboro branch office to another financial institution which also assumed approximately $6.6 million of deposit liabilities and the remaining term of the facility lease. This transaction resulted in a net reduction in BMJ's asset base of $6.3 million and a pre-tax gain of approximately $104 thousand that is included in 1994 results of operations.\n3. Securities Available for Sale\nThe amortized cost and estimated fair values of securities available for sale are as follows:\nThere were gross gains of $119,822 and gross losses of $120,042 realized on sales from the securities available for sale portfolio during 1995. Proceeds from sales of securities available for sale for the years ended December 31, 1995, 1994 and 1993 were $23,108,876, $50,000 and $75,196,000, respectively. There were no gross gains or gross losses realized on sales from the securities available for sale portfolio during 1994. Gross gains of $744,000 and gross losses of $54,000 were recognized for 1993 sales.\nAt December 31, 1995, $384 thousand of unrealized gains, net of tax, in the securities available for sale portfolio are included as a separate component of shareholders' equity.\nThe amortized cost and estimated fair value of securities available for sale at December 31, 1995 by contractual maturity are shown below. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.\nThe amortized cost of securities available for sale pledged to secure public deposits and for other purposes as required by law were $4,001,000, $1,455,000 and $8,570,000 at December 31, 1995, 1994 and 1993, respectively. There are no significant concentrations of investments (greater than 10% of shareholders' equity) in any individual security issuer at December 31, 1995.\n4. Securities Held to Maturity\nThe amortized cost and estimated fair values of securities held to maturity are as follows:\nThere were no sales from the securities held to maturity portfolio during 1995. The amortized cost of securities transferred from the held to maturity portfolio to the available for sale portfolio for the year ended December 31, 1995 was $23,109,444 which included gross unrealized gains of $119,822 and gross unrealized losses of $120,042 at the time of transfer. All transfers from the held to maturity portfolio were performed in accordance with the one-time reassessment of the held to maturity portfolio as permitted by the Financial Accounting Standards Board special report entitled \"A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities\".\nThe amortized cost and estimated fair value of securities held to maturity at December 31, 1995 by contractual maturity are shown below. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.\nThe amortized cost of securities held to maturity pledged to secure public deposits and for other purposes as required by law were $35,993,000, $42,156,000 and $30,903,000 at December 31, 1995, 1994 and 1993, respectively. There are no significant concentrations of investments (greater than 10% of shareholders' equity) in any individual security issuer at December 31, 1995.\n5. Loans, Reserves for Losses on Loans and Other Real Estate and Nonperforming Assets\nThe following table provides comparative year-end composition of the loan portfolio:\nChanges in the reserve for loan losses were as follows:\nBMJ recorded a negative provision for loan losses of $2.0 million in 1995. No provision for loan losses was recorded in 1994 and a provision of $840 thousand was recorded in 1993.\nThe negative provision of $2.0 million recorded in 1995 was driven by the continuing improvements of BMJ's asset quality, including reduced levels of nonperforming assets and net loan charge-offs. Specifically, since December 31, 1992, nonperforming loans have declined from $31.4 million to $6.0 million at December 31, 1995, and net charge-offs declined from $6.7 million during 1993 to $1.5 million during 1994 and $386 thousand during 1995. In addition, BMJ has adhered to a procedural discipline in determining both the necessary provision for loan losses to be taken from earnings and the adequacy of the allowance for loan losses. Based upon management's judgement and evaluation of this methodology, BMJ has recorded no quarterly provision for loan losses since the second quarter of 1993. As a result of BMJ's increasingly diversified loan mix, stabilized and improving regional economies, and the continuing adequacy of the reserve for loan losses subsequent to the non-recurring negative provision, it was management's and the Board of Director's judgement that the interest of BMJ's shareholders was best served by this immediate, one-time negative provision.\nAt December 31, 1995, BMJ's recorded investment in loans for which impairment has been recognized in accordance with FAS 114 amounted to $7.3 million. The reserve for loan losses at December 31, 1995 includes reserves of $1.2 million applicable to such impaired loans. All of these loans were valued using the fair value of collateral method. Based on this method, was allocated against all of the impaired loans. The remaining reserve for loan losses, totalling $8.9 million at December 31, 1995, is available to absorb losses in BMJ's entire loan portfolio. During 1995, the average recorded investment in impaired loans was approximately $7.1 million. Interest income recognized on total impaired loans during 1995 was approximately $447 thousand.\nNonaccrual loans, which generally includes all impaired loans, are comprised principally of loans where doubt exists as to the ability of the borrower to comply with the repayment terms. Loans 90 days past due or greater are those loans which are still accruing interest at previously negotiated rates yet are contractually delinquent as to principal or interest. Restructured loans are those whose contractual interest rates have been reduced to below current market rates or other concessions made due to borrowers' financial difficulties. Interest on these loans is subject to the nonaccrual policy.\nInterest recognized as income during 1995 on nonaccrual loans totaled $75 thousand, compared to $384 thousand in 1994 and $38 thousand in 1993. Additional income before taxes amounting to approximately $643 thousand for 1995, $845 thousand in 1994 and $1.4 million in 1993 would have been recognized if interest on all such loans had been recorded based upon original terms.\nThe following table sets forth information concerning other real estate owned reserve activity for the periods indicated:\nNonperforming assets were as follows:\nNonperforming loans were as follows:\nNonperforming loans as a percentage of total loans were 1.5% at December 31, 1995 and 2.81% at December 31, 1994.\n6. Premises and Equipment\nThe following table presents comparative data for premises and equipment:\nDepreciation expense was $.8 million, $.9 million and $1.0 million for the years ended December 31, 1995, 1994 and 1993, respectively.\n7. Short Term Borrowings\nThe following table presents comparative data relating to short-term borrowings of BMJ for the years ending December 31, 1995, 1994 and 1993.\nThere was no balance of Federal funds purchased or Federal Home Loan Bank advances outstanding at December 31, 1994 or 1993.\nFederal funds purchased and securities sold under agreements to repurchase represent primarily overnight borrowings providing for BMJ's short-term funding requirements and generally mature within one business day of the transaction date. The Federal Home Loan Bank advance matures in six months.\nThe Bank of Mid-Jersey joined the Federal Home Loan Bank system during 1995 and has established a line of credit of approximately $71.9 million with the Federal Home Loan Bank of New York to further support and enhance liquidity. At December 31, 1995, approximately $13.4 million was outstanding against this line of credit consisting of $7.4 million in short term advances and $6.0 million in long term debt (Note 8).\n8. Capital Notes and Long Term Debt\nThe following is a summary of capital notes and long term debt outstanding at December 31, 1995 and 1994:\n(1) These notes are in the form of equity commitments and are convertible into BMJ Common stock at $17.78 per share, subject to adjustment in certain events, at any time prior to maturity on July 15, 1996. BMJ may redeem these notes at any time at a redemption price equal to 100% of the principal amount of the notes. At maturity, BMJ will issue to electing noteholders, in exchange for the notes, common stock having an aggregate market value equal to the principal amount of the notes. BMJ has announced its intention to call these notes for early redemption in March 1996.\n(2) The Bank of Mid-Jersey has long term borrowings from the Federal Home Loan Bank totaling $6.0 million. These borrowings require membership in the Federal Home Loan Bank of New York and are secured by investment securities and loans under a blanket collateral agreement.\n(3) These notes were in the form of equity contracts and were convertible into BMJ common stock at $10.92 per share, subject to adjustment in certain events, at any time prior to maturity on July 15, 2000. BMJ had the option to redeem these notes starting July 15, 1994 at a redemption price of 105%. On July 15, 1994, $1.6 million in principal amount of these notes was redeemed and $500 thousand in principal amount of these notes was converted into 45,783 shares of BMJ common stock resulting in an extraordinary charge to operations of $87 thousand.\nThe aggregate amounts of capital notes and long term debt maturing for the five years subsequent to 1995 are $2,838,000 for 1996, $161,000 for 1997, $1,857,000 for 1998, $123,000 for 1999 and $130,000 for 2000.\n9. Common Stock\nA Dividend Reinvestment and Stock Purchase Plan is available for shareholders who wish to increase their holdings of BMJ's common stock. Under the plan, quarterly dividends may be reinvested in BMJ common stock at a discount from market value of between 0% and 10% inclusive (as determined from time to time by BMJ's Board of Directors). In addition, optional cash investments of not less than $100 nor more than a specified amount per quarterly investment period (as determined by BMJ's Board of Directors from time to time) may be made in BMJ common stock at a discount from market value of between 0% and 10% inclusive without incurring any commission or fee. BMJ has reserved the right, however, to eliminate and\/or reinstate the optional cash investment feature at any time which shall be indicated to shareholders by written notice. At present, BMJ provides no discount on dividend reinvestments and optional cash investments. BMJ permits optional cash investments by a participating shareholder of up to $5,000 per calendar quarter per account.\nDuring 1995, 16,768 shares of BMJ common stock were issued through the Plan, providing $225 thousand in new capital. During 1994, no shares were issued through the Plan. A total of 14,280 shares, providing $101 thousand in new capital, was raised through the Plan in 1993.\nOn January 22, 1996, BMJ announced a stock buy-back program for calendar year 1996. The program, approved by the Board of Directors, allows for the repurchase of up to five percent of BMJ stock at management's discretion, either on a privately negotiated basis or on the open market.\n10. Stock Option Plans\nDirector Stock Option Plan\nBMJ has in effect a Director Stock Option Plan (the \"Director Plan\") for the benefit of outside directors of BMJ and Mid-Jersey (\"Outside Directors\"). The Director Plan is intended to encourage stock ownership in BMJ by Outside Directors, to make service on the Boards of Directors of BMJ and Mid-Jersey more attractive, and to link compensation for Outside Directors to the performance of BMJ's common stock and to the interests of shareholders in general. BMJ has reserved 50,000 shares of authorized but unissued common stock under the Director Plan.\nEmployee Stock Option Plan\nBMJ also has in effect the 1994 Employee Stock Option Plan (the \"Employee Plan\") for the benefit of certain executives of BMJ and Mid-Jersey. Like the Director Plan, the Employee Plan is intended to enable BMJ to recruit and retain executive talent and to link the compensation of participating executives to the performance of BMJ's common stock and to the interests of shareholders in general. BMJ has reserved 600,000 shares of authorized but unissued shares of common stock pursuant to the Employee Plan.\nBMJ also granted options during the past two years pursuant to the Executive Long-Term Incentive Plan (the \"Executive Plan\"). The Executive Plan permitted BMJ to grant options exercisable for an aggregate total of 200,000 shares, which limit was reached in 1994.\nChanges in options outstanding during the past two years were as follows:\nBMJ executed a Forebearance Agreement with the estate of former CEO John H. Walther pursuant to which the estate agreed not to exercise any of the stock options previously granted to Mr. Walther in exchange for a cash settlement. At December 31, 1995, the estate of Mr. Walther held options on 140,000 shares of BMJ stock exercisable through April 2, 1996 at prices ranging from $6.875 to $11.25 per share. All costs associated with this transaction are included in 1995 operating results.\n11. Employee Benefits\nPENSION PLAN BMJ has a non-contributory defined benefit plan covering most employees. The benefits for this plan are based primarily on years of service and employees' estimated compensation at retirement. BMJ's policy is to fund pension costs based on the minimum funding requirements set forth in the Employee Retirement Income Security Act of 1974.\nPlan assets consist primarily of insurance company group immediate participation guarantee contracts, U.S. government and corporate debt obligations and common stock.\nThe following table presents the components of BMJ's 1995, 1994 and 1993 pension costs:\nThe funded status of the pension plan at December 31, 1995, 1994, and 1993 was as follows:\nThe projected benefit obligation was determined using an assumed discount rate of 7.0% (8.75% in 1994 and 7.0% in 1993) and an assumed long-term rate of compensation increase of 4.0%. The assumed long-term rate of return on plan assets is 7.50%.\nDEFERRED SAVINGS PLAN BMJ has a deferred savings plan for eligible employees which is a deferred arrangement under Section 401(k) of the Internal Revenue Code. Under the plan, employees can defer from 2% to 10% of annual compensation. BMJ will match 50% of employees' contributions up to 6% and the matched funds amount is automatically invested in common stock of B.M.J. Financial Corp. The 1995 limit for 401(k) elective contribution to the plan was $9,240. The contribution by BMJ was $148 thousand, $153 thousand, and $316 thousand in 1995, 1994 and 1993, respectively.\nBENEFITS BMJ's and Mid-Jersey's respective Boards of Directors have each approved a policy whereby, in the event of a merger or sale of BMJ or Mid-Jersey, all full-time officers with the title of Vice President or a more senior officer of the entity to be merged or sold will receive a guarantee of one year's employment and of severance pay of one month's salary for each year of service as a Vice President or more senior officer with that entity. Under BMJ's policy, full-time officers of BMJ will be given credit for past service as a Vice President or more senior officer with any present or past subsidiary of BMJ.\n12. Other Noninterest Expense\nOther noninterest expense items in excess of 1% of total interest and other income included the following:\n13. Income Taxes\nCurrent and deferred income tax expense (benefit) was as follows:\nBMJ adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"FAS 109\"), as of January 1, 1993, and the cumulative effect of this change was reported in the 1993 Consolidated Statement of Operations. The cumulative effect at January 1, 1993 was a charge of $1.5 million. The net deferred tax asset as of December 31, 1995 and 1994 reflects the impact of \"temporary differences\" between amounts of assets and liabilities for financial reporting purposes and such amounts as measured by tax laws.\nAs of December 31, 1993, BMJ had established a valuation allowance to reduce its net deferred tax asset to the amount expected to be realized as required under FAS 109. During 1994, management concluded that sufficient positive evidence had accumulated and that the valuation allowance established in 1993 was no longer necessary. Such positive evidence included six consecutive quarters of profitable operations, continued reductions in the level of nonperforming assets, and continued operating expense reductions. Accordingly, the book tax provision for the year ended December 31, 1994 of $2.7 million was offset by a reduction of the deferred tax asset valuation allowance. In addition, operating results for the year ended December 31, 1994 include a credit to income of $4.9 million, representing the reversal of the remaining balance of the valuation allowance plus recognition of state deferred tax assets and alternative minimum tax credits.\nMid-Jersey has net operating loss carryforwards for state income tax purposes of $6.4 million, which expire as follows: $2.0 million in 1998, $2.0 million in 1999 and $2.4 million in 2000.\nThe components of the net deferred tax asset as of December 31, 1995 and 1994 are as follows:\nThe components of income tax expense (benefit) for the years ended December 31, 1995, 1994 and 1993 that are attributable to income from operations and the reversal of the deferred tax asset valuation allowance are as follows:\nThe following is a reconciliation of the statutory Federal income tax expense and rate to the effective income tax expense and rate:\nDeferred income tax amounts of $6.1 million and $7.1 million are included in other assets as of December 31, 1995 and 1994, respectively.\nBMJ has been under examination by the Internal Revenue Service (\"IRS\") for the taxable years 1989 through 1993 as a result of net operating loss carryback refund claims previously filed by BMJ. During 1995, BMJ received the Revenue Agent's Report (\"RAR\") for the years under examination and has accepted the agent's findings. Although the agent's report and the related refund claims are subject to review by the Joint Committee on Taxation of the U.S. Congress, BMJ has evaluated its reserves for income taxes based on the acceptance of the RAR. As a result of this review, income tax expense for 1995 has been reduced by $1.0 million, representing the reversal of previously accrued income taxes. BMJ believes that the remaining income tax reserves are adequate to cover tax liabilities for all open years.\n14. Related Party Transactions\nCertain of BMJ's officers, directors and their affiliates were loan customers of BMJ's banking subsidiaries during 1995 and 1994. All loans included in such transactions 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 none represent more than a normal risk of collection. Such loans were $10.8 million at December 31, 1995 and $12.5 million at December 31, 1994. At December 31, 1995, there were no related party loans classified as nonaccrual.\nThe following table summarizes activity with respect to such loans:\n(in thousands) 1995 ------- Balance at beginning of year $12,479 Additions 1,388 Less amounts collected 3,047 ------- Balance at end of year $10,820 =======\nAdditionally, BMJ and its subsidiaries made lease payments to affiliates of directors of approximately $291 thousand during 1995, $287 thousand during 1994 and $282 thousand during 1993.\n15. Lease Commitments\nBMJ has lease arrangements primarily for the use of real property. Total lease rental expense was $.8 million, $.8 million and $1.0 million for the years ended December 31, 1995, 1994 and 1993, respectively.\nBMJ is obligated under a number of non-cancelable operating leases for premises and equipment with terms ranging from 1 to 20 years. Future minimum payments under non-cancelable operating leases as of December 31, 1995 are as follows:\n(in thousands)\nYear ended December 31, 1996 $ 836 1997 910 1998 830 1999 765 2000 459 Thereafter 4,955 ------- Total minimum lease payments $ 8,755 =======\n16. Commitments and Contingencies\nIn the normal course of business, BMJ enters into various financial instruments which are properly not recorded in the consolidated financial statements. BMJ's risk of accounting loss due to the credit risks and market risks associated with these off-balance sheet instruments varies with the type of financial instrument. Principal or notional amounts may not necessarily indicate the degree of exposure involved. Credit risk represents the possibility of a loss occurring from the failure of another party to perform in accordance with the terms of the contract. BMJ's maximum exposure to accounting loss, based upon the credit risk associated with unfunded loan commitments and letters of credit outstanding, is represented by the contractual amount of these items as of the dates indicated in the following table:\n(in millions) Contractual Amount 12\/31\/95 12\/31\/94 -------- -------- Commitments to extend credit $76.4 $57.0 Performance standby letters of credit and similar arrangements $ 2.7 $ 3.1 Financial standby letters of credit and similar arrangements $ 0.9 $ 1.1\nMany of such commitments to extend credit may expire without being drawn upon and, therefore, the total commitment amounts do not necessarily represent future cash flow requirements. In making the commitments, BMJ applies the same credit policy standards used in the lending process and periodically reassesses the customers' creditworthiness through ongoing credit reviews. BMJ also holds various forms of collateral, including cash deposits and mortgage liens on real estate, to support those commitments for which collateral is deemed necessary. Substantially all of BMJ's lending is secured by property located within Mercer, Burlington and Ocean counties in New Jersey (see note 5 for the composition of the loan portfolio). The risks associated with making these commitments are also included in BMJ's evaluation of the overall credit risk in determining the reserve for loan losses.\nFinancial standby letters of credit and similar arrangements are commitments issued by BMJ which irrevocably obligate BMJ to pay a third-party beneficiary when a customer fails to repay an outstanding loan or debt instrument.\nPerformance standby letters of credit are commitments issued by BMJ which irrevocably obligate BMJ to pay a third-party beneficiary when a customer fails to perform some contractual non-financial obligation.\nAt December 31, 1995 and 1994, BMJ had identified approximately $745 thousand and $972 thousand, respectively, of the reserve for loan losses as a general allocation of the reserve for potential losses, including losses due to off-balance sheet credit risk. During 1995 and 1994, BMJ recorded no charge-offs in connection with letters of credit. No material amount of currently outstanding commitments are to borrowers having prior outstanding balances which are classified as nonperforming or potential problem assets.\nBMJ is required to maintain cash balances to meet regulatory reserve requirements of the Federal Reserve Board. The average required reserve balances were $9.3 million and $9.5 million for 1995 and 1994, respectively.\nBMJ is subject to claims and lawsuits which arise primarily in the ordinary course of business. Based upon information currently available and advice received from legal counsel representing BMJ in connection with such claims and lawsuits, it is the opinion of management that the disposition or ultimate determination of such claims and lawsuits will not have a material adverse effect on the consolidated financial statements of BMJ.\n17. Dividend Restrictions\nCertain bank regulatory limitations exist on the availability of a subsidiary bank's undistributed net assets for the payment of dividends to the parent company without the prior approval of the bank regulatory authorities.\nThe Federal Reserve Act restricts the payment of dividends in any calendar year to the net profit of the current year combined with retained net profits of the preceding two years. Mid-Jersey may declare a dividend to the parent company only if, after payment thereof, its capital would be unimpaired and its remaining surplus would equal 50 percent of its capital. At January 1, 1996, Mid-Jersey had $19.0 million of undistributed net assets available for the payment of dividends to BMJ (parent company).\n18. Disclosures About Fair Value of Financial Instruments\nProvided below is the information required by Statement of Financial Accounting Standards No. 107, \"Disclosures about Fair Value of Financial Instruments\" (\"FAS 107\"). These amounts represent estimates of fair values at a point in time. Significant estimates regarding economic conditions, loss experience, risk characteristics associated with particular financial instruments and other factors were used for the purposes of this disclosure. These estimates are subjective in nature and involve matters of judgement. Therefore, they cannot be determined with precision. Changes in the assumptions could have a material impact on the amounts estimated.\nWhile the estimated fair value amounts are designed to represent estimates of the amounts at which these instruments could be exchanged in a current transaction between willing parties, many of BMJ's financial instruments lack an available trading market as characterized by willing parties engaging in an exchange transaction. In addition, BMJ does not hold any financial instruments for trading purposes and it is BMJ's intent to hold most of its financial instruments to maturity and, therefore, the fair value may not be realized in a current transaction.\nThe estimated fair values disclosed do not reflect the value of assets and liabilities that are not considered financial instruments. In addition, the value of long-term relationships with depositors (core deposit intangibles) is not reflected. The value of this item may be significant.\nBecause of the wide range of valuation techniques and the numerous estimates which must be made, it may be difficult to make reasonable comparisons of BMJ's fair value information to that of other financial institutions. It is important that the many uncertainties discussed above be considered when using the estimated fair value disclosures and to realize that because of these uncertainties, the aggregate fair value amount should in no way be construed as representative of the underlying value of BMJ.\nCash and due from banks and money market investments. Cash and money market investments are by definition short-term and do not present any unanticipated credit issues. Therefore, the carrying amount is a reasonable estimate of fair value.\nSecurities. The estimated fair values and carrying amounts of securities at December 31, 1995 and 1994 are provided in Notes 3 and 4 to the Consolidated Financial Statements and are based on quoted market prices, when available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.\nLoans. The carrying amount and estimated fair value of loans outstanding at December 31, 1995 (net of the reserve for loan losses) are $389.3 million and $396.8 million, respectively. The corresponding amounts at December 31, 1994 are $344.9 million and $353.8 million, respectively. In order to determine the fair values for loans, the loan portfolio was segmented based on loan type, credit quality and repricing characteristics. For variable rate loans with no significant credit concerns and frequent repricings, estimated fair values are based on the carrying values. The fair values of other loans are estimated using discounted cash flow analyses.\nThe discount rates used in these analyses are generally based on origination rates for similar loans of comparable credit quality. However, where appropriate, adjustments have been made so as to more accurately reflect market rates. Maturity estimates are based on historical experience with prepayments and current economic and lending conditions. The fair value of nonaccrual and impaired loans was based on an analysis of the value of the underlying collateral.\nOther Assets. The financial instrument included in other assets consists of accrued interest receivable which has a carrying value that approximates fair value due to its short-term maturity.\nDeposits. The carrying amount and estimated fair value of deposits outstanding at December 31, 1995 are $485.0 million and $485.7 million, respectively. The corresponding amounts at December 31, 1994 are $463.6 million and $463.1 million, respectively. Under FAS 107, the fair value of deposits with no stated maturity is equal to the amount payable on demand. Therefore, the fair value estimates for these products do not reflect the benefits that BMJ receives from the low-cost, long-term funding they provide. In management's opinion, these benefits may be significant. The estimated fair values of fixed rate time deposits are based on discounted cash flow analyses. The discount rates used in these analyses are based on market rates currently offered for deposits of similar remaining maturities. Because of the repricing characteristics and the competitive nature of BMJ's rates offered on variable rate time deposits, carrying amount is a reasonable estimate of the fair value.\nFederal funds purchased, securities sold under agreements to repurchase and other borrowed funds. Rates currently available to BMJ for such agreements with similar time and remaining maturities are used to estimate fair value. As a result, the fair value of these instruments is equal to their carrying value.\nOther liabilities. The financial instrument included in other liabilities consists of accrued interest payable which has a carrying value that approximates fair value due to its short-term maturity.\nCapital notes and long term debt. Rates currently available to BMJ for debt with similar terms and remaining maturities are used to estimate fair value of existing debt. At December 31, 1995 the capital notes and long term debt had a carrying value of $8.7 million and a fair value of $8.6 million. The corresponding amounts at December 31, 1994 are $2.7 million and $2.6 million, respectively.\nCommitments to extend credit and standby letters of credit. The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. The fair value of the commitments is deemed to be immaterial.\n19. Parent Company Only\nOn January 1, 1995, B.M.J. Financial Corp. (Parent Company) transferred a significant portion of its operations to The Bank of Mid-Jersey. This included the transfer of 84 employees and $349,000 of assets, primarily furniture and equipment. Beginning January 1, 1996, the operating results of these functions were recorded in the operating results and financial condition of The Bank of Mid-Jersey. Condensed financial information of B.M.J. Financial Corp. is as follows:\nEXHIBITS\nExhibit\n11 Statement Regarding Computation of Per Share Income (loss).\n24.1 Consent of Coopers & Lybrand L.L.P.","section_15":""}
{"filename":"790523_1995.txt","cik":"790523","year":"1995","section_1":"Item 1. BUSINESS\nPRODUCTS AND SERVICES\nIWC Resources Corporation (Resources or, together with its subsidiaries, the Company) is a holding company which owns and operates seven subsidiaries, including two waterworks systems, which supply water for residential, commercial, and industrial uses, and for fire protection service in Indianapolis, Indiana and surrounding areas. The territory served by the two utilities covers an area of approximately 309 square miles, which includes areas in Marion, Hancock, Hamilton, Hendricks, Boone and Morgan counties in central Indiana.\nResources' two waterworks systems include Indianapolis Water Company (IWC) and Harbour Water Corporation (HWC). At year's end, IWC was providing service to 232,568 customers. HWC, in the Morse Reservoir area of Hamilton County (north of Indianapolis), was serving 2,722 customers.\nIn addition to the two water utilities, Resources has five other wholly owned subsidiaries; SM&P Utility Resources, Inc. (SM&P), Miller Pipeline Corporation (MPC), Waterway Holdings, Inc., Utility Data Corporation (UDC), and IWC Services, Inc. SM&P performs underground utility locating and marking services in Indiana and other states. MPC's primary function is the installation of underground pipelines for natural gas utilities. In addition, MPC sells products and services related to infrastructure preservation and replacement. The Company, principally through Waterway Holdings, Inc., owns real estate that it expects to sell or develop in the future. UDC provides customer relations, customer billing, and other data processing services for the Company's two water utilities and other water and sewer utilities. IWC Services provides laboratory water testing services, principally for water utilities.\nThe Company, through IWC Services, is a majority partner in the White River Environmental Partnership (WREP) which, under a five-year contract entered into in December, 1993, operates and maintains two advanced wastewater treatment facilities for the city of Indianapolis. WREP is actively seeking new markets and opportunities for contract management service pursuant to expanded governmental privatization efforts.\nThe Company continues to seek expansion and diversification through the acquisition of other water utilities and other related businesses. It is expected, however, that the water utilities will continue as the majority source of earnings for the Company in the forseeable future. The utility subsidiaries of the Company are subject to regulation by the Indiana Utility Regulatory Commission, which has jurisdiction over rates, standards of service, accounting procedures, issuance of securities, and related matters. Utility operations are subject to pollution control and water quality control regulations,including those issued by the Environmental Protection Agency, the Indiana Department of Environmental Management, the Indiana Water Pollution Control Board, and the Indiana Department of Natural Resources. There are competitors operating near the Company's system, which include various municipal water utilities, as well as privately owned water utilities, some of which purchase water from the Company.\nINDUSTRY SEGMENT FINANCIAL INFORMATION\nThe Company's operations include two business segments: regulated water utilities and unregulated utility-related services. The water utilities segment includes the operations of the Company's two water utility subsidiaries. The utility-related services segment provides utility line locating services, installation, repairs and maintenance of underground pipelines, data processing and billing and payment processing, and other utility-related services to both unaffiliated utilities and to the Company's water utilities, and holds real estate for sale or development. The discussion of segment information, including selected financial data included on pages 36 through 37 of the 1995 Annual Report under \"Segment Information\", is incorporated herein by reference.\nSECURITIES AND RATE REGULATION\nThe utility subsidiaries of the Company are subject to regulation by the Indiana Utility Regulatory Commission (Commission) which has jurisdiction over rates, standards of service, accounting procedures, issuance of securities and related matters. The Commission consists of five Commissioners, appointed by the Governor of Indiana from a list of persons selected by a 7-member nominating committee whose members are: appointed by the Governor (3); and the majority (2) and minority (2) leaders of the Indiana House and Senate. Decisions of the Commission are appealable directly to the Indiana Court of Appeals.\nSecurities. The issuance of securities by Resources is not subject to approval by the Commission. The issuance of securities by, and changes in the equity capital of, the Company's utility subsidiaries, including IWC, must be approved.\nWater Rates. Rates charged by the Company for water service are approved by the Commission. It is the Company's policy to seek rate relief when necessary to maintain its service and financial soundness. The Company is not permitted to submit petitions for general rate relief more frequently than every fifteen months.\nRate Case. On May 10, 1995, the Commission approved a Settlement Agreement entered into by the UCC, four intervening customers and IWC, which provided for an annual increase in IWC's rates of $2,547,000, or approximately 4%. The parties further agreed not to seek an adjustment in IWC's basic rates and charges prior to April 1, 1997, subject to IWC's interim right to request approval of new rates to cover operating expenses connected with implementing measures which might be required in connection with new National Pollutant Discharge Elimination System permits which IWC anticipates receiving for wastewater discharges at its Fall Creek and White River Stations (NPDES permits). The parties also agreed that prior to April 1, 1997, IWC may request that the Commission approve, in a separate proceeding, the continuation of the allowance for funds used during construction (debt component only), and the deferral of depreciation, on any capital expenditures made in connection with new NPDES permits at the Fall Creek and White River Stations or IWC's anticipated new South Well Field Station until a rate base determination has been made with respect to these items in IWC's next rate case.\nOn March 22, 1995, the Commission granted IWC authority to issue, on or before December 31, 1996, and aggregate of $30,000,000 in securities, to consist of not more than $18,000,000 in the form of long-term debt and\/or preferred equity, and, assuming favorable market conditions, up to $12,000,000 in common equity. IWC issued $18,000,000 of long-term debt in September 1995, in the form of First Mortgage Bonds, 5.85% Series due 2025. Proceeds from the issuance of these securities are being used for the construction, extension and improvement of IWC's facilities, plant and distribution system, reimbursement of IWC's treasury for plant capital expenditures previously made, and the discharge or refunding of short-term debt and higher cost long-term debt. In December 1995, Resources made an equity capital contribution to IWC of $10,505,000. The amount invested by Resources was derived from proceeds of the sale of common shares of the Company through its Dividend Reinvestment and Share Purchase Plan.\nCOMPETITIVE CONDITIONS\nThe Company conducts its water utility operations, subject to regulation by the Commission, under indeterminate permit and related franchise rights, all of which may be revoked for cause. Under such permit and franchise rights, the Company may lay, maintain and operate its mains and conduits in public streets and ways throughout the area which it serves. The permit and franchise rights granted to the Company are not exclusive. There are competitors operating near the Company's service area, which include various municipal water utilities, as well as privately owned water utilities, some of which purchase water from the Company. As the Indianapolis metropolitan area has expanded to include surrounding communities or previously rural areas, the Company has faced competition for new customers from town or rural water utilities.\nThe continuing regulation of the Commission covers, among other things, matters relating to rates, service, acquisition of utility properties, accounting practices, and the issuance of securities by IWC or HWC. The Company does not pay a franchise tax, and its franchise rights are long-term in nature.\nThe Company's unregulated utility-related services segment predominately serve other utilities. Underground facility locating services are provided primarily to the electric, gas and telecommunications industries which operate in the midwest and southwest regions of the country. Installation, repairs and maintenance of underground pipelines are provided primarily to the gas industry which operate principally in Indiana and Ohio. Data processing and billing and payment processing services are provided to the city of Indianapolis, the Company's water utilities, and to other unaffiliated utilities located in the state of Indiana. Services provided by this segment are subject to competitive conditions and are generally contracted for a period of three to five years.\nRECENT AND PROPOSED CHANGES IN FACILITIES\nDuring the year ended December 31, 1995, the Company added $42,835,000 (including $14,921,000 from the acquisition of MPC) to utility plant and other property, of which $20,941,000 is applicable to the water utilities segment. Approximately 93 miles of new mains were placed in service during the year.\nDuring the past five years, additions to utility plant and other property have averaged $24,049,000 annually. The Company plans capital expenditures of approximately $150,000,000 during the five-year period 1996-2000 primarily for further extensions and improvements to the Company's utility distribution systems, further additions and improvements to its treatment, pumping and storage facilities and for other operating equipment. In 1995, construction was started on a new laboratory facility at the White River plant to alleviate the crowding conditions in the existing laboratory. The new facility will accommodate the additional equipment and personnel needed to perform the testing and monitoring required to assure water quality.\nDesign commenced on the first phase of a major new plant to be built in the South Well Field in southern Marion County. When completed, this plant will have the capacity to treat 50 million gallons of well water a day, making it the second largest treatment facility owned by the Company and the largest ground water plant in the state of Indiana.\nFor possible capital expenditures relating to environmental matters, which are not included above, see \"Environmental Matters.\"\nCAPACITY OF FACILITIES AND SOURCES OF WATER SUPPLY\nThe combined maximum daily capacity of the Company's treatment plants, together with the maximum daily capacity of its two primary well fields, is 220 million gallons per day (MGD). During 1995, the average consumption was 129 MGD and the maximum consumption was 207 MGD. See \"Operating Information by Industry Segment.\"\nThe principal sources of IWC's present water supply are (a) the White River, which flows through Indianapolis from north to south and is supplemented by Morse Reservoir on a tributary, Cicero Creek, (b) Fall Creek, which flows from the northeast and is supplemented by Geist Reservoir, (c) the city of Indianapolis' Eagle Creek Reservoir, located on Eagle Creek in northwest Marion County, from which water is purchased under a long-term contract, (d) Geist Well Field, a ground water supply located downstream of Geist Reservoir, and (e) South Well Field located in southern Marion and northern Johnson Counties. See \"Properties-Source of Water Supply.\"\nThe three large surface reservoirs are essential to providing an adequate supply during dry periods. Two are used to supplement low stream flows in the White River and Fall Creek, respectively, and water is drawn directly from the third. The reservoirs are rated at a dependable capacity designed to maintain an adequate supply during a repetition of the worst two-year drought ever recorded in the Indianapolis area.\nThe theoretical dependable supply impounded by the three combined reservoirs represents about 65 percent of the total dependable supply available today with the balance coming from natural stream flow and wells. Wells constitute the source of supply for HWC.\nThe Company has aquifer protections plans for the Geist and South well fields. Once fully developed, the Geist well field will produce 12 to 15 MGD while the South well field will produce 40 to 50 MGD. The protection plans will guide the Company's development of these newest major sources of supply, and result in land use plans to protect the aquifer systems from potential contamination sources.\nSEASONAL NATURE OF BUSINESS\nTypically, the seasonal nature of the Company's business results in a higher proportion of operating revenues being realized in the second and third quarters of the year than the first and fourth quarters of the year.\nENVIRONMENTAL MATTERS\nThe Company's utility operations are subject to pollution control and water quality control regulations, including those issued by the Environmental Protection Agency (EPA), the Indiana Department of Environmental Management (IDEM), the Indiana Water Pollution Control Board and the Indiana Department of Natural Resources. Under the Federal Clean Water Act and Indiana's regulations, the Company must obtain National Pollutant Discharge Elimination System (NPDES) permits for discharges from its White River, White River North, Fall Creek, Thomas W. Moses and the Geist treatment stations.\nThe Company's current NPDES permits were to have expired on June 30, 1989, for White River and Fall Creek stations, December 31, 1990, for Thomas W. Moses treatment station, April 30, 1994 for Geist treatment station and January 31, 1996, for the White River North Station. Applications for renewal of the permits have been filed with, but not finalized by, IDEM. (These permits continue in effect pending review of the applications.)\nUnder the federal Safe Drinking Water Act (SDWA), the Company is subject to regulation by EPA of the quality of water it sells and treatment techniques it uses to make the water potable. EPA promulgates nationally applicable maximum contaminants levels (MCLs) for contaminants found in drinking water. Management believes that the Company is currently in compliance with all MCLs promulgated to date. EPA has continuing authority, however, to issue additional regulations under the SDWA, and Congress amended the SDWA in July 1986 to require EPA, within a three-year period, to promulgate MCLs for over 80 chemicals not then regulated. EPA has been unable to meet the three-year deadline, but has promulgated MCLs for many of these chemicals and has proposed additional MCLs.\nManagement of the Company believes that it will be able to comply with the promulgated MCLs and those now proposed without any change in treatment technique, but anticipates that in the future, because of EPA regulations, the Company may have to change its method of treating drinking water to include ozonation and\/or granular activated carbon (GAC). In either case, the capital costs could be significant (currently estimated at $27,000,000 for ozonation and $105,000,000 for GAC), as would be the Company's increase in annual operating costs (currently estimated at $1,400,000 for ozonation and $5,600,000 for GAC). Actual costs could exceed these estimates. The Company would expect to recover such costs through its water rates; however, such recovery may not necessarily be timely.\nUnder a 1991 law enacted by the Indiana Legislature, a water utility, including the utility subsidiaries of the Company, may petition the Indiana Utility Regulatory Commission (Commission) for prior approval of its plans and estimated expenditures required to comply with provisions of, and regulations under, the Federal Clean Water Act and SDWA. Upon obtaining such approval, the utility may include, to the extent of its estimated costs as approved by the Commission, such costs in its rate base for ratemaking purposes and recover its costs of developing and implementing the approved plans if statutory standards are met. The capital costs for such new systems, equipment or facilities or modifications of existing facilities may be included in the utility's rate base upon completion of construction of the project or any part thereof. While use of this statute is voluntary on the part of a utility, if utilized, it should allow utilities a greater degree of confidence in recovering major costs incurred to comply with environmental related laws on a timely basis.\nEMPLOYEES\nAt December 31, 1995, Resources, its subsidiaries and affiliated partnership, employed 2,059 full time employees, including 351 water utility employees, 544 MPC employees and 928 SM&P employees. Approximately one-half of the Company's water utility employees are members of the International Brotherhood of Firemen and Oilers Local 131, AFL-CIO (Union). IWC and the Union have a four-year contract through December 31, 1998.\nOPERATION INFORMATION BY INDUSTRY SEGMENT\nOperating information by industry segment for each of the past five years follows:\nOperating Revenues-Industry Segment (in thousands)\n1995 1994 1993 1992 1991 Water Utilities: Residential $ 48,907 44,700 41,513 40,633 38,901 Commercial and Industrial 21,999 20,576 18,032 16,696 15,393 Other (1) 9,471 8,248 5,038 6,123 5,636\nTotal Water Utilities 80,377 73,524 64,583 63,452 59,930\nUtility-Related Services (2) 66,688 37,855 19,659 - -\nTotal Operating Revenues (3) $147,065 111,379 84,242 63,452 59,930 ======= ======= ======= ======= =======\n(1) Includes $4,698 and $3,611 in income taxes collected from developers in 1995 and 1994, respectively. (2) Reporting by segment was adopted in 1993 as a result of the acquisition of SM&P. Utility-related services for prior periods are not material and, accordingly, have not been reclassified to conform with the 1993 presentation. (3) Certain reclassifications have been made to originally reported amounts for 1994 and 1993 to conform with classifications adopted for 1995. These reclassifications did not have a material effect on amounts previously reported.\nOperating Statistics-Water Utilities\n1995 1994 1993 1992 1991 Water Sold (million gallons) Residential 21,723 21,402 20,232 20,644 22,493 Commercial and Industrial 17,294 17,121 15,337 14,660 15,312 Other 841 1,112 756 837 944 Total Water Sold 39,858 39,635 36,325 36,161 38,749 ====== ====== ====== ====== ====== Daily Pumpage (million gallons) Maximum 207 192 154 161 202 Minimum 100 91 93 90 91 Average 129 122 118 115 124\nUtility Customers (end of year, in thousands) 235 229 224 219 214 Fire Hydrants (end of year) 26,525 25,737 24,730 24,215 23,465 Miles of Mains (end of year) 3,033 2,940 2,827 2,759 2,673\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nGENERAL DESCRIPTION\nThe Company's water utilities' properties consist of land, easements, rights (including water rights), buildings, reservoirs, canal, wells, supply lines, purification plats, pumping stations, transmission and distribution pipes, mains and conduits, meters and other facilities used for the collection, purification, and storage of water, and the distribution of water to its customers. The water systems extend from well fields and raw water reservoirs on Cicero Creek and Fall Creek, north and northeast of Indianapolis, and from the intake structure in Indianapolis' Eagle Creek Reservoir, northwest of Indianapolis, to the service connections of the ultimate consumers. The principal properties are all located in or near Indianapolis and, except for Eagle Creek Reservoir, which is owned by the city of Indianapolis, are all owned by the Company, in fee, with the exception of its easements. Substantially all its utility property rights and interests, both tangible and intangible, are subject to the lien securing first mortgage bonds.\nThe Company's utility-related properties consist of data processing equipment used to provide data processing and billing and payment processing to both unaffiliated utilities and to the Company's water utilities, and land, buildings, vehicles and operating equipment used to provide line locating services and installation, repairs and maintenance of underground pipelines to unaffiliated utilities. The Company also owns parcels of land which it holds for possible sale or development. A general description of the principal properties is set forth in the following paragraphs.\nSOURCE OF WATER SUPPLY\nWHITE RIVER: White River, supplemented by Morse Reservoir, furnished 69% of IWC's water supply during 1995, of which 63% was provided by IWC's White River plant and 6% was provided by IWC's White River North plant. The drainage area of the White River above the intake of IWC's canal is approximately 1,200 square miles. In 1956, IWC completed Morse Reservoir on Cicero Creek, a tributary of the White River. It is located on approximately 1,692 acres of land owned by IWC of which about 1,500 acres are inundated. The storage capacity of this reservoir is approximately 6.9 billion gallons. With the reservoir supplementing the natural flow, it is estimated by IWC that the combined dependable flow in the White River can be maintained at a volume sufficient to produce 88 MGD. IWC owns and maintains a dam across White River at Broad Ripple\nwhich serves to divert the flow into a canal. Water diverted at the Broad Ripple dam flows by gravity in the open canal to the White River treatment and pumping station. IWC's White River North plant has its intake directly on the White River.\nFALL CREEK: Fall Creek, supplemented by Geist Reservoir, provided 19% of IWC's water supply in 1995. The area of the watershed drained by Fall Creek upstream from the Fall Creek Station intake is approximately 300 square miles. In 1943, IWC completed the Geist Reservoir on Fall Creek. The reservoir is situated on about 1,983 acres of land owned by IWC, of which 1,890 acres are inundated, and has a storage capacity of approximately 6.1 billion gallons. With the reservoir supplementing the natural flow in Fall Creek, it is estimated by IWC that the combined dependable flow in Fall Creek can be maintained at a volume sufficient to provide 25 MGD. At the Fall Creek Station, IWC owns and maintains a concrete dam which diverts the flow of the creek into the station intake.\nEAGLE CREEK RESERVOIR: Raw water purchased from Eagle Creek Reservoir, a multipurpose reservoir owned and operated by the city of Indianapolis, provided 9% of IWC's water supply in 1995. On October 18, 1971, IWC and the City signed a 50-year contract, with an option for an additional 25 years, providing for the withdrawal, subject to certain restrictions, of up to 12.4 MGD on an annual average basis. IWC owns and maintains a raw water intake structure, pumping station, and pipeline within the reservoir property, which delivers the allotted supply to its Thomas W. Moses Treatment Plant.\nWELLS: IWC owns 32 wells, of which 25 are supplementary or auxiliary supply and seven are primary sources of supply. Of the primary wells, three are located at the Geist Well Field and four are the first development of the South Well Field. The Company owns water rights under a total of 984 acres of land, of which 938 acres are located in Marion County and 46 acres are located in Johnson County. It is estimated that the aggregate dependable annual average yield under a repetition of the most severe two-year drought on record is approximately 14 MGD from the wells. In 1995, wells provided approximately 3% of IWC's water supply.\nThe source of supply for HWC consists of six wells having a total rated capacity and actual pumping capacity of 4.2 MGD.\nPURIFICATION\nTreatment of surface water in IWC's system involves coagulation and flocculation, after which the water flows through the sedimentation basins and then to gravity-type rapid filters. IWC has four primary surface water filtration and purification plants--two for the White River supply sources, one for the Fall Creek supply source, and one for the Eagle Creek supply source--equipped with rapid filters having a maximum operating capacity aggregating 180 MGD and two ground water treatment plants totaling 10 MGD.\nThe water treatment plant for HWC consists of four packaged filter iron removal units with a combined rated capacity of 3.5 MGD, including the new east plant which increased rated capacity by 1.5 MGD.\nPUMPING\nIWC owns seven principal pumping stations and eleven booster stations. The principal pumping stations have a total of 40 primary distribution pumps and have a maximum capacity of 326 MGD. The booster stations have 42 pumps, all of which are electrically or diesel fuel driven with a maximum capacity of 101 MGD. IWC has not to date experienced, nor does it anticipate, any shortage of electrical energy to run its pumps.\nThe high service pumping facilities for HWC consist of six electric motor-driven pumps housed in the same buildings as the treatment plants and have a maximum capacity of approximately 3.5 MGD.\nIn 1995, improvements were made to the piping at the Edmondson Booster Station, which resulted in significantly improved pressure in the southeast portion of the Company's service territory.\nFILTERED WATER STORAGE\nThe Company's aggregate storage capacity for finished water is approximately 55 million gallons. IWC owns six filtered-water underground reservoirs at its five principal pumping stations which have an aggregate storage capacity of 39 million gallons. The filtered water in storage has been treated and is available to be pumped into the distribution system. Also, there are four elevated storage tanks with an aggregate storage capacity of over four million gallons and two ground storage tanks with an aggregate storage capacity of 12 million gallons.\nThe filtered water in the two ground storage tanks has been pumped by the principal pumping stations and is available to the respective booster stations to be pumped into the distribution system served by these stations. The four outlying elevated storage tanks \"ride on\" the distribution system and provide water by gravity flow.\nThere are two ground storage tanks at HWC, the first located adjacent to the treatment plant with a storage capacity of 50,000 gallons, and the second located adjacent to the new booster station with a storage capacity of 250,000 gallons. There is also an elevated storage tank in the distribution system which \"rides on\" the system and has a capacity of 250,000 gallons.\nTRANSMISSION AND DISTRIBUTION\nThe Company's utility transmission and distribution systems are composed of 3,033 miles of mains, most of which are cast iron and ductile iron. During the past ten years, an aggregate of 765 miles of mains, or approximately 25% of the total, were added to the systems. In general, the mains are located in city streets, other public ways and occasionally in easements. The supply mains are located partly in city streets and partly in rights-of-way and land owned by the Company. The Company furnishes public fire protection service through hydrants owned by the Company and located generally within the limits of street rights-of-way.\nUTILITY-RELATED PROPERTIES\nThe Company's data processing equipment is located at IWC's general office in Indianapolis, Indiana. The Company also owns land and buildings and leases (operating leases) additional buildings, all of which are used for its line locating services and operations related to installation, repairs and maintenance of underground pipelines. Vehicles, data processing equipment, and other operating equipment used in these operations are located at the various operating offices.\nREAL ESTATE INTERESTS\nAt December 31, 1995, the Company owned undeveloped non-utility land located primarily north and west of Geist Reservoir in Hamilton County, and several additional parcels in Marion County. The Company continues to explore the possible sale or development of this land.\nOFFICE BUILDING\nThe Company's main office building and service center was constructed in 1957 on 20 acres of land located approximately two miles from the center of the main business district of Indianapolis. The building houses the general and local commercial offices of the Company and provides a garage and building for storage of materials and vehicles, as well as shop space for repairs to automotive and other equipment. In May 1994, various administrative departments moved into the new General Office addition, west of the original building.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nThere are no material pending legal proceedings, other than ordinary litigation incidental to the Company's business, to which the Company 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 during the fourth quarter of 1995 to a vote of security holders of the Registrant, through the solicitation of proxies or otherwise.\nPART II\nItem 5.","section_5":"Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nInformation regarding the trading market for the Company's Common Shares, the range of selling prices for each quarterly period during the past two years with respect to the Common Shares, the approximate number of holders of Common Shares as of December 31, 1995, the frequency and amount of dividends paid during the past two years with respect to the Common Shares and other matters is included under the captions \"Stock Statistics\" and \"Distribution of Shareholders\" on page 47 of the 1995 Annual Report, which information is incorporated herein by reference.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA\nThe data included on page 40 of the 1995 Annual Report under \"Selected Financial Data\" is incorporated herein by reference.\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe discussion entitled \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" included in the 1995 Annual Report on pages 41 through 46 is incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe consolidated financial statements included in the 1995 Annual Report and listed in Item 14.1. of this Report are incorporated herein by reference from the 1995 Annual Report.\nItem 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information required by this Item regarding nominees for Director of the Company is incorporated herein by reference to the Company's definitive proxy statement for its 1996 annual meeting of common stockholders filed with the Commission pursuant to Regulation 14A (the \"1996 Proxy Statement\").\nThe following table sets forth the current officers of IWC Resources Corporation and its principal subsidiary, Indianapolis Water Company, their ages, and (as presented below in parentheses) their positions during the past five years. There is no family relationship between any of the officers of the Company. All officers are elected for a term of one year.\nIWC RESOURCES CORPORATION\nName Age Position\nJames T. Morris 52 Chairman of the Board, Chief Executive Officer and President (President and Chief Operating Officer)\nJoseph R. Broyles 53 President-IWC Industries\nJ. A. Rosenfeld 64 President-IWC Utilities (Executive Vice President; Senior Vice President and Treasurer; Financial Consultant)\nKenneth N. Giffin 52 Senior Vice President- Governmental Relations and Real Estate\nJohn M. Davis 44 Vice President, General Counsel and Secretary\nAlan R. Kimbell 64 Vice President-Marketing\nJames W. Shaffer 46 Vice President-Corporate Affairs\nMurvin S. Enders 53 Vice President-Administrative Affairs\nJames P. Lathrop 50 Assistant Treasurer and Chief Accounting Officer (Controller)\nPeggy J. Stinson 58 Assistant Secretary\nINDIANAPOLIS WATER COMPANY\nJames T. Morris 52 Chairman of the Board and Chief Executive Officer (President and Chief Operating Officer)\nJ. A. Rosenfeld 64 President and Chief Operating Officer (Executive Vice President; Senior Vice President and Treasurer)\nKenneth N. Giffin 52 Senior Vice President-Governmental Relations (Senior Vice President- Human Resources and Corporate Relations)\nJohn M. Davis 44 Vice President, General Counsel and Secretary\nRobert F. Miller 51 Vice President-Engineering (Principal Projects Engineer)\nDavid S. Probst 57 Vice President-Business Development (Vice President-Engineering Services)\nTim K. Bumgardner 47 Vice President-Operations (Vice President-Production)\nPatricia L. Chastain 58 Vice President-Community Affairs (Director of Special Projects; Corporate Affairs Coordinator)\nJames W. Shaffer 46 Vice President - Corporate Affairs\nMartha L. Wharton 66 Vice President-Customer Service (Vice President-Customer Relations; Assistant Secretary)\nL. M. Williams 52 Vice President - Human Resources\nJames P. Lathrop 50 Assistant Treasurer and Chief Accounting Officer\nPeggy J. Stinson 58 Assistant Secretary (Executive Secretary)\nAll of the above have been employed by the Company for more than five years except for Murvin S. Enders, J. A. Rosenfeld, John M. Davis and James W. Shaffer. Mr. Enders has been employed since October, 1995 and was previously employed by Chrysler Corporation. Additionally, Mr. Enders was a member of the Company's Board of Directors. Mr. Rosenfeld has been employed since January, 1992 and was previously employed by Melvin Simon & Associates. Mr. Davis has been employed since June, 1993 and was previously employed by KPMG Peat Marwick LLP. Mr. Shaffer has been employed since January, 1993 and was previously employed by Creative Concepts, Inc.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION\nThe information required by this Item regarding compensation of the Company's officers and directors is incorporated herein by reference to the Company's 1996 Proxy Statement. The Compensation Committee Report to Shareholders and Comparative Stock Performance sections of the Company's 1996 Proxy Statement shall not be deemed \"filed\" herewith.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\n(a) Information required by this item applicable to the Company's Redeemable Preferred Stock follows:\nTitle Name and Address Amount and Nature Percent of of of Beneficial of Class Beneficial Owner Ownership Class Redeemable Patrick J. Baker 17,204 shares 33-1\/3% Preferred 1913 W. 116th St. Stock Carmel, IN 46032\nDaniel S. Baker (1) 17,204 shares 33-1\/3% 7285 Waterview Pt. Noblesville, IN 46060\nDiana L. Sosbey 17,204 shares 33-1\/3% 8596 Twin Pt. Cir. Indianapolis, IN 46236\n(1) Mr. Daniel S. Baker is President of SM&P Utility Resources, Inc., (formerly SM&P Conduit Co., Inc.) a wholly owned subsidiary of the Company.\n(b) The information required by this Item regarding the number of shares of the Company's Common Stock, beneficially owned by the nominees for Director and the officers of the Company is incorporated herein by reference to the Company's 1996 Proxy Statement.\n(c) The Company knows of no arrangements the operation of which may at a subsequent date result in a change of control of the Company.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by this Item regarding certain relationships and related transactions is incorporated herein by reference to the Company's 1996 Proxy Statement.\nPART IV\nItem 14.","section_14":"Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\nThe documents listed below are filed as a part of this report except as otherwise indicated:\n1. Financial Statements. The following described consolidated financial statements found on the pages of the 1995 Annual Report indicated below are incorporated into Item 8 of this Report by reference.\nDescription of Financial Location in 1995 Statement Item Annual Report Independent Auditors' Report Page 39 Consolidated Balance Sheets, December 31, 1995 and 1994 Pages 22 and 23 Consolidated Statements of Shareholders' Equity, Years ended December 31, 1995, 1994 and 1993 Page 24 Consolidated Statements of Earnings, Years ended December 31, 1995, 1994 and 1993 Page 25 Consolidated Statements of Cash Flows, Years ended December 31, 1995, 1994 and 1993 Page 26 Notes to Consolidated Financial Statements, Years ended Pages 27 December 31, 1995, 1994 and 1993 through 38\n2. Financial Statement Schedules.\nAll schedules for which provision is made in Regulation S-X have been omitted for the reason that they are not required, are not applicable, or the required information is set forth in the consolidated financial statements or notes thereto.\n3. Exhibits\nThe exhibits set forth on the Index to Exhibits are incorporated herein by reference.\n4. Reports on Form 8-K\nOn November 6, 1995, the Company filed Amendment No. 1 to its current report on Form 8-K originally filed September 5, 1995 to report the acquisition by merger of Miller Pipeline Corporation. Amendment No. 1 contained pro forma financial information filed under \"Item 7. Financial Statements and Exhibits\". The pro forma financial information consisted of Pro Forma Condensed Consolidation Balance Sheet of the Registrant as of June 30, 1995 (Unaudited), Pro Forma Condensed Consolidated Statement of Earnings of the Registrant for the Six Months Ended June 30, 1995 (Unaudited), Pro Forma Condensed Consolidated Statement of Earnings of the Registrant for the Year Ended December 31, 1994 (Unaudited), and Notes to Unaudited Pro Forma Condensed Consolidated Financial Statements.\nOTHER MATTERS\nFor the purposes of complying with the amendments to the rules governing Form S-8 (effective July 13, 1990) under the Securities Act of 1933, the undersigned registrant hereby undertakes as follows, which undertaking shall be incorporated by reference into registrant's Registration Statement on Form S-8 No. 33-33021 (filed August 17, 1989):\nInsofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the registrant pursuant to the foregoing provisions, or otherwise, the registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act of 1933 and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue.\nSIGNATURES\nPursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the Registrant has duly caused this annual report to be signed on its behalf by the undersigned thereunto duly authorized.\nIWC RESOURCES CORPORATION Registrant\nDate March 29, 1996 By: J. A. Rosenfeld, President IWC Utilities\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nDate March 29, 1996 By: James T. Morris, Chairman of the Board, Chief Executive Officer and President and Director\nDate March 29, 1996 By: Robert B. McConnell, Chairman of the Executive Committee\nDate March 29, 1996 By: J. A. Rosenfeld, President IWC Utilities and Director (Principal Financial Officer)\nDate March 29, 1996 By: James P. Lathrop, Assistant Treasurer (Principal Accounting Officer)\nDate March 29, 1996 By: Joseph R. Broyles, President IWC Industries and Director\nDate March 29, 1996 By: Joseph D. Barnette, Jr., Director\nDate March 29, 1996 By: Robert A. Borns, Director\nDate March 29, 1996 By: Susan O. Connor, Director\nDate March 29, 1996 By: Otto N. Frenzel III, Director\nDate March 29, 1996 By: J. B. King, Director\nDate March 29, 1996 By: J. George Mikelsons, Director\nDate March 29, 1996 By: Thomas M. Miller, Director\nDate March 29, 1996 By: Jack E. Reich, Director\nDate March 29, 1996 By: Fred E. Schlegel, Director\nDate March 29, 1996 By: Milton O. Thompson, Director\nINDEX TO EXHIBITS\n2 Reorganization Agreement dated as of July 21, 1995 (without exhibits other than the Plan and Agreement of Merger dated as of August 18, 1995), filed as Exhibit 2 to Registrant's Form 8-K filed September 5, 1995, is incorporated herein by reference.\n3A-1 Restated Articles of Incorporation of Registrant, as amended to date. The copy of this exhibit filed as Exhibit 3-A to Registrant's Registration Statement on Form S-8 effective August 17, 1989 \"Registration No. 33-30221\", is incorporated by reference.\n3-B Bylaws of Registrant, as amended to date. The copy of this exhibit filed as Exhibit 3-B to Registrant's Registration Statement on Form S-8 effective August 17, 1989 \"Registration No. 33-30221\", is incorporated by reference.\n4.1 Ninth Supplemental Indenture dated as of August 1, 1967. The copy of this exhibit filed as Exhibit 4-B5 to IWC's Annual Report on Form 10-K for the fiscal year ended December 31, 1980, is incorporated herein by reference.\n4.2 Eleventh Supplemental Indenture dated as of December 1, 1971. The copy of this exhibit filed as Exhibit 4-B6 to IWC's Annual Report on Form 10-K for the fiscal year ended December 31, 1980, is incorporated herein by reference.\n4.3 Seventeenth Supplemental Indenture dated as of March 1, 1989, between Fidelity Bank, National Association, and IWC. The copy of this exhibit filed as Exhibit 4-A9 to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1988 is incorporated herein by reference.\n4.4 Eighteenth Supplemental Indenture dated as of March 1, 1989, between Fidelity Bank, National Association and IWC. The copy of this exhibit filed as Exhibit 4-A10 to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1988, is incorporated herein by reference.\n4.5 Nineteenth Supplemental Indenture dated as of June 1, 1989, between Fidelity Bank, National Association, and IWC. The copy of this exhibit filed as Exhibit 4-A9 to Registrant's Registration Statement on Form S-2 effective December 12, 1991 (Registration No. 33-43939), is incorporated herein by reference.\n4.6 Fourteenth Supplemental Indenture dated as of January 15, 1978, between the Fidelity Bank, (formerly Fidelity-Philadelphia Trust Company) and IWC, including as Appendix A the \"Restatement of Principal Indenture of Indianapolis Water Company,\" which, except as otherwise specified, restates the granting clauses and all other sections contained in the First Mortgage dated July 1, 1936, between Fidelity-Philadelphia Trust Company and Registrant as amended by the Fourth, Fifth, Sixth, Eighth, Twelfth and Fourteenth Supplemental Indentures. A copy of this exhibit filed as Exhibit 4-B1 to IWC's Annual Report on Form 10-K for the fiscal year ended December 31, 1980, is incorporated herein by reference.\n4.7 Twentieth Supplemental Indenture dated as of December 1, 1992, between Fidelity Bank, National Association, and IWC. The copy of this Exhibit filed as Exhibit 4-A9 to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1992, is incorporated herein by reference.\n4.8 Twenty-First Supplemental Indenture dated as of December 1, 1992, between Fidelity Bank, National Association and IWC. The copy of this Exhibit filed as Exhibit 4-A10 to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1992, is incorporated herein by reference.\n4.9 Rights Agreement, dated as of February 9, 1988, between IWC Resources Corporation and Bank One, Indianapolis, NA (as Rights Agent), which includes the Form of Certificate of Designations of Series A Junior Participating Preferred Stock as Exhibit A, the Form of Right Certificate as Exhibit B and the Summary of Rights to Purchase Preferred Shares as Exhibit C. The copy of this exhibit filed as Exhibit 4 to the Registrant's Current Report on Form 8-K dated February 9, 1988, is incorporated by reference.\n4.10 Indenture of Trust dated as of March 1, 1989, between IWC, City of Indianapolis, Indiana, and Merchants National Bank & Trust Company of Indianapolis, as Trustee. The copy of this exhibit filed as Exhibit 10-F to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1988, is incorporated herein by reference.\n4.11 Indenture of Trust dated as of March 1, 1989, between IWC, Town of Fishers, Indiana, and Merchants National Bank & Trust Company of Indianapolis, as Trustee. The copy of this exhibit filed as Exhibit 10-G to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1988, is incorporated herein by reference.\n4.12 Indenture of Trust dated as of December 1, 1992, between City of Indianapolis, Indiana, and IWC to National City Bank, Indiana, as Trustee. The copy of this Exhibit filed as Exhibit 10-J to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1992, is incorporated herein by reference.\n4.13 Indenture of Trust, City of Indianapolis, Indiana, and Indianapolis Water Company to National City Bank, Indiana, as Trustee, dated as of April 1, 1993. The copy of this Exhibit filed as Exhibit 4.14 to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1993, is incorporated herein by reference.\n4.14 Twenty-Second Supplemental Indenture dated as of April 1, 1993, between Indianapolis Water Company and Fidelity Bank, National Association. The copy of this Exhibit filed as Exhibit 4.15 to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1993, is incorporated herein by reference.\n10.1 Agreement dated October 18, 1971, between IWC and the Department of Public Works of the City of Indianapolis, Indiana, relating to the purchase of water at Eagle Creek Reservoir. The copy of this exhibit filed as Exhibit 5 to IWC's Statement (No. 2-55201), effective January 14, 1976, is incorporated herein by reference.\n*10.2 The description of \"split dollar\" life insurance policies owned by IWC with respect to certain officers of Registrant is incorporated hereby by reference to the Company's 1988 Proxy Statement.\n*10.3 Form of Executive Supplemental Benefits Plan of IWC. The copy of this exhibit filed on Exhibit 10-D to IWC's Annual Report on Form 10-K for the fiscal year ended December 31, 1985, is incorporated herein by reference.\n10.4 Loan Agreement dated as of March 1, 1989, between IWC and the City of Indianapolis, Indiana. The copy of this exhibit filed as Exhibit 10-D to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1988, is incorporated herein by reference.\n10.5 Loan Agreement dated as of March 1, 1989, between IWC and Town of Fishers, Indiana. The copy of this exhibit filed as Exhibit 10-E to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1988, is incorporated herein by reference.\n10.6 Guaranty Agreement dated as of March 1, 1989, between Registrant and Merchants National Bank and Trust Company of Indianapolis re: City of Indianapolis, Indiana Industrial Development Bonds. The copy of this exhibit filed as Exhibit 10-H to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1988, is incorporated herein by reference.\n10.7 Guaranty Agreement dated as of March 1, 1989, between Registrant and Merchants National Bank & Trust Company of Indianapolis re: Town of Fishers, Indiana Industrial Development Bonds. The copy of this exhibit filed as Exhibit 10-I to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1988, is incorporated herein by reference.\n10.8 Loan Agreement dated as of December 1, 1992, between IWC and City of Indianapolis, Indiana. The copy of this exhibit filed as Exhibit 10-K to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1992, is incorporated herein by reference.\n10.9 Guaranty Agreement dated as of December 1, 1992, between Resources and National City Bank, Indiana, as Trustee. The copy of this exhibit filed as Exhibit 10-L to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1992, is incorporated herein by reference.\n10.10 Note Agreement dated as of March 1, 1994, between Registrant and American United Life Insurance Company. The copy of this exhibit filed as Exhibit 10.10 to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1993, is incorporated herein by reference.\n10.11 Loan Agreement dated as of April 1, 1993, between Indianapolis Water Company and City of Indianapolis. The copy of this exhibit filed as Exhibit 10.11 to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1993, is incorporated herein by reference.\n10.12 Guaranty Agreement between Registrant and National City Bank, Indiana, as Trustee, dated as of April 1, 1993. The copy of this exhibit filed as Exhibit 10.12 to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1993, is incorporated herein by reference.\n10.13 Agreement for the Operation and Maintenance of the City of Indianapolis, Indiana, Advanced Wastewater Treatment Facilities dated as of December 20, 1993, among the City of Indianapolis, White River Environmental Partnership, the Registrant and certain other parties. The copy of this exhibit filed as Exhibit 10.13 to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1993, is incorporated herein by reference.\n10.14 White River Environmental Partnership Agreement between IWC Services, Inc., JMM White River Corporation and LAH White River Corporation, dated as of August 20, 1993. The copy of this exhibit filed as Exhibit 10.14 to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1993, is incorporated herein by reference.\n10.15 Plan and Agreement of Merger among Registrant, Resources Acquisition Corp., S.M.& P. Conduit Co., Inc., and its shareholders dated as of June 14, 1993. The copy of this exhibit filed as Exhibit 10.15 to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1993, is incorporated herein by reference.\n*10.16 Executive Employment Agreement between Registrant and James T. Morris, dated as of December 31, 1993 (substantially similar agreements in favor of J. A. Rosenfeld, Joseph R. Broyles, John M. Davis and Kenneth N. Giffin have been omitted pursuant to Instruction 2 to Item 601 of Regulation S-K). The copy of this exhibit filed as Exhibit 10.16 to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1993, is incorporated herein by reference.\n*10.17 Employment Agreement between Miller Pipeline Corporation (surviving corporation) and Don W. Miller dated August 22, 1995, filed as Exhibit 10 (1) to Registrant's Form 8-K filed September 5, 1995, is incorporated herein by reference.\n*10.18 Employment Agreement between Miller Pipeline Corporation (surviving corporation) and Dale R. Miller dated August 22, 1995, filed as Exhibit 10 (2) to Registrant's Form 8-K filed September 5, 1995, is incorporated herein by reference.\n13 Registrant's Annual Report to Stockholders for the year ended December 31, 1995. This exhibit, except for the portions thereof that have expressly been incorporated by reference into this Report, is furnished for the information of the Commission and shall not be deemed \"filed\" as part hereof.\n21 Subsidiaries\n23 Consent of Independent Certified Public Accountants.\n27 Financial Data Schedule\n*This exhibit relates to executive compensation or benefit plans.","section_15":""}
{"filename":"823488_1995.txt","cik":"823488","year":"1995","section_1":"Item 1. Business\nVanguard Real Estate Fund II, A Sales-Commission-Free Income Properties Fund (the \"Fund\"), was organized on September 24, 1987 as a Massachusetts business trust and is a qualified finite-life real estate investment trust (\"REIT\") under the Internal Revenue Code of 1986, as amended. The Fund has no employees. The Fund's Declaration of Trust precludes the Fund from reinvesting net proceeds from the sale or repayment of its real estate investments after December 31, 1994 and contemplates the liquidation of all the Fund's investments after a period of approximately seven to twelve years following the completion of its initial public offering, or between 1995 and 2000, respectively.\nOn December 8, 1995, the Fund's Board of Trustees adopted a Plan of Liquidation and Termination (the \"Liquidation Plan\"). The Trustee's decision to adopt the Liquidation Plan at this point in the Fund's initially contemplated liquidation period was driven by several factors, including real estate market conditions affecting each investment in the Fund's portfolio and tax considerations affecting real estate investment trusts. The Liquidation Plan provides that the Fund will dispose of all of its assets, wind up its affairs, pay or adequately provide for the payment of all of its liabilities and distribute for the benefit of its shareholders all of the Fund's assets over 24 months, in complete cancellation and redemption of all issued and outstanding shares of beneficial interest. Under the Liquidation Plan, the Fund's Adviser (Aldrich, Eastman and Waltch, L.P.), Trustees and officers are authorized and directed to take any and all actions as may be necessary or convenient to market the assets of the Fund and convert them into a form that may be distributed to shareholders. The Liquidation Plan provides that the Fund's assets may be sold, conveyed, transferred or otherwise disposed of when and on such terms and conditions as are deemed by the Trustees to be in the best interests of the Fund and the shareholders.\nThe Fund is currently in the process of liquidating its real estate investments with the intention of distributing the net proceeds to its shareholders in accordance with the Liquidation Plan. At December 31, 1995, the Fund held investments in two income-producing properties, consisting of one industrial park and one shopping center. The Fund also holds a limited partnership interest in a limited partnership that owns an income producing office building. It is contemplated that the Fund will be completely liquidated and dissolved by December 12, 1997. To the extent that the Fund has not disposed of all of its assets or made provision for all of its liabilities on December 12, 1997, the Fund intends to form a liquidating trust, the beneficiaries of which will be the shareholders of the Fund. All assets and liabilities of the Fund not previously disposed of and discharged will be transferred to the liquidating trust. Shares of the Fund would no longer be traded and the beneficial interests in the liquidating trust would not be readily transferable.\nOn April 13, 1995, the Fund exercised its call right on its Bayside Business Center mortgage loan investment (\"Bayside\") and the entire balance of the loan became due and payable on October 18, 1995. The Fund and the borrower reached agreement to satisfy in full the obligations due under the loan balance by means of a discounted payoff of $7,600,000. The Fund also agreed to provide the borrower 120 days to obtain financing to make the payoff in exchange for a commitment to transfer title to the Fund in lieu of foreclosure if the borrower could not make the discounted payoff. The borrower was unable to secure the necessary financing and, accordingly, the Fund took title to Bayside in late February 1996. The former borrower remained current on all interest payments due on the loan.\nOn March 7, 1996, the Fund sold its Arapahoe Village Investment (\"Arapahoe\") in Boulder, Colorado for a gross contract price of $17,550,000. The Fund reported in November 1995 that it had then been recently advised by Aldrich, Eastman and Waltch, L.P. (\"AEW\") that soil and groundwater samples extracted from the site revealed the presence of constituents of gasoline and dry-cleaning fluid in the soil and groundwater. The samples were taken as part of an environmental assessment undertaken at the request of a contract purchaser in connection with a contemplated sale of the property. AEW subsequently engaged on the Fund's behalf attorneys and environmental consultants in an effort to further assess the scope and magnitude of the possible contamination. Pursuant to the terms of an amended sale agreement, the Fund completed the sale of Arapahoe to the same contract purchaser. The sale of Arapahoe generated a net gain to the Fund of approximately $4,100,000 over the investment's carrying cost, after payment by the Fund of applicable transaction costs, including a disposition fee payable to AEW in the amount of $250,000, Such gain will be recognized in the first quarter of 1996.\nPending disposition of the Fund's real estate investments pursuant to the Liquidation Plan, the Fund's real estate investments will continue to be subject to competition from existing commercial, industrial, and residential properties and will be subject to competition from properties that are developed in the future. The REIT provisions of the Internal Revenue Code of 1986 (\"the Code\") impose certain financial, investment and operational restrictions that are not applicable to competing entities that are not REITs.\nPursuant to the Liquidation Plan, in disposing of real estate investments, the Fund is in competition with other domestic institutional investors, including commercial banks and other financial institutions, insurance companies, pensions and other retirement funds, mortgage bankers, other real estate investment trusts, real estate brokers, developers and various types of foreign investors who may be seeking to dispose of real estate investments. The principal factors of competition for the disposition of the mortgage loan receivable include the base interest rate, contingent interest rate and the amount of loan relative to the value of the underlying property. In the case of leased properties which the Fund owns or which secure Fund investments, the marketability of the investments is also affected by how rental rates, lease terms, free rent concessions and tenant improvement allowances compare with those in local markets.\nAt present, of the Fund's three remaining real estate investments at December 31, 1995, one has been sold (Arapahoe) and the Fund, through its Adviser, is actively marketing for sale or negotiating the disposition of the other two. Based on information provided by the Adviser, it is possible that both investments could be sold during 1996. However, there can be no assurance that such sales can be completed during 1996. Upon sale of these two remaining investments, the Fund's Trustees and management intend to complete the Fund's Liquidation Plan as soon as practicable thereafter. In addition to liquidating the Fund's assets, settling all of the Fund's liabilities, making a final distribution(s) to shareholders and dissolving the Fund, such activities are expected to include, but not necessarily be limited to, (i) delisting the Fund's shares from trading on the American Stock Exchange, (ii) deregistering the Fund's shares under the Securities Exchange Act of 1934, (iii) making provision for contingent liabilities of the Fund, if any, and (iv) obtaining any necessary insurance coverages.\nPursuant to a Services Agreement dated January 19, 1988 (the \"Services Agreement\") between the Fund and The Vanguard Group, Inc. (the \"Sponsor\"), the Sponsor has been retained to provide administrative services for the Fund, including the maintenance of financial records, oversight of the performance of outside service providers and the preparation and distribution of communications to shareholders, etc., and to supervise its day-to-day business affairs. Pursuant to an Advisory Agreement dated December 23, 1986 (as amended, the \"Advisory Agreement\") between the Fund and Aldrich, Eastman & Waltch, Inc. (the \"Adviser\"), the Adviser has been retained to advise the Fund in connection with the evaluation, selection, management and disposition of its real estate investments. For additional information concerning the Sponsor, the Adviser, the Services Agreement and the Advisory Agreement, see Item 8, Financial Statements and Supplementary Data - Notes to Financial Statements, and Item 13, Certain Relationships and Related Transactions.\nThe Fund has elected to be treated as a REIT under the Code. The Fund intends to operate in a manner that will continue to maintain its qualification as a REIT during its liquidation period.\nFor additional information regarding the Fund's Liquidation Plan, 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.\nThe following table sets forth the names and positions with the Fund of the executive officers of the Fund:\nAll executive officers of the Fund also serve as executive officers of Vanguard Real Estate Fund I, A Sales-Commission-Free Income Properties Fund (\"VREFI\"). All executive officers of the Fund, with the exceptions of Mr. Packard, who was elected as an officer of the Fund in May 1988, and Mr. Klapinsky, who was elected as an officer of the Fund in May 1989, have served since the Fund's inception. Under the Fund's Declaration of Trust, the officers of the Fund serve at the pleasure of the Trustees. There are no family relationships between any Trustee or executive officer.\nMr. Bogle is Chairman of The Vanguard Group, Inc. (the Sponsor of the Fund) and each of the investment companies in The Vanguard Group. Mr. Bogle has served in such capacity during each of the past five years. Mr. Bogle also serves as a Director of The Mead Corporation and General Accident Insurance Companies.\nMr. Brennan is President of The Vanguard Group, Inc. and has served in such capacity for each of the last five years. On January 31, 1996, Mr. Brennan assumed title of Chief Executive Officer of the Fund, The Vanguard Group, Inc. and each of the investment companies in The Vanguard Group. Mr. Brennan also serves as a Director (Trustee) of The Vanguard Group, Inc., and each of the investment companies in The Vanguard Group.\nMr. Packard is Senior Vice President and Chief Financial Officer of The Vanguard Group, Inc. and has served in such capacity during each of the past five years.\nMr. Hyland is, and has served for each of the past five years as, Treasurer of The Vanguard Group, Inc. and each of the investment companies in The Vanguard Group.\nMr. Klapinsky is, and has served for each of the past five years as, Senior Vice President and Secretary of The Vanguard Group, Inc. and each of the investment companies in The Vanguard Group.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nAs of December 31, 1995, the Fund held the following real estate investments:\nEQUITY INVESTMENT\nInformation concerning the Arapahoe investment is included in Notes H and N to the Fund's Financial Statements, included in Item 8, Financial Statements and Supplementary Data, and in Schedule XI to Item 14, Exhibits, Financial Statement Schedules, and Reports on Form 8-K.\nJOINT VENTURE\n** Net of capital proceed distributions of $8,756,000, $4,612,000, and $931,000 received in 1992-1994 as a result of scheduled advances under the refinancing of the underlying property on December 31, 1992.\nInformation concerning the Mountain View investment, including the terms of the Plymouth Street, L.P. Partnership agreement, is included in Note 1 to the Plymouth Street L.P. Financial Statements, which are summarized in a footnote to the Fund's Financial Statements, and which are included in Item 14, Exhibits, Financial Statement Schedules, and Reports on Form 8-K.\nMORTGAGE INVESTMENTS\n** At December 31, 1994, a provision for possible losses of $800,000 was recorded to write down Bayside's carrying value (remaining loan balance plus a deferred interest receivable pursuant to a shared-appreciation feature of the mortgage) to the estimated fair value of the collateral securing the mortgage loan less estimated selling costs.\nInformation concerning the Bayside Investment is included in Note F to the Fund's Financial Statements, included in Item 8, Financial Statements and Supplementary Data, and in Schedule XII to Item 14, Exhibits, Financial Statement Schedules, and Reports on Form 8-K.\nSet forth below is a summary of the general competitive conditions for those properties whose book value is ten percent or more of the Fund's total assets as of December 31, 1995, or whose gross revenues are ten percent or more of the aggregate gross revenues of the Fund for the year ended December 31, 1995.\nBayside Business Center\nBayside Business Center is a mixed-use industrial project comprised of three single-story R&D and retail\/service buildings located in San Carlos, California, part of the San Francisco metropolitan area. The San Francisco metropolitan area job growth for the 1994-1995 was just under 1%, an improvement over the previous year. Employment is expected to drop slightly over the next few years. Market vacancy rates have increased to 7% but rents are still expected to rise slightly. Market rents range from $.50-$1.25 per square foot per month. In 1996, rents may be expected to increase slightly over the course of the year. The property is currently achieving rents at $.95 per square foot per month on a triple net basis.\nArapahoe Village\nArapahoe Village is a neighborhood shopping center located in Boulder, Colorado. Population in the area is expected to grow during the rest of the decade, averaging 2.4% growth per year. The Boulder retail market continues to be tight with a 3-5% vacancy range. With little competitive supply in the trade area and limited proposed construction due to the City of Boulder's growth policies, the outlook for future market rental rates is positive. Market rents range from $12.00-$18.00 per square foot annually.\nOccupancy Rates at December 31:\nAvg. Effective Rental\/Sq.Ft.\/Year:\nReal Estate Tax\/Fiscal Year:\nTenants Occupying 10% or more of rentable square footage:\nLease Expirations during the next ten years:\nBy Square Foot\nBy Annual Rental\nA mortgage loan payable, secured by the Arapahoe Village property, is outstanding at December 31, 1995. Information concerning the principal, interest, amortization and maturity provisions is included in Note H to the Fund's Financial Statements, incorporated by reference in Item 8, Financial Statements and Supplementary Data.\nInformation concerning the interest rates, shared-appreciation features, and other terms of the Fund's mortgage investments is included in Note F to the Fund's Financial Statements, included in Item 8, Financial Statements and Supplementary Data, and in Schedule XII to Item 14.\nThe Fund believes that its direct ownership property and the property underlying its mortgage and joint venture investments, are well maintained, in good repair, suitable for their intended uses and are adequately covered by insurance. For additional information regarding the Fund's real estate investments, see Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, Item 8, Financial Statements and Supplementary Data, and Schedules XI and XII to Item 14.\nInformation concerning the Federal tax basis and depreciation method and lives of the Fund's properties and components thereof and on which depreciation is taken is included in Notes A and E to the Fund's Financial Statements, included in Item 8, Financial Statements and Supplementary Data, and in Schedule XI to Item 14. All real estate owned has been depreciated over 40 years for both financial and tax reporting purposes on a straight-line basis except for leasehold improvements, which are depreciated over the term of the respective lease for financial reporting purposes.\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 Shareholder Matters\nThe Fund's shares of beneficial interest (\"Shares\") are traded on the American Stock Exchange (AMEX) under the symbol \"VRT\". The Shares have been traded on the AMEX since August 20, 1991. From August 7, 1990 to August 19, 1991, the Fund's shares were traded on the over the counter market and were quoted by the National Association of Securities Dealers Automated Quotation System (\"NASDAQ\"). Prior to August 7, 1990, there was no trading market for the Shares. As of February 29, 1996, there were approximately 8,862 holders of record of the Fund's Shares.\nSet forth below is certain information regarding the Fund's Shares for each of the eight fiscal quarters in the two-year period ended December 31, 1995:\n*A Liquidating dividend of $1.25 per share was paid on December 28, 1995.\n**A dividend of $2.00 per share, of which $1.96 per share represented a return of capital distribution, was paid on December 29, 1994.\nThe tables below indicate the amount of cash dividends per share declared and paid during the years ended December 31, 1995 and 1994.\nExcept during its offering period, the Fund has historically paid distributions on a quarterly basis and there are currently no contractual restrictions on the Fund's present or future ability to make distributions to shareholders. For additional information regarding the Fund's distributions and its ability and intent to pay distributions during the liquidation period, see Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe information required by this Item is included on page 21 of the Fund's 1995 Annual Report to Shareholders and is incorporated herein by reference thereto.\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 23 through 31 of the Fund's 1995 Annual Report to Shareholders and is incorporated herein by reference thereto.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe Fund's financial statements at December 31, 1995 and 1994, and for each of the three years in the period ended December 31, 1995, are included on pages 5-19 of the Fund's 1995 Annual Report to Shareholders and are incorporated herein by reference thereto.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nThe information required by this Item with respect to Trustees is included in the Fund's definitive Proxy Statement filed with the Securities and Exchange Commission on March 15, 1996 for its Annual Meeting of Shareholders to be held on April 24, 1996, which is incorporated herein by reference thereto. Information with respect to executive officers of the Fund is included in Item 1.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe information required by this Item is included in the Fund's definitive Proxy Statement filed with the Securities and Exchange Commission on March 15, 1996 for its Annual Meeting of Shareholders to be held on April 24, 1996, which is incorporated herein by reference thereto.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThe information required by this Item is included in the Fund's definitive Proxy Statement filed with the Securities and Exchange Commission on March 15, 1996 for its Annual Meeting of Shareholders to be held on April 24, 1996, which is incorporated herein by reference thereto.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThe information required by this Item is included in the Fund's definitive Proxy Statement filed with the Securities and Exchange Commission on March 15, 1996 for its Annual Meeting of Shareholders to be held on April 24, 1996, which 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) 1. Financial Statements:\nThe following financial statements as of, and for the years ended, December 31, 1995, 1994 and 1993 are incorporated in Item 8 herein by reference from the following pages of the Fund's 1995 Annual Report to Shareholders, which is filed as an Exhibit hereto.\nThe following financial statements of Plymouth Street, L.P., in which the Fund holds a limited partnership interest, as of December 31, 1995 and 1994, and for the years ended December 31, 1995, 1994 and 1993 are filed as part of this Report on Form 10-K.\n2. Financial Statement Schedules:\nThe financial statement schedules included in Part IV of this report should be read in conjunction with the Fund's financial statements incorporated by reference in Item 8 of this report.\nAll other schedules have been omitted since the required information is presented in the financial statements, the related notes, or is not applicable.\n3. Exhibits:\nExhibit No. Description - ----------- -----------\n2 Plan of Liquidation and Termination, dated December 8, 1995.\n3.1(a) Amended and Restated Declaration of Trust, dated as of January 8, 1988, filed as exhibit 3 to the Fund's Registration Statement on Form S-11, SEC Registration #33-17854, and incorporated herein by reference.\n3.1(b) Amendment #1 to Amended and Restated Declaration of Trust, dated as of January 19, 1988, filed as exhibit 3.1(b) to the Fund's Annual Report on Form 10-K for the year ended December 31, 1988, and incorporated herein by reference.\n3.2 By-laws, dated September 19, 1987, filed as exhibit 3 to the Fund's Registration Statement on Form S-11, SEC Registration #33-17854, and incorporated herein by reference.\n10.1 Advisory Agreement between the Registrant and Aldrich, Eastman & Waltch, Inc. dated January 19, 1988, filed as exhibit 10.1 to the Fund's Annual Report on Form 10-K for the year ended December 31, 1988, and incorporated herein by reference.\n10.2 Services Agreement between the Registrant and The Vanguard Group, Inc. dated January 19, 1988, filed as exhibit 10.2 to the fund's Annual Report on Form 10-K for the year ended December 31, 1988, and incorporated herein by reference.\n10.3(a) First Promissory Note from Brown Associates in favor of Lawrence W. Doyle, Richard F. Burns, and J. Grant Monahon, Trustees of AEW #160 Trust, established by Declaration of Trust dated December 29, 1988, dated January 12, 1989, filed as exhibit 10.3(a) to the fund's Annual Report on Form 10-K for the year ended December 31, 1988 and incorporated herein by reference.\n10.3(b) Second Promissory Note from Brown Associates in favor of Lawrence W. Doyle, Richard F. Burns, and J. Grant Monahon, Trustees of AEW #160 Trust, established by Declaration of Trust dated December 19, 1988, dated January 12, 1989, filed as exhibit 10.3(b) to the Fund's Annual Report on Form 10-K fro the year ended December 31, 1988 and incorporated herein by reference.\n10.3(c) Loan Agreement by and between Brown Associates and Lawrence W. Doyle, Richard F. Burns, and J. Grant Monahon, Trustee of AEW #160 Trust, established by Declaration of trust dated December 29,1988, dated January 12, 1989, filed as exhibit 10.3(c) to the Fund's Annual Report on Form 10-K for the year ended December 31, 1988, and incorporated herein by reference.\n10.3(d) Declaration of Trust, AEW #160 Trust and Schedule of Beneficial Interest dated January 12, 1989, filed as exhibit 10.3(d) to the Fund's Annual Report on Form 10-K for the year ended December 31, 1988, and incorporated herein by reference.\n10.4(a) Purchase and Sale Agreement of the Penn Warner Properties, between Millie C. Cassidy, Lewis W. Kresch and Michael J. Weinberger as Trustees of SRE Real Estate Fund and J. Grant Monahon, Lee H. Sandwen and Richard F. Burns, Trustees of AEW #165 Trust dated March 7, 1989 dated June 8, 1989, filed as exhibit 10.1(a) to the Fund's Quarterly Report on Form 10-Q for the quarter ended June 30, 1989, and incorporated herein by reference.\n10.4(b) Declaration of Trust, AEW #165 Trust and Schedule of Beneficial Interest, dated March 7, 1989, filed as exhibit 10.1(b) to the Fund's Quarterly Report on Form 10-Q for the quarter ended June 30, 1989, and incorporated herein by reference.\n10.5(a) Promissory Note from Harris Trust and Savings Bank, as Trustee under Trust #43584 in favor of J. Grant Monahon, Richard F. Burns and Lee H. Sandwen, as Trustees of AEW #169 Trust dated April 25, 1989, dated June 26, 1989, filed as exhibit 10.2(a) to the Fund's Quarterly Report on Form 10-Q for the quarter ended June 30, 1989, and incorporated here by reference.\n10.5(b) Declaration of Trust, AEW #169 Trust and Schedule of Beneficial Interest, dated April 15, 1989, filed as exhibit 10.2(b) to the Fund's Quarterly Report on Form 10-Q for the quarter ended June 30, 1989, and incorporated herein by reference.\n10.6(a) First Promissory Note from Bayside Business Center in favor of J. Grant Monahon, Richard F. Burns and Bruce H. Freedman, Trustees of AEW #172 Trust dated June 12, 1989, dated June 29, 1989, filed as exhibit 10.3(a) to the Fund's Quarterly Report on Form 10-Q for the quarter ended June 30, 1989, and incorporated herein by reference.\n10.6(b) First Deed of trust from Bayside Business Center for the use and benefit of J. Grant Monahon, Richard F. Burns and Bruce H. Freedman, Trustees of AEW #172 Trust dated June 12, 1989, dated June 29, 1989, filed as exhibit 10.3(b) to the Fund's Quarterly Report on Form 10-Q for the quarter ended June 30, 1989, and incorporated herein by reference.\n106.(c) Second Promissory Note from Bayside Business Center in favor of J. Grant Monahon, Richard F. Burns and Bruce H. Freedman Trustees of AEW #172 Trust dated June 12, 1989, dated June 29, 1989, filed as exhibit 10.3(c) to the Fund's Quarterly Report on Form 10-Q for the quarter ended June 30, 1989, and incorporated herein by reference.\n10.6(d) Second Deed of Trust from Bayside Business Center for the use and benefit of J. Grant Monahon, Richard F. Burns and Bruce H. Freedman Trustees of AEW #172 Trust dated June 12, 1989, dated June 19, 1989, filed as exhibit 10.3(d) to the Fund's Quarterly Report on Form 10-Q for the quarter ended June 30, 1989, and incorporated herein by reference.\n10.6(e) Declaration of Trust, AEW #172 Trust and Schedule of Beneficial Interest, dated June 12, 1989, filed as exhibit 10.3(e) to the Fund's Quarterly Report on Form 10-Q for the quarter ended June 30, 1989, and incorporated herein by reference.\n10.7(a) Agreement of Limited Partnership of Plymouth Street, L.P., by and between Mountain View Place Investors, a California general partnership, as general partner, and J. Grant Monahon, Richard F. Burns and Bruce H. Freedman, Trustees of AEW #171 Trust, established by a Declaration of Trust dated August 21, 1989, as limited partner, dated August 30, 1989, filed as exhibit 10.1(a) to the fund's Current Report on Form 8-K dated September 1, 1989, and incorporated herein by reference.\n10.7(b) Environmental Indemnification Agreement by Mountain View Place Investors, a California general partnership, to and for the benefit of J. Grant Monahon, Richard F. Burns and Bruce H. Freedman, Trustees of AEW #171 Trust established by Declaration of Trust dated August 21, 1989, and Plymouth Street, L.P., and Delaware Limited partnership, dated August 30, 1989, filed as exhibit 10.1(b) to the Fund's Current Report on Form 8-K, dated September 1, 1989, and incorporated herein by reference.\n10.7(c) Declaration of Trust, #171 Trust and Schedule of Beneficial Interest, dated August 21, 1989, filed as exhibit 10.1(c) to the Fund's Current Report on Form 8-K dated September 1, 1989, and incorporated herein by reference.\n10.8 Purchase and Sale Agreement between Boulder Arapahoe Mall Associates, LTD and Aldrich, Eastman & Waltch, Inc., agent for VREFII, dated November 18, 1989, filed as exhibit 10.8 to the Fund's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 and incorporated herein by reference.\n10.9 Agreement for deed in lieu of foreclosure of mortgaged property made on May 19, 1992, by and among Harris Trust and Savings Bank, as Trustee under Trust #43584, Landmark Holdings, an Illinois general partnership, and J. Grant Monahon, Richard F. Burns and Glenn L. Burdick, as Trustees of AEW #169 Trust under Declaration of Trust dated as of April 15, 1989, filed as exhibit 10.9 to the Fund's Quarterly Report on Form 10-Q for the quarter ended June 30,1992, and incorporated herein by reference.\n10.10 Lease\/Purchase agreement made on October 12, 1992, by and between William J. Beitel and Maryann W. Beitel, husband and wife, and J. Grant Monahon, Lee H. Sandwen and Richard F. Burns, Trustees of AEW #165 Trust, established under Declaration of Trust dated March 7, 1989, filed as exhibit 10.10 to the Fund's Quarterly Report on Form 10-Q for the quarter ended September 30, 1992, and incorporated herein by reference.\n10.11 Deed granted by Brown Associates, a California general partnership, to Eastrich #101 Corporation, a California partnership, pursuant to bankruptcy proceedings on the Sequoia Commerce Center, dated March 12, 1993, and incorporated herein by reference.\n10.12 Purchase and Sale Agreement between Evans Withycombe Residential, Inc. and Aldrich, Eastman & Waltch Inc., agent for VREFII, dated August 16, 1994, filed as exhibit 10.12 to the Fund's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 and incorporated herein by reference.\n13 1995 Annual Report to Shareholders. (With the exception of the information and data incorporated by reference in Items 6, 7, and 8 of this Annual Report on Form 10-K, no\ninformation or data appearing in the 1995 Annual Report to Shareholders is to be deemed filed as part of this report.)\n27 Financial Data Schedule. A Financial Data Schedule for the year ended December 31, 1995, was submitted in electronic format only.\n99.1(a) Current Report on Form 8-K dated June 30, 1993, relating to the Fund's acquisition of Shadow Brook Apartments, incorporated herein by reference.\n99.1(b) Report on Form 8, Amendment No. 1 to Current Report on Form 8-K dated June 30, 1992, relating to the acquisition of Shadow Brook Apartments, incorporated herein by reference.\n99.1(c) Current Report on Form 8-K dated August 16, 1994, relating to the fund's sale of Shadow Brook Apartment, incorporated herein by reference.\n(b) Reports on Form 8-K\nDuring the third quarter ended September 30, 1995, the Fund filed a Report on Form 8-K, dated June 16, 1995, reporting, in Item 5, the sale of its Raleigh Office Building. During the fourth quarter ended December 31, 1995, the Fund filed a Report on Form 8-K, dated December 22, 1995, in Item 5, the sale of its Penn Warner investment and a Report on Form 8-K dated December 8, 1995, reporting in Item 5, the adoption of the Fund's formal Plan of Liquidation and Termination.\nSCHEDULE XI\nVANGUARD REAL ESTATE FUND II, A SALES-COMMISSION-FREE INCOME PROPERTIES FUND REAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1995\n(a) The aggregate cost of wholly-owned real estate for federal income tax purposes at December 31, 1995 was $12,957,100. (b) The activity in wholly-owned real estate investments is summarized as follows:\n(c) Reconciliation of accumulated depreciation is summarized as follows:\n(d) Prior to June 30, 1995, depreciation on real estate owned was computed using the straight-line method over 40 years for buildings and costs incurred in conjunction with the acquisition of real estate investments were deferred and amortized on a straight-line basis over the life of the loan for mortgage loan investments and the life of the property for equity investments. After June 30, 1995, no depreciation or amortization expense related to the Fund's owned real estate and acquisition costs is recognized since the Fund's real estate investments are considered to be held-for-sale assets.\nVANGUARD REAL ESTATE FUND II, A SALES-COMMISSION-FREE INCOME PROPERTIES FUND REAL ESTATE JOINT VENTURE INVESTMENT DECEMBER 31, 1995\n(a) As described in Note K of the Fund's 1995 Financial Statements, incorporated in this Form 10-K by reference, the Partnership has entered into a Loan Agreement and Put Option Agreement, the proceeds of which are to be distributed in accordance with the terms of the Partnership Agreement. As of December 31, 1995, the Fund has received aggregate distributions of proceeds in excess of its carrying value of the investment. Such excess distributions are recorded on the Fund's balance sheet as of December 31, 1995 as Deferred Revenue - Mountain View and will be recognized by the Fund upon sale of the underlying property or the disposition of its investment in the Partnership.\n(b) Net of acquisition fees and costs paid.\nSCHEDULE XII\nVANGUARD REAL ESTATE FUND II, A SALES-COMMISSION-FREE INCOME PROPERTIES FUND MORTGAGE LOANS ON REAL ESTATE DECEMBER 31, 1995\n(a) Bayside is a fixed-rate, senior mortgage loan and a shared-appreciation, junior loan, both secured by the Bayside Business Center. Upon repayment of the Bayside junior loan, the Fund is entitled to receive an amount equal to the greater of (i) an amount sufficient to generate a 12.4% internal rate of return on the junior loan, or (ii) 50% of Bayside's fair market value in excess of $9 million, as described in Note F of the Fund's 1995 Financial Statements, incorporated in this Form 10-K by reference. In anticipation of the Fund exercising a call option in early 1995, at December 31, 1994, Fund management, based on: (i) an evaluation of the borrower's remaining equity in the Bayside property securing the mortgage loans and; (ii) the economic prospects of the borrower and Bayside property over its expected remaining holding period, reduced the loan's carrying value (remaining loan balance plus the deferred interest receivable pursuant to the shared-appreciation feature of the mortgage) to the then-estimated fair value of the collateral less estimated selling costs.\n(c) Represents a transfer of the property in lieu of foreclosure on the Fund's mortgage loan on the Raleigh Building, and Sequoia Commerce Center on June 5, 1992, and March 12, 1993, respectively.\nThe aggregate cost of the Fund's mortgage loan investments for federal income tax purposes at December 31, 1995 was $8,290,000.\nPLYMOUTH STREET, L.P. (A LIMITED PARTNERSHIP) FINANCIAL STATEMENTS DECEMBER 31, 1995\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Partners of Plymouth Street, L.P.\nIn our opinion, the accompanying balance sheet and the related statements of operations, of changes in partners' equity (deficit) and of cash flows present fairly, in all material respects, the financial position of Plymouth Street, L. P. at December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Partnership's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.\nPRICE WATERHOUSE LLP\nPhiladelphia, PA January 10, 1996\nPLYMOUTH STREET, L. P. (A LIMITED PARTNERSHIP) BALANCE SHEET DECEMBER 31, 1995 AND 1994 - --------------------------------------------------------------------------------\nThe accompanying notes are an integral part of these financial statements.\nPLYMOUTH STREET, L. P. (A LIMITED PARTNERSHIP) STATEMENT OF OPERATIONS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 - --------------------------------------------------------------------------------\nThe accompanying notes are an integral part of these financial statements.\nPLYMOUTH STREET, L. P. (A LIMITED PARTNERSHIP) STATEMENT OF CHANGES IN PARTNERS' EQUITY (DEFICIT) - --------------------------------------------------------------------------------\nThe accompanying notes are an integral part of these financial statements.\nPLYMOUTH STREET, L. P. (A LIMITED PARTNERSHIP) STATEMENT OF CASH FLOWS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 - --------------------------------------------------------------------------------\nThe accompanying notes are an integral part of these financial statements.\nPLYMOUTH STREET, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - --------------------------------------------------------------------------------\n1. ORGANIZATION AND OPERATIONS\nPlymouth Street, L. P. (the \"Partnership\") was formed on August 30, 1989 and organized as a Delaware Limited Partnership with Mountain View Place Investors (\"the General Partner\") as the general partner and Vanguard Real Estate Fund II (\"the Limited Partner\") as the limited partner. The Partnership was formed in order to own and operate Mountain View Place, two office buildings located in Mountain View, California. These buildings have approximately 78,000 square feet of commercial space. A single tenant occupies 58,390 square feet and accounted for 98% of rental income for 1995, 1994 and 1993.\nThe General Partner's initial contribution to the Partnership, in the form of property, was valued at $2.5 million and the Limited Partner's initial cash contribution was $14 million. Under certain circumstances defined in the Partnership Agreement, the General Partner and Limited Partner may be required to make additional capital contributions.\nAll distributable cash flows from operations (as defined in the Partnership Agreement) shall be distributed quarterly as follows: the General Partner shall receive 1% and the Limited Partner 99% until the Limited Partner receives an amount necessary to generate a 10.1% cumulative preferred annual return, compounded monthly (as defined in the Partnership Agreement); and, thereafter, each shall receive 50% of such cash flows.\nNet capital proceeds (as defined in the Partnership Agreement) shall be distributed as follows: first to the Limited Partner in an amount equal to its contributed capital, plus any unrecovered preferred annual return and an amount equal to the greater of 50% of the capital proceeds in excess of $16.5 million or the amount necessary to generate an 11.5% annual internal rate of return. Any remaining proceeds will be distributed to the General Partner. Under the terms of the First Modification of Agreement of Limited Partnership dated December 30, 1994, the General Partner was entitled to and received a priority distribution equal to the proceeds of the July 1, 1994 and 1995 loan advances under the Loan Agreement (Note 3) of $500,000.\nThe General Partner may exercise a buy\/sell option in the event that the Limited Partner fails to contribute its proportionate share under any Call Notice (as defined in the Partnership Agreement) relating to funds required to pay tenant improvements or leasing commissions or fails to fulfill any of its obligations in connection with a financing (as defined in the Partnership Agreement).\nNet income from operations of the Partnership shall be allocated 1% to the General Partner and 99% to the Limited Partner. Net loss from operations shall be allocated between the General Partner and Limited Partner in proportion to their respective proportionate shares until the capital account of either Partner is reduced to zero, then, as needed until the capital accounts of both Partners are reduced to zero and, thereafter, allocated based on each Partner's minimum gain.\nPLYMOUTH STREET, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------\n2. SIGNIFICANT ACCOUNTING POLICIES\nBASIS OF PRESENTATION The Partnership's significant accounting policies are in accordance with generally accepted accounting principles.\nREAL ESTATE Real Estate contributed to the Partnership was recorded at its fair market value on the date of contribution. Major renovations will be capitalized and routine maintenance and repairs will be charged to expense as incurred.\nCASH EQUIVALENTS The Partnership considers its short-term investments with original maturities or three months or less when purchased to be cash equivalents.\nDEPRECIATION Depreciation is computed using the straight-line method over the estimated useful lives of the assets. Buildings are depreciated over 40 years.\nAMORTIZATION Tenant improvements are being amortized using the straight-line method over the respective lease terms of three and ten years or the estimated useful life of the improvements, whichever is shorter. Lease commissions are being amortized using the straight-line method over the respective lease terms of three and ten years. Prepaid loan costs will be amortized using the effective interest method over the life of the loan.\nREVENUE RECOGNITION Rents from leases are accounted for ratably over the terms of each lease. The difference between accrued rental income and cash received has been recorded as an account receivable and aggregates $577,479 and $751,510 at December 31, 1995 and 1994, respectively. In addition, rental income aggregating $380,372, $359,995 and $343,276 for 1995, 1994, and 1993, respectively, resulted from billings to tenants for real estate taxes, certain utilities and insurance paid by the property manager.\nCASH EQUIVALENTS The Partnership considers all highly liquid short-term investments with original maturities of three months or less to be cash equivalents.\nINCOME TAXES The General Partner and Limited Partner are responsible for reporting to the taxing authorities their proportionate shares of income or loss from the Partnership. Therefore, no provision for income taxes is required in the Partnership's financial statements.\nPLYMOUTH STREET, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -----------------------------------------------------------------------------\n3. FINANCING ARRANGEMENTS\nOn December 30, 1993, the Partnership concurrently executed a Loan Agreement, an Option and Put Agreement and a Lease Agreement with an unrelated third party.\nUnder the terms of the Loan Agreement (\"Loan\"), the Partnership is to receive scheduled advances totalling $17.5 million over five years. The Loan requires monthly payments of interest only at an annual rate of 10% on the outstanding balance. The Loan matures on December 31, 1998. The Loan is secured by the property and existing leases. Scheduled advances aggregating $16.0 million have been received by the Partnership and the net proceeds of approximately $15.9 million were distributed to the limited partner in accordance with the Partnership Agreement, as amended. The remaining advances under the terms of the Loan are scheduled as follows:\nJuly 1, 1996 $ 750,000 July 1, 1997 750,000 ------------- $ 1,500,000 =============\nThe Loan also stipulates that the lender is entitled to receive, as additional interest, annual payments equal to 50% of the excess, if any, of adjusted gross receipts of the property over a base amount, as defined. No additional interest was earned during the years ended 1995, 1994 and 1993.\nUnder the terms of the Option and Put Agreement, the third party can elect, during either of two option periods, to purchase the property (\"Purchase Option\") from the Partnership for an aggregate purchase price of $19 million. The Purchase Option may be exercised during either of the periods from January 1, 1995 to November 30, 1997 or from March 1, 1998 to May 30, 1998.\nDuring the period from July 1, 1996 to December 31, 1996, if the Purchase Option has not yet been exercised, the Partnership can elect to buy back (\"Buy Back Option\") the Purchase Option for an amount equal to $2,309 per day plus the cost of all capital improvements made to the property and paid for by the third party from December 30, 1993 to the date of the closing under the Buy Back Option.\nIn addition, during the period from December 7, 1997 to February 28, 1998, the Partnership can elect to put the property (\"Put Option\") back to the third party for an aggregate purchase price of $19 million.\nPLYMOUTH STREET, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -----------------------------------------------------------------------------\nUnder the terms of the Lease Agreement, the third party will occupy approximately 19,600 square feet of the commercial rental space of the property at an annual rent of approximately $25,000. The lease expires on December 31, 1998 and the agreement contains option provisions for an additional three and one-half year period. The terms of the lease are comparable to other area leases with unrelated parties.\n4. LEASES\nMinimum future rental revenues on the initial terms of non-cancelable leases as of December 31, 1995 are:\n1996 $ 1,750,032 1997 1,821,738 1998 478,662 ------------- Total $ 4,050,432 =============\n5. RELATED PARTY TRANSACTIONS\nThe Partnership paid property management fees aggregating $50,589, $48,728 and $46,328 for 1995, 1994, and 1993, respectively, to Mountain View Place Investors, a general partnership, whose managing general partner is also the General Partner of the Partnership.\n6. INCOME TAX BASIS RECONCILIATION\nCertain items enter into the determination of the results of operations in different time periods for financial reporting (\"book\") purposes and for income tax (\"tax\") purposes. A reconciliation of the results of operations follows:\nPLYMOUTH STREET, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -----------------------------------------------------------------------------\nA reconciliation between partners' equity (deficit) for book and tax purposes follows:\nTotal assets for tax purposes aggregate $10,574,789 and $10,969,588 at December 31, 1995 and 1994, respectively.\nREPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULES\nTo the Board of Trustees of Vanguard Real Estate Fund II\nOur audits of the financial statements referred to in our report dated March 15, 1996 appearing on page 20 of the 1995 Annual Report to Shareholders of Vanguard Real Estate Fund II (which report and financial statements are incorporated by reference in this Annual Report on Form 10-K) also included audits of the Financial Statement Schedules listed in Item 14(a) of this Form 10-K. In our opinion, these Financial Statement Schedules present fairly, in all material respects, the information set forth therein when read in conjunction with the related financial statements.\nPRICE WATERHOUSE LLP\nPhiladelphia, Pennsylvania March 15, 1996\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.\nVANGUARD REAL ESTATE FUND II,\nA Sales-Commission-Free Income Properties Fund\nMarch 29, 1996 \/s\/ John J. Brennan - ---------------------- ------------------------------------- DATE John J. Brennan 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 the dates indicated.\nMarch 29, 1996 \/s\/ J. Mahlon Buck, Jr. - ---------------------- ------------------------------------- DATE J. Mahlon Buck, Jr. Trustee\nMarch 29, 1996 \/s\/ William S. Cashel, Jr. - ---------------------- ------------------------------------- DATE William S. Cashel, Jr. Trustee\nMarch 29, 1996 \/s\/ David C. Melnicoff - ---------------------- ------------------------------------- DATE David C. Melnicoff Trustee\nMarch 29, 1996 \/s\/ J. Lawrence Wilson - ---------------------- ------------------------------------- DATE J. Lawrence Wilson Trustee\nMarch 29, 1996 \/s\/ Ralph K. Packard - ---------------------- ------------------------------------- DATE Ralph K. Packard Vice President & Controller\nEXHIBIT INDEX","section_15":""}
{"filename":"714980_1995.txt","cik":"714980","year":"1995","section_1":"Item 1. Business\nCity National Bancshares Corporation (the \"Corporation\" or \"CNBC\") is a New Jersey corporation incorporated on January 10, 1983. At December 31, 1995, CNBC had consolidated total assets of $114.8 million, total deposits of $100.9 million and total stockholders' equity of $7.1 million. Its only subsidiary is City National Bank of New Jersey (the \"Bank\" or \"CNB\").\nCNB is a national banking association chartered in 1973 under the laws of the United States of America. CNB is minority owned and controlled and therefore eligible to participate in certain federal government programs. CNB is a member of the Federal Reserve Bank, the Federal Home Loan Bank and the Federal Deposit Insurance Corporation. CNB provides a wide range of retail and commercial banking services through two offices located in northern New Jersey. Deposit services include savings and checking accounts, certificates of deposit and money market and retirement accounts. The Bank also provides many forms of small to medium size business financing, including revolving credit, credit lines, term loans and all forms of consumer financing, including auto, home equity and mortgage loans and maintains banking relationships with several major domestic corporations.\nCNB specializes in providing credit and deposit services to business and individuals located within minority communities within New Jersey, particularly in the Newark area.\nDuring 1995, the Bank entered into an agreement with NatWest Bank to acquire a branch office located in Newark, New Jersey. The transaction closed on March 8, 1996.\nThe Bank has no trust department.\nCompetition\nThe market for banking and bank related services is highly competitive. The Bank competes with other providers of financial services such as other bank holding companies, commercial saving banks, 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 pressures. Competition is expected to intensify as a consequence of interstate banking laws now in effect or that may be in effect in the future. CNB competes by offering quality products and convenient services at competitive prices. CNB regularly reviews its products and locations and considers various branch acquisition prospects.\nManagement believes that as New Jersey's only African-American owned and controlled Bank, it has a unique ability to provide commercial banking services to that segment of the minority community.\nSupervision and regulation\nThe banking industry is highly regulated. The following discussion summarizes some of the material provisions of the banking laws and regulations affecting City National Bancshares Corporation and City National Bank of New Jersey.\nRegulatory matters\nOn January 21, 1992, the Bank entered into a Consent Order with the Office of the Comptroller of the Currency (\"OCC\") which replaced and superceded the Cease and Desist Order issued by the OCC in 1989. The Consent Order contained fewer articles than the Cease and Desist Order, but required, among other things, that the Bank continue to implement certain internal procedures and controls in the areas of lending practices, asset quality and loan loss review and consumer compliance and prohibited the Bank from declaring or paying any dividends without prior notification to the OCC.\nThe Consent Order also required the Bank to achieve by April 30, 1992 a minimum 5% ratio of Tier I (core) capital to total assets. This was achieved by the required date and as of December 31, 1994, the Bank remained in compliance.\nIn April 1994, the Bank was advised by the OCC that as a result of the Bank's substantial compliance with the terms of the Consent Order, such Consent Order was terminated as of March 30, 1994.\nBank holding company regulations\nCNBC is a bank holding company within the meaning of the Bank Holding Company Act (the \"Act\") of 1956, and as such, is supervised by the Board of Governors of the Federal Reserve System (the \"FRB\").\nThe Act prohibits CNBC, with certain exceptions, from acquiring 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. The Act also requires prior approval by the FRB of the acquisition by CNBC of more than five percent of the voting stock of any additional bank. The Act also restricts the types of businesses, activities, and operations in which a bank holding company may engage.\nThe Riegle-Neal Interstate Bank and Branching Efficiency Act of 1994 (the \"Branching Act\") significantly changed interstate banking rules. Pursuant to the 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 applicable state laws.\nThe 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.\nRegulation of bank subsidiary\nCNB is subject to the supervision of, and to regular examination by the Office of the Comptroller of the Currency of the United States (the \"OCC\".)\nVarious laws and the regulations thereunder applicable to CNB impose restrictions and requirement 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 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 nonbank 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 extension of credit permitted by such exceptions.\nCNBC is a legal entity separate and distinct from its subsidiary bank. CNBC's revenues (on a parent company only basis) result from dividends paid to CNBC by its subsidiary. Payment of dividends to CNBC by CNB, 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% 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. In addition, the bank regulatory agencies have the authority to prohibit a bank subsidiary from paying dividends or otherwise supplying funds to a bank holding company if the supervising agency determines that such payment would constitute an unsafe or unsound banking practice.\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 the default of a commonly controlled FDIC-insured depository institution or any assistance provided by the FDIC to a commonly controlled FDIC-insured depository institution in danger of default, or deferred by the FDIC. 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.\nThe Federal Deposit Insurance Corporation Improvement Act of 1991 (\"FDICIA\") requires 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, 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 has a total risk-based capital ratio of at least 10%, has a Tier 1 risk-based capital ratio of at least 6%, has a Tier 1 leverage ratio of at least 5%, and meets certain other requirements. An institution will be classified as \"adequately capitalized\" if it has a total risk-based capital ratio of at least 8%, has a Tier 1 risk-based capital ratio of at least 4%, and has Tier 1 leverage ratio of at least 4%. An institution will be classified as \"undercapitalized\" if it has a total risk-based capital ratio of less than 6%, has a Tier 1 risk-based capital ratio of less than 3%, or has a Tier 1 leverage ratio of less than 3%. An institution will be classified as \"significantly undercapitalized\" if it has a total risk-based capital ratio of less than 6%, or a Tier I risk-based capital ratio of less than 3%, or a Tier I leverage ratio of less than 3%. 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%. 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.\nGovernment policies\nThe earnings of the Corporation are affected not only by economic conditions, but also by the monetary and fiscal policies of the United States and its agencies, especially the Federal Reserve Board. The actions of the Federal Reserve Board influence the overall levels of bank loans, investments and deposits and also affect the interest rates charged on loans or paid on deposits. The monetary policies of the Federal Reserve Board have had a significant affect on the operating results of commercial banks in the past and are expected to do so in the future. The nature and impact of future changes in monetary and fiscal policies on the earnings of the Corporation cannot be determined.\nEmployees\nOn December 31, 1995, CNBC and its subsidiary had 57 full-time equivalent employees. Management considers relations with employees to be satisfactory.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe corporate headquarters and main office as well as the operations and data processing center of CNBC and CNB are located in Newark, New Jersey in a building owned by CNB. In connection with the aforementioned branch acquisition, the Bank leases its Hackensack office from the Resolution Trust Corporation, for which no rent is payable for five years, after which the Bank will have the opportunity to purchase the property.\nThe main office of the Bank is undergoing a major renovation which will be completed in 1996.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThere were no material pending legal proceedings to which CNBC of CNB were a party.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nDuring the fourth quarter of 1995, there were no matters submitted to stockholders for a vote.\nPart II\nItem 5.","section_5":"Item 5. Market For The Registrant's Common Equity and Related Stockholder\nThe Corporation's common stock, when publicly traded, is traded over-the-counter. The common stock is not listed on any exchange and is not quoted on the National Association of Securities Dealers' Automated Quotation System. The last customer trade effected by a market maker was unsolicited and occurred on November 2, 1990. No price quotations are currently published for the common stock , nor is any market maker executing trades. No price quotations were published during 1995.\nAt March 11, 1996, the Corporation had 1,925 common stockholders of record.\nOn May 1, 1995, the Corporation paid a cash dividend of $1.25 per share to stockholders of record on March 31, 1995. Whether cash dividends on the common stock will be paid in the future depends upon various factors, including the earnings and financial condition of the Bank and the Corporation at the time. Additionally, federal and state laws and regulations contain restrictions on the ability of the Bank and the Corporation to pay dividends.\nItem 6.","section_6":"Item 6. Selected Financial Data\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis Of Financial Condition and Results\nEarnings performance\nNet income in 1995 was $802,000 compared to $1,724,000 in 1994, which included the benefit of a $1.6 million recovery of a loan that was charged off in 1989. Returns on average stockholders'equity and average assets assets were 12.71% and .72% in 1995 and 30.24% and 1.66% in 1994. Related earnings per share on a fully diluted basis fell to $6.53 from $13.90. After giving effect to the aforementioned nonrecurring recovery and netsecurities gains, operating earnings increased 16% from $688,000 to $798,000.\nThe primary reason for the improved performance in operating earnings was an increase in net interest income, which rose 31.5% compared to 1994. Offsetting this improvement somewhat were higher costs associated with the operations of a branch office acquired in May, 1994 from the Resolution Trust Corporation of a failed savings and loan association, for a full year, a full year of salaries and benefits attributable to additions to the management team made throughout 1994 in anticipation of future expansion, and the ongoing renovations of the Bank's executive and main offices, along with the commencement of major enhancements to the Bank's technology systems to improve customer service and enhance efficiency.\nNet interest income\nNet interest income is the principal source of the Corporation's earnings and represents the amounts by which the interest and fees earned on loans and other interest earning assets exceeds the interest paid on the funding sources used to finance those assets. An analysis of the components of net interest income is facilitated when the income from tax-exempt investment securities is adjusted to a taxable equivalent basis, placing tax-exempt assets on a comparable basis with taxable interest earning assets.\nOn a fully taxable equivalent (\"FTE\") basis, net interest income rose from $3.6 million in 1994 to $4.7 million in 1995, while the related net interest margin increased from 3.63% to 4.50%. These improvements resulted from a higher level of interest earning assets, which averaged $104.4 million in 1995 compared to $97.1 million in 1994. This growth occurred primarily from the use for an entire year in 1995 of deposit proceeds resulting from the aforementioned branch acquisition. The higher net interest margin resulted from a shift in the mix of earning assets to loans from investment securities and short-term assets.\nThe yield on average interest earning assets rose 140 basis points in 1995 to 7.21% from 5.81% in 1994 due to the aforementioned emphasis on loan volume, which more than offset the lower interest rate environment that existed during 1995.\nInvestments\nTotal investment securities averaged $57 million in 1995 compared to $50.9 million in 1994, an increase of $6.1 million, or 11.9%. Most of this increase came from the proceeds received from the deposit assumption and were invested in U.S. Government agency securities and mortgage backed securities.\nIn September 1994, the Bank transferred certain U.S. Government agency securities, including structured notes, from the available for sale portfolio to the held to maturity portfolio. Immediately prior to the transfer, these securities had a book value of $6,437,000 and a market value of $5,933,000, resulting in a gross unrealized loss totalling $504,000, or $302,000 net of tax. This loss was being amortized by increasing the book values of the related securities over their remaining maturities. At December 31, 1994, the securities transferred had a book value of $5,967,000, with a related market value of $5,834,000, including structured notes with book and related market values of $4,113,000 and $4,025,000, respectively, with an additional gross unrealized loss included in stockholders' equity of $473,000.\nAt December 31, 1994, the Bank held structured notes with a book value of $11,019,000 and a related market value of $10,402,000, reflecting a gross unrealized loss of $617,000. These notes include the aforementioned transferred securities, part of which is included in the aforementioned $473,000 loss included in stockholders' equity.\nIn December 1995, the Bank transferred $21.8 million of securities from the held to maturity to the available for sale portfolio in accordance with the provisions of the FASB Guide to Implementation of Statement No. 115, which provided a one-time opportunity for banks to restructure the components of their investment portfolio.\nAt December 31, 1994, the gross unrealized loss on securities included in the available for sale portfolio totalled $504,000, which at December 31, 1995 was reduced to $135,000 due primarily to a decrease in interest rates. The held to maturity portfolio had a gross unrealized loss of $2,460,000 at December 31, 1994 compared to $61,000 a year later. In addition to the lower interest rate environment, this decrease also resulted from the removal during 1995 of three structured notes, as discussed below, and the aforementioned transfer in 1995, both of which allowed the Bank to eliminate a significant portion of the unrealized loss that was being amortized when the portfolio was marked-to-market.\nAfter the 1995 transfer, there remained in the held to maturity portfolio one security that had been transferred from available for sale in 1994. This investment had a remaining gross unrealized loss included in stockholders' equity of $112,000 at December 31, 1995.\nIncluded in the 1995 transfer were all the structured notes previously included in the 1994 transfer. These notes had a book value totalling $3,461,000 and a related market value of $3,353,000 and a remaining gross unrealized loss included in stockholders' equity of $224,000 at the time of the transfer.\nAt December 31, 1995, the structured note portfolio had a book value of $8,209,000 and related market value of $8,003,000, reflecting a gross unrealized loss of $206,000. The structured note portfolio consisted of twelve issues at December 31, 1994, of which two were called during 1995 and one became unstructured due to reaching its step-up limit. Of the nine remaining issues, dual-index notes totalled $3,497,000 in book value, step-ups amounted to $1,962,000 and deleveraged bonds totalled $2,750,000.\nThe dual-index notes are all indexed to a combination of long and short- term rates, while the deleveraged notes are indexed to the ten-year Treasury. Accordingly, the value of these securities could fluctuate depending on interest rate movements. The step-ups have less interest rate risk since their yields will increase over their remaining maturities.\nManagement believes that holding these securities will not have a significant impact upon the financial condition or operations of the Corporation.\nThe composition of the investment portfolio between the held to maturity and the available for sale changed significantly due primarily to the aforementioned transfer. At December 31, 1994, the available for sale portfolio comprised 7.5% of the total investment portfolio, while at December 31, 1995 the available for sale portfolio represented 55.5%.\nInformation pertaining to the average weighted yields of investments in debt securities at December 31, 1995 is presented below. Maturities of mortgaged-backed securities included with U.S. Government agencies are based on the maturity of the final scheduled payment. Such securities, which comprise most of the balances shown as maturing beyond five years, generally amortize on a monthly basis and are subject to prepayment. Taking into account such contractual amortization and expected prepayments, a significant amount of principal reduction on the aforementioned securities will occur within three years:\nInvestment Securities Available for Sale\nInvestment Securities Held to Maturity\nAverage yields are computed by dividing the annual interest, net of premium amortization and including discount accretion, by the amortized cost of each type of security outstanding at December 31, 1995. Average yields on obligations of states and political subdivisions have been computed on a fully taxable equivalent basis, using the statutory Federal income tax rate of 34%.\nThe average yield on the available for sale portfolio decreased from 6.28% in 1994 to 6.03% in 1995 reflecting the low yield on the short-term investments transferred from the held to maturity portfolio in 1995, as well as the lower rates securities purchased in 1995. This transfer also reduced the average maturity of the portfolio, as maturities within five years comprised 61% of the portfolio at December 31, 1995 compared to 30% a year earlier, while maturities longer than ten years comprise 39% at December 31, 1995 compared to 70% a year earlier.\nThe yield on the held to maturity portfolio rose from 5.89% in 1994 to 6.24% in 1995, reflecting the purchase during 1995 of higher coupon callable U.S. Government agency securities. The average portfolio maturity shortened during 1995 as maturities falling within the first five years represented 65.9% of the total held to maturity portfolio at December 31, 1995 compared to 57.2% a year earlier.\nConsolidated Average Balance Sheet with Related Interest and Rates\nThe table below set forth, on a fully taxable basis, an analysis of the increase (decrease) in net interest income resulting from the specific components of income and expenses due to changes in volume and rate. Because of the numerous simultaneous balance and rate changes, it is not possible to precisely allocate such changes between balances and rates. Therefore, for purposes of this table, changes which are not due solely to balance and rate changes are allocated to rate.\nLoans\nTotal loans averaged $39 million in 1995 compared to $27.3 million in 1994, an increase of 46.5%. At December 31, 1995, total loans were $45.7 million, up 75.8% from $26 million at 1994 year-end. The largest increase occurred in mortgage loans, where average volume in 1995 was $24 million, compared to $10.9 million in 1994, an increase of 120.1%.\nThis increase occurred as a result of the purchase in January 1995 of $11.5 million in seasoned residential mortgage loans from the Resolution Trust Corporation. These loans consisted of one-to-four family loans located throughout central New Jersey. Other than these loans, there was little growth in the Bank's residential mortgage portfolio, as all its fixed-rate loans are sold in the secondary market and there was a lesser demand for adjustable-rate loans during 1995 due to the declining interest rate environment.\nLoans originated for sale declined to $4.6 million in 1995 from $6.5 million in 1994. While the Bank originates Small Business Administration-guaranteed commercial loans for sale, most loans originated for sale represent Housing and Urban Development (\"HUD\") - guaranteed residential rehabilitation loans. The HUD loans are more labor intensive than the conventional residential mortgage loans that the Bank originated and sold during 1994, but are more profitable. Because of the emphasis in 1995 on HUD loans, the volume declined, but gains and commission on loan sales rose by 90.6%. Loans sold decreased, to $4.5 million in 1995 from $6.1 million in 1994. The Bank intends to expand its residential mortgage lending program by moving into Federal Housing Administration (\"FHA\") guaranteed home rehabilitation loans, which are sold to the FHA, as well as utilizing the benefits of the Federal Home Loan Bank community development financing programs.\nAt December 31, 1995, loans to churches totaled $6.3 million, representing 13.78% of total loans outstanding and are included with real estate loans. Management does not believe that this loan concentration exposes the Corporation to any unusual degree of risk.\nThe Bank generally secures its loans by obtaining primarily first liens on real estate, both residential and commercial, and does virtually no asset-based financing. Without additional side collateral, the Bank generally requires maximum loan-to-value ratios of 70% for loan transactions secured by commercial real estate.\nThe Bank's primary market area consists of northern New Jersey, particularly within the Newark area. The overall unemployment rate in the State of New Jersey was 7.3% at the end of 1995 compared to a nationwide rate of 5.6%, which was also the second highest rate of all industrialized states. In addition, several major companies located in New Jersey have recently announced layoffs, which will further affect the New Jersey economy.\nWhile management believes that its loan portfolio is well secured and able to withstand a downturn in economic conditions, its effects are being carefully considered in making credit decisions in 1996.\nManagement is unaware of any significant potential problem loans at December 31, 1995. Maturities and interest sensitivities of loans Information pertaining to maturities and the sensitivity to changes in interest rates of certain loan categorizes at December 31, 1995 is presented below.\nDue After One Due in One Year Through Due After In thousands Year or Less Five Years Five Years Total ================================================================ Commercial $ 15,335 $ 937 $ 2,015 $ 18,287 Real estate: Construction 90 - - 90 Mortgage 2,923 19,013 4,436 26,355 - ---------------------------------------------------------------- Total $ 18,348 $ 19,940 $ 6,451 $ 44,739 ================================================================ Loans at fixed interest rates $ 1,703 $ 2,433 $ 1,734 $ 5,870 Loans at variable Interest rates 16,645 17,507 4,717 38,872 - ---------------------------------------------------------------- Total $ 18,348 $ 19,940 $ 6,451 $ 44,739 ================================================================\nSummary of loan loss experience\nChanges in the reserve for possible loan losses are summarized below.\nDollars in thousands 1995 1994 ============================================================== Balance, January 1 $625 $700 - -------------------------------------------------------------- Charge-offs: Commercial loans 382 35 Real estate loans 163 103 Installment loans 14 22 - -------------------------------------------------------------- Total 559 160 - -------------------------------------------------------------- Recoveries: Commercial loans 26 1,461 Real estate loans 54 48 Installment loans 18 40 - -------------------------------------------------------------- Total 98 1,549 - -------------------------------------------------------------- Net charge-offs (recoveries) 164 (1,389) Provision (credit) for possible loan losses charged to operations 486 (1,464) - -------------------------------------------------------------- Balance, December 31 $650 $625 ============================================================== Net charge-offs (recoveries) as a percentage of average loans 1.43% (5.34)% Reserve for possible loan losses as a percentage of loans 1.45 2.44 Reserve for possible loan losses as a percentage of nonperforming loans 60.07 183.80 ===============================================================\nThe reserve for possible loan losses is maintained at a level determined by management to be adequate to provide for potential losses in the loan portfolio. The reserve is increased by provisions charged to operations and recoveries of loan charge-offs. The reserve is based on management's evaluation of the loan portfolio and several other factors, including past loan loss experience, the credit conditions of the borrower, the value of the underlying collateral, business and economic conditions and the possibility that there may be potential losses in the portfolio which cannot currently be identified.\nCharge-offs rose from $160,000 in 1994 to $559,000 in 1995 as a result of the charge-off, in the fourth quarter of 1995, of a loan that had been performing until that time where credit quality rapidly eroded to the extent that management considered the collection of the loan to be doubtful.\nDuring 1994, the Bank recovered $1.6 million as an insurance recovery for a loan that was charged off in 1989. $175,000 was recorded as other income, while $1,425,000, which represents the total amount of the loan charged off, was recorded as a recovery to the reserve for possible loan losses.\nAllocation of the reserve for possible loan losses\nThe reserve for possible loan losses has been allocated based on management's estimates of the risk elements within the loan categories set forth below at December 31: 1995 1994 =============================================================== Percentage Percentage of Loan of Loan Dollars in thousands Amount Category Amount Category =============================================================== Commercial $ 175 .98% $ 83 .63% Real estate 448 1.65 384 3.14 Installment 7 1.97 9 1.56 Unallocated 20 - 149 - - -------------------------------------------------------------- Total $ 650 1.44% $ 625 2.39% ==============================================================\nNonperforming assets\nInformation pertaining to nonperforming assets at December 31 is summarized below at December 31:\nIn thousands 1995 1994 ================================================================ Nonperforming loans Commercial $ 68 $ 17 Real estate 800 314 Installment 2 6 Lease financing receivables - 4 - ---------------------------------------------------------------- Total nonperforming loans 870 341 Other real estate owned 212 307 - ---------------------------------------------------------------- Total $1,082 $ 648 ================================================================\nThe increase in nonperforming loans in 1995 resulted primarily from the addition of one loan that management considers well-secured by a commercial property.\nDeposits\nTotal deposits decreased from $103.9 million at December 31, 1994 to $100.9 million a year later, due to a decline in demand deposits. The Bank's deposit levels may change significantly on a daily basis because deposit accounts maintained by federal and state governmental agencies represent a significant part of the Bank's deposits and are more volatile than commercial or or retail deposits.\nThese municipal and U.S. Government deposits represent a substantial part of the Bank's business, tend to have high balance relationships and comprise most of the Bank's accounts with balances of $100,000 or more at December 31, 1995. While local municipalities use the accounts for operating and short-term investments purposes, the U.S. Government uses noninterest-bearing certificates of deposit as compensating balances, representing a form of payment for services provided. All the foregoing deposits require collateralization with readily marketable U.S. Government securities. While the Bank issues certificates of deposit to municipalities in amounts of $100,000 at rates which are competitive with other institutions and somewhat more costly than other sources of deposits, the overall cost of certificates of deposit of $100,000 or more is reduced by the maintenance of the foregoing compensating balance accounts.\nWhile the collateral maintenance requirements associated with the Bank's municipal and U.S. Government account relationships might limit the ability to readily dispose of investment securities used as such collateral, management does not foresee any need for such disposal, and in the event of the loss of any of these deposits, these securities are readily marketable.\nContributing to the decline in demand deposits were new federal tax deposit regulations which went into effect on December 1, 1994, whereby large companies began making their deposits directly to the U.S. Treasury Department rather than through a commercial bank. As a result, at December 31, 1995, balances under this tax deposit program totalled $89,000 compared to $3 million a year earlier. To offset the loss of these deposits, the U.S. Treasury Department has deposited a $9.5 million noninterest bearing time deposits with CNB, which will be repaid over five years.\nAverage deposits totalled $100.3 million in 1995, an 8.7% increase from $92.3 million in 1994, with almost all the growth occurring in savings and time deposits. The branch acquisition contributed $14.7 million to the deposit growth.\nCertain corporations and governmental agencies maintain noninterest bearing savings and time deposit accounts with the Bank as compensation for services performed. In 1995, such balances averaged $469,000 and $12,756,000, respectively, contributing 39 basis points to net interest income. In 1994, these respective balances were $860,000 and $4,144,000, respectively, contributing 23 basis points.\nShort-term borrowings\nAverage short-term borrowings were lower in 1995 because of the greater liquidity available from proceeds received with the branch acquisition.\nOther operating income\nOther operating income was $1.4 million in both 1995 and 1994. There were major changes within the components, however, as service charges rose $216,000, or 44.8% due to a greater volume of service chargeable transactions. Other income decreased $213,000, or 26.1%, due primarily to the aforementioned recording in 1994 of $175,000 associated with the loan loss recovery.\nOther operating expenses\nOther operating expenses, which include expenses other than interest, income taxes and the provision for possible loan losses, totalled $4.2 million in 1995, a 16.5% increase compared to 1994. Salaries and other employee benefits comprised the largest portion of the increase, rising 23.7% from $2 million to $2.5 million in 1995. The primary reason for the increase in overall operating expenses was the operation of the acquired branch office for a full year.\nAlso contributing to the higher salary and benefit costs were the effects of increased lending and administrative staff and annual merit increases.\nOccupancy expense rose $30,000, or 24.4% from 1994 to 1995 due to higher depreciation expense arising from the completion of the renovations to the Bank's executive offices\nEquipment expense increased $74,000, or 37% from 1994 to 1995 due primarily to higher costs related to the aforementioned renovations.\nOther operating expense was nominally higher in 1995 due primarily to lower premiums for FDIC insurance coverage as well as the effectiveness of cost containment measures instituted in early 1995. These reductions partially offset the increased cost of operating the acquired branch for a full year.\nIncome tax expense\nIncome tax expense as a percentage of pre-tax income was 37%, relatively unchanged from 36.7% in 1994.\nLiquidity\nThe liquidity position of the Corporation is dependent on the successful management of its assets and liabilities so as to meet the needs of both deposit and credit customers. Liquidity needs arise primarily to accommodate possible deposit outflows and to meet borrowers' request for loans. Such needs can be satisfied by investment and loan maturities and payments, along with the ability to raise short-term funds from external sources.\nIt is the responsibility of senior management to monitor and oversee all activities relating to liquidity management and the protection of net interest income from fluctuations in interest rates.\nThe Bank depends primarily on deposits as a source of funds and also provides for a portion of its funding needs through short-term borrowings, such as Federal Funds purchased, securities sold under repurchase agreements and borrowings under the U.S. Treasury tax and loan note option program. The major contribution during 1995 from operating activities to the Corporation's liquidity came from proceeds from sales of loans originated for sale, amounting to $4.6 million, while loans originated for sale represented the greatest use from operating activities, totalling $4.6 million.\nThe purchase of loans from the Resolution Trust Corporation for $11.5 million represented the largest use of funds for investing activities, while most of the cash received from investing activities came from proceeds from maturities of investment securities, which totalled $10.5 million.\nThe primary source of funds from financing activities resulted from an increase in short-term borrowings of $3.7 million, while a reduction in deposits represented the greatest use for financing activities.\nEffects of inflation\nInflation, as measured by the CPI, has been relatively steady during recent years, advancing 2.8% in 1995, 2.7% in 1994 and 1993 and 2.9% in 1992.\nThe asset and liability structure of the Corporation and subsidiary bank differ from that of an industrial company since its assets and liabilities fluctuate over time based upon monetary policies and changes in interest rates. The growth in earning assets, regardless of the effects of inflation, will increase net income if the Corporation is able to maintain a consistent interest spread between earning assets and supporting liabilities. In an inflationary period, the purchasing power of these net monetary assets necessarily decreases. However, changes in interest rates may have a more significant impact on the Corporation's performance than inflation. While interest rates are affected by inflation, they do not necessarily move in the same direction, or in the same magnitude as the prices of other goods and services.\nThe impact of inflation on the future operations of the Corporation should not be viewed without consideration of other financial and economic indicators, as well as historical financial statements and the preceding discussion regarding the Corporation's liquidity and asset and liability management.\nInterest rate sensitivity\nThe management of interest rate risk is also important to the profitability of the Corporation. Interest rate risk arises when an earning asset matures or when its interest rate changes in a time period different from that of a supporting interest-bearing liability, or when an interest-bearing liability matures or when its interest rate changes in a time period different from that of an earning asset that it supports. While the Corporation does not match specific assets and liabilities, total earning assets and interest bearing liabilities are grouped to determine the overall interest rate risk within a number of specific time frames.\nInterest sensitivity analysis attempts to measure the responsiveness of net interest income to changes in interest rate levels. The difference between interest sensitive assets and interest sensitive liabilities is referred to as interest sensitive gap. At any given point in time, the Corporation may be in an asset-sensitive position, whereby its interest-sensitive assets exceed its interest-sensitive liabilities or in a liability-sensitive position, whereby its interest-sensitive liabilities exceed its interest-sensitive assets, depending on management's judgment as to projected interest rate trends.\nOne measure of interest rate risk is the interest-sensitivity analysis, which details the repricing differences for assets and liabilities for given periods. The primary limitation of this analysis is that it is a static (i.e., as of a specific point in time) measurement which does not capture risk that varies nonproportionally with changes in interest rates. Because of this limitation, the Corporation uses a simulation model as its primary method of measuring interest rate risk. This model, because of its dynamic nature, forecasts the effects of different patterns of rate movements and variances in the effects of rate changes on the Corporations' mix of interest-sensitive assets and liabilities.\nThe following table presents the Corporation's interest rate sensitivity position at December 31, 1995. Interest-sensitivity analysis\nAt December 31, 1995, the Corporation had a cumulative one-year gap of $(13.5) million, representing 11.74% of total assets and a ratio of .81:1. Utilizing the dynamic simulation model, management believes that this amount would not result in a significant change in net interest income should interest rates rise or fall up to 300 basis points, which is the maximum change that management uses to measure the Corporation's exposure to interest rate risk.\nCapital\nCapital adequacy is a measure of the amount of capital needed to support asset growth. Minimum capital levels for banks and bank holding companies are regulated by capital adequacy guidelines, which establish minimum capital standards related to the level of assets and off-balance sheet exposures, adjusted for credit risk. The guidelines categorize assets and off-balance sheet items into four risk-weightings and require banking institutions to maintain a minimum ratio of total capital to risk-weighted assets. Total capital consists of the sum of a core (Tier I) and qualifying supplementary (Tier II) capital elements. Tier I capital essentially is comprised of tangible stockholders' equity for common stock and certain perpetual preferred stock, and Tier II capital includes a portion of the reserve for possible loan losses, certain qualifying subordinated long-term debt and preferred stock which does not qualify as Tier I capital. The regulatory minimum for combined Tier I and Tier II capital is 8% of risk-adjusted assets, with Tier II elements which qualify for inclusion in total capital being limited to 100% of the total amount of Tier I elements.\nIn addition to the risk-adjusted guidelines discussed above, banks and bank holding companies are subject to certain leverage standards. Under these guidelines, banks and bank holding companies are required to maintain as a minimum leverage standard a Tier I capital-to-total assets ratio of 3%. Under these guidelines, institutions operating at the 3% minimum are expected to have\nwell diversified risk profiles, including no undue interest rate risk, excellent asset quality, high liquidity and strong earnings. Institutions experiencing growth or with high levels of risk would be expected to maintain Tier I capital levels 100 to 200 basis points above the minimum.\nThe following table presents the consolidated and bank-only capital components and related ratios at December 31: Bank Consolidated Only ======================================================================== Dollars in thousands 1995 1994 1995 ========================================================================\nTotal stockholders' equity $ 6,896 $ 5,588 $ 8,591 Net unrealized loss on investment securities available for sale 141 587 141 Disallowed intangibles (76) (85) (76) - ------------------------------------------------------------------------ Tier 1 capital 6,961 6,090 8,656 - ------------------------------------------------------------------------ Qualifying long-term debt 1,749 249 - Reserve for possible loan losses 516 412 516 - ------------------------------------------------------------------------ Tier 2 capital 2,265 661 563 - ------------------------------------------------------------------------ Total capital $ 9,226 $ 6,751 $ 9,172 ======================================================================== Risk-adjusted assets $41,303 $32,997 $41,303 Total assets 114,410 111,062 114,410 - ------------------------------------------------------------------------ Risk-based capital ratios: Tier 1 capital to risk-adjusted assets 15.86% 18.46% 20.96% Regulatory minimum 5.00 5.00 5.00 Total capital to risk-adjusted assets 17.81 20.46 22.21 Regulatory minimum 8.00 8.00 8.00 Leverage ratio 6.27 5.48 7.80 Total stockholders' equity to total assets 6.03 5.03 7.51 ========================================================================\nResults of operations - 1994 compared with 1993\nNet income for 1994 rose to $1,724,000, or, on a fully diluted basis, $13.90 per share compared to $568,000 , or $7.03 per share in 1993, due to a $1.6 million insurance recovery of a loan charged off in 1989. Excluding the recovery along with net security gains, net earnings from operations were $688,000, compared to $476,000 in 1993, an increase of 44.5%. Higher net interest income was the primarily reason for this increase, reflecting greater levels of interest earning assets resulting from the May, 1994 branch acquisition.\nWhile net interest income was higher, on a fully tax equivalent basis, the related net interest margin decreased from 3.99% to 3.81% due primarily to a more rate-sensitive deposit structure at the acquired branch.\nAverage deposits grew from $72 million in 1993 to $92.3 million in 1994, an increase of 28%, due to the aforementioned branch acquisition. While proceeds from the the deposit increase were spread over a number of interest earning assets, the major growth was in taxable investment securities, which grew from $39.1 million at December 31, 1993 to $53.7 million a year later.\nLoan growth during 1994 was modest, although loans originated for sale rose from $4.3 million in 1993 to $6.5 million in 1994 as the Bank expanded its residential lending program under which these loans are sold in the secondary market.\nAs a result of generally improved economic conditions in the Bank's market area as well as improvements in the Bank's asset quality, management reduced the reserve for possible loan losses from December 31, 1993 to December 31, 1994 by recording a credit to the related provision of $1,464,000.\nOther operating income\nOther operating income rose $302,000, from $898,000 to $1.2 million in 1994, primarily due to $339,000 of income earned from funds committed to loans to be acquired from the Resolution Trust Corporation in connection with the branch acquisition. Also contributing to this income were higher service fees earned for acting as lead bank in a corporate line of credit syndication. Such fees rose from $42,000 in 1993 to $158,000 in 1994.\nOffsetting these increases was a reduction in net gain on sales of investment securities, which fell from $353,000 in 1993 to $36,000 in 1994.\nOther operating expenses totalled $3.6 million in 1994, a 20.7% increase compared to 1993. Salaries comprised the largest portion of the increase, rising from $1.2 million to $1.6 million in 1994 due to the branch acquisition, annual merit increases and the added cost of new hires, made primarily in anticipation of an expansion in the Bank's lending activities.\nOccupancy expense declined 19%, from $153,000 in 1993 to $123,000 in 1994 due primarily to an increase in rental income from a building that was previously used as a branch office which was subsequently converted to storage with the remaining space leased to a commercial business.\nFurniture and equipment expense declined 17%, from $241,000 in 1993 to $200,000 in 1994 due to a decrease in equipment rental expense resulting from the purchase of data processing equipment that was being leased. Higher depreciation expense on the purchased equipment partially offset this reduction.\nOther operating expenses rose from $1.1 million in 1993 to $1.3 million in 1994, a 19% increase. Expenses attributable to the new branch comprised $133,000 of this increase. The balance occurred from increases in a broad range of expense categories due primarily to a higher volume of operations, offset in part by lower legal fees.\nIncome tax expense as a percentage of pre-tax income increased from 17.8% in 1993 to 36.7% in 1994. This increase was attributable to a decrease in 1993 in the federal deferred tax valuation allowance along with higher levels of income subject to state corporate income tax.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nCITY NATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES\nConsolidated Balance Sheet\nCITY NATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES\nConsolidated Statement of Changes in Stockholders' Equity\nSee accompanying notes to consolidated financial statements.\nCITY NATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES\nConsolidated Statement of Income\nSee accompanying notes to consolidated financial statements.\nCITY NATIONAL BANCSHARES CORPORATION AND SUBSIDIARY\nConsolidated Statement of Cash Flows\nSee accompanying notes to consolidated financial statements.\nNotes to Consolidated Financial Statements\nNote 1 Summary of significant accounting policies\nThe accounting and reporting policies of City National Bancshares Corporation (the \"Corporation\" or \"CNBC\") and its subsidiary City National Bank of New Jersey (the \"Bank\" or \"CNB\") conform with generally accepted accounting principles and to general practice within the banking industry. In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities as of the date of the balance sheet and revenues and expenses for the related periods. Actual results could differ significantly from those estimates. The following is a summary of the more significant policies and practices.\nPrinciples of consolidation\nThe financial statements include the accounts of CNBC and its wholly-owned subsidiary, CNB. All significant intercompany accounts and transactions have been eliminated in consolidation.\nCash and cash equivalents\nFor purposes of the presentation of the Statement of Cash Flows, Cash and cash equivalents includes Cash and due from banks and Federal funds sold and securities purchased under agreements to resell.\nInvestment securities held to maturity and investment securities available for sale\nOn January 1, 1994, the Corporation adopted the provisions of Statement of Financial Accounting Standards (\"SFAS\") No. 115 \"Accounting for Certain Investments in Debt and Equity Securities\". SFAS 115 addresses the accounting and reporting for investments in equity securities that have readily determinable fair values and for all investments in debt securities.\nInvestment securities are designated as held to maturity or available for sale at the time of acquisition. Securities that the Corporation has the intent and ability at the time of purchase to hold until maturity are designated as held to maturity. Investment securities held to maturity are stated at cost and adjusted for amortization of premiums to the earlier of maturity or call date and accretion of discount to maturity.\nSecurities to be held for indefinite periods of time but not intended to be held until maturity or on a long-term basis are classified as investment securities available for sale. Securities held for indefinite periods of time include securities that the Corporation intends to use as part of its interest sensitivity management strategy and that may be sold in response to changes in interest rates, resultant risk and other factors. Investment securities available for sale are reported at fair market value, with unrealized gains and losses reported as a separate component of stockholders' equity, net of deferred tax. Gains and losses realized from the sales of securities available for sale are determined using the specific identification method.\nThe Corporation holds in its investment portfolio mortgage-backed securities. Such securities are subject to changes in the prepayment rates of the underlying mortgages, which may affect both the yield and maturity of the securities.\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.\nLoans\nLoans are stated at the principal amounts outstanding, net of unearned discount and deferred loan fees. Interest income is accrued as earned, based upon the principal amounts outstanding. Loan origination fees and certain direct loan origination costs, as well as unearned discount, are deferred and recognized over the life of the loan revised for loan prepayments, as an adjustment to the loan's yield. Recognition of interest on the accrual method is generally discontinued when a loan contractually becomes 90 days or more past due or a reasonable doubt exists as to the collectibility of the loan, unless such loans are well-secured and in the process of collection. At the time a loan is placed on a nonaccrual status, previously accrued and uncollected interest is generally reversed against interest income in the current period. Interest on such loans, if appropriate, is recognized as income when payments are received. A loan is returned to an accrual status when factors indicating doubtful collectibility no longer exist.\nThe Bank originates mortgage loans for sale. Premiums received from purchasers on sales of conventional nonguaranteed one-to-four family mortgage loans are recorded as income when received.\nOnce the determination to sell a loan has been made, it is transferred to loans held for sale and carried at the lower of remaining principal balance or market value.\nAs of January 1, 1995, the Corporation adopted the provisions of Statement of Financial Accounting Standards No. 114 \"Accounting by Creditors for Impairment of a Loan\" and Statement No. 118 \"Accounting by Creditors for Impairment of a Loan Income Recognition and Disclosure\". 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, at the loans's observable market price of the fair value of the collateral if the loan is collateral dependent.\nThe Corporation has defined the population of impaired loans to be all nonaccrual loans of $100,000 or more considered by management to be inadequately secured and subject to risk of loss. Impaired loans of $100,000 or more are individually assessed to determine that the loan's carrying value does not exceed the fair value of the underlying collateral or the present value of the loan's expected future cash flows. Smaller balance homogeneous loans that are collectively evaluated for impairment such as residential mortgage and installment loans, are specifically excluded from the impaired loan portfolio. Where impaired loans are carried at the present value of expected future cash flows, any change in such value is included with the provision for possible loan losses. There have been no impaired loans recorded during 1995.\nReserve for possible loan losses\nA substantial portion of the Bank's loans are secured by real estate in New Jersey particularly within the Newark area. Accordingly, as with most financial institutions in the market area, the ultimate collectibility of a substantial portion of the Bank's loan portfolio is susceptible to changes in market conditions.\nThe reserve for possible loan losses is maintained at a level determined adequate to provide for potential losses on loans. The reserve is increased by provisions charged to operations and recoveries of loans previously charged off and reduced by loan charge-offs. The reserve is based on management's evaluation of the loan portfolio considering current economic conditions, the volume and nature of the loan portfolio, historical loan loss experience and individual credit and collateral situations.\nManagement believes that the reserve for possible loan losses is adequate. While management uses available information to determine the adequacy of the reserve, future additions may be necessary based on changes in economic conditions or in subsequently occurring events unforeseen at the time of evaluation.\nIn addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank's reserve for possible loan losses. Such agencies may require the Bank to increase the reserve based on their judgment 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 based upon estimated useful lives of 3 to 39 years, computed using the straight-line method. Expenditures for maintenance and repairs are charged to operations as incurred, while major replacements and improvements are capitalized. The net asset values of assets retired or disposed of are removed from the asset accounts and any related gains or losses are included in operations.\nOther real estate owned\nOther real estate owned acquired through foreclosure or deed in lieu of foreclosure is carried at the lower of cost or fair value less estimated cost to sell. When a property is acquired, the excess of the loan balance over the estimated fair value is charged to the reserve for possible loan losses. Operating results of other real estate owned, including rental income and operating expenses, are included in \"Other expenses\".\nCore deposit premiums\nThe premium paid for the acquisition of deposits in connection with the purchase of a branch office is amortized on an accelerated basis over the ten-year estimated useful life of the assumed deposit base.\nIncome taxes\nFederal income taxes are based on currently reported income and expense after the elimination of income which is exempt from Federal income tax. Such timing differences include depreciation and the provision for possible loan losses.\nThe Corporation adopted the provisions of Statement of Financial Accounting Standards (\"SFAS\") No. 109, Accounting for Income Taxes\" as of January 1, 1993. Under the asset and liability method of SFAS 109, deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.\nThe Corporation previously provided for income taxes under Accounting Principles Board Opinion No. 11, which provided for deferred income taxes on all significant items of income and expenses that are recognized in different periods for financial reporting and income tax purposes.\nThe cumulative effect of this change in the method of accounting for income taxes has been included in the 1993 consolidated statement of income.\nNet income per share\nPrimary income per share is calculated by dividing net income by the weighted average number of shares outstanding. Shares issuable upon conversion of the subordinate debentures have been excluded from the computation of primary income per share as they are not considered to be common stock equivalents. On a fully diluted basis, both net income and shares outstanding are adjusted to assume the conversion of the convertible subordinate debentures from the date of issue.\nReclassifications\nCertain reclassifications have been made to the 1994 and 1993 consolidated financial statements in order to conform with the 1995 presentation.\nNote 2 Restrictions on cash and due from banks\nThe Bank is required to maintain a reserve balance with the Federal Reserve Bank based primarily on deposits levels. These reserve balances averaged $857,000 in 1995 and $1,120,000 in 1994.\nNote 3 Federal funds sold and securities purchased under agreements to resell\nAt December 31, 1995 and 1994, there were no securities purchased under agreements to resell, while the average balance during 1995 and 1994 was $0 and $4,779,000, respectively. The maximum balance at any month-end during 1994 was $15 million.\nThe aforementioned repurchase agreements were collateralized by U.S. Treasury securities held for the benefit of the Bank at the Federal Reserve Bank.\nNote 4 Investment securities available for sale\nThe amortized cost and market values as of December 31 of investment securities available for sale were as follows:\nGross Gross Amortized Unrealized Unrealized Market 1995 In thousands Cost Gains Losses Value =============================================================== U.S. Treasury securities and obligations of U.S. government agencies$14,670 $ 276 $ 165 $14,781 Other securities: Mortgage-backed 15,613 93 339 15,367 Equity securities 461 - - 461 - --------------------------------------------------------------- Total $30,744 $ 369 $ 504 $30,609 ===============================================================\nGross Gross Amortized Unrealized Unrealized Market 1994 In thousands Cost Gains Losses Value =============================================================== U.S. Treasury securities $ 2,298 $ - $ 56 $ 2,242 Mortgage-backed securities 5,379 - 448 4,931 - --------------------------------------------------------------- Total $ 7,677 $ - $ 504 $ 7,173 ===============================================================\nAt December 31, 1995, the Corporation held structured notes with a total amortized cost of $4,459,000 and a related market value of $4,330,000, reflecting gross unrealized depreciation of $129,000. There were no structured notes in the available for sale portfolio at December 31, 1994. The Corporation also held structured notes in the held to maturity portfolio at December 31, 1995 and December 31, 1994.\nThe amortized cost and the market values of investments in debt securities available for sale presented below as of December 31, 1995 are distributed by contractual maturity, including mortgage-backed securities, which may have shorter estimated lives as a result of prepayments of the underlying mortgages.\nAmortized Market In thousands Cost Value ============================================================== Due within one year: U.S. Treasury securities and obligations of U.S. Government agencies $ 4,288 $ 4,281 Due after one year but within five years: U.S. Treasury securities and obligations of U.S. Government agencies 7,235 7,211 Mortgage-backed securities 7,219 7,209 Due after ten years: U.S. Treasury securities and obligations of U.S. Government agencies 3,147 3,289 Mortgage-backed securities 8,394 8,158 - -------------------------------------------------------------- Total $30,283 $30,148 ==============================================================\nThere were no sales of investment securities available for sale during 1995. During 1994, proceeds from the sale of investment securities available for sale were $2,382,000. Gross gains of $36,000 were realized on these sales.\nAll interest and dividends on investment securities available for sale were taxable in 1995, 1994 and 1993.\nInvestment securities available for sale having an amortized cost of $27,948,000 were pledged to secure public funds at December 31, 1995.\nNote 5 Investment securities held to maturity\nThe book and market values as of December 31 of investment securities held to maturity were as follows: Gross Gross Book Unrealized Unrealized Market 1995 In thousands Value Gains Losses Value ================================================================= U.S. Treasury securities and obligations of U.S. Government agencies $12,124 $ 184 $ 79 $12,229 Obligations of state and political subdivisions 2,536 26 18 2,544 Other securities: Mortgage-backed 9,834 35 208 9,661 - ----------------------------------------------------------------- Total $24,494 $ 245 $ 305 $ 24,434 ==================================================================\nAt December 31, 1995, the Corporation held structured notes with a total amortized cost of $3,750,000 and a related market value of $3,673,000, reflecting gross unrealized depreciation of $72,000. Comparable amounts as of a year earlier were $11,019,000, $10,401,000 and $618,000, respectively.\nGross Gross Book Unrealized Unrealized Market 1994 In thousands Value Gains Losses Value ================================================================== U.S. Treasury securities and obligations of U.S. Government agencies $23,367 $ 12 $ 948 $22,431 Obligations of state and political subdivisions 2,216 - 193 2,023 Other securities: Mortgage-backed 20,725 - 1,331 19,394 Other debt 200 - - 200 Other equity 70 - - 70 - ------------------------------------------------------------------ Total $46,578 $ 12 $ 2,472 $44,118 ==================================================================\nThe book value and the market value of investment securities held to maturity presented below as of December 31, 1995 are distributed by contractual maturity, including mortgage-backed securities, which have shorter average lives as a result of prepayment assumptions. Book Market In thousands Value Value =============================================================== Due after one year but within five years: U.S. Treasury securities and obligations of U.S. Government agencies $ 8,620 $ 8,661 Mortgage-backed securities 6,969 6,978 Obligations of states and political subdivisions 558 568 Due after five years but within ten years: U.S. Treasury securities and obligations of U.S. Government agencies 3,300 3,365 Mortgage-backed securities 904 890 Obligations of states and political subdivisions 1,978 1,976 Due after ten years: U.S. Treasury securities and obligations of U.S. Government agencies 204 203 Mortgage-backed securities 1,961 1,793 - --------------------------------------------------------------- Total $24,494 $24,434 ===============================================================\nThere were no sales of securities held to maturity in 1995 or 1994, while $2,170,000 of investment securities were called prior to maturity during 1995, resulting in gains of $10,000.\nInterest and dividends on investment securities held to maturity was as follows:\nIn thousands 1995 1994 1993 ============================================================== Taxable $ 2,594 $ 1,795 $ 1,642 Tax-exempt 113 84 4 - -------------------------------------------------------------- Total $ 2,707 $ 1,879 $ 1,646 ==============================================================\nInvestment securities held to maturity having a book value of $16,758,000 were pledged to secure public funds at December 31, 1995.\nNote 6 Loans\nLoans, net of unearned discount and net deferred origination fees and costs at December 31 were as follows:\nIn thousands 1995 1994 ============================================================== Commercial $18,002 $13,079 Real estate 26,764 12,121 Installment 372 470 - -------------------------------------------------------------- Total loans 45,138 26,670 Less: Unearned income 399 107 - -------------------------------------------------------------- Loans $44,739 $25,563 ==============================================================\nLoans guaranteed by the Small Business Administration totalling $7,881,000 were pledged as collateral for future borrowings under a note issued to the U.S. Treasury Department at December 31, 1995. Such borrowings totalled $3,661,000 at December 31, 1995.\nNonperforming loans include loans which are contractually past due 90 days or more or on which interest income is still being accrued, renegotiated loans whose terms have been modified due to the borrower's financial difficulties and nonaccrual loans.\nAt December 31, nonperforming loans were as follows:\nIn thousands 1995 1994 ============================================================== Nonaccrual loans $ 839 $ 312 Loans with interest or principal 90 days or more past due and still accruing 31 29 - -------------------------------------------------------------- Total nonperforming loans $ 870 $ 341 ==============================================================\nThe effect of nonaccrual loans on income before taxes is presented below.\nIn thousands 1995 1994 1993 ============================================================== Interest income foregone $ 52 $ 68 $ 94 Interest income received (55) (90) (41) - -------------------------------------------------------------- $ (3) $ (22) $ 53 ==============================================================\nAt December 31, 1995, there were no commitments to lend additional funds to borrowers for loans that were on nonaccrual or contractually past due in excess of 90 days and still accruing interest.\nA majority of the Bank's loan portfolio is concentrated in first mortgage loans to borrowers in northern New Jersey, particularly within the Newark area. Its borrowers' abilities to repay their obligations are dependent upon various factors including the borrowers' income, net worth, cash flows generated by the underlying collateral, the value of the underlying collateral and priority of the Bank's lien on the related property. Such factors are dependent upon various economic conditions and individual circumstances beyond the Bank's control. Accordingly, the Bank may be subject to risk of credit losses.\nThe Bank believes its lending policies and procedures adequately minimize the potential exposure to such risk and that adequate provisions for possible loan losses are provided for all known and inherent risk.\nNote 7 Reserve for possible loan losses\nTransactions in the reserve for possible loan losses are summarized as follows:\nIn thousands 1995 1994 1993 ============================================================== Balance, January 1 $ 625 $ 700 $ 650 Provision (credit) for possible loan losses 486 (1,464) (23) Recoveries of loans previously charged off 98 1,549 150 - -------------------------------------------------------------- 1,209 785 777 Less: Charge-offs 559 160 77 - -------------------------------------------------------------- Balance, December 31 $ 650 $ 625 $ 700 ==============================================================\nIncluded in 1994 is the $1,425,000 recovery of a loan previously charged off in 1989, along with the related effects on the provision (credit) for possible loan losses.\nNote 8 Premises and equipment\nA summary of premises and equipment at December 31 follows:\nIn thousands 1995 1994 - -------------------------------------------------------------- Land $ 240 $ 240 Premises 733 678 Furniture and equipment 1,091 879 Building improvements 1,341 892 - -------------------------------------------------------------- Total cost 3,405 2,689 Less: Accumulated depreciation and amortization 1,117 949 - -------------------------------------------------------------- Net book value $2,288 $1,740 - --------------------------------------------------------------\nDepreciation and amortization expense charged to operations amounted to $191,000, $120,000, and $90,000 in 1995, 1994, and 1993, respectively.\nNote 9 Other assets\nAt December 31, 1994, other assets included a $1,305,000 deposit with the Resolution Trust Corporation representing a deposit on a residential mortgage loan portfolio that the Bank was negotiating to purchase. The deposit was applied when the loans were purchased in January, 1995.\nNote 10 Deposits\nDeposits at December 31 are presented below.\nIn thousands 1995 1994 ============================================================== Noninterest bearing Demand $ 12,925 $ 16,448 Savings 469 469 Time 11,319 12,898 - -------------------------------------------------------------- Total noninterest bearing deposits 24,713 29,815 - -------------------------------------------------------------- Interest bearing Savings 36,550 39,146 Time 39,626 34,980 - -------------------------------------------------------------- Total interest bearing deposits 76,176 74,126 - -------------------------------------------------------------- Total deposits $100,889 $103,941 ==============================================================\nTime deposits issued in amounts of $100,000 or more have the following maturities at December 31:\nIn thousands 1995 1994 ============================================================== Three months or less $20,265 $15,647 Over three months but within six months 3,085 1,008 Over six months but within twelve months 2,557 450 Over twelve months 5,760 9,340 - -------------------------------------------------------------- Total deposits $31,627 $26,445 ==============================================================\nInterest expense on certificates of deposits of $100,000 or more was $895,000, $469,000 and $345,000 in 1995, 1994 and 1993, respectively.\nNote 11 Short-term borrowings\nInformation regarding short-term borrowings at December 31 is presented below.\nThe demand note, which has no stated maturity, issued by the Bank to the U.S. Treasury Department is payable with interest at 25 basis points less than the weekly average of the daily effective Federal Funds rate and is collateralized by various investment securities held at the Federal Reserve Bank of New York with a book value of $6,071,000, along with loans guaranteed by the Small Business Administration totalling $7,881,000.\nNote 12 Long-term debt\nIn thousands 1995 1994 ============================================================== 5.25% capital note, due December 28, 2005 $1,500 $ - 8.00% mandatory convertible debentures, due July 1, 2003 249 249 - -------------------------------------------------------------- Total $1,749 $ 249 ==============================================================\nInterest is payable semiannually on January 15 and July 15 on the convertible debentures. The debentures convert into CNBC common stock upon maturity and are convertible by the holder at any time on or before the maturity, unless previously redeemed by the Corporation into CNBC common stock at a conversion price of $18.00 per share, subject to adjustment upon the occurrence of certain events, including, among other things, the issuance of common stock as a per share price of less than $18 or the issuance of rights or options to purchase shares of common stock at a price of less than $18 per share.\nThe debentures are subordinate to all other indebtedness of the Corporation except for indebtedness which by its terms is equal and not senior in right of payment to the debentures. The debentures become immediately payable upon the bankruptcy, insolvency or receivership of the Corporation. In the event of default as to principal or interest, the Corporation is required upon the request of the holder, to pay the unpaid principal balance along with any accrued interest by issuing an amount of common stock at the conversion price in exchange for the indebtedness, subject to the holder owning not more than 9.9% of the total number of common shares outstanding when added to the shares already held by the holder. The unpaid balance of principal, if any, after conversion upon maturity, or an interest payment default is then payable in cash upon maturity of the debenture and prior to maturity would continue to accrue interest at an annual rate of 8% payable semiannually.\nOn December 29, 1995, the Corporation issued a $1.5 million capital note to a subsidiary of a major insurance company, due December 28, 2005. Interest is payable semiannually on June 30 and December 31, with principal payments commencing semiannually in June, 2001.\nThe note agreement includes restrictive covenants including the creation of liens on Bank assets, the sale of such assets and certain limitations on investments and dividend payments and requires the maintenance of certain capital levels and earning performance, asset quality and reserve for possible loan loss ratios.\nUnder the most restrictive covenant, $923,000 was available for the payment of dividends at December 31, 1995.\nNote 13 Other operating income and expenses\nThe following table presents the major items of other operating income and expenses: In thousands 1995 1994 1993 ============================================================== Other operating income Income from loans purchased from Resolution Trust Corporation prior to loan closing $ 198 $ 339 $ - Unrecorded interest income collected on loans charged off in 1989 - 175 - Service fee income 162 158 42 Other operating expenses Professional fees 181 234 277 FDIC deposit insurance 168 201 161 Stationery and supplies expense 115 147 87 Data processing 115 103 75 ==============================================================\nIncome from loans purchased from the Resolution Trust Corporation (\"RTC\") represents income earned from $1.3 million of funds which were committed to loans acquired from the RTC in January 1995 in connection with a branch acquisition, as well as interest on the difference between the amount of loans committed and the aforementioned $1.3 million. This income was recorded because of the RTC's agreement to compensate the Bank on the entire loan commitment balance, whether or not the loans were purchased. The amounts were recorded as other operating income because there were no earning assets for which to record interest income.\nNote 14 Income taxes\nThe components of income tax expense are as follows: In thousands 1995 1994 1993 ============================================================== Current Federal $ 571 $ 413 $ 55 State 103 7 1 - -------------------------------------------------------------- Total current income tax expense 674 420 56 - -------------------------------------------------------------- Deferred Federal (172) 407 148 State (31) 171 (36) - -------------------------------------------------------------- Total deferred income tax expense (203) 578 112 - -------------------------------------------------------------- Total income tax expense 471 998 168 Deferred tax benefit on unrealized loss on investment securities available for sale 105 390 - - -------------------------------------------------------------- $ 366 $ 608 $ 168 ==============================================================\nA reconciliation between income tax expense and the total expected federal income tax is computed by multiplying pre-tax accounting income by the statutory federal income tax rate is as follows:\nIn thousands 1995 1994 1993 ============================================================== Federal income tax at statutory rate $ 433 $ 925 $ 320 Increase (decrease) in income tax expense resulting from: State income taxes, net of federal benefit 48 118 (23) Tax-exempt income (34) (26) (1) Life insurance (7) - - Decrease in federal valuation allowance (1) - (97) Other, net 32 (19) (31) - --------------------------------------------------------------- Total income tax expense $ 471 $ 998 $ 168 ===============================================================\nThe tax effects of temporary differences that give rise to deferred tax assets and liabilities at December 31 are as follows:\nIn thousands 1995 1994 =============================================================== Deferred tax assets Unrealized loss on investment securities available for sale $ 55 $ 390 State net operating loss carryforward - 13 Reserve for possible loan losses - - Other 40 26 - --------------------------------------------------------------- Total deferred tax assets 95 429 Less: Valuation allowance 7 8 - --------------------------------------------------------------- Deferred tax asset 88 421 - --------------------------------------------------------------- Deferred tax liabilities Reserve for possible loan losses 343 537 Premises and equipment 14 20 Investment securities held to maturity 3 4 - -------------------------------------------------------------- Deferred tax liability 360 561 - -------------------------------------------------------------- Net deferred tax (liability) asset $(272) $(140) ==============================================================\nThe net deferred liability represents the anticipated federal and state tax liability to be incurred in future years upon the utilization of the underlying tax attributes comprising this balance. Management believes, based on current estimates of future taxable earnings, that more likely than not there will be sufficient taxable income in future years to realize the deferred tax asset.\nThe valuation allowance amounted to $74,000 at December 31, 1993 and $8,000 at December 31, 1994 and 1995, decreasing by $1,000 and $66,000 in 1995 and 1994, respectively.\nThe valuation allowance at December 31, 1995 is attributable to the state tax benefit of deductible timing differences.\nNote 15 Employee benefit plans\nIn 1994, the Corporation established an employee savings plan under section 401(k) of the Internal Revenue Code covering all employees with at least six months of service. Participants are allowed to make contributions to the plan by salary reduction, up to 15% of total compensation. The Corporation provides matching contributions of 25% of the first 4% of basic participant contribution along with a 1% discretionary contribution, subject to a vesting schedule. Contributions to the plan amounted to $36,000 in 1995 and $33,000 in 1994.\nThe aforementioned plan replaced a noncontributory retirement plan which was terminated in 1994. Proceeds from the termination were rolled over into the employee savings plan.\nThe Corporation awards profit sharing bonuses to its officers and employees based on the achievement of certain performance objectives. Bonuses charged to operating expense in 1995, 1994 and 1993 amounted to $119,000, $120,000 and $70,000, respectively.\nNote 16 Preferred stock\nOn December 28, 1995 the Corporation issued $200,000 of 6% noncumulative perpetual preferred stock. Dividends are payable annually on February 28.\nNote 17 Restrictions on subsidiary bank dividends\nSubject to applicable law, the Board of Directors of the Bank and of the Corporation may provide for the payment of dividends when it is determined that dividend payments are appropriate, taking into account factors including net income, capital requirements, financial condition, alternative investment options, tax implications, prevailing economic conditions, industry practices, and other factors deemed to be relevant at the time.\nBecause CNB is a national banking association, it is subject to regulatory limitation on the amount of dividends it may pay to CNBC, CNB's sole stockholder. Prior approval of the Office of the Comptroller of the Currency (\"OCC\") is required if the total dividends declared by the Bank in any calendar year exceeds net profit, as defined, for that year combined with the retained net profits from the preceding two calendar years.\nUnder this limitation, the Bank could declare dividends in 1996 without prior OCC approval of up to $2,453,000 plus the Bank's net profit up to the date of the declaration, subject to the restrictive covenants under long-term debt agreements included in Note 12.\nNote 18 Net income per share\nThe following table summarizes the computation of net income per share.\nIn thousands, except per share data 1995 1994 1993 ================================================================ Net income Net income applicable to primary common shares $ 802 $1,724 $ 980 Interest expense on convertible subordinated debentures, net of income taxes 13 13 13 - ---------------------------------------------------------------- Net income applicable to fully diluted common shares $ 815 $1,737 $ 993 ================================================================ Number of average shares Primary 111,141 111,141 98,267 - ---------------------------------------------------------------- Fully diluted: Average common shares outstanding 111,141 111,141 98,267 Average convertible subordinate debentures converted to common shares 13,850 13,850 13,850 - ---------------------------------------------------------------- 124,991 124,991 112,117 ================================================================ Net income per share Income before cumulative effect of accounting change and extraordinary item Primary $ 7.22 $15.51 $ 7.88 Fully diluted 6.53 13.90 7.03 Cumulative effect of accounting change Primary - - 2.09 Fully diluted - - 1.83 Net income Primary 7.22 15.51 9.97 Fully diluted 6.53 13.90 8.86 ================================================================\nNote 19 Related party transactions\nVarious directors and executive officers of the Corporation and its subsidiary, including organizations in which they are officers or have significant ownership, were customers of, and had other transactions with the Bank in the ordinary course of business during 1995 and 1994. Such transactions were on substantially the same terms, including interest rates and collateral with respect to loans, as those prevailing at the time of comparable transactions with others. Further, such transactions did not involve more than the normal risk of collectibility and did not include any unfavorable features. Total loans to the aforementioned individuals and organizations amounted to $366,000 and $191,000 at December 31, 1995 and 1994, respectively. The highest amount of such indebtedness during 1995 and 1994 amounted to $375,000 and $191,000, respectively. During 1995, $191,000 of new loans were made.\nNote 20 Fair value of financial instruments\nThe fair value of financial instruments is the amount at which an asset or obligation could be exchanged in a current transaction between willing parties, other than in a forced liquidation. Fair value estimates are made at a specific point in time based on the type of financial instrument and relevant market information.\nBecause no quoted market price exists for a significant portion of the Corporation's financial instruments, the fair values of such financial instruments are derived based on the amount and timing of future cash flows, estimated discount rates, as well as management's best judgment with respect to current economic conditions. Many of these estimates involve uncertainties and matters of significant judgment and cannot be determined with precision.\nThe fair value information provided is indicative of the estimated fair values of those financial instruments and should not be interpreted as an estimate of the fair market value of the Corporation taken as a whole. The disclosures do not address the value of recognized and unrecognized nonfinancial assets and liabilities or the value of future anticipated business. In addition, tax implications related to the realization of the unrealized gains and losses could have a substantial impact on these fair value estimates and have not been incorporated into any of the estimates.\nThe following methods and assumptions were used to estimate the fair values of significant financial instruments at December 31, 1995, the date on which the Corporation adopted the provision of Statement of Financial Accounting Standards No. 107 .\nCash and short-term investments\nThese financial instruments have relatively short maturities or no defined maturities but are payable on demand, with little or no credit risk. For these instruments, the carrying amounts represent a reasonable estimate of fair value.\nInvestment securities\nInvestment securities available for sale are reported at their fair values based on quoted market prices. The fair values of investment securities held to maturity were also based upon quoted market prices.\nLoans\nFair values were estimated for performing loans by discounting the future cash flows using market discount rates that reflect the credit and interest-rate risk inherent in the loans. Fair value for significant nonperforming loans was based on recent external appraisals of collateral securing such loans. If such appraisals were not available, estimated cash flows were discounted employing a rate incorporating the risk associated with such cash flows.\nDeposit liabilities\nThe fair values of demand deposits, savings deposits and money market accounts were the amounts payable on demand at December 31, 1995 and 1994. The fair value of time deposits was based on the discounted value of contractual cash flows. The discount rate was estimated utilizing the rates currently offered for deposits of similar remaining maturities.\nShort-term borrowings\nFor such short-term borrowings, the carrying amount was considered to be a reasonable estimate of fair value.\nLong-term debt\nThe fair value of long-term debt was estimated based on rates currently available to the Corporation for debt with similar terms and remaining maturities.\nCommitments to extend credit and letters of credit\nThe estimated fair value of financial instruments with off-balance sheet risk is not significant at December 31, 1995.\nThe following table presents the carrying amounts and fair values of financial instruments at December 31, 1995: Carrying Fair In thousands Value Value =============================================================== Financial assets: Cash and short-term investments $10,615 $10,615 Investment securities available for sale 30,609 30,609 Investment securities held to maturity 24,495 24,434 Loans 44,644 43,064\nFinancial liabilities: Deposits $100,889 $ 99,570 Short-term borrowings 3,661 3,661 Long-term debt 1,749 1,107 ===============================================================\nNote 21 Commitments and contingencies\nIn the normal course of business, the Corporation or its subsidiary may, from time to time, be party to various legal proceedings relating to the conduct of its business. In the opinion of management, the consolidated financial statements will not be materially affected by the outcome of any pending legal proceedings.\nNote 22 Financial instruments with off-balance sheet risk\nThe Bank is 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 lines of credit, commitments to extend standby letters of credit, and could involve, to varying degrees, elements of credit risk in excess of the amounts recognized in the consolidated financial statements.\nThe Bank'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 amounts of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on balance sheet instruments with credit risk.\nCommitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require the payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer's creditworthiness on a case-by-case basis, and the amount of collateral or other security obtained is based on management's credit evaluation of the customer.\nStandby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. These guarantees are primarily issued to support borrowing arrangements and extend for up to one year. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Accordingly, collateral is generally required to support the commitment.\nAt December 31,1995 the Bank had mortgage commitments of $702,500, unused corporate lines of credit of $11,600,000 and $1,650,000 of other loan commitments.\nThe aforementioned commitments and credit lines are made at both fixed and floating rates of interest based on the Bank's prime lending rate.\nNote 23 Parent company information Condensed financial statements of the parent company only are presented below.\nCondensed Balance Sheet December 31, ============================================================== In thousands 1995 1994 ============================================================== Assets Cash and cash equivalents $ 4 $ 4 Investment in subsidiary 8,143 5,833 Due from subsidiary 249 249 Other assets 11 10 - -------------------------------------------------------------- Total assets $8,655 $5,847 ============================================================== Liabilities and stockholders' equity Other liabilities $ 10 $ 10 Long-term debt 1,749 249 - -------------------------------------------------------------- Total liabilities 1,759 259 Stockholders' equity 6,896 5,588 - -------------------------------------------------------------- Total liabilities and stockholders' equity $8,655 $5,847 ==============================================================\nCondensed Statement of Income Year Ended December 31, ============================================================== In thousands 1995 1994 1993 ============================================================== Income Dividends from subsidiary $ 141 $ 112 $ - Interest from subsidiary 20 20 20 - -------------------------------------------------------------- Total income 161 132 20 - -------------------------------------------------------------- Expenses Interest expense 20 20 20 - -------------------------------------------------------------- Total expense 20 20 20 - -------------------------------------------------------------- Income before equity in undistributed net income of subsidiary 141 112 - Equity in undistributed income of subsidiary 661 1,612 980 - -------------------------------------------------------------- Net income $ 802 $ 1,724 $ 980 ==============================================================\nCondensed Statement of Cash Flows Year Ended December 31, ================================================================= In thousands 1995 1994 1993 ================================================================= Operating activities Net income $ 802 $1,724 $ 980 Adjustments to reconcile net income to cash from (used in) operating activities: Equity in undistributed net income of subsidiary (661) (1,612) (980) Increase in other assets (1) - (8) Increase in other liabilities - - 8 - ----------------------------------------------------------------- Net cash from operating activities 140 112 - - ----------------------------------------------------------------- Investing activities Capital contribution to subsidiary (1,700) - (226) - ------------------------------------------------------------------ Net cash applied to investing activities (1,700) - (226) - ------------------------------------------------------------------ Financing activities Proceeds from issuance of long-term debt 1,500 - - Proceeds from issuance of common stock - - 226 Proceeds from issuance of preferred stock 200 - - Dividends paid (140) (111) - - ----------------------------------------------------------------- Net cash from (applied to) financing activities 1,560 (111) 226 - ----------------------------------------------------------------- Increase in cash and cash equivalents - 1 - Cash and cash equivalents at beginning of year 4 3 3 - ----------------------------------------------------------------- Cash and cash equivalents at end of year $ 4 $ 4 $ 3 =================================================================\nNote 24 Summary of quarterly financial information (unaudited)\n- ------------------------------------------------------------------ Dollars in thousands, First Second Third Fourth except per share data Quarter Quarter Quarter Quarter ================================================================== Interest income $1,736 $1,850 $1,911 $1,973 Interest expense 673 681 728 747 - ------------------------------------------------------------------ Net interest income 1,063 1,169 1,183 1,226 Provision (credit) for possible loan losses 122 (3) 32 335 Net gains (losses) on sales of investment securities (1) - (1) 12 Other operating income 513 321 250 281 Other operating expenses 981 1,071 1,133 1,060 - ------------------------------------------------------------------ Income before income tax expense 473 422 267 112 Income tax expense 175 156 90 50 - ------------------------------------------------------------------ Net income $ 298 $ 266 $ 177 $ 62 ================================================================== Net income per share (primary) $2.68 $2.39 $1.59 $ .56 ================================================================== Net income per share (fully diluted) $2.41 $2.13 $1.42 $ .57 ==================================================================\n- ------------------------------------------------------------------ Dollars in thousands, First Second Third Fourth except per share data Quarter Quarter Quarter Quarter ================================================================== Interest income $1,072 $1,403 $1,562 $1,559 Interest expense 343 487 548 690 - ------------------------------------------------------------------ Net interest income 729 916 1,014 869 Provision (credit) for possible loan losses (1,463) 5 5 (11) Net gains (losses) on sales of investment securities 36 - - - Other operating income 438 235 162 540 Other operating expenses 770 859 948 1,068 - ------------------------------------------------------------------ Income before income taxes 1,860 287 223 352 Income tax expense 545 88 90 275 - ------------------------------------------------------------------ Net income $1,315 $ 199 $ 133 $ 77 ================================================================== Net income per share (primary) $11.83 $ 1.79 $ 1.20 $ .69 ================================================================== Net income per share (fully diluted) $10.54 $ 1.39 $ .79 $ .29 ==================================================================\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure There were no changes in or disagreements with accounts during 1994.\nPart III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant The information required is incorporated herein by by reference to the material responsive to such item in the Corporation's Proxy Statement for the Annual Meeting of Stockholders to be held on June 8, 1995.\nItem 11.","section_11":"Item 11. Executive Compensation The information required is incorporated herein by by reference to the material responsive to such item in the Corporation's Proxy Statement.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management The information required is incorporated herein by by reference to the material responsive to such item in the Corporation's Proxy Statement.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions The information required is incorporated herein by by reference to the material responsive to such item in the Corporation's Proxy Statement.\nPart IV\nFinancial statement schedules are omitted because they are not required or are not applicable or the required information is shown in the consolidated financial statements or notes thereto.\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.\nThe following exhibits are incorporated herein by reference or are annexed to this Annual Report:\n(a) The required financial statements and the related independent auditor's report are included in Item 8.\n(b) The required exhibits are included as follows:\n(3)(a) The Corporation's restated articles of incorporation are incorporated herein by reference to exhibit (3)(d) of the Corporation's Current Report on Form 8-K dated July 28, 1992. (3)(b) Amendments to the Corporation's article of incorporation relating to the Corporation's Non-cumulative Perpetual Preferred Stock Series A. (3)(c) Amendments to the Corporation's article of incorporation relating to the Corporation's Non-cumulative Perpetual Preferred Stock Series B. (3)(d) The amended by-laws of the Corporation are incorporated herein by reference to exhibit (3)(c) of the Corporation's Annual Report on Form 10-K for the year ended December 31, 1991. (4)(a) The debenture agreements between the Corporation and its noteholders are incorporated herein by reference to exhibit (4)(a) of the Corporation's Annual Report on Form 10-K for the year ended December 31, 1993. (4)(b) Note Agreement dated December 28, 1995 by and between the Corporation and the Prudential Foundation. (10)(a) The Employees' Profit Sharing Plan of City National Bank of New Jersey is incorporated herein by reference to Exhibit (10) of the Corporation's Annual Report on Form 10-K for the year ended December 31, 1988. (10)(b) The Employment Agreement among the Corporation, the Bank and Louis E. Prezeau is incorporated herein by reference to Exhibit (10)(b) of the Corporation's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1993. (10)(c) Limited Branch Purchase and Assumption Agreement dated May 6, 1994 by and between the RTC and City National Bank of New Jersey (10)(d) Lease and Option Agreement dated May 6, 1994 by and between the RTC and City National Bank of New Jersey (10)(e) Minority Call Option Agreement dated May 6, 1994 by and between the RTC and City National Bank of New Jersey (10)(f) Indemnity Agreement dated May 6, 1994 by and between the RTC and City National Bank of New Jersey (10)(g) The Order to Cease and Desist issued by the Office of the Comptroller of the Currency, dated May 23, 1989, with Stipulation and Consent to Issuance of an Order to Cease and Desist is incorporated herein by reference to Exhibit (28)(a) of the Corporation's Annual Report on Form 10-K for the year ended December 31, 1988. (10)(h) The Capital Plan of City National Bank of New Jersey, dated May 14, 1991, is incorporated herein by reference to Exhibit (28)(b) of the Corporation's Current Report on Form 8-K dated May 6, 1991. (10)(i) The Amended and Restated Capital Plan, dated April 14, 1992 is incorporated herein by reference to Exhibit (28)(c) of the Corporation's Current Report on Form 8-K dated July 1, 1992. (10)(j) The Consent Order issued by the Office of the Comptroller of the Currency, dated January 21, 1992 is incorporated herein by reference to Exhibit (28)(i) of the Corporation's Annual Report on Form 10-K for the year ended December 31, 1991. (10(k) Purchase and Assumption Agreement dated August 18, 1995 by and between City National Bank of New Jersey and NatWest Bank N.A. (11) Statement regarding computation of per share earnings. The required information is included on page 24. (12) Ratios have been computed using the average daily balances of the respective asset, liability and stockholders' equity accounts. (13) Annual Report to security holders for the fiscal year ended December 31, 1995. (21) Subsidiaries of the registrant. The required information is included on page 3.\n(c) No reports on Form 8-K were filed during the quarter ended December 31, 1995.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, City National Bancshares Corporation has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized:\nCITY NATIONAL BANCSHARES CORPORATION\nBy: \/s\/ Louis E. Prezeau By: \/s\/ Edward R. Wright Louis E. Prezeau Edward R. Wright President and Chief Chief Financial Officer Executive Officer and Principal Accounting Officer)\nDate: March 30, 1996 Date: March 30, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, 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 undersigned hereby constitute and appoint Louis E. Prezeau his true and lawful attorney in fact and agent, with full power of substitution and resubstitution, to sign any and all amendments to this report and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission granting unto said attorney in fact and agent, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully and to all intents and purposes as he or she might or could 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.\nSignature Title Date\n\/s\/ Douglas E. Anderson Director March 21, 1996 Douglas E. Anderson Chairperson of the Board\n\/s\/ Barbara Bell Director, March 21, 1996 Barbara Bell\n\/s\/ Leon Ewing Director March 21, 1996 Leon Ewing\n\/s\/ Eugene Giscombe Director March 21, 1996 Eugene Giscombe\n\/s\/ Norman Jeffries Director March 21, 1996 Norman Jeffries\n\/s\/ Louis E. Prezeau Director, March 21, 1995 Louis E. Prezeau President and Chief Executive Officer\n\/s\/ Lemar C. Whigham Director March 21, 1995 Lemar C. Whigham","section_15":""}
{"filename":"277356_1995.txt","cik":"277356","year":"1995","section_1":"ITEM 1. BUSINESS.\nRiverside Group, Inc., a Florida corporation formed in 1965 (\"Riverside\" also \"Parent Company\"), engages through its 36% owned subsidiary Wickes Lumber Company (\"Wickes\") in the retailing and distribution of building materials.\nThe Company also has interests in life insurance and other operations. The Company is in the process of reorganizing its life insurance operations through a proposed combination of these operations with those of a privately-held company engaged in providing financial services. Upon completion of this reorganization, the Company will own a minority interest in the combined operations and will utilize the proceeds of this reorganization to increase its ownership in Wickes to approximately 52%.\nUnless the context indicates otherwise, the term \"the Company\" as used herein refers to Riverside and its subsidiaries.\nHISTORICAL DEVELOPMENT\nBACKGROUND\nThe Company obtained its initial investment in Wickes in 1990 through the acquisition of American Founders Life Insurance Company (\"American Founders\"), which at the time of its acquisition owned approximately 10% of Wickes' common stock. In 1993, as part of a Wickes recapitalization plan, including an initial common stock public offering, the Company increased its ownership of Wickes common stock to 2,217,290 shares, including an option to purchase 374,516 shares which was exercised on August 14, 1995. The Company's ownership of Wickes shares represents approximately 36% and 39% of Wickes outstanding common stock and voting common stock, respectively. For a discussion of the Company's equity investment in Wickes and possible consequences of the litigation seeking, among other things, rescission of the transaction in which the Parent Company acquired 364,682 shares of Wickes common stock and the call option for an additional 374,516 shares, see \"Item 3. Legal Proceedings\" and Notes 2 and 13 of Notes to Consolidated Financial Statements included elsewhere herein.\nDuring 1995, the Company's life insurance operations comprised the Company's other main business segment. The Company commenced life insurance operations in 1986 and expanded these operations through the 1989 acquisition of Aztec Life Assurance Company (\"Aztec\") and the 1990 acquisition of American Founders. At the end of 1994, Aztec disposed of all of its insurance in force and ceased active operations. On December 31, 1995, the Company sold the corporate charter and state insurance licenses of another life insurance subsidiary, National American Life Insurance Company of Texas (\"NALICO of Texas\"). The Company has entered into a definitive agreement to combine its remaining life insurance operations with those of a privately-held company as discussed below under the heading \"Proposed Transactions-Life Insurance Reorganization.\"\nFrom 1986 until 1993, the Company also conducted property and casualty insurance operations through its subsidiary, Dependable Insurance Company, Inc. (\"Dependable\"). Dependable's operations were discontinued in 1993 when Dependable ceased all insurance programs and disposed of substantially all of its in force business. The Company completed the sale of Dependable in September 1995. See \"Discontinued Operations.\" PROPOSED TRANSACTIONS\nIn November 1995, the Company announced its intention to sell its remaining life insurance operations and to pursue a possible business combination or other transaction with Wickes.\nWickes Investment. On January 11, 1996, the Company and Wickes entered into a Stock Purchase Agreement (the \"Wickes Agreement\") pursuant to which the Company agreed to acquire an additional two million newly-issued shares of Wickes common stock for $10 million in cash. The terms of the agreement were approved and recommended to the Boards of Directors of the Company and Wickes by committees comprised of the independent directors of each company. Wickes' board committee also received the opinion of its financial advisor that the transaction is fair, from a financial point of view, to Wickes. Upon completion of this transaction, the Company would own approximately 52% and 55% of Wickes outstanding common stock and voting common stock, respectively.\nClosing of the Wickes Agreement is subject to, among other things, the completion of the Life Insurance Reorganization (as defined herein).\nLife Insurance Reorganization. On March 8, 1996, the Company entered into a definitive agreement (the \"Circle Agreement\") to combine its life insurance operations with those of Circle Investors, Inc. (\"Circle\"), a privately-held company engaged in providing financial services (the \"Life Insurance Reorganization\").\nPursuant to the Circle Agreement, a wholly-owned subsidiary of American Financial Acquisition Corporation (\"AFAC\") that wholly-owns all of AFAC's insurance subsidiaries, will merge with and into Circle, with Circle surviving. As a result of the merger, Circle will wholly-own the Company's life insurance subsidiaries as well as Liberty Bankers Life Insurance Company (\"Liberty Bankers\"), an Ohio-domiciled life insurance company currently wholly-owned by Circle. At and for the period ended December 31, 1995, Liberty Bankers had (on a statutory accounting basis) approximately $9.2 million of assets, $3.3 million of policyholders' surplus and total revenues of $1.0 million.\nUpon completion of this reorganization, the Company will own approximately 40% of Circle's outstanding common stock and will possess the right to vote approximately 10% of Circle's common stock and will share the right to vote approximately an additional 30%. The Company also will own 100% of a new series of Circle's preferred stock with a liquidation preference of $3.6 million. Circle has also agreed to appoint the Company's Chairman, J. Steven Wilson, or another reasonably acceptable candidate to Circle's Board of Directors. The Company will be the largest single stockholder of Circle following completion of this transaction. Other investors in Circle will include Conseco, Inc., a publicly-held financial services company, which will own a 10% non-voting interest in Circle's common stock as well as a separate class of Circle's preferred stock.\nIn connection with this reorganization, the Company will receive approximately $15 million in cash before taxes and expenses, and will retain certain assets held by American Founders, including real estate with a $2 million net appraised value (net of an $18 million mortgage) and approximately 950,000 shares of Wickes common stock. Also in connection with this transaction, Circle will replace all of AFAC's indebtedness under its bank credit agreement, which totaled $18 million at December 31, 1995.\nAfter anticipated income taxes and other expenses of approximately $1.0 million, net cash to be received by the Company in this transaction would approximate $14 million, $10 million of which it has agreed to utilize to acquire two million newly-issued shares of Wickes common stock pursuant to the Wickes Agreement.\nCompletion of the transactions contemplated by the Circle Agreement is subject to, among other things, receipt of insurance regulatory approvals and the completion by Circle of necessary financing arrangements. It is anticipated that the transactions will close in June, 1996.\nThe Company has taken a net pre-tax charge of $11 million against 1995 income from continuing operations for the life insurance reorganization and the sale of NALICO of Texas. This charge primarily reflects a write-off of $10.8 million of intangible assets acquired in the various life acquisitions. Additionally, the Company realized a $1.9 million tax benefit on the proposed merger with Circle, which partially offsets the reorganization charges.\nOperations After Proposed Transactions. Upon completion of the Wickes Agreement and the Circle Agreement, the Company will continue to be primarily engaged through Wickes (which will be a majority-owned subsidiary of the Company) in the retailing and distribution of building materials. The Company will also engage through wholly-owned subsidiaries in financial services related to the home building industry and will own a minority interest in Circle and retain certain real estate currently owned by American Founders. For a further discussion of the effects of the proposed transactions on the financial statements of the Company see Note 14 of Notes to the Consolidated Financial Statements included elsewhere herein.\nLINES OF BUSINESS\nThe following table sets forth certain financial data for the past three years of the Company's building materials, life insurance, and other segments. The Company's ownership of Wickes is accounted for on the equity method. Accordingly, the following table presents only the revenues, income and identifiable assets for Wickes at the net amounts recorded on the Company's books. \"Other\" includes all eliminating entries for intercompany transactions.\nBUILDING MATERIALS AND RELATED OPERATIONS\nThe Company retails and distributes building materials through its 36% beneficially owned subsidiary, Wickes. In addition, two wholly-owned subsidiaries of the Company market financial products, including insurance and mortgage and construction loans, to Wickes' professional builders and their customers.\nFor information concerning an agreement dated January 11, 1996, pursuant to which Riverside is to acquire an additional two million newly issued shares of Wickes common stock, bringing its ownership of Wickes to approximately 52 % and 55% of Wickes outstanding common stock and voting securities, respectively, see \"HISTORICAL DEVELOPMENT - Proposed Transactions - Wickes Investment.\"\nWICKES LUMBER COMPANY\nThe information concerning Wickes contained in this report was obtained from Wickes' Annual Report on Form 10-K for the fiscal year ended December 30, 1995 (the \"Wickes Form 10-K\"), filed by Wickes with the Securities and Exchange Commission (the \"Commission\"). For further information concerning Wickes, reference is made to the Wickes Form 10-K and the periodic reports and other information filed by Wickes with the Commission.\nWickes Lumber Company (\"Wickes\") is a major retailer and distributor of building materials. Wickes sells its products and services primarily to residential and commercial building professionals, repair and remodeling contractors, and to a lesser extent, project do-it-yourselfers (\"DIYers\") involved in major home improvement projects. Wickes operates 110 building centers in 24 states in the Midwest, Northeast, and South and eleven\ncomponent manufacturing facilities that produce and distribute pre-hung door units, roof and floor trusses, framed wall panels, and pre-assembled windows.\nBACKGROUND\nThe predecessor of Wickes commenced its operations in 1952 with the opening of a single building center in Bay City, Michigan. By 1981, the number of building centers operated had reached 280. Wickes was formed as a Delaware corporation in 1987, and in April 1988 completed the acquisition of 223 building centers and 10 component manufacturing facilities in a leveraged buy-out transaction (the \"1988 Acquisition\"). From 1988 through 1993, Wickes reduced the number of its building centers to 124 and the number of its component manufacturing plants to six.\nOn October 22, 1993, Wickes completed a plan of recapitalization (the \"Recapitalization Plan\") pursuant to which Wickes retired all outstanding indebtedness incurred in connection with the 1988 Acquisition and restructured its previously existing classes of capital stock. The Recapitalization Plan included, among other things: (i) the initial public offering by Wickes of 2,800,000 shares of its common stock, $.01 par value per share; (ii) the offering of $100,000,000 principal amount of Wickes' 11-5\/8% Senior Subordinated Notes due 2003; (iii) the retirement of Wickes' previously outstanding long-term debt; and (iv) restructuring of Wickes' equity capitalization. For further information, see Note 4 of Wickes' Consolidated Financial Statements included elsewhere herein.\nIn 1994, Wickes commenced an acquisition program which, over the next two years, resulted in the acquisition of fifteen building centers and five component manufacturing facilities, principally through the acquisition of Gerrity Lumber. See \"Business Strategy,\" \"Acquisitions\" and \"Markets.\"\nFor information concerning a restructuring plan which Wickes developed and began implementing in December of 1995, see \"Business Strategy - 1995 Restructuring Plan\" and Note 12 of Wickes' Notes to Consolidated Financial Statements included elsewhere herein.\nINDUSTRY OVERVIEW\nBased on U.S. Bureau of the Census figures, Wickes believes that sales of building materials associated with new home construction approximated $44.0 billion in 1995. According to the Home Improvement Research Institute (HIRI), sales of building materials associated with the maintenance and repair of residential housing, excluding new home construction, were approximately $133.9 billion. Despite some consolidation over the last ten years, particularly in metropolitan areas, the building material industry remains highly fragmented. Wickes believes that no building material supplier accounted for more than 10% of the total market in 1995.\nIn general, building material retailers concentrate their marketing efforts either on building professionals or consumers. Professional-oriented building material retailers, such as Wickes, tend to focus on single-family residential contractors, repair and remodeling (\"R&R\") contractors and project DIYers. These retailers compete principally on the basis of service, product assortment, price, scheduled job-site delivery and trade credit availability. In contrast, consumer-oriented building material retailers target the mass consumer market, where competition is based principally on price, merchandising, location and advertising. Consumer-oriented warehouse and home center retailers typically do not offer as wide a range of services, such as specialist advice, trade credit and scheduled job-site delivery, as do professional-oriented building material retailers.\nIndustry sales are closely linked to the level of activity in the residential building industry, which tends to be cyclical and seasonal. New residential construction is determined largely by household formations, interest rates, housing affordability, availability of mortgage financing, regional demographics, consumer confidence, job growth, and general economic conditions. According to the U.S. Bureau of the Census, U.S. housing starts, which totaled 1.01 million in 1991, the lowest level since World War II, increased to 1.20 million in 1992, 1.29 million in 1993, and 1.46 in 1994. In 1995, housing starts declined by 7.5% to 1.35 million units. Declines in Wickes' primary markets, the Midwest and Northeast, were approximately 12.1% and 15.1%, respectively. Nationally, single family housing starts, which generate the majority of Wickes' sales to building professionals, experienced a larger decline of 10.8% in 1995, from 1.20 million starts in 1994 to 1.07 million starts in 1995. The Blue Chip Economic Indicators Consensus Forecast dated February 10, 1996, projects 1996 housing starts to be 1.36 million.\nRepair and remodeling expenditures tend to be less cyclical than new residential construction and provide a more stable base for the building material supply industry. These expenditures are generally undertaken with less regard to economic conditions, but both repair and remodeling projects (including projects undertaken by DIYers) tend to increase with increasing sales of both existing and newly-constructed residences. The Home Improvement Research Institute statistics show sales of lumber and building materials to repair and remodeling professionals represented $39.6 billion, or approximately 20% of total 1995 sales of the building material supply industry, while direct sales to DIYers amounted to $94.3 billion.\nBUSINESS STRATEGY\nGeneral\nWickes' goal is for each of its building centers to be the dominant force in the sale of lumber and other building materials to the professional building contractors in the market in which it operates. To support this strategy and achieve future growth and improved profitability, Wickes will focus on continuing to provide quality products and services to its professional customers, increasing sales to the commercial builder, increasing sales of certain higher-margin, value-added products, including those manufactured or assembled by Wickes, and continuing its emphasis on cost reduction and return on assets.\n1995 Restructuring Plan\nDuring the fourth quarter of 1995 Wickes committed to a plan to reduce the number of under-performing building centers, the corresponding overhead to support these building centers, and to strengthen its capital structure. The purpose of the plan is to achieve a more focused customer and marketing strategy, to reduce costs, and to dispose of certain under-performing assets. Management anticipates the completion of this plan in 1996.\nThe operational changes contemplated by this plan were begun on December 29, 1995. Since that date, Wickes has consolidated or closed 16 building centers and has identified additional building centers for consolidation or closing. The average 1995 annual sales for the 16 centers closed on December 29 was $4.4 million. This compares with a company average of $8.4 million. Centers to be consolidated into nearby locations often performed tasks that could be performed at the remaining center more efficiently with little or no reduction in customer service.\nThe two principal financial elements of the restructuring plan are modification and extension of Wickes' bank revolving credit agreement, which was completed on March 12, 1996 and the private sale to Riverside of two million newly-issued shares of Wickes' Common Stock for $10 million. Also included in the plan was the obtaining of \"stand-alone\" financing for Wickes' operations in Russia. On February 21, 1996, Wickes and its subsidiaries involved in Russian operations entered into definitive agreements for such financing. See \"International Operations.\"\nIn connection with this restructuring plan, and other unusual items, Wickes recorded a $17.8 million charge in the fourth quarter of 1995.\nAcquisitions\nSince the 1993 Recapitalization, Wickes has actively pursued acquisitions of local or regional building centers to complement and expand its operations. For a description of acquisitions completed in 1994 and 1995, see \"Acquisitions.\" Wickes continues to believe that the fragmented nature of the building material industry presents opportunities for acquisitions of strategically located operations and may, subject to availability of adequate borrowing capacity and liquidity, pursue attractive acquisitions from time to time. Wickes is not, however, currently actively pursuing acquisitions, and there can be no assurance that Wickes will be able to identify and complete additional acquisitions in the future.\nACQUISITIONS\nDuring 1995, Wickes completed the acquisition of (i) a combination building center and component manufacturing facility in Pensacola, Florida, into which Wickes consolidated its existing Pensacola building center, (ii) a building center in South Haven, Michigan and a combination building center and component manufacturing facility in Fruitport, Michigan, (iii) a building center in Caro, Michigan, and (iv) a building center in Newtown, Connecticut into which Wickes consolidated its older and smaller Danbury, Connecticut building center. In each case, Wickes acquired the inventory and equipment of the acquired operations and entered into leases of, or in one location purchased, the sites on which the operations are located. Accounts receivable were retained by the sellers, and cash used to make the acquisitions was obtained under Wickes' bank revolving credit facility.\nDuring 1994, Wickes acquired (i) two related building centers located in Marquette and Ishpeming, Michigan, (ii) all of the Class B Common Stock of Riverside International Corporation from Riverside (see \"International Operations\") and (iii) the Gerrity Lumber business from Gerrity Company, Inc., which consisted of eight building centers and three component manufacturing facilities located in the northeastern United States. Included in the assets acquired were inventory and accounts receivable. All of the cash to effect these acquisitions was derived from Wickes' bank revolving credit agreement.\nPRODUCTS\nWickes stocks a wide variety of building products, totaling approximately 57,000 stock keeping units (\"SKUs\") company-wide, to provide its customers with the quality products needed to build, remodel and repair residential and commercial properties. Each of Wickes' building centers tailors its product mix to meet the demands of its local market. A core group of approximately 5,900 SKUs is typically stocked in each building center.\nWickes separates its products into three groups: Wood Products -- lumber, plywood, roof and floor trusses, treated lumber, sheathing, wood siding and specialty lumber; Building Products -- roofing, vinyl siding, doors, windows, mouldings, drywall and insulation; and Hardlines -- hardware products, paint, tools, kitchen and bathroom cabinets, plumbing products, electrical products, light fixtures and floor coverings. Wood Products, Building Products and Hardlines represented 51%, 36% and 13%, respectively, of Wickes' sales for 1995 and 52%, 34% and 14% of sales for 1994.\nIn addition to stock items, Wickes also fills special orders, either from its own manufacturing facilities or through outside suppliers. Wickes believes that these special order services are extremely important to its customers, particularly the building professional. In 1995, approximately 32% of Wickes' sales were of special order items, compared with 27% in 1994.\nWickes owns and operates eleven component manufacturing facilities that supply Wickes' building centers with certain higher-margin, value-added products such as pre-hung doors, framed wall panels, roof and floor trusses, and windows. These manufacturing facilities enable Wickes to serve the needs of its professional customers for such quality, custom-made products. The door manufacturing operations support 103 of Wickes' building centers by supplying approximately 54% of the pre-hung interior doors and 65% of the metal exterior doors sold by Wickes. The truss manufacturing operations supplied 41 building centers with approximately 33% of the total roof and floor truss systems sold by Wickes in 1995 and nine building centers with wall panel systems. Wickes believes that these pre-assembled products improve customer service and provide an attractive alternative to job-site construction as labor costs rise. Wickes plans to expand its manufacturing facilities to take advantage of these increased opportunities and to supply a greater number of its building centers with these products.\nMARKETS\nWickes has generally located its building centers in less populous areas, with 78% located in trade areas (10 mile radius) with fewer than 50,000 owner-occupied households. The following table sets forth the distribution of Wickes' building centers by size of community:\nIn its more densely populated markets, Wickes sells primarily to building professionals, while in smaller markets, Wickes' building centers generally emphasize sales to both building professionals and consumers. Each of Wickes' building centers operates as a separate profit center and tailors its product and service mix to the local market.\nWickes' 110 building centers are located in 24 states in the Midwest, Northeast and South. Wickes believes that its geographic diversity generally lessens the impact of economic downturns and adverse weather conditions in any one of Wickes' geographic markets. The following table sets forth certain information with respect to the locations of Wickes' building centers as of February 29, 1996:\nDuring 1995, Wickes acquired five building centers and opened two new building centers. Wickes also closed ten building centers and one component manufacturing facility and consolidated another 17 building centers into other existing or acquired centers. The following table reconciles the number of building centers and component manufacturing facilities owned by Wickes at December 31, 1994 and December 30, 1995.\nWickes is currently renovating a former building center located in Indiana into a component manufacturing facility. This facility is expected to begin producing roof and floor trusses and framed wall panels in early 1996 and will increase the number of operating component manufacturing facilities to twelve.\nDuring 1994, Wickes acquired ten building centers and three component manufacturing facilities. During 1994, Wickes closed three building centers (two in order to consolidate operations with newly-acquired facilities) and converted a fourth to a component manufacturing facility. During 1993, Wickes acquired no facilities and closed one building center.\nCUSTOMERS\nIn 1995, 82% of Wickes' sales were on trade credit, with the remaining 18% as cash and credit card transactions. Wickes has a broad base of customers, with no single customer accounting for more than 0.4% of net sales in 1995.\nHome Builders\nWickes' primary customers are single-family home builders. In 1995, all home builder customers accounted for 54% of Wickes' sales. During 1994 and 1993, these customers accounted for approximately 51% and 48%, respectively, of Wickes' sales. The majority of Wickes' sales to these customers are of high volume commodity items, such as Wood Products and Building Products. Wickes will continue its intense focus on this customer segment, offering new products and developing additional services to meet their needs.\nCommercial Contractors\nIn 1993, Wickes launched its Commercial Sales Division (\"CSD\"), which was developed specifically to serve the unique needs of commercial and multi-family contractors. In 1995, sales to this segment accounted for more than 14% of Wickes' sales, compared with 10% of Wickes' sales in 1994 and 7% in 1993.\nRepair & Remodelers\nIn 1995, R&R customers accounted for approximately 14% of Wickes' sales, compared with 17% in 1994 and 19% in 1993. The R&R segment consists of a broad spectrum of customers, from part-time handymen to large, sophisticated business enterprises. Some contractors are involved exclusively with single product application, such as roofing, siding, or insulation, while some specialize in remodeling jobs, such as kitchen or bathroom remodeling or the construction of decks, garages, or full room additions. Wickes offers the product and project expertise, special order capability, design assistance, and credit terms to serve the widely varying needs of this diverse market.\nDIYers\nSales to DIYers (both project and convenience) represented about 18% of Wickes' sales in 1995, compared with 22% in 1994 and 26% in 1993. The percentage of sales to DIYers varies widely from one building center to another, based primarily on the degree of local competition from warehouse and home center retailers. Wickes' building centers do not have the large showrooms or broad product assortments of the major warehouse or home center retailers. For small purchases, the showrooms serve as a convenience rather than a destination store. Consequently, Wickes' focus on consumer business is toward project DIYers -- customers who are involved in major projects such as building decks or storage buildings or remodeling kitchens or baths.\nSALES AND MARKETING\nWickes employs a number of marketing initiatives designed to increase sales and to support Wickes' goal of being the dominant force in the sale of lumber and other building materials to building professionals in each of its markets.\nBuilding Professional\nIn addition to its broad range of quality products, Wickes also seeks to establish long-term relationships with its professional customers by providing a higher level of customer assistance and services than are generally available at independently-owned building centers or large warehouse and home center retailers.\nWickes provides a wide range of customer services to building professionals, including expert assistance, technical support, trade credit, scheduled job-site delivery and other special services. Wickes believes that, while pricing is an important purchasing criterion for these customers, availability of quality products and services are equally or more important.\nWickes' primary link to the building professional market is its experienced sales staff. Wickes' 384 outside sales representatives (\"OSRs\") are commissioned sales persons who work with professional customers on an on-going basis at the contractors' job sites and offices. Typically, a sale to a contractor is made through a competitive bid prepared by the OSR from plans made available by the contractor. From these plans, the OSR or sales support associate prepares and provides to the contractor a bid and a complete list, or \"take-off,\" of the materials required to complete the project. Preparation of a take-off requires significant time and effort by trained and experienced sales representatives and support associates. Wickes has equipped all of its building centers with a computerized system which significantly reduces the time required to prepare take-offs. In addition, this system instantly recalculates changes and automatically includes add-on products needed to complete the project, which generally improves productivity, sales and margins. The ability of the sales representative to provide prompt and accurate take-offs, to arrange timely deliveries, and to provide additional products or services as necessary is an important element of Wickes' marketing strategy and distinguishes Wickes from many of its competitors.\nWickes expanded its emphasis on the light commercial market with the creation of the CSD in 1993. CSD provides project leads and estimating help utilizing a nationwide database and directly supports sales through a network of nine Regional Account Managers. Targeted customers include multi-family, motel, restaurant, retail, and other light commercial contractors. Wickes' direct sales program has been integrated with the CSD. In the direct sales program, sales are initiated by local OSRs, but are managed by a home office sales manager, and products are shipped directly to the job site from the manufacturer.\nWickes currently employs 172 specialty salespeople who provide expert advice to customers in project design, product selection and applications. In many of its building centers, Wickes maintains separate R&R offices. A staff of 74 trained R&R sales specialists offer special services to R&R contractors equivalent to that accorded home builders. Wickes, for many years, has made its local offices and office equipment (such as facsimile and photocopy machines) available to R&R customers, many of whom work out of their homes and have a need for these services. Wickes currently has kitchen and bath departments in all of its building centers and has a staff of 80 kitchen and bath specialists. Wickes also employs 18 specialists in other departments.\nWickes extends credit, generally due on the 10th day of the month following the sale, to qualified and approved contractors. Approximately 82% of Wickes' sales during 1995 were on credit, with the remaining 18% consisting of cash or credit card sales, including approximately 2% of sales on Wickes' private label credit card. Overall credit policy is established at the corporate level, with each building center manager and a district credit manager responsible for the administration and collection of accounts. The accounts are generally not collateralized, except to the extent Wickes is able to take advantage of the favorable materialmen's lien laws of most states applicable in the case of delinquent accounts. Wickes' credit practices have resulted in a bad debt expense of .8% of total credit sales in 1995, compared with .3% in both 1994 and 1993. Much of the increase in 1995 is attributable to the conversion of accounts at the Gerrity acquisition centers to Wickes' credit practices.\nWickes owns and leases a fleet of 837 delivery vehicles, as of February 29, 1996, to provide job-site deliveries of building materials scheduled to coordinate with project progress, including 54 specialized delivery trucks equipped for roof-top or second story delivery and 89 specialized millwork delivery vehicles. Wickes will continue to add these specialized vehicles to other markets where there is sufficient demand for such services.\nOver the past several years, Wickes has installed and will continue to increase its base of computer-aided design (\"CAD\") hardware and software. These systems include design and take-off software for kitchens, decks, outbuildings, additions and houses. With these tools, sales representatives and specialists are able to provide customers with professional-quality plans more efficiently.\nWickes advertises in trade journals and produces specialized direct mail promotional materials designed to attract specific targeted customer segments. Wickes does some select newspaper advertising, which may include circulars and run-of-press advertisements. It also has numerous product displays in its building centers to highlight special products and services.\nTo increase customer loyalty and strengthen customer relationships, Wickes, in many cases with vendor support, has increased the number of its special marketing activities, such as trade show events, informational product seminars, various outings, and professional builder trips.\nDIYers\nMost building centers also pursue sales to project DIYers through their staff of specially-trained inside sales representatives and specialists. These representatives provide professional advice to consumers for home improvement projects and assist these customers in designing specific projects with sophisticated computer design software. The sales representatives can also provide a comprehensive list of materials and detailed drawings to assist customers in completing their projects. Wickes believes that project DIYers are attracted to its building centers by this high level of service.\nWickes' showrooms generally feature product presentations such as kitchen and bath and door and window displays. The showrooms are regularly re-merchandised to reflect product trends, service improvements and market requirements.\nWhile Wickes' product offerings in hardlines are generally more limited than its consumer-oriented competitors, Wickes stocks a much larger selection of commodity products and offers a special order program for custom or specialty products. Wickes emphasizes project packages, which\ninclude all materials and detailed instructions for the assembly of the larger projects frequently undertaken by project DIYers.\nSUPPLIERS AND PURCHASING\nWickes purchases its products from numerous vendors. Substantially all commodity items are purchased directly from manufacturers, while the remaining products are purchased from a combination of manufacturers, wholesalers and other intermediaries. Wickes also manufactures approximately 33% of the roof and floor trusses, 54% of the pre-hung interior doors, and 65% of the metal exterior doors sold in its building centers. No single vendor accounted for as much as 5% of Wickes' purchases in 1995, and Wickes is not dependent upon any single vendor for any material product. Wickes believes that alternative sources of supply are readily available for substantially all of the products it offers.\nSubstantially all of Wickes' commodity purchases are made on the basis of individual purchase orders rather than supply contracts. Because approximately 31% of Wickes' average inventory consists of commodity wood products, which are subject to price volatility, Wickes attempts to match its inventory levels to short-term demand in order to minimize its exposure to price fluctuations. Wickes has developed an effective coordinated purchasing program that allows it to minimize costs through volume purchases, and Wickes believes that it has greater purchasing power than many of its smaller, local independent competitors. Wickes seeks to develop close relationships with its suppliers in order to obtain favorable pricing and service arrangements. With certain of its suppliers, Wickes has entered into purchasing arrangements which allow Wickes to purchase wood products shipped to distribution centers as such goods are needed to restock inventory or fill customer orders, thereby allowing Wickes to reduce its on-hand inventory needs.\nWickes' computerized inventory tracking and forecasting system as well as its inventory replenishment system are designed to track and maintain appropriate levels of products at each building center. These systems have increased Wickes' operating efficiencies by providing an automated inventory replenishment system, allowing more time to be devoted to sales opportunities.\nIn 1995, Wickes established a replenishment program for many of its non-commodity products through an independent hardlines distributor. This arrangement provides weekly replenishment of many hardline products in more economic quantities at competitive prices. Wickes also has experienced significant purchasing and administrative efficiencies as a result of the implementation of this program.\nWickes has active rail sidings at 65 of its building centers enabling vendors to ship products purchased by Wickes directly to these building centers by rail. Wickes also utilizes two distribution centers owned by third parties, located in Chicago, Illinois and Pottstown, Pennsylvania. Approximately 4% of Wickes' wood products inventory is distributed through these facilities.\nINTERNATIONAL OPERATIONS\nOne of Wickes' subsidiaries engages in logging, sawmill and other lumber-related activities in Russia, principally in the Archangel region.\nOn February 21, 1996, this subsidiary entered into an agreement with two investment funds. Pursuant to this agreement, the two funds are each to invest $5 million in this subsidiary and are each to receive a 25% equity interest, with Wickes retaining an interest slightly less than 50% and the subsidiary's management\nreceiving the balance of the equity. A total of $4 million of the funds' investment has been advanced to the subsidiary as a loan, which is to be converted to equity upon funding of the remaining $6 million, which is to occur on satisfaction of certain conditions, including among other things the resolution of certain legal matters and the achieving of specified operational levels.\nMANAGEMENT INFORMATION SYSTEMS\nWickes maintains an integrated distributed processing system in its building centers. This system was specifically designed for the management of building centers and provides Wickes with information regarding average cost, replacement cost, perpetual inventory, margin and bid analysis, accounts receivable and salesperson analysis. This system enables Wickes to manage and optimize margins and inventory levels and to respond to the changing demands of its markets and customers, as well as to increase productivity. Most senior management and many building center managers have remote access to this system, as well as the headquarters network, through personal computers.\nA satellite-based communications network links all building centers, component manufacturing facilities and Wickes' headquarters. This network carries data, electronic mail, and broadcast television. In 1995, all field locations were given on-line access to Wickes' replenishment system via the satellite communications network, giving control of replenishing non-commodity products to local management. The broadcast television facility is used for various company communications including the rapid deployment of training topics.\nWickes has begun implementation of a client\/server data warehouse system to upgrade its central information processing needs. Wickes also has established a home page on the world wide web which can be found at the Internet address: http:\/\/www.wickes.com\/ .\nSEASONALITY\nHistorically, Wickes' first quarter and, frequently, its fourth quarter are adversely affected by weather patterns in the Midwest and Northeast, which result in seasonal decreases in levels of construction activity in these areas. The extent of such decreases in activity is a function of the severity of winter conditions. While Wickes experienced a relatively mild first quarter in 1995, severe ice storms in the Northeast in 1994, and record setting snow falls throughout the Midwest and Northeast in January of 1996, have adversely affected construction activity in the first quarter of these years.\nCOMPETITION\nThe building material industry is highly competitive. Due to the regional and local nature of this industry, Wickes' competitive environment varies by location and by customer segment. Reduced levels of construction activity have, in the past, resulted in intense price competition among building material suppliers that has at times adversely affected Wickes' gross margins.\nWithin the professional market, Wickes competes primarily with local independent lumber yards and regional and local building material chains. Building professionals generally select building material suppliers based on quality and expertise of its sales staff, quality and breadth of product lines and services, reliability of inventory levels, competitive pricing, job-site delivery, and the availability of credit. Wickes believes that it competes favorably on each of these bases. Wickes believes that it has a significant competitive advantage in\nrural markets and small communities, where it competes primarily with local independent lumber yards, regional building material chains, and, to a lesser extent, with national building center chains and warehouse and home center retailers, which generally locate their units in more densely populated areas.\nWithin the consumer segment, Wickes competes primarily with local lumber yards and hardware stores and, in certain of its markets, with local units of larger warehouse and home center retailers. Competition within this segment is based principally on price, merchandising, location and advertising. Wickes focuses primarily on project DIYers, who tend to place much more value on product selection and the availability of special services in selecting a building materials supplier. According to Building Supply Home Centers \"1995 Giants\" report, the average product mix of consumer oriented retailers consist of 14% wood products, 11% building products and 75% hardlines, compared with 51%, 36%, and 13%, respectively, for Wickes in 1995.\nENVIRONMENTAL AND PRODUCT LIABILITY MATTERS\nMany of the building center facilities presently and formerly operated by Wickes and its predecessor contained underground petroleum storage tanks. All such tanks known to Wickes located on facilities owned or operated by Wickes have been filled, removed, or are scheduled to be removed in accordance with applicable environmental laws in effect at the time. As a result of reviews made in connection with the sale or possible sale of certain facilities, Wickes has found petroleum contamination of soil and ground water on several of these sites and has taken, and expects to take, remedial actions with respect thereto. In addition, it is possible that similar contamination may exist on properties no longer owned or operated by Wickes the remediation of which Wickes could under certain circumstances be held responsible. Since 1988, Wickes has incurred approximately $2.1 million of costs with respect to the filling or removing of underground storage tanks and related investigatory and remedial actions, and Wickes has reserved $1,000,000 towards the cost of these and other environmental and product liability matters.\nAlthough Wickes has not expended material amounts in the past eight years with respect to the foregoing, there can be no assurances that these matters will not give rise to additional compliance and other costs that could have a material adverse effect on Wickes.\nFor information concerning certain litigation concerning products containing asbestos, see \"Item 3. Legal Proceedings.\"\nTRADEMARKS AND PATENTS\nWickes has no material patents, trademarks, licenses, franchises, or concessions other than the name \"Wickes Lumber\" and the \"Flying W\" trademark.\nFINANCIAL SERVICES TO BUILDERS\nINSURANCE\nWickes Financial Services Center, Inc. (\"WFSC\") is a Florida corporation wholly-owned by Riverside that markets insurance products to Wickes' professional builder customers. WFSC commenced operations in 1993 and initially marketed the insurance products of third-party carriers through \"captive agents\" who were employees of the Company. The Company subsequently determined these operations could be structured more efficiently with WFSC operating as a managing general agent\n(MGA), and in March 1996, WFSC's \"captive agents\" became employees of various independent insurance agencies who have contracted with WFSC to market these products. The Company believes the MGA structure will allow WFSC to capitalize on its relationship with Wickes on a more cost effective and less capital intensive basis.\nWFSC currently offers a range of competitively priced products and programs developed exclusively for residential contractors. The products include worker compensation, general liability, property, commercial auto, builder risk, health, life and annuity insurance. Presently operations are active in Michigan, Wisconsin, Indiana and Alabama through fifteen independent agencies. WFSC supports the agencies through direct marketing to Wickes customers and providing leads or customer lists to the agents for follow up sales.\nDuring 1995 and 1994 WFSC's operations generated revenues of $.3 million and $.1 million and incurred pre-tax losses of approximately $.7 million and $1.0 million, respectively.\nMORTGAGE LENDING\nDuring 1995, the Company, as part of American Founders investment operations, opened two mortgage lending offices and began, on a test basis, marketing construction and permanent mortgage loans to the professional builder customers of Wickes as well as the customers of these builders. Currently the program retains construction loans for interest and fee income while permanent mortgages are sold to outside investors for service release fees under existing agreements. Since inception of the test, the Company has issued commitments or funded approximately 48 construction loans to builders aggregating approximately $8 million and approximately 36 permanent loans to homeowners aggregating approximately $5 million. The Company also believes that opportunities exist for cross-selling insurance products to builders and their customers. Currently, there are approximately 50 builders participating in the program.\nAt the end of 1995, the Company had two mortgage loan representatives located in two loan production offices. Based upon the success of the test program, the Company intends to attempt to expand its mortgage lending program under a newly-formed, wholly-owned subsidiary of the Company, Wickes Mortgage Lending, Inc., which plans to add six locations and 18 loan representatives in 1996. Expansion of this program after completion of the Life Insurance Reorganization will depend upon entering into a lending arrangement with an alternative lender or lenders to provide a source of funds for construction loans and to act as a \"warehouse lender\" for permanent loans.\nDuring 1995 and 1994, mortgage lending operations (exclusive of American Founders' investment results) generated revenues of $.2 million and $.0 million, respectively, and pre-tax losses of $.7 million and $.2 million, respectively.\nLIFE INSURANCE OPERATIONS\nGENERAL\nFor information concerning the proposed combination of the Company's life insurance operations with those of Circle in a transaction that would result in Circle's wholly-owning the Company's life insurance subsidiaries and the Company's owning a minority interest in Circle, see \"HISTORICAL DEVELOPMENT - - Proposed Transactions - Life Insurance Reorganization.\"\nAll of the Company's life insurance subsidiaries are currently wholly-owned by the Company's 99%-owned life insurance holding company subsidiary, AFAC. AFAC wholly-owns American Founders, which in turn wholly-owns Aztec.\nIn December 1995, American Founders sold the corporate charter and state insurance licenses of NALICO of Texas to General American Life Insurance Company. This sale resulted in a realized gain of approximately $.8 million. Prior to the sale, American Founders assumed all of the life and accident and health business of NALICO of Texas under an assumption reinsurance agreement.\nIn December 1994, the Company sold all in force policies of Aztec to Guardian Insurance and Annuity Company for $8.2 million in cash at a net loss of $.2 million. See Note 9 of Notes to Consolidated Financial Statements included elsewhere herein. Under terms of a related agreement, Aztec was to administer the policies for a period not less than one year from the date of closing. This agreement has been extended into 1996. The Company estimates that the sale of the Aztec business generated a decrease in profits from life insurance operations of approximately $2.5 million during 1995.\nIn January 1995, the life insurance operations successfully converted to a new policy administration software system. The new system greatly increases flexibility and efficiency for processing sophisticated life insurance products.\nThe Company presently has no active life insurance marketing operations. The Company's life subsidiaries historically distributed their products through general agents, direct response marketing and a financial institution marketing force. In 1993, in order to reduce operating costs, the Company eliminated its financial institution marketing force, which had generated the great majority of the Company's life insurance sales. Upon completion of the Life Insurance Reorganization, it is anticipated that active marketing operations will recommence under American Founders and Aztec, although American Founders and Aztec will no longer be subsidiaries of the Company.\nAmerican Founders is domiciled in Texas and licensed in 38 states and the District of Columbia. American Founders has in force a variety of products, including its universal life, term, mortgage protection and annuity products. It continues to allow sale of these products through its general agents, however, it is not actively soliciting new business.\nAztec is domiciled in California and licensed in nine states. Aztec specialized in selling, primarily through a financial institution marketing force, mortgage protection life insurance products through leads generated by the mortgage lending activities of various financial institutions. Aztec's insurance operations ceased with the sale of its business to another insurer in December 1994.\nThe following table sets forth for the past three years certain information with respect to the Company's life insurance in force:\n(1) Includes a decrease related to the sale of Aztec's business of $1,453,000.\nThe following table sets forth for the past three years certain information with respect to the account values of the Company's deferred annuities.\nPRODUCTS\nAmerican Founders' portfolio consists of two broad categories of products: universal life (flexible premium, interest-bearing products) and term life (including annually renewable term products with annually increasing premiums, a level term product with level premiums for 10 or 12 years, and mortgage term life). American Founders also has in force a substantial amount of annuity policies including a block of deferred annuities acquired from another insurer in 1991.\nOn policies issued prior to October 1990, American Founders retained no more than $50,000 of risk on any one life. American Founders retains up to $250,000 per risk on policies issued after that date.\nCLAIMS\nThe Company's life insurance claims are processed by Company personnel. Most investigations are completed internally, although occasionally outside investigation firms are used in the claimant's locale.\nRESERVES\nThe Company's life insurance subsidiaries maintain policy reserves, which are balance sheet liabilities representing estimates of amounts needed to meet future obligations on its outstanding policies. These liabilities are computed using assumptions as to future investment yield, mortality and withdrawals, which assumptions include margins for adverse deviations. See Note 1 of Notes to Consolidated Financial Statements included elsewhere herein.\nREINSURANCE CEDED\nA reinsurance transaction takes place when an insurance company transfers, or cedes, a portion or all of its exposure on insurance directly written or assumed by it to another insurer, which assumes the exposure in return for a portion or all of the premium. Life insurance companies principally cede insurance to reduce net liability on individual risks or to maintain desired financial ratios. Reinsurance is effected under agreements, or treaties, where losses above a fixed point, or retention level, are reinsured. Reinsurance treaties are also utilized to acquire or dispose of blocks of business between insurers.\nFor a description of certain reinsurance transactions entered into by the Company's life insurance subsidiaries see Note 9 of Notes to Consolidated Financial Statements included elsewhere herein.\nGEOGRAPHICAL DISTRIBUTION\nIn 1995, 1994, and 1993 approximately the following percentages of the Company's direct premiums were written in the following states:\nNo other state accounted for in excess of 5%.\nThe reduction in 1995 direct premiums in California relates primarily to the sale of Aztec business as the majority of Aztec's premiums were in California.\nCOMPETITION\nThe life insurance business is highly competitive. Many of the insurers competing with the Company are substantially larger, have a greater number of agents and have considerably greater financial resources than the Company. The proposed life insurance reorganization (see Note 14 of Notes to Consolidated Financial Statements included elsewhere herein) will not immediately enhance the competitive position of the Company's life insurance operations, since neither the Company nor Circle has active distribution systems for life insurance products.\nREGULATION\nThe Company's life insurance subsidiaries are subject to regulation and supervision by the states in which they transact business. The state of domicile exercises principal regulatory supervision of insurance companies. The purpose of such regulation and supervision is primarily to provide safeguards for policyholders rather than to protect the interests of stockholders. The states have established regulatory agencies with broad administrative powers to regulate, among other things: licenses to transact business; policy forms; trade practices; premium and commission rates; agency agreements; deposit of securities for the benefit of policyholders; form and content of financial statements; accounting practices; maintenance of reserves and capital for the protection of policyholders; dividends; examinations of insurers' affairs; and investments. The relationships among the Parent Company and its insurance subsidiaries is also subject to regulations under state insurance holding company laws. Under these laws, inter-company asset transfers, investments and other transactions, as well as dividends from insurance companies, may be subject to prior notice to, or approval by, the state insurance regulatory authority, depending upon the size of such transaction or dividend.\nFor a description of certain restrictions placed upon the dividend-paying capability of the Company's insurance subsidiaries by applicable laws, see \"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.\"\nUnder insolvency or guaranty laws in most states in which the Company operates, insurers doing business in those states can be assessed up to prescribed limits for policyholder losses by other companies that become insolvent. Under these laws, the extent of any future assessments against the Company is not determinable. However, most laws do provide that an assessment may be excused or deferred if it would threaten a solvent insurer's financial strength.\nThe National Association of Insurance Commissioners (the \"NAIC\") reviews the financial statements filed by insurance companies against certain ratios and provides the results to the insurance departments of the various states. Insurance companies with a sufficient number of ratios outside the NAIC's \"normal ranges\" are given priority ratings indicating the amount of regulatory review required. American Founders was designated as \"third priority\" in 1994. The Company has completed a preliminary calculation of the 1995 ratios which indicate \"third priority\" status would be retained. Given the decrease in the trading price of Wickes common stock during 1995 and its impact on statutory capital and surplus it is possible the NAIC may assign a higher priority status to American Founders.\nRegulatory concerns over solvency, asset diversification and asset quality have increased significantly in recent years. A number of legislative proposals have been made, at both state and federal levels, in response to these concerns. The NAIC and the Texas Department of Insurance adopted recommended levels of \"risk-based\" capital for life insurers, determined by the application of a formula that evaluates a company's capital and surplus based on various perceived risk factors related to asset type and quality, interest rate exposure, kinds and amount of insurance written and other business risks. All of the Company's life insurance companies exceed the NAIC recommended and Texas mandated levels.\nINVESTMENTS\nThe investments of the Company's life insurance subsidiaries are managed under the supervision of their respective boards of directors. Investments are subject to the statutory requirements of the states of domicile of the Company's subsidiaries and the terms of the Company's bank loan agreement.\nThe investments of the Company's insurance subsidiaries consist primarily of publicly-traded bonds, mortgage and construction loans, policy loans, real estate and short-term securities. The investment emphasis is on maximizing total portfolio return to the extent consistent with applicable regulations and maintenance of prudent portfolio quality, diversity, maturity, liquidity and income tax consequences. The investment make-up of the portfolio has been altered from time to time to respond to anticipated changes in insurance underwriting results, as well as in response to market conditions and fluctuations in interest rates. Effective December 31, 1993, the Company adopted Statement of Financial Accounting Standards No. 115 (\"SFAS 115\") \"Accounting for Certain Investments in Debt and Equity Securities.\" For a discussion of the impact of SFAS 115 see \"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations--Investment Operations.\"\nThe following table summarizes the investment results of the Company's insurance subsidiaries for the past three years.\nThe following table sets forth the classification and carrying value of the investments of the Company's insurance subsidiaries at the end of each of the past two years.\n(1) Fixed maturities as of December 31, 1995 and 1994 were all classified as available for sale.\nBased upon the ratings of Standard & Poor's Corporation, as of December 31, 1995, the quality distribution of the Company's fixed maturities was: U.S. Treasury and AAA - 38.2%; AA - 9.1%; A - 36.0%; BBB - 10.6%; BB-5.8%; and non-rated - .3%.\nAs of December 31, 1995, the Company held $43.8 million of securities backed by mortgages and other assets (\"Structured Securities\") which represented 30% of the Company's fixed maturities. These securities were composed of the following types:\nThe structured securities portfolio did not include any interest-only, principal-only, or inverse floating CMOs, nor any residual interests in CMOs. Management is of the opinion that the Structured Securities owned by the Company have good liquidity in readily available markets and were all rated investment grade, with 81% rated AAA by Moody's Investors Service or Standard & Poor's Corporation. The effective yield to maturity on the Structured Securities portfolio as of December 31, 1995 was 7.6%. The impact of interest rate trends on income derived from mortgage-backed securities did not materially affect investment operations during 1995 or 1994. Given present interest rate environments the Company does not anticipate any material changes in income during 1996. The\nCompany's philosophy has been and continues to be to invest in conservative, high quality assets which are not subject to the excessive volatility associated with other forms of mortgage-backed assets.\nThe following table sets forth maturities of the fixed-maturity investments as of the end of each of the past two years.\nIn 1995, the Company opened two mortgage lending offices and began, on a test basis, marketing construction and permanent mortgage loans to the professional builder customers of Wickes as well as the customers of these builders. As of December 31, 1995, included in mortgage and construction loans were $818,000 of permanent loans, which are held for sale to investors under existing agreements, and $3,372,000 in construction loans generated by these offices .\nIn addition, the undrawn amount of construction loans committed at December 31, 1995, totaled $2,469,000. The Company's commitment to fund the undrawn balance is contingent upon the borrowers successful completion of certain specified conditions. Approximately 95% of the total construction loans outstanding were made with respect to homes for which no purchase agreements existed.\nFor further information concerning the Company's investments, see Note 5 of Notes to Consolidated Financial Statements included elsewhere herein.\nDISCONTINUED OPERATIONS\nThe Company conducted property and casualty insurance operations beginning in 1986 through its wholly-owned subsidiary, Dependable, which was domiciled in Florida and licensed to conduct business in 47 states and in the District of Columbia. In 1993 and prior years, Dependable wrote a significant amount of credit-related (principally, collateral protection) insurance for financial institutions. Dependable also wrote certain other specialty lines of insurance including homeowners and commercial lines.\nAs a result of Hurricane Andrew in August 1992, the Company determined to discontinue property and casualty operations. After Hurricane Andrew, Dependable ceased writing new business and, in a series of transactions effected throughout 1993, Dependable disposed of substantially all of its in force business. On September 15, 1995, Riverside completed the sale of Dependable to MedMarc Insurance Company (\"MedMarc\") in a transaction that resulted in a gain of approximately $2.7 million. In connection with the sale, the Company agreed to indemnify MedMarc for certain losses on various categories of liabilities. Terms of the indemnities provided by the Company vary in regards to time limits and maximum amounts. The Company believes that these indemnities will not have a material adverse\neffect on the Company's financial position, results of operations or cash flows. See Note 3 of Notes to Consolidated Financial Statements included elsewhere herein.\nThe following table sets forth for the past three years certain information concerning the results of the Company's property and casualty operations.\n(1) 1994 net incurred losses included net claims of $3.5 million from unusually adverse loss experience on discontinued commercial lines.\n(2) GAAP Underwriting and operating expenses as a percentage of earned premiums.\nEMPLOYEES\nAt December 31, 1995, the Company had 57 full-time employees (excluding those of Wickes). As of February 29, 1996, Wickes had approximately 3,615 employees, of whom 3,011 were employed on a full-time basis. The Company believes that it has maintained favorable relations with its employees. None of Riverside's or Wickes' employees is represented by a union or covered by a collective bargaining agreement.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company leases 15,662 square feet of office space in Jacksonville, Florida, for its executive offices, under a lease expiring in 1997, with an option for one to five additional years. In addition, the Company leases 16,000 square feet of office space in Phoenix, Arizona, for its life insurance operations under a lease expiring in 1997 with an option for two additional years. Circle would assume full responsibility for the leased office space in Phoenix, Arizona upon completion of the Life Insurance Reorganization.\nWickes owns eleven component manufacturing facilities, 98 of its building centers and 94 of the sites on which such building centers are located. The remaining twelve building centers and 16 sites are leased. As of December 30, 1995, Wickes also held for sale the assets of 16 closed building centers with an aggregate book value of $4.9 million.\nWickes also owns and leases a large fleet of trucks and other vehicles, including vehicles specialized for the delivery of certain of Wickes' products.\nWickes owns its corporate headquarters, located at 706 North Deerpath Drive in Vernon Hills, Illinois.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nOn or about August 11, 1993, FynSyn Capital Corp. (\"FynSyn\") and a related entity, WLIP, sold an aggregate of 260,760 shares of Wickes' common stock, an option to acquire 374,516 additional shares of Wickes' common stock and 10.33 shares of Wickes' 9% redeemable preferred stock to Riverside. In connection with this sale, FynSyn stated that it was unable to locate the stock certificate representing the preferred stock and executed and delivered to Wickes an affidavit of loss and indemnity agreement, in reliance on which Wickes issued a replacement stock certificate to FynSyn, which was delivered to the Company upon completion of the sale. The 10.33 preferred shares were converted into approximately 103,922 shares of Wickes common stock as part of Wickes' plan of recapitalization completed on October 22, 1993. In February 1994, a third party informed Wickes that FynSyn had previously transferred the 10.33 preferred shares to the third party in 1989. In July 1994, FynSyn and WLIP commenced an action in Superior Court of New Jersey, Essex County, Chancery Division, styled FynSyn Capital Corporation and Wickes Lumber Investment Partnership vs. Bankers Trust Company, et al. FynSyn and WLIP are seeking, among other things, rescission of the affidavit of loss and indemnity agreement and the rescission or reformation of the terms of the sale of all of their Wickes securities to Riverside. In 1995, this action was removed to the United States District Court for the District of New Jersey. Riverside and Wickes have answered the complaint in this action and counterclaimed seeking, among other things, indemnity and enforcement of their contractual rights. Wickes has also sought declaratory relief as to the respective rights and liabilities of Wickes and Riverside, as well as FynSyn and the third party related to and as a consequence of these matters and seeking indemnity from FynSyn. Riverside and Wickes intend to pursue vigorously their respective rights against FynSyn, WLIP and related parties, and Riverside intends to defend vigorously the claims of FynSyn and WLIP.\nOn November 3, 1995, a complaint styled Wolfson v. Riverside Group, Inc., et al., was filed in the Court of Chancery of the State of Delaware in and for New Castle County (C.A. No. 14678). As amended, this complaint alleges, among other things, that the transaction contemplated by the Wickes Agreement is unfair and constitutes a waste of Wickes' assets and that Wickes and Riverside breached their fiduciary duties in their approval of this transaction. The amended complaint, among other things, seeks on behalf of a purported class of the Company's shareholders to enjoin, or to obtain damages with respect to, the transaction. See \"Item 1. Business - HISTORICAL DEVELOPMENT - Proposed Transactions - Wickes Investment.\"\nWickes is one of many defendants in 164 actions, each of which seek unspecified damages, brought in 1993, 1994 and 1995 in various Michigan state courts against manufacturers and building material retailers by individuals who claim to have suffered injuries from products containing asbestos. All of the plaintiffs in these actions are represented by the same counsel. Wickes is aggressively defending these actions and does not believe that these actions will have material adverse effect on Wickes.\nAs is common in the insurance industry, the Company's insurance subsidiaries are regularly engaged in the defense of claims arising out of the conduct of the insurance business. In management's opinion, none of these claims will have a material adverse effect on the Company's financial position, results of operations or cash flows.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS.\nNone.\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nThe Company's common stock trades over-the-counter and is quoted on the NASDAQ National Market System under the trading symbol \"RSGI.\" As of March 24, 1996, there were 5,311,123 shares outstanding held by approximately 1,872 stockholders of record.\nThe following table sets forth, for the periods indicated, the high and low sale prices for the Company's common stock as reported on the NASDAQ National Market System. Prices do not include retail markups, markdowns or commissions.\nThe Company did not pay cash dividends on its common stock during the last three fiscal years and anticipates that for the foreseeable future it will not pay any cash dividends on its common stock. Payment of dividends in the future is subject to the discretion of the Board of Directors of the Company and is dependent upon the Company's overall financial condition, capital requirements, compliance with regulatory and contractual requirements, earnings, and such other factors as the Board of Directors may deem relevant.\nAs a holding company, the Company is dependent on dividends from its subsidiaries to pay cash dividends to its stockholders. The Company's insurance subsidiaries are subject to state insurance laws that restrict their ability to pay dividends. In addition, AFAC's bank loan agreement restricts transfers of funds to the Parent Company. For a description of these and other restrictions on cash dividends see \"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.\"\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following summary of certain consolidated financial data of the Company is derived from the Company's Consolidated Financial Statements included elsewhere herein and should be read in conjunction with those financial statements and notes thereto and \"Item 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nThe following discussion should be read in conjunction with the Consolidated Financial Statements and Notes thereto contained elsewhere herein.\nLIQUIDITY AND CAPITAL RESOURCES\nTHE PARENT COMPANY\nThe liquidity requirements of the Parent Company consist primarily of providing funds for payment of debt and related interest, and for operating expenses.\nThe funds available to the Parent Company from operating sources continue to be limited. Pending the completion of the proposed Life Insurance Reorganization (see \"Item 1. Business - HISTORICAL DEVELOPMENT - Proposed Transactions Life Insurance Reorganization\"), sources of funds available to the Parent Company include: management fees and expense reimbursements for services provided to the Company's subsidiaries; funds that may be generated from the sale of unrestricted assets; and intercompany advances from AFAC. The Company anticipates that these sources, together with cash on hand, will be adequate to meet the Company's liquidity needs through late June 1996, by which time the Company expects to have completed the Life Insurance Reorganization.\nThe Company anticipates that the net after-tax cash proceeds of the Life Insurance Reorganization will be approximately $14 million, of which the Company has agreed to utilize $10 million under the Wickes Agreement to acquire an additional two million shares of Wickes Common Stock. See \"Item 1. Business - HISTORICAL DEVELOPMENT - Proposed Transactions - Wickes Investment.\" The Company anticipates that its funds on hand after completion of this investment in Wickes, together with its other sources of funds, will be adequate for the Company's liquidity requirements at least through the second quarter of 1997. In recent years the Company has realized a significant portion of its liquidity requirements through expense reimbursements and other distributions from its insurance subsidiaries. Following completion of the Life Insurance Reorganization these sources of funds will no longer be available. The Company's remaining operations, exclusive of Wickes (which is currently prohibited from paying dividends by reason of restrictions in its debt instruments), will consist primarily of the disposition of certain real estate and the operations of WFSC and the Company's mortgage lending operations, both of which are in the start-up phase and are anticipated to produce significant negative cash flows at least through 1996. The Company will continue to evaluate the prospects and anticipated future cash requirements and contributions of these operations.\nShould the Company not complete the Life Insurance Reorganization or comparable transaction by September 30, in order for the Company to maintain adequate liquidity and to meet the scheduled payments of principal and interest on its indebtedness, the Company would be required to obtain an extension of currently scheduled principal and interest payments, obtain additional financing or sell a\nsignificant amount of assets held by the Parent Company and to use the proceeds for Parent Company purposes, which would require the consent of the Company's current bank lenders. The Company believes that should the Circle Agreement for any reason, be terminated the Company would be able to enter into a definitive agreement for a comparable transaction in a reasonable time-frame. Although the Company believes it will complete the Life Insurance Reorganization by late June 1996, there can be no assurance that the Company will continue to have funds sufficient for its needs if the closing of the Life Insurance Reorganization or comparable transaction does not occur or occurs significantly later than expected.\nAs a result of the decrease during 1995 in the trading value of Wickes and the charges taken in the fourth quarter of 1995 related to the Life Insurance Reorganization, a waiver of certain requirements of the Company's bank credit agreement has been provided and is in the process of being extended. The Company anticipates that this waiver will remain in effect until late June 1996, to allow for completion of the Life Insurance Reorganization. Under the terms of the Life Insurance Reorganization all indebtedness under the Company's bank credit agreement is to be repaid in full by Circle. Circle has informed the Company that it believes, based upon discussions with lenders interested in providing loans to Circle, that it will be able to obtain financing sufficient to retire the Company's bank indebtedness. For a description of the terms of, and certain covenants and restrictions placed upon the Company and AFAC by the Company's bank credit agreement, see Note 6 of Notes to Consolidated Financial Statements included elsewhere herein.\nIn addition, the $10 million principal amount of the Company's 13% subordinated notes (the \"13% Notes\") is payable in September 1999. The Company anticipates that in order to repay this principal amount, the Company may need to obtain additional funds through borrowings, issuance of debt or equity securities or sale of assets held by the Parent Company (such as shares of Wickes common stock).\nDuring 1995 and early 1996, material transactions also affecting liquidity are:\n- In February 1995, the Parent Company received $600,000 in connection with the settlement of a dispute with respect to a financing proposal to the Company in late 1992.\n- In August 1995, AFAC advanced to the Parent Company the proceeds of a $1.0 million bridge loan facility it received under an amendment to the Company's bank credit agreement. This advance supplied part of the funds used to exercise the Wickes option.\n- In February, April and June of 1995 the Company advanced Wilson Financial Corporation (\"Wilson Financial\"), the Company's controlling stockholder, an aggregate of $900,000, and Wilson Financial granted the Company an option to acquire (at exercise prices ranging from $5.88 to $6.31 per share) the number of shares of the Company's common stock equal to the amount of such advance and related interest divided by the exercise price. Effective June 30, 1995, the Company elected to exercise this option, acquiring 150,680 shares of its common stock by canceling $918,310 of advances and related interest. In addition the Company purchased from Wilson Financial 23,000 shares of its common stock for an aggregate price of $125,235 in October 1995 and 27,778 common shares for an aggregate price of $125,000 in November of 1995.\n- On August 14, 1995, the Company exercised its option from Wickes Lumber Investment Partnership to purchase 374,516 shares of Wickes common stock at an aggregate price of $2.3 million. In connection with the option exercise the Company repaid in full a promissory note issued to Fynsyn Capital Corp. of $1.1 million.\n- In September 1995, the Company completed the sale of Dependable Insurance Company to MedMarc Insurance Company. Cash generated by the sale net of debt repayments and holdback of funds by the buyer pending further resolution of uncertainties was minimal.\nSee Note 13 of Notes to Consolidated Financial Statements included elsewhere herein for a description of litigation seeking, among other things, rescission of the transaction in which Riverside acquired for approximately $6.5 million an aggregate of 739,198 shares of Wickes common stock.\nDuring 1995, stockholders' equity decreased by a net of $2.7 million due to the losses sustained by Wickes and charges related to the Life Insurance Reorganization which were partially offset by changes in the market value of the Company's invested assets. The ratio of the Company's consolidated total recourse debt to stockholders' equity increased from 113% at December 31, 1994, to 120% at December 31, 1995, as a result of the decline in stockholder's equity.\nAFAC\nAFAC's liquidity requirements consist primarily of funds required to repay debt and related interest under the Company's bank credit agreement. See \"The Parent Company.\"\nSources of funds available to AFAC consist of surplus note payments from Laurel Life Insurance Company (\"Laurel\"). Laurel receives dividends from its American Founders subsidiary. In general, Texas statutes limit the amount of dividends American Founders may pay in any year to the greater of prior year's statutory net gain from operations after income taxes or 10% of statutory capital and surplus without state approval. For 1996, American Founders is eligible to pay dividends in excess of the Company's debt service requirements without state approval.\nINSURANCE SUBSIDIARIES\nGeneral. During 1995, approximately $26.7 million of cash was used by consolidated operating activities, including deposits and withdrawals of policyholders funds principally as the result of annuity surrenders and payment of death benefits.\nLife Insurance Subsidiaries. The Company's investment portfolio is highly liquid, consisting predominately of readily marketable securities. The Company does not expect any material changes in its cash requirements and is not aware of any trends, events or uncertainties that are reasonably likely to have a material effect on life operations' liquidity.\nRESULTS OF OPERATIONS\nGENERAL\nThe Company reported results of operations for the years ended December 31, 1995, 1994 and 1993 as follows:\n- --------------------------\n(1) Includes net realized investment gains (losses) of ($234,000), ($182,000) and $4,147,000 in 1995, 1994 and 1993, respectively. 1995 includes other income of $600,000 related to the settlement of a disputed financing proposal. 1994 includes other income of $558,000 from the sale of the Company's 13% subordinated notes and a gain on sale of a former subsidiary to Wickes of $613,000. (See Note 12 of Notes to the Consolidated Financial Statements included elsewhere herein.) Includes equity in earnings (loss), net of tax, of Wickes of ($5,849,000), $8,274,000 and $1,525,000 for 1995, 1994 and 1993 respectively. The Company's equity in Wickes earnings (losses) include losses of ($3.8) million related to restructuring charges incurred in 1995 and $4.2 million of tax benefits related to reversal of a deferred tax valuation allowance established in a prior year in 1994.\n(2) Charge primarily reflects the write off of intangible assets of ($10,790,000) and income tax benefits of $1,910,000.\n(3) Includes realized investment gains of $31,000, $91,000 and $7,651,000 in 1995, 1994 and 1993, respectively. 1995 includes a gain on disposal of discontinued property and casualty lines of $2,731,000. 1994 includes $3,500,000 of incurred losses, net of reinsurance, due to unusually adverse loss experience on commercial lines runoff. 1993 includes pre-tax catastrophe losses of $3,200,000 from the severe winter storm of March 1993 and gains resulting from sale of blocks of business of $2,400,000.\n(4) See Note 5 of Notes to Consolidated Financial Statements included elsewhere herein.\nQUARTERLY RESULTS AND SEASONALITY\nAlthough the Company's results historically have not been affected significantly by seasonal factors, the Company's equity investment in Wickes' results can be expected to fluctuate from period to period. Wickes' operations are adversely affected by the weather patterns in the markets in which it operates, which result in decreased levels of construction activity and lower sales historically in the first quarter and frequently, in the fourth quarter. The extent of such decreases in activity is a function of the severity of winter conditions.\nWICKES LUMBER COMPANY\nThe following table provides comparative Wickes total operating statement data and the Company's equity in net income (loss) of Wickes:\nNET SALES\nWickes net sales for 1995 decreased $14.3 million, or 1.4%, compared to 1994. The 1994 fiscal year consisted of 53 weeks compared to 52 weeks in 1995. After adjusting for the additional week in 1994, Wickes net sales decreased only $.3 million in 1995. Sales for all facilities operating throughout both years decreased 3.8%, 2.1% after adjusting for the additional week in 1994.\nIn 1995 deflation in lumber prices, of approximately 18%, accounted for an estimated $45 million in lost sales. Housing starts declined in Wickes' primary markets, the Midwest and Northeast, by approximately 12% and 15%, respectively, which also adversely affected sales in 1995. While Wickes added seven new building centers through acquisition and expansion in 1995, it closed or consolidated 26 other building centers (sixteen of these occurred at year-end 1995).\nNet sales increased $140.1 million, or 16.5%, in 1994 compared to 1993. The additional week in fiscal 1994 accounted for $14 million of additional sales. The acquisition of ten building centers and three component manufacturing facilities in 1994 contributed $24 million of additional sales. Same store sales in 1994 increased 14% over 1993 due to increased prices on wood products, increased housing starts and favorable weather during the fourth quarter which kept sales strong through year-end and offset the impact of severe weather during the first quarter of 1994.\nGROSS PROFITS\nGross profit decreased $13 million to 22.7% of net sales in 1995 compared with 23.7% of net sales in 1994. Wickes estimates that deflation in lumber prices caused $7.6 million of the decrease and that the additional week of sales in 1994 contributed approximately $3.3 million of additional gross profit in 1994.\nWickes' continued emphasis on sales to professional builders and the resulting increased sales of lower margin wood products also contributed to the change in 1995. Wickes believes that approximately 50% of the decrease in gross profit percentage is the result of the shift in customer mix from 22% consumer and 78% professional in 1994 to 18% consumer and 82% professional in 1995.\nIn 1994 gross profit decreased to 23.7% of net sales compared to 24.4% of net sales for 1993. Approximately 66% of the decrease in gross profit percentage for 1994 resulted from the shift in customer mix to emphasize the professional builder.\nNET INCOME\nNet income for Wickes decreased to a loss of $15.6 million in 1995 compared with $28.1 million in income for 1994, a change of $43.7 million. The primary components of the decrease include an increase in restructuring and unusual items of $15.8 million, a decrease in gross profit dollars of $13.0 million, an increase in selling, general and administrative (\"S, G & A\") expenses of $4.1 million, increased losses of Wickes' Russian operations of $3.1 million and an increase in interest expense of $2.7 million. Wickes also recorded a lower tax benefit in 1995 compared with 1994, increased depreciation and amortization expenses. In the fourth quarter of 1994 Wickes recorded a $1.2 million one-time gain on the sale of its private label credit card portfolio.\nThe increased restructuring and unusual items charges in 1995 results from Wickes plan to reduce the number of under-performing building centers, the corresponding overhead to support these building centers and to strengthen its capital structure. Wickes anticipates completion of this plan in 1996 and has recorded a $17.8 million charge related to this strategic restructuring plan. In 1994 Wickes incurred restructuring charges of $2 million primarily as a result of its headquarters cost reduction plan.\nNet income increased to $28.1 million in 1994 compared to $8.2 million in 1993. A deferred tax benefit of $14.4 million was recorded due to the reversal of a deferred tax valuation allowance established in a prior year. Other major contributors to the 1994 increase included the increased level of sales, reduced S, G & A expenses as a percentage of sales, reduced trademark amortization and increased other operating income, partially offset by decreased gross profit as a percentage of sales, restructuring and unusual charges and increased interest expense. In 1993 Wickes recorded a one-time extraordinary gain of $1.2 million as a result of its 1993 recapitalization plan.\nLIFE INSURANCE OPERATIONS\nOPERATING RESULTS\nThe following table sets forth comparative information with respect to the Company's life insurance operations.\nThe decrease in premiums and annuity considerations in 1995 resulted primarily from the sale of Aztec in December 1994. Decreases in 1994 relate to reductions in traditional premium writings.\nBenefits and losses decreased in 1995 due to the sale of the Aztec business. This decrease was partially offset during 1995 by higher death benefits and reserve increases. Benefits and losses decreased during 1994 as a result of reduced interest crediting rates on the Company's annuities and lower death benefits.\nPolicy acquisition expenses were lower in 1995 compared to 1994 due to the reduction in the underlying assets as a result of amounts written off at year-end 1994 and lower commission expenses in 1995 related to the sale of the inforce business of Aztec. Policy acquisition costs were lower in 1994 compared to 1993 due to decreased amortization of deferred acquisition costs as a result of a change in the emergence of gross profits on interest sensitive products.\nThe Company estimates the December 1994, sale of the Aztec business generated a decrease in pre-tax profits of the life insurance operations of $2.5 million in 1995 compared to 1994.\nINVESTMENT RESULTS\nDecreases in investment income for all years presented result from lower average invested assets and lower investment yields (See \"Investment Operations\").\nOPERATING COSTS AND INTEREST EXPENSE\nOther operating costs and expenses were $5,221,000, $8,076,000, and $15,174,000 in 1995, 1994 and 1993, respectively. Decreased operating expenses in 1995 are due to reduced lease expenses, data processing expense savings, expense reimbursements from third parties for administrative services and staff reductions. Operating expenses decreased significantly in 1994 through savings realized by staff related and other expense reductions in the life insurance subsidiaries. In 1993, cost reductions resulting from life insurance staff reductions were more than offset by a $3.6 million write-off of the excess of cost over fair value of net assets acquired for certain life operations determined to be unrecoverable.\nInterest expense for 1995, 1994 and 1993 was $3,280,000 $2,883,000, and $3,245,000, respectively. The increase in interest expense between 1995 and 1994 results principally from the increased indebtedness of AFAC incurred in April 1994 and from higher interest rates. The decreases in interest expense between 1994 and 1993 result from paydowns of debt and lower interest rates.\nINVESTMENT OPERATIONS\nInvestment operations include all invested assets of the life insurance subsidiaries and the Parent Company. Investment income, net of investment expenses, declined 17% from 1994 to 1995 and 15% from 1993 to 1994 as a result of reduced invested assets and lower investment yields as discussed below.\nAnnualized investment yields on average invested assets were 5.9% in 1995 compared to 6.2% and 6.7% in 1994 and 1993, respectively. The decrease in yields in 1995 and 1994 is primarily due to: (i) the lower yields on funds reinvested in fixed maturities and mortgages, and (ii) loss on real estate assets. Included in net investment income for 1995, 1994 and 1993 were ($316,000), ($353,000), and $668,000, of net real estate income (expenses) respectively.\nNet realized investment gains (losses) for 1995, 1994 and 1993 were ($234,000), ($182,000), and $4,147,000 respectively. Net realized investment losses for 1995 include losses of $1.5 million incurred to write down the entire carrying value of securities of The Atlantic Group, Inc. (\"Atlantic\"). Directors of the Company beneficially own approximately 75% of Atlantic. On December 31, 1993 as a result of adopting SFAS 115, management segregated certain of the life insurance companies investments in fixed maturities into a separate trading portfolio (Fixed maturities actively managed). These investments were held with the objective of generating incremental returns over those of other alternative fixed income investments within the succeeding year. These investments were liquidated in 1994. Principally as a result of rising interest rates during the first half of 1994, losses realized on the trading portfolio were ($883,000), (($583,000) net of taxes) and partially offset the $903,000 ($596,000 net of taxes) of gains recorded on the trading portfolio in 1993. The gains on the trading portfolio for 1993, net of taxes, are recorded in the consolidated statements of operations as a cumulative effect of change in accounting principles. See Note 5 of Notes to Consolidated Financial Statements included elsewhere herein for further discussion of the investment portfolio.\nMortgage and construction loans on real estate include 162 residential loans aggregating approximately 27% of the dollar value of the Company's mortgage loan portfolio. Of the total residential loans, the Company's mortgage lending operations accounted for five permanent mortgage loans (3% of mortgage portfolio total), which are held for resale to investors under existing agreements, and 34 construction financing loans (13% of mortgage portfolio total). In addition, 48 commercial mortgage loans comprised 73% of the dollar value of the mortgage loan portfolio. As of December 31, 1995 delinquencies were approximately 1% of the mortgage loan portfolio amount.\nThe Company has $6,008,000 of its investment in real estate in Florida properties, $11,799,000 in Georgia properties, and $72,000 in other states.\nDISCONTINUED OPERATIONS\nDiscontinued operations include the Company's property and casualty insurance and mortgage servicing operations.\nDuring 1993, the Company sold or canceled virtually all of its remaining in force property and casualty business. On September 15, 1995, the Company completed the sale of Dependable to Medmarc. The Company realized a gain upon disposal of these operations of $2.7 million, including an additional payment to be received in 1996 of $.2 million for the acquisition of certain tax benefits by MedMarc. Under terms of the sale the Company provided indemnification for certain losses on various categories of liabilities. Terms of the indemnities provided by the Company vary in regards to time limits and maximum amounts. The Company believes that these indemnities will not have a material adverse effect on the Company's financial position, results of operations or cash flows.\nThe following table sets forth comparative information concerning the results of the Company's property and casualty operations.\nDuring 1994, Dependable incurred $3.5 million of net losses from unusually adverse loss experience on its discontinued commercial lines of business. Included in net income (loss) for 1994 is $700,000 in gains related to reinsurance transactions.\nIncluded in net loss from discontinued operations for 1993 is approximately $2.4 million of gains resulting from Dependable's sale of several blocks of business. Also in 1993, Dependable incurred claims, net of reinsurance, of $3.2 million pre-tax as a result of damage from the severe winter storm of March 1993.\nRealized gains on sales of Dependable's investments included in discontinued operations were $31,000, $91,000, and $7,651,000 in 1995, 1994 and 1993, respectively.\nIncluded in net loss from discontinued operations is a net loss for 1993 of $4,113,000 for mortgage servicing operations. This loss resulted primarily from accelerated amortization of purchase mortgage servicing rights. On January 3, 1994, the Company sold these operations for their approximate book value.\nINCOME TAXES\nThe Company's effective income tax rate was 10% in 1995, 25% in 1994 and 13% in 1993. The low effective tax rate for 1995 is due to the inability to fully utilize losses realized on the life insurance reorganization for tax purposes. The low effective tax rate for 1994 and 1993 is due to the recognition of deferred tax assets arising from recapture of tax loss carryforwards.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nFinancial statements of the Company are set forth herein beginning on page.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nInformation required by this Item is incorporated herein by reference from the definitive proxy statement to be filed in connection with the Company's Annual Meeting of Stockholders tentatively scheduled to be held in May 20, 1996.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation required by this Item is incorporated herein by reference from the definitive proxy statement to be filed in connection with the Company's Annual Meeting of Stockholders tentatively scheduled to be held in May 20, 1996.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nInformation required by this Item is incorporated herein by reference from the definitive proxy statement to be filed in connection with the Company's Annual Meeting of Stockholders tentatively scheduled to be held in May 20, 1996.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nInformation required by this Item is incorporated herein by reference from the definitive proxy statement to be filed in connection with the Company's Annual Meeting of Stockholders tentatively scheduled to be held in May 20, 1996.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM-8-K.\n(a) LIST OF FINANCIAL STATEMENTS AND SCHEDULES FILED AS A PART OF THIS REPORT:\n(1) FINANCIAL STATEMENTS:\nRIVERSIDE GROUP, INC. AND SUBSIDIARIES:\nReport of Independent Accountants F - 1\nConsolidated Balance Sheets as of December 31, 1995 and 1994 F - 2\nConsolidated Statements of Operations for the years ended December 31, 1995, 1994 and 1993 F - 3\nConsolidated Statement of Common Stockholders' Equity for the years ended December 31, 1995, 1994 and 1993 F - 4\nConsolidated Statements of Cash Flows for the years ended December 31, 1995, 1994 and 1993 F - 5\nNotes to Consolidated Financial Statements F - 6\nWICKES LUMBER COMPANY AND SUBSIDIARIES:\nReport of Independent Accountants WF - 1\nConsolidated Balance Sheets as of December 30, 1995 and December 31, 1994 WF - 2\nConsolidated Statement of Operations for the years ended December 30, 1995, December 31, 1994 and December 25, 1993 WF - 3\nConsolidated Statements of Changes in Stockholders' Equity (deficit) for the years ended December 30, 1995, December 31, 1994 and December 25, 1993 WF - 4\nConsolidated Statements of Cash Flows for the years ended December 31, 1995, December 25, 1994 and December 26, 1993 WF - 5\nNotes to Consolidated Financial Statements WF - 6\n(2) FINANCIAL STATEMENT SCHEDULES:\nRIVERSIDE GROUP, INC. AND SUBSIDIARIES:\nReport of Independent Accountants S - 1\nSchedule I - Summary of Investments Other Than Investments in Related Parties S - 2\nSchedule II - Condensed Financial Information of Registrant S - 3\nSchedule III - Supplementary Insurance Information S - 6\nSchedule IV - Reinsurance S - 7\nWICKES LUMBER COMPANY AND SUBSIDIARIES:\nSchedule II - Valuation and Qualifying Accounts WS - 1\n(B) REPORTS ON FORM 8-K\nOn January 23, 1996, the Company filed a current report Form 8-K in regards to the signing of the Wickes Agreement, reporting under Item 5. Other Events.\n(C) EXHIBITS\n3.01 Restated Articles of Incorporation, as amended to date (previously filed as Exhibit 3.01 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994).\n3.02 Amended and Restated Bylaws, as amended to date (previously filed as Exhibit 3.02 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994):\n10.01 Form of Incentive Stock Option Agreement (previously filed as Exhibit 10.17(b) to the Company's Annual Report on Form 10-K for the year ended December 31, 1992).\n10.02 Form of Non-qualified Stock Option Agreement Sequential (previously filed as Exhibit 10.18 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992).\n10.03 Agreement, dated as of July 23, 1993, among FynSyn Capital Corp., W. Lumber Investment Partnership, Riverside Group, Inc. and American Financial Acquisition Corporation (previously filed as Exhibit 10.9 to the Company's Quarterly Report on Form 10-Q for the period ended June 30, 1993). Report on Form 10-Q for the period ended June 30, 1994).\n10.04 Settlement Agreement, dated as of August 11, 1993, among FynSyn Capital Corp., W. Lumber Investment Partnership, Riverside Group, Inc. and Arthur M. Goldberg (previously filed as Exhibit 10.10 to the Company's Quarterly Report on Form 10-Q for the period ended June 30, 1993).\n10.05 Agreement made as of September 20, 1993, among Riverside Group, Inc., American Financial Acquisition Corporation, Wickes Lumber Company and Bankers Trust (Delaware) (previously filed as Exhibit 10.19 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993).\n10.06 Plan of Recapitalization dated April 20, 1994 among the Company, Wilson\nFinancial Corporation and J. Steven Wilson (previously filed as Exhibit 10.01 to the Company's Quarterly Report on Form 10-Q for the period ended March 31, 1994).\n10.07 Agreement entered into as of February 28, 1995, between Wilson Financial Corporation and the Company (previously filed as Exhibit 10.08 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994).\n10.08* Agreement entered into as of April 30, 1995, between Wilson Financial Corporation and the Company.\n10.09* Agreement entered into as of June 1, 1995, between Wilson Financial Corporation and the Company.\n10.10 Stock Purchase Agreement dated January 11, 1996, between Riverside Group, Inc. and Wickes Lumber Company (previously filed as Exhibit 99.1 to the Company's Current Report on Form 8-K dated January 23, 1996.)\n10.11* Merger Agreement dated March 8, 1996 between American Financial Acquisition Corporation and Circle Investors, Inc.\n10.12* Employment Agreement between the Company and J. Steven Wilson dated March 26, 1996.\n21.01* Subsidiaries of the Company.\n23.01* Consent of Coopers & Lybrand L.L.P.\n27* Financial Data Schedule\nThere have been omitted certain instruments with respect to long-term debt not in excess of 10% of the consolidated total assets of the Company. The Company agrees to furnish copies of any such instruments to the Commission upon request.\n- ----------------- * Filed herewith 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.\nRIVERSIDE GROUP, INC.\n\/s\/ J. Steven Wilson ----------------------- J. Steven Wilson Chairman of the Board, President and Chief Executive Officer\nDated: March 30, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, 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\/ J. Steven Wilson \/s\/ Edward M. Carey, Sr. J. Steven Wilson Edward M. Carey, Sr. Principal Executive Officer Director, March 30, 1996 and Director, March 30, 1996\n\/s\/ Frederick H. Schultz \/s\/ Kenneth M. Kirschner Frederick H. Schultz Kenneth M. Kirschner Director, March 30, 1996 Director, March 30, 1996\n\/s\/ C. Herman Terry \/s\/ Varina M. Steuert C. Herman Terry Varina M. Steuert Director, March 30, 1996 Director, March 30, 1996\n\/s\/ Wayne A. Schreck Wayne A. Schreck Executive Vice President (Principal Accounting and Financial Officer), March 30, 1996\nMarch 30, 1996\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Stockholders, Riverside Group, Inc.:\nWe have audited the accompanying consolidated balance sheets of Riverside Group, Inc. and subsidiaries (the \"Company\") as of December 31, 1995 and 1994, and the related consolidated statements of operations, common stockholders' equity and cash flows for each of the three years in the period ended December 31, 1995. 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 Notes 1 and 14 of the Notes to Consolidated Financial Statements, the Company has entered into a definitive agreement to combine its life insurance operations with those of Circle Investors, Inc. and has estimated and recorded a loss on the reorganization of its life insurance operations of $10,972,000 at December 31, 1995 based on the estimated consideration to be received from Circle Investors, Inc.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Riverside Group, Inc. and subsidiaries as of December 31, 1995 and 1994, and the consolidated results of their operations and cash flows for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles.\nAs discussed in Note 1 of the Notes to Consolidated Financial Statements, in 1995 the Company adopted the provisions of Statement of Financial Accounting Standards No. 121 \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of\" and in 1993 the Company adopted the provisions of Statement of Financial Accounting Standards No. 115 \"Accounting for Certain Investments in Debt and Equity Securities.\"\nCoopers & Lybrand L.L.P.\nPhoenix, Arizona March 27, 1996\nRIVERSIDE GROUP, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1995 AND 1994 (in thousands)\nSee accompanying Notes to Consolidated Financial Statements.\nRIVERSIDE GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share amount)\nSee accompanying Notes to Consolidated Financial Statements.\nRIVERSIDE GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF COMMON STOCKHOLDERS' EQUITY (in thousands)\nSee accompanying Notes to Consolidated Financial Statements.\nRIVERSIDE GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)\nSee accompanying Notes to Consolidated Financial Statements.\nRIVERSIDE GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years ended December 31, 1995, 1994 and 1993\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING PRINCIPLES\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements have been prepared in accordance with generally accepted accounting principles (\"GAAP\"), which requires the use of assumptions and estimates in reporting certain assets and liabilities and related disclosures, and actual results may differ from those estimates. These financial statements include the accounts of Riverside Group, Inc. (the \"Parent\" or \"Riverside\"), Wickes Financial Services Center, Inc. and the parent's two principal insurance holding company subsidiaries, American Financial Acquisition Corporation (\"AFAC\") (99% ownership) and Dependable Insurance Group, Inc. (\"Dependable Group\") (wholly-owned) and their subsidiaries (collectively \"the Company\").\nAFAC's principal subsidiaries (all of which are, or were for the periods during which they are included, wholly-owned) are: (i) four stock life insurance companies: American Founders Life Insurance Company (\"American Founders\"); Aztec Life Assurance Company (\"Aztec\"); Laurel Life Insurance Company (\"Laurel Life\"); and National American Life Insurance Company of Texas (\"NALICO of Texas\"), through December 1995, when it was sold, and (ii) BMCO Holding Corp. (\"BMCO\"), a holding company which, until January 3, 1994, owned Riverside Mortgage Company, Ltd. (\"Riverside Mortgage\"), a limited partnership engaged in mortgage servicing operations.\nDependable Group's subsidiaries (all of which are, or were during the periods for which they are included, wholly-owned) are: (i) a stock property and casualty insurance company, Dependable Insurance Company, Inc. (\"Dependable\"), through September 1995 when it was sold, and (ii) an insurance agency, Richmond I. Barge & Associates, Inc. (\"Barge\").\nThe consolidated financial statements also include the Company's investment in Wickes Lumber Company (\"Wickes\") accounted for on the equity method, beginning in October 1993. Effective in August 1995, the Company's ownership interest in Wickes increased from 30% to 36%. See Note 2, Equity Investment in Wickes Lumber Company.\nAdditionally, the Company's consolidated financial statements include the accounts of three 74%-owned real estate entities, which own and operate office buildings which are partially occupied by the Company, through May 1995, when these investments were sold.\nAll significant intercompany accounts and transactions have been eliminated.\nDIVESTITURE OF PROPERTY AND CASUALTY AND MORTGAGE SERVICING OPERATIONS\nThe Company has included the operations of Dependable, Barge and Riverside Mortgage as discontinued operations for all periods presented in the consolidated statements of operations. For 1994 all assets and liabilities of discontinued operations are presented as net liabilities of discontinued operations in the consolidated balance sheets.\nReorganization of Life Insurance Operations\nIn November 1995, the Company announced its intention to reorganize its life insurance operations (the \"Life Insurance Reorganization\")and subsequent to December 31, 1995, the Company entered into a definitive agreement to combine its life insurance operations with those of Circle Investors, Inc. (\"Circle\"). See Note 14, \"Subsequent Events.\" Because of the Company's continued interest in the life operations as a result of the proposed retention of its equity investment in Circle, the life operations are not reflected as discontinued operations in the accompanying consolidated financial statements. The Company has estimated and recorded a loss on the reorganization of its life insurance operations at December 31, 1995 in accordance with Statement of Financial Accounting Standards (\"SFAS\") No. 121 \"Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of.\" The pre-tax loss of $10,972,000 was calculated by comparing the adjusted carrying value of the life operations to the estimated fair value of consideration to be received by the Company. The loss may be adjusted for future reporting periods based on results of additional analysis of the value of the Circle securities. The resulting loss at December 31, 1995 is reflected in the accompanying consolidated balance sheets as a reduction of excess of cost over fair value of net assets acquired.\nBasis of Financial Statement Presentation\nThe accompanying consolidated financial statements have been prepared in conformity with generally accepted accounting principles. Such accounting principles differ from statutory accounting practices prescribed or permitted for insurance companies by regulatory authorities.\nInvestments\nA. Fixed Maturities\nAs of December 31, 1993, the Company adopted SFAS 115 Accounting for Certain Investments in Debt and Equity Securities. The impact of the adoption of SFAS 115 was reported in the consolidated statements of operations for 1993 as a cumulative effect of change in accounting principle. See Note 4, \"Fair Value of Financial Instruments\", for further information on the fair market value of these investments.\nFixed maturities available for sale are securities held for indefinite periods of time and may be used as a part of the Company's asset\/liability strategy or sold in response to changes in interest rates, anticipated prepayments, risk\/reward characteristics, liquidity needs or similar economic factors. These securities are carried at market value with the corresponding unrealized appreciation or depreciation, net of deferred income taxes and deferred policy acquisition costs, reflected in common stockholders' equity.\nFixed maturities actively managed assets acquired in 1993 and sold in 1994 were purchased with the objective of generating incremental returns over those of alternative fixed income investments on a short term basis. These securities are carried at market value with changes in their market value reflected, net of deferred income taxes, in the consolidated statements of operations. During 1994, the Company liquidated its position in these securities. As of December 31, 1995, the Company did not maintain a fixed maturities actively managed portfolio.\nB. Equity Securities\nEquity securities available for sale include common stocks and nonredeemable preferred stocks and are carried at market values. Changes in the market value of these securities, net of deferred income taxes and deferred policy acquisition costs, are reflected as unrealized appreciation or depreciation in common stockholders' equity.\nC. Mortgage, Construction and Policy Loans\nMortgage and construction loans are carried at the lower of amortized cost or fair value. Policy loans are carried at unpaid principal plus accrued interest.\nD. Short-Term Investments\nShort-term and other investments are carried at cost which approximates market.\nE. Investment Real Estate\nInvestments in real estate are carried at the lower of cost or appraised value. Foreclosed property is valued at the lower of carrying amount or fair market value.\nF. Partially-Owned Companies\nInvestments in certain partially-owned companies are recorded using the equity method if the Company has significant influence over the investee's operations and the Company's ownership percentage is 50% or less. Upon completion of the proposed merger agreement with Circle, see Note 14, \"Subsequent Events\", the Company will use the equity method for reporting its investment in Circle stock.\nG. Investment Gains (Losses)\nWhen impairment of value of an investment is considered other than temporary, the decrease in value is reflected in the consolidated statements of operations as a realized investment loss and a new cost basis is established. Realized investment gains and losses are reported in the consolidated statements of operations using the specific identification method.\nPremiums\nLife premiums on traditional life products are reported as earned when due. Revenues on the Company's interest sensitive products, including annuities, consist of expense, mortality and surrender charges assessed against the policyholder. Benefits and expenses are associated with earned premiums so as to result in recognition of profits over the premium paying period. This association is accomplished by means of a provision for future policy benefit reserves and the amortization of deferred policy acquisition costs. For interest sensitive products, income is recognized over the term of the contract in proportion to the risks and functions under the contract.\nValue of Acquired Insurance In Force\nThis asset represents a valuation of future profits of the acquired insurance business in force as of the date of the acquisition of the Company's insurance subsidiaries. The value of acquired traditional insurance in force is being amortized over the premium paying period in proportion to the ratio of anticipated annual premium revenue to the anticipated total premium revenue. The value of acquired insurance in force for interest sensitive products is amortized as a level percent of the present value of anticipated gross profits from investment yields, including SFAS 115 adjustments, mortality and surrender charges. A reconciliation of the balances for the years ended December 31, 1995, 1994, and 1993 follows (in thousands):\n(1) The SFAS 115 adjustment is to reflect the effects that would have been recognized had the unrealized gains or losses of securities available for sale actually been realized.\n(2) Includes $6.5 million related to the sale of all Aztec's in force business to another insurer.\nThe estimated percentages of the December 31, 1995 balance to be amortized during each of the next five years are: 1996, 10.3%; 1997, 9.5%; 1998, 8.5%; 1999, 7.4%; and 2000, 6.9%.\nDeferred Policy Acquisition Costs\nCosts which vary with and are primarily related to the acquisition of new insurance business have been deferred to the extent such costs are recoverable through future revenues. These costs include commissions and sales costs, certain costs of policy issuance and underwriting, and premium taxes.\nTraditional life deferred policy acquisition costs are amortized over the premium paying period in proportion to the ratio of anticipated annual premium revenue to the anticipated total premium revenue. Costs deferred on interest sensitive products are amortized as a level percent of the present value of anticipated gross profits from investment yields, including SFAS 115 adjustments, mortality and surrender charges. As a result of the adoption of SFAS 115, deferred policy acquisition costs decreased $54,000 in 1995 and increased $772,000 in 1994. Investment income is considered in the recoverability analysis of deferred policy acquisition costs. Amounts amortized during 1995, 1994 and 1993, are $372,000, $6,566,000 and $6,706,000, respectively. The change in deferred acquisition costs for 1994 includes a reduction of $5,830,000 related to the sale of all Aztec's in force business to another insurer.\nExcess Of Cost Over Fair Value of Net Assets Acquired\nThe excess of cost over fair value of net assets acquired, including the value of agency contracts, licenses and other intangible items of insurance business acquired, as well as certain other items, is amortized generally over twenty-five years using the straight-line method. Excess of cost over fair value of net assets acquired of $338,000 were written-off as part of the sale of NALICO of Texas during 1995. As a part of the proposed reorganization of the Company's life insurance operations see Note 14, \"Subsequent Events\" the December 31, 1995 balance of excess of cost over fair value of net assets acquired was reduced to zero through a charge of $10,790,000 to loss on reorganization of life subsidiaries in the consolidated statements of operations. Amortization of these assets in 1995 was $458,000 exclusive of this charge. Total accumulated amortization was $8,704,000 at December 31, 1994.\nFuture Life Insurance Benefits and Policyholder Contract Deposits\nThe liability for future life insurance benefits on all traditional life business has been computed by the net level premium method based on estimated mortality, morbidity, withdrawal experience and future investment yields from 3% to 8.3%. For interest sensitive products, the liability for future benefits is based on the accumulated fund balances. Interest rate assumptions for traditional life business range from 7.8% to 9.0%. Mortality is based on multiples of the 1965-70 Select and Ultimate Table modified to reflect underwriting practices and recent industry mortality experience as it relates to the 1965-70 Table. Withdrawals are based on the Company's experience.\nDepreciation\nProperty and equipment, included in other assets, is depreciated over three to ten years using the straight-line method. Investment real estate is depreciated over nineteen to fifty years using the straight-line method. Depreciation expense was $455,000, $920,000, and $1,130,000, for 1995, 1994 and 1993, respectively, and accumulated depreciation as of December 31, 1995 and 1994 was $1,912,000 and $4,120,000, respectively. Assets with accumulated depreciation of $2.3 million at year end 1994 were fully disposed of during 1995.\nEarnings Per Share\nEarnings per share are based upon the weighted average number of shares of common stock outstanding (5,284,280 shares in 1995, 5,350,672 shares in 1994 and 5,332,430 shares in 1993), and are computed after deducting preferred dividends and preferred stock accretion of $0, $234,000, and $1,378,000 in 1995, 1994 and 1993, respectively. Dilution relating to stock options and warrants outstanding was not material.\nSeparate Account\nThe separate account assets and liabilities are associated with special contracts, wherein the investment risk lies solely with the holder of the contract rather than the Company. Investment income for these contracts is excluded from the Company's operations. The separate account has been terminated at the request of the policyholder. Payments under the policy were paid out of the separate account assets.\nFinancial Statement Presentation and Reclassification\nCertain amounts for 1994 and 1993 have been reclassified to conform with the 1995 presentation.\nStatement of Cash Flows Supplementary Disclosure\nCash includes only bank demand deposits.\nThe Company paid $4,046,000, $4,020,000 and $4,528,000 of interest (including interest paid by the consolidated real estate partnerships) in 1995, 1994 and 1993, respectively. No income tax payments were made in 1995, 1994 and 1993. See Note 11, \"Redeemable Preferred Stock and Stockholders' Equity\", for a discussion of the Series C preferred stock and plan of recapitalization. Net cash used in discontinued operating activities totaled approximately $4.2 million, $6.6 million and $32 million in 1995, 1994 and 1993, respectively.\nThe Company did not pay any dividends on its common stock during 1995, 1994 or 1993.\nRecently Issued Accounting Pronouncements\nDuring the year ended December 31, 1995, the Company adopted Statement of Financial Accounting Standards No. 121 (\"SFAS No. 121\") \"Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of\". In accordance with SFAS No. 121, the Company reviews its long-lived assets for impairment when events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. The Company's evaluation for such assets to be held is based on the estimated future cash flows expected to result from the use of the asset and its eventual disposition. If the sum of future cash flows is less than the carrying value of the asset, the Company would recognize an impairment loss. For assets to be disposed of, the Company reports the asset at the lower of the asset's carrying value or fair value less costs to sell. As a result of the Company's decision to reorganize its life insurance operations, a loss of $10,972,000 related to the assets of the life insurance operations was recorded at December 31, 1995. Prior to the change in circumstances and in prior years, the Company periodically evaluated its historical and future financial results in evaluating the recoverability of its intangible assets.\nAs of December 31, 1995, the Company has not adopted SFAS No. 123 \"Accounting for Stock-Based Compensation\" and has not determined the effects, if any, on the consolidated financial statements. However, the Company intends to adopt the disclosure provisions of SFAS No. 123. The disclosure requirements, which are effective for fiscal years beginning after December 15, 1995, require companies to provide proforma disclosures of net income and earnings per share as if they had adopted the fair value accounting method for options granted in 1995 and 1996.\nConcentrations and Uncertainties\nIn 1995, 1994, and 1993 approximately the following percentages of the Company's direct premiums were written in the following states:\nNo other state accounted for in excess of 5%.\nThe life insurance business is highly competitive. Many of the insurers competing with the Company are substantially larger, have a greater number of agents and have considerably greater financial resources than the Company. The proposed life insurance reorganization (see Note 14, \"Subsequent Events\") will not immediately enhance the competitive position of the Company's life insurance operations, since neither the Company nor Circle has active distribution systems for life insurance products.\nThe Company's life insurance subsidiaries are subject to regulation and supervision by the states in which they transact business. The state of domicile exercises principal regulatory supervision of insurance companies. The purpose of such regulation and supervision is primarily to provide safeguards for policyholders rather than to protect the interests of stockholders. The states have established regulatory agencies with broad administrative powers to regulate, among other things: licenses to transact business; policy forms; trade practices; premium and commission rates; agency agreements; deposit of securities for the benefit of policyholders; form and content of statutory financial statements; accounting practices; maintenance of reserves and capital for the protection of policyholders; dividends; examinations of insurers' affairs; and investments. The relationships among the Parent Company and its insurance subsidiaries is also subject to regulations under state insurance holding company laws. Under these laws, inter-company asset transfers, investments and other transactions, as well as dividends from insurance companies, may be subject to prior notice to, or approval by, the state insurance regulatory authority, depending upon the size of such transaction or dividend.\n(2) EQUITY INVESTMENT IN WICKES LUMBER COMPANY\nAll Wickes common share data reflect a 21.73-for-1 stock split effected on October 22, 1993.\nIn January 1996, the Company entered into a definitive agreement with Wickes to purchase two million newly issued shares of common stock at an aggregate purchase price of $10 million. Closing of the definitive agreement is subject to, among other things, completion of the proposed Life Insurance Reorganization, see Note 14, \"Subsequent Events.\" Acquisition of these shares would increase the Company's ownership in Wickes common stock to 52% of total common shares and 55% of voting common shares. The Company is presently evaluating if its controlling interest in Wickes will be temporary. If the controlling interest is temporary, the Company will continue to use the equity method for its investment in Wickes in lieu of consolidating the financial statements of Wickes with those of the Company.\nWhen the Company acquired AFAC in 1990, AFAC's subsidiary American Founders owned 10% of the common stock (217,300 shares) and 61% of the cumulative redeemable preferred stock of Wickes. On August 11, 1993, the Company purchased 10.33 additional shares of cumulative redeemable preferred stock with an aggregate liquidation preference of approximately $1.4 million, 260,760 shares of common stock of Wickes, and a two-year option to acquire an additional 374,516 Wickes common shares. The purchase price was $3.2 million in cash and a $1.1 million promissory note. The option was exercised in\nAugust of 1995 for an aggregate exercise price of $2.3 million, and at the same time the promissory note was paid in full. For a discussion of the litigation seeking, among other things, rescission of this transaction, see Note 13, \"Commitments and Contingencies.\" As a result of a previously existing right of first refusal held by another Wickes stockholder, in early October 1993 the Company sold 16,645 of these shares for an aggregate of $147,310 in cash.\nIn separate transactions on August 11 and 12, 1993, the Company purchased from certain of Wickes' former executive officers 456,330 shares of Wickes' outstanding common stock, as well as certain retirement obligations payable to them by Wickes, for an aggregate $1.4 million in cash. This purchase resolved a dispute concerning the Company's right to purchase approximately 18% of Wickes' common stock from these persons for nominal consideration. In September 1993, the Company sold a 25% interest in these retirement obligations to another stockholder for $365,000 in cash. On October 22, 1993, Wickes acquired the Company's remaining 75% interest in these retirement obligations for $1,275,000 in cash.\nWickes' public stock and senior subordinated debt offerings were completed on October 22, 1993. Pursuant to Wickes' recapitalization plan also completed on that date, (i) the Company received 838,109 shares of Wickes' common stock in exchange for its shares of Wickes' preferred stock, (ii) 76,055 shares of Wickes' common stock held by the Company were canceled, and (iii) the Company received 162,975 shares of Wickes' common stock in respect of certain warrants that the Company had the right to acquire for nominal consideration from certain of Wickes' management. In August 1995, the Company exercised its option to acquire an additional 374,516 common shares. After these transactions, the Company owns 2,217,102 shares, or approximately 36%, of Wickes' outstanding common stock. As of December 31, 1995 the Company's retained earnings includes $4.0 million of undistributed earnings of Wickes.\nSummary audited financial information of Wickes for years 1995, 1994 and 1993 follows (in thousands):\n(1) Includes restructuring charges of $10.7 million, net of income tax benefits of $7.1 million. Income tax benefits include $2.1 million related to the reverse of a deferred income tax valuation allowance established in a prior year.\n(2) Includes income of $14.4 million related to reversal of deferred income tax valuation allowance established in a prior year.\nWickes' revolving credit facility and trust indenture related to their subordinated notes contain certain covenants and restrictions. Among other things, the revolving credit facility prohibits non-stock dividends, debt prepayments and other \"restricted payments\" by Wickes, and the trust indenture restricts non-stock dividends and other restricted payments by Wickes to 50% of \"cumulative consolidated net income,\" or if cumulative consolidated net income, shall be a loss, minus 100% of such loss, of Wickes' earnings subsequent to October 22, 1993, plus the proceeds of the sale of certain equity securities after such date.\n(3) DIVESTITURE OF PROPERTY AND CASUALTY AND MORTGAGE SERVICING OPERATIONS\nDuring 1993, in accordance with a plan to discontinue its property and casualty insurance operations the Company sold or canceled virtually all of its remaining in force property and casualty business. On September 15, 1995, the Company completed the sale of Dependable to MedMarc Insurance Company (\"MedMarc\"). The Company realized a gain from disposal of Dependable of $2.7 million and a loss from operations prior to closing of $1.1 million during 1995.\nDependable and Barge are accounted for as discontinued operations and, accordingly, their operating results are reported in this manner for all periods presented. The loss from discontinued operations includes total property and casualty revenues of $932,000, $3,684,000 and $36,230,000 respectively, for 1995, 1994 and 1993. Included in loss from discontinued operations for 1993 are approximately $2,400,000 of gains resulting from Dependable's sale of several blocks of business. Also included are Dependable's realized gains of $31,000, $91,000 and $7,651,000 from sales of investments for 1995, 1994 and 1993, respectively.\nDuring 1994, Dependable incurred net claims of $4.2 million (pre-tax), net of reinsurance, primarily due to adverse loss experience on commercial lines runoff. In 1993 Dependable incurred claims, net of reinsurance, of $3.2 million (pre-tax) as a result of damage from the severe winter storm of March.\nDuring the fourth quarter of 1993, the Company decided to discontinue its mortgage servicing operations. As a result, Riverside Mortgage is accounted for as a discontinued operation and, accordingly, its operating results are reported in this manner for all periods presented. Included in loss from discontinued operations are Riverside Mortgage's total revenues of $2,401,000, and net loss of $4,113,000 for 1993. The 1993 net loss resulted primarily from accelerated amortization of purchased mortgage servicing rights. On January 3, 1994, the Company sold Riverside Mortgage for its approximate book value.\n(4) FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe following methods and assumptions are used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:\nCash, short-term and other investments - The carrying amount is a reasonable estimate of fair value.\nFixed maturities - The fair value of fixed maturities is determined by utilizing recognized fixed income pricing services and supplemented with bid side market evaluations obtained from various NASD member firms which make markets in the specified securities.\nEquity securities - The fair value of equity securities is generally determined by quoted market price.\nInvestment in Wickes Lumber Company - The fair value of Wickes is determined by the NASDAQ National Market System quoted market price.\nMortgage and construction loans - The fair value of mortgage and construction loans is calculated by discounting scheduled cash flows through the estimated maturity using the current rates at which similar loans would be made to borrowers with similar credit and interest rate risk.\nPolicy loans - As the maturities of policy loans are indeterminable, it is not practicable to estimate the fair value of the Company's policy loans.\nPolicyholder contract deposits - The fair value is approximated as the amount due to the annuity holder if the annuity contract was surrendered at the end of the year.\nNotes payable and mortgage debt - The carrying amount is a reasonable estimate of fair value, as the stated rates of interest represent current market rates.\nSubordinated debt - The estimate fair value is determined by discounting scheduled cash flows at a rate equal to those of similar instruments which have quoted market prices.\nThe estimated fair values of the Company's financial instruments are summarized as follows (in thousands):\n(5) INVESTMENTS\nAt December 31, 1993, the Company's life insurance subsidiaries had a separate trading portfolio (fixed maturities actively managed) which was included in the Company's investment portfolio at market value. As a result of adopting SFAS 115, $903,000 ($596,000 net of tax) of unrealized gains on the Company's fixed maturities actively managed were reported in results of operations as a cumulative effect of a change in accounting principle, net of tax for 1993. These investments were liquidated in 1994. Realized losses on the securities actively managed included in the consolidated statements of operations for 1994 totaled $883,000 ($583,000 net of tax benefit) which partially offset the previously discussed gains recorded in 1993. All other investments in fixed maturities are classified as available for sale and as such are carried at market value with unrealized appreciation (depreciation) reflected directly in common stockholders' equity, net of applicable deferred income taxes and net of the adjustment to deferred acquisition cost that would have been recognized had the unrealized holding gains (losses) been realized.\nThe Company's investment portfolio includes positions in securities which have a market value in excess of $2.6 million, which is 10% of common stockholder's equity, as follows:\nA. Net Investment Income\nThe major categories of investment income are summarized as follows (in thousands):\nThe Company derived no revenue during 1995 from $17,711,000 of investments in real estate.\nB. Realized Investment Gains and Losses\nNet realized investment gains (losses) are summarized below (in thousands):\n- ------------------------\n(1) Included in realized gains for 1995 is approximately $321,000 from the sale of the Company's real estate limited partnership holdings which are consolidated for financial statement purposes.\n(2) Reflects establishment of a reserve for future losses equal to the aggregate carrying value of these securities. (see Note 12, \"Related Party Transactions\").\nC. Fixed Maturities\nThe amortized cost and market values of investments in fixed maturities and equity securities at December 31, 1995 and 1994 are as follows:\nThe amortized cost and market value of fixed maturities at December 31, 1995, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties and the Company may have the right to put the obligations back to the issuer prior to the stated maturity date.\nProceeds from sales of the Company's available for sale portfolio, excluding maturities, follow:\nProceeds from sales of fixed maturities in 1993 were $81,863,000. Gross gains and (losses) on the sales of fixed maturities were $2,264,000 and ($267,000), respectively.\nBased upon the ratings of Standard & Poor's Corporation, as of December 31, 1995, the quality distribution of the Company's fixed maturities was: U.S. Treasury and AAA-38.2%; AA-9.1%; A-36.0%; BBB-10.6%; BB-5.8% and non-rated .3%.\nAs of December 31, 1995, the Company held $43.8 million of securities backed by mortgages and other assets (\"Structured Securities\"), which represented 30% of the Company's fixed maturities. These securities were composed of the following types:\nThe Structured Securities portfolio did not include any interest-only, principal-only, or inverse floating CMOs, nor any residual interests in CMOs. Management is of the opinion that the Structured Securities owned by the Company have good liquidity in readily available markets and were all rated\ninvestment grade, with 81% rated AAA by Moody's Investors Service or Standard & Poor's Corporation. The effective yield to maturity of the Company's Structured Securities portfolio as of December 31, 1995 is 7.6%.\nD. Mortgage and Construction Loans and Investment Real Estate\nMortgage and construction loans on real estate include 162 residential loans aggregating approximately 27% of the dollar value of the Company's mortgage loan portfolio. Of the total residential loans, the Company's mortgage lending operations accounted for five permanent mortgage loans (3% of mortgage portfolio total), which are held for resale to investors under existing agreements, and 34 construction financing loans (13% of mortgage portfolio total). In addition, 48 commercial mortgage loans comprised 73% of the dollar value of the mortgage loan portfolio. As of December 31, 1995, delinquencies were approximately 1% of the mortgage loan portfolio amount.\nAs of December 31, 1995, properties related to the Company's mortgage loans are located primarily in Louisiana (16%) Arizona (48%), Texas (15%), and Georgia (12%). No other state contains properties with loans aggregating more than 5% of total mortgage loans.\nAs of December 31, 1995, properties related to the Company's construction loans are located in Indiana (71%), Alabama (27%) and Florida (2%).\nIn addition, the undrawn amount of construction loans committed at December 31, 1995, totaled $2,469,000. The Company's commitment to fund the undrawn balance is contingent upon the borrowers successful completion of certain specified conditions. Approximately 95% of the total construction loans outstanding were made with respect to homes for which no purchase agreements existed.\nInvestments in real estate consist of the following:\nCertain of the Company's real estate was acquired from affiliates and has been recorded at the lower of historical carryover cost or fair value, consistent with transactions between companies under common control. Commercial rental property carrying values are net of accumulated depreciation of $117,000 and $1,160,000 at December 31, 1995 and 1994, respectively.\nAs of December 31, 1995, the Company had $6,008,000 of its investments in real estate in Florida properties, $11,799,000 in Georgia properties, and $72,000 in other states.\nE. Statutory Deposits\nAs of December 31, 1995, investment securities with a market value of approximately $23,137,000 were held on deposit for various state insurance departments.\nF. Policy Loans:\nAs of December 31, 1995, the Company had $19,827,000 in policy loans. The Company's life insurance policies that accumulate cash surrender values provide for loans to policyholders. Loan interest rates vary by policy form and presently range from 8.5% to 3.5%. Loan repayment is not required as long as sufficient cash value is maintained on each policy. Payment of death or surrender benefits on policies with loans is net of the outstanding loan balance and accrued interest.\n(6) DEBT\nThe Company's debt is summarized as follows:\nMaturities of debt in each of the five years subsequent to December 31, 1995 are: 1996 - $4,845,000; 1997 - $5,733,000; 1998 - $4,533,000, 1999 - $13,803,000 and 2000 - $2,300,000. Upon completion of the proposed Life Insurance Reorganization, the revised maturity schedule will be: 1996 - $2.8 million, 1997 - $.5 million, 1998 - $.5, and 1999 - $9.3 million, .\nBank Notes Payable: On April 19, 1994, AFAC entered into a $20 million credit agreement with Bank of Montreal and First Interstate Bank of California. This bank loan facility is guaranteed by the Parent Company, and is collateralized principally by AFAC's stock ownership in Laurel Life and shares of Wickes common stock owned by the Company.\nThe credit agreement, among other things, requires American Founders to maintain a minimum level of statutory capital and surplus, generally prohibits liens on assets of AFAC and its subsidiaries, and on the stock of AFAC held by the Company, generally prohibits dividends or other payments by AFAC to its stockholders, generally prohibits the incurrence of additional debt by AFAC and its subsidiaries, prohibits business acquisitions by AFAC and its subsidiaries, requires the Company and AFAC to maintain a minimum adjusted net worth (each as defined), restricts the business in which AFAC and its subsidiaries may engage, requires AFAC to maintain a minimum ratio of life insurance operation value and Wickes market value to loan balance outstanding and limits the permitted investments by AFAC and its subsidiaries.\nAs a result of the decrease during 1995 in the trading value of Wickes and the charges taken in the fourth quarter of 1995 related to the Life Insurance Reorganization the Company has not been in compliance with certain requirements of its bank credit agreement. A waiver has been provided and is in the process of being extended. The Company anticipates that this waiver will remain in effect until late June 1996, to allow for completion of the Life Insurance Reorganization. Under the terms of the Life Insurance Reorganization all indebtedness under the Company's bank credit agreement is to be repaid in full by Circle. Circle has informed the Company that it believes, based upon discussions with lenders interested in providing loans to Circle, that it will be able to obtain financing sufficient to retire the Company's bank indebtedness. Should the Company not complete the Life Insurance Reorganization or comparable transaction, the Company would be required to obtain an extension of currently scheduled principal and interest payments, obtain additional financing or sell assets held by the Parent Company and to use the proceeds for Parent Company purposes, which would require the consent of the Company's current bank lenders.\nSubordinated Notes: Parent - These notes may be prepaid in whole or in part upon payment of a premium of 4.333% declining to zero after September 30, 1998. These notes were recorded at an original discount of $1,256,000 which is being amortized using the interest method over the term of the notes. In February 1993, $250,000 principal amount of subordinated notes were repurchased at par by\nthe Company and retired. Certain holders have questioned whether the proposed Life Insurance Reorganization and investment in Wickes entitles them to declare an event of default, see Note 13, \"Commitments and Contingencies\".\nMortgage Notes Collateralized by Real Estate: All mortgage notes outstanding as of December 31, 1995 were retired in March, 1996.\n(7) INCOME TAXES\nDeferred 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. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.\nThe Company files multiple tax returns. The Company and its non-life insurance subsidiaries have approximately $35.2 million, and its life insurance subsidiaries have approximately $4.7 million, in net operating loss carryforwards which expire in the years 2000 through 2010. To the extent carryforwards existing at the subsidiaries' acquisition dates are utilized, the tax benefits will be reflected as reductions to the excess of cost over fair value of net assets acquired and the value of acquired insurance in force. The recognition of such utilization in 1994 resulted in a reduction to the excess of cost over fair value of assets of $1,425,000.\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. A valuation allowance has been established to reduce deferred tax assets to the amount which more likely than not will be realized in the future. The net amount of deferred tax assets recognized arises from the anticipated utilization of carryforward losses against gains to be realized in the future on the real estate assets. Significant components of the Company's deferred tax assets and liabilities as of December 31, 1995 and 1994 are as follows :\nThe life companies have a Phase III tax liability of $452,000 resulting from previously deferred taxable income. A deferred tax liability was not recognized for this liability until it became apparent that the factors contributing to the liability would reverse in the foreseeable future. The reorganization of the life insurance subsidiaries will result in the payment of this tax liability, therefore it has been recognized as a deferred liability in 1995.\nIncome tax expense for the Company consists of the following components:\nActual income tax expense (benefit) on income (loss) differs from expected tax expense computed by applying the Federal corporate tax rates of 34% in 1995, 1994 and 1993, as follows:\n(8) STATUTORY FINANCIAL DATA\nThe Company's life insurance subsidiaries are required to file Annual Statements with regulatory authorities prepared under a statutory basis of accounting. The net income (loss) and capital and surplus of the life insurance companies on the statutory basis of reporting to regulatory authorities are presented below :\nEach insurance subsidiary prepares its statutory financial statements in accordance with accounting practices prescribed or permitted by its respective domiciliary state insurance department. Prescribed statutory accounting practices include a variety of publications of the National Association of Insurance Commissioners (\"NAIC\"), as well as state laws, regulations and general administrative rules. Permitted statutory practices encompass all accounting practices not so prescribed. Insurance subsidiaries states of domicile are: American Founders and Laurel Life-Texas, and Aztec-California.\nDuring 1994, American Founders recorded realized adjustments to those invested assets whose admitted values were less than their statutory ledger value and for which no recovery was anticipated. The write down of the assets generated realized investment losses for statutory purposes of $23,592,000 charged against net income. The impact upon statutory capital and surplus was offset by the release of the previously established loss reserve for these assets.\nAmerican Founders' Board of Directors approved a plan to eliminate the accumulated deficit in unassigned surplus as provided by Texas statute. This statutory basis quasi reorganization was completed on November 30, 1994, with the transfer of $26.1 million from additional paid in capital to unassigned surplus.\nAztec's 1994 statutory basis net income resulted primarily from the sale of all its in force business see Note 9 \"Reinsurance.\" The statutory gain on this transaction of $8.0 million was partially offset by realized investment losses on bonds of BMCO of $3.3 million.\nCalifornia and Texas law restrict payment of dividends from the Company's insurance subsidiaries. In 1996, American Founders may pay dividends of $4.5 million without Texas Department of Insurance approval. Aztec is not allowed to pay dividends without special approval. Aztec received written approval from the California Insurance Department to pay a special dividend of approximately $23.7 million to American Founders following the sale of all its in force business. This transaction decreased the statutory capital and surplus of Aztec by the same amount. The receipt of the dividend did not impact statutory capital and surplus of American Founders as assets received were offset by a reduction in investments in subsidiaries.\nThe National Association of Insurance Commissioners (\"NAIC\") and Texas adopted recommended levels of \"risk-based\" capital for life insurers, determined by the application of a formula that evaluates a company's capital and surplus based on various perceived risk factors related to asset type and quality, interest rate exposure, kinds and amount of insurance written and other business risks. All of the Company's insurance subsidiaries exceed both the NAIC recommended and Texas-mandated levels of \"risk-based\" capital.\nIn accordance with instruction from the Texas Department of Insurance, American Founders carries its investment in Wickes at market value in its statutory basis financial statements. American Founders is also required to establish related statutory asset valuation reserves to moderate the impact of Wickes' market value fluctuations on statutory capital and surplus. Additionally, American Founders has agreed with the Texas Department of Insurance to either dispose of or non-admit certain real estate investments over a period of time.\n(9) REINSURANCE\nThe Company evaluates the financial condition of its reinsurers and monitors cancellations of credit risk arising from similar geographic regions, activities, or economic characteristics of the reinsurance to minimize exposure to significant losses from reinsurer insolvencies. At December 31, 1995, the Company does not believe there to be a significant concentration of credit risk related to its reinsurance program.\nLife\nOn policies issued prior to October 24, 1990, American Founders retained no more than $50,000 of risk on any one life and retains up to $250,000, per risk on policies issued subsequently. Aztec transferred all reinsurance risks to Guardian Insurance and Annuity Company (\"GIAC\") in the transaction discussed below.\nOn December 31, 1995, American Founders acquired all of the life and accident and health business of NALICO of Texas. Under the agreement, American Founders received assets equal to the liabilities transferred which were $160,000 in aggregate. No gain or loss on this transaction was recorded.\nIn December 1994, Aztec completed an asset transfer and acquisition agreement with GIAC in which Aztec ceded to GIAC all its in force insurance policies. As required by SFAS 113, the balance sheet effects of this reinsurance transaction result in the establishment of reinsurance receivable related to the ceded reserves of $21,909,000 and $22,316,000 as of December 31, 1995 and 1994, respectively. The purchase price for this block of business was $8.2 million, which resulted in a net loss of $.2 million. Under terms of the agreement Aztec is entitled to additional funds of $.2 million if the original writing agency for this business agrees to amend its commission agreement as outlined by GIAC. Aztec anticipates receipt of these funds in 1996. Under terms of a related agreement Aztec will continue to administer these policies for a period not less than one year from the closing date. This agreement has been extended into 1996.\nFollowing is a summary of net premiums and amounts earned for life operations for each of the three years ended December 31, 1995, 1994 and 1993, and certain insurance balances at December 31, 1995, and 1994:\nThe reduction in premiums from 1994 to 1995 primarily reflects the sale of Aztec's business to GIAC.\n(10) EMPLOYEE BENEFIT PLANS\nA. ESOP\nThe Company has an Employee Stock Ownership Plan and Trust (\"ESOP\") in which employees of the Company who work more than 1,000 hours in a plan year are eligible to participate. The Company's Board of Directors determines the amount, if any, of the annual contribution to the ESOP, and each participant shares in this contribution pro rata based upon the amount of the participant's compensation as compared to all participants' compensation for such year.\nDuring 1992, the Company entered into an agreement that permitted it to acquire from Wilson Financial Corporation (\"Wilson Financial\"), ,the Company's controlling stockholder, shares of its common stock at a price based on average market prices prevailing at year end prior to the times of purchase in 1993 and 1994, and aggregating $680,000 for use in the Company's employee benefit plans. Pursuant to this agreement, the ESOP purchased 111,934 shares in 1993, and 41,185 shares in 1994.\nAs of December 31, 1995, the ESOP owned 304,751 shares of the Company's common stock, of which 93,290 shares were pledged under ESOP loans from the Company. Contributions to the ESOP for payment of principal and interest on the ESOP loans, were $76,000, $38,000 and $114,000 in 1995, 1994 and 1993, respectively. Loans from the Company to the ESOP of $268,000 in 1994 were used to purchase additional shares of common stock, respectively.\nNotes receivable from the ESOP issued to purchase common shares are held by the Company and its subsidiaries. Statement of Position (\"SOP\") 93-6 issued in 1994 requires presentation of all leveraged shares held by the ESOP (\"Unearned ESOP shares\") as a reduction to additional paid in capital. Accordingly the unpaid balance of the notes receivable of $443,000 was reclassified to stockholders' equity in 1994. As of December 31, 1995 this amount has been reduced to $412,943 for the cost of ESOP shares released by repayments on these notes. Unearned ESOP shares are not treated as\noutstanding for the calculation of earnings per common share. The fair value of unearned ESOP shares as of December 31, 1995 was approximately $315,000.\nB. Stock Option Plans\nDuring 1985 the Company established the Riverside Group, Inc. Incentive Stock Option Plan (for employees) and the Non-qualified Stock Option Plan (for employees and directors). In 1995, both of these plans terminated. Additional information with respect to stock options is as follows:\nOptions outstanding as of December 31, 1995 expire in 1996 through 2003 and unused options not vested are earned equally over the next three years.\nC. 401(K)\nThe Company has a Deferred Compensation Plan for all its eligible employees which allows participants to defer up to ten percent of their salary pursuant to Section 401(k) of the Internal Revenue Code. The Company matches contributions up to a maximum of 3% of compensation for employees contributing up to 6%. Employees are 100% vested in their contributions and vest in the Company's contribution over a period of seven years. The Company's contribution to the 401(k) for matching was $56,000, $61,000 and $83,000 during 1995, 1994 and 1993, respectively.\n(11) REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY\nA. Recapitalization\nThe Company retired through a plan of recapitalization effective April 20, 1994, its outstanding shares of its Series C Preferred Stock, which had an aggregate liquidation preference of $7 million, from its\ncontrolling stockholders in exchange for approximately $1,283,000 in cash and 195,851 newly-issued shares of the Company's common stock at $9.09 per share.\nB. Warrants\nAll outstanding common stock warrants issued pursuant to a warrant agreement dated August 31, 1989 expired in 1994 unexercised.\n(12) RELATED PARTY TRANSACTIONS\nIn February, April and June of 1995 the Company advanced Wilson Financial an aggregate of $900,000 and Wilson Financial granted the Company an option to acquire at exercise prices ranging from $5.88 to $6.31 per share the number of shares of the Company's common stock equal to the amount of such advance and related interest outstanding divided by the exercise price. Effective June 30, 1995, the Company elected to exercise its option on these advances acquiring 150,680 common shares at an aggregate exercise price of $918,310 by canceling the advances and related interest with Wilson Financial previously discussed. In addition the Company purchased 23,000 common shares for an aggregate price of $125,235 in October 1995 and 27,778 common shares for an aggregate price of $125,000 in November of 1995 from Wilson Financial. In February 1993, the Company repurchased 300,000 shares of its common stock from Wilson Financial for $5.00 per share. In addition the ESOP purchased from Wilson Financial 111,934 shares in February 1993, for $3.06 per share and in January 1994, the Company purchased 41,185 shares for $6.50 per share. The Company also acquired from Wilson Financial and subsequently retired as treasury shares 40,000 shares in September 1994, at $6.44 per share and 15,000 shares in November 1994, at $6.75 per share. Following these transactions Wilson Financial owned 59% of the Company's outstanding common stock.\nOn October 1, 1992, a complaint was settled by the Company and a director, who controlled the firm that was the Company's investment advisor. Under the terms of the settlement, the Company paid $400,000 and Aegis Investments, Inc., (\"Aegis\") a corporation wholly-owned by Mr. Wilson, acquired from the plaintiff $2 million of the Company's 13% subordinated notes due 1999 plus accrued interest for $1.1 million. Aegis also received the right to acquire from the plaintiff for nominal consideration the related warrants to purchase 70,000 shares of the Company's common stock at $13 per share. AFAC advanced to Aegis $1 million of the consideration used. Aegis executed a note payable to the Company for $1.4 million which was secured by the 13% subordinated notes acquired and guaranteed by Mr. Wilson personally to the extent of $1 million. On February 24, 1994, the Company reacquired the subordinated notes by canceling its loan to Aegis and subsequently sold the subordinated notes to an unrelated third party for $1,958,000 plus accrued interest.\nA partnership in which the Company owned a 74% interest, leased office space to the Atlantic Group, Inc. (\"Atlantic\") for which Atlantic paid $37,000, $94,000 and $108,000 in 1995, 1994 and 1993, respectively. Included in securities of related parties for 1994 are certain securities of Atlantic with an aggregate carrying value of $1,500,000. In 1995, the Company wrote off the entire carrying value of these securities. Directors of the Company beneficially own approximately 75% of Atlantic's voting securities.\nIncluded in operations for 1995, 1994, and 1993, is income from reimbursements of office expenses and tax services paid to the Company by Wilson Financial of $39,000, $50,000, and $81,000\nrespectively. Also included in operations is expense paid to Wilson Financial for providing real estate management services of $31,000, $120,000, and $199,000 in 1995, 1994 and 1993, respectively.\nThe Company reimburses its share of actual costs incurred from the Company's use of an airplane owned by an affiliate of Mr. Wilson. Reimbursement expenses were $23,000 in 1995, $44,000 in 1994, and $428,000 in 1993. Included in operations for 1995, is income from reimbursements of salary expenses paid to the Company by a subsidiary of Wilson Financial, JB Aviation, of $163,000.\nIn 1993 the Company's investments were being managed by a firm whose majority stockholder is a director of the Company. Fees paid to this firm for 1993 were $112,000.\nKirschner, Main, Graham, Tanner & Demont, a law firm in which an officer and director of the Company is a stockholder, is general counsel to the Company. During 1995, 1994, and 1993, the firm rendered services to the Company for which it received $583,000, $730,000, and $948,000, respectively.\nDirectors of the Company own an aggregate of $2.0 million of the Company's 13% subordinated notes.\nIn February 1995, the Company made a loan of $225,000 to a company owned by a director of the Company. The loan bears interest at a rate of 7.5% and is scheduled to mature on March 31, 1996. the Company received interest payments of $13,555 in 1995 on this note.\n(13) COMMITMENTS AND CONTINGENCIES\nOn or about August 11, 1993, FynSyn Capital Corp. (\"FynSyn\") and a related entity, Wickes Lumber Investment Partnership (\"WLIP\"), sold an aggregate of 260,760 shares of Wickes' common stock, an option to acquire 374,516 additional shares of Wickes' common stock and 10.33 shares of Wickes' 9% redeemable preferred stock to Riverside. In connection with this sale, FynSyn stated that it was unable to locate the stock certificate representing the preferred stock and executed and delivered to Wickes an affidavit of loss and indemnity agreement, in reliance on which Wickes issued a replacement stock certificate to FynSyn, which was delivered to the Company upon completion of the sale. The 10.33 preferred shares were converted into approximately 103,922 shares of Wickes common stock as part of Wickes' plan of recapitalization completed on October 22, 1993. In February 1994, a third party informed Wickes that FynSyn had previously transferred the 10.33 preferred shares to the third party in 1989. In July 1994, FynSyn and WLIP commenced an action in Superior Court of New Jersey, Essex County, Chancery Division, styled FynSyn Capital Corporation and Wickes Lumber Investment Partnership vs. Bankers Trust Company, et al. FynSyn and WLIP are seeking, among other things, rescission of the affidavit of loss and indemnity agreement and the rescission or reformation of the terms of the sale of all of their Wickes securities to Riverside. In 1995, this action was removed to the United States District Court for the District of New Jersey. Riverside and Wickes have answered the complaint in this action and counterclaimed seeking, among other things, indemnity and enforcement of their contractual rights. Wickes has also sought declaratory relief as to the respective rights and liabilities of Wickes and Riverside, as well as FynSyn and the third party related to and as a consequence of these matters and seeking indemnity from FynSyn. Riverside and Wickes intend to pursue vigorously their respective rights against FynSyn, WLIP and related parties, and Riverside intends to defend vigorously the claims of FynSyn and WLIP.\nThe Company and its subsidiaries have various operating leases for office space for which approximately $413,000, $330,000, and $1,098,000 was expensed in 1995, 1994 and 1993 respectively. The lease terms range from month-to-month to 1997. Minimum annual rentals under these leases are 1996, $396,000 per year; and 1997, $112,000.\nIn connection with the sale of Dependable, the Company agreed to indemnify MedMarc for certain losses on various categories of liabilities. Terms of the indemnities provided by the Company vary with regards to time limits and maximum amounts. AFAC subordinated debentures in the amount of $2.1 million are pledged as collateral on these indemnities. Although future loss development will occur over a number of years the Company believes, based on all information presently available, that reserves transferred to MedMarc at the closing and those held by the Company are adequate for these indemnities. It is not anticipated that these indemnities will have a material adverse effect on the Company's financial position, results of operations or cashflows.\nAs is common in the insurance industry, the Company's insurance subsidiaries are regularly engaged in the defense of claims arising out of the conduct of the insurance business. In management's opinion, none of these claims will have a material adverse effect on the Company's financial position, results of operations or cash flows.\nThe Company is not aware of any environmental liabilities or similar issues.\n(14) SUBSEQUENT EVENTS\nIn January 1996, the Company entered into a definitive agreement with Wickes to purchase two million newly issued shares of common stock at an aggregate purchase price of $10 million. Closing of the definitive agreement is subject to, among other things, completion of the Life Insurance Reorganization. Acquisition of these shares would increase the Company's ownership in Wickes common stock to 52% of total common shares and 55% of voting common shares. Presently the Company is uncertain as to whether this transaction will require consolidation of Wickes' financial results as the resulting majority interest position may be temporary.\nOn March 8, 1996, the Company entered into a definitive agreement to combine its life insurance operations with those of a privately-held company engaged in providing financial services. Pursuant to this agreement, a wholly-owned subsidiary of AFAC that wholly-owns all of AFAC's insurance subsidiaries, will merge with and into Circle, with Circle surviving. As a result of the merger, Circle will wholly-own the Company's life insurance subsidiaries as well as Liberty Bankers Life Insurance Company (\"Liberty Bankers\"), an Ohio-domiciled life insurance company currently wholly-owned by Circle. At and for the period ended December 31, 1995, Liberty Bankers had (on a statutory accounting basis) approximately $9.2 million of assets, $3.3 million of policyholders' surplus and total revenues of $1.0 million.\nUpon completion of this reorganization, the Company will own approximately 40% of Circle's outstanding common stock and will possess the right to vote approximately 10% of Circle's common stock and will share the right to vote approximately an additional 30%. The Company also will own 100% of a new series of Circle's preferred stock with a liquidation preference of $3.6 million. Circle has also agreed to appoint the Company's Chairman, J. Steven Wilson, or another reasonably acceptable candidate to Circle's Board of Directors. The Company will be the largest single stockholder of Circle following completion of this transaction.\nIn connection with this reorganization, the Company will receive approximately $15 million in cash before taxes and expenses, and will retain certain assets held by American Founders, including real estate with a $2 million net appraised value (net of an $18 million mortgage) and approximately 950,000 shares of Wickes common stock. Also in connection with this transaction, Circle will replace all of AFAC's indebtedness under its bank credit agreement, which totaled $18 million at December 31, 1995.\nAfter anticipated income taxes and other expenses of approximately $1.0 million, net cash to be received by the Company in this transaction would approximate $14 million, $10 million of which it has agreed to utilize to acquire two million newly-issued shares of Wickes common stock pursuant to the Wickes Agreement.\nCompletion of the transactions contemplated by this agreement is subject to, among other things, receipt of insurance regulatory approvals and the completion by Circle of necessary financing arrangements. It is anticipated that the transactions will close in June, 1996.\nThe Company has taken a net pre-tax charge of $11 million against 1995 income from continuing operations for the life insurance reorganization and the sale of NALICO of Texas. This charge primarily reflects a write-off of $10.8 million of intangible assets acquired in the various life acquisitions. Additionally, the Company realized a $1.9 million tax benefit on the proposed merger with Circle, which partially offsets the reorganization charges.\nThe following provides an unaudited proforma balance sheet for the Company as of December 31, 1995 assuming completion of the above transactions and the equity method for reporting investments in Wickes and Circle.\nLife insurance operations to be combined with those of Circle generated revenues of $25.2 million, operating losses of $.5 million and net income of $.6 million (exclusive of the estimated loss arising from the reorganization) consolidated statement of operations for the year ended December 31, 1995.\n(15) INDUSTRY SEGMENT INFORMATION\nThe Company's operations are conducted through three segments: building materials, life insurance, and other. Summary financial information about the Company's operating segments for the years ended December 31, is presented in the following table (in thousands):\nBuilding materials include the Company's equity in Wickes, the importation of lumber through a subsidiary of the Company (sold to Wickes in 1994) and operations of providing financial services to Wickes' customers through a subsidiary of the Company. Other includes Parent Company corporate debt and assets of Dependable anticipated to be retained after the sale of Dependable and all eliminating entries related to intercompany transactions. Assets of discontinued operations, included in \"Other\", are net of related liabilities for 1995 and 1994.\nWickes' 110 building centers are located in 24 states in the Midwest, Northeast and South. Wickes believes that its geographic diversity generally lessens the impact of economic downturns and adverse weather conditions in any one of Wickes' geographic markets. The following table sets forth certain information with respect to the locations of Wickes' building centers as of February 29, 1996:\nQUARTERLY RESULTS OF OPERATIONS (UNAUDITED)\nThe following is an unaudited summary of quarterly performance of the Company, for the years ended December 31:\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo The Stockholders and Board of Directors\nWe have audited the accompanying consolidated balance sheets of Wickes Lumber Company and Subsidiaries (the \"Company\") as of December 30, 1995 and December 31, 1994, and the related consolidated statements of earnings, changes in common stockholders' equity (deficit) and cash flows for the years ended December 30, 1995 and December 31, 1994, and December 25, 1993. We have also audited the financial statement schedule of valuation and qualifying accounts. 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 this financial statement schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as 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 Wickes Lumber Company and Subsidiaries as of December 30, 1995 and December 31, 1994, and the consolidated results of their operations and cash flows for the years ended December 30, 1995, December 31, 1994, and December 25, 1993, 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 12, 1996\nWF-1 WICKES LUMBER COMPANY AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\nDecember 30, 1995 and December 31, 1994 (in thousands except share data)\nThe accompanying notes are an integral part of the consolidated financial statements.\nWF-2 WICKES LUMBER COMPANY AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF EARNINGS\nFor the Years Ended December 30, 1995, December 31, 1994, and December 25, 1993 (in thousands, except per share data)\nThe accompanying notes are an integral part of the consolidated financial statements.\nWF-3 WICKES LUMBER COMPANY AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CHANGES IN COMMON STOCKHOLDERS' EQUITY (DEFICIT)\nFor the Years Ended December 25, 1993, December 31, 1994 and December 30, 1995 (in thousands)\nThe accompanying notes are an integral part of the consolidated financial statements.\nWF-4 WICKES LUMBER COMPANY AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nFor the Years Ended December 30, 1995, December 31, 1994 and December 25, 1993 (in thousands)\nThe accompanying notes are an integral part of the consolidated financial statements.\nWF-5\nWICKES LUMBER COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. DESCRIPTION OF BUSINESS\nWickes Lumber Company, through its building centers, markets lumber, building materials and services to professional contractors, repair and remodelers and do-it-yourself home owners principally in the Midwest, Northeast and Southern United States. Wickes Lumber Company's wholly-owned and majority-owned subsidiaries are: Lumber Trademark Company (\"LTC\"), a holding company for the \"Flying W\" trademark; GLC Division, Inc. (\"GLC\"), which operates the Gerrity Lumber business; and Riverside International Corporation (\"RIC\"), engaged in the procurement and processing of lumber in the former Soviet Republics.\n2. ACCOUNTING POLICIES\nPrinciples of Consolidation\nThe consolidated financial statements present the results of operations, financial position, and cash flows of Wickes Lumber Company and all its wholly-owned and majority-owned subsidiaries (the \"Company\"), except for RIC, the investment in which is recorded under the equity method because control is likely to be temporary and to be lost in the near term (see Note 16). All significant intercompany balances have been eliminated.\nFiscal Year\nThe Company's fiscal year ends on the last Saturday in December.\nAccounts Receivable\nThe Company extends credit primarily to qualified contractors. The accounts receivable balance excludes consumer receivables as such receivables are sold on a nonrecourse basis. The remaining accounts and notes receivable represent credit extended to professional contractors and professional repair and remodelers, generally on a non-collateralized basis.\nInventory\nInventory consists principally of finished goods. The Company utilizes the first-in, first-out (FIFO) cost flow assumption for valuing its inventory. Inventory is valued at the lower of cost or market, but not in excess of net realizable value.\nProperty, Plant, and Equipment\nProperty, plant, and equipment are stated at cost and are depreciated under the straight-line method. Estimated lives used range from 15 to 39 years for buildings and improvements and leasehold improvements. Machinery and equipment lives range from 3 to 6 years. Expenditures for maintenance and repairs are charged to operations as incurred. Gains and losses from dispositions of property, plant, and equipment are included in the Company's results of operations as other operating income.\nWF-6 WICKES LUMBER COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nOther Assets\nOther assets consist primarily of deferred financing costs and goodwill which are being amortized on the straight line method, goodwill primarily over 35 years and deferred financing costs over the expected terms of the related debt agreements. At each balance sheet date, the Company evaluates the realizability of goodwill based upon expectations of nondiscounted cash flows and operating income for each subsidiary having a material goodwill balance. Based upon its most recent analysis, the Company believes that no impairment of goodwill exists at December 30, 1995.\nTrademark\nPrior to completion of the Recapitalization Plan (as hereinafter defined), the Company's \"Flying W\" trademark was being amortized over 10 years. Effective with the Recapitalization, certain restrictions on the trademark were eliminated, resulting in a change in the amortization of the trademark to reflect a 40-year amortization period.\nAccounts Payable\nThe Company includes outstanding checks in excess of in-transit cash in accounts payable. There were $1,672,000 outstanding checks in excess of in-transit cash at December 30, 1995 and none at December 31, 1994.\nPostretirement Benefits Other Than Pensions\nThe Company provides certain health and life insurance benefits for eligible retirees and their dependents. The Company accounts for the costs of these postretirement benefits over the employees' working careers in accordance with Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\"\nPostemployment Benefits\nThe Company provides certain other postemployment benefits to qualified former or inactive employees. The Company accounts for the costs of these postemployment benefits in the period when it is probable that a benefit will be provided in accordance with Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits\".\nIncome Taxes\nThe Company accounts for income taxes in accordance with statement of Financial Accounting Standards No. 109, \"Accounting for Income 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 for which income tax benefits will be realized in future years. Deferred tax assets are reduced by a valuation allowance when the Company cannot make the determination that it is more likely than not that some portion of the related tax asset will be realized.\nComputation of Earnings Per Common Share and Pro Forma Common Share\nWF-7 WICKES LUMBER COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nEarnings per common share is based upon the weighted average number of shares of common stock outstanding and, where dilutive, common equivalent shares (using the treasury stock method). Common equivalent shares consist of common stock warrants and common stock options. Dilution relating to common stock options was not material. Pro forma common shares is presented for fiscal year 1993, giving effect to the Recapitalization Plan as if it had occurred on December 27, 1992 (see Note 4). Computation of earnings per share on a historical basis for fiscal year 1993 is presented in Note 15.\nStock Split\nIn connection with the Recapitalization Plan, on October 14, 1993 the Company's Board of Directors declared a 21.73-for-1 stock split of its outstanding shares of common stock. The accompanying financial statements have been restated to reflect this stock split.\nCash and Cash Equivalents\nThe Company considers all highly liquid investments with a maturity date of three months or less to be cash equivalents.\nUse of Estimates in the Preparation of Financial Statements\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from the estimates reported.\nSignificant estimates made by the Company include accrued compensation liability and medical claims, accrued postemployment and postretirement benefits, accrued restructuring charges, and valuation allowances for accounts receivable, inventory and deferred tax assets. Accrued compensation liability and medical claims involve the determination of reserves for incurred but not reported claims. Accrued postemployment and postretirement benefits involve the use of actuarial assumptions, including selection of discount rates (see Note 10). Accrued restructuring charges involve an estimation of what the market will bring and specific costs incurred relating to the liquidation of certain Company assets using actual historical results (see Note 12). Determination of the valuation allowances for accounts receivable and inventory involve assumptions related to current market conditions and historical market trends. While the valuation allowance for the deferred tax assets considers estimates of projected taxable income (see Note 11). It is reasonably possible that the company's estimates for such items could change in the near term.\nRecently Issued Accounting Pronouncements\nImpairment of Long-Lived Assets. Statement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of,\" requires that long-lived assets and certain identifiable intangibles to be held and used by an entity be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Impairment is evaluated by comparing future cash flows (undiscounted and without interest charges) expected to result from the use or sale of the asset and its eventual disposition, to the carrying amount of the asset. This new accounting principle is effective for the Company's fiscal year ending December 28, 1996. The Company believes that adoption will not have a material impact on its financial position.\nWF-8 WICKES LUMBER COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nStock-Based Compensation. Statement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation,\" encourages, but does not require, companies to recognize compensation expense for grants of stock, stock options, and other equity instruments to employees based on new fair value accounting rules. Although expense recognition for employee stock based compensation is not mandatory, the pronouncement requires companies that choose not to adopt the new fair value accounting, to disclose the pro-forma net income and earning per share under the new method. This new accounting principle is effective for the Company's fiscal year ending December 28, 1996. The Company believes that adoption will not have a material impact on its financial position as the Company will not adopt the fair new value accounting, but instead comply with the disclosure requirements.\n3. ACQUISITIONS\nAll acquisitions have been accounted for as purchases; operations of the companies and businesses acquired have been included in the accompanying consolidated financial statements from their respective dates of acquisition. The excess of the purchase price over fair value of the net assets acquired is included in goodwill. The fair market value of the assets acquired were approximately $12.4 million in 1995.\nDuring 1995 the Company acquired five retail building material centers for a total cost of $8.1 million. The cost of the acquisitions have been allocated on the basis of the fair market value of the assets acquired and the liabilities assumed. This allocation resulted in goodwill for one of the acquired businesses which is being amortized over a 30 year period on a straight line basis.\nIn August 1994, the Company acquired all of the net assets of Great Lakes Building Supply, Inc. and Ishpeming Building Supply, Inc. The cost of the acquisition approximated the fair market value of the assets acquired and liabilities assumed. In addition, the Company acquired all of the outstanding Class B common stock of Riverside International Corporation, from an affiliated entity. The cost of this acquisition has been allocated on the basis of the estimated fair value of the assets acquired and liabilities assumed. In October 1994, the Company acquired the Gerrity Lumber business from the Gerrity Company, Inc. The acquired business consisted of the operating assets of eight lumber and building material centers of which three include component manufacturing plants. The purchase price has been adjusted in accordance with a post-acquisition audit of the acquired assets, resulting in an increase in goodwill. Goodwill is being amortized over 35 years under a straight line basis.\nThe following unaudited pro forma summary presents information as if the 1994 acquisitions had occurred at the beginning of the fiscal year. The pro forma information is not required for the 1995 acquisitions and is provided for 1994 for informational purposes only. 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:\nWF-9 WICKES LUMBER COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nSee Note 2 - Accounting Policies - Computation of Earnings Per Common Share and Pro Forma Common Share\n4. RECAPITALIZATION PLAN\nOn October 22, 1993, the Company completed a recapitalization plan (the \"Recapitalization Plan\"), which included (i) the initial public offering by the Company of 2,800,000 shares of common stock, par value $.01 per share (the \"Common Stock\"), which resulted in $42 million in gross proceeds; (ii) the offering of 11-5\/8% Senior Subordinated Notes due 2003, which generated $100 million in gross proceeds; (iii) the establishment of a new $135 million revolving credit facility; (iv) the payment by the Company of an aggregate of $35 million in full payment and cancellation of the subordinated note and warrant to purchase common stock of the Company issued by the Company to the holder of the subordinated note; (v) the payment by the Company of an aggregate of $65.5 million in full payment and cancellation of the term loan and warrant to purchase common stock of the Company issued to the lender of the term loan, and the repayment of all outstanding indebtedness, $32.7 million, under and termination of the Company's then-existing revolving credit working capital facility, and the payment of $1.5 million of accrued interest on the term loan and the revolving credit facility; (vi) the restructuring of the Company's outstanding capital stock pursuant to which the Company in September 1993 reclassified each share of the existing classes of common stock into one share of Common Stock or Class B non-voting common stock, par value $.01 per share, and effected a 21.73-for-1 stock split immediately prior to the consummation of the initial common stock offering, on October 22, 1993; (vii) the issuance by the Company of 1,206,881 shares of Common Stock (valued at the public offering price in the initial common stock offering, less underwriting discount) in exchange for the outstanding shares of preferred stock (including accrued and unpaid dividends to the date of the consummation of the recapitalization plan); (viii) the payment by the Company of $1.7 million in full settlement of certain supplemental retirement benefits (\"SRBs\") payable by the Company and acquired by Riverside Group, Inc. from certain former executive officers of the Company; and (ix) the payment of fees and expenses relating to the foregoing.\nUpon the completion of the Recapitalization Plan, there were 5,571,461 shares of Common Stock and 499,768 shares of Class B Non-Voting Common Stock outstanding. As a result of the Recapitalization Plan the Company recorded an extraordinary gain of $1.2 million. This gain is comprised of (i) a gain of $0.7 million on retirement of the SRBs, (ii) a gain of $4.6 million on the retirement of the previously outstanding subordinated note and accrued interest, (iii) a $3.9 million write-off of the unamortized transaction costs from the 1988 Acquisition, in which former members of senior management and other investors participated in a leveraged buy-out of the Company, and (iv) applicable income tax expense of $0.2 million.\n5. PROPERTY, PLANT, AND EQUIPMENT\nProperty, plant, and equipment is summarized as follows:\nWF-10 WICKES LUMBER COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n6. ACCRUED LIABILITIES\nAccrued liabilities consist of the following:\n7. LONG-TERM DEBT\nLong-term debt obligations are summarized as follows:\nWF-11 WICKES LUMBER COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nRevolving Line of Credit\nThe revolving credit agreement was amended and restated in its entirety on March 12, 1996. Among other things, the amendment and restatement (i) extended the term of the facility 15 months to January 1998, (ii) reduced the maximum borrowing limit $15 million to $130 million, (iii) modified certain covenants, including changes to accommodate the Company's fourth quarter 1995 restructuring charge, (iv) required the temporary addition of approximately $12 million of real estate collateral and (v) required the completion by July 31, 1996 of the receipt from Riverside Group, Inc. of $10 million from the sale of equity securities of the Company.\nUnder the revolving line of credit, the Company may borrow against certain levels of accounts receivable and inventory. Taking into account the March 12, 1996 amendment and restatement, the amount available for borrowing on December 30, 1995 would have been $9.3 million. A commitment fee of 1\/2 of 1% is payable on the unused portion of the commitment. The weighted-average interest rate on the revolving line of credit for the years ending December 30, 1995 and December 31, 1994 was approximately 8.8% and 8.2%, respectively.\nSubstantially all of the Company's accounts receivable, inventory, general intangibles and certain real estate, machinery and equipment are pledged as collateral for the revolving line of credit. Covenants under the related debt agreements require, among other restrictions, that the Company maintain certain financial ratios and certain levels of consolidated net worth. In addition, the debt agreement restricts among other things, capital expenditures, the incurrence of additional debt, asset sales, dividends, investments, and acquisitions.\nSenior Subordinated Notes\nOn October 22, 1993, the Company issued $100,000,000 in principal amount of 10-year unsecured senior subordinated notes. Interest on the notes is 11-5\/8%, payable semi-annually. Covenants under the related indenture restrict among other things, the payment of dividends, the prepayment of certain debt, the incurrence of additional debt if certain financial ratios are not met, and the sale of certain assets unless the proceeds are applied to the notes. In addition, the notes require that, upon a change in control of the Company, the Company must offer to purchase the notes at 101% of the principal thereof, plus accrued interest.\nAggregate Maturities\nThe aggregate amounts of long-term debt maturities by fiscal year are as follows:\nWF-12 WICKES LUMBER COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n8. COMMITMENTS AND CONTINGENCIES\nAt December 30, 1995, the Company had accrued approximately $1,000,000 for remediation of certain environmental and product liability matters, principally underground storage tank removal.\nMany of the building center facilities presently and formerly operated by the Company and its predecessor contained underground petroleum storage tanks. All such tanks known to the Company located on facilities owned or operated by the Company have been filled, removed, or are scheduled to be removed in accordance with applicable environmental laws in effect at the time. As a result of reviews made in connection with the sale or possible sale of certain facilities, the Company has found petroleum contamination of soil and ground water on several of these sites and has taken, and expects to take, remedial actions with respect thereto. In addition, it is possible that similar contamination may exist on properties no longer owned or operated by the Company the remediation of which the Company could under certain circumstances be held responsible. Since 1988, the Company has incurred approximately $ 2.1 million of costs with respect to the filling or removing of underground storage tanks and related investigatory and remedial actions.\nIn February 1994, the Company was notified that a stock certificate representing 103,922 shares of Common Stock that had been previously reported as lost and that had been reissued and transferred to an affiliate of the Company may in fact not have been lost but instead previously transferred by the original owner to a third party. In connection with the reissuance of the allegedly lost stock certificate, the Company examined its records, found no information concerning a possible prior transfer of the stock certificate, and received an indemnity from the original owner. If both transferees are determined to be bona fide purchasers, both may be entitled to ownership of the 103,922 shares, which would result in a corresponding increase in the number of outstanding shares of Common Stock. In such a case, the Company believes it would be entitled to indemnity from the original owner, which could be utilized to purchase and retire an equivalent number of shares. If either of the purported transferees is determined not to be a bona fide purchaser, its certificate would be canceled. Litigation has been commenced in which, among other things, the Company is seeking indemnity and a declaratory judgment concerning the rights and obligations of the various parties and the original owner is disputing its obligation to indemnify the Company.\nAt December 30, 1995, the Company's investment in RIC was $4.5 million. This investment entails significant inherent risks, including expropriation, legal, currency, crime, management, labor, weather and other operational risks.\nThe Company is one of many defendants in 164 actions, each of which seeks unspecified damages, brought in 1993, 1994 and 1995 in various Michigan state courts against manufacturers and building material retailers by individuals who claim to have suffered injuries from products containing asbestos. All of the plaintiffs in these actions are represented by the same counsel. The Company is aggressively defending these actions and does not believe that these actions will have a material adverse effect on the Company.\nOn November 3, 1995, a complaint was filed against the Company, its directors and Riverside Group, Inc. seeking to enjoin or to obtain damages with respect to the Company's agreement to issue two million newly-issued shares of common stock to Riverside Group, Inc. for $10 million (see Note 9).\nThe Company is involved in various other legal proceedings which are incidental to the conduct of its business. The Company does not believe that any of these proceedings will have a material adverse effect on the Company.\nWF-13 WICKES LUMBER COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nLeases\nThe Company has entered into operating leases for retail space, equipment and other items. These leases provide for minimum rents. These leases generally include options to renew for additional periods. Total minimum rents under all operating leases were $10,501,000, $8,086,000, and $5,482,000 for the years ended December 30, 1995, December 31, 1994, and December 25, 1993, respectively.\nFuture minimum commitments for noncancelable operating leases are as follows:\n9. STOCKHOLDERS' EQUITY\nThe Company's Recapitalization Plan is discussed in Note 4.\nPreferred Stock\nAs of December 30, 1995 the Company had authorized 3,000,000 shares of preferred stock, none of which is issued or outstanding.\nCommon Stock\nThe Company has two classes of common stock: Common Stock, par value $.01 per share, and Class B Non-Voting Common Stock, par value $.01 per share. At December 30, 1995 there were 20,000,000 shares of Common Stock authorized and 5,643,705 shares issued and outstanding, and there were 1,200,000 shares of Class B Non-Voting Common authorized and 499,768 shares issued and outstanding. Class B Non-Voting Common Stock is generally equivalent to Common Stock, except that shares of Class B Non-Voting Common Stock may not be voted except on certain matters regarding merger, consolidation, recapitalization and reorganization, and as otherwise provided by law. Class B Non-Voting Common Stock is convertible into Common Stock on a share-for-share basis in certain circumstances. In addition, at December 30, 1995, 14,589 shares of Class A Voting Common Stock were reserved for issuance under outstanding warrants.\nWarrants\nWF-14 WICKES LUMBER COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nIn 1989 and 1992, the Company issued warrants to certain members of its management. These warrants would have become exercisable for up to 195,970 shares of Common Stock upon the date of determination of the Company's attainment of certain levels of financial results. These warrants were replaced during the Recapitalization Plan by the issuance of 162,975 shares of Common Stock and warrants for 28,756 shares of Common Stock, exercisable through April 29, 1998, at a nominal exercise price.\nStock Options\nAt December 30, 1995 and December 31, 1994, the Company had outstanding, under its Director Incentive Plan, options held by members of the Company's Board of Directors to purchase 16,335 and 16,002 shares of Common Stock, respectively. These options have an exercise price of between $10.95 and $23.25 per share; approximately 3,334 of the options were exercisable at December 31, 1994, of which none were exercised during fiscal 1995. Approximately 5,779 shares were exercisable at December 30, 1995.\nIn addition, at December 30, 1995 and December 31, 1994, the Company had outstanding under its Long-Term Incentive Plan, options held by key employees to purchase 430,351 and 270,213 shares of Common Stock, respectively. These options have an exercise price of between $15.00 and $18.50 per share; approximately 29,683 of the options were exercisable at December 31, 1994, of which none were exercised during fiscal 1995. Approximately 108,295 shares were exercisable at December 30, 1995.\nProposed Sale of Common Stock\nOn January 11, 1996, the Company entered into a definitive agreement with Riverside Group, Inc. (\"Riverside\"), the Company's largest stockholder, that provides for the acquisition by Riverside of 2 million newly-issued shares of the Company's common stock for $10 million in cash. The definitive agreement was approved and recommended by committees of each company's independent directors. The sale is subject to the reorganization or sale by Riverside of one of certain of its operations. The transaction is expected to be completed prior to July 31, 1996.\n10. EMPLOYEE BENEFIT PLANS\n401(k) Plan\nThe Company sponsors a defined contribution 401(k) plan covering substantially all of its full-time employees. Additionally, the Company provides matching contributions up to a maximum of 2.5% of participating employees' salaries and wages. Total expenses under the plan for the years ended December 30, 1995, December 31, 1994, and December 25, 1993 were $1,700,000, $2,625,000, and $2,167,000, respectively.\nPostretirement Benefits Other than Pensions\nThe Company provides life and health care benefits to retired employees. Generally, employees who have attained an age of 60, have rendered 10 years of service and are currently enrolled in the medical benefit plan are eligible for postretirement benefits. The Company accrues the estimated cost of retiree benefit payments, other than pensions, during the employees' active service period.\nWF-15 WICKES LUMBER COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nThe plans' funded status is as follows:\nActuarial assumptions used were as follows:\nThe Company's postretirement health care plan at December 25, 1993 was not funded. The present value of accumulated postretirement benefits at December 25, 1993 was $1,790,000. The assumed discount rate used in determining the accumulated postretirement benefit obligation at December 25, 1993 was 6.63%.\nPostemployment Benefits\nThe Company provides certain postemployment benefits to qualified former or inactive employees who are not retirees. These benefits include salary continuance, severance, and healthcare. Salary continuance and severance pay is based on normal straight-line compensation and is calculated based on years of service. Additional severance pay is granted to eligible employees who are 40 years of age or older and have been employed by the Company five or more years. The Company accrues the estimated cost of benefits provided to former or inactive employees who have not yet retired over the employees service period or as an expense at the date of the event triggering the benefit. The Company incurred postemployment benefit expense of $160,000 (exclusive of amounts included in its restructuring liability) for the year ended December 30, 1995 (see Note 12). The total postemployment\nWF-16 WICKES LUMBER COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nbenefits expense for the years ended December 31, 1994 and December 25, 1993 was $2,000,000 and $53,000, respectively.\n11. INCOME TAXES\nThe Company files a consolidated federal tax return with its wholly-owned subsidiaries. As of December 30, 1995, the Company has net operating loss carryforwards available to offset future U.S. income of approximately $25.3 million expiring in the years 2004 through 2010; and $1.5 million of capital loss carryforwards which expire in the years 1997 through 2000.\nThe completion of the Recapitalization Plan, as discussed in Note 4, created an \"ownership change\" as defined by Section 382 of the Internal Revenue Code of 1986, as amended. As a result of this, certain of the loss carryforwards of the Company are subject to an annual limitation of approximately $2.6 million a year. Due to the inherent tax gain in the assets owned by the Company at the time of the ownership change, the annual limitation on use of the loss carryforwards will be increased by the amount of the gains as they are recognized. To the extent that the 1995 loss carryforward limitation as increased for gains recognized was not utilized in 1995, the annual limitation for 1996 will be increased. The Company has reviewed its valuation allowance for deferred tax assets, the inherent tax gain in the assets owned by the Company at the time of the ownership change, and their net operating loss availability. As a result, the Company anticipates an additional increase to the annual limitation on utilization of loss carryforwards in 1996 of approximately $1.3 million as a result of gains recognized during the year. This amount is subject to further review by the Internal Revenue Service. An additional loss carryforward of $11.2 million was generated during 1995. This amount will be available without limitations, to offset taxable income in future periods and will expire in 2010.\nTax 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 were recorded to reflect changes in temporary differences between the financial reporting basis and the tax basis of the company's assets and liabilities. These amounts are expected to be recognized in future periods . A deferred tax benefit of $11.8 million was recorded in 1995. The benefit in the current year was mainly due to differences in the restructuring liability, allowance for doubtful accounts, net operating loss carryover, intangible asset amortization and utilization of prior year capital loss carryovers. As a result of recognizing the deferred tax benefit in 1995, the Company anticipates their provision for taxes in subsequent years will reflect a normal statutory rate adjusted for state taxes. The Company continues to record a valuation allowance with respect to the future tax benefits of capital losses reflected in deferred income taxes as a result of the uncertainty of their ultimate realization due to restrictions placed on their usage. Significant components of the Company's deferred tax assets and liabilities, and their related tax effects, as of December 30, 1995 and December 31, 1994 are as follows:\nWF-17 WICKES LUMBER COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nIncome tax expense including applicable tax on extraordinary gain, consists of the following components:\nProvision for income taxes on income differs from expected tax expense computed by applying the Federal corporate tax rate of 35% in 1995, 34% in 1994 and 1993 as follows:\nDeferred tax expense results from temporary differences in the recognition of certain items of revenue and expense for tax and financial reporting purposes. The sources of these differences and the tax effect of each were as follows:\nWF-18 WICKES LUMBER COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n12. RESTRUCTURING AND UNUSUAL CHARGES\nDuring the fourth quarter of 1995, the Company committed to and began implementing a restructuring plan to improve return on assets by closing or consolidating under-performing operating centers, decreasing the corresponding overhead to support these building centers, and initiating actions to strengthen its capital structure. Management anticipates completion of the plan in 1996. The costs for closing these building material centers were based on management estimates of costs to exit these markets and actual historical experience. The Company recorded a $17.8 million charge relating to its strategic restructuring program and other one time costs which are reflected in the Company's Consolidated Statements of Operations as restructuring and unusual items.\nThe major components of this charge include the write-down of assets to their net realizable value, liabilities associated with closed building centers held for sale, postemployment benefits to qualified former employees as a result of the center closings, and other charges related to the strengthening of the Company's capital structure.\n13. FAIR VALUE OF FINANCIAL INSTRUMENTS\nIn accordance with SFAS No. 107, \"Disclosures About Fair Value of Financial Instruments,\" information has been provided about the fair value of certain financial instruments. The following methods and assumptions were used to estimate the fair value of each material class of financial instruments covered by the Statement for which it is practicable to estimate that value:\nLong-Term Debt\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 values of the Company's material financial instruments at December 30, 1995 and December 31, 1994 are as follows:\nWF-19 WICKES LUMBER COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n14. RELATED PARTY TRANSACTIONS\nIn September 1992, the Company began efforts to determine the feasibility of obtaining lumber from the former Soviet Republics. In March 1993, the Company determined to enter into a test arrangement that required the approval of one of its former lenders. This former lender declined to grant its approval but permitted the Company's participation, on a test basis, in an arrangement pursuant to which an affiliate of the Company, formed for the purpose, imported in December 1993 a load of rough sawn goods, which the Company acquired upon arrival in the United States and milled into common finishing boards and moulding. On July 31, 1994, the Company acquired the affiliate that imported the test load, Riverside International Corporation, from the Riverside Group, Inc., the Company's largest stockholder, for $895,000. The acquisition was accounted for as a purchase and ended the related party relationship. In December 1995, voting rights to 66 2\/3% of RIC's voting stock were assigned to Riverside Group, Inc. In addition, Riverside Group, Inc. obtained the right, during 1996, to acquire up to $5 million of RIC's non-voting common stock, at the then fair market value.\nIn 1995, the Company paid approximately $613,000 in reimbursements to an affiliate of the Company's chairman and to third parties for costs related to services provided to the Company during 1995 by certain employees of the affiliated company and use of a corporate aircraft. Total payments in 1994 and 1993 for similar services were approximately $810,000 and $860,000, respectively.\nThe Chairman and certain directors of the Company, as well as an affiliated company, own in the aggregate a majority of the voting securities of a private manufacturer of glass products, wooden stair parts and other building materials that supplies products, primarily through independent distributors, to the Company. The Chairman of the Company also is chairman of the board, president and chief executive officer, and one of the Company's directors is a director and officer, of this manufacturer. During 1995, the Company estimates that it purchased approximately $1,423,000 of this manufacturer's products at prices generally available from the third party distributors from which the products were obtained. This compares with $2,086,000 and $1,500,000 of similar products purchased in 1994 and 1993, respectively.\nA certain director and executive officer of the Company, is a shareholder of the law firm that is general counsel to the Company. The Company paid this firm $394,000, $623,000, and $518,000 for legal services provided to the Company during 1995, 1994, and 1993, respectively.\nFor a description of the proposed sale of 2 million newly-issued shares by the Company to Riverside Group, Inc., see Note 9.\n15. COMPUTATION OF EARNINGS PER COMMON SHARE-HISTORICAL BASIS\nThe earnings per common and common equivalent share, computed on a historical basis for fiscal year 1993, less redeemable preferred stock dividends is presented below to comply with the provisions of Accounting Principles Board Opinion No. 15:\nWF-20 WICKES LUMBER COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n16. SUBSEQUENT EVENT\nOn February 21, 1996, the Company and its RIC subsidiary entered into an agreement with two investment funds. Pursuant to this agreement, the two funds are each to invest $5 million in this subsidiary and are each to receive a 25% equity interest, with the Company retaining an interest slightly less than 50% and the subsidiary's management receiving the balance of the equity. A total of $4 million of the funds' investment has been advanced to the subsidiary as a loan, which is to be converted to equity upon funding of the remaining $6 million, which is to occur upon satisfaction of certain conditions, including among other things the resolution of certain legal matters and the achieving of specified operational levels.\nWF-21\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Stockholders, Riverside Group, Inc.:\nOur report on the consolidated financial statements of Riverside Group, Inc. and subsidiaries is included on page of the Annual Report on 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 on page 38 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.\nPhoenix, Arizona March 27, 1996\nS-1 Schedule I Riverside Group, Inc. & Subsidiaries Summary of Investments - Other Than Investments in Related Parties December 31, 1995\nS-2 Schedule II Riverside Group, Inc. (Parent Only) Condensed Financial Information of Registrant Balance Sheets (in thousands)\nS-3 Schedule II Riverside Group, Inc. (Parent Only) Condensed Financial Information of Registrant Condensed Statements of Operations (in thousands)\nS-4 Schedule II Riverside Group, Inc. (Parent Only) Condensed Financial Information of Registrant Condensed Statements of Cash Flows (in thousands)\nS-5 Schedule III Riverside Group, Inc. & Subsidiaries Supplemental Insurance Information For the Years Ended December 31, 1995, 1994, and 1993 (in Thousands)\n(1) Allocation of net investment income is based on specific identification of assets for each segment\n(2) Other operating expenses are determined by specific identification\nS-6 Schedule IV Riverside Group, Inc. & Subsidiaries Reinsurance For the Year Ended December 31, 1995 (in Thousands, except percentages)\nS-7 WICKES LUMBER COMPANY AND SUBSIDIARIES\nSchedule II-Valuation and Qualifying Accounts For the Years Ended December 30, 1995, December 31, 1994, and December 25, 1993 (dollars in thousands)\nWS-1","section_15":""}
{"filename":"74091_1995.txt","cik":"74091","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"Item 3. Legal Proceedings\nTosco's Spokane, Washington terminal is located within a site being investigated by the United States Environmental Protection Agency (the \"EPA\") and the Washington Department of Ecology (the \"WDOE\") for suspected hydrocarbon and lead contamination. Tosco has been notified by the WDOE that it, and the major oil company from which it purchased the facility, are included in the list of six parties potentially liable for cleanup of the site under state law. The area identified by the WDOE was included on the Superfund National Priorities List (the \"Superfund List\"). The source, extent and nature of the contamination have not been determined but are the subject of investigations. Tosco and other potentially liable parties are working with the WDOE with regard to the investigation of the site. The extent of Tosco's liability, if any, is unknown.\nIn 1990 the EPA and the California Regional Water Quality Control Board, San Francisco Bay Region (\"RWQCB\") issued Orders (\"Orders\") identifying suspected releases of hazardous constituents at a number of hazardous waste and solid waste management units on the Avon Refinery property, including several older inactive units which were used by Phillips Petroleum Company (\"Phillips\"), a former owner, but not by Tosco, and directed Tosco to investigate the identified releases and determine the need for corrective action. In July 1992, the RWQCB issued Waste Discharge Requirements which, among other things, ordered Tosco to submit a plan of corrective action (\"Corrective Action Plan\") to deal with the suspected releases of hazardous waste at the Avon Refinery. The Corrective Action Plan was submitted on January 4, 1993. This Plan was subsequently modified through submission of a Perimeter Groundwater Monitoring Plan (\"PGMP\") which received conditional approval by the RWQCB in September 1995. The PGMP is currently under review by EPA. The RWQCB also issued an Order in June 1990 which required Tosco to expand programs monitoring groundwater quality throughout the Avon Refinery and to investigate the presence of subsurface liquid hydrocarbons. In 1992, Tosco received an Order from the RWQCB that among other things, set a date by which significant amounts of subsurface liquid hydrocarbons were to be removed. Pursuant to a lawsuit that was settled in July 1993, Phillips and Texaco, the former owners of the refinery, for the next four years or until the funds provided under the agreement are expended (whichever is later), will pay up to an aggregate of $18 million for one-half of the costs that may be incurred for compliance with certain environmental orders, and in addition, provide Tosco a $6 million credit for past expenses. After the initial term of the agreement, the parties would be free to reinstate the suit. Tosco has not relinquished any of its rights to make claims for reimbursement for costs incurred after the date of settlement and would not be required to reimburse amounts received under the agreement.\nOn September 4, 1992, Tosco received a Report of Violation (\"ROV\") from the California Department of Toxic Substances Control (\"DTSC\"), alleging violations of hazardous waste regulations identified during an inspection of a parcel of land owned by Tosco that was used for petroleum coke storage in connection with operations of Tosco's former Bakersfield Refinery, which was sold in 1986. The ROV, without specifying dates, orders Tosco to comply with various hazardous waste handling practices in connection with the site. Tosco has entered into discussions with DTSC concerning required actions.\nOn July 19, 1995, the WDOE issued an Enforcement Order identifying Tosco, along with approximately 17 other parties, as a potentially liable party under state law for the investigation and remediation of a site known as the Yakima Railroad Area to which the parties allegedly sent carbon containing chlorinated solvents for regeneration. The source, extent and nature of the contamination has not been determined and the extent of Tosco's liability, if any, is unknown.\nA refinery in Duncan, Oklahoma, formerly owned by Tosco, is subject to investigation by the Oklahoma Department of Environmental Quality (\"ODEQ\"). The ODEQ has requested that Tosco participate with the former owner, Sun Company, Inc. (R&M) (\"Sun\"), from whom Tosco purchased the site, and the subsequent owners, including those to whom Tosco sold the site, in the investigation and potential remediation of alleged environmental contamination. On September 29, 1995, Tosco entered into a Consent Agreement and Final Order with ODEQ to investigate the extent of contamination at the refinery, and conduct certain interim remedial actions and prepare a remedial action plan. On April 10, 1995, Tosco filed a complaint for declaratory relief against Sun (Tosco Corporation v. Sun Company, Inc. (R&M), U.S. District Court, Western District of Oklahoma, Case No. Civ 95 556M) to recover the costs of complying with the ODEQ order, and seeking an order determining Tosco's and Sun's rights and legal relations under various environmental laws, including the Comprehensive Environmental Response, Compensation and Liability Act (\"CERCLA\"), the Resource Conservation and Recovery Act (\"RCRA\") and the Oil Pollution Act (\"OPA\"), and under the Purchase Agreement through which Tosco purchased the Duncan Refinery, relating to the costs of environmental investigation and potential remediation at the site.\nOn November 18, 1992, the RWQCB issued an order requiring Tosco, Phillips and Wickland Oil Company (\"Wickland\") to investigate the presence of petroleum hydrocarbons and other substances in the soil and groundwater at an oil terminal owned by Wickland. On the basis of this investigation, on January 17, 1996, the RWQCB approved a remedial work plan identifying Wickland as the party solely responsible for implementing remedial actions at the site.\nOn June 14, 1994, Lion Oil Company (\"Lion\") filed a Complaint against Tosco (Lion Oil Company v. Tosco Corporation, United States District Court, Western District of Arkansas, Case No. 94-1072) as amended on August 22, 1994, seeking an order for reimbursement under CERCLA, contribution and declaratory relief in connection with the investigation and remediation of alleged environmental contamination of a refinery formerly owned by Tosco located in El Dorado, Arkansas. Tosco sold the property to Lion pursuant to an Asset Purchase & Sale Agreement of March 22, 1985 which included specific provisions limiting Tosco's liability with respect to environmental matters. On August 10, 1995, Tosco's motion to dismiss the suit for failure to state a claim was granted. Lion Oil has appealed.\nThe operator of a landfill to which it is alleged Tosco sent hazardous waste has sued numerous alleged waste generators, including Tosco, municipalities and transporters, under CERCLA and other environmental laws, (ACME Landfill Corporation v. Althin CD Medical, Inc. et al., United States District Court, Northern District of California, Case No. C91444268 SBA) to recover the costs for closure\/post closure of the site. The extent of Tosco's liability is yet unknown.\nThe Department of Toxic Substances Control, Region 1 (\"DTSC\"), notified Tosco Corporation that DTSC was preparing an Imminent and Substantial Endangerment Order (\"Order\") naming Tosco and numerous other companies as PRPs for the remediation of the Environmental Protection Corporation (\"EPC\") Eastside Landfill located ten miles northeast of Bakersfield, California. On January 4, 1996, after extensive negotiations, Tosco and 12 other companies entered into a Consent Agreement with DTSC, under which the companies agreed to conduct an investigation of the Landfill, to be funded in part by a trust fund created by EPC and administered by DTSC.\nThe costs of remedial actions are highly uncertain due to, among other items, the complexity and evolving nature of governmental laws and regulations and their interpretations as well as the varying costs and effectiveness of alternative cleanup technologies. However, Tosco presently believes that any cost in excess of the amounts already provided for in the financial statements should not have a materially adverse effect upon Tosco's operations or financial condition. Tosco further believes, as discussed with respect to the Phillips case above, that a portion of future environmental costs, as well as environmental expenditures previously made, will be recovered from other responsible parties under contractual agreements and existing laws and regulations. See Note 15 to the Consolidated Financial Statements.\nThere are various other suits and claims pending against Tosco and its subsidiaries, which in the opinion of Tosco are not material or meritorious or are substantially covered by insurance. While it is impossible to estimate with certainty the ultimate legal and financial liability with respect to these suits and claims, Tosco believes the aggregate amount of such liabilities will not result in monetary damages which in the aggregate would be material to the business or operations of Tosco.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNone\nExecutive Officers of the Registrant\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters\nTosco's Common Stock is traded on the New York Stock Exchange (\"NYSE\") and the Pacific Stock Exchange. Set forth below are the high and low sales prices as reported on the NYSE Composite Tape.\nPrice Range of Common Stock\nThe number of Tosco shareholders of record on February 29, 1996 was 10,465.\nDividend Policy\nTosco has paid a regular quarterly cash dividend on its Common Stock since the third quarter of 1989. Pursuant to the terms of Tosco's working capital facility and its bond indentures, dividends on Tosco's Common Stock are permitted to the extent Tosco satisfies certain defined criteria. Continued payment of such quarterly dividend is also subject to profitable results of operations, which are primarily dependent on the continued favorable performance of Tosco's operating facilities and favorable operating margins. There can be no assurance that Tosco will be able to continue payment of such quarterly dividend.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe following Selected Financial Data are qualified in their entirety by the more detailed Consolidated Financial Statements and related Notes at the end of this report. The Selected Financial Data for each of the five years ended December 31, 1995 are derived from the Consolidated Financial Statements of Tosco audited by Coopers & Lybrand L.L.P., independent accountants.\nTOSCO CORPORATION AND SUBSIDIARIES SELECTED FINANCIAL DATA(a) (Millions of dollars except per share and ratio data)\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nINTRODUCTION\n1995 was a year of progress for Tosco. Excluding special items, operating results improved over 1994 despite lower refinery operating margins, a testament to Tosco's successful strategy to diversify the company's asset base by expanding downstream into retail. Tosco increased the number of company operated stations, acquired under long-term lease 28 Brown Bear car wash sites in the Puget Sound area, and entered into an agreement to acquire BP Oil's Northeast marketing and refining assets which was completed in February 1996. Tosco's balance sheet was also strengthened as the ratio of long-term debt to total capitalization dropped below 50% for the first time since 1993 when Tosco entered into its period of rapid growth. Tosco took initial steps in transitioning to an unsecured debt structure through the issuance of $125 million of unsecured 7% notes to pay down collateralized floating rate bank debt and through an agreement to sell receivables to a financial institution. West Coast administrative operations were also consolidated to achieve efficiencies.\nTosco earned $77.1 million, or $2.04 per fully diluted share, on sales of $7.3 billion for 1995 compared to $83.8 million, or $2.24 per fully diluted share, on sales of $6.4 billion for 1994. Results of operations for 1995, include a restructuring charge totaling $5.2 million ($3.1 million after tax, $.08 per share) related to a major expense reduction program at the Avon Refinery. Results of operations for 1994 include the reversal of 1993's $17.7 million ($10.7 million after tax, $.29 per share) writedown of LIFO inventories due to the recovery of prices during 1994, and a $6 million ($3.6 million after tax, $.10 per share) environmental cost accrual for probable investigative and remedial liabilities at former operating locations.\nExcluding special items, Tosco generated an operating contribution (income before selling, general and administrative expense, net interest expense and income taxes) for 1995 of $285 million, an increase of $24 million over 1994. The increase was primarily attributable to the excellent production operations of the Avon and Bayway Refineries, lower production costs, moderately higher East Coast operating margins, and the continued strong performance of expanded retail operations which more than offset declines in West Coast refinery operating margins and reduced production from the Ferndale Refinery.\n(a)Bayway's margins include the results of hedges designed to lock in a predetermined level of operating margins on a varying percentage of Bayway's production.\n(b)Avon's catcracker (the principal gasoline production unit) and the processing units at the Ferndale Refinery were shut down for scheduled maintenance during the first quarter of 1995.\n(c)Bayway's production results for 1995 reflect the benefit of expanded crude distillation capacity completed in the third quarter of 1994.\n(d) Avon's fluid coker (the refinery's principal conversion unit) and Bayway's fluid catcracker were shut down for scheduled turnaround maintenance in 1994.\n(e) As illustrated by the table, operating margins vary significantly by refinery. This variance is due to a number of reasons including marketing conditions in the principal areas served by the refineries, their configuration and complexity (ability to convert raw material into clean product) and maintenance schedules.\n(f) Restated to reflect operating contribution per charge barrel (sales minus cost of sales, excluding refinery operating costs and non-operating items divided by total refinery charges).\nThe Avon Refinery's operating contribution declined from 1994 due to poor operating margins that overshadowed record production. The fluid catalytic cracking unit (catcracker), Avon's principal gasoline production unit, was shutdown for major scheduled maintenance for 55 days in the first quarter of 1995, negatively impacting clean product yields for the year. Despite the catcracker shutdown, crude oil processed averaged 167,700 barrels per day (B\/D), an increase of 6,900 B\/D over 1994 and the highest in Avon's history. Production of clean transportation fuels (gasoline, diesel and jet fuel) increased by 4,100 B\/D to 136,800 B\/D. However, Avon's operating margin per charge barrel declined by $.67 to $5.56 per barrel for 1995 as excess supply in highly competitive markets depressed product prices, particularly in the first quarter of 1995. In response to continuing poor operating margins, Tosco implemented a restructuring program to reduce costs and increase efficiency. The restructuring cost of $5.2 million, recorded in the first and second quarters of 1995, was primarily for the then anticipated severance costs of approximately 175 people at the Avon Refinery and related support locations.\nBayway's operating contribution for 1995 improved over 1994 due to record refinery production rates, higher margins, and lower production costs. Raw material throughput increased 39,300 B\/D to a record 291,600 B\/D, while production of clean transportation fuels and heating oil also increased 36,700 B\/D to a record 241,500 B\/D. Expanded crude distillation capacity completed in 1994 and record production unit rates of the fluid catalytic cracking unit, the world's largest and Bayway's principal gasoline production unit, were the principal reasons for the record production rates. The catcracker was shutdown for scheduled turnaround maintenance in 1994. Bayway's operating margin per charge barrel improved $.25 per barrel for the year, primarily during the second half of 1995 as a result of increased sale prices. Operating margins for the year were hurt by the exceptionally weak market conditions of the first quarter of 1995 caused by the combined impact of a surplus of heating oil and poor gasoline markets. Operating margins improved during the balance of the year as demand strengthened and uncertainty over the introduction of reformulated gasoline (RFG) subsided.\nOperating contribution from Tosco Northwest, whose operations encompass retail marketing operations and the Ferndale Refinery, declined from 1994. The decrease was primarily due to poor refining margins and the shutdown of the refinery for 33 days for turnaround maintenance during the first quarter of 1995. Ferndale's operating margin per charge barrel declined $.37 per barrel and refinery throughput declined 9,000 B\/D to 81,600 B\/D. Retail operations generated an operating contribution of $75 million for 1995, an increase of $11 million from 1994. Retail volumes sold increased 18,000 B\/D to 68,000 B\/D due to the acquisitions of retail operations in Northern California and Arizona in August 1994 and December 1994, respectively. Retail gasoline margins remained approximately the same at $.10 per gallon for 1995 and 1994.\nSelling, general, and administrative expense (SG&A) for 1995 increased by $11.7 million to $95.9 due to Tosco's expanded retail operations and higher levels of incentive compensation (due to higher levels of operating income before special items) which was partially offset by certain benefit recoveries. SG&A expense for 1994 was reduced by insurance recoveries of $3.5 million (related to now-settled litigation with the predecessor owners of the Avon Refinery over environmental matters) and $1.0 million (related to a retroactive adjustment of prior year medical costs based on favorable claim experience). See Note 15 to the Consolidated Financial Statements.\nIn June 1995, Tosco entered into a three year agreement with a financial institution to sell on a revolving basis up to $100 million of an undivided percentage ownership interest in a designated pool of accounts receivable (Receivable Transfer Agreement). Costs of the Receivable Transfer Agreement, which totaled $3.1 million for six months (less than interest costs would have been on equivalent cash borrowings under Tosco's Revolving Credit Agreement), are included in cost of sales. See Note 3 to the Consolidated Financial Statements. Interest expense increased in 1995, despite the reduction in interest costs resulting from the Receivable Transfer Agreement, due to higher debt levels related to Tosco's expanded operations.\nThe provision for income taxes for 1995 increased by $.4 million despite lower pre-tax income because the tax provision for 1994 included recognition of revised income tax benefits of $2.9 million related to Tosco's discontinued fertilizer operations.\nRESULTS OF OPERATIONS - 1994\nTosco earned $83.8 million, or $2.24 per fully diluted share, on sales of $6.4 billion for 1994 compared to $80.6 million or $2.33 per fully diluted share, on sales of $3.6 billion for 1993. Despite income rising $3.3 million, earnings per fully diluted share for 1994 fell by $.09 per share because of the issuance of 2,990,000 shares of Common Stock in December 1993. Results of operations for 1994 include the reversal of 1993's $17.7 million writedown of LIFO inventories due to the recovery of prices during 1994. Tosco also recorded a $6 million environmental cost accrual for probable investigative and remedial liabilities at former operating locations.\nTosco's acquisitions and expanded wholesale operations were the principal reasons for the increase in sales and cost of sales for 1994 compared to 1993. In April 1993, Tosco purchased the Bayway Refinery and related assets from Exxon Corporation. In December 1993, Tosco acquired, through long-term lease, Northville Industries' Long Island, New York oil distribution system and purchased the Ferndale Refinery and retail marketing operations in the Pacific Northwest from BP Exploration & Oil Inc. (BP). In August 1994 and mid-December 1994, Tosco expanded its retail system through the acquisition, under long-term lease arrangements, of the retail marketing operations of BP in Northern California and Exxon in Arizona, respectively.\nTosco generated an operating contribution before special items for 1994 of $260 million from its three refineries and retail marketing operations, an increase of $8 million over 1993.\nTosco Northwest produced an operating contribution of $118.6 million in its initial year of operations due to strong retail margins, good production results from the Ferndale Refinery, and good refining margins in the Pacific Northwest. The Ferndale Refinery processed 90,600 B\/D of raw materials for 1994, a 17,100 B\/D improvement over 1993 production results under previous management. Operating margins per charge barrel were $3.62 for 1994 due to strong product prices, especially for residual fuels, while retail margins averaged $.10 per gallon on sales volume of 2.1 million gallons per day.\nThe Avon Refinery and its related commercial operations experienced a decline in operating contribution from 1993 due to reduced production levels and poor operating margins. Raw material throughput rates for 1994 fell by 5,700 B\/D to 160,800 B\/D while production of clean transportation fuels fell by 4,900 B\/D to 132,700 B\/D. Scheduled turnaround maintenance on the fluid coker, which was completed during the second quarter of 1994, was the primary reason for the fall in production. Tosco also reduced production levels in early December 1994 in response to poor operating margins and to prepare for an early start of the major upgrade and turnaround of the catcracker which occurred in January 1995. Avon's operating margins per charge barrel for 1994 declined by $1.17 to $6.23, the lowest since 1987. Increases in raw material costs were not matched by increases in product prices because of excess supply, highly competitive markets, and the lingering effects of the recession in California, Avon's principal market, which lagged the improvement in the national economy.\nBayway's operating contribution for 1994 includes the reversal of the $17.7 million writedown of LIFO inventories recorded in 1993. Excluding the inventory valuation, Bayway's operating contribution for 1994 declined from the approximate nine month operating period of 1993. The decline in operating contribution was primarily due to reduced production, weak operating margins and higher distribution costs. Raw materials processed declined by 7,000 B\/D to 252,200 B\/D while production of clean transportation fuels and heating oil declined by 9,100 B\/D to 204,800 B\/D due to scheduled turnaround maintenance of the catcracker, during the third quarter of 1994. Bayway also reduced production runs in early December in response to weak operating margins in the Northeast and to perform some minor but necessary maintenance of production units.\nOperating margins per charge barrel averaged $2.63 for the year, a decline of $.55 from 1993. Bayway, like Avon, was not able to match increases in raw material costs with comparable increases in product prices, due to excess supply in highly competitive markets. In addition, fourth quarter margins were negatively impacted by mild winter weather and market uncertainty over the introduction of cleaner burning but higher cost reformulated gasoline (RFG). Certain areas in the Northeast elected to opt out, and were permitted to do so by the federal government, of their voluntary participation in the RFG program (mandated by federal regulations for the largest metropolitan areas of the United States). Operating costs were also impacted by higher distribution costs as Bayway expanded its terminal distribution network and commercial operations.\nSelling, general and administrative expense for 1994 increased by $25.9 million to $84.1 million due to Tosco's expanded operations.\nThe increase in net interest expense for 1994 is primarily due to higher levels of debt related to Tosco's acquisitions and their associated working capital requirements and higher short-term interest rates.\nThe provision for income taxes for 1994 reflects a 1.5% reduction in the annual effective income tax rate and recognition of $2.9 million of revised income tax benefits related to Tosco's former activities. The effective rate reduction is attributable to revised state income tax allocation factors and estimated California investment tax credits. The provision for income taxes for 1993 included prior year tax credits of approximately $2.5 million which were finalized in tax returns filed in October 1993.\nRESULTS OF OPERATIONS - 1993\nTosco's continuing operations earned $80.6 million, or $2.33 per fully diluted share, on sales of $3.56 billion for 1993 as compared to income from continuing operations of $30.2 million, or $.68 per fully diluted share, on sales of $1.86 billion for 1992. Continuing operations exclude the results of Tosco's former phosphate fertilizer operations.\nTosco's operating contribution of $234.1 million for 1993, after an inventory writedown of $17.7 million, increased by $126.4 million over 1992 due to a $74.8 million increase in operating contribution from Avon and its related commercial activities and an operating contribution of $51.6 million from Bayway and its related commercial activities. Avon's improvement in operating contribution was primarily attributable to record production rates, improved operating margins and lower environmental cost accruals, partially offset by the increased refinery and product distribution costs associated with higher levels of production. Raw material throughput rates averaged a then record 166,310 B\/D for 1993 (versus 152,510 B\/D for 1992) and production of clean transportation fuels also averaged a record 137,610 B\/D (versus 126,570 B\/D for 1992). Operating margins improved by $.37 to $7.40 per barrel as per barrel costs of raw materials fell by more than the sales value of refined products produced. The improved margins (achieved despite the sluggish economy, especially in California) were assisted by the completion and start up of facilities for the production of low-sulfur, low-aromatic diesel fuel meeting the California Air Resources Board's (CARB) cleaner burning fuel standards effective October 1, 1993.\nBayway achieved an operating contribution of $51.6 million, after an inventory writedown of $17.7 million, for the period April 8, 1993 to December 31, 1993 due to strong refinery performance in a period of lackluster margins. Raw material throughput averaged 259,250 B\/D while production of clean transportation fuels and heating oil, and total production averaged 213,980 and 264,490 B\/D, respectively. Operating margins, including net realized results of hedges, averaged $3.18 per barrel.\nConsolidated selling, general and administrative expense of $58.2 million for 1993 increased by $19.4 million over 1992 primarily due to the acquisition of Bayway (including approximately $7.5 million of non-recurring costs incurred in establishing commercial, accounting and general and administrative functions at Bayway).\nConsolidated net interest expense for 1993 of $44.1 million increased by $26.2 million over 1992. Net interest expense for 1992 includes $12.8 million of intercompany interest income from discontinued operations and the writeoff of approximately $3.6 million of deferred financing costs related to previously outstanding indebtedness. Without the effect of these two items, consolidated net interest expense for 1993 increased by $17 million as the costs of higher levels of debt (resulting from the purchase of Bayway and its associated working capital requirements) more than offset the benefits of lower interest rates.\nThe provision for income taxes for 1993 includes the 1% increase in federal income tax rates effective January 1, 1993 as well as tax credits of approximately $2.5 million which were finalized in tax returns filed in October 1993.\nACQUISITIONS\nOn February 2, 1996, Tosco completed the purchase of the U.S. Northeast marketing and refining assets from BP for $59 million, excluding the value of inventories. Under the purchase agreement, Tosco obtained an exclusive license valid for 15 years, with various renewal options, to market retail gasoline and diesel fuels under the BP brand. The license covers Delaware, Maryland, the Washington D. C. metropolitan area, Pennsylvania, New Jersey, New York, Connecticut, Rhode Island, Massachusetts, Vermont, New Hampshire and Maine. Portions of western Pennsylvania and Maryland are excluded. The term of Tosco's exclusive license in nine Western states was also extended to 15 years from the closing date. The purchase also included the 180,000 B\/D Marcus Hook Refinery near Philadelphia (which was taken over in a non-operating mode), petroleum product terminals and certain associated pipeline interests (some of which are surplus to Tosco's needs and will be sold). Tosco has also offered to buy BP's one-third interest in the Harbor pipeline on which BP's partners have a right of first refusal to acquire BP's interest. BP retains environmental obligations relating to the Marcus Hook Refinery and other properties included in the sale.\nOn February 16, 1996, Tosco announced an agreement to purchase all outstanding shares of the Circle K Corporation (Circle K) for $29 per share and to merge Circle K with a subsidiary of Tosco. Circle K is a large gasoline retailer and operator of company-owned convenience stores. A definitive agreement was signed with the holders of approximately 68% of Circle K's outstanding shares (Selling Shareholders) and a merger agreement was approved by the Board of Directors of both companies. Under the stock purchase agreement, Selling Shareholders will receive a combination of cash and common stock of Tosco (Common Stock). Under the merger agreement the remaining shareholders will receive Common Stock. Payment of the total acquisition price of approximately $710 million, not including transaction and certain other costs, will consist of approximately 6.5 million shares of Common Stock and cash. The common stock to be issued is subject to adjustment if the price of Common Stock fluctuates outside an agreed range and for shares issued with respect to stock options held by certain employees of Circle K. Tosco expects to finance the cash requirements from borrowings under contemplated new debt arrangements and from available cash and credit facilities. Completion of the transaction is subject to certain conditions including the approvals of regulatory authorities and the shareholders of Circle K. The acquisition is expected to close prior to mid-year.\nOUTLOOK\nResults of operations are determined by two principal factors: the operating efficiency of the refineries and refining and retail operating margins. Scheduled major maintenance of Avon's cat cracker and the processing units at Ferndale in the first quarter of 1995 completed a cycle of heavy turnaround maintenance. Accordingly, Tosco's currently operating refineries are expected to operate at high production levels for 1996. The Marcus Hook Refinery is expected to remain in a non-operating mode in 1996. Margins at the beginning of 1996 were satisfactory but Tosco is not able to predict the level or trend of refinery and retail operating margins because of the uncertainties associated with oil markets.\nTosco, and other refiners, made significant capital expenditures to meet the cleaner burning RFG gasoline standards of the California Air Resources Board (CARB) effective March 1, 1996 (CARB Phase II gasoline). Tosco also entered into a 7 year arrangement with Chevron Products Company which provides Tosco 35,000 B\/D of CARB Phase II gasoline for 35,000 B\/D of conventional gasoline plus differentials. Tosco is not certain that the higher cost of CARB Phase II gasoline will be fully recovered in higher sales prices. In November 1995, the 22 year ban on the export of Alaskan North Slope (ANS) crude oil, a primary source of raw material for West Coast refineries, was lifted. This action may lead to higher costs for ANS and other domestic crude oils.\nIn January 1996, Atlantic Richfield Company (ARCO) informed Tosco that it would not extend its ten year exchange agreement when it expires at the end of 1996. Under the exchange agreement, ARCO presently delivers 50,000 B\/D of ANS crude oil to the Avon Refinery in exchange for a variable quantity of gasoline. The economic effects of the termination are uncertain. However, Tosco expects to acquire alternative suppliers and customers (including its own expanded retail operations) to replace ARCO when the exchange agreement expires.\nIn view of uncertain operating margins and highly competitive markets, Tosco is committed to improving its results by lowering costs in all areas of operation. Restructuring efforts taken in the first half of 1995 produced reductions in unit operating costs at the Avon Refinery. These efforts are continuing. West Coast operating and administrative functions were consolidated in late 1995 and the company was reorganized into functional organizations in February 1996. The acquisition of Circle K will also allow further economies of scale.\nTo reduce Tosco's exposure to fluctuations in refinery operating margins, Tosco has at times used futures contracts and other derivatives to lock in what it considered to be acceptable refinery operating margins on a varying percentage of future production. At December 31, 1995, Tosco had hedged approximately 3% of Bayway's expected first quarter and annual 1996 production at acceptable historical margins.\nTosco's expansion and diversification into retail marketing has been successful in providing earnings growth and stability. The acquisition of Circle K, which Tosco expects to be additive to Tosco's per share earnings after the combined operations are fully integrated, advances Tosco's goal of becoming a major gasoline retailer. It adds convenient store operations, a third major related component to Tosco's petroleum refining and gasoline retail business.\nCASH FLOWS AND LIQUIDITY - 1995\nAs summarized in the Statement of Cash Flows, cash decreased by $5 million during 1995 as cash used in investing and financing activities of $301 million and $111 million, respectively, exceeded cash provided by operating activities of $407 million.\nCash provided by operating activities of $407 million was from cash earnings of $226 million (net income plus depreciation, amortization, and deferred income taxes) plus a decrease in working capital of $180 million and $1 million from other sources.\nNet cash used in investing activities totaled $301 million, primarily for capital additions and deferred turnaround expenditures of $203 million and $48 million, respectively and increases in other assets (primarily trademarks) of $51 million.\nCash used in financing activities totaled $111 million as net repayments under short-term bank lines and the revolving credit facility of $210 million, dividend payments of $24 million and debt and other payments totaling $2 million exceeded proceeds from the 7% Notes of $125 million.\nLiquidity (as measured by cash, short-term investments and deposits and unused credit facilities) increased by $150 million during 1995 due to an increase of $156 million in unused credit facilities partially offset by a decrease in cash, cash equivalents, short-term deposits and investments of $6 million. At December 31, 1995, liquidity totaled $363 million (an amount when supplemented by cash borrowings under contemplated new debt arrangements to finance the Circle K acquisition, Tosco believes is adequate to meet its expected liquidity demands for at least the next twelve months).\nCAPITAL EXPENDITURES AND CAPITALIZATION\nTosco spent $203 million on budgeted capital projects in 1995. Tosco and BP also entered into an agreement to settle contingent participation payments related to the acquisition of BP's Pacific Northwest refining and retail assets for $35 million. See Note 8 to the Consolidated Financial Statements.\nA large portion of capital spending on refinery projects was related to the Avon Refinery's clean fuels program to meet the CARB Phase II specifications. The multi-year project, which was completed on time and on budget, converts a significant portion of Avon's gasoline production to CARB Phase II gasoline. With the exchange of conventional gasoline for CARB Phase II gasoline with Chevron, approximately 85% of Avon's gasoline production will meet CARB Phase II specifications. Other refinery capital expenditures continued to address required environmental and safety programs. The balance of Tosco's refinery capital investments targeted discretionary low cost, high return projects to lower operating costs, improve refinery throughput or yields, or increase operating flexibility and reliability. Bayway's fuel products controls were improved with the installation of a modern \"state of the art\" refinery control system. The new computer system, which monitors and directs all refinery production processes, has resulted in better production levels and yields with greater reliability, safety and environmental compliance.\nBayway Refining Company has entered into a contract to acquire a Solvent Deasphalter for approximately $32.5 million, plus the cost of agreed upon modifications and interest, at mechanical completion (as defined). Construction of this unit began in 1995 and mechanical completion is expected in the third quarter of 1996. Tosco is responsible for other capital improvements to tie in the Solvent Deasphalter into the Bayway Refinery system raising the total expected cost of the unit to approximately $48 million. When completed, this unit will process approximately 20,000 B\/D of lower-valued residual fuel to produce feedstock for the refinery's fluid catalytic cracker and reduce the amount of higher-cost, partially refined feedstocks that Bayway currently purchases from third parties.\nIn May 1995, Tosco announced a three-year, $200 million capital program to expand its western retail operations through the development of new, and enhancement of existing, retail facilities in existing and new markets, the acquisition of existing stations or systems, and development of new jobber business. In August 1995, Tosco entered into an agreement to expand an existing lease facility to finance the acquisition and improvement of up to $15 million of service station properties in Arizona. At December 31, 1995, Tosco, as agent for the lessor, had spent approximately $3.6 million but had not yet entered into leases pending completion of construction. In November 1995, Tosco acquired under long-term lease the Brown Bear car wash facilities in the Puget Sound area. The pending acquisition of Circle K has curtailed further expansion plans. Capital spending will now be focused on improving present sites that can be financed from internal cash flows.\nTosco expects to fund its 1996 capital expenditures for its refineries from cash provided by operations, available credit, and other resources. In view of the pending acquisition of Circle K, capital spending for retail operations will be refocused on the enhancement of existing retail sites and the intergration, after the acquisition, of both operations. To increase financial flexibility and reduce interest costs, Tosco amended its working capital agreement in April 1995, entered into a Receivable Transfer Agreement in June 1995, and issued $125 million of unsecured 7% Notes in July 1995. Tosco is contemplating other financing alternatives to improve its financial capacity and flexibility, including a new unsecured credit facility to be used for general corporate purposes and, to partially fund the Circle K acquisition, a $200 million public debt offering.\nAt December 31, 1995, total shareholders' equity was $627 million, an increase from December 31, 1994 of $52 million due to net income ($77 million) less dividend and other payments ($25 million). Debt, including current maturities and short-term bank borrowings, decreased by $85 million to $645 million at the end of 1995.\nIMPACT OF INFLATION\nThe impact of inflation has been less significant during recent years because of the relatively low rates of inflation experienced in the United States. Raw material costs, energy costs, and labor costs are important components of Tosco's costs. Any or all of these components could be increased by inflation, with a possible adverse effect on profitability, especially in high inflation periods when raw material and energy cost increases generally lead finished product prices. In addition, a rapid escalation of raw material and finished products prices could result in credit restrictions if working capital requirements exceed the maximum availability under Tosco's working capital facilities.\nRISK MANAGEMENT\nTosco uses a variety of strategies to reduce commodity price, interest and operational risks.\nAs discussed in Note 2 to the Consolidated Financial Statements, Tosco, at times and when able, uses futures contracts to lock in what it believes to be favorable margins on a varying portion of Bayway's production by taking offsetting long (obligation to buy at a fixed price) positions in crude oil and short (obligation to deliver at a fixed price) positions in gasoline and heating oil futures and forward contracts. This strategy hedges Bayway's exposure to fluctuations in refining margins and therefore reduces the volatility of operating results. In addition, Tosco enters into swap contracts with counterparties (typically agreeing to sell at fixed forward prices, and to buy at future variable market prices, stated volumes of residual fuels) to hedge sales prices of the Bayway Refinery's residual fuels production. At December 31, 1995, Bayway had hedged approximately 3% of its expected first quarter and annual 1996 production, respectively, at acceptable historical margins. Tosco utilizes futures and forward contracts to a lesser extent to hedge inventories stored for future sale and to hedge against adverse price movements between the cost of foreign crude oil that Bayway refines and the cost of domestic crude oil.\nTosco manages its interest rate risk by maintaining a mix of fixed rate and floating rate debt. Currently, floating rate debt, primarily borrowings under the Revolving Credit Facilities which provide up to $450 million of revolving credit availability, is used to finance Tosco's working capital requirements. Existing fixed rate debt consists primarily of $125 million unsecured non-callable notes issued in July 1995 to repay indebtedness under the Revolving Credit Facilities and $450 million of mortgage bonds issued in 1992 and 1993 to refinance previously outstanding floating rate bank debt and to finance the acquisition of capital assets including the acquisition of the Bayway Refinery. As required by the previously outstanding bank debt agreement, Tosco entered into an interest rate swap agreement which converted a predetermined percentage of floating rate bank term debt ($31.5 million at December 31, 1995) to fixed rate term debt. The interest rate swap expires in the second quarter of 1996.\nTosco carries insurance policies on insurable risks, which it believes to be appropriate at commercially reasonable rates. While Tosco believes that it is adequately insured, future losses could exceed insurance policy limits or, under adverse interpretations, be excluded from coverage. Future liability or costs, if any, incurred under such circumstances would have to be paid out of general corporate funds, if available. See Note 2 to the Consolidated Financial Statements for a discussion of Tosco's strategy to reduce credit risk.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe financial statements and supplementary data required by Part II, Item 8, are included in Part IV, as indexed at Item 14(a)(1) and (a)(2).\nITEM 9.","section_9":"ITEM 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThere is hereby incorporated by reference the information appearing under the caption \"Nominees for Election\" in the registrant's definitive Proxy Statement relating to its 1996 Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission. See also the information appearing under the caption \"Executive Officers of the Registrant\" appearing in Part I.\nTosco is not aware of any family relationship between any Director or executive officer. Each officer is generally elected to hold office until the next Annual Meeting of the Board of Directors.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThere is hereby incorporated by reference the information appearing under the caption \"Executive Compensation\" in the registrant's definitive Proxy Statement relating to its 1996 Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThere is hereby incorporated by reference the information appearing under the caption \"Stock Ownership of Officers and Directors\" and \"Other Matters - Certain Security Holdings\" in the registrant's definitive Proxy Statement relating to its 1996 Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThere is hereby incorporated by reference the information appearing under the caption \"Executive Compensation\" in the registrant's definitive Proxy Statement relating to its 1996 Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES\n(A)(1) AND (A)(2). FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES. The consolidated financial statements and financial statement schedules of Tosco Corporation and subsidiaries, required by Part II, Item 8, are included in Part IV of this report. See Index to Consolidated Financial Statements and Financial Statement Schedules on page.\n(A)(3). EXHIBITS.\n3(a). Restated Articles of Incorporation of Registrant as currently in effect, including Certificates of Voting Powers, Designations, Preferences and Relative, Participating, Optional or Other Special Rights of Preferred Stock. Incorporated by reference to Exhibit 28.2 to Registrant's Current Report on Form 8-K dated July 29, 1991.\n3(b). By-laws of Registrant as currently in effect. Incorporated by reference to Exhibit 3(b) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1992.\n4(a). Form of Indenture between Registrant and IBJ Schroder Bank and Trust Company, as Trustee, relating to 9% Series A First Mortgage Bonds due March 15, 1997 and 9 5\/8% Series B First Mortgage Bonds due March 15, 2002. Incorporated by reference to Exhibit 4.1 to Registration Statement filed by Registrant on Form S-3 dated March 4, 1992.\n4(b). Form of Indenture among Registrant, Bayway Refining Company and the First National Bank of Boston, as Trustee, relating to 8 1\/4% First Mortgage Bonds due 2003. Incorporated by reference to Exhibit 4.1 to Registration Statement filed by Registrant on Form S-4 dated April 29, 1993.\n4(c). Form of Indenture dated as of July 7,1995 between Registrant and The First National Bank of Boston, as Trustee, relating to 7% Notes due 2000. Incorporated by reference to Exhibit 4.1 to Registration Statement filed by Registrant on Form s-3 dated May 18, 1995 (No- 33-59423).\n10(a). Second Amended and Restated Credit Agreement dated as of April 7, 1995 among Tosco Corporation, Tosco Europe Limited and Bayway Refining Company, as Borrowers, and the Banks names therein, as Banks, and The Chase Manhattan Bank (National Association) as Co-Agent, Bank of America National Trust and Savings Association, as Co-Agent and Co-Arranger, and the First National Bank of Boston. as Agent and Arranger.\n10(b). Exchange Agreement dated October 2, 1986, between Registrant and Atlantic Richfield Company. Incorporated by reference to Exhibit 10(aa) to Registration Statement filed by Registrant on Form S-1 under the Securities Act of 1933 (No. 33-9578).\n10(c) Severance Agreement dated November 15, 1989, between Registrant and James M. Cleary. Incorporated by reference to Exhibit l0(i) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1990. Schedule identifying similar agreement between Registrant, or its subsidiaries, and another employee. Amendments, effective as of January 1 and February 1, 1993, to said Agreements. Incorporated by reference to Exhibit 10(e) to Registrant's Annual Report on Form 10- K for the fiscal year ended December 31, 1993.\n10(d). Severance Agreement dated January 1, 1993 between Registrant and Thomas D. O'Malley including schedule identifying similar agreements between Registrant, or its subsidiaries, and four of its employees. Incorporated by reference to Exhibit 10(g) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1993.\n10(e). Indemnification Agreement dated September 30, 1987, between Registrant and James M. Cleary, including schedule identifying similar agreements between Registrant and its Directors and\/or officers, together with related Trust Agreement. Incorporated by reference to Exhibit 10(aa) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1987.\n10(f). Sale and Purchase Agreement for Bayway Refinery and Related Facilities dated December 10, 1992 between Exxon Corporation and Bayway Refining Company. Incorporated by reference to Exhibit 10(l) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1992.\n10(g). Amendment, dated April 30, 1992, to TTTI Buy\/Sell Contract No. 35P73, dated February 22, 1990 between Texaco Trading and Transportation Inc. and Tosco Refining Company. Incorporated by reference to Exhibit 10(q) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1992.\n10(h). Amendment, dated April 30, 1992, to TTTI Buy\/Sell Contract No. 17P77, dated April 13, 1988 between Texaco Trading and Transportation Inc. and Tosco Refining Company. Incorporated by reference to Exhibit 10(r) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1992.\n10(i). Crude Oil Supply Agreement dated December 28, 1993 between BP Oil Supply Company and Tosco Corporation. Incorporated by reference to Exhibit 10(r) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1993.\n10(j). Trademark License Agreement dated December 28, 1993 between British Petroleum Company p.l.c. and Tosco Corporation. Incorporated by reference to Exhibit 10(s) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1993. Schedule Identifying (i) Amended and Restated Trademark License Agreement between British Petroleum Company p.l.c. and Tosco Corporation dated as of August 1, 1994 and (ii) Trademark License Agreement (California) between BP Oil Marketing Inc. and Tosco Corporation dated as of August 1, 1994. These agreements extended the term of the original agreement and expanded the territory of the original agreement.\n10(k). Agreement for the Purchase and Sale of Assets dated as of the 9th day of November, 1993 by and between BP Exploration & Oil Inc. and Registrant. Incorporated by reference to Exhibit 1 to Registrant's current Report on Form 8-K dated November 9, 1993.\n10(l). Stock Sale Agreement dated February 16, 1996 by and among Tosco and various stockholders of the Circle K Corporation. Incorporated by reference to Exhibit 1 to Registrant's Schedule 13D dated February 23, 1996, filed with respect to The Circle K Corporation.\n10(m) Agreement and Plan of Merger dated as of February 16, 1996 by and among Tosco, Tosco Acquisition Sub, Inc. and The Circle K Corporation. Incorporated by reference to Exhibit 2 to Registrant's Schedule 13D dated February 23, 1996, filed with respect to The Circle K Corporation.\n11. Statement regarding computation of per share earnings. See Exhibit 11 to Financial Statements (page), as required by Item 8 and appearing in Item 14 hereof.\n21. A list of all subsidiaries of the Registrant.\n. 23. Consent of Coopers & Lybrand. . 27. Financial Data Schedule\n99. Condensed Consolidating Financial Information and Report of Independent Accountants\n(B). REPORTS ON FORM 8-K\nNone\n(C). Financial Statement schedules required by Regulation S-X are excluded from the Annual Report to Shareholders by Rule 14a-3(b)(1). See Schedule II to the Financial Statements, as required by Item 8, and appearing under Item 14 hereof.\nTOSCO CORPORATION AND SUBSIDARIES\nINDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES FILED WITH THE ANNUAL REPORT OF THE COMPANY ON FORM 10-K YEAR ENDED DECEMBER 31, 1995\nPAGE(S)\nReport of Independent Accountants\nConsolidated Balance Sheets as of December 31, 1995 and 1994\nConsolidated Statements of Income for the Years Ended December 31, 1995,1994 and 1993\nConsolidated Statements of Cash Flows for the Years Ended December 31, 1995, 1994 and 1993\nConsolidated Statements of Common Shareholders' Equity for the Years Ended December 31, 1995, 1994 and 1993\nNotes to Consolidated Financial Statements -\nFinancial Statements Schedules: II - Valuation and Qualifying Accounts\nFinancial Exhibits -\nFinancial statement schedules other than those listed above have been omitted since they are either not required, are not applicable, or the required information is shown in the financial statements and related notes.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors Tosco Corporation\nWe have audited the consolidated financial statements and the financial statement schedule of Tosco Corporation and subsidiaries listed in the index on page of this Form 10-K. These financial statements and the financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and the financial statement schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and 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 Tosco Corporation and subsidiaries as of December 31, 1995 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, 1995, 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.\nOakland, California January 25,1996, except as to the information in Note 16, for which the date is February 16, 1996\nTOSCO CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS thousands of Dollars\nTOSCO CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (Thousands of Dollars Except Per Share Data)\nTOSCO CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Thousands of Dollars)\nTOSCO CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)\nSupplemental Disclosure of Cash Flow Information (Thousands of Dollars)\nThe accompanying notes are an integral part of these financial statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPrinciples of Consolidation\nThe accompanying consolidated financial statements include the accounts of Tosco Corporation and its wholly owned subsidiaries (Tosco), including Seminole Fertilizer Corporation (Seminole), a discontinued operation whose principal operating assets were sold in 1993.\nAll significant intercompany accounts and transactions have been eliminated.\nUse of Estimates\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management estimates and assumptions that affect the reported amounts of assets and liabilities and the reported result of operations and disclosure of contingent assets and liabilities .\nNature of Business\nTosco is an independent oil refiner and marketer of petroleum products with related distribution facilities and domestic and international commercial activities.\nReclassifications\nCertain previously reported amounts have been reclassified to conform to classifications adopted in 1995.\nCash, Cash Equivalents, Short-term Investments and Deposits\nCash in excess of operating requirements is invested in certificates of deposit, government securities, commercial paper and other highly liquid investments. Investments with original maturities of more than three months and less than 12 months are classified as short-term investments and carried at cost which approximates market.\nTosco purchased director and officer liability insurance coverage from its wholly owned subsidiary Loil Group Ltd. (Loil), with limits of liability coverage of approximately $14,000,000 at December 31, 1995 and 1994, (an amount approximately equal to the amount of cash and investments of Loil). The assets of Loil are restricted to payment of defense costs and claims made against the directors and officers of Tosco. At December 31, 1995 the portfolio's carrying value of marketable investments, considered \"available for sale\" in accordance with SFAS No. 115 - \"Accounting for Certain Investments in Debt and Equity Securities\", approximated fair value. Unrealized holding gains and losses and proceeds from any sale of these securities and any resulting gains and losses were not material for 1995.\nInventories\nInventories of raw materials and products are valued at the lower of cost, determined on the last-in, first-out (LIFO) basis, or market. The net realizable value of LIFO inventories is measured by aggregating similar pools on a consolidated basis.\nDeferred Charges and Turnarounds\nFinancing charges related to the acquisition or refinancing of debt are deferred and amortized over the term of the related debt using the effective interest method.\nRefinery processing units are periodically shut down for major maintenance (turnarounds). Turnaround costs are deferred and amortized on a straight-line basis over the expected period of benefit (which generally ranges from 24 to 48 months, to the next scheduled shutdown of the unit).\nPROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment, including capitalized interest, are carried at cost less accumulated depreciation. Depreciation and amortization are provided over the estimated useful lives of the respective classes of assets utilizing the straight-line method. Expenditures which materially increase values, change capacities or extend useful lives are capitalized. Routine maintenance, repairs, and replacement costs are expensed. Gains and losses on disposition of assets are reflected in results of operations.\nTrademarks and Licenses\nTrademarks and licenses are stated at cost and are amortized on a straight-line basis over their estimated useful life (predominantly 15 years).\nExcise Taxes\nExcise taxes collected on behalf of governmental agencies of $1,168,000,000 for 1995 were not included in sales, cost of sales or other expenses.\nEnvironmental Costs\nEnvironmental 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 assessment and\/or remedial efforts are probable and the costs can be reasonably estimated. Generally, the timing of these accruals coincides with completion of investigations and other studies or Tosco's commitment to a formal plan of action.\nEarnings Per Share\nPrimary earnings per share is computed by dividing net income less preferred stock dividend requirements by the weighted average number of common and common equivalent shares outstanding during the year. Fully diluted earnings per share computations for 1994 and 1993 assumed that all shares of previously outstanding convertible preferred stock were converted to common stock of Tosco (Common Stock) at the beginning of each period and that no preferred dividends were paid.\nThe weighted average number of shares used in computing earnings per share are as follows:\nYEAR ENDED DECEMBER 31, 1995 1994 1993 ------ -------- ------ (IN THOUSANDS)\nPrimary........... 37,481 34,214 29,679 Fully Diluted..... 37,738 37,408 34,641\n2. FINANCIAL INSTRUMENTS\nTosco, at times and when able, uses commodity futures to lock in what it considers to be acceptable margins between the sales value of refined products produced and the cost of raw materials purchased, on a varying percentage of Bayway Refinery production, generally for periods not exceeding one year. In addition, Tosco enters into swap contracts with counterparties (typically agreeing to sell at fixed forward prices, and to buy at future variable market prices, stated volumes of residual fuels) to hedge sales prices of Bayway's residual fuels production. Realized gains and losses on liquidated raw material futures contracts are deferred in inventory until the related refined products are sold. Tosco also utilizes commodity futures and forward contracts to a lesser extent to hedge inventories stored for future sale and to hedge against adverse price movements between the cost of foreign crude oil that Bayway refines and the cost of domestic crude oil.\nAt December 31, 1995, Tosco had, as part of its hedging program, open long (obligation to purchase) and short (obligation to deliver) futures, swap and forward contracts for crude oil and products with a notional value (number of barrels under contract multiplied by the per barrel contract value) of approximately $380,000,000 and $408,000,000 respectively. The unrecognized net loss on such open contracts as well as deferred gains and losses on closed futures and swap contracts totaling approximately $901,000 will be recognized or reversed in 1996 as an offset to realized margins on refined products sold.\nPursuant to the requirements of the commodity exchanges, margin deposits for a percentage of the value of the futures contracts have been placed with commodity brokers. The margin deposits are classified as short-term deposits on the balance sheet.\nFair Values\nThe carrying value of cash and cash equivalents, short-term investments and deposits, trade accounts receivable, and accounts payable and other current liabilities approximates fair value due to the relatively short maturity of these financial instruments. Estimated fair values of other financial instruments are as follows:\nCredit Risk\nFinancial instruments which potentially subject Tosco to concentrations of credit risk consist principally of temporary cash investments, trade receivables and commodity futures, swap and forward contracts. Tosco does not believe that it has a significant credit risk on its futures, swap and forward contracts. Futures contracts are transacted through the New York Mercantile Exchange (NYMEX) and other large commodity exchanges with established collateral and credit criteria for participants. To reduce credit risk, temporary cash investments are spread among several high quality financial institutions. In addition, Tosco conducts ongoing evaluations of its broad base of customers and counter parties and requires letters of credit or other collateral arrangements as appropriate. Tosco's actual trade receivable credit losses have not been significant.\n3. ACCOUNTS RECEIVABLE\nIn June 1995, as part of its ongoing program to reduce interest costs, Tosco entered into a three year agreement with a financial institution to sell on a revolving basis up to $100,000,000 of an undivided percentage ownership interest in a designated pool of accounts receivable (Receivable Transfer Agreement). Under the Receivable Transfer Agreement, Tosco retains substantially the same risk of credit loss as if the receivables had not been sold. Tosco also retains collection and administrative responsibilities on the participating interest sold as agent for the financial institution. Sales of accounts receivable averaged $432,000,000 per month in 1995. At December 31, 1995 accounts receivable was reduced by approximately $99,800,000 for receivables sold under the Receivable Transfer Agreement. Expenses of $3,052,000 related to this program are included in cost of sales.\n4. DISCONTINUED OPERATIONS\nOn May 4, 1993, Seminole completed the sale of its principal operating assets to Cargill Fertilizer Inc. (Cargill). The loss on disposition was accounted for as discontinued operations in 1992 and current financial statements reflect the phosphate fertilizer segment as a discontinued segment.\nNet liabilities of the discontinued segment are as follows:\nThe excess of replacement cost over the value of inventories based upon the LIFO method was $43,304,000 and $5,821,000 at December 31, 1995 and 1994, respectively.\nResults of operations for 1994 include the reversal (based on price levels at the end of 1994) of the $17,651,000 market valuation reserve recorded at December 31, 1993.\nExpenditures for maintenance and repairs (excluding the amortization of turnaround costs) were $102,552,000, $89,513,000, and $74,596,000 for 1995, 1994 and 1993, respectively.\n(a) In December 1993, Tosco acquired the Ferndale Refinery, retail marketing assets in the Pacific Northwest, and the right to market under the BP brand (Tosco Northwest) from BP Exploration and Oil Inc (BP). The purchase price for Tosco Northwest included annual contingent participation payments over the five years following the acquisition of up to $50,000,000 and $100,000,000 based on the performance of the refining and retail marketing segments, respectively. In December 1995, Tosco and BP agreed to settle all contingent participation payments, including participation payments due for 1995, for $35,000,000, payable no later than April 2, 1996. The payment was allocated to trademarks and fixed assets.\n(b) Cash borrowings of $20,000,000 (unsecured) and $41,500,000 (partially collateralized) were outstanding at December 31, 1995 and 1994, respectively, under short-term lines of credit with interest at alternative rates at Tosco's option. The weighted average interest rate was 6.6% and 6.9% for 1995 and 1994.\n(a) In March 1992, Tosco issued $300,000,000 of First Mortgage Bonds (Bonds), comprised of $100,000,000 of 9% Series A Bonds due March 15, 1997 and $200,000,000 of 9-5\/8% Series B Bonds due March 15, 2002. Interest on the Bonds is payable each March 15th and September 15th. The Bonds are non-callable and are collateralized by the Avon Refinery and certain related assets.\n(b) In connection with the acquisition of the Bayway Refinery, Tosco issued in a private placement $150,000,000 of 8-1\/4% First Mortgage Bonds due May 15, 2003, guaranteed by Bayway, with interest payable semi-annually on May 15th and November 15th (Bayway Bonds). Proceeds for the sale of the Bayway Bonds, net of $2,325,000 of costs, were contributed as an equity investment to Bayway. The Bayway guarantee is collateralized by the Bayway Refinery and related assets and a guarantee of Tosco. Effective July 7, 1993, the Bayway Bonds were exchanged, pursuant to a registration statement, for a new series of publicly traded 8-1\/4% First Mortgage Bonds (Exchange Bonds), the terms of which are substantially identical to the Bayway Bonds.\n(c) Tosco amended its collateralized credit facility effective April 7, 1995 (Amended Revolving Credit Facilities). The amendment extended the maturity of the credit facility by one year to April 1998 and reduced the cost of borrowing. Cash borrowings under the Amended Revolving Credit Facilities now bear interest at the option of Tosco at one of three alternative rates (a federal funds rate, a Eurodollar rate, or a base rate related to prime) plus an incremental margin for each rate option. The incremental margin is dependent on the credit rating of the First Mortgage Bonds. A commitment fee of approximately 3\/8% per annum on the unused portion of the commitment is also due. The Amended Revolving Credit Facilities is collateralized by investments, accounts receivable and inventory.\n(d) On December 17, 1987, The Oil Shale Corporation, a subsidiary of Tosco, exercised options to acquire certain oil shale mining claims (Ertl and Paraho oil shale properties in Rio Blanco County, Colorado) for a cash payment of $1,150,000 and execution of a promissory note of $11,562,000, payable in fifteen equal annual principal installments beginning on December 17, 1990. The promissory note, with a stated interest rate of 5%, was discounted, based upon long-term market rates, to a value of $6,356,000 at the date of issue.\n(e) In July 1995, Tosco filed a registration statement for the issuance, from time to time, of up to $250,000,000 of unsecured debt securities on terms determined by market conditions at the time of issuance. On July 12, 1995 $125,000,000 of authorized debt securities were issued under the registration statement as 7% unsecured, non-callable notes due July 15, 2000 (7% Notes). The proceeds from the public offering, net of costs, were used to repay indebtedness under the Amended Revolving Credit Facilities. Interest on the 7% Notes is payable each January 15 and July 15, beginning January 15, 1996.\n(f) The debt agreements contain covenants which limit Tosco's ability to incur additional indebtedness, pay dividends, acquire equity securities of Tosco, and make investments in certain subsidiaries and discretionary capital expenditures. In addition, the Amended Revolving Credit Agreement requires the maintenance of specified ratios and net worth. At December 31, 1995, Tosco was in compliance with all debt covenants.\nFuture Installments of Long-Term Debt\nMaturities relating to long-term debt during the next five years are as follows:\nYEARS ENDING THOUSANDS DECEMBER 31, OF DOLLARS\n1996...................... $ 771 1997...................... 100,771 1998...................... 45,771 (a) 1999...................... 771 2000...................... 125, 771\n(a) Includes cash borrowings of $45,000,000 at December 31, 1995 under the revolving credit facility.\n10. CAPITAL STOCK\nCommon Stock\nTosco has paid a regular quarterly cash dividend on its Common Stock since the third quarter of 1989. Tosco increased its quarterly dividend payment by $.01 to $.16 per share effective with the third quarter of 1994. Dividends of $.16 per share for the fourth quarter of 1995 were paid on January 2, 1996.\n11. STOCK OPTIONS AND SHARES RESERVED FOR ISSUANCE\nTosco had two stock option plans in effect at December 31, 1995: the 1992 Stock Incentive Plan (1992 Plan) and the 1989 Stock Incentive Plan (1989 Plan).\nThe 1989 and 1992 Stock Incentive Plans provide for the issuance to key employees, consultants, and non-employee directors of a maximum of 1,280,000 and 2,200,000 shares of Common Stock, respectively, in the form of stock options, restricted stock awards and\/or stock appreciation rights. Stock options may be granted as \"Incentive Stock Options\" (as defined by the Internal Revenue Code of 1986), or as nonqualified options, including nonqualified stock options whose purchase price or vesting requirements are based on the employee's achievement of established performance objectives. Options may be exercised only within ten years from the date of grant. The exercise price of nonqualified stock options is determined by the Compensation Committee of the Board of Directors and may be less than the fair value of Common Stock on the date of grant. Awards under the 1989 and 1992 Plan may be granted until March 7, 1999 and March 13, 2002, respectively.\nOptions to acquire an aggregate of 651,583 shares of Common Stock at prices ranging from $29.19 to $35.88 per share (the fair value of Common Stock on the respective dates of grant) were granted during 1995. Subject to the severance agreements with certain employees (Note 15), one-third of the options may be exercised at any time following the first anniversary of the date of grant and an additional one-third after each of the second and third anniversaries.\n12. INCOME TAXES\nA reconciliation of the provision for income taxes to income taxes computed by applying the statutory federal income tax rate to earnings before income taxes is as follows:\nEffective January 1, 1992 Tosco adopted Statement of Financing Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes.\" Under SFAS No. 109, deferred income taxes are recognized for the tax consequences of \" temporary differences\" by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities.\nTemporary differences and carry forwards which give rise to deferred tax assets and liabilities are as follows:\n13. EMPLOYEE BENEFIT AND INCENTIVE COMPENSATION PLANS\nPension Plans\nTosco has non-contributory, defined benefit pension plans covering substantially all employees located at the Avon and Bayway Refineries and its union employees at the Ferndale Refinery (collectively, the Plans). Benefits under the Plans are generally based on the employee's years of service and average earnings for the three highest consecutive calendar years of compensation during the ten years immediately preceding retirement. Contributions to the Plans are at least sufficient to meet the minimum funding requirements of applicable laws and regulations but no more than the amount deductible for federal income tax purposes. Assets of the Plans are managed by major financial institutions and invested in high quality equity securities, guaranteed investment contracts, corporate and government debt securities and real estate equity funds. The funded status of the Plans and amounts recognized in Tosco's balance sheet are as follows:\nIn connection with Tosco's acquisition of the Bayway and Ferndale refineries in 1993, pension coverage was extended to certain acquired employees. Pension benefits granted provide for recognition of past employees' service but benefits accrued through the respective acquisition dates will be paid by their former employers. Benefits are payable at the normal retirement age of 65 with reduced benefits for early retirement (as defined).\nIn 1990, Tosco adopted a Senior Executive Retirement Plan to provide retirement benefits to selected senior executives of Tosco and their beneficiaries. A provision of $1,265,000, $1,855,000 and $1,267,000 was recorded in 1995, 1994 and 1993, respectively.\nEmployee and Retiree Benefit Plans\nTosco provides health care and life insurance benefits for all employees and postretirement health care and life insurance benefits for certain employees (primarily employees at the Avon Refinery). Beginning January 1, 1988, new employees, including employees acquired in Tosco's acquisitions but excluding new employees at the Avon Refinery, are not eligible for postretirement benefits. Health care benefits for eligible employees and retirees are provided through insurance companies whose premiums are based on the benefits paid during the year. The health care plans are contributory, with employee\/retiree contributions adjusted periodically, and contain other cost-sharing features such as deductibles and coinsurance. The life insurance plans are noncontributory.\nTosco elected to prospectively recognize its accumulated postretirement benefits obligation (APBO) other than pensions of $32,661,000 as of January 1, 1992, the effective date of Tosco's adoption of SFAS No. 106. In view of the escalating costs of medical care, Tosco revised its retiree benefit plans to, among other things, limit its future obligation to absorb health care increases. These revisions as well as favorable changes in experience and cost trends reduced Tosco's APBO to $16,191,000 and $14,209,000 at December 31, 1995 and 1994, respectively. The total cost of postretirement benefits, including the amortization of the transition obligation, was $582,000 for 1995, an increase of $291,000 over the amount which would have been expensed under the pay as you go approach.\nThe funded status of the postretirement plans and the amounts recognized in Tosco's balance sheet are as follows:\n(a) The negative trend rate for 1994 was a result of premium rate reductions.\nThe changes in assumptions as well as changes in circumstances and experience resulted in a net gain of $11,461,000 in 1994 which is being recognized as a reduction in postretirement benefit expense on a straight line basis over the average remaining employee service period of 6 years Postretirement benefit expense for 1993 was $2,541,000.\nSAVINGS PLAN\nA savings plan has been established for all eligible employees (Tosco Corporation Capital Accumulation Plan (CAP)) to encourage long-term savings and to provide additional funds for retirement. Participants may make, within certain limitations, voluntary contributions under Section 401(k) of the Internal Revenue Code of a percentage of their compensation. Tosco makes matching contributions based upon years of contributory participation (as defined under the CAP) for employees who elect to make certain specified and minimum contributions. In addition, eligible employees receive an additional contribution equal to 5% of their compensation (up to $150,000 in 1994 and 1995) in lieu of pension plan benefits. Participants are immediately vested in both their voluntary and Tosco contributions.\nContributions by Tosco to the savings plan for the years ended December 31 were $7,837,000 (1995), $7,146,000 (1994), and $5,524,000 (1993).\nManagement Incentive Plans\nA Cash Incentive Plan (CIP) has been established for members of middle and senior management. The CIP sets forth discretionary and other awards which are computed as a variable percentage of a participant's base salary, which percentage is dependent upon the pretax income (as defined) of the business unit. A bonus plan was adopted in 1990 for senior executives who are not participants in the CIP based on Tosco's per share pretax income (as defined).\nResults of operations for the years ended December 31, 1995, 1994 and 1993 include incentive compensation of $13,175,000, $6,800,000 and $9,531,000 respectively, of which $10,203.000, $5,350,000 and $7,458,000, respectively, were included in selling, general and administrative expense. Special bonuses totalling $2,200,000 were also awarded to certain employees, including union employees and other employees not covered by management incentive plans.\n14. LEASE COMMITMENTS\nTosco distributes petroleum products throughout its marketing areas through a combination of owned and leased terminals. Leases for the Riverhead product distribution terminal and Northville Industries oil distribution system, both in Long Island, New York, expire in 1997 and 2002 and ten year leases for two major West Coast product distribution terminals expire in 2001. Tosco has an option to purchase the Riverhead Terminal at its fair market value at the end of the lease. Other product distribution terminal leases are generally for short periods of time and continue in effect until canceled by either party with contracted days of notice. The product distribution terminal leases, other than the Long Island leases, are subject to escalation either based on increases in annual average wage rates or as allowed by the Public Utilities Commission (PUC). A portion of the product distribution terminals' storage and handling facilities is subleased to others. Tosco has a five year lease expiring in 1999, with options to renew for two additional five year periods, with Statia Terminals for approximately 3,600,000 barrels of storage capacity at Point Tupper, Nova Scotia. The facility will be used primarily to store crude oil destined for the Bayway Refinery. At December 31, 1995, minimum annual rentals for product distribution and oil storage terminals totalled $25,339,000 for 1996, including $4,800,000 for the Point Tupper facility. Thereafter, annual rentals total $30,920,000, (including an $11,500,000 payment due at the end of the Riverhead terminal lease), $14,921,000 and $11,755,000 and $9,370,000 for the years 1997 to 2000, respectively.\nIn conjunction with the acquisition of the BP California retail system in August 1994, Tosco entered into long-term leases with a special purpose entity established to purchase land and equipment in the BP California retail system. The leases provide Tosco with options to purchase at agreed upon contracted values (a) not less than all of the leased assets at annual anniversary dates and (b) a portion of the leased assets for resale to unaffiliated parties at quarterly lease payment dates. Tosco may also cancel the leases at the second through sixth anniversary dates provided that the lessor receives minimum sales values for the leased assets. The purchase option price and guaranteed sales values decline over the applicable periods of the leases. Minimum annual rentals, which vary with a reference interest rate (LIBOR) and assume that Tosco exercises its lease renewal options, approximate $5,100,000 for the years 196 thru 1998, $4,500,000 for 1999 and 2000 and $3,000,000 for 2001. Final payments totaling $55,000,000 are due at the end of the leases. Tosco entered into similar leases in conjunction with the acquisition of Exxon's retail marketing assets in Arizona in December 1994 (Original Arizona Lease). In August 1995, Tosco entered into a $15 million expansion of the Arizona lease facility to finance, for a one year period, the acquisition and improvement of service station properties in Arizona (Additional Arizona Lease). At December 31, 1995, Tosco, as agent for the lessor, had spent approximately $3,600,000 under this facility but had not yet entered into leases pending completion of construction. Minimum annual rentals therefore currently approximate $5,600,000 over the remaining term of the Original Arizona Lease with a final payment of $44,000,000 due in December 2001 (the end of the lease). In addition, Tosco also assumed existing leases of property, with expiration dates through 2011, and subleases of retail properties, with expiration dates through 1998, in connection with the acquisitions of retail assets in Northern California and Arizona.\nIn November 1995, Tosco acquired under long-term lease the 28-site car wash operations of Brown Bear Car Wash located in the Puget Sound region. Quarterly lease payments of $670,000 are escalated over the initial fifteen year term of the lease. In connection with the transaction, Tosco acquired the right to use the Brown Bear trademark and to acquire the trademark for additional specified payments.\nTosco leases sulfuric acid and MTBE manufacturing facilities, both located at the Avon Refinery. The initial term of the leases of the sulfuric acid and MTBE facilities expire in 1998 and 2007, respectively. The leases may be extended or the facilities purchased at their estimated fair market values at the end of the lease terms. Tosco also leases transportation equipment, including railcars and trucks, as well as computer and office equipment primarily at leased office space at various locations in the United States.\nFuture minimum obligations under non-cancelable operating leases and warehousing agreements at December 31, 1995 were as follows:\nYEARS ENDING THOUSANDS DECEMBER 31, OF DOLLARS\n1996....... $ 60,623 1997....... 62,546 1998....... 39,649 1999....... 37,400 2000....... 33,870 2001 and subsequent..... 208,843 ---------- 442,931 Less future minimum sublease income...... ( 43,921) Total minimum lease payments .............$ 399,010\n15. COMMITMENTS AND CONTINGENCIES\nTosco is subject to extensive federal, state and local regulation of environmental and permitting matters relating to its petroleum refining and marketing operations. These regulations are complex and subject to differing interpretations, and Tosco is currently involved in a number of proceedings and discussions regarding the removal and mitigation of the environmental effects of subsurface liquid hydrocarbons and alleged levels of hazardous waste at the Avon Refinery and other locations, including Tosco's Spokane, Washington terminal which is located in a site on the Superfund National Priorities List. Environmental cost accruals were recorded in prior years based upon a determination that investigative work and remedial actions would be required.\nIn July 1993, outstanding litigation concerning environmental issues was settled with the predecessor owners of the Avon Refinery (Settlement Agreement). Under the Settlement Agreement, the former owners agree to pay up to $18,000,000 for one-half of the costs that may be incurred for compliance with certain environmental orders and to provide Tosco with a $6,000,000 credit for past expenses (which Tosco uses to reduce its one-half share of costs). After the initial term of the Settlement Agreement (the later of four years or until the $36,000,000 shared cost maximum is expended), the parties may elect to continue the Settlement Agreement or to reinstate litigation. Tosco and the former owners have established a committee to review and approve expenditures for environmental investigative and remedial actions at the Avon Refinery. Through December 31, 1995, the committee has spent approximately $2,100,000 on such matters. Remedial actions are subject to negotiation with governmental agencies and therefore the timing and amount of future cash expenditures is uncertain. In addition, further investigative work and negotiations with the governmental agencies may result in additional remedial actions which Tosco cannot presently predict. Tosco has not relinquished its right to make claims for reimbursement of future costs and is not required to reimburse amounts received under the Settlement Agreement. Tosco received $3,474,000 in 1994 in partial settlement of litigation cost reimbursement claims from its insurance carriers and is pursuing additional recoveries and reimbursement under insurance policies in effect during the applicable periods of coverage.\nBy agreement, Exxon is responsible for environmental obligations related to or arising out of its ownership and operation of the Bayway Refinery, purchased by Tosco in April 1993, as will be set forth in a list to be prepared under administrative consent orders between Exxon and the state of New Jersey. Bayway has the right, for a period of one year following the expected 1997 completion date of such list, to add additional items to the list. Responsibility for clean-up projects thereafter identified will be shared by Exxon and Tosco based on their respective length of ownership. Tosco has also received indemnifications with respect to environmental obligations arising out of or relating to the period prior to the respective acquisition dates of the Ferndale Refinery and retail assets in the Pacific Northwest and Northern California from BP, and the Arizona retail properties from Exxon.\nEnvironmental exposures are difficult to assess and estimate for numerous reasons including the complexity and differing interpretations of governmental regulations, the lack of reliable data, the number of potentially responsible parties and their financial capabilities, the multiplicity of possible solutions, the years of remedial and monitoring activity required, and the identification of new sites. While Tosco believes that it has adequately provided for environmental exposures, should these matters be resolved unfavorably to Tosco, they could have a material adverse effect on its long-term consolidated financial position and results of operations.\nThere are various other legal proceedings and claims pending against Tosco which are common to its operations. While it is not feasible to predict or determine the ultimate outcome of these matters, it is the opinion of management that these suits will not result in monetary damages which in the aggregate would be material to the business or operations of Tosco.\nIn October 1986, Tosco and Atlantic Richfield Co.(ARCO) entered into an agreement pursuant to which ARCO agreed for ten years (with two five-year renewal options exercisable by ARCO) to deliver to Tosco an average of 50,000 barrels per day of Alaskan North Slope crude oil in exchange for a quantity of gasoline that is a variable percentage of the amount of crude oil delivered, based upon the prices of certain crude oils (ARCO Exchange Agreement). ARCO has informed Tosco that it will not seek to extend the exchange agreement when it expires at the end of 1996. The end of the ARCO Exchange Agreement will also end Tosco's obligation to first offer the Avon Refinery for sale to ARCO if Tosco desired to sell the Avon Refinery.\nTosco has employment agreements with certain of its executive officers which provide for lump sum severance payments and accelerated vesting of options upon termination of employment under certain circumstances or a change of control, as defined. Tosco's potential obligation to nine officers was $6,418,000 at December 31, 1995.\nTosco, in keeping with industry practice, schedules periodic maintenance of major processing units for significant non-routine repairs and replacements as the units reach the end of their normal operating cycles (turnarounds). Unscheduled turnarounds also occur because of operating difficulties or external factors. Throughput and earnings are lowered, and deferred turnaround expenditures increased, during such periods.\nTosco's NOL, investment tax and AMT credit carryforwards (Note 12) are subject to various complex tax rules and regulations which may be subject to varying interpretations. These carryforwards may be adversely affected by changes in the rules and regulations or significant changes in the ownership of Tosco or its trade or business. Therefore, the future benefit of these carryforwards, although more likely than not realizable under current rules and regulations, is not assured.\nEffective December 1993, the date commercial operation of a hydrogen production facility (Hydrogen Plant) commenced, Tosco entered into 15 year agreements to purchase up to 25 million cubic feet per day of hydrogen and steam (Hydrogen Supply Agreement) and to provide utilities, wastewater disposal and other services to the Hydrogen Plant. The Hydrogen Plant, located at the Avon Refinery on property leased from Tosco, is owned and operated by a third party. The Hydrogen Supply Agreement may be modified to provide for higher levels of hydrogen at prices to be negotiated and can be terminated under certain circumstances upon payment of a stipulated fee (which decreases over the term of the agreement).\nTo control costs and improve delivery reliability, Tosco entered into a twelve year time charter agreement with Neptune Orient Lines commencing after completion of construction of four 100,000 DWT crude oil tankers. The first tanker is scheduled to be delivered in June 1996 with the last tanker scheduled for delivery in the first quarter of 1997. The tankers are expected to be utilized for the movement of crude oil from the Point Tupper Storage facility to Bayway or other locations or in direct shipments from suppliers.\nBayway Refining Company has entered into a contract to acquire a Solvent Deasphalter for approximately $32.5 million, plus the cost of agreed modifications and interest, upon its mechanical completion (as defined). Construction of this unit began in 1995 and mechanical completion is expected in the third quarter of 1996. Tosco is responsible for other capital improvements to tie in the Solvent Deasphalter into the Bayway Refinery system raising the total expected cost of the unit to approximately $48 million.\n16. SUBSEQUENT EVENTS\nOn February 2, 1996, Tosco completed the purchase of the U.S. Northeast marketing and refining assets from BP for $59 million, excluding inventories. Under the purchase agreement, Tosco obtained an exclusive license valid for 15 years, with various renewal options, to market retail gasoline and diesel fuels under the BP brand. The license covers Delaware, Maryland, the Washington D. C. metropolitan area, Pennsylvania, New Jersey, New York, Connecticut, Rhode Island, Massachusetts, Vermont, New Hampshire and Maine. Portions of western Pennsylvania and Maryland are excluded. The term of Tosco's exclusive license in nine Western states was also extended to 15 years from the closing date. The purchase also included the 180,000 B\/D Marcus Hook Refinery near Philadelphia (which was taken over in a non-operating mode), petroleum product terminals and certain associated pipeline interests (some of which are surplus to Tosco's needs and will be sold). Tosco has also offered to buy BP's one-third interest in the Harbor pipeline on which BP's partners have a right of first refusal to acquire BP's interest. BP retains environmental obligations relating to the Marcus Hook Refinery and other properties included in the sale.\nOn February 16, 1996, Tosco announced an agreement to purchase all outstanding shares of the Circle K Corporation (Circle K) and to merge Circle K with a subsidiary of Tosco. Circle K is a large gasoline retailer and operator of company-owned convenience stores. A definitive agreement was signed with the holders of approximately 68% of Circle K's outstanding shares (Selling Shareholders) and a merger agreement was approved by the Board of Directors of both companies. Under the stock purchase agreement, Selling Shareholders of Circle K will receive a combination of cash and common stock of Tosco (Common Stock). Under the merger agreement the remaining shareholders will receive Common Stock. Payment of the total acquisition price of approximately $710 million, not including transaction and certain other costs, will consist of approximately 6.5 million shares of Common Stock and cash. The common stock to be issued is subject to adjustment if the price of Common Stock fluctuates outside an agreed range and for shares issued with respect to stock options held by certain employees of Circle K. Completion of the transaction is subject to certain conditions including the approvals of regulatory authorities and the shareholders of Circle K. The acquisition is expected to close prior to mid-year.\n17. Quarterly Financial Data (Unaudited)","section_15":""}
{"filename":"80661_1995.txt","cik":"80661","year":"1995","section_1":"ITEM 1. BUSINESS\n(a) General Development of Business\nThe Progressive Corporation, an insurance holding company formed in 1965, has 64 operating subsidiaries and one mutual insurance company affiliate. The Progressive Corporation's insurance subsidiaries and its affiliate (collectively, the \"Insurance Group\") provide personal automobile insurance and other specialty property-casualty insurance and related services throughout the United States and in Canada. The Company's property-casualty insurance products protect its customers against collision and physical damage to their motor vehicles and liability to others for personal injury or property damage arising out of the use of those vehicles.\nOf the approximately 250 United States insurance company groups writing private passenger auto insurance, the Company estimates that it ranks seventh in size for 1995. Except as otherwise noted, all industry data and Progressive's market share or ranking in the industry were derived either directly from data reported by A.M. Best Company Inc. (\"A.M. Best\") or were estimated using A.M. Best data as the primary source. For 1995, the estimated industry premiums written, which include personal auto insurance in the United States and Ontario, Canada, as well as insurance for commercial vehicles, were $122 billion, and Progressive's share of this market was approximately 2.3%.\n(b) Financial Information About Industry Segments\nIncorporated by reference from Note 11, Segment Information, on page 46 of the Company's Annual Report.\n(c) Narrative Description of Business\nINSURANCE SEGMENT\nThe Insurance Group offers a number of personal and commercial property-casualty insurance products primarily related to motor vehicles. Net premiums written were $2,912.8 million in 1995, compared to $2,457.2 million and $1,819.2 million in 1994 and 1993, respectively. The underwriting profit margin was 5.7% in 1995, compared to 8.3% (excluding the elimination of the \"supplemental reserve.\" See Management's Discussion and Analysis of Financial Condition and Results of Operations beginning on page 14 for further discussion) in 1994 and 10.7% in 1993, respectively.\nThe Insurance Group's core business writes insurance for private passenger automobiles, recreational vehicles and small fleets of commercial vehicles. This business frequently has more than one program in a single state, with each targeted to a specific market segment. The core business accounted for 97% of the Company's 1995 total net premiums written.\nThe bulk of the Insurance Group's core business consists of nonstandard automobile insurance products for people cancelled or rejected by other insurers. The size of the nonstandard automobile insurance market changes with the insurance environment. Volume potential is influenced by the actions of direct competitors, writers of standard and preferred automobile insurance and state-mandated involuntary plans. The total direct premiums written in the nonstandard automobile insurance market were about $21 billion in 1995, $20 billion in 1994 and $18 billion in 1993. Approximately 280 nonstandard insurance companies, many of which are part of an affiliated group, wrote an estimated $17 billion of nonstandard auto premiums in 1995. In 1994, the Insurance Group ranked second in direct premiums written in this market and near the top in underwriting performance. Although final data has not been published, the Company estimates that its 1995 ranking and underwriting performance will be consistent with 1994.\nThe core business also writes standard and preferred automobile risks in many states. These products accounted for between 5% and 10% of the Company's total private passenger auto premiums in 1995. The strategy is to build towards becoming a low-cost provider of a full line of auto insurance and related services, distributed through whichever channel the customer prefers. The Insurance Group's goal is to compete successfully in the standard and preferred market, which comprises 80% of the personal automobile insurance market.\nThe Insurance Group's principal specialty personal lines product is motorcycle insurance. Other products offered include recreational vehicle, mobile home and boat insurance. The Insurance Group's competitors are specialty companies and large multi-line insurance carriers. Although industry figures are not available, based on the Company's analysis of this market, the Company believes that it is a significant participant in the specialty personal lines market.\nNonstandard commercial vehicle insurance covers commercial vehicle risks that are rejected or cancelled by other insurance companies. Based on the Company's analysis of this market, approximately 40 companies compete for this business on a nationwide basis. State assigned risk plans also provide this coverage.\nThe core business insurance products are marketed by thirteen divisions headquartered in or near the markets served: the Florida and Southeast divisions in Tampa, Florida; the Northeast, New York, Central States, Ohio, Commercial Vehicle and National Accounts divisions in Cleveland, Ohio; the South Central division in Austin, Texas; the Mountain division in Colorado Springs, Colorado; the Mid-Atlantic division in Richmond, Virginia; the Canada division in Ontario, Canada; and the West division in Sacramento, California. Each division is responsible for its own marketing, sales, processing and claims.\nIn an effort to better manage growth and improve customer service, the Company is moving profit and growth responsibility for high potential communities from state-focused division presidents to community managers. In 1995, eleven metropolitan areas were served by community managers.\nIn 1995, over 90% of the net premiums written by the core business were written through a network of more than 30,000 independent insurance agents located throughout the United States and in Canada. Subject to compliance with certain Company-mandated procedures, these independent insurance agents have the authority to bind the Company to specified insurance coverages within prescribed underwriting guidelines. These guidelines prescribe the kinds and amounts of coverage that may be written and the premium rates that may be charged for specified categories of risk. The agents do not have authority on behalf of the Company to settle or adjust claims, establish underwriting guidelines, develop rates or enter into other transactions or commitments. The Company also markets its products through intermediaries such as employers, other insurance companies and national brokerage agencies, and direct to customers through employed sales people and owned insurance agencies. The core business currently markets personal automobile insurance directly to the public by direct mail, television and radio advertising, primarily throughout Florida and in Ohio and Texas.\nThe Insurance Group's diversified businesses - the United Financial Casualty Company (UFCC), Professional Liability Group (PLG) and Motor Carrier division - accounted for 3% of total volume in 1995. These businesses, which are organized by customer group, are headquartered in Cleveland, Ohio. The choice of distribution channel is driven by each customer group's buying preference and service needs. Distribution channels include financial institutions and vehicle dealers. Distribution arrangements are individually negotiated between such intermediaries and the Company and are tailored to the specific needs of the customer group and the nature of the related financial or purchase transactions. The diversified businesses also market their products directly to their customers through company-employed sales forces.\nUFCC provides physical damage insurance and related tracking services to protect the commercial or retail lender's interest in collateral which is not otherwise insured against these risks. The principal product is collateral protection for automobile lenders, which is sold to financial institutions and\/or their customers. Commercial banks are UFCC's largest customer group for these services. This business also serves savings and loans, finance companies and credit unions. According to the Company's analysis of this market, numerous companies offer these products and none of them has a dominant market share.\nPLG's principal customers are community banks. Its principal products are liability insurance for directors and officers and employee dishonesty insurance. Progressive shares the risk and premium on these coverages with a small mutual reinsurer controlled by its bank customers. The program is sponsored by the American Bankers Association. This program represented less than one half of one percent of the Company's total 1995 net premiums written.\nThe Motor Carrier division primarily manages involuntary Commercial Auto Insurance Procedures. See Service Operations on page 7 for further discussion.\nCOMPETITIVE FACTORS\nThe automobile insurance and other property-casualty markets in which the Company operates are highly competitive. Property-casualty insurers generally compete on the basis of price, consumer recognition, coverages offered, claim handling, financial stability, customer service and geographic coverage. Vigorous competition is provided by large, well-capitalized national companies, some of which have broad distribution networks of employed or captive agents, and by smaller regional insurers. While the Company relies heavily on technology and extensive data gathering and analysis to segment and price markets according to risk potential, some competitors merely price their coverage at rates set lower than the Company's published rates. By avoiding extensive data gathering and analysis, these competitors incur lower underwriting costs. The Company has remained competitive by closely managing expenses and achieving operating efficiencies, and by refining its risk measurement and price segmentation skills. In addition, the Company offers prices for a wide spectrum of risks and seeks to offer a wider array of payment plans, limits of liability and deductibles than its competitors. Superior customer service and claim adjustment are also important factors in the Company's competitive strategy.\nLICENSES\nThe Insurance Group operates under licenses issued by various state or provincial insurance authorities. Such licenses may be of perpetual duration or renewable periodically, provided the holder continues to meet applicable regulatory requirements. The licenses govern the kind of insurance coverages which may be written in the issuing state. Such licenses are normally issued only after the filing of an appropriate application and the satisfaction of prescribed criteria. All licenses which are material to the Company's business are in good standing.\nINSURANCE REGULATION\nThe insurance subsidiaries are generally subject to regulation and supervision by insurance departments of the jurisdictions in which they are domiciled or licensed to transact business. At least one of the subsidiaries is licensed and subject to regulation in each of the 50 states and certain U.S. possessions, in one Canadian province and by Canadian federal authorities. The nature and extent of such regulation and supervision varies from jurisdiction to jurisdiction. Generally, an insurance company is subject to a higher degree of regulation and supervision in its state of domicile. The Company's principal insurance subsidiaries are domiciled in the states of Florida, Mississippi, Missouri, New York, Ohio, Pennsylvania, Texas, Washington and Wisconsin. State insurance departments have broad administrative power relating to licensing insurers and agents, regulating premium rates and policy forms, establishing reserve requirements, prescribing accounting methods and the form and content of statutory financial reports and regulating the type and amount of investments permitted. Rate regulation varies from \"file and use\" to prior approval to mandated rates. Most jurisdictions prohibit rates that are \"excessive, inadequate or unfairly discriminatory.\"\nInsurance departments are charged with the responsibility to ensure that insurance companies maintain adequate capital and surplus and comply with a variety of operational standards. Insurance companies are generally required to file detailed annual and other reports with the insurance department of each jurisdiction in which they conduct business. Insurance departments are authorized to make periodic and other examinations of regulated insurers' financial condition, adherence to statutory accounting principles and compliance with state insurance laws and regulations.\nInsurance holding company laws enacted in many jurisdictions grant to insurance authorities the power to regulate acquisitions of insurers and certain other transactions involving insurers and to require periodic disclosure of certain information. These laws impose prior approval requirements for certain transactions between regulated insurers and their affiliates and generally regulate dividend and other distributions, including loans and cash advances, between regulated insurers and their affiliates. See the \"Dividends\" discussion in Item 5(c) for further information on such dividend limitations.\nUnder state insolvency and guaranty laws, regulated insurers can be assessed, or required to contribute to state guaranty funds to cover policyholder losses resulting from insurer insolvencies. Insurers are also required by many states to provide coverage to certain risks as a condition of doing business in the state. Such programs generally specify the types of insurance and the level of coverage which must be offered to such involuntary risks, as well as the allowable premium.\nInsurance companies are generally required by insurance regulators to maintain sufficient surplus to support their writings. Although the ratio of writings to surplus that the regulators will allow is a function of a number of factors, including the type of business being written, the adequacy of the insurer's reserves, the quality of the insurer's assets, and the identity of the regulator, as a general rule, the regulators prefer that annual net written premium be not more than three times the insurer's total policyholders' surplus. Thus, the amount of an insurer's surplus may, in certain cases, limit its ability to grow its business.\nMany states have laws and regulations that limit an insurer's ability to exit a market. For example, certain states limit an automobile insurer's ability to cancel and non-renew policies. Furthermore, certain states prohibit an insurer from withdrawing one or more lines of business from the state, except pursuant to a plan that is approved by the state insurance department. The state insurance department may disapprove a plan that may lead to market disruption. Laws and regulations that limit cancellation and non-renewal and that subject program withdrawals to prior approval requirements may restrict an insurer's ability to exit unprofitable markets.\nRegulation of insurance constantly changes as real or perceived issues and developments arise. Some changes may be due to technical factors, such as changes in investment laws made to recognize new investment vehicles; other changes result from such general pressures as consumer resistance to price increases and concerns relating to insurer solvency. In recent years, legislation and voter initiatives have been introduced which deal with insurance rate development, rate determination and the ability of insurers to cancel or renew insurance policies, reflecting concerns about availability, prices and alleged discriminatory pricing.\nIn some states, the automobile insurance industry has been under pressure in recent years from regulators, legislators or special interest groups to reduce, freeze or set rates to or at levels that are not necessarily related to underlying costs, including initiatives to roll back automobile and other personal lines rates. This kind of activity has adversely affected, and may in the future adversely affect, the profitability and growth of the subsidiaries' automobile insurance business in those jurisdictions, and may limit the subsidiaries' ability to increase rates to compensate for increases in costs. Adverse legislative and regulatory activity limiting the subsidiaries' ability to adequately price automobile insurance may occur in the future. The impact of these regulatory changes on the subsidiaries' businesses cannot be predicted.\nThe state insurance regulatory framework has come under increased federal scrutiny, and certain state legislatures have considered or enacted laws that alter and, in many cases, expand state authority to regulate insurance companies and insurance holding company systems. Further, the National Association of Insurance Commissioners (NAIC) and state insurance regulators are re-examining existing laws and regulations, specifically focusing on insurance company investments, issues relating to the solvency of insurance companies and further limitations on the ability of regulated insurers to pay dividends. The NAIC also developed a risk-based capital (RBC) program to enable regulators to take appropriate and timely regulatory actions relating to insurers that show signs of weak or deteriorating financial conditions. RBC is a series of dynamic surplus-related formulas which contain a variety of factors that are applied to financial balances based on a degree of certain risks, such as asset, credit and underwriting risks. In addition, from time to time, the United States Congress and certain federal agencies investigate the current condition of the insurance industry to determine whether federal regulation is necessary.\nSTATUTORY ACCOUNTING PRINCIPLES\nThe Insurance Group's results are reported in accordance with generally accepted accounting principles (GAAP), which differ from amounts reported under statutory accounting principles (SAP) prescribed by insurance regulatory authorities. Specifically, under GAAP:\n1. Commissions, premium taxes and other costs incurred in connection with writing new and renewal business are capitalized and amortized on a pro rata basis over the period in which the related premiums are earned, rather than expensed as incurred, as required by SAP.\n2. Certain assets are included in the consolidated balance sheets, which for SAP are charged directly against statutory surplus. These assets consist primarily of premium receivables over 90 days, furniture and equipment and prepaid expenses.\n3. Amounts related to ceded reinsurance are shown gross as prepaid reinsurance premiums and reinsurance recoverables, rather than netted against unearned premium reserves and loss and loss adjustment expense reserves, respectively, as required by SAP.\n4. Fixed maturities securities, which are classified as available-for-sale, are reported at market values, rather than at amortized cost, or the lower of amortized cost or market depending on the specific type of security as required by SAP. Equity securities are reported at quoted market values which may differ from the NAIC market values as required by SAP.\nThe differing treatment of income and expense items results in a corresponding difference in Federal income tax expense.\nDuring 1994, the insurance subsidiaries began to reduce loss reserves for anticipated salvage and subrogation recoveries. Previously, salvage and subrogation was not reflected in the statutory financial statements until actually recovered.\nSERVICE OPERATIONS\nThe service operations of the diversified businesses consist primarily of processing business for involuntary plans and providing claim services to fleet owners and other insurance companies. Service revenues were $38.9 million in 1995, compared to $41.9 million in 1994 and $43.7 million in 1993. Pretax operating profits were $8.7 million in 1995, compared to $10.0 million and $6.8 million in 1994 and 1993, respectively.\nThe Motor Carrier division currently processes business for the Commercial Auto Insurance Procedures (CAIP) in 29 states, the Florida Joint Underwriters Association (FAJUA) and the New York Public Automobile Pool (NYPAP), which are all part of the involuntary residual market. As a CAIP servicing carrier, the division processes about one third of the premiums in the involuntary residual market, without assuming the indemnity risk. It competes with approximately 17 other providers nationwide. In 1995, the division began processing business for the FAJUA and competes with five other carriers in the state. Beginning in March 1996, the Company began processing business for the NYPAP and was granted a one-third share of new business with a three-year phase-in period.\nINVESTMENTS\nThe Company's approach to investing is consistent with its need to maintain capital adequate to support the insurance premiums written and its commitment to risk adverse investment policies. The Company's portfolio is invested primarily in short-term and intermediate-term, investment-grade fixed-income securities. The Company's investment portfolio, at market value, was $3,768.0 million at December 31, 1995, compared to $3,186.3 million at December 31, 1994. Investment income is affected by shifts in the types of investments in the portfolio, changes in interest rates and other factors. Investment income, including net realized gains on security sales, before expenses and taxes, was $245.8 million in 1995, compared to $182.3 million in 1994 and $242.4 million in 1993. See Management's Discussion and Analysis of Financial Condition and Results of Operations, beginning on page 14 herein for additional discussion.\nEMPLOYEES\nThe number of employees, excluding temporary employees, at December 31, 1995, was 8,025.\nLIABILITY FOR PROPERTY-CASUALTY LOSSES AND LOSS ADJUSTMENT EXPENSES\nThe consolidated financial statements include the estimated liability for unpaid losses and loss adjustment expenses (\"LAE\") of the Company's insurance subsidiaries. Total loss reserves are established at a level that is intended to represent the midpoint of the reasonable range of loss reserves. The liabilities for losses and LAE are determined using actuarial and statistical procedures and represent undiscounted estimates of the ultimate net cost of all unpaid losses and LAE incurred through December 31 of each year. These estimates are subject to the effect of future trends on claim settlement. These estimates are continually reviewed and adjusted as experience develops and new information becomes known. Such adjustments, if any, are reflected in the current results of operations.\nDuring 1994, based on a review of the adequacy of its total loss reserves, the Company eliminated its $71.0 million \"supplemental reserve.\" See Management's Discussion and Analysis of Financial Condition and Results of Operations beginning on page 14 for further discussion. The elimination of the supplemental reserve is reflected in the Reconciliation of Net Reserves for Losses and Loss Adjustment Expenses table on page 8 and the Analysis of Loss and Loss Adjustment Expenses Development table on page 9.\nThe accompanying tables present an analysis of property-casualty losses and LAE. The following table: (1) provides a reconciliation of beginning and ending estimated liability balances for 1995, 1994 and 1993, and (2) shows the difference between the estimated liability in accordance with GAAP and that reported in accordance with SAP.\nRECONCILIATION OF NET RESERVES FOR LOSSES AND LOSS ADJUSTMENT EXPENSES\n(1)In 1993, the Company adopted Statement of Financial Accounting Standards (SFAS) 113, \"Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts.\"\n(2)During 1994, the Company changed its method of accounting for salvage and subrogation. See Statutory Accounting Principles on page 6 for further discussion.\nThe reconciliation above shows a $56.6 million redundancy, which emerged during 1995, in the 1995 liability and a $142.5 million redundancy in the 1994 liability, based on information known as of December 31, 1995 and December 31, 1994, respectively. In addition, the incurred losses in the table above are on a SAP basis, which differ slightly from the GAAP incurred losses due to the reclassification of losses on the Company's self-insurance program to expenses for GAAP reporting.\nThe anticipated effect of inflation is explicitly considered when estimating liabilities for losses and LAE. While anticipated increases due to inflation are considered in estimating the ultimate claim costs, the increase in average severities of claims is caused by a number of factors that vary with the individual type of policy written. Future average severities are projected based on historical trends adjusted for anticipated changes in underwriting standards, inflation, policy provisions and general economic trends. These anticipated trends are monitored based on actual development and are modified if necessary.\nThe Company has not entered into any loss reserve transfers or similar transactions having a material effect on earnings or reserves.\nANALYSIS OF LOSS AND LOSS ADJUSTMENT EXPENSES DEVELOPMENT (millions)\n(1)Cumulative redundancy\/(deficiency) liability for unpaid losses and LAE.\nThe above table presents the development of balance sheet liabilities for 1985 through 1994. The top line of the table shows the estimated liability for unpaid losses and LAE recorded at the balance sheet date for each of the indicated years for the property-casualty insurance subsidiaries only. Similar reserves for the life insurance subsidiary, which are immaterial, are excluded. This liability represents the estimated amount of losses and LAE for claims arising in all prior years that are unpaid at the balance sheet date, including losses that had been incurred but not reported.\nThe upper section of the table shows the cumulative amount paid with respect to the previously recorded liability as of the end of each succeeding year. The lower portion of the table shows the re-estimated amount of the previously recorded liability based on experience as of the end of each succeeding year. The estimate is increased or decreased as more information becomes known about the frequency and severity of claims for individual years. For example, as of December 31, 1995 the companies had paid $263.2 million of the currently estimated $286.7 million of losses and LAE that had been incurred through the end of 1986; thus an estimated $23.5 million of losses incurred through 1986 remain unpaid as of the current financial statement date.\nThe \"Cumulative Redundancy (Deficiency)\" represents the aggregate change in the estimates over all prior years. For example, the 1985 liability has developed a $1.0 million deficiency over ten years. That amount has been reflected in income over the ten years and did not have a significant effect on the income of any one year. The effects on income during the past three years due to changes in estimates of the liabilities for losses and LAE is shown in the reconciliation table on page 8 as the \"prior years\" provision for incurred losses and LAE.\nIn evaluating this information, note that each cumulative redundancy (deficiency) amount includes the effects of all changes in amounts during the current year for prior periods. For example, the amount of the redundancy related to losses settled in 1988, but incurred in 1985, will be included in the cumulative deficiency or redundancy amount for years 1985, 1986 and 1987. 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.\nThe Analysis of Loss and Loss Adjustment Expenses Development table on page 9 is constructed from Schedule P, Part-1, from the 1990 through 1995 Consolidated Annual Statements, as filed with the state insurance departments, and Schedules O and P filed for years prior to 1989. This development table differs from the development displayed in Schedule P, Part-2 due to the fact Schedule P, Part-2 excludes unallocated loss adjustment expenses and reflects the change in the method of accounting for salvage and subrogation for 1994 and prior.\n(d) Financial Information about Foreign and Domestic Operations\nThe Company operates throughout the United States and in Canada. The amount of Canadian revenues and assets are approximately two percent of the Company's consolidated revenues and assets. The amount of operating income (loss) generated by its Canadian operations is immaterial with respect to the Company's consolidated operating income.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nOWNED PROPERTIES\nIn 1994, the Company completed its new corporate office complex on a 42-acre parcel in Mayfield Village, Ohio, owned by a subsidiary. The new facility consists of 517,800 square feet of space and replaces office space held under leases in a number of locations in the Cleveland, Ohio area. The project's cost of $75.5 million was funded through operating cash flows. The Company's central data processing facility occupies a modern, three-story brick, building containing approximately 107,000 square feet of office space, on this same parcel.\nThe Company owns two adjacent two-story brick buildings in Highland Heights, Ohio, which contain an aggregate of 233,000 square feet of office and warehouse space. The property was purchased in August 1994 for approximately $6.7 million. The buildings are currently being renovated to accommodate the Company's operations.\nThe Company owns a modern three-story building containing approximately 96,700 square feet of office space in Mayfield Heights, Ohio. The property was purchased in December 1993 for approximately $6.5 million, and is occupied by the Company's Northeast Division.\nThe Company's Florida Division is headquartered in a modern, two-story building containing approximately 60,000 square feet of office space in Tampa, Florida. The property was financed with, and is owned subject to a mortgage granted in connection with, industrial development revenue bonds bearing interest equal to 79.45% of a specified prime commercial lending rate. The remaining annual principal amounts payable are $368,000 in 1996 and 1997 and $92,000 in 1998.\nThe Company owns a modern 26,400 square foot building in Tampa, Florida, used for post-processing document assembly and mailing. The property was purchased on March 31, 1995, for approximately $1.4 million.\nThe Company owns a modern, two-story building containing approximately 39,000 square feet of office space in Tampa, Florida; this building is leased to a non-affiliated tenant.\nThe Company also owns a one-story brick building containing approximately 92,000 square feet of training facilities, office and warehouse space in Mayfield Village, Ohio.\nLEASED PROPERTIES\nThe Company leases approximately 590,000 square feet of modern office space at various locations throughout the United States for its other business units and staff functions. In addition, the Company leases approximately 288 processing and claim offices at various locations throughout the United States. Two offices are leased in Canada. These leases are generally short-term to medium-term leases of standard commercial office space.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIncorporated by reference from Note 4, Litigation, on page 41 of the Company's Annual Report.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nIncorporated by reference from information with respect to executive officers of The Progressive Corporation and its subsidiaries set forth in Item 10 of this Annual Report on Form 10-K.\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 Shares are traded on the New York Stock Exchange under the symbol PGR. The high and low prices set forth below are as reported on the consolidated transaction reporting system.\nThe closing price of the Company's Common Shares on February 29, 1996 was $46.00.\n(b) Holders\nThere were 4,770 shareholders of record on February 29, 1996.\n(c) Dividends\nStatutory policyholders' surplus was $1,055.1 million and $945.1 million at December 31, 1995 and 1994, respectively. Generally, under state insurance laws, the net admitted assets of insurance subsidiaries available for transfer to a corporate parent are limited to those net admitted assets, as determined in accordance with SAP, which exceed minimum statutory capital requirements. At December 31, 1995, $121.5 million of statutory policyholders' surplus represents net admitted assets of the insurance subsidiaries that are required to meet minimum statutory surplus requirements in the subsidiaries' states of domicile. Furthermore, state insurance laws limit the amount that can be paid as a dividend or other distribution in any given year without prior regulatory approval and adequate policyholders' surplus must be maintained to support premiums written. Based on the dividend laws currently in effect, the insurance subsidiaries may pay aggregate dividends of $179.2 million in 1996 out of statutory policyholders' surplus, without prior approval by regulatory authorities.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\n(millions - except per share amounts)\nAll per share amounts have been adjusted for the December 8, 1992 3-for-1 stock split.\n(1)Total revenues for 1992 include $106.0 million ($70.0 million after taxes), or $.97 per share, for the Company's California Proposition 103 reserve reduction.\n(2)During 1994, based on a review of the adequacy of its total loss reserves, the Company eliminated its $71.0 million \"supplemental reserve\" ($46.2 million after tax), resulting in a one-time increase in earnings of $.62 per share. See Management Discussion and Analysis of Financial Condition and Results of Operations set forth in Item 7","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nFINANCIAL CONDITION\nThe Progressive Corporation is a holding company and does not have any revenue producing operations of its own. It receives cash through borrowings, equity sales, subsidiary dividends and other transactions, and may use the proceeds to contribute to the capital of its insurance subsidiaries in order to support premium growth, to repurchase its Common Shares and other outstanding securities, to redeem its outstanding securities and for other business purposes. During 1995, the Company repurchased .1 million of its 9 3\/8% Serial Preferred Shares, Series A, at a cost of $2.3 million.\nDuring the three-year period ended December 31, 1995, the Company sold 4,950,000 Common Shares for net proceeds of $177.0 million and repurchased 1.2 million Common Shares at a total cost of $36.4 million (average cost of $31.92 per share) and .6 million of its 9 3\/8% Serial Preferred Shares, Series A, at a total cost of $14.4 million (average cost $27.08 per share). The Company also sold $350.0 million of notes, repaid $170.0 million borrowed under its credit facilities, and redeemed the entire $70.0 million of its 8 3\/4% Debentures. During the same period, The Progressive Corporation received $254.3 million from its insurance subsidiaries, net of capital contributions made to these subsidiaries. The regulatory restrictions on subsidiary dividends are described in Item 5(c) on page 12 herein.\nThe Company has substantial capital resources and is unaware of any trends, events or circumstances that are reasonably likely to affect its capital resources in a material way. The Company also has available a $20.0 million revolving credit agreement. Given its 31% debt to equity ratio, the Company believes it has sufficient borrowing capacity and other capital resources to support current and anticipated growth.\nThe Company's insurance operations create liquidity by collecting and investing premiums from new and renewal business in advance of paying claims. For the three years ended December 31, 1995, operations generated a positive cash flow of $1,305.4 million, and cash flow is expected to be positive in both the short-term and reasonably foreseeable future. The Company's substantial investment portfolio is highly liquid, consisting almost entirely of readily marketable securities. On or after May 31, 1996, the Company's 9 3\/8% Serial Preferred Shares, Series A, are redeemable at the Company's option at the price of $25 per share plus accrued dividends to the redemption date. If the Company elects to redeem these securities, the redemption could be funded through operating cash flows or, if market conditions warrant, funds could be raised externally on the debt or equity markets. The Company does not expect any material changes in its cash requirements and is not aware of any trends, events or uncertainties that are reasonably likely to have a material effect on its liquidity.\nTotal capital expenditures for the three years ended December 31, 1995, aggregated $156.5 million. In 1994, the Company completed its new corporate office complex in Mayfield Village, Ohio. The cost of the project was $75.5 million and was funded through operating cash flows.\nINVESTMENTS\nThe Company invests in fixed-maturity, equity and short-term securities. The Company's investment strategy recognizes its need to maintain capital adequate to support its insurance operations and commitment to risk adverse investment policies. Therefore, the Company evaluates the risk\/reward trade-offs of investment opportunities, measuring their effects on stability, diversity, overall quality and liquidity of the investment portfolio. The majority of the portfolio is invested in high-grade, fixed-income securities, of which short- and intermediate-term securities represented $2,876.2 million, or 76.4%, in 1995 and $2,319.4 million, or 72.9%, in 1994. Long-term securities were $191.9 million, or 5.1%, in 1995 and $245.0 million, or 7.7%, in 1994. The duration of the fixed-income portfolio was 2.2 years at December 31, 1995. Early in 1995, the Company eliminated a substantial portion of its municipal securities with maturities longer than 5 years in response to the proposal of a \"flat tax,\" which would effectively eliminate the tax advantage of these securities.\nA relatively small portion of the investment portfolio was invested in marketable equity securities providing risk\/reward balance and diversification. Common stocks represented $310.0 million, or 8.2%, in 1995 and $106.2 million, or 3.4%, in 1994. The increase in common stocks reflects the Company's objective to increase its position in common stock investments to 15% of the entire portfolio and to optimize value and further diversify the portfolio through foreign equity investments. The foreign equity portfolio, which may utilize stock index futures and foreign currency forwards, comprised $52.6 million of the common stock portfolio at December 31, 1995. The remainder of the equity portfolio of $382.3 million, or 10.1%, in 1995 and $370.1 million, or 11.6%, in 1994, was comprised of over 90% of fixed-rate preferred stocks with mechanisms that may provide an opportunity to liquidate at par.\nConsistent with the Company's objective to increase its common stock investments, the Company liquidated its high-yield portfolio, reducing it to .2% of the portfolio at December 31, 1995, from 4.4% at December 31, 1994, resulting in a net gain of $6.6 million.\nIn conjunction with guidance issued by the FASB, the Company reclassified $248.4 million of its held-to-maturity securities to available-for-sale, recognizing $10.4 million in gross unrealized gains. The Company had no held-to-maturity securities at December 31, 1995.\nAs of December 31, 1995, the Company's portfolio had $78.7 million in unrealized gains, compared to $41.1 million in unrealized losses in 1994. This increase in value was the result of falling interest rates and rising prices in the bond and stock market. The weighted average fully taxable equivalent book yield of the portfolio was 6.9%, 6.7% and 6.8% for the years ended December 31, 1995, 1994 and 1993, respectively.\nThe quality distribution of the fixed-income portfolio is as follows:\nInvestments in the Company's portfolio have varying degrees of risk. Equity securities generally have greater risks than the non-equity portion of the portfolio since these securities are subordinate to rights of debt holders and other creditors of the issuer. Financial instruments with off-balance-sheet risk are used to manage the risks and enhance the yields of the available-for-sale portfolio. This is accomplished by modifying the basis, duration, interest rate or foreign currency characteristics of the portfolio or hedged securities. Net cash requirements are limited to changes in market values which may vary based upon changes in interest rates and other factors. Exposure to credit risk is limited to the carrying value; unless otherwise noted, collateral is not required to support the credit risk. During 1995, the Company added a government bond trading portfolio to benefit from short-term market rate opportunities. The Company has stringent restrictions on the amount of open positions in the trading portfolio limiting its exposure to acceptable levels. At December 31, 1995, there were no trading securities or off-balance-sheet trading positions.\nAs of December 31, 1995, the Company held $729.1 million of asset-backed securities which represented 19.3% of the total investment portfolio. The portfolio included collateralized mortgage obligations (CMOs) and commercial mortgage-backed obligations (CMBs) totaling $335.2 million and $117.2 million, respectively. As of December 31, 1995, the CMO portfolio included sequential bonds representing 65.9% of the CMO portfolio ($221.0 million) with an average life of 3.1 years, and planned amortization class bonds representing 34.1% of the CMO portfolio ($114.2 million) with an average life of 1.6 years. One hundred percent of the CMOs held by the Company are rated AAA by Moody's or Standard & Poor's. At December 31, 1995, the CMB portfolio had an average life of 7.4 years and a weighted average Moody's or Standard & Poor's rating of A. At December 31, 1995, the CMO and CMB portfolios had unrealized gains of $3.9 million and $1.1 million, respectively. The single largest unrealized loss in any CMO security was $.1 million, or .5% of such position, and there were no unrealized losses in any CMB security at December 31, 1995. Both the CMO and CMB portfolios are highly liquid with readily available quotes and contain no residual interests. The remainder of the asset-backed portfolio is invested primarily in auto loan and credit card-backed securities.\nThe Company regularly reviews the individual holdings in its portfolio for evidence of impairment. Changes in market value are evaluated to determine the extent to which such changes are attributable to: (i) interest rates, (ii) market-related factors other than interest rates and (iii) financial conditions, business prospects and other fundamental factors specific to the issuer. Declines attributable to issuer fundamentals are reviewed in further detail. Available evidence is considered to estimate the realizable value of the investment. When a security in the Company's investment portfolio has a decline in market value which is other than temporary, the Company is required by GAAP to reduce the carrying value of such security to its net realizable value. It is the Company's general policy to dispose of securities when the Company determines that the issuer is unable to reverse its deteriorating financial condition and the prospects for its business within a reasonable period of time. In less severe circumstances, the Company may decide to dispose of a portion of its holdings in a specific issuer when the risk profile of the investment becomes greater than its tolerance for such risk.\nRESULTS OF OPERATIONS\nOperating income, which excludes net realized gains and losses from security sales and one-time items, was $220.1 million, or $2.84 per share, in 1995, $212.7 million, or $2.76 per share, in 1994 and $197.3 million, or $2.61 per share, in 1993. The GAAP combined ratio was 94.3 in 1995, 91.7 (88.5 including the elimination of the \"supplemental reserve\" discussed below) in 1994 and 89.3 in 1993.\nDirect premiums written increased 16% to $3,068.9 million in 1995, compared to $2,645.1 million in 1994 and $1,966.4 million in 1993. Net premiums written increased 19% to $2,912.8 million, compared to $2,457.2 million in 1994 and $1,819.2 million in 1993. The difference between direct and net premiums written is largely attributable to premiums written under state-mandated involuntary Commercial Auto Insurance Procedures (CAIP), for which the Company retains no indemnity risk, of $105.4 million in 1995, $115.4 million in 1994 and $98.0 million in 1993. During the three years ended December 31, 1995, the Company provided policy and claim processing services to 28 state CAIPs. Premiums earned, which are a function of the amount of premiums written in the current and prior periods, increased 24% in 1995, compared to 31% in 1994 and 17% in 1993.\nThe Company's Core divisions' net premiums written grew 21%, 38% and 25% for 1995, 1994 and 1993, respectively, primarily driven by an increase in unit sales. In 1995, the Company raised rates an average of 6.5%, compared to no rate changes in 1994 and a rate decrease of .8% in 1993. The Company continues to write standard and preferred auto risks which represented between 5% and 10% of total Core business volume. The Company anticipates continued growth in its Core business in 1996, which could result from the number of states in which the Company seeks to insure all auto risks, from working with independent agents dedicated to regaining market share and from integrating other buying options. The Core divisions generated underwriting profit margins of 5% in 1995, 7% in 1994 and 10% in 1993; the Company's strategy is to achieve a 4% underwriting margin.\nClaim costs, the Company's most significant expense, represent actual payments made and changes in estimated future payments to be made to or on behalf of its policyholders, including expenses required to settle claims and losses. These costs include a loss estimate for future assignments and assessments, based on current business, under state-mandated involuntary automobile programs. Claims costs are influenced by inflation and loss severity and frequency, the impact of which is mitigated by adequate pricing. Increases in the rate of inflation increase loss payments, which are made after premiums are collected. Accordingly, anticipated rates of inflation are taken into account when the Company establishes premium rates and loss reserves. Claim costs, expressed as a percentage of premiums earned, were 71% in 1995, compared to 67% (excluding the elimination of the \"supplemental reserve\") in 1994 and 62% in 1993. The Company has allowed loss costs to rise at a faster pace than rates, reflecting the Company's intent to maintain rates at competitive levels.\nDuring 1994, based on a review of the adequacy of its total loss reserves, the Company eliminated its $71.0 million \"supplemental reserve,\" resulting in a one-time increase in earnings of $.62 per share, a 3.2 point increase in the underwriting profit margin and a $46.2 million increase in capital. The Company historically established case and IBNR reserves by product with the objective of being accurate to within plus or minus 2%. Pricing has been based on these estimates of reserves by product. Because the Company desired a very high degree of comfort that aggregate reserves were adequate, aggregate reserves were established near the upper end of the reasonable range of reserves, and the difference between such aggregate reserves and the midpoint of the reasonable range of case and IBNR reserves was called the \"supplemental reserve.\" The Company concluded, after examining its historical aggregate reserves, that the practice of setting aggregate reserves at the upper end of the range of reasonable reserves provided an unnecessarily high level of comfort. At December 31, 1994, even without the high level of comfort provided by the \"supplemental reserve,\" the Company's reserves would have been redundant by approximately 2% to 4% over the previous 5 years. The Company believes that this change in the estimate of its reserves placed it more in line with the practices of other companies in the industry.\nBecause the Company is primarily an insurer of motor vehicles, it has limited exposure for environmental, product and general liability claims. The Company has established reserves for these exposures, in amounts which it believes to be adequate based on information currently known by it. The Company does not believe that these claims will have a material impact on the Company's liquidity, results of operation, cash flows or financial condition.\nDuring 1994, the Company settled the dispute, arising out of its 1985 acquisition of American Star Insurance Company (since renamed National Continental Insurance Company), over the seller's refusal to pay certain losses on pre-sale business written by American Star. Under the settlement, National Continental received $10.1 million from the seller and agreed to be solely responsible for the next $20 million of gross losses. The seller will thereafter be responsible for half the losses, net of reinsurance, if it achieves certain minimum net worth requirements. In addition to the $10.1 million, National Continental will be entitled to the proceeds of various treaty and facultative reinsurance policies that had been purchased by American Star. National Continental has established reserves for these exposures, which are mainly for product liability and environmental claims, in amounts it believes to be adequate based on information currently available to it, including a study by independent actuaries for the seller. Total reserves on this business are $27.9 million, of which $8.8 million is recoverable from reinsurers. The Company will continue to monitor these exposures, adjust the related reserves appropriately as additional information becomes known and disclose any material developments.\nPolicy acquisition and other underwriting expenses as a percentage of premiums earned were 23% in 1995, compared to 25% in 1994 and 28% in 1993. The decrease primarily reflects process improvement initiatives and lower commission programs.\nService businesses generated a pretax operating profit of $8.7 million in 1995, compared to $10.0 million in 1994 and $6.8 million in 1993.\nRecurring investment income (interest and dividends) increased 26% to $199.1 million in 1995, compared to $158.5 million in 1994 and $134.5 million in 1993, primarily due to an increase in the average investment portfolio and a mix shift in the portfolio to taxable securities. Net realized gains on security sales were $46.7 million in 1995, $23.8 million in 1994 and $107.9 million in 1993. A significant portion of the 1993 realized gains resulted from the sale of certain equity securities held in the Company's investment portfolio.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe Consolidated Financial Statements of the Company, along with the related notes, supplementary data and report of independent accountants, are incorporated by reference from the Company's 1995 Annual Report, pages 33 through 46 and pages 50 through 55.\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 description of the directors, all of whom have been nominated for election as directors at the 1996 Annual Meeting of Shareholders of the Registrant, is incorporated herein by reference from the section entitled \"Election of Directors\" in the Proxy Statement, pages 2 and 3.\nA description of the executive officers of the Registrant and its subsidiaries follows. These descriptions reflect the Company's termination of its officership program and consequent elimination of many officer positions, effective December 31, 1993. Unless otherwise indicated, the executive officer has held the position(s) indicated for at least the last five years.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nIncorporated by reference from the section of the Proxy Statement entitled \"Executive Compensation,\" pages 7 through 17.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nIncorporated by reference from the section of the Proxy Statement entitled \"Security Ownership of Certain Beneficial Owners and Management,\" pages 4 through 6.\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) Listing of Financial Statements\nThe following consolidated financial statements of the Registrant and its subsidiaries, included in the Registrant's Annual Report, are incorporated by reference in Item 8:\nReport of Independent Accountants\nConsolidated Statements of Income - December 31, 1995, 1994 and 1993\nConsolidated Balance Sheets - December 31, 1995 and 1994\nConsolidated Statements of Changes in Shareholders' Equity - December 31, 1995, 1994 and 1993\nConsolidated Statements of Cash Flows - December 31, 1995, 1994 and 1993\nNotes to Consolidated Financial Statements\nSupplemental Information*\n*Not covered by Report of Independent Accountants.\n(a)(2) Listing of Financial Statement Schedules\nThe following financial statement schedules of the Registrant and its subsidiaries, Report of Independent Accountants and Consent of Independent Accountants are included in Item 14(d):\nSchedules\nReport of Independent Accountants\nConsent of Independent Accountants\nSchedule I - Summary of Investments - Other than Investments in Related Parties\nSchedule II - Condensed Financial Information of Registrant\nSchedule III - Supplementary Insurance Information\nSchedule IV - Reinsurance\nSchedule VI - Supplemental Information Concerning Property-Casualty Insurance Operations\nNo other schedules are required to be filed herewith pursuant to Article 7 of Regulation S-X.\n(a)(3) Listing of Exhibits\nSee exhibit index contained herein at pages 36 through 39. Management contracts and compensatory plans and arrangements are identified in the Exhibit Index as Exhibit Nos. (10)(A) through (10)(J).\n(b) Reports on Form 8-K\nNone.\n(c) Exhibits\nThe exhibits in response to this portion of Item 14 are submitted concurrently with this report.\n(d) Financial Statement Schedules\nThe response to this portion of Item 14 is located at pages 27 through 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.\nTHE PROGRESSIVE CORPORATION\nMarch 15, 1996 BY: \/s\/ Peter B. Lewis ------------------ Peter B. Lewis 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.\n\/s\/ Peter B. Lewis Chairman, President, Chief Executive March 15, 1996 - ---------------------- Officer and a Director Peter B. Lewis\n\/s\/ Charles B. Chokel Treasurer and Chief Financial Officer March 15, 1996 - ---------------------- Charles B. Chokel\n\/s\/ Jeffrey W. Basch Chief Accounting Officer March 15, 1996 - ---------------------- Jeffrey W. Basch\nMilton N. Allen* Director March 15, 1996 - ---------------------- Milton N. Allen\nB. Charles Ames* Director March 15, 1996 - ---------------------- B. Charles Ames\nStephen R. Hardis* Director March 15, 1996 - ---------------------- Stephen R. Hardis\nJanet Hill* Director March 15, 1996 - ---------------------- Janet Hill\nNorman S. Matthews* Director March 15, 1996 - ---------------------- Norman S. Matthews\nDonald B. Shackelford* Director March 15, 1996 - ---------------------- Donald B. Shackelford\nPaul B. Sigler* Director March 15, 1996 - ---------------------- Paul B. Sigler\n* DAVID M. SCHNEIDER, by signing his name hereto, does sign this document on behalf of the persons indicated above pursuant to a power of attorney duly executed by such persons.\nBy \/s\/ David M. Schneider March 15, 1996 ------------------------ David M. Schneider Attorney-in-fact\nANNUAL REPORT ON FORM 10-K\nITEM 14(d)\nFINANCIAL STATEMENT SCHEDULES\nYEAR ENDED DECEMBER 31, 1995\nTHE PROGRESSIVE CORPORATION\nMAYFIELD VILLAGE, OHIO\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholders, The Progressive Corporation:\nOur report on the consolidated financial statements of The Progressive Corporation and subsidiaries has been incorporated by reference in this Form 10-K from page 33 of the 1995 Annual Report to Shareholders of The Progressive Corporation. In connection with our audits of such financial statements, we have also audited the related financial statement schedules listed in the index on pages 20 and 21 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.\nCleveland, Ohio January 24, 1996\nCONSENT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholders, The Progressive Corporation:\nWe consent to the incorporation by reference in the Registration Statement of The Progressive Corporation on Form S-8 (File No. 33-57121) filed December 29, 1994, the Registration Statement on Form S-8 (File No. 33-64210) filed June 10, 1993, the Registration Statement on Form S-8 (File No. 33-51034) filed August 20, 1992, the Registration Statement on Form S-8 (File No. 33-46944) filed April 3, 1992, the Registration Statement on Form S-8 (File No. 33-38793) filed February 4, 1991, the Registration Statement on Form S-8 (File No. 33-38107) filed December 6, 1990, the Registration Statement on Form S-8 (File No. 33-37707) filed November 9, 1990, the Registration Statement on Form S-8 (File No. 33-33240) filed January 31, 1990, and the Registration Statement on Form S-8 (File No. 33-16509) filed August 14, 1987, of our reports dated January 24, 1996, on our audits of the consolidated financial statements and financial statement schedules of The Progressive Corporation and subsidiaries as of December 31, 1995 and 1994, and for each of the three years in the period ended December 31, 1995, which reports are included in this Annual Report on Form 10-K.\nCOOPERS & LYBRAND L.L.P.\nCleveland, Ohio March 14, 1996\nSCHEDULE I -- SUMMARY OF INVESTMENTS -- OTHER THAN INVESTMENTS IN RELATED PARTIES\nTHE PROGRESSIVE CORPORATION AND SUBSIDIARIES (millions)\nThe Company did not have any securities of one issuer with an aggregate cost or market value exceeding 10% of total shareholders' equity at December 31, 1995.\nSCHEDULE II -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT\nCONDENSED STATEMENTS OF INCOME\nTHE PROGRESSIVE CORPORATION (PARENT COMPANY) (millions)\n*Eliminated in consolidation.\n(1) Represents a $4.0 million charge on extinguishment of the 8 3\/4% Debentures due 2017.\nSee notes to condensed financial statements.\nSCHEDULE II -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT (Continued)\nCONDENSED BALANCE SHEETS\nTHE PROGRESSIVE CORPORATION (PARENT COMPANY) (millions)\n*Eliminated in consolidation.\nSee notes to condensed financial statements.\nSCHEDULE II -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT (Continued)\nCONDENSED STATEMENTS OF CASH FLOWS\nTHE PROGRESSIVE CORPORATION (PARENT COMPANY) (millions)\nSee notes to condensed financial statements.\nSCHEDULE II -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)\nNOTES TO CONDENSED FINANCIAL STATEMENTS\nThe accompanying condensed financial statements of The Progressive Corporation (the \"Registrant\") should be read in conjunction with the consolidated financial statements and notes thereto of The Progressive Corporation and subsidiaries included in the Registrant's 1995 Annual Report.\nSTATEMENTS OF CASH FLOWS -- For the purpose of the Statements of Cash Flows, cash includes only bank demand deposits. The Registrant paid income taxes of $75.5 million, $89.8 million, and $91.0 million in 1995, 1994 and 1993, respectively. Total interest paid was $56.5 million for 1995, $49.8 million for 1994 and $40.9 million for 1993.\nDEBT -- Funded debt at December 31 consisted of:\nFunded debt is the amount the Registrant has borrowed and contributed to the capital of its insurance subsidiaries or borrowed for other long-term purposes.\nIn May 1990, the Registrant entered into a revolving credit arrangement with National City Bank, which is reviewed by the bank annually. Under this agreement, the Registrant had the right to borrow up to $50.0 million. In February 1994, the Registrant reduced this revolving credit arrangement to $20.0 million. By selecting from available credit options, the Registrant may elect to pay interest at rates related to the London interbank offered rate, the bank's base rate or at a money market rate. A commitment fee is payable on any unused portion of the committed amount at the rate of .125% per annum. At December 31, 1995 and 1994, the Registrant had no borrowings under this arrangement.\nIn January 1994, the Registrant sold $200.0 million of noncallable 6.60% Notes due 2004 with interest payable semiannually. The fair value of the Notes was $203.6 million and $174.2 million at December 31, 1995 and 1994, respectively.\nIn October 1993, the Registrant sold $150.0 million of noncallable 7% Notes due 2013 with interest payable semiannually. The fair value of these Notes was $156.6 million and $124.6 million at December 31, 1995 and 1994, respectively.\nIn May 1989, the Registrant issued $30.0 million of 8 3\/4% Notes due 1999 in exchange for $30.0 million of the 8 3\/4% Debentures due 2017. These Notes are noncallable and interest is payable semiannually. The fair value of these Notes was $32.7 million and $30.3 million at December 31, 1995 and 1994, respectively.\nSCHEDULE II -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT (Continued)\nNOTES TO CONDENSED FINANCIAL STATEMENTS\nIn December 1988, the Registrant sold $150.0 million of 10% Notes due 2000 and $150.0 million of 10 1\/8% Subordinated Notes due 2000. All such Notes are noncallable with interest payable semiannually on both issues. The fair value of the 10% Notes and 10 1\/8% Subordinated Notes were $175.9 million and $176.1 million, respectively, at December 31, 1995, and $159.8 million and $159.7 million, respectively, at December 31, 1994.\nIn February 1987, the Registrant sold $100.0 million ($70.0 million after the May 1989 debt exchange) of 8 3\/4% Debentures due 2017 with interest payable semiannually. In December 1993, the Registrant redeemed the entire $70.0 million principal amount of these Debentures. The Registrant redeemed the Debentures at 105.425% of the principal amount, plus accrued interest, with the proceeds of the sale of certain securities in its investment portfolios. A $4.0 million charge on debt extinguishment was recorded as a \"non-recurring item.\"\nAs of December 31, 1995, the Registrant was in compliance with its debt covenants.\nAggregate principal payments on funded debt outstanding at December 31, 1995 are $0 for 1996 through 1998, $30.0 million for 1999 and $300.0 million for 2000 and $350.0 million thereafter.\nINCOME TAXES -- The Registrant files a consolidated Federal income tax return with all subsidiaries. The Federal income taxes in the accompanying Condensed Balance Sheets represent amounts recoverable from the Internal Revenue Service by the Registrant as agent for the consolidated tax group. The Registrant and its subsidiaries have adopted, pursuant to a written agreement, a method of allocating consolidated Federal income taxes. Amounts allocated to the subsidiaries under the written agreement are included in Intercompany Receivable from Subsidiaries in the accompanying Condensed Balance Sheets.\nINVESTMENTS IN CONSOLIDATED SUBSIDIARIES -- The Registrant, through its investment in consolidated subsidiaries, recognizes the changes in unrealized gains (losses) on equity securities of the subsidiaries. These amounts were:\nOTHER MATTERS -- The information relating to incentive compensation plans is incorporated by reference from Note 8, Employee Benefit Plans, \"Incentive Compensation Plans\" on page 45 of the Registrant's 1995 Annual Report.\nSCHEDULE III -- SUPPLEMENTARY INSURANCE INFORMATION\nTHE PROGRESSIVE CORPORATION AND SUBSIDIARIES\n(1)Excluding investment expenses of $8.1 million in 1995, $8.7 million in 1994, and $10.2 million in 1993.\n(2)During 1994, based on a review of the adequacy of its total loss reserves, the Company eliminated its $71.0 million \"supplemental reserve.\" See Management's Discussion and Analysis of Financial Condition and Results of Operations beginning on page 14 for further discussion.\nSCHEDULE IV -- REINSURANCE\nTHE PROGRESSIVE CORPORATION AND SUBSIDIARIES (millions)\nSCHEDULE VI -SUPPLEMENTAL INFORMATION CONCERNING PROPERTY - CASUALTY INSURANCE OPERATIONS\nTHE PROGRESSIVE CORPORATION AND SUBSIDIARIES (millions)\nPursuant to Rule 12-18 of Regulation S-X. See Schedule III, page 33, for the additional information required in Schedule VI.\n(1)During 1994, based on a review of the adequacy of its total loss reserves, the Company eliminated its $71.0 million \"supplemental reserve.\" See Management's Discussion and Analysis of Financial Condition and Results of Operations beginning on page 14 for further discussion.\nEXHIBIT INDEX\nEXHIBIT INDEX\nEXHIBIT INDEX\nEXHIBIT INDEX\nNo other exhibits are required to be filed herewith pursuant to Item 601 of Regulation S-K.","section_15":""}
{"filename":"93319_1995.txt","cik":"93319","year":"1995","section_1":"ITEM 1. BUSINESS.\nThe Registrant, Standard Commercial Corporation, (\"Standard\" or \"the Company\") is engaged principally in the business of purchasing, processing and selling leaf tobacco for sale to domestic and foreign manufacturers of cigarettes and other tobacco products.\nFrom its beginning in 1910 as a small dealer in oriental tobacco, the Company has expanded through internal growth and acquisitions to become one of the world's largest leaf tobacco dealers. The Company itself does not manufacture cigarettes or other consumer tobacco products. For many years prior to 1978, the Company's operations were conducted almost exclusively outside of the United States. In fiscal 1995, tobacco operations accounted for 97.7% of total revenues, and approximately 35.6% of tobacco revenues resulted from sales by U.S. subsidiaries. The majority of tobacco sales consists of exports from the country of origin.\nFollowing a policy decision in January 1995 to divest its wool operations as a part of the Company's strategy to deleverage its balance sheet and to enable it to redeploy equity back into the tobacco business, the Company entered into an agreement in principle to sell its entire wool business other than the small specialty fibre unit to Chargeurs of Paris, France. The effective date of sale will be as of April 1, 1995 and it is anticipated that the sale will be completed in August 1995. Consequently, the wool business has been shown as discontinued operations as described fully in the Management's Discussion and Analysis of Results of Operations and Financial Condition and Note 2 to the Notes to Consolidated Financial Statements which are incorporated herein by reference.\nOther than the agreement to sell the wool business there have been no significant changes in business segments since April 1, 1994. Contributions to restated gross revenue from businesses other than tobacco for the past three years have not been material. See \"Other Operations and Investments.\"\nThe Company's operations are subject to the usual international business risks, including changing political conditions and currency fluctuations, and exchange controls and import\/export restrictions in some countries. The Company takes these factors into account in making its business decisions.\nTOBACCO OPERATIONS\nTRENDS IN TOBACCO CONSUMPTION\nIn recent years, American-blend cigarettes have gained market share in several major foreign markets, including Asia (particularly Japan and other Pacific Rim countries), Europe and the Middle East. In Asia, local manufacturers have imported increasing quantities of flue-cured and burley tobacco in order to produce cigarettes to compete with the growing market for imported American-or light-blend cigarettes. In addition, American-or light-blend cigarettes have gained market share in Western Europe. In Eastern Europe, several cigarette manufacturing facilities that were previously state-owned have been sold to multinational cigarette manufacturers, thereby creating new opportunities for leaf merchants.\nFollowing a period in 1992 and 1993 of significantly increased consumer demand for discount or value-priced cigarettes in the United States and certain other major markets, the U.S. market has stabilized with premium brands having regained market share. Price competition among cigarette manufacturers has remained intense, forcing independent leaf tobacco dealers to expand their ability to obtain less-expensive, foreign-grown tobacco of export quality. Accordingly, sales of foreign grown tobaccos have increased in relation to sales of United States tobaccos. The increased demand for light-blend cigarettes and less expensive tobacco has caused cigarette manufacturers to place greater reliance on the services of internationally strong leaf tobacco dealers that have the ability to purchase, process and sell tobacco on a global basis.\nWhile worldwide production of American-or light-blend cigarettes is increasing as described above, consumption of cigarettes has declined in certain countries in recent years, especially in the United States and certain other industrialized countries.\nWorldwide cigarette production largely determines the level of demand for leaf tobacco. In recent years, the consumption of cigarettes has stabilized or declined in many industrialized nations but has continued to grow in most developing countries. There has also been increased demand for higher quality cigarettes in Eastern European countries, Turkey and Russia and the other states of the former Soviet Union. Reports regarding the alleged harmful effects of cigarette smoking have been publicized for many years and, together with restrictions on cigarette advertising and smoking in public places, mandatory warning statements and increased taxes on tobacco products, have had and continue to have a negative impact on sales of tobacco products in certain markets. However, the Company believes that its broad customer base and sources of supply help to mitigate the effects of declines in consumption in particular areas of the world, as it has a large amount of business in areas where consumption is on the rise and with established customers who are catering to the increasing demand for light-blend cigarettes by consumers in Asia, Europe and the Middle East.\nPURCHASING\nThe tobacco in which the Company deals is grown in approximately 30 countries. Management believes that its diversity in sources of supply, combined with a relatively broad customer base, places it in a particularly strong position worldwide within its industry. The Company relies primarily on revolving lines of bank credit and internal resources to finance its purchases. Quite often the tobacco serves as collateral for the credit. The period of exposure, with some exceptions, generally is limited to a tobacco season lasting only a few months.\nAlthough most purchases of tobacco are made against specific customer orders or indications of interest, the Company has from time to time purchased tobacco for its own inventory when it believed there was a reasonable opportunity to resell the tobacco at a profit, or when it anticipated its customers' needs before receiving firm orders or indications of interest. Purchases for inventory are generally made in foreign markets. The Company rarely purchases tobacco in the United States without a firm order or indication of interest. All tobacco purchases are being monitored closely with a goal of reducing the Company's exposure to price fluctuations and to reducing its costs of carrying inventory. For the most part, there are no formal contracts between the Company and its various suppliers of tobacco.\nThe Company generally employs its own buyers to purchase tobacco on auction markets, directly from growers and pursuant to marketing agreements with government monopolies. Tobacco is generally sold in the United States to the highest bidder at public auction. At present, the greatest amounts of tobacco purchased by the Company outside the United States come from Argentina, Brazil, China, Greece, Malawi, Thailand, Turkey and Zimbabwe.\nApproximately 60-70% of the Company's tobacco purchases are made against customer orders or indications of interest. This committed inventory should normally total approximately $110-$150 million and the carrying costs are normally reimbursed by the customer. The orders or indications of interest may be written or oral. Historically, tobacco customers have been extremely reliable in honoring these commitments, and the Company believes that its position in respect of its committed tobacco inventories is adequately protected. By the end of fiscal 1995 the Company's committed tobacco inventory was $109 million which is consistent with somewhat lower carrying values and a conscious effort to reduce inventories.\nArgentina, Brazil, China, Greece, Turkey and Thailand are major tobacco producers, but there are no tobacco auctions in these markets. In these markets, with the exception of Brazil where the Company acts as export agent for British-American Tobacco Company (BAT), the Company buys tobacco directly from farmers or agricultural cooperatives in advance of firm orders or indications of interest although such purchases are usually made with some knowledge of its customers' requirements. The Company engages in this type of uncommitted transaction because of the strategic importance of these markets in the tobacco supply system. In order to serve its customers properly, the Company must have a presence in these markets. During fiscal 1995 the Company substantially reduced uncommitted tobacco inventories and its goal is to reduce them further. The Company's uncommitted inventory at March 31, 1995 of $60 million (excluding $25 million of unprocessed tobacco and packing material) was at the high end of the estimated range of $30-$60 million (depending on prevailing market conditions) needed to conduct normal business operations.\nPROCESSING\nTobacco purchased by the Company generally is perishable and must be processed within a relatively short period of time to prevent deterioration in quality. Consequently, processing facilities are usually located near the areas where the tobacco is purchased. Prior to processing, steps are taken to ensure consistent quality of the tobacco. These steps include regrading and removing undesirable leaves, dirt and other foreign matter. Most of the tobacco is then blended and threshed; however, some of it is processed in whole-leaf form. Threshing involves mechanically separating the stem from the tissue portions of the leaf, which are called strips, and sieving out small scrap. Considerable expertise is required to produce strips of large particle size and to minimize scrap.\nStrips and stems are redried and packed separately. Redrying involves further reducing the natural moisture left in the tobacco after it has been cured by the growers. The objective is to pack tobacco at safe moisture levels so that it can be held by the customer in storage for long periods of time. Quality control checks are continually performed during processing to ensure that the product meets customer specifications as to yield, particle size, moisture content and chemistry. Customers are frequently in attendance at the factory to monitor results while their tobacco is being processed.\nRedried tobacco is packed in hogsheads, cartons, cases or bales for storage and shipment. Packed tobacco generally is transported in the country of origin by truck or rail, and exports are moved by ocean container vessels or freighters.\nAs of the end of fiscal 1995, Standard processed its tobacco in three wholly owned plants in the United States and 11 other facilities around the world owned or leased by subsidiaries and affiliates. In addition, Standard has access to other processing plants in which it has no ownership interest. In all cases, tobacco processing is under the direct supervision of Company personnel. From time to time the Company purchases and sells tobacco processed by others. Modern laboratory facilities are maintained by the Company to assist in selecting tobacco for purchase and to test tobacco during and after processing. In addition, Standard does laboratory testing for a number of its customers and others.\nThe Company believes that its plants are highly efficient and are adequate for its purposes. The Company also believes that tobacco throughput could be increased without major capital expenditures.\nSELLING\nStandard's customers include most of the world's leading manufacturers of cigarettes and other consumer tobacco products. These customers are located in some 85 countries throughout the world. Standard employs its own salesmen, who travel extensively to visit customers and to attend tobacco markets worldwide with these customers, and it also uses agents for sales to customers in certain countries. Sales are made on open account to customers who qualify based on experience or are made against letters of credit opened by the customer prior to shipment. Virtually all sales are made in United States dollars. Payment for most tobacco sold by the Company is received after the tobacco has been processed and shipped. However, some customers pay the Company before the tobacco has been processed and shipped.\nIn fiscal 1995, the Company's five largest customers accounted for approximately 56% of total sales from continuing operations, of which Philip Morris Companies, Inc. and Japan Tobacco, Inc. each accounted for more than 10%. Also, in fiscal 1994, Japan Tobacco and Philip Morris Companies each accounted for more than 10% of the Company's total restated sales. BAT was the Company's largest customer in fiscal 1993, and accounted for more than 10% of total restated sales.\nAlthough there are no formal purchase contracts with any of these customers, the Company has done business with most of them for many years. In the unlikely event that the Company were to lose two or more of its larger customers, it could have a material adverse effect on the Company's business.\nAt March 31, 1995 and 1994, the Company had outstanding orders of approximately $109 million and $170 million, respectively, for tobacco in inventory.\nREGULATION\nReports with respect to the allegedly harmful physical effects of cigarette smoking have been publicized for many years and, together with restrictions on cigarette advertisements, requirements that warning statements be placed on cigarette packaging and in advertising, increased taxes on tobacco products and controls in certain countries on imports, production and prices, have had and continue to have an adverse impact on sales of tobacco products in many world markets. In addition, litigation is pending against some of the leading United States manufacturers of consumer tobacco products seeking damages for health problems alleged to have resulted from the use of tobacco in various forms. It is not possible to predict the outcome of such litigation or what effect adverse developments in pending or future litigation against manufacturers might have on the business of the Company.\nAlthough the consumption of cigarettes has decreased in the United States and some other countries in recent years, cigarette consumption in many countries to which the Company makes considerable sales has increased during the same period. In addition, the consumption of American-or light-blend cigarettes has increased in both Western and Eastern Europe, even though total cigarette consumption has not. Exports of cigarettes from the United States have increased significantly in recent years as well. The Company believes that any materially adverse effect on its business from a significant decrease in consumption in any area in which it does business will be reduced by its worldwide customer base though it is impossible to predict the extent to which any such decrease will affect the Company's business. In addition, governments in many countries continue to raise the excise tax on cigarettes and other tobacco products.\nDuring fiscal 1995 import quotas were introduced in the United States to aid domestic producers of tobacco. This action coincided with the elimination of the domestic content law enacted in the United States in July 1993 (effective January 1, 1994) which was determined to be in violation of GATT. While in effect, the domestic content law dramatically reduced the demand for tobaccos grown outside of the United States and contributed to the decline in world tobacco prices in 1993. Since foreign tobacco tends to be considerably cheaper than tobacco grown in the United States, this law resulted in a significant cost to domestic cigarette producers. It also disrupted the existing supply and demand balance and resulted in an oversupply of foreign tobacco in the world. In addition, there were several proposals before Congress to increase the federal excise tax imposed on a pack of cigarettes as much as $2.00 per pack. The likelihood of a tax increase of this magnitude in the near term now appears remote.\nCOMPETITION\nCompetition among independent leaf tobacco dealers is based primarily on the price charged for products and services, the ability to meet customer demands and specifications in sourcing, purchasing, blending, processing and financing tobacco and the ability to develop and maintain long-standing customer relationships by demonstrating a knowledge of customer preferences and requirements. Although most of the Company's principal customers also purchase tobacco from the Company's major competitors, the Company's relationships with its largest customers span many years and the Company believes that it has the personnel, expertise, facilities and technology to remain successful in the industry.\nCompetition for purchasing tobacco varies depending on the market involved. Normally, there are from six to eight buyers at each of the United States flue-cured and burley auctions, representing both leaf tobacco dealers and buying staffs of certain cigarette manufacturers. The number of competitors in foreign markets varies from country to country, but there is competition in all areas to purchase the available tobacco. Among independent leaf tobacco dealers, the principal competitors are Universal Corporation, DIMON Incorporated (formed by the April 1, 1995 merger of Dibrell and Monk-Austin) and Intabex Services Ltd. Of the independent leaf tobacco dealers, the Company believes it ranks third in worldwide market share.\nSEASONALITY\nThe Company's tobacco business is dependent on agricultural cycles and is seasonal in nature. For example, the Company purchases flue-cured tobacco grown in the United States during the five-month period beginning in July and ending in November, while burley tobacco grown in the United States is purchased from late November until January or February. Tobacco in Brazil is purchased from January through May. Tobacco in Malawi and Zimbabwe is purchased from April through October. Other markets around the world last for similar periods at varying times of the year. Accordingly, while the leaf tobacco business is seasonal in any given region and such seasonality may impact the Company's quarterly results of operations, the global nature of the Company's business enables it to be involved in purchasing, processing and selling tobacco throughout the year and reduces the overall effect of seasonality on the Company's business.\nThe processing cycle for leaf tobacco is relatively short. Processing is conducted throughout the tobacco purchasing season and is usually complete within two to three months following purchase of the tobacco. Consequently, the components of the Company's working capital relating to purchasing, processing and selling leaf tobacco (for example, tobacco inventory, advances to suppliers and current liabilities such as seasonal lines of credit and accounts payable) reach their peak in the second and third fiscal quarters and accounts receivable, revenues and operating income peak in the third and fourth fiscal quarters. The Company customarily invoices tobacco when it is delivered in accordance with the terms of the contract. Therefore, tobacco inventory will vary from quarter to quarter depending on fluctuations in shipping schedules and the seasonality of the Company's business.\nOTHER OPERATIONS AND INVESTMENTS\nThe Company is engaged in several other smaller activities: Carolina Home Center, a wholesale\/retail building materials and home supply center located in Wilson, North Carolina; and Bela Duty Free Import-Export (89% owned), which is the principal supplier of goods to 50 duty free shops (in which it has interests from 25% to 50%) catering to cross-border travelers in Eastern Europe.\nEMPLOYEES\nAt March 31, 1995, the Company had a total of approximately 2,005 full-time employees (including approximately 495 in the United States) and approximately 2,595 employed by affiliated tobacco companies. Of the Company's full-time employees, approximately 1,275 are in the tobacco business, approximately 690 are in the wool business and approximately 40 have duties relating to other operations. The tobacco business typically employs an additional 7,000 to 7,700 part-time employees during peak production periods.\nThe Company's principal subsidiary in the United States has a collective bargaining agreement with a union covering the majority of its hourly employees, many of whom are seasonal. The agreement expires on May 31, 1996. The Company believes its relations with employees covered by this agreement are good. Employees at the French wool plant are also represented by a labor union under an agreement subject to renewal every December 31. The Company believes that its relations with its employees in France are good.\nGENERAL\nThe Company does not own any material patents, trademarks, licenses, franchises or concessions, nor does it engage in any significant research activity.\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 have not had, and are not anticipated to have, any material effect upon the competitive position of the Company. The Company has initiated programs to comply with regulations not being enforced in certain foreign countries concerning effluent control at its wool mills.\nThe Company's consolidated operations are conducted mainly by companies registered in the United States and Europe. Segment information is shown in Note 19 of the Notes to the Consolidated Financial Statements and is incorporated herein by reference.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nStandard's principal corporate offices and the headquarters for its United States tobacco operations are located in Wilson, North Carolina. It also has administrative offices in Godalming (south of London), England.\nThe Company generally conducts its tobacco processing operations in facilities near the area of production in the case of tobacco and near its customers in the case of wool. In certain places, long-standing arrangements exist with local companies to process tobacco in their plants under the supervision of Company personnel.\nThe Company believes the properties it uses are generally well-maintained and in good operating condition and are suitable and adequate for the normal growth of its business.\nA current summary showing the principal operating properties owned or leased (as indicated by *) by the Company or its affiliates is shown below:\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThe Company has received notice of investigations by Canadian and United States authorities into alleged violations of law relating to the importation, exportation and taxation of tobacco, and has been notified that two of its\nemployees have been charged with violations of Canadian law. The investigation is ongoing and, although the Company has not been notified that it is a target, it has been requested to provide certain documents relating to specified transactions and it is cooperating fully in that regard. The Company does not foresee any claim arising from the proceedings which would have a material effect on its consolidated financial position.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNo matters were submitted to a vote of security holders during the quarter ended March 31, 1995.\nEXECUTIVE OFFICERS OF THE COMPANY AT MARCH 31, 1995\nNAME AGE POSITIONS\nEry W. Kehaya 71 Chairman of the Board J. Alec G. Murray 58 President and Chief Executive Officer and Acting Chief Financial Officer Marvin W. Coghill 61 Chairman - Tobacco Division J. Anthony Johnston 60 Chairman - Wool Division Henry R. Grunzke 63 Commercial Director - Wool Division Thomas M. Evins, Jr. 55 Regional Manager - North & Central America Tobacco Operations Guy M. Ross 62 Vice President and Secretary Ery W. Kehaya II 42 Vice President and Operations Director - Tobacco Division Mark W. Kehaya 27 Vice President Krishnamurthy Rangarajan 52 Vice President Keith H. Merrick 41 Treasurer and Assistant Secretary Hampton R. Poole, Jr. 43 Controller and Assistant Treasurer\nInformation concerning executive officers who are also directors is contained in the Company's definitive Proxy Statement for the Annual Meeting of Shareholders to be held on August 8, 1995 which, except for the material under the headings \"Compensation Committee Report\" and \"Performance Graph\" is incorporated herein by reference and made a part hereof. Business experience during the past five years of other executive officers is set forth below:\nMr. Johnston resigned as a director of the Company effective March 1995. He continues to serve as Chairman and Chief Executive Officer of the Wool Division pending completion of sale of the wool business.\nMr. Ross became Treasurer in 1980 and Secretary in 1981 following the Company's purchase of the American leaf business of Imperial Tobacco Ltd. (UK). He was employed by Imperial for 14 years including 10 as Vice President of Finance and Administration. He became a Vice President of the Company in 1992.\nEry W. Kehaya II was appointed Vice President in 1992. He became Operations Director - Tobacco Division in 1995 after being named Sales Director in 1993. He has been an officer of Standard Commercial Tobacco Co., Inc., a subsidiary, for more than five years, serving as Executive Vice President since 1992 and as Senior Vice President-Sales before that. He is the son of Ery W. Kehaya, Chairman of the Board.\nMark W. Kehaya was appointed Vice President in 1994. Prior to joining the Company in 1993 he was employed at Bankers Trust Company and Fieldstone Private Capital Group as an associate and attended Duke University Fuqua School of Business. He is the son of Ery W. Kehaya, Chairman of the Board.\nMr. Rangarajan was employed by the Company in 1978 after qualifying as a chartered accountant. He became Chief Accountant in 1981, an Assistant Vice President in 1986 and Vice President in 1988.\nMr. Merrick was employed by the Company in 1992 and became Treasurer in 1993 after being named Assistant Treasurer and Assistant Secretary in 1992. He is also a Vice President of Standard Commercial Tobacco Co., Inc., a subsidiary. He was formerly a Vice President of First Union National Bank of North Carolina.\nMr. Poole Jr. was appointed Controller and Assistant Treasurer in 1993. He has been an officer of Standard Commercial Tobacco Co., Inc., a subsidiary, for more than five years and is currently serving as Secretary-Treasurer.\nThe above persons will remain in office until the directors' meeting following the annual meeting of shareholders on August 8, 1995.\nPART II\nITEM 5","section_5":"ITEM 5 - MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS\nITEM 6","section_6":"ITEM 6 - SELECTED FINANCIAL DATA\nITEM 7","section_7":"ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe information called for by Items 5, 6 and 7 is contained in the Company's 1995 Annual Report to Shareholders as detailed below and incorporated herein by reference and made a part hereof.\nITEM CAPTION IN ANNUAL REPORT PAGE NO.\n5 Quarterly Financial Data (Unaudited) 23 6 Selected Financial Data 23 7 Management's Discussion and Analysis of Financial Condition and Results of Operations 7-10\nITEM 8","section_7A":"","section_8":"ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe data appearing on pages 11 through 21 of the Company's 1995 Annual Report to Shareholders, and the Independent Auditors' Report on page 22, are incorporated herein by reference and made a part hereof.\nITEM 9","section_9":"ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone\nPART III\nITEM 10","section_9A":"","section_9B":"","section_10":"ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nITEM 11","section_11":"ITEM 11 - EXECUTIVE COMPENSATION\nITEM 12","section_12":"ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nITEM 13","section_13":"ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information called for by items 10, 11, 12 and 13 is included in the Company's definitive Proxy Statement for the Annual Meeting of Shareholders to be held on August 8, 1995 and is incorporated herein by reference, except for the material under the heading \"Compensation Committee Report\" and \"Performance Graph.\" The information concerning executive officers of the Company follows Item 4 of Part 1 of this Report.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL SCHEDULES AND REPORTS ON FORM 8-K.\n(a) 1. Financial Statements: See Item 8.\n2. Financial Statement Schedules: The financial statement schedules called for under Regulation S-X are either not applicable or the information is included in the data mentioned in Item 8 and incorporated herein by reference.\n(b) Reports on Form 8-K: No report on Form 8-K was filed during the quarter ended March 31, 1995.\n(c) The following exhibits are filed as part of this Report:\n3. (i) There is incorporated by reference herein the Company's Restated Articles of Incorporation and the amendment thereof designating the rights, preferences and limitations of the Company's Series A Preferred Stock filed as Exhibits 4(a)(i) and (ii) to the Company's Registration on Form S-8 #33-59760.\n(ii) There is incorporated by reference herein the Company's amended Bylaws filed as Exhibit 3(ii) to the Company's report on Form 10-K for the year ended March 31, 1994.\n4. (i) There is incorporated by reference herein the Company's Shareholder Protection Rights Agreement filed as Exhibit (4) to the Company's Report on Form 8-K dated April 5, 1994.\n(ii) Master Facilities Agreement dated May 5, 1995 between the Company and certain subsidiaries and Deutsche Bank A.G. and a number of other banks.\n(iii) Loan and Security Agreement dated as of May 2, 1995 between Standard Commercial Tobacco Co., Inc., a subsidiary of the Company, and NationsBank of Georgia, N.A.\n(iv) Company Guaranty Agreement dated as of May 2, 1995 with respect to the loan referred to in 4(iii) above.\n10. Agreement dated May 2, 1995 between the Company and Ery W. Kehaya.\n11. Computation of Earnings per Common Share.\n13. The Company's Annual Report to Shareholders for the year ended March 31, 1995 which, except for information expressly incorporated by reference into Items 1, 5, 6, 7 and 8 is not deemed to be \"filed\" as a part of this Report.\n21. List of subsidiaries.\n23. Consent of Independent Public Accountants.\n27. Financial Data Schedule.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Standard has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nSTANDARD COMMERCIAL CORPORATION\nJune 16, 1995 By: \/s\/ J ALEC G MURRAY J Alec G Murray, President and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on June 16, 1995 by the following persons on behalf of the Registrant in the capacities indicated.\n\/s\/ J ALEC G MURRAY President and Director J Alec G Murray (Chief Executive Officer and Acting Chief Financial Officer)\n\/s\/ GUY M ROSS Vice President Guy M Ross (Principal Accounting Officer)\n\/s\/ ERY W KEHAYA Ery W Kehaya Chairman of the Board of Directors\n\/s\/ MARVIN W COGHILL Marvin W Coghill Director\n\/s\/ WILLIAM A ZIEGLER William A Ziegler Director\nHenry R Grunzke Director\n\/s\/ WILLIAM S BARRACK JR William S Barrack Jr Director\n\/s\/ THOMAS M EVINS JR Thomas M Evins Jr Director\n\/s\/ CHARLES H MULLEN Charles H Mullen Director\n\/s\/ DANIEL M SULLIVAN Daniel M Sullivan Director","section_15":""}
{"filename":"851478_1995.txt","cik":"851478","year":"1995","section_1":"ITEM 1. BUSINESS\nIntroduction\nBEI Electronics, Inc. (the \"Company\") is a diversified manufacturer which focuses its activity on three principal families of technology-oriented products. These include:\n1.) sensors, engineered subsystems and associated components which are used for control of precision machinery and equipment in industrial, medical, automotive, aerospace and military applications (Sensors and Systems segment);\n2.) rocket-propelled ordnance systems for military use (Defense Systems segment) (see Note C to Consolidated Financial Statements for shut down of the HYDRA 70 Rocket business); and\n3.) proprietary medical instruments and supplies for diagnostic and minimally invasive surgical procedures (Medical Systems segment).\nThe Company conducted its fiscal 1995 operations through BEI Sensors & Systems Company (Sensors and Systems), BEI Defense Systems Company (Defense Systems) and BEI Medical Systems Company (Medical Systems). The Company has major operations in Arkansas, California, New Jersey and Texas. See Note N to Consolidated Financial Statements for Business Segment Data. For a discussion of factors relating to the Company's risks, see \"Risk Factors\" below.\nThe Company incorporated in Delaware in 1974, as a successor to Baldwin Electronics, Inc., and became a publicly-owned company in 1989. BEI's principal executive offices are located at One Post Street, Suite 2500, San Francisco, California 94104 and its telephone number at that location is (415) 956-4477. Unless the context indicates otherwise, \"BEI\" and the \"Company\" refer to BEI Electronics, Inc. and its consolidated subsidiaries. BEI is a registered trademark of the Company.\nSENSORS AND SYSTEMS SEGMENT\nBEI Sensors & Systems Company produces components and systems that provide vital communication, information and control links between digital electronic equipment and precision mechanisms. Supplemental or complementary products such as motors are also manufactured. Sensors and Systems' products consist of optical encoders and servo systems, precision potentiometers, mechanical accelerometers, quartz rate sensors, pressure transducers, cryocoolers, actuators, brushless motors, quartz accelerometers, inertial guidance components and subsystems, and other control electronics which sense, drive and control the motion of a wide variety of machinery and equipment with the high accuracy and reliability required in modern industrial automation, space technology, aviation, automotive components, health care, science and office automation applications. Using standard designs, parts and subassemblies, the Company typically manufactures products to meet the specifications of end users or original equipment manufacturers (OEMs), who integrate these products into their systems, machinery and equipment. The Company's technical expertise allows it to offer its customers the flexibility to develop both customized components and fully integrated sensor and control systems that satisfy their individual requirements.\nProducts of Sensors and Systems Segment\nThe following products, which may be used alone or in combination, are produced in the Sensors and Systems segment:\nOptical Encoders and Servo Systems. Optical encoders when mechanically connected to rotating shafts translate angular motion and velocity information into digital electronic signals. These signals are then received by signal processing electronics and used to control the operation of machinery and equipment. Optical encoders include a light source, a rotating slotted code disk through which the light passes, a photoelectric sensor, which receives the light through the code disk, and a signal processor to translate the pulses of light into digital information. The Company offers a wide array of optical encoders to serve a variety of applications. The most common applications are for factory automation,\noffice automation, and transportation equipment, but specialized versions are also used for military and space hardware. Servo Systems are closed-loop electronic systems that control the position or velocity of rotating shafts or other moving parts by accepting a desired rate or position input from computers or keyboards, monitoring the position or rate of movement (using an appropriate encoder or other sensor) and constantly providing feedback which indicates whether the desired performance has been achieved.\nQuartz Rate Sensors, Mechanical Accelerometers, Quartz Accelerometers and Inertial Guidance Systems. These products provide precise and reliable measurement of minute linear and angular motions for control, guidance and instrumentation requirements in strategic systems, tactical aircraft and missiles, space systems and in commercial, industrial and automotive applications. In general, these devices operate without need for direct linkage to the driving mechanisms. Such measurements are required for stabilization and other functions of satellites, in-flight monitoring of military and commercial aircraft antenna stabilization, navigation of oil well drill bit assemblies, components used in intelligent vehicle dynamic control, and navigation systems in the automotive industry.\nMechanical accelerometers and rate sensors using traditional technology (e.g., pivot and jewel sensing mechanisms) rely on the movement of complex machined metallic parts to measure motion. The Company's miniature, solid state accelerometers and rate sensors are based on its innovative quartz technology. Quartz accelerometers are used in oil field applications for the navigation of the drill bit assembly. The Company developed the Quartz Rate Sensor (QRS) for military applications such as a replacement for traditional rotating wheel gyroscopes. Unlike a conventional gyroscope, which may contain several hundred individual parts in the sensing assembly, the QRS uses only one single element as its sensor. This element is chemically micro-machined from crystalline quartz using photolithographic methods similar to those used in the manufacture of silicon semiconductor chips. The advantages of quartz rate sensors and accelerometers over traditional mechanical units are increased reliability, reduced size, and lower production and life cycle cost.\nGyroChip Sensors. The Company's GyroChip sensors developed for commercial gyro applications, are lower cost versions of the Quartz Rate Sensor. These products have found use in such varied requirements as navigation of autonomous guided vehicles (robotics), ocean buoy and sea-state monitoring, and stabilization of optical systems. Prototype units are in use as yaw sensors in advanced next generation stability control or anti-skid systems for automobiles. The GyroChip provides performance suitable for commercial applications while offering ruggedness, long life and small size at a lower cost than military versions of the product.\nPrecision Potentiometers. Potentiometers are used as position-sensing devices for throttles, steering position, transmission controls, wiper delay and seat and mirror positions in automobiles and heavy equipment, such as earth movers, and construction and farm machinery. They are also used as position sensors in such applications as actuators on molding presses, saw mills and numerous other types of industrial equipment and in oil well logging calipers. In light of their resolution, durability and resistance to electronic noise, these devices are well suited to function as control transducers (a device which converts an input to another form of output; e.g., analog to digital). Customized versions of some potentiometers makes these sensors suitable for the high acceleration, shock and vibration levels required for control and instrumentation of missiles, satellites and space vehicles. Incorporating the potentiometer technology with the company's proprietary optical encoder technology has resulted in a multisensor that could serve as a steering wheel position sensor for an intelligent vehicle dynamic control and braking system for future automobiles.\nBrushless DC Motors. Brushless DC Motors permit high performance, drive efficiency in lightweight packages, and ease of interface with microprocessors. The motors, which feature high energy magnets, are characterized by long life and low acoustic and electrical noise. They are well suited to high speed, high reliability applications, such as in operating rooms where the risk of sparks from a brush motor would be hazardous or where electrical noise could disrupt computers or computer-controlled equipment.\nPressure Transducers. Pressure Transducers monitor aircraft engine, oil, fuel and cabin pressure and are capable of providing voltage or frequency output proportional to pressure in the range from vacuum to 10,000 psi. These products are produced to meet the requirements of low pressure ranges such as those needed for the measurement of altitude, airspeed and Mach number. Other versions accommodate higher pressure applications intended to provide accurate measurement, long life and resistance to severe vibration and shock environments. BEI's pressure transducers can be found on executive jets and turboprops, commercial and military aircraft, missiles and torpedoes, and on the Space\nShuttle. The Sensors & Systems segment is currently developing a product line of silicon based pressure sensors designed for high volume commercial\/industrial applications.\nActuators. Actuators are used in place of motors to achieve precise control of short stroke linear or limited rotary motion. Actuators using high energy magnets are also produced for specialized applications requiring intense force, torque or acceleration relative to the size of the device.\nCryogenic Coolers. This newly developed product line is a low cost, long life Stirling cycle refrigerator known for generating cryogenic temperatures required for super conducting applications and infrared detection such as night vision and surveillance cameras.\nSignificant Customers and Marketing for Sensors and Systems Segment\nThe Sensors and Systems segment marketed its products during the past fiscal year to approximately 6,000 commercial end users and OEMs, principally in the United States, through its direct sales force. Sales to the U.S. Government (or prime contractors to the U.S. Government) represented approximately 32% of Sensors and Systems net sales in fiscal 1995 and 40% in fiscal 1994. No other customer accounted for more than 10% in fiscal 1995 or fiscal 1994. While the Company has received several large orders from non-government customers, individual orders are typically less than $100,000. (See Note N to Consolidated Financial Statements.) The Company's strategy is to place increased emphasis on the development of non-government customers to offset the effects of reductions in government programs. (See Risk Factors below.)\nThe Sensors and Systems segment is represented internationally by approximately 20 sales representatives and distributors. In addition, during fiscal 1994, the Company finalized a joint U.S.-European marketing and technical assistance agreement with Ideacod, S.A. of Strasbourg, France. Under this agreement, Ideacod's direct sales network has become the principal European sales channel for the Sensors and Systems segment's commercial encoder products and BEI will market Ideacod's products in the U.S. Also, the Company entered into a marketing agreement in late fiscal 1994 with Nozaki & Company, Ltd. for exclusive distribution of quartz sensors to military, defense, space and shipbuilding markets in Japan.\nField sales engineers are trained to assist in product selection and system design. Factory-based application engineers assist in defining performance criteria and in prototype development. Customer service staffs are also available to coordinate after-sale service and support. Warranties on products typically range from a period of one to two years. Warranty costs have historically not been significant.\nBacklog for Sensors and Systems Segment\nThe segment's backlog at September 30, 1995 and October 1, 1994 was as follows:\nBacklog (dollars in thousands) September 30, 1995 October 1, 1994 ------------------ ---------------\n$41,442 $37,622\nBacklog includes aggregate contract revenues remaining to be earned by the Company over the life of existing contracts. Some contracts undertaken by the Company extend beyond one year. Accordingly, portions of such contracts are carried forward from one year to the next as part of backlog. Not all of the backlog as of September 30, 1995 is scheduled for shipment during fiscal 1996.\nIn the case of U.S. Government contracts, backlog includes only those contracts that are fully funded by a procuring Government agency. All U.S. Government contracts and subcontracts are subject to termination by the U.S. Government for convenience.\nThe Sensors and Systems segment has commercial operations that typically ship standard products within 30 to 60 days after receipt of an order. The Company believes that its competitive position in this segment depends in part on minimizing the time that elapses between receipt and shipment of an order. Products which require special analysis, design or testing, such as those produced for customers in the aviation and defense or space technology markets, are generally shipped from six to twelve months after receipt of the order.\nCompetition for Sensors and Systems Segment\nThe Company's principal competitors in the Sensors and Systems segment include Vernitron Corporation, Dynapar Corporation and Veeder-Root, subsidiaries of Danaher Controls, Dynamics Research Corporation, Renco Encoders Incorporated, a subsidiary of Heidenhain Corporation, Encoder Products Company, Allied Signal, Litton, Northrop Corporation, Rockwell International Corporation, Honeywell, CTS Corporation and Kulite Semiconductor Products, Inc. In addition, the Company also may compete with manufacturers of competing technologies, such as potentiometers, resolvers, inductosyns or laser gyros and magnetic encoders.\nManufacturing for Sensors and Systems Segment\nThe Sensors and Systems segment manufacturing operations primarily consist of the manufacture and assembly of encoders, accelerometers, rate sensors, pressure sensors, potentiometers, motors, cryogenic coolers, actuators, servo systems and other electronics. Special equipment developed by the Company generates and replicates, with a high degree of accuracy, optical code disks, which are components critical to the production of optical encoders. Production of precision components for all systems requires accurate machining capabilities. Because of the sensitivity of certain products to environmental contamination, such as encoders, quartz rate sensors and servo systems for space and military applications, these products are assembled under strict clean room conditions.\nResearch & Development for Sensors and Systems Segment\nThe major focus of this segment's R&D effort has been to improve performance, yield and predictability of existing products, with special emphasis on the quartz sensors used in high accuracy Inertial Measurement Units (IMU's) and high volume yaw rate sensors for the automotive industry. Substantial effort has also been devoted to the development of an automotive yaw rate sensor and the manufacturing methods necessary to deliver competitive prices and quality in this market. Other development has focused on expanding applications of existing sensors. New pressure sensor applications were targeted at low cost general aviation applications and a miniature transducer for petroleum exploration and production.\nThe Company has also produced prototypes of future products incorporating silicon micromachined pressure sensors geared towards next generation requirements for automotive, industrial and aerospace markets.\nU.S. Government Contracts for Sensors and Systems Segment\nApproximately 32%, 40% and 47% of the Sensors and Systems segment's net sales in fiscal 1995, 1994 and 1993, respectively, were derived from contracts with the U.S. Government or under subcontract to other prime contractors to the Government. Because a large portion of the segment's business is derived from contracts with the Department of Defense (\"DOD\") or other agencies of the U.S. Government, the Company's business is dependent upon defense and other Government spending policies, which can be subject to significant variation from year to year. At various times, the Company's results have been adversely affected by contract cutbacks and there can be no assurance that the Company's results of operations will not in the future be materially and adversely affected by changes in Government procurement policies or reductions in Government expenditures for products furnished by the Company.\nUnder applicable regulations, various audit agencies of the U.S. Government conduct regular audits of contractors' compliance with a variety of Government regulations. Because of the recurring nature of changes in laws and regulations and related regulatory audits, the Company expects it will continue to incur costs for monitoring and compliance efforts. During fiscal 1995 and 1994, these costs were higher than in the past. The Government also has the right to review retroactively the cost records of the Company under most U.S. Government contracts. Contract prices may be adjusted in the event the Company submits incomplete, inaccurate or obsolete cost or pricing data. U.S. Government contracts and\nsubcontracts generally provide for either a fixed price, negotiated fixed price or cost-plus-fixed-fee basis for remuneration. The majority of the contracts with the U.S. Government are competitive fixed price or negotiated fixed price contracts, although cost-plus contracts were approximately 22% of U.S. Government net sales of the segment in fiscal 1995. For fixed price contracts, the Company bears the risk of cost overruns and derives the benefits from cost savings. As a result, greater risks are involved under fixed price contracts than under cost-plus contracts because failure to anticipate technical problems, estimate costs accurately or control costs during contract performance may reduce or eliminate the contemplated profit or may result in a loss.\nAll U.S. Government contracts contain termination clauses that allow the contract to be terminated either for contractor default or for the convenience of the Government. In the event of termination for the convenience of the Government, the clause typically provides that the contractor will receive payment for work-in-progress, including profit. To date, termination of the Company's contracts by the Government has not had any significant effect on the Company's financial results. However, no assurance can be given that such terminations will not have a materially adverse effect on the Company's results of operations in the future. Portions of the Company's business are classified. As a result, the Company is and will be prohibited from disclosing the substance or status of such business.\nDEFENSE SYSTEMS SEGMENT\nBEI Defense Systems Company (hereafter Defense Systems) provides rocket systems, including weapons management systems, rocket motors, and combat and training warheads primarily to the Department of Defense (DOD), and also to allied foreign governments. For a number of years, Defense Systems has been the sole manufacturer and integrator of the HYDRA 70, a cost-effective, advanced free-flight rocket system that can be employed in a variety of combat and training roles. In September 1995, management of the Company reached a decision to exit the rocket manufacturing line of business which makes up a substantial portion of the Company's Defense Systems segment. For fiscal 1995, HYDRA 70 revenues represented 85% of Defense Systems' total sales. The Company estimates that HYDRA 70 revenues will represent approximately the same proportion of Defense Systems' segment revenues in fiscal 1996.\nFor production in fiscal 1997-1998, the Government has initiated competitive bidding for new HYDRA 70 contracts. The Company learned in early December 1995 that the joint bid with a team led by Alliant Techsystems was not successful. The Company will realize diminished levels of HYDRA 70 revenues in fiscal 1996 and does not anticipate any H 70 revenues thereafter (see Note C to Consolidated Financial Statements). (See also Competition, U.S. Government Contracts, Major Programs and Subcontractors below).\nProducts of Defense Systems Segment\nHYDRA 70 Rocket Systems.\nThe HYDRA 70 is a 2.75 inch free-flight rocket system which features a microprocessor-based weapons management system that provides automatic control of components such as rocket motors, fuzes and a variety of warheads, each of which is specifically adapted for use as part of the system. A pilot need only select a target and type of ammunition, and aim the sight. The management system automatically sets the fuze that subsequently detonates the warhead or deploys submunitions at the designated target. Placing the management system on board the aircraft permits a relatively inexpensive fuze to be placed in the warhead, instead of an expensive electronic guidance and control package. A selection of warheads, available from the Company or U.S. military arsenals, enables a pilot using the HYDRA 70 to select a range of combinations and effectively engage a variety of targets. As a result, the HYDRA 70 can achieve substantial cost efficiencies over more expensive guided missiles. Depending on configuration, the price for a HYDRA 70 rocket and warhead ranges from several hundred to over a thousand dollars, approximately one-tenth or less of the typical price of a guided missile. The HYDRA 70 system can either be installed on new helicopters or retrofitted to existing helicopters. The system is also qualified for use on certain fixed wing aircraft, as well as ground launch and shipboard platforms.\nRocket Motors. Defense Systems assembles rocket motors, including the MK66, the current generation of the HYDRA 70 rocket motor developed by the U.S. Navy. The MK66 provides greater range and accuracy than prior rocket motors. The MK66 is characterized by wrap-around fins, fluted nozzle and double-based propellant, which together increase acceleration and impart spin to improve accuracy through the entire trajectory.\nWarheads. Defense Systems supplies warheads with specialized capabilities that, along with other warheads produced by U.S. military arsenals, allow customers to use the HYDRA 70 system for a variety of purposes. The warheads currently sold in production quantities by Defense Systems are the Multipurpose Submunition, Multipurpose Practice Submunition, High Explosive Unitary, Signature Practice, Illumination, and Flechette Warheads. At a predetermined point in flight, Multipurpose Submunition warheads release nine grenades that each detonate on impact, creating a zone of explosive effect. Practice warheads are used for training purposes.\nFuzes. Defense Systems offers a range of fuzes for use on its rockets and warheads. Certain fuzes, which are remotely set, can be programmed at the moment of launch to deploy munitions at predetermined ranges. These fuzes provide for airburst or point detonation of warheads. Submunition fuzes provide a mechanical trigger for detonation on impact.\nOther\nWeapons Management System. Defense Systems has developed a microprocessor-based Rocket Management System that controls up to seventy-six 2.75 inch rockets. The system may be programmed to manage simultaneously up to five different warheads, to set fuzes remotely and to display the inventory of warheads remaining. Defense Systems has also developed a more compact, less expensive version of the Rocket Management System, the Armament Management System, that can be used on aerial, ground and sea-based weapons platforms. This system controls up to thirty-eight 2.75 inch rockets.\nAdvanced Rocket System. During fiscal 1995, Defense Systems concluded its development work on the Advanced Rocket System (ARS) as the major subcontractor to Lockheed Missiles and Space Company.\nSignificant Customers and Marketing for Defense Systems Segment\nDefense Systems has marketed its products primarily to the DOD either directly or indirectly as a subcontractor to prime contractors. Defense Systems has also marketed its products to allied foreign governments both through direct sales and through foreign military sales programs funded by the U.S. Government. Only limited marketing efforts were pursued during fiscal 1995 related to weapons management systems. Foreign sales constituted approximately 3%, 3% and 2% of Defense Systems' revenues in fiscal 1995, 1994 and 1993, respectively. (See Note N to Consolidated Financial Statements.) Defense Systems expects to complete its current backlog of rocket and warhead production during fiscal 1996.\nBacklog for Defense Systems Segment\nThe segment's backlog at September 30, 1995 and October 1, 1994 was as follows:\nBacklog (dollars in thousands) September 30, 1995 October 1, 1994 ------------------ ---------------\n$35,836 $73,908\nBacklog includes aggregate contract revenues remaining to be earned by the Company over the life of existing contracts. All of the backlog as of September 30, 1995 is scheduled for shipment during fiscal 1996. In the case of U.S. Government contracts, backlog includes only those contracts that are fully funded by a procuring Government agency. All U.S. Government contracts and subcontracts are subject to termination by the U.S. Government for convenience.\nMany factors affect the scheduling of projects; therefore, no assurance can be given as to when revenue will be realized on projects included in the Company's backlog. Year-to-year comparisons of backlog are not necessarily indicative of future revenue or profitability trends, and management believes that backlog as of any particular date may not be representative of actual sales for the segment for any succeeding fiscal period. The existing backlog in the Defense\nSystems segment has gross margins that are significantly lower than historical gross margins on similar Defense Systems products. In addition, delays caused by matters beyond the Company's control can, and have, resulted in increased product costs.\nCompetition for Defense Systems Segment\nThe defense industry has become increasingly competitive in recent years with the growing emphasis on competitive bidding of contracts and the decline in defense spending because of budget constraints. To date, Defense Systems has been the sole supplier of certain components and services related to the HYDRA 70. The total HYDRA 70 System program, rockets and warheads, was opened to competitive bidding during fiscal 1992. Following a winning bid in 1992, Defense Systems entered into a contract to produce the HYDRA 70 System and retained its sole source position. During 1995, a new HYDRA 70 System contract was competitively solicited by the U.S. Army for known requirements through 1998. BEI agreed to join a team led by Alliant Techsystems for this competition. Results of the bidding as of early December 1995 identified a team led by Martin Marietta as the winner of this bid. Since the Company was not awarded a portion of the 1995 competitive contract, the revenue from HYDRA 70 rockets will be zero beyond shipment of the current backlog (see Note C to Consolidated Financial Statements).\nManufacturing for Defense Systems Segment\nDefense Systems' manufacturing operations consist primarily of the production and assembly of fuzes, rocket motors, warheads and explosive devices, as well as the assembly of electronic products. Certain Defense Systems operations are subject to rigorous safety requirements which are normal to the handling of munitions and explosives.\nUnder specified U.S. military contracts, Defense Systems has been required to depend on certain materials, particularly solid propellant and components such as fuzes and rocket igniters, often furnished only by the U.S. Government or U.S. Government designated suppliers. In the past, the Company has been unable to obtain desired supply levels of propellant and has experienced quality problems with respect to propellant and these components. While these and other difficulties have resulted in interruptions of production and other dislocations, the Company maintained profitable operations during these periods. With the award in fiscal 1992 of the HYDRA 70 System contract to Defense Systems, under which deliveries began late in fiscal 1993, the Company has been required to deal directly with component suppliers and, in some cases, to initiate in-house production of certain components.\nWith respect to in-house production of certain components, there has continued to be some irregularity of production, particularly of fuzes for submunition warheads. A dispute has arisen between Defense Systems and the U.S. Government concerning the accuracy and completeness of certain Government-supplied technical data including design and manufacturing specifications. Efforts to resolve these matters are continuing (see Note C to Consolidated Financial Statements). Management believes that all fuze production required to support Defense Systems' remaining rocket backlog deliveries will be completed during fiscal 1996.\nResearch & Development for Defense Systems Segment\nGovernment-funded development during the year included completion of work required on a development contract for the Advanced Rocket System, a next generation enhanced performance rocket system.\nDuring fiscal 1995 Company funding of R&D efforts was discontinued.\nU.S. Government Contracts for Defense Systems Segment\nApproximately 97%, 97% and 98% of the Defense Systems segment's net sales in fiscal 1995, 1994 and 1993 respectively, were derived from contracts with the U.S. Government or under subcontract to other prime contractors to the Government. (See Note C to Consolidated Financial Statements.)\nUnder applicable regulations, various audit agencies of the U.S. Government conduct regular audits of contractors' compliance with a variety of Government regulations. Because of the recurring nature of changes in laws and regulations\nand related regulatory audits, the Company expects it will continually incur costs for monitoring and compliance efforts. During fiscal 1995, these costs were similar to 1994 but higher than in the past and there can be no assurance that such costs will not be material in fiscal 1996. The Government also has the right under most U.S. Government contracts to review retroactively the cost records of the Company. Contract prices may be adjusted in the event the Company submits incomplete, inaccurate or obsolete cost or pricing data.\nAll U.S. Government contracts and subcontracts generally provide for either a fixed price, negotiated fixed price or cost-plus-fixed-fee basis for remuneration. The major part of the segment's contracts with the U.S. Government are competitive fixed price or negotiated fixed price contracts. For fixed price contracts, the Company bears the risk of cost overruns and derives the benefits from cost savings. As a result, greater risks are involved under fixed price contracts than under cost-plus contracts.\nAll U.S. Government contracts contain termination clauses that allow the contract to be terminated either for contractor default or for the convenience of the Government. In the event of termination for the convenience of the Government, the clause typically provides that the contractor will receive payment for work-in-progress, including profit. To date, termination of the Company's contracts by the Government has not had any significant effect on the Company's financial results. However, no assurance can be given that such terminations will not have a materially adverse effect on the Company's results of operations in the future. Portions of the Company's business are classified. As a result, the Company is and will be prohibited from disclosing the substance or status of such business.\nMajor Programs for Defense Systems Segment\nSales of HYDRA 70 systems and components represented approximately 27%, 31% and 31% of the Company's revenues in fiscal 1995, 1994 and 1993, respectively. The Company anticipates that sales of the HYDRA 70 will continue to constitute a smaller share of revenues for fiscal 1996. The failure of the Alliant-BEI team to win the 1995 competitive award for continued HYDRA 70 production eliminates these sales from future results of operations beyond fiscal 1996.\nSubcontractors - Sources of Supplies for Defense Systems Segment\nUnder specified U.S. military contracts, Defense Systems has been required to depend on certain materials, particularly rocket propellant grain furnished only by the U.S. Government. Periodically, the Company has been unable to obtain desired levels of supply of propellant grain. The Company has also been impacted on occasion by discoveries of non-conforming materials having been delivered by certain of its suppliers despite these suppliers having provided \"Certificates of Compliance\" with these component shipments. While these difficulties have resulted in periodic disruptions of deliveries and other dislocations, production is not currently impacted. However, due to the nature of the procurement contracts involved, no assurance can be given that there will not be future supply disruptions. Any such disruption could affect the timing of shipments.\nMEDICAL SYSTEMS SEGMENT\nBEI Medical Systems Company (hereafter Medical Systems) designs, manufactures, and\/or sells electrosurgery units, various endoscopes, surgical instruments and surgical-procedure-specific intervention products and kits. It also assembles endoscopic illuminators, video imaging systems and insufflators.\nProducts\nThe following products which may be used alone or in combination are produced and\/or sold by Medical Systems.\nElectrosurgery Units. These products use radio frequency (RF) currents to cut tissue and\/or coagulate bleeding. Medical Systems produces a variety of electrosurgical generators which are designed for use in various medical and surgical procedures. These and associated supporting items are marketed under the Meditron brand and brands of OEM customers.\nDevices, Instruments & Procedure Kits. Medical Systems has a line of surgical instruments, procedure kits and devices which aid in, or enable a physician to apply various technologies to an array of medical\/surgical requirements in the field of gastroenterology, gynecology and orthopedics. These products come in a variety of disposable or reusable configurations, allowing the caregiver's institution to select the most suitable option. Products include ZUMI(TM) uterine manipulator\/injectors, ZUI(TM) uterine injectors, Z-Clamps(TM) and Z-Scissors(TM) for hysterectomy, ZSI Zip Tip(TM) cervical biopsy forceps, Corson-Myoma(TM) grasping forceps, ZSI Miya Hook(TM), micro surgical instruments, hysterectomy kits and other specialty instruments. Other products include endoscopic illuminators, cameras, various types of endoscopes and an automatic electronic insufflator. These products are used in laparoscopic procedures in gastrointestinal, orthopedic and general surgery.\nSignificant Customers and Marketing for Medical Systems Segment\nMedical Systems' products are sold to a variety of customers primarily for the gynecology markets. Other markets served include gasteoenerology, orthopedics and general surgery. In the U.S., Medical Systems utilizes 19 independent manufacturer's representative organizations, direct sales representatives, and telemarketers to market its products directly to end users, hospitals, surgical centers and doctors' offices. Products are also sold through a network of 77 domestic and international distributors. Additionally, a variety of products are private label manufactured under various OEM agreements. In fiscal 1995, OEM sales were 21% of Medical Systems sales similar to the prior year.\nBacklog for Medical Systems Segment\nBacklog is not a significant factor in the Medical Systems segment. The segment has commercial operations that typically ship instruments within one to two weeks of receipt of an order and electronic products within 30 days after receipt of an order. Disposable products are normally shipped within one day of receipt of order. Products which require special development, design, packaging and testing are generally shipped within four to six months after an order is received.\nCompetition for Medical Systems Segment\nThe Company's principal competitors in the Medical Systems segment include Valleylab, a subsidiary of Pfizer, Microvasive, a subsidiary of Boston Scientific, Circon\/ACMI, Cabot Medical, Utah Medical, Leisegang, Wallach, CooperSurgical, Inc. and Unimar.\nManufacturing for Medical Systems Segment\nMedical Systems segment manufacturing operations consist primarily of the manufacture and assembly of equipment such as electrosurgery units, endoscopic illuminators, and electronic insufflators. Additionally, some component fabrication and assembly of various non-electrical products, both disposable and reusable, is performed by the manufacturing group. The Company's facilities and documentation procedures for the manufacture of medical devices are required to conform to the Food and Drug Administration's (\"FDA\") Good Manufacturing Practices (\"GMP\"), enforced by the FDA through its facilities inspection program. Withdrawal of GMP status would have a material adverse effect on the Company's Medical Systems segment.\nResearch & Development for Medical Systems Segment\nThe Company's principal development effort for this segment has focused on proprietary devices for procedures in gynecology. In addition, the Company continued development in monopolar and bipolar electrosurgical generators and expansion of the surgical illuminator and automatic insufflator product lines for general and laparascopic surgery. The Company has continued to work with several OEM customers for the adaptation of its proprietary technology to various private label requirements.\nGovernment Regulation\nMedical Systems manufactures and sells medical devices. In the U.S. the FDA (among other governmental agencies) is responsible for regulating the introduction of new medical devices and the manufacturing, labeling and record-keeping\nfor such devices. The FDA also reviews required reports of adverse events involving such devices. The FDA has extensive enforcement authority, including the power to seize products, restrain sales or prohibit the operation of manufacturing facilities until the noted deficiencies are corrected to the FDA's satisfaction. The FDA can also monitor recalls of products from consumer locations.\nRecent developments such as the enactment of the Safe Medical Devices Act of 1990 and increased enforcement actions reflect a trend toward more stringent product regulation by the FDA. One result is an increase in the typical time elapsed between the filing of an application and the receipt of FDA clearance or approval of commercial release of a medical device. In addition, the FDA now requires more clinical data with such applications, which can increase the cost of obtaining such clearance to market. Furthermore, rigorous regulatory action may be taken in response to deficiencies noted in inspections or to any product performance problems.\nMedical device laws are also in effect in many of the countries in which Medical Systems does business outside the U.S. These range from comprehensive device approval requirements to requests for product data or certifications. The number and scope of these requirements are increasing. This trend toward increasing product regulation is evident in the European Community, where efforts are under way to harmonize the regulatory systems. Such regulatory systems include ISO 9000, ICE 601 and OE marks.\nUncertainty Related to Health Care Reform\nPolitical, economic and regulatory influences are subjecting the health care industry in the United States to fundamental change. The Company anticipates that Congress and state legislatures will continue to review and assess alternative health care delivery and payment systems. Legislative debate is expected to continue in the future, and the Company cannot predict what impact the adoption of any federal or state health care reform measures or future private sector reform may have on its Medical Systems business.\nGENERAL - ALL SEGMENTS\nEmployees\nAs of September 30, 1995, the Company had 1,174 employees, including 151 in research, development and engineering, 103 in administration, 87 in marketing and sales, 817 in operations and 16 in corporate. The Company believes that its continued success depends on its ability to attract and retain highly qualified personnel. The Company's employees are not represented by collective bargaining agreements, other than employees at the Defense Systems Camden, Arkansas Ordnance Manufacturing Plant, who are represented by the International Association of Machinists under an agreement expiring in May 1996. To date, the Company has not experienced any work stoppages and considers its employee relations to be good.\nSignificant Customers\nDuring fiscal 1995, 1994 and 1993, the U.S. Government and other Government contractors accounted for approximately 50%, 57% and 62%, respectively of the Company's total net sales.\nCompetition\nThe Company operates in highly competitive industries. Many of the Company's existing competitors in each market, and also a number of potential entrants into these markets, have significantly greater financial resources and manufacturing capabilities, are more established, have larger marketing and sales organizations and larger technical staffs. There can be no assurance that other companies will not develop more sophisticated, more cost-effective or otherwise superior products.\nIn its principal markets, the Company believes that competition is based primarily on design, performance, reliability, price, delivery, service and support. The Company believes it competes favorably with respect to these factors.\nResearch and Development\nThe Company believes that its future success will depend in part on its ability to continue to enhance its existing products, and to develop and introduce new products that maintain technological leadership, meet a wider range of customer needs and achieve market acceptance. Accordingly, the Company's internally funded research, development and related engineering expenditures were approximately $5.0 million, $7.2 million and $5.7 million in fiscal 1995, 1994 and 1993, respectively. In addition, customer funded research and development expenditures charged to cost of sales were $9.3 million, $10.4 million and $9.2 million, respectively, for the same periods.\nPatents and Licenses\nThe Company primarily relies upon trade secrets and know-how to develop and maintain its competitive position. Retention of data rights by a U.S. Government contractor is frequently difficult because the contractor is often compelled to negotiate transfer of the data rights to the Government as part of the contract for production of the product. In addition, under certain of the Company's U.S. Government contracts, the Government may require that proprietary information be disclosed directly to competitors, subject to certain restrictions upon its use.\nThe Company holds 103 U.S. patents and 49 foreign patents with expiration dates ranging from March 1996 to August 2013. Because many of these patents relate to technology that is important to certain of the Company's products, the Company considers these patents to be significant to its business. There can be no assurance, however, that any patent will provide adequate protection for the technology or product it covers.\nThe Company believes that, because of the rapid pace of technological change as well as the impact of Government requirements, factors such as technical expertise, frequent product enhancements, new product introductions and customer service and support are generally more important to its business than patents. The Company filed for several patents in the past fiscal year; however, there can be no assurance that patents will issue from any present or future applications filed by the Company or, if patents issue, that any claims allowed will be sufficiently broad to protect the Company's technology. The Company is still engaged in arbitration with respect to the license for its quartz rate sensors (see Note M to Consolidated Financial Statements).\nEnvironmental Matters\nThe Company uses certain hazardous materials in its research and manufacturing operations and, as a result, is subject to stringent federal, state and local regulations governing the storage, use and disposal of such materials. Although the Company believes that it is currently in material compliance with such laws and regulations, current or future laws and regulations could require the Company to make substantial expenditures for remedial action, reduction of chemical exposure, waste treatment or disposal. There can be no assurance that the operations, business, competitive position, earnings or assets of the Company will not be materially and adversely affected by the interpretation and enforcement of current or future environmental laws and regulations. (The State of California has filed a claim related to waste disposal, which claim is discussed in Note M to Consolidated Financial Statements and Item 3 of this Form 10-K.)\nGovernment Regulation\nThe Company is subject to significant regulation by the U.S. Government with respect to a variety of matters affecting its business, including the matters set forth below and as discussed in the U.S. Government Contracts sections above.\nFacility Security Clearance. The Company has several facility security clearances from the U.S. Government. A portion of the Company's net sales in fiscal 1995, 1994 and 1993 was derived from work for which this clearance was required. Continuation of this clearance requires that the Company remain free from foreign ownership, control or influence (FOCI). In addition, the Company is required to comply with the regulations promulgated by the Defense Investigative Service (DIS), which relate, in large part, to the Company's control of classified documents and other information. Loss of such security clearances and the related loss of U.S. Government contracts would have a materially adverse effect on the Company's results of operations. Management does not believe that there is presently any substantial risk of FOCI or DIS noncompliance that would cause any of its security clearances to be revoked.\nRegulation of Foreign Sales. All Defense Systems' and certain of Sensors and Systems' exports are subject to restrictions contained in the U.S. Department of State's International Traffic in Arms Regulations and require export licenses in order to be sold abroad. Non-defense related foreign sales are generally governed by the Bureau of Export Administration of the U.S. Commerce Department which also frequently requires export licenses. The Company's net sales to foreign customers constituted approximately 8%, 8% and 5% of revenues for fiscal 1995, 1994 and 1993, respectively. To date, the Company has not experienced any significant difficulties in obtaining the requisite licenses. In addition, the Company is subject to the Foreign Corrupt Practices Act, which prohibits payments or offers of payments to foreign officials for the purpose of influencing an act or decision by a foreign government, politician or political party in order to assist in obtaining, retaining or directing business to any person.\nRisk Factors\nDefense Spending & Government Contracting A significant portion of the Company's net sales has been derived from contracts with departments and agencies of the U.S. Government and with other Government contractors. In fiscal 1995, 1994 and 1993, such contracts accounted for approximately 50%, 57% and 62%, respectively, of the Company's total net sales. The Company believes that the success of the Company's business will continue to be dependent, in part, upon its ability to participate in various Government programs. There can be no assurance that the U.S. Government will continue its commitment to programs to which the Company's products are applicable or that the Company will continue to be awarded contracts under such programs. Please refer to the discussion regarding competition in the segment discussion above. Reductions in the federal funds available for projects the Company is performing have in the past, and may in the future have an adverse impact on the Company's results of operations.\nThe Company's contracts involving the U.S. Government are subject to various other risks, including termination for the convenience of the Government; potential disclosure of Company confidential information to competitors as part of the establishment by the Government of second-source manufacturing arrangements or competitive bidding; the failure or inability of prime contractors or Government designated subcontractors to perform under their contracts; and increased or unexpected costs causing losses or reduced profits under fixed-price contracts.\nOther Risk Factors For additional risk factors affecting the Sensors and Systems segment see: Significant Customers and Marketing, and U.S. Government Contracts, in the segment discussion above.\nFor additional risk factors affecting the Defense Systems segment see: Competition, U.S. Government Contracts, Major Programs and Subcontractors in the segment discussion above.\nFor additional risk factors affecting the Medical Systems segment see: Government Regulation and Uncertainty Related to Health Care Reform in the segment discussion above.\nEXECUTIVE OFFICERS AND DIRECTORS OF THE COMPANY\nThe executive officers and directors of the Company and their ages as of December 1, 1995 are as follows:\nName Age Position - -------------------------------------------------------------------------------- Charles Crocker 56 President, Chief Executive Officer & Chairman of the Board of Directors Gary D. Wrench 62 Senior Vice President, Chief Financial Officer & Director Dr. Lawrence A. Wan 57 Vice President of Corporate Technology Robert R. Corr 49 Secretary, Treasurer & Controller Richard M. Brooks (1) (2) 67 Director George S. Brown (2) 74 Director C. Joseph Giroir, Jr. (1) (2) 56 Director William G. Howard, Jr. (1) 54 Director Peter G. Paraskos 67 Director - -------------------------------------------------------------------------------- (1) Member of the Audit Committee (2) Member of the Compensation Committee\nMr. Crocker, a founder of the Company, has served as Chairman of the Board of Directors of the Company since October 1974. At the request of the Board of Directors, Mr. Crocker assumed the positions of President and Chief Executive Officer, effective October 1, 1995, following the retirement of Mr. Paraskos. Mr. Crocker is President of Crocker Capital, an investment company. He served as President of a predecessor company, Crocker Capital Corporation (a Small Business Investment Company), from 1970 to 1985, and as General Partner of Crocker Associates, a venture capital investment partnership, from 1970 to 1990. He currently serves as a director of Fiduciary Trust Company International, Superconductor Technologies, Inc. and Pope & Talbot, Inc. Mr. Crocker holds a B.S. from Stanford University and an M.B.A. from the University of California, Berkeley.\nMr. Wrench has served as Senior Vice President and Chief Financial Officer of the Company since July 1993 and as a Director of the Company since February 1986. He served as Vice President of the Company and President and Chief Executive Officer of Motion Systems Company, Inc., a wholly owned subsidiary of the Company, from April 1985 to July 1993. Other experience includes twenty years with Hughes Aircraft Company including an assignment as President of Spectrolab, Inc., a Hughes subsidiary. Mr. Wrench holds a B.A. from Pomona College and an M.B.A. from the University of California, Los Angeles.\nDr. Wan was appointed Vice President, Corporate Technology for the Company in April 1991. From 1984 until 1990, Dr. Wan served as Vice President, Engineering for Systron Donner Corporation. Between 1979 and 1984, he held various technical and general management positions with Systron Donner Corporation. From 1968 to 1979, he served as Chief Executive Officer for Sycom, Inc. a commercial electronics company which he founded. From 1964 to 1968, he worked for Hughes Aircraft Company, where he headed the Radar Systems Section of the Hughes Ground Systems Group. In 1962, Dr. Wan and two other professors established an Engineering School at University of California, Santa Barbara, where he also taught Engineering. Dr. Wan has a B.S., M.S. and Ph.D in Engineering and Applied Sciences from Yale University.\nMr. Corr was named Secretary of the Company in February 1995 and has served as Controller since November 1989 and Treasurer since November 1987. From 1978 to 1987, he was employed by AMPEX Corporation, an electronics and magnetic media company, in various financial positions, most recently as Assistant Controller in the Corporate Division. From 1975 to 1978, he was an Auditor for Arthur Andersen & Co. Mr. Corr received a B.B.A. from Loyola University and is a Certified Public Accountant in the State of California.\nMr. Brooks has been a director of the Company since November 1987. He is currently an independent financial consultant. From 1987 to 1990, he served as President of SFA Management Corporation, the managing general partner of St. Francis Associates, an investment partnership. He currently serves as a director of Longs Drug Store Corporation, Granite Construction Incorporated and the Western Farm Credit Bank, a private company. Mr. Brooks holds a B.S. from Yale University and an M.B.A. from the University of California, Berkeley.\nMr. Brown, a founder of the Company, has served as a director of the Company since October 1974. Mr. Brown served as President and Chief Executive Officer of the Company from October 1974, until his retirement from that position in July 1990, when he became a consultant to the Company. Prior to founding the Company, Mr. Brown served from 1971 until 1974 as Executive Vice President and General Manager of Baldwin Electronics, Inc., a subsidiary of D.H. Baldwin Company and the predecessor of the Company. Mr. Brown holds a B.S.E.E. from the University of Oklahoma.\nMr. Giroir has served as a director of the Company since 1978. He served as the Secretary of the Company from 1974 to early 1995. He is currently a member of the law firm of Giroir & Gregory, a Professional Association. From 1965 to 1988, Mr. Giroir was a member of Rose Law Firm, a Professional Association. Both law firms have rendered services to the Company. Mr. Giroir holds a B.A. and an L.L.B. from the University of Arkansas and an L.L.M. from Georgetown University.\nDr. Howard has been a director of the Company since December 1992. He is currently an independent consulting engineer in microelectronics and technology-based business planning. From 1987 to 1990, Dr. Howard served as Senior Fellow of the National Academy of Engineering and, prior to that time, held various technical and management positions with Motorola, Inc., most recently as Senior Vice President and Director of Research and Development. Dr. Howard holds a B.E.E. and an M.S. from Cornell University and a Ph.D. in electrical engineering and computer sciences from the University of California, Berkeley. He is a member of the National Academy of Engineering and a fellow of the Institute of Electrical and Electronics Engineers and of the American Association for the Advancement of Science.\nMr. Paraskos retired as President and Chief Executive Officer of the Company effective October 1, 1995. He remains a Director of the Company, as well as Chairman of Defense Systems Company, and has agreed to act as a consultant to the Company. Mr. Paraskos served as President, Chief Executive Officer and a Director of the Company from July 1990. Mr. Paraskos joined BEI in connection with the Company's acquisition from Thorn EMI of substantially all the assets of four of the six divisions of the Systron Donner Corporation. From 1986 to 1990, Mr. Paraskos served as President and Chief Executive Officer of the Systron Donner Corporation, a manufacturer of avionics and aerospace sensors and subsystems, and served in positions as Executive Vice President and Chief Operating Officer and in general management from 1983 to 1986. Mr. Paraskos holds two degrees in Engineering from Columbia University and has served in the Marine Corps as an infantry officer, fighter pilot and test pilot. He is a member of the Board of Nominations of the Aviation Hall of Fame and a life member of the Society of Experimental Test Pilots.\nThe Company has a classified Board of Directors, which may have the effect of deterring hostile takeovers or delaying changes in control or management of the Company. For purposes of determining their term of office, directors are divided into three classes, with the term of office of the first class to expire at the 1996 annual meeting of stockholders, and the term of office of the second class to expire at the 1997 annual meeting of stockholders and the term of office of the third class to expire at the 1998 annual meeting of stockholders. Class I consists of Mr. Giroir and Mr. Wrench; Class II consists of Mr. Brooks, Mr. Howard, and Mr. Paraskos; and Class III consists of Mr. Crocker and Mr. Brown. Directors elected to succeed those directors whose term expires will be elected for a three year term of office. All directors hold office until the next annual meeting of stockholders, at which their term expires, and until their successors have been duly elected and qualified. Executive officers serve at the discretion of the Board. There are no family relationships among any of the officers and directors.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's principal executive offices are located in leased office space in San Francisco, California, under a lease which expires in 1998. The Company owns or operates 11 other facilities which relate to the Sensors and Systems, Defense Systems and Medical Systems segments and maintains office space in various locations throughout the United States for sales and technical support. None of the owned principal properties is subject to any encumbrance material to the consolidated operations of the Company. In addition to its executive offices, the Company's principal facilities are as follows:\nLocation Description of Facility - -------------------------------------------------------------------------------- Sensors and Systems Segment\nMaumelle, Arkansas Owned 50,000 square foot manufacturing, engineering, administrative and research and development facility.\nConcord, California Owned 101,000 square foot manufacturing, engineering and administrative facilities. Leased 15,000 square foot manufacturing and engineering facility. Tustin, California Leased 80,000 square foot manufacturing, engineering and administrative facility.\nGoleta, California Owned 22,000 square foot manufacturing, engineering and administrative facility.\nCampbell, California Subleased 5,000 square foot manufacturing, administrative and research and development facility.\nSan Marcos, California Leased 35,000 square foot manufacturing, engineering and administrative facilities.\nSylmar, California Subleased 83,000 square foot manufacturing, engineering and administrative facility. - -------------------------------------------------------------------------------- Defense Systems Segment\nEast Camden, Arkansas Leased 413,000 square foot manufacturing, warehousing, and administrative facility.\nEuless, Texas Owned 72,000 square foot manufacturing, engineering and administrative facility and subleased 2,000 square foot warehouse facility, used primarily for record storage. - -------------------------------------------------------------------------------- Medical Systems Segment\nHackensack, New Jersey Leased 10,000 square foot manufacturing and engineering facility and 2,000 square foot administrative and marketing facility.\nChatsworth, California Leased 6,000 and 1,600 square foot manufacturing, engineering and administrative facilities.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nBEI Systron Donner Company vs. General Precision Industries, Inc., et al.\nIn connection with the acquisition of assets from Systron Donner Corporation during fiscal 1990, a subsidiary of the Company assumed an obligation to pay former shareholders of General Precision Industries (\"GPI\") $4.3 million if certain levels of confirmed orders and shipments are achieved for products developed using technology acquired from GPI in 1986 under a license agreement which expires in 2003. In September of 1991, the Licensor of the patent on which the Company's quartz technology is based advised the Company that royalties in excess of the amounts previously paid by the Company were due. The amount of royalties involved was approximately $400,000. The Company advised the Licensor that based on its understanding of the license agreement no additional amounts were due. The Licensor alleged that nonpayment of the royalties due would give the Licensor the right to terminate the license agreement. The parties were unable to resolve these differences. Accordingly, the Company elected to exercise the provision of the license agreement which required arbitration of any disputes between the parties to the agreement.\nIn June of 1993, the Company and the Licensor filed briefs with the arbitration panel. The Licensor alleged in its brief that the amount of royalties, milestone payments and accrued interest due as of September 30, 1992 was approximately $10.0 million (including the $4.3 million described above), and asked the arbitration panel to rule that the license could be terminated based on noncompliance by the Company with the terms of the license agreement.\nThe Company asked the arbitration panel to rule that the amounts of the royalties paid by the Company had been properly determined by the Company, that the original license agreement should be reformed to reduce the royalties due on future sales as a result of failure by the Licensor to disclose certain matters which significantly impacted the Company's timely ability to employ the licensed patent on production units and that the license was not subject to termination.\nThe arbitration process is ongoing. The arbitration panel bifurcated the issues in the arbitration, and issued an interim ruling in February 1995. In that interim ruling, which will become final at the close of the arbitration, the Panel concluded that the license agreement was not subject to termination, that non-recurring engineering revenues were not royalty-bearing, and that $1 million of the $4.3 million discussed above is due only if certain conditions are met in the future. The Panel also concluded that the Company is entitled to ownership of an accelerometer patent that the former Shareholders developed. Further, in September 1995, the panel ruled that certain development costs incurred by the Company could not be used to offset accrued royalties. As a result, in September 1995, the Company accrued $3.5 million for royalties and related costs based on its understanding of the amounts due under the panel's September ruling. The estimate of royalties and related amounts due under the license agreement are based on the Company's proposal to the panel and are significantly less than amounts proposed by the licensor. Under the panel's February ruling, $3.3 million of the $4.3 million became due. This amount, which is considered part of the original acquisition cost of the technology, was accrued in February 1995, paid in October 1995, and is being amortized over the remaining term of the license.\nThe second phase of the arbitration continues with further arguments having occurred in December 1995. This phase involves the final determination of royalty amounts due for unit sales of product using the acquired technology and other matters including the parties' respective claims for attorneys' fees. In the event that the arbitration panel rules that the Company's liability is more or less than the $3.5 million accrued, an adjustment to the September 30, 1995 estimate will be required. While the final outcome of this matter cannot be determined with certainty, management believes, taking all factors into account and after consultation with legal counsel, that this matter will not result in a material adverse impact on the financial position of the Company.\nState of California Department of Toxic Substances Control vs. Southland Oil, Inc., et al.\nIn October 1993, the State of California filed a first amended complaint against a division of the Company and fifty-two other defendants. The complaint sought recovery of response costs incurred by the State at a waste oil recycling facility in Commerce, California (the \"Site\").\nThe litigation with the State was recently settled in principle, requiring a dismissal of the action following the payment by defendants to the State of $2.6 million to settle all past and future response costs at the Site (as well as all other alleged damages). The State will be required, pursuant to the settlement, to perform whatever future investigation and cleanup activities are required at the Site under either state or federal law. While the litigation has not yet been dismissed, the Company anticipates that it will be once settlement documents are executed.\nThe defendants believe that there are additional parties that should be liable for the settlement amount, and some of the defendants (including the Company) have filed a third party claim against these other parties.\nThere has not yet been an allocation of the $2.6 million settlement amount either among the defendants or between the defendants and the third party defendants. Recent formulas that have been proposed for settlement and that have been discussed by the defendants and the third party defendants would result in the Company's share of the settlement amount being set at less than $20,000.\nThe division of the Company against which the claim was asserted was acquired from Systron Donner Corporation in 1990. In connection with that acquisition, Systron Donner agreed to indemnify the Company against any claims, damages and expenses in excess of $100,000 arising in connection with certain environmental matters. Management believes such indemnification would encompass this claim in the event that it were to exceed $100,000. While the outcome of this matter cannot be determined with certainty, management believes, after consultation with legal counsel, that the ultimate resolution will not have a material adverse impact on the financial position of the Company.\nCooperSurgical, Inc. vs. BEI Medical Systems Company, Inc. et al.\nIn October 1993, CooperSurgical, Inc. a subsidiary of the Cooper Companies filed a claim for unspecified damages alleging unfair competition due to actions by BEI Medical Systems and its president Richard Turner, a former employee of the Cooper Companies, and others. In May 1994, the Chancery Division for the Superior Court of New Jersey granted a partial summary judgment in favor of the plaintiff and issued an injunction against the defendants restraining them from selling certain products until June 20, 1996. In September 1994, BEI Medical Systems filed a motion to vacate the May 1994 order. In November 1994 the Court vacated the restraint order.\nManagement has vigorously defended its rights in this action and believes after discussion with legal counsel that the CooperSurgical claims are exaggerated. Expert witnesses for BEI have prepared a formal response to the CooperSurgical damage claims which was submitted in February 1995. BEI's experts stated that if CooperSurgical were entitled to damages, those damages would total less than $100,000, and would be more than offset by BEI Medical Systems' counterclaim against CooperSurgical. Discovery has been completed. The trial which was originally scheduled to begin in November will be reset for 1996. While the outcome of this matter cannot be determined at this time, management believes, taking known factors into account and after consultation with legal counsel, that this matter will not result in a material adverse impact on the financial position of the Company.\nOther\nThe Company has pending various other legal actions arising in the normal course of business. Management believes that none of these legal actions will have a material impact on the Company's operating results or financial condition.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nBEI's common stock was initially offered to the public at $9 per share in July 1989. The Company's common stock has been traded on the NASDAQ National Market System under the NASDAQ symbol \"BEII\" since August 1, 1989. Set forth below are the high and low closing sale prices on the National Market System for the periods indicated. Such quotations do not reflect retail markups, markdowns or commissions.\nCash 1995 Fiscal Year Dividend (ended 09\/30\/95) High Low Declared ------------------------------------------------------------ Fourth Quarter $8.25 $6.50 $0.02 Third Quarter $7.25 $5.50 $0.02 Second Quarter $5.88 $5.00 $0.02 First Quarter $5.75 $5.00 $0.02 ------------------------------------------------------------ 1994 Fiscal Year (ended 10\/01\/94) ------------------------------------------------------------ Fourth Quarter $6.00 $5.00 $0.02 Third Quarter $6.63 $5.50 $0.02 Second Quarter $7.25 $6.00 $0.02 First Quarter $8.38 $5.75 $0.02 ------------------------------------------------------------\nAs of November 29, 1995, there were approximately 900 holders of record of the Company's common stock. The Board of Directors has declared and the Company has paid four cash dividends of $.02 per share of common stock in each of fiscal 1995 and 1994. The Board of Directors has declared a dividend of $.02 per share of common stock to stockholders of record at December 15, 1995, payable December 29, 1995 for the first quarter of fiscal 1996. Payment of dividends is within the discretion of the Company's Board of Directors, will be subject to continual review and will depend, among other factors, upon the earnings, capital requirements, operating results and financial condition of the Company from time to time. There are no restrictions on the Company's ability to pay dividends provided the covenants set forth in its bank credit agreement and Senior Note agreement are met (see Notes E and G to Consolidated Financial Statements). The covenants primarily concern certain operating ratios and minimum balances of tangible net worth.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe selected financial data for the five fiscal years presented below is derived from the audited 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) - -------------------------------------------------------------------------------- Years Ended -------------------------------------------------------------- September 30 October 1 October 2 October 3 September 28 1995 1994 1993 1992 1991 - -------------------------------------------------------------------------------- STATEMENT OF INCOME DATA: Net sales $144,903 $138,658 $146,719 $156,622 $146,226 Net income (loss) (4,391) (1,744) 3,778 7,180 6,314 Earnings (loss) per common share and common equivalent share (0.65) (0.26) 0.56 1.05 0.94 Cash dividends per common share $ 0.08 $ 0.08 $ 0.08 $ 0.08 $ 0.08 Weighted average shares outstanding 6,759 6,657 6,783 6,836 6,741\nBALANCE SHEET DATA: Working capital $ 35,923 $ 40,189 $ 35,667 $ 16,036 $ 15,177 Total assets 113,738 112,432 108,528 96,472 95,832 Long-term debt (excluding current portion) 30,157 30,421 20,050 3,153 6,423 Stockholders' equity 53,319 57,829 59,606 55,560 50,540 - --------------------------------------------------------------------------------\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe following table sets forth, for the fiscal periods indicated, the percentage of net sales represented by certain items in the Company's Consolidated Statements of Operations.\n- -------------------------------------------------------------------------------- 1995 1994 1993 - -------------------------------------------------------------------------------- Net sales 100.0% 100.0% 100.0% Cost of sales 74.2 70.4 68.4 - -------------------------------------------------------------------------------- Gross profit 25.8 29.6 31.6 Operating expenses: Selling, general and administrative expenses 23.7 25.5 24.1 Provision for royalty and related expenses 2.4 -- -- Research, development and related expenses 3.4 5.2 3.9 - -------------------------------------------------------------------------------- Income (loss) from operations (3.7) (1.1) 3.6 Other income 0.7 0.7 1.2 Interest expense 1.7 1.7 1.0 - -------------------------------------------------------------------------------- Income (loss) before income taxes (4.7) (2.1) 3.8 Provision for income taxes (credit) (1.7) (0.8) 1.2 - -------------------------------------------------------------------------------- Net income (loss) (3.0)% (1.3)% 2.6% - --------------------------------------------------------------------------------\nSee Notes A and N to the Consolidated Financial Statements for information on acquisitions and dispositions and segment data, respectively.\nFISCAL YEARS 1995, 1994 AND 1993\nNET SALES In fiscal 1995, the Company's net sales increased 4.5% to $144.9 million from $138.7 million in fiscal 1994.\nSensors and Systems segment net sales increased 9.9% to $90.5 million from $82.4 million. This increase reflects the continued growth in sales of commercial product lines, including those for industrial, automotive and medical markets.\nOffsetting the increase from the Sensors and Systems segment, the Defense Systems segment net sales decreased 4.3% to $45.6 million from $47.6 million. The decline is primarily due to the decline in sales under a completed rocket development contract for the Advanced Rocket System. This contract represented approximately 6% of Defense Systems sales in fiscal 1995 compared to 11% in fiscal 1994. This contract has no further funding in fiscal 1996. The principal product of the Defense Systems segment is the HYDRA 70 (H 70) Rocket produced under a competatively bid fixed price contract. Fiscal 1995 sales of H 70 related products was consistent with the prior year.\nAs discussed in detail at Note C to Consolidated Financial Statements, \"HYDRA 70 Rocket Contract and Related Contingencies,\" the Defense Systems segment has certain disputes pending with the U.S. Government. In September 1995, management of the Company reached a decision to exit the rocket manufacturing line of business which makes up a substantial portion of the Defense Systems segment. The current backlog of H 70 rockets will be shipped in fiscal 1996.\nMedical Systems sales remained relatively flat at $8.8 million in fiscal 1995, a 1.9% increase from $8.7 million in fiscal 1994.\nIn fiscal 1994, the Company's net sales decreased 5.5% to $138.7 million from $146.7 million in fiscal 1993. Sensors and Systems segment net sales decreased 7.9% to $82.4 million from $89.4 million primarily reflecting decreased sales of accelerometers and nonrecurring engineering (NRE) contracts substantially as a result of U.S. Government-contract cutbacks. Also contributing to the decline was the absence of the Company's Seaton Wilson division which was sold at the\nend of fiscal 1993 (see Note A to Consolidated Financial Statements, \"Acquisitions and Dispositions\"). Partially offsetting these factors were increases in sales of several commercial product lines.\nDefense Systems segment net sales decreased 5.0% to $47.6 million in fiscal 1994 from $50.1 million in fiscal 1993. The decrease was primarily the result of lower overall shipments of H 70 products, including certain lines of rockets and warheads, shipments of which were delayed in the first half of fiscal 1994 in connection with submunition fuze production issues. H 70 shipments in fiscal 1994 represented approximately 90% of Defense Systems sales. Partially offsetting the decrease were increased billings for the Advanced Rocket System.\nMedical Systems segment net sales increased 20.5% to $8.7 million from $7.2 million in fiscal 1993. The increase was primarily the result of a full year of sales for Zinnanti Surgical Instruments, Inc. acquired during fiscal 1993 (see Note A to Consolidated Financial Statements, \"Acquisitions and Dispositions\").\nThe Company's sales to international customers were approximately 8.3%, 7.5% and 5.5% of the Company's net sales for fiscal 1995, 1994 and 1993, respectively. International sales can vary significantly as a percentage of sales depending on the timing of shipments and size of orders.\nCOST OF SALES AND GROSS PROFIT Cost of sales as a percentage of net sales was 74.2%, 70.4% and 68.4% in fiscal 1995, 1994 and 1993, respectively.\nThe increase in cost of sales as a percentage of net sales in fiscal 1995 and fiscal 1994 primarily reflects substantial increases in the Defense Systems segment cost of sales. This increase in fiscal 1995 resulted from a lower priced product mix and from the Company's decision to exit the rocket manufacturing line of business. In the fourth quarter of fiscal 1995, cost of sales for the Defense Systems segment included provisions for additional contract completion costs of $1,468,000, facilities shutdown of $500,000 and severance costs of $750,000 to reflect the wind up of rocket related business (see Note C to Consolidated Financial Statements,\"HYDRA 70 Rocket Contract and Related Contingencies\").\nDuring fiscal 1995, the Sensors and Systems segment also experienced a higher cost of sales as a percentage of sales primarily in overhead resulting from increased costs of fixed price development programs in the government sector as well as the increased costs on current year royalties for quartz products.\nIn addition to the impact of competitive bid pricing in Defense Systems segment, cost of sales in fiscal 1994 was adversely affected by the warranty costs associated with the rework of a potentially non-conforming material (see Note C to Consolidated Financial Statements, \"HYDRA 70 Rocket Contract and Related Contingencies\"). The fiscal 1994 increase in cost of sales as a percentage of sales in the Defense Systems segment was offset in part by the decrease in cost of sales as a percentage of sales in the Sensors and Systems segment. Medical Systems segment cost of sales as a percentage of sales increased slightly.\nDownward pressure on gross profit margins is expected to continue, especially for military contracts. The Company's gross profit margins from sales to the U.S. Government for military and space products are generally lower than gross profit margins from sales of commercial and industrial products. Management is continuing measures intended to reduce costs and improve average margins.\nSELLING, GENERAL AND ADMINISTRATIVE EXPENSES Selling, general and administrative expenses as a percentage of net sales were 23.7%, 25.5% and 24.1% in fiscal 1995, 1994 and 1993, respectively.\nFiscal 1995 selling, general and administrative expenses of $34.3 million included $1.1 million for the settlement of a U.S. Government Administrative contract claim. Spending was reduced in both the Defense and Medical segments as well as Corporate headquarters consistent with efforts to reduce operating losses. The Sensors and Systems segment experienced higher selling, general and administrative expenses to support sales growth in commercial product lines. In addition to selling, general and administrative expense, the Company took a charge in the fourth quarter of fiscal 1995 in the amount of 2.4% of net sales ($3.5 million) for royalty and related costs incurred on the basis of an interim arbitration ruling (see Note M to Consolidated Financial Statements, \"Contingencies and Litigation\").\nTotal fiscal 1994 selling, general and administrative expenses of $35.4 million did not change from fiscal 1993. The selling, general and administrative expenses as a percentage of net sales increased primarily due to substantially increased levels of spending in the Medical Systems segment resulting from the acquisition of Zinnanti Surgical Instruments Company, Inc. and associated spending for Medical Systems selling activities and due to increased legal costs. The percentage of spending to sales in the other segments was essentially unchanged.\nRESEARCH, DEVELOPMENT AND RELATED EXPENSES The Company's internally funded research, development and related expenses as a percentage of net sales were 3.4%, 5.2% and 3.9% for fiscal 1995, 1994 and 1993, respectively.\nThe Company eliminated a separate Corporate Research and Development function at the beginning of fiscal 1995 resulting in lower overall costs for internally funded research. Research and Development spending was concentrated in the Sensors and Systems segment to support the growth of the commercial product lines. Consequently, certain programs were phased out while emphasis on development of sensors for the automotive industry was increased.\nThe increase as a percentage of net sales in fiscal 1994 primarily resulted from increased investment in new product development in the Sensors and Systems segment and lower overall net sales.\nThe Company believes that the continued timely development of new products and enhancements to its existing products is essential to maintaining its competitive position. Accordingly, the Company anticipates that such expenses will increase in absolute amount, but may fluctuate as a percentage of sales depending on the Company's success in acquiring customer or, in some cases, U.S. Government funding.\nINTEREST EXPENSE AND OTHER INCOME Interest expense in fiscal 1995 remained consistent with fiscal 1994, increasing slightly to $2.5 million from $2.4 million in fiscal 1994. Interest is paid primarily on the Senior Note debt and a bank credit line. There was no new long term debt issued during fiscal 1995; however, the Company paid a full year's interest on Senior Notes issued in November 1993 compared to only ten months interest in fiscal 1994.\nOther income in fiscal 1995, 1994, and 1993 is comprised of royalty income from H 70 licenses and interest income earned on highly liquid investments. Total other income in fiscal 1995 was essentially unchanged from the prior year; however, the H 70 royalties from the Defense Systems segment declined slightly while interest income on invested cash increased due to positive inflows of cash primarily from the resumption of normal progress payments on the H 70 contract which were delayed in fiscal 1994.\nFiscal 1993 other income includes the impact of the net gain on sale of assets related to the Seaton-Wilson division (see Note A to the Consolidated Financial Statements, \"Acquisitions and Dispositions\").\nINCOME TAX PROVISION The Company's effective tax (benefit) rate was (35.7%), (40.0%) and 32.1%, respectively for fiscal 1995, 1994 and 1993. The effective tax rate reflects the statutory federal tax rate and the weighted average tax rate of the states in which the Company conducts business. The fiscal 1995 effective tax rate is lower than the effective rate in fiscal 1994 due to losses in certain states where realization of the benefits of the losses is uncertain. The effective tax benefit for fiscal 1994 reflects a favorable settlement of an IRS examination. The effective tax rate for fiscal 1993 was affected favorably by the adoption of Statement of Financial Accounting Standards No. 109 \"Accounting for Income Taxes\" (see Note H to Consolidated Financial Statements, \"Income Taxes\").\nDEFERRED INCOME TAXES At September 30, 1995, the Company had net deferred tax assets of $2,220,000 composed of deferred tax assets of $6,104,000, net of the valuation allowance of $1,220,000, and deferred tax liabilities of $3,884,000. The Company believes it is likely that the benefits of the deferred tax assets of $6,104,000 will be realized through the reduction of future taxable income.\nManagement has considered appropriate factors in assessing the probability of realizing these deferred tax benefits. These factors include the deferred tax liabilities of $3,884,000 and the presence of significant taxable income in fiscal 1993.\nManagement also considered the nature of certain of the items which created the deferred tax assets. The accruals established for exiting the rocket business and certain litigation matters are nonrecurring and create deferred tax assets which are expected to be realized in 1996 as the accruals are paid (see Note C \"HYDRA 70 Rocket Contract and Related Contingencies\" and Note M \"Contingencies and Litigation\" to Consolidated Financial Statements). Approximately $4.0 million of pre-tax income would result in the realization of deferred tax assets which exceed deferred tax liabilities and allowable refunds of prior year's taxes paid. Continuing expansion of commercial product lines and declining losses in the Defense Systems segment are expected to result in sufficient taxable income for the realization of the portion of the deferred tax assets dependent on future income.\nThe valuation allowance is established primarily for state net operating losses of the Medical Systems segment which cannot be offset against income of the Company or its subsidiaries in other states. These states have relatively short loss carryover periods of three to five years.\nManagement intends to evaluate the realizability of deferred tax assets on a quarterly basis by assessing the need for any additional valuation allowance.\nLIQUIDITY AND CAPITAL RESOURCES During fiscal 1995, operating activities provided $12.6 million in cash. The consolidated net loss of nearly $4.4 million was offset by non-cash charges for depreciation and amortization of $5.4 million and $2.8 million, respectively. Defense Systems experienced cash inflows from the resumption of normal progress payments for materials used in the H 70 program allowing the shipment of nearly $10.2 million in inventory which was built up during fiscal 1994. The $4.8 million in cash flow from increases in trade accounts payable, accrued expenses and other liabilities includes $6.8 million in milestone payments and accrued royalties related the GPI arbitration discussed in Note M to the Consolidated Financial Statements, \"Contingencies and Litigation.\" The milestone payment of $3.3 million was made in October 1995.\nInvesting activities, which used approximately $3.2 million in cash, included the purchase of capital equipment primarily in the Sensors and Systems segment. This level of spending is consistent with the growth of the segment.\nCash was used in financing activities to reduce long term debt in connection with scheduled payments stemming from the acquisitions of Meditron and Zinnanti Surgical Instruments in previous years. The Company declared and paid dividends on common stock and purchased treasury stock during the year.\nThe Company had no material capital commitments at September 30, 1995 except as discussed in Note M to the Consolidated Financial Statements, \"Contingencies and Litigation.\"\nIn 1991, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (\"SFAS\") No. 107 \"Disclosures About Fair Value of Financial Instruments.\" The Company will be required to adopt SFAS 107 in fiscal year 1996. Accordingly, the Company plans to adopt SFAS 107 when required, and will disclose the fair value for all of its financial instruments, if practicable. Management does not anticipate a material impact on the consolidated financial statements as a result of adoption of SFAS 107.\nAs of September 30, 1995, primarily as a result of the 1995 loss, the Company was not in compliance with a financial covenant in the Senior Note Agreement. The senior note holders waived the requirements of this covenant as of September 30, 1995.\nBased on the financial condition of the Company at September 30, 1995, management believes that the existing cash balances, cash generated from operations, and available lines of credit will be sufficient to meet the Company's planned needs for the foreseeable future. If the Company requires additional capital, it anticipates that such capital will be provided by bank or other borrowings, although there can be no assurances that funds will be available on terms as favorable as those applicable to the Company's currently outstanding debt.\nEFFECTS OF INFLATION Management believes that, for the periods presented, inflation has not had a material effect on the Company's operations.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nCONSOLIDATED BALANCE SHEETS BEI Electronics, Inc. and Subsidiaries\n- -------------------------------------------------------------------------------- September 30 October 1 dollars in thousands except par values 1995 1994 - -------------------------------------------------------------------------------- ASSETS Current assets Cash and cash equivalents $ 11,690 $ 4,197 Trade receivables: United States Government 5,054 2,488 Commercial customers, less allowances for doubtful accounts (1995--$451; 1994--$398) 13,806 16,015 - -------------------------------------------------------------------------------- 18,860 18,503\nInventories--Note D 20,482 33,185 Refundable income taxes 498 887 Other current assets 2,374 2,692 Deferred income taxes--Note H 3,106 1,324 Current assets of H 70 Rocket line of business, net--Note C 6,820 -- - -------------------------------------------------------------------------------- Total current assets 63,830 60,788\nProperty, plant and equipment--Notes G and L Land 4,093 4,325 Structures 7,216 10,135 Equipment 33,814 41,583 Leasehold improvements 1,396 1,253 - -------------------------------------------------------------------------------- 46,519 57,296\nLess allowances for depreciation and amortization 23,062 28,026 - -------------------------------------------------------------------------------- 23,457 29,270\nOther assets Tradenames, patents and related assets, less amortization (1995--$4,945; 1994--$3,513) 6,662 8,061 Technology acquired under license agreements, less amortization (1995--$2,342; 1994--$1,546)--Note M 8,125 5,621 Goodwill, less amortization (1995--$1,024; 1994--$732) 4,833 5,156 Non-current assets of H 70 Rocket line of business, net-- Note C 3,428 -- Other 3,403 3,536 - -------------------------------------------------------------------------------- 26,451 22,374\n- -------------------------------------------------------------------------------- $113,738 $112,432 ================================================================================\nSee notes to consolidated financial statements.\nCONSOLIDATED BALANCE SHEETS BEI Electronics, Inc. and Subsidiaries\n- -------------------------------------------------------------------------------- September 30 October 1 dollars in thousands except par values 1995 1994 - -------------------------------------------------------------------------------- LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities Short term debt--Note E $ -- $ -- Trade accounts payable 8,092 7,826 Accrued expenses and other liabilities--Note F 16,602 11,951 Current portion of long-term debt--Note G 259 822 Current liabilities of H 70 Rocket line of business--Note C 2,954 -- - -------------------------------------------------------------------------------- Total Current Liabilities 27,907 20,599\nLong-term debt, less current portion--Note G 30,157 30,421\nDeferred income taxes--Note H 886 1,604\nOther liabilities 1,469 1,979\nStockholders' Equity--Notes I, J and K Preferred stock ($.001 par value; authorized 2,000,000 shares; none issued) -- -- Common Stock ($.001 par value; authorized 20,000,000 shares; issued and outstanding; 1995--9,246,183; 1994--9,109,499) 9 9 Additional paid-in capital 24,112 23,533 Retained earnings 41,721 46,653 - -------------------------------------------------------------------------------- 65,842 70,195 Less: Treasury stock, at cost (1995--2,440,372 shares; 1994--2,420,872 shares) (11,793) (11,660)\nUnearned restricted stock--Note J (730) (706) - --------------------------------------------------------------------------------\nTotal Stockholders' Equity 53,319 57,829\nCommitments and contingencies--Notes C, K, L and M -- --\n- -------------------------------------------------------------------------------- $113,738 $112,432 ================================================================================ See notes to consolidated financial statements.\nCONSOLIDATED STATEMENTS OF OPERATIONS BEI Electronics, Inc. and Subsidiaries\nYears Ended ------------------------------------ September 30 October 1 October 2 dollars in thousands except per share amounts 1995 1994 1993 - -------------------------------------------------------------------------------- Net sales $144,903 $138,658 $146,719 Cost of sales 107,542 97,565 100,407 - -------------------------------------------------------------------------------- 37,361 41,093 46,312 - -------------------------------------------------------------------------------- Selling, general and administrative expenses--Note C 34,261 35,354 35,354 Provision for royalty and related expenses--Note M 3,500 -- -- Research, development and related expenses 4,963 7,246 5,737 - -------------------------------------------------------------------------------- 42,724 42,600 41,091 - -------------------------------------------------------------------------------- Income (loss) from operations (5,363) (1,507) 5,221\nOther income 990 1,016 1,805 Interest expense (2,457) (2,417) (1,457) - -------------------------------------------------------------------------------- Income (loss) before income taxes (6,830) (2,908) 5,569 Federal and state income taxes--Note H Current (credit) 61 (569) 1,940 Deferred (credit) (2,500) (595) (149) - -------------------------------------------------------------------------------- (2,439) (1,164) 1,791 - -------------------------------------------------------------------------------- Net income (loss) ($4,391) ($1,744) $3,778 ================================================================================ Earnings (loss) per common and common equivalent share--Note I ($0.65) ($0.26) $ 0.56 ================================================================================\nWeighted average shares outstanding--Note I 6,758,745 6,656,959 6,783,365 ================================================================================\nDividends per common share--Note I $0.08 $0.08 $0.08 ================================================================================\nSee notes to consolidated financial statements.\nNotes to Consolidated Financial Statements BEI Electronics, Inc. and Subsidiaries September 30, 1995\nNote A Acquisitions and Dispositions\nOn February 26, 1993, the Company purchased for cash (see Consolidated Statements of Cash Flows) and notes to the seller, all outstanding stock of Zinnanti Surgical Instruments, Inc. (\"Zinnanti\") headquartered in Chatsworth, CA. Zinnanti is engaged in the marketing of products used to perform minimally invasive surgery. The assets are used to carry on substantially the same business activities. In connection with the acquisition of Zinnanti, the Company acquired assets with a fair value of $9.0 million and assumed liabilities and incurred purchase notes of $6.7 million. If the acquisition had occurred at the beginning of fiscal 1993, the effect on consolidated net sales, net income and net income per share would not have been material. The acquisition was accounted for under the purchase method. Accordingly, the acquired assets and liabilities were recorded at their estimated fair values at the date of acquisition. Operating results are included in the consolidated statement of operations from the acquisition date.\nOn September 30, 1993, the Company sold for cash the Seaton-Wilson division of the Sensors and Systems segment (see Consolidated Statements of Cash Flows). The pre-tax gain on the disposition of $501,000 ($300,000 after tax) was included in other income in 1993. Seaton-Wilson manufactured and sold pneumatic and hydraulic valves and specialized disconnect systems designed for aerospace and defense applications.\nNote B Summary of Significant Accounting Policies\nFiscal Year: The Company's fiscal year ends on the Saturday nearest September 30. Fiscal years 1995, 1994 and 1993 each contained 52 weeks.\nConsolidation: The consolidated financial statements include the accounts of the Company and its wholly and majority owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.\nCash and Cash Equivalents: The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents.\nConcentration of Credit Risk: The Company sells a significant portion of its products directly to the U.S. Government or to U.S. Government prime contractors. The Company's remaining products are sold to commercial customers throughout the United States and in various foreign countries. Substantially all foreign sales are denominated in U.S. dollars. The Company performs ongoing credit evaluations of its commercial customers and generally does not require collateral. The Company maintains reserves for potential credit losses. Historically, such losses have been within the expectations of management.\nU.S. Government and Long-Term Contracts: Fixed price contracts are accounted for by the percentage of completion method, with percentage of completion determined primarily by units delivered. Units are considered delivered when accepted by the customer. Sales under cost reimbursement contracts are recognized as costs are incurred and include a proportion of the fees expected to be realized on the contracts. Amounts related to billed retainages, amounts not billed and amounts of uncertain claims are immaterial.\nRevenue Recognition: Revenue for products not sold under long term contracts is recognized as units are shipped or as services are provided.\nInventories: Costs incurred under U.S. Government contracts in process are carried at cost less anticipated losses, if any, on the contracts. The U.S. Government has title to, or a security interest in, certain inventories as a result of progress payments on contracts. Other inventories are carried principally at the lower of cost (first-in, first-out method) or market. Provisions for contract costs in excess of inventory are reflected as accrued contract costs in current liabilities.\nProperty, Plant and Equipment: Property, plant and equipment are recorded at cost. Depreciation and amortization are provided in amounts sufficient to amortize the cost of such assets over their estimated useful lives by the straight-line method for structures and leasehold improvements and by accelerated or straight-line methods for equipment.\nTradenames, Patents and Related Assets: Consists primarily of patents, tradenames and related non-competition agreements acquired in purchase acquisitions. Patents and non-competition agreements are being amortized over their term. Tradenames are amortized over twenty-five years.\nGoodwill and Technology Acquired: Goodwill consists of the excess of cost over fair value of net tangible assets acquired in purchase acquisitions. Goodwill is amortized by the straight-line method over 20 years. The carrying value of goodwill will be reviewed if the facts and circumstances suggest that it may be impaired.\nTechnology acquired consists primarily of exclusive rights under a license agreement to make, use and sell products utilizing quartz rate sensing technology. Technology acquired, including capitalized legal fees, is amortized on a straight-line basis over the average remaining life of the underlying patents at the date of acquisition, or the estimated useful life of the technology, whichever is less.\nImpairment is determined based on undiscounted future cash flows over the amortization period. If impairment is indicated, the carrying value of goodwill or technology acquired would be reduced by the estimated short-fall in discounted cash flows.\nEarnings Per Share: Earnings per share are computed based on the weighted average number of shares of common stock (less treasury stock) outstanding during the year, adjusted to include common stock equivalents attributable to dilutive stock options.\nResearch and Development Costs: Company-sponsored research and development costs include research and development efforts related to U.S. Government products and services. U.S. Government contractual arrangements limit the amounts of research and development and bid and proposal costs recoverable under U.S. Government contracts. Company-sponsored product development costs are charged to expense when incurred. Customer-sponsored research and development costs incurred pursuant to contracts are accounted for as other contract costs.\nPostretirement Benefits: The Company does not provide postretirement benefits other than pensions under a plan. Liabilities for postretirement benefits under individual contracts are recorded over the term of employment.\nFinancial Instruments: In 1991, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 107 (\"SFAS No. 107\"), \"Disclosures about Fair Value of Financial Instruments\". The Company is required to adopt the Statement in fiscal 1996. Management does not expect adoption of SFAS No. 107 to have a material impact on the consolidated financial statements of the Company.\nImpairment of Assets: The Company plans to adopt Statement of Financial Accounting Standards No. 121 (\"SFAS No. 121\"), \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of,\" effective October 1, 1995. Under SFAS No. 121, impairment losses are recognized when information indicates the carrying amount of long-lived assets, identifiable intangibles and goodwill related to those assets will not be recovered through future operations or sale. Impairment losses for assets to be held or used in operations will be based on the excess of the carrying amount of the asset over the asset's fair value. Assets held for disposal, except for discontinued operations, will be carried at the lower of carrying amount or fair value less cost to sell. SFAS No. 121 will be applied prospectively from the date of adoption and, based on current circumstances, management does not believe the effect of adoption will be material.\nReclassifications: Certain reclassifications have been made to the fiscal 1994 and 1993 financial statements to conform to the fiscal 1995 presentation.\nNote C HYDRA 70 Rocket Contract and Related Contingencies\nThe principal product of the Company's Defense Systems business segment is the HYDRA 70 (H 70) Rocket produced under a competitively bid fixed price contract. Contract production is conducted in Camden, Arkansas and Euless, Texas. Rockets and components are subjected to various tests and inspections by the U.S. Government. Production is based on \"build to print\" technical data packages (\"TDP\") supplied by the U.S. Government for each significant component. Certain production lots of fuzes which are components of some rockets have been determined by the Government not to meet required acceptance test specifications. Management of the Company believes that the fuzes have been manufactured in accordance with Government supplied technical data packages and that any failure to achieve required test specifications is due to the technical data packages. The Company also believes that the fuzes perform in a manner equivalent to fuzes manufactured by the Company and other manufacturers and accepted by the Government in many prior years.\nAs a result of the above noted conditions, the Company has experienced delays in production and delivery of rockets which contain the subject fuzes. As a result of delays the Company has incurred and may continue to incur additional costs relating to materials, labor and overhead. Based upon the lack of constructive response from the government to date in addressing the TDP issues, the Company has reevaluated the estimated cost to complete the H 70 contract and has recorded a reduction in gross margin on the H 70 contract of $1,468,000 in the fourth quarter of fiscal 1995. The gross margin on the contract for remaining production in 1996 would be less than 2% based on the adjusted cost to complete.\nIn September 1995, management of the Company reached a decision to exit the rocket manufacturing line of business which makes up a substantial portion of the Company's Defense Systems segment.\nThe Company's current backlog of rocket contracts will extend into late fiscal 1996. Assets of the rocket business will be disposed of by sale or liquidation. The Company expects that the sale or other disposition of the assets of the rocket line of business will be completed in fiscal 1996. Management believes the net proceeds from the disposition of assets of the rocket line of business will equal or exceed the carrying value of the assets.\nAs a result of the decision to exit the rocket line of business, the Company will incur costs relating to the closure and abandonment of the leased facility in Camden, Arkansas including employee severance and related benefits, and lease and leasehold costs. The Company will also incur similar costs related to its owned facility in Euless, Texas. The Company has accrued $1,250,000 as exit costs at September 30, 1995 composed of employee severance of $750,000, leasehold abandonment of $250,000 and owned facility costs of $250,000. These costs are included in cost of sales in the consolidated statements of operations.\nSales and cost of sales for the HYDRA 70 rocket system line of business were as follows for the fiscal periods indicated.\n(dollars in thousands) 1995 1994 1993 - -------------------------------------------------------------------------------- Sales $38,517 $38,292 $42,253 Cost of Sales 39,979 36,251 32,852 - --------------------------------------------------------------------------------\nNon-H 70 sales in the Defense Systems segment include sales under a cost-plus fee advanced rocket development contract which has no further funding in 1996. Sales under this contract were $2,893,000, $5,021,000 and $4,640,000 for fiscal 1995, 1994 and 1993 respectively.\nSales for other non-H 70 products (rocket control systems) in the Defense Systems segment were $4,171,000, $4,306,000 and $3,231,000 for fiscal 1995, 1994 and 1993, respectively.\nIn October 1995, the Company's Defense Systems subsidiary received notification from the Procuring Contracting Officer for the HYDRA 70 Rocket Systems Contract that the Government considered Defense Systems' \"failure to maintain satisfactory fuze production along with projected manufacturing cost overrun conditions endangering performance of the subject contract.\" The notice further advised that the Government may terminate the contract for default unless evidence was provided showing that this condition could be cured.\nCounsel for Defense Systems responded to the notification in early November 1995. The response set forth Defense Systems' position that termination for default is not an appropriate Government option due to Defense Systems' compliance with the contract and the Government's responsibility for fuze technical difficulties, as a result of defective technical data provided to Defense Systems.\nDefense Systems had previously filed, in August 1995, a claim against the Government relative to the fuze technical data problems experienced on previous contracts. The amount of the claim was approximately $5 million. Defense Systems also believes it has rights for additional claims against the Government arising out of the current H 70 contract. Due to the uncertainties inherent in the formal claims process, the Company has not recorded any recoveries for the aforementioned claims in the accompanying financial statements.\nIn the event that the Government goes forward with a termination for default, the Company will contest such termination for the purpose of converting it to a termination for convenience by the Government.\nAs of October 31, 1995, the amount of unliquidated progress payments relative to the subject contract was $17 million. If, contrary to the belief of management of the Company and Defense Systems, a termination for default were to be instituted by the Government and upheld, Defense Systems could be required to refund unliquidated progress payments and fund the cost of completion of the contract by another supplier. Such a result would have a material adverse impact on the Company.\nManagement of the Company and of Defense Systems, after consultation with legal counsel specializing in government procurement law, is of the opinion that the final resolution of the issues which gave rise to the Government's notice as to possible termination for default will not have a material adverse effect on the financial condition or results of operations of the Company.\nDuring a vendor survey conducted by BEI Defense Systems Company in the first quarter of fiscal 1994, a component used in the H 70 rocket motor was identified as being produced by a process that differed from the one that the vendor had certified. Subsequent to the survey and BEI's evaluation of alternative acceptable processes, BEI's customer, the U.S. Government, was notified of the potentially non-conforming material. The customer, as required by applicable contract provisions, notified Justice Department and Defense Department investigators. Management also conducted an internal investigation to determine the facts and appropriateness of follow-up actions. Due to these investigations, delivery of certain completed rockets motors was delayed beginning in late December 1993. Subsequently, the customer agreed to accept the completed but undelivered rocket motors and the Company agreed to replace the affected parts under warranty. During the fourth quarter of fiscal 1994, the Company began rework under warranty and substantial deliveries of rocket motors were completed prior to the end of fiscal 1994. The Company provided for the cost of warranty replacement of the affected parts in all undelivered rocket motors in 1994. This rework effort was completed in fiscal 1995.\nFor previously delivered rocket motors, the customer conducted extensive tests on the potentially non-conforming part to determine whether required levels of performance and reliability are achieved by the affected part. The tests were completed in fiscal 1995 and a determination was made that the performance and reliability of the affected part was satisfactory and that no further rework was required. The outcome of the Justice Department portion of the investigation is not presently determinable; however, management believes, after consultation with legal counsel, that the outcome of this matter will not have a material impact on the financial position or results of operations of the Company.\nNote E Bank Credit Agreements\nAt September 30, 1995 and October 1, 1994, the Company had a $15 million unsecured credit line with a bank. There were no borrowings under the line at these dates. Based on the borrowing capacity limitations contained in the Senior Notes described in Note G, approximately $3.8 million could be borrowed under the credit line at September 30, 1995. Interest on borrowings is based upon either the Prime Commercial Lending Rate of Canadian Imperial Bank of Commerce (\"CIBC\") or the rate which would be offered by CIBC to prime banks in the interbank Eurodollar market depending on the term of borrowing.\nUnder the line of credit, the bank will also issue standby letters of credit. At September 30, 1995, $3.7 million was available to fund letters of credit issued on behalf of the Company. There were two undrawn letters of credit outstanding under this facility totaling $0.1 million at September 30, 1995 of which one will expire no later than October 31, 1995 and one will expire no later than February 23, 1996.\nThe credit agreement, which expires in June 1996 if not extended or renewed by the lender, has covenants concerning certain financial ratios and minimum balances of net worth. At September 30, 1995, the Company was in compliance with these covenants.\nAnnual maturities of long-term debt, excluding capitalized equipment lease obligations (see Note I), are as follows: fiscal 1996--$188,000; 1997--$5,804,000; 1998--$9,174,000; 1999--$7,339,000; 2000--$5,600,000; thereafter -- $2,240,000.\nInterest of approximately $2,413,000, $2,423,000 and $1,359,000 was paid during fiscal 1995, 1994 and 1993, respectively.\nThe Senior Note Agreement contains covenants concerning certain financial ratios, dividend payments and minimum balances of net worth. At September 30, 1995, the Company was not in compliance with a covenant which requires a specified fixed charges coverage ratio. The Senior Note holders waived the requirements of this covenant as of September 30, 1995.\nNote H Income Taxes\nThe Company files a consolidated federal income tax return which includes all its eligible subsidiaries. In accordance with the tax allocation arrangement between the Company and its subsidiaries, income taxes are allocated generally as if the Company and its subsidiaries filed separate U.S. and state income tax returns.\nDeferred income taxes reflect the net tax effects of temporary differences between carrying amounts of assets and liabilites for financial reporting purposes and amounts used for income tax purposes.\nSignificant components of the Company's deferred tax liabilities and assets as of September 30, 1995 and October 1, 1994 are as follows (in thousands):\n1995 1994 - -------------------------------------------------------------------------------- Deferred tax liabilities: Depreciation and property basis difference $2,422 $2,462 Amortization of intangibles 179 283 Prepaid expenses 358 495 Accrued expenses 379 392 Other 546 284 - -------------------------------------------------------------------------------- Total deferred tax liabilities 3,884 3,916 Deferred tax assets Accrued expenses 2,604 1,407 Inventory valuation 1,254 749 Contract reserves 565 64 State net operating loss carryovers 1,223 905 Other 1,678 1,114 - -------------------------------------------------------------------------------- Total deferred tax assets 7,324 4,239 Valuation allowance for deferred tax assets 1,220 603 - -------------------------------------------------------------------------------- Total deferred tax assets 6,104 3,636 - -------------------------------------------------------------------------------- Net deferred tax (assets) liabilities ($2,220) $280 ================================================================================\nThe valuation allowance for deferred tax assets increased by a net $617,000 during the year ended September 30, 1995. The valuation allowance was increased for the uncertainty of realization of net operating losses of subsidiaries in certain states, and decreased as a result of net operating losses in other states becoming more likely of realization. State net operating loss carryovers expire generally in five to seven years.\nThe 1994 tax provision includes a benefit of approximately $130,000 for the favorable resolution of completed Internal Revenue Service examinations of 1990 and 1991.\nIncome taxes of approximately $1,420,000, $1,601,000, and $2,781,000, were paid during fiscal 1995, 1994 and 1993 respectively. Refunds of approximately $1,400,000 were received in fiscal 1995.\nNote I Stockholders' Equity\nThe preferred stock may be issued from time to time in one or more series. The Board of Directors of the Company is authorized to establish from time to time the number of shares to be included in each series, and to designate the dividend rights, dividend rate, conversion rights, voting rights, rights and terms of redemption, redemption price or prices and liquidation preferences.\nDuring fiscal 1992 and 1990 respectively, the Board of Directors of the Company authorized the purchase from time to time in open market transactions of up to 300,000 and 500,000 additional shares of common stock. As of September 30, 1995, 784,424 shares had been repurchased at a cost of $5,510,000. These shares are included as treasury stock at September 30, 1995.\nNote J Stock Option and Restricted Stock Plans\nIn 1982, the Company's stockholders voted to adopt an incentive stock option plan. The plan provided for option prices based on the fair market value of the stock on the date the option is granted. The Incentive Stock Option Plan of 1982 terminated December 15, 1991; no further shares can be granted and the options outstanding at September 30, 1995 will expire if not exercised by 1998.\nIn November 1987, the Company's stockholders voted to adopt an additional incentive stock option plan and a supplemental (nonqualified) stock option plan. The incentive stock option plan provides for option prices based on the fair market value of the stock on the date the option is granted, as determined by the Board of Directors. The supplemental stock option plan requires that the exercise price of each option shall not be less than 50% of the fair market value on the date the option is granted. Under both plans the options are generally exercisable in three approximately equal installments commencing one year from the date of grant with accumulation privileges.\nShares issued pursuant to options granted under these two plans shall not exceed 1,250,000 in the aggregate.\nAs of September 30, 1995, options for 551,668 shares were exercisable and 344,975 shares were available for stock option grants under the 1987 plans.\nIn February 1992, the Company's Board of Directors approved the 1992 Restricted Stock Plan, ratified by the Company's shareholders in February, 1993, and authorized up to 350,000 shares to be issued to certain key individuals subject to forfeiture if employment terminated prior to the end of prescribed periods. The effective date of the plan was January 1, 1992. As of September 30, 1995, 244,926 shares had been granted and of these 212,139 shares are outstanding. Of the outstanding shares 58,252 have fully vested. There are 137,861 shares reserved for issue. The market value at the date of grant of shares awarded under the plan is recorded as unearned restricted stock. The market value of shares granted is amortized to compensation expense over the periods of vesting. Compensation expense of $236,000, $196,000 and $181,000 was recorded in fiscal 1995, 1994 and 1993, respectively.\nNote K Employee Benefit Plans\nThe Company has a defined contribution retirement plan for the benefit of all eligible employees. The plan qualifies under Section 401(k) of the Internal Revenue Code thereby allowing eligible employees to make tax deductible contributions to the plan. The plan provides for a minimum annual employer contribution of 1% of total employee compensation and an employer matching contribution equal to 25% of the participant's contribution to the plan up to a maximum employer matching contribution of 1% of compensation. Additional contributions are at the discretion of the Board of Directors. The Company's contributions to the plan for fiscal 1995, 1994 and 1993 were approximately $736,000, $777,000, and $847,000, respectively.\nThe Company also has an employee stock purchase plan. The purchase plan qualifies as an employee stock purchase plan under Section 423 of the Internal Revenue Code. Under the purchase plan, the Board of Directors may authorize the participation by employees (excluding certain highly compensated employees) in offerings of its common stock. Under the purchase plan, employees may have up to 10% of their salary withheld to be used to purchase shares of common stock at a price equal to not less than 85% of the fair market value of the stock at specified applicable dates. As of September 30, 1995, 421,275 shares have been issued and 178,725 shares were reserved for purchase over the ten year life of the purchase plan.\nNote L Leases and Commitments\nTotal rental expense attributable to property, plant and equipment amounted to approximately $2,436,000, $3,082,000, and $3,984,000 for fiscal 1995, 1994 and 1993 respectively.\nLease amortization is included in depreciation and amortization of property, plant and equipment.\nOperating leases consist principally of leases for structures and land. Certain of the operating leases contain various options for renewal and\/or purchase of the related assets for amounts approximating their fair market value at the date of exercise of the option.\nNote M Contingencies and Litigation\nBEI Systron Donner Company vs. General Precision Industries, Inc. et al. - ------------------------------------------------------------------------\nIn connection with the acquisition of assets from Systron Donner Corporation during fiscal 1990, a subsidiary of the Company assumed an obligation to pay former shareholders of General Precision Industries (\"GPI\") $4.3 million if certain levels of confirmed orders and shipments are achieved for products developed using technology acquired from GPI in 1986 under a license agreement which expires in 2003. The technology acquired was assigned a value of $5.6 million for the purchase price allocation for the acquisition.\nIn September of 1991, the Licensor of the patent on which the Company's quartz technology is based advised the Company that royalties in excess of the amounts previously paid by the Company were due. The amount of royalties involved was approximately $400,000. The Company advised the Licensor that based on its understanding of the license agreement no additional amounts were due. The Licensor alleged that nonpayment of the royalties due would give the Licensor the right to terminate the license agreement. The parties were unable to resolve these differences. Accordingly, the Company elected to exercise the provision of the license agreement which required arbitration of any disputes between the parties to the agreement.\nIn June of 1993, the Company and the Licensor filed briefs with the arbitration panel. The Licensor alleged in its brief that the amount of royalties, milestone payments and accrued interest due as of September 30, 1992 was approximately $10.0\nmillion (including the $4.3 million described above), and asked the arbitration panel to rule that the license could be terminated based on noncompliance by the Company with the terms of the license agreement.\nThe Company asked the arbitration panel to rule that the amounts of the royalties paid by the Company had been properly determined by the Company, that the original license agreement should be reformed to reduce the royalties due on future sales as a result of failure by the Licensor to disclose certain matters which significantly impacted the Company's timely ability to employ the licensed patent on production units and that the license was not subject to termination.\nThe arbitration process is ongoing. The arbitration panel bifurcated the issues in the arbitration, and issued an interim ruling in February 1995. In that interim ruling, which will become final at the close of the arbitration, the Panel concluded that the license agreement was not subject to termination, that non-recurring engineering revenues were not royalty-bearing, and that $1 million of the $4.3 million discussed above is due only if certain conditions are met in the future. The Panel also concluded that the Company is entitled to ownership of an accelerometer patent that the former Shareholders developed. Further, in September 1995, the panel ruled that certain development costs incurred by the Company could not be used to offset accrued royalties. As a result, in September 1995, the Company accrued $3.5 million for royalties and related costs based on its understanding of the amounts due under the panel's September ruling. The estimate of royalties and related amounts due under the license agreement are based on the Company's proposal to the panel and are significantly less than amounts proposed by the licensor. Under the panel's February ruling, $3.3 million of the $4.3 million became due. This amount, which is considered part of the original acquisition cost of the technology, was accrued in February 1995, paid in October 1995, and is being amortized over the remaining term of the license.\nThe second phase of the arbitration continues with final arguments scheduled in December 1995. This phase involves the final determination of royalty amounts due for unit sales of product using the acquired technology and other matters including the parties' respective claims for attorneys' fees. In the event that the arbitration panel rules that the Company's liability is more or less than the $3.5 million accrued, an adjustment to the September 30, 1995 estimate will be required. While the final outcome of this matter cannot be determined with certainty, management believes, taking all factors into account and after consultation with legal counsel, that this matter will not result in a material adverse impact on the financial position of the Company.\nState of California Department of Toxic Substances Control vs. Southland Oil, - -------------------------------------------------------------------------------- Inc. et al. - -----------\nIn October 1993, the State of California filed a first amended complaint against a division of the company and fifty-two other defendants. The complaint seeks recovery of response costs incurred by the State at a waste oil recycling facility in Commerce, California (the \"Site\"). The litigation with the State was recently settled in principle, requiring a dismissal of the action following the payment by defendants to the State of $2.6 million to settle all past and future response costs at the Site (as well as all other alleged damages). The defendants believe that there are additional parties that should be liable for the settlement amount, and some of the defendants (including the Company) have filed a third party claim against these other parties. There has not yet been an allocation of the $2.6 million settlement amount either among the defendants or between the defendants and the third party defendants. Recent formulas that have been proposed for settlement and that have been discussed by the defendants and the third party defendants would result in the Company's share of the settlement amount being set at less than $20,000. While the outcome of this matter cannot be determined with certainty, management believes, after consultation with legal counsel, that the ultimate resolution will not have a material adverse impact on the financial position of the Company.\nCooperSurgical, Inc. vs. BEI Medical Systems Company, Inc. et al. - -----------------------------------------------------------------\nIn October 1993, CooperSurgical, Inc. a subsidiary of the Cooper Companies filed a claim for unspecified damages alleging unfair competition due to actions by BEI Medical Systems and its president Richard Turner, a former employee of the Cooper Companies, and others. On May 16, 1994, the Chancery Division for the Superior Court of New Jersey granted a partial summary judgment in favor of the plaintiff and issued an injunction against the defendants restraining them from selling certain products until June 20, 1996. In September 1994, BEI Medical Systems filed a motion to vacate the May 16, 1994 order. On November 28, 1994, the Court vacated the restraint order.\nManagement has vigorously defended its rights in this action and believes after discussion with legal counsel that the CooperSurgical claims are exaggerated. Expert witnesses for BEI have prepared a formal response to the CooperSurgical damage claims which was submitted in February 1995. BEI's experts stated that if CooperSurgical were entitled to damages, those damages would total less than $100,000, and would be more than offset by BEI Medical Systems' counterclaim against CooperSurgical. Discovery has been completed. The trial which was originally scheduled to begin in November will be reset for 1996. While the outcome of this matter cannot be determined at this time, management believes, taking known factors into account and after consultation with legal counsel, that this matter will not result in a material adverse impact on the financial position of the Company.\nOther - -----\nThe Company has pending various legal actions arising in the normal course of business. Management believes that none of these legal actions will have a material impact on the Company's operating results or financial condition.\nNote N Business Segment Data\nThe Company operates principally in three business segments, the Sensors and Systems segment, the Defense Systems segment and the Medical Systems segment. The Sensors and Systems segment includes precision sensors, control devices and systems used in a wide variety of equipment and machinery for aerospace, industrial, automotive and medical applications requiring high accuracy and reliability. These products are produced by BEI Sensors and Systems Company. The Defense Systems segment produces primarily rocket motors, combat and training warheads, special ordnance components and rocket control systems. See Note C regarding the Company's decision to exit the rocket manufacturing line of business. These systems are produced by BEI Defense Systems Company. The Medical Systems segment consists primarily of electrosurgical units and instruments used in minimally invasive surgery and procedures. These products are either manufactured by BEI Medical Systems Company or purchased from the manufacturer and marketed by BEI Medical Systems Company.\nNet sales to customers in foreign countries amounted to $11,961,000, $10,436,000, and $8,057,000 in fiscal 1995, 1994 and 1993, respectively. In fiscal 1995, 1994 and 1993, foreign sales did not exceed 10% of consolidated net sales in any individual geographic area.\nNet sales to the U.S. Government for the Sensors and Systems segment's products amounted to $28,930,000, $32,718,000, and $42,374,000 in fiscal 1995, 1994 and 1993, respectively. Net sales to the U.S. Government for the Defense Systems segment's products amounted to $44,012,000, $46,043,000, and $49,122,000 in fiscal 1995, 1994 and 1993, respectively.\nNote O Quarterly Results of Operations (Unaudited)\nThe Board of Directors and Shareholders BEI Electronics, Inc.\nWe have audited the accompanying consolidated balance sheets of BEI Electronics, Inc. and subsidiaries as of September 30, 1995 and October 1, 1994, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended September 30, 1995. 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 BEI Electronics, Inc. and subsidiaries at September 30, 1995 and October 1, 1994, and the consolidated results of their operations and their cash flows for each of the three years in the period ended September 30, 1995 in conformity with generally accepted accounting principles.\nErnst & Young LLP San Francisco, California November 3, 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\nCertain information with respect to directors and executive officers is set forth in Part I of this Report. Additional information required by this Item is incorporated herein by reference to the section entitled \"Compliance with Section 16(a) of the Securities and Exchange Act of 1934\" related to the Company's 1996 Annual Meeting of Stockholders to be filed by the Company with the Securities and Exchange Commission (the \"Definitive Proxy Statement\").\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by this Item is incorporated herein by reference to the sections entitled \"Executive Compensation\" and \"Certain Transactions\" of the Company's Definitive Proxy Statement.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required by this Item is incorporated herein by reference to the section entitled \"Security Ownership of Certain Beneficial Owners and Management\" of the Company's Definitive Proxy Statement.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by this Item is incorporated herein by reference to the sections entitled \"Certain Transactions\" and \"Compensation Committee Interlocks and Insider Particpation\" of the Definitive Proxy Statement.\nPART IV\nSchedules not listed above have been omitted because they are not applicable or are not required or the information required to be set forth therein is included in the Consolidated Financial Statements or Notes thereto.\n(b) No reports on Form 8-K were filed by the Company during the quarter ended September 30, 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 in the City of San Francisco, County of San Francisco, State of California, on December 21, 1995.\nBy: \/s\/ Robert R. Corr ------------------------------- Robert R. Corr Secretary, Treasurer and Controller (Principal Accounting Officer) BEI ELECTRONICS, INC.\nPOWER OF ATTORNEY\nKNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Charles Crocker and Gary D. Wrench, and each of them, as his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, for him and in his name, place, and stead, in any and all capacities, to sign any and all amendments to this Report and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.\nS-1\nReport of Independent Auditors as to Schedule\nThe Board of Directors and Shareholders BEI Electronics, Inc.\nWe have audited the consolidated financial statements of BEI Electronics, Inc. and subsidiaries as of September 30, 1995 and October 1, 1994, and for each of the three years in the period ended September 30, 1995, and have issued our report thereon dated November 3, 1995. Our audits also included the financial statement schedule listed in Item 14(a) of this Form 10-K. This schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits.\nIn our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects, the information set forth therein.\nErnst & Young LLP San Francisco, California November 3, 1995\nS-2\nConsent of Ernst & Young LLP, Independent Auditors\nWe consent to the incorporation by reference in the Registration Statement (Form S-8 No. 33-31459), as amended, pertaining to the 1982 Incentive Stock Option Plan, the 1987 Incentive Stock Option Plan, the 1987 Supplemental Stock Option Plan, and the 1989 Employee Stock Purchase Plan of BEI Electronics, Inc. and subsidiaries of our reports dated November 3, 1995, with respect to the consolidated financial statements and schedule of BEI Electronics, Inc., and subsidiaries included in the Annual Report (Form 10-K) for the year ended September 30, 1995.\nErnst & Young LLP San Francisco, California December 22, 1995\nS-3\nINDEX TO EXHIBITS\nExhibit Sequential Number Description Page Number - ------- ----------- ------------ 4.1 Reference is made to exhibits 3.1 and 3.2\n10.21 Consulting Agreement dated September 30, 1995 57\n11.1 Statement regarding computation of per share earnings 60\n21.1 Subsidiaries of the Registrant 61\n23.1 Consent of Ernst & Young LLP 55 Independent Auditors\n24.1 Power of Attorney 51\n27.1 Financial Data Schedule 62","section_14":"","section_15":""}
{"filename":"352305_1995.txt","cik":"352305","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nDreyer's Grand Ice Cream, Inc. and its consolidated subsidiaries are, unless the context otherwise requires, sometimes referred to herein as \"Dreyer's\" or the \"Company.\" The Company, successor to the original Dreyer's Grand Ice Cream business, was originally incorporated in California on February 23, 1977 and reincorporated in Delaware on December 28, 1985.\nDreyer's manufactures and distributes premium ice cream and other frozen dessert products. Since 1977, Dreyer's Grand Ice Cream has developed from a specialty ice cream sold principally in selected San Francisco Bay Area grocery and ice cream stores to a broad line of frozen dairy and other frozen desserts sold under the Dreyer's and Edy's brand names in retail outlets serving more than 85% of the households in the United States. The Dreyer's line of products are available in the thirteen western states, parts of Texas and certain markets in the Far East. The Company's products are sold under the Edy's brand name generally throughout the remaining regions of the United States. The Dreyer's and Edy's line of products are distributed through a direct-store-delivery system further described below under the caption \"Marketing, Sales and Distribution.\" The Company also distributes and, in certain instances, manufactures branded ice cream and frozen dessert products of other companies. The Dreyer's and Edy's line of ice cream and related products is relatively expensive and is sold by the Company and its independent distributors to grocery stores, convenience stores, club stores, ice cream parlors, restaurants, hotels and certain other accounts. The Dreyer's and Edy's brands enjoy strong consumer recognition and loyalty.\nMARKETS\nIce cream was traditionally supplied by dairies as an adjunct to their basic milk business. Accordingly, ice cream was marketed like milk, as a fungible commodity, and manufacturers competed primarily on the basis of price. This price competition motivated ice cream producers to seek economies in their formulations. The resulting trend to lower quality ice cream created an opportunity for the Company and other producers of premium ice creams, whose products can be differentiated on the basis of quality, technological sophistication and brand image, rather than price. Moreover, the market for all packaged ice creams was influenced by the steady increase in market share of \"private label\" ice cream products owned by the major grocery chains and the purchase or construction by the chains of their own milk and ice cream plants. The resulting reduction in the market for milk and the \"regular\" ice cream brands produced by the independent dairies has caused many such dairies to withdraw from the market. Manufacturing and formulation complexities, broader flavor requirements, consumer preference and brand identity, however, make it more difficult for the chains' private label brands to compete effectively in the premium market segment. As a result, independent premium brands such as the Company's are normally stocked by major grocery chains.\nWhile many foodservice operators, including hotels, schools, hospitals and other institutions, buy ice cream primarily on the basis of price, there are also those in the foodservice industry who purchase ice cream based on its quality. Operators of ice cream shops wanting to feature a quality brand, restaurants that include an ice cream brand on their menu and clubs or chefs concerned with the quality of their fare are often willing to pay for Dreyer's quality, image and brand identity.\nPRODUCTS\nThe Company and its predecessors have always been innovators of flavor, package development and formulation. William A. Dreyer, the creator of Dreyer's Grand Ice Cream, is credited with inventing many popular flavors including Rocky Road. Dreyer's was among the first ice creams in the West packaged in round containers with window lids that allow consumers to see the actual product they are buying. The Company was also the first to produce an ice cream lower in calories. The Company's Grand Light(R) formulation was a precursor to the reduced fat, reduced sugar and low cholesterol products in the Company's current product line.\nThe Company uses only the highest quality ingredients in its products. The Company's management philosophy is to resist changes in its formulations or production processes that compromise quality for cost even though the industry in general may adopt such new formulation or process compromises.\nDreyer's and Edy's Grand Ice Cream is the Company's flagship product. This brand of ice cream utilizes traditional formulations with all natural flavorings and is characterized by premium quality taste and texture, and diverse flavor selection. The flagship product is complimented by the Company's successful reduced fat, low cholesterol products such as Frozen Yogurt; Grand Light, No Sugar Added, Low Fat and Fat Free ice creams; and the Company's Sherbet product. The Company believes these products are well positioned in the segments of the market where products are characterized by lower levels of fat, sugar and cholesterol than those of regular ice cream. The Company also produces a premium soft serve product, Grand SoftTM, which is available as ice cream or frozen yogurt. The Company's novelty line features Dreyer's and Edy's Grand Ice Cream Bars, Tropical Fruit Bars, and Grand Cones. The Dreyer's and Edy's Grand Ice Cream Bars and Grand Cones incorporate proprietary technology which allows the Company to offer flavors that are not available in any other bar or cone. The Company also distributes and, in some instances, manufactures selected branded frozen dessert products of other companies.\nThe Company's product lines now includes over 120 flavors that are selected both on the basis of general popularity and on the intensity of consumer response. Some flavors are seasonal and are produced only as a featured flavor during particular months. The Company operates a continuous flavor development and evaluation program.\nThe Company holds registered trademarks on many of its products. Dreyer's believes that consumers associate the Company's trademarks, distinctive packaging and trade dress with its high quality products. The Company does not own any patents that are material to its business. Historically, research and development expenses have not been significant.\nMARKETING, SALES AND DISTRIBUTION\nThe Company's marketing strategy is based upon management's belief that a significant number of people prefer a quality product and quality image in ice cream just as they do in other product categories. A quality image is communicated in many ways - taste, packaging, flavor selection, price and often through advertising and promotion. If consistency in the product's quality and image are strictly maintained, a brand can develop a clearly defined and loyal consumer following. It is the Company's goal to develop such a consumer following in each major market in which it does business.\nDuring the second quarter of 1994, the Company embarked on a five year plan (the Strategic Plan) to accelerate the sales of its brand throughout the country. This plan includes three primary strategies: a quadrupling of advertising and consumer promotion spending, rapid expansion and development of the Company's direct-store-delivery system, and introduction of innovative new products. Under the Strategic Plan, the Company increased the amount of its spending for advertising and consumer promotion from 1993 levels to approximately $40,000,000 in 1994 and 1995, and plans to spend approximately $40,000,000 annually on these marketing activities from 1996 through 1998. The Company anticipates that the Strategic Plan will continue to reduce earnings during 1996 below levels that would have been attained under the former business plan. The potential benefits of the new strategy are increased market share and future earnings above those levels that would be attained in the absence of the strategy. No assurance can be given that the anticipated benefits of the strategy will be achieved. For additional information regarding the Strategic Plan see the discussion set forth under the caption \"Management's Discussion and Analysis\" which appears on pages 28-30 of this Form 10-K.\nUnlike many other ice cream manufacturers, the Company uses a direct-store-delivery system which allows distribution of the Company's products directly to the retail ice cream cabinet by either the Company's own personnel or independent distributors who primarily distribute the Company's products. This store level distribution allows service to be tailored to the needs of each store. Dreyer's believes this service ensures proper product handling, quality control, flavor selection and retail display. The implementation of this system has resulted in an ice cream distribution network capable of providing frequent direct service to grocery stores\nin every market where the Company's products are sold. Under the Strategic Plan, the Company's distribution network has been significantly expanded to where the Company's products are available to grocery stores serving approximately 85% of the United States. This distribution system is considerably larger than any other direct-store-delivery system for ice cream products currently operating in the United States.\nEach distributor, whether company-owned or independent, is primarily responsible for sales of all products within its respective market area. However, the Company provides sales and marketing support to its independent distributors, including training seminars, sales aids of many kinds, point of purchase materials, assistance with promotions and other sales support.\nThe distribution network in the West now includes ten distribution centers operated by the Company in large metropolitan areas such as Los Angeles, the San Francisco Bay Area, Phoenix, San Diego and Denver. The remaining metropolitan areas throughout the thirteen western states, Texas and the Far East are served through independent distributors.\nDistribution in the remainder of the United States is under the Edy's brand name with most of the distribution handled through eighteen Company-owned distribution centers, including centers in New York, Chicago, Washington, D.C., Tampa and Milwaukee. The Company also has independent distributors handling the Company's products in certain market areas east of the Rocky Mountains.\nTaken together, independent distributors accounted for approximately 23% of consolidated net sales in 1995. The Company's agreements with its independent distributors are generally terminable upon 30 days notice by either party.\nFor fiscal 1995, no customer accounted for more than 10% of consolidated net sales of the Company. The Company's export sales were about 2% of 1995 consolidated net sales.\nThe Company experiences a seasonal fluctuation in sales, with more demand for its products during the spring and summer than during the fall and winter.\nMANUFACTURING\nThe Company manufactures its products at its plants in Union City, California; City of Commerce, California; and Fort Wayne, Indiana. Subsequent to year end, the Company acquired an additional manufacturing plant in Houston, Texas. In order to serve high altitude markets, the Company has manufacturing agreements with two ice cream manufacturers to produce Dreyer's line of products in accordance with specifications and quality control provided by Dreyer's. Of the approximately 68 million gallons of the Company's products sold in 1995, approximately four million gallons were manufactured under these arrangements. The Company also has manufacturing agreements with two different facilities to produce a portion of its novelty products. During 1995, these facilities produced approximately three million cases of Dreyer's and Edy's Ice Cream Bars and Tropical Fruit Bars. In addition, the Company has agreements to produce products for other manufacturers. In 1995, the Company manufactured approximately eight million gallons of product under these agreements.\nThe primary factor in the Company's product costs is the price of basic dairy ingredients (cream, milk and skim milk) and sugar. The minimum prices paid for dairy ingredients are established by the market under the Federal Milk Price Support Program.\nIn order to ensure consistency of flavor, each of the Company's manufacturing plants purchases, to the extent practicable, all of its required dairy ingredients from one local supplier. These dairy products and most other ingredients or their equivalents are available from multiple sources. The Company maintains a rigorous process for evaluating qualified alternative suppliers of its key ingredients.\nCOMPETITION\nThe Company's manufactured products compete on the basis of brand image, quality and breadth of flavor selection. The ice cream industry is highly competitive and most ice cream manufacturers, including full line dairies, the major grocery chains and the other independent ice cream processors, are capable of\nmanufacturing and marketing high quality ice creams. Furthermore, there are relatively few barriers to new entrants in the ice cream business. Reduced fat, reduced sugar and low cholesterol ice cream products, however, generally require technologically sophisticated formulations in comparison to standard or \"regular\" ice cream products.\nMuch of the Company's competition comes from the \"private label\" brands produced by or for the major supermarket chains and which generally sell at prices below those charged by the Company for its products. Because these brands are owned by the retailer, they often receive preferential treatment when the retailers allocate available freezer space. The Company's competition also includes premium ice creams produced by other ice cream manufacturers, some of whom are owned by parent companies much larger than Dreyer's.\nEMPLOYEES\nOn December 30, 1995, the Company had approximately 2,500 employees. The Company's Union City manufacturing and distribution employees are represented by the Milk Drivers & Dairy Employees Union, Local 302 whose contract with the Company expired in December 1995 and the International Union of Operating Engineers, Stationary Local No. 39 whose contract with the Company expires in August 1996. The Sacramento distribution employees are represented by the Chauffeurs, Teamsters and Helpers Union, Local 150 whose contract with the Company expires in August 1999. The St. Louis distribution employees are represented by the United Food & Commercial Workers Union, Local 655 whose contract with the Company expires in December 1997. The expired union contract is currently under negotiation. The Company has never experienced a strike by any of its employees.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company owns its headquarters located at 5929 College Avenue in Oakland, California. The headquarters buildings include 54,000 square feet of office space utilized by the Company and 10,000 square feet of retail space leased to third parties.\nThe Company owns a manufacturing and distribution facility in Union City, California. This facility has approximately 60,000 square feet of manufacturing and dry storage space, 40,000 square feet of cold storage warehouse space and 15,000 square feet of office space. The plant has the current production capacity of 28 million gallons per year. During 1995, the facility produced approximately 19 million gallons of ice cream and related products.\nThe Company leases an ice cream manufacturing plant with an adjoining cold storage warehouse located in the City of Commerce, California. This facility has approximately 76,000 square feet of manufacturing and dry storage space, 25,000 square feet of cold storage space and 19,000 square feet of office space. The lease on this property, including renewal options, expires in 2022. The plant has the current production capacity of 20 million gallons per year. During 1995, the facility produced approximately 18 million gallons of ice cream and related products.\nIn 1994, the Company completed construction of a cold storage warehouse facility located on property acquired in the City of Industry, California. This facility includes 52,000 square feet of cold and dry storage warehouse space and 13,000 square feet of office space. This facility supplements the cold storage warehouse and office space leased in the City of Commerce.\nThe Company owns a manufacturing plant with an adjoining cold storage warehouse in Fort Wayne, Indiana. This facility has approximately 116,000 square feet of manufacturing and storage space and 6,000 square feet of office space. In addition, the Company leases approximately 55,000 square feet of cold storage and 8,000 square feet of office space near the Fort Wayne facility. The plant has the current production capacity of 50 million gallons per year. During 1995, the facility produced approximately 40 million gallons of ice cream and related products. The Company's original purchase and development of the Fort Wayne facility was financed by industrial development bonds and the property is pledged as collateral to secure payment of the Company's obligations to the issuer of the irrevocable letter of credit established for the benefit of the bondholders.\nSubsequent to year end, the Company completed the purchase of an additional manufacturing and distribution facility in Houston, Texas. This facility is being renovated and, upon completion, will have approximately 69,000 square feet of manufacturing and dry storage space, 46,000 square feet of cold storage warehouse space and 20,000 square feet of office space. At that time the plant's production capacity will be approximately 26 million gallons per year.\nThe Company intentionally acquires, designs and constructs its manufacturing and distribution facilities with a capacity greater than current needs require. This is done to facilitate growth and expansion and minimize future capital outlays. The cost of carrying this excess capacity is not significant.\nThe Company also leases or rents various local distribution and office facilities with leases expiring through the year 2011 (including options to renew).\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 Company's executive officers and their ages are as follows:\nAll officers hold office at the pleasure of the Board of Directors. There is no family relationship among the above officers.\nMr. Rogers has served as Dreyer's Chairman of the Board and Chief Executive Officer since its incorporation in February 1977.\nMr. Cronk has served as a director of the Company since its incorporation in February 1977 and has been the Company's President since April 1981.\nMr. Manwell has served as Secretary of the Company since its incorporation and as a director of the Company since April 1981. Since March 1982, Mr. Manwell has been a partner in the law firm of Manwell & Milton, general counsel to the Company.\nMr. Delaplane has served as Vice President -- Sales of the Company since May 1987.\nMr. Johnson has served as Vice President -- Marketing of the Company since May 1990.\nMr. Johnston has served as Vice President -- New Business of the Company since September 1995. From May 1988 to August 1995, he served as the Company's Director of Marketing.\nMr. Oldenburg has served as Vice President -- Operations of the Company since September 1986.\nMr. Woodland has served as Vice President -- Finance and Administration and Chief Financial Officer of the Company since September 1981 and as Assistant Secretary since December 1985.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe information set forth in Note 17 under the caption \"Price Range (NASDAQ)\" which appears on page 26 of this Form 10-K is incorporated herein by reference. The bid and asked quotations for the Company's Common Stock are as reported by NASDAQ.\nOn March 21, 1996, the number of holders of record of the Company's common stock was 4,098.\nThe Company paid a regular quarterly dividend of $.06 per share of common stock for each quarter of 1995. On March 5, 1996, the Board of Directors, subject to compliance with law, contractual restrictions and future review of the condition of the Company, declared its intention to issue regular quarterly dividends of $.06 per share of common stock for each quarter of 1996. Also on March 5, 1996, the Board of Directors declared a dividend of $.06 per share of common stock for the first quarter of 1996 for stockholders of record on March 29, 1996.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe information set forth under the caption \"Five Year Summary of Significant Financial Data\" which appears on page 27 of 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 set forth under the caption \"Management's Discussion and Analysis\" which appears on pages 28-30 of this Form 10-K 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 February 8, 1996, appearing on pages 14-26 of this Form 10-K 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\nThe information set forth under the captions \"Matters Submitted to the Vote of Stockholders -- Election of Directors\" and \"Compliance With Section 16(a) of the Securities Exchange Act of 1934\" in the Company's Proxy Statement for the 1996 Annual Meeting of Stockholders to be filed with the Commission on or before April 29, 1996, and the information contained in Part I of this Annual Report on Form 10-K under the caption \"Executive Officers of the Registrant,\" is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information set forth under the caption \"Executive Compensation\" in the Company's Proxy Statement for the 1996 Annual Meeting of Stockholders to be filed with the Commission on or before April 29, 1996 is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information set forth under the caption \"Security Ownership of Certain Beneficial Owners and Management\" in the Company's Proxy Statement for the 1996 Annual Meeting of Stockholders to be filed with the Commission on or before April 29, 1996 is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information set forth under the captions \"Compensation Committee Interlocks and Insider Participation\" and \"Certain Transactions\" in the Company's Proxy Statement for the 1996 Annual Meeting of Stockholders to be filed with the Commission on or before April 29, 1996 is incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES:\nThe following documents are filed as part of this report:\n(b) REPORTS ON FORM 8-K\nNot applicable.\n(c) EXHIBITS\n- ---------------\n(1) Incorporated by reference to designated exhibit to Dreyer's Grand Ice Cream, Inc.'s Registration Statement on Form S-1 and Amendment No. 1 thereto, filed under Commission File No. 2-71841 on April 16, 1981 and June 11, 1981, respectively.\n(2) Incorporated by reference to the designated exhibit to Dreyer's Grand Ice Cream, Inc.'s Annual Report on Form 10-K and Amendment No. 1 thereto for the fiscal year ended December 28, 1985 filed under Commission File No. 0-10259 on March 28, 1986 and April 14, 1986, respectively.\n(3) Incorporated by reference to the designated exhibit to Dreyer's Grand Ice Cream, Inc.'s Current Report on Form 8-K filed under Commission File No. 0-10259 on January 23, 1987.\n(4) Incorporated by reference to the designated exhibit to Dreyer's Grand Ice Cream, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1988 filed under Commission File No. 0-10259 on March 31, 1989.\n(5) Incorporated by reference to the designated exhibit to Dreyer's Grand Ice Cream, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 30, 1989 filed under Commission File No. 0-10259 on March 30, 1990.\n(6) Incorporated by reference to the designated exhibit to Dreyer's Grand Ice Cream, Inc.'s Current Report on Form 8-K filed under Commission File No. 0-10259 on March 20, 1991.\n(7) Incorporated by reference to the designated exhibit to Dreyer's Grand Ice Cream, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 29, 1990 filed under Commission File No. 0-10259 on March 29, 1991.\n(8) Incorporated by reference to the designated exhibit to Dreyer's Grand Ice Cream, Inc.'s Quarterly Report on Form 10-Q for the quarterly period ended on June 29, 1991 filed under Commission File No. 0-10259 on August 13, 1991.\n(9) Incorporated by reference to the designated exhibit to Dreyer's Grand Ice Cream, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 28, 1991 filed under Commission File No. 0-10259 on March 27, 1992.\n(10) Incorporated by reference to the designated exhibit to Dreyer's Grand Ice Cream, Inc.'s Quarterly Report on Form 10-Q for the quarterly period ended on September 26, 1992 filed under Commission File No. 0-10259 on November 10, 1992.\n(11) Incorporated by reference to the designated exhibit to Dreyer's Grand Ice Cream, Inc.'s Current Report on Form 8-K filed under Commission File No. 0-10259 on December 4, 1992.\n(12) Incorporated by reference to the designated exhibit to Dreyer's Grand Ice Cream, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 26, 1992 filed under Commission File No. 0-10259 on March 26, 1993.\n(13) Incorporated by reference to designated exhibit to Dreyer's Grand Ice Cream, Inc.'s Current Report on Form 8-K filed under Commission File No. 0-10259 on June 25, 1993.\n(14) Incorporated by reference to the designated exhibit to Dreyer's Grand Ice Cream, Inc.'s Quarterly Report on Form 10-Q for the quarterly period ended on June 26, 1993 filed under Commission File No. 0-10259 on August 10, 1993.\n(15) Incorporated by reference to the designated exhibit to Dreyer's Grand Ice Cream, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 25, 1993 filed under Commission File No. 0-14190 on March 25, 1994.\n(16) Incorporated by reference to the designated exhibit to Dreyer's Grand Ice Cream, Inc.'s Quarterly Report on Form 10-Q for the quarterly period ended March 26, 1994 filed under Commission File No. 0-14190 on May 10, 1994.\n(17) Incorporated by reference to the designated exhibit to Dreyer's Grand Ice Cream, Inc.'s Current Report on Form 8-K filed under Commission File No. 0-14190 on May 9, 1994.\n(18) Incorporated by reference to the designated exhibit to Dreyer's Grand Ice Cream, Inc.'s Quarterly Report on Form 10-Q for the quarterly period ended June 25, 1994 filed under Commission File No. 0-14190 on August 9, 1994.\n(19) Incorporated by reference to the designated exhibit to Dreyer's Grand Ice Cream, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1994 filed under Commission File No. 0-14190 on March 30, 1995.\n(20) Incorporated by reference to the designated exhibit to Dreyer's Grand Ice Cream, Inc.'s Quarterly Report on Form 10-Q for the quarterly period ended July 1, 1995 filed under Commission File No. 0-14190 on August 15, 1995.\n(21) Incorporated by reference to the designated exhibit to Dreyer's Grand Ice Cream, Inc.'s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1995 filed under Commission File No. 0-14190 on November 14, 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 28, 1996 DREYER'S GRAND ICE CREAM, INC.\nBy: \/s\/ PAUL R. WOODLAND ----------------------- (Paul R. Woodland) Vice President -- Finance and Administration, Chief Financial Officer and Assistant 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.\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:\nNot applicable.\nCONSOLIDATED STATEMENT OF INCOME\nSee accompanying Notes to Consolidated Financial Statements\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Stockholders of Dreyer's Grand Ice Cream, Inc.\nIn our opinion, the accompanying consolidated balance sheet and the related consolidated statements of income, of changes in stockholders' equity and of cash flows present fairly, in all material respects, the financial position of Dreyer's Grand Ice Cream, Inc. and its subsidiaries at December 30, 1995 and December 31, 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 30, 1995, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.\nPrice Waterhouse LLP San Francisco, California February 8, 1996\nCONSOLIDATED BALANCE SHEET\nASSETS\nSee accompanying Notes to Consolidated Financial Statements\nCONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY\nSee accompanying Notes to Consolidated Financial Statements\nCONSOLIDATED STATEMENT OF CASH FLOWS\nSee accompanying Notes to Consolidated Financial Statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1. OPERATIONS\nDreyer's Grand Ice Cream, Inc. and its subsidiaries (the Company) is a single segment industry company engaged primarily in the business of manufacturing and selling premium ice cream and other frozen dairy products to grocery and convenience stores, foodservice accounts and independent distributors in the United States.\nNOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nConsolidation\nThe consolidated financial statements include the accounts of Dreyer's Grand Ice Cream, Inc. and its subsidiaries. All material intercompany transactions have been eliminated.\nFiscal Year\nThe Company's fiscal year is a fifty-two or fifty-three week period ending on the last Saturday in December. Fiscal years 1995 and 1993 each consisted of fifty-two weeks and fiscal year 1994 consisted of fifty-three weeks.\nUse of Estimates\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions. These estimates and assumptions 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.\nFinancial Statement Presentation\nCertain reclassifications have been made to prior years' financial statements to conform to the 1995 presentation.\nCash Equivalents\nThe Company classifies financial instruments as cash equivalents if the original maturity of such investments is three months or less.\nInventories\nInventories are stated at the lower of cost (determined by the first-in, first-out method) or market. Cost includes materials, labor and manufacturing overhead.\nImpairment of Long-Lived Assets\nEffective as of the beginning of fiscal 1995, the Company adopted the provisions of Statement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of\" (SFAS 121), on a prospective basis. SFAS 121 requires the Company to review long-lived assets and certain identifiable intangibles, including goodwill and distribution rights, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The assessment of impairment is based on the estimated undiscounted future cash flows from operating activities compared with the carrying value of the assets. If the undiscounted future cash flows of an asset are less than the carrying value, a write-down would be recorded measured by the amount of the\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\ndifference between the carrying value of the asset and the fair value of the asset. The adoption of SFAS 121 did not have any effect on the Company's Consolidated Financial Statements.\nProperty, Plant and Equipment\nThe cost of additions and major improvements and repairs are capitalized, while maintenance and minor repairs are charged to expense as incurred. Depreciation of fixed assets is computed using the straight-line method over the assets' estimated useful lives, generally ranging from three to thirty-five years. Interest costs relating to capital assets under construction are capitalized.\nGoodwill and Distribution Rights\nGoodwill and distribution rights are amortized using the straight-line method over thirty to thirty-six years.\nProduct Formulations\nThe cost of product formulations purchased from others is amortized using the straight-line method over the period of minimum expected benefit, approximately twelve years.\nAdvertising Costs\nThe Company defers production costs for media advertising and expenses these costs in the period the advertisement is first run. All other advertising costs are expensed in the period incurred. Advertising expense, including consumer promotion spending, was $39,971,000, $40,287,000 and $11,486,000 in 1995, 1994 and 1993, respectively.\nIncome Taxes\nIncome taxes are accounted for using the liability method. Under this method, deferred tax liabilities and assets are recognized for the tax consequences of temporary differences between the financial reporting and tax basis of assets and liabilities.\nAccounting for Stock-Based Compensation\nIn October 1995, Statement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation,\" was issued which establishes accounting and reporting standards for stock-based compensation plans. The Company is required to adopt this standard in fiscal 1996. This standard encourages the adoption of the fair value-based method of accounting for employee stock options or similar equity instruments, but continues to allow the Company to measure compensation cost for those equity instruments using the intrinsic value-based method of accounting prescribed by Accounting Principles Board Opinion No. 25, \"Accounting for Stock Issued to Employees.\" Under the fair value-based method, compensation cost is measured at the grant date based on the value of the award. Under the intrinsic value-based method, compensation cost is the excess, if any, of the quoted market price of the stock at the grant date or other measurement date over the amount the employee must pay to acquire the stock. The Company intends to continue the use of the intrinsic value-based method. As a result, adoption of this standard will not have any effect to the Company's consolidated financial statements other than to require disclosure of the pro forma effect on net income of using the fair value-based method of accounting.\nNet (Loss) Income Per Common Share\nNet (loss) income per common share is computed using the weighted average number of shares of common stock outstanding during the period which were 13,285,000, 14,731,000, and 14,624,000 shares in 1995, 1994 and 1993, respectively. The potentially dilutive effect of the Company's redeemable convertible\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\npreferred stock, convertible subordinated debentures and other common stock equivalents was anti-dilutive for each fiscal year. Accordingly, fully diluted earnings per share are not presented.\nNOTE 3. INVENTORIES\nInventories at December 30, 1995 and December 31, 1994 consisted of the following:\nNOTE 4. PROPERTY, PLANT AND EQUIPMENT\nThe cost and accumulated depreciation of property, plant and equipment at December 30, 1995 and December 31, 1994 were as follows:\nInterest capitalized was $2,288,000, $1,788,000 and $1,271,000 in 1995, 1994 and 1993, respectively.\nDepreciation expense for property, plant and equipment was $16,412,000, $13,194,000 and $11,309,000 in 1995, 1994 and 1993, respectively.\nConstruction in progress at December 30, 1995 and December 31, 1994 included $19,046,000 and $19,265,000, respectively, of costs associated with the enhancement of management information systems.\nNOTE 5. DISTRIBUTION RIGHTS\nOn January 4, 1994, the Company entered into a long-term distribution agreement with Sunbelt Distributors, Inc. (Sunbelt), the leading independent direct-store-delivery ice cream distributor in Texas. Under the agreement, the Company paid Sunbelt $10,970,000 in cash to secure the long-term exclusive right to have its products distributed by Sunbelt in Texas and certain parts of Louisiana and Arkansas. In conjunction with this transaction, the Company recorded $11,321,000 in distribution rights, including $351,000 in transaction costs.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 6. INCOME TAXES\nThe (benefits) provisions for federal and state income taxes consisted of the following:\nThe deferred income tax liability as of December 30, 1995 and December 31, 1994 consisted of the following:\nThe federal statutory income tax rate is reconciled to the Company's effective income tax rate as follows:\nNOTE 7. EMPLOYEE BENEFIT PLANS\nThe Company maintains a defined contribution retirement plan for employees not covered by collective bargaining agreements. The plan provides retirement and other benefits based upon the assets of the plan held by the trustee. The Company contributes 7% of the eligible participants' annual compensation to the plan. The Company also maintains a salary deferral plan under which it may make a matching contribution of a percentage of each participant's deferred salary amount.\nPension expense and matching contributions under these plans were approximately $7,202,000, $5,776,000, and $4,035,000 in 1995, 1994 and 1993, respectively. The Company's liability for accrued pension contributions and salary deferrals was $7,186,000 and $5,996,000 at December 30, 1995 and December 31, 1994, respectively.\nPension expense for employees covered by multi-employer retirement plans under collective bargaining agreements was $848,000, $677,000, and $586,000 in 1995, 1994 and 1993, respectively.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 8. DESCRIPTION OF LEASING ARRANGEMENTS\nThe Company conducts certain of its operations from leased facilities, which include land and buildings, production equipment, and certain vehicles. All of these leases are classified as operating leases and expire over a period of twenty-seven years including renewal options. Certain of these leases include non-bargain purchase options.\nThe minimum rental payments required under non-cancelable operating leases at December 30, 1995 are as follows:\nRental expense for operating leases was $12,824,000, $11,474,000, and $9,804,000 in 1995, 1994, and 1993, respectively.\nNOTE 9. LONG-TERM DEBT\nLong-Term Debt\nLong-term debt at December 30, 1995 and December 31, 1994 consisted of the following:\nThe aggregate annual maturities of long-term debt as of December 30, 1995 are as follows:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDuring 1995, the Company entered into a new credit agreement with certain banks for a total revolving line of credit of $175,000,000. This agreement replaced the Company's previous revolving line of credit agreement. The total available line of credit decreases by $25,000,000 on December 31, 1997 and December 31, 1998, and expires on December 31, 1999. This line is available at three different interest rate options which are defined as the agent bank's offshore rate, same day funding rate, plus an applicable margin, or the agent bank's reference rate. At December 30, 1995, there was $111,700,000 outstanding under the line.\nConvertible Subordinated Debentures\nIn June 1993, the Company issued in a private placement $100,752,000 of 6 1\/4% convertible subordinated debentures, due June 30, 2001. These debentures were converted into redeemable convertible Series B preferred stock during 1995. (See Note 10.)\nFair Value of Financial Instruments\nAs of December 30, 1995 and December 31, 1994, the fair value of the Company's long-term debt was determined to be the same as the carrying amount. The fair value was based on quoted market prices for the same or similar issues or on the current rates offered to the Company for a term equal to the same remaining maturities. It is not practicable to estimate the fair value of the redeemable convertible Series B preferred stock due to the unique terms and conditions of these securities. (See Note 10.)\nThe Company is subject to the requirements of various financial covenants, including dividend restrictions, under its long-term debt obligations and the redeemable convertible Series B preferred stock.\nNOTE 10. REDEEMABLE CONVERTIBLE SERIES B PREFERRED STOCK\nOn August 8, 1995, the Company converted $100,752,000 of 6 1\/4% convertible subordinated debentures into 1,008,000 shares of redeemable convertible Series B preferred stock (Series B), redeemable on June 30, 2001. On the conversion date, $2,538,000 of unamortized debenture issuance costs were charged against the carrying value of the debentures to arrive at the carrying value of $98,214,000 for this preferred stock. The Company is recording accretion to increase the carrying value to the redemption value of $100,752,000 by June 30, 2001, the redemption date.\nThe Series B preferred stock is convertible, under certain conditions, into a total of 1,008,000 shares of Series A Convertible Preferred Stock (Series A), redeemable on June 30, 2001. Additionally, both the Series A preferred stock and Series B preferred stock are convertible, under certain conditions, at an initial conversion price of $34.74 into a total of 2,900,000 shares of common stock. Series B preferred stock can be called by the Company for early redemption, subject to certain limitations.\nIn preference to shares of common stock, shares of both the Series A preferred stock and the Series B preferred stock are entitled to receive cumulative cash dividends, payable quarterly in arrears. The Company pays dividends for the Series B preferred stock of approximately $1,143,000 per quarter. Dividends on the Series A preferred stock are payable at a dividend rate equal to the amount they would receive as if the shares were converted into comparable shares of common stock.\nNOTE 11. COMMON STOCK\nThe Company paid a regular quarterly dividend of $.06 per share for each quarter of 1995, 1994 and 1993.\nDuring 1987, the Board of Directors declared a dividend of one Preferred Stock Purchase Right (the Rights) for each outstanding share of common stock. Under certain conditions, the Rights become exercisable for the purchase of the Company's preferred or common stock.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNestle Equity Issuance\nOn June 14, 1994, The Company completed a transaction (the \"Nestle Agreement\") with an affiliate of Nestle USA, Inc. (\"Nestle\"), whereby Nestle purchased 3,000,000 newly issued shares of common stock of the Company for $32 per share and warrants to purchase an additional 2,000,000 shares at an exercise price of $32 per share. Warrants for 1,000,000 shares will expire on June 14, 1997 and warrants for the other 1,000,000 shares will expire on June 14, 1999. Nestle paid an aggregate of $10,000,000 for the 2,000,000 warrants. Total proceeds from the issuance of the initial 3,000,000 shares and the 2,000,000 warrants were $106,000,000. In connection with the Nestle Agreement, the Company incurred transaction costs of $3,513,000 which were recorded as a charge against capital in excess of par.\nThe Company has the right to cause Nestle to exercise the warrants at $24 per share subject to certain conditions at any time before June 14, 1997. The Company also has the right to cause Nestle to exercise the warrants at any time through the warrant expiration dates at $32 per share if the average trading price of the common stock exceeds $60 during a 130 trading day period preceding the exercise, subject to certain conditions. Furthermore, if the average trading price of the common stock equals or exceeds $60 during a 130 trading day period before June 14, 1999, Nestle will be required to pay an additional $2 for each share purchased and each share purchased upon exercise of the warrants.\nIn connection with the Nestle Agreement, the Company entered into a distribution agreement with Nestle Ice Cream Company to distribute Nestle's frozen novelty and ice cream products in certain markets.\nCommon Stock Repurchases\nDuring 1995, the Company repurchased and retired 1,291,000 shares of its common stock at prices ranging from $25.38 to $34.25 through open market purchases and negotiated transactions thereby completing the plan implemented in 1994 to repurchase up to 5,000,000 shares of common stock (the Stock Repurchase Plan). In addition, the Company repurchased and retired 28,000 shares of its common stock at prices ranging from $24.50 to $38.50 from employees who previously acquired shares under employee stock plans.\nDuring 1994, the Company repurchased and retired 3,709,000 shares of its common stock at prices ranging from $21.38 to $25.75 per share under the Stock Repurchase Plan. In addition, the Company repurchased and retired 44,000 shares of its common stock at prices ranging from $22.00 to $28.69 per share from employees who previously acquired shares under employee stock plans.\nSince the beginning of fiscal 1994, the Company charged the excess over par value for shares repurchased to capital in excess of par rather than the previous practice of charging the excess to retained earnings.\nNOTE 12. SIGNIFICANT CUSTOMERS\nFor fiscal 1995, 1994 and 1993, no customer accounted for more than 10% of consolidated net sales.\nNOTE 13. EMPLOYEE STOCK PLANS\nThe Company has three stock option plans under which options may be granted for the purchase of the Company's common stock at a price not less than 100% of the fair market value at the date of grant. The incentive stock option plan (the 1982 Plan) provides that options are not exercisable until after two years from the date of grant and generally expire six years from the date of grant. The non-qualified stock option plan (the 1992 Plan) provides that options are not exercisable until after two years from the date of grant and expire upon death or termination of employment. In 1994, the stockholders approved a stock option plan (the 1993 Plan) under which granted options may be either incentive stock options or non-qualified stock options. This plan provides that options expire no later than ten years from the date of grant. This plan also provides that most of the terms of the options, such as vesting, are within the discretion of the compensation committee,\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\ncomprising of certain members of the Board of Directors of the Company. Changes in stock options under all three plans in the aggregate were as follows:\nAt December 30, 1995, options to purchase 277,000 shares of the Company's common stock were exercisable.\nThe Company has two plans under which employees may purchase shares of the Company's common stock: the section 423 employee stock purchase plan (the 423 Plan) and the employee secured stock purchase plan (the Secured Plan). Under the 423 Plan, employees may authorize payroll deductions up to 10% of their compensation for the purpose of acquiring shares at 85% of the market price determined at the beginning of a specified twelve month period. Under this plan, employees purchased 40,000 shares at prices ranging from $20.29 to $21.67 per share in 1995, 20,000 shares at prices ranging from $20.61 to $23.16 per share in 1994, and 25,000 shares at prices ranging from $16.69 to $29.75 per share in 1993. Under the Secured Plan, on specified dates, employees may purchase shares at fair market value by paying 20% of the purchase price in cash and the remaining 80% of the purchase price in the form of a non-recourse promissory note with a term of 30 years. Under this plan, employees purchased 23,000 shares at prices ranging from $25.38 to $39.50 per share in 1995, 27,000 shares at prices ranging from $24.25 to $25.13 per share in 1994, and 10,000 shares at prices ranging from $22.50 to $27.25 per share in 1993.\nNOTE 14. INVESTMENT IN AFFILIATE\nThe Company's 49.7% ownership of M-K-D Distributors, Inc. (MKD), a company engaged in manufacturing and direct-store-distribution of ice cream in the states of Washington, Oregon, Utah and Alaska, is accounted for under the equity method. The investment included in other assets, is stated at cost adjusted for the Company's equity in undistributed earnings and was $5,517,000 and $4,738,000 at December 30, 1995 and December 31, 1994, respectively. The Company's equity in the earnings of MKD were $779,000, $1,063,000, and $695,000 in 1995, 1994, and 1993, respectively. The Company's sales of its branded products to MKD were $25,174,000, $22,583,000, and $18,360,000 in 1995, 1994 and 1993, respectively.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nSummarized financial information for MKD at December 30, 1995 and December 31, 1994, was as follows:\nNOTE 15. CONTINGENCIES\nThe Company is engaged in various legal actions as both plaintiff and defendant. Management believes that the outcome of these actions, either individually or in the aggregate, will not have a material adverse effect on the Company's financial position or results of operations.\nNOTE 16. SUBSEQUENT EVENTS\nOn February 2, 1996, the Company signed a letter of intent to purchase the remaining 50.3% of the outstanding common stock of MKD. After the purchase, the Company will own 100% of the outstanding common stock of MKD.\nSeparately, the Company is in the process of negotiating an agreement for the private placement of $50,000,000 of senior notes.\nNOTE 17. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)\n- --------------- (1) Fully diluted net (loss) income per share for each quarter of 1995 and 1994 is equivalent to primary net (loss) income per share since the potentially dilutive effect of the redeemable convertible Series B preferred stock, convertible subordinated debentures and warrants was anti-dilutive.\n(2) The number of weighted average shares outstanding used in the computation of net (loss) income per common share increases and decreases as shares are issued or repurchased during the year. For this reason, the sum of net (loss) income per common share for the quarters may not be the same as the net (loss) income per common share for the year.\nFIVE YEAR SUMMARY OF SIGNIFICANT FINANCIAL DATA\n- ---------------\n(1) Fully diluted net (loss) income per share for each fiscal year is equivalent to primary net (loss) income per share. In 1995 the potentially dilutive effect of the stock warrants and redeemable convertible Series B preferred stock was anti-dilutive, in 1994 the potentially dilutive effect of the stock warrants and the convertible subordinated debentures was anti-dilutive, in 1993 the potentially dilutive effect of the convertible subordinated debentures was anti-dilutive, and in 1992 and 1991 no potentially dilutive securities were outstanding.\n(2) Includes the cumulative effect of change in method of accounting for income taxes of $1,721,000, or $.11 per share.\nMANAGEMENT'S DISCUSSION AND ANALYSIS RESULTS OF OPERATIONS\nFiscal 1995 Compared with Fiscal 1994\nThe Company embarked on a five year plan (the Strategic Plan) during the second quarter of 1994 to accelerate the sales of its brand throughout the country. This plan includes three primary strategies: 1) a quadrupling of advertising and consumer promotion spending, 2) rapid expansion and development of the Company's direct-store-delivery system, and 3) introduction of innovative new products. As originally announced, the Company anticipated that the cost of implementing the Strategic Plan would materially reduce earnings during the fiscal years of 1994 and 1995. In fact, these development activities resulted in a net income of $1,001,000 for 1994, as compared with net income of $16,789,000 in 1993, and a net loss of $1,524,000 for 1995.\nOne of the potential benefits of the Strategic Plan is increased market share above those levels that would have been attained under the former business plan. In response to the Strategic Plan, dollar market share grew from 11.7% at the end of 1994 to 13.4% for the fourth quarter of 1995. Consolidated net sales for fiscal 1995 increased 20% (net sales increased 23% when adjusting for 52 weeks in fiscal 1995 and 53 weeks in 1994) to $678,797,000 from the $564,372,000 achieved in 1994. Sales of the Company's branded products increased 20% in all markets. This growth was led by Dreyer's and Edy's Fat Free Ice Cream and Grand Ice Cream as well as the new products of Low Fat Ice Cream and the revitalized Sherbet line introduced in 1995. Sales of branded products purchased from other companies (partner brands) increased 22%, led by sales of frozen novelty and ice cream products from Nestle Ice Cream Company introduced in 1995. Sales of partner brands represented 34% of consolidated net sales in both 1995 and 1994.\nDuring 1995, the Company expanded its direct-store-delivery system into 16 new markets. The expenses associated with this expansion effort were the primary cause of a decrease in gross margin from 24.0% in 1994 to 21.8% for 1995, resulting in a 24%, or $101,782,000, increase in cost of goods sold over 1994. The gross margin was affected to a lesser extent by the Company's continued development of its new Grand Soft business including significantly enhanced manufacturing, equipment service, and financing capabilities.\nAdvertising and consumer promotion spending continued at the annual rate of approximately $40,000,000 during 1995. The Strategic Plan anticipates continued expenditures at approximately this level of marketing spending during a period of increasing sales. The Company increased its level of trade promotion spending during 1995 by approximately $14,000,000 due principally to the initial introduction of the Company's products in new markets. This increase in promotion spending was the primary factor in the $16,145,000 growth in selling, general, and administrative expenses between 1994 and 1995. The Company regularly monitors its levels of advertising and promotion spending in an effort to enhance long-term profitability. Interest expense increased $669,000, or 7%, principally due to higher borrowings under the Company's revolving line of credit.\nIn addition to increased market share, the potential benefits of the Strategic Plan include future earnings in excess of those levels that would have been achieved in the absence of this plan. The Company anticipates an improvement in earnings during 1996 and that the earnings benefits expected under the Strategic Plan will be achieved in 1997 and future years. However, no assurance can be given that these expectations relative to future market share and earnings benefits of the strategy will be achieved. The success of the strategy will depend upon, among other things, consumer purchase responsiveness to the increased marketing expenditures, competitors' marketing responses, market conditions affecting the price of the Company's products, commodity costs, and efficiencies achieved in manufacturing and distribution operations.\nFiscal 1994 Compared with Fiscal 1993\nIn the first partial year of the implementation of the Strategic Plan, the Company's consolidated net sales for 1994 increased 20% (net sales increased 18% when adjusting for 53 weeks in fiscal 1994 and 52 weeks in 1993) to $564,372,000, compared with $470,665,000 in 1993. Driven by substantially higher advertising and consumer promotion spending in the Strategic Plan, sales of the Company's branded products increased 22%.\nDreyer's and Edy's Frozen Yogurt and Grand Ice Cream led this increase followed by the contribution from the Company's new novelty products. The increase in sales of Healthy Choice(R) low fat ice cream from ConAgra, Inc. was the primary factor in a partner brand sales increase of 12% over the prior year. Partner brands represented 34% of consolidated net sales as compared to 36% in 1993.\nCost of goods sold increased $72,542,000, or 20%, over 1993. Gross margin, however, decreased slightly from 24.3% to 24.0% primarily due to the additional expenses associated with introducing the Company's product line and expansion of the distribution system in the Texas and New England markets as well as in several cities in the southern United States. The effect of these expenses on gross margin was partially offset by a higher proportion of Company products, which carry a higher margin than partner brands.\nThe implementation of the Strategic Plan required an increase in overall marketing expenses of $40,501,000, leading to a 59%, or $47,166,000, increase in selling, general and administrative expenses over those incurred in 1993. Interest expense was $1,440,000, or 18%, higher than in 1993 due primarily to the issuance of the convertible subordinated debentures in the second quarter of 1993. (See Note 9 of Notes to Consolidated Financial Statements.)\nAs anticipated and announced, the implementation of the Strategic Plan detailed above resulted in a net income of $1,001,000 for 1994 as compared with $16,789,000 for 1993.\nFiscal 1993 Compared with Fiscal 1992\nA 27% increase in the sales of Company brands was the primary factor in the growth of consolidated net sales from $407,045,000 in 1992 to $470,665,000 in 1993, representing a 16% increase. The improvement was generated principally by established products and the introduction of Dreyer's and Edy's Ice Cream Bars and Tropical Fruit Bars. Partner brand sales represented 36% of consolidated sales as compared with 42% for 1992.\nThe higher proportion of Dreyer's and Edy's products in the sales mix was the primary cause of the increase in gross margin from 22.7% in 1992 to 24.3% in 1993, resulting in a 13%, or $41,475,000, increase in cost of goods sold over 1992. In addition to this improvement in the sales mix, the gross margin was benefited by lower manufacturing costs per unit offset in part by higher distribution expenses.\nSelling, general and administrative expenses were $14,329,000, or 22%, higher than in 1992 resulting primarily from an increase in marketing expenses in an effort to enhance the Company's long-term competitive position and increase its market share. Interest expense was $2,570,000, or 49%, higher than in 1992 due largely to the issuance of the previously mentioned convertible subordinated debentures. (See Note 9 of Notes to Consolidated Financial Statements.)\nPrice Increases\nThe effect of price increases for both Company and partner brands was not significant for each of the comparative periods.\nTax Provisions\nThe Company's income tax provisions differ from the expected tax provisions calculated at the federal statutory tax rate primarily due to the reversal of income taxes provided in prior periods and state income taxes. (See Note 6 of Notes to Consolidated Financial Statements.)\nSeasonality\nThe Company experiences more demand for its products during the spring and summer than during the fall and winter. (See Note 17 of Notes to Consolidated Financial Statements.)\nEffects of Inflation and Changing Prices\nManagement believes that the effects of inflation and changing prices are successfully managed, with both margins and earnings being protected through a combination of cost control programs and productivity\ngains. The largest component of the Company's cost of production is raw materials, principally dairy products and sugar. Historically, the Company has been able to compensate for increases in the price level of these commodities through manufacturing and distribution productivity gains. Other cost increases such as labor and general and administrative costs have also been offset by productivity gains and other operating efficiencies.\nLiquidity and Capital Resources\nWorking capital at December 30, 1995 was $20,958,000 higher than at year-end 1994 due primarily to increases in trade accounts receivable and other accounts receivable.\nWorking capital at December 31, 1994 was $8,994,000 lower than at year-end 1993 due primarily to increases in trade accounts payable and accrued liabilities, and accrued payroll and employee benefits.\nWorking capital at December 25, 1993 was $31,629,000 higher than at year-end 1992 due primarily to the decrease in short-term bank borrowings.\nRefer to the Consolidated Statement of Cash Flows for the components of increases and decreases in cash and cash equivalents for the three-year period ended December 30, 1995.\nThe Company's inventory is maintained at the same general level relative to sales throughout the year by changing production and purchasing schedules to meet demand. The ratio of inventory to sales typically does not vary significantly from year to year.\nOn August 8, 1995, the Company converted $100,752,000 of 6 1\/4% convertible subordinated debentures into 1,008,000 shares of redeemable convertible Series B preferred stock, redeemable on June 30, 2001. (See Note 10 of Notes to Consolidated Financial Statements.)\nOn June 14, 1994, the Company completed a transaction with an affiliate of Nestle USA, Inc., whereby Nestle purchased 3,000,000 newly issued shares of common stock of the Company for $32 per share and warrants to purchase an additional 2,000,000 shares at an exercise price of $32 per share. Total proceeds from the issuance of the initial 3,000,000 shares and the 2,000,000 warrants was $106,000,000. (See Note 11 of Notes to Consolidated Financial Statements.)\nDuring 1995, the Company repurchased and retired 1,291,000 shares of its common stock at prices ranging from $25.38 to $34.25 through open market purchases and negotiated transactions thereby completing the plan implemented in 1994 to repurchase up to 5,000,000 shares of common stock (the Stock Repurchase Plan).\nDuring 1994, the Company repurchased and retired 3,709,000 shares of its common stock at prices ranging from $21.38 to $25.75 per share under the Stock Repurchase Plan. (See Note 11 of Notes to Consolidated Financial Statements.)\nOn February 2, 1996, the Company signed a letter of intent to purchase the remaining 50.3% of the outstanding common stock of M-K-D Distributors, Inc. (MKD), a company engaged in manufacturing and direct-store-distribution of ice cream in the states of Washington, Oregon, Utah and Alaska. After the purchase, the Company will own 100% of the outstanding common stock of MKD.\nSeparately, the Company is in the process of negotiating an agreement for the private placement of $50,000,000 of senior notes.\nOn January 4, 1994, the Company entered into a long-term distribution agreement with Sunbelt Distributors, Inc., the leading direct-store-delivery ice cream distributor in Texas. (See Note 5 of Notes to Consolidated Financial Statements.)\nCapital expenditures for property, plant and equipment in 1996 are currently estimated to be approximately $64,000,000, primarily for the expansion of manufacturing capacity and the construction of distribution facilities. It is anticipated that these additions will be largely financed through internally generated funds and borrowings. As of year-end 1995, the Company had $3,051,000 in cash and cash equivalents, and an unused credit line of $63,300,000. The Company believes that its credit line, along with its liquid resources, internally generated cash and financing capacity are adequate to meet anticipated operating and capital requirements.\nREPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE\nTo the Board of Directors of Dreyer's Grand Ice Cream, Inc.\nOur audits of the consolidated financial statements referred to in our report dated February 8, 1996 appearing on page 14 of this 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 San Francisco, California February 8, 1996\nSCHEDULE II\nDREYER'S GRAND ICE CREAM, INC.\nVALUATION AND QUALIFYING ACCOUNTS (IN THOUSANDS)\n- ---------------\n(1) Write-off of receivables considered uncollectible.\n(2) Removal of fully-amortized assets.\nEXHIBIT INDEX","section_15":""}
{"filename":"313563_1995.txt","cik":"313563","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"Item 2. Exercise of Voting Rights. -------------------------\nThe Voting Trustees did not exercise voting rights under the Voting Trust Agreement during the fiscal year with respect to any matter, except that the Voting Trustees voted the shares of Common Stock held by them in favor of the election of 15 directors.\nItem 3.","section_3":"Item 3. Exercise of Other Powers. ------------------------\nThe Voting Trustees exercised no powers under the Voting Trust Agreement, other than voting rights and the distribution of dividends upon the underlying securities, during the fiscal year.\nItem 4.","section_4":"Item 4. Ownership of Voting Trust Certificates and Other Securities. -----------------------------------------------------------\nThe following table presents information, as of March 27, 1996, as to Voting Trust Certificates owned of record or beneficially by each Voting Trustee. As of March 27, 1996, no Voting Trustee owned any securities of Graybar other than those deposited under the Voting Agreement nor any securities of Graybar's subsidiaries. No other person owns of record, or is known by the Voting Trustees to own beneficially, more than five percent of the Voting Trust Certificates.\nItem 5.","section_5":"Item 5. Business Experience of Voting Trustees. --------------------------------------\nThe information with respect to the business experience of the Voting Trustees required to be included pursuant to this Item 5 will be included under the caption \"Directors and Executive Officers--Nominees for Election as Directors\" in Graybar's Information Statement relating to the 1996 Annual Meeting of Shareholders (the \"Information Statement\"), to be filed with the Commission pursuant to Rule 14(c)-5 under the Securities Exchange Act of 1934, and is incorporated herein by reference.\nItem 6.","section_6":"Item 6. Business and Professional Connection of Voting ---------------------------------------------- Trustees with Issuer, Affiliates and Underwriters. -------------------------------------------------\nThe information with respect to the business and professional connections of each Voting Trustee with Graybar and any of its affiliates will be included under the caption \"Directors and Executive Officers -- Nominees for Election as Directors\" in the Information Statement and is incorporated herein by reference.\nItem 7.","section_7":"Item 7. Other Activities of Voting Trustees. -----------------------------------\nExcept as described in this Annual Report, the Voting Trustees did not perform any other activities during the fiscal year.\nItem 8.","section_7A":"","section_8":"Item 8. Representation of Other Persons by Voting Trustees. --------------------------------------------------\nThe Voting Trustees represented no persons other than holders of Voting Trust Certificates during the fiscal year.\nItem 9.","section_9":"Item 9. Remuneration of Voting Trustees. -------------------------------\nThe following table presents information as to the aggregate remuneration received by each Voting Trustee for services in all capacities during the fiscal year from Graybar and its subsidiaries. No Voting Trustee received any remuneration from any person or persons for acting as Voting Trustee.\nItem 12.","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"Item 12. Lists of Exhibits Filed. -----------------------\n(4) Instruments defining the rights of security holders, including indentures.\nThe Voting Trust Agreement dated as of April 15, 1987, attached as Annex A to the Prospectus, dated January 20, 1987, constituting a part of the Registration Statement on Form S-13 (Registration No. 2-57861), is incorporated herein by reference.\nSIGNATURES\nPursuant to the requirements of the Securities Exchange Act of 1934, as amended, this Annual Report on Form 10-K, amended as prescribed by the Commission, has been signed below by the following persons, as Voting Trustees, as of March 27, 1996, said Trustees being invested with the power to bind all of the Voting Trustees.\nAs trustees under the Voting Trust Agreement dated as of April 15, 1987.\nBy \/S\/ C. L. HALL --------------------------------------- C. L. HALL\n\/S\/ R. H. HANEY --------------------------------------- R. H. HANEY\n\/S\/ G. W. HARPER --------------------------------------- G. W. HARPER\n\/S\/ R. L. MYGRANT --------------------------------------- R. L. MYGRANT\n\/S\/ R. D. OFFENBACHER --------------------------------------- R. D. OFFENBACHER","section_13":"","section_14":"","section_15":""}
{"filename":"39899_1995.txt","cik":"39899","year":"1995","section_1":"Item 1. Business. Form 10-K Information (Annual Report pp. 49-59); Note 10 - Business Segment Information (Annual Report pp. 44-45).\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties. Properties (Annual Report pp. 53, 54, 56, 58 and 59); Corporate Facilities (Annual Report p. 59); Markets We Serve (Annual Report pp. 64-66).\nItem 3.","section_3":"Item 3. Legal Proceedings. Note 9 - Commitments, Contingent Liabilities and Other Matters (Annual Report pp. 43-44); Regulation (Annual Report p. 53).\nItem 4.","section_4":"Item 4. Submission of Matters Not Applicable. to a Vote of Security Holders.\nPart II\nItem 5.","section_5":"Item 5. Market for Registrant's Gannett Shareholder Services Common Equity and (Annual Report, inside back cover); Company Profile (Annual Report, inside Related Stockholder front cover); Matters Gannett Common Stock Prices (Annual Report p. 22); Dividends (Annual Report p. 31).\nItem 6.","section_6":"Item 6. Selected Financial Eleven-Year Summary and Notes Data. to Eleven-Year Summary (Annual Report pp. 46-48).\nItem 7.","section_7":"Item 7. Management's Discussion Management's Discussion and and Analysis of Analysis Financial Condition and of Results of Operations and Results of Operations. Financial Position (Annual Report pp. 23-31).\n- 3 -\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements Consolidated Financial and Supplementary Data. Statements and Notes to Consolidated Financial State- ments (Annual Report pp. 32-45). Effects of Inflation and changing prices (Annual Report p. 31); Quarterly Statements of Income (Annual Report p. 61).\nItem 9.","section_9":"Item 9. Changes in and None. Disagreements with Accountants on Accounting and Financial Disclosure.\nPart III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Executive Officers of the Officers of the Company are listed Registrant. below:\nDenise H. Bannister - Group President, Gannett Gulf Coast Newspaper Group, and President and Publisher, Pensacola News Journal. Sara M. Bentley - Group President, Gannett Northwest Newspaper Group, and President and Publisher, Statesman Journal. Thomas L. Chapple - Senior Vice President, General Counsel, and Secretary. Richard L. Clapp - Senior Vice President, Personnel. Susan Clark-Johnson - Senior Group President, Gannett Pacific Newspaper Group, and President and Publisher, Reno (Nev.) Gazette-Journal. Michael J. Coleman - Senior Group President, Gannett South Newspaper Group, and President and Publisher, FLORIDA TODAY at Brevard County. John J. Curley - Chairman, President, and Chief Executive Officer. Thomas Curley - President and Publisher, USA TODAY. Philip R. Currie - Senior Vice President, News, Gannett Newspaper Division. Donald W. Davidson - President, Gannett Outdoor Group. Gerard R. DeFrancesco - President, Gannett Radio. Millicent A. Feller - Senior Vice President, Public Affairs and Government Relations. Lawrence P. Gasho - Vice President, Financial Analysis. George R. Gavagan - Vice President, Corporate Accounting Services. John B. Jaske - Senior Vice President, Labor Relations and Assistant General Counsel. Bern Mebane - Senior Group President, Gannett Piedmont Newspaper Group. Douglas H. McCorkindale - Vice Chairman, and Chief Financial and Administrative Officer. Larry F. Miller - Senior Vice President, Financial Planning, and Controller. W. Curtis Riddle - Senior Group President, Gannett East Newspaper Group, and President and Publisher, Wilmington (Delaware) News Journal.\n- 4 -\nCarleton F. Rosenburgh - Senior Vice President, Gannett Newspaper Division. Gary F. Sherlock - Group President, Gannett Atlantic Newspaper Group, and President and Publisher, Gannett Suburban Newspapers. Mary P. Stier - Group President, Gannett Midwest Newspaper Group, and President and Publisher, Rockford Register Star. Jimmy L. Thomas - Senior Vice President, Financial Services and Treasurer. Ronald Townsend - President, Gannett Television. Cecil L. Walker - President, Gannett Broadcasting. Gary L. Watson - President, Gannett Newspaper Division. Susan V. Watson - Vice President, Investor Relations.\nInformation concerning the Executive Officers of the Company is included in the Annual Report on pages 18 through 20. Information concerning the Board of Directors of the Company is incorporated by reference to the Company's Proxy Statement pursuant to General Instruction G(3) to Form 10-K.\nItem 11.","section_11":"Item 11. Executive Compensation. Incorporated by reference to the Company's Proxy Statement pursuant to General Instruction G(3) to Form 10-K.\nItem 12.","section_12":"Item 12. Security Ownership of Incorporated by Certain reference to the Beneficial Owners and Company's Proxy Statement Management. pursuant to General Instruction G(3) to Form 10-K.\nItem 13.","section_13":"Item 13. Certain Relationships Incorporated by and reference to the Related Transactions. Company's Proxy Statement pursuant to General Instruction G(3) to Form 10-K.\n- 5 -\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.\nThe following financial statements of the Company and the accountants' report thereon are included on pages 32 through 45 of the Company's 1995 Annual Report to Shareholders and are incorporated herein by reference:\nConsolidated Balance Sheets as of December 31, 1995 and December 25, 1994.\nConsolidated Statements of Income - Fiscal Years Ended December 31, 1995, December 25, 1994, and December 26, 1993.\nConsolidated Statements of Cash Flows - Fiscal Years Ended December 31, 1995, December 25, 1994, and December 26, 1993.\nConsolidated Statements of Changes in Shareholders' Equity - Fiscal Years Ended December 31, 1995, December 25, 1994, and December 26, 1993.\nNotes to Consolidated Financial Statements.\nReport of Independent Accountants.\n(2) Financial Statement Schedules.\nThe following financial statement schedules are incorporated by reference to \"Schedules to Form 10-K Information\" appearing on pages 62 through 63 of the Company's 1995 Annual Report to Shareholders:\nSchedule V - Property, Plant and Equipment.\nSchedule VI - Accumulated Depreciation and Amortization of Property, Plant and Equipment.\n- 6 -\nSchedule VIII - Valuation and Qualifying Accounts.\nSchedule X - Supplementary Income Statement Information.\nThe Report of Independent Accountants on Financial Statement Schedules appears on page 8 of this Annual Report on Form 10-K.\nNote: Financial statements of the registrant are omitted as the registrant is primarily an operating company and the aggregate of the minority interest in and the debt of consolidated subsidiaries is not material in relation to total consolidated assets. All other schedules are omitted as the required information is not applicable or the information is presented in the consolidated financial statements or related notes.\n(3) Pro Forma Financial Information.\nNot Applicable.\n(4) Exhibits.\nSee Exhibit Index for list of exhibits filed with this Annual Report on Form 10-K. Management contracts and compensatory plans or arrangements are identified with asterisks on the Exhibit Index.\n(b) Reports on Form 8-K.\nA Current Report on Form 8-K dated December 5, 1995 was filed in connection with the acquisition of Multimedia, Inc.\n- 7 -\nREPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULES\nTo the Board of Directors and Shareholders of Gannett Co., Inc.\nOur audits of the consolidated financial statements referred to in our report dated February 6, 1996 appearing on page 45 of the 1995 Annual Report to Shareholders of Gannett Co., 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\nWashington, D.C. February 6, 1996\n- 8 -\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the 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 20, 1996 GANNETT CO., INC. (Registrant)\nBy \/s\/Douglas H. McCorkindale -------------------------- Douglas H. McCorkindale, Vice Chairman, and Chief Financial and Administrative 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.\nDated: February 20, 1996 \/s\/John J. Curley ----------------- John J. Curley, Director, and Chairman, President and Chief Executive Officer\nDated: February 20, 1996 \/s\/Douglas H. McCorkindale -------------------------- Douglas H. McCorkindale, Director, and Vice Chairman, and Chief Financial and Administrative Officer\nDated: February 20, 1996 \/s\/Larry F. Miller ------------------ Larry F. Miller, Senior Vice President, Financial Planning, and Controller\nDated: February 20, 1996 \/s\/Andrew F. Brimmer -------------------- Andrew F. Brimmer, Director\n- 9 -\nDated: February 20, 1996 \/s\/Meredith A. Brokaw --------------------- Meredith A. Brokaw, Director\nDated: February 20, 1996 \/s\/Rosalynn Carter ------------------ Rosalynn Carter, Director\nDated: February 20, 1996 \/s\/Peter B. Clark ----------------- Peter B. Clark, Director\nDated: February 20, 1996 \/s\/Stuart T.K. Ho ----------------- Stuart T.K. Ho, Director\nDated: February 20, 1996 \/s\/Drew Lewis ------------- Drew Lewis, Director\nDated: February 20, 1996 \/s\/Josephine P. Louis --------------------- Josephine P. Louis, Director\nDated: February 20, 1996 \/s\/Rollan D. Melton ------------------- Rollan D. Melton, Director\nDated: February 20, 1996 \/s\/Thomas A. Reynolds, Jr. -------------------------- Thomas A. Reynolds, Jr., Director\nDated: February 20, 1996 --------------------------- Carl T. Rowan, Director\nDated: February 20, 1996 \/s\/Dolores D. Wharton --------------------- Dolores D. Wharton, Director\n- 10 -\nEXHIBIT INDEX\nExhibit Number Exhibit Location - ------- ----------------------------- ---------------------------------- 2-1 Agreement and Plan of Incorporated by reference to Merger dated as of July 24, Exhibit 99 to 1995 between Gannett Co., Gannett Co., Inc.'s Form 8-K and Multimedia, Inc. filed on July 26, 1995.\n3-1 Second Restated Certificate Incorporated by reference to of Incorporation of Gannett Exhibit 3-1 to Co., Inc. Gannett Co., Inc's Form 10-K for the fiscal year ended December 26, 1993 (\"1993 Form 10-K\").\nAmendment to Restated Incorporated by reference to Exhibit 3-1 the 1993 Form 10-K. Certificate of Incorporation.\n3-2 By-laws of Gannett Co., Inc. Incorporated by reference to Exhibit 3-2 to the 1993 Form 10-K.\n4-1 $1,000,000,000 Revolving Incorporated by reference to Exhibit Credit Agreement among 4-1 to the 1993 Form 10-K. Gannett Co., Inc. and the Banks named therein.\n4-2 Amendment Number One Incorporated by reference to to $1,000,000 Revolving Exhibit 4-2 Credit Agreement among to Gannett Co., Inc.'s Form 10-Q Gannett Co., Inc. and the for the fiscal quarter ended Banks named therein. June 26, 1994.\n4-3 Amendment Number Two to Attached. $1,500,000,000 Revolving Credit Agreement among Gannett Co., Inc. and the Banks named therein.\n- 11 -\n4-4 Indenture dated as of March 1, Incorporated by reference to Exhibit 4-2 1983 between Gannett Co., Inc. to Gannett Co., Inc.'s Form 10-K for the and Citibank, N.A., as Trustee. fiscal year ended December 29, 1985.\n4-5 First Supplemental Indenture Incorporated by reference to dated as of November 5, 1986 Exhibit 4 to among Gannett Co., Inc., Gannett Co., Inc.'s Form 8-K filed on Citibank, N.A., as Trustee, and November 9, 1986. Sovran Bank, N.A., as Successor Trustee.\n4-6 Rights Plan. Incorporated by reference to Exhibit 1 to Gannett Co.,Inc.'s Form 8-K filed on May 23, 1990.\n10-1 Employment Agreement dated Incorporated by reference to Gannett December 7, 1992 between Co., Inc.'s Form 10-K for the fiscal Gannett Co., Inc. and John J. year ended December 27, 1992 Curley.* (\"1992 Form 10-K\").\n10-2 Employment Agreement dated Incorporated by reference to the 1992 December 7, 1992 between Form 10-K. Gannett Co., Inc.and Douglas H. McCorkindale.*\n10-3 Agreement dated January 5, Incorporated by reference to 1995 between Gannett Tele- Gannett Co., Inc.'s Form 10-K vision and CTR Productions. for the fiscal year ended December 25, 1994.\n10-4 Gannett Co., Inc. 1978 Incorporated by reference to Executive Long-Term Incentive Exhibit 10-3 to Plan.* Gannett Co., Inc.'s Form 10-K for the fiscal year ended December 28, 1980. Amendment No. 1 incorporated by reference to Exhibit 20-1 to Gannett Co., Inc.'s Form 10-K for the fiscal year ended December 27, 1981. Amendment No. 2 incorporated by reference to Exhibit 10-2 to Gannett Co., Inc.'s Form 10-K for the fiscal year ended December 25, 1983. Amendments Nos. 3 and 4 incorporated by reference to Exhibit 4-6 to Gannett Co., Inc.'s Form S-8 Registration Statement No. 33-28413 filed on May 1, 1989. Amendments Nos. 5 and 6 incorporated by reference to Exhibit 10-8 to Gannett Co., Inc.'s Form 10-K for the fiscal year ended December 31, 1989.\n- 12 -\n10-5 Description of supplemental Incorporated by reference to insurance benefits.* Exhibit 10-4 to the 1993 Form 10-K.\n10-6 Gannett Co., Inc. Supplemental Incorporated by reference to Exhibit Retirement Plan, as amended.* 10-8 to Gannett Co., Inc's Form 10-K for the fiscal year ended December 27,1986 (\"1986 Form 10-K\").\n10-7 Gannett Co., Inc. Retirement Incorporated by reference to Exhibit Plan for Directors.* 10-10 to the 1986 Form 10-K. 1991 Amendment incorporated by reference to Exhibit 10-2 to Gannett Co., Inc.'s Form 10-Q for the quarter ended September 29, 1991. 1995 Amendments attached in Exhibit 10-7.\n10-8 Gannett Co., Inc. 1987 Incorporated by reference to Deferred Compensation Plan, Exhibit 10-8 as restated.* to the 1993 Form 10-K.\n10-9 Gannett Co., Inc. Transitional Incorporated by reference to Exhibit Compensation Plan.* 10-13 to Gannett Co., Inc.'s Form 10-K for the fiscal year ended December 30, 1990.\n11 Statement re computation of Attached. earnings per share.\n13 Portions of 1995 Annual Report Attached. to Shareholders incorporated by reference.\n21 Subsidiaries of Gannett Co., Attached. Inc.\n23 Consent of Independent Attached. Accountants.\n27 Financial Data Schedule. Attached.\nThe Company agrees to furnish to the Commission, upon request, a copy of each agreement with respect to long-term debt not filed herewith in reliance upon the exemption from filing applicable to any series of debt which does not exceed 10% of the total consolidated assets of the Company.\n* Asterisks identify management contracts, and compensatory plans or arrangements.\n- 13 -","section_15":""}
{"filename":"833079_1995.txt","cik":"833079","year":"1995","section_1":"ITEM 1. BUSINESS Introduction\nHomeplex Mortgage Investments Corporation (the \"Company\") makes short-term and intermediate- term mortgage loans on improved and unimproved real property (\"Real Estate Loans\") and owns Mortgage Assets as described herein. In 1993, the Company decided to shift its focus to making Real Estate Loans from the ownership of Mortgage Assets consisting of Mortgage Interests (commonly known as residual interests) and Mortgage Instruments. Mortgage Instruments include residential mortgage loans (\"Mortgage Loans\") and mortgage certificates representing interest in pools of residential mortgage loans (\"Mortgage Certificates\"). Mortgage Interests represent the right to receive the net cash flows (\"Net Cash Flows\") on Mortgage Instruments. Substantially all of the Company's Mortgage Instruments and the Mortgage Instruments underlying the Company's Mortgage Interests currently secure or underlie mortgage-collateralized bonds (\"CMOs\" or \"Bonds\"), mortgage pass-through certificates (\"MPCs\" or \"Pass-Through Certificates\") or other mortgage securities (collectively \"Mortgage Securities\") issued by various Mortgage Securities issuers (\"Issuers\").\nThe Company does not currently plan to acquire any additional Mortgage Assets. Instead, the Company plans in the short-term to utilize its available funds to make or acquire additional Real Estate Loans and to implement its acquisition strategy as described herein. At December 31, 1995 the Company had outstanding three Real Estate Loans aggregating $4,048,000, each with a loan term of one year and an interest rate of 16.00% per annum. The Company plans to emphasize land acquisition and development loans, residential land development loans, single family residential construction loans, commercial land development loans, and interim construction and bridge loans. The Real Estate Loans have been concentrated in Arizona.\nThe Company's strategy is to utilize available funds and equity to acquire one or more operating companies, which may include one or more entries engaged in the home-building business. The Company's management is currently reviewing a number of operating companies for potential acquisition.\nThe Company was incorporated in the State of Maryland in May 1988 and commenced operations on July 27, 1988. The Company changed its name from Emerald Mortgage Investments Corporation to Homeplex Mortgage Investments Corporation in April 1990.\nThe Company has elected to be taxed as a real estate investment trust (\"REIT\") pursuant to Sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the \"Code\"). The Company generally will not be subject to tax on its income to the extent that it distributes its earnings to stockholders and maintains its qualification as a REIT. See \"Business -- Federal Income Tax Considerations.\" The Company may consider electing to discontinue its qualification as a REIT for tax purposes as a result of its substantial tax-loss carryforward and its acquisition strategy. If such a determination were made, the Company would be taxed as a regular domestic corporation and, among other consequences, any distributions to the Company's stockholders will not be deductible by the Company in computing its taxable income.\nThe Company's Common Stock is listed on the New York Stock Exchange. Unless the context otherwise requires, the term the Company means Homeplex Mortgage Investments Corporation and its subsidiaries.\nReference is made to \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" for certain recent information with respect to the the Company.\nBusiness\nReal Estate Loans General\nThe Company makes or acquires short-term and intermediate-term Real Estate Loans. A short-term loan generally has a maturity of one year or less and an intermediate-term loan generally has a maturity of not more than three years. Such loans are expected to consist primarily of first mortgage loans, development loans, interim construction loans, bridge loans, and to a much lesser extent, junior mortgage loans and wrap-around mortgage loans.\nThe Company may make or acquire development or interim construction loans on unimproved real properties which are either expected to be developed within a reasonable period of time, generally less than one year, into income-producing properties, are being subdivided into lots for resale, or are being held for resale by the borrowers. Certain of the other loans to be made by the Company may be made on a first mortgage basis on the security of apartment complexes, shopping centers, warehouses, office buildings and other commercial and industrial properties, and as bridge loans on completed income- producing projects during leasing activities. The Company also may make or acquire junior mortgage loans and wrap-around mortgage loans, although such Real Estate Loans are not expected to represent a significant portion of the Company's Real Estate Loan portfolio.\nThe Company's Real Estate Loans may be made on both large and small properties and in various combinations and may incorporate a variety of financing techniques. There are no limitations on the types of properties on which the Company may make or acquire loans. The Company's Real Estate Loans will provide for regular debt service payments, normally consisting of interest only with repayment of principal on maturity or earlier as the result of contractual provisions requiring balloon payments of principal. The Company also may make or acquire loans on the security of apartments or office buildings with repayment to be derived from the conversion of the properties to condominiums and the sale of units.\nIn general, the amount of each Real Estate Loan made by the Company will not exceed at the date the loan is funded, when added to the amount of any existing senior indebtedness, (i) 95% of the Company's assessment of the value of the property in the case of improved income-producing property or unimproved real property and (ii) 90% of the Company's assessment of the value of the property on the assumption that construction or development, as the case may be, is completed substantially in accordance with the plans and specifications as of the date the loan commitment is provided, in the case of construction or development loans. Such loan-to-value ratio may be increased in the case of a specific Real Estate Loan if, in the judgment of the Company, the Real Estate Loan is supported by credit or collateral adequate to justify a higher ratio. The Company may make Real Estate Loans to borrowers that acquire properties for prices below their appraised values. Thus, the loan-to-cost ratios of certain of the Company's Real Estate Loans may exceed the loan-to-value ratios described above. As a result, loans by the Company may not be limited to the purchase price of a property.\nThe Company's Real Estate Loans generally provide for fixed interest rates although it may make or acquire loans which float with changes in the prime rate or other benchmark interest rates. Interest rates on Real Estate Loans will be determined by taking into account a variety of factors including the prevailing interest rate in the area for the type of loan being considered, the proposed term of the loan, the loan-to-value ratio, and the creditworthiness of the borrower and any guarantors. See \"Special Considerations -- Real Estate Loans\" for additional information respecting Real Estate Loans.\nCurrent Real Estate Loans\nThe following table sets forth information relating to the Company's outstanding Real Estate Loans at December 31, 1995.\nIn the latter half of 1995 in anticipation of a potential acquisition transaction, the Company slowed its origination of Real Estate Loans.\nTypes of Real Estate Loans In furtherance of its objectives, the Company may make and acquire a wide variety of Real Estate Loans. In connection with certain of the Company's Real Estate Loans, a portion of the Company's return could be in the form of deferred interest payments, accruing in each year of the loan but payable only on repayment of the loan. Such deferred interest may accrue at a fixed rate over the term of a loan or may accrue at a faster rate in the later period of a loan. In either case, the present value of deferred interest is less than it would be if received currently.\nThe types of Real Estate Loans which the Company may make or acquire include the following.\nFirst Mortgage Loans. First mortgage loans will be secured by first mortgages on the fee or a leasehold interest in improved income-producing real property and generally will provide for repayment in full prior to the end of the amortization period. Such loans will be in an amount which generally will not exceed 95% of the Company's assessment of value of the property.\nLand Loans. Land loans are first or junior mortgage loans on unimproved real property normally providing only for interest payments prior to maturity. Such loans are made on properties held by borrowers for inventory, investment or development purposes and generally are expected to be repaid from the proceeds of the resale of the properties. As a result and due in addition to the absence of cash flow, such loans normally are considered more risky than loans on improved property. The maximum loan-to-value ratio will generally not exceed 90% of the Company's assessment of the value of the property.\nDevelopment Loans. Development loans are mortgage loans made to finance or refinance the acquisition of unimproved land and the costs of developing such land into finished sites, including the installation of utilities, drainage, sewerage and road systems. Such loans are expected to be repaid from the proceeds of construction loans or the sale of the developed sites. The Company will not normally require the borrower to have a commitment for a construction or long-term mortgage loan on the developed property. In some instances, the Company may receive an equity participation or other interest in connection with the property being developed. The original term of any development loan made by the Company generally will not exceed three years, and the maximum loan-to-value ratio generally will not exceed 90% of the Company's assessment of the value of the property on the assumption that development is completed substantially in accordance with the plans and specifications as of the date the loan commitment is provided.\nConstruction Loans. Construction loans are mortgage loans made to finance the acquisition of land and the erection of improvements thereon, such as residential subdivisions, apartment complexes, shopping centers, office buildings, and commercial and industrial buildings. Such loans generally have maturities of less than three years and usually provide for higher yields than those prevailing on long-term mortgage loans on comparable properties. Disbursements by the Company under construction loan commitments will be related to actual construction progress. Before a construction loan is made or acquired, the Company, in most cases, will either require that the borrower have a commitment from a responsible financial institution for financing upon completion or will itself have made the determination that such a loan is readily available or unnecessary. In some cases, the Company may receive an equity participation or other interest in connection with the property being constructed. Construction loans will be in amount which generally will not exceed 90% of the Company's assessment of value of the property on the assumption that construction is completed substantially in accordance with the plans and specifications as of the date the loan commitment is provided. Construction loans made to finance single family tract developments or condominiums generally will be repaid from proceeds of the sale of completed residential units.\nJunior Mortgage Loans. Junior mortgage loans will be secured by mortgages which are subordinate to one or more prior liens on the fee or a leasehold interest in real property and generally, but not in all cases, will provide for repayment in full prior to the end of the amortization period. Such loans will be in an amount which, when added to the amount of prior liens, generally will not exceed 90% of the Company's assessment of the value of the property.\nWrap-Around Mortgage Loans. Wrap-around mortgage loans are expected to be made or acquired by the Company on real property which is already subject to prior mortgage indebtedness in an amount which, when added to the amount of prior indebtedness, generally will not exceed 90% of the Company's assessment of the value of the property. A wrap-around loan is a junior mortgage loan having a principal amount equal to the sum of the outstanding balance under the existing mortgage loans plus the amount actually advanced under the wrap-around mortgage loan. Under a wrap-around mortgage loan, the Company would make principal and interest payments to the holders of the prior mortgage loans but ordinarily only to the extent that payments are received from the borrower. The Company expects to negotiate all wrap-around mortgage loans so that the borrowers' payments to be made to the Company will equal or exceed the amount of the Company's principal and interest payments on the underlying loans.\nThe Company also is permitted to invest in agreements for sale, which for the most part are governed by contract law but generally provide a statutory method for foreclosure. In addition, the Company is permitted to acquire Real Estate Loans secured by other comparable security devices as permitted by applicable state law.\nIn those types of loans described above, the Company generally receives as security for its loan a deed of trust or mortgage on the property financed. Loans generally will be made on a nonrecourse basis by which recourse will be limited to the real properties on which the loans have been made so that in the event of default the Company would be required to rely on the value of such real property to protect its interests. In other instances, the Company's Real Estate Loans will be made on a full recourse basis so that the borrower will be liable for any deficiency in the event that proceeds of a foreclosure or trustee's sale were insufficient to repay the loan. In connection with any loans to a corporation or other non- individual borrower, the Company may require that the loan be personally guaranteed by the borrower's principal individual owners. In addition, the Company may purchase or otherwise acquire participations or fractional interests in Real Estate Loans which are originated by parties that are not affiliated with the Company or may retain participations or fractional interests in such loans which the Company has originated and a portion of which have been acquired by parties that are not affiliated with the Company. In such cases, the Company may not have control over the loan or the unrestricted right to institute foreclosure proceedings. Except for the personal guarantees of a borrower's owners, it is not intended that any loan will be guaranteed or insured.\nStandards for Real Estate Loans\nIn making or acquiring a Real Estate Loan, the Company considers various relevant real property and financial factors including the value of the property underlying the loan as security, the location and other aspects of the property, the potential for development of the property within one to three years, the income-producing capacity and quality of the property, the rate and terms of the loan (including the discount from the face amount of the note that can be obtained giving consideration to current interest rates and the Company's overall portfolio) and the quality, experience and creditworthiness of the borrower. The Company will calculate internal rates of return in reviewing the terms and purchase discount that can be obtained.\nAlthough the Company generally receives a deed of trust or mortgage on the financed property as security for each Real Estate Loan, it may use other security devices from time to time. In most cases, recourse for a Real Estate Loan will be limited to the real property securing the loan.\nThe Company will not make or acquire a Real Estate Loan on any one property if the aggregate amount of all senior mortgage loans outstanding on the property plus the loan of the Company would exceed an amount equal to 95% of the value of the property as determined by the Company. The Company may lend additional funds to the borrower if the outstanding principal amount plus any outstanding senior indebtedness encumbering the property and additional advances does not exceed 95% of the value of the underlying property at the time the Real Estate Loan is made or at the time of any new appraisal.\nIn general, the Company will make or acquire Real Estate Loans in amounts ranging from a minimum of $300,000 to a maximum of $5,000,000.\nThe Company may obtain a current independent appraisal for a property on which it plans to make or acquire a Real Estate Loan, the cost of which usually will be paid by the borrower. The Company also may require, among other things, a survey and an aerial photograph of the property underlying each Real Estate Loan. The Company, however, generally relies on its own analysis and not on appraisals and other documents in determining whether to make or acquire a particular loan. It should be noted that appraisals are estimates of value and should not be relied upon as measures of true worth or realizable value. The Company will require that the borrower obtain a mortgagee's or owner's title insurance policy or commitment as to the priority of a mortgage or the condition of title be obtained in connection with each Real Estate Loan. The Company also will require public liability insurance naming the Company as an additional insured for claims arising on or about each underlying property when making a Real Estate Loan and, to the extent permitted by the existing loan documents, when acquiring a Real Estate Loan. Such liability insurance will be for suitable amounts as determined by the Company, but to the extent that a borrower incurs uninsured liabilities or liabilities in excess of the applicable coverage, such liabilities may adversely affect the borrower's ability to repay the Real Estate Loan.\nIn some cases, the Company may attempt to obtain equity participations in connection with making Real Estate Loans. Participations are designed to provide the potential for a higher return when such equity participations are deemed by management to be in the best interests of the Company. Such a participation is expected to be in the form of additional interest based upon items such as gross receipts from the property securing the loan in excess of certain levels or appreciation in the value of the property on whose security the Company has made the Real Estate Loan based upon either sales price or increases in value. There can be no assurance, however, that any Real Estate Loans will be structured in this manner or that any such loans will provide enhanced yields.\nIn determining whether to make or acquire a Real Estate Loan, the Company also will review the borrower's ability to repay the loan. Despite such review, the ability of a borrower to repay the principal amount of a loan will depend primarily upon the borrower's ability to obtain sufficient funds to pay the outstanding principal balance of the Real Estate Loan by refinancing, sale or other disposition of the property underlying the Real Estate Loan. See \"Real Estate Loan Considerations -- Balloon Payments -- Sufficiency of Collateral.\"\nThe Company will invest in agreements for sale or real estate contracts of sale only if such contracts are in recordable form and are appropriately recorded in the chain of title.\nMaturity of Loans\nThe Company expects that its Real Estate Loans generally will provide for payment of interest only during their term and for repayment of principal in full at maturity, generally within one to two years after funding. The Company plans to reinvest the proceeds which are received by it upon loan repayments.\nThe Company believes its policy of making and acquiring short-term and intermediate-term Real Estate Loans will enable it to reinvest loan repayment proceeds in new loans and thus to vary its portfolio more quickly in response to changing economic, financial and investment conditions than would be the case if the Company were to make long-term Real Estate Loans.\nBorrowing Policies\nThe Company has a line of credit from a financial institution primarily to increase the amount of the Real Estate Loans that it is able to make or acquire and to increase its potential returns. Under a revolving line of credit agreement with a bank, the Company may borrow up to $5,000,000, upon payment of a 1\/2 % commitment fee with interest payable monthly at prime plus 1\/2 %. Such advances are to be secured by certain of the Company's Real Estate Loans with the amount advanced equal to between 40% to 60% of the principal amount of the Real Estate Loans pledged. Only Real Estate Loans approved by the bank are eligible for advances. The agreement contains certain financial covenants and expires on May 5, 1996. Through December 31, 1995, the Company has not drawn upon the line of credit. No assurance can be given that such line of credit will be renewed. In the event that any portion of an outstanding line of credit is not renewed, the Company will be required to reevaluate its reserve requirements and review its portfolio for possible disposition of Real Estate Loans.\nThe Company also may incur indebtedness in order to meet expenses of holding any property on which the Company has theretofore made a Real Estate Loan and has subsequently taken over the operation of the underlying property as a result of default or to protect a Real Estate Loan. In addition, the Company may incur indebtedness in order to complete development of a property on which the Company has theretofore made a development or land loan and has subsequently taken over the operation of the underlying property as a result of default. The Company also may utilize a line of credit in order to prevent default under senior loans or to discharge them entirely if this becomes necessary to protect the Company's Real Estate Loans. Such borrowing may be required if foreclosure proceedings are instituted by the holder of a mortgage loan that is senior to that held by the Company.\nThe amount and terms and conditions of any line of credit will affect the profitability of the Company and the funds that will be available to satisfy its obligations. Interest will be payable on a line of credit regardless of the profitability of the Company. The Company's ability to increase its return through borrowings will depend in part upon the Company's ability to generate income from its borrowed funds based upon the difference between the Company's return on investment from such borrowed funds and the interest rate charged by its lender for the funds. Adverse economic conditions could increase defaults by borrowers on the Real Estate Loans and could impact the Company's ability to make its loan payments to its lenders. Adverse economic conditions could also increase the Company's borrowing costs and cause the terms on which funds become available to be unfavorable. In such circumstances, the Company could be required to liquidate some of its loans at a significant loss.\nThe Company may pledge Real Estate Loans as security for any borrowing. In addition, any property acquired by the Company upon default and foreclosure of any Real Estate Loan may be pledged as collateral for a line of credit.\nRemedies Upon Default by Borrower\nReal Estate Loans are subject to the risk of default, in which event the Company would have the added responsibility of foreclosing and protecting its loans. In the state of Arizona, where all of the Company's Real Estate Loans have been made, the Company will have a choice of two alternative and mutually exclusive remedies in the event of default by a borrower with respect to a Real Estate Loan\nsecured by a deed of trust. In such case, the Company either can proceed to cause the trustee under the deed of trust to exercise its power of sale under the deed of trust and sell the collateral at a non-judicial sale or it can choose to have the deed of trust judicially foreclosed as if it were a mortgage. In the event of default by a borrower with respect to a Real Estate Loan secured by a mortgage, the Company will have no election of remedies and will be required to foreclose the mortgage judicially. Remedies in other states in which the Company may acquire or make Real Estate Loans could vary significantly from those available in Arizona.\nIn Arizona, mortgages must be foreclosed judicially. A judicial foreclosure is usually a time consuming and potentially expensive undertaking. Under judicial foreclosure proceedings, the borrower does not have a right to reinstate the loan and can only cure its default by either paying the entire accelerated sum owing under the note before the judicial sale or by redeeming the property within six months after the date of the judicial sale.\nThe major advantage of a deed of trust is that Arizona law permits the beneficiary of a deed of trust to foreclose the deed of trust as a mortgage through judicial proceedings or by a non-judicial trustee's sale. A non-judicial trustee's sale conducted under the power of sale provided to the trustee usually is more expedient and less expensive than a judicial foreclosure and may be held any time after 90 days from the date of recording of the trustee's notice of sale. Furthermore, unlike a judicial foreclosure, there is no redemption period following a non-judicial sale. The major disadvantage of a deed of trust is the significantly greater reinstatement rights granted to a borrower. Before a trustee's sale, the borrower under a deed of trust has a right to reinstate the contract and deed of trust as if no breach or default had occurred by payment of the entire amount then due, plus costs and expenses, reasonable attorney's fees actually incurred, the recording fee for a cancellation of notice of sale and the trustee's fee. The accelerated portion of the loan balance need not be paid in order to reinstate. As a result, a borrower could repeatedly be in default under a deed of trust and use its right to reinstate the loan under successive non-judicial sale proceedings. Nonetheless, the borrower's right to reinstate a deed of trust without payment of the accelerated portion of the loan balance can be cut off upon the filing of an action to judicially foreclose the deed of trust as a mortgage.\nIn the case of both judicial and non-judicial foreclosure, if a proceeding under the Bankruptcy Code is commenced by or against a person or other entity having an interest in the real property that secures payment of the loan, then the foreclosure will be prevented from going forward until authorization to foreclose is obtained from the Bankruptcy Court. During the period when the foreclosure is stayed by the Bankruptcy Court, it is possible that payments, including payments from any interest reserve account, may not be made on the loan if so ordered by the Bankruptcy Court. The length of time during which the foreclosure is delayed as a result of the bankruptcy, and during which the payments may not be made, is indefinite. In addition, under the Bankruptcy Code, the Bankruptcy Court may render a portion of the loan unsecured if it determines that the value of the real property that secures payment of the loan is less than the balance of the loan and, under other circumstances, may modify or otherwise impair the lien of the lender in connection with the defaulted mortgage or deed of trust.\nThe Company will have the right to bid on and purchase the property underlying a Real Estate Loan at a foreclosure or trustee's sale following a default by the borrower. If the Company is the successful bidder and purchases a property underlying a Real Estate Loan, the Company's return on such Real Estate Loan will depend upon the amount of cash or other funds that can be realized by selling or otherwise disposing of the property. There can be no assurance that the Company will be able to sell such a property on terms favorable to the Company particularly as the result of real estate market conditions. Recent conditions in real estate loan markets have affected the availability and cost of real estate loans, thereby making real estate financing difficult and costly to obtain and impeding the ability of real estate owners to sell their properties at favorable prices. Such conditions may adversely affect the ability of the Company to sell the property securing a Real Estate Loan in the event that the Company deems it in the best interests of the Company to foreclose upon and purchase the property. To the extent that the funds\ngenerated by such actions are less than the amounts advanced by the Company for such Real Estate Loan, the Company may realize a loss of all or part of the principal and interest on the loan. Thus, there can be no assurance that the Company will not experience financial loss upon a default by a borrower.\nTransactions with Affiliates and Joint Venture Investments\nThe Company does not intend to make Real Estate Loans to affiliates.\nThe Company may enter into joint ventures, general partnerships and loan participations with third parties for the purpose of acquiring or making Real Estate Loans in accordance with the Company's investment policies. Any such investments will be made consistently with the then existing Securities and Exchange Commission interpretations and case law respecting the applicability of the Investment Company Act.\nOwnership of Underlying Real Estate\nThe Company will make or acquire Real Estate Loans for investment or make or acquire Real Estate Loans primarily for sale or other disposition in the ordinary course of business. The Company may be required to engage in real estate operations if, among other things, the Company forecloses on a property on which it has made or acquired a Real Estate Loan and takes over management of the property. Since the ownership of equity interests in real estate underlying a Real Estate Loan is not an objective of the Company, such operations would only be conducted for a limited period pending sale of the properties so acquired.\nOwnership of Mortgage Assets\nThe Company owns Mortgage Assets as described herein consisting of Mortgage Interests (commonly known as \"residuals\") and Mortgage Instruments. Mortgage Instruments consist of mortgage certificates representing interests in pools of residential mortgage loans (\"Mortgage Certificates\").\nMortgage Interests entitle the Company to receive Net Cash Flows (as described below) on Mortgage Instruments securing or underlying Mortgage Securities and are treated for federal income tax purposes as interests in real estate mortgage investments conduits (\"REMICs\") under the Code. Substantially all of the Company's Mortgage Instruments and the Mortgage Instruments underlying the Company's Mortgage Interests currently secure or underlie mortgage-collateralized bonds (\"CMOs\" or \"Bonds\"), mortgage pass-through certificates (\"MPCs\" or \"Pass-Through Certificates\") or other mortgage securities (collectively \"Mortgage Securities\").\nThe Company's Mortgage Assets generate net cash flows (\"Net Cash Flows\") which result primarily from the difference between (i) the cash flows on Mortgage Instruments (including those securing or underlying various series of Mortgage Securities as described herein) together with reinvestment income thereon and (ii) the amount required for debt service payments on such Mortgage Securities, the costs of issuance and administration of such Mortgage Securities and other borrowing and financing costs of the Company. The revenues received by the Company are derived from the Net Cash Flows received directly by the Company as well as any Net Cash Flows received by subsidiaries of the Company and paid to the Company as dividends and any Net Cash Flows received by trusts in which the Company has a beneficial interest to the extent of distributions to the Company as the owner of such beneficial interest. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nMortgage Certificates consist of fully-modified pass-through mortgage-backed certificates guaranteed by GNMA (\"GNMA Certificates\"), mortgage participation certificates issued by FHLMC (\"FHLMC Certificates\"), guaranteed mortgage pass-through certificates issued by FNMA (\"FNMA Certificates\") and certain other types of mortgage certificates and mortgage-collateralized obligations (\"Other Mortgage Certificates\").\nMortgage Securities consisting of CMOs and MPCs typically are issued in series. Each such series generally consists of several serially maturing classes secured by or representing interests in Mortgage Instruments. Generally, payments of principal and interest received on the Mortgage Instruments (including prepayments on such Mortgage Instruments) are applied to principal and interest payments on\none or more classes of the CMOs or MPCs. Scheduled payments of principal and interest on the Mortgage Instruments and other collateral are intended to be sufficient to make timely payments of interest on such CMOs or MPCs and to retire each class of such CMOs or MPCs by its stated maturity or final payment date. The Company also finances its Mortgage Assets in long-term structured obligations involving borrowings or other credit arrangements secured by Mortgage Instruments or Mortgage Interests owned by the Company.\nCurrent Mortgage Assets\nAs of December 31, 1995, the Company owned approximately $52,310,000 in principal amount of Mortgage Instruments which have been pledged in a long-term financing transaction. As of December 31, 1995, the Company also owned Mortgage Interests with respect to seven separate series of Mortgage Securities with a net amortized cost balance of approximately $5,445,000 (representing the aggregate purchase price paid for such Mortgage Interests less the amount of distributions on such Mortgage Interests received by the Company representing a return of investment).\nThe Company owns Mortgage Interests which entitle it to receive the Net Cash Flows on the Mortgage Instruments pledged to secure the following four series of Bonds: (i) the Series 1 Mortgage- Collateralized Bonds issued by Westam Mortgage Financial Corporation (\"Westam\") (the \"Series 1 Bonds\" or \"Westam 1\"), (ii) the Series 3 Mortgage-Collateralized Bonds issued by Westam (the \"Series 3 Bonds\" or \"Westam 3\"), (iii) the Series 65 Mortgage-Collateralized Bonds issued by American Southwest Financial Corporation (\"ASW\") (the \"Series 65 Bonds\" or \"ASW 65\") and (iv) the Series 5 Mortgage-Collateralized Bonds issued by Westam (the \"Series 5 Bonds\" or \"Westam 5\"). Each of these series of Bonds are CMOs, and an election has been made to treat the Mortgage Instruments and other collateral securing such series of Bonds as REMICs.\nThe Company also owns the residual interest in the REMIC with respect to the Series 17 Multi-Class Mortgage Participation Certificates (Guaranteed) (\"FHLMC 17\") issued by the Federal Home Loan Mortgage Corporation (\"FHLMC\") and 20.20% and 45.07%, respectively, of the residual interests in the REMICs with respect to the FNMA REMIC Trust 1988-24 Guaranteed REMIC Pass-Through Certificates (\"FNMA 24\") and the FNMA REMIC Trust 1988-25 Guaranteed REMIC Pass-Through Certificates (\"FNMA 25\") issued by the Federal National Mortgage Association (\"FNMA\"). An election has been made to treat the Mortgage Instruments and other collateral underlying each of the above series of Mortgage Securities as REMICs. The Company has not purchased any Mortgage Interests since October 26, 1988.\nAll of the series described above collectively are referred to herein as the \"Outstanding Mortgage Securities.\" For purposes of the remainder of this section only, \"Bonds,\" \"Pass-Through Certificates,\" \"Mortgage Securities,\" \"Net Cash Flows\" and \"Mortgage Instruments\" refer to the Bonds issued by ASW and Westam, the Pass-Through Certificates issued by FHLMC and FNMA, the Outstanding Mortgage Securities, the Net Cash Flows generated by the Mortgage Instruments securing or underlying the Specified Mortgage Securities, and the Mortgage Instruments securing or underlying the Outstanding Mortgage Securities, respectively. Unless otherwise specified, information as to the Outstanding Mortgage Securities is as of their respective closing dates.\nThe Outstanding Mortgage Securities were issued during the period from April 29, 1988 through October 26, 1988 in an aggregate original principal amount of $2,700,200,000, and all are collateralized by or represent interests in Mortgage Instruments.\nThe Mortgage Instruments Securing or Underlying the Outstanding Mortgage Securities\nThe Mortgage Instruments pledged as collateral for the Bonds are beneficially owned by the Issuers of such Bonds, and the Company owns the residual interests in the REMICs with respect to the Bonds. The Mortgage Instruments contained in the pools underlying the Pass-Through Certificates are beneficially owned by the holders of the Pass-Through Certificates (including the holders of the residual interests relating thereto), and the Company owns 100%, 20.20% and 45.07% of the residual interest in the REMICs with respect to FHLMC 17, FNMA 24 and FNMA 25, respectively. The Mortgage Instruments securing or underlying the Mortgage Securities consist of mortgage-backed certificates guaranteed by\nGNMA (\"GNMA Certificates\"), mortgage participation certificates issued by FHLMC (\"FHLMC Certificates\") and guaranteed mortgage pass-through certificates issued by FNMA (\"FNMA Certificates\"). As of December 31, 1995, the GNMA Certificates had an aggregate principal balance of $196,990,000, the FHLMC Certificates had an aggregate principal balance of $59,874,000 and the FNMA Certificates had an aggregate principal balance of $137,665,000.\nThe following table sets forth the remaining principal balances, the weighted average pass-through rates, the weighted average mortgage coupon rates and the weighted average remaining terms to maturity of the Mortgage Instruments pledged as collateral for each series of Bonds or contained in the pool underlying each series of Pass-Through Certificates. The information presented in the table was provided to the Company by the respective Issuer of each series of Mortgage Securities. The Company did not issue such Mortgage Securities and is relying on the respective Issuers regarding the accuracy of the information provided.\nSummary Of Mortgage Instrument Characteristics\nWeighted Weighted Average Weighted Average Remaining Series Of Type Of Remaining Average Mortgage Term Mortgage Mortgage Principal Pass-through Coupon To Maturity Securities Instrument Balance(1) Rate Rate (Years)(1) - ------------ ------------ -------------- -------------- ---------- ------------- (In Thousands) Westam 1 GNMA $ 37,942 10.50% 11.00% 20.8 Westam 3 GNMA 44,717 9.50 10.00 21.7 ASW 65 GNMA 45,315 10.00 10.50 21.6 Westam 5 GNMA 69,016 9.00 9.50 21.2 FHLMC 17 FHLMC 59,874 10.00 10.57 21.5 FNMA 24 FNMA 56,824(2) 10.00 10.65 22.2 FNMA 25 FNMA 80,840(3) 9.50 10.14 22.2\n- ---------- (1) As of December 31, 1995. (2) The Company owns a 20.2% interest in the residual interest in the REMIC with respect to FNMA 24. (3) The Company owns a 45.07% interest in the residual interest in the REMIC with respect to FNMA 25.\nThe prepayment experience on the Mortgage Instruments securing or underlying the Mortgage Securities will significantly affect the average life of such Mortgage Securities because all or a portion of such prepayments will be paid to the holders of the related Mortgage Securities as principal payments on such Mortgage Securities. Prepayments on mortgage loans commonly are measured by a prepayment standard or model. The model used herein (the \"Prepayment Assumption Model\") is based on an assumed rate of prepayment each month of the unpaid principal amount of a pool of new mortgage loans expressed on an annual basis. 100% of the Prepayment Assumption Model assumes that each mortgage loan underlying a Mortgage Certificate (regardless of interest rate, principal amount, original term to maturity or geographic location) prepays at an annual compounded rate of 0.2% per annum of its outstanding principal balance in the first month after origination, that this rate increases by an additional 0.2% per annum in each month thereafter until the thirtieth month after origination and in the thirtieth month and in each month thereafter prepays at a constant prepayment rate of 6% per annum.\nThe Prepayment Assumption Model does not purport to be either a historical description of the prepayment experience of any pool of mortgage loans or a prediction of the anticipated rate of prepayment of any pool of mortgage loans, including the mortgage loans underlying the Mortgage Certificates, and there is no assurance that the prepayment of the mortgage loans underlying the Mortgage Certificates will conform to any of the assumed prepayment rates. The rate of principal payments on pools of mortgage loans is influenced by a variety of economic, geographic, social and other factors. In general, however, Mortgage Instruments are likely to be subject to higher prepayment rates if prevailing interest rates fall significantly below the interest rates on the mortgage loans underlying the Mortgage Certificates. Conversely, the rate of prepayment would be expected to decrease if interest rates rise above the interest\nrate on the mortgage loans underlying the Mortgage Certificates. Other factors affecting prepayment of mortgage loans include changes in mortgagors' housing needs, job transfers, unemployment, mortgagors' net equity in the mortgaged properties, assumability of mortgage loans and servicing decisions.\nDescription of the Outstanding Mortgage Securities\nEach series of Bonds constitutes a nonrecourse obligation of the Issuer of such series of Bonds payable solely from the Mortgage Instruments and any other collateral pledged to secure such series of Bonds. All of the Bonds are rated \"AAA\" by Standard & Poor's Corporation. All of the Bonds have been issued in series pursuant to indentures (the \"Indenture\") between the Issuer and a bank trustee (the \"Trustee\") which holds the underlying Mortgage Instruments and other collateral pledged to secure the related series of Bonds.\nEach series of the Bonds is structured so that the monthly payments on the Mortgage Instruments pledged as collateral for such series of Bonds, together (in certain cases) with reinvestment income on such monthly payments at the rates required to be assumed by the rating agencies rating such Bonds or at the rates provided pursuant to a guaranteed investment contract, will be sufficient to make timely payments of interest on each class of Bonds of such series (each a \"Bond Class\"), to begin payment of principal on each Bond Class not later than its \"first mandatory principal payment date\" or \"first mandatory redemption date\" (as defined in the related Indenture) and to retire each Bond Class no later than its \"stated maturity\" (as defined in the related Indenture).\nEach series of Pass-Through Certificates represents beneficial ownership interests in a pool (\"Mortgage Pool\") of Mortgage Instruments formed by the Issuer thereof and evidences the right of the holders of such Pass-Through Certificates to receive payments of principal and interest at the pass-through rate with respect to the related Mortgage Pool. Pass-Through Certificates issued by FHLMC or FNMA generally are not rated by any rating agency. The Pass-Through Certificates issued by FHLMC have been issued pursuant to an agreement (\"Pooling Agreement\") which generally provides for the formation of the Mortgage Pool and the performance of administrative and servicing functions. The Pass-Through Certificates issued by FNMA have been issued pursuant to a trust agreement (\"Trust Agreement\") between FNMA in its corporate capacity and in its capacity as trustee which generally provides for the formation of the Mortgage Pool and the performance of administrative and servicing functions. The Pass-Through Certificates are not obligations of the Issuers thereof.\nEach series of Pass-Through Certificates is structured so that the monthly payments of principal and interest on the Mortgage Instruments in the Mortgage Pool underlying such series of Pass-Through Certificates are passed through on monthly payment dates to the holders of each class of Pass-Through Certificates of such series (each a \"Pass-Through Class\") as payments of principal and interest, respectively, and each Pass-Through Class is retired no later than its \"final payment date\" or \"final distribution date\" (as defined in the related Pooling Agreement or Trust Agreement, respectively).\nWith respect to FHLMC 17, FHLMC guarantees to each holder of a Pass-Through Certificate that bears interest the timely payment of interest at the applicable interest rate on such Pass-Through Certificates. FHLMC also guarantees to each holder of a Pass-Through Certificate the payment of the principal amount of such holder's Pass-Through Certificates as payments are made on the underlying FHLMC Certificates. Such guarantees, however, do not assure the Company any particular return on its Mortgage Interests with respect to these Mortgage Securities. The FHLMC 17 Pass-Through Certificates have been issued pursuant to agreements between the holders of the Pass-Through Certificates and FHLMC, which holds and administers, or supervises the administration of, the pool of Mortgage Instruments underlying the Pass-Through Certificates.\nWith respect to FNMA 24 and FNMA 25, FNMA is obligated to distribute on a timely basis to the holders of the Pass-Through Certificates required installments of principal and interest and to distribute the principal balance of each Class of Pass-Through Certificate in full no later than its applicable \"final distribution date,\" whether or not sufficient funds are available in the \"certificate account\" (as defined in the offering circular). The guarantee of FNMA is not backed by the full faith and credit of the United States. The FNMA 24 and FNMA 25 Pass-Through Certificates represent beneficial ownership interests\nin trusts created pursuant to a Trust Agreement. FNMA is responsible for the administration and servicing of the mortgage loans underlying the FNMA Certificates, including the supervision of the servicing activities of lenders, if appropriate, the collection and receipt of payments from lenders, and the remittance of distributions and certain reports to holders of the Pass-Through Certificates.\nInterest payments on the Bond Classes and the Pass-Through Classes (together \"Classes\") are due and payable on specified payment dates, except with respect to principal only or zero coupon Classes (\"Principal Only Classes\") which do not bear interest and with respect to compound interest Classes (\"Compound Interest Classes\") as to which interest accrues but generally is not paid until other designated Classes in the same series of Mortgage Securities are paid in full. The payment dates for the Mortgage Securities are monthly. Each Class of Mortgage Securities, except the Principal Only Classes, provides for the payment of interest either at a fixed rate, or at an interest rate which resets periodically based on a specified spread from (i) the arithmetic mean of quotations of the London interbank offered rates (\"LIBOR\") for one-month Eurodollar deposits, subject to a specified maximum interest rate, (ii) the Monthly Weighted Average Cost of Funds Index for Eleventh District Savings Institutions (the \"COF Index\"), as published by the Federal Home Loan Bank of San Francisco (the \"FHLB\/SF\"), subject to a specified maximum interest rate or (iii) other indices specified in the prospectus supplement or offering circular for a series of Mortgage Securities.\nAccording to information furnished by the FHLB\/SF, the COF Index is based on financial reports submitted monthly to the FHLB\/SF by Eleventh District savings institutions and is computed by the FHLB\/SF for each month by dividing the cost of funds (interest paid during the month by Eleventh District savings institutions on savings, advances and other borrowings) by the average of the total amount of those funds outstanding at the end of that month and at the end of the prior month, subject to certain adjustments. According to such FHLB\/SF information, the COF Index reflects the interest cost paid on all types of funds held by Eleventh District savings institutions, and is weighted to reflect the relative amount of each type of funds held at the end of the particular month. The COF Index has been reported each month since August 1981.\nUnlike most other interest rate measures, the COF Index does not necessarily reflect current market rates. A number of factors affect the performance of the COF Index which may cause the COF Index to move in a manner different from indices tied to specific interest rates, such as United States Treasury Bills or LIBOR. Because of the various maturities of the liabilities upon which the COF Index is based (which may be more or less sensitive to market interest rates), the COF Index may not necessarily reflect the average prevailing market interest rates on new liabilities of similar maturities. Additionally, the COF Index may not necessarily move in the same direction as market interest rates, because as longer term deposits or borrowings mature and are renewed at prevailing market interest rates, the COF Index is influenced by the differential between the prior rates on such deposits or borrowings and the cost of new deposits or borrowings. Moreover, the COF Index represents the weighted average cost of funds for Eleventh District savings institutions for the month prior to the month in which the COF Index is customarily published, and therefore lags current rates. Movement of the COF Index, as compared to other indices tied to specific interest rates, also may be affected by changes instituted by the FHLB\/SF in the method used to calculate the COF Index.\nPrincipal payments on each Class of the Mortgage Securities are made on monthly payment dates. Payments of principal generally are allocated to the earlier maturing Classes until such Classes are paid in full. However, in certain series of Mortgage Securities, principal payments on certain Classes are made concurrently with principal payments on other Classes of such series of Mortgage Securities in certain specified percentages (as described in the prospectus supplement or offering circular for such series of Mortgage Securities). In addition, payments of principal on certain Classes (referred to as \"SAY,\" \"PAC,\" \"SMRT\" or \"SPPR\" Classes) occur pursuant to a specified repayment schedule to the extent funds are available therefor, regardless of which other Classes of the same series of Mortgage Securities remain outstanding. Each of the Principal Only Classes has been issued at a substantial discount from par value and receives only principal payments. Certain Classes of the Mortgage Securities will be subject to redemption at the option of the Issuer of such series (in the case of FHLMC 17) or upon the instruction of the Company (as the holder of the residual interest in the REMICs with respect to the other Mortgage\nSecurities Classes subject to redemption) on the dates specified herein in accordance with the specific terms of the related Indenture, Pooling Agreement or Trust Agreement, as applicable. Certain Classes which represent the residual interest in the REMIC with respect to a series of Mortgage Securities (referred to as \"Residual Interest Classes\") generally also are entitled to additional amounts, such as the remaining assets in the REMIC after the payment in full of the other Classes of the same series of Mortgage Securities and any amount remaining on each payment date in the account in which distributions on the Mortgage Instruments securing or underlying the Mortgage Securities are invested after the payment of principal and interest on the related Mortgage Securities and the payment of expenses.\nThe table below sets forth certain information regarding the Mortgage Securities with respect to which the Company owns all or a part of the Mortgage Interest.\nSummary Of The Mortgage Securities\n(14) The FHLMC 17 Pass-Through Certificates may be redeemed in whole, but not in part, on any payment date if the aggregate principal amount of such Pass-Through Certificates outstanding is less than 1% of the initial principal amount of such Pass-Through Certificates. (15) The Company owns a 20.20% interest in the residual interest in the REMIC with respect to FNMA 24. (16) Paid principal in the manner of a SAY, PAC, SMRT or SPPR Class with respect to a portion of its principal balance. (17) Determined monthly, and generally equal to 2.10% below the product of 1.15 and the arithmetic mean of LIBOR, subject to a maximum rate of 12.50%. (18) On each payment date, the Class of Pass-Through Certificates will receive the excess of the sum of all distributions payable on the FNMA Certificates underlying the Pass-Through Certificates on such payment date over all amounts distributable on such payment date as principal and interest on each Class of the Pass-Through Certificates (including amounts distributable as principal on this Class of Pass-Through Certificates). (19) Not subject to optional redemption. (20) The Company owns a 45.07% interest in the residual interest in the REMIC with respect to FNMA 25. (21) On any payment date on which the principal distributions from the FNMA Certificates underlying the FNMA 25 Pass-Through Certificates are not sufficient to reduce the principal balance of this Class of such Pass-Through Certificates to a designated amount, the amount of interest distributed from the FNMA Certificates underlying such Pass-Through Certificates not required to be paid out as interest on such Pass-Through Certificates on such payment date (\"Excess Interest\") will be applied to reduce the principal balance of this Class to the designated amount for that payment date. (22) Determined monthly, and generally equal to .7586% above the product of .9632 and the COF Index, subject to a maximum rate of 11.3054%. (23) Determined monthly, and generally equal to 1.5229% below the product of .9247 and the COF Index, subject to a maximum rate of 9.50%. (24) Determined monthly, and generally equal to 1.25% above the COF Index, subject to a maximum rate of 14.00%. (25) On any payment date on which this Class of Pass-Through Certificates receives principal payments, 30% of the Excess Interest will be applied to reduce the principal balance of this Class. (26) When Excess Interest is used to pay principal on Classes 25-A and 25-G, the amount of Excess Interest so applied will be added to the principal balance of this Class of Pass-Through Certificates. In addition, on each Payment Date, this Class of Pass- Through Certificates will receive the excess of the sum of all distributions payable on the FNMA Certificates underlying the FNMA 25 Pass-Through Certificates on such payment date over all amounts distributable on such payment date as principal and interest (including amounts distributable as principal on this Class of Pass-Through Certificates).\nNet Cash Flows\nThe Net Cash Flows available from the Company's Mortgage Assets are derived principally from three sources: (i) the favorable spread between the interest or pass-through rates on the Mortgage Instruments securing or underlying the Mortgage Securities and the interest or pass-through rates of the Mortgage Securities Classes, (ii) reinvestment income in excess of the amount thereof required to be applied to pay the principal of and interest on the Mortgage Securities, and (iii) any amounts available from prepayments on the Mortgage Instruments securing or underlying the Mortgage Securities that are not necessary for the payments on the Mortgage Securities. The amount of Net Cash Flows generally decreases over time as the Classes are retired. Distributions of Net Cash Flows represent both the return on and the return of the investment on the Mortgage Assets purchased. In addition, the Company may exercise its rights in accordance with the terms of a series of Mortgage Securities to redeem all or a part of such series prior to maturity and sell the related Mortgage Instruments, in which case the net payment (after payment of the Mortgage Securities and related costs) will be remitted to the Company.\nThe principal factors which influence Net Cash Flows are as follows:\n(1) Other factors being equal, Net Cash Flows in each payment period tend to decline over the life of a series of Mortgage Securities, because (a) as normal amortization of principal and principal prepayments occur on the Mortgage Instruments securing or underlying such Mortgage Securities, the principal balances of earlier, lower-yielding Classes of such Mortgage Securities are reduced, thereby resulting in a reduction of the favorable spread between the weighted average interest or pass-through rate on outstanding Classes and the interest or pass-through rates on the Mortgage Instruments securing or underlying such Mortgage Securities and (b) the higher coupon Mortgage Instruments are likely to be prepaid faster, reinforcing the same effect.\n(2) The rate of prepayments on the Mortgage Instruments securing or underlying a series of Mortgage Securities significantly affects the Net Cash Flows. Because prepayments shorten the life\nof the mortgage loans underlying the Mortgage Instruments securing or underlying a series of Mortgage Securities, a higher rate of prepayments normally reduces overall Net Cash Flows. The rate of prepayments may be expected to vary over the life of a series of Mortgage Securities, and the timing of prepayments will further affect their significance. The rate of prepayments is affected by mortgage interest rates and other factors. Generally, increases in mortgage interest rates reduce prepayment rates, while decreases in mortgage interest rates increase prepayment rates. Because an important component of Net Cash Flows derives from the spread between the weighted average interest or pass-through rate on the Mortgage Instruments securing or underlying a series of Mortgage Securities and the weighted average interest or pass-through rate on the outstanding classes of such Mortgage Securities Classes, a higher than expected level of prepayments concentrated during the early life of such Mortgage Securities (thereby reducing the weighted average life of the earlier, lower-yielding Classes) has a more negative effect on Net Cash Flows than the same volume of prepayments have at a constant rate over the life of such Mortgage Securities or at a later date.\n(3) With respect to Variable Rate Classes of Mortgage Securities, increases in the level of the index on which the interest rate for such Variable Rate Classes are based increase the interest or pass-through rate payable on Variable Rate Classes and thus reduce or, in some instances, eliminate Net Cash Flows, while decreases in the level of the relevant index decrease the interest or pass- through rate payable on Variable Rate Classes and thus increase Net Cash Flows.\n(4) The interest rate at which the monthly cash flow from the Mortgage Instruments securing or underlying a series of Mortgage Securities may be reinvested until payment dates for such Mortgage Securities influences the amount of reinvestment income contributing to the Net Cash Flows unless such reinvestment income is not paid to the owner of the related Mortgage Asset.\n(5) The administrative expenses of a series of Mortgage Securities (if any) may increase as a percentage of Net Cash Flows as the outstanding balances of the Mortgage Instruments securing or underlying such Mortgage Securities decline, if some of such administrative expenses are fixed. In later years, it can be expected that fixed expenses will exceed the available cash flow. Although reserve funds generally are established to cover such shortfalls, there can be no assurance that such reserves will be sufficient to cover such shortfalls. In addition, although each series of Mortgage Securities (other than FNMA 24 or FNMA 25) generally has an optional redemption provision that allows the Issuer thereof (in the case of FHLMC 17) or the Company (as the holder of the residual interest in the REMICs with respect to the other series of Mortgage Securities) to retire the remaining Classes that are subject to redemption or retirement after a certain date, there can be no assurance that the Issuer or the Company will exercise such options and, in any event, in a high interest rate environment the market value of the remaining Mortgage Instruments securing or underlying the Mortgage Securities may be less than the amount required to retire the remaining outstanding Classes. The Company may be liable for, or its return subject to, administrative expenses relating to a series of Mortgage Securities if reserves prove to be insufficient. Moreover, any unanticipated liability or expenses with respect to the Mortgage Securities could adversely affect Net Cash Flows.\nOther Policies Investment Company Act\nThe Company intends to operate in such a manner as not to be within the definition of investment company under the Investment Company Act of 1940. The Company may not invest in public entities similar to the Company and may not invest in securities of other issuers for the purpose of exercising control.\nHedging\nThe Company from time to time hedges its Mortgage Assets and indebtedness in whole or in part so as to provide protection from interest rate fluctuations or other market movements. With respect to assets, hedging can be used either to increase the liquidity or decrease the risk of holding an asset by guaranteeing, in whole or in part, the price at which such asset may be disposed of prior to its maturity. With\nrespect to indebtedness, hedging can be used to limit, fix or cap the interest rate on variable interest rate indebtedness. The Company's hedging activities may include the purchase of interest rate cap agreements, the consummation of interest rate swaps, the purchase of Stripped Mortgage Securities, the maintenance of short positions in financial futures contracts, the purchase of put options on such contracts and the trading of forward contracts. For a description of the Company's current hedging activities and the costs associated therewith, see \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\" Certain of the federal income tax requirements that the Company has been required to satisfy to qualify as a REIT have limited its ability to hedge. See \"Business -- Federal Income Tax Considerations -- Qualification of the Company as a REIT.\"\nCapital Resources\nSubject to the terms of the Company's Bylaws, the availability and cost of borrowings, various market conditions and restrictions that may be contained in the Company's financing arrangements from time to time and other factors as described herein, the Company may increase the amount of funds available for its activities with the proceeds of borrowings including borrowings under lines of credit, loan agreements, repurchase agreements and other credit facilities.\nSubject to the foregoing, the Company's borrowings may bear fixed or variable interest rates, may require additional collateral in the event that the value of existing collateral declines on a market value basis and may be due on demand or upon the occurrence of certain events. Repurchase agreements are agreements pursuant to which the Company sells assets for cash and simultaneously agrees to repurchase such assets on a specified date for the same amount of cash plus an interest component. The Company also may increase the amount of funds available for investment through the issuance of debt securities (including Mortgage Securities). In general, the Company may make use of short-term borrowings to provide additional funds when it is able to borrow at interest rates lower than the yields expected to be earned on such funds. If borrowing costs are higher than the yields generated by such funds, the Company's ability to utilize borrowed funds may be substantially reduced and it may experience losses.\nA substantial portion of the assets of the Company are pledged to secure indebtedness incurred by the Company. Accordingly, such assets will not be available for distribution to the stockholders of the Company in the event of the Company's liquidation except to the extent that the value of such assets exceeds the amount of such indebtedness.\nOn December 17, 1992, a wholly owned, limited-purpose subsidiary of the Company issued $31,000,000 of Secured Notes under an Indenture to several institutional investors. The Secured Notes bear interest at 7.81% per annum which is payable quarterly. Scheduled principal repayments were $1,532,000 per quarter during the first four quarters, $991,000 per quarter for the next 12 quarters, $901,000 per quarter for the next eight quarters and $721,000 per quarter thereafter through February 15, 2001.\nThe Secured Notes are secured by the Company's Mortgage Assets with respect to Westam 1, Westam 3, Westam 5, ASW 65, FNMA 1988-24 and FNMA 1988-25 and by a reserve fund in an initial amount of $3,100,000 with a specified maximum amount of $7,750,000. The reserve fund will be used to make the scheduled principal and interest payments on the Secured Notes if the cash flow available from the pledged Mortgage Assets is not sufficient to make the scheduled payments.\nUnder the Indenture, the cash flow from the Mortgage Assets pledged to secure the Secured Notes is used to make payments of interest and scheduled principal on the Secured Notes and to pay expenses in connection therewith. Any excess cash flow will be applied to prepay the Secured Notes at par or to increase the reserve fund up to its $7,750,000 maximum amount or will be remitted to the Company, in each case depending on the level of certain specified financial ratios set forth in the Indenture.\nThe Company used the proceeds from the issuance of the Secured Notes to repay a term loan, to repay its short-term borrowings under a repurchase agreement, to establish the reserve fund and for working capital.\nUnder a revolving line of credit agreement with a bank, the Company may borrow up to $5,000,000, upon payment of a 1\/2 % commitment fee with interest payable monthly at prime plus 1\/2 %. Such advances\nare to be secured by certain of the Company's Real Estate Loans with the amount advanced equal to between 40% to 60% of the principal amount of the Real Estate Loans pledged. Only Real Estate Loans approved by the bank are eligible for advances. The agreement contains certain financial covenants and expires on May 5, 1996. Through December 31, 1995, the Company has not drawn upon the line of credit.\nThe Company in the future may increase its capital resources by making additional offerings of its Common Stock or securities convertible into Common Stock. The effect of such offerings may be the dilution of the equity of stockholders of the Company or the reduction of the market price of shares of the Company's Common Stock, or both. The Company is unable to estimate the amount, timing or nature of future sales of its Common Stock as such sales will depend upon the Company's need for additional funds, market conditions and other factors.\nEmployees\nThe Company currently has three full time salaried employees.\nThe Subcontract Agreement\nThe Company is a party to an amended Subcontract Agreement pursuant to which American Southwest Financial Group, L.L.C. (\"ASFG\"), as assignee of American Southwest Financial Services, Inc. (\"ASFS\") performs certain services for the Company in connection with the structuring, issuance and administration of Mortgage Securities issued by the Company or by any Issuer affiliated with ASFS with respect to which the Company acquires Mortgage Interests. Under the Subcontract Agreement, the Company will be charged for any series of CMOs an issuance fee of .1% of the principal amount for such series, generally subject to a minimum fee of $10,000 and a maximum fee of $100,000, and for any series of Pass-Through Certificates an issuance fee not to exceed .125% of the principal amount of such series. In addition, the Company will be charged an administration fee for each series of CMOs equal to a maximum of $20,000 per year and for any series of Pass-Through Certificates an administration fee equal to up to .025% of the amount of the series outstanding at the beginning of each year; provided that commencing February 1, 1996 the administrative fee with respect to ASW 65, Westam 1, Westam 3, Westam 5 and Westam 6, has been reduced from $20,000 per year to $16,250 per year.\nThe Subcontract Agreement had an initial term expiring on December 31, 1989 and continuing from year to year thereafter. The Company has the right to terminate the Subcontract Agreement upon the happening of certain specified events, including a breach by ASFG of any provision contained in the Subcontract Agreement. ASFG is a privately held Arizona limited liability company and indirectly owns up to 25% of the capital interest of the preferred members of ASFG. Alan D. Hamberlin directly or indirectly owns up to 25% of the Capital Interest held by the common members of ASFG.\nBased on reports received by the Company from ASFG, ASFS received administration fees of $235,000 for the year ended December 31, 1991, $227,000 for the year ended December 31, 1992, $201,000 for the year ended December 31, 1993, $165,000 for the year ended December 31, 1994 and $144,000 for the year ended December 31, 1995.\nPursuant to the Subcontract Agreement, ASFS will not assume any responsibility other than to render the services called for therein. ASFS and its directors, officers, stockholders and employees will not be liable to the Company or any of its directors or stockholders for any acts or omissions by ASFS, its directors, officers, stockholders or employees under or in connection with the Subcontract Agreement, except by reason of acts constituting bad faith, willful misconduct, gross negligence or reckless disregard of their duties under the Subcontract Agreement.\nSpecial Considerations\nReal Estate Loan Considerations\nNew Business Activity\nThe Company has been involved in making and acquiring Real Estate Loans since December 1993. Although officers of the Company have substantial real estate investment and real estate loan experience,\nthey have no prior experience in the management or operation of a company engaged primarily in making and acquiring such loans. The Company competes for acceptable Real Estate Loans with numerous other companies, many of which have greater resources and experience than the Company and its officers.\nReal Estate Market Conditions\nThe Company's Real Estate Loan activities subject the Company to the risks generally incident to the ownership of and investment in real estate because of the impact of such risks on the ability of its borrowers' to repay their Real Estate Loans and the ability of the Company to resell, refinance or dispose of property following a foreclosure for an amount at least equal to its loan. These risks include general and local economic conditions; the investment climate for real estate investments; the demand for and supply of competing properties; local market conditions and neighborhood characteristics; unanticipated holding costs; the availability and cost of necessary utilities and services; real estate tax rates and other operating expenses; governmental rules and fiscal policies, including rent, wage and price controls; zoning and other land use regulations; environmental controls; acts of God (which may result in uninsured losses); the treatment for federal and state income tax purposes of income derived from real estate; the levels of interest rates; the availability and cost of financing in connection with the purchase, sale or refinancing of properties; and other factors beyond the control of the Company. In recent years, the presence of hazardous substances or toxic waste has adversely affected real estate values in various areas of the country and resulted in the imposition of costs and damages to real estate owners and lenders. In addition, certain expenses related to properties, such as property taxes and insurance, tend to increase over time. These and other factors could result in an increase in the Company's cost of holding any real estate it acquires as a result of a foreclosure or adversely affect the terms and conditions upon which the Company may sell or refinance any properties held by it. In addition, all Real Estate Loans, including the Company's Real Estate Loans, are subject to loss resulting from the priority of real estate tax liens, mechanic's liens and materialman's liens. Therefore, the success of the Company will depend in part upon events beyond its control.\nLack of Geographic Diversification\nThrough December 31, 1995, the Company has made Real Estate Loans on real estate located only in Arizona. As a result of this geographic concentration, unfavorable economic conditions in Arizona could increase the likelihood of defaults on the Company's Real Estate Loans and affect the Company's ability to protect the principal of and interest on such loans following foreclosures upon the real properties securing such loans. The Company intends to continue to assess real estate lending opportunity in Arizona and other parts of the Southwest.\nConcentration of Loan Amounts\nThe Company can be expected to make Real Estate Loans to a relatively small number of borrowers as a result of the amount of its funds available for lending activities. Therefore, the Company may be subject to increased risk to the extent that a single borrower defaults with respect to a loan constituting significant percentage of the Company's total Real Estate Loan portfolio.\nLoans Secured by Unimproved Properties\nThe Company's Real Estate Loans generally are secured by deeds of trust, mortgages or other similar instruments on unimproved real property. A Real Estate Loan secured by unimproved real property involves a particularly high degree of risk since such property generally does not generate income other than as the result of a sale or refinancing, and the borrower's loan payments generally will be the Company's only source of cash flow on the property until a sale or refinancing. Accordingly, the Company will be subject to a greater risk of loss in the event of delinquency or default by a borrower on a Real Estate Loan secured by a deed of trust, mortgage or similar instrument on unimproved real property than if such Real Estate Loan were secured by a deed of trust, mortgage or similar instrument on improved real property.\nBalloon Payments\nThe Company makes or acquires a significant number of Real Estate Loans that do not provide for the payment of all or any part of principal prior to maturity including all of its currently outstanding Real Estate Loans. The ability of a borrower to repay the outstanding principal amount of such a Real Estate Loan at maturity will depend primarily upon the borrower's ability to obtain, by refinancing, sale or other disposition of the property or otherwise, sufficient funds to pay the outstanding principal balance at a time when such funds may be difficult to obtain, with the result that the borrower may default on its obligation to repay the amount of the Real Estate Loan in accordance with the terms of the deed of trust, mortgage or other security instrument. In addition, a substantial reduction in the value of the property securing a Real Estate Loan could precipitate or otherwise result in the borrower's default. Any such default could result in a loss to the Company of all or part of the principal of or interest on such a Real Estate Loan.\nDevelopment and Construction Loans\nThe development and interim construction loans which the Company may make generally are expected to generate higher rates of return than other types of Real Estate Loans, but generally will entail greater risks. Such a loan will be subject to substantial risk because the ability of the borrower to complete or dispose of the project being developed or constructed on the underlying real estate and repay the loan may be affected by various factors including adverse changes in general economic conditions, interest rates, the availability of permanent mortgage funds, local conditions, such as excessive building resulting in an excess supply of real estate, a decrease in employment reducing the demand for real estate in the area, and the borrower's ability to control costs and to conform to plans, specifications and time schedules, which will depend upon the borrower's management and financial capabilities and which may also be affected by strikes, adverse weather and other conditions beyond the borrower's control. Such contingencies and adverse factors could deplete the borrower's borrowed funds and working capital and could result in substantial deficiencies precluding compliance with specified conditions of commitments for permanent mortgage funds relied on as a primary source of repayment of the loan. In addition, in some jurisdictions, construction and development lenders, such as the Company, in certain circumstances, may be liable for defective construction. The possibility of such liability may be increased if, in addition to its loan, the Company is deemed to have an equity position in the developer or contractor or in the property being developed or improved. This, however, is not likely to be the case since the Company does not plan to make construction and development loans to affiliates.\nRisk of Joint Ventures\nThe Company may enter into joint ventures, general partnerships and loan participations with third parties for the purpose of making or acquiring Real Estate Loans. Any such investments will be made consistently with the then existing Securities and Exchange Commission interpretations and case law respecting the applicability of the Investment Company Act of 1940, as amended (the \"Investment Company Act\"). Any such Real Estate Loans also will be subject to certain additional restrictions. See \"Business -- Real Estate Loans -- Transactions with Affiliates and Joint Venture Investments.\" Joint ventures, general partnerships and loan participations involve the potential risk of impass on decision making in situations in which no single party fully controls the Real Estate Loan with the result that neither the Company nor any other party will be able to exercise full authority with respect to the\nprotection of the investment in the loan. In addition, although the Company or another party to the transaction often will have the right to purchase the interest of any other party in the Real Estate Loan, the party seeking to acquire the interest of another party may not have sufficient funds to do so.\nJunior Loans\nAlthough not currently contemplated, the Company in the future may make or acquire junior mortgage loans or wrap-around mortgage loans. A junior mortgage loan or a wrap-around mortgage loan generally entails greater risks than a first mortgage loan on the same property. In the event of default under a senior loan, the holder of a junior loan may be forced to cure the default on the senior loan in order to prevent the sale of the underlying property or to discharge the senior loan entirely by paying the entire amount of principal and interest then outstanding in the event of the acceleration of the senior loan. There can be no assurance that the Company will have sufficient funds to pay amounts owing on the related first loan to prevent default or to discharge the first loan entirely. If the Company decides to cure a default under a senior mortgage loan or purchases an underlying property at a foreclosure or trustee's sale, the Company will be subject to the risks of ownership of real property.\nSufficiency of Collateral\nMany of the Company's Real Estate Loans are made on a nonrecourse basis. In such a case, the Company relies for its security solely on the value of the underlying real property and does not have any right to make any claims for repayment personally against the borrower. Other Real Estate Loans may be full recourse loans, may be secured by personal guarantees or may be secured by one or more items of real or personal property in addition to the property constituting the primary security for the Real Estate Loan. Nevertheless, the property constituting the primary security for a Real Estate Loan in most cases will be the primary source for repayment of the loan upon maturity or in the event of a default. The ability of the borrower to pay the outstanding balance of a Real Estate Loan (particularly a non- amortizing Real Estate Loan) on maturity will depend primarily upon the borrower's ability to obtain sufficient funds by refinancing, sale or other disposition of the property.\nThe risk of a Real Estate Loan will increase as the ratio of the amount of the loan to the value of the property securing such loan increases because the real property will possess less protective equity in the event of a default by the borrower. The principal amount of each Real Estate Loan, when added to the aggregate amount of any senior indebtedness outstanding on the property, generally will not exceed 95% of the Company's assessment of the value of the property at the time the loan is made or acquired. The Company will make an assessment of the loan-to-value ratio prior to making a Real Estate Loan. In making its assessment of the value of the real estate to secure a Real Estate Loan, the Company will review any available appraisals of the property by qualified appraisers, the purchase price of the property, recent sales of comparable properties, and other factors. The Company generally will rely on its own assessment of the value of a property rather than requiring a current appraisal. Although appraisals are estimates of value which should not be relied upon as measures of true worth or realizable value, neither the Company nor any of its officers are qualified real estate appraisers and the absence of an independent appraisal removes an independent estimate of value. There can be no assurance that the Company's estimated values will be comparable or bear any relation to the actual market value of a property or the amount that could be realized upon the refinancing, sale or other disposition of the property. As a result, the amount realized in connection with the refinancing, sale or other disposition of the property by the buyer in the ordinary course of business by the Company or at or following a foreclosure sale may not equal the then outstanding balance of the related Real Estate Loan.\nRemedies Upon Default by Borrower\nReal Estate Loans are subject to the risk of default, in which event the Company would have the added responsibility of foreclosing and protecting its loans. See \"Business -- Real Estate Loans -- Remedies Upon Default by Borrower\" for a discussion of remedies in the event of default by a borrower with respect to a Real Estate Loan.\nEffect of Interest Rate Fluctuations; Length of Maturity and Prepayment Provisions\nThe Company's Real Estate Loans generally are fixed-rate debt instruments of specified maturities, including all of the Company's currently outstanding Real Estate Loans. The economic value of an investment in the Company's shares may fluctuate to the extent that market rates of interest for similar Real Estate Loans of similar maturities exceed or fall below the Company's anticipated rate of return on investment on its Real Estate Loans.\nCertain Real Estate Loans may be variable or adjustable-rate Real Estate Loans under which the interest rate will be based on the prime or other benchmark rate published by a designated institutional lender, and will be periodically adjusted as such prime or other benchmark rate is adjusted. The adjustability of the interest rate with respect to such Real Estate Loans generally will reduce the risk that the economic value of an investment in the Company's shares will decline in the event that market rates of interest for similar Real Estate Loans of similar maturities exceed the Company's initial return on investment. However, in the event of a general decline in such market rates of interest, such adjustability will result in a lowering of the the Company's return on investment, thereby lowering the economic value of an investment in the Company's shares.\nThe economic value of an investment in the Company's shares also may fluctuate as a result of the length of maturity and prepayment terms of its Real Estate Loans, depending in part upon whether funds to be received by the Company upon maturity of a Real Estate Loan or prepayment of all or a portion of the principal amount of a Real Estate Loan may be reinvested at interest rates higher or lower than the return on the original Real Estate Loan. A substantial number of the Real Estate Loans comprising the Company's portfolio can be expected to allow the borrower to prepay all or a portion of the principal amount at any time without penalty.\nIn some cases, the Company may attempt to obtain equity participations in connection with making Real Estate Loans designed to provide an increased return when such equity participations are deemed by management to be in the best interests of the Company. Such a participation can be expected to be in the form of additional interest based upon items such as gross receipts from the property securing the loan in excess of certain levels or appreciation in the value of the property on whose security the Company has made the Real Estate Loan based upon either sales price or increases in appraised value. There can be no assurance, however, that any Real Estate Loans will be structured in this manner or that any such loans will provide enhanced returns.\nInterest Ceilings Under Usury Statutes\nInterest on Real Estate Loans may be subject to state usury laws imposing maximum interest charges and possible penalties for violation, including restitution of excess interest and unenforceability of the debt. Uncertainty may exist in determining what constitutes interest, including, among other things, the treatment of loan commitment fees or other fees payable by the borrower under a Real Estate Loan. The Company does not intend to make Real Estate Loans with terms that may violate applicable state usury provisions. Nevertheless, uncertainties in determining the legality of rates of interest and other borrowing charges under some statutes may result in inadvertent violations.\nEnvironmental Considerations\nReal estate in general is subject to certain environmental risks arising from the location or site on which a project is built or from materials used in construction or stored on the property. Although the Company will use commercially reasonable efforts to become aware of any environmental problem with regard to any property before it makes a loan secured by that property, the occurrence of health problems or other dangerous conditions caused by work on the property may only become apparent after a lengthy period of time. Thus, there can be no assurance that environmental problems will not develop with respect to any property securing a Real Estate Loan. If hazardous substances are discovered on such properties or discovered to be emanating from any such properties, the owner of the property (including the Company) may be held strictly liable for all costs and liabilities relating to such hazardous substances. This could negatively affect the Company's security in the Real Estate Loan.\nIn addition, the construction of improvements on such property may be adversely affected by regulatory, administrative or other procedures or by requirements by local, state or federal environmental agencies including matters relating to the clean up of hazardous or toxic substances. Such factors could impede the ability of the borrower to obtain permits and approvals for a project or result in the inability to develop or use the property.\nRisks of Leverage\nThe Company may utilize a line of credit or other financing from a financial institution to increase the amount of the Real Estate Loans that it is able to make or acquire and to increase its potential returns. The Company also may incur indebtedness in order to meet expenses of holding any property on which the Company has theretofore made a Real Estate Loan and has subsequently taken over the operation of the underlying property as a result of default or to protect a Real Estate Loan. In addition, the Company may incur indebtedness in order to complete development of a property on which the Company has theretofore made a development or land loan and has subsequently taken over the operation of the underlying property as a result of default. The Company also may utilize a line of credit in order to prevent default under senior loans or to discharge them entirely if this becomes necessary to protect the Company's Real Estate Loans. Such borrowing may be required if foreclosure proceedings are instituted by the holder of a mortgage loan that is senior to that held by the Company. In addition, any such line of credit in all likelihood will require periodic renewals, and no assurance can be given that such renewals will always be approved. In the event that any portion of an outstanding line of credit is not renewed, the Company will be required to reevaluate its reserve requirements and review its portfolio for possible disposition of Real Estate Loans. See \"Business -- Real Estate Loans -- Borrowing Policies\" for a description of the Company's current bank line of credit.\nThe amount and terms and conditions of any line of credit will affect the profitability of the Company and the funds that will be available to satisfy its obligations. Interest will be payable on a line of credit regardless of the profitability of the Company. The Company's ability to increase its return through borrowings will depend in part upon the Company's ability to generate income from its borrowed funds based upon the difference between the Company's return on investment from such borrowed funds and the interest rate charged by its lender for the funds. Adverse economic conditions could increase defaults by borrowers on the Real Estate Loans and could impact the Company's ability to make its loan payments to its lenders. Adverse economic conditions also could increase the Company's borrowing costs and cause the terms on which funds become available to be unfavorable. In such circumstances, the Company could be required to liquidate some of its loans at a significant loss.\nCompetition for Real Estate Loans\nThe Company may encounter significant competition in making or acquiring Real Estate Loans from banks, insurance companies, savings and loan associations, mortgage bankers, pension funds, real estate investment trusts, investment partnerships, investment bankers and other investors that have been or may be formed with objectives similar to those of the Company. An increase in the availability of mortgage funds may increase competition for making and acquiring Real Estate Loans and may reduce the yields available thereon.\nLack of Suitable Loans\nThe Company will attempt to make or acquire Real Estate Loans which will produce returns sufficient to allow the Company to satisfy its objectives. However, there is no assurance that interest rates will be such that the Company will be able to make or acquire Real Estate Loans that will provide a satisfactory return on investment or that any Real Estate Loans will be available which meet all of the Company's investment criteria.\nUninsured Losses\nSome, but likely not all, of the Real Estate Loans made or acquired by the Company will require that the borrower carry general public liability insurance for claims arising on or about the real property in\nsuitable amounts as determined by the Company. To the extent that a borrower incurs uninsured liabilities or liabilities in excess of the applicable coverage, such liabilities may adversely affect the borrower's ability to repay the Real Estate Loan.\nEnforceability of Loan Documents\nThe Company will attempt to determine that the instruments relating to each Real Estate Loan and the underlying real property will be legal, valid, binding and enforceable. However, there can be no assurance of such enforceability in all instances, and the unenforceability of any such instruments could result in a complete or partial loss of the principal of or interest on a Real Estate Loan. The Company will have the power to waive certain fees and penalties in connection with a default or late payments with respect to a Real Estate Loan should the Company be advised that provisions governing such fees and penalties may not be enforceable.\nMortgage Asset Considerations\nGeneral\nThe results of the Company's operations depend, among other things, on the level of Net Cash Flows generated by the Company's Mortgage Assets. The Company's Net Cash Flows vary primarily as a result of changes in mortgage prepayment rates, short-term interest rates, reinvestment income and borrowing costs, all of which involve various risks and uncertainties as set forth below. Prepayment rates, interest rates, reinvestment income and borrowing costs depend upon the nature and terms of the Mortgage Assets, the geographic location of the properties securing the mortgage loans included in or underlying the Mortgage Assets, conditions in financial markets, the fiscal and monetary policies of the United States Government and the Board of Governors of the Federal Reserve System, international economic and financial conditions, competition and other factors, none of which can be predicted with any certainty.\nThe rates of return to the Company on its Mortgage Assets will be based upon the levels of prepayments on the mortgage loans included in or underlying such Mortgage Instruments, the rates of interest or pass-through rates on such Mortgage Securities that bear variable interest or pass-through rates, and rates of reinvestment income and expenses with respect to such Mortgage Securities.\nPrepayment Risks\nMortgage prepayment rates vary from time to time and may cause declines in the amount and duration of the Company's Net Cash Flows. Prepayments of fixed-rate mortgage loans included in or underlying Mortgage Instruments generally increase when then current mortgage interest rates fall below the interest rates on the fixed-rate mortgage loans included in or underlying such Mortgage Instruments. Conversely, prepayments of such mortgage loans generally decrease when then current mortgage interest rates exceed the interest rates on the mortgage loans included in or underlying such Mortgage Instruments. See \"Business -- Special Considerations -- Mortgage Asset Considerations -- Interest Rate Fluctuation Risks.\" Prepayment experience also may be affected by the geographic location of the mortgage loans included in or underlying Mortgage Instruments, the types (whether fixed or adjustable rate) and assumability of such mortgage loans, conditions in the mortgage loan, housing and financial markets, and general economic conditions.\nIn general, without regard to the interest or pass-through rates payable on classes of a series of Mortgage Securities, prepayments on Mortgage Instruments bearing a net interest rate higher than or equal to the highest interest rate on the series of Mortgage Securities secured by or representing interests in such Mortgage Instruments (\"Premium Mortgage Instruments\") will have a negative impact on the Net Cash Flows of the Company because such principal payments eliminate or reduce the principal balance of the Premium Mortgage Instruments upon which premium interest was earned.\nNet Cash Flows on Mortgage Instruments securing or underlying a series of Mortgage Securities also tend to decline over the life of such Mortgage Securities because the classes of such Mortgage Securities with earlier stated maturities or final payment dates tend to have lower interest rates. In addition, because an important component of the Net Cash Flows on Mortgage Instruments securing or underlying a series\nof Mortgage Securities derives from the spread between the weighted average interest rate on such Mortgage Instruments and the weighted average interest or pass-through rate on the outstanding amount of such Mortgage Securities, a given volume of prepayments concentrated during the early life of a series of Mortgage Securities reduces the weighted average lives of the earlier maturing classes of such Mortgage Securities bearing lower interest or pass-through rates. Thus, an early concentration of prepayments generally has a greater negative impact on the Net Cash Flows of the Company than the same volume of prepayments at a later date.\nMortgage prepayments also shorten the life of the Mortgage Instruments securing or underlying Mortgage Securities, thereby generally reducing overall Net Cash Flows as described under \"Business -- Special Considerations -- Mortgage Asset Considerations -- Decline in Net Cash Flows from Mortgage Assets.\"\nNo assurance can be given as to the actual prepayment rate of mortgage loans included in or underlying the Mortgage Instruments in which the Company has an interest.\nInterest Rate Fluctuation Risks\nChanges in interest rates affect the performance of the Company and its Mortgage Assets. A portion of the Mortgage Securities secured by the Company's Mortgage Instruments and a portion of the Mortgage Securities with respect to which the Company holds Mortgage Interests bear variable interest or pass-through rates based on short-term interest rates (primarily LIBOR). As of December 31, 1995, $40,977,000 of the $308,381,000 of the Company's proportionate share of Outstanding Mortgage Securities associated with the Company's Mortgage Assets consisted of variable interest rate Mortgage Securities. Consequently, changes in short-term interest rates significantly influence the Company's Net Cash Flows.\nIncreases in short-term interest rates increase the interest cost on variable rate Mortgage Securities and, thus, tend to decrease the Company's Net Cash Flows. Conversely, decreases in short-term interest rates decrease the interest cost on the variable rate Mortgage Securities and, thus, tend to increase the Company's Net Cash Flows. As stated above, increases in mortgage interest rates generally tend to increase the Company's Net Cash Flows by reducing mortgage prepayments, and decreases in mortgage interest rates generally tend to decrease the Company's Net Cash Flows by increasing mortgage prepayments. Therefore, the negative impact on the Company's Net Cash Flows of an increase in short-term interest rates generally will be offset in whole or in part by a corresponding increase in mortgage interest rates while the positive impact on the Company's Net Cash Flows of a decrease in short-term interest rates generally will be offset in whole or in part by a corresponding decrease in mortgage interest rates. See \"Business -- Special Considerations -- Mortgage Asset Considerations - -- Prepayment Risks.\" However, although short-term interest rates and mortgage interest rates normally change in the same direction and therefore generally offset each other as described above, they may not change proportionally or may even change in opposite directions during a given period of time with the result that the adverse effect from an increase in short-term interest rates may not be offset to a significant extent by a favorable effect on prepayment experience and visa versa. Thus, the net effect of changes in short-term and mortgage interest rates may vary significantly between periods resulting in significant fluctuations in Net Cash Flows.\nChanges in interest rates also affect the Company's reinvestment income. See \"Business -- Special Considerations -- Mortgage Asset Considerations -- Reinvestment Income and Expense Risks.\" Changes in interest rates after the Company acquires Mortgage Assets can result in a reduction in the value of such Mortgage Assets and could result in losses in the event of a sale.\nThe Company from time to time utilizes hedging techniques to mitigate against fluctuations in market interest rates. However, no hedging strategy can completely insulate the Company from such risks, and certain of the federal income tax requirements that the Company has been required to satisfy to qualify as a REIT have severely limited the Company's ability to hedge. Even hedging strategies permitted by the federal income tax laws could result in hedging income which, if excessive, could result in the Company's disqualification as a REIT for failing to satisfy certain REIT income tests. See \"Business -- Federal\nIncome Tax Considerations -- Qualification of the Company as a REIT.\" In addition, hedging involves transaction costs, and such costs increase dramatically as the period covered by the hedging protection increases. Therefore, the Company may be prevented from effectively hedging its investments. See \"Business -- Hedging.\"\nNo assurances can be given as to the amount or timing of changes in interest rates or their effect on the Company's Mortgage Assets or income therefrom.\nReinvestment Income and Expense Risks\nIn the event that actual reinvestment rates decrease over the term of a series of Mortgage Securities, reinvestment income will be reduced, which in turn will adversely affect the Company's Net Cash Flows. The Company also may be liable for or its return may be subject to the expenses relating to such Mortgage Securities including administrative, trustee, legal and accounting costs and, in certain cases, for any liabilities under indemnifications granted to the underwriters, trustees or other Issuers. These expenses are used in projecting Net Cash Flows; however, to the extent that these expenses are greater than those assumed, such Net Cash Flows will be adversely affected. Moreover, in later years, Mortgage Instruments securing or underlying a series of Mortgage Securities may not generate sufficient cash flows to pay all of the expenses incident to such Mortgage Securities. Although reserve funds generally are established to cover such future expenses, there can be no assurance that such reserves will be sufficient.\nNo assurance can be given as to the actual reinvestment rates or the actual expenses incurred with respect to such Mortgage Securities.\nBorrowing Risks\nSubject to the terms of the Company's Bylaws, the availability and cost of borrowings, various market conditions, restrictions that may be contained in the Company's financing arrangements from time to time and other factors, the Company may increase the amount of funds available to it with funds from borrowings including borrowings under loan agreements, repurchase agreements and other credit facilities. The Company's borrowings to date generally have been secured by Mortgage Assets owned by the Company. Any borrowings may bear fixed or variable interest rates, may require additional collateral in the event that the value of existing collateral declines on a market value basis and may be due on demand or upon the occurrence of certain events. To the extent that borrowings bear variable interest rates, changes in short-term interest rates will significantly influence the cost of such borrowings and could result in losses in certain circumstances. See \"Business -- Special Considerations -- Mortgage Asset Considerations -- Interest Rate Fluctuation Risks.\" The Company also may increase the amount of its available funds through the issuance of debt securities.\nIf the Company pledges Mortgage Assets to secure borrowed funds and the cost of such borrowings increases to the extent that such cost exceeds the Net Cash Flows on such Mortgage Assets, such an increase would reduce Net Cash Flows and could result in losses in certain circumstances. No assurance can be given as to the cost or availability of any such borrowings which the Company may determine to incur. As of December 31, 1995, the Company's long-term debt represented by its Secured Notes (as described herein) totalled $7,819,000 or 42.38% of stockholders' equity.\nNo assurance can be given as to the actual effect of borrowings by the Company.\nInability to Predict Effects of Market Risks\nBecause none of the above factors including changes in prepayment rates, interest rates, reinvestment income, expenses and borrowing costs are susceptible to accurate projection, the Net Cash Flows generated by the Company's Mortgage Assets cannot be predicted.\nDecline in Net Cash Flows from Mortgage Assets\nThe Company derives income from the Net Cash Flows received on its Mortgage Assets. The rights to receive such Net Cash Flows (\"Net Cash Flow Interests\") result from the Company's ownership of Mortgage Instruments and Mortgage Interests with respect to Mortgage Instruments. Because the Company's Net Cash Flows derive principally from the difference between the cash flows on the Mortgage\nInstruments underlying Mortgage Securities and the required cash payments on the Mortgage Securities, Net Cash Flows are the greatest in the years immediately following the purchase of Mortgage Assets and decline over time unless the Company reinvests its Net Cash Flows in additional Mortgage Assets which it currently does not contemplate. This decline in Net Cash Flows over time occurs as (i) interest rates on Mortgage Securities classes receiving principal payments first generally are lower than those on later classes thus effectively increasing the relative interest cost of the Mortgage Securities over time and (ii) mortgage prepayments on Mortgage Instruments with higher interest rates tend to be higher than on those with lower interest rates thus effectively lowering the relative interest income on the Mortgage Instruments over time.\nPledged Assets\nSubstantially all of the Company's Mortgage Assets and the Net Cash Flows therefrom currently are and in the future can be expected to be pledged to secure or underlie Mortgage Securities, bank borrowings, repurchase agreements or other credit arrangements. Therefore, such Mortgage Assets and Net Cash Flows will not be available to the stockholders in the event of the liquidation of the Company except to the extent that the market value thereof exceeds the amounts due to the senior creditors. However, the market value of the Mortgage Assets is uncertain because the market for Mortgage Assets of the type owned by the Company is not well developed and fluctuates rapidly as the result of numerous market factors (including interest rates and prepayment rates) as well as the supply of and demand for such assets. In addition, the Company may pledge its Real Estate Loans in the future to secure any indebtedness that it may incur.\nMarket Price of Common Stock\nThe market price of the Company's Common Stock has been and may be expected to continue to be extremely sensitive to a wide variety of factors including the Company's operating results, dividend payments (if any), actual or perceived changes in short-term and mortgage interest rates and their relationship to each other, actual or perceived changes in mortgage prepayment rates, and any variation between the net yield on the Company's Mortgage Assets and prevailing market interest rates. Any actual or perceived unfavorable changes in the Company's operating results, or other factors resulting from the circumstances described herein or other circumstances, may adversely affect the market price of the Company's Common Stock.\nFuture Offerings of Common Stock\nThe Company in the future may increase its capital resources by making additional offerings of its Common Stock or securities convertible into its Common Stock. The actual or perceived effect of such offerings may be the dilution of the book value or earnings per share of the Company's Common Stock which may result in the reduction of the market price of the Company's Common Stock. The Company is unable to estimate the amount, timing or nature of future sales of its Common Stock as such sales will depend upon market conditions and other factors such as its need for additional equity, its ability to apply or invest the proceeds of such sales of its Common Stock, the terms upon which its Common Stock could be sold, and any restrictions on its ability to sell its Common Stock contained in any credit facility or other agreements.\nPotential Conflicts of Interest\nThe Company's Articles of Incorporation limit the liability of its directors and officers to the Company and its stockholders to the fullest extent permitted by Maryland law, and both the Company's Articles and Bylaws provide for indemnification of the directors and officers to such extent. See \"Directors and Executive Officers of Registrant.\" In addition, the Subcontract Agreement limits the responsibilities of ASFS and provides for the indemnification of ASFS, its affiliates and their directors and officers against various liabilities. See \"Business -- The Subcontract Agreement.\"\nCertain Consequences of REIT Status\nThe Company is considering making an election to not be taxed as a REIT for federal income tax purposes. See \"Business -- Introduction.\" To the extent the Company maintains its qualification as a\nREIT for federal income tax purposes, the Company must continually satisfy certain tests with respect to the sources of its income, the nature and diversification of its assets, the amount of its distributions to stockholders and the ownership of its stock. See \"Business -- Federal Income Tax Considerations -- Status of the Company as a REIT\" and \"Qualification of the Company as a REIT.\" Among other things, these restrictions may limit the Company's ability to acquire certain types of assets that it otherwise would consider desirable, limit the ability of the Company to dispose of assets that it has held for less than four years if the disposition would result in gains exceeding specified amounts, limit the ability of the Company to engage in hedging transactions that could result in income exceeding specified amounts, and require the Company to make distributions to its stockholders at times that the Company may deem it more advantageous to utilize the funds available for distribution for other corporate purposes (such as the purchase of additional assets or the repayment of debt) or at times that the Company may not have funds readily available for distribution.\nThe Company's operations from time to time may generate taxable income in excess of its net income for financial reporting purposes. The Company also may experience a situation in which its taxable income is in excess of the actual receipt of Net Cash Flows. See \"Business -- Federal Income Tax Considerations -- Activities of the Company.\" To the extent that the Company does not otherwise have funds available, either situation may result in the Company's inability to distribute substantially all of its taxable income as required to maintain its REIT status. See \"Business -- Federal Income Tax Considerations.\" The Company may be required to borrow funds to make the required distributions which could have the effect of reducing the yield to its stockholders, to sell a portion of its assets at times or for amounts that are not advantageous, or to distribute amounts that represent a return of capital which would reduce the equity of the Company. Currently, the Company has net operating losses (\"NOL\") and is allowed to offset those losses against most current taxable income. Thus, until the NOL has been used, the Company generally will not have to make dividend distributions.\nIf the Company should not qualify as a REIT in any tax year, whether voluntarily or involuntarily, it would be taxed as a regular domestic corporation and, among other consequences, distributions to the Company's stockholders would not be deductible by the Company in computing its taxable income provided it had any taxable income after application of its NOL. Any such tax liability would reduce the amount of cash available for distributions to the Company's stockholders. See \"Business -- Federal Income Tax Considerations.\" In addition, the unremedied 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 the four subsequent years. During any period that the Company was not a REIT, there would be no federal income tax restrictions on its activities.\nExcess Inclusions\nThe portion of any dividends paid by the Company and characterized as \"excess inclusions\" constitutes unrelated business taxable income to certain otherwise tax-exempt stockholders, will constitute a floor for the taxable income of stockholders not exempt from tax, and will not be eligible for any reduction (by treaty or otherwise) in the rate of income tax withholding in the case of nonresident alien stockholders. See \"Business -- Federal Income Tax Considerations -- Tax Consequences of Common Stock Ownership -- Excess Inclusion Rule.\"\nMarketability Of Shares Of Common Stock And Restrictions On Ownership\nThe Company's Articles of Incorporation prohibit ownership of its Common Stock by tax-exempt entities that are not subject to tax on unrelated business taxable income and by certain other persons (collectively \"Disqualified Organizations\"). Such restrictions on ownership exist so as to avoid imposition of a tax on a portion of the Company's income from excess inclusions.\nProvisions of the Company's Articles of Incorporation also are designed to prevent concentrated ownership of the Company which might jeopardize its qualification as a REIT under the Code if the Company continues its REIT election as well as its tax loss carryforward. Among other things, these provisions provide (i) that any acquisition of shares that would result in the disqualification of the Company as a REIT under the Code will be void, and (ii) that in the event any person acquires, owns or\nis deemed, by operation of certain attribution rules set out in the Code, to own a number of shares in excess of 9.8% of the outstanding shares of the Company's Common Stock (\"Excess Shares\"), the Board of Directors, at its discretion, may redeem the Excess Shares. In addition, the Company may refuse to effectuate any transfer of Excess Shares and certain stockholders, and proposed transferees of shares, may be required to file an affidavit with the Company setting forth certain information relating, generally, to their ownership of the Company's Common Stock. These provisions may inhibit market activity and the resulting opportunity for the Company's stockholders to receive a premium for their shares that might otherwise exist if any person were to attempt to assemble a block of shares of the Company's Common Stock in excess of the number of shares permitted under the Articles of Incorporation. Such provisions also may make the Company an unsuitable investment vehicle for any person seeking to obtain (either alone or with others as a group) ownership of more than 9.8% of the outstanding shares of Common Stock. Investors seeking to acquire substantial holdings in the Company should be aware that this ownership limitation may be exceeded by a stockholder without any action on such stockholder's part in the event of a reduction in the number of outstanding shares of the Company's Common Stock.\nOn December 13, 1993, the Board of Directors approved the adoption of a program to repurchase up to 2,000,000 shares of the Company's Common Stock in open market conditions. The decision to repurchase shares pursuant to the program, and the timing and amount of such purchases, will be based upon market conditions then in effect and other corporate considerations. Through December 31, 1995, 15,200 shares of Common Stock have been repurchased under such program.\nInvestment Consequences of Exemption from Investment Company Act\nThe Company conducts its business so as not to become regulated as an investment company under the Investment Company Act of 1940, as amended (the \"Investment Company Act\"). Accordingly, the Company does not expect to be subject to the restrictive provisions of the Investment Company Act. The Investment Company 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 Real Estate Loans, Mortgage Loans, certain Mortgage Certificates and certain other qualifying interests in real estate. The Company's ownership of certain Mortgage Assets therefore may be limited by the Investment Company 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. If the Company failed to qualify for exemption from registration as an investment company, its ability to use investment leverage would be substantially reduced, it would be prohibited from engaging in certain transactions with affiliates, and it would be unable to conduct its business as described herein. Such a failure to qualify could have a material adverse effect on the Company.\nFederal Income Tax Considerations\nQualification of The Company as a REIT\nGeneral\nThe Company has made an election to be treated as a real estate investment trust (\"REIT\"). Thus, if the Company satisfies certain tests in each taxable year with respect to the nature of its income, assets, share ownership and the amount of its distributions, among other things, it generally should not be subject to tax at the corporate level on its income to the extent that it distributes cash in the amount of such income to its stockholders.\nGenerally, the unremedied failure of the Company to be treated as a REIT for any taxable year could materially and adversely affect the stockholders as net income of the Company would be taxed at ordinary\ncorporate rate (currently a maximum of 34 percent), and the Company would not receive a deduction for any dividends to the stockholders and thus cause a material reduction of the cash available for distribution to the stockholders as dividends.\nIn order to maintain its qualification as a REIT for federal income tax purposes, the Company must continually 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 summary discussion of those various 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.\nUnder 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. The 95% income test requires that at least 95% of the Company's gross income for the taxable year must be derived from the items of income that either qualify under the 75% test or are from certain other types of passive investments. Finally, the 30% income test requires the Company to 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 or swap agreements held for less than one year, and (3) property in \"prohibited transactions.\" A prohibited transaction is a sale or disposition of dealer property that is not foreclosure property or, under certain circumstances, a real estate asset held for at least four years.\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 equal to 100% of any excess nonqualifying income. See \"Business -- Federal Income Tax considerations -- Taxation of the Company.\" There is no comparable safeguard that could protect against REIT disqualification as a result of the Company's failure to satisfy the 30% income test.\nFor so long as the Company intends to maintain its REIT election, the Company anticipates that its gross income will continue to consist principally of the income that satisfies the 75% income test. The composition and sources of the Company income should allow the Company to satisfy the income tests during each year of its existence. Certain short-term reinvestments, however, 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, the 75% income test, and\/or the 95% income test. The company intends to monitor its reinvestments and hedging transactions closely to attempt 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), federal government securities and qualifying real estate assets. Qualifying real estate assets include interests in real property and mortgages, equity interests in other REITs, any stock or debt instrument for so long as the income therefrom is qualified temporary investment income and, subject to certain limitations, interests in REMICs. The balance of the Company's assets may be invested without restriction, except that holdings of the securities of any one non-governmental issuer may not exceed 5% of the value of the Company's assets or 10% of the outstanding voting securities of that issuer.\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 will take such action as may be required to cure any failure to satisfy the 75% asset test within 30 days after\nthe 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.\nDistributions\nEach taxable year, the Company 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 noncash 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 if certain guidelines are followed. 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 Internal Revenue Service (\"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 to stockholders and certain interest and penalties to the IRS. The Company intends to make distributions to its stockholders on a basis that will allow the Company to satisfy the distribution requirement. In certain instances, however, the Company's pre-distribution taxable income may exceed its cash flow and the Company may have difficulty satisfying the distribution requirement. The Company intends to monitor closely the relationship between its pre-distribution taxable income and its cash flow. It is possible, although unlikely, that the Company may decide to terminate its REIT status as a result of any such cash shortfall. Such a termination would have adverse consequences to the stockholders. See \"Business -- Federal Income Tax considerations -- Status of the Company as a REIT.\"\nThe Company has a net operating loss carryforward for income taxes (the \"NOL\"). Under REIT tax rules, the Company is allowed to offset taxable income (except for Excess Inclusion Income) by the available NOL and thus, under most circumstances, is not currently required to make distributions to stockholders except for Excess Inclusion Income.\nOwnership of the Company\nShares of the Company's Common Stock must be held by a minimum of 100 persons for at least 335 days in each 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. 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. The Company's Articles of Incorporation contain repurchase provisions and transfer restrictions designed to prevent violation of the latter requirement. Therefore, the Company believes that its shares of Common Stock currently are owned by a sufficient number of unrelated persons to allow the Company to satisfy the ownership requirements for REIT qualification.\nTaxation of the Company\nFor any taxable year in which the Company qualifies and elects to be treated as a REIT under the Code, 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. Regardless of distributions to stockholders, however, the Company may become subject to a tax on certain types of income.\nThe Company uses the calendar year both for tax purposes and for financial reporting purposes. Due to the differences between tax accounting rules and generally accepted accounting principles, the Company's REIT Taxable Income will vary from its net income for financial reporting purposes.\nTax Consequences of Common Stock Ownership\nThe federal income tax consequences of ownership in the Company's common is a complex matter and may vary depending on the income tax status of the stockholder. Accordingly, the following discussion is intended to be general in nature. Stockholders should consult their own tax advisors regarding the income tax considerations with respect to their investments in the Company.\nDividend Income\nDistributions to stockholders out of the Company's current or accumulated earnings and profits will be taxable as \"portfolio income\" in October, November or December of any calendar year and payable to stockholders of record as of a specified date prior to the end of the year, however, that dividend will be deemed to have been received by the stockholder on December 31 if the dividend is actually paid in January of the following calendar year.\nThe Company's dividends will not be eligible for the dividends-received deduction for corporations. If the Company's total distributions for a taxable year exceed its current and accumulated earnings and profits, a portion of each distribution will be treated first as a return of capital, reducing a stockholder's basis in his shares (but not below zero), and then as capital gain in the event such distributions are in excess of a stockholder's adjusted basis in his shares.\nDistributions properly designated by the Company as \"capital gain dividends\" will be taxable to the stockholders as long-term capital gain, to the extent those dividends do not exceed the Company's actual net capital gain for the taxable year, without regard to the stockholder's holding period for his shares. The Company will notify stockholders after the close of its taxable year regarding the portions of the distributions that constitute ordinary income, return of capital and capital gain. The Company also will notify shareholders regarding their reported share of excess inclusion income. See \"Excess Inclusion Rule\" below.\nExcess Inclusion Rule\nOwnership by the Company of residual interests in REMICs may adversely affect the federal income taxation of the Company and of certain stockholders to the extent those residual interests generate \"excess inclusion income.\" The Company's excess inclusion income during a calendar quarter generally will equal the excess of its taxable income from residual interests in REMICs over its \"daily accruals\" with respect to those residual interests for the calendar quarter. The daily accruals are calculated by multiplying the adjusted issue price of the residual interest by 120 percent of the long-term federal interest rate in effect on the REMICs startup date. It is possible that the Company will have excess inclusion income without associated cash. In taxable years in which the Company has both a net operating loss and excess inclusion income it will still have to report a minimum amount of taxable income equal to its excess inclusion income. In order to maintain its REIT status, the Company will be required to distribute at least 95 percent of its taxable income, even if its taxable income is comprised exclusively of excess inclusion income and otherwise has a net operating loss.\nIn general, each stockholder is required to treat the stockholder's allocable share of the portion of the Company's \"excess inclusions\" that is not taxable to the Company as an \"excess inclusion\" received by such stockholder. The portion of the Company's dividends that constitute excess inclusions typically will rise as the degree of leveraging of the Company's activities increase. Therefore, all or a portion of the dividends received by the stockholders may be excess inclusion income. Excess inclusion income will constitute unrelated business taxable income for tax-exempt entities and may not be used to offset deductions or net operating losses from other sources for most other taxpayers.\nTax-Exempt Organizations as Stockholders\nThe Code requires a tax-exempt stockholder of the Company to treat as unrelated business taxable income its allocable share of the Company's excess inclusions. The Company is likely to receive excess inclusion income. See \"Excess Inclusion Rule,\" above. The Company's Common Stock may not be held by tax-exempt entities which are not subject to tax on unrelated business taxable income.\nTaxation of Foreign Stockholders\nDistributions of cash generated by the Company in its operations that are paid to foreign persons generally will be subject to United States withholding tax rate at a rate of 30 percent or at a lower rate if a foreign person can claim the benefit of a tax treaty. Notwithstanding the foregoing, distributions made to foreign stockholders will not be subject to treaty withholding reductions to the extent of their allocable shares of the portion of the Company's excess inclusions that are not taxable to the Company for the period under review. It is expected that the company will continue to have excess inclusions. Distributions to foreign persons of cash attributable to gain on the Company's sale or exchange of real properties, if any, generally will be subject to full United States taxation and withholding. If a foreign person holds more than five percent of the shares of the Company, gain from the sale of the person's shares could be subject to full United States taxation if the Company held any real property interests and was not a domestically controlled REIT.\nThe federal income taxation of foreign persons is a highly complex matter that may be affected by many considerations. Accordingly, foreign investors in the Company should consult their own tax advisors regarding the income and withholding tax considerations with respect to their investments in the Company. Foreign governments and organizations, and their instrumentalities, may not invest in the Company.\nBackup Withholding\nThe Company is required by the Code to withhold from dividends 20% of the amount paid to stockholders, unless the stockholder (i) files a correct taxpayer identification number with the Company, (ii) certifies as to no loss of exemption from backup withholding and (iii) otherwise complies with the applicable requirements of the backup withholding rules. The Company will report to its stockholders and the IRS the amount of dividends paid during each calendar year and the amount of tax withheld, if any. Stockholders should consult their tax advisors as to the procedure for insuring that the Company dividends to them will not be subject to backup withholding.\nState and Local Taxes\nThe discussion herein concerns only the federal income tax treatment likely to be accorded the Company and its stockholders. No discussion has been provided regarding the state or local tax treatment of the Company and its stockholders. The state and local tax treatment may not conform to the federal income tax treatment described above and each investor should discuss such issues with his state and local tax advisor.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe principal executive offices of the Company are located at 5333 North Seventh Street, Suite 219, Phoenix, Arizona 85014, telephone (602) 265-8541.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nNone\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS\nNot Applicable.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Company's Common Stock is listed on the New York Stock Exchange under the symbol \"HPX.\" The high and low sales prices of shares of the Common Stock on the New York Stock Exchange and the dividends per share paid by the Company for the periods indicated were as follows:\nDividends High Low Per Share -------- ------- ------------- First quarter .....$1 3\/4 $1 $ 0 Second quarter ... 2 1\/8 1 1\/4 0 Third quarter ..... 2 1\/8 1 1\/2 0 Fourth quarter ... 1 7\/8 1 3\/8 .03 First quarter ..... 1 1\/2 1 0 Second quarter ... 1 1\/2 1 0 Third quarter ..... 1 1\/2 1 0 Fourth quarter ... 1 3\/8 1 .02\nOn March 25, 1996, the closing sales price of the Common Stock of the Company on the New York Stock Exchange was $1 5\/8 . On December 31, 1995, the Company had outstanding 9,716,517 shares of Common Stock which were held by approximately 700 stockholders of record. Based upon information available to the Company, the Company believes that there are approximately 6,000 beneficial owners of its Common Stock.\nSo long as the Company elects 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 generally intends that the cash dividends paid each year to its stockholders will equal or exceed the Company's taxable income. The actual amount and timing of dividend payments, however, 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.\nThe Company has accumulated a net operating loss carryforward, for income tax purposes, of approximately $57,000,000 as of December 31, 1995. This tax loss may be carried forward, with certain restrictions, for up to 14 years to offset future taxable income, if any. Until the tax loss carryforward is fully utilized, the Company will not be required to distribute dividends to its stockholders except to the extent of its \"excess inclusion income.\" See \"Business -- Federal Income Tax Considerations -- Taxation of Common Stock Ownership -- Excess Inclusion Income.\"\nThe Company may apply the principal from repayments, sales and refinancings of the Company's Mortgage Assets to reduce the unpaid principal balance of its Secured Notes. The Company also may, under certain circumstances, and subject to the distribution requirements referred to above, make distributions of principal. Such distributions of principal, if any, will be made at the discretion of the Board of Directors and only to the extent permitted by the Company's Indenture with respect to the Secured Notes.\nAlthough a portion of the dividends may be designated by the Company as capital gain or may constitute a return of capital, it is anticipated that dividends generally will be taxable as ordinary income to taxpaying stockholders of the Company. With respect to tax-exempt organizations, it is likely that a significant portion of the dividends will be treated as unrelated business taxable income (\"UBTI\"). Dividends received by a corporation will not be eligible for the dividends-received deduction so long as\nthe Company qualifies as a REIT. The Company furnishes 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 gains. For a discussion of the federal income tax treatment of distributions by the Company, see \"Business -- Federal Income Tax Considerations -- Taxation of the Company, -- Tax Consequences of Common Stock Ownership, and -- Tax-Exempt Organizations as Stockholders.\"\nThe taxable income of the Company from its Mortgage Assets is increased by non-cash income from, among other things, the accretion of market discount on the Mortgage Instruments securing or underlying Mortgage Securities and is decreased by non-cash expenses, including, among other things, the amortization of the issuance costs of Mortgage Securities and the accretion of original issue discount on certain Classes of Mortgage Securities. The taxable income of the Company will differ from its net income for financial reporting purposes principally as a result of the different method used to determine the effect and timing of recognition of such non-cash income and expenses.\nBecause the Company must distribute to its stockholders an amount equal to substantially all of its net taxable income (computed after taking into account any net operating loss carryforwards that are available) so long as it elects to qualify as a REIT, the Company may be required to distribute a portion of its working capital to its stockholders, borrow funds or sell assets to make required distributions in years in which the non-cash items of taxable income exceed the Company's non-cash expenses. In the event that the Company is unable to pay dividends equal to substantially all of its taxable income, it will not continue to qualify as a REIT.\nThe Company's Articles of Incorporation, as amended to date (the \"Articles of Incorporation\"), prohibit ownership of its Common Stock by tax-exempt entities that are not subject to tax on unrelated business taxable income and by certain other persons (collectively \"Disqualified Organizations\"). Such restriction on ownership exists so as to avoid imposition of a tax on a portion of the Company's income from excess inclusions.\nProvisions of the Company's Articles of Incorporation also are designed to prevent concentrated ownership of the Company which might jeopardize its qualification as a REIT under the Code. Among other things, these provisions provide (i) that any acquisition of shares that would result in the disqualification of the Company as a REIT under the Code will be void, and (ii) that in the event any person acquires, owns or is deemed, by operation of certain attribution rules set out in the Code, to own a number of shares in excess of 9.8% of the outstanding shares of the Company's Common Stock (\"Excess Shares\"), the Board of Directors, at its discretion, may redeem the Excess Shares. In addition, the Company may refuse to effectuate any transfer of Excess Shares and certain stockholders and proposed transferees of shares may be required to file an affidavit with the Company setting forth certain information relating, generally, to their ownership of the Company's Common Stock. These provisions may inhibit market activity and the resulting opportunity for the Company's stockholders to receive a premium for their shares that might otherwise exist if any person were to attempt to assemble a block of shares of the Company's Common Stock in excess of the number of shares permitted under the Articles of Incorporation. Such provisions also may make the Company an unsuitable investment vehicle for any person seeking to obtain (either alone or with others as a group) ownership of more than 9.8% of the outstanding shares of Common Stock. Investors seeking to acquire substantial holdings in the Company should be aware that this ownership limitation may be exceeded by a stockholder without any action on such stockholder's part if the number of outstanding shares of the Company's Common Stock is reduced. On December 13, 1993, the Board of Directors approved the adoption of a program to repurchase up to 2,000,000 shares of the Company's Common Stock in open market conditions. The decision to repurchase shares pursuant to the program, and the timing and amount of such purchases, will be based upon market conditions then in effect and other corporate considerations. As of December 31, 1995, 15,200 shares of common stock have been repurchased under such program.\nITEM 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 elsewhere herein. The data has been derived from the financial statements of the Company audited by Ernst & Young LLP, independent certified public accountants, as indicated by their report thereon as specified therein which also appears elsewhere herein.\nAt December 31, ----------------------------------------------- 1995 1994 1993 1992 1991 --------- --------- -------- -------- --------- (In Thousands) BALANCE SHEET DATA: Real Estate Loans .........$ 4,048 $ 9,260 $ 320 $ -- $ -- Residual Interests ........ 5,457 7,654 17,735 66,768 112,988 Total Assets .............. 27,816 31,150 43,882 87,063 121,502 Long-Term Debt ............ 7,819 11,783 19,926 31,000 16,450 Total Liabilities ......... 9,368 13,508 21,505 32,357 43,462 Total Stockholders' Equity 18,448 17,642 22,377 54,706 78,040\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION, RESULTS OF OPERATIONS AND INTEREST RATES AND OTHER INFORMATION\nResults of Operations -- 1995 Compared to 1994\nThe Company had net income of $1,097,000 or $.11 per share in 1995 compared to a net loss of $4,524,000 or $.47 per share in 1994.\nThe Company's income from Mortgage Assets was $3,564,000 in 1995 compared to a loss of $1,203,000 in 1994. The above amounts include a net charge of $3,343,000 in 1994 to write down the Company's investments in several of its residual interests. There were no write-downs of residual interests in 1995. See \"Interest Rates and Prepayments.\"\nInterest income on real estate loans increased from $1,113,000 in 1994 to $1,618,000 in 1995 due to the expansion of the Company's real estate lending program. See \"Liquidity, Capital Resources and Commitments.\"\nThe Company's interest expense declined from $1,383,000 in 1994 to $868,000 in 1995 due to a reduction of the average aggregate long-term debt.\nGeneral and administrative expenses in 1994 include $340,000 of legal and investment banking expenses related to merger negotiations with a privately held company which were subsequently terminated.\nResults of Operations -- 1994 Compared to 1993\nThe Company incurred a net loss of $4,524,000 or $.47 per share in 1994 compared to a net loss of $31,988,000 or $3.29 per share in 1993.\nThe Company's loss from Mortgage Assets was $1,203,000 in 1994 compared to a loss of $21,814,000 in 1993. The above amounts include net charges of $3,343,000 in 1994 and $22,312,000 in 1993 to write down the Company's investments in several of its residual interests. Write-downs of residual interests declined in 1994 as compared to 1993 because of a decrease in the average balance of residual interests owned by the Company and a decline in projected prepayment rates. See \"Interest Rates and Prepayments.\"\nInterest income on real estate loans increased from $29,000 in 1993 to $1,113,000 in 1994 due to the expansion of the Company's real estate lending program. See \"Liquidity, Capital Resources and Commitments.\"\nThe Company's interest expense declined from $2,274,000 in 1993 to $1,383,000 in 1994 due to a reduction of the average aggregate long-term debt.\nGeneral and administrative expenses in 1994 include $340,000 of legal and investment banking expenses related to merger negotiations with a privately held company which were subsequently terminated.\nLiquidity, Capital Resources and Commitments\nThe Company raised $80,593,000 in connection with its initial public offering on July 27, 1988. The proceeds were immediately utilized to purchase residual interests. Subsequently, through October 1988, the Company purchased an additional $59,958,000 of residual interests which were initially financed using a combination of borrowings under repurchase agreements and the Company's bank line of credit. The Company has not purchased any residual interests since October 1988.\nSince December 1993, the Company has originated real estate loans secured by various first deeds of trust on real properties located in Arizona. The Company's loan program seeks higher returns by targeting loan opportunities to which the Company can respond on a more timely basis than traditional real estate lenders. At December 31, 1995, all of the Company's loans are secured by properties located in Arizona. As a result of this geographic concentration, unfavorable economic conditions in Arizona could increase the likelihood of defaults on these loans and affect the Company's ability to protect the principal\nand interest on such loans following foreclosures upon the real properties securing such loans. The Company may, in the future, make loans on properties located outside of Arizona. At December 31, 1995 the Company's real estate loans outstanding total $4,048,000 and bear interest at 16%, payable monthly, with all principal due within one year.\nOn December 17, 1992, a wholly owned limited-purpose subsidiary of the Company issued $31,000,000 of Secured Notes under an Indenture to a group of institutional investors. The Notes bear interest at 7.81% and require quarterly payments of principal and interest with the balance due on February 15, 1998. The Notes are secured by the Company's residual interests in Westam 1, Westam 3, Westam 5, Westam 6, ASW 65, FNMA 1988-24 and FNMA 1988-25 and by funds held by the Note Trustee. The Company used $3,100,000 of the proceeds to establish a reserve fund. The reserve fund has a specified maximum balance of $7,750,000, and is to be used to make the scheduled principal and interest payments on the Notes if the cash flow available from the collateral is not sufficient to make the scheduled payments. Depending on the level of certain specified financial ratios relating to the collateral, the cash flow from the collateral is required to either repay the Notes at par, increase the reserve fund up to its $7,750,000 maximum or is remitted to the Company. At December 31, 1995, $5,638,000 is held by the Note Trustee in the reserve and other funds under the Indenture.\nUnder a revolving line of credit agreement with a bank, the Company may borrow up to $5,000,000, upon payment of a 1\/2 % commitment fee with interest payable monthly at prime plus 1\/2 %. Such advances are to be secured by certain of the Company's real estate loans with the amount advanced equal to between 40% to 60% of the principal amount of the real estate loans pledged. Only real estate loans approved by the bank are eligible for advances. The agreement contains certain financial covenants and expires on May 5, 1996. Through December 31, 1995, the Company has not drawn upon the line of credit.\nAs a real estate investment trust (REIT), the Company is not subject to income tax at the corporate level as long as it distributes 95% of its taxable income to its stockholders. At December 31, 1995, the Company has a net operating loss carryforward, for income tax purposes, of approximately $57,000,000. This tax loss may be carried forward, with certain restrictions, for up to 14 years to offset future taxable income, if any. Until the tax loss carryforward is fully utilized or expires, the Company will not be required to distribute dividends to its stockholders except for income that is deemed to be excess inclusion income.\nThe Company anticipates that future cash flow from operations will be used for payment of operating expenses and debt service with the remainder, if any, available for investment in mortgage or real estate related assets. The Company is also exploring other strategic options including the possible termination of the REIT status in conjunction with the possible purchase of an operating company.\nInterest Rates and Prepayments\nOne of the Company's major sources of income is its income from residual interests which consists of the Company's investment in eight real estate mortgage investment conduits (\"REMICs\") as described in Note 4 to the financial statements. The Company's cash flow and return on investment from its residual interests are highly sensitive to the prepayment rate on the related mortgage certificates and the variable interest rates on variable rate CMOs and MPCs.\nAt December 31, 1995, the Company's proportionate share of floating-rate CMOs and MPCs in the eight REMICs is $36,550,000 in principal amount that pays interest based on LIBOR and $4,427,000 in principal amount that pays interest based on COFI. Consequently, absent any changes in prepayment rates on the related mortgage certificates, increases in LIBOR and COFI will decrease the Company's net income, and decreases in LIBOR and COFI will increase the Company's net income. The average LIBOR and COFI rates were as follows:\nAT DEC. 31, 1995 1994 1993 1995 ------- ------- ------- ------------- LIBOR ....... 6.00% 4.33% 3.22% 6.00% COFI ........ 4.96% 3.83% 4.16% 5.12%\nOn May 12, 1992, the Company entered into a LIBOR ceiling rate agreement with a bank for a fee of $245,000. The agreement, which had a term of two years beginning July 1, 1992, required the bank to pay a monthly amount to the Company equal to the product of $175,000,000 multiplied by the percentage, if any, by which actual one-month LIBOR (measured on the first business day of each month) exceeded 9.0%. Through the expiration of the agreement on July 1, 1994, LIBOR remained under 9.0% and, accordingly, no amounts were paid under the agreement.\nThe Company's cash flow and return on investment from residual interests also is sensitive to prepayment rates on the mortgage certificates securing the CMOs and underlying the MPCs. In general, slower prepayment rates will tend to increase the cash flow and return on investment residual from interests. The rate of principal prepayments on mortgage certificates is influenced by a variety of economic, geographic, social and other factors. In general, prepayments of the mortgage certificates should increase when the current mortgage interest rates fall below the interest rates on the fixed rate mortgage loans underlying the mortgage certificates. Conversely, to the extent that then current mortgage interest rates exceed the interest rates on the mortgage loans underlying the mortgage certificates, prepayments of such mortgage certificates should decrease. Prepayment rates also may be affected by the geographic location of the mortgage loans underlying the mortgage certificates, conditions in mortgage loan, housing and financial markets, the assumability of the mortgage loans and general economic conditions. During 1994 and 1993 high prepayment rates resulted in the Company incurring net charges of $3,343,000 and $22,312,000, respectively, to write down its residual interests. Prepayment rates slowed in 1995 and there were no write-downs of residual interests.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nReference is made to the financial statements, the report thereon and the notes thereto commencing at page of this report, which financial statements, report and notes are incorporated herein by reference.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT\nDirectors and Executive Officers\nThe directors and executive officers of the Company are as follows:\nName Age Position(s) Held - ------------------ ----- ------------------------------------------------------- Alan D. Hamberlin 47 Chairman of the Board of Directors, Director and Chief Executive Officer Jay R. Hoffman ...41 Director, President, Secretary, Treasurer and Chief Financial and Accounting Officer Larry E. Cox ......47 Director Mark A. McKinley .49 Director Gregory K. Norris 45 Director\nAlan D. Hamberlin has been a Director and Chief Executive Officer of the Company since its organization and Chairman of the Board of Directors of the Company since January 1990. Mr. Hamberlin also served as the President of the Company from its organization until September 1995. Mr Hamberlin served as the President and Chief Executive Officer of the managing general partner of the Company's former Manager. Mr. Hamberlin has been President of Courtland Homes, Inc. since July 1983. Mr. Hamberlin has served as a Director of American Southwest Financial Corporation and American Southwest Finance Co., Inc. since their organization in September 1982. Mr. Hamberlin also has served as a Director of American Southwest Affiliated Companies since its organization in March 1985 and of American Southwest Holdings, Inc. since August 1994.\nJay R. Hoffman has been the President and a Director of the Company since September 1995 and the Secretary, Treasurer and Chief Financial and Accounting Officer of the Company since July 1988. Mr. Hoffman also served as the Vice President of the Company from July 1988 to September 1995. Mr. Hoffman, a certified public accountant, engaged in the practice of public accounting with Kenneth Leventhal & Company from March 1987 through June 1988 and with Arthur Andersen & Co. from June 1976 through March 1987.\nLarry E. Cox has been a Director of the Company since November 1995. Mr. Cox is currently the managing member of Taro Properties Arizona, L.L.C. and President of Taro Properties Arizona, Inc., land development and investment companies. Prior to that, Mr. Cox was Vice President of Forward Planning for A-M Homes, a residential homebuilder, from August 1989 to January 1992. Mr. Cox is also on the Community Relations Board of the Bank of Arizona.\nMark A. McKinley has been a Director of the Company since May 1988. Mr. McKinley is currently Senior Vice President of NationsBanc Mortgage Corporation. Prior to that, he was the Co-Founder, President and Director of Cypress Financial Corporation organized in 1983 and Managing Director of Rancho Santa Margarita Mortgage Corporation, organized in 1990. From 1968 through 1983, Mr. McKinley served as Senior Vice President of The Colwell Company, a publicly held mortgage banking corporation and was responsible for administration of secondary marketing, hedging operations and loan sales.\nGregory K. Norris has been a Director of the Company since June 1990. Mr. Norris has been the President of Norris & Benedict Associates P.C., certified public accountants, or its predecessor firms since November 1979. Mr. Norris previously was engaged in the practice of public accounting with Bolan, Vassar and Borrows, certified public accountants, from December 1978 until November 1979 and with Ernst & Whinney (now Ernst & Young) from July 1974 until December 1978.\nMessrs. Cox, McKinley and Norris are members of the Company's Audit Committee.\nThe Board of Directors held a total of ten meetings during the fiscal year ended December 31, 1995. One director was absent for one of the ten meetings. The Audit Committee met separately at one formal meeting during the year ended December 31, 1995. One director was absent for such Audit Committee meeting.\nAll directors are elected at each annual meeting of the Company's stockholders for a term of one year, and hold office until their successors are elected and qualified. All officers serve at the discretion of the Board of Directors.\nThe Bylaws of the Company provide that, if the Company elects to be treated as a REIT, the majority of the members of the Board of Directors and of any committee of the Board of Directors will at all times be persons who are not \"Affiliates\" of \"Advisors of the Company.\" An Advisor is defined in the Bylaws as a person or entity responsible for directing or performing the day to day business affairs of the Company, including a person or entity to which an Advisor subcontracts substantially all such functions. An \"Affiliate\" of another person is defined in the Bylaws to mean any person directly or indirectly owning, controlling or holding the power to vote 5% or more of the outstanding voting securities of such other person or of any person directly or indirectly controlling, controlled by or under common control with such other person; 5% or more of whose outstanding voting securities are directly or indirectly owned, controlled or held with power to vote by such other person; any person directly or indirectly controlling, controlled by or under common control with such other person; and any officer, director, partner or employee of such other person. The term \"person\" includes a natural person, a corporation, partnership, trust company or other entity.\nVacancies occurring on the Board of Directors may be filled by the vote of a majority of the directors. If the Company seeks to remain qualified as a REIT, then any replacement of an Unaffiliated Director shall be nominated by a majority of any Unaffiliated Directors remaining on the Board of Directors. All transactions involving the Company in which an Advisor has an interest must be approved by a majority of the Unaffiliated Directors.\nThe Articles of Incorporation and Bylaws of the Company provide for the indemnification of the directors and officers of the Company to the fullest extent permitted by Maryland law. Maryland law generally permits indemnification of directors and officers against certain costs, liabilities and expenses which such persons may incur by reason of serving in such positions unless it is proved that: (i) the act or omission of the director or officer was material to the cause of action adjudicated in the proceeding and was committed in bad faith or was the result of active and deliberate dishonesty; (ii) the director or officer actually received an improper personal benefit in money, property or services; or (iii) in the case of criminal proceedings, the director or officer had reasonable cause to believe that the act or omission was unlawful. Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers or persons controlling the Company pursuant to the foregoing provisions, the Company has been informed 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.\nThe Articles of Incorporation of the Company provide that the personal liability of any director or officer of the Company to the Company or its stockholders for money damages is limited to the fullest extent allowed by the statutory or decisional law of the State of Maryland as amended or interpreted. Maryland law authorizes the limitation of liability of directors and officers to corporations and their stockholders for money damages except (a) to the extent that it is proved that the person actually received an improper benefit in money, property, or services for the amount of the benefit or profit in money, property or services actually received; or (b) to the extent that a judgment or other final adjudication adverse to the person is entered in a proceeding based on a finding that the person's action, or failure to act, was the result of active and deliberate dishonesty and was material to the cause of action adjudicated. Maryland law does not affect the potential liability of directors and officers to third parties, such as creditors of the Company.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nCompensation of Officers\nThe following table sets forth compensation received by the Company's Chief Executive Officer and its other executive officer for the Company's last three fiscal years ending December 31, 1995.\nSummary Compensation Table\nOfficers and key personnel of the Company are eligible to receive stock options under the Company's stock option plan. Officers serve at the discretion of the Board of Directors.\nCompensation of Directors\nThe Company pays an annual director's fee to each Unaffiliated Director equal to $20,000, a fee of $1,000 for each meeting of the Board of Directors attended by each Unaffiliated Director and reimbursement of costs and expenses for attending such meetings. During 1995, the Unaffiliated Directors also accrued dividend equivalent rights, in the amounts of 932 with respect to Mr. McKinley, 228 with respect to Mr. Norris, and 200 with respect to Mr. Cox. The dividend equivalent rights accrued to Messrs. Hamberlin and Hoffman during 1994 are included in the table on options granted to the Company's executive officers below. In addition, the Company's Directors are eligible to participate in the Company's stock option plan described below.\nIn addition, during 1995, Mr. Cox was granted 10,000 stock options at $1.50 per share under the Company's stock option plan. One-third of the options are currently exercisable, one-third become exercisable on December 13, 1996 and the remaining one-third become exercisable on December 13, 1997.\nEmployee Agreements\nHamberlin Employment and Stock Option Agreements\nIn order to more closely align Alan D. Hamberlin's compensation with the interests of the Company's shareholders, the Company entered into an Employment Agreement with Mr. Hamberlin on December 21, 1995, which superseded the previous Employment Agreement that was to expire on April 30, 1996. The term of the Employment Agreement is for the period from December 21, 1995 through December 20, 1998. The Employment Agreement provides for the employment of Mr. Hamberlin as the chief executive officer of the Company and for Mr. Hamberlin to perform such duties and services as are customary for such a position. The Employment Agreement provides for Mr. Hamberlin to receive an annual base salary of $1.00. Mr. Hamberlin will not be entitled to any bonuses except as granted by the Board of Directors in its absolute sole discretion. In lieu of the annual base salary, the Company and Mr. Hamberlin entered into a Stock Option Agreement dated December 21, 1995 pursuant to which the Company granted an option to Mr. Hamberlin to purchase 750,000 shares of the Common Stock of the Company at $1.50 per share, which was the fair market value per share of the Common Stock on December 21, 1995. A corporation owned by Mr. Hamberlin also is entitled to the payment of $15,000 annually as reimbursement for expenses incurred by such company and providing support to Mr. Hamberlin in connection with the performance of his duties.\nThe Employment Agreement terminates (a) upon the death or disability of Mr. Hamberlin, (b) by the Company for \"Cause\" (as defined in the Employment Agreement), (c) by mutual agreement following a \"Change in Control\" (as defined in the Employment Agreement) that is unanimously approved by a Board of Directors constituted entirely of the directors serving as of December 21, 1995 and\/or new directors approved by such directors (a \"Consented Termination\") and (d) upon the election of Mr. Hamberlin. Prior to a Change in Control, if the Employment Agreement terminates for any reason other than \"Cause,\" Mr. Hamberlin will be entitled to his salary and fringe benefits through the date of termination. In addition, if the Stock Option Agreement has not been approved by the Company's shareholders as of the date of termination, Mr. Hamberlin will be entitled to certain phantom stock rights. As discussed below, the type of phantom stock rights to which he will be entitled will depend on the reason for the termination. If the Employment Agreement is terminated for Cause, Mr. Hamberlin will be entitled to his salary and fringe benefits through the date of termination but will have no further rights in the Stock Option Agreement or in any phantom stock rights. The Employment Agreement also provides that if a Change in Control occurs on or before December 20, 1998 that has not been unanimously approved by the Board as described in (c) of this paragraph (a \"Non-Approved Change in Control\") and if Mr. Hamberlin's employment has not been previously terminated, the Company will pay $500,000 to Mr. Hamberlin within 10 days of such Change in Control as well as maintain in full force and effect until December 20, 1998 all plans, programs or benefits provided to employees, including those plans, programs or benefits in which Mr. Hamberlin was entitled to participate immediately prior to the Change in Control. The Employment Agreement also provides that in the event that the Company declares a dividend through which all or substantially all of the assets of the Company are distributed to its shareholders (a \"Liquidating Dividend\"), then Mr. Hamberlin will receive a bonus in the amount of $20,833 multiplied by each full or partial month of that Mr. Hamberlin was employed by the Company since December 21, 1995.\nThe Stock Option Agreement is subject to approval by the shareholders of the Company. Mr. Hamberlin has also been conditionally granted 750,000 phantom stock rights (\"PSRs\" or \"SARs\"). If approval of the Stock Option Agreement is not obtained (a) at the Company's shareholder meeting in which the Stock Option Agreement is the subject of a shareholder vote, (b) on or before December 20, 1998; (c) on or before a day prior to a Change in Control, or (d) on or before any date prior to the termination of the Employment Agreement (other than a termination of the Employment Agreement occurring as a result of termination of Mr. Hamberlin for cause), then on the earliest of the foregoing dates, the Stock Option Agreement will terminate and the PSRs granted to Mr. Hamberlin will become effective. PSRs vest according to the following schedule: (a) 200,000 of the PSRs vested on December 21, 1995; (b) 275,000 of the PSRs vest on December 21, 1996 provided Mr. Hamberlin is either employed by the Company on that date or has left employment pursuant to a Consented Termination; and (c) 275,000 of the PSRs vest on December 21, 1997 provided Mr. Hamberlin is either employed by the Company on that date or has left the employment of the Company pursuant to a Consented Termination. Notwithstanding the foregoing, all PSRs will vest upon a Non-Approved Change in Control or upon a termination of Mr. Hamberlin's employment (without his consent) by the Company for any reason other than death, disability or Cause. Once the PSRs have become effective, all or any portion of the vested PSRs may be exercised by Mr. Hamberlin upon written notice to the Company. In general, after a Consented Termination, the PSRs remain outstanding as if Mr. Hamberlin was still employed. Upon exercise of a PSR, the Company will immediately pay to Mr. Hamberlin for each PSR exercised cash in an amount equal to the excess of the fair market value of a share of the Common Stock of the Company on the date of exercise over $1.50, which was the fair market value of a share of the Common Stock of the Company on December 21, 1995. If Mr. Hamberlin dies or becomes disabled during his employment after the PSRs have become effective, but prior to the PSRs being exercised in full, the value of all unexercised PSRs which had vested prior to the date of death or disablement will be immediately paid to Mr. Hamberlin or his estate. If Mr. Hamberlin dies on or after the PSRs have become effective and after the termination of this employment pursuant to a Consented Termination, the value of all unexercised PSRs that had vested prior to the date of death will be paid to Mr. Hamberlin's estate.\nThe Employment Agreement also provides that to the extent that the Company at any time declares and pays a dividend with respect to its Common Stock (other than a Liquidating Dividend), the Company\nwill make a cash payment to Mr. Hamberlin in an amount equal to the number of PSR shares which have vested multiplied by the per-share dividend actually declared and paid with respect to the Company's Common Stock. To the extent that such dividends are declared prior to the effective date of the PSRs, such bonus will be paid on the effective date of the PSRs. All PSRs to the extent not previously exercised will terminate on December 20, 2000 or as earlier provided.\nOn December 21, 1995, the Company and Mr. Hamberlin entered into a Stock Option Agreement pursuant to which the Company granted to Mr. Hamberlin an option to purchase 750,000 shares of the Company's Common Stock at a price of $1.50 per share, which was the fair market value of a share of the Company's Common Stock on the date of grant. The options were granted in lieu of Mr. Hamberlin receiving an annual base salary under his Employment Agreement and were not granted under the Company's Plan. Therefore, the Stock Option Agreement must be approved by the Company's shareholders before Mr. Hamberlin may exercise his options. The options vest according to the following schedule: (a) 200,000 of the options vested on December 21, 1995; (b) 275,000 of the options vest on December 21, 1996 provided Mr. Hamberlin is either employed by the Company on that date or has left employment pursuant to a \"Consented Termination\" as that term is defined in the Employment Agreement; and (c) 275,000 of the options vest on December 21, 1997 provided Mr. Hamberlin is either employed by the Company on that date or has left the employment of the Company pursuant to a Consented Termination. Notwithstanding the foregoing, all options will vest upon a Non-Approved Change in Control or upon a termination of Mr. Hamberlin's employment (without his consent) by the Company for any reason other than death, disability or cause. In addition, the options will vest in their entirety prior to any merger or consolidation in which the Company is not the surviving entity or any reverse merger in which the Company is the surviving entity. If Mr. Hamberlin's employment with the Company is terminated pursuant to the Employment Agreement upon the death or disablement of Mr. Hamberlin, the options that have previously vested shall be exercisable within one year or until the stated expiration date of the option, whichever occurs first. If Mr. Hamberlin dies after a Consented Termination, the options that have vested as of the date of death shall be exercisable within one year of such date of death or until the stated expiration date of the option, whichever occurs first. In all instances the options must be exercised on or before December 21, 2000. Mr. Hamberlin may pay the exercise price of an option in cash, by check, or by delivery of previously acquired shares of the Company's Common Stock. In the discretion of the Company, Mr. Hamberlin may be provided with the election to pay the exercise price by having the Company withhold, from the Common Stock otherwise issuable pursuant to the option, a portion of those shares of Common Stock with an aggregate fair market value equal to that portion of the exercise price designated by Mr. Hamberlin.\nHoffman Severance Agreement\nOn September 1, 1995, the Company entered into a Severance Agreement with Jay R. Hoffman pursuant to which, in the event a \"Change in Control\" (as defined in the Severence Agreement) occurs prior to August 30, 1996, Mr. Hoffman will be entitled to receive a severance bonus in an amount equal to Mr. Hoffman's annual salary.\nEmployee Benefit Plans\nStock Option Plan\nIn May 1988, the Company's Board of Directors adopted a stock option plan (the \"Plan\") which was amended on July 18, 1990 to limit the redemption price available to optionholders as described below. Under the terms of the Plan, both qualified incentive stock options (\"ISOs\"), which are intended to meet the requirements of Section 422 of the Code, and non-qualified stock options may be granted. ISOs may be granted to the officers and key personnel of the Company. Non-qualified stock options may be granted to the Company's directors and key personnel. The purpose of the Plan is to provide a means of performance-based compensation in order to attract and retain qualified personnel and to provide an incentive to others whose job performance affects the Company.\nThe maximum number of shares of the Company's Common Stock which may be covered by options granted under the Plan is limited to 437,500. An option granted under the Plan may be exercised in full\nor in part at any time or from time to time during the term of the option, or provide for its exercise in stated installments at stated times during the term of the option. The exercise price for any option granted under the Plan may not be less than 100% of the fair market value of the shares of Common Stock at the time the option is granted. The optionholder may pay the exercise price in cash, bank cashier's check, or by delivery of previously acquired shares of Common Stock of the Company. No option may be granted under the Plan to any person who, assuming exercise of all options held by such person, would own directly or indirectly more than 9.8% of the total outstanding shares of Common Stock of the Company.\nAn optionholder also will receive at no additional cost \"dividend equivalent rights\" to the extent that dividends are declared on the outstanding shares of Common Stock of the Company on the record dates during the period between the date an option is granted and the date such option is exercised. The number of dividend equivalent rights which an optionholder receives on any dividend declaration date is determined by application of a formula whereby the number of shares subject to the option is multiplied by the dividend per share and divided by the fair market value per share (as determined in accordance with the Plan) to arrive at the total number of dividend equivalent rights to which the optionholder is entitled.\nThe dividend equivalent rights earned will be distributed to the optionholder (or his successor in interest) in the form of shares of the Company's Common Stock when the option is exercised. Dividend equivalent rights will be computed both with respect to the number of shares under the option and with respect to the number of dividend equivalent rights previously earned by the optionholder (or his successor in interest) and not issued during the period prior to the dividend record date. Shares of the Company's Common Stock issued pursuant to the exchange of dividend equivalent rights will not qualify for the favored tax treatment afforded shares issued upon exercise of an ISO, notwithstanding the character of the underlying option with respect to which the dividend equivalent rights were earned. The number of shares issuable upon exchange of dividend equivalent rights is not subject to the limit of the number of shares which are issuable upon exercise of options granted under the Plan.\nUnder the Plan, an exercising optionholder has the right to require the Company to purchase some or all of the optionholder's shares of the Company's Common Stock. That redemption right is exercisable by the optionholder only with respect to shares (including the related dividend equivalent rights) that he has acquired by exercise of an option under the Plan. Furthermore, the optionholder can only exercise his redemption rights within six months from the last to expire of (i) the two year period commencing with the grant date of an option, (ii) the one year period commencing with the exercise date of an option, or (iii) any restriction period on the optionholder's transfer of the shares of Common Stock he acquires through exercise of his option. The price for any shares repurchased as a result of an optionholder's exercise of his redemption right is the lesser of the book value of those shares at the time of redemption or the fair market value of the shares on the date the options were exercised.\nThe Plan is administered by the Board of Directors which will determine whether such options will be granted, whether such options will be ISOs or non-qualified stock options, which directors, officers and key personnel will be granted options, and the number of options to be granted, subject to the aggregate maximum amount of shares issuable under the Plan set forth above. Each option granted must terminate no more than 10 years from the date it is granted. Under current law, ISOs cannot be granted to directors who are not also employees of the Company, or to directors or employees of entities unrelated to the Company.\nThe Board of Directors may amend the Plan at any time, except that approval by the Company's stockholders is required for any amendment that increases the aggregate number of shares of Common Stock that may be issued pursuant to the Plan, increases the maximum number of shares of Common Stock that may be issued to any person, changes the class of persons eligible to receive such options, modifies the period within which the options may be granted, modifies the period within which the options may be exercised or the terms upon which options may be exercised, or increases the material benefits accruing to the participants under the Plan. Unless previously terminated by the Board of Directors, the Plan will terminate in May 1998.\nThe following table provides information on options and SARs granted to the Company's executive officers during 1995.\nOption\/SAR Grants in Last Fiscal Year\nThe following table provides information on options and SARs exercised in 1995 by the Company's executive officers and the value of such officer's unexercised options and SARs at December 31, 1995.\nFiscal Year End Option\/SAR Values\nSEP-IRA\nOn June 27, 1991, the Company established a simplified employee pension-individual retirement account pursuant to Section 408(k) of the Code (the \"SEP-IRA\"). Annual contributions may be made by the Company under the SEP-IRA to employees. Such contributions will be excluded from each employee's gross income and will not exceed the lesser of 15% of such employee's compensation or $22,500. The Company did not make any contributions to the SEP-IRA during 1995.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nAt March 25, 1996, there were 9,716,517 shares of Common Stock outstanding. The table below sets forth, as of March 25, 1996, those persons known by the Company to own beneficially five percent or more of the outstanding shares of Common Stock, the number of shares of Common Stock beneficially owned by each director and executive officer of the Company and the number of shares beneficially owned by all of the Company's executive officers and directors as a group, which information as to beneficial ownership is based upon statements furnished to the Company by such persons.\n(7) The nature of beneficial ownership of the 859,000 shares is 459,000 shares are owned by the InterGroup Corporation and 400,000 shares are owned by John V. Winfield. Mr. Winfield is Chairman of the Board and President of The InterGroup Corporation. As of February 7, 1995, 427,406 shares of InterGroup common stock, constituting 46% of the outstanding InterGroup shares, were owned directly or beneficially by Mr. Winfield.\nOther than options and dividend equivalent rights granted under the Company's stock option plan or under the Hamberlin Employment Agreement, there are no outstanding warrants, options or rights to purchase any shares of Common Stock of the Company, and no outstanding securities convertible into Common Stock of the Company.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nPotential Conflicts of Interest\nThe Bylaws of the Company provide that, if the Company elects to be treated as a REIT, a majority of the Board of Directors (and a majority of each committee of the Board of Directors) must not be \"Affiliates\" of \"Advisors,\" as these terms are defined in the Bylaws, and that the investment policies of the Company must be reviewed annually by these directors (the \"Unaffiliated Directors\").\nCounsel to the Company has furnished, and in the future may furnish, legal services to ASFS, ASFG and certain Issuers (including American Southwest Financial Corporation, American Southwest Finance Co., Inc. and Westam Mortgage Financial Corporation). There is a possibility that in the future the interests of certain of such parties may become adverse, and counsel may be precluded from representing one or all of such parties. If any situation arises in which the interests of the Company appear to be in conflict with those of ASFS, ASFG or any Issuer, additional counsel may be retained by one or more of the parties.\nCertain Relationships\nAlan D. Hamberlin, the Chairman of the Board of Directors, and Chief Executive Officer of the Company, also is a director of American Southwest Financial Corporation, American Southwest Finance Co., Inc., American Southwest Affiliated Companies and American Southwest Holdings, Inc. and a member of the management committee of ASFG.\nMr. Hamberlin directly and indirectly owns a total of 25% of the voting stock of American Southwest Holdings, Inc. American Southwest Holdings, Inc. directly or indirectly owns 100% of the voting stock of, among other entities, ASFS, American Southwest Financial Corporation and Westam Mortgage Financial Corporation. Mr. Hamberlin also directly and indirectly owns up to 25% of the capital interest held by the common members of ASFG and indirectly owns up to 25% of the capital interest of the preferred members of ASFG. See \"Business -- The Subcontract Agreement.\"\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) Exhibits\n(b) Financial Statements and Financial Statement Schedules filed as part of this report: 1. Financial Statements -- as listed in the \"Index to Financial Statements\" on page of this Annual Report on Form 10-K. 2. Financial Statement Schedules -- no schedules are required because of the absense of conditions under which they are required or because the information is given in the financial statements and notes beginning on page of this Annual Report on Form 10-K.\n(c) Reports on Form 8-K:\nNo Current Reports on Form 8-K were filed by the Company during the fourth quarter of 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.\nHOMEPLEX MORTGAGE INVESTMENTS CORPORATION Date: March 29, 1996 By: \/s\/ ALAN D. HAMBERLIN ------------------------------ Alan D. Hamberlin, Chairman of the Board of Directors and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons in the capacities and on the dates indicated.\nHOMEPLEX MORTGAGE INVESTMENTS CORPORATION\nPage ---- Report of Independent Auditors ........................................F-2 Consolidated Balance Sheets as of December 31, 1995 and 1994 .........F-3 Consolidated Statements of Net Income (Loss) for the Years Ended December 31, 1995, 1994 and 1993 ...............................F-4 Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 1995, 1994 and 1993 .....................................F-5 Consolidated Statements of Cash Flows for the Years Ended December 31, 1995, 1994 and 1993 .....................................F-6 Notes To Consolidated Financial Statements ............................F-7\nREPORT OF INDEPENDENT AUDITORS\nTo the Board of Directors and Stockholders of Homeplex Mortgage Investments Corporation\nWe have audited the accompanying consolidated balance sheets of Homplex Mortgage Investments Corporation and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of net income (loss), stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1995. 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 also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Homeplex Mortgage Investments Corporation and subsidiaries as of December 31, 1995 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, 1995, in conformity with generally accepted accounting principals.\nAs discussed in Note 4 to the consolidated financial statements, the Company changed its method for accounting for residual interests as of December 31, 1993. ERNST & YOUNG LLP\nPhoenix, Arizona February 13, 1996\nHOMEPLEX MORTGAGE INVESTMENTS CORPORATION CONSOLIDATED BALANCE SHEETS As of December 31, 1995 and December 31, 1994 (Dollars in Thousands Except Per Share Data)\nHOMEPLEX MORTGAGE INVESTMENTS CORPORATION CONSOLIDATED STATEMENTS OF NET INCOME (LOSS) For the Years Ended December 31, 1995, 1994 and 1993 (Dollars in Thousands Except Per Share Data)\nHOMEPLEX MORTGAGE INVESTMENTS CORPORATION CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY For the Years Ended December 31, 1995, 1994 and 1993 (Dollars in Thousands)\nHOMEPLEX MORTGAGE INVESTMENTS CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS For the Years Ended December 31, 1995, 1994 and 1993 Increase (Decrease) in Cash (Dollars in Thousands)\nHOMEPLEX MORTGAGE INVESTMENTS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDecember 31, 1995\nNOTE 1 -- ORGANIZATION\nHomeplex Mortgage Investments Corporation, a Maryland corporation, (the Company) commenced operations in July 1988. As described in Note 4 the Company has purchased interests in mortgage certificates securing collateralized mortgage obligations (CMOs) and interests relating to mortgage participation certificates (MPCs) (collectively residual interests). Since December 1993 the Company has originated various loans secured by real estate (see Note 3).\nNOTE 2 -- GENERAL AND SUMMARY OF ACCOUNTING POLICIES\nBasis of Presentation\nThe consolidated financial statements include the accounts of Homeplex Mortgage Investments Corporation and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.\nIncome Taxes\nThe Company has elected to be taxed as a real estate investment trust (REIT) under the Internal Revenue Code. As a REIT, the Company must distribute annually at least 95% of its taxable income to its stockholders. The $.03 dividend declared in 1993 consisted of $.0276 of ordinary income and $.0024 of return of capital; the $.02 dividend declared in 1994 consisted of $.0142 of ordinary income and $.0058 of return of capital, and the $.03 dividend declared in 1995 was all ordinary income to the recipients for federal income tax purposes.\nAt December 31, 1995, the Company has available, for income tax purposes, a net operating loss carryforward of approximately $57,000,000. Such loss may be carried forward, with certain restrictions, for up to 14 years to offset future taxable income, if any. Until the tax loss carryforward is fully utilized or expires, the Company will not be required to pay dividends to its stockholders except for income that is deemed to be excess inclusion income.\nThe income (loss) reported in the accompanying financial statements is different than taxable income (loss) because some income and expense items are reported in different periods for income tax purposes. The principal differences relate to the amortization of residual interests and the treatment of stock option expense.\nResidual Interests\nInterests relating to mortgage participation certificates and residual interest certificates are accounted for as described in Note 4.\nCash and Cash Equivalents\nCash and cash equivalents include demand deposits and certificates of deposit with maturities of less than three months.\nAmortization of Hedging\nThe cost of the Company's LIBOR ceiling rate agreements (see Note 7) was amortized using the straight-line method over the life of the agreements. Other expense includes $96,000 and $138,000, respectively, related to amortization of hedging costs for the years ended December 31, 1994 and 1993.\nNet Income (Loss) Per Share\nPrimary net income (loss) per share is calculated using the weighted average shares of common stock outstanding and common stock equivalents. Common stock equivalents consist of dilutive stock options. Net income (loss) per share is the same for both primary and fully diluted calculations.\nHOMEPLEX MORTGAGE INVESTMENTS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) December 31, 1995\nShort-Term Investments\nAt December 31, 1995, short-term investments consist of a Treasury Bill with a face amount of $9,000,000, maturity date of January 25, 1996 and an estimated yield to maturity of 5.30%.\nReclassification\nCertain balances in the prior year have been reclassified to conform to the current year's presentation.\nNOTE 3 -- REAL ESTATE LOANS\nThe following is a summary of real estate loans at December 31, 1995:\nEach of the preceding loans was current as of December 31, 1995. The following summarizes real estate loan activity for 1995 and 1994:\n1995 1994 ------------- ------------ Balance at beginning of year $ 9,260,000 $ 320,000 Real estate loans funded .... 3,902,000 9,610,000 Principal repayments ......... (9,114,000) (670,000) ------------- ------------ Balance at end of year .......$ 4,048,000 $ 9,260,000 ============= ============\nAt December 31, 1995, all of the Company's loans are secured by properties located in Arizona. As a result of this geographic concentration, unfavorable economic conditions in Arizona could increase the likelihood of defaults on these loans and affect the Company's ability to protect the principal and interest on such loans following foreclosures upon the real properties securing such loans.\nHOMEPLEX MORTGAGE INVESTMENTS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) December 31, 1995\nNOTE 4 -- RESIDUAL INTERESTS\nThe Company owns residual interests in collateralized mortgage obligations (CMOs) and residual interests in mortgage participation certificates (MPCs) (collectively residual interests) with respect to which elections to be treated as a real estate mortgage investment conduit (REMIC) have been made.\nResidual Interest Certificates\nThe Company owns 100% of the residual interest certificates representing the residual interests in five series of CMOs secured by mortgage certificates and cash funds held by trustee. The CMOs have been issued through Westam Mortgage Financial Corporation (Westam) or American Southwest Financial Corporation (ASW). The mortgage certificates securing the CMOs all have fixed interest rates. Certain of the classes of CMOs have fixed interest rates and certain have interest rates that are determined monthly based on the London Interbank Offered Rates (LIBOR) for one month Eurodollar deposits, subject to specified maximum interest rates.\nEach series of CMOs consists of several serially maturing classes collateralized by mortgage certificates. Generally, principal payments received on the mortgage certificates, including prepayments on such mortgage certificates, are applied to principal payments on the classes of CMOs in accordance with the respective indentures. Scheduled payments of principal and interest on the mortgage certificates securing each series of CMOs and reinvestment earnings thereon are intended to be sufficient to make timely payments of interest on such series and to retire each class of such series by its stated maturity. Certain series of CMOs are subject to redemption according to specific terms of the respective indentures.\nThe Company's residual interest certificates entitle the Company to receive the excess, if any, of payments received from the pledged mortgage certificates together with reinvestment income thereon over amounts required to make debt service payments on the related CMOs and to pay related administrative expenses of the REMICs. The Company also has the right, under certain conditions, to cause an early redemption of the CMOs. Under the early redemption feature, the mortgage certificates are sold at the then current market price and the CMOs repaid at par value. The Company is entitled to any excess cash flow from such early redemptions. The conditions under which such early redemptions may be elected vary but generally cannot be done until the remaining outstanding CMO balance is less than 10% of the original balance.\nPrior to December 31, 1993, the Company accounted for its investment in these five REMICs using the equity method of accounting. Accordingly, the Company consolidated the financial statements of the REMICs in its financial statements and included the respective REMICs income or loss in its consolidated statement of net income (loss). In the event the undiscounted estimated future net cash flows from the residual interest were less than the Company's financial reporting basis, the residual interest was considered to be impaired and the Company established a reserve for the difference. The reserves were then amortized to income as the loss actually occurred.\nHOMEPLEX MORTGAGE INVESTMENTS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) December 31, 1995\nEffective December 31, 1993, the Company adopted the prospective net level yield method with respect to these investments. The cumulative effect of the change of $6,078,000 was recorded as of December 31, 1993. Income for the years ended December 31, 1995 and 1994 has been determined using the prospective net level yield method. The following summarizes the Company's combined loss from these five REMICs for the year ended December 31, 1993 (in thousands) prior to the cumulative effect of the change in accounting principle:\nInterest income, including amortization of mortgage premium or discount, and reinvestment income from mortgage collateral ..................................................$ 57,029 CMO interest, including amortization of debt discount, and administration expense ...................................... (69,076) Write-down of investment to estimated undiscounted cash flows, net of amortization .................................. (2,320) ---------- Loss from residual interest certificates .....................$(14,367) ==========\nInterests In Mortgage Participation Certificates\nThe Company owns residual interests in REMICs with respect to three separate series of Mortgage Participation Certificates (MPCs) issued by the Federal Home Loan Mortgage Corporation (FHLMC) or by the Federal National Mortgage Association (FNMA). The Company's MPC residual interests entitle the Company to receive its proportionate share of the excess (if any) of payments received from the mortgage certificates underlying the MPCs over principal and interest required to be passed through to the holders of such MPCs. The Company is not entitled to reinvestment income earned on the underlying mortgage certificates, is not required to pay any administrative expenses related to the MPCs and does not have the right to elect early termination of any of the MPC classes. The mortgage certificates underlying the MPCs all have fixed interest rates. Certain of the classes of the MPCs have fixed interest rates and certain have interest rates that are determined monthly based on LIBOR or based on the Monthly Weighted Average Cost of Funds (COFI) for Eleventh District Savings Institutions as published by the Federal Home Loan Bank of San Francisco, subject to specified maximum interest rates.\nThe following summarizes the Company's investment in residual interests at December 31, 1995:\nType Of Company's Company's Percentage Series Investments Amortized Cost Ownership - -------------- ----------------------------- -------------- -------------------- (In Thousands) Westam 1 Residual Interest Certificate $ 703 100.00% Westam 3 Residual Interest Certificate 30 100.00% Westam 5 Residual Interest Certificate 204 100.00% Westam 6 Residual Interest Certificate 12 100.00% ASW 65 Residual Interest Certificate 2,521 100.00% FHLMC 17 Interest in MPCs 140 100.00% FNMA 1988-24 Interest in MPCs 1,220 20.20% FNMA 1988-25 Interest in MPCs 627 45.07% ------ $5,457 ======\nHOMEPLEX MORTGAGE INVESTMENTS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) December 31, 1995\nThe following summarizes the Company's proportionate interest in the aggregate assets and liabilities of the eight residual interests at December 31, 1995 (in thousands):\nAssets: Outstanding Principal Balance of Mortgage Certificates $ 357,084 Funds Held By Trustee and Accrued Interest Receivable 9,913 --------- $ 366,997 ========= Range of Stated Coupon of Mortgage Certificates ......9.0% - 10.5%\nLiabilities: Outstanding Principal Balance of CMOs and MPCs: Fixed Rate ............................................$ 320,238 Floating Rate -- LIBOR Based .......................... 36,550 Floating Rate -- COFI Based ........................... 4,427 --------- Total ............................................. 361,215 Accrued Interest Payable .............................. 2,441 --------- $ 363,656 ========= Range of Stated Interest Rates on CMOs and MPCs ......0% to 9.9%\nThe average LIBOR and COFI rates used to determine income from residual interests were as follows:\n1995 1994 1993 AT DEC. 31, 1995 ------- ------- ------- ---------------- LIBOR ....6.00% 4.33% 3.22% 6.00% COFI .....4.96% 3.83% 4.16% 5.12%\nThe Company accounts for residual interests using the prospective net level yield method. Under this method, a residual interest is recorded at cost and amortized over the life of the related CMO or MPC issuance. The total expected cash flow is allocated between principal and interest as follows:\n1. An effective yield is calculated as of the date of purchase based on the purchase price and anticipated future cash flows.\n2. In the initial accounting period, interest income is accrued on the investment balance using the effective yield calculated as of the date of purchase.\n3. Cash received on the investment is first applied to accrued interest with any excess reducing the recorded principal balance of the investment.\n4. At each reporting date, the effective yield is recalculated based on the amortized cost of the investment and the then-current estimate of the remaining future cash flows.\n5. The recalculated effective yield is then used to accrue interest income on the investment balance in the subsequent accounting period.\n6. The above procedure continues until all cash flows from the investment have been received.\nAt the end of each period, the amortized balance of the investment should equal the present value of the estimated cash flows discounted at the newly-calculated effective yield.\nHOMEPLEX MORTGAGE INVESTMENTS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) December 31, 1995\nIn May 1993 the Financial Accounting Standards Board (\"FASB\") issued Statement of Financial Accounting Standards (\"SFAS\") No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\". SFAS No. 115 is applicable to debt securities including investments in REMIC residual interests and requires all investments to be classified into one of three categories: held to maturity, available for sale, or trading. The Company acquired its residual interests without the intention to resell the assets. The Company has both the intent and ability to hold these investments to maturity and believes these investments meet the \"held to maturity\" criteria of SFAS No. 115. Under SFAS No. 115, if a residual interest is determined to have other than temporary impairment, the residual interest is written down to fair value. For the years ended December 31, 1994 and 1993, the Company incurred net charges of $3,343,000 and $22,312,000, respectively, to write down its residual interests. There were no charges for the year ended December 31, 1995.\nAt December 31, 1995, the estimated prospective net level yield of the Company's residual interests, in the aggregate, is 23% without early redemptions or terminations being considered and 57% if early redemptions or terminations are considered. At December 31, 1995, the estimated fair value of the Company's residual interests, in the aggregate, approximates the Company's aggregate carrying value.\nThe projected yield and estimated fair value of the Company's residual interests are based on prepayment and interest rate assumptions at December 31, 1995. There will be differences, which may be material, between the projected yield and the actual yield and the fair value of the residual interests may change significantly over time.\nNOTE 5 -- LONG-TERM DEBT\nOn December 17, 1992, a wholly owned, limited purpose subsidiary of the Company issued $31,000,000 of Secured Notes under an Indenture to a group of institutional investors. The Notes bear interest at 7.81% and require quarterly payments of principal and interest with the balance due on February 15, 1998. In connection with the financing, the Company paid fees of $635,000 which are included in other assets in the accompanying consolidated balance sheet and are being amortized to interest expense over the life of the financing. The Notes are secured by the Company's residual interests in Westam 1, Westam 3, Westam 5, Westam 6, ASW 65, FNMA 1988-24 and FNMA 1988-25 (see Note 4), and by Funds held by the Note Trustee. The Company used $3,100,000 of the proceeds to establish a reserve fund. The reserve fund, which has a specified maximum balance of $7,750,000, is to be used to make the scheduled principal and interest payments on the Notes if the cash flow available from the collateral is not sufficient to make the scheduled payments. Depending on the level of certain specified financial ratios relating to the collateral, the cash flow from the collateral is required to either prepay the Notes at par, increase the reserve fund up to its $7,750,000 maximum or is remitted to the Company. At December 31, 1995, Funds held by Trustee consists of $5,122,000 in the reserve fund and $516,000 of other funds pledged under the Indenture.\nNOTE 6 -- SHORT-TERM BORROWINGS\nUnder a revolving line of credit agreement with a bank, the Company may borrow up to $5,000,000, upon payment of a 1\/2 % commitment fee with interest payable monthly at prime plus 1\/2 %. Such advances are to be secured by certain of the Company's real estate loans with the amount advanced equal to between 40% to 60% of the principal amount of the real estate loans pledged. Only real estate loans approved by the bank are eligible for advances. The agreement contains certain financial covenants and expires on May 5, 1996. Through December 31, 1995, the Company has not drawn upon the line of credit.\nHOMEPLEX MORTGAGE INVESTMENTS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) December 31, 1995\nNOTE 7 -- HEDGING\nOn May 12, 1992, the Company entered into a LIBOR ceiling rate agreement with a bank for a fee of $245,000. The agreement, which had a term of two years beginning July 1, 1992, required the bank to pay a monthly amount to the Company equal to the product of $175,000,000 multiplied by the percentage, if any, by which actual one-month LIBOR (measured on the first business day of each month) exceeded 9.0%. Through the expiration of the agreement on July 1, 1994, LIBOR remained under 9.0% and, accordingly, no amounts were paid under the agreement.\nNOTE 8 -- COMMON STOCK AND STOCK OPTIONS\nThe Company has a Stock Option Plan which is administered by the Board of Directors. The plan provides for qualified stock options which may be granted to key personnel of the Company and non- qualified stock options which may be granted to the Directors and key personnel of the Company. The purpose of the plan is to provide a means of performance-based compensation in order to attract and retain qualified personnel whose job performance affects the Company.\nOptions to acquire a maximum (excluding dividend equivalent rights) of 437,500 shares of the Company's common stock may be granted under the plan. The exercise price may not be less than the fair market value of the common stock at the date of grant. The options expire ten years after date of grant.\nOptionholders also receive, at no additional cost, dividend equivalent rights which entitle them to receive, upon exercise of the options, additional shares calculated based on the dividends declared during the period from the grant date to the exercise date. At December 31, 1995 accounts payable and other liabilities in the accompanying consolidated balance sheets, include approximately $850,000 related to the Company's granting of dividend equivalent rights. This liability will remain in the accompanying consolidated balance sheets until the options to which the dividend equivalent rights relate are exercised, cancelled or expire.\nUnder the plan, an exercising optionholder also has the right to require the Company to purchase some or all of the optionholder's shares of the Company's common stock. That redemption right is exercisable by the optionholder only with respect to shares (including the related dividend equivalent rights) that the optionholder has acquired by exercise of an option under the Plan. Furthermore, the optionholder can only exercise his redemption rights within six months from the last to expire of (i) the two year period commencing with the grant date of an option, (ii) the one year period commencing with the exercise date of an option, or (iii) any restriction period on the optionholder's transfer of the shares of common stock he acquires through exercise of his option. The price for any shares repurchased as a result of an optionholder's exercise of his redemption right is the lesser of the book value of those shares at the time of redemption or the fair market value of the shares on the original date the options were exercised. During 1993, 20,368 shares were repurchased by the Company in connection with this provision of the plan. For the year ended December 31, 1993 approximately $66,000 related to the repurchase of the shares is included in general and administrative expenses in the accompanying consolidated statements of net income (loss).\nHOMEPLEX MORTGAGE INVESTMENTS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) December 31, 1995\nThe following summarizes stock option activity under the Stock Option Plan:\nAt December 31, 1995, 438,376 of the options, including dividend equivalent rights, were exercisable at effective exercise prices ranging from $1.22 per share to $4.48 per share. At December 31, 1995 and 1994, 357 and 54,357 common shares, respectively, were reserved for future grants.\nAdditionally, in December 1995, in connection with the renegotiation of the Chief Executive Officer's Employment Agreement, the Company replaced his annual salary of $250,000 plus bonus with 750,000 of non-qualified stock options which vest over the three year term of the new Employment Agreement. The exercise price of the options is $1.50 per share which was equal to the closing market price of the common stock on grant date. As of December 31, 1995, 200,000 of the options were vested, with 275,000 vesting in 1996 and the remaining 275,000 vesting in 1997. The options will immediately vest upon a change in control, as defined. The options will expire in December 2000. These stock options are subject to stockholder approval. In the event the stock options are not approved by the stockholders, the Employment Agreement provides that the options will be converted into phantom stock rights (PSRs). Such PSRs have the same vesting provisions, exercise price and expiration date as the related stock options, except that upon exercise of a PSR no stock is actually issued. Instead, the Company will make a cash payment to the holder equal to the difference between the market value of the stock on the exercise date and the exercise price of $1.50 per share. The PSRs, also, provide that the holder will receive payments equal to the product of the per share dividend amount times the number of PSRs outstanding.\nNOTE 9 -- FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe following disclosure of the estimated fair value of financial instruments is made in accordance with requirements of SFAS No. 107, \"Disclosures about Fair Values of Financial Instruments\". Although management uses its best judgement in estimating the fair value of these instruments, there are inherent limitations in any estimation technique and the estimates are thus not necessarily indicative of the amounts which the Company could realize on a current transaction.\nThe following describes the significant assumptions underlying the estimates of fair value.\n(a) Real Estate Loans -- The Company's real estate loans are all short-term (one year or less) and considered to be fully collectible. The terms and conditions of such loans are the same as would be used by the Company to fund similar type loans at December 31, 1995. As such, fair value approximates cost.\nHOMEPLEX MORTGAGE INVESTMENTS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) December 31, 1995\n(b) Short-term Investments -- Short-Term Investments consist of a Treasury Bill with a fair value that approximates cost.\n(c) Cash And Cash Equivalents\/funds Held By Trustee -- Cash and cash equivalents and funds held by Trustee consist of demand deposits and liquid money market funds with fair value approximating cost.\n(d) Residual Interests -- Residual Interests and their fair value are described in Note 4 to the financial statements.\n(e) Fair Value\/long Term Debt -- The estimated fair value of the Company's long-term debt is estimated to be its carrying value at December 31, 1995 plus the prepayment penalty the Company would be required to make to repay the debt in its entirety prior to its scheduled maturity.\nBased on these assumptions the Company estimates the fair value of its financial instruments at December 31, 1995 to be as follows (in thousands):\nCARRYING ESTIMATED AMOUNT FAIR VALUE ---------- ------------ Real Estate Loans .........$ 4,048 $ 4,048 Short-term Investments ... 8,969 8,969 Funds held by Trustee .... 5,638 5,638 Residual Interests ........ 5,457 5,457 Cash and Cash Equivalents 3,347 3,347 Long-term Debt ............ (7,819) (8,001)\nHOMEPLEX MORTGAGE INVESTMENTS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) December 31, 1995\nNOTE 10 -- QUARTERLY FINANCIAL DATA (Unaudited) (In Thousands Except Per Share Amounts)\nNet Income Net (Loss) Dividends Income (Loss) Per Share Per Share ------------- --------------- ----------- - ---- First ........ $(10,824) $ (1.11) $ -- Second ....... (8,148) (.84) -- Third ........ (4,050) (.42) -- Fourth (1) .. (8,966) (.93) .03\n- ---- First ........ $ (675) $ (.07) $ -- Second ....... (1,094) (.11) -- Third ........ 409 .04 -- Fourth (2) .. (3,164) (.33) .02\n- ---- First ........ $ 462 $ .05 $ -- Second ....... 335 .03 -- Third ........ 58 .01 -- Fourth ....... 242 .02 .03\n- ---------- (1) Net loss in the fourth quarter of 1993 includes a charge of $6,078,000 or $.63 per share, for the cumulative effect of an accounting change.\n(2) Net loss in the fourth quarter of 1994 includes a charge of $3,212,000, or $.33 per share, to record impaired residual interests at fair market value.","section_15":""}
{"filename":"351993_1995.txt","cik":"351993","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"ITEM 3. LEGAL PROCEEDINGS\nOn November 2, 1994, a putative class action was filed in Delaware Chancery Court. In that case, entitled Miller v. Cody, the plaintiff has alleged that certain named former directors of Plains and Plains have, among other things, breached their fiduciary duties and otherwise acted to entrench themselves in office. Plaintiff seeks various forms of injunctive relief, damages and an award of plaintiff's costs and disbursements.\nOn May 3, 1995, the same day Plains announced it had executed a merger agreement with the Company, a putative class action, entitled Crandon Capital Partners v. Miller, was filed in Delaware Chancery Court against Plains and the then-current members of its Board of Directors. In this suit, it is alleged that, among other things, the agreement was inadequate, plaintiff seeks various forms of declaratory and injunctive relief, damages and an award of plaintiff's costs and disbursements.\nPlains and its former directors have received a status report filed by plaintiffs' counsel in both cases indicating a \"stipulation of dismissal without prejudice will be circulated shortly.\"\nExcept as noted above, at December 31, 1995, the Company was a party to certain other 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.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS\nNo matters were submitted to a vote of the Company's security holders during the fourth quarter of the year ended December 31, 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDERS MATTERS.\n(a) Market Information. Beginning on November 29, 1994, the Company's Common Stock was listed and began trading on the New York Stock Exchange under the symbol BRR. Before trading on the New York Stock Exchange, the Company's Common Stock was traded on NASDAQ National Market System under the symbol BARC. The range of high and low sales prices for each quarterly period during the two most recent years, as reported by the New York Stock Exchange, is as follows:\n- -------- * As reported by NASDAQ, before the Company's Common Stock began trading on the NYSE.\nOn March 12, 1996, the closing price for the Company's Common Stock was $22.625 per share.\n(b) Holders. The approximate number of record holders of the Company's Common Stock as of March 12, 1996, was 4,956.\n(c) Dividends. The Company has not paid any cash dividends since its inception. The Company's credit agreement restricts payment of dividends to amounts that are less than 50 percent of net income. The Company anticipates that all earnings will be retained for the development of its business and that no cash dividends on its Common Stock will be declared in the foreseeable future.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following table sets forth certain selected financial data of the Company for each of the last five years ended December 31:\nITEM 7.","section_7":"ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nOn July 18, 1995, the Company consummated the merger of a wholly owned subsidiary of the Company with Plains Petroleum Company (\"Plains\") by issuing 12.8 million shares of its common stock to the former Plains stockholders. As a result of this merger, Plains became a wholly owned subsidiary of the Company. Also, on July 18, 1995, the Company changed its fiscal year end from September 30 to December 31 effective January 1, 1995. The merger is being accounted for using the pooling of interests method. The pooling of interests method combines previously reported results as though the combination occurred at the beginning of the periods being presented. Merger costs have been expensed during the 1995 year. The financial statements of the Company and Plains for the 1993, 1994 and 1995 years have been restated and adjusted for the merger with Plains and the change in fiscal year end. Due to this restatement, these financial statements are not comparable to the financial statements for the same periods as previously presented by the separate companies.\nLiquidity and Capital Resources\nAt December 31, 1995, the Company had cash and short-term investments of $7.5 million, working capital of $3.7 million, property and equipment of $300.7 million and total assets of $340.4 million. Compared to December 31, 1994, cash and short-term investments decreased $4.8 million, working capital increased $1.2 million and property and equipment increased $39.2 million. Total assets increased $29.5 million as the increase in property and equipment was funded by a $36.0 million increase in long-term debt. During 1995, the Company actively invested in oil and gas properties in its areas of activity, which increased both property and equipment and long-term debt.\nDuring 1995, the Company generated operating cash flow of $33.4 million before working capital changes, which is $5.6 million less than the amount generated in 1994, as production increases were offset by merger costs incurred during the year. After working capital changes, cash flow provided by operations was $35.5 million, a decrease of three percent from 1994. Excluding merger costs, cash flow from operations before working capital changes was $47.6 million, ($49.7 million after working capital changes).\nAs of December 31, 1995, the outstanding balance under the bank line of credit was $89 million, a net increase of $36 million from the balance at December 31, 1994. In July 1995, the Company entered into a $200 million credit agreement. The line of credit matures on July 19, 1999 and is funded by a consortium of six banks. The line of credit is unsecured and provides for interest rates based on LIBOR or prime rates at the Company's option. The availability under the Credit Agreement is based on the bank's review of the collateral value of the Company's oil and gas properties. The current borrowing base is $160 million determined from a review of the oil and gas reserves as of December 31, 1994 for Plains and March 31, 1995 for Barrett. The borrowing base is scheduled for a review in early 1996 based on the Company's December 31, 1995 reserves.\nDuring the year, the Company invested $72.3 million in property and equipment principally in the Piceance, Wind River and Arkoma Basins. The Company's drilling activities were primarily to develop and extend producing fields. Included in oil and gas property additions is $7.4 million to purchase interests in proved properties to acquire 4.0 Bcf of gas and 831,000 barrels of oil.\nDuring 1995, the Company increased its gas reserves by 12 percent to 514 Bcf and its oil reserves by 13 percent to 13.0 million barrels. The Company replaced 210 percent of its 1995 production. On an energy equivalent basis, the Company's reserves are 87 percent natural gas. Proved undeveloped reserves are 17 percent of the Company's total reserves, virtually unchanged from December 31, 1994. Thirty-four percent of the Company's reserves are located in the Hugoton Embayment, 20 percent are located in the Piceance Basin, and 15 percent are located in the Wind River Basin.\nReserve quantities increased 12 percent on an energy equivalent basis over the last year, while the standardized measure of discounted future net cash flows increased $67.3 million, 28 percent, primarily due to reserve additions and an increase in the sales price of oil and gas. As of December 31, 1995, the Company was receiving an average of $17.35 per barrel for its oil production and $1.77 per Mcf for its gas production. Reserve extensions and discoveries added $85.5 million to the standardized measure, and purchases of proved reserves added $7.4 million to the valuation. In addition the change in sales prices and production costs increased the standardized measure of discounted future net cash flows by $24.6 million. These additions were offset by a $62.3 million reduction due to reserves produced during the year and $33.2 million for additional income taxes being deducted in the computation. The Company's reserve values remain sensitive to gas prices in the current volatile commodities market.\nThe Company uses gas price swaps to hedge the sales price of its oil and natural gas. In a typical swap agreement, the Company and a counter party will enter into an agreement whereby one party will pay a fixed price and the other will pay an index price on a specified volume of production during a specified period of time. Settlement is made by the parties for the difference between the two prices approximately the same time as the physical transactions. The intent of hedging activities is to reduce the volatility associated with the sales price of oil and gas production.\nAs of December 31, 1995 the Company held positions to hedge 16.9 Bcf of gas and 91,000 barrels of oil for periods through March 31, 1996. Of these positions, 834,000 Mcf of gas were being hedged to reduce risks associated with gas trading activities, and the balance was associated with producing activities. These positions include various hedging instruments based on exchange based sales prices, index denominated prices or a combination of both. The positions are more fully described in the notes to the financial statements. During December 1995 the gas commodities market used as a basis for the Company's hedging activities became unusually volatile causing significant differences between the underlying commodity price and the market price of the Company's gas production in certain basins. As a result, the Company recorded an expense of $1.2 million in the fourth quarter due to the lack of correlation between the hedging instrument and the sales price of underlying natural gas.\nThe Company's merger with Plains and its drilling activities have increased its reserve base and its productive capacity and, therefore, its potential cash flow. Continued low gas prices may adversely affect cash flow. The Company intends to continue to acquire and develop oil and gas properties in its areas of activity as dictated by market conditions and financial ability. The Company retains flexibility to participate in oil and gas activities at a level that is supported by its cash flow and financial ability. Management believes that the Company's borrowing capacities and cash flow are sufficient to fund its currently anticipated activities. The Company intends to continue to use financial leverage to fund its operations as investment opportunities become available on terms that management believe warrant investment of the Company's capital resources.\nResults of Operations\n1995 VS. 1994\nDuring 1995, the Company incurred a net loss of $2.2 million ($.09 per share) compared to net income of $11.3 million ($.46 per share) in 1994. The 1995 results include merger and reorganization costs of $14.2 million. Excluding the merger costs, the Company's net income after taxes would be $9.5 million ($.38 per share).\nRevenues increased 17 percent from 1994 to $128.0 million and operating expenses, including $14.2 million of merger and reorganization costs, increased 38 percent to $128.4 million. Oil and gas production revenue increased 23 percent to $97.0 million. Lease operating expenses increased $6.3 million and depreciation, depletion and amortization increased $10.7 million.\nProduction revenues increased $18.2 million primarily due to a 43 percent increase in gas production to 47.7 Bcf (130,700 Mcf per day). Oil production increased 32 percent to 1,702,000 barrels (4,660 barrels per day). Average gas sales prices decreased 20 percent to $1.47 per Mcf, while average oil prices increased 13 percent to $15.76 per barrel. Gas production accounted for 82 percent of total production on an energy equivalent basis. The Hugoton Embayment and Piceance Basin properties accounted for 37 and 14 percent, respectively, of total gas production. The Powder River and Permian Basins accounted for 43 and 32 percent, respectively, of total oil production. The decreased gas sales price was due to an overall deterioration in gas markets during most of the year.\nLease operating expenses of $34.5 million averaged $.60 per Mcfe ($3.58 per BOE) of production compared to $.69 per Mcfe ($4.13 per BOE) in 1994. Depreciation, depletion and amortization increased $10.7 million primarily due to production increases. During 1995, depreciation, depletion and amortization on oil and gas production was provided at an average rate of $.55 per Mcfe ($3.28 per BOE) compared to an average rate of $.52 per Mcfe ($3.14 per BOE) in 1994.\nThe gross margin on trading activities was virtually unchanged from 1994 at $943,000. Gas trading volumes increased 26 percent to 22.2 Bcf in 1995.\nDuring 1995, the Company hedged 4.9 Bcf (22 percent) of its gas trading volumes to achieve the margins on specific transactions at a cost of $2.1 million. In addition, the Company hedged 11.0 Bcf (23 percent) of gas production for a net gain of $417,000. The hedging gain related to production is net of $1.2 million for an expense recorded in the fourth quarter due to a lack of correlation of the hedging instruments to the underlying commodity as of December 31, 1995. The Company enters into the hedging arrangements to minimize its exposure to price risks associated with commodities markets. Although hedging transactions associated with its production minimize the Company's exposure to losses as a result of unfavorable price changes, the transactions also limit the Company's ability to benefit from favorable price changes. At the end of December, 1995, the basis differential between the commodities markets and the market price of the Company's gas widened to historic levels. Because the increase in the commodities price was not accompanied by a similar increase in the market price of the Company's gas, the Company recorded an expense for the difference due to the inefficient hedge and positions that did not qualify for hedge accounting treatment. With respect to trading activities, the Company will not generally enter into a commitment for either a purchase or a sale unless (i) it has established a commitment for an offsetting sale or purchase, or (ii) it has established a hedge arrangement with a counter party that creates the same matching position.\nGeneral and administrative expenses of $13.4 million are one percent greater than the previous year. The 1995 amount is net of $3.8 million of operating fee recoveries compared to a $3.4 million recovery in 1994. General and administrative expense in 1995 is generally a combination of the separate companies' expenses, since the integration of the two entities did not occur until late in the year, and included costs for the Company to expand its business in existing and new activity areas. The Company expects a reduction in general and administrative expenses due to the elimination of duplicative costs throughout 1996. Interest expense increased\nsignificantly from $942,000 in 1994 to $4.6 million in 1995 as the Company financed a portion of its growth with bank debt. The Company incurred a 1995 expense of $14.2 million to combine Barrett and Plains and to integrate the separate company's operations. The costs consist primarily of $7.4 million of investment banker and other professional fees to evaluate and consummate the merger and $5.6 million for employee termination and benefit costs.\nDuring 1995, the Company recorded a $1.8 million income tax expense even though it incurred a loss before taxes due to non-deductible merger costs. Excluding non-deductible merger costs, the Company would have had a $600,000 tax benefit.\nThe Company's results of operations depend primarily on the production of natural gas which accounted for 87 percent of the Company's reserves and 82 percent of its production during 1995. Therefore, the Company's future results will depend on both the volume of natural gas production and the sales price for gas. The Company continues to explore for oil and gas to increase its production. The lack of predictability of both production volumes and sales prices may influence future operating results.\n1994 VS. 1993\nDuring 1994, the Company earned net income of $11.3 million ($.46 per share) compared to net income of $13.7 million ($.55 per share) in 1993. The 1994 results include a tax benefit of $2.1 million due to an increase in financial reporting value of the Company's net operating loss carryover. Without the tax benefit from the net operating loss carryover, the Company's net income after taxes in 1994 would have been $9.2 million ($.37 per share). The 1993 results include a tax benefit of $1.4 million from the value of the tax loss carryover and an expense of $656,000 for the cumulative effect of adopting SFAS No. 106 to recognize accumulated post retirement benefit liabilities as of January 1, 1993. Net income before income taxes and the cumulative effect of the change in accounting method was $16.4 million in 1994 compared to $21.0 million in 1993.\nRevenues increased three percent from 1993 to $109.5 million, and operating expenses increased nine percent to $93.0 million. Production revenue decreased $2.1 million, and trading revenues increased $5.2 million. These changes were offset by a decrease of $2.1 million in lease operating expenses, an increase of $2.6 million in depreciation, depletion and amortization and an increase of $5.5 million in the cost of trading.\nProduction revenues decreased $2.1 million as a five percent increase in gas production was offset by a six percent decrease in the average gas sales price and a seven percent decline in the average oil sales price. Oil production was virtually unchanged from 1993 to 1994. During 1994, the Company produced 91,200 Mcf of gas per day and 3,540 barrels of oil per day. Gas production accounted for 81 percent of total production on an energy equivalent basis of 41.0 Bcf of gas equivalent (6.8 million barrels of oil equivalent). During 1994, the average gas sales price was $1.83 per Mcf ($1.94 in 1993) and the oil sales price was $13.95 per barrel ($14.94 in 1993). The decreased oil and gas sales prices were due to an overall market reduction in the commodity prices of the products.\nLease operating expenses of $28.2 million averaged $.69 per Mcfe ($4.13 per BOE) of production compared with $.77 per Mcfe ($4.62 per BOE) in 1993. Depreciation, depletion and amortization increased $2.6 million primarily due to production increases. During 1994, depreciation, depletion and amortization on oil and gas production was provided at an average rate of $.52 per Mcfe ($3.14 per BOE) compared to an average rate of $.48 per Mcfe ($2.87 per BOE) in 1993.\nThe gross margin on trading activities decreased to $924,000 from $1.3 million in 1993. Gas trading volumes increased 62 percent to 17.5 Bcf in 1994. The reduced results are due to a reduction of margins available for gas trading activities.\nGeneral and administrative expenses of $13.3 million are 18 percent greater than the previous year. The 1994 amount is net of $3.4 million of operating fee recoveries compared to a $3.8 million recovery in 1993. The\nincreased general and administrative expense is due to additional costs incurred by the Company to expand its activities and to explore in other areas.\nDuring 1994, the Company recorded a $5.1 million net income tax expense compared to a $6.7 net income tax expense in 1993. The 1994 expense is net of a $2.1 million reduction in the valuation allowance provided for the deferred income tax benefit of the net operating loss carryover. The valuation allowance was reduced to reflect increased oil and gas reserves that are expected to generate future taxable income and the tax gain realized on the sale of the Wattenberg properties.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA\nThe Consolidated Financial Statements and schedules that constitute Item 8 are attached at the end of this Annual Report on Form 10-K. An index to these Consolidated Financial Statements and Schedules is also included in Item 14(a) 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\nNot applicable.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY\nThe following table sets forth certain information with respect to the directors and executive officers of the Company, including, with respect to each individual, his age, his position with the Company, the expiration of his term as a director, and the year in which he first became a director of the Company. Additional information concerning each of these individuals follows the table:\n- -------- (1) Member of the Audit Committee of the Board of Directors. (2) Member of the Compensation Committee of the Board of Directors. (3) Mr. Barrett and Mr. Keller are brothers-in-law. (4) Mr. Fitzgibbons served as a Director of the Company from July 1987 until October 1992. He was re-elected to the Board of Directors in January 1994. (5) All officers are elected annually at the first Board Of Directors' meeting following the annual meeting of stockholders. (6) One transaction in July 1995, required to be reported by Mr. Buford on a Statement Of Change In Beneficial Ownership Of Securities on Form 4, was reported late with the Securities and Exchange Commission (\"SEC\") on a Form 5, Annual Statement Of Changes In Beneficial Ownership. (7) A Statement Of Changes In Beneficial Ownership Of Securities on Form 4 with respect to one transaction by Mr. Schreiber in November 1995 was filed two days late with the SEC. (8) Mr. Wallace resigned as Vice Chairman and as a member of the Board of Directors of the Company effective January 11, 1996. (9) Joseph P. Barrett is the son of William J. Barrett. (10) One transaction in October 1995, required to be reported by Mr. Stevens on a Statement Of Changes In Beneficial Ownership Of Securities on Form 4, was reported late with the SEC on a Form 5, Annual Statement Of Changes In Beneficial Ownership.\nWilliam J. Barrett has been Chief Executive Officer since December 1983 and Chairman of the Board of Directors of the Company since March 1994. Mr. Barrett was President of the Company from December 1983 through September 1994. Mr. Barrett has been the Chairman of the Board, Chief Executive Officer, and a director of Plains since it became a wholly owned subsidiary of the Company as the result of a merger in July 1995. Mr. Barrett has also been a director of Barrett Fuels Corporation, a wholly owned subsidiary of the Company, since its formation in September 1990. From January 1979 to February 1982, Mr. Barrett was an independent oil and gas operator in the western United States in association with Aeon Energy, a partnership composed of four sole proprietorships. From 1971 to 1978, Mr. Barrett served as Vice President--Exploration and a director of Rainbow Resources, Inc., a publicly held independent oil and gas exploration company that merged with a subsidiary of the Williams Companies in 1978. Mr. Barrett served as President, Exploration Manager and Director for B&C Exploration from 1969 until 1971 and was a chief geologist for Wolf Exploration Company, now known as Inexco Oil Co., from 1967 to 1969. He was an exploration geologist with Pan-American Petroleum Corporation from 1963 to 1966 and worked as an exploration geologist, a petroleum geologist and a stratigrapher for El Paso Natural Gas Co. at various times from 1958 to 1963. Mr. Barrett received a B.S. Degree in Geology and an M.S. Degree in Geology from Kansas State University in 1956 and 1957, respectively.\nC. Robert Buford has been a director of the Company since December 1983 and served as Chairman of the Board of Directors from December 1983 through March 1994. Mr. Buford has been President, Chairman of the Board and controlling shareholder of Zenith Drilling Corporation (\"Zenith\"), Wichita, Kansas, since February 1966. Zenith is engaged in the oil and gas business and owns approximately three percent of the Company's Common Stock. Since 1993, Mr. Buford has served as a director of Encore Energy, Inc., a wholly owned subsidiary of Zenith engaged in the marketing of natural gas. Mr. Buford is also a member of the Board Of Directors of First Bancorp of Wichita, Kansas, a bank holding company, and Lonestar Steakhouse & Saloon, Inc., a restaurant company headquartered in Wichita, Kansas. He received a B.A. Degree in Business Administration from Oklahoma State University in 1955.\nDerrill Cody has been a director of the Company since July 1995. Mr. Cody was a director of Plains from May 1990 through July 1995. Since January 1990, Mr. Cody has been an attorney in private practice in Oklahoma City, Oklahoma. From 1986 to 1990, he was Executive Vice President of Texas Eastern Corporation, and from 1987 to 1990 he was the Chief Executive Officer of Texas Eastern Pipeline Company. He has been a director of the General partner of TEPPCO Partners, L.P. since January 1990. Mr. Cody received a B.A. Degree in History from East Central State College in 1960 and an L.L.B. from the University of Oklahoma in 1964.\nJames M. Fitzgibbons has been a director of the Company since January 1994, and previously served as a director of the Company from July 1987 until October 1992. Since October 1990, Mr. Fitzgibbons has been Chairman and Chief Executive Officer of Fieldcrest Cannon, Inc., a manufacturer of home furnishing textiles. From January 1986 until October 1990, Mr. Fitzgibbons was President of Amoskeag Company in Boston, Massachusetts. Prior to 1986, he was President of Howes Leather Company, a producer of leather. Mr. Fitzgibbons is also member of the Board Of Directors of Lumber Insurance Company, American Textile Manufacturers Institute and a Trustee of Laurel Funds, a series of mutual funds. Mr. Fitzgibbons received an A.B. Degree from Harvard College in 1956.\nHennie L.J.M. Gieskes has been a director of the Company since November 1985. Mr. Gieskes is the Managing Director of Spaarne Compagnie N.V., a Netherlands company engaged in the investment business. From before 1976 until December 1990, Mr. Gieskes was a Managing Director of Vitol Beheer B.V. (\"Vitol\"), a Netherlands trading company engaged primarily in energy-related commodities. Mr. Gieskes received a law degree from the University of Amsterdam, The Netherlands, in 1968.\nWilliam W. Grant, III has been a director of the Company since July 1995. Mr. Grant was a director of Plains from May 1987 through July 1995. He has been an advisory director of Colorado National Bankshares, Inc. and Colorado National Bank since 1993. He was a director of Colorado National Bankshares, Inc. from 1982 to 1993 and the Chairman of the Board of Colorado National Bank from 1986 to 1993. He served as the Chairman of the Board of Colorado Capital Advisors from 1989 through 1994. Mr. Grant received a B.A. Degree in English from Yale University in 1954 and attended the Harvard University Graduate School of Business' Advanced Management Program from 1970 to 1971.\nJ. Frank Keller has been Chief Financial Officer since July 1995 and an Executive Vice President, the Secretary and a director of the Company since December 1983. Mr. Keller has been the Chief Financial Officer, an Executive Vice President, the Secretary, and a director of Plains, a wholly owned subsidiary, since July 1995. He also has been the President and a director of Barrett Fuels Corporation since its formation in September 1990. Mr. Keller was an Executive Vice President of the Company from December 1983 through September 1995. Mr. Keller was the President and a co-founder of Myriam Corp., an architectural design and real estate development firm beginning in 1976, until it was reorganized as Barrett Energy in February 1982. Mr. Keller graduated from Kansas State University in 1967 with a B.S. Degree and received an M.B.A. Degree from Colorado State University in 1992.\nPaul M. Rady has been President, Chief Operating Officer, and a director of the Company since September 1994. Prior to that time Mr. Rady served as Executive Vice President--Exploration of the Company beginning February 1993. Mr. Rady has been the President, Chief Operating Officer, and a director of Plains, a wholly owned subsidiary, since July 1995. From August 1990 until July 1992, Mr. Rady served as Chief Geologist for the Company, and from July 1992 until January 1993 he served as Exploration Manager for the Company. From July 1980 until August 1990, Mr. Rady served in various positions with the Denver, Colorado regional office of Amoco Production Company, the exploration and production subsidiary of Amoco Corporation. Mr. Rady was a Geologist and Geophysicist for Amoco Production Company. While with Amoco Production Company, Mr. Rady's areas of responsibility included the Rocky Mountain Basins, Utah-Wyoming Overthrust Belt, offshore Alaska, Oklahoma, particularly with respect to the Arkoma Basin, and the New Ventures Group, which concentrated on the western United States. Mr. Rady received a B.A. Degree in Geology in 1978 from Western State College of Colorado in Gunnison, Colorado, and an M.S. Degree in Geology in 1980 from Western Washington University in Bellingham, Washington.\nA. Ralph Reed has been an Executive Vice President of the Company since November 1989 and a director of the Company since September 1990. Mr. Reed has served as Executive Vice President--Operations and a director of Plains, a wholly owned subsidiary, since July 1995. From 1986 to 1989, Mr. Reed was an independent oil and gas operator in the Mid-Continent region of the United States, including the period from January 1988 to November 1989 when he acted as a consultant to Zenith Drilling Corporation. From 1982 to 1986, Mr. Reed was President and Chief Executive Officer of Cotton Petroleum Corporation, a wholly owned exploration and\nproduction subsidiary of United Energy Resources, Inc. Prior to joining Cotton Petroleum Corporation in 1980, Mr. Reed was employed by Amoco Production Company from 1962, holding various positions including Manager of International Production, Division Production Manager and Division Engineer. Mr. Reed received a B.S. Degree in Petroleum Engineering from the University of Oklahoma in 1959 and in 1975 attended the Executive School at the University of Virginia.\nJames T. Rodgers has been a director of the Company since October 1993. Mr. Rodgers served as the President, Chief Operating Officer and a director of Anadarko Petroleum Corporation (\"Anadarko\") from 1986 through 1992. Anadarko is a Houston-based oil and gas exploration and production company. Prior to 1986, Mr. Rodgers was employed in other capacities by Anadarko and Amoco Production Company. Mr. Rodgers taught Petroleum Engineering at the University of Texas in Austin in 1958 and at Texas Tech University in Lubbock from 1958 to 1961. Mr. Rodgers currently serves as a Director of Louis Dreyfus Natural Gas Corporation and as an Advisory Director for Texas Commerce Bank in Houston. Mr. Rodgers received a B.S. Degree from Louisiana State University in 1956 and an M.S. Degree from the University of Texas in 1958.\nPhilippe S.E. Schreiber has been a director of the Company since November 1985. Mr. Schreiber is an independent lawyer and business consultant who also is of counsel to the law firm of Walter, Conston, Alexander & Green, P.C. in New York, New York. Mr. Schreiber has been affiliated with that law firm as counsel or partner since August 1985. From 1988 to mid-1992, he also was the Chairman of the Board and a principal shareholder of HSE, Inc., d\/b\/a Manhattan Kids Limited, a privately owned corporation involved in catalogue sales of American made children's clothing in Europe. From October 1985 through June 1992, Mr. Schreiber served as a director, and from July 1990 until June 1991 as Managing Director, of Owl Creek Investments Plc, a publicly traded English oil and gas company. Mr. Schreiber received an A.B. Degree from Columbia College in 1964 and a J.D. Degree from Columbia University School of Law in 1967.\nHarry S. Welch has been a director of the Company since July 1995. Mr. Welch was a director of Plains from May 1986 to July 1995. Since August 1989, he has been an attorney in private practice in Houston, Texas. He served as Vice President and General Counsel of Texas Eastern Corporation from 1988 to July 1989. Mr. Welch received a B.B.A. Degree and an L.L.B. Degree from the University of Texas in 1947 and 1949, respectively.\nJoseph P. Barrett has been a Vice President since March 1995 and has been with the Company since it began in 1982. Mr. Barrett has served as Vice President--Land and a director of Plains, a wholly owned subsidiary, since July 1995. He is a 1977 graduate of the University of Colorado where he earned a Bachelor's Degree in Business and Mineral Land Management, and a 1982 graduate of Washburn University Law School where he earned his law degree.\nRobert W. Howard has been Senior Vice President of the Company since March 1992. Mr. Howard has served as Senior Vice President and a director of Plains, a wholly owned subsidiary, since July 1995. Mr. Howard served as the Executive Vice President--Finance from December 1989 until March 1992 and served as Vice President--Finance of the Company from December 1983 until December 1989. Mr. Howard has been the Treasurer of the Company since March 1986. During 1982, Mr. Howard was a Manager\/Accountant with Weiss & Co., a certified public accounting firm. Mr. Howard received a B.B.A. Degree from the University of Wisconsin, Eau Claire, in 1976.\nEugene A. Lang, Jr. has been Senior Vice President--General Counsel of the Company since September 1995. Mr. Lang served as a Senior Vice President, General Counsel and Secretary of Plains from May 1994 to July 1995, and from October 1990 to May 1994 he served as Vice President, General Counsel and Secretary of Plains. From 1986 to 1990 he was an associate with the Houston, Texas law firm of Vinson & Elkins. From 1984 to 1986, he was General Attorney and Assistant Secretary of K N Energy, Inc. From 1978 to 1984, he was an attorney for K N Energy, Inc.\nDonald H. Stevens has been the Vice President--Corporate Relations and Capital Markets for the Company since August 1992. From July 1989 until August 1992, Mr. Stevens served as Manager of Corporate and Tax Planning for Kennecott Corporation, a mining company. From May 1986 until September 1989, Mr. Stevens served as Corporate Planning Analyst in Corporate Acquisition and Divestitures for BP America, Inc., formerly The Standard Oil Company. Prior to May 1986, Mr. Stevens served in various finance, tax and analyst positions with Seco Energy Corporation and Gulf Oil Corporation, both of which are oil and gas companies. Mr. Stevens received his B.S. Degree in Finance\/Accounting from the University of Wyoming in 1975.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nSummary Compensation Table\nThe following table sets forth, in summary form, the compensation received during each of the Company's last three completed years by the Chief Executive Officer of the Company and by the four other most highly compensated executive officers whose compensation exceeded $100,000 during the year ended December 31, 1995. Beginning with the year ended December 31, 1995, the Company changed its fiscal year end from September 30 to December 31. The figures in the following table are for each of the one year periods ended December 31, 1995, 1994, and 1993:\nSUMMARY COMPENSATION TABLE\n- -------- (1) The dollar value of base salary (cash and non-cash) earned during the year indicated. (2) The dollar value of bonus (cash and non-cash) earned during the year indicated. (3) During the period covered by the Table, the Company did not pay any other annual compensation not properly categorized as salary or bonus, including perquisites and other personal benefits, securities or property. (4) During the period covered by the Table, the Company did not make any award of restricted stock, including share units. (5) The sum of the number of shares of Common Stock to be received upon the exercise of all stock options granted. The 1994 Stock Option Plan was approved by the Board Of Directors effective April 1, 1994 and was approved by stockholders at the March 16, 1995 Annual Meeting. At the March 5, 1996 meeting of the Board Of Directors, the Board approved, subject to stockholder approval, an amendment to the 1994 Plan to increase from 400,000 to 1,000,000 the number of shares subject to the 1994 Plan. See below \"Option Grants Table\".\n(6) Except for stock option plans, the Company does not have in effect any plan that is intended to serve as incentive for performance to occur over a period longer than one fiscal year. (7) All other compensation received that the Company could not properly report in any other column of the Table including annual Company contributions or other allocations to vested and unvested defined contribution plans, and the dollar value of any insurance premiums paid by, or on behalf of, the Company with respect to term life insurance for the benefit of the named executive officer, and the full dollar of the remainder of the premiums paid by, or on behalf of, the Company. Effective in November 1993, the Company obtained directors and officers insurance. Coverage of the named officers under this policy may be considered compensation for the named officers, although it has not been included in the table. (8) Mr. Wallace's compensation was paid by Plains during the period from October 3, 1994 (when he first became an executive officer of Plains) through July 18, 1995 when Plains merged with and into the Company. Mr. Wallace resigned as an officer and director of the Company effective January 11, 1996 and as an employee of the Company effective as of March 6, 1996. (9) Consists of options to purchase 76,185 shares of Common Stock of Plains that became options to purchase 99,030 shares of Common Stock of the Company upon the merger of Plains with and into a subsidiary of the Company on July 18, 1995.\nOption Grants Table\nNo grants of stock options were made during the fiscal year ended December 31, 1995 to the Company's Chief Executive Officer or the four other most highly compensated executive officers of the Company whose compensation exceeded $100,000 during the year ended December 31, 1995.\nAggregated Option Exercises And Fiscal Year-End Option Value Table\nThe following table sets forth information concerning each exercise of stock options during the year ended December 31, 1995 by the Company's Chief Executive Officer and the four other most highly compensated executive officers of the Company whose compensation exceeded $100,000 during the year ended December 31, 1995, and the year-end value of unexercised options held by these persons:\nAGGREGATED OPTION EXERCISES FOR YEAR ENDED DECEMBER 31, 1995 AND YEAR-END OPTION\/SAR VALUES\n- -------- (1) The number of shares received upon exercise of options during the year ended December 31, 1995. (2) With respect to options exercised during the Company's year ended December 31, 1995, the dollar value of the difference between the option exercise price and the market value of the option shares purchased on the date of the exercise of the options. (3) The total number of unexercised options held as of December 31, 1995, separated between those options that were exercisable and those options that were not exercisable. (4) For all unexercised options held as of December 31, 1995, the aggregate dollar value of the excess of the market value of the stock underlying those options over the exercise price of those unexercised options. These values are shown separately for those options that were exercisable, and those options that were not yet exercisable, on December 31, 1995. As required, the price used to calculate these figures was the closing sale price of the Common Stock at year-end. On December 29, 1995, the last day of trading for the year, the closing sale price of the Common Stock was $29.375 per share. On March 12, 1996, the closing sale price was $22.625 per share.\nEmployee Retirement Plans, Long-Term Incentive Plans, And Pension Plans\nThe Company has an employee retirement plan (the \"401(k) Plan\") that qualifies under Section 401(k) of the Internal Revenue Code Of 1986, as amended. Employees of the Company are entitled to contribute to the 401(k) Plan up to 15 percent of their respective salaries. For each pay period through March 31, 1996, the Company will contribute, on behalf of each employee, 50 percent of the contribution made by that employee, up to a maximum contribution by the Company of three percent of that employee's gross salary for that pay period. Effective April 1, 1996, the Company's matching contribution will be increased to 100 percent of each participating employee's contribution, up to a maximum of six percent of base salary, with one-half of the match paid in cash and one-half of the match paid in the Company's Common Stock. Benefits payable to employees upon retirement are based on the contributions made by the employee under the 401(k) Plan, the Company's matching contributions, and the performance of the 401(k) Plan's investments. Therefore, the Company cannot estimate the annual benefits that will be payable to participants in the 401(k) Plan upon retirement at normal retirement age.\nExcluding the Company's stock option plans, the Company has no long-term incentive plan to serve as incentive for performance to occur over a period longer than one fiscal year.\nExcluding the 401(k) Plan, the Company has no defined benefit or actuarial or pension plans or other retirement plans.\nCompensation of Directors\nStandard Arrangements. Pursuant to the Company's standard arrangement for compensating directors of the Company, no compensation for serving as a director is paid to directors who are not also employees of the Company, and those directors who are not also employees of the Company (\"Outside Directors\") receive an annual retainer of $20,000 paid in equal quarterly installments. In addition, for each meeting attended, each Outside Director receives a $750 meeting attendance fee, and will have options to purchase 500 shares of the Common Stock become exercisable. Although these options become exercisable only at the rate of 500 for each Board Of Directors meeting attended, each director will be granted options to purchase 10,000 shares at the time the person initially becomes a director. Any options that have not become exercisable at the time of termination of a director's service will expire at that time. At such time that the options to purchase all 10,000 shares have become exercisable, options to purchase an additional 10,000 shares will be granted to the director subject to the restrictions on exercise. The options are granted to the Outside Directors pursuant to the Company's Non-Discretionary Stock Option Plan, and their exercise price is equal to the closing sales price for the Company's Common Stock on the date of grant. These options expire upon the later to occur of (i) five years after the date of grant, and (ii) two years after the date those options first become exercisable.\nEffective in November 1993, the Company obtained directors and officers insurance coverage. Coverage of the directors of the Company under this policy may be considered compensation for the directors.\nOther Arrangements. During the year ended December 31, 1995, no compensation was paid to directors of the Company other than pursuant to the standard compensation arrangements described in the previous section.\nEmployment Contracts And Termination Of Employment And Change-In-Control Arrangements\nThe Company does not have any written employment contracts with respect to any of its executive officers named in the Summary Compensation Table except for William F. Wallace. The Company entered into a six month employment agreement with Mr. Wallace effective at the consummation of the Barrett-Plains merger. In addition, Mr. Wallace is a party to an agreement with Plains to which the Company became bound as a result of the Barrett-Plains merger. That agreement provides, among other things, that if, within three years after a \"Change In Control\" (as defined in the agreement), Mr. Wallace's employment with Plains is involuntarily terminated or is terminated by Mr. Wallace for \"Good Reason\", Mr. Wallace is to be paid a cash amount equal to (a) 299 percent of the higher of (i) his then annual compensation (including salary, bonuses and incentive compensation) or (ii) 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, plus, (b) an amount equal to any excise taxes payable by Mr. Wallace with respect to these amounts and any excise or income taxes payable by Mr. Wallace as a result of the reimbursement of the excise taxes. \"Good Reason\" is defined as a reduction in Mr. Wallace's compensation or employment responsibilities, a required relocation outside the greater Denver, Colorado area or, generally, any conduct by Plains that renders Mr. Wallace unable to discharge his employment duties effectively. Following the cessation of Mr. Wallace's employment with the Company on March 6, 1996, the Company paid to Mr. Wallace $1,024,440 in satisfaction of the Company's obligations pursuant to Mr. Wallace's employment agreement with Plains. The Company has no other compensatory plan or arrangement that results or will result from the resignation, retirement, or any other termination of the employment with the Company and its subsidiaries of the executive officers named in the Summary Compensation Table or from a change-in-control, except that (i) in January 1994, the Board Of Directors approved a resolution allowing all options outstanding under the Company's 1990 Stock Option Plan to become exercisable if an announcement is made concerning a business combination with the Company; and (ii) in September 1994, the Compensation Committee committed to Mr. Reed that all stock options that has been granted to him as of September 10, 1994 would become exercisable upon termination of his employment provided that he remains in the employment of the Company continuously until September 10, 1997, and further provided that the Compensation Committee, or its successor, determines as of the date of his termination that his employment performance has satisfied the Company's employment standards for executive officers.\nCompensation Committee Interlocks And Insider Participation\nDuring the year ended December 31, 1995, each of C. Robert Buford, James M. Fitzgibbons, Derrill Cody, Hennie L.J.M. Gieskes, James T. Rodgers, Philippe S.E. Schreiber and Harry S. Welch served as members of the Compensation Committee of the Board Of Directors. Mr. Schreiber served as the President of Excel Energy Corp. prior to the 1985 merger of Excel with and into the Company and Mr. Gieskes served as Chairman Of The Board of Excel at the time of the merger of Excel with and into the Company. No other person who served as a member of the Compensation Committee during the year ended December 31, 1995 was, during that year, an officer or employee of the Company or of any of its subsidiaries, or was formerly an officer of the Company or of any of its subsidiaries. For a description of transactions involving Mr. Buford and the Company, please see Item 13. \"Certain Relationships and Related Transactions\".\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following table summarizes certain information as of March 12, 1996 with respect to the ownership by each director, by each executive officer named in the \"Executive Compensation\" section above, by all executive officers and directors as a group, and by each other person known by the Company to be the beneficial owner of more than five percent of the Common Stock:\n- -------- (1) The number of shares indicated includes 6,790 shares owned by Louise K. Barrett, Mr. Barrett's wife, 230,000 shares owned by the Barrett Family L.L.L.P., a Colorado limited partnership for which Mr. Barrett and his wife are general partners and owners of an aggregate of 77.21462 percent of the partnership interests, and 49,998 shares underlying options that currently are exercisable or become exercisable within the next 60 days. Pursuant to Rule 161-1(a)(4) under the Securities Exchange Act of 1934 (the \"1934 Act\"), Mr. Barrett disclaims ownership of all but 177,594 shares held by the Barrett Family L.L.L.P., which constitutes Mr. and Mrs. Barrett's proportionate shares of the shares held by the Barrett Family L.L.L.P. (2) C. Robert Buford is considered the beneficial owner of the 604,830 shares of which Zenith Drilling Corporation (\"Zenith\") is the record owner. Mr. Buford owns approximately 89 percent of the outstanding common stock of Zenith. The number of shares indicated for Mr. Buford also includes 10,000 shares that are owned by Aguilla Corporation, which is owned by Mr. Buford's wife and adult children. Mr. Buford disclaims beneficial ownership of the shares held by Aguilla Corporation pursuant to Rule 16a- 1(a)(4) under the 1934 Act. The number of shares indicated also includes 8,000 shares underlying options currently exercisable at $10.375 per share. (3) The number of shares indicated consists of or includes the following number of shares underlying options that currently are exercisable or that become exercisable within the next 60 days that are held by each of the following persons: Derrill Cody, 9,300; James M. Fitzgibbons, 6,500; Hennie L.J.M. Gieskes, 7,000; William W. Grant, III, 12,900; J. Frank Keller, 22,350; Paul M. Rady, 26,500; James T. Rodgers, 8,500; Philippe S.E. Schreiber, 6,500; William F. Wallace, 99,030; and Harry S. Welch, 14,200. Mr. Wallace resigned as an executive officers of the Company effective January 11, 1996 and as an employee of the Company effective March 6, 1996. (4) Less than one percent of the Common Stock outstanding. (5) The number of shares indicated includes 12,500 shares owned by Mary C. Reed, Mr. Reed's wife and 35,800 shares underlying options currently are exercisable or that become exercisable within the next 60 days. (6) The number of shares indicated includes the shares owned by Zenith that are beneficially owned by Mr. Buford as described in note (2), and the aggregate of 306,578 shares underlying the options described in notes (1), (2), (3) and (5), an aggregate of 27,127 shares owned by four executive officers not named in the above table, an aggregate of 745 shares the beneficial ownership of which is disclaimed by the four executive officers not named in the above table, and an aggregate of 74,109 shares underlying options that currently are exercisable or that are exercisable within 60 days that are held by those four executive officers. (7) Wellington Management company, in its capacity as investment adviser, may be deemed the beneficial owner of these shares which are owned by numerous investment counseling clients.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nDuring the year ended December 31, 1995, Zenith, which owns a working interest in many of the leases for which the Company is the operator, paid to the Company, as operator, approximately $1,062,000 as Zenith's portion of the lease operating expenses and development costs for those leases. Also, as a result of its working interest in those leases, Zenith received approximately $942,000 as its share of revenues. Zenith owns working interests ranging from three to 50 percent in leases of which the Company is the operator. All terms and arrangements between Zenith and the Company with respect to these working interests are the same as those between the Company and the other working interest owners in the leases. Zenith is 89 percent owned by Mr. Buford.\nMr. Buford also is the President of Grand Valley Corporation (\"GVC\"), which owns approximately a 10 percent interest in the pipeline gathering system and related facilities on the Company's Grand Valley Field. Ten percent of GVC is owned by Mr. Buford, and 90 percent of GVC is owned by Mr. Buford's three adult children. During the year ended December 31, 1995, GVC's proportionate share of the pipeline gathering system's expenses, not including depreciation, was approximately $148,000, and its share of the pipeline gathering system's revenues was approximately $909,000. All terms and arrangements between GVC and the Company with respect to this gathering system are the same as those between the Company and the other owners of the gathering system.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL SCHEDULES, AND REPORTS ON FORM 8-K\n(a)(1) and (a)(2) Financial Statements And Financial Statement Schedules\nINDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nAll other schedules are omitted because the required information 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) Exhibits\nSee \"EXHIBIT INDEX\" on page 33.\n(b) Reports On Form 8-K. No reports on Form 8-K were filed during the fourth quarter of the year ended December 31, 1995.\nEXHIBIT INDEX\nREPORT OF ARTHUR ANDERSEN LLP\nINDEPENDENT PUBLIC ACCOUNTANTS\nThe Board of Directors Barrett Resources Corporation Denver, Colorado 80202\nWe have audited the accompanying consolidated balance sheets of Barrett Resources Corporation (a Delaware corporation) and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1995. 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 Barrett Resources Corporation and subsidiaries as of December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\nAs explained in Note 8 to the financial statements, effective January 1, 1993, the Company changed its method of accounting for postretirement benefits.\nArthur Andersen LLP\nDenver, Colorado March 1, 1996\nBARRETT RESOURCES CORPORATION\nCONSOLIDATED BALANCE SHEETS\nDECEMBER 31, 1995 AND 1994 (IN THOUSANDS)\nSee accompanying notes.\nBARRETT RESOURCES CORPORATION\nCONSOLIDATED STATEMENTS OF INCOME\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (IN THOUSANDS, EXCEPT PER SHARE DATA)\nSee accompanying notes.\nBARRETT RESOURCES CORPORATION\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (IN THOUSANDS)\nSee accompanying notes.\nBARRETT RESOURCES CORPORATION\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (IN THOUSANDS)\nSee accompanying notes.\nBARRETT RESOURCES CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1995, 1994 AND 1993\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBusiness\nBarrett Resources Corporation (the \"Company\") is an independent natural gas and oil exploration and production company with producing properties located in the mid-continent states and Rocky Mountain region of the United States. Barrett also operates gas gathering systems and related facilities in the areas which are synergistic to the Company's production. Barrett has a gas marketing and trading subsidiary, which allows the Company to market the Company's natural gas production and to purchase and sell other companies' natural gas.\nPrinciples of consolidation\nThe consolidated financial statements include the accounts of the Company and its subsidiaries, all of which are wholly-owned. All significant intercompany transactions have been eliminated in consolidation. Certain reclassifications have been made to 1993 and 1994 amounts to conform to the 1995 presentation.\nUse of estimates\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities 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. There are many factors, including global events, that may influence the production, processing, marketing, and valuation of crude oil and natural gas. A reduction in the valuation of oil and gas properties resulting from declining prices or production could adversely impact depletion rates and ceiling test limitations.\nPartnerships\nThe consolidated financial statements include the Company's proportionate share of the assets, liabilities, revenues and expenses of its oil and gas partnership interests.\nCash and cash equivalents\nCash in excess of daily requirements is invested in money market accounts and commercial paper with maturities of three months or less. Such investments are deemed to be cash equivalents for purposes of the consolidated statements of cash flows. The carrying amount of cash equivalents approximates fair value because of the short maturity of those instruments.\nOil and gas properties\nThe Company utilizes the full cost method of accounting for oil and gas properties whereby all productive and nonproductive costs paid to third parties that are incurred in connection with the acquisition, exploration and development of oil and gas reserves are capitalized. No gains or losses are recognized upon the sale, conveyance or other disposition of oil and gas properties except in extraordinary transactions.\nCapitalized costs are accumulated on a country-by-country basis subject to a cost center ceiling and amortized using the units-of-production method. The Company presently has only one cost center since all of its properties are located in the United States. Amortizable costs include developmental drilling in progress as well\nBARRETT RESOURCES CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDECEMBER 31, 1995, 1994 AND 1993 as estimates of future development costs of proved reserves but exclude the costs of unevaluated oil and gas properties. Accumulated depreciation and amortization is written off as assets are retired. Depletion and amortization equaled approximately $.55, $.52 and $.48 per Mcfe ($3.28, $3.14 and $2.87 per BOE) during the years ended December 31, 1995, 1994 and 1993, respectively.\nThe Company capitalizes interest costs on amounts expended on assets during the period in which activities are occurring to place the asset in service. Amounts spent to develop properties included in the full cost center of oil and gas properties are excluded from the interest capitalization computation.\nThe Company acquires nonproducing acreage for its exploration and development activities. The cost of these leases is included in unevaluated oil and gas property costs recorded at the lower of cost or fair market value.\nThe Company operates many of the wells in which it owns an economic interest. The operating agreements for these activities provide for a fee structure to allow the Company to recover a portion of its direct and overhead charges related to its operating activities. The fees collected under the operating agreements are recorded as a reduction of general and administrative expenses. Any amounts collected from a sale of oil and gas interests or earned as a result of assembling oil and gas drilling activities are applied to reduce the book value of oil and gas properties.\nOther property and equipment\nOther property and equipment is recorded at cost. Renewals and betterments which substantially extend the useful life of the assets are capitalized. Maintenance and repairs are expensed when incurred. Depreciation is provided using accelerated and straight-line methods over the estimated useful lives, ranging from five to ten years, of the assets.\nAmounts payable to oil and gas property owners\nAmounts payable to oil and gas property owners consist of cash calls from working interest owners to pay for development costs of properties being currently developed, production revenue that the Company, as operator, is collecting and distributing to revenue interest owners and production revenue taxes that the Company, as operator, has withheld for timely payment to the tax agencies.\nTrading and hedging activities\nThe Company's business activities include buying and selling of natural gas. The Company recognizes revenue and costs on gas trading transactions at the point in time when gas is delivered to the purchaser.\nThe Company uses both commodity futures contracts and price swaps to hedge the impact of price fluctuations on a portion of its production and trading activities. The Company enters into a hedging position for specific transactions that management deems expose the Company to an unacceptable market price risk. Price swaps or commodities transactions without corresponding scheduled physical transactions (scheduled physical transactions include committed trading activities or production from producing wells) do not qualify for hedge accounting. The Company classifies these positions as trading positions and records these instruments at fair value. Gains and losses are recognized as fair values fluctuate from time to time compared to cost.\nGains or losses on hedging transactions are deferred until the physical transaction occurs for financial reporting purposes. Deferred gains and losses and unrealized gains and losses are evaluated in connection with\nBARRETT RESOURCES CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDECEMBER 31, 1995, 1994 AND 1993 the physical transaction underlying the hedge position. Hedging gains or losses significantly exceeding the price movement of the underlying physical transaction are recorded in the consolidated statements of income in the period in which the lack of correlation occurred. Gains or losses on hedging activities are recorded in the consolidated statements of income as adjustments of the revenue or cost of the underlying physical transaction. Hedging transactions are reported as operating activities in the consolidated statements of cash flows.\nEarnings per share\nPer share amounts were computed using the weighted average number of shares of common stock and common stock equivalents outstanding during each year: 1995--24,931,000; 1994--24,967,000 and 1993--24,778,000. Options to purchase stock are included as common stock equivalents, when dilutive, using the treasury stock method.\nChange in fiscal year\nOn July 18, 1995, the Company changed its fiscal year-end from September 30 to December 31. A transition report for the period October 1, 1994 through December 31, 1994 was filed with the Securities and Exchange Commission. During the three months ended December 31, 1994, the Company reported revenues of $15 million and net income of $207,000.\n2. MERGER\nOn July 18, 1995 Plains Petroleum Company (\"Plains\") was merged with and into a subsidiary of the Company, resulting in Plains becoming a wholly-owned subsidiary of the Company. Approximately 12.8 million shares of the Company's common stock were issued in exchange for all of the outstanding common stock of Plains. Additionally, outstanding options to acquire Plains common stock were converted to options to acquire approximately 593,000 shares of the Company's common stock. In connection with the merger, the Company's authorized number of shares of common stock was increased to 35 million. The merger was accounted for as a pooling of interests, and accordingly, the accompanying financial statements have been restated to include the accounts and operations of Plains for all periods prior to the merger.\nPlains used the successful efforts method of accounting for its oil and gas exploration and development activities. In conjunction with the merger, Plains adopted the full cost method used by the Company resulting in increases of net property and equipment due to the capitalization of exploration costs, reversal of impairment and adjustments of depreciation, depletion and amortization expense for periods prior to the merger. The financial statements for 1994 and 1993 have been retroactively restated for the change in accounting method which resulted in increased net income. Retained earnings and deferred income taxes have been adjusted for the effect of the retroactive application of the new method.\nBARRETT RESOURCES CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDECEMBER 31, 1995, 1994 AND 1993\nCertain reclassifications have been made to the historical consolidated financial statements of the separate companies to conform the financial statements to a comparable presentation. There were no intercompany transactions between the Company and Plains. Separate results for the periods preceding the merger, including the conversion to full cost for Plains and the change to a December 31 year-end for the Company, were as follows (in 000's):\n- -------- (1) Restated to full cost to conform accounting policies (2) To conform year ends\nIn connection with the merger, approximately $14.2 million of merger and reorganization costs and expenses were incurred and have been charged to expense in the Company's third and fourth quarters of fiscal 1995. These nonrecurring costs and expenses consist of (1) investment banker and professional fees of $7.4 million; (2) severance and employee benefit costs of $5.6 million for approximately 38 employees, terminated through consolidation of administrative and operational functions; (3) a non-cash credit of approximately $.9 million associated with the termination of Plains' postretirement benefit plans and other related benefit plans and (4) other merger and reorganization related costs of $2.1 million.\n3. RECEIVABLES\nThe Company's accounts receivable are primarily due from medium size oil and gas entities in the Rocky Mountain region. Collection of joint interest billings is generally secured by future production. The Company performs periodic credit evaluations of customers purchasing production for which no collateral is required. Historically, the Company has not experienced significant losses related to these extensions of credit.\nAs of December 31, 1995 and 1994, receivables are recorded net of allowance for doubtful accounts of $201,000 and $224,000, respectively.\nBARRETT RESOURCES CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDECEMBER 31, 1995, 1994 AND 1993\n4. PROPERTY AND EQUIPMENT\nThe Company capitalized interest costs of $403,000 in 1995 with respect to qualifying properties. Total interest costs incurred after recognition of the capitalized interest amount was $4.6 million in 1995.\n5. UNEVALUATED OIL AND GAS PROPERTY COSTS\nUnevaluated oil and gas property costs consist of the following:\nThe unevaluated costs were incurred for projects which are being explored. The Company anticipates that substantially all unevaluated costs will be classified as evaluated costs within the next three years.\n6. LONG-TERM DEBT\nThe Company has a reserve-based line of credit with a group of banks which provides up to $200 million for a four year period ending July 19, 1999. The amount actually available to the Company under the line at any given time is limited to the collateral value of proved reserves as determined by the lenders. Based on the lenders' determination of collateral value, as of December 31, 1995 (which was based on the March 31, 1995 and December 31, 1994 reserve reports), the Company has a borrowing limit of $160 million. In order to reduce the commitment fees, the Company voluntarily requested that the lenders limit the maximum borrowing to $90 million through December 31, 1995. Subsequent to December 31, 1995, the Company increased the maximum borrowing limit to $110 million. The lenders are currently reviewing the December 31, 1995 reserve report to determine current collateral value. The Company is required to pay interest only during the revolving period. At its option, the Company has elected to use the London interbank eurodollar rate (LIBOR) plus a spread ranging from .5 percent to 1.0 percent (depending on the Company's borrowing relative to its borrowing base) for a substantial portion of the outstanding balance. As of December 31, 1995 the Company's outstanding balance under the line of credit was $89 million of which $83 million was accruing interest at an average LIBOR based rate of 6.62 percent and $6 million was accruing interest on a prime based rate of 8.50 percent. The line of credit agreement restricts the payment of dividends, borrowings, sale of assets, loans to others, investment and merger\nBARRETT RESOURCES CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDECEMBER 31, 1995, 1994 AND 1993 activity over certain limits without the prior consent of the bank and requires the Company to maintain certain net worth and debt to equity levels. Based on the variable borrowing rates and re-pricing terms currently available to the Company for the line of credit, management believes the fair value of long-term debt approximates the carrying value.\n7. OPTIONS\nThe Company has two employee stock option plans, a 1990 Plan and a 1994 Plan, under which the Company's common stock may be granted to officers and employees of the Company and subsidiaries. The 1990 Plan, as amended, provided for the granting of 775,000 shares. The 1994 Plan provides for the granting of 400,000 shares of the Company's common stock. In addition, the Company has a non-discretionary stock option plan under which options for an aggregate of 100,000 shares of the Company's common stock may be granted to non-employee directors. In connection with the merger discussed in Note 2, the Company assumed preexisting Plains stock option plans and converted all options then outstanding into options to acquire shares of the Company's common stock. No further options will be granted under the Plains' plans.\nSummary of options granted, exercised and outstanding during 1994 and 1995 is as follows:\n8. RETIREMENT BENEFITS\nThe Company has a voluntary 401(k) employee savings plan. Under this plan, the Company matches 50% of each of the participating employees' contributions, up to a maximum of 6% of base salary. Effective April 1, 1996, the Company's match will be increased to 100% of each of the participating employees contributions, up to a maximum of 6% of base salary, with one-half of the match paid in cash and one half of the match paid in the Company's common stock. The Company's matching contributions are subject to a vesting schedule. Company contributions were $239,000, $179,000 and $166,000 in 1995, 1994 and 1993, respectively.\nPlains had several employee benefit plans described below. Pursuant to the terms of the merger agreement between Plains and the Company, these plans were terminated.\nPlains' qualified, defined benefit retirement plan covered substantially all of its employees. The benefits were based on a specified level of the employee's compensation during plan participation. As of July 18, 1995, the plan froze benefit accruals. Pursuant to the plan, all participants became fully vested. Plan assets consist of\nBARRETT RESOURCES CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDECEMBER 31, 1995, 1994 AND 1993 cash and equivalents, corporate stocks and bonds, U.S. treasury notes, insured annuity contracts, and accrued interest. Contributions totaled $169,000, $312,000 and $341,000 for the 1995, 1994 and 1993 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 4.5% (termination rates). The rate of increase used for compensation levels was nil in 1995 and 5% in 1994 and 1993, respectively. The expected long-term rate of return on assets was 8.5%.\nPlains also contributed the lesser of 10% of its net earnings or 10% of employee compensation to a profit sharing plan of Plains. No contributions were made for 1995. Plains contributed $334,000 and $188,000 for 1994 and 1993, respectively.\nThrough June 30, 1995 and during 1994, Plains matched 401(k) plan deferrals with contributions equal to 50% of each deferral up to 6% of current salary. This matching contribution was invested in Plains stock and were subject to a vesting schedule. Participants became fully vested with the merger with and into Barrett. Contributions were approximately $112,000, $192,000 and $250,000 for 1995, 1994 and 1993, respectively.\nThe above described profit-sharing and 401(k) plans were terminated July 1, 1995; the pension plans were terminated September 18, 1995. Internal Revenue Service approval for termination of these plans was received in January 1996. Final distribution of plan assets will be made to participants in the second quarter of 1996.\nPlains' executive deferred compensation plan and directors' deferred plan permitted the deferral of current salary or directors' fees for the purpose of providing funds at retirement or death for employees, directors and\nBARRETT RESOURCES CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDECEMBER 31, 1995, 1994 AND 1993 their beneficiaries. These plans were terminated effective June 30, 1995 and will be disbursed to the participants by the trustee of the assets over a period ending January 1, 1997. Total accrued liability under these plans at December 31, 1995 and 1994 was $36,000 and $1,006,000, respectively.\nConcurrently with the effective date of the merger, Plains' postretirement healthcare benefit and salary continuation plans were terminated. Participants in the salary continuation plan received (1) a lump sum benefit equal to the present value of the remaining monthly payments if receiving Death Benefits under the plan at the date of the termination, or (2) insurance policies, the cost of which was limited to the cash values of the life insurance policies owned by Plains. Benefits associated with the postretirement healthcare benefit plan were terminated and, accordingly, accrued postretirement benefit costs were relieved.\nEffective January 1, 1993, Plains adopted Statement No. 106 (FAS 106) issued by the Financial Accounting Standards Board on accounting for postretirement benefits other than pensions. In accordance with this statement, Plains elected to recognize the accumulated postretirement benefit liability as of the effective date, totaling approximately $800,000 (pretax). With the termination of these plans in 1995, all future obligations were settled and ceased to exist.\nObligations for previous periods were as follows:\n9. HEDGING ACTIVITIES\nThe Company uses various hedging techniques to reduce the effect of price volatility on the sales price of a portion of its oil and gas sales. The objective of its hedging activities is to achieve more predictable revenues and cash flows. The following is a summary of the Company's hedging transactions in effect as of December 31, 1995.\nA. The Company is the fixed price payor for hedging transactions relating to 6,000 MMBtu of gas per day for 1996 at $1.33 per MMBtu and approximately 7,000 MMBtu of gas per day for January through May 1996 at an average price of $2.12 per MMBtu. Under these price swap arrangements, the Company has agreed to buy gas at a fixed price and sell gas at an index price. These price swaps were entered to accommodate markets desiring fixed price supplies.\nBARRETT RESOURCES CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDECEMBER 31, 1995, 1994 AND 1993\nB. The Company will receive fixed prices ranging from $1.46 to $2.12 per MMBtu in swap transactions associated with an average of 52,000 MMBtu of gas per day to be produced by the Company subsequent to December 31, 1995 through March 1996. The Company is required to pay an index price to its financial counterparty. The Company sold a call option on 20,000 MMBtu per day for April through October 1996. Under this option, the Company will receive $1.86 per MMBtu should the option holder elect to exercise.\nC. The Company's gas hedges also include a collar in which the Company sold a call and purchased a put with respect to 10,000 MMBtu per day in 1996 with an average floor (put) price of $1.60 per MMBtu and an average ceiling (call) price of $1.92 per MMBtu. Under this arrangement, the Company receives a payment if the index price falls below the floor and makes a payment to the counterparty if the index price exceeds the ceiling. To reduce exposure to increasing index prices, the Company purchased call options with prices averaging $2.673 per MMBtu January--March and $1.969 per MMBtu April--December, 1996.\nD. The Company has entered into basis swaps to minimize different index price fluctuations. The Company will receive a payment in the event that the New York Mercantile Exchange (\"NYMEX\") price per MMBtu for a reference period exceeds the average specified index price by more than an average of $.29 on 10,000 MMBtu of gas per day from January through March 1996 ($.44 on 5,000 MMBtu of gas per day for April 1996). In separate basis swaps, the Company will receive a payment in the event the specified index price exceeds the NYMEX price net of a basis adjustment of an average of $.48 on 10,000 MMBtu of gas per day from January through October 1996. Conversely, the Company will be required to make payments to the counterparty if the opposite situation exists in these swaps. These swaps were entered to offset a portion of the risk associated with the Company's long-term firm transportation portfolio.\nE. With respect to crude oil production, the Company entered into a price swap whereby the Company will receive a fixed price of $18.00 per Bbl for 1,000 Bbls per day through March 1996. The Company is required to pay the counterparty a NYMEX settlement price.\nAs of December 31, 1995, some of the Company's hedging positions described above did not qualify for hedge accounting due to reduced correlation between the index price and the prices to be realized for certain physical gas deliveries. Accordingly, the Company recognized hedging losses of $1.2 million in the fourth quarter of 1995. These losses offset hedging gains of $1.6 million realized in 1995. The net hedging gain was included in oil and gas revenues. The Company paid and received certain premiums related to its option contracts for future periods. The unrealized hedging losses and net deferred premium costs have been included in other liabilities.\nDuring 1995, the Company incurred a net cost of $2.1 million to hedge the index based price for a portion of its gas purchased in various transactions for gas trading activities. These payments allowed the Company to purchase gas on a fixed price basis to satisfy fixed price sales commitments. This hedging allowed the Company to avoid gas price fluctuations for the related transactions so that the Company realized the gross profit margins anticipated upon entering into the trading arrangements. This hedging cost is included in the income statement as a component of \"Cost of Trading.\"\nBARRETT RESOURCES CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDECEMBER 31, 1995, 1994 AND 1993\n10. COMMITMENTS AND CONTINGENCIES\nLease Commitments\nThe minimum future payments under the terms of operating leases, principally for office space, are as follows:\nThe Company plans to sublet office space vacated with the consolidation and relocation of its Denver offices and accordingly anticipates a substantial reduction in rental expense for the years 1996 through 1999. Rent expense was $956,000, $859,000 and $788,000 for the years ended December 31, 1995, 1994 and 1993, respectively.\nLitigation\nOn November 2, 1994, a putative class action was filed in Delaware Chancery Court. In that case, entitled Miller v. Cody, the plaintiff has alleged that certain named former directors of Plains, and Plains, have, among other things, breached their fiduciary duties 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.\nOn May 3, 1995, the same day Plains announced it had executed a merger agreement with the Company, a putative class action, entitled Crandon Capital Partners v. Miller, was filed in Delaware Chancery Court against Plains and the then-current members of its Board of Directors. In this suit it is alleged that, among other things, the agreement was inadequate, plaintiff seeks various forms of declaratory and injunctive relief, damages and an award of plaintiff's costs and disbursements.\nPlains and its former directors have received a status report filed by plaintiffs' counsel in both cases indicating a \"stipulation of dismissal without prejudice will be circulated shortly.\"\nExcept as noted above, at December 31, 1995, the Company was a party to certain other 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 year end 1995, 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.\nBARRETT RESOURCES CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDECEMBER 31, 1995, 1994 AND 1993\nMajor Purchaser\nDuring 1995, one purchaser accounted for 18 percent of the Company's total revenue (24 percent of oil and gas revenues.) Sales of gas to this purchaser represented 19 percent and 29 percent of total revenues in 1994 and 1993, respectively.\n11. INCOME TAXES\nThe provision for income taxes consists of the following:\nThe difference between the provision for income taxes and the amounts which would be determined by applying the statutory federal income tax rate to income before provision for income taxes is analyzed below:\nBARRETT RESOURCES CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDECEMBER 31, 1995, 1994 AND 1993\nLong-term deferred tax assets (liabilities) are comprised of the following at December 31, 1995 and 1994:\nValuation allowances of $1,193,000 and $797,000 were provided at December 31, 1995 and 1994, respectively, based on carryforward amounts which may not be utilized before expiration and the possible effect of exploratory drilling costs.\nThe Company has the following net operating loss and investment tax credit carryforwards available:\n- -------- A substantial portion of the net operating losses were acquired in conjunction with purchased operations.\nThe 1990 public offering of common stock by the Company before the Plains merger resulted in a change in the Company's ownership as defined in Section 382 of the Internal Revenue Code. The effect of this change in ownership limits the utilization of net operating losses for income tax purposes to approximately $3,069,000 per year which affects $13,590,000 of the net operating losses. The 1995 merger with Plains also resulted in a\nBARRETT RESOURCES CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDECEMBER 31, 1995, 1994 AND 1993 change in the Company's and Plains' ownership as defined by Section 382 of the Internal Revenue Code. The change effectively limits the utilization of the remaining net operating losses for income tax purposes to approximately $14,000,000 for each company. Portions of the above limitations which are not used each year may be carried forward to future years.\nThe Internal Revenue Service (IRS) is currently examining the federal tax returns of Plains and subsidiaries for calendar years 1991, 1992 and 1993. The examinations are not yet complete, but based on preliminary comments from the IRS examiner, management anticipates that the IRS will propose adjustments to disallow net operating loss deductions claimed by Plains thereby increasing taxable income for the years under examination. Management is of the opinion that the federal tax returns of Plains for years 1991 through 1993 reflect the proper federal income tax liability as supported by relevant authority. The Company intends to vigorously dispute any adjustments proposed by the examining agent and furthermore believes that the Company will prevail in its positions.\n12. SUPPLEMENTAL CASH FLOW SCHEDULES AND INFORMATION\nCash paid during years\nIn May 1994, Plains completed a contingent provision 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 Plains' common stock and cash subject to reserves additions on certain property interests owned by MRA prior to the merger. Under this Agreement, 31,873 shares of Plains' common stock were issued and a cash payment of $1.5 million was paid to MRA's shareholders in settlement of this obligation.\n13. RELATED PARTIES\nDuring the years ended December 31, 1995, 1994 and 1993 Zenith Drilling Corporation (\"Zenith\") was billed by the Company as operator, approximately $1,062,000, $1,853,000 and $2,555,000, respectively, for Zenith's portion of lease operating expenses and development costs in certain leases operated by the Company. Also as a result of Zenith's working interest ownership, the Company distributed oil and gas revenue of approximately $942,000, $936,000 and $1,074,000 to Zenith during 1995, 1994 and 1993, respectively. Zenith owns its working interests subject to the same terms and arrangements that exist for all working interest owners in the properties. Zenith owns approximately three percent of the Company's common stock and its president is a member of the Company's board of directors.\nDuring 1993, the Company and Zenith both sold their respective interests in the Wattenberg field. The Company and Zenith jointly negotiated the sale but the purchaser independently determined the individual offer prices and entered into separate sales agreements with each party.\nGrand Valley Corporation owns approximately 10 percent of a pipeline joint venture for gas gathering of which a subsidiary of the Company owns approximately 29 percent. A member of the Company's board of\nBARRETT RESOURCES CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDECEMBER 31, 1995, 1994 AND 1993 directors owns 10 percent of the outstanding stock, and is the president of Grand Valley Corporation. His three adult children own the remaining 90 percent of the outstanding stock of Grand Valley Corporation.\n14. QUARTERLY INFORMATION (UNAUDITED)\nSUPPLEMENTAL OIL AND GAS INFORMATION\nThe following is information pertaining to the Company's oil and gas producing activities for the years ended December 31, 1995, 1994 and 1993.\nCosts incurred in oil and gas property acquisition, exploration, and development activities:\nOIL AND GAS RESERVE INFORMATION (UNAUDITED):\nThe following reserve related information for 1995 is based on estimates prepared by the Company. The 1995 reserve information for the Company, exclusive of the reserves owned by its subsidiary, Plains, were reviewed by Ryder Scott, an independent reservoir engineer. The 1995 reserve information for Plains was reviewed by Netherland, Sewell & Associates, Inc., an independent reservoir engineer. The Company's 1994 and 1993 reserves, exclusive of Plains were prepared by the Company and reviewed by Ryder Scott as of September 30, of each year. The 1994 and 1993 proved developed reserve estimates of Plains were prepared by Netherland, Sewell & Associates, Inc. whereas the proved undeveloped reserve estimates were prepared by Plains. Reserve estimates are inherently imprecise and are continually subject to revisions based on production history, results of additional exploration and development, prices of oil and gas and other factors.\nThe following is the standardized measure of discounted future net cash flows relating to proved oil and gas reserves in which the Company has an interest.\nThe future income tax expenses have been computed considering the tax basis of the oil and gas properties, and net operating and other loss carryforwards.\nThe following are the principal sources of changes in the standardized measure of discounted future net cash flows:\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.\nBarrett Resources Corporation\n\/s\/ William J. Barrett Date: March 5, 1996 By: _________________________________ WILLIAM J. BARRETT, CHIEF EXECUTIVE OFFICER\nDate: March 5, 1996 \/s\/ John F. Keller By: _________________________________ JOHN F. KELLER, CHIEF FINANCIAL OFFICER, SECRETARY, AND PRINCIPAL FINANCIAL AND ACCOUNTING OFFICER\nSIGNATURE TITLE DATE\n\/s\/ William J. Barrett Director March 5, 1996 - ------------------------------------- WILLIAM J. BARRETT\n\/s\/ C. Robert Buford Director March 5, 1996 - ------------------------------------- C. ROBERT BUFORD\n\/s\/ Derrill Cody Director March 5, 1996 - ------------------------------------- DERRILL CODY\n\/s\/ James M. Fitzgibbons Director March 5, 1996 - ------------------------------------- JAMES M. FITZGIBBONS\n\/s\/ Hennie L.J.M. Gieskes Director March 5, 1996 - ------------------------------------- HENNIE L.J.M. GIESKES\n\/s\/ William W. Grant, III Director March 5, 1996 - ------------------------------------- WILLIAM W. GRANT, III\n\/s\/ John F. Keller Director March 5, 1996 - ------------------------------------- JOHN F. KELLER\n\/s\/ Paul M. Rady Director March 5, 1996 - ------------------------------------- PAUL M. RADY\n\/s\/ A. Ralph Reed Director March 5, 1996 - ------------------------------------- A. RALPH REED\n\/s\/ James T. Rodgers Director March 5, 1996 - ------------------------------------- JAMES T. RODGERS\n\/s\/ Philippe S.E. Schreiber Director March 5, 1996 - ------------------------------------- PHILIPPE S.E. SCHREIBER\n\/s\/ Harry S. Welch Director March 5, 1996 - ------------------------------------- HARRY S. WELCH\nII-1","section_15":""}
{"filename":"835541_1995.txt","cik":"835541","year":"1995","section_1":"ITEM 1. BUSINESS\nSolectron Corporation is an independent provider of customized manufacturing services to electronics original equipment manufacturers (OEMs). Solectron provides a wide variety of pre-manufacturing, manufacturing and post- manufacturing services. The Company's goal is to offer its customers competitive advantages such as access to advanced manufacturing technologies, shortened product time-to-market, reduced cost of production and more effective asset utilization that can be attained from outsourcing their manufacturing. The Company currently conducts operations in the Western and Eastern United States, Europe and Southeast Asia. The Company believes that the geographically diverse locations of its facilities enable it to build closer regional relationships with its customers and to better meet its customer's cost and local market content requirements.\nSolectron Corporation was incorporated in California in August 1977. Solectron's corporate headquarters are located at 777 Gibraltar Drive, Milpitas, California 95035. The Company's telephone number is (408) 957-8500. As used herein, \"Solectron\" and the \"Company\" refer to Solectron Corporation and its subsidiaries, unless the context otherwise requires.\nIndustry Overview\nSolectron is benefiting from increased worldwide market acceptance of the use of manufacturing specialists in the electronics industry. Many electronics OEMs have adopted and are becoming increasingly reliant upon manufacturing outsourcing strategies. The Company believes the trend towards outsourcing manufacturing will continue. OEMs utilize manufacturing specialists for many reasons including the following:\nReduce Time to Market. Due to intense competitive pressures in the electronics industry, OEMs are faced with increasingly shorter product life-cycles and therefore have a growing need to reduce the time required to bring a product to market. OEMs can reduce their time to market by using a manufacturing specialist's manufacturing expertise and infrastructure.\nReduce Capital Investment. As electronic products have become more technologically advanced, the manufacturing process has become increasingly automated, requiring a greater level of investment in capital equipment. Manufacturing specialists enable OEMs to gain access to advanced manufacturing facilities, thereby reducing the OEMs' overall capital equipment requirements.\nFocus Resources. Because the electronics industry is experiencing greater levels of competition and more rapid technological change, many OEMs increasingly are seeking to focus their resources on activities and technologies in which they add the greatest value. By offering comprehensive electronics assembly and related manufacturing services, manufacturing specialists allow OEMs to focus on their own core competencies such as product development and marketing.\nAccess Leading Manufacturing Technology. Electronic products and electronics manufacturing technology have become increasingly sophisticated and complex, making it difficult for OEMs to maintain the necessary technological expertise to manufacture products internally. OEMs are motivated to work with a manufacturing specialist in order to gain access to the specialist's expertise in interconnect, test and process technologies.\nImprove Inventory Management and Purchasing Power. Electronics industry OEMs are faced with increasing difficulties in planning, procuring and managing their inventories efficiently due to frequent design changes, short product life-cycles, large investments in electronic components, component price fluctuations and the need to achieve economies of scale in materials procurement. OEMs can reduce production costs by using a manufacturing specialist's volume procurement capabilities. In addition, a manufacturing specialist's expertise in inventory management can provide better control over inventory levels and increase the OEM's return on assets.\nAccess Worldwide Manufacturing Capabilities. OEMs are increasing their international activities in an effort to lower costs and access foreign markets. Manufacturing specialists with worldwide capabilities are able to offer such OEMs a variety of options on manufacturing locations to better address their objectives regarding cost, shipping location, frequency of interaction with manufacturing specialists and local content requirements of end-market countries.\nStrategy\nThe Company's strategy emphasizes the following key elements:\nQuality. Solectron believes that product quality is a critical success factor in the electronics manufacturing market. The Company strives for continuous improvement of its processes and has adopted a number of quality improvement and measurement techniques to monitor its performance. The Company has received numerous superior service and quality awards, including the Malcolm Baldrige National Quality Award in October 1991, the State of California Governor's Golden State Award in September 1994, and numerous awards from its customers such as Apple Computer, Applied Materials, Exabyte, Hewlett-Packard Company, International Business Machines Corporation (IBM) and Sun Microsystems, Inc. Nearly all the Company's manufacturing facilities are certified under ISO-9002, an international quality standard for manufacturing and distribution management systems.\nManufacturing Partnerships. An important element of Solectron's strategy is to establish partnerships with major and emerging OEM leaders in the electronics industry. Due to the costs inherent in supporting customer relationships, the Company focuses its efforts on customers with which the opportunity exists to develop long-term business partnerships. The Company's goal is to provide its customers with total manufacturing solutions for both new and more mature products, as well as across product generations. The Company's manufacturing services range from providing just-in-time delivery on low to medium volume turnkey and consignment projects and projects that require more value-added services, to servicing OEMs that require price-sensitive, high-volume production. In order for the Company to continue to develop long-term business partnerships with leading OEMs in the electronics industry, the Company will be required to continue to increase staffing and other expenses, as well as its expenditures on capital equipment and leasehold improvements. The Company's customers generally do not commit to firm production schedules for more than one quarter. Should the Company increase its expenditures in anticipation of a future level of sales which does not materialize, its profitability would be adversely affected. On occasion, customers may require rapid increases in production which can place an excessive burden on the Company's resources. In order to maintain its sales growth and profitability, the Company will be required to continue managing its assets efficiently.\nTurnkey Capabilities. Another element of Solectron's strategy is to provide a complete range of manufacturing management and value-added services, including materials management, board design, concurrent engineering, assembly of complex printed circuit boards and other electronic assemblies, test engineering, software manufacturing, accessory packaging and post-manufacturing services. The Company believes that as manufacturing technologies become more complex and as product life-cycles shorten, OEMs will increasingly contract for manufacturing on a turnkey basis as they seek to reduce their time to market and capital asset and inventory costs. A substantial portion of the Company's revenue is from its turnkey business. The Company believes that the ability to manage and support large turnkey projects is a critical success factor and a significant barrier to entry for the market it serves. In addition, the Company believes that due to the difficulty and long lead-time required to change manufacturers, turnkey projects generally increase an OEM's dependence on its manufacturing specialist, resulting in greater stability of the Company's customer base and in closer working relationships. The Company has been successful in establishing sole source positions with many of its customers for certain of their products.\nAdvanced Manufacturing Process Technology. Solectron intends to continue to offer its customers the most advanced manufacturing process technologies, including surface mount technology (SMT) assembly and testing and emerging interconnect technologies. The Company has developed substantial SMT expertise including advanced, vision-based component placement equipment. The Company believes that the cost of SMT assembly facilities and the technical capability required to operate a high-yield SMT operation are significant competitive factors in the market for electronic assembly. The Company also has the capability to manufacture using tape-automated-bonding, chip-on-substrate, chip-on-flex, ball- grid arrays and other more advanced manufacturing processes. However, to date the Company has not utilized these manufacturing processes on a significant scale.\nDiverse Geographic Operations. An important element of Solectron's strategy is to establish production facilities in areas of high customer density or where manufacturing efficiencies can be achieved. The Company currently has operations in the Western and Eastern United States, Europe and Southeast Asia. The Company believes that its facilities in these diverse geographic locations enable Solectron to better address its customers' objectives regarding cost, shipping location, frequency of interaction with manufacturing specialists and local content requirements of end-market countries. See \"International Manufacturing Capability\" below. In addition, the Company also has a business development office in Tokyo, Japan. Solectron intends to continue to expand its operations as necessary to continue to serve its existing customers and to develop new business.\nInternational Manufacturing Capability\nWestern United States. The Company's headquarters and largest manufacturing operations are located in Silicon Valley, principally at a single site in Milpitas, California. The Company believes that the location of these facilities in one of the largest concentrations of OEM electronics manufacturers permits it to more efficiently provide electronic assembly, manufacturing management and other services to such OEMs. In September 1993, the Company acquired operations in Everett, Washington. In addition to serving customers in that region, this facility specializes in low volume, high mix production.\nEastern United States. The Company's Eastern United States operations are located in Charlotte, North Carolina and were acquired in September 1992 from IBM. This facility is staffed by personnel with extensive electronics manufacturing and product design experience. The Company believes that the Charlotte facility allows it to better pursue new business opportunities with new and existing customers with Eastern United States operations because of Charlotte's status as a transportation hub and its relative proximity to major Eastern United States electronics markets.\nEurope. The Company has three European sites. One site is located in Bordeaux, France and was also acquired in September 1992 from IBM. The Bordeaux facility is staffed largely by former IBM employees, many with extensive electronics manufacturing and product design experience. In connection with the acquisitions from IBM, IBM committed to purchase from the Bordeaux facility certain volumes of sub-assemblies for a period of three years ending in December 1995. While the Company expects to continue to do business with IBM after the agreement expires, there can be no guarantee that such business will be avaialable at satisfactory terms to the Company. However, Solectron believes that its Bordeaux facility will continue to allow it to better serve IBM and to develop new business with other customers having European operations.\nIn September 1993, the Company also acquired operations in Dunfermline, Scotland. The facility was expanded in fiscal 1995 to accommodate increased customer demand. Solectron believes that this facility allows it to better serve the many electronics OEMs located in the United Kingdom and Ireland.\nIn November 1995, the Company completed a transaction with Hewlett-Packard GmbH (HP), a subsidiary of Hewlett -Packard Company, to acquire the assets of HP's printed circuit board assembly operation in Boeblingen, Germany. This facility is expected to allow the Company to better serve the German market and Hewlett-Packard.\nSoutheast Asia. The Company's Southeast Asia manufacturing operation is located in Penang, Malaysia and was opened in 1991. This facility was expanded in fiscal 1994 due to increased customer demand. The Penang operation was established to better serve the needs of OEMs requiring price-sensitive, high-volume production capabilities and to provide more efficient manufacturing services to customers located in Southeast Asia. The facility currently provides electronics assembly, materials management and other services to customers located in Malaysia, Singapore, Japan, the United States and other locations.\nThe Company has established operations in five new locations since September 1992. As the Company manages the existing operations and expands geographically, it may experience certain inefficiencies from the management of geographically dispersed operations. In addition, the Company's results of operations will be adversely affected if these new facilities do not achieve revenue growth sufficient to offset increased expenditures associated with geographic expansion.\nIn fiscal 1995, approximately 38% of the Company's sales were from operations outside of the United States. As a result of continued customer demand overseas, the Company expects foreign sales as a percentage of total sales to increase. As a result of its foreign sales and facilities, the Company's operations are subject to risks of doing business abroad, including fluctuations in the value of currency, export duties, import controls and trade barriers (including quotas), restrictions on the transfer of funds, employee turnover, work stoppages, longer payment cycles, greater difficulty in accounts receivable collection, burdens of complying with a wide variety of foreign laws and, in certain parts of the world, political instability. While to date these factors have not had an adverse impact on the Company's results of operations, there can be no assurance that there will not be such an impact in the future.\nManufacturing\nSolectron's Approach\nTo achieve excellence in manufacturing, the Company combines advanced manufacturing technology, such as computer-aided manufacturing and testing, with Japanese manufacturing techniques, including just-in-time manufacturing, total quality control, statistical process control and continuous flow manufacturing. Just-in-time manufacturing is a production technique which minimizes work-in-process inventory and manufacturing cycle time while enabling the Company to deliver products to customers in the quantities and time frame required. Total quality control is a management philosophy which seeks to impart high levels of quality in every operation of the Company and is accomplished by the setting of quality objectives for every operation, tracking performance against those objectives, identifying work flow and policy changes required to achieve higher quality levels and a commitment by executive management to support changes required to deliver higher quality. Statistical process control is a set of analytical and problem-solving techniques based on statistics and process capability measurements through which the Company can track process inputs and resulting quality and determine whether a process is operating within specified limits. The goal is to reduce variability in the process, as well as eliminate aberrations which contribute to quality below the acceptable range of each process performance standard. Continuous flow manufacturing is a manufacturing technique for making operators responsible for quality, thereby eliminating separate quality control staffs and minimizing the perpetuation of defects through large quantities of assembled units.\nIn order to successfully implement these management techniques, Solectron has developed the ability to timely collect and utilize large amounts of data. The Company believes this ability is critical to a successful assembly operation and represents a significant competitive factor, especially in large turnkey projects. To manage this data, the Company uses sophisticated computer systems for material resource planning, shop floor control, work-in-process tracking, statistical process control and activity-based product costing.\nIn implementing its manufacturing approach, the Company emphasizes timely delivery and accurate, up-to-date documentation for each product. The Company develops an appropriate production process and a complete set of manufacturing process instructions, inspection plans and a quality assurance plan. In the case of turnkey orders, the Company analyzes each customer's materials specifications to identify the suppliers from whom to purchase the materials. The Company then plans and executes purchase orders and receives, inspects and warehouses components, expedites critical components and delivers a complete set of components to the production floor for assembly in sufficient time to meet customer requirements.\nResponsiveness to customers, particularly as to engineering changes once manufacturing has commenced, is an important component of Solectron's manufacturing approach. Many products manufactured by the Company are in the early stages of their product life cycle and therefore may have many design or engineering changes. Upon receiving an engineering change notice, the Company identifies the impact of such changes on the production process, current inventory and open purchase orders. To support a continuous production flow while minimizing excess and obsolete inventory costs for the customer, the Company restructures bills of material and expedites orders for new components, as authorized. The Company also identifies and makes changes to its manufacturing instructions and test plans. In order to assure prompt customer response, the Company assigns each project a project manager, quality assurance engineer, product engineer, test engineer and customer service representative. Solectron maintains regular contact with its customers to assure adequate information exchange, document control and activities coordination necessary to support a high level of quality and on-time delivery.\nElectronic Assembly and Other Services\nSolectron's electronic assembly activities consist primarily of the placement and attachment of electronic and mechanical components on printed circuit boards and flexible cables. The Company also assembles higher-level sub-systems and systems incorporating printed circuit boards and complex electromechanical components, in some cases manufacturing and packaging products for shipment directly to the customer's distributors. In addition, Solectron provides other manufacturing services including refurbishment, disk duplication and packaging services and remanufacturing. Solectron manufactures on a turnkey basis with Solectron directly procuring some or all of the components necessary for production, and on a consignment basis, where the OEM customer supplies all components for assembly.\nIn conjunction with its assembly activities, Solectron also provides computer-aided testing of printed circuit boards, sub-systems and systems, which contributes significantly to the Company's ability to deliver high quality products on a consistent basis. The Company has developed specific strategies and routines to test board and system level assemblies. In-circuit tests verify that all components have been properly inserted and that the electrical circuits are complete. Functional tests determine if the board or system assembly is performing to customer specifications. The Company either designs and procures test fixtures and develops its own test software or utilizes the customer's existing test fixtures and test software. In addition, the Company also provides environmental stress tests of the board or system assembly.\nSolectron provides turnkey manufacturing management to meet its customers' requirements, including procurement and materials management and consultation on board design and manufacturability. Individual customers may select various services from among the Company's full range of turnkey capabilities.\nProcurement and materials management consists of the planning, purchasing, expediting, warehousing, preparing and financing of the components and materials required to assemble a printed circuit board or electronic system. OEMs have increasingly utilized electronic manufacturing specialists to purchase all or some components directly from component manufacturers or distributors and to finance and warehouse the components.\nThe Company also assists its customers in evaluating board designs for manufacturability. Solectron evaluates the board design for ease and quality of manufacture and, when appropriate, recommends design changes to reduce manufacturing costs or lead times or to increase the quality of finished assemblies. The Company also offers board design services for a fee. Board design services consist of the engineering and design associated with the arrangement and interconnection of specified components on printed circuit boards to achieve an OEM's desired level of functionality.\nSales and Marketing\nSales and marketing at Solectron is an integrated process involving direct salespeople and project managers, as well as the Company's senior executives. The Company's sales resources are directed at multiple management and staff levels within targeted accounts. The Company also uses independent sales representatives in certain geographic areas. The Company also receives unsolicited inquiries resulting from advertising and public relations activities, as well as referrals from current customers. These opportunities are evaluated against the Company's customer selection criteria and are assigned to direct salespeople or independent sales representatives, as appropriate. Historically, the Company has had substantial recurring sales from existing customers.\nOver 90% of the Company's net sales during fiscal 1995 were derived from customers which were also customers during fiscal 1994. Although Solectron seeks to diversify its customer base, a small number of customers currently are responsible for a significant portion of the Company's net sales. During fiscal 1995, 1994, and 1993, the Company's ten largest customers accounted for over 70%, 73%, and 75% of consolidated net sales respectively. However, with the exception of IBM Corporation, which represented 21%, 28% and 26% of net sales in fiscal 1995, 1994 and 1993, respectively, Apple Computer, Inc. which represented 12% of net sales in fiscal 1994, and Sun Microsystems, Inc. which represented 12% of net sales in fiscal 1993, no other individual customer accounted for more than 10% of the Company's net sales in any of these years.\nBacklog\nBacklog consists of contracts or purchase orders with delivery dates scheduled within the next twelve months. At August 31, 1995, Solectron's backlog was approximately $520 million. The backlog was approximately $350 million at August 31, 1994. Because customers may cancel or reschedule deliveries, backlog is not a meaningful indicator of future financial results.\nCompetition\nThe electronic assembly and manufacturing industry is comprised of a large number of companies, several of which have achieved substantial market share. The Company also faces competition from current and prospective customers which evaluate Solectron's capabilities against the merits of manufacturing products internally. Solectron competes with different companies depending on the type of service or geographic area. Certain of the Company's competitors have broader geographic breadth. They also may have greater manufacturing, financial, research and development and marketing resources than the Company. The Company believes that the primary basis of competition in its targeted markets is manufacturing technology, quality, responsiveness, the provision of value-added services and price. To remain competitive, the Company must continue to provide technologically advanced manufacturing services, maintain quality levels, offer flexible delivery schedules, deliver finished products on a reliable basis and compete favorably on the basis of price. The Company currently may be at a competitive disadvantage as to price when compared to manufacturers with lower cost structures, particularly with respect to manufacturers with established facilities where labor costs are lower.\nEmployees\nAs of August 31, 1995, the Company employed 11,049 persons, including 2,982 temporary employees. Of the Company's 11,049 persons employed, 4,579 were employed by the Company's foreign operations.\nPatents and Trademarks\nThe Company obtained a limited number of U.S. patents in 1995 related to the process and equipment used in its surface mount technology. These patents are considered valuable to the Company.\nAlthough the Company does not believe that its manufacturing process infringes on the intelectual property rights of third parties, there can be no assurance that third parties will not assert infringement claims against the Company in the future. If such an assertion where to be made, it may become necessary or useful for the Company to enter into licensing arrangements or to resolve such an issue through litigation. However, there can be no asurance that such license rights would be available to the Company on commercially acceptable terms or that any such litigation could be resolved favorably. Additionally, such litigation could be lengthy and costly and could have a material adverse effect on the Company's financial condition regardless of the outcome of such litigation.\nThe Company does not believe that trademark protection is an important competitive factor in its market.\nITEM 2:","section_1A":"","section_1B":"","section_2":"ITEM 2: PROPERTIES\nThe Company's domestic manufacturing facilities are located in California, North Carolina and Washington. In and around Milpitas, California, Solectron Corporation leases approximately 1,112,000 square feet of facilities under leases expiring through 2000. In Charlotte, North Carolina, the Company owns a single facility of approximately 175,000 square feet on 73 acres of land and occupies an additional facility of approximately 36,000 square feet under a short-term lease. In Everett, Washington, the Company leases approximately 70,000 square feet.\nIn Europe, the Company owns approximately 319,000 square feet of facilities on 240 acres of land in Bordeaux, France. In Dunfermline, Scotland, the Company owns two facilities totaling approximately 213,000 square feet on approximately 15 acres of land. In connection with the November 1995 acquisition its site in Boeblingen, Germany, the Company now leases facilities in Boeblingen approximating 50,000 square feet.\nThe Company's Asian manufacturing operation is located in Penang, Malaysia. The Company owns facilities of 196,000 square feet on 5 acres of land which are leased pursuant to a 60-year lease.\nAround the world, the Company is subject to a variety of environmental regulations relating to the use, storage, discharge and disposal of hazardous chemicals used during its manufacturing process. Any failure by the Company to comply with present and future regulations could subject it to future liabilities or the suspension of production. In addition, such regulations could restrict the Company's ability to expand its facilities or could require the Company to acquire costly equipment or to incur other significant expenses to comply with environmental regulations.\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 the fiscal year covered by this report.\nPART II\nITEM 5:","section_5":"ITEM 5: MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDERS MATTERS\nCommon Stock Information The following table sets forth the quarterly high and low per share sales prices of the Company's common stock for the two- year period ended August 31, 1995, as quoted on the New York Stock Exchange.\nPer share trading price range:\nFirst Quarter Second Quarter Third Quarter Fourth Quarter\n1995 1994 1995 1994 1995 1994 1995 1994 High 31 3\/8 28 5\/8 27 1\/4 33 1\/4 31 32 1\/2 38 5\/8 31 1\/4 Low 24 3\/4 20 3\/4 22 1\/2 26 1\/8 22 7\/8 25 3\/4 30 1\/8 23 3\/4\nITEM 6:","section_6":"ITEM 6: SELECTED FINANCIAL DATA\nFive year selected financial highlights (in thousands except per share data)\nFor the years ended 8\/31, 1995 1994 1993 1992 1991\nConsolidated Statement of Income Data:\nNet Sales $2,065,559 $1,456,779 $836,326 $406,883 $265,363 Operating income 123,434 88,350 53,140 27,153 17,903 Income before income taxes 120,494 84,159 48,613 24,144 16,442 Net income 79,526 55,545 30,600 14,488 9,229 Fully diluted net income per share $1.62 $1.18 $0.75 $0.44 $0.35\nConsolidated Balance Sheet Data:\nWorking capital $355,603 $309,203 $265,025 $199,254 $35,313 Total Assets 940,855 766,395 603,285 308,737 135,117 Long-term debt and capital 30,043 140,709 137,011 130,933 12,479 lease obligations Shareholder's equity 538,141 330,789 260,980 104,245 47,146\nITEM 7:","section_7":"ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nGeneral Solectron's net sales are derived from sales to electronics original equipment manufacturers. The majority of the Company's customers compete in the telecommunications, computer peripherals, workstation, and personal computer segments of the electronics industry. The Company uses advanced manufacturing technologies in assembly and manufacturing management of complex printed circuit boards and electronics systems. Operating results are affected by a number of factors, including the degree of turnkey manufacturing, the material content and volume of products built, manufacturing efficiencies, utilization of capacity, start-up costs associated with new customer projects, and price competition. Over the past several years, the Company's strategy has been to increase the percentage of sales it derives from turnkey manufacturing, which currently represents a substantial portion of the Company's sales. Turnkey projects, in which the Company procures some or all of the components necessary for production, typically generate higher net sales and higher gross profits with lower gross margins than consignment projects due to the inclusion in the Company's operating results of sales and costs associated with the purchase and sale of components. The increase in gross profit and the decrease in gross margin over the past several years has been due primarily to this shift toward turnkey manufacturing. More recently, the Company has assembled products with varying degrees of material content, which has caused the Company's gross margin to fluctuate. In addition, the degree of startup costs and inefficiencies associated with new customer projects has affected the Company's gross margin. The Company has manufacturing operations in six locations: three in the U.S., two in Europe, and one in Malaysia. Additionally, on August 17, 1995, the Company executed definitive agreements with Hewlett-Packard GmbH (HP), a subsidiary of Hewlett-Packard Company, to acquire HP's printed circuit board assembly operation in Boeblingen, Germany. This transaction is expected to close in November 1995. As the Company manages its existing operations and expands geographically, it may experience certain inefficiencies from the management of geographically dispersed operations. Around the world, the Company is subject to a variety of environmental regulations relating to the use, storage, discharge, and disposal of hazardous chemicals used during its manufacturing process. Any failure by the Company to comply with present and future regulations could subject it to future liabilities or the suspension of production. In addition, such regulations could restrict the Company's ability to expand its facilities or could require the Company to make significant expenditures to comply with environmental regulations. The Company competes within the electronics manufacturing services (EMS) segment of the electronics industry. The EMS segment is currently growing at a faster rate than the overall electronics industry, but the EMS segment is also comprised of a large number of companies, some of which have achieved substantial market share. In addition to competing with other EMS companies, the Company also faces competition from current and prospective customers that evaluate Solectron's capabilities against the merits of manufacturing products internally. The Company believes that the primary basis of competition in its targeted markets is manufacturing technology, quality, responsiveness, the provision of value- added services, and price.\nResults of Operations The following table sets forth the percentage of net sales of certain items in the Consolidated Statements of Income. The financial information and the discussion below should be read in conjunction with the Consolidated Financial Statements and Notes thereto.\nYears ended August 31, 1995 1994 1993 Net sales 100.0% 100.0% 100.0% Cost of sales 90.2 90.0 88.2\nGross profit 9.8 10.0 11.8 Operating expenses: Selling, general and administrative 3.6 3.6 5.0 Research and development 0.2 0.3 0.4\nOperating income 6.0 6.1 6.4 Net interest expense 0.1 0.3 0.6\nIncome before income taxes 5.9 5.8 5.8 Income taxes 2.0 2.0 2.1\nNet income 3.9% 3.8% 3.7%\nNet Sales During the past few years, the Company's net sales have increased significantly due primarily to an increasing trend toward outsourcing within the electronics industry. In fiscal 1995, net sales grew to $2.1 billion, an increase of $609 million, or 42%, over the previous year. Net sales in fiscal 1994 were $1.5 billion, an increase of $620 million, or 74%, over fiscal 1993. The increase in fiscal 1995 was due to increased orders from existing customers, the addition of new customers, and growth in the Company's turnkey business. The increase in fiscal 1994 was due to increased orders from existing customers, conversion of certain customers to turnkey arrangements, and the acquisition in September 1993 of manufacturing sites in Scotland and Washington. The Company's two largest customers during fiscal 1995 and 1994 were International Business Machines Corporation (IBM) and Apple Computer, Inc. (Apple). Net sales to IBM in fiscal 1995 and 1994 were 21% and 28% of consolidated net sales, respectively. Net sales to Apple in fiscal 1995 and 1994 were less than 10% and 12% of consolidated net sales, respectively. While net sales to these customers increased in absolute amounts during fiscal 1995 compared to fiscal 1994, the Company has obtained significant new business from other customers, thereby reducing its dependency on these accounts. Net sales to the Company's top ten customers accounted for 70% of consolidated net sales during both fiscal 1995 and fiscal 1994. The Company is dependent upon continued revenues from IBM, Apple, and the rest of its top ten customers. Any material change in orders from these or other customers could have a material effect on the Company's results of operations. Net sales at the Company's foreign sites grew at a faster rate over the last year than net sales at the Company's domestic sites. Foreign locations contributed 38% of consolidated net sales in fiscal 1995, compared to 35% for fiscal 1994. As a result of the Company's foreign sales and facilities, the Company's operations are subject to risks of doing business abroad, including fluctuations in the value of currency, changes to import and export regulations, possible restrictions on the transfer of funds, and in certain parts of the world, political instability. While to date these dynamics have not had a materially adverse impact on the Company's results of operations, there can be no assurance that there will not be such an impact in the future. The Company's operation in California contributed a substantial portion of the Company's net sales and operating income during fiscal 1995 and 1994. The performance of this operation is expected to continue as a significant factor in the overall financial results of the Company. Any material change to the customer base, product mix, efficiency, or other attributes of this site could have a material effect on the Company's consolidated results of operations. Over the past few years, the Company's revenues have grown substantially. The Company believes that its ability to continue to achieve rapid growth will depend primarily on growth in sales to existing customers for their current and future product generations and successful marketing to new customers. The Company has no firm long-term volume commitments from its customers and over the last few years has experienced reduced lead-time in customer orders. Customer contracts can be canceled and volume levels can be changed or delayed. The timely replacement of delayed, canceled, or reduced orders with new business cannot be assured. The Company has a manufacturing services agreement with IBM at the France facility that expires on December 31, 1995. While the Company expects to continue business with IBM after the agreement expires, there can be no guarantee that such business will be available at satisfactory terms to the Company. Because of these factors, there can be no assurance that the Company's historical revenue growth rate will continue. The Company currently serves the electronics industry, which is subject to rapid technological change, product obsolescence, and price competition. These and other factors affecting the electronics industry, or any of the Company's major customers in particular, could have a materially adverse effect on the Company's results of operations. Gross Profit Gross profit increased by $55.5 million, or 38%, in fiscal 1995 compared to fiscal 1994 and $47.5 million, or 48%, during fiscal 1994 compared to fiscal 1993. Gross margin decreased to 9.8% in fiscal 1995, from 10.0% in fiscal 1994 and 11.8% in fiscal 1993. The slight decrease in gross margin in fiscal 1995 compared to fiscal 1994 resulted primarily from underutilization of the facility in France, manufacturing inefficiencies at the Scotland and North Carolina sites from new project start-up costs, and growth in turnkey business at the Scotland site. Offsetting these factors were improved efficiencies at the Company's operation in California and improvements in product mix. In fiscal 1994, the Company's gross margin was lower than fiscal 1993 due to an increase in turnkey business and larger concentrations of high volume, low margin business. In the future, the Company's gross margin is expected to depend primarily on product mix, the level of inefficiencies associated with new customer projects, and pricing within the electronics industry. While the availability of raw materials appears adequate to meet the Company's current revenue projections, component availability to support revenue increases beyond the Company's current plans is limited. Furthermore, availability of customer-consigned parts and unforeseen shortages of components on the world market are beyond the Company's control and could adversely affect revenue levels and operating efficiencies.\nSelling, General and Administrative Expenses Selling, general and administrative (SG&A) expenses increased to $73.6 million in fiscal 1995, compared to $53.8 million in fiscal 1994 and $42.0 million in fiscal 1993. However, SG&A expenses as a percentage of net sales decreased to 3.6% in fiscal 1995 and 1994 from 5.0% in fiscal 1993, as the Company leveraged its fixed operating expenses. The increases in SG&A expenses during these periods were due primarily to growth in personnel and related departmental expenses at all manufacturing locations and investments in information systems. These expenditures are designed to support the increased size and complexity of the Company's business. In fiscal 1994, the increase in SG&A expenses was also due to the acquisitions of the Scotland and Washington sites in September 1993. The Company anticipates SG&A expenses will increase in absolute amounts in the future as the Company builds the infrastructure necessary to support its current and prospective business.\nResearch and Development Expenses The primary focus of the Company's recent research and development efforts has been on developing high density interconnecting technologies and deploying processes into manufacturing. Technologies include ball-grid array (plastic, ceramic, and tape platforms), chip-on-substrate by wire bonding, tape-automated bonding, flip-chip, VOC-free, no-clean manufacturing, no-lead soldering, and fluxless soldering. Research and development expenses increased to $4.8 million in fiscal 1995 from $4.2 million in fiscal 1994 and $3.8 million in fiscal 1993.\nNet Interest Expense Net interest expense was $2.9 million in fiscal 1995, compared to $4.2 million in fiscal 1994 and $4.5 million in fiscal 1993. The decrease in fiscal 1995 compared to fiscal 1994 was due primarily to the voluntary conversion of nearly 80% of the Company's outstanding zero-coupon subordinated notes during the fourth quarter of fiscal 1995.\nIncome Taxes Income taxes increased to $41.0 million in fiscal 1995 from $28.6 million in fiscal 1994 and $18.0 million in fiscal 1993, due primarily to increased income before income taxes. The Company's effective income tax rate decreased from 37% in fiscal 1993 to 34% in fiscal 1994 and remained at 34% in fiscal 1995. The principal reasons for a lower effective income tax rate in fiscal 1995 and 1994 compared to fiscal 1993 were an increase in profits from foreign operations which are taxed at lower rates than in the United States and the impact of certain tax advantaged short-term investments in the United States. The Company has a tax holiday in Malaysia that expires in January 1997, subject to certain extensions. If the tax holiday is not extended, the Company's effective income tax rate may increase.\nLiquidity and Capital Resources Working capital was $355.6 million at the end of fiscal 1995, an increase of $46.4 million from the end of fiscal 1994. This increase reflects primarily the growth in net sales during fiscal 1995 and the required investment in working capital to support this growth. The increase in working capital was financed primarily by cash generated from operations. The Company anticipates that further increases in working capital will be required to support anticipated revenue growth.\nDuring fiscal 1995 the Company invested $113.6 million in new capital assets, primarily surface mount assembly and test equipment to meet current and expected production levels. To support growth and to replace aging equipment, the Company expects capital expenditures in fiscal 1996 to be in the range of $75 million to $120 million. Beginning in September 1997, the Company will be required to pledge approximately $44 million of cash or marketable securities as collateral for its obligation under the terms of the Company's operating lease for certain of its facilities in California. The lease expires in September 1999. In addition to the Company's working capital as of August 31, 1995, which includes cash and cash equivalents of $90.0 million and short-term investments of $58.6 million, the Company also has available a $100 million unsecured domestic revolving credit facility, subject to financial covenants and restrictions, and $33 million in available foreign credit facilities. During the fourth quarter of fiscal 1995, nearly 80% of the Company's outstanding zero-coupon subordinated notes were voluntarily converted to common stock. The result of these conversions was to decrease long-term debt by $113.9 million, decrease other assets by $3.0 million (unamortized debt issuance costs), and increase common stock by $110.9 million.\nITEM 8:","section_7A":"","section_8":"ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The information required by item 8 of form 10-K is presented here in the following order:\nUnaudited Quarterly Financial Information\nConsolidated Balance Sheets Consolidated Statements of Income Consolidated Statements of Shareholders' Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements\nIndependent Auditors' Report\nUnaudited Quarterly Financial Information\nFor each fiscal quarter during the two fiscal years ended August 31, (in thousands, except per share data) First Quarter Second Quarter Third Quarter Fourth Quarter Net sales $506,678 $471,266 $516,892 $570,723 Gross profit $ 45,443 $ 46,369 $ 52,379 $ 57,639 Gross margin 9.0% 9.8% 10.1% 10.1% Operating income $ 28,721 $ 28,419 $ 31,917 $ 34,377 Operating margin 5.7% 6.0% 6.2% 6.0% Net income $ 18,194 $ 18,034 $ 20,328 $ 22,970 Primary net income per share $ 0.43 $ 0.43 $ 0.48 $ 0.48 Fully diluted net income per share $ 0.38 $ 0.38 $ 0.42 $ 0.45\nNet sales $321,840 $327,208 $365,083 $442,648 Gross profit $ 32,879 $ 34,768 $ 38,585 $ 40,096 Gross margin 10.2% 10.6% 10.6% 9.1% Operating income $ 19,168 $ 20,267 $ 23,697 $ 25,218 Operating margin 6.0% 6.2% 6.5% 5.7% Net income $ 11,890 $ 12,375 $ 14,690 $ 16,590 Primary net income per share $ 0.28 $ 0.29 $ 0.35 $ 0.39 Fully diluted net income per share $ 0.26 $ 0.27 $ 0.31 $ 0.35\nConsolidated Balance Sheets\nAs of August 31, (in thousands) 1995 1994\nAssets Current assets: Cash and cash equivalents $ 89,959 $ 67,906 Short-term investments 58,643 94,070 Accounts receivable, less allowances of $3,501 and $2,459, respectively 254,898 188,794 Inventories 298,809 232,389 Prepaid expenses and other current assets 24,049 18,977 Total current assets 726,358 602,136\nNet property and equipment 203,609 147,822 Other assets 10,888 16,437 Total assets $940,855 $766,395\nLiabilities and Shareholders' Equity Current liabilities: Current portion of long-term debt and capital lease obligations $ 4,796 $ 3,149 Accounts payable 310,680 241,930 Accrued employee compensation 28,705 21,598 Accrued expenses 15,264 16,257 Other current liabilities 11,310 9,999 Total current liabilities 370,755 292,933\nLong-term debt and capital lease obligations 30,043 140,709 Other long-term liabilities 1,916 1,964 Total liabilities 402,714 435,606\nShareholders' equity: Preferred stock, no par value; 1,200 shares authorized; no shares issued --- --- Common stock, no par value; 80,000 shares authorized; 49,584 and 41,302 shares issued and outstanding, respectively 329,265 206,257 Retained earnings 206,321 126,795 Cumulative translation adjustment and other 2,555 (2,263) Total shareholders' equity 538,141 330,789\nCommitments\nTotal liabilities and shareholders' equity $940,855 $766,395\nSee accompanying notes to consolidated financial statements.\nConsolidated Statements of Income\n(in thousands, except per share data) Years ended August 31, 1995 1994 1993 Net sales $2,065,559 $1,456,779 $836,326 Cost of sales 1,863,729 1,310,451 737,458\nGross profit 201,830 146,328 98,868 Operating expenses: Selling, general and administrative 73,554 53,816 41,965 Research and development 4,842 4,162 3,763 Operating income 123,434 88,350 53,140\nInterest income 6,611 6,484 6,051 Interest expense (9,551) (10,675) (10,578) Income before income taxes 120,494 84,159 48,613\nIncome taxes 40,968 28,614 18,013 Net income $ 79,526 $ 55,545 $ 30,600\nNet income per share: Primary $ 1.82 $ 1.32 $ 0.80 Fully diluted $ 1.62 $ 1.18 $ 0.75 Weighted average number of shares: Primary 43,773 42,205 38,132 Fully diluted 52,582 52,033 47,816\nSee accompanying notes to consolidated financial statements.\nConsolidated Statements of Shareholders Equity\nCumulative Common Common Translation Total Stock Stock Retained Adjustment Shareholders' (In thousands) Shares Amount Earnings and Other Equity\nBalances as of 8\/31, 1992 32,988 $63,595 $40,650 $ --- $104,245 Proceeds from public offering, net 6,644 127,566 --- --- 127,566 Options exercised 881 2,028 --- --- 2,028 Stock issued under employee purchase plan 123 1,740 --- --- 1,740 Tax benefit associated with exercise of stock options --- 2,810 --- --- 2,810 Net income --- --- 30,600 --- 30,600 Cumulative translation adjustment and other --- --- --- (8,009) (8,009)\nBalances as of 8\/31, 1993 40,636 197,739 71,250 (8,009) 260,980 Options exercised 527 3,601 --- --- 3,601 Stock issued under employee purchase plan 126 2,697 --- --- 2,697 Conversion of long-term debt 13 174 --- --- 174 Tax benefit associated with exercise of stock options --- 2,046 --- --- 2,046 Net income --- --- 55,545 --- 55,545 Cumulative translation adjustment and other --- --- --- 5,746 5,746\nBalances as of 8\/31, 1994 41,302 206,257 126,795 (2,263) 330,789 Options exercised 573 7,858 --- --- 7,858 Stock issued under employee purchase plan 131 2,901 --- --- 2,901 Conversion of long-term debt 7,578 110,915 --- --- 110,915 Tax benefit associated with exercise of stock options --- 1,334 --- --- 1,334 Net income --- --- 79,526 --- 79,526 Cumulative translation adjustment and other --- --- --- 4,818 4,818\nBalances as of 8\/31, 1995 49,584 $329,265 $206,321 $ 2,555 $538,141\nSee accompanying notes to consolidated financial statements.\nConsolidated Statements of Cash Flows\nYears ended August 31, (in thousands) 1995 1994 1993\nCash flows from operating activities: Net income $ 79,526 $ 55,545 $ 30,600 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 61,416 45,708 26,381 Interest accretion on zero-coupon subordinated note 8,240 8,894 8,235 Other 3,763 2,349 1,745 Changes in operating assets and liabilities: Accounts receivable (64,906) (51,870) (82,192) Inventories (63,654) (66,221) (97,383) Prepaid expenses and other current assets (4,566) (6,470) (5,243) Accounts payable 63,681 65,283 116,778 Accrued expenses and other current liabilities 3,223 12,689 21,625 Net cash provided by operating activities 86,723 65,907 20,546\nCash flows from investing activities: Purchases of short-term investments (183,299) (338,192) (391,824) Sales and maturities of short-term investments 218,805 380,335 319,574 Purchases of facilities, equipment, and other assets --- (14,383) (55,215) Capital expenditures (113,613) (58,959) (68,286) Other (426) (1,998) (950) Net cash used in investing activities (78,533) (33,197) (196,701)\nCash flows from financing activities: Proceeds from bank lines of credit 4,366 --- --- Repayments of long-term debt and capital lease obligations (3,484) (8,864) (7,245) Net proceeds from sale of common stock 10,759 6,298 131,334 Net cash provided by (used in) financing activities 11,641 (2,566) 124,089\nEffect of exchange rate changes on cash and cash equivalents 2,222 2,530 (1,208)\nNet increase (decrease) in cash and cash equivalents 22,053 32,674 (53,274) Cash and cash equivalents at beginning of year 67,906 35,232 88,506 Cash and cash equivalents at end of year $ 89,959 $ 67,906 $ 35,232\nSupplemental Disclosures Cash paid: Interest $ 482 $ 1,242 $ 2,436 Income taxes 44,429 25,551 10,552 Non-cash investing and financing activities: Issuance of common stock upon conversion of long-term debt 110,915 174 --- Tax benefit associated with exercise of stock options 1,334 2,046 2,810 New equipment acquired under long-term debt --- --- 1,800 Debt incurred to purchase facilities, equipment, and other assets --- --- 3,640\nSee accompanying notes to consolidated financial statements.\nNotes to Consolidated Financial Statements\nNote 1 Summary of Significant Accounting Policies (a) Description of Operations and Principles of Consolidation Solectron Corporation (the Company) is an independent provider of customized manufacturing services to original equipment manufacturers in the electronics industry and operates in this one industry segment. The Company's primary services include materials procurement, materials management, and the manufacture and testing of printed circuit board assemblies. Other manufacturing services include systems assembly, flexible cable assembly, disk duplication, and packaging. In addition, the Company provides pre-manufacturing services, such as consultation on product design and manufacturability, and post-manufacturing services, including fulfillment, repair and refurbishment, upgrades, and end-of-product-life manufacturing. The Company's services include turnkey services, where the Company procures certain or all of the materials required for product assembly, and consignment services, where the customer supplies the materials necessary for product assembly. Turnkey services include material procurement and warehousing in addition to manufacturing, and involve greater resource investment than consignment services. The Company has manufacturing operations located in the United States, Europe, and Asia. The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries after elimination of intercompany accounts and transactions. (b) Cash Equivalents and Short-Term Investments Cash equivalents are highly liquid investments purchased with an original maturity of less than three months. The Company adopted Statement of Financial Accounting Standards (SFAS) No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" effective September 1, 1994. Under the provisions of SFAS No. 115, the Company has classified its investments in debt securities as \"available- for-sale.\" Such investments are recorded at fair value, as determined from quoted market prices, and the cost of securities sold is determined based on the specific identification method. Unrealized gains and losses are included in shareholders' equity. Adoption of SFAS No. 115 did not have a material effect on the Company's consolidated financial position. See Note 2. (c) Inventories Inventories are stated at the lower of weighted average cost or market. See Note 3. (d) Property and Equipment Property and equipment are recorded at cost. Depreciation and amortization are computed based on the shorter of the estimated useful lives or the lease terms of the respective assets, using the straight-line method. Estimated useful lives are presented below. See Note 4. Machinery and equipment 2 - 5 years Equipment recorded under capital lease 3 - 5 years Furniture and fixtures 3 - 5 years Leasehold improvements Lease term Buildings 6 - 50 years The Financial Accounting Standards Board recently issued SFAS No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.\" This statement requires long-lived assets to be evaluated for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Company will adopt SFAS No. 121 on September 1, 1996 and does not expect its provisions to have a material effect on the Company's consolidated results of operations in the year of adoption. (e) Other Assets Other assets include debt issuance costs associated with the outstanding zero-coupon subordinated notes described in Note 6 and goodwill related to the purchase of facilities and equipment described in Note 13. Debt issuance costs are amortized using the effective interest rate method over the debt term (20 years). Goodwill is amortized using the straight- line method over ten years. (f) Income Taxes As described in Note 9, the Company adopted SFAS No. 109, \"Accounting for Income Taxes,\" effective September 1, 1993. The adoption of SFAS No. 109 did not have a material effect on the Company's consolidated results of operations. (g) Net Income Per Share Primary net income per share is computed using the weighted average number of common shares and dilutive common equivalent shares outstanding during the related period. Common equivalent shares consist of stock options which are computed using the treasury stock method. Fully diluted net income per share assumes full conversion of the Company's outstanding zero-coupon subordinated notes. (h) Revenue Recognition The Company recognizes revenue upon shipment of product to its customers. (i) Foreign Currency Assets and liabilities of foreign subsidiaries where the local currency is the functional currency are translated at year-end exchange rates. The effects of these translation adjustments are reported as a component of shareholders' equity. Exchange gains and losses arising from transactions denominated in a currency other than the functional currency of the entity involved and remeasurement adjustments for foreign operations where the U.S. dollar is the functional currency are included in income. To date, the effect on income of such amounts has been immaterial. (j) Derivatives Gains and losses on foreign currency forward exchange contracts designated as hedges of assets and liabilities are included in income concurrently with the offsetting losses and gains on the related balance sheet item. See Note 7. (k) Year-End The Company's financial reporting year consists of either 52- or 53-week periods ending on the last Friday in August. Fiscal years 1993, 1994, and 1995 each contained 52 weeks; however, fiscal year 1996 will contain 53 weeks. For purposes of presentation in the accompanying financial statements and notes thereto, the Company has indicated its accounting years as ending on August 31.\nNote 2 Cash, Cash Equivalents, and Short-term Investments Cash, cash equivalents, and short-term investments consisted of the following:\nCash and Cash Short-term As of August 31, 1995 (in thousands) Investments Equivalents\nCash $32,050 $ --- Money market funds 41,342 --- Certificates of deposit 11,909 7,944 U.S. government securities --- 11,225 Municipal obligations 3,000 39,474 Other 1,658 --- Total $89,959 $58,643\nAs of August 31, 1995 unrealized gains and losses were not material. All of the Company's short-term investments mature within two years, except certain municipal obligations which have stated maturities greater than nine years. For these securities, the Company has the option of adjusting the respective interest rates or liquidating these investments at face value on stated auction dates at intervals up to 180 days.\nNote 3 Inventories Inventories consisted of:\nAs of August 31, (in thousands) 1995 1994\nRaw materials $206,221 $164,817 Work-in-process 92,588 67,572 Total $298,809 $232,389\nNote 4 Property and Equipment Property and equipment consisted of:\nAs of August 31, (in thousands) 1995 1994\nLand, buildings and improvements $ 36,100 $ 29,686 Equipment recorded under capital leases --- 1,235 Machinery and equipment 261,702 165,212 Furniture and fixtures 36,296 27,517 Leasehold improvements 15,923 12,398 Construction-in-progress 908 2,049 Total 350,929 238,097 Less accumulated depreciation and amortization 147,320 90,275\nNet property and equipment $203,609 $147,822\nAccumulated amortization on equipment under capital leases was $1,235,000 as of August 31, 1994. The related amortization expense is included in depreciation expense in the accompanying consolidated financial statements.\nNote 5 Lines of Credit The Company has $100 million available under an unsecured domestic revolving line of credit expiring June 30, 1997, which, at the Company's option, currently bears interest at either the bank's prime rate, the London interbank offering rate (LIBOR) plus 0.8%, or the bank's certificate of deposit rate plus 0.8%. As of August 31, 1995 and 1994, there were no borrowings under this line of credit. The agreement contains certain financial covenants; limits new indebtedness, business acquisitions, and repurchases of the Company's common stock, and prohibits the payment of cash dividends. The agreement also stipulates that if the Company pledges any cash, cash equivalents, or short-term investments, the amount of available borrowing under this line of credit will be reduced. The Company also has $37 million in foreign lines of credit and other bank facilities. Borrowings are payable on demand. The interest rates range from the bank's prime lending rate to the bank's prime rate plus 2.0%. As of August 31, 1995, borrowings under these lines of credit were $4.4 million and are included in other current liabilities in the accompanying consolidated financial statements.\nNote 6 Long-Term Debt Long-term debt and capital lease obligations consisted of:\nAs of August 31, (in thousands) 1995 1994\nZero-coupon subordinated notes due 2012, convertible into 1,973 and 9,551 shares of common stock, respectively $30,043 $135,848 Term loans, bearing interest at rates ranging from 7.2% to 12% due serially until June 1996; secured by equipment 1,054 4,205 Other 3,742 3,805 Total long-term debt and capital lease obligations 34,839 143,858 Less current portion of long-term debt and capital lease obligations 4,796 3,149\nTotal Long-term debt $30,043 $140,709\nIn May 1992, the Company issued 460,000 zero-coupon subordinated notes at an initial issue price of $252.57 per note. These notes have a maturity value of $1,000 each payable on May 5, 2012. The Company is accreting the issue price to the maturity value using the effective interest rate (approximately 7%). The notes are subordinated to all existing and future senior indebtedness of the Company. Each note is convertible at any time by the holder into 20.792 shares of common stock. Notes may be redeemed by the holder on May 5, 1997, 2002, and 2007 for a per note purchase price of $356.28, $502.57, and $708.92, respectively. The Company, at its option, may pay the purchase price on any of these redemption dates in cash or common stock, or any combination of both. Beginning on May 5, 1996, the notes are redeemable for cash at the option of the Company, in whole or in part, at redemption prices equal to the issue price plus accrued original issue discount through the date of redemption. The indenture governing the zero-coupon subordinated notes contains cross-default provisions. The market price of these notes, based on a market transaction on August 22, 1995, was $734 per note. During fiscal 1995, 364,457 notes were voluntarily converted by the holders of the notes into 7,577,802 shares of common stock. If these conversions had occurred at the beginning of fiscal 1995, primary net income per share for fiscal 1995 would have been $1.67.\nNote 7 Financial Instruments (a) Fair Value of Financial Instruments The fair value of the Company's cash, cash equivalents, accounts receivable, and accounts payable approximates the carrying amount due to the relatively short maturity of these items. The fair value of the Company's short-term investments and long-term debt is determined based on quoted market prices (see Notes 2 and 6). (b) Derivatives The Company enters into forward exchange contracts to hedge foreign currency exposures on a continuing basis for periods consistent with its committed exposures. The Company's hedging transactions are considered non-trading and do not involve speculation. These transactions do not subject the Company to risk of accounting loss because gains and losses on these contracts offset losses and gains on the assets, liabilities, and transactions being hedged. The Company is exposed to credit-related losses in the event of nonperformance by the parties in these contracts. The amount of unrealized gain at risk was immaterial as of August 31, 1995. The Company had $77.0 million and $38.0 million of net foreign currency forward exchange contracts outstanding at the end of fiscal years 1995 and 1994, respectively, primarily for the purchase of European currencies. (c) Business and Credit Concentrations Financial instruments which potentially subject the Company to concentrations of credit risk consist of cash, cash equivalents, short-term investments, and trade accounts receivable. The Company's cash, cash equivalents, and short- term investments are managed by recognized financial institutions which follow the Company's investment policy. The Company's investments are comprised of investment grade short- term debt instruments, and the Company's investment policy limits the amount of credit exposure in any one issue. Concentrations of credit risk result from sales to major customers as discussed in Note 12. The Company generally does not require collateral for sales on credit. The Company closely monitors extensions of credit and has not experienced significant credit losses in the past.\nNote 8 Commitments The Company leases various facilities under operating lease agreements. The facility leases expire at various dates through 2000. Substantially all leases require the Company to pay property taxes, insurance, and normal maintenance costs. All of the Company's leases have fixed minimum lease payments except the lease for certain facilities in California. Payments under this lease are periodically adjusted based on LIBOR rates. This lease provides the Company with the option at the end of the lease of either acquiring the property at its original cost or arranging for the property to be acquired. The Company is contingently liable under a first loss clause for a decline in market value of the leased facilities up to $44.2 million in the event the Company does not purchase the property at the end of the five-year lease term. The Company must also maintain compliance with financial covenants similar to its credit facilities. Future minimum payments related to lease obligations are $9.4 million, $8.0 million, $7.0 million, $5.5 million, and $1.6 million in each of the years in the five-year period ending August 31, 2000. Rent expense was $10.8 million, $11.1 million, and $9.4 million for the years ended August 31, 1995, 1994, and 1993, respectively.\nNote 9 Income Taxes The Company adopted SFAS No. 109 effective September 1, 1993. The cumulative effect of this change in accounting for income taxes was not material. Prior years' financial statements have not been restated to apply the provisions of SFAS No. 109. The components of income taxes are as follows:\nYears ended August 31, (in thousands) 1995 1994 1993\nCurrent: Federal $34,922 $17,682 $11,569 State 4,370 4,151 3,361 Foreign 4,346 7,121 3,375 total current 43,638 28,954 18,305 Deferred: Federal (3,474) (313) (292) State 15 (67) --- Foreign 789 40 --- total deferred $40,968 $28,614 $18,013\nThe overall effective income tax rate (expressed as a percentage of financial statement income before income taxes) differs from the expected U.S. income tax rate as follows:\nYears ended August 31, 1995 1994 1993\nFederal tax rate 35.0% 35.0% 34.0% State income tax, net of federal tax benefit 2.4 3.2 4.5 Tax exempt interest (0.7) (1.0) (2.0) Income of foreign subsidiaries taxed at different rates (4.2) (3.5) (1.7) Other 1.5 0.3 2.2 Effective income tax rate 34.0% 34.0% 37.0%\nThe tax effects of temporary differences that give rise to significant portions of deferred tax assets and liabilities are as follows:\nAs of August 31, (in thousands) 1995 1994\nDeferred tax assets: Accruals, allowances, and reserves $ 10,326 $ 7,006 State income tax 920 478 Pre-operating costs 164 277 Acquired intangible assets 463 72 Other 278 434 Total deferred tax assets 12,151 8,267\nDeferred tax liabilities: Plant and equipment (1,779) (1,642) Other (2,070) (996) Total deferred tax liabilities (3,849) (2,638)\nNet deferred tax assets $ 8,302 $ 5,629\nBased on the Company's historical operating income, management believes it is more likely than not that the Company will realize the benefit of the deferred tax assets recorded and, accordingly, has established no valuation allowance. Worldwide income before income taxes consisted of the following:\nYears ended August 31, (in thousands) 1995 1994 1993 U.S. $ 91,537 $54,241 $36,163 Non-U.S. 28,957 29,918 12,450 Total $120,494 $84,159 $48,613\nThe Company has not provided for U.S. federal and foreign withholding taxes on approximately $55.5 million of foreign subsidiaries' undistributed earnings as of August 31, 1995 because such earnings are intended to be reinvested indefinitely. The amount of income tax liability that would result had such earnings been repatriated is approximately $9.2 million. The Company has a tax holiday in Malaysia that expires in January, 1997 subject to certain extensions.\nNote 10 Shareholders' Equity (a) Stock Split On October 11, 1993 the Board of Directors approved a 2 for 1 split of the Company's common stock effective October 27, 1993. The consolidated financial statements have been retroactively adjusted to reflect the stock split. (b) Stock Option Plans The Company's stock option plans provide for grants of options to employees to purchase common stock at the fair market value of such shares on the grant date. The options vest over a four- year period beginning generally on the grant date. The term of the options is five years for options granted prior to November 17, 1993 and seven years for options granted thereafter. A summary of stock option activity under the plans follows:\nYears ended August 31, 1995 1994\nNumber of Exercise Number of Exercise Shares Price Shares Price Outstanding at beginning of year 4,067,143 $1.81-$30.75 2,923,526 $0.94-$23.69 Granted 778,250 26.63- 37.38 1,836,000 26.94- 30.75 Exercised (572,780) 1.81- 30.75 (526,629) 0.94- 27.31 Canceled (280,773) 1.94- 37.38 (165,754) 1.94- 30.75 Outstanding at end of year 3,991,840 $1.94-$37.38 4,067,143 $1.81-$30.75\nExercisable at end of year 1,924,029 $1.94-$37.38 1,390,228 $1.81-$30.75\nA total of 7,188,395 shares of common stock remain reserved for issuance under the plans as of August 31, 1995. Each independent member of the Company's Board of Directors is granted 6,000 stock options each December 1 at the fair market value as of that date. Such options vest over one year. (c) Employee Stock Purchase Plan Under the Company's Employee Stock Purchase Plan (the Purchase Plan), employees meeting specific employment qualifications are eligible to participate and can purchase shares quarterly through payroll deductions at the lower of 85% of the fair market value of the stock at the commencement or end of the offering period. The Purchase Plan permits eligible employees to purchase common stock through payroll deductions for up to 10% of qualified compensation. As of August 31, 1995, 1,529,981 shares remain available for issuance under the Purchase Plan.\nNote 11 Business Segment Information Information about the Company's operations in different geographic regions is presented in the table below:\nOperating Identifiable (in thousands) Net Sales Income Assets Fiscal 1995 United States $1,280,397 $ 94,078 $609,245 Europe 534,038 15,316 213,996 Asia 251,124 14,040 117,614 Total $2,065,559 $123,434 $940,855\nFiscal 1994 United States $ 945,742 $ 58,488 $485,854 Europe 389,257 22,286 201,262 Asia 121,780 7,576 79,279 Total $1,456,779 $ 88,350 $766,395\nFiscal 1993 United States $ 601,449 $ 40,908 $441,658 Foreign (primarily Europe) 234,877 12,232 161,627 Total $ 836,326 $ 53,140 $603,285\nNote 12 Major Customers Net sales to major customers as a percentage of consolidated net sales were as follows: Years ended August 31, 1995 1994 1993 IBM 21% 28% 26% Apple < 10% 12% < 10% Sun Microsystems, Inc. < 10% < 10% 12%\nNote 13 Asset Acquisitions In September 1992, the Company purchased facilities and printed circuit board assembly equipment located in Charlotte, North Carolina and Bordeaux, France, from IBM for a purchase price of $58.9 million. In September 1993, the Company acquired similar operations in Dunfermline, Scotland and printed circuit board assembly equipment in Everett, Washington. In conjunction with these asset acquisitions, the Company also purchased inventory and hired certain employees associated with the assembly operations conducted at these sites. These acquisitions have been accounted for by the purchase method of accounting, and accordingly the purchase price has been allocated to the assets acquired based on estimated fair values at the date of acquisition. The excess of purchase price over the estimated fair values of the assets acquired has been recorded as goodwill, which is being amortized over ten years. On August 17, 1995, the Company executed definitive agreements with Hewlett-Packard GmbH (HP), a subsidiary of Hewlett-Packard Company, to acquire HP's printed circuit board assembly operation in Boeblingen, Germany. The transaction is expected to close in November 1995.\nThe Board of Directors and Shareholders Solectron Corporation: We have audited the accompanying consolidated balance sheets of Solectron Corporation and subsidiaries as of August 31, 1995 and 1994, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the years in the three-year period ended August 31, 1995. 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 financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Solectron Corporation and subsidiaries as of August 31, 1995 and 1994, and the results of their operations and their cash flows for each of the years in the three-year period ended August 31, 1995, in conformity with generally accepted accounting principles. KPMG PEAT MARWICK LLP San Jose, California September 8, 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 REGISTRANT\nThe Company's executive officers and directors and their ages as of August 31, 1995 are as follows:\nName Age Position\nCharles A. Dickinson (3) 71 Chairman of the Board, President Solectron Europe, and Director\nKoichi Nishimura,Ph.D. 57 President, Chief Executive Officer, and Director\nStephen T. Ng 40 Senior Vice President and Chief Materials Officer\nLeslie T. Nishimura 51 Senior Vice President and President Solectron Washington, Inc.\nKen Tsai 52 Senior Vice President and President Solectron Asia\nSusan S. Wang 44 Senior Vice President, Chief Financial Officer, and Secretary\nWalter W. Wilson 51 Senior Vice President and President Solectron North America\nSaeed Zohouri, Ph.D. 44 Senior Vice President and Chief Technology Officer\nWinston H. Chen, Ph.D.(3) 53 Director\nRichard A. D'Amore (1) 41 Director\nKenneth E. Haughton, Ph.D.(3) 67 Director\nPaul R. Low, Ph.D. (2)(1) 62 Director\nW. Ferrell Sanders (2) 58 Director\nOsamu Yamada 65 Director\n(1) Member of the Audit Committee (2) Member of the Compensation Committee (3) Member of the Nominating Committee\nMr. Charles A. Dickinson has served as a director of the Company since 1984, and as Chairman of the Board of Directors from 1986 to 1990 and from 1994 to the present. He served as an independent management consultant to the Company from 1991 to 1993. He served as President, Solectron France, S.A. from 1992 to 1993 and has served as President, Solectron Europe since 1993. From 1986 to 1990, he was Chairman of the Board of Directors, President and Chief Executive Officer of Vermont Micro Systems, Inc., a manufacturer of microcomputer-based graphics cards. He currently serves as a director of Vermont Micro Systems, Inc.\nDr. Koichi Nishimura has served as a director since 1991, Chief Executive Officer since 1992 and President since 1990. He was Co-Chief Executive Officer from 1991 to 1992 and Chief Operating Officer from 1988 to 1991. From 1964 to 1988, Dr. Nishimura was employed by International Business Machines Corporation (\"IBM\") in various technology and management positions. He also serves as a director of Merix Corporation, a manufacturer of technologically advanced electronic interconnection products.\nMr. Leslie T. Nishimura is President of Solectron Washington, Inc. and has served as Senior Vice President of the Company since 1989, President of Solectron Asia from 1991 to 1993, Secretary of the Company from 1989 to 1992 and Vice President, Manufacturing Technology of the Company from 1978 to 1989. Mr. Nishimura's prior experience includes various materials, production control and inventory control supervisory positions at Ritter Co., Burndy Corporation and the Norden Division of United Technologies, Inc.\nMs. Susan S. Wang has served as Secretary of the Company since 1992 and Senior Vice President and Chief Financial Officer of the Company since 1990. She was Vice President, Finance and Chief Financial Officer of the Company from 1986 to 1990 and Director of Finance of the Company from 1984 to 1986. Prior to joining the Company, Ms. Wang held various accounting and finance positions with Xerox Corporation. Ms. Wang also held accounting and auditing positions with Westvaco Corp. and Price Waterhouse & Co. She is a certified public accountant.\nMr. Walter W. Wilson has served as President, Solectron North America since September 1995, President, Solectron California Corporation since March 1992 and Senior Vice President of the Company since 1990. From 1989 to 1990 he served as an operational Vice President of the Company. From 1965 to 1989 Mr. Wilson was employed by IBM in manufacturing and product development. During his IBM tenure, he held management positions in the United States, West Germany and Japan.\nMr. Ken Tsai is President of Solectron Asia and has served as Senior Vice President of the Company since May 1995, Vice President of the Company from 1990 to 1995. He served as Director of Manufacturing for the Company from 1989 to 1990 and in various manufacturing and other positions from 1984 to 1989. Prior to joining Solectron, Mr. Tsai served in various management and business planning positions at American Cyanamid Company from 1968 to 1984.\nDr. Winston H. Chen has served as a director of the Company since 1978, Chairman of the Board from 1990 to 1994, President from 1979 to 1990, Chief Executive Officer from 1984 to 1991, and as Co-Chief Executive Officer from 1991 through 1992. Dr. Chen is currently Chairman of the Paramitas Foundation. From 1970 to 1978, Dr. Chen served as Process Technology and Development Manager of IBM. He also serves as a director of Intel Corporation, Megatest Corporation, SCEcorp and Paramitas Investment Corp.\nMr. Richard A. D'Amore has served as a director of the Company since 1985. Mr. D'Amore has been a general partner of various venture capital funds affiliated with Hambro International Venture Funds since 1982 and a general partner of North Bridge Venture Partners since 1992. He also serves as a director of Math Soft, Inc. and VEECO.\nDr. Kenneth E. Haughton has served as a director of the Company since 1985. Dr. Haughton is currently an independent consultant. From 1990 to 1991, he was Vice President of Engineering at Da Vinci Graphics, a computer graphics firm. From 1989 to 1990, Dr. Haughton was an independent consultant, and from 1982 to 1989, he served as Dean of Engineering at Santa Clara University. He also serves as a director of Seagate Technology, a manufacturer of disk drives.\nDr. Paul R. Low has served as a director of the Company since 1993 and is currently the President of PRL Associates. Prior to founding PRL Associates, Dr. Low worked for IBM from 1957 to 1992. Dr. Low held senior management and executive positions with successively increasing responsibility, including President, General Technology Division and IBM Corporate Vice President; President of General Products Division; and General Manager, Technology Products business line, also serving on IBM's corporate management board. He also serves as a director of Applied Materials, Inc., VEECO, Nexgen, and Number Nine.\nMr. W. Ferrell Sanders has served as a director of the Company since 1986. Since 1987, Mr. Sanders has been a general partner of Asset Management Associates Venture Fund, a venture capital management firm. From 1981 to 1987, he was an independent management consultant. He also serves as a director of Adaptec, Inc.\nMr. Osamu Yamada has served as a director of the Company since 1994. Mr. Yamada is currently an advisor to The Mitsubishi Bank, Limited. From 1990 to 1991, he was Chairman and Chief Executive Officer of BankCal Tri-State Corporation, a wholly owned subsidiary of The Mitsubishi Bank, Limited. From 1987 to 1990, he was Senior Managing Director of The Mitsubishi Bank, Limited, and in an overlapping period from 1985 to 1990, he was also Chairman, President and Chief Executive Officer of Bank of California. Prior to that, he held a number of key management positions with The Mitsubishi Bank, Limited organization. Mr. Yamada currently serves as a director of PictureTel and on number of boards of major universities and cultural centers.\nMr. Stephen T. Ng joined Solectron in September 1989 as Vice President, Worldwide Material Purchasing and is currently Senior Vice President and Chief Materials Officer of the Company. Prior to joining Solectron, Mr. Ng had 11 years experience in materials management in various capacities with Xerox Corporation. His last position prior to joining Solectron was Manager, Material Operations at Xerox Corporation. Mr. Ng holds an MBA from the University of Dallas and is a certified purchasing manager.\nDr. Saeed Zohouri is Senior Vice President and Chief Technology Officer at Solectron Corporation. Dr. Zohouri joined Solectron in 1980; he has held various management positions and has also served as Director of Technology. Dr. Zohouri was promoted to his current position in 1994. His prior experience includes teaching chemistry at a major international university. Dr. Zohouri holds a master of science degree in organic chemistry from Manchester University in England and a doctorate degree in chemistry from Stanford University.\nThere is no family relationship among any of the foregoing individuals.\nITEM 11:","section_11":"ITEM 11: EXECUTIVE COMPENSATION\nThe information required by item 11 of Form 10-K is incorporated by reference to the information contained in the section captioned \"Executive Officer Compensation\" of the Registrant's definitive Proxy Statement (Notice of Annual Meeting of Shareholders) for the fiscal year ended August 31, 1995 to be held on January 9, 1996 which the Company will file with the Securities and Exchange Commission within 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\nInformation regarding this item is incorporated herein by reference from the section entitled \"Security Ownership of Certain Beneficial Owners and Management\" of the Registrant's definitive Proxy Statement (Annual Meeting of Shareholders) for the fiscal year ended August 31, 1995.\nITEM 13:","section_13":"ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation with respect to this item is incorporated herein by reference from the section entitled \"Certain Transactions\" of the Registrant's definitive Proxy Statement (Annual Meeting of Shareholders) for the fiscal year ended August 31, 1995.\nPART IV\nITEM 14:","section_14":"ITEM 14: EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) 1. Financial Statements. The financial statements listed in Item 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA, above are filed as part of this Annual Report on Form 10-K.\n2. Financial Statement Schedules. The financial statement Schedule ii - VALUATION AND QUALIFYING ACCOUNTS is filed as part of this annual report in Form 10-K.\n3. Exhibits. The exhibits listed in the accompanying Index to Exhibits are filed as part of this Annual Report on Form 10-K.\n(b) Reports on Form 8-K During the fiscal quarter ended August 31, 1995 no current reports on Form 8-K 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.\nSOLECTRON CORPORATION (Registrant)\nDate: November 20, 1995 By \/s\/ Koichi Nishimura (Koichi Nishimura, 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.\nName Title Date\nPresident, Chief Executive \/s\/ Koichi Nishimura Officer, and Director 11\/20\/1995 Koichi Nishimura\nChief Financial Officer (Principal Financial and Accounting Officer), Senior \/s\/ Susan S. Wang Vice President, and Secretary 11\/20\/1995 Susan S. Wang\nChairman of the Board, President Solectron Europe, \/s\/ Charles A. Dickinson and Director 11\/20\/1995 Charles A. Dickinson\n\/s\/ Winston H. Chen Director 11\/20\/1995 Winston H. Chen\n\/s\/ Richard A. D'Amore Director 11\/20\/1995 Richard A. D'Amore\n\/s\/ Kenneth E. Haughton Director 11\/20\/1995 Kenneth E. Haughton\n\/s\/ Paul R. Low Director 11\/20\/1995 Paul R. Low\n\/s\/ W. Ferrell Sanders Director 11\/20\/1995 W. Ferrell Sanders\n\/s\/ Osamu Yamada Director 11\/20\/1995 Osamu Yamada\nSOLECTRON CORPORATION AND SUBSIDIARIES SCHEDULE ii - VALUATION AND QUALIFYING ACCOUNTS (in thousands)\nAmounts Charged Balance at (Credited) Balance at Beginning To Recoveries End Description of Period Operations (Deductions) of Period\nFiscal 1993 Allowance for doubtful accounts recievable $1,010 $849 $3 $1,861\nFiscal 1994 Allowance for doubtful $1,861 $989 ($391) $2,459 accounts receivable\nFiscal 1995 Allowance for doubtful accounts receivable $2,459 $1,602 ($560) $3,501 accounts receivable\nINDEX TO EXHIBITS\nExhibit Number Description\n3.1 [viii] Articles of Incorporation of Company, as amended 3.2 [viii] Bylaws of Company 4.1 [ii] Form of Certificate for Liquid Yield Option Notes (LYONs) 4.2 [ii] Form of Indenture between the Company and Bankers Trust Company, relating to the LYONs. 10.1 [i] Preferred Stock Purchase Agreement dated September 29, 1983, together with amendments thereto dated February 28, 1984 and June 23, 1988. 10.2 [i] Form of Indemnification Agreement between Company and its officers, directors and certain other key employees. 10.3 [i] Amendment to form of Indemnification Agreement. 10.4 [iv] 1983 Incentive Stock Option Plan, as amended August 13, 1991. 10.5 [vi] 1988 Employee Stock Purchase Plan, as amended October 1992. 10.6 [v] Amended and Restated 1992 Stock Option Plan. 10.7 [iii] Master Asset Transfer and Stock Purchase Agreement dated August 17, 1992, as amended, between Company and International Business Machines Corporation. 10.8 [vi]+ ECAT Manufacturing Agreement dated August 17, 1992, between Company and International Business Machines Corporation (the \"ECAT Agreement\"). 10.9 [vi]+ Amendment to the ECAT Agreement dated September 30, 1992 between Company and International Business Machines. 10.10 [vii] Stock Acquisition Agreement dated August 28, 1993, between Company and Solectron California Corporation 10.11 [vii] Multicurrency Credit Agreement dated June 30, 1993, between Company and Bank of America National Trust and Savings Association as Agent and Issuing Bank 10.12 [viii] Lease Agreement between BNP Leasing Corporation, as Landlord, and Company, as Tenant, Effective September 6, 1994. 10.13 [viii] Purchase Agreement, by and between Company and BNP Leasing Corporation, dated September 6, 1994 10.14 [viii] Pledge and Security Agreement, by and between Company, As Debtor, and BNP Leasing Corporation, as Secured Party, dated September 6, 1994 10.15 [viii] Assignment and Assumption Agreement between Company and Solectron California Corporation, dated November 9, 1994 10.16 [viii] Custodial Agreement by and between Company, Banque Nationale De Paris, and BNP Leasing Corporation, dated September 6, 1994 10.17 [viii] First Amendment to Multicurrency Credit Agreement, dated August 29, 1994 10.18 [viii] Second Amendment to Multicurrency Credit Agreement, dated September 30, 1994 11.1 Statement re: Computation of Net Income Per Share. 21.1 Subsidiaries of the Registrant 23.1 Consent of Independent Auditors 27.1 Financial Data Schedule\nINDEX TO EXHIBITS (Continued)\nFootnotes Description\n[i] Incorporated by reference to the Exhibits to Company's Registration Statement on Form S-1 (File No. 33-22840). [ii] Incorporated by reference to the Exhibits to Company's Registration Statement on Form S-1 filed April 6, 1992 (Registration No. 33-46971). [iii] Incorporated by reference to the Company's Form 8-K filed October 15, 1992. [iv] Incorporated by reference to the Exhibits to Company's Registration Statement on Form S-8 (File No. 33-46686) [v] Incorporated by reference to the Exhibits to Company's Registration Statement on Form S-8, filed Febuary 2, 1995 (File No. 33-75270) [vi] Incorporated by reference to the Exhibits to Company's Form 10-K for the year ended August 31, 1992 [vii] Incorporated by reference to the Exhibits to Company's Form 10-K for the year ended August 31, 1993 [viii] Incorporated by reference to the Exhibits to Company's Form 10-K for the year ended August 31, 1994\n+ Confidential treatment has been granted for certain portions of these documents.\nExhibit 11.1\nSOLECTRON CORPORATION AND SUBSIDIARIES STATEMENT REGARDING COMPUTATION OF NET INCOME PER SHARE (in thousands, except per share data)\nTwelve months ended August 31, 1995 1994 1993\nWeighted average number of common stock equivalents:\nPrimary: Common stock 42,861 41,023 36,698 Common stock equivalents - stock options 912 1,182 1,434 43,773 42,205 38,132\nFully diluted: Common shares issuable upon assummed conversion of zero-coupon subordinated notes 8,286 9,557 9,562 Incremental increase in common stock equivalent options using end of period market price 523 271 122 52,582 52,033 47,816\nNet income $ 79,526 $ 55,545 $ 30,600\nInterest accretion on zero-coupon subordinated notes, net of taxes 5,439 5,944 5,283\nNet income - fully diluted $ 84,965 $ 61,489 $ 35,883\nNet income per share - primary $1.82 $1.32 $0.80\nNet income per share - fully diluted $1.62 $1.18 $0.75\nExhibit 21.1\nSOLECTRON CORPORATION\nSUBSIDIARIES\nJurisdiction of Subsidiary Incorporation or Organization\nSolectron California Corporation California\nSolectron Technology, Inc. California\nSolectron Washington, Inc. California\nSolectron France, S.A. France\nSolectron Scotland Limited Scotland\nSolectron Japan, Inc. Japan\nSolectron Technology SDN. BHD. Malaysia\nExhibit 23.1\nConsent of Independent Auditors\nThe Board of Directors and Shareholders Solectron Corporation:\nWe consent to incorporation by reference in the registration statements (Nos. 33-75270, 33-58580, 33-46686 and 33-33461) on Form S-8 of Solectron Corporation of our report dated September 8, 1995, relating to the consolidated balance sheets of Solectron Corporation and subidiaries as of August 31, 1995 and 1994, and the related consolidated statements of income, shareholders' equity, cash flows for each of the years in the three-year period ended August 31, 1995, and related schedule, which report appears in the August 31, 1995, annual report on Form 10-K of Solectron Corporation.\nKPMG Peat Marwick LLP\nSan Jose, California November 16, 1995\nExhibit 27.1 _______________________________ TMTrademark of Merrill Lynch & Co., Inc.","section_15":""}
{"filename":"1003010_1995.txt","cik":"1003010","year":"1995","section_1":"ITEM 1. BUSINESS\nSuperior Wholesale Inventory Financing Trust I (the \"Trust\" or the \"Issuer\") was formed pursuant to a Trust Agreement, dated as of January 25, 1994, between Wholesale Auto Receivables Corporation and Citibank Delaware, as Owner Trustee. On January 25, 1994, the Trust issued Floating Rate Asset-Backed Certificates, Class A with an aggregate initial certificate balance of $132,000,000. On January 25, 1994, the Trust also issued Floating Rate Asset-Backed Term Notes, Series 1994-A in the aggregate principal amount of $1,250,000,000 and Floating Rate Asset-Backed Revolving Notes, Series 1994-RN1 with a specified maximum balance of $1,250,000,000 pursuant to An Indenture, as of January 25, 1994, between the Issuer and The Bank of New York, as Indenture Trustee.\nSuperior Wholesale Inventory Financing Trust II (the \"Trust\" or the \"Issuer\") was formed pursuant to a Trust Agreement, dated as of August 22, 1995, between Wholesale Auto Receivables Corporation and The Chase Manhattan Bank (USA), as Owner Trustee. On August 22, 1995, the Trust issued Floating Rate Asset-Backed Certificates, Class A with an aggregate initial certificate balance of $72,750,000. On August 22, 1995, the Trust also issued Floating Rate Asset-Backed Term Notes, Series 1995-A in the aggregate principal amount of $1,000,000,000 and Floating Rate Asset-Backed Revolving Notes, Series 1995-RN1 with a specified maximum balance of $1,000,000,000 pursuant to an Indenture, as of August 22, 1995, between the Issuer and The Bank of New York, as Indenture Trustee.\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.\nThe Trusts were formed pursuant to individual trust agreements between Wholesale Auto Receivables Corporation (the \"Seller\") and Citibank Delaware, as Owner Trustee for Superior Wholesale Inventory Financing Trust I and The Chase Manhattan Bank (USA), as Owner Trustee for Superior Wholesale Inventory Financing Trust II. Each Trust has issued the following floating rate Asset- Backed Notes and Certificates, and acquired certain eligible wholesale finance receivables from the Seller in the aggregate amounts as shown below in exchange for Asset-Backed Notes and Asset-Backed Certificates representing undivided interests in each of the respective Trusts. Each Trust's property includes a pool of wholesale receivables generated in a portfolio of revolving financing arrangements with dealers to finance inventories of new and used automobiles and light trucks and collections thereon and certain other property.\nWholesale Date of Finance Sale and Initial Servicing Sale Asset-Backed Asset-Backed Trust Agreement Amount Notes Certificates - -------- ---------- ---------- ------------ ------------ (millions) (millions) (millions)\nSuperior January 25, 1994 $2,232.3 Term Notes $1,250.0 $132.0 Wholesale Inventory Revolving Financing Notes $ 850.3 Trust I\nSuperior August 22, 1995 $1,889.5 Term Notes $1,000.0 $72.8 Wholesale Inventory Revolving $ 816.7 Financing Notes Trust II\nGeneral Motors Acceptance Corporation (GMAC), the originator of the wholesale receivables, continues to service the receivables for each of the aforementioned Trusts and receives compensation and fees for such services. Investors receive monthly payments of interest for each type of note and certificate at a floating monthly interest rate.\nII-1\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nCROSS REFERENCE SHEET\nExhibit No. Caption Page - ----------- ------------------------------------------------- ------\n-- Superior Wholesale Inventory Financing Trust I, Independent Auditors' Report, Financial Statements II-3 and Selected Quarterly Data for the year ended December 31, 1995.\n-- Superior Wholesale Inventory Financing Trust II, Independent Auditors' Report, Financial Statements II-9 and Selected Quarterly Data for the period August 22, 1995 (inception) through December 31, 1995.\n27.1 Financial Data Schedule for Superior Wholesale Inventory Financing Trust I (for SEC electronic -- filing purposes only).\n27.2 Financial Data Schedule for Superior Wholesale Inventory Financing Trust II (for SEC electronic -- filing purposes only).\nII-2\nINDEPENDENT AUDITORS' REPORT\nMarch 1, 1996\nThe Superior Wholesale Inventory Financing Trust I, its Noteholders and Certificateholders, Wholesale Auto Receivables Corporation, Citibank Delaware, Owner Trustee, and The Bank of New York, Indenture Trustee:\nWe have audited the accompanying Statement of Assets, Liabilities and Equity of the Superior Wholesale Inventory Financing Trust I as of December 31, 1995 and 1994, and the related Statement of Distributable Income for the year ended December 31, 1995 and the period January 25, 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 audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates 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 Superior Wholesale Inventory Financing Trust I at December 31, 1995 and 1994, and its distributable income and distributions for the year ended December 31, 1995 and the period January 25, 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-3\nSUPERIOR WHOLESALE INVENTORY FINANCING TRUST I\nSTATEMENT OF ASSETS, LIABILITIES AND EQUITY\nDecember 31, 1995 1994 -------- -------- (in millions of dollars) ASSETS\nReceivables (Note 2) .................... $2,632.0 $2,578.0 -------- --------\nTOTAL ASSETS ............................ $2,632.0 $2,578.0 ======== ========\nLIABILITIES (Notes 2 and 3)\nAsset-Backed Term Notes ................. $1,250.0 $1,250.0\nAsset-Backed Revolving Notes ............ $1,250.0 1,196.0 -------- -------- TOTAL LIABILITIES ....................... 2,500.0 2,446.0\nEQUITY\nAsset-Backed Certificates (Notes 2 and 3) 132.0 132.0 -------- --------\nTOTAL LIABILITIES AND EQUITY ............ $2,632.0 $2,578.0 ======== ========\nReference should be made to the Notes to Financial Statements.\nII-4\nSUPERIOR WHOLESALE INVENTORY FINANCING TRUST I\nSTATEMENT OF DISTRIBUTABLE INCOME\nYear Ended December 31, 1995 1994* ----------- ---------- (in millions of dollars) Distributable Income\nAllocable to Interest . . . . . . . . . . 159.1 85.0 ------- -------\nDistributable Income . . . . . . . . . . . 159.1 85.0 ======= ======= Income Distributed . . . . . . . . . . . . 159.1 85.0 ======= =======\n* Represents the period January 25, 1994 (inception) through December 31, 1994.\nReference should be made to the Notes to Financial Statements.\nII-5\nSUPERIOR WHOLESALE INVENTORY FINANCING TRUST I\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1. BASIS OF ACCOUNTING\nThe financial statements of Superior Wholesale Inventory Financing Trust I (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 Wholesale Auto Receivables Corporation (the \"Seller\").\nNOTE 2. SALE OF NOTES AND CERTIFICATES\nOn January 25, 1994, the Trust acquired the Seller's right, title and interest in wholesale finance receivables totaling approximately $2,232.3 million from the Seller in exchange for two types of Asset-Backed Notes representing indebtedness of the Trust of $1,250.0 million Floating Rate Term Notes, $850.3 million Floating Rate Revolving Notes and $132.0 million Asset-Backed Certificates representing equity interests in the Trust. The Trust property includes certain Eligible Receivables in Accounts included in a Pool of Accounts, certain Receivables generated under each such Account from time to time secured by new and used automobiles and light trucks, certain monies due or received thereunder, an interest rate basis swap and certain other property.\nNOTE 3. PRINCIPAL AND INTEREST PAYMENTS\nIn the ordinary course, no principal payments will be made on the Term Notes until the commencement of the Wind Down Period (January 1997). During the Revolving Period, the Trust will make payments of principal on, or additional borrowings (up to the Maximum Revolver Balance) under, the Revolving Notes on a daily basis.\nThe then-unpaid principal balance of the Term Notes, Revolving Notes, and Certificates will be payable on January 15, 1999.\nPayments of interest on the existing Notes and Certificates 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, (each, a \"Distribution Date\"), commencing February 15, 1994 (the \"Initial Distribution Date\").\nThe Term Notes interest rate equals LIBOR plus 15 basis points per annum for each Distribution Date. Interest on the Term Notes will accrue from, and including, the most recent Distribution Date to, but excluding, the current Distribution Date. The Term Noteholders received interest at a weighted average rate of 5.354 percent per annum from January 25, 1994 through December 14, 1995.\nThe Revolving Notes interest rate equals LIBOR plus 30 basis points per annum for each Distribution Date. Interest on the Revolving Notes accrue for the Collection Period (calendar month) immediately preceding each Distribution Date. The Revolving Noteholders received interest at a weighted average rate of 5.617 percent per annum from January 25, 1994 through November 30, 1995.\nII-6\nSUPERIOR WHOLESALE INVENTORY FINANCING TRUST I\nNOTES TO FINANCIAL STATEMENTS\nNOTE 3. PRINCIPAL AND INTEREST PAYMENTS (concluded)\nThe Certificates interest rate equals LIBOR plus 45 basis points per annum for each Distribution Date. Interest on the Certificates accrues from, and including, the most recent Distribution Date to, but excluding, the current Distribution Date. The Certificateholders received interest at a weighted average rate of 5.654 percent per annum from January 25, 1994 through December 14, 1995. The final scheduled distribution date for the Certificates is January 15, 1999.\nNOTE 4. DERIVATIVE FINANCIAL INSTRUMENTS AND RISK MANAGEMENT\nThe Trust is a party to an interest rate basis swap contract with an embedded interest rate floor to manage exposure to interest rate fluctuations. The interest rate basis swap, which relates to the Asset-Backed Term Notes and the Asset-Backed Certificates, is a contractual agreement between the Trust and GMAC to exchange floating interest rate payments (i.e. the Trust pays Prime and receives London Interbank Offering Rate (LIBOR) plus 185 basis points). The embedded floor, which relates to the Asset-Backed Revolving Notes, provides the Trust with monthly cash settlements from GMAC for an amount equal to the excess, if any, of the One Month LIBOR rate plus 150 basis points over the Prime rate.\nMarket risk is mitigated because the derivatives are used to hedge a portfolio of underlying debt and equity obligations. Credit risk of the instruments is limited to payments due from GMAC. If GMAC had defaulted, the potential benefit (cost) to the Trust, if the positions were replaced at market rates in effect at December 31, 1995 and 1994, would have been as follows:\n1995 1994 (in millions of dollars) Interest Rate Basis Swap $(14.5) $(16.4) Interest Rate Floor .1 4.3 $(14.4) $(12.1)\nThe notional amount of the interest rate basis swap including the embedded interest rate floor approximates the outstanding balance in the Asset-Backed Notes and Asset-Backed Certificates.\nNOTE 5. 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 acceptance of a Note or Certificate, agrees to treat the Note as indebtedness and the Certificate as an equity interest in the Trust for federal, state and local income and franchise tax purposes.\nII-7\nSUPERIOR WHOLESALE INVENTORY FINANCING TRUST I\nSUPPLEMENTARY FINANCIAL DATA (unaudited)\nSUMMARY OF QUARTERLY DISTRIBUTABLE INCOME\n1995 Quarters Interest - ------------------------------------ --------- (in millions of dollars)\nFirst quarter ...................... $ 38.3\nSecond quarter ..................... 42.7\nThird quarter ...................... 40.0\nFourth quarter ..................... 38.1 --------- Total ......................... $ 159.1 =========\n1994 Quarters Interest - ------------------------------------ --------- (in millions of dollars)\nFirst quarter ...................... $ 9.6\nSecond quarter ..................... 24.4\nThird quarter ...................... 25.1\nFourth quarter ..................... 25.9 --------- Total ......................... $ 85.0 =========\nII-8\nINDEPENDENT AUDITORS' REPORT\nMarch 1, 1996\nThe Superior Wholesale Inventory Financing Trust II, its Noteholders and Certificateholders, Wholesale Auto Receivables Corporation, The Chase Manhattan Bank (USA), Owner Trustee, and The Bank of New York, Indenture Trustee:\nWe have audited the accompanying Statement of Assets, Liabilities and Equity of the Superior Wholesale Inventory Financing Trust II as of December 31, 1995, and the related Statement of Distributable Income for the period August 22, 1995 (inception) through December 31, 1995. 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, liabilities and equity of the Superior Wholesale Inventory Financing Trust II at December 31, 1995, and its distributable income and distributions for the period August 22, 1995 (inception) through December 31, 1995, on the basis of accounting described in Note 1.\ns\\ DELOITTE & TOUCHE LLP - ------------------------ DELOITTE & TOUCHE LLP 600 Renaissance Center Detroit, Michigan 48243\nII-9\nSUPERIOR WHOLESALE INVENTORY FINANCING TRUST II\nSTATEMENT OF ASSETS, LIABILITIES AND EQUITY\nDecember 31, 1995 ------------------- ASSETS (in millions of dollars)\nReceivables (Note 2) .................... $ 2,072.8 --------\nTOTAL ASSETS ............................ $ 2,072.8 ========\nLIABILITIES (Notes 2 and 3)\nAsset-Backed Term Notes ................. $ 1,000.0\nAsset-Backed Revolving Notes ............ 1,000.0 --------\nTOTAL LIABILITIES ....................... $ 2,000.0\nEQUITY\nAsset-Backed Certificates (Notes 2 and 3) 72.8 --------\nTOTAL LIABILITIES AND EQUITY ............ $ 2,072.8 ========\nReference should be made to the Notes to Financial Statements.\nII-10\nSUPERIOR WHOLESALE INVENTORY FINANCING TRUST II\nSTATEMENT OF DISTRIBUTABLE INCOME\nYear Ended December 31, 1995* ------------------- (in millions of dollars) Distributable Income\nAllocable to Interest . . . . . . . . . . $ 36.2 -------\nDistributable Income . . . . . . . . . . . $ 36.2 ======= Income Distributed . . . . . . . . . . . . $ 36.2 =======\n* Represents the period August 22, 1995 (inception) through December 31, 1995.\nReference should be made to the Notes to Financial Statements.\nII-11\nSUPERIOR WHOLESALE INVENTORY FINANCING TRUST II\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1. BASIS OF ACCOUNTING\nThe financial statements of Superior Wholesale Inventory Financing Trust II (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 Wholesale Auto Receivables Corporation (the \"Seller\").\nNOTE 2. SALE OF NOTES AND CERTIFICATES\nOn August 22, 1995, the Trust acquired the Seller's right, title and interest in wholesale finance receivables totaling approximately $1,889.5 million from the Seller in exchange for two types of Asset-Backed Notes representing indebtedness of the Trust of $1,000.0 million Floating Rate Term Notes, $816.7 million Floating Rate Revolving Notes and $72.8 million Asset-Backed Certificates representing equity interests in the Trust. The Trust property includes certain Eligible Receivables in Accounts included in a Pool of Accounts, certain Receivables generated under each such Account from time to time secured by new and used automobiles and light trucks, certain monies due or received thereunder, an interest rate basis swap and certain other property.\nThe terms of the sale transaction include a revolving and a wind down period. The revolving period began on August 18, 1995 and the wind down period will begin on the day immediately following the scheduled revolving period termination date. The scheduled revolving period termination date, initially June 30, 1996, will automatically be extended to the last day of each succeeding month (but not beyond June 30, 1998) unless GMAC gives notice that it has elected not to cause such extension.\nNOTE 3. PRINCIPAL AND INTEREST PAYMENTS\nIn the ordinary course, no principal payments will be made on the Term Notes until the commencement of the Wind Down Period. During the Revolving Period, the Trust will make payments of principal on, or additional borrowings (up to the Maximum Revolver Balance) under, the Revolving Notes on a daily basis.\nThe then-unpaid principal balance of the Term Notes, Revolving Notes, and Certificates will be payable on August 15, 2000.\nPayments of interest on the existing Notes and Certificates 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, (each, a \"Distribution Date\"), commencing September 15, 1995 (the \"Initial Distribution Date\").\nThe Term Notes interest rate equals LIBOR plus 13 basis points per annum for each Distribution Date. Interest on the Term Notes will accrue from, and including, the most recent Distribution Date to, but excluding, the current Distribution Date. The Term Noteholders received interest at a weighted average rate of 5.990 percent per annum from August 22, 1995 through December 14, 1995.\nII-12\nSUPERIOR WHOLESALE INVENTORY FINANCING TRUST II\nNOTES TO FINANCIAL STATEMENTS\nNOTE 3. PRINCIPAL AND INTEREST PAYMENTS (concluded)\nThe Revolving Notes interest rate equals LIBOR plus 28 basis points per annum for each Distribution Date. Interest on the Revolving Notes accrue for the Collection Period (calendar month) immediately preceding each Distribution Date. The Revolving Noteholders received interest at a weighted average rate of 6.112 percent per annum from August 22, 1995 through November 30, 1995.\nThe Certificates interest rate equals LIBOR plus 30 basis points per annum for each Distribution Date. Interest on the Certificates accrues from, and including, the most recent Distribution Date to, but excluding, the current Distribution Date. The Certificateholders received interest at a weighted average rate of 6.160 percent per annum from August 22, 1995 through December 14, 1995. The final scheduled distribution date for the Certificates is August 15, 2000.\nNOTE 4. DERIVATIVE FINANCIAL INSTRUMENTS AND RISK MANAGEMENT\nThe Trust is a party to an interest rate basis swap contract with an embedded interest rate floor and a termination option to manage exposure to interest rate fluctuations. The interest rate basis swap, which relates to the Asset-Backed Term Notes and the Asset-Backed Certificates, is a contractual agreement between the Trust and GMAC to exchange floating interest rate payments (i.e. the Trust pays Prime and receives London Interbank Offering Rate (LIBOR) plus 294 basis points). The embedded floor, which relates to the Asset-Backed Revolving Notes, provides the Trust with monthly cash settlements from GMAC for an amount equal to the excess, if any, of the One Month LIBOR rate plus 150 basis points over the Prime rate. In addition, the interest rate basis swap will terminate at the time the outstanding principal balance of the Revolving and Term Notes and the Certificates has been paid in full. In the event that GMAC gives notice that it has elected not to extend the revolving period of the sale transaction, the notional amount of the interest rate basis swap would amortize at the same rate as the outstanding balance of the related debt and equity obligations.\nMarket risk is mitigated because the derivatives are used to hedge a portfolio of underlying debt and equity obligations. Credit risk of the instruments is limited to payments due from GMAC. If GMAC had defaulted, the potential benefit (cost) to the Trust, if the positions were replaced at market rates in effect at December 31, 1995, would have been as follows:\n(in millions of dollars) Interest Rate Basis Swap $ 4.5 Interest Rate Floor .1 Termination Option (5.4) $ ( .8)\nThe notional amount of the interest rate basis swap including the embedded interest rate floor and termination option approximates the outstanding balance in the Asset-Backed Notes and Asset-Backed Certificates.\nII-13\nSUPERIOR WHOLESALE INVENTORY FINANCING TRUST II\nNOTES TO FINANCIAL STATEMENTS\nNOTE 5. 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 acceptance of a Note or Certificate, agrees to treat the Note as indebtedness and the Certificate as an equity interest in the Trust for federal, state and local income and franchise tax purposes.\nII-14\nSUPERIOR WHOLESALE INVENTORY FINANCING TRUST II\nSUPPLEMENTARY FINANCIAL DATA (unaudited)\nSUMMARY OF QUARTERLY DISTRIBUTABLE INCOME\n1995 Quarters Interest - ------------------------------------ -------- (in millions of dollars)\nThird quarter ...................... $ 5.7\nFourth quarter ..................... 30.5 --------- Total ......................... $ 36.2 =========\nII-15\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-- Superior Wholesale Inventory Financing Trust I Financial Statements for the year ended December 31, 1995.\n-- Superior Wholesale Inventory Financing Trust II Financial Statements for the period August 22, 1995 (inception) through December 31, 1995.\n27.1 Financial Data Schedule for Superior Wholesale Inventory Financing Trust I (for SEC electronic filing purposes only).\n27.2 Financial Data Schedule for Superior Wholesale Inventory Financing Trust II (for SEC electronic filing purposes only).\n(b) REPORTS ON FORM 8-K.\nNo current reports on Form 8-K have been filed by the above-mentioned Trusts during the fourth quarter ended December 31, 1995.\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 Owner Trustee has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.\nSUPERIOR WHOLESALE INVENTORY FINANCING TRUST I\nby: Citibank Delaware ---------------------------------- (Owner Trustee, not in its individual capacity but solely as Owner Trustee on behalf of the Issuer.)\ns\\ Michael Migliore ---------------------------------- Vice President and Trust Officer\nDate: March 13, 1996 --------------\nIV-2\nSIGNATURE\nPursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the Owner Trustee has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.\nSUPERIOR WHOLESALE INVENTORY FINANCING TRUST II\nby: Chase Manhattan Bank ---------------------------------- (Owner Trustee, not in its individual capacity but solely as Owner Trustee on behalf of the Issuer.)\ns\\ John Mack ---------------------------------- Second Vice President\nDate: March 13, 1996 --------------\nIV-3\nWHOLESALE AUTO RECEIVABLES CORPORATION 3044 W. Grand Boulevard Detroit, MI 48202\nMarch 13, 1996\nSecurities and Exchange Commission 450 5th Street, N.W. Attn: Filing Desk Stop 1-4 Washington, D.C. 20549-1004\nGentlemen:\nEnclosed is an electronic data transmission under EDGAR for the following Superior Wholesale Inventory Financing Trust I and Superior Wholesale Inventory Financing Trust II on Form 10-K for the year ended December 31, 1995.\nTRUST CIK NO. ----- ------\nSUPERIOR WHOLESALE INVENTORY FINANCING TRUST I 894358\nSUPERIOR WHOLESALE INVENTORY FINANCING TRUST II 894358\nVery truly yours,\ns\\ Gerald E. Gross --------------------------- Gerald E. Gross, Comptroller\nRegistrant's Telephone Number 313-556-1240","section_15":""}
{"filename":"700913_1995.txt","cik":"700913","year":"1995","section_1":"Item 1 Business I-1\nItem2 Properties I-3\nItem3 Legal Proceedings I-4\nItem4 Submission of Matters to a Vote of Security Holders I-4\nPART II\nItem5 Market for the Partnership's Limited Partnership Interests and Related Security Holder Matters II-1\nItem6 Selected Financial Data II-1\nItem7 Management's Discussion and Analysis of Financial Condition and Results of Operations II-2\nItem8 Financial Statements and Supplementary Data II-5\nItem9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure II-5\nPART III\nItem 10 Directors and Executive Officers of the Partnership III-1\nItem 11 Executive Compensation III-3\nItem 12 Security Ownership of Certain Beneficial Owners and Management III-3\nItem 13 Certain Relationships and Related Transactions III-3\nPART IV\nItem 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K IV-1\nSIGNATURES IV-2\nINDEX TO EXHIBITS IV-3\nFINANCIAL STATEMENTS AND SUPPLEMENTARY DATA to\nPART I\nItem 1. Business\nPaine Webber Qualified Plan Property Fund Two, LP (the \"Partnership\") is a limited partnership formed in March 1982 under the Uniform Limited Partnership Act of the State of Delaware for the purpose of investing in a diversified portfolio of existing income-producing real properties through land purchase- leaseback transactions and first mortgage loans. From the sale of Limited Partnership units (the \"Units\"), the Partnership raised $36,236,000 (36,236 Units at $1,000 per Unit) from July 1, 1982 to June 30, 1983 pursuant to a Registration Statement filed on Form S-11 under the Securities Act of 1933 (Registration No. 2-76379). In addition, the Initial Limited Partner contri- buted $5,000 for 5 Units of Limited Partnership Interest. Limited Partners will not be required to make any additional capital contributions.\nThe Partnership originally owned land and made first mortgage loans secured by buildings with respect to six operating properties. As discussed below, as of August 31, 1995 the Partnership's mortgage loan and land lease investments on two of the original properties were still outstanding, and the Partnership owns an equity interest in one operating property through a joint venture partnership which resulted from the settlement of a default under the terms of a first mortgage loan held by the Partnership. In addition, the Partnership foreclosed on one operating property under the terms of its first mortgage loan due to a payment default and now owns that property directly. The Partnership's operating property, properties securing its remaining loan investments and the property in which the Partnership has a joint venture interest are described below. Type of Property name Property and Type of and Location Date of Investment Size Ownership (1)\nMercantile Tower (2) Office Building Building has Fee ownership of Kansas City, MO 4\/29\/83 213,500 rentable land and sq. ft.; 32,000 improvements sq. ft. of land\nMarshall's at East Lake (3) Shopping Center Building has Fee ownership of Marietta, GA 6\/24\/83 55,175 net land and leasable sq. ft.; improvements 6.7 acres (through joint of land venture)\nEden West Apartments Apartments 215 units; Fee ownership of Omaha, NE 6\/6\/84 10.2 acres land and first of land mortgage lien on improvements\nThe Timbers Apartments Apartments 176 units; 18 acres Fee ownership Raleigh, NC 9\/7\/84 of land of land and first mortgage lien on improvements\n(1)See Notes to the Financial Statements filed with this Annual Report for a description of the transactions through which the Partnership has acquired these real estate investments.\n(2)On April 12, 1993, the Partnership was granted title to the Mercantile Tower property and assumed ownership as a result of certain defaults by the borrower under the terms of the Partnership's mortgage loan receivable. The Partnership is currently operating the property utilizing the services of a local property management company. See Note 6 to the financial statements accompanying this Annual Report for a further discussion of this event.\n(3)During the year ended August 31, 1990 the borrower of the mortgage loan secured by the Marshall's at East Lake Shopping Center failed to make its required monthly payments of interest in accordance with the terms of the mortgage loan. On June 12, 1990 the borrower filed for protection under a Chapter 11 Bankruptcy Petition. During fiscal 1991, the Partnership reached a settlement agreement which involved the formation of a joint venture between the Partnership and the borrower to own and operate the property on a go-forward basis. The formation of the joint venture was approved by the Bankruptcy Court and became effective on December 11, 1991. See Note 5 to the financial statements accompanying this Annual Report for a further discussion of these events.\nTo date, the Partnership has been prepaid on its investments with respect to two of the original operating properties, including one during fiscal 1995. On April 1, 1994, the Partnership liquidated its investments in a Howard Johnson's Motor Lodge, located in Orlando, Florida. The total net proceeds received by the Partnership amounted to approximately $5.9 million. In accordance with the third modification of the mortgage loan agreement, such proceeds included the payment of $292,000 of deferred debt service and ground rent. The remaining proceeds of approximately $5,608,000 were less than the combined carrying value of the mortgage loan and land investments of $6,150,000, resulting in a loss of approximately $542,000 which was charged against an outstanding general loan loss reserve. On August 25, 1995, the borrower of the loan secured by Harbour Bay Plaza, a retail shopping center located in Sewall's Point, Florida, repaid the Partnership's first leasehold mortgage and purchased the underlying land for total consideration of $3,833,000. The principal balance of the mortgage loan was $2,850,000 plus interest accrued through August 25, 1995 of $23,000. The original cost of the land to the Partnership was $750,000. Pursuant to the ground lease, the Partnership received $211,000 in excess of the outstanding mortgage loan and land investments as its share of the appreciation in value of the operating investment property above a specified base amount.\nThe Partnership's investment objectives are to:\n(1)preserve and protect Limited Partners' capital and related buying power; (2)provide the Limited Partners with cash distributions from investment income; and (3)achieve long-term capital appreciation in the value of the Partnership's investments.\nThrough August 31, 1995, the Limited Partners had received cumulative cash distributions totalling $36,875,000, or $1,046 per original $1,000 investment for the Partnership's earliest investors. This return includes a distribution of $155 per original $1,000 investment in May 1994 from the liquidation of the Howard Johnson's mortgage loan and land investments. Such distributions do not include the net proceeds of the Harbour Bay Plaza prepayment transaction, which were paid out to the Limited Partners subsequent to year-end. On October 13, 1995, the Partnership made a special distribution of the Harbour Bay Plaza net proceeds in the amount of $106 per original $1,000 investment. As of August 31, 1995, the Partnership retained an interest in four of the original six properties underlying its original mortgage loan and land investments. The Partnership's success in meeting its capital appreciation objective will depend upon the proceeds received from the final liquidation of its investments. The amount of such proceeds will ultimately depend upon the value of the underlying investment properties at the time of their final liquidation, which cannot presently be determined. At the present time, real estate values for commercial office buildings remain generally depressed nationwide due to an oversupply of competing space in many markets and the trend of corporate consolidations and downsizing which has followed in the wake of the last national recession. In addition, values for retail shopping centers in certain markets have begun to be affected by the effects of overbuilding and consolidations among retailers which have resulted in an oversupply of space. Management believes that such conditions are temporary and will change as certain market corrections occur.\nThe Partnership expects to finance or sell its investments and have its mortgage loans repaid from time to time. It is expected that most sales and repayments will be made after a period of between seven and fifteen years after the conclusion of the offering period, although sales and repayments may occur at earlier or later dates. Due to the combination of relatively low mortgage interest rates and increased availability of funds for sales and mortgage refinancings which has existed over the past two years, the likelihood of the Partnership's loans being prepaid has increased. In addition to the Harbour Bay Plaza transaction, which closed at the end of the fourth quarter of fiscal 1995, the Partnership has been approached by another borrower regarding a potential prepayment transaction. See Item 7 for a further discussion. In deciding whether to sell any of the Partnership's investments, the Managing General Partner will consider such factors as the amount of appreciation in value, if any, to be realized, the risks of continued investment and the anticipated advantages to be gained from continuing to hold the investment. The proceeds from such sales, financings or refinancings of the investments will not be reinvested but will be distributed to the Partners, so that the Partnership will in effect be self-liquidating.\nThe Partnership's operating property, along with the property in which the Partnership owns an equity interest and the properties securing the Partnership's mortgage loan investments, are located in real estate markets in which they face significant competition for the revenues they generate. The apartment complexes compete with numerous projects of similar type generally on the basis of price, location and amenities. Apartment properties in all markets also compete with the local single family home market for prospective tenants. The availability of low home mortgage interest rates over the past three years has generally caused this competition to increase in all areas of the country. The shopping center and the office building also compete for long-term commercial tenants with numerous projects of similar type generally on the basis of rental rates, location and tenant improvement allowances. The Partnership has no real estate investments located outside the United States. The Partnership is engaged solely in the business of real estate investment. Therefore, a presentation of information about industry segments is not applicable.\nThe Partnership has no employees; it has, however, entered into an Advisory Contract with PaineWebber Properties Incorporated (the \"Adviser\"), which is responsible for the day-to-day operations of the Partnership. The Adviser is a wholly-owned subsidiary of PaineWebber Incorporated (\"PWI\"), a wholly-owned subsidiary of PaineWebber Group Inc. (\"PaineWebber\").\nThe general partners of the Partnership (the \"General Partners\") are Second Qualified Properties, Inc. and Properties Associates. Second Qualified Properties, Inc., a wholly-owned subsidiary of PaineWebber, is the Managing General Partner of the Partnership. The Associate General Partner is Properties Associates, a Massachusetts general partnership, certain general partners of which are also officers of the Adviser and the Managing General Partner. Subject to the Managing General Partner's overall authority, the business of the Partnership is managed by the Adviser.\nThe terms of transactions between the Partnership and affiliates of the Managing General Partner of the Partnership are set forth in Items 11 and 13 below to which reference is hereby made for a description of such terms and transactions.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nAs of August 31, 1995, the Partnership owns, and has leased back to the sellers, the land related to the two investments referred to under Item 1 above to which reference is made for the name, location and description of each property. Additionally, the Partnership owns one operating property directly and owns an equity interest in another operating property through a joint venture partnership as noted in Item 1.\nOccupancy figures for each fiscal quarter during 1995, along with an average for the year, are presented below for each property:\nPercent Leased At\nFiscal 1995 11\/30\/94 2\/28\/95 5\/31\/95 8\/31\/95 Average\nMercantile Tower 59% 63% 67% 67% 64%\nMarshall's at East Lake 89% 92% 89% 97% 92%\nEden West Apartments 98% 98% 99% 99% 99%\nThe Timbers Apartments 96% 96% 97% 92% 95%\nItem 3.","section_3":"Item 3. Legal Proceedings\nIn November 1994, a series of purported class actions (the ``New York Limited Partnership Actions') were filed in the United States District Court for the Southern District of New York concerning PaineWebber Incorporated's sale and sponsorship of various limited partnership investments, including those offered by the Partnership. The lawsuits were brought against PaineWebber Incorporated and Paine Webber Group Inc. (together `PaineWebber''), among others, by allegedly dissatisfied partnership investors. In March 1995, after the actions were consolidated under the title In re PaineWebber Limited Partnership Litigation, the plaintiffs amended their complaint to assert claims against a variety of other defendants, including Second Qualified Property Fund, Inc. and Properties Associates (\"PA\"), which are the General Partners of the Partnership and affiliates of PaineWebber. On May 30, 1995, the court certified class action treatment of the claims asserted in the litigation.\nThe amended complaint in the New York Limited Partnership Actions alleges that, in connection with the sale of interests in Paine Webber Qualified Plan Property Fund Two, LP., PaineWebber, Second Qualified Property Fund, Inc. and PA (1) failed to provide adequate disclosure of the risks involved; (2) made false and misleading representations about the safety of the investments and the Partnership's anticipated performance; and (3) marketed the Partnership to investors for whom such investments were not suitable. The plaintiffs, who purport to be suing on behalf of all persons who invested in Paine Webber Qualified Plan Property Fund Two, LP, also allege that following the sale of the partnership interests, PaineWebber, Second Qualified Properties, Inc. and PA misrepresented financial information about the Partnership's value and performance. The amended complaint alleges that PaineWebber, Second Qualified Properties, Inc. and PA violated the Racketeer Influenced and Corrupt Organizations Act (`RICO'') and the federal securities laws. The plaintiffs seek unspecified damages, including reimbursement for all sums invested by them in the partnerships, as well as disgorgement of all fees and other income derived by PaineWebber from the limited partnerships. In addition, the plaintiffs also seek treble damages under RICO. The defendants' time to move against or answer the complaint has not yet expired.\nPursuant to provisions of the Partnership Agreement and other contractual obligations, under certain circumstances the Partnership may be required to indemnify Second Qualified Properties, Inc., PA and their affiliates for costs and liabilities in connection with this litigation. The General Partners intend to vigorously contest the allegations of the action, and believe that the action will be resolved without material adverse effect on the Partnership's financial statements, taken as a whole.\nThe Partnership is not subject to any other material pending legal proceedings.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNone. PART II\nItem 5.","section_5":"Item 5. Market for the Partnership's Limited Partnership Interests and Related Security Holder Matters\nAt August 31, 1995, there were 5,609 record holders of Units in the Partnership. There is no public market for the resale of Units, and it is not anticipated that a public market for Units will develop. The Managing General Partner will not redeem or repurchase Units.\nItem 6.","section_6":"Item 6. Selected Financial Data\nPAINEWEBBER QUALIFIED PLAN PROPERTY FUND TWO, LP For the years ended August 31, 1995, 1994, 1993, 1992 and 1991 (in thousands, except per Unit data)\n1995 1994 1993 1992 1991\nRevenues $ 1,747 $ 2,237 $ 2,588 $ 3,427 $ 3,671\nOperating income $ 1,029 $ 1,414 $ 1,395 $ 2,073 $ 2,678\nPartnership's share of venture's income $ 143 $ 168 $ 201 $ 149 -\nGain on sale of land $ 211 - - - -\nLoss on foreclosure - - $ (1,000) - -\nProvision for possible investment loss - $ (1,200) - - - Income (loss) from operations of investment property held for sale $ (738) $ (766) $ 163 - -\nNet income (loss) $ 645 $ (384) $ 759 $ 2,221 $ 2,678\nPer Limited Partnership Unit: Net income (loss) $ 17.60 $ (10.49)$ 20.72 $ 60.68 $ 73.16\nCash distributions from operations $ 19.86 $ 20.25 $ 57.50 $ 70.00 $ 72.50\nCash distributions from sale, refinancing and other disposition transactions - $155.00 - - -\nTotal assets $ 25,506 $ 25,010 $ 31,091 $32,112 $32,445\nThe above selected financial data should be read in conjunction with the financial statements and related notes appearing elsewhere in this Annual Report.\nThe above per Limited Partnership Unit information is based upon the 36,241 Limited Partnership Units outstanding during each year.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Result of Operations\nLIQUIDITY AND CAPITAL RESOURCES\nThe Partnership offered Limited Partnership Interests to the public from July 1982 to June 1983 pursuant to a Registration Statement filed under the Securities Act of 1933. Gross proceeds of $36,241,000 were received by the Partnership and, after deducting selling expenses and offering costs, $32,575,000 was invested in six operating property investments in the form of mortgage loans and land purchase-leaseback transactions. During fiscal 1994, the Partnership was prepaid with respect to the land and mortgage loan investments secured by the Howard Johnson's Motor Lodge. Due to the poor performance of the Howard Johnson's property and its depressed market value at the time of the prepayment, the Partnership recovered less than the full amount of its investments in the land and mortgage loan by approximately $542,000. In addition, as discussed further below, during fiscal 1995 the Partnership accepted repayment in full on the land and mortgage loan investments secured by the Harbour Bay Plaza Shopping Center and received a premium of $211,000. During fiscal 1993, the Partnership assumed 100% equity ownership of the Mercantile Tower Office Building through a deed-in-lieu of foreclosure transaction resulting from uncured monetary defaults under the terms of the Partnership's mortgage loan and ground lease. Also, during fiscal 1992 the Partnership's mortgage loan and land investments with respect to the Marshall's at East Lake Shopping Center were converted to an equity interest in the operating property as a result of the settlement of a default under the terms of the related loan agreement.\nThe mortgage loans secured by the Eden West Apartments and The Timbers Apartments bear interest at annual rates of 11.5% and 11.75%, respectively. The loan secured by the Harbour Bay Plaza Shopping Center bore interest at 11.75%. As previously reported, since current market interest rates for first mortgage loans are considerably lower than these rates, and with the increased availability of credit in the capital markets for real estate transactions, the likelihood of the Partnership's mortgage loan investments being prepaid has been high for those mortgage loans which have terms that allow for prepayment. The Harbour Bay Plaza loan became fully prepayable without penalty in January 1994. The Eden West loan prohibited prepayment through June 1, 1994 and includes a prepayment premium for any prepayment between June 1994 and May 1998 at rates between 5% and 1.25% of the mortgage loan balance. The Timbers loan contains a prohibition against prepayment until September 1, 1997. As discussed further below, during fiscal 1995 the borrowers on both the Harbour Bay Plaza and Eden West loan investments approached the Partnership regarding potential prepayment transactions. On August 24, 1995, the owner of Harbour Bay Plaza repaid the Partnership's mortgage loan and purchased the underlying land. The total net proceeds received by the Partnership amounted to approximately $3.8 million. The Partnership's mortgage loan and land investments had an aggregate cost basis of $3.6 million. Pursuant to the ground lease, the Partnership received $211,000 in excess of the outstanding mortgage loan and land investments as its share of the appreciation in value of the operating investment property above a specified amount. The net proceeds from this transaction, in the amount of $106 per original $1,000 unit, were distributed to the Limited Partners subsequent to year-end, on October 13, 1995. During the last quarter of fiscal 1995, the Partnership received notice from the Eden West borrower of its intent to prepay the Partnership's mortgage loan and repurchase the underlying land. The amount to be received by the Partnership as its share of the appreciation of the Eden West property has not been agreed upon to date. The terms of the Partnership's ground lease provide for the possible resolution of disputes between the parties over value issues through an arbitration process. Presently, the Partnership and the borrower continue to try to resolve their differences regarding the value of the property. If an agreement cannot be reached, the borrower could force the Partnership to submit to arbitration during fiscal 1996. In addition to the amount to be determined as the Partnership's share of the property's appreciation under the ground lease, the terms of the Eden West mortgage loan require a prepayment penalty which would be equal to 3.75% of the outstanding principal balance of $3,500,000. If completed, the proceeds of this transaction would be distributed to the Limited Partners. However, the transaction remains contingent on, among other things, a resolution of the value issue and the borrower obtaining sufficient financing to repay its obligations to the Partnership. Accordingly, there are no assurances that this transaction will be consummated.\nOccupancy at the Marshall's at East Lake Shopping Center as of August 31, 1995 was 97%, up from its level of 89% as of August 31, 1994. The Partnership received cash flow distributions from the Marshall's joint venture of approximately $198,000 for the year ended August 31, 1995. Cash flow from the venture for fiscal 1996 is projected to increase to $272,000 as a result of the successful leasing activity during fiscal 1995. There currently is only one 1,600 square foot space available at the shopping center. The leasing of the one remaining vacant space would bring the center to 100% occupancy for the first time in several years with the next lease expirations not scheduled until the spring of 1996. As previously reported, Marshall's, the center's anchor tenant, opened another store in 1994 at a new competitive center approximately four miles from the Marshall's at East Lake Shopping Center. Marshall's sales at East Lake have been relatively strong and their management has confirmed that they plan to keep the East Lake store open through at least 1997. However, there can be no assurances that such plans are not subject to change. The initial term of the Marshall's lease at East Lake runs through January 31, 2003. Notwithstanding their obligation under the lease agreement, the loss of the center's only anchor tenant could have serious adverse effects on management's ability to retain its other tenants and to lease vacant space. Management continues to monitor this situation closely. Management is also monitoring the operating performance of a 3,000 square foot tenant which has indicated that unless it experiences strong holiday sales it may be unable to continue its operations beyond the scheduled expiration of its lease agreement in May 1996.\nThe occupancy level at the wholly-owned Mercantile Tower Office Building had increased to 67% at August 31, 1995, up from 59% as of August 31, 1994. However, the pace of the lease-up has been below management's expectations. Furthermore, subsequent to year-end the occupancy level has declined to 62% with the loss of several small tenants. With significant vacancy remaining in the downtown Kansas City office market, management is finding it difficult to obtain economically viable lease terms from the limited number of tenants which are looking to lease space in this market. During fiscal 1994, the Partnership closed on a $2 million line of credit which was to be used to pay for the majority of the required tenant improvement and capital enhancement costs expected to be incurred to achieve a stabilized occupancy level. This nonrecourse, fully amortizable line of credit is payable with interest at 1% over prime, and has a 7-year term with interest-only payments in the first year. Monthly payments due under the borrowing agreement began to include scheduled principal amortization effective in March 1995. The line of credit borrowings are collateralized by a first lien against the Mercantile Tower property, which includes an adjoining parking facility. The draw period has a 2-year term which ends in March 1996, and draw downs under the line of credit can only be made in connection with costs associated with signed leases and contracts for capital improvements. As of August 31, 1995, the Partnership had drawn approximately $1,415,000 under the line of credit. With leasing activity at a standstill as of the fourth quarter of fiscal 1995, it now appears likely that the Partnership will not draw down the entire $2,000,000 balance of the line of credit before the expiration of the draw period. In order to achieve its leasing goals, management may need to request an extension of the draw period. However, there are no assurances that the lender would agree to such a request or that the Partnership will be able to successfully secure leases with new tenants which would be necessary to achieve such goals. Stabilizing the Mercantile Tower property remains the primary goal of management, which is presently analyzing alternative operating strategies in light of the current market conditions. Until a stabilized occupancy level is achieved, the Partnership's investment in Mercantile Tower is not expected to generate any significant excess cash flow.\nAt August 31, 1995, the Partnership had available cash and cash equivalents of $5,379,000. Such balance includes the proceeds received in August 1995 from the prepayment of the Harbour Bay Plaza loan and the sale of the underlying land. Such proceeds, in the aggregate amount of $3.8 million, were paid out to the Limited Partners subsequent to year-end, on October 13, 1995. The remaining balance of cash and cash equivalents will be used for the Partnership's working capital requirements and for distributions to the partners. The source of future liquidity and distributions to the partners is expected to be through cash generated from the operations of the Partnership's real estate and mortgage loan investments, repayment of the Partnership's mortgage loans receivable and the proceeds from the sales or refinancings of the underlying land, the operating investment property and the joint venture investment property. The Partnership began implementing small increases in the quarterly distribution rate to the Limited Partners commencing with the payment made in October 1994 for the quarter ended August 31, 1994. The distribution rate was increased to 2.5% per annum on remaining invested capital during the third quarter of fiscal 1995. The distribution rate is expected to stabilize at 2.5% pending the completion of the Eden West prepayment transaction discussed further above. In the event that this potential prepayment transaction is completed and the net proceeds are returned to the Limited Partners, the Partnership's quarterly distribution rate on remaining invested capital may have to be adjusted downward to reflect the reduction in cash flows which would result from such a transaction.\nRESULTS OF OPERATIONS1995 Compared to 1994\nFor the year ended August 31, 1995, the Partnership reported net income of $645,000 as compared to a net loss of $384,000 recognized in fiscal 1994. This change in the Partnership's net operating results was primarily due to a provision for possible investment loss of $1,200,000 recognized in fiscal 1994 due to a decline in management's estimate of the fair value of the Mercantile Tower property. The gain of $211,000 recognized in fiscal 1995 on the sale of the Harbour Bay Plaza land offset a decline of $214,000 in mortgage interest income and land rent compared to fiscal 1994. The fiscal 1994 revenues include income from the Howard Johnson's investments through April 1, 1994, the date of the sale. A decline in the provision for possible uncollectible amounts of $135,000 also contributed to the favorable change in the Partnership's net operating results for fiscal 1995. In both years, the provision reflects the accrued but unpaid interest due under the modified terms of The Timbers mortgage loan. In fiscal 1995, the Partnership collected an additional $178,000 from the owner of The Timbers which was offset against the current year provision. A recovery of bad debt of $292,000 recorded in fiscal 1994 partly offset the favorable changes in net operating results. This recovery related to the Howard Johnson's prepayment transaction, in which the Partnership recovered an amount of previously reserved mortgage interest and land rent receivable.\nA decline of $28,000 in the net loss recognized from the operations of the wholly-owned Mercantile Tower property offset a decline of $25,000 in the net income from the Marshall's at East Lake joint venture in fiscal 1995. Revenues from Mercantile Tower were higher for the twelve months ended August 31, 1995 as a result of the occupancy gains achieved over the past year. The net operating results of the Mercantile Tower Office Building in fiscal 1995 and 1994 include the costs of the improvements and leasing costs incurred at the property. As a result of the Partnership's accounting policy with regard to its investment properties held for sale, all costs associated with holding the asset are expensed as incurred. The Partnership's share of venture's income decreased in fiscal 1995 due to lower rental revenues at the Marshall's at East Lake Shopping Center as a result of a decline in effective rental rates over the past two fiscal years as well as a decrease in cost recoveries.\n1994 Compared to 1993\nFor the year ended August 31, 1994, the Partnership reported a net loss of $384,000 as compared to net income of $759,000 recognized in fiscal 1993. This unfavorable change in the Partnership's net operating results was primarily due to a decline in mortgage interest income and land rent, along with an increase in property operating expenses at the Mercantile Tower property which is reflected in the income (loss) from investment property held for sale. The decrease in mortgage interest income and land rent resulted primarily from the foreclosure of the Mercantile Tower Office Building on April 12, 1993. This resulted in a combined reduction in interest income and land rent of $426,000 for the year ended August 31, 1994. Also contributing to the decrease in mortgage interest and ground rent was the sale of the Howard Johnson's Motor Lodge effective April 1, 1994. The Partnership recorded only seven months of mortgage interest and ground rent in fiscal 1994, as compared to twelve months in fiscal 1993. The net operating results of the Mercantile Tower Office Building in fiscal 1994 included the costs of the improvements implemented by the management company prior to obtaining the line of credit referred to above, as well as certain leasing costs incurred in the fourth quarter subsequent to obtaining the credit line. As a result of the Partnership's accounting policy with regard to its investment properties acquired through foreclosures, all costs associated with holding the asset are expensed as incurred. The Partnership also recognized a provision for possible investment loss of $1,200,000 in fiscal 1994 due to a decline in management's estimate of the fair value of the Mercantile Tower property. Such provision exceeded the $1 million loss recorded in fiscal 1993 to write down the carrying value of the property as of the date of foreclosure. In addition, the Partnership's share of venture's income decreased by $32,000 in fiscal 1994 due to a decline in rental revenues at Marshall's at East Lake as a result of the decline in occupancy and effective rental rates.\nThe unfavorable changes in the Partnership's operations were partially offset by the receipt of accrued interest owed on the Howard Johnson's mortgage loan in the amount of approximately $292,000 at the time of the repayment in fiscal 1994. The accrued interest had been fully reserved for in fiscal 1993, accordingly, was recorded as a recovery of bad debt in fiscal 1994. Furthermore, the provision for possible uncollectible amounts decreased by approximately $253,000 in fiscal 1994 due to the foreclosure of the Mercantile Tower Office Building and the sale of the Howard Johnson's Motor Lodge. During fiscal 1993, the Partnership was reflecting interest income and a corresponding reserve due to the default status of the mortgage loans secured by these investments. Also offsetting the adverse change in net operating results were declines in management fees and general and administrative expenses during fiscal 1994. General and administrative expenses decreased by approximately $59,000 mainly due to a decline in legal fees. Legal fees were higher in fiscal 1993 due to costs incurred in connection with the borrower defaults on the Mercantile Tower and Howard Johnson's investments.\n1993 Compared to 1992\nThe Partnership's net income decreased by $1,463,000 for the year ended August 31, 1993 in comparison to fiscal 1992 mainly because the Partnership recorded a loss on foreclosure of the Mercantile Tower Office Building of $1,000,000 and experienced a decline in mortgage interest income and land rent in fiscal 1993. The loss on foreclosure represented an adjustment to reduce the carrying value of the investment in the Mercantile Tower property to management's estimate of its fair value, net of selling expenses, at the time of foreclosure. The combined balance of the Partnership's mortgage loan and land investments in Mercantile Tower was $10,500,000 prior to foreclosure. Based on an independent appraisal of the property, management estimated that the property's fair value, net of selling expenses, was $9,500,000. The decrease in mortgage interest income and land rent resulted primarily from the foreclosure of the Mercantile Tower Office Building on April 12, 1993, as discussed above. This resulted in a combined reduction in interest income and land rent of $829,000. Also, contributing to the decrease was the third modification agreement of the Howard Johnson's mortgage loan effective in May of 1993. The agreement reduced the effective interest rate on the note from 8.955% per annum to 5.91% per annum and resulted in a decrease in interest income of $51,000. Also contributing to the decline in net income was an increase in general and administrative expenses primarily due to legal fees incurred in fiscal 1993 associated with the defaults by the borrowers of the Mercantile Tower and Howard Johnson's mortgage loans.\nThe effect of these items on net income in the year ended August 31, 1993 was partially offset by the income recorded from the Mercantile Tower building after foreclosure of $163,000. Also, the provision for possible uncollectible amounts decreased by $215,000 in fiscal 1993 mainly because the Partnership stopped accruing interest on the Mercantile Tower mortgage loan once its was deemed likely that the default would not be cured. Also partially offsetting the decrease in net income during fiscal 1993 was a decline of $55,000 in management fees. The decline in the management fees resulted from the reduction in the Partnership's annual distribution rate, upon which such fees are based.\nInflation\nThe Partnership completed its thirteenth full year of operations in 1995, and the effects of inflation and changes in prices on revenues and expenses to date have not been significant. The impact of inflation in future periods may be offset, in part, by an increase in revenues because the Partnership's land leases provide for additional rent based upon increases in the revenues of the related operating properties which would be expected to rise with inflation. Revenues from the Mercantile Tower Office Building and Marshall's at East Lake Shopping Center would also be expected to rise with inflation due to the tenant leases which contain rental escalation and\/or expense reimbursement clauses based on increases in tenant sales and property operating expenses. Such increases in revenues would be expected to at least partially offset the increases in Partnership and property operating expenses resulting from inflation. As noted above, the wholly-owned Mercantile Tower Office Building currently has a significant amount of unleased space. During a period of significant inflation, increased operating expenses attributable to space which remained unleased at such time would not be recoverable and would adversely affect the Partnership's net cash flow.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe financial statements and supplementary data are included under Item 14 of this Annual Report.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone. PART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Partnership\nThe Managing General Partner of the Partnership is Second Qualified Properties, Inc., a Delaware corporation, which is a wholly-owned subsidiary of PaineWebber. The Associate General Partner of the Partnership is Properties Associates, a Massachusetts general partnership, certain general partners of which are also officers of the Adviser and the Managing General Partner. The Managing General Partner has overall authority and responsibility for the Partnership's operations, however, the day-to-day business of the Partnership is managed by the Adviser pursuant to an advisory contract.\n(a) and (b) The names and ages of the directors and executive officers of the Managing General Partner of the Partnership are as follows:\nDate elected Name Office Age to Office\nLawrence A. Cohen President and Chief Executive Officer 42 1\/30\/89 Albert Pratt Director 84 2\/2\/82 * J. Richard Sipes Director 48 6\/9\/94 Walter V. Arnold Senior Vice President and Chief Financial Officer 48 10\/29\/85 James A. Snyder Senior Vice President 50 7\/6\/92 John B. Watts III Senior Vice President 42 6\/6\/88 David F. Brooks First Vice President and Assistant Treasurer 53 2\/2\/82 * Timothy J. Medlock Vice President and Treasurer 34 6\/1\/88 Thomas W. Boland Vice President 33 12\/1\/91 Dorothy F. Haughey Secretary 69 2\/2\/82 **\nThe date of incorporation of the Managing General Partner.\n(c) There are no other significant employees in addition to the directors and executive officers mentioned above.\n(d) There is no family relationship among any of the foregoing directors and executive officers of the Managing General Partner of the Partnership. All of the foregoing directors and executive officers have been elected to serve until the annual meeting of the Managing General Partner.\n(e) All of the directors and officers of the Managing General Partner hold similar positions in affiliates of the Managing General Partner, which are the corporate general partners of other real estate limited partnerships sponsored by PWI, and for which Paine Webber Properties Incorporated serves as the Adviser. The business experience of each of the directors and executive officers of the Managing General Partner is as follows:\nLawrence A. Cohen is President and Chief Executive Officer of the Managing General Partner and President and Chief Executive Officer of the Adviser which he joined in January 1989. He is a also member of the Board of Directors and the Investment Committee of the Adviser. From 1984 to 1988, Mr. Cohen was First Vice President of VMS Realty Partners where he was responsible for origination and structuring of real estate investment programs and for managing national broker-dealer relationships. He is a member of the New York Bar and is a Certified Public Accountant.\nAlbert Pratt is a Director of the Managing General Partner, a Consultant of PWI and a General Partner of the Associate General Partner. Mr. Pratt joined PWI as Counsel in 1946 and since that time has held a number of positions including Director of both the Investment Banking Division and the International Division, Senior Vice President and Vice Chairman of PWI and Chairman of PaineWebber International, Inc.\nJ. Richard Sipes is a Director of the Managing General Partner and a Director of the Adviser. Mr. Sipes is an Executive Vice President at PaineWebber. He joined the firm in 1978 and has served in various capacities within the Retail Sales and Marketing Division. Before assuming his current position as Director of Retail Underwriting and Trading in 1990, he was a Branch Manager, Regional Manager, Branch System and Marketing Manager for a PaineWebber subsidiary, Manager of Branch Administration and Director of Retail Products and Trading. Mr. Sipes holds a B.S. in Psychology from Memphis State University.\nWalter V. Arnold is a Senior Vice President and Chief Financial Officer of the Managing General Partner and a Senior Vice President and Chief Financial Officer of the Adviser which he joined in October 1985. Mr. Arnold joined PWI in 1983 with the acquisition of Rotan Mosle, Inc. where he had been First Vice President and Controller since 1978, and where he continued until joining the Adviser. Mr. Arnold is a Certified Public Accountant licensed in the state of Texas.\nJames A. Snyder is a Senior Vice President of the Managing General Partner and a Senior Vice President and Member of the Investment Committee of the Adviser. Mr. Snyder re-joined the Adviser in July 1992 having served previously as an officer of PWPI from July 1980 to August 1987. From January 1991 to July 1992, Mr. Snyder was with the Resolution Trust Corporation where he served as the Vice President of Asset Sales prior to re-joining PWPI. From February 1989 to October 1990, he was President of Kan Am Investors, Inc., a real estate investment company. During the period August 1987 to February 1989, Mr. Snyder was Executive Vice President and Chief Financial Officer of Southeast Regional Management Inc., a real estate development company.\nJohn B. Watts III is a Senior Vice President of the Managing General Partner and a Senior Vice President of the Adviser which he joined in June 1988. Mr. Watts has had over 16 years of experience in acquisitions, dispositions and finance of real estate. He received degrees of Bachelor of Architecture, Bachelor of Arts and Master of Business Administration from the University of Arkansas.\nDavid F. Brooks is a First Vice President and Assistant Treasurer of the Managing General Partner and a First Vice President and an Assistant Treasurer of the Adviser. Mr. Brooks joined the Adviser in March 1980. From 1972 to 1980, Mr. Brooks was an Assistant Treasurer of Property Capital Advisors, Inc. and also, from March 1974 to February 1980, the Assistant Treasurer of Capital for Real Estate, which provided real estate investment, asset management and consulting services.\nTimothy J. Medlock is a Vice President and Treasurer of the Managing General Partner and a Vice President and Treasurer of the Adviser which he joined in 1986. From June 1988 to August 1989, Mr. Medlock served as the Controller of the Managing General Partner and the Adviser. From 1983 to 1986, Mr. Medlock was associated with Deloitte Haskins & Sells. Mr. Medlock graduated from Colgate University in 1983 and received his Masters in Accounting from New York University in 1985.\nThomas W. Boland is a Vice President of the Managing General Partner and a Vice President and Manager of Financial Reporting of the Adviser which he joined in 1988. From 1984 to 1987, Mr. Boland was associated with Arthur Young & Company. Mr. Boland is a Certified Public Accountant licensed in the state of Massachusetts. He holds a B.S. in Accounting from Merrimack College and an M.B.A. from Boston University.\nDorothy F. Haughey is Secretary of the Managing General Partner, Assistant Secretary of PaineWebber and Secretary of PWI. Ms. Haughey joined PaineWebber in 1962.\n(f) None of the directors and officers was involved in legal proceedings which are material to an evaluation of his or her ability or integrity as a director or officer.\n(g) Compliance With Exchange Act Filing Requirements: The Securities Exchange Act of 1934 requires the officers and directors of the Managing General Partner, and persons who own more than ten percent of the Partnership's limited partnership units, to file certain reports of ownership and changes in ownership with the Securities and Exchange Commission. Officers, directors and ten-percent beneficial holders are required by SEC regulations to furnish the Partnership with copies of all Section 16(a) forms they file.\nBased solely on its review of the copies of such forms received by it, the Partnership believes that, during the year ended August 31, 1995 all filing requirements applicable to the officers and directors of the Managing General Partner and ten-percent beneficial holders were complied with.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe directors and officers of the Partnership's Managing General Partner receive no current or proposed renumeration from the Partnership.\nThe Partnership is required to pay certain fees to the Adviser and the General Partners are entitled to receive a share of Partnership cash distributions and a share of profits and losses. These items are described in Item 13.\nThe Partnership has paid cash distributions to the Unitholders on a quarterly basis at rates ranging from 8.5% to approximately 2% per annum on remaining invested capital over the past five years. However, the Partnership's Units of Limited Partnership Interest are not actively traded on any organized exchange, and no efficient secondary market exists. Accordingly, no accurate price information is available for these Units. Therefore, a presentation of historical Unitholder total returns would not be meaningful.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\n(a) The Partnership is a limited partnership issuing Units of Limited Partnership Interest, not voting securities. All the outstanding stock of the Managing General Partner, Second Qualified Properties, Inc., is owned by PaineWebber. Properties Associates, the Associate General Partner, is a Massachusetts general partnership, general partners of which are also officers of the Adviser and the Managing General Partner. Properties Associates is the Initial Limited Partner of the Partnership and owns 5 Units of Limited Partnership Interest in the Partnership. No Limited Partner is known by the Partnership to own beneficially more than 5% of the outstanding interests of the Partnership.\n(b) Neither the directors and officers of the Managing General Partner nor the general partners of the Associate General Partner, individually own any Units of limited partnership interest of the Partnership. No director or officer of the Managing General Partner nor the general partner of the Associate General Partner possesses a right to acquire beneficial ownership of Units of Limited Partnership Interest of the Partnership.\n(c) There exists no arrangement, known to the Partnership, the operation of which may at a subsequent date result in a change in control of the Partnership.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThe Managing General Partner of the Partnership is Second Qualified Properties, Inc., a wholly-owned subsidiary of PaineWebber Group Inc. (\"PaineWebber\"). The Associate General Partner is Properties Associates, a Massachusetts general partnership, certain general partners of which are also officers of the Managing General Partner and PaineWebber Properties Incorporated. Subject to the Managing General Partner's overall authority, the business of the Partnership is managed by PaineWebber Properties Incorporated (the \"Adviser\") pursuant to an advisory contract. The Adviser is a wholly-owned subsidiary of PaineWebber Incorporated (\"PWI\"), a wholly-owned subsidiary of PaineWebber.\nThe General Partners, the Adviser and PWI receive fees and compensation determined on an agreed-upon basis, in consideration of various services performed in connection with the sale of the Units, the management of the Partnership and the acquisition, management, financing and disposition of Partnership investments.\nIn connection with investing Partnership capital, the Adviser received acquisition fees paid by the borrowers and sellers aggregating approximately 3% of the gross proceeds of the offering. The Adviser may receive a real estate brokerage commission, in an amount not yet determinable, upon the disposition of certain Partnership investments.\nAll distributable cash, as defined, for each fiscal year will be distributed quarterly in the ratio of 99% to the Limited Partners and 1% to the General Partners. Residual proceeds resulting from disposition of Partnership investments will be distributed, generally, 85% to the Limited Partners and 15% to the General Partners, after the prior receipt by the Limited Partners of their original capital contributions and a cumulative annual return based upon a formula related to U.S. Treasury Bill interest rates, as defined in the Partnership Agreement.\nPursuant to the terms of the Partnership Agreement, any taxable income or tax loss of the Partnership will be allocated 99% to the Limited Partners and 1% to the General Partners. Allocations of the Partnership's net income or loss for financial accounting purposes have been made in conformity with the allocations of taxable income or loss. Taxable income or tax loss arising from disposition of Partnership investments will be allocated to the Limited and General Partners generally as residual proceeds are distributed.\nUnder the advisory contract, the Adviser has specific management responsibilities; to administer the day-to-day operations of the Partnership, and to report periodically the performance of the Partnership to the General Partners. The Adviser is paid a basic management fee (6% of adjusted cash flow) and an incentive management fee (3% of adjusted cash flow subordinated to a noncumulative annual return to the Limited Partners equal to 10% based upon their adjusted capital contribution) for services rendered. The Adviser earned basic management fees of $45,000 for the year ended August 31, 1995. No incentive management fees have been earned to date.\nAn affiliate of the Managing General Partner performs certain accounting, tax preparation, securities law compliance and investor communications and relations services for the Partnership. The total costs incurred by this affiliate in providing such services are allocated among several entities, including the Partnership. Included in general and administrative expenses for the year ended August 31, 1995 is $176,000 representing reimbursements to this affiliate for providing such services to the Partnership.\nThe Partnership uses the services of Mitchell Hutchins Institutional Investors, Inc. (`Mitchell Hutchins'') for the managing of cash assets. Mitchell Hutchins is a subsidiary of Mitchell Hutchins Asset Management, Inc., an independently operated subsidiary of PaineWebber. Mitchell Hutchins earned fees of $2,000 (included in general and administrative expenses) for managing the Partnership's cash assets during the year ended August 31, 1995. Fees charged by Mitchell Hutchins are based on a percentage of invested cash reserves which varies based on the total amount of invested cash which Mitchell Hutchins manages on behalf of PWPI.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\n(a) The following documents are filed as part of this report:\n(1) and (2) Financial Statements and Schedules:\nThe response to this portion of Item 14 is submitted as a separate section of this report. See Index to Financial Statements and Financial Statement Schedules at page.\nFinancial statements for the properties securing the Partnership's mortgage loans have not been included since the Partnership has no contractual right to the information and cannot otherwise practicably obtain the information.\n(3) Exhibits:\nThe exhibits listed on the accompanying index to exhibits at page IV-3 are filed as part of this Report.\n(b) In September 1995 a Form 8-K was filed by the registrant reporting the prepayment of the Harbour Bay Plaza loan and the purchase of the underlying land.\n(c) Exhibits\nSee (a)(3) above. (d) Financial Statement Schedules\nThe response to this portion of Item 14 is submitted as a separate section of this report. See Index to Financial Statements and Financial Statement Schedules at page.\nSIGNATURES Pursuant 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.\nPAINE WEBBER QUALIFIED PLAN PROPERTY FUND TWO, LP\nBy: Second Qualified Properties, Inc. Managing General Partner\nBy: \/s\/ Lawrence A. Cohen Lawrence A. Cohen President and Chief Executive Officer\nBy: \/s\/ Walter V. Arnold Walter V. Arnold Senior Vice President and Chief Financial Officer\nBy: \/s\/ Thomas W. Boland Thomas W. Boland Vice President\nDated: November 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 Partnership in the capacity and on the dates indicated.\nBy: \/s\/ Albert Pratt Date: November 27, 1995 Albert Pratt Director\nBy: \/s\/ J. Richard Sipes Date: November 27, 1995 J. Richard Sipes Director\nANNUAL REPORT ON FORM 10-K ITEM 14(A)(3)\nPAINE WEBBER QUALIFIED PLAN PROPERTY FUND TWO, LP\nINDEX TO EXHIBITS PAGE NUMBER IN THE REPORT EXHIBIT NO. DESCRIPTION OF DOCUMENT OR OTHER REFERENCE\n(3) and (4) Prospectus of the Registrant Filed with the Commission dated July 1, 1982, supplemented, pursuant to Rule 424(c) with particular reference to the and incorporated herein by Restated Certificate and Agreement reference. Limited Partnership.\n(10) Material contracts previously filed as Filed with the Commission exhibits to registration statements and pursuant to Section 13 or amendments thereto of the registrant 15(d) of the Securities together with all such contracts filed Exchange Act of 1934 and as exhibits of previously filed Forms incorporated 8-K and Forms 10-K are hereby herein by reference. incorporated herein by reference.\n(13) Annual Reports to Limited Partners No Annual Report for the year ended August 31, 1995 has been sent to the Limited Partners. An Annual Report will be sent to the Limited Partners subsequent to this filing.\nANNUAL REPORT ON FORM 10-K ITEM 14(A)(1) AND (2) AND 14(D)\nPAINE WEBBER QUALIFIED PLAN PROPERTY FUND TWO, LP\nINDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nReference\nPAINE WEBBER QUALIFIED PLAN PROPERTY FUND TWO, LP:\nReport of independent auditors\nReport of independent auditors relating to Marshall's at East Lake Partnership\nBalance sheets as of August 31, 1995 and 1994\nStatements of operations for the years ended August 31, 1995, 1994 and 1993\nStatements of changes in partners' capital (deficit) for the years ended August 31, 1995, 1994 and 1993\nStatements of cash flows for the years ended August 31, 1995, 1994 and 1993\nNotes to financial statements\nFinancial statement schedules:\nSchedule III - Real Estate Owned Schedule IV - Investments in Mortgage Loans on Real Estate\nOther schedules have been omitted since the required information is not present or not present in amounts sufficient to require submission of the schedule, or because the information required is included in the financial statements, including the notes thereto.\nREPORT OF INDEPENDENT AUDITORS\nThe Partners of Paine Webber Qualified Plan Property Fund Two, LP:\nWe have audited the accompanying balance sheets of Paine Webber Qualified Plan Property Fund Two, LP as of August 31, 1995 and 1994, and the related statements of operations, changes in partners' capital (deficit) and cash flows for each of the three years in the period ended August 31, 1995. 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. We did not audit the financial statements of Marshall's at East Lake Partnership (an unconsolidated venture). The Partnership's equity investment in Marshall's at East Lake Partnership totalled $3,198,000 and $3,253,000 as of August 31, 1995 and 1994, respectively, and the Partnership's share of the net income of Marshall's at East Lake Partnership totalled $143,000, $168,000 and $201,000 for the years ended August 31, 1995, 1994 and 1993, respectively. Those statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to data included for Marshall's at East Lake Partnership, 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 and the report of other auditors provide a reasonable basis for our opinion.\nIn our opinion, based on our audits and the report of other auditors, the financial statements referred to above present fairly, in all material respects, the financial position of Paine Webber Qualified Plan Property Fund Two, LP at August 31, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended August 31, 1995 in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.\n\/s\/ ERNST & YOUNG ERNST & YOUNG LLP\nBoston, Massachusetts November 20, 1995\nSMITH & RADIGAN Certified Public Accountants\nSuite 675 Ashford Perimeter 4151 Ashford-Dunwoody Road, N.E. Atlanta, Georgia 30319-1462\nINDEPENDENT AUDITORS' REPORT\nThe Partners of Marshall's at East Lake Partnership:\nWe have audited the balance sheets of Marshall's at East Lake Partnership as of August 31, 1995 and 1994, and the related statements of income, partners' capital and cash flows for the years then ended (not presented herein). These financial statements 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 (not presented herein) present fairly, in all material respects, the financial position of Marshall's at East Lake Partnership as of August 31, 1995 and 1994, and the results of its operations and its cash flows for the years then ended in conformity with generally accepted accounting principles.\n\/s\/ Smith & Radigan SMITH & RADIGAN\nAtlanta, Georgia September 28, 1995\nPAINE WEBBER QUALIFIED PLAN PROPERTY FUND TWO, LP\nBALANCE SHEETS August 31, 1995 and 1994 (In Thousands, except per Unit data)\nASSETS 1995 1994 Real estate investments: Land $ 1,000 $ 1,750 Mortgage loans, net 7,327 10,177 Investment in joint venture, at equity 3,198 3,253 Investment property held for sale, net of allowance for possible investment loss of $1,200 8,300 8,300 19,825 23,480\nCash and cash equivalents 5,379 1,042 Tax and insurance escrow 197 188 Interest and other receivables 90 286 Prepaid expenses 15 14 $ 25,506 $ 25,010\nLIABILITIES AND PARTNERS' CAPITAL\nAccrued real estate taxes $ 183 $ 170 Accounts payable and accrued expenses 95 246 Accounts payable - affiliates 12 11 Tenant security deposits and other liabilities 56 48 Note payable 1,311 604 Total liabilities 1,657 1,079\nPartners' capital: General Partners: Capital contributions 1 1 Cumulative net income 282 275 Cumulative cash distributions (316) (308) Limited Partners ($1,000 per Unit, 36,241 Units issued): Capital contributions, net of offering costs 32,906 32,906 Cumulative net income 27,851 27,212 Cumulative cash distributions (36,875) (36,155) Total partners' capital 23,849 23,931 $ 25,506 $ 25,010\nSee accompanying notes.\nPAINE WEBBER QUALIFIED PLAN PROPERTY FUND TWO, LP\nSTATEMENTS OF OPERATIONS For the years ended August 31, 1995, 1994 and 1993 (In Thousands, except per Unit data)\n1995 1994 1993 REVENUES: Interest from mortgage loans $ 1,477 $1,612 $2,156 Land rent 203 282 423 Interest and other income 67 51 9 Recovery of bad debt - 292 - 1,747 2,237 2,588\nEXPENSES: Management fees 45 42 99 General and administrative 438 411 471 Provision for possible uncollectible amounts 235 370 623 718 823 1,193\nOperating income 1,029 1,414 1,395\nPartnership's share of venture's income 143 168 201\nGain on sale of land 211 - -\nInvestment property held for sale: Loss on foreclosure - - (1,000) Provision for possible investment loss - (1,200) - Income (loss) from operations (738) (766) 163 (738) (1,966) (837)\nNET INCOME (LOSS) $ 645 $ (384) $ 759\nNet income (loss) per Limited Partnership Unit $17.60 $(10.49) $20.72 Cash distributions per Limited Partnership Unit $19.86 $175.25 $57.50\nThe above net income (loss) and cash distributions per Limited Partnership Unit are based upon 36,241 Units of Limited Partnership Interest outstanding during each year.\nSee accompanying notes.\nPAINE WEBBER QUALIFIED PLAN PROPERTY FUND TWO, LP\nSTATEMENTS OF CHANGES IN PARTNERS' CAPITAL (DEFICIT) For the years ended August 31, 1995, 1994 and 1993 (In Thousands)\nGeneral Limited Partners Partners Total\nBALANCE AT AUGUST 31, 1992 $ (8) $32,028 $32,020\nCash distributions (21) (2,084) (2,105)\nNet income 8 751 759\nBALANCE AT AUGUST 31, 1993 (21) 30,695 30,674\nCash distributions (7) (6,352) (6,359)\nNet loss (4) (380) (384)\nBALANCE AT AUGUST 31, 1994 (32) 23,963 23,931\nCash distributions (7) (720) (727)\nNet income 6 639 645\nBALANCE AT AUGUST 31, 1995 $ (33) $23,882 $23,849\nSee accompanying notes.\nPAINE WEBBER QUALIFIED PLAN PROPERTY FUND TWO, LP\nSTATEMENTS OF CASH FLOWS For the years ended August 31, 1995, 1994 and 1993 Increase (Decrease) in Cash and Cash Equivalents (In Thousands)\n1995 1994 1993\nCash flows from operating activities: Net income (loss) $ 645 $ (384) $ 759 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Gain on sale of land (211) - - Partnership's share of venture's income (143) (168) (201) Loss on foreclosure - - 1,000 Provision for possible investment loss - 1,200 - Changes in assets and liabilities: Tax and insurance escrow (9) 111 (299) Interest and other receivables 196 (100) 17 Prepaid expenses (1) (1) (14) Accrued real estate taxes 13 (94) 264 Accounts payable and accrued expenses (151) 169 50 Accounts payable - affiliates 1 (44) (10) Tenant security deposits and other liabilities 8 27 21 Total adjustments (297) 1,100 828 Net cash provided by operating activities 348 716 1,587\nCash flows from investment activities: Proceeds received from repayment of mortgage loan and sale of land 3,811 5,608 - Distributions from joint venture 198 255 340 Net cash provided by investment activities 4,009 5,863 340\nCash flows from financing activities: Proceeds received from issuance of note payable 811 604 - Principal payments on note payable (104) - - Distributions to partners (727) (6,359) (2,105) Net cash used for financing activities (20) (5,755) (2,105)\nNet increase (decrease) in cash and cash equivalents 4,337 824 (178)\nCash and cash equivalents, beginning of year 1,042 218 396\nCash and cash equivalents, end of year $ 5,379 $ 1,042 $ 218\nCash paid during the year for interest $ 105 $ 4 $ -\nSee accompanying notes.\n1. General\nPaine Webber Qualified Plan Property Fund Two, LP (the \"Partnership\") is a limited partnership organized pursuant to the laws of the State of Delaware in March 1982 for the purpose of investing in a diversified portfolio of existing income-producing real properties through land purchase-leaseback transactions and first mortgage loans. The Partnership authorized the issuance of units (the \"Units\") of Partnership interests, of which 36,241 (at $1,000 per Unit) were subscribed and issued between July 1, 1982 and June 30, 1983.\n2. Summary of Significant Accounting Policies\nThe Partnership's investments in land subject to ground leases are carried at the lower of cost or net realizable value. The net realizable value of a real estate investment held for long-term investment purposes is measured by the recoverability of the investment through expected future cash flows on an undiscounted basis, which may exceed the property's current market value. The net realizable value of a property held for sale approximates its current market value. None of the Partnership's land investments were held for sale as of August 31, 1995 or 1994. The Partnership has reviewed FAS No. 121 `Accounting for the Impairment of Long-Lived Assets and for Long- Lived Assets To Be Disposed Of''which is effective for financial statements for years beginning after December 15, 1995, and believes this new pronouncement will not have a material effect on the Partnership's financial statements.\nMortgage loans receivable are carried at cost. Amounts representing deferred interest and land rent receivable resulting from loan and ground\nlease modifications are fully reserved until collected. The Partnership's policy is to provide for any valuation allowances on its mortgage loan investments on a specific identification basis, principally by evaluating the market value of the underlying collateral since the loans are collateral dependent. In addition, a general loan loss reserve was recorded in fiscal 1990 in an amount equal to $990,000, reflecting management's assessment of the general credit risk applicable to the Partnership's portfolio of mortgage loan investments taken as a whole. During fiscal 1994, $542,000 of this loan loss reserve was applied against the loss incurred in conjunction with the repayment of the Howard Johnson's mortgage loan (see Note 4). The balance in the general loan loss reserve at August 31, 1995 was $448,000.\nThe accompanying financial statements include the Partnership's investment in a joint venture partnership which owns one operating property. The Partnership accounts for its investment in the joint venture using the equity method because the Partnership does not have a voting control interest in the venture. Under the equity method the venture is carried at cost adjusted for the Partnership's share of the venture's earnings or losses and distributions. See Note 5 for a description of the joint venture partnership.\nInvestment property held for sale represents an asset acquired by the Partnership through foreclosure proceedings on a first mortgage loan. The Partnership's policy is to carry this asset at the lower of cost or estimated fair value (net of selling expenses). The Partnership's cost basis is equal to the fair value of the asset at the date of foreclosure. Declines in the estimated fair value of the asset subsequent to foreclosure are recorded through the use of a valuation allowance. Subsequent increases in the estimated fair value of the asset result in reductions in the valuation allowance, but not below zero. All costs incurred to hold the asset are charged to expense and no depreciation expense is recorded.\nFor purposes of reporting cash flows, the Partnership considers all highly liquid investments with original maturities of 90 days or less to be cash equivalents.\nNo provision for income taxes has been made as the liability for such taxes is that of the partners rather than the Partnership.\n3. The Partnership Agreement and Related Party Transactions\nThe Managing General Partner of the Partnership is Second Qualified Properties, Inc., a wholly-owned subsidiary of PaineWebber Group Inc. (\"PaineWebber\"). The Associate General Partner is Properties Associates, a Massachusetts general partnership, certain general partners of which are also officers of the Managing General Partner and PaineWebber Properties Incorporated. Subject to the Managing General Partner's overall authority, the business of the Partnership is managed by PaineWebber Properties Incorporated (the \"Adviser\") pursuant to an advisory contract. The Adviser is a wholly-owned subsidiary of PaineWebber Incorporated (\"PWI\"), a wholly- owned subsidiary of PaineWebber.\nThe General Partners, the Adviser and PWI receive fees and compensation determined on an agreed-upon basis, in consideration of various services performed in connection with the sale of the Units, the management of the Partnership and the acquisition, management, financing and disposition of Partnership investments.\nIn connection with investing Partnership capital, the Adviser received acquisition fees paid by the borrowers and sellers aggregating approximately 3% of the gross proceeds of the offering. The Adviser may receive a real estate brokerage commission, in an amount not yet determinable, upon the disposition of certain Partnership investments.\nAll distributable cash, as defined, for each fiscal year will be distributed quarterly in the ratio of 99% to the Limited Partners and 1% to the General Partners. Residual proceeds resulting from disposition of Partnership investments will be distributed, generally, 85% to the Limited Partners and 15% to the General Partners, after the prior receipt by the Limited Partners of their original capital contributions and a cumulative annual return based upon a formula related to U.S. Treasury Bill interest rates, as defined in the Partnership Agreement.\nPursuant to the terms of the Partnership Agreement, any taxable income or tax loss of the Partnership will be allocated 99% to the Limited Partners and 1% to the General Partners. Allocations of the Partnership's net income or loss for financial accounting purposes have been made in conformity with the allocations of taxable income or loss. Taxable income or tax loss arising from disposition of Partnership investments will be allocated to the Limited and General Partners generally as residual proceeds are distributed.\nUnder the advisory contract, the Adviser has specific management responsibilities; to administer the day-to-day operations of the Partner- ship, and to report periodically the performance of the Partnership to the General Partners. The Adviser is paid a basic management fee (6% of adjusted cash flow) and an incentive management fee (3% of adjusted cash\nflow subordinated to a noncumulative annual return to the Limited Partners equal to 10% based upon their adjusted capital contribution) for services rendered. The Adviser earned basic management fees of $45,000, $42,000 and $99,000 for the years ended August 31, 1995, 1994 and 1993, respectively. No incentive management fees have been earned to date. Accounts payable - affiliates at August 31, 1995 and 1994 includes $12,000 and $11,000, respectively, of management fees payable to the Adviser.\nIncluded in general and administrative expenses for the years ended August 31, 1995, 1994 and 1993 is $176,000, $161,000 and $157,000, respectively, representing reimbursements to an affiliate of the Managing General Partner for providing certain financial, accounting and investor communication services to the Partnership.\nThe Partnership uses the services of Mitchell Hutchins Institutional Investors, Inc. (\"Mitchell Hutchins\") for the managing of cash assets. Mitchell Hutchins is a subsidiary of Mitchell Hutchins Asset Management, Inc., an independently operated subsidiary of PaineWebber. Mitchell Hutchins earned fees of $2,000, $1,000 and $1,000 (included in general and administrative expenses) for managing the Partnership's cash assets during fiscal 1995, 1994 and 1993, respectively.\n4. Mortgage Loan and Land Investments\nThe following first mortgage loans were outstanding at August 31, 1995 and 1994 (in thousands):\nDate of Loan Amount of Loan and Property 1995 1994 Interest Rate Maturity\nHarbour Bay Plaza $ - $ 2,850 11.75% 12\/8\/83 Sewall's Point, FL (1) 12\/1\/95\nEden West Apts. 3,500 3,500 Years 1 to 3 - 11% 6\/6\/84 Omaha, NE Years 4 to 6 - 11.25% 6\/6\/99 Thereafter - 11.50%\nThe Timbers 6,570 6,335 11.75% 9\/7\/84 Apartments (2) (2,295) (2,060) 9\/1\/98 Raleigh, NC 4,275 4,275\nSubtotal 7,775 10,625\nLess: General loan reserve (3) (448) (448) $ 7,327 $10,177\n(1) See below for a discussion of the repayment of the Harbour Bay Plaza mortgage loan during fiscal 1995. The Partnership no longer holds any interest in this property.\n(2) See discussion below regarding interest pay rate modifications for the Timbers mortgage loan. Deferred interest is added to the principal balance of the mortgage loan receivable. The Partnership's policy is to reserve for deferred interest until collected.\n(3) The Partnership recorded a general loan loss reserve of $990,000 in 1990 (see Note 2). During fiscal 1994, $542,000 of this loan loss reserve was applied against the loss incurred in connection with the repayment of the Howard Johnson's mortgage loan (see discussion below).\nThe loans are secured by first mortgages on the properties, the owner's leasehold interest in the land and an assignment of all tenant leases, where applicable. Interest is payable monthly and the principal is due at maturity.\nIn relation to the above-mentioned mortgage loans, the following land purchase-leaseback transactions had also been entered into as of August 31, 1995 and 1994 (in thousands):\nCost of Land to the Partnership Property 1995 1994 Annual Base Rent\nHarbour Bay Plaza (1) $ - $ 750 $ 88,125\nEden West Apartments 400 400 Years 1 to 3 - $44,000 Years 4 to 6 - $45,000 Thereafter - $46,000\nThe Timbers Apartments 600 600 $ 70,500\n$ 1,000 $1,750\n(1)See below for a discussion of the sale of the Harbour Bay Plaza's land investment during fiscal 1995. The Partnership no longer holds any interest in this property.\nThe land leases have terms of 40 years. Among the provisions of the lease agreements, the Partnership is entitled to additional rent based upon the gross revenues in excess of a base amount, as defined. Additional rental income of $16,000 was received from the Harbour Bay Plaza investment during the year ended August 31, 1993. No additional rent was received during fiscal 1995 or 1994. The lessees have the option to purchase the land for specified periods of time at a price based on the fair market value, as defined, but not less than the original cost to the Partnership. As of August 31, 1995, all options to purchase the land were exercisable.\nThe objectives of the Partnership with respect to its mortgage loan and land investments are to provide current income from fixed mortgage interest payments and base land rents, then to provide increases to this current income through participation in the annual revenues generated by the properties as they increase above specified base amounts. In addition, the Partnership's investments are structured to share in the appreciation in value of the underlying real estate. Accordingly, upon either sale, refinancing, maturity of the mortgage loans or exercise of the options to repurchase the land, the original terms of the leases called for the Partnership to receive a 37% to 52% share of the appreciation above a specified base amount. Certain original terms of the mortgage loans and ground leases have been amended by the modification agreements discussed below.\nHARBOUR BAY PLAZA\nEffective August 25, 1995, the borrower of the Harbour Bay Plaza loan repaid the Partnership's first leasehold mortgage loan secured by Harbour Bay Plaza Shopping Center and purchased the Partnership's interest in the underlying land for total consideration of $3,833,000. The principal balance of the mortgage loan was $2,850,000 plus interest accrued through August 25, 1995 of $23,000. The cost of the land was $750,000. Pursuant to the ground lease, the Partnership received $211,000 in excess of the outstanding mortgage loan and land investments as its share of the appreciation in value of the operating investment property above a specified base amount. The net proceeds from this transaction were distributed to the Limited Partners as a Special Distribution of $106 per original $1,000 investment subsequent to year-end, on October 13, 1995.\nTHE TIMBERS APARTMENTS\nThe Partnership had also previously agreed to modify the payment terms of the loan secured by The Timbers Apartments. Under the terms of The Timbers modification, which was effective on October 1, 1986, for a period of approximately thirty months, a portion of the interest payable was deferred and added to the principal balance. During fiscal 1989, the debt modification expired and a new modification was negotiated. The terms included an extension of the deferral period and the loan maturity to September of 1998. The amount due to the Partnership will continue to be equal to the cash flow of the property available after the payment of operating expenses not to exceed 11.75% of the note balance, but in no event less than 7.75% of the note balance. The amount deferred each year will accrue interest at the original rate of 11.75% beginning at the end of that year and the total deferred amount plus accrued interest will be payable upon maturity of the note in September of 1998.\nDuring fiscal 1994 and 1993, the Partnership received the minimum payments due under the note of $331,000. During fiscal 1995, the Partnership received payments totalling $509,000 toward the interest owed on the loan secured by The Timbers. Due to the Partnership's policy of reserving for deferred interest until collected, such cash payments reflect the interest income recognized in the Partnership's statements of operations for such years (net of the provision for possible uncollectible amounts). Gross interest income at the original rate of 11.75% per annum would have accrued for each of the three years ended August 31, 1995, 1994 and 1993 in the amount of $502,000 had the modifications referred to above not been necessary. The Partnership has established an allowance for possible uncollectible amounts for the cumulative amount of deferred interest owed under the Timbers modification ($2,295,000 and $2,060,000 at August 31, 1995 and 1994, respectively) due to the uncertainty as to the collection of the deferred interest from this investment.\nEDEN WEST APARTMENTS\nDuring the last quarter of fiscal 1995, the Partnership received notice from the Eden West borrower of its intent to prepay the Partnership's mortgage loan and repurchase the underlying land. The amount to be received by the Partnership as its share of the appreciation of the Eden West property has not been agreed upon to date. The terms of the Partnership's ground lease provide for the possible resolution of disputes between the parties over value issues through an arbitration process. Presently, the\nPartnership and the borrower continue to try to resolve their differences regarding the value of the property. If an agreement cannot be reached, the borrower could force the Partnership to submit to arbitration during fiscal 1996. In addition to the amount to be determined as the Partnership's share of the property's appreciation under the ground lease, the terms of the Eden West mortgage loan require a prepayment penalty which would be equal to 3.75% of the outstanding principal balance of $3,500,000. If completed, the proceeds of this transaction would be distributed to the Limited Partners. However, the transaction remains contingent on, among other things, a resolution of the value issue and the borrower obtaining sufficient financing to repay its obligations to the Partnership. Accordingly, there are no assurances that this transaction will be consummated.\nHOWARD JOHNSON'S MOTOR LODGE\nAn agreement for a third modification of the Howard Johnson's mortgage loan was reached between the borrower and the Partnership during fiscal 1993. As part of the workout agreement, the borrower had until June 30, 1994 to market the property for sale. Under the agreement, the Partnership earned a blended rate of 7% per annum on the unpaid principal balance of the loan ($5,050,000) and the cost basis of the land ($1,100,000). In the event that the borrower failed to comply with the terms of this modification, the deed to the property, which was placed in escrow, was to have been released to the Partnership, resulting in a foreclosure pursuant to the terms of the first mortgage loan and a termination of the ground lease. The borrower was also required to personally guarantee payment of the mortgage interest and land rent until the property was sold or deeded back to the Partnership. The agreement further provided that if there had been no default, as defined, and the property was sold, all proceeds up to $5.2 million would be\npaid to the Partnership. Additional proceeds would go to the Partnership until delinquent debt service through April 30, 1993, as defined, was paid in full. Thereafter, any additional proceeds would be paid 25% to the Partnership and 75% to the borrower.\nEffective April 1, 1994, the borrower sold the Howard Johnson's Motor Lodge and repaid the Partnership's land and loan investments in accordance with the terms of the third modification agreement. The total net proceeds received by the Partnership amounted to approximately $5.9 million. In accordance with the third modification agreement, such proceeds included the payment of $292,000 of deferred debt service and ground rent, which had previously been fully reserved for. The remaining proceeds of approximately $5,608,000 were less than the combined carrying value of the mortgage loan and land investments of $6,150,000. The resulting deficiency, of approximately $542,000, was charged against the outstanding general loan loss reserve. Accordingly, the aforementioned transaction did not result in the recognition of a loss for financial reporting purposes in fiscal 1994. Management believes that the remaining balance of the general loan loss reserve, of approximately $448,000, is sufficient to cover any potential losses on the remaining outstanding loan investments. The Partnership retained approximately $283,000 of the net proceeds from the Howard Johnson's disposition in order to maintain adequate cash reserve balances. The remainder was paid out to the Limited Partners through a special distribution of $155 per original $1,000 investment which was made on May 25, 1994.\n5. Investment in Joint Venture\nOn June 12, 1990, the borrower of the mortgage loan secured by the Marshall's at East Lake Shopping Center, Oxford\/Concord Associates, filed a Chapter 11 petition with the United States Bankruptcy Court for the Northern District of Georgia. On November 14, 1990, the Bankruptcy Court ordered that both the Partnership and the borrower submit plans for the restructuring of the mortgage loan and ground lease agreements. During fiscal 1991, the Partnership and the borrower reached a settlement agreement which involved the formation of a joint venture to own and operate the property on a go- forward basis. The formation of the joint venture was approved by the Bankruptcy Court and became effective in December of 1991. The Partnership contributed its rights and interests under its mortgage loan to the joint venture and the loan was extinguished. In addition, the Partnership contributed the land underlying the operating property to the joint venture and the related ground lease was terminated. Oxford\/Concord Associates contributed all of its rights, title and interest in and to the improvements, subject to the Partnership's loan, to the joint venture.\nSince the Partnership received an equity interest in full satisfaction of its outstanding mortgage loan receivable, the transaction was accounted for as a troubled debt restructuring in accordance with Statement of Financial Accounting Standards No. 15, \"Accounting by Debtors and Creditors for Troubled Debt Restructurings\". Accordingly, the Partnership would have recognized a loss to the extent that the face amount of the mortgage loan and the carrying value of the land exceeded the fair value of the equity interest acquired. However, management estimated that the fair value of the equity interest acquired was approximately equal to the face amount of the loan and the investment in land. Therefore, no loss was recorded at the time of the restructuring. The carrying value of the mortgage loan receivable and land comprising the Partnership's investment in Marshall's at East Lake, which\ntotalled $3,500,000, was reclassified to investment in joint venture effective December 11, 1991. Subsequent to the restructuring, the Partnership has accounted for its equity investment as if it had acquired the interest for cash, in accordance with SFAS No. 15. Based upon the provisions of the joint venture agreement, the Partnership's investment in the Marshall's joint venture is accounted for on the equity method in the Partnership's financial statements. Under the equity method, the investment is carried at cost, adjusted for the Partnership's share of earnings, losses and distributions.\nCondensed financial statements of this joint venture follow.\nCONDENSED BALANCE SHEET August 31, 1995 and 1994 (in thousands) Assets\n1995 1994\nCurrent assets $ 16 $ 36 Operating investment property, net 3,162 3,226 Other assets 74 78 $ 3,252 $ 3,340\nLiabilities and Partners' Capital\nCurrent liabilities $ 37 $ 69 Other liabilities 17 18\nPartnership's share of capital 3,198 3,253 $ 3,252 $ 3,340\nCONDENSED SUMMARY OF OPERATIONS For the years ended August 31, 1995, 1994, 1993 (in thousands)\n1995 1994 1993 Rental income and expense reimbursements $ 444 $ 468 $ 548 Interest and other income 2 1 1 446 469 549\nInterest expense - 2 3 Property operating expenses 161 167 219 Depreciation and amortization 142 132 126 303 301 348 Net income $ 143 $ 168 $ 201\nNet income: Partnership's share of net income $ 143 $ 168 $ 201 Co-venturer's share of net income - - - $ 143 $ 168 $ 201\nThis joint venture is subject to a partnership agreement which determines the distribution of available funds, the disposition of the venture's assets and the rights of the partners, regardless of the Partnership's percentage ownership interest in the venture. Substantially all of the Partnership's investment in this joint venture is restricted as to distributions.\nA description of the operating property owned by the joint venture and the terms of the joint venture agreement are summarized below:\nMARSHALL'S AT EAST LAKE PARTNERSHIP\nMarshall's at East Lake Partnership, a Delaware general partnership (\"the joint venture\") was organized on December 11, 1991 by the Partnership and Oxford\/Concord Associates (\"Oxford\"), a Georgia joint venture, to acquire, own and operate Marshall's at East Lake Shopping Center. The property, which was 97% leased as of August 31, 1995, is a 55,175 square foot shopping center on approximately 6.7 acres of land.\nThe joint venture agreement provides that all taxable income for any fiscal year will, in general, be allocated to the Partnership until it has received income allocations equal to a cumulative 9% return upon its defined invested capital ($4,250,000 at August 31, 1995). Thereafter, taxable income will be allocated 80% to the Partnership and 20% to Oxford. In general, all tax losses will be allocated to the Partnership.\nThe joint venture agreement also provides that cash flow, as defined, be distributed monthly to the Partnership until it has received cumulative distributions equal to a 9% return upon its defined invested capital.\nThereafter, cash flow will be distributed 80% to the Partnership and 20% to Oxford. The Partnership received distributions from the joint venture totalling $198,000, $255,000 and $340,000 during the years ended August 31, 1995, 1994 and 1993, respectively. The Partnership would need to receive additional distributions of $439,000 to reach a cumulative non-compounded return of nine percent on its defined investment capital as of August 31, 1995. Proceeds from any capital transaction, as defined, shall be distributed first to the Partnership until it has received aggregate distributions equal to a 9% return upon its defined invested capital; second, to the Partnership until it has received an amount equal to its defined invested capital; and the balance, if any, will be distributed 80% to the Partnership and 20% to Oxford.\nThe Partnership entered into a property management contract with New Market Management Company (the \"Manager\"), an affiliate of Oxford, for the management of the property. As compensation for management services provided to the joint venture, the Manager receives a management fee equal to 5% of gross cash receipts, as defined, subject to a monthly minimum of $2,000. Such fees amounted to $25,000, $23,000 and $29,000 for the years ended August 31, 1995, 1994 and 1993, respectively. The Partnership and Oxford must make all decisions unanimously relating to the business and affairs of the joint venture. However, the Partnership can unilaterally, without the approval of Oxford, terminate upon thirty days' written notice the current management company.\n6. Investment Property Held for Sale\nMERCANTILE TOWER OFFICE BUILDING\nThe Partnership assumed ownership of the Mercantile Tower office building, in Kansas City, Missouri, on April 12, 1993 through a deed-in-lieu of foreclosure action following a default under the terms of a first mortgage loan held by the Partnership. The Partnership complies with the guidelines set forth in the Statement of Position entitled \"Accounting for Foreclosed Assets\", issued by the American Institute of Certified Public Accountants, to account for its investment properties acquired through foreclosures. Under the Statement of Position, a foreclosed asset is recorded at the lower of cost or estimated fair value, reduced by the estimated costs to sell the asset. Cost is defined as the fair value of the asset at the date of the foreclosure. Declines in the estimated fair value of the asset subsequent to foreclosure are recorded through the use of a valuation allowance. Subsequent increases in the estimated fair value of the asset result in reductions in the valuation allowance, but not below zero. The combined balance of the land and the mortgage loan investment at the time title was transferred was $10,500,000. The estimated fair value of the operating property at the date of foreclosure, net of selling expenses, was $9,500,000. Accordingly, a write-down of $1,000,000 was recorded as a loss on foreclosure in the accompanying statement of operations for fiscal 1993. In fiscal 1994, the Partnership recorded a provision for possible investment loss in the amount of $1,200,000 to reflect a decline in management's estimate of the fair value of the investment property. The net carrying value of the Mercantile Tower investment property at August 31, 1995 and 1994 of $8,300,000 is classified as an investment property held for sale on the Partnership's balance sheet.\nThe Partnership records income from the investment property held for sale in the amount of the difference between the property's gross revenues and property operating expenses (including leasing costs and improvement\nexpenses), taxes and insurance. Summarized operating results for Mercantile Tower for the years ended August 31, 1995 and 1994 and the period from April 12, 1993 (the effective date of foreclosure) to August 31, 1993 is as follow (in thousands):\n1995 1994 1993\nRental revenues and expense recoveries $1,654 $1,574 $ 860 Other income - 2 1 1,654 1,576 861\nProperty operating expenses 1,993 2,044 536 Property taxes and insurance 287 294 162 Interest expense 112 4 - 2,392 2,342 698 Income (loss) from investment property held for sale $ (738) $ (766) $ 163\n7. Note payable\nNote payable as of August 31, 1995 and 1994 consists of the following secured indebtedness (in thousands):\n1995 1994 Line-of-credit borrowings secured by the Mercantile Tower property (see Note 6). Draws under the line, up to a maximum of $2,000,000, can be made through March 15, 1996, only to fund approved leasing and capital improvements costs related to the Mercantile Tower property. The outstanding borrowings bear interest at the prime rate plus 1% per annum. Interest-only payments were due on a monthly basis through February 1995. Thereafter, monthly principal and interest payments are due through maturity on February 10, 2001. $ 1,311 $ 604\nScheduled maturities of the outstanding debt for the next six years are as follows (in thousands):\n1996 $ 225 1997 241 1998 241 1999 241 2000 241 2001 122 $ 1,311\n8. Leases\nThe Partnership leases office space at the Mercantile Tower office building under operating leases which provide for fixed minimum rents and reimbursements of certain operating costs. Rental revenues are recognized on a straight-line basis over the life of the related lease. Minimum future rental revenues to be received by the Partnership under noncancellable operating leases for the next five years and thereafter are as follows (in thousands):\n1996 $1,556 1997 1,458 1998 1,061 1999 927 2000 722 Thereafter 2,864\n$8,588\n9. Subsequent Events\nOn October 13, 1995, the Partnership distributed $191,000 to the Limited Partners and $2,000 to the General Partners for the quarter ended August 31, 1995. In addition, on that same date the Limited Partnership received a special distribution of $106 per original $1,000 investment, or $3,842,000, representing the net proceeds from the Harbour Bay Plaza prepayment transaction (see Note 4).\n10.Contingencies\nThe Partnership is involved in certain legal actions. The Managing General Partner believes these actions will be resolved without material adverse effect on the Partnership's financial statements, taken as a whole.","section_15":""}
{"filename":"837985_1995.txt","cik":"837985","year":"1995","section_1":"ITEM 1. BUSINESS\nCNL Income Fund V, Ltd. (the \"Registrant\" or the \"Partnership\") is a limited partnership which was organized pursuant to the laws of the State of Florida on August 17, 1988. The general partners of the Partnership are Robert A. Bourne, James M. Seneff, Jr. and CNL Realty Corporation, a Florida corporation (the \"General Partners\"). Beginning on December 16, 1988, the Partnership offered for sale up to $25,000,000 in limited partnership interests (the \"Units\") (50,000 Units at $500 per Unit) pursuant to a registration statement on Form S-11 under the Securities Act of 1933, as amended. The offering terminated on June 7, 1989, as of which date the maximum offering proceeds of $25,000,000 had been received from investors who were admitted to the Partnership as limited partners (the \"Limited Partners\").\nThe Partnership was organized to acquire both newly constructed and existing restaurant properties, as well as properties upon which restaurants were to be constructed (the \"Properties\"), which are leased primarily to operators of national and regional fast-food and family-style restaurant chains (the \"Restaurant Chains\"). Net proceeds to the Partnership from its offering of Units, after deduction of organizational and offering expenses, totalled $22,125,000, and were used to acquire 30 Properties, including interests in three Properties owned by joint ventures in which the Partnership is a co-venturer. During the year ended December 31, 1995, the Partnership sold its Property in Myrtle Beach, South Carolina, to the tenant of this Property and accepted a promissory note for the full sales price of the Property. As a result of the above transaction, the Partnership currently owns 29 Properties, including interests in three Properties owned by joint ventures in which the Partnership is a co-venturer. Generally, the Properties are leased on a triple-net basis with the lessee responsible for all repairs and maintenance, property taxes, insurance and utilities.\nThe Partnership will hold its Properties until the General Partners determine that the sale or other disposition of the Properties is advantageous in view of the Partnership's investment objectives. In deciding whether to sell Properties, the General Partners will consider factors such as potential capital appreciation, net cash flow and federal income tax considerations. Certain lessees also have been granted options to purchase Properties, generally at the Property's then fair market value after a specified portion of the lease term has elapsed. In general, the General Partners plan to seek the sale of some of the Properties commencing seven to 12 years after their acquisition. The Partnership has no obligation to sell all or any portion of a Property at any particular time, except as may be required under property or joint venture purchase options granted to certain lessees.\nLeases\nAlthough there are variations in the specific terms of the leases, the following is a summarized description of the general structure of the Partnership's leases. The leases of the Properties owned by the Partnership and the joint ventures in which the Partnership is a co-venturer provide for initial terms, ranging from seven to 20 years (the average being 18 years) and expire between 1997 and 2012. All leases are on a triple-net basis, with the lessee responsible for all repairs and maintenance, property taxes, insurance and utilities. The leases of the Properties provide for minimum base annual rental payments (payable in monthly installments) ranging from approximately $37,800 to $150,400. Generally, the leases provide for percentage rent, based on sales in excess of a specified amount, to be paid annually. In addition, a majority of the leases provide that, commencing in the sixth lease year, the percentage rent will be an amount equal to the greater of the percentage rent calculated under the lease formula or a specified percentage (ranging from one-fourth to five percent) of either the purchase price paid by the Partnership for the Property or gross sales.\nGenerally, the leases of the Properties provide for two to four five- year renewal options subject to the same terms and conditions as the initial lease. Certain lessees also have been granted options to purchase Properties at the Property's then fair market value, or pursuant to a formula based on the original cost of the Property, after a specified portion of the lease term has elapsed. Additionally, one lease provides the lessee an option to purchase up to a 49 percent interest in the Property, after a specified portion of the lease term has elapsed, at an option purchase price similar to those described above multiplied by the percentage interest in the Property with respect to which the option is being exercised.\nThe leases also generally provide that, in the event the Partnership wishes to sell the Property subject to that lease, the Partnership first must offer the lessee the right to purchase the Property on the same terms and conditions, and for the same price, as any offer which the Partnership has received for the sale of the Property.\nDuring 1993, CNL\/Longacre Joint Venture, in which the Partnership has a 66.5% interest, terminated its original lease relating to the Property in Lebanon, New Hampshire, and entered into a new lease with the same tenant. The new lease provided for reduced base rental amounts. The tenant defaulted under the terms of the lease and in February 1995, ceased operations of the restaurant on the Property. The Partnership is currently seeking a replacement tenant.\nIn February 1994, the tenant of the Properties in Belding and South Haven, Michigan, defaulted under the terms of its leases and a new operator began occupying the Properties on a month-to-month basis for reduced rental amounts. In October 1994, the new operator ceased operations of the Belding Property and in October 1995, the new operator of the South Haven Property ceased operations. The Partnership is currently seeking a replacement tenant for both Properties.\nMajor Tenants\nDuring 1995, one lessee of the Partnership and its consolidated joint venture, Shoney's, Inc., contributed more than ten percent of the Partnership's total rental income (including rental income from the Partnership's consolidated joint venture and the Partnership's share of the rental income from two Properties owned by unconsolidated joint ventures). As of December 31, 1995, Shoney's, Inc. was the lessee under leases relating to four restaurants. It is anticipated that, based on the minimum rental payments required by the leases, Shoney's, Inc. will continue to contribute more than ten percent of the Partnership's total rental income in 1996 and subsequent years. In addition, three Restaurant Chains, Perkins, Denny's and Wendy's Old Fashioned Hamburger Restaurants, each accounted for more than ten percent of the Partnership's total rental income in 1995 (including rental income from the Partnership's consolidated joint venture and the Partnership's share of the rental income from two Properties owned by unconsolidated joint ventures). In subsequent years, it is anticipated that these three Restaurant Chains each will continue to account for more than ten percent of the total rental income to which the Partnership is entitled under the terms of the leases. Any failure of Shoney's, Inc. or these Restaurant Chains could materially affect the Partnership's income. No single tenant or group of affiliated tenants lease Properties with an aggregate carrying value, excluding acquisition fees and certain acquisition expenses, in excess of 20 percent of the total assets of the Partnership.\nJoint Venture Arrangements\nThe Partnership has entered into three separate joint venture arrangements, CNL\/Longacre Joint Venture, Cocoa Joint Venture and Halls Joint Venture, to purchase and hold three Properties through such joint ventures. Each joint venture arrangement provides for the Partnership and its joint venture partners to share in all costs and benefits associated with the joint venture in proportion to each partner's percentage interest in the joint venture. The Partnership and its joint venture partners are jointly and severally liable for all debts, obligations, and other liabilities of the joint ventures.\nEach joint venture has an initial term of 20 to 30 years and, after the expiration of the initial term, continues in existence from year to year unless terminated at the option of either joint venturer or unless terminated by an event of dissolution. Events of dissolution include the bankruptcy, insolvency or termination of any joint venturer, sale of the Property owned by the joint venture and mutual agreement of the Partnership and its joint venture partner to dissolve the joint venture.\nThe Partnership has management control of the CNL\/Longacre Joint Venture and shares management control equally with affiliates of the General Partners for Cocoa Joint Venture and Halls Joint Venture. The joint venture agreements restrict each venturer's ability to sell, transfer or assign its joint venture interest without first offering it for sale to its joint venture partner, either upon such terms and conditions as to which the venturers may agree or, in the event the venturers cannot agree, on the same terms and conditions as any offer from a third party to purchase such joint venture interest.\nNet cash flow from operations of CNL\/Longacre Joint Venture, Cocoa Joint Venture and Halls Joint Venture is distributed 66.5%, 43.0% and 49.0%, respectively, to the Partnership and the balance is distributed to each of the other joint venture partners. Any liquidation proceeds, after paying joint venture debts and liabilities and funding reserves for contingent liabilities, will be distributed first to the joint venture partners with positive capital account balances in proportion to such balances until such balances equal zero, and thereafter in proportion to each joint venture partner's percentage interest in the joint venture.\nCertain Management Services\nCNL Investment Company, an affiliate of the General Partners, provided certain services relating to management of the Partnership and its Properties pursuant to a management agreement with the Partnership through December 31, 1994. Under this agreement, CNL Investment Company was responsible for collecting rental payments, inspecting the Properties and the tenants' books and records, assisting the Partnership in responding to tenant inquiries and notices and providing information to the Partnership about the status of the leases and the Properties. CNL Investment Company also assisted the General Partners in negotiating the leases. For these services, the Partnership had agreed to pay CNL Investment Company an annual fee of one percent of the sum of gross operating revenues from Properties wholly owned by the Partnership plus the Partnership's allocable share of gross revenues of joint ventures in which the Partnership is a co-venturer, but not in excess of competitive fees for comparable services. Under the management agreement, the management fee is subordinated to receipt by the Limited Partners of an aggregate, ten percent, cumulative, noncompounded annual return on their adjusted capital contributions (the \"10% Preferred Return\"), calculated in accordance with the Partnership's limited partnership agreement (the \"Partnership Agreement\").\nEffective January 1, 1995, certain officers and employees of CNL Investment Company became officers and employees of CNL Income Fund Advisors, Inc., an affiliate of the General Partners, and CNL Investment Company assigned its rights in, and its obligations under, the management agreement with the Partnership to CNL Income Fund Advisors, Inc. In addition, effective October 1, 1995, CNL Income Fund Advisors, Inc. assigned its rights in, and its obligations under, the management agreement with the Partnership to CNL Fund Advisors, Inc. All of the terms and conditions of the management agreement, including the payment of fees, as described above, remain unchanged.\nThe management agreement continues until the Partnership no longer owns an interest in any Properties unless terminated at an earlier date upon 60 days' prior notice by either party.\nCompetition\nThe fast-food and family-style restaurant business is characterized by intense competition. The restaurants on the Partnership's Properties compete with independently owned restaurants, restaurants which are part of local or regional chains, and restaurants in other well-known national chains, including those offering different types of food and service.\nAt the time the Partnership elects to dispose of its Properties, other than as a result of the exercise of tenant options to purchase Properties, the Partnership will be in competition with other persons and entities to locate purchasers for its Properties.\nEmployees\nThe Partnership has no employees. The officers of CNL Realty Corporation and the officers and employees of CNL Fund Advisors, Inc. perform certain services for the Partnership. In addition, the General Partners have available to them the resources and expertise of the officers and employees of CNL Group, Inc., a diversified real estate company, and its affiliates, who may also perform certain services for the Partnership.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nAs of December 31, 1995, the Partnership owned, either directly or through joint venture arrangements, 29 Properties located in 12 states. Reference is made to the Schedule of Real Estate and Accumulated Depreciation filed with this report for a listing of the Properties and their respective costs, including acquisition fees and certain acquisition expenses.\nDescription of Properties\nLand. The Partnership's Property sites range from approximately 12,300 to 135,000 square feet depending upon building size and local demographic factors. Sites purchased by the Partnership are in locations zoned for commercial use which have been reviewed for traffic patterns and volume.\nBuildings. Generally, each of the Properties owned by the Partnership includes a building that is one of a Restaurant Chain's approved designs. The buildings generally are rectangular and are constructed from various combinations of stucco, steel, wood, brick and tile. Building sizes range from approximately 1,700 to 10,100 square feet. All buildings on Properties acquired by the Partnership are freestanding and surrounded by paved parking areas. Buildings are suitable for conversion to various uses, although modifications may be required prior to use for other than restaurant operations.\nGenerally, a lessee is required, under the terms of its lease agreement, to make such capital expenditures as may be reasonably necessary to refurbish buildings, premises, signs and equipment so as to comply with the lessee's obligations, if applicable, under the franchise agreement to reflect the current commercial image of its Restaurant Chain. These capital expenditures are required to be paid by the lessee during the term of the lease.\nLeases with Major Tenants. The terms of each of the leases with the Partnership's major tenant as of December 31, 1995 (see Item 1. Business - Major Tenants), are substantially the same as those described in Item 1. Business - Leases.\nShoney's, Inc. leases two Shoney's restaurants and two Captain D's restaurants with an initial term of 20 years (expiring in 2008) and average minimum base annual rent of approximately $63,000 (ranging from approximately $49,000 to $84,700).\nThe General Partners consider the Properties to be well-maintained and sufficient for the Partnership's operations.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nNeither the Partnership, nor its General Partners or any affiliate of the General Partners, nor any of their respective properties, is a party to, or 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\nAs of February 29, 1996, there were 2,507 holders of record of the Units. There is no public trading market for the Units, and it is not anticipated that a public market for the Units will develop. Limited Partners who wish to sell their Units may offer the Units for sale pursuant to the Partnership's distribution reinvestment plan (the \"Plan\"), and Limited Partners who wish to have their distributions used to acquire additional Units (to the extent Units are available for purchase), may do so pursuant to such Plan. The General Partners have the right to prohibit transfers of Units. The price paid for any Unit transferred pursuant to the Plan has been $475 per Unit. The price to be paid for any Unit transferred other than pursuant to the Plan is subject to negotiation by the purchaser and the selling Limited Partner. The Partnership will not redeem or repurchase Units.\nThe following table reflects, for each calendar quarter, the high, low and average sales prices for transfers of Units during 1995 and 1994 other than pursuant to the Plan, net of commissions (which ranged from zero to 19 percent).\n1995 (1) 1994 (1) --------------------- --------------------- High Low Average High Low Average ------ ----- ------- ------ ----- ------- First Quarter $475 $450 $472 $460 $381 $424 Second Quarter 475 440 452 383 327 355 Third Quarter 475 415 442 475 460 470 Fourth Quarter 475 340 460 475 396 432\n(1) A total of 1,133 and 211 Units were transferred other than pursuant to the Plan for the years ended December 31, 1995 and 1994, respectively.\nThe capital contribution per Unit was $500. All cash available for distribution will be distributed to the partners pursuant to the provisions of the Partnership Agreement.\nFor each of the years ended December 31, 1995 and 1994, the Partnership declared cash distributions of $2,300,000 to the Limited Partners. Distributions of $575,000 were declared at the close of each of the Partnership's calendar quarters during 1995 and 1994 to the Limited Partners. These amounts include monthly distributions made in arrears for the Limited Partners electing to receive distributions on this basis. No amounts distributed to partners for the years ended December 31, 1995 and 1994, are required to be or have been treated by the Partnership as a return of capital for purposes of calculating the Limited Partners' return on their adjusted capital contributions. No distributions have been made to the General Partners to date.\nThe Partnership intends to continue to make distributions of cash available for distribution to the Limited Partners on a quarterly basis, although some Limited Partners, in accordance with their election, receive monthly distributions, for an annual fee.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\n(1) Revenues include equity in earnings of unconsolidated joint ventures and minority interest in income or loss of the consolidated joint venture.\n(2) Net income for the year ended December 31, 1995, includes $5,924 from a gain on sale of land and building.\nThe above selected financial data should be read in conjunction with the financial statements and related notes contained in Item 8 hereof.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe Partnership was organized on August 17, 1988, to acquire for cash, either directly or through joint venture arrangements, both newly constructed and existing restaurant Properties, as well as land upon which restaurant Properties were to be constructed, which are leased primarily to operators of selected national and regional fast-food and family-style Restaurant Chains. The leases are triple-net leases, with the lessee generally responsible for all repairs and maintenance, property taxes, insurance and utilities. As of December 31, 1995, the Partnership owned 29 Properties, either directly or indirectly through joint venture arrangements.\nLiquidity and Capital Resources\nThe Partnership's primary source of capital for the years ended December 31, 1995, 1994 and 1993, was cash from operations (which includes cash received from tenants, distributions from joint ventures and interest received, less cash paid for expenses). Cash from operations was $2,142,918, $2,177,079 and $2,215,658 for the years ended December 31, 1995, 1994 and 1993, respectively. The decrease in cash from operations during 1995 and 1994, as compared to the previous year, is primarily a result of changes in income and expenses as discussed in \"Results of Operations\" below and changes in the Partnership's working capital, during each of the respective years. Cash from operations was also affected by the following during the years ended December 31, 1995, 1994 and 1993.\nDuring 1994, the tenant of the Properties in Belding and South Haven, Michigan, continued to be in default under the terms of a promissory note with the Partnership. In addition, in February 1994, the tenant defaulted under the terms of its leases with the Partnership and vacated the Properties. As a result, the Partnership established an allowance for doubtful accounts of $138,716 for amounts relating to the note and other rental payments due to the Partnership for these two Properties and a new operator began operating the Properties on a month-to-month basis for reduced rental amounts. The new operator ceased operations and rental payments in October 1994 and October 1995 for the Properties in Belding and South Haven, Michigan, respectively. Due to the fact that the Partnership does not expect to receive any additional amounts from the original tenant of these Properties, the Partnership reversed all past due rental and other amounts relating to these two Properties, and the related allowance for doubtful accounts of $138,716 during 1995.\nOther sources and uses of capital included the following during the years ended December 31, 1995, 1994 and 1993.\nIn August 1995, the Partnership sold its Property in Myrtle Beach, South Carolina, to the tenant of the Property for $1,040,000, and in connection therewith, accepted a promissory note in the principal sum of $1,040,000, collateralized by a mortgage on the Property. The note bears interest at a rate of 10.25% per annum and is being collected in 59 equal monthly installments of $9,319, with a balloon payment of $1,006,004 due in July 2000. Collections commenced August 1, 1995. In accordance with Statement of Financial Accounting Standards No. 66, \"Accounting for Sales of Real Estate,\" the Partnership recorded the sale of the Property using the installment sales method. Therefore, the gain on the sale of the Property was deferred and is being recognized as income proportionately as payments under the mortgage note are collected. The Partnership recognized a gain of $1,571 for financial reporting purposes for the year ended December 31, 1995, and had a deferred gain in the amount of $141,641 at December 31, 1995. The mortgage note receivable balance at December 31, 1995, was $895,736 including accrued interest of $8,786 and net of the remaining deferred gain of $141,641. The General Partners anticipate that payments collected under the mortgage note will be reinvested in additional Properties or used for other Partnership purposes.\nIn October 1995, the Partnership sold a portion of the land relating to its Property in Daleville, Indiana, as the result of a right of way taking. In connection therewith, the Partnership received sales proceeds of $7,625 and recognized a gain of $4,353 for financial reporting purposes for the year ended December 31, 1995.\nThe General Partners have the right, but not the obligation, to make additional capital contributions if they deem it appropriate in connection with the operations of the Partnership. During the year ended December 31, 1995, the corporate General Partner contributed $31,500 in connection with the operations of the Partnership. No such contributions were made during the years ended December 31, 1994 and 1993. In addition, in January 1996, the corporate General Partner contributed capital of $100,000 in connection with the operations of the Partnership.\nCurrently, rental income from the Partnership's Properties is invested in money market accounts or other short-term, highly liquid investments pending the Partnership's use of such funds to pay Partnership expenses or to make distributions to the partners. At December 31, 1995, the Partnership had $319,052 invested in such short-term investments as compared to $425,600 at December 31, 1994. The balance of funds at December 31, 1995, will be used for the payment of distributions and other liabilities.\nNone of the Properties owned by the Partnership or the joint ventures in which the Partnership owns an interest is or may be encumbered. Under its Partnership Agreement, the Partnership is prohibited from borrowing for any purpose; provided, however, that the General Partners or their affiliates are entitled to reimbursement, at cost, for actual expenses incurred by the General Partners or their affiliates on behalf of the Partnership. Affiliates of the General Partners from time to time incur certain operating expenses on behalf of the Partnership for which the Partnership reimburses the affiliates without interest.\nDuring 1995, 1994 and 1993, affiliates of the General Partners incurred on behalf of the Partnership $114,204, $126,417 and $107,496, respectively, for certain operating expenses. As of December 31, 1995 and 1994, the Partnership owed $61,519 and $19,934, respectively, to affiliates for such amounts and accounting and administrative services. Amounts payable to other parties, including distributions payable, increased to $673,098 at December 31, 1995, from $663,368 at December 31, 1994. Liabilities at December 31, 1995, to the extent they exceed cash and cash equivalents at December 31, 1995, will be paid from future cash from operations, from General Partner capital contributions of $100,000 received in January 1996, from amounts collected under the mortgage note described above or, in the event the General Partners elect to make additional capital contributions, from future General Partner contributions.\nBased primarily on current and anticipated future cash from operations, and to a lesser extent additional capital contributions from the General Partners, the Partnership declared distributions to the Limited Partners of $2,300,000 for each of the years ended December 31, 1995, 1994 and 1993. This represents distributions of $46 per Unit for each of the years ended December 31, 1995, 1994 and 1993. The Partnership intends to continue to make distributions of cash available for distribution to the Limited Partners on a quarterly basis.\nThe General Partners believe that the Properties are adequately covered by insurance. In addition, during 1995, the General Partners obtained contingent liability and property coverage for the Partnership. This insurance policy is intended to reduce the Partnership's exposure in the unlikely event a tenant's insurance policy lapses or is insufficient to cover a claim relating to the Property.\nThe Partnership's investment strategy of acquiring Properties for cash and generally leasing them under triple-net leases to operators who generally meet specified financial standards minimizes the Partnership's operating expenses. The General Partners believe that the leases will continue to generate cash flow in excess of operating expenses.\nDue to low operating expenses and ongoing cash flow, the General Partners do not believe that working capital reserves are necessary at this time. In addition, because all leases of the Partnership's Properties are on a triple-net basis, it is not anticipated that a permanent reserve for maintenance and repairs will be established at this time. To the extent, however, that the Partnership has insufficient funds for such purposes, the General Partners will contribute to the Partnership an aggregate amount of up to one percent of the offering proceeds for maintenance and repairs.\nResults of Operations\nDuring 1995, 1994 and 1993, the Partnership owned and leased 27 wholly owned Properties (including one Property in Myrtle Beach, South Carolina, which was sold in August 1995). In addition, during 1995, 1994 and 1993, the Partnership was a co-venturer in three separate joint ventures that each owned and leased one Property. As of December 31, 1995, the Partnership owned, either directly or through joint venture arrangements, 29 Properties which are, in general, subject to long-term, triple-net leases. The leases of the Properties provide for minimum base annual rental amounts (payable in monthly installments) ranging from approximately $37,800 to $150,400. Generally, the leases provide for percentage rent based on sales in excess of a specified amount to be paid annually. In addition, a majority of the leases provide that, commencing in the sixth lease year, the percentage rent will be an amount equal to the greater of the percentage rent calculated under the lease formula or a specified percentage (ranging from one-fourth to five percent) of either the purchase price paid by the Partnership for the Property or gross sales. For further description of the Partnership's leases and Properties, see Item 1. Business - Leases and Item 2. Properties, respectively.\nDuring the years ended December 31, 1995, 1994 and 1993, the Partnership and its consolidated joint venture, CNL\/Longacre Joint Venture, earned $2,068,342, $2,174,472 and $2,230,589, respectively, in rental income from operating leases and earned income from direct financing leases. Rental income in 1995, as compared to 1994, decreased approximately $51,400 as a result of the sale of its Property in Myrtle Beach, South Carolina, in August 1995, as described above in \"Liquidity and Capital Resources.\"\nIn addition, rental and earned income in 1995 and 1994, each as compared to the prior year, decreased approximately $51,000 and $36,700, respectively, as a result of the fact that in February 1994, the former tenant of the Properties in Belding and South Haven, Michigan, defaulted under the terms of its leases and the Partnership began accepting reduced rent on a month-to- month basis from a new operator as discussed above in Item 1. Business - Leases. The new operator ceased operations and rental payments for the Property in Belding, Michigan, in October 1994. In addition, in October 1995, the new operator ceased operations of the Property in South Haven, Michigan, after becoming delinquent with its rental payments. Due to the fact that the Partnership does not expect to receive any additional amounts from the original tenant of these Properties, the Partnership reversed all past due rental and other amounts relating to these two Properties, and the related allowance for doubtful accounts of approximately $153,800 for the year ended December 31, 1995. The Partnership currently is not receiving any rental income relating to these two Properties and the General Partners are seeking replacement tenants for these Properties.\nRental income in 1994, as compared to 1993, also decreased approximately $58,800 as a result of the Partnership's consolidated joint venture increasing its allowance for doubtful accounts for rental amounts unpaid by the tenant of the Property in Lebanon, New Hampshire. The tenant defaulted under the terms of the lease and in February 1995, ceased operations of the restaurant on the Property; therefore, the General Partners are currently seeking a replacement tenant for this Property. Due to the fact that the joint venture does not expect to receive any additional amounts relating to this Property from the former tenant, the joint venture reversed all past due rental and other amounts relating to this Property, and the related allowance for doubtful accounts of approximately $275,500 during 1995.\nRental and earned income for 1996 are expected to remain at reduced amounts until such time as the Partnership executes new leases for its Properties in Belding and South Haven, Michigan, and Lebanon, New Hampshire.\nRental and earned income also decreased approximately $16,300 during 1994, as compared to 1993, due to the fact that effective January 1994, the leases relating to the Properties in Daleville and New Castle, Indiana, were amended to provide for the payment of reduced annual rent with no scheduled rent increases. However, the lease amendments provide for lower percentage rent breakpoints, as compared to the original lease agreements, a change that is designed to result in higher annual percentage rent payments at any time that percentage rent becomes due. The General Partners anticipate that total rental payments under the amended leases will be equal to or greater than the original leases during the terms of the leases. As a result of the lease amendments, the lease relating to the Property in New Castle, Indiana, was reclassified from a direct financing lease to an operating lease during 1994.\nThe decrease in rental and earned income during 1994, was partially offset by (i) an increase of approximately $18,000 due to the fact that during 1993 the Partnership reversed accrued rental income previously recorded and associated with the former tenant of the Property in Franklin, Tennessee, and (ii) an increase of approximately $31,600 due to the fact that the Partnership entered into a new lease relating to this Property in August 1993, which resulted in a full year of rental income during 1994.\nFor the years ended December 31, 1995, 1994 and 1993, the Partnership earned $104,455, $115,011 and $113,375, respectively, in contingent rental income. The decrease in contingent rental income during 1995, as compared to 1994, is primarily attributable to a decrease in gross sales of certain restaurant Properties whose leases require the payment of contingent rental income. However, contingent rental income increased approximately $7,700 and $3,900 in 1995 and 1994, respectively, each as compared to the prior year, as a result of the lower percentage rent breakpoints provided for in the lease amendments for the Properties in Daleville and New Castle, Indiana, as described above. The increase in contingent rental income during 1994 was partially offset by a decrease as a result of (i) decreased gross sales relating to certain restaurant Properties and (ii) the default of the tenant of the Properties in Belding and South Haven, Michigan.\nDuring the years ended December 31, 1995, 1994 and 1993, the Partnership earned $83,180, $11,002 and $14,252 in interest and other income. The increase in interest and other income during 1995, as compared to 1994, was primarily attributable to the interest earned on the mortgage note receivable accepted in connection with the sale of the Property in Myrtle Beach, South Carolina, in August 1995. Interest and other income also increased during 1995, as compared to 1994, as the result of recognizing storage income from holding the restaurant equipment of the former tenant of the Property in Lebanon, New Hampshire, on behalf of the tenant's lender, who repossessed the restaurant equipment from the tenant.\nIn addition, for the years ended December 31, 1995, 1994 and 1993, the Partnership earned $47,018, $47,219 and $45,711, respectively, attributable to net income earned by unconsolidated joint ventures in which the Partnership is a co-venturer.\nDuring the years ended December 31, 1995, 1994 and 1993, one lessee of the Partnership and its consolidated joint venture, Shoney's, Inc., contributed more than ten percent of the Partnership's total rental income (including rental income from the Partnership's consolidated joint venture and the Partnership's share of the rental income from two Properties owned by unconsolidated joint ventures). As of December 31, 1995, Shoney's, Inc. was the lessee under leases relating to four restaurants. It is anticipated that, based on the minimum rental payments required by the leases, Shoney's, Inc. will continue to contribute more than ten percent of the Partnership's total rental income during 1996 and subsequent years. In addition, three Restaurant Chains, Perkins, Denny's and Wendy's Old Fashioned Hamburger Restaurants, each accounted for more than ten percent of the Partnership's total rental income in 1995 (including rental income from the Partnership's consolidated joint venture and the Partnership's share of the rental income from two Properties owned by unconsolidated joint ventures). In subsequent years, it is anticipated that these three Restaurant Chains each will continue to account for more than ten percent of the total rental income to which the Partnership is entitled under the terms of the leases. Any failure of Shoney's, Inc. or these Restaurant Chains could materially affect the Partnership's income.\nOperating expenses, including depreciation and amortization expense, were $640,922, $611,952 and $626,892 for the years ended December 31, 1995, 1994 and 1993, respectively. Operating expenses increased during 1995 primarily as the result of an increase in (i) accounting and administrative expenses associated with operating the Partnership and its Properties and (ii) insurance expense as a result of the General Partners' obtaining contingent liability and property coverage for the Partnership as discussed above in \"Liquidity and Capital Resources.\"\nThe decrease in operating expenses during 1994, as compared to 1993, was partially attributable to the fact that in 1993, CNL\/Longacre Joint Venture incurred taxes relating to the filing of various state tax returns and the Partnership incurred expenses in locating a new tenant for the Property in Franklin, Tennessee. In addition, during 1993, the Partnership expensed approximately $17,700 in unamortized lease costs relating to the lease with the former tenant of the Property in Franklin, Tennessee. No such amounts were incurred in 1994 or 1995.\nDuring the year ended December 31, 1994, the Partnership recorded a loss upon the termination of the leases relating to the Properties in Belding and South Haven, Michigan. As a result of the lease terminations, the Partnership reclassified these leases from direct financing leases to operating leases, whereby the Properties were recorded at cost. Due to the fact that the net carrying value of the Properties as direct financing leases exceeded the cost of the Properties, the Partnership recognized a loss during 1994 for financial reporting purposes only. In addition, the Partnership accrued approximately $26,500, $38,900 and $22,700 during the years ended December 31, 1995, 1994 and 1993, for real estate taxes relating to these two Properties. The Partnership expects to continue to incur real estate tax and other expenses relating to these two Properties until such time as new leases are executed for such Properties.\nOperating expenses during 1995 and 1993 also included approximately $20,600 and $48,400, respectively, in real estate taxes relating to the Property in Lebanon, New Hampshire, as to which the tenant defaulted under the terms of its lease and in February 1995, ceased operations of the restaurant Property. The tenant was responsible for payment of the taxes; however, the Partnership accrued amounts in 1993 relating to the current and prior years due to the fact that the tenant had not paid the taxes. During 1994, the Partnership collected escrowed real estate taxes from the tenant sufficient to pay the 1994 taxes; therefore, no expense was recorded for 1994. The Partnership expects to continue to incur real estate tax and other expenses relating to the Property in Lebanon, New Hampshire, until such time as a new lease is executed for such Property.\nDepreciation expense decreased during 1995, as compared to 1994, as a result of the sale of the Property in Myrtle Beach, South Carolina. In addition, depreciation expense increased during 1994, as compared to 1993, due to the reclassification of the leases relating to the Properties in New Castle, Indiana, and Belding and South Haven, Michigan, from direct financing leases to operating leases during 1994.\nIn addition, in connection with the sale of its Property in Myrtle Beach, South Carolina, as described above in \"Liquidity and Capital Resources,\" for $1,040,000, the Partnership recognized a gain for financial reporting purposes of $1,571 for the year ended December 31, 1995. In accordance with Statement of Financial Accounting Standards No. 66, \"Accounting for Sales of Real Estate,\" the Partnership recorded the sale using the installment sales method. As such, the gain on sale was deferred and is being recognized as income proportionately as payments under the mortgage note are collected. Therefore, the balance of the deferred gain of $141,641 at December 31, 1995, will be recognized as income in future periods as payments are collected. For federal income tax purposes, a gain of approximately $136,900 from the sale of this Property was also deferred and is being recognized as payments under the mortgage note are collected. In October 1995, the Partnership also sold a portion of the land relating to its Property in Daleville, Indiana, as the result of a right of way taking and recognized a gain for financial reporting purposes of $4,353 during the year ended December 31, 1995. No Properties were sold during the years ended December 31, 1994 and 1993.\nIn March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.\" The Statement, which is effective for fiscal years beginning after December 15, 1995, requires that an entity review long-lived assets and certain identifiable intangibles, to be held and used, for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. The Partnership will adopt this standard in 1996. The General Partners believe that adoption of this standard currently would not have had a material effect on the Partnership's financial position or results of operations.\nThe Partnership's leases as of December 31, 1995, are, in general, triple-net leases and contain provisions that the General Partners believe mitigate the adverse effect of inflation. Such provisions include clauses requiring the payment of percentage rent based on certain restaurant sales above a specified level and\/or automatic increases in base rent at specified times during the term of the lease. Management expects that increases in restaurant sales volumes due to inflation and real sales growth should result in an increase in rental income over time. Continued inflation also may cause capital appreciation of the Partnership's Properties. Inflation and changing prices, however, also may have an adverse impact on the operating margins of the restaurants and on potential capital appreciation of the Properties.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nCNL INCOME FUND V, LTD. (A Florida Limited Partnership)\nCONTENTS --------\nPage ----\nReport of Independent Accountants 13\nFinancial Statements:\nBalance Sheets 14\nStatements of Income 15\nStatements of Partners' Capital 16\nStatements of Cash Flows 17\nNotes to Financial Statements 20\nReport of Independent Accountants ---------------------------------\nTo the Partners CNL Income Fund V, Ltd.\nWe have audited the financial statements and the financial statement schedules of CNL Income Fund V, Ltd. (a Florida limited partnership) listed in Item 14(a) of this Form 10-K. 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 financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of CNL Income Fund V, Ltd. as of December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995 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.\n\/s\/Coopers & Lybrand L.L.P.\nOrlando, Florida January 20, 1996\nCNL INCOME FUND V, LTD. (A Florida Limited Partnership)\nBALANCE SHEETS --------------\nDecember 31, ASSETS 1995 1994 ----------- -----------\nLand and buildings on operating leases, less accumulated depreciation $16,640,635 $17,935,158 Net investment in direct financing leases 1,987,793 2,033,245 Investment in joint ventures 473,138 479,525 Mortgage note receivable, less deferred gain 895,736 - Cash and cash equivalents 319,052 425,600 Receivables, less allowance for doubtful accounts of $4,490 and $430,464 68,204 81,731 Prepaid expenses 11,921 11,387 Accrued rental income 309,357 278,873 Other assets 54,346 54,346 ----------- -----------\n$20,760,182 $21,299,865 =========== ===========\nLIABILITIES AND PARTNERS' CAPITAL\nAccounts payable $ 13,963 $ 4,562 Accrued and escrowed real estate taxes payable 84,135 83,806 Distributions payable 575,000 575,000 Due to related parties 61,519 19,934 Rents paid in advance 29,370 19,865 ----------- ----------- Total liabilities 763,987 703,167\nMinority interest 301,435 313,258\nPartners' capital 19,694,760 20,283,440 ----------- -----------\n$20,760,182 $21,299,865 =========== ===========\nSee accompanying notes to financial statements.\nCNL INCOME FUND V, LTD. (A Florida Limited Partnership)\nSTATEMENTS OF INCOME --------------------\nYear Ended December 31, 1995 1994 1993 ---------- ---------- ----------\nRevenues: Rental income from operating leases $1,878,584 $1,980,954 $1,858,993 Earned income from direct financing leases 189,758 193,518 371,596 Contingent rental income 104,455 115,011 113,375 Interest and other income 83,180 11,002 14,252 ---------- ---------- ---------- 2,255,977 2,300,485 2,358,216 ---------- ---------- ----------\nExpenses: General operating and administra- tive 157,741 94,279 110,863 Professional services 20,741 24,641 37,231 Bad debt expense 1,541 4,788 - Real estate taxes 47,182 36,926 71,907 State and other taxes 15,982 17,740 44,472 Loss on termination of direct financing leases - 30,431 - Depreciation and amortization 397,735 403,147 362,419 ---------- ---------- ---------- 640,922 611,952 626,892 ---------- ---------- ----------\nIncome Before Minority Interest in Loss of Consolidated Joint Venture, Equity in Earnings of Unconsolidated Joint Ventures and Gain on Sale of Land and Building 1,615,055 1,688,533 1,731,324\nMinority Interest in Loss of Consolidated Joint Venture 11,823 7,277 17,859\nEquity in Earnings of Unconsoli- dated Joint Ventures 47,018 47,219 45,711\nGain on Sale of Land and Building 5,924 - - ---------- ---------- ----------\nNet Income $1,679,820 $1,743,029 $1,794,894 ========== ========== ==========\nAllocation of Net Income: General partners $ 16,754 $ 17,430 $ 17,949 Limited partners 1,663,066 1,725,599 1,776,945 ---------- ---------- ----------\n$1,679,820 $1,743,029 $1,794,894 ========== ========== ==========\nNet Income Per Limited Partner Unit $ 33.26 $ 34.51 $ 35.54 ========== ========== ==========\nWeighted Average Number of Limited Partner Units Outstanding 50,000 50,000 50,000 ========== ========== ==========\nSee accompanying notes to financial statements.\nCNL INCOME FUND V, LTD. (A Florida Limited Partnership)\nSTATEMENTS OF CASH FLOWS ------------------------\nYear Ended December 31, 1995 1994 1993 ----------- ----------- -----------\nIncrease (Decrease) in Cash and Cash Equivalents:\nCash Flows from Operating Activities: Cash received from tenants $ 2,216,111 $ 2,272,510 $ 2,349,015 Distributions from uncon- solidated joint ventures 53,405 52,701 52,571 Cash paid for expenses (173,597) (155,948) (196,578) Interest received 46,999 7,816 10,650 ----------- ----------- ----------- Net cash provided by operating activities 2,142,918 2,177,079 2,215,658 ----------- ----------- -----------\nCash Flows from Investing Activities: Proceeds from sale of portion of land for right of way purposes 7,625 - - Collections on mortgage note receivable 11,409 - - ----------- ----------- ----------- Net cash provided by investing activities 19,034 - - ----------- ----------- -----------\nCash Flows from Financing Activities: Contributions from general partner 31,500 - - Distributions to limited partners (2,300,000) (2,300,000) (1,735,129) Distributions to holder of minority interest - - (10,725) ----------- ----------- ----------- Net cash used in financing activities (2,268,500) (2,300,000) (1,745,854) ----------- ----------- -----------\nNet Increase (Decrease) in Cash and Cash Equivalents (106,548) (122,921) 469,804\nCash and Cash Equivalents at Beginning of Year 425,600 548,521 78,717 ----------- ----------- -----------\nCash and Cash Equivalents at End of Year $ 319,052 $ 425,600 $ 548,521 =========== =========== ===========\nReconciliation of Net Income to Net Cash Provided by Operating Activities:\nNet income $ 1,679,820 $ 1,743,029 $ 1,794,894 ----------- ----------- ----------- Adjustments to reconcile net income to net cash provided by operating activities: Loss on termination of direct financing leases - 30,431 - Depreciation 397,735 402,980 341,680 Minority interest in loss of consolidated joint venture (11,823) (7,277) (17,859) Amortization - 167 20,739 Equity in earnings of unconsolidated joint ventures, net of distributions 6,387 5,482 6,860 Gain on sale of land and building (5,924) - - Increase in accrued interest on mortgage note receivable (8,786) - - Decrease in receivables 13,527 13,656 15,871 Decrease (increase) in prepaid expenses (534) 1,383 (4,262) Decrease in net investment in direct financing leases 42,180 38,532 24,185 Increase in accrued rental income (30,484) (64,929) (36,637) Increase in accounts payable and accrued expenses 9,730 3,982 64,276 Increase in due to related parties 41,585 10,513 5,334 Increase (decrease) in rents paid in advance 9,505 (870) 577 ----------- ----------- ----------- Total adjustments 463,098 434,050 420,764 ----------- ----------- -----------\nNet Cash Provided by Operating Activities $ 2,142,918 $ 2,177,079 $ 2,215,658 =========== =========== ===========\nSupplemental Schedule of Non-Cash Investing and Financing Activities:\nNet investment in direct financing leases reclassi- fied to land and buildings on operating leases as a result of lease amendment or termination $ - $ 1,987,609 $ - =========== =========== ===========\nMortgage note accepted in connection with sale of land and building $ 1,040,000 $ - $ - =========== =========== ===========\nDistributions declared and unpaid at December 31 $ 575,000 $ 575,000 $ 575,000 =========== =========== ===========\nSee accompanying notes to financial statements.\nCNL INCOME FUND V, LTD. (A Florida Limited Partnership)\nNOTES TO FINANCIAL STATEMENTS -----------------------------\nYears Ended December 31, 1995, 1994 and 1993\n1. Significant Accounting Policies: -------------------------------\nOrganization and Nature of Business - CNL Income Fund V, Ltd. (the \"Partnership\") is a Florida limited partnership that was organized for the purpose of acquiring both newly constructed and existing restaurant properties, as well as properties upon which restaurants were to be constructed, which are leased primarily to operators of national and regional fast-food and family-style restaurant chains.\nThe general partners of the Partnership are CNL Realty Corporation (the \"Corporate General Partner\"), James M. Seneff, Jr. and Robert A. Bourne. Mr. Seneff and Mr. Bourne are also 50 percent shareholders of the Corporate General Partner. The general partners have responsibility for managing the day-to-day operations of the Partnership.\nLand and Buildings on Operating Leases - Generally, land and buildings on operating leases are stated at cost. Buildings are depreciated using the straight-line method over their estimated useful lives ranging from 25 to 30 years. When properties are sold, the related cost and accumulated depreciation are removed from the accounts and gains and losses from sales are reflected in income in accordance with Statement of Financial Accounting Standards No. 66, \"Accounting for Sales of Real Estate.\" For any sales in which the installment sales method applies, gain resulting from the sale of land and building is deferred and the gain is recognized proportionately as the sales value is collected. For any sales in which the full accrual method applies, gain resulting from the sale of land and building is recognized at the date of sale and is reflected in income.\nThe properties will be written down to net realizable value in the event the general partners believe that the undepreciated cost cannot be recovered through operations. The general partners determine whether an impairment in value has occurred by comparing the estimated undiscounted future cash flows with the carrying cost of the individual properties.\nLease Accounting and Rental Income - Land and buildings are leased to others on a triple-net lease basis, whereby the tenant is generally responsible for all operating expenses relating to the property, including property taxes, insurance, maintenance and repairs.\nThe leases are accounted for using either the direct financing or the operating method. Such methods are described below:\nDirect financing method - Leases accounted for using the direct financing method are recorded at their net investment (Note 4). Unearned income is deferred and amortized to income over the lease terms so as to produce a constant periodic rate of return on the Partnership's net investment in the lease.\nOperating method - Generally, land and buildings are recorded at cost, revenue is recognized as rentals are earned and depreciation is charged to operations as incurred. When scheduled rentals vary during the lease term, income is recognized on a straight-line basis over the lease term so as to produce a constant periodic rent. Accrued rental income is the aggregate difference between the scheduled rents which vary during the lease term and the income recognized on a straight-line basis.\nWhen the collection of amounts recorded as rental or other income are considered to be doubtful, an adjustment is made to increase the allowance for doubtful accounts, which is netted against receivables, and to decrease rental or other income or increase bad debt expense for the current period, although the Partnership continues to pursue collection of such amounts. If amounts are subsequently determined to be uncollectible, the corresponding receivable and allowance for doubtful accounts are decreased accordingly.\nInvestment in Joint Ventures - The Partnership accounts for its 66.5% interest in CNL\/Longacre Joint Venture, a Florida general partnership, using the consolidation method. Minority interest represents the minority joint venture partner's proportionate share of the equity in the Partnership's consolidated joint venture. All significant intercompany accounts and transactions have been eliminated.\nThe Partnership's investments in Cocoa Joint Venture and Halls Joint Venture are accounted for using the equity method since the Partnership shares control with affiliates which have the same general partners.\nCash 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 and cash equivalents consist of demand deposits at commercial banks, money market funds and overnight repurchase agreements backed by government securities. Cash equivalents are stated at cost plus accrued interest, which approximates market value.\nCash accounts maintained on behalf of the Partnership in demand deposits at commercial banks and money market funds may exceed federally insured levels; however, the Partnership has not experienced any losses in such accounts. The Partnership limits investment of temporary cash investments to financial institutions with high credit standing; therefore, the Partnership believes it is not exposed to any significant credit risk on cash and cash equivalents.\nIncome Taxes - Under Section 701 of the Internal Revenue Code, all income, expenses and tax credit items flow through to the partners for tax purposes. Therefore, no provision for federal income taxes is provided in the accompanying financial statements. The Partnership is subject to certain state taxes on its income and properties.\nAdditionally, for tax purposes, syndication costs are included in Partnership equity and in the basis of each partner's investment. For financial reporting purposes, syndication costs are netted against partners' capital and represent a reduction of Partnership equity and a reduction in the basis of each partner's investment.\nUse of Estimates - The general partners of the Partnership have made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare these financial statements in conformity with generally accepted accounting principles. Actual results could differ from those estimates.\nReclassification - Certain items in the prior years' financial statements have been reclassified to conform to 1995 presentation. These reclassifications had no effect on partners' capital or net income.\nNew Accounting Standard - In March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long- Lived Assets to Be Disposed Of.\" The Statement, which is effective for fiscal years beginning after December 15, 1995, requires that an entity review long-lived assets and certain identifiable intangibles, to be held and used, for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. The Partnership will adopt this standard in 1996. The general partners believe that adoption of this standard currently would not have had a material effect on the Partnership's financial position or results of operations.\n2. Leases: ------\nThe Partnership leases its land and buildings primarily to operators of national and regional fast-food and family-style restaurants. The leases are accounted for under the provisions of Statement of Financial Accounting Standards No. 13, \"Accounting for Leases.\" The leases generally are classified as operating leases; however, four leases have been classified as direct financing leases. Substantially all leases are for 15 to 20 years and provide for minimum and contingent rentals. In addition, the tenant generally pays all property taxes and assessments, fully maintains the interior and exterior of the building and carries insurance coverage for public liability, property damage, fire and extended coverage. The lease options generally allow tenants to renew the leases for two to four successive five-year periods subject to the same terms and conditions as the initial lease. Most leases also allow the tenant to purchase the property at fair market value after a specified portion of the lease has elapsed.\n3. Land and Buildings on Operating Leases: --------------------------------------\nLand and buildings on operating leases consisted of the following at December 31:\n1995 1994 ----------- -----------\nLand $ 7,666,704 $ 7,926,931 Buildings 11,102,384 11,881,287 ----------- ----------- 18,769,088 19,808,218 Less accumulated depreciation (2,128,453) (1,873,060) ----------- -----------\n$16,640,635 $17,935,158 =========== ===========\nIn August 1995, the Partnership sold its property in Myrtle Beach, South Carolina, to the tenant for $1,040,000 and accepted the sales proceeds in the form of a promissory note (Note 6). The total carrying value of the property was $896,788, including acquisition fees and miscellaneous acquisition expenses and net of accumulated depreciation. As a result of this sale being accounted for using the installment sales method for financial reporting purposes as required by Statement of Financial Accounting Standards No. 66, \"Accounting for Sales of Real Estate,\" the Partnership recognized a gain of $1,571 for the year ended December 31, 1995, and had a deferred gain in the amount of $141,641 at December 31, 1995 (Note 6).\nSome leases provide for escalating guaranteed minimum rents throughout the lease terms. Income from these scheduled rent increases is recognized on a straight-line basis over the terms of the leases. For the years ended December 31, 1995, 1994 and 1993, the Partnership recognized $30,484, $64,929 and $36,637, respectively, of such rental income.\nThe following is a schedule of the future minimum lease payments to be received on noncancellable operating leases at December 31, 1995:\n1996 $ 1,744,714 1997 1,727,951 1998 1,698,635 1999 1,708,363 2000 1,736,212 Thereafter 13,610,416 -----------\n$22,226,291 ===========\n4. Net Investment in Direct Financing Leases: -----------------------------------------\nThe following lists the components of the net investment in direct financing leases at December 31:\n1995 1994 ----------- -----------\nMinimum lease payments receivable $ 3,043,263 $ 3,275,201 Estimated residual values 828,783 832,055 Less unearned income (1,884,253) (2,074,011) ----------- -----------\nNet investment in direct financing leases $ 1,987,793 $ 2,033,245 =========== ===========\nThe following is a schedule of future minimum lease payments to be received on direct financing leases at December 31, 1995:\n1996 $ 231,938 1997 231,938 1998 231,938 1999 231,938 2000 231,938 Thereafter 1,883,573 ----------\n$3,043,263 ==========\nIn October 1995, the Partnership sold a portion of land relating to its Property in Daleville, Indiana, in connection with a right of way taking and received sales proceeds of $7,625. In connection therewith, the Partnership recognized a gain of $4,353 for financial reporting purposes for the year ended December 31, 1995.\nDuring the year ended December 31, 1994, two of the Partnership's leases were terminated. As a result of the lease terminations, the Partnership reclassified these leases from direct financing leases to operating leases, whereby the properties were recorded at cost. Due to the fact that the net carrying value of the properties as direct financing leases exceeded the cost of the properties, the Partnership recognized a loss of $30,431 for financial reporting purposes for the year ended December 31, 1994.\n5. Investment in Joint Ventures: ----------------------------\nThe Partnership has a 43 percent and a 49 percent interest in the profits and losses of Cocoa Joint Venture and Halls Joint Venture, respectively. The remaining interests in these joint ventures are held by affiliates of the Partnership which have the same general partners.\nCocoa Joint Venture and Halls Joint Venture each own and lease one property to an operator of national fast-food or family-style restaurants. The following presents the joint ventures' combined, condensed financial information at December 31:\n1995 1994 ---------- ---------- Land and buildings on operating leases, less accumulated depreciation $ 967,182 $ 987,958 Cash 112 373 Prepaid expenses 80 - Accrued rental income 58,970 52,035 Other assets - 11 Liabilities 447 644 Partners' capital 1,025,897 1,039,733 Revenues 124,356 124,058 Net income 100,215 100,632\nThe Partnership recognized income totalling $47,018, $47,219 and $45,711 for the years ended December 31, 1995, 1994 and 1993, respectively, from these joint ventures.\n6. Mortgage Note Receivable: ------------------------\nIn connection with the sale of its property in Myrtle Beach, South Carolina, the Partnership accepted a promissory note in the principal sum of $1,040,000, collateralized by a mortgage on the property. The promissory note bears interest at 10.25% per annum and is being collected in 59 equal monthly installments of $9,319, with a balloon payment of $1,006,004 due in July 2000.\nThe mortgage note receivable consisted of the following at December 31, 1995:\nPrincipal balance $1,028,591 Accrued interest receivable 8,786 Less deferred gain on sale of land and building (141,641) ----------\n$ 895,736 ==========\nStatement of Financial Accounting Standards No. 107, \"Disclosures About Fair Value of Financial Instruments,\" requires disclosure of the year- end fair value of significant financial instruments. The general partners believe, based upon the current terms, that the estimated fair value of the Partnership's mortgage note receivable is $1,037,377. The difference between the carrying value and the estimated fair value of the mortgage note receivable represents the deferred gain on the sale of land and building that is being recognized as income proportionately as payments under the note are collected.\n7. Allocations and Distributions: -----------------------------\nAll net income and net losses of the Partnership, excluding gains and losses from the sale of properties, are allocated 99 percent to the limited partners and one percent to the general partners. Distributions of net cash flow are made 99 percent to the limited partners and one percent to the general partners; provided, however, that the one percent of net cash flow to be distributed to the general partners is subordinated to receipt by the limited partners of an aggregate, ten percent, cumulative, noncompounded annual return on their adjusted capital contributions (the \"10% Preferred Return\").\nGenerally, net sales proceeds from the sale of properties, to the extent distributed, will be distributed first to the limited partners in an amount sufficient to provide them with their 10% Preferred Return, plus the return of their adjusted capital contributions. The general partners will then receive, to the extent previously subordinated and unpaid, a one percent interest in all prior distributions of net cash flow and a return of their capital contributions. Any remaining sales proceeds will be distributed 95 percent to the limited partners and five percent to the general partners.\nAny gain from the sale of a property is,in general, allocated in the same manner as net sales proceeds are distributable. Any loss from the sale of a property is, in general, allocated first, on a pro rata basis, to partners with positive balances in their capital accounts; and thereafter, 95 percent to the limited partners and five percent to the general partners.\nDuring each of the years ended December 31, 1995, 1994 and 1993, the Partnership declared distributions to the limited partners of $2,300,000. No distributions have been made to the general partners to date.\n8. Income Taxes: ------------\nThe following is a reconciliation of net income for financial reporting purposes to net income for federal income tax purposes for the years ended December 31:\n1995 1994 1993 ---------- ---------- ----------\nNet income for financial reporting purposes $1,679,820 $1,743,029 $1,794,894\nDepreciation for tax reporting purposes in excess of depreciation for financial reporting purposes (26,980) (31,009) (92,309)\nGain on disposition of land and building for financial reporting purposes in excess of gain for tax reporting purposes (69) - -\nDirect financing leases recorded as operating leases for tax reporting purposes 42,180 38,532 24,185\nLoss on termination of direct financing leases - 30,431 -\nEquity in earnings of unconsolidated joint ventures for tax reporting purposes less than equity in earnings of unconsolidated joint ventures for financial reporting purposes (2,926) (3,954) (2,448)\nAllowance for doubtful accounts (150,480) 35,321 8,239\nAccrued rental income (30,484) (64,929) (36,637)\nRents paid in advance 9,505 (870) 577\nMinority interest in timing differences of consolidated joint venture (370) (370) 36,952 ---------- ---------- ----------\nNet income for federal income tax purposes $1,520,196 $1,746,181 $1,733,453 ========== ========== ==========\n9. Related Party Transactions: --------------------------\nOne of the individual general partners, James M. Seneff, Jr., is one of the principal shareholders of CNL Group, Inc., the parent company of CNL Investment Company and CNL Fund Advisors, Inc. The other individual general partner, Robert A. Bourne, is the president of CNL Investment Company and CNL Fund Advisors, Inc. CNL Income Fund Advisors, Inc. was a wholly owned subsidiary of CNL Group, Inc. until its merger, effective January 1, 1996, with CNL Fund Advisors, Inc. During the years ended December 31, 1995, 1994 and 1993, CNL Investment Company, CNL Income Fund Advisors, Inc. and CNL Fund Advisors, Inc. (hereinafter referred to collectively as the \"Affiliates\") each performed certain services for the Partnership, as described below.\nDuring the years ended December 31, 1995, 1994 and 1993, certain Affiliates acted as manager of the Partnership's properties pursuant to a management agreement with the Partnership. In connection therewith, the Partnership agreed to pay the Affiliates a management fee of one percent of the sum of gross revenues from properties wholly owned by the Partnership and the Partnership's allocable share of gross revenues from joint ventures, but not in excess of competitive fees for comparable services. These fees are payable only after the limited partners receive their 10% Preferred Return. Due to the subordinated nature of these fees, no management fees have been incurred since inception.\nCertain Affiliates are also entitled to receive a deferred, subordinated real estate disposition fee, payable upon the sale of one or more properties based on the lesser of one-half of a competitive real estate commission or three percent of the sales price if the Affiliates provide a substantial amount of services in connection with the sale. In addition, the real estate disposition fee is subordinated to receipt by the limited partners of their aggregate 10% Preferred Return, plus their adjusted capital contributions. No deferred, subordinated real estate disposition fees have been incurred since inception.\nDuring the years ended December 31, 1995, 1994 and 1993, the Affiliates provided accounting and administrative services to the Partnership on a day-to-day basis. The Partnership incurred $83,882, $47,314 and $42,252 for the years ended December 31, 1995, 1994 and 1993, respectively, for such services.\nThe due to related parties at December 31, 1995 and 1994 of $61,519 and $19,934, respectively, represents amounts due to Affiliates for accounting and administrative services and for expenditures incurred on behalf of the Partnership.\n10. Concentration of Credit Risk: ----------------------------\nFor the years ended December 31, 1995, 1994 and 1993, total rental and earned income from Shoney's, Inc. was $247,353, $248,176 and $253,355, respectively, each representing more than ten percent of the Partnership's total rental and earned income (including the Partnership's share of total rental and earned income from joint ventures).\nIn addition, the following schedule presents total rental and earned income from individual restaurant chains, each representing more than ten percent of the Partnership's total rental and earned income (including the Partnership's share of total rental and earned income from joint ventures) for at least one of the years ended December 31:\n1995 1994 1993 -------- -------- --------\nDenny's $314,057 $307,596 $321,062 Wendy's Old Fashioned Hamburger Restaurant 278,127 280,075 293,096 Perkins 226,898 278,754 283,595 Hardees 183,123 237,671 273,317\nAlthough the Partnership's properties are geographically diverse and the Partnership's lessees operate a variety of restaurant concepts, failure of any one of these lessees or restaurant chains, could significantly impact the results of operations of the Partnership. However, the general partners believe that the risk of such a default is reduced due to the essential or important nature of these properties for the on- going operations of the lessees.\n11. Subsequent Event: ----------------\nIn January 1996, the corporate general partner contributed capital of $100,000 in connection with the operations of the Partnership.\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 General Partners of the Registrant are James M. Seneff, Jr., Robert A. Bourne and CNL Realty Corporation, a Florida corporation. The General Partners manage and control the Partnership's affairs and have general responsibility and the ultimate authority in all matters affecting the Partnership's business. The Partnership has available to it the services, personnel and experience of CNL Investment Company, CNL Fund Advisors, Inc., and CNL Group, Inc. and its affiliates, all of which are affiliates of the General Partners. In addition, during 1995, the Partnership had available to it the services, personnel and experience of CNL Income Fund Advisors, Inc., prior to its merger with CNL Fund Advisors, Inc., effective January 1, 1996.\nJames M. Seneff, Jr., age 49, is a principal stockholder of CNL Group, Inc., a diversified real estate company, and has served as its Chairman of the Board of Directors and Chief Executive Officer since its formation in 1973. CNL Group, Inc. is the parent company of CNL Securities Corp., CNL Investment Company, CNL Fund Advisors, Inc., and prior to its merger with CNL Fund Advisors, Inc., effective January 1, 1996, CNL Income Fund Advisors, Inc. Mr. Seneff has been a director and registered principal of CNL Securities Corp., which served as the managing dealer in the Partnership's offering of Units, since its formation in 1979. Mr. Seneff also has held the position of President and a director of CNL Management Company, a registered investment advisor, since its formation in 1976, has served as Chairman of the Board and Chief Executive Officer of CNL Investment Company and Chief Executive Officer and Chairman of the Board of Commercial Net Lease Realty, Inc. since 1992, has served as Chairman of the Board and Chief Executive Officer of CNL Realty Advisors, Inc. since its inception in 1991, served as Chairman of the Board and Chief Executive Officer of CNL Income Fund Advisors, Inc. since its inception in 1994 through December 31, 1995, has served as Chairman of the Board and Chief Executive Officer of CNL Fund Advisors, Inc. since its inception in 1994, and has held the position of Chief Executive Officer and a director of CNL Institutional Advisors, Inc., a registered investment advisor, since its inception in 1990. Mr. Seneff previously served on the Florida State Commission on Ethics and is a former member and past Chairman of the Florida Investment Advisory Council, which recommends to the Florida Board of Administration investments for various Florida employee retirement funds. The Florida Board of Administration, Florida's principal investment advisory and money management agency, oversees the investment of more than $40 billion of retirement funds. Since 1971, Mr. Seneff has been active in the acquisition, development and management of real estate projects and, directly or through an affiliated entity, has served as a general partner or joint venturer in approximately 100 real estate ventures involved in the financing, acquisition, construction and rental of office buildings, apartment complexes, restaurants, hotels and other real estate. Included in these 100 real estate ventures are approximately 57 privately offered real estate limited partnerships in which Mr. Seneff, directly or through an affiliated entity, serves or has served as a general partner. Also included are CNL Income Fund, Ltd., CNL Income Fund II, Ltd., CNL Income Fund III, Ltd., CNL Income Fund IV, Ltd., CNL Income Fund VI, Ltd., CNL Income Fund VII, Ltd., CNL Income Fund VIII, Ltd., CNL Income Fund IX, Ltd., CNL Income Fund X, Ltd., CNL Income Fund XI, Ltd., CNL Income Fund XII, Ltd., CNL Income Fund XIII, Ltd., CNL Income Fund XIV, Ltd., CNL Income Fund XV, Ltd., CNL Income Fund XVI, Ltd., CNL Income Fund XVII, Ltd. and CNL Income Fund XVIII, Ltd. (the \"CNL Income Fund Partnerships\"), public real estate limited partnerships with investment objectives similar to those of the Partnership, in which Mr. Seneff serves as a general partner. Mr. Seneff received his degree in Business Administration from Florida State University in 1968.\nRobert A. Bourne, age 48, is President and Treasurer of CNL Group, Inc., President, a director and a registered principal of CNL Securities Corp., President and a director of CNL Investment Company, CNL Fund Advisors, Inc., and prior to its merger with CNL Fund Advisors, Inc., effective January 1, 1996, CNL Income Fund Advisors, Inc., and President, Chief Investment Officer and a director of CNL Institutional Advisors, Inc., a registered investment advisor. Mr. Bourne also has served as a director since 1992, as President from July 1992 to February 1996, as Vice Chairman of the Board of Directors, Secretary and Treasurer and since February 1996, of Commercial Net Lease Realty, Inc. In addition, Mr. Bourne has served as a director since its inception in 1991, as President from 1991 to February 1996, and as Secretary and Treasurer since February 1996, of CNL Realty Advisors, Inc. Upon graduation from Florida State University in 1970, where he received a B.A. in Accounting, with honors, Mr. Bourne worked as a certified public accountant and, from September 1971 through December 1978, was employed by Coopers & Lybrand, Certified Public Accountants, where he held the position of tax manager beginning in 1975. From January 1979 until June 1982, Mr. Bourne was a partner in the accounting firm of Cross & Bourne and from July 1982 through January 1987, he was a partner in the accounting firm of Bourne & Rose, P. A., Certified Public Accountants. Mr. Bourne, who joined CNL Securities Corp. in 1979, has participated as a general partner or joint venturer in approximately 100 real estate ventures involved in the financing, acquisition, construction and rental of office buildings, apartment complexes, restaurants, hotels and other real estate. Included in these 100 real estate ventures are approximately 57 privately offered real estate limited partnerships in which Mr. Bourne, directly or through an affiliated entity, serves or has served as a general partner. Also included are the CNL Income Fund Partnerships, public real estate limited partnerships with investment objectives similar to those of the Partnership, in which Mr. Bourne serves as a general partner.\nCNL Realty Corporation is a corporation organized on November 26, 1985, under the laws of the State of Florida. Its sole directors and shareholders are James M. Seneff, Jr. and Robert A. Bourne, the individual General Partners. CNL Realty Corporation was organized to serve as the corporate general partner of real estate limited partnerships, such as the Partnership, organized by one or both of the individual General Partners. CNL Realty Corporation currently serves as the corporate general partner of the CNL Income Fund Partnerships.\nCNL Investment Company, which through December 31, 1994, provided certain management services in connection with the Partnership and its Properties, is a corporation organized in 1990 under the laws of the State of Florida. Its principal office is located at 400 East South Street, Suite 500, Orlando, Florida 32801. CNL Investment Company is a wholly owned subsidiary of CNL Group, Inc., a diversified real estate company, and was organized to perform property acquisition, property management and other services.\nCNL Income Fund Advisors, Inc., for the period January 1, 1995 through September 30, 1995, provided certain management services in connection with the Partnership and its Properties following the assignment by CNL Investment Company of its rights and obligations under the management agreement. CNL Income Fund Advisors, Inc. was a corporation organized in 1994 under the laws of the State of Florida, and its principal office was located at 400 East South Street, Suite 500, Orlando, Florida 32801. CNL Income Fund Advisors, Inc. was a wholly owned subsidiary of CNL Group, Inc., a diversified real estate company, and was organized to perform property acquisition, property management and other services. CNL Income Fund Advisors, Inc. merged with CNL Fund Advisors, Inc. effective January 1, 1996.\nCNL Fund Advisors, Inc., effective October 1, 1995, began providing certain management services in connection with the Partnership and its Properties following the assignment by CNL Income Fund Advisors, Inc. of its rights and obligations under the management agreement. CNL Fund Advisors, Inc. is a corporation organized in 1994 under the laws of the State of Florida, and its principal office located at 400 East South Street, Suite 500, Orlando, Florida 32801. CNL Fund Advisors, Inc. is a wholly owned subsidiary of CNL Group, Inc., a diversified real estate company, and was organized to perform property acquisition, property management and other services.\nCNL Group, Inc., which is the parent company of CNL Investment Company and CNL Fund Advisors, Inc., is a diversified real estate corporation organized in 1980 under the laws of the State of Florida. Other subsidiaries and affiliates of CNL Group, Inc. include a property development and management company, two investment advisory companies, and six corporations organized as strategic business units. James M. Seneff, Jr., an individual General Partner of the Partnership, is the Chairman of the Board, Chief Executive Officer, and a director of CNL Group, Inc. Mr. Seneff and his wife own all of the outstanding shares of CNL Group, Inc.\nThe following persons serve as operating officers of CNL Group, Inc. or its affiliates or subsidiaries in the discretion of the Boards of Directors of those companies, but, except as specifically indicated, do not serve as members of the Boards of Directors of those entities. The Boards of Directors have the responsibility for creating and implementing the policies of CNL Group, Inc. and its affiliated companies.\nJohn T. Walker, age 37, joined CNL Group, Inc. in September 1994, as Senior Vice President, responsible for Research and Development. He currently serves as the Chief Operating Officer and Executive Vice President of CNL Fund Advisors, Inc. and CNL American Properties Fund, Inc. From May 1992 to May 1994, he was Executive Vice President for Finance and Administration and Chief Financial Officer of Z Music, Inc., a television network which was subsequently acquired by Gaylord Entertainment, where he was responsible for overall financial and administrative management and planning. From January 1990 through April 1992, Mr. Walker was Chief Financial Officer of the First Baptist Church in Orlando, Florida. From April 1984 through December 1989, he was a partner in the accounting firm of Chastang, Ferrell & Walker, P.A., where he was the partner in charge of audit and consulting services, and from 1981 to 1984, Mr. Walker was a Senior Consultant\/Audit Senior at Price Waterhouse. Mr. Walker is a Cum Laude graduate of Wake Forest University with a B.S. in Accountancy and is a Certified Public Accountant.\nLynn E. Rose, age 47, a certified public accountant, has served as Chief Financial Officer and Secretary of CNL Group, Inc. since December 1993, and served as Controller and Secretary of CNL Group, Inc. from 1987 until December 1993. She has served as Chief Operating Officer of CNL Corporate Services, Inc. since November 1994. Ms. Rose also has served as Chief Financial Officer of CNL Institutional Advisors, Inc. since its inception in 1990, a director of CNL Realty Advisors, Inc. since its inception in 1991, Secretary and Treasurer of CNL Realty Advisors, Inc. from 1991 to February 1996, Secretary and Treasurer of Commercial Net Lease Realty, Inc. from 1992 to February 1996, Secretary of CNL Income Fund Advisors, Inc. since its inception in 1994 to December 1995, and Secretary and Treasurer of CNL Fund Advisors, Inc. since its inception in 1994. Ms. Rose also has served as Chief Financial Officer, Secretary and Treasurer of CNL American Properties Fund, Inc. since its inception in 1994. In addition, Ms. Rose oversees the management information services, administration, legal compliance, accounting, tenant compliance, and reporting for over 200 corporations, partnerships, and joint ventures. Prior to joining CNL, Ms. Rose was a partner with Robert A. Bourne in the accounting firm of Bourne & Rose, P.A., Certified Public Accountants. Ms. Rose holds a B.A. in Sociology from the University of Central Florida and is a registered financial and operations principal of CNL Securities Corp. She was licensed as a Certified Public Accountant in 1979.\nJeanne A. Wall, age 37, has served as Chief Operating Officer of CNL Investment Company and of CNL Securities Corp. since November 1994 and previously served as Executive Vice President of CNL Investment Company since January 1991. In 1984, Ms. Wall joined CNL Securities Corp. as its Partnership Administrator. In 1985, Ms. Wall became Vice President of CNL Securities Corp. and, in 1987, she became a Senior Vice President of CNL Securities Corp. In this capacity, Ms. Wall serves as national marketing director and oversees the national marketing plan for the CNL investment programs. In addition, Ms. Wall oversees the partnership administration and investor services for programs offered through participating brokers. Ms. Wall also has served as Senior Vice President of CNL Institutional Advisors, Inc., a registered investment advisor, from 1990 to 1993, as Vice President of CNL Realty Advisors, Inc. since its inception in 1991, as Vice President of Commercial Net Lease Realty, Inc. since 1992, as Executive Vice President of CNL Income Fund Advisors, Inc. from its inception in 1994 to December 1995, as Executive Vice President of CNL Fund Advisors, Inc. since its inception in 1994, and as Executive Vice President of CNL American Properties, Inc. since its inception in 1994. Ms. Wall holds a B.A. in Business Administration from Linfield College and is a registered principal of CNL Securities Corp. Ms. Wall currently serves as a trustee on the board of the Investment Program Association and on the Direct Participation Program committee for the National Association of Securities Dealers (NASD).\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nOther than as described in Item 13, the Partnership has not paid and does not intend to pay any executive compensation to the General Partners or any of their affiliates. There are no compensatory plans or arrangements regarding termination of employment or change of control.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nAs of February 29, 1996, no person was known to the Registrant to be a beneficial owner of more than five percent of the Units.\nThe following table sets forth, as of February 29, 1996, the beneficial ownership interests of the General Partners in the Registrant.\nTitle of Class Name of Partner Percent of Class -------------- --------------- ----------------\nGeneral Partnership Interests James M. Seneff, Jr. 45% Robert A. Bourne 45% CNL Realty Corporation 10% ---- 100% ====\nNeither the General Partners, nor any of their affiliates, owns any interest in the Registrant except as noted above. There are no arrangements which at a subsequent date may result in a change in control of the Registrant.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe table below summarizes the types, recipients, methods of computation and amounts of compensation, fees and distributions paid or payable by the Partnership to the General Partners and their affiliates for the year ended December 31, 1995, exclusive of any distributions to which the General Partners or their affiliates may be entitled by reason of their purchase and ownership of Units.\nAmount Incurred Type of Compensation For the Year and Recipient Method of Computation Ended December 31, 1995 - --------------------- --------------------- -----------------------\nReimbursement to Operating expenses are Operating expenses affiliates for reimbursed at the lower incurred on behalf of operating expenses of cost or 90 percent of the Partnership: the prevailing rate at $114,204 which comparable services could have been Accounting and obtained in the same administrative services: geographic area. $83,882 Affiliates of the General Partners from time to time incur certain operating expenses on behalf of the Partnership for which the Partnership reimburses the affiliates without interest.\nAnnual, subordinated One percent of the sum $ - 0 - management fee to of gross operating affiliates revenues from Properties wholly owned by the Partnership plus the Partnership's allocable share of gross revenues of joint ventures in which the Partnership is a co-venturer, subordinated to certain minimum returns to the Limited Partners. The management fee will not exceed competitive fees for comparable services.\nDeferred, subordinated A deferred, subordinated $ - 0 - real estate real estate disposition disposition fee fee, payable upon sale payable to affiliates of one or more Properties, in an amount equal to the lesser of (i) one-half of a competitive real estate commission, or (ii) three percent of the sales price of such Property or Properties. Payment of such fee shall be made only if affiliates of the General Partners provide a substantial amount of services in connection with the sale of a Property or Properties and shall be subordinated to certain minimum returns to the Limited Partners.\nGeneral Partners' A deferred, subordinated $ - 0 - deferred, sub- share equal to one ordinated share of percent of Partnership Partnership net cash distributions of net flow cash flow, subordinated to certain minimum returns to the Limited Partners.\nGeneral Partners' A deferred, subordinated $ - 0 - deferred, sub- share equal to five ordinated share of percent of Partnership Partnership net sales distributions of such proceeds from a sale net sales proceeds, or sales subordinated to certain minimum returns to the Limited Partners.\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\nReport of Independent Accountants\nBalance Sheets at December 31, 1995 and 1994\nStatements of Income for the years ended December 31, 1995, 1994 and 1993\nStatements of Partners' Capital for the years ended December 31, 1995, 1994 and 1993\nStatements of Cash Flows for the years ended December 31, 1995, 1994 and 1993\nNotes to Financial Statements\n2. Financial Statement Schedules\nSchedule II - Valuation and Qualifying Accounts for the years ended December 31, 1995, 1994 and 1993\nSchedule III - Real Estate and Accumulated Depreciation at December 31, 1995\nNotes to Schedule III - Real Estate and Accumulated Depreciation at December 31, 1995\nSchedule IV - Mortgage Loan on Real Estate at December 31, 1995\nAll other Schedules are omitted as the required information is inapplicable or is presented in the financial statements or notes thereto.\n3. Exhibits\n3.1 Amended and Restated Affidavit and Certificate of Limited Partnership of CNL Income Fund V, Ltd. (Included as Exhibit 3.1 to Form 10-K filed with the Securities and Exchange Commission on March 31, 1994, and incorporated herein by reference.)\n4.1 Amended and Restated Affidavit and Certificate of Limited Partnership of CNL Income Fund V, Ltd. (Included as Exhibit 3.1 and incorporated herein by reference.)\n4.2 Amended and Restated Certificate and Agreement of Limited Partnership of CNL Income Fund V, Ltd. (Included as Exhibit 4.2 to Form 10-K filed with the Securities and Exchange Commission on March 31, 1994, and incorporated herein by reference.)\n10.1 Management Agreement (Included as Exhibit 10.1 to Form 10-K filed with the Securities and Exchange Commission on March 31, 1994, and incorporated herein by reference.)\n10.2 Assignment of Management Agreement from CNL Investment Company to CNL Income Fund Advisors, Inc. (Included as Exhibit 10.2 to Form 10-K filed with the Securities and Exchange Commission on March 30, 1995, and incorporated herein by reference.)\n10.3 Assignment of Management Agreement from CNL Income Fund Advisors, Inc. to CNL Fund Advisors, Inc. (Filed herewith.)\n(b) The Registrant filed no reports on Form 8-K during the period from October 1, 1995 through December 31, 1995.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 28th day of March, 1996.\nCNL INCOME FUND V, LTD.\nBy: CNL REALTY CORPORATION General Partner\n\/s\/ Robert A. Bourne ----------------------------- ROBERT A. BOURNE, President\nBy: ROBERT A. BOURNE General Partner\n\/s\/ Robert A. Bourne ----------------------------- ROBERT A. BOURNE\nBy: JAMES M. SENEFF, JR. General Partner\n\/s\/ James M. Seneff, Jr. ----------------------------- JAMES M. SENEFF, JR.\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nSignature Title Date --------- ----- ----\n\/s\/ Robert A. Bourne President, Treasurer and March 28, 1996 - ------------------------ Director (Principal Robert A. Bourne Financial and Accounting Officer)\n\/s\/ James M. Seneff, Jr. Chief Executive Officer March 28, 1996 - ------------------------ and Director (Principal James M. Seneff, Jr. Executive Officer)\nCNL INCOME FUND V, LTD. (A Florida Limited Partnership)\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS -----------------------------------------------\nYears Ended December 31, 1995, 1994 and 1993\nAdditions ----------------------- Balance at Charged to Charged to Balance Beginning Costs and Other at End Year Description of Year Expenses Accounts Deductions of Year - ---- ----------- ---------- ---------- ----------- ----------- --------\n1993 Allowance for doubtful accounts (a) $111,410 $19,210 $144,872(b) $ - $275,492 ======== ======= ======== ======== ========\n1994 Allowance for doubtful accounts (a) $275,492 $ 4,788 $150,184(b) $ - $430,464 ======== ======= ======== ======== ========\n1995 Allowance for doubtful accounts (a) $430,464 $ - $ 19,561(b) $445,535(c) $ 4,490 ======== ======= ======== ======== ========\n(a) Deducted from receivables on the balance sheet.\n(b) Reduction of rental and other income.\n(c) Amounts written off as uncollectible.\nCNL INCOME FUND V, LTD. (A Florida Limited Partnership)\nSCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION -------------------------------------------------------\nDecember 31, 1995\n(A) (B) (C) (D) (E)\nCosts Capitalized Subsequent Initial Cost To Acquisition ----------------------- ------------------- Buildings Encum- and Improve- Carrying brances Land Improvements ments Costs ------- ---------- ------------ ---------- --------\nProperties the Partnership has Invested in Under Operating Leases:\nBurger King Restaurant: Lawrenceville, GA - $ 482,070 $ - $ 368,416 $ -\nCaptain D's Restaurant: Belleville, IL - 186,050 383,781 - -\nDenny's Restaurant: New Castle, Indiana - 117,394 471,340 - - Port Orange, FL - 530,689 506,630 53,247 -\nGolden Corral Family Steakhouse Restaurants: Livingston, TX - 156,382 429,107 - - Victoria, TX - 504,787 742,216 - -\nHardee's Restaurants: Richmond, IN - 267,763 - 474,121 - Belding, MI - 113,884 564,805 - - Connorsville, IN - 279,665 - 466,137 - South Haven, MI - 120,847 599,339 - -\nKFC Restaurant: Salem, NH - 654,024 - 511,053 -\nPerkins Restaurants: Port St. Lucie, FL - 586,159 - 674,446 -\nPizza Hut Restaurant: Mexia, TX - 237,944 200,501 - -\nPonderosa Steakhouse Restaurant: St. Cloud, FL - 382,634 - 670,476 -\nShoney's Restaurant: Tyler, TX - 312,404 533,990 - -\nTaco Bell Restaurants: Bountiful, UT - 330,164 - 319,511 - Centralia, WA - 215,302 - 378,836 -\nWendy's Old Fashioned Hamburger Restaurants: Tampa, FL - 336,218 462,400 - - Tampa, FL - 290,479 430,134 - - Endicott, NY - 277,965 243,839 - - Ithaca, NY - 310,462 208,618 - -\nOther: Lebanon, NH (e) - 448,724 - 696,741 - Franklin, TN (f) - 524,694 - 712,700 - ---------- ---------- ---------- --------\n$7,666,704 $5,776,700 $5,325,684 $ - ========== ========== ========== ========\nProperty of Joint Venture in Which the Partnership has a 43% Interest and has Invested in Under an Operating Lease: Waffle House Restaurant: Cocoa, FL - $ 183,229 $ 192,857 $ - $ - ========== ========== ========== ========\nProperty of Joint Venture in Which the Partnership has a 49% Interest and has Invested in Under an Operating Lease:\nBurger King Restaurant: Knoxville, TN - $ 283,961 $ 430,406 $ - $ - ========== ========== ========== ========\nProperties the Partnership has Invested in Under Direct Financing Leases: Captain D's Restaurant: Zanesville, OH - $ 99,651 $ 390,518 $ - $ -\nDenny's Restaurants: Dalesville, IN - 125,562 458,914 - - Huron, OH - 27,418 456,139 - -\nShoney's Restaurant: Smyrna, TN - 129,757 480,003 - - ---------- ---------- --------- --------\n$ 382,388 $1,785,574 $ - $ - ========== ========== ========= ========\nCNL INCOME FUND V, LTD. (A Florida Limited Partnership)\nSCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION - CONTINUED -------------------------------------------------------------------\nDecember 31, 1995\n(F) (G) (H) (I)\nGross Amount at Which Carried at Close of Period (c) ------------------------------------- Buildings and Accumulated Land Improvements Total Depreciation ---------- ------------ ----------- ------------\nProperties the Partnership has Invested in Under Operating Leases:\nBurger King Restaurant: Lawrenceville, GA $ 482,070 $ 368,416 $ 850,486 $ 79,824\nCaptain D's Restaurant: Belleville, IL 186,050 383,781 569,831 86,884\nDenny's Restaurant: New Castle, IN 117,394 471,340 588,734 37,569 Port Orange, FL 530,689 559,877 1,090,566 119,212\nGolden Corral Family Steakhouse Restaurants: Livingston, TX 156,382 429,107 585,489 90,587 Victoria, TX 504,787 742,216 1,247,003 149,295\nHardee's Restaurants: Richmond, IN 267,763 474,121 741,884 106,019 Belding, MI 113,884 564,805 678,689 43,129 Connorsville, IN 279,665 466,137 745,802 99,763 South Haven, MI 120,847 599,339 720,186 45,766\nKFC Restaurant: Salem, NH 654,024 511,053 1,165,077 100,792\nPerkins Restaurants: Port St. Lucie, FL 586,159 674,446 1,260,605 130,205\nPizza Hut Restaurant: Mexia, TX 237,944 200,501 438,445 45,113\nPonderosa Steakhouse Restaurant: St. Cloud, FL 382,634 670,476 1,053,110 140,614\nShoney's Restaurant: Tyler, TX 312,404 533,990 846,394 120,148\nTaco Bell Restaurants: Bountiful, UT 330,164 319,511 649,675 67,896 Centralia, WA 215,302 378,836 594,138 76,819\nWendy's Old Fashioned Hamburger Restaurants: Tampa, FL 336,218 462,400 798,618 105,325 Tampa, FL 290,479 430,134 720,613 98,572 Endicott, NY 277,965 243,839 521,804 49,444 Ithaca, NY 310,462 208,618 519,080 42,302\nOther: Lebanon, NH (e) 448,724 696,741 1,145,465 149,993 Franklin, TN (f) 524,694 712,700 1,237,394 143,182 ---------- ----------- ----------- ----------\n$7,666,704 $11,102,384 $18,769,088 $2,128,453 ========== =========== =========== ==========\nProperty of Joint Venture in Which the Partnership has a 43% Interest and has Invested in Under an Operating Lease: Waffle House Restaurant: Cocoa, FL $ 183,229 $ 192,857 $ 376,086 $ 38,624 ========== =========== =========== ==========\nProperty of Joint Venture in Which the Partnership has a 49% Interest and has Invested in Under an Operating Lease: Burger King Restaurant: Knoxville, TN $ 283,961 $ 430,406 $ 714,367 $ 84,647 ========== =========== =========== ==========\nProperties the Partnership has Invested in Under Direct Financing Leases: Captain D's Restaurant: Zanesville, OH (d) (d) (d) (d)\nDenny's Restaurants: Dalesville, IN (d) (d) (d) (d) Huron, OH (d) (d) (d) (d)\nShoney's Restaurant: Smyrna, TN (d) (d) (d) (d)\nCNL INCOME FUND V, LTD. (A Florida Limited Partnership)\nSCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION - CONTINUED -------------------------------------------------------------------\nDecember 31, 1995\n(J) (K) (L)\nLife on Which Depreciation in Latest Date Income of Con- Date Statement is struction Acquired Computed --------- -------- ------------\nProperties the Partnership has Invested in Under Operating Leases:\nBurger King Restaurant: Lawrenceville, GA 1989 04\/89 (b)\nCaptain D's Restaurant: Belleville, IL 1988 03\/89 (b)\nDenny's Restaurant: New Castle, IN 1989 02\/89 (g) Port Orange, FL 1989 07\/89 (b)\nGolden Corral Family Steakhouse Restaurants: Livingston, TX 1986 09\/89 (b) Victoria, TX 1989 12\/89 (b)\nHardee's Restaurants: Richmond, IN 1989 02\/89 (b) Belding, MI 1989 03\/89 (h) Connorsville, IN 1989 03\/89 (b) South Haven, MI 1989 03\/89 (h)\nKFC Restaurant: Salem, NH 1990 05\/89 (b)\nPerkins Restaurants: Port St. Lucie, FL 1990 11\/89 (b)\nPizza Hut Restaurant: Mexia, TX 1985 03\/89 (b)\nPonderosa Steakhouse Restaurant: St. Cloud, FL 1989 06\/89 (b)\nShoney's Restaurant: Tyler, TX 1988 03\/89 (b)\nTaco Bell Restaurants: Bountiful, UT 1989 05\/89 (b) Centralia, WA 1989 08\/89 (b)\nWendy's Old Fashioned Hamburger Restaurants: Tampa, FL 1987 02\/89 (b) Tampa, FL 1980 02\/89 (b) Endicott, NY 1976 12\/89 (b) Ithaca, NY 1977 12\/89 (b)\nOther: Lebanon, NH (e) 1989 03\/89 (b) Franklin, TN (f) 1989 06\/89 (b)\nProperty of Joint Venture in Which the Partnership has a 43% Interest and has Invested in Under an Operating Lease: Waffle House Restaurant: Cocoa, FL 1986 12\/89 (b)\nProperty of Joint Venture in Which the Partnership has a 49% Interest and has Invested in Under an Operating Lease: Burger King Restaurant: Knoxville, TN 1985 01\/90 (b)\nProperties the Partnership has Invested in Under Direct Financing Leases: Captain D's Restaurant: Zanesville, OH 1988 03\/89 (d)\nDenny's Restaurants: Dalesville, IN 1974 02\/89 (d) Huron, OH 1971 05\/89 (d)\nShoney's Restaurant: Smyrna, TN 1988 03\/89 (d)\nCNL INCOME FUND V, LTD. (A Florida Limited Partnership)\nNOTES TO SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION ----------------------------------------------------------------\nDecember 31, 1995\n(a) Transactions in real estate and accumulated depreciation during 1994, 1993 and 1992, are summarized as follows:\nAccumulated Cost Depreciation ----------- ------------\nProperties the Partnership has Invested in Under Operating Leases:\nBalance, December 31, 1992 $17,820,609 $1,128,400 Depreciation expense - 341,680 ----------- ----------\nBalance, December 31, 1993 17,820,609 1,470,080 Reclassified from direct financing leases 1,987,609 - Depreciation expense - 402,980 ----------- ----------\nBalance, December 31, 1994 19,808,218 1,873,060 Depreciation expense - 397,735 Dispositions (1,039,130) (142,342) ----------- ----------\nBalance, December 31, 1995 $18,769,088 $2,128,453 =========== ==========\nProperty of Joint Venture in Which the Partnership has a 43% Interest and has Invested in Under an Operating Lease:\nBalance, December 31, 1992 $ 376,086 $ 19,338 Depreciation expense - 6,429 ----------- ----------\nBalance, December 31, 1993 376,086 25,767 Depreciation expense - 6,428 ----------- ----------\nBalance, December 31, 1994 376,086 32,195 Depreciation expense - 6,429 ----------- ----------\nBalance, December 31, 1995 $ 376,086 $ 38,624 =========== ==========\nProperty of Joint Venture in Which the Partnership has a 49% Interest and has Invested in Under an Operating Lease:\nBalance, December 31, 1992 $ 714,367 $ 41,606 Depreciation expense - 14,347 ----------- ----------\nBalance, December 31, 1993 714,367 55,953 Depreciation expense - 14,347 ----------- ----------\nBalance, December 31, 1994 714,367 70,300 Depreciation expense - 14,347 ----------- ----------\nBalance, December 31, 1995 $ 714,367 $ 84,647 =========== ==========\n(b) Depreciation expense is computed for buildings and improvements based upon estimated lives of 30 years.\n(c) As of December 31, 1995, the aggregate cost of the Properties owned by the Partnership and its consolidated joint venture, and the unconsolidated joint ventures for federal income tax purposes was $20,939,126 and $1,090,453, respectively. All of the leases are treated as operating leases for federal income tax purposes.\n(d) For financial reporting purposes, the lease for the land and building has been recorded as a direct financing lease. The cost of the land and building has been included in net investment in direct financing leases, therefore, the cost is not shown. Depreciation is not applicable.\n(e) The restaurant on the property in Lebanon, New Hampshire, was converted from a Ponderosa Steakhouse restaurant to a local, independent restaurant in 1992.\n(f) The restaurant on the property in Franklin, Tennessee, was converted from a Po Folks restaurant to a local bank in 1993.\n(g) Effective January 1, 1994, the lease for this property was amended, resulting in the reclassification of the building portion of the lease as an operating lease. The building was recorded at net book value as of January 1, 1994, and depreciated over its remaining estimated life of approximately 25 years.\n(h) Effective February 1, 1994, the lease for this property was terminated, resulting in the lease's reclassification as an operating lease.\n(1) The tax carrying value of the note is $901,994, which is net of a deferred gain of $135,383.\n(2) Monthly payments of principal and interest at an annual rate of 10.25%, with a balloon payment at maturity of $1,006,004.\n(3) The changes in the carrying amounts are summarized as follows:\n1995 1994 1993 ---------- ---------- ----------\nBalance at beginning of period $ - $ - $ -\nNew mortgage loan 1,040,000 - -\nAccrued interest 8,786 - -\nCollections of principal (11,409) - -\nDeferred gain on sale of land and building (141,641) - - ---------- ---------- ----------\nBalance at end of period $ 895,736 $ - $ - ========== ========== ==========\nEXHIBITS\nEXHIBIT INDEX\nExhibit Number - --------------\n3.1 Amended and Restated Affidavit and Certificate of Limited Partnership of CNL Income Fund V, Ltd. (Included as Exhibit 3.1 to Form 10-K filed with the Securities and Exchange Commission on March 31, 1994, and incorporated herein by reference.)\n4.1 Amended and Restated Affidavit and Certificate of Limited Partnership of CNL Income Fund V, Ltd. (Included as Exhibit 3.1 and incorporated herein by reference.)\n4.2 Amended and Restated Certificate and Agreement of Limited Partnership of CNL Income Fund V, Ltd. (Included as Exhibit 4.2 to Form 10-K filed with the Securities and Exchange Commission on March 31, 1994, and incorporated herein by reference.)\n10.1 Management Agreement (Included as Exhibit 10.1 to Form 10-K filed with the Securities and Exchange Commission on March 31, 1994, and incorporated herein by reference.)\n10.2 Assignment of Management Agreement from CNL Investment Company to CNL Income Fund Advisors, Inc. (Included as Exhibit 10.2 to Form 10-K filed with the Securities and Exchange Commission on March 30, 1995, and incorporated herein by reference.)\n10.3 Assignment of Management Agreement from CNL Income Fund Advisors, Inc. to CNL Fund Advisors, Inc. (Filed herewith.)","section_15":""}
{"filename":"202172_1995.txt","cik":"202172","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"ITEM 3. LEGAL PROCEEDINGS - ------ -----------------\nA tax assessment (the \"Assessment\") has been made by the Commonwealth of Massachusetts against a former wholly-owned subsidiary of the Company, which was dissolved in July 1990. The Massachusetts Department of Revenues (the \"MDR\") stated, in a notice dated February 15, 1992, that the amount due and owing was $1.2 million and it is believed that additional interest and\/or penalties have been imposed with regard to the Assessment. On November 29, 1993, an Offer in Settlement (the \"Offer\") was forwarded to the MDR with respect to the Assessment which was rejected by the MDR on October 26, 1995. The ultimate outcome of the Assessment cannot be determined at this time.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - ------ ---------------------------------------------------\nNot Applicable.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT'S COMMON - ------ -------------------------------------------------------- EQUITY AND RELATED STOCKHOLDER MATTERS --------------------------------------\nThe Company's Common Stock is traded over the counter. During 1995, there was only one identifiable stock transaction for 100 shares at $.01 per share.\nOn February 29, 1996, there were approximately 765 stockholders of record of the Company's Common Stock. There were no dividends paid on the Company's Common Stock in 1995 and 1994.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA - ------ -----------------------\nITEM 6. SELECTED FINANCIAL DATA, CONTINUED - ------ -----------------------\n(1) Restated to reflect a 10 for 1 reverse stock split in September 1992.\nQUARTERLY FINANCIAL DATA\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF - ------ --------------------------------------- FINANCIAL CONDITION AND RESULTS OF OPERATIONS ---------- -----------------------------------\nDIVESTITURE OF THE LINCOLN SAVINGS BANK, FSB, LIQUIDITY AND GOING CONCERN, AND CONTINUING OPERATIONS\nThe Lincoln Savings Bank, FSB (\"Lincoln\") was the primary asset of Lincorp Holdings, Inc., (the \"Company\"). On January 20, 1993, in connection with the transaction described below, the Company relinquished control of Lincoln by placing the common stock of Lincoln into a trust for eventual sale, and by filing a divestiture notice with the Office of Thrift Supervision (the \"OTS\").\nOn March 4, 1994, Lincoln entered into a definitive agreement (the \"Acquisition Agreement\") with Anchor Savings Bank FSB (\"Anchor\") whereby Anchor would acquire all of the assets in the trust (the \"Trust Assets\"), including outstanding preferred and common stock of Lincoln and a senior secured note, for $80 million in cash. The transaction was subject to, among other things, regulatory approval of the OTS and the Federal Deposit Insurance Corporation. Approval of the transaction was granted on July 12, 1994, and the transaction was completed on August 12, 1994. As anticipated under the Acquisition Agreement, the Company received none of the proceeds from the sale of Lincoln but two of the Company's lenders received a total of $6.1 million as repayment of a portion of the principal amount of debt owed them. This payment to the Company's lenders represented a reduction in the loss recorded in 1992 relating to the Company's writedown of its investment in Lincoln. Accordingly, the Company recorded a $6.1 million income adjustment in 1994 relating to the discontinued operations of Lincoln.\nAt December 31, 1995, the Company had approximately $158.0 million of principal indebtedness and accrued and unpaid interest (the \"Indebtedness\") outstanding under its Senior, Subordinated and Junior credit facilities. The Company's parent company, Unicorp Energy Corporation (\"UEC\"), holds $144.5 million of the Indebtedness and Hees International Bancorp, Inc. (\"Hees\"), which currently owns an indirect 24.6% non-voting equity interest in UEC, holds the balance of the Indebtedness, $13.5 million. The Company is in payment default under each of the above mentioned credit facilities. These credit facilities are secured by a security interest in all of the Company's non real estate assets. See Note 6 to the Company's Financial Statements.\nThe Company's sources of operating funds during the year ended December 31, 1995, and to date have been primarily from the sales of marketable securities and payments received from mortgage receivables. The assets being utilized to fund the Company's operations are part of collateral package securing the above described credit facilities. Unless the Company's lenders are prepared to continue to defer in realizing on\nthe pledged collateral and allow the Company to utilize the proceeds from such collateral to fund its ongoing operations, the Company will be unable to continue as a going concern.\nEffective January 1, 1995, as a result of an improving real estate market, the Company reformulated their business plan to focus on such activity. Accordingly, effective January 1, 1995, the Company restated its balance sheet to reflect the real estate operations as a continuing operation. The restatement had no effect on prior period Statements of Operations and effective January 1, 1995, the Company recognized the results of its real estate operations as part of its results from continuing operations. This included recording its equity in the operating results of its real estate joint ventures in accordance with the equity method of accounting as well as recording rental and other income and expenses from its other real estate activities. See Note 1 to the Company's Financial Statements.\nRESULTS OF OPERATIONS\n1995 COMPARED TO 1994 - ---------------------\nFor the year ended December 31, 1995, the Company's continuing operations had a loss of $12.8 million compared to a loss of $9.8 million for the year ended December 31, 1994.\nAs previously stated, effective January 1, 1995, the Company reflected the results of its real estate operations as a continuing operation whereas these same operations during 1994 were accounted for as a discontinued operation with no effect on operating results.\nTotal income for 1995 decreased by $.7 million compared to 1994 as 1994 included other income of $1.5 million resulting from the reversal of certain prior period reserves while 1995 includes no such reversals. However, 1995, does include $.5 million in rental income which was included in discontinued operations in 1994, and a $.3 million gain on the sale of mortgage receivables, which is included in other income.\nDuring 1995, the Company sold substantially all of its interest in the Main and California Partnerships for $6.9 million which equalled the Company's recorded net book value for these investments.\nInterest expense increased $2.6 million, of which $1.6 million is attributable to the debt on real estate assets and $.8 million is attributable to Hees debt, both of which were included in discontinued operations during 1994, and the balance reflects an increase in interest rates.\n1994 COMPARED TO 1993 - ---------------------\nFor the year ended December 31, 1994, the Company had net income of $4.2 million compared to a net loss of $11.5 million for the year ended December 31, 1993. This $15.7 million change from 1993 to 1994 is primarily attributable to the following:\n(1) A $6.1 million recovery on the writedown of its investment in Lincoln as two of the Company's lenders received a total of $6.1 million, as repayment of a portion of the principal amount of debt owed them, in connection with the closing of the Lincoln sale to Anchor. (2) A $4.5 million decrease in the estimated writedown of assets from discontinued real estate operations primarily due to an improved real estate market. (3) A $3.4 million reversal of accrued income taxes relating to discontinued operations reflecting a revision of the Company's estimate of this liability. (4) A $1.5 million increase in other income related to the reversal of certain prior period reserves that are no longer needed.\nFINANCIAL POSITION\nMATERIAL CHANGES DURING 1995 - ----------------------------\nEffective January 1, 1995, as a result of an improving real estate market, the Company reformulated their business plan to focus on such activity. Accordingly, effective January 1, 1995, the Company restated its' balance sheet to reflect the real estate operations as a continuing operation. The restatement had no effect on prior period Statements of Operations and effective January 1, 1995, the Company recognized the results of its real estate operations as part of its results from continuing operations. This included recording its equity in the operating results of its real estate joint ventures in accordance with the equity method of accounting as well as recording rental and other income and expenses from its other real estate activities.\nAs of January 1, 1995, the Company's real estate investments included two 50% limited partnership investments (the \"Main Partnership\" and the \"California Partnership\") which own and operate several commercial real estate properties. These Partnerships have the same \"General Partner\" and as discussed below, the Company sold substantially all of it's interest in these two Partnerships to the General Partner during 1995. In addition, the Company has a 25% limited partnership investment in a commercial building (the Colorado State Bank Building located in Denver, Colorado (\"CSBB\")) and, a commercial land lease (the Montgomery St. Land Lease located in San Francisco California (\"MSLL\")). See Note 1 to the Company's Financial Statements.\nAt December 31, 1995, the Company had approximately $158.0 million of principal indebtedness and accrued and unpaid interest (the \"Indebtedness\") under its Senior, Subordinated and Junior credit facilities. The Company's parent company, Unicorp Energy Corporation (\"UEC\"), holds $144.5 million of the Company's Indebtedness and Hees International Bancorp, Inc. (\"Hees\"), which currently owns an indirect 24.6% non-voting equity interest in UEC, holds the balance of the Indebtedness, $13.5 million. The Company is in payment default under each of the above mentioned credit facilities. These credit facilities are secured by a security interest in all the Company's non real estate assets. As of December 31, 1995, the Company's net worth was a negative $161.7 million. See Note 6 to the Company's Financial Statements.\nDuring July, 1995, the Company made a $845,000 loan to a developer to refinance land previously purchased by the developer for residential home development. The Company will receive a $60,000 transaction fee, of which $5,000 was paid up front, and the balance was rolled into the loan. The total loan of $900,000 is for one year and carries a 10% interest rate, payable monthly, and is secured by a first mortgage on the land. In order to make this loan, the Company borrowed $550,000 from UEC under its existing Junior credit facility.\nDuring September, 1995, the Company sold substantially all of its limited partnership interests in the Main and California Partnerships to the General Partner for $6.9 million. In connection with the sale, the Company granted the General Partner an option, which expires December 31, 1996, to purchase it's remaining Main Partnership interest not sold (1%) for $70,000.\nThe proceeds from the sale were used to repay loans from the General Partner relating to the Company's real estate investments in CSBB and MSLL.\nDuring September 1995, the Company drew down $6.0 million of an existing but unutilized line of credit provided by the General Partner and secured by the Company's investment in the CSBB, for the purpose of investing an additional $2.3 million in CSBB and making an additional repayment against the MSLL loan. See Note 6 to the Company's Financial Statements.\nAt the end of September 1995, UEC purchased from the General Partner the outstanding balance on the Company's loans secured by CSBB and MSLL at face value, which at December 31, 1995, was $6.2 million and $9.5 million, respectively. As a result of this transaction, all of the Company's debt is now held by UEC and Hees. See Note 6 to the Company's Financial Statements.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - ------ -------------------------------------------\nThe Financial Statements of the Company are set forth in Part IV on pages to and incorporated herein by reference. See \"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\" for a complete list of Financial Statements and Financial Statement Schedules.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS - ------ --------------------------------------------- ON ACCOUNTING AND FINANCIAL DISCLOSURE --- -----------------------------------\n(i) On November 11, 1994, Price Waterhouse, LLP declined to stand for re- election as the independent accountants for the Company.\n(ii) The reports of Price Waterhouse, LLP on the financial statements for the two fiscal years ended December 31, 1993 contained no adverse opinion or disclaimer of opinion and were not qualified or modified as to audit scope or accounting principle. The reports of Price Waterhouse, LLP on the financial statements for the two fiscal years ended December 31, 1993, were qualified as to going concern uncertainty.\n(iii) The Company's Board of Directors participated in and approved the decision to change independent accountants.\n(iv) In connection with its audits for the two fiscal years ended December 31, 1993, and through November 11, 1994, there have been no disagreements with Price Waterhouse, LLP 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 Price Waterhouse, LLP would have caused them to make reference thereto in their report on the financial statements for such years.\n(v) During the fiscal year ended December 31, 1993, and through November 11, 1994, there have been no reportable events (as defined in Regulation S-K Item 304 (a) (i) (v)).\n(vi) On November 11, 1994, KPMG Peat Marwick LLP was engaged as the independent accountants for the Company.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - ------- --------------------------------------------------\nDIRECTORS AND EXECUTIVE OFFICERS\nThe term of each director is for one year and thereafter until his successor shall have been elected and qualified. The Company's executive officers are elected by, and serve at the discretion of the Board of Directors.\nThe following table sets forth the name, age, principal occupation and position with the Company, if any, of each director and executive officer of the Company on March 22, 1996, and the year each director was first elected to the Board of Directors of the Company:\n- -------------- (1) Member of the Executive Committee. (2) Member of the Audit Committee. (3) Member of the Arms Length Committee.\nIan G. Cockwell has been President of Westcliff Management Services Inc. since prior to 1988, and UEC since 1992. He has been a Director of the Company since November 1994.\nWilliam Kirschenbaum has been the Chairman of the Board of Hamilton Financial Services Corporation, successor to Hamilton Savings Bank, since prior to 1988.\nGeorge S. Mann has served as Chairman of the Board and President of the Company since 1981, and 1989, respectively. He served as Chairman of the Board of UEC from 1983, until June 1990, and now serves as a Director. In connection with the Lincoln Agreement, without admitting or denying the allegations contained therein, and in order to avoid the significant costs of potential litigation, Mr. Mann consented to the entry of an order by the OTS which permanently prohibited him from participation in the conduct of the affairs of, or exercising any voting rights with respect to, depository institutions in the United States.\nRalph V. Marra has been the Chairman and President of ELM Consulting Corporation since October of 1994. He was the Chief Financial Officer of Lincoln from November 1989, until October of 1994, and was the Chief Accounting Officer and Treasurer of Lincoln from December 1988, through November 1989. From March 1988, to December 1988, Mr. Marra was the Chief Administrative Officer of Lincoln. From August 1984, to December 1993, he was a Senior Vice President of the Company and from March 1987, until December 1993, he was the Company's Treasurer. He has been a Director of the Company since November 1994.\nHerbert R. Silverman was Chairman, Finance Committee, of Helmsley-Spear, Inc., a nationwide real estate organization, from 1974, until his retirement on January 31, 1990. He is Senior Advisor to Bank Julius Baer, an affiliate of the Julius Baer Group of Switzerland. Through 1993, Mr. Silverman was Vice Chairman of the Board of Trustees of New York University, and is a life member of the Board of Trustees of Rutgers University and a trustee of Neuberger and Berman Mutual Funds. He has been a member of the Board of Directors of Hamilton Financial Services Corporation since November 1993, and a member of the Board of Directors of National Patent Systems since 1994.\nCOMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT\nSection 16(a) of the Exchange Act requires the Company's officers and directors and persons who own more than 10% of the Company's Common Stock to file initial reports of ownership and reports of changes of ownership (Forms 3, 4 and 5) of the Company's Common Stock with the Securities and Exchange Commission (the \"SEC\").\nOfficers, directors and beneficial owners of more than 10% of the Company's Common Stock are required by the SEC regulations to furnish the Company with copies of such forms that they file.\nTo the Company's knowledge, based soley on the Company's review of the copies of such reports received by the Company during the fiscal year ended December 31, 1995, all Section 16(a) filing requirements applicable to its officers, directors and beneficial owners of more than 10% of the Company's Common Stock, were complied with.\nDIRECTORS REMUNERATION - ----------------------\nDirectors of the Company receive a quarterly fee of $1,500 in addition to a fee of $600 for actual attendance at each directors' or committee meeting. For meetings of any committee held on the same day as any meeting of the Board of Directors, the fee for attendance at the committee meetings is $300. Where meetings of the Board or committees thereof are held by telephone conference, directors receive a fee of $150. Fees paid to all directors for attendance at the Board and committee meetings during the year ended December 31, 1995, totaled $33,150.\nDIRECTORS MEETING AND COMMITTEES - --------------------------------\nThe Board of Directors of the Company held 5 meetings during the fiscal year ended December 31, 1995. No member of the Board attended fewer than 3 of the 5 meetings held during the fiscal year.\nThe Board of Directors has a standing Audit Committee which represents the Board of Directors in its relations with the Company's independent accountants and oversees the Company's compliance with operating procedures and policies. This committee also approves the scope of the Company's financial statement examinations, monitors the adequacy of the Company's internal controls and reviews and monitors any other activity that the committee deems necessary or appropriate. The Company does not have a standing Compensation or Nominating Committee. The Executive Committee is authorized to act on behalf of the Board of Directors between Board meetings and to have such powers and duties which may lawfully be assigned to it under Delaware law. The Board of Directors has an Arms Length Committee comprised of independent directors to review transactions involving both the Company and UEC.\nThe only Committee which held a meeting during the Company's fiscal year ended December 31, 1995, was the Audit Committee which held one meeting.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION - ------- ----------------------\nGeorge S. Mann, the Chief Executive Officer (\"CEO\") of the Company, did not receive any compensation for his services as CEO during any of the fiscal years ended December 31, 1995, 1994 or 1993. No other executive officer of the Company received in excess of $100,000 per annum in any of the fiscal years ended December 31, 1995, 1994 or 1993.\nNo compensation committee report or performance graph is included herein because the chief executive officer draws no salary from the Company.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF DIRECTORS, NOMINEES AND OFFICERS AND - ------- ---------------------------------------------------------- OTHER PRINCIPAL HOLDERS OF THE COMPANY'S VOTING SECURITIES ----------------------------------------------------------\nThe table below sets forth information concerning the shares of the Common Stock beneficially owned by the individual directors, all directors and officers of the Company as a group without naming them and each person who is known by the Company to be the beneficial owner of more than five percent of the Common Stock as of February 29, 1996. The address of each of the directors is c\/o Lincorp Holdings, Inc., 250 Park Avenue, Suite 2020, New York, New York 10017. The address of UEC is BCE Place Suite 2320 Toronto, Ontario, Canada M5J151.\n- ------------\n* Less than 1%\n(1) The stockholdings indicated for Messrs. Cockwell and Mann are all owned directly by UEC. Messrs. Cockwell and Mann disclaim beneficial ownership of all such shares.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - ------- ----------------------------------------------\nSee Item 2 - Real Estate Transactions.\nPART IV\nITEM 14.","section_14":"ITEM 14. - -------\nEXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\nAll schedules have been omitted because they are not required or because the required information is contained in the financial statements or notes thereto.\n(b) Reports on Form 8-K\nNone.\n(c) Exhibits PAGE ----\n3.1 Restated Certificate of Incorporation of the Company, * as amended to date (incorporated by reference to Exhibit 3.1 to the Company's Annual Report on Form 10-K for the year ended December 31, 1987).\n3.2 By-Laws of the Company as amended to date (incorporated * by reference to Exhibit 3.2 to the Company's Annual Report Form 10-K for the year ended December 31, 1986).\n10.01 Subscription and Purchase Agreement dated December * 31, 1987, between the Company and UEC (incorporated by reference to Exhibit 2.2 to the Company's Current Report Form 8-K dated January 14, 1988).\n10.02 Letter Agreement re: Line of Credit dated November 30, 1989, * between UEC and the Company (incorporated by reference to Exhibit 10.23 to the Company's Annual Report on Form 10-K for the year ended December 31, 1989).\n10.03 Revolving Demand Note dated November 30, 1989, * from the Company to UEC (incorporated by reference to Exhibit 10.24 to the Company's Annual Report on Form 10-K for the year ended December 31, 1989).\n10.04 Consulting Agreement dated as of February 13, 1990, * between the Company and Coscan Inc. (incorporated by reference to Exhibit 10.27 to the Company's Annual Report on Form 10-K for the year ended December 31, 1989).\n10.05 Letter Agreement re: Operating Deficit Loan Agreement * dated February 13, 1990, between the Company and Coscan Inc. (incorporated by reference to Exhibit 10.28 to the Company's Annual Report on Form 10-K for the year ended December 31, 1989).\n10.06 Form of Promissory Note from the Company to Coscan Inc. * (incorporated by reference to Exhibit 10.29 to the Company's Annual Report on Form 10-K for the year ended December 31, 1989).\n10.07 Closing Agreement, dated as of July 23, 1990, among * the Company, Coscan Colorado Inc. (\"CCI\"), Coscan Colorado LHI Inc. and Coscan Commercial Limited Partnership, a California Limited Partnership (\"Coscan California) (incorporated by reference to Exhibit 28.1 to the Company's Report on Form 8-K dated August 13, 1990).\n10.08 Closing Agreement, dated as of July 23, 1990, among the * Company, Coscan California Commercial Inc. (\"CCC\"), Coscan California LHI Inc. and Coscan Commercial Limited Partnership, a California Limited Partnership (\"Coscan California) (incorporated by reference to Exhibit 28.2 to the Company's Report on Form 8-K dated August 13, 1990).\n10.09 Agreement of Limited Partnership of Coscan Commercial, * dated as of July 23, 1990 (incorporated by reference to Exhibit 28.3 to the Company's Report on Form 8-K dated August 13, 1990).\n10.10 Agreement of Limited Partnership of Coscan Commercial, * dated as of July 23, 1990 (incorporated by reference to Exhibit 28.3 to the Company's Report on Form 8-K dated August 13, 1990).\n10.11 Letter Agreement, dated as of July 23, 1990, among CCI, * CCC, the Company, Coscan Commercial and Coscan California, regarding loans by CCI and CCC (incorporated by reference to Exhibit 28.5 to the Company's Report on Form 8-K dated August 13, 1990).\n10.12 $24,000,000 Secured Revolving Credit Agreement, dated * as of July 25, 1990 (the \"Senior Credit Agreement\"), among the Company, Hees International Bancorp Inc. (\"Hees\"), National Bank of Canada (\"NBC\") and NBC, as Agent (incorporated by reference to Exhibit 28.6 to the Company's Report on Form 8-K dated August 13, 1990).\n10.13 Amended and Restated Credit Agreement, dated as of July * July 25, 1990, between the Company and NBC (incorporated by reference to Exhibit 28.7 to the Company's Report on Form 8-K dated August 13, 1990).\n10.14 Letter Agreement, dated July 25, 1990, between UEC * and the Company regarding the revolving line of credit from UCC to the Company (incorporated by reference to Exhibit 28.8 to the Company's Report on Form 8-K dated August 13, 1990).\n10.15 Securities Pledge Agreement, dated as of July 25, 1990, * by the Company in favor of UEC (incorporated by reference to Exhibit 28.8 to the Company's Report on Form 8-K dated August 13, 1990).\n10.16 Lincorp Pledge Agreement, dated as of July 25, 1990, by Lincorp * Inc. in favor of UEC (incorporated by reference to Exhibit 28.10 to the Company's Report on Form 8-K dated August 13, 1990).\n10.17 Subsidiaries Pledge Agreement, dated as of July 25, 1990, * by Unicorp Delaware I, Inc., Unicorp Delaware II, Inc. and ITT Missouri Corp. in favor of UEC (incorporated by reference to Exhibit 28.11 to the Company's Report on Form 8-K dated August 13, 1990).\n10.18 Security Agreement, dated as of July 25, 1990, by the * Company in favor of UEC (incorporated by reference to Exhibit 28.12 to the Company's Report on Form 8-K dated August 13, 1990).\n10.19 Agreement Relating to the Lincoln Savings Bank, FSB dated * as of December 31, 1992, among the OTS, the Company and certain other parties (incorporated by reference to Exhibit A to the Company's Current Report on Form 8-K dated January 20, 1993).\n10.20 Trust Agreement dated as of January 20, 1993, among the * OTS, the Company and certain other parties (incorporated by reference to Exhibit B to the Company's Current Report on Form 8-K dated January 20, 1993).\n10.21 Consent Agreement dated March 4, 1994, among UEC, * Union Holdings, Inc., Lincorp, Inc., the Company, Hees International Bancorp, Inc., National Bank of Canada, Anthony M. Frank, as trustee, the Lincoln Savings Bank, FSB and Anchor Savings Bank FSB (incorporated by referenced to Exhibit 10.23 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993).\n10.22 Loan Modification Agreement dated as of September 28, * 1995, by and between Coscan, Inc. and the Company (incorporated by reference to Exhibit B to the Company's Report on Form 8-K dated September 28, 1995).\n10.23 Loan Modification Agreement dated as of September 28, * 1995, by and between CCI and the Company (incorporated by reference to Exhibit C to the Company's Report on Form 8-K dated September 28, 1995.)\n10.24 Agreement dated as of September 5, 1995,by and among CCI, the Company, Coscan Limited Partner Corporation, CCC, Coscan California Limited Partner Corporation and Coscan, Inc.\n22 Subsidiaries of the Company.\n- ---------- * 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 in New York, New York.\nDated: March 22, 1996\nLINCORP HOLDINGS, INC.\nBy: s\/ Jack R. Sauer ---------------- Jack R. Sauer 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.\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Stockholders of Lincorp Holdings, Inc.:\nWe have audited the accompanying balance sheets of Lincorp Holdings, Inc. (\"Company\") as of December 31, 1995 and 1994, and the related statements of operations, changes in stockholders' deficit, 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 incudes assessing the accounting principles used and significant estimates made by management, as 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 Lincorp Holdings, Inc., as of December 31, 1995 and 1994, and the results of its operations and its cash flows for the years then ended in conformity with generally accepted accounting principles.\nThe accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the financial statements, the Company is in default on all of its credit facilities and, at December 31, 1995 has $105.2 million of principal indebtedness, and $52.8 million of accrued and unpaid interest. In addition the Company has a net capital deficiency of $161.7 million as of December 31, 1995. These maters raise substantial doubt about the Company's ability to continue as a going concern. The Company's plans in regard to these matters are also described in Note 2. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.\nKPMG Peat Marwick LLP\nNew York, New York February 21, 1996\n[LETTERHEAD OF PRICE WATERHOUSE LLP] [LOGO]\nREPORT OF INDEPENDENT ACCOUNTANTS ---------------------------------\nApril 8, 1994\nTo the Board of Directors and Stockholder of Lincorp Holdings, Inc.\nIn our opinion, the accompanying statements of operations, of changes in stockholders' deficit and of cash flows for the year ended December 31, 1993 (appearing on pages through of the Lincorp Holdings, Inc. Annual report on Form 10-K for the year ended December 31, 1995), present fairly, in all material respects, the results of operations and cash flows of Lincorp Holdings, Inc. for the year ended December 31, 1993, in conformity with generally accepted accounting principles. These financial statements are the responsibility of Lincorp Holdings, Inc.'s management; our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit 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 audit provides a reasonable basis for the opinion expressed above. We have not audited the consolidated financial statements of Lincorp Holdings, Inc. for any period subsequent to December 31, 1993.\nThe accompanying financial statements have been prepared assuming that Lincorp Holdings, Inc. will continue as a going concern. As described in Notes 2 and 3, on January 20, 1993, Lincorp Holdings, Inc. relinquished control of its primary asset and only operating entity, The Lincoln Savings Bank, FSB (\"Lincoln\"), and wrote-off its investment in Lincoln. Lincorp Holdings, Inc, (the \"Company\") has experienced significant losses in operations, is in default on all of its credit facilities and, at December 31, 1993, has $111.3 million of principal indebtedness, $29.7 million of accrued and unpaid interest and $1.2 million of assets. The Company's parent and lenders have indicated that they are not prepared to (1) defer in collecting the amounts due them and (2) provide funds to meet the Company's liabilities during the next 12 months. These matters raise substantial doubt about the Company's ability to continue as a going concern. The Company's plans in regard to these matters are also described in Note 3. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.\nPrice Waterhouse LLP\nLINCORP HOLDINGS, INC. BALANCE SHEETS\nLIABILITIES AND STOCKHOLDERS' DEFICIT\nThe accompanying notes are an integral part of these financial statements.\nLINCORP HOLDINGS, INC. STATEMENTS OF OPERATIONS\nThe accompanying notes are an integral part of these financial statements.\nLINCORP HOLDINGS, INC. STATEMENTS OF CHANGES IN STOCKHOLDERS' DEFICIT\nThe accompanying notes are an integral part of these financial statements.\nLINCORP HOLDINGS, INC. STATEMENTS OF CASH FLOWS\nThe accompanying notes are an integral part of these financial statements.\nLINCORP HOLDINGS, INC. STATEMENTS OF CASH FLOWS (continued)\nThe accompanying notes are an integral part of these financial statements.\nNOTE 1 - REAL ESTATE OPERATIONS - -------------------------------\nEffective January 1, 1995, as a result of an improving real estate market, the Company reformulated their business plan to focus on such activity. Accordingly, effective January 1, 1995, the Company restated its balance sheet to reflect the real estate operations as a continuing operation. The restatement had no effect on prior period Statements of Operations but effective January 1, 1995, the Company recognized the results of its real estate operations as part of its results from continuing operations. This included recording its equity in the operating results of its real estate joint ventures in accordance with the equity method of accounting as well as recording rental and other income and expenses from its other real estate activities. During 1994 the real estate operations had total income of approximately $ 1.8 million and a net loss of approximately $.3 million, which was charged against the net liability of real estate operations.\nAs of January 1, 1995, the Company's real estate investments included two 50% limited partnership investments (the \"Main Partnership\" and the \"California Partnership\") which own and operate several commercial real estate properties. These Partnerships have the same \"General Partner\" and as discussed below, the Company sold substantially all of it's interest in these two Partnerships to the General Partner during 1995. In addition, the Company has a 25% limited partnership investment in a commercial building (the Colorado State Bank Building located in Denver, Colorado (\"CSBB\")) and, a commercial land lease (the Montgomery St. Land Lease located in San Francisco California (\"MSLL\")).\nThe following is the restated balance sheet of the Company as of January 1, 1995 (dollars in thousands):\nPrior to January 1, 1995, the Company's real estate operations were accounted for as discontinued operations.\nLINCORP HOLDINGS, INC. NOTES TO FINANCIAL STATEMENTS\nThe net liability for discontinued operations at December 31, 1994, consisted of the following:\nASSETS\/(LIABILITIES) (DOLLARS IN THOUSANDS) ----------------------\nInvestment in real estate assets, net (a) $18,971 Other assets 278 Debt on real estate assets (18,971) Other borrowed funds, including accrued interest (10,066) Other liabilities (730) ---- $(10,518) --------\n(a) Recorded at estimated net realizable value.\nDuring July, 1995, the Company made a $845,000 loan to a developer to refinance land previously purchased by the developer for residential home development. The Company will receive a $60,000 transaction fee, of which $5,000 was paid up front, and the balance was rolled into the loan. The total loan of $900,000 is for one year and carries a 10% interest rate, payable monthly, and is secured by a first mortgage on the land. In order to make this loan, the Company borrowed $550,000 from UEC under its existing Junior credit facility.\nDuring September, 1995, the Company sold substantially all of its limited partnership interests in the Main and California Partnerships to the General Partner for $6.9 million, which equalled the Company's recorded net book value for these investments. In connection with the sale, the Company granted the General Partner an option, which expires December 31, 1996, to purchase it's remaining Main Partnership interest not sold (1%) for $70,000.\nThe proceeds from the above stated sale were used to repay loans from the General Partner relating to the Company's real estate investments in CSBB and MSLL.\nDuring September 1995, the Company drew down $6.0 million of an existing but unutilized line of credit provided by the General Partner and secured by the Company's investment in the CSBB, for the purpose of investing an additional $2.3 million in CSBB and making an additional repayment against the MSLL loan.\nLINCORP HOLDINGS, INC. NOTES TO FINANCIAL STATEMENTS\nAt the end of September 1995, UEC purchased from the General Partner the outstanding balance on the Company's loans secured by CSBB and MSLL at face value. As a result of this transaction, all of the Company's debt is now held by UEC and Hees.\nThe following summarizes the Company's net investment in real estate assets as of December 31, 1995 (dollars in thousands):\nThe following summarizes the financial statements of CSBB for the year ended December 31, 1995 (dollars in thousands):\nNOTE 2 - DIVESTITURE OF THE LINCOLN SAVINGS BANK, FSB - -----------------------------------------------------\nAs previously reported, the Lincoln Savings Bank, FSB (\"Lincoln\") was the primary asset of Lincorp Holdings, Inc., (the \"Company\"). On January 20, 1993, in connection with the transaction described below, the Company relinquished control of Lincoln by placing the common stock of Lincoln into a trust for eventual sale, and by filing a divestiture notice with the Office of Thrift Supervision (the \"OTS\").\nOn March 4, 1994, Lincoln entered into a definitive agreement (the \"Acquisition Agreement\") with Anchor Savings Bank FSB (\"Anchor\") whereby Anchor would acquire all of the assets in the trust including outstanding preferred and common stock of Lincoln and a senior secured note, for $80 million in cash. The transaction was subject to, among other things, regulatory approval of the OTS and the Federal Deposit Insurance Corporation. Approval of the transaction was granted on July 12, 1994 and the transaction\nLINCORP HOLDINGS, INC. NOTES TO FINANCIAL STATEMENTS\nwas completed on August 12, 1994. As anticipated under the Acquisition Agreement, the Company received none of the proceeds from the sale of Lincoln but two of the Company's lenders received a total of $6.1 million as repayment of a portion of the principal amount of debt owed them. This payment to the Company's lenders represented a reduction in the loss recorded in 1992, relating to the Company's writedown of its investment in Lincoln. Accordingly, the Company recorded a $6.1 million income adjustment in 1994, relating to the discontinued operations of Lincoln.\nNOTE 3 - LIQUIDITY AND GOING CONCERN - ------------------------------------\nAt December 31, 1995, the Company had approximately $158.0 million of principal indebtedness and accrued and unpaid interest (the\"Indebtedness\") outstanding under its Senior, Subordinated and Junior credit facilities. The Company's parent company, Unicorp Energy Corporation (\"UEC\"), holds $144.5 million of the Indebtedness and Hees International Bancorp, Inc. (\"Hees\"), which currently owns an indirect 24.6% non-voting equity interest in UEC, holds the balance of the Indebtedness, $13.5 million. The Company is in payment default under each of the above mentioned credit facilities. These credit facilities are secured by a security interest in all of the Company's remaining non real estate assets.\nThe Company's sources of operating funds during the year ended December 31, 1995, and to date have been primarily from the sales of marketable securities and payments received from mortgage receivables. The assets being utilized to fund the Company's operations are part of collateral package securing the above described credit facilities. Unless the Company's lenders are prepared to continue to defer in realizing on the pledged collateral and allow the Company to utilize the proceeds from such collateral to fund its ongoing operations, the Company will be unable to continue as a going concern.\nNOTE 4 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - ---------------------------------------------------\nINCOME TAXES\nIn January 1993, the Company adopted Statement of Financial Accounting Standards No. 109 (\"FAS 109\"), Accounting for Income Taxes, resulting in no cumulative effect from prior periods. 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 apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The\nLINCORP HOLDINGS, INC. NOTES TO FINANCIAL STATEMENTS\neffect on deferred tax assets and liabilities of change in tax rates is recognized in income in the period that includes the enactment date.\nUSE OF ESTIMATES\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nNOTE 5 - OTHER LIABILITIES - --------------------------\nA summary of other liabilities is as follows:\nNOTE 6 - DEBT ON REAL ESTATE ASSETS AND OTHER BORROWED FUNDS - ------------------------------------------------------------\nThe Company's debt on real estate assets are as follows:\nAt December 31, 1994, the Company had outstanding indebtedness totaling $19 million on two of its real estate assets. This indebtedness was held by the General Partner to several of the Company's real estate joint ventures (see Note 1). Prior to January 1, 1995, when the Company's real estate operations were reclassified as continuing operations, this indebtedness was included as part of the net liability of real estate discontinued operations. During September, 1995, the outstanding debt on the real estate\nassets was purchased by UEC from the General Partner at face value. The amount and terms of this debt with UEC is as follows:\n(a) This is a $9 million promissory note line of credit which is secured by the Company's investment in CSBB and is to be used to fund the Company's share of any operating shortfalls of CSBB. This note matures July 22, 2000, and carries interest at prime rate plus 1%. Also, under the terms of this note, additional interest may be due each year through the note maturity date equal to 50% of the net cash flow generated by CSBB, as defined. As of December 31, 1995, no additional interest is due. At December 31, 1995, the total principal amount outstanding on this note is $6 million.\nUnder the provisions of this note, since CSBB is not providing current cash distributions to the Company, the monthly interest payments due on this note have been deferred until the note's maturity date.\n(b) This is an $11 million promissory note line of credit secured by the Company's investment in MSLL. This note matures July 22, 1996, and carries interest at prime rate plus 1%. Also, under the terms of this note, additional interest may be due each year through the note maturity date equal to 50% of the net cash flow generated by MSLL, as defined. As of December 31, 1995, no additional interest is due. At December 31, 1995, the total principal amount outstanding on this note is $9 million.\nUnder the provisions of this note, the Company is required to make monthly interest payments up to the net cash flow, as defined, generated by MSLL. Through September 30, 1995, the Company made all of the monthly payments required. With the purchase of this note by UEC at the end of September, 1995, the Company, requested and received from UEC a month to month waiver in making the monthly payments.\nThe Company's other borrowed funds are as follows:\n(a) This is a $24 million facility with UEC and Hees which expired in August 1991. The Company has made no interest payments on this facility since its expiration. At December 31, 1995, $12.0 million of the debt is with UEC and $7.9 million is with Hees. As of December 31, 1994, the Hees debt ($7.9 million) and accrued interest of $2.1 million was allocated to and included in the net liability for discontinued operations (see Note 1).\n(b) This $65 million facility with UEC matures in August 1997 and calls for interest-only payments at a fixed rate of 11.4 %, payable semi-annually. The Company may prepay the loan at any time in whole or in amounts aggregating $1 million or any larger multiple of $1 million. The term loan includes convenants, among others, that require the maintenance of a minimum level of tangible net worth and limit aggregate levels of additional indebtedness. As a result of the losses incurred by the Company, it was not in compliance with the above covenants and has not paid its semi-annual interest payment since August 1991.\n(c) In November 1989, the Company entered into an agreement with UEC that provided the Company with a line of credit in the aggregate amount of $30 million (amended to $25 million on July 25,1990) due on demand with an interest rate of prime plus 3.5% and a standby fee of one quarter of one percent of the unused portion of the commitment. During 1995, the Company borrowed $65 thousand against this facility.\nDuring 1995, the weighted average amount of total debt outstanding was $123.0 million (1994, - $109.0 million) and the weighted average interest cost of these funds during the year was 10.82 % (1994 - 10.45 %). The maximum amount of borrowed funds at any one time during 1995 and 1994 was approximately $124.7 million and $111.3 million, respectively.\nIn December 1991, the Financial Accounting Standards Board issued SFAS No. 107 \"Disclosures about Fair Value of Financial Instruments\" (\"FAS 107\"). The statement generally became effective for fiscal years ending after December 15, 1992, at which time entities were required to disclose the fair value of on and off-balance sheet financial instruments, determined on a basis consistent with the requirements of FAS 107. In view of the financial position of the Company at December 31, 1995, management has determined it is not practicable to estimate the fair value of debt and other borrowed funds.\nLINCORP HOLDINGS, INC. NOTES TO FINANCIAL STATEMENTS\nNOTE 7 - INCOME TAXES - ---------------------\nSet forth below is an analysis of the Company's provision for income taxes for the years ended December 31, 1995, 1994 and 1993.\nA reconciliation of the total provision for income taxes to amounts computed by applying the federal tax rate to income is as follows:\nThe accompanying balance sheets reflect no deferred tax assets or liabilities as of December 31, 1995 and 1994, as a result of the application of FAS 109.\nAs part of the sale of Lincoln (see Note 2), the Company's debt previously owed to the National Bank of Canada (\"NBC\") of approximately $77 million plus accrued and unpaid interest was transferred to UEC. The debt acquired from NBC by UEC was acquired at a cost of $4.7 million. As a result of the transfer of the debt to an affiliate of the Company, the amount of debt transferred which is in excess of the face amount is, for federal and state income tax purposes, considered forgiveness of debt of the Company and therefore is required to be included as taxable income by the Company. The Company will not have to pay federal or state taxes on this income because of its insolvency pursuant to Internal Revenue Service Code Section 108 (Discharge of Indebtedness). However, tax attributes of the Company (net operating loss carry forwards, capital losses and built-in losses) will be reduced to the extent of the forgiveness of indebtedness. Additionally, for federal tax purposes, the Company may realize a bad debt loss of approximately $85 million, as well as certain as yet undetermined and unrealized potential capital losses. The Company has fully reserved any deferred tax benefit associated with the net operating loss carryforwards.\nLINCORP HOLDINGS, INC. NOTES TO FINANCIAL STATEMENTS\nIn May 1990, a subsidiary of the Company conveyed a property to one of its lenders, in the form of a deed in lieu of foreclosure, resulting in a tax assessment of $1.2 million being made by the Massachusetts Department of Revenue (the\"MDR\") on such transfer. Shortly thereafter, this subsidiary was dissolved but the tax liability remains outstanding. On November 29, 1993, an Offer of Settlement was forwarded to the MDR with respect to this assessment which was rejected by the MDR on October 26, 1995. The ultimate outcome of this assessment cannot be determined at this time.\nEXHIBIT INDEX -------------","section_15":""}
{"filename":"806028_1995.txt","cik":"806028","year":"1995","section_1":"Item 1. Business. --------\nNew England Pension Properties V; A Real Estate Limited Partnership (the \"Partnership\") was organized under the Uniform Limited Partnership Act of the Commonwealth of Massachusetts on October 23, 1986, to invest primarily in to-be-developed, newly-constructed and existing income-producing real properties.\nThe Partnership was initially capitalized with contributions of $2,000 in the aggregate from Fifth Copley Corp. (the \"Managing General Partner\") and ECOP Associates Limited Partnership (the \"Associate General Partner\") (collectively, the \"General Partners\") and $10,000 from Copley Real Estate Advisors, Inc. (the \"Initial Limited Partner\"). The Partnership filed a Registration Statement on Form S-11 (the \"Registration Statement\") with the Securities and Exchange Commission on November 12, 1986, with respect to a public offering of 60,000 units of limited partnership interest at a purchase price of $1,000 per unit (the \"Units\") with an option to sell up to an additional 60,000 Units (an aggregate of $120,000,000). The Registration Statement was declared effective on January 9, 1987.\nThe first sale of Units occurred on July 23, 1987, at which time the Initial Limited Partner withdrew its contribution from the Partnership. Investors were admitted to the Partnership thereafter at monthly closings; the offering terminated and the last group of subscription agreements was accepted by the Partnership on December 31, 1987. As of January 31, 1988, a total of 83,291 Units had been sold, a total of 12,900 investors had been admitted as limited partners (the \"Limited Partners\") and a total of $82,761,530 had been contributed to the capital of the Partnership. The remaining 36,709 Units were de-registered on March 17, 1988.\nThe Partnership makes available 2% of Cash Flow, as defined in the Partnership's Amended and Restated Agreement of Limited Partnership dated July 23, 1987, for the purpose of repurchasing Units. See Note 1 of the Financial Statements in Item 8 hereof.\nAs of December 31, 1995, the Partnership had invested, or had committed to invest in nine real property investments; Two of these investments were sold in 1994. Sales proceeds were distributed in the amount of $48 per Unit in 1994 and $28 per Unit in 1995, after the Partnership made its final strategic decisions on projects yet to be developed. The Partnership has no current plan to renovate, improve or further develop any of its real property other than as described in E. below. In the opinion of the Managing General Partner, the properties are adequately covered by insurance.\nThe Partnership has no employees. Services are performed for the Partnership by the Managing General Partner and affiliates of the Managing General Partner.\nA. Land in Germantown, Maryland (\"Waters Landing II\"). --------------------------------------------------\nOn May 26, 1987, the Partnership acquired a 60% interest in a joint venture with Waters Landing Two - Oxford Limited Partnership (\"Oxford\"). As of December 31, 1995, the Partnership had contributed $1,392,126 to the capital of the joint venture out of a maximum obligation of $4,682,400. The joint venture agreement entitles the Partnership to receive a monthly preferred return on its invested capital at the rate of 10.5% per annum. Prior to December 1, 1994, such monthly preferred return was permitted to accrue to the extent that the joint venture did not have sufficient cash to pay it. The joint venture agreement also entitles the Partnership to receive 60% of all remaining cash flow from operations and 60% of net sale and refinancing proceeds following the return of the Partnership's equity. The Partnership also committed to make a loan of up to $3,121,600 to Oxford for investment in the venture of which $928,084 had been funded as of December 31, 1995. Interest only on the loan is payable monthly at the rate of 10.5% per annum. The loan will be due upon the sale of the joint venture's assets or the sale of Oxford's interest in the joint venture. Oxford must apply any cash flow received from operations of the joint venture to interest payments on the loan and must apply proceeds of financings or sales received from the joint venture to payments of the interest on and principal of the loan. The loan is secured by Oxford's interest in the joint venture.\nThe joint venture owns approximately 8.5 acres of land in Germantown, Maryland and originally intended to construct a 144-unit apartment complex. Development had been postponed due to the excess supply of apartment units in the Germantown area. During 1995, the joint venture undertook a\nnumber of feasibility studies of alternative development proposals for the site and determined development would not yield a sufficient return to justify the investment risk. Accordingly, the Partnership intends to sell the land parcel when market conditions improve.\nB. Warehouse Building in Fontana, California (\"Dahlia\"). ----------------------------------------------------\nOn September 21, 1987, the Partnership acquired a 60% interest in a joint venture formed with an affiliate of Investment Building Group. As of December 31, 1995, the Partnership had contributed $7,081,593 to the capital of the joint venture out of a maximum obligation of $7,250,000. The joint venture agreement entitles the Partnership to receive a monthly preferred return on its invested capital at the rate of 10% per annum. The joint venture agreement also entitles the Partnership to receive 60% of the remaining cash flow and 60% of sale and refinancing proceeds following the return of the Partnership's equity. On September 1, 1995, the joint venture was converted into a California limited partnership with the Partnership as the general partner and the affiliate of Investment Building Group as the limited partner.\nThe limited partnership owns approximately 12.9 acres of land in Fontana, California and has completed construction thereon of a one-story warehouse building containing approximately 278,220 square feet of space. As of December 31, 1995, the building was 100% leased.\nC. Office\/Warehouse Buildings in Phoenix, Arizona (\" University Business --------------------------------------------------------------------- Park\"). ------\nOn September 30, 1987, the Partnership acquired a 60% interest in a joint venture formed with an affiliate of The Hewson Company. As of December 31, 1995, the Partnership had contributed $7,976,784 to the capital of the joint venture out of a maximum obligation of $9,450,000. The joint venture agreement entitles the Partnership to receive a monthly preferred return on its invested capital at the rate of 10% per annum. The joint venture agreement also entitles the Partnership to receive 60% of the remaining cash flow and 60% of sale and refinancing proceeds following return of the Partnership's equity. Effective January 1, 1996, the joint venture was dissolved and ownership of the joint venture assets was assigned to the Partnership.\nThe Partnership owns approximately 8.5 acres of land in Phoenix, Arizona and has completed construction thereon of five warehouse buildings containing approximately 109,930 square feet of space. As of December 31, 1995, the buildings were 98% leased.\nD. Office\/Research and Development Buildings in Columbia, Maryland --------------------------------------------------------------- (\"Columbia Gateway Corporate Park\"). -----------------------------------\nOn December 21, 1987, the Partnership acquired a 33% interest in a joint venture formed with New England Life Pension Properties IV; A Real Estate Limited Partnership, an affiliate of the Partnership (the \"Affiliate\"), which had a 17% interest, and M.O.R. Gateway 51 Associates Limited Partnership.\nAs of April 20, 1989, the joint venture agreement was amended and restated to reflect a decrease in the Partnership's interest in the joint venture to 15.25% and an increase in the Affiliate's interest in the joint venture to 34.75%. In addition, the amended and restated joint venture agreement increased the Affiliate's maximum obligation to contribute capital to the joint venture and reallocated the capital contributed to the joint venture by the Partnership and the Affiliate. As of December 31, 1995, the Partnership had contributed $6,181,690 to the capital of the joint venture out of a maximum obligation of $6,402,000.\nThe joint venture agreement entitles the Partnership and the Affiliate to receive a preferred return on their respective invested capital at the rate of 10.5% per annum. Such preferred return will be payable currently until the Partnership and the Affiliate have received an aggregate of $8,865,000; thereafter, if sufficient cash flow is not available therefor, the preferred return will accrue and bear interest at the rate of 10.5% per annum, compounded monthly. The joint venture agreement also entitles the Partnership to receive 15.25% of cash flow following payment of the preferred return and 15.25% of the net proceeds of sales and refinancings following return of the Partnership's and the Affiliate's equity.\nThe joint venture owns approximately 20.85 acres of land in the Columbia Gateway Corporate Park in Columbia, Maryland. The intended development plan for this land was for a two stage development of seven office and research and development buildings. The first phase of this development was completed in 1992 and included the construction of four, one-story office and research and development buildings containing 142,545 square feet. The second phase of this development commenced in the spring of 1994 in which two buildings totaling 46,000 square feet were constructed and leased to a single tenant for a lease term of ten years. As of December 31, 1995 the project was 92% occupied.\nE. Industrial Building in Brea, California (\"Puente Street\"). ---------------------------------------------------------\nOn April 28, 1988, the Partnership acquired a 60% interest in a joint venture formed with an affiliate of The Muller Company. In April, 1990, the Partnership increased its commitment to the joint venture by $625,000 to $13,725,000 of which $13,475,000 had been contributed as of June 1, 1991. The joint venture agreement entitled the Partnership to receive a monthly preferred return on its invested capital at the rate of 10.5% per annum. The joint venture agreement also entitled the Partnership to receive 60% of the remaining cash flow and 60% of sale and refinancing proceeds following the return of the Partnership's equity. As of June 1, 1991, because of the developer partner's inability to fund its share of capital contributions, the Partnership assumed 100% ownership of the joint venture's assets.\nThe Partnership owns approximately 16.75 acres of land in Brea, California and has completed renovation of an existing building thereon containing 181,200 square feet. Construction of an approximately 37,320 square foot addition was completed during the first quarter of 1989. Construction of a parking lot and storage area on the remaining vacant land was completed during 1990.\nThe building, including the addition, was 100% leased to Mark Industries; however, the tenant declared bankruptcy on July 15, 1991. The tenant's business was subsequently purchased by another company which leased the building on a month-to-month basis. The tenant moved out of the space and stopped paying rent as of October 31, 1992. The Partnership filed a claim against Mark Industries for $160,000 in unpaid post-petition rent, $1,420,000 in unpaid future rental obligations and $60,000 in legal expenses. In early 1994 the Partnership received $160,000 in payment of the post-petition rent. On September 14, 1994 the Trustee for Mark Industries filed a claim against the Partnership contending that $106,000 in rental payments made by the tenant prior to filing bankruptcy was a preferential transfer. In early 1995 all parties agreed to a stipulated settlement to include: 1) the dismissal of the preferential transfer claim; 2) the payment by the Trustee to the Partnership of $23,000 in full settlement of its administrative claim for attorney's fees relating to the tenant's post petition lease obligations; and 3) the payment by the Trustee to the Partnership of $20,000 in full settlement of its claim against the tenant for future rental obligations. As of December 31, 1995, the building was 100% leased to two tenants. The first tenant assumed occupancy of 152,576 square feet in December 1993 and has a lease whose term expires in February 2004. The remaining space was leased in April 1994 for a term of five years.\nOn December 8, 1995 the Partnership was named as a defendant in a complaint filed in the Superior Court of the State of California for the County of Orange by an existing tenant, Bridgeport Management Services, Inc. alleging breach of lease. On January 17, 1996 the Partnership filed an answer denying the allegations presented by the plaintiff. The Partnership believes this suit is without merit.\nThe Partnership continues to evaluate the alternatives of developing additional space on the 2.8 acres of land currently improved with a parking lot, or selling the land.\nF. Shopping Center in Salinas, California (\"Santa Rita Plaza\"). -----------------------------------------------------------\nOn February 1, 1989, the Partnership acquired a 60% interest in a joint venture formed with Rodde McNellis\/Salinas. On July 20, 1990, the Partnership committed to increase its maximum obligation from $9,500,000 to $11,350,000, of which $6,500,000 is characterized as Senior Capital and $4,850,000 is characterized as Junior Capital. As of December 31, 1995, the Partnership had contributed $10,950,840 to the capital of the joint venture. The joint venture agreement entitles the Partnership to receive a monthly preferred return on its Senior Capital at the rate of 10.5% per annum during months 1-24 of the joint venture's operations and a monthly preferred return to reduce its outstanding Senior Capital, together with a return at the rate of 10.5% per annum, based on a 27-year amortization schedule,\nduring months 25-120 of the joint venture's operations. The entire outstanding Senior Capital is due and payable ten years after the date of the Partnership's first investment of Senior Capital. The joint venture agreement also entitles the Partnership to receive a priority return payment on its Junior Capital at the rate of 10.5% per annum. Such junior priority return payment will accrue and bear interest at the rate of 10.5% per annum, if sufficient cash is not available therefor. At such time as the aggregate of accrued junior priority return payments total $1,000,000, all junior priority return payments and the return on the accrued junior priority return payments will thereafter be paid currently; provided, however, that the $1,000,000 threshold will be increased by each dollar of Junior Capital which the Partnership elects not to contribute to fund its return. The Junior Capital will be due and payable after the fifteenth year of the joint venture's operations. On August 1, 1995 the joint venture was converted into a California limited partnership with the Partnership as the general partner with a 63% ownership interest and an affiliate of Rodde\/McNellis Salinas as the limited partner with a 37% interest. The joint venture agreement also entitles the Partnership to receive 63% of cash flow remaining after payment of the preferred return and 63% of sale and refinancing proceeds following the return of the Partnership's equity.\nThe limited partnership has a leasehold interest in approximately 10.56 acres of land in Salinas, California (the \"Land\") and has completed construction thereon of five one-story retail buildings containing a total of approximately 125,247 square feet. The ground lease has a term of 75 years with two options to extend, for ten years each. Under the ground lease, fixed rent of $390,000 per annum is payable. A percentage rent equal to 11.55% of rents in excess of $1,400,000 received by the ground lessee from subtenants, excluding expense reimbursements, is also payable. As of December 31, 1995, the buildings were 91% leased.\nOn August 1, 1995 the Partnership made a $1,750,000 loan to Nielsen Properties, Ltd., which is the ground lessor, for a term of 15 years. The loan earns interest at 8.75% and the Partnership can require full payment of the note on or after August 1, 2000. The note is secured by a deed of trust on the Land. In conjunction with this loan, Nielsen Properties, Inc. repaid the limited partnership $1,299,052, representing full payment of two outstanding notes receivable.\nG. Office\/Retail\/Industrial Buildings in Las Vegas, Nevada (\"Palms --------------------------------------------------------------- Business Center III and IV\"). ----------------------------\nOn March 7, 1988, the Partnership acquired a 60% interest in a joint venture formed with an affiliate of B.H. Miller Companies. As of January 1, 1995, the Partnership had contributed $11,589,888 to the capital of the joint venture out of a maximum obligation of $11,700,000. The joint venture agreement entitled the Partnership to receive a monthly preferred return at the rate of 11% per annum on the daily balance of its invested capital during each month, of which 9.5% per annum was to be paid currently and up to 1.5% per annum will be deferred if sufficient cash was not available therefor. All invested capital, monthly payments of preferred return and deferred monthly payments of preferred return were due and payable at the end of the tenth year of the joint venture's operations. The joint venture agreement also entitled the Partnership to receive 60% of net cash flow and 60% of sale and refinancing proceeds following the return of the Partnership's equity capital. Effective January 1, 1995, the joint venture partner's ownership interest was transferred and assigned to the Partnership.\nThe Partnership owns approximately 11.75 acres of land in Las Vegas, Nevada and has completed construction thereon of twelve single-story office\/industrial buildings and one single-story retail building containing a total of approximately 173,574 square feet. As of December 31, 1995, the buildings were 95% leased. In October 1994, the Clark County of Public Works paid the Partnership $18,600 to acquire a necessary strip of land to widen the road that fronts a portion of the property, in conjunction with planned road improvements in the area.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe following table sets forth the annual realty taxes for the Partnership's properties and information regarding tenants who occupy 10% or more of gross leasable area (GLA) in the Partnership's properties.\nThe following table sets forth for each of the last five years the gross leasable area, occupancy rates, rental revenue, and net effective rent for the Partnership's properties:\nNote: N\/A for commercial properties indicates property was not constructed as of this date.\n* Net Effective Rent calculation is based on average occupancy during the respective years.\nFollowing is a schedule of lease expirations for each of the next ten years for the Partnership's properties based on the annual contract rent in effect at December 31, 1995:\n* Does not include expenses paid by tenants.\nNote: N\/A denotes that the disclosure is not applicable based on the nature of the property.\n(1) Remaining leases expire beyond 2005.\nThe following table sets forth for each of the Partnership's properties the: (i) federal tax basis, (ii) rate of depreciation, (iii) method of depreciation, (iv) life claimed, and (v) accumulated depreciation, with respect to each property or component thereof for purposes of depreciation:\nSL= Straight Line DB= Declining Balance\nFollowing is information regarding the competitive market conditions for each of the Partnership's properties. This information has been gathered from sources deemed reliable. However, the Partnership has not independently verified the information and, as such, cannot guarantee its accuracy or completeness.\nIndustrial Buildings in Brea, California - ----------------------------------------\nThis property is located within the Orange County industrial market, consisting of 230 million square feet. Brea is a desirable industrial location due to its close proximity to Los Angeles County and the central portion of Orange County. The property more specifically is located within the North Orange County industrial submarket, which has an inventory of 101 million square feet, or 44% of the total Orange County market. As of September 30, 1995 the North Orange County vacancy rate was 8%, down slightly from the 11% vacancy rate reported one year ago and 13% two years ago. While a small amount of speculative construction occurred in 1995, most of the construction related to build-to-suit contracts. As a result of the low vacancy and minimal speculative construction, overall industrial rental rates have stabilized. Rental rates on quality buildings have begun to increase.\nShopping Center in Salinas, California - --------------------------------------\nThis property is located in Salinas, a strong retail community known as the commercial center for much of Monterey County. There are nearly 3.6 million square feet of major shopping centers in Salinas, and for the approximately 2 million square feet that directly competes with this property, overall vacancy was 2% as of December 31, 1995, the same as one year ago. Occupancy and market rents are stable, although an additional 1 million square feet currently under construction in the Salinas area may negatively impact achievable rents at the property until the newly completed space is leased.\nOffice\/Research and Development Buildings in Columbia, Maryland - ---------------------------------------------------------------\nThe Howard County R&D market contains approximately 3.2 million square feet and exhibited a vacancy rate of 10% as of December 31, 1995. The 10% vacancy rate is a strong improvement from the 1990-to-1993 period when the vacancy rate hovered in the 22% to 24% range.\nOffice\/Warehouse Buildings in Phoenix, Arizona - ----------------------------------------------\nThis property is located in the metropolitan Phoenix market which has an inventory of approximately 142 million square feet of industrial space, of which 6% was vacant as of year end 1995, compared to the 7% and 12% vacancy rates as of December 31, 1994 and 1993, respectively. The office market, consisting of 39 million square feet, was 11% vacant at year end 1995 compared to 1993 and 1994 vacancies of 20% and 13%, respectively. Rental rates in the Phoenix area continue to increase.\nWarehouse Building in Fontana, California - -----------------------------------------\nThis property is located within the greater Los Angeles industrial market, consisting of 950 million square feet. More specifically, the property is located within the Inland Empire industrial market, which consists of 113 million square feet, or 12% of the total Los Angeles industrial market. As of September 30, 1995, the Inland Empire industrial vacancy rate was approximately 8% as compared to the 11% vacancy level reported a year earlier. Similar to other areas of southern California, a small amount of speculative construction occurred in 1995, although most of the construction related to build-to-suit contracts. Low vacancy and minimal speculative construction have resulted in the stabilization of rental rates. Rental rates on quality buildings have begun to increase.\nOffice\/Industrial\/Retail Buildings in Las Vegas, Nevada - -------------------------------------------------------\nThe healthy business climate of Las Vegas, fueled by the gaming and service industries, is responsible for a strong industrial market, which exhibits a low vacancy rate of approximately 2% on a base inventory of 38 million square feet. Rental rates have increased over the past year and most free rent concessions have been eliminated. Given the low vacancy level, new construction in all product types and sizes is underway.\nItem 3.","section_3":"Item 3. Legal Proceedings. -----------------\nThe Partnership is not a party to, nor are any of its properties subject to, any material pending legal proceedings. A tenant of one of the Partnership's properties has sued the Partnership for breach of the lease. See Item 1.E.\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 Annual Report on Form 10-K.\nPART II -------\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters. ---------------------------------------------------------------------\nThere is no active market for the Units. Trading in the Units is sporadic and occurs solely through private transactions.\nAs of December 31, 1995, there were 13,127 holders of Units.\nThe Partnership's Amended and Restated Agreement of Limited Partnership dated July 23, 1987, as amended to date (the \"Partnership Agreement\"), requires that any Distributable Cash (as defined therein) be distributed quarterly to the Partners in specified proportions and priorities. There are no restrictions on the Partnership's present or future ability to make distributions of Distributable Cash. Cash distributions paid in 1995 or distributed after year end with respect to 1995 to the Limited Partners as a group totaled $6,389,408, including $2,313,164 of returned capital from the proceeds of two property sales. Cash distributions paid in 1994 or distributed after year end with respect to 1994 to the Limited Partners as a group totaled $7,229,361, including $3,968,640 of returned capital from the proceeds of property sales.\nCash distributions exceeded net income in 1995 and, therefore, resulted in a reduction of partners' capital. However, operating cash distributions were less than net cash provided by operating activities. Reference is made to the Partnership's Statement of Changes in Partners' Capital (Deficit) and Statement of Cash Flows in Item 8 hereof.\nItem 6.","section_6":"Item 6. Selected Financial Data -----------------------\nItem 7","section_7":"Item 7 - ------\nManagement's Discussion and Analysis of Financial Condition and Results of - -------------------------------------------------------------------------- Operations - ----------\nLiquidity and Capital Resources\nThe Partnership completed its offering of units of limited partnership interest in December 1988. A total of 83,291 units were sold. The Partnership received proceeds of $74,895,253, net of selling commissions and other offering costs, which have been used for investment in real estate, for the payment of related acquisition costs and for working capital reserves. The Partnership made the real estate investments described in Item 1 herein. Two investments have been sold; one in June 1994 and the other in August 1994.\nAs a result of the sales, capital of $6,281,804 has been returned to the limited partners through December 31, 1995. On September 15, 1994, the Partnership made a capital distribution of $48 per limited partnership unit, which reduced the adjusted capital contribution to $952 from $1,000 per unit. A capital distribution in July 1995 of $28 per limited partnership unit further reduced the adjusted capital contribution to $924. A portion of the sales proceeds was used to pay previously accrued, but deferred, management fees to the advisor ($183,426 in 1995 and $1,259,988 in 1994).\nAt December 31, 1995, the Partnership had $11,655,405 in cash, cash equivalents and short-term investments, of which $1,011,274 was used for cash distributions to partners on January 25, 1996; the remainder will be used to complete the funding of real estate investments or be retained as working capital reserves. The source of future liquidity or cash distributions to partners will be cash generated by the Partnership's real estate and short-term investments. Quarterly distributions of cash from operations relating to 1995 and 1994 were made at the annualized rate of 5.25% and 4%, respectively, on the weighted average adjusted capital contribution during the period. The distribution rate was increased due to the stabilization of property operations and the attainment of appropriate cash reserve levels.\nThe Partnership maintains a fund for the purpose of repurchasing limited partnership units pursuant to the terms and conditions set forth in the Partnership Agreement. Two percent of cash flow, as defined, is designated for this fund which had a balance of $32,572 and $4,447 at December 31, 1995 and 1994, respectively. Through December 31, 1995, the Partnership had repurchased and retired 755 limited partnership units for an aggregate cost of $729,132.\nThe carrying value of real estate investments in the financial statements at December 31, 1995 is at depreciated cost, or if the investment's carrying value is determined not to be recoverable through expected undiscounted future cash flows, the carrying value is reduced to estimated fair market value. The fair market value of such investments is further reduced by the estimated cost of sale for properties held for sale. Carrying value may be greater or less than current appraised value. At December 31, 1995, the appraised value of certain investments exceeded the related carrying values by an aggregate of approximately $4,900,000, and the remaining investments had carrying values which exceeded their appraised values by a total of approximately $2,400,000. The current appraised value of real estate investments has been estimated by the Managing General Partner and is generally based on a combination of traditional appraisal approaches performed by the Partnership's advisor and independent appraisers. Because of the subjectivity inherent in the valuation process, the estimated\ncurrent appraised value may differ significantly from that which could be realized if the real estate were actually offered for sale in the marketplace.\nResults of Operations - ---------------------\nForm of Real Estate Investments\nEffective January 1, 1995, Palms Business Center joint venture was restructured and the venture partner's ownership interest was assigned to the Partnership. Effective August 1, 1995 and September 1, 1995, respectively, the Santa Rita Plaza and Dahlia joint venture investments were restructured to grant the Partnership control over management decisions. Accordingly, these investments have been accounted for as wholly-owned properties since those dates. The Puente Street investment is also a wholly-owned property. The other three investments in the portfolio are structured as joint ventures with real estate development\/management firms. The C.S. Graham and Lakewood Apartments investments, which were sold in 1994, were also joint ventures.\nOperating Factors\nOccupancy at University Business Park was at 98% at December 31, 1995, an increase from 89% at December 31, 1994 and 80% a year earlier. Rental rates are increasing and occupancy levels have remained high as the Phoenix market appears to have stabilized.\nOverall occupancy at the Columbia Gateway Corporate Park remained at 92% at December 31, 1995, unchanged from the preceding year end. Construction of a 46,000 square foot build-to-suit facility was completed during the third quarter of 1994 and the tenant assumed occupancy on September 1, 1994. Occupancy was 73% at December 31, 1993.\nOccupancy at Puente Street has been 100% since the first quarter of 1994. Prior to that date, occupancy was at 70%. Notwithstanding the improvement in leasing, the carrying value of this investment was reduced in 1993 and 1994 to estimated net realizable value, due to depressed market conditions.\nDuring 1995, the joint venture undertook a number of feasibility studies of alternative development plans for the Waters Landing II site. Based on the results, it was determined that it is not in the best interest of the limited partners to develop this site. Accordingly, the carrying value was reduced to estimated fair market value less cost of sale.\nOccupancy increased from 92% to 95% at the Palms Business Center III and IV during 1995. Occupancy was 98% at December 31, 1993. The majority of the tenants are renewing leases upon their expirations, and as a result of demand, rents are increasing.\nOccupancy at the Dahlia property remained at 100% during 1995. It was 89% at December 31, 1993. The market conditions for industrial space in this area of California are improving.\nSanta Rita Plaza was 91% leased at December 31, 1995, which approximated the occupancy over the past three years. While occupancy at the Plaza has been high, performance has been affected by tenant delinquencies and turnover due to business failures.\nInvestment Results\nInterest on short-term investments and cash equivalents increased significantly in 1994 as compared to 1993, and again in 1995, due to both an increase in interest rates and a higher average investment balance resulting from the temporary investment of proceeds from the C.S. Graham and Lakewood sales.\nSignificant Transactions\nThe Managing General Partner determined during the second quarter of 1995 not to develop the Waters Landing II site. Accordingly, the carrying value of this investment was reduced to its estimated fair market value less cost of sale with a $600,000 charge to operations. As a result of depressed market conditions, the Managing General Partner has determined that the carrying value of the Puente Street investment should be reduced to estimated net realizable value through a charge to operations of $1,500,000 in 1993 and further reduced in 1994 by $1,400,000. During 1993, the Managing General Partner also reduced the carrying value of Columbia Gateway Corporate Park to its estimated net realizable value which resulted in an investment valuation allowance of $500,000.\nThe gains recognized by the Partnership in 1994 on the sale of the C.S. Graham and Lakewood properties were $409,982 and $1,380,488, respectively. An additional $6,209 was received in 1995 in final settlement of the Lakewood sale.\n1995 Compared to 1994\nExclusive of the investment valuation allowances, the gain on sales of property by joint ventures and the operating results from C.S. Graham and Lakewood Apartments recognized in 1994 ($273,429), total real estate operations were $2,828,940 in 1995 and $2,733,686 in 1994. Operating income increased at Puente Street ($303,000) and Columbia Gateway Park ($127,000). The improvement at Puente Street results from the lease-up of the property during the first quarter of 1994. The improvement at Columbia Gateway Park is due to improvements in rental income. These increases were partially offset by a decline in net operating income at Santa Rita Plaza ($275,000) due to tenant delinquencies and turnover due to business failures. Net operating income also decreased at Palms Business Center III and IV and at University Business Park due to costs associated with tenant turnover in advance of lease expirations.\nExclusive of operating distributions from Lakewood Apartments and C.S. Graham ($358,198) during 1994, cash flow from operations increased from $2,128,608 to $4,738,007. Cash flow from operations in 1994 included two significant transactions. The Partnership paid $1,259,988 of the previously accrued, but deferred management fee to the advisor. In addition, the Partnership granted rental concessions and paid a lease commission related to the new tenant at Puente Street, which totalled $410,000. The balance of the increase in cash flow from operations primarily stems from the assumption of joint venture cash balances in connection with the three ownership restructurings and from decreases in working capital items.\n1994 Compared to 1993\nOperating income from Puente Street increased significantly between 1994 and 1993, with the lease-up of the property.\nExclusive of the operating results from C.S. Graham, Lakewood and Puente Street, joint venture earnings were $2,499,676 in 1994 and $2,126,010 in 1993. This $373,666 or 18% increase resulted from improved operating results at all of the joint venture projects. Columbia Gateway Corporate Park improved by approximately $123,000, due to an increase in rental revenue of $50,000 and a decrease in expenses of $73,000. Dahlia improved by approximately $62,000, due to a decrease in property operating expenses of $103,000 which was partially offset by a decrease in rental revenue of $42,000 (although rental revenue in 1993 included $300,000 from a settlement of past due rents from a former tenant). Palms Business Center III and IV, Santa Rita Plaza and University Business Park also improved by approximately $57,000, $68,000 and $62,000, respectively.\nExclusive of operating cash flow from Lakewood and C.S. Graham of $358,198 in 1994 and $331,453 in 1993, operating cash flow increased by $713,946 or 50% between the respective years. In addition to the effect of improved operating results, cash flow increased during 1994 as a result of the timing of cash distributions to the Partnership from certain joint ventures which had been retaining additional working capital reserves. This reduction in working capital reserves was most notable at Palms Business Center III and IV ($950,000), Dahlia ($630,000) and Columbia Gateway Corporate Park ($150,000). These increases were partially offset by the payment of deferred, but previously accrued, management fees to the advisor ($1,259,988). Operating cash flow at Puente Street declined due primarily to the payment of lease commissions. Also, cash flow at University Business Park declined by approximately $175,000 due to timing of distributions.\nPortfolio Expenses\nThe Partnership management fee is 9% of distributable cash flow from operations after any increase or decrease in working capital reserves as determined by the Managing General Partner. General and administrative expenses consist primarily of real estate appraisal, printing, legal, accounting and investor servicing fees.\n1995 Compared to 1994\nThe Partnership management fee increased due to an increase in distributable cash flow from operations. General and administrative expenses increased $57,459 or 21%, primarily due to an increase in legal costs associated with the various joint venture restructurings.\n1994 Compared to 1993\nThe Partnership management fee increased due to an increase in distributable cash flow. General and administrative expenses increased $30,453 or 13%, primarily due to professional and servicing fees.\nInflation - ---------\nBy their nature, real estate investments tend not to be adversely affected by inflation. Inflation may result in appreciation in the value of the Partnership's real estate investments over time if rental rates and replacement costs increase. Declines in real property values during the period of Partnership operations, due to market and economic conditions, have overshadowed the positive effect inflation may have on the value of the Partnership's investments.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data. -------------------------------------------\nSee the Financial Statements of the Partnership included 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. --------------------\nThe Partnership has had no disagreements with its accountants on any matters of accounting principles or practices or financial statement disclosure.\nPART III --------\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant. --------------------------------------------------\n(a) and (b) Identification of Directors and Executive Officers. --------------------------------------------------\nThe following table sets forth the names of the directors and executive officers of the Managing General Partner and the age and position held by each of them as of December 31, 1995.\nMr. O'Connor and Mr. Coughlin have served in an executive capacity since the organization of the Managing General Partner on October 23, 1986. Mr. Gardiner and Mr. Twining have served in their capacities since June 1994, and Mr. Mackowiak has served in his capacity as of January 1, 1996. All of these individuals will continue to serve in such capacities until their successors are elected and qualified.\n(c) Identification of Certain Significant Employees. -----------------------------------------------\nNone.\n(d) Family Relationships. --------------------\nNone.\n(e) Business Experience. -------------------\nThe Managing General Partner was incorporated in Massachusetts on October 23, 1986. The background and experience of the executive officers and directors of the Managing General Partner are as follows:\nJoseph W. O'Connor has been President, Chief Executive Officer and a Director of Copley Real Estate Advisors, Inc. (\"Copley\") since January, 1982. He was a Principal of Copley from 1985 to 1987 and has been a Managing Director of Copley since January 1, 1988. He has been active in real estate for 27 years. From June, 1967, until December, 1981, he was employed by New England Mutual Life Insurance Company (\"The New England\"), most recently as a Vice President in which position he was responsible for The New England's real estate portfolio. He received a B.A. from Holy Cross College and an M.B.A. from Harvard Business School.\nDaniel J. Coughlin was a Principal of Copley from 1985 to 1987 and has been a Managing Director of Copley since January 1, 1988 and a Director of Copley since July 1994. Mr. Coughlin has been active in financial management and control for 21 years. From June, 1974 to December, 1981, he was a Real Estate Administration Officer in the Investment Real Estate Department at The New England. Since January, 1982, he has been in charge of the asset management division of Copley. Mr. Coughlin is a Certified Property Manager and a licensed real estate broker. He received a B.A. from Stonehill College and an M.B.A. from Boston University.\nPeter P. Twining is a Managing Director and General Counsel of Copley. As such, he is responsible for general legal oversight and policy with respect to Copley and its investment portfolios. Before being promoted to\nthis position in January 1994, he was a Vice President\/Principal and senior lawyer responsible for assisting in the oversight and management of Copley's legal operations. Before joining Copley in 1987, he was a senior member of the Law Department at The New England and was associated with the Boston law firm, Ropes and Gray. Mr. Twining is a graduate of Harvard College and received his J.D. in 1979 from Northeastern University.\nWesley M. Gardiner, Jr. joined Copley in 1990 and has been a Vice President at Copley since January, 1994. From 1982 to 1990, he was employed by Metric Realty, a nationally-known real estate investment advisor and syndication firm, as a portfolio manager responsible for several public and private limited partnerships. His career at Copley has included asset management responsibility for the company's Georgia and Texas holdings. Presently, as a Vice President and Team Leader, Mr. Gardiner has overall responsibility for all the partnerships advised by Copley whose securities are registered under the Securities and Exchange Act of 1934. He received a B.A. in Economics from the University of California at San Diego.\nDaniel C. Mackowiak has been a Vice President of Copley since January 1989 and has been a Vice President and the Principal Financial and Accounting Officer of the Managing General Partner since January 1996. Mr. Mackowiak previously held the offices of Chief Accounting Officer of Copley from January 1989 through April 1994 and Vice President and Principal Financial and Accounting Officer of the Managing General Partner between January 1989 and May 1994. From 1975 until joining Copley, he was employed by the public accounting firm of Price Waterhouse, most recently as a Senior Audit Manager. He is a certified public accountant and has been active in the field of accounting his entire business career. He received a B.S. from Nichols College and an M.B.A. from Cornell University.\nMr. O'Connor is a director of Copley Properties, Inc., a Delaware corporation organized as a real estate investment trust which is listed for trading on the American Stock Exchange. None of the other directors of the Managing General Partner is a director of a company with a class of securities registered pursuant to Section 12 of the Securities Exchange Act of 1934. All of the directors and officers of the Managing General Partner also serve as directors and officers of one or more corporations which serve as general partners of publicly-traded real estate limited partnerships which are affiliated with the Managing General Partner.\n(f) Involvement in Certain Legal Proceedings. ----------------------------------------\nNone.\nItem 11.","section_11":"Item 11. Executive Compensation. ----------------------\nUnder the Partnership Agreement, the General Partners and their affiliates are entitled to receive various fees, commissions, cash distributions, allocations of taxable income or loss and expense reimbursements from the Partnership. See Note 1, Note 2 and Note 6 of Notes to Financial Statements.\nThe following table sets forth the amounts of the fees and cash distributions and reimbursements for out-of-pocket expenses which the Partnership paid to or accrued for the account of the General Partners and their affiliates for the year ended December 31, 1995. Cash distributions to General Partners include amounts distributed after year end with respect to 1995.\nFor the year ended December 31, 1995 the Partnership allocated $31,706 taxable income to the General Partners.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management. --------------------------------------------------------------\n(a) Security Ownership of Certain Beneficial Owners. -----------------------------------------------\nNo person or group is known by the Partnership to be the beneficial owner of more than 5% of the outstanding Units at December 31, 1995. Under the Partnership Agreement, the voting rights of the Limited Partners are limited and, in some circumstances, are subject to the prior receipt of certain opinions of counsel or judicial decisions.\nExcept as expressly provided in the Partnership Agreement, the right to manage the business of the Partnership is vested exclusively in the Managing General Partner.\n(b) Security Ownership of Management. --------------------------------\nThe General Partners of the Partnership owned no Units at December 31, 1995.\n(c) Changes in Control. ------------------\nThere exists no arrangement known to the Partnership the operation of which may at a subsequent date result in a change in control of the Partnership.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions. ----------------------------------------------\nThe Partnership has no relationships or transactions to report other than as reported in Item 11, above.\nPART IV -------\nItem 14.","section_14":"Item 14. Exhibits, Financial Statements, and Reports on Form 8-K. -------------------------------------------------------\n(a) The following documents are filed as part of this report:\n(1) Financial Statements--The Financial Statements listed on the accompanying Index to Financial Statements and Schedule are filed as part of this Annual Report.\n(2) Financial Statement Schedule - The Financial Statement Schedule listed on the accompanying Index to Financial Statements and Schedule are filed as part of this Annual Report.\n(3) Exhibits--The Exhibits listed in the accompanying Exhibit Index are filed as a part of this Annual Report and incorporated in this Annual Report as set forth in said Index.\n(b) Reports on Form 8-K. During the last quarter of the year ending December 31, 1995, the Partnership filed no Current Reports on Form 8-K.\nNew England\nPension Properties V;\nA Real Estate Limited Partnership\nFinancial Statements\n* * * * * * * *\nDecember 31, 1995\nNEW ENGLAND PENSION PROPERTIES V; --------------------------------- A REAL ESTATE LIMITED PARTNERSHIP ---------------------------------\nINDEX TO FINANCIAL STATEMENTS AND SCHEDULE ------------------------------------------\nReport of Independent Accountants ---------------------------------\nTo the Partners\nNew England Pension Properties V; A Real Estate Limited Partnership\nIn our opinion, based upon our audits and the reports of other auditors, the financial statements listed in the accompanying index present fairly, in all material respects, the financial position of New England Pension Properties V; A Real Estate Limited Partnership (the \"Partnership\") at December 31, 1995 and 1994, and the results of its operation and its cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles. These financial statements are the responsibility of Fifth Copley Corp., the Managing General Partner of the Partnership; our responsibility is to express an opinion on these financial statements based on our audits. We did not audit the financial statements of the Partnership's investments in Santa Rita Plaza, Palms Business Center III and IV, and Dahlia for the years ended December 31, 1995, 1994 and 1993. Operating income for these investments aggregated $1,594,233 for the year ended December 31, 1995, and equity in joint venture income aggregated $2,200,515 and $2,014,952 for the years ended December 31, 1994 and 1993. We also did not audit the financial statements of the Partnership's investment in Puente Street for the year ended December 31, 1995. Operating income for this investment totalled $784,895 for the year ended December 31, 1995. We also did not audit the financial statements of the Partnership's Columbia Gateway Corporate Park joint venture investee for the year ended December 31, 1995, which results of operations are recorded using the equity method of accounting in the Partnership's financial statements. Equity in joint venture income for this venture was $371,986 for the year ended December 31, 1995. We also did not audit the financial statements of the Partnership's Lakewood joint venture investee for the year ended December 31, 1993, which results of operations are recorded using the equity method of accounting in the Partnership's financial statements. Equity in joint venture income for this venture was $274,968 for the year ended December 31, 1993. Those statements were audited by other auditors whose reports thereon have been furnished to us, and our opinion expressed herein, insofar as it relates to the amounts included for operating income and equity in joint venture income for Santa Rita Plaza, Palms Business Center III and IV, and Dahlia for the years ended December 31, 1995, 1994 and 1993, for Puente Street for the year ended December 31, 1995, and for Lakewood for the year ended December 31, 1993, is based solely on the reports 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 the Managing General Partner, and evaluating the overall financial statement presentation. We believe that our audits and the reports of other auditors for the years ended December 31, 1995, 1994 and 1993 provide a reasonable basis for the opinion expressed above.\n\/s\/ Price Waterhouse LLP - ------------------------- Price Waterhouse LLP\nBoston, Massachusetts March 11, 1996\nNEW ENGLAND PENSION PROPERTIES V; A REAL ESTATE LIMITED PARTNERSHIP\nBALANCE SHEET\n(See accompanying notes to financial statements)\nNEW ENGLAND PENSION PROPERTIES V; A REAL ESTATE LIMITED PARTNERSHIP\nSTATEMENT OF OPERATIONS\n(See accompanying notes to financial statements)\nNEW ENGLAND PENSION PROPERTIES V; A REAL ESTATE LIMITED PARTNERSHIP\nSTATEMENT OF CHANGES IN PARTNERS' CAPITAL (DEFICIT)\n(See accompanying notes to financial statements)\nNEW ENGLAND PENSION PROPERTIES V; A REAL ESTATE LIMITED PARTNERSHIP\nSTATEMENT OF CASH FLOWS\nNon-cash transactions:\nThree of the Partnership's joint venture investments were converted to wholly-owned properties in 1995. The carrying value of these investments at their respective conversion dates totalled $27,938,099.\n(See accompanying notes to financial statements)\nNEW ENGLAND PENSION PROPERTIES V; A REAL ESTATE LIMITED PARTNERSHIP\nNOTES TO FINANCIAL STATEMENTS\nNote 1 - Organization and Business - ----------------------------------\nGeneral\nNew England Pension Properties V; A Real Estate Limited Partnership (the \"Partnership\") is a Massachusetts limited partnership organized for the purpose of investing primarily in to-be-developed, newly constructed and existing income-producing real properties. It primarily serves as an investment for qualified pension and profit sharing plans and other entities intended to be exempt from federal income tax. The Partnership commenced operations in May 1987, and acquired the seven real estate investments it currently owns prior to the end of 1989. It intends to dispose of its investments within twelve years of their acquisition, and then liquidate.\nThe Managing General Partner of the Partnership is Fifth Copley Corp., a wholly-owned subsidiary of Copley Real Estate Advisors, Inc. (\"Copley\"). The associate general partner is ECOP Associates Limited Partnership, a Massachusetts limited partnership, the general partners of which are managing directors of Copley and\/or officers of the Managing General Partner. Subject to the Managing General Partner's overall authority, the business of the Partnership is managed by Copley pursuant to an advisory contract. Copley is an indirect wholly-owned subsidiary of New England Investment Companies, L.P. (\"NEIC\"), a publicly traded limited partnership. New England Mutual Life Insurance Company (\"The New England\"), the parent of NEIC's predecessor, is NEIC'S principal unitholder. In August 1995, The New England announced an agreement to merge (the \"Merger\") with Metropolitan Life Insurance Company (\"Metropolitan Life\"), with Metropolitan Life to be the surviving entity. This merger, which is subject to various policyholder and regulatory approvals, is expected to take place in the first half of 1996. Metropolitan Life is the second largest life insurance company in the United States in terms of total assets, having assets of over $130 billion (and adjusted capital of over $8 billion) as of June 30, 1995 .\nThe Partnership maintains a repurchase fund for the purpose of repurchasing limited partnership units. Two percent of cash flow, as defined, is designated for this fund which had a balance of $32,572 and $4,447 at December 31, 1995 and 1994, respectively. Through December 31, 1995 and 1994, the Partnership had repurchased and retired 755 units and 678 units, respectively.\nManagement\nCopley, as advisor, is entitled to receive stipulated fees from the Partnership in consideration of services performed in connection with the management of the Partnership and the acquisition and disposition of Partnership investments in real property. Partnership management fees are 9% of distributable cash flow from operations, as defined, before deducting such fees. Payment of 50% of management fees is deferred until cash distributions to limited partners exceed a specified rate or until payable from sales proceeds. Copley is also reimbursed for expenses incurred in connection with administering the Partnership ($20,081 in 1995, $15,322 in 1994, and $8,696 in 1993). Acquisition fees were based on 2% of gross proceeds from the offering. Disposition fees are generally 3% of the selling price of property, but are subject to the prior receipt by the limited partners of their capital contributions plus a stipulated return thereon. Deferred disposition fees were $267,715 at December 31, 1995 and 1994.\nNew England Securities Corporation, a direct subsidiary of The New England, is engaged by the Partnership to act as its unit holder servicing agent. Fees and out-of pocket expenses for such services totaled $16,774, $26,717, and $19,122 in 1995, 1994 and 1993, respectively.\nNote 2 - Summary of Significant Accounting Policies - ---------------------------------------------------\nAccounting Estimates\nThe preparation of financial statements in conformity with generally accepted accounting principles requires the Managing General Partner to make estimates affecting the reported amounts of assets and liabilities, and of revenues and expenses. In the Partnership's business, certain estimates require an assessment of factors not within management's control, such as the ability of tenants to perform under long-term leases and the ability of the properties to sustain their occupancies in changing markets. Actual results, therefore, could differ from those estimates.\nReal Estate Joint Ventures\nInvestments in joint ventures, including loans made to venture partners, which are in substance real estate investments, are stated at cost plus (minus) equity in undistributed joint venture income (losses). Allocations of joint venture income (losses) were made to the Partnership's venture partners as long as they had substantial economic equity in the project. Economic equity is measured by the excess of the appraised value of the property over the Partnership's total cash investment plus accrued preferential returns and interest thereon. Currently, the Partnership records an amount equal to 100% of the operating results of each joint venture, after the elimination of all inter-entity transactions, except for the one venture jointly owned by an affiliate of the Partnership which has substantial economic equity in the project.\nProperty\nProperty includes land and buildings and improvements, which are stated at cost, less accumulated depreciation, and other operating net assets (liabilities). The initial carrying value of a property previously owned by a joint venture equals the Partnership's carrying value of the predecessor investment on the conversion date.\nTenant leases at the properties provide for rental increases over the respective lease terms. Rental revenue is being recognized on a straight-line basis over the lease terms.\nCapitalized Costs\nMaintenance and repair costs are expensed as incurred. Significant improvements and renewals are capitalized. Depreciation is computed using the straight-line method based on estimated useful lives of the buildings and improvements. Leasing costs are also capitalized and amortized over the related lease terms.\nAcquisition fees have been capitalized as part of the cost of real estate investments. Amounts not related to land are amortized using the straight-line method over the estimated useful lives of the underlying property.\nRealizability of Real Estate Investments\nThe Partnership considers a real estate investment to be impaired when it determines the carrying value of the investment is not recoverable through undiscounted cash flows generated from the operations and disposition of property. Effective January 1, 1995, with its adoption of Statement of Financial Accounting Standards No. 121 (SFAS 121) entitled, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of,\" the Partnership measures the impairment loss based on the excess of the investment's carrying value over its estimated fair market value. For investments being held for sale, the impairment loss is measured based on the excess of the investment's carrying value over its estimated fair market value less estimated costs of sale. Property held for sale is not depreciated during the holding period. The Waters Landing II investment was reduced to its estimated fair market value less the cost of sale during 1995. (See Note 3.) Prior to the adoption of SFAS 121, the impairment loss was measured based on the excess of the investment's carrying value over its net realizable value.\nDuring 1993, the Managing General Partner determined that the carrying value of the Puente Street and Columbia Gateway Corporate Park investments should be reduced to their respective estimated net realizable values. During 1994, the Managing General Partner further reduced the carrying value of the Puente Street investment. (See Notes 3 and 4.)\nThe carrying value of an investment may be more or less than its current appraised value. At December 31, 1995 and 1994, the appraised values of certain investments exceeded their related carrying values by an aggregate of $4,900,000 and $2,200,000, respectively, and the appraised values of the remaining investments were less than their related carrying values by an aggregate of $2,400,000 and $2,900,000, respectively.\nThe current appraised value of real estate investments has been estimated by the Managing General Partner, and is generally based on a combination of traditional appraisal approaches performed by the advisor and independent appraisers. Because of the subjectivity inherent in the valuation process, the estimated current appraised value may differ significantly from that which could be realized if the real estate were actually offered for sale in the marketplace.\nCash Equivalents and Short-Term Investments\nCash equivalents are stated at cost, plus accrued interest. The Partnership considers all highly liquid debt instruments purchased with a maturity of ninety days or less to be cash equivalents; otherwise, they are classified as short-term investments.\nThe Partnership has the positive intent and ability to hold all short-term investments to maturity; therefore, short-term investments are carried at cost plus accrued interest which approximates market value. At December 31, 1995 and 1994, all investments were in commercial paper with less than seven months and four months, respectively, remaining to maturity.\nDeferred Disposition Fees\nDisposition fees due to Copley related to sales of investments are included in the determination of gains or losses resulting from such transactions. According to the terms of the advisory contract, payment of such fees has been deferred until the limited partners first receive their capital contributions, plus a stipulated return thereon.\nIncome Taxes\nA partnership is not liable for income taxes and, therefore, no provision for income taxes is made in the financial statements of the Partnership. A proportionate share of the Partnership's income is reportable on each partner's tax return.\nPer Unit Computations\nNet income per unit is computed based on the weighted average number of units of limited partnership interest outstanding during the year. The actual per unit amount will vary by partner depending on the date of admission to, or withdrawal from, the Partnership.\nNote 3 - Real Estate Joint Ventures - -----------------------------------\nThe Partnership had invested in eight real estate joint ventures, each organized as general partnership with a real estate development\/management firm. Two joint venture projects were sold in 1994, and three ventures were converted to wholly-owned investments in 1995. Joint venture investments are in either of two forms. In one form, the Partnership makes an equity contribution which is subject to preferential cash distributions at a specified rate and to priority distributions with respect to sale or refinancing transactions. In the second form of joint venture, the Partnership makes an equity contribution to the venture, subject to preferential returns, and also makes a loan to its venture partner which, in turn, contributes the proceeds to the venture. The loans bear interest at a specified rate, mature in full in ten years, and are secured by the venture partner's interest in the venture. These loans have been accounted for as a real estate investment due to the attendant risks of ownership. The joint venture agreements provide for the funding of cash flow deficits in proportion to ownership interests and for the dilution of ownership share in the event a venture partner does not contribute proportionately.\nThe Partnership's venture partners are responsible for day-to-day development and operating activities, although overall authority and responsibility for the business is shared by the venturers. The respective real estate development\/management firms or their affiliates also provide various services to the joint ventures for a fee.\nThe following is a summary of cash invested in joint ventures, net of returns of capital and excluding acquisition fees:\nWaters Landing II\nOn May 26, 1987, the Partnership entered into a joint venture with an affiliate of Oxford Development Corporation. The Partnership committed to make a maximum equity contribution of $4,682,400 and a loan to the venture partner of $3,121,600. The venture acquired land to develop an apartment complex.\nDuring the second quarter of 1995, the Managing General Partner determined that it was not in the best interest of the limited partners to develop the Waters Landing II site. Accordingly, the carrying value of this investment has been reduced to its estimated net fair market value with the recognition of an investment valuation allowance of $600,000.\nDahlia\nOn September 21, 1987, the Partnership entered into a joint venture agreement with an affiliate of Investment Building Group to construct and operate an industrial facility. The Partnership committed to make a maximum equity contribution of $7,250,000, of which $7,081,593 was funded as of December 31, 1995.\nEffective September 1, 1995, this investment was converted to a wholly-owned property for financial reporting purposes, pursuant to an amendment to the joint venture agreement granting the Partnership control over management decisions. (See Note 4.)\nUniversity Business Park\nOn September 30, 1987, the Partnership entered into a joint venture agreement with an affiliate of The Hewson Company to construct and operate five multi-tenant industrial buildings. The Partnership committed to make a maximum equity contribution of $9,450,000. Subsequent to December 31, 1995, and effective January 1, 1996, the joint venture was dissolved and the venture partner's ownership interest was assigned to the Partnership. The minimum future rental payments to the venture under non-cancelable operating leases are: $653,000 in 1996; $596,000 in 1997; $508,000 in 1998; $434,000 in 1999; and $203,000 in 2000.\nColumbia Gateway Corporate Park\nOn December 21, 1987, the Partnership entered into a joint venture agreement with an affiliate of the Partnership and an affiliate of Manekin Corporation to construct and operate seven research and development \/office buildings, of which six have been constructed to date. The Partnership committed to make a $6,402,000 equity contribution to the joint venture. The Partnership and its affiliate collectively have a 50% ownership interest in the joint venture. The minimum future rental payments to the venture under non-cancelable operating leases are: $1,316,589 in 1996; $1,176,845 in 1997; $1,116,297 in 1998; $1,038,834 in 1999; $411,261 in 2000, and $1,507,959 thereafter.\nAt December 31, 1993, the Managing General Partner had determined that the carrying value of this investment would not be recovered through estimated undiscounted future cash flows. Accordingly, the carrying value was reduced by $500,000 to estimated net realizable value.\nPalms Business Center III and IV\nOn March 7, 1988, the Partnership entered into a joint venture with an affiliate of B.H. Miller Companies to construct and operate thirteen commercial buildings.\nEffective January 1, 1995, the venture partner's ownership interest was assigned to the Partnership. (See Note 4.)\nSanta Rita Plaza\nOn February 1, 1989, the Partnership entered into a joint venture with an affiliate of Rodde McNellis to acquire a ground leasehold interest and construct and operate a shopping center. The Partnership committed to make a maximum equity contribution of $11,350,000, of which $10,950,840 was funded as of December 31, 1995. Capital contributions of $6,500,000, and accrued preferential return related thereto, began amortizing over a 27-year period in February 1991, with a balloon payment due on February 1, 1999. The remaining $4,850,000 contribution together with any accrued preferential return balance is payable in full in 2004.\nEffective August 1, 1995 this investment was converted to a wholly-owned property for financial reporting purposes, pursuant to an admendment to the joint venture agreement granting the Partnership control over management decisions and increasing its ownership interest from 60% to 63%. (See Note 4.)\nSale of C.S. Graham and Lakewood\nOn June 30, 1987, the Partnership entered into a joint venture agreement with an affiliate of Connell Scott and Associates to own and operate a warehouse facility. The Partnership contributed a total of $3,185,246 to the venture. On June 17, 1994, the joint venture sold its property. The total sales price was $3,925,000. After closing costs, the Partnership received proceeds of $3,720,076 and recognized a gain of $409,982 ($4.91 per weighted average limited partnership unit). A disposition fee of $117,750 was accrued but not paid to the advisor.\nOn August 12, 1988, the Partnership entered into a joint venture with an affiliate of the Partnership and with an affiliate of Evans Withycombe Company to construct and operate an apartment complex. The Partnership's total equity contribution was $ 3,167,615. On August 17, 1994, the joint venture sold its property to a real estate investment trust sponsored by Evans Withycombe. After closing costs, the payment of preferential returns to the Partnership, and the allocation to the venture partner, the Partnership received its share of the proceeds of $4,297,367 and recognized a gain of $1,380,488 ($16.53 per weighted average limited partnership unit). A disposition fee of $149,965 was accrued but not paid to the advisor. An additional $6,209 was received in 1995 in final settlement of the Lakewood sale.\nOn September 15, 1994, the Partnership made a capital distribution of $3,968,640 ($48 per limited partnership unit) from the proceeds of the C.S. Graham and Lakewood sales. A second capital distribution of $2,313,164 ($28 per limited partnership unit) was made in July, 1995. A portion of the proceeds was used to pay previously accrued, but deferred, management fees due to the advisor ($183,426 in 1995 and $1,259,988 in 1994).\nSummarized Financial Information\nThe following summarized financial information is presented in the aggregate for the joint ventures:\nAssets and Liabilities ----------------------\nResult of Operations --------------------\nLiabilities and expenses exclude amounts owed and attributable to the Partnership and (with respect to two joint ventures) its affiliates on behalf of their various financing arrangements with the joint ventures.\nThe C.S. Graham and Lakewood investments were sold on June 17, 1994 and August 17, 1994, respectively. The above amounts include their results of operations through the respective sale dates. The Palms Business Center, Santa Rita Plaza and Dahlia investments were converted to wholly-owned properties effective January 1, 1995, August 1, 1995, and September 1, 1995, respectively. The above amounts include their results of operations through their respective conversion dates.\nNote 4 - Property\nPalms Business Center III and IV\nEffective January 1, 1995, the Palms Business Center joint venture was restructured and the venture partner's ownership interest was assigned to the Partnership. Since that date, the investment is being accounted for as a wholly-owned property. The carrying value at conversion ($10,308,265) was allocated to land, building and improvements and other net operating assets.\nThe buildings and improvements of Palms Business Center are being depreciated over 25 years, beginning January 1, 1995. The minimum future rental payments venture under non-cancelable operating leases are: $1,230,644 in 1996; $1,180,926 in 1997; $787,018 in 1998; $604,737 in 1999; $536,145 in 2000; and $24,810 thereafter.\nSanta Rita Plaza\nEffective August 1, 1995, the Santa Rita Plaza joint venture was restructured into a limited partnership, whereby the Partnership was granted control over management decisions. Accordingly, as of such date, the investment is being accounted for as a wholly-owned property. The carrying value of the joint venture investment at conversion ($10,216,659) was allocated to building and improvements, mortgage loan receivable from the ground lessor and other net operating assets. On this same date, the Partnership made a fifteen-year loan in the amount of\n$1,750,000 to the ground lessor, who used a portion of the proceeds to repay a loan from the Santa Rita venture which, in turn, paid approximately $1,300,000 to the Partnership as a partial return of its capital investment in the venture. The Partnership can require full payment of the loan after August 1, 2000. The ground lease requires an annual base payment of $390,000 per year through 2063, plus 11.55% of rents, as defined.\nThe buildings and improvements of Santa Rita Plaza are being depreciated over 25 years beginning August 1, 1995. The loan to ground lessor bears interest at 8.75%, with payments to be made monthly based on a 15 year amortization schedule, and is secured by the ground lessor's interest in the Santa Rita Plaza land. The minimum future rental payments from tenants under non-cancelable operating leases are: $1,239,214 in 1996; $1,178,683 in 1997; $1,069,823 in 1998; $951,248 in 1999; $846,850 in 2000; and $3,991,114 thereafter.\nDahlia\nEffective September 1, 1995, the Dahlia joint venture was restructured into a limited partnership, whereby the Partnership was granted control over management decisions. Accordingly, as of this date, the investment is being accounted for as a wholly-owned property. The carrying value at conversion ($7,413,175) was allocated to land, building and improvements, and other net operating assets. During 1993, the joint venture agreed to a settlement with a former tenant for past due rent. This settlement is secured by an attachment on 36 acres of land in Scottsdale, Arizona. The land is currently being marketed for sale pursuant to the settlement agreement.\nThe buildings and improvements of Dahlia are being depreciated over 25 years beginning September 1, 1995. The minimum future rental payments due under non-cancelable operating leases are: $852,324 in 1996; $777,924 in 1997; $678,685 in 1998; $607,805 in 1999; $612,680 in 2000; and $1,610,370 thereafter.\nPuente Street\nOn April 28, 1988, the Partnership entered into a joint venture with an affiliate of The Muller Company. Effective June 1, 1991, in accordance with the joint venture agreement, the Partnership assumed total ownership of this property due to the venture partner's inability to fund its proportionate share of operating deficits. The property includes an industrial building, together with a parking lot and storage area in Brea, California.\nThe Managing General Partner determined that the carrying value of this investment exceeded its estimated net realizable value because of the effect of depressed market conditions on rental rates. Accordingly, the carrying value was reduced to its estimated net realizable value by $1,500,000 in 1993. Due to a further deterioration in market conditions, the carrying value was further reduced during the fourth quarter of 1994 by $1,400,000.\nThe building and improvements at Puente Street are being depreciated over 30 years beginning June 1, 1991. The minimum future rentals under non-cancelable operating leases are: $717,487 in 1996; $799,044 in 1997; $816,300 in 1998; $707,683 in 1999; $644,220 in 2000; and $2,295,111 thereafter.\nThe following is a summary of the Partnership's investment in property (four in 1995 and one in 1994):\nNote 5 - Income Taxes - ---------------------\nThe Partnership's income for federal income tax purposes differs from that reported in the accompanying statement of operations as follows:\nNote 6 - Partners' Capital - --------------------------\nAllocation of net income from operations and distributions of distributable cash from operations, as defined, are in the ratio of 99% to the limited partners and 1% to the general partners. Cash distributions are made quarterly.\nNet sale proceeds and financing proceeds are allocated first to limited partners to the extent of their contributed capital plus a stipulated return thereon, as defined, second to pay disposition fees, and then 85% to the limited partners and 15% to the general partners. The adjusted capital contribution per limited partnership unit was reduced from $1,000 to $952 in 1994, and further reduced to $924 in 1995, as a result of the return of capital from the sale of two\ninvestments. No capital distributions have been made to the general partners. Income from a sale is allocated in proportion to the distribution of related proceeds, provided that the general partners are allocated at least 1%. Income or losses from a sale, if there are no residual proceeds after the repayment of the related debt, will be allocated 99% to the limited partners and 1% to the general partners.\nNote 7 - Subsequent Event - -------------------------\nDistributions of cash from operations relating to the quarter ended December 31, 1995 were made on January 25, 1996 in the aggregate amount of $1,011,274 ($12.13 per limited partnership unit).\nNEW ENGLAND PENSION PROPERTIES V; A REAL ESTATE LIMITED PARTNERSHIP SCHEDULE III REAL ESTATE AND ACCUMULATED DEPRECIATION AT DECEMBER 31, 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.\nNEW ENGLAND PENSION PROPERTIES V; A REAL ESTATE LIMITED PARTNERSHIP\nDate: March 11, 1996 By: \/s\/ Joseph W. O'Connor --- ---------------------- Joseph W. O'Connor President of the Managing 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 ---------- ----- ----\nPresident, Principal Executive Officer and Director of the \/s\/ Joseph W. O'Connor Managing General Partner March 11, 1996 - ---------------------- --- Joseph W. O'Connor\nPrincipal Financial and Accounting Officer of the \/s\/ Daniel C. Mackowiak Managing General Partner March 11, 1996 - ----------------------- --- Daniel C. Machowiak\nDirector of the \/s\/ Daniel J. Coughlin Managing General Partner March 11, 1996 - ---------------------- --- Daniel J. Coughlin\nDirector of the \/s\/ Peter P. Twining Managing General Partner March 11, 1996 - -------------------- --- Peter P. Twining\nEXHIBIT INDEX -------------\nExhibit Page Number Exhibit Number - ------ ------- ------\n10A. Joint Venture Agreement of Waters Landing * Partners Two, dated as of May 26, 1987 between the Partnership and Waters Landing Two-Oxford Limited Partnership, a Maryland limited partnership (\"Oxford\").\n10B. Promissory Note dated May 26, 1987 from Oxford * to the Partnership in the original principal amount of $3,121,600.\n10C. Joint Venture Interest Pledge and Security * Agreement, dated as of May 26, 1987, between the Partnership and Oxford.\n10D. Joint Venture Agreement of Graham Road Joint * Venture, dated as of June 30, 1987, between the Partnership and Connell-Scott Ventures V.\n10E. General Partnership Agreement of IBG Dahlia * Associates, dated as of September 21, 1987, between the Partnership and 20 Dahlia Partnership.\n10F. General Partnership Agreement of Hewson University * Associates, dated as of September 30, 1987, between Hewson Properties, Inc. and the Partnership.\n10G. General Partnership Agreement of Gateway 51 * Partnership, dated as of December 21, 1987, among M.O.R. Gateway 51 Associates Limited Partnership, the Partnership and New England Life Pension Properties IV; A Real Estate Limited Partnership.\n10H. Ground Lease dated January 23, 1988 between * Nielson Properties, LTD., a California limited partnership (\"Landlord\"), and Rodde McNellis\/Salinas, a California general partnership (\"Tenant\").\n10I. Leasehold Indenture dated February 12, 1988 by * Rodde McNellis\/Salinas, Borrower, to Santa Clara Land Title Company, Trustee, for New England Pension Properties V, A Real Estate Limited Partnership (\"NEPP V\"), Beneficiary.\n- ----------\n* Previously filed and incorporated herein by reference.\nEXHIBIT INDEX -------------\nExhibit Page Number Exhibit Number - ------ ------- ------\n10J. Promissory Note dated February 12, 1988 in * the principal amount of $1,800,000 by Rodde McNellis\/Salinas to NEPP V.\n10K. Pledge of Note and Security Agreement dated as * of February 12, 1988 by and between Rodde McNellis\/Salinas and NEPP V.\n10L. R\/M Salinas Predevelopment Agreement dated * February 12, 1988 by and between NEPP V and Rodde McNellis\/Salinas.\n10M. Joint Venture Agreement of Rancho Road * Associates II dated as of March 7, 1988 by and between NEPP V and Commerce Centre Partners.\n10N. Pledge and Security Agreement dated as of * March 7, 1988 by and between Commerce Centre Partners and NEPP V.\n10O. General Partnership Agreement of Muller Brea * Associates dated as of April 29, 1988 between Tar Partners and the Registrant.\n10P. Lakewood Associates General Partnership * Agreement dated August, 1988 between EW Lakewood Limited Partnership, Copley Pension Properties VI; A Real Estate Limited Partnership and Registrant.\n10Q. First Amendment to Rancho Road Associates II Joint * Venture Agreement dated as of May 31, 1988 by and between the Registrant and Commerce Centre Partners.\n10R. First Amendment to Pledge and Security Agreement * dated as of May 31, 1988 by and between the Registrant and Commerce Centre Partners.\n10S. Joint Venture Agreement of R\/M Salinas Venture dated * as of February 1, 1989 by and between New England Pension Properties V; A Real Estate Limited Partnership and Rodde McNellis\/Salinas.\n- ----------\n* Previously filed and incorporated herein by reference.\nEXHIBIT INDEX -------------\nExhibit Page Number Exhibit Number - ------ ------- ------\n10T. First Amendment to Joint Venture Agreement of R\/M * Salinas Venture dated as of February 1, 1989 by and between New England Pension Properties V; A Real Estate Limited Partnership and Rodde McNellis\/Salinas.\n10U. Amended and Restated General Partnership Agreement * of Gateway 51 Partnership dated as of April 20, 1989 between M.O.R. Gateway 51 Associates Limited Partnership, New England Life Pension Properties IV; a Real Estate Limited Partnership and New England Pension Properties V; a Real Estate Limited Partnership.\n10V. Second Amendment to Pledge and Security * Agreement dated as of June 20, 1990 by and between Commerce Centre Partners, a California general partnership and Registrant.\n10W. Second Amendment to Rancho Road Associates * II Joint Venture Agreement dated as of June 20, 1990 by and between Registrant and Commerce Centre Partners.\n10X. Second Amendment to Joint Venture Agreement of * R\/M Salinas Venture dated as of July 20, 1990 by and between the Registrant and Rodde McNellis\/ Salinas.\n10Y. Agreement for Dissolution, Distribution and * Winding-up of Muller Brea Associates dated May 31, 1991 by and between TAR Partners, a California partnership, and the Registrant.\n10Z. Property Management Agreement effective as of * May 31, 1991 by and between TAR Partners, a California general partnership, and the Registrant.\n10AA. Asset Contribution Agreement by and among Evans Withycombe Residential, Inc., a Maryland Corporation, * and Evans Withycombe Residential, L.P., a Delaware limited partnership, as Purchasers and Lakewood Associates, an Arizona limited Partnership composed of Registrant, Copley Pension Properties VI and EW Lakewood L.P., as Sellers dated June 9, 1994.\n10BB. Purchase and Sale Agreement between Graham Road * Joint Venture and Prentiss Properties Atlanta Industrial Properties, L.P., dated June 17, 1994.\n10CC. $1,750,000 note secured by Deed of Trust between the Partnership, as Lender, and Nielsen Properties, Ltd, as Borrower dated August 1, 1995.\n10DD. Third Amendment to Agreement of Lease dated August 1, 1995 by and between Nielsen Properties, Ltd., a California limited partnership, R\/M Salinas Venture, a California general partnership, and R\/M Salinas, L.P., a California limited partnership.\n10EE. R\/M Salinas L.P. Limited Partnership Agreement dated August 1, 1995 between Rodde McNellis\/Salinas, a California general partnership and Registrant.\n10FF. Limited Partnership Agreement of IBG Dahlia Associates dated September 1, 1995 between Registrant and 20 Dahlia Partnership, a California limited partnership.\n- ----------\n* Previously filed and incorporated herein by reference.","section_15":""}
{"filename":"80172_1995.txt","cik":"80172","year":"1995","section_1":"ITEM 1. BUSINESS\nA. The business of National Presto Industries, Inc., and its consolidated subsidiaries (the \"Company\") consists of a single business category. Comments on individual portions of that category follow.\nCOMMERCIAL\nThe Company manufactures and distributes small electrical appliances and housewares, including comfort appliances, pressure cookers and canners, private label and premium sales products.\nElectrical appliances and housewares sold by the Company include pressure cookers and canners; the Presto(R) Control Master(R) single thermostatic control line of fry pans in several sizes, griddles and combination griddle\/warmers and multi-purpose cookers; deep fryers of various sizes; can openers, slicer\/shredders, curly cutters, potato chippers, ice cream makers and electric shoe polishers; electric heaters; corn poppers (hot air and microwave); coffeemakers; electric tea kettles; electric knives; bread slicing systems; electric knife sharpeners; and timers.\nPressure cookers and canners are available in various sizes and are fabricated of aluminum and, in the case of cookers, of stainless steel. The Company believes it is one of the principal manufacturers of pressure cookers in the United States.\nFor the year ended December 31, 1995, approximately 45% of consolidated revenues were provided by cast products (fry pans, griddles, deep fryers and electric cookers), approximately 22% by motorized nonthermal appliances (can openers, slicer\/shredders, curly cutters, ice cream makers, knife sharpeners, potato chippers, electric knives, bread slicing systems and shoe polishers), and approximately 29% by noncast\/thermal appliances (stamped cookers and canners, stainless steel cookers, corn poppers (hot air and microwave), coffeemakers, tea kettles, and heaters). For the year ended December 31, 1994, approximately 43% of consolidated revenues were provided by cast products, approximately 22% by motorized nonthermal appliances and approximately 31% by noncast\/thermal appliances. For the year ended December 31, 1993, approximately 48% of consolidated revenues were provided by cast products, approximately 26% by motorized nonthermal appliances and approximately 20% by noncast\/thermal appliances.\nWal-Mart Stores, Inc., accounted for 36%, 35% and 34% of consolidated revenues for the years ended December 31, 1995, 1994 and 1993, respectively.\nProducts are sold directly to retailers throughout the United States and also through independent distributors. Although the Company has long established relationships with many of its customers, it does not have long-term supply contracts with them. The loss of, or material reduction in, business from any of the Company's major customers could adversely affect the Company's business.\nThe Company has a sales force of approximately nineteen employees which sells to and services customers. In selected geographic areas sales are handled by manufacturers' representatives who may handle other product lines. Sales promotional activities include television and radio. The Company's commercial business is highly competitive and seasonal, with the normal peak sales period occurring in the fourth quarter of the year prior to the holiday season. Many companies compete for sales of housewares and small appliances, some of which are larger than the Company and others which are smaller. Product competition extends to special product features, product pricing, marketing programs, warranty provisions, service policies and other factors. New product introductions are an important part of the Company's sales to offset the morbidity rate of other products and\/or the effect of lowered acceptance of seasonal products due to weather conditions. New products entail unusual risks. Engineering and tooling costs are increasingly expensive, as are components and finished goods that may not have a ready market or achieve a widespread consumer acceptance. High-cost advertising commitments accompanying such new products or to maintain sales of existing products may not be fully absorbed by ultimate product sale. Initial production schedules, set in advance of introduction, carry the possibility of excess unsold inventories. New product introductions are further subject to delivery delays from supply sources, which can impact availability for the Company's most active selling periods.\nResearch and development costs related to new product development for the years 1995, 1994 and 1993 were absorbed in operations for these years and were not a material element in the aggregate costs incurred by the Company.\nPresto products are generally warranted to the original owner to be free from defects in material and workmanship for a period of two years from date of purchase. The Company allows a sixty-day over-the-counter initial failure return privilege through cooperating dealers. The Company services its products through independent service stations throughout the United States and the corporate service repair operation. The Company's service and warranty programs are competitive to those offered by other manufacturers in the industry.\nThe Company's commercial products are manufactured in plants located at Jackson, Mississippi and Alamogordo, New Mexico. The Company also purchases a significant portion of its products from nonaffiliated companies located outside the United States.\nDEFENSE\nThe Company commenced defense production in 1942. From 1966 through 1980, 105MM projectiles were produced in the Eau Claire facility (utilizing Government owned equipment in Company owned buildings). Production of 8\" projectiles also occurred intermittently during this period. Since completion of production in 1980, standby contracts had been received and renewed on an annual basis through September, 1992. For the period October, 1992 through September, 1993 a storage only contract was received. In September, 1993, the Pentagon exercised its option of abandoning, in place, the production equipment formerly utilized for projectile fabrication. Most of this equipment has been sold and work is in progress to restore the plant for manufacturing, or other purposes.\nSee Section B3 for comments regarding Defense related Environmental Protection Agency matters.\nWAREHOUSING AND TRANSPORTATION SERVICES\nFor a number of years, the Company has warehoused and distributed its commercial products from a centrally located distribution center. Selective use is made of a fleet of tractors and trailers with backhauls scheduled on return trips carrying goods consigned for internal corporate use.\nFINANCIAL MANAGEMENT\nA separate subsidiary of the Company, a Delaware holding company, carries responsibility for the maintenance and management of funds not currently required for business activities and therefore temporarily available for investments. (See Footnote B(3) in Notes to Consolidated Financial Statements.) Income from Financial Management activities is included in Other Income in the accompanying financial statements.\nEarnings for this subsidiary may vary widely from year to year depending on interest yields on instruments meeting the investment criteria, and the extent to which funds may be needed for newly identified business activities.\nB. OTHER COMMENTS\n1. Sources and Availability of Materials\nProduction levels at commercial plants may be affected by vendor failure to deliver tooling, material and critical parts within commitments. While recent years have witnessed virtual elimination of these circumstances, there is no assurance against recurrence.\nDeliveries of new products, many of which have been sourced overseas, could be delayed by labor or supply problems at the vendors or in transportation. As a consequence, these products may not be available in sufficient quantities during the prime selling period. While there has been no major incidence of such problems and the Company has made every reasonable effort to prevent occurrence, there is no assurance that such effort will be totally effective.\n2. Trademarks, Licenses, Franchises and Concessions Held\nWith increased sales volume being generated by new products, patents have become more meaningful to operating results. Trademarks and know-how are considered material. The Company's current and future success depends upon judicial protection of its intellectual property rights ( patents, trademarks and trade dress). Removal of that protection would expose the Company to competitors who seek to take advantage of the Company's innovations and proprietary rights. To date, the Company has vigorously protected its rights and enjoyed success in all its intellectual property suits.\n3. Effects of Compliance with Environmental and OSHA Regulations\nIn May 1986, the Company's Eau Claire, Wisconsin, site was placed on the United States Environmental Protection Agency's (EPA) National Priorities List (NPL) under the Comprehensive Environmental Reponse, Compensation and Liability Act of 1980 (CERCLA) because of alleged hazardous waste deposited on the property. During July 1986, the Company entered into an agreement with the EPA and the Wisconsin Department of Natural Resources to conduct a Remedial Investigation and Feasibility Study at the site. The Remedial Investigation was completed in 1992, the Feasibility Study in 1994, and the remedial action activities initiated during 1993 and 1994 which have not been completed, are continuing.\nAs a result of an April 1989 EPA Unilateral Order, an August 1990 EPA Record of Decision, followed by a directive from the Department of the Army, the Company implemented an alternative drinking water system for approximately 200 homes and businesses in an area adjacent to the site. This system has since been installed and become fully operational. In August 1993, after extensive negotiations with the EPA, the Company entered into a settlement agreement to reimburse remediation costs, plus interest, for groundwater contamination affecting a municipal well field allegedly related to the site.\nIn February 1988 the Company entered into an agreement with the Department of the Army pursuant to which the Army funded $5,000,000 of environmental restoration costs related to the site. Based on Remedial Investigation\/Feasibility Study costs, the Army's direction to implement the alternative drinking water system and costs for remedial action, it became apparent that additional government funding was necessary (a factor that was identified as a possibility in the original agreement with the government). Further legislative action in 1992 resulted in an additional $7,000,000 for funding environmental restoration activities, which was placed under a funding agreement with the Company in 1993. A further supplement of $15,000,000 was included in 1995 legislation, funding for which has not yet been received and may require additional Congressional action during 1996.\nIt does not presently appear that the ultimate liability associated with the unresolved environmental contingencies will have a material effect on the financial condition of the Company. If the Army honors its contractual obligations there will not be any material effect on the results of operations. There is, of course, always the possibility that something unforeseen could occur.\n4. Number of Employees of the Company\nAs of December 31, 1995, the Company had 614 employees.\n5. Industry Practices Related to Working Capital Requirements\nThe major portion of the Company's commercial sales were made with terms of 90 days or shorter. A small portion of the sales were made with seasonal dating provisions.\nInventory levels increase in advance of the selling period for products which are seasonal, such as pressure canners, heaters, and in preparation for new product introductions. Inventory build-up also occurs to create stock levels required to support the higher sales which occur in the latter half of each year. Recent changes in the buying practices of the Company's customers indicate a movement away from substantial advance stocking orders and to smaller, more frequent orders. As this trend continues and is expanded upon, the Company is being required to carry larger finished goods inventories than those historically maintained. The Company purchases components and raw materials in advance of production requirements where such purchases are required to ensure supply or provide advantageous long-term pricing.\n6. Backlog\nShipment of most of the Company's commercial products occurs within a relatively short time after receipt of the order and, therefore, there is usually no substantial order backlog. New product introductions do result in order backlogs which vary from product to product and as to timing of introduction.\nC. INDUSTRY SEGMENTS\nThe Company operates in one Business Segment.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES (Owned Except Where Indicated)\nThe Company's principal Eau Claire facilities are approximately 560,000 square feet of which 428,000 square feet were related to ordnance activities. Leases for 31,000 square feet have been entered into with outside tenants.\nThe Company's corporate office is also located in Eau Claire.\nThe Company manufactures consumer products in Jackson, Mississippi and Alamogordo, New Mexico.\nThe Jackson plant contains 283,000 square feet, of which 119,600 square feet is used for warehousing.\nThe facility at Alamogordo contains 163,200 square feet, of which 24,800 square feet is used for warehousing.\nThe Company has a 162,400 square foot building at Canton, Mississippi which is used primarily for warehousing, distribution and in part for product service functions. An additional 24,000 square feet has been leased in adjacent buildings for storage area.\nITEM 3.","section_3":"ITEM 3.LEGAL PROCEEDINGS\nThe Company is subject to various action incidental to its normal business operations. In the opinion of management such actions will be resolved for amounts which in the aggregate will not be material in relation to the financial statements.\nSee Item 1.B.3. for comment regarding environmental actions.\nITEM 4.","section_4":"ITEM 4.SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe following information is provided with regard to the executive officers of the registrant:\nMr. Cohen was elected Chairman of the Board in May, 1975. Prior to that date he was President, a position which he again held from November, 1986 to May, 1989.\nMs. Cohen was elected Treasurer in September, 1983, to the additional positions of Vice-President in May, 1986 and President in May 1989. She has been associated with the registrant since 1976. Prior to becoming an officer, she was Associate Resident Counsel and Assistant to the Treasurer.\nMr. Anderl was elected Vice-President in May, 1989. He has been associated with the registrant since 1963 and prior to becoming an officer, he was Director of Engineering.\nMr. Bartl was elected Secretary in May, 1978. He has been associated with the registrant since 1969. Prior to becoming an officer, he was Resident Counsel and Director of Industrial Relations, positions he continues to hold.\nMr. Lieble was elected Treasurer in November, 1995. He has been associated with the registrant since 1977. Prior to becoming an officer, he was Manager of Investments and Contracts.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nCommon stock of National Presto Industries, Inc., is traded on the New York Stock Exchange under the symbol NPK. As of December 31, 1995, there were 1,200 stockholders. There were 1,176 stockholders as of February 29, 1996, the latest practicable date.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\n(In thousands except per share data)\n* The 1993 dividend was paid on December 28, 1992.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION\n1995 Compared to 1994\nNet sales decreased by $7,898,000 from $128,070,000 to $120,172,000, primarily due to a unit volume decrease.\nGross profit for 1995 decreased by $7,885,000 from $50,681,000 to $42,796,000 due to the volume decrease and cost increases stemming from rising cumulative 1994 and 1995 vendor prices without appreciable price relief from the Company's retail customers. The decline was offset in part by the impact of the LIFO adjustment which was less unfavorable in 1995 than in 1994. See footnote C for additional information on the LIFO adjustments. Gross margins as a percentage of sales was 36% versus 40% in 1995 and 1994, respectively.\nSelling and general expenses increased $1,178,000 due to increased bad debt write-offs and higher administrative expenses. As a percentage of net sales, selling and general expenses increased from 21% to 23%.\nOther income increased from the 1994 level primarily as a result of a higher pre-tax rate of return on the Company's portfolio of short-term marketable securities.\nThe other, principally litigation settlement, was the result of a non-operational receipt of $2.85 million in damages and interest resulting from the Court of Appeals for the Federal Circuit decision that Black & Decker infringed Presto's patent on its SaladShooter(R) electric slicer\/shredder. It was offset in part by the cost of retiring a convertible debenture.\nEarnings before provision for income taxes decreased $5,116,000 from $30,519,000 to $25,403,000. The provision for income taxes decreased from $9,064,000 to $6,434,000, which resulted in an effective income tax rate decrease from 30% to 25%, as a result of decreased earnings subject to tax. Net earnings decreased $2,486,000 from $21,455,000 to $18,969,000, or 12%.\nThe Company maintains adequate liquidity for all its anticipated capital requirements and dividend payments. As of year-end 1995, there were no material capital commitments outstanding.\nForward looking statements in this Report are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. There are certain important factors that could cause results to differ materially from those anticipated by some of the statements made above. Investors are cautioned that all forward looking statements involve risks and uncertainty. In addition to the factors discussed above, among the other factors that could cause actual results to differ materially are the following: consumer spending and debt levels; interest rates; continuity of relationships with and purchases by major customers; product mix; competitive pressure on sales and pricing, and increase in material or production cost which cannot be recouped in product pricing.\n1994 Compared to 1993\nNet sales increased by $9,490,000 from $118,580,000 to $128,070,000, primarily due to new product introductions, offset in part by a decrease in sales from products that were either no longer part of the line or that had matured, and the cessation of revenues from the storage and maintenance of government equipment.\nGross profit for 1994 increased $2,775,000 primarily due to the increased volume, offset in part by cost increases stemming from higher commodity prices, costs entailed in storage and handling of carryover products, and the impact of the LIFO adjustment which was considerably more unfavorable in 1994 than in 1993. See Footnote C for additional information on the LIFO adjustments. Gross margins as a percentage of sales were 40% in both periods.\nSelling and general expenses decreased $823,000 primarily as a result of decreased selling and advertising expenses. As a percentage of sales, selling and general expenses decreased from 23% to 21%.\nOther income increased from the 1993 level primarily as a result of a higher level of invested funds and a higher pretax rate of return on the Company's portfolio of short-term marketable securities.\nEarnings before provision for income taxes increased $4,357,000 from $26,162,000 to $30,519,000. The provision for income taxes increased from $7,507,000 to $9,064,000, the effective income tax rate increased from 29% to 30%, as a result of increased earnings subject to tax. Net earnings increased $2,800,000 from $18,655,000 to $21,455,000, or 15%.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nA. The consolidated financial statements of National Presto Industries, Inc. and its subsidiaries and the related Report of Independent Certified Public Accountants are contained on pages through of this report.\nB. Quarterly financial data is contained in Note M in Notes to Consolidated Financial Statements.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nA listing of the Executive Officers of the Registrant is included in Part I. See Note following Item 13.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nSee Note following Item 13.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nSee Note following Item 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nSee Note following.\nNOTE: Within 120 days after the close of the registrant's fiscal year ended December 31, 1995, the registrant will file a definitive proxy statement pursuant to regulations 14A. Therefore, pursuant to the Rules and Regulations of the Securities Exchange Act of 1934, the additional information required for Items 10, 11, 12 and 13 has been omitted and is incorporated herein from the Proxy by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\nA. The following consolidated financial statements of National Presto Industries, Inc., and its subsidiaries and the related Report of Independent Certified Public Accountants are included in this report:\nAll other Schedules and Exhibits 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. Columns omitted from schedules filed have been omitted because the information is not applicable.\nSIGNATURE\nPursuant to the Requirements of Section 13 or 14 (d) of the 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 PRESTO INDUSTRIES, INC. (registrant)\nBy: \/S\/ Walter G. Ryberg By: \/S\/ Melvin S. Cohen Walter G. Ryberg Melvin S. Cohen Director\nBy: \/S\/ John M. Sirianni By: \/S\/ James F. Bartl John M. Sirianni James F. Bartl Director\nBy: \/S\/ Ralph Strangis By: \/S\/ Maryjo Cohen Ralph Strangis Maryjo Cohen Director\nDate: March 27, 1996\nThe accompanying notes are an integral part of the financial statements.\nThe accompanying notes are an integral part of the financial statements.\nThe accompanying notes are an integral part of the financial statements.\nThe accompanying notes are an integral part of the financial statements.\nNATIONAL PRESTO INDUSTRIES, INC. PAGE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nA. NATURE OF OPERATIONS: The Company manufactures and distributes small electrical appliances and housewares. Products are sold directly to retail outlets throughout the United States and also through independent distributors. The manufacturing of these products is done in plants located at Jackson, Mississippi; Alamogordo, New Mexico; and a significant portion of its products are imported from nonaffiliated companies in the Pacific Rim countries. A separate subsidiary of the Company, a Delaware holding company, carries responsibility for the maintenance and management of funds not currently required for business activities and therefore temporarily available for investments.\nB. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:\n(1) USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS: In preparation of the Company's consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and related revenues and expenses. Actual results could differ from the estimates used by management.\n(2) PRINCIPLES OF CONSOLIDATION: The consolidated financial statements include the accounts of National Presto Industries, Inc. and its subsidiaries all of which are wholly-owned. All material intercompany accounts and transactions are eliminated.\n(3) CASH, CASH EQUIVALENTS AND MARKETABLE SECURITIES: The Company considers all highly liquid marketable securities with a maturity of one week or less to be cash equivalents. Cash equivalent securities totaled $92,851,000 and $109,733,000 at December 31, 1995 and 1994. The Company's cash equivalents and marketable securities are diversely invested, principally in A-rated or higher tax exempt bonds issued by entities throughout the United States.\nThe Company has classified all cash equivalents and marketable securities as available for sale which requires the securities to be reported at fair value, with unrealized gains and losses reported as a separate component of stockholders' equity. At December 31, 1995 and 1994, cost approximated market value for all securities using the specific identification method.\nThe contractual maturities of the marketable securities held at December 31, 1995 were $79,525,000 in 1996, $23,364,000 in 1997, $8,253,000 in 1998, and $1,441,000 with indeterminate maturities.\n(4) INVENTORIES: Inventories are stated at the lower of cost or market with cost being determined principally on the last-in, first-out (LIFO) method.\n(5) PROPERTY, PLANT AND EQUIPMENT: Property, plant and equipment are stated at cost. For machinery and equipment, all amounts which are fully depreciated have been eliminated from both the asset and allowance accounts. Depreciation is provided in amounts sufficient to relate the costs of depreciable assets to operations over their service lives which are estimated at 15 to 40 years for buildings and 3 to 7 years for machinery and equipment.\n(6) REVENUE RECOGNITION: The Company recognizes revenues when product is shipped.\nPAGE\n(7) ADVERTISING: Advertising expense was $16,479,000, $17,338,000 and $17,652,000 in 1995, 1994 and 1993.\n(8) NEW ACCOUNTING STANDARDS: The Financial Accounting Standards Board has issued two accounting standards which the Company is required to adopt January 1, 1996. The first standard establishes guidance on when and how to measure impairment of long-lived assets, certain identifiable intangibles, and how to value long-lived assets to be disposed of. The second standard establishes accounting and reporting for stock-based compensation plans. This standard permits the Company to select the new fair value based method of accounting for employee stock options or the existing intrinsic value method which the Company currently follows. The Company intends to continue to use the intrinsic value method which will require additional footnote disclosures concerning its stock-based compensation plans. Management believes the adoption of these new accounting standards will not have a material effect on the Company's consolidated financial statements.\nC. INVENTORIES:\nThe aggregate amount of inventories valued on the LIFO basis is $24,543,000 and $17,886,000 as of December 31, 1995 and 1994, respectively. Under LIFO, inventories are valued at approximately $11,524,000 and $10,550,000 below current cost determined on a first-in, first-out (FIFO) basis at December 31, 1995 and 1994. The Company uses the LIFO method of inventory accounting to improve matching of costs and revenues.\nThe following table describes that which would have occurred if LIFO inventories had been valued at current cost determined on a FIFO basis:\nIncrease (Decrease) ------------------- Cost of Net Earnings Year Sales Earnings Per Share ---- ----- -------- --------- 1995 $ (974,000) $ 604,000 $ 0.08 1994 (1,682,000) 1,043,000 0.14 1993 (674,000) 418,000 0.06\nThis information is provided for comparison with companies using the FIFO basis.\nD. ACCRUED LIABILITIES: At December 31, 1995 accrued liabilities consisted of payroll $2,482,000, insurance $9,928,000, environmental $3,612,000 and other $3,223,000. At December 31, 1994 accrued liabilities consisted of payroll $2,466,000, insurance $9,051,000, environmental $3,612,000 and other $3,229,000.\nE. LONG-TERM DEBT: Long-term debt at December 31, 1994 consisted of a Convertible Senior Debenture, with interest at 10%. The Company retired the Debenture during 1995 and issued common stock for the call premium.\nF. TREASURY STOCK: The Board of Directors has authorized corporate reacquisition of up to 750,000 common shares of the Company stock. During 1995, 1,000 shares were reacquired. No shares were reacquired in 1994 and 1993.\nPAGE\nG. NET EARNINGS PER COMMON SHARE: Net earnings per common share are computed using the weighted average common shares outstanding during each year and the common equivalent shares assuming conversion of the Convertible Debenture. Earnings for calculation of the per share data are adjusted to reflect add-back of interest expense on the Convertible Debenture.\nH. STOCK OPTION PLAN: The National Presto Industries, Inc. Stock Option Plan reserves 100,000 shares of the Company's common stock for key employees of the Company. Stock options for 1,000 shares at $39.88 per share and 2,500 shares at $41.75 per share were outstanding at December 31, 1995. Stock options for 1250 shares at $39.88 per share were outstanding at December 31, 1994.\nI. RETIREMENT PLANS: Pension Plans: The Company has pension plans which cover the majority of employees. Pension benefits are based on an employee's years of service and compensation near the end of those years of service. The Company's funding policy has been to contribute such amounts as necessary, computed on an actuarial basis, to provide the plans with assets sufficient to meet the benefits to be paid to plan members. Plan assets consist primarily (82%) of interest bearing securities with the balance in corporate stocks, principally National Presto Industries, Inc. common stock.\nAssumptions used to calculate costs and actuarial present values are reviewed regularly by the Company and its independent actuaries. The assumptions used are as follows: 7% and 8% discount rate in 1995 and 1994, 4.5% and 5.0% increase in compensation levels in 1995 and 1994, and 7.5% long term rate of return on investments. The funded status of the plans is summarized below: (In thousands) -------------- As of December 31 1995 1994 1993 ----------------- ---- ---- ---- Fair value of plan assets $ 9,137 $ 9,330 $ 9,889 Projected benefit obligation 8,957 8,003 8,008 ------------------------------------- Excess plan assets $ 180 $ 1,327 $ 1,881 =====================================\nPrepaid pension expense $ 3,012 $ 3,190 $ 3,333 =====================================\n401(k) Plan: The Company has a 401(k) retirement plan which covers substantially all employees. At its discretion, the Company will match up to 25% of the first 4% contributed by employees to the plan. The Company's matching contribution can be made with either cash or common stock. Company contributions made from the Company's treasury stock, including the Company's cash dividends, totaled $81,000 in 1995, $99,000 in 1994, and $91,000 in 1993.\nPAGE\nJ. INCOME TAXES: The effective rate of the provision for income taxes as shown in the consolidated statements of earnings differs from the applicable statutory federal income tax rate for the following reasons:\nPercent of Pre-tax Income ------------------------- 1995 1994 1993 ---- ---- ---- Statutory rate 35.0% 35.0% 35.0% State tax 2.4% 2.6% 2.5% Tax exempt interest and dividends -12.0% -7.8% -8.5% Other -0.1% -0.1% -0.3% ------------------------------------- Effective rate 25.3% 29.7% 28.7% =====================================\nThe Company follows the liability method of computing deferred income taxes. The liability method provides that deferred tax assets and liabilities are recorded based on the differences between the tax basis of assets and liabilities and their carrying amounts for financial reporting purposes. The tax effects of the cumulative temporary differences resulting in a deferred tax asset are as follows at December 31:\n(In thousands) -------------- 1995 1994 ---- ---- Insurance $ 3,810 $ 3,467 Environmental 1,376 1,377 Pension (1,160) (1,234) Other 912 823 ------------------------- $ 4,938 $ 4,433 =========================\nK. CONCENTRATIONS: One customer accounts for 36%, 35% and 34% of net sales for the years ended December 31, 1995, 1994 and 1993.\nProduction levels at commercial plants may be affected by vendor failure to deliver tooling, material and critical parts within commitments. While recent years have witnessed virtual elimination of these circumstances, there is no assurance against recurrence. Deliveries of new products, some of which have been sourced overseas, could be delayed by labor or supply problems at the vendors or in transportation. As a consequence, these products may not be available in sufficient quantities during the prime selling period. While there has been no major incidence of such problems and the Company has made every reasonable effort to prevent occurrence, there is no assurance that such effort will be totally effective.\nL. ENVIRONMENTAL: The Company is involved in certain environmental investigation matters and restoration activities with governmental agencies. The Company has entered into an agreement with the Department of Army that provides a vehicle for funding costs related to environmental restoration. A total of $12,000,000 has been appropriated in connection with that agreement to date. Based on costs incurred as of December 31, 1995 of $10,300,000 and anticipated future remediation activities, additional funds beyond the $12,000,000 are required. A further supplement of $15,000,000 was included in 1995 legislation for fiscal 1996. However, those funds have not yet been obligated by the Army. To the extent the Army honors its contractual obligations, there will be no material effect on the results of operations. Management believes that the impact of these environmental matters, if any, on the Company's financial condition will not be material.\nPAGE\nM. INTERIM FINANCIAL INFORMATION (UNAUDITED): The following represents unaudited financial information for 1995, 1994, and 1993:\n(In thousands) -------------- Net Gross Net Earnings Quarter Sales Profit Earnings Per Share ------- ----- ------ -------- ---------\nFirst $ 17,962 $ 5,207 $ 2,547 $ 0.35 Second 15,882 4,482 2,497 0.35 Third 29,039 9,691 4,797 0.65 Fourth 57,289 23,416 9,128 1.26 ------------------------------------------------------ Total $ 120,172 $ 42,796 $ 18,969 $ 2.61 ======================================================\nFirst $ 16,202 $ 5,207 $ 2,192 $ 0.31 Second 16,487 5,200 2,220 0.30 Third 35,488 14,202 4,799 0.66 Fourth 59,893 26,072 12,244 1.65 ------------------------------------------------------ Total $ 128,070 $ 50,681 $ 21,455 $ 2.92 ======================================================\nFirst $ 22,370 $ 7,612 $ 3,096 $ 0.43 Second 14,275 5,344 2,628 0.36 Third 24,663 10,364 4,335 0.60 Fourth 57,272 24,586 8,596 1.16 ------------------------------------------------------ Total $ 118,580 $ 47,906 $ 18,655 $ 2.55 ======================================================\nThe Company's operations are in one industry segment.\nPAGE REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nStockholders and Board of Directors National Presto Industries, Inc.\nWe have audited the accompanying consolidated balance sheets of National Presto Industries, Inc. (a Wisconsin corporation) and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of earnings, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1995. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of National Presto Industries, Inc. and subsidiaries as of December 31, 1995 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, 1995 in conformity with generally accepted accounting principles.\nWe have also audited Schedule II of National Presto Industries, Inc. and subsidiaries for each of the three years in the period ended December 31, 1995. In our opinion, this schedule presents fairly, in all material respects, the information required to be set forth therein.\n\/S\/ Grant Thornton LLP Minneapolis, Minnesota February 15, 1996\nPAGE\nNATIONAL PRESTO INDUSTRIES, INC. AND SUBSIDIARIES\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS\nFor the Years Ended December 31, 1995, 1994 and 1993\nNotes: (A) Amounts charged to selling and general expenses\n(B) Principally bad debts written off, net of recoveries","section_15":""}
{"filename":"831861_1995.txt","cik":"831861","year":"1995","section_1":"Item 1. Business.\nGeneral. The Company was incorporated in New Jersey on September 30, 1982 and consummated its initial public offering in July 1988. Its principal offices and administrative headquarters are located at 35 Mileed Way, Avenel, New Jersey, 07001. The Company's manufacturing facilities are located in the People's Republic of China (\"PRC\"). The Company has two distribution subsidiaries in North and Central America, four in Europe and one in Hong Kong. Unless the context indicates otherwise, when used in this report the word \"Company\" refers to Concord Camera Corp. and its subsidiaries and unless otherwise indicated, any twelve month period ending or ended on June 30, will be referred to as \"Fiscal\" with the appropriate year specified.\nThe Company's principal business has been and is the design, manufacture, marketing, distribution and sale of popularly-priced, easy to use 110 film cartridge and traditional and single use 35 millimeter cameras. The Company's objective is to respond to consumer demands for popularly-priced cameras with contemporary design and modern technology. To this end, the Company designs and manufactures various models of cameras in popular colors. The Company currently produces numerous series of 110 film cartridge and 35 millimeter (including single use) cameras with suggested United States retail sales prices ranging from $5.99 to $60.\nDomestic and Foreign Sales, Markets and Marketing\nIn Fiscal 1995, sales by the Company to United States customers, including sales made by the Company's Hong Kong subsidiary, constituted approximately 58.4% of total sales. Such sales were primarily to major discount, drugstore and retail chains, including Wal-Mart Stores, Target Stores, Walgreens, Eckerd Drugs, Family Dollar, and Toys-R-Us and to distributors and through direct mail and accounts which use cameras as premiums in connection with products sales. Approximately 41.6% of total sales in Fiscal 1995 were made by the Company's foreign subsidiaries to customers outside the United States. The Company also manufactured and sold, on an OEM basis, both finished single-use cameras and unassembled single-use cameras without film and batteries to The Minnesota Mining & Manufacturing Co. and Agfa-Gevaert AG.\nThe Company's sales are somewhat seasonal resulting in a higher sales volume during its first and second fiscal quarters. Increased volume is attributable to purchases for the holiday season. Company's sales for the first six months of Fiscal 1995 were $33,272,000 compared to $28,867,000 for the second six months of that year. Sales for the first six months of Fiscal 1994 were $29,800,000 compared to $25,017,000 for the second six months of that year. [See Consolidated Financial Statements]\nUnited States. A large portion of the Company's United States sales are made by its own sales personnel with the assistance of approximately 21 non-affiliated representative organizations that operate as selling agents in geographic areas specified by agreements. Sales representatives receive commissions at rates ranging from 1% to 5% of net\nsales and the Company believes this type of arrangement is prevalent in its industry. Certain of the sales representatives act as selling agents for manufacturers and distributors of other products. The loss by the Company of any of its sales representatives would not, in the Company's opinion, have a materially adverse impact upon sales because the Company believes that its own sales staff alone, or in conjunction with the services of other of its representatives, could provide the services now provided.\nCanada. In Fiscal 1995, 1994 and 1993 sales by Concord Camera Canada Corp. (\"Concord Canada\") accounted for approximately 4.8%,6.8%,and 13.7% respectively of the Company's total sales for those fiscal years. The decrease in Canadian sales from Fiscal 1993 to Fiscal 1995 was primarily attributable to the reduction in non-camera revenues, the successful implementation of certain sales programs with the Company's larger customers which are on an FOB Hong Kong basis, and the depressed economic conditions of the Canadian market.\nPanama. In February 1992, the Company formed Concord Camera (Panama) Corp. (\"Concord Panama\") to market products in Central and South America. Concord Panama accounted for approximately 3.6%, 3.6%, and 2.1% of the Company's total sales for Fiscal 1995, 1994 and 1993, respectively.\nConcord Americas. The United States, Canada, and Panama (collectively \"Concord Americas\") are now in position to better service their customers in a growing market place and increase their market shares in the Americas. The Company is in the process of of centralizing certain administrative, accounting and warehousing functions of the United States, Canadian and Panamanian operations in order to control costs and improve operations.\nEurope. Consolidated sales of Concord Camera GmbH (\"Concord Germany\"), Concord Camera UK Limited (\"Concord UK\"), Concord Camera France SARL (\"Concord France\"), and Concord Camera (Hungary) Ltd. (\"Concord Hungary), accounted for approximately 14.9%, 12.5%, and 10.6% of the Company's total sales in Fiscal 1995, 1994 and 1993, respectively. Sales in those regions continued to improve in Fiscal 1995 and are expected to continue to improve in the near future.\nDuring the first quarter of Fiscal 1994, the Company formed Concord Hungary which commenced operations in that quarter. In an effort to decrease worldwide administrative expenses during the first quarter of Fiscal 1996, the Company decided to transition its sales activities in Hungary to an independent sales representative. During the fourth quarter of Fiscal 1994, the Company formed Concord France which commenced operations on July 1, 1994.\nConcord Germany, Concord UK, and Concord France (collectively \"Concord Europe\") are now in position to better service their customers in a growing market place and increase their market shares in Europe. The Company intends to continue to centralize certain administrative, accounting and warehousing functions in Concord Europe in order to reduce the costs associated with those functions.\nFar East. Sales by Concord Camera HK Limited (\"Concord HK\") accounted for approximately 44.9%, 24.2%, and 26.3% of the Company's total sales for Fiscal 1995, 1994 and 1993 respectively. Concord HK's sales were made throughout the Far East, including Japan, and to other worldwide customers who purchase on an FOB Hong Kong basis. The Company believes that sales in the Far East will continue to represent a significant percentage of total sales.\nDuring the quarter ended December 31, 1993, Concord HK signed a twenty year agreement with Shenzhen Baoan Contat Camera Factory of the PRC (\"Contat\"), a joint venture between Longhua Economic Development Company and Shenzhen Santat Enterprise Development Company. Under the terms of that agreement, Concord HK will sell camera components to Contat, make available certain equipment, provide management assistance and technical advisors and supervise the technical quality of Contat's products. Contat will market and sell the camera products it produces in the PRC under the \"Concord\" trade name and trademark, under a sublicense from the Company. Included in other assets is a note receivable from Contat for approximately $431,000. [See Note 5 to the Financial Statements]\nHungary. In Fiscal 1990, the Company formed a joint venture with Hungarian Optical Works, Fine Mechanical and Optical Ltd. and the Hungarian Credit Bank Ltd. to manufacture and assemble cameras in Hungary for distribution in that country and in other Eastern Bloc countries. Because of the financial instability of the Company's joint venture partners, the joint venture is being liquidated which is anticipated to be completed in Fiscal 1996. The Company had intended to continue its activities in Hungary and the former Eastern Bloc Countries through a wholly owned subsidiary, however, in the first quarter of Fiscal 1996 the Company transferred its sales activities for Hungary and certain of the former Eastern Bloc Countries to an independent sales representative. [See Consolidated Financial Statements]\nLicensing Activities. In May 1995, the Company executed a license agreement with Hallmark Licensing, Inc., as agent for Binney & Smith Properties, Inc. (\"Binney & Smith\") under which the Company licensed certain Binney & Smith trademarks with regard to Crayola(R) and certain associated marks, tradenames, and logos for use with single-use cameras, pocket 110 cameras and 35 millimeter cameras. The agreement expires December 31, 1997 but the Company may renew the agreement for an additional one year term if actual royalties payable under the agreement exceed a pre-determined minimum level.\nCustomers. In Fiscal 1995 and 1994, approximately 56.9% and 51.9% of Company's sales were to its 10 largest customers. The consolidated sales to two customers (The Minnesota Mining & Manufacturing Company and Wal-Mart Stores, Inc.)in Fiscal 1995 and 1994 amounted to approximately $15,759,000 (25.4%) and $12,176,000 (22.2%), respectively. The loss of either of these customers could have a material impact on the Company. The Company has executed agreements for the supply of single-use cameras as an original equipment manufacturers with each of Minnesota\nMining & Manufacturing Co. and Agfa-Gevaert AG. Each agreement is for a one year term and requires each of those entities to purchase several million single-use cameras.\nAdvertising. The Company engages in a limited amount of advertising and in the past has given allowances to customers who advertise its products. Advertising allowances and other discounts were approximately $829,000. $587,000, and $858,000 in Fiscal 1995, 1994, and 1993 respectively.\nManufacturing\nGeneral. The Company's operations and profitability are substantially dependent on its manufacturing and assembly activities, all of which are conducted in the PRC. The Company currently conducts engineering, design, purchasing and certain distribution and warehouse activities in Hong Kong. The Company's manufacturing activities in the PRC are conducted pursuant to the PRC agreements (the \"PRC Agreements\") with various local municipal and government agencies and sub-divisions located in Baoan County, Shenzhen Municipality, PRC (collectively, the \"PRC Entities\"). The Company's initial agreement in Baoan County was approved on September 12, 1985 by the local Foreign Economic Relations Office (\"FERO\") and FERO approval is necessary to assure the validity and enforceability of the PRC Agreements. The Company's most recent PRC Agreement covering its manufacturing activities was approved by the PRC Entities and FERO in 1993 and expires in 2002. The Company intends to continue to expand its operations in the PRC, although there can be no assurance that it will be able to do so.\nThe Company did not experience any interruption in its manufacturing or other operations as a result of political events (Tiananmen Square) in the PRC in June 1989, other than a brief interruption of deliveries between Hong Kong and the PRC. There can be no assurance that similar events will not occur in the PRC in the future and, if they do occur, that they will not result in material interruption of manufacturing or other operations.\nAlthough in the past the Company has contract manufactured non- photographic products in the PRC, at present the Company is not performing any contract manufacturing but continues to explore opportunities related thereto. The Company continues to explore the possibility of contract manufacturing of non-photographic products in the PRC in cases where manufacturing is labor intensive and requires the application of manufacturing processes and techniques similar to those currently employed by the Company. See \"Dependence on Agreements with the PRC.\" and \"Item 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nUnited States Offices and Warehouses. The Company's principal offices containing the Company's domestic warehouse and administrative offices are in a 35,000 square foot facility located at 35 Mileed Way, Avenel, N.J. The Company's lease on this facility provides a rent of $15,000 per month and that lease expires in December of 1997.\nHong Kong. The Company owns one floor and leases one floor constituting approximately 13,000 square feet of warehouse and business space at Fortei Building, 98 Texaco Road, Tsuen Wan, New Territories, Hong Kong at a cost of approximately $6,600 per month, including rent and maintenance.\nOther Jurisdictions. The Company leases warehouse and\/or office space in France, Canada, Germany, UK, Hungary and Panama in connection with the activities of its subsidiaries in those jurisdictions.\nPRC -- Operations. Cameras and components are manufactured and assembled at three manufacturing facilities located in Baoan County, Shenzhen Municipal, PRC. Two of the manufacturing facilities are leased from a PRC Entity (the \"Leased Facilities\") for which the Company pays rent of approximately $21,000 per month. The other manufacturing facility is owned by the Company (the \"Company Facility\"). The Leased Facilities and the Company Facility each have a related employee dormitory (the \"Related Dormitory\"). The aggregate square footage of the Leased Facilities, Company Facility and their respective Related Dormitory is approximately 384,000 square feet.\nIn Fiscal 1996 the Company expects to commence construction of an additional factory building on the same plot of land as the current Company facility (the \"Addition\")to accommodate increased production and to facilitate the consolidation of the Leased Facilities into the Company Facility. The total cost to construct and complete the Addition will be approximately $750,000. The Company had also anticipated commencing construction of a new dormitory in Fiscal 1995. In lieu of the construction, the Company leased a new dormitory facility commencing in July 1995. Certain improvements will be made to the new dormitory at an approximate cost of $250,000. In addition, the current dormitory owned by the Company will be converted to office and administrative space and engineering facility as well as a small factory for pilot runs and living quarters for foreign employees at an approximate cost of $250,000. Total cost for all the construction described above is estimated to be approximately $1,250,000. Such cost\nwill be amortized over the expected useful life of the Addition once completed and placed in service, which is expected to be by the end of Fiscal 1996. If production requirements continue to increase, the Company may be required to provide for an additional dormitory.\nThe Company negotiated and executed agreements (the \"Land Use Agreements\") with PRC Entities for the use of PRC Land (the \"PRC Land\") for the Company Facility and the Addition. Under the Land Use Agreements, which have FERO approval, the Company obtained land use rights for approximately 8 acres of land from a PRC Entity for the Company Facilities, the Addition and construction of factories, dormitories and other ancillary buildings. The Company has the right to use the PRC Land through 2042 (the \"Term\"). Under the Land Use Agreements, the Company paid approximately $825,000 in fees and related expenses to obtain the Land Use Rights Certificate from the PRC Entity. In satisfaction of a portion of its obligations under the Land Use Agreement the Company had intended to issue 33,108 shares of Common Stock valued at $132,365 on November 9, 1994. While such shares were actually issued, they were never, in fact, delivered to the PRC Entity. The PRC Entity insisted on renegotiation of the terms allowing for payment in the Company's Common Stock. During the fourth quarter of Fiscal 1995 the shares were canceled and payment was made in cash. In addition, the Company will also be responsible for stipulated land management fees and for the installation of certain utilities. The Land Use Agreements permit the Company, to transfer, lease or mortgage its rights under the Land Use Agreements and in the buildings developed thereunder during the Term. At the end of the Term, all facilities on the PRC Land will belong to the PRC Entity and the Company shall have the right to lease the PRC Land and facilities thereon at the prevailing rent under regular lease terms.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nRoland Kohl. During the last quarter of Fiscal 1990, Concord HK terminated for cause certain of its former officers and directors, including Roland Walter Kohl (\"Kohl\"), its former Managing Director. On April 10, 1990, the Company and Concord HK instituted proceedings in the Supreme Court of Hong Kong, High Court against such individuals for alleged breach of employment contracts and breach of duties owed to Concord HK. Concord HK's claims against those persons included damages caused by an alleged conspiracy to impede Concord HK's production capabilities, disruption of Concord HK's business, ordering of unnecessary or obsolete inventory, impeding Concord HK from obtaining credit and loss of profits. The Company and Concord HK claimed damages of approximately $5.9 million, including claims for lost business. The defendants served answers and counter-claimed for arrears of salary, salary in lieu of notice and bonuses held in escrow by Concord HK's former attorneys.\nThe Company has executed a settlement agreement with all of the defendants. The settlement documents are subject to finalization. The settlement resulted in all claims and counter claims being dismissed. As a result of the settlement, the Company will not recover any alleged damages. The Company will not pay any money to Kohl and one other defendant. Payment will, however, be made by the Company to certain other defendants who had claims for salary arrearages and legal fees incurred in asserting those claims in the aggregate amount of $800,000 which will be paid by the release of certain escrowed funds of approximately $287,000 (which sum was originally posted by Concord HK to secure payments under the employment agreements to those defendants) with the balance being payable over time, through May 1996.\nSEC Investigation. In December of 1990, Michael J. Rea (\"Rea\"), the Company's then Chief Financial and Accounting Officer was terminated by the Company. On February 7, 1991, Rea instituted suit against the Company and Jack C. Benun (\"Benun\") individually, the Company's former Chairman and Chief Executive Officer, in the Superior Court of New Jersey, Law Division, Middlesex County. Rea alleged, among other things, that his employment had been terminated in breach of his employment contract, and in retaliation for Rea's discovery and investigation of certain misconduct involving, among others, Benun, who Rea alleged had misappropriated at least $150,000 from the Company.\nOn November 1, 1991, the Company was advised that the Securities and Exchange Commission (the \"Commission\") had issued an order on October 21, 1991 directing a private investigation (the \"Commission Investigation\") of Rea's allegations and related matters to determine whether any persons, including the Company and certain of its officers, directors, employees and affiliates, had engaged in, are engaging in, or are about to engage in, acts or practices in violation of various provisions of the 1933 Act and the Exchange Act and the rules and regulations thereunder.\nAn initial investigation was instituted in 1991 by an Ad Hoc Committee of the Company's Board of Directors regarding the allegations of misconduct against Benun. The Ad Hoc Committee reported in 1992 that they had been unable to find any substantial evidence of wrongdoing by Benun. When new evidence became available in 1993, the Ad Hoc Committee was reconstituted with two new members and one member of the prior committee panel and its investigation was continued.\nOn July 13, 1994, the Company's Board received and adopted a report from the Ad Hoc Committee, concluding that the credible evidence indicated Benun had misappropriated $150,000 from the Company and recommended that Benun be terminated. As a consequence of the new report and the Ad Hoc Committee's recommendation, on July 14, 1994 the Company announced that it had terminated Benun for cause. On September 16, 1994, as required by his settlement agreement with the Commission, Benun paid the Company $215,243, representing reimbursement of the $150,000 allegedly misappropriated and interest thereon from May 1, 1990.\nOn September 1, 1994, the Company settled the Commission Investigation as it related to the Company without monetary damages or penalties. The settlement became effective upon the filing of an Administrative Order in which the Company, without admitting any wrongdoing, agreed to cease and desist from filing false reports and proxy statements, and keeping inaccurate books and records.\nJack C. Benun. On November 18, 1994 the Company filed a demand for arbitration in New Jersey, for money damages in excess of $1.5 million, against Benun. This action was taken due to Benun's failure to fully compensate the Company for damages it sustained as a result of Benun's breaching his employment obligations, his fiduciary obligations and perpetrating frauds upon the Company including the misappropriation of funds from the Company. [See above SEC Investigation]\nMr. Benun has submitted a counterclaim in which he alleges among other things a wrongful termination by the Company. The Company intends to vigorously pursue its action as well as defend the counterclaim. The Company has reserved its rights under any other claims it may have against Mr. Benun. [See below Purported Class Action]\nPurported Class Action. On February 22, 1995 the Company was served with a complaint purporting to be a class action on behalf of purchasers of the Company's common stock throughout the period from January 1, 1991 through December 31, 1994 seeking damages in an unspecified amount. The complaint appeared to be predicated on the wrongdoing of the Company's former chief executive officer who was terminated for cause by the Company in July 1994 and an alleged failure by the Company to promptly disclose such wrongdoing to the public. By way of responding to the complaint, the Company and the individual defendants (comprised of present and former Board members) filed a motion to dismiss the complaint. On September 5, 1995 plaintiffs responded by filing a cross-motion to file an amended complaint. The Company intends vigorously to contest the litigation and believes that it has good defenses to the purported claims asserted in the complaint and amended complaint. The matter is in its earliest stage and there can be no assurance as to its eventual outcome. The Company has already commenced an arbitration proceeding described above against its former chief executive officer and intends to file a claim against him for all costs incurred by the Company in connection with the purported class action litigation.\nArgus. Effective March 31, 1992, the Company sold to Argus, a company controlled by two former Company executives, the rights to the ARGUS trademark and trade name in Mexico and the United States for approximately $500,000, and agreed to sell to Argus the related inventories at their wholesale value of $1.5 million. Argus agreed to purchase the inventories over a twelve month period in equal monthly installments. Of the $500,000 sales price, $200,000 was paid in cash and the balance was paid by a promissory note (\"the Argus Note\").\nArgus failed to comply with certain payment and other terms in the purchase agreement and the Company declared a default under such agreement. On November 23, 1992, Argus commenced litigation against the Company and its subsidiary Concord Camera Illinois Corp. in the Superior Court of New Jersey alleging, among other things, that the Company breached its agreements with Argus and violated the New Jersey Civil RICO statute. Argus sought, among other relief, injunctions and monetary damages.\nIn connection with the Argus litigation and Argus' default on certain of its purchase obligations the Company, in response, mitigated damages by selling certain of the inventories to third parties (the \"Resale\") and filed two motions for partial summary judgement seeking recovery for the deficiency of approximately $70,000 resulting from the Resale and for approximately $39,000 for unsold inventory. The Court granted both of the Company's motions and entered judgements in those amounts. Argus had satisfied the judgement of approximately $39,000 and the Company initiated proceedings to levy upon certain Argus assets to satisfy the judgement of approximately $70,000. Prior to finalization of those proceedings the parties settled all of the claims between them on terms favorable to the Company but which do not have any material impact on the Company's financial condition. All monies due from Argus were paid to the Company in the first quarter of Fiscal 1996.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nNone.\nPart II\nItem 5.","section_5":"Item 5. Market for Company's Common Equity and Related Shareholder Matters.\nThe Company's common stock is traded on the NASDAQ National Market System under the symbol LENS. The approximate high and low bid prices for the shares tabulated below, are as reported by the NASDAQ National Market System and represent interdealer quotations which do not include retail mark-ups, mark-downs or commissions. They do not necessarily represent actual transactions. As of September 15, 1995, there were 10,497,526 shares outstanding, held by 1,225 record holders. There are in excess of 3,300 beneficial holders of the Company's common stock.\nPeriod Bid Price ------------- --------------------- Quarter Ended High Low ------------- ---- --- September 30, 1993 ......................... 6 3 7\/8 December 31, 1993 .......................... 7 3\/4 4 5\/8 March 31, 1994 ............................. 9 3\/8 5 3\/8 June 30, 1994 .............................. 5 3\/4 2 1\/2 September 30, 1994 ......................... 4 5\/8 2 1\/4 December 30, 1994 .......................... 3 1\/2 1 7\/8 March 31, 1995 ............................. 3 3\/4 2 1\/8 June 30, 1995 .............................. 4 1\/2 2 1\/2\nThe Company has never paid cash dividends and has no present intention to pay cash dividends.\nItem 7.","section_6":"","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 notes thereto presented elsewhere in this Report.\nResults of Operations\nThe following table sets forth the relationship between total sales and certain expenses and earnings items for the three years ended June 30, 1995, 1994 and 1993.\nYear Ended June 30, ----------------------------- 1995 1994 1993 ---- ---- ---- Net Sales ................................ 100.0% 100.0% 100.0% Cost of Product Sold ..................... 67.6 68.7 67.8 ----- ----- ----- Gross Profit ............................. 32.4 31.3 32.2 Operating Expenses ....................... 30.1 32.4 32.7 Other Expense, net ....................... .2 .4 11.9 ----- ----- ----- Income (loss) before Provision for income taxes ........................... 2.1 (1.5) (12.4) ----- ----- ----- Provision for income taxes ............... .2 .2 .5 ----- ----- ----- Net income (loss) ........................ 1.9% (1.7)% (12.9)% ===== ===== =====\nFiscal 1995 Compared to Fiscal 1994\nRevenues\nTotal revenues for Fiscal 1995 and 1994 were approximately $62,139,000 and $54,817,000, respectively, an increase of approximately $7,322,000 or 13.4%. The increase, which is net of decreases in non-camera revenues and revenues from promotional sales, is due to the Company's European expansion, continued acceptance of the Company's new products, principally the single-use and slim-line camera models, and an increase in OEM revenues. Revenues from traditional camera sales and OEM sales increased by approximately $5,359,000 or 13.2% and $6,948,000 or 104.5%, respectively, for Fiscal 1995 to $46,067,000 and $13,596,000, respectively, from $40,708,000 and $6,648,000, respectively, for Fiscal 1994. Included in net sales during Fiscal 1995 were approximately $2,476,000 of non-camera sales and no revenues from one time promotional sales compared to approximately $4,561,000 and $2,900,000, respectively, of such sales in Fiscal 1994. Non-camera sales were substantially discontinued by the Company as of the end of the quarter ended September 30, 1994. The increase in OEM sales is attributable to contract obligations and increased purchases from the Company's preexisting OEM customer and from sales to a new OEM customer.\nFiscal 1995 sales included sales of approximately $27,107,000 or 43.6% of total sales of the Company's single use camera product line, as compared to $19,541,000 or 35.6% in Fiscal 1994, an increase of $7,566,000 or 38.7%. The Company believes that sales of its single use camera product line will continue to grow in Fiscal 1996.\nSales by Concord HK in Fiscal 1995 and 1994 were approximately $27,910,000 and $13,289,000, respectively, an increase of approximately $14,621,000 or 110.0%. The increase is due to the continued acceptance of the Company's new products, principally the single-use and slim-line camera\nmodels and the successful implementation of FOB Hong Kong sales programs with the Company's larger customers and a change in the point of sale from the United States to Hong Kong during the quarter ended December 31, 1994. The Company effectuated a change in the OEM point of sale in order to secure an additional working capital line from the Bank of East Asia, New York (see Bank of East Asia, New York). Payment of FOB sales are primarily by letter of credit.\nSales by the Company's United States operation in Fiscal 1995 and 1994 were approximately $20,161,000 and $29,014,000, respectively, a decrease of approximately $8,853,000 or 30.5%. United States net sales for Fiscal 1995 and 1994 included OEM sales with point of sale out of U.S. of approximately $2,225,000 and $6,648,000, respectively, a decrease of approximately $4,423,000 or 66.5%; non-camera revenues of approximately $2,476,000 and $4,561,000, respectively, a decrease of approximately $2,085,000 or 45.7%; and no revenues from a one time promotional sale in Fiscal 1995 as compared to $2,900,000 for Fiscal 1994. If the foregoing sales were eliminated from U.S. operations from each of Fiscal 1995 and Fiscal 1994 it would reflect an increase in traditional camera sales in the United States for Fiscal 1995 of approximately $555,000 or 3.7% over such sales for Fiscal 1994. In addition, certain United States customers increased merchandise purchases on an FOB Hong Kong basis from Concord HK, which merchandise was previously purchased from Concord in the United States. During Fiscal 1995 and 1994, United States customers purchased approximately $11,914,000 and $7,478,000, respectively, from Concord HK, an increase of approximately $4,436,000 or 59.3%. If this increase were added to Fiscal 1995 U.S. sales, sales to U.S. customers would have increased by 22.3%.\nSales by Concord Panama into select areas of Central and South American markets for Fiscal 1995 and 1994 were approximately $1,824,000 and $1,957,000, respectively, representing a decrease of approximately $133,000 or 6.8%.\nSales by Concord Canada for Fiscal 1995 and 1994 were approximately $2,966,000 and $3,701,000, respectively, representing a decrease of approximately $735,000 or 19.9%. The decrease was primarily a result of the reduction of non-camera revenues, the successful implementation of certain sales programs with the Company's larger customers which are on an FOB Hong Kong basis, and the depressed economic conditions of the Canadian market.\nConsolidated sales of Concord Europe, for Fiscal 1995 and 1994, were approximately $9,278,000 and $6,856,000, respectively, an increase of approximately $2,422,000 or 35.3%. In addition, certain European customers increased merchandise purchases on an F.O.B. Hong Kong basis from Concord HK. During Fiscal 1995 and 1994 European customers purchased approximately $2,491,000 and $1,886,000, respectively, from Concord HK, an increase of approximately $605,000 or 32.1%. If this increase were added to 1995 European sales, sales to European customers would have increased by 34.6%. During the first quarter of Fiscal 1994, the Company formed Concord Hungary which had sales of approximately $105,000 in the fourth quarter of Fiscal 1994. During the quarter ended June 30, 1994, the Company formed Concord France which commenced operations on July 1, 1994. Sales by Concord Hungary and Concord France were $379,000 and $1,817,000, respectively, during Fiscal 1995. After giving effect to the sales by the new subsidiaries, sales by Concord Europe increased by approximately $331,000 or 4.8%. This increase is primarily attributable to\nsales to new customers by the Company's increased European Sales and Marketing force. Sales in this region are improving, but are still affected by the sluggish economic conditions in the Region.\nGross Profit\nGross profit, expressed as a percentage of sales, increased to 32.4% for Fiscal 1995 from 31.3% for Fiscal 1994. This increase was primarily due to improved control over costs, production and inventory levels during the past fiscal year.\nOperating Expenses\nOperating expenses, consisting of selling, general and administrative and financial expenses, increased to $18,685,000 in Fiscal 1995 from $17,734,000 in Fiscal 1994, an increase of $951,000 or 5.4%. As a percentage of sales, operating expenses decreased to 30.1% in Fiscal 1995 from 32.4% in Fiscal 1994.\nSelling expenses increased to $7,298,000 or 11.7% of net sales in Fiscal 1995 from $5,569,000 or 10.2% of net sales in Fiscal 1994. The increase was primarily attributable to the Company's expansion and enhancement of the worldwide sales force including increases in sales salaries, sales commissions, co-operative advertising expenses, marketing and trade show related expenses.\nGeneral and Administrative expenses decreased to $8,110,000 or 13.1% of net sales in Fiscal 1995 from $9,123,000 or 16.6% of net sales in Fiscal 1994. The decrease is primarily due to cost control on a worldwide basis, which includes but is not limited to, a reduction in officer salaries and bonuses, administrative salaries, related payroll expenses, rent and engineering expenses, net of approximately $250,000 in increased expenses attributable to opening the two new subsidiaries (see \"Revenues\").\nFinancial expenses decreased to $1,413,000 or 2.3% of net sales in Fiscal 1995 from $1,889,000 or 3.5% of net sales in Fiscal 1994. Such decrease was primarily a result of a reduction in average debt outstanding during Fiscal 1995, and a reduction in loan costs and guarantee fees.\nLitigation and settlement costs in Fiscal 1995 and 1994 were approximately $1,864,000 and $1,153,000, respectively. The Company incurred significant legal expenses and settlement costs in connection with non-operating matters, primarily the demand for arbitration against Jack Benun, the Purported Class Action, the Roland Kohl litigation, the Argus Settlement, and the SEC Investigation. See \"Item 3. Legal Proceedings.\" above.\nOther Expense, Net\nOther expense, net includes directors fees, certain public relations costs, and foreign exchange gains and losses net of interest income and gains from the sale of fixed assets.\nWith respect to foreign exchange gains and losses, the Company operates on a worldwide basis and its results may be adversely or positively affected by fluctuations of various foreign currencies against the U.S. Dollar, specifically, the Canadian Dollar, German Mark, British Pound Sterling, Hungarian Forints, French Francs, and Japanese Yen. Each\nof the Company's foreign subsidiaries purchases its inventories in U.S. Dollars and sells them in local currency, thereby creating an exposure to fluctuations in foreign currency exchange rates. Certain components needed to manufacture cameras are priced in Japanese Yen. The translation from the applicable currencies to U.S. dollars is performed for balance sheet accounts using current exchange rates in effect at the balance sheet date and for revenue and expense accounts using a weighted average exchange rate during the period. The impact of foreign exchange transactions is reflected in the profit and loss statement which in Fiscal 1995 included a loss of approximately $95,000.\nIn Fiscal 1995, the Company's hedging activities were immaterial and, at June 30, 1995 there were no forward exchange contracts outstanding.\nIncome Taxes\nThe income tax provision for Fiscal 1995 of $106,990 is comprised of deferred taxes of $12,515 and a current provision of $94,475. The Company's provision for income taxes for Fiscal 1995 is primarily related to the earnings of the Company's Far East operations, net of benefits relating to overpayments\/refunds on the Company's other foreign Subsidiaries.\nAs of June 30, 1995, Concord had net operating loss carryforwards for U.S. tax purposes of approximately $14,732,000 which expire as follows: $1,586,000 in 2005; $16,000 in 2006; $444,000 in 2007; $6,630,000 in 2008 and $2,770,000 in 2009, and $3,280,000 in 2010. Losses for state tax purposes begin to expire in 1997.\nThe realization of the deferred tax assets relate directly to the Company's ability to generate taxable income for certain foreign and U.S. federal and state tax purposes. Management is not able to conclude that realization of these deferred tax assets is more likely than not as a result of the Company's earnings history. Reductions to the valuation allowance will be recorded when, in the opinion of management, the Company's ability to generate taxable income in these jurisdictions is more certain.\nNet Income (Loss)\nAs a result of matters described above, the Company had net income of approximately $1,209,000 in Fiscal 1995, compared to a net loss of approximately $945,000 in Fiscal 1994, a turnaround in net income of $2,154,000.\nFiscal 1994 Compared to Fiscal 1993\nRevenues\nTotal revenues for Fiscal 1994 and 1993 were approximately $54,817,000 and $59,131,000, respectively, a decrease of approximately $4,314,000 or 7.3%. Approximately $2,010,000 of the total decrease was from a reduction in non-camera revenues and a result of the Company's plan to streamline its worldwide operations and focus more closely on the\nmanufacture and distribution of cameras and camera related accessories. In addition, net sales in Fiscal 1993 included a significant amount of closeout merchandise, sold at reduced prices to generate working capital.\nFiscal 1994 sales include approximately $19,541,000 or 35.6% of total sales of the Company's single use camera product line, as compared to $14,846,000 of total sales or 25.1% in Fiscal 1993, an increase of $4,695,000 or 31.6%.\nSales by Concord HK in Fiscal 1994 and 1993 were approximately $13,289,000 and $15,532,000, respectively, a decrease of approximately $2,243,000 or 14.5%. The decrease was primarily attributable to a significant amount of initial sales into the Japanese market in Fiscal 1993.\nSales by the Company's United States operation in Fiscal 1994 and 1993 were approximately $29,014,000 and $27,985,000, respectively, an increase of approximately $1,029,000 or 3.7%. Sales in Fiscal 1994 and 1993 include approximately $9,580,000 and $2,957,000, respectively, of the Company's single use product line sold on an OEM basis or through private labels. The significant increase is primarily a result of a $2,900,000 premium sale made in Fiscal 1994 and increased sales of single use products to 3M Company. If OEM sales were eliminated for the U.S. operations sales for each of Fiscal 1994 and Fiscal 1993, sales by the United States operation would have decreased by approximately $6,912,000 or 25.7%. The decrease is primarily a result of the reduction in non-camera revenue and the inclusion of a significant amount of closeout merchandise in Fiscal 1993, as discussed above.\nSales by Concord Panama in Fiscal 1994 and 1993 were approximately $1,957,000 and $1,222,000, respectively, representing an increase of approximately $735,000 or 60.1%. Concord Panama commenced operations in Fiscal 1992 and, over its first two full years of operation, has successfully marketed the Company's product in Central and South America.\nSales by Concord Canada in Fiscal 1994 and 1993 were approximately $3,701,000 and $8,114,000, respectively, representing a decrease of approximately $4,413,000 or 54.4%. The significant decrease was primarily a result of the reduction of non-camera revenues, as discussed above and the depressed economic conditions of the Canadian market.\nSales by Concord Europe in Fiscal 1994 and 1993, were approximately $6,857,000 and $6,278,000, respectively, an increase of approximately $579,000 or 9.2%. The increase is a result of improving economic conditions in Europe and increased marketing efforts.\nGross Profit\nGross profit, expressed as a percentage of sales, decreased to 31.3% for Fiscal 1994 from 32.2% for Fiscal 1993. This slight decrease was\nprimarily due to reductions in prices of certain products as a result of competition, especially in the single use camera market and the liquidation of non-camera inventory at prices approximating cost.\nOperating Expenses\nOperating expenses, consisting of selling, general and administrative and financial expenses, decreased to $17,735,000 in Fiscal 1994 from $19,335,000 in Fiscal 1993, a decrease of $1,600,000 or 8.3%. As a percentage of sales, operating expenses decreased to 32.4% in Fiscal 1994 from 32.7% in Fiscal 1993.\nSelling expenses decreased to $5,569,000 or 10.2% of net sales in Fiscal 1994 from $6,102,000 or 10.3% of net sales in Fiscal 1993. The decrease was primarily attributable to reduced sales salaries and related costs as a result of the Company's worldwide management restructuring in Fiscal 1993 which continued into Fiscal 1994. In addition, customer advertising and other sales allowances continued to decrease in Fiscal 1994 as a result of the improved internal and operational controls instituted by the Company in Fiscal 1993 and Fiscal 1994.\nGeneral and administrative expenses decreased to $9,123,000 or 18.8% of net sales in Fiscal 1994 from $10,125,000 or 17.1% of net sales in Fiscal 1993. The decrease is primarily a result of reductions in operating expenses of the Company's subsidiaries operations.\nFinancial expenses decreased to $1,889,000 or 3.5% of net sales in Fiscal 1994 from $3,108,000 or 5.3% of net sales in Fiscal 1993. Included in the Fiscal 1993 total is approximately $1,045,000 of amortization related to a warrant issued to Ira J. Hechler (\"Hechler\"), a director of the Company. After excluding such amortization, financial expenses decreased to $1,889,000 or 3.5% of net sales in Fiscal 1994 from approximately $2,063,000 or 3.5% of net sales in Fiscal 1993. Such decrease was primarily a result of a reduction in average short term debt outstanding in Fiscal 1994.\nLitigation and Settlement costs in Fiscal 1994 were approximately $1,153,000. The Company incurred significant legal expenses and settlement costs in connection with non-operating matters primarily the demand and arbitration against Jack Benun, the Roland Kohl litigation, Argus litigation, and the SEC investigation. [See Item 3. Legal Proceedings above.]\nOther Expense, Net\nOther expense, net include directors fees, certain public relations costs, the Company's share of losses incurred by its joint venture in Hungary and foreign exchange gains and losses.\nWith respect to foreign exchange gains and losses, the Company operates on a worldwide basis and its results may be adversely or positively affected by fluctuations of various foreign currencies against the United States Dollar, specifically, the Canadian Dollar, German Mark, British Pound Sterling and Japanese Yen. Each of the Company's foreign subsidiaries purchases its inventories in United States Dollars and sells them in local currencies, thereby creating an exposure to fluctuations in currency exchange rates. Certain components required for the manufacture of cameras are priced in Japanese Yen. The impact of foreign exchange\ntransactions is reflected in the profit and loss statement which in Fiscal 1994 included a loss of approximately $776,000.\nIn Fiscal 1994, the Company's hedging activities were immaterial and at June 30, 1994 there were no forward exchange contracts outstanding.\nProduct Line Rationalization\nAs a result of the Company's success in the introduction of single use cameras, that product's acceptance in the market and the Company's belief that demand for that product will continue, the Company decided to curtail certain of its 35 millimeter and 110 product lines and to focus a significant amount of its efforts on single use camera. In connection with those changes, the Company suspended production of certain camera models. As a consequence in Fiscal 1993, provisions for certain component parts inventory and certain fixed assets (principally tools and molds) used in connection with the manufacturing of those models were made to reduce those items to their net realizable values. Such assets have been recorded at a negligible amount which the Company recovered in Fiscal 1994. The total amount recorded was $4,478,000.\nReorganization and Restructuring\nIn connection with the reorganization and upgrading of its worldwide management, finances, and management information systems and procedures, certain expenses have been and will be incurred. Substantially all of the manufacturing joint ventures which operated prior to the Company's purchase of the interests of its joint venture partners have been consolidated with the Company's manufacturing operations, new management has been hired and new worldwide management information system and\nprocedures were implemented and installed. In addition, the Company is in the process of liquidating its joint venture in Hungary as a result of financial instability of its joint venture partners. In Fiscal 1993, the Company recorded provisions for current and future expenditures of approximately $234,000 for compensation and severance costs, $260,000 for certain professional fees and $378,000 for organization and consolidation costs. In addition, the Company recorded provisions of approximately $492,000 against certain of its inventories in the joint ventures and $158,000 for certain deferred refinancing costs.\nThe effects of the reorganization and restructuring can not be quantified, however, management expects that such steps will yield more efficient operations and enhance internal and operating controls.\nProposed Transaction Costs\nAs a result of the termination of its agreement with Gestetner Holdings PLC, the parent of the Vivitar Group of Companies (\"Vivitar\"), in Fiscal 1993 the Company wrote off $904,000 of costs incurred in connection with the Vivitar Transaction.\nIncome Taxes\nThe net income tax provision of $123,050, is comprised of deferred income taxes of $185,944 and a refund due of $62,894, both of which relate to the Company's Far East operation.\nNet Loss\nAs a result of the matters described above, the Company incurred a net loss of approximately $945,000 in Fiscal 1994, compared to a net loss of approximately $7,634,000 in Fiscal 1993, a decrease of $6,689,000 (87.6%).\nLiquidity and Capital Resources\nAt June 30, 1995, the Company had working capital of $17,432,000 as compared to $21,115,000 at June 30, 1994. Cash flow provided by (used in) operating activities was approximately $5,088,000 for the fiscal year ended June 30, 1995 compared to ($2,165,000) for the fiscal year ended June 30, 1994. Capital expenditures, excluding assets financed under capital leases, for the fiscal year ended June 30, 1995 and 1994 were approximately $2,261,000 and $1,690,000, respectively. During the fiscal year ended June 30, 1994, the Company purchased an interest bearing $1,000,000 time deposit in connection with a short-term credit arrangement (see Bank of East Asia, Limited - Hong Kong below). The Company's principal funding requirement has been, and is expected to continue to be, the financing of accounts receivable and inventory.\nDuring Fiscal 1994, certain warrants and options to purchase the Company's common stock were exercised. Such exercises generated net proceeds of approximately $5,772,000 which were used to reduce debt and for working capital purposes.\nThe Bank of East Asia, Limited New York (\"BOEA NY\")\nOn December 20, 1994, the Company obtained a one year, $1,500,000 revolving credit facility with BOEA NY which expires on December 20, 1995. The BOEA NY Facility is secured by certain accounts receivable of the Company's Hong Kong operations and bears interest at 2% above BOEA NY's prime lending rate, which was 9.0% at June 30, 1995. Availability under the BOEA NY Facility is subject to advance formulas based on eligible accounts receivable with no minimum borrowing. At June 30, 1995, approximately $547,000 was outstanding and classified as short-term debt under the BOEA NY Facility.\nOn September 20, 1995, the Company executed an amendment to its revolving line of credit with BOEA NY to increase the credit facility to $3,000,000. The closing of the amendment is contingent on the delivery of certain closing documents.\nThe CIT Group\/Credit Finance, Inc (\"CIT\")\nOn March 30, 1994, the Company obtained a two year $10,000,000 credit facility with CIT (the \"CIT Facility\") which expires on March 29, 1996. The CIT Facility is secured by accounts receivable inventory and other related assets of the Company's United States operations and bears interest at 2% above CIT's prime lending rate, which was 9.0% at June 30, 1995. Availability under the CIT Facility is subject to advance formulas based on eligible inventory and accounts receivable with minimum borrowing of $2,000,000. At June 30, 1995, approximately $2,214,000 was outstanding and classified as short-term debt under the CIT Facility.\nBank of East Asia, Limited (\"BOEA\") - Hong Kong\nEffective August 2, 1993, Concord HK entered into a credit arrangement (the \"BOEA Facility\") with BOEA that provides Concord HK with up to $4,000,000 of financing, including, but not limited to trade finance and overdraft privileges. On January 11, 1994, BOEA increased the total amount available under the BOEA Facility to $4,800,000 as follows: letters of credit and standby letters of credit $3,300,000, overdraft and packing loan of $1,500,000. As of June 30, 1995, approximately $4,164,000 was utilized and approximately $636,000 was available under the BOEA Facility. Approximately $2,841,000 of the total $4,164,000 utilized, was in the form of trade finance, including but not limited to import letters of credit. The BOEA Facility, which is payable on demand, bears interest at 2% above BOEA's prime lending rate for letters of credit and 2.25% above BOEA's prime lending rate for overdraft and packing loans. At June 30, 1995 BOEA's prime lending rate was 9.0%. In connection with the BOEA Facility, Concord HK has placed a $1,075,000 time deposit with BOEA, which is included in prepaid and other current assets at June 30, 1995 and such deposit is pledged as collateral for the BOEA facility. In addition, all amounts outstanding under the BOEA Facility are guaranteed by Concord.\nIn the fourth quarter of Fiscal 1995, East Asia Finance Company, a wholly-owned subsidiary of BOEA, extended to Concord HK a five year equipment leasing facility in the amount of approximately one million dollars.\nOn June 27, 1995 the Company received a commitment letter from the BOEA to increase the amount available under the BOEA facility up to $6,375,000 as follows: letters of credit and standby letters of credit $3,600,000 overdraft and packing loan of 2,300,000, and an installment loan $475,000. The installment loan will be utilized in part to repay the current mortgage outstanding on the Hong Kong office property with the Bank of China.\nCanadian Imperial Bank of Commerce\nThe Company and Concord Canada were parties to a loan agreement with CIBC\n(the \"CIBC Facility\"). On April 18, 1994, all borrowings under the CIBC Facility were repaid by the Company.\nOther arrangements and future cash commitments\nIn connection with the acquisition of certain production equipment and intellectual property, in the three months ended September 30, 1991 the Company entered into a five year financing lease with EDS (the \"EDS Lease\"). During April 1994, the Company and EDS amended the EDS Lease and applied a $1 million certificate of deposit which had been pledged to EDS to the outstanding principal balance due under the EDS Lease. This $1,000,000 principal payment reduced the monthly payments under the EDS Lease from $114,700 to $72,048. As of June 30, 1995, the balance outstanding under the EDS Lease was approximately $673,000.\nIn connection with the upgrading of its worldwide information systems, the Company has committed to purchase hardware and software and incur other costs of approximately $670,000 for its United States and Far East operations; at June 30, 1995, approximately $516,000 of that amount had been paid. The Company anticipates incurring approximately $154,000 of additional costs for hardware, software and other related items for the balance of the Company's worldwide operations.\nIn connection with its construction activities in China, the Company anticipates incurring costs of approximately $1,250,000. [See Item 2. Properties.]\nManagement believes that the anticipated cash flow from operations together with financing from CIT and BOEA will be sufficient to fund its operating cash needs over the next twelve months.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Data and Supplemental Data.\nThe financial statements listed in Item 14(a) (1) and (2) are included in this Report beginning on page.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures.\nOn the recommendation of its Audit Committee and by action of its Board of Directors, Registrant, On May 18, 1995, terminated the engagement of the firm of Deloitte & Touche LLP (\"Deloitte & Touche\") as independent public accountants, effective immediately and appointed Ernst & Young LLP (\"Ernst & Young\") as its new independent public accountants. During the two most recent fiscal years and for the period through May 18, 1995, the Registrant has not consulted with Ernst & Young on items which (1) were or should have been subject to SAS 50 or (2) concerned the subject matter of a disagreement or reportable event with the former auditor (as described in Regulation S-K Item 304 (a)(2)).\nDeloitte & Touche's report on the Registrant's financial statements for the fiscal years ended June 30, 1994 and 1993 contained no adverse opinion or a disclaimer of opinion, nor was it qualified or modified as to uncertainty, audit scope, or accounting principles.\nIn connection with its audits for the fiscal years ended June 30, 1994 and 1993 and in the subsequent interim period preceding the termination of Deloitte & Touche's engagement and the engagement of Ernst &\nYoung, there have been no disagreements with Deloitte & Touche on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which, if not resolved to the satisfaction of Deloitte & Touche would have caused it to make a reference to the subject matter of the disagreements in connection with its report.\nNo \"Reportable event\", as defined in Regulation S-K, Item 304 (a)(1)(v) has occurred within the last two fiscal years and in the subsequent interim period preceding the termination of Deloitte & Touche.\nDeloitte & Touche furnished Registrant with a letter addressed to the Securities and Exchange Commission stating it agreed with the foregoing statements. A copy of Deloitte & Touche's letter to the Securities and Exchange Commission was filed as an exhibit to Form 8-K, dated May 18, 1995.\nPart III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Company.\nYear First Elected\/ Nominated Name of Directors Age Director Positions and Offices with the Company - ----------------- --- -------- -------------------------------------- Ira B. Lampert (1) ... 50 1993 Chairman, Chief Executive Officer, President, Chief Operating Officer and Director; Director of Concord Camera HK Limited, Concord Camera GmbH, Concord Camera UK Limited and Concord Camera France\nEli Arenberg (2) ..... 68 1988 Director\nJoel L. Gold (3) ..... 54 1991 Director\nMorris H. Gindi (4) .. 51 1988 Director\nJ. David Hakman (5) .. 54 1993 Director\nIra J. Hechler (6) ... 77 1992 Director\nKent M. Klineman (7) . 63 1993 Director\n- ------------ (1) On July 13, 1994 Ira B. Lampert was appointed to the additional positions of Chairman and Chief Executive Officer of the Company. Mr. Lampert has been President and Chief Operating Officer since June 1, 1993, and a Director of the Company since June 29, 1993. Mr. Lampert is also a director of Concord HK, Concord UK, Concord Germany and Concord France. From April 1992 through May 30, 1993, Mr. Lampert's services were made available to the Company under various consulting agreements with Whitehall Enterprises Inc. (\"WEI\"), an investment banking company for the middle-market, of which Mr. Lampert was the President since August 1990. During the 1980's through the early 1990's, Mr. Lampert also served as a director and\/or officer of Summit Ventures, Inc., and related entities which developed and managed Ascutney Mountain Resort, a year-round destination resort located in Vermont. In June 1990, Mr. Lampert filed a petition for personal bankruptcy pursuant to Chapter 11 of the Federal Bankruptcy Code which he caused to be converted to Chapter 7 in July 1993. On January 24, 1994 the Bankruptcy Court issued an order discharging Mr. Lampert. The bankruptcy resulted from contingent and other liabilities incurred in the development of Ascutney Mountain Resort. Mr. Lampert is a Board Member of the Queens College Foundation which is part of the City University of New York and is the Treasurer of the Boys Brotherhood Republic, a non-profit organization for underprivileged children in the New York City area.\n(2) Eli Arenberg joined the Company in April 1984 as Vice President of Sales and Marketing and in September 1989 was promoted to Senior Vice President of Sales. In February 1992 Mr. Arenberg retired from such positions. In July 1994 Mr. Arenberg made his services available to the Company under a consulting agreement with ELA Enterprises, Inc. (the \"ELA Enterprises Consulting Agreement\"), a Florida corporation wholly-owned by Mr. Arenberg.\n(3) Joel L. Gold is currently a managing director at Fechtor Detwiler & Co., Inc. an investment bank. From January 1992 through April, 1995 Mr. Gold was a managing director at Furman Selz Incorporated, an investment bank. From April 1990 through December 1991 Mr. Gold was a managing director at Bear, Stearns & Co. Inc., New York, New York. From April 1971 through February 1990 Mr. Gold was a managing director at Drexel Burnham Lambert. Mr. Gold is currently a member of the board of directors of Biomechanics Corporation of America, Action Industries, Inc. and Life Medical Sciences.\n(4) Morris H. Gindi is the Chief Executive Officer of Notra Trading Inc., located in Woodbridge, New Jersey, and has served in such capacity since 1983. Notra Trading Inc. is an import agent in the housewares and domestics industry. Mr. Gindi has over 26 years experience in importing.\n(5) J. David Hakman is the owner and Chief Executive Officer of Hakman and Company Inc. a merchant banking concern, and has held such position since 1980. Mr. Hakman is President of Hakman & Company, Inc., an investment banking concern and a member of the National Association of Securities Dealers, Inc., and has held such position since 1974. Mr. Hakman has been a director since 1989 and a member of the Audit and Nominating Committees since 1991 of Hanover Direct, Inc., a firm engaged in the direct marketing business. Mr. Hakman was the Chairman and a director of AFD Acquisition Corporation which filed for protection under Chapter 11 of the U.S. Bankruptcy Laws in June 1991 and emerged from Chapter 11 in September 1993.\n(6) Ira J. Hechler is a partner and a director of the investment firm Ira J. Hechler & Associates located in New York, New York. Mr. Hechler has been associated with such firm since June 1987. The firm's principal business is holding stock, partnership interests and other property for investment purposes. Mr. Hechler is currently a member of the board of directors of The Leslie Fay Companies, Inc. and United States Banknote Corporation. Mr. Hechler was appointed to the Board and given the right (since terminated) to appoint two other designees to the Board in connection with certain loans he made to the Company. The Company has agreed to indemnify Mr. Hechler and any of his nominees against certain liabilities in connection with their service on the Board pursuant to an indemnification agreement. See \"Certain Relationships and Related Transactions.\"\n(7) Kent M. Klineman is an attorney and private investor and serves as a director of several closely-held companies. He is also a general partner of ConArb Partners, L.P., a securities dealer engaged in arbitrage and trading of convertible securities for its own account. Mr. Klineman is a director, Secretary and a member of the Compensation Committee of EIS International, Inc. See \"Certain Relationships and Related Transactions.\"\nMeetings and Committees\nIn Fiscal 1995, the Board held eight meetings of which two were telephonic. The Board has an Audit Committee, a Compensation Committee, a Stock Option Committee, an Executive Committee, an Ad Hoc Committee and a Nominating Committee.\nThe Audit Committee, consisting of Kent M. Klineman (Chairman), J. David Hakman and Eli Arenberg, reviews and reports to the Board with respect to various auditing and accounting matters, including the recommendations to the Board as to the selection of the Company's independent public accountants, the scope of audit procedures, general accounting policy matters and the performance of the Company's independent public accountants. The Audit Committee held three meetings in Fiscal 1995.\nThe Compensation and Stock Option Committee, consisting of Joel L. Gold (Chairman), Ira J. Hechler, and Morris Gindi, was formed to review and make recommendations to the Board regarding all executive compensation. The Compensation Committee held two meetings in Fiscal 1995.\nThe Executive Committee, consisting of Ira B. Lampert, Kent Klineman and Ira J. Hechler, oversees the operations of the Company and has the full power of the Board when the Board is not in session.\nOn November 10, 1994 the Board established a Nominating Committee for the purpose of nominating those persons who shall be invited to stand for election to the Board of Directors as management nominees at any and all ensuing meetings of the shareholders of the Company or pursuant to any actions with respect to the election of directors to be taken by written consent of the shareholders. The Nominating Committee consists of Ira B. Lampert, Joel Gold, Ira J. Hechler and Kent Klineman. Shareholder suggestions of one or more nominees for election to the Board may be sent in writing to the Nominating Committee, Attention: Chairman, C\/O the Company, 35 Mileed Way, Avenel, New Jersey 07001.\nIn Fiscal 1995, all of the directors attended at least 75% of the aggregate of the total number of meetings of the Board and committees of which they were members.\nDirectors Compensation\nNon-employee members of the Board receive (i) an annual fee of $10,000, (ii) a $2,500 annual fee for serving on each committee of the Board with the Chairman thereof receiving a $3,500 annual fee, and (iii) a meeting fee of $750 for each meeting attended in person and $250 for each meeting attended telephonically. In addition, under the Company's Incentive Plan non-employee directors received options pursuant to a formula with certain vesting requirements to purchase up to 21,000 Common Shares. The Incentive Plan also provides for the grant of an immediately exerciseable option to purchase 1,000 Common Shares on each anniversary of the original grant.\nEXECUTIVE OFFICERS\nThe names of the current executive officers of the Company together with certain biographical information for each of them (other than Mr. Lampert for whom biographical information is provided above) is set forth below:\nName of Executive Officer Age Positions and Offices with the Company - ------------------------- --- -------------------------------------- Eli Shoer ............... 48 Senior Vice President of the Company and Managing Director of Concord HK\nGary M. Simon ........... 35 Chief Financial Officer, Secretary and Treasurer\nHarlan I. Press ......... 31 Chief Accounting Officer\nSteve Jackel ............ 59 Consultant\nEli Shoer is Senior Vice President of the Company and Managing Director of Concord HK and has held such positions since August 1994. From April 1991 to August 1994 Mr. Shoer was Director of Operations of Concord HK and managed the Company's manufacturing facilities in the Far East. Mr. Shoer worked as Senior Vice President for Operations of Keystone Camera Corporation from November 1990 through February 1991.\nGary M. Simon is Chief Financial Officer, Treasurer and Secretary of the Company. Mr. Simon has been Chief Financial Officer and Treasurer since June 1992 and was appointed Secretary in January 1994. From December 1989 through May 1992, Mr. Simon was a Vice President of Oxbridge Partners, a Merchant Bank.\nSteve Jackel's services are rendered to the Company pursuant to a consulting agreement dated May 1, 1995 between the Company and Harjac Consulting Corp., a corporation owned by Mr. Jackel. Mr. Jackel is not an employee of the Company and does not have a corporate title. His consulting activities on behalf of the Company, however, have evolved to the point where Mr. Jackel is considered to be a member of the Company's senior management team performing a policy making function. From February 1993 to 1994 Mr. Jackel was President of McCrory's Corporation and Chairman\nof McCrory Stores. From June 1992 through February 1993 he was Co-President and Chairman of McCrory Stores. From February 1991 through June 1992 he was Executive Vice President Specialty Operation for McCrory Stores. Prior to that time Mr. Jackel was an Independent Management Consultant.\nHarlan I. Press is Chief Accounting Officer and has held this position since November 1994. Mr. Press was a Senior Field Examiner for the CIT Group from April 1993 through April 1994. From December 1991 through April 1993, Mr. Press served as the Production Manager and Inventory Controller for Sandberg and Sikorski Diamond Corp., a jewelry manufacturer. Prior to then Mr. Press was a Senior Accountant in BDO Seidman's Audit Division.\nSection 16 Reporting Obligations\nThe following officers and directors of the Company filed late reports under Section 16(a) of the Securities Exchange Act of 1934, as amended (the Exchange Act\") during the period July 1, 1994 through June 30, 1995: (I) Mark Welland, former President of U.S. Branch Operations and a Vice President of the Company, late filing of a Form 4 due July 10, 1994; (ii) Gary M. Simon, Chief Financial Officer, late filing of a Form 4 due August 10, 1994; (iii) Eli Arenberg, Director, late filing of Forms 4 due August 10 and September 16, 1994; (iv) Ira B. Lampert, Chairman and CEO, late filing of a Form 4 due October 10, 1994; and (v) Harlan I. Press late filing a Form 3 due February 25, 1995. There are no known failures to file a required report for any of the Company's reporting persons during such time period.\nItem 11.","section_11":"Item 11.\nEXECUTIVE COMPENSATION\nI. SUMMARY COMPENSATION TABLE\n- -------------\n(1) Includes $53,012 paid to Mr. Benun for his auto allowance.\n(2) All options granted to Mr. Benun were canceled upon his termination on July 13, 1994.\n(3) Represents a $184,096 fee paid to Mr. Benun for his guarantee of certain loans, and reimbursement of taxes $26,580 paid to Mr. Benun for interest accrued on loans from Mr. Benun to the Company, and $9,765 paid for Mr. Benun's insurance premiums.\n(4) Represents amounts paid to Mr. Benun for certain income tax related interest and penalties which resulted from the Company being unable to timely repay loans made by Mr. Benun to the Company.\n(5) Includes 150,000 Common Shares underlying stock options which were canceled in January 1994.\n(6) Represents interest accrued on loans from Mr. Benun to the Company.\n(7) Includes $24,260 and $25,179 paid to Mr. Lampert for his auto allowance and reimbursement of taxes, respectively, and $22,210 paid for partial housing costs.\n(8) Includes $25,208 paid by the Company for insurance premiums and $21,992 paid to Mr. Lampert for consulting fees and expenses in connection with consulting services provided by Mr. Lampert pursuant to the Company's consulting agreement with WEI, which terminated upon Mr. Lampert's employment with the Company.\n(9) Includes a $60,000 housing allowance paid to Mr. Shoer for his living arrangements in the Far East.\n(10) Represents a housing allowance paid to Mr. Shoer for his living arrangements in the Far East.\n(11) Represents amount paid by the Company for insurance premiums.\n(12) Includes $25,000 paid to Mr. Welland for the Company's repurchase of his option relating to 10,000 Common Shares underlying such option.\n(13) Includes $46,558 and $102,740 paid for and to Mr. Lampert for his auto lease and costs and reimbursement of taxes respectively and $47,350 paid for partial housing costs.\n(14) Represents payment for auto allowances.\n(15) Mr. Welland resigned from the Company on July 28, 1995.\n(16) Mr. Jackel's services are rendered to the Company pursuant to a consulting agreement dated May 1, 1995 between the Company and Harjac Consulting Corp., a corporation owned by Mr. Jackel. Mr. Jackel is not an employee of the Company and he does not have any corporate title. His consulting activities on behalf of the Company, however, have evolved to the point where Mr. Jackel is considered to be a member of the Company's senior management team performing a policy making function. Therefore, the Company considers Mr. Jackel to be an officer of the Company for Securities Acts purposes. The consulting agreement has a one year term and calls for payment of consulting fees of $300,000 for the term as well as reimbursement of automobile expenses of up to $2,000 per month and reimbursement of certain insurance payments.\n(17) These options include options previously issued, cancelled, repriced and re-issued during the fiscal year.\n(18) Does not include 150,000 options contingent upon the consummation of an acquisition described in Mr. Lampert's employment agreement.\nII. OPTION GRANTS IN FISCAL 1995 [See Note 20 of Notes to the Financial Statements for Stock Purchase Awards made in August 1995].\n(1) The Company granted incentive stock options under the Company's 1988 Stock Option Plan and the Company's Incentive Plan to purchase an aggregate of 649,450 Common Shares. Mr. Lampert's options are issued pursuant to a separate plan applicable only to Mr. Lampert and are not included in the computation herein.\n(2) The market price on date of grant was either above or equal to the option price on the date of the grant.\n(3) Mr. Lampert's grant of stock options is under a separate plan and are not issued under the Company's Incentive Plan. The grant of 150,000 shares at $6.00 is contingent upon the consumation of an acquisition described in Mr. Lampert's employment agreement.\n(4) Includes options repriced during Fiscal 1995 for Messrs. Lampert, Simon and Shoer.\nIII. AGGREGATED OPTION EXERCISES IN FISCAL YEAR 1995 AND FISCAL YEAR-END OPTION VALUES\n- ------------\n(1) The closing price of the Company's Common Stock at 1995 fiscal year end was $4.44\n(2) Mr. Welland was granted options to purchase 20,000 Common Shares at an exercise price of $8.00 per share with the right to put to the Company at $10.50 per share 10,000 of such options per year. In Fiscal 1995, Mr. Welland exercised such right and the Company repurchased for Mr. Welland the option as to 10,000 Common Shares for $25,000.\nExecutive Employment Contracts, Termination of Employment and Change in Contract Arrangements\nOn July 13, 1994 the Board of Directors of the Company (the \"Board\") terminated Jack C. Benun for cause from his positions as Chairman and Chief Executive Officer and his status as a director of the Company as a result of its adoption of a report from the Ad Hoc Committee of the Board indicating that Mr. Benun had misappropriated $150,000 from the Company. Accordingly, the employment agreement between the Company and Mr. Benun executed on July 12, 1988, and amended and restated on September 15, 1993, which provided that Mr. Benun serve in the capacities of Chairman and Chief Executive Officer of the Company and be paid an annual salary of $600,000 for a term of three years, was terminated.\nThe employment agreement between the Company and Ira B. Lampert effective July 1, 1993 was amended and restated as of September 1, 1994 (the \"Lampert Agreement\"). The Lampert Agreement provides that Mr. Lampert serve in the additional capacities of Chairman and Chief Executive Officer of the Company. The Lampert Agreement provides for an annual salary of $500,000, has a term of four years and provides for automatic one year renewals, unless prior written notice is given by either party. Under the Lampert Agreement, Mr. Lampert's grant of an option to purchase 340,000 Common Shares was amended and restated to an exercise price of $4.00 per share, of which 177,500 are presently exercisable with the balance exercisable in allotments of 12,500 on each November 30, February 28 (or February 29 as the case may be), May 31 and August 31 until exercisable as to the entire amount. Such shares have anti-dilution provisions and are exercisable through July 2003. In addition, the Lampert Agreement granted Mr. Lampert an additional option to purchase 260,000 Common Shares at an exercise price of $4.00 per share, of which 97,500 are presently exercisable with the balance exercisable in allotments of 12,500 on each November 30, February 28 (or February 29 as the case may be), May 31 and August 31 until exercisable as to the entire amount. Such shares also have anti-dilution provisions and are exercisable through September 2004. The Lampert Agreement prohibits Mr. Lampert from competing with the Company for a one year period upon expiration of the Lampert Agreement. The Lampert Agreement also provides that if the Company consummates an acquisition identified in the Lampert Agreement during Mr. Lampert's term of employment with the Company, Mr. Lampert will receive a cash bonus of $300,000 and will be granted an option to purchase 150,000 Common Shares at an exercise price of $6.00 per share.\nEffective October 1, 1994, the Company entered into an employment agreement with Eli Shoer, whereby Mr. Shoer is employed as Managing Director of Operations of the Company's Far East operations and as Senior Vice President of the Company. The employment agreement has a term of three years and provides for an annual salary of $210,000. In addition, Mr. Shoer receives an annual housing allowance of $75,000. Mr. Shoer's employment agreement prohibits Mr. Shoer from competing with the Company for a one year period upon termination of such employment agreement. The agreement also provides that previous stock option agreements for an aggregate of 145,000 shares at varying prices ranging from a high of $8.875\nto a low of $4.4375 are relinquished by Mr. Shoer. In lieu of such options he was granted options for 75,000 shares at $3.25 and 75,000 shares at $4.00. This agreement supersedes the July 1, 1993 agreement between Mr. Shoer and the Company.\nEffective June 1, 1994, the Company entered into an employment agreement with Gary M. Simon whereby Mr. Simon is employed as Chief Financial Officer and Treasurer of the Company. The Agreement is for a term of three years and provides for an annual salary of $175,000. Under the Agreement Mr. Simon was granted an option to purchase 30,000 Common Shares at an exercise price of $3.00 per share, 7,500 of which are presently exercisable with the balance exercisable in allotments of 7,500 after the completion of the first, second and third years of his term of employment. In addition, Mr. Simon was granted a presently exercisable options to purchase 40,000 Common Shares at $3.00 per share; and 120,000 Common Shares at an exercise price of $4.00 per share which options vest as follows: 24,000 on June 1, 1995; 48,000 on June 1, 1996; and 48,000 on June 1, 1997. Options to purchase 50,000 Common Shares granted to Mr. Simon prior to June 1, 1994 were canceled. Mr. Simon's employment agreement prohibits Mr. Simon from competing with the Company for a one year period upon termination of such employment agreement.\nDuring the first quarter of Fiscal 1996, the Company entered into a consulting agreement with Harjac Consulting, Inc. for the services of Steve Jackel. The agreement provides for options to purchase 25,000 Common Shares at $3.00 per share and 75,000 Common Shares at $4.00 per share. [See Note 13 to the Financial Statements.]\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThe following table sets forth certain information as of August 22, 1995 with respect to (i) those persons or groups known to the Company to beneficially own more than 5% of the Common Stock, (ii) each of the directors and nominees of the Company, (iii) the Company's executive officers named in the summary compensation table, and (iv) for the Company's directors and executive officers as a group:\nName and Address of Amount and Nature of Percent Beneficial Owner Beneficial Ownership(1) of Class(1) - ------------------ ----------------------- ----------- (i) Beneficial Owners of More than 5% of the Common Shares\nJack C. Benun .......................... 556,065(7) 5.3% 80 Wickapecko Drive Allenhurst, New Jersey 07711\nTheodore H. Kruttschnitt ............... 1,205,000 11.5% 1350 Bayshore Blvd Suite 850 Burlingame, California 94010\nName and Address of Amount and Nature of Percent Beneficial Owner Beneficial Ownership(1) of Class(1) - ------------------ ----------------------- -----------\nVC Holdings, Inc.(3) .................. 927,306 8.8% 250 Park Avenue New York, New York 10017\nJack Silver ............................ 727,000(4) 6.9% c\/o Silverman, Collura & Chernis, P.L. 381 Park Avenue South New York, New York 10016\n(ii) Directors and Nominees of the Company\nIra B. Lampert ......................... 780,000(6) 7.4% Concord Camera Corp. 35 Mileed Way Avenel, New Jersey 07001\nEli Arenberg ........................... 53,500(5) * 9578 Harbour Lake Circle Boynton Beach, Florida 33437\nJoel L. Gold ........................... 31,500(5) * Fechtor & Detwiler 230 Park Avenue New York, New York 10169\nMorris Gindi ........................... 21,000(5) * Notra Trading, Inc. One Woodbridge Center Woodbridge, NJ 07095\nJ. David Hakman ........................ 21,000(5) * Hakman & Co., Inc. Suite 300 1350 Bayshore Highway Burlingame, CA 94010\nIra. J. Hechler ........................ 467,000(2) * Ira J. Hechler and Associates 45 Rockefeller Plaza New York, New York 10111\nName and Address of Amount and Nature of Percent Beneficial Owner Beneficial Ownership(1) of Class(1) - ------------------ ----------------------- ----------- Kent M. Klineman ....................... 93,400(5) * c\/o Klineman Assoc., Inc. 1270 Avenue of the Americas New York, NY 10020\n(iii) Executive Officers\nEli Shoer .............................. 150,000(5) 1.4% Concord Camera Corp. 35 Mileed Way Avenel, New Jersey 07001\nGary M. Simon .......................... 190,000(5) 1.8% Concord Camera Corp. 35 Mileed Way Avenel, New Jersey 07001\nSteve Jackel ........................... 100,000 * Concord Camera Corp. 35 Mileed Way Avenel, New Jersey 07001\nMark Welland ........................... -0- * Concord Camera Corp. 35 Mileed Way Avenel, New Jersey 07001\nHarlan Press ........................... 10,000 * Concord Camera Corp. 35 Mileed Way Avenel, New Jersey 07711\n(iv) All executive officers and\ndirectors as a group (11 Persons) ...... 1,787,400 17.0%\n- ----------- * Indicates less than 1%.\n(1) All information is as of August 22, 1995 and was determined in accordance with Rule 13d-3 under the Exchange Act based upon information furnished by the persons listed or contained in filings\nmade by them with the Commission. As of August 22, 1995, the Company had issued and outstanding 10,497,526 Common Shares, the Company's only class of voting securities outstanding. Unless otherwise indicated, beneficial ownership disclosed consists of sole voting and dispositive power.\n(2) Does not include any shares owned by any other party to the Management Agreement (as herein defined) which the Company believes is no longer effective. Mr. Benun and Mr. Hechler agreed to vote their Common Shares in accordance with the terms of the Management Agreement. See \"Certain Relationships and Related Transactions.\"\n(3) VC Holding, Inc. is the sole manager and holds 100% of the voting interests of Venture Capital Equities, L.L.C. Dominion Capital, Inc. contributed all of its interests in a specified portfolio of investments, including the above described Company securities to Venture Capital, L.L.C.\n(4) Mr. Silver's holdings include shares held by Mr. Silver or his wife for the benefit of his children and 426,000 shares held by Siar Money Purchase Plan. In addition, Mr. Silver holds warrants to purchase 73,333 shares of the Company's common stock.\n(5) Represents Common Shares underlying stock options.\n(6) Represents Common Shares underlying stock options and 30,000 shares purchased in the open market.\n(7) Based upon Mr. Benun's last filed amendment to his 13-D dated as of January 30, 1995 and notice of actual sales provided to the Company by the counsel for Mr. Benun.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nA warrant (the \"Warrant\") to purchase 1,500,000 Common Shares at an exercise price of $6.00 per share was issued to Ira J. Hechler in exchange for certain short term loans and other financial accommodations provided to the Company by Mr. Hechler during the period May 29, 1992 through December 31, 1992 (the \"Hechler Loans\"). The market value of the Warrant on the date of issuance was determined to be in the range of $.30 to $.60 per share and was amortized as a financing cost through December 31, 1992. In November 1993 Mr. Hechler exercised his right under the Warrant and purchased 900,000 Common Shares at $6.00 per share. Such exercise generated net proceeds of approximately $5,364,000 which was used to reduce debt and for working capital purposes. The Warrant for the remaining 600,000 shares expired on June 2, 1994.\nIn connection with the Hechler Loans, Mr. Hechler was appointed to the Board and given the right (since terminated) to nominate two other designees to the Board (the \"Hechler Nominees\"). The Company agreed to include these nominees as management's nominees in any proxy solicitation and to indemnify Mr. Hechler and such nominees against certain liabilities pursuant to an indemnification agreement. Mr. Hechler nominated Kent M. Klineman to the Board in 1993.\nIn connection with Mr. Hechler's purchase of Common Shares in a private placement completed on December 31, 1992 (the \"Private Placement\"),\nthe Company, Mr. Benun and Mr. Hechler entered into a certain Management Agreement, dated December 31, 1992 (the \"Management Agreement\"), which provided among other matters that (i) Mr. Benun would retain, on and after the closing of a proposed loan facility with a new lender his position as Chairman and Chief Executive Officer of the Company (Mr. Benun's employment with the Company was terminated on July 13, 1994), (ii) Mr. Benun would propose, at any Meetings to Elect Directors, a slate consisting of the Hechler Nominees, Mr. Benun and other members of whom a majority would, to the extent practical, be new \"unaffiliated\" or \"independent\" members of the Board, (iii) Mr. Benun would vote all Common Shares over which he had sole voting power on the date of the Management Agreement or acquired thereafter in favor of the Hechler Nominees for election to the Board at all Meetings to Elect Directors, (iv) Mr. Hechler would vote or cause to be voted all Common Shares over which he has sole voting power on the date of the Management Agreement or acquired thereafter and all Common Shares purchased by him or his designee in the Private Placement in favor of the Benun Nominees at all Meetings to Elect Directors, (v) neither Mr. Benun nor Mr. Hechler, Hechler & Associates or any of their respective affiliates (the \"Hechler Group\"), without the consent of two-thirds of the Board, from December 31, 1992 through December 1, 1994 would (a) solicit proxies with respect to securities of the Company or become a \"participant\" in any \"election contest\" relating to the election of directors of the Company (as such terms are used in Rule 14a-11 of Regulation 14A under the Exchange Act), or seek to advise or influence any person or entity with respect to the voting of any voting securities of the Company, (b) make any public announcement with respect to, or submit a formal proposal for a transaction between any member of the Hechler Group and the Company or any of its securities holders except proposals recommending transactions in the ordinary course of the Company's business, (c) act to seek control of management, Board or policies of the Company except in any such person's capacity as a director, or (d) form, join or participate in a group for purposes of any transactions referred to in (a), (b), or (c) above, and (vi) the Warrant be amended (a) to extend the exercise period of the Warrant until December 1, 1993, (b) to eliminate the mandatory exercise and early termination provisions of the Warrant and (c) provide that the purchase by all purchasers in the Private Placement will not trigger the anti-dilution provisions of the Warrant. The Company believes that Mr. Benun no longer has any rights under the Management Agreement to nominate directors of the Company. Mr. Benun has asserted that he continues to have such rights and intends to enforce them.\nCertain of the Company's and Concord HK's financing and credit arrangements in the past have been secured by the personal guarantees and\/or assets of Mr. Benun and Mr. Hechler. During Fiscal 1994, Mr. Benun was a guarantor of all of the Company's borrowings under the loan agreements with Midlantic National Bank and Canadian Imperial Bank of Commerce and the Bank of East Asia until their termination in March and April 1994, respectively, when such loans were repaid. Mr. Benun is currently a guarantor of the Company's borrowings under the loan agreement with The CIT Group\/Credit Finance, Inc.\nAt June 30, 1995 the Company was indebted to Mr. Benun for certain loans made by him to the Company in the principal amount of $100,000, which amount bears interest at a rate per annum equal to 2% over CIT's prime lending rate. The Company incurred approximately $11,000 in interest expense in Fiscal 1995 in connection with the loans from Mr. Benun and suspended payment of the loans because the Company believes that it has valid claims against Mr. Benun vastly in excess of said loans. The Company believes that any amounts which may otherwise have been due Mr. Benun will be offset by the amounts which Mr. Benun will be found to owe the Company when all claims by the Company against Mr. Benun are finally arbitrated or adjudicated. (See Litigation.)\nThe Company and Mr. Benun entered into and executed a Pledge Agreement on each of March 7, and April 6, 1994 to secure the prompt payment of any liability to the Company that Mr. Benun may incur as a result of the matters then under investigation. Mr. Benun was terminated as Chief Executive Officer on July 14, 1994. The Company holds 30,770 shares of the Company's Common Stock owned by Mr. Benun and pledged to the Company in connection with the Pledge Agreement.\nOn August 1, 1994 ELA Enterprises, Inc., a Company owned by Eli Arenberg, was granted an option under the Company's Incentive Plan to purchase 10,000 Common Shares at an exercise price of $3.00 per share, 10,000 Common Shares at an exercise price of $4.00 per share, and 10,000 Common Shares at an exercise price of $5.00 per share, in connection with consulting services provided by Mr. Arenberg to the Company pursuant to the ELA Enterprises, Inc. Consulting Agreement. All options previously granted to Mr. Arenberg were canceled. In addition, ELA Enterprises, Inc. will be paid at an hourly rate for consulting services provided to the Company.\nPart IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedule, and Reports on Form 8-K.\n(a) (1) and (2) Financial Statements and Financial Statement Schedule\nThe following consolidated financial statements of the Company and the notes thereto, the related reports thereon of the certified public accountants, and financial statement schedule, are filed under Item 8 of this Report:\n(a) (1) Financial Statements\nPage ---- Independent Auditors' Reports ....................................\nConsolidated Balance Sheets at June 30, 1995 and 1994 ............\nConsolidated Statements of Operations for the years ended June 30, 1995, 1994 and 1993 ...................................\nConsolidated Statements of Cash Flows for the years ended June 30, 1995, 1994 and 1993 ...................................\nConsolidated Statements of Stockholders' Equity for the years ended June 30, 1995, 1994 and 1993 .......................\nNotes to Consolidated Financial Statements .......................\n(2) Financial Statement Schedule\nSchedule II--Valuation and Qualifying Accounts and Reserves ......\nAll other financial statement schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the instructions to Item 8 or are inapplicable, and therefore have been omitted.\n(3) Exhibits:\nPage ---- 3.1 Certificate of Incorporation of the Company(1).....................\nPage ---- 3.2 Amendments to Certificate of Incorporation of the Company(1)........\n3.3 Amendment No. 4 to Certificate of Incorporation of the Company(12)..\n3.4 Restated By-Laws of the Company ....................................\n4.1 Form of Common Stock Certificate(1) ................................\n10.1 Settlement Agreement between the Company and the Commission effective September 1, 1994 ......................................\n10.2 Employment Agreement between the Company and Ira B. Lampert, dated as of July 15, 1993(16) ....................................\n10.3 Employment Agreement between the Company and Gary M. Simon dated as of June 1, 1994 .........................................\n10.4 Employment Agreement between Concord France and Jean Louis Vinant dated as of July 1, 1994 .........................................\n10.5 Employment Agreement between Concord UK and Mark Easterbrook dated as of January 1, 1994 ......................................\n10.6 Employment Agreement between the Company and Mark Welland dated as of March 1, 1993(15) ....................................\n10.7 Employment Agreement between the Company and Hans Dieter Kuehn dated as of April 1, 1993(16) ....................................\n10.8 Employment Agreement between the Company and Eli Shoer dated as of July 1, 1993(16) .....................................\n10.9 Pledge Agreement between the Company and Benun dated as of March 7, 1994(20) ....................................\n10.10 Pledge Agreement between the Company and Benun dated as of April 6, 1994(20) ....................................\n10.11 Compensation Trade Agreement between Concord HK and Shenzhen Baoan Contat Camera Factory and translation dated November 23, 1993(17) ......................................\n10.12 Processing Trade Agreement, dated October 28, 1986, between Concord Camera Enterprises Company Ltd. and Baoan County Foreign Trade Company and Concord Electronic Factory Henggang, Baoan County and translation(1) ..................................\n10.13 Filing Certificate for Joint Venture, Cooperative Venture, Compensation Trade and Foreign-Related Processing and Assembly Agreements (Contracts) issued by the Foreign economic Relations Office People's Government of Baoan County, Shenzhen November 1, 1986 and translation(1)...............................\nPage ---- 10.14 Processing and Assembly Contract, dated July 25, 1987, between Concord Camera Enterprises Company Ltd. and Baoan County Foreign Trade Company and Concord Electronic Factory, Henggang, Baoan County and translation(1) ........................\n10.15 Processing Trade Agreement, dated September 6, 1985, between Dialbright Company Limited and Baoan County Foreign Trade Company and Dialbright Electronic Factory, Henggang, Baoan County and translation(1) ..................................\n10.16 Filing Certificate for Joint Venture, Cooperative Venture, Compensation Trade and Foreign-Related Processing and Assembly Agreements (Contracts) issued by the Foreign Economic Relations Office, People's Government of Baoan County, Shenzhen on September 12, 1985 and translation(1) .........................\n10.17 Notice Concerning the Approval of Import Projects issued by the Foreign Economic Relations Office, Baoan County, Shenzhen on September 12, 1985 and translation(1) ............................\n10.18 Supplementary Agreement, dated September 27, 1985, between Dialbright Company Limited and Baoan County Foreign Trade Company and Dialbright Electronic Factory, Henggang, Baoan County and translation(1) ........................................\n10.19 Notice Concerning the Approval of Supplementary Agreement dated September 27, 1985 issued by the Foreign Economic Relations Office, Baoan County on October 4, 1985 and translation(1) .......\n10.20 Processing and Assembly Contract, dated September 27, 1985, between Dialbright Company Limited and Baoan County Foreign Trade Company and Dialbright Electronic Factory, Henggang, Baoan County and translation(1) ..................................\nPage ---- 10.21 Supplementary Agreement, dated October 30, 1985, between Dialbright Company Limited and Baoan County Foreign Trade Company and Dialbright Electronic Factory, Henggang, Baoan County and translation(1) ..................................\n10.22 Processing and Assembly Contract, dated December 17, 1985, between Dialbright Company Limited and Baoan County Foreign Trade Company and Dialbright Electronic Factory, Henggang, Baoan County and translation(1) ..................................\n10.23 Processing and Assembly Contract between Dialbright Company Limited and Baoan County Foreign Trade Company and Dialbright Electronic Factory, Henggang, Baoan County and translation(1) ....\n10.24 Supplementary Agreement, dated July 9, 1986, between Dialbright Company Limited and Baoan County Foreign Trade Company and Dialbright Electronic Factory, Henggang, Baoan County and translation(1) ...................................................\n10.25 Processing and Assembly Contract, dated July 11, 1986, between Dialbright Company Limited and Baoan County Foreign Trade Company and Dialbright Electronic Factory, Henggang, Baoan County and translation(1) ........................................\n10.26 Processing and Assembly Contract, dated August 14, 1986, between Dialbright Company Limited and Baoan County Foreign Trade Company and Dialbright Electronic Factory, Henggang, Baoan County and translation(1) ..................................\n10.27 Supplementary Agreement, dated August 26, 1986, between Dialbright Company Limited and Baoan County Foreign Trade Company and Dialbright Electronic Factory, Henggang, Baoan County and translation(1) ........................................\n10.28 Agreement for the Provision of Land, Management Services and Labor between Company and Wan Kong Economic Development Corporation of Baoan County, dated July 10, 1988 (English Translation with Chinese Original attached)(2) ...................\n10.29 Agreement between Dialbright and Development Corporation, Baoan County, dated September 23, 1988(2) ........................\nPage ---- 10.30 Agreement between Dialbright and Henggang Economic Development Corporation, dated September 23, 1988 and translation(2) .........\n10.31 Construction Works Contract between Concord Factory Henggang and Henggang Economic Development Corporation dated February 25, 1989 and translation(2) .............................\n10.32 Agreement between Concord HK and Baoan Henggang Joint Stock Investment Company, Ltd., dated February 15, 1993 and translation(14) ..................................................\n10.33 Contract for the Utilization of Land in Factory Construction between Concord HK and Henggang Investment Holdings Limited dated June 20, 1994 and translation ..............................\n10.34 Supplemental Agreement to the Contract for the Utilization of Land in Factory Construction between Concord HK and Henggang Investment Holdings Limited dated June 20, 1994 and translation ..................................................\n10.35 Loan and Security Agreement between the Company, Concord-Keystone Sales Corp. and CIT dated March 30, 1994(19) ....\n10.36 Loan Agreement between Concord HK and BOEA dated June 15, 1993(16) .\n10.37 Amendment to Loan Agreement between Concord HK and BOEA dated January 11, 1994(18) .............................................\n10.38 Incentive Plan, effective November 29, 1993 ........................\n10.39 Amended and restated 1988 Stock Option Plan(14) ....................\n10.40 Letter of intent to form a joint venture with Hungarian Optical Works, Fine Mechanical and Optical Ltd. and the Hungarian Credit Bank Ltd.(3) ....................................\n10.41 Deed of Association of Concord-MOM Camera Manufacturing and Trading -- Limited Liability Company, dated April 24, 1990(4) ....\n10.42 Employment Agreement between Concord Canada and Saul Ehrentreu dated March 1, 1990(4) ...........................................\n10.43 Lease Agreement dated May 21, 1991, between EDS and the Company(6) ...................................................\nPage ---- 10.44 Security Agreement dated May 21, 1991, between EDS and the Company(6) .......................................................\n10.45 Amendment to Equipment Lease Agreement between EDS and the Company executed on April 6, 1994(20) ............................\n10.46 Purchase Agreement, dated May 29, 1992, between the Company and Ira J. Hechler, with exhibits(12) ............................\n10.47 Management, Voting, Warrant Extension and Standstill Agreement, dated December 31, 1992, among the Company, Jack C. Benun and Ira J. Hechler(14) .............................\n10.48 Extension and Amendment of Lease dated January 28, 1991, by and between Howard H. Gelb and Eunice Gelb and the Company(14) ...\n10.49 Second Extension and Amendment of Lease dated December 23, 1993 by and between Howard H. Gelb and Eunice Gelb and the Company ..........................................................\n10.50 Third Extension and Amendment of Lease dated April 18, 1994 by and between Howard H. Gelb and Eunice Gelb and the Company ..........................................................\n10.51 Employment Agreement between the Company and Eli Shoer dated as of October 1, 1994(21) ........................................\n10.52 Employment Agreement between the Company and Gary Kaess dated as of November 1994(21) ....................................\n10.53 Amended and Restated Employment Agreement between Concord Camera HK Limited and Arthur Zawodny dated as of October 21, 1994(21) .........................................................\n10.54 Consulting Agreement between the Company and Harjac Consulting, Inc., dated as of May 1, 1995 ....................................\n16 Letter of Deloitte & Touche LLP regarding change in the Company's auditors(22) ...........................................\n21. List of Subsidiaries of Company(13) ................................\n27. Financial Data schedule\nThe Financial Statement Schedules required to be filed pursuant to this Item 14(d) are listed above.\nFOOTNOTES:\n(1) This document has been previously filed with the Securities and Exchange Commission as an Exhibit to Company's Registration Statement on Form S-18 (No. 33-21156), declared effective July 12, 1988, and is incorporated herein by reference.\n(2) This document has been previously filed with the Securities and Exchange Commission as an Exhibit to Company's annual report on Form 10-K for the fiscal year ended June 30, 1989 and is incorporated herein by reference.\n(3) This document has been previously filed with the Securities and Exchange Commission as an Exhibit to Company's Registration Statement on Form S-1, filed with the Commission on November 1, 1989, and is incorporated herein by reference.\n(4) This document has been previously filed with the Securities and Exchange Commission as an Exhibit to Company's annual report on Form 10-K for the fiscal year ended June 30, 1990 and is incorporated herein by reference.\n(5) This document has been previously filed with the Securities and Exchange Commission as an Exhibit to Company's quarterly report on Form 10-Q, for the fiscal quarter ended March 31, 1991 and is incorporated herein by reference.\n(6) This document has been previously filed with the Securities and Exchange Commission as an Exhibit to Company's Report on Form 8-K dated May 21, 1991 and is incorporated herein by reference.\n(7) This document has been previously filed with the Securities and Exchange Commission as an Exhibit to Company's annual report on Form 10-K for the fiscal year ended June 30, 1991 and is incorporated herein by reference.\n(8) This document has been previously filed with the Securities and Exchange Commission as an Exhibit to Company's quarterly report on Form 10-Q for the fiscal quarter ended September 30, 1991 and is incorporated herein by reference.\n(9) This document has been previously filed with the Securities and Exchange Commission as an Exhibit to Company's quarterly report on Form 10-Q for the fiscal quarter ended December 31, 1991 and is incorporated herein by reference.\n(10) This document has been previously filed with the Securities and Exchange Commission as an Exhibit to Company's Registration Statement on Form S-3 (No. 33-43853), declared effective January 17, 1992, and is incorporated herein by reference.\n(11) This document has been previously filed with the Securities and Exchange Commission as an Exhibit to Company's quarterly report on Form 10-Q for the fiscal quarter ended March 31, 1992 and is incorporated herein by reference.\n(12) This document has been previously filed with the Securities and Exchange Commission as an Exhibit to Company's interim report on Form 8-K dated May 29, 1992 and is incorporated herein by reference.\n(13) This document has been previously filed with the Securities and Exchange Commission as an Exhibit to Company's annual report on Form 10-K for the fiscal year ended June 30, 1992 and is incorporated herein by reference.\n(14) This document has been previously filed with the Securities and Exchange Commission as an Exhibit to the Company's Registration Statement on Form S-1 (33-59398), filed with the Commission on March 11, 1993, and is incorporated herein by reference.\n(15) This document has been previously filed as Exhibit 10.46 to Amendment No. 2 to the Company's Registration Statement on Form S-1, filed June 1, 1993, and is incorporated herein by reference.\n(16) This document has been previously filed with the Securities and Exchange Commission as an Exhibit to the Company's annual report on Form 10-K for the fiscal year ended June 30, 1993 and is incorporated herein by reference.\n(17) This document has been previously filed with the Securities and Exchange Commission as an Exhibit to the Company's interim report on Form 8-K dated November 23, 1993 and is incorporated herein by reference.\n(18) This document has been previously filed with the Securities and Exchange Commission as an Exhibit to the Company's quarterly report on Form 10-Q for the fiscal quarter ended December 31, 1993 and is incorporated herein by reference.\n(19) This document has been previously filed with the Securities and Exchange Commission as an Exhibit to the Company's interim report on Form 8-K dated March 30, 1994 and is incorporated herein by reference.\n(20) This document has been previously filed with the Securities and Exchange Commission as an Exhibit to the Company's quarterly report on Form 10-Q for the fiscal quarter ended March 31, 1994 and is incorporated herein by reference.\n(21) This document has been previously filed with the Securities and Exchange Commission as an Exhibit to the Company's quarterly report on Form 10-Q for the Fiscal period ended March 31, 1995 and is incorporated herein by reference.\n(22) This document has been previously filed with the Securities and Exchange Commission as an Exhibit to the Company's current report on Form 8-K dated May 18, 1995.\nINDEPENDENT AUDITORS' REPORT\nBoard of Directors and Shareholders of Concord Camera Corp. Avenel, New Jersey\nWe have audited the balance sheet of Concord Camera Corp. and subsidiaries as of June 30, 1995, and the related statements of operations, shareholders' equity, and cash flows for the year then ended. Our audit also included the financial statement schedule listed in the Index in Item 14(a)(2). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audit.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Concord Camera Corp. and subsidiaries as of June 30, 1995 and the consolidated results of their operations and their cash flows for the year then ended in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, 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.\nErnst & Young LLP\nMetroPark, New Jersey August 23, 1995\nINDEPENDENT AUDITORS' REPORT\nBoard of Directors and Shareholders of Concord Camera Corp. Avenel, New Jersey\nWe have audited the accompanying consolidated balance sheets of Concord Camera Corp. and subsidiaries as of June 30, 1994 and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the two years in the period ended June 30, 1994. Our audits also included the financial statement schedule listed in the Index in Item 14. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, such consolidated financial statements present fairly, in all material respects, the consolidated financial position of Concord Camera Corp. and its subsidiaries as of June 30, 1994 and the results of their operations and their cash flows for each of the two years in the period ended June 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.\nDeloitte & Touche LLP Parsippany, New Jersey\nSeptember 23, 1994\nPART I. FINANCIAL INFORMATION\nItem 1. Financial Statements\nConcord Camera Corp.\nConsolidated Balance Sheets\nJune 30, ----------------------------- 1995 1994 ----------- -----------\nCurrent assets:\nCash ....................................... $ 4,533,216 $ 3,394,658 Accounts Receivable, net ................... 8,589,790 8,489,661 Inventories ................................ 18,865,323 19,107,018 Prepaid expenses and other current assets... 2,494,559 2,610,127 ----------- ----------- Total current assets ....................... 34,482,888 33,601,464 Plant and equipment, net ................... 10,802,688 10,306,659 Goodwill, net .............................. 1,678,629 1,728,783 Investment in joint ventures ............... 91,984 168,634 Other assets ............................... 3,132,566 2,377,018 ----------- ----------- Total assets ............................... $50,188,755 $48,182,558 =========== ===========\nCurrent liabilities:\nShort-term debt ............................ $ 5,742,063 $ 3,708,976 Current portion of long-term debt .......... 24,836 23,646 Current obligations under capital leases ... 788,165 877,998 Accounts payable ........................... 6,993,857 5,436,932 Accrued expenses ........................... 2,902,282 1,947,521 Income taxes payable ....................... 294,584 184,471 Due to officer ............................. 0 100,000 Other current liabilities .................. 305,175 207,333 ----------- ----------- Total current liabilities .................. 17,050,962 12,486,877\nSee accompanying notes to consolidated financial statements\nJune 30, ----------------------------- 1995 1994 ----------- -----------\nDeferred income taxes ...................... $ 484,842 $ 09,190 Long-term debt ............................. 264,432 3,284,534 Obligations under capital leases ........... 123,626 713,721 Other long term liabilities ................ 648 133,011 ----------- ----------- Total liabilities .......................... 17,924,510 17,127,333 ----------- -----------\nStockholders' equity:\nCommon stock, no par value, 20,000,000 authorized; 10,490,526 issued as of June 30, 1995 and 1994 ................... 36,935,174 36,935,174 Paid in capital ............................ 850,786 850,786 Deficit .................................... (5,068,796) (6,277,816) ----------- ----------- 32,717,164 31,508,144 Less: treasury stock, at cost; 63,553 shares ............................... (452,919) (452,919) ----------- ----------- Total stockholders' equity ................. 32,264,245 31,055,225 ----------- ----------- Total liabilities and stockholders' equity.. $50,188,755 $48,182,558 =========== ===========\nSee accompanying notes to consolidated financial statements.\nConcord Camera Corp.\nConsolidated Statements of Operations\nSee accompanying notes to consolidated financial statements.\nConcord Camera Corp.\nConsolidated Statements of Cash Flows\nSee accompanying notes to consolidated financial statements\nSee accompanying notes to consolidated financial statements.\nSee note 17 -- Supplemental disclosure of cash flow information.\nConcord Camera Corp.\nConsolidated statements of stockholders' equity\nSee accompanying Notes to consolidated financial statements\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1 -- BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:\nPrinciples of Consolidation\nThe accompanying consolidated financial statements include the accounts of Concord Camera Corp. (\"Concord\") and its wholly-owned subsidiaries, Concord Camera HK Limited (\"Concord HK\") (formerly Dialbright Company Limited) a Hong Kong corporation, Concord Camera GmbH (\"GmbH\") Concord Camera Canada Corp. (\"Canada\") Concord Camera UK Ltd. (\"UK\"), Starprint Corporation (\"Starprint\"), Concord-Keystone Sales Corp. (\"Concord Keystone\"), Concord Holding Corp. (\"Concord Holding\"), Concord Camera Illinois Corp. (\"Concord Illinois\"), Concord Camera (Panama) Corp. (\"Panama\") commencing operations 1992, Concord Camera (Hungary) (\"Concord Hungary\") commencing operations 1994, and Concord Camera France SARL (\"France\") commencing operations 1995 (collectively, the \"Company\"). All material intercompany balances and transactions have been eliminated.\nThe Company ceased the operations of Starprint and Concord Camera Canada Corp. during February of 1992 and June 1995, respectively as part of its plan to consolidate its worldwide operations and focus more closely on its core business. The Company will continue to service customers throughout Canada through Concord Illinois.\nNature of Business\nThe Company is engaged in the design, manufacture, marketing and worldwide distribution of cameras and related accessories. Substantially all of the Company's products are assembled in the People's Republic of China (\"PRC\"). The consolidated sales to two customers in fiscal 1995 and 1994 amounted to approximately $15,759,000 (25.4%) and $12,176,000 (22.2%), respectively. The Company believes that the loss of such customers would not have a material effect on the Company and its subsidiaries taken as a whole. No other customer accounted for 10% or more of consolidated sales during the years ended June 30, 1995, 1994, and 1993.\nReclassifications\nCertain Fiscal 1994 amounts have been reclassified to conform with the Fiscal 1995 presentation.\nInventories\nInventories are stated at the lower of cost or market. Cost is determined on the first-in, first-out basis.\nEarnings (Loss) Per Share\nCommon stock equivalents were not included in the calculation of income\n(loss) per share for the fiscal years ended June 30, 1995, 1994, and 1993 because their effect was anti-dilutive.\nProperty, Plant and Equipment\nProperty, plant and equipment are stated at cost. Depreciation and amortization are computed based upon the estimated useful lives of the respective assets, using accelerated methods for income tax purposes and the straight-line method for financial reporting purposes. Small tools and accessories used in production in the PRC are charged to operations when purchased.\nIntangible Assets\nCost in excess of net assets acquired (goodwill) is being amortized on a straight-line basis over fifteen years. Accumulated amortization at June 30, 1995 and 1994 for such intangible asset is approximately, $816,000 and $658,000, respectively.\nForeign Currency Remeasurement\nThe Company operates on a worldwide basis and its results may be adversely or positively affected by fluctuations of various foreign currencies against the U.S. Dollar, specifically, the Canadian Dollar, German Mark, British Pound Sterling, Hungarian Forints, French Francs, and Japanese Yen. Each of the Company's foreign subsidiaries purchases its inventories in U.S. Dollars and sells them in local currency, thereby creating an exposure to fluctuations in foreign currency exchange rates. Certain components needed to manufacture cameras are priced in Japanese Yen. The translation from the applicable currencies to U.S. dollars is performed for balance sheet accounts using current exchange rates in effect at the balance sheet date and for revenue and expense accounts using a weighted average exchange rate during the period. Gains or losses resulting from foreign currency transactions are included in \"Other expense, net\" in the Consolidated Statements of Operations. For the fiscal years ended June 30, 1995, 1994, and 1993, consolidated other income includes approximately $57,000, $22,000, and $893,000, respectively, of net foreign currency losses from remeasurement.\nForward Exchange Contracts\nDuring the fiscal years ended June 30, 1995, 1994 and 1993, the Company's hedging activities were immaterial and, as of June 30, 1995, there were no forward exchange contracts outstanding. The Company continues to analyze the benefits and costs associated with hedging against foreign currency fluctuations.\nIncome Taxes\nThe Company adopted Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes\", effective July 1, 1993. This statement supersedes Statement of Financial Accounting Standards (SFAS) No. 96, \"Accounting for Income Taxes\". The adoption of SFAS No. 109 had no effect on\nthe Company's financial results as of July 1, 1993.\nRevenue Recognition\nRevenues are recorded when the product is shipped to a customer, net of appropriate reserves for returns.\nNOTE 2 -- ACCOUNTS RECEIVABLE:\nAccounts receivable consist of the following:\nJune 30, ---------------------------- 1995 1994 ----------- -----------\nTrade accounts receivable ...................... $ 9,631,561 $10,123,835\nLess: Allowance for doubtful accounts, discounts and allowances ..................... (1,041,771) (1,634,174) ----------- ----------- $ 8,589,790 $ 8,489,661 =========== ===========\nNOTE 3 -- INVENTORIES:\nInventories are comprised of the following:\nJune 30, ---------------------------- 1995 1994 ----------- -----------\nRaw materials and components ................... $ 7,162,899 $ 5,648,318\nFinished goods ................................. 11,702,424 13,458,700 ----------- ----------- $18,865,323 $19,107,018 =========== ===========\nNOTE 4 -- NOTE RECEIVABLE:\nDuring the fiscal year ended June 30, 1991, the Company purchased certain assets which bear the ARGUS and SAFARI trade names, formerly belonging to Optex, Inc. Effective March 31, 1992, the Company sold the rights to the ARGUS trademark and trade name in Mexico and the United States. Of the $500,000 sales price, $200,000 was paid in cash and the $300,000 balance was paid by a note (the \"Argus Note\") payable in monthly installments over a three year period through July 1995 and bearing interest at 5% per annum. Argus failed to comply with certain payment and other terms in the purchase agreement and the Company declared a default under such agreement. The Company agreed to settle all outstanding obligations between Concord and Argus Industries, Inc. for a payment in the amount of $68,371 from Argus. Said amount was paid in full in the first quarter of Fiscal 1996.\nIncluded in other assets as of June 30, 1995 is a note receivable for approximately $431,000 from Shenzhen Baoan Contat Camera Factory, a Chinese Company in settlement of an account receivable. The note is payable in equal annual installments over five years and bears interest at 4% per annum.\nNOTE 5 -- PLANT AND EQUIPMENT:\nPlant and equipment consist of the following:\nJune 30, ------------------------------ 1995 1994 ------------- -------------\nBuilding and building under capital lease .... $ 2,685,278 $ 1,864,583\nEquipment and equipment under capital lease .. 12,371,625 11,306,291\nOffice furniture and equipment ............... 2,449,385 2,256,511\nAutomobiles .................................. 110,486 89,910\nLeasehold improvements ....................... 1,382,089 1,356,802 ------------- ------------- 18,998,864 16,874,097 Less: Accumulated depreciation and amortization ............................... (8,196,176) (6,567,438) ------------- ------------- $ 10,802,688 $ 10,306,659 ============= =============\nNOTE 6 -- INVESTMENT IN JOINT VENTURES:\nDuring the fiscal years 1991 through 1993, Concord HK maintained a 50% ownership interest in as many as eight joint ventures (the \"Ventures\"), the operations of which were based in the PRC and\/or Hong Kong. Such Ventures provided various production materials and\/or services to Concord HK. The Company has over the past several fiscal years, purchased the remaining ownership interest of the joint ventures whose operations were most significant to the Company's manufacturing process. In addition, over the past several fiscal years, the Company has sold or liquidated, or is in the process of liquidating, the other joint ventures (See Note 10 -- Asset Acquisition and Disposition). The acquisition or disposition of such joint ventures is consistent with the Company's objective to consolidate its manufacturing operations in the PRC in order to better control manufacturing costs and quality of component parts produced. As of June 30, 1995, there were no active joint ventures.\nConcord maintains a 50% ownership interest in a joint venture in Budapest, Hungary. During the quarter ended March 31, 1994 and because of the financial instability of its joint venture partners, such joint venture ceased its operations. The remaining assets and liabilities of this joint\nventure is being liquidated which liquidation is anticipated to be completed in Fiscal 1996. The Company has recorded provisions for any losses it may sustain as a result of the liquidation.\nThe Company continued its activities in Hungary through a wholly-owned subsidiary from the fourth quarter of Fiscal 1994 through the first quarter of Fiscal 1996. The Company has decided to transition its sales activities in Hungary to an independent sales representative. The Company has recorded provisions for any losses it may sustain as a result of the liquidation.\nSummarized combined financial information for unconsolidated joint ventures is as follows (in 000's):\nJune 30, ---------------------- 1995 1994 1993 ---- ---- ---- Balance sheet:\nCurrent assets .................................. $125 $176 $206\nNoncurrent assets ............................... 2 2 2\nCurrent liabilities ............................. 102 134 224\nNoncurrent liabilities .......................... -- -- --\nJune 30, ---------------------- 1995 1994 1993 ---- ---- ----\nIncome Statement:\nGross revenues .................................. $ 2 $270 $ 227\nGross profit .................................... 1 167 19\nIncome (loss)from continuing operations ......... (11) 50 (219)\nNet income (loss) ............................... $ (11) $ 50 $(219)\nNOTE 7 -- SHORT-TERM DEBT:\nShort Term Debt is Comprised of:\nJune 30, (in 000's) --------------------- 1995 1994 --------- ---------\nThe Bank of East Asia -- NY .................... $ 547 --\nThe CIT Group\/Credit Finance ................... 2,214 $ 947\nThe Bank of East Asia -- HK .................... 2,841 2,762\nOther .......................................... 140 -- ------ ------\n$5,742 $3,709 ====== ======\nThe Bank of East Asia, Limited New York (\"BOEA NY\")\nOn December 20, 1994, the Company obtained a one year, $1,500,000 revolving credit facility with BOEA NY which expires on December 20, 1995. The BOEA NY Facility is secured by certain accounts receivable of the Company's Hong Kong operations and bears interest at 2% above BOEA NY's prime lending rate, which was 9.0% at June 30, 1995. Availability under the BOEA NY Facility is subject to advance formulas based on eligible accounts receivable with no minimum borrowing. At June 30, 1995, approximately $547,000 was outstanding and classified as short-term debt under the BOEA NY Facility.\nOn September 20, 1995, the Company executed an amendment to its revolving line of credit with BOEA NY to increase the credit facility to $3,000,000. The closing of the amendment is contingent on the delivery of certain closing documents.\nThe CIT Group\/Credit Finance, Inc (\"CIT\")\nOn March 30, 1994, the Company obtained a two year $10,000,000 credit facility with CIT (the \"CIT Facility\") which expires on March 29, 1996. The CIT Facility is secured by accounts receivable inventory and other related assets of the Company's United States operations and bears interest at 2% above CIT's prime lending rate, which was 9.0% at June 30, 1995. Availability under the CIT Facility is subject to advance formulas based on eligible inventory and accounts receivable with minimum borrowing of $2,000,000. At June 30, 1995, approximately $2,214,000 was outstanding and classified as short-term debt under the CIT Facility.\nBank of East Asia, Limited (\"BOEA\") -- Hong Kong\nEffective August 2, 1993, Concord HK entered into a credit arrangement (the \"BOEA Facility\") with BOEA that provides Concord HK with up to $4,000,000 of financing, including, but not limited to trade finance and overdraft privileges. On January 11, 1994, BOEA increased the total amount available\nunder the BOEA Facility to $4,800,000 as follows: letters of credit and standby letters of credit $3,300,000, overdraft and packing loan of $1,500,000. As of June 30, 1995, approximately $4,164,000 was utilized and approximately $636,000 was available under the BOEA Facility. Approximately $2,841,000 of the total $4,164,000 utilized, was in the form of trade finance, including but not limited to import letters of credit. The BOEA Facility, which is payable on demand, bears interest at 2% above BOEA's prime lending rate for letters of credit and 2.25% above BOEA's prime lending rate for overdraft and packing loans. At June 30, 1995 BOEA's prime lending rate was 9.0%. In connection with the BOEA Facility, Concord HK has placed a $1,075,000 time deposit with BOEA, which is included in prepaid and other current assets at June 30, 1995 and such deposit is pledged as collateral for the BOEA facility. In addition, all amounts outstanding under the BOEA Facility are guaranteed by Concord.\nIn the fourth quarter of Fiscal 1995, East Asia Finance Company, a wholly-owned subsidiary of BOEA, extended to Concord HK a five year equipment leasing facility in the amount of approximately one million dollars.\nOn June 27, 1995 the Company received a commitment letter from the BOEA to increase the amount available under the BOEA facility up to $6,375,000 as follows: Letters of credit and standby letters of credit $3,600,000, overdraft and packing loan of $2,300,000, and an installment loan $475,000. The installment loan will be utilized in part to repay the current mortgage outstanding on the Hong Kong Office property with the Bank of China.(See Note 8 - -- Long-term Debt.)\nNOTE 8 - LONG-TERM DEBT:\nLong-term debt consists of the following:\nJune 30, ---------------------- 1995 1994 -------- ---------- Long-term portion of CIT facility, payable on March 29, 1996 and bearing interest at 2% above CIT's prime lending rate (9.0% at June 30, 1995) ...................... -- $3,000,000\nMortgage with Bank of China, payable through May 2004, monthly payments of $2,100, plus interest at bank's prime lending rate (9.0% at June 30, 1995), plus 1% secured by property with an approximate net book value of $462,000 at June 30, 1995 ..................................... $289,268 308,180 -------- ---------- 289,268 3,308,180 Current portion of long-term debt ................... (24,836) (23,646) -------- ---------- Long-term portion ................................... $264,432 $3,284,534 ======== ==========\nFuture maturities of long-term debt, exclusive of capital lease obligations, are as follows:\nFiscal year:\n1996 .................... $ 24,836 1997 .................... 24,836 1998 .................... 24,836 1999 .................... 24,836 2000 .................... 24,836 Thereafter .............. 140,252 -------- $264,432 ========\nNOTE 9 -- ASSET ACQUISITIONS AND DISPOSITIONS:\nDuring Fiscal 1994, Concord HK sold its 60% interest in a joint venture for approximately $381,000 to its former joint venture partner. Of the total consideration paid, approximately $180,000 was in the form of lens making machinery and the balance in cash. The Company will continue to manufacture, at its production facility in the PRC, the hybrid and plastic lenses previously supplied by this joint venture. The Company has recorded provisions for losses and costs associated with the liquidation of the inactive subsidiaries and joint ventures in Hong Kong.\nNOTE 10 -- COMMON STOCK:\nThe Company's Incentive Plan, permits the Compensation Committee of the Company's Board of Directors to grant a variety of common stock awards and provides for a formula plan for annual grants to non-employee directors. The maximum number of shares of common stock available for awards under the Incentive Plan is 2,000,000. Upon the adoption of the Incentive Plan, the Company's 1988 Stock Option Plan was terminated except with respect to any unexercised options outstanding thereunder.\nStock option activity is as follows:\nAt June 30, 1995, 1,193,800 are available for future grants. [See Note 20 for a description of Common Stock purchase awards made pursuant to the Incentive Plan in August 1995.]\nAn aggregate of 1,000,000 shares of the Company's common stock are subject to options which were granted under the Company's stock option plan for Jack C. Benun, formerly Chairman and Chief Executive Officer, (the \"Benun Plan\") at prices ranging from $5.00 - $12.00. On July 14, 1994, all of such options were cancelled in connection with Benun's termination. (See Note 14--Litigation and Settlements.)\nAs of June 30, 1995, the Company had the following options and warrants outstanding:\nWarrants to purchase 15,000 and 50,000 shares of the Company's common stock at per share exercise prices of $5.75 and $6.00, respectively, were issued in connection with certain consulting services provided to the Company by Jack Silver. The warrant to purchase 15,000 shares expires on March 31, 1997 and the warrant to purchase the 50,000 shares expires on December 13, 1995.\nPursuant to his amended employment agreement, 600,000 shares of the Company's common stock are subject to options which were granted to Ira B. Lampert, Chairman and Chief Executive Officer, (\"Lampert\") at an exercise price of $4.00 per share. An additional 150,000 shares of the Company's common stock are subject to options which will be granted to Lampert contingent upon the consummation of an acquisition described in Mr. Lampert's amended employment agreement at an exercise price of $6.00 per share.\nAs of June 30, 1995, a total of 3,033,400 shares of common stock have been reserved for issuance.\nNOTE 11 -- INCOME TAXES:\nFor financial reporting purposes, pre-tax income (loss) consists of the following:\nJune 30, --------------------------------------------- 1995 1994 1993 -------- --------- --------- (In 000's)\nUnited States ................. $ (4,024) $ (4,141) $ (6,651) Foreign ....................... 5,340 3,320 (685) -------- --------- --------- $ 1,316 $ (821) $ (7,336) ======== ========= =========\nThe provision for income taxes principally related to foreign operations is comprised of the following:\nJune 30, --------------------------------------------- 1995 1994 1993 -------- --------- --------- Current ....................... $ 94,475 $ (62,894) $ 98,788 Deferred ...................... 12,515 185,944 198,893 -------- --------- --------- $106,990 $ 123,050 $ 297,681 ======== ========= =========\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 carryforwards. The tax effects of significant items comprising the Company's net deferred tax liability as of June 30, 1995 are as follows:\nThe tax effects of significant items comprising the Company's net deferred tax liability as of June 30, 1994 were as follows:\nIn May 1992, the Hong Kong Inland Revenue Department notified Concord HK that its annual tax rate had been reduced from 16.5% to 8.25% from April 1, 1990 to June 30, 1992 and that its annual tax rate commencing July 1, 1992 will be 8.75%. The Company currently does not pay taxes or import\/export duties in the PRC, but there can be no assurance that the Company will not be required to pay such taxes or duties in the future.\nThe Company has never paid any income or turnover tax to the PRC on account of its business activities in the PRC. Existing PRC statutes can be construed as providing for a minimum of 10% to 15% income tax and a 3% turnover tax on the Company's business activities; however, the PRC has never attempted to enforce those statutes. The Company has been advised that the PRC's State Tax Bureau is reviewing the applicability of those statutes to processing activities of the type engaged in by the Company, but it has not\nyet announced any final decisions as to the taxability of those activities. After consultation with its tax advisors, the Company does not believe that any tax exposure it may have on account of its operations in the PRC will be material to its financial condition.\nThe Company does not provide U.S. Federal income taxes on undistributed earnings of its foreign subsidiaries as it intends to permanently reinvest such earnings. Undistributed earnings of its foreign subsidiaries approximated $15 million dollars as of June 30, 1995. It is not practicable to estimate the amount of tax that might be payable on the eventual remittance of such earnings. Upon eventual remittance, no withholding taxes will be payable.\nAs of June 30, 1995, Concord had net operating loss carryforwards for U.S. tax purposes of approximately $14,732,000 which expire as follows: $1,586,000 in 2005; $16,000 in 2006; $444,000 in 2007; $6,630,000 in 2008 and $2,770,000 in 2009, and $3,280,000 in 2010. Losses for state tax purposes begin to expire in 1997.\nThe realization of the deferred tax assets relate directly to the Company's ability to generate taxable income for certain foreign and U.S. federal and state tax purposes. Management is not able to conclude that realization of these deferred tax assets is more likely than not as a result of the Company's earnings history. Reductions to the valuation allowance will be recorded when, in the opinion of management, the Company's ability to generate taxable income in these jurisdictions is more certain.\nA reconciliation of income tax expense computed at the statutory U.S. Federal rate to the actual provision for income taxes is as follow:\nNOTE 12--RESEARCH AND DEVELOPMENT:\nThe Company's products are created, designed and engineered principally in Hong Kong by its engineers. The Company expended approximately $598,000,\n$1,021,000, and $2,100,000 during the fiscal years ended June 30, 1995, 1994 and 1993, respectively, for product design and development (including redesign and redevelopment). The large increase in Fiscal 1993 is due to the significant development costs incurred with respect to the Company's new single use and traditional 35 millimeter cameras.\nNOTE 13--COMMITMENTS AND CONTINGENCIES:\nIn connection with the acquisition of certain production equipment and intellectual property in Fiscal 1991, the Company secured a five year financing lease from EDS Financial Corporation (\"EDS\"), a division of Electronic Data Systems Corporation. During April 1994, the Company re-negotiated the original terms of the lease with EDS. Such renegotiation included the application of the $1,000,000 certificate of deposit which was pledged to EDS as collateral under the lease to the outstanding principal balance. The $1,000,000 principal payment reduced the monthly lease payment from $114,700 to $72,048. All other terms under the lease remain the same. As of June 30, 1995 the balance outstanding with respect to such lease approximated $673,000.\nConcord leases its corporate office and warehouse facilities which, under the current lease terms, expires in December 1997. The lease requires monthly payments of approximately $15,000 and also requires the Company to pay the related real estate taxes. The Company is currently reviewing its requirements for both administrative and warehouse space.\nThe Company also leases various office equipment which have been classified as capital leases. The initial terms of such capital leases range from three to five years and expire at various times through 1997. Monthly payments on those leases range from approximately $70 to $3,300.\nThe following is a summary of assets under capitalized leases:\nJune 30, ------------------------------ 1995 1994 ---------- -----------\nAssets under capitalized leases ............. $4,436,392 $ 4,868,061 Less: accumulated amortization .............. (1,009,398) (916,717) ---------- ----------- $3,426,994 $ 3,951,344 ========== ===========\nFuture minimum rental payments are as follows:\nOperating Leases Capital Leases ---------------- -------------- Fiscal year: 1996 ....................... $ 670,180 $ 869,013 1997 ....................... 451,465 82,857 1998 ....................... 225,082 52,665 1999 ....................... 23,195 21,828 2000 ....................... 15,155 9,095 Thereafter ................. 92,195 -- ---------- ---------- 1,035,458\nTotal minimum payments ..... 1,477,272 ========== Less: Amount representing interest ................... (123,667) ---------- Present value of net minimum lease payments .......... $ 911,791 ==========\nThe effective interest rates on capital leases range from approximately 12% to 14%. Rental expense for operating leases of approximately $1,033,000, $1,004,000, and $957,000 was incurred for fiscal years ended June 30, 1995, 1994 and 1993, respectively.\nThe Company has employment agreements with certain of its key employees. The agreements are for periods of one to four years and expire at various dates through fiscal 1999. Under the terms of such employment arrangements, the Company is committed to pay annual salaries of approximately $1,481,000, $1,240,000 and $675,000 and $83,000 for the fiscal year ending June 30, 1996, 1997, 1998 and 1999, respectively. Certain of the agreements also provide for other incentives which are based on the operating performance of the Company.\nDuring the first quarter of fiscal 1996, and effective as of May 1, 1995, the Company entered into a one year consulting agreement with Harjac Consulting Inc., a company of which Steve Jackel is president, for the services of Mr. Jackel as a special assistant to the Chairman and Chief Executive Officer. The agreement provides for remuneration at the rate of $300,000 for the term of the agreement plus certain expenses. The agreement also provides for options to purchase 25,000 shares of the Company's common stock at $3.00 per share and 75,000 at $4.00 per share. The options have a five year term and are exercisable as of December 31, 1995 and May 1, 1996, respectively.\nNOTE 14 -- LITIGATION AND SETTLEMENTS\nRoland Kohl During Fiscal 1990, the Company terminated for cause certain of its former officers and directors including its former Hong Kong managing director, Roland Kohl and instituted legal proceedings for damages estimated at $5.9 million. The defendants counter-claimed for arrears of salary and bonuses held in escrow. The Company executed a settlement agreement with the defendants, however, the value of the defendants' assets was severely diminished and there existed a substantial question as to whether any judgement against Kohl could be satisfied. The Company decided not to pursue the case with Kohl and settled with the other defendants for claims for salary arrearages and legal fees in the amount of $800,000.\nSEC Investigation On November 1, 1991, the Company was advised that the Securities and Exchange Commission (SEC) had issued an order directing a private investigation of certain allegations made against the Company and Jack C. Benun, the Company's former Chairman and Chief Executive Officer by the Company' former Chief Financial Officer. An initial investigation by an Ad Hoc Committee of the Company's Board of Directors reported that the Company was unable to find any substantial evidence of wrongdoing by Benun. When new evidence became available in 1993, the Ad Hoc Committee reported that Benun had misappropriated $150,000 from the Company. As a consequence of the new report, the Company terminated Benun for cause. On September 16, 1994, as required by his settlement agreement with the SEC, Benun paid the Company $215,243, representing settlement of the misappropriation and interest thereon.\nOn September 1, 1994, the Company settled the SEC Investigation as it related to the Company without monetary damages or penalties.\nJack C. Benun On November 18, 1994 the Company filed a demand for arbitration for money damages in excess of $1.5 million against Jack C. Benun. This action was taken due to Mr. Benun's failure to compensate the Company for damages it sustained as a result of Benun's breaching his employment obligations, his fiduciary obligations and perpetrating frauds upon the Company. Mr. Benun has submitted a counterclaim in which he alleges among other things a wrongful termination by the Company. The Company intends to vigorously pursue its action as well as defend the counterclaim.\nAt June 30, 1995 the Company was indebted to Mr. Benun for $100,000. Interest on the loans incurred by the Company during the fiscal years ended June 30, 1995 and 1994 approximately $11,000 and $27,000 respectively.\nPurported Class Action\nOn February 22, 1995, the Company was served a complaint purporting to be a class action on behalf of purchasers of the Company's common stock. The complaint is predicated on the wrongdoing of Mr. Benun and an alleged failure by the Company to promptly disclose such wrongdoing to the public. On September 5, 1995, plaintiffs, in response to motions to dismiss by the Company and the individual defendants, filed a motion to file an amended complaint. The Company intends to vigorously contest the litigation and believes that it has good defenses to the purported claims in the complaint and the amended complaint.\nNOTE 15 -- FOREIGN OPERATIONS:\nSet forth below is a summary of significant financial information regarding the Company's foreign operations (in 000's):\nJune 30, ------------------------------- 1995 1994 1993 ------- ------- ------- Current assets .............. $32,814 $31,428 $24,260 Noncurrent assets ........... 13,576 12,598 13,601 ------- ------- ------- Total assets ................ 46,390 44,026 37,861 Liabilities ................. 27,325 33,102 27,208 ------- ------- ------- Equity ...................... $19,065 $10,924 $10,653 ======= ======= ======= Net sales (including intercompany sales) ....... $61,560 $51,574 $54,028 Costs and expenses .......... 56,599 50,666 53,620 ------- ------- ------- Net income .................. $ 4,961 $ 908 $ 408 ======= ======= =======\nSignificant financial information regarding the Company's operations, which includes the effect of the elimination of intercompany transactions, is as follows (in 000's):\nJune 30, ------------------------------- 1995 1994 1993 ------- ------- ------- Sales to unaffiliated customers: United States .............................. $20,161 $29,014 $27,985 Canada ..................................... 2,966 3,701 8,114 Central America ............................ 1,824 1,957 1,222 Hong Kong\/People's Republic of China ....... 27,910 13,288 15,532 Federal Republic of Germany ................ 3,509 3,853 4,317 United Kingdom ............................. 3,573 2,898 1,961 Hungary .................................... 379 106 -- France ..................................... 1,817 -- -- ------- ------- ------- $62,139 $54,817 $59,131 ======= ======= =======\nSales to unaffiliated customers exclude intercompany sales (in 000's) of approximately $19,757, $27,400, and $24,600 for fiscal years 1995, 1994 and\n1993, respectively. The basis of accounting for intercompany sales is cost plus a manufacturing profit.\nJune 30, --------------------------- 1995 1994 1993 ------ ------ ------- Operating profit (loss): United States ................................. ($4,827) ($2,822) ($11,503) Canada ........................................ (384) (1,228) (712) Central America ............................... (134) 64 (34) Hong Kong\/People's Republic of China .......... 6,776 3,217 5,256 Federal Republic of Germany ................... 131 (11) 302 United Kingdom ................................ (371) (50) (645) Hungary ....................................... 0 8 France ........................................ 125 -- -- ------ ------ ------- $1,316 ($ 822) ($ 7,336) ====== ====== =======\nJune 30, ----------------------------- 1995 1994 1993 ------- ------- ------- Identifiable assets: United States ................................. $ 9,563 $15,805 $14,904 Canada ........................................ 1,366 1,516 2,891 Central America ............................... 1,594 1,701 1,061 Hong Kong\/People's Republic of China .......... 30,128 22,842 23,847 Federal Republic of Germany ................... 3,939 4,422 3,028 United Kingdom ................................ 1,968 1,687 987 Hungary ....................................... 313 210 -- France ........................................ 1,318 -- -- ------- ------- ------- $50,189 $48,183 $46,718 ======= ======= =======\nNOTE 16 -- RELATED PARTY TRANSACTIONS:\nDuring the first quarter of fiscal 1995, the Company entered into an agreement with a member of the Board to provide sales and marketing consulting services. Selling expenses include $63,000 for such consulting services and related expenses during the fiscal year ended June 30, 1995.\nDuring the fiscal years ended June 30, 1994 and 1993, the Company paid consulting fees and expenses of approximately $22,000 and $459,000, respectively to a firm, the President of which was appointed Chief Operating Officer and President of the Company in June 1993 and Chairman and Chief Executive Officer in July 1994.\nNOTE 17 -- SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:\nJune 30, ---------------------------------- 1995 1994 1993 -------- ---------- ---------- Cash paid for interest ..................... $820,000 $1,126,000 $1,693,000 ======== ========== ========== Cash paid for taxes ........................ $ 88,000 $ 86,000 $ 313,000 ======== ========== ==========\nNoncash investing and financing activities: Fair value of assets acquired ............ $ $ $ 747,998 Cash paid ................................ -- -- (45,200) Liabilities incurred ....................... -- -- 108,241) -------- ---------- ---------- Liabilities assumed ........................ $ -- $ -- $ 391,529 ======== ========== ==========\nDuring the fiscal year ended June 30, 1995 and 1994, capital lease obligations of approximately $130,000 and $252,000 were incurred when the Company entered into leases for new equipment.\nNOTE 18 -- OTHER INCOME (EXPENSE) -- NET\nJune 30, ----------------------------------- 1995 1994 1993 --------- --------- --------- Gain on sales of long term assets ......... $ 5,000 $ 229,000 $ 107,000 Other interest income ..................... 135,000 74,000 49,000 Settlements from legal proceedings ........ -- 447,000 -- Other income (expense), net ............... (27,000) 17,000 (48,000) Directors fees ............................ (173,000) (212,000) (219,000) Foreign exchange gain (loss), net ......... (95,000) (776,000) (36,000) --------- --------- --------- .......................................... $(155,000) ($221,000) $(147,000) ========= ========= =========\nNOTE 19 -- REORGANIZATION AND RESTRUCTURING:\nProduct Line Rationalization\nAs a result of the Company's success in the introduction of the single use cameras, the product's acceptance in the market and the Company's belief that the demand for this product will continue, the Company has decided to curtail certain of its 35 millimeter and 110 product line and focus a significant amount of its efforts on this emerging market. In connection with this rationalization of the product line, the Company had suspended production of certain models that it produced in the past and anticipated producing in the future. As a consequence, provisions for certain component parts inventory in the manufacturing facility as well as certain fixed assets (principally tools and molds) used in connection with the manufacturing of those models were being recorded in order to reduce such items to net realizable value. The total provisions recorded in fiscal 1993 were $4,477,523.\nReorganization & Restructuring\nIn connection with the reorganization and ongoing upgrade of worldwide management, finances, and management information systems and procedures, certain expenses have been and will be incurred. Substantially all of the manufacturing joint ventures that had been operating individually prior to the Company's purchase of its partners interest in the joint ventures have now been consolidated with the Company's manufacturing operations, new management has been hired and new worldwide management information systems and procedures are being implemented and installed. In addition, the Company is in the process of liquidating its joint venture in Budapest, Hungary as a result of its joint venture partners' financial instability. In Fiscal 1993, the Company recorded a provision of $1,522,477 for such consolidation, severance and other reorganization costs.\nProposed Transaction Costs\nAs a result of the termination of its agreement with Gestetner Holdings PLC, the parent of the Vivitar Group of Companies (\"Vivitar\"), in Fiscal 1993, the Company wrote off $904,000 of costs incurred in connection with the Vivitar transaction.\nNOTE 20 -- SUBSEQUENT EVENTS\nEffective July 1, 1995 the Company took certain actions to liquidate its Canadian Subsidiary as part of the Company's plans to consolidate its North America operations and to take advantage of certain tax benefits available to it. The Company continues to operate in Canada as a branch of one of its United States subsidiaries.\nSenior management common stock purchase awards -- On August 23, 1995, the Compensation Committee of the Board of Directors approved stock purchase\nawards under the Company's Incentive Plan (See Note 10 Common Stock) pursuant to which 500,000 shares of the Company's no par value common stock were made (subject to earlier maturity upon the occurrence of certain events) available for purchase by senior management of the Company at a price per share equal to $5.375 per share (the closing price of the common stock on August 23, 1995) pursuant to binding commitments to be made by such persons by August 31, 1995. The Company received commitments for the purchase of 444,000 of such shares made available for purchase. The purchase price will be paid by a loan from the Company to the participating senior executives and evidenced by a full recourse promissory note secured by the common stock purchased by the executives. The notes will mature five years from the date of purchase and will bear interest at 6%. Each senior management purchaser will also be granted a contingent restricted stock award covering a number of shares equal to the number of shares purchased by such purchaser. The restricted stock will only be issued based upon attainment of increases in shareholder value in accordance with the Incentive Plan.\nAt the Board of Directors meeting of August 23, 1995, a Management Incentive Compensation Program was approved for the 1995 Fiscal year and for subsequent periods. The Plan was enacted in order to foster increased efforts by senior executives on behalf of the Company by giving them a direct financial interest in the Company's performance and to encourage key employees to remain with the Company as well as to provide an incentive in the recruitment of senior management. The incentive pool is to be earned if the Company achieves certain return on equity goals. The goals are reviewable each year by the Board and may be amended. If the goals are achieved an Incentive Fund is to be established of up to 10% of earnings after taxes and any unawarded portion of an Incentive fund from previous years. Included in general and administrative expenses in Fiscal 1995 is an accrual of $350,000 allocated to the Incentive Fund for Fiscal 1995 incentive compensation payments.\nConcord Camera Corp. Schedule II\nValuation and qualifying accounts and reserves - ----------------------------------------------\nColumn A Column B Column C Column D Column E -------- -------- -------- -------- -------- Additions --------- Balance at Charged to Charged to Balance at beginning costs and other end of Description of period expenses accounts Deductions period - ----------- ---------- ---------- ---------- ---------- ---------- Reserve for doubtful accounts, discounts and allowances\nFiscal year:\n1993 2,770,811 2,667,764 -- 3,277,050 2,161,525 1994 2,161,525 613,353 -- 1,140,704 1,634,174 1995 1,634,174 218,496 810,899 1,041,771\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.\nCONCORD CAMERA CORP. (Company)\nDate: September 15, 1995\nBy: \/s\/ IRA B. LAMPERT --------------------- Ira B. Lampert, 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 Company and in the capacities and on the dates indicated.\nSignature Office Date --------- ------ ----\n\/s\/ IRA B. LAMPERT - ---------------------------- Director, Chairman and September 15, 1995 Ira B. Lampert Chief Executive Officer\n\/s\/ GARY M. SIMON - ---------------------------- Chief Financial Officer September 15, 1995 Gary M. Simon Secretary and Treasurer\n\/s\/ HARLAN I. PRESS - ---------------------------- Chief Accounting Officer September 15, 1995 Harlan I. Press\n\/s\/ ELI ARENBERG - ---------------------------- Director September 15, 1995 Eli Arenberg\n\/s\/ MORRIS H. GINDI - ---------------------------- Director September 15, 1995 Morris H. Gindi\n\/s\/ JOEL L. GOLD - ---------------------------- Director September 15, 1995 Joel L. Gold\n- ---------------------------- Director J. David Hakman\n\/s\/ IRA J. HECHLER - ---------------------------- Director September 15, 1995 Ira J. Hechler\n\/s\/ KENT M. KLINEMAN - ---------------------------- Director September 15, 1995 Kent M. Klineman","section_15":""}
{"filename":"712843_1995.txt","cik":"712843","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nELXSI Corporation (the \"Company\") is a Delaware corporation that was formed in September 1980 as Trilogy Limited, a Bermuda corporation. The Company changed its name to ELXSI Ltd. in January 1987, and changed its incorporation from Bermuda to Delaware and became known as ELXSI Corporation in August 1987. A public company since November 1983, the Company acquired ELXSI (\"ELXSI\"), a California corporation, in October 1985. In December 1987, the Company's other California subsidiary, Trilogy Systems Corporation was merged into ELXSI.\nIn September 1989 and January 1990, the Company entered into Stock and Note Purchase Agreements (the \"Stock Purchase Agreement\") with and among, The Airlie Group L.P. (\"Airlie\"), Continental Illinois Equity Corporation (\"CIEC\") and Milley & Company (\"M&C\"), (hereinafter referred to collectively as the \"Buyers\") whereby the Buyers acquired 960,000 shares (par value $.001 per share (\"Common Stock\"), $2,000,000 aggregate principal amount of the Company's notes and warrants to purchase 1,204,000 shares of the Company's Common Stock. Subsequent to these transactions, the Company announced its intention of pursuing a program of identifying, acquiring and managing middle-market companies. The Company is not limiting its opportunities to any single industry.\nOn July 1, 1991, ELXSI acquired 30 restaurants operating under the Bickford's or Bickford's Family Fare names and 12 Howard Johnson's restaurants operating under the Howard Johnson's name, which were located in Massachusetts, Vermont, New Hampshire, Rhode Island and Connecticut, from Marriott Family Restaurants, Inc. for a purchase price of approximately $23,867,000, including fees.\nBetween 1991 and 1994, ELXSI sold six of its Howard Johnson's restaurants and converted five of the remaining six Howard Johnson's into Bickford's Family Restaurants. During the same time period, ELXSI opened six new Bickford's Family Restaurants.\nDuring 1995, ELXSI opened one new Bickford's Family Restaurant and on July 3, 1995 acquired sixteen Abdow's Family Restaurants (\"Abdow's\") located in western Massachusetts and Connecticut for approximately $3,800,000, including fees. During the third and fourth quarters of 1995 and the first quarter of 1996, ELXSI converted four of the Abdow's into Bickford's Family Restaurants and completed negotiations to sell the Vernon, Connecticut Abdow's Restaurant for approximately $1,225,000. This sale was completed on February 1, 1996. Currently, ELXSI operates forty-six Bickford's Family Restaurants (\"Bickford's\"), eleven Abdow's and one Howard Johnson's Restaurant, in its Bickford's Family Restaurant division (the \"Bickford's Division\" or \"Restaurant Division\"). As used herein the term \"Restaurants\" refers to Bickford's and\/or Abdow's and\/or Howard Johnson's restaurants owned and operated in the Restaurant Division.\nOn October 30, 1992, ELXSI acquired Cues, Inc., of Orlando, Florida and its two wholly-owned subsidiaries, Knopafex, Ltd., of Toronto, Canada, and Cues B.V., of Maastricht, The Netherlands. The Cues business in the United States is owned and operated as a division of ELXSI, and such division, Knopafex Ltd. and Cues B.V. are hereinafter collectively referred to as \"Cues\" or the \"Cues Division\".\nCues is principally engaged in the manufacture and servicing of video inspection and rehabilitation equipment for wastewater and drainage systems primarily for governmental municipalities, service contractors and industrial users.\nFINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS\nReference is made to the information set forth in Note 12 (Segment Reporting) to the Consolidated Financial Statements included herein, which information is hereby incorporated by reference herein.\nRESTAURANT DIVISION\nThe Restaurants are family-oriented and offer full service and relatively inexpensive meals. Featuring a breakfast menu available throughout the day, the Restaurants appeal to customers who are interested in a casual, low-to moderately-priced meal. The Company has been successful at marketing the breakfast menu concept to customers regardless of the time of day, and has expanded lunch and dinner patronage by also offering improved traditional lunch and dinner items. Most menu items are priced between $2.75 and $7.25, with the average customer check being approximately $5.12, $4.96 and $4.74 in 1995, 1994 and 1993, respectively. Major categories of menu items are pancakes, waffles and french toast, eggs and omelettes, \"country\" dinners, soups and side orders, salads, hamburgers and sandwiches, and desserts. Breakfast items and coffee accounted for approximately 73% of food sales.\nEach Restaurant is open seven days a week, with most generally open from 7:00 a.m. to 11:00 p.m. during the week and later on weekends and with some open twenty-four hours on the weekends. Some Restaurants are open twenty-four hours every day. Approximately 60% of weekly sales volume is generated Friday through Sunday.\nWhile the Company believes that the Restaurants appeal to a wide variety of customers, they primarily cater to senior citizens and families which are attracted to the high-quality, moderately-priced meals. Each Restaurant generally draws its customers from within a five-mile radius and, consequently, repeat business is extremely important to the Restaurant Division's success. Repeat business accounts for a majority of the Restaurant's sales.\nEach of the original thirty Bickford's consists of a free standing building that covers approximately 2,700 to 7,000 square feet, and they are typically located adjacent to major roads and highways and shopping malls. Nearly all contain two dining areas, smoking and non-smoking. At December 31, 1995, twelve of the Bickford's buildings are owned, while the remaining thirty-two\nare a combination of leased or owned buildings on leased land. All of the Abdow's acquired in 1995 are leased properties, all but two of which consist of free standing buildings covering approximately 4,000 to 6,000 square feet. The Howard Johnson's restaurant is a leased property.\nEach Restaurant has a kitchen equipped with grill space and ovens for service of baked foods. Seating capacity ranges from 100 to 200 people. Five of the Bickford's provide counter service.\nRestaurant Expansion and Renovation\nThe acquisition by ELXSI provided an opportunity to renovate the existing locations and to acquire additional Restaurants. Capital expenditures during the years ended December 31, 1995, 1994 and 1993 were as follows:\n1995 1994 1993 ------------ ------------ ------------ Expansion $ 221,000 $ 485,000 $ 914,000 Conversions 243,000 86,000 -- Purchase Leased Property -- 346,000 -- Renovation 415,000 95,000 289,000 Refurbishment & Equipment 1,088,000 1,003,000 463,000 ------------ ------------ ------------ $ 1,967,000 $ 2,015,000 $ 1,666,000\nAcquisition of Abdow's Restaurants $ 2,575,000 $ -- $ -- ============ ============ ============\nThe Company currently plans to spend $1,650,000 for renovations, refurbishments and equipment replacements, $600,000 for conversions and $450,000 for Restaurant expansion during 1996.\nThe Company believes that increased profitability of the Restaurants will come mainly from gaining market share by continuing its programs to improve food products and service, and through its programs of remodeling existing units, opening new units and to a lesser extent, from price increases. The Company believes that it is partially due to the foregoing that sales at the original thirty Bickford's have increased. The 1995 comparison with 1994 is negatively impacted by the inclusion of a 53rd week in 1994 and only 52 weeks in 1995. Sales at the original thirty Bickford's increased 1.3% in 1995, 6.1% in 1994 (including a 53rd week) and 5.8% in 1993, in each case, over the prior year's sales; customer counts at the original thirty Bickford's Restaurants decreased 1.8% in 1995, increased 1.5% in 1994 (including a 53rd week) and increased 3.9% in 1993, in each case, over the prior year's counts; sales at same Restaurants, including the five converted and one remaining Howard Johnson's units, decreased .4% in 1995, increased 5.8% in 1994 (including a 53rd week) and increased 5.9% in 1993, in both cases, over the prior year's sales, and customer counts at same Restaurants decreased 3.4% in 1995, increased 1.2% in 1994 (including a 53rd week) and increased 4.3% in 1993, in each case, over the prior year's counts.\nThe Company takes an opportunistic approach to expansion. Management evaluates both purchase and lease opportunities, and, in most instances, new Restaurants will be opened utilizing leased properties. The Company will open a new Restaurant only if it can reasonably be expected to meet the Company's return on investment criteria.\nRestaurant Management and Supervision\nEach Restaurant has a manager and one to three assistant managers, at least one of whom must be on duty at all times during restaurant hours. The managers are responsible for hiring all personnel at the Restaurant level, managing the payroll and employee hours and ordering necessary food and supplies. Subsequent to the Abdow's acquisition, the Bickford's Division has nine district managers who, between them, cover all the Restaurants. The district managers are responsible for the complete operation of the Restaurants located in assigned geographical areas, including responsibility for sales, profits and all operational policies and procedures. The district managers, managers and assistant managers are all salaried personnel, but are also compensated with performance incentives which can provide a significant portion of their total compensation. Bonuses paid under the program are based principally upon monthly sales volume, attainment of certain cost targets and store profitability.\nSources and Availability of Materials\nFood supplies are distributed by various Company-approved wholesalers and purveyors, which deliver directly to the Restaurant locations. Essential supplies and raw materials are available from several sources, and the Company is not dependent upon any one supplier for its food supplies. The Company does not maintain or engage in any warehousing or commissary operations.\nSeasonality\nThe Restaurants experience slightly higher revenues in the summer months.\nCustomers\nThe Restaurants are not dependent upon a single customer or group of customers, although a large portion of each Restaurant's customers live within a five mile radius thereof and, accordingly, repeat customers are important to the Bickford's Division's success.\nCompetition\nThe Restaurants are in direct competition with many local restaurants providing family-oriented meals, some of which are owned, operated and\/or franchised by national and regional chains. The restaurant business is highly competitive with respect to price, service, location and food quality. The Company believes that its attention to quality and service, along with low-to-moderately-priced menu items, will continue to attract customers. In 1995, the Company noticed an increase\nin the number of restaurants offering buffet style dining in New England. The Company believes that the freshness of its food and its reasonable pricing compare favorable to these buffet concepts.\nEmployees\nAs of December 31, 1995, the Restaurant Division employed approximately 2,500 persons, of whom approximately 2,050 were part-time hourly employees, approximately 230 were full-time hourly employees and approximately 220 were salaried personnel. This represents an increase since December 31, 1994 of approximately 750 persons, which increase consists mainly of part-time employees as a result of the Abdow's acquisition. None of the employees are represented by unions.\nEnvironmental Matters\nThe Restaurant Division is subject to various federal, state and local laws, rules and regulations relating to the protection of the environment that are typical for companies in its industry. Management believes that it complies with all such rules and that it has no material effect on its capital expenditures, earnings or competitive position.\nCUES DIVISION\nCues manufactures systems which utilize closed circuit television and highly specialized rehabilitation equipment to inspect and repair underground sewer lines. The infiltration of groundwater into sewer pipelines through leaking joints and pipe fractures burdens the capacity of sewage treatment plants by increasing the volume of fluids being treated. Leaking joints and pipe fractures can also contribute to sewer line damage which can be repaired, in severe cases, only by costly excavation. Cues installs its systems in specially designed trucks and vans which are sold as mobile units. Cues also provides product servicing and replacement parts for its customers and distributes chemical grout sealants used in connection with its sealing equipment. The principal customers of Cues are municipalities and contractors engaged in sewer inspection and repair. Cues is not engaged in the service business of maintaining and repairing sewer lines.\nInspection and Sealing Equipment\nCues's inspection and sealing equipment constitutes an integrated system that combines the capability of inspecting underground sewer lines with remote control television cameras creating a permanent maintenance record of the condition of the sewer lines; pressure testing sewer line joints; and applying chemical sealants to repair leaking joints and small pipe fractures.\nCues's inspection and sealing systems are placed in sewer lines through manholes. The module and the television camera, which is a part of the module, delays a television picture of the interior of that sewer line via cable to a monitoring station in a mobile unit above ground. The television inspection system employs a three inch diameter color camera that can be remotely adjusted for\nclose-up viewing of problem areas. By recording the position of the camera as it moves through the sewer lines, the Cues's inspection and sealing equipment gives the customers a permanent record of the condition of their sewer lines. If the television camera inspection of the sewer lines discloses a leaking joint or pipe fracture, the sealing portion of the module may immediately be positioned through use of the camera to make the repair. Once the module is positioned, inflatable packers seal off the line at either end of the damaged area and apply a chemical sealant which penetrates the leak or fractures as well as the earth surrounding the pipe, hardening to seal the line. The sealing module may also be used to determine the structural integrity of the joint by applying air or water pressure against the walls of the joint. This pressure test enables the customers to detect leaking joints that may not be easily detected visually.\nThe sealing module manufactured by Cues is used to repair sewer lines where infiltration or inflow of water occurs through leaking joints and pipe fractures. Repairs can last 20 years or more, depending upon the structural soundness of the sewer line or repaired joints. Cues's sealing equipment is not designed to repair a severely damaged or collapsed pipe, which must be excavated and replaced in the traditional manner or repaired by the use of other sewer line repair technology. However, Cues's television inspection system is often used to inspect and identify structurally deficient or collapsed sewer lines in conjunction with the use of other sewer line repair technology. Cues has also adapted its sewer line inspection equipment for use in the inspection, but not the repair of underground water wells, as well as large pipe storm drains.\nCues also manufactures and sells a line of portable T.V. inspection equipment used primarily for lateral inspection of pipes ranging in size from 2 inches to 6 inches.\nProduct Servicing, Replacement Parts and Chemicals\nCues provides product servicing and repair at its facilities in Orlando, Florida, Sacramento, California, Toronto, Canada and Maastricht, The Netherlands. In Orlando, Cues also maintains an inventory of replacement parts for distribution and sale to customers. Cues recorded warranty expense of approximately $255,000, $196,000 and $139,000, during the years 1995, 1994 and 1993, respectively.\nProduct Development\nCues has an ongoing program to improve its existing products and to develop new products. During the twelve months ended December 31, 1995, 1994 and 1993, approximately $311,000, $287,000 and $290,000, respectively, was expended by Cues for product development, excluding the salary expense and benefits of the Cues engineering department. Although Cues holds United States patents for components of its products, management believes the expiration or invalidity of any or all of such patents will not have a material adverse effect on the business. For 1996, Cues plans to spend approximately $350,000 for product development activities.\nSource and Availability of Raw Materials\nCues manufactures certain components of its system and purchases certain television camera modules, monitors, video recorders, vehicles, etc., which are readily available from a number of sources.\nCues has agreements with Orlando, Florida truck dealers to deliver truck bodies that are used in the manufacture of certain Cues's systems. Under these agreements, Cues reimburses the dealers floor plan financing costs for those vehicles held by the dealer until delivery.\nMarketing\nCues markets its products and services in the United States though thirteen salesmen. In addition, technical service representatives are located in Orlando, Toronto and Maastricht. Major customers include municipalities contractors engaged in sewer line inspection and repair as well as privately-owned sewer systems. No customer accounted for more the 5% of Cues's 1995 sales. Cues participates in trade shows and uses trade magazine advertising in the marketing of its products and services. The Cues name is well established, affording it and its products wide recognition within its industry.\nOutside North America, Cues markets its products in five continents, either directly or through distributors, agents or dealers. During 1995, 1994 and 1993, export sales to foreign countries represented approximately 14%, 16% and 16% of total Cues sales, respectively. Sales by Cues B.V. and Knopafex, Ltd. to foreign countries represent approximately 72%, 66% and 57% of total foreign sales in 1995, 1994 and 1993, respectively.\nCompetition\nCompetition for the type of products sold by Cues is on the basis of price, service and reliability, and management believes that it competes effectively in these respects. Management also believes that there are six companies which produce and sell products which are competitive with those produced by Cues. A significant portion of sales are generated through a bidding process initiated by municipalities. This process has become extremely price sensitive requiring Cues to meet or beat competitor's bids in order to secure sales.\nEmployees\nAt December 31, 1995, Cues had 140 full and part-time employees, none of whom was represented by a union. This includes 8 employees at Knopafex, Ltd. and 4 employees at Cues B.V.\nEnvironmental\nThe Cues Division is subject to various federal, state and local laws, rules and regulations relating to the protection of the environment that are typical for companies in its industry. Management\nbelieves that compliance therewith will have no material effect on its capital expenditures, earnings or competitive position.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Restaurant Division conducts a substantial portion of its operations utilizing leased facilities. ELXSI leases land and\/or buildings at forty-six of its fifty-eight restaurants, under lease agreements expiring (including options) on various dates through 2032. The majority of these leases provide that the Company pay taxes, maintenance, insurance and other occupancy expenses related to the leased premises. The rental payments for a majority of the Restaurant locations are based upon minimum annual rental payments and a percentage of their respective sales.\nBelow is a summary of the Restaurant properties as of December 31, 1995 (excluding the Abdow's Restaurant located in Vernon, Connecticut held for sale at December 31, 1995).\nHoward Bickford's Johnson's Abdow's Total ---------- --------- ------- -----\nMassachusetts: Owned 8 -- -- 8 Leased 18 1 9 28\nConnecticut: Owned 2 -- -- 2 Leased 4 -- 4 8\nRhode Island: Owned -- -- -- -- Leased 5 -- -- 5\nNew Hampshire: Owned 2 -- -- 2 Leased 5 -- -- 5\nTotal: Owned 12 -- -- 12 Leased 32 1 13 46\nELXSI also owns a 4,000 square foot building in Boston, Massachusetts, which is used for its Restaurant Division management and administrative headquarters, and a 26,000 square foot office and manufacturing facility in Orlando, Florida for its Cues Division. In addition, Cues B.V. owns an office and manufacturing facility in Maastricht, The Netherlands, and Knopafex, Ltd. rents office and manufacturing space in Toronto, Canada.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThere are no material pending legal proceedings to which the Company or ELXSI is a party, to which any of their property is the subject of, nor are there any proceedings known to be contemplated by governmental authorities against the Company or ELXSI.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThere were no matters submitted to vote of shareholders during the fourth quarter of 1995.\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 quoted in the automated quotation system of the National Association of Securities Dealers, Inc.- National Market System (\"NASDAQ\"), under the symbol ELXS. The following table sets forth high and low closing sales prices for the fiscal quarters indicated, as reported by NASDAQ.\n1995 1994 ---------------- ----------------- High Low High Low ---- --- ---- ---\nFirst Quarter $7.38 $5.00 $9.25 $5.88 Second Quarter 7.13 5.63 7.38 5.38 Third Quarter 7.81 5.88 7.13 5.75 Fourth Quarter 6.50 4.88 6.00 4.75\nOn March 18, 1996, the reported last sale price for the Company's Common Stock in NASDAQ was $6.50 per share. The above quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.\nHolders\nAs of March 18, 1996 there were 6,104 holders of record of the Company's Common Stock.\nDividend History\nThe Company has never paid nor is there any intention to pay any dividends in the foreseeable future. It is likely that the Company will retain future earnings for use in the development of its business.\nStock Transfer Agent\nThe Company's stock transfer agent is Continental Stock Transfer and Trust Co., 2 Broadway, New York, New York 10004, (212) 509-4000.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA (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\nRESULTS OF OPERATIONS\nSee Note 1 to the Consolidated Financial Statements for background on the Company. In July 1989, the Company announced a major restructuring of its operations and the termination of ELXSI's development of large scale multiprocessor computer systems and cessation of manufacturing operations at its facility in San Jose, California.\nThe Company sold stock, notes and warrants to a group of investors in connection with its restructuring efforts. Following the sale, the Company withdrew from the computer business and now intends to continue a program of identifying, acquiring and managing middle market companies.\nBoth the Company's corporate functions and Cues Division have fiscal years consisting of four calendar quarters ending on December 31. The Restaurant Division's fiscal years consist of four 13-week quarters (and, accordingly, one 52-week period) ending on the last Saturday in December closest to the 31; however, this requires that every six or seven years the Restaurant Division add an extra week at the end of the fourth quarter and fiscal year.\nYEAR ENDED DECEMBER 31, 1995\nThe Company's 1995 revenues and expenses resulted from the operation of ELXSI's Restaurant and Cues Divisions and the Company's corporate expenses (\"Corporate\"). For the year ended December 31, 1995, the Company's sales of $74,674,000, cost of sales of $58,347,000, selling, general and administrative expenses of $7,484,000, and depreciation and amortization of $2,206,000, yielded operating income of $6,637,000. The operating income of $6,637,000 was increased by interest income of $125,000, reduced by interest expense of $1,767,000, increased by other income of $65,000 and reduced by income taxes of $514,000 resulting in net income of $4,546,000.\nRestaurant Division The Restaurants had sales of $54,270,000, cost of sales of $43,729,000, selling, general and administrative expense of $1,620,000 and depreciation and amortization expense of $1,833,000, which yielded operating income of $7,088,000. In addition, the Restaurants had $297,000 of interest expense related to the amortization of deferred financing fees and capital leases, resulting in income before taxes of $6,791,000.\nCues Division Cues had sales of $20,404,000, cost of sales of $14,618,000, selling, general and administrative expenses of $4,425,000 and depreciation and amortization expense of $373,000, which yielded operating income of $988,000. In addition, Cues had $22,000 of interest expense, $2,000 of interest income, $68,000 of other income and $4,000 of tax expense adjustments resulting in income before taxes of $1,032,000.\nCorporate Corporate general and administrative expenses were $1,439,000. The major components of general and administrative expense include the management fee paid to Cadmus Corporation (\"Cadmus\") (see NOTE 6 to the Consolidated Financial Statements), the compensation accrual related to the Bickford's Phantom Stock Option Plan (see the Company's 1995 proxy statement for further information), legal expense, corporate and Bickford's audit expense and shareholder services and financial reporting expense. The services rendered by Cadmus include participating actively in the management of the Company and of ELXSI; it is through the management agreement that the Company is provided the services of many of its officers and through which those officers are compensated. Examples of management services provided include the ongoing evaluation of management, preparing and reviewing division operating budgets and plans, evaluating new restaurant locations, divesting under performing assets, negotiating environmental matters, negotiating with lenders, evaluating financing options, complying with public reporting requirements, communicating with shareholders, negotiating and arranging insurance programs, monitoring tax compliance, evaluating and approving capital spending, preparing market research, developing and improving management reporting systems, surfacing and evaluating acquisitions, etc. Interest expense was $1,448,000, consisting of senior bank debt interest of $1,275,000 and subordinated note interest of $173,000. In addition, the Company recorded interest income of $123,000, other expense of $3,000 and a consolidated tax provision of $510,000 at the corporate level.\nEarnings Per Share Earnings per share and the weighted average number of shares outstanding for the year ended December 31, 1995 were $0.89 and 5,093,000, respectively. This compares to $0.79 per share for 1994, when there were 6,014,000 shares outstanding. The average stock price during 1995 and 1994 was $6.12 and $5.42, respectively. The market price at December 31, 1995 and 1994 was $6.13 and $6.34, respectively. Due to the outstanding warrants and options, which are considered common stock equivalents, a higher stock price results in a greater number of outstanding shares for the earnings per share calculation.\nYEAR ENDED DECEMBER 31, 1994\nThe Company's 1994 revenues and expenses resulted from the operation of ELXSI's Restaurant and Cues Divisions and from \"Corporate\". For the year ended December 31, 1994, the Company's sales of $62,423,000, cost of sales of $47,440,000, selling, general and administrative expenses of $6,630,000, and depreciation and amortization of $1,794,000, yielded operating income of $6,559,000. The operating income of $6,559,000 was increased by interest income of $8,000 and reduced by interest expense of $1,426,000, other expense of $41,000 and income taxes of $366,000 resulting in net income of $4,734,000.\nRestaurant Division The Restaurants had sales of $43,391,000, cost of sales of $34,234,000, selling, general and administrative expense of $1,293,000 and depreciation and amortization expense of $1,460,000, which yielded operating income of $6,404,000. In addition, the Restaurants had $266,000 of interest expense related to the amortization of deferred financing fees and capital leases, resulting in income before taxes of $6,138,000.\nIncluded in the 1994 results, the fifty-third week added approximately $810,000 in sales and, management estimates, approximately $200,000 in operating income.\nCues Division Cues had sales of $19,032,000, cost of sales of $13,206,000, selling, general and administrative expenses of $4,146,000 and depreciation and amortization expense of $334,000, which yielded operating income of $1,346,000. In addition, Cues had $32,000 of interest expense, $27,000 of other expense and $5,000 of tax adjustments resulting in income before taxes of $1,282,000.\nCorporate Corporate general and administrative expenses were $1,191,000 in 1994. The major components of general and administrative expense include the management fee paid to Cadmus, the compensation accrual related to the Bickford's Phantom Stock Option Plan, legal expense, corporate and Bickford's audit expense and shareholder services and financial reporting expense. Interest expense was $1,128,000, consisting of senior bank debt interest of $418,000 and subordinated note interest of $710,000. In addition, the Company recorded interest income of $8,000, other expense of $14,000 and a consolidated tax provision of $361,000 at the corporate level.\nEarnings Per Share Earnings per share and the weighted average number of shares outstanding for the year ended December 31, 1994 were $0.79 and 6,014,000, respectively, both on a primary and fully diluted share basis. The average stock price during 1994 was $5.42 and the market price at December 31, 1994 was $5.25.\nYEAR ENDED DECEMBER 31, 1993\nThe Company's 1993 revenues and expenses resulted from the operation of ELXSI's Restaurant and Cues Division and from \"Corporate\". For the year ended December 31, 1993, the Company's sales of $55,682,000, cost sales of $41,338,000, selling, general and administrative expenses of $6,406,000, and depreciation and amortization of $1,589,000, yielded operating income of $6,349,000. The operating income of $6,349,000 was reduced by interest expense of $1,653,000, other expense of $80,000 and income taxes of $348,000 resulting in net income of $4,268,000.\nRestaurant Division The Restaurants had sales of $38,903,000, cost of sales of $30,152,000, selling, general and administrative expense of $1,248,000 and depreciation and amortization expense of $1,288,000, which yielded operating income of $6,215,000. In addition, the Restaurants had $293,000 of interest expense primarily related to the amortization of deferred financing fees resulting in income before taxes of $5,922,000.\nCues Division Cues had sales of $16,779,000, cost of sales of $11,186,000, selling, general and administrative expenses of $4,082,000 and depreciation and amortization expense of $301,000, which yielded operating income of $1,210,000. In addition, Cues had $26,000 of interest expense, $75,000 of other expense and $3,000 of tax adjustments resulting in income before taxes of $1,106,000.\nCorporate Corporate general and administrative expenses were $1,076,000 in 1993. The major components of general and administrative expense include the management fee paid to Cadmus the compensation accrual related to the Bickford's Phantom Stock Option Plan, legal expense, corporate and Bickford's audit expense and shareholder services and financial reporting expense. Interest expense was $1,334,000, consisting of senior bank debt interest of $594,000 and senior subordinated note interest of $740,000. In addition, the Company recorded other expense of $5,000 and a consolidated tax provision of $345,000 at the corporate level.\nEarnings Per Share Earnings per share for the year ended December 31, 1993 were $0.72 ($0.69 per share fully diluted). The weighted average number of shares outstanding for 1993 was 5,947,000 (6,234,000 shares fully diluted).\nCOMPARISON OF 1995 RESULTS TO 1994 RESULTS\nThe 1995 sales increased $12,251,000, or 19.6%, gross profit increased $1,344,000, or 9.0%, selling, general and administrative expense increased $854,000, or 12.9% and depreciation and amortization increased $412,000 or 23.0% resulting in an operating income increase of $78,000 or 1.2% in each case as compared to the corresponding period in 1994. Interest expense increased by $341,000, or 23.9%, interest income increased by $117,000, other income and expense increased from expense of $41,000 in 1994 to income of $65,000 in 1995 and income taxes increased by $148,000, or 40.4% resulting in a decrease in net income of $188,000, or 4.0%.\nRestaurant Division Restaurant sales increased by $10,879,000, or 25.1%, in 1995. The sales increase is attributable to a decrease in the same store sales of $152,000 offset by the addition of new restaurants which added $11,031,000 to 1995 sales. The 1995 sales increase due to new restaurants consisted of $8,112,000 from the fourteen Abdow's, $873,000 from the two Abdow's converted in 1995 and $2,046,000 from other new Bickford's. Same store restaurant sales decreased by $152,000, or .4% mainly due to the inclusion of a 53rd week in 1994 which added $763,000 to those restaurants 1994 sales. The original thirty Bickford's acquired in 1991 had a sales increase of $405,000, or 1.3%, the nine other comparable Bickford's including the five converted Howard Johnson's had a sales decrease of $494,000, or 5.1%, while the one remaining Howard Johnson's unit had a sales decline of $63,000, or 4.1%. Included in the above comparisons is the effect of the fifty-third week in 1994 which added sales of $582,000, $155,000 and $26,000 to the original thirty Bickford's, the nine other comparable Bickford's and the one remaining Howard Johnson Restaurant, respectively. Excluding the 53rd week from 1994 sales, the same store restaurant sales increased by $611,000, or 1.5%.\nThe original thirty Bickford's, the nine other comparable Bickford's and the one Howard Johnson's Restaurant had a decrease in customer counts of 1.8%, 7.6% and 9.8%, respectively. Excluding the 53rd week from 1994, the original thirty Bickford's, the nine other comparable Bickford's and the one Howard Johnson's Restaurant had an increase (decrease) in customer counts of .1%, (6.2)% and (8.3)%, respectively. The last Howard Johnson's Restaurant is located near one of the\nthree Bickford's licensed to an unrelated third party and may not be converted into a Bickford's. Management is continuing to focus on improving sales at all Restaurants through attention to customer service, food quality, new menu items and Restaurant refurbishments.\nRestaurant gross profit increased by $1,384,000, but declined as a percentage of sales from 21.1% in 1994 to 19.4% in 1995. The main factor in the 1.7% decline in the gross profit percentage was a 1.5% increase in food costs as a percentage of sales primarily attributable to the Abdow's. It is anticipated that upon conversion of the Abdow's into Bickford's that the food cost as a percentage of sales will decline to the Bickford's level thereby increasing the gross profit percentage. The Bickford's food costs increased as a percentage of sales as a result of the sale of higher-cost dinner items and an increase in the cost of individual food items including eggs, bacon and sausage partially offset by a decline in coffee costs. In addition to the food cost increase, variable costs as a percentage of sales increased by .4% in 1995. Labor costs as a percentage of sales declined by .2% from 34.6% to 34.4% despite higher labor costs as a percentage of sales at the sixteen Abdow's. The sixteen Abdow's (including the two converted into Bickford's) had labor costs as a percentage of sales of 37.2%. Management does not intend to reduce the labor costs immediately upon conversion of the Abdow's into Bickford's and will evaluate the benefits of additional labor as evidenced by the excellent service reputation historically enjoyed by the Abdow's. However, as management intends to keep up to six of the acquired restaurants operating as lower margin Abdow's, the overall margins will continue to be negatively influenced by the Abdow's.\nRestaurant selling, general and administrative expense increased by $327,000 during 1995 over 1994 mainly as a result of adding additional support personnel as a result of the acquisition of the Abdow's.\nRestaurant depreciation and amortization increased by $373,000 during 1995 compared to 1994. Restaurant depreciation and amortization will continue to increase each year with the addition of new Restaurants or until such time as assets valued and recorded at the date of the restaurant acquisition in July 1991 become fully depreciated. The equipment acquired in that acquisition has a seven year useful life, and will become fully depreciated in 1998.\nAs a result of the above, Restaurant operating income increased by $684,000 in 1995 compared to the fifty three weeks ended December 31, 1994. Management estimates that the inclusion of a 53rd week in 1994 added approximately $200,000 to operating income that year.\nCues Division. Cues's sales increased by $1,372,000, or 7.2%, in 1995 compared to 1994. As a percentage of sales, Cues's gross profit declined by 2.3% in 1995 compared to 1994 causing gross profit to decrease by $40,000. Operating income was negatively impacted by an increase in selling, general and administrative expense of $279,000 and an increase in depreciation and amortization expense of $39,000. As a result of the above, operating income decreased by $358,000 in 1995 compared to 1994. Management anticipates that gross and operating margins will continue to experience pressure in 1996 due to the fact that Cues's customers continue to stress pricing factors in awarding contracts through the competitive bidding process.\nCorporate. Corporate general and administrative expenses increased by $248,000 during 1995 as compared to 1994, mainly due to an increase in the Bickford's management compensation accrual related to its Phantom Stock Option Plan. Interest expense increased by $320,000 in 1995 compared to 1994, due to a higher average debt balance in 1995 partially offset by a decrease in interest rates in 1995. The higher average debt balance in 1995 was the result of spending approximately $3.8 million to purchase Abdow's Restaurants and $7.4 million to purchase the Company's common stock, warrants to purchase common stock and subordinated notes at the end of 1994 and beginning of 1995. The bank interest rate applicable to Company borrowing was 1% above the prime lending rate or 9.5% at December 31, 1995 and 1.5% above the prime lending rate or 10.0% at December 31, 1994.\nCOMPARISON OF 1994 RESULTS TO 1993 RESULTS\nThe 1994 sales increased $6,741,000, or 12.1%, gross profit increased $639,000, or 4.5%, selling, general and administrative expense increased $224,000, or 3.5% and depreciation and amortization increased $205,000 or 12.9% resulting in an operating income increase of $210,000 or 3.3% in each case as compared to the corresponding period in 1993. Interest expense decreased by $227,000, or 13.7%, interest income increased by $8,000, or 100%, other expense decreased by $39,000, or 48.8% and income taxes increased by $18,000, or 5.2% resulting in an increase in net income of $466,000, or 10.9%.\nRestaurant Division Restaurant sales increased by $4,488,000, or 11.5%, in 1994, which, included a 53rd week. Including the 53rd week in 1994, the original thirty Bickford's acquired in 1991 had a sales increase of $1,791,000, or 6.1%, and the five converted Howard Johnson's had a sales increase of $399,000, or 6.6%, while the one remaining Howard Johnson's unit had a sales decline of $51,000, or 3.2%. New Restaurants accounted for the remaining portion of the sales increase, totalling $2,349,000. The sales increase is mainly attributable to an increase in the average guest check ($1,694,000), the addition of new restaurants ($2,375,000) and the inclusion of a 53rd week in 1994 ($810,000), partially offset by a customer count decline ($391,000). Including the 53rd week, the original thirty Bickford's had a 1.5% increase in customer counts, the five converted Howard Johnson's Restaurants had a 1.8% increase in customer counts, while the one Howard Johnson's Restaurant had a 7.1% decline in customer counts.\nRestaurant gross profit increased by $406,000, but declined as a percentage of sales from 22.5% in 1993 to 21.1% in the 53 weeks ended December 31, 1994. The main factor in the 1.4% decline in the gross profit percentage was a .8% increase in food costs as a percentage of sales, which was primarily attributable to the sale of higher-cost dinner items and an increase in coffee prices during 1994. Other factors that contributed to the decrease in the gross margin were a .4% increase in labor costs due to increases in taxes, medical insurance and workers compensation insurance premiums and a .4% increase in fixed costs consisting mainly of increases in real estate taxes as a result of receiving and recording in 1993 tax abatements for 1993 and prior years.\nRestaurant selling, general and administrative expense increased by $45,000 during 1994 over 1993. No individual items represented a major portion of the increase.\nRestaurant depreciation and amortization increased by $172,000 during 1994 compared to 1993.\nAs a result of the above, Restaurant operating income increased by $189,000 for the 53 weeks ended December 31, 1994 compared to 1993. Management estimates that the inclusion of a 53rd week in 1994 added approximately $200,000 to operating income that year.\nCues Division Cues's sales increased by $2,253,000, or 13.4%, in 1994 compared to 1993. As a percentage of sales, Cues's gross profit declined by 2.7% in 1994 compared to 1993. Despite the decline in the gross profit percentage, Cues's gross profit increased by $233,000. This was partially offset by a $64,000 increase in selling, general and administrative expense and a $33,000 increase in depreciation and amortization expense. As a result of the above, operating income increased by $136,000 in 1994 compared to 1993.\nCorporate Corporate general and administrative expenses increased by $115,000 during 1994 as compared to 1993, mainly due to an increase in the Bickford's management compensation accrual related to its Phantom Stock Option Plan, an increase in professional fees and corporate move-related costs. Interest expense decreased by $206,000 in 1994 as compared to 1993, due to lower debt balances partially offset by a higher average bank interest borrowing rate in 1994. The borrowing rate remained at prime plus 1.5% during 1994, however the prime rate increased by 2.5% from 6% at January 1, 1994 to 8.5% at December 31, 1994.\nACQUISITIONS\nOn July 3, 1995, ELXSI acquired 16 Abdow's Family Restaurants from Abdow Corporation of Springfield, MA for a price of approximately $3,800,000 including estimated expenses of $300,000. The transaction includes the leasing of 16 restaurant sites and the purchase of associated assets located in western Massachusetts and central Connecticut. On February 1, 1996, ELXSI completed its sales of the Vernon, Connecticut Abdow's restaurant for net proceeds of $1,225,000.\nELXSI purchased Cues on October 30, 1992. In connection with the acquisition, the Company issued 751,000 shares of it's Common Stock valued at $4.25 per share and a Series C Warrant to purchase an additional 68,762 common shares at $4.36 per share to the former parent of Cues. In addition, ELXSI borrowed $4,211,000 on its amended bank line of credit to pay the outstanding debt of Cues to its former parent. The acquisition was accounted for as a purchase and the results of Cues are included in the consolidated statement of operations from the date of acquisition. The excess of the cost over the fair value of net assets acquired of $3,690,000 is being amortized on a straight line basis over 35 years. The acquisition included all of the assets and liabilities of Cues, and its subsidiaries. The shares and warrants issued in this acquisition were subsequently distributed by Cues's former parent to is stockholders, including Milley Management, Inc.\nOn July 1, 1991, ELXSI acquired the Restaurants, which are located in Massachusetts, Vermont, New Hampshire, Rhode Island and Connecticut, from Marriott for a purchase price of approximately $23,867,000, including fees. The Bickford's and Howard Johnson's are family oriented restaurants with a wide ranging, moderately priced menu, with a focus on breakfast fare.\nINCOME TAXES AND INFLATION\nIn 1995, the Company recorded a provision for federal alternative minimum taxes of $118,000 (after the benefit of federal net operating loss carryforwards of $1,619,000), and a state income tax provision of $396,000 (after the benefit of state net operating loss carryforwards). In 1994, the Company recorded a provision for federal alternative minimum taxes of $88,000 (after the benefit of federal net operating loss carryforwards of $1,526,000), and a state income tax provision of $278,000 (after the benefit of state net operating loss carryforwards). In 1993, the Company recorded a provision for federal alternative minimum taxes of $116,000 (after the benefit of federal net operating loss carryforwards of $1,615,000), and a state income tax provision of $232,000 (after the benefit of state net operating loss carryforwards). Approximately one-half of ELXSI's consolidated taxable income is apportioned to Massachusetts. The final year that the net operating loss is available to ELXSI to offset Massachusetts taxable income was 1994 because the five year Massachusetts carryforward period expired in 1995. During 1994 and 1993, ELXSI would have recorded a provision for additional state income taxes of $190,000 and $230,000, respectively, had the Massachusetts net operating loss carryforwards not been available. At December 31, 1995, the Company had approximately $221,000,000 in federal net operating loss carryforwards, which begin to expire in 1997 if not used. In addition, the Company had $6,500,000 in investment tax credit and research and development credit carryforwards available to reduce future federal income taxes.\nInflation and changing prices have not had a material impact on the Company's results of operations.\nLIQUIDITY AND CAPITAL RESOURCES\nAvailable Resources The Company's consolidated unrestricted cash positions at December 31, 1995 and 1994 were $0. The Company has instituted a cash management system whereby the net cash generated by operations is immediately used to reduce bank debt. The immediate reduction of outstanding debt provides the Company with a reduction in interest expense greater than the interest income that the cash could earn from alternative investments. Working capital needs, when they arise, are met by daily borrowings.\nDuring 1995, the Company had cash flow from operations before working capital and other changes of $7,032,000. Working capital changes and other assets and liabilities decreased cash flow from operations to $4,003,000, which along with a net borrowing of $2,334,000 in long-term debt funded the purchase of property, plant and equipment totalling $2,357,000 (including the one new Restaurant opened in 1995), the net cost of acquiring the fifteen Abdow's totalling $2,575,000, the repurchase of Common Stock of $1,224,000, the payment of bank fees of $125,000 and the principal payments on capital leases of $56,000. The $2,334,000 net borrowing of long-term debt consists of borrowing of bank debt of $2,429,000, payment of other Cues's debt of $12,000 and repayment of long-term 15% Senior Subordinated Notes (\"15% Notes\") of $83,000. During 1995, current assets increased by $4,034,000 primarily due to an increase in Cues's inventory and the recording of an asset held for sale at December 31, 1995 related to the\nVernon, Connecticut Abdow's restaurant. The December 31, 1995 balance included in the asset held for sale of $1,075,000 was collected on February 1, 1996. Inventory increased due to the introduction and development of new products and an increase in equipment used for demonstrations. The increase in current assets was partially offset by an increase in current liabilities of $647,000 (excluding the current portion of the long-term debt and current portion of long-term capital leases).\nDuring 1994, the Company had cash flow from operations before working capital and other changes of $6,730,000. Working capital changes and other assets and liabilities increased cash flow from operations to $6,871,000, which along with a net borrowing of $225,000 in long-term debt funded the acquisition of property, plant and equipment totalling $2,363,000 (including the two new Restaurants opened in 1994), a loan to ELX Limited Partnership (\"ELX\") of which Alexander M. Milley is the sole general partner of $1,156,000, the repurchase of Common Stock and seven-year Series A Warrants to purchase Common Stock of $3,499,000 and the payment of bank fees of $109,000. The $225,000 net borrowing of long-term debt consists of borrowing of bank debt of $3,427,000, borrowing of other Cues's debt of $19,000 and repayment of long-term 14.5% Senior Subordinated Notes (\"14.5% Notes\") and 15% Notes of $3,221,000. During 1994, current assets increased by $286,000 primarily due to an increase in Cues's inventory partially offset by a decline in Cues's accounts receivable and a decrease in Bickford's Division prepaid expenses. Inventory increased due to increased monthly production volume caused by increased sales orders at Cues and the introduction and development of new products. The increase in current assets was partially offset by an increase in current liabilities of $136,000 (excluding the current portion of the long-term debt and current portion of long-term capital leases).\nDuring 1993, the Company had cash flow from operations before working capital and other changes of $6,032,000. Working capital changes and other assets and liabilities reduced cash flow from operations to $4,023,000, which funded the acquisition of property, plant and equipment totalling $1,856,000 (including the three new Restaurants opened in 1993), the payment of long-term bank debt of $1,946,000, the payment of other Cues debt of $189,000 and the payment of capital leases obligations of $32,000. During 1993, current assets increased by $2,675,000 primarily due to an increase in Cues's accounts receivable and inventory. The increase in accounts receivable was mainly attributable to current accounts receivable (i.e., those accounts less than 30 days old), which increased by $571,000 at December 31, 1993 as compared to December 31, 1992. The percentage of accounts greater than sixty days old decreased from 26% at December 31, 1992 to 24% at December 31, 1993. Cues's inventory increased due to increased monthly production volume caused by increased sales orders and the introduction and development of new products. The increase in current assets was partially offset by an increase in current liabilities of $813,000.\nFuture Needs For and Sources of Capital Management believes that cash generated by operations is sufficient to fund current operations including the interest payments on the senior bank debt and interest payments on the remaining $1,187,000 of 14.5% Notes and 15% Notes. With bank approval, excess funds are available under the Company's loan Agreement to finance additional acquisitions.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe Consolidated Financial Statements of the Company for each of the fiscal years in the three-year period ended December 31, 1995, together with the report thereon of Price Waterhouse LLP dated March 21, 1996 are filed as part of this report commencing on page.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThe Company did not change its independent accountants during the year nor were there any disagreements with such accountants on accounting principals or practices, financial 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 under this item is incorporated herein by reference from the ELXSI Corporation Proxy Statement to be filed within 120 days after December 31, 1995 for the annual Meeting of Stockholders to be held May 22, 1996.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required under this item is incorporated herein by reference from the ELXSI Corporation Proxy Statement to be filed within 120 days after December 31, 1995 for the annual Meeting of Stockholders to be held May 22, 1996.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required under this item is incorporated herein by reference from the ELXSI Corporation Proxy Statement to be filed within 120 days after December 31, 1995 for the annual Meeting of Stockholders to be held May 22, 1996.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required under this item is incorporated herein by reference from the ELXSI Corporation Proxy Statement to be filed within 120 days after December 31, 1995 for the annual Meeting of Stockholders to be held May 22, 1996.\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:\nIndex to Consolidated Financial Statements - ------------------------------------------ Page 1. Financial Statements Number(s) --------- Report of Independent Certified Public Accountants Consolidated Balance Sheets at December 31, 1995 and 1994 to Consolidated Income Statements for the three years ended December 31, 1995 Consolidated Statements of Stockholders' Equity for the three years ended December 31, 1995 Consolidated Statements of Cash Flows for the three years ended December 31, 1995 to Notes to Consolidated Financial Statements to\n2. Financial Statement Schedules\nSchedule Number Description Page ------ ----------- ---- VIII Valuation and Qualifying Accounts and Reserves S-1\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 Number Description - ------ -----------\n2.1 Agreement and Plan of Merger by and among ELXSI Corporation, ELXSI, Cadmus Corporation and Holdingcues, Inc. dated as of October 16, 1992, including form of Series C Warrant. (Incorporated herein by reference to Exhibit 2.7 of the Company's Current Report on Form 8-K as filed November 13, 1992 (File No 0-11877)).\n2.2 Family Restaurant Sale and Purchase Agreement, between Marriott Family Restaurants Inc. (\"Marriott\") and the Company dated February 28, 1991. (Incorporated herein by reference to Exhibit 2.1 of the Company's Current Report on Form 8-K, dated July 16, 1991 (File No. 0-11877)).\n2.3 Side Letter to the Family Restaurant Sale and Purchase Agreement between Marriott and the Company dated February 28, 1991. (Incorporated herein by reference to Exhibit 2.2 of the Company's Current Report on Form 8-K, dated July 16, 1991 (File No. 0-11877)).\n2.4 Assignment and Guaranty of Family Restaurants Sale and Purchase Agreement and Side Letter, between the Company, Marriott and ELXSI dated June 29, 1991. (Incorporated herein by reference to Exhibit 2.3 of the Company's Current Report on Form 8-K, dated July 16, 1991 (File No. 0-11877)).\n2.5 Closing Side Letter Agreement Regarding Family Restaurants Sale and Purchase Agreement between ELXSI and Marriott dated July 1, 1991. (Incorporated herein by reference to Exhibit 2.4 of the Company's Current Report on Form 8-K, dated July 16, 1991 (File No. 0- 11877)).\n2.6 Real Estate Closing Side Letter Agreement Regarding Family Restaurants Sale and Purchase Agreement between ELXSI and Marriott dated July 1, 1991. (Incorporated herein by reference to Exhibit 2.5 of the Company's Current Report on Form 8-K, dated July 16, 1991 (File No. 0-11877)).\n2.7 Agreement Concerning Massachusetts and Connecticut Liquor Licenses between ELXSI and Marriott dated July 1, 1991. (Incorporated herein by reference to Exhibit 2.6 of the Company's Current Report on Form 8-K, dated July 16, 1991 (File No. 0-11877)).\n3.1 Restated Certificate of Incorporation of the Company, as amended. (Incorporated herein by reference to Exhibit 3.1 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 (file No. 0-11877)).\n3.2 Certificate of Amendment of Restated Certificate of Incorporation of the Company dated May 27, 1992. (Incorporated herein by reference to Exhibit 3.2 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (file No. 0-11877)).\n3.3 Bylaws of the Company. (Incorporated herein by reference to Exhibit 3.1 of the Company's Registration Statement on Form S-4, as amended. (file No. 0-11877)).\n4.1 Series A Warrant No. A-4 to purchase 50,000 shares of Common Stock issued to MMI. (Incorporated herein by reference to Exhibit 4.1 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (file No. 0-11877)).\n4.2 Series A Warrant No. A-6 to purchase 150,500 shares of Common Stock issued to the Alexander M. Milley Irrevocable Trust I U\/A dated May 9, 1994. (Incorporated herein by reference to Exhibit 4.2 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (file No. 0-11877)).\n4.3 Series B Warrant No. B-1 to purchase 604,656 shares of Series A Non-Voting Convertible Preferred Stock issued to CIEC. (Incorporated herein by reference to Exhibit 4.6 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 (file No. 0-11877)).\n4.4 Series C Warrant No. C-2 to purchase 68,762 shares of Common Stock issued to MMI. (Incorporated herein by reference to Exhibit 4.4 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (file No. 0-11877)).\n4.5 Amended and Restated Registration Rights Agreement dated as of January 23, 1990 among the Company, M&C and CIEC. (Incorporated herein by reference to Exhibit 4.7 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 (file No. 0-11877)).\n4.6 Exercise of option and Assignment of Registration Rights executed by ELX and Airlie dated November 30, 1994. (Incorporated herein by reference to Exhibit 4.6 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (file No. 0- 11877)).\n4.7 15% Senior Subordinated Note issued by the Company to CIEC in the amount of $401,765.00. (Incorporated herein by reference to Exhibit 10.18 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 (file No. 0-11877)).\n4.8 14.5% Senior Subordinated Note issued by the Company to CIEC in the amount of $502,206.25 dated June 27, 1991. (Incorporated herein by reference to Exhibit 4.8 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (file No. 0-11877)).\n4.9 Amended and Restated Loan and Security Agreement, dated as of October 30, 1992 between ELXSI and Continental Bank N.A. (now Bank of America Illinois). (Incorporated herein by reference to Exhibit 10.21 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1992 (file No. 0-11877)).\n4.10 First Amendment to Amended and Restated Loan and Security Agreement, dated as of February 4, 1993 between ELXSI and Bank of America Illinois (formerly Continental Bank N.A.) (Incorporated herein by reference to Exhibit 4.10 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (file No. 0-11877)).\n4.11 Second Amendment to Amended and Restated Loan and Security Agreement, dated as of December 6, 1994 between ELXSI and Bank of America Illinois (formerly Continental Bank N.A.) (Incorporated herein by reference to Exhibit 4.11 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (file No. 0-11877)).\n4.12 14.5% Senior Subordinated Note issued by the Company to Pan Fixed Income Fund, Ltd., dated as of November 16, 1993 in the amount of $250,000. (Incorporated herein by reference to Exhibit 4.12 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (file No. 0-11877)).\n4.13 14.5% Senior Subordinated Note issued by the Company to Rona Jaffe, dated as of November 16, 1993 in the amount of $100,000. (Incorporated herein by reference to Exhibit 4.13 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (file No. 0-11877)).\n4.14 14.5% Senior Subordinated Note issued by the Company to Anne Strassler A.C.S.W. P.C., dated as of November 16, 1993 in the amount of $25,000. (Incorporated herein by reference to Exhibit 4.14 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (file No. 0-11877)).\n4.15 Third Amendment to Amended and Restated Loan and Security Agreement, dated as of January 25, 1995 between ELXSI and Bank of America Illinois (formerly Continental Bank N.A.)\n4.16 Fourth Amendment to Amended and Restated Loan and Security Agreement, dated as of May 25, 1995 between ELXSI and Bank of America Illinois (formerly Continental Bank N.A.)\n4.17 Fifth Amendment to Amended and Restated Loan and Security Agreement, dated as of July 3, 1995 between ELXSI and Bank of America Illinois (formerly Continental Bank N.A.)\n10.1 The Company's 1987 Incentive Stock Option Plan as amended. (Incorporated by reference to Exhibit 10.1 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1987 (file No. 0-11877)).\n10.2 The Company's 1987 Supplemental Stock Option Plan as amended. (Incorporated by reference to Exhibit 10.2 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1987 (file No. 0-11877)).\n10.3 The Company's 1993 Incentive Stock Option Plan. (Incorporated herein by reference to Exhibit 10.3 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (file No. 0-11877)).\n10.4 The ELXSI 1991 Phantom Stock Option Plan for the management of the Bickford's Division. (Incorporated herein by reference to Exhibit 10.4 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (file No. 0-11877)).\n10.5 Amendment No. 1 to the ELXSI 1991 Phantom Stock Option Plan for the management of the Bickford's Division. (Incorporated herein by reference to Exhibit 10.5 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (file No. 0- 11877)).\n10.6 Promissory Note of ELX Limited Partnership payable to the Company dated December 8, 1994 in the amount of $1,155,625.00 due December 8, 1997. (Incorporated herein by reference to Exhibit 10.6 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (file No. 0-11877)).\n10.7 Non-Qualified Stock Option Agreement issued to Robert C. Shaw for the purchase of 12,500 shares of Common Stock, dated October 30, 1992. (Incorporated herein by reference to Exhibit 10.7 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (file No. 0-11877)).\n10.8 Non-Qualified Stock Option Agreement issued to John C. Savage for the purchase of 10,000 shares of Common Stock, dated October 30, 1992. (Incorporated herein by reference to Exhibit 10.8 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (file No. 0-11877)).\n10.9 Non-Qualified Stock Option Agreement issued to Farrokh K. Kavarana for the purchase of 10,000 shares of Common Stock, dated October 30, 1992. (Incorporated herein by reference to Exhibit 10.9 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (file No. 0-11877)).\n10.10 Non-Qualified Stock Option Agreement issued to Kevin P. Lynch for the purchase of 20,000 shares of Common Stock, dated October 30, 1992. (Incorporated herein by reference to Exhibit 10.10 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (file No. 0-11877)).\n10.11 Non-Qualified Stock Option Agreement issued to Alexander M. Milley for the purchase of 30,000 shares of Common Stock, dated October 30, 1992. (Incorporated herein by reference to Exhibit 10.11 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (file No. 0-11877)).\n10.12 Non-Qualified Stock Option Agreement issued to Thomas R. Druggish for the purchase of 30,000 shares of Common Stock, dated October 30, 1992. (Incorporated herein by reference to Exhibit 10.12 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (file No. 0-11877)).\n10.13 Stock and Note Purchase Agreement dated as of August 31, 1989 by and among the Company, Airlie and M&C. (Incorporated herein by reference to Exhibit 2.1 of the Company's Current Report on Form 8-K as filed October 3, 1989 (File No 0-11877)).\n10.14 Stock and Note Purchase Agreement dated as of January 23, 1990 among Airlie, CIEC and M&C. (Incorporated herein by reference to Exhibit 10.14 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (file No. 0-11877)).\n10.15 Management Agreement (\"Management Agreement\") between Winchester National, Inc. (d\/b\/a as M&C) and the Company dated September 25, 1989. (Incorporated herein by reference to Exhibit 10.21 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991 (file No. 0-11877)).\n10.16 Assignment of Management Agreement dated June 28, 1991 among the Company, Winchester National, Inc., ELXSI and MMI. (Incorporated herein by reference to Exhibit 10.16 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (file No. 0-11877)).\n10.17 Management Agreement Extension dated September 25, 1992 between ELXSI and MMI. (Incorporated herein by reference to Exhibit 10.17 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (file No. 0-11877)).\n10.18 Assignment to Cadmus on January 1, 1994 of MMI's rights under the extended Management Agreement dated September 25, 1992 between ELXSI and MMI. (Incorporated herein by reference to Exhibit 10.18 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (file No. 0-11877)).\n10.19 The Company's 1995 Incentive Stock Option Plan. (Incorporated herein by reference to Form S-8 filed with the commission on November 14, 1995. (file No. 0-11877)).\n21.1 Subsidiaries of the Company. (Incorporated by reference to Exhibit 22.1 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990 (file No. 0- 11877)).\n23.1 Consent of Price Waterhouse LLP\n27 Financial Data Schedule\n(b) Reports on Form 8-K\nIn connection with the acquisition of sixteen Abdow's Family Restaurants from Abdow Corporation of Springfield, MA, the Company filed a current report on Form 8-K dated July 3, 1995.\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.\nELXSI CORPORATION\nBY: \/s\/ Alexander M. Milley ------------------------------------------- Alexander M. Milley Chairman of the Board, President and Chief Executive Officer\nDated: March 25, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, 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\/ Alexander M. Milley Chairman of the Board, March 25, 1996 - ------------------------------ Alexander M. Milley President and Chief Executive Officer (Principal Executive Officer)\n\/s\/ Robert C. Shaw Director and Vice President March 25, 1996 - ------------------------------ Robert C. Shaw\n\/s\/ Thomas R. Druggish Vice President, Treasurer March 25, 1996 - ------------------------------ and Secretary (Chief Thomas R. Druggish Accounting Officer and Principal Financial Officer)\n\/s\/ Kevin P. Lynch Director and Vice President March 25, 1996 - ------------------------------ Kevin P. Lynch\n\/s\/ Farrokh K. Kavarana Director March 25, 1996 - ------------------------------ Farrokh K. Kavarana\n\/s\/ John C. Savage Director March 25, 1996 - ------------------------------ John C. Savage\nReport of Independent Certified Public Accountants\nTo the Board of Directors and Shareholders of ELXSI Corporation\nIn our opinion, the consolidated financial statements listed in the index appearing under Item 14(a)(1) and (2) on page 22, present fairly, in all material respects, the financial position of ELXSI Corporation and its subsidiary at December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995, 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.\n\/s\/ Price Waterhouse LLP Price Waterhouse LLP\nOrlando, Florida March 21, 1996\nELXSI CORPORATION CONSOLIDATED BALANCE SHEETS (Dollars in Thousands)\nA S S E T S\nDecember 31, December 31, 1995 1994 ----------- ----------- Current assets:\nAccounts receivable, less allowance for doubtful accounts of $58 and $35 in 1995 and 1994, respectively $ 2,776 $ 2,278\nInventories 8,477 6,208\nPrepaid expenses and other current assets 397 205\nAsset held for sale 1,075 -- --------- ---------\nTotal current assets 12,725 8,691\nProperty, buildings and equipment, net 27,458 24,275\nIntangible assets, net 5,703 5,891\nDeferred debt costs, net 212 322\nNote receivable - related party 1,156 1,156\nOther 445 181 --------- ---------\nTotal assets $ 47,699 $ 40,516 ========= =========\nThe accompanying notes are an integral part of these consolidated financial statements.\nELXSI CORPORATION CONSOLIDATED BALANCE SHEETS (Dollars in Thousands, Except Per Share Data)\nLIABILITIES AND STOCKHOLDERS' EQUITY\nDecember 31, December 31, 1995 1994 ----------- ----------- Current liabilities: Accounts payable and drafts payable $ 4,269 $ 4,016 Accrued expenses 4,396 4,002 Capital lease obligations - current 137 33 Current portion of long-term debt 1,485 1,063 --------- ---------\nTotal current liabilities 10,287 9,114\nCapital lease obligations - non current 1,732 1,569 Long-term debt, net of discount 11,570 9,639 Other non current liabilities 1,396 796 --------- ---------\nTotal liabilities 24,985 21,118\nCommitments and contingencies (Note 8) -- --\nStockholders' equity: Preferred Stock, Series A Non-voting Convertible, par value $0.002 per share Authorized--5,000,000 shares Issued and outstanding--none -- -- Common Stock, par value $0.001 per share Authorized--160,000,000 shares Issued and outstanding--4,792,353 at December 31, 1995 and 5,032,333 at December 31, 1994 5 5 Additional paid-in-capital 229,666 230,890 Accumulated deficit (206,895) (211,441) Cumulative foreign currency translation adjustment (62) (56) --------- ---------\nTotal stockholders' equity 22,714 19,398 --------- ---------\nTotal liabilities and stockholders' equity $ 47,699 $ 40,516 ======== =========\nThe accompanying notes are an integral part of these consolidated financial statements.\nELXSI CORPORATION CONSOLIDATED INCOME STATEMENTS (Amounts in Thousands, Except Per Share Data)\nYear Ended December 31, --------------------------------------- 1995 1994 1993 ---------- --------- ---------- Net sales $ 74,674 $ 62,423 $ 55,682\nCosts and expenses: Cost of sales 58,347 47,440 41,338 Selling, general and administrative 7,484 6,630 6,406 Depreciation and amortization 2,206 1,794 1,589 --------- --------- ---------\nOperating income 6,637 6,559 6,349\nOther income (expense): Interest income 125 8 -- Interest expense (1,767) (1,426) (1,653) Other income (expense) 65 (41) (80) --------- --------- ---------\nIncome before income taxes 5,060 5,100 4,616\nProvision for income taxes 514 366 348 --------- --------- ---------\nNet income $ 4,546 $ 4,734 $ 4,268 ========= ========= =========\nPrimary net income per common share $ 0.89 $ 0.79 $ 0.72 ========= ========= ========= Fully diluted net income per common $ 0.89 $ 0.79 $ 0.69 share ========= ========= =========\nWeighted average number of common and common equivalent shares Primary 5,093 6,014 5,947 ========= ========= ========= Fully Diluted 5,093 6,014 6,234 ========= ========= =========\nThe accompanying notes are an integral part of these consolidated financial statements.\nELXSI CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Dollars in Thousands) Cumulative Foreign Additional Accum- Currency Common Paid-In- ulated Translation Stock Capital Deficit Adjustment ------- ---------- --------- ------------ Balance at December 31, 1992 $ 5 $ 234,331 $(220,443) $ (8)\nForeign currency translation adjustment -- -- -- (27)\nNet income -- -- 4,268 -- -------- --------- --------- --------\nBalance at December 31, 1993 5 234,331 (216,175) (35)\nForeign currency translation adjustment -- -- -- (21)\nPurchase of 354,963 shares of Common Stock and warrants to purchase 761,638 shares of Common Stock -- (3,499) -- --\nExercise of Common Stock options to purchase 18,400 shares of Common Stock -- 58 -- --\nNet income -- -- 4,734 -- -------- --------- --------- --------\nBalance at December 31, 1994 5 230,890 (211,441) (56)\nForeign currency translation adjustment -- -- -- (6)\nPurchase of 240,000 shares of Common Stock -- (1,224) -- --\nNet income -- -- 4,546 -- -------- --------- --------- --------\nBalance at December 31, 1995 $ 5 $ 229,666 $(206,895) $ (62) ======== ========= ========= =========\nThe accompanying notes are an integral part of these consolidated financial statements.\nELXSI CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in Thousands)\nYear Ended December 31, ------------------------------- 1995 1994 1993 ------- -------- -------- Cash flows provided by operating activities:\nNet income $ 4,546 $ 4,734 $ 4,268 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 2,206 1,794 1,589 Amortization of deferred debt costs 213 126 157 Amortization of debt discount 19 90 43 Loss on disposal of equipment 54 7 2 Other (6) (21) (27)\n(Increase) decrease in assets: Accounts receivable (498) 301 (996) Inventories (2,269) (794) (1,709) Prepaid expenses and other current assets (192) 207 30 Asset held for sale (1,075) -- -- Other (242) (9) (110) Increase (decrease) in liabilities: Accounts payable and drafts payable 253 305 1,197 Accrued expenses 394 281 (671) Other current liabilities -- (450) -- Other non current liabilities 600 300 250 -------- -------- -------- Net cash provided by operating activities 4,003 6,871 4,023 -------- -------- --------\nCash flows used in investing activities:\nAcquisition of Abdow's Restaurants (2,575) -- -- Purchase of property, building and equipment(2,357) (2,363) (1,856) Note receivable - related party -- (1,156) -- -------- -------- -------- Net cash used in investing activities (4,932) (3,519) (1,856) -------- -------- --------\nThe accompanying notes are an integral part of these consolidated financial statements.\nELXSI CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued) (Dollars in Thousands)\nYear Ended December 31, ---------------------------- 1995 1994 1993 ---- ---- ----\nCash flows provided by (used in) financing activities: Net borrowing (payment) of line of credit 2,429 3,446 (2,135) Payments of long-term senior subordinated debt (83) (3,221) -- Payments of long-term debt (12) -- -- Purchase of Common Stock and warrants to purchase Common Stock (1,224) (3,499) -- Proceeds from exercise of Common Stock options -- 58 -- Payment of deferred bank fee (125) (109) -- Principal payments on capital lease obligations (56) (27) (32) ------- -------- -------- Net cash provided by (used in) financing activities 929 (3,352) (2,167) ------- -------- -------- (2,167)\nDecrease in cash and cash equivalents -- -- --\nCash and cash equivalents, beginning of period -- -- -- ------ -------- --------\nCash and cash equivalents, end of period $ -- $ -- $ -- ======== ======== ========\nSupplemental Disclosure of Cash Flow Information: Cash paid during the year for: Interest $ 1,544 $ 1,324 $ 1,482 Taxes 563 455 223\nSupplemental Disclosure of Noncash Investing and Financing Activities:\nIn September 1989, the Company recorded a $301,000 warrant discount upon issuance of $2,000,000 in senior subordinated notes. Interest expense on the Consolidated Income Statement for each of the years ended December 31, 1995, 1994 and 1993 includes $19,000, $43,000 and $43,000, respectively of amortization of this debt discount. During 1994, the Company prepaid a portion of the senior subordinated notes and wrote off an additional $47,000 of the debt discount, which is included in interest expense during 1994.\nThe accompanying notes are an integral part of these consolidated financial statements.\nELXSI CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1995\nNOTE 1. The Company\nGeneral Prior to 1990, ELXSI Corporation (together with its subsidiary, the \"Company\") operated principally through its wholly-owned California subsidiary, ELXSI. During that period, the principal business of ELXSI was the design, manufacture, sale and support of minisupercomputers. In July 1989, the Company announced a major restructuring of its computer operations. In September 1989, the Company discontinued all computer operations.\nIn September 1989 and January 1990, the Company entered into agreements with, and between, The Airlie Group L.P. (\"Airlie\"), Continental Illinois Equity Corporation (\"CIEC\") and Milley & Company (\"M&C\"), (hereinafter referred to collectively as the \"Buyers\") whereby the Buyers acquired 960,000 shares of the Company's Common Stock for $3,000,000 in cash. In addition, the Buyers loaned the Company $2,000,000 (see Note 6). Subsequent to these transactions, the Company announced its intention of pursuing an active program of identifying, acquiring and managing middle market companies.\nOn July 1, 1991, ELXSI acquired thirty Bickford's Restaurants and twelve Howard Johnson's Restaurants, which are located in Massachusetts, Vermont, New Hampshire, Rhode Island and Connecticut , from Marriott Family Restaurants, Inc.\nDuring 1992, ELXSI sold six of its Howard Johnson's Restaurants, converted four others into Bickford's Restaurants and opened one new Bickford's Restaurant. During 1993, ELXSI opened three new Bickford's Restaurants. During 1994, ELXSI opened two new Bickford's Restaurants and converted one of its two remaining Howard Johnson's Restaurants into a Bickford's Restaurant. During 1995, ELXSI opened one new Bickford's Restaurant, acquired sixteen Abdow's Family Restaurants (\"Abdows\") and converted two of the Abdows into Bickford's Restaurants. As of December 31, 1995, ELXSI operated forty-four Bickford's, fourteen Abdows and one Howard Johnson's Restaurant, (the \"Restaurants\" or the \"Restaurant Division\").\nOn October 30, 1992, ELXSI acquired Cues, Inc. of Orlando, Florida and its two wholly-owned subsidiaries Knopafex, Ltd., a Canadian company, and Cues B.V., a Dutch company, together referred to as (\"Cues\").\nCues is engaged in the manufacture and servicing of video inspection and repair equipment for wastewater and drainage systems primarily for governmental municipalities, service contractors and industrial users.\nNOTE 2. Summary of Significant Accounting Policies\nPrinciples of Consolidation The consolidated financial statements include the accounts of ELXSI Corporation and its wholly-owned subsidiary. All material intercompany accounts and transactions have been eliminated.\nBoth the Company's corporate functions and Cues Division have fiscal years consisting of four calendar quarters ending on December 31. The Restaurant Division's fiscal year consists of four 13-week quarters (one 52-week period) ending on the last Saturday in December closest to the 31; however, this requires that every six or seven years the Restaurant Division add an extra week at the end of the fourth quarter and fiscal year.\nCash and Cash Equivalents The Company has instituted a cash management system whereby cash generated by operations is immediately used to reduce debt. Accordingly the Company maintains no cash or cash equivalents.\nFair Value of Financial Instruments The carrying amount of accounts and note receivable, asset held for sale, accounts and drafts payable, accrued expenses and long-term debt approximates fair value because of the short maturity of those instruments and the variable nature of the interest rates associated with the debt.\nInventories Inventories are stated at the lower of cost or market determined by the first-in, first-out method.\nProperty, Buildings and Equipment Property, buildings and equipment, including buildings under capital leases, are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are provided using the straight-line method for book purposes. Buildings held pursuant to capital leases are amortized over the shorter of the term of the respective lease including options or the estimated useful life. The estimated lives used are:\nBuildings and improvements 30 years Equipment, furniture and fixtures 7 years\nDepreciation and amortization expense for 1995, 1994 and 1993 was $2,018,000, $1,614,000 and $1,409,000, respectively.\nIntangibles The excess of cost over fair value of net assets acquired is being amortized over 35 years using the straight-line method. Amortization expense for 1995, 1994 and 1993 was $153,000, $151,000 and $151,000, respectively. Management periodically reviews the potential impairment of intangible assets in order to determine the proper carrying value of such intangible assets as of each consolidated balance sheet presented.\nTrademarks are being amortized over 35 years using the straight-line method. Amortization expense for 1995, 1994 and 1993 was $35,000, $29,000 and $29,000, respectively.\nDeferred Debt Costs Deferred debt costs are amortized over the term of the loan to interest expense using the effective interest method. As of December 31, 1995 and 1994, $212,000 and $322,000, respectively remain to be amortized over future periods. Amortization expense in 1995, 1994 and 1993 was $213,000, $126,000 and $157,000, respectively.\nUse of Estimates The preparation of consolidated 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 consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nForeign Currency Translation The assets and liabilities of the Canadian and Dutch subsidiaries of Cues are translated into U.S. dollars at year end exchange rates, and revenue and expense items are translated at average rates of exchange prevailing during the year. Resulting translation adjustments are accumulated in a separate component of stockholders' equity.\nIncome Taxes The Company has adopted Statement of Financial Accounting Standards Number 109 \"Accounting For Income Taxes\" (\"SFAS 109\"). This Statement provides for accounting for taxes under an asset and liability approach. This approach requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax basis of other assets and liabilities. Temporary differences giving rise to deferred tax assets and liabilities include certain accrued liabilities and net operating loss carryforwards. The provision for income taxes includes the amount of income taxes payable for the year as determined by applying the provisions of the current tax law to the taxable income for the year and the net change during the year in the Company's deferred tax assets and liabilities (see Note 5).\nAdvertising Advertising costs, included in selling, general and administrative expense, are expensed as incurred and were $862,000, $753,000 and $558,000 in 1995, 1994 and 1993.\nNet Income Per Common Share Net income per common share is computed using the weighted average number of common and, when dilutive, common equivalent shares outstanding during the respective periods.\nNOTE 3. Acquisitions\nOn July 3, 1995, ELXSI acquired Abdow's Family Restaurants from Abdow Corporation of Springfield, MA, for a price of approximately $3,800,000 including estimated expenses of approximately $300,000. The transaction includes the leasing of 16 restaurant sites and the purchase of associated assets located in western Massachusetts and central Connecticut. ELXSI intends to convert most of the Abdows locations into Bickford's Restaurants over the next 12 to 18 months. Shortly after the acquisition, ELXSI negotiated the sale of the Vernon, Connecticut Abdow's Restaurant for a net sales price of approximately $1,225,000, which approximated the fair market value of the Restaurant on the date of its acquisition by ELXSI. The balance receivable from the sale is reflected as an asset held for sale at December 31, 1995. The balance of the purchase price of $2,575,000 was allocated to the equipment, leasehold improvements and leasehold interests of the remaining fifteen Abdow's restaurants. The sale of the Vernon Connecticut, Abdows Restaurant was consummated on February 1, 1996.\nThe acquisition was financed by an increase in ELXSI's existing line of credit with the Bank of America Illinois, which was extended to June 30, 1997. The total available credit on July 3, 1995 was increased to $15,840,000. The minimum monthly reductions in available credit were increased from $220,000 per month to $280,000 per month from July to December 1995 and $3,330,000 annually thereafter.\nNOTE 4. Composition of Certain Financial Statement Components\nYear Ended December 31, ------------------------------ 1995 1994 ------------ ------------ Inventories: Raw materials and finished goods $ 5,715,000 $ 4,191,000 Work in process 2,762,000 2,017,000 ------------ ------------ $ 8,477,000 $ 6,208,000 ============ ============\nProperty, buildings and equipment: Land $ 7,298,000 $ 7,298,000 Buildings and improvements 14,696,000 12,865,000 Buildings held pursuant to capital leases 1,671,000 1,671,000 Equipment, furniture and fixtures 10,080,000 6,855,000 ------------ ------------ 33,745,000 28,689,000 Accumulated depreciation and amortization (6,287,000) (4,414,000) ------------ ------------ $ 27,458,000 $ 24,275,000 ============ ============\nIntangible assets: Excess of cost over fair value of net assets acquired $ 5,249,000 $ 5,249,000 Trademarks 1,030,000 1,030,000 Liquor licenses 85,000 85,000 ------------ ------------ 6,364,000 6,364,000 Accumulated amortization (661,000) (473,000) ------------ ------------ $ 5,703,000 $ 5,891,000 ============ ============\nThe excess of cost over fair value of net assets acquired, trademarks and liquor licenses represent the value assigned to these intangible assets upon the acquisition of the Restaurants and Cues by ELXSI.\nYear Ended December 31, ------------------------------- 1995 1994 ------------- ------------- Accrued expenses: Accrued salaries, benefits and vacation $1,452,000 $ 1,092,000 Other taxes 678,000 463,000 Other reserves 355,000 683,000 Accrued utilities 306,000 221,000 Accrued insurance 304,000 167,000 Accrued rents 233,000 257,000 Accrued professional fees 146,000 213,000 Warranty accrual 180,000 150,000 Accrued interest and bank fees 126,000 240,000 Accrued royalty 72,000 -- Accrued acquisition costs 56,000 84,000 Accrued management fees - related party 18,000 20,000 State and federal income taxes 6,000 17,000 Other accrued expenses 464,000 395,000 ------------ ------------ $ 4,396,000 $ 4,002,000 ============ ============\nNOTE 5. Income Taxes\nEffective January 1, 1993, the Company adopted the provisions of SFAS 109. As a result of the adoption of SFAS 109, the Company recorded a deferred tax asset of $88,698,000 which was fully offset by a valuation allowance in accordance with the provisions of SFAS 109 at January 1, 1993.\nPre-tax income for the years ended December 31, 1995, 1994 and 1993 was as follows:\n1995 1994 1993 ---------- ---------- ----------\nDomestic $4,941,000 $4,911,000 $4,575,000 Foreign 119,000 189,000 41,000 --------- --------- --------- Total $5,060,000 $5,100,000 $4,616,000 ========== ========== ==========\nIncome tax expense for the years ended December 31, 1995, 1994 and 1993 is as follows:\nYear Ended December 31, ------------------------------------- 1995 1994 1993 --------- --------- --------- Current tax expense Federal $ 118,000 $ 88,000 $ 116,000 State and local 396,000 278,000 232,000 --------- --------- --------- Total current $ 514,000 $ 366,000 $ 348,000 ========= ========= =========\nDeferred tax (liabilities) assets are comprised of the following at December 31, 1995 and 1994:\n1995 1994 ------------ ------------\nAccrued expenses and other $ (1,422,000) $ (1,174,000) ------------ ------------ Gross deferred tax liabilities (1,422,000) (1,174,000) ------------ ------------\nSyndication costs 1,662,000 1,662,000 Acquisition costs 421,000 421,000 Accrued expenses and other 1,380,000 1,031,000 Loss carryforwards 75,217,000 76,854,000 Credit carryforwards 6,730,000 6,730,000 ------------ ------------ Gross deferred tax assets 85,410,000 86,698,000 ------------ ------------\nDeferred tax asset valuation allowance (83,988,000) (85,524,000) Net deferred taxes $ -- $ --\nThe Company has net operating loss carryforwards for federal income tax purposes of approximately $221 million and $226 million at December 31, 1995 and 1994, respectively. The decrease in the deferred tax asset valuation allowance primarily resulted from the use of net operating loss carryforwards to offset the 1995 estimated federal taxable income. The net operating loss carryforwards expire between 1997 and 2005. The Company also has investment tax credit carryforwards of approximately $3.2 million, research and development tax credit carryforwards of approximately $3.3 million and minimum tax credit carryforwards of approximately $230,000. The investment tax credit and research and development tax credit\ncarryforwards expire between 1997 and 2003,and the minimum tax credit carryforwards have an unlimited carryforward period.\nA reconciliation of the statutory federal tax rate and the Company's effective income tax rate for the years ended December 31, 1995, 1994 and 1993 is as follows:\nYear Ended December 31, ------------------------------------- 1995 1994 1993 --------- ----------- ---------- Federal income tax rate 34.0% 34.0% 34.0% State income taxes, net of federal benefit 7.7 5.3 4.9 Other .5 (.1) .6 Recognition of net operating loss (32.0) (32.0) (32.0) --------- ---------- --------- Effective income tax rate 10.2% 7.2% 7.5% ========= ========== =========\nThe utilization of the Company's net operating loss and tax credit carryforwards may be impaired or reduced under certain circumstances. Events which may 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.\nNOTE 6. Long-Term Debt and Related Party Transactions\nOn September 25, 1989, the Company consummated a Stock and Note Purchase Agreement (\"Agreement\") with Airlie and M&C, whereby Airlie and M&C loaned the Company $1,750,000 and $250,000, respectively, for 15% senior subordinated ten-year notes, and warrants to purchase 1,053,500 and 150,500 shares, respectively, of the Company's Common Stock. The Company recorded as paid-in-capital (relating to the warrants) a discount of $301,000 to reflect a valuation of $0.25 per warrant which was determined by the Company to represent the fair market value of the warrants at the inception of the Agreement. The warrants have an exercise price of $3.125 per share, are immediately exercisable, and expire on September 25, 1996. The notes bear interest at 15% payable quarterly, commencing on November 15, 1989. Principal is to be repaid in five annual $400,000 installments commencing on September 25, 1995. In addition, Airlie purchased 960,000 shares of the Company's Common Stock for $3,000,000 in cash and granted to ELX Limited Partnership (\"ELX\"), of which the President of the Company is the sole general partner and other officers of the Company are limited partners, a currently exercisable seven-year option to purchase up to 480,000 of the 960,000 shares of the Common Stock, at an exercise price of $3.125 per share.\nIn January 1990, CIEC purchased from Airlie 220,400 shares of the Company's Common Stock as well as $402,000 principal amount of notes. In addition, the Company and Airlie modified the warrants, described above, for the purchase of 1,053,500 shares of the Common Stock of the Company, in that such warrants were exchanged for two warrants, one exercisable for 811,638 shares of Common Stock and the second exercisable for 24,186 shares of the Company's Series A Non-Voting Convertible Preferred Stock, which is convertible, under certain specified conditions, into 241,862 shares of the Common Stock. The Series A Non-Voting Convertible Preferred Stock carries a liquidation preference of $0.002 per share and does not have voting rights, but otherwise has substantially the same rights as the Common Stock. Following the issuance of the two warrants, the second warrant was sold by Airlie to CIEC. In addition, in connection with such purchases, the option previously granted by Airlie to ELX was amended to be exercisable for\n369,800 shares of Common Stock, and an option to purchase 110,200 shares of Common Stock at a price of $3.125 per share was granted by CIEC to ELX.\nOn June 27, 1991, in connection with the Restaurant purchase, Airlie, CIEC and M&C purchased an additional, $1,685,000, $502,000 and $313,000, respectively, of the Company's senior subordinated notes. The notes bear interest at 14.5% and are payable in five annual installments of $500,000 commencing on June 27, 1997.\nOn November 15, 1993, Airlie sold $500,000 of its 14.5% seniaor subordinated notes. In connection with the sale, Milley Management, Inc., a management consulting firm, of which the President of the Company is the President and majority stockholder, acquired 50,000 of the outstanding warrants previously issued by the Company to Airlie. In addition, Cadmus Corporation (\"Cadmus\"), whose President and principal owner is Alexander M. Milley, purchased $125,000 of the senior subordinated notes from Airlie. The remaining $375,000 was purchased by three unrelated entities.\nOn May 19, 1994, the Company purchased all of the 15.0% and 14.5% senior subordinated notes held by Milley Management, Inc. at their face value of approximately $250,000 and $313,000, respectively. Milley Management, Inc. waived the prepayment penalties.\nOn December 8, 1994, in connection with a complete divestiture of Airlie's holdings in the Company, the Company purchased all of the 15.0% and 14.5% senior subordinated notes held by Airlie at their face value of approximately $1,348,000 and $1,185,000, respectively. Airlie waived the prepayment penalties and the Company agreed to cancel the remaining debt commitment due from Airlie. In addition to the two notes, the Company purchased and retired 354,963 shares of the Company's Common Stock at $5.25 per share and 761,638 warrants to purchase the Company's common stock for $2.125 per share.\nIn conjunction with the above transaction, the Company loaned ELX approximately $1,156,000 on December 8, 1994. ELX used the proceeds to exercise its option to purchase 369,800 shares held by Airlie under an existing option. The note bears interest at 1\/2% above the Company's senior debt borrowing rate, and the principal and interest are due on December 8, 1997.\nOn December 8, 1994, Cadmus purchased 50,000 shares of the Company Common Stock held by Airlie for $5.25 per share. The above December 8, 1994 transactions represented a complete divestiture of the Company's securities held by Airlie. The source of the funds was the bank line of credit.\nTransactions with Cadmus Corporation In connection with the Agreement described above, ELXSI (as assignee of ELXSI Corporation) entered into a management agreement on September 25, 1989 with Cadmus. The management agreement which was scheduled to expire in September 1992 was extended for a minimum of three additional years. Certain of the Company's officers and directors are affiliated with Cadmus. The management agreement provides for Cadmus to receive for management services rendered, compensation of $500,000 per year commencing as soon as the Company has operating income, as defined, of $1,250,000 for a fiscal quarter, plus reimbursement for reasonable expenses. The fee shall be discontinued immediately following a year in which the Company has operating income, as defined, of less than $4,000,000 and shall be reinstated in the month following a quarter in which the Company has operating income, as defined, of $1,250,000. During 1995, 1994 and 1993, the Company was charged management\nfees of $500,000 each year. Cadmus also provides the Company with general and administrative services. During 1995, 1994 and 1993, the Company was charged $36,000, $41,000 and $42,000, respectively, for such items. At December 31, 1995 and 1994, accrued expenses include $18,000 and $20,000, respectively, due to Cadmus under such agreement.\nNOTE 7. Long-Term Debt\nLong-term debt consists of the following: December 31, ------------------------- 1995 1994 ----------- ----------- 1. ELXSI\nBank Line of Credit, $14,160,000, as amended, interest due monthly at prime plus 1% (9.5% at December 31, 1995), maturing on June 28, 1997. The line of credit provides for minimum reductions in available credit of $3,330,000 annually. The line is secured by assets of the Company, including real estate and the outstanding stock of ELXSI. The note provides for interest of .3% on the unused portion of the line of credit. In addition, the agreement restricts the payment of cash dividends on Common Stock to an amount not to exceed 50% of the excess cash flow as defined in the agreement. $ 11,709,000 $ 9,280,000\n2. ELXSI Corporation\nUnsecured senior subordinated note payable with interest at 15% payable quarterly in arrears, commencing November 15, 1989. The principal is payable in five equal annual installments of approximately $80,000 commencing September 25, 1995. At issuance, ELXSI Corporation recorded the note at a discount, which is being amortized to interest expense on a straight line basis over the life of the note. 310,000 374,000\n3. ELXSI Corporation\nUnsecured senior subordinated notes payable with interest at 14.5% payable quarterly in arrears, commencing August 15, 1991. The principal is payable in five equal annual installments of approximately $175,000 commencing June 27, 1997. 877,000 877,000\n4. Cues\nMortgage payable at 8.25% on the land and building owned by Cues B.V. 141,000 141,000\nDecember 31, ---------------------------- 1995 1994 ---- ----\nOther $ 18,000 $ 30,000 ------------ ------------ 13,055,000 10,702,000\nLess current portion (1,485,000) (1,063,000) ----------- ----------- Long-Term Debt $ 11,570,000 $ 9,639,000 ============ ============\nThe above debt, contains, among other provisions, financial covenants related to the maintenance of minimum net worth, restrictions on capital expenditures and compliance with certain ratios including liabilities to net worth and interest coverage. Aggregate maturities of long-term debt for the five years ending December 31, 2000 and thereafter are as follows:\n1996 $ 1,485,000 1997 10,596,000 1998 265,000 1999 265,000 2000 184,000 Thereafter 260,000 ------------ $ 13,055,000 ============\nAt December 31, 1995, the Company was in default of two financial debt covenants relating to the bank line of credit facility. The Company received a waiver from the bank for these defaults for the quarter ended December 31, 1995. Further, the bank has agreed to modify those existing covenants, which the Company expects to be in violation of during 1996, based on its 1996 budget. Management expects to meet its 1996 budget and to be in compliance with the related covenants in the coming year.\nNOTE 8. Commitments and Contingencies\nELXSI conducts a substantial portion of its operations utilizing leased facilities. ELXSI leases land and\/or buildings at forty-six of its fifty-eight restaurants under terms of numerous lease agreements expiring on various dates including options through 2032. The majority of the leases provide that ELXSI pay taxes, maintenance, insurance, and other occupancy expenses related to leased premises. The rental payments for a majority of the restaurant locations are based on a minimum annual rental plus a percentage of sales, as defined in the related agreements. Generally, the leases provide for renewal options and in most cases, management expects that in the normal course of business, lease agreements will be renewed or replaced by other leases.\nCues has several noncancelable operating leases, primarily for certain office and transportation equipment, that expire over the next three years and generally provide for purchases or renewal options.\nThe following is a schedule of future minimum lease commitments for the five years ending December 31:\nCapital Leases Operating Leases -------------- ----------------\n1996 $ 276,000 $ 2,623,000 1997 276,000 2,637,000 1998 273,000 2,417,000 1999 175,000 2,366,000 2000 175,000 2,347,000 Thereafter 2,718,000 17,254,000 ------------ ------------ Total minimum lease payments 3,893,000 $ 29,644,000 ============ Less - Amount representing interest (2,024,000) ------------ Present value of net minimum capital lease payments 1,869,000 Less - current portion (137,000) ----------- Long-term capital lease obligation $ 1,732,000 ============\nIncluded in the above schedule of future minimum lease commitments are sublease rental income of $32,000 in 1996 and $23,000 in each year from 1997 to 2005. Rent expense charged to operations amounted to $2,235,000, $1,701,000 and $1,516,000 during 1995, 1994, and 1993, respectively.\nAt December 31, 1995 and 1994, ELXSI had outstanding letters of credit totalling $500,000 and $600,000, respectively.\nCues has agreements with truck dealers to deliver truck bodies which are used in the manufacture of certain Cues products. Under these agreements, Cues reimburses the dealers floor-plan financing costs for those vehicles held by the dealers until delivery to Cues. The amount of this reimbursement for 1995, 1994 and 1993 was $56,000, $57,000 and $25,000, respectively. At December 31, 1995 and 1994, truck bodies held by the dealers under these agreements were valued at $688,000 and $719,000, respectively.\nNOTE 9. Thrift and Profit Sharing Plan\nIn 1986, Cues established a contributory trusteed thrift and profit sharing plan covering all of its employees who have completed one year of eligible service. The plan's enrollment dates are January 1, April 1, July 1, and October 1, of each year. Participants have the option of making after-tax or deferred cash contributions, not to exceed 6% of their annual compensation, which are supplemented by employer matching contributions in the amount of 50% of the participant's contribution. The participants may make additional voluntary contributions to the plan which are not supplemented by employer contributions. Participants partially vest in the employer's contributions after the second year of service and are fully vested after the sixth year of service. Thrift and profit sharing expense for 1995, 1994 and 1993 was $48,000, $40,000 and $48,000, respectively.\nDuring 1995, the Restaurant division established a non-contributory trusteed thrift and profit sharing plan covering all of its employees who are over the age of twenty-one and have completed one year of eligible service.\nNOTE 10. Common Stock\nActivity in common stock shares for the years ended December 31, 1995, 1994 and 1993 was as follows: 1995 1994 1993 ------------ ------------ ------------ Common Stock Issued: Balance at beginning of year 5,032,333 5,368,870 5,282,359 Issuance of fractional shares 20 26 357 Options exercised -- 18,400 -- Warrants exercised -- -- 86,154 Shares repurchased and cancelled (240,000) (354,963) -- ------------ ------------ ------------ Balance at end of year 4,792,353 5,032,333 5,368,870 ============ ============ ============\nNOTE 11. Common Stock Options and Warrants\nCommon Stock Options At December 31, 1995, the Company had a total of 644,587 common shares reserved for issuance under its stock option plans. Options under the Company's plans are granted at prices determined by the Board of Directors, but not less than the fair market value of the Common Stock on the date of grant. Options generally become exercisable in cumulative annual installments beginning one year after the date of grant, are fully exercisable after five years, and expire after 10 years. During 1995, stockholders approved the 1995 Incentive Stock Option Plan (the \"1995 Plan\") consisting of 125,000 shares. Under the 1995 Plan 104,500 shares were granted at an exercise price of $5.75 per share. The shares become exercisable on November 19, 1995. During 1993, stockholders approved the 1993 Incentive Stock Option Plan (the \"1993 Plan\") consisting of 300,000 shares. Under the 1993 Plan 21,000, 115,000 and 100,400 shares were granted at exercise prices of $5.375, $5.75 and $5.375 per share in 1995, 1994 and 1993, respectively. The shares become exercisable on October 24, 1996, November 19, 1994 and March 8, 1994, respectively. During the year ended December 31, 1992, the Company granted stock options for the purchase of 100,000 shares at an exercise price of $5.00 per share. The grant became fully exercisable when ratified by the Company's stockholders at its annual meeting on May 27, 1993.\nShares Option Prices ------ ------------- Outstanding at December 31, 1993 220,600 $3.125 -$26.50 Granted 115,000 $5.75 Exercised (18,400) $3.125 ------------ Outstanding at December 31, 1994 317,200 $3.125 -$26.50 Granted 125,500 $5.375 - $5.75 Exercised (600) $3.125 Cancelled (4,190) $5.375 - $5.75 ------------ Outstanding at December 31, 1995 437,910 $5.375 -$26.50 ============\nOptions available for grant under all of the these plans total 206,677 shares and 202,987 shares at December 31, 1995 and 1994, respectively.\nWarrants At December 31, 1995, the Company had a total of 511,124 common shares reserved for issuance pursuant to the warrants as follows:\nIn connection with the acquisition of Cues, the Company issued a warrant to purchase 68,762 shares of the Company's Common Stock to the former parent of Cues. The warrants remain unexercised at December 31, 1995, have an exercise price of $4.36 per share, are currently exercisable and expire on January 31, 1997.\nIn connection with the Stock and Note Purchase Agreement (see Note 6), the Company issued warrants to acquire up to an aggregate of 1,204,000 shares of the Company's Common Stock to private investors in 1989. On December 8, 1994, the Company repurchased the warrant for 761,638 shares from Airlie for $2.125 per share. The remaining 442,362 warrants remain unexercised at December 31, 1995, are currently exercisable, expire on September 25, 1996 and have an exercise price of $3.125 per share.\nIn connection with a 1987 private placement of Common Stock, the Company issued fully paid warrants to acquire up to an aggregate of 86,154 shares of the Company's Common Stock. These warrants were exercised during 1993.\nPhantom Option Plan The phantom stock option plan was implemented in 1992 as a long-term incentive plan for four key Bickford's Restaurants employees (the \"Group\"). At the inception of the plan, the Group paid an initial investment totalling approximately $116,000. Each participant is entitled to receive, upon exercise, a cash payment equal to his individual vested percentage of the appraised value of Bickford's Restaurants, as defined, less the balance of his exercise price payable upon exercise. Full vesting occurs on July 1, 1996, at which time the Group, as a whole, is entitled to 13.9% of the appraised value of Bickford's, as defined. The phantom stock options may be exercised on the earliest of July 1, 2001, the termination of the employees' employment or the sale of the Restaurant Division. During 1995, 1994 and 1993, the Company recorded compensation expense related to the phantom stock option plan of $600,000, $300,000 and $250,000, respectively.\nNOTE 12. Segment Reporting\nThe Company operates in two segments, restaurant management and equipment manufacturing. Summarized financial information by business segment for the years ended December 31, 1995, 1994 and 1993 is as follows:\n1995 1994 1993 ------------ ------------ ------------ Net Sales: Restaurants $ 54,270,000 $ 43,391,000 $ 38,903,000 Equipment 20,404,000 19,032,000 16,779,000 ------------ ------------ ------------ $ 74,674,000 $ 62,423,000 $ 55,682,000 ============ ============ ============ Operating Income: Restaurants $ 7,088,000 $ 6,404,000 $ 6,215,000 Equipment 988,000 1,346,000 1,210,000 Corporate (1,439,000) (1,191,000) (1,076,000) ------------ ------------ ------------ $ 6,637,000 $ 6,559,000 $ 6,349,000 ============ ============ ============ Total Assets: Restaurants $ 30,008,000 $ 25,989,000 $ 25,828,000 Equipment 16,321,000 13,182,000 12,688,000 Corporate 1,370,000 1,345,000 4,000 ------------ ------------ ------------ $ 47,699,000 $ 40,516,000 $ 38,520,000 ============ ============ ============\n1995 1994 1993 ------------ ------------ ------------ Depreciation and Amortization: Restaurants $ 1,833,000 $ 1,460,000 $ 1,288,000 Equipment 373,000 334,000 301,000 ------------ ------------ ------------ $ 2,206,000 $ 1,794,000 $ 1,589,000 ============ ============ ============ Capital Expenditures: Restaurants $ 1,967,000 $ 2,015,000 $ 1,666,000 Equipment 390,000 348,000 190,000 ------------ ------------ ------------ $ 2,357,000 $ 2,363,000 $ 1,856,000 ============ ============ ============\nCapital expenditures exclude amounts in connection with acquisition and divestitures.\nThere were no intersegment sales or transfers during 1995, 1994, and 1993. Operating income by business segment excludes interest income, interest expense, and unallocated corporate expenses. Corporate assets consist principally of prepaid expenses and the related party note receivable.\nForeign assets, revenues, and export sales each represents less than ten percent of the Company's totals. No material amount of the Company's sales are dependent upon a single customer.\nNOTE 13. Subsequent Event\nOn February 1, 1996, ELXSI completed the sale of its Vernon, Connecticut Abdow's Restaurant for a net price of $1,225,000. At December 31, 1995 the Company reflected the $1,075,000 balance receivable of as an asset held for sale on the Consolidated Balance Sheet. No gain or loss will be recognized on this sale as the net proceeds approximated the estimated fair market value on the July 3, 1995 acquisition date.\nNOTE 14. Quarterly Financial Data - (Unaudited)\nThe following summarizes quarterly financial data for 1995 and 1994 (in thousands, except per share data): --------------------------------------------- Mar. 31, June 30, Sep. 30, Dec. 31, -------- -------- -------- -------- Net sales $ 15,614 $ 16,914 $ 22,048 $ 20,098 Gross profit 3,410 3,903 4,504 4,510 Income before income taxes 833 1,222 1,591 1,414 Net income $ 745 $ 1,084 $ 1,432 $ 1,285 Earnings per common share: Primary $ .15 $ .21 $ .28 $ .25 Fully diluted $ .15 $ .21 $ .28 $ .25\nMar. 31, June 30, Sep. 30, Dec. 31, -------- -------- -------- -------- Net sales $ 14,228 $ 15,631 $ 16,844 $ 15,720 Gross profit 3,000 3,864 4,190 3,929 Income before income taxes 535 1,345 1,769 1,451 Net income $ 489 $ 1,239 $ 1,631 $ 1,375 Earnings per common share: Primary $ .08 $ .20 $ .27 $ .24 Fully diluted $ .08 $ .20 $ .27 $ .24\nSCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES\nELXSI CORPORATION AND SUBSIDIARIES (Dollars in Thousands)\nS-1\nELXSI Corporation Exhibits Index 1995 - Form 10-K\nExhibit Number Description Page No. - ------ ----------- --------\n2.1 Agreement and Plan of Merger by and among ELXSI Corporation, ELXSI, Cadmus Corporation and Holdingcues, Inc. dated as of October 16, 1992, including form of Series C Warrant. (Incorporated herein by reference to Exhibit 2.7 of the Company's Current Report on Form 8-K as filed November 13, 1992 (File No 0-11877)).\n2.2 Family Restaurant Sale and Purchase Agreement, between Marriott Family Restaurants Inc. (\"Marriott\") and the Company dated February 28, 1991. (Incorporated herein by reference to Exhibit 2.1 of the Company's Current Report on Form 8-K, dated July 16, 1991 (File No. 0-11877)).\n2.3 Side Letter to the Family Restaurant Sale and Purchase Agreement between Marriott and the Company dated February 28, 1991. (Incorporated herein by reference to Exhibit 2.2 of the Company's Current Report on Form 8-K, dated July 16, 1991 (File No. 0-11877)).\n2.4 Assignment and Guaranty of Family Restaurants Sale and Purchase Agreement and Side Letter, between the Company, Marriott and ELXSI dated June 29, 1991. (Incorporated herein by reference to Exhibit 2.3 of the Company's Current Report on Form 8-K, dated July 16, 1991 (File No. 0-11877)).\n2.5 Closing Side Letter Agreement Regarding Family Restaurants Sale and Purchase Agreement between ELXSI and Marriott dated July 1, 1991. (Incorporated herein by reference to Exhibit 2.4 of the Company's Current Report on Form 8-K, dated July 16, 1991 (File No. 0-11877)).\n2.6 Real Estate Closing Side Letter Agreement Regarding Family Restaurants Sale and Purchase Agreement between ELXSI and Marriott dated July 1, 1991. (Incorporated herein by reference to Exhibit 2.5 of the Company's Current Report on Form 8-K, dated July 16, 1991 (File No. 0-11877)).\n2.7 Agreement Concerning Massachusetts and Connecticut Liquor Licenses between ELXSI and Marriott dated July 1, 1991. (Incorporated herein by reference to Exhibit 2.6 of the Company's Current Report on Form 8-K, dated July 16, 1991 (File No. 0-11877)).\n3.1 Restated Certificate of Incorporation of the Company, as amended. (Incorporated herein by reference to Exhibit 3.1 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 (file No. 0-11877)).\n3.2 Certificate of Amendment of Restated Certificate of Incorporation of the Company dated May 27, 1992. (Incorporated herein by reference to Exhibit 3.2 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (file No. 0-11877)).\n3.3 Bylaws of the Company. (Incorporated herein by reference to Exhibit 3.1 of the Company's Registration Statement on Form S-4, as amended. (file No. 0-11877)).\n4.1 Series A Warrant No. A-4 to purchase 50,000 shares of Common Stock issued to MMI. (Incorporated herein by reference to Exhibit 4.1 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (file No. 0- 11877)).\n4.2 Series A Warrant No. A-6 to purchase 150,500 shares of Common Stock issued to the Alexander M. Milley Irrevocable Trust I U\/A dated May 9, 1994. (Incorporated herein by reference to Exhibit 4.2 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (file No. 0-11877)).\n4.3 Series B Warrant No. B-1 to purchase 604,656 shares of Series A Non-Voting Convertible Preferred Stock issued to CIEC. (Incorporated herein by reference to Exhibit 4.6 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 (file No. 0-11877)).\n4.4 Series C Warrant No. C-2 to purchase 68,762 shares of Common Stock issued to MMI. (Incorporated herein by reference to Exhibit 4.4 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (file No. 0- 11877)).\n4.5 Amended and Restated Registration Rights Agreement dated as of January 23, 1990 among the Company, M&C and CIEC. (Incorporated herein by reference to Exhibit 4.7 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 (file No. 0-11877)).\n4.6 Exercise of option and Assignment of Registration Rights executed by ELX and Airlie dated November 30, 1994. (Incorporated herein by reference to Exhibit 4.6 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (file No. 0-11877)).\n4.7 15% Senior Subordinated Note issued by the Company to CIEC in the amount of $401,765.00. (Incorporated herein by reference to Exhibit 10.18 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 (file No. 0-11877)).\n4.8 14.5% Senior Subordinated Note issued by the Company to CIEC in the amount of $502,206.25 dated June 27, 1991. (Incorporated herein by reference to Exhibit 4.8 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (file No. 0-11877)).\n4.9 Amended and Restated Loan and Security Agreement, dated as of October 30, 1992 between ELXSI and Continental Bank N.A. (now Bank of America Illinois). (Incorporated herein by reference to Exhibit 10.21 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1992 (file No. 0- 11877)).\n4.10 First Amendment to Amended and Restated Loan and Security Agreement, dated as of February 4, 1993 between ELXSI and Bank of America Illinois formerly Continental Bank N.A.) (Incorporated herein by reference to Exhibit 4.10 of the\nCompany's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (file No. 0-11877)).\n4.11 Second Amendment to Amended and Restated Loan and Security Agreement, dated as of December 6, 1994 between ELXSI and Bank of America Illinois (formerly Continental Bank N.A.) (Incorporated herein by reference to Exhibit 4.11 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (file No. 0-11877)).\n4.12 14.5% Senior Subordinated Note issued by the Company to Pan Fixed Income Fund, Ltd., dated as of November 16, 1993 in the amount of $250,000. (Incorporated herein by reference to Exhibit 4.12 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (file No. 0- 11877)).\n4.13 14.5% Senior Subordinated Note issued by the Company to Rona Jaffe, dated as of November 16, 1993 in the amount of $100,000. (Incorporated herein by reference to Exhibit 4.13 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (file No. 0-11877)).\n4.14 14.5% Senior Subordinated Note issued by the Company to Anne Strassler A.C.S.W. P.C., dated as of November 16, 1993 in the amount of $25,000. (Incorporated herein by reference to Exhibit 4.14 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (file No. 0- 11877)).\n4.15 Third Amendment to Amended and Restated Loan and Security Agreement, dated as of January 25, 1995 between ELXSI and Bank of America Illinois (formerly Continental Bank N.A.)\n4.16 Fourth Amendment to Amended and Restated Loan and Security Agreement, dated as of May 25, 1995 between ELXSI and Bank of America Illinois (formerly Continental Bank N.A.)\n4.17 Fifth Amendment to Amended and Restated Loan and Security Agreement, dated as of July 3, 1995 between ELXSI and Bank of America Illinois (formerly Continental Bank N.A.)\n10.1 The Company's 1987 Incentive Stock Option Plan as amended. (Incorporated by reference to Exhibit 10.1 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1987 (file No. 0-11877)).\n10.2 The Company's 1987 Supplemental Stock Option Plan as amended. (Incorporated by reference to Exhibit 10.2 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1987 (file No. 0-11877)).\n10.3 The Company's 1993 Incentive Stock Option Plan. (Incorporated herein by reference to Exhibit 10.3 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (file No. 0-11877)).\n10.4 The ELXSI 1991 Phantom Stock Option Plan for the management of the Bickford's Division. (Incorporated herein by reference to Exhibit 10.4 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (file No. 0-11877)).\n10.5 Amendment No. 1 to the ELXSI 1991 Phantom Stock Option Plan for the management of the Bickford's Division. (Incorporated herein by reference to Exhibit 10.5 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (file No. 0-11877)).\n10.6 Promissory Note of ELX Limited Partnership payable to the Company dated December 8, 1994 in the amount of $1,155,625.00 due December 8, 1997. (Incorporated herein by reference to Exhibit 10.6 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (file No. 0- 11877)).\n10.7 Non-Qualified Stock Option Agreement issued to Robert C. Shaw for the purchase of 12,500 shares of Common Stock, dated October 30, 1992. (Incorporated herein by reference to Exhibit 10.7 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (file No. 0- 11877)).\n10.8 Non-Qualified Stock Option Agreement issued to John C. Savage for the purchase of 10,000 shares of Common Stock, dated October 30, 1992. (Incorporated herein by reference to Exhibit 10.8 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (file No. 0-11877)).\n10.9 Non-Qualified Stock Option Agreement issued to Farrokh K. Kavarana for the purchase of 10,000 shares of Common Stock, dated October 30, 1992. Incorporated herein by reference to Exhibit 10.9 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (file No. 0-11877)).\n10.10 Non-Qualified Stock Option Agreement issued to Kevin P. Lynch for the purchase of 20,000 shares of Common Stock, dated October 30, 1992. (Incorporated herein by reference to Exhibit 10.10 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (file No. 0-11877)).\n10.11 Non-Qualified Stock Option Agreement issued to Alexander M. Milley for the purchase of 30,000 shares of Common Stock, dated October 30, 1992. (Incorporated herein by reference to Exhibit 10.11 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (file No. 0-11877)).\n10.12 Non-Qualified Stock Option Agreement issued to Thomas R. Druggish for the purchase of 30,000 shares of Common Stock, dated October 30, 1992. (Incorporated herein by reference to Exhibit 10.12 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (file No. 0-11877)).\n10.13 Stock and Note Purchase Agreement dated as of August 31, 1989 by and among the Company, Airlie and M&C. (Incorporated herein by reference to Exhibit 2.1 of the Company's Current Report on Form 8-K as filed October 3, 1989 (File No 0-11877)).\n10.14 Stock and Note Purchase Agreement dated as of January 23, 1990 among Airlie, CIEC and M&C. (Incorporated herein by reference to Exhibit 10.14 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (file No. 0-11877)).\n10.15 Management Agreement (\"Management Agreement\") between Winchester National, Inc. (d\/b\/a as M&C) and the Company dated September 25, 1989. (Incorporated herein by reference to Exhibit 10.21 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991 (file No. 0- 11877)).\n10.16 Assignment of Management Agreement dated June 28, 1991 among the Company, Winchester National, Inc., ELXSI and MMI. (Incorporated herein by reference to Exhibit 10.16 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (file No. 0-11877)).\n10.17 Management Agreement Extension dated September 25, 1992 between ELXSI and MMI. (Incorporated herein by reference to Exhibit 10.17 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (file No. 0-11877)).\n10.18 Assignment to Cadmus on January 1, 1994 of MMI's rights under the extended Management Agreement dated September 25, 1992 between ELXSI and MMI. (Incorporated herein by reference to Exhibit 10.18 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (file No. 0- 11877)).\n10.19 The Company's 1995 Incentive Stock Option Plan. (Incorporated herein by reference to Form S-8 filed with the commission on November 14, 1995. (file No. 0-11877)).\n21.1 Subsidiaries of the Company. (Incorporated by reference to Exhibit 22.1 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990 (file No. 0-11877)).\n23.1 Consent of Price Waterhouse LLP\n27 Finacial Data Schedule","section_15":""}
{"filename":"54056_1995.txt","cik":"54056","year":"1995","section_1":"ITEM 1. BUSINESS\nThe Registrant is a diversified communications and media company. Its 1995 revenues, broken down by business segments, were: publishing - 44.5%; printing - 34.2%; broadcast - 12.6%; telecommunications - 6.7%, and direct marketing - 2.0%. Material developments in the Registrant's business in 1995 included: the launching of a new Milwaukee newspaper from the merger of its two daily newspapers; the acquisition of its first radio duopoly (in Omaha) and reaching an agreement to acquire a second multi-station radio operation (in Tucson); extending its label printing market into Latin America; the divestiture of Perry Printing Corporation, a long-run printer of magazines and catalogs; the launching of a major expansion of its fiber optic network in northern Wisconsin; the acquisition of a direct mail business; the adverse impact on earnings of a forty percent (40%) increase in the price of newsprint, and the final payment that settled a 16-year patent infringement lawsuit. In addition to the information provided below, see Item 6, \"Selected Financial Data,\" Item 7, \"Management Discussion and Analysis\" and Item 8, \"Consolidated Financial Statements and Supplementary Data.\"\nThe following indicates the percent of consolidated revenues derived from the activities noted for the past three (3) years:\nSource 1995 1994 1993 Publications 44.5% 42.2% 44.1% Advertising 35.3 32.7 33.6 Circulation 9.2 9.5 10.5 Broadcast 12.6 10.0 9.8 Commercial Printing 34.2 40.9 40.4 Telecommunications 6.7 5.7 5.7 Direct Marketing 2.0 1.2 0.0\nPublishing\nJournal Sentinel Inc., a wholly-owned subsidiary of the Registrant, publishes the major daily newspaper in the Milwaukee, Wisconsin, market. Prior to April 2, 1995, it had published the evening Milwaukee Journal (The Journal) since 1882, the Sunday edition of The Journal (Sunday Journal) since 1911, and the morning Milwaukee Sentinel (the Sentinel) since it was acquired in 1962. On April 2, 1995, both daily newspapers were merged and became one morning newspaper, the Milwaukee Journal Sentinel. Average paid circulation for the twelve months ended March 31, 1995, for the last five years, as audited by the Audit Bureau of Circulation, was:\n1995 1994 1993 1992 1991\nJournal 211,801 228,454 238,351 240,566 260,480 Sentinel 173,895 173,019 171,271 166,085 172,772 Sunday Journal 486,422 492,425 490,077 490,361 497,777\nSince the newspapers were combined, average daily paid circulation for the six months ended September 30, 1995, as provided to the Audit Bureau of Circulations, was 309,137.\nAdvertising volume in column inches and units for the Company's Milwaukee newspapers for the last five calendar years was:\n(in thousands) 1995 1994 1993 1992 1991 Column Inches Full Run 2,289.7 2,666.0 2,657.6 2,619.0 2,526.8 Part Run 257.1 213.4 260.9 181.3 195.5 Units Preprint 2.8 2.4 1.9 1.6 1.5\nThere are 101 other newspapers and shoppers published in the four-county Milwaukee market. Most of these are weekly publications, while a few are biweekly, fortnightly or monthly. Of these 101 publications, 39 are paid subscription and 62 are delivered without charge or are available free at various public locations. These publications cover a wide variety of interests, including community, business, labor, religious, ethnic, foreign language or other special interest newspapers.\nOne other daily newspaper, The Freeman, is published in Waukesha and is circulated in portions of Waukesha County. In addition, editions of USA Today, Chicago Tribune, Chicago Sun Times, Madison Capitol-Times, Wisconsin State Journal and New York Times are sold in the Milwaukee market. Journal Sentinel Inc.'s newspaper also competes for advertising revenue or support with five (5) network-affiliated commercial television stations, five (5) independent television stations (two (2) of which are low power television stations), two public television stations and 34 AM and FM radio stations located in the four-county market, several cable television companies and several direct mail services. One network- affiliated television station and two radio stations in the Milwaukee market are owned by a subsidiary of the Registrant.\nThe Milwaukee Journal Sentinel maintains news bureau offices in Madison, Wisconsin, and Washington, D.C. It also has suburban bureaus in Waukesha and Cedarburg and correspondents based in West Bend and Stevens Point, Wisconsin. The Journal Sentinel is a member of the Associated Press and subscribes to these wire services: the Washington Post-Los Angeles Times News Service, the New York Times News Service, the Knight-Ridder News Service and the feature portion of the Gannett News Service. The Journal Sentinel is also a contributing member of the Scripps Howard News Service.\nThe April 1995 merger resulted in a work-force reduction. Severance, early retirement payments and other non-recurring costs associated with the launch of the Milwaukee Journal Sentinel resulted in a pre-tax charge of $17.5 million.\nDuring 1995, while the cost of newsprint increased by 40%, newsprint consumption at the Milwaukee newspapers was higher than the prior year. Newsprint is purchased from four Canadian and two American suppliers. Supplies for 1996 are considered sufficient and newsprint costs are expected to stabilize.\nThe Registrant also publishes, through its ADD, Inc. subsidiary, eight (8) weekly newspapers in southwestern Connecticut; six (6) weekly newspapers and one (1) monthly controlled-circulation business publication in Wisconsin; three (3) weekly newspapers and one (1) daily newspaper in Florida; forty-six (46) shopper publications, with twenty-two (22) in Wisconsin, fifteen (15) in Ohio, two (2) in Florida, two (2) in Pennsylvania, two (2) in Vermont, one (1) in Georgia, one (1) in Louisiana and one (1) in New York; three (3) paid auto publications, with two (2) in Louisiana and one (1) in Wisconsin; two (2) paid boating publications, with one in Louisiana and one in Florida; three (3) free auto publications in Ohio; two (2) free monthly Health & Fitness publications, with one (1) in Pennsylvania and one (1) in Louisiana; six (6) monthly real estate publications and two (2) senior citizens' publications in Ohio published six (6) times per year, and one (1) nationwide electronic classified advertising database.\nPrinting\nImperial Printing Company, a wholly-owned subsidiary acquired on October 6, 1992, specializes in the production of short to medium runs (1,000 to 50,000 copies) of medical, legal and technical journals for various trade associations, documentation manuals for hardware and software manufacturers and the duplication of CD-ROM's, floppy disks and computer tapes. Imperial is based in St. Joseph, Michigan, and has additional operations in Fremont, San Jose and Irvine, California and Roncq, France. No supply restrictions are anticipated in 1996 for the raw materials Imperial utilizes.\nIn June 1994, the heat-set web offset operations of Perry Printing Corporation (\"Old Perry\"), a wholly-owned subsidiary of the Registrant, were spun off into a new subsidiary corporation. Perry Printing Corporation changed its name to NorthStar Print Group, Inc., and the name of the new corporation, a subsidiary of NorthStar Print Group, Inc., was changed to Perry Printing Corporation (\"New Perry\"). The assets and business of New Perry were sold in May 1995 for $95 million plus the assumption of trade and other liabilities. Payment was made by the issuance of 115,000 shares of the buyer's preferred stock with a value of $11.5 million and the delivery of the balance in cash.\nNorthStar Print Group, Inc., a wholly-owned subsidiary of the Registrant, the continuing portion of Old Perry, is headquartered in Brown Deer, Wisconsin, and has manufacturing operations in Brown Deer, Green Bay and Watertown, Wisconsin, and Norway, Michigan. It employs a wide array of printing technologies in the various markets it serves. These include sheed-fed offset, rotogravure and flexographic processes that are used to print point-of-purchase materials, labels for consumer goods and industry manufacturers (including in-mold labels), and out-of-home media. NorthStar Print Group, Inc., is one of the nation's largest producers of beer bottle labels and completed an arrangement in 1995 to extend its label market to the largest beer brewer in Brazil. Its supply of raw materials is considered adequate. NorthStar remains the owner of the properties in Waterloo, Wisconsin, that are being leased to New Perry.\nTrumbull Printing, Inc., though a wholly-owned subsidiary of the Registrant, is managed by a subsidiary of ADD, Inc. that is co-located in Trumbull, Connecticut. Trumbull Printing, Inc., is a small web offset printer of newspapers and newspaper inserts. Its principal raw materials, paper and ink, are expected to be in sufficient supply at stable prices in 1996.\nBroadcasting\nJournal Broadcast Group, Inc., a wholly-owned subsidiary of the Registrant (formerly known as WTMJ, Inc.), operates three television stations and eleven (11) radio stations in six (6) states. All operate under licenses from the Federal Communications Commission.\nIn Milwaukee, Journal Broadcast Group, Inc. has been the pioneer and leading broadcaster since it started AM operations in 1927, FM in 1941 (discontinued 1950-1960) and television in 1947. News reporting and editorial operations at Journal Broadcast Group, Inc., are independent of the Registrant's newspaper operations.\nRegistrant's three (3) Milwaukee broadcast operations, WTMJ-TV, WTMJ-AM and WKTI-FM, consistently rank high in audience rating surveys. Competition for advertising revenue in the ten-county area of dominant influence (\"ADI\") includes nine (9) other commercial television stations (including two (2) low power television stations), two (2) noncommercial stations, thirty-four (34) other radio stations, several cable television companies, seven (7) daily newspapers (including one owned by Registrant), and numerous weekly newspapers.\nJournal Broadcast Group, Inc. also operates: KTNV-TV, Las Vegas, Nevada, an ABC affiliate; WSYM-TV, Lansing, Michigan, a Fox affiliate; two radio stations in Wausau, Wisconsin, WSAU-AM and WIFC-FM, both ABC radio affiliates; KQRC-FM, Kansas City\/Leavenworth, Kansas, affiliated with The Source\/Westwood One network; KEZO-AM, KEZO-FM and KKCD-FM in Omaha, Nebraska where KEZO-AM and KKCD-FM are affiliated with the CBS Spectrum Network, and KMXZ-FM, KKND-AM and KKHG-FM in Tucson, Arizona. WTMJ-TV is affiliated with the NBC network. WTMJ-AM is affiliated with the CBS Radio network, and WKTI-FM is affiliated with the ABC radio network.\nTelecommunications\nMRC Telecommunications, Inc. (MRC), a wholly-owned subsidiary, provides telecommunications services. Its services include terrestrial and satellite transmission of broadcast-quality video signals. In addition, MRC offers state-of-the-art, bulk, network transmission, including SONET and bandwidth-on-demand, to other common carriers. NorLight, Inc., is a wholly-owned subsidiary of MRC. NorLight, Inc., MRC's business-to- business service, markets advanced data circuits, frame relay, and switched voice services including domestic, international and calling card services, to medium and large businesses in Wisconsin, Michigan, Minnesota and Illinois where NorLight is authorized by the public service commissions to offer services. NorLight has two wholly-owned subsidiaries, Telephone Associates Long Distance, Inc. (TALD) and Bemidji Long Distance, Inc. (BLD), which provide switched voice services to residential and small business customers in Minnesota, Michigan and Wisconsin.\nMRC Telecommunications, Inc., is a co-founding member of UniSPAN, a national and international consortium of other regional carriers that provide frame relay services.\nDirect Marketing\nPrimeNet Marketing, Inc., a wholly-owned subsidiary, was acquired in January 1994. Located in St. Paul, Minnesota, it is engaged in the business of providing personalized database marketing services to merchandisers and manufacturers, which services include the design and development of database systems; the creation, maintenance and enhancement of data files; the development of personalized communications for the purpose of executing specific promotions; mail processing; receiving orders and\/or requests through its 1-800 Response Center, and fulfilling such orders and requests.\nMega Direct, Inc., was acquired on June 22, 1995, by ADD, Inc., a wholly- owned subsidiary of the Registrant. Mega Direct is a marketing firm that provides complete direct mail services, including design, printing and distribution. It is one of the largest direct mail firms in the country serving the automotive industry.\nCompliance with Environmental Laws\nNo operation of the Registrant has suffered material adverse effects from having to bring its operations into compliance with environmental laws.\nMethods of Distribution\nThe Registrant's newspapers are distributed through networks of carriers, most of whom are independent contractors. Advertising for Registrant's newspapers and broadcast stations is generally sold by employees, with some national advertising obtained by agents. Sales for the Registrant's commercial printing, telecommunications and direct marketing operations are generally obtained by employees and a limited number of agents.\nEmployees\nThe Registrant and its subsidiaries, as of December 31, 1995, had approximately 4,510 full-time and 2,040 part-time employees.\nFinancial Information About Industry Segments\nFinancial information about Registrant's industry segments is presented in Note 10 to the Consolidated Financial Statements appearing on pages 27 and 28 of this report.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nPrincipal properties operated by the Registrant and its subsidiaries are summarized as follows:\nSubsidiary Location How Held Square Footage\nJournal Sentinel Inc. (Publishing) Offices\/Plant Milwaukee, WI Owned 464,000 Garage Milwaukee, WI Owned 67,500 Distribution Centers Milwaukee, WI Leased 166,100\nADD, Inc. (Publishing) Office\/Plant WI, OH, GA, FL Owned or Leased 252,500 VT, NY, PA, LA\nHometown Publications, Inc. (Publishing) Office Trumbull, CT Leased 5,600\nAuto Mart Publishing, Inc. (Publishing) Office Dayton, Columbus Leased 4,300 & Cincinnati, OH\nMega Direct, Inc. (Direct Marketing) Office Clearwater, FL Leased 39,700\nJournal Broadcast Group, Inc. (Broadcasting) Office and Studios Milwaukee, WI Owned 101,500 KTNV-TV Studios Las Vegas, NV Owned 20,300 WSYM-TV Studios Lansing, MI Leased 10,300 WSAU-AM\/WIFC-FM Studios Wausau, WI Owned 5,600 KQRC-FM Studios Kansas City\/ Leavenworth, KS Leased 3,700 KEZO-AM\/FM & KKCD-FM Office and Studios Omaha, NE Leased 12,200\nNorthStar Print Group, Inc. (Commercial Printing) Office\/Plant Brown Deer, WI Owned 127,300 Office\/Plant Norway, MI Owned 101,700 Office\/Plant Watertown, WI Owned 201,700\nLabel Products & Design Inc. (Commercial Printing) Office and Plant Green Bay, WI Owned 39,600\nPPC Liquidations, Inc. (Real Estate Holding) Office & Warehouses Waterloo, WI Owned 120,000\nTrumbull Printing, Inc. (Commercial Printing) Office\/Plant Trumbull, CT Owned 51,600\nImperial Printing Company (Commercial Printing) Office\/Plant\/ Warehouse St. Joseph, MI Leased 318,500 Office\/Plant Fremont, CA Leased 98,700 Office\/Plant Irvine, CA Leased 49,000 Office\/Plant\/ Warehouse San Jose, CA Leased 226,000 Office\/Plant San Jose, CA Leased 83,000\nMRC Telecommunications, Inc. (Fiber optic & Rubicon, WI Owned 3,800 microwave Skokie, IL Owned 6,100 transmission Afton, WI Owned 3,800 services) Arden Hills, MN Owned 1,700 Minneapolis, MN Leased 2,100 Brookfield, WI Leased 15,600\nNorLight, Inc. (Fiber optics & microwave transmission services) Office Minneapolis, MN Leased 1,300\nTelephone Associates Long Distance, Inc. & Bemidji Long Duluth, MN Leased 5,200 Distance, Inc. Bemidji, MN (Long distance telecommunications service)\nNordoc Software Services, S.A. (Commercial Printing) Office\/Plant Roncq, France Leased 80,700\nPrimeNet Marketing, Inc. (Data Base Management) Mendota Heights, Office\/Plant Minnesota Leased 87,200\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS The Company paid damages of $18.6 million in 1991 and $5.7 million in February 1996 in settlement of a patent infringement lawsuit. Otherwise, the Company is involved in various claims and lawsuits incidental to its business, which, in the opinion of management, will not have a material effect in the aggregate on the Company's financial position or operations.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None.\nITEM 4A. EXECUTIVE OFFICERS OF REGISTRANT\nThe executive officers of Registrant, as of March 25, 1996, all of whom hold office until the next annual meeting of the board of directors, which will be held immediately following the annual meeting of shareholders on June 4, 1996, are:\nName Age Office Held Since\nRobert A. Kahlor 62 Chairman of the Board\/CEO September 4, 1992 Steven J. Smith 45 President September 4, 1992 Thomas M. Karavakis 65 Senior Vice President June 2, 1987 Douglas G. Kiel 47 Senior Vice President June 2, 1992 Keith K. Spore 53 Senior Vice President September 6, 1995 Paul M. Bonaiuto 45 Senior Vice President March 5, 1996 Robert M. Dye 48 Vice President June 5, 1990 Gregory H. Forbes 46 Vice President June 8, 1993 Stephen O. Huhta 40 Vice President June 8, 1993 Ronald G. Kurtis 48 Vice President June 8, 1993 James J. Ditter 34 Vice President September 6, 1995 William T. Lutzen 34 Vice President June 7, 1994 Daniel L. Harmsen 40 Vice President March 5, 1996 Paul E. Kritzer 53 Vice President June 5, 1990 & Secretary September 1, 1992 Christine A. Farnsworth 47 Assistant Secretary June 8, 1993\nAll of the executive officers of the Registrant except Messrs. Forbes, Bonaiuto and Ditter have been employed by the Company in key management positions for more than five (5) years. Mr. Forbes joined the Company in October 1992 when Imperial Printing Company, of which he was president and owner, was acquired by the Registrant. Mr. Bonaiuto has been Chief Financial Officer of the Registrant since January 1996 and was elected a Senior Vice President in March 1996. Previously Mr. Bonaiuto had been President of NorthStar Print Group, Inc., a subsidiary of the Registrant, from June 1994 to January 1996; Senior Vice President and Chief Financial Officer of Perry Printing Corporation, then a subsidiary of the Registrant, from July 1992 to June 1994, and executive vice president of The Peterson Group, Wilmington, Delaware, a private equity investment firm, for the remainder of the past five-year period. Mr. Ditter was elected President of MRC Telecommunications, Inc., a subsidiary of the Registrant, in September 1995 after serving as that company's senior vice president and chief financial officer since August 1992. Prior to that, Mr. Ditter had been the controller of Peck Foods Corporation, Milwaukee.\nPART II ITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nThere is no established public trading market for the Registrant's common stock. Units representing beneficial interests in the Registrant's common stock can be purchased only by full-time employees with ninety (90) days service and part-timers with two consecutive years of service of one thousand (1,000) hours each year. As of March 13, 1996, the Journal Employes' Stock Trust (the \"Trust\") owned of record 12,960,000 of the issued common stock shares or 90% of the issued common stock of the Registrant. The Trust issues units, each representing a beneficial interest in one share of the Registrant's stock, to eligible employees (\"unitholders\"). On March 13, 1996, 2,623 unitholders owned 11,195,983 units (representing 83.1% of Registrant's outstanding common stock) and thus were the beneficial owners of a like number of shares of the Registrant's stock held by the Trust. The balance of 1,764,017 units issued by the Trust were, on the above date, held by personal trusts and employee benefit trusts or by the Company, which are treated as treasury stock and not voted.\nPrior to all meetings of shareholders of the Registrant, the Trustees are required to deliver to each active employee-unitholder a proxy, with the right of substitution, for the number of the Registrant's shares represented by his or her units.\nUnitholders may sell their units only through procedures, and at a formula price, dictated pursuant to the Stock Trust Agreement and only to other employees designated by President of the Registrant. Whenever a unitholder ceases to be an employee, for any reason except retirement, corporate downsizing or divestiture, he or she must offer his or her units for resale to active employees designated by the President of the Company. Employees who retire may retain a decreasing percentage of their units for up to ten (10) years after the first anniversary of their retirement. All units held by retirees are voted by the Trustees. Units may also be held by employee benefit trusts, and unitholders may transfer units to personal trusts and to charitable, educational or religious trusts. All units held by such trusts are likewise voted by the Trustees of the Stock Trust. As of March 13, 1996, retirees, personal trusts, an employee benefit trust, and other trusts held 5,302,026 units, representing a beneficial interest in 39.3% of the Registrant's outstanding common stock.\nAll of the Trustees under the Journal Employes' Stock Trust Agreement are directors of the Registrant. They have no financial interest in the Registrant's stock owned by the Trust other than through the units they own individually.\nThe Registrant's unit price and dividend history for the past decade are presented in the following table:\nEmployee Stock Ownership Plan\nUnit Unit Unit Price Total Price Price Increase Cash Annual Year Begin End (Decrease) Dividend Return\n1995 - 4th Qtr 35.95 36.24 0.29 0.55 8.3 1995 - 3rd Qtr 36.12 35.95 (0.17) 0.55 1995 - 2nd Qtr 35.62 36.12 0.50 0.55 1995 - 1st Qtr 35.40 35.62 0.22 0.45 1994 - 4th Qtr 34.97 35.40 0.43 0.55 7.7 1994 - 3nd Qtr 34.92 34.97 0.05 0.45 1994 - 2nd Qtr 34.84 34.92 0.08 0.45 1994 - 1st Qtr 34.64 34.84 0.20 0.45 1993 33.60 34.64 1.04 1.80 8.5 1992 32.60 33.60 1.00 1.80 8.6 1991 31.48 32.60 1.12 1.80 9.3 1990 29.66 31.48 1.82 1.70 11.9 1989 26.65 29.66 3.01 1.70 17.7 1988 23.71 26.65 2.94 1.50 18.7 1987 20.94 23.71 2.77 1.38 19.8 1986 18.54 20.94 2.40 1.25 19.7\nIn addition to the Journal Employees' Stock Trust, there are two (2) other record holders of stock of the Registrant. The Registrant is not aware of any recent sales of such stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nSelected financial data of the Registrant is presented in the table on following page.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT ANALYSIS AND DISCUSSION\nConsolidated Revenue from continuing operations in 1995 was $591.8 million, a 14.3% increase over 1994 revenue of $517.6 million. Revenue from continuing operations in 1993 was $454.7 million. In 1995, operating earnings were $41.4 million, a decrease from 1994 earnings of $66.3 million. The decrease in operating earnings was a result of the one-time newspaper merger charges of $17.5 million and the Webcraft lawsuit settlement of $5.7 million. In 1993, operating earnings were $65.9 million. During 1995, the improving economic conditions and an increase in advertising market share helped to increase advertising revenue and operating profits for the broadcast segment. The printing segment experienced growth through increased revenues in the computer software industry. Operating results, however, declined in the publications segment due to the 40% increase in newsprint prices. The direct marketing segment showed a net loss.\nPublications The publications segment includes daily and weekly newspapers, shoppers and specialty publications. In 1995, revenue was $267.1 million, up 2.2% over 1994 and 9.3% better than in 1993. In 1994 and 1993, revenues from this segment were $261.3 million and $244.5 million, respectively. Operating earnings in 1995 were $16 million, including newspaper merger charges of $17.5 million. Without the $17.5 million in merger charges, operating earnings decreased 23.8% from 1994. Operating earning for 1994 were $44 million, an increase of 9.4% over 1993 operating earnings of $40.2 million. Journal Sentinel Inc. is the largest company in the publications segment. Revenue in 1995 rose by 1.2% to $212.2 million compared with $209.5 million in 1994. In 1995, operating earnings excluding the merger charge were down 25.7% from the prior year. The decrease in operating earnings was the result of drastic increases in newsprint cost. Newsprint costs are expected to stabilize in 1996. Operating earnings in 1994 were up from 1993 by 14.1%. The increase was the result of increased classified advertising revenue and lower newsprint cost. Advertising revenue in 1995, 1994 and 1993 was $155.9 million, $149.4 million and $138 million, respectively. In 1995, classified revenue was up 6.8% over 1994 due to increased employment lineage and rate increases. Retail advertising revenue increase by 4.2% from 1994. General advertising revenue decreased by 8.5%, as a result of decreased volume. Pre-print revenues rose 1.7% compared with 1994. From 1993 to 1994, classified advertising revenue increased by 14%. Retail advertising revenue was approximately equal to the prior year, while general advertising revenue rose by 21% during the 1993-'94 period. In 1995, circulation revenue was $53.1 million, down 6% from 1994. In 1994, circulation revenue was $56.5 million, while in 1993 it was $55.9 million. ADD, Inc. is the other operation in the publications segment. Its 1995 revenue was $54.9 million, a 6% increase over 1994 revenue of $51.8 million. In 1993, revenue was $47.8 million. Operating earnings in 1995 showed a slight decrease from the prior year, decreasing 2.5%. This resulted from the substantial increase in newsprint prices. In 1995, revenue for the Wisconsin and Ohio operations increased by 11.1% and 17.5%, respectively. During 1995, the Wisconsin operations showed significant improvement in operating earnings over the previous year while the Ohio, Louisiana and Pennsylvania operations showed declines.\nBroadcast In 1995, revenue was $74.6 million, an increase of 17.6% over 1994 revenue of $63.4 million and 35.9% higher than 1993 revenue of $54.9 million. Operating earnings in 1995 increased 34.6% and 81% over 1994 and 1993, respectively. The 1995 increase was a result of strong national and local advertising sales and excellent ratings at all broadcast operations. In 1995, the company's television stations accounted for 68.8% of the segment's revenue and 82.9% of its operating earnings. At the Milwaukee, Las Vegas and Lansing television stations, the operating earnings showed substantial growth over the prior year. The company acquired three radio stations in Omaha during 1995. Operating earnings in 1995 for the Milwaukee and Kansas City radio stations were ahead of the 1994 operating results. In 1996, the company acquired three radio stations in Tucson.\nPrinting The 1995 revenue for NorthStar Print Group, Inc. was $53.9 million, a 6.7% decrease from the prior year's revenue of $57.8 million. In 1993, revenue was $51.8 million. NorthStar increased operating earnings to $0.6 million from an operating loss of $0.7 million in 1994. In 1995, significant operating efficiencies were attained at the Norway\/Watertown operation. The Milwaukee and Green Bay operations experienced a decrease in revenue and operating earnings for 1995. At Imperial Printing Company, doing business as IPC Software\/Publishing Services (\"IPC\"), 1995 revenue was $122 million, a 66.2% increase over 1994 revenue of $73.4 million The 1995 operating earnings increased by 116.3% compared with 1994. Increased revenue at the Fremont, California, operation contributed to the increase in operating earnings. Nordoc Software Services, located in Roncq, France (near Lille), showed a 97.2% revenue gain, but incurred an operating loss for the year. In 1995, revenue for Trumbull Printing Inc. was $14.1 million, a 24.8% increase compared with 1994 revenue of $11.3 million. Revenue in 1994 was up 45.2% over 1993 revenue. In 1995, operating earnings increased by 13.7% from the 1994 results. The printing plants of ADD Inc. had revenue of $12.5 million in 1995, a 34.4% increase over 1994 revenue of $9.3 million and 115.5% over 1993 revenue of $5.8 million. In 1995, operating earnings increased by 4.8% from 1994.\nTelecommunications In the telecommunications segment, 1995 revenue increased by 11.1% to $40 million. This increase is a result of a substantial increase in the private line circuits sold and MRC Telecommunications, Inc.'s (\"MRC\") entrance into the \"switched voice\" services market. NorLight, Inc. purchased the business and substantially all the assets of Telephone Associates Long Distance, Inc. (\"TALD\") and Bemidji Long Distance, Inc. in mid-1994. TALD and Bemidji are \"resellers\" of long distance services. Operating earnings at MRC increased by 4.5% in 1995 compared with 1994 and 8.2% compared with 1993.\nDirect Marketing PrimeNet Marketing, Inc., doing business as PrimeNet Data Systems, which was purchased on January 11, 1994, experienced a decrease in revenue from $7.8 million in 1994 to $6.9 million in 1995. An operating loss was incurred in both 1995 and 1994 as the company restructured. On June 22, 1995, a subsidiary of ADD, Inc. purchased the business and substantially all the assets of Mega Direct, Inc. Mega Direct specializes in customized direct marketing services, primarily for the automotive industry. In 1995, Mega Direct had revenue of $4.7 million and operating earnings of $1 million.\nNewspaper Merger Charges On April 2, 1995, Journal Sentinel Inc. merged The Milwaukee Journal and the Milwaukee Sentinel into a morning newspaper called the Milwaukee Journal Sentinel. The merger of the newspapers resulted in a pretax charge of $17.5 million. The charge consisted of $11.3 million in termination benefits for approximately 250 full-time employees and $6.2 million for non-recurring start-up costs of the new newspaper. The 1995 cash outlay of $11.4 million was funded by cash flow from operations and proceeds from the sale of Perry Printing Corporation.\nOther Income and Expenses Dividends and interest income were $4.8 million, an increase from $1.7 million in 1994. The 1995 increase was a result of the increase in short- term investments and dividends received from preferred stock. In 1993, this amount was $1.5 million. The company investments in short-term securities have increased due to the proceeds from the sale of Perry.\nIncome Taxes Income taxes were 39.6% of pretax earnings in 1995, 40.1% in 1994 and 39.2% in 1993. The decrease is a result of a change in the effective state tax rate. Permanent tax \"differences\" exist for goodwill amortization for acquisitions before 1993 and the increase in cash surrender value of the company's life insurance investment pool.\nEarnings from Continuing Operations Earnings from continuing operations of $27.9 million or $2.01 per share in 1995 were $12.7 million or $0.89 per share less than in 1994. The merger charges and the Webcraft settlement reduced 1995 earnings per share by $1.00. Excluding the merger charges and the Webcraft settlement, earnings per share from continuing operations were $3.01 in 1995. In 1993, earnings from continuing operations were $41 million or $2.93 per share.\nDiscontinued Operations On April 27, 1995, the company sold substantially all the assets used in the business of its wholly-owned subsidiary, Perry Printing Corporation. Perry is a heatset web offset printer of long-run catalogs and publications. The sale of Perry allowed the company to redirect its assets to other segments of the company and earn a better return on investment. As a result, the Perry operations have been accounted for as a discontinued operation. Net revenues were $45.9 million, $117 million and $105.9 million in 1995, 1994 and 1993, respectively. Earnings from discontinued operations were $1.4 million, $3.3 million and $3.2 million during the same years. The aggregate sale price was approximately $95 million plus the assumption of trade and other liabilities. Payment was made by the issuance of 115,000 shares of the buyer's preferred stock with a value of $11.5 million and the payment of the balance in cash. Proceeds were used to fund the ADD, Inc. and Journal Broadcast Group acquisitions, the Journal Sentinel merger charges and increase the cash reserves.\nNet Earnings Net earnings from 1995 were $44.2 million or $3.18 per share, versus net earnings of $43.9 million, or $3.13 per share in 1994. In 1993, net earnings for the year were $44.2 million or $3.16 per share.\nLiquidity and Capital Resources Cash provided by continuing operations, which is a significant source of the company's liquidity, totaled $43.2 million in 1995, $59.3 million in 1994 and $54 million in 1993. Principal uses of cash during this period were for property and equipment expenditures and acquisitions. Capital expenditures for property and equipment were $33.4 million, $36.6 million and $31.2 million in 1995, 1994 and 1993, respectively. In 1996, capital expenditures are expected to approximate the 1995 level. The company also has remained active in acquiring other businesses. Cash used for acquisitions was $22.8 million in 1995, $12.7 million in 1994 and $1.6 million in 1993. During 1995, the company made acquisitions that expanded its broadcast, shopper and direct marketing operations. In late January and early February 1996, the company acquired three radio stations in Tucson, Arizona. The cash purchase price was approximately $16.1 million. Cash provided by discontinued operations was $82.8 million, $7.2 million and $5.4 million in 1995, 1994 and 1993, respectively. Cash used for financing activities was: 1995 - $46.5 million; 1994 - $24.8 million; and 1993 - $23.7 million. Dividends paid during 1995 were $29.2 million, or $2.10 per share. This compares with $26.7 million ($1.90 per share) in 1994 and $25.2 million ($1.80 per share) in 1993. Net working capital at the end of 1995 increased by $3.4 million to $111.1 million. Commitments for television programs not yet produced as of December 31, 1995, were $9 million. The company has traditionally not used debt as a source of funds.\nEffect of Inflation The company's results of operations and financial conditions have not been significantly affected by general inflation. The company has reduced the effect of rising costs through improvements in productivity, cost containment programs and, where the competitive environment permits, increased selling prices. See publications section for discussion on impact of newsprint costs.\nITEM 8.","section_7A":"","section_8":"ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe Financial Statements with Report of Independent Public Auditors are presented on the pages immediately following.\nReport of Ernst & Young LLP, Independent Auditors\nThe Board of Directors and Stockholders Journal Communications Inc.\nWe have audited the accompanying consolidated balance sheets of Journal Communications Inc. as of December 31, 1995 and 1994, and the related consolidated statements of earnings and retained earnings, and cash flows for each of the three years in the period ended December 31, 1995. Our audits also included the financial statement schedule listed in the index in Item 14(a). 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 based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as 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 Journal Communications Inc. at December 31, 1995 and 1994, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles. 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 herein.\nERNST & YOUNG LLP\nMilwaukee, Wisconsin February 13, 1996\nJOURNAL COMMUNICATIONS INC. CONSOLIDATED BALANCE SHEETS\nDecember 31 ASSETS 1995 1994 Current assets: Cash $10,133,273 $ 12,884,740 Short-term investments (Note 1) 61,362,172 38,964,215 Receivables, net (Note 1) 94,670,354 81,386,307 Inventories (Note 1) 31,292,261 25,443,053 Prepaid expenses 9,211,795 10,249,166 Prepaid income taxes 4,197,508 454,222 Deferred income taxes (Note 3) 4,706,000 5,347,000 Net current assets of discontinued operations (Note 9) - 16,550,403 ----------- ----------- Total current assets 215,573,363 191,279,106\nProperty and equipment, at cost: Land and land improvements 11,997,665 10,502,363 Buildings 53,509,836 49,060,730 Equipment 301,388,897 275,766,234 ----------- ----------- 366,896,398 335,329,327 Less accumulated depreciation 206,463,640 185,642,365 ----------- ----------- Net property and equipment 160,432,758 149,686,962 Net non-current assets of discontinued operations (Note 9) - 49,924,513 Goodwill (Note 1) 33,258,717 28,864,047 Other intangible assets, net (Note 1) 34,798,493 24,287,121 Corporate life insurance investment pool 16,390,303 14,208,090 Other assets (Note 9) 14,284,589 3,166,028 ------------ ------------ $474,738,223 $461,415,867 ============ ============\nLIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 33,591,498 $ 31,363,719 Accrued compensation 18,241,478 19,856,229 Customer service deposits 11,705,228 11,823,750 Accrued employee benefits (Note 2) 21,166,388 12,442,829 Other current liabilities 12,864,104 4,916,352 Current portion of long-term obligations 6,889,035 3,201,437 ------------ ----------- Total current liabilities 104,457,731 83,604,316\nLong-term obligations (Note 5) 2,761,802 2,946,636 Deferred income taxes (Note 3) 1,189,000 7,436,000\nStockholders' equity (Note 6): Common stock, $.25 par value; authorized and issued 14,400,000 shares 3,600,000 3,600,000 Retained earnings 390,278,614 373,625,977 Treasury stock, at cost (Note 6) (27,548,924) (9,797,062) ------------ ----------- Total stockholders' equity 366,329,690 367,428,915 ------------ ----------- $474,738,223 $461,415,867 ============ ============\nSee accompanying notes.\nJOURNAL COMMUNICATIONS INC. CONSOLIDATED STATEMENTS OF EARNINGS\nYears ended December 31 1995 1994 1993 Continuing operations: Operating revenue: Publications: Advertising $208,857,471 $198,214,122 $182,536,690 Circulation 54,499,666 57,951,504 57,272,146 Other 3,790,626 5,137,396 4,720,547 Broadcast 74,623,031 63,444,709 54,850,495 Printing 202,556,016 151,853,351 126,401,157 Telecommunications 39,977,523 35,973,931 32,411,290 Direct Marketing 11,577,881 7,799,072 - Eliminations (4,049,726) (2,793,364) (3,501,062) ------------ ----------- ---------- $591,832,488 $517,580,721 $454,691,263 Operating costs and expenses: Cost of sales 346,144,072 289,383,027 250,260,769 Selling and administrative expenses 181,091,296 161,922,335 138,499,227 Merger and litigation charges(Notes 4 & 8) 23,218,055 - - ----------- ----------- ----------- 550,453,423 451,305,362 388,759,996\nOperating earnings 41,379,065 66,275,359 65,931,267 Other income(deductions): Dividends and interest - net 4,806,225 1,668,931 1,542,596 Gain(loss) on sale of assets 45,629 (113,566) 24,252 ---------- ---------- ---------- 4,851,854 1,555,365 1,566,848 ---------- ---------- ---------- Earnings from continuing operations before income taxes 46,230,919 67,830,724 67,498,115\nProvision for income taxes (Note 3) 18,330,000 27,230,000 26,460,000 ---------- ---------- ---------- Earnings from continuing operations 27,900,919 40,600,724 41,038,115 ---------- ---------- ---------- Discontinued operations (Note 9) Earnings, net of applicable income taxes of $915,000, $2,170,000 and $2,140,000 1,371,473 3,266,421 3,166,003\nGain on sale, net of applicable income tax expense of $9,960,000 14,940,942 - - ---------- ---------- ---------- Net Earnings $ 44,213,334 $ 43,867,145 $44,204,118 ========== ========== ========== Earnings per share (Note 1) Continuing operations $2.01 $2.90 $2.93 Discontinued operations 1.17 0.23 0.23 ------ ----- ----- Net earnings $3.18 $3.13 $3.16 ===== ===== =====\nSee accompanying notes.\nJOURNAL COMMUNICATIONS INC. CONSOLIDATED STATEMENTS OF RETAINED EARNINGS\nYears ended December 31 1995 1994 1993 Retained earnings:\nBalance at beginning of year $373,625,977 $355,878,873 $336,553,427\nNet earnings 44,213,334 43,867,145 44,204,118\nCash dividends (per share, 1995 $2.10, 1994 $1.90, 1993 $1.80) (29,156,648) (26,699,455) (25,156,340)\nTreasury stock transactions (Note 6) 616,303 416,530 365,145\nCurrency translation adjustment 979,648 162,884 (87,477) ----------- ----------- ----------- Balance at end of year $390,278,614 $373,625,977 $355,878,873 =========== ========== ===========\nSee accompanying notes.\nJOURNAL COMMUNICATIONS INC. CONSOLIDATED STATEMENTS OF CASH FLOWS\nYears ended December 31 1995 1994 1993\nCash flow from operating activities: Earnings from continuing operations: $27,900,919 $40,600,724 $41,038,115 Adjustments for non-cash items: Depreciation and amortization 34,413,368 29,778,626 28,335,179 Deferred income taxes (5,610,000) (400,000) (1,200,000) Net loss (gain) from sales of assets (45,629) 113,566 (24,252) Change in: Receivables (15,892,523) (15,991,602) (11,033,367) Inventories (5,414,490) (8,057,754) (1,492,355) Accounts payable 7,814,280 7,814,136 (6,566,235) Other current assets and liabilities of continuing operations 22,372 5,429,337 4,936,314 ---------- ---------- ----------\nNet cash provided by operating activities 43,188,297 59,287,033 53,993,399\nCash flow from investing activities: Proceeds from sales of assets 1,031,417 2,029,798 773,637 Property and equipment expenditures (33,406,269) (36,569,338) (31,170,841) Net (increase) decrease in short-term investments (22,397,956) 11,201,801 3,787,446 Assets of businesses acquired (22,773,013) (12,697,391) (1,572,769) Other - net (4,748,507) (5,189,473) (5,552,888) ---------- ----------- ---------- Net cash used for investing activities (82,294,328) (41,224,603) (33,735,415) ----------- ----------- ----------- Net cash provided by discontinued operations (Note 9) 82,831,605 7,193,410 5,375,462\nCash flow from financing activities: Net increase (decrease)in long-term obligations (184,834) (731,975) 1,232,349 Purchase of treasury stock (25,487,943) (1,834,240) (3,865,125) Sales and distribution of treasury stock 8,352,384 4,485,108 4,122,332 Cash dividends (29,156,648) (26,699,455) (25,156,340) ----------- ----------- ----------- Net cash used for financing activities (46,477,041) (24,780,562) (23,666,784) ----------- ----------- ----------- Net increase (decrease) in cash (2,751,467) 475,278 1,966,662\nCash at beginning of year 12,884,740 12,409,462 10,442,800 ---------- ---------- ---------- Cash at end of year $10,133,273 $12,884,740 $12,409,462 ========== ========== ========== Cash paid for income taxes $47,557,000 $29,108,000 $31,122,000 ========== ========== ==========\nSee accompanying notes.\nJOURNAL COMMUNICATIONS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1995, 1994 and 1993\nl.Principal accounting policies\nBasis of consolidation - The consolidated financial statements include the accounts of Journal Communications, Inc. and its wholly owned subsidiaries (collectively, the Company). All significant intercompany balances and transactions have been eliminated.\nForeign currency translation - Assets and liabilities of foreign subsidiaries are translated into U.S. dollars at year-end exchange rates while income and expense items are translated at the average exchange rates for the year. Resulting translation adjustments are reflected in retained earnings.\nEarnings per share - Earnings per share is based on the weighted average shares outstanding during each period.\nShort-term investments - Short-term investments, which consist principally of government securities, commercial paper and bank certificates of deposit with maturities of one year or less, are stated at cost, which approximates market value.\nReceivables - Allowance for doubtful accounts at December 31, 1995 and 1994 was $2,475,670 and $2,065,012, respectively.\nInventories - Inventories are stated at the lower of cost (first in, first out method) or market. Inventories at December 31, consist of the following:\n1995 1994 Paper and Supplies $19,142,582 $15,265,140 Work in Process 4,559,107 4,812,159 Finished Goods 7,590,572 5,365,754 ---------- ---------- $31,292,261 $25,443,053 ========== ==========\nProperty and equipment - Property and equipment are recorded at cost. Depreciation of property and equipment is computed principally using the straight-line method.\nGoodwill - Goodwill arising from acquisitions subsequent to November 1, 1970, is amortized on a straight-line basis over 40 years. Goodwill prior to November 1, 1970, is amortized when it is determined that such intangible assets have a limited useful life. At December 31, 1995, $3,095,000 of goodwill was not being amortized. Accumulated amortization at December 31, 1995 and 1994 was $9,567,294 and $8,662,555, respectively.\nOther intangible assets - Identifiable intangible assets resulting from acquisitions are amortized on a straight-line basis for a period up to 30 years. Accumulated amortization relating to intangible assets at December 31, 1995 and 1994 was $22,989,814 and $17,923,152 respectively. Other intangible assets also include the costs of television program contracts, recorded under the gross method, which are deferred and amortized over the estimated number of runs of the related programs.\nUse of estimates - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.\nReclassification - Certain reclassifications have been made to the 1994 and 1993 financial statements to conform with the 1995 presentation.\n2.Employee benefit plans\nContributory and noncontributory pension and savings plans cover substantially all employees. The amount charged against earnings with respect to all of these plans was $9,908,000, of which $4.0 million relates to the merger of the newspapers, $6,225,000, and $5,712,000 in 1995, 1994 and 1993, respectively.\nNet pension cost for the defined benefit plan includes the following components:\n(thousands of dollars) 1995 1994 1993 Service cost $ 2,068 $2,481 $2,233 Interest on projected benefit obligation 6,015 5,526 5,551 Return on plan assets (10,644) 865 (4,768) One-time recognition of costs related to newspaper merger 4,000 - - Net amortization and deferral 4,860 (6,570) (683) ------- ------- ------ Net pension cost $6,299 $2,302 $2,333 ===== ===== =====\nActuarial assumptions used to project the benefit obligations and the net pension cost were:\n1995 1994 1993\nDiscount rate 7.50% 8.00% 7.25% Rate of increase in compensation levels 5.00% 5.25% 4.75% Expected long-term rate of return on plan assets 9.50% 9.50% 9.50%\nThe assets of the plan consist primarily of government and other bonds and listed stocks. The accrued pension liability at December 31, 1995 and 1994 was $10,199,000 and $7,715,000, respectively.\nThe funded status of the plan at December 31 was as follows:\n(thousands of dollars) 1995 1994\nActuarial present value of benefit obligations: Vested benefits $67,428 $60,232 Nonvested benefits 2,949 3,074 ------- ------- Accumulated benefit obligation 70,377 63,306 Effect of projected compensation levels 13,396 13,073 ------- ------- Projected benefit obligation 83,733 76,379 Less: plan assets at fair value 63,047 57,342 ------ ------ Projected benefit obligation in excess of plan assets $20,726 $19,037 ====== ======\nOn January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (SFAS 106). This standard requires that the expected cost of postretirement health and life insurance benefits be charged to expense during the years the employees render service. The Company has elected to amortize the unfunded obligation of $25,324,000 at January 1, 1993 over a period of 20 years. Postretirement benefit expense includes the following components:\n(thousands of dollars) 1995 1994 1993 Service cost $433 $572 $454 Interest cost on accumulated postretirement benefit obligation 2,067 1,991 2,073 Amortization of transition obligation 1,139 1,266 1,266 One-time recognition of costs related to newspaper merger 2,092 - - ----- ----- ----- Postretirement benefit expense $5,731 $3,829 $3,793 ===== ===== =====\nThe funded status of the plans on an aggregate basis at December 31 was as follows:\n(thousands of dollars) 1995 1994 Accumulated postretirement benefit obligation: Retirees $19,756 $15,156 Fully eligible participants 855 1,645 Other active participants 7,859 8,131 ------- ------ Total accumulated postretirement benefit obligation 28,470 24,932 Unrecognized actuarial gain (loss) (1,655) 837\nLess: Unrecognized transition obligation 18,871 22,102 ------- ------ Accrued postretirement benefit cost liability $ 7,944 $ 3,667 ====== ======\nThe assumed health care costs trend rates used in measuring the accumulated postretirement benefit obligation (APBO) for pre-age retirees for 1996 are 9.0% grading down to 5.0% in 2010 and thereafter, and for 1995 was 9.5% grading down to 5.5% in 2008 and thereafter, and for post-age (65) retirees for 1996 are 8.0% grading down to 5.0% in 2006 and thereafter, and 1995 was 8.5% grading down to 5.5% in 2004 and thereafter. The benefit cost trend rates have a significant effect on the amounts reported. The impact of a 1% increase in the health care cost trend rates would have increased the APBO 5.4% at December 31, 1995, and would have increased the aggregate service cost and interest cost components of the postretirement benefit expense by 6.7%. The weighted average discount rate used in determining the accumulated postretirement benefit obligation was 7.5% and 8.0% for 1995 and 1994, respectively.\n3. Income Taxes\nThe provision for income taxes consists of the following:\n(thousands of dollars) 1995 1994 1993 Current Federal $18,670 $21,400 $21,870 State 5,270 6,230 5,790 ------- ------- ------- 23,940 27,630 27,660 Deferred (5,610) (400) (1,200) ------- ------- ------- $18,330 $27,230 $26,460 ======= ======= =======\nThe components of net deferred taxes as of December 31 were as follows:\n(thousands of dollars) Deferred tax assets: 1995 1994 Accrued compensation and employee benefits $ 9,520 $ 6,902 Intangible assets 569 896 Inventories 390 49 Accounts receivable 855 648 Domestic loss carryforwards 2,491 1,056 Foreign loss carryforwards 1,121 - Other 540 687 ------- ------- Total deferred tax assets 15,486 10,238\nDeferred tax liability: Property, plant and equipment 11,969 12,327 ------- ------- Net deferred tax asset (liability) included in balance sheet $ 3,517 $(2,089) ======= =======\n4. Litigation\nIn November 1995, a judgement was issued against the Company for $8.4 million in connection with a patent infringement lawsuit. In February 1996, the judgement was settled for $5.7 million, which has been recorded in fiscal 1995. The settlement fully relieves the Company of all past and future obligations under this matter.\n5. Long-term obligations\nDecember 31, 1995 1994 Note payable,8%, due June 1996 $4,458,565 $ - Capital lease & other obligations, average interest 8% in 1995 1,510,508 1,924,895 Television program contracts, due through 1999 3,681,764 4,223,178 ---------- ---------- 9,650,837 6,148,073 Less current portion 6,889,035 3,201,437 ---------- ----------\n$2,761,802 $2,946,636 ========== ==========\nIn addition, the Company has the rights to broadcast certain television programs during the years 1996-2000 under contracts aggregating $8,964,075.\n6. Stockholders' equity\nThe Company periodically purchases units of beneficial interest in The Journal Employees' Stock Trust (JESTA) for use in its Incentive Compensation Plan and for resale to its employees. Treasury stock activity is as follows:\n7. Acquisitions\nOn January 24, 1995 and February 1, 1995, the Company acquired the business and substantially all of the assets of KEZO-FM, KEZO-AM and KKCD-FM in Omaha, Nebraska. The combined cash purchase price was approximately $12.7 million.\nOn June 22, 1995, the Company acquired the business and substantially all of the assets of Mega Direct, a direct marketing company based in Clearwater, Florida, at a purchase price of approximately $8 million.\nThe acquisitions were accounted for using the purchase method. Accordingly, the operating results and cash flows of the acquired businesses are included in the Company's consolidated financial statements from the dates of acquisition. Had KEZO-FM, KEZ0-AM, KKCD-FM and Mega Direct been acquired as of January 1, 1995, the effect of the acquisitions on the Company's consolidated results of operations would not have been material.\n8. Merger Charges\nOn April 2, 1995, Journal Sentinel Inc. merged The Milwaukee Journal and the Milwaukee Sentinel into a morning newspaper called the Milwaukee Journal Sentinel. This resulted in a pretax charge of $17.5 million, which consisted of $11.3 million in termination benefits for approximately 250 employees and $6.2 million for other nonrecurring costs associated with the launch of the new newspaper. In 1995, $5.2 million of the termination benefits and all of the other costs were paid.\n9. Discontinued Operations\nEffective April 27, 1995, the Company sold substantially all the assets used in the business of its wholly owned subsidiary, Perry Printing Corporation (\"Perry\"). Perry was a heatset web offset printer of long run catalogs and publications. The assets sold consisted of accounts receivable, inventories, fixtures, equipment and certain real estate.\nThe Perry operations have been reflected as discontinued operations,and accordingly, prior period financial statements have been restated to reflect this treatment.\nNet revenues of discontinued operations were as follows:\n1995 1994 1993\nNet Revenues $45,945,666 $116,967,239 $105,914,558\nThe sale price was approximately $95 million, which included 115,000 shares of the buyer's preferred stock with a value of $11.5 million, plus the assumption of trade and other liabilities by the buyer. The Company has recorded an after tax gain on the sale of $14.9 million.\n10. Segment analysis\nJournal Communications, Inc. is an employee-owned, diversified communications company with operations in 16 states and France. The Company's principal lines of business are publishing, broadcasting, printing, telecommunications and direct marketing. The Milwaukee Journal Sentinel and 75 paid and free periodicals are published. The broadcasting business consists of eight radio and three television stations. The printing of short-run publications, circulars and periodicals, computer software documentation and diskette duplication, quality labels and packaging and promotional materials is provided by the printing business. The telecommunications business provides a full range of services with one of the largest digital networks in the Midwest. Personalized direct marketing services are provided to merchandisers and manufacturers.\nITEM 9.","section_9":"ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None.\nPART III ITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS OF THE REGISTRANT\nDirectors Anderson, Barr, Christman, D'Alexander, Davis, Knoche, Koenan Woodall and Thomas are members of the Unitholders Council who were selected by unitholders to be nominated for election to the Board of Directors. Messrs. Bonaiuto, Ditter, Forbes, Davis and Thomas and Ms. D'Alexander have less than five years of service with the Company. The other directors, except for Mr. Meissner, have been employed by the Company or its subsidiaries in key management positions for more than five years. Information regarding the executive officers of the Company is set forth in Part I, Item 4A above. Mr. Meissner is Executive Director of the Public Policy Forum, Milwaukee. Additional information in response to this item is incorporated herein by reference to the Company's proxy statement, which shall be filed with the Securities and Exchange Commission no later than April 29, 1996.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation in response to this item is incorporated herein by reference to the Company's proxy statement, which shall be filed with the Securities and Exchange Commission no later than April 29, 1996.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following chart states the equity ownership of each Director of the Registrant and the chief executive officer and four next most highly compensated individuals who will be named as such in the Registrant's Proxy Statement, which will be filed with the Securities and Exchange Commission no later than April 29, 1996:\nUnits Held Percent of as of Ownership Held Office March 13, *denotes Name Age Since 1996(1) <1%(2)\nDavid A. Anderson 44 June 6, 1995 4,630 * Margaret E. Barr 48 June 7, 1994 9,700 * Paul M. Bonaiuto 45 June 8, 1993 13,000 * Sue Ellen Christman 53 June 6, 1995 1,350 * Judith M. D'Alexander 48 June 6, 1995 200 * John C. Davis 33 June 6, 1995 3,230 * James J. Ditter 34 September 6, 1995 2,740 * Robert M. Dye 47 March 6, 1990 41,580 * Christine A. Farnsworth 47 June 8, 1993 31,550 * Gregory H. Forbes 46 June 8, 1993 25,000 * Stephen O. Huhta 40 June 8, 1993 26,355 * Robert A. Kahlor 62 March 6, 1973 85,435 * Thomas M. Karavakis 65 June 5, 1984 77,035 * Douglas G. Kiel 47 June 4, 1991 26,300 * Eldon M. Knoche 56 June 6, 1995 11,330 * M. J. L. Koenan Woodall 29 June 6, 1995 1,495 * Paul E. Kritzer 53 June 5, 1990 35,070 * Ronald G. Kurtis 48 June 8, 1993 49,800 * David G. Meissner 58 June 7, 1988 --(3) --(3) Steven J. Smith 45 June 2, 1987 73,880 * Keith K. Spore 53 September 6, 1995 22,000 * Christopher S. Thomas 26 June 6, 1995 570 * All directors as a group(4) 5,844,276 45.1%\n(1) A \"Unit\" represents a beneficial interest in one share of the common stock of Journal Communications, Inc.\n(2) Represents percentage of the 12,960,000 units outstanding on March 13, 1996.\n(3) Mr. Meissner owns no Units but is an officer and director of Matex Inc., which owns 1,320,000 shares of Journal stock. Mr. Meissner's wife is also an officer and director of Matex Inc. and together with her children owns or has a beneficial interest in 33% of the outstanding common stock of Matex Inc. Mrs. Meissner also has a 33% beneficial interest in 120,000 shares of Journal Communications, Inc. common stock. Other members of Mrs. Meissner's family own or have a beneficial interest in the remaining 67% of the Matex Inc. shares and the 120,000 shares of Journal stock.\n(4) Each of Messrs. Bonaiuto, Kahlor, Karavakis, Kiel and Smith has voting power arising under the Trust Agreement establishing the Trust in respect to the number of units set forth opposite such individual's name. In addition, as a group as trustees of the Trust, such individuals have voting power arising under the Trust Agreement establishing the Trust, as of March 13, 1996, in respect of 5,302,026 units held by retirees and other former employees of the Registrant, employee benefit trusts, employees' personal trusts and charitable, educational or religious trusts.\nAdditional information in response to this item is incorporated herein by reference to the Company's proxy statement, which shall be filed with the Securities and Exchange Commission no later than April 29, 1996.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation in response to this item is incorporated herein by reference to the Company's proxy statement, which shall be filed with the Securities and Exchange Commission no later than April 29, 1996.\nPART IV ITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) 1. Financial Statements and Financial Statement Schedules The following consolidated financial statements of the Registrant are included in Item 8:\nForm 10-K Page Number Consolidated Balance Sheets at December 31, 1995, 1994 and 1993 18\nConsolidated Statements of Earnings and Retained Earnings for each of the three years in the period ended December 31, 1995 19-20\nConsolidated Statements of Cash Flows for each of the three years in the period ended December 31, 1995 21\nNotes to Consolidated Financial Statements 22-28\nFinancial Statement Schedules: Consolidated schedules for each of the three years in the period ended December 31, 1995: II - Valuation and qualifying accounts 32\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.\n2. Exhibits The exhibits listed below are filed as part of this annual report.\nExhibits\n( 3.1) Articles of Association, filed herewith\n( 3.2) By-Laws [Incorporated by reference to Exhibit 3.1 to Journal Communications, Inc.'s Current Report on Form 8-K dated March 5, 1996 (Commission File No. 0-7831)]\n( 9) Journal Employees' Stock Trust Agreement, dated May 15, 1937, as amended, filed herewith\n(10.1) Management Long Term Incentive Plan, filed herewith\n(10.2) Management Annual Incentive Plan, filed herewith\n(21) Subsidiaries of the Registrant, filed herewith\n(23) Consent of Independent Auditors, filed herewith\n(27) Financial Data Schedule, filed herewith\nJOURNAL COMMUNICATIONS, INC.\nSCHEDULE II - CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS\nYears ended December 31, 1995, 1994 and 1993\nBalance at Additions Deductions Balance beginning charged to from at end of year earnings allowances of year Allowance for doubtful receivables:\n1995 $2,065,012 $3,007,365 $2,596,707 $2,475,670 ========== ========== ========== ========== 1994 $2,500,533 $2,952,136 $3,387,657 $2,065,012 ========== ========== ========== ========== 1993 $2,612,329 $2,336,437 $2,448,233 $2,500,533 ========== ========== ========== ==========\nNote:\n(a) Accounts receivable written off, less recoveries, against the allowance.\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.\nJOURNAL COMMUNICATIONS, INC.\nBy: \/s\/ Robert a. Kahlor Robert A. Kahlor Chairman of the Board and CEO\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:\n\/s\/ David A. Anderson April 1, 1996 David A. Anderson, Director\n\/s\/ Margaret E. Barr April 1, 1996 Margaret E. Barr, Director\n\/s\/ Paul M. Bonaiuto April 1, 1996 Paul M. Bonaiuto, Director & Chief Financial Officer (Principal Financial Officer)\n\/s\/ Sue Ellen Christman April 1, 1996 Sue Ellen Christman, Director\n\/s\/ Judith M. D'Alexander April 1, 1996 Judith M. D'Alexander, Director\n\/s\/ John C. Davis April 1, 1996 John C. Davis, Director\n\/s\/ James J. Ditter April 1, 1996 James J. Ditter, Director\n\/s\/ Robert M. Dye April 1, 1996 Robert M. Dye, Director\n\/s\/ Christine A. Farnsworth April 1, 1996 Christine A. Farnsworth, Director\n\/s\/ Gregory H. Forbes April 1, 1996 Gregory H. Forbes, Director\n\/s\/ Stephen O. Huhta April 1, 1996 Stephen O. Huhta, Director\n\/s\/ Robert A. Kahlor April 1, 1996 Robert A. Kahlor, Director & Chairman of the Board (Principal Executive Officer)\n\/s\/ Thomas M. Karavakis April 1, 1996 Thomas M. Karavakis, Director\n\/s\/ Douglas G. Kiel April 1, 1996 Douglas G. Kiel, Director\n\/s\/ Eldon M. Knoche April 1, 1996 Eldon M. Knoche, Director\n\/s\/ Mary Jane L. Koenen Woodall April 1, 1996 Mary Jane L. Koenen Woodall, Director\n\/s\/ Paul E. Kritzer April 1, 1996 Paul E. Kritzer, Director\n\/s\/ Ronald G. Kurtis April 1, 1996 Ronald G. Kurtis, Director\n\/s\/ David G. Meissner April 1, 1996 David G. Meissner, Director\n\/s\/ Steven J. Smith April 1, 1996 Steven J. Smith, Director\n\/s\/ Keith K. Spore April 1, 1996 Keith K. Spore, Director\n\/s\/ Christopher S. Thomas April 1, 1996 Christopher S. Thomas, Director\nJOURNAL COMMUNICATIONS, INC.\nINDEX TO EXHIBITS (Item 14(a))\nExhibits\n( 3.1) Articles of Association, filed herewith\n( 3.2) By-Laws [Incorporated by reference to Exhibit 3.1 to Journal Communications, Inc.'s Current Report on Form 8- K dated March 5, 1996 (Commission File No. 0-7831)]\n( 9) Journal Employees' Stock Trust Agreement, dated May 15, 1937, as amended, filed herewith\n(10.1) Management Long Term Incentive Plan, filed herewith\n(10.2) Management Annual Incentive Plan, filed herewith\n(21) Subsidiaries of the Registrant, filed herewith\n(23) Consent of Independent Auditors, filed herewith\n(27) Financial Data Schedule, filed herewith","section_15":""}
{"filename":"722487_1995.txt","cik":"722487","year":"1995","section_1":"Item 1. Business\nGENERAL\nComdisco, Inc. (with its subsidiaries, the \"Company\" or \"Comdisco\") is primarily engaged in the buying, selling and leasing of new and used computer and other high technology equipment and in providing disaster recovery services (also referred to as \"business continuity services\"). In addition, the Company provides technology planning and asset management services, integrating leasing and business continuity services with customized asset acquisition, asset management software tools and data center moves and\/or consolidations, disposition and migration strategies. These services are designed to provide integrated, long-term, cost effective asset and technological planning to users of high technology equipment.\nNote 9 of Notes to Consolidated Financial Statements on page 42 of the Annual Report to Stockholders for the year ended September 30, 1995 is incorporated herein by reference (said footnote contains information regarding discontinued operations).\nThe Company was founded in 1969 and incorporated in Delaware in 1971. The executive offices of the Company are located in the Chicago area, at 6111 North River Road, Rosemont, Illinois 60018, and its telephone number is (708) 698-3000. At September 30, 1995, the Company had approximately 2,100 full-time employees.\nThe Company does not own any patents, trademarks, licenses, or franchises which would be considered significant to the Company's businesses.\nThe Company's businesses are not seasonal, however, quarter-to-quarter results from operations can vary significantly.\nThe amount of backlog orders is not applicable to the Company's businesses.\nThe Company's operations are conducted through its principal office in the Chicago area and approximately fifty offices in the United States, Canada, Europe and the Pacific Rim. The Company also operates in South America, however, it does not maintain local offices. Subsidiaries in Europe and Canada offer services similar to those offered in the United States, although the Company's European leasing operations are predominately in the computer marketplace. The Company's disaster recovery activities include the domestic, Canadian and European marketplaces.\nSee \"International Operations\" on page 30 of the Annual Report to Stockholders for the fiscal year ended September 30, 1995 (which is incorporated herein by reference) for a discussion of the Company's geographic results of operations in fiscal 1995, 1994 and 1993 and Note 15 of Notes to Consolidated Financial Statements on pages 46 and 47 of the Annual Report to Stockholders for the year ended September 30, 1995, which includes geographic segment and export sales information and is incorporated herein by reference.\nLEASING\nIn its leasing activities, the Company specializes in central processing units, desktop equipment, electronics, telecommunications equipment and, through a subsidiary, medical equipment.\nThe Company offers its customers alternatives in managing high technology equipment needs, including the leasing of equipment. The Company works closely with its customers to develop strategies governing when and where to acquire equipment, when to upgrade existing equipment and when to order new equipment to take advantage of current technology. The Company also has the ability to act as an outlet for the equipment being displaced.\nThe Company's customers include \"Fortune 1000\" corporations or companies of a similar size as well as smaller corporations. A substantial portion of the Company's transactions are with repeat customers. The Company's business is not dependent on any single customer or on any single source for the purchasing, selling or leasing of equipment.\nComputer: Central Processing Units: The Company buys or leases, and in turn sells, leases or subleases IBM computer equipment as well as equipment manufactured by others. The Company's sale and lease transactions include the \"mainframe\" central processing units, midrange, and\/or various peripherals, such as printers, tape and disk drives and other equipment used with a mainframe.\nThe mainframe industry has been characterized by rapid and continuous technological advances permitting broadened user applications. The introduction of new equipment and\/or technology by IBM or other manufacturers does not cause existing equipment to become technically obsolete, but usually results in adjustments in the \"price\/performance ratio\" (the number of computations or relative performance per dollar of cost) of the existing equipment. Users upgrade equipment as their existing equipment becomes inappropriate for their needs or as a result of changes in the required amount of data processing capacity. To the extent equipment replaced by newer models becomes available for remarketing, a secondary market in used equipment is created. Recent technological advances in mainframe technology by International Business Machines (\"IBM\") have focused on \"parallel processing\" systems. These systems include transaction processing and database server models, designed for both \"legacy\" and newer technologies in open systems.\nSee \"Leasing\" on pages 27 and 28 of the Annual Report to Stockholders for the fiscal year ended September 30, 1995 for a discussion of mainframes and client\/server (which is incorporated herein by reference).\nThe focus of the Company's activities with respect to particular models of computer equipment changes periodically as a result of changes in market conditions and advances in computer technology. During the last eighteen months, the mainframe market has remained strong. Recent announcements by the major manufacturers indicate a backlog in orders. In September, 1994, IBM began shipping the first of its CMOS-based parallel processors, which have been positioned as price-competitive replacements models for pre-1990 IBM mainframes and the Company includes these models in its activities. Additionally, Hitachi Data Systems has announced the \"Skyline\" family of processors that are expected to begin shipment in late 1995. In addition to mainframes there are technological advances in both direct access storage devices and tape drives. The Company remains an active participant in the mainframe, client\/server and related peripheral markets.\nAdvances in technology affect the market for computer products and may also have an impact on the way the Company conducts its leasing activities.\nDesktop: The Company leases PC's and workstations made by most of the leading manufacturers. The Company's lease transactions also include high-end servers,\nprinters and other desktop related equipment. The Company's integrated asset management software tools let customers order, track and manage their inventory of desktop equipment. The Company has business partnerships and\/or vendor leasing programs with major workstation manufacturers.\nOther services: In fiscal 1994, the Company formed a systems integration group to address the needs of the developing open systems market, including client\/server (client\/server computing is a type of processing in which a client requests a service or information from a server that performs the service and\/or returns the requested information to the client). The Company provides services and consultants to assist customers in implementing or utilizing an open systems platform. These services, which are designed to complement the company's computer leasing activities, include transitional strategies, integration planning and implementation, financing (hardware and software), and business continuity planning. The Company, together with its consultants and strategic alliances with client\/server product providers, provides customers with solutions based on requirements and goals.\nThe Company's asset management services assist customers in: planning and implementing major data center relocations and consolidations; evaluating information technology needs and system assessments; equipment procurement strategies and timing.\nOther High Technology Equipment: Medical: Through its subsidiaries, the Company leases medical and other high technology equipment to healthcare providers, including used, reconditioned medical equipment. The Company's portfolio includes angiography, MRI systems, CT Scanners and nuclear imaging devices. Additionally, the Company has a comprehensive medical equipment refurbishing facility and has earned ISO 9002 certification for its facility.\nElectronics: The Company leases new and used electronic manufacturing, testing and monitoring equipment, including semiconductor production equipment, automated test equipment, assembly equipment and scientific\/analytical instrumentation. Additionally, the Company maintains a dedicated refurbishing and sales facility in the Silicon Valley area.\nTelecommunications: The Company buys, sells, and leases new and refurbished telecommunications equipment throughout North America. The Company also provides its customers with a market for, and a source of, used equipment. The telecommunications portfolio includes PBX systems, VSATs, voice mail, modems and bridges, routers and concentrators. The Company also reconditions and configures used systems.\nOther: The Company buys, sells and leases new and used point-of-sale terminals and leases other office equipment such as fax machines and copiers, test equipment such as oscillascopes, analyzers and testers and laboratory equipment such as microscopes and centrifuges.\nThe Company competes in the leasing marketplace as a lessor and as a dealer of new and used computer and selected other high technology equipment. The Company competes with different firms in each of its activities. The Company's competition includes equipment manufacturers such as IBM, Hewlett Packard, Amdahl, Hitachi Data Systems, AT&T, Rolm, Hitachi Medical Systems, Siemens Medical Systems and General Electric, other equipment dealers, brokers and leasing companies (including captive or related leasing companies of IBM, AT&T and General Electric and others) as well as financial institutions, including commercial banks and investment banking firms. While its competitive methodologies will differ, in general, the Company competes mainly on the basis of its expertise in remarketing equipment, terms offered in its transactions, its reliability in meeting its commitments, its manufacturers' independence and its ability to develop and offer alternative solutions and options to high technology equipment users. The Company believes it is a full service lessor. Primarily as a result of technological changes, competition has increased in the leasing industry and the number of companies offering competitive services, such as asset management and other high technology equipment leasing, has increased. Competitive alliances have also impacted the leasing industry.\nIn mainframes the Company believes that it competes primarily with the manufacturers and their captive or related leasing companies, if any, and with a few other leasing companies. The Company also believes that, aside from IBM and its captive leasing company, IBM Credit Corp., it is one of the largest purchasers, sellers and lessors of IBM equipment. The Company does not believe that a significant amount of used IBM equipment is sold independently by owner-users of the equipment to other owner-users. The Company's continued ability to compete effectively may be affected by policies of IBM.\nIn desktop, medical, electronics and telecommunications, the Company believes it competes with the manufacturers and their captive leasing companies and approximately five significant leasing companies, as well as banks and other lessors and financial and lending institutions throughout the United States and Canada. In its other services, the Company competes with manufactures and other national and regional consulting and services organizations.\nThe Company's continued ability to compete is also affected by its ability to attract and retain well qualified personnel and the availability of financing.\nDISASTER RECOVERY SERVICES\nThese services include emergency data processing backup, principally for large system users of IBM and IBM-compatible equipment, business (end user) recovery, including workarea and voice recovery capabilities, consulting services in business continuity planning, network services and data protection, as well as other related data processing services, throughout the United States, Canada and Europe. These services are designed to help minimize the impact of a significant interruption of the operations of, or inaccessibility to, the customer's data processing facility and\/or communications network. The Company also provides backup capabilities for Digital Equipment Corporation, IBM midrange processors, Unisys, Hewlett Packard, Stratus, and Tandem System equipment users.\nThe Company believes that it competes with approximately two significant domestic companies, IBM and SunGard Data Systems, Inc., as well as other regional firms in the domestic, Canadian and European marketplace, which provide contract disaster recovery services and that it is the largest international provider of such services.\nThrough its network and facilities strategy entitled CDRS Net, the Company offers customers access to its North American facilities, including a range of data processing recovery services at hot sites, Customer Control Centers (\"CCC\") and shell sites. Hot sites are equipped computer facilities that include central processing units, peripherals and communications equipment. A CCC interfaces customers to geographically separated hot sites by means of telecommunications lines. Most facilities also include workarea, voice, and network capabilities. Capabilities also include client\/server platforms and midrange systems.\nOf the Company's thirty-one locations, nine serve as data center recovery environments providing hot site and\/or shell site services. These nine regional recovery centers serve major commercial centers, including New York, Chicago, Northern and Southern California, Texas, Georgia, as well as a location in Southern New Jersey that serves the Mid-Atlantic region and a center located in Toronto, Canada. Each recovery center has at least one hot site or CCC and\nincludes telecommunications capabilities, conference rooms, office space, support areas, and appropriate on-site technical personnel.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company owns its principal executive office building in Rosemont, Illinois that has approximately 269,000 square feet, and has pledged the property as part of a mortgage agreement. The Company leases office space for sales offices in various domestic and international locations. The Company's technical services division utilizes a 250,000 square foot building owned by the Company in Schaumburg, Illinois. This space is used primarily for refurbishing, maintenance and equipment storage. The Company's disaster recovery services division presently occupies eight recovery centers owned by the Company, including 151,000 square feet in Illinois, 34,000 square feet in Texas, 42,000 square feet in Georgia, 56,000 square feet in Toronto, Canada, two recovery centers each in New Jersey of 81,000 and 72,000 square feet, and California of 52,000 and 38,000 square feet. The Company's disaster recovery services division also leases 255,000, 14,000 and 10,000 square feet in New Jersey, Missouri, and Canada, respectively. Existing Company-owned facilities can be enlarged and expanded as required to support additional growth. The Company's disaster recovery services division also owns and leases facilities in several European countries. The Company's medical refurbishment subsidiary leases approximately 100,000 square feet in Wood Dale, Illinois. The Company's electronic group leases approximately 35,000 square feet in San Jose, California, to be used primarily for refurbishing, maintenance and equipment storage.\nItem 3.","section_3":"Item 3. Legal Proceedings\nNo 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 the three months ended September 30, 1995.\nPART II.\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters\nSTOCK SPLIT\nOn November 7, 1995, the Board of Directors authorized a three-for-two split of the Company's common stock to be distributed on December 8, 1995, to holders of record on November 17, 1995. Accordingly, all references in the Company's Annual Report to Stockholders' for the year ended September 30, 1995 and the Company's Annual Report on Form 10-K for the year ended September 30, 1995 to common share data have been adjusted to reflect the split.\nPRICE RANGE OF COMMON STOCK\nPrice Range of Common Stock on page 30 of the Annual Report to Stockholders for the year ended September 30, 1995 is incorporated herein by reference.\nCOMMON STOCK REPURCHASE PROGRAM\nDuring fiscal 1995, the company purchased 5,260,167 shares of its outstanding common stock at an aggregate cost of $86 million. These purchases, when added to the shares purchased in prior years, bring the total number of common shares purchased to 24.1 million (1.5 million shares were issued upon conversion of a 6% convertible subordinated promissory note in fiscal 1995 and an additional 2.9 million shares were distributed as a common stock dividend on March 30, 1992), at an aggregate cost of $283 million. At September 30, 1995, the company had a remaining authorization of approximately $16 million to purchase common stock. An additional 760,200 shares of common stock were purchased between September 30, 1995 and November 7, 1995 at a cost of $14 million. On November 7, 1995, the Board of Directors authorized an additional $50 million for the company's stock repurchase program.\nSHAREHOLDER RIGHTS PLAN\nOn November 18, 1987, the Board adopted a shareholders rights plan and pursuant thereto declared a dividend distribution of one Right for each outstanding share of common stock of the Company to stockholders of record at the close of business on November 27, 1987 (the \"Record Date\"). The shareholder rights plan was amended and restated as of November 7, 1994. Each Right entitles the registered holder under certain circumstances to purchase from the Company one share of common stock at a Purchase Price of $63.49, subject to adjustment in certain circumstances. The Purchase Price is to be paid in cash. The Rights become exercisable if (i) a person or group (other than any holder of 20% or more of the common stock on the Record Date and its successors) (an \"Acquiring Person\") becomes the beneficial owner of 15% or more of the outstanding common stock (and the Company does not redeem the Rights within 15 days thereafter), (ii) a person or group makes a tender or exchange offer which upon consummation would result in such person or group beneficially owning 15% or more of the common stock (and the Company does not redeem the Rights within 15 days thereafter) or (iii) the Board of Directors determines that a beneficial owner of 10% or more of the common stock is an Adverse Person (as defined in the Rights Agreement). Upon the occurrence of any such event, each Right (other than those held by an Acquiring Person or Adverse Person) will become exercisable for one share of common stock at an adjusted Purchase Price equal to 20% of the then market price of the common stock. The terms of the Rights are set forth in the amended and restated Rights Agreement, dated as of November 7, 1994 (the \"Rights Agreement\"), between the Company and Chemical Bank, N.A. (formerly Manufacturers Hanover Trust Company), as Rights Agent. The Rights Agreement and a related form of the rights certificate is incorporated by reference to Exhibit 4.04 filed with the Company's Current Report on Form 8-K, filed on December 6, 1994, File No. 1-7725. The foregoing description of the shareholder rights plan does not purport to be complete and is qualified in its entirety by reference to such exhibit.\nDIVIDENDS\nThe Company has paid cash dividends quarterly since February 1979. Cash dividends paid on common stock were $13 million in both fiscal 1995 and 1994. The most recently declared quarterly common stock cash dividend, $.07 per share, was paid on December 8, 1995 to stockholders of record on November 17, 1995. Subject to the prior right of the holders of the Series A and Series B Preferred Stock, there are no restrictions on the Company's present or future ability to pay common dividends, except its agreement to maintain a debt to net worth ratio pursuant to, and certain other limitations contained in, the Company's multi-option and global revolving credit agreements, none of which have any current application. The Company expects to continue its policy of paying regular cash dividends, although there is no assurance as to future dividends because they are dependent upon the Company's profit levels and capital requirements as well as financial and other conditions existing at the time. Common stock cash dividends paid were $.24 per share in fiscal 1995 and $.23 per share in fiscal 1994.\nItem 6.","section_6":"Item 6. Selected Financial Data\nSix Year Summary on pages 24 and 25 of the Annual Report to Stockholders for the fiscal year ended September 30, 1995 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 26 through 30 of the Annual Report to Stockholders for the fiscal year ended September 30, 1995 is incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nConsolidated Financial Statements and the accompanying Notes to Consolidated Financial Statements on pages 31 through 47 of the Annual Report to Stockholders for the fiscal year ended September 30, 1995 is incorporated herein by reference. Quarterly Financial Data on page 46 of the Annual Report to Stockholders for the fiscal year ended September 30, 1995 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\nA description of Directors and Executive Officers of Registrant contained in the Company's definitive Proxy Statement filed within one hundred twenty days of the last day of the year ended September 30, 1995 is incorporated herein by reference.\nItem 11.","section_11":"Item 11. Executive Compensation\nA description of Executive Compensation contained in the Company's definitive Proxy Statement filed within one hundred twenty days of the last day of the year ended September 30, 1995 is incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nA description of Security Ownership of Certain Beneficial Owners and Management contained in the Company's definitive Proxy Statement filed within one hundred twenty days of the last day of the year ended September 30, 1995 is incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nA description of Certain Relationships and Related Transactions contained in the Company's definitive Proxy Statement filed within one hundred twenty days of the last day of the year ended September 30, 1995 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) and (a)(2) Certain Documents Filed as Part of the Form 10-K:\nThe financial statements, including supporting schedules, listed in the Index to Financial Statements and Financial Statement Schedule are filed as part of this Form 10-K on page 12.\n(a)(3) Exhibits: See Index to Exhibits filed as part of this Form 10-K on pages 15 through 19.\n(b) Reports on Form 8-K:\nOn November 27, 1995, the Company filed a current report on Form 8-K, dated November 7, 1995, reporting Item 5. Other Events and Item 7. Financial Statements and Exhibits. The filing was for the Company's announcement of fourth quarter and fiscal 1995 results of operations and included the Company's press release dated November 7, 1995.\n(c) Exhibits: Included in Item (a)(3) above.\n(d) Financial Statement Schedules Required by Regulation S-X:\nIncluded in Item (a)(1) and (a)(2) above.\nThe Registrant hereby undertakes to furnish to the Commission any instrument with respect to long-term debt of the Registrant which does not exceed 10 percent of the total assets of the Registrant and its subsidiaries.\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.\nCOMDISCO, INC.\nDATE: December 20, 1995 By: \/s\/ David J. Keenan David J. Keenan Vice President and Corporate Controller\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.\n\/s\/ John F. Slevin John F. Slevin Chief Executive Officer ______________________ (Principal Executive Officer), Philip A. Hewes President and Director Director\n\/s\/ John J. Vosicky \/s\/ Alan J. Andreini John J. Vosicky Alan J. Andreini Chief Financial Officer (Principal Director Financial Officer), Treasurer and Director\n\/s\/ David J. Keenan \/s\/ William N. Pontikes David J. Keenan William N. Pontikes Vice President (Principal Accounting Officer) Director and Corporate Controller\n__________________________ \/s\/ Nicholas K. Pontikes Robert A. Bardagy Nicholas K. Pontikes Director Director\n\/s\/ Edward H. Fiedler, Jr. \/s\/ Rick Kash Edward H. Fiedler, Jr. Rick Kash Director Director\n\/s\/ C. Keith Hartley \/s\/ Basil R. Twist, Jr. C. Keith Hartley Basil R. Twist, Jr. Director Director\n_________________________ Thomas H. Patrick Director Each of the above signatures is affixed as of December 20, 1995\nComdisco, Inc. and Subsidiaries\nINDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE\nThe following consolidated financial statements and notes to consolidated financial statements of Comdisco, Inc. and Subsidiaries and related Independent Auditors' Report, included in the Registrant's Annual Report to Stockholders for the fiscal year ended September 30, 1995, are incorporated by reference in Item 8:\nAnnual Report Page Number -------------\nConsolidated Statements of Earnings -- Years Ended September 30, 1995, 1994 and 1993.................... 31\nConsolidated Balance Sheets -- September 30, 1995 and 1994......... 32\nConsolidated Statements of Stockholders' Equity -- Years Ended September 30, 1995, 1994 and 1993.................... 33\nConsolidated Statements of Cash Flows -- Years Ended September 30, 1995, 1994 and 1993.................... 34-35\nNotes to Consolidated Financial Statements......................... 36 - 47\nIndependent Auditors' Report....................................... 48\nThe following consolidated financial statement schedule of Comdisco, Inc. and Subsidiaries is included in Item 14(d):\nForm 10-K Page Number ----------- Schedule II -- Valuation and Qualifying Accounts.................. 14\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[KPMG Peat Marwick LLP Letterhead]\nIndependent Auditors' Report\nThe Board of Directors and Stockholders Comdisco, Inc.:\nUnder date of November 7, 1995, we reported on the consolidated balance sheets of Comdisco, Inc. and subsidiaries as of September 30, 1995 and 1994, and the related consolidated statements of earnings, stockholders' equity, and cash flows for each of the years in the three-year period ended September 30, 1995, as contained in the 1995 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 ended September 30, 1995. In connection with our audits of the aforementioned consolidated financial statements, we also have audited the related consolidated financial statement schedule as listed in the accompanying index. The financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statement schedule based on our audits.\nIn our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.\n\/s\/KPMG PEAT MARWICK LLP\nChicago, Illinois November 7, 1995\nComdisco, Inc. and Subsidiaries\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS\nFor the Three Years Ended September 30, 1995 (in millions)\nComdisco, Inc. and Subsidiaries INDEX TO EXHIBITS\nExhibit No. Description of Exhibit ---------- --------------------------------------------------------- 3.01 Restated Certificate of Incorporation of Registrant dated February 12, 1988\nIncorporated by reference to Exhibit 4.1 filed with the Company's Registration Statement on Forms S-8 and S-3, File No. 33-20715, filed March 8, 1988.\n3.02 Certificate of Designations with respect to the Company's 8 3\/4% Cumulative Preferred Stock, Series A, as filed with the Secretary of State of Delaware on September 18,\nIncorporated by reference to Exhibit 4.1 filed with the Company's Current Report on Form 8-K dated September 17, 1992, as filed with the Commission October 9, 1992, File No. 1-7725.\n3.03 Certificate of Designations with respect to the Company's 8 3\/4% Cumulative Preferred Stock, Series B, as filed with the Secretary of State of the State of Delaware on July 2, 1993\nIncorporated by reference to Exhibit 4.1 filed with the Company's Current Report on Form 8-K dated June 30, 1993, as filed with the Commission July 21, 1993, File No. 1-7725.\n3.04 By-Laws of Registrant as amended through November 18,1987\nIncorporated by reference to Exhibit 3.5 filed with the Company's Annual Report for the year ended September 30, 1987 on Form 10-K, File No. 1-7725.\n4.01 Indenture Agreement between Registrant and Citibank,N.A., as Trustee dated as of June 15, 1992\nIncorporated by reference to Exhibit 4.1 filed with the Company's Current Report on Form 8-K dated September 1, 1992, as filed with the Commission on September 2, 1992, File No. 1-7725, the copy of Indenture, dated as of June 15, 1992, between Registrant and Citibank, N.A., as Trustee (said Indenture defines certain rights of security holders).\n4.02 Indenture Agreement between Registrant and Chemical Bank, N.A., as Trustee, dated as of April 1, 1988\nIncorporated by reference to Exhibit 4.5 filed with the Company's Form 8 dated February 21, 1991, File No. 1-7725, the copy of Indenture dated as of April 1, 1988, between Registrant and Manufacturers Hanover Trust Company (said Indenture defines certain rights of security holders).\n4.03 First Supplemental Indenture between Registrant and Chemical Bank, N.A., as Trustee, dated as of January 1, 1990\nIncorporated by reference to Exhibit 4.8 filed with the Company's Quarterly Report on Form 10-Q for the quarter ended December 31, 1990, File No. 1-7725, the copy of the First Supplemental Indenture dated as of January 1, 1990, between Registrant and Manufacturers Hanover Trust Company, as Trustee (said Indenture defines certain rights of security holders).\nExhibit No. Description of Exhibit ------------- --------------------------------------------------------\n4.04 Shareholder Rights Agreement, dated as of November 18, 1987, as amended and restated as of November 7, 1994, between Comdisco, Inc. and Chemical Bank, as Rights Agent, which includes as Exhibit A thereto the Form of Rights Certificate.\nIncorporated by reference to Exhibit 4.1 filed with the Company's Current Report on Form 8-K, filed on December 6, 1994, File No. 1-7725.\n4.05 Indenture Agreement between Registrant and The Fuji Bank and Trust Company, as Trustee, dated as of February 1, 1995\nIncorporated by reference to Exhibit 4.1 filed with the Company's Current Report on Form 8-K dated May 15, 1995, as filed with the Commission on May 15, 1995, File No. 1-7725, the copy of the Indenture dated as of February 1, 1995 between the Registrant and The Fuji Bank and Trust Company, as Trustee (said Indenture defines certain rights of security holders).\n10.01 Employment Agreement with John F. Slevin dated October 20, 1994\nIncorporated by reference to Exhibit 10.01 filed with the Company's Annual Report for the year ended September 30, 1994 on Form 10-K, File No. 1-7725.\n10.02 Amendment to Employment Agreement dated September 29,1995\n10.03 1979 Stock Option Plan of the Registrant\nIncorporated by reference to Exhibit 10.3 filed with the Company's Annual Report for the year ended September 30, 1982 on Form 10-K, File No. 1-7725.\n10.04 1981 Stock Option Plan of the Registrant\nIncorporated by reference to Exhibit 10.4 filed with the Company's Annual Report for the year ended September 30, 1982 on Form 10-K, File No. 1-7725.\n10.05 Amendment to 1979 and 1981 Stock Option Plans of the Registrant dated December 15, 1986\nIncorporated by reference to Exhibit 10.6 filed with the Company's Annual Report for the year ended September 30, 1987 on Form 10-K, File No. 1-7725.\n10.06 1987 Stock Option Plan of the Registrant\nIncorporated by reference to Exhibit 10.7 filed with the Company's Annual Report for the year ended September 30, 1988 on Form 10-K, File No. 1-7725.\n10.07 Amendment to 1979, 1981 and 1987 Stock Option Plans of the Registrant dated November 4, 1987\nIncorporated by reference to Exhibit 10.9 filed with the Company's Annual Report for the year ended September 30, 1987 on Form 10-K, File No. 1-7725.\nExhibit No. Description of Exhibit -------------- ---------------------------------------------------------\n10.08 1989 Non-Employee Director Stock Option Plan.\nIncorporated by reference to Exhibit 10.11 filed with the Company's Annual Report for the year ended September 30, 1990 on Form 10-K, File No. 1-7725.\n10.09 1991 Stock Option Plan\nIncorporated by reference to Exhibit 10.08 filed with the Company's Annual Report for the year ended September 30, 1992 on Form 10-K, File No. 1-7725.\n10.10 1992 Long-Term Stock Ownership Incentive Plan\nIncorporated by reference to Exhibit 10.09 filed with the Company's Annual Report for the year ended September 30, 1992 on Form 10-K, File No. 1-7725\n10.11 Comdisco, Inc. Employee Stock Purchase Plan\nIncorporated by reference to Exhibit 15 to the Company's Registration Statement on Form S-8 filed on March 19, 1982 and Post-Effective Amendment filed December 21, 1982, File No. 2-76569.\n10.12 Management Compensation Arrangements and Plans\n10.13 Purchase\/Sale Agreement - Riverway Project\nIncorporated by reference to Exhibit 10.1 filed with the Company's Form 10-Q dated March 31, 1988, File No. 1-7725.\n10.14 Financing Agreement - Riverway Project\nIncorporated by reference to Exhibit 10.18 filed with the Company's Annual Report for the year ended September 30, 1988 on Form 10-K, File No. 1-7725.\n10.15 Facility agreement dated December 30, 1994 and made between Comdisco, Inc. National Westminster Bank PLC, Barclays Bank PLC and the banks thereto\nIncorporated by reference to Exhibit 10.01 filed with the Company's Current Report on Form 8-K, filed February 15, 1995, File No. 1-7725.\n10.16 Revolving Credit Facility dated December 30, 1994 between the Company and National Westminster Bank PLC as arranger and administrative agent, the Co-Agents (as defined therein) and the Banks (as defined therein)\nIncorporated by reference to Exhibit 10.01 filed with the Company's Current Report on Form 8-K, filed February 15, 1995, File No. 1-7725.\n10.17 Note Agreement dated as May 31, 1991\nIncorporated by reference to Exhibit 10.23 filed with the Company's Annual Report for the year ended September 30, 1992 on Form 10-K, file No. 1-7725.\nExhibit No. Description of Exhibit ----------- --------------------------------------------------------\n10.18 Third Amended and Restated Global Credit Agreement by and among Comdisco, Inc., Citibank, N.A. and Nationsbank of North Carolina, N.A. as Co-agents and Co-arrangers and the Financial Institutions Party thereto dated as of December 20, 1994\nIncorporated by reference to Exhibit 10.01 filed with the Company's Current Report on Form 8-K, filed February 15, 1995, File No. 1-7725.\n10.19 Credit Agreement by and among Comdisco, Inc., Citibank, N.A. and Nationsbank of North Carolina, N.A. as Co-agents and Co-arrangers and the Financial Institutions Party thereto dated as of December 20, 1994\nIncorporated by reference to Exhibit 10.01 filed with the Company's Current Report on Form 8-K, filed February 15, 1995, File No. 1-7725.\n10.20 Purchase Agreement dated January 27, 1995 by and among Computer Discount Corporation, Nicholas K. Pontikes, as executor of the Estate of Kenneth N. Pontikes, and Nicholas K. Pontikes as trustee of the Pontikes Trust\nIncorporated by reference to Exhibit 2 to Amendment No. 2 to Schedule 13-D filed by Nicholas K. Pontikes, the Pontikes Trust and the Ponchil Limited Partnership, dated as of January 27, 1995 and filed with the Commission on February 2, 1995, File No. 1-7725.\n10.21 Agreement and Plan of Dissolution of NBB Oil & Gas Partners (U.S.A.) among Comdisco, Inc. and Comdisco Exploration, Inc. and Comdisco Resources, Inc. and NBB Energy Partners I, L.P.\nIncorporated by reference to Exhibit 10.24 filed with the Company's Annual Report for the year ended September 30, 1994 on Form 10-K, File No. 1-7725.\n10.22 Exchange Agreement among NBB Oil & Gas Partners (USA)\nIncorporated by reference to Exhibit 10.25 filed with the Company's Annual Report for the year ended September 30, 1994 on Form 10-K, File No. 1-7725.\n11.00 Computation of Earnings Per Share\n12.00 Ratio of Earnings to Combined Fixed Charges and Preferred Stock Dividends\n13.00 Annual Report to Security Holders\nSix Year Summary, Management's Discussion and Analysis of Financial Condition and Results of Operations, and the Consolidated Financial Statements on pages 24 through 47 and the Quarterly Financial Data on page 46 and the Independent Auditors' Report on page 48 of the Annual Report to security holders for the fiscal year ended September 30, 1995 have been incorporated by reference as part of this Form 10-K.\n21.00 Subsidiaries of Registrant\n23.00 Consent of KPMG Peat Marwick LLP dated December 20, 1995\nExhibit No. Description of Exhibit ----------- -------------------------------------------------\n27.00 Financial Data Schedule","section_15":""}
{"filename":"13021_1995.txt","cik":"13021","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nBolt Beranek and Newman Inc. (\"BBN\" or the \"Company\", each of which terms includes, unless the context indicates otherwise, BBN and its consolidated subsidiaries) was incorporated as a Massachusetts corporation in 1953 as the successor to a partnership formed in 1948.\nIn fiscal 1995, the Company consisted of five operating units: the Company's BBN Systems and Technologies Division, BBN Software Products Corporation, LightStream Corporation, BBN Planet Corporation, and BBN HARK Systems Corporation. The BBN Systems and Technologies Division includes internetworking services and products, and collaborative systems and acoustic technologies. BBN Software Products Corporation, a wholly-owned subsidiary of the Company, develops, markets, and supports data analysis and process optimization software products designed primarily for health industry and manufacturing applications. LightStream Corporation, an 80%-owned subsidiary of the Company which made asynchronous transfer mode (\"ATM\") network switches, sold substantially all of its assets to Cisco Systems, Inc. on January 11, 1995. BBN Planet Corporation, a 95%-owned subsidiary of the Company, provides Internet services to businesses and other organizations. BBN HARK Systems Corporation, a wholly-owned subsidiary of the Company, is an early stage company which develops and markets commercial speech recognition software products.\nDuring fiscal 1995, the Company reported financial information in three business segments: Internetworking, Data Analysis Software, and Collaborative Systems and Acoustic Technologies. The Internetworking business segment includes that part of the activities of the Company's BBN Systems and Technologies Division relating to advanced network systems (including the Company's defense communications activities) and network services and products, the activities of BBN Planet Corporation, and the activities of LightStream Corporation up to the date of sale of substantially all of its assets on January 11, 1995. The Data Analysis Software business segment includes the activities of BBN Software Products Corporation. The Collaborative Systems and Acoustic Technologies business segment includes that part of the activities of the BBN Systems and Technologies Division relating to collaborative systems, sensor systems, and acoustic technologies, and the activities of BBN HARK Systems Corporation.\nThe Company's overall business strategy is to capitalize upon its technical expertise and problem solving experience in the internetworking, data analysis, and collaborative systems and acoustic technologies areas. This strategy is to create focused, entrepreneurial subsidiary companies while maintaining contract research and development activities within the parent corporation. As of July 1, 1995 the Company is comprised of five distinct and complementary business units, including two operating divisions and three operating subsidiaries, as described below:\n- BBN Systems and Technologies Division, an operating division of the Company which generates a majority of the Company's revenue, provides a range of services, including advanced systems and technologies to government and commercial organizations, and performs most of the Company's government contract activities, and its results are reported in part in the Internetworking business segment, and in part in the Collaborative Systems and Acoustic Technologies business segment. The Internetworking activities of the BBN Systems and Technologies Division include advanced network systems and network services and products, and a majority of the revenue of these activities is related to defense communications. The Collaborative Systems and Acoustic Technologies activities of the BBN Systems and Technologies Division also includes sensor systems. (See \"Advanced Network Systems and Services\", \"Network Services and Products\", \"Collaborative Systems\", \"Acoustic Technologies\", and \"Sensor Systems\" below.)\n- BBN Software Products Corporation, a wholly-owned subsidiary of the Company, the name of which is being changed to BBN Domain Corporation, develops and markets data analysis and process optimization software products, and its results comprise the Data Analysis Software segment. (See \"BBN Domain Corporation\" below.)\n- BBN Planet Corporation (formerly named BBN Internet Services Corporation), a 95%-owned subsidiary of the Company, provides Internet services to businesses and other organizations. BBN Planet Corporation, which was incorporated in 1994 to pursue certain commercial Internet-related business opportunities, utilizes the Company's experience and technical expertise in computer networking and Internet-related activities (which dates back to 1968 when BBN participated in the design and implementation of the ARPAnet, the foundation of today's Internet). BBN Planet Corporation has expanded through the acquisition of three regional Internet access providers (including NEARnet in June 1993, and BARRNet and SURAnet in fiscal 1995), and its results are included in the Internetworking segment. (See \"BBN Planet Corporation\" below.)\n- BBN HARK Systems Corporation, a wholly-owned subsidiary of the Company, was established in 1994 (continuing certain of the Company's prior development activities in speech recognition previously residing in the BBN Systems and Technologies Division) to develop and market commercial speech recognition computer software products and services which are marketed primarily to the customer telephony market for call centers and enhanced telephone services applications. Its results are included in the Collaborative Systems and Acoustic Technologies business segment. (See \"BBN HARK Systems Corporation\" below.)\n- BBN Acoustic Technologies Division, an operating division of the Company formed in July 1995, consolidates BBN's expertise in acoustic and environmental technologies (continuing those activities previously performed by the BBN Systems and Technologies Division). The BBN Acoustic Technologies Division provides structural acoustic, environmental, and noise control consulting services primarily to government customers, and designs and develops Active Noise and Vibration Control products and systems. Its results are reported in the Collaborative Systems and Acoustic Technologies business segment. (See \"Acoustic Technologies\" below.)\nThe Company's strategy is to continue to develop advanced technologies at its BBN Systems and Technologies Division, and to create operating subsidiaries and divisions focused on transforming these technologies into services and products for the commercial and government markets. BBN Software Products Corporation, BBN HARK Systems Corporation, and BBN Planet Corporation all were founded on technologies that were originally developed at the BBN Systems and Technologies Division, and the Division continues to work on a range of advanced technologies. In addition, collaboration among the Company's operating subsidiaries and divisions and its BBN Systems and Technologies Division is designed to expand the opportunities of each for shared customers.\nBBN has in the past sold minority interests in subsidiary companies to outside investors in private transactions. That strategy is expected to continue, as appropriate, with the Company considering from time to time the sale of a minority interest in one or more subsidiary companies to outside investors, including in public sales.\nA significant portion of BBN's revenue continues to be derived from its business with the U.S. government and its agencies, particularly the Department of Defense. The Company's business with the Department of Defense has been adversely affected by reduced defense spending. The Company expects overall defense budgets to continue to decline over the next several years, and anticipates attendant increased competition within the consolidating defense industry. These factors have reduced the Company's U.S. government revenue and operating margins in recent fiscal years, and this trend is expected to continue at least through fiscal 1996, particularly in the Company's defense communications, acoustic technologies, and sensor systems activities. (See \"United States Government Contracts\" below.)\nBBN conducts its commercial businesses in environments characterized by intense competition, shortened product life cycles, and rapid technological change, which require significant research and development expenditures to develop new products and services to address emerging market requirements and to improve existing products and services. In recent years, the Company's traditional commercial businesses, consisting principally of RS\/Series(TM) data analysis software products and X.25 network systems, have been experiencing substantially lower revenue. The Company has discontinued sales of most of its traditional X.25 systems and products, and has substantially eliminated its development efforts and significantly reduced its selling efforts\nrelated to this business. In recent periods, the Company has been investing heavily in development of new products, including the LightStream Corporation ATM network switches, Cornerstone(TM) data analysis and visualization software, the T\/10(TM) Integrated Access Device (\"IAD\") for computer networks, and the BBN HARK(TM) speech recognition software. In fiscal 1995, the Company made significant investment in Internet services.\nDuring the three most recent fiscal years, BBN's operating results have been adversely affected by this high level of investment in new products and services, by declines in the Company's defense communications and acoustic technologies businesses, by substantially lower demand for the Company's traditional X.25 network systems and RS\/Series data analysis software products, and by restructuring charges in fiscal 1993 relating to downsizing and staff reductions.\nIn January 1995, Cisco Systems, Inc. acquired substantially all of the assets of LightStream Corporation, resulting in a $105 million gain to the Company before taxes and minority interest. The Company's fiscal 1995 results include revenue of approximately $8.4 million and an operating loss of approximately $3.7 million relating to LightStream Corporation's activities (through the date of sale to Cisco in January 1995). (See \"LightStream Corporation\" below.)\nThe Company continues to invest in its commercial businesses, and recorded operating losses for fiscal 1995 at BBN Planet Corporation, BBN HARK Systems Corporation, and BBN Software Products Corporation, as well as decreased operating income at the BBN Systems and Technologies Division. The Company expects to incur significant operating losses at BBN Planet Corporation during fiscal 1996, which is expected to adversely impact the financial performance of the Company. The outlook could also be affected by further expenditures on commercial business opportunities available to the Company. The Company's objective is to achieve increased revenue growth in fiscal 1996. However, this outlook is strongly dependent upon achieving a significant increase in revenue, primarily from BBN Planet Corporation and BBN Software Products Corporation. There can be no assurance that such an increase will be realized. The Company's revenue growth objective is dependent upon market acceptance of BBN Planet Corporation's Internet-related services and BBN Software Products Corporation's offerings; the Company's ability to continue to recruit entrepreneurial marketing and sales leadership, develop a support infrastructure, and establish productive customer relationships, particularly in the commercial marketplace; and the Company's success at maintaining comparable levels of the Company's government business. The implementation of the Company's overall business strategy will continue to require significant additional investment in sales and marketing and product development.\nThe Company's contracts and subcontracts involving the U.S. government and its agencies represented approximately 58%, 67%, and 62% of BBN's total revenue in fiscal years 1995, 1994, and 1993, respectively.\nINTERNETWORKING\nADVANCED NETWORK SYSTEMS\nOverview.\nBBN designs, develops, and operates wide-area communications network systems, designs and develops advanced routers and other communications network products, and offers and performs contract research,\ndevelopment, and consulting services, primarily for government organizations and, to a lesser extent, for commercial organizations. (For certain information on the Company's Internet services activities, see generally the discussion under \"BBN Planet Corporation\" below.)\nFor the past several years, BBN has provided network systems and services to the U.S. Department of Defense, including to the Defense Data Network (\"DDN\"), a common-user data network serving the Department of Defense. In fiscal 1991, the Defense Information Systems Agency (\"DISA\") awarded BBN a one-year contract in support of the DDN, with up to four one-year optional extensions. The Company is currently performing under the fourth option year of that DDN contract, valued at approximately $15 million, which will continue the Company's existing activities through October 1995. The Company has been awarded a six-month extension of the DDN contract, which will continue these activities through April 1996. The value of this extension award is approximately $7.5 million. The Company does not expect that this activity will continue beyond April 1996, although the Company may compete for follow-on contracts for the DDN, at reduced funding levels.\nBBN provides a range of other network services, systems, and products, for use primarily by the U.S. government under various contracts. BBN provides research, development, hardware, software, and professional services for wide-area networks supporting distributed simulation and training, warfighting simulation, and command and control functionality; advanced Internet routers supporting integrated video, voice, and data requirements; and cryptographic systems and products for sophisticated network security applications.\nThe Company's newly organized \"Enterprise Networks\" commercial consulting services group is currently offering consulting services, strategic analysis and planning, network management, network security, and advanced technology integration for large commercial organizations.\nIn March 1995, the Company entered into an agreement with America Online, Inc. (\"AOL\") to build, maintain, and operate a portion of AOL's nationwide, high-speed, dial-in network. The Company's five-year agreement with AOL, valued at approximately $11 million per year, includes substantial pass-through costs to BBN for telecommunications circuits and other services provided by local and interexchange carriers. In connection with the provision of such services to AOL, the Company has built a Network Operations Center (\"NOC\") based in Columbia, Maryland. As part of BBN's agreement with AOL, the Company has access to use of the excess capacity of the portion of the network operated by BBN, and BBN has the right to resell such excess capacity. The Company is exploring opportunities to resell such excess capacity, the availability of which is currently limited primarily to business hours.\nMarketing.\nThe primary market for BBN's advanced network systems is U.S. government agencies, primarily the U.S. Department of Defense. BBN markets its advanced network systems to government customers both directly and through teaming arrangements with large defense contractors. The general decline in the U.S. Department of Defense budget, coupled with increased competition, are factors that may affect BBN's future success in the government marketplace. (See \"United States Government Contracts\" below.) The Company is also targeting for its services offerings large commercial organizations with significant existing network infrastructures that need to integrate, migrate, or build new enterprise networks that incorporate emerging internetworking technologies.\nThe Company's success in offering advanced network systems is dependent upon the Company's continued ability to recruit, hire, and retain suitable scientific and engineering personnel who possess a high level of technical expertise, knowledge, and experience in the computer networking field.\nCompetition.\nCompetition in the field of advanced network systems is intense. Government contracts may be awarded either through a sole-source or competitive procurement, although competitive procurements are increasingly common. The market for developing and operating wide-area networks for government agencies is dominated by large companies with substantially greater financial and marketing resources than BBN.\nThe Company believes that the primary factors of competition in the government sector are the technical expertise and experience of the supplier, and price. BBN believes that its ability to compete successfully will depend heavily upon the Company's ability to attract and retain employees with a high-level of technical expertise, knowledge, and experience.\nIn the commercial marketplace, the Company believes that its success will depend upon BBN Systems and Technologies Division's success in continuing to provide advanced networking consulting and contract research and development services to certain U.S. government customers, including the Advanced Research Projects Agency. These efforts provide the Company with extensive knowledge and expertise relating to future internetworking trends and opportunities. Factors of competition in the commercial sector include the extensiveness of the supplier's consulting capabilities and service offerings, reputation, responsiveness, and to a lesser extent, price.\nNETWORK SERVICES AND PRODUCTS\nBBN markets and supports network services and products, as described below.\nBBN's X.25 network systems and products, which are based upon packet-switching technology, include switching equipment, access devices, and network management systems. The Company's X.25 network services and products business has experienced significantly lower revenue for several years. Substantially all of the Company's X.25 network services and products revenue in fiscal 1995 was generated from sales into the Company's existing customer base in connection with the maintenance and support of networks previously installed by BBN. The Company has discontinued sales of most of its traditional X.25 systems and products, and has substantially eliminated its development efforts and significantly reduced its selling efforts related to this business.\nBBN's T\/10 IAD is designed to help customers consolidate traffic from their traditional terminal-to-computer and computer-to-computer traffic with newer desktop computing applications over a single enterprise network. The T\/10 IAD operates simultaneously as an Internet Protocol router, X.25 packet switch, and async, bisynch, and SNA packet assembler\/disassembler, and provides frame relay functionality. To date, revenue from the Company's T\/10 IAD activities has been substantially below expectations, and the Company has experienced operating losses in connection with that business. The Company has substantially reduced spending relating to the T\/10 IAD from prior year levels.\nThe Company's T\/10 IAD activities are now being primarily focused on a limited number of reseller and strategic licensing opportunities, and the future success of the T\/10 IAD is highly dependent on these opportunities. In July 1995, the Company entered into an agreement with NEC Corporation (\"NEC\") granting to NEC technology and manufacturing license rights in the T\/10 IAD and in the Company's T\/40(TM) Video Internet Router (which BBN has under development), and agreed to perform certain development activities in connection with the joint development of a new multi-media access device. The value of the NEC agreement is approximately $4.6 million, $1.9 million of which relates to future development efforts.\nThe Company has outsourced most of its manufacturing capabilities for its internetworking products. The Company does not currently maintain a qualified second manufacturing source for the T\/10 IAD and certain X.25 network products.\nField service, consisting of on-site hardware and software maintenance for BBN's products, is provided both directly by BBN and through third party maintenance organizations. The Company maintains dedicated field service personnel at sites in the United States and in a limited number of foreign countries, serving the field service requirements of its U.S. government customers, primarily for the DDN.\nMarketing.\nThe market for the Company's X.25 network services and products is primarily BBN's existing commercial customer base. These customers typically require ongoing maintenance, upgrade, operation, or expansion of a private X.25 network system previously installed by the Company. The Company markets its X.25 network services and products both directly and through third party resellers, although the Company has\nsubstantially reduced its direct selling and marketing capabilities for X.25 network services and products in recent years.\nCompetition.\nThe Company believes that the primary factors of competition for X.25 network services and products are functionality, product performance, price, reliability, and experience of the supplier. Several important trends have adversely affected the Company's X.25 network services and products business, including the growth of desktop computing, the widespread installation of LANs, and increased transmission circuit speed and improved circuit quality. These trends have led to market requirements for networking technologies such as routers. The Company is not currently investing in additional development of its X.25 products.\nBBN PLANET CORPORATION\nOverview.\nBBN Planet Corporation (\"BBN Planet\") provides Internet services to businesses and other organizations by operating a high-bandwidth digital data communications network providing dedicated local access to its customers across the United States. BBN Planet's Internet access services include a range of dedicated leased line connectivity options, network design, implementation, management, monitoring and problem-resolution services. BBN Planet also intends to develop or acquire additional Internet-related value added services. In addition to Internet access services, the Company currently offers managed network security, World Wide Web server hosting, and application development services.\nIn June 1993, BBN organized its commercial Internet-related business activities into a new subsidiary which acquired the assets of the New England Academic Research Network (\"NEARnet\"). This organization, evolving into BBN Planet, has since acquired the business and assets of two additional regional Internet access providers (including BARRNet in 1994 and SURAnet in 1995), expanding its geographical service area and customer base, and supplementing the technical expertise and the approximately 100 employees transferred to BBN Planet from BBN. In addition, BBN Planet has recently hired senior management and marketing personnel.\nBBN Planet's high-bandwidth network utilizes both BBN Planet-owned network points of presence (\"POPs\") and interconnected frame-relay and switched multi-megabit facilities provided by local exchange and interexchange carriers, in order to make available to its customers local Internet access throughout the United States. BBN Planet is beginning to expand and upgrade its network backbone, in order to meet the anticipated increase in Internet traffic and the demand for high capacity Internet connections. To support its service offerings, BBN Planet maintains a primary network operations center staffed 7 days-a-week, 24 hours per day, as well as two operations support centers that can serve as limited back-up network operations centers in the event of an emergency. Field service staff, consulting service engineers, and applications design personnel are located in regional offices to provide technical sales and customer support.\nMarketing.\nCurrently, BBN Planet's customers consist of over 1,300 businesses, universities, and governmental customers. BBN Planet intends to target organizational and business customers, in particular organizations and businesses with extensive customer service and support requirements, including computer and computer software companies, telecommunications companies, high technology companies, consumer-oriented financial services companies, publishers, manufacturers, and professional service firms. BBN Planet currently sells its services through its own sales force and through AT&T Corp. (\"AT&T\").\nIn June 1995, BBN Planet and AT&T entered into a strategic relationship under which BBN Planet is to be the exclusive provider for a period of up to three years of dedicated Internet access and managed network security services to AT&T for resale to customers of AT&T's Business Communications Services division (\"BCS\") in the United States. During such three year period, as long as BBN Planet is the exclusive provider of dedicated Internet access and managed Internet security services to customers of BCS, BBN Planet is\nprohibited from providing such services to, or in conjunction with, other telecommunications carriers or on-line service providers. Under the agreement, AT&T provides certain incentives to BBN Planet to develop additional Internet-related value-added services for sale to such customers. BBN Planet will also provide training and sales support and post-sale implementation support to AT&T. The agreement provides AT&T with discounts off of benchmark pricing, based upon comparable pricing to BBN Planet's most favored customers. In addition, either AT&T or BBN Planet may at any time initiate modifications in the benchmark pricing for BBN Planet's Internet access services, as necessary to ensure that BBN Planet's prices remain competitive with the prices charged by other providers of similar services. AT&T's BCS sales force will resell BBN Planet's dedicated Internet access services to AT&T customers. The relationship offers to BBN Planet an opportunity to accelerate the expansion of BBN Planet's Internet access and related value-added services business. AT&T has agreed to purchase the following minimum order amounts of services during the first three years of the agreement: year one, $20 million; year two, $40 million; and year three, $60 million (subject to potential reduction under specified circumstances). In addition, in years 4 and 5 of the agreement, AT&T has agreed, to the extent BCS continues to receive revenue from the sale of dedicated Internet access services, to purchase services from BBN Planet such that in general BBN Planet's revenue from the sale of services to AT&T and AT&T customers in such years is not less than two-thirds and one-third, respectively, of BBN Planet's revenue from the sale of dedicated Internet access services to AT&T and continuing AT&T customers during year 3 of the agreement. AT&T's obligations to purchase a minimum amount of services in years 4 and 5 of the agreement will terminate, among other reasons, if a telecommunications carrier or on-line service provider having the right to appoint a director of BBN or BBN Planet acquires ownership of 15% or more of the outstanding stock of BBN or BBN Planet. In addition to certain other termination provisions, AT&T may cancel the agreement in the event either BBN or BBN Planet merges with, or becomes controlled by, another telecommunications carrier or an on-line service provider and has the right to terminate the exclusivity obligation and to withhold other financial benefits in certain other situations. BBN Planet's performance of the AT&T agreement has been guaranteed by BBN. In July 1995, AT&T Venture Company L.P., a venture capital partnership with AT&T as the sole limited partner, made an $8.0 million investment in BBN Planet.\nCompetition.\nThe market for Internet services is rapidly expanding, and there are considerable uncertainties as to how the market will develop. The market for Internet access and related value-added services is highly competitive and in general there are no substantial barriers to entry. BBN Planet believes there are certain key marketing considerations in this market, including: price; quality of service; technical expertise; the quality of network backbone and infrastructure; and the quality and scope of sales, marketing, and distribution channels. BBN Planet expects that competition in the market will intensify in the future.\nBBN Planet's current and prospective competitors may, in general, be divided into the following four groups: (1) Internet access providers, such as Performance Systems International, Inc. and UUNET Technologies Inc.; (2) telecommunications companies, such as AT&T, MCI Telecommunications, Inc., Metropolitan Fiber Systems Communications, Inc., Sprint, Inc., regional Bell operating companies, and various cable companies; (3) on-line services providers, such as AOL and CompuServe Incorporated (a division of H&R Block, Inc.); and (4) value-added networks and systems integrators, such as General Electric Information Services and International Business Machines Corporation's Advantis. Many of these competitors have greater market presence and have engineering, marketing, financial, technological, and personnel resources greater than those available to BBN Planet. As a result, they may be able to develop and expand their communications and network infrastructures more quickly, adapt more swiftly to new or emerging technologies and changes in customer requirements, take advantage of acquisition and other opportunities more readily, and devote greater resources to the marketing and sale of their products than can BBN Planet. BBN Planet expects that all of the major online services and telecommunications companies will compete fully in the Internet services market, and that new competitors, including large computer hardware, software, media, and other technology and telecommunications companies, will enter the Internet services market, resulting in even greater competition for BBN Planet.\nAs a result of increased competition in the industry, the Company expects to encounter pricing pressure, which in turn could result in significant reductions in the selling price of BBN Planet's Internet access services (including changes to the pricing to AT&T under BBN Planet's agreement with AT&T). In addition, those of BBN Planet's competitors which are telecommunications companies may be able to provide customers with reduced overall communications costs by combining Internet access services with other services, thereby reducing the overall cost of their Internet access services and increasing pricing pressures on BBN Planet. There can be no assurance that BBN Planet will be able to offset the effects of any such price reductions with an increase in the number of its customers, higher revenue from value-added services, cost reductions, or otherwise. There can be no assurance that BBN Planet will have the financial resources, technical expertise, or marketing and support capabilities to continue to compete successfully.\nBBN Planet's success will primarily depend upon the development and expansion of the market for Internet access services and products and the networks which comprise the Internet; the capacity, reliability, and security of its network infrastructure; its ability to develop value-added products and services that meet changing customer requirements or acquire rights to such products and services from BBN or other providers; its ability to attract and retain additional highly qualified management, technical, marketing, and sales personnel; and its ability to manage its growth.\nLIGHTSTREAM CORPORATION\nUntil January 1995, BBN had invested heavily for several years in the development of networking products based on ATM technology. The Company's ATM development activities were conducted from October 1993 by LightStream Corporation, a BBN subsidiary 80% owned by the Company and 20% owned by UB Networks, Inc. (formerly Ungermann-Bass, Inc.), a wholly-owned subsidiary of Tandem Computers, Inc. Sales of LightStream ATM switches were approximately $1.5 million in fiscal year 1994 and $8.4 million for the six months ended December 31, 1994. Operating losses relating to the LightStream ATM activities were approximately $14.8 million in fiscal year 1994 and $3.7 million for the six months ended December 31, 1994.\nIn January 1995, LightStream Corporation sold substantially all of its assets to Cisco Systems, Inc. (\"Cisco\"), which resulted in a $105.0 million gain to the Company before taxes and minority interest. BBN realized approximately $80 million in cash from this transaction.\nSimultaneous with the sale of LightStream Corporation, BBN entered into an agreement with Cisco providing the Company with significant discounts on the purchase of up to $30 million in Cisco equipment. The Company also formed a strategic alliance with Cisco relating to Internet services. BBN was also selected as a primary provider of Internet access services to Cisco and currently manages part of Cisco's internal network.\nDATA ANALYSIS SOFTWARE\nBBN DOMAIN CORPORATION\nOverview.\nThrough its wholly-owned subsidiary BBN Software Products Corporation, the name of which is being changed to BBN Domain Corporation (herein sometimes referred to as \"BBN Domain\"), the Company develops, markets, and supports data analysis and process optimization software products and services primarily designed for companies in the health and manufacturing industries. The Company's data analysis and process optimization software products embody data management, data analysis, and domain-specific methodologies in visually-oriented, client\/server environments.\nBBN Domain's offerings of software products, including RS\/Series, Clintrial(TM), Clintrace(TM), Cornerstone, BBN\/Probe(TM), and BBN\/Patterns(TM) computer software, are described more fully below:\n- RS\/Series. The RS\/Series of data analysis and visualization software includes RS\/1(R), RS\/Explore(R), RS\/Discover(R), and RS\/QCA II(TM) software. RS\/1 software is a fully integrated data analysis system\nused by engineers in manufacturing companies. RS\/Explore, RS\/Discover, and RS\/QCA II software are sold as product options to RS\/1 software. Collectively, the RS\/Series software is used to monitor and improve processes through the use of data analysis, statistical process control, and design of experiments.\n- Clintrial and Clintrace. Clintrial and Clintrace data management software are health industry applications software products used by pharmaceutical, biotechnology, and medical devices companies, as well as contract research organizations. Clintrial software is designed to support data management of clinical trials, and Clintrace software is designed to unify a company's adverse events processing.\n- Cornerstone. Cornerstone data analysis and visualization software provides integrated data access, visualization, analysis, and presentation of results within a single consistent graphical user interface. Cornerstone software is specifically designed for use on desktop computers in a client\/server environment, and operates on workstations and personal computers from a number of manufacturers.\n- BBN\/Probe and BBN\/Patterns. BBN\/Probe and BBN\/Patterns software provide recognition, visualization, and analysis of complicated time-series data. BBN\/Probe software is used by engineers, primarily in the aerospace and defense industries, to access and analyze complicated time-series data. BBN\/Patterns software helps engineers and scientists in the manufacturing and aerospace industries recognize simple to complex signatures in their data streams.\nBBN Domain software products operate on a variety of operating systems, as applicable, including VMS and Open VMS from Digital Equipment Corporation; Windows 3.x, Windows95, and Windows NT from Microsoft Corporation; SunOS from Sun Microsystems; HP-UX from Hewlett-Packard Corporation; and AIX from IBM Corporation.\nThe Company's traditional data analysis software products, including mini-computer based versions of the Company's RS\/Series software, have been affected over the last several years by a number of market changes, most notably the growth of distributed processing and the associated use of personal computers, workstations, and other desktop computers. As demand for minicomputer-based software has declined, the Company has experienced substantially lower RS\/Series software revenue and downward pressure on prices. In response to the trend toward desktop computing, the Company has developed desktop versions of certain RS\/Series software products including RS\/Series for Windows, and in 1994 the Company introduced Cornerstone software, a desktop-based data analysis and visualization software tool. Sales of Cornerstone software to date have been substantially below expectations. Commencing in fiscal 1995, BBN Domain is more tightly integrating its Cornerstone software with its RS\/Series software products to provide platform migration and ease of use for its existing RS\/Series customer base, and to provide greater capabilities and flexibility in client\/server computing environments.\nRecently, the Company has refocused its traditional data analysis software activities, and now targets customers principally in the health and manufacturing industries. The Company's products are typically used in research, development, and manufacturing operations.\nIn fiscal 1995, BBN acquired from IBM the exclusive rights to IBM's Process Analysis Navigation System (\"PANS\") technology and software for manufacturing processes. The Company is currently integrating and significantly enhancing this methodology and technology with BBN's data analysis and visualization software for manufacturers, and BBN Domain expects to release the resulting product in fiscal 1996. The product is intended to combine data analysis and visualization capabilities with process optimization methodology to assist customers in reengineering on a statistical basis their manufacturing processes to improve productivity in bringing products to market.\nIn the health industry, BBN Domain is participating with pharmaceutical companies in the development of new features and functions for its Clintrial clinical data management software for client\/server computing environments.\nThe Company is increasing its development expenditures at BBN Domain, and is investing in additional sales and marketing personnel. The Company believes that the future success of its data analysis and process\noptimization software will depend primarily on the development and marketing of software applications that permit operation on personal computers; on continued market acceptance of its health industry software products; on development and acceptance of its PANS manufacturing methodology; and on timely integration of its Cornerstone and RS\/Series software.\nBBN Domain also offers maintenance, training, and consulting services to its software customers. Maintenance services consist principally of system updates, new releases, and telephone hotline support. Training is offered both in product use and use of statistical methods embodied in the Company's software products. Consulting services include principally installation, implementation, and customization of BBN's software products for its customers.\nMarketing.\nThe primary markets targeted by BBN Domain for its software products are the health and manufacturing industries. In the health industry, the Company's software products are used primarily by administrative and management personnel who are responsible for conducting and managing clinical research, clinical trials, drug safety, and regulatory affairs in the pharmaceutical, biotechnology, and medical devices fields, and contract research organizations supporting such companies. In the manufacturing industry, the Company's software products are used primarily by engineers and management personnel in the semiconductor, electronics, automotive, chemical, and pharmaceutical fields. The manufacturing market is characterized by a need to acquire, analyze, visualize, graph, and report engineering and manufacturing data.\nBBN Domain markets its software products to organizations worldwide. Selling and marketing is done principally through a direct sales force at offices in the United States, Western Europe, and the Pacific Rim. The Company is increasing its international activities, and has recently opened sales offices in the People's Republic of China and Singapore.\nSales of the Company's health industry software have increased recently. In June 1995, the Company announced that the Pharma Division of Ciba-Geigy Limited will standardize on Clintrial software for its worldwide drug development projects. In addition, in August 1995 the Company announced that Eli Lilly and Company had licensed Clintrial and Clintrace software to help standardize its clinical data management processes. However, the market for Clintrial and Clintrace software is primarily pharmaceutical, biotechnology, and medical devices companies and contract research organizations. Accordingly, the Company's ability to continue to sustain revenue growth from its health industry software is dependent upon the continued development by the Company of enhancements and new product offerings for its limited customer base.\nCompetition.\nBBN Domain's software for the health and manufacturing industries competes principally with customized software solutions developed by in-house programmers for internal use by corporations. Many of the companies using in-house systems are also clients of the Company. The Company believes that there is currently no other company offering a similar level of integrated process optimization solutions to companies in the manufacturing industry, but many competitors do offer discrete software products that improve a company's processes. BBN Domain's principal competition for data analysis and visualization software products from non-in-house suppliers is from statistical software packages offered by independent software vendors and, to a lesser degree, by spreadsheet vendors whose products are widely used in business and technical environments for data organization, simple statistics, and graphics. Several of these packages are marketed by organizations with established reputations and with financial and marketing resources greater than those of BBN.\nBBN Domain believes that competition in the data analysis and visualization software market is primarily based upon the quality, features, price, ease-of-use, and support offered by a particular product. In addition to providing the sophisticated statistical functionality required to analyze and visualize complex technical data, BBN Domain believes that its products provide the market with a higher level of functional integration than is generally available from most competitors. However, there are significant portions of the overall market which\ndo not need the level of functional integration which is embedded within the Company's applications software products.\nCOLLABORATIVE SYSTEMS AND ACOUSTIC TECHNOLOGIES\nCOLLABORATIVE SYSTEMS\nOverview.\nBBN designs, develops, and markets collaborative systems, primarily in the fields of distributed computing, speech and language processing, and education technology. In each of these fields, BBN offers customized solutions to complex problems.\nIn the field of distributed computing, the Company offers research, development, and consulting services, primarily to government agencies, to develop and implement advanced systems in the area of human-computer applications, integrating advanced computing, expert systems, and artificial intelligence capabilities. The Company has designed and built intelligent systems for a number of government customers, including the U.S. Army (mission-critical intelligent system for logistics planning) and the U.S. Advanced Research Projects Agency (distributed collaborative planning systems for joint task force operations).\nIn the field of speech and language processing, the Company offers research, development, and consulting services, primarily to government customers, relating to speech recognition, natural language processing, spoken language systems, and text processing. For example, under contract to the U.S. Advanced Research Projects Agency, the Company is developing interactive spoken language systems enabling military personnel to interface efficiently and effectively with intelligent computer applications. (The Company's commercial speech recognition activity is carried on primarily through BBN HARK Systems Corporation. See \"BBN HARK Systems Corporation\" below).\nIn the field of education technology, BBN offers a variety of research, development, and consulting services, primarily to government organizations such as the National Institutes of Health and the National Science Foundation, and to public and private educational institutions. For example, under contract to the New American Schools Development Corporation, the Company has developed and is assisting in the implementation of the \"Cooperative Networked Educational Community for Tomorrow\" (Co-NECT(TM)) School Design program, utilizing computer and networked communications technology as part of a project-based curriculum. In fiscal 1995, the Company announced an agreement with the Dade County Public School system to assist in the creation of three model middle schools in the Miami, Florida area.\nThe Company also designs, develops, and markets collaborative systems in the fields of advanced command and control, cognitive sciences and systems, intelligent systems, and underwater simulation.\nMarketing.\nLarge government and commercial organizations face increasingly complex challenges, including around-the-clock operations, globally dispersed operations, and rapid response requirements. Effective computer-based solutions to these challenges require transition from centralized, isolated computing focused on managing information to connected, collaborative computing focused on using information (including real time data capture), communications across heterogeneous platforms and networks, and rapid analysis and reporting. The systems and products provided by the Company to address these challenges are called \"collaborative systems\".\nBBN markets collaborative systems and related services and products principally to U.S. government agencies. Substantially all of BBN's collaborative systems contracts are won on the basis of the technical merits of BBN's proposals and BBN's professional reputation. BBN's reputation is enhanced through the visibility of its employees in professional pursuits and, accordingly, BBN encourages participation by its employees in various professional associations and sponsors the presentation and publication of technical papers by employees at professional meetings and in technical journals.\nCompetition.\nThe primary factors of competition for collaborative systems are superior technical expertise and price. BBN believes that its ability to maintain its competitive position depends upon its ability to attract and retain talented employees and to maintain a competitive cost structure.\nBBN faces competition from a large number of organizations, many of which have substantially greater financial resources and larger technical staffs than BBN. Competitors include corporations and non-profit organizations (including non-profit federal contract research centers) that may derive a substantial portion of their revenue from research and development contracts with the U.S. government and its agencies. In addition, some government agencies have internal research departments that may perform some of the services offered by BBN, although the Company's services generally supplement the capabilities and talents available within such agencies. Increased competition for its collaborative systems and services has had an adverse impact on the Company's profit margins. Information as to the Company's U.S. government contract activities may be found in the section captioned \"United States Government Contracts\" below.\nBBN HARK SYSTEMS CORPORATION\nOverview.\nThrough its wholly-owned subsidiary, BBN HARK Systems Corporation (\"BBN HARK\"), the Company develops, markets, and supports commercial speech recognition computer software products and services, which are marketed primarily to the customer telephony market for call centers and enhanced telephone services applications. The foundation of the Company's commercial speech recognition software-based solutions is the BBN HARK Recognizer software product, which provides speaker independent, continuous speech recognition based on a scalable, client\/server architecture. The BBN HARK Recognizer is a software-only system that operates on a number of standard workstations and personal computers equipped with a standard audio interface, without additional specialized digital signal processing hardware. The Company also provides contract research and development services to commercial customers to develop and implement customized speech recognition-based software applications. BBN HARK is an early-stage company which is currently incurring operating losses.\nMarketing.\nThe market for commercial speech recognition products and services consists of two principal market segments, the customer telephony market (focused on speech recognition capabilities for call centers and enhanced telephone services) and the desktop speech market (focused on speech recognition capabilities for operating system and applications software for desktop computers and dictation systems). The principal market currently targeted by the Company for its speech recognition products and services is the telephony call center market. Potential customers for BBN HARK speech recognition products and services include companies that interact with their customers through call centers in a variety of fields, including the telephone, travel, transportation, financial services, and health care industries, for a range of applications, including customer service, reservations, sales and direct marketing, help desk, product support, collection, fundraising, and dispatch.\nThe Company markets and sells its commercial speech recognition products and services through a combination of direct and indirect channels, principally in the United States. Currently, the Company has only modest direct sales capabilities for its speech recognition products and services. In addition to utilizing a direct sales force, the Company intends to establish multiple distribution channels with telephony and computer hardware platform providers, systems integrators, and value-added resellers.\nIn July 1995, the Company announced a distribution agreement for its speech recognition software with IBM and a pilot program with AT&T for application of the BBN HARK software in networked telephony applications. During fiscal 1995, the Company also entered into an agreement with Time Warner Cable to develop systems design for integrating speech recognition into Time Warner's prototype interactive cable services, to be deployed in the later phases of a field trial in Orlando, Florida.\nThe Company's speech recognition software products are currently available only in English-language versions, and are currently marketed primarily to commercial organizations in the United States.\nComputer speech recognition is an emerging market. Although the Company expects that the telephony call center market segment presents greater opportunities for the Company's speech recognition products and services than the desktop speech market segment, there currently exists only a limited market demand. In addition, the sale of the Company's speech recognition products and services is characterized by long sales cycles, often including a lengthy small-scale \"pilot\" test phase. Accordingly, the Company's success in the commercial speech recognition marketplace will depend heavily upon the development of market demand for large vocabulary speech recognition capabilities; the ability of the Company to sustain technological superiority, ease-of-use, and cost-competitiveness for its speech recognition products and services; the development of third party applications incorporating the BBN HARK speech recognition technology; and the establishment of productive distribution channels (including strategic alliances) on a timely basis.\nCompetition.\nThe primary factors of competition for commercial speech recognition products are the availability of appropriate end-use applications, technological capabilities of the product (including speed, reliability, accuracy, features, programmability, and ease-of-use), price, technical and support system engineering services, and experience and reputation of the supplier.\nThe Company competes against other providers of commercial speech recognition products and systems in the telephony and desktop markets. Although the Company believes its technical resources compare favorably with its competition, some competitors have established reputations and financial, marketing, and distribution resources substantially greater than those of BBN, and accordingly there can be no assurance of success in this highly competitive market.\nACOUSTIC TECHNOLOGIES\nOverview.\nBBN performs contract research, development, and consulting services primarily for U.S. government agencies in the defense application fields of sonar, submarine, surface ship, and ocean environmental acoustics; signal and information processing; shock and vibration analysis; marine systems; radar cross-section reduction; materials engineering; and psychoacoustics.\nBBN, through its BBN Acoustic Technologies Division, also is exploring commercial applications for active noise and vibration control (\"ANVC\") products and systems. Active control of noise and vibration is accomplished by introducing one or more secondary sources of noise and vibration to generate \"anti-waves\" that significantly reduce the original disturbance.\nThe market for acoustic technologies with defense applications has changed dramatically in recent years. The end of the Cold War has led to the cancellation or reduction in scope of a number of large procurements. In addition, the Department of Defense is placing increased emphasis on research, development, training, and evaluation, often stopping short of full-scale production of a system until necessary. The Company experienced an approximately 30% decline in defense acoustic technologies revenue for fiscal year 1995 as compared to the prior fiscal year. In light of these changes, BBN believes its ability to sustain revenue in the acoustic technologies business area will depend on continued program funding for acoustic systems by the U.S. government, and an increase in commercial customer revenue, particularly in connection with ANVC systems.\nMarketing.\nThe primary customers for BBN's acoustic technologies consist of the U.S. Navy, the U.S. Advanced Research Projects Agency, anti-submarine warfare prime contractors, and the National Aeronautics and Space Agency.\nBBN markets its defense acoustic technologies capabilities to customers both directly and, in connection with some large government procurements, through teaming arrangements with large defense contractors. Periodically, government agencies issue requests for proposals or broad-area announcements seeking suppliers with specific technology skills and BBN often can respond to these requests. Alternatively, the Company may propose systems-related work to government agencies. The Company also may be invited to bid, or may seek to team with one or more companies bidding, on a larger procurement of which a system or subsystem within BBN's field of expertise is one component.\nThe Company is now targeting certain of its acoustic technologies capabilities to commercial customers, primarily in the ANVC area. The market for ANVC products and systems is slowly emerging, and manufacturers in the automotive, aerospace, industrial equipment, and consumer products industries are exploring applications of ANVC technology. This market is characterized by a need to control noise and vibrations produced by systems such as automobiles, airplanes, machine tools, commercial HVAC Systems, mining and construction machinery, and office equipment. Company revenue from such commercial customers has not been significant to date. In connection with the marketing of ANVC products and systems, the Company is seeking to augment its direct sales capabilities through the establishment of strategic alliances and other distribution channels.\nCompetition.\nThe primary factors of competition for acoustic technologies are superior technical expertise, experience of the supplier, and price.\nCompetition in the field of acoustic technologies with defense applications is dominated by large defense contractors with substantially greater financial and marketing resources than BBN. In major programs, where BBN's technical expertise supports the allocation to BBN of a portion of the work, BBN typically teams with a large defense contractor. In teaming arrangements where BBN acts in a subcontractor capacity, BBN relies heavily on the effectiveness of its prime contractor to win a given award. In defense-related areas, the Company anticipates that competition will continue to be intense. (See also \"United States Government Contracts\" below.)\nThe ANVC systems market is slowly emerging, and a number of manufacturers are developing in-house ANVC applications. In addition, some competitors have been actively pursuing patent rights in certain segments of ANVC technologies, which could impact the Company's ability to compete in certain areas of the commercial ANVC market.\nSENSOR SYSTEMS\nOverview.\nBBN designs, develops, and markets underwater acoustic sonar and prototype sensor systems, both fixed and mobile, primarily for U.S government agencies. BBN combines experience in acoustics, signal analysis, and information processing, to develop major sensor systems, from initial concept through full-scale engineering development and deployment.\nBBN is currently teamed with Loral Federal Systems to perform engineering and development services in connection with two U.S. Navy procurements, the Fixed Distributed System Shore Signal and Information Processing Segment (\"FDS SSIPS\") program and the Advanced Deployable Systems (\"ADS\") program. Both the FDS SSIPS and ADS programs are components of the U.S. Navy's Integrated Underwater Surveillance System. In connection with the FDS SSIPS program, BBN's role has been to define the overall operational concept for FDS SSIPS, and to provide software development and operational training. BBN expects to perform a similar role in connection with the ADS program. Although the scale of the FDS SSIPS program has been reduced since its inception, the Company currently believes that it will continue to be involved in the FDS SSIPS program for several more years. The award of the ADS program to the BBN\/Loral team is currently the subject of a bid protest. While there exists some uncertainty over the U.S. government's long-term level of funding for the FDS SSIPS and ADS programs, the Company believes that\nthe U.S. Navy will continue to fund development programs for its underwater surveillance system. (See \"United States Government Contracts\" below.)\nMarketing.\nThe primary customers for BBN's sensor systems consist of the U.S. Navy and the Advanced Research Projects Agency. BBN markets its sensor systems to customers both directly and through teaming arrangements with large defense contractors. Periodically, government agencies issue requests for proposals or broad-area announcements seeking suppliers with specific technology skills and BBN often can respond to these requests. Alternatively, the Company may propose systems-related work to government agencies. The Company also may be invited to bid, or may seek to team with one or more companies bidding, on a larger procurement of which a system or subsystem within BBN's field of expertise is one component.\nThe market for sensor systems has changed dramatically in recent years. The end of the Cold War has led to the cancellation or reduction in scope of a number of large sensor systems procurements. In addition, the Department of Defense is placing increased emphasis on research, development, training, and evaluation, often stopping short of full-scale production of a system until necessary. BBN believes its ability to sustain revenue in this business area will depend on continued contract research and development and program funding for underwater sensor systems by the U.S. government.\nCompetition.\nThe primary factors of competition for sensor systems are superior technical expertise, experience of the supplier, and price.\nCompetition in the field of sensor systems is dominated by large defense contractors with substantially greater financial and marketing resources than BBN. In major programs, where BBN's technical expertise supports the allocation to BBN of a portion of the work, BBN typically teams with a large defense contractor. In teaming arrangements where BBN acts in a subcontractor capacity, BBN relies heavily on the effectiveness of its prime contractor to win a given award. In connection with contract research and development activities, the Company occasionally contracts directly with the U.S. government. In defense-related areas, the Company anticipates that competition will continue to be intense. (See also \"United States Government Contracts\" below.)\nSIMULATION SYSTEMS\nUntil April 1993, BBN designed, marketed, built, and supported distributed simulation systems, combining computer image generators with networking capabilities, primarily for tactical team training. BBN's customers included the U.S. Army (through the SIMNET program) and the German Army (through the AGPT program under a subcontract with Wegmann & Co. GmbH). In April 1993, in view of ongoing capital requirements and an uncertain sales outlook, the Company sold the fixed assets, inventory, and technology of its simulation systems business, and transferred more than one hundred employees of that business, to a subsidiary of Loral Corporation. The results of the Company's former simulation systems business are included as appropriate in the Collaborative Systems and Acoustic Technologies business segment.\nPRODUCT DEVELOPMENT\nThe Company's commercial businesses are characterized by rapid technological change, which requires continued research and development expenditures by the Company to improve its existing products and services, and to develop new software and hardware products and new services to address emerging market requirements. The Company has incurred substantial internally funded research and development costs, including $25,306,000, $23,306,000, and $34,048,000 in fiscal 1995, 1994, and 1993, respectively.\nIn fiscal 1995, the largest portion of the Company's internally funded research and development spending was directed principally toward data analysis and process optimization software products at BBN Domain (see\n\"BBN Domain Corporation\"). The Company's continued significant investment in research and development is dependent upon the timely market acceptance of its new products.\nAdditional information as to the research and development activities of the Company may be found on pages 27 and 29, and on page 39 under the caption \"Research and Development Costs\" in the Notes to Consolidated Financial Statements below.\nUNITED STATES GOVERNMENT CONTRACTS\nDuring fiscal 1995, 1994, and 1993, approximately 58%, 67%, and 62%, respectively, of BBN's total revenue was derived from contracts and subcontracts involving the U.S. government and its agencies. In fiscal 1995, approximately $106,000,000 were sales pursuant to contracts funded through the Department of Defense. Of these sales, contracts sponsored by three agencies of the Department of Defense (under several programs in each case) contributed approximately $42,000,000, $19,000,000 and $19,000,000, respectively.\nThe U.S. government accounted for approximately the following percentages of revenue in each of the Company's current business segments in fiscal 1995, 1994, and 1993:\nThe decreased percentage of U.S. government revenue in the Internetworking business segment for fiscal 1995 reflects increased revenue in BBN's commercial Internetworking subsidiaries (BBN Planet Corporation and LightStream Corporation), as well as decreased advanced network systems revenue. The decreased percentage of U.S. government revenue in the Collaborative Systems and Acoustic Technologies business segment for fiscal 1995 reflects increased revenue in the Company's commercial speech subsidiary BBN HARK.\nThe decreased percentage of U.S. government revenue in the Internetworking business segment for fiscal 1994 reflects decreased advanced network systems revenue due to the substantial completion of the Company's Mobile Subscriber Equipment program under subcontract with GTE Government Systems, and lower revenue in connection with the Company's DDN contract. The increased percentage of U.S. government revenue in the Collaborative Systems and Acoustic Technologies business segment for fiscal 1994 reflects the fiscal 1993 sale of the Company's simulation systems business (which had significant non-U.S. government revenue in fiscal 1993). (See \"Advanced Network Systems\" and \"Simulation Systems\" above.)\nAll of the Company's contracts and subcontracts involving the U.S. government are subject to termination at the convenience of the government. Should a contract be so terminated by the government, BBN would be reimbursed for its allowable costs to the date of termination and would be paid a proportionate amount of the stipulated profit attributable to the work actually performed.\nThe U.S. government contracts for its procurement needs either through formal advertising procedures or by negotiation. The government is authorized to forego formal advertising under various circumstances, including the procurement of experimental, developmental, or research services. Negotiated procurements may or may not involve the solicitation of competitive proposals. If competitive proposals are involved, the government selects the proposal most advantageous to the government and normally conducts negotiations with the selected offeror. Certain negotiated procurements are accomplished without a competitive solicitation, such as when supplies or services can be obtained from only one person or firm (\"sole source\") or when there is otherwise no substantial question as to choice of source. In most noncompetitive procurements, after the offeror submits a proposal, the government then negotiates the price and other terms in accordance with guidance received from technical personnel of the procuring agency and the profit or fee guidelines set forth in the applicable regulations. Certain of the Company's contracts with the government involve negotiated procurement procedures accomplished without competitive solicitation; however, most of the Company's\ngovernment contracts are subject to competitive bidding procedures, and the government has adopted certain policy initiatives generally placing more emphasis on competitive procurement.\nThe majority of BBN's revenue from the U.S. government and its agencies is pursuant to contracts priced on a cost-plus-fixed-fee basis, under which the government reimburses the contractor for its allowable costs (within the contractual terms and conditions) and pays the contractor a negotiated fee.\nMany of the government programs in which the Company participates as a contractor or subcontractor may extend for several years, but they are normally funded on an annual basis. The Company's government contracts and subcontracts are subject to reduction or modification in the event of changes in the government's requirements or budgetary constraints. Government curtailment of expenditures for systems or services of the type sold by the Company in the internetworking or collaborative systems and acoustic technologies fields can have an adverse impact on BBN's revenue and results from operations. The Department of Defense intends to make increasing use of the commercial off-the-shelf (\"COTS\") policy in acquiring high technology systems for certain non-combat related applications, and BBN's participation in such programs would be dependent upon its ability to supply such COTS equipment on a cost-effective basis.\nThe Company, like other companies doing business with the Department of Defense, has been adversely affected by reduced defense spending and expects this general decline and attendant increased competition within the defense industry to continue over the next several years. Uncertainty continues to exist on the size and scope of reductions in future defense budgets and their impact on the Company's defense-related business. Further, there is the possibility that funding limitations could result in a reduction, delay, or cancellation of existing or emerging programs. These factors have reduced the Company's U.S. government revenue and operating margins in recent fiscal years, and this trend is expected to continue in fiscal 1996, particularly in the Company's defense communications, acoustic technologies, and sensor systems activities.\nThe Company anticipates that competition in all defense-related areas will continue to be intense. Accordingly, the Company is experiencing competitive pressure which is reducing profitability and decreasing government revenue, particularly in the defense communications and acoustic areas. In addition, the Company expects that the consolidation of large defense contractors into a smaller number of very large, diverse organizations will continue, and that this will result in additional competitive pressure.\nThe books and records of the Company are subject to audit by the Defense Contract Audit Agency (\"DCAA\"); such audits can result in adjustments to contract billings. Final contract billing rates have been established for years through fiscal 1991, except for the Company's former BBN Communications activities for which final contract billing rates have been established only through fiscal 1984. BBN expects that any adjustments which may be made as a result of audits of fiscal years 1985 through 1995 of the Company will not have a material adverse effect on the Company's results of operations.\nThe Company, like other companies doing business with the U.S. government, is subject to routine audit, and in certain circumstances to inquiry, review, or investigation, by U.S. government agencies, of its compliance with government procurement policies and practices. Based upon government procurement regulations, under certain circumstances a contractor violating or not complying with procurement regulations can be subject to legal or administrative proceedings, including fines and penalties, as well as be suspended or debarred from contracting with the government. The Company's policy has been and continues to be to conduct its activities in compliance with all applicable rules and regulations.\nIn April 1991, the Company was informed that it was the subject of an investigation by U.S. government agencies of its compliance with certain government procurement policies and practices. No allegations were made by the government agencies and the Company was informed in August 1995 that the investigation had been concluded. The audit of the Company's former BBN Communications activities by the DCAA for fiscal years 1985 through 1993, which was delayed as a result of the investigation, is currently in process. U.S. government revenue for the Company's former BBN Communications activities, during the nine year period under audit, represented approximately 40% of the Company's total U.S. government revenue.\nBACKLOG\nBBN's backlog of orders at June 30, 1995 and June 30, 1994 was approximately $213,000,000 and $158,000,000, respectively. The increased backlog at June 30, 1995 compared to June 30, 1994 particularly reflects the backlog from a contract with America Online, Inc. (\"AOL\") in the Internetworking business segment. This AOL agreement is valued at approximately $55,000,000 over a five-year period, and includes substantial pass-through revenue to BBN for telecommunications circuits and other telecommunications services. The backlog at June 30, 1995 does not include minimum order amounts for Internet services under BBN Planet's agreement with AT&T. Under that agreement, AT&T has agreed to purchase from BBN Planet a minimum of $120,000,000 of services over three years (subject to potential reduction under specified circumstances). For additional information about the AT&T agreement with BBN Planet, see \"BBN Planet Corporation\" above.\nThe backlog at June 30, 1995 includes approximately $55,000,000 of funded U.S. government orders (expenditures appropriated by Congress), approximately $60,000,000 of unfunded government orders, and approximately $98,000,000 of commercial orders (approximately $55,000,000 of which is under the AOL agreement). The amounts include estimates relating to customer-requirements contracts, and to long-term contracts of a cost-reimbursement nature. Assuming no terminations, cancellations, or changes, and completion of orders in the normal course, BBN estimates that approximately 60% of the June 30, 1995 backlog relates to work expected to be performed during fiscal 1996.\nAll of BBN's contracts and subcontracts involving the U.S. government are subject to termination at the convenience of the government. Many of the government programs in which the Company participates may extend for several years, but they are normally funded only on an annual basis; the major portion of the Company's other contracts cover a period of twelve months or less. (See \"United States Government Contracts\" above.) A few significant contract orders, primarily with the U.S. government, make up a substantial portion of the backlog for the Company, and significant contract awards and extensions occur randomly during the year. For these and other reasons, backlog data, and comparisons of backlog as of different dates, may not be a reliable indicator of either future sales or the ratio of future U.S. government sales to other sales.\nBacklog is not a significant factor at BBN Domain (where the majority of products are shipped almost immediately after receipt of an order). BBN HARK has a small backlog in connection with certain custom development contracts, although currently such backlog is not material.\nPATENTS AND PROPRIETARY RIGHTS\nThe Company utilizes appropriate patent, trademark, copyright, and other proprietary rights procedures to protect its commercial products, and has applied for a limited number of patents in connection with certain recent development activities at the Company's BBN Systems and Technologies Division (principally in the Collaborative Systems and Acoustic Technologies segment), and at its BBN Domain and BBN HARK subsidiaries. However, although BBN owns a limited number of patents, none are of significant value to the Company's current business.\nThe Company believes that certain of its commercial competitors, many of whom have significantly greater financial, technical, and legal resources than the Company, are actively seeking patent protection in connection with their new products and technologies and that there has recently been a general increase in patent activity by others in each of the commercial business segments in which the Company conducts its business. In response, the Company has increased its patent activity. However, the Company's patent efforts cover a wide range of technologies, and it is probable that a competitor in any one technology can outspend the Company's patent program in that area. The Company believes that the award of patent rights to a competitor could have an adverse material impact on the ability of BBN to conduct its business activities in areas covered by any such patent award. However, the Company is not currently aware of any patents or patent applications that impact or are likely to impact materially the ability of BBN to conduct its current business activities.\nIt may be possible for commercial competitors to replicate aspects of BBN's products and services even though BBN regards such aspects as proprietary. However, BBN currently believes that, in general, due to the rapid pace of technological change in its commercial businesses, patent or other formal protection of proprietary information is less significant than the knowledge and experience of BBN personnel and the ability of BBN to develop, enhance, and market its products and services.\nGenerally, patents on inventions developed by BBN under government contract are owned by BBN, with the government retaining a royalty-free license to use and to permit others to use such inventions for government purposes. Also, the government has certain proprietary rights to technical data and software programs resulting from the Company's services under government contracts and the government may generally disclose such data and programs to third parties, including competitors of the Company.\nThe Company believes that patent or proprietary rights protection are not significant competitive factors in connection with its non-commercial contract research and development activities, and that the success of the Company in those activities depends primarily upon the technical expertise and creative abilities of its employees.\nEMPLOYEES\nAs of September 14, 1995, the Company employed approximately 2,000 persons, a majority of whom are professional or technical persons having high levels of education, training, and skill in the areas in which the Company operates. BBN's domestic employees are not covered by any collective bargaining agreements, and the Company believes its employee relations are excellent.\nRecently, there have been a number of management changes at the Company. In January 1994, George H. Conrades became president and chief executive officer of the Company, succeeding Stephen R. Levy who continued as chairman of the board. BBN has named new presidents to each of its three operating subsidiaries and to one operating division in the last fifteen months, including John T. Kish, Jr. at BBN Software Products Corporation (June 1994), Julie R. Donahue at BBN HARK Systems Corporation (October 1994), Paul R. Gudonis at BBN Planet Corporation (November 1994), and David N. Campbell at BBN Systems and Technologies Division (July 1995).\nA number of senior executives have left the Company in the last fifteen months. These include Frank Heart, former president of the Company's BBN Systems and Technologies Division, who retired in July 1994 after 28 years with the Company; W.B. Barker, former senior vice president of the Company, who left in January 1995 after 26 years with the Company; and David C. Walden, former senior vice president of the Company, who left in January 1995 after 24 years with the Company. In addition, Stephen R. Levy, Chairman of the Board and former chief executive officer of the Company, has announced his retirement as an officer and employee of the Company after 29 years of service, effective November 6, 1995.\nBBN, along with other high-technology companies, faces competition in hiring and retaining skilled technical, professional, marketing, and sales personnel. In certain areas, such as emerging technologies and marketing, the supply of such people is limited. The Company believes that its future success depends in part upon its ability to attract and retain such personnel. The Company is actively recruiting for a number of marketing, product management, and sales positions throughout the Company.\nEXPORT SALES\nExport sales by the Company in fiscal 1995 were concentrated in the data analysis software and network services and products areas. Revenue in fiscal 1995, 1994, and 1993 included U.S. export sales of $24,000,000, $27,300,000, and $51,100,000, respectively. These figures include U.S. export sales relating to the Company's former simulation systems business of approximately $19,000,000 in fiscal 1993.\nThe Company's foreign operations, which are conducted in Western Europe and the Pacific Rim, consist largely of sales and marketing activities for the Company's commercial products. In the countries in which BBN focuses its export sales activities, the Company knows of no unusual risks. Under certain circumstances,\nhowever, the export of the Company's products and services requires the express authorization of U.S. government agencies. Foreign sales of the Company's applications software products, including its data analysis software and speech recognition software products, are impacted by the current unavailability of foreign language versions.\nThe Company enters into foreign exchange contracts to hedge certain of its exposures to foreign currency fluctuations against the U.S. dollar. Such contracts are with large banking institutions, and are based upon a direct, non-multiple relationship between the dollar and the foreign currency being hedged (primarily the British pound, the German mark, the Japanese yen, and the French franc). At June 30, 1995 and 1994, BBN had foreign exchange contracts to sell $950,000 and $750,000, respectively, of foreign currencies. To date, the Company has not repatriated significant foreign currencies, the level of Company sales denominated in non-US currencies has not been material to the Company, and the impact of foreign exchange rate changes on the Company's financial statements has not been material.\nINDUSTRY SEGMENTS\nFinancial information with respect to the Company's activities in its three industry segments may be found in the section captioned \"Segment Information\" appearing in the Notes to the Consolidated Financial Statements below.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company's executive offices, its primary research, development, and consulting facilities, and the majority of its computer, laboratory, and manufacturing facilities are currently located in its Cambridge, Massachusetts complex, which contains approximately 641,600 square feet of building space, of which approximately 106,800 square feet is currently leased or subleased by the Company to unaffiliated parties. Approximately 122,700 square feet of the Cambridge, Massachusetts complex is owned by the Company; the remaining space is leased by the Company, primarily under long-term leases granting the Company the option to extend the lease. The Company also has first refusal rights and\/or options to purchase most of the leased space. The aggregate rental to be paid by the Company for all its leased Massachusetts facilities, net of sublease income and including taxes and certain operating expenses, will be approximately $8,800,000 in fiscal 1996.\nThe Company also leases, on a short-term basis, office space at 24 other domestic locations containing an aggregate of approximately 156,800 square feet of space, net of subleases. The aggregate rental to be paid by the Company for such locations, net of sublease income and including taxes and certain operating expenses, will be approximately $2,600,000 in fiscal 1996.\nThe Company also occupies office space in 7 foreign countries, containing an aggregate of approximately 31,000 square feet of space, net of subleases. The aggregate rental to be paid by the Company for such office space, net of sublease income and including taxes and certain operating expenses, will be approximately $1,800,000 in fiscal 1996.\nThe Company believes that its facilities and equipment are well maintained and are in good operating condition.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThere are no material pending legal proceedings involving the Company.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNo matter was submitted to shareholders of the Company during the fourth quarter of fiscal 1995.\nITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT.\nThe executive officers of the Company, the age of each, and the period during which each has served in his or her current office are as follow:\nAll of the executive officers except Messrs. Levy and Goldwasser have been employed by the Company in their current or other capacities for less than the past five years.\nMr. Conrades has been the President and Chief Executive Officer of the Company since January 1994. Prior to that time, he had been employed for over 30 years at International Business Machines Corporation. During his employment with IBM, Mr. Conrades held a number of marketing-management and general-management positions, including most recently senior vice president, corporate marketing and services and general manager of IBM United States, with responsibility for all of that company's customer-related operations in the United States, including hardware, software, maintenance, and services. Mr. Conrades retired from IBM in March 1992, and since that time and prior to his appointment as President of the Company, Mr. Conrades was consulting in venture capital businesses and was on the board of directors of several small technology ventures, including the board of LightStream Corporation, a subsidiary of the Company. Mr. Conrades is also a director of Westinghouse Electric Corporation, Pioneer Companies, Inc., and CRA Managed Care, Inc., and is chairman of the board of the Company's operating subsidiaries, including BBN Planet Corporation, BBN Software Products Corporation, and BBN HARK Systems Corporation.\nMr. Levy, Chairman of the Board and former chief executive officer of the Company, has announced his retirement as an officer and employee of the Company after 29 years of service, effective November 6, 1995.\nMr. Campbell was elected Senior Vice President of the Company in July 1995, and has served as President of the Company's BBN Systems and Technologies Division since that time. Prior to that time, he was with Computer Task Group, Incorporated, an international integrated information technology services company, from 1968 to 1994, most recently serving as its chairman and chief executive officer, responsible for the Company's approximately 4,500 employees. Mr. Campbell is a director of the Company's operating subsidiaries, including BBN Planet Corporation, BBN Software Products Corporation, and BBN HARK Systems Corporation. Mr. Campbell is also a director of Dunlop Tire Corp., First Empire State Corporation, Gibraltar Steel Corp., and National Fuel Gas Company.\nMs. Donahue was elected Vice President of the Company in October 1994, and has served as President and Chief Executive Officer of BBN HARK Systems Corporation, a subsidiary of the Company, since that time. Prior to joining the Company, she was president and chief operating officer of Voice Processing Corporation, a speech recognition board manufacturer with approximately 60 employees, serving from August 1993 to September 1994. Prior to that, Ms. Donahue was senior vice president, marketing and business development at Dun & Bradstreet Software Services, Inc., where she was responsible for strategic planning, mergers and acquisitions, marketing, and channel development. Ms. Donahue has also held management positions at Cullinet Software and Motorola\/Four Phase Systems. Ms. Donahue is a director of BBN HARK Systems Corporation.\nMr. Gudonis was elected Vice President of the Company in November 1994, and has served as Chief Executive Officer and President of BBN Planet Corporation, a subsidiary of the Company, since November 1994 and January 1995, respectively. From October 1990 to October 1994, Mr. Gudonis worked at Electronic Data Systems Corporation (\"EDS\"), a worldwide provider of information technology services, most recently as vice president and general manager -- international of its Communications Industry Group. At EDS, Mr. Gudonis was responsible for building a global division of EDS serving the telecommunications and media industries. Mr. Gudonis had worldwide financial responsibility for this division, which directed the activities of approximately 400 EDS employees in over 20 countries. Prior to that, Mr. Gudonis worked at Appex Corporation, a provider of software and services to the cellular phone industry, from 1989 to October 1990, most recently as a senior vice president and general manager. Appex Corporation was acquired by EDS in October 1990. Mr. Gudonis is a director of BBN Planet Corporation.\nMr. Kish was elected Vice President of the Company in August 1994, and has served as President and Chief Executive Officer of BBN Software Products Corporation, a subsidiary of the Company, since June 1994. Prior to joining BBN, Mr. Kish had been employed for approximately five years at Oracle Corporation in a number of senior management positions, including vice president, desktop division, and most recently as senior vice president, business development, with a staff of approximately 150 employees. After leaving Oracle in 1993 and prior to joining BBN, Mr. Kish provided management consulting, and development services for the telecommunications, entertainment, financial, and information services industries. Mr. Kish is a director of BBN Software Products Corporation.\nMr. Hurley joined BBN in March 1992 as Vice President and Controller of the Company. Prior to joining BBN, Mr. Hurley had worked for approximately 19 years at Wyman Gordon Co., a manufacturer of forgings, investment castings, and advanced composite structures. At Wyman Gordon, Mr. Hurley served in various management positions in the accounting and finance areas, including most recently as vice president and controller from 1988 to 1992. Mr. Hurley has announced his resignation from the employ of the Company, effective October 6, 1995.\nEach of the chairman, president, and treasurer has been elected to hold office until the first meeting of the directors following the next annual meeting of shareholders and until his or her successor is chosen and qualified, and each other executive officer has been elected to his or her described office to hold office until the first meeting of directors following the next annual meeting of shareholders.\nNone of the directors or executive officers of the Company has any relationship to any other director or executive officer of the Company or its subsidiaries, by blood, marriage, or adoption, not more remote than first cousin.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nThe Registrant's shares of Common Stock are traded under the symbol \"BBN\" primarily on the New York Stock Exchange, and to a lesser extent on the Boston, Cincinnati, Midwest, Pacific, and Philadelphia exchanges. The Registrant's 6% Convertible Subordinated Debentures due 2012 are traded under the symbol \"BBN12\" on the New York Stock Exchange. Options in the Registrant's Common Stock are traded on the Chicago Board Options Exchange.\nQuarterly information related to high and low sales prices for the Registrant's Common Stock may be found under the caption \"Quarterly Financial Data (Unaudited)\" appearing on page 46.\nInformation related to holders of the Registrant's Common Stock and as to dividends paid on the Registrant's Common Stock may be found under the caption \"Item 6.","section_6":"","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nFY1995 COMPARED TO FY1994\nINTRODUCTION\nIn FY1995, the Company consisted of five operating units: the Company's BBN Systems and Technologies Division, BBN Software Products Corporation, LightStream Corporation, BBN Planet Corporation, and BBN HARK Systems Corporation. The BBN Systems and Technologies Division (\"Systems and Technologies\") includes internetworking services and products, and collaborative systems and acoustic technologies. BBN Software Products Corporation, the name of which is being changed to BBN Domain Corporation (\"BBN Domain\"), a wholly-owned subsidiary of the Company, develops, markets, and supports data analysis and process optimization software products designed primarily for health industry and manufacturing applications. LightStream Corporation (\"LightStream\"), an 80%-owned subsidiary of the Company which made asynchronous transfer mode (\"ATM\") network switches, sold substantially all of its assets to Cisco Systems, Inc. on January 11, 1995. BBN Planet Corporation (\"BBN Planet\"), a 95%-owned subsidiary of the Company, provides Internet services to businesses and other organizations. BBN HARK Systems Corporation (\"BBN HARK\"), a wholly-owned subsidiary of the Company, is an early stage company which develops and markets commercial speech recognition software products.\nSUMMARY\nFor the year ended June 30, 1995, the Company reported net income of $64.8 million, or $3.61 per share, on revenue of $215.0 million, compared with a net loss of $7.8 million, or $.48 per share, on revenue of $196.1 million for the same period a year earlier. These results include a $105.0 million gain, before taxes and minority interest, from the sale of the assets of LightStream in January 1995. Primarily as a result of the LightStream sale, the Company's cash and cash equivalents balance as of June 30, 1995 rose to $110.8 million and the Company's equity increased to $82.6 million.\nFor the year, the Company reported a loss from operations of $18.8 million, compared to an $8.4 million loss for the same period a year earlier. The FY1995 results reflect significant investment in sales, marketing, and new product development, and include an operating loss of $3.7 million relating to the LightStream activities (sold on January 11, 1995), an operating loss of $12.7 million at BBN Planet, and an operating loss of $3.7 million at BBN Domain. The Systems and Technologies Division experienced a reduction in profitability for the fiscal year due to declines in its defense communications and acoustics businesses, and increased investment in sales and marketing activities.\nThe Company continues to invest in its commercial businesses, and recorded operating losses for FY1995 at BBN Planet, BBN HARK, and BBN Domain as well as declining operating income at BBN Systems and Technologies. The Company expects to incur significant operating losses at BBN Planet during FY1996, which is expected to adversely impact the financial performance of the Company. The outlook could also be affected by further expenditures on commercial business opportunities available to the Company.\nREVENUE\nRevenue for FY1995 increased $18.9 million from FY1994. Internetworking segment revenue increased by $11.5 million, reflecting $8.6 million of increased revenue at BBN Planet and $6.9 million of increased revenue at LightStream. LightStream revenue for FY1995 included up-front technology license fees of $3.6 million. These increases were partially offset by declines in revenue in the Systems and Technologies Division's defense communications business. Revenue of the Company's data analysis software products business segment increased by approximately $4.0 million in FY1995, reflecting higher health industry related software sales, with particularly significant sales to major pharmaceutical companies. In the collaborative systems and acoustic technologies segment, revenue increases of approximately $3.4 million reflected increases in government related contracts for collaborative systems and technologies as well as revenue increases at BBN HARK, offset in part by declines in acoustic-related activities.\nThe Company, like other companies doing business with the U.S. Department of Defense, has been adversely affected by reduced defense spending and expects this general decline and attendant increased competition within the defense industry to continue over the next several years. Uncertainty continues to exist on the size and scope of reductions in future defense budgets and their impact on the Company's defense-related business. Further, there is the possibility that funding limitations could result in a reduction, delay, or cancellation of existing or emerging programs. These factors have reduced the Company's U.S. government revenue and operating margins in recent fiscal years, and this trend is expected to continue in FY1996, particularly in the defense communications, acoustic technologies, and sensor systems activities.\nThe Company anticipates that competition in all defense-related areas will continue to be intense. Accordingly, the Company is experiencing competitive pressure which is reducing profitability and decreasing government revenue, particularly in the defense communications and acoustic areas. In addition, the Company expects that the consolidation of large defense contractors into a smaller number of very large, diverse organizations will continue, and that this will result in additional competitive pressure.\nIn FY1991, the Defense Information Systems Agency (\"DISA\") awarded the Company a one-year contract in support of the Defense Data Network (\"DDN\"), with up to four one-year optional extensions. In September 1994, the Company completed the third option year of the contract, valued at approximately $20 million. In October 1994, the Company was awarded the fourth option year of the contract, valued at approximately $15 million, which will continue these activities through October 1995. The Company has been awarded a six-month extension of the DDN contract, which will continue these activities through April 1996. The value of this extension award is approximately $7.5 million. The Company does not expect that this activity will continue beyond April 1996, although the Company may compete for follow-on contracts for the DDN, at reduced funding levels. Approximately $17.8 million and $20.5 million of revenue has been recorded under the DDN contract in FY1995 and FY1994, respectively.\nThe Company conducts its commercial businesses in environments characterized by intense competition, shortened product life cycles, and rapid technological change, which require significant research and development expenditures to develop new products and services to address emerging market requirements and to improve existing products and services. In recent years, the Company's traditional commercial businesses, consisting principally of RS\/Series data analysis software products and X.25 network systems, have been experiencing substantially lower revenue. The Company has discontinued sales of most of its traditional X.25 systems and products, and has substantially eliminated its development efforts and significantly reduced its selling efforts related to this business. In recent periods, the Company has been investing heavily in development of new products, including the LightStream Corporation ATM network switches, Cornerstone data analysis and visualization software, the T\/10 Integrated Access Device (\"IAD\") for computer networks, and the BBN HARK speech recognition software. In FY1995, the Company made significant investment in Internet services.\nThe sale on January 11, 1995 of substantially all of the assets of LightStream Corporation to Cisco Systems, Inc., is reflected in the Company's FY1995 results. Reference is made to the Notes to the Consolidated Financial Statements for further discussion of this transaction. The Company's T\/10 IAD activities are now being primarily focused on a limited number of reseller and strategic licensing opportunities, and the future success of the T\/10 IAD is highly dependent on these opportunities. The Company has experienced operating losses in connection with that business. The Company has substantially reduced spending relating to the T\/10 IAD from prior year levels. In July 1995, the Company entered into an agreement with NEC Corporation granting to NEC technology and manufacturing license rights in the T\/10 IAD and the T\/40 Video Internet Router under development, and agreed to perform certain development activities in connection with the joint development of a new multi-media access device. The value of the NEC agreement is approximately $4.6 million, of which $1.9 million is related to future development efforts.\nThe Company's BBN Planet subsidiary (formerly BBN Internet Services Corporation) is significantly increasing its investment in the emerging market for Internet access services. In August 1994, BBN Planet acquired, from Stanford University, the Bay Area Regional Research Network (\"BARRNet\"), a leading provider of Internet services in the San Francisco Bay area, for approximately $6.5 million.\nIn March 1995, BBN Planet acquired substantially all of the assets of the Southeastern Universities Research Association Internet service (\"SURAnet\"), a leading provider of Internet services in the southeastern United States, for approximately $13.0 million in cash and the assumption of certain operating liabilities of approximately $5.1 million.\nIn June 1995, BBN, BBN Planet, and AT&T Corp. (\"AT&T\") entered into an agreement under which BBN Planet is to be the exclusive provider for a period of up to three years of dedicated Internet access and managed network security services to AT&T for resale to business customers in the United States of AT&T's Business Communications Services division. AT&T has agreed to purchase a minimum of $120 million of services during the first three years of the agreement. The relationship provides BBN Planet with an opportunity to accelerate the expansion of its Internet services business. In July 1995, AT&T Venture Company L.P., a venture partnership with AT&T as the sole limited partner, made an $8.0 million investment in BBN Planet.\nBBN's objective is to provide Internet-related services to business and other organizational customers which enhance interaction within the customers' organizations and with their customers, suppliers, and business partners. In support of its Internet business strategy, the Company may make additional acquisitions or enter into strategic alliances.\nThe market for Internet services is rapidly expanding, and there are considerable uncertainties as to how the market will develop. The market is highly competitive, in general there are no substantial barriers to entry, and the Company expects that competition with its Internet activities will intensify in the future. The Company expects that all of the major on-line services and telecommunications companies will compete fully in the Internet services market, and that new competitors, including large computer hardware, software, media, and other technology and telecommunications companies will enter the Internet services market, resulting in even greater competition for the Company's services and significant pricing pressure, which may impact operating results.\nThe success of BBN's Internet services will primarily depend upon the development and expansion of the market for Internet access services and products and the networks which comprise the Internet; the capacity, reliability, and security of its network infrastructure; its ability to develop value-added products and services that meet changing customer requirements; its ability to attract and retain additional highly qualified management, technical, marketing, and sales personnel; and its ability to manage its growth.\nIn March 1995, the Systems and Technologies Division entered into an agreement with America Online, Inc. (\"AOL\") to build, maintain, and operate a portion of AOL's nationwide, high-speed, dial-in network. The Company's five-year agreement with AOL, valued at approximately $11 million per year, includes substantial pass-through costs to BBN for telecommunications circuits and other services provided by local and inter-exchange carriers. As part of BBN's agreement with AOL, the Company has access to use of the excess capacity of the portion of the network operated by the Company, and the Company has the right to resell such excess capacity. The Company is exploring opportunities to resell such excess capacity, the availability of which is currently limited primarily to business hours.\nThe Company's traditional data analysis software business has been affected by the growth of distributed processing and the associated use of personal computers, workstations, and other desktop computers. The Company's mature data analysis software products, primarily the RS\/Series software, currently operate primarily on minicomputer systems. As demand for minicomputer-based software continues to decline, the Company is experiencing substantially lower RS\/Series software revenue and downward pressure on prices. In response to the trend toward desktop computing, BBN Domain has been investing in recent years in Cornerstone software, a desktop-based data analysis and visualization software tool. Sales of Cornerstone software to date have been substantially below expectations. Commencing in FY1995, the Company is more tightly integrating its Cornerstone software with its RS\/Series software products to provide platform migration and ease of use for its existing RS\/Series customer base, and to provide greater capabilities and flexibility in client\/server computing environments.\nThe Company is also focusing its software application solutions on the health and manufacturing industries. BBN Domain health industry offerings include applications for clinical data management (Clintrial(TM)) and adverse events tracking (Clintrace(TM)). In March 1995 BBN acquired, for $0.7 million, the exclusive rights to IBM's Process Analysis Navigation System (\"PANS\"), a manufacturing methodology and software system. BBN Domain intends to integrate and significantly enhance PANS methodology and technology with its data analysis and process optimization software for manufacturers.\nAs part of these efforts, BBN Domain is increasing its development expenditures in its software business and is investing in additional sales and marketing personnel. The Company believes that the future success of its data analysis and process optimization software will depend primarily on the development and marketing of software applications that permit operation on personal computers, on continued market acceptance of its health industry software products, on development and acceptance of its PANS manufacturing methodology, and on development and timely integration of its Cornerstone and RS\/Series software.\nCOST OF SALES\nCost of services and products as a percentage of revenue was 63% in FY1995 compared to 64% in FY1994. The decrease in the cost of sales percentage is principally related to increased sales of high margin software products sales and $3.6 million in technology license and initial development fees, with higher gross margins at LightStream. These decreases were offset by higher costs in the Company's government contracting business.\nRESEARCH AND DEVELOPMENT EXPENSES\nResearch and development expenses for FY1995 were $25.3 million compared to $23.3 million for FY1994. The largest portion of the Company's FY1995 internally funded research and development spending was directed principally toward data analysis and process optimization software products, including the $0.7 million charge related to the purchase of IBM's PANS manufacturing methodology software system. The increase in research and development expense was partially offset by decreased spending on the ATM switch at LightStream and the T\/10 IAD. Research and development expenses for the ATM switch for FY1995 were $3.9 million compared to $8.9 million for FY1994.\nSELLING, GENERAL AND ADMINISTRATIVE EXPENSES\nSelling, general, and administrative expenses for FY1995 increased $18.5 million from FY1994 reflecting the investment the Company is making primarily in the sales and marketing of its new services and products at BBN Planet and BBN Domain. The Company anticipates continued increased spending related to its commercial activities in FY1996.\nINTEREST\nInterest income increased $2.2 million in FY1995 from FY1994 primarily as a result of the increased cash balances resulting from the sale of LightStream assets.\nOTHER INCOME\nIn January 1995, LightStream sold substantially all of its assets to Cisco Systems, Inc., which resulted in a $105.0 million gain to the Company before taxes and minority interest. Refer to footnote, \"Sale of LightStream Corporation\", for further discussion of this transaction.\nIn December 1994, the Company settled a claim with the U.S. government for approximately $0.7 million. This settlement resulted in an approximately $2.6 million reduction in liabilities and is included in other income for FY1995.\nOther income in each of FY1995 and FY1994 also includes approximately $0.9 million resulting from lower than expected costs associated with a previously divested contract.\nLIQUIDITY AND CAPITAL RESOURCES\nAs of June 30, 1995, the Company's cash and equivalents, which consisted primarily of money market funds, short-term U.S. government securities, and commercial paper, were $110.8 million, an increase of $43.7 million from June 30, 1994. The increase is primarily attributable to the sale of LightStream assets which provided approximately $80.0 million of net cash proceeds (including $12.1 million which is restricted for a period under the sale agreement) to the Company after payment of amounts due for taxes, initial payments to the minority shareholder, and certain expenses associated with the sale.\nFor FY1995, the $80.0 million of cash proceeds from the LightStream sale and $4.6 million of cash proceeds from employee stock purchase and option plans have been offset by $15.0 million expended for the SURAnet and BARRNet acquisitions, $18.5 million for capital expenditures, and $28.7 million of cash used by operations. Of the $12.1 million restricted cash under the LightStream sale agreement, $4.0 million became available on July 11, 1995 and the remainder will become available to the Company in varying amounts, net of any claims, within two years of the January 11, 1995 closing of the LightStream sale.\nThe $12.4 million increase in the Company's accounts receivable balance at June 30, 1995 is primarily due to the increase in fourth quarter revenue.\nThe Company's accrued restructuring balance relates to excess facilities costs under long-term leases, which were associated with the Company's FY1993 downsizing. The Company has sublet or assigned the majority of its excess facilities under agreements with terms expiring between 1998 and 2005.\nThe Company anticipates a continued high level of capital expenditures for the near-term in support of the investment being made in Internet services. In addition, the Company may use a portion of its cash resources for acquisitions of or investments in businesses, products, or technologies or through the formation of strategic partnerships with other companies.\nThe Company believes that its liquidity in the form of existing cash resources is adequate to meet its operating requirements through FY1996. Currently, the Company does not have any bank lines of credit.\nFY1994 COMPARED TO FY1993\nINTRODUCTION\n(The management's discussion and analysis which follows reflects the Company's organization in effect prior to FY1995.)\nIn FY1994, the Company consisted of three operating units, the Systems and Technologies Division, BBN Software Products Corporation, and LightStream Corporation. The Systems and Technologies Division (\"Systems and Technologies\") includes internetworking services and products, collaborative systems, and acoustic technologies. BBN Software Products Corporation (\"BBN Software Products\"), a wholly-owned subsidiary of the Company, develops, markets, and supports data analysis software products designed primarily for manufacturing, engineering, and health industry applications. LightStream Corporation (\"LightStream\"), an 80%-owned subsidiary of the Company, develops, markets and supports networking products based on asynchronous transfer mode (\"ATM\") technology.\nSUMMARY\nFor the year ended June 30, 1994, the Company had a loss of $7.8 million, or $.48 per share, on revenue of $196.1 million, compared to a loss of $32.3 million, or $2.05 per share, on revenue of $233.5 million for FY1993. Results for the prior year included a restructuring charge of $20.5 million, or $1.30 per share, and a gain of $3.2 million, or $.20 per share, resulting from the sale of the Company's advanced simulation business in April 1993. The reduction in revenue from the prior year reflected the sale of the advanced simulation business and reduced defense communications systems revenue. The Company's losses continued to reflect significant expenditures on its LightStream ATM switch, T\/10 Integrated Access Device (\"IAD\"), and Cornerstone software, while revenue from these new products remained financially insignificant. These losses were partially offset by operating income at Systems and Technologies.\nREVENUE\nRevenue decreased $37.3 million, or 16%, in FY1994 compared to FY1993. The reduction reflected approximately $25.3 million in FY1993 revenue provided by the Company's former advanced simulation business unit, as well as declines in the Company's defense communications business and lower revenue in FY1994 from its mature X.25 network products and RS\/Series software.\nRESEARCH AND DEVELOPMENT EXPENSES\nThe majority of the Company's internally funded research and development spending was directed principally toward the LightStream ATM products, the T\/10 IAD, and Cornerstone software. Research and development expenses in FY1994 were $23.3 million compared to $34.0 million in FY1993. The reduction in FY1994 reflected lower spending for the T\/10 program and Cornerstone software, as well as the sale of the advanced simulation business in FY1993.\nSELLING, GENERAL AND ADMINISTRATIVE EXPENSES\nSelling, general, and administrative expenses decreased $8.1 million in FY1994 from FY1993, primarily as a result of lower selling expenses in the defense communications business and at BBN Software Products, as well as the cost reduction actions taken in FY1993.\nINTEREST\nInterest income increased $0.7 million in FY1994 from FY1993 primarily in connection with a state tax refund.\nOTHER INCOME\nOther income decreased $2.2 million in FY1994 from FY1993 primarily reflecting the $3.2 million gain in FY1993 resulting from the sale of the Company's advanced simulation business and $.9 million in FY1994 resulting from lower than expected costs associated with a previously divested contract.\nThe accompanying notes are an integral part of the consolidated financial statements.\nThe accompanying notes are an integral part of the consolidated financial statements.\nThe accompanying notes are an integral part of the consolidated financial statements.\nThe accompanying notes are an integral part of the consolidated financial statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nSUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the accounts of the Company and its majority- and wholly-owned subsidiaries. All significant intercompany transactions and balances have been eliminated. Certain amounts reported in prior years have been reclassified to be consistent with the current year's presentation. These reclassifications primarily relate to the formation in fiscal year 1995 of distinct commercial business units.\nREVENUE RECOGNITION\nRevenue from cost-reimbursement contracts, principally consisting of services, is recorded as costs are incurred and fees are earned. Revenue from fixed-price contracts, relating to services and certain systems, is recognized using the percentage-of-completion method of accounting in the proportion that costs incurred bear to total estimated costs at completion. Losses, if any, are provided for in the period in which the loss is determined.\nProducts revenue is recognized at the time of shipment.\nServices revenue (including monthly service fees relating to Internet services) is recognized as the services are provided. Advance billings and payments are deferred until such services are provided.\nSoftware license revenue is recognized upon delivery and receipt of a signed software contract. Technology fees, advance royalties and other fees received from customers on a non-refundable basis where the Company has no significant obligations remaining are recognized as services revenue upon receipt of payment.\nISSUANCE OF STOCK BY SUBSIDIARIES\nAt the time a subsidiary sells stock to unrelated parties at a price different from its book value, the Company's net investment in that subsidiary changes. If at that time the subsidiary is an operating entity and not engaged principally in research and development, the Company records the change as a gain or loss in its consolidated statements of operations. Otherwise, the Company records the change as an equity transaction in its consolidated statements of shareholders' equity as a sale of subsidiary stock.\nCASH AND CASH EQUIVALENTS\nCash includes all cash and cash equivalents, generally with maturities of three months or less at the time of purchase, carried at original cost plus accrued interest, which approximates market value. At June 30, 1995 and 1994, cash equivalents consisted principally of money market funds (invested in U.S. government securities and other highly rated financial instruments), U.S. government securities, and highly rated commercial paper.\nAVAILABLE-FOR-SALE INVESTMENTS\nEffective July 1, 1994, the Company adopted Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" (\"SFAS 115\"). The Company classifies its securities as available-for-sale since the Company may liquidate these investments currently. SFAS 115 requires that unrealized gains and losses on available-for-sale securities be excluded from earnings and reported as a component of shareholders' equity. Realized gains and losses are recorded in the consolidated statements of operations and the cost assigned to securities sold is based on the specific identification method. The unrealized loss at June 30, 1995 was immaterial.\nINVENTORIES\nInventories are stated at the lower of cost (using the first-in, first-out method) or market.\nPROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment is stated at cost less accumulated depreciation and amortization. Depreciation is computed over the assets' estimated useful lives using the straight-line method. Useful lives used in computing depreciation are as follows: buildings -- 15 to 25 years, computer equipment -- 3 years, furniture and fixtures -- 5 years. Leasehold improvements are amortized over the shorter of the lease period or their estimated useful lives using the straight-line method. Maintenance and repairs are charged to expense as incurred; improvements are capitalized. The Company's policy is to remove the amounts related to fully depreciated assets from its accounting records.\nSOFTWARE COSTS\nThe Company capitalizes purchased software technology and certain internally developed computer software costs to be sold or otherwise marketed to customers. Costs incurred internally after establishing technological feasibility and before general release of a computer software product as well as costs incurred for purchased software technology are capitalized and amortized on a product-by-product basis at an annual amortization computed using the straight-line method over the remaining estimated economic life of the product, generally three years. Amortization commences on the date of initial product shipment.\nGOODWILL\nGoodwill represents the excess of the cost to acquire businesses over the estimated fair value of the net assets acquired. These amounts are amortized using the straight-line method over the estimated useful lives. Accumulated amortization at June 30, 1995 was $737,000. The Company periodically reviews goodwill to assess recoverability, and impairments would be recognized in operating results if a permanent dimunition in value were to occur.\nFOREIGN CURRENCY TRANSLATION AND TRANSACTION ACTIVITY\nThe assets and liabilities of the Company's foreign subsidiaries are translated at year-end exchange rates, and the related statements of operations are translated at average exchange rates for the year. Translation gains and losses are accumulated as a separate component of shareholders' equity. Transaction gains and losses, which are immaterial, are included in \"Other income (expense), net\" in the consolidated statements of operations.\nINCOME TAXES\nIn accordance with Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes,\" a deferred tax asset or liability is determined based on both the difference between the financial statement and tax basis of assets and liabilities as measured by the enacted tax rates which will be in effect when these differences reverse, and the future tax benefit to be derived from tax loss and tax credit carryforwards. A valuation allowance has been established to reflect the likelihood of realization of deferred tax assets.\nNET INCOME (LOSS) PER SHARE\nNet income (loss) per share is calculated based on the weighted average number of common and common equivalent shares outstanding. Common equivalent shares result primarily from the assumed exercise of dilutive stock options and are generally excluded from the calculation when the Company incurs net losses. The Company's 6% convertible subordinated debentures are not considered common stock equivalents for per-share calculations.\nACCOUNTS RECEIVABLE\nUnbilled amounts represent receivables for work performed for which billings have not been presented to the customers or which were not yet contractually billable. Unbilled receivables, except for retentions, are generally billed and collected within one year. Retentions amounted to $4,000,000 and $3,662,000 at June 30, 1995 and 1994, respectively. A significant portion of the retentions at June 30, 1995 is anticipated to be collected after fiscal year 1996.\nPROPERTY, PLANT AND EQUIPMENT\nCONVERTIBLE SUBORDINATED DEBENTURES\nThe 6% convertible subordinated debentures due 2012 (the \"debentures\") may be converted by the bondholder into the Company's common stock at a price of $30.00 per share or may be redeemed by the Company at any time prior to maturity. Redemption of the debentures prior to April 1, 1998 requires payment of a premium. The Company has reserved 2,823,000 shares of its authorized but unissued common stock to be available for the conversion of the debentures. The debentures are unsecured obligations of the Company and are subordinated in right of payment to all of the Company's senior indebtedness. Debt issuance costs are being amortized over the term of the debentures. The unamortized balance at June 30, 1995 of $1,087,000 is\nincluded in \"Other assets\" in the consolidated balance sheets. The fair market value of the debentures, which is based on quoted market prices, was $75,715,000 at June 30, 1995.\nThe Company is required to contribute to a sinking fund with annual payments equal to 5% of the aggregate principal amount issued. The sinking fund is calculated to retire 70% of the original debentures prior to maturity. By utilizing the $11,190,000 (face value) of debentures purchased and retired to date by the Company, contributions to satisfy the annual sinking fund requirements can be deferred until April 1, 2000.\nLEASES\nMinimum lease payments have not been reduced by future minimum sublease rentals of $4,200,000 due under noncancelable subleases. In January 1995, the Company assigned a lease in the United Kingdom with a remaining term of 18 1\/2 years. Under the terms of the assignment, the assignee has the option of cancelling the assignment in January 2002 and in January 2005. The Company's operating leases for real estate generally provide for renewal options and options to purchase the leased property.\nTotal rent expenditures, net of sublet income, under all operating leases and rental agreements amounted to $17,060,000, $16,980,000 and $18,180,000 in fiscal years 1995, 1994 and 1993, respectively.\nCOMMON STOCK\nIn December 1993, in connection with his hiring, the Company's chief executive officer made an investment of $212,500 in the Company by purchasing from the Company 20,202 restricted shares of the Company's common stock at a 15% discount from the closing market price on the date of the transaction. The restricted shares were treasury shares and were not registered under the Securities Act of 1933 (the \"Act\") and may not be sold, assigned, pledged, or otherwise transferred before the sooner of two years or the filing of an effective registration statement under the Act.\nThe Company has a Common Stock Rights Plan (the \"plan\") to protect the interests of the Company's shareholders. Under the plan, holders of each share of the Company's common stock have the right to purchase one additional share of common stock at $90 per share, subject to adjustment, exercisable under certain defined conditions. In the event that the rights become exercisable due to an acquisition of the Company or under certain other conditions, holders of the rights would be entitled to purchase common stock of the surviving Company having a value of two times the exercise price of the rights. The holder of a right is not entitled to vote or receive dividends until the right is exercised. The rights are redeemable by action of the Board of Directors at $.01 per right. The Company is not currently aware of any activities which would cause the rights to become exercisable.\nEMPLOYEE BENEFIT PLANS\nStock Compensation Plans\nUnder the Company's stock option plan, options may be granted to purchase shares of the Company's common stock at a price not less than 50% of the fair market value of the common stock on the date of grant. All options granted in fiscal years 1995, 1994 and 1993 were at fair market value on the dates of grant. The plan, as amended in fiscal year 1995, provides that directors who are not employees of the Company receive a non-qualified option for 3,000 shares each year. The plan also provides for granting of other stock-based awards at the discretion of the Board of Directors and for granting of incentive stock options. Options vest generally over four years and expire not more than ten years from the dates of grant. Options which are canceled become available for future grant.\nAt June 30, 1995 and 1994, 415,000 shares and 73,000 shares, respectively, of authorized but unissued common stock were reserved and available for granting additional options.\nDuring fiscal years 1995 and 1994, BBN Planet, BBN Software Products, and BBN HARK adopted stock option plans under which options may be granted enabling the purchase at a price not less than the par value of the common stock on the date of grant. Options granted under these plans are exercisable 90 days after the closing of an initial public offering of the respective subsidiaries' common stock. As of June 30, 1995, options to purchase shares of subsidiaries' common stock ranged from 8% to 12% of the common shares outstanding of the respective subsidiaries and substantially all of the options were granted at the fair value on the date of grant.\nIn fiscal year 1994, LightStream adopted stock option plans enabling employees of LightStream and the Company to purchase shares of LightStream common stock at the fair value of the common stock on the date of grant. In connection with the sale of LightStream assets, stock options held by LightStream employees were exchanged for a cash payment. Stock options held by employees of the Company were not vested and were canceled.\nEmployee Stock Purchase Plan\nUnder the Company's 1983 Stock Purchase Plan, as amended, an aggregate of 3,600,000 shares of common stock were made available for purchase by employees who have completed at least six months of\ncontinuous service in the employ of the Company, upon exercise of options granted semi-annually. The options are exercisable six months after grant, at the lower of 85% of the fair market value of the common stock at the beginning or the end of the six-month period, but in no event for less than the Company's net book value per share as of the end of the quarter next preceding the exercise. Amounts are accumulated through payroll deductions ranging from 2% to 10% of each participating employee's compensation, as defined, but in no event more than $12,500 or 1,000 shares during any six-month option period.\nOptions were exercised to purchase 194,000, 185,000, and 283,000 shares for a total of $2,154,000, $1,519,000, and $1,125,000 in fiscal years 1995, 1994 and 1993, respectively. At June 30, 1995, 493,000 shares of authorized but unissued common stock were reserved for future issuance under this plan.\nRetirement Plans\nThe Company has a defined contribution retirement plan (the \"plan\") covering substantially all of its domestic employees. The Company's contribution to the plan is discretionary and is based on a percentage of employees' eligible compensation, as defined. Employees may also contribute to the plan. Effective July 1, 1994, the Company adopted an amendment to the plan which has been qualified under Section 401(k) of the Internal Revenue Code. Eligible employees are permitted to contribute to the plan through payroll deductions within the statutory limitations and subject to any limitations included in the plan. The plan also provides for matching contributions as determined annually by the Company's Board of Directors. The Company's total costs pursuant to the plan were $5,603,000, $5,517,000 and $6,515,000 in fiscal years 1995, 1994 and 1993, respectively.\nEffective April 1, 1995, the Company adopted a non-qualified deferred compensation plan. Eligible employees are permitted to defer a portion of their salary and incentive compensation subject to limitations. On an annual basis, the deferred compensation plan also provides for a discretionary retirement contribution by the Company for selected employees. The Company's cost pursuant to its deferred compensation plan in fiscal year 1995 was insignificant.\nIncentive Compensation Plans\nThe Company maintains incentive compensation and other performance related bonus plans for key employees, including its executive management. Awards under these plans are paid in recognition of individual contribution to divisional or corporate performance as determined by management or the Compensation and Stock Option Committee of the Board of Directors. Total costs pursuant to the Company's incentive compensation plans were $1,014,000, $1,820,000 and $510,000 in fiscal years 1995, 1994 and 1993, respectively.\nRESEARCH AND DEVELOPMENT COSTS\nThe Company performs research and development under contracts principally with the U.S. government. Costs incurred under these contracts are charged to \"Cost of services\" in the consolidated statements of operations as the related services revenue is recorded. Costs classified as \"Research and development expenses\" in the consolidated statements of operations are costs incurred under internally-initiated programs, including independent research and development as defined by government procurement regulations.\nCOMMITMENTS AND CONTINGENCIES\nThe Company, like other companies doing business with the U.S. government, is subject to routine audit, and in certain circumstances to inquiry, review, or investigation, by U.S. government agencies, of its compliance with government procurement policies and practices. Based upon government procurement regulations, under certain circumstances a contractor violating or not complying with procurement regulations can be subject to legal or administrative proceedings, including fines and penalties, as well as be suspended or debarred from contracting with the government. The Company's policy has been and continues to be to conduct its activities in compliance with all applicable rules and regulations.\nThe books and records of the Company are subject to audit by the Defense Contract Audit Agency (\"DCAA\"); such audits can result in adjustments to contract billings. Final contract billing rates have been established for years through fiscal year 1991, except for the Company's former BBN Communications activities for which final contract billing rates have been established only through fiscal year 1984. BBN expects that any adjustments which may be made as a result of audits of fiscal years 1985 through 1995 of the Company will not have a material adverse effect on the Company's results of operations.\nIn April 1991, the Company was informed that it was the subject of an investigation by U.S. government agencies of its compliance with certain government procurement policies and practices. No allegations were made by the government agencies and the Company was informed in August 1995 that the investigation had been concluded. The audit of the Company's former BBN Communications activities by the DCAA for fiscal years 1985 through 1993, which was delayed as a result of the investigation, is currently in process. U.S. government revenue for the Company's former BBN Communications activities, during the nine year period under audit, represented approximately 40% of the Company's total U.S. government revenue.\nThe Company is subject to other legal proceedings and claims which arise in the ordinary course of its business. In the opinion of management, the results of these other legal proceedings and claims will not have a material effect on the Company's consolidated financial position and results of operations.\nINCOME TAXES\nDuring fiscal year 1995, a significant portion of the Company's net operating losses and tax credit carryforwards were utilized in connection with the sale of LightStream assets. The remaining net operating losses and general business credits expire in fiscal years 2008 through 2012. A portion of the net operating loss carryforward is related to a fiscal year 1987 acquisition and is subject to certain limitations. The tax benefits of approximately $1,600,000 related to the exercise of stock options will be credited to additional paid-in capital when certain tax credit carryforwards are utilized.\nSUPPLEMENTAL CASH FLOW INFORMATION\nIn connection with the Company's fiscal year 1995 acquisitions of BARRNet and SURAnet, the Company assumed certain operating liabilities of $5,100,000 and issued 270,270 shares of BBN's common stock and 200,000 shares of BBN Planet's common stock. Refer to the \"Acquisitions\" footnote for further discussion of these transactions.\nIncome tax refunds received in fiscal year 1993 included $805,000 of interest.\nRESTRUCTURING CHARGE\nOperating results for fiscal year 1993 included a restructuring charge of $20,470,000 primarily associated with employee severance and excess facilities costs, reflecting a reduction of employment of approximately 300 employees in fiscal year 1993. The accrued restructuring charges at June 30, 1995 relates to excess facilities costs. The Company has sublet or assigned the majority of its excess facilities under agreements with terms expiring between 1998 and 2005.\nOTHER INCOME\nRefer to the \"Sale of LightStream Corporation\" footnote for discussion of the gain included in other income for fiscal year 1995.\nIn December 1994, the Company settled a claim with the U.S. government for approximately $700,000. This settlement resulted in an approximate $2,550,000 reduction in liabilities and is included in other income for fiscal year 1995.\nOther income in each of fiscal years 1995 and 1994 includes approximately $900,000 resulting from lower than expected costs associated with a previously divested contract.\nIn the fourth quarter of fiscal year 1993, the Company sold the fixed assets, inventory and technology of its Advanced Simulation business for $6,000,000 in cash. Results for fiscal year 1993 included a gain of $3,191,000 in connection with the sale.\nFOREIGN EXCHANGE CONTRACTS\nThe Company may enter into foreign exchange contracts to hedge certain of its exposures to foreign currency fluctuations. Gains or losses resulting from these contracts are offset against the effects of the foreign currency translation. At June 30, 1995 and 1994, the Company had foreign exchange contracts to sell $950,000 and $750,000, respectively, of foreign currencies.\nSALE OF LIGHTSTREAM CORPORATION\nThe sale of the assets of the Company's majority-owned subsidiary LightStream Corporation to Cisco Systems, Inc. (\"Cisco\") for a cash consideration of $120,000,000 which was completed on January 11, 1995, is reflected in the Company's fiscal year 1995 results. The Company's portion is 83% of the net proceeds and Ungermann-Bass Networks, Inc., which owns the minority interest in LightStream, will receive the remainder. Of the cash consideration paid to LightStream, $12,000,000 was placed in a restricted Escrow Fund, and periodically declining portions of such amount together with interest are to be maintained for up to two years following the closing of the transaction, subject to any claims under the Asset Purchase Agreement by Cisco. On July 11, 1995 $4,000,000 was released from the Escrow Fund. As part of the sale, Cisco hired substantially all of the employees of LightStream, and is operating from the Company's former facility in Billerica, Massachusetts. The Company recorded a pre-tax gain from the sale of approximately $105,000,000 before minority interest of $11,800,000 and income taxes of $13,500,000. LightStream's fiscal year 1995 results through the date of the sale included revenue of approximately $8,400,000 and an operating loss of approximately $3,700,000. In fiscal year 1994, the Company's ATM activities, which prior to the formation of LightStream were conducted by its then Communications Division, had aggregate revenue of approximately $1,500,000 and an operating loss of approximately $14,800,000.\nACQUISITIONS\nBARRNet Acquisition\nOn August 19, 1994, BBN Planet acquired, from Stanford University, the Bay Area Regional Research Network (\"BARRNet\"), a leading provider of Internet services in the San Francisco Bay area, for approximately $6,500,000 consisting principally of $2,000,000 cash, 270,270 shares of BBN common stock and 200,000 shares of BBN Planet common stock. The common stocks issued were valued at their fair value which reflects a discount attributable to their restricted nature. The transaction was accounted for using the purchase method of accounting. Accordingly, the acquired assets and liabilities were recorded at their estimated fair values on the date of the acquisition. The aggregate cost in excess of net assets acquired of approximately $4,500,000 is being amortized over ten years.\nSURAnet Acquisition\nOn March 31, 1995, BBN Planet acquired from the Southeastern Universities Research Association, the SURAnet Internet services organization, a provider of Internet services in the Southeastern United States. Substantially all of the SURAnet net assets were acquired for approximately $12,960,000 in cash and the assumption of certain operating liabilities of approximately $5,100,000. The transaction was accounted for using the purchase method of accounting. Accordingly, the acquired assets and liabilities were recorded at\ntheir estimated fair values on the date of the acquisition. The aggregate cost in excess of net assets acquired of approximately $14,000,000 is being amortized over ten years.\nSEGMENT INFORMATION\nBusiness Segments\nDuring fiscal year 1995, the Company reported financial information in three business segments: Internetworking, Data Analysis Software, and Collaborative Systems and Acoustic Technologies. The Internetworking business segment includes that part of the activities of the Company's BBN Systems and Technologies Division relating to advanced network systems (including the Company's defense communications activities) and network services and products, the activities of BBN Planet Corporation, and the activities of LightStream Corporation up to the date of sale of substantially all of its assets on January 11, 1995. The Data Analysis Software business segment includes the activities of BBN Domain. The Collaborative Systems and Acoustic Technologies business segment includes that part of the activities of the BBN Systems and Technologies Division relating to collaborative systems, sensor systems, and acoustic technologies, and the activities of BBN HARK Systems Corporation. In fiscal year 1993, the Collaborative Systems and Acoustic Technologies segment included the results of the Company's former simulation business. The following is a summary of business segments information for the fiscal years ended June 30, 1995, 1994, and 1993, respectively. All data are shown net of intersegment transactions.\nGeographic Segments\nRevenue includes U.S. export sales primarily to Western Europe and Japan of $24,000,000, $27,300,000 and $51,100,000 in fiscal years 1995, 1994, and 1993, respectively.\nSUBSEQUENT EVENT\nOn July 12, 1995, the Company announced that AT&T Venture Company, L.P. made an investment in BBN Planet by purchasing 1,000,000 shares of BBN Planet's Series A Convertible Preferred Stock at $8.00 per share. Such preferred shares are subject to mandatory conversion into 1,000,000 shares of BBN Planet common stock upon a public offering of BBN Planet, and may be put to the Company or BBN Planet at $8.00 per share within twelve months.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Shareholders and Board of Directors Bolt Beranek and Newman Inc. Cambridge, Massachusetts\nWe have audited the consolidated balance sheets of Bolt Beranek and Newman Inc., at June 30, 1995 and 1994, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended June 30, 1995. 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 Bolt Beranek and Newman Inc., at June 30, 1995 and 1994, and the consolidated results of its operations and its cash flows for each of the three years in the period ended June 30, 1995, in conformity with generally accepted accounting principles.\nBoston, Massachusetts August 8, 1995\nQUARTERLY FINANCIAL DATA (UNAUDITED)\nQuarterly financial data for the years ended June 30, 1995 and 1994 was as follows:\nITEM 9.","section_7A":"","section_8":"","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNone\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nInformation in response to this item may be found in the section entitled \"1. Election of Directors\" in the Company's definitive Proxy Statement dated September 29, 1995 for the Registrant's Annual Meeting to be held on November 6, 1995, and such information is incorporated herein by reference.\nInformation in response to executive officers of the registrant appears in Item 4A entitled \"Executive Officers of the Registrant\" on pages 21 and 22 of this report, and such information is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nInformation in response to this item may be found in the section entitled \"1. Election of Directors\" under the caption \"Board of Directors and Committee Organization\", in the sections entitled \"Compensation and\nCertain Other Transactions Involving Executive Officers\", \"Summary Compensation Table\", \"Option Grants in Last Fiscal Year\", and \"Option Exercises in Fiscal Year 1995 and Year-End Option Values\", in the section entitled \"Report of Compensation and Stock Option Committee on Annual Executive Compensation\", and in the section entitled \"Comparative Stock Performance\", each in the Company's definitive Proxy Statement dated September 29, 1995 for the Registrant's Annual Meeting to be held on November 6, 1995, and such information is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nInformation in response to this item may be found in the section entitled \"1. Election of Directors\" under the caption \"Biographical Information\", and in the section entitled \"Principal Holders of Company Common Stock\", each in the Company's definitive Proxy Statement dated September 29, 1995 for the Registrant's Annual Meeting to be held on November 6, 1995, and such information is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nInformation in response to this may be found in the section entitled \"Compensation and Certain Other Transactions Involving Executive Officers\" in the Company's definitive Proxy Statement dated September 29, 1995 for the Registrant's Annual Meeting to be held on November 6, 1995, and such information 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) List of Financial Statements, Financial Statement Schedules, and Exhibits.\n1. Financial Statements\nConsolidated Statements of Operations (page 30)\nConsolidated Balance Sheets (page 31)\nConsolidated Statements of Shareholders' Equity (page 32)\nConsolidated Statements of Cash Flows (page 33)\nNotes to Consolidated Financial Statements (pages 34-44)\nReport of Independent Accountants (page 45)\n2. FINANCIAL STATEMENT SCHEDULES\nSchedules other than those listed below have been omitted because they are inapplicable or are not required.\nII Valuation and Qualifying Accounts, Years Ended June 30, 1995, 1994, and 1993 (page 51)\n3. LIST OF EXHIBITS\nNone\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on this 28th day of September, 1995.\nBOLT BERANEK AND NEWMAN INC.\n\/S\/ GEORGE H. CONRADES By:................................. GEORGE H. CONRADES (PRESIDENT, CHIEF EXECUTIVE OFFICER, AND DIRECTOR)\nLIST OF EXHIBITS","section_15":""}
{"filename":"712534_1995.txt","cik":"712534","year":"1995","section_1":"ITEM 1. BUSINESS. - --------------------------------------------------------------------------------\nGENERAL\nFirst Merchants Corporation (the \"Corporation\") was incorporated under Indiana law on September 20, 1982, as the bank holding company for First Merchants Bank, National Association (\"First Merchants\"), a national banking association incorporated on February 6, 1893. Prior to December 16, 1991, First Merchants' name was The Merchants National Bank of Muncie. On November 30, 1988, the Corporation acquired Pendleton Banking Company (\"Pendleton\"), a state chartered commercial bank organized in 1872. On July 31, 1991, the Corporation acquired First United Bank (\"First United\"), a state chartered commercial bank organized in 1882.\nAs of December 31, 1995, the Corporation had consolidated assets of $707.9 million, consolidated deposits of $588.2 million and stockholders' equity of $80.5 million.\nThe Corporation is headquartered in Muncie, Indiana, and is presently engaged in conducting commercial banking business through the 21 offices of its three banking subsidiaries. As of December 31, 1995, the Corporation and its subsidiaries had 379 full-time equivalent employees.\nThrough its subsidiaries, the Corporation offers a broad range of financial services, including: accepting time and transaction deposits; making consumer, commercial, agri-business and real estate mortgage loans; issuing credit cards; renting safe deposit facilities; providing personal and corporate trust services; and providing other corporate services, letters of credit and repurchase agreements.\nACQUISITION POLICY AND PENDING TRANSACTIONS\nThe Corporation anticipates that it will continue its policy of geographic expansion through consideration of acquisitions of additional financial institutions. Management of the Corporation periodically engages in reviewing and analyzing potential acquisitions. The Corporation is a party to a definitive agreement to merge with Union National Bancorp and thereby acquire its wholly-owned subsidiary, The Union County National Bank of Liberty. Union National Bancorp's principal executive offices are located in Liberty, Indiana. The Corporation is also a party to a definitive agreement to merge with Randolph County Bancorp and thereby acquire its wholly-owned subsidiary, The Randolph County Bank. Randolph County Bancorp's principal executive offices are located in Winchester, Indiana.\nCOMPETITION\nThe Corporation's banking subsidiaries are located in Delaware, Madison, and Henry counties, Indiana. In addition to the competition provided by the lending and deposit gathering subsidiaries of national manufacturers, retailers, insurance companies and investment brokers, the banking subsidiaries compete vigorously with other banks, thrift institutions, credit unions and finance companies located within their service areas.\nSUPERVISION AND REGULATION\nThe Corporation is a bank holding company (\"BHC\") subject to regulation under the Bank Holding Company Act of 1956, as amended (the \"Act\"). The Act generally requires a BHC to obtain prior approval of the Federal Reserve Board (the \"FRB\") to acquire or hold more than a 5% voting interest in any bank. The Act restricts the non-banking activities of BHCs to those which are closely related to banking activities. As a result of the provisions in the Financial Institutional Reform, Recovery and Enforcement Act of 1989, BHCs may now own and operate savings and loan\n- --------------------------------------------------------------------------------\nSUPERVISION AND REGULATION (CONTINUED)\nassociations or savings banks which, in the past, was prohibited. First Merchants is a national bank and is supervised, regulated and examined by the Comptroller of the Currency. Pendleton and First United are state banks and are supervised, regulated and examined by the Indiana Department of Financial Institutions (the \"DFI\"). In addition, First Merchants, as a member of the Federal Reserve System, is supervised and regulated by the Federal Reserve. In addition, Pendleton and First United, which are not members of the Federal Reserve System, are supervised and regulated by the Federal Deposit Insurance Corporation (\"FDIC\"). The deposits of First Merchants, Pendleton, and First United (the \"Banks\") are insured by the FDIC. Each regulator has the authority to issue cease-and-desist orders if it determines their activities represent an unsafe and unsound practice or violation of law.\nUnder the Act and under regulations of the FRB, the Corporation and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with the extension of credit and are subject to limitations as to certain intercompany transactions.\nSubject to certain limitations, an Indiana bank may establish branches de novo and may establish branches by acquisition in any location or locations within Indiana. Indiana law permits intrastate bank holding company acquisitions, subject to certain limitations. Effective July 1, 1992, Indiana bank holding companies were permitted to acquire banks, and banks and bank holding companies in Indiana were permitted to be acquired by bank holding companies, located in any state in the United States which permits reciprocal entry by Indiana bank holding companies. Prior to July 1, 1992, such interestate bank holding company acquisitions were permitted only on a regional, as opposed to national, basis. Neither the Corporation nor its subsidiaries presently contemplate engaging in any non-banking related business activities.\nDuring 1991, Congress passed the Federal Deposit Insurance Corporation Improvement Act (\"FDICIA\"). In addition to addressing the insurance fund's financial needs, FDICIA expanded the power of the federal banking regulators. FDICIA introduced a new system of classifying financial institutions with respect to their capitalization. Effective in 1993, FDICIA also requires certain financial institutions, such as First Merchants, to have annual audits and requires management to issue supplemental reports attesting to an institution's compliance with laws and regulations and to the adequacy of its internal controls and procedures.\nThe Riegle Community Development and Regulatory Improvement Act of 1994 (Act) was signed into law in 1994. The Act contains seven titles pertaining to community development and home ownership protection, small business capital formation, paperwork reduction and regulatory improvement, money laundering and flood insurance. The Act grants the authority to several agencies to promulgate regulations under the Act. No regulations have yet been promulgated. The Corporation cannot predict with certainty the impact of the Act on the banking industry.\nIn September, 1994, the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (Interstate Act) was enacted into law. The Interstate Act authorized interstate acquisitions, mergers and bank branching and agency banking with affiliates in different states. The Interstate Act amends the Bank Holding Company Act to allow adequately capitalized and managed bank holding companies to acquire a bank located in another state beginning in September, 1995. The new act permits full interstate branching after June 1, 1997. After that date, BHCs may merge\n- --------------------------------------------------------------------------------\nSUPERVISION AND REGULATION (CONTINUED)\nexisting bank subsidiaries into one bank, with banks also permitted to merge unaffiliated banks across state lines. States may permit interstate branching earlier than June 1, 1997, where both states involved with a bank merger expressly permit it by statute. The Interstate Act permits states to enact a law expressly prohibiting interstate mergers. Such laws must apply equally to all out-of-state banks and be passed before June 1, 1997.\nThe monetary policies of regulatory authorities, including the Federal Reserve Board, have a significant effect on the operating results of banks and bank holding companies. The nature of future monetary policies and the effect of such policies on the future business and earnings of the Corporation and its subsidiary banks cannot be predicted.\nThe Corporation is under the jurisdiction of the Securities and Exchange Commission and state securities commission for matters relating to the offering and sale of its securities and is subject to the Securities and Exchange Commission's rules and regulations relating to periodic reporting, reporting to stockholders, proxy solicitation, and insider trading.\nThe Corporation's income is principally derived from dividends paid on the common stock of its subsidiaries. The payment of these dividends are subject to certain regulatory restrictions.\nCAPITAL REQUIREMENTS\nThe Corporation and its subsidiary banks must meet certain minimum capital requirements mandated by the FRB, the FDIC and DFI. These regulatory agencies require BHCs and banks to maintain certain minimum ratios of primary capital to total assets and total capital to total assets. As of January 1, 1991, the FRB required bank holding companies to maintain a minimum Tier 1 leverage ratio to 3 per cent capital to total assets; however, for all but the most highly rated institutions which do not anticipate significant growth, the minimum Tier 1 ratio is 3 per cent plus an additional cushion of 100 to 200 basis points. As of December 31, 1995, the Corporation's leverage ratio of capital to total assets was 11.13 per cent.\nThe FRB and FDIC each have approved the imposition of \"risk-adjusted\" capital ratios on BHCs and financial institutions. The Corporation and its subsidiaries had capital to assets ratios and risk-adjusted capital ratios at December 31, 1995, in excess of the applicable regulatory minimum requirements.\nThe following table summarizes the Corporation's risk-adjusted capital ratios under FRB guidelines at December 31, 1995:\n- -------------------------------------------------------------------------------- STATISTICAL DATA The following tables set forth statistical data relating the Corporation and its subsidiaries.\nDISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS' EQUITY; INTEREST RATES AND INTEREST DIFFERENTIAL\nThe daily average balance sheet amounts, the related interest income or expense, and average rates earned or paid are presented in the following table.\n- --------------------------------------------------------------------------------\nSTATISTICAL DATA (Continued)\nANALYSIS OF CHANGES IN NET INTEREST INCOME\nThe following table presents net interest income components on a tax-equivalent basis and reflects changes between periods attributable to movement in either the average balance or average interest rate for both earning assets and interest-bearing liabilities. The volume differences were computed as the difference in volume between the current and prior year times the interest rate of the prior year, while the interest rate changes were computed as the difference in rate between the current and prior year times the volume of the prior year. Volume\/rate variances have been allocated on the basis of the absolute relationship between volume variances and rate variances.\nSTATISTICAL DATA (Continued)\nINVESTMENT SECURITIES\nThe amortized cost, gross unrealized gains, gross unrealized losses and approximate market value of the investment securities at the dates indicated were:\n- -------------------------------------------------------------------------------\nSTATISTICAL DATA (Continued)\nThe Fair Value of Federal Reserve and Federal Home Loan Bank stock approximates cost.\nThe maturity distribution (dollars in thousands) and average yields for the securities portfolio at December 31, 1995 were:\nSecurities available for sale December 31, 1995:\n- -------------------------------------------------------------------------------\nSTATISTICAL DATA (Continued)\nSecurities held to maturity at December 31, 1995:\n*Interest yields on state and municipal securities are presented on a fully taxable equivalent basis using a 35% rate.\nFederal Reserve and Federal Home Loan Bank stock at December 31, 1995:\nSTATISTICAL DATA (Continued)\nLOAN PORTFOLIO\nTypes of Loans - --------------\nThe loan portfolio at the dates indicated is presented below:\nAt December 31, 1995, the Corporation had Residential Real Estate Loans Held for Sale of $735,522.\nMATURITIES AND SENSITIVITIES OF LOANS TO CHANGES IN INTEREST RATES\nPresented in the table below are the maturities of loans (excluding commercial real estate, farmland, residential real estate and individuals' loans) outstanding as of December 31, 1995. Also presented are the amounts due after one year classified according to the sensitivity to changes in interest rates.\nSTATISTICAL DATA (Continued)\nNonaccruing loans are loans which are reclassified to a nonaccruing status when in management's judgment the collateral value and financial condition of the borrower do not justify accruing interest. Interest previously recorded but not deemed collectible is reversed and charged against current income. Interest income on these loans is then recognized when collected.\nRestructured loans are loans for which the contractual interest rate has been reduced or other concessions are granted to the borrower because of a deterioration in the financial condition of the borrower resulting in the inability of the borrower to meet the original contractual terms of the loans.\nInterest income of $55,601 for the year ended December 31, 1995, was recognized on the nonaccruing and restructured loans listed in the table above, whereas interest income of $59,168 would have been recognized under their original loan terms.\nPotential problem loans:\nManagement has identified certain other loans totaling $3,122,000 as of December 31, 1995, not included in the risk elements table, which are current as to principal and interest, about which there are doubts as to the to the borrowers' ability to comply with present repayment terms.\nSTATISTICAL DATA (Continued)\nSUMMARY OF LOAN LOSS EXPERIENCE\nThe following table summarizes the loan loss experience for the years indicated.\nSTATISTICAL DATA (Continued)\nALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES AT DECEMBER 31:\nPresented below is an analysis of the composition of the allowance for loan losses and per cent of loans in each category to total loans:\nSTATISTICAL DATA (Continued)\nLOAN LOSS CHARGEOFF PROCEDURES\nThe Banks have weekly meetings at which loan delinquencies, maturities and problems are reviewed. The Board of Directors receive and review reports on loans monthly.\nThe Executive Committee of First Merchants' Board meets bimonthly to approve or disapprove all new loans in excess of $1,000,000 and the Board reviews all commercial loans in excess of $50,000 which were made or renewed during the preceding month. Pendleton's and First United's loan committees, consisting of all loan officers and the president, meet as required to approve or disapprove any loan which is in excess of an individual loan officer's lending limit.\nAll chargeoffs are approved by the senior loan officer and are reported to the Banks' Boards. The Banks charge off loans when a determination is made that all or a portion of a loan is uncollectible or as a result of examinations by regulators and the independent auditors.\nPROVISION FOR LOAN LOSSES\nIn banking, loan losses are one of the costs of doing business. Although the Banks' management emphasize the early detection and chargeoff of loan losses, it is inevitable that at any time certain losses exist in the portfolio which have not been specifically identified. Accordingly, the provision for loan losses is charged to earnings on an anticipatory basis, and recognized loan losses are deducted from the allowance so established. Over time, all net loan losses must be charged to earnings. During the year, an estimate of the loss experience for the year serves as a starting point in determining the appropriate level for the provision. However, the amount actually provided in any period may be greater or less than net loan losses, based on management's judgment as to the appropriate level of the allowance for loan losses. The determination of the provision in any period is based on management's continuing review and evaluation of the loan portfolio, and its judgment as to the impact of current economic conditions on the portfolio. The evaluation by management includes consideration of past loan loss experience, changes in the composition of the loan portfolio, and the current condition and amount of loans outstanding.\nImpaired loans are measured by the present value of expected future cash flows, or the fair value of the collateral of the loans, if collateral dependent. Impaired loans totaled $3,122,000 at December 31, 1995. An allowance for losses at December 31, 1995, was not deemed necessary for impaired loans totaling $1,900,000, but an allowance of $559,000 was recorded for the remaining balance of impaired loans of $1,222,000. The average balance of impaired loans for 1995 was $1,682,000.\nSTATISTICAL DATA (Continued)\nDEPOSITS\nThe following table shows the average amount of deposits and average rate of interest paid thereon for the years indicated.\nAs of December 31, 1995, certificates of deposit and other time deposits of $100,000 or more mature as follows:\nSTATISTICAL DATA (Continued)\nSHORT-TERM BORROWINGS\nSecurities sold under repurchase agreements are borrowings maturing within one year and are secured by U. S. Treasury and Federal agency obligations.\nPertinent information with respect to short-term borrowings is summarized below:\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe headquarters of the Corporation and First Merchants are located in a five- story building at 200 East Jackson Street, Muncie, Indiana. This building and eight branch buildings are owned by First Merchants; five remaining branches of First Merchants are located in leased premises. Ten automated cash dispensers are located in leased premises; one cash dispenser is located in premises that are provided free of charge. All of the Corporation's and First Merchants' facilities are located in Delaware and Madison Counties of Indiana.\nThe principal offices of Pendleton are located at 100 West State Street, Pendleton, Indiana. Pendleton also operates three branches. All of Pendleton's properties are owned by Pendleton and are located in Madison County, Indiana. One automated dispenser is located in leased premises.\nThe principal offices of First United are located at 790 West Mill Street, Middletown, Indiana. First United also operates two branches. All of First United's properties are owned by First United and are located in Henry County, Indiana.\nNone of the properties owned by the banks are subject to any major encumbrances. The net investment of the Corporation and subsidiaries in real estate and equipment at December 31, 1995 was $10,475,935.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThere is no pending legal proceeding, other than ordinary routine litigation incidental to the business of the Corporation or its subsidiaries, of a material nature to which the Corporation or its subsidiaries is a party or of which any of their properties are subject. Further, there is no material legal proceeding in which any director, officer, principal shareholder, or affiliate of the Corporation, or any associate of any such director, officer or principal shareholder, is a party, or has a material interest, adverse to the Corporation.\nNone of the routine legal proceedings, individually or in the aggregate, in which the Corporation or its affiliates are involved are expected to have a material adverse impact on the financial position or the results of operations of the Corporation.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNo matters were submitted during the fourth quarter of 1995 to a vote of security holders, through the solicitation of proxies or otherwise.\nSUPPLEMENTAL INFORMATION - EXECUTIVE OFFICERS OF THE REGISTRANT.\nThe names, ages, and positions with the Corporation and subsidiary banks of all executive officers of the Corporation are listed below.\nSUPPLEMENTAL INFORMATION - EXECUTIVE OFFICERS OF THE REGISTRANT.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe information required under this item is incorporated by reference to page 2 of the Corporation's 1995 Annual Report to Stockholders under the caption \"Stockholder Information,\" Exhibit 13.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe information required under this item is incorporated by reference to page 1 of the Corporation's 1995 Annual Report to Stockholders under the caption \"Five- Year Summary of Selected Financial Data,\" Exhibit 13.\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 incorporated by reference to page 2 through 7 of the Corporation's 1995 Annual Report to Stockholders under the caption \"Management's Discussion and Analysis,\" Exhibit 13.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe financial statements and supplementary data required under this item are incorporated herein by reference to inside cover and pages 8 through 24 of the Corporation's 1995 Annual Report to Stockholders, Exhibit 13.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nIn connection with its audits for the two most recent fiscal years ended December 31, 1995, there have been no disagreements with the Corporation's independent certified public accountants on any matter of accounting principles or practices, financial statement disclosure or audit scope or procedure, nor have there been any changes in accountants.\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 relating to directors is incorporated by reference to the Corporation's 1996 Proxy Statement furnished to its stockholders in connection with an annual meeting to be held April 4, 1996 (the \"1996 Proxy Statement\"), under the caption \"Election of Directors,\" which Proxy Statement has been filed with the Commission. The information required under this item relating to executive officers is set forth in Part I, \"Supplemental Information - Executive Officers of the Registrant\" of this annual report on Form 10-K.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe information required under this item is incorporated by reference to the Corporation's 1996 Proxy Statement, under the captions, \"Compensation of Directors\" and \"Compensation of Executive Officers,\" which Proxy Statement has been filed with the Commission.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe information required under this item is incorporated by reference to the Corporation's 1996 Proxy Statement, under the caption, \"Security Ownership of Certain Beneficial Owners and Management,\" which Proxy Statement has been filed with the Commission.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe information required under this item is incorporated by reference to the Corporation's 1996 Proxy Statement, under the caption \"Interest of Management in Certain Transactions,\" which Proxy Statement has been filed with the Commission.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.\n(a)3. Exhibits:\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. (Continued)\n(A) Incorporated by reference to Registrant's Registration Statement on Form S-4 (SEC File No. 33-110) ordered effective on September 30, 1988. (B) Incorporated by reference to Registrant's Registration Statement on Form S-8 (SEC File No. 33-28900) effective on May 24, 1989. (C) Incorporated by reference to Registrant's Registration Statement on Form S-8 (SEC File No. 33-28901) effective on May 24, 1989. (D) Incorporated by reference to Registrant's Form 10-K for year ended December 31, 1990. (E) Incorporated by reference to Registrant's Form 10-K for year ended December 31, 1993. (F) Incorporated by reference to Registrant's Form 10-K for year ended December 31, 1994.\n(b) Reports on Form 8-K:\nNo reports on Form 8-K were filed for the three months ended December 31, 1995.\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on this 12th day of March, 1996.\nFIRST MERCHANTS CORPORATION\nBy \/s\/ Stefan S. Anderson ---------------------------------------- Stefan S. Anderson, Chairman\nPursuant to the requirements of the Securities Exchange Act of 1934, this report on Form 10-K has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nINDEX TO EXHIBITS\n(A) Incorporated by reference to Registrant's Registration Statement on Form S-4 (SEC File No. 33-110) ordered effective on September 30, 1988. (B) Incorporated by reference to Registrant's Registration Statement on Form S-8 (SEC File No. 33-28900) effective on May 24, 1989. (C) Incorporated by reference to Registrant's Registration Statement on Form S-8 (SEC File No. 33-28901) effective on May 24, 1989. (D) Incorporated by reference to Registrant's Form 10-K for year ended December 31, 1990. (E) Incorporated by reference to Registrant's Form 10-K for year ended December 31, 1993. (F) Incorporated by reference to Registrant's Form 10-K for year ended December 31, 1994.\nEXHIBIT 21--SUBSIDIARIES OF THE REGISTRANT\nState of Name Incorporation ---- -------------\nFirst Merchants Bank, National Association. . . . . . . . . U.S.\nPendleton Banking Company . . . . . . . . . . . . . . . . . Indiana\nFirst United Bank . . . . . . . . . . . . . . . . . . . . . Indiana\nEXHIBIT 23--CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nWe hereby consent to the incorporation by reference to Registration Statements on Form S-8, File Numbers 33-28900 and 33-28901, of our report dated January 19, 1996, except for Note 2 as to which the date is January 24, 1996 on the consolidated financial statements of First Merchants Corporation, which report is incorporated by reference in the Annual Report on Form 10-K of First Merchants Corporation.\n\/s\/ Geo. S. Olive & Co. LLC\nIndianapolis, Indiana March 18, 1996\nEXHIBIT 99.1--FINANCIAL STATEMENTS AND INDEPENDENT AUDITOR'S REPORT FOR FIRST MERCHANTS CORPORATION EMPLOYEE STOCK PURCHASE PLAN\nThe annual financial statements and independent auditor's report thereon for First Merchants Corporation Employee Stock Purchase Plan for the year ending June 30, 1996, will be filed as an amendment to the 1995 Annual Report on Form 10-K no later than October 28, 1996.","section_15":""}
{"filename":"704271_1995.txt","cik":"704271","year":"1995","section_1":"Item 1. Business.\nCentury Properties Fund XVIII (the \"Registrant\") was organized in July 1982 as a California limited partnership under the Uniform Limited Partnership Act of the California Corporations Code. Fox Partners, a California general partnership, is the general partner of the Registrant. The general partners of Fox Partners are Fox Capital Management Corporation (the \"Managing General Partner\"), a California corporation, Fox Realty Investors (\"FRI\"), a California general partnership, and Fox Partners 82, a California general partnership.\nThe Registrant's Registration Statement, filed pursuant to the Securities Act of 1933 (No. 2-78495), was declared effective by the Securities and Exchange Commission on November 5, 1982. The Registrant marketed its securities pursuant to its Prospectus dated November 5, 1982, as revised December 30, 1982, which was thereafter supplemented (hereinafter the \"Prospectus\"). The Prospectus was filed with the Securities and Exchange Commission pursuant to Rule 424(b) of the Securities Act of 1933.\nThe principal business of the Registrant is and has been to acquire, hold for investment and ultimately sell income-producing real property. The Registrant is a \"closed\" limited partnership real estate syndicate formed to acquire multi-family residential properties. For a further description of the business of the Registrant, see the sections entitled \"Risk Factors\" and \"Investment Objectives and Policies\" of the Prospectus.\nFrom February 1983 through September 1983, the Registrant offered and sold $75,000,000 in Limited Partnership Units. The net proceeds of this offering were used to purchase twelve income-producing real properties. The Registrant's original property portfolio was geographically diversified with acquired properties located in seven states. The Registrant's acquisition activities were completed in June 1984, and since then the principal activity of the Registrant has been managing its portfolio. In the period from 1987 through February 1994 ten properties were sold or otherwise disposed of. See \"Item 2, Properties\" for a description of the Registrant's properties.\nThe Registrant is involved in only one industry segment, as described above. The business of the Registrant is not seasonal. The Registrant does not engage in any foreign operations or derive revenues from foreign sources.\nBoth the income and the expenses of operating the properties owned by the Registrant are subject to factors outside the Registrant's control, such as oversupply of similar rental facilities resulting from overbuilding, increases in unemployment or population shifts, changes in zoning laws or changes in patterns of needs of the users. Expenses, such as local real estate taxes and management expenses, are subject to change and cannot always be reflected in\nrental increases due to market conditions or existing leases. The profitability and marketability of developed real property may be adversely affected by changes in general and local economic conditions and in prevailing interest rates, and favorable changes in such factors will not necessarily enhance the profitability or marketability of such property. Even under the most favorable market conditions, there is no guarantee that any property owned by the Registrant can be sold by it or, if sold, that such sale can be made upon favorable terms.\nIt is possible that legislation on the state or local level may be enacted in the states where the Registrant's properties are located which may include some form of rent control. There have been, and it is possible there may be other, Federal, state and local regulations enacted relating to the protection of the environment. The Managing General Partner is unable to predict the extent, if any, to which such new legislation or regulations might occur and the degree to which such existing or new legislation or regulations might adversely affect the properties still owned by the Registrant.\nThe Registrant monitors its properties for evidence of pollutants, toxins and other dangerous substances, including the presence of asbestos. In certain cases environmental testing has been performed, which resulted in no material adverse conditions or liabilities. In no case has the Registrant received notice that it is a potentially responsible party with respect to an environmental clean up site.\nThe Registrant maintains property and liability insurance on the properties and believes such coverage to be adequate.\nAt this time, it appears that the original investment objective of capital growth from the inception of the Registrant will not be attained and that investors will not receive a return of all their invested capital. The extent to which invested capital is returned to investors is dependent upon the success of the Registrant's strategy as set forth in \"Item 7\" as well as upon significant improvement in the performance of the Registrant's remaining properties and the markets in which such properties are located and on the sales price of the remaining properties. In this regard, the remaining properties have been held longer than originally expected.\nProperty Matters\nOverlook Point Apartments - The Registrant modified its existing first mortgage on Overlook Point Apartments in February 1994. Principal of $7,166,000 and contingent interest of $1,213,000 were outstanding on the original loan which was due August 1995. The Registrant paid down $129,000 of accrued interest from its escrow accounts with the lender and secured a new loan for the balance of $8,250,000. The new loan requires monthly debt service payments of approximately $62,000, bears interest at 8.25% per annum and is being amortized over 30 years. The loan matures in 1999 with a balloon payment due of approximately $7,869,000. See \"Item 8, Financial Statements and Supplementary Data - Note 5.\"\nPlantation Ridge Apartments - Plantation Ridge Apartments was sold on February 15, 1994 for $15,353,000. After the buyer's assumption of the existing loan of $13,653,000 and expenses of sale of $210,000 (including sales\ncommissions of $154,000 paid to an outside broker), the proceeds to the Registrant were approximately $1,490,000. Net proceeds realized from the sale were used to fully repay $608,000 of demand notes, plus accrued interest of $230,000, due to NPI Realty and to further replenish working capital. See, \"Item 8, Financial Statements and Supplementary Data - Note 7.\"\nEmployees\nServices are performed for the Registrant at its remaining properties by on-site personnel all of whom are employees of NPI-AP Management, L.P., (\"NPI-AP\") an affiliate of the Managing General Partner, which directly manages the Registrant's remaining properties. All payroll and associated expenses of such on-site personnel are fully reimbursed by the Registrant to NPI-AP. Pursuant to a management agreement, NPI-AP provides certain property management services to the Registrant in addition to providing on-site management.\nChange in Control\nFrom March 1988 through December 1993, the Registrant's affairs were managed by Metric Management, Inc. (\"MMI\") or a predecessor. On December 16, 1993, the services agreement with MMI was modified and, as a result thereof, the Managing General Partner began directly providing real estate advisory and asset management services to the Registrant. As advisor, such affiliate provides all partnership accounting and administrative services, investment management, and supervisory services over property management and leasing.\nOn December 6, 1993, the shareholders of the Managing General Partner entered into a Voting Trust Agreement with NPI Equity Investments II, Inc. (\"NPI Equity II\") pursuant to which NPI Equity II was granted the right to vote 100% of the outstanding stock of the Managing General Partner. In addition, NPI Equity II became the managing partner of FRI. As a result, NPI Equity II indirectly became responsible for the operation and management of the business and affairs of the Registrant and the other investment partnerships originally sponsored by the Managing General Partner and\/or FRI. The individuals who had served previously as partners of FRI and as officers and directors of the Managing General Partner contributed their general partnership interests in FRI to a newly formed limited partnership, Portfolio Realty Associates, L.P. (\"PRA\"), in exchange for limited partnership interests in PRA. The shareholders of the Managing General Partner and the prior partners of FRI, in their capacity as limited partners of PRA, continue to hold indirectly certain economic interests in the Registrant and such other investment limited partnerships, but have ceased to be responsible for the operation and management of the Registrant and such other partnerships.\nOn August 10, 1994, an affiliate of Apollo Real Estate Advisors, L.P. (\"Apollo\") obtained general and limited partnership interests in NPI-AP.\nOn October 12, 1994, Apollo acquired one-third of the stock of National Property Investors, Inc. (\"NPI\"), the parent corporation of NPI Equity II. Pursuant to the terms of the stock acquisition, Apollo was entitled to designate three of the seven directors of the Managing General Partner and NPI Equity II. In addition, the approval of certain major actions on behalf of the Registrant required the affirmative vote of at least five directors of the Managing General Partner.\nOn August 17, 1995, the stockholders of NPI entered into an agreement to sell to IFGP Corporation, a Delaware corporation, an affiliate of Insignia Financial Group, Inc., a Delaware corporation (\"Insignia\"), all of the issued and outstanding common stock of NPI, for an aggregate purchase price of $1,000,000. NPI is the sole shareholder of NPI Equity II, the general partner of FRI, and the entity which controls the Managing General Partner. The closing of the transactions contemplated by the above mentioned agreement (the \"Closing\") occurred on January 19, 1996.\nUpon the Closing, the officers and directors of NPI, NPI Equity II and the Managing General Partner resigned and IFGP Corporation caused new officers and directors of each of those entities to be elected. See \"Item 10, Directors and Executive Officers of the Registrant.\"\nThe Tender Offer\nOn October 12, 1994, affiliates of Apollo acquired (i) one-third of the stock of the respective general partners of DeForest Ventures I L.P. (\"DeForest I\") and DeForest Ventures II L.P. and (ii) an additional equity interest in NPI-AP (bringing its total equity interest in such entity to one-third). NPI-AP is a limited partner of DeForest I which was formed for the purpose of making tender offers for limited partnership units in the Registrant as well as 11 affiliated limited partnerships.\nOn January 19, 1996, DeForest I and certain of its affiliates sold all of its interest in the Registrant to Insignia NPI L.L.C. (\"Insignia LLC\"), an affiliate of Insignia. Pursuant to a Schedule 13-D filed by Insignia LLC with the Securities and Exchange Commission, Insignia LLC acquired 21,513 limited partnership units or approximately 28.7% of the total limited partnership units of the Registrant. (See \"Item 12, Security Ownership of Certain Beneficial Owners and Management.\")\nCompetition\nThe Registrant is affected by and subject to the general competitive conditions of the residential real estate industry. Many of the Registrant's properties which are or were located in oil industry related and other weakened markets have been adversely affected by economic conditions in these markets. In addition, each of the Registrant's properties competes in an area which normally contains numerous other multi-family residential properties which may be considered competitive.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nA description of the multi-family residential properties in which the Registrant has an ownership interest is as follows. All of the Registrant's properties are owned in fee.\nDate of Name and Location Purchase Size - ----------------- --------- --------- Overlook Point Apartments 07\/83 304 units 4700 South Street\nSalt Lake City, Utah\nOak Run Apartments 11\/83 420 units 5801 Preston Oaks Road Dallas, Texas\nSee \"Item 8, Financial Statements and Supplementary Data\" for information regarding any encumbrances to which the properties of the Registrant are subject.\nThe following chart sets forth the occupancy rates at December 31, 1995, 1994, 1993, 1992 and 1991 for the Registrant's remaining properties:\nOCCUPANCY SUMMARY\nAverage Occupancy Rate(%) for the Year Ended December 31, -------------------------------- 1995 1994 1993 1992 1991 ---- ---- ---- ---- ----\nOverlook Point Apartments 96 95 95 95 94 Oak Run Apartments 98 97 94 93 91\nItem 3.","section_3":"Item 3. Legal Proceedings.\nLawrence M. Whiteside, on behalf of himself and all others similarly situated, v. Fox Capital Management Corporation et, al., Superior Court of the State of California, San Mateo County, Case No. 390018. (\"Whiteside\")\nBonnie L. Ruben and Sidney Finkel, on behalf of themselves and all others similarly situated, v. DeForest Ventures I L.P., DeForest Capital I Corporation, MRI Business Properties Fund, Ltd. II, MRI Business Properties Fund, Ltd. III, NPI Equity Investments II, Inc., Montgomery Realty Company-84, MRI Associates, Ltd. II, Montgomery Realty Company-85 and MRI Associates, Ltd. III, United States District Court, Northern District of Georgia, Atlanta Division(\"Ruben\").\nRoger L. Vernon, individually and on behalf of all similarly situated persons v. DeForest Ventures I L.P. et. al., Circuit Court of Cook County, County Departments, Chancery Division, Case No. 94CH0100592. (\"Vernon\")\nJames Andrews, et al., on behalf of themselves and all others similarly situated v. Fox Capital Management Corporation, et al., United States District Court, Northern District of Georgia, Atlanta Division, Case No. 1-94-CV-3351-JEC. (\"Andrews\")\nIn the fourth quarter of fiscal 1994, limited partners in certain limited partnerships affiliated with the Registrant, commenced actions in and against, among others, the Managing General Partner. The actions alleged, among other things, that the tender offers made by DeForest Ventures I L.P. (\"DeForest I\") and DeForest Ventures II L.P. (\"DeForest II\") in October 1994, constituted (a) breach of the fiduciary duty owed by the Managing General Partner to the limited\npartners of the Registrant, and (b) a breach of, and an inducement to breach, the provisions of the Partnership Agreement of the Registrant. The actions, which had been brought as class actions on behalf of limited partners sought monetary damages in an unspecified amount and, in the Whiteside action, to enjoin the tender offers. The temporary restraining order sought in the Whiteside action was denied by the court on November 3, 1994, and on November 18, 1994, the court denied Whiteside a preliminary injunction.\nOn March 16, 1995, the United States Court for the Northern District of Georgia, Atlanta, Division, entered an order which granted preliminary approval to a settlement agreement (the \"Settlement Agreement\") in the Ruben and Andrews actions, conditionally certified two classes for purpose of settlement, and authorized the parties to give notice to the classes of the terms of the proposed settlement. Plaintiffs counsel in the Vernon and Whiteside action joined in the Settlement Agreement as well. The Settlement Agreement received final approval on May 19, 1995, and the actions were dismissed subject to satisfaction of the terms of the Settlement Agreement. The two certified classes constituted all limited partners of the Registrant and the eighteen other affiliated partnerships who either tendered their units in connection with the October tender offers or continued to hold their units in the Registrant and the other affiliated partnerships. Pursuant to the terms of the Settlement Agreement, which were described in the notice sent to the class members in March 1995, (and more fully described in the Amended Stipulation of Settlement submitted in the court on March 14, 1995) all claims which either were made or could have been asserted in any of the class actions would be dismissed with prejudice and\/or released. In consideration for the dismissal and\/or release of such claims, among other things, DeForest I paid to each unit holder who tendered their units in the Registrant an amount equal to 15% of the original tender offer price less attorney's fees and expenses. In addition, DeForest I commenced a second tender offer on June 2, 1995, for an aggregate number of units of the Registrant (including the units purchased in the initial tender) constituting up to 49% of the total number of units of the Registrant at a price equal to the initial tender price plus 15% less attorney's fees and expenses. Furthermore, under the terms of the Settlement Agreement, the Managing General Partner agreed, among other things, to provide the Registrant a credit line of $150,000 per property which would bear interest at the lesser of the prime rate plus 1% and the rate permitted under the partnership agreement of the Registrant. The second tender offer closed on June 30, 1995.\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 period covered by this Report.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Equity and Related Security Holder Matters.\nThe Limited Partnership Unit holders are entitled to certain distributions as provided in the Partnership Agreement. As of March 1, 1996, cash distributions from operations for each unit holder have ranged from $47 to $58 for each $1,000 of original investment. No market for Limited Partnership Units exists, nor is any expected to develop.\nNo distributions from operations were made during the years ended December 31, 1995 and 1994. See \"Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations\" for a discussion of the Registrant's financial ability to make distributions.\nAs of March 1, 1996, the approximate number of holders of Limited Partnership Units was 5,371.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nThe following represents selected financial data for the Registrant for the years ended December 31, 1995, 1994, 1993, 1992 and 1991. The data should be read in conjunction with the financial statements included elsewhere herein. This data is not covered by the independent auditors' report.\nFor the Year Ended December 31, ------------------------------------------------ 1995 1994 1993 1992 1991 ---- ---- ---- ---- ---- (Amounts in thousands except per unit data)\nTOTAL REVENUES $ 4,511 $ 5,729 $10,701 $ 11,248 $ 11,660 ======= ======= ======== ======== ========\n(LOSS) INCOME BEFORE EXTRAORDINARY ITEM (4) 732 (4,938) (3,875) (4,917)\nEXTRAORDINARY ITEMS - - 6,501 - 4,324 ------- ------- ------- ------- --------\nNET INCOME (LOSS) $ (4) $ 732 $ 1,563 $ (3,875) $ (593) ======= ======= ======= ======== ========\nNET INCOME (LOSS) PER LIMITED PARTNERSHIP UNIT(1): (Loss) income before extraordinary item $ (.05) $ 8.77 $(59.63) $ (46.55) $ (59.05) Extraordinary item - - 78.09 - 51.89 ------- ------- ------- -------- -------\nNET INCOME (LOSS) $ (.05) $ 8.77 $ 18.46 $ (46.55) $ (7.16) ======== ======= ======= ======== =========\nTOTAL ASSETS $19,840 $20,053 $34,296 $ 61,081 $ 63,315 ======= ======= ======= ======== ========\nLONG-TERM OBLIGATIONS: Notes Payable $19,127 $19,303 $32,126 $ 55,321 $ 55,627 ======= ======= ======= ======== ======== - -------------- (1) $1,000 original contribution per unit after giving effect to the allocation of net income (loss) to the general partner.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nLiquidity and Capital Resources\nThe Registrant's remaining real estate properties consist of two residential apartment complexes located in Utah and Texas, which are currently leased to tenants subject to leases of up to one year. The Registrant receives rental income from its properties and is responsible for operating expenses, administrative expenses, capital improvements and debt service payments. Both of the Registrant's remaining properties generated positive cash flow for the year ended December 31, 1995. As of March 1, 1996, ten of the twelve properties originally purchased by the Registrant were sold or otherwise disposed.\nThe Registrant uses working capital reserves provided from any undistributed cash flow from operations, refinancing proceeds and sales proceeds as its primary source of liquidity. For the long term, it is anticipated that cash from operations will remain the Registrant's primary source of liquidity. Cash distributions from operations remained suspended during 1995. In order to preserve working capital reserves required for future capital improvements to properties and potential debt modifications, it is not currently anticipated that the Registrant will make any distributions from operations in the foreseeable future.\nThe level of liquidity based upon cash and cash equivalents experienced a $34,000 decrease at December 31, 1995, as compared to December 31, 1994. The Registrant's $541,000 of cash provided by operating activities was offset by $318,000 of improvements to real estate (investing activities) and $257,000 of mortgage principal payments (financing activities). Additions to real estate consisted of exterior renovations at the Registrant's Oak Run Apartments property and parking lot improvements at the Registrant's Overlook Point Apartments property. The Managing General Partner is currently evaluating the capital improvement requirements of the Registrant's properties. All other increases (decreases) in certain assets and liabilities are the result of the timing of receipt and payment of various operating activities.\nWorking capital reserves are invested in a money market account or repurchase agreements secured by United States Treasury obligations. The Managing General Partner believes that, if market conditions remain relatively stable, cash flow from operations, when combined with working capital reserves, will be sufficient to fund required capital improvements and regular debt service payments in 1996 and the foreseeable future. The Registrant has substantial balloon payments due in 1999 and 2000 of approximately $7,869,000 and $6,745,000, respectively. Although the Managing General Partner anticipates that these mortgages can be replaced, if the mortgages are not extended or refinanced, or the properties are not sold, the properties could be lost through foreclosure.\nAs required by the terms of the settlement of the actions brought against, among others, DeForest Ventures I L.P. (\"DeForest I\") relating to the tender offer made by DeForest I in October 1994, (the \"First Tender Offer\") for units of limited partnership interest in the Registrant and certain affiliated partnerships, DeForest I commenced a second tender offer (the \"Second Tender Offer\") on June 2, 1995, for units of limited partnership interest in the\nRegistrant. Pursuant to the Second Tender Offer, DeForest I acquired an additional 3,667 units of the Registrant which, when added to the units acquired during the First Tender Offer, represented approximately 29% of the total number of outstanding units of the Registrant.\nAlso in connection with the settlement, an affiliate of the Managing General Partner has made available to the Registrant a credit line of up to $150,000 per property owned by the Registrant. At the present time, the Registrant has no outstanding amounts due under this line of credit. Based on present plans, management does not anticipate the need to borrow in the near future. Other than cash and cash equivalents the line of credit is the Registrant's only unused source of liquidity.\nOn January 19, 1996, the stockholders of NPI, the sole shareholder of NPI Equity II, sold to IFGP Corporation all of the issued and outstanding stock of NPI. In addition, an affiliate of Insignia purchased the limited partnership units held by DeForest I and certain of its affiliates. IFGP Corporation caused new officers and directors of NPI Equity II and the Managing General Partner. The Managing General Partner does not believe these transactions will have a significant effect on the Registrant's liquidity or results of operations. See \"Item 1 Business-Change in Control\".\nAt this time, it appears that the investment objective of capital growth will not be attained and that investors will not receive a return of all of their invested capital. The extent to which invested capital is returned to investors is dependent upon the performance of the Registrant's properties and the markets in which such properties are located and on the sales price of the remaining properties. In this regard, the remaining properties have been held longer than originally expected. The ability to hold and operate these properties is dependent on the Registrant's ability to obtain refinancing or debt modification as required.\nReal Estate Market\nThe business in which the Registrant is engaged is highly competitive, and the Registrant is not a significant factor in its industry. Each investment property is located in or near a major urban area and, accordingly, competes for rentals not only with similar properties in its immediate area but with hundreds of similar properties throughout the urban area. Such competition is primarily on the basis of location, rents, services and amenities. In addition, the Registrant competes with significant numbers of individuals and organizations (including similar partnerships, real estate investment trusts and financial institutions) with respect to the sale of improved real properties, primarily on the basis of the prices and terms of such transactions.\nResults of Operations\n1995 Compared to 1994\nOperating results declined by $736,000 for the year ended December 31, 1995, as compared to 1994. The decline in operating results is due to the $1,246,000 gain on the disposition of Plantation Ridge Apartments recognized in 1994.\nRevenues declined by $1,218,000 for the year ended December 31, 1995, as compared to 1994, due to the previously mentioned property disposition. With respect to the remaining properties, rental revenue increased by $366,000 due to an increase in rental rates, coupled with a slight increase in occupancy at both of the Registrant's remaining properties. In addition, interest income increased by $8,000 due to an increase in average working capital reserves available for investment and the effect of higher interest rates.\nExpenses decreased by $482,000 for the year ended December 31, 1995, as compared to 1994, due to the disposition of Plantation Ridge Apartments in February 1994. With respect to the remaining properties, expenses increased by $12,000, due to an increase in interest expenses of $62,000 and depreciation expense of $6,000, which was partially offset by a decrease in operating expenses of $56,000. Operating expenses decreased primarily due to a decrease in repairs at the Registrant's Oak Run Apartments property which was partially offset by exterior painting at the Registrant's Overlook Point Apartments property. Interest expense increased due to higher interest rates on the variable rate mortgage encumbering the Registrant's Oak Run Apartments property, which was partially offset by the modification of the Registrant's Overlook Apartments at a lower interest rate in February 1994. In addition, general and administrative expenses declined by $45,000 due to a reduction in asset management costs effective July 1, 1994.\n1994 Compared to 1993\nOperating results, before the $6,501,000 extraordinary gain on extinguishment of debt, improved by $5,670,000 for the year ended December 31, 1994, as compared to 1993. The improvement in operating results is primarily due to the disposition of the following properties with negative operating results: Dover Village Apartments in March 1993, Reflections Apartments in May 1993 and Northgreen Apartments in August 1993. The $1,246,000 gain on disposition of Plantation Ridge Apartments in February 1994 and the net loss on sale of properties during 1993, substantially contributed to the improvement in operations.\nRevenues declined by $4,972,000 for the year ended December 31, 1994, as compared to 1993, due to the previously mentioned property dispositions. With respect to the remaining properties, revenues increased by $317,000 due to an increase in rental income. Rental revenue increased due to increases in rental rates at Overlook Point and Oak Run Apartments, coupled with an increase in occupancy at Oak Run Apartments. Interest and other income remained constant.\nExpenses decreased by $10,642,000 for the year ended December 31, 1994, as compared to 1993, due to the disposition of the previously mentioned properties. With respect to the remaining properties, expenses declined by $2,239,000 as the decrease in interest expense of $2,602,000 and general and administrative expenses of $74,000 were only partially offset by increases in operating expenses of $418,000 and depreciation expense of $19,000.\nInterest expense declined primarily due to accrued contingent interest expense of $1,213,000 on the Registrant's Overlook Point Apartments and $688,000 of discount amortization written off on the Registrant's Oak Run Apartments as a result of modifications of the note payable in the prior comparative period. This was compounded by a reduced principal balance at the Registrant's\nrefinanced Oak Run Apartments, the modification of the Overlook Point Apartments at a lower interest rate and the satisfaction of the note payable to an affiliate of the general partner. The decrease in general and administrative expenses is primarily attributable to a reduction in asset management fees effective July 1994, which was only partially offset by costs associated with the management transition. The increase in operating expenses for the remaining properties is primarily due to increased spending on deferred maintenance at both of the Registrant's remaining properties. Depreciation expense increased due to the effect of fixed asset additions, primarily at the Registrant's Oak Run Apartment complex.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nCENTURY PROPERTIES FUND XVIII (A Limited Partnership)\nFINANCIAL STATEMENTS\nYEAR ENDED DECEMBER 31, 1995\nINDEX\nTo the Partners Century Properties Fund XVIII Atlanta, Georgia\nIndependent Auditors' Report\nWe have audited the accompanying balance sheets of Century Properties Fund XVIII (a limited partnership) (the \"Partnership\") as of December 31, 1995 and 1994, and the related statements of operations, partners' equity and cash flows for the years then ended. Our audits also included the additional information supplied pursuant to Item 14(a)(2). 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 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 Century Properties Fund XVIII as of December 31, 1995 and 1994, and the results of its operations and its cash flows for the year 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.\nImowitz Koenig & Co., LLP\nCertified Public Accountants New York, N.Y. January 22, 1996\nINDEPENDENT AUDITORS' REPORT\nCentury Properties Fund XVIII:\nWe have audited the accompanying consolidated statements of operations, partners' equity and cash flows of Century Properties Fund XVIII (a limited partnership) (the \"Partnership\") and its wholly-owned subsidiaries for the year 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 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 the Partnership and its wholly-owned subsidiaries for the year ended December 31, 1993 in conformity with generally accepted accounting principles.\nDELOITTE & TOUCHE LLP\nSan Francisco, California March 18, 1994\nCENTURY PROPERTIES FUND XVIII (A Limited Partnership)\nBALANCE SHEETS\nSee notes to financial statements.\nCENTURY PROPERTIES FUND XVIII (A Limited Partnership)\nSTATEMENTS OF OPERATIONS\nSee notes to financial statements.\nCENTURY PROPERTIES FUND XVIII (A Limited Partnership)\nSTATEMENTS OF PARTNERS' EQUITY (DEFICIT)\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSee notes to financial statements.\nCENTURY PROPERTIES FUND XVIII (A Limited Partnership)\nSTATEMENTS OF CASH FLOWS\nSee notes to financial statements.\nCENTURY PROPERTIES FUND XVIII (A Limited Partnership)\nNOTES TO FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nOrganization\nCentury Properties Fund XVIII (the \"Partnership\") is a limited partnership organized under the laws of the State of California to acquire, hold for investment, and ultimately sell income-producing real property. The Partnership currently owns two residential complexes located in Utah and Texas. The general partner of the Partnership is Fox Partners, a California general partnership, whose general partners are Fox Capital Management Corporation (\"FCMC\"), a California corporation, Fox Realty Investors (\"FRI\"), a California general partnership and Fox Partners 82, a California general partnership. The original capital contributions of $75,000,000 ($1,000 per unit) were made by the limited partners, including 100 limited partnership units purchased by FCMC.\nOn December 6, 1993, the shareholders of FCMC entered into a Voting Trust Agreement with NPI Equity Investments II, Inc. (\"NPI Equity\" or the \"Managing General Partner\") pursuant to which NPI Equity was granted the right to vote 100 percent of the outstanding stock of FCMC and NPI Equity became the managing general partner of FRI. As a result, NPI Equity became responsible for the operation and management of the business and affairs of the Partnership and the other investment partnerships originally sponsored by FCMC and\/or FRI. NPI Equity is a wholly-owned subsidiary of National Property Investors, Inc. (\"NPI, Inc.\"). The shareholders of FCMC and the partners in FRI retain indirect economic interests in the Partnership and such other investment limited partnerships, but have ceased to be responsible for the operation and management of the Partnership and such other partnerships.\nIn October 1994 DeForest Ventures I L.P. (\"DeForest I\") made a tender offer for limited partnership interests in the partnership, as well as eleven affiliated limited partnerships. DeForest Ventures II, L.P. (\"DeForest II\") made tender offers for limited partnership interests in seven affiliated limited partnerships. Shareholders who controlled DeForest Capital I Corporation, the sole general partner of DeForest I, also controlled NPI, Inc. As of December 31, 1995, DeForest I had acquired approximately 29% of total limited partnership units of the Partnership (see Note 8).\nOn January 19, 1996, the stockholders of NPI, Inc. sold all of the issued and outstanding stock of NPI, Inc. to an affiliate of Insignia\nFinancial Group, Inc. (\"Insignia\"). In addition, an affiliate of Insignia acquired the limited partnership interests of the Partnership held by DeForest I and certain of its affiliates (see Note 8).\nCENTURY PROPERTIES FUND XVIII (A Limited Partnership)\nNOTES TO FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)\nUse of Estimates\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.\nFair Value of Financial Instruments\nIn 1995, the Partnership implemented Statement of Financial Accounting Standards (\"SFAS\") No. 107, \"Disclosures about Fair Value of Financial Instruments,\" as amended by SFAS No. 119, \"Disclosures about Derivative Financial Instruments and Fair Value of Financial Instruments,\" which requires disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate fair value. Fair value is defined in the SFAS 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 that the carrying amount of its financial instruments (except for long term debt) approximates fair value due to the short term maturity of these instruments. The fair value of the Partnership's long term debt, after discounting the scheduled loan payments to maturity, approximates its carrying balance.\nReal Estate\nReal estate is stated at cost. Acquisition fees are capitalized as a cost of real estate. In 1995, the Partnership adopted SFAS No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of \", which requires impairment losses to be recognized for long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows are not sufficient to recover the asset's carrying amount. The impairment loss is measured by comparing the fair value of the asset to its carrying amount. The adoption of the SFAS had no effect on the Partnership's financial statements.\nCash and Cash Equivalents\nThe Partnership considers all highly liquid investments with an original maturity of three months or less at the time of purchase to be cash equivalents.\nConcentration of Credit Risk\nThe Partnership maintains cash balances at institutions insured up to $100,000 by the Federal Deposit Insurance Corporation. Balances in excess of $100,000 are usually invested in United States Treasury repurchase agreements, which are collateralized by United States Treasury obligations. Cash balances exceeded these insured levels during the year.\nCENTURY PROPERTIES FUND XVIII (A Limited Partnership)\nNOTES TO FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)\nDepreciation\nDepreciation is computed by the straight-line method over estimated useful lives currently ranging from 27.5 to 30 years for buildings and improvements and six to seven years for furnishings.\nDeferred Financing Costs\nDeferred financing costs are amortized over the lives of the related loans, or expensed, if financing is not obtained. At December 31, 1995 and 1994, accumulated amortization of deferred financing costs totaled $262,000 and $205,000, respectively.\nNet Income (Loss) Per Limited Partnership Unit\nThe net income (loss) per limited partnership unit is computed by dividing net income (loss) allocated to the limited partners by 75,000 units outstanding.\nIncome Taxes\nTaxable income or loss of the Partnership is reported in the income tax returns of its partners. Accordingly, no provision for income taxes is made in the financial statements of the Partnership.\nReclassification\nCertain amounts from 1994 and 1993 have been reclassified to conform to the 1995 presentation.\n2. TRANSACTIONS WITH THE GENERAL PARTNER AND AFFILIATES\nIn accordance with the Partnership Agreement, the Partnership may be charged by the general partner and affiliates for services provided to the Partnership. From March 1988 to December 1992 such amounts were assigned pursuant to a services agreement by the general partner and affiliates to Metric Realty Services, L.P. (\"MRS\"), which performed partnership management and other services for the Partnership.\nOn January 1, 1993, Metric Management, Inc., (\"MMI\"), successor to MRS, a company which is not affiliated with the general partners, commenced providing certain property and portfolio management services to the Partnership under a new services agreement. As provided in the new services agreement, effective January 1, 1993, no reimbursements were made to the general partners and affiliates after December 31, 1992. Subsequent to December 31, 1992, reimbursements were made to MMI. On December 16, 1993, the services agreement with MMI was modified and, as a result thereof, NPI Equity began directly providing cash management and other Partnership services on various dates commencing December 23, 1993. On March 1, 1994, an affiliate of NPI Equity commenced providing certain property management services.\nCENTURY PROPERTIES FUND XVIII (A Limited Partnership)\nNOTES TO FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n2. TRANSACTIONS WITH THE GENERAL PARTNER AND AFFILIATES (Continued)\nRelated party expenses for the years ended December 31, 1995, 1994 and 1993 were as follows:\nProperty management fees are included in operating expenses. Reimbursed expenses are primarily included in general and administrative expenses. In addition, approximately $107,000 of insurance premiums which were paid to an affiliate of NPI Inc. under a master insurance policy arranged by such affiliate are included in operating expenses for the year ended December 31, 1995.\nIn accordance with the partnership agreement, the general partners received (1) a partnership management incentive equal to an allocation of nine percent of net and taxable income (loss) before gain on property dispositions and (2) a one percent continuing interest of net and taxable income (loss) before gain on property dispositions after the above allocation of the partnership management incentive. The general partners were also allocated ten percent of gain on property dispositions to the extent of its deficit capital account and cash available for distribution. Upon sale of all properties and termination of the Partnership, the general partners may be required to contribute certain funds to the Partnership in accordance with the partnership agreement.\n3. REAL ESTATE\nReal estate, at December 31, 1995 and 1994, is summarized as follows:\nCENTURY PROPERTIES FUND XVIII (A Limited Partnership)\nNOTES TO FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n4. NOTES PAYABLE\nIndividual rental properties are pledged as collateral for the related notes payable. Interest rates on the notes payable ranged from 8.25 to 9.00 percent during the year ended December 31, 1995. Principal payments at December 31, 1995 are required as follows:\n1996 $ 264,000 1997 271,000 1998 278,000 1999 8,064,000 2000 6,909,000 Thereafter 3,341,000 ------------ Total $ 19,127,000 ============\nThe Partnership modified its note payable on Overlook Point Apartments in February 1994. Principal of $7,166,000 plus contingent interest of $1,213,000 was outstanding on the original loan which was due August 1995. The Partnership paid down $129,000 of the accrued interest from its escrow accounts with the lender and secured a new loan for the balance of $8,250,000. The new loan requires monthly payments of $62,000 at 8.25% interest and is being amortized over 30 years. The loan matures in 1999 with a balloon payment of approximately $7,869,000.\nIn October 1993, the Partnership obtained replacement financing on the Oak Run Apartments' $4,358,000 wrap note equity portion which was due in October 1993, as well as on the two underlying first loans in the amount of $2,147,000 and $2,950,000 which were scheduled to mature in October 2009 and September 1994, respectively. The new loan, in the amount of $7,200,000 was used to pay off the two first loans, including prepayment premiums of $51,000 and refinancing costs of $333,000 (including a $70,000 interest rate cap cost). The new loan has a variable interest rate of 4.25 percent over 30-day LIBOR not to exceed 11 percent for the first four years of the new loan and is scheduled to mature in September 2000. The pay rate is nine percent for the first two years, 9.5 percent for years three through five and ten percent for years six and seven. Any difference between the contract interest rate and the pay rate will be applied to the outstanding principal balance. The remaining proceeds of approximately $1,719,000 were used to pay down a portion of the wrap note equity portion. The remaining balance of the wrap note equity portion of $4,127,000 will only be paid to the lender as a participation in future cash flow and sales proceeds from the property. The Partnership paid the participant approximately $116,000 and $75,000 during 1995 and 1994, respectively, which was treated as a reduction in principal.\nAmortization of deferred financing costs totaled $57,000, $78,000 and $121,000 for 1995, 1994 and 1993, respectively.\nCENTURY PROPERTIES FUND XVIII (A Limited Partnership)\nNOTES TO FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n5. NOTE PAYABLE TO AFFILIATES OF THE GENERAL PARTNER\nIn February 1994, the Partnership paid $608,000 of principal and $230,000 of accrued interest to an affiliate of the general partner. Interest charged on the note was $5,000 and $109,000 for the years ended December 31, 1994 and 1993, respectively.\n6. DISPOSITION OF RENTAL PROPERTIES\nIn February 1994, the Partnership sold Plantation Ridge Apartments, located in Marietta, Georgia for $15,353,000. The existing loans of $13,653,000 were assumed by the buyer at the time of sale. After assumption of the existing loans and costs of the sale of $210,000, proceeds to the Partnership were $1,490,000. At the date of sale, the carrying amount of real estate was $13,897,000. For financial statement purposes, the Partnership recorded a $1,246,000 gain on sale of property for the year ended December 31, 1994.\nIn March 1993, the Partnership sold Dover Village Apartments, located in Orlando, Florida for $9,300,000. After payment of the first and second loan balances of $5,674,000 and $2,490,000, respectively, and costs of sale of $358,000 (including $186,000 real estate commissions paid to an outside broker), the net proceeds to the Partnership were $778,000. In addition, accrued but unpaid interest of $707,000 on the second loan was forgiven by the lender and was recognized in 1993 as an extraordinary item-gain on debt forgiveness. At the date of sale, the carrying amount of land and improvements, net of the $961,000 provision for impairment of value recognized in 1992, was $9,302,000. The loss on sale of $360,000 was recognized at the time of sale.\nIn May 1993, the Partnership sold Reflections Apartments, located in Aurora, Colorado, for $7,924,000. After payment of the existing loan balance of $5,111,000 and costs of sale of $285,000 (including $238,000 of real estate commissions paid to outside brokers), net proceeds to the Partnership were $2,528,000. At the date of sale, the carrying amount of land and improvements, net of the $551,000 provision for impairment of value recognized in 1991, was $5,861,000. The gain on sale of $1,778,000 was recognized at the time of sale.\nIn August 1993, the Partnership sold Northgreen Apartments, located in Oklahoma City, Oklahoma, for $8,763,000. In addition, the Partnership received a $137,000 property tax reimbursement from the buyer. After payment of a portion of the existing loan of $8,750,000 and costs of sale of $51,000, the net proceeds to the Partnership were $99,000. Principal and accrued interest outstanding on the existing loan at the time of sale was $14,545,000, of which $5,794,000 was forgiven by the lender at the time of sale. At the date of sale, the carrying amount of land and improvements was $11,138,000. The loss on sale was $2,289,000 and $5,794,000 (consisting of $3,350,000 in principal and $2,444,000 in accrued interest) was recognized as an extraordinary item-gain on debt\nforgiveness in 1993.\nCENTURY PROPERTIES FUND XVIII (A Limited Partnership)\nNOTES TO FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n7. RECONCILIATION TO INCOME TAX METHOD OF ACCOUNTING\nThe differences between the accrual method of accounting for income tax reporting and the accrual method of accounting used in the financial statements are as follows:\nCENTURY PROPERTIES FUND XVIII (A Limited Partnership)\nNOTES TO FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n8. SUBSEQUENT EVENT\nOn January 19, 1996, the stockholders of NPI, Inc. sold all of the issued and outstanding stock of NPI, Inc. to an affiliate of Insignia. In addition, an affiliate of Insignia acquired the limited partnership interests of the Partnership held by DeForest I and certain of its affiliates (see Note 1). As a result of the transaction, the Managing General Partner of the Partnership is controlled by Insignia. Insignia affiliates now provide property and asset management services to the Partnership, maintain its books and records and oversee its operations.\nSCHEDULE III\nCENTURY PROPERTIES FUND XVIII (A Limited Partnership)\nREAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1995\nSee accompanying notes.\nSCHEDULE III\nCENTURY PROPERTIES FUND XVIII (A Limited Partnership)\nREAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1995\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures.\nEffective April 22, 1994, the Registrant dismissed its prior Independent Auditors, Deloitte & Touche, LLP (\"Deloitte\") and retained as its new Independent Auditors, Imowitz Koenig & Company, LLP. Deloitte's Independent Auditors' Report on the Registrant's financial statements for the calendar year ended December 31 1993 did not contain an adverse opinion or a disclaimer of opinion, and were not qualified or modified as to audit scope or accounting principles. The decision to change Independent Auditors was approved by the Managing General Partner's Directors. During calendar year ended 1993 and through April 22, 1994 there were no disagreements between the Registrant and Deloitte on any matter of accounting principles or practices, financial statement disclosure, or auditing scope of procedure which disagreements if not resolved to the satisfaction of Deloitte, would have caused it to make reference to the subject matter of the disagreements in connection with its reports.\nEffective April 22, 1994, the Registrant engaged Imowitz Koenig & Company, LLP as its Independent Auditors. The Registrant did not consult Imowitz Koenig & Company, LLP regarding any of the matters or events set forth in Item 304(a)(2)(i) and (ii) of Regulation S-K prior to April 22, 1994.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant.\nNeither the Registrant, nor Fox Partners (\"Fox\"), the general partner of the Registrant, has any officers or directors. Fox Capital Management Corporation (the \"Managing General Partner\"), the managing general partner of Fox, manages and controls substantially all of the Registrant's affairs and has general responsibility and ultimate authority in all matters affecting its business. NPI Equity Investments II, Inc., which controls the Managing General Partner, is a wholly-owned affiliate of National Property Investors, Inc., which in turn is owned by an affiliate of by Insignia (See \"Item 1, Business - Change in Control\"). Insignia is a full service real estate service organization performing property management, commercial and retail leasing, investor services, partnership administration, mortgage banking, and real estate investment banking services for various entities. Insignia commenced operations in December 1990 and is the largest manager of multifamily residential properties in the United States and is a significant manager of commercial property. It currently provides property and\/or asset management services for over 2,000 properties. Insignia's properties consist of approximately 300,000 units of multifamily residential housing and approximately 64 million square feet of commercial space.\nAs of March 1, 1996, the names and positions held by the officers and directors of the Managing General Partner are as follows:\nHas served as a Director and\/or\nOfficer of the Managing Name Positions Held General Partner since - ---- -------------- ----------------------- William H. Jarrard, Jr. President and Director January 1996\nRonald Uretta Vice President and January 1996 Treasurer\nJohn K. Lines, Esquire Vice President, January 1996 Secretary and Director\nThomas R. Shuler Director January 1996\nKelley M. Buechler Assistant Secretary January 1996\nWilliam H. Jarrard, Jr. age 49, has been President and a Director of the Managing General Partner since January 1996. Mr. Jarrard has been a Managing Director - Partnership Administration of Insignia since January 1991.\nRonald Uretta, age 40, has been Insignia's Chief Financial Officer and Treasurer since January 1992. Since September 1990, Mr. Uretta has also served as the Chief Financial Officer and Controller of Metropolitan Asset Group.\nJohn K. Lines, Esquire, age 36, has been a Director and Vice President and Secretary of the Managing General Partner since January 1996, Insignia's General Counsel since June 1994, and General Counsel and Secretary since July 1994. From May 1993 until June 1994, Mr. Lines was the Assistant General Counsel and Vice President of Ocwen Financial Corporation, West Palm Beach, Florida. From October 1991 until May 1993, Mr. Lines was a Senior Attorney with Banc One Corporation, Columbus, Ohio. From May 1984 until October 1991, Mr. Lines was an attorney with Squire Sanders & Dempsey, Columbus, Ohio.\nThomas R. Shuler, age 50, has been Managing Director - Residential Property Management of Insignia since March 1991 and Executive Managing Director of Insignia and President of Insignia Management Services since July 1994.\nKelley M. Buechler, age 38, has been Assistant Secretary of the Managing General Partner since January 1996 and Assistant Secretary of Insignia since 1991.\nNo family relationships exist among any of the officers or directors of the Managing General Partner.\nEach director and officer of the Managing General Partner will hold office until the next annual meeting of stockholders of the Managing General Partner and until his successor is elected and qualified.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe Registrant is not required to and did not pay any compensation to the officers or directors of the Managing General Partner. The Managing General Partner does not presently pay any compensation to any of its officers or directors. (See \"Item 13, Certain Relationships and Related Transactions.\")\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nThe Registrant is a limited partnership and has no officers or directors. The Managing General Partner has discretionary control over most of the decisions made by or for the Registrant in accordance with the terms of the Partnership Agreement. The Managing General Partner directly owns 100 limited partnership units in the Registrant.\nThe following table sets forth certain information regarding limited partnership units of the Registrant owned by each person who is known by the Registrant to own beneficially or exercise voting or dispositive control over more than 5% of the Registrant's limited partnership units, by each of the Managing General Partner's directors and by all directors and executive officers of the Managing General Partner as a group as of March 1, 1996.\nName and address of Amount and nature of Beneficial Owner Beneficial Ownership % of Class - ------------------- -------------------- ---------- Insignia NPI, L.L.C. (1) 21,513 29 All directors and executive officers as a group (5 persons) - - - ------------------\n(1) The business address for Insignia NPI, L.L.C. is One Insignia Financial Plaza, Greenville, South Carolina 29602.\nThere are no arrangements known to the Registrant, the operation of 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.\nIn accordance with the Partnership Agreement, the Registrant may be charged by the general partner and affiliates for services provided to the Registrant. From March 1988 to December 1992 such amounts were assigned pursuant to a services agreement by the general partner and affiliates to Metric Realty Services, L.P. (\"MRS\"), which performed partnership management and other services for the Registrant.\nOn January 1, 1993, Metric Management, Inc., (\"MMI\"), successor to MRS, a company which is not affiliated with the general partners, commenced providing certain property and portfolio management services to the Registrant under a new services agreement. As provided in the new services agreement, effective January 1, 1993, no reimbursements were made to the general partners and affiliates after December 31, 1992. Subsequent to December 31, 1992, reimbursements were made to MMI. On December 16, 1993, the services agreement with MMI was modified and, as a result thereof, NPI Equity II began directly providing cash management and other the Registrant services on various dates commencing December 23, 1993. On March 1, 1994, an affiliate of NPI Equity II commenced providing certain property management services. Related party expenses for the years ended December 31, 1995, 1994 and 1993 were as follows:\n1995 1994 1993 --------- --------- ---------\nProperty management fees $ 212,000 $ 177,000 $ - Reimbursement of operational expenses: Partnership accounting and investor services 162,000 173,000 - Professional services - 9,000 - --------- --------- ---------\nTotal $ 374,000 $ 364,000 $ - ========= ========= =========\nInterest expense $ - $ 5,000 $ 109,000 ========= ========= =========\nProperty management fees are included in operating expenses. Reimbursed expenses are primarily included in general and administrative expenses. In addition, approximately $107,000 of insurance premiums which were paid to an affiliate of NPI Inc. under a master insurance policy arranged by such affiliate are included in operating expenses for the year ended December 31, 1995.\nIn accordance with the partnership agreement, the general partners received (1) a partnership management incentive equal to an allocation of nine percent of net and taxable income (loss) before gain on property dispositions and (2) a one percent continuing interest of net and taxable income (loss) before gain on property dispositions after the above allocation of the Partnership management incentive. The general partners were also allocated ten percent of gain on property dispositions to the extent of its deficit capital account and cash available for distribution. Upon sale of all properties and termination of the Registrant, the general partners may be required to contribute certain funds to the Registrant in accordance with the partnership agreement.\nAs a result of its ownership of 21,513 limited partnership units, Insignia NPI L.L.C. (\"Insignia LLC\") could be in a position to significantly influence all voting decisions with respect to the Registrant. Under the Partnership Agreement, unitholders holding a majority of the Units are entitled to take action with respect to a variety of matters. When voting on matters, Insignia LLC would in all likelihood vote the Units it acquired in a manner favorable to the interest of the Managing General Partner because of its affiliation with the Managing General Partner. However, Insignia LLC has agreed for the benefit of non-tendering unitholders, that it will vote its Units: (i) against any proposal to increase the fees and other compensation payable by the Registrant to the Managing General Partner and any of its affiliates; and (ii) with respect to any proposal made by the Managing General Partner or any of its affiliates, in proportion to votes cast by other unitholders. Except for the foregoing, no other limitations are imposed on Insignia LLC's right to vote each Unit acquired.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.\n(a)(1)(2) Financial Statements and Financial Statement Schedules:\nSee \"Item 8\" of this Form 10-K for Financial Statements of the Registrant, Notes thereto, and Financial Statement Schedules. (A Table of Contents to Financial Statements and Financial Statement Schedules is included in \"Item 8\" and incorporated herein by reference.)\n(a)(3) Exhibits\n2.1 NPI, Inc. Stock Purchase Agreement, dated as of August 17, 1995, incorporated by reference to the Registrant's Current Report on Form 8-K dated August 17, 1995.\n2.2 Partnership Units Purchase Agreement dated as of August 17, 1995 incorporated by reference to Exhibit 2.1 to Form 8-K filed by Insignia Financial Group, Inc. (\"Insignia) with the Securities and Exchange Commission on September 1, 1995.\n2.3 Management Purchase Agreement dated as of August 17, 1995 incorporated by reference to Exhibit 2.2 to Form 8-K filed by Insignia with the Securities and Exchange Commission on September 1, 1995.\n2.4 Limited Liability Company Agreement of Riverside Drive L.L.C., dated as of August 17, 1995 incorporated by reference to Exhibit 2.4 to Form 8-K filed by Insignia with the Securities and Exchange Commission on September 1, 1995.\n2.5 Master Indemnity Agreement dated as of August 17, 1995 incorporated by reference to Exhibit 2.5 to Form 8-K filed by Insignia with the Securities and Exchange Commission on September 1, 1995.\n3.4 Agreement of Limited Partnership, incorporated by reference to Exhibit A to the Prospectus of the Registrant dated October 7, 1977 and thereafter supplemented, included in the Registrant's Registration Statement on Form S-11 (Reg. No. No. 2-58978).\n16. Letter dated April 27, 1994 from the Registrant's Former Independent Auditors incorporated by reference to the Registrant's Current Report on Form 8-K dated April 22, 1994.\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 this 28 day of March, 1996.\nCENTURY PROPERTIES FUND XVIII\nBy: Fox Partners Its General Partner\nBy: Fox Capital Management Corporation Its Managing General Partner\nBy: William H. Jarrard, Jr. William H. Jarrard, Jr. President\nPursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the date indicated.\nSignature\/Name Title Date - -------------- ----- ----\n\/s\/ William H. Jarrard, Jr. President and March 28, 1996 - --------------------------- William H. Jarrard, Jr. Director\n\/s\/ Ronald Uretta Principal Financial March 28, 1996 - ----------------- Ronald Uretta Officer and Principal Accounting Officer\n\/s\/ John K. Lines Director March 28, 1996 - ----------------- John K. Lines\nExhibit Index\nExhibit Page - ------- ---- 2.1 NPI, Inc. Stock Purchase Agreement (1)\n2.2 Partnership Units Purchase Agreement (2)\n2.3 Management Purchase Agreement (3)\n2.4 Limited Liability Company Agreement of (4) Riverside Drive L.L.C.\n2.5 Master Indemnity Agreement (5)\n3.4. Agreement of Limited Partnership (2)\n16 Letter from the Registrant's former Independent (3) Auditor dated April 27, 1994\n- ---------------\n(1) Incorporated by reference to Exhibit 2 to the Registrant's Current Report on Form 8-K dated August 17, 1995.\n(2) Incorporated by reference to Exhibit 2.1 to Form 8-K filed by Insignia Financial Group, Inc. with the Securities and Exchange Commission on September 1, 1995.\n(3) Incorporated by reference to Exhibit 2.2 to Form 8-K filed by Insignia Financial Group, Inc. with the Securities and Exchange Commission on September 1, 1995.\n(4) Incorporated by reference to Exhibit 2.4 to Form 8-K filed by Insignia Financial Group, Inc. with the Securities and Exchange Commission on September 1, 1995.\n(5) Incorporated by reference to Exhibit 2.5 to Form 8-K filed by Insignia Financial Group, Inc. with the Securities and Exchange Commission on September 1, 1995.\n(6) Incorporated by reference to Exhibit A to the Prospectus of the Registrant dated November 5, 1982, as revised December 30, 1982, and thereafter supplemented contained in the Registrant's Registration Statement on Form S-11 (Reg. No. 2-78495)\n(7) Incorporated by reference to exhibit 10 to the Registrant's Current Report on Form 8-K dated April 22, 1994.","section_15":""}
{"filename":"351754_1995.txt","cik":"351754","year":"1995","section_1":"ITEM 1. BUSINESS\nCORPORATE STRUCTURE\nKEMPER INVESTORS LIFE INSURANCE COMPANY (\"KILICO\"), founded in 1947, is incorporated under the insurance laws of Illinois. KILICO is licensed in the District of Columbia and all states except New York. KILICO is a wholly owned subsidiary of Kemper Corporation (\"Kemper\"), a nonoperating holding company.\nCORPORATE CONTROL EVENTS\nOn January 4, 1996, an investor group comprised of Zurich Insurance Company (\"Zurich\"), Insurance Partners, L.P. (\"IP\") and Insurance Partners Offshore (Bermuda), L.P. (together with IP, \"Insurance Partners\") acquired all of the issued and outstanding common stock of Kemper. As a result of the change in control, Zurich and Insurance Partners indirectly and directly own 80 percent and 20 percent, respectively, of Kemper and therefore KILICO.\nSTRATEGIC INITIATIVES\nDuring 1992 and 1993, in order to streamline management, control costs and improve profitability, the management, operations and strategic directions of KILICO were integrated with those of another Kemper subsidiary, Federal Kemper Life Assurance Company (\"FKLA\"). Headquartered in Long Grove, Illinois, FKLA markets term and interest-sensitive life insurance as well as certain annuity products through brokerage general agents and other independent distributors. The integration encompassed virtually all aspects of operations, distribution channels and product development and was designed to promote increased efficiencies and productivity and to expand both companies' distribution capabilities. As described below, KILICO has emphasized different products and distribution methods.\nSince late 1991, KILICO intensified its management of real estate-related investments due to adverse market conditions. KILICO also successfully implemented strategies over the last several years to reduce both its joint venture operating losses and the level of its real estate-related investments. These strategies included individual property sales, cash sales of real estate-related investments amounting to $646.0 million since 1991 to affiliated non-life realty companies, refinancings and restructurings as well as bulk sale transactions completed in December 1995 in anticipation of the 1996 change in control. As a result of these strategies, KILICO reduced its holdings of real estate-related investments from 36.2 percent of its total invested assets and cash at year-end 1991 to 6.3 percent at year-end 1995.\nFurther addressing the quality of its investment portfolio, KILICO reduced its holdings of below investment-grade securities (excluding real estate-related investments) from 20.0 percent of its total invested assets and cash at year-end 1990 to 1.8 percent at year-end 1995.\nSince 1991, KILICO has also received $342.5 million in capital contributions from Kemper. KILICO also ceded approximately $932 million of fixed-rate annuity liabilities in reinsurance transactions in 1991 and 1992.\nNARRATIVE DESCRIPTION OF BUSINESS\nKILICO offers both individual fixed-rate (general account) and individual and group variable (separate account) annuity contracts, as well as individual universal life and variable life insurance products through various distribution channels. KILICO's broad product selection is designed for diverse economic environments. KILICO structures its products to offer investment-oriented products, guaranteed returns or a combination of both to help policyholders meet multiple insurance and financial objectives. Financial institutions, securities brokerage firms, insurance agents and financial planners are important distribution channels for KILICO's products. In 1995, INVEST Financial Corporation, an affiliated company, and EVEREN Securities, Inc., (\"EVEREN\"), an affiliated company until September 13, 1995, accounted for approximately 37 percent and 21 percent, respectively, of KILICO's first-year sales, compared with 36 percent and 20 percent, respectively, in 1994. KILICO's sales mainly consist of deposits received on certain long duration annuity contracts. (See the table captioned \"Sales\" on page 8.)\nAnnuities accounted for approximately 99 percent of KILICO's sales in recent years. KILICO's annuities generally have surrender charges that are a specified percentage of policy values and decline as the policy ages. General account annuity and interest-sensitive life policies are guaranteed to accumulate at specified interest rates but allow for periodic crediting rate changes.\nOver the last several years, in part reflecting the current interest rate environment, and to reduce its exposure to investment risk, KILICO's strategy has been to place more emphasis on marketing its separate account products. Unlike the fixed-rate annuity business where KILICO manages spread revenue, variable annuities pose minimal investment risk for KILICO, as policyholders invest in one or more of several underlying investment funds. KILICO in turn receives administrative fee revenue. KILICO's separate account assets totaled $1.76 billion at December 31, 1995 and $1.50 billion at December 31, 1994 and 1993. KILICO's sales of its separate account annuities were $151.3 million in 1995, $250.7 million in 1994 and $263.7 million in 1993. Despite KILICO's strategy to emphasize the sale of variable annuities, such sales have declined in each of the last two years due to competitive conditions in certain distribution channels, in part reflecting KILICO's financial strength and performance ratings and uncertainty concerning KILICO's ownership. Rating improvements in 1996 (see \"Rankings and ratings\" on page 4) and the 1996 change in control are expected to increase KILICO's future sales.\nIn order to increase variable annuity sales, KILICO introduced Kemper PASSPORT in 1992. Kemper PASSPORT is a variable and market value adjusted annuity featuring a choice of investment portfolios, an increasing estate benefit, tax- free transfers and guaranteed rates for a variety of terms. In 1994, KILICO changed Kemper PASSPORT from a single premium annuity to one with a flexible premium structure and also added a small capitalization equity subaccount as another investment portfolio option. In 1995, KILICO also added seven new subaccounts as investment portfolio choices for certain purchasers of the Kemper Advantage III variable annuity product.\nReductions in crediting rates and investment portfolio issues have also lowered general account annuity sales for KILICO over the last several years. Beginning in the second half of 1994 and in early 1995, KILICO began raising crediting rates on certain of its existing and new general account products, reflecting both competitive conditions and a rising interest rate environment during 1994 and early 1995. As a result of these actions, sales of general account annuities increased and represented 62.0 percent of KILICO's total sales in 1995, compared with 46.0 percent in 1994, and 47.9 percent in 1993.\nNAIC RATIOS\nThe National Association of Insurance Commissioners (the \"NAIC\") annually calculates certain statutory financial ratios for most insurance companies in the United States. These calculations are known as the Insurance Regulatory Information System (\"IRIS\") ratios. There presently are twelve IRIS ratios. The primary purpose of the ratios is to provide an \"early warning\" of any negative developments. The NAIC reports the ratios to state regulators who may then contact the companies if three or more ratios fall outside the NAIC's \"usual ranges\".\nBased on statutory financial data as of December 31, 1995, KILICO had three ratios outside the usual ranges. KILICO's net income to total income was adversely affected by realized investment losses, primarily from dispositions of real estate-related investments. (See the discussion captioned \"INVESTMENTS\" beginning on page 9.) KILICO's change in premium and change in reserving ratios reflected declines in variable annuity sales and interest-sensitive life sales, respectively. Other than certain states requesting quarterly financial reporting and\/or explanations of the underlying causes for certain ratios, no state regulators have taken any action due to KILICO's IRIS ratios for 1995 or earlier years.\nGUARANTY ASSOCIATION ASSESSMENTS\nFrom time to time, mandatory assessments are levied on KILICO by life and health guaranty associations of most states in which KILICO is licensed to cover losses to policyholders of insolvent or rehabilitated insurance companies. These associations levy assessments (up to prescribed limits) on all member insurers in a particular state in order to pay claims on the basis of the proportionate share of premiums written by member insurers in the lines of business in which the insolvent or rehabilitated insurer engaged. These assessments may be deferred or forgiven in certain states if they would threaten an insurer's financial strength, and, in some states, these assessments can be partially recovered through a reduction in future premium taxes.\nIn the early 1990s, there were a number of failures of life insurance companies. KILICO's financial statements include provisions for all known assessments that will be levied against KILICO by various state guaranty associations as well as an estimate of amounts (net of estimated future premium tax recoveries) that KILICO believes will be assessed in the future for failures which have occurred to date and for which the life insurance industry has estimated the cost to cover losses to policyholders. Assessments levied against KILICO and charged to expense in 1995, 1994 and 1993 amounted to $5.8 million, $0.0 million and $5.8 million, respectively. Such amounts relate to accrued guaranty fund assessments of $5.0 million, $4.0 million and $8.9 million at December 31, 1995, 1994 and 1993, respectively. No assessments were charged to expense during 1994 as KILICO had established adequate accruals for all known insolvencies where an estimate of the cost to cover losses to policyholders was available as of December 31, 1994. Additional assessments\ncharged to expense in 1995 reflect accruals for the life insurance industry's revised loss estimates for certain insolvent insurance companies.\nRISK-BASED CAPITAL\nSince the early 1990s, reflecting a recessionary environment and the insolvencies of a few large life insurance companies, both state and federal legislators have increased scrutiny of the existing insurance regulatory framework. While various initiatives, such as a new model investment law, are being considered for future implementation by the NAIC, it is not presently possible to predict the future impact of potential regulatory changes on KILICO.\nUnder asset adequacy and risk-based capital rules adopted in 1993 in Illinois (the domiciliary state of KILICO), state regulators may mandate remedial action for inadequately reserved or inadequately capitalized companies. The new asset adequacy rules are designed to assure that reserves and assets are adequate to cover liabilities under a variety of economic scenarios. The focus of the new capital rules is a risk-based formula that applies prescribed factors to various risk elements in an insurer's business and investments to develop a minimum capital requirement designed to be proportional to the amount of risk assumed by the insurer. KILICO has capital levels substantially exceeding any which would mandate action under the risk-based capital rules and is in compliance with applicable asset adequacy rules.\nRESERVES AND REINSURANCE\nThe following table provides a breakdown of KILICO's reserves for future policy benefits by product type at December 31, 1995, 1994 and 1993 (in millions):\nCeded future policy benefits shown above reflect coinsurance (indemnity reinsurance) transactions in which KILICO reinsured liabilities of approximately $516 million in 1992 and $416 million in 1991 with Fidelity Life Association (\"FLA\"), an affiliated mutual insurance company. FLA shares management, operations and employees with FKLA and KILICO pursuant to an administrative and management services agreement. FLA produces whole life policies not produced by FKLA or KILICO as well as other policies similar to certain FKLA policies. At December 31, 1995, KILICO's reinsurance recoverable from FLA related to these coinsurance transactions totaled approximately $502.8 million. KILICO remains primarily liable to its policyholders for this amount. Utilizing FKLA's employees, KILICO is the servicing company for this coinsured business and is reimbursed by FLA for the related servicing expenses. Excluding this coinsurance, KILICO, because it is primarily an annuity company, reinsures only a very limited portion of its business. KILICO has immaterial exposure to mortality losses. (See the note captioned \"Reinsurance\" in the notes to the consolidated financial statements.)\nCOMPETITION\nKILICO is in a highly competitive business and competes with a large number of other stock and mutual life insurance companies, many of which are larger financially, although none is truly dominant in the industry. KILICO, with its emphasis on annuity products, also competes for savings dollars with securities brokerage and investment advisory firms as well as other institutions that manage assets, produce financial products or market other types of investment products.\nKILICO's principal methods of competition continue to be innovative products, often designed for selected distribution channels and economic conditions, as well as appropriate product pricing, careful underwriting, expense control and the quality of services provided to policyholders and agents. Certain of KILICO's financial strength ratings and claims-paying\/performance ratings, however, were lower in 1993, 1994 and 1995 than in earlier years, and they were under review in 1994 and 1995 due to uncertainty with respect to Kemper's and KILICO's ownership. These ratings impacted sales efforts in certain markets; however, increases in KILICO's financial strength ratings and claims-paying\/performance ratings in January 1996 should favorably impact future sales.\nTo address its competition, KILICO has adopted certain business strategies. These include systematic reductions of investment risk and strengthening of its capital position; continued focus on existing and new variable annuity products; distribution through diversified channels; and ongoing efforts to continue as a low-cost provider of insurance products and high-quality services to agents and policyholders through the use of technology.\nRANKINGS AND RATINGS\nAccording to BEST'S AGENTS GUIDE TO LIFE INSURANCE COMPANIES, 1995, as of December 31, 1994, KILICO ranked 61 of 1,315 life insurers by admitted assets; 440 of 1,137 by insurance in force; and 143 of 1,219 by net premiums written.\nFollowing the January 1996 change in control, certain of KILICO's financial strength ratings and claims-paying ability ratings were upgraded. KILICO's ratings are as follows:\nEMPLOYEES\nAt December 31, 1995, KILICO utilized the services of approximately 380 employees of FKLA which are also shared with FLA. On January 1, 1996, approximately 160 employees of Zurich Life Insurance Company of America (\"Zurich Life\"), an affiliated company, became employees of FKLA in connection with the integration of Zurich Life's operations with those of FKLA's. Beginning on January 5, 1996, KILICO, FKLA, FLA and Zurich Life operate under the trade name the Zurich Kemper Life Insurance Companies.\nREGULATION\nKILICO is generally subject to regulation and supervision by the insurance departments of Illinois and other jurisdictions in which KILICO is licensed to do business. These departments enforce laws and regulations designed to assure that insurance companies maintain adequate capital and surplus, manage investments according to prescribed character, standards and limitations and comply with a variety of operational standards. The departments also make periodic examinations of individual companies and review annual and other reports on the financial condition of each company operating within their respective jurisdictions. Regulations, which often vary from state to state, cover most aspects of the life insurance business, including market practices, forms of policies and accounting and financial reporting procedures.\nInsurance holding company laws enacted in many states grant additional powers to state insurance commissioners to regulate acquisition of and by domestic insurance companies, to require periodic disclosure of relevant information and to regulate certain transactions with related companies. These laws also impose prior approval requirements for certain transactions with affiliates and generally regulate dividend distributions by an insurance subsidiary to its holding company parent.\nIn addition, variable life insurance and annuities offered by KILICO, and the related separate accounts, are subject to regulation by the Securities and Exchange Commission (the \"SEC\").\nKILICO believes it is in compliance in all material respects with all applicable regulations. For information on regulatory and other dividend restrictions, see ITEM 5(c).\nINVESTMENTS\nChanging marketplace dynamics have affected the life insurance industry in recent years. To accommodate customers' increased preference for safety over higher yields, KILICO has systematically reduced its investment risk, as investments are an integral part of KILICO's business, and strengthened its capital position.\nKILICO's cash flow is carefully monitored and its investment program is regularly and systematically planned to provide funds to meet all obligations and to optimize investment return. Portfolio management is handled by an affiliated company, Zurich Kemper Investments, Inc. (\"ZKI\"), and its subsidiaries and affiliates, with KILICO's real estate-related investments being handled by a Kemper subsidiary. Investment policy is directed by KILICO's board of directors. KILICO's investment strategies take into account the nature of each annuity and life insurance product, the respective crediting rates and the estimated future policy benefit maturities. See \"INVESTMENTS\" in ITEM 7.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nKILICO primarily shares the office space leased by FKLA from Lumbermens Mutual Casualty Company, a former affiliate, (\"Lumbermens\"), 78,000 sq. ft. in Long Grove, Illinois. FKLA anticipates increasing its Long Grove office space by up to 43,000 sq. ft. in 1996. KILICO also has utilized 12,000 sq. ft. of office space presently leased by ZKI in Chicago, although virtually all of this space is expected to be eliminated by the end of 1996.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nKILICO has been named as defendant in certain lawsuits incidental to its insurance business. KILICO's management, based on the advice of legal counsel, believes that the resolution of these various lawsuits will not result in any material adverse effect on KILICO's consolidated financial position.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nDuring the fourth quarter of 1995, pursuant to a written consent of the sole shareholder of KILICO effective October 1, 1995, Jerome J. Cwiok was elected to serve as a member of the board of directors. The remaining directors whose terms continued after October 1, 1995 were John H. Fitzpatrick, David B. Mathis, John B. Scott and Stephen B. Timbers. Effective January 4, 1996, KILICO's board of directors changed reflecting the acquisition of Kemper and therefore KILICO by Zurich and Insurance Partners. See ITEM 10 below.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\n(a) There is no established public trading market for KILICO's common stock.\n(b) Kemper owns all of the common stock of KILICO as of the date of this filing.\n(c) KILICO has declared no cash dividends on its common stock in 1994, 1995 or 1996 through the date of filing of this Form 10-K.\nRESTRICTIONS ON DIVIDENDS\nDividend distributions from KILICO to its stockholder are restricted by state insurance laws. In Illinois, where KILICO is domiciled, if such dividend, together with other distributions during the 12 preceding months would exceed the greater of (a) ten percent of the insurer's statutory surplus as regards policyholders as of the preceding December 31, or (b) the statutorily adjusted net income for the preceding calendar year, then such proposed dividend must be reported to the director of insurance at least 30 days prior to the proposed payment date and may be paid only if not disapproved. The Illinois insurance laws also permit payment of dividends only out of earned surplus, exclusive of most unrealized capital gains.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following table sets forth selected financial information for KILICO for the five years ended December 31, 1995. Such information should be read in conjunction with KILICO's consolidated financial statements and notes thereto included in ITEM 8 of this Annual Report on Form 10-K. All amounts are shown in millions.\n- --------------- (1) Total revenue and net income (loss) for 1995 were adversely impacted by real estate-related investment losses. Such losses reflect a change in KILICO's strategy with respect to its real estate-related investments in connection with the January 4, 1996 acquisition of Kemper by the Zurich-led investor group. See \"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\nKILICO recorded a net loss of $133.0 million in 1995, compared with net income of $26.4 million in 1994 and $14.0 million in 1993. The net loss in 1995 was primarily due to an increase in the level of real estate-related realized investment losses. In connection with the Zurich-led investor group's acquisition of Kemper in early January 1996, KILICO's strategy with respect to its real estate-related investments changed dramatically as of year-end 1995. This change, as further discussed below, resulted in significant reductions in real estate-related investments and significant realized capital losses in the second half of 1995.\nThe improvement in 1994 net income, compared with 1993, was primarily the result of increases in spread income, an increase in fees and other income and a decrease in commissions, taxes, licenses and fees. These improvements in 1994 were partially offset by higher realized investment losses in 1994, compared with 1993.\nThe following table reflects the major components of realized investment results included in net income (loss). (See \"INVESTMENTS\" beginning on page 9, and the note captioned \"Invested Assets and Related Income\" in the notes to the consolidated financial statements.)\nREALIZED INVESTMENT RESULTS, AFTER TAX (in millions)\nReal estate-related losses increased in 1995, compared with 1994 and 1993, reflecting realized capital losses predominately from real estate-related bulk sale transactions in December 1995 and a higher level of write-downs on real estate-related investments. These sales and write-downs reflect Zurich's and Insurance Partners' strategies, now adopted by KILICO, with respect to the disposition of real estate-related investments. Other realized investment gains and losses for 1995, 1994 and 1993 relate primarily to the sale of fixed maturity investments. The fixed maturity losses generated in 1994 arose primarily from the sale of $330.7 million of fixed maturity investments, consisting of lower yielding investment-grade corporate securities and collateralized mortgage obligations, related to a repositioning of KILICO's fixed maturity investment portfolio in September 1994. The $306.9 million of proceeds from the repositioning, together with $275.0 million of cash and short-term investments, were reinvested into higher yielding U.S. government and agency guaranteed mortgage pass-through securities issued by the Government National Mortgage Association and the Federal National Mortgage Association. (See \"INVESTMENTS\" beginning on page 9.)\nOperating earnings (net income excluding realized investment results) improved to $74.2 million in 1995, compared with $61.9 million and $33.7 million in 1994 and 1993, respectively, primarily due to an increase in fees and other income, reductions in operating expenses and an increase in the net deferral of insurance acquisition costs, offset by an increase in commissions, taxes, licenses and fees. Operating earnings also improved in 1994, compared with 1993, as a result of improvements in spread income.\nKILICO improved spread income by increasing investment income in 1993 and 1994 and by also reducing crediting rates on certain existing blocks of fixed annuity and interest-sensitive life insurance products in 1993 and through most of 1994. Such reductions in crediting rates occurred as overall interest rates also declined. Operating earnings then began to improve as crediting rates declined at a faster rate than KILICO's investment income. Beginning in late 1994, however, as a result of rising interest rates and other competitive market factors, KILICO began to increase crediting rates on such interest-sensitive products which actions adversely impacted spread income. The recent declines in interest rates during the last three quarters of 1995, however, have mitigated at present competitive pressures to increase existing renewal crediting rates further.\nInvestment income was positively impacted in 1995, 1994 and 1993 from the benefits of capital contributions to KILICO and from reductions in the level of nonperforming real estate-related investments, primarily from the sales of certain real estate-related investments to affiliated non-life realty companies. These sales totaled $3.5 million in 1995, $154.0 million in 1994, $343.7 million in 1993 and $144.8 million in 1992 and resulted in no realized gain or loss to KILICO. Investment income in 1995 and 1994 also benefitted from the above-mentioned repositioning of KILICO's investment portfolio and\na $5.0 million pre-tax adjustment in 1994 related to the amortization of the discount or premium on mortgage-backed securities. Investment income for 1995, 1994 and 1993 has also been impacted by a shift over the last few years to higher-quality, lower yielding investments and foregone income on nonperforming investments.\nSALES (in millions)\nSales of annuity products consist of total deposits received. The increase in 1995 general account (fixed annuity) sales reflected KILICO's strategy to increase sales of fixed annuities. KILICO's longer-term strategy is to direct its sales efforts toward separate account (variable annuity) products, which increase administrative fees earned and pose minimal investment risk for KILICO as policyholders invest in one or more of several underlying investment funds. Despite this strategy, separate account sales declined in 1995 and 1994, compared with 1993, due to competitive conditions in certain distribution channels, in part reflecting KILICO's financial strength and performance ratings and uncertainty concerning KILICO's ownership. KILICO believes that the increase in its financial strength and performance ratings in January 1996 together with KILICO's association with Zurich, will assist in KILICO's future sales efforts.\nIncluded in fees and other income are administrative fees received from KILICO's separate account products of $21.9 million in 1995, compared with $20.8 million and $18.1 million in 1994 and 1993, respectively. Administrative fee revenue increased in each of the last three years due to growth in average separate account assets. Also included in other income in 1995 is a ceding commission experience adjustment which resulted in income of $4.4 million related to certain reinsurance transactions entered into by the Company during 1992. (See the note captioned \"Reinsurance\" in the notes to the consolidated financial statements.) Other income also included surrender charge revenue of $7.7 million in 1995, compared with $7.4 million and $6.3 million in 1994 and 1993, respectively, as total general account and separate account policyholder surrenders and withdrawals increased in each of the last three years.\nPOLICYHOLDER SURRENDERS AND WITHDRAWALS (in millions)\nPolicyholder withdrawals increased during each of the last three years due to planned reductions in fixed annuity crediting rates, a rising interest rate environment during the last half of 1994 and early 1995, uncertainty regarding KILICO's ownership until 1996 and KILICO's financial strength ratings and claims-paying\/performance ratings which were lower in 1993, 1994, and 1995 than in earlier years and in 1996. KILICO's crediting rate increases in late 1994 and in early 1995 were designed to reduce the level of future withdrawals. As a result of increases in renewal crediting rates and declining interest rates in the last three quarters of 1995, together with the benefits of the planned association with Zurich, policyholder surrenders and withdrawals for the last half of 1995 declined substantially from the level of surrenders and withdrawals in the first half of 1995. KILICO expects that the level of surrender and withdrawal activity experienced should remain relatively stable for 1996 as a result of projected stable interest rates, the majority ownership of KILICO by Zurich and the upgrades in KILICO's ratings in January 1996.\nCommissions, taxes, licenses and fees were higher in 1995, compared with 1994, primarily reflecting an increased level of guaranty fund assessments. Expenses for such assessments totaled $5.8 million, $0.0, and $5.8 million in 1995, 1994 and 1993, respectively. (See \"Guaranty association assessments\" in ITEM 1 on page 2.) Commissions, taxes, licenses and fees were lower in 1994, compared with 1993, primarily reflecting lower annuity sales and reduced guaranty fund assessments.\nThe higher level of deferral of policy acquisition costs in 1995, compared with 1994, reflected an increase in the amount of imputed interest capitalized due to improvements in projected future revenue streams primarily as a result of the decline in the level of nonperforming real estate-related investments. The amortization of policy acquisition costs was favorably impacted during 1995 due to real estate-related capital losses and in 1994 due to the repositioning of KILICO's investment portfolio. These repositionings in 1995 and 1994 favorably impacted the amortization of policy acquisition costs because they resulted in current realized investment losses as well as an increase in projected future net investment income, which together are expected to increase KILICO's projected future estimated gross profits in later years. Excluding the effects of the repositionings, the amortization of policy acquisition costs increased in both 1995 and 1994, compared with 1993, primarily as a result of improved net operating earnings during 1995 and 1994.\nOperating expenses in 1995, compared with 1994 and 1993, declined as a result of expense control efforts and the integration of the two life insurance subsidiaries' operations and management beginning in 1992. Operating expenses in 1995 declined by approximately 18 percent, compared with the 1994 level.\nSince year-end 1990, KILICO has taken many steps to improve its earnings, financial strength and competitive marketing position. These steps included adjustments in crediting rates, reductions of operating expenses, reductions of below investment-grade securities, a strategy not to embark on new real estate projects, additional provisions for real estate-related losses, sales of $646.0 million of certain real estate-related investments to affiliated non-life realty companies through December 31, 1995, third-party sales and refinancings of certain mortgage and other real estate loans, approximately $932 million in annuity reinsurance transactions with an affiliated mutual life insurance company, and capital contributions of $342.5 million through December 31, 1995.\nINVESTMENTS\nKILICO's principal investment strategy is to maintain a balanced, well-diversified portfolio supporting the insurance contracts written. KILICO makes shifts in its investment portfolio depending on, among other factors, the interest rate environment, liability durations and changes in market and business conditions. In addition, as previously discussed, KILICO's strategy with respect to its real estate-related investments changed dramatically by year-end 1995.\nINVESTED ASSETS AND CASH (in millions)\n- ---------------\n(1) National Association of Insurance Commissioners (\"NAIC\"). -- Class 1 = A- and above -- Class 2 = BBB- through BBB+ (2) Excludes $49.9 million, or 1.0 percent, at December 31, 1994 of bonds carried in other real estate-related investments. All such bonds were sold during 1995. (3) A joint venture mortgage loan is recharacterized in the current period as a third-party mortgage loan when KILICO and its affiliates have disposed of their related equity interest in that venture. (4) See the note captioned \"Financial Instruments--Off-Balance-Sheet Risk\" in the notes to the consolidated financial statements.\nFIXED MATURITIES\nKILICO is carrying its fixed maturity investment portfolio, which it considers available for sale, at estimated fair value, with the aggregate unrealized appreciation or depreciation being recorded as a separate component of stockholder's equity, net of any applicable income tax expense. The aggregate unrealized appreciation, net of tax, on fixed maturities at December 31, 1995 was $70.4 million, compared with unrealized depreciation of $243.6 million, at December 31, 1994. KILICO does not record a net deferred tax benefit for the aggregate unrealized depreciation on investments. Fair values are sensitive to movements in interest rates and other economic developments and can be expected to fluctuate, at times significantly, from period to period.\nAt December 31, 1995, investment-grade fixed maturities and cash and short-term investments accounted for 85.2 percent of KILICO's invested assets and cash, compared with 72.3 percent at December 31, 1994. Approximately 66 percent of KILICO's NAIC Class 1 bonds were rated AAA or equivalent at year-end 1995, compared with 70 percent at December 31, 1994.\nApproximately 45.7 percent of KILICO's investment-grade fixed maturities at December 31, 1995 were mortgage-backed securities, down from 49.2 percent at December 31, 1994. These investments consist primarily of marketable mortgage pass-through securities issued by the Government National Mortgage Association, the Federal National Mortgage Association or the Federal Home Loan Mortgage Corporation and other investment-grade securities collateralized by mortgage pass-through securities issued by these entities. KILICO has not made any investments in interest-only or other similarly volatile tranches of mortgage-backed securities. KILICO's mortgage-backed investments are generally of AAA credit quality, and the markets for these investments have been and are expected to remain liquid. KILICO plans to continue to reduce its holding of such investments over time.\nFuture investment income from mortgage-backed securities may be affected by the timing of principal payments and the yields on reinvestment alternatives available at the time of such payments. Due to the fact that KILICO's investments in mortgage-backed securities were predominately made since 1992, the current interest rate environment is not expected to cause any material extension of the average maturities of these investments. With the exception of many of KILICO's September 1994 purchases of such investments, most of these investments were purchased by KILICO at discounts. Prepayment activity on securities purchased at a discount is not expected to result in any material losses to KILICO because prepayments would generally accelerate the reporting of the discounts as investment income. Prepayment activity resulting from a decline in interest rates on such securities purchased at a premium would accelerate the amortization of the premiums which would result in reductions of investment income related to such securities. At December 31, 1995, KILICO had unamortized discounts and premiums of $17.0 million and $11.0 million, respectively, related to mortgage-backed securities. Given the credit quality, liquidity and anticipated payment characteristics of KILICO's investments in mortgage-backed securities, KILICO believes that the associated risk can be managed without material adverse consequences on its consolidated financial statements.\nBelow investment-grade securities holdings (NAIC classes 3 through 6), representing securities of 11 issuers at December 31, 1995, totaled 1.8 percent of cash and invested assets at December 31, 1995, compared with 2.8 percent at December 31, 1994. See the note captioned \"Invested Assets and Related Income\" in the notes to the consolidated financial statements. Below investment-grade securities are generally unsecured and often subordinated to other creditors of the issuers. These issuers may have relatively higher levels of indebtedness and be more sensitive to adverse economic conditions than investment-grade issuers. KILICO has significantly reduced its exposure to below investment-grade securities since 1990. This strategy takes into account the more conservative nature of today's consumer and the resulting demand for higher-quality investments in the life insurance and annuity marketplace.\nREAL ESTATE-RELATED INVESTMENTS\nThe $300 million real estate portfolio held by KILICO, consisting of joint venture and third-party mortgage loans and other real estate-related investments, constituted 6.3 percent of cash and invested assets at December 31, 1995, compared with $907 million, or 18.4 percent, at December 31, 1994. The decrease in real estate-related investments was primarily due to bulk sale transactions in December 1995, write-downs reflecting Kemper's and therefore KILICO's new owners' future plans for real estate-related investments and other sales during 1995.\nSUMMARY OF GROSS AND NET REAL ESTATE INVESTMENTS (in millions)\nAs reflected in the \"Real estate portfolio\" table on the following page, KILICO has continued to fund both existing projects and legal commitments. The future legal commitments were $248.2 million at December 31, 1995. This amount represented a net decrease of $127.9 million since December 31, 1994, primarily due to sales and fundings in 1995. As of December 31, 1995, KILICO expects to fund approximately $56.4 million of these legal commitments, along with providing capital to existing projects. The disparity between total legal commitments and the amount expected to be funded relates principally to standby financing arrangements that provide credit enhancements to certain tax-exempt bonds, which KILICO does not presently expect to fund. The total legal commitments, along with estimated working capital requirements, are considered in KILICO's evaluation of reserves and write-downs. (See the note captioned \"Financial Instruments--Off-Balance-Sheet Risk\" in the notes to the consolidated financial statements.)\nGenerally, at the inception of a real estate loan, KILICO anticipated that it would roll over the loan and reset the interest rate at least one time in the future, although KILICO is not legally committed to do so. As a result of the continued weakness in real estate markets and fairly restrictive lending practices by other lenders in this environment, KILICO expects that all or most loans maturing in 1996 will be rolled over, restructured or foreclosed if not earlier disposed of.\nExcluding the $0.5 million of real estate owned and $17.1 million of net equity investments in joint ventures, KILICO's real estate loans totaled $282.0 million at December 31, 1995, after reserves and write-downs. Of this amount, $278.5 million are on accrual status with a weighted average interest rate of approximately 8.2 percent. Of these accrual loans, 33.0 percent have terms requiring current periodic payments of their full contractual interest, 46.0 percent require only partial payments or payments to the extent of cash flow of the borrowers, and 21.0 percent defer all interest to maturity.\nThe equity investments in real estate at December 31, 1995 consisted of KILICO's other equity investments in joint ventures. These equity investments include KILICO's share of periodic operating results. KILICO, as an equity owner or affiliate thereof, has the ability to fund, and historically has elected to fund, operating requirements of certain joint ventures.\nREAL ESTATE PORTFOLIO (in millions)\n- --------------- (1) Net of $139.6 million reserve and write-downs. Excludes $29.8 million of real estate-related accrued interest.\n(2) KILICO's real estate-related bonds, all of which were rated below investment-grade, were generally unsecured and were issued to KILICO by real estate finance or development companies generally to provide financing for Kemper's or KILICO's joint ventures for various purposes. All such bonds were disposed of during 1995.\n(3) The other real estate loans were notes receivable evidencing financing, primarily to joint ventures, for purposes similar to those funded by real estate-related bonds.\n(4) Net of $33.2 million reserve and write-downs. Excludes $5.6 million of real estate-related accrued interest.\nREAL ESTATE CONCENTRATIONS\nKILICO's real estate portfolio is distributed by geographic location and property type. However, KILICO has concentration exposures in certain states and in certain types of properties. In addition to these exposures, KILICO also has exposures to certain real estate developers and partnerships. (See the notes captioned \"Unconsolidated Investors\" and \"Concentration of Credit Risk\" in the notes to the consolidated financial statements.)\nPROVISIONS FOR REAL ESTATE-RELATED LOSSES\nKILICO evaluates its real estate-related investments (including accrued interest) by estimating the probabilities of loss. (See the discussion of SFAS 114, \"Accounting by Creditors for Impairment of a Loan\" in the note captioned \"Summary of Significant Accounting Policies\" in the notes to the consolidated financial statements.) Because KILICO's real estate review process includes estimates, there can be no assurance that current estimates will prove accurate over time due to changing economic conditions and other factors.\nKILICO's real estate reserve was allocated as follows:\nREAL ESTATE RESERVE (in millions)\nThe substantial reductions in reserves and write-downs by year-end 1995 reflect the sales of real estate-related investments primarily in the fourth quarter of 1995.\nREAL ESTATE OUTLOOK\nKILICO's $300 million investment in real estate-related investments is expected to decline further through future sales. KILICO's net income could be materially reduced in future periods if real estate market conditions worsen in areas where KILICO's portfolio is located or if Kemper's and KILICO's plans with respect to certain projects change.\nThe following table is a summary of KILICO's troubled real estate-related investments:\nTROUBLED REAL ESTATE-RELATED INVESTMENTS (BEFORE RESERVES AND WRITE-DOWNS, EXCEPT FOR REAL ESTATE OWNED) (in millions)\n- --------------- (1) These are real estate-related investments where KILICO, based on known information, has serious doubts about the borrowers' abilities to comply with present repayment terms and which KILICO anticipates may go into nonaccrual, past due or restructured status. (2) Interest more than 90 days past due but not on nonaccrual status. (3) KILICO does not accrue interest on real estate-related investments when it judges that the likelihood of collection of interest is doubtful. (4) KILICO defines a \"restructuring\" of debt as an event whereby KILICO, for economic or legal reasons related to the debtor's financial difficulties, grants a concession to the debtor it would not otherwise consider. Such concessions either stem from an agreement between KILICO and the debtor or are imposed by law or a court. By this definition, restructured loans do not include any loan that, upon the expiration of its term, both repays its principal and pays interest then due from the proceeds of a new loan that KILICO, at its option, may extend (roll over).\nKILICO continues to devote significant attention to its real estate portfolio, enhancing monitoring of the portfolio and formulating specific action plans addressing nonperforming and potential problem loans. KILICO is continuing to analyze various potential transactions designed to further reduce both its joint venture operating losses and the amount of its real estate-related investments. Specific types of transactions under consideration (and previously utilized) include loan sales, property sales, mortgage refinancings and real estate investment trusts. However, there can be no assurance that such efforts will result in continued improvements in the performance of KILICO's real estate portfolio.\nNET INVESTMENT INCOME\nKILICO's pre-tax net investment income totaled $348.4 million in 1995, compared with $353.1 million in 1994 and $339.3 million in 1993. Included in pre-tax net investment income is KILICO's share of the operating losses from equity investments in real estate consisting of other income less depreciation, interest and other expenses. Such operating results exclude interest expense on loans by KILICO which are on nonaccrual status.\nKILICO's total foregone investment income before tax on both nonperforming fixed maturity investments and nonaccrual real estate-related investments was as follows:\nFOREGONE INVESTMENT INCOME (dollars in millions)\nForegone investment income from the nonaccrual of real estate-related investments is net of KILICO's share of interest expense on these loans excluded from KILICO's share of joint venture operating results. Based on the level of nonaccrual real estate-related investments at December 31, 1995, KILICO estimates foregone investment income in 1996 will decrease compared with the 1995 level. Any increase in nonperforming securities, and either worsening or stagnant real estate conditions, would increase the expected adverse effect on KILICO's future investment income and realized investment results.\nFuture net investment income, results of operations and cash flow will reflect KILICO's current levels of investments in investment-grade securities, real estate fundings treated as equity investments, nonaccrual real estate loans and joint venture operating losses. KILICO expects, however, that any adverse effects should be offset to some extent by certain advantages that it expects to realize over time from its other investment strategies, its product mix and its continuing cost-control measures. Other mitigating factors include marketing advantages that could result from KILICO having lower levels of investment risk, higher financial strength and claims-paying ability ratings and earnings improvements from KILICO's ability to adjust crediting rates on annuities and interest-sensitive life products over time.\nREALIZED INVESTMENT RESULTS\nReflected in net income are after-tax realized investment losses of $207.2 million, $35.5 million and $19.7 million for 1995, 1994 and 1993, respectively. (See the note captioned \"Invested Assets and Related Income\" in the notes to the consolidated financial statements.)\nUnrealized gains and losses on fixed maturity investments are not reflected in KILICO's net income. These changes in unrealized value are included within a separate component of stockholder's equity, net of any applicable income taxes. If and to the extent a fixed maturity investment suffers an other-than-temporary decline in value, however, such security is written down to net realizable value, and the write-down adversely impacts net income.\nKILICO regularly monitors its investment portfolio and as part of this process reviews its assets for possible impairments of carrying value. Because the review process includes estimates, there can be no assurance that current estimates will prove accurate over time due to changing economic conditions and other factors.\nA valuation allowance was established upon adoption of SFAS 109 \"Accounting for Income Taxes\" at January 1, 1993 (and is evaluated as of each reported period end) to reduce the deferred tax asset for investment losses to the amount that, based upon available evidence, is in management's judgment more likely than not to be realized. (See the note captioned \"Income Taxes\" in the notes to the consolidated financial statements.)\nINTEREST RATES\nIn 1994, rapidly rising short-term interest rates resulted in a much flatter yield curve as the Federal Reserve Board raised rates five times during the year and once during first-quarter 1995. Interest rates subsequently declined through the remainder of 1995.\nWhen maturing or sold investments are reinvested at lower yields in a low interest rate environment, KILICO can adjust its crediting rates on fixed annuities and other interest-bearing liabilities. However, competitive conditions and contractual commitments do not always permit the reduction in crediting rates to fully or immediately reflect reductions in investment yield, which can result in narrower spreads.\nThe rising interest rate environment in 1994 contributed to an increase in net investment income as well as to both realized and unrealized fixed maturity investment losses in 1994. Also, lower renewal crediting rates on annuities, compared with competitors' higher new money crediting rates influenced certain annuity holders to seek alternative products. KILICO mitigates this risk somewhat by charging surrender fees which decrease over time when annuity holders withdraw funds prior to maturity on certain annuity products. Approximately one-half of KILICO's fixed annuity liabilities as of December 31, 1995, however, were no longer subject to significant surrender fees.\nAs interest rates rose during 1994 and early 1995, KILICO's capital resources were adversely impacted by unrealized loss positions from its fixed maturity investments. As interest rates declined during the remainder of 1995, KILICO's capital resources were positively impacted by the elimination of the 1994 year-end unrealized loss position on its fixed maturity investments.\nLIQUIDITY AND CAPITAL RESOURCES\nKILICO carefully monitors cash and short-term investments to maintain adequate balances for timely payment of policyholder benefits, expenses, taxes and policyholder's account balances. In addition, regulatory authorities establish minimum liquidity and capital standards. The major ongoing sources of KILICO's liquidity are deposits for fixed annuities, investment income, other operating revenue and cash provided from maturing or sold investments. (See the Policyholder surrenders and withdrawals table and related discussion on page 8 and \"INVESTMENTS\" beginning on page 9.)\nRATINGS\nRatings are an important factor in establishing the competitive position of life insurance companies. Rating organizations continue to review the financial performance and condition of life insurers and their investment portfolios, including those of KILICO. Any reductions in KILICO's claims-paying ability or financial strength ratings could result in its products being less attractive to consumers. Any reductions in KILICO's parent's ratings could also adversely impact KILICO's financial flexibility.\nRatings reductions for Kemper or its subsidiaries and other financial events can also trigger obligations to fund certain real estate-related commitments to take out other lenders. In such events, those lenders can be expected to renegotiate their loan terms, although they are not contractually obligated to do so.\nEach rating is subject to revision or withdrawal at any time by the assigning organization and should be evaluated independently of any other rating. (See \"Ranking and ratings\" on page 4.)\nSTOCKHOLDER'S EQUITY\nStockholder's equity totaled $605.9 million at December 31, 1995, compared with $434.0 million and $654.6 million at December 31, 1994 and 1993, respectively. The 1995 increase in stockholder's equity was primarily due to a $304.9 million benefit related to the change in the unrealized gain position of KILICO's fixed maturity investment portfolio due to declining interest rates, offset by a net loss of $133.0 million. The 1994 decrease in stockholder's equity was primarily due to a $329.5 million unrealized loss related to the change in the unrealized loss position of KILICO's fixed maturity investment portfolio due to rising interest rates, offset by a capital contribution of $82.5 million and net income of $26.4 million.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nThe Board of Directors Kemper Investors Life Insurance Company:\nWe have audited the consolidated balance sheet of Kemper Investors Life Insurance Company and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations, stockholder's equity and cash flows for each of the years in the three-year period ended December 31, 1995. In connection with our audits of the consolidated financial statements, we also have audited the supplementary schedule as listed in the accompanying index. These consolidated financial statements and the supplementary schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and the supplementary 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 Kemper Investors Life Insurance Company and subsidiaries at December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1995, in conformity with generally accepted accounting principles. Also in our opinion, the related supplementary schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.\nAs discussed in the notes to the consolidated financial statements, effective January 1, 1994, the Company changed its method of accounting for investment securities to adopt the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards (\"SFAS\") 115, ACCOUNTING FOR CERTAIN INVESTMENTS IN DEBT AND EQUITY SECURITIES. Also, as discussed in the notes, effective January 1, 1993, the Company changed its method of accounting for impairment of loans receivable to adopt the provisions of SFAS 114, ACCOUNTING BY CREDITORS FOR IMPAIRMENT OF A LOAN, and changed its method of accounting for income taxes to adopt the provisions of SFAS 109, ACCOUNTING FOR INCOME TAXES.\nKPMG PEAT MARWICK LLP Chicago, Illinois March 15, 1996\nKEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEET (in thousands, except share data)\nSee accompanying notes to consolidated financial statements.\nKEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES\nCONSOLIDATED STATEMENT OF OPERATIONS (in thousands)\nSee accompanying notes to consolidated financial statements.\nKEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES\nCONSOLIDATED STATEMENT OF STOCKHOLDER'S EQUITY (in thousands)\nSee accompanying notes to consolidated financial statements.\nKEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS (in thousands)\nSee accompanying notes to consolidated financial statements.\nKEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBASIS OF PRESENTATION\nKemper Investors Life Insurance Company and subsidiaries (the \"Company\") issues fixed and variable annuity products and interest-sensitive life insurance products marketed primarily through a network of financial institutions, nonaffiliated and affiliated securities brokerage firms, insurance agents and financial planners. The Company is licensed in the District of Columbia and all states except New York. The Company is a wholly-owned subsidiary of Kemper Corporation (\"Kemper\"). On January 4, 1996, an investors group comprised of Zurich Insurance Company (\"Zurich\"), Insurance Partners, L.P. (\"IP\") and Insurance Partners Offshore (Bermuda), L.P. (together with IP, \"Insurance Partners\") acquired all of the issued and outstanding common stock of Kemper. As a result of the change in control, Zurich and Insurance Partners indirectly and directly own 80 percent and 20 percent, respectively, of Kemper and therefore the Company. The consolidated financial statements of the Company as of December 31, 1995 have been prepared on a historical cost basis and have not been adjusted to reflect the fair values of the Company's assets and liabilities as of the date of the acquisition by Zurich and Insurance Partners.\nThe consolidated financial statements have been prepared in accordance with generally accepted accounting principles. The statements include the accounts of the Company on a consolidated basis. All significant intercompany balances and transactions have been eliminated.\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that could affect the reported amounts of assets and liabilities as well as the disclosure of contingent assets or liabilities at the date of the financial statements. As a result, actual results reported as revenue and expenses could differ from the estimates reported in the accompanying financial statements. As further discussed in the accompanying notes to the consolidated financial statements, significant estimates and assumptions affect deferred insurance acquisition costs, provisions for real estate-related losses and reserves, other than temporary declines in values for fixed maturities, the valuation allowance for deferred income taxes and the calculation of fair value disclosures for certain financial instruments.\nLIFE INSURANCE REVENUE AND EXPENSES\nRevenue for annuities and interest-sensitive life insurance products consists of investment income, and policy charges such as mortality, expense and surrender charges. Expenses consist of benefits and interest credited to contracts, policy maintenance costs and amortization of deferred insurance acquisition costs. Also reflected in fees and other income is a ceding commission experience adjustment received in 1995 as a result of certain reinsurance transactions entered into by the Company during 1992. (See the note captioned \"Reinsurance\".)\nDEFERRED INSURANCE ACQUISITION COSTS\nThe costs of acquiring new business, principally commission expense and certain policy issuance and underwriting expenses, have been deferred to the extent they are recoverable from estimated future gross profits on the related contracts and policies. The deferred insurance acquisition costs for annuities, separate account business and interest-sensitive life insurance products are being amortized over the estimated contract life in relation to the present value of estimated gross profits. Beginning in 1994, deferred insurance acquisition costs reflect the estimated impact of unrealized gains or losses on fixed maturities held as available for sale in the investment portfolio, through a credit or charge to stockholder's equity, net of income tax.\nFUTURE POLICY BENEFITS\nLiabilities for future policy benefits related to annuities and interest-sensitive life contracts reflect net premiums received plus interest credited during the contract accumulation period and the present value of future payments for contracts that have annuitized. Current interest rates credited during the contract accumulation period range from 4 percent to 8.35 percent. Future minimum guaranteed interest rates vary from 4 percent to 8.35 percent for periods ranging from a portion of 1996 up to a portion of 1998 and are generally 3 percent to 4.5 percent thereafter. For contracts that have annuitized, interest rates used in determining the present value of future payments range principally from 3 percent to 11.25 percent.\nKEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)\nINVESTED ASSETS AND RELATED INCOME\nInvestments in fixed maturities are carried at fair value. Short-term investments are carried at cost, which approximates fair value. (See the note captioned \"Fair Value of Financial Instruments\".)\nMortgage loans are carried at their unpaid balance net of unamortized discount and any applicable reserves or write-downs. Other real estate-related investments net of any applicable reserve and write-downs include certain bonds issued by real estate finance or development companies; notes receivable from real estate ventures; investments in real estate ventures carried at cost, adjusted for the equity in the operating income or loss of such ventures; and real estate owned carried primarily at fair value.\nReal estate reserves are established when declines in collateral values, estimated in light of current economic conditions and calculated in conformity with Statement of Financial Accounting Standards (\"SFAS\") 114, ACCOUNTING BY CREDITORS FOR IMPAIRMENT OF A LOAN, indicate a likelihood of loss. Prior to year-end 1995, the Company evaluated its real estate-related assets (including accrued interest) by estimating the probabilities of loss utilizing various projections that included several factors relating to the borrower, property, term of the loan, tenant composition, rental rates, other supply and demand factors and overall economic conditions. Generally, at that time, the reserve was based upon the excess of the loan amount over the estimated future cash flows from the loan discounted at the loan's contractual rate of interest taking into consideration the effects of recourse to, and subordination of loans held by, affiliated non-life realty companies. At year-end 1995, reflecting the Company's change in strategy with respect to its real estate portfolio, and the disposition thereof, real estate-related investments were valued using an estimate of the investments observable market price, net of estimated costs to sell.\nSFAS 114 defines \"impaired loans\" as loans in which it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. In the fourth quarter of 1994, the Company adopted SFAS 118, ACCOUNTING BY CREDITORS FOR IMPAIRMENT OF A LOAN--INCOME RECOGNITION AND DISCLOSURES. SFAS 118 amends SFAS 114, providing clarification of income recognition issues and requiring additional disclosures relating to impaired loans. The adoption of SFAS 118 had no effect on the Company's financial position or results of operations at or for the year ended December 31, 1994.\nRealized gains or losses on sales of investments, determined on the basis of identifiable cost on the disposition of the respective investment, recognition of other-than-temporary declines in value and changes in real estate-related reserves and write-downs are included in revenue. Unrealized gains or losses on revaluation of investments are credited or charged to stockholder's equity. Such unrealized gains are recorded net of deferred income tax expense, while unrealized losses are not tax benefitted.\nThe amortized cost of fixed maturities is adjusted for amortization of premiums and accretion of discounts to maturity, or in the case of mortgage-backed securities, over the estimated life of the security. Such amortization is included in net interest income. Amortization of the discount or premium from mortgage-backed securities is recognized using a level effective yield method which considers the estimated timing and amount of prepayments of the underlying mortgage loans and is adjusted to reflect differences which arise between the prepayments originally anticipated and the actual prepayments received and currently anticipated. To the extent that the estimated lives of mortgage-backed securities change as a result of changes in prepayment rates, the adjustment is also included in net investment income. The Company does not accrue interest income on fixed maturities deemed to be impaired on an other-than-temporary basis, or on mortgage loans, real estate-related bonds and other real estate loans where the likelihood of collection of interest is doubtful.\nPolicy loans are carried at their unpaid balance. Other invested assets consist primarily of venture capital investments and a leveraged lease and are carried at cost. Other invested assets also included equity securities which are carried at fair value.\nSEPARATE ACCOUNT BUSINESS\nThe assets and liabilities of the separate accounts represent segregated funds administered and invested by the Company for purposes of funding variable annuity and variable life insurance contracts for the exclusive benefit of variable annuity and variable life insurance contract holders. The Company receives administrative fees from the separate account and\nKEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) retains varying amounts of withdrawal charges to cover expenses in the event of early withdrawals by contract holders. The assets and liabilities of the separate accounts are carried at fair value.\nINCOME TAX\nThe operations of the Company have been included in the consolidated Federal income tax return of Kemper. Income taxes receivable or payable have been determined on a separate return basis, and payments have been received from or remitted to Kemper pursuant to a tax allocation arrangement between Kemper and its subsidiaries, including the Company. The Company generally had received a tax benefit for losses to the extent such losses can be utilized in Kemper's Federal consolidated tax return.\nUnder SFAS 109, ACCOUNTING FOR INCOME TAXES, deferred taxes are provided on the temporary differences between the tax and financial statement basis of assets and liabilities.\n(2) CASH FLOW INFORMATION\nThe Company defines cash as cash in banks and money market accounts. Federal income tax paid to (refunded by) Kemper under the tax allocation arrangement for the years ended December 31, 1995, 1994 and 1993 amounted to $(25.2 million), $(10.7 million) and $4.2 million, respectively.\nNot reflected in the statement of cash flows are rollovers of mortgage loans, other loans and investments totaling approximately $57.0 million and $146.0 million in 1994 and 1993, respectively.\nThe Company also transferred its equity ownership interests in two limited partnerships during 1994 and 1993. (See the note captioned \"Related-Party Transactions\".)\n(3) INVESTED ASSETS AND RELATED INCOME\nThe Company is carrying its fixed maturity investment portfolio at estimated fair value as fixed maturities are considered available for sale, depending upon certain economic and business conditions. The carrying value (estimated fair value) of fixed maturities compared with amortized cost, adjusted for other-than-temporary declines in value, at December 31, 1995 and 1994, were as follows:\nUpon default or indication of potential default by an issuer of fixed maturity securities, the Company-owned issue(s) of such issuer would be placed on nonaccrual status and, since declines in fair value would no longer be considered by the\nKEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(3) INVESTED ASSETS AND RELATED INCOME (CONTINUED) Company to be temporary, would be analyzed for possible write-down. Any such issue would be written down to its net realizable value during the fiscal quarter in which the impairment was determined to have become other than temporary. Thereafter, each issue on nonaccrual status is regularly reviewed, and additional write-downs may be taken in light of later developments.\nThe Company's computation of net realizable value involves judgments and estimates, so such value should be used with care. Such value determination considers such factors as the existence and value of any collateral security; the capital structure of the issuer; the level of actual and expected market interest rates; where the issue ranks in comparison with other debt of the issuer; the economic and competitive environment of the issuer and its business; the Company's view on the likelihood of success of any proposed issuer restructuring plan; and the timing, type and amount of any restructured securities that the Company anticipates it will receive.\nThe Company's $300 million real estate portfolio consists of joint venture and third-party mortgage loans and other real estate-related investments.\nAt December 31, 1995 and 1994, total impaired loans amounted to $21.9 million and $75.9 million, respectively. Impaired loans with reserves were $21.9 million and $67.6 million with corresponding reserves of $6.5 million and $18.8 million at December 31, 1995 and 1994, respectively. The Company had an average balance of $124.2 million and $93.9 million in impaired loans for 1995 and 1994, respectively. Cash payments received on impaired loans are generally applied to reduce the outstanding loan balance. At December 31, 1995 and 1994, loans on nonaccrual status amounted to $3.5 million and $274.6 million, respectively. Impaired loans are generally included in the Company's nonaccrual loans.\nAt December 31, 1995, securities carried at approximately $5.9 million were on deposit with governmental agencies as required by law.\nProceeds from sales of investments in fixed maturities prior to maturity were $297.6 million, $910.9 billion and $1.7 billion during 1995, 1994 and 1993, respectively. Gross gains of $21.2 million, $6.0 million and $80.4 million and gross losses of $4.7 million, $55.9 million and $37.8 million were realized on sales of fixed maturities in 1995, 1994 and 1993, respectively.\nThe following table sets forth the maturity aging schedule of fixed maturity investments at December 31, 1995:\n- --------------- (1) Weighted average maturity of 5.4 years.\nThe sources of net investment income were as follows:\nKEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(3) INVESTED ASSETS AND RELATED INCOME (CONTINUED) Realized gains (losses) for the years ended December 31, 1995, 1994 and 1993, were as follows:\nUnrealized gains (losses) are computed below as follows: fixed maturities--the difference between fair value and amortized cost, adjusted for other-than-temporary declines in value; equity securities and other--the difference between fair value and cost. The change in unrealized investment gains (losses) by class of investment for the years ended December 31, 1995, 1994 and 1993 were as follows:\n(4) UNCONSOLIDATED INVESTEES\nAt December 31, 1995, the Company, along with other Kemper subsidiaries, directly held partnership interests or options to acquire equity interests (or has made loans with additional interest features) in a number of real estate joint ventures. The Company's direct and indirect real estate joint venture investments are accounted for utilizing the equity method, with the Company recording its share of the operating results of the respective partnerships. The Company, as an equity owner, has the ability to fund, and historically has elected to fund, operating requirements of certain of the joint ventures. Consolidation accounting methods are not utilized as the Company, in most instances, does not own more than 50 percent in the aggregate, and in any event, major decisions of the partnership must be made jointly by all partners.\nAs of December 31, 1995 and 1994, the Company's net equity investment in unconsolidated investees amounted to $17.1 million and $45.4 million, respectively. The Company's share of net losses related to such unconsolidated investees amounted to $453 thousand and $6.3 million for the years ended December 31, 1995 and 1994, respectively.\nAlso at December 31, 1995, the Company had joint venture-related loans totaling $21.8 million before reserves to partnerships in which Lumbermens Mutual Casualty Company, an affiliate until August 1993 (\"Lumbermens\"), and Fidelity Life Association (\"FLA\"), an affiliated mutual insurance company, had equity interests. These joint venture-related loans totaled $37.5 million before reserves at December 31, 1994. (See the note captioned \"Financial Instruments--Off-Balance-Sheet Risk\".)\n(5) CONCENTRATION OF CREDIT RISK\nThe Company generally strives to maintain a diversified invested asset portfolio; however, certain concentrations of credit risk exist in mortgage-backed securities (see \"INVESTMENTS\" beginning on page 9) and real estate.\nKEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(5) CONCENTRATION OF CREDIT RISK (CONTINUED) The Company's real estate portfolio is distributed by geographic location and property type, as shown in the following two tables:\nGEOGRAPHIC DISTRIBUTION AS OF DECEMBER 31, 1995\n- --------------- (1) No other single location exceeded 2.0 percent.\nDISTRIBUTION BY PROPERTY TYPE AS OF DECEMBER 31, 1995\nReal estate markets have been depressed in recent periods in areas where most of the Company's real estate portfolio is located. California real estate market conditions have continued to be worse than in many other areas of the country. Real estate markets in northern California and Illinois show some stabilization and improvement.\nUndeveloped land represented approximately 17.2 percent of the Company's real estate portfolio at December 31, 1995. To maximize the value of certain land and other projects, additional development has been proceeding or has been planned. Such development of existing projects would continue to require funding, either from the Company or third parties. In the present real estate markets, third-party financing can require credit enhancing arrangements (e.g., standby financing arrangements and loan commitments) from the Company. The values of development projects are dependent on a number of factors, including Kemper's and the Company's plans with respect thereto, obtaining necessary permits and market demand for the permitted use of the property. The values of certain development projects have been written down as of December 31, 1995, reflecting changes in plans in connection with the Zurich-led acquisition of Kemper. There can be no assurance that such permits will be obtained as planned or at all, nor that such expenditures will occur as scheduled, nor that Kemper's and the Company's plans with respect to such projects may not change substantially.\nThe majority of the Company's real estate loans are on properties or projects where the Company, Kemper, or their affiliates have taken ownership positions in joint ventures with a small number of partners. (See the note captioned \"Unconsolidated Investees\".)\nAt December 31, 1995, loans to and investments in joint ventures in which Patrick M. Nesbitt or his affiliates (\"Nesbitt\") have interests constituted approximately $99.7 million, or 33.3 percent, of the Company's real estate portfolio. The Nesbitt ventures primarily consist of eleven hotel properties. At December 31, 1995, the Company did not have any Nesbitt-related off-balance-sheet legal funding commitments outstanding.\nAt December 31, 1995, loans to and investments in a master limited partnership (the \"MLP\") between subsidiaries of Kemper and subsidiaries of Lumbermens, constituted approximately $66.0 million, or 22.0 percent, of the Company's real estate portfolio. The Company's interest in the MLP is a less than one percent limited partnership interest, and Kemper's interest is 75 percent at December 31, 1995. Prior to 1995, Kemper's interest was 50 percent. At December 31, 1995, MLP-related commitments accounted for approximately $29.8 million of the Company's off-balance-sheet legal commitments, of which the Company expects to fund $17.0 million.\nAt December 31, 1995, the Company's loans to and investments in projects with the Prime Group, Inc. or its affiliates totaled approximately $24.8 million, or 8.3 percent, of the Company's real estate portfolio. Prime Group-related commitments accounted for $165.6 million of the off-balance-sheet legal commitments at December 31, 1995, of which the Company expects to fund $15.0 million.\nKEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(6) INCOME TAXES\nIncome tax expense (benefit) was as follows for the years ended December 31, 1995, 1994 and 1993:\nIncluded in the current tax benefit is the recognition of a net operating loss carryover at December 31, 1995 which will be utilized against taxable income on Kemper's consolidated short period Federal income tax return for the January 1 through January 4, 1996 tax year. Beginning January 5, 1996, the Company will file a stand alone Federal income tax return. Previously, the Company had filed a consolidated Federal income tax return with Kemper. In the first quarter of 1996, the Company and Kemper settled the outstanding balances for the short period under the tax allocation agreement with Kemper making a payment to the Company of approximately $30 million. The Company's receivable from Kemper for all remaining balances under the tax allocation agreement, after adjusting for the $30 million payment, totaled approximately $82.6 million at December 31, 1995. Such remaining amounts are expected to be settled in the fourth quarter of 1996.\nThe actual income tax expense (benefit) for 1995, 1994 and 1993 differed from the \"expected\" tax expense (benefit) for those years as displayed below. \"Expected\" tax expense (benefit) was computed by applying the U.S. Federal corporate tax rate of 35 percent in 1995, 1994, and 1993 to income (loss) before income tax expense (benefit) and cumulative effect of change in accounting principle.\nUnder SFAS 109 ACCOUNTING FOR INCOME TAXES, deferred tax assets and liabilities are generally 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. 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. SFAS 109 allows recognition of deferred tax assets if future realization of the tax benefit is more likely than not, with a valuation allowance for the portion that is not likely to be realized.\nThe implementation of SFAS 109 in 1993 resulted in a one-time increase to earnings of $2.4 million.\nUnder SFAS 109, a valuation allowance is established to reduce the deferred Federal tax asset related to real estate and other investments to the amount that, based upon available evidence, is, in management's judgment, more likely than not to be realized. Any reversals of the valuation allowance are contingent upon the recognition of future capital gains in Kemper's Federal income tax return or a change in circumstances which causes the recognition of the benefits to become more likely than not. During 1995 and 1994, the change in the valuation allowance related solely to the change in the net deferred Federal tax asset or liability from unrealized gains or losses on investments.\nKEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(6) INCOME TAXES (CONTINUED) The tax effects of temporary differences that give rise to significant portions of the Company's net deferred Federal tax liability were as follows:\nThe valuation allowance is subject to future adjustments based on, among other items, Kemper's estimates of future operating earnings and capital gains.\nThe tax returns through the year 1986 have been examined by the Internal Revenue Service (\"IRS\"). Changes proposed are not material to the Company's financial position. The tax returns for the years 1987 through 1990 are currently under examination by the IRS.\n(7) RELATED-PARTY TRANSACTIONS\nThe Company received cash capital contributions of $82.5 million and $90.0 million during 1994 and 1993, respectively.\nIn 1994 and 1993, the Company transferred the majority of its deficit equity ownership interest in two limited partnerships to another Kemper subsidiary resulting in an increase of the Company's additional paid-in capital of $71 thousand and $9.2 million, respectively. The Company also paid a non-cash dividend of $530 thousand in December 1993, which represented the positive equity ownership interests of the majority of one of its limited partnerships. Net losses associated with the Company's ownership interests in these limited partnerships amounted to $0.4 million, $1.4 million and $5.4 million in 1995, 1994 and 1993, respectively, and are included in the Company's consolidated statement of operations.\nThe Company has loans to joint ventures, consisting primarily of mortgage loans on real estate, in which the Company and\/or one of its affiliates has an ownership interest. At December 31, 1995 and 1994, joint venture mortgage loans totaled $120 million and $351 million, respectively, and during 1995, 1994 and 1993, the Company earned interest income on these joint venture loans of $19.6 million, $22.0 million and $63.1 million, respectively.\nAll of the Company's personnel are employees of Federal Kemper Life Assurance Company (\"FKLA\"), an affiliated company. The Company is allocated expenses for the utilization of FKLA employees and facilities, the investment management services of Zurich Kemper Investments, Inc. (\"ZKI\"), an affiliated company, and the information systems of Kemper Service Company (\"KSvC\"), a ZKI subsidiary, based on the Company's share of administrative, legal, marketing, investment management, information systems and operation and support services. During 1995, 1994 and 1993, expenses allocated to the Company from ZKI and KSvC amounted to $4.4 million, $6.5 million and $3.1 million, respectively. The Company also paid to ZKI investment management fees of $3.4 million, $6.0 million and $6.7 million\nKEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(7) RELATED-PARTY TRANSACTIONS (CONTINUED)\nduring 1995, 1994 and 1993, respectively. In addition, expenses allocated to the Company from FKLA during 1995, 1994 and 1993 amounted to $14.3 million, $11.1 million and $13.1 million, respectively.\nDuring 1995, 1994 and 1993, the Company sold certain mortgages and real estate-related investments, net of reserves, amounting to approximately $3.5 million, $154.0 million and $343.7 million respectively, to KFC Portfolio Corp., an affiliated non-life realty company, in exchange for cash. No gain or loss was recognized on these sales. The Company also paid KFC Portfolio Corp. $1.8 million in 1995 related to the management of the Company's real estate portfolio.\n(8) REINSURANCE\nIn the ordinary course of business, the Company enters into reinsurance agreements to diversify risk and limit its overall financial exposure to certain blocks of fixed-rate annuities. The Company generally cedes 100 percent of the related annuity liabilities under the terms of the reinsurance agreements. Although these reinsurance agreements contractually obligate the reinsurers to reimburse the Company, they do not discharge the Company from its primary liabilities and obligations to policyholders. As such, these amounts paid or deemed to have been paid are recorded on the Company's consolidated balance sheet as reinsurance recoverables and ceded future policy benefits.\nIn 1992 and 1991, the Company entered into 100 percent indemnity reinsurance agreements ceding $515.7 million and $416.3 million, respectively, of its fixed-rate annuity liabilities to FLA. FLA is a mutual insurance company that shares common management with the Company and FKLA and common board members with the Company, FKLA and Kemper. As of December 31, 1995, the reinsurance recoverable related to the fixed-rate annuity liabilities ceded to FLA amounted to approximately $503 million. During 1995 the Company recorded income of $4.4 million related to a ceding commission experience adjustment from the 1992 reinsurance agreement.\n(9) POSTRETIREMENT BENEFITS OTHER THAN PENSIONS\nThe Company and FKLA sponsor a welfare plan that provides medical and life insurance benefits to their retired and active employees and the Company is allocated a portion of the costs of providing such benefits. The Company is self insured with respect to medical benefits, and the plan is not funded except with respect to certain disability-related medical claims. The medical plan provides for medical insurance benefits at retirement, with eligibility based upon age and the participant's number of years of participation attained at retirement. The plan is contributory for pre-Medicare retirees, and will be contributory for all retiree coverage for most current employees, with contributions generally adjusted annually. Postretirement life insurance benefits are noncontributory and are limited to $10,000 per participant.\nThe discount rate used in determining the allocated postretirement benefit obligation was 7.25 percent and 8 percent for 1995 and 1994, respectively. The assumed health care trend rate used was based on projected experience for 1995 and 1996, 10 percent in 1997, gradually declining to 6 percent by the year 2000 and remaining at that level thereafter.\nKEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(9) POSTRETIREMENT BENEFITS OTHER THAN PENSIONS (CONTINUED) The status of the plan as of December 31, 1995 and 1994, was as follows:\nAccumulated postretirement benefit obligation:\nA one percentage point increase in the assumed health care cost trend rate for each year would increase the accumulated postretirement benefit obligation as of December 31, 1995 and 1994 by $146 thousand and $48 thousand, respectively, and the net postretirement health care interest and service costs for the years ended December 31, 1995 and 1994 by $24 thousand and $14 thousand, respectively.\nDuring 1994, the Company adopted certain severance-related policies to provide benefits, generally limited in time, to former or inactive employees after employment but before retirement. The effect of adopting these policies was immaterial.\n(10) COMMITMENTS AND CONTINGENT LIABILITIES\nThe Company is involved in various legal actions for which it establishes liabilities where appropriate. In the opinion of the Company's management, based upon the advice of legal counsel, the resolution of such litigation is not expected to have a material adverse effect on the consolidated financial statements.\nAlthough none of the Company or its joint venture projects have been identified as a \"potentially responsible party\" under Federal environmental guidelines, inherent in the ownership of or lending to real estate projects is the possibility that environmental pollution conditions may exist on or near or relate to properties owned or previously owned on properties securing loans. Where the Company has presently identified remediation costs, they have been taken into account in determining the cash flows and resulting valuations of the related real estate assets. Based on the Company's receipt and review of environmental reports on most of the projects in which it is involved, the Company believes its environmental exposure would be immaterial to its consolidated results of operations. However, the Company may be required in the future to take actions to remedy environmental exposures, and there can be no assurance that material environmental exposures will not develop or be identified in the future. The amount of future environmental costs is impossible to estimate due to, among other factors, the unknown magnitude of possible exposures, the unknown timing and extent of corrective actions that may be required, the determination of the Company's liability in proportion to others and the extent such costs may be covered by insurance or various environmental indemnification agreements.\nSee the note captioned \"Financial Instruments--Off-Balance-Sheet Risk\" below for the discussion regarding the Company's loan commitments and standby financing agreements.\nThe Company is liable for guaranty fund assessments related to certain unaffiliated insurance companies that have become insolvent during the years 1995 and prior. The Company's financial statements include provisions for all known assessments that are expected to be levied against the Company as well as an estimate of amounts (net of estimated future premium tax recoveries) that the Company believes it will be assessed in the future for which the life insurance industry has estimated the cost to cover losses to policyholders. The Company is also contingently liable for any future guaranty fund assessments related to insolvencies of unaffiliated insurance companies, for which the life insurance\nKEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(10) COMMITMENTS AND CONTINGENT LIABILITIES (CONTINUED) industry has been unable to estimate the cost to cover losses to policyholders. No specific amount can be reasonably estimated for such insolvencies as of December 31, 1995.\n(11) FINANCIAL INSTRUMENTS--OFF-BALANCE-SHEET RISK\nAt December 31, 1995, the Company had loan commitments and stand-by financing agreements totaling $248.2 million to support the financing needs of various real estate investments. To the extent these arrangements are called upon, amounts loaned would be secured by assets of the joint ventures, including first mortgage liens on the real estate. The Company's criteria in making these arrangements are the same as for its mortgage loans and other real estate investments. The Company presently expects to fund approximately $56.4 million of these arrangements. These commitments are included in the Company's analysis of real estate-related reserves and write-downs. The fair values of loan commitments and standby financing agreements are estimated in conjunction with and using the same methodology as the fair value estimates of mortgage loans and other real estate-related investments.\n(12) DERIVATIVE FINANCIAL INSTRUMENTS\nThe Company is party to derivative financial instruments in the normal course of business for other than trading purposes to hedge exposures in foreign currency fluctuations related to certain foreign fixed maturity securities held by the Company. The following table summarizes various information regarding these derivative financial instruments as of December 31, 1995 and 1994:\nThe Company's hedges relating to foreign currency exposure are implemented using forward contracts on foreign currencies. These are generally short duration contracts with U.S. money-center banks. The Company records realized and unrealized gains and losses on such investments in net income on a current basis. The amounts of gain (loss) included in net income during 1995, 1994 and 1993 totaled $(1.0 million), $6.4 million and $(2.8 million), respectively.\n(13) FAIR VALUE OF FINANCIAL INSTRUMENTS\nFair value estimates are made at specific points in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company's entire holdings of a particular financial instrument. A significant portion of the Company's financial instruments are carried at fair value. (See the note captioned \"Invested Assets and Related Income\".) Fair value estimates for financial instruments not carried at fair value are generally determined using discounted cash flow models and assumptions that are based on judgments regarding current and future economic conditions and the risk characteristics of the investments. Although fair value estimates are calculated using assumptions that management believes are appropriate, changes in assumptions could significantly affect the estimates and such estimates should be used with care.\nFair value estimates are determined for existing on- and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and certain liabilities that are not considered financial instruments. Accordingly, the aggregate fair value estimates presented do not represent the underlying value of the Company. For example, the Company's subsidiaries are not considered financial instruments, and their value has not been incorporated into the fair value estimates. In addition, tax ramifications related to the realization of unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of the estimates.\nThe following methods and assumptions were used by the Company in estimating the fair value of its financial instruments:\nFixed maturities and equity securities: Fair values for fixed maturity securities and for equity securities were determined by using market quotations, or independent pricing services that use prices provided by market makers or estimates of\nKEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(13) FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)\nfair values obtained from yield data relating to instruments or securities with similar characteristics, or fair value as determined in good faith by the Company's portfolio manager, ZKI.\nCash and short-term investments: The carrying amounts reported in the consolidated balance sheet for these instruments approximate fair values.\nMortgage loans and other real estate-related investments: Fair values for mortgage loans and other real estate-related investments for year-end 1994 were estimated on a project-by-project basis. Generally, the projected cash flows of the collateral were discounted using a discount rate of 10 to 12 percent. The resulting collateral estimates were then used to determine the value of the Company's real estate-related investments. Fair values for mortgage loans and other real estate-related investments for year-end 1995 were estimated based upon the investments observable market price, net of estimated costs to sell. The estimates of fair value should be used with care given the inherent difficulty of estimating the fair value of real estate due to the lack of a liquid quotable market.\nOther loans and investments: The carrying amounts reported in the consolidated balance sheet for these instruments approximate fair values. The fair values of policy loans were estimated by discounting the expected future cash flows using an interest rate charged on policy loans for similar policies currently being issued.\nLife policy benefits: Fair values of the life policy benefits regarding investment contracts (primarily deferred annuities) and universal life contracts were estimated by discounting gross benefit payments, net of contractual premiums, using the average crediting rate currently being offered in the marketplace for similar contracts with maturities consistent with those remaining for the contracts being valued. The Company had projected its future average crediting rate in 1995 and 1994 to be 4.5 percent and 5.5 percent, respectively, while the assumed average market crediting rate was 5.5 percent in 1995 and 6.5 percent in 1994.\nThe carrying values and estimated fair values of the Company's financial instruments at December 31, 1995 and 1994 were as follows:\n- --------------- (1) Includes $112 and $18 carrying value and fair value for 1995 and 1994, respectively, of derivative securities used to hedge the foreign currency exposure on certain specific foreign fixed maturity investments.\n(14) STOCKHOLDER'S EQUITY--RETAINED EARNINGS\nThe maximum amount of dividends which can be paid by insurance companies domiciled in the State of Illinois to shareholders without prior approval of regulatory authorities is restricted. (See \"Restrictions on dividends\" on page 6.) The maximum amount of dividends which can be paid by the Company without prior approval in 1996, assuming that there is sufficient statutory earned surplus, is $38.3 million. The Company paid no cash dividends in 1995, 1994 or 1993.\nThe Company's net income (loss) and stockholder's equity as determined in accordance with statutory accounting principles were as follows:\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nTABLE I SUMMARY COMPENSATION TABLE\n- --------------- (1) Also served in same positions for FKLA and FLA. An allocation of the time devoted to duties as executive officer of KILICO has been made. All compensation items reported in the Summary Compensation Table reflect this allocation.\n(2) The amounts disclosed in this column include:\n(a) Amounts paid as non-preferential dividend equivalents on shares of restricted stock and phantom stock units.\n(b) The cash value of shares of Kemper common stock when awarded under the Kemper Anniversary Award Plan. Employees were awarded shares on an increasing scale beginning with their 10th year of employment and every 5 years thereafter, with a pro rata award at retirement.\n(c) The taxable benefit from personal use of an employer-provided automobile and certain estate planning services facilitated for executives.\n(d) Relocation expense reimbursements of $109,760 in 1994 and $15,474 in 1995 for Mr. Cwiok.\n(e) Compensation income reported in 1994 of $384,822 for Mr. Scott and $55,974 for Ms. Frye, based on the market value on the vesting date of restricted stock awarded under Kemper's long-term incentive plans.\n(3) Due to the June 1994 vesting of all outstanding shares of restricted stock granted in 1992 or earlier and the cancellation of shares awarded in 1993 and 1994, no shares of restricted stock were held by any of the named executive officers at December 31, 1995.\n(4) Options were granted under Kemper stock option plans maintained for selected officers and employees of Kemper and its subsidiaries.\n(5) The amounts in this column include:\n(a) The amounts of employer contributions allocated to the accounts of the named persons under profit sharing plans or under supplemental plans maintained to provide benefits in excess of applicable ERISA limitations.\n(b) Distributions from the Kemper and FKLA supplemental plans.\n(c) Amounts representing a portion of the executives' income tax payments arising from the June 1994 vesting of shares of restricted stock due to the approval of a merger agreement among Kemper, Conseco, Inc. (\"Conseco\") and a wholly owned subsidiary of Conseco (the \"Conseco Merger Agreement.\") The Committee on Compensation and Organization of the Kemper board of directors (the \"Committee\") authorized such payments to 16 senior executives who were either precluded under pertinent securities law limitations or discouraged as a matter of appearance from subsequently selling their vested shares of restricted stock prior to the closing of the then-planned Conseco merger transaction. The executives' tax liabilities were based on the $61.375 fair market value of the restricted stock on the vesting date. Kemper's payments to the executives were derived from a formula based on certain relative stock values but approximated one-third of the executives' total income tax liabilities from the imputed income on vesting. Mr. Scott and Ms. Frye received $96,318 and $17,103, respectively, reported for 1994, under this tax liability payment arrangement.\n(d) Income related to the distribution of shares of the preferred stock of EVEREN to holders of Kemper employee stock options and\/or phantom stock units as a result of the spin-off of EVEREN by Kemper.\n(6) Pursuant to the Conseco Merger Agreement, the restricted stock awards for 1993 and 1994 were cancelled. To replace these awards, on June 30, 1994, the Committee, under the Kemper Bonus Restoration Plan and in its sole discretion, granted cash awards to the named executive officers and other affected executives entitling each of them to receive an amount in cash immediately prior to the effective time of the then-planned Conseco merger equal to the product of the number of shares of restricted stock previously granted to such individual under the 1993 Senior Executive Long-Term Incentive Plan multiplied by the consideration payable in the merger. As a result of the termination of the Conseco Merger Agreement, no cash awards were paid pursuant to the Kemper Bonus Restoration Plan.\nIn January 1995, the board of directors, upon the advice of the Committee, approved the adoption of the Kemper 1995 Executive Incentive Plan under which active employee holders of the previously cancelled shares of restricted stock were granted phantom stock units by the Committee equal to the number of shares cancelled plus an added amount representing 20 percent of the aggregate cancelled shares. The 20 percent supplement was awarded in recognition of the imposition of new vesting periods on the phantom awards (to the extent the restricted stock held prior to cancellation would otherwise have vested in June 1994 had stockholder approval of the affected restricted stock plan been obtained as earlier anticipated).\nBy their terms, the phantom stock units associated with cancelled shares of restricted stock originally awarded in 1993, as supplemented, would have vested on December 31, 1995 and entitle the holders to a cash payment (net of any required tax withholding) determined by the value of Kemper's common stock based on an average trading range to December 31, 1995, and those phantom stock units associated with the cancelled restricted stock originally awarded in 1994 could similarly have vested and been paid on December 31, 1996, subject to ongoing employment to the respective vesting dates. Notwithstanding these vesting provisions, the phantom stock units earlier vested and entitled payment upon the consummation of a \"change of control\" of Kemper. Dividend equivalents were payable to holders of the phantom stock units as compensation income when and as dividends were paid on Kemper's outstanding common stock, and the Executive Incentive Plan provided for standard anti-dilution adjustments.\nPhantom units awarded to the named executive officers subject to vesting on December 31, 1995 and December 31, 1996, were Mr. Scott 5,400 and 12,600 phantom units, respectively, Ms. Frye 1,680 and 1,680 phantom units, respectively, and Mr. Cwiok 0 and 1,680 phantom units, respectively. All phantom stock units vested and were paid immediately prior to the effectiveness of the January 4, 1996 acquisition of Kemper by Zurich and Insurance Partners. Messrs. Scott and Cwiok and Ms. Frye received allocated cash out payments of $430,272, $41,832 and $80,317, respectively, in 1996.\n(7) Pursuant to the terms of a Termination Protection Agreement with Kemper dated March 17, 1994, Mr. Scott received payments in 1995 and 1996. These payments were made by Kemper and no portion of the payments were allocated to KILICO.\nTABLE II OPTION\/SAR GRANTS IN LAST FISCAL YEAR\n- --------------- (1) Each of the options reflected in the table, when granted, were subject to installment vesting provisions whereby only a portion of the underlying stock would become eligible for exercise on successive anniversaries of the date of grant. Such options became exercisable in full, however, in connection with the approval of the merger agreement with Zurich and Insurance Partners in May, 1995.\n(2) Based on 654,750 shares, the total number of shares under options granted in 1995 for all eligible employees of KILICO, Kemper and eligible affiliates.\n(3) The option exercise price assigned was the last sale price for Kemper common stock on the date of the respective grants.\n(4) All unexercised Kemper stock options were cancelled immediately prior to the January 4, 1996 effectiveness of the acquisition of Kemper by Zurich and Insurance Partners. Optionees were paid the spread between their option exercise price and $49.80 per share. Mr. Cwiok and Ms. Frye received $84,150 and $112,370, respectively, in 1996 as a result of such payments. Mr. Scott exercised 133,325 options in 1996 prior to the acquisition for a total realized income of $1,525,185.\nTABLE III AGGREGATED OPTION\/SAR EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION\/SAR VALUES\n- ---------------\n(1) See footnote (4) under Table II above.\n(2) Includes options granted related to service for FKLA.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\n(A) AS OF MARCH 1, 1996, 100% OF THE OUTSTANDING SHARES OF KILICO WERE OWNED BY KEMPER CORPORATION, 1 KEMPER DRIVE, LONG GROVE, ILLINOIS 60049.\n(B) NOT APPLICABLE.\n(C) CHANGES IN CONTROL.\nThere are no arrangements known to KILICO, which may at a subsequent date result in a change in control of KILICO.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\n(A) TRANSACTIONS WITH MANAGEMENT AND OTHERS--none.\n(B) CERTAIN BUSINESS RELATIONSHIPS--not applicable.\n(C) INDEBTEDNESS OF MANAGEMENT--not applicable.\n(D) TRANSACTIONS WITH PROMOTERS--not applicable.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(A)(1) FINANCIAL STATEMENTS.\nA listing of all financial statements filed as part of this Annual Report on Form 10-K is included on page 16 in ITEM 8.\n(A)(2) SCHEDULES.\nThe following schedule is supplemental to the financial statements of KILICO and its subsidiaries for 1995 and is included in this Form 10-K at the page indicated below. All other schedules are omitted because the information required to be stated therein is included in the financial statements or notes thereto or because they are inapplicable.\n- --------------- * This schedule for the years ended December 31, 1994 and 1993 is incorporated by reference to KILICO's Form 10-K filed on March 28, 1995 and Form S-1 filed on March 29, 1994, respectively.\n(A)(3) EXHIBITS.\nThe exhibits listed on the accompanying Index to Exhibits on page 42 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 were filed during the fourth quarter of 1995.\nPOWER OF ATTORNEY\nEach person whose signature appears below hereby appoints Frederick L. Blackmon, Senior Vice President and Chief Financial Officer, and Robert A. Daniel, Vice President, Treasurer and Controller, his true and lawful attorney-in-fact with authority together or individually to execute in the name of each such signatory, and with authority to file with the Securities and Exchange Commission, any and all amendments to this Annual Report on Form 10-K, together with any exhibits thereto and other documents therewith, necessary or advisable to enable Kemper Investors Life Insurance Company to comply with the Securities Exchange Act of 1934, as amended, and any rules, regulations and requirements of the Securities and Exchange Commission in respect thereof, which amendments may make such other changes in the Annual Report on Form 10-K as the aforesaid attorney-in-fact executing the same deems appropriate.\nSIGNATURES\nPursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, Kemper Investors Life Insurance Company has duly caused this Annual Report on Form 10-K for the fiscal year ended December 31, 1995 to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Long Grove, State of Illinois, on the 25th day of March, 1996.\nKEMPER INVESTORS LIFE INSURANCE COMPANY\nBy: \/s\/ JOHN B. SCOTT ----------------------------------- John B. Scott President and Chief Executive Officer\nPURSUANT TO THE REQUIREMENTS OF THE SECURITIES AND EXCHANGE ACT OF 1934, THIS ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 1995 HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF KEMPER INVESTORS LIFE INSURANCE COMPANY IN THE CAPACITIES INDICATED ON THE 25TH DAY OF MARCH, 1996.\nSCHEDULE V KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES\nVALUATION AND QUALIFYING ACCOUNTS\nYEAR ENDED DECEMBER 31, 1995 (in thousands)\n- --------------- (1) These deductions represent the net effect on the valuation reserve of write-downs, sales, foreclosures and restructurings.\nINDEX TO EXHIBITS","section_15":""}
{"filename":"65270_1995.txt","cik":"65270","year":"1995","section_1":"ITEM 1. BUSINESS\nMethode Electronics, Inc. was incorporated in 1946 as an Illinois corporation and reincorporated in Delaware in 1966. As used herein, Methode Electronics, Inc. shall be referred to as the \"Registrant\" or the \"Company\".\nThe Registrant operates in one industry segment, which consists of the manufacture of electronic components and devices that connect, control and convey electrical energy, pulse and signal, including connectors, controls, interconnect devices, printed circuits, and current carrying distribution systems. Components and devices manufactured by the Registrant are used in the production of electronic equipment and other products with applications in the automotive, computer, voice and data communications equipment, industrial, military and aerospace, and consumer electronics industries.\nThe following tabulation reflects the percentages of net sales from continuing operations of the major classes of products of the Registrant for the last three fiscal years:\nThe sales activities of the Registrant are directed by sales managers who are supported by engineering personnel who provide technical services. The Registrant's products are sold through its sales staff and through independent manufacturers' representatives with offices throughout the world. Sales are made primarily to original equipment manufacturers and also to independent distributors.\nSources and Availability of Raw Materials. Principal raw materials purchased by Registrant include copper-clad laminate, ferrous and copper alloy strips, plastic molding materials, fiber optic cable, etching and plating chemicals, die castings and precious metals. All of these items are available from several suppliers, and the Registrant generally relies on more than one for each item.\nPatents; Licensing Agreements. The Registrant has various patents and licensing agreements, but does not consider its business to be materially dependent upon such patents and licensing agreements.\nSeasonality. The business of the Registrant is not seasonal.\nWorking Capital Items. The Registrant is required to maintain adequate levels of inventory to meet scheduled delivery requirements of customers. It is not normal for the Registrant to carry significant amounts of finished goods, as the preponderance of orders received are for scheduled future deliveries.\nMaterial Customers. During the year ended April 30, 1995, shipments to Chrysler Corporation and Ford Motor Corporation each were 10% or greater of consolidated net sales and, in the aggregate, amounted to approximately 42% of consolidated net sales. Such shipments included a wide variety of the Registrant's automotive controls products.\nBacklog. The Registrant's backlog of orders for its continuing operations was approximately $42,500,000 at May 31, 1994 and $53,100,000 at May 31, 1995. It is expected that most of the total backlog at May 31, 1995 will be shipped within the current fiscal year.\nContracts Subject to Termination at the Election of the Government. Shipments as a subcontractor for various military programs constitute a significant portion of the Registrant's multi layer printed circuitry output, although not material to the Registrant's business as a whole. Although existing government orders\nare subject to termination at the election of the Government, the Registrant historically has never experienced a significant termination and has no information to lead it to believe that there is a likelihood of such an event during fiscal year 1996.\nCompetitive Conditions. The markets in which the Registrant operates are highly competitive and characterized by rapid changes due to technological improvements and developments. Registrant competes with a large number of other manufacturers in each of its product areas; many of these competitors have greater resources and total sales. Price, service and product performance are significant elements of competition in the sale of Registrant's products.\nResearch and Development. Registrant maintains a Research and Development program involving a number of professional employees who devote a majority of their time to the development of new products and processes and the advancement of existing ones. Senior management of the Registrant also participates directly in the program. Expenditures for the aforementioned activities amounted to $8,880,000, $11,120,000 and $14,120,000 for the fiscal years ended April 30, 1993, 1994 and 1995, respectively.\nEnvironmental Quality. Compliance with federal, state and local provisions regulating the discharge of materials into the environment has not materially affected capital expenditures, earnings or the competitive position of the Registrant. Currently, there are no environmental-related lawsuits or material administrative proceedings pending against the Registrant. Further information as to environmental matters affecting the Registrant is presented in Note 7 to the consolidated financial statements included in Item 14(a)(1).\nEmployees. At April 30, 1994 and 1995, Registrant had approximately 2,500 and 3,000 employees, respectively.\nForeign Sales. Information about the Registrant's operations in different geographic regions is summarized in Note 9 to the consolidated financial statements included in Item 14 (a) (1).\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Registrant has 17 manufacturing and three service facilities containing approximately 730,000 square feet of space, of which approximately 84,000 square feet are leased. Ten of the facilities are located in Illinois, two in California, one in Connecticut, one in New Jersey, one in Maryland, one in Ireland, two in Singapore and two in the United Kingdom. The Registrant has a $107,000 Industrial Revenue Bond obligation covering 130,000 square feet in Carthage, Illinois. Approximately 90,000 square feet of space for the manufacture of connectors and controls was added in fiscal 1995 and it is anticipated that a 20,000 square foot Research Center will be added in 1996. Management believes that the Registrant's production capacity is sufficient to supply current orders and anticipated increased demands. Registrant's manufacturing facilities have been modernized as necessary in the opinion of management to keep pace with developments in the electronics industry.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nAs of July 14, 1995, the Registrant was not involved in any material litigation or any litigation or material administrative proceedings with governmental authorities pertaining to the discharge of materials into the environment.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThere were no matters submitted to security holders during the fourth quarter of fiscal 1995.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nAll executive officers serve a term of office of one year which, for the current year, expires on September 12, 1995, or until their successors are duly elected and qualified.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Registrant's Class A and Class B Common Stock are traded on the Nasdaq National Market System under the symbols METHA and METHB. The following is a tabulation of high and low sale prices for the periods indicated as reported by Nasdaq.\nThe Registrant pays dividends quarterly and during the first three quarters of fiscal 1994, it paid at an annual rate of $.048 and $.040 on the Class A and Class B Stock. The dividend on the Class A and Class B Common Stock was raised to an annual rate of $.06 and $.05, respectively, effective with the fourth quarter of fiscal 1994 and again to an annual rate of $.12 and $.10, respectively, effective for the first quarter of fiscal\n1995. On June 26, 1995, the Board of Directors of the Registrant voted to raise the annual payout rate on its Class B shares from $.10 to $.12. Following this action, the Board voted to double the cash dividend on its Class A and Class B Common Stock to an annual rate of $.24, and declared a dividend of $.06 per Class A share and Class B share, payable on July 31, 1995 to holders of record on July 14, 1995.\nThe Registrant expects to continue its policy of paying regular cash dividends, although there is no assurance as to future dividends because they are dependent on future earnings, capital requirements and financial condition.\nAs of July 14, 1995, the approximate number of record holders of the Company's Class A Stock was 1,208 and the approximate number of record holders of the Company's Class B Stock was 563.\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\nNet sales increased 27%, 24% and 16% in fiscal 1995, 1994 and 1993. Gains in sales of connectors and controls were significant during these periods led by increases in sales of automotive controls of 22% in 1995, 35% in 1994 and 25% in 1993. Methode manufactures electronic devices for the automotive, computer, voice and data communications, industrial, military and aerospace, and consumer marketplaces. In fiscal years 1993 through 1995, sales were split about evenly between automotive controls and shipments of other electronic components. Sales of automotive control devices benefitted from a buoyant automotive market and an increase in per-vehicle controls requirements. Fiscal 1995 also was helped by the commencement of production of automotive airbag products by our Dumbarton, Scotland, plant to service the European market. Network buss sales contributed significantly to the sales gain in 1995 by more than doubling 1994 levels,\nprimarily the result of improvement in the mainframe computer market and an agreement entered into in late fiscal 1994 which allows Methode access to some new customers, products and technology. Our fiber optic connector products and our dataMate termination products also had strong year-to-year sales gains during the three year period. Overall connector sales posted gains of 34%, 16% and 18% in 1995, 1994 and 1993 and were helped by the acquisition of two molded cable assembly operations in the second quarter of 1995 and a fiber optic connector business in the first quarter of 1994. Sales of printed circuits were depressed during the three year period as a result of reductions in defense spending and were further reduced in 1994 by the California earthquake that interrupted production at our largest circuit board facility.\nOther income consisted primarily of earnings from an automotive joint venture, interest income from short-term investments and royalties. All three sources of other income increased significantly from year-to-year during the three year period.\nCost of products sold as a percentage of sales for 1995, 1994 and 1993 were 72.8%, 71.9% and 72.9%. Gross margins improved in 1994, primarily due to the volume gains discussed above. Gross margins narrowed in 1995 due in part to a slowdown in sales of our catalog connector products, price pressure in the Far East and lower margins on the cable assembly business acquired in 1995.\nSelling and administrative expenses as a percentage of sales were 13.3%, 13.4% and 14.9% in 1995, 1994 and 1993. Reductions in legal and other professional fees and volume gains in 1995 and 1994 were largely responsible for the improvement over 1993.\nThe effective income tax rates were 36.1%, 37.3% and 34.6% for the years ended April 30, 1995, 1994 and 1993. The effective income tax rates exceed the statutory federal rate of 35% (34% in 1993) because of the effect of state income taxes partially offset by lower statutory rates on foreign operations. Fiscal 1993 benefitted from tax-free earnings of a foreign subsidiary granted full tax holiday status through December, 1992.\nFINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES\nNet cash provided by operating activities was $37,320,000, $16,896,000 and $18,626,000 in 1995, 1994 and 1993, respectively. The decrease in 1994 from 1993 was primarily the result of increased accounts receivable and inventory levels due to higher sales volumes. The increases in 1995 were primarily the result of a leveling off of working capital requirements and increased net income. The molded cable assembly business acquisition, previously mentioned above, was purchased for cash of just under $2,600,000. Capital expenditures and depreciation expenses were $17,422,000 and $10,608,000 in 1995, $12,697,000 and $8,988,000 in 1994, and $16,963,000 and $7,809,000 in 1993. Capital spending included the purchase of a new test lab facility in 1995 and the purchase of two manufacturing facilities and expansion of a third in 1993. Comparable expenditures were not made in 1994. It is presently expected that fixed asset additions for fiscal 1996 will approximate $20,000,000 and will be financed with internally generated funds.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nSee Item 14 for an Index to Financial Statements and Financial Statement Schedules. 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 DISCLOSURES\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 included under the caption \"Election of Directors\" in the Registrant's proxy statement to be dated on or about August 10, 1995, and is incorporated herein by reference. Information regarding the executive officers of the Registrant 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 \"Executive Compensation\" in the Registrant's proxy statement to be dated on or about August 10, 1995 and is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation regarding the above is included under the caption \"Security Ownership\" in the Registrant's proxy statement to be dated on or about August 10, 1995 and is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation regarding the above is included under the caption \"Election of Directors\" in the Registrant's proxy statement to be dated on or about August 10, 1995 and is incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) (1) (2) LIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nThe response to this portion of Item 14 is included in this report under the caption \"List of Financial Statements and Financial Statement Schedules\" which is incorporated herein by reference.\n(a) (3) LIST OF EXHIBITS REQUIRED BY ITEM 601 OF REGULATION S-K\nSee \"Exhibit Index\" immediately following the financial statement schedules.\n(b) REPORTS ON FORM 8-K\nNo reports on Form 8-K have been filed during the last quarter of the period covered by this report.\n(c) EXHIBITS REQUIRED BY ITEM 601 OF REGULATION S-K\nSee \"Exhibit Index\" immediately following the financial statement schedules.\n(d) FINANCIAL STATEMENT SCHEDULES\nThe response to this portion of Item 14 is included in this report under the caption \"List of Financial Statements and Financial Statement Schedules\" which is incorporated herein by reference.\nSchedules and exhibits other than those listed are omitted for the reasons that they are not required, are not applicable or that equivalent information has been included in the financial statements, and notes thereto, or 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.\nMethode Electronics, Inc. (Registrant)\nBy: _________________________________ Kevin J. Hayes Vice President, Treasurer & Director\nDated: July 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.\nMETHODE ELECTRONICS, INC. AND SUBSIDIARIES\nFORM 10-K\nITEM 14(A)(1) AND (2) LIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nThe following consolidated financial statements of Methode Electronics, Inc. and subsidiaries are included in Item 8:\nConsolidated Balance Sheets--April 30, 1995 and 1994\nConsolidated Statements of Income--Years Ended April 30, 1995, 1994, and 1993\nConsolidated Statements of Shareholders' Equity--Years Ended April 30, 1995, 1994, and 1993\nConsolidated Statements of Cash Flows--Years Ended April 30, 1995, 1994, and 1993\nNotes to Consolidated Financial Statements\nThe 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 inappropriate and, therefore, have been omitted.\nREPORT OF INDEPENDENT AUDITORS\nThe Board of Directors and Shareholders Methode Electronics, Inc.\nWe have audited the accompanying consolidated balance sheets of Methode Electronics, Inc. and subsidiaries as of April 30, 1995 and 1994, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended April 30, 1995. 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 Methode Electronics, Inc. and subsidiaries at April 30, 1995 and 1994, and the consolidated results of their operations and their cash flows for each of the three years in the period ended April 30, 1995, in conformity with generally accepted accounting principles.\nErnst & Young LLP\nChicago, Illinois June 20, 1995\nMETHODE ELECTRONICS, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\nSee notes to consolidated financial statements.\nMETHODE ELECTRONICS, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF INCOME\nSee notes to consolidated financial statements.\nMETHODE ELECTRONICS, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY\nYEARS ENDED APRIL 30, 1995, 1994, AND 1993\nSee notes to consolidated financial statements.\nMETHODE ELECTRONICS, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nSee notes to consolidated financial statements.\nMETHODE ELECTRONICS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nAPRIL 30, 1995\n1. SIGNIFICANT ACCOUNTING POLICIES\nPrinciples of Consolidation\nThe consolidated financial statements include the accounts and operations of the Company and its subsidiaries, all of which are wholly owned.\nCash Equivalents\nAll highly liquid investments with a maturity of three months or less when purchased are carried at their approximate fair value and classified in the balance sheet as cash equivalents.\nInventories\nInventories are stated at the lower of cost (first in, first out method) or market.\nProperty, Plant and Equipment\nProperties are stated on the basis of cost. The Company amortizes such costs by annual charges to income, computed on the straight-line method for financial reporting purposes and on accelerated methods for income tax purposes.\nResearch and Development Costs\nCosts associated with the development of new products are charged to expense when incurred. Research and development costs for continuing operations for the years ended April 30, 1995, 1994, and 1993 amounted to $14,120,000, $11,120,000, and $8,880,000, respectively.\nEarnings Per Share\nNet income per Common Share is based on the weighted average number of Common Shares outstanding. The dilutive effect on net income per Common Share assuming the vesting of unearned Stock Awards is not significant.\nFair Value of Financial Instruments\nThe carrying amounts of the Company's borrowings under its short-term revolving credit agreements approximate their fair value. The weighted average interest rates on such borrowings for the years ended April 30, 1995, 1994, and 1993 were 5.28%, 4.51%, and 2.91%, respectively.\n2. ACQUISITIONS AND DISPOSALS\nOn September 9, 1994, the Company purchased for cash, a molded cable assembly business with operations located in North Haven, Connecticut, and Limerick, Ireland.\nOn April 30, 1993, the Company issued 119,690 shares of Common Stock, Class A, as an advance on the purchase of Mikon, Ltd., a manufacturer of fiber-optic cable assemblies located in England. On June 28, 1993, 102,496 additional shares of Common Stock, Class A, were issued upon completion of this acquisition.\nBoth acquisitions were accounted for as purchases. Had these acquisitions been made as of the beginning of fiscal 1993, sales and operating results would not have been materially different than reported.\nOn February 8, 1993, the Company sold the operations of Trace Instruments Co. Inc., a manufacturer of automatic circuit verification test equipment. The operating results of Trace have been reflected as discontinued operations for all years presented. Net sales for Trace were $2,286,570 in 1993.\nMETHODE ELECTRONICS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\n3. SHAREHOLDERS' EQUITY\nPreferred Stock\nThe Company has 50,000 authorized shares of Series A, 4% cumulative convertible Preferred Stock, par value $100 per share, of which none was outstanding at April 30, 1995.\nCommon Stock\nCommon Stock, Class A, is entitled to dividends at least equivalent to those paid on the shares of Common Stock, Class B. The Common Stock, Class A, has more limited voting rights than the Common Stock, Class B. Generally the holders of Common Stock, Class A, are entitled to elect 25% of the Company's Board of Directors and are entitled to one-tenth of one vote per share respecting other matters. Holders of Common Stock, Class B, are entitled to one vote per share. Each share of Common Stock, Class B, is convertible into one share of Common Stock, Class A, at the option of the holder. At April 30, 1995, 1,953,894 shares of Common Stock, Class A, are reserved for future issuance in connection with the conversion of shares of Common Stock, Class B, and the Company's Incentive Stock Award Plans.\nCommon Stock, par value $.50 per share, authorized, issued and in treasury, was as follows:\nStock Awards\nThe Company has an Incentive Stock Award Plan (Incentive Plan) which permits the issuance of up to 2,000,000 shares of Common Stock, Class A, to certain officers and key employees of the Company, of which 1,413,822 shares have been awarded through April 30, 1995. Pursuant to the terms of the Incentive Plan, the granted stock does not vest until two years after the award date. If, for any reason other than retirement, disability, or death an employee terminates his service before the two-year period, the stock will not vest and will be made available for future grants.\nThe Company also has an Incentive Stock Award Plan for Nonemployee Directors which permits the issuance of up to 80,000 shares of Common Stock, Class A, to nonemployee directors, of which 56,000 shares have been awarded at April 30, 1995. Shares awarded pursuant to this plan have no vesting restrictions.\n4. EMPLOYEE STOCK OWNERSHIP PLAN\nThe Company has an Employee Stock Ownership Plan for the benefit of full-time employees who have completed one year of service. The purpose of the Plan is to assist employees to accumulate capital ownership in the Company and through that ownership to promote in them a strong interest in the successful operation of the Company. The Company made cash contributions of $1,200,000, $1,100,000, and $900,000 to the Plan during fiscal 1995, 1994, and 1993, respectively.\n5. SUPPLEMENTAL EXECUTIVE BENEFIT PLAN\nIn fiscal 1992, the Company adopted an unfunded defined-benefit plan covering certain key executives. Benefits under the Plan are in recognition of significant contributions to the success of the Company made by the executives during their many years of service with the Company prior to adoption of the Plan. Annual payments of $900,000 pursuant to the plan are being made through fiscal year 2001.\nMETHODE ELECTRONICS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nThe net periodic cost recognized as expense for this plan was as follows:\nThe weighted-average assumed discount rate used to measure the projected benefit obligation in all years was 6 2\/3%.\n6. INCOME TAXES\nEffective May 1, 1993, the Company changed its method of accounting for income taxes as required by Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes.\" As permitted by SFAS No. 109, the Company has elected not to restate the consolidated financial statements of any prior periods to apply the provisions of SFAS No. 109. The cumulative effect on prior years of this change in accounting for income taxes as of May 1, 1993 and the effect of this change on the provision for income taxes for the year ended April 30, 1994 were not material.\nUnder SFAS 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. 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.\nSignificant components of the Company's deferred tax assets and liabilities as of April 30 were as follows:\nMETHODE ELECTRONICS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) Income taxes on income from continuing operations consisted of the following:\nA reconciliation of the consolidated provisions for income taxes to amounts determined by applying the prevailing statutory federal income tax rate (35% in 1995 and 1994 and 34% in 1993) to pretax earnings is as follows:\nDeferred income tax credits for the fiscal year 1993 resulted from the following:\nThe Company paid income taxes of approximately $14,147,000 in 1995, $9,885,000 in 1994, and $7,297,000 in 1993. No provision has been made for income taxes of approximately $4,500,000 at April 30, 1995, which would be payable should undistributed net income of $11,623,000 of foreign operations be distributed as dividends, as the Company plans to continue these foreign operations and does not contemplate such distributions in the foreseeable future.\n7. ENVIRONMENTAL MATTERS\nThe Company is involved in environmental investigation and\/or remediation at certain of its present plant sites. The Company is not yet able to determine when such remediation activity will be complete.\nAt April 30, 1995 and 1994, the Company had accruals, primarily based upon independent engineering studies, for environmental matters of approximately $4,000,000 and $5,700,000, respectively. The Company believes the provisions it has made for environmental matters are adequate to satisfy its liabilities relating to such matters.\nIn 1995, the Company spent $1,615,000 on remediation cleanups and related studies compared with $502,000 in 1994, and $529,000 in 1993. In 1995, the costs associated with environmental matters as they relate to day-to-day activities were not material.\nMETHODE ELECTRONICS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\n8. PENDING LITIGATION\nCertain litigation arising in the normal course of business is pending against the Company. The Company is of the opinion that the resolution of such litigation will not have a significant effect on the consolidated financial statements of the Company.\n9. DESCRIPTION OF BUSINESS\nThe Company operates in one industry segment, which consists of the manufacture of electronic components that connect, convey and control electrical energy, pulse and signal, including connectors, interconnect devices, controls, printed circuits, and current-carrying distribution systems. The Company manufactures products with applications in the automotive, computer, voice and data communications, industrial, military and aerospace, and consumer electronics industries.\nSales to two automotive customers approximated 42%, 45%, and 33% of net sales from continuing operations in the years ended April 30, 1995, 1994, and 1993, respectively.\nAt April 30, 1995 and 1994, accounts receivable from customers in the automotive industry were approximately $22,147,000 and $24,511,000, respectively. Receivables are generally due within 30 days. Credit losses relating to all customers consistently have been within management's expectation.\nInformation about the Company's continuing operations in different geographic regions is as follows:\nMETHODE ELECTRONICS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONCLUDED)\n10. SUMMARY OF QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)\nThe following is a summary of unaudited quarterly results of operations for the two years ended April 30, 1995.\nINDEX TO EXHIBITS\n- -------- (1) Previously filed with Registrant's Form S-3 Registration Statement No. 33- 61940 filed April 30, 1993 and incorporated herein by reference. (2) Previously filed with Registrant's Registration Statement No. 2-80666 filed December 1, 1982 and incorporated herein by reference. (3) Previously filed with Registrant's S-8 Registration Statement No. 2-60613 and incorporated herein by reference.\n(4) Carthage Precision Electric Co., a former subsidiary of the Registrant, was merged into the Registrant on July 30, 1984. (5) Previously filed with Registrant's Registration Statement No. 2-92902 filed August 23, 1984 and incorporated herein by reference. (6) Previously filed with Registrant's Form 10-Q for three months ended January 31, 1994 and incorporated herein by reference. (7) Previously filed with Registrant's Form 10-K for the year ended April 30, 1994 and incorporated herein by reference. (8) Previously filed with Registrant's S-8 Registration Statement No. 33-88036 and incorporated herein by reference. *Management contract or compensatory plan or arrangement required to be filed as an exhibit to this Annual Report on Form 10-K pursuant to Item 14(c) of Form 10-K.","section_15":""}
{"filename":"96763_1995.txt","cik":"96763","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"ITEM 2 PROPERTIES - ------------------ The following properties were owned or leased by the Company at December 31, 1995. The Trevose and Philadelphia locations are used in more than one business segment. All other properties are used exclusively in one segment, as identified.\nThe Company believes its facilities to be adequate for its present needs.\nPage 6 of 38\nITEM 3","section_3":"ITEM 3 PENDING LEGAL PROCEEDINGS - --------------------------------- The Company is a defendant in several lawsuits which it considers to be in the normal 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 - NONE - -------------------------------------------------------------------\nPART II\nITEM 5","section_5":"ITEM 5 MARKET PRICE OF REGISTRANT'S COMMON STOCK AND RELATED SECURITY MATTERS - ------------------------------------------------------------------------------ Technitrol Inc.'s common stock is traded on the American Stock Exchange. The following table reflects the high and low sales prices on such Exchange and the dividends paid to shareholders in each quarterly period during Technitrol's last two fiscal years.\nQUARTER 1ST 2ND 3RD 4TH ------- ------- ------- ------- 1995 HIGH $15.625 $15.000 $18.000 $23.750\n1995 LOW $13.375 $13.250 $14.000 $15.875\n1995 DIVIDENDS PAID $ 0.095 $ 0.095 $ 0.100 $ 0.100\n1994 HIGH $11.792 $12.917 $14.500 $16.000\n1994 LOW $ 9.875 $10.875 $11.583 $12.000\n1994 DIVIDENDS PAID $ .093 $ .093 $ .093 $ .095\nThe approximate number of holders of record of the common stock, Technitrol Inc.'s only class of stock outstanding, as of January 12, 1996 was:\nTITLE OF CLASS NUMBER OF SHAREHOLDERS -------------- ---------------------- Common Stock 745 par value $.125 per share\nPage 7 of 38\nPage 8 of 38\nITEM 7","section_6":"","section_7":"ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ----------------------------------------------------------------\nLiquidity and Capital Resources - -------------------------------\nCash and cash equivalents totalled $13.9 million at December 31, 1995, compared to $8.7 million a year earlier. Working capital was $43.2 million, compared to $32.7 million at December 31, 1994. The financial performance during the fourth quarter of 1995, which included the operations of Pulse Engineering, Inc. (\"Pulse\"), contributed to the year-to-year increase in working capital. Pulse was acquired at the end of September 1995 and the large increases in consolidated accounts receivable and inventory were due primarily to the Pulse balances acquired. Pulse had a favorable working capital ratio prior to the acquisition and it remained strong subsequent to the acquisition. Additional information regarding the Pulse acquisition is included in Note 2 of Notes to the Consolidated Financial Statements.\nCash provided by 1995 operating activities was $18.2 million. The positive cash flow was composed mainly of net earnings of $9.3 million, depreciation and amortization of $6.2 million, and increases in accounts payable and accrued expenses of $1.2 million and $1.7 million, respectively. Depreciation and amortization amounts included three months of depreciation on the Pulse assets and three months of amortization of the goodwill resulting from the Pulse acquisition. Significant decreases in prepaid expenses and other assets (excluding amounts acquired from Pulse) also provided cash during the year. Cash was provided by a decrease in accounts receivable of $1.3 million while cash of $2.8 million was consumed by an increase in inventories. The increase in inventories includes amounts produced by the Electronic Components Segment, which includes Pulse, in anticipation of the Chinese New Year holiday in February 1996. The Company's production operations in the Peoples Republic of China (the \"PRC\") and in Taiwan are typically closed for one to two weeks for this holiday and inventory is built in anticipation of the lost production time.\nInvesting activities consumed $11.6 million during 1995. Capital expenditures constituted $5.9 million, excluding acquisitions. Separately, cash of $5.9 million was paid for the capital stock of Pulse stockholders, net of cash acquired. The cash portion of the purchase price, including the cash paid to the former stockholders of Pulse and related acquisition costs, was approximately $27.6 million. Cash acquired from Pulse and used to partially fund the acquisition was approximately $21.7 million. Additional financing for the acquisition was provided by bank borrowings as described below. Projected 1996 capital expenditures are expected to be financed by internally generated funds.\nCash used in financing activities was a net $1.3 million. Cash consumed by financing activities was due to combined debt reduction of $7.8 million and $2.5 million of dividend payments. It is expected that dividends will continue to be paid on a quarterly basis during 1996. Proceeds from long-term borrowings were $9.0 million. The proceeds included $5.0 million which was used to finance the May 1995 purchase of warrants for Pulse common stock. In connection with the September 1995 closing of the Pulse acquisition, an additional $4.0 million was borrowed under a bank syndicated credit facility which authorized Technitrol to borrow up to $50 million on an unsecured basis. Technitrol used approximately $18.0 million of this credit facility to refinance existing indebtedness (including the $5.0 million which had been borrowed to fund the Pulse warrant purchase in May 1995) and, separately, approximately $4.0 million of the credit facility to partially fund the acquisition costs and cash payments to former shareholders of Pulse. On December 29, 1995, the credit facility was amended in conjunction with a partial repayment and the total facility was reduced to $45.0 million. Further payments in advance of the due date were made in February and March of 1996 in amounts of $6.0 million and $1.0 million, respectively. Approximately $3.6 million (before payment of related transaction expenses and costs) was received at the end of February 1996 from the sale of the Products Division as explained in Note 14 of Notes to the Consolidated Financial Statements. A portion of these funds were applied in March, as aforementioined, to pay off all amounts outstanding under the line of credit. The balance of the funds received will be used for general working capital purposes.\nPage 9 of 38\nThe Company's foreign sales are conducted primarily through its foreign subsidiaries, principally in the Far East and Europe. In the Far East, the Company's sales are denominated primarily in U.S. dollars. In Europe, sales are denominated in local currencies (consisting mainly of English pounds and French francs) and in U.S. dollars. Since a very significant portion of the Company's foreign sales are denominated in U.S. dollars, the Company does not believe that its potential exposure to currency fluctuations is material to its business. During 1994, the Company did not purchase any currency exchange forward contracts or similar instruments generally utilized to reduce the risk of currency fluctuations. During 1995, a limited number of short-term forward contracts were purchased by a Pulse subsidiary in Europe. All such contracts were closed prior to the end of the year. These contracts are purchased in order to guarantee a predetermined currency exchange rate at the time the contract is purchased by transferring the risk or benefit of currency fluctuations to a third party.\nSlightly more than one-quarter of the Company's identifiable assets are located in the Far East and significant sales and operating profits are generated in that region. (See the geographic segment data included in Note 13 of Notes to the Consolidated Financial Statements.) The Company's operations in the region include manufacturing plants in the PRC, Taiwan and the Philippines. If unfavorable political, economic or other events occur in that region, they could have a material adverse effect on the Company's liquidity and capital resources. Management monitors events in the region and takes steps to reduce the risk of uncertainty when possible.\nBalance Sheet Composition at December 31:\nRESULTS OF OPERATIONS - ---------------------\n1995 and 1994 - -------------\nRevenues - -------- Consolidated sales for the Company were $176.4 million in 1995, an increase of 20.5% from 1994. The increase was largely due to the sales of Pulse, acquired at the end of September 1995. The Pulse sales included in the consolidated results of the Company were approximately $25.4 million. The sales increases of the Electronic Components Segment (which includes Pulse) and the Test & Measurement Products Segment exceeded a sales decrease experienced by the Metallurgical Products Segment. The Company's backlog at December 31, 1995 was $55.9 million, including $28.2 million for Pulse.\nPage 10 of 38\nThe sales of the Electronic Components Segment increased from $41.2 million in 1994 to $68.4 million in 1995. The Fil-Mag Group and Pulse, along with the Components Division of the Company, have been combined into one world-wide operation serving the needs of the local area network (LAN) and telecommunications marketplaces. In addition to the Pulse sales noted above, sales of the Fil-Mag Group increased during the year. The lower sales level of the Components Division, which was caused by a decline in domestic demand for that Division's products, was more than offset by increased demand for products manufactured by Fil-Mag and Pulse. The strong demand of these markets for products produced by Pulse and the Fil-Mag Group continued into the beginning of 1996, as evidenced by solid backlog and order levels at the end of 1995. Operating profits for the Segment in 1995 were $10.7 million compared to $5.0 million in 1994. The sales and operating profits of the Segment included three months of Pulse activity.\nThe Metallurgical Products Segment experienced a number of challenges during 1995 and the sales and operating profits of this Segment were lower than the 1994 levels. Sales in 1995 were $75.3 million, down from $76.5 million in 1994. A sales decrease at Advanced Metallurgy, Inc. (\"AMI\") exceeded a sales increase at Chace Precision Metals, Inc. (\"Chace\"). The sales of AMI and, to a lesser extent, Chace are affected by general trends in the domestic economy, particularly those in housing, automotive, appliances and capital equipment markets. During the second half of 1995, there was a softening in demand for the products of this Segment. In addition, the Segment's operating profits were negatively impacted by increased price competition and rapidly escalating raw material costs, particularly in the nonprecious metals markets. Management has focused significant attention on attaining increased manufacturing efficiencies and has implemented a partial pass-through of the raw material price changes by way of both a price increase and a metals factor. Operating profits of the Segment were $1.8 million in 1995, down from $4.8 million in 1994.\nIn the Test & Measurement Products Segment, sales increases at John Chatillon & Sons, Inc. (\"Chatillon\") and Lloyd Instruments, Inc. (\"Lloyd\") exceeded a sales decrease at the Products Division. That sales decrease was primarily caused by weak domestic demand for the currency counters and dispensers manufactured by the Products Division. The February 1996 sale of the Products Division evidenced management's intention to focus on the test and measurement product lines within this Segment. Relative to the 1995 results, Lloyd in particular contributed to the higher sales and operating profits of the Segment. The 1995 Lloyd sales included a full year of the sales of Erichsen, a German subsidiary acquired late in 1994. Chatillon's sales benefited from recent product development efforts. Sales for the Segment increased from $28.7 million in 1994 to $32.8 million in 1995 while operating profits increased from $2.7 million to $2.9 million.\nCost of Sales - ------------- In 1995, the Company's gross margin increased by 6%, from 29.6% of sales in 1994 to 31.5% in 1995. This margin increase was driven primarily by the strong product demand and increased manufacturing efficiencies within the Electronic Components Segment. These gains offset the lower gross profits of the Metallurgical Products Segment which experienced significant decreases in gross profits versus the prior year, with the majority of the gross profit decline occurring at AMI. The softer demand, increased price competition and rising metal costs noted above caused this decline.\nOperating Expenses - ------------------ The Company's selling, general and administrative expenses increased to $40.2 million in 1995 from $30.8 million in 1994. This represented 22.8% of sales in 1995 and 21.0% of sales in 1994. The increase was primarily caused by the addition of Pulse for the fourth quarter.\nInterest - -------- Interest expense increased from $1.1 million in 1994 to $1.4 million in 1995 reflecting the incremental borrowing related to the Pulse acquisition.\nPage 11 of 38 Income Taxes - ------------ The Company's effective income tax rate declined to 36% in 1995 from 39% in 1994. During 1995, proportionately higher taxable income was earned by the Company's foreign operations, which generally have lower tax rates than the domestic operations.\nDuring 1995, the Financial Accounting Standards Board issued Financial Accounting Standard No. 123, Accounting for Stock-Based Compensation (\"FAS123\"). Under the new standard, companies have the option of including certain stock-based compensation in the company's statement of earnings or, alternately, providing disclosure of the related compensation amounts in a note to the financial statements. The new disclosures apply to financial statements for years beginning after December 15, 1995. The Company intends to adopt the disclosure alternative and does not expect FAS123 to have a material impact on its pro forma results of operations. During 1995, the Company did not grant incentive stock options to employees. However, in connection with the acquisition of Pulse on September 29, 1995 (see Note 2 to Consolidated Financial Statements), outstanding options to purchase Pulse common stock were assumed by the Company and converted into options to purchase Technitrol common stock. The difference between the exercise price and the market value of Technitrol stock at the date of acquisition was capitalized as part of the purchase price. No additional options are expected to be issued under the assumed plans. See Note 11 to the Consolidated Financial Statements for additional information regarding stock-based compensation provided by the Company.\nThe Statement of Financial Accounting Standards No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of, is effective for fiscal years beginning after December 15, 1995. The adoption of this standard is not expected to have a material impact on the Company.\n1994 and 1993 - -------------\nRevenues - -------- In 1994, consolidated sales were $146.4 million compared to $100.5 million in 1993. The 45.7% increase was due to the $30.8 million sales of the Fil-Mag Group, acquired in January 1994, and a combined sales increase of $15.1 million realized by the other businesses of the Company. All three of the Company's segments experienced increased sales in 1994 from 1993.\nThe December 31 backlog was $28.7 million in 1994 and $14.9 million in 1993. Contributing to the increase was the Fil-Mag Group's backlog.\nThe increase in sales of the Electronic Components Segment to $41.2 million included the sales of the Fil-Mag Group as noted above. Operating profit of the Electronics Components Segment increased to $5.0 million in 1994, compared to $1.7 million in the prior year. The increase reflected the fifty weeks of profits of the Fil-Mag Group since its acquisition in January 1994. As a percentage of sales, this segment's annual operating profits equaled 12.2% which was the highest of the Company's three product segments. Year end backlog and order volumes indicated a softening in the segment's domestic markets, while offshore demand remained relatively strong.\nThe Metallurgical Products Segment produced increased sales, operating profit and operating profit as a function of sales in 1994 as compared to 1993. AMI experienced its largest sales and profit improvements to the product line which was acquired from Engelhard Corporation in 1991. Housing starts continued to have an eventual impact on demand for various AMI products. Management monitored the indirect effect that interest rate increases had on AMI backlog levels which were stable entering the first quarter of 1995. Separately, Chace sales and operating profits also grew year-to-year. On-going efforts aimed at cost containment and quality improvements contributed to the growth in sales volume and profits. Chace's proven ability to compete in a demanding industrial market was reflected by a strong backlog position as it began 1995.\nPage 12 of 38\nTwo of the three operating units within the Test & Measurement Products Segment experienced an increase in sales and operating profits. Chatillon sales volume and profitability improved in its primary product families, as the improved economic climate contributed to more favorable market conditions. Lloyd's year-to-year sales increase reflected incremental unit sales and the absence of the unfavorable currency translation which negatively impacted 1993 results. Lower sales and operating profit occurred at the Company's Products Division. Domestic demand for currency counters and dispensers decreased during 1994, which was also the first full year subsequent to the Division withdrawing as a provider of engineering services on a prime contract basis to an agency of the U.S. Government.\nCost of Sales - ------------- In 1994, the Company's overall gross margin increased to 29.6% of sales from 26.9% in 1993. Improvements were made in each of the Company's three business segments. The addition of the Fil-Mag Group within the Electronic Components Segment, cost containment and quality improvements within the Metallurgical Products Segment and the higher sales of Chatillon and Lloyd included in the Test & Measurement Products Segment all contributed to a higher gross margin in 1994.\nOperating Expense - ----------------- The Company's selling, general and administrative expenses increased to $30.8 million in 1994 from $21.6 million in 1993. The key reason for the increase was the addition of the Fil-Mag Group.\nInterest - -------- Interest expense grew to $1.1 million, caused by the $10 million increase in outstanding debt to fund the Fil-Mag Group acquisition and rising interest rates during the year.\nIncome Taxes - ------------ 1994 income tax expenses increased as a function of pre-tax earnings. The 1994 effective income tax rate rose to 39% from 35% in 1993 as a result of proportionately higher taxable income being earned by the Company's domestic operations. Effective income tax rates of the domestic operations generally exceed those of the Company's offshore operations.\nITEM 8","section_7A":"","section_8":"ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - --------------------------------------------------- The Company's consolidated financial statements, notes to the consolidated financial statements, together with the opinion of the Company's independent auditors and the supplementary financial information required by this item are attached hereto and made part hereof.\nITEM 9","section_9":"ITEM 9 DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE - NONE - -------------------------------------------------------------------\nPage 13 of 38\nPART III\nCROSS REFERENCE INDEX\nFORM 10-K ITEM NUMBER AND CAPTION INCORPORATED MATERIAL ------------------------------ ------------------------------ ITEM 10","section_9A":"","section_9B":"","section_10":"ITEM 10 DIRECTORS, EXECUTIVE OFFICERS, REGISTRANT'S DEFINITIVE PROXY PROMOTERS & CONTROL PERSONS STATEMENT ITEM 11","section_11":"ITEM 11 EXECUTIVE COMPENSATION REGISTRANT'S DEFINITIVE PROXY STATEMENT ITEM 12","section_12":"ITEM 12 SECURITY OWNERSHIP OF CERTAIN REGISTRANT'S DEFINITIVE PROXY BENEFICIAL OWNERS AND STATEMENT MANAGEMENT ITEM 13","section_13":"ITEM 13 CERTAIN RELATIONSHIPS AND REGISTRANT'S DEFINITIVE PROXY RELATED TRANSACTIONS STATEMENT\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\nFinancial Statements --------------------\nIndependent Auditors' Report Consolidated Balance Sheets - December 31, 1995 and 1994 Consolidated Statements of Earnings and Retained Earnings - Years ended December 31, 1995, 1994 and 1993 Consolidated Statements of Cash Flows - Years ended December 31, 1995, 1994 and 1993 Notes to Consolidated Financial Statements\nFinancial Statement Schedules -----------------------------\nSchedule II, Valuation and Qualifying Accounts\n(b) The Company filed a report on Form 8-K on October 13, 1995 regarding the acquisition of Pulse Engineering on September 29, 1995.\n(c) Exhibits\n(11) Computation of Primary and Fully Diluted Earnings Per Share (21) Subsidiaries of the Registrant (23) Consent of Certified Public Accountants (27) Financial Data Schedule (electronic filing only)\nPage 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 report to be signed on its behalf by the undersigned, thereunto duly authorized.\nTECHNITROL, INC.\nBy \/s\/Thomas J. Flakoll ------------------------------------- Thomas J. Flakoll Chief Executive Officer and Director\nDate March 20, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, 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\/Stanley E. Basara By \/s\/Drew A. Moyer ------------------------------- ------------------------------ Stanley E. Basara Drew A. Moyer Director Corporate Controller (Principal Accounting Officer)\nDate March 20, 1996 Date March 20, 1996\nBy \/s\/John E. Burrows, Jr. By \/s\/James M. Papada, III ------------------------------- ------------------------------ John E. Burrows, Jr. James M. Papada, III Director Chairman of the Board of Directors\nDate March 20, 1996 Date March 20, 1996\nBy \/s\/J. Barton Harrison By \/s\/James J. Rafferty, Jr. ------------------------------- ------------------------------ J. Barton Harrison James J. Rafferty, Jr. Director Vice President and Director\nDate March 20, 1996 Date March 20, 1996\nBy \/s\/Roy E. Hock By \/s\/Albert Thorp, III ------------------------------- ------------------------------ Roy E. Hock Albert Thorp, III Director Vice President - Finance and Treasurer (Principal Financial Officer)\nDate March 20, 1996 Date March 20, 1996\nBy \/s\/Graham Humes ------------------------------- Graham Humes Director\nDate March 20, 1996\nBy \/s\/Edward M. Mazze ------------------------------ Edward M. Mazze Director\nDate March 20, 1996\nPage 15 of 38\nINDEX TO FINANCIAL STATEMENTS AND SCHEDULES\nFinancial Statements -------------------- Independent Auditors' Report\nConsolidated Balance Sheets - December 31, 1995 and 1994\nConsolidated Statements of Earnings and Retained Earnings - Years ended December 31, 1995, 1994 and 1993\nConsolidated Statements of Cash Flows - Years ended December 31, 1995, 1994 and 1993\nNotes to Consolidated Financial Statements\nFinancial Statement Schedules ----------------------------- Schedule II - Valuation and Qualifying Accounts\nPage 16 of 38\nIndependent Auditors' Report\nThe Board of Directors and Shareholders Technitrol, Inc.:\nWe have audited the consolidated financial statements of Technitrol, Inc. and subsidiaries as listed in the accompanying index. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule as listed in the accompanying index. These consolidated financial statements and the financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and the financial statement schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Technitrol, Inc. and subsidiaries at December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1995 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 6 to the consolidated financial statements, the Company changed its method of accounting for income taxes in 1993 to adopt the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\"\nKPMG Peat Marwick LLP\nPhiladelphia, Pennsylvania March 1, 1996\nPage 17 of 38\nTECHNITROL, INC. AND SUBSIDIARIES\nConsolidated Balance Sheets\nDecember 31, 1995 and 1994\nIn thousands of dollars, except for share data\nAssets 1995 1994 ------ -------- ------- Current Assets: Cash and cash equivalents $ 13,894 $ 8,716 Receivables: Trade 33,431 22,614 Other 308 139 Inventories 32,962 21,714 Prepaid expenses and other current assets 2,019 851 -------- ------- Total current assets 82,614 54,034\nProperty, plant and equipment 81,063 55,180 Less accumulated depreciation 35,935 30,809 -------- ------- Net property, plant and equipment 45,128 24,371 Deferred income taxes 4,132 2,409 Excess of cost over net assets acquired 10,957 2,320 Other assets 2,109 1,621 -------- ------- $144,940 $84,755 ======== =======\nLiabilities and Shareholders' Equity ------------------------------------ Current liabilities: Current installments of long-term debt $ 2,023 $ 22 Short-term debt -- 756 Accounts payable 8,359 5,841 Accrued expenses 28,990 14,739 -------- ------- Total current liabilities 39,372 21,358\nLong-term liabilities: Long-term debt, excluding current installments 15,102 15,124 Accrued pension expense 2,237 2,516 Other long-term liabilities 3,468 --\nCommitments and contingencies (Note 7)\nShareholders' equity: Common stock, $.125 par. 30,000,000 shares authorized and 10,733,832 issued in 1995; 10,000,000 shares authorized and 8,943,960 issued in 1994. 1,342 1,118 Additional paid-in capital 36,907 4,329 Retained earnings 52,517 45,923 -------- ------- 90,766 51,370\nLess: Cost of treasury stock (2,897,963 shares in 1995, and 2,922,508 in 1994) (4,535) (4,573) Unearned compensation under stock award plan (697) (560) Cumulative translation adjustment (773) (480) -------- ------- Total shareholders' equity 84,761 45,757 -------- ------- $144,940 $84,755 ======== =======\nSee accompanying Notes to Consolidated Financial Statements.\nPage 18 of 38\nTECHNITROL, INC. AND SUBSIDIARIES Consolidated Statements of Earnings and Retained Earnings Years ended December 31, 1995, 1994 and 1993 In thousands, except per share data\n1995 1994 1993 -------- -------- -------- Net sales $176,419 $146,444 $100,457 Cost of sales 120,765 103,096 73,480 -------- -------- -------- Gross profit 55,654 43,348 26,977\nSelling, general and administrative expenses 40,165 30,787 21,602 -------- -------- -------- Operating profit 15,489 12,561 5,375 Other income (expense): Interest income 374 140 108 Interest expense (1,383) (1,130) (389) Other, net 61 (182) 71 -------- -------- -------- (948) (1,172) (210) -------- -------- -------- Earnings before income taxes 14,541 11,389 5,165 Income taxes 5,201 4,445 1,809 -------- -------- --------\nNet earnings before cumulative effect of a change in accounting for income taxes $ 9,340 $ 6,944 $ 3,356\nCumulative effect on prior years (to January 1, 1993) of a change in accounting for income taxes (Note 6) -- -- 261 -------- -------- -------- Net earnings $ 9,340 $ 6,944 $ 3,617 ======== ======== ======== Earnings per share: Before cumulative effect of a change in accounting for income taxes $ 1.43 $ 1.15 $ .56 Cumulative effect of a change in accounting for income taxes $ -- $ -- $ .04 -------- -------- -------- Total earnings per share $ 1.43 $ 1.15 $ .60 ======== ======== ======== Average outstanding common and equivalent shares 6,538 6,015 5,989 ======== ======== ======== Retained earnings: Balance at beginning of year $ 45,923 $ 41,993 $ 40,614 Net earnings for the year 9,340 6,944 3,617 -------- -------- -------- $ 55,263 $ 48,937 $ 44,231 200% Common stock dividend -- 745 -- Cash dividends declared: ($.395 per share in 1995, $.376 in 1994 and $.373 in 1993) 2,746 2,269 2,238 -------- -------- -------- Balance at end of year $ 52,517 $ 45,923 $ 41,993 ======== ======== ========\nSee accompanying Notes to Consolidated Financial Statements.\nPage 19 of 38\nTECHNITROL, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows Years ended December 31, 1995, 1994, and 1993 In thousands of dollars\nCash flows from operating activities: 1995 1994 1993 ------- ------- ------- Net earnings $ 9,340 $ 6,944 $ 3,617 Cumulative effect of a change in accounting for income taxes -- -- (261) Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation and amortization 6,245 5,271 4,991 Loss (gain) on disposal of equipment (40) 88 (60) Changes in assets and liabilities net of effect of acquisitions: Increase in deferred tax benefits (1,711) (1,019) (492) Increase in accounts payable 1,216 1,082 689 Increase in accrued expenses 1,704 4,967 1,779 (Increase)decrease in accounts receivable 1,346 (4,626) 142 (Increase)decrease in inventories (2,769) (2,482) 1,031 Other, net 2,848 (606) 112 ------- ------- -------\nNet cash provided by operating activities 18,179 9,619 11,548 ------- ------- -------\nCash flows from investing activities: Acquisition of capital stock of the Fil-Mag Group, net of cash acquired -- (8,805) -- Acquisition of Pulse, net of cash acquired (5,872) -- -- Capital expenditures, exclusive of acquisitions (5,864) (4,429) (2,655) Proceeds from sale of property, plant and equipment 158 282 71 ------- ------- ------- Net cash used in investing activities (11,578) (12,952) (2,584) ------- ------- -------\nCash flows from financing activities: Repayment of Fil-Mag Group funded indebtedness -- (1,014) -- Principal payments on long-term debt (7,022) (21) (8,421) Net repayments of short term debt (756) (2,504) -- Proceeds of long-term borrowings 9,000 10,000 6,700 Dividends paid (2,534) (2,255) (2,237) ------- ------- ------- Net cash provided by (used in) financing activities (1,312) 4,206 (3,958) ------- ------- ------- Net effect of exchange rate changes on cash (111) 122 (33)\nNet increase in cash and cash equivalents 5,178 995 4,973\nCash and cash equivalents at beginning of year 8,716 7,721 2,748 ------- ------- -------\nCash and cash equivalents at end of year $13,894 $ 8,716 $ 7,721 ======= ======= =======\nSee accompanying Notes to Consolidated Financial Statements.\nPage 20 of 38\nTECHNITROL, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\n(1) Summary of Significant Accounting Policies ------------------------------------------\nPrinciples of Consolidation - --------------------------- The consolidated financial statements include the accounts of Technitrol, Inc. (the \"Company\") and all of its subsidiaries. All material intercompany accounts and transactions are eliminated in consolidation.\nCash and Cash Equivalents - ------------------------- Cash and cash equivalents include funds invested in a variety of liquid short-term investments with a maturity of three months or less.\nInventories - ----------- Inventories are stated at the lower of cost or market. Cost is determined by the first-in, first-out (FIFO) method. In addition to the inventories included in the accompanying balance sheets, the Company has custody of inventories on consignment from suppliers ($11,118,000 at December 31, 1995 and $14,063,000 at December 31, 1994). This inventory consists primarily of silver which is used in the Company's metal contact manufacturing business.\nProperty, Plant and Equipment - ----------------------------- Property, plant and equipment are stated at cost. Depreciation is based upon the estimated useful life of the assets and has been provided for on both the accelerated and the straight line methods. The estimated useful lives range from 5 to 30 years for buildings and improvements and from 3 to 10 years for machinery and equipment. Expenditures for maintenance and repairs are charged to operations as incurred, and major renewals and betterments are capitalized. Upon sale or retirement, the cost of the asset and related accumulated depreciation are removed from the balance sheet, and any resulting gains or losses are included in earnings.\nExcess of Cost over Net Assets - ------------------------------ Excess of cost over net assets acquired (which the Company believes has continuing value) is being amortized on a straight-line basis over 15 years. The recoverability of its carrying value is evaluated on a recurring basis by determining whether the amortization of its remaining balance can be recovered through future operating cash flows of the acquired operation.\nEarnings per Share - ------------------ Earnings per share are calculated by dividing earnings by the weighted average number of common shares outstanding during the year, including common share equivalents. Common share equivalents are incremental shares attributed to outstanding options to purchase common stock. Relevant earnings per share amounts have been restated to reflect a 200% stock dividend recorded on September 18, 1994.\nForeign Currency Translation - ---------------------------- Most foreign subsidiaries' functional currency is the U.S. dollar; those entities 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 depreciation and cost of sales which are translated at historical rates. Gains or losses from changes in exchange rates are recognized in earnings in the year of occurrence. The remaining entities use the local currency as the functional currency and translate net assets at year-end rates while income and expense accounts are translated at average exchange rates. Adjustments resulting from these translations are reflected in the shareholders' equity section titled \"Cumulative translation adjustment.\"\nFair Value of Financial Instruments - ----------------------------------- The carrying value of cash and cash equivalents, receivables, other current assets, accounts payable and accrued expenses approximates fair value because of the short maturity of those instruments. The carrying value of long term debt approximates fair value after taking into consideration current rates offered to the Company for similar debt instruments of comparable maturities.\nPage 21 of 38\nTECHNITROL, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, continued\n(1) Summary of Significant Accounting Policies, continued ------------------------------------------ Estimates - --------- The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions. These estimates and assumptions may affect the reported amounts of assets and liabilities and the 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.\nReclassifications - ----------------- Certain amounts in the prior year financial statements have been reclassified to conform with the current year presentation.\n(2) Acquisitions ------------ On September 29, 1995, the Company completed the acquisition of Pulse Engineering, Inc. (\"Pulse\"), pursuant to an Agreement and Plan of Merger dated May 23, 1995. As a result of the merger, Pulse became a wholly-owned subsidiary of the Company. Pulse, headquartered in San Diego, California, and with operations in Hong Kong, the People's Republic of China and Ireland, designs, manufactures and markets electronic components and modules primarily for manufacturers of local area networks and telecommunications systems.\nThe total purchase price approximated $61.5 million and consisted of cash paid to the former Pulse stockholders, stock issued to the former Pulse stockholders, stock options assumed, and related acquisition costs. The fair value of the assets acquired and liabilities assumed approximated $66.5 million and $14.0 million, respectively. The excess of cost over net assets acquired approximated $9.0 million.\nApproximately 1,785,000 shares of Technitrol common stock at a fair market value of $16.375 per share were issued to former holders of Pulse common stock. The cash portion of the purchase price, including cash paid to the former stockholders of Pulse and related acquisition costs, was approximately $27.6 million. In addition, all outstanding options to purchase Pulse common stock were assumed by the Company. At the date of acquisition, approximately 269,000 shares of Technitrol common stock were issuable upon exercise of such options and, except for approximately 33,000 options which were not yet vested, all assumed options were exercisable immediately at prices ranging from $1.73 to $15.61. The options have various expiration dates, the latest of which is in April 2001. The shares issued and the options outstanding were included in the weighted average shares outstanding used for calculating earnings per share for the quarter and the year ended December 31, 1995.\nIn conjunction with the Pulse acquisition, Technitrol established a credit facility with a group of banks which authorized Technitrol to borrow up to $50 million on an unsecured basis. Technitrol initially used approximately $18 million of this credit facility to refinance existing indebtedness and, separately, approximately $4 million of the credit facility to partially fund the cash portion of the merger consideration. On December 29, 1995, the credit facility was amended in conjunction with a partial repayment and the total facility was reduced to $45 million.\n(continued)\nPage 22 of 38\nTECHNITROL, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, continued\n(2) Acquisitions, continued ------------ Since the shares issued to the former holders of Pulse common stock and the options assumed in connection with the acquisition were outstanding for the entire fourth quarter (but only for a portion of the entire year), the weighted average shares outstanding were considerably different for the year than for the fourth quarter alone. As a result, the earnings per share for the year will not equal the sum of the four quarterly earnings per share amounts.\nThe acquisition has been accounted for by the purchase method of accounting. Had Pulse been acquired on January 1, 1994, unaudited consolidated pro forma results of operations would have been (in thousands, except for earnings per share):\nYear Ended Year Ended Dec. 31, 1995 Dec. 31, 1994 ------------- ------------- Sales $252,104 $177,913 Net earnings $16,825 $8 Earnings per share $2.10 $0.00\nThis unaudited information is provided for comparative purposes only. It does not purport to be indicative of the results that actually would have occurred if the acquisition had been consummated on the date indicated or which may be obtained in the future. The pro forma earnings per share amounts include the effect of shares issued and stock options assumed in connection with the merger.\nOn January 17, 1994, the Company, through its wholly-owned subsidiary, Technitrol International, Inc., a Delaware corporation, acquired from FEE Technology, S.A. all of the issued and outstanding capital stock of FEE Fil-Mag Taiwan Corporation (\"FFT\"), FEE Fil-Mag Singapore Pte. Corporation (\"FFS\") and Fil-Mag, Inc. (\"FMI\"). FFT, FFS and FMI are referred to below as the \"Fil-Mag Group\". The Fil-Mag Group is a supplier of magnetic components to domestic and international manufacturers of PCs, network interface cards, network controllers and other devices that are connected to data communications networks such as Token Ring and Ethernet. The Fil- Mag Group conducted manufacturing operations in its plants in Taiwan and the Philippines; engineering activities at its San Diego, California location; and sales operations through offices in France, Singapore and San Diego.\nThe purchase price of the Fil-Mag Group was $9,082,000 (net of expenses). In addition, the Company caused FMI to repay to FEE Technology, S.A. approximately $1 million of indebtedness. FFT was indebted to local banks in the amount of approximately $3.3 million, all of which has been retired since the acquisition. The assets acquired and liabilities assumed approximated $15.5 million and $8.6 million, respectively. The excess of cost over net assets acquired approximated $2.5 million. The purchase price and the $1 million debt repayment were financed by borrowing $10 million under a temporary acquisition line of credit and cash on-hand of approximately $400,000.\n(continued)\nPage 23 of 38\nTECHNITROL, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, continued\n(2) Acquisitions, continued ------------ Subsequent to the acquisition, eight key employees of the Fil-Mag Group entered into a covenant against competition with the Company in exchange for which the Fil-Mag Group paid them, in the aggregate, $1 million during the twelve months subsequent to the acquisition. The $1 million was financed by cash on-hand and is being amortized on a straight- line basis over the life of the agreement.\nThe purchase price for Pulse and the purchase price for the Fil-Mag Group were arrived at pursuant to arms-length negotiations, taking into account all pertinent factors including, but not limited to, the nature, monetary and strategic value of the assets being acquired, business prospects of Pulse and each member of the Fil-Mag Group and the synergies of the businesses with the current operations of the Company.\n(3) Financial Statement Details --------------------------- The following provides details for certain financial statement captions at December 31, 1995 and 1994:\n1995 1994 ------- ------- Inventories Finished goods $12,926 $ 5,471 Work in progress 8,888 8,420 Raw materials and supplies 11,148 7,823 ------- ------- $32,962 $21,714 ======= =======\nProperty, plant and equipment Land $ 2,152 $ 1,044 Buildings and improvements 23,026 15,074 Machinery and equipment 55,885 39,062 ------- ------- $81,063 $55,180 ======= =======\nAccrued expenses Income taxes payable $ 7,082 $ 1,916 Dividends payable 784 572 Accrued compensation 5,980 3,118 Current portion of accrued pension expense 2,321 2,073 Other accrued expenses 12,823 7,060 ------- ------- $28,990 $14,739 ======= =======\n(continued)\nPage 24 of 38\nTECHNITROL, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, continued\n(4) Long-term Debt -------------- Long-term debt was as follows (in thousands):\n1995 1994 ---- ---- Bank Loans - ----------\nFixed rate term loan (6.65%) due December 29, 2000 $10,000 $ --\nVariable rate revolving credit facility with $35.0 million maximum draw, due September 29, 1998 $ 7,000 --\nVariable-rate (LIBOR plus 0.75%) bank loan facility with $20.0 million maximum draw, due March 1997 (6.97% rate at December 31, 1994) $ -- $15,000 ------- ------- Total bank loans $17,000 $15,000\nMortgage Notes, secured by mortgages on land, buildings, and certain equipment:\n4.5% mortgage notes, due in monthly installments until 2000 125 146 ------- ------- Total long-term debt 17,125 15,146\nLess current installments 2,023 22 ------- ------- Long-term debt excluding current installments $15,102 $15,124 ======= =======\nAt the Company's option, interest on the revolving credit facility at December 31, 1995 may be based on the prime rate or on the LIBOR rate plus 0.625%. At December 31, 1995, $5 million was outstanding under the prime rate (then 8.5%) and $2 million was outstanding under the LIBOR rate alternative (then 6.5%).\nPrincipal payments due within the next five years are as follows (in thousands): 1996 $ 2,023 1997 2,024 1998 9,025 1999 2,026 2000 2,027\nThe Bank Loan facilities are unsecured and contain certain covenants requiring maintenance of minimum net worth and other customary and normal provisions. The Company is in compliance with all such covenants.\n(continued) Page 25 of 38\nTECHNITROL, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, continued\n(5) Research and Development Expense -------------------------------- Research and development expense is included in selling general and administrative expenses and has not exceeded 11% of such expenses in 1995, 1994 and 1993.\n(6) Income Taxes ------------ During 1992, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"FAS 109\"). FAS 109 required a change from the deferred method of accounting for income taxes of Accounting Principles Board 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. The change in these deferred tax assets or liabilities, including the effect of a change in tax rates, if any, from the beginning to the end of the period generally is recognized as deferred tax expense or benefit. Effective January 1, 1993, the Company adopted FAS 109 and has reported the cumulative effect of that change in the method of accounting for income taxes in the consolidated statement of earnings for the year ended December 31, 1993.\nEarnings before income taxes were as follows (in thousands):\n1995 1994 1993 ------- ------- ------ Domestic $ 1,941 $ 8,406 $4,540 Foreign 12,600 2,983 625 ------- ------- ------ Total $14,541 $11,389 $5,165 ======= ======= ======\nIncome tax expense was as follows (in thousands):\nCurrent: 1995 1994 1993 ------- ------- ------ Federal $ 2,019 $ 2,837 $1,394 State and local 651 898 630 Foreign 3,629 1,390 277 ------- ------- ------ 6,299 5,125 2,301\nDeferred (benefit) (1,098) (680) (492) ------- ------- ------ $ 5,201 $ 4,445 $1,809 ======= ======= ======\nFor the year ended December 31, 1995, approximately $24,000 was credited to Additional Paid-In Capital to record the tax benefit of dividends paid on restricted stock. Additional Paid-In Capital was also credited for approximately $36,000 for the tax effect of the change in value from the award date to the release date of restricted stock which was released during the period.\n(continued)\nPage 26 of 38\nTECHNITROL, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, continued\n(6) Income Taxes, continued ------------- A reconciliation of the statutory Federal income tax rate with the effective income tax rate follows:\n1995 1994 1993 ---- ---- ---- Statutory Federal income tax rate 34% 34% 34% Increase(decrease) resulting from: Tax exempt earnings of subsidiaries in Puerto Rico (2) (5) (14) State and local income taxes, net of federal benefit 3 6 10 Non-deductable expenses 1 1 2 Foreign (3) (1) 1 Other, net 3 4 2 -- -- -- Effective tax rate 36% 39% 35% == == ==\nDeferred tax assets and liabilities included the following (in thousands):\nAssets: 1995 1994 Inventories, principally due to additional costs valued for tax purposes $ 596 $ 500 Vacation pay and other compensation 396 162 Pension expense 573 1,158 Stock awards 845 637 Accrued liabilities 2,187 549 Other 97 131 ------ ------ Total deferred tax assets $4,694 $3,137 ====== ======\nLiabilities: Plant and equipment, principally due to differences in depreciation $ 109 $ 194 Local tax on Puerto Rico-sourced income 36 74 Other 417 460 ------ ------ Total deferred tax liabilities $ 562 $ 728 ------ ------ Net deferred tax asset $4,132 $2,409 ====== ======\nBased on the Company's history of taxable income and its projection of future earnings, management believes that it is more likely than not that sufficient taxable income will be generated in the foreseeable future to realize the deferred tax assets.\n(continued)\nPage 27 of 38\nTECHNITROL, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, continued\n(7) Commitments and Contingencies -----------------------------\nLease Commitments\nThe Company conducts a portion of its operations from leased premises and also leases certain equipment under operating leases.\nTotal rental expense for the years ended December 31, 1995, 1994 and 1993 was $1,795,000, $1,483,000 and $1,183,000, respectively. The aggregate minimum rental commitments under non-cancellable leases in effect at December 31, 1995 are as follows (in thousands):\nYear ending December 31 ------------- 1996 $ 3,083 1997 2,808 1998 2,277 1999 2,176 2000 2,014 Thereafter 9,227 ------- $21,585 =======\nEnvironment\nThe Company is involved in several legal actions relating to waste disposal sites. The Company's involvement in these matters has generally arisen from the alleged disposal by licensed waste haulers of small amounts of waste material many years ago. The Company has established reserves which it believes are adequate for its expected future liability in these matters.\n(continued)\nPage 28 of 38\nTECHNITROL, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, continued\n(8) Shareholders' Equity -------------------- Changes were as follows (in thousands):\nOn August 3, 1994, the Company's Board of Directors approved a three- for-one split of the Company's common stock in the form of a 200% common stock dividend for shareholders of record as of August 18, 1994. A total of 5,962,640 shares were issued in connection with the split. The stated par value of each share was not changed from $.125. A total of $745,000 was reclassified from the Company's retained earnings account to the Company's common stock account. All relevant share and per share amounts have been restated to retroactively reflect the stock split. The cumulative translation adjustment was $773,000, $480,000, and $885,000 at December 31, 1995, 1994 and 1993, respectively.\n(continued)\nPage 29 of 38\nTECHNITROL, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, continued\n(9) Employee Benefit Plans The Company and its subsidiaries maintain defined benefit pension plans and make contributions to multi-employer plans covering certain union employees. Certain non-U.S. subsidiaries have varying types of retirement plans providing benefits for substantially all of their employees.\nPension expense was as follows (in thousands):\n1995 1994 1993 ------ ------ ------ Principal defined benefit plans $1,449 $1,310 $ 932 Contributions to multi-employer and other plans 176 201 170 Other non-U.S. plans 34 160 -- ------ ------ ------ $1,659 $1,671 $1,102 ====== ====== ======\nThe expense for the principal defined benefit pension plans include the following components (in thousands):\n1995 1994 1993 ------ ------ ------ Service cost - benefits earned during the period $1,369 $1,286 $ 963 Interest cost on projected benefit obligation 1,319 1,206 991 Actual return on plan assets (3,867) (124) (1,585) Net amortization and deferral 2,628 (1,058) 563 ------ ------ ------ Net periodic pension cost $1,449 $1,310 $ 932 ====== ====== ======\nThe financial status of the principal defined benefit plans at December 31, was as follows (in thousands):\n1995 1994 ------- ------- Actuarial present value of obligations: Accumulated benefit obligation (including vested benefits of $11,990,000 in 1995 and $10,863,000 in 1994) $13,653 $12,401 ------- ------- Projected benefit obligation for services to date 20,404 18,499 Plan assets at fair value 20,261 15,446 ------- ------- Plan assets (less than) projected benefit obligation (143) (3,053)\nUnrecognized net (gain) from past experience different from that assumed. (3,661) (1,206)\nPrior service costs not yet recognized 559 612\nUnrecognized net obligation at January 1, 1987 being recognized over 18 years 31 35 ------- ------- Accrued pension costs at December 31 $(3,214) $(3,612) ======= =======\n(continued)\nPage 30 of 38\nTECHNITROL, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, continued\n(9) Employee Benefit Plans, continued ----------------------- Benefits are based on years of service and average final compensation. For U.S. plans, the Company funds, annually, at least the minimum amount required by the Employee Retirement Income Security Act of 1974. Plan assets consist principally of short-term investments and listed bonds and stocks. Assumptions used to develop data for 1995 and 1994 were as follows:\nDiscount rates 7.25 to 7.5% Annual compensation increases 4.75 to 7.0% Expected long-term rates of return on plan assets 7.50 to 9.0%\nThe Company maintains defined contribution 401(k) plans covering substantially all U.S. employees not affected by certain collective bargaining agreements. Under the primary 401(k) plan, the Company contributes a matching amount equal to $.50 for each $1.00 of the participant's contribution not in excess of 3% of the participant's annual wages. The total contribution expense under the 401(k) plans was $319,000, $165,000 and $177,000 in 1995, 1994, and 1993, respectively.\nThe Company does not provide any significant post-retirement benefits other than the pension plans and 401(k) plans described above.\n(10) Quarterly Financial Data (Unaudited) ------------------------------------\nQuarterly results of operations (unaudited) for 1995 and 1994 are summarized as follows (in thousands, except per share data):\nQuarter ended ------------- Mar. 31 June 30 Sept. 30 Dec. 31 ------- ------- -------- ------- 1995: Net sales $40,043 $39,394 $35,940 $61,042 Gross profit 11,390 12,657 10,446 21,161 Net earnings 1,692 2,020 1,673 3,955 Net earnings per share .28 .33 .28 .49\n1994: Net sales $34,960 $37,816 $36,591 $37,077 Gross profit 10,329 11,206 10,850 10,963 Net earnings 1,370 1,742 1,884 1,948 Net earnings per share .23 .29 .31 .32\nThe shares issued and options assumed in connection with the Pulse acquisition affected the weighted average shares outstanding used for calculating earnings per share in 1995. Refer to Note 2 for additional information.\n(continued)\nPage 31 of 38\nTECHNITROL, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, continued\n(11) Stock-Based Compensation The Company has an incentive compensation plan for key employees of the Company and its subsidiaries. The Plan grants the recipient the right of ownership of Technitrol, Inc. common stock, conditional on the attainment of defined performance goals and\/or continued employment with the Company. A summary of the shares under the incentive compensation plan is as follows:\nAwarded, Available to Not Yet be Granted Released ------------ -------- Shares authorized 600,000 Awarded during years prior to 1995 (377,510) 377,510 Shares released to recipients prior to 1995 (197,810) ------- -------- Balance at December 31, 1994 222,490 179,700 Awarded during 1995, net 24,545 Shares released to recipients during 1995 (41,955) ------- ------- Balance at December 31, 1995 197,945 137,745 ======= =======\nDuring the years ended December 31, 1995, 1994 and 1993, the Company issued to employees, net of cancellations, Incentive Compensation Shares having an approximate fair value at date of issue of $375,000, $414,000 and $159,000, respectively. Shares are held by the Company until the defined performance goals and\/or continued employment requirement have been attained. The market value of the shares at the date of grant is charged to expense during the vesting period on a straight-line basis. Amounts charged to expense as a result of the incentive compensation plan and related expenses were $1,517,000 in 1995, $994,000 in 1994 and $658,000 in 1993.\nSeparately, in connection with the Pulse acquisition, options which had been granted for the purchase of Pulse common shares were assumed by the Company and converted into options to purchase Technitrol common stock. Additional information about the options assumed is provided in Note 2. At December 31, 1995, 265,000 options remained outstanding. No additional options are expected to be granted under the assumed plans.\n(continued)\nPage 32 of 38\nTECHNITROL, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, continued\n(12) Supplementary Information, --------------------------\nCharged directly to costs and expenses (in thousands):\n1995 1994 1993 ------ ----- ------ Depreciation $5,828 $5,016 $4,901 Amortization of intangible assets 417 255 90 Advertising 1,118 1,159 1,117 Repairs and maintenance 2,540 1,936 1,162 Bad debt expense 109 114 76\nCash payments made (in thousands):\nIncome taxes $3,559 $3,663 $1,320 Interest 1,428 1,058 389\n(13) Segment Information ------------------- The \"Industry Segment Information\" and \"Geographic Information\" sections on pages 2, 3 and 4 of this Form 10-K is an integral part of the Company's financial statements.\n(14) Subsequent Event ---------------- On February 27, 1996 the Company sold certain assets of the Products Division to an unrelated party. As a result of the sale, the Company will discontinue its production and marketing of document counters and dispensers, the sales of which approximated $4.9 million in 1995. The consideration received approximated $3.6 million and the pre-tax gain realized on the sale (after recognition of related costs and expenses) approximated $1.5 million.\nPage 33 of 38\nTECHNITROL, INC. AND SUBSIDIARIES\nFINANCIAL STATEMENT SCHEDULE II\nVALUATION AND QUALIFYING ACCOUNTS\n(In thousands of dollars)\n(1) This amount represents the acquired reserve of Pulse Engineering, Inc. The additions and deductions to the reserve represents Pulse's 1995 activity subsequent to its acquisition by Technitrol.\nDoubtful accounts are written-off as identified.\nPage 34 of 38\nEXHIBIT INDEX\nDOCUMENT - -------- 3. (a) Articles of Incorporation Filed herewith (b) By-laws Filed herewith 4. Instruments defining rights of Incorporated by reference to security holders Form 10-K for the year ended December 31, 1982. 11. Computation of Primary and Fully Diluted Earnings Per Share Page 36 21. Subsidiaries of Registrant Page 37 23. Consent of Certified Public Accountants Page 38 27. Financial Data Schedule Electronic Filing Only\nPage 35 of 38","section_15":""}
{"filename":"74058_1995.txt","cik":"74058","year":"1995","section_1":"ITEM 1. BUSINESS.\nThe primary business of The Oilgear Company (\"Oilgear\" or the \"Registrant\"; together with its subsidiaries, the \"Company\") and its subsidiaries is the manufacture and distribution of systems and value engineered components for a broad range of industrial machinery and industrial processes. Oilgear was incorporated under the laws of Wisconsin in 1921.\nPrincipal Products, Markets and Methods of Distribution\nThe Company's products primarily involve the flow, pressure, condition, control and measurement of liquids, which the Company refers to as Fluid Power. The Company provides advanced technology in the design and production of Fluid Power components, systems and electronic controls. Its product line includes hydraulic pumps, high pressure intensifier pumps, valves, controls, cylinders, motors, and fluid meters. The Company manufactures both radial and axial piston type hydraulic pumps in sizes delivering from approximately 4 gallons per minute to approximately 230 gallons per minute at pressures ranging up to 15,000 pounds per square inch. The intensifier pumps are reciprocating pumps operating at pressures up to 120,000 pounds per square inch. The valves manufactured are pressure control, directional control, servo valves and prefill valves for pressures up to 15,000 pounds per square inch. The Company's pumps and valves are controlled through the actions of manual, hydraulic, pneumatic, electric, and electrohydraulic controls or control systems. The cylinders manufactured are heavy duty special purpose cylinders operating at up to 3,500 pounds per square inch. The Company's bent axis and axial piston motors are produced in sizes ranging from .85 cubic inch per revolution to 44 cubic inch per revolution.\nThe Company offers an engineering and manufacturing team capable of providing advanced technology in the design and production of unique fluid power components, systems and electronic controls. The Company's global involvement focuses its expertise on markets in which customers demand top quality, prompt delivery, high performance and responsive aftermarket support. Its piston pumps, motors, valves, controls, manifolds, electronic systems and components, cylinders, reservoirs, skids, meters and other products are utilized in many industries such as the primary metals, machine tool, automobile, petroleum, construction equipment, chemical, plastic, glass, lumber, rubber and food industries. The Company strives to serve those markets requiring high technology and expertise where reliability, top performance and longer service life are needed. The products are sold as individual components or integrated into high performance systems. A portion of the Company's business comes from responsive, high quality aftermarket sales and flexible rebuilding services which include exchange, factory rebuild and field repair service, along with customer education.\nThe Company's products are sold in the United States and Canada directly through 8 district sales offices and by a network of approximately 60 distributors. Sales offices are located in Milwaukee, Wisconsin; Novi, Michigan; Cleveland, Ohio; Dallas and Longview, Texas; Laguna Hills, California; Lynnwood, Washington; Atlanta, Georgia; Kansas City, Missouri; St. George, Utah; and Doylestown, Pennsylvania. The Company's international sales are generated directly by employees located in Milwaukee, Wisconsin; Bedford and Leeds, England; Paris and Lyons, France; Hernani, Spain; Hattersheim-Eddersheim, Germany; Montirone, Italy; Taren Point, Australia; Belgaum, India; Song Nam City, South Korea; and Mexico City, Mexico; and by a worldwide network of approximately 20 distributors. An Oilgear licensee, Oilgear Japan, is responsible for sales of all equipment sold in Japan. The Company is also part of a joint venture company in India, Oilgear Towler Polyhydron Pvt. Ltd., which distributes products manufactured in the United States, as well as repairs and manufactures designated Oilgear products for the Indian market.\nCompetition\nThe Company is a supplier of components for the capital goods industry. Vigorous competition exists in this industry. The Company's products compete worldwide against the products of a number of domestic and foreign firms presently engaged in the industry, most of which are of greater overall size and resources than the Company. The principal methods of competition include price, product performance, product availability, service, and warranty.\nCustomers\nNo material part of the Company's business is dependent upon a single customer or a very few customers.\nBacklog\nThe Company's backlog of orders believed to be firm as of December 31, 1995 was approximately $21,900,000, an increase of approximately $7,000,000 from the backlog of orders as of December 31, 1994, which was approximately $14,900,000. The Company expects that substantially all such orders will be filled in 1996. The Company's backlog is significant to its operations but is not seasonal in any significant respect. Backlog is generally dependent upon economic cycles affecting capital spending in the industries that utilize the Company's products.\nRaw Materials\nDuring the year, iron and steel castings, bearings, steel and other raw materials were generally available from a number of sources, and the Company is generally not dependent on any one supplier.\nPatents, Licenses, Franchises\nThe Company has a number of United States and foreign patents. It does not consider its business to be materially dependent upon any patent, patent application or patent license agreement.\nResearch and Development\nThe Company's research and development activities are conducted by members of the engineering staff at its Milwaukee and Leeds, England plants, who spend a substantial amount of their time on research and development. During 1995, the Company expended $2,127,000, and during 1994 and 1993, $1,752,000 and $1,653,000, respectively, on the research and development activities of its engineering staff. The emphasis of the Company's product development efforts continues to be the expansion of its line of axial piston pumps and the customizing of products to suit specific customer applications.\nEnvironmental Matters\nTo date, compliance with federal, state and local provisions which have been enacted or adopted regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, has not had any material effect on the capital expenditures, earnings and competitive position of the Company. The Company does not presently anticipate that compliance with such provisions will have any material effect on its capital expenditures, earnings and competitive position in the future.\nEmployees\nAt December 31, 1995, the Company had 932 employees.\nSeasonal Aspects of Business\nThe Company's business is not seasonal to any significant extent.\nIndustry Segments and Principal Products\nThe Company is engaged in one industry, the manufacture and distribution of fluid power systems and components for industrial machinery and industrial processes. The Company also provides repair parts and service for most of the products it manufactures. See \"Principal Products, Markets and Methods of Distribution\" above.\nForeign and Domestic Operations and Export Sales\nIncorporated by reference to Note 2 of \"Notes To Consolidated Financial Statements\" on page 15 of the Registrant's Annual Report to Shareholders for the fiscal year ended December 31, 1995 (\"1995 Annual Report\").\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nOilgear owns a one-story general office and factory building located on 20 acres of land at 2300 South 51st Street in Milwaukee, Wisconsin. This building is constructed of concrete, steel and brick and contains approximately 276,000 square feet of floor space.\nOilgear owns a manufacturing plant in Longview, Texas, constructed of concrete block and steel, which contains approximately 44,000 square feet.\nA 99,000 square foot manufacturing facility is located in Fremont, Nebraska. To manage the increased demand for the Company's new products, the Company expanded its Fremont, Nebraska facility in 1995.\nThe Company's Oilgear Towler GmbH subsidiary owns an approximately 25,000 square foot concrete block and steel manufacturing facility in Hattersheim- Eddersheim, Germany, subject to a mortgage.\nThe Company's Oilgear Towler Ltd. subsidiary owns a one-story manufacturing plant and two office buildings constructed of concrete, steel and brick totaling approximately 62,000 square feet on six acres of land in Leeds, England, and an additional prefabricated facility being used by the electrical engineering department.\nThe Company's Oilgear Towler Ltd. subsidiary also owns a small service and sales facility in Bedford, England.\nThe Company's Oilgear Towler S.A. Spanish subsidiary owns a two-story manufacturing plant and office constructed of concrete and brick totaling approximately 35,000 square feet on approximately one acre of land in Hernani, Spain.\nThe Company's Oilgear Towler S.A. French subsidiary owns, subject to a mortgage, a 9,000 square foot office building constructed of prefabricated steel materials located on approximately one-half acre of land in Paris, France.\nThe Company's Oilgear Towler S.r.l. Italian subsidiary owns a two-story prefabricated concrete building on .6 acre of land in Montirone, Italy. The facility is used to repair and assemble customer equipment, as well as house sales and service functions.\nThese properties are maintained in good condition and are adequate for present operations.\nBorrowings under the Company's domestic and foreign loan agreements are collateralized by substantially all domestic property, plant and equipment and by substantially all assets of the applicable foreign subsidiaries, respectively. See Notes 4 and 5 of \"Notes To Consolidated Financial Statements\" on page 16 in the 1995 Annual Report.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThe Company is a defendant in several product liability actions which it believes are adequately covered by insurance, and certain other litigation incidental to its business.\nIn October 1992, the United States Environmental Protection Agency (\"EPA\") contacted the Company for information regarding the possible disposal of waste at the Muskego Sanitary Landfill in Muskego, Wisconsin. The EPA made its request pursuant to the provisions of the Comprehensive Environmental Response, Compensation and Liability Act (\"CERCLA\") and the Resource Conservation and Recovery Act. The Company duly responded, noting that \"ordinary trash\" may have been hauled to the Muskego site. In November 1992, the EPA notified the Company that it had been identified as a responsible party for purposes of remedial action at the Muskego Sanitary Landfill. On December 9, 1992, the EPA issued a unilateral administrative order under CERCLA directing 46 respondents to perform remedial action for the first operable unit (source control) and to reimburse the EPA for oversight costs. The Company was not named in the order. In a subsequent unilateral administrative order dated June 6, 1995 (the \"1995 Order\"), the EPA directed the Company and 55 other respondents to design and implement remedial measures for the second operable unit (groundwater remediation) at the Muskego site. The Company is participating with a group of respondents to address allocation issues. While the cost of remediation under the 1995 Order is not yet known, and while the allocation process is not yet complete, the Company's share is presently expected to be less than $40,000. It is not certain what further action involving the Company, if any, may be brought regarding this matter, nor is it possible at this time to predict the ultimate outcome of any litigation or negotiation that might involve the Company.\nOilgear is a member of a De Minimis Group of small volume waste contributors to the Conservation Chemical Company of Illinois, Inc. facility located in Gary, Indiana (the \"CCCI Site\"). The CCCI Site is the subject of a clean-up effort commenced by the EPA under CERCLA in 1985. The amount of waste contributed by Oilgear to the CCCI Site has been identified by the EPA as .0046% of the total contributed by the more than 200 waste generators identified by the EPA. The Company has accepted a de minimis settlement offered by the EPA pursuant to which the Company has agreed to pay $1,388.25. The Company expects the settlement to be finalized by mid-1996.\nIn August 1995, the EPA contacted the Company for information regarding the possible disposal of waste by the Company at the former PCB Treatment, Inc. facilities in Kansas City, Missouri and Kansas, respectively. The EPA made its request pursuant to the provisions of CERCLA. The Company duly responded. The Company has had no further communications from the EPA since its response. It is not certain what further involvement the Company may have in this matter, if any, and, accordingly, it is not possible at this time to predict the exposure, if any, to the Company as a result of this matter.\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 1995.\nEXECUTIVE OFFICERS OF THE REGISTRANT.\nThe names, ages, offices and positions held, and periods of service in their present offices, of all executive officers of the Registrant are listed below. Except in the case of mid-term vacancies, officers are elected for one-year terms at the Board of Directors meeting following the annual meeting of shareholders each year.\n- ------------------ (1) Mr. Zuege was Secretary - Treasurer from 1972 to 1978, Vice President - Finance and Secretary from 1979 to 1993, Senior Vice President and Secretary for a portion of 1993, and Executive Vice President and Chief Operating Officer during the remainder of 1993 through 1995. He has been a member of the Board of Directors since 1982.\n(2) Mr. Bahner has been employed with the Company in the engineering department since 1973. He has served as Director of Engineering from 1987 to 1991 and Managing Director of Oilgear's subsidiary, Oilgear Towler Ltd., from 1989 to 1991. He has been a member of the Board of Directors since 1992.\n(3) Mr. Price has been employed in various positions with the Company since 1966. He served as Controller of the Company from 1977 to 1986, as Treasurer\/Controller from 1987 to 1993, and as Treasurer\/Controller and Secretary from 1993 to 1994.\n(4) Mr. Bursch has been employed in various positions with the Company's European operations since 1966. He served as Geschaftsfuhrer of Oilgear GmbH (now Oilgear Towler GmbH) before his appointment as Chairman of the Board of Management - Europe in 1991, which office he held until January 1, 1994.\nFORWARD-LOOKING INFORMATION\nItems 1, 3 and 7 of this Annual Report on Form 10-K and other documents or oral presentations contain or may contain forward-looking statements made by or on behalf of the Registrant which involve risks and uncertainties that could cause the Company's actual results to differ materially from those discussed in such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, the following: world economies, foreign currency conversion rates and world political stability.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nIncorporated by reference to \"Quarterly Financial Information\" and \"Equity\" on pages 9 and 10, respectively, of the 1995 Annual Report.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nIncorporated by reference to \"5 Year Summary\" on page 11 of the 1995 Annual Report.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nIncorporated by reference to \"Management's Discussion\" on pages 8 through 11 of the 1995 Annual Report.\nThe second, third and fourth paragraphs under \"Legal Proceedings\" in Item 3 hereof are also incorporated herein in response to this item.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe financial statements and supplementary financial information required by this item are set forth on pages 12 through 20 and page 11, respectively, of the 1995 Annual Report and are incorporated by reference.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNot applicable.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nIncorporated by reference to \"Election of Directors\" on pages 2 and 3 of the Registrant's Proxy Statement, dated March 22, 1996, for its Annual Meeting of Shareholders on April 16, 1996 (\"1996 Annual Meeting Proxy Statement\"), and \"Executive Officers of the Registrant\" in Part I hereof.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nIncorporated by reference to \"Executive Compensation\" and \"Compensation Committee Interlocks and Insider Participation\" on pages 6 through 10 and page 13, respectively, of the 1996 Annual Meeting Proxy Statement.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nIncorporated by reference to \"Security Ownership of Certain Beneficial Owners and Management\" on pages 4 and 5 of the 1996 Annual Meeting Proxy Statement.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nNot applicable. PART 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 \"Index to Consolidated Financial Statements and Schedule,\" which is incorporated herein by reference.\n3. Exhibits. See Exhibit Index included as last part of this report, which index is incorporated herein by reference. Each management contract or compensatory plan or arrangement required to be filed as an exhibit to this report is identified in the Exhibit Index by two asterisks preceding its exhibit number.\n(b) Reports on Form 8-K.\nNo reports on Form 8-K were filed during the last quarter of 1995.\nTHE OILGEAR COMPANY AND SUBSIDIARIES\nIndex to Consolidated Financial Statements and Schedule - -----------------------------------------------------------------------------\nThe consolidated financial statements of The Oilgear Company and subsidiaries together with the report thereon of KPMG Peat Marwick LLP dated February 28, 1996, appearing on pages 12 through 20 of the 1995 Annual Report, are incorporated by reference into this Annual Report on Form 10-K. The following additional financial data should be read in conjunction with the consolidated financial statements in the 1995 Annual Report.\nADDITIONAL FINANCIAL DATA\nIndependent Auditors' Report on Financial Statement Schedule\nSubmitted:\nII - Valuation and Qualifying Accounts\nAll other schedules are omitted because they are not applicable or because the required information is given in the consolidated financial statements and the notes thereto.\nINDEPENDENT AUDITORS' REPORT ON FINANCIAL STATEMENT SCHEDULE\nThe Board of Directors The Oilgear Company:\nUnder date of February 28, 1996, we reported on the consolidated balance sheets of The Oilgear Company and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations and shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1995, which are incorporated by reference in the Company's annual report on Form 10-K for the year ended December 31, 1995. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related financial statement schedule as listed in the accompanying index. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement schedule based on our audits.\nIn our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.\nKPMG Peat Marwick LLP\nMilwaukee, Wisconsin February 28, 1996\nTHE OILGEAR COMPANY AND SUBSIDIARIES SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n(1) INCLUDES ADJUSTMENTS DUE TO FOREIGN CURRENCY TRANSLATION.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nTHE OILGEAR COMPANY (Registrant)\nBy \/s\/ THOMAS J. PRICE March 29, 1996 ------------------------------------- Thomas J. Price, Vice President of Finance and Corporate Secretary\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Carl L. Gosewehr, Otto F. Klieve and David A. Zuege, and each of them, his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments to this report, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their substitutes, may lawfully do or cause to be done by virtue hereof.\n______________________\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.*\n*Each of these signatures is affixed as of March 29, 1996.\nS-1\nTHE OILGEAR COMPANY (THE \"REGISTRANT\") (COMMISSION FILE NO. 0-822)\n* * * * *\nEXHIBIT INDEX\n1995 ANNUAL REPORT ON FORM 10-K\n____________________\n*Pursuant to Item 601(b)(4)(iii)(A) of Regulation S-K, the Registrant agrees to furnish to the Securities and Exchange Commission, upon request, a copy of any unfiled instrument with respect to long-term debt.\n**Management contracts and executive compensation plans or arrangements required to be filed as exhibits pursuant to Item 14(c) of Form 10-K.\nEI-1\n____________________\n**Management contracts and executive compensation plans or arrangements required to be filed as exhibits pursuant to Item 14(c) of Form 10-K.\nEI-2\nEI-3","section_15":""}
{"filename":"3499_1995.txt","cik":"3499","year":"1995","section_1":"Item 1. Business\nGENERAL\nAlexander's, Inc. (\"the Company\") is a real estate company engaged in leasing, managing, developing and redeveloping properties, focusing primarily on the locations where its department stores (which ceased operations in 1992) formerly operated. The Company believes that its properties, which are located in New York City and Bergen County, New Jersey, offer advantageous retail opportunities, principally because of their size and location in areas where comparable store sites are not readily available.\nAlexander's has nine properties consisting of:\nOperating properties: (i) a recently redeveloped 359,000 square foot building, two-thirds of which is leased to Sears and Marshalls, on Queens Boulevard and 63rd Road in Rego Park, Queens, New York (\"Rego Park I\"), (ii) a 50% interest in the 427,000 square feet of mall stores at the Kings Plaza regional shopping center on Flatbush Avenue in Brooklyn, New York, (iii) a 303,000 square foot building leased to Caldor on Fordham Road in the Bronx, New York, (iv) a 177,000 square foot building subleased to Caldor at Roosevelt Avenue and Main Street in Flushing, New York and (v) a 173,000 square foot building leased to an affiliate of Conway located at Third Avenue and 152nd Street in the Bronx, New York, and\nNon-operating properties to be redeveloped: (i) the square block, including a 418,000 square foot building, bounded by Lexington Avenue and Third Avenue and 58th and 59th Streets in Manhattan, New York, in which the Company has the general partnership interest and a 92% limited partnership interest, (ii) 39.3 acres at the intersection of Routes 4 and 17 in Paramus, New Jersey, (iii) a 320,000 square foot anchor store which is one of the two anchor stores at the Kings Plaza regional shopping center and (iv) one and one-half blocks of vacant land adjacent to the Rego Park I location (\"Rego Park II\").\nSee Item 2","section_1A":"","section_1B":"","section_2":"Item 2 \"Paramus Property\" and \"Tax Certiorari Proceedings\" on page 6. Although there can be no assurance, the Company believes that these cash sources will be adequate to fund cash requirements until its operations generate adequate cash flow.\nThe Company intends to file, with its federal income tax return for 1995, an election to be taxed as a real estate investment trust (\"REIT\") under sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the \"Code\"), effective for the taxable year ended December 31, 1995 - see \"Reconstitution as a REIT\" on page 5.\nThe Company's principal executive office is located at Park 80 West, Plaza II, Saddle Brook, New Jersey 07663, telephone (201) 587-8541.\nRelationship with Vornado Realty Trust (\"Vornado\")\nOn March 2, 1995, Vornado, which previously owned 2.2% of the Company's Common Stock, purchased 27.1% of the Company's Common Stock owned by Citibank, N.A. In connection with the acquisition, Vornado and a bank lent the Company $75,000,000. The loan has a three-year term and is secured by mortgages on all of the Company's assets and\/or pledges of the stock of subsidiaries owning the assets and\/or guarantees of such subsidiaries (see \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources -- 1995 Financings\"). In addition, Vornado agreed to act as manager of the Company pursuant to a three-year management and development agreement (the \"Management Agreement\"). Vornado is a fully integrated real estate company with significant experience in the ownership, development, redevelopment, leasing, operation and management of retail and industrial properties.\nThe annual management fee payable by the Company to Vornado is $3,000,000, plus 6% of development costs with a minimum guaranteed fee for the development portion of $1,650,000 in the first year and $750,000 in each of the second and third years. On July 6, 1995, Vornado assigned its Management Agreement to Vornado Management Corp., an affiliate of Vornado.\nThe fee pursuant to the Management Agreement is in addition to the leasing fee the Company pays to Vornado under the leasing agreement (the \"Leasing Agreement\") which has been in effect since 1992. Subject to the payment of rents by tenants, Vornado is due $7,868,000. Such amount is payable annually in an amount not to exceed $2,500,000, until the present value of such installments (calculated at a discount rate of 9% per annum) equals the amount that would have been paid had it been paid on September 21, 1993, or at the time the transactions which gave rise to the commissions occurred, if later. The term of the Leasing Agreement has been extended to be coterminous with the term of the Management Agreement.\nSteven Roth is Chief Executive Officer and a director of the Company, the Managing General Partner of Interstate Properties (\"Interstate\") and Chairman of the Board and Chief Executive Officer of Vornado. Interstate owns 27.1% of the outstanding common stock of the Company and owns 27.7% of the outstanding common shares of beneficial interest of Vornado. In addition, Mr. Roth owns 3.3% of the outstanding common shares of beneficial interest of Vornado. Mr. Roth, Interstate and the other two general partners of Interstate, David Mandelbaum and Russell B. Wight, Jr. (who are also directors of the Company and trustees of Vornado) own, in the aggregate, 32.1% of the outstanding common shares of beneficial interest of Vornado.\nEffective March 2, 1995, for a three-year period, Vornado and Interstate agreed not to own in excess of two-thirds of the Company's common stock or to enter into certain other transactions with the Company, other than the transactions described above, without the consent of the Company's independent directors.\nEmergence From Chapter 11\nIn May 1992, at a time when the Company's business consisted of retail store operations, the Company and sixteen of its subsidiaries filed petitions for relief under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the Southern District of New York (the \"Bankruptcy Court\"). In September 1993, the Bankruptcy Court confirmed the Joint Plan of Reorganization (the \"Plan\"), pursuant to which the Company and its subsidiaries reorganized their business as a real estate company.\nIn March 1995, the Company paid holders of allowed general unsecured claims in full, together with accrued interest in respect of their claims. Such payments aggregated $24,000,000. The Official Committee of Unsecured Creditors has been dissolved and all secured and unsecured creditors having allowed claims in the Bankruptcy Court cases have received the cash payments or debt instruments contemplated to be delivered to them under the Plan. A number of claims are being disputed by the Company and therefore are not allowed claims. An escrow account has been established for the resolution of these claims. The Bankruptcy Court has retained jurisdiction to resolve these disputed claims and for other limited purposes.\n1995 Financings\nThe Company borrowed approximately $148,000,000 during 1995. The proceeds of these borrowings were used primarily for (i) construction costs associated with the Rego Park I property of $26,700,000, (ii) prepayment of $39,600,000 of outstanding funded debt and $24,000,000 of allowed general unsecured claims, (iii) funding of (a) interest-bearing escrow accounts for unpaid real estate taxes ($7,000,000) and the remaining disputed claims in the Bankruptcy Court cases as they become allowed ($4,000,000) and (b) collateral accounts for the Rego Park I construction ($6,000,000) and (iv) payment of $40,700,000, net, of overhead, interest and property carrying costs. Substantially all of the assets of the Company and its subsidiaries have been pledged and \/or mortgaged to secure such indebtedness. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources -- 1995 Financings\".\nRECONSTITUTION AS A REIT\nTo qualify for taxation as a REIT, the Company must meet various federal income tax law requirements. In general, a REIT that distributes to its stockholders at least 95% of its taxable income as a dividend for a taxable year and that meets certain other conditions will not be taxed on income distributed that year. If the Company fails to qualify as a REIT in any taxable year, it will be subject to federal income tax (including any applicable alternative minimum tax) on its taxable income at regular corporate rates, and distributions to its stockholders in any year in which the Company fails to so qualify will not be deductible by the Company in computing its taxable income, nor generally will they be required to be made under the Code.\nAs of December 31, 1995, the Company had reported net operating loss carryovers (\"NOLs\") of approximately $130,000,000 of which approximately $5,000,000, $52,000,000, $22,000,000, $15,000,000, $16,000,000 and $20,000,000 expire in 2005, 2006, 2007, 2008, 2009 and 2010, respectively. The Company's NOLs generally would be available to offset the amount of the Company's REIT taxable income that otherwise would be required to be distributed to its stockholders. The Company currently does not anticipate making any distributions during 1996.\nTo help maintain its eligibility to be taxed as a REIT and reduce the risk of triggering limitations on the use of its existing NOLs, the Company has included certain restrictions relating to the transfer and ownership of its securities in its Amended and Restated Certificate of Incorporation. Such restrictions are applicable even if a REIT election is not made.\nTAX CERTIORARI PROCEEDINGS\nIn December 1995, the Company completed a tax certiorari proceeding with the City of New York regarding the Kings Plaza Shopping Center property. The Company and its joint venture partner have agreed with the City of New York to a reduction in the assessed values covering the tax years 1988\/1989 through 1995\/1996, generating tax credits of $28,350,000. The Company's allocated share of these credits, approximately $8,600,000, net of expenses, was recorded as follows: (i) $6,100,000 as income from discontinued operations and (ii) $2,500,000 as a reduction of previously capitalized real estate taxes. As a result of this settlement, all amounts held in escrow for unpaid real estate taxes ($8,000,000) are being released.\nThe Company continues to negotiate certiorari proceedings with the City of New York on several of its other properties.\nAlexander's Department Stores of Valley Stream, Inc. (\"ADS of Valley Stream\") is a party to a tax certiorari proceeding against The Board of Assessors and The Board of Assessment Review of the County of Nassau (the \"Board\") for overpayment of taxes on its former Valley Stream store property during the assessment rolls from 1986 to 1992. In January 1995, the Supreme Court of Nassau County, New York ruled that ADS of Valley Stream is entitled to an assessment reduction which would result in a refund of approximately $10,100,000 (including interest currently aggregating $3,500,000). Both the Board and the Company have appealed the Court's decision.\nENVIRONMENTAL MATTERS\nCompliance with applicable provisions of federal, state and local laws regulating the discharge of materials into the environment or otherwise relating to the protection of the environment have not had, and, although there can be no assurance, are not expected to have, a material effect on the Company's operations, earnings, competitive position or capital expenditures.\nThe results of a 1993 Phase I environmental study at the Kings Plaza Shopping Center's (\"Center\") property show that certain adjacent properties owned by third parties have experienced petroleum hydrocarbon contamination. Based on this study and preliminary investigation of the Center's property and its history, there is potential for contamination on the property. The study also revealed an underground storage tank which failed an integrity test, although no contamination has been observed to date. The tank failure has been reported to the New York State Department of Environmental Conservation (\"DEC\") and the tank was fixed in early 1994. In October 1994, independent testing revealed that all of the Center's underground storage tanks (used for storing heating oil) and related distribution lines passed a tank and line leak status test. Such results were furnished to the DEC. If contamination is found on the property, the Center may be required to engage in remediation activities; management is unable to estimate the financial impact of potential contamination if any is discovered in the future. If further investigations reveal that there is contamination on its site, since the Center believes such contamination would have resulted from activities of third parties, the Center intends to pursue all available remedies against any of these third parties.\nThe Company is aware of the presence of asbestos-containing materials at several of its properties and believes that it manages such asbestos in accordance with applicable laws. The Company plans to abate or remove such asbestos as appropriate.\nThe Company believes that known and potential environmental liabilities will not have a material adverse effect on the Company's business, assets or results of operations. However, there can be no assurance that the confirmation of the existence of contamination or the identification of potential new areas of contamination would not be material to the Company.\nCOMPETITION\nThe Company conducts its real estate operations in the New York metropolitan area, a highly competitive market. The Company's success depends upon, among other factors, the trends of the national and local economies, the financial condition and operating results of current and prospective tenants, the availability and cost of capital, interest rates, construction and renovation costs, income tax laws, governmental regulations and legislation, population trends, the market for real estate properties in the New York metropolitan area, zoning laws and the ability of the Company to lease, sublease or sell its properties at profitable levels. The Company competes with a large number of real estate property owners. In addition, although the Company believes that it will realize significant value from its properties over time, the Company anticipates that it may take a number of years before all of its properties generate cash flow at or near anticipated levels. Its success is also subject to its ability to finance its development and to refinance its debts as they come due.\nEMPLOYEES\nThe Company currently employs two people.\nItem 2. Properties\nThe following table shows the location, approximate size and leasing status as of December 31, 1995 of each of the Company's properties.\n(1) Excludes parking garages.\n(2) Excludes approximately 150,000 square feet of enclosed, common area space.\n(3) Leased to the Company through January 2027.\n(4) The Lexington Avenue property is owned by Seven Thirty One Limited Partnership (the \"Partnership\"), of which 7.64% is owned by non-affiliated limited partners.\n(5) The Lexington Avenue property is comprised of the Main Building, containing approximately 418,000 square feet, and several smaller buildings, containing approximately 173,000 square feet.\nOperating Properties:\nRego Park I\nThe Rego Park I property encompasses the entire block fronting on Queens Boulevard and bounded by 63rd Road, 62nd Drive, 97th Street and Junction Boulevard, and includes the Company's former three-floor store.\nThe Company has leased 195,000 square feet to Sears comprising the entire first floor and approximately two-thirds of the second floor. The balance of the second floor, approximately 39,000 square feet, has been leased to Marshalls. Rents pursuant to these leases commenced in March 1996. The lease with Sears expires in March 2021 and the lease with Marshalls expires in September 2008 (March 2021 including renewal option). The existing building has been redeveloped and a multi-level parking structure has been constructed. The parking structure is being operated for the benefit of the Company, and provides paid parking spaces for approximately 1,200 vehicles. In connection with this redevelopment, the Company has expended approximately $26,700,000 during the year ended December 31, 1995, and expects to expend approximately $11,000,000 through the first half of 1996 to complete the project. At December 31, 1995 there was $12,200,000 available under a $60,000,000 construction loan to fund these expenditures.\nThe Company had leased the entire third floor (125,000 square feet) to Caldor. On February 28, 1996, Caldor filed for Bankruptcy Court approval to reject the lease. After the Bankruptcy Court's approval, Caldor would no longer have any obligations under this lease. Alexander's will file a claim for damages based on such rejection. The Company is currently in discussions with several major retailers to re-lease this space.\nKings Plaza Shopping Center\nThe Kings Plaza Shopping Center and Marina (the \"Kings Plaza Shopping Center\") comprises a two-level mall (the \"Kings Plaza Mall\" or the \"Mall\"), and two four-level anchor stores. It contains approximately 1.1 million square feet and occupies a 24.3-acre site at the intersection of Flatbush Avenue and Avenue U located in Brooklyn, New York. Among its features are a marina, a five-level parking structure and an energy plant that generates the shopping center's electrical power. The Company owns one anchor store in the shopping center of approximately 320,000 square feet (see \"Kings Plaza Store\" - Redevelopment Properties), and an undivided one-half interest in the Mall (see Kings Plaza Mall). The other anchor is a Macy's store.\nKings Plaza Mall\nThe Mall contains approximately 427,000 leasable square feet. As of December 31, 1995, 88% of the leasable area was leased to approximately 120 tenants.\nThe following table shows lease expirations for the next ten years, assuming none of the tenants exercise renewal options:\nThe following table shows the occupancy rate and the annual rent per square foot as of:\nCentercorp, Inc. manages the Mall. Interstate Properties, through Vornado, is the leasing agent.\nThe Company's share of the mortgage on the Kings Plaza Mall property, which matures on December 1, 2001, is $4,583,000 at December 31, 1995. The interest rate is 8 1\/2%. Since the Kings Plaza Mall is an unconsolidated joint venture, the mortgage on the Kings Plaza Mall is not reflected on the Company's books and records.\nFordham Road\nThe Company owns the Fordham Road property, which is located at the intersection of Fordham Road and the Grand Concourse in the Bronx, New York. The property includes a five-floor building containing approximately 303,000 square feet located in the center of a shopping complex in one of the busiest shopping areas of the Bronx.\nThe Company net leased the Fordham Road property to Caldor. The lease commenced in April 1993 and expires in March 2013 (March 2028 including renewal option). The minimum annual base rent for 1995 under the lease was $3,537,000, or $11.67 per square foot. Further, the lease provides for percentage rent. Caldor has invested a substantial amount in refurbishing the Fordham Road store, including the installation of new heating and lighting systems, escalators and elevators.\nFlushing\nThe Flushing property is located on Roosevelt Avenue and Main Street in the downtown, commercial section of Flushing, Queens. Roosevelt Avenue and Main Street are active shopping districts with many national retailers located in the area. A subway entrance is located directly in front of the property with bus service across the street. It comprises a four-floor building containing 177,000 square feet and a parking garage.\nThe Company leases the Flushing property from its owner under a long-term lease. Under the lease, the Company is obligated to pay net rent to the owner of the Flushing property in the amount of $496,000 per year through January 1997, $331,000 per year from January 1997 through 2007, $220,000 per year from January 2007 through 2017 and $147,000 per year from January 2017 through January 2027.\nThe Company net subleased the Flushing property (other than the portion currently being used as a parking garage) to Caldor. The lease commenced in April 1993 and expires in January 2027. The minimum annual base rent for 1995 under the lease was $2,600,000 or $14.97 per square foot. Further, the lease provides for percentage rent.\nThe parking garage, which was not subleased to Caldor, provides parking for approximately 343 cars and currently generates approximately $120,000 of annual revenues (before expenses of approximately $95,000).\nThird Avenue\nThe Company owns the Third Avenue property, a four-floor building and a small surface parking lot located at the intersection of Third Avenue and 152nd Street in the Bronx, New York. The store is located in a densely populated neighborhood.\nThe Third Avenue property is net leased to an affiliate of Conway, a New York area discount retailer. The lease commenced in May 1993 and expires in April 2023. The minimum annual base rent for 1995 under the lease was $1,150,000 or $6.65 per square foot.\nRedevelopment Properties:\nLexington Avenue\nAs of December 31, 1995, the Company owns an approximately 92% interest in the Seven Thirty One Limited Partnership (the \"Partnership\"), a limited partnership which owns the Lexington Avenue property. This property comprises the entire square block bounded by Lexington Avenue, East 59th Street, Third Avenue and East 58th Street and is situated in the heart of one of Manhattan's busiest business and shopping districts with convenient access to several subway and bus lines. The property is located directly across the street from Bloomingdale's flagship store and only a few blocks away from both Fifth Avenue and 57th Street. The Company is considering redeveloping the existing former store building principally for retail use at an estimated cost of approximately $20 million to $25 million. No development decisions have been finalized.\nThe Company believes that, along with a number of other locations, a portion of the Lexington Avenue property has been considered by the Port Authority of New York and New Jersey (the \"Port Authority\") for the site of the terminus for a rail link from midtown Manhattan to LaGuardia and Kennedy Airports. Recent statements by Port Authority officials have indicated that the rail link between midtown Manhattan and the airports is not likely to be developed in the foreseeable future. Since the nature and scope of any plans being considered by the Port Authority, and whether any such plans would ultimately affect the Lexington Avenue property, cannot be fully assessed by the Company at this time, it is impossible to determine the ultimate effect that a taking, or any uncertainty with respect thereto, would have on the Company's use or development of the Lexington Avenue property.\nParamus\nThe Company owns 39.3 acres of land, including its former store building, located at the intersection of Routes 4 and 17 in Paramus, New Jersey. The Company's property is located directly across from the Garden State Plaza regional shopping mall, within two miles of three other regional shopping malls and within 10 miles of New York City.\nThe State of New Jersey has notified the Company of its intention to condemn approximately 10 acres (one-quarter) of the Paramus property. The land subject to condemnation is located on the periphery of the property and will be used for improvements at this major intersection. The New Jersey Department of Transportation (\"DOT\") has made an offer to purchase the land which is the subject of the condemnation proceeding for $15,400,000 based on an appraisal performed on its behalf. The Company is negotiating with the DOT to attempt to reach agreement on the value and other terms. In the event that the Company and the DOT do not reach agreement, a formal process may be initiated by the DOT, pursuant to which, among other things, a group of independent commissioners will be appointed by a court to adjudicate the disputed matters.\nThe Company is considering various options with respect to the redevelopment of the Paramus property, including razing its former store building and developing a new shopping center which may be multi-level. The Company anticipates leasing space to \"big box\" users and estimates redevelopment costs of approximately $50 million to $60 million.\nPrior to New Jersey's notification of its intent to condemn a portion of the property, Alexander's had a redevelopment plan for the use of all of the site and had signed leases with two tenants (Home Depot and B.J.'s Wholesale Clubs). These leases are no longer in effect because governmental approvals to begin construction could not be obtained on a timely basis as a result of the pending condemnation.\nThe Paramus property is subject to a mortgage securing a $13,591,000 loan which matures on December 31, 1998. The interest rate (currently 8.08% at December 31, 1995) is a floating rate, fixed annually, equal to 2.5% above the one-year U.S. Treasury bill rate with a floor of 6.5%. The loan is prepayable at anytime.\nKings Plaza Store\nThe Company's anchor store in the Kings Plaza Shopping Center is a four-floor building containing approximately 320,000 square feet. Access to the Store is available from entrances on Flatbush Avenue and the parking lot and from entrances on both levels of the Mall.\nThe Company is having discussions with major retailers and with other \"big box\" retailers who lease large spaces. The Company may need to demise the property and install vertical transportation which may have an improvement cost between $10 million and $20 million and will take from six to twelve months to complete.\nRego Park II\nThe Company owns two additional land parcels adjacent to the Rego Park I property. They are the entire square block bounded by the Long Island Expressway, 97th Street, 62nd Drive and Junction Boulevard (the \"Back Lot\"), and a smaller parcel of approximately one-half square block at the intersection of 97th Street and the Long Island Expressway (the \"Z Parcel\"). Both parcels are currently zoned for residential use with the Z parcel having a commercial zoning overlay. Both parcels are being used for public paid parking. The Company intends to continue to use these properties for paid parking while it evaluates the feasibility of having these properties re-zoned for commercial use.\nInsurance\nThe Company carries comprehensive liability, fire, flood, extended coverage and rental loss insurance with respect to its properties with policy specifications and insured limits customarily carried for similar properties. Management of the Company believes that the Company's insurance coverage conforms to industry norms.\nItem 3.","section_3":"Item 3. Legal Proceedings\nSee Item 1, \"Business -- Tax Certiorari\" for a discussion of the tax certiorari proceedings involving Alexander's Department Stores of Valley Stream, Inc.\nThe Company has no significant litigation, except for the matters referred to herein, and the matters referred to in Footnote 5 of the Notes to Consolidated Financial Statements relating to the final resolution of all claims filed or continuing to be filed against the Company in the Company's bankruptcy proceedings. Neither the Company nor any of its subsidiaries is a party to, nor is their property the subject of, any material pending legal proceeding other than routine litigation incidental to their businesses. The Company believes that these legal actions will not be 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 security holders during the fourth quarter of the year ended December 31, 1995.\nExecutive Officers of the Company\nThe following is a list of the names, ages, principal occupations and positions with the Company of the executive officers of the Company and the positions held by such officers during the past five years.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters\nEquity and Related Stockholder Matters\nThe common stock, par value $1.00 per share, of the Company is traded on the New York Stock Exchange under the symbol \"ALX\". Set forth below are the high and low sales prices for the Company's common stock for each full quarterly period within the two most recent years:\nAs of December 31, 1995, there were approximately 2,000 holders of record of the Company's common stock. No dividends were paid in 1995 and 1994. The Company currently does not anticipate paying any dividends during 1996.\nItem 6.","section_6":"Item 6. Selected Financial Data\n1. In November 1993, the Company changed to a calendar year from a fiscal year ending on the last Saturday in July.\n2. Includes 53 weeks.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nRESULTS OF OPERATIONS\nContinuing Operations - Years Ended December 31, 1995 and December 31, 1994\nThe Company's revenues, which consist of property rentals, tenant expense reimbursements, equity in income of unconsolidated joint venture and parking lot revenue were $14,016,000 in 1995, compared to $12,674,000 in 1994, an increase of $1,342,000 or 10.6%. This increase resulted primarily from an increase in the equity in income of the unconsolidated joint venture (the Kings Plaza Shopping Center).\nOperating expenses were $2,795,000 in 1995, compared to $1,714,000 in 1994, an increase of $1,081,000. Of this increase (i) $700,000 was fees under the Management Agreement, (ii) $234,000 was higher real estate taxes, maintenance and utility expenses, which were primarily passed through to tenants and (iii) $147,000 was bad debt expense. Operating expenses are offsets to both tenant expense reimbursements and parking lot revenue.\nGeneral and administrative expenses were $5,087,000 in 1995, compared to $2,983,000 in 1994, an increase of $2,104,000. This increase resulted from (i) professional fees of $1,134,000, primarily related to the Company's REIT formation, (ii) non-recurring payroll and other costs of $622,000 related to the Company's closing of its New York City office and (iii) fees under the Management Agreement ($1,800,000) exceeding 1994 expense levels by $348,000.\nDepreciation and amortization expense in 1995 did not change significantly from 1994.\nReorganization costs were $1,938,000 in 1995, compared to $3,721,000 in 1994, a decrease of $1,783,000. These expenses were primarily due to professional fees incurred in connection with investigating financing alternatives, becoming a REIT and bankruptcy expenses. As stated in the Company's second quarter Form 10-Q, the Company expects no further significant reorganization costs, and in the third and fourth quarters of this year incurred no such costs.\nInterest and debt expense was $13,156,000 in 1995, compared to $3,331,000 in 1994, an increase of $9,825,000. Of this increase approximately (i) $6,000,000 was attributable to higher levels of debt, (ii) $200,000 was attributable to higher interest rates, (iii) $1,800,000 was attributable to the amortization of debt issuance costs, and (iv) $2,200,000 resulted primarily from interest and debt expense for 1994 being charged against the accrual for losses from discontinued operations. This increase was partially offset by a $400,000 increase in interest capitalized during development.\nInterest and other income, net was $1,716,000 in 1995 compared to $4,768,000 in 1994, a decrease of $3,052,000. This decrease resulted from other income of $4,550,000 recorded in 1994 from the settlement of a zoning-related matter, partially offset by higher interest income earned in 1995 on increased average cash invested due to additional borrowings.\nAs a result of the Company's intention to elect to be taxed as a REIT for the year ended December 31, 1995, the deferred tax balance of $1,406,000 at December 31, 1994 was reversed, resulting in an income tax benefit.\nDiscontinued Operations - Year Ended December 31, 1995\nThe Company recorded income from discontinued operations of $10,133,000 comprising (i) $6,133,000 from the settlement of a tax certiorari proceeding with the City of New York regarding the Kings Plaza Shopping Center and (ii) $4,000,000 resulting from the reduction of other liabilities of discontinued operations to amounts considered necessary to cover the remaining estimates of these liabilities.\nContinuing Operations Years Ended December 31, 1994 and December 31, 1993 (Unaudited)\nThe Company's revenues, which consist of property rentals, tenant expense reimbursements, equity in income of unconsolidated joint venture and parking lot revenue, were $12,674,000 in 1994, compared to $10,150,000 in 1993, an increase of $2,524,000 or 24.9%. The increase was due primarily to the commencement of rents under new long-term leases during the second quarter of 1993.\nOperating expenses were $1,714,000 in 1994, compared to $1,290,000 in 1993, an increase of $424,000. This increase was due primarily to expenses being charged against the accrual for losses from discontinued operations during the first quarter of 1993. Operating expenses are offsets to both tenant expense reimbursements and parking lot revenue.\nGeneral and administrative expenses were $2,983,000 in 1994, compared to $1,041,000 in 1993, an increase of $1,942,000. This increase was primarily a result of certain expenses being charged against the accrual for losses from discontinued operations during the first nine months of 1993.\nDepreciation and amortization expense in 1994 did not change significantly from 1993.\nReorganization costs were $3,721,000 in 1994, compared to $4,400,000 in 1993, a decrease of $679,000. This decrease resulted primarily from (a) a reduction in legal fees of $1,994,000 due to the confirmation of a plan of reorganization in September 1993 and the settlement of allowed general unsecured claims, offset by (b) an increase in professional fees in connection with the investigation of financing alternatives and the conversion of the Company to a REIT.\nInterest and debt expense was $3,331,000 in 1994, compared to $855,000 in 1993, an increase of $2,476,000. Of this increase (i) approximately $637,000 was attributable to a short-term loan obtained by the Company in September, 1994, (ii) $376,000 resulted from the nonpayment of real estate taxes in 1994, and (iii) approximately $1,463,000 resulted from a substantial portion of interest and debt expense for 1993 being charged against the accrual for losses from discontinued operations during the first nine months of 1993.\nInterest and other income was $4,768,000 in 1994, compared to $1,270,000 in 1993, an increase of $3,498,000. This increase resulted from the net of (i) $4,550,000 recorded in 1994 from the settlement of a zoning-related matter, (ii) the receipt in 1993 of approximately $421,000, representing the Company's pro rata receipt, net of expenses, from its unsecured allowed claim in an unrelated bankruptcy proceeding and (iii) a refund in 1993 of approximately $489,000 for real estate taxes previously paid.\nThe Company recorded a pre-tax gain of approximately $161,000 in 1994 from the sale of an approximately 20,000 square foot warehouse located in the Bronx, New York. In 1993, the Company recorded a pre-tax gain of approximately $7,686,000, of which approximately $7,313,000 resulted from the assignment back to the Port Authority of the real property lease for its former store located in the World Trade Center, New York and approximately $373,000 resulted from the Company's sale of its leasehold interest in real property located in the Bronx, New York.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company's cash position, including short-term investments, was $8,471,000 at December 31, 1995, as compared to $2,363,000 at December 31, 1994, an increase of $6,108,000.\nCASH FLOWS\nYear Ended December 31, 1995\nCash used in operating activities of $33,210,000 was comprised of: (i) the payment of liabilities of discontinued operations of $29,488,000, (ii) adjustments for non-cash items of $5,260,000 and (iii) a net change in operating assets and liabilities of $899,000, offset by net income of $2,437,000 (including income from discontinued operations of $10,133,000). The adjustments for non-cash items are comprised of (i) change in other liabilities of discontinued operations of $4,322,000, (ii) equity in income of unconsolidated joint venture of $4,285,000 and (iii) the effect of straight-lining of rental income of $1,340,000, offset by depreciation and amortization of $4,687,000.\nNet cash used in investing activities of $62,838,000 was comprised of (i) capital expenditures of $45,933,000, (ii) cash restricted for construction financing of $6,181,000 and (iii) cash restricted for operating liabilities of $10,724,000.\nNet cash provided by financing activities of $102,156,000 was comprised of proceeds from the issuance of debt of $142,034,000 (net of deferred debt expense), offset by repayments of debt of $39,878,000.\nYear Ended December 31, 1994\nCash used in operating activities of $1,831,000 for the year ended December 31, 1994, was comprised of: (i) the payment of liabilities of discontinued operations of $5,229,000 and (ii) adjustments for non-cash items of $751,000, offset by (iii) net income of $4,033,000 and (iv) a net change in operating assets and liabilities of $116,000. The adjustments for non-cash items are comprised of (i) equity in income of unconsolidated joint venture of $1,260,000, (ii) gain on sale of real estate of $161,000 and (iii) the effect of straight-lining of rental income of $1,581,000, offset by depreciation and amortization of $2,251,000.\nNet cash used in investing activities of $10,195,000 was comprised of additions to real estate of $11,170,000, offset by (i) the use of restricted cash of $775,000 and (ii) proceeds received on the sale of real estate of $200,000.\nNet cash provided by financing activities of $7,336,000 was comprised of proceeds from the issuance of debt (net of deferred debt expense) of $8,111,000, offset by $775,000 of debt repayments.\nFive Months Ended December 31, 1993\nCash used in operating activities of $16,454,000 was comprised of the payment of liabilities of discontinued operations of $21,567,000, offset by (i) net income of $946,000, (ii) adjustments for non-cash items of $3,208,000 and (iii) a net change in operating assets and liabilities of $959,000.\nNet cash used in investing activities of $2,178,000 was comprised of additions to real estate of $2,549,000, offset by cash restricted for operating liabilities of $371,000.\nNet cash used in financing activities of $2,991,000 was comprised of debt repayments of $2,314,000 and deferred debt expense of $677,000.\nFifty-Three Weeks Ended July 31, 1993\nCash used in operating activities of $26,224,000 was comprised of: (i) the payment of liabilities of discontinued operations of $27,422,000, (ii) adjustments for non-cash items of $27,547,000, offset by (iii) net income of $27,151,000 and (iv) a net change in operating assets and liabilities of $1,594,000. The adjustments for non-cash items is comprised of (i) $28,779,000 of gains on sales of real estate and real estate leases, (ii) equity in income of unconsolidated joint venture of $326,000 and (iii) the effect of straight-lining of rental income of $566,000, offset by depreciation and amortization of $2,124,000.\nCash provided by investing activities of $35,534,000 resulted from (i) receipt of proceeds from the sales of real estate of $33,701,000 and (ii) cash restricted for operating liabilities of $1,833,000.\nCash used in financing activities of $94,000 resulted from (i) payment of capital lease obligations of $144,000 and (ii) deferred debt expense of $575,000, offset by $625,000 resulting from the exercise of a stock option by a former officer of the Company.\nIn connection with the redevelopment of the existing building and the construction of a multi-level parking structure on its Rego Park I property, the Company has expended approximately $26,700,000 during the year ended December 31, 1995, and expects to expend approximately $11,000,000 through the first half of 1996 to complete the project. At December 31, 1995, there was $12,200,000 available under a $60,000,000 construction loan to fund these expenditures. The Company estimates that its capital expenditure requirements for other redevelopment projects will include: (i) the redevelopment of the Paramus property at a cost of approximately $50,000,000 to $60,000,000, (ii) the demising of the Kings Plaza store and installation of vertical transportation which may have an improvement cost between $10,000,000 and $20,000,000 and (iii) the renovation of the existing former Lexington Avenue store building principally for retail use at an estimated cost of approximately $20,000,000 to $25,000,000. While the Company anticipates that financing will be available after tenants have been obtained for these redevelopment projects, there can be no assurance that such financing will be obtained or if obtained, that such financings will be on terms that are acceptable to the Company. In addition, it is uncertain as to when these projects will commence.\nOn September 18, 1995, Caldor, which leases the Fordham Road and Flushing properties from the Company, filed for relief under Chapter 11 of the United States Bankruptcy Code. Caldor accounted for approximately 56% and 64% of the Company's consolidated revenues for the years ended December 31, 1995 and 1994. Caldor leased these properties \"as is\", expended the entire cost of refurbishing these stores and continues to pay rent on both of these locations. The loss of property rental payments under any of these leases could have a material adverse effect on the financial condition and results of operations of the Company. In addition, Caldor has failed to meet certain financial tests, which results in the Company being required, commencing January 1, 1996, to escrow net cash flow of approximately $500,000 per annum from the Fordham Road Property into an account of the lender as a reserve against future payments under the loan (see \"1995 Financings\").\nCaldor was also a lessee for a portion of the Rego Park I property. On February 28, 1996, Caldor filed for Bankruptcy Court approval to reject the lease. After Bankruptcy Court approval, Caldor would no longer have any obligations under this lease. Alexander's will file a claim for damages based on such rejection.\nAlexander's current operating properties (five of its nine properties) do not generate sufficient cash flow to pay all of its expenses. The Company's four non-operating properties (Lexington Avenue, Paramus, the Kings Plaza Store and Rego Park II) are in various stages of redevelopment. As rents commence from a portion of the redevelopment properties, the Company expects that cash flow will become positive.\nThe Company estimates that the fair market values of its assets are substantially in excess of their historical cost and that there is additional borrowing capacity. Alexander's continues to evaluate its needs for capital which may be raised through (a) property specific or corporate borrowing, (b) the sale of securities and (c) asset sales.\nIn December 1995, the Company completed a tax certiorari proceeding with the City of New York regarding the Kings Plaza Shopping Center property. The Company and its joint venture partner have agreed with the City of New York to a reduction in the assessed values covering the tax years 1988\/1989 through 1995\/1996, generating tax credits of $28,350,000. The Company's allocated share of these credits, approximately $8,600,000, net of expenses, was recorded as follows: (i) $6,100,000 as income from discontinued operations and (ii) $2,500,000 as a reduction of previously capitalized real estate taxes. As a result of this settlement, all amounts held in escrow for unpaid real estate taxes ($8,000,000) are being released.\nIn addition, the Company may receive the proceeds from other tax certiorari and\/or condemnation proceedings -- see Note 11 \"Paramus Property\" and \"Tax Certiorari Proceedings\".\nAlthough there can be no assurance, the Company believes that these cash sources will be adequate to fund cash requirements until its operations generate adequate cash flow.\n1995 FINANCINGS\nThe Company borrowed approximately $148,000,000 during 1995. The proceeds of these borrowings were used primarily for (i) construction costs associated with the Rego Park I property of $26,700,000, (ii) prepayment of $39,600,000 of outstanding funded debt and $24,000,000 of allowed general unsecured claims, (iii) funding of (a) interest-bearing escrow accounts for unpaid real estate taxes ($7,000,000) and the remaining disputed claims in the Bankruptcy Court cases as they become allowed ($4,000,000), and (b) collateral accounts for the Rego Park I construction ($6,000,000) and (iv) payment of $40,700,000, net, of overhead, interest and property carrying costs. Substantially all of the assets of the Company and its subsidiaries have been pledged and\/or mortgaged to secure such indebtedness. The borrowings consist of:\n(1) A $25,000,000 five year loan maturing February 24, 2000, secured principally by, a mortgage on the Company's Fordham Road property and guaranteed by the parent. The loan bears annual interest at 30 day LIBOR plus 4.25% (10.28% at December 31, 1995), capped at LIBOR 9.75% (all-in rate, 14%) and requires amortization based on a 20 year term with an assumed interest rate of 9 1\/2%. Beginning in year four, all cash flow of the property, after debt service, will further amortize the loan. The loan is not prepayable for the first six months of its term and is only prepayable with yield maintenance during the next twelve months in the event of certain types of refinancings. For the remainder of the term, it is prepayable without penalty. The loan contains customary mortgage covenants, including, among others, a default by the existing tenant. Further, in the event debt service coverage falls below certain levels or the existing tenant's financial condition, as defined, deteriorates, then during the first three years of the loan term, all cash flow of the property, after debt service, will be escrowed with the lender (see fourth paragraph on previous page).\n(2) A $75,000,000 three year loan secured by mortgages on all of the Company's assets and\/or pledges of the stock of subsidiaries owning the assets and\/or guarantees of such subsidiaries and the parent. The loan bears interest at a blended rate of 13.8% per annum for the first two years and is comprised of two separate notes of $45,000,000 to Vornado and $30,000,000 to a bank. Each note is separately secured by the collateral described above. The Vornado loan is subordinate to that of the bank and bears interest at 16.43% per annum (effective rate 17.54%) for the first two years and at a fixed rate for the third year of 992 basis points over the one-year Treasury bill rate. The bank's loan bears interest at 9.86% for the first two years and at a fixed rate for the third year of 325 basis points over the one-year Treasury bill rate. The Company paid a loan origination fee to Vornado and the bank of $1,500,000 and $375,000, respectively. The loans are prepayable at the end of the second year of their term without penalty. The loans contain customary covenants including, among others, lease approval rights, limitations on additional debt, dividends, acquisitions, mergers, property sales and restrict the Company from developing property without signed leases for more than 50% of such property's leasable space. No dividends can be paid unless required to maintain Real Estate Investment Trust (\"REIT\") status.\n(3) A two year $60,000,000 construction loan and a two year $25,000,000 bridge loan from a group of banks, each secured by a mortgage on the Rego Park I property. As of December 31, 1995, approximately $47,806,000 was funded under such construction loan and there were no borrowings under the $25,000,000 bridge loan. The loans mature on April 1, 1997 (but may be extended at the Company's option, subject to certain conditions, for an additional year) and bear annual interest at (i) LIBOR plus 1.625% or (ii) the greater of (a) Federal Funds Rate plus 1.125% or (b) prime plus 0.625%, at the option of the Company (7.36% at December 31, 1995). The ability of the Company to borrow the $25,000,000 under the bridge loan is based on conditions that cannot be met today and may not be met during the term of this loan. The Company has not relied on this amount in its determination of its ability to fund its current cash needs but believes that it will be able to refinance the Rego Park I property at a level exceeding $60,000,000 upon the completion of construction and commencement of tenants paying rent.\nIn addition to the above, in January 1995, the Seven Thirty One Limited Partnership (\"the Partnership\"), redeemed the first portion of the non-affiliated limited partners' interest by giving such limited partners a promissory note due in August 1998 in the amount of $21,812,000 (the \"Note\"). The Note bears annual interest at Prime plus 1% (9.50% at December 31, 1995) and is secured by a third mortgage on the Lexington Avenue property. The non-affiliated limited partners have the right to put their remaining 7.64% interest to the Partnership until October 1998, in exchange for a five year secured note in the principal amount of $15,000,000, bearing annual interest at Prime plus 1%.\nA summary of maturities of debt is as follows (amounts in thousands):\nThe Company believes that its sources of cash as described above are adequate to service its debt.\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.\nINDEPENDENT AUDITORS' REPORT\nBoard of Directors and Stockholders of Alexander's, Inc. Saddle Brook, New Jersey\nWe have audited the accompanying consolidated balance sheets of Alexander's, Inc. and Subsidiaries (the \"Company\") as of December 31, 1995 and 1994 and the related consolidated statements of operations, deficiency in net assets and cash flows for the years ended December 31, 1995 and 1994, for the five months ended December 31, 1993 and the 53 weeks ended July 31, 1993. Our audits also included the financial statement schedules listed in the index at Item 14(a)(2). These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, such financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 1995, and 1994, and the results of their operations and their cash flows for the years ended December 31, 1995 and 1994, for the five months ended December 31, 1993 and the 53 weeks ended July 31, 1993 in conformity with generally accepted accounting principles. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nAs discussed in Note 12 to the financial statements, the Company changed in Fiscal 1993 its method of accounting for postretirement healthcare benefits to conform with Statement of Financial Accounting Standards No. 106.\nDELOITTE & TOUCHE LLP\nParsippany, New Jersey March 7, 1996\nALEXANDER'S, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS (amounts in thousands except share amounts)\n- --------------------------------------------------------------------------------\nSee notes to consolidated financial statements\nALEXANDER'S, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS (continued) (amounts in thousands except share amounts)\n- --------------------------------------------------------------------------------\nSee notes to consolidated financial statements\nALEXANDER'S, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF OPERATIONS (amounts in thousands except per share amounts)\n- --------------------------------------------------------------------------------\nSee notes to consolidated financial statements.\nALEXANDER'S, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF DEFICIENCY IN NET ASSETS (amounts in thousands)\nSee notes to consolidated financial statements.\nALEXANDER'S, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS (amounts in thousands)\n- --------------------------------------------------------------------------------\nThe 1995 amounts exclude an increase in real estate of $20,838 and debt of $21,812 and a reduction in minority interest of $974 as a result of the Company acquiring a partnership interest (see Note 6).\nSee notes to consolidated financial statements.\nALEXANDER'S, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n- --------------------------------------------------------------------------------\n1. EMERGENCE FROM CHAPTER 11\nIn May 1992, at a time when the Company's business consisted of retail store operations, the Company and sixteen of its subsidiaries filed petitions for relief under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the Southern District of New York (the \"Bankruptcy Court\"). In September 1993, the Bankruptcy Court confirmed the Joint Plan of Reorganization (the \"Plan\"), pursuant to which the Company and its subsidiaries reorganized their business as a real estate company.\nIn March 1995, the Company paid holders of allowed general unsecured claims in full, together with accrued interest in respect of their claims. Such payments aggregated $24,000,000. The Official Committee of Unsecured Creditors has been dissolved and all secured and unsecured creditors having allowed claims in the Bankruptcy Court cases have received the cash payments or debt instruments contemplated to be delivered to them under the Plan. A number of claims are being disputed by the Company and therefore are not allowed claims. An escrow account has been established for the resolution of these claims. The Bankruptcy Court has retained jurisdiction to resolve these disputed claims and for other limited purposes.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBusiness -- The Company is engaged in the business of leasing, managing, developing and redeveloping real estate properties, focusing on the properties where its department stores (which ceased operations in 1992) formerly operated. The Company's properties are located in mature, densely populated areas in New York City and Paramus, New Jersey.\nAlexander's current operating properties (five of its nine properties) do not generate sufficient cash flow to pay all of its expenses. The Company's four non-operating properties (Lexington Avenue, Paramus, the Kings Plaza Store and Rego Park II) are in various stages of redevelopment. As rents commence from a portion of the development properties, the Company expects that cash flow will become positive. See Note 7 - \"Leases\" for significant tenants.\nThe Company estimates that the fair market values of its assets are substantially in excess of their historical cost, and that there is additional borrowing capacity. Alexander's continues to evaluate its needs for capital, which may be raised through (a) property specific or corporate borrowing, (b) the sale of securities and (c) asset sales. In addition, the Company may receive the proceeds from certain tax certiorari and\/or condemnation proceedings -- see Note 11, \"Paramus Property\" and \"Tax Certiorari Proceedings\". Although there can be no assurance, the Company believes that these cash sources will be adequate to fund cash requirements until its operations generate adequate cash flow.\nThe consolidated financial statements are prepared in conformity with generally accepted accounting principles. Management has made 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 periods. Actual results could differ from those estimates.\nBasis of Presentation -- The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, and the Partnership, a partnership in which the Company held a majority interest at December 31, 1995. Investments in real estate and other property which are 50% owned joint ventures are accounted for under the equity method. All material intercompany accounts and transactions have been eliminated.\nALEXANDER'S, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n- --------------------------------------------------------------------------------\nEffective January 1, 1995, to be consistent with prevalent real estate industry practice, the Company changed the presentation of its consolidated statements of operations to show tenant reimbursements, previously offset against operating expenses, as part of revenues. Further, operating expenses and general and administrative expenses have been shown separately. Prior period's amounts have been reclassified to conform with the current year's presentation.\nCash and Cash Equivalents -- The Company includes in cash and cash equivalents both cash and short-term highly liquid investments purchased with original maturities of three months or less. Cash and cash equivalents does not include cash restricted for construction financing and operating liabilities which is disclosed separately.\nReal Estate and Other Property -- Real estate and other property is carried at cost, net of accumulated depreciation. Depreciation is provided on buildings and improvements on a straight-line basis over their estimated useful lives. When real estate and other property is undergoing development activities, all property operating expenses, including interest expense, are capitalized to the cost of the real property to the extent that management believes such costs are recoverable through the value of the property.\nThe Company's policy, pursuant to the Financial Accounting Standards Board Statement No. 121, \"Accounting For the Impairment of Long-Lived Assets and For Long-Lived Assets to be Disposed Of\" (SFAS No. 121), is to annually assess any impairment in value by making a comparison of the current and projected operating cash flows of each of its properties over its remaining useful life on an undiscounted basis, to the carrying amount of such property. Such carrying amount would be adjusted, if necessary, to reflect an impairment in the value of the asset.\nDeferred Lease Expense -- The Company capitalizes the costs incurred in connection with obtaining long-term leases. Deferred lease expense is amortized on the straight-line method over the initial terms of the leases.\nDeferred Finance and Debt Expense -- The Company capitalizes the costs incurred in connection with obtaining short-term or long-term debt or refinancing existing debt. These costs are amortized on the straight-line method over the initial terms of the debt, which approximates the interest method.\nLeases -- All leases are operating leases whereby rents and reimbursements of operating expenses are recorded as real estate operating revenue. The straight-line basis is used to recognize rents under leases entered into which provide for varying rents over the lease terms.\nIncome Taxes -- The Company intends to file, with its federal income tax return for 1995, an election to be taxed as a real estate investment trust (\"REIT\") under sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the \"Code\"). To qualify for taxation as a REIT, the Company must meet various federal income tax law requirements. In general, a REIT that distributes to its stockholders at least 95% of its taxable income as a dividend for a taxable year and that meets certain other conditions will not be taxed on income distributed that year.\nThe net basis in the Company's assets and liabilities for tax purposes is approximately $31,000,000 lower than the amount reported for financial statement purposes.\nReorganization Costs -- Reorganization costs consist of legal, accounting and other professional fees incurred in connection with consultations on restructuring alternatives of the Company.\nAmounts Per Share -- Amounts per share are computed based upon the weighted average number of shares outstanding during the period.\nALEXANDER'S, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n- --------------------------------------------------------------------------------\n3. COMPARABLE TRANSITIONAL PERIOD FINANCIAL DATA\nIn November 1993, the Company changed to a calendar year from a fiscal year ending on the last Saturday in July to be consistent with the predominant real estate industry practice. The change of fiscal year resulted in a transition period of five months beginning on August 1, 1993 and ending on December 31, 1993. Presented below is the financial data for the year ended December 31, 1993, (unaudited) (amounts in thousands):\nALEXANDER'S, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n- --------------------------------------------------------------------------------\n4. INVESTMENT IN UNCONSOLIDATED 50% OWNED JOINT VENTURE (KINGS PLAZA MALL)\nSummary financial information for the Kings Plaza Mall is as follows (amounts in thousands):\nIn December 1995, the Company completed a tax certiorari proceeding with the City of New York regarding the Kings Plaza Shopping Center property. The Company and its joint venture partner have agreed with the City of New York to a reduction in the assessed values covering the tax years 1988\/1989 through 1995\/1996, generating tax credits of $28,350,000 (of which $6,050,000 was applied to 1995 taxes). The Company's allocated share of these credits, approximately $8,600,000, net of expenses, was recorded as follows: (i) $6,100,000 as income from discontinued operations and (ii) $2,500,000 as a reduction of previously capitalized real estate taxes. As a result of this settlement, all amounts held in escrow for unpaid real estate taxes ($8,000,000) are being released.\nALEXANDER'S, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n- --------------------------------------------------------------------------------\n5. DISCONTINUED OPERATIONS\nThe Company provided significant reserves for estimated expenses and losses to be incurred in connection with discontinuing its retail operations. During the year ended December 31, 1995, the Company recorded income from discontinued operations of $10,133,000 comprising (i) $6,133,000 from the settlement of a tax certiorari proceeding with the City of New York regarding the Kings Plaza Shopping Center and (ii) $4,000,000 resulting from the reduction of other liabilities of discontinued operations to amounts considered necessary to cover the remaining estimates of these liabilities. A reconciliation of the liabilities from the discontinued retail operations is as follows:\nIt is the opinion of management that these reserves represent a reasonable estimation of the remaining claims associated with discontinuing the retail operations. However, due to the continuing uncertainties with respect to (i) the final resolution of all bankruptcy claims filed or continuing to be filed against the Company in the Bankruptcy Court cases and (ii) the final cost of interest accruing on unpaid unsecured creditors' claims, the ultimate amount of such costs to be incurred is presently not determinable. Any future additions to these reserves will be provided when known. Management periodically evaluates the reserves and adjusts them accordingly.\nALEXANDER'S, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n- --------------------------------------------------------------------------------\n6. DEBT\nDebt comprises:\n(1) First mortgage loans are comprised of:\n(a) A $24,674,000 five year loan maturing February 24, 2000, secured principally by mortgage on the Company's Fordham Road property and guaranteed by the parent. The loan bears annual interest at 30 day LIBOR plus 4.25% (10.28% at December 31, 1995), capped at LIBOR 9.75% (all-in rate, 14%) and requires amortization based on a 20 year term with an assumed interest rate of 9 1\/2%. The weighted average interest rate for 1995 was 10.25%. Beginning in year four, all cash flow of the property, after debt service, will further amortize the loan. The loan is not prepayable for the first six months of its term and is only prepayable with yield maintenance during the next twelve months in the event of certain types of refinancings. For the remainder of the term, it is prepayable without penalty. The loan contains customary mortgage covenants, including, among others, a default by the existing tenant. Further, in the event debt service coverage falls below certain levels or the existing tenant's financial condition, as defined, deteriorates, then during the first three years of the loan term, all cash flow of the property, after debt service, will be escrowed with the lender. Caldor, who is the tenant at this property has failed to meet certain financial tests and as a result, the Company is required, commencing January 1, 1996, to escrow net cash flow of approximately $500,000 per annum into an account of the lender as a reserve against future payments under the loan.\n(b) A $13,591,000 loan maturing December 31, 1998, secured principally by a mortgage on the Company's Paramus property. The loan bears interest at a floating rate (8.08% at December 31, 1995), fixed annually, equal to 2.5% above the one-year U.S. Treasury bill rate with a floor of 6.5%. The weighted average interest rate for 1995 was 8.41%. The loan contains customary mortgage covenants and events of default. The loan is prepayable at any time.\nALEXANDER'S, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n- --------------------------------------------------------------------------------\n(2) A $75,000,000 three year loan secured by mortgages on all of the Company's assets and\/or pledges of the stock of subsidiaries owning the assets and\/or guarantees of such subsidiaries and the parent. The loan bears interest at a blended rate of 13.8% per annum for the first two years and is comprised of two separate notes of $45,000,000 to Vornado and $30,000,000 to a bank. Each note is separately secured by the collateral described above. The Vornado loan is subordinate to that of the bank and bears interest at 16.43% per annum (effective rate 17.54%) for the first two years and at a fixed rate for the third year of 992 basis points over the one-year Treasury bill rate. The bank's loan bears interest at 9.86% for the first two years and at a fixed rate for the third year of 325 basis points over the one-year Treasury bill rate. The Company paid a loan origination fee to Vornado and the bank of $1,500,000 and $375,000, respectively. The loans are prepayable at the end of the second year of their term without penalty. The loans contain customary covenants including, among others, lease approval rights, limitations on additional debt, dividends, acquisitions, mergers, property sales and restrict the Company from developing property without signed leases for more than 50% of such property's leasable space. No dividends can be paid unless required to maintain Real Estate Investment Trust (\"REIT\") status.\n(3) A two year $60,000,000 construction loan and a two year $25,000,000 bridge loan from a group of banks, each secured by a mortgage on the Rego Park I property. As of December 31, 1995, approximately $47,806,000 was funded under such construction loan and there were no borrowings under the $25,000,000 bridge loan. The loans mature on April 1, 1997 (but may be extended at the Company's option, subject to certain conditions, for an additional year) and bear annual interest at (i) LIBOR plus 1.625% or (ii) the greater of (a) Federal Funds Rate plus 1.125% or (b) prime plus 0.625%, at the option of the Company (7.36% at December 31, 1995). The weighted average interest rate for 1995 was 7.77%. The ability of the Company to borrow the $25,000,000 under the bridge loan is based on conditions that cannot be met today and may not be met during the term of this loan. The Company has not relied on this amount in its determination of its ability to fund its current cash needs but believes that it will be able to refinance the Rego Park I property at a level exceeding $60,000,000 upon the completion of construction and commencement of tenants paying rent.\n(4) In January 1995, the Seven Thirty One Limited Partnership (\"the Partnership\"), redeemed the first portion of the non-affiliated limited partners' interest by giving such limited partners a promissory note due in August 1998 in the amount of $21,812,000 (the \"Note\"). The Note bears annual interest at Prime plus 1% (9.50% at December 31, 1995) and is secured by a third mortgage on the Lexington Avenue property. The weighted average interest rate for 1995 was 9.83%. The non-affiliated limited partners have the right to put their remaining 7.64% interest to the Partnership until October 1998, in exchange for a five year secured note in the principal amount of $15,000,000, bearing annual interest at Prime plus 1%.\nA summary of maturities of debt is as follows (amounts in thousands):\nAll of the Company's debt is secured by mortgages and\/or pledges of the stock of subsidiaries holding the properties. The net carrying value of real estate collateralizing the debt amounted to $150,435,000 at December 31, 1995.\nALEXANDER'S, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n- --------------------------------------------------------------------------------\n7. LEASES\nAs Lessor\nThe Company currently (i) net leases to the Caldor Corporation (\"Caldor\") its Fordham Road property, (ii) net subleases to Caldor its Flushing property and (iii) net leases its Third Avenue property to an affiliate of Conway Stores, Inc. (\"Conway\").\nThe rental terms for the properties leased to Caldor and Conway range from 20 years to approximately 34 years. The leases provide for the payment of fixed base rentals payable monthly in advance and for the payment by the lessees of additional rents based on a percentage of the tenants' sales as well as reimbursements of real estate taxes, insurance and maintenance.\nAs of December 31, 1995, future base rental revenue under noncancellable operating leases is as follows:\nOn September 18, 1995, Caldor filed for relief under Chapter 11 of the United States Bankruptcy Code. Caldor accounted for approximately 56% and 64% of the Company's consolidated revenues for the years ended December 31, 1995 and 1994. Caldor leased the Fordham Road and Flushing properties \"as is\", expended the entire cost of refurbishing these stores and has not affirmed either of these leases, but continues to pay rent on both of these locations. Revenues from the Conway lease represented approximately 13% and 14% of the Company's consolidated revenues for the years ended December 31, 1995 and 1994, respectively. The loss of property rental payments under any of these leases could have a material adverse effect on the financial condition and results of operations of the Company.\nAs Lessee\nThe Company is a tenant under a long-term lease for the Flushing property which expires on January 31, 2027. Future minimum lease payments under the operating lease at December 31, 1995 are as follows:\nRent expense was $496,000 for each of the years ended December 31, 1995, December 31, 1994 and July 31, 1993 and $207,000 for the five months ended December 31, 1993.\nALEXANDER'S, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n- --------------------------------------------------------------------------------\nAssignment and Sales of Leases\nDuring the 53 weeks ended July 31, 1993, the Company sold its interests in four real property leases and assigned another real property lease. The Company received proceeds of $33,701,000, and recorded a pre-tax gain of $28,779,000.\n8. INTEREST AND OTHER INCOME, NET\nInterest and other income, net is comprised of (amounts in thousands):\n9. INCOME TAXES\nThe Company intends to elect to be taxed as a real estate investment trust (\"REIT\") under sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the \"Code\"), effective for the taxable year ended December 31, 1995. Under the Code, the Company's net operating loss (\"NOL\") carryovers generally would be available to offset the amount of the Company's REIT taxable income that otherwise would be required to be distributed as a dividend to its stockholders. The Company currently does not anticipate making any dividend distributions during 1996. In addition, the Company had a deferred tax liability of approximately $1,406,000 at December 31, 1994, which amount was reversed in 1995 when the Company intends to elect to be taxed as a REIT.\nThe Company has reported NOL carryovers for federal tax purposes of approximately $130,000,000 at December 31, 1995, of which $5,000,000, $52,000,000, $22,000,000, $15,000,000, $16,000,000 and $20,000,000 expire in 2005, 2006, 2007, 2008, 2009 and 2010, respectively. The Company also had investment tax and targeted jobs tax credits of approximately $3,000,000 expiring in 2002 through 2005.\n10. RELATED PARTY TRANSACTIONS\nSteven Roth is Chief Executive Officer and a Director of the Company, the Managing General Partner of Interstate Properties (\"Interstate\") and Chairman of the Board and Chief Executive Officer of Vornado Realty Trust (\"Vornado\"). Interstate owns 27.1% of the outstanding common stock of the Company and owns 27.7% of the outstanding common shares of beneficial interest of Vornado. In addition, Mr. Roth owns 3.3% of the outstanding common shares of beneficial interest of Vornado. Mr. Roth, Interstate and the other two general partners of Interstate, David Mandelbaum and Russell B. Wight, Jr. (who are also directors of the Company and trustees of Vornado) own, in the aggregate, 32.1% of the outstanding common shares of beneficial interest of Vornado. Vornado owns 29.3% of the outstanding common stock of the Company, including 27.1% purchased in March 1995.\nALEXANDER'S, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n- --------------------------------------------------------------------------------\nIn March 1995, the Company and Vornado entered into a three-year management and development agreement (the \"Management Agreement\"). The annual management fee payable by the Company to Vornado is $3,000,000, plus 6% of development costs with a minimum guaranteed fee for the development portion of $1,650,000 in the first year and $750,000 in each of the second and third years. On July 6, 1995, Vornado assigned its Management Agreement to Vornado Management Corp., an affiliate of Vornado.\nThe fee pursuant to the Management Agreement is in addition to the leasing fee the Company pays to Vornado under the leasing agreement (the \"Leasing Agreement\") which has been in effect since 1992. Subject to the payment of rents by tenants, Vornado is due $7,868,000. Such amount is payable annually in an amount not to exceed $2,500,000, until the present value of such installments (calculated at a discount rate of 9% per annum) equals the amount that would have been paid had it been paid on September 21, 1993, or at the time the transactions which gave rise to the commissions occurred, if later. Two leases which Vornado previously negotiated on behalf of the Company for its Paramus property terminated in the second quarter of 1995 because governmental approvals to begin construction could not be obtained on a timely basis as a result of a pending condemnation (see Note 11 below), resulting in $2,424,000 of previously recorded leasing fees payable and the corresponding deferred lease expense, being reversed. The term of the Leasing Agreement has been extended to be coterminous with the term of the Management Agreement.\nIn March 1995, the Company borrowed $45,000,000 from Vornado, the subordinated tranche of a $75,000,000 secured financing (see Note 6(2)). The Company incurred interest on the loan of $5,976,000 for the year ended December 31, 1995, of which $1,294,000 was capitalized.\nEffective March 2, 1995, for a three-year period, Vornado and Interstate agreed not to own in excess of two-thirds of the Company's common stock or to enter into certain other transactions with the Company, other than the transactions described above, without the consent of the Company's independent directors.\nIn September 1994, the Company obtained from Interprop Fordham, Inc., an affiliate of Interstate, and Citibank, N.A. a short-term secured loan of $10,000,000 which enabled the Company to make a $2,600,000 payment to the unsecured creditors and to fund a portion of the Company's working capital and capital expenditure requirements. This loan was repaid during the first quarter of 1995.\nDuring the years ended December 31, 1995 and 1994, the five months ended December 31, 1993 and the fiscal year 1993, Vornado through Interstate was paid $463,000, $57,000, $2,000 and $445,000, respectively, by the Kings Plaza Shopping Center for performing leasing services.\n11. COMMITMENTS AND CONTINGENCIES\nParamus Property\nThe State of New Jersey has notified the Company of its intention to condemn approximately 10 acres (one-quarter) of the Paramus property. The land subject to condemnation is located on the periphery of the property and will be used to lessen traffic congestion at this major intersection. The New Jersey Department of Transportation (\"DOT\") has made an offer to purchase the land for $15,400,000 based on an appraisal performed on its behalf. The Company is negotiating with the DOT to attempt to reach agreement on the value and other terms. In the event that the Company and the DOT do not reach agreement, a formal process may be initiated by the DOT pursuant to which, among other things, a group of independent commissioners will be appointed by a court to adjudicate the disputed matters.\nALEXANDER'S, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n- --------------------------------------------------------------------------------\nLexington Avenue Property\nThe Company believes that, along with a number of other locations, a portion of the Lexington Avenue property has been considered by the Port Authority of New York and New Jersey (the \"Port Authority\") for the site of the terminus for a rail link from midtown Manhattan to La Guardia and Kennedy Airports. Recent statements by Port Authority officials have indicated that the rail link between midtown Manhattan and the airports is not likely to be developed in the foreseeable future. Since the nature and scope of any plans being considered by the Port Authority, and whether any such plans would ultimately affect the Lexington Avenue property, cannot be fully assessed by the Company at this time, it is impossible to determine the ultimate effect that a taking, or any uncertainty with respect thereto, would have on the Company's use or redevelopment of the Lexington Avenue property.\nTax Certiorari Proceedings\nThe Company is currently negotiating certiorari proceedings with the City of New York on several of its properties.\nAlexander's Department Stores of Valley Stream, Inc. (\"ADS of Valley Stream\") is a party to a tax certiorari proceeding against The Board of Assessors and The Board of Assessment Review of the County of Nassau (the \"Board\") for overpayment of taxes on its former Valley Stream store property during the assessment rolls from 1986 to 1992. In January 1995, the Supreme Court of Nassau County, New York ruled that ADS of Valley Stream is entitled to an assessment reduction which would result in a refund of approximately $10,100,000 (including interest currently aggregating $3,500,000). Both the Board and the Company have appealed the Court's decision.\nEnvironmental\nThe results of a 1993 Phase I environmental study at the Kings Plaza Shopping Center's (\"Center\") property show that certain adjacent properties owned by third parties have experienced petroleum hydrocarbon contamination. Based on this study and preliminary investigation of the Center's property and its history, there is potential for contamination on the property. The study also revealed an underground storage tank which failed an integrity test, although no contamination has been observed to date. The tank failure has been reported to the New York State Department of Environmental Conservation (\"DEC\") and the tank was fixed in early 1994. In October 1994, independent testing revealed that all of the Center's underground storage tanks (used for storing heating oil) and related distribution lines passed a tank and line leak status test. Such results were furnished to the DEC. If contamination is found on the property, the Center may be required to engage in remediation activities; management is unable to estimate the financial impact of potential contamination if any is discovered in the future. If further investigations reveal that there is contamination on its site, since the Center believes such contamination would have resulted from activities of third parties, the Center intends to pursue all available remedies against any of these third parties.\nThe Company is aware of the presence of asbestos-containing materials at several of its properties and believes that it manages such asbestos in accordance with applicable laws. The Company plans to abate or remove such asbestos as appropriate.\nThe Company believes that known and potential environmental liabilities will not have a material adverse effect on the Company's business, assets or results of operations. However, there can be no assurance that the confirmation of the existence of contamination or the identification of potential new areas of contamination would not be material to the Company.\nLetters of Credit\nApproximately $900,000 in standby letters of credit were issued at December 31, 1995.\nALEXANDER'S, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n- --------------------------------------------------------------------------------\n12. EMPLOYEE BENEFITS PLAN\nThe Company sponsors a postretirement health care benefit plan covering substantially all former employees who retired under certain age and service requirements. The plan provides for covered medical expenses. Such benefits are funded from the general assets of the Company. The Company has the right to amend, modify or terminate the plan. Generally, employees of the Company retiring on or after attaining age 62, who have rendered at least 40 years of service, are entitled to postretirement health care coverage. Costs of this benefit are funded on a claims-paid basis and benefit payments for the five months ended December 31, 1993 and the 53 weeks ended July 31, 1993 approximated $500,000 and $1,300,000, respectively. Early adoption of SFAS No. 106, elected by the Company effective July 26, 1992, resulted in a one-time transition charge of approximately $21,400,000. It also had the effect of increasing the loss from discontinued retail operations by approximately $500,000 for the year ended July 31, 1993.\nIn accordance with the Company's Plan of Reorganization, the Company has made certain changes in its postretirement health care benefit plan. Commencing on February 1, 1994, the full amount of any premium increases effective on or after November 1, 1993 will be added to the contributions which retirees are required to make on behalf of themselves and their dependents. Employees who retired prior to May 1, 1988, for whom no contribution was previously required, will pay 50% of the amount required of later retirees on and after February 1, 1994, rising to 75% on October 1, 1994 and 100% as of October 1, 1995. The deferred gains resulting from the negative plan amendments are being amortized over the estimated life span of the retired workers receiving benefits (13 years).\nThe following table sets forth the plan's funded status, reconciled with amounts recognized in the Company's balance sheet as of December 31, 1995 (in $000s):\nFor measurement purposes, a 13 percent trend rate was used for post-65 per capita costs and a 14 percent trend rate was used for pre-65 per capita benefits for fiscal 1993; the rate was assumed to decrease gradually to 5.5 percent until the year 2002 and remain level thereafter. The weighted average discount rate used in determining the accumulated postretirement benefit obligation was 6.3 percent as of December 31, 1995.\nThe healthcare cost trend rate assumption does not have a significant effect on the amounts reported since increases in medical costs are assumed to be passed directly to the retirees through increases in their contribution rate.\n13. FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe 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\" which was adopted by the Company on December 31, 1995. The estimated fair value of cash and cash equivalents, accounts receivable, accounts payable, and accrued expenses are reflected in the balance sheet. The fair value of debt has been estimated by discounting cash flows at the current rate at which similar loans would be made to borrowers with similar credit ratings for the remaining term. At December 31, 1995, fair value of the debt was estimated to be $184,883,000 compared to a carrying value of $182,883,000. The fair value estimates presented herein are based on pertinent information available to management as of December 31, 1995.\nALEXANDER'S, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n- --------------------------------------------------------------------------------\n14. SUMMARY OF QUARTERLY RESULTS (UNAUDITED) (amounts in thousands except per share amounts)\n(1) During the quarter ended December 31, 1995, the Company recorded income from discontinued operations of (i) $6,133,000 upon completion of a tax certiorari proceeding and (ii) $4,000,000 from the reduction of other liabilities of discontinued operations to amounts considered necessary to cover the remaining estimates of these liabilities.\n(2) During the quarter ended December 31, 1994, the Company recorded income from a zoning related matter of $4,550,000, partially offset by $1,639,000 of reorganization costs.\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 will be contained in a definitive Proxy Statement involving the election of directors which the Company will file with the Securities and Exchange Commission pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended, not later than 120 days after December 31, 1995, and such information is incorporated herein by reference. Information relating to Executive Officers of the Registrant appears on page 14 of this Annual Report on Form 10-K.\nItem 11.","section_11":"Item 11. Executive Compensation\nInformation relating to executive compensation will be contained in the Proxy Statement referred to above in Item 10, \"Directors and Executive Officers of the Registrant\", and such information 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 will be contained in the Proxy Statement referred to in Item 10, \"Directors and Executive Officers of the Registrant\", and such information is incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nInformation relating to certain relationships and related transactions will be contained in the Proxy Statement referred to in Item 10, \"Directors and Executive Officers of the Registrant\", and such information is incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(a) Documents filed as part of this Report\n1. The consolidated financial statements are set forth in Item 8 of this Annual Report on Form 10-K.\n2. Financial Statement Schedules.\nAll other consolidated financial schedules are omitted because they are inapplicable, not required, or the information is included elsewhere in the consolidated financial statements or the notes thereto.\n3. Exhibits\nSee Exhibit Index on page 57\n(b) Reports on Form 8-K\nThe Company has filed a current report on Form 8-K, dated January 3, 1996. In the fourth quarter of fiscal 1995, the Company did not file a current report on Form 8-K.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nALEXANDER'S, INC.\nBy: \/s\/ Joseph Macnow ---------------------------------- Joseph Macnow, Vice President, Chief Financial Officer\nDate: March 25, 1996 ----------------------------------\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nALEXANDER'S, INC. AND SUBSIDIARIES SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1995\n(Amounts in thousands)\n(1) Three-year loan which is secured by mortgages on all of the Company's assets and\/or pledges of the stock of subsidiaries owning the assets and\/or guarantees of such subsidiaries and the parent.\n(2) Initial cost is as of May 15, 1992 (the date on which the Company commenced real estate operations) unless acquired subsequent to that date. See Column H.\n(3) Cost capitalized subsequent to acquisition does not include development costs at December 31, 1995 of $33,165,000.\n(4) Aggregate cost is approximately the same for federal income tax purposes.\n(5) Date represents lease acquisition date.\n(6) Date acquired represents the date on which the Company commenced its real estate operations.\nALEXANDER'S, INC. AND SUBSIDIARIES\nSCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION (Amounts in thousands)\nINDEPENDENT AUDITORS' REPORT\nTo the Co-Venturers Kings Plaza Shopping Center and Marina Brooklyn, New York\nWe have audited the accompanying balance sheets of Kings Plaza Shopping Center and Marina (a joint venture) as of December 31, 1995 and June 30, 1995, and the related statements of earnings, equity of the co-venturers and cash flows for each of the three years in the period ended June 30, 1995. 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 Kings Plaza Shopping Center and Marina at December 31, 1995 and June 30, 1995, and the results of its operations and its cash flows for the six months ended December 31, 1995 and for each of the three years in the period ended June 30, 1995 in conformity with generally accepted accounting principles.\nParsippany, New Jersey Deloitte & Touche LLP\nFebruary 15, 1996\nKINGS PLAZA SHOPPING CENTER AND MARINA (A JOINT VENTURE)\nSee notes to financial statments.\nKINGS PLAZA SHOPPING CENTER AND MARINA (A JOINT VENTURE)\nSee notes to financial statements.\nKINGS PLAZA SHOPPING CENTER AND MARINA (A JOINT VENTURE)\nSee notes to financial statements.\nKINGS PLAZA SHOPPING CENTER AND MARINA (A JOINT VENTURE)\nSupplemental disclosure of noncash financing activities:\nOn October 1, 1993, accrued interest of $681,992 due on the Alexander's 50% portion of the mortgage note was capitalized as a term note payable. (See Note 3).\nSee Note 9.\nSee notes to financial statements.\nKINGS PLAZA SHOPPING CENTER AND MARINA (A JOINT VENTURE)\nNOTES TO FINANCIAL STATEMENTS SIX MONTH ENDED DECEMBER 31,1995 AND YEARS ENDED JUNE 30, 1995, 1994 AND 1993 - --------------------------------------------------------------------------------\n1. ORGANIZATION AND CHAPTER 11 PROCEEDINGS\nKings Plaza Shopping Center of Avenue U, Inc. (a wholly-owned subsidiary of Federated Department Stores, Inc. (formerly R.H. Macy & Co. Inc. (\"Macy's\")) and Alexander's Department Stores of Brooklyn, Inc. (wholly-owned by Alexander's, Inc. (\"Alexander's\")), formed a joint venture for the purpose of owning and operating Kings Plaza Shopping Center and Marina (\"Center\"), including the energy plant servicing the entire shopping center, but exclusive of the Macy's and Alexander's stores and land thereunder located in the Center. The store Alexander's previously occupied has been closed and Alexander's is in the process of leasing it. The co-venturers each have an undivided 50% interest as tenants in common in the property and equipment.\nIn 1992, R.H. Macy & Co., Inc. and subsidiaries and Alexander's Inc. and subsidiaries separately filed petitions for relief under Chapter 11 of the United States Bankruptcy Code with the United States Bankruptcy Court. As a result of such bankruptcy filings, the Center and the co-venturers were prohibited from paying pre-petition liabilities, except as approved by the Bankruptcy Court. During 1993 and 1994, Alexander's and Macy's, respectively, each filed a joint plan of reorganization, which was approved by the Bankruptcy Court and thereby emerged from Chapter 11. Certain payments were made by the Center for Alexander's share of their liabilities, including the mortgage and related interest which was accrued at its contractual rate for all periods (see below). On October 6, 1993, the Center paid $1,859,797 (or 95% of the total claim) in settlement of Alexander's 50% share of real estate taxes and related interest for the period through June 30, 1993. This resulted in a $80,918 gain on the settlement of real estate taxes.\nThe following table summarizes the joint ventures' payments of pre-petition liabilities:\nReal estate taxes of $2,860,854, previously accrued as of June 30, 1995, were reversed as a result of the tax credits received from the City of New York in December 1995 (see Note 9).\nThe profit or loss of the Center was allocated on a 50\/50 basis to each of the co-venturers. As a result of the settlement of certain pre-petition liabilities, the co-venturers are allocating the gain or loss on the settlements of certain liabilities on a basis which is different than the current 50\/50 basis provided for in the Joint Venture Agreement.\nFor financial reporting purposes, liabilities which remain to be settled under Macy's Chapter 11 process, have remained classified as \"Liabilities Subject to Settlement Under Reorganization Proceedings.\"\n2. SIGNIFICANT ACCOUNTING POLICIES\na. BASIS OF PRESENTATION - The financial statements are prepared in conformity with generally accepted accounting principles. Management has made 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 periods. Actual results could differ from those estimates.\nCertain amounts have been reclassified for prior years to conform to 1995 presentation.\nb. PROPERTY AND EQUIPMENT - Property and equipment is stated at cost. Depreciation of property and equipment is provided on a straight-line basis over the following periods:\nAdditions and improvements to property and equipment are capitalized and depreciated over their estimated remaining lives. Maintenance and repairs are charged to operations as incurred.\nThe Center has adopted early the Financial Accounting Standards Board Statement No. 121 (Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of), which did not have a material impact on the financial statements. SFAS No. 121 requires management of the Center to assess any impairment in value by making a comparison of the current and projected operating cash flow of the Center into the foreseeable future on an undiscounted basis, to the carrying amount of such property. Such carrying amount would be adjusted, if necessary, to reflect an impairment in the value of an asset.\nc. DEFERRED CHARGES - Deferred charges include lease commissions and other costs paid to tenants to acquire the rights to their leased space. Lease commissions are amortized on a straight-line basis over the life of the applicable leases. Other lease acquisition costs are amortized over the life of the respective replacement leases.\nd. REVENUE RECOGNITION - Base rents, additional rent based on tenant's sales volume and reimbursement of the tenant's share of certain operating expenses are generally recognized when due from tenants. The straight-line basis is used to recognize base rents on the leases which provide for varying rents over the lease terms.\n3. MORTGAGE NOTES PAYABLE\nThe mortgage notes payable were issued by the co-venturers. The notes are collateralized by a mortgage on all property and equipment, and by assignment of leases and charges due thereunder. Mortgage notes payable consists of the following:\nThe Center continued to record interest expense through December 19, 1994 on the Macy's note at 7% and additional interest at 15% on all aggregate rental overages in accordance with the original terms of the note. Additional interest amounted to $359,803, $547,603 and $1,125,843 for the years ended June 30, 1995, 1994 and 1993, respectively.\n4. COMMITMENTS\na. Joint Venture as Lessor - The joint venture leases space to tenants in its shopping center for which the Center charges fixed minimum rents. The terms of the leases are generally ten years and provide for fixed minimum rents as follows:\nIn addition to minimum rents, most of the leases provide for percentage rents when the tenants' sales volumes exceed stated amounts per lease agreements and reimbursements for certain of the Center's operating expenses. During the six months ended December 31, 1995, the Center adjusted its billings to tenants for certain reimbursable expenses in accordance with the lease agreements. This adjustment gave rise to an increase of approximately $600,000 in amounts due from tenants and a corresponding increase in other income attributable to the portion of the tenants' lease year included in the Center's year ended June 30, 1995.\nb. Joint Venture as Lessee - On January 27, 1970, U & F Realty Corporation, an affiliate, assigned to the joint venture a lease with the City of New York for certain real property. The lease, which was\namended on May 25, 1976 for additional real property, extends for a period of fifty years from the original lease date at annual rentals (payable quarterly in advance) in future periods as follows:\nThe lessee may extend the lease for a total of another forty-nine years, with individual renewal options and annual rentals of $122,957, $147,548, $177,058, $212,470 and $254,964, for each succeeding ten-year period and the final nine-year period.\n5. FEDERAL INCOME TAX\nUnder the provisions of Section 701 of the Internal Revenue Code, the Center is not subject to Federal income tax. The income or loss of the joint venture is reportable by the co-venturers in proportion to their respective investment in the joint venture. Similar circumstances apply to state and city income taxes. Further, any investment credit realized by the joint venture is passed on to the co-venturers. Accordingly, no provision or liabilities for Federal, state or city income taxes are required to be reflected on the books of the Center.\n6. RELATED PARTY TRANSACTIONS\nInterstate Properties owns 27.1% of the outstanding common stock of Alexander's, Inc. During the six months ended December 31, 1995 and for the years ended June 30, 1995, 1994 and 1993 Interstate Properties was paid $389,000, $165,000, $445,000 and $906,000, respectively, by the Center for performing leasing services for space located in the Center.\n7. FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe estimated fair value of cash, accounts receivable, notes receivable, accounts payable, accrued expenses and mortgage notes payable are reflected in the balance sheet. The fair value estimates are based on information available as of December 31, 1995. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, a comprehensive revaluation has not been performed for purposes of this financial statement disclosure and current estimates of fair value may differ significantly from those amounts reflected in the balance sheet.\n8. ENVIRONMENTAL INVESTIGATION\nIn September 1993, the Center had a Phase I environmental study performed on its property. The results of the study show that certain adjacent properties not owned by the Center have experienced petroleum hydrocarbon contamination. Based on this study and preliminary investigation of the Center's property and its history, there is potential for contamination on the Center's property. The study also revealed the potential for a release in the vicinity of an underground storage tank which failed an integrity test, although no contamination has been observed to date. The tank failure has been reported to the New York State Department of Environmental Conservation (\"DEC\"). Such tank was fixed in early 1994, and in October 1994, independent testing revealed that all of the Center's underground storage tanks\n(used for storing heating oil) and related distribution lines passed a tank and line leak status test. Such results were furnished to the DEC. If contamination is found on the property, the Center may be required to engage in remediation activities.\nManagement is unable to estimate the financial impact of potential contamination if any is discovered in the future. If further investigations reveal that there is contamination on its site, since the Center believes such contamination would have resulted from activities of third parties, the Center intends to pursue all available remedies against any of these third parties. No provision has been made in the financial statements for costs, if any, associated with any additional investigations and\/or clean-up if required because currently such costs are neither probable nor reasonably estimable.\n9. TAX CERTIORARI PROCEEDINGS\nIn December 1995, the Center completed a tax certiorari proceeding with the City of New York. Each of the co-venturers has agreed with the City of New York to a reduction in the assessed values covering the tax years 1988\/1989 through 1995\/1996, generating tax credits of $28,350,000, of which $18,836,000 relates to the co-venturer's stores. As a result, real estate taxes previously accrued for each of the co-venturers were reversed. The estimated amount due to tenants resulting from the tax certiorari proceedings was $8,391,954.\n******\nIndex to Exhibits\nThe following is a list of all exhibits filed as part of this Report:\n* The basic operating agreements have been filed herewith or incorporated by reference. Certain amendments, supplements and other related agreements which are not material to current operations have not been filed but will be made available upon request.\n- 61-","section_15":""}
{"filename":"317859_1995.txt","cik":"317859","year":"1995","section_1":"Item 1. BUSINESS \t General Development of Business - -------------------------------\n\tSuper 8 Motels III, Ltd. (the \"Partnership\") is a limited partnership which was organized under the Uniform Limited Partnership Act of the State of California on June 2, 1980.\n\tThe General Partner of the Partnership is Grotewohl Management Services, Inc., a California corporation which is wholly-owned by Philip B. Grotewohl.\n\tThrough two public offerings of units of limited partnership interest in the Partnership (the \"Units\"), the Partnership sold 5,941 Units at a price of $1,000 per Unit.\n\tThe net proceeds of the offerings have been expended for the acquisition in fee and development of properties located in San Bernardino, California and Bakersfield, California. Motel operations commenced on March 6, 1982 at the San Bernardino property, and on September 20, 1982 at the Bakersfield property.\nNarrative Description of Business - ---------------------------------\n(a) Franchise Agreements - -------------------------\n\tThe Partnership operates each of its motel properties as a franchisee of Super 8 Motels, Inc. through sub-franchises obtained from Super 8 Management Corporation. In March 1988, Brown & Grotewohl, a California general partnership which is an affiliate of the General Partner (the \"Manager\"), became sub-franchisor in the stead of Super 8 Management Corporation. As of December 31, 1995, Super 8 Motels, Inc. had franchised a total of 1,366 motels having an aggregate of 83,748 guest rooms in operation.\n\tThe objective of the Super 8 Motel chain is to maintain a competitive position in the motel industry by offering to the public comfortable, no-frills accommodations at a budget price. Each Super 8 Motel provides its guests with attractively decorated rooms, free color television, direct dial telephone and other basic amenities, but eliminates or modifies other items to provide substantial cost reduction without seriously affecting comfort or convenience. Some of these savings are accomplished by reductions in room size, elimination of expensive lobbies, and by substantial economies in building construction.\n\tBy the terms of each franchise agreement with Super 8 Motels, Inc., the Partnership pays monthly franchise fees equal to 4% of its gross room revenues (half of which is paid to the\n\t\t\t\t - 2 -\nsub-franchisor) and contributes an additional 1% of its gross room revenues to a fund administered by Super 8 Motels, Inc. to finance the national reservation and promotions program.\n(b) Operation of the Motels - ----------------------------\n\tThe Manager manages and operates the Partnership's motels. The Manager's responsibilities include, but are not limited to, supervision and direction of the Partnership's employees having direct responsibility for the operation of each motel, establishment of room rates and direction of the promotional activities of the Partnership's employees. In addition, the Manager directs the purchase of replacement equipment and supplies, maintenance activity and the engagement or selection of all vendors, suppliers and independent contractors. The Partnership's financial activities are performed by the individual motel staffs and a centralized accounting staff, all of which work under the direction of the Manager. Together, these staffs perform all bookkeeping duties in connection with each motel, including all collections and all disbursements to be paid out of funds generated by motel operations or otherwise supplied by the Partnership.\n\tAs of December 31, 1995, the Partnership employed a total of 32 persons, either full or part-time at its two motel properties, including nine desk clerks, 19 housekeeping and laundry personnel, two maintenance personnel and two motel managers.\n\tIn addition, and as of the same date, the Partnership employed 12 persons in administrative positions at its central office in Sacramento, California, all of whom worked for the Partnership on a part-time basis. They included accounting, investor service, sales and marketing and motel supervisory personnel, an attorney, secretarial personnel, and purchasing personnel. The attorney, who is also the Director of Operations, is David P. Grotewohl, son of Philip B. Grotewohl. Also employed by the Partnership on a part-time basis is Julie Grotewohl, daughter of Philip Grotewohl, as Director of Sales, and Mark Grotewohl, son of Philip Grotewohl, as Director of Marketing.\n(c) Property Acquisition and Development - -----------------------------------------\n\tThe net proceeds of the offering of the Units, and financing in the amount of $870,000 secured by a deed of trust on the Bakersfield motel, was expended in connection with the acquisition and development of two properties located in San Bernardino and Bakersfield, California, respectively.\n\tIt is the present intention of the General Partner that the proceeds of any sale or refinancing be distributed to the Limited Partners rather than reinvested.\n\t\t\t\t - 3 -\n(d) Competition - ----------------\n\tAs discussed in greater detail below, in each area in which its motel properties are located the Partnership faces intense competition from motels of varying quality and size, including other budget motels which are part of nationwide chains and which have access to nationwide reservation systems.\n\tSuper 8 Motels offer accommodations at the upper end, in terms of facilities and prices, of the budget segment of the lodging industry. Generally, Super 8 Motels offer larger rooms and higher quality furnishings at higher rates than motels franchised under the trade-names Motel 6, Western 6, Econolodge, Red Roof Inns and E-Z 8.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES \t (a) San Bernardino, California --------------------------\n\tThe San Bernardino motel, which consists of 81 guest rooms on approximately 1.87 acres of land, commenced operations on March 6, 1982. The average monthly occupancy rates and average monthly room rates during the three most recent years are as follows: \t Average Occupancy Rate \t\t1995 1994 1993 \t\t----- ----- ----- January 57.9% 52.3% 59.1% February 63.1% 63.0% 77.9% March 69.1% 70.7% 71.8% April 55.8% 57.0% 65.1% May 63.0% 62.0% 72.6% June 57.0% 65.4% 66.4% July 53.1% 55.8% 62.4% August 57.6% 63.8% 75.0% September 59.3% 60.2% 57.8% October 46.7% 56.2% 61.6% November 39.9% 50.4% 66.5% December 41.8% 52.8% 62.4%\nAnnual Average 55.3% 59.1% 66.5%\n\t\t\t\t - 4 -\n\t\t Average Room Rate \t\t 1995 1994 1993 \t\t------ ------ ------ January $40.04 $38.22 $36.10 February $39.52 $39.13 $37.02 March $39.73 $41.86 $36.07 April $41.11 $41.89 $37.14 May $40.60 $41.36 $38.41 June $40.51 $43.08 $40.17 July $40.82 $42.73 $38.00 August $40.16 $42.14 $40.86 September $39.60 $41.41 $39.60 October $40.99 $43.09 $40.67 November $40.60 $41.11 $39.34 December $40.14 $35.73 $37.59\nAnnual Average $40.29 $41.07 $38.41\n\tWhile prior to 1993 the San Bernardino motel received approximately 5% to 7% of its guest room revenue from Norton Air Force Base, the corresponding amounts for 1993 and for 1994 were 3% and 0.7%, respectively. The reduction was attributable to the final closing of Norton Air Force Base in March, 1994. Currently, the Partnership's San Bernardino motel provides accommodations to no one customer, the loss of which could materially affect the Partnership's operations.\n\tThe following lodging facilities provide direct and indirect competition to the Partnership's San Bernardino motel:\n\t\t\t\t\t APPROXIMATE \t\t NUMBER DISTANCE FACILITY OF ROOMS FROM MOTEL - ------------------ ---------- -------------------------- Comfort Inn 50 Adjacent Hilton Inn 200 Across street La Quinta Motel 154 200 yards Travelodge 90 200 yards EZ-8 Motel 117 0.13 miles\n(b) Bakersfield, California ------------------------\n\tThe Bakersfield motel, which consists of 90 guest rooms on approximately 2.32 acres of land, commenced operations on September 20, 1982. The average monthly occupancy rate and average monthly room rate for the three most recent years are as follows:\n\t\t\t\t - 5 -\n\t\tAverage Occupancy Rate \t\t 1995 1994 1993 \t\t----- ----- ----- January 87.4% 86.6% 81.0% February 82.2% 90.4% 91.5% March 86.4% 93.9% 97.7% April 91.0% 95.1% 97.4% May 89.6% 92.7% 93.3% June 92.2% 97.1% 98.8% July 89.3% 85.3% 93.9% August 90.0% 88.1% 95.9% September 84.6% 88.3% 92.7% October 85.1% 93.4% 98.4% November 78.4% 89.6% 89.4% December 70.6% 79.1% 76.7%\nAnnual Average 85.6% 89.9% 92.2%\n\t\t Average Room Rate \t\t 1995 1994 1993 \t\t------ ------ ------ January $30.06 $31.46 $31.47 February $30.24 $31.60 $32.17 March $30.72 $31.46 $32.22 April $30.63 $31.79 $32.44 May $31.63 $30.65 $32.13 June $31.73 $31.14 $32.70 July $31.89 $31.13 $33.62 August $31.51 $31.52 $33.55 September $30.78 $30.60 $32.35 October $31.64 $29.12 $32.13 November $30.06 $28.92 $31.87 December $28.86 $29.20 $30.99\nAnnual Average $30.87 $30.73 $32.34\n\tFrom October 1, 1982 to January 31, 1993, an agreement was in effect granting the Partnership the first opportunity to provide rooms to employees of Santa Fe Railroad at a room rate of $20.00. Though expired according to its terms, the contract continues to be observed by both parties, except that the agreed rate is now $23.00 per room night. Revenue attributable to this agreement constituted approximately 32%, 20%, and 14% of the motel's total guest revenues during 1995, 1994 and 1993, respectively.\n\tOn December 31, 1992, the Partnership entered into a written agreement with the National Railroad Passenger Corporation (Amtrak) for the provision of lodging services to its employees at a room rate of $25.75, which included a transportation credit of $1.75 per room night payable to the Partnership for providing transportation from the train terminal. Due to competitive bids, the rate was lowered to $24.00 per room night effective October 1, 1994. Amtrak provided approximately 26%, 19% and 17% of the motel's guest room revenue in 1995, 1994 and 1993, respectively.\n\t\t\t\t - 6 -\n\tExcept as set forth above, the Bakersfield motel provides accommodations to no one customer, the loss of which could materially affect the Partnership's operations.\n\tThe following lodging facilities provide direct or indirect competition to the Partnership's Bakersfield motel: APPROXIMATE \t\t\t\t NUMBER DISTANCE FACILITY OF ROOMS FROM MOTEL - ------------------------- ------------------ ---------------- California Inn 74 Adjacent Motel 6 160 0.50 miles EZ-8 Motel 100 0.50 miles Travelodge Plaza 61 0.75 miles Comfort Inn South 80 0.75 miles Four Points Inn 199 1.00 mile Best Western- Kern River 200 1.00 mile La Quinta Inn 150 1.00 mile Days Inn 120 1.00 mile Roderunner 49 1.50 miles Economy Motels of America 140 1.50 miles Rio Mirada 209 2.00 miles Comfort Inn 60 2.00 miles Econo Lodge 100 2.00 miles Holiday Inn Express 100 6.00 miles\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\n\t Inapplicable.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\n\tInapplicable.\n\t\t\t\t PART II\nItem 5.","section_5":"Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED \t STOCKHOLDER MATTERS\nMarket Information - ------------------\n\tThe Units are not freely transferable and no public market for the Units has developed or is expected to develop.\nHolders - -------\n\tAs of December 31, 1995 a total of 1,074 individuals (the \"Limited Partners\") held Units in the Partnership.\nDistributions - --------------\nCash distributions are made on a quarterly basis from Cash\n\t\t\t\t - 7 -\nAvailable for Distribution, defined in the Partnership's Certificate and Agreement of Limited Partnership (the \"Partnership Agreement\") as Cash Flow, less adequate cash reserves for obligations of the Partnership for which there is no provision. Cash Flow means cash funds provided from operations of the Partnership, without deduction for depreciation, but after deducting cash funds used to pay or provide for the payment of debt service, capital improvements and replacements and the operating expenses of the Partnership's property. Of the Cash Available for Distribution in any year, the General Partner will receive 10% thereof, of which 9% will constitute a subordinated fee for managing the Partnership and 1% will be attributable to its interest in the profits of the Partnership. The balance will be distributed to the Limited Partners. Notwithstanding the preceding, the General Partner will not receive distributions of Cash Available for Distribution in any year in which the Limited Partners do not receive distributions of Cash Available for Distribution in an amount at least equal to 10% per annum cumulative on their adjusted capital contributions.\nIn addition, the Partnership will promptly distribute net proceeds of the sale and refinancing of its motel properties to the General Partner and the Limited Partners, to the extent such proceeds are not reinvested in the acquisition of additional properties. Of the sale or refinancing proceeds available for distribution in any year, the General Partner will receive 15% thereof, and the balance will be distributed to the Limited Partners. Notwithstanding the preceding, the General Partner will not receive distributions of Sale or Refinancing Proceeds until each Limited Partner has received from all sources distributions equal to 100% of his capital contributions plus 10% per annum cumulative on his adjusted capital contributions.\n\tThe Partnership has made no distributions during the two most recent fiscal years.\n\t\t\t\t - 8 -\nItem 6.","section_6":"Item 6. Selected Financial Data\n\t Year Ended December 31, 1995 \t 1995 1994 1993 1992 1991 1990 \t ---------- ---------- ---------- ---------- ---------- ---------- Guest Room Income $1,526,742 $1,625,581 $1,734,535 $1,622,825 $1,687,071 $1,790,810 Net Income (Loss) $68,750 $33,851 $49,083 $(31,203) $97,596 $182,389\nPer Partnership Unit:\nCash dis- tributions $ - $ - $ - $25.00 $25.00 $50.00 Net income (loss) $11.46 $5.64 $8.18 $(5.20) $16.26 $30.39\n\t Year Ended December 31, 1995 \t 1995 1994 1993 1992 1991 1990 \t ---------- ---------- ---------- ---------- ---------- ---------- Total Assets $3,411,456 $3,632,719 $3,793,456 $3,852,557 $4,045,669 $4,142,738 Long-Term Debt $75,493 $390,484 $595,214 $724,636 $741,069 $755,944\n\t\t\t\t - 9 -\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL \t CONDITION AND RESULTS OF OPERATIONS\nLiquidity - ---------\n\tThe General Partner believes that the Partnership's liquidity, defined as its ability to generate cash to satisfy its cash needs, is adequate. The Partnership's primary source of liquidity is its cash flow from operations. As of December 31, 1995 the Partnership had current assets of $369,966 and current liabilities of $162,995, providing an operating reserve of $206,971. This reserve is below the $297,050 reserve target required by the Partnership Agreement inasmuch as the Partnership made supplemental principal payments on its mortgage debt to reduce net interest expense. The General Partner authorized the pay-down as cash flow from operations has been increasing over the last three years. The decrease in total cash during 1995 was also due to the $225,000 in extraordinary loan repayments.\n\t This loan, in the original principal amount of $855,000 at a 10% per annum fixed interest rate, has a maturity date of September 1997 when, according to the loan's original terms, $648,230 would have been due. As a result of the payments reflected in the following table, if no further supplemental principal payments are made, a balloon payment will be approximately $36,000 in September 1997.\n\t\t\t\t\t1995 1994 1993\nStandard monthly payments 89,800 89,800 89,800 Supplemental principal payments 225,000 150,000 100,000 \t\t\t\t ------- ------- ------- Total Debt Service 314,800 239,800 189,800\n\t While the General Partner is considering the possibility of refinancing this loan, it presently plans to continue making any supplemental principal payments from operating cash flows and, if necessary, from the relatively large reserve fund to liquidate this loan. The General Partner has suspended the quarterly distributions to the Limited Partners in order to accumulate the funds necessary for the extra principal payments\n\tIn addition to the debt reduction discussed above, the liquidity of the Partnership is enhanced by the fact that the San Bernardino motel is presently unencumbered. Although the General Partner knows of no trend likely to create a material deficiency in the Partnership's liquidity, if the need arises, cash could be generated through leveraging the property.\n\tDuring 1996, the General Partner anticipates making certain capital expenditures, as noted below under the caption \"Capital Resources,\" although the amount of such expenditures will not be such as to compromise the Partnership's liquidity. Other than\n\t\t\t\t - 10 -\nas described below and above the General Partner foresees no significant trends, demands, commitments, events or uncertainties which are likely to affect the Partnership's liquidity, on either a long-term or short-term basis.\nCapital Resources - -----------------\n\tThe Partnership has no material commitments for capital expenditures. However, the General Partner anticipates that during 1996 the Partnership will spend an as yet undetermined amount for the refurbishment of its motels and their furnishings. In particular, the Bakersfield parking lot needs resurfacing and the motel needs painting.\n\tDuring the fiscal year covered by this report, the Partnership expended $81,620 for renovations and replacements, of which $45,880 was capitalized. The capitalized items included $20,759 for guest room carpet, $4,314 for replacement of televisions, $15,191 for Amtrak shuttle vehicles and $3,789 for a replacement ice machine. The uncapitalized items include $8,351 for bedspreads, $7,325 for guest room chairs, $5,827 for mattress sets, $5,081 for replacement lamps and lamp shades, and $4,000 for major boiler repairs.\n\tOther than as described above under \"Liquidity,\" the General Partner knows of no material trends likely to affect or to require a change in the mix of its capital resources.\nNew Accounting Standards - ------------------------\n\tSFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of, requires the Partnership to disclose information about potential impairment to the value of long-lived assets. The Partnership is not required to adopt and does not currently plan to adopt SFAS No. 121 until its fiscal year ending December 31, 1996. The Partnership does not anticipate that any disclosures about impairment of long-lived assets under SFAS No. 121 will be necessary.\nResults of Operations - ---------------------\nCombined Financial Results - --------------------------\n\tThe following tables summarize the operating results of the Partnership for the fiscal years ended December 31, 1995, 1994 and 1993 on a combined basis. The results of the individual properties follow in separate subsections. The income and expense numbers in the following table are shown on an accrual basis and other payments on a cash basis.\n\t\t\t\t - 11 -\n\t\t\tAverage Average \t\t Occupancy Room Fiscal Year Ended: Rate Rate \t\t -------- -------- December 31, 1993 80.0% $34.73 December 31, 1994 75.3% $34.57 December 31, 1995 71.3% $34.33\n\t\t\t\t\t Total \t\t\t\t Expenditures Partnership \t\t\t Total and Cash Flow Fiscal Year Ended: Revenues Debt Service (1) \t\t\t---------- ------------ ------------- December 31, 1993 $1,790,383 $1,751,180 $39,203 December 31, 1994 $1,671,022 $1,715,903 $(44,881) December 31, 1995 $1,571,111 $1,671,151 $(100,040)\n\t(1) While Partnership Cash Flow as it is used here is not an amount found in the financial statements, this amount is the best indicator of the annual change in the amount, if any, available for distribution to the Limited Partners. This calculation is reconciled to the financial statement in the following table.\n\tReconciliation of Partnership Cash Flow (included in the chart above) to Net Income as shown on the Statements of Operations (in the financial statements) is as follows:\n\t\t\t\t 1995 1994 1993 \t\t\t\t ---------- --------- --------- Partnership Cash Flow $(100,040) $(44,881) $39,203 Principal Payments on Financial Obligations 285,133 185,326 117,153 Additions to Fixed Assets 45,880 64,261 43,634 Depreciation and Amortization (164,599) (172,398) (151,886) Other Items 2,376 1,543 979 \t\t\t\t -------- -------- -------- Net Income $68,750 $33,851 $49,083 \t\t\t\t ======== ======== ========\n\tFollowing is a reconciliation of the Partnership Cash Flow (shown above) to the aggregate total of Cash Flow from Property Operations for the Partnership's two motels which are segregated In the tables below under the captions \"San Bernardino Motel\" and \"Bakersfield Motel\".\n\t\t\t\t - 12 -\n\t\t\t\t\t1995 1994 1993 \t\t\t\t --------- --------- --------- San Bernardino Motel $41,110 $24,211 $23,099 Bakersfield Motel (159,959) (78,601) 5,861 \t\t\t\t ------- ------- ------- Aggregate Cash Flow from Property Operations (118,849) (54,390) 28,960\nInterest on Cash Reserves 10,071 8,727 10,013 Other Partnership Income, (net of Other Expenses) not allocated to the properties 8,738 782 230 \t\t\t\t ------- ------- ------- Partnership Cash Flow $(100,040) $(44,881) $39,203 \t\t\t\t ======= ======= =======\n\tThe Partnership experienced a $99,911 (or 6.0%) decrease in total revenues during the fiscal year covered by this report as compared to the previous fiscal year. The decline in revenue is due to reduced average occupancy at both motels and slightly reduced or stagnant average room rates at the San Bernardino motel. Amplified discussion can be found in the individual property subsections that follow.\n\tThe Partnership experienced a $119,361 (6.7%) decline in total revenues during the fiscal year ended December 31, 1994 as compared to the previous fiscal year. The decline in revenue is due to reduced average occupancy at both motels and reduced average room rates at the Bakersfield motel.\n\tThe Partnership achieved a $44,752 reduction in combined expenditures and debt service during the fiscal year covered by this report as compared to the previous fiscal year. Debt service increased by $75,000. The increase in debt service was offset by a $100,095 reduction in motel operating expenses, due primarily to the reduced average occupancy.\n\tThe Partnership had a $35,277 decrease in combined expenditures and debt service during the fiscal year ended December 31, 1994 as compared to the previous fiscal year. After consideration of the extraordinary loan payments, the $85,277 decrease in expenditures was due to a cost-cutting program installed by the General Partner.\nSan Bernardino Motel - --------------------\n\t\t Average Average \t\t Occupancy Room Fiscal Year Ended: Rate Rate \t\t --------- -------- December 31, 1993 66.5% $38.41 December 31, 1994 59.1% $41.07 December 31, 1995 55.3% $40.29\n\t\t\t\t - 13 -\n\t\t\t\t\t Total Cash Flow \t\t\t\t Expenditures from \t\t\t Total and Property Fiscal Year Ended: Revenues Debt Service Operations \t\t\t-------- ------------ ---------- December 31, 1993 $775,431 $752,332 $23,099 December 31, 1994 $741,564 $717,353 $24,211 December 31, 1995 $678,561 $637,451 $41,110\n\tThe San Bernardino motel experienced a $63,003 (8.5%) decrease in total revenue during the fiscal year covered by this report as compared to the previous fiscal year. Guest room revenue from the corporate and leisure market segments decreased approximately $10,000. The number of guest room nights generated from these two market segments remained substantially unchanged while the average room rate received for the corporate market segment increased slightly and the average room rate received from the leisure market declined more substantially. Average occupancy from the discounted room and group traveler market segments declined sharply resulting in a decrease of approximately $50,000 in guest room revenue.\n\tThe San Bernardino motel experienced a $33,867 (4.4%) decline in total revenues during the fiscal year ended December 31, 1994 as compared to the previous fiscal year. The motel experienced an 11.1% decline in average occupancy, which has been partially offset by a 6.9% increase in average room rate. Rooms from the corporate market segment experienced a $63,000 reduction during the fiscal year, due to increased competition for that market segment. This loss was partially offset by some additional leisure business.\n\tThe San Bernardino motel achieved a $79,902 (11.1%) reduction in total expenses and debt service during the fiscal year covered by this report as compared to the previous fiscal year. The motel achieved an $8,663 reduction in bad debts, an $8,102 reduction in housekeeping wages, an $18,229 reduction in maintenance wages and a $41,727 reduction in renovation and replacements. As discussed in the next paragraph, the previous year was subject to an unusually high level of replacement and renovation expense.\n\tThe San Bernardino motel achieved a $34,979 (4.6%) reduction in total expenses and debt service during the fiscal year ended December 31, 1994 as compared to the previous fiscal year. Staffing changes resulted in the following reductions: front desk wages were reduced $16,189 and housekeeping wages were reduced $25,670. Other significant savings from of the General Partner's cost-cutting program included $10,635 in print advertising and $6,090 in complimentary breakfast. Renovation and replacement expenditures increased from $33,038 to $79,227, and included $9,303 for televisions, $17,098 for parking lot repairs, $26,052 in replacement guest room carpets, $4,002 in guest room chairs, $4,562 in painting and $3,748 for 20% of the operations manager's vehicle.\n\t\t\t\t - 14 -\nBakersfield Motel - -----------------\n\t\t Average Average \t\t Occupancy Room Fiscal Year Ended: Rate Rate \t\t --------- -------- December 31, 1993 92.2% $32.34 December 31, 1994 89.9% $30.73 December 31, 1995 85.6% $30.87\n\t\t\t\t\t Total Cash Flow \t\t\t\t\tExpenditures from \t\t\t Total and Property Fiscal Year Ended: Revenues Debt Service Operations \t\t\t---------- -------------- ------------ December 31, 1993 $1,004,710 $998,849 $5,861 December 31, 1994 $919,367 $997,968 $(78,601) December 31, 1995 $882,261 $1,042,220 $(159,959)\n\tThe Bakersfield motel experienced a $37,106 (4.0%) decrease in total revenues during the fiscal year covered by this report as compared to the previous fiscal year. Decreased revenue generated from the corporate, group, discount and trucker market segments was substantially, but not completely, offset by increased revenue from the leisure market segment and the railroad accounts.\n\tThe Partnership's Bakersfield motel experienced an $85,343 (8.5%) decline in total revenues during the fiscal year ended December 31, 1994 as compared to the previous fiscal year. Both average occupancy and average room rates declined due to increased competitive pressures. The Partnership, in order to meet a competitor's offer and retain Amtrak business, agreed to a $1.75 per night rate reduction effective October 1, 1994. The corporate segment declined $152,333. This decline was partially offset by small increases in the leisure and trucker market segments. The reduction in the corporate guests was due primarily to increased competition for that market segment in the Bakersfield area. The room previously occupied by corporate guests became available for other types of travelers.\n\tThe Partnership's Bakersfield motel experienced a $44,252 (4.4%) increase in total expenses and debt service during the fiscal year covered by this report. Excluding the $75,000 comparative increase in debt service, the motel achieved a $30,748 reduction in other expenditures. Included in this reduction were savings of $10,242 in front desk wages, $10,120 in maintenance wages, $8,780 in housekeeping wages, $6,635 in resident manager expense and $5,653 in workers' compensation insurance. These reduced expenditures were partially offset by increased costs associated with transporting railroad employees from the train station to the motel. The cost savings was due to adjustments to staffing levels and to a lessor extent to reduced average occupancy.\n\t\t\t\t - 15 -\n\tThe Bakersfield motel achieved a $49,120 decrease in total expenditures (excluding changes in debt service discussed previously) during the fiscal year ended December 31, 1994 as compared to the previous fiscal year. This savings was committed to additional principal payments on the motel's mortgage: the partnership made $150,000 in extra principal payments during 1994 compared to $100,000 of such payments during 1993. Staffing changes resulted in increased front desk wages of $10,172 and maintenance wages of $8,106, while housekeeping wages were reduced $9,855 and the resident manager's salary cost was reduced $4,552. Savings from the General Partner's cost-cutting program included $6,508 for guest supplies and $6,709 for complimentary breakfast. Renovation and replacement expenditures were $35,940 as compared to $35,224 during the previous fiscal year. Replacements included $11,280 in guest room carpets, $4,629 for televisions, $9,250 for railroad shuttle vehicles, $3,990 for repairs of fiberglass tubs and $3,400 for painting.\nFuture Trends - -------------\n\tThe General Partner believes that competitive conditions in the San Bernardino and Bakersfield markets are such as to prevent the Partnership from reflecting inflation in increased room rates at its motels. Accordingly, an increase in the inflation rate could have a deleterious effect on Partnership operations.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\n\tSee Financial Statements and Notes to Financial Statements attached hereto at pages through.\n\t\t\t\t - 16 -\n\t\t\t ANNUAL REPORT ON FORM 10-K\n\t\t\t\t ITEM 8\n\t\t\t FINANCIAL STATEMENTS\n\t\t\t SUPER 8 MOTELS III, LTD.\n\t\t\t SACRAMENTO, CALIFORNIA\n\t\t\t DECEMBER 31, 1995\n\t\t\t\t\nItem 8: Financial Statements\n\t\t\t SUPER 8 MOTELS III, LTD.\n\t\t INDEX OF FINANCIAL STATEMENTS\n\t\t\t\t\t\t\t\t Pages\n\tReport of Independent Certified Public Accountants\n\tBalance Sheets, December 31, 1995 and 1994\n\tStatements of Operations for the years ended December 31, 1995, \t 1994 and 1993\n\tStatements of Partners' Equity for the years ended December 31, \t 1995, 1994 and 1993 \t\t\t \tStatements of Cash Flows for the years ended December 31, 1995, to \t 1994 and 1993 \t \tNotes to Financial Statements to \t\t\t\t\t\t\t\t\t\nNote: All other schedules have been omitted since the required information is not present or not present in amounts sufficient to require submission of the schedule or because the information required is included in the financial statements or notes thereto.\n\t\t\t\t\n\t\t REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nTo the Partners Super 8 Motels III, Ltd.\nWe have audited the accompanying balance sheets of Super 8 Motels III, Ltd., a California limited partnership, as of December 31, 1995 and 1994, and the related statements of operations, partners' equity, and cash flows for each of the three years in the period ended December 31, 1995. These financial state- ments are the responsibility of the Partnership's management. Our responsibil- ity is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing stan- dards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of mater- ial misstatement. An audit includes examining, on a test basis, evidence sup- porting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement pre- sentation. 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 Super 8 Motels III, Ltd. as of December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\nVOCKER KRISTOFFERSON AND CO.\nFebruary 16, 1996 San Mateo, California\n\t\t\t\t\n\t\t\t SUPER 8 MOTELS III, LTD. \t\t (A California Limited Partnership) \t\t\t BALANCE SHEETS \t\t\tDecember 31, 1995 and 1994\n\t\t\t\t ASSETS\n\t\t\t\t\t\t 1995 1994 Current Assets: ---------- ---------- Cash and temporary investments (Notes 1 and 3) $ 285,554 $ 370,107 Accounts receivable 72,824 85,882 Prepaid expenses 11,588 10,722 \t\t\t\t\t\t --------- --------- Total Current Assets 369,966 466,711\nProperty and Equipment (Note 2): Land 1,670,129 1,670,129 Capital improvements 26,175 26,175 Buildings 3,276,870 3,276,870 Furniture and equipment 742,531 779,563 \t\t\t\t\t\t --------- --------- \t\t\t\t\t\t 5,715,705 5,752,737 Accumulated depreciation and amortization (2,674,215) (2,586,729) \t\t\t\t\t\t --------- --------- Property and Equipment, Net 3,041,490 3,166,008 \t\t\t\t\t\t --------- --------- Total Assets $3,411,456 $3,632,719 \t\t\t\t\t\t ========= =========\nLIABILITIES AND PARTNERS' EQUITY\nCurrent Liabilities: Current portion of note payable (Note 5) $ 77,963 $ 48,106 Accounts payable and accrued liabilities 85,032 81,999 Due to related parties - 7,912 \t\t\t\t\t\t --------- --------- Total Current Liabilities 162,995 138,017\nLong-term Liabilities, Net of Current Portion: Note payable (Note 5) 75,493 390,484 \t\t\t\t\t\t --------- --------- \t\t\tTotal Liabilities 238,488 528,501 \t\t\t\t\t\t --------- ---------\nPartners' Equity: General Partner 19,194 18,506 Limited Partners 3,153,774 3,085,712 \t\t\t\t\t\t --------- --------- Total Partners' Equity 3,172,968 3,104,218 \t\t\t\t\t\t --------- ---------\nTotal Liabilities and Partners' Equity $3,411,456 $3,632,719 \t\t\t\t\t\t ========= =========\n\t See accompanying notes to financial statements.\n\t\t\t\t\n\t\t\t SUPER 8 MOTELS III, LTD. \t\t (A California Limited Partnership) \t\t\t STATEMENTS OF OPERATIONS\n\t\t\t\t Years Ended December 31: \t\t\t\t 1995 1994 1993 Income: ----------- ----------- ----------- Guest room $1,526,742 $1,625,581 $1,734,535 Telephone and vending 32,654 33,352 33,762 Interest 10,071 8,727 10,013 Other 1,644 3,363 12,073 \t\t\t\t --------- --------- --------- Total Income 1,571,111 1,671,023 1,790,383\nExpenses: Motel operations (Notes 4, 5 and 6) 1,174,475 1,274,570 1,373,744 General and administrative (Note 4) 57,956 54,428 55,406 Depreciation and amortization (Note 2) 164,599 172,398 151,886 Interest 27,290 52,932 71,668 Property management fees (Note 4) 78,041 82,844 88,596 \t\t\t\t --------- --------- --------- Total Expenses 1,502,361 1,637,172 1,741,300 \t\t\t\t --------- --------- ---------\nNet Income $68,750 $33,851 $49,083 \t\t\t\t ========= ========= =========\nNet Income Allocable to General Partner $688 $339 $491 \t\t\t\t ==== ==== ====\nNet Income Allocable to Limited Partners $68,062 $33,512 $48,592 \t\t\t\t ======= ======= =======\nNet Income Per Partnership Unit (Note 1) $11.46 $5.64 $8.18 \t\t\t\t ====== ===== =====\nDistributions to Limited Partners Per Partnership Unit (Note 1) $ - $ - $ - \t ====== ====== ======\n\t See accompanying notes to financial statements.\n\t\t\t\t\n\t\t\t SUPER 8 MOTELS III, LTD. \t\t (A California Limited Partnership) \t\t STATEMENTS OF PARTNERS' EQUITY\n\t\t\t\t Years Ended December 31: \t\t\t\t\t1995 1994 1993 General Partner: ----------- ------------ ------------ Balance, beginning of year $ 18,506 $ 18,167 $ 17,676 Net income 688 339 491 \t\t\t\t --------- --------- --------- Balance, End of Year 19,194 18,506 18,167\nLimited Partners: Balance, beginning of year 3,085,712 3,052,200 3,003,608 Net income 68,062 33,512 48,592 Less: Cash distributions to limited partners - - - \t\t\t\t --------- --------- --------- Balance, End of Year 3,153,774 3,085,712 3,052,200 \t\t\t\t --------- --------- ---------\nTotal Partners' Equity $3,172,968 $3,104,218 $3,070,367 \t\t\t\t ========= ========= =========\n\t See accompanying notes to financial statements.\n\t\t\t\t\n\t\t\t SUPER 8 MOTELS III, LTD. \t\t (A California Limited Partnership) \t\t\t STATEMENTS OF CASH FLOWS\n\t\t\t\t\t\t \t\t\t\t\t\t \t\t\t\t\t Years Ended December 31: \t\t\t\t\t\t1995 1994 1993 Cash Flows From Operating Activities: ----------- ----------- ----------- Received from motel operations $1,575,015 $1,678,452 $1,751,071 Expended for motel operations and general and administrative expenses (1,313,408) (1,419,657) (1,508,008) Interest received 9,154 8,649 9,989 Interest paid (29,666) (54,476) (72,645) \t\t\t\t\t --------- --------- --------- Net Cash Provided by Operating Activities 241,095 212,968 180,407\nCash Flows From Investing Activities: Proceeds from sale of equipment 5,366 3,550 - Purchases of property and equipment (45,880) (64,261) (43,634) \t\t\t\t\t --------- --------- --------- Net Cash Used by Investing Activities (40,514) (60,711) (43,634)\nCash Flows From Financing Activities: Payments on notes payable (285,134) (185,326) (117,153) \t\t\t\t\t --------- --------- --------- Net Cash Used by Financing Activities (285,134) (185,326) (117,153)\nNet Increase (Decrease) in Cash and Temporary Investments (84,533) (33,069) 19,620\nCash and Temporary Investments: Beginning of year 370,107 403,176 383,556 \t\t\t\t\t --------- --------- --------- End of Year $285,554 $370,107 $403,176 \t\t\t\t\t ========= ========= =========\n\t See accompanying notes to financial statements.\n\t\t\t\t\n\t\t\t SUPER 8 MOTELS III, LTD. \t\t (A California Limited Partnership) \t\t STATEMENTS OF CASH FLOWS (Continued)\n\t\t\t\t\t\t \t\t\t\t\t Years Ended December 31: \t\t\t\t\t\t1995 1994 1993 Reconciliation of Net Income to Net Cash ----------- ----------- ----------- Provided by Operating Activities: Net income $ 68,750 $ 33,851 $ 49,083 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 164,599 172,398 151,886 Loss on disposition of property and equipment 433 1,860 - (Increase) decrease in accounts receivable 13,058 16,078 (29,323) (Increase) decrease in prepaid expenses (866) (1,957) (208) Increase (decrease) in accounts payable and accrued liabilities 3,033 (8,246) 8,338 Increase (decrease) in due to related parties (7,912) (1,016) 631 \t\t\t\t\t ------- ------- ------- Total Adjustments 172,345 179,117 131,324 \t\t\t\t\t ------- ------- ------- Net Cash Provided by Operating Activities $241,095 $212,968 $180,407 \t\t\t\t\t ======= ======= ======= \t\t\t\t\n\t See accompanying notes to financial statements.\n\t\t\t\t\n\t\t\t SUPER 8 MOTELS III, LTD. \t\t (A California Limited Partnership) \t\t NOTES TO FINANCIAL STATEMENTS\nNOTE 1 - THE PARTNERSHIP\nSuper 8 Motels III, Ltd.is a limited partnership organized under California law on June 2, 1980 to acquire and operate motel properties in San Bernardino and Bakersfield, California. The San Bernardino motel was opened in March, 1982, and the Bakersfield motel was opened in September, 1982. The Partnership grants credit to customers, substantially all of which are local businesses in San Bernardino or Bakersfield.\nThe general partner is Grotewohl Management Services, Inc., the sole stock- holder and officer of which is Philip B. Grotewohl.\nThe net income or net loss of the Partnership is allocated 1% to the General Partner and 99% to the Limited Partners. Net income and distributions per Partnership unit are based on 5,941 units outstanding. All Partnership units are owned by the Limited Partners.\nThe Partnership agreement requires that the Partnership maintain working cap- ital reserves for normal repairs, replacements, working capital and contin- gencies in an amount of at least 5% of adjusted capital contributions ($297,050 at December 31, 1995). As of December 31, 1995 the Partnership had working capital of $206,971. During the year ended December 31, 1995, $90,079 ($297,050 less $206,971) of the reserves, plus additional amounts, were used to make loan repayments on the mortgage payable.\nNOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nItems of Partnership income are passed through to the individual partners for income tax purposes, along with any income tax credits. Therefore, no federal or California income taxes are provided for in the financial statements of the Partnership.\nProperty and equipment are recorded at cost. Depreciation and amortization are computed using the following estimated useful lives and methods:\nDescription Methods Useful Lives\nCapital improvements 150-200% declining balance 10-20 years \t\t\t\t\t\t\t Buildings Straight-line and 10-25 years \t\t\t 150% declining balance\nFurniture and equipment 200% declining balance 4-7 years\nCosts incurred in connection with maintenance and repair are charged to ex- pense. Major renewals and betterments that materially prolong the lives of assets are capitalized.\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect certain reported amounts and disclosures. Accordingly, actual re- sults could differ from those estimates. \t\t\t\t\n\t\t\t SUPER 8 MOTELS III, LTD. \t\t (A California Limited Partnership) \t NOTES TO FINANCIAL STATEMENTS (Continued)\nNOTE 3 - CASH AND TEMPORARY INVESTMENTS\nCash and temporary investments as of December 31, 1995 and 1994 consists of the following:\n\t\t\t\t\t\t\t1995 1994 \t\t\t\t\t\t --------- --------- \tCash in bank $ 45,031 $ 61,590 \tMoney market accounts 140,523 208,517 \tCertificates of deposit and commercial paper 100,000 100,000 \t\t\t\t\t\t ------- -------- \t Total Cash and Temporary Investments $285,554 $370,107\nTemporary investments are recorded at cost, which approximates market value. The Partnership considers temporary investments and all highly liquid market- able securities with original maturities of three months or less to be cash equivalents for purposes of the statement of cash flows.\nNOTE 4 - RELATED PARTY TRANSACTIONS\nFranchise Fees Super 8 Motels, Inc., now a wholly-owned subsidiary of Hospitality Franchise Systems, Inc., is franchisor of all Super 8 Motels. The Partnership pays to the franchisor monthly fees equal to 4% of the gross room revenues of each motel and contributes an additional 1% of its gross room revenues to an advert- ising fund administered by the franchisor. In return, the franchisor provides the right to use the name \"Super 8,\" a national institutional advertising pro- gram, an advance room reservation system, and inspection services. These costs ($76,337, $81,077 and $86,316 for the years ended December 31, 1995, 1994 and 1993, respectively) are included in motel operations expense in the accompany- ing statements of operations. The Partnership operates its motel properties as a franchisee of Super 8 Motels, Inc., through a sub-franchise agreement with Brown & Grotewohl, a California general partnership, of which Grotewohl Manage- ment Services, Inc. (see Note 1) is a 50% owner. Under the sub-franchise agree- ment, Brown & Grotewohl earned 40% of the above franchise fees, which amounted to $30,535, $32,431 and $34,526 for the years ended December 31, 1995, 1994 and 1993, respectively.\nProperty Management Fees The General Partner, or its affiliates, handles the management of the motel pro- perties of the Partnership. The fee for this service is 5% of the gross revenues from Partnership operations, as defined in the Partnership agreement, and amounted to $78,041, $82,844 and $88,596 for the years ended December 31, 1995, 1994 and 1993, respectively.\nSubordinated Partnership Management Fees During the Partnership's operational stage, the General Partner is to receive 9% of cash available for distributions for Partnership management services, along with an additional 1% of cash available for distributions on account of its interest in the profit and losses subordinated, however, to receipt by the Limited Partners of a 10% per annum cumulative pre-tax return on their adjusted capital contributions. At December 31, 1995, the Limited Partners had not rec-\n\t\t\t\t\n\t\t\t SUPER 8 MOTELS III, LTD. \t\t (A California Limited Partnership) \t NOTES TO FINANCIAL STATEMENTS (Continued)\nNOTE 4 - RELATED PARTY TRANSACTIONS (Continued)\neived the 10% cumulative return, and accordingly, no Partnership management fees are presently payable and therefore are not reflected in these financial statements. Management believes it is not likely that these fees will become payable in the future. This fee is payable only from cash funds provided from operations of the Partnership, and may not be paid from the proceeds of sale or a refinancing. As of December 31, 1995, the cumulative amount of these fees was $421,787. \t\t\t\t\nNOTE 4 - RELATED PARTY TRANSACTIONS (Continued)\nSubordinated Incentive Distributions Under the terms of the Partnership agreement, the General Partner is to re- ceive 15% of distributions of net proceeds from the sale or refinancing of Partnership properties remaining after distribution to the Limited Partners of any portion thereof required to cause distributions to the Limited Partners from all sources to be equal to their capital contributions plus a cumulative 10% per annum pre-tax return on their adjusted capital contributions. Through December 31, 1995, there had been no such sales or refinancings.\nAdministrative Expenses Shared by the Partnership and Its Affiliates There are certain administrative expenses allocated between the Partnership and other partnerships managed by the General Partner and its affiliates. These expenses, which are allocated based on usage are telephone, data processing, rent of the administrative office, and administrative salaries. The adminis- trative expenses allocated to the Partnership were approximately $223,000, $207,000 and $219,000 during the years ended December 31, 1995, 1994 and 1993, respectively, and are included in general and administrative and motel operat- ing expenses in the accompanying statements of operations. Included in admin- istrative salaries are allocated amounts paid to three employees who are re- lated to Philip B. Grotewohl, the sole stockholder of Grotewohl Management Services, Inc., the general partner.\nNOTE 5 - NOTE PAYABLE\nThe note payable consists of a note due to a bank and is collateralized by a first deed of trust on real property in Bakersfield, California. During 1995, the note, which was held in trust by Wells Fargo Bank for Mr. Bruce J. Bailey, was split into two notes, one due to Wells Fargo and the other due to Mr. Bailey. The combined balances of the new notes were equal to the prior balance of the original Wells Fargo note.\nThe note payable due to Wells Fargo is payable in equal monthly installments of $4,989, including interest at 10% per annum, through April, 1997, at which time a final payment equal to the remaining balance of $3,033 is due.\nThe note payable due to Mr. Bailey is payable in equal monthly payments of $2,494, including interest at 10% per annum, through September, 1997, at which time a final payment equal to the remaining balance of $36,104 is due.\n\t\t\t\t\n\t\t\t SUPER 8 MOTELS III, LTD. \t\t (A California Limited Partnership) \t NOTES TO FINANCIAL STATEMENTS (Continued)\nNOTE 5 - NOTE PAYABLE (Continued)\nNote payable maturities are as follows:\n\t Years Ending \t December 31: Amount \t ------------ ------ \t 1996 77,963 \t 1997 75,493 \t\t\t\t ------- \t Total $153,456 \t\t\t\t =======\nNOTE 6 - MOTEL OPERATING EXPENSES\nThe following table summarizes the major components of motel operating costs for the following years:\n\t\t\t\t 1995 1994 1993\nSalaries and related costs $ 441,334 $ 514,133 $ 552,246 Utilities 121,969 130,871 126,004 Allocated costs, mainly indirect salaries 181,607 169,656 180,492 Renovations and replacements 35,740 50,906 24,628 Other operating expenses 393,825 409,004 490,374 \t\t\t\t --------- --------- --------- Total motel operating expenses $1,174,475 $1,274,570 $1,373,744 \t\t\t\t ========= ========= =========\n\t\t\t\t\nItem 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON \t ACCOUNTING AND FINANCIAL DISCLOSURE\n\t Inapplicable.\n\t\t\t\t PART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\n\tThe original general partners of the Partnership were Dennis A. Brown and Philip B. Grotewohl, as the managing general partners, and Borel Associates (a partnership of which Robert J. Dana was a partner), as the associate general partner. Upon Mr. Brown's death on February 25, 1988, Mr. Grotewohl and Borel Associates elected to continue the Partnership. During March 1988, Mr. Grotewohl appointed Grotewohl Management Services, Inc., a California corporation, his successor as General Partner. Upon the liquidation of Borel Associates in April 1990, Grotewohl Management Services, Inc., as the sole remaining General Partner, elected to continue the Partnership.\n\tThe General Partner was organized in 1981 to serve as a general partner of limited partnerships to be formed for the purpose of investing in Super 8 Motels. The sole shareholder, director and officer of the General Partner is Mr. Grotewohl.\n\tMr. Grotewohl, age 77, is an attorney-at-law and was engaged in the private practice of law in San Mateo County, California, between 1967 and 1978. Since 1978, Mr. Grotewohl's principal occupation has been as a promoter and general partner of Super 8 Motels limited partnerships.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION\n\tAlthough Mr. Brown ceased to be a general partner of the Partnership upon his death, a trust of Mr. Brown share in certain of the compensation otherwise payable to the General Partner and its affiliates. Similarly, although Borel Associates ceased to have any interest in the Partnership upon its dissolution, Mr. Dana continues to share in such compensation.\n\tThe following is a description of the fees paid or payable to the General Partner, the Brown trust and Mr. Dana.\nProperty Management Fees - ------------------------\n\tThe Manager is managing and will manage all motel properties of the Partnership. The fee for this service is 5% of the gross proceeds from the operations of each motel. This compensation is in addition to the cost of compensating the Partnership's employees and the cost of goods and services acquired for the Partnership from independent contractors.\n\t\t\t\t - 17 -\n\tThe Partnership accrued and paid such fees to the Manager in the amount of $78,041 during the year ended December 31, 1995.\nFranchise Fees and Advertising Fees - -----------------------------------\n\tThe Partnership operates its motels as a franchisee of Super 8 Motels, Inc., pursuant to sub-franchises from the Manager. In connection with the operation of each of its motels, the Partnership, as franchisee, pays 4% of its gross room revenues to the franchisor. One-half of the franchise fee is paid to the Manager. In addition to the franchise fee, the Partnership pays 1% of its gross room revenues to the franchisor as an advertising fee. No part of this fee is paid to the Manager.\n\tThe total of franchise fees accrued during the year ended December 31, 1995 to Super 8 Motels, Inc. was $61,070, of which $30,535 accrued to the Manager. The total advertising fees paid to Super 8 Motels, Inc. was $15,267. All the above amounts have been paid.\nGeneral Partner's Interest in Cash Available for Distribution - ------------------------------------------------------------- \t\t\t\t\t\t\t \tAt quarterly intervals, the total amount of the Partnership's Cash Available for Distribution is determined at the discretion of the General Partner. (See Item 5 above.) Distributions therefrom are made as follows: (1) 90% of such distributions are paid to the Limited Partners; (2) 9% thereof is paid to the General Partner as Partnership management fees; and (3) 1% thereof is paid to the General Partner in accordance with its interest in the income and losses of the Partnership.\n\tNotwithstanding the foregoing, however, distributions of Cash Available for Distribution which would otherwise be paid to the General Partner are deferred and paid only after payment to the Limited Partners of distributions of Cash Available for Distribution in an amount equal to 10% per annum cumulative on their adjusted capital contributions.\n\tNo such cash distributions were paid by the Partnership to the General Partner, the Brown Trust, Robert J. Dana, or their affiliates during the fiscal year ended December 31, 1995. A total of $421,787 has been accrued to such persons since commencement of the Partnership, but is not set forth as a liability in the Partnership's financial statements due to the uncertainty of payment. In order for this amount to be payable the Limited Partners must receive $4,596,486 in prior years' preference distributions and $594,100 in each future year before any payments can be made to management.\n\t\t\t\t - 18 -\nGeneral Partner's Interest in Net Proceeds of Sales, Financing and Refinancing of Partnership Properties - ---------------------------------------------------------------\n\tThe proceeds from the sale or refinancing of properties not reinvested are to be distributed first to the Limited Partners until they have received cumulative payments from all distribution sources equal to 100% of their original capital contribution and a cumulative 10% per annum return on their adjusted capital contributions. When the foregoing requirement has been satisfied, any remaining funds from the sale or refinancing of properties is to be distributed 15% to the General Partner and 85% to the Limited Partners.\n\tNo such distributions were paid or accrued for the account of the General Partner, the Brown trust, Robert J. Dana or their affiliates during the fiscal year covered by this report.\nAllocation of General Partners' Interest - ----------------------------------------\nCompensation to the General Partners and their affiliates in the form of franchise fees and property management fees is allocated 1\/3 each to the Brown trust, the General Partner and Robert J. Dana.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND \t MANAGEMENT\nSecurity Ownership of Certain Beneficial Owners - -----------------------------------------------\n\tNo person is known by the Partnership to be the beneficial owner of more than 5% of the Units.\nSecurity Ownership of Management - --------------------------------\n\tThe General Partner is not the beneficial owner of any Units.\nChanges in Control - ------------------\n\tWith the consent of all other General Partners and Limited Partners holding more than 50% of the Units, a General Partner may designate a successor or additional general partner, in each case with such participation in such General Partner's interest as such General Partner and successor or additional general partner may agree upon, provided that the interests of the Limited Partners are not affected thereby.\n\tA General Partner may withdraw from the Partnership at any time upon 60 days' prior written notice to the Limited Partners and any other General Partners, or may transfer his interest to an entity controlled by him; provided, however, that in either such event, if it is determined that the Partnership business is\n\t\t\t\t - 19 -\nto be continued rather than dissolved and liquidated upon the happening thereof, the withdrawal or transfer will be effective only after receipt by the Partnership of an opinion of counsel to the effect that such withdrawal or transfer will not cause the Partnership to be classified as an association taxable as a corporation rather than as a partnership for federal income tax purposes.\nThe Limited Partners shall take no part in the management of the Partnership's business; however, a majority in interest of the Limited Partners, without the concurrence of the General Partner, shall have the right to amend the Partnership Agreement, dissolve the Partnership, remove a General Partner or any successor general partner, elect a new general partner or general partners upon the removal, retirement, death, insanity, insolvency or bankruptcy of a General Partner, and approve or disapprove the sale, exchange or pledge in a single transaction of all or substantially all of the properties acquired by the Partnership.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nAdministrative Expenses Shared by the Partnership and its Affiliates - ----------------------------------------------------------\n\tThere are certain administrative expenses allocated between the Partnership and other partnerships managed by the General Partner and its affiliates. These expenses, which are allocated based on usage, are telephone, data processing, rent of administrative offices and administrative salaries. The administrative expenses allocated to the Partnership were approximately $223,000 in 1995 are included in general and administrative expenses and motel operations expenses in the Partnership's financial statements. Included in administrative salaries are allocated amounts paid to three employee who are related to Philip B. Grotewohl, the sole shareholder of the General Partner.\n\t\t\t\t - 20 -\n\t\t\t\tPART 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 Included in Part II of this Report \t Report of Independent Certified Public Accountants \t Balance Sheets, December 31, 1995 and 1994 \t Statements of Operations for the Years Ended December 31, \t 1995, 1994 and 1993 \t Statements of Partners' Equity for the Years Ended \t December 31, 1995, 1994 and 1993 \t Statements of Cash Flow for the Years Ended December 31, \t 1995, 1994 and 1993 \t Notes to Financial Statements 2. Financial Statement Schedules Included in this Report \t None 3. Exhibits \t 3.1 and 4.1 The Partnership Agreement filed as Exhibits 3.1 \t and 4.1 to the annual report on Form 10-K for the fiscal year \t ended December 31, 1994 is incorporated herein by reference. \t 3.2 & 4.2 The Amendment to Partnership Agreement, included \t as Exhibit 3.2 & 4.2 to the annual report on Form 10-K for the \t fiscal year ended December 31, 1989 is incorporated herein by \t reference. \t Exhibits 10.1 through 10.4, filed as Exhibits 10.1 through \t 10.4, respectively, to the annual report on Form 10-K for the \t fiscal year ended December 31, 1989 are hereby incorporated \t herein by reference. \t 10.1 Santa Fe Railway Agreement with the Partnership's \t Bakersfield Motel. \t 10.2 Amtrak Contract with the Partnership's Bakersfield \t Motel. \t 10.3 Franchise Agreement for the Bakersfield Property. \t 10.4 Franchise Agreement for the San Bernardino Property. \t 10.5 Amtrak Contract Amendment filed as Exhibit 10.5 to the \t annual report on Form 10-K for the fiscal year ended December \t 31, 1994 is incorporated herein by reference.\n(b) Reports on Form 8-K \tInapplicable. \t \t\n\t\t\t\t - 21 -\n\t \t \t\t\t\t SIGNATURES\n\tPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\n(Registrant) SUPER 8 MOTELS III, LTD.\nBy (Signature and Title) \/s\/ Philip B. Grotewohl \t\t\t ---------------------------------------------- \t\t\t Philip B. Grotewohl, \t\t\t President of Grotewohl Management Services, Inc., \t\t\t General Partner\nDate March 28, 1996\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.\nBy (Signature and Title) \/s\/ Philip B. Grotewohl \t\t\t ------------------------------------------------- \t\t\t Philip B. Grotewohl, \t\t\t Chief executive officer, chief financial officer, \t\t\t chief accounting officer and sole director of \t\t\t Grotewohl Management Services, Inc., General Partner\nDate March 28, 1996\n\t\t\t\t - 22 -","section_15":""}
{"filename":"802019_1995.txt","cik":"802019","year":"1995","section_1":"ITEM 1. BUSINESS\nThis Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Actual results could differ materially from those projected in the forward-looking statements as a result of the risk related factors set forth herein.\nThis Annual Report on Form 10-K contains registered and other trademarks and tradenames of Atari and other companies.\nPROPOSED MERGER WITH JT STORAGE, INC.\nOn February 12, 1996, Atari Corporation (\"Atari\" or the \"Company\") entered into a merger agreement with JT Storage, Inc. (\"JTS\") providing for the merger of the Company and JTS (the \"Merger\"). On April 8, 1996, the merger agreement was amended and restated. As a result of the Merger, Atari would be merged with and into JTS, and each outstanding share of Atari Common Stock would be exchanged and converted into one share of JTS Common Stock. JTS was incorporated on February 3, 1994 to develop, market and manufacture hard disk drives. The Merger must be approved by the stockholders of Atari and JTS and is subject to certain other conditions. The Merger is expected to close late in the second quarter of calendar year 1996.\nIn connection with the Merger, on February 13, 1996, Atari loaned $25.0 million to JTS pursuant to a Subordinated Secured Convertible Promissory Note (the \"Note\") which is secured by substantially all of the assets of JTS. Interest accrues on the unpaid principal amount of the Note at the rate of 8.5% per annum. The Note provides that JTS shall repay the outstanding principal and interest under the Note on September 30, 1996 if the Merger has not occurred prior to such time. In the event that the Merger Agreement is terminated, either party may, under certain conditions, elect to convert the outstanding indebtedness under the Note into shares of JTS Series A Preferred Stock. The Note is expressly subordinated to outstanding indebtedness in connection with JTS' primary bank loan agreement, up to an amount of $5.0 million at any given time.\nBased on the number of shares of outstanding Atari Common Stock, JTS Common Stock and JTS Series A Preferred Stock as of April 5, 1996, immediately after consummation of the Merger, a total of 102,628,429 shares of JTS Common Stock would be issued and outstanding, of which 63,727,318 shares, or 62%, would represent shares issued in the Merger upon conversion of Atari Common Stock.\nUpon the closing of the Merger, it is expected that the directors of JTS will be Sirjang L. Tandon, David T. Mitchell, Alain L. Azan, Jean D. Deleage, Roger W. Johnson, Lip-Bu Tan, Jack Tramiel and Michael Rosenberg. Messrs. Tandon, Mitchell, Azan, Deleage, Johnson and Tan are currently directors of JTS, and Messrs. Tramiel and Rosenberg are currently directors of Atari. The executive officers of JTS immediately prior to the Merger are expected to be the executive officers of JTS after the Merger. The parties have also agreed that Jack Tramiel or a person designated by Jack Tramiel shall be a member of each committee of the JTS Board of Directors after the Merger.\nBUSINESS\nAtari was incorporated under the laws of Nevada in May 1984. From 1984 to 1992, Atari designed, manufactured and marketed proprietary personal computers and video games and related software. Over the past several years, Atari has undergone significant change. In 1992 and 1993, Atari significantly downsized operations, decided to exit the computer business and focused on its video game business. As a result, revenues from computer products as a percentage of total revenues declined from 67% in 1993 to 16% in 1994 and 12% in 1995, while sales of entertainment systems and related software and peripheral products and the receipt of royalties represented the balance of revenues in each such year. These actions resulted in significant restructuring charges for closed operations and write-downs of computer and certain video game inventories in 1992 and 1993.\nWhile restructuring, Atari developed its 64-bit Jaguar interactive multimedia entertainment system, which was introduced in selected markets in the fourth quarter of 1993. For 1995 and 1994, total sales of Jaguar and related products were $9.9 million and $29.3 million, respectively, and represented 68% and 76% of Atari's net revenues, respectively. These Jaguar sales were substantially below Atari's expectations, and Atari's business and financial results were materially adversely affected in 1995 as Atari continued to invest heavily in Jaguar game development, entered into arrangements to publish certain licensed titles and reduced the retail price for its Jaguar console unit. Atari attributes the poor performance of Jaguar to a number of factors including (i) extensive delays in development of software for the Jaguar which resulted in reduced orders due to consumer concern as to when titles for the platform would be released and how many titles would ultimately be available, and (ii) the introduction of competing products by Sega and Sony in May 1995 and September 1995, respectively. Atari presently has a substantial unsold inventory of Jaguar and related products and there can be no assurance that such inventory can be sold at current prices.\nBy late 1995, Atari recognized that despite the significant commitment of financial resources that were devoted to the Jaguar and related products, it was unlikely that Jaguar would ever become a broadly accepted video game console or that Jaguar technology would be broadly adopted by software title developers. As a result, Atari decided to significantly downsize its Jaguar operations. This downsizing resulted in significant reductions in Atari's workforce, and significant curtailment of research and development and sales and marketing activities for Jaguar and related products. Accordingly, Atari decided to focus its efforts on selling its inventory of Jaguar and related products and to emphasize its existing licensing and development activities related to multimedia entertainment software for various platforms.\nPRODUCTS\nAtari's principal products are described below:\nJaguar Entertainment System. Atari introduced its 64-bit Jaguar interactive multimedia entertainment system in late November 1993 into selected markets. During 1994, Atari rolled out a nationwide program and commenced initial shipments into Europe. From its launch through the end of 1994, Jaguar's suggested retail price was $249.99. As a result of competition and cost reductions, during the first quarter of 1995, Atari reduced the retail price of Jaguar to $149.99. The current retail price of Jaguar is $99.99. Despite its substantially lower retail price, sales of Jaguar continue to be disappointing, and Atari is test marketing different price points and software bundles for the Jaguar in an attempt to sell its substantial inventory of such product.\nThe Jaguar is a 64-bit interactive multimedia system that incorporates two proprietary chips developed by Atari which are specialized for multimedia entertainment. The proprietary chips include four processors (graphics processing unit, object processor, blitter and digital signal processor) and a standard Motorola 68000 microprocessor. The computational speed of the system is approximately 44 MIPS and the bus bandwidth is 106.4 megabytes per second. The video features include 24-bit graphics with up to 16.8 million colors and a 3-D engine which can render 3-D shaded or texture mapped polygons in real time. The sound system is based on a high-speed custom digital signal processor dedicated to audio. The audio is 16-bit compact disk (\"CD\") quality from cartridge-based software, and can be processed from simultaneous sources of audio data. This allows for very realistic sounds in the software, including human voices. Through the use of a compression\ntechnology customized by Atari (called \"JAGPEG\"), software developers can compress data to the point that a 100-megabit game can fit into a 16-megabit ROM cartridge. This allows for more exciting experiences both visually and in game play due to the vast amount of data available.\nJaguar Software Titles. From 1994 through 1995, Atari developed titles for the Jaguar primarily under contract with third party software developers. To date, Atari has published approximately 45 software titles for the Jaguar. These titles include an array of licensed and nonlicensed titles, some of which utilize 3-D graphics, high speed animation, 16.8 million colors, full motion video, motion capture techniques and 16-bit stereo sound. Atari's software library includes titles which are cartridge based (ROM chips) and CD based. Since 1995, the development of titles for Jaguar has been curtailed substantially and Atari is currently developing a very limited number of titles which it expects to publish in either cartridge or CD format. In addition to Atari's software development efforts, in 1994 and 1995 Atari licensed independent software vendors (\"ISVs\") to develop and publish titles for the Jaguar. Atari is not aware of any current development of Jaguar titles by ISVs and does not expect any such development in the foreseeable future.\nJaguar Peripherals. Atari offers a CD-ROM peripheral for the Jaguar that enables software end users to have full motion video clips and more complex games than are available on cartridges. Publishers can take advantage of lower media cost and quicker turnaround on orders with CD-ROM software as compared to a ROM cartridge. The CD-ROM peripheral is a double speed player that can play Jaguar video games, regular audio CD's and CD + G (graphics). The suggested retail price of the CD-ROM peripheral is $149.99. The success of the CD-ROM peripheral is substantially dependent on the size of the installed base of cartridge-based Jaguar consoles.\nPC Software. As a result of Atari's investment in game design, art and programming for its Jaguar software, Atari has ported certain of its Jaguar titles to the IBM PC compatible platform. Atari intends to publish and\/or license these titles in 1996. In this regard, Atari commenced shipment of the PC CD-ROM version of Tempest 2000 in Europe during the first quarter of 1996.\nLibrary of Titles. In 1996, Atari plans to increase its efforts to license titles from its game library to third party publishers. Atari has over 100 titles in its game library, including the following:\nCOMPETITION\nThe video game business is intensely competitive. Since its introduction in late 1993, Jaguar has failed to achieve broad market acceptance. Atari does not expect that Jaguar, even at its substantially reduced price, will ever become a broadly accepted video game console, or that Jaguar technology will be broadly adopted by software title developers. The video game industry is also characterized by unpredictable and rapid shifts in the popularity of certain platforms, by severe price competition, and by frequent new technology and product introductions. In this regard, numerous companies have introduced or have developed and are expected to introduce video game consoles that are or may become competitive with Jaguar. In addition, an increasing number of entertainment titles are being developed for or ported to the PC platform. Most of Atari's competitors have greater experience and expertise in 3D graphics and multimedia technology and have substantially greater engineering, marketing and financial resources than Atari. Jaguar presently competes with products offered by the following companies:\n- Nintendo commenced development, in collaboration with Silicon Graphics, Inc., of the Nintendo 64 player, expected to be released in Autumn 1996 in the United States. Nintendo also sells the 16 bit Super NES at a retail price of $99.95.\n- Sega commenced shipment of the Sega Saturn in the United States in May 1995 with a current retail price of $299.00. Sega also sells the 16 bit Genesis at a retail price of $99.95.\n- Sony released the Sony PlayStation in the United States in late 1995 with a current retail price of $299.00.\n- The 3DO Company licenses the 3DO Interactive Multiplayer System console architecture for retail sale worldwide.\nMARKETING AND DISTRIBUTION\nAtari distributes its products domestically through various independent channels. Jaguar is sold primarily through national retailers, consumer electronic specialty stores and distributors of electronic products. European sales are conducted from Atari's European headquarters in London, U.K. Jaguar and Atari's PC titles are sold in European markets through substantially the same channels of distribution as those in the United States. Net sales outside North America for fiscal years 1995, 1994 and 1993 constituted approximately 44%, 40% and 75%, respectively, of total net revenues. No single customer accounted for 10% or more of total net revenues for the years ended December 31, 1995, 1994 or 1993.\nRESEARCH AND DEVELOPMENT\nMost of Atari's products, including Jaguar, were developed by its internal engineering and software groups as well as independent software developers under contract with Atari. Atari's research and development expenses totaled $5.4 million, $5.8 million and $4.9 million in 1995, 1994, and 1993, respectively. Atari has significantly downsized its research and development efforts and currently has five employees dedicated to such efforts. As a result, Atari expects its research and development expenses to decline substantially in 1996.*\nAtari's current development efforts are dedicated to developing a limited number of Jaguar software titles and porting certain existing Jaguar titles to the PC platform. As part of this development process, Atari has agreements with third parties to develop and\/or license properties. Under these agreements, Atari will make payments to these parties as either development fees and\/or advance royalties, and is obligated to make certain minimum royalty guarantees on future sales. There can be no assurance that all payments for development fees and\/or advance royalties will be recoverable through future sales of products.\nMANUFACTURING\nAtari has placed no manufacturing orders for the Jaguar console since mid-1995. Based on current and expected sales and inventory levels, Atari does not intend to pursue additional Jaguar manufacturing. The Jaguar console unit was assembled in the United States by a third-party subcontractor under a manufacturing arrangement. The agreement may be canceled by either party with 90 days' notice. Jaguar software products and accessories are manufactured by several suppliers and are assembled by subcontractors. Atari believes that it could readily replace these sources of supply and assembly, if necessary.\nINTELLECTUAL PROPERTY RIGHTS\nAtari has exclusive use of its \"Atari\" name and \"Fuji\" logo in all areas other than coin-operated arcade video game use. Atari also has a portfolio of other intellectual properties including patents, trademarks, and copyrights associated with its video game and computer businesses. Atari believes its patents, trademarks and other intellectual property are important assets. As of December 31, 1995, Atari held over 150 patents in the United States and other jurisdictions which expire from 1996 to 2010 and had applications pending for three additional patents. There can be no assurance that any of these patent rights will be upheld in the future or that Atari will be able to preserve any of its other intellectual property rights. Atari has in the past received communications from third parties asserting rights to certain of its intellectual property. Atari has also been involved in several major lawsuits regarding its intellectual property, including a suit with Nintendo which was\n- ---------------\n* This statement is a forward-looking statement reflecting current expectations. Actual results could differ materially from those projected in the forward-looking statement due to numerous factors, including the risk related factors set forth herein.\nsettled in March 1994 and a suit with Sega which was settled in September 1994. In the event any third party were to make a valid claim with respect to Atari's intellectual property and a license were not available on commercially reasonable terms, Atari's business, financial condition and results of operations would be materially and adversely affected. Litigation, which has in the past and could in the future result in substantial costs and diversion of resources, may also be necessary to enforce Atari's patents or other intellectual property rights or to defend against third-party infringement claims. The occurrence of litigation relating to patent infringement or other intellectual property matters, regardless of the outcome, could have a material adverse effect on Atari's business, financial condition and results of operations.\nBACKLOG\nOrders are usually placed by purchasers on an as-needed basis, are sometimes cancelable before shipment, and are usually filled from inventory shortly after receipt. Atari currently has a substantial inventory of finished products and product components for which there are no orders. Although Atari is taking steps to realize revenue from such inventory, Atari recognized substantial inventory write-downs in 1995 and there can be no assurance that substantial additional write-downs will not be required.\nEMPLOYEES\nDue to disappointing sales of Jaguar and related products, Atari reduced its workforce from 101 persons at December 31, 1994 to 73 persons at December 31, 1995 and 31 persons at March 31, 1996. Atari does not presently anticipate any further reductions in its workforce. As of March 31, 1996, Atari had approximately 25 employees in the U.S., including five in engineering and product development, 12 in marketing, sales and distribution, two in purchasing and six in general administration and management. In addition, Atari had six employees outside the United States at March 31, 1996. None of the employees are represented by a labor union. Atari considers its employee relations to be good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nAtari leases its 7,200 square feet headquarters facility in Sunnyvale, California under a lease which expires in 2001. Atari also leases a 33,600 square feet international sales facility in Slough, England and a 19,400 square feet vacant facility in Viannen, Holland. Atari also holds certain properties in Southern California and Texas for sale. Some of these properties are currently being leased by Atari. These properties are reported as real estate held for sale in the Consolidated Financial Statements. See Note 7 of Notes to Consolidated Financial Statements.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nAtari is a defendant in a civil action brought in the Superior Court of the State of California in and for the County of Santa Clara by Citizen America Corporation, a former supplier, in February 1994 seeking damages of approximately $900,000 for alleged breach of contract and related claims. Atari believes this action will have no material adverse effect on its business, financial condition or results of operations.*\nAtari is a defendant and counter claimant in a civil action for alleged breach of contract brought in U.S. District Court for the Northern District of New York, case number 95 Civ. 1945, by Tradewell, Inc., a New York corporation, seeking specific performance for release of goods having a value of $1.6 million. Atari has counterclaimed seeking specific performance for the purchase of media or, alternatively, damages in the amount of $3.3 million. As a result of a partial settlement, Atari now seeks damages of approximately $1.3 million. Atari believes this action will have no material adverse effect on its business, financial condition or results of operations.*\n- ---------------\n* This statement is a forward-looking statement reflecting current expectations. Actual results could differ materially from those projected in the forward-looking statement due to numerous factors, including the risk related factors set forth herein.\nAtari is a plaintiff in a civil action brought in the Superior Court of the State of California in and for the County of Santa Clara brought against Phillips Laser Magnetic Storage (\"Phillips\") for breach of contract and breach of implied covenant of good faith and fair dealing arising out of Phillips' failure to deliver goods to Atari. Atari has been advised that Phillips intends to file an unspecified counterclaim. Atari believes this action will have no material adverse effect on its business, financial condition or results of operations.*\nAtari is a plaintiff in a civil action brought in the Superior Court of the State of California in and for the County of Santa Clara and removed to the United States District Court, Northern District of California brought against Probe Entertainment Limited and Acclaim Entertainment for breach of contract and related claims. Counterclaims have been filed against Atari for alleged breach of contract. Atari believes this action will have no material adverse effect on its business, financial condition or results of operations.*\nAtari is not aware of any other pending legal proceedings against Atari and its consolidated subsidiaries other than routine litigation incidental to their normal business.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNot applicable.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nAtari's Common Stock has traded on the American Stock Exchange under the symbol \"ATC\" since November 7, 1986. As of the close of business on April 5, 1996, 63,727,318 shares of Atari Common Stock were outstanding and no shares of Preferred Stock were outstanding. As of that date, there were approximately 2,800 stockholders of record of Atari Common Stock. The following table sets forth the high and low sale prices of Atari's Common Stock for the periods indicated as reported on the consolidated transaction system.\nAtari has never paid cash dividends on its Common Stock and does not anticipate a change in this practice in the foreseeable future.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following selected consolidated financial data of Atari have been derived from the historical consolidated financial statements of Atari, included elsewhere herein, with the exception of the Consolidated Statement of Operations Data prior to fiscal 1993 and the Consolidated Balance Sheet Data prior to December 31, 1994 which were derived from historical consolidated financial statements not included herein. The information set forth below should be read in conjunction with the Company's Consolidated Financial Statements and notes thereto and with Management's Discussion and Analysis of Financial Condition and Results of Operations.\n- --------------- (1) Includes a gain from the settlement of patent litigation of $32.1 million in 1994 and a gain from the sale of a Taiwan manufacturing facility of $40.9 million in 1991.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThis Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Actual results could differ materially from those projected in the forward-looking statements as a result of certain factors, including the risk related factors set forth herein.\nOver the past several years, Atari has undergone significant change. In 1992 and 1993, Atari significantly downsized operations, decided to exit the computer business and focused on its video game business. As a result, revenues from computer products as a percentage of total revenues declined from 67% in 1993 to 16% in 1994 and 12% in 1995, while sales of entertainment systems and related software and peripheral products and the receipt of royalties represented the balance of revenues in each such year. These actions resulted in significant restructuring charges for closed operations and write-downs of computer and certain video game inventories in 1992 and 1993.\nWhile restructuring, Atari developed its 64-bit Jaguar interactive multimedia entertainment system, which was introduced in selected markets in the fourth quarter of 1993. For 1995 and 1994, total sales of Jaguar and related products were $9.9 million and $29.3 million, respectively, and represented 68% and 76% of Atari's net revenues, respectively. These Jaguar sales were substantially below Atari's expectations, and Atari's business and financial results were materially adversely affected in 1995 as Atari continued to invest heavily in Jaguar game development, entered into arrangements to publish certain licensed titles and reduced the retail price for its Jaguar console unit. Atari attributes the poor performance of Jaguar to a number of factors including (i) extensive delays in development of software for the Jaguar which resulted in reduced orders due to consumer concern as to when titles for the platform would be released and how many titles would ultimately be available, and (ii) the introduction of competing products by Sega and Sony in May 1995 and September 1995, respectively. Atari presently has a substantial unsold inventory of Jaguar and related products and there can be no assurance that such inventory can be sold at current prices.\nBy late 1995, Atari recognized that despite the significant commitment of financial resources that were devoted to the Jaguar and related products, it was unlikely that Jaguar would ever become a broadly accepted video game console or that Jaguar technology would be broadly adopted by software title developers. As a result, Atari decided to significantly downsize its Jaguar operations. This downsizing resulted in significant reductions in Atari's workforce, and significant curtailment of research and development and sales and marketing activities for Jaguar and related products. Accordingly, Atari decided to focus its efforts on selling its inventory of Jaguar and related products and to emphasize its existing licensing and development activities related to multimedia entertainment software for various platforms.\nYEAR ENDED DECEMBER 31, 1995 COMPARED TO YEAR ENDED DECEMBER 31, 1994\nTotal revenues for 1995 were $14.6 million compared to $38.7 million for 1994. Sales of Jaguar and related products represented 68% and 76% of total revenues for 1995 and 1994, respectively, and sales of other products and royalties represented the balance of revenues in each such year. The reduction in revenues was primarily the result of lower unit volumes of Jaguar products and lower average selling prices of Jaguar and certain of its software titles. In the first quarter of 1995, Atari reduced the suggested retail price of Jaguar from its original price of $249.99 to $149.99. The current suggested retail price of Jaguar is $99.99. As a result of the Jaguar price reductions, the substantial curtailment of sales and marketing activities for Jaguar and the substantial curtailment of efforts by Atari and independent software developers to develop additional software titles for Jaguar, Atari expects sales of Jaguar and related products to decline substantially in 1996 and thereafter.*\n- ---------------\n* This statement is a forward-looking statement reflecting current expectations. Actual results could differ materially from those projected in the forward-looking statement due to numerous factors, including the risk related factors set forth herein.\nCost of revenues for 1995 was $44.2 million compared to $35.2 million for 1994. Included in cost of revenues for 1995 were accelerated amortization and write-offs of capitalized game software development costs of $16.6 million and inventory write-downs of $12.6 million primarily relating to Jaguar products. As a result of these charges and lower selling prices for Jaguar products and provisions for returns and allowances and price protection, gross margin for the year was a loss of $29.6 million. For 1994, gross margin was $3.5 million, or 9.2% of revenues. Included in cost of revenues for 1994 were write-downs of inventory of $3.6 million and amortization and the write-off of capitalized game software development costs of $1.5 million. From the introduction of Jaguar in late 1993 through the end of 1995, Atari sold approximately 125,000 units of Jaguar. As of December 31, 1995, Atari had approximately 100,000 units of Jaguar in inventory and the value of Jaguar inventory and related software was approximately $9.9 million. Due to disappointing sales of Jaguar and increased competition from products introduced by Sega and Sony, Atari reduced the suggested retail price of Jaguar to $99.99 and recorded an inventory write-down of $12.6 million in 1995. There can be no assurance that Atari's substantial unsold inventory of Jaguar and related software can be sold at current or reduced prices, if at all. In addition, any further decrease in the value of such inventory could result in substantial additional inventory write-downs by Atari.\nResearch and development expenses for 1995 were $5.4 million compared to $5.8 million for 1994. During 1995 and 1994, a significant number of Atari employees and consultants were devoted to developing hardware and software for the Jaguar, and Atari contracted with third-party software developers to develop Jaguar software titles. As a result of Jaguar's poor sales performance, in the third and fourth quarters of 1995, Atari accelerated its amortization of contracted software development which resulted in charges in those quarters of $6.0 million and $10.6 million, respectively. At December 31, 1995 and 1994, Atari had capitalized software development costs of $758,000 and $5.1 million, respectively. In the fourth quarter of 1995, Atari eliminated its internal Jaguar development teams and other development staff as titles for Jaguar were completed. As a result, Atari expects research and development expenses will be substantially lower for the foreseeable future.*\nMarketing and distribution expenses for 1995 were $12.7 million compared to $14.7 million for 1994. Such costs included television and print media, promotions and other activities to promote Jaguar. Due to the substantial curtailment of the Jaguar marketing program, Atari expects these expenses will be substantially lower for the foreseeable future.*\nGeneral and administrative expenses for 1995 were $5.9 million compared to $7.2 million for 1994. The decrease in such expenses was primarily a result of staff reductions, reduced legal fees and other operating costs. Due to the substantial reduction in general and administrative personnel in 1995 and the first quarter of 1996, Atari expects these expenses will be substantially lower for the foreseeable future.*\nAtari experienced a gain on foreign currency exchange of $13,000 for 1995 compared to a gain of $1.2 million for 1994. These changes were a result of lower foreign asset exposure and a greater percentage of sales made in U.S. dollars which further reduced exposure to foreign currency transaction fluctuations.\nIn 1994, Atari received $2.2 million in connection with the settlement of litigation between Atari, Atari Games Corporation and Nintendo. In 1994, Atari also reached an agreement with Sega, which resulted in a gain of $29.8 million, after contingent legal fees, and the sale of 4,705,883 shares of Atari Common Stock to Sega at $8.50 per share for an aggregate of $40.0 million.\nDuring 1995, Atari sold a portion of its holdings in Dixon PLC, a retailer in England, and realized a gain of $2.4 million, of which $1.8 million was realized in the fourth quarter of 1995. In the first quarter of 1996, Atari sold the remaining portion of its holdings and realized a gain of $6.1 million. The 1995 gain of $2.4 million together with other income items resulted in a total other income of $2.7 million compared to $484,000 for 1994.\n- ---------------\n* This statement is a forward-looking statement reflecting current expectations. Actual results could differ materially from those projected in the forward-looking statement due to numerous factors, including the risk related factors set forth herein.\nFor each of 1995 and 1994, interest expense was approximately $2.3 million on the Atari Convertible Subordinated Debentures (the \"Atari Debentures\"). In 1995, Atari repurchased a portion of the Atari Debentures and realized a gain of $582,000. As of December 31, 1995, the outstanding balance of these debentures was $42.4 million.\nInterest income for 1995 and 1994 was $3.1 million and $2.0 million, respectively. The increase in interest income was primarily attributable to higher average cash balances in 1995.\nAs a result of Atari's operating losses, there was no provision for income taxes in 1995. See Note 11 to the Consolidated Financial Statements.\nAs a result of the factors discussed above, Atari reported a net loss for 1995 of $49.6 million compared to net income of $9.4 million in 1994.\nIn connection with the restructuring of Atari's business in 1992 and 1993 and Atari's decision in late 1995 to significantly downsize its Jaguar operations, Atari has terminated and plans to terminate numerous contracts and business relationships, including several related to software development activities. The termination of contracts and relationships has, from time to time, resulted in litigation, diverting management and financial resources. There can be no assurance that the parties to such contracts will not commence or threaten to commence litigation related to such contracts. Any such litigation or threatened litigation would further divert management and financial resources and could have a material adverse effect on Atari's business, operating results and financial condition. In addition, Atari holds several properties for sale, some of which are currently being leased. The ownership and use of such properties subjects Atari to numerous risks, including risks of environmental and personal injury liabilities. Although Atari is attempting to sell certain of such properties, such sales are not expected to eliminate all the risks associated with Atari's ownership of such properties.\nYEAR ENDED DECEMBER 31, 1994 COMPARED TO YEAR ENDED DECEMBER 31, 1993\nTotal revenues for 1994 were $38.7 million compared to $29.1 million for 1993. The increased revenues were primarily a result of Atari's national rollout of the Jaguar and related products. Sales of Jaguar products represented 76% of revenues in 1994 compared to 13% of revenues in 1993. Jaguar was introduced in selected markets in late 1993, and approximately 100,000 units were sold by the end of 1994 at a suggested retail price of $249.99. Sales of Atari's proprietary personal computers and certain discontinued video game products represented 24% of revenues for 1994 compared to 87% of revenues for 1993.\nGross margin for 1994 was $3.5 million, or 9.2% of revenues, compared to a gross loss of $13.7 million for 1993. Included in cost of revenues are inventory write-downs of $3.6 million and $18.1 million for 1994 and 1993, respectively, and a write-off of capitalized game software development costs of $804,000 in 1994. These write-downs of proprietary personal computers and video game products to estimated realizable values were made concurrently with the introduction and change in marketing focus to Jaguar products.\nResearch and development expenses for 1994 were $5.8 million compared to $4.9 million for 1993. The increase resulted from increased expenditures for the Jaguar product line.\nMarketing and distribution expenses for 1994 were $14.7 million compared to $9.0 million for 1993. The increase in expenditures was primarily the result of the national rollout in 1994 of the Jaguar. Such costs included television and print media promotions and other activities.\nGeneral and administrative expenses for 1994 were $7.2 million compared to $7.6 million for 1993. The marginally lower general and administrative expenses were primarily due to Atari's restructuring program in 1993. During 1993, Atari made provisions for restructuring totaling $12.4 million, which included closing many of Atari's operations in Europe, Asia and Australia, including, but not limited to, severance payments, rental commitments and other closure costs.\nFor 1994, Atari experienced a gain on foreign currency exchange of $1.2 million compared to a loss on exchange of $2.2 million in 1993. This change was a result of fluctuation in exchange rates, a lower foreign asset exposure and a greater percentage of sales made in U.S. dollars, thereby further reducing exposure to foreign currency transaction fluctuations.\nFor each of 1994 and 1993, interest expense was approximately $2.3 million on the Atari Debentures.\nAtari utilized net operating loss carryforwards and, as a result, there was no provision for income taxes in 1994.\nAs a result of the factors discussed above, Atari reported net income for 1994 of $9.4 million compared to a net loss of $48.9 million in 1993.\nLIQUIDITY AND CAPITAL RESOURCES\nAt December 31, 1995, Atari held cash and marketable securities of $50.6 million compared to $81.0 million at December 31, 1994. The decrease in cash and marketable securities was primarily the result of operating losses incurred during 1995.\nDuring 1995, Atari sold a portion of its holding in Dixon PLC., a U.K. retailer, and realized a gain on the sale of these securities in the amount of $2.4 million. In the first quarter of 1996, Atari sold its remaining interest in Dixon PLC. and realized a gain of $6.1 million. As of December 31, 1995, Atari's balance sheet reflected an unrealized gain on marketable securities of $7.1 million.\nIn February 1996, Atari loaned $25.0 million to JTS in connection with the Merger. The loan is due to be repaid by JTS in September 1996 and is secured by substantially all of the assets of JTS. Atari's security interest in such assets is junior to existing security interests in favor of a bank and certain equipment lessors. In the event the Merger is not consummated, there can be no assurance that Atari's security interest in such assets will adequately protect Atari in the event JTS is unable to repay the loan. In addition, the loan is convertible into shares of JTS Series A Preferred Stock at the option of Atari or JTS upon the occurrence of certain conditions, including a breach of the Merger Agreement by the other party. In the event such conversion occurs, Atari would hold a significant percentage of JTS' outstanding equity securities and would be subject to the numerous risks associated with JTS' business. There can be no assurance that such securities would be freely tradeable at the time of conversion, if ever.\nAs of December 31, 1995, Atari had $42.4 million of its 5 1\/4% convertible subordinated debentures due April 29, 2002 outstanding. The market value of the Atari Debentures was approximately $20.0 million at December 31, 1995. The Atari Debentures may be redeemed at Atari's option, upon payment of a premium. The debentures, at the option of the holders, are convertible into Atari Common Stock at $16.3125 per share. A default with respect to other indebtedness of Atari in an aggregate amount exceeding $5 million would result in an event of default whereby the Atari Debentures would be due and payable immediately.\nAtari believes its existing cash balances are sufficient to meet its requirements at least through 1996.*\n- ---------------\n* This statement is a forward-looking statement reflecting current expectations. Actual results could differ materially from those projected in the forward-looking statement due to numerous factors, including the risk related factors set forth herein.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nATARI CORPORATION AND SUBSIDIARIES\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE\nAll other schedules are omitted because they are not required or the required information is shown in the financial statements or the notes thereto.\nINDEPENDENT AUDITORS' REPORT\nTo the Shareholders and Board of Directors of Atari Corporation:\nWe have audited the accompanying consolidated balance sheets of Atari Corporation and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1995. Our audits also included the financial statement schedule listed in the Index at Item 8. 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 Atari Corporation and subsidiaries at December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.\nDELOITTE & TOUCHE LLP\nSan Jose, California March 1, 1996\n(April 8, 1996 as to Note 16)\nATARI CORPORATION\nCONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)\nLIABILITIES AND SHAREHOLDERS' EQUITY\nSee notes to consolidated financial statements.\nATARI CORPORATION\nCONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\nSee notes to consolidated financial statements.\nATARI CORPORATION\nCONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (IN THOUSANDS)\nSee notes to consolidated financial statements.\nATARI CORPORATION\nCONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)\nSee notes to consolidated financial statements.\nATARI CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. COMPANY\nNature of Operations -- The Company designs and markets interactive multimedia entertainment systems and related software and peripheral products. Manufacture of these products is performed by third parties. The principal methods of distribution are through mass market retailers, consumer electronic specialty stores and distributors of electronic products.\nProduct Focus -- Since 1992, the Company has focused its research and development effort on its 64-bit Jaguar interactive multimedia entertainment system. This product was introduced in 1993 and, in 1995 and 1994, 68% and 76% of revenues, respectively, were associated with this product. Sales of the Jaguar in 1995 were disappointing and the Company is currently test marketing different price points and software bundles for the Jaguar in an attempt to sell its substantial inventory of such products.\nIn December 1994, the Company planned price reductions beginning in early 1995 and recognized the impact of this decision on finished and in-process inventory through a write down of inventory of $3.6 million, which is included in cost of sales in the fourth quarter of 1994. In December 1995, the Company planned further price reductions beginning in early 1996 and recognized the impact of this decision through a $10.9 million write down of inventory, which is included in cost of sales in the fourth quarter of 1995.\nThe Company continues to carry limited quantities of its older 8-bit and 16-bit video games and computer product lines. As a result of rapid technological change and intense competition, the Company wrote down inventories of these products by $18.1 million in 1993 which was included in cost of sales.\nEstimates -- The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect recorded amounts of assets, liabilities, revenues and expenses as of the dates and for the periods presented. In connection with the change of the Company's focus, measurement of assets and liabilities is dependent upon management's ability to accurately predict future operating results. Actual results could differ from these estimates.\nRestructuring -- The Company has active operations in the United States and the United Kingdom. During 1993 and 1992, the Company significantly restructured its operations around the world, closing operations in Australia and the Far East, in several European countries and in Canada and Mexico. These operational closures resulted in the bankruptcy of subsidiaries in Australia and Germany and may result in the voluntary or involuntary liquidation or bankruptcy of other subsidiary companies. Charges for restructuring have been separately reported in the consolidated statements of operations for 1993. The remaining accruals of $351,000 at December 31, 1995 relate to employee benefits in Italy and lease obligations in the Netherlands.\n2. SIGNIFICANT ACCOUNTING POLICIES\nPrinciples of Consolidation -- The consolidated financial statements include the Company and its subsidiaries. All transactions and balances between the companies are eliminated.\nCash and Equivalents -- Cash equivalents are stated at cost, which approximates market value, have maturities not exceeding ninety days upon acquisition and generally consist of certificates of deposit, time deposits, treasury notes and commercial paper.\nMarketable Securities -- Effective January 1, 1994, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" Marketable securities are carried as available-for-sale securities and reported at the fair market value. The cumulative effect of adoption of SFAS 115 as of January 1, 1994 was not material. Unrealized gains and losses are reported as a separate component of shareholders' equity. Realized gains and losses are recorded in the statements of operations and realized gains were $2.4 million in 1995. The cost of securities sold is based on average cost.\nATARI CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nInventories -- Inventories are stated at the lower of cost or market. Cost is computed using standard costs which approximate actual cost on a first-in, first-out basis. Market for each of the Company's product lines is determined by reference to expected sales prices less direct selling expenses.\nPrepaid Advertising -- Included in other current assets at December 31, 1994 is $3.2 million of prepaid advertising resulting from a barter transaction. The amount recorded as prepaid advertising equals the carrying value of certain inventory exchanged for advertising credits. The Company expensed the prepaid advertising as utilized during 1995.\nEquipment and Tooling -- Equipment and tooling are stated at cost. Depreciation on equipment is computed using the straight-line method based on estimated useful lives of the assets of two to five years. Tooling is depreciated on a units of production basis. Leasehold improvements are amortized over the estimated useful life or lease term, as appropriate. Fully depreciated assets, and related depreciation, are excluded from the consolidated financial statements.\nReal Estate Held for Sale -- Real property associated with closed operations in the U.S. is stated at estimated market value as determined by recent valuations, appraisals or pending sales offers.\nRevenue Recognition -- Sale of consoles, software game cartridges and related products are recorded as revenue at the time of shipment to customers. Concurrently, the Company establishes reserves for estimated returns, which are recorded as a reduction of sales, and for cooperative advertising allowances, which are recorded as marketing and distribution expense. Royalty revenues are recognized when earned and collection is probable.\nIncome Taxes -- The Company adopted SFAS No. 109 \"Accounting for Income Taxes\" in the first quarter of 1993 which requires an asset and liability method for financial accounting and reporting of income taxes. The impact of the adoption of SFAS 109 was not material.\nForeign Currency Translation -- Assets and liabilities of operations outside the United States are translated into United States dollars using current exchange rates, and the effects of foreign currency translation adjustments are deferred and included as a component of shareholders' equity.\nIncome (Loss) per Common Share -- Per share amounts are computed based on the weighted average number of common and dilutive common equivalent shares (stock options) outstanding during each period. The effect of the assumed conversion of the 5 1\/4% convertible subordinated debentures was antidilutive for all periods presented and excluded from the computation.\nFiscal Year -- The Company uses a 52\/53 week fiscal year which ends on the Saturday closest to December 31. All fiscal years presented contain 52 weeks. For simplicity of presentation, the date December 31 is used to represent the fiscal year end.\nReclassifications -- Certain items have been reclassified in the 1994 and 1993 financial statements to conform to the 1995 presentation and had no effect on operating results or shareholders' equity.\nRecently Issued Pronouncements -- In October 1995, the Financial Accounting Standards Board issued FASB No. 123, \"Accounting for Stock-Based Compensation.\" The new standard defines a fair value method of accounting for stock options and other equity instruments, such as stock purchase plans. Under this method, compensation cost is measured based on the fair value of the stock award when granted and is recognized as an expense over the service period, which is usually the vesting period. This standard will be effective for the Company beginning in 1996, and requires measurement of awards made beginning in 1995. The new standard permits companies to continue to account for equity transactions with employees under existing accounting rules, but requires disclosure in a note to the financial statements of the pro forma net income and earnings per share as if the Company had applied the new method of accounting. The Company intends to follow these\nATARI CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\ndisclosure requirements for its employee stock plans. As a result, adoption of the new standard will not impact reported earnings or earnings per share, and will have no effect on the Company's cash flows.\n3. FINANCIAL INSTRUMENTS\nMarketable Securities -- Marketable securities available for sale consist of (in thousands):\nThe contractual maturities of the government securities range from two to four years. The Eurodollar notes matured during 1995.\nConcentration of Credit Risk -- The Company sells to mass market retailers, consumer electronic specialty stores and to distributors of electronic products throughout the United States and Europe. The Company makes ongoing credit evaluations of customers and, at times, requires letters of credit from some foreign customers. Sales to foreign customers are generally stated in the currency of the customer. To date, the Company has not entered into hedges of these foreign currency exposures.\nFair Value of Financial Instruments -- In accordance with the provisions of SFAS No. 107, \"Disclosure About Fair Value of Financial Instruments,\" which requires the disclosure of fair value information about both on and off balance sheet financial instruments where it is practicable to estimate the value, the Company has estimated the fair value of its financial instruments. The estimated fair value of the 5 1\/4% convertible subordinated debentures at December 31, 1995 was approximately $20 million based primarily on quoted market prices. The carrying amounts of the remainder of the Company's financial instruments, including cash and equivalents, marketable securities, accounts receivable and accounts payable, approximate fair values due to their short maturities.\n4. INVENTORIES\nInventories at December 31 consist of the following (in thousands):\n5. GAME SOFTWARE DEVELOPMENT COSTS\nInternal game software development costs are expensed as incurred as these costs relate primarily to development tools. External development costs are capitalized once technological feasibility has been determined. During 1995 and 1994, the Company capitalized $12.8 million and $5.8 million, respectively, of\nATARI CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\namounts paid to third parties, primarily as prepaid licenses, in connection with game development for the Jaguar. The Company amortizes such costs over the shorter of 12 months from game introduction or the estimated unit sales of the game title. The Company assesses the recoverability of capitalized games software development costs in light of many factors, including, but not limited to, anticipated future revenues, estimated economic useful lives and changes in software and hardware technologies. Amortization expense and adjustments for management's assessment of recoverability were $17.1 million (including a write-off of $16.6 million) and $1.5 million (including a write-off of $804,000) for the years ended December 31, 1995 and 1994, respectively.\n6. EQUIPMENT AND TOOLING\nEquipment and tooling at December 31 consists of the following (in thousands):\n7. REAL ESTATE HELD FOR SALE\nProperty held for sale at December 31, 1995 consists of nine properties in California and Texas, from the discontinued consumer electronics and home entertainment products operation. Certain of the properties have rental tenants, although all properties are available for sale. Rental income, net of rental expense and depreciation, is included in other income (expense) and was not material. Disposals in 1994 represented the Company's building in Germany and land and building in France, which were disposed of with no significant gain or loss.\n8. ACCRUED LIABILITIES\nAccrued liabilities at December 31 consist of the following (in thousands):\n9. LETTERS OF CREDIT AND RESTRICTED CASH\nAt December 31, 1995, cash balances of $700,000 were collateral for outstanding commercial letters of credit associated with inventory components and software development. At December 31, 1994, cash balances of $4.5 million were collateral for outstanding letters of credit.\nATARI CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n10. LONG-TERM DEBT OBLIGATIONS\nConvertible Subordinated Debentures -- The Company has $42.4 million of 5 1\/4% convertible subordinated debentures due April 29, 2002. The debentures may be redeemed at the Company's option, upon payment of a premium. The debentures, at the option of the holders, are convertible into common stock at $16.3125 per share. At December 31, 1995, 2,596,414 shares of common stock were reserved for issuance upon conversion. Default with respect to other indebtedness of Atari Corporation in an aggregate amount exceeding $5 million would result in an event of default whereby the outstanding debentures would be due and payable immediately.\nIn 1995, the Company reacquired in the open market and extinguished $1.1 million face value of these debentures for $500,000, resulting in an extraordinary credit of $582,000.\nTerm Loans on Real Estate in Europe -- At December 31, 1993, the Company had two secured term loans outstanding totaling $7.5 million for its building in Germany and a term loan of $2.0 million for its land and building in France. These loans were repaid or exchanged in 1994 from the sale or transfer of the properties.\n11. SETTLEMENTS OF PATENT LITIGATION\nDuring the first quarter of 1994, the Company received $2.2 million with respect to the settlement of litigation between the Company, Atari Games Corporation and Nintendo. Although not part of the litigation, the Company sold 1,500,000 shares of its common stock to Time Warner (parent company of Atari Games Corporation), Inc. for $12.8 million.\nDuring the fourth quarter of 1994, the Company completed a comprehensive agreement (\"Agreement\") with Sega Enterprises, Ltd. (\"Sega\") concerning resolution of disputes, equity investment and patent and product licensing agreements. The results of the Agreement were as follows: (i) Sega acquired 4,705,883 shares of the Company's common stock for $40.0 million; (ii) the Company received a payment of $29.8 million ($50.0 million from Sega, net of $20.2 million of legal fees and associated costs) in exchange for a license from Atari covering the use of a library of Atari patents issued between 1977 through 1984 (excluding patents which exclusively claim elements of the Company's Jaguar and Lynx products) through the year 2001; and (iii) the Company and Sega agreed to cross-license up to five software game titles each year through the year 2001.\n12. INCOME TAXES\nThe credit for income taxes consists of the following (in thousands):\nAt December 31, 1995, the Company has a U.S. income tax operating loss carryforward of $165 million which expires in 2006 through 2010, a research and development tax credit carryforward of $1.8 million which expires in 2002 through 2010, and a California income tax operating loss carryforward of $60 million which expires as follows: $16.4 million in 1997, $16.7 million in 1998, $1.6 million in 1999 and $21.8 million in 2000.\nATARI CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nThe effective income tax rates for 1995, 1994 and 1993 were 0%, 0%, and (1)%, respectively, and differ from the federal statutory rate of 35% as follows (in thousands):\nThe components of the net deferred tax asset at December 31 consist of (in thousands):\nDue to the uncertainty surrounding the timing and realization of the benefits of its favorable tax attributes in future years, the Company has established a valuation allowance to offset its net deferred tax assets.\nCurrent federal and state tax law includes certain provisions limiting the use of net operating loss carryforwards in the event of certain defined changes in stock ownership. The annual use of the Company's net operating loss carryforwards could be limited according to these provisions, and there can be no assurance that such limitations will not result in the loss of carryforward benefits during the carryforward period.\n13. STOCK OPTIONS\nThe Company's stock option plan and restricted stock plan provide for the issuance of up to 3,000,000 shares of common stock through the issuance of incentive stock options to employees and nonqualified stock options and restricted stock to employees, directors and consultants. Under the plans, stock options or restricted stock may be granted at not less than fair market value as determined by the Board of Directors. Stock options become exercisable as established by the Board (generally ratably over five years) and expire up to ten years from date of grant. The Company's right to repurchase restricted stock lapses over a maximum period of five years. At December 31, 1995, options for 551,925 shares were exercisable and options for 602,310 shares were available for future grant. At December 31, 1995, no restricted stock under the restricted stock plan had been issued.\nATARI CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nAdditional information with respect to the stock option plan is as follows:\n14. SEGMENT INFORMATION\nThe Company operates in one industry segment -- the design and sale of consumer electronic products.\nThe Company's foreign operations at December 31, 1995 consist of sales and distribution facilities in Europe. Transfers between geographic areas are accounted for at amounts generally above cost and in accordance with the rules and regulations of the respective governing tax authorities. Corporate assets are primarily cash and equivalents, marketable securities and real estate held for sale.\nThe following tables present a summary of operations by geographic region (in thousands):\nATARI CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNo single customer accounted for more than 10% of total revenues for the years ended December 31, 1995, 1994 or 1993.\n15. COMMITMENTS AND CONTINGENT LIABILITIES\nThe Company leases various facilities and equipment under noncancellable operating lease arrangements. These leases generally provide renewal options of five additional years. Minimum future lease payments under noncancellable operating leases as of December 31, 1995 are as follows (in thousands):\nRent expense for operating leases was $1,193,000, $1,218,000 and $1,251,000 for the years 1995, 1994 and 1993, respectively.\nCertain claims and suits arising in the ordinary course of business have been filed or are pending against the Company. The number of such claims has increased as the Company significantly downsized its development operations. In the opinion of management, all such matters have been adequately provided for, are without merit, or are such that if settled unfavorably would not have a material adverse effect on the Company's consolidated financial position and results of operations.\n16. SUBSEQUENT EVENT\nOn February 12, 1996, the Company entered into a merger agreement with JT Storage, Inc. (JTS) providing for the merger of the Company and JTS. On April 8, 1996, the merger agreement was amended and restated. JTS was incorporated on February 3, 1994 to develop, market and manufacture hard disk drives. The merger requires shareholder approval and is expected to be consummated in the second quarter of 1996. In connection with the merger, the Company extended a bridge loan to JTS in the amount of $25.0 million maturing on September 30, 1996 with a stated interest rate of 8 1\/2% per annum. If the merger is not consummated, the bridge loan is convertible at the option of Atari or JTS into shares of JTS Series A Preferred Stock and warrants to acquire JTS Series A Preferred Stock, subject to certain conditions.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe following table lists the names, ages and positions held by all directors and executive officers of Atari as of March 31, 1996.\nJACK TRAMIEL and a group of associates purchased the assets and liabilities of Atari from Warner Communications in May 1984 and Mr. Tramiel has served as Chairman of Atari's Board of Directors since such time. Mr. Tramiel served as Atari's Chief Executive Officer from May 1984 through May 1988.\nSAM TRAMIEL has served as President and as a member of the Board of Directors of Atari since June 1984, as Chief Executive Officer of Atari since May 1988 and as Chief Financial Officer of Atari since March 1996.\nLEONARD I. SCHREIBER has served as a member of the Board of Directors of Atari since May 1984. Mr. Schreiber was a partner of Schreiber & McBride, a private law firm, from 1980 to 1995.\nMICHAEL ROSENBERG has served as a member of the Board of Directors of Atari since May 1987. Mr. Rosenberg has served as Chief Executive Officer of Ross & Roberts, Inc., a plastics company, since September 1987. Mr. Rosenberg is a Certified Public Accountant.\nAUGUST J. LIGUORI has served as a member of the Board of Directors of Atari since 1992. Since March 1996, Mr. Liguori has served as Vice President, Finance of Marvel Entertainment Group, Inc. From October 1986 to February 1996, Mr. Liguori served in several positions with Atari, including Vice President and General Manager of Atari U.S. Corp., an Atari subsidiary, from October 1986 to October 1989, Vice President of Atari Corporation from October 1989 to October 1990, and Vice President, Finance, Treasurer and Chief Financial Officer from October 1990 to February 1996.\nLAURENCE M. SCOTT, JR. has served as Vice President, Manufacturing and Operations of Atari since 1992. Prior to joining Atari, Mr. Scott served as President of Radofin Electronics (FE) Ltd., a contract manufacturing firm, from 1978 to 1991.\nLEONARD TRAMIEL has served Vice President, Advanced Software Development of Atari since March 1991. Mr. Tramiel served as Vice President, Software Development of Atari from July 1984 to March 1991.\nAll directors hold office until the next annual meeting of stockholders and until their successors have been duly elected and qualified. Executive officers of Atari are appointed by and serve at the discretion of the Atari Board of Directors. Jack Tramiel is the father of Sam Tramiel and Leonard Tramiel.\nSECTION 16(A) REPORTING DELINQUENCIES\nBased solely on its review of copies of filings under Section 16(a) of the Securities Exchange Act of 1934, as amended, received by it, or written representations from certain reporting persons, the Company believes that during fiscal 1995 all Section 16 filing requirements were met.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nCOMPENSATION OF EXECUTIVE OFFICERS\nThe following table sets forth all compensation earned during the past three fiscal years by the Chief Executive Officer of the Company and the three current and former executive officers of the Company other than the Chief Executive Officer that were most highly compensated for services rendered to the Company during the last fiscal year (collectively, \"Executive Officers\"):\nSUMMARY COMPENSATION TABLE\n- --------------- (1) Represents payments for group term life insurance benefits.\n(2) Mr. Liguori left the Company effective March 1, 1996.\n(3) Mr. Hoff joined the Company in June 1995 and left the Company effective December 31, 1995.\nSTOCK OPTIONS\nThe following table sets forth information as to options to purchase Common Stock granted to each of the Executive Officers during 1995.\nOPTION GRANTS IN LAST FISCAL YEAR\n- --------------- (1) This option was granted to Mr. Hoff pursuant to the Company's 1986 Stock Option Plan, as amended. The exercise price of the option was equal to the fair market value of the Company's Common Stock on the date of grant. These options expired unexercisable when Mr. Hoff left the Company effective December 31, 1995.\nThe following table is a summary of the stock options exercised by each of the Executive Officers during fiscal 1995, and the number and value of stock options held by each of the Executive Officers as of December 31, 1995.\nAGGREGATE OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES\n- --------------- (1) The exercise price of each of the options was greater than the market value of the Common Stock at year end ($1.375 on December 29, 1995).\nCOMPENSATION OF DIRECTORS\nEach of the non-employee directors of Atari, Messrs. Jack Tramiel, Rosenberg and Schreiber, receives $500 for each meeting of the Atari Board of Directors which such individual attends. In 1995, each non-employee director also received an option to purchase 20,000 shares of the Company's Common Stock pursuant to the Company's 1986 Stock Option Plan, as amended. The exercise price of the options was $2.69 per share, which was equal to the fair market value of the Company's Common Stock on the date of grant. Each such option vests as to 20% of the shares on the anniversary of the date of grant such that the option shall be vested in full on the fifth anniversary of the grant date. Each such option expires six years after the date of grant, unless terminated earlier due to such director's resignation or removal from the Company's Board of Directors.\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\nThe Compensation Committee of the Board of Directors consists of Messrs. Jack Tramiel, Rosenberg and Schreiber, none of whom was an officer or employee of the Company during fiscal 1995. Mr. Tramiel\nserved as the Company's Chief Executive Officer from 1984 through 1988, and Mr. Schreiber served as a Vice President of the Company from 1984 through 1986. No member of the Compensation Committee or executive officer of the Company has a relationship that would constitute an interlocking relationship with executive officers or directors of another entity.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following table sets forth information, as of April 5, 1996, with respect to beneficial ownership of Atari Common Stock owned by (a) each person (or group of affiliated persons) known by Atari to be the beneficial owners of more than 5% of Atari's Common Stock, (b) each of Atari's directors, (c) each of Atari's Executive Officers and (d) all directors and executive officers as a group.\n- ---------------\n* Less than 1%\n(1) Based on 63,727,318 shares of Atari Common Stock outstanding as of April 5, 1996.\n(2) Includes 11,597,315 shares held by Jack Tramiel's wife. Also includes 155,690 shares held by Mr. Tramiel's wife as trustee of trusts for the benefit of Mr. Tramiel's minor grandchildren.\n(3) In connection with the proposed Merger with JTS, Messrs. Jack Tramiel, Sam Tramiel, Leonard Tramiel and Garry Tramiel have entered into Voting Agreements with JTS. The terms of such Voting Agreements provide (i) that such stockholders will not transfer (except as may be specifically required by court order), sell, exchange, pledge (except in connection with a bona fide loan transaction) or otherwise dispose of or encumber the shares of Atari Common Stock beneficially owned by them, or any new shares of such stock they may acquire, at any time prior to the effective time or earlier termination of the Merger, and (ii) that such stockholders will vote all shares of Atari Common Stock beneficially owned by them in favor of the approval of the Merger Agreement and the Merger. Such voting\nagreements are accompanied by irrevocable proxies whereby such stockholders provided to JTS the right to vote their shares on the proposals relating to the Merger Agreement and the Merger at the Atari Shareholders Meeting which will be called to vote on such matters.\n(4) Includes 7,100,000 shares held by Warner Communications Investors, Inc., 1,500,000 shares held by Warner Communications, Inc., and 70,000 shares held by Atari Games, a subsidiary of Time Warner, Inc.\n(5) Includes 352,062 shares held by Sam Tramiel as custodian on behalf of his children, 8,100 shares held by Mr. Tramiel's wife and an aggregate of 97,416 shares held by Mr. Tramiel's minor children. Also includes 225,000 shares subject to options which are vested or become vested within 60 days following March 31, 1996.\n(6) Includes 40,000 shares held by Leonard Tramiel's wife and 10,000 shares held by Mr. Tramiel's minor children.\n(7) Based on a Schedule 13 G filed with the Securities and Exchange Commission on February 7, 1996.\n(8) Includes 55,000 shares subject to options which are vested or become vested within 60 days following March 31, 1996.\n(9) Includes 165,000 shares subject to options which are vested or become vested within 60 days following March 31, 1996.\n(10) Includes 12,000 shares subject to options which are vested or become vested within 60 days following March 31, 1996.\n(11) Includes 12,000 shares subject to options which are vested or become vested within 60 days following March 31, 1996.\n(12) Represents shares subject to options which are vested or become vested within 60 days following March 31, 1996.\n(13) Includes 479,000 shares subject to options which are vested or become vested within 60 days following March 31, 1996.\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. Financial Statements\nThe financial statements required to be filed hereunder are listed in the accompanying Index to Consolidated Financial Statements and Financial Statement Schedule on page 12 hereof.\n2. Financial Statement Schedule\nThe financial statement schedule required to be filed hereunder are listed in the accompanying Index to Consolidated Financial Statements and Financial Statement Schedule on page 12 hereof.\n3. Exhibits\nThe exhibits listed under Item 14(c) are filed as part of this Annual Report on Form 10-K.\n(b) Reports on Form 8-K: None.\n(c) Exhibits\n- --------------- * Management contract or compensatory plan or arrangement required to be filed as an exhibit to this Form 10-K pursuant to Item 14(c) of this report.\n(1) Incorporated by reference to the Company's Form S-1 Registration Statement (File No. 33-12753) filed with the Commission on July 2, 1987.\n(2) Incorporated by reference to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989.\n(3) Incorporated by reference to the Company's Form 14D-1 and 13D Statement, filed with the Commission on August 28, 1987.\n(4) Incorporated by reference to the Company's Proxy Statement relating to its Annual Meeting of Shareholders held on May 16, 1989.\n(5) Incorporated by reference to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991.\n(6) Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the fiscal period ended March 31, 1994.\n(7) Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the fiscal period ended September 30, 1994.\nSCHEDULE II\nATARI CORPORATION\nVALUATION AND QUALIFYING ACCOUNTS (AMOUNTS IN THOUSANDS)\n- --------------- (1) Amounts written off, net\n(2) Customer returns allowed\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the 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 11th day of April 1996.\nATARI CORPORATION\nBy: \/s\/ SAM TRAMIEL\n------------------------------------ Sam Tramiel, President\nPOWER OF ATTORNEY\nKNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below hereby constitutes and appoints Jack Tramiel and Sam Tramiel, and each of them acting individually, as his attorney-in-fact, each with full power of substitution, for him in any and all capacities, to sign any and all 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 our signatures as they may be signed by our said attorney to any and all amendments to said Report.\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 and on the dates indicated.","section_15":""}
{"filename":"799064_1995.txt","cik":"799064","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL DESCRIPTION OF PARTNERSHIP\nSwift Energy Income Partners 1986-A, Ltd., a Texas limited partnership (the \"Partnership\" or the \"Registrant\"), is a partnership formed under a public serial limited partnership offering denominated Swift Energy Income Partners II (Registration Statement No. 33-1875 on Form S-1, originally declared effective January 14, 1986, and amended effective October 8, 1986 [the \"Registration Statement\"]). The Partnership was formed effective May 13, 1986 under a Limited Partnership Agreement dated May 6, 1986. The initial 689 limited partners made capital contributions of $3,775,536.\nThe Partnership is principally engaged in the business of acquiring, developing and, when appropriate, disposing of working interests in proven oil and gas properties within the continental United States. The Partnership does not engage in exploratory drilling. Each working interest held by the Partnership entitles the Partnership to receive, in kind or in value, a share of the production of oil and gas from the producing property, and obligates the Partnership to participate in the operation of the property and to bear its proportionate share of all operating costs associated therewith. The Partnership typically holds less than the entire working interest in its producing properties.\nAt December 31, 1995, the Partnership had expended or committed to expend 100% of the limited partners' net commitments (I.E., limited partners' commitments available to the Partnership for property acquisitions after payment of organization fees and expenses) in the acquisition and development of producing properties, which properties are described under Item 2, \"Properties,\" below. The Partnership's revenues and profits are derived almost entirely from the sale of oil and gas produced from its properties and from the sale of acquired oil and gas properties, when the sale of such properties is economically preferable to continued operation.\nThe Partnership's business and affairs are conducted by its Managing General Partner, Swift Energy Company, a Texas corporation (\"Swift\"). The Partnership's Special General Partner, VJM Corporation, a California corporation (\"VJM\"), consults with and advises Swift as to certain financial matters. Swift is the designated operator of many of the properties in which the Partnership owns interests. The remaining properties are operated by industry operators designated by the owners of a majority of the working interest in each property.\nThe general manner in which the Partnership acquires producing properties and otherwise conducts its business is described in detail in the Registration Statement under \"Proposed Activities,\" which is incorporated herein by reference.\nCOMPETITION, MARKETS AND REGULATIONS\nCOMPETITION\nThe oil and gas industry is highly competitive in all its phases. The Partnership encounters strong competition from many other oil and gas producers, many of which possess substantial financial resources, in acquiring economically desirable Producing Properties.\nMARKETS\nThe amounts of and price obtainable for oil and gas production from Partnership Properties will be affected by market factors beyond the control of the Partnership. Such factors include the extent of domestic production, the level of imports of foreign oil and gas, the general level of market demand on a regional, national and worldwide basis, domestic and foreign economic conditions that determine levels of industrial production, political events in foreign oil-producing regions, and variations in governmental regulations and tax laws and the imposition of new governmental requirements upon the oil and gas industry. There can be no assurance that oil and gas prices will not decrease in the future, thereby decreasing net Revenues from Partnership Properties.\nFrom time to time, there may exist a surplus of natural gas or oil supplies, the effect of which may be to reduce the amount of hydrocarbons that the Partnerships may produce and sell while such oversupply exists. In recent years, initial steps have been taken to provide additional gas transportation lines from Canada to the United States. If additional Canadian gas is brought to the United States market, it could create downward pressure on United States gas prices.\nI-1\nSWIFT ENERGY INCOME PARTNERS 1986-A, LTD.\nREGULATIONS\nENVIRONMENTAL REGULATION\nThe federal government and various state and local governments have adopted laws and regulations regarding the control of contamination of the environment. These laws and regulations may require the acquisition of a permit by Operators before drilling commences, prohibit drilling activities on certain lands lying within wilderness areas or where pollution arises and impose substantial liabilities for pollution resulting from operations, particularly operations near or in onshore and offshore waters or on submerged lands. These laws and regulations may also increase the costs of routine drilling and operation of wells. Because these laws and regulations change frequently, the costs to the Partnership of compliance with existing and future environmental regulations cannot be predicted. However, the Managing Partner does not believe that the Partnership is affected in a significantly different manner by these regulations than are its competitors in the oil and gas industry.\nFEDERAL REGULATION OF NATURAL GAS\nThe transportation and sale of natural gas in interstate commerce is heavily regulated by agencies of the federal government. The following discussion is intended only as a summary of the principal statutes, regulations and orders that may affect the production and sale of natural gas from Partnership Properties. This summary should not be relied upon as a complete review of applicable natural gas regulatory provisions.\nPRICE CONTROLS - Prior to January 1, 1993, the sale of natural gas production was subject to regulation under the Natural Gas Act and the Natural Gas Policy Act of 1978 (\"NGPA\"). Under the Natural Gas Wellhead Decontrol Act of 1989, however, all price regulation under the NGPA and Natural Gas Act rate, certificate and abandonment requirements were phased out effective as of January 1, 1993.\nFERC ORDERS\nSeveral major regulatory changes have been implemented by the Federal Energy Regulatory Commission (\"FERC\") from 1985 to the present that affect the economics of natural gas production, transportation and sales. In addition, the FERC continues to promulgate revisions to various aspects of the rules and regulations affecting those segments of the natural gas industry that remain subject to the FERC's jurisdiction. In April 1992, the FERC issued Order No. 636 pertaining to pipeline restructuring. This rule requires interstate pipelines to unbundle transportation and sales services by separately stating the price of each service and by providing customers only the particular service desired, without regard to the source for purchase of the gas. The rule also requires pipelines to (i) provide nondiscriminatory \"no-notice\" service allowing firm commitment shippers to receive delivery of gas on demand up to certain limits without penalties, (ii) establish a basis for release and reallocation of firm upstream pipeline capacity, and (iii) provide non-discriminatory access to capacity by firm transportation shippers on a downstream pipeline. The rule requires interstate pipelines to use a straight fixed variable rate design. The rule imposes these same requirements upon storage facilities.\nFERC Order No. 500 affects the transportation and marketability of natural gas. Traditionally, natural gas had been sold by producers to pipeline companies, which then resold the gas to end-users. FERC Order No. 500 altered this market structure by requiring interstate pipelines that transport gas for others to provide transportation service to producers, distributors and all other shippers of natural gas on a nondiscriminatory, \"first-come, first-served\" basis (open access transportation\"), so that producers and other shippers can sell natural gas directly to end-users. FERC Order No. 500 contains additional provisions intended to promote greater competition in natural gas markets.\nIt is not anticipated that the marketability of and price obtainable for natural gas production from Partnership Properties will be significantly affected by FERC Order No. 500. Gas produced from Partnership Properties normally will be sold to intermediaries who have entered into transportation arrangements with pipeline companies. These intermediaries will accumulate gas purchased from a number of producers and sell the gas to end-users through open access pipeline transportation.\nI-2\nSWIFT ENERGY INCOME PARTNERS 1986-A, LTD.\nSTATE REGULATIONS\nProduction of any oil and gas from Partnership Properties will be affected to some degree by state regulations. Many states in which the Partnership will operate have statutory provisions regulating the production and sale of oil and gas, including provisions regarding deliverability. Such statutes, and the regulations promulgated in connection therewith, are generally intended to prevent waste of oil and gas and to protect correlative rights to produce oil and gas between owners of a common reservoir. Certain state regulatory authorities also regulate the amount of oil and gas produced by assigning allowable rates of production to each well or proration unit.\nFEDERAL LEASES\nSome of the Partnership's properties are located on federal oil and gas leases administered by various federal agencies, including the Bureau of Land Management. Various regulations and orders affect the terms of leases, exploration and development plans, methods of operation and related matters.\nEMPLOYEES\nThe Partnership has no employees. Swift, however, has a staff of geologists, geophysicists, petroleum engineers, landmen, and accounting personnel who administer the operations of Swift and the Partnership. As of December 31, 1995, Swift had 176 employees. Swift's administrative and overhead expenses attributable to the Partnership's operations are borne by the Partnership.\nI-3\nSWIFT ENERGY INCOME PARTNERS 1986-A, LTD.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nAs of December 31, 1995, the Partnership has acquired interests in producing oil and gas properties which are generally described below.\nPRINCIPAL OIL AND GAS PRODUCING PROPERTIES\nThe most valuable fields in the Partnership, based upon year-end engineering estimates of discounted future net revenues using constant pricing and costs, are described below.\n1. The Valentine Field is in La Fourche Parish, Louisiana (JPM and Valentine acquisition). One well produces from the SC-3-A formation, accounting for 52% of the value.\n2. The East Bridges Field is in Shelby County, Texas (Jones O'Brien, acquisition). Swift operates two wells which produce from the Mooringsport and James Lime formations. These wells account for 26% of the value.\nThe remaining value in the Partnership is attributable to numerous properties none of which equals or exceeds 15 percent of the total Partnership value.\nTITLE TO PROPERTIES\nTitle to substantially all significant producing properties of the Partnership has been examined. The properties are subject to royalty, overriding royalty and other interests customary in the industry. The Managing General Partner does not believe any of these burdens materially detract from the value of the properties or will materially detract from the value of the properties or materially interfere with their use in the operation of the business of the Partnership.\nPRODUCTION AND SALES PRICE\nThe following table summarizes the sales volumes of the Partnership's net oil and gas production expressed in equivalent barrels of oil. Equivalent barrels are obtained by converting gas to oil on the basis of their relative energy content; one barrel equals 6,000 cubic feet of gas.\nI-4\nSWIFT ENERGY INCOME PARTNERS 1986-A, LTD.\nNET PROVED OIL AND GAS RESERVES\nPresented below are the estimates of the Partnership's proved reserves as of December 31, 1995, 1994 and 1993. All of the Partnership's proved reserves are located in the United States.\nRevisions of previous quantity estimates are related to upward or downward variations based on current engineering information for production rates, volumetrics and reservoir pressure. Additionally, changes in quantity estimates are the result of the increase or decrease in crude oil and natural gas prices at each year end which have the effect of adding or reducing proved reserves on marginal properties due to economic limitations.\nI-5\nSWIFT ENERGY INCOME PARTNERS 1986-A, LTD.\nThe following table summarizes by acquisition the Registrant's reserves and gross and net interests in producing oil and gas wells as of December 31, 1995:\nThere are numerous uncertainties inherent in estimating quantities of proved reserves and in projecting the future rates of production, timing and plan of development. Oil and gas reserve engineering must be recognized as a subjective process of estimating underground accumulations of oil and gas that cannot be measured in an exact way, and estimates of other engineers might differ from those above, audited by H. J. Gruy and Associates, Inc., an independent petroleum consulting firm. The accuracy of any reserve estimate is a function of the quality of available data and of engineering and geological interpretation and judgment. Results of drilling, testing and production subsequent to the date of the estimate may justify revision of such estimate, and, as a general rule, reserve estimates based upon volumetric analysis are inherently less reliable than those based on lengthy production history. Accordingly, reserve estimates are often different from the quantities of oil and gas that are ultimately recovered.\nIn estimating the oil and natural gas reserves, the Registrant, in accordance with criteria prescribed by the Securities and Exchange Commission, has used prices received as of December 31, 1995 without escalation, except in those instances where fixed and determinable gas price escalations are covered by contracts, limited to the price the Partnership reasonably expects to receive. The Registrant does not believe that any favorable or adverse event causing a significant change in the estimated quantity of proved reserves has occurred between December 31, 1995 and the date of this report.\nFuture prices received for the sale of the Partnership's products may be higher or lower than the prices used in the evaluation described above; the operating costs relating to such production may also increase or decrease from existing levels. The estimates presented above are in accordance with rules adopted by the Securities and Exchange Commission.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Partnership is not aware of any material pending legal proceedings to which it 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\nNo matters were submitted to a vote of limited partners during the fourth quarter of the fiscal year covered by this report.\nI-6\nSWIFT ENERGY INCOME PARTNERS 1986-A, LTD.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET PRICE OF AND DISTRIBUTIONS ON THE REGISTRANT'S UNITS AND RELATED LIMITED PARTNER MATTERS\nMARKET INFORMATION\nUnits in the Partnership were initially sold at a price of $1,000 per Unit. Units are not traded on any exchange and there is no established public trading market for the Units. Swift is aware of negotiated transfers of Units between unrelated parties; however, these transfers have been limited and sporadic. Due to the nature of these transactions, Swift has no verifiable information regarding prices at which Units have been transferred.\nHOLDERS\nAs of December 31, 1995, there were 689 Limited Partners holding Units in the Partnership.\nDISTRIBUTIONS\nThe Partnership generally makes distributions to Limited Partners on a quarterly basis, subject to the restrictions set forth in the Limited Partnership Agreement. In the fiscal years ending December 31, 1994 and 1995, the Partnership distributed a total of $47,200 and $7,600, respectively, to holders of its Units. Cash distributions constitute net proceeds from sale of oil and gas production after payment of lease operating expenses and other partnership expenses. Some or all of such amounts or any proceeds from the sale of partnership properties could be deemed to constitute a return of investors' capital.\nOil and gas investments involve a high risk of loss, and no assurance can be given that any particular level of distributions to holders of Units can be achieved or maintained. Although it is anticipated that quarterly distributions will continue to be made through 1996, the Partnership's ability to make distributions could be diminished by any event adversely affecting the oil and gas properties in which the Partnership owns interests or the amount of revenues received by the Partnership therefrom.\nThe Partnership's Limited Partnership Agreement contains various provisions which might serve to delay, defer or prevent a change in control of the Partnership, such as the requirement of a vote of Limited Partners in order to sell all or substantially all of the Partnership's properties or the requirement of consent by the Managing General Partner to transfers of limited partnership interests.\nII-1\nSWIFT ENERGY INCOME PARTNERS 1986-A, LTD.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following selected financial data, prepared in accordance with generally accepted accounting principles as of December 31, 1994, 1993, 1992, 1991 and 1990, should be read in conjunction with the financial statements included in Item 8.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nLIQUIDITY AND CAPITAL RESOURCES\nThe Partnership has expended all of the partners' net commitments available for property acquisitions (\"net commitments\") and development by acquiring producing oil and gas properties. The partnership invests primarily in proved producing properties with nominal levels of future costs of development for proven but undeveloped reserves. Significant purchases of additional reserves or extensive drilling activity are not anticipated. Oil and gas reserves are depleting assets and therefore often experience significant production declines each year from the date of acquisition through the end of the life of the property. The primary source of liquidity to the Partnership comes almost entirely from the income generated from the sale of oil and gas produced from ownership interests in oil and gas properties. This source of liquidity and the related results of operations will decline in future periods as the oil and gas produced from these properties also declines.\nThe MGP anticipates that the Partnership will have adequate liquidity from income from continuing operations to satisfy any future capital expenditure requirements. Funds generated from bank borrowings and proceeds from the sale of oil and gas properties will be used to supplement this effort if deemed necessary.\nRESULTS OF OPERATIONS\nOil and gas sales decreased 26 percent in 1994 vs. 1993. Production volumes decreased 24 percent due to a 14 percent gas production decrease and a 60 percent oil production decline. Since the partnership's reserves are 82 percent gas, the decrease in gas production, due to an accelerated production decline on the Gautreaux #1 well, which was recompleted in 1993, and production curtailments due to declining prices, had a major impact on partnership performance. The Partnership experienced a decline in oil prices of 12 percent or $1.93\/BBL, which further contributed to the decreased revenues. The average sales price per equivalent BBL decreased 3 percent in 1994.\nOil and gas sales increased 98 percent in 1993 vs. 1992. Production volumes increased 83 percent due to an 83 percent gas production increase and an 80 percent oil production increase. The successful recompletion of the Gautreaux #1 well in the third quarter of 1993 greatly increased 1993 production volumes. An increase of 9 percent in the average sales price per equivalent Bbl further increased revenues. 1993 gas prices increased 22 percent or $.38\/MCF compared to 1992.\nProduction cost per equivalent Bbl decreased 45 percent in 1994 compared to 1993 and total production costs decreased 58 percent in 1994. Production cost per equivalent Bbl decreased 56 percent in 1993 compared to 1992 and total production costs decreased 20 percent in 1993.\nAssociated depreciation expense decreased 21 percent in 1994 when compared to 1993 and increased 202 percent in 1993 when compared to 1992.\nII-2\nSWIFT ENERGY INCOME PARTNERS 1986-A, LTD.\nThe Partnership recorded an additional provision in depreciation, depletion and amortization in 1994 and 1993 when the present value, discounted at ten percent, of estimated future net revenues from oil and gas properties, using the guidelines of the Securities and Exchange Commission, was below the fair market value paid for oil and gas properties resulting in a full cost ceiling impairment.\nDuring 1995, Partnership revenues and costs will be shared between the limited and general partners in a 90:10 ratio, based on the annualized rate of cash distributions by the Partnership during a certain period prior to December 31, 1994. Based on current oil and gas prices, current levels of oil and gas production and expected cash distributions during 1995, the MGP anticipates that the Partnership sharing ratio will continue to be 90:10.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nSee Part IV, Item 14(a) for index to financial statements.\nITEM 9.","section_9":"ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nII-3\nSWIFT ENERGY INCOME PARTNERS 1986-A, LTD.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nAs a limited partnership, the Registrant has no directors or executive officers. The business and affairs of the Registrant are managed by Swift as Managing General Partner. Set forth below is certain information as of March 15, 1995 regarding the directors and executive officers of Swift.\nPOSITION(S) WITH NAME AGE SWIFT AND OTHER COMPANIES ---- --- ------------------------- DIRECTORS --------- A. Earl Swift 61 President, Chief Executive Officer and Chairman of the Board\nVirgil N. Swift 66 Executive Vice President - Business Development, Vice Chairman of the Board\nG. Robert Evans 63 Director of Swift; Chairman of the Board, Material Sciences Corporation; Director, Consolidated Freightways, Inc., Fibreboard Corporation, Elco Industries, and Old Second Bancorp\nRaymond O. Loen 70 Director of Swift; President, R. O. Loen Company\nHenry C. Montgomery 59 Director of Swift; Chairman of the Board, Montgomery Financial Services Corporation; Director, Southwall Technology Corporation\nClyde W. Smith, Jr. 46 Director of Swift; President, Somerset Properties, Inc.\nHarold J. Withrow 67 Director of Swift\nEXECUTIVE OFFICERS ------------------\nTerry E. Swift 39 Executive Vice President, Chief Operating Officer\nJohn R. Alden 49 Senior Vice President - Finance, Chief Financial Officer and Secretary\nBruce H. Vincent 47 Senior Vice President - Funds Management\nJames M. Kitterman 50 Senior Vice President - Operations\nAlton D. Heckaman, Jr. 37 Vice President - Finance and Controller\nIII-1\nSWIFT ENERGY INCOME PARTNERS 1986-A, LTD.\nFrom time to time, Swift as Managing General Partner of the Partnership purchases Units in the Partnership from investors who offer the Units pursuant to their right of presentment, which purchases are made pursuant to terms set out in the Partnership's original Limited Partnership Agreement. Due to the frequency and large number of these transactions, Swift reports these transactions under Section 16 of the Securities Exchange Act of 1934 on an annual rather than a monthly basis. In some cases such annual reporting may constitute a late filing of the required Section 16 reports under the applicable Section 16 rules.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nAs noted in Item 10, \"Directors and Executive Officers of the Registrant,\" above, the Partnership has no executive officers. The executive officers of Swift and VJM are not compensated by the Partnership.\nCertain fees and allowances contemplated by the Limited Partnership Agreement have been paid by the Partnership to Swift and VJM. See Note (4) in Notes To Financial Statements (Related-Party Transactions) for further discussion.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nSwift Energy Company, the Managing General Partner, located at 16825 Northchase Drive, Suite 400, Houston, Texas 77060, owns 682 Limited Partnership Units, which is 18.05 percent of all outstanding Limited Partnership Units. All Limited Partnership Units owned by Swift were acquired from investors who offered the Limited Partnership Units pursuant to their right of presentment. As the Managing General Partner, Swift is not permitted generally, under the Limited Partnership Agreement, to vote its Limited Partnership Units. Swift also owns a general partnership interest of 9 percent of all partnership interests in the Partnership.\nSwift and VJM are not aware of any arrangement, the operation of which may at a subsequent date result in a change in control of the Partnership.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nAs noted in Item 10, \"Directors and Executive Officers of the Registrant,\" above, the Partnership has no executive officers or directors, and thus has not engaged in any transactions in which any such person had an interest. The Partnership is permitted to engage in certain transactions with Swift as Managing General Partner and VJM as Special General Partner, subject to extensive guidelines and restrictions described in the \"Conflicts of Interest\" section of the Amended Prospectus contained in the Registration Statement, which is incorporated herein by reference.\nSummarized below are the principal transactions that have occurred between the Partnership and Swift, VJM and their affiliates.\n1. The oil and gas properties acquired by the Partnership, as described in Item 2, \"Properties\" above, were typically acquired initially by Swift from the seller thereof and subsequently transferred to the Partnership. Such transfers were made by Swift at its Property Acquisition Costs (as defined in the Limited Partnership Agreement), less any amounts received from sale of production between the time of acquisition by Swift and the time of sale to the Partnership.\n2. Swift acts as operator for many of the wells in which the Partnership has acquired interests and has received compensation for such activities in accordance with standard industry operating agreements.\n3. The Partnership paid to Swift and VJM certain fees as contemplated by the Limited Partnership Agreement. See Note (4) in Notes To Financial Statements (Related-Party Transactions) for further discussion.\nIII-2\nSWIFT ENERGY INCOME PARTNERS 1986-A, LTD.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\na(1) FINANCIAL STATEMENTS PAGE NO. -------------------- --------\nReport of Independent Public Accountants IV-2\nBalance Sheets as of December 31, 1994 and 1993 IV-3\nStatements of Operations for the years ended December 31, 1994, 1993 and 1992 IV-4\nStatements of Partners' Capital for the years ended December 31, 1994, 1993 and 1992 IV-5\nStatements of Cash Flows for the years ended December 31, 1994, 1993 and 1992 IV-6\nNotes to Financial Statements IV-7\na(2) FINANCIAL STATEMENT SCHEDULES -----------------------------\nAll schedules required by the SEC are either inapplicable or the required information is included in the Financial Statements, the Notes thereto, or in other information included elsewhere in this report.\na(3) EXHIBITS --------\n3.1 Certificate of Limited Partnership of Swift Energy Income Partners 1986-A, Ltd. (including Limited Partnership Agreement of Swift Energy Income Partners 1986-A, Ltd. dated May 6, 1986), as filed May 13, 1986, with the Texas Secretary of State (excluding list of limited partners filed as part of Certificate). (Form 10-K for year ended December 31, 1988, Exhibit 3.1).\n99.1 A copy of the following sections of the Prospectus dated January 14, 1986, contained in Pre-Effective Amendment No. 1 to Registration Statement No. 33-1875 on Form S-1 for Swift Energy Income Partners II as filed on January 14, 1986, which have been incorporated herein by reference: \"Proposed Activities\" (pp. 27-32) and \"Conflicts of Interest\" (pp. 44-48). (Form 10-K for year ended December 31, 1989, Exhibit 28.1).\nb(1) REPORTS ON FORM 8-K -------------------\nNo reports on Form 8-K have been filed during the quarter ended December 31, 1994.\nSUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT TO SECTION 15(d) OF THE ACT BY REGISTRANTS WHICH HAVE NOT REGISTERED SECURITIES PURSUANT TO SECTION 12 OF THE ACT.\nNo annual report to security holders covering the Partnership's 1994 fiscal year, or proxy statement, form of proxy or other proxy soliciting material has been sent to Limited Partners of the Partnership.\nIV-1\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo Swift Energy Income Partners 1986-A, Ltd.:\nWe have audited the accompanying balance sheets of Swift Energy Income Partners 1986-A, Ltd., (a Texas limited partnership) as of December 31, 1994 and 1993, and the related statements of operations, partners' capital and cash flows for the years ended December 31, 1994, 1993 and 1992. 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 Swift Energy Income Partners 1986-A, Ltd., as of December 31, 1994 and 1993, and the results of its operations and its cash flows for the years ended December 31, 1994, 1993 and 1992, in conformity with generally accepted accounting principles.\n\/s\/ ARTHUR ANDERSEN LLP ------------------------- Arthur Andersen LLP\nHouston, Texas February 17, 1995\nIV-2\nSWIFT ENERGY INCOME PARTNERS 1986-A, LTD. BALANCE SHEETS DECEMBER 31, 1994 AND 1993\nSEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.\nIV-3\nSWIFT ENERGY INCOME PARTNERS 1986-A, LTD. STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\nSEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.\nIV-4\nSWIFT ENERGY INCOME PARTNERS 1986-A, LTD. STATEMENTS OF PARTNERS' CAPITAL FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\nSEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.\nIV-5\nSWIFT ENERGY INCOME PARTNERS 1986-A, LTD. STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\nSEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.\nIV-6\nSWIFT ENERGY INCOME PARTNERS 1986-A, LTD. NOTES TO FINANCIAL STATEMENTS\n(1) ORGANIZATION AND TERMS OF PARTNERSHIP AGREEMENT -\nSwift Energy Income Partners 1986-A, Ltd., a Texas limited partnership (the Partnership), was formed on May 13, 1986, for the purpose of purchasing and operating producing oil and gas properties within the continental United States. Swift Energy Company (\"Swift\"), a Texas corporation, and VJM Corporation (\"VJM\"), a California corporation, serve as Managing General Partner and Special General Partner of the Partnership, respectively. The general partners are required to contribute up to 1\/99th of limited partner net contributions. The 689 limited partners made total capital contributions of $3,775,536.\nProperty acquisition costs and the management fee are borne 99 percent by the limited partners and one percent by the general partners. Organization and syndication costs were borne solely by the limited partners.\nInitially, all continuing costs (including development costs, operating costs, general and administrative reimbursements and direct expenses) and revenues are allocated 85 percent to the limited partners and 15 percent to the general partners. After a certain period of partnership operations, but prior to partnership payout, as defined, one-third of these costs and revenues otherwise allocable to the general partners will be reallocated to the limited partners if the cash distribution rate (as defined in the Partnership Agreement) is less than 17.5 percent. Through December 31, 1987, the Partnership's continuing costs and revenues were allocated 85 percent to the limited partners and 15 percent to the general partners. Thereafter one-third of the general partners share was reallocated to the limited partners as the cash distribution rate fell below 17.5 percent. Payout had not occurred as of December 31, 1994.\n(2) SIGNIFICANT ACCOUNTING POLICIES -\nOIL AND GAS PROPERTIES -\nFor financial reporting purposes, the Partnership follows the \"full-cost\" method of accounting for oil and gas property costs. Under this method of accounting, all productive and nonproductive costs incurred in the acquisition and development of oil and gas reserves are capitalized. Such costs include lease acquisitions, geological and geophysical services, drilling, completion, equipment and certain general and administrative costs directly associated with acquisition and development activities. General and administrative costs related to production and general overhead are expensed as incurred. No general and administrative costs were capitalized during the years ended December 31, 1994, 1993 and 1992.\nFuture development, site restoration, dismantlement and abandonment costs, net of salvage values, are estimated on a property-by-property basis based on current economic conditions and are amortized to expense as the Partnership's capitalized oil and gas property costs are amortized.\nThe unamortized cost of oil and gas properties is limited to the \"ceiling limitation\", (calculated separately for the Partnership, limited partners, and general partners). The \"ceiling limitation\" is calculated on a quarterly basis and represents the estimated future net revenues from proved properties using current prices, discounted at ten percent, and the lower of cost or fair value of unproved properties. Proceeds from the sale or disposition of oil and gas properties are treated as a reduction of oil and gas property costs with no gains or losses being recognized except in significant transactions.\nThe Partnership computes the provision for depreciation, depletion and amortization of oil and gas properties on the units-of-production method. Under this method, the provision is calculated by multiplying the total unamortized cost of oil and gas properties, including future development, site restoration, dismantlement and abandonment costs, by an overall amortization rate that is determined by dividing the physical units of oil and gas produced during the period by the total estimated units of proved oil and gas reserves at the beginning of the period.\nIV-7\nSWIFT ENERGY INCOME PARTNERS 1986-A, LTD. NOTES TO FINANCIAL STATEMENTS (CONTINUED)\nSTATEMENTS OF CASH FLOWS -\nHighly liquid debt instruments with an initial maturity of three months or less are considered to be cash equivalents.\n(3) OIL AND GAS CAPITALIZED COSTS -\nThe following table sets forth capital expenditures related to the Partnership's oil and gas operations:\nAll oil and gas property acquisitions are made by Swift on behalf of the Partnership. The costs of the properties include the purchase price plus any costs incurred by Swift in the evaluation and acquisition of properties.\nDuring 1994, 1993 and 1992, the Partnership's unamortized oil and gas property costs exceeded the quarterly calculations of the \"ceiling limitation\" resulting in additional provisions for depreciation, depletion and amortization of $330,552, $66,595 and $177,464, respectively. In computing the Partnership's third quarter 1994 ceiling limitation, the Partnership utilized the product prices in effect at the date of the filing of the Partnership's report on Form 10-Q. Utilizing these subsequent prices, the write down recorded by the Partnership was $46,740 less than the amount that would have been recorded using product prices in effect at September 30, 1994.\nIn addition, the limited partners' share of unamortized oil and gas property costs exceeded their \"ceiling limitation\" in 1994, 1993 and 1992, resulting in valuation allowances of $297,277, $56,732 and $164,804, respectively. These amounts are included in the income (loss) attributable to the limited partners shown in the statements of partners' capital together with \"combining adjustments\" for the differences between the limited partners' valuation allowances and the Partnership's valuation allowances. The \"combining adjustments\" change quarterly as the Partnership's total depreciation, depletion and amortization provision is more or less than the combined depreciation, depletion and amortization provision attributable to general and limited partners.\n(4) RELATED-PARTY TRANSACTIONS -\nAn affiliate of the Special General Partner, as Dealer Manager, received $94,388 for managing and overseeing the offering of limited partnership units.\nA one-time management fee of $94,388 was paid to Swift in 1986 for services performed for the Partnership. In 1994, 1993 and 1992, Swift absorbed all the general and administrative overhead attributable to the Partnership.\nIV-8\nSWIFT ENERGY INCOME PARTNERS 1986-A, LTD. NOTES TO FINANCIAL STATEMENTS (CONTINUED)\n(5) FEDERAL INCOME TAXES -\nThe Partnership is not a tax-paying entity. No provision is made in the accounts of the Partnership for federal or state income taxes, since such taxes are liabilities of the individual partners, and the amounts thereof depend upon their respective tax situations.\nThe tax returns and the amount of distributable Partnership income are subject to examination by the federal and state taxing authorities. If the Partnership's ordinary income for federal income tax purposes is ultimately changed by the taxing authorities, the tax liability of the limited partners could be changed accordingly. Ordinary income\/(loss) reported on the Partnership's federal return of income for the years ended December 31, 1994, 1993 and 1992 was $146,220, $178,940, and $(34,685), respectively. The difference between ordinary income\/(loss) for federal income tax purposes reported by the Partnership and net income or loss reported herein primarily results from the exclusion of depletion (as described below) from ordinary income reported in the Partnership's federal return of income.\nFor federal income tax purposes, depletion with respect to production of oil and gas is computed separately by the partners and not by the Partnership. Since the amount of depletion on the production of oil and gas is not computed at the Partnership level, depletion is not included in the Partnership's income for federal income tax purposes but is charged directly to the partners' capital accounts to the extent of the cost of the leasehold interests, and thus is treated as a separate item on the partners' Schedule K-1. Depletion for federal income tax purposes may vary from that computed for financial reporting purposes in cases where a ceiling adjustment is recorded, as such amount is not recognized for tax purposes.\n(6) DEFERRED REVENUES -\nDeferred Revenues represent a gas imbalance liability assumed as part of property acquisitions. The imbalance is accounted for on the entitlements method, whereby the Partnership records its share of revenue, based on its entitled amount. Any amounts over or under the entitled amount are recorded as an increase or decrease to deferred revenues.\n(7) CONCENTRATIONS OF CREDIT RISK -\nThe Partnership extends credit to various companies in the oil and gas industry which results in a concentration of credit risk. This concentration of credit risk may be affected by changes in economic or other conditions and may accordingly impact the Partnership's overall credit risk. However, the Managing General Partner believes that the risk is mitigated by the size, reputation, and nature of the companies to which the Partnership extends credit. In addition, the Partnership generally does not require collateral or other security to support customer receivables.\nIV-9\nSWIFT ENERGY INCOME PARTNERS 1986-A, LTD.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.\nSWIFT ENERGY INCOME PARTNERS 1986-A, LTD. (Registrant)\nBy: SWIFT ENERGY COMPANY General Partner\nDate: March 15, 1995 By: s\/b A. Earl Swift ----------------------- -------------------------------- A. Earl Swift President\nDate: March 15, 1995 By: s\/b John R. Alden ----------------------- -------------------------------- John R. Alden Principal Financial Officer\nDate: March 15, 1995 By: s\/b Alton D. Heckaman, Jr. ----------------------- -------------------------------- Alton D. Heckaman, Jr. 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.\nSWIFT ENERGY INCOME PARTNERS 1986-A, LTD. (Registrant)\nBy: SWIFT ENERGY COMPANY General Partner\nDate: March 15, 1995 By: s\/b A. Earl Swift ----------------------- -------------------------------- A. Earl Swift Director and Principal Executive Officer\nDate: March 15, 1995 By: s\/b Virgil N. Swift ----------------------- -------------------------------- Virgil N. Swift Director and Executive Vice President - Business Development\nIV-10\nSWIFT ENERGY INCOME PARTNERS 1986-A, LTD.\nDate: March 15, 1995 By: s\/b G. Robert Evans ----------------------- -------------------------------- G. Robert Evans Director\nDate: March 15, 1995 By: s\/b Raymond O. Loen ----------------------- -------------------------------- Raymond O. Loen Director\nDate: March 15, 1995 By: s\/b Henry C. Montgomery ----------------------- -------------------------------- Henry C. Montgomery Director\nDate: March 15, 1995 By: s\/b Clyde W. Smith, Jr. ----------------------- -------------------------------- Clyde W. Smith, Jr. Director\nDate: March 15, 1995 By: s\/b Harold J. Withrow ----------------------- -------------------------------- Harold J. Withrow Director\nIV-11\nFORM 10-Q\nSECURITIES AND EXCHANGE COMMISSION\nWASHINGTON, D.C. 20549\n[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934\nFOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1995\nOR\n[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934\nFOR THE TRANSITION PERIOD FROM _________ TO _________\nCOMMISSION FILE NUMBER 33-1875-01\nSWIFT ENERGY INCOME PARTNERS 1986-A, LTD. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)\nTEXAS 76-0185864 (STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER OF ORGANIZATION) IDENTIFICATION NO.)\n16825 NORTHCHASE DRIVE, SUITE 400 HOUSTON, TEXAS 77060 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)\n(713)874-2700 (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)\nNONE (FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR, IF CHANGED SINCE LAST REPORT)\nIndicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.\nYes X No --- ---\nSWIFT ENERGY INCOME PARTNERS 1986-A, LTD.\nINDEX\nPART I. FINANCIAL INFORMATION PAGE ---- ITEM 1. FINANCIAL STATEMENTS\nBalance Sheets\n- September 30, 1995 and December 31, 1994 3\nStatements of Operations\n- Three month and nine month periods ended September 30, 1995 and 1994 4\nStatements of Cash Flows\n- Nine month periods ended September 30, 1995 and 1994 5\nNotes to Financial Statements 6\nITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 7\nPART II. OTHER INFORMATION 9\nSIGNATURES 10\nSWIFT ENERGY INCOME PARTNERS 1986-A, LTD. BALANCE SHEETS\nSee accompanying notes to financial statements.\nSWIFT ENERGY INCOME PARTNERS 1986-A, LTD. STATEMENTS OF OPERATIONS (UNAUDITED)\nSEE ACCOMPANYING NOTE TO FINANCIAL STATEMENTS.\nSWIFT ENERGY INCOME PARTNERS 1986-A, LTD. STATEMENTS OF CASH FLOWS (UNAUDITED)\nSEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.\nSWIFT ENERGY INCOME PARTNERS 1986-A, LTD. NOTES TO FINANCIAL STATEMENTS (UNAUDITED)\n(1) GENERAL INFORMATION -\nThe financial statements included herein have been prepared by the Partnership and are unaudited except for the balance sheet at December 31, 1994 which has been taken from the audited financial statements at that date. The financial statements reflect adjustments, all of which were of a normal recurring nature, which are, in the opinion of the managing general partner, necessary for a fair presentation. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been omitted pursuant to the rules and regulations of the Securities and Exchange Commission (\"SEC\"). The Partnership believes adequate disclosure is provided by the information presented. The financial statements should be read in conjunction with the audited financial statements and the note included in the latest Form 10-K.\n(2) DEFERRED REVENUES -\nDeferred Revenues represent a gas imbalance liability assumed as part of property acquisitions. The imbalance is accounted for on the entitlements method, whereby the Partnership records its share of revenue, based on its entitled amount. Any amounts over or under the entitled amount are recorded as an increase or decrease to deferred revenues.\n(3) CONCENTRATION OF CREDIT RISK -\nThe Partnership extends credit to various companies in the oil and gas industry which results in a concentration of credit risk. This concentration of credit risk may be affected by changes in economic or other conditions and may accordingly impact the Partnership's overall credit risk. However, the Managing General Partner believes that the risk is mitigated by the size, reputation, and nature of the companies to which the Partnership extends credit. In addition, the partnership generally does not require collateral or other security to support customer receivables.\nSWIFT ENERGY INCOME PARTNERS 1986-A, LTD. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nGENERAL\nThe Partnership was formed for the purpose of investing in producing oil and gas properties located within the continental United States. In order to accomplish this, the Partnership goes through two distinct yet overlapping phases with respect to its liquidity and results of operations. When the Partnership is formed, it commences its \"acquisition\" phase, with all funds placed in short-term investments until required for such property acquisitions. The interest earned on these pre-acquisition investments becomes the primary cash flow source for initial partner distributions. As the Partnership acquires producing properties, net cash from operations becomes available for distribution, along with the investment income. After partnership funds have been expended on producing oil and gas properties, the Partnership enters its \"operations\" phase. During this phase, oil and gas sales generate substantially all revenues, and distributions to partners reflect those revenues less all associated partnership expenses. The Partnership may also derive proceeds from the sale of acquired oil and gas properties, when the sale of such properties is economically appropriate or preferable to continued operation.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Partnership has completed the acquisition of producing oil and gas properties, expending all of the limited partners' net commitments available for property acquisitions.\nThe Partnership does not allow for additional assessments from the partners to fund capital requirements. However, funds in addition to the remaining unexpended net capital commitments of the partners are available from partnership revenues, borrowings or proceeds from the sale of partnership property. The Managing General Partner believes that the funds currently available to the Partnership will be adequate to meet any anticipated capital requirements.\nRESULTS OF OPERATIONS\nThe following analysis explains changes in the revenue and expense categories for the quarter ended September 30, 1995 (current quarter) when compared to the quarter ended September 30, 1994 (corresponding quarter), and for the nine months ended September 30, 1995 (current period), when compared to the nine months ended September 30, 1994 (corresponding period).\nTHREE MONTHS ENDED SEPTEMBER 30, 1995 AND 1994\nOil and gas sales declined $17,914 or 40 percent in the current quarter of 1995 when compared to the corresponding quarter in 1994, primarily due to decreased gas production. Current quarter gas production declined 31 percent, when compared to third quarter 1994 production volumes. A decline in gas prices of 13 percent or $.24\/MCF further contributed to decreased revenues.\nAssociated depreciation expense decreased 61 percent or $22,435.\nThe Partnership recorded an additional provision in depreciation, depletion and amortization in the third quarter of 1994 for $132,446 when the present value, discounted at ten percent, of estimated future net revenues from oil and gas properties based on the prices in effect at the filing date, using the guidelines of the Securities and Exchange Commission, was below the fair market value originally paid for oil and gas properties. The additional provision results from the Managing General Partner's determination that the fair market value paid for properties may or may not coincide with reserve valuations determined according to guidelines of the Securities and Exchange Commission. Using prices in effect at September 30, 1994, the Partnership would have recorded an additional provision at September 30, 1994 in the amount of $179,186.\nSWIFT ENERGY INCOME PARTNERS 1986-A, LTD. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\nNINE MONTHS ENDED SEPTEMBER 30, 1995 AND 1994\nOil and gas sales decreased $143,083 or 62 percent in the first nine months of 1995 over the corresponding period in 1994. A decline of 51 percent in gas production was a contributing factor to the decreased revenues for the period. Also, current period gas prices decreased 37 percent or $.82\/MCF compared to the corresponding period in 1994, further contributing to decreased income.\nAssociated depreciation expense decreased 67 percent or $105,900.\nThe Partnership recorded an additional provision in depreciation, depletion and amortization in the first nine months of 1995 and 1994 for $33,416 and $238,958, respectively, when the present value, discounted at ten percent, of estimated future net revenues from oil and gas properties, using the guidelines of the Securities and Exchange Commission, was below the fair market value originally paid for oil and gas properties. The additional provision results from the Managing General Partner's determination that the fair market value paid for properties may or may not coincide with reserve valuations determined according to guidelines of the Securities and Exchange Commission.\nDuring 1995, partnership revenues and costs will be shared between the limited partners and general partners in a 90:10 ratio.\nSWIFT ENERGY INCOME PARTNERS 1986-A, LTD. PART II - OTHER INFORMATION\nITEM 5. OTHER INFORMATION\n-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.\nSWIFT ENERGY INCOME PARTNERS 1986-A, LTD. (Registrant)\nBy: SWIFT ENERGY COMPANY Managing General Partner\nDate: November 13, 1995 By: \/s\/ John R. Alden ----------------- ------------------------------- John R. Alden Senior Vice President, Secretary and Principal Financial Officer\nDate: November 13, 1995 By: \/s\/ Alton D. Heckaman, Jr. ----------------- ------------------------------- Alton D. Heckaman, Jr. Vice President, Controller and Principal Accounting Officer\nH.J. GRUY AND ASSOCIATES, INC. - ----------------------------------------------------------------------------- 1200 SMITH STREET, SUITE 3040, HOUSTON, TEXAS 77002 - FAX (713) 739-6112 - (713)739-1000\nFebruary 17, 1995\nSwift Energy Company 16825 Northchase Drive, Suite 400 Houston, Texas 77060\nSWIFT ENERGY INCOME PARTNERS 1986-A LTD. 94-003-116\nGentlemen:\nAt your request, we have made an audit of the reserves and future net revenue as of December 31, 1994, prepared by Swift Energy Company (\"Swift\") for certain interests owned by the limited partners in Swift Energy Income Partners 1986-A Ltd. This audit has been conducted according to the standards pertaining to the estimating and auditing of oil and gas reserve information approved by the Board of Directors of the Society of Petroleum Engineers on October 30, 1979. We have reviewed these properties and where we disagreed with the Swift reserve estimates, Swift revised its estimates to be in agreement. The estimated net reserves, future net revenue and discounted future net revenue are summarized by reserve category as follows:\nSwift Energy Company -2- February 17, 1995\nThe discounted future net revenue is not represented to be the fair market value of these reserves and the estimated reserves included in this report have not been adjusted for risk.\nThe estimated future net revenue shown is that revenue which will be realized from the sale of the estimated net reserves after deduction of royalties, ad valorem and production taxes, direct operating costs and required capital expenditures, when applicable. Surface and well equipment salvage values and well plugging and field abandonment costs have not been considered in the revenue projections. Future net revenue as stated in this report is before the deduction of federal income tax.\nIn the economic projections, prices, operating costs and development costs remain constant for the projected life of each lease.\nFor those wells with sufficient production history, reserve estimates and rate projections are based on the extrapolation of established performance trends. Reserves for other producing and nonproducing properties have been estimated from volumetric calculations and analogy with the performance of comparable wells. The reserves included in this study are estimates only and should not be construed as exact quantities. Future conditions may affect recovery of estimated reserves and revenue, and all categories of reserves may be subject to revision as more performance data become available. The proved reserves in this report conform to the applicable definitions promulgated by the Securities and Exchange Commission. Attachment 1, following this letter, sets forth all reserve definitions incorporated in this study.\nExtent and character of ownership, oil and gas prices, production data, direct operating costs, capital expenditure estimates and other data provided by Swift have been accepted as represented. The production data available to us were through the month of October, 1994 except in those instances in which data were available through December. Interim production to December 31, 1994 has been estimated. No independent well tests, property inspections or audits of operating expenses were conducted by our staff in conjunction with this study. We did not verify or determine the extent, character, obligations, status or liabilities, if any, arising from any current or possible future environmental liabilities that might be applicable.\nIn order to audit the reserves, costs and future revenues shown in this report, we have relied in part on geological, engineering and economic data furnished by our client. Although we have made a best efforts attempt to acquire all pertinent data and analyze it carefully with methods accepted by the petroleum industry, there is no guarantee that the volumes of oil and gas or the revenues projected will be realized.\nProduction rates may be subject to regulation and contract provisions and may fluctuate according to market demand or other factors beyond the control of the operator. The reserve and revenue projections presented in this report may require revision as additional data become available.\nSwift Energy Company -3- February 17, 1995\nWe are unrelated to Swift and we have no interest in the properties included in the information reviewed by us. In particular:\n1. We do not own a financial interest in Swift or its oil and gas properties.\n2. Our fee is not contingent on the outcome of our work or report.\n3. We have not performed other services for or have any other relationship with Swift that would affect our independence.\nIf investments or business decisions are to be made in reliance on these estimates by anyone other than our client, such person with the approval of our client is invited to visit our office at his expense so that he can evaluate the assumptions made and the completeness and extent of the data available on which our estimates are based.\nAny distribution or publication of this report or any part thereof must include this letter in its entirety.\nYours very truly,\nH.J. GRUY AND ASSOCIATES, INC.\n\/s\/ JAMES H. HARTSOCK ------------------------------------- James H. Hartsock, Ph\/D., P.E. Executive Vice President\nJHH:llb\nAttachment\nATTACHMENT 1\nATTACHMENT 1 DEFINITIONS FOR OIL AND GAS RESERVES\nPROVED OIL AND GAS RESERVES\nProved oil and gas reserves are the estimated quantities of crude oil, natural gas, and natural gas liquid which geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic and operating conditions, i.e., prices and costs as of the date the estimate is made. Prices include consideration of changes in existing prices provided only by contractual arrangements, but not on escalations based upon future conditions.\nReservoirs are considered proved if economic producibility is supported by either actual production or conclusive formation test. The area of a reservoir considered proved includes (A) that portion delineated by drilling and defined by gas-oil and\/or oil-water contacts, if any, and (B) the immediately adjoining portions not yet drilled, but which can be reasonable judged as economically productive on the basis of available geological and engineering data. In the absence of information on fluid contacts, the lowest known structural occurrence of hydrocarbons controls the lower proved limit of the reservoir.\nReserves which can be produced economically through application of improved recovery techniques (such as fluid injection) are included in the \"proved\" classification when successful testing by a pilot project, or the operation of an installed program in the reservoir, provides support for the engineering analysis on which the project or program was based.\nEstimates of proved reserves do not include the following: (A) Oil that may become available from known reservoirs but is classified separately as \"indicated additional reserves\"; (B) crude oil, natural gas, and natural gas liquids, the recovery of which is subject to reasonable doubt because of uncertainty as to geology, reservoir characteristics, or economic factors; (C) crude oil, natural gas, and natural gas liquids, that may occur in undrilled prospects; and (D) crude oil, natural gas, and natural gas liquids, that may be recovered from oil shales, coal, gilsonite and other such sources.\nPROVED DEVELOPED OIL AND GAS RESERVES\nProved developed oil and gas reserves are reserves that can be expected to be recovered through existing wells with existing equipment and operating methods. Additional oil and gas expected to be obtained through the application of fluid injection or other improved recovery techniques for supplementing the natural forces and mechanisms of primary recovery should be included as \"proved developed reserves\" only after testing by a pilot project or after the operation of an installed program has confirmed through production response that increased recovery will be achieved.\nPROVED UNDEVELOPED RESERVES\nProved undeveloped oil and gas reserves that are expected to be recovered from new wells on undrilled, acreage, or from existing wells where a relatively major expenditure is required for recompletion. Reserves on undrilled acreage shall be limited to those drilling units offsetting productive units that are reasonably certain of production when drilled. Proved reserves for other undrilled units can be claimed only where it can be demonstrated with certainty that there is continuity of production from the existing productive formation. Under no circumstances should estimates for proved undeveloped reserves be attributable to any acreage for which an application of fluid injection or other improved recovery technique is contemplated, unless such techniques have been proved effective by actual tests in the area and in the same reservoir.","section_15":""}
{"filename":"796333_1995.txt","cik":"796333","year":"1995","section_1":"Item 1. Business\nBrown-Flournoy Equity Income Fund Limited Partnership (the \"Fund\") is a Delaware limited partnership formed on June 25, 1986 to develop and operate four residential apartment communities in Georgia and South Carolina. The capital raised from the admission of investors enabled the Fund to acquire the property and improvements and complete the construction of the four apartment communities by the end of 1987. See Item 2, Properties, herein.\nThe General Partners of the Fund are Brown Equity Income Properties, Inc., a Maryland corporation (the \"Administrative General Partner\"), and John F. Flournoy (the \"Development General Partner\").\nReference is made to the Prospectus (the \"Prospectus\") of the Registrant, dated August 28, 1986, filed with the Securities and Exchange Commission pursuant to Rule 424 (b) under the Securities Act of 1933, as amended, in connection with the Registrant's Registration Statement on Form S-11 (file No. 33-6924). Supplements to the Prospectus (\"Supplements\") have been filed with the Securities and Exchange Commission upon completion of the minimum offering, dated October 29, 1986, and subsequent closings dated December 8, 1986, January 14, 1987, and February 16, 1987. Pursuant to the Registration Statement, a maximum of 27,000 units were registered under the Securities and Exchange Act of 1933, as amended. During 1986 and 1987, all 27,000 units were sold, and the Registrant's net proceeds available for investment aggregated $25,110,000 (gross proceeds of $27,000,000 less selling commissions and offering and promotion expenses paid of $1,797,300 and volume discounts of $92,700).\nFunding for the acquisition of the land and improvements and construction of the apartment units was initially provided by capital raised by the Fund's $27,000,000 equity offering which commenced in the latter part of 1986 and was fully subscribed in February, 1987 with the admission of investors holding the final Class A Limited Partnership interests (the \"Units\"). Each of the four apartment communities was built within the terms of the fixed price construction contracts and all were completed ahead of the schedule required by the construction contracts.\nThe Fund secured first mortgage loans of $20.8 million on its properties on August 30, 1989. The loan proceeds were used to return approximately 60% of original equity to investors (approximately $16.2 million), repay certain deferred fees and establish reserves. The Fund took on the additional expense of monthly debt service payments resulting in a reduction of operating cash available for future distributions. Throughout 1995, the Fund's working capital not currently needed for improvements or other needs was invested, primarily in certificates of deposit or money market accounts.\nThe Fund's residential apartment communities face competition with similar properties in their locations. The competition is based on the properties proximity to area employers and commercial and retail facilities. In addition, consideration has been given to the comparability of quality, amenities, rental rates and unit sizes. The Fund's annual report discusses the current leasing at the properties and is incorporated by reference in Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K, herein.\nPursuant to the terms of a property management agreement with the Fund, each of the Properties is managed by Flournoy Properties, Inc., the property manager, and the agreement is now renewable on a year-to-year basis. The property manager receives a property management fee for each Property of 5% of gross monthly operating revenues of the Property. Under the terms of each of the property management agreements, the property manager is responsible for performing, or paying others to perform on its behalf, all leasing-related and other property management services for the properties. The management and administration of the Fund is performed by the General Partners or an affiliate thereof.\nBROWN-FLOURNOY EQUITY INCOME FUND LIMITED PARTNERSHIP\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Fund owns the land and improvements as described below:\nName and Location of Property\nDescription of Property\nSouthland Station Warner Robins, Houston County, Georgia\nA 160-unit garden apartment community consisting of twelve two-story buildings, a swimming pool, tennis courts and a clubhouse on approximately 15 acres of land.\nPark Place Spartanburg County, South Carolina\nA 184-unit garden apartment community consisting of thirteen two-story buildings, a swimming pool, tennis courts and a clubhouse on approximately 14.4 acres of land.\nHidden Lake - Phase Two Union City, Fulton County, Georgia\nA 160-unit garden apartment community consisting of thirteen two-story buildings. The property shares two swimming pools, tennis courts, a sport court and a clubhouse with an existing 160-unit apartment complex adjacent to the site and is located on approximately 16.2 acres of land.\nHigh Ridge Athens, Clarke County, Georgia\nA 160-unit garden apartment community consisting of eleven two-and-three-story buildings, swimming pools, tennis courts and a clubhouse on approximately 18 acres of land.\nFor additional information on the properties, reference is made to the information set forth under \"The Properties\" at pages 36 through 47 of the Prospectus, which is incorporated herein by reference.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe Fund is not subject to any material pending legal proceedings.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nThere were no matters submitted to the security holders for a vote during the last 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\nAn established public trading market for the Units does not exist and the Fund does not anticipate that a public market will develop. Transfer of Units by an investor and purchase of Units by the Fund may be accommodated under certain terms and conditions. Reference is made to \"Transfer and Repurchase of Units\" at pages 84 and 85 of the Prospectus and to the Amended and Restated Agreement of Limited Partnership, Article VII, \"Admission of Additional and Substitute Limited Partners and Transferability of a Limited Partner's Interest\" set forth at pages 23 through 25 of Exhibit B to the Prospectus, which are incorporated herein by reference.\nBROWN-FLOURNOY EQUITY INCOME FUND LIMITED PARTNERSHIP\nItem 5. Market for Registrant's Common Equity and Related Stockholder Matters (continued)\nAs of December 31, 1995, there were 1,148 holders of Units of the registrant, owning an aggregate of 27,000 units. In 1995, the Fund made four quarterly distributions from operations totaling $551,020 and a special distribution from settlement proceeds received in 1994 of $275,511. In 1994, the Fund made four quarterly distributions from operations totaling $551,020, and a special distribution of financing proceeds to Class A Limited Partners of $800,000. In 1993, the Fund made four quarterly distributions from operations totaling $551,020. In 1992, the Fund made four quarterly distributions from operations of $385,818 and $165,202 from working capital reserves, aggregating $551,020. In 1991, the Fund made four quarterly distributions from operations of $298,989, and $252,031 from working capital reserves, aggregating $551,020.\nItem 6.","section_6":"Item 6. Selected Financial Data\nRevenues and net earnings (loss) information furnished below is for the years ended December 31:\nThe above selected financial data should be read in conjunction with the financial statements and accompanying notes incorporated by reference in this report.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nLiquidity and Capital Resources\nAt December 31, 1995, the Fund had a working capital position of unrestricted cash and cash equivalents of $1,317,137 and accounts payable and accrued expenses of $453,493. Restricted cash represents amounts retained from tenants for security deposits and totaled $130,542 at December 31, 1995. The working capital balance represents reserves for future contingencies that were established from mortgage loan proceeds and are deemed sufficient to meet the Fund's liquidity requirements even under very pessimistic operating scenarios. Reserves may be distributed as the General Partners deem appropriate.\nCash and cash equivalents decreased $290,394 during 1995. This decrease represents the net effect of $734,773 in cash provided by operating activities, $88,700 disbursed for capital expenditures, $16,000 in proceeds provided by a lawsuit settlement, $125,936 disbursed as principal payments on first mortgage debt and distributions to investors of $826,531.\nBROWN-FLOURNOY EQUITY INCOME FUND LIMITED PARTNERSHIP\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)\nLiquidity and Capital Resources (continued)\nDistributions to investors during 1995 included $551,020 of cash provided by operating activities and a special distribution of $275,511, representing proceeds received from the settlement of a lawsuit regarding polybutelane piping utilized in the construction of one of the properties.\nIn February, 1996 the Fund made a cash distribution to its investors of $137,755. This distribution was derived from cash provided by operating activities during the fourth quarter of 1995.\nThe provisions of the mortgages for each of the Fund's four properties require repayment by September 30, 1996 of the outstanding principal balances totaling approximately $20 million. The Fund intends to repay these balances with proceeds from mortgage refinancings. Currently, there are no material commitments for capital expenditures or other uses of cash, other than ongoing debt service and the September 30, 1996 mortgage repayments.\nResults of Operations\nRental income increased 4% and 5% during 1995 and 1994, respectively. These increases are primarily attributable to increased rental rates and reduced use of concessions. In addition, during 1994, the properties achieved a slightly higher overall occupancy level, as compared to the prior year.\nInterest income increased during 1995, due to higher interest rates. Lower interest rates during 1994 resulted in a decrease in interest income for that year as compared to 1993.\nDuring 1995, the Fund recognized $299,228 representing proceeds from the settlement of a lawsuit regarding polybutelane piping utilized in the construction of one of the properties.\nTotal expenses increased $215,523 in 1995, due primarily to higher maintenance and repairs costs. During 1995, the Fund completed its program, begun in 1994, of painting each of the properties. The Park Place and Southland Station properties were painted during the year for a total cost of approximately $110,000. Additional maintenance and repairs programs during 1995 included pool resurfacing and landscaping enhancements.\nDuring 1994, the High Ridge and Hidden Lake properties were painted for a total cost of approximately $100,000, contributing to the increase in maintenance and repairs expenses for that year as compared to 1993.\nOverall occupancy for the Fund's properties averaged 94% during 1995, a slight decrease from 1994's average of 95%. While rental rates were increased at all four properties during 1995, added competition from new construction tempered the acceptance of these increases by the market, as evidenced by the slightly lower occupancy levels. In spite of reduced overall occupancy levels, the Fund achieved a $193,282 increase in rental income, as compared to the prior year. Each property achieved some level of increase, with the High Ridge property contributing the largest year to year improvement.\nThe High Ridge property, located in Athens, Georgia, achieved an average occupancy during the year of 97%, 1% higher than 1994. However, rental income was 6% improved over the prior year, bolstered by rental rate increases which totaled $51 on average per unit by the end of the year. These results were achieved in spite of the addition to competition from a newly constructed property nearby.\nOccupancy at the Hidden Lake property averaged 96% during 1995, a slight increase from 1994's average of 95%. Monthly rents were increased an average of $24 per unit during the year, contributing to a 3% increase in rental income as compared to 1994.\nBROWN-FLOURNOY EQUITY INCOME FUND LIMITED PARTNERSHIP\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)\nResults of Operations (continued)\nIn-migration to the Spartanburg, South Carolina area continued to provide a substantial source of new residents for multifamily communities in that market, including the Fund's Park Place property. These new residents are typically short term renters with plans to build or buy a new home. In the interim, they are relatively price insensitive, which has allowed management at Park Place to increase rental rates throughout the year by an average of $26. The short term nature of these residents' stay, however, causes large fluctuations in occupancy levels. While occupancy averaged 93% for the year, consistent with 1993, it ranged from as low as 87% in March to as high as 97% in October. Overall, the property achieved a 5% increase in rental income during the year.\nThe Southland Station property, located in Warner Robins, Georgia, achieved an average occupancy during 1995, of 92%, a substantial decrease from 1994's average of 97%. However, ongoing rental rate increases throughout the year resulted in an overall increase in rental income of 3%, as compared to 1994. Long term prospects for the property appear very strong, as the nearby Warner Robins Air Force Base was again excluded from the round of base closures announced in 1995. However, this news had some negative short term impact as some tenants who had been delaying a home purchase, decided to move ahead with their plans based on the promising long term outlook for the area. These moveouts contributed substantially to the drop in occupancy during the year.\nConstruction of new apartment communities has increased in many markets of the southeastern United States. This new competition has tempered rental rate increases and slowed previous trends of rental income gains. Each of the Fund's four properties experienced heightened competition during 1995 from new construction. In some cases, 1996 will present additional challenges from new construction. Management intends to meet these challenges in the upcoming year through their ongoing marketing programs and commitment to high tenant service. The properties have been very well maintained since construction, including the painting of all four in 1994 and 1995, and are well prepared to compete in their markets.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nIndex to Financial Statements and Financial Statement Schedule\nPage(s) Herein Annual Report\nIndependent Auditors' Report 11 5 Balance Sheets 6 Statements of Operations 7 Statements of Partners' Capital (Deficit) 8 Statements of Cash Flows 9 Notes to Financial Statements 10-14 Financial Statement Schedule Schedule III - Real Estate and Accumulated Depreciation 12\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.\nBROWN-FLOURNOY EQUITY INCOME FUND LIMITED PARTNERSHIP\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 General Partners of the Fund are Brown Equity Income Properties, Inc., the Administrative General Partner, and John F. Flournoy, the Development General Partner. The Fund's principal executive offices are located at 225 East Redwood Street, Baltimore, Maryland 21202, telephone (410) 727-4083. The General Partners have primary responsibility for overseeing the performance of those who contract with the Fund, as well as making decisions with respect to the financing, sale and liquidation of the Fund's assets. The General Partners are responsible for all reports to and communications with investors and others, all distributions and allocations to investors, the administration of the Fund's business and all filings with the Securities and Exchange Commission and other federal or state regulatory authorities. The Fund's Partnership Agreement provides for the removal of a General Partner and the election of successor additional general partners by investors holding a majority of the Units.\nThe directors and executive officers of the Fund are as follows:\nThe Development General Partner\nJohn F. Flournoy, age 55, the Development General Partner, is the majority shareholder and Chief Executive Officer of Flournoy Development Company, a Georgia corporation that he organized in 1967 for the purpose of engaging in real estate development. Flournoy Construction Company, the general contractor for the Properties, is a wholly-owned subsidiary of Flournoy Development Company. Mr. Flournoy is also the majority shareholder of Flournoy Properties, Inc., the property manager of the properties.\nMr. Flournoy is a graduate of the University of North Carolina Business School. In his various capacities as a principal of Flournoy Development Company and Flournoy Construction Company, he participates actively in all aspects of real estate development and construction.\nThe Administrative General Partner\nBrown Equity Income Properties, Inc., the Administrative General Partner, is a Maryland corporation and is wholly owned by Alex. Brown Realty, Inc. The Administrative General Partner is responsible for administering the business of the Fund including providing clerical services, investor communications services and reports, and for making all reports and filings to regulatory authorities. The Administrative General Partner is reimbursed for such services to the Fund on a cost basis.\nThe following individuals are the directors and principal officers of Brown Equity Income Properties, Inc.:\nJohn M. Prugh, age 47, has been a Director and President of the General Partner since 1986 and of Alex. Brown Realty, Inc. and Armata Financial Corp. since 1984. Mr. Prugh graduated from Gettysburg College in 1970, and was designated a Certified Property Manager by the Institute of Real Estate Management in 1979. He has worked in property management for H. G. Smithy Co., in Washington, D.C., and Dreyfuss Bros., Inc. in Bethesda, Maryland. Since 1977, Mr. Prugh has been involved in managing, administering, developing and selling real estate investment projects sponsored by Alex. Brown Realty, Inc. and its subsidiaries.\nBROWN-FLOURNOY EQUITY INCOME FUND LIMITED PARTNERSHIP\nItem 10. Directors and Executive Officers of the Registrant (continued)\nThe Administrative General Partner (continued)\nPeter E. Bancroft, age 43, has been a Director and Vice President of the General Partner since 1986 and a Senior Vice President of Alex. Brown Realty, Inc. and Armata Financial Corp. since 1983. Mr. Bancroft graduated from Amherst College in 1974, attended the University of Edinburgh, and received a J.D. degree from the University of Virginia School of Law in 1979. Prior to joining Alex. Brown Realty, Inc. in 1983, Mr. Bancroft held legal positions with Venable, Baetjer and Howard and T. Rowe Price Associates, Inc.\nTerry F. Hall, age 49, has been the Secretary of the General Partner and a Vice President and Secretary of, and Legal Counsel for Alex. Brown Realty, Inc. since 1989. Mr. Hall graduated from the University of Nebraska- Lincoln in 1968, and received a J.D. degree from the University of Pennsylvania Law School in 1973. Prior to joining Alex. Brown Realty, Inc. in 1986, Mr. Hall was a Partner at the law firm of Venable, Baetjer and Howard from 1981 to 1986 and an associate at the same firm from 1973 to 1981.\nTimothy M. Gisriel, age 39, has been the Treasurer of the General Partner and of Alex. Brown Realty, Inc. and Armata Financial Corp. since 1990. He was the Controller of Alex. Brown Realty, Inc. and Armata Financial Corp. from 1984 through 1990. Mr. Gisriel graduated from Loyola College in 1978 and received his Masters of Business Administration degree from the Robert G. Merrick School of Business, University of Baltimore. Prior to joining Alex. Brown Realty, Inc. in 1984, Mr. Gisriel was an audit supervisor in the Baltimore office of Coopers & Lybrand. He is a Maryland Certified Public Accountant.\nThere is no family relationship among the Development General Partner or the officers and directors of the Administrative General Partner.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe Development General Partner and the officers and directors of the Administrative General Partner received no compensation from the Partnership.\nThe General Partners are entitled to receive a share of cash distributions and a share of profits and losses as described in the Limited Partnership Agreement, Article IV, \"Allocation Distributions and Applicable Rules\" at pages 12 through 17 of Exhibit B to the Prospectus herein incorporated by reference.\nFor a discussion of compensation and fees to which the General Partners are entitled, see Item 13, Certain Relationships and Related Transactions, herein.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nNo person is known to the Fund to own beneficially more than 5% of the outstanding interests of the Fund.\nThe General Partners each have a 1% interest in the Fund as General Partners, but hold no Class A Limited Partnership interest.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThe General Partners and their affiliates have engaged in and are permitted to engage in transactions with the Fund as described in \"Compensation and Fees to the General Partners and Affiliates\" and under the caption \"Transactions Between the Fund and General Partners and Affiliates\" set forth in \"Conflicts of Interest\" at pages 13 through 17 of the Prospectus, herein incorporated by reference.\nBROWN-FLOURNOY EQUITY INCOME FUND LIMITED PARTNERSHIP\nItem 13. Certain Relationships and Related Transactions (continued)\nFor a summary of fees paid to the General Partners and their affiliates for the three years ended December 31, 1995, see Note 5, \"Related Party Transactions\", in Item 8, Financial Statements and Supplementary Data, herein.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\n(a) 1. Financial Statements: See Index to Financial Statements and Financial Statement Schedule in Item 8 on Page 7.\n2. Financial Statement Schedule: See Index to Financial Statements and Financial Statement Schedule in Item 8 on Page 7.\n3. Exhibits: (3, 4) Limited Partnership Agreement on pages 1 through 32 of Exhibit B to the Fund's Registration Statement on Form S-11 (File No. 33-6924) included herein by reference.\n(13) Annual Report for 1995.\n(b) Reports on Form 8-K: None.\nINDEPENDENT AUDITORS' REPORT\nThe Partners Brown-Flournoy Equity Income Fund Limited Partnership:\nUnder date of January 16, 1996, we reported on the balance sheets of Brown-Flournoy Equity Income Fund Limited Partnership as of December 31, 1995 and 1994, and the related statements of operations, partners' capital (deficit) and cash flows for each of the years in the three-year period ended December 31, 1995, as contained in the 1995 Annual Report. These financial statements and our report thereon are incorporated by reference in the Annual Report on Form 10-K for 1995. In connection with our audits of the aforementioned financial statements, we also have audited the related financial statement schedule as listed in the accompanying index. This financial statement schedule is the responsibility of the Fund's management. Our responsibility is to express an opinion on the financial statement schedule based on our audits.\nIn our opinion, such financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.\nKPMG PEAT MARWICK LLP\nBaltimore, Maryland January 16, 1996\nBROWN-FLOURNOY EQUITY INCOME FUND LIMITED PARTNERSHIP SCHEDULE III. REAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1995\n(2) AGGREGATE COST FOR FEDERAL INCOME TAX PURPOSES IS $23,825,965 AT DECEMBER 31, 1995.\n(3) SEE NOTE 5 OF NOTES TO THE FINANCIAL STATEMENTS FOR INFORMATION CONCERNING TRANSACTIONS WITH AFFILIATES.\n(4) SEE NOTE 6 OF NOTES TO THE FINANCIAL STATEMENTS FOR INFORMATION REGARDING MORTGAGE LOAN AGREEMENTS, COLLATERALIZED BY THE LAND, BUILDING AND IMPROVEMENTS.\n(5) DEDUCTION IS DUE TO IMPAIRMENT TO ASSETS RESULTING FROM DEFECTIVE MATERIALS AND SUBSEQUENT REIMBURSEMENT OF SETTLEMENT PROCEEDS.\nBROWN-FLOURNOY EQUITY INCOME FUND LIMITED PARTNERSHIP SCHEDULE III. REAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1995\nBROWN-FLOURNOY EQUITY INCOME FUND LIMITED PARTNERSHIP\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.\nBROWN-FLOURNOY EQUITY INCOME FUND LIMITED PARTNERSHIP\nDATE: 3\/22\/96 BY: \/s\/ John F. Flournoy John F. Flournoy Development General Partner\nPursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed by the following in the capacities and on the dates indicated.\nDATE: 3\/25\/96 BY: \/s\/ John M. Prugh John M. Prugh President and Director Brown Equity Income Properties, Inc. Administrative General Partner\nDATE: 3\/25\/96 BY: \/s\/ P. E. Bancroft Peter E. Bancroft Vice President and Director Brown Equity Income Properties, Inc. Administrative General Partner\nDATE: 3\/25\/96 BY: \/s\/ Terry F. Hall Terry F. Hall Secretary Brown Equity Income Properties, Inc. Administrative General Partner\nDATE: 3\/25\/96 BY: \/s\/ Timothy M. Gisriel Timothy M. Gisriel Treasurer Brown Equity Income Properties, Inc. Administrative General Partner","section_15":""}
{"filename":"84244_1995.txt","cik":"84244","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company's headquarters is located in a building owned by the Company at One Rollins Plaza, Wilmington, DE 19803.\nThe Company's principal operating properties consist of land and buildings used in its truck leasing and rental business. Rollins owns or leases 201 facilities in 42 states.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nNeither the Company nor any of its subsidiaries is a party to any material legal proceedings. The Company and its subsidiaries are engaged in ordinary routine litigation incidental to the business.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNONE. PART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS.\nSTOCK PRICES AND DIVIDENDS\nThe range of share prices for the Common Stock on the New York and Pacific Stock Exchanges and per share dividends paid on Common Stock for the fiscal years ended September 30, 1995 and 1994 are as follows:\nPrices Dividends 1995 1994 1995 1994 High Low High Low Fiscal Quarter First .......... $12 1\/2 $11 $14 $11 1\/4 $.04 $.033 Second ......... 14 1\/2 11 3\/8 14 3\/8 11 1\/2 .04 .033 Third .......... 12 5\/8 10 3\/8 12 3\/8 11 1\/8 .04 .033 Fourth ......... 11 3\/4 10 1\/4 12 1\/2 10 7\/8 .04 .033\nAt September 30, 1995, there were 2,663 holders of record of the Common Stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nResults of Operations\nFiscal Year 1995 vs. 1994 Revenues increased by $31.7 million (7.0%) to $482.6 million from $450.9 million as full-service leasing, commercial rental and dedicated carriage service revenues all improved over the prior year. This revenue improvement was realized despite a continuing sluggish economic climate. Business conditions were excellent during the first fiscal quarter ended December 31, 1994, but the economy weakened beginning in January, 1995 which affected the Company's short-term commercial rental business for the remainder of the year.\nOperating expenses increased by $10.9 million (5.9%) reflecting the increase in revenues and the costs associated with opening new facilities and making improvements to existing facilities. Operating expenses as a percentage of revenues decreased to 40.2% in 1995 from 40.6% in 1994. The increased revenues combined with lower maintenance costs on new equipment and continued expense control efforts accounted for the lower operating cost ratio.\nDepreciation expense increased by $16.3 million (12.5%) due to the increased investment in equipment on operating leases and related transportation service facilities. The higher levels of investment in property and equipment reflect, in addition to the higher level of business, increased prices paid for recently acquired equipment. Depreciation as a percentage of revenues was 30.4% in 1995 compared with 28.9% in 1994. The higher percentage in 1995 reflected both higher equipment costs and the effects of competitive conditions which limited price increases.\nGain on the sale of property and equipment was $12.7 million, an increase of $4.2 million (49.4%) over the 1994 gain of $8.5 million. During 1995, the Company sold more vehicles at higher prices resulting in the increased gain.\nSelling and administrative expenses increased by $.7 million and were 8.9% of revenues in 1995 compared with 9.4% of revenues in 1994.\nInterest expense increased by $7.3 million (19.8%) principally due to the increase in average borrowings related to the purchase of additional equipment and higher short-term interest rates.\nThe effective income tax rates for 1995 and 1994 were 38.4% and 40.0%, respectively. The 1995 effective tax rate was favorably impacted by the resolution of certain state income tax matters.\nNet earnings increased by $1.5 million (3.8%) to $41.3 million or $.91 per share from $39.8 million or $.86 per share in 1994. Net earnings as a percentage of revenues was 8.6% in 1995 compared with 8.8% in 1994. Higher depreciation and interest expenses combined with a lower level of profitability from the commercial rental fleet, offset in part by a higher gain on the sale of equipment, contributed to 1995's lower net profit margin.\nFiscal Year 1994 vs. 1993\nRevenues increased by $42.1 million (10.3%) as full-service lease, commercial rental and dedicated contract carriage revenues all improved over the prior year.\nOperating expenses increased by $16.0 million (9.6%) reflecting the higher revenues. Operating expenses as a percentage of revenues decreased to 40.6% in 1994 from 40.9% in 1993. This improved operating cost ratio resulted from lower maintenance costs on new equipment and continued expense control efforts.\nNet depreciation expense increased by $10.0 million (8.9%) due to the increased gross investment in equipment on operating leases and transportation service facilities offset in part by increased gains on the sale of equipment, which are shown as a reduction of depreciation expense. Equipment sale gains increased to $8.5 million from $6.1 million in 1993 as the used equipment market remained strong during 1994.\nSelling and administrative expenses increased by $2.0 million (5.0%) mainly due to higher payroll costs in the sales area and to continued emphasis on sales and marketing programs. Selling and administrative expenses decreased to 9.4% of revenues in 1994 from 9.9% of revenues in 1993.\nInterest expense increased by $2.4 million (7.0%) due to the increase in average borrowings and higher short-term interest rates offset in part by the refinancing of certain higher interest rate debt.\nThe effective income tax rates for 1994 and 1993 were 40.0% and 44.4%, respectively.\nNet earnings increased by $9.4 million (30.9%) to $39.8 million or $.86 per share from $30.4 million or $.66 per share in 1993. The improvement in net earnings was due mainly to increased revenues and the lower operating cost ratio offset in part by higher depreciation, selling and administrative and interest expenses.\nLiquidity and Capital Resources\nThe Company's primary operation is the full-service leasing and rental of tractors, trucks and trailers which requires substantial amounts of capital and constant access to financing sources. Funds for the acquisition of this equipment are provided principally by the cash flows from operations, the proceeds from the sale of used equipment and borrowings under the Company's revolving credit facility. Cash flows from operations arising from net earnings, depreciation and changes in deferred income taxes and working capital were $198.5 million in 1995, a 14.3% increase from $173.7 million in 1994. Because the primary source of funds from operations is from existing leases, the Company expects a similar amount of funds to be generated in 1996.\nAt September 30, 1995, equipment on operating leases of $727.9 million represented 70.9% of the Company's assets. The Company's equity in this equipment after deducting equipment financing obligations increased by $14.9 million (10.7%) to $154.3 million in 1995 from $139.4 million in 1994 as shown below (in millions):\nSeptember 30 1995 1994 Increase Equipment on operating leases, net $727.9 $637.8 $90.1 Less equipment financing obligations (573.6) (498.4) (75.2) Equity in equipment $154.3 $139.4 $14.9\nThe Company's principal subsidiary, Rollins Leasing Corp., has a $100.0 million revolving credit facility of which $86.0 million was available at September 30, 1995. This facility is used primarily to finance vehicle purchases on an interim basis pending placement of long-term financing. On March 15, 1995, the Company closed on a private placement of $100.0 million of 8.27% Series N Collateral Trust Debentures due March 15, 2002 and on May 15, 1995, the Company sold $50.0 million of 7.25% Series O Collateral Trust Debentures due May 15, 2005. Additionally, on June 7, 1995, the Company arranged for the private placement of $75.0 million of 6.89% Series P Collateral Trust Debentures due March 15, 2004. Closing will occur on March 15, 1996 with the proceeds used to refinance certain existing indebtedness and for new equipment purchases committed for delivery in the Spring of 1996.\nAt September 30, 1995, the Company could sell an additional $90.0 million of Collateral Trust Debentures under its current shelf registration statement. Based on its access to the debt markets and relationships with current lending institutions and others who have expressed an interest in providing financing, the Company expects to continue to be able to obtain financing for its equipment and facility purchases at market rates and under satisfactory terms and conditions.\nAt September 30, 1995, the debt to equity ratio of the Company was 2.1 to 1.\nCapital expenditures were $319.0 million in 1995 compared with $297.5 million in 1994. The level of economic activity, which in part dictates demand for the Company's services, was strong during the Company's first fiscal quarter. The economy weakened in early January 1995 and such conditions continued for the remainder of the fiscal year. At September 30, 1995, the Company's commitment for the purchase of revenue equipment was $102.6 million. Based on the current level of business and including commitments already made at September 30, 1995, the Company anticipates spending approximately $300.0 million for equipment and facilities in 1996.\nDuring 1995, the Company purchased for cash and retired 962,500 shares of its $1 par value common stock for $10.1 million. The Company is authorized to purchase 2.1 million additional shares of its stock.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe consolidated financial statements of the Company, the Independent Auditors' Report and the financial statement schedules included in this report are shown on the Index to the Consolidated Financial Statements and Schedules on page 9.\nITEM 9.","section_9":"ITEM 9. DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNONE.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nExcept as presented below, the information called for by this Item 10 is incorporated by reference from the Company's Proxy Statement to be filed pursuant to Regulation 14A for the Annual Meeting of Shareholders to be held on January 25, 1996.\nExecutive Officers of the Registrant. As of October 31, 1995, the Executive Officers of the registrant were:\nName Position Age Term of Office\nPatrick J. Bagley Vice President-Finance and 48 7\/87 to date Treasurer 1\/87 to date\nDavid F. Burr Chairman and Chief Executive 57 10\/92 to date Officer, Rollins Leasing Corp.\nMichael B. Kinnard Vice President-General Counsel 38 10\/94 to date and Secretary 10\/94 to date\nJohn W. Rollins Chairman of the Board and 79 1954 to date Chief Executive Officer 10\/74 to date\nJohn W. Rollins, Jr. President and Chief Operating 53 9\/75 to date Officer and Director\nHenry B. Tippie Chairman of the Executive 68 3\/74 to date Committee and Vice Chairman of the Board\nThe Company's Executive Officers are elected for the ensuing year and until their successors are elected.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe information called for by this Item 11 is incorporated by reference from the Company's Proxy Statement to be filed pursuant to Regulation 14A for the Annual Meeting of Shareholders to be held on January 25, 1996.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe information called for by this Item 12 is incorporated by reference from the Company's Proxy Statement to be filed pursuant to Regulation 14A for the Annual Meeting of Shareholders to be held on January 25, 1996.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nDuring the year ended September 30, 1995, the following officers and\/or directors of the Company were also officers and\/or directors of Rollins Environmental Services, Inc.; Patrick J. Bagley, Michael B. Kinnard, 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, Michael B. Kinnard, William B. Philipbar, Jr., John W. Rollins, John W. Rollins, Jr. and Henry B. Tippie. John W. Rollins owns directly and of record 6.2% and 12.0% of the outstanding shares of Common Stock of Rollins Environmental Services, Inc. and Matlack Systems, Inc., respectively at October 31, 1995. The description of transactions between the Company and Rollins Environmental Services, Inc. and between the Company and Matlack Systems, Inc. appears under the caption \"Transactions with Related Parties\" on page 21 of this 1995 Annual Report on Form 10-K.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(a) Financial Statements, Financial Statement Schedules and Exhibits.\n(1) Financial Statements - See accompanying Index to Consolidated Financial Statements and Schedules on page 9.\n(2) Financial Statements Schedules - See accompanying Index to Consolidated Financial Statements and Schedules on page 9.\n(3) Exhibits: (3)(a) Restated Certificate of Incorporation of Rollins Truck Leasing Corp. as last amended on January 25, 1990 as filed with the Company's annual report on Form 10-K for the fiscal year ended September 30, 1992 is incorporated herein by reference.\n(3)(b) By-Laws of Rollins Truck Leasing Corp. as last amended on November 25, 1987 as filed with the Company's annual report on Form 10-K for the fiscal year ended September 30, 1992 is incorporated herein by reference.\n(4)(a) Collateral Trust Indenture dated as of March 21, 1983, between RLC CORP. (now known as Rollins Truck Leasing Corp.) and Bank of America Illinois (formerly Continental Illinois National Bank and Trust Company of Chicago), as Trustee, as filed with the Company's Registration Statement No. 33-40476 on Form S-3 dated May 10, 1991, is incorporated herein by reference.\n(4)(b) Third Supplemental Collateral Trust Indenture dated February 20, 1986 to the Collateral Trust Indenture dated March 21, 1983 between RLC CORP. (now known as Rollins Truck Leasing Corp.) and Bank of America Illinois (formerly Continental Illinois National Bank and Trust Company of Chicago), as Trustee, as filed with the Company's Registration Statement No. 33-40476 on Form S-3 dated May 10, 1991, is incorporated herein by reference.\n(4)(c) Sixth Supplemental Collateral Trust Indenture dated March 15, 1988 to the Collateral Trust Indenture dated March 21, 1983 as supplemented and amended by a Third Supplemental Indenture thereto dated as of February 20, 1986, between RLC CORP. (now known as Rollins Truck Leasing Corp.) and Bank of America Illinois (formerly Continental Illinois National Bank and Trust Company of Chicago), as Trustee.\n(4)(d) Seventh Supplemental Collateral Trust Indenture dated March 15, 1989 to the Collateral Trust Indenture dated March 21, 1983 as supplemented and amended by a Third Supplemental Indenture thereto dated as of February 20, 1986, between RLC CORP. (now known as Rollins Truck Leasing Corp.) and Bank of America Illinois (formerly Continental Bank N.A.), as Trustee.\n(4)(e) Eighth Supplemental Collateral Trust Indenture dated May 15, 1990 to the Collateral Trust Indenture dated March 21, 1983 as supplemented and amended by a Third Supplemental Indenture thereto dated as of February 20, 1986, between Rollins Truck Leasing Corp. and Bank of America Illinois (formerly Continental Bank, N.A.), as Trustee, as filed with the Company's Registration Statement No. 33-67682 on Form S- 3 dated August 20, 1993 is incorporated herein by reference.\n(4)(f) Ninth Supplemental Collateral Trust Indenture dated December 1, 1991 to the Collateral Trust Indenture dated March 21, 1983 as supplemented and amended by a Third Supplemental Indenture thereto dated as of February 20, 1986 and by an Eighth Supplemental Indenture dated May 15, 1990, between Rollins Truck Leasing Corp. and Bank of America Illinois (formerly Continental Bank, N.A.), as Trustee, as filed with the Company's report on Form 8-K dated December 12, 1991, is incorporated herein by reference.\n(4)(g) Tenth Supplemental Collateral Trust Indenture dated April 28, 1992 to the Collateral Trust Indenture dated March 21, 1983 as supplemented and amended by a Third Supplemental Indenture thereto dated as of February 20, 1986 and by an Eighth Supplemental Indenture dated May 15, 1990, between Rollins Truck Leasing Corp. and Bank of America Illinois (formerly Continental Bank, N.A.), as Trustee, as filed with the Company's report on Form 8-K dated April 28, 1992, is incorporated herein by reference.\n(4)(h) Eleventh Supplemental Collateral Trust Indenture dated March 15, 1993 to the Collateral Trust Indenture dated March 21, 1983 as supplemented and amended by a Third Supplemental Indenture thereto dated as of February 20, 1986 and by an Eighth Supplemental Indenture dated May 15, 1990, between Rollins Truck Leasing Corp. and Bank of America Illinois (formerly Continental Bank, N.A.), as Trustee, as filed with the Company's report on Form 8-K dated March 30, 1993, is incorporated herein by reference.\n(4)(i) Twelfth Supplemental Collateral Trust Indenture dated March 15, 1994 to the Collateral Trust Indenture dated March 21, 1983 as supplemented and amended by a Third Supplemental Indenture thereto dated as of February 20, 1986 and by an Eighth Supplemental Indenture dated May 15, 1990, between Rollins Truck Leasing Corp. and Bank of America Illinois (formerly Continental Bank, N.A.), as Trustee, as filed with the Company's report on Form 8-K dated March 21, 1994, is incorporated herein by reference.\n(4)(j) Thirteenth Supplemental Collateral Trust Indenture dated March 15, 1995 to the Collateral Trust Indenture dated March 21, 1983 as supplemented and amended by a Third Supplemental Indenture thereto dated as of February 20, 1986 and by an Eighth Supplemental Indenture dated May 15, 1990, between Rollins Truck Leasing Corp. and Bank of America Illinois (formerly Continental Bank, N.A.), as Trustee, as filed with the Company's report on Form 10-Q dated April 26, 1995, is incorporated herein by reference.\n(4)(k) Fourteenth Supplemental Collateral Trust Indenture dated May 15, 1995 to the Collateral Trust Indenture dated March 21, 1983 as supplemented and amended by a Third Supplemental Indenture thereto dated as of February 20, 1986 and by an Eighth Supplemental Indenture dated May 15, 1990, between Rollins Truck Leasing Corp. and Bank of America Illinois (formerly Continental Bank, N.A.), as Trustee, as filed with the Company's report on Form 8-K dated May 16, 1995 is incorporated herein by reference.\n(4)(l) RLC CORP. (now known as Rollins Truck Leasing Corp.) Rights Agreement dated as of June 14, 1989 as filed as an Exhibit to Registration Statement on Form 8-A filed by Registrant on June 15, 1989 is incorporated herein by reference.\n(10)(a) RLC CORP. (now known as Rollins Truck Leasing Corp.) 1982 Incentive Stock Option Plan, as filed with the Company's Proxy Statement for the Annual Meeting of Shareholders held on January 27, 1983, is incorporated herein by reference.\n(10)(b) RLC CORP. (now known as Rollins Truck Leasing Corp.) 1986 Stock Option Plan, as filed with the Company's Proxy Statement for the Annual Meeting of Shareholders held on January 29, 1987, is incorporated herein by reference.\n(10)(c) Rollins Truck Leasing Corp. 1993 Stock Option Plan, as filed with the Company's Proxy Statement for the Annual Meeting of Shareholders held on January 27, 1994, is incorporated herein by reference.\n(21) Rollins Truck Leasing Corp. Subsidiaries at September 30, 1995.\n(23) Consent of KPMG Peat Marwick LLP, Independent Auditors, for incorporation by reference in Registration Statement No. 33- 67682 filed on Form S-3.\n(27) Rollins Truck Leasing Corp. Financial Data Schedule at September 30, 1995.\n(b) Reports on Form 8-K.\nNo reports on Form 8-K were filed by Rollins Truck Leasing Corp. during the last quarter of the period covered by this report.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the 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: December 1, 1995 ROLLINS TRUCK LEASING CORP. (Registrant)\nBY: \/s\/ John W. Rollins, Jr. John W. Rollins, Jr. President and Chief Operating Officer and Director\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated:\n\/s\/ Patrick J. Bagley Vice President-Finance December 1, 1995 Patrick J. Bagley and Treasurer Chief Financial Officer Chief Accounting Officer\n\/s\/ John W. Rollins Chairman of the Board and December 1, 1995 John W. Rollins Chief Executive Officer\n\/s\/ Gary W. Rollins Director December 1, 1995 Gary W. Rollins\n\/s\/ Henry B. Tippie Chairman of the Executive December 1, 1995 Henry B. Tippie Committee and Vice Chairman of the Board\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES\n(1) Consolidated Page(s) Independent Auditors' Report on Financial Statements and Financial Statement Schedules 10\nConsolidated Statement of Earnings for the years ended September 30, 1995, 1994 and 1993 11\nConsolidated Balance Sheet at September 30, 1995 and 1994 12\nConsolidated Statement of Cash Flows for the years ended September 30, 1995, 1994 and 1993 13\nNotes to the Consolidated Financial Statements 14 to 20\n(2) Financial Statement Schedules\nRollins Truck Leasing Corp. (Parent) Schedule I - Condensed Financial Information\nBalance Sheet at September 30, 1995 and 1994 21\nStatement of Earnings for the years ended September 30, 1995, 1994 and 1993 22\nStatement of Cash Flows for the years ended September 30, 1995, 1994 and 1993 23\nNotes to the Financial Statements 24\nRollins Truck Leasing Corp. and Subsidiaries Consolidated\nSchedule II - Valuation and Qualifying Accounts for the the years ended September 30, 1995, 1994 and 1993 25\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. Independent Auditors' Report\nThe Shareholders and Board of Directors Rollins Truck Leasing Corp.\nWe have audited the consolidated financial statements of Rollins Truck Leasing Corp. and subsidiaries as listed in the accompanying index. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedules as listed in the accompanying index. These consolidated financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Rollins Truck Leasing Corp. and subsidiaries as of September 30, 1995 and 1994, and the results of their operations and their cash flows for each of the years in the three-year period ended September 30, 1995, 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\nPhiladelphia, Pennsylvania October 24, 1995\nCONSOLIDATED STATEMENT OF EARNINGS\nYear Ended September 30, 1995 1994 1993 Revenues $482,612,000 $450,903,000 $408,778,000 Expenses: Operating 194,073,000 183,222,000 167,248,000 Depreciation 146,777,000 130,512,000 118,144,000 Gain on sale of property and equipment (12,657,000) (8,530,000) (6,139,000) Selling and administrative 43,146,000 42,473,000 40,440,000 371,339,000 347,677,000 319,693,000\nEarnings before interest and income taxes 111,273,000 103,226,000 89,085,000 Interest income 272,000 593,000 1,023,000 Interest (expense) (44,453,000) (37,429,000) (35,451,000) Earnings before income taxes 67,092,000 66,390,000 54,657,000 Income taxes 25,756,000 26,562,000 24,241,000\nNet earnings $ 41,336,000 $ 39,828,000 $ 30,416,000\nEarnings per share $ .91 $ .86 $ .66\nAverage common shares and equivalents outstanding 45,365,000 46,310,000 46,260,000\nThe Notes to the Consolidated Financial Statements are an integral part of these statements.\nCONSOLIDATED BALANCE SHEET September 30, 1995 1994 ASSETS Current assets Cash $ 22,708,000 $ 15,094,000 Accounts receivable, net of allowance for doubtful accounts: 1995-$1,635,000; 1994 -$1,770,000 56,946,000 52,031,000 Inventory of parts and supplies 8,612,000 8,558,000 Prepaid expenses 14,366,000 12,726,000 Refundable income taxes 1,667,000 2,571,000 Deferred income taxes 6,241,000 11,472,000 Total current assets 110,540,000 102,452,000 Equipment on operating leases, at cost, net of accumulated depreciation 727,893,000 637,768,000 Other property and equipment, at cost, net of accumulated depreciation 171,343,000 146,618,000 Note receivable-Matlack, Inc. - 6,000,000 Excess of cost over net assets of businesses acquired 11,677,000 11,903,000 Other assets 5,576,000 4,976,000 Total assets $1,027,029,000 $ 909,717,000\nLIABILITIES AND SHAREHOLDERS' EQUITY\nCurrent liabilities (excluding equipment financing obligations) Accounts payable $ 8,115,000 $ 7,205,000 Accrued liabilities 43,167,000 40,114,000 Current maturities of long-term debt 150,000 146,000 Total current liabilities 51,432,000 47,465,000 Equipment financing obligations including maturities due within one year: 1995- $21,469,000; 1994-$30,214,000 573,554,000 498,365,000 Long-term debt 632,000 782,000 Other liabilities 10,028,000 8,898,000 Deferred income taxes 115,830,000 103,010,000\nCommitments and contingent liabilities (see Notes to the Consolidated Financial Statements)\nShareholders' equity: Common stock, $1 par value, outstanding: 1995-44,954,679 shares; 1994-45,770,678 shares 44,955,000 45,771,000 Capital in excess of par value 11,453,000 20,319,000 Retained earnings 219,145,000 185,107,000 Total shareholders' equity 275,553,000 251,197,000 Total liabilities and shareholders' equity $1,027,029,000 $ 909,717,000 The Notes to the Consolidated Financial Statements are an integral part of these statements.\nCONSOLIDATED STATEMENT OF CASH FLOWS\nYear Ended September 30, 1995 1994 1993 Cash flows from operating activities: Net earnings $ 41,336,000 $ 39,828,000 $ 30,416,000 Reconciliation of net earnings to net cash flows from operating activities: Depreciation and amortization 147,003,000 130,741,000 118,366,000 Net gain on sale of property and equipment (12,657,000) (8,530,000) (6,139,000) Changes in assets and liabilities: Notes and accounts receivable 1,085,000 (3,114,000) 9,769,000 Accounts payable and accrued liabilities 3,963,000 3,856,000 3,892,000 Current and deferred income taxes 18,956,000 12,946,000 11,542,000 Other, net (1,165,000) (2,072,000) (1,315,000) Net cash provided by operating activities 198,521,000 173,655,000 166,531,000\nCash flows from investing activities: Purchase of property and equipment (318,983,000) (297,492,000) (242,910,000) Proceeds from sales of equipment 70,013,000 58,376,000 48,953,000 Net cash used in investing activities (248,970,000) (239,116,000) (193,957,000)\nCash flows from financing activities: Proceeds of equipment financing obligations 239,128,000 177,126,000 177,498,000 Repayment of equipment financing obligations (163,939,000) (106,068,000) (140,447,000) Repayment of long-term debt (146,000) (203,000) (7,414,000) Payment of dividends (7,298,000) (6,092,000) (5,452,000) Proceeds of stock options exercised 446,000 780,000 759,000 Common stock acquired and retired (10,128,000) - - Other - (69,000) - Net cash provided by financing activities 58,063,000 65,474,000 24,944,000\nNet increase (decrease) in cash 7,614,000 13,000 (2,482,000) Cash beginning of period 15,094,000 15,081,000 17,563,000 Cash end of period $ 22,708,000 $ 15,094,000 $ 15,081,000\nSupplemental information: Interest paid $ 42,692,000 $ 36,425,000 $ 34,933,000 Income taxes paid $ 6,800,000 $ 13,616,000 $ 12,699,000\nThe Notes to the Consolidated Financial Statements are an integral part of these statements.\nNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS\nAccounting Policies\nThe consolidated financial statements include the accounts of all subsidiaries. Intercompany transactions and balances among these subsidiaries have been eliminated.\nLease, rental and other transportation service revenues are recognized over the terms of the respective contracts.\nEarnings per common share are computed assuming the conversion of all potentially dilutive outstanding stock options.\nThe excess of cost over net assets of businesses acquired prior to October 30, 1970 amounting to $4,588,000 is not being amortized since its value, in management's opinion, has not diminished. The excess of cost over net assets of businesses acquired subsequently is being amortized on a straight-line basis over 40 years.\nInventories of transportation equipment parts and supplies are valued at the lower of first-in, first-out cost or market.\nProperty and equipment is carried at cost, net of applicable allowances. Tires placed in service on new equipment are capitalized as part of the original equipment cost. Depreciation is provided on a straight-line, specific-item basis. Depreciable lives for equipment on operating leases and other property and equipment range from 3 to 12 years and 3 to 45 years, respectively. The cost and related accumulated depreciation of property and equipment sold or retired are eliminated from the property accounts and the resulting gain or loss is reflected in the Consolidated Statement of Earnings. Repairs and maintenance are expensed as incurred. Replacement tires are expensed when placed in service. Major additions and improvements are capitalized and written off over the remaining depreciable lives of the assets.\nLeasing operations consist of the long-term leasing and short-term rental of transportation equipment. All leases are classified as operating leases and expire on various dates during the next ten years.\nThe Company retains a specific portion of insurable risks with regard to public liability and workers' compensation claims. Retention levels are currently $500,000. Reserves are established for claims incurred plus an estimate for claims incurred but not reported. Reserve requirements are evaluated and established utilizing historical trends, the Company's experience, claim severity and other factors. Claims estimated to be paid within one year have been classified in accrued liabilities with the balance included with other liabilities.\nEquipment on Operating Leases\nThe Company's investment in equipment on operating leases is as follows:\nSeptember 30, 1995 1994 Transportation equipment $1,058,643,000 $ 951,349,000 Less accumulated depreciation (330,750,000) (313,581,000) $ 727,893,000 $ 637,768,000\nCommitments for the purchase of transportation equipment amounted to $102,601,000 at September 30, 1995.\nAt September 30, 1995, minimum future revenues from non-cancelable leases are as follows:\nYear Ending September 30, 1996 $195,024,000 1997 166,187,000 1998 133,091,000 1999 95,901,000 2000 59,043,000 Later Years 45,926,000 Total future minimum lease revenues $695,172,000\nRevenues include contingent rentals, which represent all commercial rental revenues and the mileage charges on full-service leases, of $183,399,000 in 1995, $169,755,000 in 1994 and $128,528,000 in 1993.\nIndebtedness\nEquipment financing obligations are as follows: September 30, 1995 1994 Revolving Credit Agreement $ 14,000,000 $ 33,500,000 Collateral Trust Debentures: Series G, 9 7\/8% - 50,000,000 Series H, 10.60%, due 1999 75,000,000 75,000,000 Series I, 10.35%, due 2000 50,000,000 50,000,000 Series J, 8 5\/8%, due 1998 30,000,000 30,000,000 Series K, 7 3\/4%, due 1997 50,000,000 50,000,000 Series L, 7 %, due 2003 70,000,000 70,000,000 Series M, 7 %, due 2001 60,000,000 60,000,000 Series N, 8.27 %, due 2002 100,000,000 - Series O, 7.25 %, due 2005 50,000,000 - Other equipment financing obligations 74,554,000 79,865,000 $573,554,000 $498,365,000\nAt September 30, 1995, $21,469,000 of other equipment financing obligations were due within one year with the balance payable through 2000. Interest rates on these obligations averaged 6.9% at September 30, 1995. The other equipment financing obligations are collateralized by certain leasing equipment. The Collateral Trust Debentures are secured by notes from a subsidiary. Two banks provide an unsecured $100,000,000 line under a Revolving Credit Agreement (\"the Revolver\"). At the option of the banks, the Revolver and the Collateral Trust Debentures may be secured by certain leasing equipment. Termination of the Revolver would result in repayment of the outstanding balance over 60 months in equal installments; otherwise, no repayments are required unless the financing value of the eligible equipment available as security falls below the outstanding loan balance. At September 30, 1995, interest rates on borrowings under the Revolver averaged 6.5%. The Revolver provides for the maintenance of specified financial ratios and restricts payments to the Company by a consolidated subsidiary. Net assets of all subsidiaries not restricted under the Revolver totaled $167,193,000 at September 30, 1995.\nEquipment financing obligations due within one year are not classified as current liabilities as the Company intends and has the ability to refinance them on a long-term basis through available credit facilities.\nOn June 7, 1995, the Company arranged for the private placement of $75,000,000 of 6.89% Series P Collateral Trust Debentures due March 15, 2004. Closing will occur on March 15, 1996.\nBased on published bid prices, at September 30, 1995, the estimated fair value of the Company's Collateral Trust Debentures was $508,081,000 compared to the recorded book amount of $485,000,000. The fair value of the remaining $88,554,000 of equipment indebtedness approximates its recorded amount.\nLong-term debt consists of real estate and other obligations payable in installments over various periods to 2001, at interest rates ranging from 6.0% to 9.0%. Land and buildings with a carrying value of $1,816,000 are pledged as collateral.\nThe aggregate amounts of maturities for all indebtedness over the next five years are as follows: 1996-$21,619,000; 1997-$69,055,000; 1998- $15,377,000; 1999-$113,949,000 and 2000-$52,543,000.\nOther Property and Equipment\nThe Company's other property and equipment accounts are as follows:\nSeptember 30, 1995 1994 Land $ 40,117,000 $ 35,376,000 Transportation service facilities 154,943,000 128,414,000 Other operating assets 34,580,000 33,951,000 Less accumulated depreciation (58,297,000) (51,123,000) $171,343,000 $146,618,000\nIncome Taxes\nThe tax provisions for the three years ended September 30, 1995 are comprised as follows:\nYear Ended September 30, 1995 1994 1993 Current: Federal $ 6,584,000 $ 8,692,000 $ 9,101,000 State 1,128,000 2,796,000 2,280,000 Deferred: Federal 16,256,000 13,516,000 8,362,000 State 1,788,000 1,558,000 2,223,000 Rate change - - 2,275,000 Total income taxes $25,756,000 $26,562,000 $24,241,000\nA reconciliation of the tax provisions for the three years ended September 30, 1995 with amounts calculated by applying the statutory federal income tax rate (35.0% in 1995 and 1994 and 34.75% in 1993) to earnings before income taxes for those years is as follows:\nYear Ended September 30, 1995 1994 1993 Federal tax at statutory rate $23,482,000 $23,236,000 $18,993,000 State taxes 1,896,000 2,830,000 2,939,000 Rate change - - 2,275,000 Other 378,000 496,000 34,000 Total income taxes $25,756,000 $26,562,000 $24,241,000\nThe tax effect of temporary differences and the tax credit carryforwards which comprise the current and non-current deferred income tax amounts shown on the balance sheet are as follows: September 30 1995 1994 Depreciation $124,775,000 $111,833,000 Expenses deductible when paid (9,198,000) (8,214,000) Alternative minimum tax credit carryforward (6,924,000) (12,861,000) Other 936,000 780,000 Deferred income taxes, net $109,589,000 $ 91,538,000\nAt September 30, 1995, the Company had alternative minimum tax credit carryforwards of $6,924,000 which have no expiration date. The Company has no tax credit carryforwards for financial reporting purposes since all such credits have been considered in the determination of deferred tax amounts.\nLease Commitments\nThe Company leases some of the premises and equipment used in its operations. Leases classified as operating leases expire on various dates during the next 19 years. Some of the leases are renewable at the Company's option. Minimum future rental payments required under operating leases having non-cancelable terms in excess of one year as of September 30, 1995 are as follows:\nYear Ending September 30, 1996 $ 3,644,000 1997 2,657,000 1998 2,081,000 1999 1,508,000 2000 1,312,000 Later years 5,108,000 Total minimum payments required $16,310,000\nTotal rental expense for all operating leases except those with terms of a month or less was $7,560,000 in 1995, $7,695,000 in 1994 and $8,134,000 in 1993.\nPension Plans\nThe Company maintains a noncontributory pension plan for eligible employees not covered by pension plans under collective bargaining agreements. Pension costs are funded in accordance with the provisions of the Internal Revenue Code. The Company also maintains a nonqualified, noncontributory defined benefit pension plan for certain employees to restore pension benefits reduced by federal income tax regulations. The cost associated with the plan is determined using the same actuarial methods and assumptions as those used for the Company's qualified pension plan.\nThe following table sets forth the funded status and the amount recognized in the Company's balance sheet for the plans:\nSeptember 30, 1995 1994 Actuarial present value of accumulated benefit obligation: Vested $27,081,000 $24,708,000 Non-vested 1,267,000 1,227,000 $28,348,000 $25,935,000\nProjected benefit obligation $33,734,000 $31,190,000 Plan assets at market value 35,230,000 27,481,000 Projected benefit obligation (under) in excess of plan assets (1,496,000) 3,709,000 Unrecognized gain 6,929,000 1,289,000 Unrecognized prior service costs (755,000) (998,000) Unrecognized overfunding at adoption 351,000 421,000 Accrued pension liability $ 5,029,000 $ 4,421,000\nAt September 30, 1995, the assets of the pension plans were invested 74% in equity securities, 22% in fixed income securities and the balance in other short-term interest bearing accounts.\nThe discount rate and the rate of assumed compensation increase for all three years were 8.0% and 5.0%, respectively. The expected long-term rate of return on assets was 9.0% for 1995 and 9.5% for 1994 and 1993.\nThe components of net periodic pension cost are as follows:\nYear Ended September 30, 1995 1994 1993 Service cost $2,175,000 $2,283,000 $1,798,000 Interest cost 2,371,000 2,152,000 1,846,000 Return on plan assets (7,420,000) (947,000) (4,336,000) Net amortization and deferral 4,907,000 (1,580,000) 2,271,000 Net periodic pension cost $2,033,000 $1,908,000 $1,579,000\nEffective October 1, 1994, the Company established a defined contribution 401(k) plan which permits participation by substantially all employees not represented under a collective bargaining agreement.\nThe Company expensed payments to multi-employer pension plans required by collective bargaining agreements of $131,000 in 1995, $172,000 in 1994 and $265,000 in 1993. The actuarial present value of accumulated plan benefits and net assets available for benefits to employees under these plans are not currently available.\nAccrued Liabilities\nAccrued liabilities are as follows: September 30, 1995 1994 Employee compensation $ 7,491,000 $ 8,722,000 Interest 7,541,000 6,052,000 Taxes other than income 10,195,000 9,349,000 Insurance reserves 6,113,000 6,013,000 Environmental 2,817,000 2,178,000 Unbilled services and supplies 7,802,000 5,846,000 Other 1,208,000 1,954,000 $43,167,000 $40,114,000\nShareholders' Equity\nChanges in the components of shareholders' equity are as follows:\nThe Company is authorized to issue 100,000,000 shares of its $1 Par Value Common Stock and 1,000,000 shares of Preferred Stock. The preferred shares are without par value, with terms and conditions of each issue as determined by the Board of Directors.\nEach share of common stock outstanding includes one common stock purchase right (a \"Right\") which is non-detachable and nonexercisable until certain defined events occur, including certain tender offers or the acquisition by a person or group of affiliated or associated persons of 20% of the Company's common stock. Upon the occurrence of certain defined events, the Right entitles the registered holder to purchase one share of common stock of the Company for $26.67 and may be modified to permit certain holders to purchase common stock of the Company or common stock of an acquiring company at a 50% discount. The Rights expire on June 30, 1999 unless earlier redeemed by the Company at a price of $.0045 per Right as permitted under certain conditions.\nThe terms of a credit agreement restrict the Company's dividend payments to consolidated net income earned subsequent to September 30, 1984 subject to certain adjustments. At September 30, 1995, $163,242,000 of retained earnings were available for the payment of cash dividends.\nStock Option Plans\nUnder the Company's stock option plans, options to purchase common stock of the Company may be granted to officers and key employees at not less than 100% of the fair market value at the date of grant. Option activity is as follows:\nYear Ended September 30, 1995 1994 1993 Number of options: Outstanding at beginning of year 1,121,499 1,368,005 1,388,700 Granted 359,500 7,515 261,900 Exercised (146,501) (226,321) (268,164) Expired or canceled (7,725) (27,700) (14,431) Outstanding at September 30 1,326,773 1,121,499 1,368,005\nAt September 30: Options available for grant 954,014 1,305,789 85,604 Options exercisable 539,662 470,500 409,163\nPer share prices: Options granted $11.00 to $11.50 $12.08 $11.92 Options exercised $ 2.39 to $ 7.56 $ 2.39 to $7.56 $ 2.39 to $7.56 Options outstanding $ 2.39 to $12.08 $ 2.39 to $12.08 $ 2.39 to $11.92\nTransactions with Related Parties\nCertain directors and officers of the Company are also directors and officers of Rollins Environmental Services, Inc. and Matlack Systems, Inc.\nThe Company sold materials (principally vehicle fuel) and services (including data processing services) and rented transportation equipment and office space to Rollins Environmental Services, Inc. The aggregate charges for these materials and services, which have been included in revenues or offset against operating expense, as appropriate, in the Consolidated Statement of Earnings, were $6,617,000 in 1995, $6,551,000 in 1994 and $7,359,000 in 1993.\nThe Company provided administrative services and rented office space to Matlack, Inc. for aggregate charges of $3,286,000 in 1995, $2,949,000 in 1994 and $3,077,000 in 1993, which have been included in revenues or offset against operating expense, as appropriate, in the Consolidated Statement of Earnings. Interest charges to Matlack, Inc. were $272,000 in 1995, $593,000 in 1994 and $1,023,000 in 1993.\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 $9,099,000 in 1995, $8,166,000 in 1994 and $7,068,000 in 1993.\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.\nEnvironmental Regulation\nThe Company is subject to certain regulations of the Environmental Protection Agency in that it stores and dispenses petroleum products. Most of these regulations address testing and replacement of underground tanks. The Company's adherence to these regulations is part of its normal business operations. These regulations have not had any material adverse effect upon the Company.\nCommitments and Contingent Liabilities\nThere are various routine claims and legal actions pending against the Company incidental to the ordinary operation of its business. The Company is of the opinion, based on the advice of counsel, that it is only remotely likely that the ultimate resolution of these claims and actions will be material.\nSCHEDULE I - Condensed Financial Information\nROLLINS TRUCK LEASING CORP. BALANCE SHEET ($000 Omitted)\nAssets September 30, 1995 1994 Current Assets (excluding notes receivable from subsidiaries) Cash $ 860 $ 699 Accounts receivable 59 80 Accounts receivable from subsidiaries* 14 14 Other current assets 146 63 Total current assets 1,079 856 Note receivable - Matlack, Inc. - 6,000 Notes receivable from subsidiary* 485,000 379,000 Investments in subsidiaries, at equity* 262,291 234,263 Advances to subsidiaries* 16,830 18,430 Property and equipment, at cost, net of accumulated depreciation 908 921 Other assets 195 173 Total assets $766,303 $639,643\nLiabilities and Shareholders' Equity\nCurrent Liabilities Accounts payable to subsidiaries* $ 29 $ 37 Accounts payable to others 163 164 Accrued liabilities 488 571 Income taxes payable 1,500 769 Total current liabilities 2,180 1,541 Collateral Trust Debentures 9 7\/8% Series - 50,000 10.60% Series H, due 1999 75,000 75,000 10.35% Series I, due 2000 50,000 50,000 8 5\/8% Series J, due 1998 30,000 30,000 7 3\/4% Series K, due 1997 50,000 50,000 7 % Series L, due 2003 70,000 70,000 7 % Series M, due 2001 60,000 60,000 8.27 % Series N, due 2002 100,000 - 7.25 % Series O, due 2005 50,000 - Advances from subsidiaries* 3,160 1,450 Other liabilities - 81 Deferred federal income taxes 410 374 Commitments and contingent liabilities - see notes to the financial statements\nShareholders' equity Common shares $1 Par Value, 100,000,000 shares authorized; issued and outstanding: 1995: 44,954,679; 1994: 45,770,678 44,955 45,771 Capital in excess of par value 11,453 20,319 Retained earnings 219,145 185,107 Total shareholders' equity 275,553 251,197 Total liabilities and shareholders' equity $766,303 $639,643\n* Eliminated in consolidation.\nThe Notes to the Financial Statements are an integral part of these statements.\nSCHEDULE I - Condensed Financial Information (continued)\nROLLINS TRUCK LEASING CORP. STATEMENT OF EARNINGS ($000 Omitted)\nYear Ended September 30, 1995 1994 1993\nRevenues: Dividends from subsidiaries $12,501 $ 1,800 $ 4,800 Other income 5,301 4,502 171 17,802 6,302 4,971\nExpenses: Administrative 3,365 3,418 3,686 Depreciation and amortization 220 193 216 Loss (gain) on sale of property and equipment 9 11 (5) 3,594 3,622 3,897\nEarnings before interest and income taxes 14,208 2,680 1,074\nInterest income 36,995 31,700 29,451 Interest (expense) (36,995) (31,700) (29,451)\nEarnings before income taxes 14,208 2,680 1,074\nIncome taxes (benefit) 980 825 (1,460)\nNet earnings of Rollins Truck Leasing Corp. 13,228 1,855 2,534\nEquity in undistributed net earnings of subsidiaries 28,108 37,973 27,882\nNet earnings $41,336 $39,828 $30,416\nThe Notes to the Financial Statements are an integral part of these statements.\nSCHEDULE I - Condensed Financial Information (continued)\nROLLINS TRUCK LEASING CORP. STATEMENT OF CASH FLOWS ($000 Omitted)\nYear Ended September 30, 1995 1994 1993\nCash flows from operating activities: Earnings prior to equity in subsidiaries' undistributed earnings $ 13,228 $ 1,855 $ 2,534\nReconciliation of earnings to net cash flows from operating activities: Depreciation and amortization 220 193 216 Loss (gain) on sale of property and equipment 9 11 (5) Changes in assets and liabilities: Accounts receivable 70 28 74 Accounts payable and accrued liabilities (92) 9 (230) Current and deferred income taxes 767 275 (176) Other, net (235) (252) 92 Net cash provided by operating activities 13,967 2,119 2,505\nCash flows from investing activities: Purchase of equipment (148) (152) (108) Proceeds from sale of equipment 12 - 5 Net cash used in investing activities (136) (152) (103)\nCash flows from financing activities: Proceeds of equipment financing 150,000 60,000 70,000 Notes receivable from subsidiaries (150,000) (56,300) (68,072) Repayment of notes by subsidiaries 45,600 - 39,500 Repayment of note by Matlack, Inc. 6,000 - 7,750 Repayment of equipment financing (50,000) - (47,250) Payment of dividends (7,298) (6,092) (5,452) Proceeds of stock options exercised 446 780 759 Common stock acquired and retired (10,128) - - Notes payable to subsidiary 1,710 - - Other - (69) - Net cash used in financing activities (13,670) (1,681) (2,765)\nNet increase (decrease) in cash 161 286 (363)\nCash beginning of period 699 413 776\nCash end of period $ 860 $ 699 $ 413\nSupplemental information:\nInterest paid $ 35,291 $ 31,525 $ 29,979 Income taxes paid $ 6,710 $ 10,660 $ 9,572\nThe Notes to the Financial Statements are an integral part of these statements.\nSCHEDULE I - Condensed Financial Information (continued)\nROLLINS TRUCK LEASING CORP. Notes to the Financial Statements\nAccounting Policies\nThe accounting policies of the Registrant and its subsidiaries are set forth on page 14 of this 1995 Annual Report on Form 10-K.\nThe Company's principal sources of earnings are dividends and management fees paid by its subsidiaries. Certain loan agreements restrict payments to the Company by its subsidiaries. Net assets of subsidiaries not restricted under such loan agreements totaled $167,193,000 at September 30, 1995. The Company also realizes cash receipts by assessing subsidiaries for federal taxes on income and expends cash in payment of such taxes on a consolidated basis. Tax assessments are based on the amount of federal income taxes which would be payable (recoverable) by each subsidiary company based on its current year's earnings (loss) reduced by that subsidiary's applicable portion of any consolidated carryforward or carryback of net operating losses, investment tax credits, alternative minimum tax credits or similar items utilized currently in the consolidated federal income tax return.\nInterest income on notes receivable from a subsidiary and from Matlack, Inc. which are pledged to secure the Collateral Trust Debentures (described on page 15 of this 1995 Annual Report on Form 10-K) was $36,995,000, $31,700,000 and $29,451,000 in 1995, 1994 and 1993, respectively.\nCommitments and Contingencies\nThe Company is obligated to an affiliated company for $404,000 annually ($2,523,000 in the aggregate) of future rentals under a lease to 2001. Rent expense was $398,000 in 1995 and $391,000 in 1994 and 1993.\nCommitments of the Company have been collateralized by bank letters of credit issued on behalf of the Company in the amount of $4,950,000.\nThe aggregate amounts of maturities for the Collateral Trust Debentures during the next five years are $50,000,000 in 1997, $105,000,000 in 1999 and $50,000,000 in 2000.\nROLLINS TRUCK LEASING CORP. AND SUBSIDIARIES SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS ($000 OMITTED)\n(1) Recoveries. (2) Write-offs.\nROLLINS TRUCK LEASING CORP.\nExhibits to Form 10-K\nFor Fiscal Year Ended September 30, 1995\nIndex to Exhibits Page Nos.\nExhibit 21 Rollins Truck Leasing Corp. 27 Subsidiaries at September 30, 1995\nExhibit 23 Consent of Independent Auditors 28\nExhibit 27 Rollins Truck Leasing Corp. 29 Financial Data Schedule at September 30, 1995\nExhibit 21\nROLLINS TRUCK LEASING CORP. Subsidiaries of Registrant at September 30, 1995\nJURISDICTION OF NAME INCORPORATION\nRollins Logistics Inc. Delaware\nRollins Leasing Corp. Delaware\nRollins Properties, Inc. Delaware\nTransrisk, Limited Bermuda\nExhibit 23\nThe Board of Directors Rollins Truck Leasing Corp.:\nWe consent to incorporation by reference in Registration Statement No. 33-67682 filed on Form S-3 by Rollins Truck Leasing Corp. of our report dated October 25, 1995, relating to the consolidated balance sheets of Rollins Truck Leasing Corp. and subsidiaries as of September 30, 1995 and 1994 and the related consolidated statements of earnings and cash flows and related schedules for each of the years in the three-year period ended September 30, 1995, which report appears on page 10 of this 1995 Annual Report on Form 10-K of Rollins Truck Leasing Corp.\nKPMG Peat Marwick LLP\nPhiladelphia, Pennsylvania November 29, 1995","section_15":""}
{"filename":"810481_1995.txt","cik":"810481","year":"1995","section_1":"ITEM 1. BUSINESS - ------ --------\nORGANIZATION - ------------\nMcNeil Real Estate Fund XXVII, L.P. (the \"Partnership\"), formerly known as Southmark Prime Plus, L.P., was organized by affiliates of Southmark Corporation (\"Southmark\") on January 16, 1987 as a limited partnership under the provisions of the Delaware Revised Uniform Limited Partnership Act to make short-term loans to affiliates of the general partner. The general partner of the Partnership is McNeil Partners, L.P. (the \"General Partner\"), a Delaware limited partnership, an affiliate of Robert A. McNeil (\"McNeil\"). The General Partner was elected at a meeting of limited partners on March 30, 1992, at which time an amended and restated partnership agreement (the \"Amended Partnership Agreement\") was adopted. Prior to March 30, 1992, the general partner of the Partnership was Prime Plus Corp. (the \"Original General Partner\"), a wholly-owned subsidiary of McNeil. The Original General Partner was purchased from Southmark by McNeil on March 13, 1991, as discussed further below. The principal place of business for the Partnership and the General Partner is 13760 Noel Road, Suite 700, Dallas, Texas 75240.\nThe sole limited partner of the Partnership was initially Southmark Depositary Corp. (the \"Depositary\"), a wholly-owned subsidiary of Southmark. On August 14, 1987, the Partnership registered with the Securities and Exchange Commission (\"SEC\") under the Securities Act of 1933 (File No. 33-11824) and commenced a public offering for sale of $100,000,000 of Depositary units. The sale of Depositary units closed on August 14, 1988, with 5,548,888 units sold at $10 each, or gross proceeds of $55,488,880 to the Partnership. The Partnership subsequently filed a Form 8-A Registration Statement with the SEC and registered its Depositary units under the Securities Exchange Act of 1934 (File No. 0-17173). The Depositary assigned the principal attributes of its aggregate limited partner interest in the Partnership to the Depositary unit holders. As further discussed, the Depositary units were subsequently converted to limited partnership units. The Depositary, Depositary units or limited partnership units are referred to herein as \"Units\" and the holders thereof as \"Unitholders.\" The Units represent equity interests in the Partnership and entitle the Unitholders to participate in certain allocations and distributions of the Partnership. As of December 31, 1995, 275,003 of the Units have been repurchased pursuant to the terms of the Amended Partnership Agreement.\nSOUTHMARK BANKRUPTCY AND CHANGE IN GENERAL PARTNER - --------------------------------------------------\nOn July 14, 1989, Southmark filed a voluntary petition for reorganization under Chapter 11 of the U.S. Bankruptcy Code. Neither the Partnership, the General Partner nor the Original General Partner were included in the filing. Southmark's reorganization plan became effective August 10, 1990. Under the plan, most of Southmark's assets, which included Southmark's interests in the Original General Partner, are being sold or liquidated for the benefit of creditors.\nIn accordance with Southmark's reorganization plan, Southmark, McNeil and various of their affiliates entered into an asset purchase agreement on October 12, 1990, providing for, among other things, the transfer of control to McNeil or his affiliates of 34 limited partnerships (including the Partnership) in the Southmark portfolio.\nOn February 14, 1991, pursuant to the asset purchase agreement as amended on that date, McNeil Real Estate Management, Inc. (\"McREMI\"), an affiliate of McNeil, acquired the assets relating to the property management and partnership administrative business of Southmark and its affiliates. On March 13, 1991, McREMI commenced management of the Partnership's properties pursuant to an assignment of the existing property management agreements from the Southmark affiliates.\nOn March 30, 1992, the Unitholders approved a restructuring proposal that provided for (i) the replacement of the Original General Partner with the General Partner; (ii) the adoption of the Amended Partnership Agreement which (a) substantially alters the provisions of the original Partnership Agreement relating to, among other things, compensation, reimbursements of expenses, and voting rights and (b) makes Depositary unit holders direct limited partners of the Partnership; (iii) the approval of an amended property management agreement with McREMI, the Partnership's property manager; and (iv) the approval to change the Partnership's name to McNeil Real Estate Fund XXVII, L.P. Under the Amended Partnership Agreement, the Partnership began accruing an asset management fee,\nretroactive to March 13, 1991, which is payable to the General Partner. For a discussion of the methodology for calculating the asset management fee, see Item 13 - Certain Relationships and Related Transactions. The proposals approved at the March 30, 1992 meeting were implemented as of that date.\nSettlement of Claims:\nThe Partnership filed claims with the United States Bankruptcy Court for the Northern District of Texas, Dallas Division (the \"Bankruptcy Court\") against Southmark for damages relating to improper overcharges, breach of contract and breach of fiduciary duty. The Partnership settled these claims in 1991, which totaled approximately $17,024,326, for the full amount claimed and such settlement was approved by the Bankruptcy Court.\nPursuant to the settlement agreement, the Partnership released Southmark and its affiliates and the Original General Partner from any further liability in connection with the claims made with the Bankruptcy Court. In return, an affiliate of McNeil agreed to waive payment on a dollar for dollar basis in an amount equal to the settled claims against Partnership advances owed at that time. In addition, the Partnership received Southmark bankruptcy plan assets in respect to its claims which were not offset against the Partnership advances. Because the Partnership's claims against Southmark were settled for $17,024,326, the Partnership advances of $223,800 owed at that time were reduced in their entirety and the claims had a remaining balance of $16,800,526. Although the Partnership settled the claims against Southmark for the full amount claimed, the settlement agreement provided that the Partnership receive a distribution of Southmark bankruptcy plan assets based on a claim amount of approximately $9,157,000.\nAn Order Granting Motion to Distribute Funds to Class 8 Claimants dated April 14, 1995 was issued by the Bankruptcy Court. In accordance with the Order, in May 1995, the Partnership received in full satisfaction of its claims, $984,649 in cash, and common and preferred stock in the reorganized Southmark which was subsequently sold for $317,675. These amounts represent the Partnership's pro-rata share of Southmark assets available for Class 8 Claimants.\nCURRENT OPERATIONS - ------------------\nGeneral:\nUnder the original partnership agreement, the Partnership's primary business was to make short-term nonrecourse mortgage or deed of trust loans to affiliates of the Original General Partner and to partnerships or real estate investment trusts sponsored by affiliates of the Original General Partner formed for the purpose of acquiring income-producing real properties. Due to borrower defaults and foreclosures on the properties securing all but one of these mortgages, the Partnership's business also includes ownership and operation of real estate. Since the beginning of operations and prior to the restructuring, the Partnership funded twelve mortgage loans, seven in 1987 and five in 1988, which completed the Partnership's investment of the proceeds from the sale of Units.\nThe borrowers on the mortgage loan investments held by the Partnership were all affiliates of Southmark. During the early part of the terms of the loans, to the extent that property operations were insufficient to pay required interest, Southmark supported the borrowers with cash and the Partnership's loans were kept current. On July 14, 1989, Southmark filed for bankruptcy protection, and such support ceased and all loans went into default.\nIn 1994, the remaining mortgage loan investment, which is secured by a mini-storage warehouse in Stone Mountain, Georgia that was sold to an unaffiliated borrower, was modified. Principal and interest payments under the modified terms have been received by the Partnership. See Item 8 - Note 5 - \"Mortgage Loan Investment.\"\nIn 1992, the Partnership received the proceeds from a $7,000,000 mortgage note payable secured by five of the Partnership's mini-storage warehouses located in Florida. A portion of the proceeds from the loan was used to make nonrecourse mortgage loans to affiliates of the General Partner in accordance with the Amended Partnership Agreement. The loans were secured by income-producing real estate and were either junior or senior to other indebtedness as more fully described in Item 8 - Note 6 - \"Mortgage Loan Investments - Affiliates.\" The mortgage note payable was repaid by the Partnership in 1995 and a $5 million line of credit was obtained that will be used to fund any future loans made to affiliates of the General Partner. See Item 8 - Note 7 - \"Long-Term Debt.\"\nThe Partnership is engaged in the ownership, operation and management of commercial real estate and other real estate related assets. At December 31, 1995, the Partnership owned one mortgage loan investment to an unaffiliated borrower, three mortgage loan investments to affiliates of the General Partner, and ten income-producing properties as described in Item 2","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES - ------ ----------\nThe following table sets forth the real estate investment portfolio of the Partnership at December 31, 1995. All of the buildings and the land on which they are located are owned in fee. The two office buildings and Kendall Sunset Mini-Storage secure a $5 million line of credit as described more fully in Item 8 - Note 7 - \"Long-Term Debt.\" No borrowings were outstanding under the line of credit as of December 31, 1995. The remaining properties are unencumbered by mortgage indebtedness. See also Item 8 - Note 4 - \"Real Estate Investments\" and Schedule III - Real Estate Investments and Accumulated Depreciation and Amortization. In the opinion of management, the properties are adequately covered by insurance.\n- ----------------------------------------- Total: Office Buildings - 222,398 sq. ft. Mini-storage and self-storage warehouses - 6,074 units\nThe following table sets forth the properties' occupancy rate and rent per square foot for the last five years:\nOccupancy rate represents all units leased divided by the total number of units for mini-storage properties and square footage leased divided by total square footage for other properties as of December 31 of the given year. Rent per square foot represents all revenue, except interest, derived from the property's operations divided by the leasable square footage of the property.\nCompetitive conditions: - ----------------------\nAAA Century Airport - -------------------\nAAA Century Airport Self-Storage consists of three, two-story self-storage warehouse buildings and one apartment\/leasing office. The rentable space is divided into 567 units, including 10 recreational vehicle parking spaces. Each unit is individually alarmed for additional security. The property does not offer climate-controlled units.\nThe property is located approximately two miles from the Los Angeles International Airport in Inglewood, California. Inglewood is a relatively mature area with growth to the west generated by development around the airport. There is little competition which represents a threat to the property. The property raised rental rates in 1995 and plans to increase rental rates slightly in 1996. The Partnership expects to maintain occupancy in the low to middle 90% range in 1996.\nAAA Sentry - ----------\nAAA Sentry Mini-Storage consists of five, two-story self-storage warehouse buildings and one apartment\/leasing office. The rentable space is divided into 803 units, with 85% of these units air conditioned.\nThe property is located in a predominately commercial area, with a mixture of single and multi-family residential properties. The property's rental rates and occupancy are currently higher than the competition in the immediate area. A rental rate increase is not planned until late 1996 since a new competing facility was recently built that may affect occupancy. Management anticipates maintaining occupancy in the middle 90% range in 1996.\nBurbank - -------\nBurbank Mini-Storage consists of two, two-story and one, three-story self-storage warehouse buildings and one apartment\/leasing office. The rentable space is divided into 986 units, with 10 of these units being recreational\nvehicle parking spaces. All of the buildings have fire sprinklers, but do not offer climate-controlled environments.\nThe property is located in the eastern quadrant of Burbank, California, just west of Interstate 5 and approximately twenty miles north of downtown Los Angeles and seven miles south of the Burbank Airport. There are two competing self-storage properties with superior visibility and highway access. Another competing property has recently been built closer to the airport that may have a negative effect on Burbank's occupancy. Due to the property's lack of air conditioning and third floor units that are far away from stairwells or elevators, an increase in occupancy is not likely. The Partnership expects to maintain occupancy in the low 80% range in 1996.\nForest Hill - -----------\nForest Hill Mini-Storage consists of nine, one-story self-storage warehouse buildings and one apartment\/leasing office. The rentable space is divided into 679 units, with 20 of these units being recreational vehicle parking spaces. 35% of the units are air conditioned.\nThe property is located in a predominately residential neighborhood in West Palm Beach, Florida consisting of single family homes and small businesses to the east and multi-family apartment communities to the south and west. The property's rental rates and occupancy are currently higher than the competition in the immediate area.\nConstruction of two competing facilities within one mile of Forest Hill is currently being considered, which could have a negative impact on the property. The Partnership expects to maintain occupancy in the middle 90% range. An increase in rental rates is anticipated in 1996.\nFountainbleau - -------------\nFountainbleau Mini-Storage consists of three, two-story self-storage warehouse buildings and one apartment\/leasing office. The rentable space is divided into 769 units. 56% of the units are air conditioned.\nThe property is located in the central western quadrant of the Miami metroplex and is in close proximity to the Miami International Airport. The immediate neighborhood is predominately industrial with single family residential and multi-family communities further to the south and north. The tenant profile consists of local businesses and a major international moving company that leases more than 90 of the units and receives a 5% discount. The Partnership expects to maintain occupancy in the high 90% range in 1996. Surrounding vacant property is currently being marketed for future mini-storage development. If facilities are built, it could have an impact on the property's performance.\nKendall Sunset - --------------\nKendall Sunset Mini-Storage consists of ten, one-story self-storage warehouse buildings and one apartment\/leasing office. The rentable space is divided into 940 units. 35% of the units are air conditioned.\nThe property is located in a residential neighborhood at the southwestern edge of the Miami metroplex. The area is tropical in nature and is in close proximity to the Everglades and Key West. The property's rental rates and occupancy are currently higher than the competition in the immediate area. The Partnership expects to maintain occupancy in the middle 90% range in 1996. Margate\nMargate Mini-Storage consists of four, one-story and one, three-story self-storage warehouse buildings and one apartment\/leasing office. The rentable space is divided into 642 units, with 11 of the units being recreational vehicle parking spaces. 52% of the units are air conditioned.\nThe property is located in a predominately commercial\/retail neighborhood with single family homes and multi-family communities along the secondary streets. The property's rental rates and occupancy are currently higher than the competition in the immediate area. The development of a new self-storage facility near the property had an adverse effect on the property's occupancy at the end of 1995. However, the Partnership expects to increase occupancy slightly in 1996.\nMilitary Trail - --------------\nMilitary Trail Mini-Storage consists of eight, one-story self-storage warehouse buildings and one apartment\/leasing office. The rentable space is divided into 688 units, with 16 of the units being recreational vehicle parking spaces. 35% of the units are air conditioned.\nThe property is located in a predominately commercial\/retail neighborhood. The majority of the apartment complexes in the area are to the north with single family residences to the west. The location is the most positive feature with direct access on Military Trail, a major thoroughfare. There are two competitors in the immediate area with similar access and appearance but inferior management. The Partnership expects to maintain occupancy in the low 90% range throughout 1996.\nOne Corporate Center I and One Corporate Center III - ---------------------------------------------------\nOne Corporate Center I and III are six-story class \"B\" office buildings located in the southwest suburban Minneapolis\/St. Paul metropolitan area. The buildings are two of four identical buildings located in a commercial development identified as One Corporate Center.\nThere has been no new office development in the past three years and no new speculative construction is currently underway, so there has been a continued demand for a decreasing supply of space. Developers are currently actively seeking tenants for potential competing construction. Management will concentrate on retaining existing tenants in 1996. The properties will continue to perform capital improvements in 1996 in order to replace aging building systems and to upgrade common areas to remain competitive in the marketplace. The Partnership will continue to lease up vacancies with few concessions and higher rental rates. The Partnership expects to maintain occupancy in the middle 90% range.\nThe following schedule shows lease expirations for each of the Partnership's commercial properties for 1996 through 2005:\nNo mini-storage tenant leases 10% or more of the available rental space except for a moving company that leases approximately 12% of the units at Fountainbleau Mini-Storage on a month-to-month basis. The following schedule reflects information on commercial tenants occupying 10% or more of the leasable square feet for each property:\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS - ------ -----------------\nThe Partnership is not party to, nor are any of the Partnership's properties the subject of, any material pending legal proceedings, other than ordinary, routine litigation incidental to the Partnership's business, except for the following:\n1) HCW Pension Real Estate Fund, Ltd. et al. v. Ernst & Young, BDO Seidman et al. (Case #92-06560-A). This suit was filed on behalf of the Partnership and other affiliated partnerships (the \"Affiliated Partnerships\") on May 26, 1992, in the 14th Judicial District Court of Dallas County. The petition sought recovery against the Partnership's former auditors, Ernst & Young, for negligence and fraud in failing to detect and\/or report overcharges of fees\/expenses by Southmark, the former general partner. The former auditors initially asserted counterclaims against the Affiliated Partnerships based on alleged fraudulent misrepresentations made to the auditors by the former management of the Affiliated Partnerships (Southmark) in the form of client representation letters executed and delivered to the auditors by Southmark management. The counterclaims sought recovery of attorneys' fees and costs incurred in defending this action. The counterclaims were later dismissed on appeal, as discussed below.\nThe trial court granted summary judgment against the Partnership based on the statute of limitations; however, on appeal, the Dallas Court of Appeals reversed the trial court and remanded for trial the Affiliated Partnerships' fraud claims against Ernst & Young. The Texas Supreme Court denied Ernst & Young's application for writ of error on January 11, 1996. The Partnership is continuing to pursue vigorously its claims against Ernst & Young; however, the final outcome of this litigation cannot be determined at this time.\n2) Robert Lewis v. McNeil Real Estate Fund XXVII, L.P. and McNeil Partners, L.P., Civil Action No. 13287 (Del. Ch.). This complaint alleged, among other things, that the General Partner caused the Partnership to loan money to affiliated partnerships at rates lower than the Partnership's cost of borrowing, which the plaintiff alleged constituted a breach of the General Partner's fiduciary duties. The complaint alleged that the affiliate loans were designed to enable the affiliated partnerships to continue in business so as to enable the General Partner to continue collecting fees from them. An answer to the complaint was filed on February 3, 1994, denying the material averments of wrongdoing and asserting affirmative defenses. In 1995, the plaintiff and the Partnership executed a Stipulation and Order of Dismissal, which dismissed the action without prejudice.\n3) Helen Pasco v. McNeil Real Estate Fund XXVII, L.P., Southmark Prime Plus Corp., et al. and Does 1-50 Inclusive. This complaint alleges that several limited partnerships and funds, including the Partnership, along with McMachen, Prudential Securities, Inc. and other unidentified defendants, transmitted false and misleading information to the plaintiff which was used to entice the plaintiff into investing her money with the defendants. The complaint also alleges that the defendants misrepresented speculative, illiquid limited partnerships as safe, income-producing investments suitable for safety-conscious and conservative investors. Although the Partnership is included as a defendant, the plaintiff's allegations do not specify in what way the Partnership was involved in improper conduct. The complaint does not state, other than by broad allegations, that the Partnership acted in an improper manner with regard to the operation or management of the limited partnership. An answer was filed on behalf of the Partnership in February 1994, and there has been no further action in this matter. The ultimate outcome of this case cannot be determined at this time.\nFor a discussion of the Southmark bankruptcy, see Item 1 - Business.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - ------ ---------------------------------------------------\nNone. PART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S UNITS OF LIMITED PARTNERSHIP - ------ -------------------------------------------------------- AND RELATED SECURITY HOLDER MATTERS -----------------------------------\n(A) There is no established public trading market for limited partnership units, nor is one expected to develop.\n(B) Title of Class Number of Record Unit Holders -------------- -----------------------------\nLimited partnership units 2,715 as of February 16, 1996\n(C) No distributions were paid to the partners in 1995 or 1994. Distributions have been suspended since the first quarter of 1992. See Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations, and Item 8 - Note 1 - \"Organization and Summary of Significant Accounting Policies - Distributions.\"\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA - ------ -----------------------\nThe following table sets forth a summary of certain financial data for the Partnership. This summary should be read in conjunction with the Partnership's financial statements and notes thereto appearing in Item 8.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION - ------ ----------------------------------------------------------- AND RESULTS OF OPERATIONS -------------------------\nFINANCIAL CONDITION - -------------------\nUnder the original partnership agreement, the Partnership was formed to engage in the business of making short-term nonrecourse mortgage or deed of trust loans to affiliates of the Original General Partner and to partnerships or real estate investment trusts sponsored by affiliates of the Original General Partner formed for the purpose of acquiring income-producing real properties and reinvesting the proceeds from repayment of such loans in additional affiliate loans. In 1989, the Partnership initiated foreclosure proceedings on the collateral securing each of its mortgage loan investments. The Partnership acquired two office buildings in 1989 and eight mini-storage warehouses in 1990 as a result of the foreclosures. Also in 1990, one loan was collected in full when the borrower sold the mini-storage warehouse securing the loan. The remaining mortgage loan investment, secured by a mini-storage warehouse owned by an unaffiliated limited partnership, was modified in 1994.\nIn October 1992, the Partnership received approximately $6.5 million of net proceeds from a $7 million loan secured by five of the Partnership's mini-storage warehouses located in Florida. A portion of the proceeds were used for working capital and for general partnership purposes. The loan proceeds were also used to make such loans to affiliates in accordance with the Amended\nPartnership Agreement as more fully described in Item 8","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - ------ -------------------------------------------\nAll other schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Partners of McNeil Real Estate Fund XXVII, L.P.:\nWe have audited the accompanying balance sheets of McNeil Real Estate Fund XXVII, L.P. (a Delaware limited partnership) as of December 31, 1995 and 1994, and the related statements of operations, partners' equity (deficit) and cash flows for each of the three years in the period ended December 31, 1995. These 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 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 McNeil Real Estate Fund XXVII, L.P. as of December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\nOur audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule listed in the index to financial statements is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in our audits of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\n\/s\/ Arthur Andersen, LLP\nDallas, Texas March 21, 1996\nMCNEIL REAL ESTATE FUND XXVII, L.P.\nBALANCE SHEETS\nSee accompanying notes to financial statements.\nMcNEIL REAL ESTATE FUND XXVII, L.P. STATEMENTS OF OPERATIONS\nSee accompanying notes to financial statements.\nMcNEIL REAL ESTATE FUND XXVII, L.P.\nSTATEMENTS OF PARTNERS' EQUITY (DEFICIT)\nFor the Years Ended December 31, 1995, 1994 and 1993\nSee accompanying notes to financial statements.\nMcNEIL REAL ESTATE FUND XXVII, L.P.\nSTATEMENTS OF CASH FLOWS\nIncrease (Decrease) in Cash and Cash Equivalents\nSee accompanying notes to financial statements.\nMcNEIL REAL ESTATE FUND XXVII, L.P.\nSTATEMENTS OF CASH FLOWS\nReconciliation of Net Income to Net Cash Provided by Operating Activities\nSee accompanying notes to financial statements.\nMcNEIL REAL ESTATE FUND XXVII, L.P.\nNOTES TO FINANCIAL STATEMENTS\nDECEMBER 31, 1995\nNOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - ------ -----------------------------------------------------------\nOrganization - ------------\nMcNeil Real Estate Fund XXVII, L.P. (the \"Partnership\"), formerly known as Southmark Prime Plus, L.P., was organized by affiliates of Southmark Corporation (\"Southmark\") on January 16, 1987, as a limited partnership under the provisions of the Delaware Revised Uniform Limited Partnership Act to make short-term loans to affiliates of the general partner. The general partner of the Partnership is McNeil Partners, L.P. (the \"General Partner\"), a Delaware limited partnership, an affiliate of Robert A. McNeil (\"McNeil\"). The General Partner was elected at a meeting of limited partners on March 30, 1992, at which time an amended and restated partnership agreement (the \"Amended Partnership Agreement\") was adopted. Prior to March 30, 1992, the general partner of the Partnership was Prime Plus Corp. (the \"Original General Partner\"), a wholly-owned subsidiary of McNeil. The Original General Partner was purchased from Southmark by McNeil on March 13, 1991. The principal place of business for the Partnership and the General Partner is 13760 Noel Road, Suite 700, Dallas, Texas 75240.\nThe sole limited partner of the Partnership was initially Southmark Depositary Corp. (the \"Depositary\"), a wholly-owned subsidiary of Southmark. The Depositary assigned the principal attributes of its aggregate limited partner interest in the Partnership to the Depositary unit holders. The Depositary units were subsequently converted to limited partnership units. The Depositary, Depositary units or limited partnership units are referred to herein as \"Units\" and the holders thereof as \"Unitholders.\"\nUnder the original partnership agreement, the Partnership's primary business was to make short-term nonrecourse mortgage or deed of trust loans to affiliates of the Original General Partner and to partnerships or real estate investment trusts sponsored by affiliates of the Original General Partner formed for the purpose of acquiring income-producing real properties. Due to borrower defaults and foreclosures on the properties securing all but one of these mortgages, the Partnership's business also includes ownership and operation of real estate.\nIn 1992, the Partnership received the proceeds from a $7 million mortgage note payable secured by five of the Partnership's mini-storage warehouses located in Florida. A portion of the proceeds from the loan was used to make nonrecourse mortgage loans to affiliates of the General Partner in accordance with the Amended Partnership Agreement. The loans were secured by income-producing real estate and were either junior or senior to other indebtedness as more fully described in Note 6 - \"Mortgage Loan Investments - Affiliates.\" The mortgage note payable was repaid by the Partnership in 1995 and a $5 million line of credit was obtained that will be used to fund any future loans made to affiliates of the General Partner. See Note 7 - \"Long-Term Debt.\"\nThe Partnership is engaged in the ownership, operation and management of commercial real estate and other real estate related assets. At December 31, 1995, the Partnership owned one mortgage loan investment to an unaffiliated borrower, three mortgage loan investments to affiliates of the General Partner, and ten income-producing properties as described in Note 4 - \"Real Estate Investments.\"\nBasis of Presentation - ---------------------\nThe accompanying financial statements have been prepared in conformity with generally accepted accounting principles (\"GAAP\"). The preparation of financial statements in conformity with GAAP 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.\nReal Estate Investments - -----------------------\nReal estate investments are generally stated at the lower of cost or net realizable value. Real estate investments are monitored on an ongoing basis to determine if the property has sustained a permanent impairment in value. At such time, a write-down is recorded to reduce the basis of the property to its net realizable value. A permanent impairment is determined to have occurred when a decline in property value is considered to be other than temporary based upon management's expectations with respect to projected cash flows and prevailing economic conditions.\nImprovements and betterments are capitalized and expensed through depreciation charges. Repairs and maintenance are charged to operations as incurred.\nIn March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of.\" This statement requires that long-lived assets and certain identifiable intangibles to be held and used by an entity be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. This statement is effective for financial statements for fiscal years beginning after December 15, 1995. The Partnership has not adopted the principles of this statement within the accompanying financial statements; however, it is not anticipated that adoption will have a material effect on the carrying value of the Partnership's long-lived assets.\nDepreciation and Amortization - -----------------------------\nBuildings and improvements are depreciated using the straight-line method over the estimated useful lives of the assets, ranging from 5 to 25 years. Tenant improvements are capitalized and are amortized over the terms of the related tenant lease, using the straight-line method.\nMortgage Loan Investments - -------------------------\nMortgage loan investments are recorded at their original basis, net of any allowance for uncollectible amounts. Interest income is recognized as it is earned. Interest accrual is ceased at such time as management determines collection is doubtful.\nCash and Cash Equivalents - -------------------------\nCash and cash equivalents include cash on hand and cash on deposit in financial institutions with original maturities of three months or less. Carrying amounts for cash and cash equivalents approximate fair value.\nDeferred Borrowing Costs - ------------------------\nLoan fees and other related costs incurred to obtain long-term financing on real property are capitalized and amortized using a method that approximates the effective interest method over the term of the related mortgage note payable or line of credit agreement. Amortization of deferred borrowing costs is included in interest expense on the Statements of Operations.\nRental Revenue - --------------\nThe Partnership leases its mini-storage warehouses under short-term operating leases. Lease terms generally are less than one year in duration. Rental revenue is recognized as earned.\nThe Partnership leases its commercial properties under non-cancelable operating leases. Certain leases provide concessions and\/or periods of escalating or free rent. Rental revenue is recognized on a straight-line basis over the term of the related leases. The excess of the rental revenue recognized over the contractual rental payments is recorded as accrued rent receivable and is included in accounts receivable on the Balance Sheets.\nIncome Taxes - ------------\nNo provision for Federal income taxes is necessary in the financial statements of the Partnership because, as a partnership, it is not subject to Federal income tax and the tax effect of its activities accrues to the partners.\nAllocation of Net Income and Net Loss - -------------------------------------\nThe Amended Partnership Agreement provides for net income and net losses of the Partnership to be allocated 99% to the Unitholders and 1% to the General Partner.\nFederal income tax law provides that the allocation of loss to a partner will not be recognized unless the allocation is in accordance with a partner's interest in the partnership or the allocation has substantial economic effect. Internal Revenue Code Section 704(b) and accompanying Treasury Regulations establish criteria for allocation of Partnership deductions attributable to debt. The Partnership's tax allocations for 1995, 1994, and 1993 have been made in accordance with these provisions.\nDistributions - -------------\nAt the discretion of the General Partner, distributions to the partners are paid from cash from operations available after payment of affiliate compensation. Under the terms of the Amended Partnership Agreement, the General Partner is not entitled to distributions from operations.\nCash from operations available for distribution is determined by provisions of the Amended Partnership Agreement, and differs from the amount reported as net cash provided by operating activities in the accompanying Statements of Cash Flows. Cash from operations available for distribution consists of cash received from operations of the Partnership during a given period of time less (1) operational cash disbursements during the same period of time including capital improvements, unscheduled mortgage principal reductions and repayment of Partnership advances from affiliates, (2) a reasonable allowance for reserves, contingencies and anticipated obligations as determined at the discretion of the General Partner, (3) proceeds held pending investment in affiliate loans, and (4) any monies reserved for repurchase of Units.\nLiquidation proceeds will be distributed when the Partnership is dissolved and wound up after taking into account all items of income, gain, loss or deduction. Distribution of liquidation proceeds will then be made to the partners with positive capital account balances.\nNo distributions were paid to the partners in 1995, 1994 or 1993. In March 1996, the Partnership distributed $3,000,000 to the limited partners.\nNet Income Per Hundred Limited Partnership Units - ------------------------------------------------\nNet income per one hundred Units is computed by dividing net income allocated to the limited partners by the weighted average number of Units outstanding expressed in hundreds. Per unit information has been computed based on 53,109, 53,483 and 53,914 (in hundreds) Units outstanding in 1995, 1994 and 1993, respectively.\nNOTE 2 - TRANSACTIONS WITH AFFILIATES - ------ ----------------------------\nThe Partnership pays property management fees equal to 5% of the gross rental receipts for its mini-storage warehouses and 6% of gross rental receipts for its commercial properties to McNeil Real Estate Management, Inc. (\"McREMI\"), an affiliate of the General Partner, for providing property management services for the Partnership's mini-storage warehouses and commercial properties and leasing services for its mini-storage warehouses. McREMI may also choose to provide leasing services for the Partnership's commercial properties, in which case McREMI will receive property management fees from such commercial properties equal to 3% of the property's gross rental receipts plus leasing commissions based on the prevailing market rate for such services where the property is located.\nThe Partnership reimburses McREMI for its costs, including overhead, of administering the Partnership's affairs.\nUnder the terms of the Amended Partnership Agreement, the Partnership is paying an asset management fee to the General Partner. Through 1999, the asset management fee is calculated as 1% of the Partnership's tangible asset value. Tangible asset value is determined by using the greater of (i) an amount calculated by applying a capitalization rate of 9 percent to the annualized net operating income of each property or (ii) a value of $30 per gross square foot for mini-storage warehouses and $50 per gross square foot for commercial properties to arrive at the property tangible asset value. The property tangible asset value is then added to the book value of all other assets excluding intangible items. The fee percentage decreases subsequent to 1999.\nCompensation and reimbursements paid to or accrued for the benefit of the General Partner or its affiliates are as follows:\nUntil March 13, 1991, the Original General Partner was entitled to receive, out of cash from operations, a performance incentive fee equal to 20% of all points received by the Partnership on mortgage loans if the Unitholders received distributions of cash from operations equal to a 10% cumulative noncompounding annual return on their original capital investment. Such fees were cumulative, were accrued in the years earned and are to be paid when conditions were met. Conditions for payment have not yet been met and, at December 31, 1995 and 1994, $141,647 of amounts accrued in prior years are included in payable to affiliates on the Balance Sheets.\nUnder the terms of the Amended Partnership Agreement, the Partnership is expressly permitted to make loans to affiliates of the General Partner, so long as such loans meet certain conditions. See Note 6 - \"Mortgage Loan Investments - Affiliates\" for a discussion of these transactions.\nPayable to affiliates at December 31, 1995 and 1994 consisted primarily of the performance incentive fee of $141,647 accrued in prior years, property management fees, Partnership general and administrative expenses, asset management fees and prepaid interest as further discussed in Note 6 - \"Mortgage Loan Investments - Affiliates.\" Except for the performance incentive fee and prepaid interest, all accrued fees are due and payable from current operations.\nNOTE 3 - TAXABLE INCOME - ------ --------------\nMcNeil Real Estate Fund XXVII, L.P. is a partnership and is not subject to Federal and state income taxes. Accordingly, no recognition has been given to income taxes in the accompanying financial statements of the Partnership since the income or loss of the Partnership is to be included in the tax returns of the individual partners. The tax returns of the Partnership are subject to examination by Federal and state taxing authorities. If such examinations result in adjustments to distributive shares of taxable income or loss, the tax liability of the partners could be adjusted accordingly.\nThe Partnership's net assets and liabilities for financial reporting purposes exceeded the net assets and liabilities for tax purposes by $11,258,459 in 1995, $10,569,292 in 1994 and $10,682,379 in 1993.\nNOTE 4 - REAL ESTATE INVESTMENTS - ------ -----------------------\nThe basis and accumulated depreciation of the Partnership's real estate investments at December 31, 1995 and 1994 are set forth in the following tables:\nThe Partnership leases its office buildings under non-cancelable operating leases. Future minimum rents to be received as of December 31, 1995 are as follows:\n1996.................................... $2,242,000 1997.................................... 1,968,000 1998.................................... 1,157,000 1999.................................... 436,000 2000.................................... 232,000 Thereafter.............................. 125,000 --------- Total $6,160,000\nFuture minimum rents do not include expense reimbursements for common area maintenance, property taxes and other expenses. These expense reimbursements amounted to $130,560, $127,069 and $74,999 for the years ended December 31, 1995, 1994 and 1993, respectively.\nNOTE 5 - MORTGAGE LOAN INVESTMENT - ------ ------------------------\nIn 1987, the Partnership made a nonrecourse mortgage loan to an affiliate of Southmark secured by A-Quality Mini-Storage. The property was subsequently sold to an unaffiliated borrower subject to the Partnership's first priority mortgage loan. On August 6, 1990, the Partnership was advised that Southmark Storage Associates, the borrower on the A-Quality mortgage loan, had filed a petition for bankruptcy in the United States Bankruptcy Court of Connecticut. This action served to automatically stay foreclosure proceedings.\nIn April 1994, the borrower and the Partnership reached a settlement concerning the loan. Under the settlement, the borrower paid the Partnership $150,000 in cash and the loan was renewed for $1,453,194 (representing the original $2,100,000 principal balance less all post bankruptcy petition payments made by the borrower) effective January 1, 1994. An additional second lien loan was executed in the amount of $134,397 at an interest rate of 6%, which was paid in full in the third quarter of 1995. Principal and interest at a rate of prime plus 2% are payable monthly on the first lien loan which matures in January 1997.\nEffective January 1, 1994, the Partnership adopted Statement of Financial Accounting Standards No. 114, \"Accounting by Creditors for Impairment of a Loan\" (\"SFAS 114\"). The impact of adopting SFAS 114 was immaterial to the Partnership's financial statements. In accordance with SFAS 114, the measure of impairment for a loan restructured in a troubled debt restructuring is based on the present value of expected future cash flows discounted at the original contractual rate. Accordingly, upon the April 1994 modification, the Partnership measured the impairment of the mortgage loan investment and determined that an allowance for impairment was still required. For the year ended December 31, 1993, there were no changes in the balance of the allowance for impairment. For the years ended December 31, 1995 and 1994, the allowance for impairment decreased by $172,164 and $83,257, respectively. The 1995 decrease in the allowance was due to the passage of time (the allowance is measured based on discounted cash flows) and the 1994 decrease was primarily due to the April 1994 modification which changed the expected future cash flows.\nSince the April 1994 modification, interest income has been recorded at an interest rate that equates the expected future cash flows to the mortgage loan investment balance. The expected cash flows change slightly from year to year. Additionally, any changes in the allowance for impairment that result from changes in the discount rate or passage of time are also recorded as interest income. This accounting treatment resulted in the recognition of $149,334 and $159,337 of interest income for the years ended December 31, 1995 and 1994, respectively. The effective interest rate of this interest income was 10.4% and 10.3% for 1995 and 1994, respectively. Interest income of $154,909 and $136,417 would have been recognized under the terms of the modification agreement for the years ended December 31, 1995 and 1994, respectively, if the Partnership had not adopted SFAS 114.\nThe following sets forth the Partnership's mortgage loan investment to an unaffiliated borrower at December 31, 1995 and 1994.\n(a) Under the modification terms, interest accrues on the first mortgage loan at a rate equal to the prime lending rate of Bank of America in effect as of the first day of each calendar month plus 2%. The prime lending rate at December 31, 1995 and 1994 was 8.5%. The monthly payment is based on a 240 month amortization, which changes as the interest rate changes.\n(b) One half of the net cash flow of the property (after payments on the first lien loan) was payable monthly on the second lien loan. The second lien loan was paid in full in the third quarter of 1995.\nBased on market lending rates for mortgage loan investments with similar terms, risks and average maturities, the fair value of the mortgage loan investment was approximately $1,407,000 at December 31, 1995.\nThe cost of the mortgage loan investment for Federal income tax purposes was $1,416,547 at December 31, 1995.\nOn March 21, 1996, the mortgage loan investment plus accrued interest was paid in full by the borrower.\nNOTE 6 - MORTGAGE LOAN INVESTMENTS - AFFILIATES - ------ --------------------------------------\nUnder the terms of the Amended Partnership Agreement, the Partnership is expressly permitted to make nonrecourse mortgage loans to affiliates of the General Partner so long as such loans meet certain conditions, including that such loans bear interest at a rate equal to the prime lending rate of Bank of America plus 2.5%, or plus 3.5% if the loan is junior to other indebtedness. These loans are secured by income-producing real estate and may be either junior or senior to other indebtedness secured by such property. At December 31, 1995, the Partnership had outstanding loans receivable of $2,235,902, of which $1,435,902 were first priority loans and $800,000 were junior priority loans. For the year ended December 31, 1995, the Partnership recognized $291,324 of interest income related to these loans. The following sets forth the Partnership's mortgage loan investments to affiliates of the General Partner at December 31, 1995 and 1994. Loans were funded by the proceeds from the mortgage note payable entered into in October 1992 (see Note 7 - \"Long-Term Debt\") or other available funds. Interest only is due monthly. The monthly payment varies according to the prime lending rate.\n(a) The loans bear interest at the prime lending rate of Bank of America plus 2.5% for senior priority loans and prime plus 3.5% for junior priority loans. The prime lending rate was 8.5% at December 31, 1995 and 1994.\nOn May 1, 1992, the Partnership agreed to loan an aggregate of $1.115 million to McNeil Pension Investment Fund, Ltd. (\"McPIF\"), an affiliate of the General Partner, at an interest rate of prime plus 1% per annum (the maximum rate allowed to be incurred by McPIF in connection with borrowings from affiliates pursuant to McPIF's partnership agreement). In 1994, 1993 and 1992, $88,000, $330,364 and $65,000, respectively, was borrowed by McPIF pursuant to this commitment. This loan is secured by a first lien on Brice Road Office Building located in Reynoldsburg, Ohio. The original loan matured in May 1995, at which time a new loan under substantially the same terms was executed. Interest on the loan is payable monthly. Principal is payable on the third anniversary date of issuance.\nOn August 15, 1994, the Partnership agreed to loan an aggregate of $1 million to McNeil Real Estate Fund X, Ltd. (\"Fund X\"), at an interest rate of prime plus 1% per annum (the maximum rate allowed to be incurred by Fund X in connection with borrowings from affiliates pursuant to Fund X's partnership agreement). In 1994, $800,000 was borrowed by Fund X pursuant to this commitment. This loan is secured by a second lien on Lakeview Plaza Shopping Center located in Lexington, Kentucky. Interest on the loan is payable monthly, with principal payable on the third anniversary date of issuance.\nOn May 1, 1992, the Partnership agreed to loan an aggregate of $972,000 at an interest rate of prime plus 3.5% to McNeil Real Estate Fund XXI, L.P. (\"Fund XXI\"). In 1992, $972,000 was borrowed by Fund XXI pursuant to this commitment. This loan was secured by a third lien on Suburban Plaza Shopping Center located in Knoxville, Tennessee. Interest on the loan was payable monthly. The loan was repaid in full in 1995.\nOn March 1, 1993, the Partnership agreed to loan an aggregate of $1.536 million at an interest rate of prime plus 2.5% to McNeil Real Estate Fund XXVI, L.P. (\"Fund XXVI\"). In 1993, $952,538 was borrowed by Fund XXVI pursuant to this commitment. This loan was secured by a first lien on Continental Plaza Office Building located in Scottsdale, Arizona. Interest on the loan was payable monthly, with principal payable on the third anniversary date of issuance. The loan was paid in full in January 1996.\nIn order to induce the Partnership to lend funds to the foregoing affiliates of the General Partner, the General Partner entered into agreements with the Partnership whereby the General Partner agreed to pay: (i) the difference between the interest rate required by the Partnership's Amended Partnership Agreement to be charged to affiliates (either prime plus 2.5% or prime plus 3.5%) and the interest rate actually paid by Fund X and McPIF to the Partnership (prime plus 1%), and (ii) all points (1.5% of the principal amount if a first priority security interest is obtained and 2% of the principal amount if a junior priority security interest is obtained), closing costs and expenses required to be received by the Partnership pursuant to the Partnership's Amended Partnership Agreement in connection with such affiliated financing arrangements. At December 31, 1994 and 1993, the General Partner had paid, net of repayments, $27,250 and $88,509, respectively, representing the aggregate amount of interest which would be owed for one year pursuant to this arrangement. No such interest was prepaid in 1995 since no funds were borrowed by Fund X or McPIF in 1995. In addition, the General Partner paid $27,193, $28,249 and $114,889 of interest, points, closing costs and expenses required to be received by the Partnership on all affiliate loans during 1995, 1994 and 1993, respectively. All other requirements for affiliated loans, as specified in the Partnership's Amended Partnership Agreement, were met at December 31, 1995, 1994 and 1993, in connection with these loans.\nA summary of activity for the mortgage loan investments from affiliates is as follows:\nBased on the lending rates prescribed by the Amended Partnership Agreement for affiliate mortgage loan investments, the fair value of mortgage loan investments-affiliates approximated book value at December 31, 1995.\nThe cost of the mortgage loan investments for Federal income tax purposes is the same as the carrying amount for financial statement purposes.\nNOTE 7 - LONG-TERM DEBT - ------ --------------\nAs more fully described below, the long-term debt of the Partnership was converted from a mortgage note payable to a revolving credit agreement during 1995.\nThe following sets forth the mortgage note payable of the Partnership at December 31, 1995 and 1994. The mortgage note payable was secured by the related real estate investments.\n(a) In October 1992, the Partnership entered into a loan agreement to borrow an aggregate of $7 million. Principal on this loan was due and payable seven years following issuance, with interest payable annually at a rate of 10.5% per annum for the first three years and prime plus 2% thereafter. The loan was secured by certain mini-storage warehouses owned by the Partnership. McNeil personally guaranteed up to $1.75 million of the aggregate loan amount. The Partnership received net proceeds of approximately $6.5 million from the loan, the balance of the loan amount being used to defray certain closing costs and to establish an escrow account for real estate taxes. The net loan proceeds were used to make loans to various affiliates of the General Partner and to fund working capital needs. The balance of the proceeds was invested, in accordance with the terms of the Amended Partnership Agreement, in short-term interest-bearing accounts.\nIn May 1995, the Partnership paid down its mortgage note payable by $4,628,250. In June 1995, the Partnership secured a $5 million line of credit that may be used to fund any loans made to affiliates of the General Partner as well as for working capital and general partnership purposes. In connection with obtaining the line of credit, the Partnership paid off the remaining $2,019,844 balance of its mortgage note payable. In connection with the repayments, the Partnership paid prepayment penalties of $66,949 and wrote off $185,453 of deferred borrowing costs, resulting in an extraordinary loss of $252,402 in 1995.\nNo amounts had been received by the Partnership under the $5 million line of credit agreement as of December 31, 1995. Any borrowings under the line of credit would bear interest at prime plus one half of one percent or a LIBOR-based rate, if so elected by the Partnership. The Partnership is required to pay a commitment fee equal to one quarter of one percent per annum on any unused portion of the line of credit. Total commitment fees paid during 1995 were $3,542. The Partnership incurred loan costs of $195,059 related to the line of credit. The line of credit expires in July 1997 and is secured by One Corporate Center I and III office buildings and Kendall Sunset Mini-Storage.\nNOTE 8 - GAIN ON INVOLUNTARY CONVERSION - ------ ------------------------------\nIn September 1992, extensive hurricane damage occurred at Fountainbleau and Kendall Sunset Mini-Storage warehouses. Although repairs were substantially complete at the end of the year, reimbursements from the insurance company had not yet been fully received. In 1993, the Partnership received $398,034 from the insurance company and recognized a $229,147 gain on involuntary conversion, which represents the amount of insurance reimbursements received in excess of the basis of the properties damaged.\nNOTE 9 - REPURCHASE OF LIMITED PARTNERSHIP UNITS - ------ ---------------------------------------\nUnder the provisions of both the original partnership agreement and the Amended Partnership Agreement, the Partnership is required to repurchase Units in amounts totaling up to .6% of gross proceeds per year. The repurchase amount is equal to the lesser of 90% of adjusted invested capital, or $9 per Unit. Repurchase is based on written requests from Unitholders submitted between October 1 and October 20 of each year. The requirement was first effective in 1989. In January 1996, $332,928 was used to repurchase 36,992 Units for requests submitted in 1995. In January 1995, $332,931 was used to repurchase 37,408 Units for requests submitted in 1994. In January 1994, $332,933 was used to repurchase 43,126 Units for requests submitted in 1993.\nNOTE 10 - GAIN ON LEGAL SETTLEMENT - ------- ------------------------\nThe Partnership filed claims with the United States Bankruptcy Court for the Northern District of Texas, Dallas Division (the \"Bankruptcy Court\") against Southmark Corporation (\"Southmark\") for damages relating to improper overcharges, breach of contract and breach of fiduciary duty. The Partnership settled these claims in 1991, which totaled approximately $17,024,326, for the full amount claimed and such settlement was approved by the Bankruptcy Court.\nPursuant to the settlement agreement, the Partnership released Southmark and its affiliates and the Original General Partner from any further liability in connection with the claims made with the Bankruptcy Court. In return, an affiliate of McNeil agreed to waive payment on a dollar for dollar basis in an amount equal to the settled claims against Partnership advances owed at that time. In addition, the Partnership received Southmark bankruptcy plan assets in respect to its claims which were not offset against the Partnership advances. Because the Partnership's claims against Southmark were settled for $17,024,326, the Partnership advances of $223,800 owed at that time were reduced in their entirety and the claims had a remaining balance of $16,800,526. Although the Partnership settled the claims against Southmark for the full amount claimed, the settlement agreement provided that the Partnership receive a distribution of Southmark bankruptcy plan assets based on a claim amount of approximately $9,157,000.\nAn Order Granting Motion to Distribute Funds to Class 8 Claimants dated April 14, 1995 was issued by the Bankruptcy Court. In accordance with the Order, in May 1995, the Partnership received in full satisfaction of its claims, $984,649 in cash, and common and preferred stock in the reorganized Southmark which was subsequently sold for $317,675. These amounts represent the Partnership's pro-rata share of Southmark assets available for Class 8 Claimants and were recorded as a gain on legal settlement on the Statements of Operations.\nNOTE 11 - LEGAL PROCEEDINGS - ------- -----------------\nThe Partnership is not party to, nor are any of the Partnership's properties the subject of, any material pending legal proceedings, other than ordinary, routine litigation incidental to the Partnership's business, except for the following:\n1) HCW Pension Real Estate Fund, Ltd. et al. v. Ernst & Young, BDO Seidman et al. (Case #92-06560-A). This suit was filed on behalf of the Partnership and other affiliated partnerships (the \"Affiliated Partnerships\") on May 26, 1992, in the 14th Judicial District Court of Dallas County. The petition sought recovery against the Partnership's former auditors, Ernst & Young, for negligence and fraud in failing to detect and\/or report overcharges of fees\/expenses by Southmark, the former general partner. The former auditors initially asserted counterclaims against the Affiliated Partnerships based on alleged fraudulent misrepresentations made to the auditors by the former management of the Affiliated Partnerships (Southmark) in the form of client representation letters executed and delivered to the auditors by Southmark management. The counterclaims sought recovery of attorneys' fees and costs incurred in defending this action. The counterclaims were later dismissed on appeal, as discussed below.\nThe trial court granted summary judgment against the Partnership based on the statute of limitations; however, on appeal, the Dallas Court of Appeals reversed the trial court and remanded for trial the Affiliated Partnerships' fraud claims against Ernst & Young. The Texas Supreme Court denied Ernst & Young's application for writ of error on January 11, 1996. The Partnership is continuing to pursue vigorously its claims against Ernst & Young; however, the final outcome of this litigation cannot be determined at this time.\n2) Robert Lewis v. McNeil Real Estate Fund XXVII, L.P. and McNeil Partners, L.P., Civil Action No. 13287 (Del. Ch.). This complaint alleges, among other things, that the General Partner caused the Partnership to loan money to affiliated partnerships at rates lower than the Partnership's cost of borrowing, which the plaintiff alleges constitutes a breach of the General Partner's fiduciary duties. The complaint alleges that the affiliate loans are designed to enable the affiliated partnerships to continue in business so as to enable the General Partner to continue collecting fees from them. An answer to the complaint was filed on February 3, 1994, denying the material averments of wrongdoing and asserting affirmative defenses. In 1995, the plaintiff and the Partnership executed a Stipulation and Order of Dismissal, which dismissed the action without prejudice.\n3) Helen Pasco v. McNeil Real Estate Fund XXVII, L.P., Southmark Prime Plus Corp., et al. and Does 1-50 Inclusive. This complaint alleges that several limited partnerships and funds, including the Partnership, along with McMachen, Prudential Securities, Inc. and other unidentified defendants, transmitted false and misleading information to the plaintiff which was used to entice the plaintiff into investing her money with the defendants. The complaint also alleges that the defendants misrepresented speculative, illiquid limited partnerships as safe, income-producing investments suitable for safety-conscious and conservative investors. Although the Partnership is included as a defendant, the plaintiff's allegations do not specify in what way the Partnership was involved in improper conduct. The complaint does not state, other than by broad allegations, that the Partnership acted in an improper manner with regard to the operation or management of the limited partnership. An answer was filed on behalf of the Partnership in February 1994, and there has been no further action in this matter. The ultimate outcome of this case cannot be determined at this time.\nMcNEIL REAL ESTATE FUND XXVII, LTD. SCHEDULE III REAL ESTATE INVESTMENTS AND ACCUMULATED DEPRECIATION AND AMORTIZATION December 31, 1995\nSee accompanying notes to Schedule III.\nMcNEIL REAL ESTATE FUND XXVII, LTD. SCHEDULE III REAL ESTATE INVESTMENTS AND ACCUMULATED DEPRECIATION AND AMORTIZATION December 31, 1995\n(a) For Federal Income tax purposes, the properties are depreciated over lives ranging from 15-25 years using ACRS or MACRS methods. The aggregate cost of real estate investments for Federal income tax purposes was $34,399,151 and accumulated depreciation was $4,896,484 at December 31, 1995.\n(b) The carrying values of One Corporate Center I and III Office Buildings were each reduced by $1,300,000 in 1991.\n(c) These properties secure a $5 million line of credit; however, no borrowings were outstanding under the line of credit at December 31, 1995.\nSee accompanying notes to Schedule III.\nMcNEIL REAL ESTATE FUND XXVII, LTD. SCHEDULE III REAL ESTATE INVESTMENTS AND ACCUMULATED DEPRECIATION AND AMORTIZATION December 31, 1995\nMcNEIL REAL ESTATE FUND XXVII, L.P.\nNotes to Schedule III\nReal Estate Investments and Accumulated Depreciation and Amortization\nA summary of activity for the Partnership's real estate investments and accumulated depreciation and amortization is as follows:\nPART III\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND - ------ --------------------------------------------------------------- FINANCIAL DISCLOSURES ---------------------\nNone.\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - ------- --------------------------------------------------\nNeither the Partnership nor the General Partner has any directors or executive officers. The names and ages of, as well as the positions held by, the officers and directors of McNeil Investors, Inc., the general partner of the General Partner, are as follows:\nEach director shall serve until his successor shall have been duly elected and qualified.\nSection 16 (a) of the Securities Exchange Act of 1934 requires the Partnership's General Partner and the directors and executive offers of the General Partner (Including McNeil Investors, Inc. as the general partner of the General Partner and the officers and directors of McNeil Investors, Inc.) to file, with the Securities and Exchange Commission, reports of ownership and changes in ownership of the Partnership's Units. The Partnership is required to identify any of those persons who failed to file such reports on a timely basis.\nDuring 1995, Mrs. McNeil inadvertently failed to file on a timely basis one report relating to one transaction. In making this disclosure, the Partnership has relied solely on written representations of these and other individuals and on copies of the reports that they have filed with the Securities and Exchange Commission.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION - ------- ----------------------\nNo direct compensation was paid or payable by the Partnership to directors or officers (since it does not have any directors or officers) for the year ended December 31, 1995, nor was any direct compensation paid or payable by the Partnership to directors or officers of the general partner of the General Partner for the year ended December 31, 1995. The Partnership has no plans to pay any such remuneration to any directors or officers of the general partner of the General Partner in the future.\nSee Item 13 - Certain Relationships and Related Transactions for amounts of compensation and reimbursements paid by the Partnership to the General Partner and its affiliates.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - ------- --------------------------------------------------------------\n(A) Security ownership of certain beneficial owners.\nNo individual or group, as defined by Section 13(d)(3) of the Securities Exchange Act of 1934, was known by the Partnership to own more than 5% of the Units, other than the General Partner, as noted in (B) below.\n(B) Security ownership of management.\nThe General Partner and the officers and directors of its general partner, collectively own 410,300 limited partnership units, which represents approximately 7.78% of the outstanding limited partnership units as of February 29, 1996.\n(C) Change in control.\nNone\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - ------- ----------------------------------------------\nThe amendments to the Partnership compensation structure included in the Amended Partnership Agreement provide for an asset management fee to replace all other forms of general partner compensation other than property management fees and reimbursements of certain costs. Through 1999, the asset management fee is calculated as 1% of the Partnership's tangible asset value. Tangible asset value is determined by using the greater of (i) an amount calculated by applying a capitalization rate of 9 percent to the annualized net operating income of each property or (ii) a value of $30 per gross square foot for mini-storage warehouses and $50 per gross square foot for commercial properties to arrive at the property tangible asset value. The property tangible asset value is then added to the book value of all other assets excluding intangible items. The fee percentage decreases subsequent to 1999. For the year ended December 31, 1995, the Partnership paid or accrued $572,631 of such asset management fees.\nUntil March 13, 1991, the Original General Partner was entitled to receive, out of cash from operations, a performance incentive fee equal to 20% of all points received by the Partnership on mortgage loans if the Unit holders receive distributions of cash from operations equal to a 10% cumulative noncompounding annual return on their original capital investment. Such fees were cumulative and were accrued in the years earned and are to be paid when conditions are met. Conditions for payment have not yet been met and, at December 31, 1995, $141,647 of amounts accrued in prior years are included in payable to affiliates on the Balance Sheets.\nThe Partnership pays property management fees equal to 5% of the gross rental receipts of mini-storage properties (6% for commercial) to McREMI, an affiliate of the General Partner, for providing property management services. Additionally, the Partnership reimburses McREMI for its costs, including overhead, of administering the Partnership's affairs. For the year ended December 31, 1995, the Partnership paid or accrued $859,201 of such property management fees and reimbursements. See Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations and Item 8 - Note 2 - \"Transactions With Affiliates.\"\nUnder the terms of the Amended Partnership Agreement, the Partnership is expressly permitted to make loans to affiliates of the General Partner, so long as such loans meet certain conditions, including that such loans bear interest at a rate of either prime of Bank of America plus 2.5% or prime plus 3.5%, depending on whether the security for such loans is first priority or junior priority.\nOn May 1, 1992, the Partnership agreed to loan an aggregate of $1.115 million to McNeil Pension Investment Fund, Ltd. (\"McPIF\"), an affiliate of the General Partner, at an interest rate of prime plus 1% per annum (the maximum rate allowed to be incurred by McPIF in connection with borrowings from affiliates pursuant to McPIF's partnership agreement). In 1994, 1993 and 1992, $88,000, $330,364 and $65,000, respectively, was borrowed by McPIF pursuant to this commitment. This loan is secured by a first lien on Brice Road Office Building located in Reynoldsburg, Ohio. The original loan matured in May 1995, at which time a new loan under substantially the same terms was executed. Interest on the loan is payable monthly. Principal is payable on the third anniversary date of issuance.\nOn August 15, 1994, the Partnership agreed to loan an aggregate of $1 million to McNeil Real Estate Fund X, Ltd. (\"Fund X\"), at an interest rate of prime plus 1% per annum (the maximum rate allowed to be incurred by Fund X in connection with borrowings from affiliates pursuant to Fund X's partnership agreement). In 1994, $800,000 was borrowed by Fund X pursuant to this commitment. This loan is secured by a second lien on Lakeview Plaza Shopping Center located in Lexington, Kentucky. Interest on the loan is payable monthly, with principal payable on the third anniversary date of issuance.\nOn May 1, 1992, the Partnership agreed to loan an aggregate of $972,000 at an interest rate of prime plus 3.5% to McNeil Real Estate Fund XXI, L.P. (\"Fund XXI\"). In 1992, $972,000 was borrowed by Fund XXI pursuant to this commitment. This loan was secured by a third lien on Suburban Plaza Shopping Center located in Knoxville, Tennessee. Interest on the loan was payable monthly. The loan was repaid in full in 1995.\nOn March 1, 1993, the Partnership agreed to loan an aggregate of $1.536 million at an interest rate of prime plus 2.5% to McNeil Real Estate Fund XXVI, L.P. (\"Fund XXVI\"). In 1993, $952,538 was borrowed by Fund XXVI pursuant to this commitment. This loan was secured by a first lien on Continental Plaza Office Building located in Scottsdale, Arizona. Interest on the loan was payable monthly, with principal payable on the third anniversary date of issuance. The loan was paid in full in January 1996.\nIn order to induce the Partnership to lend funds to affiliates of the General Partner, the General Partner entered into agreements with the Partnership whereby the General Partner agreed to pay: (i) the difference between the interest rate required by the Partnership's Amended Partnership Agreement to be charged to affiliates (either prime of Bank of America plus 2.5% or 3.5%) and the interest rate actually paid by Fund X and McPIF to the Partnership (prime plus 1%), and (ii) all points (1.5% of the principal amount if a first priority security interest is obtained and 2% of the principal amount if a junior priority security interest is obtained), closing costs and expenses required to be received by the Partnership pursuant to the Partnership's Amended Partnership Agreement in connection with such affiliated financing arrangements. In 1995, the General Partner paid $27,193 of interest, points, closing costs and expenses required to be received by the Partnership on all affiliate loans during 1995. In connection with these loans, all other requirements for affiliated loans, as specified in the Partnership's Amended Partnership Agreement, were met.\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K - ------- -----------------------------------------------------------------\nSee accompanying Index to Financial Statements at Item 8.\n(A) Exhibits --------\nExhibit Number Description ------- -----------\n4.2 Amended and Restated Limited Partnership Agreement of McNeil Real Estate Fund XXVII, L.P. (incorporated by reference to the Current Report of the registrant on Form 8-K dated March 30, 1992, as filed on April 10, 1992).\n10. Mutual Release and Settlement Agreement between Southmark Storage Associates Limited Partnership and McNeil Real Estate Fund XXVII, L.P. (incorporated by reference to the Quarterly Report of the registrant on form 10-Q for the period ended March 31, 1995, as filed on May 15, 1995).\n10.1 Assignment of Partnership Advances dated March 13, 1991 between Prime Plus Corp. and McNeil Partners, L.P. (1)\n10.2 Revolving Credit Agreement dated August 6, 1991, between McNeil Partners, L.P. and various selected partnerships, including the registrant (incorporated by reference to the Annual Report of the registrant on Form 10-K for the period ended December 31, 1993, as filed on March 30, 1994).\n10.5 Property Management Agreement dated March 30, 1992, between McNeil Real Estate Fund XXVII, L.P. and McNeil Real Estate Management, Inc. (2)\n10.6 Amendment of Property Management Agreement dated March 5, 1993, by McNeil Real Estate Fund XXVII, L.P. and McNeil Real Estate Management, Inc. (2)\n10.7 Promissory Note dated October 23, 1992, between Community Bank, N.A. and McNeil Real Estate Fund XXVII, L.P. (2)\n10.8 Loan Agreement dated October 23, 1992, between Community Bank, N.A. and McNeil Real Estate Fund XXVII, L.P. (2)\n10.9 Guaranty Agreement dated October 23, 1992, between Community Bank, N.A. and Robert A. McNeil. (2)\n10.10 Revolving Credit Loan Agreement dated June 21, 1995, between PNC Bank, National Association and McNeil Real Estate Fund XXVII, L.P.\n10.11 Consolidated, Amended and Restated Revolving Credit Note dated June 21, 1995, between PNC Bank, National Association and McNeil Real Estate Fund XXVII, L.P.\n11. Statement regarding computation of Net Income (Loss) per Hundred Limited Partnership Units (see Note 1 to Financial Statements).\n(1) Incorporated by reference to the Annual Report of the registrant on Form 10-K for the period ended December 31, 1990, as filed on March 29, 1991.\n(2) Incorporated by reference to the Annual Report of the registrant on Form 10-K for the period ended December 31, 1992, as filed on March 30, 1993.\n(B) Reports on Form 8-K. There were no reports on Form 8-K filed by the Partnership during the quarter ended December 31, 1995.\nMcNEIL REAL ESTATE FUND XXVII, L.P. A Limited Partnership\nSIGNATURE PAGE\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.","section_15":""}
{"filename":"770470_1995.txt","cik":"770470","year":"1995","section_1":"ITEM 1. BUSINESS.\nPaineWebber R&D Partners, L.P. (the \"Partnership\" or \"Registrant\"), is a Delaware limited partnership that commenced operations on March 6, 1986. PWDC Holding Company (the \"Manager\") is the general partner of PaineWebber Technologies, L.P. (the \"General Partner\"), which is the general partner of the Partnership. PWDC Holding Company is a wholly owned subsidiary of PaineWebber Development Corporation (\"PWDC\"), an indirect wholly owned subsidiary of Paine Webber Group Inc. (\"PWG\"). The principal objective of the Partnership was to provide long-term capital appreciation to investors through investing in the development and commercialization of new products (the \"Projects\") with technology companies, which were expected to address significant market opportunities. The Partnership will terminate on December 31, 1998, unless its term is extended or reduced by the General Partner.\nOn November 14, 1994, the General Partner commenced with the dissolution of the Partnership's assets. The General Partner does not intend to terminate the Partnership until the contingent payment rights (\"CPR\") (now owned directly by the Partners (hereinafter defined) and serviced by the Partnership) due from Amgen, Inc. (\"Amgen\") from the sale of Neupogen has been fully paid and a lawsuit with Centocor, Inc. (\"Centocor\") has been fully resolved. Amgen is required to make CPR payments through the year 2005. On April 21, 1995, the Partnership distributed the CPR to its General Partner and limited partners (the \"Limited Partners\"; together with the General Partner, the \"Partners\"). The Partnership received its final CPR payment for income accrued as of March 31, 1995, in June 1995, but continues to receive CPR payments on account of, and for distribution to, the Partners. On July 12, 1995, the Partnership commenced an action against Centocor in the Supreme Court of New York arising from certain agreements entered into by Centocor and Eli Lilly & Company (\"Lilly\") in July 1992. The Partnership's complaint seeks damages, interest and expenses. There is no assurance that the Partnership's claim will be successful. See Item 3, Legal Proceedings - \"Action Against Centocor, Inc.\", for a discussion on the current status of the action. At December 31, 1995, the Partnership's assets consisted primarily of cash and a money market fund. The Partnership was not engaged in any Projects, nor will it do so in the future.\nPARTNERSHIP MANAGEMENT\nThe Partnership has delegated to the Manager, pursuant to a management agreement (the \"Management Contract\"), responsibility for management and administrative services necessary for the operation and dissolution of the Partnership. Under the Management Contract, the Manager was entitled to receive an annual management fee for management and administrative services provided to the Partnership. As of January 1, 1994, the Manager elected to discontinue charging a management fee to the Partnership.\nDISTRIBUTIONS\nAll distributions to the Partners from the Partnership have been made pro rata in accordance with their respective net capital contributions. The following table sets forth the proportion of each distribution to be received by Limited Partners and the General Partner, respectively:\n(ITEM 1 CONTINUED)\nAt December 31, 1995, the Partnership has made cash and security distributions, as valued on the date of distribution, since inception of $889 and $593 per Unit, respectively. The security distributions of $593 do not include the distribution of the CPR in April 1995.\nOTHER\nAt December 31, 1995, the Partnership and the General Partner had no employees, and PWDC Holding Company, the general partner of the General Partner, had no employees other than its executive officers (see Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT). The Partnership is in dissolution and was engaged in one primary business segment, the management of investments in technology products and companies.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Partnership does not own or lease any office, manufacturing or laboratory facilities.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nIN RE: PAINEWEBBER LIMITED PARTNERSHIP LITIGATION\nAs previously disclosed on the Partnership's Form 10-K for the year ended December 31, 1994, PaineWebber Technologies, L.P., the General Partner of the Partnership, was named as one of several defendants in a class action lawsuit against PaineWebber Incorporated (\"PWI\") and a number of its affiliates relating to PWI's sale of 70 direct investment offerings, including the offering of interests in the Partnership. In January 1996, PWI signed a memorandum of understanding with the plaintiffs in the class action outlining the terms under which the parties have agreed to settle the case. Pursuant to that memorandum of understanding, PWI irrevocably deposited $125 million into an escrow fund under the supervision of the United States District Court for the Southern District of New York (the \"Court\") to be used to resolve the litigation in accordance with a definitive settlement agreement and a plan of allocation which the parties expect to submit to the Court for its consideration and approval within the next several months. Until a definitive settlement and plan of allocation is approved by the Court, there can be no assurance what, if any, payment or non-monetary benefits will be made available to the Partnership.\nIn February 1996, approximately 150 plaintiffs filed an action in Sacramento, California Superior Court against PWI and various affiliated entities, including the General Partner of the Partnership, concerning the plaintiffs' purchases of various limited partnership interests. The complaint alleges, among other things, that PWI and its related entities committed fraud and misrepresentation and breached fiduciary duties allegedly owed to the plaintiffs by selling or promoting limited partnership investments that were unsuitable for the plaintiffs and by overstating the benefits, understating the risks and failing to state material facts concerning the investments. The complaint seeks compensatory damages of $15 million plus punitive damages.\nACTION AGAINST CENTOCOR, INC.\nIn July 1995, the Partnership commenced an action in the Supreme Court of the State of New York against Centocor arising out of Centocor's July 1992 transaction with Lilly.\n(ITEM 3 CONTINUED)\nIn 1986, the Partnership and others purchased limited partnership interests in Centocor Partners II, L.P. (\"CP II\"), a limited partnership formed to develop and sell Centoxin, a Centocor drug. On February 21, 1992, Centocor exercised its option to purchase all of the limited partnership interests in CP II, including those held by the Partnership. The purchase agreement provided that Centocor would thereafter pay to the former limited partners 50% of Centocor's revenues from the licensing or sublicensing of Centoxin and 8% of Centocor's revenues from Centoxin sales, with such payments to be made on the last business day of the calendar quarter in which they were earned.\nIn July 1992, Centocor entered into a set of agreements with Lilly for the stated purposes of Lilly making an equity investment in Centocor and furthering the testing and eventual distribution of Centoxin. Pursuant to those agreements, Lilly paid Centocor a total of $100 million, and Centocor conveyed to Lilly, among other things, two million shares of Centocor common stock, exclusive marketing rights to Centoxin and an option to acquire exclusive marketing rights to CentoRx (now ReoPro), another Centocor drug.\nThe Partnership's complaint alleges, among other things, that part of the $100 million paid by Lilly constitutes revenues to Centocor from the licensing, sublicensing and\/or sale of Centoxin, and that Centocor is obligated to pay a percentage of that part to the former limited partners of CP II, including the Partnership. Centocor has taken the position that it is not obligated to make any such payment. The Partnership is seeking to proceed on behalf of itself and all other former limited partners of CP II whose interests were acquired by Centocor in February 1992 (the \"Class\"). The complaint seeks damages, interest and expenses. Centocor has moved to dismiss the complaint on the grounds that New York is allegedly an inconvenient forum.\nPWDC has been advancing, and may continue to advance, the funds necessary to pay the Partnership's legal fees and expenses relating to this action. In the event of a recovery on behalf of the Class, the court may award legal fees and expenses to the Partnership's counsel, to be paid out of the recovery. It is anticipated that: the net proceeds of any recovery will be distributed to the members of the Class, including the Partnership, on a pro rata basis; the Partnership and\/or its counsel will reimburse PWDC; and any remaining Partnership proceeds will be distributed to the Partners of the Partnership on a pro rata basis.\nIn February 1996, another former limited partner of CP II commenced a purported class action in the Court of Common Pleas of the State of Pennsylvania against Centocor and Lilly. The claims in that action are similar to those asserted in the Partnership's complaint.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nThere is no existing public market for the Units, and no such market is expected to develop. Effective February 1995, the General Partner discontinued the right of Limited Partners to transfer Units, except for transfers that may occur as a result of the laws of descent and distribution or by operation of law. As of December 31, 1995, there were 6,932 limited partners.\nThe Partnership distributes to its Partners, when available, the net proceeds, if any, from royalty distributions, interest payments on portfolio securities and from disposition of portfolio securities and any other cash or other unrestricted securities of the Partnership in excess of amounts that are necessary for the dissolution of the Partnership. The Partnership distributed to its Partners $2,481,752 ($65 per Unit; $24,818 to the general partnership interest) and $6,185,290 ($162 per Unit; $61,853 to the general partnership interest) for the years ended December 31, 1995 and 1994, respectively.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nSee the \"Selected Financial Data (Unaudited)\" on Page in this filing.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nLIQUIDITY AND CAPITAL RESOURCES\nPartners' capital was $0.1 million at December 31, 1995, compared to $1.7 million at December 31, 1994, a decrease of $1.6 million. The reduction in partners' capital was principally a result of cash distributions to the Partners of $2.4 million that were offset by net income of $0.8 million (as discussed in Results of Operations below).\nThe Partnership's working capital is invested in a money market fund. Liquid assets at December 31, 1995 totaled $0.2 million, a decrease of $0.4 million from the balance of $0.6 million at December 31, 1994. The decrease is due to payment of general and administrative expenses and the excess of distributions paid to Partners over the income received from Projects by the Partnership. The balance of working capital will be used for the payment of administrative costs related to the dissolution of the Partnership and distributions to the Partners, if any.\nRESULTS OF OPERATIONS\nYEAR ENDED DECEMBER 31, 1995 COMPARED TO THE YEAR ENDED DECEMBER 31, 1994:\nNet income for the year ended December 31, 1995 was $0.8 million compared to net income of $4.3 million for the year ended December 31, 1994, a decrease of $3.5 million resulting from the dissolution of the Partnership including the satisfaction of Partnership liabilities.\n(ITEM 7 CONTINUED)\nRevenues for the year ended December 31, 1995 were $1.1 million compared to $4.6 million for the same period in 1994. Revenues consisted primarily of income accrued or received from Amgen with respect to the CPR as a result of the product sales of Neupogen, until the CPR was distributed to the Partners. In 1995, revenues from Amgen decreased by $3.9 million from 1994. Effective April 1, 1995, the Partnership distributed to its Partners the CPR, which constitutes the rights to receive future income from Amgen to its Partners. The Partnership received its final CPR payment in June 1995 attributable to the first quarter of 1995. In 1994, the Partnership recognized a loss on sale of an investment of $0.4 million (see Results of Operations - Year ended December 31, 1994 compared to year ended December 31, 1993). Expenses for the Partnership consisted solely of general and administrative costs of $0.3 million for 1995 and 1994.\nYEAR ENDED DECEMBER 31, 1994 COMPARED TO THE YEAR ENDED DECEMBER 31, 1993:\nNet income for the year ended December 31, 1994 was $4.3 million compared to net income of $4.0 million for the year ended December 31, 1993, an increase of $0.3 million. The variance of $0.3 million is due to a decrease of $3.0 million in expenses offset by a decrease of $2.7 million in revenues.\nRevenues for the year ended December 31, 1994 were $4.6 million compared to $7.3 million for the same period in 1993, a decrease of $2.7 million. The unfavorable variance is primarily attributable to a decrease in revenues from the Partnership's product development projects of $2.2 million and a loss on the sale of an investment of $0.4 million. The product development income earned during 1994 and 1993 consisted primarily of distributions received from Amgen. In 1994, the Partnership recognized a loss of $0.4 million resulting from the exchange of its investment in DAVID Systems, Inc. (\"DSI\") pursuant to the terms of a merger between DSI and Chipcom Corporation.\nExpenses for the year ended December 31, 1994 were $0.3 million compared to $3.3 million for the same period in 1993, a decrease of $3.0 million. The variance is primarily attributable to a $2.4 million writedown in the Partnership's investment in DSI in 1993 and a decrease of $0.6 million in management fees. In 1993, the investment in DSI was written down from $3.2 million to $0.8 million. As of January 1, 1994, the Manager elected to discontinue the management fee charged to the Partnership (See ITEM 1. BUSINESS). The management fee for 1993 was $0.6 million.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe information in response to this item may be found under the following captions included in this filing on Form 10-K:\nReport of Independent Auditors (F-4) Statements of Financial Conditions (Page) Statements of Operations (Page) Statements of Changes in Partners' Capital (Page) Statements of Cash Flows (Page) Notes to Financial Statements (Pages to)\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 directors or executive officers. The Registrant is managed by PWDC Holding Company (the \"Manager\"), the general partner of PaineWebber Technologies, L.P. (the \"General Partner\"), which is the general partner of the Partnership.\nThe Partnership has delegated to the Manager, pursuant to the Management Contract, responsibility for management and administrative services necessary for the operation of the Partnership. The Manager has sole responsibility for the dissolution of the Partnership.\nThe following table sets forth certain information with respect to the persons who are directors and executive officers of the Manager, as well as PWDC, the parent company of the Manager. On December 31, 1991, the Manager succeeded PWDC as the general partner of the General Partner. The following table sets forth such persons' positions as directors and executive officers of PWDC at December 31, 1995.\nThe directors have a one-year term of office. The officers are elected by a majority of the directors and hold office until their successors are chosen by the directors.\n(1) Mr. Matalene and Mr. Smith were appointed to these positions at PWDC Holding Company in September 1993; Mr. Voytko was appointed to this position at PWDC Holding Company in May 1994; Mr. Goertz was appointed to this position at PWDC Holding Company in April 1995.\n(2) Mr. Matalene was appointed to this position at PWDC Holding Company in September 1993; Mr. Voytko was appointed to this position at PWDC Holding Company in May 1994; Mr. Smith and Ms. Haughey were appointed to these positions at PWDC Holding Company in December 1991.\n(ITEM 10 CONTINUED)\nDIRECTORS\nMR. MATALENE is a Managing Director of PWI. Mr. Matalene joined the Invest- ment Banking Division of PWI in 1987. Prior to joining PWI, Mr. Matalene worked at Drexel Burnham Lambert in the Investment Banking Division from 1986 to 1987. Before joining Drexel Burnham Lambert, he worked at Kidder, Peabody & Co. in the Corporate Finance Department from 1979 through 1986. Mr. Matalene is a Director of PaineWebber Properties, Incorporated, American Bankers Insurance Group, Bankers American Life Insurance Company and Empire of Carolina, Inc. His Bachelor of Arts degree is from University of North Carolina at Chapel Hill. Mr. Matalene received a Master's degree in Business Administration with honors from Columbia University.\nMR. GOERTZ is a Senior Vice President and Director of Private Investments of PWI. Prior to joining PWI in December 1990, Mr. Goertz was with CG Realty Advisors and the Freeman Company. He received his Bachelor of Arts degree in Business Administration in 1979 from Vanderbilt University and his Juris Doctorate and Masters of Business Administration from Memphis State University in 1982.\nMR. SMITH is Treasurer of PWG and Executive Vice President and Treasurer of PWI. Mr. Smith joined PWG in 1987. From 1982 to 1987, Mr. Smith was Senior Vice President and Treasurer for Norwest Corporation, a multibank holding company in Minneapolis. From 1980 to 1982, Mr. Smith was Vice President of the Treasury Department for Mellon Bank in Pittsburgh and from 1973 to 1980 was Vice President for various subsidiaries of Commercial Credit Company. Mr. Smith received a Bachelor of Science degree in Electrical Engineering from Yale University and a Master's degree in Business Administration from Stanford University. He also served as a lieutenant in the United States Coast Guard.\nMR. VOYTKO is Deputy Director and Chief Operating Officer of the Investment Banking Division of PWI. He joined PWI in 1981 as a research analyst and became Director of Research in 1988 overseeing equity, credit, high yield and derivatives research. Prior to joining PWI he was director of the office of the Chairman of the Interstate Commerce Commission in Washington, D.C. Mr. Voytko is currently a director of Nexgen Microsystems and PaineWebber Properties, Incorporated. Mr. Voytko received a Bachelor of Arts degree from Carnegie Mellon University, a Master's degree in Public Administration from the University of Washington and a Master's degree in Public Policy from Harvard University.\n(Item 10 continued)\nExecutive Officers\nMR. MATALENE, President, see \"Directors\" above.\nMR. VOYTKO, Executive Vice President, see \"Directors\" above.\nMR. SMITH, Treasurer, see \"Directors\" above.\nMS. HAUGHEY, Secretary, joined PWI in 1962. She is Assistant Secretary of PWG.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION.\nNo Compensation was paid to executives of PWDC Holding Company by the Registrant. PWDC Holding Company serves as the Manager for the Registrant, and pursuant to a Management Contract, is entitled to receive an annual management fee for management and administrative services provided to the Partnership. As of January 1, 1994 the Manager elected to discontinue the management fee charged to the Partnership. See the section entitled \"Related Party Transactions\" under the caption \"Notes to Financial Statements\" on pages through included in this filing on Form 10-K.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe table below lists all investors who are known to be beneficial owners at March 1, 1996 of more than five percent of the Registrant's Units.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nInformation in response to this item may be found in the section entitled \"Related Party Transactions\" under the caption \"Notes to Financial Statements\" on pages through included in this filing on Form 10-K.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES, AND REPORTS ON FORM 8-K.\nThe following documents are filed as part of the filing on Form 10-K.\nFINANCIAL STATEMENTS\nThe financial statements, together with the report of Ernst & Young LLP, are listed in the accompanying index to financial statements and notes to financial statements appearing on page.\nReport of Independent Auditors (Page) Statements of Financial Condition (Page) Statements of Operations (Page) Statements of Changes in Partners' Capital (Page) Statements of Cash Flows (Page) Notes to Financial Statements (Pages to)\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the 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 29th day of March 1996.\nPAINEWEBBER R&D PARTNERS, L.P.\nBy: PaineWebber Technologies, L.P. (General Partner)\nBy: PWDC Holding Company (General partner of the General Partner)\nBy: Eugene M. Matalene, Jr. \/s\/ ------------------------------------------ Eugene M. Matalene, Jr. President and Principal Executive Officer\nBy: Pierce R. Smith\/s\/ ------------------------------------------ Pierce R. Smith Principal Financial and Accounting Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated*, each on this 29th day of March 1996.\nEugene M. Matalene, Jr. \/s\/ ------------------------------------------ Eugene M. Matalene, Jr. President (principal executive officer) and Director\nPierce R. Smith \/s\/ ------------------------------------------ Pierce R. Smith Principal Financial and Accounting Officer and Director\nGerald F. Goertz, Jr.\/s\/ ------------------------------------------ Gerald F. Goertz, Jr. Director\nJames M. Voytko\/s\/ ------------------------------------------ James M. Voytko Director\n* The capacities listed are with respect to PWDC Holding Company, the Manager, as well as the general partner of the General Partner of the Registrant.\nPage\nPAINEWEBBER R&D PARTNERS, L.P. (a Delaware Limited Partnership)\nDESCRIPTION PAGE\nIndex to Financial Statements\nSelected Financial Data (Unaudited)\nQuarterly Financial Information (Unaudited)\nReport of Independent Auditors\nStatements of Financial Condition, at December 31, 1995 and 1994\nStatements of Operations, for the years ended December 31, 1995, 1994 and 1993\nStatements of Changes in Partners' Capital, for the years ended December 31, 1995, 1994 and 1993\nStatements of Cash Flows, for the years ended December 31, 1995, 1994 and 1993\nNotes to Financial Statements to\nAll schedules are omitted either because they are not applicable or the information required to be submitted has been included in the financial statements or notes thereto.\nPage\nPAINEWEBBER R&D PARTNERS, L.P. (a Delaware Limited Partnership)\n(A) Based on 37,799 partnership units.\nPage\nPAINEWEBBER R&D PARTNERS, L.P. (a Delaware Limited Partnership)\n(A) Based on 37,799 limited partnership units and a 1% general partnership interest. (B) Revenues have been restated from the amount reported at March 31, 1994.\nPage\nReport of Independent Auditors\nTo the Partners of PaineWebber R&D Partners, L.P.:\nWe have audited the accompanying statements of financial condition of PaineWebber R&D Partners, L.P. as of December 31, 1995 and 1994, and the related statements of operations, changes in partners' capital, and cash flows for each of the three years in the period ended December 31, 1995. 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 PaineWebber R&D Partners, L.P. at December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\nErnst & Young, LLP New York, New York March 29, 1996\nPage\nPAINEWEBBER R&D PARTNERS, L.P. (a Delaware Limited Partnership)\nStatements of Financial Condition - ------------------------------------------------------------------------------ December 31, December 31, 1995 1994 - ------------------------------------------------------------------------------ Assets:\nCash $ 74,542 $ 25,667\nMarketable securities, at market value 105,814 526,502\nInterest receivable 581 1,566\nRoyalty income receivable 1,500 1,330,800 ---------- ------------\nTotal assets $ 182,437 $ 1,884,535 ========== ============\n- ------------------------------------------------------------------------------\nLiabilities and partners' capital:\nAccrued liabilities $ 92,372 $ 155,544\nPartners' capital 90,065 1,728,991 ----------- ------------\nTotal liabilities and partners' capital $ 182,437 $ 1,884,535 =========== ============\n- ------------------------------------------------------------------------------\nSee notes to financial statements.\nPage\nPAINEWEBBER R&D PARTNERS, L.P. (a Delaware Limited Partnership) Statements of Operations\n- ------------------------------------------------------------------------------- For the years ended December 31, 1995 1994 1993 - -------------------------------------------------------------------------------\nRevenues: Interest income $ 26,706 $ 39,390 $ 111,585 Income from product development projects 1,075,767 4,976,776 7,221,316 Unrealized depreciation of marketable securities - (61,454) (6,250) Realized loss on sale of marketable securities (10,456) - (28,971) Realized loss on sale of investment - (385,415) - --------- --------- --------- 1,092,017 4,569,297 7,297,680 ---------- --------- ---------\nExpenses: Management fees - - 613,948 General and administrative costs 249,191 275,377 273,096 Write-down of investment - - 2,455,998 ---------- --------- --------- 249,191 275,377 3,343,042 ---------- --------- --------- Net income $ 842,826 $4,293,920 $3,954,638 ========== ========== ==========\nNet income per partnership unit: Limited partners (based on 37,799 units) $ 22.07 $ 112.46 $ 103.58 General partner $ 8,428.26 $42,939.20 $39,546.38\n- ------------------------------------------------------------------------------- See notes to financial statements.\nStatements of Changes in Partners' Capital Years ended December 31, 1995, 1994 and 1993 - ------------------------------------------------------------------------------- Limited General Partners Partner Total - -------------------------------------------------------------------------------\nBalance at January 1, 1993 $ 8,020,699 $ 60,075 $ 8,080,774\nNet income 3,915,092 39,546 3,954,638\nCash distributions to partners (8,330,900) (84,151) (8,415,051) ---------- --------- ----------\nBalance at December 31, 1993 3,604,891 15,470 3,620,361\nNet income 4,250,981 42,939 4,293,920 Cash distributions to partners (6,123,437) (61,853) (6,185,290) ---------- --------- ----------\nBalance at December 31, 1994 1,732,435 (3,444) 1,728,991\nNet income 834,398 8,428 842,826 Cash distributions to partners (2,456,934) (24,818) (2,481,752) ---------- --------- ----------\nBalance at December 31, 1995 $ 109,899 $ (19,834) $ 90,065 ========== ========= ========== - ------------------------------------------------------------------------------- See notes to financial statements.\nPage\nPAINEWEBBER R&D PARTNERS, L.P. (a Delaware Limited Partnership) Statements of Cash Flows\n- ------------------------------------------------------------------------- Supplemental disclosure of cash flow information:\nThe Partnership paid no cash for interest or taxes during the years ended December 31, 1995, 1994 and 1993.\n- ------------------------------------------------------------------------- See notes to financial statements.\nPage\nPAINEWEBBER R&D PARTNERS, L.P. (a Delaware Limited Partnership)\nNOTES TO FINANCIAL STATEMENTS\n1. Organization and Business\nPaineWebber R&D Partners, L.P. (the \"Partnership\"), is a Delaware limited partnership that commenced operations on March 6, 1986. PWDC Holding Company (the \"Manager\") is the general partner of PaineWebber Technologies, L.P. (the \"General Partner\"), which is the general partner of the Partnership. PWDC Holding is a wholly owned subsidiary of PaineWebber Development Corporation (\"PWDC\"), an indirect wholly owned subsidiary of PaineWebber Group Inc. The Partnership will terminate on December 31, 1998, unless its term is extended or reduced by the General Partner.\nThe principal objective of the Partnership was to provide long-term capital appreciation to investors through investing in the development and commercialization of new products with technology companies (\"Sponsor Companies\"), which were expected to address significant market opportunities. In connection with product development projects (the \"Projects\"), the Partnership sought to obtain warrants to purchase the common stock of Sponsor Companies.\nOn November 14, 1994, the General Partner commenced with the dissolution of the Partnership's assets. The General Partner does not intend to terminate the Partnership until the contingent payment rights (\"CPR\") (now owned directly by the Partners (hereinafter defined) and serviced by the Partnership) due from Amgen, Inc. (\"Amgen\") from the sale of Neupogen have been fully paid and a lawsuit with Centocor, Inc. (\"Centocor\") has been fully resolved (see Note 7). Amgen is required to make CPR payments through the year 2005. On April 21, 1995, the Partnership distributed the CPR to its General Partner and limited partners (the \"Limited Partners\"; together with the General Partner, the \"Partners\"). The distribution of the CPR had no impact on the financial statements of the Partnership. The Partnership received its final CPR payment for income accrued as of March 31, 1995, in June 1995, but continues to receive CPR payments on account of, and for distribution to, the Partners.\nAll distributions to the Partners from the Partnership have been made pro rata in accordance with their respective net capital contributions. The following table sets forth the proportion of each distribution to be received by the Limited Partners and the General Partner, respectively:\nLIMITED GENERAL PARTNERS PARTNER\nI. Until the value of the aggregate distributions for each limited partnership unit (\"Unit\") equals $1,850 plus interest on such amount accrued at 5% per annum, compounded annually (\"Contribution Payout\") 99% 1%\nII. After Contribution Payout and until the value of the aggregate distributions for each Unit equals $9,250 (\"Final Payout\") 80% 20%\nIII. After Final Payout 75% 25%\nPage\nPAINEWEBBER R&D PARTNERS, L.P. (a Delaware Limited Partnership)\nNOTES TO FINANCIAL STATEMENTS\n(NOTE 1 CONTINUED)\nDuring 1995, the Partnership made aggregate cash distributions of $2,481,752 ($65 per Unit; $24,818 to the General Partner). At December 31, 1995, the Partnership has made cash and security distributions since inception of $889 and $593 per Unit, respectively. The security distributions of $593 do not include the distribution of the CPR in April 1995.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nThe financial statements are prepared in conformity with generally accepted accounting principles which require management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.\nThe Partnership adopted the provisions of Statement of Financial Accounting Standards No. 115 \"Accounting for Certain Investments in Debt and Equity Securities\" (\"Statement No. 115\") for investments held as of or acquired after January 1, 1994. In accordance with Statement No. 115, prior period financial statements have not been restated to reflect the change in accounting method. There was no financial statement impact as of January 1, 1994 of adopting Statement No. 115.\nMarketable securities consist of readily marketable securities that are valued at market value. Marketable securities are not considered cash equivalents for the Statements of Cash Flows.\nThe Partnership's investments consisting of convertible preferred stock were not publicly traded and were subject to fluctuations in value dependent on the underlying value of the issuing company. Non-publicly traded securities were valued at cost, except when a decrease was required based on the Manager's evaluations. These evaluations were based on available information and did not necessarily represent the amount which might ultimately be realized, since such an amount depended on future circumstances and could not reasonably be determined until the position was actually liquidated.\nRealized and unrealized gains or losses are determined on a specific identification method and are reflected in the Statements of Operations during the period in which the change in value occurs.\nThe Partnership had investments in Projects, as more fully described in Note 5, through one of the following two vehicles:\nProduct Development Contracts The Partnership paid amounts to Sponsor Companies under product development contracts. Such amounts were expensed by the Partnership when incurred by the Sponsor Companies. Income from the Sponsor Companies is reflected in the Statements of Operations for the period in which the income is earned.\nProduct Development Limited Partnerships The Partnership participated as a limited partner in product development limited partnerships formed to develop specific products. The Partnership accounted for its investments in limited partnerships using the equity method. Such partnerships expensed product development costs when incurred.\nPage\nPAINEWEBBER R&D PARTNERS, L.P. (a Delaware Limited Partnership)\nNOTES TO FINANCIAL STATEMENTS\n(NOTE 2 CONTINUED)\nThe Partnership carried warrants at a zero value in cases where the Sponsor Company's stock was not publicly traded or the exercise period had not been attained. To the extent that the Partnership's warrant was currently exercisable and the Sponsor Company's stock was publicly traded, the warrant was carried at intrinsic value (the excess of market price per share over the exercise price per share), which approximated fair value.\n3. MARKETABLE SECURITIES AND INVESTMENTS\nMARKETABLE SECURITIES:\nThe money market fund consists of obligations with maturities of one year or less that are subject to fluctuations in value.\nAt December 31, 1995 and 1994, the Partnership held the following marketable securities, at market value:\n1995 1994 -------- -------\nMoney Market Fund $105,814 $469,211\n41,666 shares of AgriDyne Technologies Inc. common stock --- 57,291 -------- -------- $105,814 $526,502 ======== ========\nIn June 1995 the Partnership sold its investment of 41,666 shares of AgriDyne Technologies, Inc. (\"AgriDyne\") at $1.125 per share resulting in a loss (net of expenses) of $10,456 for the year ended December 31, 1995. The common shares had a cost basis of zero. At December 31, 1994, the market value per share was $1.375.\nIn November 1993, 33,921 shares of AgriDyne common stock were sold at a market price of $5.00 per share. The total market value of such shares of AgriDyne common stock on the date of the sale was approximately $170,000 compared to the original cost of $500,000. An unrealized loss (net of sales commission) of approximately $330,000 was recognized by the Partnership in prior years.\nIn November 1993, 1,152 shares of Amgen common stock, with an original cost of approximately $9,000 and a book value of $81,000, were sold for approximately $53,000 ($46.00 per share). An unrealized gain of approximately $72,000 was recognized by the Partnership in prior years resulting in a realized loss upon sale of approximately $29,000.\nINVESTMENTS:\nAt December 31, 1994, the Partnership had an investment of 9,000,000 shares of Applied Diagnostics, Inc. (a subsidiary of Teknowledge Corporation (\"Teknowledge\") (formerly Cimflex Teknowledge Corpration)) Series A Convertible Preferred Stock with a carrying value of zero. As of December 31, 1995,\nPage\nPAINEWEBBER R&D PARTNERS, L.P. (a Delaware Limited Partnership)\nNOTES TO FINANCIAL STATEMENTS\n(NOTE 3 CONTINUED)\nthe Partnership had been advised of the dissolution of Applied Diagnostics, Inc. The Partnership received no distributions as a result of the dissolution. In addition, the Partnership had one warrant to purchase 1,050,000 shares of Teknowledge common stock with an exercise price of $3.83 which expired in September 1995. The warrant was carried at a cost basis of zero.\nIn 1993, based on the Manager's evaluation of the current and projected financial performance of DAVID Systems, Inc. (\"DSI\"), a decision was made to write down the Partnership's investment in DSI from an aggregate value of $3,205,998 to $750,000. In August 1994, the merger of DSI into Chipcom Corporation (\"Chipcom\") was approved at a special meeting of shareholders. According to the terms of the merger, the Partnership exchanged its DSI preferred stock for cash in the amount of $364,585 resulting in the recognition of a loss of $385,415 for the year ended December 31, 1994 in the accompanying Statements of Operations.\n4. RELATED PARTY TRANSACTIONS\nPrior to January 1, 1994, the Manager received an annual management fee for management and administrative services provided to the Partnership calculated pursuant to the terms of a management agreement. As of January 1, 1994, the Manager elected to discontinue the management fee charged to the Partnership. The management fee paid by the Partnership to the Manager for the year ended December 31, 1993 was $613,948.\nThe Partnership's portfolio which consists of a money market fund is managed by Mitchell Hutchins Institutional Investors (\"MHII\"), an affiliate of PWDC. PWDC pays MHII a fee with respect to such money management services.\nPWDC and PaineWebber Incorporated, and its affiliates, have acted in an investment banking capacity for several of the Sponsor Companies. In addition, PWDC and its affiliates have had direct limited partnership interests in the same product development limited partnerships as the Partnership.\n5. PRODUCT DEVELOPMENT PROJECTS\nThe Partnership has completed funding its eight Projects. If the Projects had produced any product for commercial sale, the Sponsor Companies had the option to enter into joint ventures or royalty arrangements with the Partnership to manufacture and market the products developed. In addition, the Sponsor Companies had the option to purchase the Partnership's interest in the technology. In consideration for granting such purchase options, the Partnership received warrants to purchase shares of common stock of the Sponsor Companies. As of January 1, 1995, the Partnership had one warrant to purchase 1,050,000 shares of Teknowledge Corporation (\"Teknowledge\") (formerly Cimflex Teknowledge Corporation) with an exercise price of $3.83 and a cost basis of zero. The warrant expired in September 1995 and was not exercised because the exercise price exceeded the market price of the stock.\nPage\nPAINEWEBBER R&D PARTNERS, L.P. (a Delaware Limited Partnership)\nNOTES TO FINANCIAL STATEMENTS\n(NOTE 5 CONTINUED)\nThe Partnership's warrant to purchase 231,000 shares of Bolt Beranek and Newman Inc. common stock at $31.00 per share expired in May 1994. In addition, the Partnership's warrant to purchase 75,000 shares of AgriDyne at $22.50 per share expired in June 1994. The warrants were not exercised because the warrants' exercise prices exceeded the market prices of the stock. The Partnership's warrant to purchase 454,919 shares of DSI was cancelled due to DSI's merger with Chipcom.\nIn 1993, the Partnership's warrant for 61,742 shares of Centocor common stock, exercisable at $21.50 per share, expired. The warrant was not exercised by the Partnership or distributed to the Partners because the warrant's exercise price was greater than the market price of the stock.\nIn 1993, Amgen exercised its partnership purchase option to buy back the Partnership's interest in a Project. The Partnership received $2,200,000 on March 23, 1993 in return for a lower royalty rate subsequent to the purchase option. In April 1995, the Partnership distributed its rights to future payments from Amgen to its Partners.\n6. INCOME TAXES\nThe Partnership is not subject to federal, state or local income taxes. Accordingly, the individual Partners are required to report their distributive shares of realized income or loss on their individual federal and state income tax returns.\n7. LEGAL PROCEEDING\nOn July 12, 1995, the Partnership commenced an action against Centocor in the Supreme Court of New York arising from certain agreements entered into by Centocor and Eli Lilly & Company (\"Lilly\") in July 1992.\nIn 1986, the Partnership and others purchased limited partnership interests in Centocor Partners II, L.P. (\"CP II\"), a limited partnership formed to develop and sell Centoxin, a Centocor drug. On February 21, 1992, Centocor exercised its option to purchase all of the limited partnership interests in CP II, including those held by the Partnership. The purchase agreement provided that Centocor would thereafter pay to the former limited partners 50% of Centocor's revenues from the licensing or sublicensing of Centoxin and 8% of Centocor's revenues from Centoxin sales, with such payments to be made on the last business day of the calendar quarter in which they were earned.\nIn July 1992, Centocor entered into a set of agreements with Lilly for the stated purposes of Lilly making an equity investment in Centocor and furthering the testing and eventual distribution of Centoxin. Pursuant to those agreements, Lilly paid Centocor a total of $100 million, and Centocor conveyed to Lilly, among other things, two million shares of Centocor common stock, exclusive marketing rights to Centoxin and an option to acquire exclusive marketing rights to CentoRx (now ReoPro), another Centocor drug.\nPage\n(Note 7 Continued)\nThe Partnership's complaint alleges, among other things, that part of the $100 million paid by Lilly constitutes revenues to Centocor from the licensing, sublicensing and\/or sale of Centoxin, and that Centocor is obligated to pay a percentage of that part to the former limited partners of CP II, including the Partnership. Centocor has taken the position that it is not obligated to make any such payment. The Partnership is seeking to proceed on behalf of itself and all other former limited partners of CP II whose interests were acquired by Centocor in February 1992 (the \"Class\"). The Partnership seeks damages, interest and expenses. There is no assurance that the Partnership's claim will be successful.\nPWDC has been advancing, and may continue to advance, the funds necessary to pay the Partnership's legal fees and expenses relating to this action. In the event of a recovery on behalf of the Class, the court may award legal fees and expenses to the Partnership's counsel, to be paid out of the recovery. It is anticipated that: the net proceeds of any recovery will be distributed to the members of the Class, including the Partnership, on a pro rata basis; the Partnership and\/or its counsel will reimburse PWDC; and any remaining Partnership proceeds will be distributed to the Partners of the Partnership on a pro rata basis.\n8. SUBSEQUENT EVENT\nIn March 1996, the General Partner restored its deficit capital account balance as of December 31, 1995, to appropriately reflect a 1% investment in the Partnership.","section_15":""}
{"filename":"804742_1995.txt","cik":"804742","year":"1995","section_1":"ITEM 1. BUSINESS\nOVERVIEW\nAllwaste, Inc. provides integrated industrial and environmental cleaning and maintenance services primarily in the United States, Canada and Mexico. Unless the context otherwise requires, references to the \"Company\" or \"Allwaste\" refer to Allwaste, Inc., a Delaware corporation incorporated on August 21, 1986, and its subsidiaries, affiliates and predecessors.\nThe Company, through its operating subsidiaries and affiliates, provides to its industrial and commercial customers a range of industrial and environmental services, including: on-site industrial cleaning and waste management services; waste transportation and processing; wastewater pretreatment; site remediation; maintenance services; turnaround and outage services; container cleaning and repair services; emergency spill response services; and other general plant support services.\nEffective September 1, 1995, the Company sold its glass recycling operations through the sale of all the issued and outstanding capital stock of its wholly-owned subsidiary, ARI Glass Newco, Inc. (\"ARI\"), to Equus Acquisition Company (now Strategic Materials Holding, Inc., \"SMHI\") and another affiliate of Equus II Incorporated (together, \"Equus\"). As consideration for the sale of the shares of common stock of ARI to Equus, the Company received an aggregate of $57.1 million, consisting of (i) $42.5 million in cash, (ii) a 12% Subordinated Note due 2002 in the original principal amount of $6.61 million, (iii) 8,000,000 shares of the 7% redeemable Series A Preferred Stock, redemption value $1.00 per share, of SMHI, and (iv) a stock purchase warrant exercisable to purchase up to 2,153,846 shares of the common stock of SMHI, par value $.001 per share (the \"SMHI Common Stock\"), which shares represented approximately 35% of the outstanding shares of SMHI Common Stock. The Company has since transferred to certain members of the SMHI management group stock purchase warrants exercisable to purchase an aggregate of 184,615 shares, or 3%, of SMHI Common Stock. See also \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and Note 3 of Notes to Consolidated Financial Statements.\nThe Company has, in the past, divided its operations into three industry segments: environmental services, recycling and container services. With the completion of the sale of the Company's glass recycling operations, the Company has combined the prior industry segments of environmental services and container services into a single operation. The following table presents the percentage of total revenues for each of the Company's principal service lines for each of the fiscal years ended August 31, 1995, 1994 and 1993, excluding the Company's discontinued glass recycling operations.\nSince its initial public offering in December 1986, the Company has pursued a strategy of acquiring local independent operators within the industrial service industry, thereby creating, through consolidation, opportunities to benefit from economies of scale, professional management, shared marketing techniques and greater access to capital. To date, the Company has acquired over 90 businesses through this strategy. See \"Business Expansion Program\" and Note 2 of Notes to Consolidated Financial Statements.\nDespite its historical growth through acquisitions, the Company has, in recent years, experienced more internal growth than acquisition-related growth. See \"Business Expansion Program.\" The Company has focused on realizing increased internal growth primarily by providing solution-oriented and preventive services that focus on improving customer efficiency and profitability, transferring technology and knowledge among the Company's various operating locations, implementing national marketing programs that target major industries served by the Company, introducing services in new geographic areas and developing services that address environmental concerns associated with new\nproducts. The Company recently launched ALLIES(TM), a new approach of collaboration between the Company and its customers that focuses on creating flexible and innovative solutions to a customer's problems and stresses the Company's services as an economically-efficient outsourcing alternative that can maximize a customer's competitive role in the emerging global market. See \" -- Marketing.\"\nThe Company's operations are subject to stringent federal, state and local governmental regulation. Because of the evolving and uncertain nature of these often complex regulations, the Company cannot predict the effect, if any, that the enactment, amendment, repeal or enforcement of applicable governmental statutes or rules and regulations will have on the Company's operations. See \" - -- Government Regulation\" and \"Legal Proceedings -- Environmental Proceedings.\" Legislation and governmental regulations relating to the protection of the environment, both existing and future, may also require the Company to outlay certain capital expenditures to purchase or replace certain equipment and to upgrade certain facilities. It is anticipated that such capital expenditures, if any, will not have a material effect on the Company's financial position or results of operations. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations --Liquidity and Capital Resources.\"\nUnless the context indicates otherwise, all statistical and financial information included in Items I, II and III of this Report is given as of August 31, 1995 and excludes the Company's discontinued glass recycling operations.\nBUSINESS SERVICES\nON-SITE INDUSTRIAL AND WASTE MANAGEMENT SERVICES. The largest component of the Company's business is the provision of industrial cleaning and waste management services at customer facilities. The Company provides industrial cleaning and waste management services from approximately 98 locations in North America (four of which are in Canada) and is currently providing such services under long-term contracts at customers' facilities at an additional 11 locations in North America. The Company provides a number of specialized services for the handling and processing of solid, industrial and hazardous wastes, including air-moving and liquid vacuuming, hydroblasting and gritblasting, dredging, dewatering and sludge processing, sludge pumping, chemical cleaning and jet rodding.\nAir-moving is an efficient method of removing and handling industrial wastes or salvageable materials contained in customers' tanks, containers or other process configurations by means of pneumatic conveyance or vacuuming with controlled air velocity. The Company performs its air-moving services using truck and trailer-mounted air-moving equipment. Typically, the Company's air-mover truck is driven onto the customer's facility near the actual work site. The Company's employees extend pipe and\/or hose from the air-mover truck into the customer's tank, container or other process configuration holding the waste or salvageable material. The material is then conveyed into the air-mover truck or container for transportation to a proper customer-designated disposal site.\nThe Company's hydroblasting services are performed using high-pressure pumps capable of achieving water pressures of up to 35,000 pounds per square inch. Hydroblasting is an effective method of removing hard deposits from surfaces, such as heat exchangers, boilers, aboveground storage tanks and pipelines, that may be unsuitable for other conventional cleaning techniques. Gritblasting, although similar to hydroblasting, utilizes both abrasive and non-abrasive media to clean surfaces. Gritblasting is often used to clean electrostatic precipitators and boilers and prepare metal surfaces for protective coatings and non-destructive testing. In many cases, hydroblasting or gritblasting can be used as an alternative to chemical cleaning.\nThe Company's dewatering services involve the use of centrifuges, filter presses and belt presses to separate liquids from solids, a process typically utilized to minimize disposal volumes. These services are frequently used to process the waste generated by tank cleaning or dredging services.\nCONTAINER SERVICES. The Company conducts container services operations from 31 locations (three of which are in Canada). The Company's container services operations can be divided into three distinct components: cleaning, inspection and repair. Over-the-highway tank-trailers, railcar tanks and intermodal containers and intermediate bulk containers (\"IBCs\") require thorough cleaning before shipping a new or different product. The Company also inspects all cleaned containers, in accordance with applicable governmental regulations, to insure no product or moisture remains in the cleaned container. The Company provides repair services for tank-trailer units, intermodal containers and IBCs. The Company believes that its container services business is the largest non-carrier operation in the industry in terms of total revenues and number of containers serviced.\nTRANSPORTATION, ROLL-OFF AND TANK RENTAL SERVICES. The Company provides both short and long-distance transportation of hazardous and non-hazardous wastes from customer sites to customer-designated landfills, recycling and reclamation facilities, and treatment, storage and disposal facilities. The Company provides these transportation services primarily on a unit-price or per-loaded mile basis. At certain locations, the Company owns air-tight, water-tight roll-off containers of various sizes, which it utilizes to collect and transport materials within the customer's facility\nor to customer-designated disposal sites. The Company also operates liquid tank transports equipped with vacuum pumps. Most of the Company's liquid tank transports are certified for the transportation of hazardous materials.\nEXCAVATION AND SITE REMEDIATION SERVICES. The Company's excavation and site remediation services involve the use of heavy equipment such as bulldozers and scrapers for the purpose of grading or otherwise restructuring existing terrain. The Company primarily provides these services to industrial customers for site preparation, construction and maintenance of industrial settlement ponds and lagoons, including the periodic cleaning or remediation of such ponds and lagoons. The Company also provides these services in connection with the construction of landfills.\nWASTEWATER PRETREATMENT. The Company currently operates, as part of its container services group, four facilities that accept non-hazardous commercial and industrial waste products, primarily from third parties. Waste products received and treated at the Company's facilities include wastewaters, sludges and hydrocarbon-bearing liquids. The Company processes a variety of materials at these facilities, including solid waste landfill leachate, restaurant grease-trap wastes, petroleum-contaminated wastewaters, commercial sandtrap or sump wastes, food-processing wastewaters and a variety of industrial wastewaters.\nCUSTOMERS\nThe Company provides industrial and environmental services to four primary industry groups: the petrochemical and refining, electric power, pulp and paper and automotive industries. All four of these industry groups utilize the Company's on-site industrial cleaning and waste management services. The Company also provides extensive excavation, sludge dewatering and transportation-related services to its petrochemical and refining and electric power industry customers. The Company provides certain industrial services to commercial businesses; steel, mining and manufacturing customers; and governmental agencies and municipalities. The Company has customarily provided tank-trailer cleaning services to contract carriers who own trucks that have been used to transport hazardous and non-hazardous substances and has been increasingly providing tank-trailer cleaning services to chemical manufacturers. Chemical manufacturers represent the Company's primary customer for its railcar tank cleaning and IBC cleaning services. No single customer accounted for more than 10% of the Company's consolidated revenues for the fiscal years ended August 31, 1995, 1994 and 1993, and the loss of any single customer would not have a material adverse effect on the financial position of the Company taken as a whole.\nThe Company seeks to enter into master service agreements or project-specific contracts with its industrial and environmental services customers. Under these master service agreements, the customer issues purchase orders for requested services, if any, on an as-needed basis. In the alternative, the Company receives stand-alone purchase orders, pursuant to which customers order services for a short-term project, with jobs typically lasting from one to several days. The Company generally provides its industrial services at prescribed rates, subject to negotiation with the customer, or based on competitive bidding. The Company often provides excavation and site remediation services under fixed-price, unit-price or time-and-materials based contracts. The Company typically provides container services on a \"first come, first served\" basis and maintains a published price list for its container services.\nMARKETING\nThe Company utilizes a combination of sales representatives, facility managers and other designated management employees to solicit business from industrial customers and tank transportation fleets. The Company has also implemented national marketing programs designed to increase penetration of three of the Company's largest customer groups: the petrochemical and refining, electric power and pulp and paper industries. The Company provides a number of complementary services from various operating locations to customers in certain major industries. Through concentrated marketing of the full range of industrial cleaning and waste management and transportation services to these customers and focusing on broadening the scope of the services it can offer its customers from a wide range of locations, the Company expects to increase its penetration of these industries. Given the strict environmental rules and regulations applicable to generators and transporters of hazardous wastes, in marketing its container services, the Company emphasizes its state-of-the-art wastewater pretreatment systems and computerized residual waste tracking systems in order to alleviate customers' concerns regarding proper treatment of wastes for which they are responsible. The Company also encourages customers to utilize the Company's container services facilities as their dispatch locations to minimize \"dead-head\" miles to and from the cleaning location.\nAs part of its focus on its national marketing strategy, the Company recently launched the Allwaste's Integrated Environmental Services (ALLIES(TM)) program, an approach of collaboration between the Company and its customers that is being implemented by the Company's operating locations on a national level. ALLIES(TM) encourages the Company's operating managers to focus on creating flexible and innovative solutions to a customer's problems and to stress the Company's services as an economically-efficient outsourcing alternative that can maximize a customer's competitive position in the emerging global market. Because the Company believes that one of its chief advantages\nover its competitors is the wide number of complementary service lines that it can offer its customers, the Company intends for the ALLIES(TM) program, with its emphasis on the Company as a solution-oriented, customer-focused provider of industrial and environmental services, to provide the Company with a stronger national identity. Rather than competing solely on the basis of hourly rate, the Company's overall marketing strategy, and the focus of the ALLIES(TM) program, is to provide a \"value-added\" service, primarily decreasing a customer's plant downtime through higher levels of productivity; decreasing disposal costs by recovering, recycling and\/or minimizing waste volumes; and improving unit operating efficiency by increasing heat transfer and unit run time and reducing unscheduled downtime through preventive maintenance. The Company believes that this focus has a positive impact on its customers' profitability, thereby contributing to their competitive position.\nCOMPETITION\nThe industrial services industry is highly competitive and fragmented. The Company believes that it is one of the largest industrial service companies in the country in terms of total revenues, geographic coverage and depth of service capability. The Company faces competition from local owner-operated service contractors and from national and regionally-based companies that perform a variety of industrial and environmental services. Competition for industrial services is based primarily on hourly rates, productivity, innovative approaches and quality of service. The Company attempts to add value through providing a safer and more efficient level of service to differentiate itself from competitors.\nThe Company also experiences competition in providing container services from independently-owned and operated facilities and certain large tank-trailer transport companies that also operate tank cleaning facilities. Three large tank-trailer transport companies have numerous cleaning facilities throughout the United States and are also major customers of the Company. The important competitive factors in the Company's container services operations are geographic location, efficient service, price and the ability to satisfy the customers' concerns regarding proper waste disposal.\nGOVERNMENT REGULATION\nThe Company provides its customers with services designed to increase environmental protection by cleaning and removing materials or substances from its customers' equipment or sites that must be properly handled, recycled, or removed from the sites for ultimate disposal. The Company's customers are subject to regulation under a complex conglomeration of local, state and federal statutes, codes and regulations that govern the handling, processing, use, treatment, storage, transportation and disposal of non-hazardous and hazardous materials and wastes. A core component of the Company's business is advising and assisting its customers in complying with this complex regulatory system; thus, the central tenet of the Company's business philosophy is that its operations will meet, and in most cases exceed, the requirements imposed by this regulatory system. This commitment ensures that the Company's customers, as well as the Company itself, are in full compliance with the environmental regulatory system.\nAlthough there are many statutory requirements that apply to the Company and its customers, the principal regulatory schemes within which the Company must operate are: the Comprehensive Environmental Response, Compensation and Liability Act of 1980, 42 U.S.C. ss. 9601, ET SEQ., as amended (\"CERCLA\"); the Resource Conservation and Recovery Act, 42 U.S.C. ss. 6901, ET SEQ., as amended (\"RCRA\"); the Hazardous Materials Transportation Uniform Safety Act, 49 App. U.S.C. ss. 2001, ET SEQ.; the regulations promulgated by the United States Department of Transportation (\"USDOT\"); and the Occupational Health and Safety Act, 29 U.S.C. ss.651, ET. SEQ. (the \"OSHA Act\"). The Company's wholly-owned Canadian subsidiaries are subject to similar Canadian regulations.\nCERCLA imposes, without regard to fault or negligence, liability on the generators of hazardous materials, on the owners and operators of treatment, storage and disposal sites and sites where hazardous materials are emitted, released or discharged, either by accident or design, and on companies that transport hazardous materials from generators to recycling, reclamation or disposal sites. With the exception of certain of the container service facilities, the Company generates hazardous wastes at its operating locations in DE MINIMIS quantities and solely in connection with its business operations. At certain of its container services locations, hazardous wastes may be generated as a result of the Company's heel management program (discussed below). The Company does not own or operate hazardous waste disposal sites. Consequently, it has minimal potential liability under CERCLA with respect to such issues. As a transporter of hazardous materials, however, the Company is potentially responsible for the cleanup and remediation at any site to which it transports hazardous materials. In addition, although the Company does not own or operate any landfills, the Company does contract with, on behalf of its customers, the owners and operators of non-hazardous (also known as solid waste) and hazardous landfills. Under CERCLA, the Company is potentially responsible as an \"arranger for disposal\" under these circumstances. To protect against liability under CERCLA as either a transporter or an \"arranger for disposal\", the Company works with its customers to ensure that such sites are carefully selected prior to the use of such facilities and also attempts to protect itself\nthrough its contractual relationship with its customers. The Company's employees that are involved with the handling, processing or transportation of hazardous materials are required to participate in approved safety and emergency response training under the OSHA Act.\nRCRA imposes liability on the owners and operators of facilities that are used to store, treat or dispose of hazardous materials and imposes \"cradle to grave\" liability on the generators of hazardous materials. The Company does not own or operate any facility that requires a RCRA Part B permit, which removes the Company from the jurisdiction of the most complex and costly areas of compliance under RCRA. Since the Company generates only DE MINIMIS quantities of hazardous materials at its operating locations, with the exception of the container services locations discussed below, the Company's potential liability under RCRA is limited. However, since waste materials are recycled, reclaimed and stored at several of the Company's facilities, the Company is required to comply with the RCRA regulations with respect to those facilities. Most significantly, RCRA imposes a stringent set of regulations on the identification, storage, treatment, transportation and disposal of wastes. Thus, when handling, processing and transporting a customer's wastes, the Company must carefully observe these regulations. To minimize potential liability under RCRA, the Company works closely with its customers to ensure that the wastes generated by the customer have been properly identified so that such wastes can be appropriately handled, processed and transported and also attempts to protect itself through its contractual relationship with its customers.\nWith respect to the Company's container services operations, the Company has potential liability under both CERCLA and RCRA as a generator, storer and disposer of certain materials that the Company drains or melts from containers (\"heels\" as they are referred to in the industry). In some instances, the Company may be considered to be the generator of those heels that may be classified as hazardous wastes (within the meaning of applicable regulations). The Company has instituted a heel management program to minimize this potential liability under both CERCLA and RCRA. When an over-the-highway tank trailer, railcar tank, intermodal container or IBC arrives at one of the Company's container services facilities, the Company correctly identifies the last substance hauled in a given container and \"empties\" the container in accordance with applicable governmental regulations. All such heels are collected in an approved manner, labeled as hazardous wastes, if applicable, manifested and transported by a licensed waste transporter to an approved treatment, recycling or disposal facility, all in accordance with applicable law. The container cleaning procedures and the cleaning materials utilized depend largely on the configuration of the container being cleaned and the last material transported in such container. The Company's cleaning systems capture all water, chemical and residue produced from preflushing, final rinsing and steaming. This wastewater is pretreated and discharged into the sewer system in accordance with local requirements. The Company then collects, labels and manifests all solid residues generated by the pretreatment of wastewater and all contaminated cleaning solvents and transports them to approved treatment, recycling or disposal sites through a licensed waste transporter.\nThe Company's business depends, in part, on the issuance of permits from state and federal agencies to allow the Company to transport hazardous materials, to operate certain of the Company's equipment and to operate the Company's container cleaning and wastewater pretreatment facilities. The Company believes that it will be able to obtain and retain the applicable and necessary permits from governmental authorities. The majority of these permits are required to be renewed annually, and accordingly, such permits may be subject to revocation, modification or denial. There can be no assurance that the Company will receive necessary permits on a timely basis or that such permits will not be revoked, modified or denied. The Company believes, however, that it has sufficient duplicity of permits so that the loss of any one permit or group of permits would not have a material adverse effect on the Company's financial position or results of operations.\nIn connection with several of the Company's service lines, there are significant, but often unforeseeable, inherent business risks that may materially impact the Company's operations, including, but not limited to: (i) the potential that the Company will handle, process, transport or dispose of material that has been misidentified by its customer, resulting in unanticipated exposure to hazardous wastes by the Company's employees and\/or disposal of such wastes at an unsuitable facility; (ii) the potential for governmental actions at the local, state or federal level that impose unforeseen restrictions on the handling, transportation or disposal of waste, which actions may result in declining volumes of waste that may be handled, treated, or transported by the Company's existing service lines; and (iii) the potential imposition of liability on the Company for the historical use of a landfill, and the corresponding allocation of responsibility on the Company for the costs of remediating such facilities.\nThe Company may not always be able to accurately assess significant business risks related to regulatory compliance because of its inability to predict the future enactment of additional environmental regulations or the amendment, modification or repeal of existing statutes or regulations. Frequently, public pressure causes local, state or federal regulators to act precipitously, with the result that newly-enacted legislation or regulations may contradict existing regulations. Consequently, although the Company makes a significant effort to monitor and to participate in anticipated regulatory, political and legal developments that may affect its operations, it is very difficult for the Company to predict the enactment, amendment, repeal or modification of applicable statutes, rules and regulations\npertaining to the protection of the environment or the effect that such actions will have on its financial position or results of operations.\nThe complexity of environmental regulations offers the Company vast potential to provide expanded services to its customers, particularly with respect to the Company's industrial cleaning and waste management and waste minimization service lines. Under the current regulatory scheme, the Company's customers are facing increasing restrictions on the generation, treatment, processing and disposal of non-hazardous and hazardous materials. For example, changes to the RCRA regulations have increased the types of materials that may no longer be disposed in landfills, which has caused the Company's customers to find alternative treatment methods for such materials. Similarly, changes over the last few years in the RCRA regulations have resulted in the closure of many landfills, which closures have increased the demand for the development of a process that will minimize the types and amounts of materials required to be disposed in landfills.\nThe Company may also experience increased business potential as a result of the increasing scrutiny placed on companies that provide industrial and environmental services. Many states have successfully enacted legislation that allows the state permitting authorities to consider the \"fitness\" of a permit applicant. Consequently, companies with a history of environmental violations have been, and will likely continue to be, unable to renew the permits that allow them to transport and\/or operate as environmental service companies in certain jurisdictions. The inability of the Company's competitors to withstand similar scrutiny should offer the Company increased potential to attract new customers in marketplaces affected by these statutes. Although there can be no assurance that the Company will be able to successfully withstand scrutiny under such \"applicant fitness\" statutes or regulations in the future or in all jurisdictions that may enact such legislation, to date the Company has not encountered any significant difficulty in meeting the requirements of these statutes and has been able to obtain required permits notwithstanding the increased level of scrutiny.\nBUSINESS EXPANSION PROGRAM\nThe Company is seeking to expand its service capabilities through the addition of selected service lines at existing locations, acquisitions of existing businesses and the establishment of Company-owned start-up operations in strategic geographic marketplaces. A major factor in the growth of the Company has been its acquisition program; however, management expects an important portion of future growth will be achieved through investment in start-up operations and internal expansion of existing operations.\nINTERNAL GROWTH. The Company has and will continue to open new facilities with its own resources, equipment and personnel. With respect to its on-site industrial cleaning and waste management operations, the Company seeks to add service lines to existing locations as customer demand dictates needs for such additional services. The Company also seeks to expand its customers' awareness of its service capabilities through national marketing programs targeted to specific industry groups. See \" -- Marketing.\" The Company expects to expand its IBC service capacity and to upgrade its wastewater pretreatment capabilities to handle additional third party waste streams.\nThe Company has also started four internal ventures to explore expansion of its service capabilities to its industrial customers. These ventures into industrial water and wastewater services, energy services, contract labor services and leak sealing and valve restoration services target specific services that the Company believes represent substantial opportunities for internal growth. Additionally, the Company expects to continue to pursue investment opportunities pursuant to which it would acquire minority ownership or otherwise partner with other business entities to expand its service capabilities for its industrial customers.\nACQUISITIONS. The Company intends to continue pursuing opportunities to acquire the stock or assets of suitable industrial and environmental service businesses for consideration consisting of cash, convertible subordinated notes, promissory notes, common stock of the Company (the \"Common Stock\") or some combination thereof. The Company may supplement the acquisition of small local companies or companies engaged in complementary service lines by acquiring larger companies that would be attractive to the Company's customer base. There can be no assurance that the Company will be able to successfully complete any such acquisitions. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nA significant portion of any shares of Common Stock issued in connection with acquisitions is typically restricted as to resale, generally for two years. The Company also often requires as a condition of an acquisition that the prior owners of the acquired business enter into non-competition agreements and that the key members of existing management of the acquired business contract, through employment agreements, to remain as managers of the acquired business. For additional information regarding the Company's acquisitions, see Note 2 of Notes to Consolidated Financial Statements.\nINSURANCE AND BONDING\nThe Company maintains insurance coverage for normal business risks, including workers' compensation for its employees and auto and general liability insurance, including products and completed operations coverage. Comprehensive insurance for environmental accidents and pollution occurring at the Company's facilities has been expensive and difficult to obtain, and certain policies purchased by the Company specifically exclude certain perils and\/or operations that could give cause for such claims. Effective as of September 1, 1995, the Company has purchased pollution liability coverage for its container services operations. Should the Company experience difficulty in obtaining adequate insurance coverage at reasonable rates in the future, this could have a material adverse effect on the Company's financial position or results of operations. To date, the Company has never incurred significant fines, penalties or liabilities for pollution, environmental damage or toxic torts. However, a successful liability claim for which the Company is only partially insured or completely uninsured could have a material adverse effect on the Company's financial position and results of operations.\nThe Company cannot predict the future availability or cost of insurance. The Company's total cost of property and casualty insurance, including workers' compensation premiums, was $14.8 million, $10.1 million and $10.7 million for the fiscal years ended August 31, 1995, 1994 and 1993, respectively. The increased cost in fiscal 1995 is attributable to the overall increase in the size of the Company and a significant increase in the adverse development of existing claims, offset by a reduction in fixed costs and the positive impact of the Company's safety programs implemented in the three previous years.\nA substantial portion of the Company's current and prior year insurance coverages are \"high deductible\" or retrospective policies in which the Company, in many cases, is responsible for the payment of incurred claims up to specified individual and aggregate limits, over which a third party insurer is contractually liable for any additional payment of such claims. Accordingly, the Company bears certain economic risks related to these coverages. On a continual basis, and as of each balance sheet date, the Company records an accrual equal to the estimated costs expected to result from incurred claims plus an estimate of claims incurred but not reported as of such date based on the best available information at such date. However, the nature of these claims is such that actual development of the claims may vary significantly from the estimated accruals. All changes in the accrual estimates are accounted for on a prospective basis and can have a significant impact on the Company's financial position or results of operations.\nCertain of the Company's customers require the Company to post performance bonds that are equivalent to the full amount of the contracts and guarantee their completion. Although the Company has previously obtained bonds through relationships with various sureties, there can be no assurance that these relationships will continue or that the Company will not be forced to seek alternative sources for bonding.\nEMPLOYEES\nAs of August 31, 1995, the Company had a total of 4,057 full-time employees. At 12 of the Company's service operations, the Company is, or is anticipated to be, bound by collective bargaining agreements governing the Company's relationship with its labor force at such locations. These agreements apply to approximately 248 of the Company's employees and expire at various times from 1996 to 1998, when they will have to be renegotiated in accordance with applicable law. No prediction can be made as to the ultimate outcome of such negotiations, although the Company's management knows of no reason why agreements could not be reached. Additionally, management believes that any failure to come to terms in such negotiations would not have a material adverse effect on the Company's financial position or results of operations. The Company believes its employee relations are good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nMore than half of the Company's operating locations in its industrial and environmental services business are leased premises under written agreements that expire at various times through 2004. The majority of the leases have renewal options at the Company's option for six month to fifteen-year periods. The Company owns its industrial service facilities in 29 locations. Management does not anticipate any major problems in negotiating new leases on expiration of any existing leases. However, should any problems arise, management believes that it will be able to obtain adequate facilities on terms acceptable to the Company since these operations are all in industrial marketplaces.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIn the normal course of its operations, the Company can become involved in a variety of legal disputes. Currently, the Company is a defendant in several legal proceedings, including workers' compensation matters and minor business disputes, the majority of which are being handled or are expected to be handled by the Company's insurance carriers. The Company believes that a decision adverse to the Company in any one or all of these proceedings would not have a material effect on the Company's financial position or results of operations.\nENVIRONMENTAL PROCEEDINGS\nWhile the Company's paramount goal is to conduct its operations in compliance with all applicable statutes and regulations, in the normal course of operations, the Company, as with all other companies engaged in the industrial and environmental service business, has been and may continue to be the subject of enforcement proceedings initiated by local, state and federal regulatory authorities. In general, such proceedings allege technical violations of licenses or permits under which the Company operates and often are the result of either a misunderstanding with respect to the applicability of a particular regulation or a difference in opinion between the Company and a regulatory agency with respect to the interpretation of a regulation. These enforcement proceedings can result in the imposition of fines and\/or penalties on the Company, and the agreement, by the Company, to change certain operating practices and procedures to more closely comply with the interpretation of the environmental regulations favored by the local, state or federal regulatory agency. Although the Company's experience to date has been that such proceedings have not had, either individually or in the aggregate, a material adverse effect on the Company's financial position or results of operations, there can be no assurance that a future proceeding will not have such a material adverse effect.\nVarious subsidiaries of the Company have been identified as Potentially Responsible Parties (\"PRPs\") at sites listed on the United States Environmental Protection Agency's (\"EPA\") National Priorities List (\"NPL\"), which identifies sites that have been selected for remedial activity by the EPA under CERCLA (the NPL is sometimes referred to as the \"Superfund List\"). In addition, various subsidiaries of the Company have been sent information requests by EPA, seeking to determine whether or not such subsidiaries have been involved with additional sites on the NPL. The Company's responsibility as a PRP, if any, at these additional sites has not been determined. All NPL sites at which the Company has been identified as a PRP, or for which the Company has been requested to submit information, are disposal sites owned and operated by third parties and are sites to which the Company is one of multiple parties (sometimes in excess of one hundred) alleged to have transported material. However, when a subsidiary of the Company has been formally identified as a PRP, such subsidiaries have uniformly been identified as DE MINIMIS contributors to such sites, and the Company's management anticipates that its status at additional sites at which it may be named as a PRP in the future would be similar. The Company's status as a DE MINIMIS contributor will entitle its subsidiaries to consider settlements extended by the EPA and\/or those parties that have been identified as significant contributors to such sites. Prior to accepting such a settlement, the Company's management will review its subsidiary's role with respect to each site, the amount and types of materials transported by the subsidiary to the site, and the availability of indemnification protection from the subsidiary's customers whose waste was sent to the site. As a result of this review, as well as the Company's continual review of such exposures, the Company may elect to accrue for an anticipated settlement of such Superfund proceeding. The majority of Superfund proceedings involve several years of negotiation between the group of parties identified as PRPs and EPA; therefore, the actual expenditure for a PRP settlement occurs years, if not decades, after the use of the NPL site and typically years after notification of potential liability as a PRP. Based on the Company's prior experience at NPL sites, the Company's management anticipates that it will accept DE MINIMIS settlements at any site at which it is identified as a PRP. In addition, it is anticipated that such settlements 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\nNo matters were submitted to a vote of the Company's security holders during the fourth quarter of the fiscal year ended August 31, 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Company's Common Stock is traded on the New York Stock Exchange under the symbol \"ALW.\" The following table sets forth the range of high and low per share sales prices for the Company's Common Stock for the Company's two most recently completed fiscal years:\nHIGH LOW ---------- ---------- Fiscal 1994 -- First quarter ended November 30, 1993 .......... $ 5.000 $ 4.000 Second quarter ended February 28, 1994 ......... 5.250 4.375 Third quarter ended May 31, 1994 ............... 6.000 4.875 Fourth quarter ended August 31, 1994 ........... 7.000 5.500\nFiscal 1995 -- First quarter ended November 30, 1994 .......... $ 7.500 $ 5.875 Second quarter ended February 28, 1995 ......... 6.125 4.750 Third quarter ended May 31, 1995 ............... 6.375 5.125 Fourth quarter ended August 31, 1995 ........... 5.875 5.000\nAccording to the Company's transfer agent, on November 22, 1995, there were 2,947 holders of record of the Company's Common Stock.\nThe Company has never paid cash dividends on its Common Stock and does not anticipate paying any cash dividends in the foreseeable future. In addition, the Company's credit facility prohibits the payment of cash dividends. The policy of the Board of Directors at this time is to retain earnings to provide funds for the growth of the Company.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe Selected Financial Data below includes the accounts of all companies acquired through August 31, 1995. The businesses, all of which were acquired in transactions accounted for as purchases during the past five years, are included from their respective dates of acquisition. The selected financial data has been restated for all years presented to display the Company's glass recycling business as a discontinued operation.\nThe Selected Financial Data should be read in conjunction with the accompanying Consolidated Financial Statements and the related notes thereto and \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\n\"Management's Discussion and Analysis of Financial Condition and Results of Operations\" has been restated for all periods discussed to exclude the Company's discontinued glass recycling operations. For information regarding acquisitions and dispositions made by the Company, refer to Notes 2 and 3, respectively, of Notes to Consolidated Financial Statements.\nRESULTS OF OPERATIONS\nFISCAL YEARS ENDED AUGUST 31, 1993, 1994 AND 1995\nREVENUES -- The Company's consolidated revenues grew by 20% from fiscal 1994 to 1995 and by 18% from fiscal 1993 to 1994. From fiscal 1994 to 1995, approximately 57% of the revenue growth was from internal sources with the balance of 43% coming externally. Of the Company's total revenue growth from fiscal 1993 to 1994, approximately 74% of such growth was internally-generated and 26% was derived from external sources. The following is a summary of revenues by major service line:\n1995 1994 1993 ---- ---- ---- ON-SITE INDUSTRIAL AND WASTE MANAGEMENT SERVICES Air-moving and liquid vacuuming ........................... 18% 19% 19% Hydroblasting and gritblasting ............................ 18% 19% 19% Dredging and dewatering ................................... 6% 6% 7% Other ..................................................... 13% 10% 10% --- --- --- Subtotal ................................................ 55% 54% 55% --- --- --- CONTAINER SERVICES .......................................... 14% 16% 15% TRANSPORTATION, ROLL-OFF AND TANK RENTAL SERVICES ........... 12% 13% 15% EXCAVATION AND SITE REMEDIATION SERVICES .................... 11% 9% 9% ALL OTHER SERVICES .......................................... 8% 8% 6% --- --- --- Total ................................................... 100% 100% 100% === === ===\nDuring fiscal 1994, overall demand increased for day-to-day service and project work due to an improvement in the general economy and work deferrals from fiscal 1993 that were performed in fiscal 1994. Internal revenue growth benefited from a strong turnaround season in the refining industry, and strong outage seasons in the utility industry in the Northeastern and Western United States. Revenues in the Southeastern United States increased due to an improvement in the offshore oil and gas exploration and production industry. Due to the effects of the general economic recovery, demand also increased within the automotive industry in Canada. The remaining $11.4 million or 26% revenue increase resulted from companies acquired during fiscal 1993 and 1994.\nAirmoving and liquid vacuuming revenues increased $8.7 million or 19% in fiscal 1994 primarily due to the previously discussed internal growth. Container services revenues increased $7.6 million or 20% in fiscal 1994 as a result of primarily volume increases in IBC and tank trailer cleaning and $1.8 million in acquisition-related growth. Hydroblasting and gritblasting revenues increased $6.4 million or 14% in fiscal 1994 with $1.4 million in acquisition related growth and $5.0 million in internal growth due to the factors previously stated. Excavation and site remediation revenues increased $4.2 million or 20% in fiscal 1994 primarily due to internal growth in the pulp and paper industry business in the Eastern United States. Dredging and dewatering revenues increased $2.4 million or 15% primarily due to internal growth in the refining and petrochemical industry in the Gulf Coast.\nThe Company's 13 other industrial service lines had aggregate revenue increases of $14.0 million or 18% in fiscal 1994. These increases primarily occurred in labor services, spill response, scaffolding and construction. Emergency spill response work increased primarily as a result of pipeline ruptures caused by the severe earthquake in southern California in mid-January 1994.\nIn general, the strong surge in business activity that began in fiscal 1994 continued into the first half of fiscal 1995. The Company began to experience a weakening in business activity during the latter part of fiscal 1995. Specifically, the Company experienced a decline in turnaround activity in the refining and petrochemical industry, particularly in the Pacific Coast region of the United States. During fiscal 1995, the strongest increase in internally-generated revenue occurred in the Southeastern United States as operations in that area of the country benefited from increased penetration of the pulp and paper and refining and petrochemical industries in Louisiana and a significant public works project in Alabama. Additionally, the Company completed a significant dewatering and roll-off\ntransportation project in Louisiana. The remaining $24.8 million or 43% revenue increase resulted from companies acquired during fiscal 1994 and 1995.\nExcavation and site remediation revenues increased $11.4 million or 45% in fiscal 1995 primarily due to increased market penetration in the Louisiana pulp and paper industry and a significant public works contract in Alabama. Hydroblasting and gritblasting revenues increased $7.7 million or 14% in fiscal 1995 as a result of increased tank cleaning and gritblasting services provided to the refining and petrochemical industry in the Southeastern United States and to the offshore oil and gas exploration and production industry in the Gulf of Mexico, respectively. Air-moving and liquid vacuuming revenues increased $7.4 million or 14% in fiscal 1995. Approximately $4.2 million or 57% of the increase in this service line is attributable to acquisition growth. The remaining increase is due to overall higher levels of turnaround activity along the Gulf Coast, increased penetration of the refining market in Hawaii and a non-recurring governmental clean-up job. These increases were partially offset by less spill response work and a lower level of turnaround activity in the refining industry in the Pacific Coast region. Container service revenues increased $4.8 million or 11% in fiscal 1995. Approximately $1.2 million or 25% of the increase in container services revenues is due to revenues generated by the Company's Atlanta wastewater pretreatment plant, which was accounted for on the equity method of accounting in the prior year previous to the Company's ownership increase in late fiscal 1994. The remaining increase in this service line is due to expansion of IBC service capabilities and a significant wastewater pretreatment project in Louisiana. Dredging and dewatering revenues increased $3.6 million or 19% as a result of acquisitions and a significant project for a refining customer in Louisiana.\nIn fiscal 1995, the Company's 24 other industrial service lines had aggregate revenue increases of $22.5 million or 39%. These increases primarily occurred in the service lines of sewer rehabilitation, transportation, roll-off and tank rental, labor, scaffolding, chemical cleaning, underground utility locating and air monitoring.\nGROSS PROFIT MARGINS -- Gross profit, as a percentage of revenues (\"gross margin\"), for fiscal 1993, 1994 and 1995 was 29%, 29% and 26%, respectively.\nAlthough the Company's gross margin was flat at 29% from fiscal 1993 to fiscal 1994, a decline of 3% to 26% was experienced in fiscal 1995. Approximately one-third of the margin decline is attributable to unusually high development of existing risk insurance claims under the Company's high deductible and retrospective risk management programs. Such decline was partially offset by the Company's record year in fiscal 1995 for safety performance. Margins were also affected by a higher mix of lower margin subcontract and disposal revenues and a significant loss on a governmental transportation project. Gross margins in the Company's Pacific Coast operations were adversely affected by lower volumes and lower pricing in the California refinery market and the nonrecurrence of high margin spill response work caused by the severe earthquake in Southern California in January 1994. The container services gross margin was adversely affected by inclusion of the results of the Company's Atlanta wastewater pretreatment facility which had low margins and had previously been accounted for under the equity method of accounting in fiscal 1994 and by lower margins at railcar operations that were primarily caused by a change in revenue mix.\nWRITE-DOWNS OF OPERATING EQUIPMENT\nDuring fiscal 1995, the Company booked write-downs in recognition of the permanent impairment of certain operating assets totaling $6.9 million. The affected assets included certain operating equipment in Mexico and California, a wastewater pretreatment facility, equipment relating to two small businesses which were exited and various owned facilities held for sale.\nSELLING, GENERAL AND ADMINISTRATIVE (\"SG&A\") EXPENSES\nThe Company's SG&A expense as a percentage of revenues was 22% during the fiscal year 1993 and 21% for fiscal years 1994 and 1995. SG&A expenses increased 11% from $53.0 million in fiscal 1993 to $59.0 million in fiscal 1994 and increased 24% to $73.0 million in fiscal 1995. The increased expense in fiscal 1994 is primarily attributable to the growth of the industrial services operations and to the acquisition of businesses during the year. SG&A related to acquisitions completed subsequent to fiscal 1992 contributed approximately 20% of the increase from fiscal 1993 to 1994. The remainder of the increase for fiscal 1994 is due to SG&A expenses of internal start-up locations, including the Company's Mexican operations, costs related to the Company's safety and management incentive plans and direct overhead expenses related to the internal expansion of the Company's operations. In fiscal 1993, SG&A expenses included significant legal costs associated with protecting the Company's interests relating to a previous acquisition which was favorably settled in early fiscal 1994.\nIncremental SG&A from acquisitions completed subsequent to fiscal 1993 contributed approximately 30% of the increase from fiscal 1994 to fiscal 1995. A significant part of the remaining increase is attributable to higher bad debt expenses, the write-off of unrealizable organizational costs relating to a realignment of the Company's Mexico joint ventures and higher legal and professional fees. The Company also increased its staffing to support its sales, safety and\ncompliance programs and to maintain strong financial systems and controls. These increases in SG&A were partially offset by lower costs relating to the Company's management incentive compensation plans.\nINTEREST EXPENSE -- Interest expense increased $.8 million from fiscal 1993 to 1994 and $3.2 million from fiscal 1994 to 1995. In fiscal 1994, the increase in interest expense is primarily the result of higher average debt levels required to fund acquisitions and capital expenditures required for internal growth. In the second half of fiscal 1994, the Company experienced higher average interest rates than in the corresponding prior year period. In fiscal 1995, the increase in interest expense was caused by a balanced combination of the above-mentioned higher average debt levels and higher average interest rates.\nINTEREST AND OTHER INCOME (EXPENSE), NET -- For the years ended August 31, 1993, 1994 and 1995, interest income was $338,000, $484,000 and $402,000, respectively. Other income for fiscal 1993 primarily reflects a $3.0 million gain on sale of the Company's IBC leasing operations in December 1992, partially offset by a $2.1 million pretax loss recorded in connection with the Company's decision to terminate management service agreements and acquire three investor-owned industrial services companies previously operated by the Company, and other charges totaling $.4 million.\nOther income for fiscal 1994 consists of a $2.7 million gain on the sale of the Company's investment in the common stock of Sanifill, Inc. and a $1.4 million gain, net of related fiscal 1994 legal expenses, on the settlement of a lawsuit associated with protecting the Company's interests relating to a previous acquisition. Included in other expense for fiscal 1994 is $2.4 million in write-offs relating to notes receivable and other reserves arising from the sale of businesses. Additionally, in the first quarter of fiscal 1994, the Company recorded $1.0 million in losses relating to its investment in a wastewater pretreatment facility, a gain of $.5 million on the sale of a joint venture interest, and other charges totaling $.7 million. Other expense for fiscal 1994 also includes $1.8 million in net operating losses recorded on the equity method of accounting at a wastewater pretreatment facility.\nOther expense in fiscal 1995 is primarily attributable to $1.0 million in allowances provided for a note receivable and the write-off of the Company's remaining investment of $2.0 million in previously-owned businesses. Also, the Company settled a lawsuit for $.6 million related to its previously discontinued asbestos abatement business.\nINCOME TAXES -- The effective income tax rates for the years ended August 31, 1993 and 1994 were 42% and 40%, respectively. The effective rates were higher than the statutory federal rate of 35% for fiscal 1994 and 34% for fiscal 1993, primarily due to the effect of nondeductible amortization of goodwill, state income taxes and Canadian earnings which are taxed at a higher statutory rate. The effective tax rate in 1994 was reduced by $1.4 million of nontaxable income received in fiscal 1994.\nIn fiscal 1995, the Company recorded a tax provision of $2.2 million despite a pre-tax loss of $2.1 million. Such tax provision was attributable to the above-mentioned items, nondeductible meals and entertainment and valuation allowances relating to the Company's Mexico joint ventures.\nFINANCIAL CONDITION\nShareholders' equity increased from $121.2 million at August 31, 1994 to $128.3 million at August 31, 1995. Long-term obligations increased from $134.6 million to $172.9 million. At August 31, 1995, $120.1 million was outstanding under the Company's revolving credit agreement, representing an increase of $35.7 million in net borrowings during fiscal 1995. These borrowings, along with $38.1 million in cash from operating activities, were used primarily to fund capital expenditures ($47.2 million) and cash consideration paid to the former owners of acquired businesses ($20.7 million). Additionally, there was a $5.0 million net increase in convertible subordinated debt issued as partial consideration for businesses acquired during fiscal 1995, which was offset by a $1.0 million decrease in deferred income tax liability in fiscal 1995, and long-term obligations which became current during fiscal 1995.\nOn September 1, 1995, the Company completed the sale of its glass recycling operations. Of the total sales price of $57.1 million, the Company received $42.5 million in cash which was utilized to reduce borrowings under the Company's revolving credit facility. Working capital increased from $25.6 million at August 31, 1994 to $26.9 million at August 31, 1995, reflecting increased overall levels of activity which resulted in an increase in trade receivables, lower current maturities of long-term debt and the working capital related to the businesses acquired during fiscal 1995. These increases were partially offset by higher insurance accruals and a decline in prepaid income taxes.\nLIQUIDITY AND CAPITAL RESOURCES\nCapital expenditures during fiscal 1994 and 1995 were $34.1 million and $47.2 million, respectively. Capital expenditures in 1995 were primarily related to purchases of operating equipment for existing service lines expanded to other locations or for expansion of service lines in existing markets. The Company anticipates capital expenditure requirements for existing operations of approximately $36.0 million in fiscal 1996. The Company's fiscal 1996 capital expenditure and acquisition programs will be funded from a combination of cash flows from operating activities and utilization of the Company's revolving credit facility. The Company has in the past and may in the future issue its own stock and\/or its convertible subordinated notes to former owners as consideration for acquired businesses. The Company considers its financial resources adequate to fund its capital expenditures and anticipated acquisition levels for fiscal 1996.\nIn December 1993, the Company entered into a revolving credit agreement with a group of banks. This agreement, as amended in August 1995, provides an unsecured $160 million revolving credit line to the Company through January 31, 1999, at which time any outstanding borrowings convert to a term loan due in equal quarterly installments through January 31, 2003. Unutilized borrowing capacity was $23.3 million at November 22, 1995.\nIn October 1994, the Company entered into an interest rate swap agreement through June 1997 to potentially lower the overall cost of borrowings. The agreement which modified $30 million of 7.25% fixed rate debt to a LIBOR-based floating rate plus .24% debt, was terminated on May 31, 1995. The $.5 million received in the termination transaction will be recorded as a reduction of interest expense over the remaining life of the original agreement.\nIn July 1995, the Board of Directors authorized the Company to repurchase up to 5,000,000 shares of the Company's Common Stock, either in the open market or in privately negotiated transactions. Subsequent to August 31, 1995, the Company has repurchased 288,300 shares of its stock at an average cost of $4.80 per share. Future repurchases of the Company's Common Stock will be dependent upon prevailing market conditions and other investment opportunities.\nFLUCTUATIONS IN RESULTS OF OPERATIONS\nCertain customers have varying levels of demand for the Company's services based on the time of year. Most of the Company's service lines tend to be slowest in the winter months (the Company's second quarter). Services provided to electric utility customers are typically performed in the fall and spring when demand for electricity is reduced and maintenance work can be performed more efficiently. Likewise, services provided to refining and petrochemical customers tend to be greater in the fall and spring when most planned turnarounds at customer plants occur. See also Note 13 of Notes to Consolidated Financial Statements for quarterly financial data. In addition, the Company's acquisition program can affect not only future results and rates of growth but also previously reported results because of restatements if acquisitions are accounted for as poolings-of-interests.\nThe impact of inflation on the Company has been minimal.\nFISCAL 1996 OUTLOOK\nManagement expects to continue to achieve strong revenue growth in fiscal 1996 through a combination of internal growth programs and acquisitions. Internal growth is expected to come from new market penetration in industrial and environmental services, the continued expansion of service lines in existing operations and the expansion of wastewater pretreatment capabilities at existing container services facilities. As a facilitator of revenue growth, the Company has launched its ALLIES(TM) marketing program which is an integrated approach to selling the Company's full range of services, primarily to national customers. The ALLIES(TM) program focuses on the themes of partnering, value-added service and customer profit improvement.\nAnother area of focus in fiscal 1996 will be cost control and margin expansion. In this regard, it is the Company's intention to push for selected price increases where market conditions permit and as a by-product of value-added selling efforts. Also, the Company has identified certain expenses that it anticipates will be opportunities for cost reduction.\nThe Company has clearly defined the industrial customer as the focus of its business strategy. On September 1, 1995, the Company completed the sale of its former glass recycling operations in order to narrow its focus on providing services to the industrial customer and to provide additional capital for expansion of this core business. During fiscal 1996, the Company is developing new opportunities to serve the industrial customer independently or through partnering arrangements in the areas of water and wastewater management, energy services, contract labor services and leak sealing and valve restoration services.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo Allwaste, Inc.:\nWe have audited the accompanying Consolidated Balance Sheets of Allwaste, Inc. (a Delaware corporation) and subsidiaries as of August 31, 1995 and 1994, and the related Consolidated Statements of Operations, Shareholders' Equity and Cash Flows for each of the three years in the period ended August 31, 1995. These Consolidated Financial Statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these Consolidated Financial Statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the Consolidated Financial Statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the Consolidated Financial Statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the Consolidated Financial Statements referred to above present fairly, in all material respects, the financial position of Allwaste, Inc. and subsidiaries as of August 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended August 31, 1995, in conformity with generally accepted accounting principles.\nARTHUR ANDERSEN LLP\nHouston, Texas November 17, 1995\nALLWASTE, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARES)\nThe accompanying notes are an integral part of these Consolidated Financial Statements.\nALLWASTE, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA)\nThe accompanying notes are an integral part of these Consolidated Financial Statements.\nALLWASTE, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (IN THOUSANDS)\nThe accompanying notes are an integral part of these Consolidated Financial Statements.\nALLWASTE, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)\nThe accompanying notes are an integral part of these Consolidated Financial Statements.\nALLWASTE, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES --\nPRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION\nThe Consolidated Financial Statements include the accounts of Allwaste, Inc. (\"Allwaste\" or the \"Company) and all of its wholly-owned and majority-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. Prior year amounts in the Consolidated Financial Statements and Notes to Consolidated Financial Statements have been restated to reflect the Company's glass recycling operations as a discontinued operation, as discussed in Note 3. Additionally, certain prior year amounts have been reclassified to conform with the fiscal 1995 presentation.\nREVENUE RECOGNITION\nRevenues are recorded as services are performed. Revenues derived from services provided under fixed-price contracts are recognized on a percentage-of-completion basis, using the cost-to-cost method. If it is determined that a contract may result in a loss, a provision for the loss is accrued at such time.\nINVENTORIES\nInventories are stated at the lower of average cost or market. Amounts are removed from inventory using the estimated average cost per unit method. The inventory balances at August 31, 1995 and 1994 were $1.8 million and $2.0 million, respectively. Inventories are included in deferred taxes and other current assets in the Consolidated Balance Sheets.\nPROPERTY AND EQUIPMENT\nProperty and equipment are stated at cost. The Company provides depreciation over the estimated useful lives of the depreciable assets using the straight-line method as follows: YEARS ------- Buildings .................................................... 10 - 30 Service equipment and related vehicles ....................... 2 - 20 Other ........................................................ 3 - 10\nThe cost of major improvements are capitalized. Expenditures for maintenance, repairs and minor improvements are expensed as incurred. Maintenance and repairs were $13.6 million, $11.9 million and $9.4 million for the years ended August 31, 1995, 1994 and 1993, respectively. When property and equipment are sold or retired, the remaining cost and accumulated depreciation are removed from the accounts and the resulting gain or loss is included in the results of operations.\nInterest is capitalized in connection with the construction of major facilities and equipment. The capitalized interest is recorded as part of the asset to which it relates and is depreciated over the asset's estimated useful life. Capitalized interest primarily relates to improvements and expansions at container services facilities and was $319,000, $141,000 and $144,000 for the years ended August 31, 1995, 1994 and 1993, respectively.\nGOODWILL\nGoodwill represents the excess of the aggregate price paid by the Company in the acquisition of businesses accounted for as purchases over the fair market value of the net assets acquired (see Note 2). Goodwill is being amortized on a straight-line basis over 40 years. The Company continually evaluates whether subsequent events or circumstances have occurred that indicate the remaining useful life of goodwill may warrant revision or that the remaining balance of goodwill may not be recoverable. When factors indicate that goodwill may be impaired, the Company uses an estimate of the business component's undiscounted net income over the remaining life of the goodwill in measuring whether the goodwill is recoverable. Management believes that there have been no events or circumstances which warrant revision to the remaining useful life or which affect the recoverability of goodwill. Accumulated amortization at August 31, 1995 and 1994 was $6.6 million and $4.9 million, respectively.\nINCOME TAXES\nThe Company accounts for income taxes in accordance with Statement of Financial Accounting Standards (\"SFAS\") No. 109 \"Accounting for Income Taxes\" which was adopted in the first quarter of fiscal 1994. The implementation of SFAS No. 109 did not have a material effect on the Company's consolidated financial position or its results of operations.\nDeferred tax assets and liabilities are determined based on the estimated future tax effects of differences between the financial statement and tax bases of assets and liabilities. On the accompanying Consolidated Balance Sheets, current and non-current deferred tax assets and liabilities are netted within each tax jurisdiction. The following table sets forth the gross deferred tax assets (liabilities) recorded as of August 31 (in thousands):\n1995 1994 ------ ------ Current deferred tax assets .................... $ 8,512 $ 3,622 Non-current deferred tax assets ................ 5,003 1,496 Valuation allowance ............................ (1,156) -- -------- -------- Total deferred tax assets ................. 12,359 5,118\nCurrent deferred tax liabilities ............... -- (1,755) Non-current deferred tax liabilities ........... (14,998) (12,529) -------- -------- Total deferred tax liabilities ............ (14,998) (14,284)\nNet deferred tax liabilities ................... $ (2,639) $ (9,166) ======== ========\nThe Company is required to record valuation allowances for deferred tax assets where management believes it is more likely than not that the tax benefit will not be realized. Accordingly, the Company established valuation allowances against certain deferred tax assets; primarily those attributable to the Company's net operating losses of its joint ventures in Mexico.\nPOSTEMPLOYMENT BENEFITS\nThe Company adopted SFAS No. 112 \"Employers' Accounting for Postemployment Benefits\" in the first quarter of fiscal 1995. There were no liabilities related to postemployment benefits provided to former or inactive employees, their beneficiaries, and covered dependents after employment but before retirement at August 31, 1995.\nENVIRONMENTAL EXPENDITURES\nEnvironmental expenditures are expensed or capitalized based upon their future economic benefit. Costs which improve a property, as compared with the condition of the property when originally constructed or acquired, and costs which prevent future environmental contamination are capitalized. Costs related to environmental damage resulting from operating activities subsequent to acquisition are expensed. Liabilities for these expenditures are recorded when it is probable that obligations have been incurred and the amounts can be reasonably estimated.\nMINORITY INTEREST\nDuring fiscal 1993, the Company contributed cash in exchange for an aggregate 60% joint venture interest in each of two companies in Mexico. A Mexican company owns the remaining 40% interest in each entity. One of the companies performs various industrial services, including site remediation and aboveground storage tank cleaning services. The primary operations of the other company are underground storage tank testing services.\nFor financial reporting purposes, the joint ventures' assets and liabilities are consolidated with those of the Company. The Mexican company's minority interests, $.4 million at August 31, 1995 and $.7 million at August 31, 1994, are included in the Company's Consolidated Balance Sheets in deferred income taxes and other liabilities. The joint venture experienced pre-tax losses of $1.2 million in fiscal 1995, excluding the effect of write-downs of certain operating equipment and $.9 million in fiscal 1994, net of the minority partner's interest in such losses.\nFOREIGN CURRENCY TRANSLATION\nThe Company's Canadian and Mexican subsidiaries maintain their books and records in Canadian dollars and Mexican pesos, respectively. Assets and liabilities of these operations are translated into U.S. dollars at the exchange rate in effect at the end of each accounting period, and income and expense accounts are translated at the average exchange rate prevailing during the period. Gains and losses resulting from such translation are included as a separate\ncomponent of shareholders' equity. Gains and losses from transactions in foreign currencies are credited or charged to income currently and are not significant.\nINVESTMENT ACTIVITY\nIn fiscal 1993 and for most of fiscal 1994, the Company owned a 40% interest in a wastewater pretreatment facility and recorded such investment using the equity method of accounting. Prior to increasing its ownership in late fiscal 1994, the Company's equity in losses of this partnership were $1.8 million and $.2 million for the years ended August 31, 1994 and 1993, respectively, and are included in other income (expense), net in the accompanying Consolidated Statements of Operations. Additionally, in fiscal 1994, the Company recorded $1.0 million in losses relating to its investment in this facility which is recorded in other income (expense), net in the accompanying Consolidated Statements of Operations.\nThe Company acquired 181,000 shares of Sanifill, Inc. (\"Sanifill\"), a publicly traded corporation involved in the collection and disposal of solid waste, pursuant to a private offering in 1989 at an average cost of $1.62 per share. In November 1993, the Company sold all of its shares of Sanifill. The sale resulted in a pretax gain of $2.7 million which is reflected in other income (expense), net in the accompanying Consolidated Statements of Operations.\nThe Company operated three investor-owned industrial service companies under separate management service agreements. In February 1993, the Company decided to terminate the agreements and acquired the companies from the investor groups in consideration of the assumption of the liabilities of each entity. In connection with the termination of the management service agreements and the acquisition of the companies, the Company recognized a nonrecurring pretax loss of approximately $2.1 million for the year ended August 31, 1993 in other income (expense), net in the accompanying Consolidated Statements of Operations. A non-employee former member of the Board of Directors of the Company owned a 25% interest in one of the companies, and the brother of the Chairman of the Board of Directors of the Company owned a 13% and 17% interest, respectively, in two of the companies.\nIn August 1991, as consideration for the sale of its asbestos abatement division to IAM\/Environmental, Inc. (\"IAM\"), the Company accepted notes receivable of $2.9 million. During January 1994, the Company negotiated an exchange of the above-mentioned notes receivable for redeemable preferred stock of IAM. Prior to the above-mentioned exchange, the Company recorded an allowance for potential uncollectibility of the notes of approximately $.9 million during the first fiscal quarter of 1994. In fiscal 1995, the Company reduced its investment in IAM to zero. The related write-off of $2.0 million is recorded in other income (expense), net in the accompanying Consolidated Statements of Operations. The investment is reflected in other assets in the accompanying 1994 Consolidated Balance Sheet at the net book value of the surrendered notes receivable.\nThe Company continues to guarantee a $3.5 million bank line of credit for IAM through January 1997 unless earlier cancellation of the guarantee is triggered by specified events. IAM's borrowing capacity under the line of credit is restricted by a percentage of the amount of qualified trade receivables available for use as collateral.\nSPECIAL CHARGES\nDuring fiscal 1995, the Company recorded special charges of $11.9 million. Such charges include $6.9 million of charges classified as write-downs of operating equipment in the accompanying Consolidated Statements of Operations. These write-downs relate to the permanent impairment of certain operating equipment in Mexico and California, a wastewater pretreatment facility, equipment relating to two small businesses exited and various owned facilities held for sale. Included in SG&A expenses in the accompanying Consolidated Statements of Operations is $1.1 million of charges primarily representing the write-off of organizational expenses relating to the Mexico joint ventures. The Consolidated Statements of Operations also reflects $.6 million in interest expense relating to the write-off of previously unamortized loan costs in connection with the bank amendment to the revolving credit facility completed in August 1995. Other income (expenses), net in the accompanying Consolidated Statements of Operations reflects $3.6 million in charges relating to an allowance provided for a note receivable and the write-off of the Company's remaining investment in IAM and another previously-owned business, as well as the settlement of a lawsuit related to the previously discontinued asbestos abatement business. Certain of the charges relating to the Mexico joint venture are partially offset by the minority interest effect of such charges.\nCASH FLOW REPORTING\nHighly liquid debt instruments with an original maturity of three months or less are considered to be cash equivalents. Cash payments for interest during 1995, 1994 and 1993 were $10.0 million, $6.3 million and $5.6 million, respectively, and cash payments for income taxes during 1995, 1994 and 1993 were $4.5 million, $8.4 million and $3.4 million, respectively.\nNEW ACCOUNTING PRONOUNCEMENTS\nIn May 1993, the Financial Accounting Standards Board issued SFAS No. 114, \"Accounting by Creditors for Impairment of a Loan\". In October 1994, SFAS 114 was amended by SFAS No. 118 \"Accounting for Impairment of a Loan - Income Recognition and Disclosure\". The Company is required to adopt SFAS No. 114, as amended by SFAS No. 118, in fiscal 1996. Management believes that the adoption of SFAS No. 114 and SFAS No. 118 will not have a material effect on the Company's financial position or results of operations.\nIn March 1995, the Financial Accounting Standards Board issued SFAS No. 121, \"Accounting for the Impairment of Long-Lived Assets to be Disposed Of\". The Company is required to adopt SFAS No. 121 for fiscal 1997. Management has not yet determined what impact, if any, the adoption of SFAS No. 121 will have on the Company's financial position or results of operations.\n(2) ACQUISITIONS --\nUnder the purchase method of accounting, the results of acquired businesses are included with the Company from their respective acquisition dates. The following table summarizes the Company's business acquisitions accounted for under the purchase method (dollars in thousands):\nThe allocations of the purchase price to the fair market value of the net assets acquired in the fiscal 1995 acquisitions are based on preliminary estimates of fair market value and may be revised when additional information concerning asset and liability valuations is obtained.\nAs an integral part of each of the above acquisitions, all former shareholders signed non-compete agreements and key management entered into agreements with the Company to continue managing these businesses.\nIn connection with six acquisitions made from fiscal 1991 through 1995, the Company agreed to make contingent payments to the former owners over periods up to five years based on formulas in the respective acquisition agreements. At the Company's option these payments may be made in either cash or common stock of the Company. At August 31, 1995, the maximum aggregate amount of contingent payments was $4.2 million. In management's opinion, based on the current performance levels of the individual acquisitions involved, the ultimate settlement of these contingent payment obligations is likely to be substantially less than the $4.2 million maximum aggregate. Approximately $.3 million in contingent payments were made during 1995. Amounts earned under the terms of these agreements are recorded as additional goodwill and amortized over the remaining amortization period.\n(3) DISCONTINUED OPERATIONS --\nIn September 1995, the Company sold its glass recycling operations to a company formed by Equus II Incorporated, a Houston-based, publicly-traded business development company. The consideration totaled $57.1 million, including $42.5 million in cash, $8.0 million of 7% redeemable Series A preferred stock payable in 2002, and a $6.6 million 12% subordinated note receivable due in 2002. The preferred stock and notes receivable obtained as consideration are payable by Strategic Materials Holdings, Inc. an affiliate of Equus II Incorporated. The Company also received warrants for common stock providing a right to own up to 32% in the new company. Allwaste may receive additional consideration in the form of an adjustment to the purchase price in the event that Equus' internal rate of return, as defined, exceeds certain predetermined targets. The amount of such additional compensation, if any, is not presently determinable. The consideration is also subject to certain post-closing adjustments which may be significant and which are not determinable at this time. Accordingly, the amount of the anticipated gain on the glass recycling transaction is not reasonably estimable. Revenues of the glass recycling operations, net of intercompany sales, were $70.0, $63.2 and $58.2 million for fiscal years ended 1995, 1994 and 1993, respectively.\nThe net assets of the glass recycling operations consisted of the following (in thousands): AUGUST 31, ----------------------- 1995 1994 ----------------------- Net working capital ............................ $ 7,726 $ 7,054 Property and equipment, net .................... 21,335 17,918 Goodwill and other assets ...................... 19,264 18,341 Long-term debt ................................. 440 98 Deferred income taxes and other ................ 1,734 1,297\nIncome from discontinued operations in the Consolidated Statements of Operations is presented net of allocated interest expense of $1,569,000, $1,047,000 and $621,000 and net of applicable income taxes of $1,825,000, $1,596,000 and $1,341,000 for fiscal years 1995, 1994 and 1993, respectively. The interest was allocated based upon the net assets of the glass recycling operations in relation to the Company's consolidated net assets plus general corporate debt.\n(4) RECEIVABLES --\nReceivables included in current assets consisted of the following (in thousands): AUGUST 31, ------------------------ 1995 1994 ------------------------ Trade accounts ................................... $ 80,619 $ 62,755 Employees ........................................ 996 581 Other ............................................ 2,133 4,190 -------- -------- 83,748 67,526 Less -- Allowance for doubtful accounts .......... (3,683) (2,650) -------- -------- $ 80,065 $ 64,876 ======== ========\nNotes receivable recorded as non-current assets consisted of the following (in thousands): AUGUST 31, ------------------------ 1995 1994 ------------------------ Notes receivable from employees ................ $ 2,483 $ 2,331 Notes receivable from sale of discontinued asbestos abatement operation .................................... 2,888 2,888 Notes receivable from sale of businesses ................................... 790 1,415 Other .......................................... 522 546 ------- ------- 6,683 7,180 Less -- Loss reserves .......................... (1,790) (790) ------- ------- $ 4,893 $ 6,390 ======= =======\n(5) DEBT --\nLONG-TERM DEBT\nLong-term debt consisted of the following (in thousands):\nRevolving credit agreement\nIn December 1993, the Company replaced its previous credit agreement by entering into a revolving credit agreement with a group of banks. This agreement, as amended in August 1995, provides an unsecured $160 million revolving credit line to the Company through January 31, 1999, at which time any outstanding borrowings convert to a term loan due in equal quarterly installments through January 31, 2003. Interest on outstanding borrowings is charged, at the Company's option, at the banks' prime rate (8 3\/4% at August 31, 1995), adjusted Eurodollar Rate or the banks' reserve adjusted certificate of deposit rate (CD rate) plus 0% to 1.625% as determined by the calculation of the debt to cash flow ratio (as defined). A commitment fee of .25% is payable on the unused portion of the line. Three of the banks participating in the revolving credit agreement have also extended to the Company uncommitted, short-term lines of credit with interest rates which may be more favorable to the Company than those available under the revolving credit agreement. As of August 31, 1995, the Company had $120.1 million outstanding under the revolving credit agreement and the uncommitted lines of credit and had utilized $25 million of the facility for letters of credit to secure certain insurance obligations and performance bonds. Under the terms of the agreement, the Company must maintain a minimum fixed charge coverage ratio (as defined) and certain other minimum financial ratios. Borrowing availability is subject to the Company meeting minimum leverage and other ratios. As of November 22, 1995, unutilized borrowing capacity, as defined under the agreement, was $23.3 million. The credit agreement prohibits the payment of cash dividends.\nMaturities of long-term debt outstanding at August 31, 1995 are as follows (in thousands):\nFor the year ending August 31 -- 1996 686 1997 326 1998 119 1999 30,030 2000 30,020 Thereafter 60,040 -------- $121,221 ========\nCONVERTIBLE SUBORDINATED DEBT\nConvertible Subordinated Debentures\nIn June 1989, the Company completed a public offering of $30.0 million of 7.25% Convertible Subordinated Debentures due June 1, 2014 (the \"Debentures\"); net proceeds to the Company were $28.7 million. Direct offering costs related to the Debentures are included in other assets in the accompanying Consolidated Balance Sheets and are being amortized over the term of the Debentures. The Debentures are convertible by the holder, at any time, into shares of the Company's Common Stock at a price of $11.94 per share and are redeemable for cash at the option of the Company. The Debentures provide for annual mandatory sinking fund payments equal to 5% of the aggregate principal amount of the Debentures issued, commencing June 1, 1999. Interest is payable semi-annually, on June 1 and December 1.\nIn October 1994, the Company entered into an interest rate swap agreement through June 1997 to potentially lower the overall cost of borrowings. The agreement modified the $30.0 million of 7.25% fixed rate debt to a LIBOR-based floating rate plus .24% debt, which was reset quarterly. On May 31, 1995, the Company terminated the agreement and will record the $.5 million received as a reduction of interest expense over the remaining term of the original swap.\nConvertible Subordinated Notes\nDuring fiscal years 1995 and 1994, the Company issued $5.0 million and $7.0 million, respectively, of additional convertible subordinated notes to former owners of certain acquired businesses (the \"Notes\") as partial consideration of the acquisition purchase price. The Company has $2.7 million of similar notes outstanding from prior years. The Notes bear interest, payable quarterly, at a weighted average rate of 6.1% and are convertible by the holder into shares of the Company's Common Stock at a weighted average price of $7.16 per share. The Notes are redeemable for cash or the Company's Common Stock at the option of the Company at any time after one year of issuance.\nMaturities of the Notes outstanding at August 31, 1995 are as follows (in thousands):\nFor the year ending August 31 -- 1996 $ 2,685 1997 6,987 1998 4,985 ------- $14,657 ======= (6) INCOME TAXES --\nThe Company and its United States (\"U.S.\") subsidiaries file a consolidated federal income tax return. Acquired entities file appropriate tax returns through their respective acquisition dates (absent certain administrative elections) and thereafter are included in the Company's consolidated return. Foreign income taxes consist primarily of Canadian federal and provincial taxes attributable to the Company's Canadian subsidiaries.\nForeign pretax book income (loss) net of certain intercompany interest expense and other items was ($432,474) (consisting of a Mexican loss of ($1,318,703) and Canadian income of $886,229), $1,239,000 and $2,589,000 for the years ended August 31, 1995, 1994 and 1993, respectively.\nFederal, state and foreign income tax provisions are as follows (in thousands): FOR THE YEARS ENDED AUGUST 31, ---------------------------------- 1995 1994 1993 -------- -------- -------- Federal -- Current $ 6,536 $ 1,599 $ 1,376 Deferred (6,260) 3,819 2,498 ------- ------- ------- 276 5,418 3,874 ------- ------- ------- State -- Current 1,494 584 561 Deferred (430) 179 19 ------- ------- ------- 1,064 763 580 ------- ------- ------- Foreign -- Current 667 840 1,087 Deferred 163 (24) (60) ------- ------- ------- 830 816 1,027 ------- ------- ------- $ 2,170 $ 6,997 $ 5,481 ======= ======= =======\nThe differences in the income taxes provided and the amount determined by applying the U.S. federal statutory rate to income before income taxes are summarized as follows:\nFOR THE YEARS ENDED AUGUST 31, ------------------------------ 1995 1994 1993 -------- -------- -------- Federal income tax at statutory rate 35% 35% 34% Effect of valuation allowance ...... (55) -- -- State income taxes, net of benefit for federal deduction ............ (33) 3 3 Effect of meals and entertainment limitation ....................... (21) -- -- Effect of nondeductible amortization of goodwill ...................... (16) 2 3 Effect of nondeductible expenses ... (7) -- -- Foreign income taxes at higher rates (3) 1 1 Other .............................. (3) (1) 1 ---- ---- ----\n(103)% 40% 42% ==== ==== ====\nDeferred income tax expense results principally from the use of different capital recovery and revenue and expense recognition methods for tax and financial accounting purposes. The sources of these temporary differences and related tax effect were as follows (in thousands):\nFOR THE YEARS ENDED AUGUST 31, --------------------------------- 1995 1994 1993 -------- -------- -------- Depreciation and amortization $ 901 $ 1,361 $ 2,538 Accruals and reserves not deductible until paid ...... (5,186) 1,926 34 Write-downs of assets ........ (1,580) -- -- Sale of IBC leasing operations (305) (222) (188) Other, net ................... (357) 909 73 ------- ------- ------- Total deferred income taxes provided (benefited) . $(6,527) $ 3,974 $ 2,457 ======= ======= =======\nPrepaid income taxes of $1.2 million and $4.1 million are included in prepaid expenses at August 31, 1995 and 1994, respectively.\n(7) SHAREHOLDERS' EQUITY --\nPREFERRED STOCK\nThe Company can issue up to 500,000 shares of Preferred Stock, none of which are issued or outstanding. The Board of Directors is authorized to provide for the issuance of the Preferred Stock in series, to establish the number of shares to be included in each such series and to fix the designation, powers, preferences and rights of the shares of each such series and the qualifications, limitations or restrictions, thereof. This includes, among other things, any voting rights, conversion privileges, dividend rates, redemption rights, sinking fund provisions and liquidation rights which shall be superior to the Common Stock. No holder of Preferred Stock will have preemptive rights.\nSTOCK OPTION PLANS\nIn January 1995, the Company's stockholders approved the Amended and Restated 1989 Replacement Non-Qualified Stock Option Plan (the \"Plan\"), which increased the number of shares issuable under the Plan from 3,000,000 shares to 4,500,000 shares. Under the Plan and notwithstanding certain restrictions placed upon grants of options to persons subject to Section 16(a) of the Securities Exchange Act of 1934, through August 31, 1999, all forfeited, expired and exercised options automatically become available for grants of new options under the Plan; therefore, the number of granted option shares plus those remaining available for grant shall remain constant at 4,500,000 through such date. Stock options are granted under the Plan at an exercise price which equals the fair market value of the Common Stock on the date of grant or on the date which marks the occurrence of the event pursuant to which the options are granted.\nAt August 31, 1995, options were outstanding under the Plan at prices ranging from $3.88 to $10.88 per share, of which 1,618,886 option shares were exercisable. Subsequent to August 31, 1995, an additional 391,950 options were granted under the Plan at the per share exercise price of $4.75.\nIn October 1992, the Company's Board of Directors adopted a supplemental option plan (\"Supplemental Plan\") to enable the Company to fulfill obligations to former employees. A total of 1,500,000 shares are issuable under the amended Supplemental Plan. At August 31, 1995, options were outstanding under the Supplemental Plan at prices ranging from $.50 to $10.88 per share, of which 785,646 option shares were exercisable.\nThe following table summarizes stock option activity of the Company's stock option plans for each of the three years ended August 31:\nTREASURY STOCK\nIn October 1993, the Company reached a settlement of a lawsuit with a former owner of an acquired business and other parties. In exchange for a full and complete release of all claims against the parties, the Company received $982,500 in cash and 250,000 shares of the Company's Common Stock. This transaction resulted in a gain of $1.4 million, net of related fiscal 1994 legal expenses, which is reflected in other income (expense), net in the Consolidated Statements of Operations.\nIn July 1995, the Board of Directors of the Company approved a Stock Repurchase Plan which authorizes management of the Company to repurchase up to 5,000,000 shares of common stock. Subsequent to August 31, 1995, the Company purchased 288,300 shares of its common stock under this plan at an average price of $4.80 per share.\n(8) COMMITMENTS AND CONTINGENCIES --\nLEASE COMMITMENTS\nThe Company has entered into various operating lease agreements, primarily for office space, service facilities and service equipment utilized for operations. Minimum annual rental payments under noncancellable operating leases as of August 31, 1995 were as follows (in thousands):\nFor the year ending August 31 -- 1996 $ 3,942 1997 3,375 1998 2,691 1999 1,939 2000 1,372 Thereafter 2,899 ------- $16,218 =======\nRental expense under operating leases was $15.1 million, $11.8 million and $6.7 million for the years ended August 31, 1995, 1994 and 1993, respectively. These amounts include a service facility leased from the Company's Chairman of the Board of Directors, for which rental expense was $126,000, $90,000 and $84,000 for the years ended August 31, 1995, 1994 and 1993, respectively.\nLEGAL MATTERS\nIn the normal course of its operations, the Company can become involved in a variety of legal disputes. Currently, the Company is a defendant in several legal proceedings, including worker's compensation matters and minor business disputes, the majority of which are being handled or are expected to be handled by the Company's insurance carriers. As a company that handles and transports hazardous waste, the Company is involved in various administrative and court proceedings under environmental laws and regulations relating to permit applications, operating authorities and alleged liabilities related to the Comprehensive Environmental Response, Compensation and Liability Act of 1980. Management of the Company believes that a decision adverse to the Company in any one or in all of these proceedings would not have a material effect on the financial position or the results of operations of the Company.\nINSURANCE\nThe Company maintains worker's compensation insurance for its employees and other coverages for normal business risks. A substantial portion of the Company's current and prior year insurance coverages are \"high deductible\" or retrospective policies in which the Company, in many cases, is responsible for the payment of incurred claims up to specified individual and aggregate limits, over which a third party insurer is contractually liable for any additional payment of such claims. Accordingly, the Company bears certain economic risks related to these coverages. On a continual basis, and as of each balance sheet date, the Company records an accrual equal to the estimated costs expected to result from incurred claims plus an estimate of claims incurred but not reported as of such date based on the best available information at such date. However, the nature of these claims is such that actual development of the claims may vary significantly from the estimated accruals. All changes in the accrual estimates are accounted for on a prospective basis and can have a significant impact on the Company's financial position or results of operations.\nInsurance for environmental accidents and pollution has historically been expensive and difficult to obtain. The Company currently maintains insurance for environmental accidents and pollution relating to the performance of services at customer locations. To date, the Company has never incurred significant fines, penalties or liabilities for pollution, environmental damage or toxic torts. However, in the event a claim is successful against the Company for pollution or toxic tort liability for which the Company is only partially insured or completely uninsured, there could be a material adverse effect on the Company.\n(9) RETIREMENT PLANS --\nEffective October 1, 1990, the Company established a defined contribution employee benefit plan, the Allwaste Retirement Savings Plan, which covered substantially all full-time non-union U.S. employees having at least one year of service. On July 1, 1995, the Company adopted the Allwaste Employee Retirement Plan (the \"Retirement Plan\"), which amended and restated the Allwaste Retirement Savings Plan. Eligible employees may contribute up to 15% of their compensation, subject to certain Internal Revenue Code limitations. The Company matches 50% of each participant's contributions up to 3% of eligible compensation. Retirement Plan participants may select among six investment options, one of which is the Company's Common Stock. At August 31, 1995, the Retirement Plan held 419,346 shares of the Company's Common Stock (market value of $2.3 million) which represented 29.4% of the Retirement Plan's assets. In addition to the Plan, the Company maintains three other defined contribution employee benefit plans which cover a small group of union employees. Defined contribution expense related to all plans for the Company was $620,000, $509,000 and $429,000 for fiscal years 1995, 1994 and 1993, respectively.\n(10) DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS --\nThe following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to do so.\nThe Company's notes receivable 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.\nLong-term investments are based on the carrying value of the asset.\nThe Company's long-term debt and convertible subordinated debt are estimated based on quotations obtained from broker-dealers who make markets in these and similar securities. The bank credit facilities are based on floating interest rates and, as such, the carrying amount is a reasonable estimate of fair value.\nLetters of credit are based on the face amount of the related obligations and performance bonds.\nThe estimated fair values of the Company's financial instruments are as follows (in thousands):\n(11) NET INCOME (LOSS) PER COMMON SHARE --\nNet income (loss) per common share is computed by dividing net income (loss) by the weighted average number of shares of Common Stock and equivalents outstanding during the year as shown below (in thousands, except per share data):\nFully diluted net income per common share is not presented for any period as it is not materially different from the above primary calculations.\nCommon stock equivalents include stock options to purchase Common Stock. The convertible subordinated debt is not a common stock equivalent and does not have a dilutive effect on net income (loss) per common share for any of the three years presented.\n(12) BUSINESS OPERATIONS AND GEOGRAPHIC INFORMATION --\nThe primary business of the Company involves the provision of on-site waste management, container, waste transportation, excavation and site remediation and wastewater pretreatment services to the industrial customer. The Company's operations are primarily located in the United States, Canada and Mexico, as summarized below (in thousands):\n(13) QUARTERLY FINANCIAL DATA (UNAUDITED) --\nThe table below sets forth consolidated operating results by fiscal quarter for the years ended August 31, 1995 and 1994 excluding the Company's discontinued glass recycling operations (in thousands, except per share data):\nDue to changes in weighted average common shares outstanding, the sum of the quarterly per share amounts for fiscal 1995 and 1994 do not equal earnings per share for the respective years.\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 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 above items will be included in the Company's proxy statement to be filed within 120 days after the close of the fiscal year end in connection with the 1996 Annual Shareholders' Meeting.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(A) 1. FINANCIAL STATEMENTS.\nReport of Independent Public Accountants\nConsolidated Balance Sheets as of August 31, 1995 and 1994\nConsolidated Statements of Operations for the years ended August 31, 1995, 1994 and 1993\nConsolidated Statements of Shareholders' Equity for the years ended August 31, 1995, 1994 and 1993\nConsolidated Statements of Cash Flows for the years ended August 31, 1995, 1994 and 1993\nNotes to Consolidated Financial Statements\n2. FINANCIAL STATEMENT SCHEDULES.\nReport of Independent Public Accountants on Financial Statement Schedules\nSchedule II - Valuation and Qualifying Accounts\nAll other schedules are omitted because they are not applicable or the required information is provided in the Consolidated Financial Statements or notes thereto.\n3. EXHIBITS.\n3. EXHIBITS.\n- --------------- * This information appears only in the manually signed and sequentially numbered original.\n(B) REPORTS ON FORM 8-K.\nAllwaste, Inc. (the \"Company\") Current Report on Form 8-K dated September 1, 1995, filed on September 15, 1995, and the Company's Current Report on Form 8-K\/A dated and filed on November 14, 1995, related to the disposition of the Company's glass recycling operations.\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. 33-46048 (filed February 28, 1992), 33-37684 (filed November 8, 1990), 33-55210 (filed December 1, 1992), 33-61639 (filed August 7, 1995) and 33-61641 (filed August 7, 1995):\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.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULES\nTo Allwaste, Inc.:\nWe have audited in accordance with generally accepted auditing standards, the Consolidated Financial Statements of Allwaste, Inc. and subsidiaries included in this Form 10-K, and have issued our report thereon dated November 17, 1995. Our audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule listed in Part IV, Item 14 (a)(2) for Allwaste, Inc. and subsidiaries 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 schedule has 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 17, 1995\nSCHEDULE II ALLWASTE, INC. AND SUBSIDIARIES (1)\nVALUATION AND QUALIFYING ACCOUNTS\n(1) Restated to exclude the discontinued glass recycling operations; see Note 3 of Notes to Consolidated Financial Statements. (2) Uncollectible accounts written off, net of recoveries on accounts previously written off.\nSIGNATURE PAGE\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant, Allwaste, Inc., has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nALLWASTE, INC. By: \/s\/ ROBERT M. CHISTE Robert M. Chiste, 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, Allwaste, Inc., and in the capacities and on the dates indicated.\nSIGNATURE TITLE DATE - -------------------------- --------------------------------- ----------------- \/s\/ ROBERT M. CHISTE President and Chief Executive November 22, 1995 Robert M. Chiste Officer (Principal Executive Officer); Director\n\/s\/ DARREN B. MILLER Vice President - Treasurer November 22, 1995 Darren B. Miller (Principal Financial Officer and Principal Accounting Officer)\n\/s\/ R. L. NELSON, JR. Chairman of the Board November 22, 1995 R.L. Nelson, Jr.\n\/s\/ MICHAEL A. BAKER Director November 22, 1995 Michael A. Baker\n\/s\/ DAVID H. BATCHELDER Director November 22, 1995 David H. Batchelder\n\/s\/ RICARDO J. BESQUIN L. Director November 22, 1995 Ricardo J. Besquin L.\n\/s\/ JOHN U. CLARKE Director November 22, 1995 John U. Clarke\nRobert L. Knauss Director November 22, 1995\n\/s\/ THOMAS J. TIERNEY Director November 22, 1995 Thomas J. Tierney\n\/s\/ T. MICHAEL YOUNG Director November 22, 1995 T. Michael Young","section_15":""}
{"filename":"751341_1995.txt","cik":"751341","year":"1995","section_1":"Item 1. Business - ----------------\nBalcor Realty Investors 85-Series I A Real Estate Limited Partnership (the \"Registrant\") is a limited partnership formed in 1983 under the laws of the State of Illinois. The Registrant raised $82,697,000 from sales of Limited Partnership Interests. The Registrant's operations consist exclusively of investment in and operation of income-producing real property, and all financial information included in this report relates to this industry segment.\nThe Registrant utilized the net offering proceeds to acquire ten real property investments and minority joint venture interests in three additional properties. The Registrant has disposed of three of these properties in prior years and disposed of one of the properties in which it held a minority joint venture interest during 1995 and one during February 1996. The seven properties and two minority joint venture interests held at December 31, 1995 are described under Item 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties - ------------------\nAs of December 31, 1995, the Registrant owned the seven properties described below:\nLocation Description of Property - -------- -----------------------\nChesterfield County, Boulder Springs Apartments: a 284-unit Virginia complex located on approximately 32 acres.\nArlington, Texas Forest Ridge Apartments (Phase I): a 332-unit complex located on approximately 14 acres.\nEast Baton Rouge Parish, Forestwood Apartments: a 272-unit complex Louisiana located on approximately 11 acres.\nOklahoma City, Oklahoma Heather Ridge Apartments: a 356-unit complex located on approximately 16 acres.\nColorado Springs, Colorado Templeton Park Apartments: a 496-unit complex located on approximately 21 acres.\nAltamonte Springs, Florida Timberlake Apartments (Phase I): a 480-unit complex located on approximately 43 acres.\nTown & Country, Missouri Willow Bend Apartments: a 208-unit complex located on approximately 21 acres.\nEach of the above properties is held subject to various forms of financing.\nThe Registrant also held minority joint venture interests in North Hill Apartments, DeKalb County, Georgia; and Seabrook Apartments, Orange County, Florida. Seabrook Apartments was sold in February 1996. See Note 6 of Notes to Financial Statements for additional information.\nIn the opinion of the General Partner, the Registrant has provided for adequate insurance coverage for its real estate investment properties.\nSee Notes to Financial Statements for other information regarding real property investments.\nItem 3.","section_3":"Item 3. Legal Proceedings - --------------------------\nProposed class action - ---------------------\nOn February 29, 1996, a proposed class action complaint was filed, Raymond Masri vs. Lehman Brothers, Inc., et al., Case No. 96\/103727 (Supreme Court of the State of New York, County of New York). The Registrant, additional limited partnerships which were sponsored by The Balcor Company, three limited partnerships sponsored by the predecessor of Lehman Brothers, Inc. (together with the Registrant and the affiliated partnerships, the \"Defendant Partnerships\"), Lehman Brothers, Inc. and Smith Barney Holdings, Inc. are defendants. The complaint alleges, among other things, common law fraud and deceit, negligent misrepresentation and breach of fiduciary duty relating to the disclosure of information in the offering of limited partnership interests in the Defendant Partnerships. The complaint seeks judgment for compensatory damages equal to the amount invested in the Defendant Partnerships by the proposed class plus interest accrued thereon; general damages for injuries arising from the defendants' actions; recovery from the defendants of all profits received by them as a result of their actions relating to the Defendant Partnerships; exemplary damages; attorneys' fees and other costs.\nThe defendants intend to vigorously contest this action. No class has been certified as of this date. Management of each of the defendants believes they have meritorious defenses to contest the claims. It is not determinable at this time whether or not an unfavorable decision in this action would have a material adverse impact on the Registrant.\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 1995.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Stockholder - ------------------------------------------------------------------------- Matters - -------\nThere has not been an established public market for Limited Partnership Interests and it is not anticipated that one will develop; therefore, the market value of the Limited Partnership Interests cannot reasonably be determined. For information regarding distributions see Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nAs of December 31, 1995, the number of record holders of Limited Partnership Interests of the Registrant was 7,701.\nItem 6.","section_6":"Item 6. Selected Financial Data - -------------------------------\nYear ended December 31, ---------------------------------------------------------- 1995 1994 1993 1992 1991 ---------- ----------- ----------- ----------- -----------\nTotal income $16,503,016 $14,888,075 $15,484,410 $17,331,431 $16,137,937 Income (loss) before gains on sales of assets and extraordinary items 2,142,234 529,539 (465,069) (1,653,732) (2,904,684) Net income (loss) 2,142,234 663,204 7,210,490 (1,653,732) (2,904,684) Net income (loss) per Limited Partnership Interest 25.65 7.94 86.32 (19.80) (34.77) Total assets 54,596,297 59,911,923 58,158,518 75,012,096 76,644,481 Mortgage notes payable 56,466,198 57,381,930 55,919,126 79,230,302 79,520,953 Distributions per Limited Partner- ship Interest (A) 77.50 5.00 None None None\n(A) These amounts include a distribution of original capital of $29 per Limited Partnership Interest for 1995.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and - ----------------------------------------------------------------------- Results of Operations - ---------------------\nOperations - ----------\nSummary of Operations - ---------------------\nThe Pinebrook Apartments, which was owned by a joint venture consisting of Balcor Realty Investors 85 - Series I A Real Estate Limited Partnership (the \"Partnership\") and an affiliate, was sold in 1995. The Partnership recognized its share of the gain on sale which is the primary reason the Partnership generated higher net income in 1995 as compared to 1994. In addition, during 1995 certain of the Partnership's properties had improved operations. As a result of the foreclosure of Suncrest Village Apartments and sale of Sahara Palms Apartments in 1993, the Partnership recognized gains which resulted in significantly higher net income in 1993 as compared to 1994. Further discussion of the Partnership's operations is summarized below.\n1995 Compared to 1994 - ---------------------\nIncreased rental rates during 1995 at most of the Partnership's properties resulted in increased rental and service income.\nInterest income on short-term investments increased in 1995 as compared to 1994 due to an increase in interest rates earned on short-term investments.\nPinebrook Apartments, in which the Partnership held a minority joint venture interest, was sold during February 1995. As a result of the gain recognized in connection with the sale, the Partnership recognized income from participation in joint ventures with affiliates during 1995 as compared to a loss in 1994.\nThe Partnership incurred legal, consulting, printing and postage costs in connection with a tender offer during the fourth quarter of 1995. As a result, administrative expenses increased during 1995 as compared to 1994.\nNorth Hill Apartments is owned by a joint venture consisting of the Partnership and an affiliate. In connection with the December 1994 North Hill Apartments refinancing, the joint venture received a refund relating to prior year payments made to Mutual Benefit Life Insurance Company representing its 1% guaranty fee on the original North Hills Apartments mortgage loan. As a result, the joint venture recognized a $534,659 extraordinary gain on forgiveness of debt in 1994, of which $133,665 represents the Partnership's share.\n1994 Compared to 1993 - --------------------- As a result of the Suncrest Village Apartments foreclosure in May 1993 and the Sahara Palms Apartments sale in July 1993, rental and service income, interest expense, depreciation expense, property operating expense, real estate taxes and property management fees decreased during 1994 as compared to 1993.\nIncreased rental and\/or occupancy rates during 1994 at all of the Partnership's seven remaining properties partially offset the decrease in rental and service income due to the 1993 property dispositions.\nThe increase in cash flow from the Partnership's properties, the proceeds from the July 1993 sale of Sahara Palms Apartments, and the net proceeds received in connection with the refinancing of the mortgage loan on Heather Ridge Apartments in July 1994 caused the Partnership's cash balances to increase. This, together with higher interest rates, resulted in an increase in interest income on short-term investments during 1994 as compared to 1993.\nParticipation in loss of joint ventures with affiliates increased in 1994 as compared to 1993 due to increased interest expense on the Pinebrook Apartments mortgage loan.\nIn addition to the decrease resulting from the 1993 property dispositions, interest expense decreased during 1994 as compared to 1993 due to the refinancing of the Timberlake - Phase I Apartments mortgage loan in October 1993, as well as the contractual decrease in the interest rate on the Templeton Park Apartments mortgage loan, effective December 1993. The decrease in interest expense was partially offset by increased interest expense for the Forest Ridge - Phase I and Heather Ridge loans due to higher principal balances resulting from the refinancings during 1994. In conjunction with the 1994 Forest Ridge - Phase I and Heather Ridge refinancings, the remaining deferred expenses were written-off and this combined with the amortization of expenses related to the 1993 Forestwood and Timberlake - Phase I mortgage refinancings caused amortization of deferred expenses to increase during 1994 as compared to 1993.\nProperty operating expense decreased during 1994 as compared to 1993 due to the 1993 property dispositions and maintenance and repairs expense incurred in 1993 at the Forestwood Apartments for which the Partnership received an insurance reimbursement in 1994. However, increases in carpet replacement at Forest Ridge - - Phase I, Forestwood, Timberlake - Phase I and Willowbend apartment complexes as well as higher insurance expense at all of the Partnership's properties partially offset the decrease for 1994 as compared to 1993.\nAs a result of the sale of Sahara Palms Apartments in July 1993 and the relinquishment of title through foreclosure of Suncrest Village Apartments in May 1993, the Partnership recognized a gain on sale of property of $4,194,237 in 1993 and extraordinary gain on foreclosure of property of $3,118,578 in 1993, respectively.\nIn October 1993, the Partnership completed the refinancing of the Timberlake - Phase I first mortgage loan, and obtained a new first mortgage loan from an unaffiliated lender. The Partnership received a $362,744 discount from the previous lender for prepayment of the mortgage note and consequently recognized an extraordinary gain on debt forgiveness in 1993.\nLiquidity and Capital Resources - -------------------------------\nThe cash position of the Partnership significantly decreased as of December 31, 1995 when compared to December 31, 1994, primarily due to special distributions paid to the Limited Partners in 1995. The Partnership's cash flow provided by operating activities was generated primarily from the Partnership's properties, and was partially offset by the payment of administrative expenses. The\nPartnership's net cash provided by investing activities consisted of a net distribution from joint ventures with affiliates, comprised primarily of the net proceeds received from the sale of the Pinebrook Apartments in which the Partnership held a minority joint venture interest. Financing activities consisted of distributions to Limited Partners, net proceeds from the refinancing of the underlying mortgage loan on the Boulder Apartments, payment of deferred expenses and funding of improvement escrows in connection with the refinancing and principal payments on mortgage notes payable.\nThe Partnership classifies the cash flow performance of its properties as either positive, a marginal deficit or a significant deficit, each after consideration of debt service payments unless otherwise indicated. A deficit is considered to be significant if it exceeds $250,000 annually or 20% of the property's rental and service income. The Partnership defines cash flow generated from its properties as an amount equal to the property's revenue receipts less property related expenditures, which include debt service payments. During 1995 and 1994, all seven of the Partnership's properties generated positive cash flow. Of the remaining two properties in which the Partnership holds minority joint venture interests, North Hill Apartments generated positive cash flow while Seabrook Apartments generated a marginal cash flow deficit during 1995 and 1994. Pinebrook Apartments, in which the Partnership held a minority joint venture interest, was sold in February 1995 and generated a marginal cash flow deficit in both 1995 and 1994. As of December 31, 1995, the occupancy rates of the Partnership's properties ranged from 92% to 99%.\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 improving operating performance and seeking rent increases where market conditions allow.\nThe General Partner had previously advised the Limited Partners that its strategy was to sell the Partnership's remaining assets over the next three to four years. The General Partner also stated that the timing of the liquidation could be lengthened or shortened due to changes in market conditions, economic factors, interest rates and unforeseen events. Since November 1995, the General Partner believes that the market for multifamily housing properties has become increasingly favorable to sellers of these properties. This belief is based on the results of the sales and marketing activities of the Partnership as described below and based upon the similar results of such activities by various other partnerships affiliated with the Partnership. These favorable market conditions are in part attributable to the increasing strength of the capital markets and the re-entry of REITs into the acquisition market. Since November 1995, the Partnership has sold one of its properties in which it held a minority joint venture interest. Of its remaining properties, the General Partner (i) has entered into a contract to sell one of the properties; (ii) is actively marketing one of the properties in which it holds a minority joint venture interest for sale; and (iii) if the market remains favorable, intends to begin actively marketing more of the remaining properties for sale. If the current market conditions for sales remain favorable and the General Partner can obtain appropriate sales prices, the Partnership's liquidation strategy may be accelerated.\nEach of the Partnership's properties is owned through the use of third-party mortgage loan financing and, therefore, the Partnership is subject to the financial obligations required by such loans. See Note 4 of Notes to Financial Statements for information concerning outstanding balances, maturity dates, interest rates, and other items related to each of these mortgage loans. No mortgage loan financing matures during 1996. During 1997, approximately $5,714,000 of mortgage loan financing collateralized by the Willow Bend Apartments matures. The Partnership has a contract to sell the Willow Bend Apartments with a scheduled closing date of March 29, 1996.\nIn May 1995, the Boulder Springs mortgage loan was refinanced. Proceeds from the new loan of $8,140,000 were used to repay the existing loan of $7,786,649. See Note 4 of Notes to the Financial Statements for additional information.\nThe Pinebrook Apartments was owned by a joint venture consisting of the Partnership and an affiliate (\"Joint Venture\") . In February 1995, the Joint Venture sold the property in an all cash sale for $6,140,000. From the proceeds, $5,058,226 was paid to the third party mortgage holders in satisfaction of the first, second and fourth mortgage loans. Additionally, $716,729 was paid in satisfaction of the third mortgage note payable to Pinebrook Limited Partnership, a separate joint venture consisting of the Partnership and the affiliate. Total proceeds received from this transaction were $871,599, of which $422,115 was the Partnership's share. See Note 4 of Notes to the Financial Statements for additional information.\nThe Seabrook Apartments was owned by a joint venture (\"Joint Venture\") consisting of the Partnership and two affiliates. In February 1996, the Joint Venture sold the Seabrook Apartments in an all cash sale for $5,915,000. From the proceeds, the Joint Venture paid the outstanding balance of the first mortgage loan collateralized by the property of $5,081,898. Total proceeds received from the sale were approximately $640,000, of which the Partnership's share was approximately $100,000. See Note 12 of Notes to Financial Statements and Item 1. Business for additional information.\nIn January 1996, the Partnership made a distribution of $620,228 ($7.50 per Interest) to the holders of Limited Partnership Interests representing the quarterly distribution for the fourth quarter of 1995. The Partnership commenced distributions in the fourth quarter of 1994 and made four distributions totaling $77.50 per Interest during 1995 and one distribution of $5.00 during 1994. Distributions were comprised of $48.50 and $5.00 of Net Cash Receipts during 1995 and 1994, respectively, and $29 of Net Cash Proceeds during 1995. Including the January 1996 distribution, Limited Partners have received cumulative cash distributions of $90.00 per $1,000 Interest as well as certain tax benefits. Of this amount, $61.00 has been from Net Cash Receipts and $29.00 has been from Net Cash Proceeds. The General Partner expects to continue quarterly distributions to Limited Partners. However, the level of future distributions, if available, will depend on 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 all of their original investment.\nIn 1995, the Financial Accounting Standards Board issued Statement No. 121 \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of\". This statement has been adopted by the Partnership as of January 1, 1995, and did not have a material impact on the financial position or results of operations of the Partnership.\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, 1995 December 31, 1994 ------------------------- ------------------------- Financial Tax Financial Tax Statements Returns Statements Returns ------------- --------- ----------- ------------ Total assets $54,596,297 $42,014,617 $59,911,923 $48,360,939 Partners' capital (deficit) accounts: General Partner (694,758) (1,502,386) (716,180) (1,589,662) Limited Partners (2,459,643)(16,080,496) 1,828,563 (11,454,275) Net income (loss): General Partner 21,422 87,276 6,632 (32,039) Limited Partners 2,120,812 1,782,797 656,572 (1,293,926) Per Limited Part- nership Interest 25.65 21.56 7.94 (15.65)\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-XVI, its General Partner, has either a Board of Directors or a Board of Advisors.\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 Senior Vice President Alexander J. Darragh Senior Vice President Josette V. Goldberg Senior Vice President Alan G. Lieberman Senior Vice President, Chief Brian D. Parker Financial Officer, Treasurer and Assistant Secretary Senior Vice President John K. Powell, Jr.\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. He is also Senior Vice President of American Express Company and is responsible for its real estate operations worldwide. 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.\nAlexander J. Darragh (February 1955) joined Balcor in September 1988 and is responsible for due diligence analysis and real estate advisory services for Balcor and American Express Company. He also has supervisory responsibility for Balcor's environmental matters. Mr. Darragh received masters' degrees in Urban Geography from Queen's University and in Urban Planning from Northwestern University.\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 MIS functions. 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 Balcor's property sales and capital markets functions. Mr. Lieberman is a Certified Public Accountant.\nBrian D. Parker (June 1951) joined Balcor in March 1986 and, as Chief Financial Officer and Chief Accounting Officer, is responsible for Balcor's financial, legal and treasury functions. He is a Director of The Balcor Company. 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 portfolio and asset management matters relating to Balcor's partnerships. Mr. Powell also has supervisory responsibility for Balcor's risk management and investor services functions. He received a Master of Planning degree from the University of Virginia. Mr. Powell 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.\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 1995.\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 8 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-XVI 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 880 Interests 1.06%\nRelatives and affiliates of the officers and partners of the General Partner own an additional fifteen 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 8 of Notes to Financial Statements for additional information relating to transactions with affiliates.\nSee Note 3 of Notes to Financial Statements for information relating to the Partnership Agreement and the allocation of distributions and profits and losses.\n(c) No management person is indebted to the Registrant.\n(d) The Registrant has no outstanding agreements with any promoters.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedule, and Reports on Form 8-K - ------------------------------------------------------------------------\n(a) (1 & 2) See Index to Financial Statements and Financial Statement Schedule in this Form 10-K.\n(3) Exhibits:\n(3) The Amended and Restated Agreement and Certificate of Limited Partnership is set forth as Exhibit 3 to Amendment No. 1 to the Registrant's Registration Statement on Form S-11 dated November 29, 1984 (Registration No. 2-92777), and said Agreement and Certificate is incorporated herein by reference.\n(4) The Subscription Agreement as set forth as Exhibit 4.1 to Amendment No. 1 to Registrant's Registration Statement on Form S-11 dated November 29, 1984 (Registration No. 2-92777) and Form of Confirmation regarding Interests in the Partnership as 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. 0-14353) are incorporated herein by reference.\n(27) Financial Data Schedule of the Registrant for 1995 is attached hereto.\n(b) Reports on Form 8-K: There were no reports filed on Form 8-K during the quarter ended December 31, 1995.\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 I A REAL ESTATE LIMITED PARTNERSHIP\nBy: \/s\/Brian D. Parker -------------------------------- Brian D. Parker Senior Vice President, and Chief Financial Officer (Principal Accounting and Financial Officer) of Balcor Partners-XVI, the General Partner\nDate: March 28, 1996 --------------\nPursuant to the requirements of the Securities Exchange Act of 1934, 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- \/s\/Thomas E. Meador XVI, the General Partner March 28, 1996 - -------------------- --------------- Thomas E. Meador\nSenior Vice President, and Chief Financial Officer (Principal Accounting and Financial Officer) of Balcor Partners-XVI, the General Partner \/s\/Brian D. Parker March 28, 1996 - -------------------- --------------- Brian D. Parker\nINDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE\nReport of Independent Accountants\nFinancial Statements:\nBalance Sheets, December 31, 1995 and 1994\nStatements of Partners' Capital, for the years ended December 31, 1995, 1994 and 1993\nStatements of Income and Expenses, for the years ended December 31, 1995, 1994 and 1993\nStatements of Cash Flows, for the years ended December 31, 1995, 1994 and 1993\nNotes to Financial Statements\nFinancial Statement Schedule:\nIII - Real Estate and Accumulated Depreciation, as of December 31, 1995\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 I A Real Estate Limited Partnership:\nWe have audited the financial statements and the financial statement schedule of Balcor Realty Investors 85 - Series I A Real Estate Limited Partnership (An Illinois Limited Partnership) as listed in the index of this Form 10-K. These financial statements and financial statement schedule are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Balcor Realty Investors 85-Series I A Real Estate Limited Partnership at December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995 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 23, 1996\nBALCOR REALTY INVESTORS 85-SERIES I A REAL ESTATE LIMITED PARTNERSHIP (An Illinois Limited Partnership)\nBALANCE SHEETS December 31, 1995 and 1994\nASSETS\n1995 1994 ----------- ----------- Cash and cash equivalents $ 2,369,231 $ 6,475,393 Accounts and accrued interest receivable 19,630 28,827 Escrow deposits 1,652,919 1,140,420 Prepaid expenses 158,090 Deferred expenses, net of accumulated amortization of $302,544 in 1995 and $213,273 in 1994 1,027,098 973,153 ------------- ------------- 5,226,968 8,617,793 ------------- ------------- Investment in real estate: Land 12,380,326 12,380,326 Buildings and improvements 65,940,832 65,940,832 ------------- ------------- 78,321,158 78,321,158 Less accumulated depreciation 28,951,829 27,027,028 ------------- ------------- Investment in real estate, net of accumulated depreciation 49,369,329 51,294,130 ------------- ------------- $ 54,596,297 $ 59,911,923 ============= =============\nLIABILITIES AND PARTNERS' (DEFICIT) CAPITAL\nAccounts payable $ 218,237 $ 133,743 Due to affiliates 24,501 75,413 Accrued liabilities, principally real estate taxes 330,103 366,628 Security deposits 262,183 288,084 Losses in excess of investments in joint ventures with affiliates 449,476 553,742 Mortgage notes payable 56,466,198 57,381,930 ------------- ------------- Total liabilities 57,750,698 58,799,540 ------------- ------------- Limited Partners' (deficit) capital (82,697 Interests issued and outstanding) (2,459,643) 1,828,563\nGeneral Partner's deficit (694,758) (716,180) ------------- ------------- Total partners' (deficit) capital (3,154,401) 1,112,383 ------------- ------------- $ 54,596,297 $ 59,911,923 ============= ============= The accompanying notes are an integral part of the financial statements.\nBALCOR REALTY INVESTORS 85-SERIES I A REAL ESTATE LIMITED PARTNERSHIP (An Illinois Limited Partnership)\nSTATEMENTS OF PARTNERS' (DEFICIT) CAPITAL for the years ended December 31, 1995, 1994 and 1993\nPartners' (Deficit) Capital Accounts -------------- ------------- ------------- General Limited Total Partner Partners -------------- ------------- -------------\nBalance at December 31, 1992 $ (6,347,826) $ (794,917) $ (5,552,909)\nNet income for the year ended December 31, 1993 7,210,490 72,105 7,138,385 -------------- ------------- ------------- Balance at December 31, 1993 862,664 (722,812) 1,585,476\nCash distributions (A) (413,485) (413,485)\nNet income for the year ended December 31, 1994 663,204 6,632 656,572 -------------- ------------- ------------- Balance at December 31, 1994 1,112,383 (716,180) 1,828,563\nCash distributions (A) (6,409,018) (6,409,018)\nNet income for the year ended December 31, 1995 2,142,234 21,422 2,120,812 -------------- ------------- ------------- Balance at December 31, 1995 $ (3,154,401) $ (694,758) $ (2,459,643) ============== ============= =============\n(A) Summary of cash distributions per Interest:\n1995 1994 1993 -------------- ------------- ------------- First Quarter $ 5.00 None None Second Quarter 5.00 None None Third Quarter 45.00 None None Fourth Quarter 22.50 $ 5.00 None\nThe accompanying notes are an integral part of the financial statements.\nBALCOR REALTY INVESTORS 85-SERIES I A REAL ESTATE LIMITED PARTNERSHIP (An Illinois Limited Partnership)\nSTATEMENTS OF INCOME AND EXPENSES for the years ended December 31, 1995, 1994 and 1993\n1995 1994 1993 -------------- ------------ ------------ Income: Rental and service $ 15,525,153 $ 14,972,425 $ 15,565,175 Interest on short-term investments 325,145 233,282 113,266 Participation in income (losses) of joint ventures with affiliates before extraordinary item 652,718 (317,632) (194,031) -------------- ------------- ------------- Total income 16,503,016 14,888,075 15,484,410 -------------- ------------- ------------- Expenses: Interest on mortgage notes payable 4,768,731 4,969,653 5,853,947 Depreciation 1,924,801 1,925,074 2,216,451 Amortization of deferred expenses 156,022 154,912 96,490 Property operating 5,179,036 4,985,291 5,371,265 Real estate taxes 923,313 991,624 1,051,338 Property management fees 765,223 747,795 778,849 Administrative 643,656 584,187 581,139 -------------- ------------- ------------- Total expenses 14,360,782 14,358,536 15,949,479 -------------- ------------- ------------- Income (loss) before gain on sale of property and extraordinary items 2,142,234 529,539 (465,069) Gain on sale of property 4,194,237 -------------- ------------- ------------- Income before extraordinary items 2,142,234 529,539 3,729,168 -------------- ------------- ------------- Extraordinary items: Gain on forgiveness of debt 362,744 Gain on foreclosure of property 3,118,578 Participation in gain on forgiveness of debt from joint venture with an affiliate 133,665 ------------- ------------- Total extraordinary items 133,665 3,481,322 -------------- ------------- ------------- Net income $ 2,142,234 $ 663,204 $ 7,210,490 ============== ============= =============\nThe accompanying notes are an integral part of the financial statements.\nBALCOR REALTY INVESTORS 85-SERIES I A REAL ESTATE LIMITED PARTNERSHIP (An Illinois Limited Partnership)\nSTATEMENTS OF INCOME AND EXPENSES for the years ended December 31, 1995, 1994 and 1993 (Continued)\n1995 1994 1993 -------------- ------------- ------------- Income before extraordinary items allocated to General Partner $ 21,422 $ 5,295 $ 37,292 ============== ============= ============= Income before extraordinary items allocated to Limited Partners $ 2,120,812 $ 524,244 $ 3,691,876 ============== ============= ============= Income before extraordinary items per Limited Partnership Interest (82,697 issued and outstanding) $ 25.65 $ 6.34 $ 44.64 ============== ============= ============= Extraordinary items allocated to General Partner NONE $ 1,337 $ 34,813 ============== ============= ============= Extraordinary items allocated to Limited Partners NONE $ 132,328 $ 3,446,509 ============== ============= ============= Extraordinary items per Limited Partnership Interest (82,697 issued and outstanding) NONE $ 1.60 $ 41.68 ============== ============= ============= Net income allocated to General Partner $ 21,422 $ 6,632 $ 72,105 ============== ============= ============= Net income allocated to Limited Partners $ 2,120,812 $ 656,572 $ 7,138,385 ============== ============= ============= Net income per Limited Partnership Interest (82,697 issued and outstanding) $ 25.65 $ 7.94 $ 86.32 ============== ============= =============\nThe accompanying notes are an integral part of the financial statements.\nBALCOR REALTY INVESTORS 85-SERIES I A REAL ESTATE LIMITED PARTNERSHIP (An Illinois Limited Partnership)\nSTATEMENTS OF CASH FLOWS for the years ended December 31, 1995, 1994 and 1993\n1995 1994 1993 -------------- ------------- ------------- Operating activities: Net income $ 2,142,234 $ 663,204 $ 7,210,490 Adjustments to reconcile net income to net cash provided by operating activities: Gain on forgiveness of debt (362,744) Gain on foreclosure of property (3,118,578) Gain on sale of property (4,194,237) Participation in (income) losses of joint ventures with affiliates before extraordinary item (652,718) 317,632 194,031 Participation in gain on forgiveness of debt from joint venture with an affiliate (133,665) Depreciation of properties 1,924,801 1,925,074 2,216,451 Amortization of deferred expenses 156,022 154,912 96,490 Net change in: Accounts and accrued interest receivable 9,197 426,996 (203,405) Escrow deposits (233,177) 29,178 (360,225) Prepaid expenses (158,090) Accounts payable 84,494 29,230 (244,111) Due to affiliates (50,912) (4,149) (4,061) Accrued liabilities (36,525) (2,758) (494,386) Security deposits (25,901) (11,015) (78,091) -------------- ------------- ------------- Net cash provided by operating activities 3,159,425 3,394,639 657,624 -------------- ------------- ------------- Investing activities: Capital contributions to joint ventures with affiliates (42,706) (280,003) (49,751) Distributions from joint ventures with affiliates 591,158 125,610 91,904 Improvements to properties (118,767) Proceeds from sale of real estate 13,200,000 Payment of selling costs (99,559) -------------- ------------- ------------- Net cash provided by or used in investing activities 548,452 (154,393) 13,023,827 -------------- ------------- -------------\nThe accompanying notes are an integral part of the financial statements.\nBALCOR REALTY INVESTORS 85-SERIES I A REAL ESTATE LIMITED PARTNERSHIP (An Illinois Limited Partnership)\nSTATEMENTS OF CASH FLOWS for the years ended December 31, 1995, 1994 and 1993 (Continued)\n1995 1994 1993 -------------- ------------- ------------- Financing activities: Distributions to Limited Partners (6,409,018) (413,485) Repayment of mortgage note payable (7,786,649) (10,563,000) (29,604,431) Proceeds from issuance of mortgage notes payable 8,140,000 12,890,000 17,600,000 Principal payments on mortgage notes payable (1,269,083) (864,196) (465,471) Disbursements from improvement escrows 89,678 Payment of deferred expenses (209,967) (396,203) (684,351) Funding of improvement escrows (369,000) (547,760) -------------- ------------- ------------- Net cash used in or provided by financing activities (7,814,039) 105,356 (13,154,253) -------------- ------------- ------------- Net change in cash and cash equivalents (4,106,162) 3,345,602 527,198 Cash and cash equivalents at beginning of period 6,475,393 3,129,791 2,602,593 -------------- ------------- ------------- Cash and cash equivalents at end of period $ 2,369,231 $ 6,475,393 $ 3,129,791 ============== ============= =============\nThe accompanying notes are an integral part of the financial statements.\nBALCOR REALTY INVESTORS 85-SERIES I A REAL ESTATE LIMITED PARTNERSHIP (An Illinois Limited Partnership)\nNOTES TO FINANCIAL STATEMENTS\n1. Nature of the Partnership's Business:\nBalcor Realty Investors 85-Series I A Real Estate Limited Partnership is engaged principally in the operation of residential real estate located in various markets within the United States.\n2. Accounting Policies:\n(a) The preparation of the financial statements in conformity with generally accepted accounting principles requires the General Partner 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 vary from those estimates.\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 30 Furniture and fixtures 5\nMaintenance and repairs are charged to expense when incurred. Expenditures for improvements are charged to the related asset account.\nInterest incurred while properties were under construction was capitalized.\nWhen properties are sold, the related costs and accumulated depreciation are removed from the respective accounts. Any gain or loss on disposition is recognized in accordance with generally accepted accounting principles.\n(c) Effective January 1, 1995 the Partnership adopted Statement of Financial Accounting Standards, No. 121 (SFAS 121), \"Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of\". Under SFAS 121, the Partnership records its investments in real estate at the lower of cost or fair value, and periodically assesses, but not less than on an annual basis, possible impairment to the value of its properties. The General Partner estimates the fair value of its properties by dividing the property's expected net operating income by a risk adjusted rate of return which considers economic and demographic conditions in the market. In the event the General Partner determines an impairment in value has occurred, and the carrying amount of the real estate asset will not be recovered, a provision is recorded to reduce the carrying basis of the property to its estimated fair value. The General Partner considers the method referred to above to result in a reasonable measurement of a property's fair value, unless other factors affecting the property's value indicate otherwise.\n(d) Investment in joint ventures with affiliates represents the Partnership's 25% and 15.4% interests in the North Hill Apartments and Seabrook Apartments, respectively at December 31, 1995 and also included a 48.4% interest in Pinebrook Apartments at December 31, 1994, all of which are recorded under the equity method of accounting. Under this method, 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 ventures has resulted in the Partnership's share of cumulative losses exceeding the net amounts invested in the joint ventures. This has resulted in the classification of the investment as \"Losses in excess of investments in joint ventures with affiliates\" in the accompanying financial statements.\n(e) Deferred expenses consist of loan modification and financing fees which are amortized over the terms of the respective agreements.\n(f) The Financial Accounting Standard Board's Statement No. 107, \"Disclosures About Fair Value of Financial Instruments\", requires disclosure of fair value information about financial instruments for which it is practicable to estimate that value. Since quoted market prices are not available for the Partnership's financial instruments, fair values have been based on estimates using present value techniques. These techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, may not be realized in immediate settlement of the instrument. Statement No. 107 does not apply to all balance sheet items and excludes certain financial instruments and all non-financial instruments such as real estate and investment in joint ventures from its disclosure requirements.\n(g) Revenue is recognized on an accrual basis in accordance with generally accepted accounting principles.\n(h) Cash and cash equivalents include all unrestricted highly liquid investments with an original maturity of three months or less when purchased.\n(i) The Partnership is not liable for Federal income taxes and each partner recognizes his proportionate share of the Partnership income or loss in his tax return; therefore no provision for income taxes is made in the financial statements of the Partnership.\n(j) A reclassification has been made to the previously reported 1994 and 1993 financial statements to conform with the classification used in 1995. This reclassification has not changed the 1994 and 1993 results.\n3. Partnership Agreement:\nThe Partnership was organized on August 1, 1983. The Partnership Agreement provides for Balcor Partners-XVI to be the General Partner and for the admission of Limited Partners through the sale of up to 100,000 Limited Partnership Interests at $1,000 per Interest, 82,697 of which were sold through April 30, 1985, the termination date of the offering.\nThe Partnership Agreement generally provides that the General Partner will be allocated 1% of the profits and losses. One hundred percent of Net Cash Receipts available for distribution shall be distributed to the holders of\nInterests in proportion to their participating percentages as of the record date for such distributions. However, there shall be accrued for the benefit of the General Partner as its distributive share from operations, an amount equivalent to approximately 1% of the total Net Cash Receipts being distributed, which will be paid only out of distributed Net Cash Proceeds in excess of total Adjusted Original Capital plus a 6% Cumulative Distribution. Under certain circumstances, the General Partner may participate in the Net Cash Proceeds of the sale or refinancing of Partnership properties. The General Partner's participation is limited to 15% of excess Net Cash Proceeds after the return of Original Capital plus a Cumulative Distribution of 6% to the holders of Interests, as defined in the Partnership Agreement.\n4. Mortgage Notes Payable:\nMortgage notes payable at December 31, 1995 and 1994 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\/95 12\/31\/94 Rate Date Payment Payment - -------------- ---------- ---------- ------ ------ -------- ---------- Apartment Complexes: Boulder Springs(A) $8,097,672 $7,813,574 7.590% 2002 $57,419 $7,485,000 Forest Ridge Phase I (B) 7,613,575 7,668,517 8.963% 2001 61,671 7,206,000 Forestwood 5,790,811 5,836,145 9.130% 2001 48,026 5,465,000 Heather Ridge (C) 5,174,909 5,212,157 8.950% 2001 41,653 4,872,000 Templeton Park (D) 12,512,165 13,385,348 6.381% 2016 97,701 None Timberlake Phase I 11,467,036 11,579,411 7.750% 2003 83,820 10,210,000 Willow Bend 5,810,030 5,886,778 9.500% 1997 53,230 5,714,000 ---------- ----------\nTotal $56,466,198$57,381,930 =========== ==========\n(A) In May 1995, this loan was refinanced. The interest rate decreased from 12.875% to 7.59%, the maturity date was extended from June 1995 to June 2002, and the monthly payment decreased from $90,457 to $57,419. A portion of the proceeds from the new $8,140,000 first mortgage loan was used to repay the existing first mortgage loan balance of $7,786,649.\n(B) In July 1994, this loan was refinanced. The interest rate decreased from 9.025% to 8.963%, the maturity date was extended from November 1994 to August 2001 and the monthly payments increased from $50,698 to $61,671. A portion of the proceeds from the new $7,690,000 first mortgage loan was used to repay the existing first mortgage loan of $6,741,000.\n(C) In July 1994, this loan was refinanced. The interest rate decreased from 9.025% to 8.95%, the maturity date was extended from November 1994 to August 2001 and the monthly payments increased from $28,745 to $41,653. A portion of the proceeds from the new $5,200,000 first mortgage loan was used to repay the existing first mortgage loan of $3,822,000.\n(D) In accordance with the 1989 loan modification, the interest rate will be adjusted on certain \"adjustment dates\". The next adjustment date is June 1,\n1998 with subsequent adjustments every five years thereafter. In addition, 50% of property cash flow must be paid annually and will be applied against the outstanding principal on the loan. Upon the sale or refinancing of the property, the lender will participate in a percentage of the proceeds in excess of the outstanding mortgage debt.\nDuring 1995, 1994 and 1993, the Partnership incurred interest expense on mortgage notes payable to unaffiliated parties of $4,768,731, $4,969,653 and $5,853,947 and paid interest expense of $4,768,731, $4,969,653 and $6,213,241, respectively.\nThe Partnership's loans described above all require current monthly payments of principal and interest.\nReal estate with an aggregate carrying value of $49,369,329 at December 31, 1995 was pledged as collateral for repayment of mortgage loans.\nFive-year scheduled maturities of the mortgage notes payable are approximately as follows:\n1996 $ 830,000 1997 6,503,000 1998 887,000 1999 875,000 2000 982,000\n5. Management Agreements:\nAs of December 31, 1995, all of the properties owned by the Partnership are managed by a third-party management company. These management agreements provide for annual fees of 5% of gross operating receipts.\n6. Investment in Joint Ventures with Affiliates:\nThe Partnership owned a 48.4% joint venture interest in Pinebrook Apartments which was sold in February 1995. As of December 31, 1995, the Partnership owns 25% and 15.4% joint venture interests in North Hill Apartments and Seabrook Apartments, respectively. The joint venturers are affiliates of the Partnership with investment objectives similar to those of the Partnership. During 1995 and 1993, the Partnership received net capital distributions of $548,452 and $42,153, respectively and during 1994, the Partnership made net capital contributions of $154,393.\nSeabrook Apartments was acquired by a joint venture (\"Joint Venture\") consisting of the Partnership and two affiliates. In February 1996, the Joint Venture sold the property for a sale price of $5,915,000. See Note 12. for additional information.\nPinebrook Apartments was acquired by a joint venture (\"Joint Venture\") consisting of the Partnership and an affiliate. The Partnership and the affiliate held participating percentages in the Joint Venture of 48.43% and 51.57%, respectively. In February 1995, the Joint Venture sold the property for a sale price of $6,140,000. From the proceeds of the sale, the Joint\nVenture paid $5,058,226 to the third party mortgage holders in full satisfaction of the outstanding amount of the first, second and fourth mortgage loans, as well as a brokerage commission and other closing costs. Additionally, the Joint Venture paid approximately $716,729 to Pinebrook Limited Partnership in full satisfaction of the outstanding amount of its loan. The Joint Venture recognized a gain of $1,814,970 in 1995 of which $780,279 is the Partnership's share. The Partnership's share of the gain is included in \"Participation in income of joint ventures with affiliates\" and is partially offset by the Partnership's share of operating losses through the sale date. The Joint Venture received total proceeds of $871,599 from this transaction of which $422,115 was the Partnership's share.\nNorth Hill Apartments is owned by a joint venture (\"Joint Venture\") in which the Partnership and an affiliate have participating percentages of 25% and 75%, respectively. The $18,700,000 tax-exempt bond issue which funded the first mortgage financing collateralized by the property was in technical default due to the insolvency of the guarantor of the bonds. In April 1993, the Joint Venture and the trustee for the bondholders entered into an agreement in which the loan was modified and the trustee agreed to forebear from commencing foreclosure proceedings while the Joint Venture sought alternate financing. In December 1994, the bonds which funded the previous North Hill Apartments mortgage loan were refinanced. The interest rate increased from 6.75% to 8.09% and the maturity date was extended from December 1994 to December 2024. As a condition of the new agreement, on January 1, 2005, at the discretion of both the Joint Venture and the lender, the bonds will either be repaid or remarketed. Under the terms of the new loan, monthly payments increased from $105,188 to $124,920. The Joint Venture repaid the existing mortgage loan of $18,700,000 with proceeds from the new mortgage loan of $16,795,600, which was net of a discount of $84,400, proceeds of a $1,350,000 note to an unaffiliated party, and Joint Venture cash reserves, which included amounts previously held in escrow by the trustee which were refunded to the Joint Venture in conjunction with the refinancing. See Note 10 of Notes to Financial Statements.\nThe $1,350,000 note to an unaffiliated party is non-interest bearing, is not collateralized by the property, and will be repaid only to the extent net sales proceeds exceed a certain predetermined level.\n7. 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 return due to the different treatment of various items as specified in the Internal Revenue Code. The net effect of these accounting differences is that the net income for 1995 in the financial statements is $272,161 more than the tax income of the Partnership for the same period.\n8. Transactions with Affiliates:\nFees and expenses paid and payable by the Partnership to affiliates are:\nYear Ended Year Ended Year Ended 12\/31\/95 12\/31\/94 12\/31\/93 -------------- -------------- -------------- Paid Payable Paid Payable Paid Payable ------ ------- ------ ------- ------ -------\nProperty management fees None None $738,965 None $790,418 $59,512 Reimbursement of expenses to General Partner at cost: Accounting $43,360 $2,930 61,640 25,026 58,782 4,865 Data processing 30,442 3,365 53,294 10,763 32,212 6,338 Investor communications 6,695 None 20,271 8,230 18,986 1,571 Legal 21,029 2,121 12,118 4,920 9,444 782 Other 9,920 167 15,653 6,355 19,649 1,626 Portfolio management 118,040 15,918 49,554 20,119 59,473 4,868\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, however, the General Partner is reimbursed for expenses. The Partnership paid premiums to the deductible insurance program of $105,794, $146,555 and $98,035 in 1995, 1994 and 1993, respectively.\nAllegiance Realty Group, Inc., an affiliate of the General Partner, managed all seven of the Partnership's properties until the affiliate was sold to a third party in November 1994.\n9. Property Sale:\nDuring 1993, the Partnership sold the Sahara Palms Apartments for an all cash sale price of $13,200,000. From the proceeds of the sale, the Partnership paid $12,356,625 in full satisfaction of the property's mortgage loans. The basis of the property was $8,906,204, net of accumulated depreciation of $4,134,055, and the Partnership recognized a gain on the sale of the property of $4,194,237.\n10. Extraordinary Items:\n(a) North Hill Apartments is owned by a joint venture consisting of the Partnership and an affiliate. In connection with the December 1994 North Hill Apartments refinancing, the joint venture received a refund of the escrow account held by the trustee representing the amount which would have been paid to Mutual Benefit Life Insurance Company as its 1% guaranty fee on the original mortgage loan. As a result, the joint venture recognized a $534,659 extraordinary gain on forgiveness of debt in 1994, of which $133,665 represents the Partnership's share.\n(b) During 1993, title to the Suncrest Village Apartments was relinquished through foreclosure. The Partnership wrote-off the mortgage loan balance of $10,478,532, accrued real estate taxes of $140,710, security deposit of $27,716, and the property basis of $7,528,380, net of accumulated depreciation of $3,495,674. The Partnership recognized an extraordinary gain of $3,118,578 during 1993 for financial statement purposes.\n(c) During 1993, the Partnership completed the refinancing of the $12,091,471 Timberlake - Phase I first mortgage loan and obtained a new first mortgage loan from an unaffiliated lender in the amount of $11,700,000. The Partnership received a $362,744 discount from the previous lender for prepayment of the mortgage note which was recognized as an extraordinary gain on debt forgiveness.\n11. Fair Value of Financial Instruments:\nThe carrying amounts and fair values of the Partnership's financial instruments at December 31, 1995 are as follows:\nThe carrying value of cash and cash equivalents, accounts and accrued interest receivable and accounts payable approximates fair value.\nBased on borrowing rates available to the Partnership at the end of 1995 for mortgage loans with similar terms and maturities, the fair value of the mortgage notes payable approximates the carrying value.\n12. Subsequent Events:\n(a) In January 1996, the Partnership made a distribution of $620,228 ($7.50 per Interest) to the holders of Limited Partnership Interests for the fourth quarter of 1995.\n(b) In February 1996, the Partnership and an affiliate of the Partnership (together the \"Joint Venture\") sold the Seabrook Apartments for a sale price of $5,915,000. The Partnership and the affiliate held effective ownership interests of 15.43% and 84.57%, respectively from the proceeds of the sale, the Joint Venture paid $5,081,898 in full satisfaction of the property's mortgage loan. The basis of the property was $4,361,052, net of accumulated depreciation of $2,625,226, and the Joint Venture recognized a gain on the sale of the property of $1,363,431. The Partnership's share of the total proceeds was approximately $100,000.\n(c) On February 29, 1996, a proposed class action complaint was filed, Raymond Masri vs. Lehman Brothers, Inc., et al., Case No. 96\/103727 (Supreme Court of the State of New York, County of New York). The Partnership, additional limited partnerships which were sponsored by The Balcor Company, three limited\npartnerships sponsored by the predecessor of Lehman Brothers, Inc. (together with the Partnership and the affiliated partnerships, the \"Defendant Partnerships\"), Lehman Brothers, Inc. and Smith Barney Holdings, Inc. are defendants. The complaint alleges, among other things, common law fraud and deceit, negligent misrepresentation and breach of fiduciary duty relating to the disclosure of information in the offering of limited partnership interests in the Defendant Partnerships. The complaint seeks judgment for compensatory damages equal to the amount invested in the Defendant Partnerships by the proposed class plus interest accrued thereon; general damages for injuries arising from the defendants' actions; recovery from the defendants of all profits received by them as a result of their actions relating to the Defendant Partnerships; exemplary damages; attorneys' fees and other costs.\nThe defendants intend to vigorously contest this action. No class has been certified as of this date. Management of each of the defendants believes they have meritorious defenses to contest the claims. It is not determinable at this time whether or not an unfavorable decision in this action would have a material adverse impact on the Registrant.\nBALCOR REALTY INVESTORS 85-SERIES I A REAL ESTATE LIMITED PARTNERSHIP (An Illinois Limited Partnership) as of December 31, 1995\nSee notes (a) through (g)\nBALCOR REALTY INVESTORS 85-SERIES I A REAL ESTATE LIMITED PARTNERSHIP (An Illinois Limited Partnership) as of December 31, 1995\nSee notes (a) through (g) *\nBALCOR REALTY INVESTORS 85-SERIES I A REAL ESTATE LIMITED PARTNERSHIP (An Illinois Limited Partnership)\nNOTES TO SCHEDULE III\n(a) Consists of legal fees, appraisal fees, title costs, other related professional fees and capitalized construction period interest.\n(b) Guaranteed income earned on properties under the terms of certain management and guarantee agreements was recorded by the Partnership as a reduction of the basis of the property to which the guaranteed income related.\n(c) The aggregate cost of land for Federal income tax purposes is $13,595,151 and the aggregate cost of buildings and improvements for Federal income tax purposes is $63,571,184. The total of these is $77,166,335.\n(d) Reconciliation of Real Estate ----------------------------- 1995 1994 1993 ---------- ----------- ---------- Balance at beginning of year $78,321,158 $78,321,158 $102,266,703 Additions during year: Improvements None None 118,767 Deductions during year: Foreclosure of investment property None None (11,024,054) Cost of real estate sold None None (13,040,258) ----------- ------------ ------------ Balance at close of year $78,321,158 $78,321,158 $ 78,321,158 ============ ============ ============\nReconciliation of Accumulated Depreciation ------------------------------------------ 1995 1994 1993 ---------- ----------- ---------- Balance at beginning of year $27,027,028 25,101,954 $30,515,232 Depreciation expense for the year 1,924,801 1,925,074 2,216,451 Accumulated depreciation of foreclosed investment property None None (3,495,674) Accumulated depreciation of real estate sold None None (4,134,055) ------------ ------------ ------------ Balance at close of year $28,951,829 $27,027,028 $25,101,954 ============ ============ ============\n(e) See descriptions of the mortgage notes payable in Note 4 of Notes to Financial Statements.\n(f) Depreciation expense is computed based upon the estimated useful lives of 30 years for buildings and improvements and five years for furniture and fixtures.\n(g) This amount consists primarily of a reduction of basis due to a provision for investment property write down during 1989.","section_15":""}
{"filename":"101830_1995.txt","cik":"101830","year":"1995","section_1":"Item 1. Business\nTHE CORPORATION\nSprint Corporation (Sprint), incorporated in 1938 under the laws of Kansas, is primarily a holding company. Sprint's principal subsidiaries provide domestic and international long distance and local exchange telecommunications services. Other subsidiaries are engaged in the wholesale distribution of telecommunications products and the publishing and marketing of white and yellow page telephone directories. Beginning in January 1996, Sprint will operate a small telephone refurbishing business in the state of Kansas. In March 1996, Sprint spun-off its cellular division to holders of Sprint's common stock.\nSprint is a 40 percent partner in Sprint Spectrum LP, a partnership with Tele-Communications Inc. (TCI), Comcast Corporation (Comcast) and Cox Communications, Inc. (Cox) to provide wireless personal communications services (PCS) on a broad geographic basis within the United States.\nSprint is also a partner in Global One, a joint venture with France Telecom (FT) and Deutsche Telekom AG (DT) to provide seamless global telecommunications services to business, consumer and carrier markets worldwide. The interests of DT and FT in the venture are held by their own joint venture, referred to as Atlas. The operating group serving Europe (excluding Germany and France) is owned one-third by Sprint and two-thirds by Atlas. The operating group for the worldwide activities outside the United States and Europe is owned 50 percent by Sprint and 50 percent by Atlas. Home country markets will be served by DT in Germany, FT in France and Sprint in the United States.\nTELECOMMUNICATIONS LAW\nThe Telecommunications Act of 1996, which was signed into law in February 1996, promotes competition in all aspects of telecommunications. In particular, the new law removes barriers to competition that will enable local and long distance companies and cable TV companies to enter each others' markets. The regional Bell Operating Companies (RBOCs) were allowed to provide out-of-region and incidental long distance service upon enactment. The RBOCs will be allowed to provide in-region long distance service once they obtain state certification of compliance with a competitive \"checklist\" and a Federal Communications Commission (FCC) ruling that it is in the public interest and that a facilities based competitor exists in each market (or the failure of potential providers to request local access). The new law directs the FCC to conclude a large number of rule-makings in a relatively short period of time, including defining the requirements of the competitive \"checklist\"; such rules will significantly influence the amount and shape of competition in both local and long distance markets in the future.\nThe new law eliminates regulatory barriers to entry into local telephone markets and imposes several obligations upon incumbent local exchange carriers (LECs). They must allow local resale without unreasonable restrictions, provide number portability (to the extent technically feasible) and dialing parity, afford access to rights-of-way, establish reciprocal compensation arrangements, negotiate interconnection agreements, provide nondiscriminatory access to unbundled network elements and allow collocation of interconnection equipment by competitors. The FCC is presently developing regulations to implement these requirements. Some of Sprint's LECs in rural areas may be exempted from some of these requirements. Many states, including most of the states in which Sprint's LECs operate, allow some competitive entry into the intraLATA long-distance and local service markets. The federal law preempts inconsistent state laws.\nThe impact of the Act on Sprint is unknown because a number of important implementation issues (such as the nature and extent of continued subsidies for local rates) still need to be decided by state or federal regulators. However, the Act offers opportunities as well as risks. Sprint should benefit from the opportunity to enter local telephone markets. The new competitive environment should lead to a reduction in local access fees, the largest single cost in providing long distance service today. The risk aspect of local competition is that historical prices and market shares of Sprint's LECs in their current operating regions (approximately 4 percent of the nation's local phone lines) are likely to decline.\nThe removal of the long distance restrictions on the RBOCs is not anticipated to have an immediate significant adverse impact on Sprint because of the substantial preconditions that must be met before RBOCs can provide most in-region long distance services. In addition, Sprint could potentially offset some losses of long distance customers at the retail level if it were successful in becoming the underlying carrier for resellers (including the RBOCs) entering the long distance market.\nLONG DISTANCE COMMUNICATIONS SERVICES\nSprint's long distance division is the nation's third largest long distance telephone company, operating a nationwide all-digital long distance communications network utilizing state-of-the-art fiber-optic and electronic technology. The division provides domestic and international long distance voice, video, and data communications services, and consists principally of Sprint Communications Company L.P. (the Limited Partnership). The terms under which the division offers its services to the public are subject to different levels of state and federal regulation, but rates are not subject to rate-base regulation except nominally in some states. The division had net operating revenues of $7.3 billion, $6.8 billion and $6.1 billion in 1995, 1994 and 1993, respectively.\nAT&T dominates the long distance communications market and is expected to continue to dominate the market for some years into the future. MCI Communications Corporation (MCI) is the nation's second largest long distance telephone company. Sprint's long distance division competes with AT&T, MCI and other telecommunications providers in all segments of the long distance communications market. Competition is based upon price and pricing plans, the types of services offered, customer service, and communications quality, reliability and availability.\nAs competition has developed in long distance markets in recent years, the FCC has streamlined regulation of interstate interexchange carriers, including AT&T. Nondominant competitive long distance carriers (like Sprint) have been subject to considerably less regulation, because market forces served as a more effective regulator of prices. As AT&T lost domestic market share, it sought to be relieved of regulation as well. The FCC ended rate-of-return regulation of AT&T in 1989, and removed some competitive services from price caps regulation in 1991. In October 1995, the FCC reclassified AT&T as a nondominant domestic carrier, in exchange for commitments to protect rates charged to low income, low volume, and reseller customers. The FCC did not find that the long distance market was completely competitive and some interstate regulation continues to apply. AT&T also subsequently sought to be declared a nondominant international carrier, and that request is pending.\nSee \"Telecommunications Law\" for a discussion of the new telecommunications legislation and its potential impact on the long distance division.\nLOCAL COMMUNICATIONS SERVICES\nThe local division is comprised of regulated LECs which serve approximately 6.7 million access lines in 19 states. In addition to furnishing local exchange services, the division provides intraLATA toll service and interLATA access by telephone customers and other carriers to Sprint's local exchange facilities.\nThe division had net operating revenues of $4.7 billion, $4.4 billion and $4.1 billion in 1995, 1994 and 1993, respectively. Florida and North Carolina were the only jurisdictions in which 10 percent or more of the division's total 1995 net operating revenues were generated. The following table reflects major revenue categories as a percentage of the division's total net operating revenues:\nAT&T is the division's largest customer for network access services. In 1995, 15.2 percent of the division's net operating revenues was derived from services provided to AT&T, primarily network access services, compared to 16.6 percent in 1994 and 17.3 percent in 1993. While AT&T is a significant customer, Sprint does not believe the division's revenues are dependent upon AT&T, as customers' demand for interLATA 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 LECs comprising the division are subject to the jurisdiction of the FCC and the public service commissions of each of the states in which they operate. In each state in which the commission exercises authority to grant certificates of public convenience and necessity, the LECs have been granted certificates of indefinite duration to provide local exchange telephone service in their current service areas.\nEffective January 1, 1991, the FCC adopted a price caps regulatory format for the RBOCs and the GTE local exchange companies. Other LECs could voluntarily 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. Sprint elected to be subject to price caps regulation. The LECs owned by Centel Corporation did not originally elect price caps, but as a result of the merger with Sprint, these LECs adopted price caps effective July 1, 1993. During 1995, the FCC adopted modifications to the price cap plan to reset productivity elections, change certain rate adjustment methods, address new service offerings and generally reduce regulatory requirements. Under these changes, Sprint's LECs elected a productivity factor that allows them to avoid sharing of interstate access earnings.\nSee \"Telecommunications Law\" for a discussion of the new telecommunications legislation and its potential impact on the local communications division.\nPRODUCT DISTRIBUTION AND DIRECTORY PUBLISHING\nNorth Supply Company (North Supply), a wholesale distributor of telecommunications and security and alarm products, distributes products of more than 1,200 manufacturers to approximately 9,500 customers. Products range from basics, such as wire and cable, telephones and repair parts, to complete PBX systems, transmission systems and security and alarm equipment. North Supply also provides material management services to several of its affiliates and to several subsidiaries of the Bell Operating Companies.\nThe nature of competition in North Supply's markets demands a high level of customer service to succeed, as a number of competitors, including other national wholesale distributors, sell the same products and services.\nNorth Supply sells to telephone companies and other users of telecommunications products, including Sprint's local and long distance divisions, other local and long distance telephone companies, and companies with large private networks. Other North Supply customers include original equipment manufacturers, interconnect companies, security and alarm dealers and local, state and federal governments. Sales to affiliates represented 39.5 percent of North Supply's total sales in 1995, 42.4 percent in 1994 and 39.3 percent in 1993. North Supply's net operating revenues were $854 million, $829 million, and $677 million in 1995, 1994 and 1993, respectively.\nSprint Publishing & Advertising along with Centel Directory Company publish and market white and yellow page telephone directories in certain of Sprint's local exchange territories, as well as in the greater metropolitan areas of Milwaukee, Wisconsin and Chicago, Illinois. The companies publish approximately 325 directories in 20 states with a circulation of 17 million copies. Sprint Publishing & Advertising's net operating revenues were $294 million, $280 million and $268 million in 1995, 1994 and 1993, respectively. Centel Directory Company operates through The CenDon Partnership, a general partnership between Centel Directory Company and The Reuben H. Donnelley Corporation. Revenues of Sprint Publishing & Advertising and The CenDon Partnership are principally derived from selling directory advertisements. The companies compete with publishers of telephone directories and others for advertising revenues.\nJOINT VENTURES\nIn March 1995, Sprint Spectrum achieved a national wireless presence in the first round of PCS license auctions by the FCC. Sprint Spectrum and its affiliates won the rights to PCS licenses in 30 major trading areas at a cost of $2.2 billion. It is Sprint Spectrum`s objective to begin offering PCS in 20 to 25 major metropolitan markets, with a population of approximately 100 million, by the end of 1996.\nAlso in March 1995, the four partners agreed that Sprint Spectrum would provide local telecommunications services on a national basis using the facilities of the cable partners. Effective as of January 31, 1996, the four partners entered into a series of agreements amending their approach to providing competitive local services. Under the revised agreements, local offerings in each market will be the subject of individual joint ventures to be negotiated between Sprint and the applicable cable company. However, there can be no assurances that any such joint ventures will be formed.\nOn January 31, 1996, Sprint consummated its global joint venture (Global One) with DT and FT. Sprint contributed to the joint venture certain subsidiaries which conducted its international telecommunications business and certain assets of its U.S. subsidiaries used in such business.\nENVIRONMENT\nSprint'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 are usually associated with generators, batteries or fuel storage. Certain Sprint subsidiaries have been designated a potentially responsible party at sites relating to either landfill contamination or discontinued power generation operations. Sprint's expenditures relating to environmental compliance and remediation have not been material to the financial statements or to the operations of Sprint and are not expected to have any future material effects.\nPATENTS, TRADEMARKS AND LICENSES\nSprint and its subsidiaries own numerous patents, patent applications and trademarks in the U.S. and other countries. Sprint and its subsidiaries are also licensed under domestic and foreign patents and trademarks owned by others. In the aggregate, these patents, patent applications, trademarks and licenses are of material importance to Sprint's business. Generally, Sprint's trademarks and trademark licenses have no limitation on duration; Sprint's patents and the patents to which Sprint is licensed range generally in duration from 1 to 17 years.\nEMPLOYEE RELATIONS\nAs of December 31, 1995, Sprint and its subsidiaries had approximately 48,300 employees, of whom approximately 26 percent are represented by unions. During 1995, Sprint and its subsidiaries had no material work stoppages caused by labor controversies.\nINFORMATION AS TO INDUSTRY SEGMENTS\nSprint's net operating revenues from affiliates and non-affiliates, by segment, for the three years ended December 31, 1995, 1994 and 1993, are as follows (in millions):\nIn accordance with Statement of Financial Accounting Standards (SFAS) No. 71, \"Accounting for the Effects of Certain Types of Regulation,\" revenues and related net income of nonregulated operations attributable to intercompany transactions with Sprint's regulated telephone companies have not been eliminated in the above table or the accompanying consolidated financial statements. Intercompany revenues of such entities amounted to $262 million, $285 million and $225 million in 1995, 1994 and 1993, respectively. In conjunction with the adoption of accounting principles for a competitive marketplace (see Note 2 of Notes to Consolidated Financial Statements) such intercompany amounts will be eliminated beginning in 1996. All other significant intercompany transactions have been eliminated. For additional information as to industry segments of Sprint, refer to \"Segmental Results of Operations\" within Management's Discussion and Analysis of Financial Condition and Results of Operations filed as part of this report (pages 23 through 26).\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe aggregate cost of Sprint's property, plant and equipment was $19.9 billion as of December 31, 1995, of which $12.6 billion relates to local communications services and $6.8 billion relates to long distance communications services. These properties consist primarily of land, buildings, digital fiber-optic network, switching equipment, microwave radio and cable and wire facilities and are in good operating condition. Certain switching equipment and several general office facilities are located on leased premises. The long distance division has been granted easements, rights-of-way and rights-of-occupancy, primarily by railroads and other private landowners, for its fiber-optic network.\nThe properties of the product distribution and directory publishing businesses consist primarily of office and warehouse facilities to support the business units in the distribution of telecommunications products and publication of telephone directories.\nSprint owns its corporate headquarters building and certain other property located in the greater Kansas City metropolitan area.\nProperty, plant and equipment with an aggregate cost of approximately $11.2 billion is either pledged as security for first mortgage bonds and certain notes or is restricted for use as mortgaged property.\nItem 3.","section_3":"Item 3. Legal Proceedings\nFollowing announcement of the Sprint\/Centel merger agreement in May 1992, class action suits were filed against Centel and certain of its officers and directors. The federal actions were consolidated in the United States District Court for the Northern District of Illinois. An amended complaint was filed against the Company and two officers\/directors. The amended complaint alleges violations of federal securities laws by failing to disclose pertinent information regarding the value of Centel common stock. The plaintiffs seek damages in an unspecified amount. In January 1995, a purported class action suit was filed against Centel's financial advisors in state court in New York in connection with the Sprint\/Centel merger. In October 1995, the New York trial court granted a motion to dismiss that suit, but the plaintiffs have appealed from the order dismissing their claims. Sprint may have indemnification obligations to the financial advisors in connection with this suit.\nOther suits arising in the ordinary course of business are pending against Sprint and its subsidiaries. Sprint cannot predict the ultimate outcome of these actions or the above-described litigation, but believes they will not result in a material effect on Sprint's consolidated financial statements.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nOn January 29, 1996, Sprint held a Special Meeting of Shareholders to vote on three proposals relating to the investment in Sprint by DT and FT (see \"Management's Discussion and Analysis of Financial Condition and Results of Operations. - Strategic Developments - Global One\" (pages 20 and 21) for further discussion related to this investment). The shareholders approved all three proposals.\nThe following votes were cast with respect to the proposal to approve and adopt the Investment Agreement dated as of July 31, 1995, as amended, among Sprint, FT and DT and the transactions contemplated by the Investment Agreement (Proposal No. 1).\nFOR 254,701,899 AGAINST 11,925,847 ABSTAIN 2,178,235\nThe following votes were cast with respect to the proposal to approve and adopt the Charter Amendments and the Bylaw Amendments contemplated by the Investment Agreement (Proposal No. 2).\nFOR 251,797,486 AGAINST 14,749,579 ABSTAIN 2,258,916\nThe following votes were cast by the common stock, voting as a separate class, with respect to the proposal to approve and adopt the Charter Amendments and the Bylaw Amendments contemplated by the Investment Agreement (Proposal No. 2).\nFOR 251,666,480 AGAINST 14,747,104 ABSTAIN 2,249,151\nThe following votes were cast with respect to the proposal to approve and adopt the Control Share Acquisitions Plan and to accord to the shares acquired pursuant to such plan full voting rights (Proposal No. 3).\nFOR 257,433,764 AGAINST 6,447,938 ABSTAIN 4,924,279\nThe following votes were cast with respect to the proposal to approve and adopt the Control Share Acquisitions Plan and to accord to the shares acquired pursuant to such plan full voting rights, excluding shares held by (i) FT, DT or any member of a group with FT and DT that makes or proposes to make a \"control share acquisition\" (as defined in the Kansas Control Share Acquisitions Statute), (ii) officers of Sprint and (iii) employees of Sprint who are also directors of Sprint (Proposal No. 3).\nFOR 256,780,521 AGAINST 6,449,252 ABSTAIN 4,924,777\nPart II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters\nAs of March 1, 1996, there were approximately 100,000 record holders of Sprint's common stock. The principal trading market for Sprint's common stock is the New York Stock Exchange. The common stock is also listed and traded on the Chicago and Pacific Stock Exchanges. Sprint has declared dividends of $0.25 per quarter during each of the years ended December 31, 1995 and 1994.\nItem 6.","section_6":"Item 6. Selected Financial Data\nFor information required by Item 6, refer to the \"Selected Financial Data\" section of the Financial Statements, Financial Statement Schedule and Supplementary Data filed as part of this report (page 19).\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nFor information required by Item 7, refer to the \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" section of the Financial Statements, Financial Statement Schedule and Supplementary Data filed as part of this report (pages 20 through 32).\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nFor information required by Item 8, refer to the \"Consolidated Financial Statements and Schedule\" and \"Quarterly Financial Data\" sections of the Financial Statements, Financial Statement Schedule and Supplementary Data filed as part of this report (pages 35 through 61).\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\nPursuant to Instruction G(3) to Form 10-K, the information relating to Directors of Sprint required by Item 10 is incorporated by reference from Sprint's definitive proxy statement filed pursuant to Regulation 14A.\nFor information pertaining to Executive Officers of Sprint, as required by Instruction 3 of Paragraph (b) of Item 401 of Regulation S-K, refer to the \"Executive Officers of the Registrant\" section of Part I of this report (pages 8 and 9).\nItem 11.","section_11":"Item 11. Executive Compensation\nPursuant to Instruction G(3) to Form 10-K, the information required by Item 11 is incorporated by reference from Sprint's definitive proxy statement filed pursuant to Regulation 14A.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nPursuant to Instruction G(3) to Form 10-K, the information required by Item 12 is incorporated by reference from Sprint's definitive proxy statement filed pursuant to Regulation 14A.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nPursuant to Instruction G(3) to Form 10-K, the information required by Item 13 is incorporated by reference from Sprint's definitive proxy statement filed pursuant to Regulation 14A.\nPart IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedule, and Reports on Form 8-K\n(a) 1. The consolidated financial statements of Sprint and supplementary financial information filed as part of this report are listed in the Index to Financial Statements, Financial Statement Schedule and Supplementary Data (page 18).\n2. The consolidated financial statement schedule of Sprint filed as part of this report is listed in the Index to Financial Statements, Financial Statement Schedule and Supplementary Data (page 18).\n3. The following exhibits are filed as part of this report:\nEXHIBITS\n(3) Articles of Incorporation and Bylaws:\n(a) Articles of Incorporation, as amended (filed as Exhibit 4A to Sprint Corporation Current Report on Form 8-K dated January 31, 1996 and incorporated herein by reference).\n(b) Bylaws, as amended (filed as Exhibit 4B to Sprint Corporation Current Report on Form 8-K for the year ended January 31, 1996 and incorporated herein by reference).\n(4) Instruments defining the Rights of Sprint's Equity Security Holders:\n(a) The rights of Sprint's equity security holders are defined in the Fifth, Sixth, Seventh and Eighth Articles of Sprint's Articles of Incorporation. See Exhibit 3(a).\n(b) Rights Agreement dated as of August 8, 1989, between Sprint Corporation (formerly United Telecommunications, Inc.) and UMB Bank, n.a. (formerly United Missouri Bank of Kansas City, N.A.), as Rights Agent (filed as Exhibit 2(b) to Sprint Corporation Registration Statement on Form 8-A dated August 11, 1989 (File No. 1-4721), and incorporated herein by reference).\n(c) Amendment and supplement dated June 4, 1992 to Rights Agreement dated as of August 8, 1989 (filed as Exhibit 2(c) to Amendment No. 1 on Form 8 dated June 8, 1992 to Sprint Corporation Registration Statement on Form 8-A dated August 11, 1989 (File No. 1-4721), and incorporated herein by reference).\n(d) Second Amendment to Rights Agreement dated as of July 31, 1995 between Sprint Corporation and UMB Bank, n.a. (filed as Exhibit 2(d) to Form 8-A\/A-2 dated October 20, 1995 amending Sprint Corporation Registration Statement on Form 8-A dated August 11, 1989 (File No. 1-4721) and incorporated herein by reference).\n(e) Standstill Agreement dated as of July 31, 1995, by and among Sprint Corporation, France Telecom and Deutsche Telekom AG (filed as Exhibit (10)(c) to Sprint Corporation Quarterly Report on Form 10-Q for the quarter ended June 30, 1995 and incorporated herein by reference).\n(10) Material Agreements - Joint Ventures:\n(a) Joint Venture Agreement dated as of June 22, 1995 among Sprint Corporation, Sprint Global Venture, Inc., France Telecom and Deutsche Telekom AG (filed as Exhibit (10)(a) to Sprint Corporation Quarterly Report on Form 10-Q for the quarter ended June 30, 1995 and incorporated herein by reference).\n(b) Amendment No. 1 to Joint Venture Agreement, dated as of January 31, 1996, among Sprint Corporation, Sprint Global Venture, Inc., France Telecom, Deutsche Telekom AG and Atlas Telecommunications, S.A. (filed as Exhibit 99A to Sprint Corporation Current Report on Form 8-K dated January 31, 1996 and incorporated herein by reference).\n(c) Investment Agreement dated as of July 31, 1995 among Sprint Corporation, France Telecom and Deutsche Telekom AG (including as an exhibit the Stockholders' Agreement among France Telecom, Deutsche Telekom AG and Sprint Corporation) (filed as Exhibit (10)(b) to Sprint Corporation Quarterly Report on Form 10-Q for the quarter ended June 30, 1995 and incorporated herein by reference).\n(d) Amended and Restated Agreement of Limited Partnership of MajorCo., L.P., dated as of January 31, 1996, among Sprint Spectrum, L.P., TCI Network Services, Comcast Telephony Services and Cox Telephony Partnership (filed as Exhibit 99C to Sprint Corporation Current Report on Form 8-K dated January 31, 1996 and incorporated herein by reference).\n(e) Parents Agreement dated as of January 31, 1996, between Sprint Corporation and Tele-Communications, Inc. (filed as Exhibit 99D to Sprint Corporation Current Report on Form 8-K dated January 31, 1996 and incorporated herein by reference).\n(f) Parents Agreement dated as of January 31, 1996, between Sprint Corporation and Comcast Corporation (filed as Exhibit 99E to Sprint Corporation Current Report on Form 8-K dated January 31, 1996 and incorporated herein by reference).\n(g) Parents Agreement dated as of January 31, 1996, between Sprint Corporation and Cox Communications, Inc. (filed as Exhibit 99F to Sprint Corporation Current Report on Form 8-K dated January 31, 1996 and incorporated herein by reference).\n(10) Executive Compensation Plans and Arrangements\n(h) 1985 Stock Option Plan, as amended (filed as Exhibit (10)(c) to Sprint Corporation Quarterly Report on Form 10-Q for the quarter ended September 30, 1995 and incorporated herein by reference). Appendix to Stock Option Plans.\n(i) 1990 Stock Option Plan, as amended (filed as Exhibit (10)(d) to Sprint Corporation Quarterly Report on Form 10-Q for the quarter ended September 30, 1995 and incorporated herein by reference). Appendix to Stock Option Plans. See Exhibit (10)(h).\n(j) 1990 Restricted Stock Plan, as amended (filed as Exhibit 99 to Sprint Corporation Registration Statement No. 33-65147 and incorporated herein by reference).\n(k) Executive Deferred Compensation Plan, as amended.\n(l) Management Incentive Stock Option Plan, as amended (filed as Exhibit (10)(g) to Sprint Corporation Quarterly Report on Form 10-Q for the quarter ended September 30, 1995 and incorporated herein by reference). Appendix to Stock Option Plans. See Exhibit (10)(h).\n(m) Long-Term Stock Incentive Program, as amended (filed as Exhibit (10)(h) to Sprint Corporation Quarterly Report on Form 10-Q for the quarter ended September 30, 1995 and incorporated herein by reference).\n(n) Sprint Supplemental Executive Retirement Plan (filed as Exhibit (10)(i) to Sprint Corporation Quarterly Report on Form 10-Q for the quarter ended September 30, 1995 and incorporated herein by reference).\n(o) Amended and Restated Centel Directors Deferred Compensation Plan (filed as Exhibit (10)(j) to Sprint Corporation Quarterly Report on Form 10-Q for the quarter ended September 30, 1995 and incorporated herein by reference).\n(p) Restated Memorandum Agreements Respecting Supplemental Pension Benefits between Sprint Corporation (formerly United Telecommunications, Inc.) and two of its current and former executive officers (filed as Exhibit 10(i) to Sprint Corporation Annual Report on Form 10-K for the year ended December 31, 1992, and incorporated herein by reference).\n(q) Executive Long-Term Incentive Plan (filed as Exhibit 10(j) to Sprint Corporation Annual Report on Form 10-K for the year ended December 31, 1993 and incorporated herein by reference).\n(r) Executive Management Incentive Plan (filed as Exhibit 10(k) to Sprint Corporation Annual Report on Form 10-K for the year ended December 31, 1993 and incorporated herein by reference).\n(s) Long-Term Incentive Compensation Plan (filed as Exhibit 10(j) to United Telecommunications, Inc. Annual Report on Form 10-K for the year ended December 31, 1989, and incorporated herein by reference).\n(t) Short-Term Incentive Compensation Plan (filed as Exhibit 10(k) to United Telecommunications, Inc. Annual Report on Form 10-K for the year ended December 31, 1989, and incorporated herein by reference).\n(u) Retirement Plan for Directors, as amended (filed as Exhibit 10(b) to Sprint Corporation Quarterly Report on Form 10-Q for the quarter ended March 31, 1994 and incorporated herein by reference).\n(v) Key Management Benefit Plan, as amended (filed as Exhibit 10(o) to Sprint Corporation Annual Report on Form 10-K for the year ended December 31, 1993 and incorporated herein by reference).\n(w) Agreement Regarding Special Compensation and Post Employment Restrictive Covenants between Sprint Corporation and one of its Executive Officers.\n(x) Director's Deferred Fee Plan, as amended.\n(y) Form of Contingency Employment Agreements between Sprint Corporation and certain of its executive officers (filed as Exhibit 10(b) to Sprint Corporation Quarterly Report on Form 10-Q for the year ended March 31, 1995, and incorporated herein by reference).\n(z) Form of Indemnification Agreements between Sprint Corporation (formerly United Telecommunications, Inc.) and its Directors and Officers (filed as Exhibit 10(s) to Sprint Corporation Annual Report on Form 10-K for the year ended December 31, 1991, and incorporated herein by reference).\n(aa) Summary of Executive Officer and Board of Directors Benefits.\n(bb) Agreements Regarding Special Compensation and Post Employment Restrictive Covenants between Sprint Corporation and four of its executive officers (filed as Exhibit 10(d) to Sprint Corporation Quarterly Report on Form 10-Q for the quarter ended September 30, 1994 and incorporated herein by reference).\n(cc) Amended and Restated Centel Stock Option Plan (filed as Exhibit 10(w) to Sprint Corporation Annual Report on Form 10-K for the year ended December 31, 1994 and incorporated herein by reference). Appendix to Stock Option Plans. See Exhibit (10)(h).\n(dd) Agreements Regarding Special Compensation and Post Employment Restrictive Covenants between Sprint Corporation and three of its executive officers (filed as Exhibit 10(x) to Sprint Corporation Annual Report on Form 10-K for the year ended December 31, 1993, and incorporated herein by reference).\n(ee) Description of agreement regarding Supplemental Pension Benefits between Sprint Corporation and one of its executive officers (filed as Exhibit 10(e) to Sprint Corporation Quarterly Report on Form 10-Q for the quarter ended September 30, 1994, and incorporated herein by reference).\n(ff) Amended and Restated Centel Director Stock Option Plan (filed as Exhibit 10(aa) to Sprint Corporation Annual Report on Form 10-K for the year ended December 31, 1993, and incorporated herein by reference).\n(11) Computation of Earnings Per Common Share.\n(12) Computation of Ratio of Earnings to Fixed Charges.\n(21) Subsidiaries of Registrant.\n(23) Consent of Ernst & Young LLP.\n(27) Financial Data Schedules:\n(a) 1995 Financial Data Schedule.\n(b) Restated 1994 Financial Data Schedule.\nSprint will furnish to the Securities and Exchange Commission, upon request, a copy of the instruments 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 instruments does not exceed 10 percent of the total assets of Sprint and its subsidiaries on a consolidated basis.\n(b) Reports on Form 8-K\nSprint filed a Current Report on Form 8-K dated January 31, 1996 in which it reported the investment of $3.0 billion in Sprint by FT and DT and the consummation of the global venture with FT and DT (see \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Strategic Developments - Global One\" (pages 20 and 21) for further discussion). It also reported that Sprint, TCI, Comcast and Cox had entered into a series of agreements amending in certain respects their previously announced joint venture to engage in the communications business (see \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Strategic Developments - Sprint Spectrum LP\" (page 21) for further discussion).\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.\nSPRINT CORPORATION (Registrant)\nBy \/s\/ W. T. Esrey William T. Esrey Chairman and Chief Executive Officer\nDate: March 11, 1996\nPursuant to the requirements of the 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 11th day of March, 1996.\n\/s\/ W. T. Esrey William T. Esrey Chairman and Chief Executive Officer\n\/s\/ Arthur B. Krause Arthur B. Krause Executive Vice President and Chief Financial Officer\n\/s\/ John P. Meyer John P. Meyer Senior Vice President and Controller Principal Accounting Officer\nSIGNATURES\nSPRINT CORPORATION (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 11th day of March, 1996.\n\/s\/ DuBose Ausley DuBose Ausley, Director\n\/s\/ Warren L. Batts Warren L. Batts, Director\n\/s\/ Michel Bon Michel Bon, Director\n\/s\/ Ruth M. Davis Ruth M. Davis, Director\n\/s\/ W. T. Esrey William T. Esrey, Director\n\/s\/ Donald J. Hall Donald J. Hall, Director\n\/s\/ Harold S. Hook Harold S. Hook, Director\n\/s\/ Ronald T. LeMay Ronald T. LeMay, Director\n\/s\/ Linda K. Lorimer Linda Koch Lorimer, Director\n\/s\/ Charles E. Rice Charles E. Rice, Director\n\/s\/ Ron Sommer Ron Sommer, Director\n\/s\/ Stewart Turley Stewart Turley, Director\n(1) The accompanying Selected Financial Data have been restated to reflect the spin-off of Sprint's cellular and wireless division (Cellular) to Sprint shareholders. Accordingly, Cellular's operating results have been excluded from income from continuing operations and are reported as discontinued operations.\n(2) During 1995, nonrecurring charges of $88 million were recorded related to a restructuring within the local division. Such charges reduced consolidated 1995 income from continuing operations by $55 million ($0.16 per share).\nDuring 1993, nonrecurring charges of $293 million were recorded related to (a) transaction costs associated with the merger with Centel and the expenses of integrating and restructuring the operations of the two companies and (b) a realignment and restructuring within the long distance division. Such charges reduced consolidated 1993 income from continuing operations by $193 million ($0.56 per share).\n(3) During 1994, Sprint sold an investment in equity securities, realizing a gain of $35 million, which increased consolidated 1994 income from continuing operations by $22 million ($0.06 per share).\nDuring 1993, as a result of the enactment of the Revenue Reconciliation Act of 1993, Sprint was required to adjust its deferred income tax assets and liabilities to reflect the increased tax rate. Such adjustment reduced consolidated 1993 income from continuing operations by $11 million ($0.03 per share).\nDuring 1992 and 1991, gains were recognized related to the sales of certain local telephone properties, which increased consolidated 1992 income from continuing operations by $44 million ($0.13 per share) and consolidated 1991 income from continuing operations by $64 million ($0.19 per share).\n(4) Free cash flow is an internal measurement utilized by Sprint to assess the coverage of capital expenditures and dividends paid by cash provided from operating activities of continuing operations. This measurement is not an alternative to operating income determined in accordance with generally accepted accounting principles as an indicator of operating performance. Such amount for 1992 excludes the additional proceeds from the sale of accounts receivable of $300 million.\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF Sprint Corporation FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nStrategic Developments\nTelecommunications Law\nIn February 1996, the Telecommunications Act of 1996 (the Act) was signed into law. The purpose of the Act is to promote competition in all aspects of telecommunications. The Act requires telecommunications carriers to interconnect with other carriers and to provide for resale, number portability, dialing parity, access to rights-of-way and compensation for reciprocal traffic. Additionally, incumbent local telephone companies are required to provide nondiscriminatory unbundled access, resale at wholesale rates and notice of changes that would affect interoperability of facilities and networks. The Federal Communications Commission (FCC) is to adopt mechanisms to ensure that essential telecommunications services are affordable.\nThe Act also provides that regional Bell Operating Companies (RBOCs) may provide long distance service upon enactment that is out-of-region or incidental to: (1) audio\/video programming; (2) Internet for schools; (3) mobile services; (4) information or alarm services; and (5) telecommunications signaling. In order for an RBOC to provide in-region long distance service, the Act requires the RBOC to comply with a comprehensive competitive checklist and expands the role of the U.S. Department of Justice in the FCC's determination of whether the entry of an RBOC into the competitive long distance market is in the public interest. Additionally, there must be a real facilities-based competitor for residential and business local telephone service (or the failure of potential providers to request access) prior to an RBOC providing in-region long distance service. RBOCs must provide long distance services through a separate subsidiary for at least three years. Until the RBOCs are allowed into long distance or three years have passed, long distance carriers with more than 5 percent of the nation's access lines may not jointly market RBOC resold local telephone service, and states may not require RBOCs to provide intraLATA dialing parity.\nTelecommunications companies may also provide video programming and cable operators may provide telephone service in the same service area. The Act prohibits telecommunications carriers and cable operators from acquiring more than 10 percent of each other, except in rural and other specified areas.\nThe impact of the Act on Sprint is unknown because a number of important implementation issues (such as the nature and extent of continued subsidies for local rates) still need to be decided by state or federal regulators. However, the Act offers opportunities as well as risks. Sprint should benefit from the opportunity to enter local telephone markets. The new competitive environment should lead to a reduction in local access fees, the largest single cost in providing long distance service today. The risk aspect of local competition is that historical prices and market shares of Sprint's local telephone companies (approximately 4 percent of the nation's local telephone access lines) are likely to decline.\nThe removal of the long distance restrictions on the RBOCs is not anticipated to have an immediate significant adverse impact on Sprint because of the substantial preconditions that must be met before RBOCs can provide most in-region long distance services. In addition, Sprint could potentially offset some losses of long distance customers at the retail level if it were successful in becoming the underlying carrier for resellers (including the RBOCs) entering the long distance market.\nGlobal One\nOn January 31, 1996, Sprint, along with Deutsche Telekom (DT) and France Telecom (FT), consummated their joint venture, operating as Global One, which will provide seamless global telecommunications services to business, consumer and carrier markets worldwide. The interests of DT and FT in the venture are held by their own joint venture, referred to as Atlas. The operating group serving Europe (excluding Germany and France) will be owned one-third by Sprint and two-thirds by Atlas. The operating group for the worldwide activities outside the United States and Europe will be owned 50 percent by Sprint and 50 percent by Atlas. Home country markets will be served by DT in Germany, FT in France and Sprint in the United States.\nUpon closing of the agreement, DT and FT acquired shares of a new class of preference stock for a total of $3.0 billion, which resulted in DT and FT each holding approximately 7.5 percent of the Sprint voting power. DT and FT will make the remainder of their investment in Sprint following the spin-off of Sprint's Cellular and Wireless Division (Cellular) to shareholders of Sprint common stock. Following their full investment, DT and FT will each own shares of Class A common stock with approximately 10 percent of Sprint's voting power. Depending on the price of Cellular shares at the time of the spin-off, the total amount of the investment is expected to be between $3.5 billion and $3.7 billion.\nDT and FT, as the holders of the Class A Stock, will have the right in most circumstances to proportionate representation on Sprint's board of directors and to purchase additional shares of Class A Stock from Sprint to enable them to maintain their ownership level at 20 percent. In addition, the holders of Class A Stock will have disapproval rights with respect to Sprint's undertaking certain types of transactions. DT and FT have also entered into a standstill agreement with Sprint that contains restrictions on their ability to acquire voting securities of Sprint other than as contemplated by the investment agreement and related agreements, as well as customary provisions restricting DT and FT from initiating or participating in any proposal with respect to the control of Sprint.\nIn connection with the closing of the Global One joint venture, the long distance division contributed certain assets and the related operations of its international business unit to Global One.\nSprint Spectrum\nSprint, along with Tele-Communications Inc. (TCI), Comcast Corporation (Comcast) and Cox Communications, Inc. (Cox), have formed a joint venture, Sprint Spectrum LP, formerly known as Sprint Telecommunications Venture to provide wireless communications services on a broad geographic basis within the United States. In March 1995, Sprint Spectrum took a critical first step to a national wireless capabilities. In the first round of broadband Personal Communications Services (PCS) license auctions by the FCC, Sprint Spectrum and its affiliates won the rights to PCS licenses in 30 major trading areas (MTAs) at a cost of $2.2 billion. Sprint Spectrum's wireless presence, including Sprint Spectrum wireless affiliates, covers a population of more than 182 million in the United States.\nIn March 1995, Sprint, TCI, Comcast and Cox signed a definitive joint venture agreement to provide competitive local telecommunications services on a national basis using the facilities of the cable partners. In February 1996, the four partners announced a change in their approach to providing such services. The previous agreement called for the conversion of cable systems passing 10 million homes by the end of 1997 and had a fixed compensation formula between Sprint Spectrum and the cable companies. Under the revised agreements, competitive local telephone services will be the subject of individual joint ventures to be negotiated between Sprint and each cable partner, rather than through Sprint Spectrum. This approach will allow greater flexibility to decide specific terms and timing for entry into local telephone markets. However, there can be no assurance that any such joint ventures will be formed.\nIn conjunction with the approval of a business plan for Sprint Spectrum to build out a national wireless network, the four partners have committed to make cash capital contributions to Sprint Spectrum of approximately $4.2 billion through the end of 1997, of which Sprint's portion is estimated to be approximately $1.7 billion. Approximately $960 million of this commitment has already been contributed by Sprint to Sprint Spectrum, primarily to fund amounts paid to the FCC in connection with licenses won in the PCS auction.\nIn November 1995, American Personal Communications (APC), an affiliate of Sprint Spectrum, launched Sprint Spectrum, the nation's first broadband PCS system. Sprint Spectrum will serve a large geographic area encompassing Washington, D.C., all of Maryland and more than half of Virginia. It is Sprint Spectrum's objective to begin offering personal communications service in as many as 20 to 25 major metropolitan areas by December 1996, covering over 100 million people, and to substantially complete construction of the remainder of its system by December 1998. Sprint Spectrum has executed contracts with two vendors of Code Division Multiple Access (CDMA) to deploy this new developing technology across the venture's nationwide wireless communications network.\nSpin-off of Cellular Division\nDue in part to divestiture requirements imposed by the FCC with respect to PCS licenses awarded to Sprint Spectrum, the Sprint board of directors has approved the spin-off of Cellular to the holders of Sprint common stock. Sprint has received a favorable ruling from the Internal Revenue Service regarding the tax-free nature of the spin-off. After the spin-off, Cellular will market its wireless service under the 360 Communications Company brand name and will no longer be included under the umbrella of the Sprint brand name.\nThe spin-off will be effected by distributing to all holders of Sprint common stock all shares of Cellular common stock at a rate of 1 share of Cellular common stock for every 3 shares of Sprint common stock held. In connection with the closing, Cellular will repay approximately $1.4 billion of intercompany debt owed by Cellular to Sprint and its subsidiaries, and Sprint will contribute to the equity capital of Cellular any debt owed by Cellular in excess of the intercompany debt being repaid.\nPrior years' consolidated financial statements have been restated to reflect the spin-off of Cellular. Accordingly, the operating results, net assets and cash flows of Cellular are separately classified as discontinued operations.\nResults of Operations\nConsolidated\nSprint's two primary divisions -- long distance and local exchange -- generated record levels of net operating revenues and improved operating results in 1995. The long distance division generated a 7 percent growth in traffic volumes in 1995, and the number of access lines served by the local division grew 4.7 percent.\nTotal net operating revenues for the year ended December 31, 1995 were $12.8 billion, a 6 percent increase over net operating revenues of $12.0 billion for 1994. Total net operating revenues for the year ended December 31, 1993 were $10.9 billion. For the year ended December 31, 1995, income from continuing operations was $946 million, or $2.69 per share, compared with $899 million, or $2.57 per share, for 1994 and $517 million, or $1.50 per share, for 1993. Income from continuing operations for the year ended December 31, 1995 included a charge related to the restructuring of Sprint's local division ($0.16 per share). Income from continuing operations for the year ended December 31, 1994 included a gain related to the sale of an investment in equity securities ($0.06 per share). Income from continuing operations for the year ended December 31, 1993 included charges related to the merger and integration costs associated with the Centel merger and the realignment and restructuring of Sprint's long distance division ($0.56 per share) and a charge associated with the enactment of the Revenue Reconciliation Act of 1993 ($0.03 per share).\nSegmental Results of Operations\nLong Distance Communications Services\n(1) Excluding the merger, integration and restructuring costs of $45.9 million, operating income and margin for 1993 would have been $499.2 million and 8.1 percent, respectively.\nSprint's long distance division provides domestic and international voice, video and data communications services. The terms under which the division offers its services to the public are subject to different levels of state and federal regulation, but rates are not subject to rate-base regulation except nominally in some states.\nNet operating revenues increased 7 percent in 1995, following an 11 percent increase in 1994. Traffic volume increased 7 percent and 11 percent over the same periods. Revenue growth was primarily driven by strong performance in the data services market, which includes sales to consumer on-line services and Internet connectivity, transaction processing such as credit card authorizations and check guarantees, data communication for multinational corporations and data-intensive applications such as image transfer and client\/server exchange. Also contributing to this growth was the business market which continued to experience growth in \"800\" services and private line services, the international market which reflects the division's continuing efforts to target new geographic markets, and the residential market which reflects the success of the Sprint Sense (sm) calling plan.\nInterconnection costs consist of amounts paid to local exchange carriers, other domestic service providers and foreign telephone companies for the completion of calls made by the division's customers. Interconnection costs increased in 1995 and 1994 primarily as a result of traffic volume growth. Also contributing to these increases were increases in access costs associated with the growth in data products and international interconnection costs. These increases were partially offset by reduced costs of connecting to networks domestically as a result of lower interstate access rates. As a percentage of net operating revenues, interconnection costs were 42.6 percent in 1995 compared to 44.0 percent and 44.2 percent in 1994 and 1993, respectively.\nOperations expense consists of costs related to operating and maintaining the long distance network; costs of providing various services such as operator services, public payphones, telecommunications services for the hearing impaired, and video teleconferencing; and costs of data systems sales. Operations expense increased $121 million in 1995 and $68 million in 1994. The 1995 increase was primarily due to increased costs associated with growth within the data products market and increased international network operations costs reflecting growth in overseas products and foreign operations. The 1994 increase was primarily due to expanded product offerings as well as providing services to new customers.\nSelling, general and administrative (SG&A) expense increased $103 million and $189 million in 1995 and 1994, respectively, generally reflecting the overall growth in the division's operating activities. These increases were generally due to increased advertising expenses resulting from the ongoing sales and marketing efforts which are important in the intensely competitive long distance marketplace. The division has continued to focus on cost containment of SG&A expenses in an effort to further enhance the division's profitability. As a result, SG&A expense as a percentage of net operating revenues decreased from 25.5 percent for 1994 to 25.3 percent for 1995.\nDepreciation and amortization increased $31 million in 1995 and $27 million in 1994, generally due to an increase in the asset base. The increase in 1995 was generally due to an increase in the asset base in support of data revenue growth and synchronous optical network (SONET) deployment. SONET provides significantly improved transport capacity.\nLocal Communications Services\nThe local division consists principally of Sprint's regulated telephone companies which provide local exchange services, access by telephone customers and other carriers to local exchange facilities, and long distance services within specified geographic areas.\nNet operating revenues increased 7 percent in both 1995 and 1994. Increased local service revenues reflect a 4.7 percent and 4.8 percent increase in the number of access lines served for 1995 and 1994, respectively, as well as growth in add-on services, such as custom calling features.\nNetwork access revenues, derived from interexchange long distance carriers' use of the local network to complete calls, increased during 1995 and 1994 as a result of increased traffic volumes, a portion of which is due to a migration of traffic related to toll service revenues as described below. The increase was partially offset by periodic reductions in network access rates charged. The FCC announced a new interim interstate price caps plan during the first quarter of 1995. Under the new plan, which became effective August 1, 1995, the local division adopted a rate formula based on the maximum productivity factors that effectively removed the earnings cap on the division's interstate access revenues. Interstate access revenues comprise approximately 60 percent of the division's network access revenues.\nToll service revenues, related to the provision of long distance services within specified geographical areas and the reselling of interexchange long distance services, decreased 8 percent in 1995 following an increase of 5 percent in 1994. The 1995 decrease primarily reflects increased competition in the intrastate long distance markets as interexchange long distance carriers are now offering intraLATA long distance service in certain states. While toll service revenues have declined as a result of this increased competition, this reduction has been partially recovered through an increase in network access revenues resulting from additional use of the local network by interexchange long distance carriers.\nOther revenues, including revenues from directory publishing fees, billing and collection services, and sales of telecommunications equipment, increased 22 percent in 1995 and 14 percent in 1994 generally due to growth in equipment sales and increases in nonregulated revenues.\nPlant operations expense includes network operations costs; repair and maintenance costs of property, plant and equipment; and other costs associated with the provision of local exchange services. The 5 percent and 8 percent increases in such costs in 1995 and 1994, respectively, were primarily related to increases in the costs of providing services resulting from access line growth. Additionally, certain states have implemented revised toll plans requiring payment of access charges for calls terminating in the service areas of other local exchange carriers, resulting in increased plant operations expense. The 1995 increase also reflects increases in repair and maintenance costs in the division's Florida and Mid-Atlantic regions related to bad weather conditions, including the flooding rains and hurricanes which occurred in 1995. Increased expenditures related to switching system software associated with advanced calling features contributed to the higher level of plant operations expense in 1994.\nDepreciation and amortization expense increased $41 million in 1995, following a $62 million increase in 1994. These increases generally reflect system-wide plant additions and also include the effects of depreciation rate changes, special short-term amortizations and nonrecurring charges approved by state regulatory commissions.\nCustomer operations expense includes costs associated with business office operations and billing services, marketing costs, and expenses related to providing operator and directory assistance and other customer services. These costs increased 9 percent and 3 percent in 1995 and 1994, respectively. The increases in 1995 and 1994 were related to increased costs associated with the overall growth in access lines. Expense levels in 1995 were also affected by marketing costs to promote new products and services, increased business office operations costs resulting from longer office hours for greater customer accessibility and customer costs related to increased nonregulated activities.\nOther operating expenses increased $41 million and $42 million in 1995 and 1994, respectively, primarily due to costs associated with the growth in equipment sales.\nIn November 1995, Sprint initiated a realignment and restructuring of its local communications division, including the elimination of approximately 1,600 positions primarily in the network and finance functions. This restructuring is intended to streamline current processes in order to reduce costs in an increasingly competitive marketplace. These actions resulted in a nonrecurring charge of $88 million. The accrued liability associated with this charge specifically relates to the benefits that affected employees will receive upon termination.\nSprint adopted accounting principles for a competitive marketplace effective December 31, 1995 and discontinued applying Statement of Financial Accounting Standards (SFAS) No. 71, \"Accounting for the Effects of Certain Types of Regulation,\" to its local division. The accounting impact to Sprint was a noncash, extraordinary charge of $565 million, net of related income tax benefits. See Note 2 of Notes to Consolidated Financial Statements for additional discussion.\nSprint does not expect the discontinued application of SFAS No. 71 to have a significant impact on 1996 depreciation expense. Additionally, future business transactions of the local division will be recorded following their economic substance, and regulatory assets and liabilities pursuant to SFAS No. 71 will no longer be recognized. Furthermore, revenues and related net income of nonregulated operations attributable to transactions with Sprint's regulated local exchange carriers, which were previously not eliminated in the accompanying Consolidated Financial Statements in accordance with SFAS No. 71, will be eliminated. Intercompany revenues of such entities amounted to $262 million, $285 million and $225 million in 1995, 1994 and 1993, respectively.\nProduct Distribution and Directory Publishing\nNorth Supply, a wholesale distributor of telecommunications products, had 1995 net operating revenues of $854 million compared to $829 million in 1994 and $677 million in 1993. The increase in 1995 primarily reflects growth in sales to nonaffiliates as well as overall price increases. The increase in 1994 primarily reflects increased sales to the local division, partially as a result of sales to the merged Centel telephone operations. As a percentage of net operating revenues, operating expenses for 1995, 1994 and 1993 were 94.4 percent, 95.5 percent and 96.5 percent, respectively.\nSprint Publishing & Advertising, a publisher and marketer of telephone directories, had net operating revenues of $294 million in 1995 compared to $280 million in 1994 and $268 million in 1993. As a percentage of net operating revenues, operating expenses for 1995, 1994 and 1993 were 86.9 percent, 86.7 percent and 84.9 percent, respectively.\nNonoperating Items\nInterest Expense\nInterest expense related to continuing operations totaled $261 million in 1995 compared to $301 million in 1994 and $367 million in 1993. Interest expense related to the operations of Cellular totaled $124 million, $97 million and $85 million in 1995, 1994 and 1993, respectively, and is included in discontinued operations in the Consolidated Statements of Income. Sprint's average debt outstanding, including the debt incurred to fund intercompany advances to Cellular, increased by $668 million in 1995 compared to the prior year. The increase in average debt outstanding during 1995 was primarily from short-term borrowings incurred to fund investments in Sprint Spectrum. Because the interest costs on the borrowings associated with Sprint's investment in this venture are being capitalized until Sprint Spectrum commences operations, interest expense did not increase proportionately to the increase in average debt outstanding. Sprint's effective interest rate decreased 44 basis points from 1994 to 1995 primarily due to the increase in short-term borrowings as a percent of total borrowings. Sprint's average debt outstanding decreased by $334 million and $596 million in 1994 and 1993, respectively, and the effective interest rate decreased 52 and 15 basis points, respectively, due to debt refinancings which occurred during 1993 and 1992.\nOther Expense, Net\nThe components of other income (expense) are as follows (in millions):\nIncome Tax Provision\nSprint's income tax provisions for 1995, 1994 and 1993 resulted in effective tax rates of 36.1 percent, 35.2 percent and 36.4 percent, respectively. During 1993, the Revenue Reconciliation Act of 1993 was enacted which, among other changes, raised the federal income tax rate to 35 percent from 34 percent. As a result, Sprint adjusted its deferred income tax assets and liabilities to reflect the revised rate. See Note 5 of Notes to Consolidated Financial Statements for information regarding the differences which cause the effective income tax rates to vary from the statutory federal income tax rate.\nAs of December 31, 1995, Sprint had recorded deferred income tax assets of $501 million, net of a $17 million valuation allowance. See Note 5 of Notes to Consolidated Financial Statements for information regarding the sources which gave rise to these assets. Sprint's management has determined that it is more likely than not that these deferred income tax assets, net of the valuation allowance, will be realized based on current income tax laws and expectations of future taxable income stemming from the reversal of existing deferred tax liabilities or ordinary operations. Uncertainties surrounding income tax law changes, shifts in operations between state taxing jurisdictions, and future operating income levels may, however, affect the ultimate realization of all or some portion of these deferred income tax assets.\nDiscontinued Operations - Cellular Division\nAs a result of the tax-free spin-off of Cellular to shareholders of Sprint common stock, the operating results, net assets and cash flows of Cellular have been separately classified as discontinued operations and are excluded from amounts for the continuing operations of Sprint.\nCellular's operating results exclude its share of Sprint's corporate overhead expenses. These expenses have been reallocated to Sprint's continuing operations in the accompanying Consolidated Statements of Income as well as in the accompanying Segmental Results of Operations. Accordingly, Cellular's results of operations as reflected below may not be indicative of its futures operating results once the spin-off is completed. Such expenses were $13 million, $12 million and $12 million for each of the years ended December 31, 1995, 1994 and 1993, respectively. See Note 3 of Notes to Consolidated Financial Statements for further discussion.\nCellular's results of operations are summarized as follows:\nNet operating revenues increased $208 million during 1995 and $216 million during 1994. These increases resulted principally from the growth in the number of cellular customers, which increased 44 percent in 1995 and 59 percent in 1994. The effect of this growth was partially offset by a decline in service revenue per customer.\nOperating expenses increased $146 million for 1995 and $155 million for 1994. These increases resulted principally from the growth in the number of cellular customers and increased advertising costs.\nDiscontinued Operations - Other\nFor the year ended December 31, 1994, Sprint recognized $7 million of income associated with the settlement of matters related to a discontinued operation. Also, during 1993, Sprint incurred a loss from discontinued operations of $12 million, net of income tax benefits.\nExtraordinary Items\nAs described in Note 2 of Notes to Consolidated Financial Statements, Sprint adopted accounting principles for a competitive marketplace and discontinued applying SFAS No. 71 to its local division effective December 31, 1995. The application of SFAS No. 71 requires the accounting recognition of the rate actions of regulators where appropriate. Sprint determined that the local division no longer met the criteria for application of SFAS No. 71 due to changes in the regulatory framework, which continues to evolve from rate-base regulation to price regulation, as the latter does not provide for the recovery of specific costs. In addition, the division operates in an evolving competitive environment in which the level and types of competition are increasing such that they may no longer allow for service and product pricing that provides for the recovery of specific costs. As a result, Sprint recorded a noncash, extraordinary charge of $565 million ($1.61 per share), net of related income tax benefits.\nIn 1993, Sprint incurred extraordinary losses related to the early extinguishment of debt of $29 million, net of related income tax benefits.\nAccounting Changes\nEffective January 1, 1993, Sprint changed its method of accounting for postretirement and postemployment benefits by adopting SFAS No. 106 and No. 112 and effected another accounting change. The cumulative effect of these changes in accounting principles reduced 1993 net income by $383 million ($1.12 per share).\nFinancial Condition\nSprint's consolidated assets totaled $15.2 billion at December 31, 1995 compared to $14.5 billion at December 31, 1994. Accounts receivable increased $136 million from 1994 to 1995, generally due to a 6 percent increase in consolidated net operating revenues. Sprint's allowance for doubtful accounts as a percentage of gross accounts receivable increased from 8 percent at December 31, 1994 to 13 percent at December 31, 1995. The increased percentage generally reflects the timing of sales and customer payments as well as reserves established during 1995 relative to certain of the long distance division's reseller customers. The reseller market has experienced significant competition, which has had a negative impact on these customers' repayment patterns. This increase has not had a significant impact on the revenue growth for the long distance division. Property, plant and equipment, net of accumulated depreciation, decreased $543 million from 1994 to 1995. This decrease was primarily due to the discontinued application of SFAS No. 71, which resulted in a $979 million increase to accumulated depreciation. Exclusive of this write-off, net property, plant and equipment increased $436 million due to increased capital expenditures to enhance and upgrade Sprint's networks, to expand service capabilities and to increase productivity.\nCurrent maturities of long-term debt decreased $52 million from 1994 to 1995 due to scheduled debt payments. As of December 31, 1995, Sprint's total capitalization aggregated $10.4 billion, consisting of short-term borrowings, long-term debt (including current maturities), redeemable preferred stock, and common stock and other shareholders' equity. Short-term borrowings and long-term debt (including current maturities) comprised 54.8 percent of total capitalization as of December 31, 1995 compared to 52.0 percent at year-end 1994. The increase in the debt-to-capital ratio is attributable to increased short-term borrowings to fund investments in Sprint Spectrum.\nLiquidity and Capital Resources\nCash Flows - Operating Activities\nCash flows from operating activities, which are Sprint's primary source of liquidity, were $2.6 billion, $2.3 billion and $2.0 billion in 1995, 1994 and 1993, respectively, for continuing operations. The increased cash flows in 1995 reflect improved operating results and reduced working capital requirements. Operating cash flows for 1994 and 1993 reflect improved operating results, partially offset by expenditures of $86 million and $155 million for 1994 and 1993, respectively, related to the 1993 merger, integration and restructuring actions.\nCash Flows - Investing Activities\nInvesting activities of Sprint's continuing operations used cash of $2.8 billion, $1.8 billion and $1.5 billion in 1995, 1994 and 1993, respectively. Capital expenditures, which represent Sprint's most significant investing activity, were $1.9 billion, $1.8 billion and $1.4 billion in 1995, 1994 and 1993, respectively.\nLong distance capital expenditures were incurred each year primarily to meet increased demand for data related services, to enhance network reliability and to upgrade capabilities for providing new products and services. Capital expenditures for the local division were made to accommodate access line growth, to continue the conversion to digital technologies, and to expand the division's capabilities for providing enhanced telecommunications services.\nDuring 1995 and 1994, Sprint contributed $911 million and $52 million, respectively, to Sprint Spectrum. In 1995, $840 million of this contribution was used to fund Sprint's share of payments to the FCC for licenses acquired in the PCS auction. The remainder was used to fund Sprint's share of the venture's acquisition of a limited partnership interest in APC, as well as related capital and operating requirements. The 1994 contribution funded Sprint's share of the initial payment to the FCC for the PCS auction. Investing activities for 1994 also included $118 million received in connection with the sale of an investment in equity securities.\nCash Flows - Financing Activities\nSprint's financing activities provided cash of $423 million in 1995 and used cash of $457 million and $615 million in 1994 and 1993, respectively. During 1995, Sprint issued $261 million of long-term debt and increased short-term borrowings $1.1 billion. The proceeds from these borrowings were primarily used to fund commitments associated with Sprint Spectrum. Proceeds were also used to repay scheduled long-term debt maturities and to repay $282 million of 9.875 percent notes prior to maturity. The redemption premiums associated with this early retirement were not significant.\nLong-term debt retirements during 1994 included the redemption of $102 million of debt called, prior to scheduled maturity, in 1993.\nDuring 1993, 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 was used to finance the redemption prior to scheduled maturities of $1.2 billion of debt.\nDuring 1995, Sprint renewed its revolving credit agreement with a syndicate of domestic and international banks for five years, through October 2000. In addition to the extension, the revolving credit agreement was increased to $1.5 billion from $1.1 billion.\nSprint paid dividends to common and preferred shareholders of $352 million, $349 million and $347 million in 1995, 1994 and 1993, respectively. Sprint's indicated annual dividend rate on common stock is currently $1.00 per share.\nCash Flows - Discontinued Operations\nCellular's cash flows from operating activities were $163 million, $173 million and $198 million in 1995, 1994 and 1993, respectively. Cellular's investing activities used cash of $325 million, $272 million and $170 million in 1995, 1994 and 1993, respectively, primarily consisting of capital expenditures. The increases in capital expenditures reflect the significant increases in the number of cellular customers served.\nCapital Requirements\nOn January 31, 1996, DT and FT invested $3.0 billion in Sprint and, upon the spin-off of Cellular, will make an additional aggregate investment of approximately $500 million to $700 million. Also in conjunction with the spin-off, Cellular will repay approximately $1.4 billion of intercompany debt payable to Sprint and its subsidiaries. Sprint does not expect to require any additional external financing during 1996.\nCash proceeds received from DT, FT and Cellular are expected to be used to repay approximately $2.1 billion in short-term borrowings and approximately $500 million in long-term borrowings. Approximately $600 million of the proceeds will also be required to fund the termination of an accounts receivable sales agreement. An additional $600 million will be used to fund commitments associated with Sprint Spectrum and its affiliates. Remaining cash proceeds will be invested on a temporary basis.\nDuring 1996, Sprint anticipates funding capital expenditures of approximately $2.0 billion and dividends of approximately $426 million with cash flows from operating activities.\nLiquidity\nAt year-end 1995, Sprint had the ability to borrow $880 million under revolving credit agreements with a syndicate of domestic and international banks and other bank commitments. Other available financing sources include a Medium-Term Note program, under which Sprint may offer for sale up to $175 million of unsecured senior debt securities. Additionally, pursuant to shelf registration statements filed with the Securities and Exchange Commission, up to $1.0 billion of debt securities could be offered for sale as of December 31, 1995.\nThe aggregate amount of additional borrowings which can be incurred is ultimately limited by certain covenants contained in existing debt agreements. As of December 31, 1995, Sprint had borrowing capacity of approximately $3.6 billion under the most restrictive of its debt covenants.\nGeneral Hedging Policies\nSprint, on a limited basis, utilizes certain derivative financial instruments in an effort to manage exposure to interest rate risk and foreign exchange risk. Sprint's utilization of such derivative financial instruments related to hedging activities is generally limited to interest rate swap agreements and forward contracts and options in foreign currencies. Sprint will in no circumstance take speculative positions and create an exposure to benefit from market fluctuations. All hedging activity is in accordance with board-approved policies. Any potential loss or exposure related to Sprint's use of derivative instruments is immaterial to its overall operations, financial condition and liquidity. See Note 11 of Notes to Consolidated Financial Statements for more information related to Sprint's portfolio of derivative instruments.\nInterest Rate Risk Management\nSprint's interest rate risk management program focuses on minimizing vulnerability of net income to movements in interest rates, setting an optimal mixture of floating-rate and fixed-rate debt in the liability portfolio and preventing liquidity risk. Sprint primarily employs a gap methodology to measure interest rate exposure and utilizes simulation analysis to manage interest rate risk. Sprint takes an active stance in modifying hedge positions to benefit from the value of timing flexibility and fixed-rate\/floating-rate adjustments.\nForeign Exchange Risk Management\nSprint's foreign exchange risk management program focuses on optimizing consolidated cash flows and stabilizing accounting results. Sprint does not hedge translation exposure because it believes that optimizing consolidated cash flows will, over time, maintain shareholder value. Sprint's primary transaction exposure in foreign currencies results from changes in foreign exchange rates between the dates Sprint incurs and settles liabilities (payable in a foreign currency) to overseas telephone companies for the costs of terminating international calls made by Sprint's domestic customers.\nImpact of Recently Issued Accounting Pronouncements\nIn March 1995, the Financial Accounting Standards Board (FASB) issued SFAS No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of,\" which is effective for fiscal years beginning after December 15, 1995. SFAS No. 121 requires that assets to be held and used be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Sprint does not anticipate that the requirements of SFAS No. 121 will have a material effect on its 1996 operating results.\nIn October 1995, the FASB issued SFAS No. 123, \"Accounting for Stock-Based Compensation,\" which is effective for fiscal years beginning after December 15, 1995. SFAS No. 123 encourages companies to account for stock compensation awards under a fair value based method, whereby compensation cost is measured at the grant date based on the value of the award and is recognized over a service period. Companies may choose not to apply the new accounting method and may continue to apply current accounting requirements, which generally result in no recognition of compensation cost for most fixed stock option plans. Those that so choose, however, will be required to disclose in the notes to the financial statements what net income and earnings per share would have been if they had followed the FASB's new accounting method. Sprint has elected to continue to apply the current accounting requirements for stock-based compensation and will comply with the disclosure requirements in the notes to its 1996 consolidated financial statements.\nMANAGEMENT REPORT\nThe management of Sprint Corporation has the responsibility for the integrity and objectivity of the information contained in this Annual Report. Management is responsible for the consistency of reporting such information and for ensuring that generally accepted accounting principles are used.\nIn discharging this responsibility, management maintains a comprehensive system of internal controls and supports an extensive program of internal audits, has made organizational arrangements providing appropriate divisions of responsibility and has established communication programs aimed at assuring that its policies, procedures and codes of conduct are understood and practiced by its employees.\nThe consolidated financial statements included in this Annual Report have been audited by Ernst & Young LLP, independent auditors. Their audit was conducted in accordance with generally accepted auditing standards and their report is included herein.\nThe responsibility of the Board of Directors for these financial statements is pursued primarily through its Audit Committee. The Audit Committee, composed entirely of directors who are not officers or employees of Sprint, meets periodically with the internal auditors and independent auditors, both with and without management present, to assure that their respective responsibilities are being fulfilled. The internal and independent auditors have full access to the Audit Committee to discuss auditing and financial reporting matters.\n\/s\/ W. T. Esrey William T. Esrey Chairman and Chief Executive Officer\n\/s\/ Arthur B. Krause Arthur B. Krause Executive Vice President and Chief Financial Officer\nREPORT OF INDEPENDENT AUDITORS\nThe Board of Directors and Shareholders Sprint Corporation\nWe have audited the accompanying consolidated balance sheets of Sprint Corporation (Sprint) as of December 31, 1995 and 1994, and the related consolidated statements of income, cash flows, and common stock and other shareholders' equity for each of the three years in the period ended December 31, 1995. Our audits also included the financial statement schedule listed in the Index to Financial Statements, Financial Statement Schedule and Supplementary Data. These financial statements and the schedule are the responsibility of the management of Sprint. 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 consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Sprint at December 31, 1995 and 1994, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, 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, Sprint discontinued accounting for the operations of its local telecommunications division in accordance with Statement of Financial Accounting Standards No. 71, \"Accounting for the Effects of Certain Types of Regulation,\" in 1995. As discussed in Notes 1 and 4 to the consolidated financial statements, Sprint changed its method of accounting for postretirement benefits, postemployment benefits and circuit activity costs in 1993.\nERNST & YOUNG LLP\nKansas City, Missouri February 14, 1996\nSee accompanying Notes to Consolidated Financial Statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS Sprint Corporation\n1. Summary of Significant Accounting Policies\nThis summary of significant accounting policies of Sprint Corporation is presented to assist in understanding the accompanying consolidated financial statements.\nBasis of Consolidation and Presentation\nThe accompanying consolidated financial statements include the accounts of Sprint Corporation and its wholly-owned and majority-owned subsidiaries (Sprint). Investments in entities in which Sprint does not have a controlling interest are accounted for using the equity method.\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nPrior years' financial statements have been restated to reflect Sprint's spin-off of its cellular and wireless communications services division (Cellular) (see Note 3). The operating results, net assets and cash flows of Cellular are separately classified as discontinued operations and are excluded from amounts reported for the continuing operations of Sprint. Intercompany transactions with Cellular and its subsidiaries, which were previously eliminated in consolidation, are now reflected in Sprint's consolidated financial statements.\nCertain other amounts previously reported for prior periods have been reclassified to conform to the current period presentation in the accompanying consolidated financial statements. Such reclassifications had no effect on the results of operations or shareholders' equity as previously reported.\nIn accordance with Statement of Financial Accounting Standards (SFAS) No. 71, \"Accounting for the Effects of Certain Types of Regulation,\" revenues and related net income of nonregulated operations attributable to intercompany transactions with Sprint's regulated telephone companies have not been eliminated in the accompanying consolidated financial statements. Intercompany revenues of such entities amounted to $262 million, $285 million and $225 million in 1995, 1994 and 1993, respectively. In conjunction with the adoption of accounting principles for a competitive marketplace (see Note 2), such intercompany amounts will be eliminated beginning in 1996. All other significant intercompany transactions have been eliminated.\nClassification of Operations\nThe long distance communications services division provides domestic and international voice, video and data communications services. The terms under which the division offers its services to the public are subject to different levels of state and federal regulation, but rates are generally not subject to rate-base regulation.\nThe local communications services division consists principally of the operations of Sprint's regulated telephone companies. These operations provide local exchange services, access by telephone customers and other carriers to local exchange facilities and long distance services within specified geographical areas.\nThe product distribution and directory publishing businesses include the wholesale distribution of telecommunications products and the publishing and marketing of white and yellow page telephone directories.\n1. Summary of Significant Accounting Policies (continued)\nRevenue Recognition\nOperating revenues for the long distance and local communications services divisions are recognized as communications services are rendered. Operating revenues for the long distance communications services division are recorded net of an estimate for uncollectible accounts. Operating revenues for Sprint's product distribution business are recognized upon delivery of products to customers.\nCash and Equivalents\nCash equivalents generally include highly liquid investments with original maturities of three months or less and are stated at cost, which approximates market value. As part of its cash management program, Sprint utilizes controlled disbursement banking arrangements. As of December 31, 1995 and 1994, outstanding checks in excess of cash balances of $131 million and $126 million, respectively, are included in accounts payable. Sprint had sufficient funds available to fund these outstanding checks when they were presented for payment.\nInvestments in Equity Securities\nInvestments in equity securities are classified as available for sale and are reported at fair value (estimated based on quoted market prices) as of December 31, 1995 and 1994. As of December 31, 1995 and 1994, the cost of such investments was $109 million each year. These investments had gross unrealized holding gains of $154 million and $69 million for 1995 and 1994, respectively, which are reflected as an addition to other shareholders' equity, net of related income taxes.\nDuring 1994, Sprint sold an investment in equity securities, realizing a gain of $35 million.\nInventories\nInventories, consisting principally of those related to Sprint's product distribution business, are stated at the lower of cost (principally first-in, first-out method) or market.\nProperty, Plant and Equipment\nProperty, plant and equipment are recorded at cost. Generally, ordinary asset retirements and disposals are charged against accumulated depreciation with no gain or loss recognized. Repairs and maintenance costs are expensed as incurred.\nEffective January 1, 1993, Sprint's long distance communications services division changed its method of accounting for certain costs related to connecting new customers to its network. The change was made to conform Sprint's accounting to the predominant industry practice for such costs. Under the new method, such costs (which were previously capitalized) are being expensed when incurred. The resulting nonrecurring, noncash charge of $32 million ($0.09 per share), net of related income tax benefits, is reflected in the 1993 Consolidated Statement of Income as a cumulative effect of change in accounting principle.\n1. Summary of Significant Accounting Policies (continued)\nDepreciation\nThe cost of property, plant and equipment for Sprint's local communications division was generally depreciated on a straight-line composite basis over the lives prescribed by regulatory commissions. In connection with the discontinuation of SFAS No. 71, Sprint will begin recording depreciation expense based on estimated economic useful lives rather than those prescribed by regulatory commissions (see Note 2).\nThe cost of property, plant and equipment of Sprint's other divisions is depreciated generally on a straight-line basis over the estimated economic useful lives.\nIncome Taxes\nDeferred income taxes are provided for certain temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for tax purposes.\nInvestment tax credits related to regulated telephone property, plant and equipment have been deferred and are being amortized over the estimated useful lives of the related assets.\nCapitalized Interest\nInterest costs associated with the construction of capital assets, including interest costs on borrowings incurred to fund Sprint's investment in Sprint Spectrum, are capitalized. Total amounts capitalized during 1995, 1994 and 1993 were $57 million, $8 million and $7 million, respectively.\nEarnings Per Share\nEarnings per common share amounts are based on the weighted average number of shares both outstanding and issuable assuming exercise of all dilutive options, as applicable. See Note 12 for a discussion of the consummation of the Global One joint venture and the pro forma impact of the related issuance of shares on earnings per share.\n2. Adoption of Accounting Principles for a Competitive Marketplace\nEffective December 31, 1995, Sprint determined that its local communications services division no longer met the criteria necessary for the continued application of the provisions of SFAS No. 71. As a result of the decision to discontinue the application of SFAS No. 71, Sprint recorded a noncash, extraordinary charge of $565 million, net of income tax benefits of $437 million.\nSprint's determination that it was no longer eligible for the continued application of the accounting required by SFAS No. 71 was based on changes in the regulatory framework, which continues to evolve from rate-base regulation to price regulation and the convergence of competition in the telecommunications industry. Based on these occurrences, Sprint no longer believes that it can be assured that prices will be maintained at levels which will provide for the recovery of specific costs.\nThe adjustment to the accumulated depreciation balance was determined by the completion of depreciation reserve and impairment studies. The depreciation reserve study analyzed, by individual plant asset categories, the impacts of regulator-prescribed depreciable asset lives compared to Sprint's estimated economic lives. The results identified the cumulative under depreciation of certain asset categories. The impairment study, which validated the results of the depreciation study, estimated the impact on future revenues caused by price changes and developing industry competition, and the resulting effects on cash flows.\nThe following is a summary of the telecommunications plant in service asset balances and corresponding reserve adjustment (in millions).\n2. Adoption of Accounting Principles for a Competitive Marketplace (continued)\nThe discontinued application of SFAS No. 71 also required Sprint to eliminate from its consolidated balance sheet the effects of any actions of regulators that had been recognized as assets and liabilities pursuant to SFAS No. 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 deferred postretirement benefit obligations and deferred debt financing costs. Additionally, revenues and related net income of nonregulated operations attributable to transactions with Sprint's regulated local exchange carriers, which were previously not eliminated in the accompanying consolidated financial statements in accordance with SFAS No. 71, will be eliminated beginning in 1996. Intercompany revenues of such entities amounted to $262 million, $285 million and $225 million in 1995, 1994 and 1993, respectively.\nThe tax-related adjustments were required to adjust deferred income tax amounts to the currently enacted statutory rates and to eliminate tax-related regulatory assets and liabilities. Sprint's local division uses the deferral method of accounting for investment tax credits and amortizes the credits as a reduction to tax expense over the life of the asset that gave rise to the tax credit. Since plant asset lives were shortened, the related investment tax credits were adjusted to reduce the unamortized balance by a corresponding amount.\n3. Spin-off of Cellular Division\nDue in part to divestiture requirements imposed by the Federal Communications Commission (FCC) with respect to Personal Communications Services (PCS) licenses awarded to Sprint Spectrum, the Sprint board of directors has approved the spin-off of Cellular to the holders of Sprint common stock. Sprint has received a favorable ruling from the Internal Revenue Service regarding the tax-free nature of the spin-off.\nThe spin-off will be effected by distributing to all holders of Sprint common stock all shares of Cellular common stock at a rate of 1 share of Cellular common stock for every 3 shares of Sprint common stock held. In connection with the closing, Cellular will repay approximately $1.4 billion of intercompany debt owed by Cellular to Sprint and its subsidiaries, and Sprint will contribute to the equity capital of Cellular any debt owed by Cellular in excess of the intercompany debt being repaid.\nThe net operating results of Cellular have been separately classified as discontinued operations in the Consolidated Statements of Income as summarized below. Interest expense has been allocated to Cellular based on the assumed repayment of intercompany debt to Sprint by Cellular. The operating expenses as presented below do not include Cellular's share of general corporate overhead expenses. These expenses have been reallocated to Sprint's other operating segments. Accordingly, Cellular's results of operations as reflected below may not be indicative of its future operating results once the spin-off is completed. Such expenses were $13 million, $12 million and $12 million for each of the years ended December 31, 1995, 1994 and 1993, respectively.\n3. Spin-off of Cellular Division (continued)\nThe net assets and liabilities of Cellular have been separately classified as net investment in cellular division in the Consolidated Balance Sheets as summarized below (in millions):\n4. Employee Benefit Plans\nDefined Benefit Pension Plan\nSubstantially all Sprint employees are covered by a noncontributory defined benefit pension plan. For participants of the plan represented by collective bargaining units, 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.\nSprint'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, 1995, 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 (credits) and related weighted average assumptions are as follows (in millions):\n4. Employee Benefit Plans (continued)\nThe funded status and amounts recognized in the Consolidated Balance Sheets for the plan, as of December 31, are as follows (in millions):\nThe projected benefit obligations as of December 31, 1995 and 1994 were determined using discount rates of 7.25 percent and 8.5 percent, respectively, and anticipated composite rates of future increases in compensation of 4.25 percent and 5.0 percent, respectively.\nDefined Contribution Plans\nSprint sponsors defined contribution employee savings plans covering substantially all employees. Participants may contribute portions of their compensation to the plans. Contributions of participants represented by collective bargaining units are matched by Sprint based upon defined amounts as negotiated by the respective parties. Contributions of participants not covered by collective bargaining agreements are also matched by Sprint. For these participants, Sprint provides matching contributions in common stock equal to 50 percent of participants' contributions up to 6 percent of their compensation and may, at the discretion of the Board of Directors, provide additional matching contributions based upon the performance of Sprint's common stock in comparison to other telecommunications companies. Sprint's matching contributions aggregated $51 million, $47 million and $49 million in 1995, 1994 and 1993, respectively.\nPostretirement Benefits\nSprint sponsors postretirement benefit (principally health care benefits) arrangements covering substantially all employees. Employees who retired before specified dates are eligible for these benefits at no cost or a reduced cost. Employees retiring after specified dates are eligible for these benefits on a shared cost basis. Sprint funds the accrued costs as benefits are paid.\nEffective January 1, 1993, Sprint changed or modified its method of accounting for postretirement benefits by adopting SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" The resulting nonrecurring, noncash charge of $339 million ($1.00 per share), net of related income tax benefits, is reflected in the 1993 Consolidated Statement of Income as a cumulative effect of change in accounting principle.\n4. Employee Benefit Plans (continued)\nThe components of the net postretirement benefits cost are as follows (in millions):\nFor measurement purposes, a weighted average 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 increase in the assumed trend rates would have increased the 1995 net postretirement benefits cost by approximately $14 million. The discount rates for 1995, 1994 and 1993 were 8.5 percent, 7.5 percent and 8.0 percent, respectively.\nThe amounts recognized in the Consolidated Balance Sheets, as of December 31, are as follows (in millions):\nThe accumulated benefits obligations as of December 31, 1995 and 1994 were determined using discount rates of 7.25 percent and 8.5 percent, respectively. A weighted average annual health care trend rate of 9.6 percent was assumed for 1996, gradually decreasing to 5 percent by 2001 and remaining constant thereafter. The effect of a 1 percent annual increase in the assumed health care cost trend rates would have increased the accumulated benefits obligation as of December 31, 1995 by approximately $100 million.\nPostemployment Benefits\nEffective January 1, 1993, Sprint adopted SFAS No. 112, \"Employers' Accounting for Postemployment Benefits.\" Upon adoption, Sprint recognized certain previously unrecorded obligations for benefits being provided to former or inactive employees and their dependents after employment, but before retirement. The resulting nonrecurring, noncash charge of $11 million ($0.03 per share), net of related income tax benefits, is reflected in the 1993 Consolidated Statement of Income as a cumulative effect of change in accounting principle. Such postemployment benefits offered by Sprint include severance, disability and workers compensation benefits, including the continuation of other benefits such as health care and life insurance coverage.\n5. Income Taxes\nThe components of the income tax provisions allocated to continuing operations are as follows (in millions):\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. Accordingly, Sprint adjusted its deferred income tax assets and liabilities to reflect the revised rate. The resulting adjustment related to Sprint's nonregulated subsidiaries increased the 1993 deferred income tax provision by $11 million ($0.03 per share). Adjustments to the net deferred income tax liabilities associated with the regulated telephone companies were generally recorded as reductions to regulatory liabilities and have been subsequently eliminated in connection with Sprint's discontinued application of SFAS No. 71 (see Note 2).\nThe differences which cause the effective income tax rate to vary from the statutory federal income tax rate of 35 percent in 1995, 1994 and 1993 are as follows (in millions):\n5. Income Taxes (continued)\nThe income tax provisions (benefits) allocated to other items are as follows (in millions):\nDeferred income taxes are provided for the temporary differences between the carrying amounts of Sprint'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, 1995 and 1994, along with the income tax effect of each, are as follows (in millions):\nDuring 1995, 1994 and 1993, the valuation allowance related to deferred income tax assets decreased $4 million, $1 million and $7 million, respectively.\nAs of December 31, 1995, Sprint has available, for income tax purposes, $9 million of alternative minimum tax credit carryforwards to offset regular income tax payable in future years, and tax benefits of $27 million associated with state operating loss carryforwards. The loss carryforwards expire in varying amounts annually from 1996 through 2010.\n6. Borrowings\nLong-term debt, as of December 31, is as follows (in millions):\n(1) Notes are exchangeable for 4.4 million shares of Southern New England Telecommunications Corporation common stock owned by Sprint and included in investments in equity securities at December 31, 1995.\n6. Borrowings (continued)\nLong-term debt maturities during each of the next five years are as follows (in millions):\nProperty, plant and equipment with an aggregate cost of approximately $11.2 billion is either pledged as security for first mortgage bonds and certain notes or is restricted for use as mortgaged property.\nNotes payable and commercial paper outstanding and related weighted average interest rates, as of December 31, are as follows (in millions):\nAs of December 31, 1995, $2.1 billion of notes payable and commercial paper was classified as short-term borrowings. As of December 31, 1995 and 1994, $43 million and $1.1 billion, respectively, of notes payable and commercial paper were classified as long-term debt. Such classifications were based on Sprint's ability and intent to refinance such borrowings on a long-term basis.\nThe bank notes are renewable at various dates throughout the year. Sprint pays a fee to certain commercial banks to support current and future credit requirements based upon loan commitments. Lines of credit may be withdrawn by the banks if there is a material adverse change in Sprint's financial condition.\nAt December 31, 1995, Sprint had aggregate credit arrangements which provided $2.8 billion. Of the $2.2 billion of notes payable and commercial paper outstanding at December 31, 1995, $2.0 billion had been specifically borrowed under such credit arrangements, resulting in $790 million of availability.\nSprint is in compliance with all restrictive or financial covenants relating to its debt arrangements at December 31, 1995.\nDuring 1993, Sprint redeemed or called for redemption prior to scheduled maturities $1.3 billion of first mortgage bonds, senior notes and debentures. Excluding amounts deferred by the rate-regulated telephone companies as required by certain regulatory commissions, the prepayment penalties incurred in connection with early extinguishments of debt and the write-off of related debt issuance costs aggregated $29 million, net of related income tax benefits, and is reflected as an extraordinary loss in the Consolidated Statements of Income.\n7. Redeemable Preferred Stock\nSprint has 20 million authorized shares and subsidiaries have approximately 5 million authorized shares of preferred stock, including nonredeemable preferred stock. The redeemable preferred stock outstanding, as of December 31, is as follows (in millions):\nSprint's third series preferred stock was called in January 1996. In March 1996, 24,000 shares will be redeemed at a price of $100.00 per share and the remaining shares will be redeemed at a price of $101.77 per share.\nSprint's fifth series preferred stock must be redeemed in full in 2003. If less than full dividends have been paid for four consecutive dividend periods or if the total amount of dividends in arrears exceeds an amount equal to the dividend payment for six dividend periods, the holders of the fifth series preferred stock are entitled to elect a majority of directors standing for election until all arrears in dividend payments have been paid.\n8. Common Stock\nCommon stock activity during 1995 and shares reserved for future grants under stock option plans or for future issuances under various arrangements are as follows (in millions):\nAs of December 31, 1995, elections to purchase 2 million of Sprint's common shares were outstanding under the 1994 offering of the Employees Stock Purchase Plan (ESPP). The purchase price under the offering cannot exceed $32.35 per share, such price representing 85 percent of the average market price on the offering date, or fall below $12.00 per share. The 1994 offering terminates on June 30, 1996. Upon the spin-off of Cellular, the number of shares underlying elections by non-Cellular employees and the related per share purchase price will be adjusted to maintain both the aggregate fair market value of stock underlying the elections and the relationship between the per share purchase\n8. Common Stock (continued)\nprice and the related per share market value. At the option of Cellular employees, elections made by Cellular employees are expected to be terminated under the terms and conditions of Sprint's ESPP, or to be replaced by elections to purchase shares of the common stock of Cellular. As of December 31, 1995, Cellular employees held elections to purchase approximately 58,000 shares of Sprint common stock under the ESPP.\nUnder various stock option plans, shares of common stock are reserved for issuance to officers, outside directors and certain employees. All options are granted at 100 percent of the market price at date of grant. Approximately 1 percent of all options outstanding as of December 31, 1995 provide for the granting of stock appreciation rights as an alternate method of settlement upon exercise. A summary of stock option activity under the plans is as follows (in millions, except per share data):\nUpon the spin-off of Cellular, the number of shares underlying options held by non-Cellular employees and the related per share purchase price will be adjusted to maintain both the aggregate fair market value of stock underlying the options and the relationship between the per share purchase price and the related per share market value. Options held by Cellular employees are expected to be converted into options to purchase shares of Cellular common stock. As of December 31, 1995, Cellular employees held options to purchase approximately 320,000 shares of Sprint common stock.\n8. Common Stock (continued)\nDuring 1990, the Savings Plan Trust, an employee savings plan, acquired shares of common stock from Sprint in exchange for a $75 million promissory note payable to Sprint. The note bears an interest rate of 9 percent and is to be repaid from the common stock dividends received by the plan and the contributions made to the plan by Sprint in accordance with plan provisions. The remaining balance of the note receivable of $55 million as of December 31, 1995 is reflected as a reduction to other shareholders' equity. At December 31, 1995 the Savings Plan Trust held approximately 18 million shares of Sprint common stock.\nUnder a Shareholder Rights plan, one-half of a Preferred Stock Purchase Right is attached to each share of common stock. Each Right, which is exercisable and detachable only upon the occurrence of certain takeover events, entitles shareholders to buy units consisting of one one-hundredth of a newly issued share of Preferred Stock-Fourth Series, Junior Participating at a price of $235.00 per unit or, in certain circumstances, common stock. Under certain circumstances, Rights beneficially owned by an acquiring person become null and void. Sprint's Preferred Stock-Fourth Series is without par value. It is voting, cumulative and accrues dividends equal generally to the greater of $10.00 per share or 200 times the aggregate per share amount of all common stock dividends. No shares of Preferred Stock-Fourth Series were issued or outstanding at December 31, 1995. The Rights may be redeemed by Sprint at a price of $0.01 per Right and will expire on September 8, 1999.\nDuring 1995, 1994 and 1993, Sprint declared and paid annual dividends on common stock of $1.00 per share, and Centel declared pre-merger (see Note 10) common stock dividends of $0.15 per share during 1993. The most restrictive covenant applicable to dividends on common stock results from the $1.5 billion revolving credit agreement. Among other restrictions, this agreement requires Sprint to maintain specified levels of consolidated net worth, as defined. As a result of this requirement, $1.9 billion of Sprint's $2.8 billion consolidated retained earnings were effectively restricted from the payment of dividends as of December 31, 1995. The indentures and financing agreements of certain of Sprint's subsidiaries contain various provisions restricting the payment of cash dividends on subsidiary common stock held by Sprint. In connection with these restrictions, $192 million of the related subsidiaries' $653 million total retained earnings is restricted as of December 31, 1995. The flow of cash in the form of advances from the subsidiaries to Sprint is generally not restricted.\n9. Commitments and Contingencies\nLitigation, Claims and Assessments\nFollowing announcement in 1992 of Sprint's merger agreement with Centel (see Note 10), class action suits were filed against Centel and certain of its officers and directors in federal and state courts. The state suits have been dismissed, while the federal suits have been consolidated into a single action which seeks damages for alleged violations of securities laws. On October 12, 1995, the New York trial court granted the motion of Centel's financial advisors to dismiss a purported class action suit filed against them in connection with their representation of Centel in the merger. The plaintiffs have appealed from the order dismissing their claims. Sprint may have indemnification obligations to the financial advisors in connection with this suit. Various other suits arising in the ordinary course of business are pending against Sprint. Management cannot predict the ultimate outcome of these actions but believes they will not result in a material effect on Sprint's consolidated financial statements.\nAccounts Receivable Sold with Recourse\nUnder an agreement available through December 1996, Sprint could sell on a continuous basis, with recourse, up to $600 million of undivided interests in a designated pool of its accounts receivable. Subsequent collections of receivables sold to investors were typically reinvested in the pool. Sprint was required to repurchase the designated pool of accounts receivable only upon the occurrence of specified events involving non-collectibility of accounts. As of December 31, 1995, Sprint had not been required to repurchase receivables\n9. Commitments and Contingencies (continued)\nunder this recourse provision. Because Sprint retained credit losses associated with its accounts receivable, any exposure related to this retention was estimated in conjunction with Sprint's calculation of its reserve for uncollectible accounts. Receivables sold that remained uncollected as of December 31, 1995 and 1994 aggregated $600 million. In January 1996, Sprint elected to terminate this agreement.\nCommitments\nSee \"Liquidity and Capital Resources\" in \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" for a discussion of cash commitments associated with Sprint Spectrum.\nOperating Leases\nMinimum rental commitments as of December 31, 1995 for all noncancelable operating leases, consisting principally of leases for data processing equipment and real estate, are as follows (in millions):\nGross rental expense aggregated $402 million in 1995, $379 million in 1994 and $382 million in 1993. The amount of rental commitments applicable to subleases, contingent rentals and executory costs is not significant.\n10. Sprint \/ Centel Merger\nEffective March 9, 1993, Sprint consummated its merger with Centel, a telecommunications company with local exchange and cellular and wireless communications services operations. Pursuant to the merger agreement dated May 27, 1992, Sprint issued 1.37 shares of its common stock in exchange for each outstanding share of Centel common stock, or approximately 119 million shares. The transaction costs associated with the merger (consisting primarily of investment banking and legal fees) and the expenses of integrating and restructuring the operations of the two companies (consisting primarily of employee severance and relocation expenses and costs of eliminating duplicative facilities) resulted in nonrecurring charges of $259 million, which reduced 1993 income from continuing operations by $172 million ($0.50 per share). The merger was accounted for as a pooling of interests.\n11. Additional Financial Information\nSegment Information\nInformation related to Sprint's operating business segments is included in the tables in \"Segmental Results of Operations\" of \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\" The net operating revenues and operating expenses shown in such tables include revenues and expenses eliminated in consolidation totaling $ 380 million, $340 million and $296 million for the years ended December 31, 1995, 1994 and 1993, respectively. Sprint incurred capital expenditures of $37 million, $57 million and $46 million for the years ended December 31, 1995, 1994 and 1993, respectively, and had assets, including the net assets of the discontinued cellular division, of $2.9 billion, $1.8 billion and $1.8 billion at December 31, 1995, 1994 and 1993, respectively, not attributable to operating segments. Additionally, Sprint incurred $54 million of merger, integration and restructuring costs not attributable to its segmental operations for the year ended December 31, 1993.\nRealignment and Restructuring Charge\nDuring 1995, Sprint initiated a realignment and restructuring of its local communications services division, including the elimination of approximately 1,600 positions primarily in the network and finance functions. These actions resulted in a nonrecurring charge of $88 million, which reduced income from continuing operations by $55 million ($0.16 per share). The accrued liability associated with this charge specifically relates to the benefits that affected employees will receive upon termination.\nDuring 1993, Sprint initiated a realignment and restructuring of its long distance communications services division, including the elimination of approximately 1,000 positions and the closure of two facilities. These actions resulted in a nonrecurring charge of $34 million, which reduced income from continuing operations by $21 million ($0.06 per share).\nConcentrations of Credit Risk\nSprint's accounts receivable are not subject to any concentration of credit risk. Interest rate swap agreements and foreign currency contracts involve the risk of dealing with counterparties and their ability to meet the terms of the contracts. Notional principal amounts often are used to express the volume of these transactions, but the amounts subject to credit risk are significantly smaller. In the event of nonperformance by the counterparties, Sprint's accounting loss would be limited to the net amount that it would be entitled to receive under the terms of the applicable interest rate swap agreement or foreign currency contract. However, Sprint does not anticipate nonperformance by any of the counterparties with which it has such agreements. Sprint controls the amount of credit risk as well as the concentration of credit risk of its interest rate swap agreements and foreign currency contracts through credit approvals, dollar exposure limits and internal monitoring procedures.\n11. Additional Financial Information (continued)\nFinancial Instruments\nSprint estimates the fair value of its financial instruments using available market information and appropriate valuation methodologies. Accordingly, the estimates presented herein are not necessarily indicative of the values Sprint could realize in a current market exchange. Although management is not aware of any factors that would affect the estimated fair value amounts presented as of December 31, 1995, such amounts have not been comprehensively revalued for purposes of these financial statements since that date and, therefore, estimates of fair value subsequent to that date may differ significantly from the amounts presented herein. The carrying amounts and estimated fair values of Sprint's financial instruments, as of December 31, are as follows (in millions):\nThe carrying values of Sprint's cash equivalents approximate fair value as of December 31, 1995 and 1994. The fair value of Sprint's investments in equity securities are estimated by reference to quoted market prices. The fair values of Sprint's long-term debt are estimated based on quoted market prices for publicly traded issues, and the present value of estimated future cash flows using a discount rate commensurate with the risks involved for all other issues. The fair value of interest rate swap agreements is estimated as the cost that Sprint would receive (pay) to terminate the swap agreements at December 31, 1995 and 1994, taking into account the then-current interest rates. The fair value of foreign currency contracts is estimated as the replacement cost of the contracts at December 31, 1995 and 1994, taking into account the then-current foreign currency exchange rates.\nInterest Rate Swap Agreements\nInterest rate swap agreements are utilized by Sprint as part of its interest rate risk management program. Net interest paid or received related to such agreements is recorded using the accrual method and is recorded as an adjustment to interest expense. Sprint had interest rate swap agreements with notional amounts of $275 million and $125 million outstanding at December 31, 1995 and 1994, respectively. Net interest (income) expense related to interest rate swap agreements was ($400,000), $1 million and $2 million for the years ended December 31, 1995, 1994 and 1993, respectively. There were no deferred gains or losses relating to any terminated interest rate swap agreements at December 31, 1995, 1994 and 1993.\n11. Additional Financial Information (continued)\nForeign Currency Contracts\nAs part of its foreign currency exchange risk management program, Sprint purchases and sells over-the-counter forward contracts and options in various foreign currencies. Sprint had outstanding approximately $13 million of open forward contracts to buy various foreign currencies at both December 31, 1995 and 1994. Sprint had no outstanding open forward contracts to sell various foreign currencies at December 31, 1995 and $1 million outstanding at December 31, 1994. Sprint had approximately $24 million of outstanding open purchase option contracts to call various foreign currencies at December 31, 1995. The premium paid for an option is amortized over the life of the option. The unamortized premiums paid for options outstanding at December 31, 1995 were $300,000. There were no foreign currency option contracts outstanding at December 31, 1994. The forward contracts open at December 31, 1995 all had an original maturity of six months or less. The net gain or loss recorded to reflect the fair value of such contracts is recorded in the period incurred. Total net losses of $1 million, $2 million and $1 million were recorded related to foreign currency transactions and contracts for the years ended December 31, 1995, 1994 and 1993, respectively.\nAt December 31, 1995, 1994 and 1993, Sprint had foreign currency translation gains (losses) of ($10) million, $1 million and $2 million, respectively, included in \"Other, net\" in the Consolidated Statements of Common Stock and Other Shareholders' Equity.\n12. Subsequent Event\nOn January 31, 1996, Sprint, along with Deutsche Telekom (DT) and France Telecom (FT), consummated their joint venture, operating as Global One, which will provide seamless global telecommunications services to business, consumer and carrier markets worldwide. Upon closing of the agreement, DT and FT acquired shares of a new class of preference stock for a total of $3.0 billion, which resulted in DT and FT each holding approximately 7.5 percent of the Sprint voting power. DT and FT will make the remainder of their investment in Sprint following the spin-off of Cellular. Following their full investment, DT and FT will each own shares of Class A common stock with approximately 10 percent of Sprint's voting power. Depending on the price of Cellular shares at the time of the spin-off, the total amount of the investment is expected to be between $3.5 billion and $3.7 billion.\nAssuming the $3.0 billion of proceeds from the issuance of the Class A preference stock was initially used to the extent possible to repay debt outstanding at December 31, 1995, and such issuance and repayment is assumed to have taken place as of January 1, 1995, Sprint's earnings per share from continuing operations would have decreased from $2.69 per share to $2.52 per share for the year ended December 31, 1995.\nSPRINT CORPORATION SCHEDULE II -- CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS Years Ended December 31, 1995, 1994 and 1993 (In Millions)\nQUARTERLY FINANCIAL DATA (Unaudited)\n(1) The accompanying Quarterly Financial Data have been restated from previously reported amounts to reflect the spin-off of Sprint's cellular and wireless division (Cellular) to shareholders of Sprint common stock. Accordingly, Cellular's operating results have been excluded from income from continuing operations and are reported as discontinued operations.\n(2) During fourth quarter 1995, nonrecurring charges of $88 million were recorded related to a restructuring within the local communications division. Such charges reduced net income by $55 million ($0.16 per share). See Note 11 of Notes to Consolidated Financial Statements for additional information.\n(3) During first quarter 1994, Sprint sold an investment in equity securities, realizing a gain of $35 million, which increased net income by $22 million ($0.06 per share).\n(4) During fourth quarter 1995, Sprint adopted accounting principles for a competitive marketplace for its local communications division and discontinued the application of SFAS No. 71. As a result, Sprint recorded a noncash, after-tax extraordinary charge of $565 million ($1.61 per share). See Note 2 of Notes to Consolidated Financial Statements for additional information.\nEXHIBIT INDEX\nEXHIBIT NUMBER\n(3) Articles of Incorporation and Bylaws:\n(a) Articles of Incorporation, as amended (filed as Exhibit 4A to Sprint Corporation Current Report on Form 8-K dated January 31, 1996 and incorporated herein by reference).\n(b) Bylaws, as amended (filed as Exhibit 4B to Sprint Corporation Current Report on Form 8-K for the year ended January 31, 1996 and incorporated herein by reference).\n(4) Instruments defining the Rights of Sprint's Equity Security Holders:\n(a) The rights of Sprint's equity security holders are defined in the Fifth, Sixth, Seventh and Eighth Articles of Sprint's Articles of Incorporation. See Exhibit 3(a).\n(b) Rights Agreement dated as of August 8, 1989, between Sprint Corporation (formerly United Telecommunications, Inc.) and UMB Bank, n.a. (formerly United Missouri Bank of Kansas City, N.A.), as Rights Agent (filed as Exhibit 2(b) to Sprint Corporation Registration Statement on Form 8-A dated August 11, 1989 (File No. 1-4721), and incorporated herein by reference).\n(c) Amendment and supplement dated June 4, 1992 to Rights Agreement dated as of August 8, 1989 (filed as Exhibit 2(c) to Amendment No. 1 on Form 8 dated June 8, 1992 to Sprint Corporation Registration Statement on Form 8-A dated August 11, 1989 (File No. 1-4721), and incorporated herein by reference).\n(d) Second Amendment to Rights Agreement dated as of July 31, 1995 between Sprint Corporation and UMB Bank, n.a. (filed as Exhibit 2(d) to Form 8-A\/A-2 dated October 20, 1995 amending Sprint Corporation Registration Statement on Form 8-A dated August 11, 1989 (File No. 1-4721) and incorporated herein by reference).\n(e) Standstill Agreement dated as of July 31, 1995, by and among Sprint Corporation, France Telecom and Deutsche Telekom AG (filed as Exhibit (10)(c) to Sprint Corporation Quarterly Report on Form 10-Q for the quarter ended June 30, 1995 and incorporated herein by reference).\n(10) Material Agreements - Joint Ventures:\n(a) Joint Venture Agreement dated as of June 22, 1995 among Sprint Corporation, Sprint Global Venture, Inc., France Telecom and Deutsche Telekom AG (filed as Exhibit (10)(a) to Sprint Corporation Quarterly Report on Form 10-Q for the quarter ended June 30, 1995 and incorporated herein by reference).\n(b) Amendment No. 1 to Joint Venture Agreement, dated as of January 31, 1996, among Sprint Corporation, Sprint Global Venture, Inc., France Telecom, Deutsche Telekom AG and Atlas Telecommunications, S.A. (filed as Exhibit 99A to Sprint Corporation Current Report on Form 8-K dated January 31, 1996 and incorporated herein by reference).\n(c) Investment Agreement dated as of July 31, 1995 among Sprint Corporation, France Telecom and Deutsche Telekom AG (including as an exhibit the Stockholders' Agreement among France Telecom, Deutsche Telekom AG and Sprint Corporation) (filed as Exhibit (10)(b) to Sprint Corporation Quarterly Report on Form 10-Q for the quarter ended June 30, 1995 and incorporated herein by reference).\n(d) Amended and Restated Agreement of Limited Partnership of MajorCo., L.P., dated as of January 31, 1996, among Sprint Spectrum, L.P., TCI Network Services, Comcast Telephony Services and Cox Telephony Partnership (filed as Exhibit 99C to Sprint Corporation Current Report on Form 8-K dated January 31, 1996 and incorporated herein by reference).\n(e) Parents Agreement dated as of January 31, 1996, between Sprint Corporation and Tele-Communications, Inc. (filed as Exhibit 99D to Sprint Corporation Current Report on Form 8-K dated January 31, 1996 and incorporated herein by reference).\n(f) Parents Agreement dated as of January 31, 1996, between Sprint Corporation and Comcast Corporation (filed as Exhibit 99E to Sprint Corporation Current Report on Form 8-K dated January 31, 1996 and incorporated herein by reference).\n(g) Parents Agreement dated as of January 31, 1996, between Sprint Corporation and Cox Communications, Inc. (filed as Exhibit 99F to Sprint Corporation Current Report on Form 8-K dated January 31, 1996 and incorporated herein by reference).\n(10) Executive Compensation Plans and Arrangements\n(h) 1985 Stock Option Plan, as amended (filed as Exhibit (10)(c) to Sprint Corporation Quarterly Report on Form 10-Q for the quarter ended September 30, 1995 and incorporated herein by reference). Appendix to Stock Option Plans.\n(i) 1990 Stock Option Plan, as amended (filed as Exhibit (10)(d) to Sprint Corporation Quarterly Report on Form 10-Q for the quarter ended September 30, 1995 and incorporated herein by reference). Appendix to Stock Option Plans. See Exhibit (10)(h).\n(j) 1990 Restricted Stock Plan, as amended (filed as Exhibit 99 to Sprint Corporation Registration Statement No. 33-65147 and incorporated herein by reference).\n(k) Executive Deferred Compensation Plan, as amended.\n(l) Management Incentive Stock Option Plan, as amended (filed as Exhibit (10)(g) to Sprint Corporation Quarterly Report on Form 10-Q for the quarter ended September 30, 1995 and incorporated herein by reference). Appendix to Stock Option Plans. See Exhibit (10)(h).\n(m) Long-Term Stock Incentive Program, as amended (filed as Exhibit (10)(h) to Sprint Corporation Quarterly Report on Form 10-Q for the quarter ended September 30, 1995 and incorporated herein by reference).\n(n) Sprint Supplemental Executive Retirement Plan (filed as Exhibit (10)(i) to Sprint Corporation Quarterly Report on Form 10-Q for the quarter ended September 30, 1995 and incorporated herein by reference).\n(o) Amended and Restated Centel Directors Deferred Compensation Plan (filed as Exhibit (10)(j) to Sprint Corporation Quarterly Report on Form 10-Q for the quarter ended September 30, 1995 and incorporated herein by reference).\n(p) Restated Memorandum Agreements Respecting Supplemental Pension Benefits between Sprint Corporation (formerly United Telecommunications, Inc.) and two of its current and former executive officers (filed as Exhibit 10(i) to Sprint Corporation Annual Report on Form 10-K for the year ended December 31, 1992, and incorporated herein by reference).\n(q) Executive Long-Term Incentive Plan (filed as Exhibit 10(j) to Sprint Corporation Annual Report on Form 10-K for the year ended December 31, 1993 and incorporated herein by reference).\n(r) Executive Management Incentive Plan (filed as Exhibit 10(k) to Sprint Corporation Annual Report on Form 10-K for the year ended December 31, 1993 and incorporated herein by reference).\n(s) Long-Term Incentive Compensation Plan (filed as Exhibit 10(j) to United Telecommunications, Inc. Annual Report on Form 10-K for the year ended December 31, 1989, and incorporated herein by reference).\n(t) Short-Term Incentive Compensation Plan (filed as Exhibit 10(k) to United Telecommunications, Inc. Annual Report on Form 10-K for the year ended December 31, 1989, and incorporated herein by reference).\n(u) Retirement Plan for Directors, as amended (filed as Exhibit 10(b) to Sprint Corporation Quarterly Report on Form 10-Q for the quarter ended March 31, 1994 and incorporated herein by reference).\n(v) Key Management Benefit Plan, as amended (filed as Exhibit 10(o) to Sprint Corporation Annual Report on Form 10-K for the year ended December 31, 1993 and incorporated herein by reference).\n(w) Agreements Regarding Special Compensation and Post Employment Restrictive Covenants between Sprint Corporation and one of its Executive Officers.\n(x) Director's Deferred Fee Plan, as amended.\n(y) Form of Contingency Employment Agreements between Sprint Corporation and certain of its executive officers (filed as Exhibit 10(b) to Sprint Corporation Quarterly Report on Form 10-Q for the year ended March 31, 1995, and incorporated herein by reference).\n(z) Form of Indemnification Agreements between Sprint Corporation (formerly United Telecommunications, Inc.) and its Directors and Officers (filed as Exhibit 10(s) to Sprint Corporation Annual Report on Form 10-K for the year ended December 31, 1991, and incorporated herein by reference).\n(aa) Summary of Executive Officer and Board of Directors Benefits.\n(bb) Agreements Regarding Special Compensation and Post Employment Restrictive Covenants between Sprint Corporation and four of its executive officers (filed as Exhibit 10(d) to Sprint Corporation Quarterly Report on Form 10-Q for the quarter ended September 30, 1994 and incorporated herein by reference).\n(cc) Amended and Restated Centel Stock Option Plan (filed as Exhibit 10(w) to Sprint Corporation Annual Report on Form 10-K for the year ended December 31, 1994 and incorporated herein by reference). Appendix to Stock Option Plans. See Exhibit (10)(h).\n(dd) Agreements Regarding Special Compensation and Post Employment Restrictive Covenants between Sprint Corporation and three of its executive officers (filed as Exhibit 10(x) to Sprint Corporation Annual Report on Form 10-K for the year ended December 31, 1993, and incorporated herein by reference).\n(ee) Description of agreement regarding Supplemental Pension Benefits between Sprint Corporation and one of its executive officers (filed as Exhibit 10(e) to Sprint Corporation Quarterly Report on Form 10-Q for the quarter ended September 30, 1994, and incorporated herein by reference).\n(ff) Amended and Restated Centel Director Stock Option Plan (filed as Exhibit 10(aa) to Sprint Corporation Annual Report on Form 10-K for the year ended December 31, 1993, and incorporated herein by reference).\n(11) Computation of Earnings Per Common Share.\n(12) Computation of Ratio of Earnings to Fixed Charges.\n(21) Subsidiaries of Registrant.\n(23) Consent of Ernst & Young LLP.\n(27) Financial Data Schedules:\n(a) 1995 Financial Data Schedule.\n(b) Restated 1994 Financial Data Schedule.","section_15":""}
{"filename":"724176_1995.txt","cik":"724176","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nIn connection with the tender offer by YPFA Corp. and Merger, a number of holders of Common Stock sued in the Chancery Court of the State of Delaware. In the various complaints, the plaintiffs purported to sue individually and on behalf of classes comprised of the holders of shares of Common Stock, stockholders of the Company or all holders of the Company's securities. The complaints named as defendants the Company, the directors and certain of the officers of the Company, a former director of the Company and, with respect to some of the complaints, YPF, and alleged, among other things, that the defendant directors and officers of the Company breached their fiduciary duties in approving the Offer and the Merger and that YPF aided and abetted the alleged breach of duties. The plaintiffs purported to seek orders enjoining the consummation of the Offer and the Merger (or the rescission of those transactions) or, in the alternative, an accounting for any damages to the alleged classes, together with their attorneys' fees and other relief. These lawsuits were consolidated into one action and, in September 1995, were settled with no payment to the class members. However, as a part of the settlement, the Company was ordered to pay $800,000 in attorneys' fees to the plaintiffs' class counsel.\nIn November 1995, OxyChem filed suit in Texas state court seeking a declaration of certain of the parties' rights and obligations under the sales agreement pursuant to which the Company sold Chemicals to Occidental. Henkel joined in said lawsuit as a plaintiff in January 1996. Specifically, OxyChem and Henkel are seeking a declaration that the Company is required to indemnify them for 50% of certain environmental costs incurred on projects involving remedial activities relating to chemical plant sites or other property used in connection with the business of Chemicals on the Closing Date which relate to, result from or arise out of conditions, events or circumstances discovered by OxyChem or Henkel and as to which the Company is provided written notice by OxyChem or Henkel prior to the expiration of ten years following the Closing Date, irrespective of when OxyChem or Henkel incurs and gives notice of such costs, subject to an aggregate $75 million cap. The Company believes that this lawsuit is without merit and intends to defend same vigorously.\nAs of December 31, 1995, the Company had paid OxyChem and Henkel a total of approximately $39 million against said $75 million cap. The Company cannot predict what portion of the approximately $36 million remaining as of that date Occidental and Henkel may actually pay or incur prior to September 4, 1996, the tenth anniversary of the Closing Date, if they accelerate spending with respect to such environmental costs.\nSee also the heading \"Health, Safety and Environmental Controls\" under \"Items 1 and 2. Business and Properties\" of this report for a description of certain other legal proceedings, which description is incorporated herein by reference.\nThe Company is involved in various other legal proceedings incidental to its business, the outcome of any of which should not have a material adverse effect on its financial position.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS.\nInapplicable.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nThere is no established public trading market for the Common Stock. At March 1, 1996, YPF was the sole holder of record of the Common Stock.\nMidgard and Maxus Indonesia, Inc., subsidiaries of the Company, are parties to separate credit agreements which places certain restrictions on the ability of these subsidiaries to make or declare certain payments, advances and loans specified therein, including dividends to the Company. (For a further description of these credit agreements, see \"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations--Significant Events 1995\"). While these restrictions could impact the ability of the Company to pay dividends on its Common Stock, the Company has paid no such dividends since 1987, and cash flows are currently being dedicated to exploration and development projects rather than to such payment. The Company intends to continue paying regular quarterly dividends on its $4.00 Preferred Stock, $9.75 Cumulative Convertible Preferred Stock (\"$9.75 Preferred Stock\") and $2.50 Preferred Stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nFIVE-YEAR FINANCIAL SUMMARY (DOLLARS IN MILLIONS, EXCEPT FOR PER SHARE DATA)\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nSignificant Events 1995\nOn June 8, 1995, a special meeting of the stockholders of Maxus Energy Corporation (the \"Company\" or \"Maxus\") was held to approve the Agreement of Merger (\"Merger Agreement\") dated February 28, 1995, between the Company, YPF Acquisition Corp. (the \"Purchaser\" or \"YPFA Corp.\") and YPF Sociedad Anonima (\"YPF\"). The holders of the Company's common stock, $1.00 par value per share (the \"Shares\"), and $4.00 Cumulative Convertible Preferred Stock (the \"$4.00 Preferred Stock\" and together with the Shares, the \"Voting Shares\") approved the Merger Agreement, and the Purchaser was merged into the Company (the \"Merger\") on June 8, 1995 (the \"Merger Date\").\nPursuant to the Merger Agreement, a tender offer (the \"Offer\") was commenced on March 6, 1995 by the Purchaser for all the outstanding Shares at $5.50 per Share. Pursuant to the Offer, in April 1995 the Purchaser acquired 120,000,613 Shares representing approximately 88.5% of the then-outstanding Shares of the Company. As a result of the Merger, each outstanding Share (other than Shares held by the Purchaser, YPF or any of their subsidiaries or in the treasury of the Company, all of which were cancelled in the second quarter of 1995, and Shares of holders who perfected their appraisal rights under Section 262 of the Delaware General Corporation Law) was converted into the right to receive $5.50 in cash, and YPF became the sole holder of all outstanding Shares. The Company's preferred stock, consisting of the $4.00 Preferred Stock, $2.50 Cumulative Preferred Stock (the \"$2.50 Preferred Stock\") and $9.75 Cumulative Convertible Preferred Stock (the \"9.75 Preferred Stock\"), remain outstanding. YPF currently owns approximately 96.9% of the outstanding Voting Shares.\nThe total amount of funds required by the Purchaser to acquire the entire common equity interest in the Company, including the purchase of Shares pursuant to the Offer and the payment for Shares converted into the right to receive cash pursuant to the Merger, was approximately $762 million. On April 5, 1995, the Purchaser entered into a credit agreement (the \"Credit Agreement\") with lenders for which The Chase Manhattan Bank (National Association) (\"Chase\") acted as agent, pursuant to which the lenders extended to the Purchaser a credit facility for up to $550 million (the \"Purchaser Facility\"). On April 5, 1995, the Purchaser borrowed $442 million under the Purchaser Facility and received a capital contribution of $250 million from YPF. The Purchaser used borrowings under the Purchaser Facility and the funds contributed to it by YPF to purchase 120,000,613 Shares pursuant to the Offer. Subsequent to the Merger, these Shares and all other outstanding Shares vested in YPF.\nFollowing the Merger, Chase provided two additional credit facilities aggregating $425 million: (i) a credit facility of $250 million extended to Midgard Energy Company (\"Midgard\"), a wholly owned subsidiary of the Company, and (ii) a credit facility of $175 million extended to Maxus Indonesia, Inc. (\"Holdings\"), a wholly owned subsidiary of the Company. The proceeds of the loans made pursuant to these facilities were used to repay, in part, the Purchaser Facility, which was assumed by the Company pursuant to the Merger. In addition, the Company applied $8 million of its available cash to repayment of the Purchaser Facility and used approximately $86 million of its available cash to pay holders of Shares converted into the right to receive cash in the Merger.\nEffective April 1, 1995, the Company used the purchase method of accounting to record the acquisition of the Company by YPF. In a purchase method combination, the purchase price is allocated to the acquired assets and assumed liabilities based on their fair values at the date of acquisition. As a result, the assets and liabilities of the Company were revalued to reflect the approximate $762 million cash purchase price paid by YPF to acquire the Company. The Company's oil and gas properties were assigned carrying amounts based on their relative fair market values. The Company's pre-Merger Consolidated Balance Sheet as of March 31, 1995, together with the purchase method accounting adjustments, became the Company's opening post-Merger Consolidated Balance Sheet on April 1, 1995. Because of these purchase adjustments, which were effected April 1, 1995, the Company's financial statements for the nine-month period ended December 31, 1995, are not comparable to such statements for prior periods. Accordingly, separate financial statements for periods prior to April 1, 1995 and for the nine-month period ended December 31, 1995 are presented.\nSignificant Events 1994\nMaxus responded to many financial and operational challenges in 1994 which culminated with the Company's agreement to merge with YPF in 1995.\nFinancially, significant natural gas and crude oil price declines in 1994 contributed to Maxus' decision to streamline operations by decreasing overhead and operating expenses, lowering program spending and redeeming certain preferred stock. During the second quarter of 1994, the Company also sold its interest in Diamond Shamrock Offshore Partners Limited Partnership (\"Offshore Partners\") and certain producing oil and gas properties in Maxus' U.S. Southern Division for $325 million net (\"the Divested Properties\"). Additionally, the Company sold its geothermal subsidiary, Thermal Power Company, for approximately $58 million net in cash and a note for $6.5 million. A portion of the proceeds from these sales was used to reduce debt and redeem 625,000 shares of the $9.75 Preferred Stock for $63 million.\nOperationally, the Company initiated production from all three of Maxus' South American operations--Ecuador, Bolivia and Venezuela. The Sunray gas plant experienced its first full year of operation and achieved the operating efficiencies and cost savings (approximately $14 million annually) that had been anticipated. Additionally, net production from the Northwest Java gas project averaged approximately 44 million cubic feet per day (\"mmcfpd\") during 1994, resulting in $30 million of additional revenues.\nResults for the Nine Months Ended December 31, 1995\nFor the nine months ended December 31, 1995, Maxus reported a net loss of $74 million. Comparative information for the nine months ended December 31, 1994, is not presented due to the Merger with YPF which was effective April 1, 1995.\nSales and Operating Revenues. Sales and operating revenues for the nine months ended December 31, 1995, were $464 million composed of $298 million from Maxus' Indonesian operations, $129 million from U.S. operations and $37 million from South American operations.\nMaxus' net worldwide crude oil sales volumes were 64 thousand barrels per day (\"mbpd\") during the nine-month period ended December 31, 1995, which were comprised of 53 mbpd from Maxus' Indonesian operations, 10 mbpd from South American operations and one mbpd from U.S. operations. Maxus' net worldwide crude oil sales volumes increased from 60 mbpd in the third quarter of 1995 to 73 mbpd in the fourth quarter of 1995 due primarily to the recognition of cumulative year-to-date production from the Southern Amo Field in Ecuador in the fourth quarter of 1995, as this production had not previously been approved by the Ecuadorian government, and the sole crude oil sale in Bolivia in October 1995. Despite natural declines in gross crude oil production in Indonesia over the nine months ended December 31, 1995, Indonesian crude oil sales volumes increased slightly due primarily to higher cost recovery. During the nine months ended December 31, 1995, Maxus' average worldwide crude oil price was $16.31 per barrel.\nDuring the nine-month period ended December 31, 1995, U.S. natural gas sales volumes were 172 mmcfpd and U.S. natural gas prices averaged $1.49 per thousand cubic feet (\"mcf\"). Although U.S. natural gas sales volumes remained relatively flat over the nine months ended December 31, 1995, the success of the 1995 Midgard infill drilling program offset the natural declines from the area. In the future, Maxus expects its Midgard infill drilling program to continue to offset any natural declines. U.S. natural gas prices rose from $1.40 per mcf in the third quarter of 1995 to $1.64 per mcf in the fourth quarter of 1995 which favorably impacted revenues $4 million. During the nine-month period ended December 31, 1995, Northwest Java natural gas sales volumes were 61 mmcfpd and Northwest Java natural gas prices averaged $2.62 per mcf.\nNatural gas liquids sales volumes in the U.S. were 18 mbpd and U.S. natural gas liquids prices averaged $10.49 per barrel.\nCosts and Expenses. Costs and expenses were $536 million during the nine months ended December 31, 1995. Costs and expenses during this period included operating expenses of $174 million; gas purchase costs of\n$41 million; exploration expenses of $51 million; depreciation, depletion and amortization (\"DD&A\") of $142 million; interest and debt expenses of $105 million and other costs and expenses totaling $23 million.\nDD&A of $142 million during the nine-month period ended December 31, 1995, included $43 million of additional DD&A reflecting the impact of the purchase price allocation which increased the book value of the Company's oil and gas properties and equipment. The book value of oil and gas properties and equipment increased approximately $1.3 billion as a result of the purchase price allocation.\nIn the nine-month period ended December 31, 1995, interest and debt expenses of $105 million included $27 million of interest expense associated with the Purchaser Facility and, Midgard and Holdings credit facilities. Also included in interest and debt expenses during this period was $6 million of interest associated with the accretion of discount on the Company's long-term debt which was outstanding prior to the Merger. These borrowings were recorded at their fair market value in the purchase method of accounting which resulted in a reduction in their carrying value of $115 million. This reduction in carrying value will be amortized to interest expense over the remaining term of the borrowings.\nOther Revenues, Net. During the nine months ended December 31, 1995, other revenues, net were $7 million which included $10 million of interest income, a $2 million gain which represented the final settlement of the Company's sole interest rate swap agreement prior to its termination and a $2 million gain recognized on the sale of U.S. Treasury notes partially offset by a $3 million production bonus payment stemming from the Company's Indonesian operations and $5 million of accrued expenses. In the future, the Company anticipates recognizing less interest income as a result of maintaining only minimal balances of cash, cash equivalents and short-term investments to cover working capital fluctuations. Capital contributions from YPF are expected to cover any additional funding needs.\nIncome Taxes. Income tax expense of $9 million for the nine-month period ended December 31, 1995, included $63 million of current foreign income tax expense primarily from Indonesian operations partially offset by a $49 million deferred tax benefit due primarily to the higher DD&A associated with the increase in book value of the Company's oil and gas properties and equipment as a result of the purchase price allocation. In addition, the Company received $5 million of interest income on U.S. federal income tax refunds. This interest income was not previously accrued in prior periods. In the future, the Company expects to realize additional deferred tax benefits as a result of the higher DD&A.\nComparison of Results\nThree Months Ended March 31, 1995 vs. Three Months Ended March 31, 1994\nMaxus reported a net loss of $57 million for the first quarter of 1995 compared to a net loss of $11 million for the first quarter of 1994. The first quarter 1995 results reflect $42 million of pre-Merger costs incurred by the Company prior to the Merger. Such costs included expenses associated with financial consulting and legal services, severance payments pursuant to change of control agreements and payments for surrender of stock options and restricted stock.\nSales and Operating Revenues. Sales and operating revenues for the first quarter of 1995 were $143 million, compared to $187 million for the same 1994 period. The loss of production from the Divested Properties which were sold in the second quarter of 1994 and lower volumes of purchased gas accounted for $45 million of the revenue decline. Additionally, U.S. natural gas prices fell, which also unfavorably impacted revenues $12 million for the three months ended March 31, 1995. These declines were partially offset by first quarter 1995 revenue of $8 million from South America. Initial sales from the Company's South American operations were recorded in the third quarter 1994.\nNet worldwide crude oil production was 60 mbpd in the first quarter 1995, compared to 69 mbpd in the same quarter a year ago. Domestic crude oil volumes declined four mbpd during the period due to the loss of production from the Divested Properties resulting in lower revenues of $5 million. Crude oil sales from the Company's Indonesian operations were also down 12 mbpd during the period primarily as a result of lower entitlements due to higher crude oil sales prices and lower production. Offsetting these declines, production from South America of seven mbpd provided an additional $8 million of revenues in 1995.\nU. S. natural gas sales for the first quarter of 1995 were 167 mmcfpd, a decrease of 208 mmcfpd as compared to the first quarter 1994 resulting in lower revenues of $42 million. The decline was driven by the loss of production from the Divested Properties and lower volumes of gas purchased for resale. The average gas price received in the U. S. was $1.45 per mcf in the first quarter 1995 as compared to $2.24 per mcf in the same 1994 period.\nNorthwest Java natural gas volumes of 40 mmcfpd in the first quarter 1995 were eight mmcfpd higher than the first quarter 1994. Natural gas sales prices improved to an average of $2.65 per mcf during the first quarter 1995 from $1.81 per mcf during the same period last year due to the change in contract terms which increased the price received for \"old\" gas production from $0.20 per mcf to $2.65 per mcf effective January 1, 1995. The higher Northwest Java natural gas volumes coupled with the higher average natural gas price resulted in increased revenues of $4 million in the first quarter of 1995.\nNatural gas liquids sales in the U. S. for the first quarter 1995 were 18 mbpd, a slight decrease over first quarter last year. The average sales price for U.S. natural gas liquids in the first quarter of 1995 was $10.38 per barrel, an increase of $1.15 per barrel from 1994.\nCosts and Expenses. Costs and expenses for the first quarter of 1995 were $190 million which were relatively flat compared to the first quarter of 1994. Costs and expenses for the first quarter of 1995 included Maxus pre-Merger costs of $42 million which were partially offset by lower gas purchase costs of $31 million when compared to the first quarter of 1994.\nGas purchase costs were $31 million lower in the first quarter of 1995 as compared to first quarter 1994 due to the lower volumes of gas purchased to aggregate with the production from the Divested Properties, the reduction in volumes of gas purchased for resale and lower natural gas prices.\nDD&A of $30 million for the first quarter 1995 was $8 million lower than the same period of the prior year. Approximately $11 million of this decline represents DD&A from the Divested Properties included in the first quarter of 1994. Partially offsetting this decline was $4 million of DD&A in the first quarter of 1995 associated with South American operations which did not go into production until late 1994.\nIncome Taxes. Income tax expense was $19 million and $16 million in the first quarters of 1995 and 1994, respectively. The increase in income tax expense was primarily due to higher Indonesian taxes as a result of increased taxable income from the Company's Indonesian operations.\nComparison of Results\nTwelve Months Ended December 31, 1994 vs. Twelve Months Ended December 31,\nMaxus reported a net loss of $23 million in 1994 compared to a net loss of $49 million in 1993.\nSales and Operating Revenues. Sales and operating revenues dropped 13%, or $105 million, during 1994 when compared to 1993. The loss of production from the Divested Properties and lower volumes of purchased gas which were aggregated and sold with the production from the Divested Properties accounted for $86 million of the revenue decline. Additionally, worldwide oil and gas prices fell, which further compounded the loss of revenues. However, initial production from South America and new gas production from Northwest Java added $54 million to revenues during 1994, partially offsetting the overall negative revenue variances.\nThe Company's total net crude oil production was 67 mbpd in 1994, essentially flat compared to 1993. Production from South American operations added five mbpd during 1994 and favorably impacted revenues by $24 million. Crude oil volumes in the United States declined three mbpd, resulting in a $15 million negative volume variance, primarily from the loss of production from the Divested Properties. Crude oil sales from the Company's Indonesian operations were also down approximately three mbpd ($20 million negative volume variance), primarily in Northwest Java. A portion of the 1994 decline was the result of temporary production problems, which were corrected. Also, the 1993 volumes in Northwest Java reflected additional barrels received through cost recovery due to the substantial capital outlay for the gas project, which was completed in late 1993. Maxus' 1994 average worldwide crude price hit a five-year low of $15.31 per barrel, negatively impacting income by $39 million.\nUnited States natural gas sales volumes fell from 365 mmcfpd to 275 mmcfpd in 1994 with the decline attributable to the loss of production from the Divested Properties and the decrease in purchased gas volumes which were aggregated and sold with the production from the Divested Properties. The decline was partially offset by increased sales volumes of nine mmcfpd from Midgard. United States natural gas revenues declined approximately $83 million during 1994, with $68 million occurring as a result of the Divested Properties and $14 million attributable to declining prices. Maxus' United States natural gas prices averaged $1.95 per mcf in 1994 and $2.08 per mcf in 1993.\nNorthwest Java gas volumes increased from 13 mmcfpd in 1993 to 44 mmcfpd during 1994. The Company realized an additional $30 million of revenues during 1994 from the Northwest Java gas project, which came on stream in fourth quarter 1993.\nNatural gas liquids sales in the United States increased slightly from 17.4 mbpd to 17.9 mbpd in 1994 but average prices received declined from $11.14 per barrel in 1993 to $10.07 per barrel. Overall, liquids revenues were down $5 million compared to 1993 due to the price declines.\nCosts and Expenses. Costs and expenses, excluding restructuring, were $728 million in 1994 compared to $781 million in 1993. The decline was primarily due to the elimination of expenses related to the Divested Properties.\nOverall, operating expenses were down $21 million, of which approximately $15 million related to the Divested Properties. Operating expenses declined in Indonesia as well as in the United States, but were partially offset by the additional operating expenses incurred in South America due to the start-up of production in Ecuador, Bolivia and Venezuela.\nGas purchase costs were $39 million lower than 1993 primarily as a result of lower purchased gas prices and the reduction in volumes of purchased gas which were previously aggregated and sold with the production from the Divested Properties.\nExploration expenses were $24 million lower than 1993 due to management's decision to curtail exploratory spending in new frontiers during 1994. The Company had previously announced its decision to concentrate spending in its core areas of the United States and Indonesia and its emerging areas in South America.\nDD&A declined $13 million in 1994. The Divested Properties created a $32 million favorable variance. Partially offsetting this favorable variance was a $7 million increase in DD&A in South America due to the start-up of production in Ecuador, Bolivia and Venezuela. DD&A in Indonesia was also up $13 million as a result of higher DD&A rates and additional depreciation from the Northwest Java gas project, which came on-stream in fourth quarter 1993.\nThe Company increased its reserve for environmental liabilities in 1994 by $60 million, primarily in response to the EPA's recently proposed chromium clean-up standards and for additional costs expected to be incurred at the Company's former Newark, New Jersey plant site. The 1993 environmental accrual of $18 million related to expected costs of engineering studies for the Passaic River in New Jersey and the Newark plant site.\nRestructuring. The 1994 results reflect a $101 million pre-tax net benefit from the Company's restructuring activities, which included a pre-tax gain of $202 million from the Divested Properties. This gain was partially offset by restructuring costs, including a non-cash, pre-tax $70 million write-off associated with the Company's undeveloped Alaska coal leases. The restructuring also included costs associated with staff reductions and the write-off of non-producing assets outside the Company's core areas.\nOther Revenues, Net. Other revenues, net were approximately $31 million lower in 1994 compared to 1993. This decline was due primarily to a loss of $13 million stemming from the sale of the Company's geothermal subsidiary in the third quarter of 1994 and to gains recorded on the sale of investments in U.S. Treasury notes and other securities of $12 million during 1993.\nIncome Taxes. The Company's provision for income taxes in 1994 was comprised primarily of Indonesian income tax. The 1994 Indonesian tax was $12 million less than that of 1993 as a result of lower operating profit. United States federal and state taxes increased $9 million in 1994 compared to 1993. This increase was the result of tax on asset sales, which was offset by tax benefit from the write-off of undeveloped Alaska coal leases and the favorable resolution of a federal tax refund suit.\nChange in Accounting Principle. In 1993, Maxus adopted Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits,\" which requires an accrual method of recognizing postemployment benefits. The Company recognized a one-time charge of $4 million to recognize the cumulative effect of the change in accounting for postemployment benefits.\nExtraordinary Item. During 1993, the Company recorded an extraordinary loss of $7 million after tax, representing call premium and unamortized issuance costs for the early retirement of debt. Approximately $115 million of outstanding 11 1\/4% sinking fund debentures were redeemed at 105.329% of the principal amount.\nLiquidity and Capital Resources\nLiquidity refers to the ability of an enterprise to generate adequate amounts of cash to satisfy its financial needs. Maxus' primary needs for cash are to fund its exploration and development program, service debt, pay existing trade obligations, meet redemption obligations on redeemable preferred stock and pay dividends to preferred stockholders. The Company's primary sources of liquidity have been from operating activities, asset sales, debt financing and equity issuances.\nPursuant to the Merger Agreement, in the event that the Company is unable to meet its obligations as they come due, whether at maturity or otherwise, including, solely for the purposes of this undertaking, dividend and redemption payments with respect to the $9.75 Preferred Stock, the $4.00 Preferred Stock and the $2.50 Preferred Stock, YPF has agreed to capitalize the Company in an amount necessary to permit the Company to meet such obligations; provided that YPF's aggregate obligation will be: (i) limited to the amount of debt service obligations under the Purchaser Facility, the Midgard credit facility and the Holdings credit facility and (ii) reduced by the amount, if any, of capital contributions by YPF to the Company after the Merger Date and by the amount of the net proceeds of any sale by the Company of common stock or non-redeemable preferred stock after the Merger Date. The foregoing obligations of YPF (the \"Keepwell Covenant\") will survive until June 8, 2004. In addition, YPF has guaranteed the Company's outstanding debt as of the Merger Date, the principal amount of which was approximately $976 million. The debt covered by the YPF guarantee includes the Company's outstanding 11 1\/4%, 11 1\/2% and 8 1\/2% Sinking Fund Debentures, its outstanding 9 7\/8%, 9 1\/2% and 9 3\/8% Notes, and its outstanding medium-term notes. YPF has also guaranteed the payment and performance of the Company's obligations to the holders of its $9.75 Preferred Stock.\nEach of the Midgard facility and the Holdings facility contains restrictive covenants including limitations upon the sale of assets, mergers and consolidations, the creation of liens and additional indebtedness, investments, dividends, the purchase or repayment of subordinated indebtedness, transactions with affiliates and modifications to certain material contracts. The obligors under the Midgard facility and the Holdings facility may not permit (a) consolidated tangible net worth to be less than $200 million, in the case of the Midgard facility, or $350 million, in the case of the Holdings facility, plus (or minus), in the case of Midgard, the amount of any adjustment in the book value of assets or, in the case of Holdings, 70% of the amount of any adjustment to net worth, resulting from the merger of YPFA Corp. into the Company, (b) the ratio of consolidated cash flow to consolidated debt service to be less than 1.1 to 1.0 at the end of any fiscal quarter and (c) the ratio of consolidated cash flow to consolidated interest expense to be less than 1.25 to 1.0 at the end of any fiscal quarter. In addition, mandatory prepayments of the loans under the Midgard facility and the Holdings facility may be required in connection with certain asset sales and casualty losses, upon the issuance of subordinated indebtedness and in 1996 and in each year thereafter if, after semi-annual review, the agent and the lenders determine that a borrowing base deficiency exists. No borrowing base deficiencies existed at December 31, 1995.\nMaxus has guaranteed the obligation under the Midgard facility (the \"Midgard Guaranty\") and under the Holdings facility (the \"Subsidiaries Guaranty\"). The Midgard Guaranty and the Subsidiaries Guaranty contain restrictions upon mergers and consolidations, the creation of liens and the business activities in which Maxus and its subsidiaries may engage. In addition, Midgard, in the case of the Midgard Guaranty, and Holdings and its subsidiaries, in the case of the Subsidiaries Guaranty, are required to be wholly owned subsidiaries of Maxus, except to the extent YPF or a subsidiary of YPF (other than Maxus or a subsidiary of Maxus) makes capital contributions to Midgard or Holdings or one of Holdings subsidiaries, as the case may be.\nIn management's opinion, cash on hand and cash from operations will be inadequate to fund the 1996 program spending budget, service debt, meet redemption obligations on redeemable preferred stock and pay preferred stock dividends and trade obligations. During 1996 through the date of this report, YPF has made capital contributions to the Company in the aggregate amount of $64 million pursuant to the terms of the Keepwell Covenant. It is anticipated that YPF could be required to make capital contributions in 1996 totaling approximately $200 million to $250 million to fund the Company's obligations. Actual capital contributions made by YPF could vary significantly depending on, among other circumstances, oil and gas prices and program spending commitments. Such capital contributions will be credited to YPF's obligations under the Keepwell Covenant and will entitle YPF to shares of Common Stock.\nOperating Activities. During the nine months ended December 31, 1995, net cash provided by operating activities was $57 million. Excluding the change in working capital requirements, net cash from operating activities was $44 million during this period. Working capital requirements provided an additional $13 million primarily as a result of U.S. federal income tax refunds of approximately $60 million. These tax refunds were partially offset by lower accrued liabilities of $32 million due primarily to payment of Maxus pre-Merger costs coupled with higher inventories of $13 million.\nNet cash provided by operating activities during the three months ended March 31, 1995, was $62 million of which $18 million was provided by operating activities and $44 million was from working capital. Working capital was favorably impacted by higher accrued liabilities of $26 million of which $11 million was due to higher accrued interest, lower oil and gas receivables of $24 million and a U.S. federal income tax refund of $9 million partially offset by lower accounts payable of $15 million.\nNet cash provided by operating activities totaled $70 million and $137 million in 1994 and 1993, respectively. Excluding the change in working capital requirements, net cash from operating activities was $58 million lower in 1994 than in 1993. Cash flow from operations was negatively impacted by lower crude oil and natural gas prices, the loss of production from the Divested Properties and costs associated with staff reductions, but was partially offset by additional gas volumes from Northwest Java ($30 million). Net working capital requirements of $42 million for 1994 were $9 million higher than 1993 due to lower accounts payable primarily as a result of timing of expenditures in Ecuador.\nInvesting Activities. During 1995, the Company continued to concentrate its capital spending in core areas of the United States, Indonesia and Ecuador plus development of the emerging areas: the Mamore Block in Bolivia and the Quiriquire Block in Venezuela. Spending in 1995 increased modestly compared to 1994, with the largest increase occurring in the U.S. due to the implementation of an aggressive program of infill drilling designed to increase production and cash flow. Only Ecuador experienced lower capital spending in 1995 as spending for major infrastructure and facilities was completed in 1994. Approximately 45% of the 1994 capital spending was for development of oil reserves in South America. Initial production began in the third quarter of 1994 in Ecuador, Bolivia and Venezuela. Spending in Ecuador in 1994 was $31 million below 1993 as spending for major infrastructure and facilities was being completed. In 1993, the development of gas reserves in Northwest Java and development of Block 16 in Ecuador alone accounted for $167 million of spending. The Northwest Java gas project was completed on time and within budget in the fourth quarter of 1993. Additionally, construction of the Sunray gas plant in the Texas Panhandle, which was started in mid-1991, was completed during the first quarter of 1993.\nIn December 1995, the Company sold its overriding royalty interest in the Recetor Block in Colombia for $25 million. There was no gain or loss recognized on this transaction.\nOn April 25, 1994, Offshore Partners sold its interests in Main Pass Blocks 72, 73 and 74. On April 26, 1994, Maxus and its subsidiaries sold all of their partnership interests in Offshore Partners. In the second quarter of 1994, Maxus also sold the McFarlan Field and Grand Isle Block 25, both producing oil and gas properties. In total, the Company received $325 million of proceeds and recorded a pre-tax gain of $202 million from these transactions. A portion of the proceeds from these sales was used to reduce senior debt by $70 million net and to redeem $63 million of the $9.75 Preferred Stock due in February 1995.\nDuring the second quarter of 1994, Maxus Bolivia, Inc., a subsidiary of Maxus, signed an agreement to take BHP Petroleum as a partner in its Bolivian oil development project. The Company received $10 million from BHP in exchange for a 50% interest in the project. Also during the second quarter of 1994, Maxus Venezuela (C.I.) Ltd. (\"Maxus Venezuela\"), a subsidiary of Maxus, signed an agreement with BP Exploracion de Venezuela S.A., granting BP a 45% interest in the Quiriquire Unit in eastern Venezuela. Maxus Venezuela remains the operator with a 50% interest and Corporacion Energetica S. 21, C.A., a Venezuelan company, holds the remaining 5%.\nThe Company sold its geothermal subsidiary, Thermal Power Company, in September 1994. The sale was for $58 million net in cash and a $7 million promissory note due from the purchaser in 1997. The Company recorded a loss of $13 million on the transaction.\nIn 1993, the Company purchased $52 million of U.S. Treasury notes. To partially fund the 1993 capital program budget and cover working capital fluctuations, the Company subsequently sold $142 million of U.S. Treasury notes realizing a gain of $8 million. Additionally, during 1993, Maxus received stock and other securities from The LTV Corporation (\"LTV\") in settlement of its bankruptcy claims against LTV. The Company sold these securities for approximately $22 million, realizing a $2 million gain. During 1994, the Company purchased an additional $112 million of short-term investments with the proceeds from the sales of assets. To partially fund the capital program budget and pay Merger-related costs in 1995, the Company liquidated all its short-term investments. Additionally, the Company sold its remaining long-term investment in U.S. Treasury notes for $31 million realizing a gain on the sale of $2 million. In the future, the Company anticipates maintaining only minimal balances of cash, cash equivalents and short-term investments to cover working capital fluctuations.\nDuring 1995, the Company was able to release a significant portion of its restricted cash, of which $48 million supporting letters of credit were released and $17 million of assets held in trust as required by certain insurance policies were released due to YPF's guarantees. Additionally, in 1995, the Company restricted $8 million as required by the Holdings credit agreement. During 1993, the Company restricted $36 million backing its spending commitment in Venezuela. The $36 million in restricted cash backing the letters of credit in Venezuela were released in 1994 when the Company took on a partner and reduced its interest to 50%.\nFinancing Activities. During 1995, most of Maxus' financing activity was impacted by the Merger. The Company received $851 million from the issuance of debt under the Purchaser Facility and the Midgard and Holdings credit facilities and a $250 million capital infusion from YPF to partially fund the Merger. In connection with the Merger, the Company also paid $14 million to redeem rights attached to Shares, repaid the Purchaser Facility, and, pursuant to the Merger, either assumed or paid $746 million of purchase consideration for the Shares outstanding plus transaction costs. Of the approximate $762 million purchase price paid by YPF to acquire the Company, as of December 31, 1995, $16 million remained to be paid in respect of Shares and Merger costs. This liability was recorded in accrued liabilities.\nAt December 31, 1995, the Company had $7 million of advances outstanding from YPF. The Company and YPF intend to enter into a loan agreement during 1996 to facilitate short-term loans by YPF to the Company and short-term loans by the Company to YPF of excess cash balances. It is expected that loans will be made by the parties under the loan agreement during 1996; however, the number and amounts thereof are not presently known.\nThe Company's only derivative financial instruments are an interest rate swap agreement, natural gas price swap agreements and natural gas and crude oil futures contracts, which are not used for trading purposes. During the third quarter of 1995 the Company recorded a $2 million gain which represented the final\nsettlement of the Company's sole interest rate swap agreement prior to its termination. This gain was recorded in other revenues, net. The Company also received a $5 million termination payment, which has been deferred.\nOver the two-year period from January 1, 1993, to December 31, 1994, Maxus took steps to restructure its debt and equity position. The overall intent was to provide immediate funding for its major development and construction projects (the Sunray gas plant, the Northwest Java gas project and the development of Block 16 in Ecuador) and to match the repayment schedules of the debt with the future cash flow expected from these projects while maintaining necessary working capital balances required for flexibility. The Company was able to take advantage of lower interest rates and, at the same time, to extend the average debt maturities.\nDebt rose significantly in 1993 due to the completion of two of the Company's major projects and the near completion of the initial phase of the Ecuador project. These projects contributed to substantial capital spending in 1993. To cover the shortfall between cash from operations and the cash used in investing activities, incremental new debt was issued. Of the $412 million proceeds received in 1993 from the issuance of long-term debt, $204 million was used to refinance currently maturing debt and to fund the early retirement of a portion of the Company's 11 1\/4% sinking fund debentures, with the remainder partially funding the 1993 capital spending program.\nDuring 1994, the Company issued $101 million of additional long-term debt. Debt issuances, along with a portion of the proceeds from asset sales, were used to repay approximately $170 million of debt obligations due 1994 and beyond and to prepay $63 million of $9.75 Preferred Stock due in February 1995.\nIn 1993, Maxus issued a new class of preferred stock, the $2.50 Preferred Stock. Of the $85 million in net proceeds received from the offering, $63 million was used to redeem 625,000 shares of $9.75 Preferred Stock as required in February 1994.\nAccounting Standards\nEffective April 1, 1995, the Company used the purchase method of accounting to record the acquisition of the Company by YPF. In a purchase method combination, the purchase price is allocated to the assets acquired and liabilities assumed based on their fair values at the date of acquisition. In connection with the purchase price allocation, the Company adopted Statement of Financial Accounting Standards No. 121 (\"SFAS 121\"), \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of,\" which requires a review of long-lived assets for impairment whenever events or changes in circumstance indicate that the carrying amount of the asset may not be recoverable. Under SFAS 121, if the expected future cash flow of a long-lived asset is less than the carrying amount of the asset, an impairment loss shall be recognized to value the asset at its fair value. Maxus revalued its assets and liabilities to fair value in the purchase price allocation effective April 1, 1995. There was no impact on the Company's results of operations resulting from the adoption of SFAS 121 during the nine months ended December 31, 1995.\nEnvironmental Matters\nFederal, state and local laws and regulations relating to health and environmental quality in the United States, as well as environmental laws and regulations of other countries in which the Company operates, affect nearly all of the operations of the Company. These laws and regulations set various standards regulating certain aspects of health and environmental quality, provide for penalties and other liabilities for the violation of such standards and establish in certain circumstances remedial obligations. In addition, especially stringent measures and special provisions may be appropriate or required in environmentally sensitive foreign areas of operation, such as those in Ecuador.\nMany of the Company's United States operations are subject to requirements of the Safe Drinking Water Act, the Clean Water Act, the Clean Air Act (as amended in 1990), the Occupational Safety and Health Act, the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended (\"CERCLA\"), and other federal, as well as state, laws. Such laws address, among other things, limits on the discharge of wastes associated with oil and gas operations, investigation and clean-up of hazardous substances,\nand workplace safety and health. In addition, these laws typically require compliance with associated regulations and permits and provide for the imposition of penalties for noncompliance. The Clean Air Act Amendments of 1990 may benefit the Company's business by increasing the demand for natural gas as a clean fuel.\nThe Company believes that its policies and procedures in the area of pollution control, product safety and occupational health are adequate to prevent unreasonable risk of environmental and other damage, and of resulting financial liability, in connection with its business. Some risk of environmental and other damage is, however, inherent in particular operations of the Company and, as discussed below, the Company has certain potential liabilities associated with former operations. The Company cannot predict what environmental legislation or regulations will be enacted in the future or how existing or future laws or regulations will be administered or enforced. Compliance with more stringent laws or regulations, as well as more vigorous enforcement policies of the regulatory agencies, could in the future require material expenditures by the Company for the installation and operation of systems and equipment for remedial measures and in certain other respects. Such potential expenditures cannot be reasonably estimated.\nIn connection with the sale of the Company's former chemical subsidiary, Diamond Shamrock Chemicals Company (\"Chemicals\"), to Occidental Petroleum Corporation (\"Occidental\") in 1986, the Company agreed to indemnify Chemicals and Occidental from and against certain liabilities relating to the business or activities of Chemicals prior to the September 4, 1986 closing date (the \"Closing Date\"), including certain environmental liabilities relating to certain chemical plants and waste disposal sites used by Chemicals prior to the Closing Date.\nIn addition, the Company agreed to indemnify Chemicals and Occidental for 50% of certain environmental costs incurred by Chemicals for which notice is given to the Company within 10 years after the Closing Date on projects involving remedial activities relating to chemical plant sites or other property used in the conduct of the business of Chemicals as of the Closing Date and for any period of time following the Closing Date, with the Company's aggregate exposure for this cost sharing being limited to $75 million. The total expended by the Company under this cost sharing arrangement was about $39 million as of December 31, 1995. Occidental Chemical Corporation (\"OxyChem\"), a subsidiary of Occidental, and Henkel Corporation (\"Henkel\"), an assignee of certain of Occidental's rights and obligations, have filed a declaratory judgment action in Texas state court with respect to the Company's agreement in this regard (see \"Legal Proceedings\").\nIn connection with the spin-off of Diamond Shamrock R&M, Inc., now known as Diamond Shamrock, Inc. (\"DSI\"), in 1987, the Company and DSI agreed to share the costs of losses (other than product liability) relating to businesses disposed of prior to the spin-off, including Chemicals. Pursuant to this cost-sharing agreement, the Company bore the first $75 million of such costs and DSI bore the next $37.5 million. Under the arrangement, such ongoing costs are now borne one-third by DSI and two-thirds by the Company. This arrangement will continue until DSI has borne an additional $47.5 million, following which such costs will be borne solely by the Company. As of December 31, 1995, DSI's remaining responsibility is approximately $8 million and is included in accounts receivable in the accompanying balance sheet.\nFor the year ended December 31, 1995, the Company spent $6 million in environmental related expenditures in its oil and gas operations. Expenditures in 1996 are expected to be approximately $8 million.\nThe Company's total expenditures for environmental compliance for disposed of businesses, including Chemicals, were approximately $38 million in 1995, $12 million of which were recovered from DSI under the above described cost-sharing agreement. Those expenditures are projected to be approximately $23 million in 1996 after recovery from DSI under such agreement.\nAt December 31, 1995, reserves for the environmental contingencies discussed herein totaled $119 million. Management believes it has adequately reserved for all environmental contingencies which are probable and can be reasonably estimated; however, changes in circumstances could result in changes, including additions, to such reserves in the future.\nThe insurance companies that wrote Chemicals' and the Company's primary and excess insurance during the relevant periods have to date refused to provide coverage for most of Chemicals' or the Company's cost of\nthe personal injury and property damage claims related to environmental claims, including remedial activities at chemical plant sites and disposal sites. In two actions filed in New Jersey state court, the Company has been conducting litigation against all of these insurers for declaratory judgments that it is entitled to coverage for certain of these claims. In 1989, the trial judge in one of the New Jersey actions ruled that there is no insurance coverage with respect to the claims related to the Newark plant (discussed below). The trial court's decision was upheld on appeal and that action is now ended. The other suit, which is pending, covers disputes with respect to insurance coverage related to certain other environmental matters.\nNewark, New Jersey. A consent decree, previously agreed upon by the U.S. Environmental Protection Agency (the \"EPA\"), the New Jersey Department of Environmental Protection and Energy (the \"DEP\") and Occidental, as successor to Chemicals, was entered in 1990 by the United States District Court of New Jersey and requires implementation of a remedial action plan at Chemicals' former Newark, New Jersey agricultural chemicals plant. Engineering for such plan, which will include an engineering estimate of the cost of construction, is progressing. Construction is expected to begin in 1997, cost approximately $22 million and take three to four years to complete. The work is being supervised and paid for by the Company pursuant to its above described indemnification obligation to Occidental. The Company has fully reserved the estimated costs of performing the remedial action plan and required ongoing maintenance costs.\nStudies have indicated that sediments of the Newark Bay watershed, including the Passaic River adjacent to the plant, are contaminated with hazardous chemicals from many sources. Studies performed by the Company and others suggest that contaminants historically discharged by the Newark plant are buried under several feet of more recent sediment deposits and are not moving. The Company, on behalf of Occidental, negotiated an agreement with the EPA under which the Company is conducting further testing and studies to characterize contaminated sediment in a six-mile portion of the Passaic River near the plant site. The Company currently expects such testing and studies to be completed in 1999 and cost from $4 million to $6 million after December 31, 1995. The Company has reserved its estimate of the remaining costs to be incurred in performing these studies as of December 31, 1995. The Company has been conducting similar studies under its own auspices for several years. Until these studies are completed and evaluated, the Company cannot reasonably forecast what regulatory program, if any, will be proposed for the Passaic River or the Newark Bay watershed and therefore cannot estimate what additional costs, if any, will be required to be incurred.\nHudson County, New Jersey. Until 1972, Chemicals operated a chromium ore processing plant at Kearny, New Jersey. According to the DEP, wastes from these ore processing operations were used as fill material at a number of sites in Hudson County.\nAs a result of negotiations between the Company (on behalf of Occidental) and the DEP, Occidental signed an administrative consent order with the DEP in 1990 for investigation and remediation work at certain chromite ore residue sites in Kearny and Secaucus, New Jersey. The work is being performed by the Company on behalf of Occidental, and the Company is funding Occidental's share of the cost of investigation and remediation of these sites and is currently providing financial assurance for performance of the work in the form of a self-guarantee in the amount of $20 million subject to the Company's continuing ability to satisfy certain financial tests specified by the State. This financial assurance may be reduced with the approval of the DEP following any annual cost review. While the Company has participated in the cost of studies and is implementing interim remedial actions and conducting remedial investigations and feasibility studies, the ultimate cost of remediation is uncertain. The Company anticipates submitting its investigation and feasibility reports to the DEP in late 1996 or 1997. The results of the DEP's review of these reports could impact the cost of any further remediation that may be required. The Company has reserved its best estimate of the remaining cost to perform the investigations and remedial work as being $50 million at December 31, 1995. In addition, the DEP has indicated that it expects Occidental and the Company to participate with the other chromium manufacturers in the funding of certain remedial activities with respect to a number of so-called \"orphan\" chrome sites located in Hudson County, New Jersey. Occidental and the Company have declined participation as to those sites for which there is no evidence of the presence of residue generated by Chemicals. The Governor of New Jersey issued an Executive Order requiring state agencies to provide specific justification for\nany state requirements more stringent than federal requirements. The DEP has indicated that it may be revising its soil action level upwards towards the higher soil screening levels proposed by the EPA in 1994.\nPainesville, Ohio. From about 1912 through 1976, Chemicals operated manufacturing facilities in Painesville, Ohio. The operations over the years involved several discrete but contiguous plant sites over an area of about 1,300 acres. The primary area of concern historically has been Chemicals' former chromite ore processing plant (the \"Chrome Plant\"). For many years, the site of the Chrome Plant has been under the administrative control of the EPA pursuant to an administrative consent order under which Chemicals is required to maintain a clay cap over the site and to conduct certain ground water and surface water monitoring. Many other sites have previously been clay-capped and one specific site, which was a waste disposal site from the mid-1960s until the 1970s, has been encapsulated and is being controlled and monitored. In September 1995, the Ohio Environmental Protection Agency (the \"OEPA\") issued its Directors' Final Findings and Order (the \"Director's Order\") by consent ordering that a remedial investigation and feasibility study (the \"RIFS\") be conducted at the former Painesville plant area. The Company has agreed to participate in the RIFS as required by the Director's Order. It is estimated that the total cost of performing the RIFS will be $3 million to $5 million over the next three years. In spite of the many remedial, maintenance and monitoring activities performed, the former Painesville plant site has been proposed for listing on the National Priority List under CERCLA; however, the EPA has stated that the site will not be listed so long as it is satisfactorily addressed pursuant to the Director's Order and OEPA's programs. The Company has accrued the estimate of its share of the cost to perform the RIFS. The scope and nature of any further investigation or remediation that may be required cannot be determined at this time; however, as the RIFS progresses, the Company will continuously assess the condition of the Painesville plant site and make any changes, including additions, to its reserve as may be required.\nOther Former Plant Sites. Environmental remediation programs are in place at all other former plant sites where material remediation is required in the opinion of the Company. Former plant sites where remediation has been completed are being maintained and monitored to insure continued compliance with applicable laws and regulatory programs. The Company has reserved $6 million at December 31, 1995, related to these sites, none of which are individually material.\nThird Party Sites. Chemicals has also been designated as a potentially responsible party (\"PRP\") by the EPA under CERCLA with respect to a number of third party sites, primarily off of Chemicals' properties, where hazardous substances from Chemicals' plant operations allegedly were disposed of or have come to be located. Numerous PRPs have been named at substantially all of these sites. At several of these, Chemicals has no known exposure. Although PRPs are almost always jointly and severally liable for the cost of investigations, cleanups and other response costs, each has the right of contribution from other PRPs and, as a practical matter, cost sharing by PRPs is usually effected by agreement among them. Accordingly, the ultimate cost of these sites and Chemicals' share of the costs thereof cannot be estimated at this time, but are not expected to be material except possibly as a result of the matters described below.\n1. Fields Brook; Ashtabula, Ohio. At the time that Chemicals was sold to Occidental, Chemicals operated a chemical plant at Ashtabula, Ohio which is adjacent to Fields Brook. Occidental has continued to operate the Ashtabula plant. In 1986, Chemicals was formally notified by the EPA that it was a PRP for the Fields Brook site. The site is defined as Fields Brook, its tributaries and surrounding areas within the Fields Brook watershed. At least 15 other parties are presently considered to be financially responsible PRPs. In 1986, the EPA estimated the cost of sediment remediation at the site would be $48 million. The PRPs, including Occidental, have developed an allocation agreement for sharing the costs of the work in Fields Brook ordered by the EPA. Under the allocation, the Occidental share for Chemicals' ownership of the Ashtabula plant would be about five percent of the total, assuming all viable PRPs were to participate.\nIn 1990, the OEPA, as state trustee for natural resources under CERCLA, advised previously identified PRPs, including Chemicals, that the OEPA intended to conduct a Natural Resource Damage Assessment of the Fields Brook site to calculate a monetary value for injury to surface water, groundwater, air, and biological and geological resources at the site. Also, although Fields Brook empties into the Ashtabula River which flows into Lake Erie, it is not known to what extent, if any, the EPA will propose remedial action beyond Fields\nBrook for which the Fields Brook PRPs might be asked to bear some share of the costs. Until all preliminary studies and necessary governmental actions have been completed and negotiated or judicial allocations have been made, it is not possible for the Company to estimate what the response costs, response activities or natural resource damages, if any, may be for Fields Brook or related areas, the parties responsible therefore or their respective shares.\nIt is the Company's position that costs attributable to the Ashtabula plant fall under the Company's above-described cost sharing arrangement with Occidental under which the Company bears one-half of certain costs up to an aggregate dollar cap. Occidental, however, has contended that it is entitled to full indemnification from the Company for such costs, and the outcome of this dispute cannot be predicted. The Company has reserved its estimate of its share of potential cleanup costs based on the assumption that this site falls under the Occidental cost sharing arrangement.\n2. French Limited Disposal Site; Crosby, Texas. The PRPs, including Chemicals (represented by the Company), entered into a consent decree and a related trust agreement with the EPA with respect to this disposal site. The consent decree was entered by the federal court as a settlement of the EPA's claim for remedial action. Chemical's share of the cost to complete remediation at this site at December 31, 1995 is expected to be approximately $500,000 and such amount is fully accrued.\n3. SCP\/Carlstadt Site; Carlstadt, New Jersey. Chemicals' share of remediation costs at this CERCLA site would be approximately one percent, based on relative volume of waste shipped to the site. An interim remedy has now been implemented at the site by the PRPs but no estimate can be made at this time of ultimate costs of remediation which may extend to certain off-site locations.\n4. Chemical Control Site; Elizabeth, New Jersey. The DEP has demanded of PRPs (including Chemicals) reimbursement of the DEP's alleged $34 million (including interest through December 31, 1995) in past costs for its partial cleanup of this site. The PRPs and the EPA have settled the federal claims for cost recovery and site remediation, and remediation is now complete. Based on the previous allocation formula, it is expected that Chemicals' share of any money paid to the DEP for its claim would be approximately two percent. The Company has fully reserved its estimated liability for this site.\nLegal Proceedings\nIn November 1995, OxyChem filed suit in Texas state court seeking a declaration of certain of the parties' rights and obligations under the sales agreement pursuant to which the Company sold Chemicals to Occidental. Henkel joined in said lawsuit as a plaintiff in January 1996. Specifically, OxyChem and Henkel are seeking a declaration that the Company is required to indemnify them for 50% of certain environmental costs incurred on projects involving remedial activities relating to chemical plant sites or other property used in connection with the business of Chemicals on the Closing Date which relate to, result from or arise out of conditions, events or circumstances discovered by OxyChem or Henkel and as to which the Company is provided written notice by OxyChem or Henkel prior to the expiration of ten years following the Closing Date, irrespective of when OxyChem or Henkel incurs and gives notice of such costs, subject to an aggregate $75 million cap. The Company believes that this lawsuit is without merit and intends to defend same vigorously. The Company has established reserves based on its 50% share of costs expected to be paid or incurred by OxyChem and Henkel prior to September 1996.\nAs of December 31, 1995, the Company had paid OxyChem and Henkel a total of approximately $39 million against said $75 million cap. The Company cannot predict what portion of the approximately $36 million remaining as of that date Occidental and Henkel may actually pay or incur prior to September 4, 1996, the tenth anniversary of the Closing Date if they accelerate spending with regard to such environmental costs; however, the Company has approximately $7 million reserved at December 31, 1995, based on 50% of OxyChem's and Henkel's historical annual expenditures. In the event OxyChem and Henkel prevail in this lawsuit, the Company could be required to provide up to approximately $29 million in additional reserves related to this indemnification.\nThe Company has established reserves for legal contingencies in situations where a loss is probable and can be reasonably estimated.\nFuture Outlook\nIn addition to maintaining and developing its core and emerging areas, it is expected that, beginning in 1996, the Company will acquire or assume responsibility for certain YPF exploration interests in South America (outside Argentina) and the United States Gulf of Mexico. The Company will continue to focus on maximizing the value of its core producing assets and seek new investment opportunities in associated ventures.\nMaxus currently projects total program spending (capital expenditures plus exploration expenses) for 1996 to be approximately $249 million, compared to $231 million in 1995. Indonesia will receive nearly $79 million, Midgard (U.S.) $72 million, South America $62 million and exploration interests outside Argentina acquired or assumed from YPF $25 million. The remaining $11 million will be allocated to domestic and overseas new ventures. Funding for the 1996 spending program is expected to be provided through cash and cash equivalents on hand at the beginning of the year, expected cash from operations and capital contributions from YPF as necessary. In addition to the 1996 program, Maxus has financial and\/or performance commitments for exploration and development activities in 1997 and beyond none of which are material except for the recently acquired Guarapiche block in Venezuela discussed below.\nIn January 1996, the Company and its partners were successful in acquiring the highly prospective Guarapiche block in Venezuela's first auction awards for equity production in over 20 years. Guarapiche is located on the same trend as the five billion barrel El Furrial field in northeastern Venezuela. The Company, together with its partners, paid $109 million (approximately $27 million net to the Company) to the Venezuelan government for rights to explore the Guarapiche block. BP Exploration Orinoco Limited is the operator with a 37.5% working interest while Amoco Production Company and the Company hold 37.5% and 25% working interests, respectively. The Company's net exploration commitment is anticipated to total approximately $15 million over the next five years.\nThe Company has begun discussions with other companies concerning the establishment of a joint venture or other alliance with regard to Midgard's business and assets. The objectives of such a joint venture or alliance would be lowering unit costs, creating economies of scale and improving marketing leverage. No joint venture or other partner has been selected and no assurances can be given that the attempts to establish a joint venture or other alliance will be successful. In addition, Maxus is considering a number of possible capital and business restructuring alternatives; however, no decisions have been made to take any specific action nor can there be any assurance that any specific action will be taken.\nBy the end of 1995, management had streamlined the Maxus organizational structure, reduced Maxus' overhead costs and improved communications and decision making. In addition, a \"management by objectives\" program was introduced to make each business unit and staff group directly responsible for their accomplishments. These actions are expected to result in significant cost savings.\nThe Company's foreign petroleum exploration, development and production activities are subject to political and economic uncertainties, expropriation of property and cancellation or modification of contract rights, foreign exchange restrictions and other risks arising out of foreign governmental sovereignty over the areas in which the Company's operations are conducted, as well as risks of loss in some countries due to civil strife, guerrilla activities and insurrection. Areas in which the Company has significant operations include the United States, Indonesia, Ecuador, Bolivia and Venezuela.\nIn Ecuador, pipeline capacity available to the Company is sufficient to transport only about 60% of the oil the Company expected to be able to produce daily, and none of the various projects to increase transportation capacity that have been considered has been approved by the government of Ecuador. In addition, the Company is involved in a number of contract, auditing and certification disputes with various government entities. Together, the lack of pipeline capacity and the various disputes with government entities are retarding the Company's ability to proceed with the economic development of Block 16. Although the Company can\ngive no assurances concerning the outcome of these discussions, progress has recently been made on several important issues. The Company intends to reduce program spending in Ecuador in 1996 to $19 million from $32 million in 1995.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe information required by this item appears on pages to of this report.\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.\nExecutive Officers of the Company\nThe following table sets forth certain information as of March 1, 1996 concerning the executive officers of the Company.\nOfficers are elected annually by the Board of Directors (sometimes referred to as the \"Board\") and may be removed at any time by the Board. There are no family relationships among the executive officers listed and there are no arrangements or understandings with third parties pursuant to which any of them were elected as officers, except that Mr. Monti received $120,000 from YPF in respect of the period from August 21, 1995, when he was elected President, Chief Executive Officer and a director of the Company, until October 9, 1995, when he became an employee of the Company. Certain information regarding the principal occupations and employment of each of the officers named above during the prior five years is set forth below.\nMr. Monti was elected President and Chief Executive Officer and a director of the Company effective August 21, 1995 and became an employee of the Company on October 9, 1995. Prior to joining Maxus, Mr. Monti served as the President of Dowell, a division of Schlumberger Limited. Since joining the oilfield services company in 1963, Mr. Monti has held various positions with Schlumberger, including president and vice president of various divisions or subsidiaries.\nMr. Miller was elected Executive Vice President and Treasurer of the Company in November 1995. Mr. Miller joined a former subsidiary of Maxus in 1981 as Manager, Taxes and has held various positions with the Company since such time, including Director, Exploration and Production Taxes; Director, Operations Auditing; General Manager, Indonesia; and Vice President of the Company.\nMr. Forrest joined the Company in 1992 as special assistant to the Chairman and later that year was elected Vice Chairman and Chief Operating Officer. Prior to 1992, he was with Shell U.S.A. for more than five years, last serving as President of its subsidiary, Pecten International Company. Mr. Forrest was named Senior Vice President, Business Development of the Company in 1994. Mr. Forrest has been a Senior Vice President of the Company since 1994.\nMr. Wadsworth was elected Vice President, Legal of the Company in June 1995. Mr. Wadsworth joined Natomas Company, a former subsidiary of Maxus, in 1979. He has served in various positions with the Company, including Associate General Counsel and Corporate Secretary, since such time.\nMrs. Engelbrecht was elected Controller of the Company in November 1995. She joined a former subsidiary of the Company in 1978 as a financial associate and has held various positions with the Company, including Director of Financial Reporting and Assistant Controller, since such time.\nDirectors of the Company\nCertain information regarding each director, including his age, is set forth below. Each director is elected at the annual meeting of stockholders for a term of one year.\nCHARLES L. BLACKBURN: 68, a director of the Company since 1986. For more than five years prior to his retirement in April 1995, he was also the Chairman, President and Chief Executive Officer of Maxus. He is currently an international consultant for the Company. Mr. Blackburn also serves as a director of Lone Star Technologies, Inc. and Landmark Graphics Corporation.\nCEDRIC BRIDGER: 60, a director of the Company since April 1995. Mr. Bridger has been Vice President, Finance and Corporate Development of YPF since 1992. From 1989 to 1992, he was employed by CBV Industrias Mecanicas in Brazil, last serving as Marketing Manager. Previously, he was associated with Hughes Tool Company from 1964 to 1989.\nGEORGE L. JACKSON: 67, a director of the Company since 1987. Mr. Jackson has been an oil field service consultant for more than five years.\nNELLS LEON: 69, a director of the Company since June 1995. Mr. Leon has been a director of YPF since 1991, and was elected President of YPF in May 1995. Mr. Leon held various positions with YPF from 1956 to 1977 and from 1983 to 1987. Since 1990, he has served as Executive Vice President. He was Vice President of Operations of Sol Petroleo S.A. from 1987 to 1990.\nJAMES R. LESCH: 74, a director of the Company since April 1995. Mr. Lesch has been a director of YPF since 1993. He is currently retired, having retired from Hughes Tool Company in 1986. He was Chief Executive Officer (1979-1986) and Chairman of the Board (1981-1986) of Hughes Tool Company and also served as Commissioner, State of Texas Department of Commerce (1988-1992). Previously, he served as Director of the American Petroleum Institute. Mr. Lesch also serves as a director of TransTexas Gas Corporation.\nROBERTO MONTI: 57, a director, President and Chief Executive Officer of the Company since August 1995. Prior to such time, Mr. Monti had been employed since 1963 by Schlumberger Limited, an oil field services company, in various capacities. He most recently served as President of Dowell, a division of Schlumberger Limited.\nP. DEXTER PEACOCK: 54, a director of the Company since April 1995. Mr. Peacock has been a partner of the law firm of Andrews & Kurth L.L.P. since 1975. He is a member of the firm's Management Committee. He currently serves as a director of Texas Commerce Bank National Association and as an alternate director of YPF.\nR. A. WALKER: 39, a director of the Company since 1994. He is a Managing Director of Prudential Capital Group and a Vice President of The Prudential Insurance Company of America (\"Prudential\"). Mr. Walker has held similar positions with Prudential Capital Group for the past five years. He was elected to the Board of Directors of Maxus by Prudential pursuant to the terms of the $9.75 Preferred Stock.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nDIRECTOR COMPENSATION\nThe Company pays each director who is not an employee of the Company or YPF (other than Mr. Blackburn) an annual retainer of $20,000 and a fee of $1,000 for each meeting of the Board attended and for each committee meeting attended. For so long as Mr. Blackburn is an international consultant to the Company, he will not be entitled to such compensation paid to other non-employee Directors. See--\"Employment Contracts and Termination of Employment and Change in Control Agreements.\"\nEXECUTIVE OFFICER COMPENSATION\nThe following tables set forth compensation awarded to, earned by or paid to the executive officers named below in 1993, 1994 and 1995.\nSUMMARY COMPENSATION TABLE\n- ---------------\n(1) Mr. Monti became a consultant, officer and director of the Company on August 21, 1995, and an employee of the Company on October 9, 1995. He received $120,000 of this amount from YPF in respect of his serving as President and Chief Executive Officer of the Company prior to the date on which he became an employee. (2) Mr. Monti was paid this amount as a signing bonus upon commencement of his employment with the Company. (3) These payments represent the Company's matching contributions to this individual's qualified and non-qualified savings plans' accounts. (4) $76,592 of this amount represents a payment made in accordance with Mr. Miller's employment agreement (see--\"Employment Contracts, Termination of Employment and Change in Control Agreements\"), and $10,494 of such amount represents the Company's matching contributions to Mr. Miller's qualified and non-qualified savings plan accounts. (5) $1,075,383 of this amount represents a payment made in accordance with Mr. Forrest's change in control agreement (see--\"Employment Contracts, Termination of Employment and Change in Control Agreements\"); $199,988 represents payment in respect of the surrender pursuant to the terms of the Merger Agreement of options and stock appreciation rights (\"SARs\") held by Mr. Forrest (see table below entitled \"Aggregated Option\/SAR Exercises in the Last Fiscal Year and FY-End Option\/SAR Values\"); and $15,661 of such amount represents the Company's matching contributions to Mr. Forrest's qualified and non-qualified savings plan accounts. (6) $120,000 of this amount represents payments in connection with Mr. Blackburn's consulting agreement with the Company (see--\"Employment Contracts and Termination of Employment and Change in Control Agreements\"), $2,662,070 of such amount represents a severance payment made in accordance with Mr. Blackburn's change in control agreement (see \"-- Employment Contracts, Termination of Employment and Change in Control Agreements\"); $1,943,632 of such amount represents a lump sum payment to Mr. Blackburn in respect of the Company's retirement plans, including the Supplemental Executive Retirement Plan; $298,396 represents a distribution from Mr. Blackburn's savings plan accounts; $104,588 represents payment in respect of restricted shares of Common Stock, the restrictions on which lapsed on May 1, 1995 in accordance with their terms; and $10,400 of such amount represents the Company's matching contributions to Mr. Blackburn's qualified and non-qualified savings plan accounts. (7) Mr. Gaffney became a consultant and an officer of the Company on April 21, 1995 and an employee of the Company on June 6, 1995. Pursuant to an agreement between Mr. Gaffney and the Company, he received a total of $300,000, $195,721 of which was paid with respect of the period during which he was an employee of the Company. (8) $835,893 of this amount represents a severance payment made in accordance with Mr. Pasley's change in control agreement (see--\"Employment Contracts, Termination of Employment and Change in Control Agreements\"); $162,774 represents a distribution or rights to a distribution from Mr. Pasley's savings plan accounts; and $8,578 of such amount represents the Company's matching contributions to Mr. Pasley's qualified and non-qualified savings plan accounts. (9) $619,877 of this amount represents a severance payment made in accordance with Mr. Brown's change in control agreement (see--\"Employment Contracts, Termination of Employment and Change in Control Agreements\"); $84,999 represents payment in respect of the surrender pursuant to the terms of the Merger Agreement of options and SARs held by Mr. Brown (see table below entitled \"Aggregated Option\/SAR Exercises in the Last Fiscal Year and FY-End Option\/SAR Values\"); $13,772 represents payment in respect of restricted shares of Common Stock, the restrictions on which lapsed on May 1, 1995 in accordance with their terms; $213,560 represents a distribution or rights to a distribution from Mr. Brown's savings plan accounts; and $10,226 represents the Company's matching contributions to Mr. Brown's qualified and non-qualified savings plan accounts.\nAGGREGATED OPTION\/SAR EXERCISES IN THE LAST FISCAL YEAR AND FY-END OPTION\/SAR VALUES\n- ---------------\n(1) These payments were made in respect of the surrender of options and any SARs held by the named executive officers as contemplated by the terms of the Merger Agreement. No shares of stock were acquired in these transactions.\n(2) Although each of these named executive officers surrendered all of his options and SARs in 1995, payment was not made in 1995 by the Company in respect of a certain number of such options and SARs due to then pending tax and other questions. Such questions have been resolved and these named officers received the following amounts in 1996 for their surrendered options and SARs: Mr. Monti--0; Mr. Miller--0; Mr. Forrest--$182,102; Mr. Wadsworth--0; Mrs. Engelbrecht--0; Mr. Blackburn--$939,256; Mr. Gaffney--0; Mr. Pasley--$307,173; and Mr. Brown--$87,502.\nEMPLOYMENT CONTRACTS AND TERMINATION OF EMPLOYMENT AND CHANGE IN CONTROL AGREEMENTS\nEmployment Contracts. On April 5, 1995, the Company entered into an agreement with Mr. Gaffney, a director and the President and Chief Executive Officer of the Company from April 21, 1995 to August 21, 1995, whereby Mr. Gaffney served in the capacity of chief executive officer of the Company in consideration of payment of $50,000 a month from the date of such agreement through September 30, 1995. A total of $300,000 was paid to Mr. Gaffney under this agreement, $195,721 during the period he was an employee. In addition, Gaffney, Cline, an oil and gas technical and management consulting firm of which Mr. Gaffney is a Senior Partner, entered into an agreement with the Company obligating the Company to pay Gaffney, Cline $500,000 in consideration of Gaffney, Cline granting Mr. Gaffney a leave of absence to enable him to serve as the Company's chief executive officer.\nThe Company entered into an agreement effective July 1, 1995 in replacement of a change in control agreement dated November 1, 1991 with Mr. Miller, Executive Vice President and Treasurer of the Company, under which Mr. Miller is to be employed for a term of four years at not less than his then current salary, plus an annual bonus not less than the amount of the largest bonus paid to Mr. Miller in respect of the years 1992, 1993 or 1994, and a \"sign-on\" bonus in the amount of $76,592. In addition, a \"stay on\" bonus in the amount of $76,592 is payable under this agreement on each of July 1, 1996, 1997 and 1998 provided, as to each such \"stay on\" bonus, that Mr. Miller continues to be an employee of the Company on the respective payment date. Under the agreement, in the event that Mr. Miller's employment is terminated under certain circumstances, severance compensation will be paid to Mr. Miller as specified therein.\nOn December 27, 1995, the Company entered an agreement with Mr. Monti, a director and the President and Chief Executive Officer of the Company, pursuant to which his Foreign Service Pay, as defined in such agreement, payable with respect to services rendered from and after January 1, 1996 will be credited by the Company to a deferral account which will bear interest at a specified rate and the balance of which will be paid to Mr. Monti under certain circumstances, including termination of his employment with the Company.\nMr. Blackburn, a director and formerly the Chairman, President and Chief Executive Officer of the Company, became an international consultant during 1995 to YPF pursuant to a consulting agreement which was subsequently assigned to Maxus. Under the two-year contract, Mr. Blackburn will be available to render consulting services for a minimum of 60 days per year and be paid a retainer of $180,000 per year. Mr. Blackburn will be paid $3,000 per day for each day of consulting provided in excess of 60 days per year. Office space is made available to him in Dallas and Buenos Aires. During 1995, Mr. Blackburn was paid a total of $120,000 under the terms of this contract.\nTermination of Employment Agreements. On August 3, 1995, the Company entered into an agreement with Mr. Monti under which he will receive a severance payment from the Company in the amount of $3 million in the event that his employment with the Company is terminated (i) by Mr. Monti or the Company for reason of death or disability; (ii) by the Company other than for cause; (iii) by Mr. Monti for any reason within six months following a take-over (other than to accept employment with YPF); and (iv) by Mr. Monti for any reason after reaching age 65.\nSeparation Pay Plan. Under the Separation Pay Plan, most employees (other than non-resident aliens), excluding Mr. Monti (who has waived any rights thereunder) but including the other named executive\nofficers, are eligible for separation pay if their employment is terminated for any reason other than death, voluntary termination of employment, voluntary retirement or discharge for reasons of criminal activity, willful misconduct, gross negligence in the performance of duties or violation of Company policy. The payment to be received under the plan by a particular employee depends on his job classification and length of service and whether termination occurs after the elimination of the employee's position or a change in control of the Company (as defined in the plan). In the case of the named executive officers, the plan provides in most cases for separation pay in an amount equal to two-weeks' base pay for each year of service with the Company, plus three months' base pay, not to exceed a maximum of 12 months' base pay; and, in the case of a change in control of the Company, separation pay in an amount equal to one month's base pay for each year of service with the Company, but not less than 12 months' base pay nor more than 24 months' base pay. The plan requires that employees sign releases as a condition of receiving separation pay. Executive officers are not entitled to separation pay under the plan to the extent they receive severance payments under the change in control agreements discussed below or employment contracts discussed above. The acquisition of the Company by YPF constitutes a change in control under the Separation Pay Plan, thereby triggering the post-change in control separation formula until April 5, 1997.\nChange in Control Agreements. In 1987 or thereafter, the Company entered into agreements with certain executives including Messrs. Blackburn, Forrest, Brown, Pasley and Miller which were binding upon execution but were to become operative on a change of control of the Company. Pursuant to the terms of said agreements, they became operative when YPF acquired control of the Company.\nUnder these agreements, the executive officer is entitled to continue in the employ of the Company until the earlier of the expiration of the third anniversary of the occurrence of a \"change in control\" or the executive's death at an annual base salary of not less than the rate in effect upon the occurrence of a change in control plus an incentive award of not less than the highest such award received by the executive for any year in the three calendar years immediately preceding the change in control. Under the agreements, a \"change of control\" includes the following: (i) the merger, consolidation or reorganization of the Company after which a majority of voting power of the Company is held by persons other than the holders thereof prior to such event; (ii) the sale of all or substantially all of the assets of the Company to an entity, the majority of the voting power of which is not held by holders of the voting power of the Company before such sale; (iii) a report is filed on Schedule 13D or Schedule 14D-1 showing that a person is the beneficial owner of 25% or more of the voting power of the Company; (iv) the Company files a Form 8-K or proxy statement disclosing that a change in control has or may occur; or (v) a change in the composition of the majority of the Board under certain circumstances occurs during any period of two consecutive years. In the event the Company terminates the executive's employment during such term without cause, the executive will be entitled to receive as severance compensation a lump-sum payment equal to the present value of the cash compensation payable under the agreement in the absence of such termination, not to exceed 299% of his \"base amount\" as defined in the Internal Revenue Code of 1986, as amended (the \"Code\"), without any reduction for subsequent earnings.\nUnder these agreements, continuation of benefits under employee benefit plans of the Company is provided after termination during the remainder of the original term of employment. The agreements include provisions which limit the amounts payable under them in certain circumstances in which the net after-tax amount received by the officer would be reduced as a result of the applicability of the 20% excise tax imposed in respect of certain change in control payments under the Code. The Company has assumed the obligation to pay certain fees and expenses of counsel incurred by the executive officers if legal action is required to enforce their rights under the agreements and has secured such obligation by obtaining a letter of credit issued by a commercial bank.\nOn April 7, 1995, all of the Company's then executive officers, including Messrs. Blackburn, Forrest, Pasley and Brown, gave notice of their intent to resign under circumstances in which they had the right to receive severance payments under the change in control agreements. In order to facilitate the transition following the acquisition by YPF, the Company and the eight executive officers who were parties to such agreements (Messrs. Blackburn, Forrest, Pasley, Brown, S. G. Crowell, M. J. Barron, M. J. Gentry and M. Middlebrook) agreed that such executive officers would continue to work for the Company in their then present positions at their then current levels of compensation until June 30, 1995 or such date as otherwise\nmutually agreed. The Company also agreed to pay such executive officers' said severance payments no later than April 15, 1995. Mr. Blackburn resigned as Chairman, Chief Executive Officer and President of the Company on April 21, 1995 and retired as an employee of the Company on April 30, 1995. Messrs. Brown and Pasley resigned effective December 15, 1995 and August 31, 1995, respectively. All of such other executive officers resigned on June 30, 1995, except Mr. Forrest who agreed to continue in the employment of the Company at a reduced salary and as an \"at will\" employee. Pursuant to said agreements and the change in control agreements, the named executive officers and all of the executive officers as a group (including said former executive officers) received \"severance\" payments in the following amounts: Mr. Monti--$0; Mr. Miller--$0; Mr. Forrest--$1.0 million; Mr. Wadsworth--$0; Mrs. Engelbrecht--$0; Mr. Blackburn--$2.7 million; Mr. Gaffney--$0; Mr. Pasley--$0.9 million; and Mr. Brown--$0.6 million and the executive officers (including said former executive officers) as a group, $7.9 million.\nRETIREMENT PROGRAM\nEffective February 1, 1987, the Company adopted a new retirement income plan (the \"New Retirement Income Plan\") applicable to most of its employees to replace the Company's former retirement income plans under which such employees ceased to accrue benefits on January 31, 1987. Under the New Retirement Income Plan, a covered employee acquires a right upon retirement to a yearly amount equal to 2% of the employee's earnings during each year from February 1, 1987 forward (rather than on final compensation or average final compensation) without offset for social security benefits. Benefits under the New Retirement Income Plan become vested after five years of service. Benefits may be paid in equal monthly installments, starting on the date of retirement and continuing until death, or employees may select one of a number of optional forms of payment having equal actuarial value as provided in the plan. The benefits payable under the New Retirement Income Plan are subject to maximum limitations under the Employee Retirement Income Security Act of 1974, as amended (\"ERISA\"), and the Code. In the case of the named executives, if benefits at the time of retirement exceed the then permissible limits of such statutes, the excess would be paid by the Company from the \"SERP\" described below.\nThe Company has an unfunded Supplemental Executive Retirement Plan that provides additional benefits to the Company's highest ranking officer, the other named executives and to certain executive employees designated by the highest ranking officer. Under the SERP, a participant acquires the right to a lump sum amount upon retirement which is the actuarial equivalent of a straight life or, if married, a 50% joint and survivor annuity payable monthly in an amount equal to (a) the sum of (i) 1.6% of the participant's average monthly compensation in 1986 times the years of service through January 31, 1987, plus (ii) 2% of the participant's average monthly compensation after January 31, 1987 times the years of service after January 31, 1987 plus an additional five years less (b) the amount of the benefits calculated for such participant under the Company's other retirement plans. The maximum benefit payable is 60% of the participant's high three-year average pay. The amounts calculated under the SERP are not subject to any reduction for Social Security and are not determined primarily by final compensation or average final compensation and years of service. If a participant dies while still employed by the Company and is survived by an eligible spouse, the surviving spouse will receive a lump-sum payment equal to the present value of one-half of the benefit which would have been payable to the participant at his normal retirement age under the SERP assuming the participant had terminated employment with the Company at the time of death with a vested interest under the SERP and that the participant survived to the normal retirement age. In the case of retirement after age 55 but before age 60, the supplemental retirement benefits generally will be reduced by 5% for each year that the employee's actual retirement date precedes age 60. The benefits provided under the plan will vest upon completion of five years of service or attainment of age 55.\nThe estimated annual benefits payable upon retirement at normal retirement age (or January 1, 1996 in those cases where the participant's age on that date was greater than normal retirement age) under the Company's retirement plans as supplemented by the SERP based on service and compensation through December 31, 1995 for the executive officers named in the compensation table are as follows: Mr. Monti-- $82,668, Mr. Miller--$46,751, Mr. Forrest--$64,502, Mr. Wadsworth--$52,900, Mrs. Engelbrecht--$33,863 and Mr. Gaffney--$0. The annual benefits payable under the Company's retirement plans as supplemented by\nthe SERP to Mr. Blackburn who retired on April 30, 1995 (and received a lump sum distribution of his retirement benefits) were $193,006. The annual benefits payable at normal retirement age to Mr. Brown who resigned from the Company effective December 15, 1995 are $61,207 and to Mr. Pasley who resigned from the Company effective August 31, 1995 are $58,002.\nWhether any amounts actually become payable in whole or in part depends on the contingencies and conditions governing the applicable retirement plan.\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\nFrom January 1, 1995 to April 21, 1995, the Compensation Committee of the Board of Directors consisted of J. David Barnes, B. Clark Burchfiel, Charles W. Hall, George L. Jackson and Richard W. Murphy. From April 21, 1995 to June 7, 1995, the Compensation Committee consisted of Jose Estenssoro, Cedric Bridger and James R. Lesch. On June 7, 1995, Nells Leon replaced Mr. Estenssoro.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nExcept as provided in the next succeeding sentence, the following table sets forth the beneficial ownership (as defined in the rules of the Securities and Exchange Commission) as of February 1, 1996 of the equity securities of the Company and YPF by the directors, the named executive officers and all directors and executive officers as a group. At such date, none of the directors or executive officers beneficially owned any $4.00 Preferred Stock, $9.75 Preferred Stock or $2.50 Preferred Stock.\n- ---------------\n(1) Does not include Common Stock owned by YPF, as to which each of Messrs. Bridger, Leon, Lesch and Peacock disclaim any beneficial ownership.\n(2) Does not include 347 YPF Class \"D\" shares owned by Mr. Leon's wife, as to which Mr. Leon disclaims any beneficial ownership.\n(3) Does not include equity securities owned by Prudential, as to which Mr. Walker disclaims beneficial ownership.\n(4) Directors and executive officers individually and as a group did not own more than 1% of the Common Stock or YPF Class D shares.\nTo the knowledge of the Company, as of February 1, 1996, no person beneficially owned more than 5% of any class of the Company's voting securities except as set forth below:\n- ---------------\n(1) Prudential reported on Amendment No. 7 to Schedule 13G, dated February 12, 1996, in connection with beneficial ownership at December 31, 1995, that it had sole voting and dispositive power with respect to all 7,910,000 shares of Common Stock indicated above as beneficially owned by it. The information herein regarding such shares assumes that Prudential's ownership had not changed as of February 1, 1996 and is included in reliance on such Amendment No. 7, except that the percent of class is based upon the Company's calculations made in reliance upon the information regarding such shares contained in such Amendment No. 7.\n(2) On February 28, 1995, the Company and Prudential entered into an agreement pursuant to which Prudential waived certain rights, including conversion rights and registration rights. See \"Item 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe Company has business transactions and relationships in the ordinary course of business with unaffiliated corporations and institutions with which certain of its directors, executive officers and substantial stockholders are affiliated, including the transactions discussed below. All such transactions are conducted on an arm's-length basis.\nGaffney, Cline, an oil and gas technical and management consulting firm of which Mr. Gaffney, the President and Chief Executive Officer and a director of the Company from April 21, 1995 to August 21, 1995, is a Senior Partner, has provided oil and gas technical and management consulting services to the Company for which the Company paid Gaffney, Cline approximately $490,000 during 1995. The Company and Gaffney, Cline have agreed that Gaffney, Cline will continue to provide such services in 1996 and it is anticipated that the fees for such services will be lower.\nDuring 1996 through the date of this report, YPF has made capital contributions to the Company in the aggregate amount of $64 million pursuant to the terms of the Keepwell Covenant (see \"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources\"). It is anticipated that YPF could be required to make capital contributions in 1996 totaling approximately $200 million to $250 million to fund the Company's obligations. Actual capital contributions made by YPF could vary significantly depending on, among other circumstances, oil and gas prices and program spending commitments. Such capital contributions will be credited to YPF's obligations under the Keepwell Covenant and will entitle YPF to shares of Common Stock.\nDuring 1995, YPF made an advance to the Company in the amount of $7 million. The Company and YPF intend to enter into a loan agreement during 1996 to facilitate short-term loans by YPF to the Company and short-term loans by the Company to YPF of excess cash balances. It is expected that loans will be made by the parties under the loan agreement during 1996, and while the number and amounts thereof are not presently known, it is expected that they will aggregate in excess of $60,000.\nMr. Peacock, a director of the Company, is a partner in the law firm of Andrews & Kurth L.L.P. Andrews & Kurth provided certain legal services to the Company (including services rendered to YPFA Corp. in connection with the Merger), the fees for which the Company paid Andrews & Kurth approximately $3,180,000 in 1995. It is anticipated that Andrews & Kurth will continue to provide legal services to the Company during 1996 and that the fees for such services will be significantly lower.\nThe Company and YPF intend to enter into a services agreement whereby the Company would render or arrange for services to be rendered to or for the benefit of YPF and YPF would render or arrange for services to be rendered to or for the benefit of the Company, and each party would be compensated on the basis of the cost to them of such services. It is not presently known what the cost of these services will be to either party but it is expected that it will exceed $60,000.\nDuring 1995, Prudential was the record or beneficial owner of more than 5% of one or more of the classes of the Company's voting securities. Mr. Walker, an officer of Prudential, was elected as a director of the Company by Prudential as holder of all of the $9.75 Preferred Stock and pursuant to the terms thereof. The Company offers its employees the opportunity to participate in medical programs administered by Prudential. In addition, Prudential provides services and coverages relating to pension and life insurance programs for retired employees of Gateway Coal Company, a partnership owned by the Company. During 1995, the Company paid Prudential approximately $238,000 for these services. The Company and Prudential have agreed that Prudential will continue to perform such services during 1996 and anticipate that the fees for the year will be somewhat higher.\nAlso during 1995, Prudential and the Company entered into an agreement to induce Prudential, as the holder of the $9.75 Preferred Stock, to consent to the Merger as required by the terms of the Company's Restated Certificate of Incorporation. Under the agreement, the Company and Prudential agreed to waive certain rights and covenants with respect to the $9.75 Preferred Stock and the Company paid Prudential a restructuring fee of $250,000.\nCOMPLIANCE WITH SECTION 16(A) OF THE SECURITIES EXCHANGE ACT OF 1934\nDuring 1995, a former director of the Company, Raymond A. Hay, filed a Form 4 reporting a sale of Common Stock in the month following the date upon which such filing was due.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(a) Documents filed as part of this report:\n(1) Financial Statements--The following financial statements appear on pages through and through of this report.\nConsolidated Statement of Operations for the years ended December 31, 1994 and 1993, the three months ended March 31, 1995 and nine months ended December 31, 1995.\nConsolidated Balance Sheet at December 31, 1995 and 1994.\nConsolidated Statement of Cash Flows for the years ended December 31, 1994 and 1993, the three months ended March 31, 1995 and nine months ended December 31, 1995.\nNotes to Consolidated Financial Statements.\nReport of Independent Public Accountants.\nSupplementary Financial Information (unaudited).\nQuarterly Data (unaudited).\n(2) Financial Statement Schedules.\nNone\nCondensed parent company financial information has been omitted, since the amount of restricted net assets of consolidated subsidiaries does not exceed 25% of total consolidated net assets. Also, footnote disclosure regarding restrictions on the ability of both consolidated and unconsolidated subsidiaries to transfer funds to the parent company has been omitted since the amount of such restrictions does not exceed 25% of total consolidated net assets.\n(3) Exhibits.\nEach document marked by an asterisk is incorporated herein by reference to the designated document previously filed with the Securities and Exchange Commission (the \"Commission\"). Each of Exhibits Nos. 10.1 through 10.10 and 10.15 through 10.25 is a management contract or compensatory plan, contract or arrangement required to be filed as an exhibit hereto by Item 14(c) of Form 10-K.\n(b) Reports on Form 8-K.\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.\nMAXUS ENERGY CORPORATION\nBy ROBERTO MONTI* Roberto Monti President and Chief Executive Officer\nMarch 21, 1996\nPursuant to the requirements of the Securities Exchange Act 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.\nLynne P. Ciuba, by signing her name hereto, does hereby sign this report on Form 10-K on behalf of each of the above-named officers and directors of the registrant pursuant to a power of attorney executed by each of such officers and directors.\nMAXUS ENERGY CORPORATION\nCONSOLIDATED STATEMENT OF OPERATIONS\nSee Notes to Consolidated Financial Statements.\nMAXUS ENERGY CORPORATION\nCONSOLIDATED BALANCE SHEET\nSee \"Commitments and Contingencies.\" See Notes to Consolidated Financial Statements. The Company uses the successful efforts method to account for its oil and gas producing activities.\nMAXUS ENERGY CORPORATION\nCONSOLIDATED STATEMENT OF CASH FLOWS\nSee Notes to Consolidated Financial Statements.\nMAXUS ENERGY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nPRESENTATION\nOn June 8, 1995, a special meeting of the stockholders of Maxus Energy Corporation (together with its foreign and domestic subsidiaries, the \"Company\" or \"Maxus\") was held to approve the Agreement of Merger (\"Merger Agreement\") dated February 28, 1995, between the Company, YPF Acquisition Corp. (the \"Purchaser\") and YPF Sociedad Anonima (\"YPF\"). The holders of the Company's common stock, $1.00 par value per share, and $4.00 Cumulative Convertible Preferred Stock approved the Merger Agreement, and the Purchaser was merged into the Company (the \"Merger\") on June 8, 1995.\nEffective April 1, 1995, the Company used the purchase method of accounting to record the acquisition of the Company by YPF. In a purchase method combination, the purchase price is allocated to acquired assets and assumed liabilities based on their fair values at the date of acquisition. As a result, the Company's assets and liabilities were revalued to reflect the approximate $762 million cash purchase price paid by YPF to acquire the Company. The Company's pre-Merger Consolidated Balance Sheet as of March 31, 1995, together with the purchase method accounting adjustments became the Company's opening post-Merger Consolidated Balance Sheet on April 1, 1995.\nThe following pre-Merger data is for the three months ended March 31, 1995, and the years ended December 31, 1994 and 1993 and dollar amounts in tables are in millions, except per share amounts. The financial statements for the three-month period ended March 31, 1995, and the years ended December 31, 1994 and 1993 are presented separately as pre-Merger and post-Merger financial information are not comparable. Certain data for 1994 and 1993 has been reclassified to conform with the 1995 presentation.\nNOTE ONE--SIGNIFICANT ACCOUNTING POLICIES\nThe Consolidated Financial Statements have been prepared in conformity with generally accepted accounting principles, the most significant of which are described below.\nConsolidation and Equity Accounting\nThe Consolidated Financial Statements include the accounts of Maxus Energy Corporation and all domestic and foreign subsidiaries. The Company used the equity method to account for its less than majority owned investments in affiliates and joint ventures (\"Associated Companies\"). Under the equity method, the Company recognizes its proportionate share of the net income or loss of Associated Companies currently, rather than when realized through dividends or disposal. The Company used the proportionate consolidation method to account for its investment in Diamond Shamrock Offshore Partners Limited Partnership (\"Offshore Partners\"). The Company sold its investment in Offshore Partners in the second quarter of 1994 (See Note Four). All significant intercompany accounts and transactions have been eliminated.\nStatement of Cash Flows\nInvestments with original maturities of three months or less at the time of original purchase are considered cash equivalents for purposes of the accompanying Consolidated Statement of Cash Flows. Short-term investments include investments with maturities over three months but less than one year.\nMAXUS ENERGY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNet cash provided by operating activities reflects cash receipts for interest income and cash payments for interest expense and income taxes as follows:\nInventory Valuation\nInventories are valued at the lower of historical cost or market value and are primarily comprised of well equipment and supplies. Historical cost is determined primarily by using the weighted average cost method.\nProperties and Equipment\nProperties and equipment are carried at cost. Major additions are capitalized; expenditures for repairs and maintenance are charged against earnings.\nThe Company uses the successful efforts method to account for costs incurred in the acquisition, exploration, development and production of oil and gas reserves. Under this method, all geological and geophysical costs are expensed; all development costs, whether or not successful, are capitalized as costs of proved properties; exploratory drilling costs are initially capitalized, but if the effort is determined to be unsuccessful, the costs are then charged against earnings; depletion is computed based on an aggregation of properties with common geologic structural features or stratigraphic conditions, such as reservoirs or fields.\nFor investment in unproved properties in the United States, a valuation allowance (included as an element of depletion) is provided by a charge against earnings to reflect the impairment of unproven acreage. Investment in international non-producing leasehold costs are reviewed periodically by management to insure the carrying value is recoverable based upon the geological and engineering estimates of total possible and probable reserves expected to be added over the remaining life of each concession. Based upon increases to proved reserves determined by reserve reports, a portion of the investment in international non-producing leasehold costs will be periodically transferred to investment in proved properties.\nDepreciation and depletion related to the costs of all development drilling, successful exploratory drilling and related production equipment is calculated using the unit of production (\"UOP\") method based upon estimated proved developed reserves. Leasehold costs are amortized using the UOP method based on estimated total proved reserves. Other properties and equipment are depreciated generally on the straight-line method over their estimated useful lives. Intangible assets are amortized on the straight-line method over their legal or estimated useful lives, not to exceed 40 years. Estimated future dismantlement, restoration and abandonment costs for major facilities, net of salvage value, are taken into account in determining depreciation, depletion and amortization.\nThe Company capitalizes the interest cost associated with major property additions and mineral development projects while in progress, such amounts being amortized over the useful lives, and applying the same depreciation method, as that used for the related assets.\nWhen complete units of depreciable property are retired or sold, the asset cost and related accumulated depreciation are eliminated with any gain or loss reflected in other revenues, net. When less than complete units of depreciable property are disposed of or retired, the difference between asset cost and salvage or sales value is charged or credited to accumulated depreciation and depletion.\nMAXUS ENERGY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDeferred Charges\nDeferred charges are primarily comprised of debt issuance costs and are amortized over the terms of the related debt agreements.\nRevenue Recognition\nOil and gas sales are recorded on the entitlements method. Differences between the Company's actual production and entitlements result in a receivable when underproduction occurs and a payable when overproduction occurs. These underproduced or overproduced volumes are valued based on the weighted average sales price for each respective property. The Company's gross underproduced and overproduced values at March 31, 1995, are not material.\nPensions\nThe Company has a number of trusteed noncontributory pension plans covering substantially all full-time employees. The Company's funding policy is to contribute amounts to the plans sufficient to meet the minimum funding requirements under governmental regulations, plus such additional amounts as management may determine to be appropriate. The benefits related to the plans are based on years of service and compensation earned during years of employment. The Company also has a noncontributory supplemental retirement plan for executive officers.\nOther Postretirement and Postemployment Benefits\nThe Company provides certain health care and life insurance benefits for retired employees and certain insurance and other postemployment benefits for individuals whose employment is terminated by the Company prior to their normal retirement. The Company accrues the estimated cost of retiree benefit payments, other than pensions, during employees' active service period. Employees become eligible for these benefits if they meet minimum age and service requirements. The Company accounts for benefits provided after employment but before retirement by accruing the estimated cost of postemployment benefits when the minimum service period is met, payment of the benefit is probable and the amount of the benefit can be reasonably estimated. The Company's policy is to fund other postretirement and postemployment benefits as claims are incurred.\nEnvironmental Expenditures\nEnvironmental liabilities are recorded when environmental assessments and\/or remediation are probable and material and such costs to the Company can be reasonably estimated. The Company's estimate of environmental assessment and\/or remediation costs to be incurred are based on either 1) detailed feasibility studies of remediation approach and cost for individual sites or 2) the Company's estimate of costs to be incurred based on historical experience and publicly available information, based on the stage of assessment and\/or remediation of each site. As additional information becomes available regarding each site or as environmental remediation standards change, the Company revises its estimate of costs to be incurred in environmental assessment and\/or remediation.\nIncome Taxes\nThe Company reports income taxes in accordance with Statement of Financial Accounting Standards No. 109 (\"SFAS 109\"), Accounting for Income Taxes. SFAS 109 requires the use of an asset and liability approach to measure deferred tax assets and liabilities resulting from all expected future tax consequences of events that have been recognized in the Company's financial statements or tax returns. Additionally, SFAS 109 requires that annual taxes are to be allocated to interim periods on the basis of the requirements of\nMAXUS ENERGY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nAccounting Principles Board Opinion No. 28 (\"APB 28\"), Interim Financial Reporting. The reporting requirements of APB 28 are based on the view that each interim period is an integral part of the related annual period.\nBecause the tax year of the Company did not close in any relevant jurisdiction on March 31, 1995, taxes were not measured on deferred tax liabilities and assets at that time. In accordance with APB 28 and SFAS 109, taxes were allocated to the period based on the estimated annual effective tax rate for the period ended December 31, 1995.\nEarnings per Share\nPrimary earnings per share are based on the weighted average number of shares of common stock and common stock equivalents outstanding, unless the inclusion of common stock equivalents has an antidilutive effect on earnings per share. Fully diluted earnings per share are not presented due to the antidilutive effect of including all potentially dilutive common stock equivalents.\nFinancial Instruments with Off-Balance-Sheet Risk and Concentrations of Credit Risk\nThe Company's financial instruments that are exposed to concentrations of credit risk consist primarily of cash equivalents, short-term investments, restricted cash and trade receivables.\nThe Company's cash equivalents, short-term investments and restricted cash represent high-quality securities placed with various high investment grade institutions. This investment practice limits the Company's exposure to concentrations of credit risk.\nThe Company's trade receivables are dispersed among a broad domestic and international customer base; therefore, concentrations of credit risk are limited. The Company carefully assesses the financial strength of its customers. Letters of credit are the primary security obtained to support lines of credit.\nThe Company has minimal exposure to credit losses in the event of nonperformance by the counterparties to its interest rate swap agreement, natural gas price swap agreements and nonderivative financial assets. The Company does not obtain collateral or other security to support financial instruments subject to credit risk but restricts such arrangements to investment-grade counterparties.\nInvestments in Marketable Securities\nEffective January 1, 1994, the Company adopted Statement of Financial Accounting Standards No. 115, (\"SFAS 115\") \"Accounting for Certain Investments in Debt and Equity Securities.\" SFAS 115 requires that investments in debt and equity securities be reported at fair value except for those investments in debt securities which management has the intent and the ability to hold to maturity. Investments in debt securities which are held-for-sale are classified based on the stated maturity and management's intent to sell the securities. Unrealized gains and losses on investments in marketable securities, except for debt securities classified as \"held-to-maturity\", are reported as a separate component of stockholders' equity. The cumulative effect of adopting SFAS 115 of $2.4 million was recorded as a valuation reserve in shareholders' equity. The Company's gross unrealized loss on its involvement in marketable securities which are included in long-term investments at March 31, 1995, was $1.3 million which was entirely comprised of unrealized losses on the Company's investment in U. S. Treasury Notes. Prior to the adoption of SFAS 115, the Company accounted for its investments in debt securities at amortized cost and classified such investments according to the stated maturity of the underlying securities.\nMAXUS ENERGY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDerivatives\nThe Company periodically hedges the effects of fluctuations in the price of crude oil and natural gas through price swap agreements and futures contracts. The Company historically has hedged no more than 50% of its U. S. gas production. Gains and losses on these hedges are deferred until the related sales are recognized and are recorded as a component of sales and operating revenues. The Company periodically enters into interest rate swap agreements to hedge interest on long-term debt. The gain or loss on interest rate swaps is recognized monthly as a decrease or increase to interest expense.\nTake-or-Pay Obligations\nThe Company records payments received for take-or-pay obligations for unpurchased contract volumes as deferred revenue, which is included in Other Liabilities in the consolidated balance sheet. The deferred revenue is recognized in the income statement as quantities are delivered which fulfill the take-or-pay obligation. At March 31, 1995, the Company had $13.6 million in deferred revenue as a result of a take-or-pay payment received related to its Indonesian operations.\nNOTE TWO--MASTER LIMITED PARTNERSHIP\nIn 1994, the Company sold its interests in Offshore Partners, a master limited partnership, which explored for and produced natural gas and crude oil on federal offshore leases in the Gulf of Mexico (See Note Four). Maxus Offshore Exploration Company, a wholly owned subsidiary of the Company, and the Company had a combined 1% general partner's interest in Offshore Partners and were the managing general partner and special general partner, respectively. The Company had an aggregate interest in Offshore Partners of approximately 87.1% at December 31, 1993.\nNOTE THREE--PRE-MERGER COSTS\nIn March 1995, the Company recorded $42.4 million of pre-merger costs associated with the Merger. Such costs, which included expenses associated with financial consulting and legal services, severance payments pursuant to change of control agreements and payments for surrender of stock options and restricted stock, were recorded in accrued liabilities in the consolidated balance sheet.\nNOTE FOUR--RESTRUCTURING\nAsset Sales\nOn April 25, 1994, Offshore Partners sold its interests in Main Pass Blocks 72, 73 and 74. On April 26, 1994, Maxus and its subsidiaries sold all of their partnership interests in Offshore Partners. On June 22, 1994, Maxus also sold the McFarlan Field and Grand Isle Block 25, both producing oil and gas properties. In total, the Company received $324.6 million of proceeds and recorded a net gain of $201.9 million from these transactions.\nRestructuring Costs\nIn June 1994, the Company recorded a $100.9 million restructuring charge. The charge included a $69.8 million write-off associated with undeveloped Alaska coal leases, the development of which does not fit within the Company's strategy to commit funds only to oil and gas exploration and production. The charge also included costs associated with staff reductions and the write-off of non-producing assets outside the Company's core areas.\nMAXUS ENERGY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE FIVE--ASSET ACQUISITIONS AND DIVESTITURES\nIn September of 1994, the Company sold its geothermal subsidiary, Thermal Power Company, for approximately $58 million net in cash and a $6.5 million promissory note due from the purchaser in 1997. A $12.6 million loss on the sale of these assets was recognized.\nIn November of 1993, the Company transferred its working interest in the Recetor Block in Colombia to its partner for partial recoupment of its investment. Maxus received $10 million and retained an overriding royalty interest (\"ORI\"). There was no gain or loss recognized on this transaction. In December 1995, the Company sold its ORI to the same party for $25 million.\nIn October 1993, the Company and its Venezuelan partner, Otepi Consultores, S.A., were awarded an operating service agreement to reactivate Venezuelan oil fields with Lagoven, S.A., an affiliate of the national oil company, Petroleos de Venezuela, S.A. Under the terms of the operating service agreement, Maxus will be a contractor for Lagoven and will be responsible for overall operations of the Quiriquire Unit, including all necessary investments to reactivate the fields comprising the unit. Maxus will receive a fixed fee in U.S. dollars for each barrel of crude oil produced based on an average international crude oil price. Maxus is reimbursed in U.S. dollars for its capital expenditures, provided that such fee and expense reimbursement cannot exceed the maximum dollar amount per barrel set forth in the agreement. The Venezuelan government will retain full ownership of all hydrocarbons in the field.\nDuring the second quarter of 1994, Maxus Venezuela (C.I.) Ltd., a subsidiary of Maxus, signed an agreement with BP Exploracion de Venezuela S.A., granting BP a 45% interest in the Quiriquire Unit in eastern Venezuela. Maxus Venezuela remained the operator with a 50% interest and Otepi Consultores, a Venezuelan company, holds the remaining 5%. Also, during the second quarter of 1994, Maxus Bolivia, Inc., a subsidiary of Maxus, signed an agreement to take BHP Petroleum as a partner in its Bolivian oil development project. The Company received $10 million from BHP in exchange for a 50% interest in the project.\nNOTE SIX--GEOGRAPHIC DATA\nThe Company is engaged primarily in the exploration for and the production and sale of crude oil and natural gas. Sales, operating profit and identifiable assets by geographic area were as follows:\nMAXUS ENERGY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNet foreign assets were $685.5 million at March 31, 1995, $701.4 million at December 31, 1994 and $673.5 million at December 31, 1993.\nIncome from foreign operations, after applicable local income taxes, was $16.7 million for the three months ended March 31, 1995 and $63.9 million and $77.8 million for the years ended December 31, 1994 and 1993, respectively.\nSales to three customers for the three months ended March 31, 1995 and the year ended December 31, 1994 and 1993 each represented 10% or more of consolidated sales:\nThe Company does not believe that the loss of Mitsubishi Corporation and Phillips Petroleum Company as customers would adversely affect the Company's ability to market its oil and gas production. Sales to the Company's largest customer, the Indonesian Government, are made primarily pursuant to long-term\nMAXUS ENERGY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nproduction sharing contracts between the Company's Indonesian operations and the Indonesian Government. The Indonesian Government is required to purchase a specified amount of the Company's oil and gas production throughout the life of its operations in Indonesia based on these contracts.\nNOTE SEVEN--TAXES\nThe Company reports income taxes in accordance with SFAS 109 (See Note One). The standard was adopted in January 1993. Adoption, which was made prospectively, had no impact on 1993 earnings or cash flow; however, $21.0 million of deferred tax liabilities which were considered current under SFAS 96 were reclassified as noncurrent and $4.1 million of deferred tax assets were reclassified as current assets.\nIncome before income taxes, extraordinary item and cumulative effect of change in accounting principle was comprised of income (loss) from:\nThe Company's provision for income taxes was comprised of the following:\nMAXUS ENERGY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nThe principal reasons for the difference between tax expense at the statutory federal income tax rate of 35% and the Company's provision for income taxes were:\n\"Items not related to current year earnings\" in 1994 includes tax benefit from the favorable resolution of a federal tax refund suit.\nThe tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities for the three months ended March 31, 1995, December 31, 1994 and 1993 were as follows:\nMAXUS ENERGY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nThe valuation allowance was $92.6 million upon adoption of SFAS 109. The valuation allowance was increased $23.4 million during 1994 and $13.9 million during the first three months of 1995, primarily due to the increase in loss carryforwards.\nBecause the tax year of the Company did not close on March 31, 1995, tax carryovers are not measured at that date. At December 31, 1994, the Company had $13.1 million of general business credit carryforwards that expire between 1996 and 2002; $103.8 million of U.S. net operating loss carryforwards that expire in 2003, 2005 and 2008; and $10.1 million of minimum tax credit that can be carried forward indefinitely.\nAs a result of the Merger, effective April 1, 1995, the Company's ability to utilize its existing net operating loss carryforwards will be limited by statute to approximately $92.0 million each year until exhausted. To the extent certain gains are recognized in the future, the annual limitation may be increased to the extent that the gains are built-in gains within the meaning of the U.S. Internal Revenue Code.\nThere are accumulated undistributed earnings after applicable local taxes of foreign subsidiaries of $6.4 million at March 31, 1995 for which no provision was necessary for foreign withholding or other income taxes because that amount had been reinvested in properties and equipment and working capital in the foreign jurisdictions.\nTaxes other than income taxes were comprised of the following:\nNOTE EIGHT--POSTEMPLOYMENT BENEFITS\nPensions\nThe components of net periodic pension expense are as follows:\nDue to an early retirement program offered to former employees, the Company recognized a settlement loss of $1.7 million on one of its plans in 1994.\nMAXUS ENERGY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nPlan assets are primarily invested in short-term investments and stocks and bonds. The principal assumptions used to estimate the benefit obligations of the plans on the measurement date, October 1, 1994 were as follows:\nThe funded status of the plans at March 31, 1995 and December 31, 1994 were as follows:\nAt March 31, 1995 and December 31, 1994, the Company's accumulated postretirement benefit obligation (\"APBO\") exceeded the plan assets. In accordance with Statement of Financial Accounting Standards No. 87, \"Employers' Accounting for Pensions,\" the Company recorded a minimum pension liability of $19.2 million and a charge to equity of $18.3 million at March 31, 1995 and December 31, 1994.\nIn addition to the defined benefit plans, the Company has a defined contribution plan which covers Indonesian nationals. Employee contributions of 2% of each covered employee's compensation are matched by the Company with a contribution of 6% of compensation by the Company. Contributions to the plan were $.1 million in the first quarter of 1995 and $.4 million in 1994.\nOther Postretirement Benefits\nEffective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 106 (\"SFAS 106\"), \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" for its retiree health and welfare benefits plan. Under SFAS 106, the Company is required to accrue the estimated cost of retiree benefit payments, other than pensions, during employees' active service period. The Company previously expensed the cost of these benefits, which are principally medical benefits, as claims were incurred. The Company currently administers several unfunded postretirement medical and life insurance plans covering primarily U. S. employees which are, depending on the type of plan, either contributory or noncontributory. Employees become eligible for these benefits if they meet minimum age and service\nMAXUS ENERGY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nrequirements. At January 1, 1993, the estimated APBO was $46.1 million, which the Company elected to amortize over a 20-year period.\nDuring 1994, the Company's postretirement medical and life insurance plans experienced a partial curtailment due to the Company's decision to reduce staff. The effect of the curtailment was a $6.6 million charge to earnings in 1994, which was included as a component of the restructuring costs (See Note Four), primarily due to accelerated recognition of the transition obligation.\nThe components of net periodic postretirement benefit expense for the three months ended March 31, 1995 and for the years ended December 31, 1994 and 1993 are as follows:\nThe APBO as of March 31, 1995 was $44.4 million. The amount recognized in the Company's statement of financial position at March 31, 1995 and December 31, 1994 is as follows:\nA discount rate of 8.5% was used in determining the APBO for the three months ended March 31, 1995 and the year ended December 31, 1994. The APBO was based on a 10.4% increase in the medical cost trend rate, with the rate trending downward .6% per year to 5% in 2003 and remaining at 5% thereafter. This assumption has a significant effect on annual expense, as it is estimated that a 1% increase in the medical trend rate would increase the APBO by $4.2 million and increase the net periodic postretirement benefit cost by $.4 million per year.\nOther Postemployment Benefits\nIn 1993 the Company adopted, Statement of Financial Accounting Standards No. 112 (\"SFAS 112\"), \"Employers' Accounting for Postemployment Benefits,\" to account for benefits provided after employment but before retirement. SFAS 112 requires an accrual method of recognizing the cost of providing postemployment benefits. Prior to 1993, postemployment benefit expenses were recognized as paid. The Company recognized the cumulative effect of the change in accounting for postemployment benefits in 1993, which resulted in a charge of $4.4 million. This liability primarily represents medical benefits for long-term disability recipients. Future annual costs are expected to be immaterial. Net periodic postemployment benefit expense\nMAXUS ENERGY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nwas insignificant for the three months ended March 31, 1995 and for the years ended December 31, 1994 and 1993.\nNOTE NINE--FINANCIAL 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 value of financial instruments approximates their recorded values.\nRestricted Cash\nThe fair value of the Company's restricted cash, which is invested primarily in U. S. Treasury notes, marketable securities and trust accounts is based on the quoted market prices for the same or similar securities at the reporting date.\nLong-Term Investments\nThe fair value of the Company's long-term investments, which are primarily U. S. Treasury notes and long-term notes receivable, is based on the quoted market prices for the same or similar investments at the reporting date.\nLong-Term Debt\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.\nThe estimated fair value of the Company's financial instruments are as follows:\nFor information on the Company's derivative financial instruments, see Note Seventeen.\nNOTE TEN--RECEIVABLES\nMAXUS ENERGY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE ELEVEN--PROPERTIES AND EQUIPMENT\nThe charge against earnings for depreciation, depletion and amortization of property and equipment was $29.9 million for the three months ended March 31, 1995, and $138.9 million and $152.3 million for the years ended December 31, 1994 and 1993, respectively. The charge against earnings for maintenance and repairs was $7.4 million for the three months ended March 31, 1995, and $38.9 million and $35.0 million for the years ended December 31, 1994 and 1993, respectively.\nNOTE TWELVE--INVESTMENTS AND LONG-TERM RECEIVABLES\nIn September 1994, the Company sold its geothermal subsidiary, Thermal Power Company, which owned Union-Magma-Thermal Tax Partnership (\"UMT\") (See Note Five). The investment in UMT was carried on the equity method prior to the sale of Thermal Power Company. The following schedule presents certain summarized financial information of UMT:\nThe Company's equity earnings are principally from UMT and were $5.2 million in 1994 and $10.2 million in 1993.\nNOTE THIRTEEN--RESTRICTED CASH\nAt March 31, 1995 and December 31, 1994, the Company had $128.4 million and $140.6 million, respectively, in restricted cash, of which $64.0 million in 1995 and $78.5 million in 1994 represented collateral for outstanding letters of credit. Assets held in trust as required by certain insurance policies were $64.4 million in 1995 and $62.1 million in 1994. Approximately $48.5 million and $46.4 million of collateral for outstanding letters of credit at March 31, 1995 and December 31, 1994, respectively, was classified as a current asset.\nMAXUS ENERGY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE FOURTEEN--INTANGIBLE ASSETS\nIntangibles, primarily the excess of cost over fair market value of net assets acquired, were $50.0 million at March 31, 1995 and December 31, 1994. Accumulated amortization at March 31, 1995 and December 31, 1994 was $14.5 million and $14.2 million, respectively. The charge against earnings for amortization of intangible assets was $0.3 million for the three months ended March 31, 1995 and $1.3 million for the years ended December 31, 1994 and 1993.\nNOTE FIFTEEN--ACCRUED LIABILITIES\nNOTE SIXTEEN--LONG-TERM DEBT AND CREDIT ARRANGEMENTS\nThe aggregate maturities of long-term debt outstanding at March 31, 1995, for the next five years will be as follows:\nMAXUS ENERGY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nAt March 31, 1995 and December 31, 1994, the Company had $149.3 million of medium-term notes outstanding, which were issued in prior years, with maturities from 1995 to 2004 and annual interest rates ranging from 7.57% to 11.08%.\nThe Company maintains a $25.0 million uncommitted credit facility (the \"credit facility\") which is used for the issuance of documentary or standby letters of credit and\/or the payment of shipping documents. The credit facility can be secured by cash or the accounts receivable which are financed through the letters of credit. At March 31, 1995, there were $24.5 million of cash collateralized letters of credit outstanding under this credit facility.\nTotal interest and debt expenses incurred, including capitalized interest, were as follows:\nNOTE SEVENTEEN--DERIVATIVE FINANCIAL INSTRUMENTS\nThe Company's only derivative financial instruments are an interest rate swap agreement with an investment broker, natural gas price swap agreements and crude oil and natural gas futures contracts, which are not used for trading purposes.\nInterest Rate Swap Agreement\nEffective January 27, 1993, the Company entered into an interest rate swap agreement under which it pays the counterparty interest at a variable rate based on the London Interbank Offering Rate (LIBOR) and the counterparty pays the Company interest at 6.73% on the notional principal of $100.0 million. This agreement is effective through January 27, 2003. The Company is not required to collateralize its obligation under this agreement unless it is in an unfavorable position. At December 31, 1993, the Company had borrowings of $5.8 million against its then favorable position in this interest rate swap agreement. Due to higher interest rates in 1994, the Company's position in the interest rate swap became unfavorable. As a result, the Company was required to collateralize $7.9 million, which was recorded in deferred charges at December 31, 1994. As interest rates declined during the first three months of 1995, the Company reduced its collateralized position by $3.4 million, leaving a balance of $4.5 million recorded in deferred charges at March 31, 1995.\nNatural Gas Price Swap Agreements\nUnder the price swap agreements used to hedge fluctuations in the price of natural gas, the Company receives or makes payments based on the differential between the Company's specified price and the counterparty's specified price of natural gas. Depending on the agreement, the Company pays a fixed or variable price per million British Thermal Units (\"Mmbtu\") and receives a fixed or variable price per Mmbtu. During the three months ended March 31, 1995, the Company had swap agreements with other companies to exchange payments on 0.8 million Mmbtu of gas. Under these swap agreements, the Company paid fixed or variable prices averaging $1.61 per Mmbtu and received fixed or variable prices averaging $1.58 per Mmbtu. Gross gains and gross losses realized on these swap agreements were immaterial.\nMAXUS ENERGY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNatural Gas and Crude Oil Futures Contracts\nUnder the natural gas futures contracts used to hedge fluctuations in the price of natural gas, the Company receives or makes payments based on the differential between the selling price and the settlement price per Mmbtu. During the three months ended March 31, 1995, the Company settled futures contracts with other companies on 1.2 million Mmbtu of gas. Under these futures contracts, the Company received selling prices averaging $1.65 per Mmbtu and paid settlement prices averaging $1.46 per Mmbtu. Realized gross gains on these futures contracts were $0.2 million.\nUnder the crude oil futures contracts used to hedge fluctuations in the price of crude oil, the Company receives or makes payments based on the differential between the selling price and the settlement price per barrel. During the three-month period ended March 31, 1995, crude oil volumes hedged under these futures contracts were insignificant as were gross unrealized gains and losses.\nNOTE EIGHTEEN--PREFERRED STOCK\nThe Company has the authority to issue 100,000,000 shares of Preferred Stock, $1.00 par value. The rights and preferences of shares of authorized but unissued Preferred Stock are established by the Company's Board of Directors at the time of issuance.\n$9.75 Cumulative Convertible Preferred Stock\nIn 1987, the Company sold 3,000,000 shares of $9.75 Cumulative Convertible Preferred Stock (the \"$9.75 Preferred Stock\"). Since such time, the Company has entered into various agreements, most recently on June 8, 1995, with the sole holder of the $9.75 Preferred Stock pursuant to which, among other things, the Company has repurchased 500,000 shares and the parties have waived or amended various covenants, agreements and restrictions relating to such stock. Currently, 1,250,000 shares of $9.75 Preferred Stock are outstanding, each receiving an annual cash dividend of $9.75. In addition, 375,000 of such shares (the \"Conversion Waiver Shares\") each receive an additional quarterly cash payment of $.25 ($.50 in certain circumstances). For the 12-month period commencing February 1, 1995, each share of the $9.75 Preferred Stock has a liquidation value of $101.0836 ($126.4 million in the aggregate) which reduces to $100 at February 1, 1996, in each case plus accrued dividends. Since February 1, 1994, the stock has been subject to mandatory redemption at the rate of 625,000 shares per year. The $9.75 Preferred Stock currently is neither convertible by the holder nor redeemable at the Company's option and has no associated registration rights. The $9.75 Preferred Stock entitles the holder to vote only on certain matters separately affecting such holder, and the $9.75 Preferred Stock other than the Conversion Waiver Shares entitles the holder to elect one individual to the Board of Directors of the Company. In addition, pursuant to the June 8, 1995 agreement, the holder of the $9.75 Preferred Stock waived previously granted rights to approve certain \"self-dealing\" transactions and certain financial covenants pertaining to the Company, and the Company waived its right of first offer with respect to the transfer of the $9.75 Preferred Stock and certain transfer restrictions on such stock.\n$4.00 Cumulative Convertible Preferred Stock\nEach outstanding share of $4.00 Cumulative Convertible Preferred Stock (the \"$4.00 Preferred Stock\") is entitled to one vote, is convertible at any time into shares of the Company's Common Stock (2.29751 shares at March 31, 1995), is entitled to receive annual cash dividends of $4.00 per share, is callable at and has a liquidation value of $50.00 per share ($217.8 million in the aggregate at March 31, 1995) plus accrued but unpaid dividends, if any.\nMAXUS ENERGY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\n$2.50 Cumulative Preferred Stock\nEach outstanding share of the $2.50 Preferred is entitled to shall receive annual cash dividends of $2.50 per share, is callable after December 1, 1998 at and has a liquidation value of $25.00 per share ($87.5 million in the aggregate at March 31, 1995) plus accrued but unpaid dividends, if any.\nThe holders of the shares are entitled to limited voting rights under certain conditions. In the event the Company is in arrears in the payment of six quarterly dividends, the holders of the $2.50 Preferred Stock have the right to elect two members to the Board of Directors until such time as the dividends in arrears are current and a provision is made for the current dividends due.\nNOTE NINETEEN--COMMON STOCK\nOn July 30, 1991, the Company's Dividend Reinvestment and Stock Purchase Plan (the \"Plan\") became effective. The Plan allowed holders of Common Stock to purchase additional shares at a 3% discount from the current market prices without paying brokerage commissions or other charges. In addition, if the Company paid a dividend on its Common Stock in the future, common stockholders could reinvest the amount of those dividends in additional shares also at a 3% discount from the current market prices. In November 1992, the Company effectively suspended the Plan by raising the threshold price.\nAt March 31, 1995 and December 31, 1994, respectively, there were 32.4 million and 35.8 million shares of Common Stock reserved for issuance upon conversion of Preferred Stock, exercises of stock options or issuance under certain employee benefit plans.\nIn 1992, Kidder, Peabody & Co. Incorporated purchased eight million warrants from the Company. Each warrant represents the right to purchase one share of the Company's Common Stock at $13.00 per share at any time prior to the expiration of the warrants on October 10, 1997.\nThe Company has an Employee Shareholding and Investment Plan (\"ESIP\") which allows eligible participating employees to contribute a certain percentage of their salaries (1%-10%) to a trust for investment in any of six funds, one of which consists of the Company's Common Stock. The Company matches the participating employee's contribution to the ESIP (up to 6% of base pay); such matching contribution is charged against earnings and invested in the ESIP fund which consists of the Company's Common Stock. The charge against earnings for the Company's contribution to the ESIP was $0.6 million, $2.8 million and\nMAXUS ENERGY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\n$2.6 million at March 31, 1995, December 31, 1994, and December 31, 1993, respectively. Subsequent to the Merger, contributions can no longer be invested in the Company's Common Stock.\nIn 1988, the Company adopted a Preferred Share Purchase Rights Plan. The plan issued one right for each share of Common Stock and 7.92 rights for each share of $9.75 Cumulative Convertible Preferred Stock outstanding as of the close of business on September 12, 1988. The rights, which entitle the holder to purchase from the Company one one-hundredth of a share of a new series of junior preferred stock at $23.00 per share, become exercisable if a person becomes the beneficial owner of 20% or more of the Company's Common Stock or of an amount that the Board of Directors determines is intended to cause the Company to take certain actions not in the best long-term interests of the Company and its stockholders. The rights also become exercisable if a person makes a tender offer or exchange offer for 30% or more of the Company's outstanding Common Stock. The rights may be redeemed at $.10 per right under certain circumstances. In the Merger Agreement, the Company agreed to redeem the rights. On February 28, 1995, the Board of Directors of the Company took action to redeem the rights, effective as of March 22, 1995. Holders of Common Stock on the close of business on that date received the redemption price of $0.10 per right. Under a separate agreement with the sole holder of the $9.75 Preferred Stock, such holder waived its right to receive the redemption price with respect to the rights associated with the $9.75 Preferred Stock, subject to consummation of the Merger.\nNOTE TWENTY--PAID-IN CAPITAL AND ACCUMULATED DEFICIT\nMAXUS ENERGY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE TWENTY-ONE--UNREALIZED LOSS ON INVESTMENT IN MARKETABLE SECURITIES\nThe amortized cost and estimated fair value of marketable securities at March 31, 1995 are as follows:\nAt March 31, 1995, securities categorized as held-to-maturity are included in cash equivalents, short-term investments and short- and long-term restricted cash. The securities held-for-sale consist of U. S. Treasury notes which mature in August, 2002 and are classified as long-term investments (See Note Twelve).\nThe amortized cost and estimated fair value of marketable securities at December 31, 1994 are as follows:\nAt December 31, 1994, securities categorized as held-to-maturity with maturities of 90 days or less are classified as cash equivalents and those with maturities greater than ninety days are classified as short-term investments. The securities held-for-sale consist of U. S. Treasury notes which mature in August, 2002 and are classified as long-term investments (See Note Twelve).\nNOTE TWENTY-TWO--COMMON TREASURY STOCK\nNOTE TWENTY-THREE--STOCK OPTIONS\nTwo plans, a Long-Term Incentive Plan and a Director Stock Option Plan, were approved by the stockholders in 1992. The Company's 1986 and 1992 Long-Term Incentive Plans (the \"Incentive Plans\"), administered by the Compensation Committee of the Board of Directors, permit the grant to officers and certain key employees of stock options, stock appreciation rights (\"SARs\"), performance units and awards of Common Stock or other securities of the Company on terms and conditions determined by the Compensation Committee of the Board of Directors.\nMAXUS ENERGY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nThe Director Stock Option Plan became effective on September 1, 1992. Under this plan, non-employee directors received options to purchase shares of Common Stock on the effective date of the plan. Thereafter, upon initial election or re-election of a non-employee director at an annual meeting, the non-employee directors automatically receive options to purchase shares of Common Stock. The plan terminated on June 7, 1995.\nThe grant or exercise of an option does not result in a charge against the Company's earnings because all options have been granted at exercise prices approximating the market value of the stock at the date of grant. However, any excess of Common Stock market price over the option price of options, which includes SARs, does result in a charge against the Company's earnings; a subsequent decline in market price results in a credit to earnings, but only to a maximum of the earnings charges incurred in prior years on SARs.\nStock option activity was as follows:\nExercise prices of stock options outstanding at March 31, 1995 ranged from $5.00 to $13.75 per share. There was a credit to earnings for SARs in 1993 of $.1 million. There was no earnings activity related to SARs in 1994 or for the period ended March 31, 1995. Effective upon the Merger, all stock options and restricted stock outstanding under Company-sponsored incentive plans were surrendered to the Company.\nUnder the 1986 Long-Term Incentive Plan, the Company granted Restricted Stock. The amount of the grant price is amortized over the vesting period of the grant as a charge against earnings. The charge against earnings was $0.5 million for the period ended March 31, 1995, $1.4 million in 1994 and $2.4 million in 1993.\nIn 1993, the Company issued performance units under the Long-Term Incentive Plan. The performance unit entitles the grantee to the value of a share of Common Stock contingent upon the performance of the Company compared to a selected group of peer companies. The value of the performance unit is amortized over the vesting period based on a weighted probability of expected payout levels. The charge against earnings was $0.6 million in 1993. There was no earnings activity related to performance units in 1994. For the period ended March 31, 1995, there was a credit to earnings of $0.6 million.\nEffective upon the Merger, all stock options and restricted stock outstanding under Company-sponsored incentive plans were surrendered to the Company. In March 1995, the Company recorded a $9.9 million charge to earnings to record the estimated cost to redeem all outstanding options and restricted stock. This charge was included in pre-Merger costs in the Company's consolidated statement of operations (See Note Three).\nMAXUS ENERGY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE TWENTY-FOUR--LEASES\nThe Company leases certain machinery and equipment, facilities and office space under cancelable and noncancelable operating leases, most of which expire within 20 years and may be renewed.\nMinimum annual rentals for non-cancelable operating leases at March 31, 1995, were as follows:\nMinimum annual rentals have not been reduced by minimum sublease rentals of $38.7 million due in the future under noncancelable subleases.\nRental expense for operating leases was as follows:\nNOTE TWENTY-FIVE--COMMITMENTS AND CONTINGENCIES\nLike other energy companies, Maxus' operations are subject to various laws related to the handling and disposal of hazardous substances which require the cleanup of deposits and spills. Compliance with the laws and protection of the environment worldwide is of the highest priority to Maxus management. In the first quarter of 1995, the Company spent $1.4 million in environmental related expenditures for its oil and gas operations.\nIn addition, the Company is implementing certain environmental projects related to its former chemicals business (\"Chemicals\") sold to an affiliate of Occidental Petroleum Corporation (collectively, \"Occidental\") in 1986 and certain other disposed of businesses. The environmental projects discussed below relating to Chemicals' business are being conducted on behalf of Occidental pursuant to the sale agreement.\nThe Company has agreed to remediate the site of the former agricultural chemical plant in Newark, New Jersey as required by a consent decree entered into in 1990 by Occidental, the United States Environmental Protection Agency (the \"EPA\") and the New Jersey Department of Environmental Protection and Energy (the \"DEP\"). Pursuant to an agreement with the EPA, the Company is conducting further testing and studies to characterize contaminated sediment in a portion of the Passaic River near the plant site. The Company has been conducting similar studies under its own auspices for several years.\nUnder an Administrative Consent Order issued by the DEP in 1990, covering sites primarily in Kearny and Secaucus, New Jersey, the Company will continue to implement interim remedial measures and to perform remedial investigations and feasibility studies and, if necessary, will implement additional remedial actions at various locations where chromite ore residue, allegedly from the former Kearny plant, was utilized, as well as at the plant site.\nMAXUS ENERGY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nUntil 1976, Chemicals operated manufacturing facilities in Painesville, Ohio. The Company has heretofore conducted many remedial, maintenance and monitoring activities at this site. The former Painesville plant area has been proposed for listing on the national priority list of Superfund sites. The scope and nature of further investigation or remediation which may be required cannot be determined at this time.\nThe Company also has responsibility for Chemicals' share of the remediation cost for a number of other non-plant sites where wastes from plant operations by Chemicals were allegedly disposed of or have come to be located, including several commercial waste disposal sites.\nAt the time of the spin-off by the Company of Diamond Shamrock, Inc. (\"DSI\") in 1987, the Company executed a cost-sharing agreement for the partial reimbursement by DSI of environmental expenses related to the Company's disposed of businesses, including Chemicals. DSI is expected to reach its total reimbursement obligation in 1996.\nThe Company's total expenditures for environmental compliance for disposed of businesses, including Chemicals, were $7.9 million in the first quarter of 1995, $2.6 million of which was recovered from DSI under the cost-sharing agreement.\nReserves have been established for environmental liabilities where they are material and probable and can be reasonably estimated. At March 31, 1995 and December 31, 1994, reserves for the above environmental contingencies totaled $84.7 million and $87.1 million, respectively. During 1994, the Company increased its reserve for future environmental liabilities by $60.5 million, primarily in response to the EPA's proposal of chromium clean-up standards and for additional costs expected to be incurred at Chemicals' former Newark, New Jersey plant site.\nThe Company enters into various operating agreements and capital commitments associated with the exploration and development of its oil and gas properties. Such contractual financial and\/or performance commitments are not material.\nThe Company's foreign petroleum exploration, development and production activities are subject to political and economic uncertainties, expropriation of property and cancellation or modification of contract rights, foreign exchange restrictions and other risks arising out of foreign governmental sovereignty over the areas in which the Company's operations are conducted, as well as risks of loss in some countries due to civil strife, guerrilla activities and insurrection. Areas in which the Company has significant operations include the United States, Indonesia, Ecuador, Bolivia and Venezuela.\nThe Company has begun discussions with various government entities in Ecuador regarding a number of issues related to Block 16 and the Tivacuno area, including the Company's cost recovery claims, the approval of budgets, contract terms and other operating matters. The Company believes these matters will be satisfactorily resolved.\nREPORT OF MANAGEMENT\nTo the Stockholders of Maxus Energy Corporation\nThe Consolidated Financial Statements have been prepared in conformity with generally accepted accounting principles and have been audited by Arthur Andersen LLP, independent accountants, for the three months ended March 31, 1995 and the nine months ended December 31, 1995 and have been audited by Price Waterhouse LLP, independent accountants, for the two years in the period ended December 31, 1994.\nIn meeting its responsibility for the reliability of the Consolidated Financial Statements, the Company depends on its accounting and control systems. These systems are designed to provide reasonable assurance that assets are safeguarded against loss from unauthorized use and that transactions are executed in accordance with the Company's authorizations and are recorded properly. The Company believes that its accounting and control systems provide reasonable assurance that errors or irregularities that could be material to the Consolidated Financial Statements are prevented or would be detected within a timely period. The Company also requires that all officers and other employees adhere to a written business conduct policy.\nThe independent accountants provide an objective review as to the Company's reported operating results and financial position. The Company also has an active operations auditing program which monitors the functioning of the Company's accounting and control systems and provides additional assurance that the Company's operations are conducted in a manner which is consistent with applicable laws.\nThe Board of Directors pursues its oversight role for the Consolidated Financial Statements through the Audit Review Committee which is composed solely of directors who are not employees of the Company. The Audit Review Committee meets with the Company's financial management and operations auditors periodically to review the work of each and to monitor the discharge of their responsibilities. The Audit Review Committee also meets periodically with the Company's independent accountants without representatives of the Company present, to discuss accounting, control, auditing and financial reporting matters.\n\/s\/ W. MARK MILLER W. Mark Miller Executive Vice President and Treasurer (Principal Financial Officer)\n\/s\/ LINDA R. ENGELBRECHT Linda R. Engelbrecht Controller (Principal Accounting Officer)\nDallas, Texas February 2, 1996\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Stockholders and Board of Directors of Maxus Energy Corporation\nWe have audited the accompanying consolidated balance sheets of Maxus Energy Corporation (a Delaware corporation) and subsidiaries as of March 31, 1995 and December 31, 1995, and the related consolidated statements of operations and cash flows for the three months ended March 31, 1995 and the nine months ended December 31, 1995. 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 provides a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Maxus Energy Corporation and its subsidiaries as of March 31, 1995 and December 31, 1995, and the results of its operations and its cash flows for the three months ended March 31, 1995 and the nine months ended December 31,1995, in conformity with generally accepted accounting principles.\n\/s\/ ARTHUR ANDERSEN LLP ARTHUR ANDERSEN LLP\nDallas, Texas February 2, 1996\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Stockholders and Board of Directors of Maxus Energy Corporation\nIn our opinion, 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 Maxus Energy Corporation and its subsidiaries at December 31, 1994 and the 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. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.\nAs discussed in Notes 1, 7 and 8 to the Consolidated Financial Statements, the Company changed its methods of accounting for income taxes, postretirement benefits and postemployment benefits in 1993.\n\/s\/ PRICE WATERHOUSE LLP PRICE WATERHOUSE LLP\nDallas, Texas February 28, 1995\nFINANCIAL SUPPLEMENTARY INFORMATION (Unaudited)\n(DATA IS AS OF DECEMBER 31 FOR THE YEARS ENDED 1993 AND 1994 AND AS OF MARCH 31 FOR THE FIRST QUARTER THEN ENDED 1995. THE DOLLAR AMOUNTS IN TABLES ARE IN MILLIONS, EXCEPT PER SHARE)\nOIL AND GAS PRODUCING ACTIVITIES\nThe following are disclosures about the oil and gas producing activities of the Company as required by Statement of Financial Accounting Standards No. 69 (\"SFAS 69\").\nResults of Operations\nResults of operations from all oil and gas producing activities are shown below. These results exclude revenues and expenses related to the purchase of natural gas and the subsequent processing and resale of such natural gas plus the sale of natural gas liquids extracted therefrom.\n- ---------------\n(a) Includes United States gathering and processing costs related to sales. Such costs were $3.1 million, $11.8 million and $15.1 million for March 31, 1995, December 31, 1994 and 1993, respectively.\n(b) Production costs, Exploration costs and Other have been restated for the years ended December 31, 1994 and 1993 to be consistent with current period presentation.\nCapitalized Costs\nIncluded in properties and equipment are capitalized amounts applicable to the Company's oil and gas producing activities. Such capitalized amounts include the cost of mineral interests in properties, completed and incomplete wells and related support equipment as follows:\nCosts Incurred\nCosts incurred by the Company in its oil and gas producing activities (whether capitalized or charged against earnings) were as follows:\n- ---------------\n(a) Exploration costs have been restated for the years ended December 31, 1994 and 1993 to be consistent with current period presentation.\nOil and Gas Reserves\nThe following table represents the Company's net interest in estimated quantities of developed and undeveloped reserves of crude oil, condensate, natural gas liquids and natural gas and changes in such quantities at quarter-end March 31, 1995 and at year-end 1994 and 1993. Net proved reserves are the 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 reserve volumes that can be expected to be recovered through existing wells with existing equipment and operating methods. Proved undeveloped reserves are proved reserve volumes that are expected to be recovered from new wells on undrilled acreage or from existing wells where a significant expenditure is required for recompletion.\nEstimates of reserves were prepared by the Company using standard geological and engineering methods generally accepted by the petroleum industry and in accordance with the rules and regulations of the Securities and Exchange Commission (\"SEC\"). The choice of method or combination of methods employed in the analysis of each reservoir was determined by experience in the area, stage of development, quality and completeness of basic data, and production history. There are numerous uncertainties inherent in estimating quantities of proved reserves and in projecting future rates of production and timing of development expenditures, including many factors beyond the control of the producer. Reserve engineering is a subjective process of estimating underground accumulations of crude oil and natural gas that cannot be measured in an exact manner, and the accuracy of any reserve estimate is a function of the quality of available data and of engineering and geological interpretation and judgment. As a result, estimates of different engineers often vary. In addition, results of drilling, testing and production subsequent to the date of an estimate may justify revision of such estimate. Accordingly, reserve estimates are often different from the quantities of crude oil and natural gas that are ultimately recovered. The meaningfulness of such estimates is highly dependent upon the accuracy of the assumption upon which they were based. The reserve estimates were subjected to economic tests to determine economic limits. The estimates may change as a result of numerous factors including, but not limited to, additional development activity, evolving production history, and continued reassessment of the viability of production under varying economic conditions.\n- ---------------\n(a) The changes reflect the impact of the change in the price of crude oil on the barrels to which the Company is entitled under the terms of the Indonesian production sharing contracts. The Indonesian production sharing contracts allow the Company to recover tangible production and exploration costs, as well as operating costs. As the price of crude oil fluctuates, the Company is entitled to more or less barrels of cost recovery oil. Increasing prices at the end of 1994 resulted in a decrease of 11.7 million barrels. Decreasing prices resulted in an increase of 24.3 million barrels in 1993.\n(b) Natural gas is reported on the basis of actual or calculated volumes which remain after removal, by lease or field separation facilities, of liquefiable hydrocarbons and of non-hydrocarbons where they occur in sufficient quantities to render the gas unmarketable. Natural gas reserve volumes include liquefiable hydrocarbons approximating 11% of total gas reserves in the United States and 5% in Indonesia which are recoverable at natural gas processing plants downstream from the lease or field separation facilities. Such recoverable liquids also have been included in natural gas liquids reserve volumes.\n(c) Reserves in Venezuela attributable to an operating service agreement under which all hydrocarbons are owned by the Venezuelan government have not been included. Production reported in Oil and Gas reserves does not include Venezuela production but it is included in net oil sales reported in Exploration and Production Statistics. The SFAS 69 Results of Operations, Capitalized Costs and Costs Incurred disclosures include costs related to Venezuela.\n(d) Reserves are estimated at year end only. Reserves at March 31, 1995 are December 31, 1994 reserves adjusted only for the production for the first quarter of 1995 and purchase of properties in the United States.\nFuture Net Cash Flows\nThe standardized measure of discounted future net cash flows relating to the Company's proved oil and gas reserves is calculated and presented in accordance with Statement of Financial Accounting Standards\nNo. 69. Accordingly, future cash inflows were determined by applying year-end oil and gas prices (adjusted for future fixed and determinable price changes) to the Company's estimated share of future production from proved oil and gas reserves. Future income taxes were derived by applying year-end statutory tax rates to the estimated net future cash flows. A prescribed 10% discount factor was applied to the future net cash flows.\nIn the Company's opinion, this standardized measure is not a representative measure of fair market value, and the standardized measure presented for the Company's proved oil and gas reserves is not representative of the reserve value. The standardized measure is intended only to assist financial statement users in making comparisons between companies.\nFuture net cash flows and changes in the standardized measure are only prepared at year-end, therefore, no data is presented as of March 31, 1995. Information as of December 31, 1995 is included in the Post-merger section.\nThe following are the principal sources for change in the standardized measure:\nMAXUS ENERGY CORPORATION\nCONSOLIDATED STATEMENT OF OPERATIONS\nSee Notes to Consolidated Financial Statements.\nMAXUS ENERGY CORPORATION\nCONSOLIDATED BALANCE SHEET\nSee \"Commitments and Contingencies.\" See Notes to Consolidated Financial Statements. The Company uses the successful efforts method to account for its oil and gas producing activities. The Consolidated Balance Sheet at April 1, 1995 which represents the opening post-merger consolidated balance sheet is unaudited.\nMAXUS ENERGY CORPORATION\nCONSOLIDATED STATEMENT OF CASH FLOWS\nSee Notes to Consolidated Financial Statements.\nMAXUS ENERGY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nPRESENTATION\nOn June 8, 1995, a special meeting of the stockholders of Maxus Energy Corporation (together with its foreign and domestic subsidiaries, the \"Company\" or \"Maxus\") was held to approve the Agreement of Merger (\"Merger Agreement\") dated February 28, 1995, between the Company, YPF Acquisition Corp. (the \"Purchaser\") and YPF Sociedad Anonima (\"YPF\"). The holders of the Company's common stock, $1.00 par value per share, and $4.00 Cumulative Convertible Preferred Stock approved the Merger Agreement, and the Purchaser was merged into the Company (the \"Merger\") on June 8, 1995.\nEffective April 1, 1995, the Company used the purchase method of accounting to record the acquisition of the Company by YPF. In a purchase method combination, the purchase price is allocated to acquired assets and assumed liabilities based on their fair values at the date of acquisition. As a result, the Company's assets and liabilities were revalued to reflect the approximate $762 million cash purchase price paid by YPF to acquire the Company. The Company's pre-Merger Consolidated Balance Sheet as of March 31, 1995, together with the purchase method accounting adjustments, became the Company's opening unaudited post-Merger Consolidated Balance Sheet on April 1, 1995, which is included in the accompanying balance sheet.\nThe following post-Merger data is for the nine months ended December 31, 1995 and dollar amounts in tables are in millions, except per share amounts. Post-Merger financial information is not comparable to prior periods due to the application of purchase accounting effective April 1, 1995.\nNOTE ONE--SIGNIFICANT ACCOUNTING POLICIES\nThe Consolidated Financial Statements have been prepared in conformity with generally accepted accounting principles, the most significant of which are described below.\nConsolidation Accounting\nThe Consolidated Financial Statements include the accounts of Maxus Energy Corporation and all domestic and foreign subsidiaries. All significant intercompany accounts and transactions have been eliminated.\nStatement of Cash Flows\nInvestments with original maturities of three months or less at the time of original purchase are considered cash equivalents for purposes of the accompanying Consolidated Statement of Cash Flows. Short-term investments include investments with maturities over three months but less than one year.\nNet cash provided by operating activities reflects cash receipts for interest income and cash payments for interest expense and income taxes as follows:\nInventory Valuation\nInventories are valued at the lower of historical cost or market value and are primarily comprised of well equipment and supplies. Historical cost is determined primarily by using the weighted average cost method.\nMAXUS ENERGY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nProperties and Equipment\nProperties and equipment are carried at cost. Major additions are capitalized; expenditures for repairs and maintenance are charged against earnings.\nThe Company uses the successful efforts method to account for costs incurred in the acquisition, exploration, development and production of oil and gas reserves. Under this method, all geological and geophysical costs are expensed; all development costs, whether or not successful, are capitalized as costs of proved properties; exploratory drilling costs are initially capitalized, but if the effort is determined to be unsuccessful, the costs are then charged against earnings; depletion is computed based on an aggregation of properties with common geologic structural features or stratigraphic conditions, such as reservoirs or fields.\nFor investment in unproved properties in the United States, a valuation allowance (included as an element of depletion) is provided by a charge against earnings to reflect the impairment of unproven acreage. Investment in international non-producing leasehold costs are reviewed periodically by management to insure the carrying value is recoverable based upon the geological and engineering estimates of total possible and probable reserves expected to be added over the remaining life of each concession. Based upon increases to proved reserves determined by reserve reports, a portion of the investment in international non-producing leasehold costs will be periodically transferred to investment in proved properties.\nDepreciation and depletion related to the costs of all development drilling, successful exploratory drilling and related production equipment is calculated using the unit of production (\"UOP\") method based upon estimated proved developed reserves. Leasehold costs are amortized using the UOP method based on estimated total proved reserves. Other properties and equipment are depreciated generally on the straight-line method over their estimated useful lives. Estimated future dismantlement, restoration and abandonment costs for major facilities, net of salvage value, are taken into account in determining depreciation, depletion and amortization.\nThe Company capitalizes the interest cost associated with major property additions and mineral development projects while in progress, such amounts being amortized over the useful lives, and applying the same depreciation method, as that used for the related assets.\nWhen complete units of depreciable property are retired or sold, the asset cost and related accumulated depreciation are eliminated with any gain or loss reflected in other revenues, net. When less than complete units of depreciable property are disposed of or retired, the difference between asset cost and salvage or sales value is charged or credited to accumulated depreciation and depletion.\nDeferred Charges\nDeferred charges are primarily comprised of debt issuance costs and are amortized over the terms of the related debt agreements.\nRevenue Recognition\nOil and gas sales are recorded on the entitlements method. Differences between the Company's actual production and entitlements result in a receivable when underproduction occurs and a payable when overproduction occurs. These underproduced or overproduced volumes are valued based on the weighted average sales price for each respective property. The Company's gross underproduced and overproduced volumes at December 31, 1995, are not material.\nPensions\nThe Company has a number of trusteed noncontributory pension plans covering substantially all full-time employees. The Company's funding policy is to contribute amounts to the plans sufficient to meet the\nMAXUS ENERGY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nminimum funding requirements under governmental regulations, plus such additional amounts as management may determine to be appropriate. The benefits related to the plans are based on years of service and compensation earned during years of employment. The Company also has a noncontributory supplemental retirement plan for executive officers.\nOther Postretirement and Postemployment Benefits\nThe Company provides certain health care and life insurance benefits for retired employees and certain insurance and other postemployment benefits for individuals whose employment is terminated by the Company prior to their normal retirement. The Company accrues the estimated cost of retiree benefit payments, other than pensions, during employees' active service period. Employees become eligible for these benefits if they meet minimum age and service requirements. The Company accounts for benefits provided after employment but before retirement by accruing the estimated cost of postemployment benefits when the minimum service period is met, payment of the benefit is probable and the amount of the benefit can be reasonably estimated. The Company's policy is to fund other postretirement and postemployment benefits as claims are incurred.\nEnvironmental Expenditures\nEnvironmental liabilities are recorded when environmental assessments and\/or remediation are probable and material and such costs to the Company can be reasonably estimated. The Company's estimate of environmental assessment and\/or remediation costs to be incurred are based on either 1) detailed feasibility studies of remediation approach and cost for individual sites or 2) the Company's estimate of costs to be incurred based on historical experience and publicly available information, based on the stage of assessment and\/or remediation of each site. As additional information becomes available regarding each site or as environmental remediation standards change, the Company revises its estimate of costs to be incurred in environmental assessment and\/or remediation.\nIncome Taxes\nThe Company reports income taxes in accordance with Statement of Financial Accounting Standards No. 109 (\"SFAS 109\"), Accounting for Income Taxes. SFAS 109 requires the use of an asset and liability approach to measure deferred tax assets and liabilities resulting from all expected future tax consequences of events that have been recognized in the Company's financial statements or tax returns. Additionally, SFAS 109 requires that annual taxes are to be allocated to interim periods on the basis of the requirements of Accounting Principles Board Opinion No. 28 (\"APB 28\"), Interim Financial Reporting. The reporting requirements of APB 28 are based on the view that each interim period is an integral part of the annual period.\nBecause the tax year of the Company did not close in any relevant jurisdiction on March 31, 1995, taxes were not measured on deferred tax liabilities and assets at that time. Thus, taxes were allocated to the nine month period ended December 31, 1995 based on an allocation of taxes for the annual period ended December 31, 1995, in accordance with APB 28 and SFAS 109. Deferred tax assets and liabilities were measured at December 31, 1995.\nEarnings per Share\nPrimary earnings per share are based on the weighted average number of shares of common stock and common stock equivalents outstanding, unless the inclusion of common stock equivalents has an antidilutive effect on earnings per share. Fully diluted earnings per share are not presented due to the antidilutive effect of including all potentially dilutive common stock equivalents.\nMAXUS ENERGY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nFinancial Instruments with Off-Balance-Sheet Risk and Concentrations of Credit Risk\nThe Company's financial instruments that are exposed to concentrations of credit risk consist primarily of cash equivalents, short-term investments and trade receivables.\nThe Company's cash equivalents, short-term investments and restricted cash represent high-quality securities placed with various high investment grade institutions. This investment practice limits the Company's exposure to concentrations of credit risk.\nThe Company's trade receivables are dispersed among a broad domestic and international customer base; therefore, concentrations of credit risk are limited. The Company carefully assesses the financial strength of its customers. Letters of credit are the primary security obtained to support lines of credit.\nThe Company has minimal exposure to credit losses in the event of nonperformance by the counterparties to its interest rate swap agreement, natural gas price swap agreements and nonderivative financial assets. The Company does not obtain collateral or other security to support financial instruments subject to credit risk but restricts such arrangements to investment-grade counterparties.\nInvestments in Marketable Securities\nInvestments in debt and equity securities are reported at fair value except for those investments in debt securities which management has the intent and the ability to hold to maturity. Investments in debt securities which are held-for-sale are classified based on the stated maturity and management's intent to sell the securities. Unrealized gains and losses on investments in marketable securities, except for debt securities classified as \"held-to-maturity\", are reported as a separate component of stockholders' equity.\nDerivatives\nThe Company periodically hedges the effects of fluctuations in the price of crude oil and natural gas through price swap agreements and futures contracts. The Company historically has hedged no more than 50% of its U. S. gas production although the Company anticipates it may hedge up to 90% of its U. S. gas production during 1996. Gains and losses on these hedges are deferred until the related sales are recognized and are recorded as a component of sales and operating revenues. The Company periodically enters into interest rate swap agreements to hedge interest on long-term debt. The gain or loss on interest rate swaps is recognized monthly as a decrease or increase to interest expense.\nTake-or-Pay Obligations\nThe Company records payments received for take-or-pay obligations for unpurchased contract volumes as deferred revenue, which is included in Other Liabilities in the consolidated balance sheet. The deferred revenue is recognized in the income statement as quantities are delivered which fulfill the take-or-pay obligation. At December 31, 1995, the Company had $12.4 million in deferred revenue as a result of a take-or-pay payment received related to its Indonesian operations.\nNOTE TWO--MERGER\nOn June 8, 1995, a special meeting of the stockholders of the Company was held to approve the Agreement of Merger (\"Merger Agreement\") dated February 28, 1995, between the Company, YPF Acquisition Corp. (the \"Purchaser\") and YPF Sociedad Anonima (\"YPF\"). The holders of the Company's common stock, $1.00 par value per share (the \"Shares\"), and $4.00 Cumulative Convertible Preferred Stock (the \"$4.00 Preferred Stock\") and together with the Shares, the (\"Voting Shares\") approved the Merger Agreement, and the Purchaser was merged into the Company (the \"Merger\") on June 8, 1995 (the \"Merger Date\").\nMAXUS ENERGY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nThe Merger was the consummation of all transactions contemplated by the Merger Agreement. Pursuant to the Merger Agreement, a tender offer (the \"Offer\") was commenced on March 6, 1995 by the Purchaser for all the outstanding Shares at $5.50 per Share. Pursuant to the Offer, in April 1995 the Purchaser acquired 120,000,613 Shares representing approximately 88.5% of the then-outstanding Shares of the Company. As a result of the Merger, each outstanding Share (other than Shares held by the Purchaser, YPF or any of their subsidiaries or in the treasury of the Company (all of which were cancelled in the second quarter of 1995) and Shares of holders who perfected their appraisal rights under Section 262 of the Delaware General Corporation Law) was converted into the right to receive $5.50 in cash, and YPF became the sole holder of all outstanding Shares. The Company's preferred stock, consisting of the $4.00 Preferred Stock, $2.50 Cumulative Preferred Stock (\"$2.50 Preferred Stock\") and $9.75 Cumulative Convertible Preferred Stock (the \"$9.75 Preferred Stock\") remain outstanding. YPF currently owns approximately 96.9% of the outstanding Voting Shares.\nThe total amount of funds required by the Purchaser to acquire the entire common equity interest in the Company, including the purchase of Shares pursuant to the Offer and the payment for Shares converted into the right to receive cash pursuant to the Merger, was approximately $762 million. On April 5, 1995 the Purchaser entered into a credit agreement (the \"Credit Agreement\") with lenders for which The Chase Manhattan Bank (National Association) (\"Chase\") acted as agent, pursuant to which the lenders extended to the Purchaser a credit facility for up to $550 million (the \"Purchaser Facility\"). On April 5, 1995, the Purchaser borrowed $442 million under the Purchaser Facility and received a capital contribution of $250 million from YPF. The Purchaser used borrowings under the Purchaser Facility and the funds contributed to it by YPF to purchase 120,000,613 Shares pursuant to the Offer. Subsequent to the Merger, these Shares and all other outstanding Shares vested in YPF.\nDuring the second quarter of 1995, the Company used the purchase method to record the acquisition of the Company by YPF. In a purchase method combination, the purchase price is allocated to the acquired assets and assumed liabilities based on their fair values at the date of acquisition. As a result, the assets and liabilities of the Company were revalued to reflect the approximate $762 million cash purchase price paid by YPF plus all liabilities assumed to acquire the Company. The Company's oil and gas properties were assigned carrying amounts based on their relative fair market values. In connection with the purchase price allocation, the Company adopted Statement of Financial Accounting Standards No. 121 (\"SFAS 121\"), \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of,\" which requires a review of long-lived assets for impairment whenever events or changes in circumstance indicate that the carrying amount of the asset may not be recoverable. Under SFAS 121, if the expected future cash flow of a long-lived asset is less than the carrying amount of the asset, an impairment loss shall be recognized to value the asset at its fair value. Maxus revalued its assets and liabilities on April 1, 1995 following the provisions of SFAS 121. There was no impact on the Company's results of operations due to the adoption of SFAS 121 during the nine months ended December 31, 1995.\nFollowing the Merger, Chase provided two additional credit facilities aggregating $425 million: (i) a credit facility of $250 million extended to Midgard Energy Company (\"Midgard\"), a wholly owned subsidiary of the Company, and (ii) a credit facility of $175 million extended to Maxus Indonesia, Inc. (\"Holdings\"), a wholly owned subsidiary of the Company. The proceeds of the loans made pursuant to these facilities were used to repay, in part, the Purchaser Facility, which was assumed by the Company pursuant to the Merger. In addition, the Company applied $8 million of its available cash to repay the Purchaser Facility and used approximately $86 million of its available cash to pay holders of Shares converted into the right to receive cash in the Merger.\nMAXUS ENERGY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE THREE--ASSET DIVESTITURES\nIn December 1995, the Company sold its overriding royalty interest in the Recetor Block in Colombia for $25 million. There was no gain or loss recognized on this transaction as the sales price approximated the carrying value of the investment in the Recetor Block.\nNOTE FOUR--GEOGRAPHIC DATA\nThe Company is engaged primarily in the exploration for and the production and sale of crude oil and natural gas.\nSales, operating profit and identifiable assets by geographic area were as follows:\nNet foreign assets were $1,296.7 million at December 31, 1995. Income from foreign operations, after applicable local taxes, was $6.9 million for the nine months ended December 31, 1995.\nMAXUS ENERGY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nSales to two customers for the nine months ended December 31, 1995 each represented 10% or more of consolidated sales:\nThe Company does not believe that the loss of Mitsubishi Corporation as a customer would adversely affect the Company's ability to market its oil and gas production. Sales to the Company's largest customer, the Indonesian Government, are made primarily pursuant to long-term production sharing contracts between the Company's Indonesian operations and the Indonesian Government. The Indonesian Government is required to purchase a specified amount of the Company's oil and gas production throughout the life of its operations in Indonesia based on these contracts.\nNOTE FIVE--TAXES\nIncome before income taxes was comprised of income (loss) from:\nThe Company's provision for income taxes was comprised of the following:\nMAXUS ENERGY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nThe principal reasons for the difference between tax expense at the statutory federal income tax rate of 35% and the Company's provision for income taxes were:\nThe tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities as of and for the nine months ended December 31, 1995 were as follows:\nAs a result of an increase in U. S. net operating loss carryforwards, the valuation allowance was increased $11.7 million during the nine months ended December 31, 1995.\nMAXUS ENERGY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nAt December 31, 1995, the Company had $14.4 million of general business credit carryforwards that expire between 1996 and 2002; $207.7 million of U.S. net operating loss carryforwards that expire from 2003 to 2010; and $5.5 million of minimum tax credit that can be carried forward indefinitely.\nAs a result of the Merger, effective April 1, 1995, the Company's ability to utilize its existing net operating loss carryforwards will be limited by statute to approximately $92.0 million each year until exhausted. To the extent certain gains are recognized in the future, the annual limitation may be increased to the extent that the gains are built-in gains within the meaning of the U.S. Internal Revenue Code.\nThere are accumulated undistributed earnings after applicable local taxes of foreign subsidiaries of $5.7 million at December 31, 1995 for which no provision was necessary for foreign withholding or other income taxes because that amount had been reinvested in properties and equipment and working capital in the foreign jurisdictions.\nTaxes other than income taxes were comprised of the following:\nNOTE SIX--POSTEMPLOYMENT BENEFITS\nPensions\nThe components of net periodic pension expense are as follows:\nPlan assets are primarily invested in short-term investments, stocks and bonds. The principal assumptions used to estimate the benefit obligations of the plans on the measurement date, October 1, 1995, were as follows:\nMAXUS ENERGY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nThe funded status of the plans at December 31, 1995 were as follows:\nAs a result of the Merger, the Company was required to fully accrue its obligation for pension benefits in purchase accounting (See Note Two). Therefore, effective April 1, 1995, the Company increased its balance sheet liability to reflect any previously unrecognized gains and losses, transition obligations and prior service costs. Additionally, several of the Company's pension plans experienced a partial curtailment due to workforce reductions following the Merger. The impact of the partial curtailment, which had no impact on the Company's net periodic pension expense, reduced the Company's projected benefit obligation by $1.1 million.\nAt December 31, 1995, the Company's accumulated postretirement benefit obligation (\"APBO\") exceeded the plan assets. In accordance with Statement of Financial Accounting Standards No. 87, \"Employers' Accounting for Pensions,\" the Company recorded a minimum pension liability of $5.9 million and a charge to equity of $5.9 million.\nIn addition to the defined benefit plans, the Company has a defined contribution plan which covers the Indonesian nationals. Employee contributions of 2% of each covered employee's compensation are matched by the Company with a contribution of 6% of compensation. Contributions to the plan were $.4 million for the nine months ended December 31, 1995.\nOther Postretirement Benefits\nAs a result of the Merger, the Company was required to fully accrue its obligation for postretirement benefits other than pensions in purchase accounting (See Note Two). Therefore, effective April 1, 1995, the Company increased its balance sheet liability by $31.7 million to reflect any previously unrecognized gains and unrecognized transition obligation at March 31, 1995.\nThe components of net periodic postretirement benefit expense for the nine months ended December 31, 1995 are as follows:\nMAXUS ENERGY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nThe APBO as of December 31, 1995 was $46.6 million. The amount recognized in the Company's statement of financial position at December 31, 1995 is as follows:\nA discount rate of 7.5% was used in determining the APBO at December 31 1995. The APBO was based on a 9% increase in the medical cost trend rate, with the rate trending downward .5% per year to 5% in 2003 and remaining at 5% thereafter. This assumption has a significant effect on annual expense, as it is estimated that a 1% increase in the medical trend rate would increase the APBO at December 31, 1995 by $4.6 million and increase the net periodic postretirement benefit cost by $.4 million per year.\nNOTE SEVEN--FINANCIAL 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 value of financial instruments approximates their recorded values.\nRestricted Cash\nThe fair value of the Company's restricted cash, which is invested primarily in U. S. Treasury notes, marketable securities and trust accounts, is based on the quoted market prices for the same or similar securities at the reporting date. The Company's gross unrealized gain on its restricted cash was $2.3 million at December 31, 1995.\nLong-Term Debt\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.\nThe estimated fair value of the Company's financial instruments are as follows:\nFor information on the Company's derivative financial instruments, see Note Thirteen.\nMAXUS ENERGY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE EIGHT--RECEIVABLES\nNOTE NINE--PROPERTIES AND EQUIPMENT\nThe charge against earnings for depreciation, depletion and amortization of property and equipment was $142.1 million for the nine months ended December 31, 1995 and the charge against earnings for maintenance and repairs, which is included in operating expenses, was $25 million.\nNOTE TEN--RESTRICTED CASH\nAt December 31, 1995 the Company had $80.4 million in restricted cash, of which $30.7 million represented collateral for outstanding letters of credit and $7.4 million represented six months of interest on outstanding borrowings as required by the Holdings credit agreement. Assets held in trust as required by certain insurance policies were $42.3 million. Approximately $19.0 million of collateral for outstanding letters of credit at December 31, 1995, was classified as a current asset as these amounts are expected to be released during 1996.\nNOTE ELEVEN--ACCRUED LIABILITIES\nMAXUS ENERGY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE TWELVE--LONG-TERM DEBT AND CREDIT ARRANGEMENTS\nAs a result of the Merger, the Company was required to revalue its outstanding debt to market value. Consequently, the Company reduced the carrying amount of its debt by recording $115.1 million of unamortized discount on April 1, 1995. Total debt outstanding at April 1, 1995 of $1,295.4 million, as included in the accompanying unaudited balance sheet, reflected the unamortized discount. For the nine months ended December 31, 1995 $5.9 million of discount amortization was included as a component of interest expense.\nThe aggregate maturities of long-term debt outstanding at December 31, 1995, for the next five years will be as follows:\nAt December 31, 1995, the Company had $144.8 million of medium-term notes outstanding, which were issued in prior years, with maturities from 1996 to 2004 and annual interest rates ranging from 7.57% to 11.08%.\nThe Company maintains a $25.0 million uncommitted credit facility (the \"credit facility\"), which is used for the issuance of documentary or standby letters of credit and\/or the payment of shipping documents. The credit facility can be secured by cash or the accounts receivable which are financed through the letters of credit. At December 31, 1995, there were $13.8 million of cash collateralized letters of credit outstanding under this credit facility.\nMAXUS ENERGY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nTotal interest and debt expenses incurred, including capitalized interest, were as follows:\nCREDIT FACILITIES\nOn April 5, 1995, the Company borrowed $442 million under the Purchaser Facility (See Note Two) and received a capital contribution of $250 million from YPF. The Purchaser used borrowings under the Purchaser Facility and the funds contributed to it by YPF to purchase 120,000,613 Shares pursuant to the Offer.\nPursuant to a commitment letter from Chase, Chase provided two additional credit facilities aggregating $425 million: (i) a credit facility of $250 million extended to Midgard Energy Company (\"Midgard\"), a wholly owned subsidiary of the Company and (ii) a credit facility of $175 million extended to Maxus Indonesia, Inc. (\"Holdings\"), a wholly owned subsidiary of the Company. The proceeds of these loans were used to repay in part, the Purchaser Facility, which was assumed by the Company. In addition, the Company applied $8 million of its available cash to repayment of the Purchaser Facility. The Company capitalized $16.8 million of debt issue costs during 1995 in connection with the Midgard and Holdings credit facilities. These costs are recorded as deferred charges and amortized over the terms of the related borrowings. For the nine months ended December 31, 1995 $1.2 million of debt issue costs amortization was included as a component of interest expense.\nMidgard Facility. Approximately $250 million of the loans under the Purchaser Facility were repaid on June 8, 1995 with funds provided to the Company by Midgard. Midgard provided these funds from the proceeds of a $250 million loan (the \"Midgard Loan\") extended to it pursuant to a credit agreement (the \"Midgard Facility\") entered into on such date. In addition, approximately $8 million of the loans outstanding under the Purchaser Facility, including accrued interest on the Purchaser Facility loans, were repaid on June 8, 1995 utilizing cash held by the Company.\nThe Midgard Loan, which was made in a single drawing, will mature on December 31, 2003 and will be repaid in up to 28 consecutive equal quarterly installments commencing on March 31, 1997, subject to semi-annual borrowing base redeterminations. At December 31, 1995, the borrowing base for the Midgard Facility was $250 million. The borrowing base is subject to redetermination on April 1, 1996. At Midgard's option, the interest rate applicable to the Midgard Loan will be, until March 31, 1997, either (i) the one-, two- or three-month London Interbank Offered Rate (\"LIBOR\") plus a margin of 1 3\/4% or (ii) the Base Rate (as defined in the Midgard Facility) plus a margin of 3\/4% and, thereafter, either (iii) the one-, two- or three-month LIBOR plus a margin of 2 1\/4% or (iv) the Base Rate plus a margin of 1 1\/4%. At December 31, 1995, the interest rate on the Midgard Facility based on the one-month LIBOR plus 1 3\/4% was 7.6875%. The Midgard Loan is not secured but is guaranteed by YPF and the Company. The agreement evidencing the Midgard Loan contains, among other things, a negative pledge on all assets of Midgard, subject to customary exceptions. It is anticipated that the Midgard Loan will be repaid with funds generated by Midgard's business operations.\nHoldings Facility. Approximately $175 million of the Purchaser Facility was repaid with funds provided on June 16, 1995 to the Company by Holdings. Holdings provided these funds from the proceeds of a $175 million loan (the \"Subsidiaries Loan\") extended to it pursuant to a credit agreement (the \"Holdings Facility\") entered into on such date.\nMAXUS ENERGY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nThe Subsidiaries Loan, which was made in a single drawing on June 16, 1995, will mature on December 31, 2002 and will be repaid in up to 24 consecutive equal quarterly installments commencing on March 31, 1997, subject to semi-annual borrowing base redeterminations. At December 31, 1995, the borrowing base for the Holdings Facility was $175 million. The borrowing base is subject to redetermination on April 1, 1996. At the option of Holdings, the interest rates applicable to the Subsidiaries Loan will be, until March 31, 1997, either (i) the one-, two- or three-month LIBOR plus a margin of 2 1\/4% or (ii) the Base Rate (as defined in the Holdings Facility) plus a margin of 1 1\/4% and, thereafter, either (iii) the one-, two- or three-month LIBOR plus a margin of 2 3\/4% or (iv) the Base Rate plus a margin of 1 3\/4%. At December 31, 1995, the interest rate on the Holdings Facility based on the one-month LIBOR plus 2 1\/4% was 8.125%. The Subsidiaries Loan to Holdings is secured by the stock of Maxus Northwest Java, Inc. (\"Java\") and Maxus Southeast Sumatra, Inc. (\"Sumatra\") (collectively, the \"Holdings Subsidiaries\") and by the interest of Holdings, Java and Sumatra in certain accounts maintained at Chase into which the proceeds of sales of hydrocarbons are to be deposited, and is guaranteed by Java, Sumatra, YPF and the Company. The agreement evidencing the Subsidiaries Loan contains a negative pledge on all of the other assets of Holdings, subject to customary exceptions. It is anticipated that the Subsidiaries Loan will be repaid with funds generated by the Holdings Subsidiaries' business operations.\nEach of the Midgard Facility and the Holdings Facility contains restrictive covenants including limitations upon the sale of assets, mergers and consolidations, the creation of liens and additional indebtedness, investments, dividends, the purchase or repayment of subordinated indebtedness, transactions with affiliates and modifications to certain material contracts. The obligors under the Midgard Facility and the Holdings Facility may not permit (a) consolidated tangible net worth to be less than $200 million, in the case of the Midgard Facility, or $350 million, in the case of the Holdings Facility, plus (or minus), in the case of Midgard, the amount of any adjustment in the book value of assets or, in the case of Holdings, 70% of the amount of any adjustment to net worth, resulting from the merger of YPF Acquisition Corp. into the Company, (b) the ratio of consolidated cash flow to consolidated debt service to be less than 1.1 to 1.0 at the end of any fiscal quarter and (c) the ratio of consolidated cash flow to consolidated interest expense to be less than 1.25 to 1.0 at the end of any fiscal quarter. In addition, mandatory prepayments of the loans under the Midgard Facility and the Holdings Facility may be required in connection with certain asset sales and casualty losses, upon the issuance of subordinated indebtedness and in 1996 and in each year thereafter if, after semi-annual review, the agent and the lenders determine that a borrowing base deficiency exists. No borrowing base deficiencies existed at December 31, 1995.\nThe guaranty by Maxus of the obligation under the Midgard Facility (the \"Midgard Guaranty\") and under the Holdings Facility (the \"Subsidiaries Guaranty\") contains restrictions upon mergers and consolidations, the creation of liens and the business activities in which Maxus and its subsidiaries may engage. In addition, Midgard, in the case of the Midgard Guaranty, and Holdings and its subsidiaries, in the case of the Subsidiaries Guaranty, are required to be wholly owned subsidiaries of Maxus, except to the extent YPF or a subsidiary of YPF (other than Maxus or a subsidiary of Maxus) makes capital contributions to Midgard or Holdings or one of Holdings subsidiaries, as the case may be.\nKeepwell Covenant\nPursuant to the Merger Agreement, in the event that the Company is unable to meet its obligations as they come due, whether at maturity or otherwise, including, solely for the purposes of this undertaking, dividend and redemption payments with respect to the $9.75 Preferred Stock, the $2.50 Preferred Stock and the $4.00 Preferred Stock, YPF has agreed to capitalize the Company in an amount necessary to permit the Company to meet such obligations; provided that YPF's aggregate obligation will be: (i) limited to the amount of debt service obligations under the Purchaser Facility, the Midgard Facility and the Holdings Facility and (ii) reduced by the amount, if any, of capital contributions by YPF to the Company after the Merger Date and by the amount of the net proceeds of any sale by the Company of common stock or\nMAXUS ENERGY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nnonredeemable preferred stock after the Merger Date. The foregoing obligations of YPF (the \"Keepwell Covenant\") will survive until June 8, 2004. YPF has made no capital contributions under the Keepwell Covenant as of December 31, 1995. In addition, YPF has guaranteed the Company's outstanding debt as of the Merger Date, the principal amount of which was approximately $976 million. The debt covered by the YPF guarantee includes the Company's outstanding 11 1\/4%, 11 1\/2% and 8 1\/2% Sinking Fund Debentures, its outstanding 9 7\/8%, 9 1\/2% and 9 3\/8% Notes, and its outstanding medium-term notes. YPF has also guaranteed the payment and performance of the Company's obligations to the holders of its $9.75 Preferred Stock.\nAdvances from Parent\nBased on 1996 projections, the Company anticipates that YPF will make capital contributions of approximately $200 million to $250 million under the Keepwell Covenant during 1996. At December 31, 1995, the Company had $6.6 million outstanding of advances from its parent, YPF, which is included in long- term debt.\nThe Company and YPF intend to enter into a loan agreement during 1996 to facilitate short-term loans by YPF to the Company and short-term loans by the Company to YPF of excess cash balances. It is expected that loans will be made by the parties under the loan agreement during 1996; however, the number and amounts thereof are not presently known.\nNOTE THIRTEEN--DERIVATIVE FINANCIAL INSTRUMENTS\nThe Company's only derivative financial instruments are natural gas price swap agreements and crude oil and natural gas futures contracts, which are not used for trading purposes. During the nine-month period ended December 31, 1995, the Company unwound its sole interest rate swap agreement and recorded a $2.4 million final settlement gain in other revenues. The Company also received a $4.5 million termination payment, which has been deferred.\nNatural Gas Price Swap Agreements\nUnder the price swap agreements used to hedge fluctuations in the price of natural gas, the Company receives or makes payments based on the differential between the Company's specified price and the counterparty's specified price of natural gas. Depending on the agreement, the Company pays a fixed or variable price per million British Thermal Units (\"Mmbtu\") and receives a fixed or variable price per Mmbtu. During the nine months ended December 31, 1995, the Company had swap agreements with other companies to exchange payments on 10.7 million Mmbtu of gas. Under these swap agreements, the Company paid fixed or variable prices averaging $1.68 per Mmbtu and received fixed or variable prices averaging $1.53 per Mmbtu. Gross losses realized on these swap agreements of $2.1 million were partially offset by gross gains of $0.5 million resulting in a net loss of $1.6 million during the nine months ended December 31, 1995.\nAs of December 31, 1995, the Company has outstanding price swap agreements with other companies to exchange payments on 5.5 million Mmbtu of gas during the first quarter of 1996. Under these swap agreements, the Company will pay variable prices averaging $2.00 per Mmbtu and receive fixed prices averaging $1.74 per Mmbtu resulting in gross unrealized losses of $1.4 million based on gas sales prices at period end. Actual gains and losses realized upon settlement of these price swap agreements will depend upon the variable prices received at the time of settlement.\nNatural Gas and Crude Oil Futures Contracts\nUnder the natural gas futures contracts used to hedge fluctuations in the price of natural gas, the Company receives or makes payments based on the differential between the selling price and the settlement price per Mmbtu. During the nine months ended December 31, 1995, the Company settled futures contracts\nMAXUS ENERGY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nwith other companies on 4.9 million Mmbtu of gas. Under these futures contracts, the Company received selling prices averaging $1.71 per Mmbtu and paid settlement prices averaging $1.70 per Mmbtu. Realized gross gains and losses on these futures contracts were immaterial.\nAs of December 31, 1995, the Company had outstanding futures contracts with other companies to sell 3.6 million Mmbtu of gas. Under these futures contracts, the Company will receive selling prices averaging $2.01 per Mmbtu and pay settlement prices averaging $2.76 per Mmbtu resulting in gross unrealized losses of $2.7 million based on gas prices at period end. Actual gains and losses realized upon expiration of these futures contracts will depend upon the settlement prices.\nUnder the crude oil futures contracts used to hedge fluctuations in the price of crude oil, the Company receives or makes payments based on the differential between the selling price and the settlement price per barrel. During the nine-month period ended December 31, 1995, crude oil volumes hedged under these futures contracts were insignificant as were gross unrealized gains and losses. The Company had no open crude oil futures contracts at December 31, 1995.\nNOTE FOURTEEN--PREFERRED STOCK\nThe Company has the authority to issue 100,000,000 shares of Preferred Stock, $1.00 par value. The rights and preferences of shares of authorized but unissued Preferred Stock are established by the Company's Board of Directors at the time of issuance.\n$9.75 Cumulative Convertible Preferred Stock\nIn 1987, the Company sold 3,000,000 shares of $9.75 Preferred Stock. Since such time, the Company has entered into various agreements, most recently on June 8, 1995, with the sole holder of the $9.75 Preferred Stock pursuant to which, among other things, the Company has repurchased 500,000 shares and the parties have waived or amended various covenants, agreements and restrictions relating to such stock. Currently, 1,250,000 shares of $9.75 Preferred Stock are outstanding, each receiving an annual cash dividend of $9.75. In addition, 375,000 of such shares (the \"Conversion Waiver Shares\") each receive an additional quarterly cash payment of $.25 ($.50 in certain circumstances). For the twelve month period commencing February 1, 1996, each share of the $9.75 Preferred Stock has a liquidation value of $100.00 ($125.0 million in the aggregate) plus accrued dividends. Since February 1, 1994, the stock has been subject to mandatory redemption at the rate of 625,000 shares per year. The $9.75 Preferred Stock currently is neither convertible by the holder nor redeemable at the Company's option and has no associated registration rights. The $9.75 Preferred Stock entitles the holder to vote only on certain matters separately affecting such holder, and the $9.75 Preferred Stock other than the Conversion Waiver Shares entitles the holder to elect one individual to the Board of Directors of the Company. In addition, pursuant to the June 8, 1995 agreement, the holder of the $9.75 Preferred Stock waived previously granted rights to approve certain \"self-dealing\" transactions and certain financial covenants pertaining to the Company, and the Company waived its right of first offer with respect to the transfer of the $9.75 Preferred Stock and certain transfer restrictions on such stock.\n$4.00 Cumulative Convertible Preferred Stock\nEach outstanding share of $4.00 Preferred Stock is entitled to one vote, is convertible at any time into shares of the Company's Common Stock (2.29751 shares at December 31, 1995), is entitled to receive annual cash dividends of $4.00 per share, is callable at and has a liquidation value of $50.00 per share ($217.8 million in the aggregate at December 31, 1995) plus accrued but unpaid dividends, if any.\nMAXUS ENERGY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\n$2.50 Cumulative Preferred Stock\nEach outstanding share of the $2.50 Preferred Stock is entitled to receive annual cash dividends of $2.50 per share, is callable after December 1, 1998 at and has a liquidation value of $25.00 per share ($87.5 million in the aggregate at December 31, 1995) plus accrued but unpaid dividends, if any.\nThe holders of the shares are entitled to limited voting rights under certain conditions. In the event the Company is in arrears in the payment of six quarterly dividends, the holders of the $2.50 Preferred Stock have the right to elect two members to the Board of Directors until such time as the dividends in arrears are current and a provision is made for the current dividends due.\nNOTE FIFTEEN--COMMON STOCK\nPursuant to the offer in April 1995, YPF acquired 120,000,613 shares of Maxus Common Stock at $5.50 per Share representing 88.5% of the then-outstanding Shares of the Company. As a result of the Merger, each outstanding Share (other than Shares held by YPF or any of their subsidiaries or in the treasury of the Company, all of which were cancelled in the second quarter of 1995, and Shares of holders who perfected their appraisal rights under Section 262 of the Delaware General Corporation Law) was converted into the right to receive $5.50, and accordingly, the Company's common stock ceased to be publicly traded. (See Note Two).\nAt December 31, 1995, there were 10.0 million shares of Common Stock reserved for issuance upon conversion of Preferred Stock. However, since the Company's Common Stock is not publicly traded, there would be no market for the common shares.\nIn 1992, Kidder, Peabody & Co. Incorporated purchased eight million warrants from the Company. Each warrant represents the right to purchase one share of the Company's Common Stock at $13.00 per share at any time prior to the expiration of the warrants on October 10, 1997.\nThe Company has an Employee Shareholding and Investment Plan (\"ESIP\") which allows eligible participating employees to contribute a certain percentage of their salaries (1%-10%) to a trust for investment in any of five funds. Prior to the Merger employees could also invest in a fund consisting of the Company's Common Stock. However, the Maxus Energy Stock Fund was eliminated from the ESIP plan effective April 19, 1995. The Company matches the participating employees contributions to the ESIP (up to 6% of base pay). Such matching contribution is charged against earnings and prior to April 19, 1995, was invested in the ESIP fund which consisted of the Company's Common Stock. Subsequent to April 19, 1995, the Company's matching contribution is invested in any of five funds as directed by the employee. For the nine months ended December 31, 1995, the charge against earnings for the Company's contribution was $1.7 million.\nMAXUS ENERGY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE SIXTEEN--PAID-IN CAPITAL AND ACCUMULATED DEFICIT\nNOTE SEVENTEEN--UNREALIZED GAIN ON INVESTMENT IN MARKETABLE SECURITIES\nThe amortized cost and estimated fair value of marketable securities at December 31, 1995 are as follows:\nAt December 31, 1995, securities categorized as held-to-maturity are included in cash equivalents, short-term investments and short- and long-term restricted cash.\nNOTE EIGHTEEN--COMMON TREASURY STOCK\nSee Note Two.\nNOTE NINETEEN--STOCK OPTIONS\nTwo plans, a Long-Term Incentive Plan and a Director Stock Option Plan, were approved by the stockholders in 1992. The Company's 1986 and 1992 Long-Term Incentive Plans (the \"Incentive Plans\"), administered by the Compensation Committee of the Board of Directors, permit the grant to officers and certain key employees of stock options, stock appreciation rights (\"SARs\"), performance units and awards of Common Stock or other securities of the Company on terms and conditions determined by the Compensation Committee of the Board of Directors.\nThe Director Stock Option Plan became effective on September 1, 1992. Under this plan, non-employee directors received options to purchase shares of Common Stock on the effective date of the plan. Thereafter, upon initial election or re-election of a non-employee director at an annual meeting, the non-employee directors automatically received options to purchase shares of Common Stock. The plan terminated on June 7, 1995.\nMAXUS ENERGY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nThe grant or exercise of an option does not result in a charge against the Company's earnings because all options have been granted at exercise prices approximating the market value of the stock at the date of grant. However, any excess of Common Stock market price over the option price of options, which includes SARs, does result in a charge against the Company's earnings; a subsequent decline in market price results in a credit to earnings, but only to a maximum of the earnings charges incurred in prior years on SARs.\nStock option activity was as follows:\nThere will be no further grants of stock options, restricted stock or performance units subsequent to April 1, 1995 under the Company's Long-Term Incentive Plans. Effective upon the Merger, all stock options and restricted stock outstanding under Company-sponsored incentive plans were surrendered to the Company. The Company anticipates replacing the Long-Term Incentive Plans in 1996.\nIn 1993, the Company issued performance units under the 1992 Long-Term Incentive Plan. The performance unit entitles the grantee to the value of a share of Common Stock contingent upon the performance of the Company compared to a selected group of peer companies. The value of the performance unit is amortized over the vesting period based on a weighted probability of expected payout levels. There was no earnings activity related to performance units for the nine months period ended December 31, 1995 as outstanding performance units had no value.\nNOTE TWENTY--LEASES\nThe Company leases certain machinery and equipment, facilities and office space under cancelable and noncancelable operating leases, most of which expire within 20 years and may be renewed.\nMinimum annual rentals for non-cancelable operating leases at December 31, 1995, were as follows:\nMinimum annual rentals have not been reduced by minimum sublease rentals of $36.9 million due in the future under noncancelable subleases.\nMAXUS ENERGY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nRental expense for operating leases was as follows:\nNOTE TWENTY-ONE--RELATED PARTY TRANSACTIONS\nA director of the Company, who is also a member of the Audit Committee of the Board of Directors, is a partner in a law firm which provides legal services to the Company. Fees for such services amounted to $3.2 million during 1995. Additionally, the Company has $6.6 million outstanding in advances from its parent, YPF.\nNOTE TWENTY-TWO--COMMITMENTS AND CONTINGENCIES\nFederal, state and local laws and regulations relating to health and environmental quality in the United States, as well as environmental laws and regulations of other countries in which the Company operates, affect nearly all of the operations of the Company. These laws and regulations set various standards regulating certain aspects of health and environmental quality, provide for penalties and other liabilities for the violation of such standards and establish in certain circumstances remedial obligations. In addition, especially stringent measures and special provisions may be appropriate or required in environmentally sensitive foreign areas of operation, such as those in Ecuador.\nMany of the Company's United States operations are subject to requirements of the Safe Drinking Water Act, the Clean Water Act, the Clean Air Act (as amended in 1990), the Occupational Safety and Health Act, the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended (\"CERCLA\"), and other federal, as well as state, laws. Such laws address, among other things, limits on the discharge of wastes associated with oil and gas operations, investigation and clean-up of hazardous substances, and workplace safety and health. In addition, these laws typically require compliance with associated regulations and permits and provide for the imposition of penalties for noncompliance. The Clean Air Act Amendments of 1990 may benefit the Company's business by increasing the demand for natural gas as a clean fuel.\nThe Company believes that its policies and procedures in the area of pollution control, product safety and occupational health are adequate to prevent unreasonable risk of environmental and other damage, and of resulting financial liability, in connection with its business. Some risk of environmental and other damage is, however, inherent in particular operations of the Company and, as discussed below, the Company has certain potential liabilities associated with former operations. The Company cannot predict what environmental legislation or regulations will be enacted in the future or how existing or future laws or regulations will be administered or enforced. Compliance with more stringent laws or regulations, as well as more vigorous enforcement policies of the regulatory agencies, could in the future require material expenditures by the Company for the installation and operation of systems and equipment for remedial measures and in certain other respects. Such potential expenditures cannot be reasonably estimated.\nIn connection with the sale of the Company's former chemical subsidiary, Diamond Shamrock Chemicals Company (\"Chemicals\"), to Occidental Petroleum Corporation (\"Occidental\") in 1986, the Company agreed to indemnify Chemicals and Occidental from and against certain liabilities relating to the business or activities of Chemicals prior to the September 4, 1986 closing date (the \"Closing Date\"),\nMAXUS ENERGY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nincluding certain environmental liabilities relating to certain chemical plants and waste disposal sites used by Chemicals prior to the Closing Date.\nIn addition, the Company agreed to indemnify Chemicals and Occidental for 50% of certain environmental costs incurred by Chemicals for which notice is given to the Company within 10 years after the Closing Date on projects involving remedial activities relating to chemical plant sites or other property used in the conduct of the business of Chemicals as of the Closing Date and for any period of time following the Closing Date, with the Company's aggregate exposure for this cost sharing being limited to $75 million. The total expended by the Company under this cost sharing arrangement was about $39 million as of December 31, 1995. Occidental Chemical Corporation (\"OxyChem\"), a subsidiary of Occidental, and Henkel Corporation (\"Henkel\"), an assignee of certain of Occidental's rights and obligations, have filed a declaratory judgment action in Texas state court with respect to the Company's agreement in this regard (see \"Legal Proceedings\").\nIn connection with the spin-off of Diamond Shamrock R&M, Inc., now known as Diamond Shamrock, Inc. (\"DSI\"), in 1987, the Company and DSI agreed to share the costs of losses (other than product liability) relating to businesses disposed of prior to the spin-off, including Chemicals. Pursuant to this cost-sharing agreement, the Company bore the first $75 million of such costs and DSI bore the next $37.5 million. Under the arrangement, such ongoing costs are now borne onethird by DSI and two-thirds by the Company. This arrangement will continue until DSI has borne an additional $47.5 million, following which such costs will be borne solely by the Company. As of December 31, 1995, DSI's remaining responsibility is approximately $8 million and is included in accounts receivable in the accompanying balance sheet.\nDuring the nine months ended December 31, 1995, the Company spent $5 million in environmental related expenditures in its oil and gas operations. Expenditures for the full year 1996 are expected to be approximately $8 million.\nFor the nine months ended December 31, 1995, the Company's total expenditures for environmental compliance for disposed of businesses, including Chemicals, were approximately $30 million, $9 million of which was recovered from DSI under the above described cost-sharing agreement. Those expenditures are projected to be approximately $23 million for the full year 1996 after recovery from DSI under such agreement.\nAt December 31, 1995, reserves for the environmental contingencies discussed herein totaled $119 million. Management believes it has adequately reserved for all environmental contingencies which are probable and can be reasonably estimated; however, changes in circumstances could result in changes, including additions, to such reserves in the future.\nThe insurance companies that wrote Chemicals' and the Company's primary and excess insurance during the relevant periods have to date refused to provide coverage for most of Chemicals' or the Company's cost of the personal injury and property damage claims related to environmental claims, including remedial activities at chemical plant sites and disposal sites. In two actions filed in New Jersey state court, the Company has been conducting litigation against all of these insurers for declaratory judgments that it is entitled to coverage for certain of these claims. In 1989, the trial judge in one of the New Jersey actions ruled that there is no insurance coverage with respect to the claims related to the Newark plant (discussed below). The trial court's decision was upheld on appeal and that action is now ended. The other suit, which is pending, covers disputes with respect to insurance coverage related to certain other environmental matters.\nNewark, New Jersey. A consent decree, previously agreed upon by the U.S. Environmental Protection Agency (the \"EPA\"), the New Jersey Department of Environmental Protection and Energy (the \"DEP\") and Occidental, as successor to Chemicals, was entered in 1990 by the United States District Court of New Jersey and requires implementation of a remedial action plan at Chemicals' former Newark, New Jersey agricultural chemicals plant. Engineering for such plan, which will include an engineering estimate of the cost of construction, is progressing. Construction is expected to begin in 1997, cost approximately $22 million and\nMAXUS ENERGY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\ntake three to four years to complete. The work is being supervised and paid for by the Company pursuant to its above described indemnification obligation to Occidental. The Company has fully reserved the estimated costs of performing the remedial action plan and required ongoing maintenance costs.\nStudies have indicated that sediments of the Newark Bay watershed, including the Passaic River adjacent to the plant, are contaminated with hazardous chemicals from many sources. Studies performed by the Company and others suggest that contaminants historically discharged by the Newark plant are buried under several feet of more recent sediment deposits and are not moving. The Company, on behalf of Occidental, negotiated an agreement with the EPA under which the Company is conducting further testing and studies to characterize contaminated sediment in a six-mile portion of the Passaic River near the plant site. The Company currently expects such testing and studies to be completed in 1999 and cost from $4 million to $6 million after December 31, 1995. The Company has reserved its estimate of the remaining costs to be incurred in performing these studies as of December 31, 1995. The Company has been conducting similar studies under its own auspices for several years. Until these studies are completed and evaluated, the Company cannot reasonably forecast what regulatory program, if any, will be proposed for the Passaic River or the Newark Bay watershed and therefore cannot estimate what additional costs, if any, will be required to be incurred.\nHudson County, New Jersey. Until 1972, Chemicals operated a chromium ore processing plant at Kearny, New Jersey. According to the DEP, wastes from these ore processing operations were used as fill material at a number of sites in Hudson County.\nAs a result of negotiations between the Company (on behalf of Occidental) and the DEP, Occidental signed an administrative consent order with the DEP in 1990 for investigation and remediation work at certain chromite ore residue sites in Kearny and Secaucus, New Jersey. The work is being performed by the Company on behalf of Occidental, and the Company is funding Occidental's share of the cost of investigation and remediation of these sites and is currently providing financial assurance for performance of the work in the form of a self-guarantee in the amount of $20 million subject to the Company's continuing ability to satisfy certain financial tests specified by the State. This financial assurance may be reduced with the approval of the DEP following any annual cost review. While the Company has participated in the cost of studies and is implementing interim remedial actions and conducting remedial investigations and feasibility studies, the ultimate cost of remediation is uncertain. The Company anticipates submitting its investigation and feasibility reports to the DEP in late 1996 or 1997. The results of the DEP's review of these reports could impact the cost of any further remediation that may be required. The Company has reserved its best estimate of the remaining cost to perform the investigations and remedial work as being $50 million at December 31, 1995. In addition, the DEP has indicated that it expects Occidental and the Company to participate with the other chromium manufacturers in the funding of certain remedial activities with respect to a number of so-called \"orphan\" chrome sites located in Hudson County, New Jersey. Occidental and the Company have declined participation as to those sites for which there is no evidence of the presence of residue generated by Chemicals. The Governor of New Jersey issued an Executive Order requiring state agencies to provide specific justification for any state requirements more stringent than federal requirements. The DEP has indicated that it may be revising its soil action level upwards towards the higher soil screening levels proposed by the EPA in 1994.\nPainesville, Ohio. From about 1912 through 1976, Chemicals operated manufacturing facilities in Painesville, Ohio. The operations over the years involved several discrete but contiguous plant sites over an area of about 1,300 acres. The primary area of concern historically has been Chemicals' former chromite ore processing plant (the \"Chrome Plant\"). For many years, the site of the Chrome Plant has been under the administrative control of the EPA pursuant to an administrative consent order under which Chemicals is required to maintain a clay cap over the site and to conduct certain ground water and surface water monitoring. Many other sites have previously been clay-capped and one specific site, which was a waste disposal site from the mid-1960s until the 1970s, has been encapsulated and is being controlled and monitored.\nMAXUS ENERGY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nIn September 1995, the Ohio Environmental Protection Agency (the \"OEPA\") issued its Directors' Final Findings and Order (the \"Director's Order\") by consent ordering that a remedial investigation and feasibility study (the \"RIFS\") be conducted at the former Painesville plant area. The Company has agreed to participate in the RIFS as required by the Director's Order. It is estimated that the total cost of performing the RIFS will be $3 million to $5 million over the next three years. In spite of the many remedial, maintenance and monitoring activities performed, the former Painesville plant site has been proposed for listing on the National Priority List under CERCLA; however, the EPA has stated that the site will not be listed so long as it is satisfactorily addressed pursuant to the Director's Order and OEPA's programs. The Company has accrued the estimate of its share of the cost to perform the RIFS. The scope and nature of any further investigation or remediation that may be required cannot be determined at this time; however, as the RIFS progresses, the Company will continuously assess the condition of the Painesville plant site and make any changes, including additions, to its reserve as may be required.\nOther Former Plant Sites. Environmental remediation programs are in place at all other former plant sites where material remediation is required in the opinion of the Company. Former plant sites where remediation has been completed are being maintained and monitored to insure continued compliance with applicable laws and regulatory programs. The Company has reserved $6 million at December 31, 1995, related to these sites, none of which are individually material.\nThird Party Sites. Chemicals has also been designated as a potentially responsible party (\"PRP\") by the EPA under CERCLA with respect to a number of third party sites, primarily off of Chemicals' properties, where hazardous substances from Chemicals' plant operations allegedly were disposed of or have come to be located. Numerous PRPs have been named at substantially all of these sites. At several of these, Chemicals has no known exposure. Although PRPs are almost always jointly and severally liable for the cost of investigations, cleanups and other response costs, each has the right of contribution from other PRPs and, as a practical matter, cost sharing by PRPs is usually effected by agreement among them. Accordingly, the ultimate cost of these sites and Chemicals' share of the costs thereof cannot be estimated at this time, but are not expected to be material except possibly as a result of the matters described below.\n1. Fields Brook; Ashtabula, Ohio. At the time that Chemicals was sold to Occidental, Chemicals operated a chemical plant at Ashtabula, Ohio which is adjacent to Fields Brook. Occidental has continued to operate the Ashtabula plant. In 1986, Chemicals was formally notified by the EPA that it was a PRP for the Fields Brook site. The site is defined as Fields Brook, its tributaries and surrounding areas within the Fields Brook watershed. At least 15 other parties are presently considered to be financially responsible PRPs. In 1986, the EPA estimated the cost of sediment remediation at the site would be $48 million. The PRPs, including Occidental, have developed an allocation agreement for sharing the costs of the work in Fields Brook ordered by the EPA. Under the allocation, the Occidental share for Chemicals' ownership of the Ashtabula plant would be about five percent of the total, assuming all viable PRPs were to participate.\nIn 1990, the OEPA, as state trustee for natural resources under CERCLA, advised previously identified PRPs, including Chemicals, that the OEPA intended to conduct a Natural Resource Damage Assessment of the Fields Brook site to calculate a monetary value for injury to surface water, groundwater, air, and biological and geological resources at the site. Also, although Fields Brook empties into the Ashtabula River which flows into Lake Erie, it is not known to what extent, if any, the EPA will propose remedial action beyond Fields Brook for which the Fields Brook PRPs might be asked to bear some share of the costs. Until all preliminary studies and necessary governmental actions have been completed and negotiated or judicial allocations have been made, it is not possible for the Company to estimate what the response costs, response activities or natural resource damages, if any, may be for Fields Brook or related areas, the parties responsible therefore or their respective shares.\nIt is the Company's position that costs attributable to the Ashtabula plant fall under the Company's above-described cost sharing arrangement with Occidental under which the Company bears one-half of\nMAXUS ENERGY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\ncertain costs up to an aggregate dollar cap. Occidental, however, has contended that it is entitled to full indemnification from the Company for such costs, and the outcome of this dispute cannot be predicted. The Company has reserved its estimate of its share of potential cleanup costs based on the assumption that this site falls under the Occidental cost sharing arrangement.\n2. French Limited Disposal Site; Crosby, Texas. The PRPs, including Chemicals (represented by the Company), entered into a consent decree and a related trust agreement with the EPA with respect to this disposal site. The consent decree was entered by the federal court as a settlement of the EPA's claim for remedial action. Chemical's share of the cost to complete remediation at this site at December 31, 1995, is expected to be approximately $500,000 and such amount is fully accrued.\n3. SCP\/Carlstadt Site; Carlstadt, New Jersey. Chemicals' share of remediation costs at this CERCLA site would be approximately one percent, based on relative volume of waste shipped to the site. An interim remedy has now been implemented at the site by the PRPs but no estimate can be made at this time of ultimate costs of remediation which may extend to certain off-site locations.\n4. Chemical Control Site; Elizabeth, New Jersey. The DEP has demanded of PRPs (including Chemicals) reimbursement of the DEP's alleged $34 million (including interest through December 31, 1995) in past costs for its partial cleanup of this site. The PRPs and the EPA have settled the federal claims for cost recovery and site remediation, and remediation is now complete. Based on the previous allocation formula, it is expected that Chemicals' share of any money paid to the DEP for its claim would be approximately two percent. The Company has fully reserved its estimated liability for this site.\nLegal Proceedings. In November 1995, OxyChem filed suit in Texas state court seeking a declaration of certain of the parties' rights and obligations under the sales agreement pursuant to which the Company sold Chemicals to Occidental. Henkel joined in said lawsuit as a plaintiff in January 1996. Specifically, OxyChem and Henkel are seeking a declaration that the Company is required to indemnify them for 50% of certain environmental costs incurred on projects involving remedial activities relating to chemical plant sites or other property used in connection with the business of Chemicals on the Closing Date which relate to, result from or arise out of conditions, events or circumstances discovered by OxyChem or Henkel and as to which the Company is provided written notice by OxyChem or Henkel prior to the expiration of ten years following the Closing Date, irrespective of when OxyChem or Henkel incurs and gives notice of such costs, subject to an aggregate $75 million cap. The Company believes that this lawsuit is without merit and intends to defend same vigorously. The Company has established reserves based on its 50% share of costs expected to be paid or incurred by OxyChem and Henkel prior to September 1996.\nAs of December 31, 1995, the Company had paid OxyChem and Henkel a total of approximately $39 million against said $75 million cap. The Company cannot predict what portion of the approximately $36 million remaining as of that date Occidental and Henkel may actually pay or incur prior to September 4, 1996, the tenth anniversary of the Closing Date if they accelerate spending with regard to such environmental costs; however, the Company has approximately $7 million reserved at December 31, 1995, based on 50% of OxyChem's and Henkel's historical annual expenditures. In the event OxyChem and Henkel prevail in this lawsuit, the Company could be required to provide up to approximately $29 million in additional reserves related to this indemnification.\nThe Company has established reserves for legal contingencies in situations where a loss is probable and can be reasonably estimated.\nIn Ecuador, pipeline capacity available to the Company is sufficient to transport only about 60% of the oil the Company expects to be able to produce daily, and none of the various projects to increase transportation capacity that have been considered has been approved by the government of Ecuador. In addition, the Company is involved in a number of contract, auditing and certification disputes with various government entities. Together, the lack of pipeline capacity and the various disputes with government entities are retarding\nMAXUS ENERGY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nthe Company's ability to proceed with the economic development of Block 16. Although the Company can give no assurances concerning the outcome of these discussions, progress has recently been made on several important issues. The Company intends to reduce program spending in Ecuador in 1996 to $19 million from $32 million in 1995.\nNOTE TWENTY-THREE--SUBSEQUENT EVENTS\nIn January 1996, the Company and its partners were successful in acquiring the highly prospective Guarapiche block in Venezuela's first auction awards for equity production in over 20 years. Guarapiche is located on the same trend as the five billion barrel El Furrial field in northeastern Venezuela. The Company, together with its partners, paid $109 million ($27 million net to Maxus) to the Venezuelan government for rights to explore the Guarapiche block. BP Exploration Orinoco Limited is the operator with a 37.5% working interest while Amoco Production Company and the Company hold the remaining 37.5% and 25%, respectively. The Company's net exploration commitment for this block is anticipated to total approximately $15 million over the next five years.\nFINANCIAL SUPPLEMENTARY INFORMATION (Unaudited)\nDATA IS FOR THE NINE MONTHS ENDED DECEMBER 31, 1995. THE DOLLAR AMOUNTS IN TABLES ARE IN MILLIONS, EXCEPT PER SHARE)\nOIL AND GAS PRODUCING ACTIVITIES\nThe following are disclosures about the oil and gas producing activities of the Company as required by Statement of Financial Accounting Standards No. 69 (\"SFAS 69\").\nResults of Operations\nResults of operations for the nine months ended December 31, 1995 from all oil and gas producing activities are shown below. These results exclude revenues and expenses related to the purchase of natural gas and the subsequent processing and resale of such natural gas plus the sale of natural gas liquids extracted therefrom.\n- ---------------\n(a) Includes United States gathering and processing costs related to sales. Such costs were $9.1 million for the nine months ended December 31, 1995.\nCAPITALIZED COSTS\nIncluded in properties and equipment are capitalized amounts applicable to the Company's oil and gas producing activities. Such capitalized amounts include the cost of mineral interests in properties, completed and incomplete wells and related support equipment. In addition, the Company's gas plants that process not only the Company's gas but also third party gas, has been included in capitalized costs. Approximately 52% of the volumes processed through the Company's gas plants is the Company's gas. Only the revenue and cost related to the Company's produced gas is included in results of operations and costs incurred. Capitalized costs at December 31, 1995 were:\nCOSTS INCURRED\nCosts incurred by the Company in its oil and gas producing activities for the nine months ended December 31, 1995 (whether capitalized or charged against earnings) were as follows:\nOil and Gas Reserves\nThe following table represents the Company's net interest in estimated quantities of developed and undeveloped reserves of crude oil, condensate, natural gas liquids and natural gas and changes in such quantities for the nine months ended December 31, 1995. Net proved reserves are the 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 reserve volumes that can be expected to be recovered through existing wells with existing equipment and operating methods. Proved undeveloped reserves are proved reserve volumes that are expected to be recovered from new wells on undrilled acreage or from existing wells where a significant expenditure is required for recompletion.\nEstimates of reserves for December 31, 1995 were prepared by Gaffney, Cline & Associates, petroleum engineers, using standard geological and engineering methods generally accepted by the petroleum industry and in accordance with the rules and regulations of the Securities and Exchange Commission (\"SEC\"). The choice of method or combination of methods employed in the analysis of each reservoir was determined by experience in the area, stage of development, quality and completeness of basic data, and production history.\nThere are numerous uncertainties inherent in estimating quantities of proved reserves and in projecting future rates of production and timing of development expenditures, including many factors beyond the control of the producer. Reserve engineering is a subjective process of estimating underground accumulations of crude oil and natural gas that cannot be measured in an exact manner, and the accuracy of any reserve estimate is a function of the quality of available data and of engineering and geological interpretation and judgment. As a result, estimates of different engineers often vary. In addition, results of drilling, testing and production subsequent to the date of an estimate may justify revision of such estimate. Accordingly, reserve estimates are often different from the quantities of crude oil and natural gas that are ultimately recovered. The meaningfulness of such estimates is highly dependent upon the accuracy of the assumption upon which they were based. The reserve estimates were subjected to economic tests to determine economic limits. The estimates may change as a result of numerous factors including, but not limited to, additional development activity, evolving production history, and continued reassessment of the viability of production under varying economic conditions.\n- ---------------\n(a) The changes reflect the impact of the change in the price of crude oil on the barrels to which the Company is entitled under the terms of the Indonesian production sharing contracts. The Indonesian production sharing contracts allow the Company to recover tangible production and exploration costs, as well as operating costs. As the price of crude oil fluctuates, the Company is entitled to more or less barrels of cost recovery oil. Increasing prices resulted in a decrease of 9.9 million barrels in 1995.\n(b) Natural gas is reported on the basis of actual or calculated volumes which remain after removal, by lease or field separation facilities, of liquefiable hydrocarbons and of non-hydrocarbons where they occur in sufficient quantities to render the gas unmarketable. Natural gas reserve volumes include liquefiable hydrocarbons approximating 11% of total gas reserves in the United States and 4% in Indonesia which are recoverable at natural gas processing plants downstream from the lease or field separation facilities. Such recoverable liquids also have been included in natural gas liquids reserve volumes.\n(c) Reserves in Venezuela are attributable to an operating service agreement under which all hydrocarbons are owned by the Venezuelan government, however, the Company receives payment for production and development services performed based on production.\nFuture Net Cash Flows\nThe standardized measure of discounted future net cash flows relating to the Company's proved oil and gas reserves as of December 31, 1995 is calculated and presented in accordance with Statement of Financial Accounting Standards No. 69. Accordingly, future cash inflows were determined by applying year-end oil and gas prices (adjusted for future fixed and determinable price changes) to the Company's estimated share of future production from proved oil and gas reserves. Future income taxes were derived by applying year-end statutory tax rates to the estimated net future cash flows. A prescribed 10% discount factor was applied to the future net cash flows.\nIn the Company's opinion, this standardized measure is not a representative measure of fair market value, and the standardized measure presented for the Company's proved oil and gas reserves is not representative of the reserve value. The standardized measure is intended only to assist financial statement users in making comparisons between companies.\n- ---------------\n(a) Future income taxes undiscounted are $161.6 for the United States, $508.2 for Indonesia and $57.1 for South America at December 31, 1995.\nThe following are the principal sources for change in the standardized measure:\nThe principle sources for change in the standardized measure are presented for the year-ended December 31, 1995, rather than the nine months period ended December 31, 1995, as reserve reports from which this information is derived are only prepared on an annual basis.\nQuarterly Data\n- ---------------\n(a) Gross profit is sales and operating revenues less purchases and operating expenses, gas purchase costs and depreciation, depletion and amortization.\n(b) Gross profit has been restated to conform to the 1995 presentation.\n(c) In the fourth quarter of 1994, the Company increased its reserve for future environmental liabilities by $49.0 million.\nEXPLORATION AND PRODUCTION STATISTICS (historic)\nINDEX TO EXHIBITS","section_15":""}
{"filename":"63330_1995.txt","cik":"63330","year":"1995","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 13 to Consolidated Financial Statements on page 18 of the Maui Land & Pineapple Company, Inc. 1995 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 1995 Maui Pineapple Company, Ltd. recorded an operating loss (before corporate expenses, interest expense and income taxes) of $3.5 million compared to an operating loss of $867,000 in 1994. During the year we focused on meeting case sales volume, pricing objectives, recovery goals and on lowering the unit cost per case. We did achieve higher pricing levels than in 1994, but we were unable to meet our objectives in the other three key measures of performance. In 1995 the Island of Maui experienced a severe drought with especially dry conditions on the Haliimaile plantation. Dry weather reduced fruit size and caused sunburned, porous fruit. This in turn lowered recovery in canned pineapple and juice products. The lower recovery resulted in fewer cases packed than originally planned, which raised per case production costs. We reduced some effects of the drought by using drip irrigation systems; however, there was not enough water to adequately irrigate the Haliimaile plantation.\nThe Company's overall case volume declined by 5% compared to 1994. In total, canned fruit sales volume was unchanged compared with 1994. The grocery and government segments showed modest gains. Institutional sales moved down sharply due to several customers purchasing large inventories of canned pineapple at the end of 1994. Total juice sales volume declined by 11%. The grocery, government and institutional juice segments declined 5%, 82% and 4% respectively. We experienced the largest decline in the government segment due to the loss of the USDA and Department of Defense bids; they were awarded to smaller regional juice packers. Concentrate sales were down 26%, a planned volume reduction. Although sales were down slightly for the year, we did retain our customer base and were able to acquire a number of new customers late in the year. Mainland Jet Fresh and local fresh fruit sales declined in 1995. On May 30, 1995, the United States Department of Commerce announced the results of the antidumping investigation and imposed duties of between 2% and 51% on imports by Thailand pineapple companies. On June 30, 1995, the International Trade Commission ruled 6-0 in the Company's favor on final injury determination. All four Thai respondents have filed an appeal with the U.S. Trade Court in New York. They are challenging the Department of Commerce's methodology in calculating the duty. They make no challenge to the final determination on injury to the domestic industry. The Company also has filed an appeal with the same court to allow us to introduce new evidence to help the Department of Commerce defend its decision. We do not expect a decision on the appeal before December 1996. We believe the appeal by the Thai respondents adds a degree of uncertainty to the marketplace, which will dampen price increases until the matter is resolved. Many Thailand producers shipped additional inventory into the U.S. before the final antidumping determination. This oversupply of canned pineapple continued to exert downward pressure on prices and volume during the first half of the year. By year-end the situation had improved. Drought-related crop conditions in the Far East and the favorable antidumping decision reduced U.S. imports. As a result, most pineapple producers announced moderate fruit price increases beginning in the third quarter. These increases ranged from 8.5% for nationally branded products to 20% for regionally distributed imports. These conditions allowed Maui Pineapple Company to make its first significant price increase in four years. The increase began to impact revenues in the fourth quarter. In 1994 we commenced a modest consumer-focused marketing effort to promote awareness of Hawaiian pineapple. During 1995 we expanded on this effort in selected geographical areas of the U.S., positioning our product as the only 100% Hawaiian U.S.A. canned pineapple. We are moving toward our diversification objectives. Soon we will begin selling Costa Rican fresh pineapple to U.S. east coast customers under the label of Royal Coast. This addition of fresh pineapple allows us to provide a line extension to our existing east coast customer base. We are continuing research and development on fresh chilled pineapple and intend to enter this rapidly expanding market in 1996. 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 76% of the fruit processed in 1995. The balance of fruit processed was purchased from independent growers. 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 1995, approximately 20 domestic customers accounted for about 51% of pineapple sales. Export sales, chiefly to Japan, Canada and Western Europe, amounted to approximately 7.1%, 6.2% and 5.2% of total pineapple sales in 1995, 1994 and 1993, respectively. Sales to the U.S. government amounted to approximately 13.1%, 11.8% and 8.5% of total pineapple sales in 1995, 1994 and 1993, 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. Foreign production has the advantage of lower hourly labor costs. Other canned fruits and fruit juices are also a source of competition. 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, operate its cannery and sell and market its product, the Company employed approximately 910 year-round employees and hired approximately 590 seasonal workers in 1995.\n(2) Resort Kapalua Land Company, Ltd. had an operating profit (before corporate expenses, interest expense and income taxes) of $7.3 million in 1995 compared with an operating loss of $2.2 million in 1994. Most of this improvement was due to the reversal of previously allocated losses from Kaptel Associates, The Ritz-Carlton Kapalua Hotel joint venture. Development activities other than the Kaptel joint venture improved by $900,000 over the previous year while profits from ongoing Resort operations declined by $500,000. Although The Ritz-Carlton Kapalua Hotel has consistently generated a positive cash flow from operations, beginning in February 1995 Kaptel was only able to make partial payment on its debt service and defaulted on its loan. NI Hawaii Resort, Inc. (NI), the major general partner, commenced negotiations with the lenders to acquire the loan and on October 31, 1995, the partners concluded an agreement to dissolve the partnership.\nAs a result, we transferred our 25% ownership interest in the partnership to NI and reversed all of the previously allocated losses. This represents an increase in earnings of $5.0 million for 1995 compared to an allocated loss of $4.1 million in 1994. An amended management agreement was also negotiated with The Ritz- Carlton Hotel Company as the hotel operator and a revised ground lease was negotiated with us. Under the terms of the agreement, we retain ownership of the land (subject to a $65 million first mortgage) with a reduced rent, but with important controls related to the use of this property. Additionally, $4.75 million of off-site construction loan debt is to be repaid solely from ground rent and any balance remaining on the loan at January 1, 1999 will be canceled. We will not recognize any ground rent income until 1999. Since April of last year, the owners of the Kapalua Bay Hotel actively tried to sell the hotel, but were unsuccessful in their efforts. In December 1995, the owners filed bankruptcy under Chapter 11 and are presently still trying to conclude a sale. Under terms of our ground lease, we have a right of first refusal regarding any potential sale. Our primary interest is to make sure the hotel is properly positioned with strong financial ownership and experienced quality management. Other development activities at the Resort included the sale of one of the remaining five lots in Plantation Estates Phase I. As a result, Plantation Club Associates contributed $152,000 to operating profits. In 1994 the Resort's share of the loss from this joint venture was $766,000. Real estate activity within the Resort slowed during 1995, but prices remained stable. Capital expenditures for the Resort water system and sewer capacity decreased from $3.4 million in 1994 to $800,000 in 1995. Last year we completed payment on water system improvements needed to comply with the Environmental Protection Agency Safe Drinking Water Act. On December 12, 1995, the Public Utility Commission ruled favorably on our application for a rate increase for our water and waste treatment companies. This increase provides a fair return on our investment in water system infrastructure and will have a positive impact on our operating results going forward. We also continued our funding of the expansion of the Lahaina Sewage Treatment Plant and expect to make our final payment in 1996. This investment provides us with the required sewage capacity for future development.\nResort on-going operations posted a profit of $2.3 million in 1995 compared with a profit of $2.8 million in 1994. Resort revenues were $34.3 million in 1995 compared to $34.1 million in 1994. Cash flow from Resort operations increased to $5.0 million from $4.4 million in 1994. Maui destination resorts experienced a modest increase in occupancy in 1995. Resort occupancy at Kapalua remained the same at 56%. This was well below the average occupancy for Maui as competition in the over-built luxury hotel market remains intense. In our recreation departments, the number of paid golf rounds declined by 2% from 1994 levels, but total golf and merchandise revenues were up slightly. Tennis play was comparable with prior year levels and profitability improved. Our Kapalua villa program continues to grow with a 7% increase in the number of units in the program, a 10% increase in the number of occupied rooms and a 7% improvement in profitability. The addition of a sales representative in February resulted in a noticeable impact on bookings late in the year. 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 development and operating subsidiary for 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 Kapalua 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 1988 to finance and develop a third 18-hole golf course and Plantation Estates Phase I and Phase II, two residential development projects at Kapalua. Four lots in Plantation Estates Phase I and allocated planning and offsite costs related to Plantation Estates Phase II remain in inventory at December 31, 1995. Kapalua Investment Corp. (KIC), a wholly-owned subsidiary of the Company, was a general partner in Kaptel Associates, the partnership that owned The Ritz-Carlton Kapalua Hotel. In October of 1995 KIC transferred its 25% interest in Kaptel to the major general partner, NI Hawaii Resorts, Inc. 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 370 employees in its resort operations at December 31, 1995.\n(3) Commercial & Property The Company's Commercial & Property business segment produced a substantially lower operating profit in 1995 on about the same level of revenues as compared to 1994. Revenues were $10.1 million compared to $10.6 million in 1994. Operating profit (before corporate expenses, interest expense and income taxes) was $3.6 million compared to $5.4 million in 1994. Land sales arising from four transactions contributed a total of $3.4 million profit and cash flow in 1995. The largest of these, the final payment from the State of Hawaii for the 50-acre parcel taken under condemnation for the King Kekaulike High School, was received in June and amounted to $1.8 million. Three other transactions involved the sale of homes on Baldwin Avenue in Makawao which generated $1.6 million in operating profit and cash flow. Kaahumanu Center's results were lower than expected due to the depressed level of retail sales on Maui caused by the relatively weak local economy. Job layoffs in the sugar industry, a low level of construction activity and continued weakness in the visitor industry all combined in 1995 to result in a poor business environment for retailers on the Island. Kaahumanu Center, while achieving a dominant position as the largest retail center, was negatively affected throughout the year by the weak economy. While Kaahumanu Center's main market has been and will continue to be Island residents, the Center has improved its attractions for Maui's visitors. JTB, Japan's largest tour company, has signed a lease and started construction of its \"Oli Oli Station,\" a briefing and processing facility for JTB's group tour business. Approximately 50,000 visitors are expected to use this facility in its first year of operation. Kaahumanu Center is also the terminus for the West Maui, South Maui and Airporter bus systems, effectively Maui's only mass transportation system. 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, 1995, 94% of the available gross leasable area was occupied by 114 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, 1995, 80% of the gross leasable area was occupied by 18 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 (ERS) as a limited partner. As of April 30, 1995, the Company and ERS each have a 50% ownership interest in KCA. Prior to that, the ownership interests were 99% for the Company and 1% for ERS. The renovation which was completed in November of 1994, expanded the Center from approximately 315,000 to 572,000 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 $410,000 in 1995, $375,000 in 1994 and $416,000 in 1993. 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. The 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 1996 includes $2 million for a system which will totally replace the existing method of disposing of processing waste water. In total, the Company employed approximately 1,940 people in 1995.\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 28,600 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 mortgage on the fee and leasehold interest of the 36-acre Ritz- Carlton Kapalua Hotel site, which secures a loan to the ground lessee for up to $65 million (See Note 3 to Consolidated Financial Statements in the Maui Land & Pineapple Company, Inc. 1995 Annual Report to Shareholders.); (2) a perpetual conservation easement granted to the State of Hawaii on a 13-acre parcel at Kapalua; (3) certain existing easements and rights-of-way that do not materially affect the Company's use of such property; (4) a mortgage on the three golf courses at Kapalua, which secures the Company's $22 million revolving credit arrangement; (5) a permanent conservation easement granted to The Nature Conservancy of Hawaii, a non-profit corporation, covering approximately 8,600 acres; and (6) 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. 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 28 acres are located in Kahului, Maui. The 22,400 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 6,400 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 with interconnected warehouses at the cannery site where finished product is stored. The remaining land is primarily in pasture or forest reserve. Approximately 3,000 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 eleven leases expiring variously through 2012. The aggregate land rental for these leases was $390,000 in 1995.\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. PART 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. 1995 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. 1995 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. 1995 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\" and \"Notes to Consolidated Financial Statements\" on pages 7 through 18 of the Maui Land & Pineapple Company, Inc. 1995 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. PART III Item 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 29, 1996, is incorporated herein by reference. The Company has the following executive officers: Principal Occupation Name During Last 5 Years Gary L. Gifford President & Chief Executive Officer since April (Age 48) 1995; Executive Vice President\/Resort from 1987 to 1995.\nPaul J. Meyer Executive Vice President\/Finance since 1984; (Age 48) Treasurer since 1994.\nDouglas R. Schenk Executive Vice President\/Pineapple since 1995; (Age 43) Vice President\/Pineapple from 1993 to 1995; Cannery Manager of Maui Pineapple Company, Ltd. from 1989 to 1993.\nDonald A. Young Executive Vice President\/Resort since April 1995; (Age 48) Executive Vice President\/Operations of Kapalua Land Company, Ltd. from 1992 to 1995; Vice President\/Operations of Kapalua Land Company, Ltd. from 1985 to 1992.\nScott A. Crockford Vice President\/Retail Property since 1995; (Age 40) General Manager of Kaahumanu Center from 1989 to 1995.\nJulie L. Salady Vice President\/Human Resources since 1995; (Age 32) Director of Human Resources from 1991 to 1995.\nWarren A. Suzuki Vice President\/Land Management since October 1995; (Age 43) Vice President\/Construction & Planning of Kapalua Land Company, Ltd. from May 1995 to October 1995; Director of Project Coordination of Kapalua Land Company, Ltd. from 1988 to 1995.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION The information set forth under the caption \"Executive Compensation\" on pages 9 through 11 of the Maui Land & Pineapple Company, Inc. Proxy Statement, dated March 29, 1996, 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 29, 1996, 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 pages 13 to 14 of the Maui Land & Pineapple Company, Inc. Proxy Statement, dated March 29, 1996, 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, 1995 and 1994 Consolidated Statements of Operations and Retained Earnings for the Years Ended December 31, 1995, 1994 and 1993 Consolidated Statements of Cash Flows for the Years Ended December 31, 1995, 1994 and 1993 Notes to Consolidated Financial Statements\n(a) 2. Financial Statement Schedules The Financial Statements of Kaahumanu Center Associates for the Years Ended December 31, 1995, 1994 and Period from June 23, 1993 (Date of Formation) Through December 31, 1993 are filed as exhibits.\nThe Financial Statements of Kaptel Associates for the Years Ended December 31, 1994 and 1993 are filed as exhibits.\n(a) (3) Exhibits Exhibits are listed in the \"Index to Exhibits\" found on pages 17 to 20 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, 1996 By \/s\/GARY L. GIFFORD Gary L. Gifford 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, 1996 Mary C. Sanford Chairman of the Board\nBy \/s\/RICHARD H. CAMERON Date March 29, 1996 Richard H. Cameron Vice Chairman of the Board\nBy \/s\/PAUL J. MEYER Date March 29, 1996 Paul J. Meyer Exec. Vice Pres.\/Finance & Treasurer\nBy \/s\/TED PROCTOR Date March 29, 1996 Ted Proctor Controller & Assistant Treasurer\nBy \/s\/PETER D. BALDWIN Date March 29, 1996 Peter D. Baldwin Director\nBy \/s\/JOSEPH W. HARTLEY, JR. Date March 29, 1996 Joseph W. Hartley, Jr. Director\nBy \/s\/RANDOLPH G. MOORE Date March 29, 1996 Randolph G. Moore Director\nBy \/s\/FRED E. TROTTER III Date March 29, 1996 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. (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. Exhibit 10.1(vi) to Form 10-K for the year ended December 31, 1994. (vii) Sixth Loan Modification Agreement, effective as of March 31, 1995. Exhibit (10) to Form 10-Q for the quarter ended June 30, 1995. (viii)* Seventh Loan Modification Agreement, effective as of December 31, 1995.\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. (vi) Amendment No. 1 to Limited Partnership Agreement of Kaahumanu Center Associates. Exhibit (10)B to Form 8-K, dated as of April 30, 1995.\n(vii) Conversion Agreement, dated April 27, 1995. Exhibit (10)C to Form 8-K, dated as of April 30, 1995. (viii) Indemnity Agreement, dated April 27, 1995. Exhibit (10)D to Form 8-K, dated as of April 30, 1995.\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. (iii)* Second Amendment to Note Purchase Agreement, dated as of November 13, 1995.\n10.4(i) 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. (ii) Dissolution Agreement, dated October 31, 1995. Exhibit (10)A to Form 10-Q for the quarter ended September 30, 1995. (iii)* First Mortgage, Security Agreement, Financing Statement and Assignment of Rentals covering the fee simple interest and the leasehold interest, securing a loan of $65,000,000, dated February 24, 1996. (iv)* Subordination, Nondisturbance and Attornment Agreement (Ground Lessor), dated February 24, 1996. (v)* Hotel Ground Lease by and between Maui Land & Pineapple Company, Inc. (Lessor) and NI Hawaii Resort, Inc. (Lessee), effective January 1, 1996. (vi)* Amendment Relating to Off-Site Loan, dated January 9, 1996 and Effective January 1, 1995. (vii)* Letter Agreement, dated January 1, 1996, Re: Nonrecourse Open Account For Off-Site Improvements. (viii)* Agreement with NI Hawaii Resort, Inc. (Ground Lease), dated January 9, 1996. (ix)* Amendment and Restatement of Tennis Operating Agreement by and between Kapalua Land Company, Ltd. (Operator) and NI Hawaii Resort, Inc. (Owner), dated January 9, 1996. (x)* Assignment Agreement (Assignment of Amended and Restated Tennis Operating Agreement), dated January 9, 1996. (xi)* Golf Course Use Agreement by and between Maui Land & Pineapple Company, Inc. and NI Hawaii Resort, Inc. dated, January 9, 1996. (xii)* Memorandum of Understanding between Maui Hotels, Kapalua Investment Corp. and NI Hawaii Resort, Inc., effective October 31, 1995.\n(xiii)* Supplemental Agreement, entered into among Maui Hotels, Kapalua Investment Corp. and NI Hawaii Resort, Inc. as of February 15, 1996. (xiv)* Release of Real Property Mortgage, Security Agreement and Financing Statement, dated March 12, 1996.\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 Fifteen million dollar ($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. 1995 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.\n99.1* Financial Statements of Kaahumanu Center Associates for the years ended December 31, 1995 and 1994 and period from June 23, 1993 (date of formation) through December 31, 1993.\n99.2 Financial Statements of Kaptel Associates for the years ended December 31, 1994 and 1993. Exhibit 99.1 to Form 10-K for the year ended December 31, 1994.","section_15":""}
{"filename":"40643_1995.txt","cik":"40643","year":"1995","section_1":"Item 1. Business (Dollars in thousands unless otherwise indicated)\nGeneral Housewares Corp. (hereinafter referred to as the \"Company\") manufactures and markets consumer durable goods. The Company limits itself to product categories in which, through market share, product innovation or brand image, it is considered a leader. Through the acquisition and\/or development of products that \"delight and excite\" the consumer, (i.e., deliver unexpected value, simplify and enhance a task or redefine a task) the Company believes that it is able to establish such a leadership position. The Company currently enjoys such a position in the following product categories: cookware, cutlery, kitchen tools and precision cutting tools. Cookware, cutlery and kitchen tools are grouped into the Housewares reportable segment, while precision cutting tools also constitute a reportable segment. For financial information related to the two reportable segments, see Note 12 in the financial statements included in this report.\nHOUSEWARES\nApproximately 71% of this segment's products sold by the Company during 1995 were produced domestically, primarily in factories owned and operated by the Company.\nThe remaining products are obtained from seven foreign sources (some of which buy from sub-contractors) primarily located in the Far East. The Company believes that a loss of any individual foreign source would not have a material impact on future results of operations.\nCOOKWARE\nIn 1995, the Company was one of the country's largest manufacturers and marketers of cookware, distributing its products throughout the United States, Canada and selected European markets. The Company's collection of leading, brand name cookware products has enabled it to deliver, to both retailers and consumers, products which satisfy a complete range of functional, aesthetic and value requirements. The Company competed in four main cookware product categories in 1995, covering a broad range of materials, designs, colors and prices. The categories included cast aluminum, cast iron, stamped and spun aluminum and enamelware.\nIn January of 1996, the Company announced its intention to exit the cast aluminum and cast iron product categories during the first half of 1996 in an effort to focus on faster growing, more profitable product categories. The Company is in discussions with buyers possibly interested in acquiring the associated product lines and the related manufacturing facility located in Sidney, Ohio. The cast iron and cast aluminum product lines include Magnalite(R), Magnalite Professional(R), Magnalite Professional(R) with Eclipse(R) and Wagner's(R) 1891 Original Cast Iron brand names. Gross revenues derived from the categories to be exited were $18,927 in 1995.\nRemaining cookware lines include enamelware and stamped and spun aluminum. The Company is the only domestic manufacturer of enamelware and has developed a leading market share. Ceramic on Steel(TM) cookware products produced by the Company are sold under the Columbian and Graniteware brand names. As of September 1, 1994, the Company acquired the Normandy line of enamelware from National Housewares, Inc. Normandy enamelware products, similar to the Company's Ceramic on Steel(TM) cookware products, were, at the time, manufactured in Mexico. In 1995, the Normandy line of enamelware was discontinued and sourcing to service the Normandy customers was transitioned to the Company's Ceramic on Steel (TM) manufacturing operations. Enamelware is in demand because of its easy cleanup and popular price. It is particularly popular for roasting and specialty top-of-stove uses (e.g., spaghetti cookers and vegetable steamers). Products in this category are primarily sold in discount stores, mass merchandise outlets and warehouse clubs. Heavy gauge, large capacity stamped and spun aluminum products are marketed under the brand name Leyse Professional(TM) and distributed through department stores, mass merchants and specialty shops. Leyse products are purchased from a domestic manufacturer. Gross revenues derived from enamelware and stamped and spun aluminum were $25,577 in 1995.\nThe total United States market for cookware, defined as metal pots and pans used for top-of-stove and oven cooking, is estimated by the Cookware Manufacturers Association at approximately $1.9 billion in terms of annual sales. Domestic industry unit sales have remained relatively flat during the past five years and, as a result, domestic manufacturers have lost market share to imports, which the Association estimates have grown from 42% of the market in 1990 to 47% in 1995. Imported merchandise, principally from Korea, Taiwan, Mexico and the Peoples Republic of China, has been successful in penetrating the market through comparable quality products at lower prices.\nThe cookware industry is highly competitive and fragmented. In addition, it is characterized by little product differentiation. The Company believes that known brand names, price-value relationships, product design, quality and creative merchandising programs, as well as responsive, superior customer service, are key factors contributing to success.\nCUTLERY AND ASSOCIATED PRODUCTS\nThe Company is a manufacturer and marketer of quality kitchen cutlery with the leading domestic brand name (Chicago Cutlery(R)) and market share in its industry. The Company markets for consumers, under the Chicago Cutlery(R) brand umbrella, three complete lines of kitchen knives for consumers, sharpening tools, storage units and cutting boards. Its most popular household cutlery line is The Walnut Tradition(R), which features a solid American walnut handle with a Taper Grind(R) edge on the blade. The Company manufactures and sells a popular priced knife under the Cherrywood(TM) brand name. For the consumer that prefers a synthetic handled knife, the Company manufactures and sells the Metropolitan(TM) product line which features a durable high-impact plastic handle and a Taper Grind(R) edge.\nAll Chicago Cutlery(R) blades are made from high carbon stainless steel that resists rusting, pitting and staining. The Taper Grind(R) edge provides a uniform and smooth taper, thereby facilitating the blade's movement through the object being cut.\nThe Company also sells a line of promotionally priced cutlery under the banner \"Designed and Marketed by Chicago Cutlery(R)\". These products compete in both the fine edge and \"never-needs-sharpening\" segments of the cutlery industry and are purchased from suppliers in the Far East. Promotional cutlery \"Designed and Marketed by Chicago Cutlery(R)\" consists of thirteen separate cutlery brands, seven of which are sold exclusively through department stores, and the remaining lines are distributed through department stores, mass merchandisers and catalog showrooms.\nWhile the overall market for kitchen cutlery in the United States has remained relatively unchanged in recent years, foreign products, including the Company's promotionally priced imported cutlery, have made significant inroads. The Company believes that imports in 1995 accounted for more than half of domestic sales in dollars and 75% of domestic sales in units. As a result of its widely recognized brand name and reputation for high quality at a good price, the Company has gained market share in the kitchen cutlery industry by marketing a combination of the promotionally priced imports and the traditional Chicago Cutlery(R) products.\nThe Company also manufactures a full line of knives for the commercial poultry processing market. These molded handle knives are designed to meet the special needs of professionals and have specialized blade shapes for specific cutting jobs. The handles are textured to be slip-resistant and feature a finger guard for safety, as well as, in some cases, ergonomic handles.\nUnder the Idaho Woodworks(TM) and Chicago Cutlery(R) names, the Company manufactures and markets cutting boards made of wood, polyethylene, and combinations of wood and acrylic, marble or polyethylene.\nGross revenues derived from cutlery and associated products were $39,251 in 1995.\nKITCHEN TOOLS\nEffective October 1, 1992, the Company purchased all of the partnership interests in OXO International L.P. (\"OXO\"), a New York limited partnership, marketing a broad line of kitchen tools under the Good Grips(R), Prima(R) Plus(TM) and Basics brand names. The purchase price was $6,250 and consisted of a cash payment of $5,500 and Subordinated Promissory Note in the principal amount of $750 bearing interest at 8% per annum. The OXO products are primarily made by manufacturers located in the Far East according to OXO's designs and specifications. The kitchen tools sold by OXO generally utilize a proprietary handle which is covered by patents owned by the Company which run through 2002. OXO(R) kitchen tools are distributed primarily in the United States through department stores, gourmet and specialty outlets and mass merchandisers. OXO also sells a line of garden tools that utilizes its proprietary handle. Garden tools are primarily distributed through specialty outlets. The OXO product category has experienced significant growth since acquisition.\nGross revenues derived from the kitchen tool category were $16,262 in 1995.\nPRECISION CUTTING TOOLS\nEffective October 1, 1994, the Company purchased certain assets of Walter Absil Company Limited and Olfa Products Corp. (collectively referred to as the \"Olfa Products Group\"). The purchase price was $13,576 and consisted of a cash payment of $6,843, Subordinated Promissory Notes in the principal amount of $2,233 bearing interest at 6% per annum and 400,000 restricted shares (valued at $4,500) of the Company's common stock. The Olfa Products Group is the exclusive distributor, in the United States and Canada, of precision cutting tools and accessories manufactured by Olfa Corporation of Osaka, Japan. The Company believes that relations with Olfa Corporation are strong and that a long-term relationship will continue. Products of the Olfa Products Group are sold both to distributors and direct to hobby, craft, hardware and fabric stores.\nThe North American hobby and craft market is both large and diverse with sales exceeding $10 billion. Products distributed through the Olfa Products Group compete in small selected segments in this market. Typically, these products compete on the basis of performance and value.\nGross revenues derived from the precision cutting tool segment were $16,605 in 1995.\nDISTRIBUTION\nHousewares products are sold by the Company to most major retail and wholesale distribution organizations in the United States and Canada through its direct sales force and through independent commissioned sales representatives. The Olfa Products Group utilizes a combination of a direct sales force and independent commissioned sales representatives.\nIn addition, the Company sells products through a chain of manufacturers' retail outlet stores operating under the name \"Chicago Cutlery etc., Inc.\" Gross revenues derived from the stores were $9,248 in 1995.\nMAJOR CUSTOMERS\nDuring 1995, the ten largest customers of the Company accounted for 46% of the Company's gross sales. Sales to the Company's largest customer, Wal-mart, were $13.0 million or approximately 10% of total gross sales. The Company has had good long-term relationships with its major customers.\nEMPLOYEES\nThe Company employs approximately 845 persons, of whom 480 are involved in manufacturing with the balance serving in sales, general and administrative capacities. The Company believes that its relations with employees are good.\nApproximately 390 employees are represented by three different labor organizations, which have contracts expiring in February, March and July of 1996.\nIncluded in these Company totals are approximately 220 people employed at the Sidney, Ohio, manufacturing facility, 200 of which are represented by two labor organizations. It is anticipated that the sale of product lines manufactured at the plant and possibly the facility itself, will reduce headcount at the Company by these amounts.\nEXPORT SALES\nExports account for less than 10% of the Company's total sales.\nRAW MATERIALS\nThe principal raw materials used in manufacturing the Company's housewares products are steel, iron, aluminum, ceramic compounds, plastic compounds and hardwood products. All of these materials are generally available from numerous suppliers, and the Company believes that the loss of any one supplier would not have a significant impact on its operations. The Company's precision cutting tool products are imported as finished goods.\nSEASONALITY\nShipments of cookware, cutlery and kitchen tools are higher in the second half of the year and highest in the fourth quarter due to the seasonality of housewares retail sales. Shipments of precision cutting tools vary little from quarter to quarter.\nWORKING CAPITAL\nThe Company is increasingly forced to meet rapid delivery requirements from customers, and increased inventory levels have resulted. The Company believes that increased technological and supply chain initiatives, for which implementation began in 1995, will position it well for the heightened customer requirements.\nWhile the Company normally sets payment terms at net 30 days, industry practice has dictated an occasional extension of such terms. Accordingly, certain customers have been given extensions of payment terms.\nFOREIGN OPERATIONS\nThe Company operates a wholly owned subsidiary located in Montreal, Canada. Revenues, Operating Income and Assets of the subsidiary are all less than 10% of total Company Revenues, Operating Income and Assets.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe following table sets forth the location and size of the Company's principal properties.\nOPERATING FACILITIES\nProperty Leased: [CAPTION]\nIn addition, the Company leases an average of 2,700 square feet of retail space in 27 factory outlet malls with initial lease terms ranging from 3 to 7 years.\nIn the opinion of the Company's management, the properties and plants described above are in good condition and repair and are adequate for the particular operations for which they are used.\nNON-OPERATING FACILITIES\nProperty Owned: (Reported as \"other assets\" in the financial statements in this Report) [CAPTION]\nIn addition, at December 31, 1995, the Company owned a candle manufacturing facility located in Hyannis, Massachusetts which it leased to a third party. The 74,600 square feet facility was sold on January 17, 1996. The Company received cash consideration that approximated net book value.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe Company and its wholly owned subsidiary, Chicago Cutlery, Inc., instituted an action on February 2, 1995, against the personal representatives of the Estate of Ronald J. Gangelhoff in the United States District Court for the District of Minnesota, Fourth Division. The action was instituted in order to comply with Minnesota probate practices for settling claims against estates. The action seeks indemnity and\/or contribution for all losses and expenses suffered and incurred, and to be suffered and incurred, by the plaintiffs arising from the New Hampshire Department of Environmental Services mandated clean-up of hazardous substances generated at the Antrim, New Hampshire, manufacturing site owned by Chicago Cutlery, Inc. and arising from the remediation of the site and the landfill at which some of the substances were disposed. The action also seeks a declaratory judgement that the defendants are liable to the Company. The action is brought on the basis of the breach of representations and warranties in the 1988 Stock Purchase Agreement pursuant to which the Company purchased the stock of Chicago Cutlery, Inc. from Ronald J. Gangelhoff. It is also brought under the provisions of the Comprehensive Environmental Response, Compensation, and Liability Act, the provisions of the New Hampshire Hazardous Waste Clean-up and Contribution statutes and under common law causes of action. It is the opinion of the Company's in-house legal counsel that adequate support exists in favor of the Company in the case.\nBefore the death of Mr. Gangelhoff, Chicago Cutlery, Inc. had instituted an action on October 8, 1993, against David D. Hurlin in the United States District Court for the District of New Hampshire, seeking damages and a declaratory judgement that Mr. Hurlin is liable to plaintiff for losses and expenses suffered and incurred, and to be suffered and incurred, arising from the mandated clean-up of hazardous substances generated at the Antrim, New Hampshire, manufacturing site during the period it was owned by Goodell Company and arising from remediation of the site. The basis of the action against Mr. Hurlin is that as chief executive officer, a director and substantial stockholder of the Goodell Company he was in control of, or in a position to control and direct, hazardous substances handling and disposal practices at the site when hazardous substances were improperly released to the environment. The action is brought under the provisions of the Comprehensive Environmental Response, Compensation, and Liability Act, the provisions of the New Hampshire Hazardous Waste Clean-up and Contribution statutes and under common law causes of action. To the extent that recovery is made against David D. Hurlin, the amount of the Company's claim against the assets of the late Ronald J. Gangelhoff will be reduced.\nFor information concerning various environmental matters with which the Company is involved, see Notes to Consolidated Financial Statements on page 20 of this Report.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nNot applicable.\nEXECUTIVE OFFICERS OF THE COMPANY\nThe following individuals are executive officers of the Company, each of whom will serve in the capacities indicated until May 2, 1996, or until the election and qualification of a successor.\nMessrs. Saxton, Evans and Gray have been executive officers of the Company for more than five years. Mr. Kulla has been employed with the Company since November 14, 1995, and an executive officer since January 1, 1996. Prior thereto, he was Vice President, General Counsel and Secretary of AXIA Incorporated. Mr. Blackwell has been employed with the Company and an executive officer since March 20, 1995. Prior thereto, he served as Vice President, Sales and Marketing, for EMX Corporation, Executive Vice President, Sales and Marketing of Moulinex Appliances, Inc. and President and General Manager of Oster Housewares, a division of Sunbeam\/Oster Company. Mr. Brown has been employed with the Company and an executive officer since July 3, 1995. Prior thereto, he served as Managing Director of Bottom Line Logistics, a management consulting firm. Mr. Scales has been employed with the Company and an executive officer since July 10, 1995. Prior thereto, he served as Controller at Cosco, Inc. and Hoosier Energy Rural Electric Cooperative, Inc. and as a Senior Audit Manager at Price Waterhouse.\nPART II\nItem 5.","section_5":"Item 5. Market for the Company's Common Stock and Related Stockholder Matters\nThe market on which the Company's Common Stock is traded is the New York Stock Exchange, Inc. The high and low sales prices of the Company's Common Stock and the cash dividends declared for each quarterly period during the last two fiscal years is disclosed in quarterly financial information presented in Item\n8.\nThe approximate number of holders of Common Stock as of March 18, 1996, including beneficial owners of shares held in nominee accounts of whom the Company is aware, was 1,000.\nItem 6.","section_6":"Item 6. Selected Financial Data\nSELECTED CONSOLIDATED 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\n(Dollars in Thousands Except per Share Amounts)\nYear Ended December 31, 1995 versus 1994\nNet sales for 1995 were $119,340, an increase of 22% over net sales of $97,729 in 1994. The increase stems primarily from acquisitions made in the third and fourth quarters of 1994, as well as market penetration in the Company's kitchen tool product line. Revenue increases resulting from acquisitions represent approximately $14,660 or 15% of the growth in total sales. The sales increase in the kitchen tool product line was driven primarily by volume with modest price increases also a contributing factor. Gross profit increased from $35,010 in 1994 to $40,312 in 1995 as a result of increased sales volume. As a percentage of net sales, gross profit decreased 2% from 1994. Gross profit percentage was adversely affected by an increased cost of aluminum, an unfavorable change in sales mix as well as inventory balancing that resulted in adjustments to inventory and cost of sales. Selling, general and administrative expenses increased to $33,232 from $28,373 in 1994. As a percentage of sales, selling, general and administrative expenses decreased from 29.0% in 1994 to 27.8% in 1995. Of the gross dollar increase, approximately $3,500 was directly attributable to 1994 acquisitions. In addition, significant personnel changes were made in 1995 resulting in approximately $450 of increased severance and employment costs. Increases in contractual incentive payments to the former owners of the kitchen tool product line and royalty payments related to the design of the kitchen tool product line driven by increased sales accounted for $516 of the increase. A restructuring of distribution activities and the move of a manufacturing facility resulted in an increase of $269. The decrease as a percentage of sales is a result of increased sales activity covering fixed selling, general and administrative costs.\nOperating income for 1995 was $7,080, representing a $443 increase over operating income of $6,637 in the prior year. Interest expense increased from $1,699 in 1994 to $3,115 in 1995. Increased debt related to the 1994 acquisitions and working capital needs to support improved customer service were primarily responsible for the increases in interest expense. Net income for the year was $2,286 as compared to $2,750 in 1994; related earnings per share dropped from $0.80 in 1994 to $0.61 in 1995. Earnings per share were calculated on 3,769 weighted average shares as compared to 3,440 for 1994, reflecting additional shares issued in connection with the 1994 acquisition activity.\nYear Ended December 31, 1994 versus 1993\nNet sales for 1994 were $97,729, an increase of 10% when compared to net sales of $88,529 for 1993. Sales increased as a result of growth in the Company's kitchen tool and retail outlet store businesses and as a result of acquisitions.\nThe increase in total net sales tied to acquisitions was $7,274. Of the remaining increase, the spread between the kitchen tool and retail outlet store businesses varied little. These increases were driven primarily by volume with slight increases in price. While the dollar amount of gross profit increased modestly, gross profit margins declined, reflecting competitive pricing pressures and increased raw material costs. Selling, general and administrative expense increased slightly. Increased costs related to the higher sales volume and a partial year's amortization of goodwill (related to the purchases of the assets of Walter Absil Company Limited, Olfa Products Corp. and National Housewares, Inc.) were offset by reduced general and administrative costs. Included in operating expense were additions of $391 to bad debt reserves to cover customer bankruptcies during the year and $153 (exclusive of amounts for which recovery from third parties is expected) to the reserve provisions for environmental remediation. The increase in environmental remediation estimates was a result of updated communications from environmental authorities.\nNet income was $2,750 or $0.80 per share in 1994 compared to $3,036 or $0.91 per share in 1993. The effective tax rate applied to pre-tax income increased to 44% in 1994, compared to 41% in 1993. The effective tax rate increase was attributable to provision for potential assessments with regard to ongoing review by the Internal Revenue Service of years 1991-1993.\nSeasonality\nSales are higher in the second half of the year (and highest in the fourth quarter) due to the seasonality of housewares retail sales.\nCapital Resources and Liquidity\nInventories increased from $20,841 in 1994 to $26,867 in 1995. The increase was due to Company-wide goals of improving customer service coupled with a soft retail holiday buying season that resulted in below forecast sales in the fourth quarter of 1995. Inventories increased from $11,765 in 1993 to $20,841 in 1994.\nOf this increase, $5,292 was directly attributable to acquisitions. The remaining increase was a result of aggressive sales plans for 1995 that required an increase in inventory levels.\nOn November 30, 1994, the Company completed a financing package consisting of a $30,000 three-year bank loan agreement and the private placement of $20,000 of 8.41% Senior Notes. Proceeds from the new financing package were used to refinance existing bank loans incurred to support working capital requirements and for acquisitions. As a result of the new financing, the Company believes that it has sufficient liquidity to fund existing operations and to continue to make acquisitions.\nSubstantially all of the expenditures made by the Company to comply with environmental regulations were for the remediation of previously contaminated sites. The Company has established a reserve to cover such expenses (see Note 11 to the Consolidated Financial Statements). In addition to the amounts provided for in the reserve, the Company may be required to make certain additional capital expenditures which, in aggregate, are not expected to be material.\nSubsequent to the completion of the remediation contemplated in setting the reserve, the Company believes that the ongoing costs of compliance with environmental regulation, including the cost of monitoring, pollution abatement and disposal of hazardous materials, will not be material.\nOn January 4, 1996, the Company announced its intention to exit its cast iron and cast aluminum cookware businesses during the first half of 1996. The proceeds from such disposition and the concomitant reduction in ongoing working capital requirements will result in a reduction of debt outstanding and improved liquidity.\nEffect of Inflation\nFor the year ended December 31, 1995, price increases in certain commodities used by the Company (e.g., aluminum ingot (44%), steel (5%) and packaging materials (10%)) had an adverse effect on the operations of the Company. The impact of the aluminum ingot increase adversely impacted operating income by approximately $800. For the years ended December 31, 1993 and 1994, there were no significant effects related to price increases.\nEffect of New Accounting Principles\nStatement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long Lived Assets and Long Lived Assets to be Disposed of,\" establishes the financial accounting and reporting standards for the recognition of impairments to long lived assets. The implementation of this statement, which will be required in 1996, is not expected to have a material effect on the Company's consolidated financial position or cash flow.\nStatement of Financial Accounting Standards No. 123, \"Accounting for Stock Based Compensation,\" establishes a fair-value based method of accounting for stock options and other equity instruments. The Company has not identified the financial reporting effect of the implementation of this statement, which will be required in 1996.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nFinancial Statements:\nReport of Independent Accountants\nConsolidated Statement of Income for the three years ended December 31, 1995\nConsolidated Statement of Changes in Stockholders' Equity for the three years ended December 31, 1995\nConsolidated Balance Sheet at December 31, 1995 and\nConsolidated Statement of Cash Flows for the three years ended December 31, 1995\nNotes to Consolidated Financial Statements\nQuarterly Financial Information\nFinancial Statement Schedule:\nFor the three years ended December 31, 1995 VII - Valuation and Qualifying Accounts\nAll other 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\nPrice Waterhouse LLP\nTo the Board of Directors and Stockholders of General Housewares Corp.\nIn our opinion, the accompanying consolidated balance sheet and the related consolidated statements of income, of stockholders' equity and of cash flows present fairly, in all material respects, the financial position of General Housewares Corp., and its subsidiaries at December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.\nPRICE WATERHOUSE LLP Indianapolis, Indiana February 2, 1996\nCONSOLIDATED STATEMENT OF INCOME\nSee notes to consolidated financial statements.\nCONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY\nSee notes to consolidated financial statements\nCONSOLIDATED BALANCE SHEET\nSee notes to consolidated financial statements.\nCONSOLIDATED STATEMENT OF CASH FLOWS\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands except per share amounts)\n1. Nature of Operations\nThe Company manufactures and markets consumer durable goods with principal lines of business consisting of housewares (cookware, cutlery and kitchen tools) and precision cutting tools. In addition, the Company sells products through a chain of manufacturer's retail outlet stores. The majority of the Company's sales are derived from the cookware and cutlery lines, with these two lines approximately equal in size. Substantially all of the remaining sales are in the kitchen tool and precision cutting tool lines which are approximately equal in size.\n2. Accounting Policies\nPrinciples of Consolidation - The Consolidated Financial Statements include the accounts of General Housewares Corp. and its subsidiaries, all of which are wholly-owned.\nInventories - Inventories are stated at the lower of cost or market and at December 31 were comprised of the following:\nCost, at December 31, 1995, is determined on a last-in, first-out (LIFO) basis for approximately 74% (80% at December 31, 1994) of the Company's inventories. The remaining inventories are determined on a first-in, first-out (FIFO) basis. During 1993, 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 1993 purchases, the\neffect of which decreased cost of goods sold by approximately $285 and increased net income by approximately $170. There were no significant liquidations in 1994 or 1995.\nProperty, Plant and Equipment - Property, plant and equipment is recorded at cost and depreciated using the straight-line method on useful lives of 20 to 45 years for buildings and 3 to 15 years for machinery and equipment.\nProperty, Plant and Equipment is as follows:\nOther Current Assets - Included in other current assets is a receivable related to an anticipated recovery of $150 ($400 in 1994) of estimated environmental costs (See Note 11) and other miscellaneous receivables and prepaid expenses.\nOther Assets - Included in other assets are three manufacturing facilities (Land and Buildings - cost of $5,857 with accumulated depreciation of $1,546) that the Company no longer operates. The Company sold one of these facilities in January 1996 (see Note 13). The other two facilities are currently being leased to unaffiliated third parties under non-cancelable leases. Income generated by these leases is not significant to the consolidated operations of the Company. Each of these facilities is being depreciated over its estimated useful life using the straight-line method. Other assets also include prepaid pension expense.\nIntangible Assets - The cost in excess of net assets acquired is amortized using the straight-line method over periods ranging from 10 to 40 years. Other intangible assets arising from acquisitions are included in patents and other intangible assets and are amortized using the straight-line method over periods of 5 to 15 years. Amortization of intangible assets was approximately $1,793 in 1995 ($1,179 in 1994 and $1,008 in 1993) and accumulated amortization was $6,561 and $4,768 at December 31, 1995 and 1994, respectively. The Company assesses the recoverability of costs in excess of net assets acquired based on undiscounted future cash flows. No write-downs to such costs were incurred for the periods ended December 31, 1995, 1994 or 1993. At December 31, 1995 and 1994, the Company recognized an intangible asset related to the recording of a minimum pension liability in accordance with Statement of Financial Accounting Standards No. 87.\nAdvertising - The Company participates in cooperative advertising programs with certain customers. Advertising expense related to the programs is matched with associated revenues and was $3,675, $5,366, and $5,245 for the periods ended December 31, 1995, 1994 and 1993, respectively.\nDeferred Liabilities - Deferred liabilities include a minimum pension liability, deferred income taxes and deferred compensation.\nEarnings per Share - Earnings per share are computed using the weighted average number of shares of common stock and common stock equivalents outstanding during the year.\nSales to Significant Customers - During 1995 and 1994, the Company had gross sales to a single customer of $12,980 and $13,278, respectively, which represented approximately 10% and 13% of total sales for 1995 and 1994, respectively.\nAccounts Receivable - Substantially all accounts receivable are uncollateralized and arise from sales to the retail industry. Accounts receivable allowances include reserves for doubtful accounts, returns, adjustments and cooperative advertising allowances to customers.\nReclassification - Certain 1994 and 1993 amounts have been reclassified to conform with the 1995 presentation.\nCash Equivalents - The Company considers all highly liquid temporary cash investments with low interest rate risk to be cash equivalents. Temporary cash investments are stated at cost, which approximates market value.\nCurrency Translation - The net assets of foreign operations are translated into U.S. dollars using year-end exchange rates. Revenue and expenses are translated at average exchange rates during the reporting period.\nUse of Estimates - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nLong-Lived Assets - FAS No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of,\" is applicable for financial statements for fiscal years beginning after December 15, 1995. The Company does not expect the standard to have a significant impact on its 1996 financial statements.\nStock Based Compensation - FAS No. 123, \"Accounting for Stock Based Compensation,\" is applicable for financial statements for fiscal years beginning after December 15, 1995. The standard establishes a fair value based method of accounting for stock options and other equity instruments with such fair value recognized in the income statement or disclosed in the footnotes to the financial statements. The Company has not selected the accounting treatment to be used, as defined by FAS No. 123, and therefore is not in a position to identify the possible related financial statement impact.\n3. Acquisitions\nEffective October 1, 1994, the Company purchased the assets of Walter Absil Company Limited and Olfa Products Corp. (collectively referred to as \"Olfa Products Group\"). The Olfa Products Group is the exclusive distributor, for the United States and Canada, of precision cutting tools and accessories manufactured by Olfa Corporation of Osaka, Japan. Assets acquired included accounts receivable, inventories and equipment.\nThe purchase price was $13,576 and consisted of a cash payment of $6,843,\nSubordinated Promissory Notes in the principal amount of $2,233 bearing interest at 6% per annum and 400,000 restricted shares (valued at $4,500) of the Company's common stock. The common stock issued in connection with this acquisition is restricted as to both sale and voting rights. All such restrictions will expire no later than September 30, 1999.\nThe acquisition was accounted for as a purchase and the net assets and results of operations are included in the Company's Consolidated Financial Statements beginning October 1, 1994. The purchase price was allocated to the assets acquired and liabilities assumed of the Olfa Products Group based on their estimated respective fair values. Cost in excess of net assets acquired was $6,349 and is being amortized over 20 years.\nIn connection with the issuance of restricted common stock related to the acquisition of Olfa Products Group, the Company has agreed, under certain circumstances, to make payments of up to $600 to the former owners upon sale of the restricted common stock. In addition, the Company has agreed to make payments of up to approximately $3,565 to the management of the Olfa Products Group based upon the achievement of a specific aggregate financial target for the three-year period ending December 31, 1997.\nEffective September 1, 1994, the Company purchased the assets of Normandy, the enamel on steel cookware business of National Housewares, Inc., for a cash consideration of $1,800 and deferred payments equal to $3,767 plus an incentive payment of $382 based upon operational performance for the remainder of 1994. The cash payment was equivalent to the fair market value of the inventories acquired. Cost in excess of net assets acquired was $4,149 and is being amortized over 10 years.\nThe following unaudited pro forma information combines the consolidated results of operations of the Company, the Olfa Products Group and Normandy as if the acquisitions had occurred at the beginning of 1994 and 1993. The pro forma information is not necessarily indicative of the results of operations which would have actually occurred during such periods.\n(Unaudited)\n4. Debt\nLong-term and short-term debt includes the following:\nAt December 31, 1995 and 1994, all of the Company's debt outstanding was unsecured.\nThe bank debt outstanding at December 31, 1995, relates to a Credit Agreement with two banks with an aggregate commitment of $30,000 of which $5,000 is reserved for letters of credit at December 31, 1995. The commitment will expire on November 30, 1997, but may be renewed, under certain circumstances, for two additional one-year periods. Amounts outstanding under such Credit Agreement are classified as short-term debt as of December 31, 1995, as the Company intends to repay such outstanding amounts from current working capital and the proceeds from the sale of assets disclosed in Note 13. Drawings under the Credit Agreement are priced based on the banks' Prime or LIBOR with spreads calculated on an incentive formula. At December 31, 1995, the Company could borrow under the Credit Agreement at Prime or LIBOR + 1%. The interest rates on outstanding amounts on December 31, 1995, range from 6.93% to 8.75%. Commitment fees of .25% of the unused balance on the line of credit are included in interest expense. In addition, during 1994, the Company sold $20,000 of 8.41% Senior Notes payable to a group of institutional investors.\nTerms of the Credit Agreement and the Senior Notes require, among other things, that the Company maintain certain minimum financial ratios. In addition, the agreements provide for limits on dividends, certain investments and lease commitments.\nThe 12% subordinated note payable is due the estate of the former principal owner of Chicago Cutlery, Inc., a wholly-owned subsidiary of the Company. The estate is a significant stockholder of the Company. The principal balance of the note was reduced by $632 in 1995 as an offset to payments made with regard to the environmental remediation program discussed in Note 11.\nThe deferred payment obligation was incurred in connection with the acquisition of the assets of the Normandy enamel on steel cookware business of National Housewares, Inc. In addition to the obligation listed in the above table, the Company had additional obligations related to the transaction of $2,382, all of which were paid in January, 1995.\nTerms of the Deferred Payment Obligation and all of the Subordinated Notes provide for the right of offset upon the occurrence of certain events.\nAggregate principal payments for the five years subsequent to December 31, 1995, are as follows:\nCash paid during 1995 for interest, net of cash received, was $2,798 (1994 - $1,614; 1993 - $1,361). Of this amount, $562, $450 and $615 consisted of amounts paid related parties in 1995, 1994 and 1993, respectively.\nAs of January 1, 1996, the Company was not in compliance with one of the covenants in the Bank Credit Agreement. This non-compliance has been waived through March 31, 1996. Based on the disposition of assets discussed in Note 13 and the Company's current operating performance, it is likely that the Company will not be in compliance with certain covenants contained in the Bank Credit Agreement at the end of the first quarter of 1996. Management intends to seek waivers for any such non-compliance at such time as the impact of the disposition of assets becomes determinable. The Company believes that such waivers will be obtained.\n5. Common Stock and Rights\nCommon stock reserved at December 31, 1995, included 303,770 shares reserved for outstanding stock options.\nIn February 1989, the Company effected a dividend distribution of one Right for each outstanding share of common stock. Under certain circumstances, each Right may be exercised to purchase 1\/100th of a share of Series A Junior Participating Preferred Stock, at a purchase price of $25, subject to adjustment to prevent dilution. Each preferred share fraction is designed to be equivalent in voting and dividend rights to one share of common stock. The Rights may only be exercised after a person acquires, or has the right to acquire, 21% or more of the common stock or makes an offer for 30% or more of the common stock. The Rights, which do not have voting rights and do not entitle the holder to dividends, expire on February 27, 1999, and may be redeemed by the Company prior to their being exercisable at a price of $.01 per Right.\n6. Stock Plans\nThe Company maintains a stock plan for key employees which provides for the granting of options or awards of restricted stock until January 31, 2003. A summary of transactions under the plan follows:\nOptions granted under the plan provide for the issuance of common stock at not less than 100% of the fair market value on the date of grant. When options are exercised, proceeds received are credited to common stock and capital in excess of par value. Stock options were exercised at prices ranging from $7.125 to $13.750 in 1995. Options outstanding at December 31, 1995, were granted at prices ranging from $7.125 to $14.00 per share. Options for 179,069 shares were exercisable at December 31, 1995.\nRestricted stock granted under the plan is subject to restrictions relating to earnings targets of the Company and\/or continuous employment or other relationships.\nOn July 1, 1992, the Company introduced its Employee Stock Purchase Plan. The plan, administered by a Committee appointed by the Board of Directors, is intended to qualify as an \"employee stock purchase plan\" within the meaning of Section 423 of the Internal Revenue Code. The Employee Stock Purchase Plan provides that shares of the Company's Common Stock will be purchased at the end of each calendar quarter with funds deducted from the payroll of eligible employees. Employees receive a bargain purchase price equivalent to 90% of the lower of the opening or closing stock price of each calendar quarter. Dividends paid to the Employee Stock Purchase Plan fund are reinvested in the fund to buy additional shares. At December 31, 1995, the balance in the plan consisted of 17,951 shares of General Housewares Corp. Common Stock (13,072 shares in 1994).\n7. Employee Benefit Plans\nThe Company sponsors four defined benefit pension plans which cover substantially all salaried and hourly employees. Pension benefit formulas are related to final average pay or fixed amount per year of service. It is the Company's policy to fund at least the minimum amounts required by applicable regulations.\nNet periodic pension cost included the following components:\nThe funded status of the plans as of December 31 was as follows:\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 December 31, 1995 and 1994, representing the excess of the accumulated benefit obligation over the fair value of plan assets and prepaid pension asset. The minimum liability for plans with accumulated benefits in excess of assets of $1,199 at December 31, 1995, has been included in the Company's consolidated balance sheet as a deferred liability with an offset in other intangible assets and equity. In addition, a deferred tax asset of $336 has been recognized for the minimum liability charge to equity.\nThe actuarial present value of the projected benefit obligation at December 31, 1995 and 1994, was determined using a weighted average discount rate of 7.25% and 8.0%, respectively, and a rate of increase in future compensation levels of 4%. The weighted average expected long-term rate of return on assets was 9% at December 31, 1995 and 1994. As of December 31, 1995, approximately 32% (1994 - 59%) of the plan's assets were invested in fixed income funds.\nIn addition to the defined benefit plans described above, the Company also sponsors a 401(K) plan for all full-time employees. The Company matches a portion of each employee contribution. The Company's contribution expense was $316 in 1995 ($302 in 1994 and $335 in 1993).\nThe Company maintains a non-qualified, unfunded deferred compensation plan for certain key executives providing payments upon retirement. The present value of the deferred compensation is included in deferred liabilities.\n8. Income Taxes\nThe components of the provision for income taxes were as follows:\nA reconciliation of the federal statutory rate to the Company's effective tax rate is as follows:\nDeferred tax assets (liabilities) are comprised of the following at December 31:\nCash paid for income taxes during 1995 was $318 (1994 - $1,659; 1993 - $1,939).\nThe Company reached a settlement with the Internal Revenue Service in 1995 relating to the review of the Company's tax returns for the years ended December 31, 1991, 1992 and 1993. The settlement did not have a significant effect on the results of operations for the year ended December 31, 1995.\n9. Operating Leases\nThe Company leases warehouses, administrative offices, computer equipment and retail outlet store space. Certain of the retail store leases provide for contingent rental payments, generally based on the sales volume of the applicable retail unit. All leases in which the Company is engaged are classified as operating leases.\nFuture minimum annual lease payments under these operating leases, the majority of which have initial or remaining non-cancelable lease terms in excess of one year, were as follows at December 31, 1995:\nCertain leases require payments of real estate taxes, insurance, repairs and other charges. Total rental expense was $2,098 in 1995 (1994 - $1,455; 1993 - $1,106).\n10. Fair Value of Financial Instruments\nFAS No. 107, \"Disclosures about Fair Value of Financial Instruments,\" requires disclosure of information about the fair value of certain financial instruments for which it is practical to estimate that value. The Company has performed fair value calculations on its financial instruments (principally debt obligations) and has determined that fair value approximates carrying value.\n11. Commitments and Contingent Liabilities\nThe Company is currently involved in the review and evaluation, or remediation, of seven sites posing potential or identified environmental contamination problems. Based on information currently available, management's best estimate of probable remediation costs, recorded as a liability, is $403 at December 31, 1995 ($1,549 at December 31, 1994) which aggregate amount management believes will be paid out during the course of the next five years. Based on provisions in the stock purchase agreement related to the acquisition of Chicago Cutlery, Inc., the Company has recovered $932 through an offset to amounts owed to the holders of the 12% subordinated note (see Note 4) and based on the opinion of legal counsel, considers it probable that it will retain such amounts. Additional amounts are also expected to be recovered from the subordinated note holder as a result of environmental remediation activities at a Chicago Cutlery facility. The holders of the 12% subordinated note have not agreed to such offset. Within a range of\nreasonably possible environmental cleanup liabilities established on the basis of current information, the recorded liability represents approximately 68% of the currently estimable maximum loss that has been identified by the Company and its environmental advisors. While neither the timing nor the amount of the ultimate costs associated with environmental matters can be accurately determined, management does not expect that these matters will have a material effect on the Company's consolidated financial position and cash flow.\n12. Segment Information\nThe Company's principal business involves the manufacture and marketing of consumer durable goods. These operations are classified into two reportable segments:\nHousewares - Included in this segment are the Company's cookware, cutlery and kitchen tool products, as well as a chain of manufacturer's retail outlet stores with sales derived primarily from these products. These products are used primarily in commercial and residential food preparation and are distributed primarily through mass merchandisers, department stores and specialty shops.\nPrecision Cutting Tools - Included in this segment is the Company's Olfa Products Group. Products in this segment are designed and marketed for diverse commercial and residential use including hobby, craft, sewing and construction. The goods are sold both directly and through distributors, primarily to hardware stores and sewing\/hobby\/craft stores.\nFinancial information by reportable segments is as follows:\nThe Precision Cutting Tools segment was added in October of 1994 as a result of an acquisition of assets. As such, 1994 results for this segment represent only three months of activity.\nDuring 1995, the Housewares segment had gross sales to one customer of $12,577, which represents approximately 11% of total Housewares segment gross sales for 1995. During 1994 and 1993, the Company had gross sales to that same customer of $13,046 and $11,130, representing 14% and 13% of total Housewares segment gross sales.\n13. Subsequent Events\nOn January 4, 1996, the Company announced its intention to exit its cast iron and cast aluminum cookware businesses during the first half of 1996. The Company is in discussions with buyers interested in acquiring the associated product lines and possibly the related manufacturing facility located in Sidney, Ohio. A charge related to this transaction and other restructuring efforts, including the closure of certain of the Company's retail outlet stores, will be recorded in 1996. At this time, the Company is unable to determine the financial statement impact related to these transactions that will be recorded in 1996.\nOn January 17, 1996, the Company sold a non-operating facility located in Hyannis, Massachusetts. The Company received cash consideration of $1,300 for the facility, which represented an amount slightly above net book value. The book gain and related tax liability will be reflected in first quarter 1996 financial statements.\nQUARTERLY FINANCIAL INFORMATION (UNAUDITED)\nThe following table summarizes the 1995 and 1994 unaudited interim financial information: (in thousands of dollars except per share amounts - reclassifications have been made to conform with income statement presentation for the periods ended December 31, 1995 and 1994)\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.\nThere have been no changes in or disagreements with the Company's independent accountants on accounting and financial disclosure.\nPART III\nThe information required by Part III, Items 10, 11, 12 and 13 with respect to the directors and executive officers of the Company has been omitted because this information appears on pages 1 to 9 of the Company's definitive proxy statement which the Company expects to file with the Securities and Exchange Commission on or prior to March 31, 1996, and which is incorporated herein by reference, except with respect to the identification and business experience of executive officers required by Item 10, which is set forth under the caption \"Executive Officers of the Company\" in Part I of this Report. The Report of the Compensation Committee and the Performance Graph, which begin on page 9 and on page 12, respectively, of the Company's definitive proxy statement, are not incorporated 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. Financial Statements - See item 8 - index to financial statements.\n(a) 2. Financial Statement Schedule - See item 8 - index to financial statements.\n(a) 3. Exhibits\n3. (i) Restated Certificate of Incorporation, filed May 7, 1987 (filed as Exhibit 3 to the Company's Annual Report on Form 10-K for the year ended December 31, 1988, and incorporated herein by reference).\n(ii) By-laws as amended February 7, 1995 (filed as Exhibit 3. (i) to the Company's Annual Report on Form 10-K for the year ended December 31, 1994, and incorporated herein by reference).\n5. Rights Agreement dated as of February 22, 1989 (filed with the Securities and Exchange Commission as an Exhibit to a Registration Statement on Form 8-A, and incorporated herein by reference).\n10. Material Contracts\n10.1 Note Purchase Agreement, dated November 30, 1994 among the Company and certain institutional investors (filed as Exhibit 10.1 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994, and incorporated herein by reference).\n10.2 Credit Agreement, dated November 30, 1994, between the Company and Harris Trust and Savings Bank as agent, and The First National Bank of Chicago (filed as Exhibit 10.2 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994, and incorporated herein by reference).\n*10b. Employment and Consulting Agreement, dated July 1, 1990, between the Company and John H. Muller, Jr. (filed as Exhibit 10b to the Company's Annual Report on Form 10-K for the year ended December 31, 1990, and incorporated herein by reference).\n*10c. Compensation Agreement, dated August 7, 1987, between the Company and Paul A. Saxton relating to retirement and termination agreements (filed as Exhibit 10c to the Company's Annual Report on Form 10-K for the year ended December 31, 1992, and incorporated herein by reference).\n*10e. Employment Agreement, dated April 12, 1990, between the Company and Robert L. Gray, relating, among other matters, to termination arrangements (filed as Exhibit 10e to the Company's Annual Report on Form 10-K for the year ended December 31, 1992, and incorporated herein by reference).\n*10f. The Company's Severance Compensation Plan, as amended and restated August 6, 1985, in which all of the named executive officers participate, and form of designation of participation (filed as Exhibit 10f to the Company's Annual Report on Form 10-K for the year ended December 31, 1994, and incorporated herein by reference).\n*10g. Employment Agreement, dated March 20, 1995, between the Company and John C. Blackwell, relating, among other matters, to retirement and termination agreements.\n*10h. Employment Agreement, dated July 3, 1995, between the Company and Gordon H. Brown, relating, among other matters, to retirement and termination agreements.\n*10i. Employment Agreement, dated November 11, 1995, between the Company and Ray J. Kulla, relating, among other things, to retirement and termination agreements.\n11. Computation of primary earnings per share.\n21. Subsidiaries of the registrant.\n23. Consent of Price Waterhouse, independent accountants, to the incorporation by reference constituting part of Registration Statements on Form S-8 (Nos. 33-33328, 2-77798 and 33-48336) of their report dated February 2, 1996.\n99. Audited financial statements of the Company's Employee Stock Purchase Plan.\n* Represents a contract, plan or arrangement pursuant to which compensation or benefits are provided to certain Executive Officers or Directors of the Company.\n(b) Reports on Form 8-K\nNo reports on Form 8-K were filed during the period ended December 31, 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.\nGENERAL HOUSEWARES CORP.\nBy \/s\/ Robert L. Gray 3\/18\/96 Robert L. Gray Date Vice President, Finance and Treasurer Principal Financial Officer\nBy \/s\/ Mark S. Scales 3\/18\/96 Mark S. Scales Date Controller 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.\n\/s\/ Paul A. Saxton 3\/18\/96 Paul A. Saxton Date Chairman of the Board President and Chief Executive Officer\n\/s\/ Charles E. Bradley 3\/18\/96 Charles E. Bradley - Director Date\n\/s\/ John S. Crowley 3\/18\/96 John S. Crowley - Director Date\n\/s\/ Thomas L. Francis 3\/18\/96 Thomas L. Francis - Director Date\n\/s\/ Joseph Hinsey IV 3\/18\/96 Joseph Hinsey IV - Director Date\n\/s\/ Ann Manix 3\/18\/96 Ann Manix - Director Date\n\/s\/ John H. Muller, Jr. 3\/18\/96 John H. Muller, Jr. - Director Date\n\/s\/ Phillip A. Ranney 3\/18\/96 Phillip A. Ranney - Director Date\nINDEX TO EXHIBITS\nExhibit No.\n10g. Employment Agreement\n10h. Employment Agreement\n10i. Employment Agreement\n11. Computation of primary earnings per share\n21. Subsidiaries of the registrant\n23. Consent of Price Waterhouse\n27. Financial Data Schedule\n99. Financial statements of the Company's Employee Stock Purchase Plan","section_15":""}
{"filename":"722723_1995.txt","cik":"722723","year":"1995","section_1":"ITEM 1. BUSINESS.\nIntroduction\nHanger Orthopedic Group, Inc. (\"Hanger\" or the \"Company\") is one of the nation's largest practice management companies in the orthotic and prosthetic (\"O&P\") rehabilitation industry. In addition to providing O&P patient care services through its operating subsidiaries, Hanger also manufactures and distributes components and finished patient care products to the O&P industry. Hanger's largest subsidiary, J. E. Hanger, Inc. (\"JEH\"), was founded in 1861 by a Civil War amputee and is the oldest company in the O&P industry in the United States.\nOrthotics is the design, fabrication, fitting and supervised use of custom-made braces and other devices such as knee, spinal, neck and cervical braces and foot orthoses, that provide external support to treat musculoskeletal disorders. Musculoskeletal disorders are ailments of the back, extremities or joints caused by traumatic injuries, chronic conditions, diseases, congenital disorders or injuries resulting from sports or other activities. Prosthetics is the design, fabrication and fitting of custom-made artificial limbs for patients who have lost limbs as a result of traumatic injuries, vascular diseases, diabetes, cancer or congenital disorders.\nThe Company manages O&P patient care practices. Care of O&P patients is part of a continuum of rehabilitation services from diagnosis to treatment and prevention of future injury. This continuum involves the integration of several medical disciplines that begins with the attending physician's diagnosis. Once a course of treatment is determined, the physician, generally an orthopedic surgeon, vascular surgeon or physiatrist, refers a patient to one of Hanger's patient care centers for treatment. A Hanger practitioner then consults with both the referring physician and the patient to formulate the prescription for and design of an orthotic or prosthetic device to meet the patient's needs.\nThe fitting process involves several stages in order to successfully achieve desired functional and cosmetic results. The practitioner creates a cast and takes detailed measurements of the patient to ensure an anatomically correct fit. All of the prosthetic devices fitted by Hanger's practitioners are custom designed and fabricated by skilled practitioners who can balance fit, support and comfort. Of the orthotic devices provided by Hanger, approximately one-half are custom designed, fabricated and fitted and the other half are prefabricated but custom fitted.\nCustom devices are fabricated by the Company's skilled technicians using the castings, measurements and designs made by the practitioner. Technicians use advanced materials and technologies to fabricate a custom device under stringent quality assurance guidelines. After final adjustments to the device by the practitioner, the patient is instructed in the use, care and maintenance of the device. A program of scheduled follow-up and maintenance visits is used to provide post-fitting treatment, including adjustments or replacements as the patient's physical condition and lifestyle\nchanges. Generally, the useful life of most custom designed and fabricated O&P devices ranges from three to five years.\nA substantial portion of Hanger's O&P services involves treatment of a patient in a non-hospital setting, such as one of Hanger's patient care centers, a physician's office, an out-patient clinic or other facilities. In addition, O&P services are increasingly rendered to patients in hospitals, nursing homes, rehabilitation centers and other alternate-site healthcare facilities. In a hospital setting, the practitioner works with a physician to provide either orthotic devices or temporary prosthetic devices that are later replaced by permanent prostheses. Hanger's distribution division allows its personnel faster access to the products needed to fabricate devices for patients. This is accomplished at competitive prices, as a result of direct purchases by the Company's distribution division from manufacturers. As a result of faster access to products, the length of a patient's treatment in the hospital can be reduced, thereby contributing to healthcare cost containment.\nEach of the Company's patient care centers is closely supervised by one or more Certified Practitioners, which enables the Company to assure the highest quality of services and patient care satisfaction. Hanger currently employs 313 patient care practitioners, of whom 98 are Certified Practitioners or candidates for formal certification by the American Board of Certification in Orthotics and Prosthetics. The balance of the Company's patient care practitioners are highly trained technical personnel who assist in the provision of services to patients and fabricate various O&P devices.\nThe O&P practices currently managed by the Company provide O&P services through patient care centers in Alabama, Arizona, California, Colorado, Connecticut, Delaware, District of Columbia, Florida, Kentucky, Maryland, Massachusetts, Michigan, Mississippi, Montana, New Mexico, New York, North Carolina, Pennsylvania, South Carolina, Tennessee, Texas, Virginia, West Virginia and Wyoming. Hanger also manufactures a number of specialized O&P components and finished patient care products at its manufacturing facilities in Florida, Illinois, Maryland and New York and maintains a central distribution facility in Maryland.\nThe Company was originally incorporated under Colorado law in March 1983. It initially engaged in activities other than its current line of business, which activities were discontinued during 1986 when the Company entered the O&P business. The Company changed its name to Sequel Corporation (\"Sequel\") in February 1986 and reincorporated under Delaware law in April 1988. On May 15, 1989, the Company acquired JEH in a transaction which was treated for accounting purposes as a reverse acquisition, i.e., as though JEH acquired Hanger. The Company changed its name to Hanger Orthopedic Group, Inc. in July 1989. The Company's executive offices are located at 7700 Old Georgetown Road, Bethesda, Maryland 20814. Its telephone number is (301) 986-0701. Hanger is a holding company which transacts business through its subsidiaries. Unless the context otherwise requires, all references herein to Hanger include its subsidiaries.\nTHE MARKET FOR ORTHOPEDIC REHABILITATION SERVICES\nIn addition to O&P patient care practice management, the Company is engaged in O&P product manufacturing and distribution activities. The O&P industry in the United States, including\npatient care services, manufacturing and distribution, is estimated to generate $1 billion in sales annually. Of that amount, an estimated $700 million is attributed to the patient care services sector, a highly fragmented market with over 2,740 Certified Practitioners and 1,230 certified O&P facilities, generally operated as small group practices. The Company believes that the demand for orthopedic rehabilitation is increasing at a rapid rate due to a combination of the following factors:\n- Growing Elderly Population. The growth rate of the over-65 age group is nearly triple that of the under-65 age group. The elderly require orthopedic rehabilitation more frequently than younger age groups. With broader medical insurance coverage, increasing disposable income, longer life expectancy, greater mobility and improved technology and devices they are expected to seek orthopedic rehabilitation services more often.\n- Cost-effective Reduction in Hospitalization. As public and private payors encourage reduced hospital admissions and reduced length of stay, out-patient rehabilitation is in greater demand. O&P services and devices have enabled patients to become ambulatory more quickly after receiving medical treatment in the hospital. The Company believes that significant cost savings can be achieved through the early use of O&P services. The provision of O&P services in many cases reduces the need for more expensive treatment modalities, thus representing a cost savings to the third-party payor.\n- Growing Physical Health Consciousness. There is a growing emphasis on physical fitness, leisure sports and conditioning, such as running and aerobics, which has led to increased injuries requiring orthopedic rehabilitative services and products. In addition, as the current middle-age population ages, it brings its more active life-style and accompanying emphasis on physical fitness to the over-65 age group. These trends are evidenced by the increasing demand for new devices which provide support for injuries, prevent further or new injuries or enhance physical performance.\n- Advancing Technology. The range and effectiveness of treatment options have increased in connection with the technological sophistication of O&P devices. Advances in design technology and lighter, stronger and more cosmetically acceptable materials have enabled the industry to produce more new O&P products, which provide greater comfort, protection and patient acceptability. Therefore, treatment can be more effective and of shorter duration, contributing to greater mobility and a more active lifestyle for the patient. Orthotic devices are more prevalent and visible in many sports, including but not limited to skiing.\n- Need for Replacement and Continuing Care. Because the useful life of most custom fitted and fabricated O&P devices is approximately three to five years, such devices need retrofitting and replacement. There is also an attendant need for continuing patient care services, which contributes to the increasing demand for orthopedic rehabilitation.\nBUSINESS STRATEGY\nThe Company's business strategy is to significantly expand its O&P practice management presence in the patient care services segment of the O&P industry, which is a highly fragmented market with over 2,740 Certified Practitioners and 1,230 certified O&P facilities in the United States. Most of these facilities operate as small group practices. The Company's strategy involves: (i) broadening the Company's presence in targeted geographic areas through a program of selected acquisitions; (ii) expanding and improving O&P practice management operations at existing and acquired patient care facilities through more efficient operating practices and the use of professional marketing programs not generally utilized in the O&P industry; (iii) increasing in the manufacturing and distribution of O&P components and products used by others in the O&P industry as well as by its own patient care centers; (iv) opening new patient care centers in existing markets including centers within rehabilitation hospitals; (v) developing contract business with managed care organizations, including health maintenance organizations (\"HMOs\") and preferred provider organizations (\"PPOs\"); and (vi) developing a proprietary referral network between selected O&P service providers and the Company's contract business with managed care organizations. See \"Acquisitions\" and \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.\"\nACQUISITION STRATEGY\nThe Company considers both operating and financial factors in evaluating prospective acquisitions. Operating factors include Hanger's emphasis on high standards of professionalism and patient care and the presence of Certified Practitioners at each of its facilities. Financial factors include historical earnings and cash flow history and the projected benefits of applying Hanger's management, marketing, information systems and other operational programs, such as access to its manufacturing and wholesale distribution facilities, to the acquired company's business. Hanger's acquisition criteria also include the retention and support of the existing management of the acquired company, typically through the use of employment contracts, non-compete agreements and incentive programs. In evaluating acquisitions in geographic areas where the Company has an established presence, Hanger targets businesses that complement its existing network of patient care centers. In locations where the Company has not yet established a presence, the Company generally focuses on strong regional businesses which have multiple patient care centers and experienced practitioners. The Company also reviews the operational and financial performance of its acquisitions to determine whether to maintain or dispose of any such acquisition. In the event an acquisition performs at levels which meet or exceed the operational and financial standards of the Company, then such acquisition will be maintained by the Company. However, in the event an acquired operation performs at levels which are below the operational and financial standards of the Company, even after sufficient remedial efforts have been applied, then such operation will be sold or closed by the Company.\nThe Company also plans to expand its contractual relationships with large rehabilitation hospitals pursuant to which Hanger operates such facilities' O&P patient care centers. In 1989, the Company commenced the provision of all in-patient O&P services to patients of The Rusk Institute of Rehabilitation Medicine at the New York University Medical Center. In 1990, by virtue of its acquisition of Scott Orthopedics, Inc. (\"Scott\"), the Company commenced provision of all O&P services to the patients of the Rocky Mountain Regional Spinal Injury Center of the Craig Hospital in\nColorado. In March 1992, the Company commenced a similar service with the Harmarville Rehabilitation Center in Pennsylvania.\nOPERATIONAL STRATEGY\nThe Company's O&P practice management operational strategy includes the continued development and implementation of programs designed to enhance the efficiency of its consolidated clinical practices. These programs permit its Certified Practitioners to allocate a greater portion of their time to patient care activities by reducing the administrative responsibilities of operating the business. Such programs include: (i) sales and marketing initiatives designed to attract new patient referrals through established relationships with physicians, therapists, employers, managed care organizations, such as HMOs and PPOs, hospitals, rehabilitation centers, out-patient clinics and insurance companies; (ii) professional management and information systems designed to improve efficiencies of administrative and operational functions under guidelines of the Company's patient care centers; (iii) professional educational programs for practitioners emphasizing state-of-the-art developments in the increasingly sophisticated field of O&P clinical therapy; (iv) the regional centralization of fabrication and purchasing activities which provides overnight access to component parts and products at prices that are typically 20% lower than traditional procurement methods; and (v) the acquisition of state-of-the-art equipment which is financially more difficult for smaller, independent facilities to obtain. Management believes that the programs which have been created by the Company to enhance its operational strategy have made the Company attractive to clinical practices, which enhances the Company's ability to expand through acquisitions.\nSALES AND MARKETING\nThe Company believes that the application of modern sales and marketing techniques is a key element of its O&P practice management business strategy. While patient referrals have always been a source of new business, historically there has been an absence of a comprehensive sales and marketing effort in the patient care segment of the O&P industry. The success of an O&P business has been largely a function of its local reputation for quality of care, responsiveness and length of service in the community. This is due primarily to the fragmented nature of the industry, with individual practitioners relying almost exclusively on referrals from local physicians or physical therapists.\nHanger's patient care marketing efforts are managed by a Vice President of Marketing hired in 1992 and are directed toward referring physicians, therapists, employers, HMOs, PPOs, hospitals, rehabilitation centers, out-patient clinics and insurance companies on both a local, regional and national basis. While specialized physicians, such as orthopedic and vascular surgeons and physiatrists, have been principal referral sources, regional and national third-party payors such as managed care organizations, including HMOs and PPOs, have grown important as sources of patient referrals. Hanger has also targeted other rehabilitation professionals in the continuum of care for O&P patients, including physical therapists, orthopedic nurses and technicians and other professionals. Hanger employs personnel whose responsibilities include the solicitation of new business from these referral sources. The Company has been successful in procuring the approval of broad-based managed care plans and other institutional healthcare providers and payors. As part of\nthis effort, the Company employed a Vice President of Contract Services in 1993 whose primary responsibility is to develop and implement new marketing techniques directed toward such managed-care plans and other institutional healthcare providers and payors.\nAlthough referrals are instrumental in establishing initial contact with patients, the Company's O&P practice management policies continue to emphasize the primary importance of its service to its patients. Hanger believes that it is important to develop the doctor\/patient relationship in order to properly meet the needs of the patient, ensure the patient's satisfaction with the O&P device and establish a long-term relationship between the doctor and patient in order for the patient to understand adequately the rehabilitation program, which is attendant to regaining mobility, and the proper maintenance of the O&P device to ensure ongoing performance of the brace or device. The patient orientation of Hanger's services are designed to ensure the patient's return to Hanger for his or her orthotic or prosthetic needs.\nACQUISITIONS\nThe following table sets forth information regarding the O&P businesses which the Company has acquired since 1986:\n(1) Opened Monterey in January 1992; San Jose in October 1992; Beckley in November 1992; Santa Teresa in March 1993; Portsmouth, Virginia in November 1993, Bozeman and Cordova in September 1993; Salinas in December 1993; Clarksburg, Denton and St. Louis in January 1994; Corinth and Florence in February 1994; Martinsburg in September 1994; Rocky Mount, Thermopolis, Jackson and Ann Arbor in June 1994; Charleston and Tucson in September 1994; Brighton in June 1994; Santa Clara in September 1994. Vienna Virginia in May 1995, Washington, D.C. in June 1995 and Worcester, Massachusetts in April 1995.\n(2) The Company's central distribution facility was opened at this location in Maryland in August 1991 as a result of the combination of the Company's existing distribution division, Washington Prosthetic Services, and the inventory and certain other assets of Northeast Paramedical Industries, Inc., a distributor of components for O&P devices, that were purchased by the Company and moved from New York to its central distribution facility in Maryland. In 1992, the Company closed its sales office in New York and moved it to Forestville, Maryland.\n(3) Operations commenced at one of the New York City locations pursuant to an agreement, effective July 1989, with New York University Medical Center to provide all in-patient O&P services to patients of The Rusk Institute of Rehabilitation Medicine. Operations at the Pittsburgh location commenced in March 1992 pursuant to an agreement with the Harmarville Rehabilitation Center to provide O&P services to its patients.\n(4) In 1995, the Company closed the following offices or sold the assets relating to the following operations: Denton in January 1995; Santa Clara in February 1995; Long Beach, Cyprus and Orange in March 1995; Voorhees in July 1995 and Elmsford in November 1995.\n(5) In 1992, the Company moved its Madison, Kentucky office to Union City, Tennessee. In June 1994, the Company moved one of its Boston, Massachusetts offices to Brighton, Massachusetts.\nThe Company continues to be engaged in discussions with prospective acquisition candidates and with several other O&P companies relating to the Company's possible acquisition of their patient care centers. The Company's investigations of such other companies' affairs are in their formative stages and no final representations can be made as to whether, when or on what terms such possible acquisitions will be effected.\nMANUFACTURING AND DISTRIBUTION\nIn addition to on-site fabrication of custom devices incidental to the services rendered at its O&P patient care centers, Hanger also manufactures a number of non-customized orthotic components and finished patient care products at DOBI-Symplex, Inc. (\"DOBI-Symplex\"), a facility in Orlando, Florida, a Ralph Storrs, Inc. facility in Kankakee, Illinois, a Lenox Hill facility in Long Island City, New York and an Ortho-Mold facility in Forestville, Maryland. The principal products manufactured are pre-fabricated and custom-made spinal orthoses as well as a custom and off-the-shelf Precision Fit derotation knee braces. These products are supplied to Hanger's patient care centers, as well as sold to unaffiliated O&P patient care facilities. For the years ended December 31, 1991, 1992, 1993, 1994 and 1995 sales of products manufactured by the Company accounted for 7% ,10%, 18%, 18% and 16%, respectively, of Hanger's historical net sales.\nO&P Express, a division of JEH located in Forestville, Maryland, is primarily engaged in the distribution of O&P products, a majority of which are manufactured by others and distributed by O&P Express primarily to others in the O&P industry. The O&P Express facility inventories over 20,000 items. For the years ended December 31, 1991, 1992, 1993, 1994 and 1995 revenues attributable to distribution by O&P Express accounted for 6%, 6%, 5%, 4% and 5%, respectively, of Hanger's historical net sales.\nMarketing of Hanger's manufactured products and distribution services is conducted on a national basis, primarily through catalogues and through exhibits at industry and medical meetings and conventions. Hanger directs specialized catalogues to segments of the healthcare industry, such as orthopedic surgeons and physical and occupational therapists, and also directs its broad-based marketing to the O&P industry.\nThe Company's manufacturing activities and capabilities were expanded with the acquisition of Ralph Storrs, Inc. (\"Storrs\") in November 1990. Storrs' revenues are derived primarily from the manufacture of orthotic devices. One such device is a hyperextension brace for lumbar and thoracic spinal support which Storrs holds a United States patent which expires in 1996. Another orthopedic device, for which Storrs manufactures the brace components pursuant to what was a requirements arrangement with the patent holder, is an internationally recognized derotation knee orthosis, and\nwhich business Hanger acquired on December 31, 1992 from Minnesota Mining and Manufacturing Company (\"3M\"). See \"Acquisitions.\"\nTo provide timely custom fabrication and service to its patients, the Company employs technical personnel and maintains laboratories at each of its patient care centers. Hanger also maintains several larger, fully staffed central fabrication facilities to service its patient care centers. These centrally-located facilities enable Hanger to fabricate those O&P products which are more easily produced in larger quantities and in a more cost effective manner, as well as serving as an auxiliary production center for products normally fabricated at individual patient care centers. The Company believes that the laboratories in its patient care centers are critical for the provision of patient care services.\nDOBI-Symplex is engaged primarily in the manufacture and distribution of plastic spinal orthotic devices. Its activities include: (i) the fabrication of custom-made plastic orthotic devices from patient molds and\/or measurements, which account for approximately 80% of its annual revenues; (ii) the manufacture of prefabricated plastic orthotic devices that are mass-produced and sold to distributors and patient care providers, which account for approximately 15% of its annual revenues; and (iii) the fabrication of custom-made prosthetic devices. A significant product manufactured and sold by DOBI-Symplex is the custom-made Charleston Bending Brace, an orthotic device designed for nocturnal use to correct spinal curvature in adolescents.\nOn December 31, 1992, DOBI-Symplex, as a wholly-owned subsidiary of the Company, acquired from 3M substantially all of 3M's assets relating to the custom derotation knee brace business primarily known in the O&P industry as the \"Lenox Hill\" derotation knee brace. The purchase of 3M's Lenox Hill derotation knee brace business complements the manufacturing activities of DOBI-Symplex, which include the fabrication of custom-made plastic orthotic devices and the manufacture of pre-fabricated plastic orthotic devices. Storrs, another subsidiary of the Company, has, since 1980, manufactured and sold metal components used by Lenox Hill in its custom knee brace manufacturing activities.\nOn September 1, 1993, DOBI-Symplex purchased from 3M substantially all of 3M's assets relating directly and solely to its off-the-shelf Precision-Fit knee brace business. The purchase of the off-the-shelf Precision-Fit knee brace business compliments the custom Lenox Hill derotation knee brace business.\nOn April 15, 1994, the Company acquired from Brunswick Medical Corporation substantially all the assets relating to the custom fitted thermo-plastic spinal brace business primarily known as Ortho-Mold. The purchase of the Ortho-Mold business complements the manufacturing activities of DOBI-Symplex, which includes the pre-fabricated plastic insert to the Ortho-Mold product.\nPatient Reimbursement Sources\nThe principal reimbursement sources for Hanger's O&P services are: (i) private payor\/third-party insurer sources which consist of individuals, private insurance companies, HMOs, PPOs, hospitals, vocational rehabilitation, workers' compensation and similar sources; (ii) Medicare, which is\na Federally funded health insurance program providing health insurance coverage for persons age 65 or older and certain disabled persons, and Medicaid, which is a health insurance program jointly funded by Federal and state governments providing health insurance coverage for certain persons in financial need, regardless of age, and which may supplement Medicare benefits for financially needy persons aged 65 or older; and (iii) the United States Veterans Administration, with which Hanger has entered into contracts to provide O&P services.\nMedicare, Medicaid, the United States Veterans Administration and certain state agencies have set maximum reimbursement levels for payments for O&P services and products. The healthcare policies and programs of these agencies have been subject to changes in payment and methodologies during the past several years. There can be no assurance that future changes will not reduce reimbursements for O&P services and products from these sources.\nThe Company provides O&P services to eligible veterans pursuant to several contracts with the United States Veterans Administration. The United States Veterans Administration establishes rates for reimbursement for itemized products and services under contracts, which expire in March 1996, with the option to renew for a one year period. The contracts, awarded on a non-exclusive basis, establish the amount of reimbursement to the eligible veteran if the veteran should choose to use the Company's products and services. The Company has been awarded United States Veterans Administration contracts in the past and expects that it will obtain additional contracts when its present agreements expire.\nThe Omnibus Budget Reconciliation Act of 1990 (\"OBRA 1990\"), which was enacted on November 5, 1990, provides for the separate treatment of O&P reimbursement and the general category of durable medical equipment (\"DME\") reimbursement for Medicare purposes. Previously, O&P devices were included within the DME category which failed to acknowledge the fact that O&P devices are custom fabricated and subjected O&P to the same budget reductions that were applicable to DME. The separate recognition of O&P for Medicare reimbursement purposes will enable O&P to have its own budget estimates and administration process in connection with the regulatory activities of the United States Health Care Financing Administration (\"HCFA\"). Pursuant to OBRA 1990, HCFA has established separate professional O&P fee schedules that generally reflect the cost of O&P services. Effective January 1, 1992, HCFA commenced the regionalization of O&P fee schedules whereby regional fee schedule averages may not exceed 125% of the national fee schedule average. The Company believes that OBRA 1990's separation of O&P from DME for Medicare reimbursement purposes will not adversely affect the Company.\nCompetition\nThe O&P industry is highly fragmented, with approximately 1,230 certified facilities providing patient care services in the United States. There are also several regional and multi-regional competitors which operate a number of patient care centers. The competition among O&P patient care centers is primarily for referrals from physicians, therapists, employers, HMOs, PPOs, hospitals, rehabilitation centers, out-patient clinics and insurance companies on both a local and regional basis. In addition to O&P facilities, Hanger competes with other providers of O&P services, such as hospitals, physicians and therapists. The Company believes that distinguishing competitive\nfactors in the O&P industry are quality and timeliness of patient care, service to the customer and referring source and, to a lesser degree, charges for services. While the Company believes it is one of the largest suppliers of O&P services in the U.S., certain competitors may have greater financial and personnel resources than Hanger. Hanger competes with others in the industry for trained personnel. To date, however, Hanger has been able to achieve its staffing needs and has experienced a relatively low turnover rate of employees.\nThe Company has not encountered significant competition to date in the identification and acquisition of O&P businesses. However, no assurance can be given that such competition will not be encountered in the future.\nGovernment Regulations and O&P Certification\nCertain state and Federal agencies require that practitioners providing services to such agencies be certified by the American Board for Certification in Orthotics and Prosthetics (the \"ABC\"). Hanger's practitioners currently comply with all such requirements. Hanger provides services under various contracts to such Federal agencies. These contracts are subject to regulations governing Federal contracts, including the ability of the government to terminate for its convenience. Revenue from such contracts is not material to Hanger.\nThe Company's manufactured or fabricated devices are not subject to approval or review of the U.S. Food and Drug Administration nor are there any requirements for governmental certification of orthotists or prosthetists or accreditation of Hanger's facilities.\nThe ABC conducts a certification program for practitioners and an accreditation program for patient care centers. The minimum requirements for a Certified Practitioner are a college degree, completion of an accredited academic program, one year of staff experience at a patient care center under the supervision of a Certified Practitioner and successful completion of certain examinations. Minimum requirements for an ABC-accredited patient care center include the presence of a Certified Practitioner and specific plant and equipment requirements.\nEmployees\nAs of March 4, 1996, Hanger had 497 full-time employees. Of these employees, 313 are patient care practitioners. The balance are executive, sales and administrative personnel. None of the Company's employees is subject to a collective bargaining agreement. The Company considers its relationship with its employees to be good.\nInsurance\nThe Company currently maintains insurance of the type and in the amount customary in the orthopedic rehabilitation industry, including coverage for malpractice liability, product liability, workers' compensation and property damage. Hanger's general liability insurance coverage is at least $500,000 per incident. Based on the Company's experience and prevailing industry practices, Hanger believes its coverage is adequate as to risks and amount.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nDuring 1995, Hanger operated 93 patient care centers and facilities in 23 states and in Washington, D.C. Of these, ten centers are owned by Hanger. The remaining centers are occupied under leases expiring between the years of 1995 and 2002. Hanger believes that the centers leased or owned by it are adequate for carrying on its current O&P operations at its existing locations, as well as its anticipated future needs at those locations. Hanger believes it will be able to renew such leases as they expire or find comparable or additional space on commercially suitable terms.\nHanger also leases manufacturing and distribution facilities in Illinois, New York, Maryland and Florida, its corporate headquarters in Bethesda, Maryland and a corporate office in New Canaan, Connecticut. Several of Hanger's O&P related properties are pledged to collateralize debt incurred in connection with acquisitions made by Hanger. See Notes H and K to Hanger's Consolidated Financial Statements.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nLegal proceedings to which Hanger is subject arise in the ordinary course of business. Currently, Hanger is not a party to any material legal proceedings.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNo matter was submitted during the fourth quarter of the fiscal year covered by this report to a vote of stockholders through the solicitation of proxies or otherwise.\nITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT.\nThe following table sets forth information regarding the Company's current executive officers:\nIvan R. Sabel has been Chairman of the Board and Chief Executive Officer of Hanger since August 1995 and President since November 1987. Mr. Sabel also served as Chief Operating Officer of Hanger from November 1987 to August 1995. Prior to that time, Mr. Sabel was Vice President - Corporate Development since September 1986. From 1968 until joining Hanger in 1986,\nMr. Sabel was the founder and President of Capital Orthopedics, Inc. Mr. Sabel is a Certified Prosthetist and Orthotist (\"CPO\"), a clinical instructor in orthopedics at Georgetown University Medical School in Washington, D.C., a member of the Board of Directors of the American Orthotic and Prosthetic Association, a former Chairman of the National Commission for Health Certifying Agencies, a former member of the Strategic Planning Committee and a current member of the Veterans Administration Affairs Committee of the American Orthotic and Prosthetic Association and a former President of the American Board for Certification in Orthotics and Prosthetics.\nRichard A. Stein has been Vice President - Finance, Secretary and Treasurer of Hanger since April 1987. Mr. Stein was also the President of Greiner & Saur Orthopedics, Inc., a subsidiary of the Company, from April 1987 until November 1989. Mr. Stein is a Certified Public Accountant and was employed by Coopers & Lybrand from September 1982 until he joined Hanger in 1987.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nThe following table sets forth for the periods indicated the high and low closing sales prices per share for the Common Stock on the AMEX:\nAs of February 23, 1996 there were 500 holders of record of the Common Stock.\nDividend Policy\nThe Company has never paid cash dividends on its Common Stock and intends to continue this policy for the foreseeable future. Hanger plans to retain earnings for use in its business. The terms of Hanger's agreements with its financing sources and certain other agreements prohibit the payment of dividends on its Common Stock and Preferred Stock and such agreements will continue to prohibit the payment of dividends in the future. Any future determination to pay cash dividends will be at the discretion of the Board of Directors of the Company and will be dependent on Hanger's results of operations, financial condition, contractual and legal restrictions and any other factors deemed to be relevant.\nITEM 6.","section_6":"ITEM 6. SELECTED CONSOLIDATED FINANCIAL INFORMATION.\nThe selected financial information presented below has been derived from the consolidated financial statements of the Company.\n(1) Restructuring costs recorded in 1994 are associated with the closing of unprofitable patient care centers. See Note F to the Company's consolidated financial statements.\n(2) The loss from disposal of assets recorded in 1994 relates to the 1995 sale of the Company's southern California patient care centers. See Note D to the Company's consolidated financial statements.\n(3) Loss from discontinued operations consists of the loss from discontinued operations and the sale of the discontinued operation of the Company's Apothecaries, Inc. subsidiary which was sold in 1994. See Note E to the Company's Consolidated Financial Statements.\n(4) Net income (loss) per common share, which has been adjusted for preferred stock dividends, is computed on the basis of the weighted average number of shares of Common Stock issued and outstanding.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nSet forth below is a discussion of the results of the Company's operations for the years ended December 31, 1993, 1994 and 1995, and the Company's liquidity and capital resources at December 31, 1995. The discussion which follows should be read in conjunction with Hanger's Selected Consolidated Financial Statements and the Consolidated Financial Statements included elsewhere herein.\nRESULTS OF OPERATIONS\nGrowth in net sales during the last three fiscal periods has been achieved principally through acquisitions and growth in net sales attributable to patient care centers and facilities that were in operation during the three periods. Gross profit as a percent of net sales has fluctuated between approximately 53% and 55% during these periods. Fluctuations in gross profit were a result of the timing of acquisitions and pricing pressures from managed care companies. Selling, general and administrative expenses have fluctuated between 37% and 42% as a percent of net sales. The decrease in general and administrative expenses as a percent of net sales in 1995 is primarily a result of implementing a plan to restructure its operations providing for the sale or closure of certain under-performing assets and focused plans to reduce overhead costs, including payroll and other operating costs. Interest expense has fluctuated between 2.7% and 3.9% as a percent of net sales due to an increase in bank debt used to consummate additional acquisitions in 1993 through 1995 and an increase in average interest rates.\nThe following table sets forth for the periods indicated certain items of the Company's statements of operations and their percentage of the Company's net sales:\n(1) Includes Anne Arundel Orthopaedics, Inc. from February 5, 1993, Billings Orthopaedic, Inc. from April 16, 1993, Certified Orthopedics, Inc. from May 20, 1993, Winter Park Orthotics & Prosthetics, Inc. from May 26, 1993, Billings Comfort Shoes, Inc. from September 30, 1993, Institute for the Advancement of Prosthetics, Inc. from October 18, 1993.\n(2) Includes all companies listed in footnote (1) for the entire period: Columbia Brace Shop from January 3, 1994, Orthotic and Prosthetic Division of M-D Medical, a Division of Health Industries, Inc. from January 7, 1994, Pedi-Mac Shoe Company, Inc. from January 31, 1994, Ortho-Mold from April 15, 1994 and J.E. Hanger, Inc. of New England from October 7, 1994.\n(3) Includes all companies listed in footnotes (1) and (2) for the entire period: Summit Prosthetics and Orthotics from January 5, 1995, Gulf Coast Orthopaedic Supply, Inc. from March 17, 1995 and excludes the nine patient care centers sold or closed during 1994.\nYEAR ENDED DECEMBER 31, 1995 COMPARED TO YEAR ENDED DECEMBER 31, 1994\nNet sales for the year ended December 31, 1995 amounted to approximately $52,468,000, an increase of approximately $2,168,000, or 4.3%, over net sales of approximately $50,300,000 for the year ended December 31, 1994. The increase was primarily a result of an increase of $2,059,000, or an increase of 5%, in net sales attributable to patient care centers and facilities that were in operation during both periods (\"Internal Base Net Sales\"). Of the $2,059,000 increase in Internal Base Net Sales, $1,704,000, or an increase of 5%, was attributable to patient care centers and $355,000 was attributable to the Company's manufacturing and distribution activities. The balance of the increase in net sales was attributable to O&P patient care centers and facilities acquired by the Company in late 1994 and 1995. The increase of $2,168,000 in net sales occurred notwithstanding the sale or closure of nine patient care centers during late 1994 and the first quarter of 1995 in connection with the restructuring (the \"Restructuring\") undertaken by the Company in 1994 and consummated in March 1995. These nine centers accounted for net sales of $1,770,000 during the year ended December 31, 1994 compared with only $74,000 during the year ended December 31, 1995.\nGross profit increased by approximately $805,000, or 3.0%, over the prior year. Gross profit as a percent of net sales decreased from 53.9% in 1994 to 53.2% in 1995. The cost of products and services sold for the year ended December 31, 1995 amounted to $24,572,000 compared to $23,209,000 for the year ended December 31, 1994. Gross profit as a percent of net sales for patient care services remained the same during 1994 and 1995 at 53%. Gross profit as a percent of net sales for manufacturing and distribution declined from 37% in 1994 to 36% in 1995. This decline resulted principally from pricing pressures in the distribution and manufacturing divisions.\nSelling, general and administrative expenses in 1995 decreased by approximately $1,978,000, or 9.3%, compared to 1994. In addition to decreasing in dollar amount, selling, general and administrative expenses as a percent of net sales decreased to 36.9% for the year ended December 31, 1995 from 42.4% of net sales for the year ended December 31, 1994. The decrease in selling, general and administrative expenses was primarily a result of the sale and closure of nine patient care centers during late 1994 and the first quarter of 1995 in connection with the Restructuring undertaken by the Company in 1994, and consummated in March 1995. These nine centers accounted for selling, general and administrative expenses of $1,043,000 during the year ended December 31, 1994 compared with only $67,000 during the year ended December 31, 1995. The remaining reduction in selling, general\nand administrative expenses was primarily a result of additional cost cutting at the patient care center level.\nPrincipally as a result of the above, income from operations in 1995 totalled approximately $5,843,000, an increase of $5,839,000 over the prior year. Income from operations as a percent of net sales increased 11% in 1995 as compared to 1994.\nInterest expense for the year ended December 31, 1995 amounted to approximately $2,056,000, which is an increase of $310,000, or 17.8%, over the $1,746,000 of interest expense incurred during the year ended December 31, 1994. The increase in interest expense was primarily attributable to the facts that (i) average borrowings in 1995 were $1.8 million higher than the average borrowing during 1994, and (ii) borrowing rates from the bank were 1% higher in 1995 when compared to 1994.\nThe provision for income taxes in 1995 amounted to approximately $1,544,000, as compared to $358,000 in 1994. The increase of $1,186,000 was primarily a result of a $5,839,000 increase in income from operations and a reduction in the non-tax deductible amortization of excess cost over net assets acquired, offset by the reversal of the valuation allowance relating to state net operating loss carryforwards.\nAs a result of the above, the Company reported net income of $2,135,000, or $.26 per share, for the year ended December 31, 1995, as compared to a net loss of $2,687,000, or $.33 per share, for the year ended December 31, 1994.\nYEAR ENDED DECEMBER 31, 1994 COMPARED TO YEAR ENDED DECEMBER 31, 1993\nNet sales for the year ended December 31, 1994, amounted to approximately $50,300,000, an increase of approximately $6,423,000, or 14.6%, over net sales of approximately $43,877,000 for the year ended December 31, 1993. The increase was primarily attributable to the $7,804,000 net sales contribution of O&P patient care centers and facilities acquired by the Company in 1994 and late 1993, offset by a decline in net sales attributable to patient care centers and facilities that were in operation during both years (\"Internal Base Net Sales\") of $1,381,000, or 3%. The decline in Internal Base Net Sales was primarily due to severe weather conditions in the first quarter of 1994. Of the $1,381,000 decline in Internal Base Net Sales, $1,158,000 was attributable to patient care centers and $223,000 was attributable to the Company's manufacturing and distribution activities.\nGross profit increased by approximately $2,884,000, or 11.9%, in 1994 over the prior year. Gross profit as a percent of net sales decreased to 53.9% in 1994 from 55.2% in 1993. The cost of products and services sold for the year ended December 31, 1994 amounted to $23,208,000 compared to $19,669,000 for the year ended December 31, 1993. Gross profit as a percent of net sales for patient care services declined from 54% in 1993 to 53% in 1994. This decline resulted primarily from the decrease in base business growth in the first quarter of 1994 due principally to severe weather conditions while labor costs remained constant. Gross profit as a percent of net sales for manufacturing and distribution declined from 38% in 1993 to 37% in 1994. This decline resulted\nprincipally from pricing pressures in the distribution division offset by an increase in gross profit as a percent of net sales for the manufacturing division.\nSelling, general and administrative expenses in 1994 increased by approximately $4,216,000, or 24.6%, over 1993 due in significant part to the acquisition of additional patient care and manufacturing companies by the Company. Selling, general and administrative expenses as a percent of net sales increased from 39.0% in 1993 to 42.4% in 1994. This increase in selling, general and administrative expenses resulted primarily from the decline in Internal Base Net Sales as a result of severe weather conditions in the first quarter of 1995 while selling, general and administrative expenses remained the same.\nThe $460,000 of non-recurring Restructuring costs recorded in 1994 relate to the closure of unprofitable start-up patient care centers located in Elmsford, Aurora and the Long Beach location of Rehab Systems, Inc. Such Restructuring costs primarily consist of charges to reserve for non-cancellable future lease commitments for the facilities that have been closed.\nThe $2.15 million loss from the disposal of assets recorded during 1994 relate to the 1995 sale of the Company's southern California patient care centers located in Long Beach, Cyprus and Orange, California in connection with the Restructuring. In March 1995, the Company entered into an agreement to sell such patient care centers for $288,000 under a 10-year promissory note bearing interest at 8% per annum.\nPrincipally as a result of the above, income from operations in 1994 totalled approximately $4,000, a decrease of $4,424,000 from the prior year. Income from operations as a percent of net sales decreased to .0% in 1994 from 10.1% in 1993.\nInterest expense in 1994 amounted to approximately $1,746,000, an increase of approximately $579,000, or 49.6%, above the $1,167,000 of interest expense incurred in 1993. Interest expense as a percent of net sales amounted to 3.5% in 1994, as compared to 2.7% in 1993. The increase in interest expense was primarily attributable to the issuance of approximately $3,000,000 in bank term loans in connection with additional acquisitions in late 1993 and 1994 and the increase in the bank's lending rate.\nThe provision for income taxes in 1994 amounted to approximately $358,000, as compared to $1,627,000 in 1993. A net income tax expense was incurred in 1994, notwithstanding a pre-tax loss, due to the fact that nondeductible goodwill was included in the Company's pre-tax loss during 1994. Such goodwill resulted from the loss from the disposal of assets related to certain of the Company's southern California patient care centers.\nIncome (loss) from discontinued operations represents the loss from operations of the Company's subsidiary, Apothecaries, Inc., totalling $248,000 (net of a tax benefit of $179,000) and the loss on disposal of the assets totalling $159,000 (net of a tax benefit of $115,000). This subsidiary was the only non-orthotic and prosthetic division the Company operated. The sale of the assets in September 1994 was for $181,000 in cash.\nAs a result of above, the Company reported a net loss of $2,687,000, or $.33 per share for the year ended December 31, 1994, as compared to net income of $2,655,000, or $.32 per share for the year ended December 31, 1993.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company's consolidated working capital at December 31, 1995 was approximately $20,622,000. Cash and cash equivalents available at that date was approximately $1,456,000. The net cash provided by operations in 1995 was $3,722,000. The Company's cash resources available during 1995 were satisfactory to meet its obligations during the year.\nThe Company's total long-term debt at December 31, 1995, including a current portion of approximately $1.8 million, was approximately $24.7 million. Such indebtedness included: (i) $4.0 million principal amount of an 8.5% Convertible Note; (ii) $1.0 million principal amount of an 8.25% Convertible Note; (iii) $12.7 million borrowed under the Company's revolving credit facility with NationsBank, N.A. (formerly Maryland National Bank; the \"Bank\"); (iv) a total of $4.6 million in term loans borrowed from the Bank; and (v) approximately $2.4 million of other indebtedness.\nUnder the terms of the Financing and Security Agreement, as amended, between the Bank and the Company (the \"Financing Agreement\"), the Bank currently provides a $13.0 million revolving credit facility (the \"Revolving Credit Facility\"), which reflects a reduction from its original amount of $13.5 million. The Revolving Credit Facility bears interest, at the Company's option, at either a fluctuating rate equal to the Bank's prime lending rate plus .25% or a fixed rate equal to the three-month London InterBank Offered Rate (\"LIBOR\") plus 2.5%. On June 30, 1995, the Company made a mandatory curtailment payment of $250,000 to the Bank to reduce the maximum amount of the Revolving Credit Facility from $13.5 million to $13.25 million. On October 2, 1995, the Company and the Bank entered into Amendment No. 8 to the Financing Agreement which reduced the mandatory curtailment payment required by the Company under the Revolving Credit Facility from a $1.0 million curtailment to a $250,000 curtailment at September 30, 1995. On September 30, 1995, the Company made such mandatory curtailment payment of $250,000 to the Bank to reduce the maximum amount of the Revolving Credit Facility from $13.25 million to its current amount of $13.0 million. On November 13, 1995, the Company and the Bank agreed to the terms of Amendment No. 9 to the Financing Agreement, which (i) eliminated the previously required mandatory curtailment payments of the Revolving Credit Facility of $250,000 at each of December 31, 1995 and March 31, 1996, and (ii) extended the expiration date of the Revolving Credit Facility from September 30, 1996 to June 30, 1997.\nThe Revolving Credit Facility is collateralized by substantially all the assets of the Company and contains convenants restricting, among other things, the payment of dividends, the making of acquisitions and other transactions, and imposes net worth, fixed charge ratio, debt service coverage and other financial maintenance requirements. In the first quarter of 1995, the Company was in default under the debt to net worth covenant of the Financing Agreement. The Bank has issued a waiver to the Company for this default.\nIn September 1994, the Company repaid a $1.8 million term loan from the Bank with a portion of the proceeds from a new $3.0 million term loan provided by the Bank. This new $3.0 million term loan bears interest at prime plus .75%, provides for monthly principal and interest payments and matures on March 31, 1998. In addition to such new term loan, the Company also has three other existing term loans with the Bank, consisting of: (i) a $1.575 million term loan provided by the Bank on November 17, 1993 which currently bears interest at a fixed rate equal to the three-month LIBOR plus 2.75% and matures on November 30, 1998; (ii) a $600,000 term loan provided by the Bank on December 22, 1993, which currently bears interest at a fixed rate equal to the Bank's prime lending rate plus .50% and matures on December 31, 1998; and (iii) a $200,000 term loan provided by the Bank on May 3, 1994, which currently bears interest at a fixed rate equal to the three-month LIBOR plus 2.75% and matures on April 30, 1999. The Company has the option to periodically elect to change the interest rates under each of these term loans between either a fluctuating rate equal to the Bank's prime lending rate plus .50% or a fixed rate equal to LIBOR plus 2.75%.\nThe Company plans to finance future acquisitions through internally generated funds or borrowings under the Revolving Credit Facility, the issuance of notes or shares of common stock of the Company, or through a combination thereof.\nThe Company is actively engaged in ongoing discussions with prospective acquisition candidates. The Company plans to continue to expand its operations through acquisitions, at a slower rate, with a view towards increasing efficiency and profitability of its existing facilities.\nDuring the year ended December 31, 1995, the Company acquired two orthotic and prosthetic companies. Negotiations relating to those acquisitions commenced prior to the Restructuring. The total purchase price of the acquisitions effected during that period was $385,000, of which $210,000 was paid in cash and $175,000 was financed through seller notes. The cash paid to effect such acquisitions was borrowed under the Revolving Credit Facility established between the Company and the Bank.\nOTHER\nInflation has not had a significant effect on the Company's operations, as increased costs to the Company generally have been offset by increased prices of products and services sold.\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nThe Company primarily provides customized devices or services throughout the United States and is reimbursed, in large part, by the patients' third party insurers or governmentally funded health insurance programs. The ability of the Company's debtors to meet their obligations is principally dependent upon the financial stability of the insurers of the Company's patients and future legislation and regulatory actions.\nIn March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (\"SFAS\") No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of\" which is effective for years beginning after December 15, 1995. This statement established criteria for recognizing, measuring and disclosing impairments of long-lived assets, including intangibles and goodwill. The Company plans to adopt SFAS 121 in 1996, but does not expect that the adoption will have a material effect on its consolidated financial position or results of operations.\nIn October 1995, the Financial Accounting Standards Board issued SFAS No. 123, \"Accounting for Stock-Based Compensation.\" SFAS No. 123 is required to be adopted for fiscal years beginning after December 15, 1995. SFAS No. 123 encourages a fair value based method of accounting for employee stock options or similar equity instruments, but allows continued use of the intrinsic value based method of accounting prescribed by Accounting Principles Board (\"APB\") Opinion No. APB 25, \"Accounting for Stock Issued to Employee.\" Companies electing to continue to use APB No. 25 must make proforma disclosures of net income and earnings per share as if the fair value based method of accounting had been applied. The Company is evaluating the provisions of SFAS No. 123, but has not yet determined whether it will continue to follow the provisions of APB No. 25 or change to the fair value method of SFAS No. 123.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe consolidated financial statements and schedules required hereunder and contained herein are listed under Item 14(a) below. The Company is not subject to the requirement to file selected quarterly financial data under Item 302 of Regulation S-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.\nPursuant to General Instruction G(3) of Form 10-K, the information called for by this item regarding directors is hereby incorporated by reference from the Company's definitive proxy statement or amendment hereto to be filed pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this report. Information regarding the Company's executive officers is set forth under Item 4A of this Form 10-K.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nPursuant to General Instruction G(3) of Form 10-K, the information called for by this item is hereby incorporated by reference from the Company's definitive proxy statement or amendment hereto to be filed pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this report.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nPursuant to General Instruction G(3) of Form 10-K, the information called for by this item is hereby incorporated by reference from the Company's definitive proxy statement or amendment hereto to be filed pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this report.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nPursuant to General Instruction G(3) of Form 10-K, the information called for by this item is hereby incorporated by reference from the Company's definitive proxy statement or amendment hereto to be filed pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this report.\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON FORM 8-K.\n(a) Financial Statements and Financial Statement Schedule:\n(1) Financial Statements:\nHANGER ORTHOPEDIC GROUP, INC.\nReport of Independent Accountants\nConsolidated Balance Sheets as of December 31, 1994\nand 1995\nConsolidated Statements of Operations for the years ended December 31, 1993, 1994 and 1995\nConsolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 1993, 1994 and 1995\nConsolidated Statements of Cash Flows for the years ended December 31, 1993, 1994 and 1995\nNotes to Consolidated Financial Statements\n(2) Financial Statements Schedule:\nReport of Independent Accountants\nSchedule II - Valuation and qualifying accounts\nAll other schedules are omitted either because they are not applicable or required, or because the required information is included in the financial statements or notes thereto:\n(b) Reports on Form 8-K: None. (c) Exhibits: The following exhibits are filed herewith or incorporated by reference:\nExhibit No. Document ----------- --------\n3(a) Certificate of Incorporation, as amended, of the Registrant. (Incorporated herein by reference to Exhibit 3.1 to the Registrant's Annual Report on Form 10-K for the fiscal year ended September 30, 1988.)\n3(b) Certificate of Amendment of the Registrant's Certificate of Incorporation (which, among other things, changed the Registrant's corporate name from Sequel Corporation to Hanger Orthopedic Group, Inc.), as filed on August 11, 1989 with the Office of the Secretary of State of Delaware. (Incorporated herein by reference to Exhibit 3(b) to the Registrant's Current Report on Form 10-K dated February 13, 1990.)\n3(c) Certificate of Agreement of Merger of Sequel Corporation and Delaware Sequel Corporation. (Incorporated herein by reference to Exhibit 3.1(a) to the Registrant's Annual Report on Form 10-K for the fiscal year ended September 30, 1988.)\n3(d) Certificate of Ownership and Merger of Hanger Acquisition Corporation and J. E. Hanger, Inc. as filed with the Office of the Secretary of the State of Delaware on April 11, 1989. (Incorporated herein by reference to Exhibit 2(f) to the Registrant's Current Report on Form 8-K dated May 15, 1989.)\n3(e) Certificate of Designation, Preferences and Rights of Preferred Stock of the Registrant as filed on February 12, 1990 with the Office of the Secretary of State of Delaware. (Incorporated herein by reference to Exhibit 3(a) of the Registrant's Current Report on Form 8-K dated February 13, 1990.)\n3(f) By-Laws of the Registrant, as amended. (Incorporated herein by reference to Exhibit 3 to the Registrant's Current Report on Form 8-K dated May 15, 1989.)\n10(a) Employment and Non-Compete Agreements, dated May 15, 1989 between Sequel Corporation and each of Gerald E. Bisbee, Jr., Ivan R. Sabel and Richard A. Stein. (Incorporated herein by reference to Exhibit 10(i) to the Registrant's Current Report on Form 8-K dated May 15, 1989.) *\n10(b) Guaranty Agreement, dated May 15, 1989, by Sequel Corporation, Capital Orthopedics, Inc. and Greiner and Saur Orthopedics, Inc. in favor of Chemical Equity Associates. (Incorporated herein by reference to Exhibit 10(j) to the Registrant's Current Report on Form 8-K dated May 15, 1989.)\n10(c) Stockholders' Agreement, dated as of May 15, 1989, by and among Sequel Corporation, Ronald J. Manganiello, Joseph M. Cestaro, Gerald E. Bisbee, Jr., Ivan R. Sabel, Richard A. Stein, Chemical Venture Capital Associates and Chemical Equity Associates. (Incorporated herein by reference to Exhibit 10(k) to the Registrant's Current Report on Form 8-K dated May 15, 1989.)\n10(d) Registration Agreement, dated May 15, 1989, between Sequel Corporation, First Pennsylvania Bank, N.A., Gerald E. Bisbee, Jr., Ivan R. Sabel, Richard A. Stein, Ronald J. Manganiello, Joseph M. Cestaro and Chemical Venture Capital Associates. (Incorporated herein by reference to Exhibit 10(l) to the Registrant's Current Report on Form 8-K dated May 15, 1989.)\n10(e) Amendment to Employment Agreement, dated February 28, 1989, between J. E. Hanger, Inc. and Joseph M. Cestaro; and Employment and Non-Compete Agreement, dated as of February 28, 1989, between J. E. Hanger, Inc. and Ronald J. Manganiello. (Incorporated herein by reference to Exhibit 10(n) to the Registrant's Current Report on Form 8-K dated May 15, 1989.) *\n* Management contract or compensatory plan.\n10(f) Amendment No. 1, dated as of February 12, 1990, to the Stockholders' Agreement, dated May 15, 1989, by and among Hanger Orthopedic Group, Inc., Ivan R. Sabel, Richard A. Stein, Ronald J. Manganiello, Joseph M. Cestaro, Chemical Venture Capital Associates and Chemical Equity Associates. (Incorporated herein by reference to Exhibit 10(l) to the Registrant's Current Report on Form 8-K dated February 13, 1990.)\n10(g) First Amendment dated as of February 12, 1990, to the Registration Agreement, dated as of May 15, 1989, by and among Hanger Orthopedic Group, Inc., First Pennsylvania Bank, N.A., Ivan R. Sabel, Richard A. Stein, Ronald J. Manganiello, Joseph M. Cestaro and Chemical Venture Capital Associates. (Incorporated herein by reference to Exhibit 10(m) to the Registrant's Current Report on Form 8-K dated February 13, 1990.)\n10(h) Third Amendment, dated as of February 12, 1990, to the Stock and Note Purchase Agreement, dated as of February 28, 1989 and as amended on May 9, 1989 and May 15, 1989, by and among J. E. Hanger, Inc., as successor to Hanger Acquisition Corporation, Ronald J. Manganiello, Chemical Venture Capital Associates and Chemical Equity Associates. (Incorporated herein by reference to Exhibit 10(n) to the Registrant's Current Report on Form 8-K dated February 13, 1990.)\n10(i) Form of Stock Option and Vesting Agreements, dated as of August 13, 1990, between Chemical Venture Capital Associates and Ronald J. Manganiello, Ivan R. Sabel, Joseph M. Cestaro and Richard A. Stein. (Incorporated herein by reference to Exhibit 10(ccc) to the Registrant's Registration Statement on Form S-2, File No. 33-37594.) *\n10(j) Fourth Amendment, dated as of June 19, 1990 to the Stock and Note Purchase Agreement, dated as of February 28, 1989 and as amended on May 9, 1989, May 15, 1989 and February 12, 1990, by and among J. E. Hanger, Inc., as successor to Hanger Acquisition Corporation, Hanger Orthopedic Group, Inc., Ronald J. Manganiello, Joseph M. Cestaro, Chemical Venture. (Incorporated herein by reference to Exhibit 10(qqq) to the Registrant's Registration Statement on Form S-2, File No. 33-37594.)\n10(k) Form of Stock Option Agreements, dated as of August 13, 1990, between Hanger Orthopedic Group, Inc. and Thomas P. Cooper, James G. Hellmuth, Walter F. Abendschein, Jr., Norman Berger, Bruce B. Grynbaum and Joseph S. Torg. (Incorporated herein by reference to Exhibit 10(rrr) to the Registrant's Registration Statement on Form S-2, File No. 33-37594.) *\n* Management contract or compensatory plan.\n10(l) Amendment No. 3, dated as of November 8, 1990, to the Stockholders' Agreement, dated as of May 15, 1989 and as amended on February 12, 1990 and August 13, 1990, by and among Hanger Orthopedic Group, Inc., Gerald E. Bisbee, Jr., Ivan R. Sabel, Richard A. Stein, Ronald J. Manganiello, Joseph M. Cestaro, Chemical Venture Capital Associates and Chemical Equity Associates. (Incorporated herein by reference to Exhibit 10(www) to the Registrant's Registration Statement on Form S-2, File No. 33-37594.)\n10(m) Form of Stock Option and Vesting Agreements, dated March 14, 1991, between Chemical Venture Capital Associates and Ronald J. Manganiello, Ivan R. Sabel and Richard A. Stein. (Incorporated herein by reference to Exhibit 10(cccc) to the Registrant's Registration Statement on Form S-2, File No. 33-37594.) *\n10(n) Convertible Junior Subordinated Note Agreement, dated as of March 1, 1992, from Hanger Orthopedic Group, Inc. to R. S. Lauder, Gaspar & Co., L.P. regarding $4,000,000 8.5% Convertible Junior Subordinated Notes due March 31, 1999. (Incorporated herein by reference to Exhibit 10(jjjj) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1991.)\n10(o) Form of Sixth Amendment to the Subordination Agreement, dated as of February 20, 1992, between CoreStates Bank, N.A., Chemical Equity Associates, and Chemical Venture Capital Associates. (Incorporated herein by reference to Exhibit 10(mmmm) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1991.)\n10(p) Form of Eighth Amendment to the Stock and Note Purchase Agreement, dated as of February 20, 1992, by and among J.E. Hanger, Inc., Hanger Orthopedic Group, Inc., Ronald J. Manganiello, Joseph M. Cestero, Chemical Venture Capital Associates and Chemical Equity Associates. (Incorporated herein by reference to Exhibit 10(nnnn) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1991.)\n10(q) Form of Amendment to Stock Option and Vesting Agreement and Amendment Agreement, dated as of February 20, 1992, by and among Chemical Venture Capital Associates, Chemical Equity Associates, Exeter Capital L.P., Hanger Orthopedic Group, Inc., Ronald J. Manganiello, Ivan R. Sabel and Richard A. Stein. (Incorporated herein by reference to Exhibit 10(pppp) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1991.) *\n* Management contract or compensatory plan.\n10(r) Form of Asset Purchase Agreement between DOBI Assets Acquisition Corp., Hanger Orthopedic Group, Inc., National Orthopedic & Rehabilitation Services, Inc. and Caretenders Health Corp. (Incorporated herein by reference to Exhibit 10(rrrr) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1991.)\n10(s) Amendment No. 9, dated as of April 30, 1992, to the Bank Credit Agreement, dated as of May 15, 1989 and as amended through April 30, 1992, among Hanger Orthopedic Group, Inc., Albuquerque Prosthetic Center, Inc., Apothecaries, Inc., Capital Orthopedics, Inc., DOBI-Symplex, Inc., Dorsch Prosthetics and Orthotics, Inc., Greiner & Saur Orthopedics, Inc., J.E. Hanger, Inc., J.E. Hanger of California, Inc., Memphis Orthopedic, Inc., Metzgers Orthopaedic Services, Inc., Ralph Storrs, Inc., Scott Orthopedics, Inc., Scott Orthopedics, of Northern Colorado, Inc., York Prosthetics, Inc., Zielke Orthotics & Prosthetics, Inc. and CoreStates Bank, N.A. (Incorporated by reference to Exhibit 22 to the Registrant's Current Report on Form 8-K dated March 31, 1992.)\n10(t) Amendment No. 10, dated as of September 3, 1992, to the Bank Credit Agreement, dated as of May 15, 1989 and as amended through September 3, 1992, among Hanger Orthopedic Group, Inc., Albuquerque Prosthetic Center, Inc., Apothecaries, Inc., Capital Orthopedics, Inc., DOBI-Symplex, Inc., Dorsch Prosthetics & Orthotics, Inc., Greiner & Saur Orthopedics, Inc., J.E. Hanger, Inc., J.E. Hanger of California, Inc., Memphis Orthopedic, Inc., Metzgers Orthopaedic Services, Inc., Ralph Storrs, Inc., Scott Orthopedics, Inc., Scott Orthopedics of Northern Colorado, Inc., York Prosthetics, Inc., Zielke Orthotics & Prosthetics, Inc. and CoreStates Bank, N.A. (Incorporated by reference to Exhibit 22 to the Registrant's Current Report on Form 8-K dated March 31, 1992.)\n10(u) Amendment No. 11, dated as of December 8, 1992, to the Bank Credit Agreement, dated as of May 15, 1989 and as amended through December 8, 1992, among Hanger Orthopedic Group, Inc., Albuquerque Prosthetic Center, Inc., Apothecaries, Inc., Capital Orthopedics., Inc., DOBI-Symplex, Inc., Dorsch Prosthetics & Orthotics, Inc., Greiner & Saur Orthopedics, Inc., J.E. Hanger, Inc., J.E. Hanger of California, Inc., Memphis Orthopedic, Inc., Metzgers Orthopaedic Services, Inc., Ralph Storrs, Inc., Scott Orthopedics, Inc., Scott Orthopedics of Northern Colorado, Inc., York Prosthetics, Inc., Zielke Orthotics & Prosthetics, Inc. and CoreStates Bank, N.A. (Incorporated by reference to Exhibit 22 to the Registrant's Current Report on Form 8-K dated March 31, 1992.)\n10(v) Asset Purchase Agreement, dated as of December 31, 1992, between DOBI-Symplex, Inc. and Minnesota Mining and Manufacturing Company. (Incorporated\nherein by reference to Exhibit 2 to the Registrant's Current Report on Form 8-K, dated March 31, 1992.)\n10(w) Amendment No. 12 dated as of March 12, 1993, to the Bank Credit Agreement referred to in Exhibit 10(u) above. (Incorporated herein by reference to Exhibit 10 (w) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993.)\n10(x) Convertible Junior Subordinated Note Agreement dated as of May 7, 1993, from Hanger Orthopedic Group, Inc. to R.S. Lauder, Gaspar & Co., L.P. regarding $1,000,000 8.25% Convertible Junior Subordinated Notes due March 31, 1999. (Incorporated herein by reference to Exhibit 10 (x) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993.)\n10(y) Amendment No. 1, dated as of May 7, 1993, to the Convertible Junior Subordinated Note Agreement referred to in Exhibit (x) above. (Incorporated herein by reference to Exhibit 10 (y) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993.)\n10(z) Revolving Promissory Note, dated as of July 2, 1993 from Hanger Orthopedic Group, Inc., Albuquerque Prosthetic Center, Inc., Apothecaries, Inc., Capital Orthopedics, Inc., Dorsch Prosthetics & Orthotics, Inc., DOBI-Symplex, Inc., Greiner and Saur Orthopedics, Inc., J.E. Hanger, Inc., J.E. Hanger of California, Inc., Memphis Orthopedic, Inc., Metzgers Orthopaedic Services, Inc., Ralph Storrs, Inc., Scott Orthopedics of Northern Colorado, Inc., York Prosthetics, Inc., Zielke Orthotics & Prosthetics, Inc., to Maryland National Bank regarding $12,500,000 principal amount due June 30, 1996. (Incorporated herein by reference to Exhibit 10 (z) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993.)\n10(aa) Financing and Security Agreement between Maryland National Bank and Hanger Orthopedic Group, dated as of July 2, 1993. (Incorporated herein by reference to Exhibit 10 (aa) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993.)\n10(bb) Asset Purchase Agreement, dated August 31, 1993, between DOBI-Symplex, Inc., Hanger Orthopedic Group, Inc. and Minnesota Mining and Manufacturing Company. (Incorporated herein by reference to Exhibit 10 (bb) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993.)\n* Management contract or compensatory plan.\n10(cc) Incentive Stock Option Agreement, dated as of September 14, 1993, between Hanger Orthopedic Group, Inc. and Ronald J. Manganiello. (Incorporated herein by reference to Exhibit 10 (cc) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993.)*\n10(dd) Incentive Stock Option Agreement, dated as of September 14, 1993, between Hanger Orthopedic Group, Inc. and Ivan R. Sabel. (Incorporated herein by reference to Exhibit 10 (dd) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993.)*\n10(ee) Incentive Stock Option Agreement, dated as of September 14, 1993, between Hanger Orthopedic Group, Inc. and Richard A. Stein. (Incorporated herein by reference to Exhibit 10 (ee) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993.)*\n10(ff) Non-qualified Stock Option Agreement, dated as of October 12, 1993, between Hanger Orthopedic Group, Inc. and Thomas P. Cooper. (Incorporated herein by reference to Exhibit 10 (ff) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993.)*\n10(gg) Non-qualified Stock Option Agreement, dated as of October 12, 1993, between Hanger Orthopedic Group, Inc. and James H. Hellmuth. (Incorporated herein by reference to Exhibit 10 (gg) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993.)*\n10(hh) Non-qualified Stock Option Agreement, dated as of October 12, 1993, between Hanger Orthopedic Group, Inc. and B. Martha Cassidy. (Incorporated herein by reference to Exhibit 10 (hh) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993.)*\n10(ii) Non-qualified Stock Option Agreement, dated as of October 12, 1993, between Hanger Orthopedic Group, Inc. and William L. McCulloch. (Incorporated herein by reference to Exhibit 10 (ii) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993.)*\n10(jj) Non-qualified Stock Option Agreement, dated as of October 12, 1993, between Hanger Orthopedic Group, Inc. and Walter J. McNerney. (Incorporated herein by reference to Exhibit 10 (jj) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993.)*\n10(kk) Non-qualified Stock Option Agreement, dated as of October 12, 1993, between Hanger Orthopedic Group, Inc. and Robert J. Glaser. (Incorporated herein by reference to Exhibit 10 (kk) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993.)*\n* Management contract or compensatory plan.\n10(ll) Term Note, dated as of November 17, 1993, from Hanger Orthopedic Group, Inc. to Maryland National Bank regarding $1,575,000 principal amount due November 30, 1998. (Incorporated herein by reference to Exhibit 10 (ll) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993.)\n10(mm) Amendment No. 1, dated as of November 17, 1993, to the Financing and Security Agreement, dated as of July 2, 1993, and as amended through November 17, 1993, among Hanger Orthopedic Group, Inc. and Maryland National Bank. (Incorporated herein by reference to Exhibit 10 (mm) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993.)\n10(nn) Term Note, dated as of December 22, 1993, form Hanger Orthopedic Group, Inc. to Maryland National Bank regarding $600,000 principal amount due December 31, 1998. (Incorporated herein by reference to Exhibit 10 (nn) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993.)\n10(oo) Amendment No. 2, dated as of December 22, 1993, to the Financing and Security Agreement, dated as of July 2, 1993, and as amended through December 22, 1993, among Hanger Orthopedic Group, Inc. and Maryland National Bank. (Incorporated herein by reference to Exhibit 10 (oo) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993.)\n10(pp) Asset Purchase Agreement, dated as of January 3, 1994, between Columbia Brace Shop, Inc., Austin T. Moore, Jr., Columbia Brace Acquisitions Corp. and Hanger orthopedic Group, Inc. (Incorporated herein by reference to Exhibit 10 (pp) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994.)\n10(qq) Asset Purchase Agreement, dated as of January 10,1994, between J.E. Hanger of California, Inc., Health Industries, Inc., Louis Goldstein and Barbara Goldstein. (Incorporated herein by reference to Exhibit 10 (qq) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994.)\n10(rr) Asset Purchase Agreement, dated as of January 31, 1994, between J.E. Hanger, Inc., Pedi-Mac Shoe Company, Inc., and Thomas McGillicuddy. (Incorporated herein by reference to Exhibit 10 (rr) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994.)\n10(ss) Amendment No. 3, dated as of April 15, 1994, to the Financing and Security Agreement, dated as of July 2, 1993, and as amended through April 15, 1994, from Hanger Orthopedic Group, Inc. and Maryland National Bank.\n(Incorporated herein by reference to Exhibit 10 (ss) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994.)\n10(tt) Promissory Note, dated as of April 15, 1994, from Hanger Orthopedic Group, Inc. and Maryland National Bank regarding $1,800,000 principal amount due September 30, 1994. (Incorporated herein by reference to Exhibit 10 (tt) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994.)\n10(uu) Amendment No. 4, dated as of May 3, 1994, to the Financing and Security Agreement, dated as of July 2, 1993, and as amended through May 3, 1994, among Hanger Orthopedic Group, Inc. and NationsBank, N.A. (formerly Maryland National Bank). (Incorporated herein by reference to Exhibit 10 (uu) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994.)\n10(vv) Term Note, dated as of May 3, 1994, from Hanger Orthopedic Group, Inc. and NationsBank, N.A. (formerly Maryland National Bank) regarding $200,000 principal amount due April 30, 1999. (Incorporated herein by reference to Exhibit 10 (vv) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994.)\n10(ww) Employment and Non-Compete Agreement, dated as of May 16, 1994, between Hanger Orthopedic Group, Inc. and Ronald J. Manganiello.* (Incorporated herein by reference to Exhibit 10 (ww) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994.)\n10(xx) Employment and Non-Compete Agreement, dated as of May 16, 1994, between Hanger Orthopedic Group, Inc. and Ivan R. Sabel.* (Incorporated herein by reference to Exhibit 10 (xx) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994.)\n10(yy) Employment and Non-Compete Agreement, dated as of May 16, 1994, between Hanger Orthopedic Group, Inc. and Richard A. Stein.* (Incorporated herein by reference to Exhibit 10 (yy) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994.)\n* Management contract or compensatory plan.\n10(zz) Second Amendment, dated as of May 16, 1994, to the Stock Option and Vesting Agreements, dated as of March 14, 1991 and as amended through May 16, 1994, by and among Chemical Venture Capital Associates, Chemical Equity Associates, Exeter Capital L.P., Hanger Orthopedic Group, Inc. Ronald J. Manganiello, Ivan R. Sabel and Richard A. Stein.* (Incorporated herein by reference to Exhibit 10 (zz) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994.)\n10(aaa) Stock Option Agreement, dated as of May 16, 1994, between Chemical Venture Capital Associates and Ronald J. Manganiello.* (Incorporated herein by reference to Exhibit 10 (aaa) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994.)\n10(bbb) Stock Option Agreement, dated as of May 16, 1994, between Chemical Venture Capital Associates and Ivan R. Sabel.* (Incorporated herein by reference to Exhibit 10 (bbb) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994.)\n10(ccc) Stock Option Agreement, dated as of May 16, 1994, between Chemical Venture Capital Associates and Richard A. Stein.* (Incorporated herein by reference to Exhibit 10 (ccc) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994.)\n10(ddd) Non-qualified Stock Option Agreement, dated as of June 22, 1994, between Hanger Orthopedic Group, Inc. and B. Martha Cassidy.* (Incorporated herein by reference to Exhibit 10 (ddd) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994.)\n10(eee) Non-qualified Stock Option Agreement, dated as of June 22, 1994, between Hanger Orthopedic Group, Inc. and Thomas P. Cooper.* (Incorporated herein by reference to Exhibit 10 (eee) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994.)\n10(fff) Non-qualified Stock Option Agreement, dated as of June 22, 1994, between Hanger Orthopedic Group, Inc. and Robert J. Glaser.* (Incorporated herein by reference to Exhibit 10 (fff) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994.)\n10(ggg) Non-qualified Stock Option Agreement, dated as of June 22, 1994, between Hanger Orthopedic Group, Inc. and James H. Hellmuth.* (Incorporated herein by reference to Exhibit 10 (ggg) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994.)\n* Management contract or compensatory plan.\n10(hhh) Non-qualified Stock Option Agreement, dated as of June 22, 1994, between Hanger Orthopedic Group, Inc. and William L. McCulloch.* (Incorporated herein by reference to Exhibit 10 (hhh) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994.)\n10(iii) Non-qualified Stock Option Agreement, dated as of June 22, 1994, between Hanger Orthopedic Group, Inc. and Walter J. McNerney.* (Incorporated herein by reference to Exhibit 10 (iii) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994.)\n10(jjj) Amendment No. 5, dated as of August 12, 1994, to the Financing and Security Agreement, dated as of July 2, 1993, and as amended through August 12, 1994, among Hanger Orthopedic Group, Inc. and NationsBank, N.A. (formerly Maryland National Bank). (Incorporated herein by reference to Exhibit 10 (jjj) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994.)\n10(kkk) Amendment No. 6, dated as of September 13, 1994, to the Financing and Security Agreement, dated as of July 2, 1993, and as amended through September 13, 1994, among Hanger Orthopedic Group, Inc. and NationsBank, N.A. (formerly Maryland National Bank). (Incorporated herein by reference to Exhibit 10 (kkk) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994.)\n10(lll) Amended and Restated Revolving Promissory Note, dated September 13, 1994, from Hanger orthopedic Group, Inc. to NationsBank, N.A. (formerly Maryland National Bank) regarding $13,500,000 principal amount. (Incorporated herein by reference to Exhibit 10 (lll) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994.)\n10(mmm) Term Note, dated as of September 13, 1994, from Hanger Orthopedic Group, Inc. and NationsBank, N.A. (formerly Maryland National Bank) regarding $3,000,000 principal amount due March 31, 1998. (Incorporated herein by reference to Exhibit 10 (mmm) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994.)\n10(nnn) Third Amendment, dated as of September 22, 1994, to the Stock Option and Vesting Agreements, dated as of March 14, 1991 and as amended through September 22, 1994, by and among Chemical Venture Capital Associates, Chemical Equity Associates, Exeter Capital L.P., Hanger Orthopedic Group, Inc., Ronald J. Manganiello, Ivan R. Sabel and Richard A. Stein.* (Incorporated herein by reference to Exhibit 10 (nnn) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994.)\n* Management contract or compensatory plan.\n10(ooo) Letter Agreement, dated as of September 29, 1994, between Apothecaries Inc. and Eakles Drug Store, Inc. (Incorporated herein by reference to Exhibit 10 (ooo) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994.)\n10(ppp) Asset Purchase Agreement, dated as of October 7, 1994, between J.E. Hanger, Inc., J.E. Hanger, Inc. of New England and Samuel Polsky. (Incorporated herein by reference to Exhibit 10 (ppp) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994.)\n10(qqq) Agreement, dated as of November 30, 1994, between J.E. Hanger, Inc., G.O. Formation, L.L.C. and Barbara Ziegler. (Incorporated herein by reference to Exhibit 10 (qqq) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994.)\n10(rrr) Asset Purchase Agreement, dated as of January 5, 1995, between J.E. Hanger of California, Inc., Summit Prosthetics & Orthotics and Timothy R. Chaffin. (Incorporated herein by reference to Exhibit 10 (rrr) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994.)\n10(sss) Incentive Stock Option Agreement, dated as of January 31, 1995, between Hanger Orthopedic Group, Inc. and Ronald J. Manganiello.* (Incorporated herein by reference to Exhibit 10 (sss) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994.)\n10(ttt) Incentive Stock Option Agreement, dated as of January 31, 1995, between Hanger Orthopedic Group, Inc. and Ivan R. Sabel.* (Incorporated herein by reference to Exhibit 10 (ttt) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994.)\n10(uuu) Incentive Option Agreement, dated as of January 31, 1995, between Hanger Orthopedic Group, Inc. and Richard A. Stein.* (Incorporated herein by reference to Exhibit 10 (uuu) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994.)\n10(vvv) Amendment No. 7, dated as of March 24, 1995, to the Financing and Security Agreement, dated as of July 2, 1993, and as amended through March 24, 1995, among Hanger Orthopedic Group, Inc. and NationsBank, N.A. (formerly Maryland National Bank). (Incorporated herein by reference to Exhibit 10 (vvv) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994.)\n* Management contract or compensatory plan.\n10(www) Amended and Restated Revolving Promissory Note, dated March 24, 1995, from Hanger Orthopedic Group, Inc. to NationsBank, N.A. (formerly Maryland National Bank) regarding $13,500,000 principal amount. (Incorporated herein by reference to Exhibit 10 (www) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994.)\n10(xxx) Letter Agreement, dated March 17, 1995, relating to the purchase by Hanger Orthopedic Group, Inc. of the assets of Gulf Coast Orthopedic Supply, Inc.\n10(yyy) Non-Qualified Stock Option Agreement, dated as of June 14, 1995, between Hanger Orthopedic Group, Inc. and B. Martha Cassidy.*\n10(zzz) Non-Qualified Stock Option Agreement, dated as of June 14, 1995, between Hanger Orthopedic Group, Inc. and Thomas P. Cooper.*\n10(aaaa) Non-Qualified Stock Option Agreement, dated as of June 14, 1995, between Hanger Orthopedic Group, Inc. and Robert J. Glaser.*\n10(bbbb) Non-Qualified Stock Option Agreement, dated as of June 14, 1995, between Hanger Orthopedic Group, Inc. and James C. Hellmuth.*\n10(cccc) Non-Qualified Stock Option Agreement, dated as of June 14, 1995, between Hanger Orthopedic Group, Inc. and William L. McCulloch.*\n10(dddd) Non-Qualified Stock Option Agreement, dated as of June 14, 1995, between Hanger Orthopedic Group, Inc. and Walter J. McNerney.*\n10(eeee) Agreement, dated as of July 31, 1995, between Hanger Orthopedic Group, Inc. and Ronald J. Manganiello.\n10(ffff) Amendment No. 8, dated as of October 2, 1995, the Financing and Security Agreement, dated as of July 2, 1993 and as amended through October 2, 1995, among Hanger Orthopedic Group, Inc. and NationsBank, N.A. (formerly Maryland National Bank).\n10(gggg) Fourth Amendment, dated as of October 27, 1995, to the Stock Option and Vesting Agreements, dated as of March 14, 1991 and as amended through October 27, 1995, by and among Chemical Venture Capital Associates, Chemical Equity Associates, Exeter Capital L.P., Hanger Orthopedic Group, Inc., Ronald J. Manganiello, Ivan R. Sabel and Richard A. Stein.*\n* Management contract or compensatory plan.\n10(hhhh) Fifth Amendment, dated as of October 27, 1995, to the Stock Option and Vesting Agreements, dated as of March 14, 1991 and as amended through October 27, 1995, by and among Chemical Venture Capital Associates, Chemical Equity Associates, Exeter Capital L.P., Hanger Orthopedic Group, Inc., Ronald J. Manganiello, Ivan R. Sabel and Richard A. Stein*\n10(iiii) Amendment No. 9, dated as of November 16, 1995, to the Financing and Security Agreement, dated as of July 2, 1993 and as amended through November 16, 1995, among Hanger Orthopedic Group, Inc. and NationsBank, N.A. (formerly Maryland National Bank).\n10(jjjj) Second Amended and Restated Revolving Promissory Note, dated November 16, 1995, from Hanger Orthopedic Group, Inc. to NationsBank, N.A. (formerly Maryland National Bank) regarding $13,000,000 principal amount.\n10(kkkk) Incentive Stock Option Agreement, dated as of February 21, 1996, between Hanger Orthopedic Group, Inc. and Ivan R. Sabel.*\n10(llll) Incentive Stock Option Agreement, dated as of February 21, 1996, between Hanger Orthopedic Group, Inc. and Richard A. Stein.*\n11 Computation of earnings per share. 21 List of Subsidiaries of the Registrant. 23 Consent of Coopers & Lybrand L.L.P.\n* Management contract or compensatory plan.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons, on behalf of the Registrant and in the capacities and on the dates indicated.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholders of Hanger Orthopedic Group, Inc.\nWe have audited the accompanying consolidated balance sheets of Hanger Orthopedic Group, Inc. and Subsidiaries as of December 31, 1994 and 1995 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, 1995. 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 Hanger Orthopedic Group, Inc., and subsidiaries as of December 31, 1994 and 1995 and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles.\nAs discussed in Note B to the consolidated financial statements, the Company changed its method of accounting for income taxes in 1993.\nCoopers & Lybrand L.L.P.\n2400 Eleven Penn Center Philadelphia, Pennsylvania March 8, 1996\nHANGER ORTHOPEDIC GROUP, INC. CONSOLIDATED BALANCE SHEETS\nTHE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL STATEMENTS.\nHANGER ORTHOPEDIC GROUP, INC. CONSOLIDATED BALANCE SHEETS\nTHE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL STATEMENT\nHANGER ORTHOPEDIC GROUP, INC. CONSOLIDATED STATEMENTS OF OPERATIONS For the Years Ended December 31,\nTHE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL STATEMENTS.\nHANGER ORTHOPEDIC GROUP, INC CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY For the Years Ended December 31, 1993, 1994 and 1995\nTHE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL STATEMENTS.\nHANGER ORTHOPEDIC GROUP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS For the Years Ended December 31,\nTHE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL STATEMENTS.\nHANGER ORTHOPEDIC GROUP, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE A - THE COMPANY\nHanger Orthopedic Group, Inc. (\"the Company\") is one of the nation's largest practice management companies in the orthotic and prosthetic (\"O&P\") rehabilitation industry. In addition to providing O&P patient care services through its operating subsidiaries, the Company also manufactures and distributes components and finished patient care products to the O&P industry primarily in the United States. Hanger's largest subsidiary, J.E. Hanger, Inc. (\"JEH\"), was founded in 1861 by a Civil War amputee and is the oldest company in the O&P industry in the United States. Orthotics is the design, fabrication, fitting and supervised use of custom-made braces and other devices that provide external support to treat musculoskeletal disorders. Prosthetics is the design, fabrication and fitting of custom-made artificial limbs.\nNOTE B - SIGNIFICANT ACCOUNTING POLICIES\nPrinciples of Consolidation: The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany transactions and balances have been eliminated.\nUse of Estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, 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.\nCash and Cash Equivalents: Cash includes currency on hand and demand deposits with financial institutions. Cash equivalents are highly liquid investments with original maturities of three months or less at the date of purchase.\nFair Value of Financial Instruments: At December 31, 1994 and 1995, the carrying value of financial instruments such as cash and cash equivalents, trade receivables, trade payables, and debt approximates fair value.\nInventories: Inventories, which consist principally of purchased parts, are stated at the lower of cost or market using the first-in, first-out (FIFO) method.\nLong-Lived Asset Impairment: In March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard (\"SFAS\") No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of\" which is effective for years beginning after December 15, 1995. This statement established criteria for recognizing, measuring and disclosing impairments of long-lived assets, including intangibles and goodwill. The\nCompany plans to adopt SFAS 121 in 1996, and does not expect that the adoption will have a material effect on its consolidated financial position or results of operations.\nProperty, Plant and Equipment: Property, plant and equipment are recorded at cost. The cost and related accumulated depreciation of assets sold, retired or otherwise disposed of are removed from the respective accounts, and any resulting gains or losses are included in the statement of operations. Depreciation is computed for financial reporting purposes using the straight-line method over the estimated useful lives of the related assets. Depreciation expense was approximately $875,000, $1,090,000 and $1,136,000 for the years ended December 31, 1993, 1994 and 1995, respectively.\nIntangible Assets: Intangible assets, including non-compete agreements, are recorded based on agreements entered into by the Company and are being amortized over their estimated useful lives ranging from 5 to 7 years using the straight-line method. Other intangible assets are recorded at cost and are being amortized over their estimated useful lives of up to 16 years using the straight-line method. Excess cost over net assets acquired represents the excess of purchase price over the value assigned to net identifiable assets of purchased businesses and is being amortized using the straight-line method over 40 years. It is the Company's policy to periodically review and evaluate whether there has been a permanent impairment in the value of excess cost over net assets acquired and other intangible assets. Factors considered in the evaluation include current operating results, trends, prospects and anticipated undiscounted future cash flows.\nPre-opening Costs: The Company capitalizes certain costs relating to the pre-opening of new patient care centers. These costs are amortized over a twelve-month period using the straight-line method commencing on the date in which the patient care center opens.\nRevenue Recognition: Revenue on the sale of orthotic and prosthetic devices is recorded when the device is accepted by the patient. Deferred revenue represents billings made prior to the final fitting and acceptance by the patient. Revenue is recorded at its net realizable value, taking into consideration all governmental and contractual discounts and allowances.\nCredit Risk: The Company primarily provides customized devices or services throughout the United States and is reimbursed by the patients' third-party insurers or governmentally funded health insurance programs. The Company performs ongoing credit evaluations of its distribution customers. The accounts receivable are not collateralized. The ability of the Company's debtors to meet their obligations is dependent upon the financial stability of the insurers of the Company's customers and future legislation and regulatory actions. Additionally, the Company maintains reserves for potential losses from these receivables that historically have been within management's expectations. The Company maintains its cash and cash equivalents with high quality financial institutions.\nIncome Taxes: Effective January 1, 1993, the Company adopted SFAS No. 109 \"Accounting for Income Taxes\" (SFAS 109), which requires recognition of deferred income 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 income tax liabilities and assets are\ndetermined 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. SFAS 109 also provides for the recognition of deferred tax assets if it is more likely than not that the assets will be realized in future years. The Company recognized a cumulative effect to January 1, 1993 of the change in accounting for income taxes of approximately $1,189,000 ($.14 per share). Approximately $2,918,000 of the net operating loss carryforwards recognized by the Company in the cumulative effect on January 1, 1993 were generated prior to the acquisition of the Company in 1989. As a result, the Company has reduced excess of cost over net assets acquired related to this acquisition by approximately $992,000 through the recording of the cumulative effect.\nNet Income (Loss) Per Share: Net income (loss) per common share is computed on the basis of the weighted average number of shares of common stock issued and outstanding. In 1994 common share equivalents are not included in the per share calculations because they are anti-dilutive. Income (loss) before extraordinary item and cumulative effect of accounting change applicable to common stock has been adjusted for the dividends declared applicable to certain classes of cumulative preferred stock.\nStock Based Compensation: In October 1995, the Financial Accounting Standards Board issued SFAS No. 123, \"Accounting for Stock-Based Compensation.\" SFAS No. 123 is required to be adopted for fiscal years beginning after December 15, 1995. SFAS No. 123 encourages a fair value based method of accounting for employee stock options or similar equity instruments, but allows continued use of the intrinsic value based method of accounting prescribed by Accounting Principles Board (APB) Opinion No. 25, \"Accounting for Stock Issued to Employee.\" Companies electing to continue to use APB No. 25 must make proforma disclosures of net income and earnings per share as if the fair value based method of accounting had been applied. The Company is evaluating the provisions of SFAS No. 123, but has not yet determined whether it will continue to follow the provisions of APB No. 25 or change to the fair value method of SFAS No. 123.\nNOTE C - SUPPLEMENTAL CASH FLOW FINANCIAL INFORMATION\nThe following are the supplemental disclosure requirements for the statements of cash flows:\nNOTE D - ACQUISITIONS AND SALE OF ASSETS\nDuring 1993, the Company acquired the net assets of several orthotic and prosthetic companies and one manufacturer of orthotic devices. The purchase price for these companies was $2,987,473 in cash plus $1,600,000 in notes and 53,793 shares of common stock valued at $330,000. The notes are payable over 3 to 5 years with interest ranging from 6% to 7%.\nDuring 1994, the Company acquired the net assets of several orthotic and prosthetic companies and one manufacturer of orthotic devices. The purchase price for these companies was $2,780,000 in cash, plus $1,925,000 in notes and 32,653 shares of common stock valued at $200,000. The notes are payable over one to five years with interest from 6% to 7%.\nDuring 1995, the Company acquired two orthotic and prosthetic companies. The aggregate purchase price was $385,000 comprised of $210,000 in cash and $175,000 in promissory notes. The cash portion of the purchase prices for these acquisitions was borrowed under the Company's revolving credit facility.\nAll of the above acquisitions have been accounted for as business combinations in accordance with the purchase method. The results of operations for these acquisitions are included in the Company's results of operations from their date of acquisition. Excess cost over net assets acquired in these acquisitions amounting to approximately $3,557,000 and $376,000 in 1994 and 1995, respectively, are amortized using the straight-line method over 40 years.\nThe following table summarizes the unaudited consolidated pro forma information, assuming the acquisitions had occurred at the beginning of each of the following periods:\nThe pro forma results do not necessarily represent results which would have occurred if the acquisitions had taken place at the beginning of each period, nor are they indicative of the results of future combined operations.\nDuring 1994, the Company commenced discussions and on March 23, 1995, the Company entered into an agreement to sell certain assets related to its operations in southern California for $288,000 under a 10-year promissory note bearing interest at 8%. As a result, the Company recorded a loss in 1994 of $2,150,000, which primarily consisted of the write-off of the related goodwill.\nNOTE E - DISCONTINUED OPERATIONS\nIn the fourth quarter of 1993, the Company declared its intent to seek a buyer for the assets of its subsidiary, Apothecaries, Inc. (\"Apothecaries\"). On September 30, 1994, the Company sold those assets for $181,000 in cash and reported a loss on the sale of $159,379 (net of a tax benefit of $115,412). Apothecaries has been classified in the Consolidated Statements of Operations as a discontinued operation, with all revenue, expenses and other income having been excluded from continuing operations.\nThe operating results of Apothecaries for the year ended December 31, 1993, and for the nine months ended September 30, 1994, were as follows:\nNOTE F - RESTRUCTURING COSTS\nResults of operations for 1994 include a charge of $460,000 which was recorded in the fourth quarter for costs associated with the closing of several patient care centers in conjunction with management's plan to consolidate the Company's operations. The restructuring charges include future rental payments on buildings that the Company has abandoned, for which the leases cannot be cancelled and subleasing attempts have been unsuccessful.\nNOTE G - INVENTORY\nInventories at December 31, 1994 and 1995 consist of the following:\nNOTE H - LONG-TERM DEBT\nLong-term debt consists of the following at December 31, 1994 and 1995:\nUnder the terms of the Financing and Security Agreement, as amended, between NationsBank, N.A. (\"the Bank\") and the Company (the \"Financing Agreement\"), the Bank currently provides a $13.0 million revolving credit facility (the \"Revolving Credit Facility\"), which reflects a reduction from its original amount of $13.5 million. The Revolving Credit Facility bears interest, at the Company's option, at either a fluctuating rate equal to the Bank's prime lending rate plus .25% or a fixed rate equal to the three-month London InterBank Offered Rate (\"LIBOR\") plus 2.5%. On June 30, 1995, the Company made a mandatory curtailment payment of $250,000 to the Bank to reduce the maximum\namount of the Revolving Credit Facility from $13.5 million to $13.25 million. On October 2, 1995, the Company and the Bank entered into Amendment No. 8 to the Financing Agreement which reduced the mandatory curtailment payment by the Company under the Revolving Credit Facility from a $1.0 million curtailment to a $250,000 curtailment at September 30, 1995. On September 30, 1995, the Company made such mandatory curtailment payment of $250,000 to the Bank to reduce the maximum amount of the Revolving Credit Facility from $13.25 million to its current amount of $13.0 million. On November 13, 1995, the Company and the Bank agreed to the terms of Amendment No. 9 to the Financing Agreement, which (i) eliminated the previously required mandatory curtailment payments of the Revolving Credit Facility of $250,000 at each of December 31, 1995 and March 31, 1996, and (ii) extended the expiration date of the Revolving Credit Facility from September 30, 1996 to June 30, 1997. Borrowings outstanding under the Revolving Credit Facility amounted to $12.7 million at December 31, 1995.\nThe Revolving Credit Facility is collateralized by substantially all the assets of the Company and contains covenants restricting, among other things, the payment of dividends, the making of acquisitions and other transactions, and imposes net worth, debt service coverage and other financial maintenance requirements. At December 31, 1994, the Company was in default under the fixed charge ratio covenant of the Revolving Credit Facility. The event was cured by a March 31, 1995 amendment. In the first quarter of 1995, the Company was in default under the debt to net worth covenant of the Revolving Credit Facility. The Bank has issued a waiver to the Company for this default.\nIn September 1994, the Company repaid a $1.8 million term loan from the Bank with a portion of the proceeds from a new $3.0 million term loan provided by the Bank. This new $3.0 million term loan bears interest at the Bank's prime rate plus .75%, provides for monthly principal and interest payments and matures on March 31, 1998. In addition to such new term loan, the Company also has three other existing term loans with the Bank, consisting of: (i) a $1.575 million term loan provided by the Bank on November 17, 1993 which currently bears interest at a fixed rate equal to the three-month LIBOR plus 2.75% and matures on November 30, 1998; (ii) a $600,000 term loan provided by the Bank on December 2, 1993, which currently bears interest at the Bank's prime lending rate plus .50% and matures on December 31, 1998; and (iii) a $200,000 term loan provided by the Bank on May 3, 1994, which currently bears interest at the three-month LIBOR plus 2.75% and matures on April 30, 1999.\nThe Company has a $4,000,000 Convertible Junior Subordinated Note with (the \"8.5% Junior Note\") interest payable semi-annually. The 8.5% Junior Note matures in March 1999 and is convertible into shares of common stock at $8.80 per share. The Company may require, subject to certain conditions, that the 8.5% Junior Note be fully converted in the event the market price of the common stock exceeds $18.00 for ten consecutive business days. The interest rate of the 8.5% Junior Note may increase by up to two percent in the event of an uncured default. The 8.5% Junior Note is not collateralized.\nThe Company has a $1,000,000 Convertible Junior Subordinated Note (the \"8.25% Junior Note\") which matures in March 1999 in the principal amount of $1,000,000 at 8.25% interest payable semi-annually. The Junior Note matures in March 1999 and is convertible into shares of common stock at $6.74 per share. The Company may require that the Junior Note be fully converted in the event the market price of the common stock exceeds $9.16 for ten consecutive business days. The 8.25% Junior Note is not collateralized.\nDeferred financing costs of $39,000 relating to retirement of debt have been expensed and accounted for as an extraordinary item in 1993.\nMaturities of long-term debt, at December 31, 1995 are as follows:\nNOTE I - INCOME TAXES\nThe provisions for income taxes for the years ended December 31, 1993, 1994 and 1995 consisted of the following:\nA reconciliation of the federal statutory tax rate to the effective tax rate for the years ended December 31, 1993, 1994 and 1995 is as follows:\nTemporary differences and carryforwards which give rise to deferred tax assets and liabilities as of December 31, 1994 and 1995 are as follows:\nFor Federal and State tax purposes at December 31, 1995, the Company has available approximately $1,087,000 of net operating loss carryforwards expiring from 1998 through 2007 and\nare subject to a limitation in their utilization of approximately $149,000 per year as a result of several changes in shareholder control.\nAt December 31, 1995, the Company evaluated the realizability of the state net operating losses, and based upon revised projections of taxable income by state, has concluded that a valuation allowance is not necessary. The remaining balance of the deferred tax assets should be realized through future taxable income and the reversal of taxable temporary differences.\nNOTE J - COMMITMENTS AND CONTINGENT LIABILITIES\nThe Company is engaged in legal proceedings in the normal course of business. The Company believes that any unfavorable outcome from these suits not covered by insurance would not have a material adverse effect on the financial position or results of operations of the Company.\nNOTE K - OPERATING LEASES\nThe Company leases office space under noncancellable operating leases. Certain of these leases contain escalation clauses based on the consumer price index. Future minimum rental payments, by year and in the aggregate, under operating leases with terms of one year or more consist of the following at December 31, 1995:\nRent expense was approximately $2,172,000, $2,499,000 and $2,144,000 for the years ended December 31, 1993, 1994 and 1995 respectively.\nNOTE L- PENSION AND PROFIT SHARING PLANS\nPreviously, the Company had a 401(k) Saving and Retirement Plan (the \"Plan\") available to all employees of J.E. Hanger, Inc. (\"JEH\"), a wholly-owned subsidiary of the Company. The Company matched the participant's contributions and made discretionary matching contributions. On January 1, 1993, the Company froze the Plan such that no new employees of JEH were able to participate. On December 31, 1995, the Company terminated the Plan. There was no employer contribution made to the Plan in 1995. Benefit expense was $132,000 and $130,000 for the years ended December 31, 1993 and 1994, respectively.\nThe Company maintains a 401(k) Savings and Retirement plan to include all of the employees of the Company. The Company may make discretionary contributions. Under this 401(k) plan, employees may defer such amounts of their compensation up to the levels permitted by the Internal Revenue Service. The Company has not made any contributions to this plan.\nNOTE M - REDEEMABLE PREFERRED STOCKS\nThe Company has 10,000,000 authorized shares of preferred stock, par value $.01 per share, which may be issued in various classes with different characteristics.\nThe 300 issued and outstanding shares of non-voting, non-convertible Class C preferred stock have an aggregate liquidation value equal to $150,000 plus accrued dividends at 9% and are required to be redeemed on February 1, 2000. Accrued dividends at December 31, 1994 and 1995, were $20,000 and $22,000 respectively.\nThe 100,000 authorized shares of Class F preferred stock, accrues dividends cumulatively at 16.5% and is required to be redeemed prior to any other class of preferred stock, before September 1998, for the aggregate liquidation value of $1,000 per share, plus accrued dividends. As of December 31, 1994 and 1995, none of the Class F preferred stock was issued or outstanding.\nNOTE N - WARRANTS AND OPTIONS\nWARRANTS\nIn November 1990, the Company entered into a $2,450,000 Note which required the Company, based on certain repayment provisions, to issue to an affiliate in 1991 warrants to purchase 297,883 and 322,699 shares of common stock at $4.16 and $7.65 per share, respectively. These warrants are exercisable through December 31, 2001. The Company had allocated $1,600,000 of the debt proceeds to the warrant. In 1992, the Note was repaid and the unamortized portion of the debt discount was expensed. No warrants have been exercised to date.\nOPTIONS\nUnder the Company's 1991 Stock Option Plan (\"SOP\"), 1,500,000 shares of common stock are authorized for issuance under options that may be granted to employees. The number of shares that remain available for grant at December 31, 1994 and 1995, were 1,007,417 and 892,790, respectively. Under the SOP, options may be granted at an exercise price not less than the fair market value of the common stock on the date of grant. Vesting and expiration periods are established by the Compensation Committee of the Board of Directors and generally vest three years following grant and generally expire eight to ten years after grant.\nIn addition to the SOP, non-qualified options may be granted with exercise prices that are less than the current market value. Accordingly, compensation expense for the difference between current market value and exercise price is recorded at the date of grant.\nThe following is a summary of option transactions and exercise prices:\nIn August 1990, a principle shareholder (the \"Grantor\") granted options (the \"Manager Options\") to three members of management (the \"Managers\") of the Company to purchase 413,750 shares of Company Common Stock owned by the Grantor at an exercise price of $6.00 per share. The Grantor agreed upon exercise of the Manager Options to transfer 27.5% of the exercise price of each Manager Option to the Company as a capital contribution. The Manager Options were scheduled to expire in May 1994.\nIn March 1991, the Grantor granted options (the \"Additional Manager Options\") to the Managers to purchase 248,265 and 100,000 shares of Company Common Stock owned by the Grantor at exercise prices of $6.00 and $8.00 per share, respectively. The Additional Manager Options were to expire in December 1994.\nIn May 1994, the Manager Options expired and the Grantor (i) agreed to extend the expiration date from December 1994 to December 1995 relating to an aggregate of 264,124 shares of Company Common Stock, and (ii) grant new options (the \"New Manager Options\") to the Managers to purchase 313,788 shares of Company Common Stock owned by the Grantor at an exercise price of $6.00 per share. The remaining 84,141 shares of Company Common Stock which underlied the balance of the Additional Manager Options continued to have an expiration date of December 1994. The New Manager Options vested immediately upon the date of grant and were scheduled to expire in May 1995.\nIn September 1994, the Grantor agreed to (i) decrease the option exercise price of each of the New Manager Options and the previously extended portion of the Additional Manager Options relating to 264,124 shares of Company Common Stock to the then current market price of the Company Common Stock of $3.875 per share and (ii) extend the expiration dates of all such New Manager Options and such portion of the Additional Manager Options to March 1996.\nIn October 1995, the Grantor agreed to allow for the payment of the option exercise price of all New Manager Options and Additional Manager Options in cash and\/or the reduction in the remaining number of shares issuable upon the exercise of such options, as well as to extend the\nexpiration dates of all the New Manager Options and Additional Manager Options as follows: (i) the expiration date of New Manager Options relating to 232,720 shares was extended from March 22, 1996 to March 22, 1997, (ii) the expiration date of new Manager Options relating to 81,068 shares was extended from March 22, 1996 to December 31, 1997, (iii) the expiration date of Additional Manager Options relating to 93,389 shares was extended from March 22, 1996 to March 22, 1997 and (iv) the expiration date of Additional Manager Options relating to 170,735 shares was extended from March 22, 1996 to December 31, 1997.\nUnder the Company's 1993 Non-Employee Director Stock Option Plan, 250,000 shares of common stock are authorized for issuance to directors of the Company who are not employed by the Company or any affiliate of the Company. Under this plan, an option to purchase 5,000 shares of common stock is granted automatically on an annual basis to each eligible director on the third business day following the date of each Annual Meeting of Stockholders of the Company at which the eligible director is elected. The exercise price of each option will be equal to 100% of the fair market value of the common stock on the date of grant. Each option will vest at the rate of 25% each year for the first four years after the date of grant of the option and each such option will expire ten years from the date of grant; provided, however, that in the event of termination of a director's service other than by reason of total and permanent disability or death, then the outstanding options of such holder will expire three months after such termination. Outstanding options remain exercisable for one year after termination of service by reason of total and permanent disability or death. The number of shares that remain available for grant at December 31, 1994 and 1995 were 190,000 and 160,000, respectively.\nREPORT OF INDEPENDENT ACCOUNTANTS\nOur report on the consolidated financial statements of Hanger Orthopedic Group, Inc. 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 schedule listed in the index on Page 43 of this Form 10-K.\nIn our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.\nCoopers & Lybrand L.L.P.\n2400 Eleven Penn Center Philadelphia, Pennsylvania March 8, 1996\nS-1 HANGER ORTHOPEDIC GROUP, INC.\nSCHEDULE II VALUATION AND QUALIFYING ACCOUNTS\nS-2","section_15":""}
{"filename":"752895_1995.txt","cik":"752895","year":"1995","section_1":"ITEM 1. BUSINESS\nConsolidated Resources Health Care Fund IV (the \"Partnership\") was organized on August 10, 1984, as a Limited Partnership under the provisions of the Georgia Uniform Limited Partnership Act.\nAt December 31, 1995, the Partnership had three general partners (the \"General Partners\"), WelCare Consolidated Resources Corporation of America, a Nevada corporation, serving as the Corporate General Partner (\"WCRCA\" or the \"Corporate General Partner\"), Consolidated Associates IV, and WelCare Service Corporation-IV (\"WSC-IV\" or the \"Managing General Partner\"), a Georgia Corporation, serving as Manager General Partner. WCRCA and WSC-IV are wholly- owned subsidiaries of WelCare Acquisition Corp., a Georgia corporation, which is in turn a wholly-owned subsidiary of WelCare International, Inc. (\"WelCare\"). WelCare, a privately-owned Georgia corporation, is engaged in the operation, acquisition, property management and oversight management of long- term care facilities. Consolidated Associates IV, a Georgia general partnership, is composed of WCRCA, as the managing general partner, and individuals who were previously associated with Consolidated Resources Corporation of America (\"CRCA\").\nPursuant to an agreement dated October 30, 1985, CRCA, a Georgia corporation that initially was the corporate general partner of the Partnership, was merged into a subsidiary of Southmark Corporation (\"Southmark\"). The name of the surviving Southmark subsidiary was then changed to Southmark Consolidated Resources Corporation of America (\"SCRCA\"). Southmark, a Georgia corporation, emerged from Chapter 11 bankruptcy on August 10, 1990, and liquidated most of its assets under its plan of reorganization. On November 20, 1990, WelCare, through its subsidiary WelCare Acquisition Corp., acquired from Southmark all the stock of SCRCA whose name was then changed to WelCare Consolidated Resources Corporation of America. Southmark has not been affiliated with the Partnership since November 1990. WSC-IV was added as the Managing General Partner of the Partnership on January 7, 1992, following the approval by a majority-in-interest of the Partnership's limited partners. The acquisition of SCRCA by WelCare Acquisition Corp., and the addition of WSC-IV as Managing General Partner did not result in a change in the compensation paid the General Partners (See Item 8, Notes 1 and 2, and Item 13).\nOn October 15, 1984, a Registration Statement on Form S-1 was declared effective by the Securities and Exchange Commission whereby the Partnership offered for sale $30,000,000 of Limited Partnership Units. The Limited Partnership Units represent equity interests in the Partnership and entitle the holders thereof (\"Limited Partners\") to participate in certain allocations and distributions of the Partnership. The sale of Limited Partnership Units closed in April 1985 with 26,283 units sold at $1,000 each, for gross proceeds of $26,283,000 to the Partnership.\nThe Partnership's primary business and only industry segment is to own, operate and ultimately dispose of a diversified portfolio of health care related real properties for the benefit of its Limited Partners. As of December 31, 1995, the Partnership owned two nursing homes in Kansas. During October 1995, a nursing home in Missouri owned by the Partnership was sold (see Note 7).\nCurrent Developments\nA majority-in-interest of the Partnership's Limited Partners approved a proposal, on October 18, 1994, which provides for the sale of all of the Partnership's remaining assets and the eventual dissolution of the Partnership, as outlined in a proxy statement dated September 28, 1994. Under the approved proposal, the Limited Partners consented for the Managing General Partner to attempt to sell or otherwise dispose of its remaining properties prior to October 18, 1997. Upon the disposition of all of its assets, the approved proposal requires that the Managing General Partner dissolve the Partnership.\nAs discussed in Item 8, Note 4, the Partnership's mortgage debt obligations were in default as of December 31, 1995. The Partnership will continue to operate the facilities and plans to (A) sell the properties to prospective purchasers, or (B) negotiate a settlement with its lenders.\nOperation of Nursing Home Facilities\nAt the beginning of 1991, all six of the Partnership's existing nursing homes were managed by National Heritage, Inc. (\"NHI\"). NHI, a New York Stock Exchange listed company, was affiliated with the Partnership prior to WelCare's subsidiary's acquisition of the Corporate General Partner on November 20, 1990. Effective March 1, 1991, NHI was terminated as manager of Kent's Nursing Center and Life Care Centers of America, Inc. (\"LCCA\"), a privately-owned corporation, began managing this facility. In September 1991, the Partnership terminated NHI as manager of the Partnership's three facilities located in Kansas. In the fourth quarter of 1991, the Partnership notified NHI that effective January 31, 1992, NHI was terminated from providing management services at the Partnership's remaining two facilities. Lawsuits between the Partnership and NHI ensued and on December 31, 1991, NHI and the Partnership entered into a Consent Order which allowed NHI to perform accounting services for two facilities under the supervision of the Corporate General Partner and the Court (See Item 3). This litigation was resolved in October 1993 and NHI no longer performs accounting or any other services for the Partnership's facilities. (See Note 9).\nAn affiliate of the Corporate General Partner assumed direct management responsibilities for the three Kansas facilities following NHI's termination effective September 1, 1991, and at River Oaks Care Center and Heritage Manor of Mountain Grove effective February 1, 1992. This affiliate received a management fee of 6% of gross revenues at Heritage Manor of Hiawatha, Heritage Manor of Mountain Grove and Heritage Manor of Emporia, and an aggregate management and accounting fee of 6% of gross revenues at Heritage Manor of Hoisington and River Oaks Care Center. An affiliate of the Corporate General Partner provided oversight management services for Kent's Nursing Center and received a fee equal to 1% of gross revenues. A management fee of 5% of Kent's Nursing Center's gross revenues was paid to LCCA. Kent's Nursing Center, Heritage Manor of Hiawatha and River Oaks Care Center were sold by the Partnership during 1993.\nAs a result of efforts made by the Corporate General Partner, in 1991 a distribution of $150,000 was made to the Limited Partners, the first such distribution since 1987. No distributions were made in 1992. During 1993, the Partnership distributed $750,000 to the Limited Partners as proceeds from the facility sales. During 1994, the Partnership distributed $1,000,000 to the Limited Partners from the sale of Rainbow Springs. No distributions were made during 1995.\nThe Partnership's Rainbow Springs parcel contained undeveloped land, a partially developed hotel and two operating 18-hole golf courses. The Rainbow Springs facility competed with other golf courses in the Milwaukee market, as well as against other facilities with spring and summer recreational activities. In 1989, the joint owner of Rainbow Springs filed for bankruptcy protection. The bankruptcy court, having jurisdiction over this joint owner, ordered a public auction to take place on January 31, 1994, and the sale of the property was closed on March 21, 1994.\nAs of December 31, 1995, the Partnership employed approximately 140 persons, including administrative, nursing, dietary, social services and maintenance personnel.\nThe services provided at the Partnership's nursing facilities consist of long- term nursing care. Nursing care consists of 24 hour professional nursing care and related medical services prescribed by the resident's physician, as well as assistance or supervision with activities of daily living such as dressing, grooming, bathing, medication and dietary needs.\nAll of the nursing facilities are certified to receive benefits under joint Federal and State funded programs administered by the respective states to provide medical assistance to the indigent, known generally as the \"Medicaid\". Benefits under the Federal Health Insurance for the Aged Act (\"Medicare\") are for skilled care only in those facilities which are certified for this program. Medicaid reimbursement formulas vary by state and are established in accordance with Federal guidelines. Typically, Medicaid provides for reimbursement for nursing home care of an all-inclusive nature up to specified limits based on historical costs, with adjustments for inflation. Federal law requires that Medicaid reimbursement rates be reasonable and adequate to meet the costs which must be incurred by efficiently and economically operated facilities to provide care and services in conformity with applicable laws, regulations and quality and safety standards. Medicaid payments are generally set prospectively for each facility, with the exception of a few states, where retrospective settlement exists.\nThe Medicare and Medicaid programs are subject to statutory and regulatory changes, administrative rulings, interpretations of policy and determinations by intermediaries, and to governmental funding restrictions, all of which may materially increase or decrease program payments to long-term care facilities and could adversely affect the operations of the Partnership's nursing home facilities.\nIn the operation and sale of its long-term care facilities, the Partnership competes with a number of individuals and entities, including large, national nursing home chains and small, locally owned geriatric facilities. Some competing operators have greater financial resources than the Partnership or may operate on a nonprofit basis or as charitable organizations. The degree of success with which the Partnership's facilities compete varies by location and depends on a number of factors. The Partnership believes that the quality of care provided, the reputation and physical appearance of facilities and, in the case of private pay patients, charges for services, are significant competitive factors. There is limited, if any, competition in price with respect to Medicaid and Medicare patients since revenues for services to such patients are strictly controlled and based on fixed rates and cost reimbursement principles. In light of these factors, the Partnership seeks to meet competition in each locality by improving the quality of services provided at its facilities, establishing a reputation within the local medical community for providing excellent care services, and by responding appropriately to regional variations in demographics and tastes. In most states, approval by state healthcare regulatory agencies must be obtained and a Certificate of Need (\"CON\") or authorization issued before new long-term care beds can be constructed. This tends to stabilize competition. However, some states have already or are considering a repeal of CON programs. Kansas, in which the Partnership owns two facilities, does not currently require a CON.\nThe following table sets forth information regarding the average daily census and sources of patient revenues at the Partnership's facilities at December 31, 1995:\n\t\t Average Daily Census for Revenues for \t\t Year Ended Year Ended \t\t December 31 ,1995 December 31 ,1995\nMedicaid 73 55.0% 49.0% Private Pay 54 41.0% 44.0% VA, Medicare and Other 5 4.0% 7.0%\n\t\t 132 100% 100%\nOverall Occupancy Rate 89%\nBecause of a changing census mix (i.e. private pay patients vs. government reimbursed patients), the occupancy required for a facility to achieve an operating break-even point cannot be determined precisely. Generally, a greater ratio of Medicaid patients will require a higher occupancy to reach a break-even point. On the other hand, a high Medicare census can lower the number of patients necessary to reach the break-even point due to a higher reimbursement rate.\nAll licensed beds in the operating facilities are available except in a few instances where a small number of rooms have been taken out of service to be utilized as office space and ancillary support areas, including revenue generating rehabilitation services.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. DESCRIPTION OF PROPERTY\nThe following table sets forth the investment portfolio of the Partnership at December 31, 1995. The buildings of the projects and the land on which they are located are owned by the Partnership and its majority-owned partnerships. The fee is subject in each case to secured debt, as set forth more fully in Item 8, Note 4.\n\t\t Properties (dollars in 000's) \t\t Net \tSecured Acquisition Book Date Property Debt Cost Value Acquired\nHeritage Manor of Emporia Emporia, KS 79 Licensed Nursing Home Beds $1,115 $2,809 $313(1) October 1985\nHeritage Manor of Hoisington Hoisington, KS 70 Licensed Nursing Home Beds 649 1,387 431(1) July 1985\nTotals $1,764 $4,196 $744\nThese facilities have a total of 149 beds.\n(1) A provision was made to write down the facility, for Partnership financial statement purposes, to its estimated fair value or net realizable value at the time of the write-down as determined by the Corporate General Partner (See Item 8, Note 6). The amount reflects this write-down.\nOccupancy Levels and Rental Rates\nThe following table sets forth the occupancy levels and rental rates for the past four years for the facilities owned by the Partnership as of December 31, 1995. Rental rates are presented as Per-Patient-Day amounts (\"PPD\"), the standard of comparison used in the long-term care industry. The PPD amount represents the average revenue received per day of care provided.\n\t 1995 1994 1993 1992 1991\nHeritage Manor of Emporia\nOccupancy Rate 86% 89% 91% 78% 48% Rental Rate (PPD) $70.00 $64.00 $57.00 $47.00 $42.00 \t\t\t\t\t Heritage Manor \tof Hoisington\nOccupancy Rate 92% 94% 98% 97% 97% Rental Rate \t(PPD) $68.00 $61.00 $53.00 $49.00 $47.00\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nAt December 31, 1995, the Partnership was not a party to any material pending legal proceeding, other than ordinary litigation routine to the Partnership's business.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\n\tPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S UNITS OF LIMITED PARTNERSHIP \tAND SECURITY HOLDER MATTERS\n(A) No market for Limited Partnership Units exists nor is one \texpected to develop.\n(B) Title of Class Number of Record Unit Holders\n\tLimited Partnership Units 2,914 as of March 1, 1996\n(C) Due to improvements in operations following WelCare's subsidiary's acquisition of the Corporate General Partner and proceeds received from the sale of Heritage Manor of Red Boiling Springs, the Corporate General Partner caused the Partnership to distribute $150,000 to the Limited Partners in 1991. This was the first distribution to the Limited Partners since 1987. In 1994 and 1993, the Partnership distributed $1,000,000 and $750,000, respectively, of proceeds from facility sales.\n\tFuture distributions are dependent on the Partnership's ability to meet its ongoing obligations and to generate proceeds from the sale of its assets in excess of existing debt. Cumulative distributions paid to the Limited Partners as of December 31, 1995, were $5,446,590. There have been no distributions to the General Partners. See Liquidity and Capital Resources section of Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations and Item 8, Note 5 for discussion of distributions.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following table sets forth a summary of selected financial data for the Partnership. This summary should be read in conjunction with the notes to the Partnership's financial statements appearing in Item 8.\n\t\t\tYears Ended December 31, (dollars in 000's, \t\t\t except per share figures) Statements of Operations 1995(1) 1994(2) 1993(3) 1992 1991\nOperating revenue $5,321 $4,997 $9,319 $11,111 $10,406 Income (loss) before extraordinary gain (365) (356) 1,520 (3,049) (1,279) Net income (loss) 1,901 (46) 2,853 (3,049) (1,279) Income (loss) before extraordinary gain per weighted average Limited Partnership Unit (12.90) (12.30) 58.25 (111.38) (46.72) Net income (loss) per weighted average Limited Partnership Unit 69.86 (0.99) 108.49 (111.33) (46.72) Distribution paid per weighted average Limited Partnership Unit - 38.05 28.54 - 5.71\n\t\t\tYears Ended December 31, (dollars in 000's, \t\t\t except per share figures) Balance Sheets 1995(1) 1994(2) 1993(3) 1992 1991\nProperty and equipment, net $ - $ - $3,506 $5,443 $7,590 Property held for sale 744 3,268 2,016 3,558 4,000 Total assets 1,953 5,194 7,870 11,186 14,087 Long-term debt obligations, less current maturities - - 2,825 5,380 5,436 Partners equity (deficit) (241) (2,142) (1,096) (3,200) (150)\n(1) During 1995, the Partnership sold one facility. (2) During 1994, the Partnership sold one facility. (3) During 1993, the Partnership sold three facilities.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL \tCONDITION AND RESULTS OF OPERATIONS\nPlan of Operations\nA majority-in-interest of the Partnership's Limited Partners approved a proposal, on October 18, 1994, which provides for the sale of all of the Partnership's remaining assets and the eventual dissolution of the Partnership, as outlined in a proxy statement dated September 28, 1994. Under the approved proposal, the Limited Partners consented for the Managing General Partner to attempt to sell or otherwise dispose of its remaining properties prior to October 18, 1997. Upon the disposition of all of its assets, the approved proposal requires that the Managing General Partner dissolve the Partnership.\nAs discussed in Item 8, Note 4, the Partnership's two mortgage debt obligations were in default as of December 31, 1995. The Partnership will continue to operate the facilities and plans to negotiate an extension with its lenders while it proceeds with the sale of its properties.\nAt December 31, 1995, the Partnership has held available for sale all of its nursing home facilities. Accordingly, the Partnership has classified the facilities as Property held for sale in the accompanying balance sheet.\nResults of Operations\nRevenue:\n1995 compared to 1994\nOperating revenues increased by $323,347 for 1995 compared to the prior year. This increase is due primarily to a change in patient mix at the Oaks of Mountain Grove (\"Mountain Grove\"). On October 18, 1995, Mountain Grove was sold. During the time it was owned by the Partnership in 1995, Mountain Grove generated $2,274,988 in revenues. During 1994, Mountain Grove generated $1,873,943 in revenues. The remaining increase over the prior year was due primarily to increases in rates at the Partnership's two remaining facilities and partially to an increase in Medicare census.\n1994 compared to 1993:\nOperating revenues decreased by $4,322,083 for 1994, compared to the prior year, primarily due to the sale River Oaks Care Center (\"River Oaks\"), Kent's Nursing Center (\"Kent's\"), Heritage Manor of Hiawatha (\"Hiawatha\") and Rainbow Springs (\"Rainbow\"). River Oaks was sold effective April 1, 1993, Kent's and Hiawatha were sold effective October 1, 1993, and Rainbow was sold effective March 21, 1994. These sold properties generated revenue of $4,408,703 for the Partnership in 1993. Revenue increased at the Partnership's remaining facilities in 1994 due to Medicaid rate increases at the Kansas facilities and increased Medicare utilization at all facilities.\nExpenses:\n1995 compared to 1994\nOperating expenses increased by $95,817 for 1995. As discussed above, Mountain Grove was sold during 1995. This facility incurred $2,114,511 in operating expenses during the time it was owned by the Partnership in 1995. During 1994, Mountain Grove incurred $1,933,092 in operating expenses. The increase at Mountain Grove was due primarily to salary increases and additional therapy utilization as compared to the prior year. The reduction in operating expenses at the Partnership's remaining facilities was due to reductions in expenses associated with a decrease in overall patient census.\n1994 compared to 1993:\nOperating expenses decreased by $2,972,738 for 1994, compared to the prior year, primarily due to the sale during 1993 of the Kent's, River Oaks, Hiawatha and Rainbow facilities. These sold properties produced operating expenses of approximately $4,390,564 for the full year of 1993. Operating expenses at the Partnership's remaining facilities increased due to increased staffing levels, salaries and insurance costs. Interest expense decreased $188,412 due to the sales and retirements of debts on Kent's, River Oaks, and Hiawatha in 1993.\nLiquidity and Capital Resources\nAs discussed in the financial statements (see Item 8, Note 3), the Partnership's financial statements have been presented on the basis that it is a going concern. The Partnership does not anticipate improved liquidity during the remainder of 1996, due to the expected operating cash flow from the Partnership's two remaining facilities, monthly debt service payments and the payment of recurring partnership expenses. As discussed in more detail below, the Partnership is currently seeking an extension on debt obligations secured by its two remaining facilities. Should the lenders of these debts pursue their satisfaction, the related facilities could be lost to foreclosure and the financial resources and liquidity of the Partnership could be adversely impacted.\nAt December 31, 1995, the Partnership held cash and cash equivalents of $628,543. Cash is being held in reserve for working capital, capital improvements and operating contingencies.\nDuring 1995, the Partnership maintained current debt service payments on all of its debt secured by facilities currently owned by the Partnership. The Partnership should produce sufficient cash flow from operations during 1996 to continue to satisfy current monthly debt service obligations.\nOn September 14, 1995, the Partnership received $250,000 in payment of its note receivable from the Purchaser of Red Boiling Springs, a facility sold by the Partnership in 1991. These funds will be used to meet working capital requirements.\nAs of December 31, 1995, the Partnership was not obligated to perform any major capital additions or renovations and no such capital expenditures or renovations are planned for 1996. Necessary minor repairs, maintenance and capital expenditures are expected to be funded by existing cash reserves.\nSignificant changes have and will continue to be made in government reimbursement programs, and such changes could have a material impact on future reimbursement formulas. Based on information currently available, Management does not believe that proposed legislation will have an adverse effect on the Partnership's operations. However, as health care reform is ongoing, the long-term effects of such changes cannot be accurately predicted at the present time.\nThe Partnership is in default on the long-term debt obligations secured by Heritage Manor of Hoisington and Heritage Manor of Emporia as these loans were due April 1, 1996. The Partnership is currently seeking extensions from the lender on these debts. The inability to obtain extensions could result in foreclosure and a loss of these facilities. The Partnership is currently seeking purchasers for these facilities at a sales price that would satisfy the operating and debt obligations of the facilities. The Managing General Partner anticipates obtaining extensions sufficient to allow for the orderly sale of these facilities, however, there can be no assurance that the facilities can be sold prior to foreclosure. As long as these default situations exist, the Partnership remains at risk relative to these loans. The Partnership has no existing lines of credit to draw upon should present resources or cash flow from operations be inadequate.\nAccounting Prouncement\nThe Financial Accounting Standards Board has issued Statement on Financial Accounting Standards No. 121,\"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of\" (SFAS No. 121). The Company will adopt this standard in Fiscal 1996. In management's opinion, there will be no material effect on the Company's financial statements of adopting SFAS No. 121.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nIndex Page Number\nReport of Independent Certified Public Accountants 13\nConsolidated Financial Statements\n\t\tBalance Sheets - December 31, 1995 and 1994 14-15\n\t\tStatements of Operations 16 \t\t- Years ended December 31, 1995, 1994 and 1993\n\t\tStatements of Partners' Deficit 17 \t\t - Years ended December 31, 1995, 1994 and 1993 \t \t\tStatements of Cash Flows 18 \t\t- Years ended December 31, 1995, 1994 and 1993\n\t\tSummary of Significant Accounting Policies 19-21\n\t\tNotes to Consolidated Financial Statements 22-27\nThe following financial statement schedule for the years ended December 31, 1995, 1994 and 1993 of the Registrant is submitted herewith in response to Item 14 (a)(2):\nSchedule II - Valuation and Qualifying Accounts 29\nAll other schedules of the Partnership for which provision is made in the applicable regulations of the Securities and Exchange Commission are not required under the related instructions, are inapplicable or have been disclosed in the notes to the consolidated financial statements and, therefore, have been omitted.\nReport of Independent Certified Public Accountants\nThe Partners Consolidated Resources Health Care Fund IV and Subsidiaries\nWe have audited the accompanying consolidated balance sheets of Consolidated Resources Health Care Fund IV and Subsidiaries (limited partnerships) (the \"Partnership\") as of December 31, 1995 and 1994, and the related consolidated statements of operations, partners' deficit and cash flows for each of the three years in the period ended December 31, 1995. We have also audited the schedule listed in the accompanying index. These consolidated financial statements and schedule 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 audits to obtain reasonable assurance about whether the consolidated financial statements and schedule are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements and schedule. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements and schedule. 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 Consolidated Resources Health Care Fund IV and Subsidiaries (limited partnerships) at December 31, 1995 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, 1995, in conformity with generally accepted accounting principles.\nAlso, in our opinion, the schedule presents fairly, in all material respects, the information set forth therein.\nThe accompanying consolidated financial statements have been prepared assuming that the Partnership will continue as a going concern. As discussed in Notes 3 and 4 of the consolidated financial statements, the Partnership has suffered recurring losses from operations, has a working capital deficiency, has defaulted on certain debt, and has no assurance of any financial support from the General Partners. These conditions raise substantial doubt about the Partnership's ability to continue as a going concern and to realize its plan to sell or otherwise dispose of its remaining properties by October 18, 1997. Management's plans regarding these matters are described in the Summary of Significant Accounting Policies and Note 3. The consolidated financial statements and schedule do not include any adjustments that might result from the outcome of these uncertainties.\n\t\tBDO Seidman, LLP\nAtlanta, Georgia March 1, 1996\nConsolidated Resources Health Care Fund IV and Subsidiaries (limited partnerships)\nConsolidated Balance Sheets\n\t\t\t\t\t December 31, 1995 1994\nAssets\nCurrent Cash and cash equivalents (Note 12) $ 628,543 $ 820,321 Patient accounts receivable and third party settlements, net of allowance for doubtful accounts of $72,978 (Note 11) 477,805 367,145 Prepaid expenses and other 18,529 37,952 Property held for sale (Notes 4, 6 and 7) 744,147 3,268,042\nTotal current assets 1,869,024 4,493,460\nOther Restricted escrow and other deposits (Note 4 49,241 329,589 Note receivable (Note 7) - 250,000 Deferred loan costs, net of accumulated amortization of $71,312 and $90,048 34,931 120,699 \t\t\t\t\t Total other assets 84,172 700,288\n\t\t\t\t\t $1,953,196 $5,193,748\nSee accompanying summary of significant accounting policies and notes to consolidated financial statements.\nConsolidated Resources Health Care Fund IV and Subsidiaries (limited partnerships)\nConsolidated Balance Sheets\n\t\t\t\t\t December 31, 1995 1994\nLiabilities and Partners' Deficit\nCurrent liabilities Mortgage debt obligations including debt in default of $1,763,962 and $4,683,405 (Note 4) $1,763,962 $4,683,405 Accounts payable and accrued expenses 156,102 112,059 Accrued compensation 126,004 144,832 Insurance payable 58,255 38,129 Accrued interest (Notes 1 and 4) 46,637 72,515 Accrued real estate taxes 43,376 18,833\nTotal current liabilities 2,194,336 5,069,773\nAdvances from affiliates and former affiliates (Notes 1 and 8) - 2,266,170\nTotal liabilities 2,194,336 7,335,943\nCommitments and Contingencies (Notes 3, 4, 8, and 11)\nPartners' equity (deficit) (Note 5) Limited partners 432,856 (1,403,484) General partners (673,996) (738,711)\nTotal partners' deficit (241,140) (2,142,195)\n\t\t\t\t\t\t $1,953,196 $5,193,748\nSee accompanying summary of significant accounting policies and notes to consolidated financial statements.\nConsolidated Resources Health Care Fund IV and Subsidiaries (limited partnerships)\nConsolidated Statements of Operations\nYears ended December 31, 1995 1994 1993\nRevenue Operating revenue (Notes 7 and 11) $5,320,578 $4,997,231 $ 9,319,314 Interest income 29,587 73,854 43,816\nTotal revenue 5,350,165 5,071,085 9,363,130\nExpenses Operating expenses (Note 7) 4,814,084 4,718,267 7,691,005 Interest expense (Notes 1 and 4) 445,608 453,979 642,391 Depreciation and amortization 302,419 324,202 607,138 Management fees (Note 2) 313,790 317,271 774,555 Real estate taxes 43,518 41,284 365,415 Partnership administration costs (Note 2) 173,452 179,060 171,660 Total operating costs and expenses 6,092,871 6,034,063 10,252,164 \t Operating loss (742,706) (962,978) (889,034) Gain on sale of properties (Note 7) 377,591 607,169 2,408,667 Income (loss) before extraordinary item (365,115) (355,809) 1,519,633 Extraordinary gain on extinguishment of debt (Notes 1, 8 and 9) 2,266,170 309,730 1,333,802 Net income (loss) $1,901,055 $(46,079) $2,853,435 Net income (loss) per limited partnership unit before extraordinary gain $(12.90) $(12.30) $ 58.25 Extraordinary gain from debt extinguishment 82.76 11.31 50.24 Net income (loss) per limited partnership unit $ 69.86 $ (0.99) $108.49 Distributions paid per limited partnership unit $ - $ 38.05 $ 28.54 Limited partnership units outstanding 26,283 26,283 26,283\nSee accompanying summary of significant accounting policies and notes to consolidated financial statements.\nConsolidated Resources Health Care Fund IV and Subsidiaries (limited partnerships)\nConsolidated Statements of Partners' Deficit Years Ended December 31, 1995, 1994 and 1993\n\tTotal \tPartners' \tLimited General Deficit\nBalance, at January 1, 1993 $(2,484,998) $(714,553) $(3,199,551) Net income 2,851,572 1,863 2,853,435 Distributions (Note 5) (750,000) - (750,000)\nBalance, at December 31, 1993 (383,426) (712,690) (1,096,116) Net loss (20,058) (26,021) (46,079) Distributions (Note 5) (1,000,000) - (1,000,000)\nBalance, at December 31, 1994 (1,403,484) (738,711) (2,142,195) Net income 1,836,340 64,715 1,901,055\nBalance, at December 31 , 1995 $ 432,856 $(673,996) $ (241,140)\nSee accompanying summary of significant accounting policies and notes to consolidated financial statements.\nYears ended December 31, 1995 1994 1993\nOperating activities Net income (loss) $1,901,055 $(46,079) $2,853,435 Adjustments to reconcile net income (loss) to cash used in operating activities: Depreciation and amortization 302,419 324,202 607,138 Gain on sale of properties (377,591) (607,169) (2,408,667) Extraordinary gain on debt forgiveness (2,266,170) (309,730) (1,333,802) Changes in assets and liabilities: Accounts receivable (110,660) 270,172 11,011 Prepaid expenses and other 19,423 38,184 178,176 Other assets 80,511 3,743 35,055 Accounts payable and accrued liabilities 174,167 (34,444) (335,260) Cash used in operating activities (276,846) (361,121) (392,914)\nInvesting activities Additions to property held for sale (70,489) (74,263) - Payment for purchases of property and equipment - - (83,699) Net proceeds from sale of properties - 1,410,283 5,374,810 Proceeds from repayment of note receivable 250,000 - - Payment for settlement of obligations owed to former affiliates - - (425,000)\nCash provided by investing \tactivities 179,511 1,336,020 4,866,111\nFinancing activities Principal payments on long term debt obligations (94,443) (148,398) (3,325,747) Distributions to limited partners - (1,000,000) (750,000) Cash proceeds from settlement - 76,342 -\nCash used in financing activities (94,443) (1,072,056) (4,075,747)\nNet increase (decrease) in cash and cash equivalents (191,778) (97,157) 397,450\nCash and cash equivalents, beginning of year 820,321 917,478 520,028\nCash and cash equivalents, end of year $628,543 $820,321 $917,478\nSee accompanying summary of significant accounting policies and notes to consolidated financial statements.\nConsolidated Resources Health Care Fund IV and Subsidiaries (limited partnerships)\nSummary of Significant Accounting Policies\nOrganization\nConsolidated Resources Health Care Fund IV (the \"Partnership\") was organized on August 10, 1984 as a Limited Partnership under the provisions of the Georgia Uniform Limited Partnership Act for the purpose of acquiring, operating and holding for investment and future capital appreciation income producing, healthcare related real properties.\nThe General Partners of the Partnership are WelCare Consolidated Resources Corporation of America, (\"WCRCA\" or the \"Corporate General Partner\"), a Nevada corporation, WelCare Service Corporation-IV as managing general partner (\"WSC- IV\" or the \"Managing General Partner\"), a Georgia corporation, and Consolidated Associates IV (\"CA-IV\"), a Georgia general partnership (collectively the \"General Partners\"). WCRCA and WSC-IV are wholly-owned subsidiaries of WelCare Acquisition Corp., which in turn, is a subsidiary of WelCare International, Inc. (\"WelCare\"). WelCare, a privately owned Georgia corporation, is engaged in the operation, acquisition, property management and oversight management of long-term care facilities. Consolidated Associates IV is composed of WCRCA, as the managing general partner, and individuals who were associated with Consolidated Resources Corporation of America (\"CRCA\"). Pursuant to an agreement dated October 30, 1985, CRCA, a Georgia corporation that initially was the Corporate General Partner of the Partnership, was merged into a subsidiary of Southmark Corporation (\"Southmark\"). The name of the surviving Southmark subsidiary was then changed to Southmark Consolidated Resources Corporation of America (\"SCRCA\"). Southmark emerged from Chapter 11 bankruptcy on August 10, 1990 and is liquidating most of its assets under its plan of reorganization. On November 20, 1990, WelCare Acquisition Corp. acquired from Southmark all the stock of SCRCA whose name was then changed to WelCare Consolidated Resources Corporation of America. Effective January 1992, WSC-IV, was added as the Managing General Partner to the Partnership.\nA majority in interest of the Partnership's Limited Partners approved a proposal, on October 18, 1994, which provides for the sale of all of the Partnership's remaining assets and the eventual dissolution of the Partnership, as outlined in a proxy statement dated September 28, 1994. Under the approved proposal, the Limited Partners consented for the Managing General Partner to attempt to sell or otherwise dispose of its remaining properties prior to October 18, 1997. Upon the disposition of all of its assets, the approved proposal requires that the Managing General Partner dissolve the Partnership.\nAs discussed in Item 8, Note 4, the Partnership's two mortgage debt obligations were in technical default as of December 31, 1995. These obligations mature April 1, 1996. The Partnership is currently seeking an extension from the lender to allow for the sale of the facilities.\nThe Partnership will continue to operate the facilities and plans to negotiate an extension with its lenders while it proceeds with the sale of its properties.\nAt December 31, 1995, the Partnership has held available for sale all of its nursing home facilities. Accordingly, the Partnership has classified the facilities as property held for sale in the accompanying balance sheet.\nThe consolidated financial statements do not reflect assets the partners may have outside their interests in the Partnership, nor any personal obligations, including income taxes, of the individual partners.\nConsolidated Resources Health Care Fund IV and Subsidiaries (limited partnerships)\nSummary of Significant Accounting Policies\nConsolidation\nThe consolidated financial statements include the accounts of the Partnership and the partnership in which it holds a majority interest. All significant intercompany balances and transactions have been eliminated. The amount of minority interest is immaterial.\nProperty Held for Sale\nProperty held for sale at December 31, 1995, consists of two nursing home facilities owned by the Partnership. In accordance with a plan approved by the Limited Partners on October 18, 1994, the Managing General Partner has been given permission to either sell or otherwise dispose of the Partnership's assets by October 18, 1997. Property held for sale at December 31, 1994 consisted of three nursing home facilities owned by the Partnership. As discussed in Note 7, one of these facilities was sold in October 1995.\nThe Financial Accounting Standards Board has issued Statement on Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of\" (SFAS No. 121). The Company will adopt this standard in Fiscal 1996. In management's opinion, there will be no material effect on the Company's financial statements of adopting SFAS No. 121.\nDepreciation and Amortization\nProperty and equipment are depreciated using the straight-line method over lives of 5 to 30 years. Amortization of leased assets is included in depreciation and amortization expense. Renewals and betterments are capitalized and repairs and maintenance are charged to operations as incurred.\nDeferred Loan Costs\nDeferred loan costs are amortized over the terms of the respective loans using the straight-line method. Amortization of deferred loan costs is included in depreciation and amortization expense.\nOperating Revenue\nOperating revenue is recorded when services are rendered and includes amounts reimbursable by Medicaid and Medicare. Medicare revenue is recorded at the applicable net reimbursement rates; therefore, no contractual adjustments are reported.\nIncome Taxes\nNo provision has been made in the financial statements for Federal income taxes because under current law, no Federal income taxes are paid directly by the Partnership. The Partnership reports certain transactions differently for tax and financial statement purposes.\nAllocation of Net Income or Net Loss\nThe Partnership's net profits and net losses (other than net profits or net losses from a sale or refinancing of Partnership property) are allocated 96% to the Limited Partners and 4% to the General Partners. Distributions are allocated on the basis described in Note 5.\nConsolidated Resources Health Care Fund IV and Subsidiaries (limited partnerships)\nSummary of Significant Accounting Policies\nNet profits and losses resulting from a sale or refinancing shall be allocated 99% to the Limited Partners and 1% to the General Partners. Net profits resulting from a sale or refinancing shall be allocated in the following order: (a) First, 1% to the General Partners and 99% to the Limited Partners until the net profits allocated to the Limited Partners from such sale or refinancing equals the excess of the greater of the following items over their capital account immediately prior to such sale or refinancing:\na) zero; or\nb) the Limited Partners' invested capital immediately prior to such sale or refinancing plus 9% per annum of the Limited Partners' average invested capital for all fiscal years to the extent not received through prior distributions of distributable cash from operations or sale or refinancing proceeds; or\nc) the amount of sale or refinancing proceeds distributable to the Limited Partners;\n(b) Second, to the General Partners until the net profits allocated to the General Partners from such sale or refinancing equals the excess of the greater of the following items over their capital account immediately prior to such sale or refinancing:\na) zero; or\nb) the amount of sale or refinancing proceeds distributable to the General Partners from such sale or refinancing;\n(c) Third, any remaining net profits shall be allocated 15% to the General Partners and 85% to the Limited Partners.\nNet Income (Loss) Per Limited Partnership Unit\nNet income (loss) per Limited Partnership Unit is computed by dividing net income (loss) allocated to the Limited Partners by the number of Limited Partnership units outstanding.\nReclassifications\nCertain 1994 and 1993 amounts have been reclassified to conform to the 1995 presentation.\nConsolidated Resources Health Care Fund IV and Subsidiaries (limited partnerships)\nSummary of Significant Accounting Policies\nStatements of Cash Flows\nFor purposes of this statement, cash equivalents include bank repurchase agreements backed by U.S. Government Securities, U.S. Treasury Obligations and money market funds.\nUse of Estimates\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nConsolidated Resources Health Care Fund IV and Subsidiaries (limited partnerships)\nNotes to Consolidated Financial Statements\n1. Transactions With Former Affiliates\nThe Partnership paid property management fees based on a percentage of gross property operating revenues to National Heritage, Inc. (\"NHI\"), a former affiliate of Southmark, for supervising the maintenance and operations of the Partnership's properties. At the beginning of 1991, all seven of the Partnership's nursing homes were managed by NHI. During 1991, one of the facilities was sold and a company that is unaffiliated with WelCare, Southmark or NHI assumed management of another facility. Also, during 1991, the Partnership terminated NHI as manager of three more facilities and effective January 31, 1992, the Partnership terminated NHI as manager of the remaining two facilities. NHI provided accounting services for a varying number of homes through September 30, 1993. For services provided during its management period, fees paid to NHI ranged from 1% to 2% of operating revenues for accounting services and 4% to 5% of operating revenues for management services.\nIn December 1991, NHI, through a lawsuit, sought to take possession of certain of the Partnership's properties. In 1993, the Partnership and NHI reached an agreement which settled all lawsuits and claims (See Note 9). In connection with this settlement, the Partnership retained possession of all of the properties.\nAmounts claimed payable to former affiliates (primarily Southmark and the Corporate General Partner) totalled $2,266,170 including accrued interest, at December 31, 1994, and are classified as Advances from affiliates and former affiliates on the 1994 balance sheet. In July 1991, Southmark filed suit demanding payment of these alleged advances. In 1991, after WelCare's affiliate acquired the Corporate General Partner, it challenged the validity of these payables through claims filed against the Southmark Bankruptcy Estate. In February 1994, the suits were settled whereby the Partnership was released of all liabilities to Southmark (see Note 8). Accordingly, during 1995 and 1994, the Partnership recorded a gain on debt extinguishment related to this settlement totalling $2,266,170 and $309,730, respectively. Amounts included in the gain on debt forgiveness in 1994 include payables to Southmark and former affiliates of Southmark of $233,388 plus settlement proceeds paid to the Partnership by Southmark totalling $76,342. In 1995, the Corporate General Partner released the Partnership from all remaining liabilities resulting in a gain on debt forgiveness of $2,266,170.\n2. Management Fees and Affiliate Transactions\nAn affiliate of the Corporate General Partner was responsible for management of three facilities as of December 31, 1991, and assumed responsibility for two additional facilities effective January 31, 1992. During 1994 and 1995, the affiliate of the Corporate General Partner received a fee of 6 % of gross operating revenues on the facilities that the affiliate managed.\nDuring 1995, 1994 and 1993, the affiliate of the Corporate General Partner received oversight fees and management fees from the Partnership amounting to $313,790, $317,271 and $351,882, respectively, and was reimbursed for costs incurred in connection with the administration of Partnership activities of $58,176, $55,928 and $59,762, respectively. The reimbursed costs are included in the Partnership administration costs on the Statements of Operations.\nDuring 1993, an affiliate of the Corporate General Partner advanced funds to a subsidiary of the Partnership to pay off the bond financing secured by Heritage Manor of Hiawatha. These advances were repaid when the facility was sold. Total interest paid on these advances during 1993 was $30,287, which accrued at 7%. Consolidated Resources Health Care Fund IV and Subsidiaries (limited partnerships)\nNotes to Consolidated Financial Statements\n3. Going Concern\nThe Partnership's consolidated financial statements have been presented on the basis that it is a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. At December 31, 1995, the Partnership has experienced working capital deficiencies, had defaulted on certain debt obligations and had no assurance of any financial support from the General Partners.\nThe Partnership's continued existence is dependent upon its ability to generate sufficient cash flow to meet its obligations on a timely basis, to comply with the terms of its financing agreements, and to obtain additional financing as may be required. The Partnership is in the process of seeking buyers for its two remaining facilities. Debt obligations secured by these facilities matured April 1, 1996. The Partnership is currently seeking an extension of the due date on these obligations. The inability to obtain extensions could result in foreclosure and a loss of the facilities. The Partnership does not anticipate improved liquidity during the remainder of 1996. Should the Partnership's cash reserves prove inadequate, the Partnership has no existing lines of credit to draw on, or the ability to increase its borrowings on its two remaining facilities.\n4. Mortgage Obligations\nMortgage debt obligations consisted of:\n\t1995 1994\n9.6% note related to Heritage Manor of Emporia, collateralized by real estate with recourse to other assets of the Partnership, payable in monthly installments of principal and interest of $16,215, due April 1, 1996. $1,115,192 $1,174,905\n9.6% note related to Heritage Manor of Hoisington, collateralized by real estate with recourse to other assets of the Partnership, payable in monthly installments of principal and interest of $9,194, due April 1, 1996. 648,770 683,500\n10.25% First Mortgage Revenue Bonds, related to The Oaks of Mountain Grove, retired in October 1995 in conjunction with the sale of the Oaks of Mountain Grove. - 2,825,000\n\t\t\t\t\t $1,763,962 $4,683,405\nThe Partnership was in default on the mortgage debt related to Heritage Manor of Hoisington and Heritage Manor of Emporia at December 31, 1995 and 1994 due to failure to maintain certain minimum debt service escrow balances. As a result, these obligations are classified as current liabilities in the accompanying balance sheets for 1995 and 1994.\nAt December 31, 1995 and 1994, substantially all property held for sale is held as collateral for mortgage debt obligations.\nThe Partnership paid interest of $471,486, $430,665 and $800,379 in 1995, 1994 and 1993, respectively.\nConsolidated Resources Health Care Fund IV and Subsidiaries (limited partnerships)\nNotes to Consolidated Financial Statements\nDue to the default provisions described above, it is not practical to estimate the fair value of the Partnership's mortgage obligations.\n5. Distributions\nDistributions to the Partners are paid from operations of the Partnership's properties, or from sales or refinancing of properties. Cash from operations is distributed 96% to the Limited Partners and 4% to the General Partners. However, no distributions of cash from operations may be made to the General Partners in any year until the Limited Partners have received distributions for such year equal to 9% of their invested capital.\nDistributions of cash from sales and refinancing are made in the following order:\n(a) first to the Limited Partners in an amount equal to their invested capital; then,\n(b) to the Limited Partners in an amount necessary to provide the Limited Partners with a 9% cumulative, non-compounded return on invested capital to the extent not previously received through distributions of distributable cash from operations; then,\n(c) to the General Partners in an amount up to 3% of the sales price of all properties on a cumulative basis; then,\n(d) the balance 15% to the General Partners and 85% to the Limited Partners.\nDue to improvements in operations obtained after WelCare's affiliate acquired the Corporate General Partner, the Corporate General Partner caused the Partnership to distribute $150,000 to the Limited Partners during 1991. No distributions were made in 1992. During 1993, the Partnership distributed $750,000 of proceeds from facility sales (see Note 7). During 1994, the Partnership distributed $1,000,000 of proceeds from the sale of the Rainbow Springs facility (see Note 7). No distributions were made during 1995. Cumulative distributions paid to the Limited Partners as of December 31, 1995 were $5,446,590. There have been no distributions to the General Partners.\n6. Property Held for Sale and Loss from Write-Down of Properties\nThe Partnership recorded write-downs in prior years to reduce the carrying value of certain properties to their estimated net realizable value as determined by the Corporate General Partner. These writedowns were as follows as of December 31, 1995:\n\t\t\t\t\t\t\t 1995 1994\nHeritage Manor of Emporia $1,317,825 $1,317,825 Heritage Manor of Hoisington 447,506 447,506 Heritage Manor of Mountain Grove(1) - 470,941 \t\t\t\t\t\t $1,765,331 $2,236,272 (1) Property was sold in 1995\nProperty held for sale at December 31 1995, consisted of the Partnership's two nursing home facilities. At December 31, 1994, Property held for sale also included the net book value of property and equipment of The Oaks of Mountain Grove, which was sold in 1995 (See Note 7).\nConsolidated Resources Health Care Fund IV and Subsidiaries (limited partnerships)\nNotes to Consolidated Financial Statements\nHeritage Manor of Emporia $431,140 Heritage Manor of Hoisington 313,007 \t\t\t\t $744,147\n7. Property Dispositions\nThe Oaks of Mountain Grove (\"Mountain Grove\") was sold effective October 18, 1995, and a gain of $377,591 was recognized. Under the terms of the agreement, the purchaser acquired all the assets except patient receivables, Medicaid receivables and Medicare receivables through the closing, and assumed bonds payable of $2,825,000 and accrued interest thereon. In connection with the sale, the Partnership paid cash of $45,697, which included closing costs and certain accrued operating expenses. During the period January 1 through October 18, 1995, Mountain Grove earned approximately $2,275,000 in revenues and incurred approximately $2,115,000 in expenses.\nThe Partnership sold its interest in Heritage Manor of Hiawatha (\"Hiawatha\") and Kent's Nursing Care Center (\"Kent's\") pursuant to a purchase and sale agreement dated as of October 1, 1993. These facilities were sold for $3,900,000, of which $3,150,000 was allocated for Kent's and $750,000 for Hiawatha. Each of these facilities was sold for a purchase price that equaled or exceeded the appraised value of the facility. The Partnership received gross proceeds of $3,750,000 and a note from the Purchaser in the amount of $200,000 which was repaid in 1994. The Partnership recognized a total gain of approximately $2,076,000 from the sale, $1,886,000 and $190,000 from Kent's and Hiawatha, respectively.\nDuring the nine month period ended September 30, 1993, Kent's earned approximately $1,737,000 in revenue and incurred approximately $1,668,000 in expenses. During the same period, Hiawatha earned approximately $903,000 in revenue and incurred approximately $1,075,000 in expenses.\nOn April 1, 1993, River Oaks Care Center (\"River Oaks\") was sold in a transaction whereby the purchaser acquired the facility and rights to its net operating cash flow for the period from January 1, 1993 through March 31, 1993. A gain of $332,913 was recognized by the Partnership from the sale. The Partnership received cash of $590,000 (net of $10,000 in closing costs). During the three month period ended March 31, 1993, River Oaks earned approximately $602,000 in revenues and incurred the same amount of expenses.\nHeritage Manor of Red Boiling Springs was sold effective April 30, 1991, and a loss of $26,521 was recognized. The total sales price was $2,950,000. The Partnership received cash of $1,115,000 and a note receivable from the purchaser for $250,000 (quarterly interest payments are due with interest at the rate of 11% per annum, with principal and any unpaid accrued interest due April 30, 1996). The note receivable was collected in September 1995.\nIn 1989, the joint owner of Rainbow Springs filed for bankruptcy protection. Rainbow Springs was auctioned for sale by the bankruptcy court with jurisdiction over this joint owner on January 31, 1994. The sale was closed on March 31, 1994 at a sales price of $4,200,000. Under the allocation of proceeds, the Partnership received proceeds of $1,410,283 (net of delinquent real estate taxes totalling $1,213,468) and recognized, a gain on sale of $607,169.\nConsolidated Resources Health Care Fund IV and Subsidiaries (limited partnerships)\nNotes to Consolidated Financial Statements\n8. Southmark Litigation\nIn November 1990, the Partnership filed claims against Southmark in the United States Bankruptcy Court for the Northern District of Texas. In August 1991, the Partnership was served notice that on July 12, 1991, Southmark filed suit against the Partnership, the Corporate General Partner, partnerships controlled by affiliates of the Corporate General Partner and partnerships and corporations which are unaffiliated with the Partnership or the Corporate General Partner. The suit was also filed in the United States Bankruptcy Court for the Northern District of Texas, Dallas Division. On October 15, 1991, the Partnership filed its response, including counterclaims against Southmark, for alleged fraud and misrepresentation and asserting that in fact Southmark owed amounts to the Partnership as represented by Proof of Claims filed against Southmark's bankruptcy estate.\nThe Partnership and Southmark reached a settlement agreement effectively filed with the Bankruptcy Court in January 1994, regarding the claims filed by the Partnership against Southmark and Southmark's suit against the Partnership. Under this settlement agreement, Southmark releases all claims against the Partnership and recognized the Partnership's claims. In settlement of the Partnership's claims, Southmark paid $76,345 to the Partnership in 1994.\n9. NHI Settlement\nThe Partnership had filed a lawsuit against NHI seeking to void all promissory notes from the Partnership to NHI. NHI had also brought suit against the Partnership seeking payment of the notes and mortgage foreclosure. In October 1993, the Partnership reached a settlement of all matters between the Partnership and NHI. NHI agreed to accept $425,000 as full settlement of all matters outstanding, including workers' compensation liabilities of $415,246, secured notes of $750,000, accrued interest of $445,271 and other liabilities of $148,285. In connection with this settlement, NHI discontinued the performance of accounting services for Heritage Manor of Hoisington (See Note 1).\n10. Workers' Compensation\nThe Partnership's facilities participated in a self-insured program for workers' compensation liability insurance through July 1989, covering all facilities managed by NHI. The Partnership had satisfied this obligation as part of the settlement with NHI (See Note 9) as of December 31, 1993.\n11. Cost Reimbursements\nAccounts receivable and operating revenue include amounts estimated by management to be reimbursable by Medicaid under the provisions of cost reimbursement formulas in effect. Final determination of amounts earned is subject to audit by the intermediaries. In the opinion of management, adequate provision has been made for any adjustments that may result from such audits. Differences between estimated provisions and final settlement are reflected as charges or credits to operating revenue in the year finalized. Medicaid accounted for approximately 49%, 51% and 55% of operating revenue during 1995, 1994 and 1993, respectively.\nSignificant changes have and will continue to be made in government reimbursement programs, and such changes could have a material impact on future reimbursement formulas.\nConsolidated Resources Health Care Fund IV and Subsidiaries (limited partnerships)\nNotes to Consolidated Financial Statements\nAccounts receivable are recorded at net realizable value and relate principally to amounts due from various state Medicaid programs. Receivables from these programs were approximately as follows:\n\t\t\t\t\t\t\t 1995 1994\nKansas $110,000 $122,000 Missouri 75,000 132,000\nAmounts due from Medicaid programs are usually paid on an interim and final basis, depending on the state, generally within 30 to 60 days from date of billing.\n12. Concentration of Credit Risk\nAt December 31, 1995, the Partnership had cash invested in U.S. Treasury Obligations totalling $200,000 and cash on deposit with a bank which exceeded Federal Deposit Insurance Corporation limits by $721,005.\n13. Supplemental Disclosures of Cash Flow Information\nAs discussed in Note 1, the Partnership had a forgiveness of debt due to the Corporate General Partner during 1995. In connection with the forgiveness, a gain of $2,266,170 was recorded.\nThe above amount is included in the extraordinary gain of debt forgiveness on the accompanying statement of cash flows.\nAs a part of the sale of The Oaks of Mountain Grove described in Note 7, the following assets and liabilities were excluded from the statement of cash flows for the year ended December 31, 1995:\nAccounts receivable $155,445 Accounts payable (47,762)\nCash of disposed property $107,683\nSCHEDULES\nConsolidated Resources Health Care Fund IV and Subsidiaries (limited partnerships)\nSchedule II - Valuation and Qualifying Accounts Years Ended December 31, 1995, 1994 and 1993\n\t\t\t Additions \t Balance at charged to \t beginning of costs and Balance at \t\t year expenses Deductions(1) end of year Allowance for doubtful accounts $ 72,978 $ - $ - $72,978\nAllowance for doubtful accounts $ 80,864 $9,754 $(17,640) $72,978\nAllowance for doubtful accounts $166,742 $- $(85,878) $80,864\n(1) Represents direct write-offs of receivables.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON \tACCOUNTING 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 officers or directors. At December 31, 1991, the General Partners of the Partnership were WelCare Consolidated Resources Corporation of America (\"WCRCA\"), and Consolidated Associates IV. Effective January 7, 1992, WSC-IV was added as Managing General Partner of the Partnership. The executive officers and director of WSC-IV and WCRCA, who control the affairs of the Partnership, are as follows:\nName and Position Age Other Principal Occupations and Other \t\t\t Directorships During the Past 5 Years\nJ. Stephen Eaton Mr. Eaton has been President and Director of President and 45 WelCare International, Inc. since its formation in Director February 1989. WelCare International, Inc., an \t\t\t affiliate of the General Partners, is engaged in \t\t\t the operation, acquisition, property management \t\t\t and oversight management of long-term care \t\t\t facilities. Since 1988, Mr. Eaton has served as a \t\t\t Director and is currently Chairman of St. Joseph's \t\t\t Mercy Care Corporation, a non-profit corporation.\nKent C. Fosha, S 54 Mr. Fosha has been Executive Vice President of Executive Vice WelCare International, Inc. since 1990. WelCare President International, Inc., an affiliate of the General Operations Partners, is engaged in the operation, \t\t\t acquisition, property management and oversight \t\t\t management of long-term care facilities. Mr. \t\t\t Fosha is a licensed nursing home administrator in \t\t\t the state of Georgia.\nAlan C. Dahl 35 Mr. Dahl has been Executive Vice President of Executive Vice WelCare International, Inc. since February 1991. President WelCare International, Inc., an affiliate of the \t\t\t General Partners, is engaged in the operation, \t\t\t acquisition, property management and oversight \t\t\t management of long-term care facilities. Mr. Dahl \t\t\t is a certified public accountant.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nNo individual principal or principals as a group received any direct remuneration from the Partnership.\nThe General Partners are not compensated directly for their services as general partners of the Partnership. See Item 13 and Item 8, Note 2 for further discussion of compensation paid to affiliates of the General Partners.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\n(A) Security ownership of certain beneficial owners.\nNo individual or group as defined by Section 13(d)(3) of the Securities Exchange Act of 1934, known to the Partnership is the beneficial owner of more than 5% of the Partnership's securities.\n(B) Security ownership of management.\nThe General Partners and their management own less than 1%.\nThe General Partners are entitled to distributions of cash from operations and from \"other sources\" (primarily from the sale or refinancing of Partnership properties, as set forth in Item 8, Note 4).\n(C) Change in control.\n\tNone.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nAffiliates and former affiliates of the General Partners, in accordance with the Partnership Agreement, may receive compensation for services rendered. The following is a summary of compensation paid to or accrued for the benefit of the General Partners and affiliates in 1995:\nOversight management and management fees $313,790 Administration of partnership activities (1) 58,176\n(1) For reimbursement of expenses incurred by the Corporate General Partner in performing certain administrative functions, including investor relations and accounting.\nSee Note 2 to the accompanying consolidated financial statements appearing in Item 8.\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\t(1) Consolidated Financial Statements:\n\t\tReport of Independent Certified Public Accountants\n\t\tBalance Sheets \t\t\tas of December 31, 1995 and 1994\n\t\tStatements of Operations \t\t\tfor the Years Ended December 31, 1995, 1994 and 1993\n\t\tStatements of Partners' Deficit \t\t\tfor the Years Ended December 31, 1995, 1994 and 1993\n\t\tStatements of Cash Flows \t\t\tfor the Years Ended December 31, 1995, 1994 and 1993\n\t\tSummary of Significant Accounting Policies\n\t\tNotes to Consolidated Financial Statements\n\t\tSchedule included in Part II, Item 8:\n\t\tSchedule II - Valuation and Qualifying Accounts \t\t\tfor the Years Ended December 31, 1995, 1994 and 1993\nOther schedules are omitted since they are not required, are not applicable or the financial information required is included in the financial statements or notes thereto.\n\t(2) Exhibits:\nThe following exhibits are incorporated by reference and are an integral part of this Form 10-K.\nExhibit Number (as per Exhibit Table) Document Description \t 2.1 Liquidation Proposal incorporated by reference to the Proxy Statement filed on September 28, 1994 file 0-14435. \t 3.1 Amended and Restated Agreement of Limited Partnership of Consolidated Resources Health Care Fund IV incorporated by reference to Exhibit A to the Registration Statement on Form S-1, Page A-1, File No. 2-93219. \t 3.2 Amendment to Amended and Restated Agreement of Limited Partnership of Consolidated Resources Health Care Fund IV incorporated by reference to Exhibit A to Proxy Statement filed on November 19, 1991, File No. 0-14435. \t 22 Subsidiaries \t 27 Financial Data Schedules\n(b) Reports on Form 8-K\n\t(1) None\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.\n\tCONSOLIDATED RESOURCES HEALTH CARE FUND IV \t(Registrant) \t \tBy: WELCARE CONSOLIDATED RESOURCES \tCORPORATION OF AMERICA \tCorporate General Partner \t \tBy:\/S\/ J. Stephen Eaton Date J. Stephen Eaton, \tPresident \t Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons, on behalf of the Registrant and in the capacities and on the dates indicated: \t \t \tBy:\/S\/ J. Stephen Eaton Date J. Stephen Eaton, \tSole Director and Principal \tExecutive Officer of the \tCorporate General Partner \t \tBy:\/S\/ Alan C. Dahl Date Alan C. Dahl \tChief Financial Officer of the Corporate \tGeneral Partner \t \t \t\nExhibit Index\nExhibit Number Description Sequential Page Number \t\t 3.1 Amended and Restated Agreement of Limited \tPartnership of Consolidated Resources \t Health Care Fund IV incorporated by \t reference to Exhibit A to the Registration \t Statement on Form S-1, Page A-1, File \t No. 2-93219. N\/A \t\t 3.2 Amendment to Amended and Restated Agreement \t of Limited Partnership of Consolidated Resources \t Health Care Fund IV incorporated by reference \t to Exhibit A to Proxy Statement filed on \t November 19, 1991, File No. 0-14435. N\/A \t\t 22 Subsidiaries 35 \t\t \t\t 27 Financial Data Schedules N\/A \t\t\nExhibit 22\nSUBSIDIARY (LIMITED PARTNERSHIPS)\nHiawatha Healthcare, Ltd. (Inactive) Rainbow Springs Associates, L.P. (Inactive)","section_15":""}
{"filename":"711393_1995.txt","cik":"711393","year":"1995","section_1":"Item 1. Business\nPaine Webber\/CMJ Properties, LP (the \"Partnership\") is a limited partnership formed in December 1982 under the Uniform Limited Partnership Act of the State of Delaware for the purpose of investing in a portfolio of local limited partnerships owning apartment projects which receive governmental assistance in the form of low interest rate mortgages and rent subsidies. The Partnership sold $8,745,000 in Limited Partnership units (8,745 units at $1,000 per unit) from May 1983 to April 1984, pursuant to a Registration Statement filed on Form S-11 under the Securities Act of 1933 (Registration No. 2-81003). In addition, the Initial Limited Partner contributed $1,000 for one unit (a \"Unit\") of Limited Partnership Interest. Limited Partners will not be required to make any additional capital contributions.\nAs of December 31, 1995, the Partnership owned, through local limited partnerships, interests in six apartment properties as set forth in the following table:\nPercent Name of Local Interest in Limited Partnership Date of Local Limited Name of Property Acquisition Partnership Location Size of Interest (1) (2) - ------------------------- ---- ----------- ------------\nFawcett's Pond Apartments Company Village at Fawcett's Pond 100 6\/30\/83 95% Hyannis, Massachusetts units\nQuaker Meadows Apartments Company Quaker Court and The Meadows 104 6\/30\/83 95% Lynn, Massachusetts units\nSouth Laurel Apartments Limited Partnership Villages at Montpelier 520 6\/30\/83 85% Laurel, Maryland units\nMarvin Gardens Associates Marvin Gardens 37 7\/29\/83 95% Cotati, California units\nColonial Farms Ltd. Colonial Farms 100 7\/29\/83 95% Modesto, California units\nHolbrook Apartments Company Ramblewood Apartments 170 8\/30\/83 85% Holbrook, Massachusetts units\n(1) The Partnership owns limited partnership interests in the local limited partnerships owning the apartment properties and improvements.\n(2) See Notes to the Financial Statements filed with this Annual Report for current outstanding mortgage balances and a description of the long-term mortgage indebtedness collateralized by the operating property investments of the local limited partnerships and for a description of the local limited partnership agreements through which the Partnership has acquired these real estate interests.\nThe Partnership's original investment objectives were to invest the net cash proceeds from the offering of limited partnership units in rental apartment properties receiving various forms of federal, state or local assistance with the goals of providing:\n(1) tax losses from deductions generated by investments; (2) capital preservation; (3) potential capital appreciation; and (4) potential future cash distributions from operations (on a limited basis), or from the sale or refinancing of the projects owned by the local limited partnerships, or from the sale of interests in the local limited partnerships.\nThe Partnership has generated tax losses since inception. However, the benefits of such losses to investors have been significantly reduced by changes in federal income tax law subsequent to the organization of the Partnership. The Partnership continues to retain an ownership interest in all six of its original operating investment properties. As of December 31, 1995, all of the properties are generating sufficient cash flow from operations to cover their operating expenses and debt service payments, and all properties are generating excess cash flow, a portion of which is being distributed to the Partnership on an annual basis in accordance with the respective regulatory and limited partnership agreements. Given the improvements in cash flow and the strong operating performances of the investment properties in recent years, management instituted a program of regular quarterly distributions in 1994 at an annual rate of 2% on original invested capital. Annual distributions to the Limited and General Partners totalled $177,000 during 1995. Management intends to maintain distributions at the present level for 1996 unless actual results of operations, economic conditions or other factors differ substantially from the assumptions used in setting the planned distribution rate.\nThe Partnership's success in meeting its capital appreciation objective will depend upon the proceeds received from the final sales of its investments. The amount of such proceeds will ultimately depend upon the value of the underlying investment properties at the time of their final disposition, which cannot presently be determined. Because of the government restrictions on rental revenues and the related capital expenditure reserve requirements and cash flow distribution limitations, there is a limited number of potential buyers in the market for government subsidized, low-income housing properties such as the Partnership has invested in. Furthermore, the current uncertainty regarding potential future reductions in the level of federal government assistance for these programs may further restrict the properties' marketability. Accordingly, management does not expect the General Partners of the local limited partnerships, which receive management fee revenues from the properties, to attempt to sell any of the properties in the near term. As discussed further in Item 7, as a limited partner in the local limited partnerships, the Partnership's ability to influence major business decisions, including any decision to sell the properties is restricted under the terms of the agreements.\nAll of the properties owned by the local limited partnerships in which the Partnership invested are located in real estate markets in which they face competition for the revenues they generate. The Partnership's apartment complexes, which are all government-assisted, low-income housing facilities, compete with several projects of similar type generally on the basis of price, location and amenities. The tenants at the Partnership's apartment properties are not as likely to be candidates for single-family home ownership as tenants of non-subsidized properties would be. Therefore, competition from the single family home market is not a significant factor.\nThe Partnership is engaged solely in the business of real estate investment, therefore, presentation of information about industry segments is not applicable. The Partnership has no real estate investments located outside the United States.\nThe Partnership has no employees; it has, however, entered into an Advisory Contract with PaineWebber Properties Incorporated (the \"Adviser\"), which is responsible for the day-to-day operations of the Partnership. The Adviser is a wholly-owned subsidiary of PaineWebber Incorporated (PWI), a wholly-owned subsidiary of PaineWebber Group Inc. (\"PaineWebber\").\nThe Managing General Partner of the Partnership is PW Shelter Fund, Inc. (the \"Managing General Partner\"), a wholly-owned subsidiary of PaineWebber. Subject to the Managing General Partner's overall authority, the business of the Partnership is managed by the Adviser. The associate general partner is Properties Associates (the \"Associate General Partner\"), a Massachusetts general partnership, certain general partners of which are also officers of the Adviser and the Managing General Partner.\nThe terms of transactions between the Partnership and affiliates of the Managing General Partner of the Partnership are set forth in Items 11 and 13 below to which reference is hereby made for a description of such terms and transactions.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Partnership has acquired interests in six operating properties through investing in local limited partnerships. The local limited partnerships and related properties are referred to under Item 1 above to which reference is made for the description, name, location, and ownership interest in each property.\nOccupancy figures for each quarter during 1995, along with an average for the year, are presented below for each property:\nPercent Occupied At 3\/31\/95 6\/30\/95 9\/30\/95 12\/31\/95Average ------- ------- ------- -------- ------\nVillage at Fawcett's Pond Apartments 100% 100% 100% 99% 100%\nQuaker Court and The Meadows 100% 99% 99% 99% 99%\nVillages at Montpelier Apartments 96% 96% 93% 94% 95%\nMarvin Gardens Apartments 100% 100% 99% 100% 100%\nColonial Farms Apartments 96% 98% 98% 98% 98%\nRamblewood Apartments 98% 99% 98% 99% 99%\nItem 3.","section_3":"Item 3. Legal Proceedings\nAs previously disclosed, in November 1994 PaineWebber Shelter Fund, Inc. and Properties Associates, L.P., the General Partners of the Partnership, were named as defendants in a class action lawsuit filed in the United States District court for the Southern District of New York against PaineWebber Incorporated (\"PaineWebber\") and a number of its affiliates relating to PaineWebber's sale of 70 direct investment offerings, including the offering of interests in the Partnership. The amended complaint in the New York Limited Partnership Actions alleges that, in connection with the sale of units of limited partnership interests in the Partnership, the defendants (1) failed to provide adequate disclosure of the risks involved; (2) made false and misleading representations about the safety of the investments and the Partnership's anticipated performance; and (3) marketed the Partnership to investors for whom such investments were not suitable. The plaintiffs, who purported to be suing on behalf of all persons who invested in the Partnership also alleged that following the sale of the Partnership interests, the defendants misrepresented financial information about the Partnership's value and performance. The amended complaint also alleges that the defendants violated the Racketeer Influenced and Corrupt Organizations Act (\"RICO\") and the federal securities laws. The plaintiffs sought unspecified damages, including reimbursement for all sums invested by them in the Partnership, as well as disgorgement of all fees and other income derived by PaineWebber from the Partnership. In addition, the plaintiffs also sought treble damages under RICO. In January 1996, PaineWebber signed a memorandum of understanding with the plaintiffs in this class action outlining the terms under which the parties have agreed to settle the case. Pursuant to that memorandum of understanding, PaineWebber irrevocably deposited $125 million into an escrow fund under the supervision of the court to be used to resolve the litigation in accordance with a definitive settlement agreement and a plan of allocation which the parties expect to submit to the court for its consideration and approval within the next several months. Until a definitive settlement and plan of allocation is approved by the court, there can be no assurance what, if any, payment or non-monetary benefits will be made available to unitholders in PaineWebber\/CMJ Properties LP. Under certain limited circumstances, pursuant to the Partnership Agreement and other contractual obligations, PaineWebber affiliates could be entitled to indemnification for expenses and liabilities in connection with this class action litigation. At the present time, the General Partners are unable to estimate the impact, if any, that the resolution of this litigation may have on the Partnership's financial statements, taken as a whole.\nIn February 1996, approximately 150 plaintiffs filed an action entitled Abbate v. PaineWebber Inc. in Sacramento, California Superior Court against PaineWebber Incorporated and various affiliated entities concerning the plaintiffs' purchases of various limited partnership interests, including those offered by the Partnership. The complaint alleges, among other things, that PaineWebber and its related entities committed fraud and misrepresentation and breached fiduciary duties allegedly owed to the plaintiffs by selling or promoting limited partnership investments that were unsuitable for the plaintiffs and by overstating the benefits, understating the risks and failing to state material facts concerning the investments. The complaint seeks compensatory damages of $15 million plus punitive damages. The eventual outcome of this litigation and the potential impact, if any, on the Partnership's unitholders cannot be determined at the present time.\nThe Partnership and the local limited partnerships are not subject to any other material pending legal proceedings.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNone.\nPART II\nItem 5.","section_5":"Item 5. Market for the Partnership's Limited Partnership Interests and Related Security Holder Matters\nAt December 31, 1995 there were 902 record holders of Units in the Partnership. There is no public market for the Units, and it is not anticipated that a public market for Units will develop. The Managing General Partner will not redeem or repurchase Units.\nReference is made to Item 6","section_6":"Item 6. Selected Financial Data\nPaine Webber\/CMJ Properties, LP (In thousands, except per Unit data)\nYears Ended December 31, 1995 1994 1993 1992 1991 ---- ---- ---- ---- ----\nRevenues $ 244 $ 179 $ 293 $ 208 $ 128\nExpenses $ 288 $ 268 $ 289 $ 285 $ 287\nPartnership's share of local limited partnerships' income $ 174 $ 186 $ 203 $ 162 $ 155\nNet income (loss) $ 130 $ 97 $ 207 $ 85 $ (4)\nCash distributions per Limited Partnership Unit $20.00 $10.00 - - -\nNet income (loss) per Limited Partnership Unit $14.75 $11.01 $23.45 $9.63 $(0.45)\nTotal assets $ 486 $ 525 $ 729 $ 519 $ 801\n(a) The above selected financial data should be read in conjunction with the financial statements and related notes appearing elsewhere in this Annual Report.\n(b) The above per Limited Partnership Unit information is based upon the 8,746 Limited Partnership Units outstanding during each year.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nLiquidity and Capital Resources\nThe Partnership offered limited partnership interests to the public from May 1983 to April 1984 pursuant to a Registration Statement filed under the Securities Act of 1933. The Partnership received gross proceeds of $8,746,000, and after deducting selling expenses and offering costs, the Partnership invested approximately $6,960,000 in six local limited partnerships owning housing projects that receive various forms of federal, state or local assistance and that may be classified as \"low-income housing\" under the Internal Revenue Code. The Partnership does not have any commitments for additional capital expenditures or investments.\nThroughout the country the market for multi-family residential properties continued its trend of gradual improvement during 1995 as the ongoing absence of significant new construction activity allowed for further improvement in market occupancy and rental rates. The effects of the gradually improving market conditions on the Partnership's operating property investments, while positive, are limited by the government restrictions on rental rate increases to which the properties are subject. With the exception of The Villages at Montpelier Apartments, which has only 20% of its units restricted for low-income housing, cash flow from the properties in which the Partnership has invested is restricted by the Department of Housing and Urban Development (\"HUD\") and other applicable state housing agencies, which set rental rates for low-income units and require significant cash reserves to be established for future capital improvements. In addition, a substantial amount of the revenues generated by these properties comes from rental subsidy payments made by federal or state housing agencies. These features, which are characteristic of all subsidized low-income housing properties, significantly limit the pool of potential buyers for these real estate assets. Furthermore, the current uncertainty regarding potential future reductions in the level of federal government assistance for these programs may further restrict the properties' marketability. Accordingly, management does not expect the general partners of the local limited partnerships, which receive management fee revenues from the properties, to attempt to sell any of the properties in the near term. As a limited partner of the local limited partnerships, the Partnership does not control property disposition decisions. The partnership agreements state that the limited partner may cause the sale of the assets of the local limited partnerships subsequent to June 30, 1995, but not earlier than one year after it has given written notice to the operating general partner of its intent to cause such sale, and only if, during such one year period, the operating general partner does not cause the sale of such assets. If the operating general partner has not caused the assets of the partnership to be sold within such one year period the limited partner may cause such sale, but only after it has offered to sell such assets to the operating general partner, and either the operating general partner does not accept such offer within 90 days of receiving it, or the operating general partner does not complete the sale in accordance with such offer after accepting the terms.\nAll six of the Partnership's operating investment properties receive rental subsidy payments from the federal government under Section 8 of the National Housing Act. With the exception of The Villages at Montpelier Apartments, the subsidy agreements covering the operating investment properties do not expire for another 5 to 7 years. The subsidy agreement covering the 20% portion of The Villages at Montpelier Apartments is scheduled to expire in July 1997. Based on current market conditions, in the event that the agreement is not renewed, management believes that the units currently designated as low-income units could be re-leased at market rates which would keep the total revenues of the local limited partnership relatively unchanged from the current subsidized level. In addition, if the market for conventional multi-family apartment properties remains strong over the next 18 months, the expiration of the rental subsidy agreement at The Villages at Montpelier Apartments could enhance the property's marketability for a potential sale to a third-party. However, there are no assurances that the market conditions will remain strong over this period. If conditions were to deteriorate, The Villages at Montpelier Apartments could experience declines in occupancy and revenues upon the expiration of the subsidy agreement. It is uncertain at this time, what operating decisions and strategic actions the general partner of the local limited partnership will make concerning the expiration of this subsidy agreement. For the five properties which contain 100% low-income housing units, the government subsidy payments range from 75% to 82% of the total revenues of the related local limited partnerships. At the present time, certain legislative initiatives and governmental budget negotiations could result in a reduction in funds available for the various HUD-administered housing programs and new limitations on increases in subsidized rent levels. Such changes could adversely impact the net operating income generated by the local limited partnerships. In light of the uncertainty regarding the near term prospects for government assisted, low-income housing and the restrictions on the Partnership's ability to cause a sale of the operating properties, and since the properties are currently generating a stable, self-sustaining cash flow stream, management does not have any plans, at the present time, to initiate the sale process under the terms of the agreements described above. In addition, as noted above, management is not aware of any plans or intentions of the general partners of these partnerships to sell any of the investment properties in the near future.\nDuring 1995, all six of the properties in which the Partnership has invested generated sufficient cash flow from operations to cover their operating expenses and debt service payments, and all properties generated excess cash flow, a portion of which will be distributed to the Partnership during 1996 in accordance with the respective regulatory and limited partnership agreements. The Partnership received distributions totalling $435,000 in 1995 ($407,000 in 1994) from its six limited partnership investments. The distributions received in the current year represent the available cash flow for distribution as of December 31, 1994, as determined by the general partners of the local limited partnerships in accordance with the partnership, financing and regulatory agreements. Distributions of 1995 cash flow will generally be made in the second quarter of 1996 and are expected to be at approximately the same level as the current year distributions. The distributions received in 1995 were more than sufficient to cover the Partnership's management fees and administrative expenses, which totalled $288,000, and enabled the Partnership to continue its program of regular quarterly distributions to the Limited and General Partners. During 1995, annual distributions to the Limited and General Partners totalled $177,000. Management intends to maintain distributions at the present level for 1996, unless actual results of operations, economic conditions or other factors differ substantially from the assumptions used in setting the planned distribution rate.\nAt December 31, 1995, the Partnership had available cash and cash equivalents of approximately $325,000, which it intends to use for its working capital requirements and for distributions to partners. The source of future liquidity and distributions to the partners is expected to be from cash generated from the operations of the Partnership's real estate investments and from the proceeds received from the sale or refinancing of the properties owned by the local limited partnerships. Such sources of liquidity are expected to be sufficient to meet the Partnership's needs on both a short-term and long-term basis.\nResults of Operations 1995 Compared to 1994\nThe Partnership recorded net income of $130,000 for the year ended December 31, 1995, as compared to net income of $97,000 for 1994. The increase in net income of $33,000 is mainly the result of an increase in other income from local limited partnerships of $64,000. Distributions from the local limited partnerships are recorded as income for those investments for which the Partnership's equity method carrying value has been reduced to zero. Distributions totalling $221,000 from five partnerships were recorded as other income in the year ended December 31, 1995, as compared to $157,000 from the same five partnerships for 1994. The favorable change in other income from local limited partnerships was partially offset by an increase of $20,000 in the Partnership's general and administrative expenses in 1995.\nIn accordance with the equity method of accounting for limited partnership interests, the Partnership does not recognize losses from investment properties when losses exceed the Partnership's equity method basis in these properties. Five of the Partnership's six investments had an equity method basis of zero as of December 31, 1995 and 1994. Distributions from the Holbrook Apartments Company (Ramblewood Apartments), the only remaining investment which still has a positive equity method carrying value, are recorded as reductions of the investment carrying value and totalled $214,000 and $250,000 for 1995 and 1994, respectively. Distributions from the other five limited partnerships increased by $64,000 in 1995, as reflected in the change in other income. This increase results primarily from an increase of $47,000 in distributions from The Villages at Montpelier Apartments, which, as noted above, is the only one of the Partnership's properties which is not 100% low-income housing. The distributions received in 1995 reflect the available cash flow from 1994 operations.\nThe Partnership's recorded share of local limited partnerships' income in the current year consists of income of $174,000 from the Ramblewood Apartments limited partnership, as compared to income of $186,000 from the same partnership in 1994. Net income was down slightly at Ramblewood, mainly due to increases in salaries expense and real estate taxes. Overall, an increase in combined property operating expenses of $282,000 for the six local limited partnerships exceeded the increase in combined revenues of $75,000. Occupancy levels remained high throughout the year with the 1995 average occupancy above 95% at all properties. Revenues were up at all properties except at The Villages at Montpelier Apartments. At The Villages at Montpelier Apartments, revenues decreased slightly during 1995 due to a temporary decline in occupancy experienced in the third quarter. Occupancy at The Villages at Montpelier Apartments averaged 95% for 1995, but dropped to 91% in August 1995 as a result of management's efforts to increase rental rates for the market-rate units. Management stepped up its marketing efforts in conjunction with the rate increases. After the initial decline in occupancy, the marketing efforts are generating positive results as the occupancy level has recovered and the number of prospective tenants visiting the property has increased. Expenses in general were up at all of the local limited partnerships as repairs and maintenance expenses run high at these properties due to a combination of their ages, applicable regulatory requirements and management's operating philosophy. Such expenses do, however, fluctuate from year to year.\n1994 Compared to 1993\nFor the year ended December 31, 1994, the Partnership recorded net income of $97,000, as compared to net income of $207,000 for the prior year. The decrease in net income was the result of a decrease in other income from local limited partnerships and a decrease in the Partnership's share of local limited partnerships' income. These unfavorable changes in net income were offset, in part, by a decrease in general and administrative expenses of $21,000 for 1994.\nFive of the six investments had an equity method basis of zero as of December 31, 1994 and 1993. Other income from local limited partnerships reflects cash distributions received from investments which have an equity method basis of zero. Distributions from the Holbrook Apartments Company (Ramblewood Apartments), the only remaining investment which had a positive equity method carrying value, are recorded as reductions of the investment carrying value and totalled $250,000 and $204,000 for 1994 and 1993, respectively. Distributions from the other five limited partnerships declined by $123,000 in 1994, as reflected in the change in other income. This decrease resulted primarily from a decline in distributions from the Fawcett's Pond limited partnership of $54,000 and a drop in distributions from The Villages at Montpelier Apartments of $76,000. The distributions received in 1994 reflect the available cash flow from 1993 operations. The decline in distributions from these two properties primarily related to certain extraordinary maintenance projects completed in 1993. The Partnership's recorded share of local limited partnerships' income in 1994 consisted of income of $186,000 from the Ramblewood Apartments limited partnership. In the prior year, income of $206,000 from the operations of the Ramblewood Apartments was recorded in addition to a loss of $3,000 from the Colonial Farms limited partnership. The carrying value of the Partnership's investment in Colonial Farms was reduced to zero during 1993. The decrease in income from the Ramblewood Apartments in 1994 is mainly the result of higher management fees and real estate tax expenses.\nIn the aggregate, rental revenues increased at five of the six investment properties during 1994. The combined total rental revenues increased by $218,000, with the largest increase occurring at The Villages at Montpelier Apartments. Occupancy levels remained stable throughout 1994 at the Fawcett's Pond, Marvin Gardens, Quaker Court and Meadows and Ramblewood properties. At Colonial Farms, revenues decreased slightly during 1994 due to a temporary decline in occupancy experienced in the second and third quarters. Occupancy at Colonial Farms averaged 99% for 1993. Average occupancy for 1994 declined to 96%, although the property had rebounded to 98% as of December 31, 1994. The increase in revenues at The Villages at Montpelier Apartments was primarily attributable to the increase in the average occupancy of the property, from 89% for 1993 to 93% for 1994. In addition, management was able to reduce the level of concessions used to attract tenants throughout 1994. In addition to the improvement in revenues, the combined total expenses of the six operating properties decreased by $201,000 in 1994, primarily due to a decrease in repairs and maintenance expenses at certain of the properties. Several nonrecurring maintenance projects were completed at the properties during 1993. In general, repairs and maintenance expenses run high at these properties due to a combination of their ages, applicable regulatory requirements and management's operating philosophy. Such expenses do, however, fluctuate from year to year.\n1993 Compared to 1992\nThe Partnership recorded net income of $207,000 for the year ended December 31, 1993, as compared to net income of $85,000 for the prior year. The increase in net income of $122,000 was mainly the result of an increase in the Partnership's share of local limited partnerships' income of $42,000 and an increase in other income from local limited partnerships of $88,000. Distributions from the local limited partnerships are recorded as income for those investments for which the Partnership's equity method carrying value has been reduced to zero. Distributions totalling $280,000 were recorded as other income in the year ended December 31, 1993, as compared to $192,000 for 1992. The increase in other income resulted from the increase in the level of distributions from 1992 property operations, as well as the fact that the Colonial Farms investment carrying value was reduced to zero during 1993.\nThe Partnership's recorded share of local limited partnerships' income for the year ended December 31, 1993 consisted of income of $206,000 from the Ramblewood Apartments limited partnership and a loss of $3,000 from the Colonial Farms Limited Partnership. In 1992, the Partnership recorded income from the Ramblewood and Colonial Farms partnerships in the amounts of $112,000 and $50,000, respectively. The increase in income from the Ramblewood Apartments was the result of an increase in rental income coupled with a decline in operating expenses. The increase in revenues was mainly due to improved rental rates. The decline in operating expenses was primarily due to a decrease in repairs and maintenance expenses and real estate taxes. Colonial Farms reported a slight decrease in revenues, coupled with an increase in property operating expenses. The increase in the Colonial Farm property operating expenses in 1993 resulted from an increase in repairs and maintenance costs and a non-recurring expense resulting from the settlement of an ongoing dispute. During 1993, the limited partnership refunded $147,000 of prior year excess rent subsidy income to The California Housing Finance Agency in final settlement of a dispute regarding the terms of the regulatory agreement. As of December 31, 1993, the Partnership's investments in Fawcett's Pond, Quaker\/Meadows, Marvin Gardens, Colonial Farms, and Villages at Montpelier had equity method carrying values of zero and accumulated losses of approximately $179,000, $1,058,000, $127,000, $155,000 and $262,000, respectively.\nIn the aggregate, the revenues increased at three of the six properties in the year ended December 31, 1993. Rental rate increases pertaining to the Partnership's government-assisted low-income housing apartments are set by HUD and other applicable state housing agencies and are limited by law to 5% annually. Three of the investment properties with 100% of the units designated for low-income tenants achieved rental revenue increases during 1993 of between 2% and 5%. The combined total expenses of the six properties increased by $394,000, or 4%, in 1993 primarily due to an increase in certain property operating expenses (principally repairs and maintenance). The increase in property operating expenses was partially offset by a decrease in interest expense at the Marvin Gardens and Colonial Farms limited partnerships. During 1992, the interest rates on the mortgage debts secured by the Marvin Gardens and Colonial Farms properties were reduced in connection with a redemption and re-issuance of the tax-exempt bonds which financed the acquisitions of these properties. Annual cash flow savings from the reduction in debt service payments for the Marvin Gardens and Colonial Farms limited partnerships total $45,000 and $40,000, respectively.\nInflation\nThe Partnership completed its twelfth full year of operations in 1995. To date, the effects of inflation and changes in prices on the Partnership's operating results have not been significant.\nIn the future, with regard to the local limited partnerships, contract rental rates under \"Section 8\" agreements may be increased by the Department of Housing and Urban Development in response to inflationary pressures to cover increases in operating expenses due to inflation.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe financial statements and supplementary data are included under Item 14 of this Annual Report.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Principal Executive Officers of the Partnership\nThe Managing General Partner of the Partnership is PW Shelter Fund, Inc., a Delaware corporation which is a wholly-owned subsidiary of PaineWebber. The Associate General Partner of the Partnership is Properties Associates, a Massachusetts general partnership, certain general partners of which are also officers of the Adviser and the Managing General Partner. The Managing General Partner has overall authority and responsibility for the Partnership's operation, however, the day-to-day business of the Partnership is managed by the Adviser pursuant to an advisory contract.\n(a) and (b) The names and ages of the directors and principal executive officers of the Managing General Partner of the Partnership are as follows:\nDate Elected Name Office Age to Office ---- ------ --- ---------\nLawrence A. Cohen President, Chief Executive 42 5\/15\/91 Officer and Director Albert Pratt Director 84 12\/10\/82 * J. Richard Sipes Director 49 6\/9\/94 Walter V. Arnold Senior Vice President and Chief Financial Officer 48 10\/29\/85 James A. Snyder Senior Vice President 50 7\/6\/92 John B. Watts III Senior Vice President 42 6\/6\/88 David F. Brooks First Vice President and Assistant Treasurer 53 12\/10\/82 * Timothy J. Medlock Vice President and Treasurer 34 6\/1\/88 Thomas W. Boland Vice President 33 12\/1\/91\n* The date of incorporation of the Managing General Partner\n(c) There are no other significant employees in addition to the directors and executive officers mentioned above.\n(d) There is no family relationship among any of the foregoing directors and\/or executive officers of the Managing General Partner of the Partnership. All of the foregoing directors and executive officers have been elected to serve until the annual meeting of the Managing General Partner.\n(e) All of the directors and officers of the Managing General Partner hold similar positions in affiliates of the Managing General Partner, which are the corporate general partners of other real estate limited partnerships sponsored by PWI, and for which PaineWebber Properties Incorporated serves as the Adviser. The business experience of each of the directors and principal executive officers of the Managing General Partner is as follows:\nLawrence A. Cohen is President and Chief Executive Officer of the Managing General Partner and President and Chief Executive Officer of the Adviser which he joined in January 1989. He is also a member of the Board of Directors and the Investment Committee of the Adviser. From 1984 to 1988, Mr. Cohen was First Vice President of VMS Realty Partners where he was responsible for origination and structuring of real estate investment programs and for managing national broker-dealer relationships. He is a member of the New York Bar and is a Certified Public Accountant.\nAlbert Pratt is a Director of the Managing General Partner, a consultant of PWI and a general partner of the Associate General Partner. Mr. Pratt joined PWI as Counsel in 1946 and since that time has held a number of positions including Director of both the Investment Banking Division and the International Division, Senior Vice President and Vice Chairman of PWI and Chairman of PaineWebber International, Inc.\nJ. Richard Sipes is a Director of the Managing General Partner and a Director of the Adviser. Mr. Sipes is an Executive Vice President at PaineWebber. He joined the firm in 1978 and has served in various capacities within the Retail Sales and Marketing Division. Before assuming his current position as Director of Retail Underwriting and Trading in 1990, he was a Branch Manager, Regional Manager, Branch System and Marketing Manager for a PaineWebber subsidiary, Manager of Branch Administration and Director of Retail Products and Trading. Mr. Sipes holds a B.S. in Psychology from Memphis State University.\nWalter V. Arnold is a Senior Vice President and Chief Financial Officer of the Managing General Partner and Senior Vice President and Chief Financial Officer of the Adviser which he joined in October 1985. Mr. Arnold joined PWI in 1983 with the acquisition of Rotan Mosle, Inc. where he had been First Vice President and Controller since 1978, and where he continued until joining the Adviser. Mr. Arnold is a Certified Public Accountant licensed in the state of Texas.\nJames A. Snyder is a Senior Vice President of the Managing General Partner and a Senior Vice President and Member of the Investment Committee of the Adviser. Mr. Snyder re-joined the Adviser in July 1992 having served previously as an officer of PWPI from July 1980 to August 1987. From January 1991 to July 1992, Mr. Snyder was with the Resolution Trust Corporation where he served as the Vice President of Asset Sales prior to re-joining PWPI. From February 1989 to October 1990, he was President of Kan Am Investors, Inc., a real estate investment company. During the period August 1987 to February 1989, Mr. Snyder was Executive Vice President and Chief Financial Officer of Southeast Regional Management Inc., a real estate development company.\nJohn B. Watts III is a Senior Vice President of the Managing General Partner and a Senior Vice President of the Adviser which he joined in June 1988. Mr. Watts has had over 16 years of experience in acquisitions, dispositions and finance of real estate. He received degrees of Bachelor of Architecture, Bachelor of Arts and Master of Business Administration from the University of Arkansas.\nDavid F. Brooks is a First Vice President and Assistant Treasurer of the Managing General Partner and a First Vice President and an Assistant Treasurer of the Adviser. Mr. Brooks joined the Adviser in March 1980. From 1972 to 1980, Mr. Brooks was an Assistant Treasurer of Property Capital Advisors, Inc. and also, from March 1974 to February 1980, the Assistant Treasurer of Capital for Real Estate, which provided real estate investment, asset management and consulting services.\nTimothy J. Medlock is a Vice President and Treasurer of the Managing General Partner and Vice President and Treasurer of the Adviser which he joined in 1986. From June 1988 to August 1989, Mr. Medlock served as the Controller of the Managing General Partner and the Adviser. From 1983 to 1986, Mr. Medlock was associated with Deloitte Haskins & Sells. Mr. Medlock graduated from Colgate University in 1983 and received his Masters in Accounting from New York University in 1985.\nThomas W. Boland is a Vice President of the Managing General Partner and a Vice President and Manager of Financial Reporting of the Adviser which he joined in 1988. From 1984 to 1987 Mr. Boland was associated with Arthur Young & Company. Mr. Boland is a Certified Public Accountant licensed in the state of Massachusetts. He holds a B.S. in Accounting from Merrimack College and an M.B.A. from Boston University.\n(f) None of the directors and officers were involved in legal proceedings which are material to an evaluation of her or his ability or integrity as a director or officer.\n(g) Compliance With Exchange Act Filing Requirements: The Securities Exchange Act of 1934 requires the officers and directors of the Managing General Partner, and persons who own more than ten percent of the Partnership's limited partnership units, to file certain reports of ownership and changes in ownership with the Securities and Exchange Commission. Officers, directors and ten-percent beneficial holders are required by SEC regulations to furnish the Partnership with copies of all Section 16(a) forms they file.\nBased solely on its review of the copies of such forms received by it, the Partnership believes that, during the year ended December 31, 1995, all filing requirements applicable to the officers and directors of the Managing General Partner and ten-percent beneficial holders were complied with.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe directors and officers of the Partnership's Managing General Partner receive no current or proposed remuneration from the Partnership.\nThe Partnership is required to pay certain fees to the Adviser, and the General Partners are entitled to receive a share of cash distributions and a share of profits or losses. These items are described under Item 13.\nThe Partnership began paying cash distributions to the Unitholders on a quarterly basis at a rate of 2% per annum on original invested capital during 1994. The first payment was made on August 15, 1994 for the quarter ended June 30, 1994. However, the Partnership's Units of Limited Partnership Interest are not actively traded on any organized exchange, and no efficient secondary market exists. Accordingly, no accurate price information is available for these Units. Therefore, a presentation of historical Unitholder total returns would not be meaningful.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\n(a) The Partnership is a limited partnership issuing Units of limited partnership interest, not voting securities. All the outstanding stock of the Managing General Partner, PW Shelter Fund, Inc. is owned by PaineWebber. Properties Associates, the Associate General Partner, is a Massachusetts general partnership, general partners of which are also officers of the Adviser and the Managing General Partner. Properties Associates is also the Initial Limited Partner of the Partnership and owns one Unit of limited partnership interest. No limited partner is known by the Partnership to own beneficially more than 5% of the outstanding interests of the Partnership.\n(b) Neither officers and directors of the Managing General Partner nor the general partners of the Associate General Partner, individually, own any Units of limited partnership interest of the Partnership. No officer or director of the Managing General Partner, nor any general partner of the Associate General Partner, possesses a right to acquire beneficial ownership of Units of limited partnership interest of the Partnership.\n(c) There exists no arrangement, known to the Partnership, the operation of which may at a subsequent date result in a change in control of the Partnership.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThe General Partners of the Partnership are PW Shelter Fund, Inc. (the \"Managing General Partner\"), a wholly-owned subsidiary of PaineWebber Group Inc. (\"PaineWebber\") and Properties Associates (the \"Associate General Partner\"), a Massachusetts general partnership, certain general partners of which are also officers of the Managing General Partner and PaineWebber Properties Incorporated (the \"Adviser\"). Subject to the Managing General Partner's overall authority, the business of the Partnership is managed by the Adviser pursuant to an advisory contract. The Adviser is a wholly-owned subsidiary of PaineWebber Incorporated (\"PWI\"), a wholly-owned subsidiary of PaineWebber. The General Partners, the Adviser and PWI receive fees and compensation, determined on an agreed-upon basis, in consideration of various services performed in connection with the sale of the Units, the management of the Partnership and the acquisition, management, financing and disposition of Partnership investments. In addition, the Managing General Partner and the Adviser are reimbursed for their out-of-pocket expenses relating to the offering of Units, the administration of the Partnership and the acquisition and operation of the Partnership's real property investments.\nDistributable cash, as defined, for each fiscal year shall be distributed annually in the ratio of 99% to the Limited Partners and 1% to the General Partners. However, it is not one of the investment objectives of the Partnership to generate any significant cash flow from property operations for distribution to the Limited Partners. All sale or refinancing proceeds will be distributed in varying proportions to the Limited and General Partners, as specified in the Partnership Agreement.\nPursuant to the terms of the Partnership Agreement, taxable income or tax loss of the Partnership will be allocated 99% to the Limited Partners and 1% to the General Partners. Taxable income or tax loss arising from a sale or refinancing of investment properties will be allocated to the Limited Partners and the General Partners in proportion to the amounts of sale or refinancing proceeds to which they are entitled; provided that the General Partners shall be allocated at least 1% of taxable income arising from a sale or refinancing. If there are no sale or refinancing proceeds, taxable income or tax loss from a sale or refinancing will be allocated 99% to the Limited Partners and 1% to the General Partners. Allocations of the Partnership's operations between the General Partner and the Limited Partners for financial accounting purposes have been made in conformity with the allocations of taxable income or tax loss.\nUnder the advisory contract, the Adviser has specific management responsibilities, to administer the day-to-day operations of the Partnership and to report periodically the performance of the Partnership to the Managing General Partner. The Adviser earns a basic management fee of .5% of invested assets for these services. Invested assets is the sum of the amount invested by the Partnership in each local limited partnership plus a proportionate interest in the mortgage debt initially incurred by the local limited partnerships. The Adviser earned management fees of $199,000 for the year ended December 31, 1995.\nIn connection with the sale of each property, the Adviser may receive a disposition fee in an amount equal to 1% based on the selling price of the property, subordinated to the payment of certain amounts to the Limited Partners.\nAn affiliate of the Managing General Partner performs certain accounting, tax preparation, securities law compliance and investor communications and relations services for the Partnership. The total costs incurred by this affiliate in providing such services are allocated among several entities, including the Partnership. Included in general and administrative expenses for the year ended December 31, 1995 is $32,000, representing reimbursements to this affiliate for providing such services to the Partnership.\nThe Partnership uses the services of Mitchell Hutchins Institutional Investors, Inc. (\"Mitchell Hutchins\") for the managing of cash assets. Mitchell Hutchins is a subsidiary of Mitchell Hutchins Asset Management, Inc., an independently operated subsidiary of PaineWebber. Mitchell Hutchins earned fees of $2,000 (included in general and administrative expenses) for managing the Partnership's cash assets during the year ended December 31, 1995. Fees charged by Mitchell Hutchins are based on a percentage of invested cash reserves which varies based on the total amount of invested cash which Mitchell Hutchins manages on behalf of PWPI.\nSee Note 3 to the accompanying financial statements for a further discussion of certain relationships and related party transactions.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\n(a) The following documents are filed as part of this report:\n(1) and (2) Financial Statements and Schedules:\nThe response to this portion of Item 14 is submitted as a separate section of this report. See Index to Financial Statements at page.\n(3) Exhibits:\nThe exhibits listed on the accompanying index to exhibits at page IV-3 are filed as part of this report.\n(b) No reports on Form 8-K were filed during the last quarter of 1995.\n(c) Exhibits\nSee (a) (3) above.\n(d) Financial Statement Schedules\nThe response to this portion of Item 14 is submitted as a separate section of this report. See Index to Financial Statements at page.\nSIGNATURES ----------\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Partnership has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nPAINE WEBBER\/CMJ PROPERTIES, LP LIMITED PARTNERSHIP\nBy: PW Shelter Fund, Inc. Managing General Partner\nBy: \/s\/ Lawrence A. Cohen Lawrence A. Cohen President and Chief Executive Officer\nBy: \/s\/ Walter V. Arnold Walter V. Arnold Senior Vice President and Chief Financial Officer\nBy: \/s\/ Thomas W. Boland Thomas W. Boland Vice President\nDated: April 10, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Partnership and in the capacities and on the dates indicated.\nBy: \/s\/ Albert Pratt Date: April 10 , 1996 Albert Pratt Director\nBy: \/s\/ J. Richard Sipes Date: April 10, 1996 J. Richard Sipes Director\nANNUAL REPORT ON FORM 10-K Item 14(a)(3)\nPAINE WEBBER\/CMJ PROPERTIES, LP\nINDEX TO EXHIBITS\nPage Number in the Report Exhibit No. Description of Document Or Other Reference - ---------- ----------------------- -------------------------\n(3) and (4) Prospectus of the Partnership Filed with the Commission dated May 25 1983, as pursuant to Rule 424(c) supplemented, with particular and incorporated reference to the Restated herein by reference. Certificate and Agreement of Limited Partnership\n(10) Material contracts previously Filed with the Commission filed as exhibits to registration pursuant to Section 13 or statements and amendments thereto 15(d) of the Securities of the registrant together with all Act of 1934 and such contracts filed as exhibits of incorported herein previously filed Forms 8-K and by reference. Forms 10-K are hereby incorporated herein by reference.\n(13) Annual Report to Limited Partners No Annual Report for the year ended December 31, 1995 has been sent to the Limited Partners. An Annual Report will be sent to the Limited Partners subsequent to this filing.\n(22) List of subsidiaries Included in Item I of Part I of this Report Page I-1, to which reference is hereby made.\n(27) Financial Data Schedule Filed as the last page of EDGAR submission following the Financial Statements required by Item 14.\nANNUAL REPORT ON FORM 10-K\nItem 14(a) (1) and (2) and 14(d)\nPAINE WEBBER\/CMJ PROPERTIES, LP\nPaine Webber\/CMJ Properties, LP Reference\nIndependent Auditors' Report\nBalance sheets at December 31, 1995 and 1994\nStatements of operations for the years ended December 31, 1995, 1994 and 1993\nStatements of changes in partners' capital (deficit) for the years ended December 31, 1995, 1994 and 1993\nStatement of cash flows for the years ended December 31, 1995, 1994 and 1993\nNotes to financial statements\nFawcett's Pond Apartments Company\nIndependent Auditors' Report\nBalance sheets at December 31, 1995 and 1994\nStatements of operations for the years ended December 31, 1995, 1994 and 1993\nStatements of partners' deficit for the years ended December 31, 1995, 1994 and 1993\nStatements of cash flows for the years ended December 31, 1995, 1994 and 1993\nNotes to financial statements\nQuaker Meadows Apartments Company\nIndependent Auditors' Report\nBalance sheets at December 31, 1995 and 1994\nStatements of operations for the years ended December 31, 1995, 1994 and 1993\nStatements of partners' deficit for the years ended December 31, 1995, 1994 and 1993\nStatements of cash flows for the years ended December 31, 1995, 1994 and 1993\nNotes to financial statements\nPAINE WEBBER\/CMJ PROPERTIES, LP\nINDEX TO FINANCIAL STATEMENTS - continued\nReference\nSouth Laurel Apartments Limited Partnership\nIndependent Auditors' Report\nBalance sheets at December 31, 1995 and 1994\nStatements of operations for the years ended December 31, 1995, 1994 and 1993\nStatements of partners' deficit for the years ended December 31, 1995, 1994 and 1993\nStatements of cash flows for the years ended December 31, 1995, 1994 and 1993\nNotes to financial statements\nMarvin Gardens Associates\nIndependent Auditors' Report\nBalance sheets at December 31, 1995 and 1994\nStatements of operations for the years ended December 31, 1995, 1994 and 1993\nStatements of partners' deficit for the years ended December 31, 1995, 1994 and 1993\nStatements of cash flows for the years ended December 31, 1995, 1994 and 1993\nNotes to financial statements\nColonial Farms, Ltd.\nIndependent Auditors' Report\nBalance sheets at December 31, 1995 and 1994\nStatements of operations for the years ended December 31, 1995, 1994 and 1993\nStatements of partners' deficit for the years ended December 31, 1995, 1994 and 1993\nStatements of cash flows for the years ended December 31, 1995, 1994 and 1993\nNotes to financial statements\nPAINE WEBBER\/CMJ PROPERTIES, LP\nINDEX TO FINANCIAL STATEMENTS - continued\nReference\nHolbrook Apartments Company\nIndependent Auditors' Report\nBalance sheets at December 31, 1995 and 1994\nStatements of operations for the years ended December 31, 1995, 1994 and 1993\nStatements of partners' deficit for the years ended December 31, 1995, 1994 and 1993\nStatements of cash flows for the years ended December 31, 1995, 1994 and 1993\nNotes to financial statements\nAll schedules have been omitted since the required information is not applicable, or because the information required is included in the financial statements, including the notes thereto.\nINDEPENDENT AUDITORS' REPORT\nThe Partners of Paine Webber\/CMJ Properties, LP\nWe have audited the accompanying balance sheets of Paine Webber\/CMJ Properties, LP (a Limited Partnership) as of December 31, 1995 and 1994, and the related statements of operations, changes in partners' capital (deficit), and cash flows for each of the three years in the period ended December 31, 1995. 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 Paine Webber\/CMJ Properties, LP at December 31, 1995 and 1994, and the results of its operations, changes in partners' capital (deficit), and its cash flows for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles.\n\/s\/ Reznick Fedder & Silverman REZNICK FEDDER & SILVERMAN\nBaltimore, Maryland February 20, 1996\nPAINE WEBBER\/CMJ PROPERTIES, LP\nBALANCE SHEETS December 31, 1995 and 1994 (In thousands, except per Unit data)\nASSETS\n1995 1994 ---- ----\nInvestments in local limited partnerships, at equity $ 161 $ 201 Cash and cash equivalents 325 324 -------- ------- $ 486 $ 525 ======== =======\nLIABILITIES AND PARTNERS' CAPITAL\nAccrued expenses $ 22 $ 14\nPartners' capital: General Partners: Capital contributions 1 1 Cumulative net losses (70) (71) Cumulative distributions (3) (1)\nLimited Partners ($1,000 per Unit; 8,746 Units issued): Capital contributions, net of offering costs 7,679 7,679 Cumulative net losses (6,881) (7,010) Cumulative distributions (262) (87) -------- ------- Total partners' capital 464 511 -------- ------- $ 486 $ 525 ======== =======\nThe accompanying notes are an integral part of these financial statements.\nPAINE WEBBER\/CMJ PROPERTIES, LP\nSTATEMENTS OF OPERATIONS For the years ended December 31, 1995, 1994 and 1993 (In thousands, except per Unit data)\n1995 1994 1993 ---- ---- ---- Revenues: Interest income $ 23 $ 22 $ 13 Other income from local limited partnerships 221 157 280 -------- --------- -------- 244 179 293\nExpenses: Management fees 199 199 199 General and administrative 89 69 90 -------- --------- -------- 288 268 289 -------- --------- --------\nOperating income (loss) (44) (89) 4\nPartnership's share of local limited partnerships' income 174 186 203 -------- --------- --------\nNet income $ 130 $ 97 $ 207 ======== ======== ========\nNet income per Limited Partnership Unit $14.75 $11.01 $23.45 ======== ======== ========\nCash distributions per Limited Partnership Unit $20.00 $10.00 $ - ====== ====== ======\nThe above net income and cash distributions per Limited Partnership Unit are based upon the 8,746 Limited Partnership Units outstanding during each year.\nThe accompanying notes are an integral part of these financial statements.\nPAINE WEBBER\/CMJ PROPERTIES, LP\nSTATEMENTS OF CHANGES IN PARTNERS' CAPITAL (DEFICIT) For the years ended December 31, 1995, 1994 and 1993 (In thousands)\nGeneral Limited Partners Partners Totals -------- -------- ------\nBalance at December 31, 1992 $ (73) $ 368 $ 295\nNet income 2 205 207 ----- ------- ------\nBalance at December 31, 1993 (71) 573 502\nCash distributions (1) (87) (88)\nNet income 1 96 97 ----- ------- ------\nBalance at December 31, 1994 (71) 582 511\nCash distributions (2) (175) (177)\nNet income 1 129 130 ------ ------- ------\nBalance at December 31, 1995 $ (72) $ 536 $ 464 ====== ====== ======\nThe accompanying notes are an integral part of these financial statements.\nPAINE WEBBER\/CMJ PROPERTIES, LP\nSTATEMENT OF CASH FLOWS For the years ended December 31, 1995, 1994 and 1993 Increase (Decrease) in Cash and Cash Equivalents (In thousands)\n1995 1994 1993 ---- ---- ----\nCash flows from operating activities: Net income $ 130 $ 97 $ 207 Adjustments to reconcile net income to net cash used in operating activities: Other income from local limited partnerships (221) (157) (280) Partnership's share of local limited partnerships' income (174) (186) (203) Changes in assets and liabilities: Accounts receivable - - 1 Accounts payable - affiliates - (204) - Accrued expenses 8 (8) 2 ------ -------- -------- Total adjustments (387) (555) (480) ------ -------- -------- Net cash used in operating activities (257) (458) (273) ------ -------- --------\nCash flows from investing activities: Distributions from local limited partnerships 435 407 483 ------ -------- -------- Net cash provided by investing activities 435 407 483 ------ -------- --------\nCash flows from financing activities: Distributions to partners (177) (88) - ------ -------- -------- Net cash used in financing activities (177) (88) - ------ -------- --------\nNet increase (decrease) in cash and cash equivalents 1 (139) 210\nCash and cash equivalents, beginning of year 324 463 253 ------ -------- --------\nCash and cash equivalents, end of year $ 325 $ 324 $ 463 ======= ======== ========\nThe accompanying notes are an integral part of these financial statements.\nPAINE WEBBER\/CMJ PROPERTIES, LP\nNOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995\n1. Organization\nPaine Webber\/CMJ Properties, LP (the \"Partnership\") is a limited partnership organized pursuant to the laws of the State of Delaware in December 1982 for the purpose of investing in a portfolio of interests in local limited partnerships owning apartment projects which receive governmental assistance in the form of low rate mortgages and rent subsidies. All of the properties owned by the local limited partnerships were developed by Corcoran, Mullins, Jennison, Inc. (\"CMJ\") or its affiliates. The initial capital was $2,000, representing capital contributions of $1,000 by the General Partners and $1,000 for one unit (a \"Unit\") by the Initial Limited Partner. The Partnership authorized the issuance of a maximum of 15,000 Partnership Units of which 8,745 were subscribed and issued between May 25, 1983 and April 30, 1984.\n2. Summary of Significant Accounting Policies\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nThe accompanying financial statements include the Partnership's investments in six local limited partnerships which own operating properties. The Partnership accounts for its investments in local limited partnerships using the equity method. Under the equity method, the investment is carried at cost adjusted for the Partnership's share of the local limited partnerships' earnings and losses and distributions. In accordance with the equity method of accounting for limited partnership interests, the Partnership does not record losses for those limited partnership investments whose equity method basis has been reduced to zero, recognizing future income from these entities only when it exceeds the previously unrecorded losses. Distributions received from investments in limited partnerships whose basis has been reduced to zero are recorded as other income in the Partnership's statement of operations. See Note 4 for a description of the local limited partnerships.\nThe local limited partnerships in which the Partnership has invested own operating investment properties. The Partnership has reviewed FAS No. 121 \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets To Be Disposed Of\", which is effective for financial statements for years beginning after December 15, 1995, and believes this new pronouncement will not have a material effect on the Partnership's financial statements.\nFor purposes of reporting cash flows, cash and cash equivalents include all highly liquid investments with original maturities of 90 days or less when acquired. The Partnership's cash reserves are invested in financial instruments which potentially subject the Partnership to concentrations of credit risk. The Partnership currently invests primarily in investment-grade rated commercial paper with overnight maturities. Management believes that no significant concentration of credit risk exists with respect to these cash investments as of December 31, 1995.\nNo provision for income taxes has been made, as the liability for such taxes is that of the partners rather than the Partnership. The cumulative difference between the book basis and tax basis of the Partnership's investment in local limited partnerships is approximately $16,890,000 due to the losses on investments recognized on the tax basis in excess of the book basis.\nThe carrying amount of cash and current liabilities approximates their fair value due to the short-term maturities of these instruments.\n3. The Partnership Agreement and Related Party Transactions\nThe General Partners of the Partnership are PW Shelter Fund, Inc. (the \"Managing General Partner\"), a wholly-owned subsidiary of PaineWebber Group Inc. (\"PaineWebber\") and Properties Associates (the \"Associate General Partner\"), a Massachusetts general partnership, certain general partners of which are also officers of the Managing General Partner and PaineWebber Properties Incorporated (the \"Adviser\"). Subject to the Managing General Partner's overall authority, the business of the Partnership is managed by the Adviser pursuant to an advisory contract. The Adviser is a wholly-owned subsidiary of PaineWebber Incorporated (\"PWI\"), a wholly-owned subsidiary of PaineWebber. The General Partners, the Adviser and PWI receive fees and compensation, determined on an agreed-upon basis, in consideration of various services performed in connection with the sale of the Units, the management of the Partnership and the acquisition, management, financing and disposition of Partnership investments.\nDistributable cash, as defined, for each fiscal year shall be distributed annually in the ratio of 99% to the Limited Partners and 1% to the General Partners. However, it is not one of the investment objectives of the Partnership to generate any significant cash flow from property operations for distribution to the Limited Partners. All sale or refinancing proceeds will be distributed in varying proportions to the Limited and General Partners, as specified in the Partnership Agreement.\nPursuant to the terms of the Partnership Agreement, taxable income or tax loss of the Partnership will be allocated 99% to the Limited Partners and 1% to the General Partners. Taxable income or tax loss arising from a sale or refinancing of investment properties will be allocated to the Limited Partners and the General Partners in proportion to the amounts of sale or refinancing proceeds to which they are entitled; provided that the General Partners shall be allocated at least 1% of taxable income arising from a sale or refinancing. If there are no sale or refinancing proceeds, taxable income or tax loss from a sale or refinancing will be allocated 99% to the Limited Partners and 1% to the General Partners. Allocations of the Partnership's operations between the General Partner and the Limited Partners for financial accounting purposes have been made in conformity with the allocations of taxable income or tax loss.\nUnder the advisory contract, the Adviser has specific management responsibilities, to administer the day-to-day operations of the Partnership and to report periodically the performance of the Partnership to the Managing General Partner. The Adviser earns a basic management fee of .5% of invested assets for these services. Invested assets is the sum of the amount invested by the Partnership in each local limited partnership plus a proportionate interest in the mortgage debt initially incurred by the local limited partnerships. The Adviser earned management fees of $199,000 for each of the three years in the period ended December 31, 1995.\nIn connection with the sale of each property, the Adviser may receive a disposition fee in an amount equal to 1% based on the selling price of the property, subordinated to the payment of certain amounts to the Limited Partners.\nIncluded in general and administrative expenses for the years ended December 31, 1995, 1994 and 1993 is $32,000, $38,000 and $39,000, respectively, representing reimbursements to an affiliate of the Managing General Partner for providing certain financial, accounting and investor communication services to the Partnership.\nThe Partnership uses the services of Mitchell Hutchins Institutional Investors, Inc. (\"Mitchell Hutchins\"), an affiliate of the Managing General Partner, for the managing of cash assets. Mitchell Hutchins is a subsidiary of Mitchell Hutchins Asset Management, Inc., an independently operated subsidiary of PaineWebber. Mitchell Hutchins earned fees of $2,000, $1,000 and $1,000 (included in general and administrative expenses) for managing the Partnership's cash assets during 1995, 1994 and 1993, respectively.\n4. Local Limited Partnerships\nThe Partnership has investments in six local limited partnerships. These local limited partnerships are accounted for on the equity method in the Partnership's financial statements. Condensed combined financial statements of these local limited partnerships follow:\nCondensed Combined Balance Sheets December 31, 1995 and 1994 (In thousands) Assets 1995 1994 ---- ---- Current assets $ 1,872 $ 2,000 Restricted assets 1,778 1,757 Operating investment property, net 26,565 27,324 Other assets 1,088 1,129 -------- -------- $31,303 $32,210 ======== ======== Liabilities and Capital\nCurrent liabilities $ 1,303 $ 1,235 Due to general partner 2,509 2,509 Long-term mortgage debt, less current portion 33,368 33,846\nPartnership's share of combined partners' deficit accounts (2,826) (2,377) Local partners' shares of combined partners' deficit accounts (3,051) (3,003) -------- -------- $31,303 $32,210 ======== ========\nCondensed Combined Summary of Operations For the years ended December 31, 1995, 1994 and 1993 (In thousands)\n1995 1994 1993 ---- ---- ---- Rental revenues, including government subsidies $ 9,891 $ 9,851 $ 9,633 Other income 103 68 56 ------- ------- ------- 9,994 9,919 9,689\nProperty operating expenses 5,701 5,419 5,637 Interest expense and mortgage insurance 3,005 3,042 3,081 Depreciation and amortization 1,294 1,246 1,190 ------- ------- ------- 10,000 9,707 9,908 ------- ------- ------- Net income (loss) $ (6) $ 212 $ (219) ======= ======= =======\nNet income (loss): Partnership's share of operations $ (15) $ 183 $ (207) Local partners' share of operations 9 29 (12) ------- ------- ------- $ (6) 212 $ (219) ======= ======= =======\nReconciliation of Partnership's share of operations (In thousands)\n1995 1994 1993 ---- ---- ---- Partnership's share of operations, as shown above $ (15) $ 183 $ (207) Losses in excess of basis not recognized by Partnership 234 108 421 Income offset with prior year unrecognized losses (45) (105) (11) ------- ------- ------- Partnership's share of local limited partnerships' income $ 174 $ 186 $ 203 ======= ======= =======\nReconciliation of Partnership's Investments (In thousands) 1995 1994 ---- ----\nPartnership's share of combined partners' deficit accounts, as shown above $(2,826) $(2,377) Accumulated losses in excess of basis not recognized by Partnership 1,978 1,784 Cumulative distributions in excess of investment basis 994 773 Excess basis in local limited partnerships 15 21 ------- ------- Investments in local limited partnerships, at equity $ 161 $ 201 ======= =======\n\"Investments in local limited partnerships, at equity\" is the Partnership's net investment in the local limited partnerships. These local limited partnerships are subject to partnership agreements which determine the distribution of available funds, the disposition of the limited partnership's assets and the rights of the partners, regardless of the Partnership's percentage ownership interest in the local limited partnership.\n\"Investments in local limited partnerships, at equity\" on the balance sheets is comprised of the following local limited partnership investments, at the balances indicated (in thousands):\n1995 1994 ---- ----\nFawcett's Pond Apartments Company $ - $ - Quaker Meadows Apartments Company - - South Laurel Apartments Limited Partnership - - Marvin Gardens Associates - - Colonial Farms Ltd. - - Holbrook Apartments Company 161 201 ----- ------ Investments in local limited partnerships, at equity $ 161 $ 201 ===== ======\nThe Partnership received cash distributions from the limited partnerships as set forth below (in thousands):\n1995 1994 1993 ---- ---- ----\nFawcett's Pond Apartments Company $ 24 $ 24 $ 78 Quaker Meadows Apartments Company 66 59 55 South Laurel Apartments Limited Partnership 63 16 92 Marvin Gardens Associates 27 12 7 Colonial Farms Ltd. 40 46 47 Holbrook Apartments Company 215 250 204 ------- ------ ----- $ 435 $ 407 $ 483 ======= ====== =====\nThe investments in Fawcett's Pond Apartments Company, Quaker Meadows Apartments Company, South Laurel Apartments Limited Partnership, Marvin Gardens Associates and Colonial Farms Ltd. at December 31, 1995 do not reflect accumulated losses therefrom of $55,000, $1,208,000, $392,000, $163,000 and $160,000, respectively, because the equity method carrying values of such investments have been reduced to zero. Future income from these entities will not be recorded until it exceeds the previously unrecognized accumulated losses.\nA description of the local limited partnership properties and the terms of the local limited partnership agreements is summarized below:\na) Village at Fawcett's Pond - Hyannis, Massachusetts\nOn June 30, 1983, the Partnership acquired a 95% limited partnership interest in Fawcett's Pond Apartments Company, an existing Massachusetts limited partnership (\"Fawcett's Pond\"), that owns and operates a 100-unit housing project in Hyannis, Massachusetts. The Federal Housing Administration (FHA) contracted with the limited partnership under Section 8 of Title II of the Housing and Community Development Act of 1974 to make housing assistance payments to the limited partnership on behalf of qualified tenants. The agreement expires August 19, 2002. Total rent subsidies received by the limited partnership during 1995, 1994 and 1993 were $768,000, $769,000 and $752,000, respectively. Such amounts comprised approximately 79%, 81% and 80%, respectively, of the limited partnership's total revenues for such years.\nThe aggregate investment by the Partnership for the 95% interest was $879,606, comprised of cash and notes payable to the seller (including an acquisition fee of $63,025 payable to the Adviser of the Partnership). The Partnership's interest is held subject to a permanent nonrecourse mortgage loan due April 1, 2024 from the Government National Mortgage Association (GNMA) with an outstanding balance at December 31, 1995 of approximately $4,328,000, payable in monthly installments of $30,746 including principal and interest at 7.5%.\nThe partnership agreement generally provides that the Partnership will receive 95% of annual distributable cash flow payable annually and that the local partners will be entitled to receive 5% of annual distributable cash flow. Cash distributions are limited by agreements between the limited partnership and HUD to the extent of surplus cash, as defined by HUD.\nThe agreement also provides that taxable income and tax loss in each year will be allocated, generally, in the same proportion as cash flow is distributed in that year.\nGenerally, the first $1,105,725 of proceeds from the sale or refinancing of the investment property will be distributed to the Partnership. The remaining proceeds will be distributed to the local general partners and the Partnership in accordance with the local limited partnership agreement.\nThe local limited partnership entered into a property management contract with an affiliate of the local general partners. The management fee is 5% of gross receipts. An incentive management fee will also be paid on an annual basis in the event that the property's cash flow exceeds certain target amounts. Incentive management fees of $6,000, $6,000 and $44,000 were paid to an affiliate of the local general partners for the years ended December 31, 1995, 1994 and 1993, respectively.\nb) Quaker Court and The Meadows - Lynn, Massachusetts\nOn June 30, 1983, the Partnership acquired a 95% limited partnership interest in Quaker Meadows Apartments Company, an existing Massachusetts limited partnership (\"Quaker Meadows\"), that owns and operates two apartment complexes in Lynn, Massachusetts. There are a total of 104 apartment units in the two complexes. FHA contracted with the limited partnership under Section 8 of Title II of the Housing and Community Development Act of 1974 to make housing assistance payments to the limited partnership on behalf of qualified tenants. The agreement expires in May 2002 and has two five-year renewal options. Total rent subsidies received by the limited partnership during 1995, 1994 and 1993 were $1,335,000, $1,321,000 and $1,302,000, respectively. Such amounts comprised approximately 82% of the limited partnership's total revenues in each of such years.\nThe aggregate investment by the Partnership for the 95% interest was $1,378,906 (including an acquisition fee of $104,525 paid to the Adviser of the Partnership). The Partnership's interest is held subject to a permanent nonrecourse mortgage loan due September 1, 2013 with an outstanding balance at December 31, 1995 of approximately $5,297,000, payable in monthly installments of $62,930 including principal and interest at 12.5%.\nThe restated partnership agreement generally provides that the Partnership will receive 95% of annual distributable cash flow payable annually and that the local partners will be entitled to receive 5% of annual distributable cash flow.\nThe agreement also provides that taxable income and tax loss in each year will be allocated, generally, in the same proportion as cash flow is distributed in that year.\nGenerally, the first $1,739,424 of proceeds from the sale or refinancing of the investment properties will be distributed to the Partnership. Remaining proceeds will be distributed to the local venture partners and the Partnership in accordance with the local limited partnership agreement.\nThe local limited partnership entered into a property management contract with an affiliate of the local general partners. The management fee is 4% of gross receipts. An incentive management fee will also be paid on an annual basis in the event that the property's cash flow exceeds certain target amounts. Incentive management fees of $45,000, $38,000 and $35,000 were paid to an affiliate of the local general partners for the years ended December 31, 1995, 1994 and 1993, respectively.\nc) Villages at Montpelier - Laurel, Maryland\nOn June 30, 1983, the Partnership acquired an 85% limited partnership interest in South Laurel Apartments Limited Partnership, an existing Maryland limited partnership (\"South Laurel\"), that owns and operates a 520-unit housing project in Laurel, Maryland. FHA contracted with the limited partnership under Section 8 of Title II of the Housing and Community Development Act of 1974 to make housing assistance payments to the limited partnership on behalf of qualified tenants for 20% of the rental units. The agreement expires July 31, 1997. Total rent subsidies received by the limited partnership during 1995, 1994 and 1993 were $677,000, $694,000 and $685,000, respectively. Such amounts comprised approximately 17% of the limited partnership's total revenues for each of such years.\nThe aggregate investment by the Partnership for the 85% interest was $2,446,135 (including an acquisition fee of $186,725 paid to the Adviser of the Partnership). The Partnership's interest is held subject to a permanent nonrecourse mortgage loan due December 1, 2023 with an outstanding balance at December 31, 1995 of approximately $12,119,000, payable to GNMA in monthly installments of $86,395 including principal and interest at 7.5%.\nThe restated partnership agreement generally provides that the Partnership will receive 85% of annual distributable cash flow payable annually and that the local partners will be entitled to receive 15% of annual distributable cash flow. Cash distributions are limited by agreements between the limited partnership and HUD to the extent of surplus cash, as defined by HUD.\nThe agreement also provides that taxable income and tax loss in each year will be allocated, generally, in the same proportion as cash flow is distributable in that year.\nGenerally, the first $3,107,104 of proceeds from the sale or refinancing of the investment property will be distributed to the Partnership. Remaining proceeds will be distributed to the local venture partners and the Partnership in accordance with the local limited partnership agreement.\nThe local limited partnership entered into a property management contract with an affiliate of the local general partners. The management fee is 5.25% of gross receipts. An incentive management fee will also be paid on an annual basis in the event that the property's cash flow exceeds certain target amounts. Incentive management fees of $1,000 and $24,000 were paid to an affiliate of the local general partners for 1995 and 1993, respectively. No incentive management fees were earned for the year ended December 31, 1994.\nd) Marvin Gardens Apartments, Cotati, California\nOn July 29, 1983, the Partnership acquired a 95% limited partnership interest in Marvin Gardens Associates, an existing California limited partnership that owns a 37-unit apartment complex project in Cotati, California. The apartment complex operates under Section 8 of the National Housing Act and, therefore, receives monthly rental subsidies from the Federal Department of Housing and Urban Development (HUD). The agreement expires in July 2003 and has two five-year renewal options. Total rent subsidies received by the limited partnership during 1995, 1994 and 1993 were $337,000, $332,000 and $324,000, respectively. Such amounts comprised approximately 81%, 82% and 81%, respectively, of the limited partnership's total revenues for such years.\nThe aggregate investment by the Partnership for the 95% interest was $379,581 (including an acquisition fee of $27,800 paid to the Adviser of the Partnership). The Partnership's interest was acquired subject to a permanent nonrecourse mortgage loan due June 1, 2013 with an outstanding balance at December 31, 1995 of approximately $1,707,000, payable to the California Housing Finance Agency (CHFA). Effective August 1, 1992, the terms of the mortgage loan were modified as a result of a bond redemption by CHFA which lowered the effective annual interest rate from 11.25% to 8.15% and monthly principal and interest payments from $19,105 to $15,138.\nThe restated partnership agreement generally provides that the Partnership will receive 95% of annual distributable cash flow payable annually and that the local partners will be entitled to receive 5% of annual distributable cash flow. Cash distributions are limited by agreements between the limited partnership and CHFA to $20,151 per year to the extent of surplus cash and stated equity, as defined by CHFA. Undistributed amounts are cumulative and may be distributed in subsequent years if future operations provide surplus cash in excess of current requirements.\nThe agreement also provides that taxable income and tax loss in each year will be allocated, generally, in the same proportion as cash flow is distributed in that year.\nGenerally, the first $462,336 of proceeds from the sale or refinancing of the investment property will be distributed to the Partnership. Remaining proceeds will be distributed to the local venture partners and the Partnership in accordance with the local limited partnership agreement.\nThe local limited partnership entered into a property management contract with an affiliate of the local general partners who in turn hired an unaffiliated management agent to provide management services on their behalf. An incentive management fee will also be paid on an annual basis in the event that the property's cash flow exceeds certain target amounts. Incentive management fees of $12,000 and $2,000 were paid to an affiliate of the local general partners for the years ended December 31, 1995 and 1994, respectively. No incentive management fees were earned for the year ended December 31, 1993.\ne) Colonial Farms - Modesto, California\nOn July 29, 1983, the Partnership acquired a 95% limited partnership interest in Colonial Farms Ltd. an existing California limited partnership that owns a 100-unit apartment project in Modesto, California. The apartment complex operates under Section 8 of the National Housing Act and, therefore, receives monthly rental subsidies from the Federal Department of Housing and Urban Development (HUD). The agreement expires in July 2002 and has two five-year renewal options. Total rent subsidies received by the limited partnership during 1995, 1994 and 1993 were $586,000, $556,000 and $563,000, respectively. Such amounts comprised approximately 74%, 72% and 73%, respectively, of the limited partnership's total revenues for such years. During 1993, the limited partnership refunded $147,000 of prior year excess rent subsidy income to CHFA in final settlement of a dispute regarding the terms of the regulatory agreement. This amount is recorded in property operating expenses in the accompanying condensed combined summary of operations for 1993.\nThe aggregate investment by the Partnership for the 95% interest was $623,351 (including an acquisition fee of $48,125 paid to the Adviser to the Partnership). The Partnership's interest is held subject to a permanent nonrecourse mortgage loan due June 1, 2013 with an outstanding balance at December 31, 1995 of approximately $2,860,000, payable to CHFA. Effective August 1, 1992, the terms of the mortgage loan were modified as a result of a bond redemption by CHFA which lowered the effective annual interest rate from 10.8% to 9.15% and monthly principal and interest payments from $30,770 to $27,411.\nThe restated partnership agreement generally provides that the Partnership will receive 95% of annual distributable cash flow payable annually and that the local partners will be entitled to receive 5% of annual distributable cash flow. Cash distributions are limited by agreements between the limited partnership and CHFA to $35,299 per year to the extent of surplus cash and stated equity, as defined by CHFA. Undistributed amounts are cumulative and may be distributed in subsequent years if future operations provide surplus cash in excess of current requirements.\nThe agreement also provides that taxable income and tax loss in each year will be allocated, generally, in the same proportion as cash flow is distributed in that year.\nGenerally, the first $800,928 of proceeds from the sale or refinancing of the investment property will be distributed to the Partnership. Remaining proceeds will be distributed to the local venture partners and the Partnership in accordance with the local limited partnership agreement.\nThe local limited partnership entered into a property management contract with an affiliate of the local general partners who in turn hired an unaffiliated management agent to provide management services on their behalf. An incentive management fee will also be paid to the affiliate of the local general partners on an annual basis in the event that the property's cash flow exceeds certain target amounts. Incentive management fees of $16,000, $20,000 and $21,000 were paid to an affiliate of the local general partners for the years ended December 31, 1995, 1994 and 1993, respectively.\nf) Ramblewood Apartments - Holbrook, Massachusetts\nOn August 30, 1983, the Partnership acquired an 85% limited partnership interest in Holbrook Apartments Company, an existing Massachusetts limited partnership that owns and operates a 170-unit housing project in Holbrook, Massachusetts. FHA contracted with the limited partnership under Section 8 of Title II of the Housing and Community Development Act of 1974 to make housing assistance payments to the limited partnership on behalf of qualified tenants. The agreement expires July 1, 2001. Total rent subsidies received by the limited partnership during 1995, 1994 and 1993 were $1,587,000, $1,577,000 and $1,555,000, respectively. Such amounts comprised approximately 75%, 76% and 75% respectively, of the limited partnership's total revenues for such years.\nThe aggregate investment by the Partnership for the 85% interest was $1,250,583, (including an acquisition fee of $94,500 paid to the Adviser of the Partnership). The Partnership's interest was acquired subject to a nonrecourse first mortgage loan due February 1, 2023 with an outstanding balance at December 31, 1995 of approximately $7,535,000, payable to GNMA in monthly installments of $54,207 including principal and interest at 7.5%.\nThe restated partnership agreement generally provides that the Partnership will receive 85% of annual distributable cash flow payable annually and that the local partners will be entitled to receive 15% of annual distributable cash flow. Cash distributions are limited by agreements between the limited partnership and HUD to the extent of surplus cash, as defined by HUD.\nThe agreement also provides that taxable income and tax loss in each year will be allocated, generally, in the same proportion as cash flow is distributed in that year.\nGenerally, the first $1,571,956 of proceeds from the sale or refinancing of the investment property will be distributed to the Partnership. Remaining proceeds will be distributed to the local partners and the Partnership in accordance with the local limited partnership agreement.\nThe local limited partnership entered into a property management contract with an affiliate of the local general partners. The management fee is 4.75% of gross receipts. An incentive management fee will also be paid on an annual basis in the event that the property's cash flow exceeds certain target amounts. Incentive management fees of $138,000, $166,000 and $129,000 were paid to an affiliate of the local general partners for the years ended December 31, 1995, 1994 and 1993, respectively.\n5. Subsequent Event\nOn February 15, 1996, the Partnership distributed approximately $4,000 to the General Partners and $40,000 to the Limited Partners for the quarter ended December 31, 1995.\n6. Contingencies\nThe Partnership is involved in certain legal actions. At the present time, the Managing General Partner is unable to estimate the impact, if any, of these matters on the Partnership's financial statements, taken as a whole.\nINDEPENDENT AUDITORS' REPORT\nTo the Partners Fawcett's Pond Apartments Company\nWe have audited the accompanying balance sheets of Fawcett's Pond Apartments Company as of December 31, 1995 and 1994, and the related statements of operations, partners' deficit and cash flows for each of the three years in the period ended December 31, 1995. 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 Fawcett's Pond Apartments Company as of December 31, 1995 and 1994, and the results of its operations, changes in partners' deficit and its cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\n\/s\/ Reznick Fedder & Silverman REZNICK FEDDER & SILVERMAN\nBaltimore, Maryland January 27, 1996\nFawcett's Pond Apartments Company\nBALANCE SHEETS\nDecember 31, 1995 and 1994\n1995 1994 ---- ----\nASSETS\nCURRENT ASSETS Cash and cash equivalents $ 239,549 $ 183,321 Accounts receivable - HAP 1,218 472 Prepaid expenses 14,016 13,898 ---------- ----------\nTotal current assets 254,783 197,691 ---------- ----------\nRESTRICTED DEPOSITS AND FUNDED RESERVES Tenants' security deposits 24,400 23,257 Mortgage escrow deposits 34,824 35,202 Reserve for replacements 222,853 194,321 ---------- ---------- 282,077 252,780 ---------- ----------\nPROPERTY AND EQUIPMENT, less accumulated depreciation of $1,892,521 and $1,756,280 3,556,441 3,650,737 ---------- ----------\nDEFERRED FINANCING COSTS, net of accumulated amortization of $105,784 and $97,622 230,969 239,131 ---------- ----------\nTotal assets $4,324,270 $4,340,339 ========== ==========\nLIABILITIES AND PARTNERS' DEFICIT\nCURRENT LIABILITIES Current maturities of mortgage payable $ 45,914 $ 42,607 Accounts payable and accrued expenses 22,046 16,783 Accrued interest payable 27,049 27,315 Rent deferred credits 583 2,272 ---------- ---------- Total current liabilities 95,592 88,977\nLONG-TERM LIABILITIES Mortgage payable, less current maturities 4,281,973 4,327,887 Due to general partner 277,400 277,400 Tenants' security deposits 21,170 20,165 ---------- ---------- Total liabilities 4,676,135 4,714,429\nPARTNERS' DEFICIT (351,865) (374,090) ---------- ----------\nTotal liabilities and partners' deficit $4,324,270 $4,340,339 ========== ========== The accompanying notes are an integral part of these financial statements.\nFawcett's Pond Apartments Company\nSTATEMENTS OF OPERATIONS\nYears ended December 31, 1995, 1994 and 1993\n1995 1994 1993 ---- ---- ----\nRevenue Rental income $940,355 $935,002 $920,673 Vacancies - (1,128) (364) Financial revenue 16,052 6,579 4,766 Other income 16,371 15,236 15,140 -------- -------- --------\nTotal revenue 972,778 955,689 940,215 -------- -------- --------\nExpenses Operating expenses Marketing 804 801 1,014 Administration 53,043 52,130 51,637 Utilities 35,578 27,940 38,891 Management fee 46,933 46,686 45,886 Maintenance and repairs 129,259 90,131 99,828 Salaries 73,337 72,087 81,201 Insurance 21,667 21,674 22,128 Real estate taxes 65,567 61,375 59,833 -------- -------- --------\nTotal operating expenses 426,188 372,824 400,418 -------- -------- --------\nNon-operating expenses Interest 326,076 329,165 332,719 Mortgage insurance premium 21,737 21,943 22,134 Depreciation and amortization 144,403 142,344 129,072 Incentive management fee 6,303 6,303 44,124 Miscellaneous financial expenses 632 615 - -------- -------- --------\nTotal non-operating expenses 499,151 500,370 528,049 -------- -------- --------\nTotal expenses 925,339 873,194 928,467 -------- -------- --------\nEXCESS OF REVENUE OVER EXPENSES $ 47,439 $ 82,495 $ 11,748 ======== ======== ========\nThe accompanying notes are an integral part of these financial statements.\nFawcett's Pond Apartments Company\nSTATEMENTS OF PARTNERS' DEFICIT\nYears ended December 31, 1995, 1994 and 1993\nGeneral Limited Partner Partner Total\nPartners' deficit, December 31, 1992 $(74,918) $(286,257) $(361,175)\nDistributions (4,097) (77,847) (81,944)\nExcess of revenue over expenses 587 11,161 11,748 -------- -------- --------\nPartners' deficit, December 31, 1993 (78,428) (352,943) (431,371)\nDistributions (1,261) (23,953) (25,214)\nExcess of revenue over expenses 4,125 78,370 82,495 -------- -------- --------\nPartners' deficit, December 31, 1994 (75,564) (298,526) (374,090)\nDistributions (1,261) (23,953) (25,214)\nExcess of revenue over expenses 2,372 45,067 47,439 -------- -------- --------\nPartners' deficit, December 31, 1995 $ (74,453) $(277,412) $ (351,865) ========== ========= ==========\nProfit and loss sharing percentage 5% 95% 100% == == ====\nThe accompanying notes are an integral part of these financial statements.\nFawcett's Pond Apartments Company\nSTATEMENTS OF CASH FLOWS\nYears ended December 31, 1995, 1994 and 1993\n1995 1994 1993 ---- ---- ----\nCash flows from operating activities Rental income received $ 938,666 $ 933,799 $ 919,503 Interest received 9,468 2,599 1,990 Other income received 15,625 15,089 15,033 Administration expenses paid (83,865) (46,686) (80,621) Management fees paid (46,933) (83,189) (45,886) Utilities paid (35,266) (27,959) (34,469) Maintenance and repairs expenses paid (160,520) (123,364) (147,189) Real estate taxes paid (65,567) (61,375) (59,833) Payroll taxes paid (7,107) (7,812) (8,026) Property insurance paid (10,191) (9,909) (11,031) Other taxes and insurance paid (11,664) (11,161) (11,682) Interest paid on mortgage (326,342) (329,413) (332,260) Mortgage insurance paid (21,667) (21,877) (22,073) Miscellaneous financial expenses paid (632) (615) (688) Increase (decrease) in mortgage escrow deposits 378 (3,704) 349 Mortgagor entity expenses paid (6,303) (6,303) (44,124) Net security deposits (paid) received (138) (899) 4,000 -------- -------- ---------\nNet cash provided by operating activities 187,942 217,221 142,993 -------- -------- ---------\nCash flows from investing activities Additions to property and equipment (41,945) (101,603) (21,783) Deposits to reserve for replacements (21,948) (22,440) (20,940) -------- -------- ---------\nNet cash used in investing activities (63,893) (124,043) (42,723) -------- -------- ---------\nCash flows from financing activities Repayment of mortgage payable (42,607) (39,538) (36,689) Distributions (25,214) (25,214) (81,944) -------- -------- ---------\nNet cash used in financing activities (67,821) (64,752) (118,633) -------- -------- ---------\nNET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 56,228 28,426 (18,363)\nCash and cash equivalents, beginning 183,321 154,895 173,258 -------- -------- ---------\nCash and cash equivalents, ending $ 239,549 $ 183,321 $ 154,895 ========= ========= =========\nThe accompanying notes are an integral part of these financial statements.\nFawcett's Pond Apartments Company\nSTATEMENTS OF CASH FLOWS - CONTINUED\nYears ended December 31, 1995, 1994 and 1993\n1995 1994 1993 ---- ---- ----\nReconciliation of excess of revenue over expenses to net cash provided by operating activities Excess of revenue over expenses $ 47,439 $ 82,495 $ 11,748 Adjustments to reconcile excess of revenue over expenses to net cash provided by operating activities Depreciation 136,241 134,182 120,910 Amortization 8,162 8,162 8,162 Interest earned on reserve for replacements (6,584) (3,980) (2,776) Changes in assets and liabilities Decrease in tenant accounts receivable - 71 1,776 Increase in accounts receivable - other (746) (147) (107) Decrease (increase) in mortgage escrow deposits 378 (3,704) 349 (Increase) decrease in tenants' security deposits - net (138) (899) 4,000 (Increase) decrease in prepaid expenses (118) 670 (524) Increase in accounts payable and accrued expenses 5,263 758 2,266 Decrease in accrued interest payable (266) (248) (229) Decrease in rent deferred credits (1,689) (139) (2,582) -------- ------- --------\nNet cash provided by operating activities $ 187,942 $ 217,221 $ 142,993 ========= ======== =========\nThe accompanying notes are an integral part of these financial statements.\nFawcett's Pond Apartments Company\nNOTES TO FINANCIAL STATEMENTS - CONTINUED\nDecember 31, 1995, 1994 and 1993\nNOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nThe Partnership was formed as a limited partnership under the laws of the State of Massachusetts on June 30, 1983, for the purpose of constructing and operating a rental housing project under Section 221(d)(4) of the National Housing Act. The project consists of 100 units located in Hyannis, Massachusetts and is currently operating under the name of Fawcett's Pond Apartments. All leases between the Partnership and the tenants of the property are operating leases.\nCash distributions are limited by agreements between the Partner-ship and HUD to the extent of surplus cash as defined by HUD.\nUse of Estimates\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.\nCash and Cash Equivalents\nCash and cash equivalents consist of cash and repurchase agreements with maturities of three months or less when acquired, stated at cost, which approximates market.\nProperty and Equipment\nProperty and equipment are carried at cost. Depreciation is provided for in amounts sufficient to relate the cost of depreciable assets to operations over their estimated service lives by use of the straight-line method for financial reporting purposes. For income tax purposes, accelerated lives and methods are used.\nDeferred Financing Costs\nDeferred financing costs are amortized over the term of the mortgage using the straight-line method.\nRental Income\nRental income is recognized as rentals become due. Rental payments received in advance are deferred until earned.\nIncome Taxes\nNo provision or benefit for income taxes has been included in these financial statements since taxable income or loss passes through to, and is reportable by, the partners individually.\nNOTE B - CASH HELD IN ESCROW FOR TENANT SECURITY DEPOSITS\nAt December 31, 1995 and 1994, the Partnership maintained tenant security deposits of $4,843 and $3,772, respectively, in an interest-bearing escrow bank account. At December 31, 1995, tenant security deposits included $19,557 in a U.S. Treasury Bill at a 5.483% interest rate which matures June 1, 1996. At December 31, 1994, tenant security deposits included $19,485 in a U.S. Treasury Bill at a 6.124% interest rate which matured on June 1, 1995. The investment in a U.S. Treasury Bill is held to maturity and is carried at cost which approximates market.\nNOTE C - MORTGAGE PAYABLE\nThe mortgage payable represents a permanent mortgage from the Government National Mortgage Association (GNMA) which is insured by the Federal Housing Administration (FHA) and is collateralized by a deed of trust on the rental property. The mortgage, which is due April 1, 2024, is payable in equal monthly installments of principal and interest totalling $30,746 and bears interest at a rate of 7.5%. Interest incurred during December 31, 1995, 1994, and 1993 amounted to $326,076, $329,165, and $332,719, respectively.\nUnder agreements with the mortgage lender and FHA, the Partnership is required to make monthly escrow deposits for taxes, insurance and replacement of project assets, and is subject to restrictions as to operating policies, rental charges, operating expenditures and distributions to partners.\nThe liability of the Partnership under the mortgage is limited to the underlying value of the real estate, plus other amounts deposited with the lender.\nAggregate maturities of the mortgage payable for the five years following December 31, 1995 are as follows:\n1996 $45,914 1997 $49,479 1998 $53,320 1999 $57,459 2000 $61,920\nManagement believes it is not practical to estimate the fair value of the mortgage payable insured by FHA because programs with similar characteristics are not currently available to the Partnership.\nNOTE D - HOUSING ASSISTANCE PAYMENT AGREEMENT\nFHA contracted with the Partnership under Section 8 of Title II of the Housing and Community Development Act of 1974, to make housing assistance payments to the Partnership on behalf of qualified tenants for all units. The agreement expires August 19, 2002. Total housing assistance payments received during 1995, 1994, and 1993 were $768,409, $769,446, and $752,000, respectively.\nNOTE E - RELATED PARTY TRANSACTIONS\nDue to General Partners\nAt December 31, 1995 and 1994, due to general partner consisted of unpaid developer advances of $277,400. These advances are non-interest bearing and payable from proceeds upon sale or refinancing of the project after certain priority payments, as defined in the Partnership agreement.\nManagement Fees\nManagement fees of 5% of gross receipts are paid to CMJ Management Company, Inc., an affiliate of the general partner, for its services as managing agent to the project pursuant to a management agreement approved by HUD. Such fees amounted to $46,933, $46,686, and $45,886 for the years ended December 31, 1995, 1994, and 1993, respectively. In addition, CMJ Management Company received incentive management fees of $6,303, $6,303, and $44,124 for the years ended December 31, 1995, 1994, and 1993, respectively.\nReimbursed Costs\nCMJ Management Company, Inc., an affiliate of the general partner, makes monthly expenditures (primarily payroll, central office accounting services, direct marketing and insurance costs) on behalf of the Partnership which are reimbursed the following month.\nNOTE F - TAX BASIS INCOME\nThe reconciliation of the excess of revenue over expenses reported in the accompanying statements of operations with the profit reported on the federal income tax basis follows:\n1995 1994 1993 ---- ---- ----\nExcess of revenue over expenses per statement of operations $ 47,439 $ 82,495 $ 11,748 Additional depreciation and amortization on tax basis (75,550) (63,352) (107,925) (Decrease) increase in deferred rental income (1,689) (139) (2,582) -------- -------- --------- Income (loss) for federal tax purposes $(29,800) $ 19,004 $ (98,759) ======== ========= =========\nNOTE G - CONCENTRATION OF CREDIT RISK\nThe Partnership maintains its cash balances in one bank, which consists of an operating account and security deposits held in trust. The operating account is comprised of an overnight repurchase agreement backed by government securities and a checking account. The security deposits held in trust are comprised of a United States Treasury Bill and a savings account. Account balances are insured by the Federal Deposit Insurance Corporation up to $100,000 by each bank. The Partnership also has a reserve for replacements and escrow funds totalling $257,677 at December 31, 1995, on deposit with Reilly Mortgage Group, Inc.\nINDEPENDENT AUDITORS' REPORT\nTo the Partners Quaker Meadows Apartments Company\nWe have audited the accompanying balance sheets of Quaker Meadows Apartments Company as of December 31, 1995 and 1994, and the related statements of operations, partners' deficit, and cash flows for each of the three years in the period ended December 31, 1995. 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 Quaker Meadows Apartments Company as of December 31, 1995 and 1994, and the results of its operations, changes in partners' deficit and its cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\n\/s\/ Reznick Fedder & Silverman REZNICK FEDDER & SILVERMAN\nBaltimore, Maryland January 30, 1996\nQuaker Meadows Apartments Company\nBALANCE SHEETS\nDecember 31, 1995 and 1994\nASSETS\n1995 1994 ---- ---- CURRENT ASSETS Cash and cash equivalents $ 154,566 $ 197,822 Accounts receivable 2,772 1,558 Other receivables 16,114 6,522 Prepaid expenses 10,394 10,219 ----------- ----------- Total current assets 183,846 216,121 ----------- -----------\nRESTRICTED FUNDS Mortgage escrow deposits 16,938 16,391 Reserve for replacements 265,353 239,160 Tenants' security deposits 20,009 19,174 ----------- ----------- 302,300 274,725 ----------- ----------- PROPERTY AND EQUIPMENT, less accumulated depreciation of $3,526,272 and $3,269,189 4,208,046 4,441,160 ----------- -----------\nDEFERRED FINANCING COSTS, net of accumulated amortization of $54,396 and $50,331 75,755 79,820 ----------- ----------- Total assets $ 4,769,947 $ 5,011,826 =========== ===========\nLIABILITIES AND PARTNERS' DEFICIT\nCURRENT LIABILITIES Current maturities of mortgage payable $ 94,935 $ 84,413 Accounts payable and accrued expenses 42,822 42,481 Accrued interest payable 60,082 60,082 Rent deferred credits 2,519 5,102 ----------- ----------- Total current liabilities 200,358 192,078\nLONG-TERM LIABILITIES Mortgage payable, less current maturities 5,201,613 5,296,548 Due to general partner 1,072,952 1,072,952 Tenants' security deposits 15,892 16,205 ----------- ----------- Total liabilities 6,490,815 6,577,783\nPARTNERS' DEFICIT (1,720,868) (1,565,957) ----------- -----------\nTotal liabilities and partners' deficit $ 4,769,947 $ 5,011,826 =========== ===========\nThe accompanying notes are an integral part of these financial statements.\nQuaker Meadows Apartments Company\nSTATEMENTS OF OPERATIONS\nYears ended December 31, 1995, 1994 and 1993\n1995 1994 1993 ---- ---- ---- Revenue Rental income $1,596,066 $1,589,728 $1,574,805 Vacancies (5,331) (350) (993) Other income 27,834 13,819 9,548 ---------- ---------- ----------\nTotal revenue 1,618,569 1,603,197 1,583,360 ---------- ---------- ---------- Expenses Operating expenses Administration 122,910 128,528 121,823 Management fees to affiliate 63,546 63,567 62,785 Utilities 125,584 122,063 112,540 Maintenance and repairs 310,136 282,689 258,222 Insurance 15,416 16,208 18,083 Real estate taxes 65,161 65,218 65,391 ---------- ---------- ---------- Total operating expenses 702,753 678,273 638,844 ---------- ---------- ---------- Nonoperating expenses Interest 671,237 680,607 688,937 Depreciation and amortization 261,148 258,164 252,264 Incentive management fee to affiliate 45,390 38,239 34,761 Social services expenses 23,062 20,081 18,632 ---------- ---------- ---------- Total nonoperating expenses 1,000,837 997,091 994,594 ---------- ---------- ---------- Total expenses 1,703,590 1,675,364 1,633,438 ---------- ---------- ---------- EXCESS OF EXPENSES OVER REVENUE $ (85,021) $ (72,167) $ (50,078) ========== ========== ==========\nThe accompanying notes are an integral part of these financial statements.\nQuaker Meadows Apartments Company\nSTATEMENTS OF PARTNERS' DEFICIT\nYears ended December 31, 1995, 1994 and 1993\nGeneral Limited Partner Partner Total ------ ------ -----\nPartners' deficit, December 31, 1992 $(311,725) $(1,011,469) $(1,323,194)\nDistributions (2,918) (55,457) (58,375)\nExcess of expenses over revenue (2,504) (47,574) (50,078) --------- ----------- -----------\nPartners' deficit, December 31, 1993 (317,147) (1,114,500) (1,431,647)\nDistributions (3,107) (59,036) (62,143)\nExcess of expenses over revenue (3,608) (68,559) (72,167) --------- ----------- -----------\nPartners' deficit, December 31, 1994 (323,862) (1,242,095) (1,565,957)\nDistributions (3,494) (66,396) (69,890)\nExcess of expenses over revenue (4,251) (80,770) (85,021) --------- ----------- -----------\nPartners' deficit, December 31, 1995 $(331,607) $(1,389,261) $(1,720,868) ========= =========== ===========\nProfit and loss sharing percentage 5% 95% 100% == ==== ====\nThe accompanying notes are an integral part of these financial statements.\nQuaker Meadows Apartments Company\nSTATEMENTS OF CASH FLOWS\nYears ended December 31, 1995, 1994 and 1993\n1995 1994 1993 ---- ---- ----\nCash flows from operating activities Rental income received $1,572,590 $1,588,714 $1,569,771 Interest received 22,043 13,212 12,184 Other income received 10,547 2,233 42 Administration expenses paid (122,910) (137,263) (122,857) Management fees paid (63,546) (63,567) (62,785) Utilities paid (119,506) (122,063) (104,641) Maintenance and repair expenses paid (315,873) (312,077) (217,647) Real estate taxes paid (65,161) (65,218) (65,319) Property insurance paid (16,081) (15,834) (18,083) Interest paid on mortgage (670,747) (680,102) (688,937) Incentive fees paid (68,452) (58,320) (53,393) Increase in mortgage escrow deposits (547) (5,463) - Net security deposits (paid) received (1,148) (863) 280 --------- --------- --------\nNet cash provided by operating activities 161,209 143,389 248,615 --------- --------- --------\nCash flows from investing activities Acquisition of land, building and equipment (23,969) (13,751) (61,602) Increase in reserve for replacements (26,193) (26,565) (63) --------- --------- -------- Net cash used in investing activities (50,162) (40,316) (61,665)\nCash flows from financing activities Repayment of mortgage payable (84,413) (75,058) (66,739) Distributions (69,890) (62,143) (58,375) --------- --------- -------- Net cash used in financing activities (154,303) (137,201) (125,114) --------- --------- -------- NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (43,256) (34,128) 61,836\nCash and cash equivalents, beginning 197,822 231,950 170,114 --------- --------- -------- Cash and cash equivalents, ending $ 154,566 $ 197,822 $231,950 ========= ========= ========\nQuaker Meadows Apartments Company\nSTATEMENTS OF CASH FLOWS - CONTINUED\nYears ended December 31, 1995, 1994 and 1993\n1995 1994 1993 ---- ---- ----\nReconciliation of excess of expenses over revenue to net cash provided by operating activities Excess of expenses over revenue $ (85,021) $ (72,167) $ (50,078) Adjustments to reconcile excess of expenses over revenue to net cash provided by operating activities Depreciation and amortization 261,148 258,164 252,264 Changes in assets and liabilities (Increase) decrease in accounts receivable (10,806) 1,073 2,831 Increase in mortgage escrow deposits (547) (5,463) - (Increase) decrease in tenants' security deposits - net (1,148) (864) 280 (Increase) decrease in prepaid expenses (175) 879 (1,034) Increase (decrease) in accounts payable and accrued expenses 341 (38,122) 48,546 Decrease in rent deferred credits (2,583) (111) (4,194) ---------- ----------- ----------\nNet cash provided by operating activities $ 161,209 $ 143,389 $ 248,615 ========== ========== ==========\nThe accompanying notes are an integral part of these financial statements.\nQuaker Meadows Apartments Company\nNOTES TO FINANCIAL STATEMENTS - CONTINUED\nDecember 31, 1995, 1994 and 1993\nNOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nThe Partnership was formed as a limited partnership under the laws of the State of Massachusetts on February 1, 1982, for the purpose of constructing and operating a rental housing project under Massachusetts Housing Finance Agency's (MHFA) housing program. The project consists of 104 units located in Lynn, Massachusetts and is currently operating under the name of Quaker Meadows Apartments. All leases between the Partnership and tenants of the property are operating leases.\nUse of Estimates\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.\nCash and Cash Equivalents\nCash and cash equivalents consist of all highly liquid debt instruments with maturities of three months or less when acquired, stated at cost which approximates fair value.\nProperty and Equipment\nProperty and equipment are carried at cost. The Partnership provides for depreciation by use of the straight-line method over estimated useful lives of the assets as follows: buildings, 30 years, and equipment, 3-8 years.\nDeferred Financing Costs\nDeferred financing costs, which consist principally of financing fees are amortized by the straight-line method over the life of the related debt.\nRental Income\nRental income is recognized as rentals become due. Rental payments received in advance are deferred until earned.\nIncome Taxes\nNo provision or benefit for income taxes has been included in these financial statements since taxable income or loss passes through to, and is reportable by, the partners individually.\nNOTE B - CASH HELD IN ESCROW FOR TENANTS' SECURITY DEPOSITS\nAt December 31, 1995 and 1994, the Partnership maintained tenants' security deposits of $20,009 and $19,174 in an interest-bearing escrow bank account and U.S. Treasury bills, with a maturity of six months or less when acquired, stated at cost, which approximates market.\nNOTE C - MORTGAGE PAYABLE\nThe mortgage payable represents a permanent mortgage from the Massachusetts Housing Finance Agency (MHFA), due September 1, 2013, and payable in equal monthly installments of $62,930 (principal and interest) at an interest rate of 12.5%. The terms of the permanent mortgage also require monthly escrow deposits for real estate taxes and a replacement reserve.\nThe liability of the Partnership under the mortgage is limited to the underlying value of the real estate, plus other amounts deposited with the lender.\nAggregate maturities of the mortgage payable for the five years following December 31, 1995 are as follows:\n1996 $ 94,935 1997 $106,768 1998 $119,880 1999 $135,044 2000 $151,877\nManagement believes it is not practical to estimate the fair value of the mortgage payable insured by MHFA because programs with similar characteristics are not currently available to the Partnership.\nNOTE D - HOUSING ASSISTANCE PAYMENT AGREEMENT\nThe Federal Housing Administration (FHA) has contracted with the Partnership under Section 8 of Title II of the Housing and Community Development Act of 1974, to make housing assistance payments to the Partnership on behalf of qualified tenants. The agreement expires May 2002 and has two five-year renewal options. Total housing assistance payments received during 1995, 1994 and 1993 were $1,335,437, $1,321,357, and $1,301,889, respectively.\nNOTE E - RECONCILIATION OF FINANCIAL STATEMENT INCOME TO TAX BASIS INCOME\nThe reconciliation of the loss reported in the accompanying statement of operations with the loss reported on a federal income tax basis follows:\n1995 1994 1993 ---- ---- ----\nNet loss per statement of operations $(85,021) $(72,167) $(50,078) Decrease (increase) in depreciation 8,071 (18,503) (36,813) (Decrease) increase in deferred rental income (2,583) (111) (4,194) -------- -------- -------- Loss for federal income tax purposes $(79,533) $(90,781) $(91,085) ======== ======== ========\nNOTE F - RELATED PARTY TRANSACTIONS\nAt December 31, 1995 and 1994, due to the general partner consists of development advances totaling $1,072,952. These advances are non-interest bearing and payable from proceeds upon the sale or refinancing of the project as defined in the Partnership agreement.\nManagement fees of 4% of gross receipts are paid to CMJ Management Company, Inc., an affiliate of the general partner, for its services as management agent to the project, pursuant to a management agreement approved by MHFA. Such fees amounted to $63,546, $63,567, and $62,785, and for the years ended December 31, 1995, 1994 and 1993, respectively. In addition, CMJ Management Company, Inc., received incentive management fees of $45,390, $38,239 and $34,761 for the years ended December 31, 1995, 1994 and 1993 respectively.\nCMJ Management Company, Inc., an affiliate of the general partner, makes monthly expenditures (primarily payroll, central office accounting, direct marketing and insurance costs) on behalf of the Partnership which are reimbursed the following month.\nNOTE G - CONCENTRATION OF CREDIT RISK\nThe Partnership maintains its cash balances with one bank, which consists of an overnight repurchase agreement backed by government securities and an operating checking account. Account balances are insured by the Federal Deposit Insurance Corporation up to $100,000 by each bank. The Partnership also has a reserve for replacements and escrow funds totaling $282,291 on deposit with the Massachusetts Housing Finance Agency.\nINDEPENDENT AUDITORS' REPORT\nTo the Partners South Laurel Apartments Limited Partnership\nWe have audited the accompanying balance sheets of South Laurel Apartments Limited Partnership as of December 31, 1995 and 1994, and the related statements of operations, partners' deficit and cash flows for each of the three years in the period ended December 31, 1995. 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 South Laurel Apartments Limited Partnership as of December 31, 1995 and 1994, and the results of its operations, changes in partners' deficit and its cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\n\/s\/ Reznick Fedder & Silverman REZNICK FEDDER & SILVERMAN\nBaltimore, Maryland January 27, 1996\nSouth Laurel Apartments Limited Partnership\nBALANCE SHEETS\nDecember 31, 1995 and 1994\nASSETS\n1995 1994 ---- ---- CURRENT ASSETS Cash and cash equivalents $ 282,541 $ 329,635 Accounts receivable 98,186 67,210 Other receivables 63,452 10,134 Prepaid expenses 171,166 214,272 ----------- ----------- Total current assets 615,345 621,251\n----------- ----------- RESTRICTED DEPOSITS AND FUNDED RESERVES Tenants' security deposits 110,774 115,697 Mortgage escrow deposits 159,086 169,745 Reserve for replacements 124,923 210,867 ----------- ----------- 394,783 496,309 ----------- ----------- PROPERTY AND EQUIPMENT, less accumulated depreciation of $5,949,207 and $5,515,858 9,189,556 9,352,404 ----------- -----------\nDEFERRED FINANCING COSTS, net of accumulated amortization of $161,272 and $149,110 349,454 361,616 ----------- -----------\nTotal assets $10,549,138 $10,831,580 =========== ===========\nLIABILITIES AND PARTNERS' DEFICIT\nCURRENT LIABILITIES Current maturities of mortgage payable $ 132,273 $ 122,744 Accounts payable and accrued expenses 151,002 146,012 Accrued interest payable 75,746 76,513 Rent deferred credits 56,668 32,074 Deferred income - laundry 45,000 50,000 ----------- ----------- Total current liabilities 460,689 427,343\nLONG-TERM LIABILITIES Mortgage payable, less current maturities 11,987,062 12,119,335 Due to general partner 645,989 645,989 Tenants' security deposits 106,558 99,501 ----------- -----------\nTotal liabilities 13,200,298 13,292,168 PARTNERS' DEFICIT (2,651,160) (2,460,588) ----------- ----------- Total liabilities and partners' deficit $10,549,138 $10,831,580 =========== ===========\nThe accompanying notes are an integral part of these financial statements.\nSouth Laurel Apartments Limited Partnership\nSTATEMENTS OF OPERATIONS\nYears ended December 31, 1995, 1994 and 1993\n1995 1994 1993 ---- ---- ----\nRevenue Rental income $4,188,172 $4,230,214 $4,295,874 Vacancies (210,793) (233,900) (466,248) Financial revenue 27,955 15,885 15,232 Other income 87,625 81,660 82,531 ---------- ---------- ----------\nTotal revenue 4,092,959 4,093,859 3,927,389 ---------- ---------- ----------\nExpenses Operating expenses Marketing 118,426 99,484 262,768 Administration 368,243 434,060 337,689 Utilities 556,935 553,622 593,199 Management fee 215,298 211,572 205,377 Maintenance and repairs 647,209 588,592 538,752 Salaries 545,833 498,319 461,609 Insurance 68,236 85,604 102,767 Real estate taxes 264,590 257,736 265,935 ---------- ---------- ----------\nTotal operating expenses 2,784,770 2,728,989 2,768,096 ---------- ---------- ----------\nNonoperating expenses Interest 913,226 922,124 933,875 Mortgage insurance premium 60,882 61,475 62,025 Depreciation and amortization 445,511 413,901 388,703 Incentive management fee 806 - 23,563 Miscellaneous financial expenses 4,142 3,801 - ---------- ---------- ----------\nTotal nonoperating expenses 1,424,567 1,401,301 1,408,166 ---------- ---------- ----------\nTotal expenses 4,209,337 4,130,290 4,176,262 ---------- ---------- ----------\nEXCESS OF EXPENSES OVER REVENUE $ (116,378) $ (36,431) $ (248,873) ========== ========== ==========\nThe accompanying notes are an integral part of these financial statements.\nSouth Laurel Apartments Limited Partnership\nSTATEMENTS OF PARTNERS' DEFICIT\nYears ended December 31, 1995, 1994 and 1993\nSpecial Class A Class B General Limited Limited Limited Partners Partners Partner Partners Total ------- ------- ------- ------- -----\nPartners' deficit, December 31, 1992 $ (97,479) $(1,241,052) $(263,986) $(445,663)$(2,048,180)\nDistributions (1,083) (4,333) (92,079) (10,833) (108,328)\nExcess of expenses over revenue (2,489) (9,955) (211,542) (24,887) (248,873) --------- ---------- --------- -------- ----------\nPartners' deficit, December 31, 1993 (101,051) (1,255,340) (567,607) (481,383)(2,405,381)\nDistributions (188) (751) (15,960) (1,877) (18,776)\nExcess of expenses over revenue (364) (1,457) (30,967) (3,643) (36,431) --------- ---------- --------- -------- ----------\nPartners' deficit, December 31, 1994 (101,603) (1,257,548) (614,534) (486,903)(2,460,588)\nDistributions (742) (2,967) (63,065) (7,420) (74,194)\nExcess of expenses over revenue (1,164) (4,655) (98,921) (11,638) (116,378) --------- ---------- --------- -------- ----------\nBalance, December 31, 1995 $(103,509)$(1,265,170) $(776,520) $(505,961)$(2,651,160) ========= =========== ========= ========= ==========\nProfit and loss sharing percentage 1% 4% 85% 10% 100% == == === === ====\nThe accompanying notes are an integral part of these financial statements.\nSouth Laurel Apartments Limited Partnership\nSTATEMENTS OF CASH FLOWS\nYears ended December 31, 1995, 1994 and 1993\n1996 1995 1994 ---- ---- ---- Cash flows from operating activities Rental income received $ 3,970,997 $3,985,744 $3,845,652 Interest received 21,737 15,694 9,348 Other income received 82,130 82,103 62,386 Administration expenses paid (616,037) (642,875) (711,618) Management fees paid (215,298) (224,966) (205,377) Utilities paid (543,544) (583,140) (565,116) Maintenance and repairs expenses paid (1,026,412) (893,727) (784,262) Real estate taxes paid (265,876) (253,363) (272,051) Payroll taxes paid (45,663) (50,570) (53,534) Property insurance paid (46,696) (24,158) (33,752) Other taxes and insurance paid (36,565) (55,401) (72,827) Mortgage insurance paid (1,465) (60,682) (123,700) Interest paid on mortgage (913,993) (922,836) (931,041) Miscellaneous financial expenses paid (4,142) (3,801) (3,494) (Increase) decrease in mortgage escrow deposits 11,980 (59,029) 58,522 Mortgagor entity expenses paid (806) - (23,563) Net security deposits received (paid) 10,659 52,083 (2,340) ---------- --------- --------- Net cash provided by operating activities 381,006 361,076 193,233 ---------- --------- ---------\nCash flows from investing activities Additions to property and equipment (270,501) (155,382) (133,154) Deposits to reserve for replacements (52,520) (120,744) (52,520) Withdrawals from reserve for replacements 91,859 153,186 162,094 ---------- --------- --------- Net cash used in investing activities (231,162) (122,940) (23,580) ---------- --------- --------- Cash flows from financing activities Mortgage principal payments (122,744) (113,902) (105,696) Distributions to partners (74,194) (18,776) (108,328) ---------- --------- --------- Net cash used in financing activities (196,938) (132,678) (214,024) ---------- --------- --------- NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (47,094) 105,458 (44,371)\nCash and cash equivalents, beginning 329,635 224,177 268,548 ---------- --------- --------- Cash and cash equivalents, ending $ 282,541 $ 329,635 $ 224,177 =========== ========== ==========\nSouth Laurel Apartments Limited Partnership\nSTATEMENTS OF CASH FLOWS - CONTINUED\nYears ended December 31, 1995, 1994 and 1993\n1996 1995 1994 ---- ---- ----\nReconciliation of excess of expenses over revenue to net cash provided by operating activities Excess of expenses over revenue $ (116,378) $ (36,431) $ (248,873) Adjustments to reconcile excess of expenses over revenue to net cash provided by operating activities Depreciation 433,349 401,739 376,541 Amortization 12,162 12,162 12,162 Interest on reserve for replacements (6,218) (191) (5,884) Changes in assets and liabilities (Increase) decrease in tenant accounts receivable (30,976) 17,829 (1,638) (Increase) decrease in accounts receivable - other (495) 5,443 (15,145) Decrease (increase) in prepaid expenses 43,106 7,129 (65,670) Decrease (increase) in mortgage escrow deposits 10,659 (59,029) 58,522 Increase (decrease) in accounts payable and accrued expenses 4,990 (5,547) 73,557 Decrease in accrued interest payable (767) (712) (660) Tenants' security deposits received (paid) - net 11,980 52,083 (2,340) Increase (decrease) in rent - deferred credits 24,594 (28,399) 17,661 Decrease in deferred laundry income (5,000) (5,000) (5,000) ---------- --------- ---------\nNet cash provided by operating activities $ 381,006 $ 361,076 $ 193,233 ========== ========= ==========\nThe accompanying notes are an integral part of these financial statements.\nSouth Laurel Apartments Limited Partnership\nNOTES TO FINANCIAL STATEMENTS - CONTINUED\nDecember 31, 1995, 1994 and 1993\nNOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nThe Partnership was formed as a limited partnership under the laws of the State of Maryland on June 30, 1983, for the purpose of constructing and operating a rental housing project under Section 221(d)(4) of the National Housing Act. The project consists of 520 units located in Laurel, Maryland and is currently operating under the name of Villages at Montpelier. All leases between the Partnership and the tenants of the property are operating leases.\nCash distributions are limited by agreements between the Partner-ship and HUD to the extent of surplus cash as defined by HUD.\nUse of Estimates\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.\nCash and Cash Equivalents\nCash and cash equivalents consist of cash and repurchase agree-ments with a bank with maturities of three months or less when acquired, stated at cost, which approximates market.\nProperty and Equipment\nProperty and equipment are carried at cost. Depreciation is provided for in amounts sufficient to relate the cost of depreciable assets to operations over their estimated service lives by use of the straight-line method for financial reporting purposes. For income tax purposes, accelerated lives and methods are used.\nDeferred Financing Costs\nDeferred financing costs are amortized over the term of the mortgage using the straight-line method.\nRental Income\nRental income is recognized as rentals become due. Rental payments received in advance are deferred until earned.\nIncome Taxes\nNo provision or benefit for income taxes has been included in these financial statements since taxable income or loss passes through to, and is reportable by, the partners individually.\nNOTE B - CASH HELD IN ESCROW FOR TENANTS' SECURITY DEPOSITS\nAt December 31, 1995 and 1994, the Partnership maintained tenant security deposits of $11,906 and $16,476, respectively, in an interest-bearing escrow bank account. At December 31, 1995, tenant security deposits included $98,868 in a U.S. Treasury Bill at a 5.45% interest rate which matures March 21, 1996. At December 31, 1994, tenant security deposits included $99,221 in a U.S. Treasury Bill at a 5.5% interest rate which matured on February 23, 1995. The investments in U.S. Treasury Bills are held to maturity and are carried at cost which approximates market.\nNOTE C - MORTGAGE PAYABLE\nThe mortgage is insured by the Federal Housing Administration (FHA) and collateralized by a deed of trust on the rental property. The mortgage, which is due December 1, 2023, is payable in equal monthly installments of principal and interest totalling $86,395 and bears interest at a rate of 7.5%. Interest incurred during 1995, 1994, and 1993 amounted to $913,226, $922,124, and $933,875, respectively.\nUnder agreements with the mortgage lender and FHA, the Partnership is required to make monthly escrow deposits for taxes, insurance and replacement of partnership assets, and is subject to restrictions as to operating policies, rental charges, operating expenditures and distributions to partners.\nThe liability of the Partnership under the mortgage is limited to the underlying value of the real estate, plus other amounts deposited with the lender.\nAggregate maturities of the mortgage payable for the five years following December 31, 1995 are as follows:\n1996 $132,273 1997 $142,542 1998 $153,608 1999 $165,533 2000 $178,384\nManagement believes it is not practical to estimate the fair value of the mortgage payable insured by FHA because programs with similar characteristics are not currently available to the Partnership.\nNOTE D - HOUSING ASSISTANCE PAYMENT AGREEMENT\nFHA contracted with the Partnership under Section 8 of Title II of the Housing and Community Development Act of 1974, to make housing assistance payments to the Partnership on behalf of qualified tenants for 20% of the rental units. The agreement expires July 31, 1997. Total housing assistance payments received during 1995, 1994, and 1993 were $677,108, $694,002, and $685,324, respectively.\nNOTE E - RELATED PARTY TRANSACTIONS\nDue to General Partner\nAt December 31, 1995 and 1994, due to general partner consists of unpaid development advances of $645,989. These advances are non-interest bearing and payable from proceeds upon sale or refinancing of the project after certain priority payments as defined in the Partnership agreement.\nManagement Fees\nManagement fees of 5.25% of gross receipts are paid to CMJ Man-agement Company, Inc., an affiliate of the general partner, for its services as management agent to the project pursuant to a management agreement approved by HUD. Such fees amounted to $215,298, $211,572, and $205,377 for the years ended December 31, 1995, 1994 and 1993, respectively. In addition, CMJ Management Company, Inc., received incentive management fees of $808, $ - 0 -, and $23,563 for the years ended December 31, 1995, 1994 and 1993, respectively.\nReimbursed Costs\nCMJ Management Company, Inc., an affiliate of the general part-ner, makes monthly expenditures (primarily payroll, central office accounting, direct marketing and insurance costs) on behalf of the Partnership which are reimbursed the following month.\nNOTE F - TAX BASIS LOSS\nThe reconciliation of the excess of expenses over revenue reported in the accompanying statement of operations with the loss reported on a federal income tax basis follows:\n1995 1994 1993 ---- ---- ----\nExcess of expenses over revenue per statement of profit and loss $(116,378) $ (36,431) $(248,873) Increase (decrease) in deferred rental and laundry income 19,593 (33,399) 12,661 Additional depreciation and amortization (181,224) (172,836) (190,322) ---------- ---------- ---------\nLoss for federal income tax purposes $(278,009) $(242,666) $(426,534) ========= ========= =========\nNOTE G - CONCENTRATION OF CREDIT RISK\nThe Partnership maintains its cash balances in two banks. The operating account consists of an overnight repurchase agreement backed by government securities and a checking account. The tenant security deposit accounts are held in trust and consist of a checking account and a United States Treasury Bill. The balances are insured up to $100,000 by each bank. The Partnership also has $284,009 of money market funds held in escrow by Reilly Mortgage Group, Inc., carried at cost, which approximates fair value.\nINDEPENDENT AUDITORS' REPORT\nTo the Partners Marvin Gardens Associates\nWe have audited the accompanying balance sheets of Marvin Gardens Associates as of December 31, 1995 and 1994, and the related statements of operations, partners' deficit, and cash flows for each of the three years in the period ended December 31, 1995. 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 Marvin Gardens Associates as of December 31, 1995 and 1994, and the results of its operations, changes in its partners' deficit and its cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\n\/s\/ Reznick Fedder & Silverman REZNICK FEDDER & SILVERMAN\nBaltimore, Maryland January 27, 1996\nMarvin Gardens Associates\nBALANCE SHEETS\nDecember 31, 1995 and 1994\nASSETS\n1995 1994 ---- ---- CURRENT ASSETS Cash $ 15,301 $ 65,733 Accounts receivable 837 812 Accounts receivable - tenant subsidy 3,221 3,036 Prepaid expenses 6,643 6,046 ---------- ---------- Total current assets 26,002 75,627 ---------- ----------\nRESTRICTED DEPOSITS AND FUNDED RESERVES Tenants' security deposits 9,241 8,865 Real estate tax impound fund 6,128 6,319 Replacement reserve fund 116,539 123,853 Insurance impound fund 4,190 3,902 Interest income receivable - impounds 1,198 1,098 ---------- ---------- 137,296 144,037 ---------- ----------\nPROPERTY AND EQUIPMENT, less accumulated depreciation of $964,277 and $891,240 1,443,439 1,483,640 ---------- ----------\nDEFERRED FINANCING COSTS, net of accumulated amortization of $18,199 and $16,859 28,170 29,510 ---------- ----------\nTotal assets $1,634,907 $ 1,732,814 ========== ===========\nLIABILITIES AND PARTNERS' DEFICIT\nLIABILITIES Current maturities of mortgage payable $ 46,375 $ 42,757 Accounts payable 14,539 13,736 Accrued expenses 4,241 3,886 Deferred rental income 2,055 - ---------- ---------- Total current liabilities 67,210 60,379\nMortgage payable, less current maturities 1,660,927 1,707,302 Due to general partner 194,019 194,019 Tenants' security deposits 6,960 6,773 ---------- ---------- Total liabilities 1,929,116 1,968,473\nPARTNERS' DEFICIT (294,209) (235,659 ---------- ----------)\nTotal liabilities and partners' deficit $1,634,907 $1,732,814 ========== ==========\nThe accompanying notes are an integral part of these financial statements.\nMarvin Gardens Associates\nSTATEMENTS OF OPERATIONS\nYears ended December 31, 1995, 1994 and 1993\n1995 1994 1993 ---- ---- ---- Revenue Rental income $409,395 $399,915 $392,060 Vacancies (1,533) (2,258) (901) Financial revenue 7,817 5,989 6,669 Other income 3,174 3,430 3,451 -------- -------- --------\nTotal revenue 418,853 407,076 401,279 -------- -------- --------\nExpenses Operating expenses Administration 15,866 17,876 12,677 Utilities 27,992 22,262 19,051 Management fee 17,052 15,852 14,652 Maintenance and repairs 73,953 58,546 68,196 Salaries 57,141 55,854 52,215 Insurance 7,839 7,361 6,320 Real estate taxes 21,824 21,152 19,888 -------- -------- --------\nTotal operating expenses 221,667 198,903 192,999 -------- -------- --------\nNon-operating expenses Interest 141,056 144,392 147,467 Depreciation and amortization 74,377 70,272 69,033 Incentive management fee 12,090 1,970 - -------- -------- --------\nTotal non-operating expenses 227,523 216,634 216,500 -------- -------- --------\nTotal expenses 449,190 415,537 409,499 -------- -------- -------- EXCESS OF EXPENSES OVER REVENUE $ (30,337) $ (8,461) $ (8,220) ========= ======== ========\nThe accompanying notes are an integral part of these financial statements.\nMarvin Gardens Associates\nSTATEMENTS OF PARTNERS' DEFICIT\nYears ended December 31, 1995, 1994 and 1993\nSpecial General Limited Limited Partner Partner Partner Total ------- ------- ------- ------\nBeginning, December 31, 1992 $(7,904) $(65,738) $(124,255) $(197,897)\nDistributions (81) (322) (7,648) (8,051)\nExcess of expenses over revenue (82) (329) (7,809) (8,220) ------ -------- --------- ---------\nBalance, December 31, 1993 (8,067) (66,389) (139,712) (214,168)\nDistributions (130) (521) (12,379) (13,030)\nExcess of expenses over revenue (85) (338) (8,038) (8,461) ------ -------- --------- ---------\nBalance, December 31, 1994 (8,282) (67,248) (160,129) (235,659)\nDistributions (282) (1,129) (26,802) (28,213)\nExcess of expenses over revenue (303) (1,214) (28,820) (30,337) ------ -------- --------- ---------\nBalance, December 31, 1995 $(8,867) $(69,591) $(215,751) $(294,209) ======= ======== ========= =========\nProfit and loss sharing percentage 1% 4% 95% 100% == == === ====\nThe accompanying notes are an integral part of these financial statements.\nMarvin Gardens Associates\nSTATEMENTS OF CASH FLOWS\nYears ended December 31, 1995, 1994 and 1993\n1995 1994 1993 ---- ---- ----\nCash flows from operating activities Rental income received $ 409,707 $ 393,918 $ 398,713 Interest received 1,797 1,884 1,571 Other income received 3,074 3,430 3,451 Administration expenses paid (15,866) (17,876) (12,676) Management fees paid (16,952) (15,852) (14,615) Utilities paid (26,892) (22,262) (21,396) Salaries and wages paid (43,690) (42,383) (39,336) Maintenance and repairs expenses paid (74,165) (71,309) (63,664) Real estate taxes paid (21,824) (21,152) (19,888) Payroll taxes paid (13,281) (13,471) (12,859) Property and other insurance paid (8,436) (7,433) (7,160) Interest paid on mortgage (141,056) (144,392) (147,467) Decrease (increase) in real estate tax impound fund 191 (35) (210) Incentive management fee paid (12,090) (1,970) - Increase in insurance impound fund (288) (196) (234) Net security deposits (paid) received (189) (1) 89 -------- -------- ---------\nNet cash provided by operating activities 40,040 40,900 64,319 -------- -------- ---------\nCash flows from investing activities Additions to property and equipment (32,836) (9,776) (14,034) Deposits to reserve for replacements (16,064) (15,700) (15,426) Withdrawals from reserve for replacements 29,398 37,473 22,919 -------- -------- ---------\nNet cash (used in) provided by investing activities (19,502) 11,997 (6,541) -------- -------- ---------\nCash flows from financing activities Repayment of mortgage payable (42,757) (39,422) (36,346) Distributions (28,213) (13,030) (8,051) -------- -------- ---------\nNet cash used in financing activities (70,970) (52,452) (44,397) -------- -------- ---------\nNET (DECREASE) INCREASE IN CASH (50,432) 445 13,381\nCash, beginning 65,733 65,288 51,907 -------- -------- ---------\nCash, ending $ 15,301 $ 65,733 $ 65,288 ========= ========= =========\nMarvin Gardens Associates\nSTATEMENTS OF CASH FLOWS - CONTINUED\nYears ended December 31, 1995, 1994 and 1993\n1995 1994 1993 ---- ---- ----\nReconciliation of excess of expenses over revenue to net cash provided by operating activities Excess of expenses over revenue $ (30,337) $ (8,461) $ (8,220) Adjustments to reconcile excess of expenses over revenue to net cash provided by operating activities Depreciation 73,037 68,932 67,693 Amortization of deferred financing costs 1,340 1,340 1,340 Interest earned on reserve for replacements (6,020) (5,457) (5,151) Changes in assets and liabilities (Increase) decrease in accounts receivable - rent subsidy (185) (3,036) 7,711 Increase in tenant accounts receivable (25) (676) (99) (Increase) decrease in interest income receivable - impounds (100) 1,352 23 Increase in prepaid expense (597) (72) (840) Decrease (increase) in real estate tax impound fund 191 (35) (210) Increase in insurance impound fund (288) (196) (234) Increase (decrease) in accounts payable - trade 803 (12,793) 2,244 Increase in accrued expenses 355 30 31 Increase (decrease) in deferred rent credits 2,055 (27) (58) Net security deposits (paid) received (189) (1) 89 -------- -------- ---------\nNet cash provided by operating activities $ 40,040 $ 40,900 $ 64,319 ========= ========= =========\nThe accompanying notes are an integral part of these financial statements.\nMarvin Gardens Associates\nNOTES TO FINANCIAL STATEMENTS - CONTINUED\nDecember 31, 1995, 1994 and 1993\nNOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nMarvin Gardens Associates (the Partnership) is a California Limited Partnership which commenced operations in February 1983. The Partnership owns and operates a 37-unit rental housing project (the project). The project operates under Section 8 of the National Housing Act and, therefore, receives monthly rental subsidies from the U.S. Department of Housing and Urban Development (HUD). The agreement expires in July 2003 and has two five year renewal options. For the years ended December 31, 1995, 1994 and 1993, rental subsidies for the project totaled $337,072, $332,339, and $324,256, respectively. All leases between the Partnership and the tenants of the property are operating leases.\nCash distributions are limited by agreements between the Partner-ship and the California Housing Finance Agency (CHFA) to $20,151 per year to the extent of surplus cash and stated equity, as defined by CHFA. Undistributed amounts are cumulative and may be distributed in subsequent years if future operations provide surplus cash in excess of current requirements.\nUse of Estimates\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.\nProperty and Equipment\nProperty and equipment are carried at cost. The Partnership provides for depreciation by use of the straight-line method over estimated useful lives as follows: buildings, 30 years and equipment, 3-8 years.\nDeferred Financing Costs\nDeferred financing costs are amortized by the straight-line method over the life of the related debt.\nRental Income\nRental income is recognized as rentals become due. Rental payments received in advance are deferred until earned.\nIncome Taxes\nNo provision or benefit for income taxes has been included in these financial statements since taxable income or loss passes through to, and is reportable by, the partners individually.\nNOTE B - CASH HELD IN TENANTS' SECURITY DEPOSIT FUND\nAt December 31, 1995 and 1994, the Partnership maintained tenants' security deposit fund balances of $9,241 and $8,865, respectively, in an interest bearing bank account and a certificate of deposit.\nNOTE C - MORTGAGE PAYABLE\nThe mortgage payable represents a mortgage from the CHFA which is due on June 1, 2013 and is collateralized by a deed of trust on the rental property and the CHFA has been granted a security interest in rental subsidies. The terms of the mortgage require monthly principal and interest payments of $15,138 and bear interest at the rate of 8.15%. Interest charged to operations during 1995, 1994 and 1993 amounted to $141,056, $144,392, and $147,467, respectively. Terms of the loan agreement also require monthly escrow deposits to be made to fund real estate tax, insurance, and a replacement reserve account.\nThe liability of the Partnership under the mortgage is limited to the underlying value of the real estate, plus other amounts deposited with the lender.\nAggregate maturities of the mortgage payable for the five years following December 31, 1995 are as follows:\n1996 $46,375 1997 $50,299 1998 $54,555 1999 $59,171 2000 $64,178\nManagement believes it is not practical to estimate the fair value of the mortgage payable to CHFA because programs with similar characteristics are not currently available to the Partnership.\nNOTE D - RECONCILIATION OF FINANCIAL STATEMENT INCOME TO TAX BASIS INCOME\nThe reconciliation of the excess (deficiency) of revenue over expenses reported in the accompanying statements of operations with the loss reportable on a federal income tax basis for the years ended December 31, 1995, 1994 and 1993 follows:\n1995 1994 1993 ---- ---- ----\nExcess of expenses over revenue per statements of operations $(30,337) $ (8,461) $ (8,220) Additional depreciation for tax purposes (12,556) (12,630) (30,730) Deferred rental income adjustments 2,055 (27) (58) -------- --------- --------\nLoss for federal income tax purposes $(40,838) $(21,118) $(39,008) ======== ======== ========\nNOTE E - RELATED PARTY TRANSACTIONS\nAt December 31, 1995 and 1994, due to developer\/general partner consisted of development advances of $194,019. These advances are non-interest bearing and payable from proceeds upon sale or refinancing of the project after certain priority payments as defined in the Partnership agreement.\nThe Partnership has a contractual management agreement with CMJ Management Company, Inc., an affiliate of the general partner, to provide property management services for the project. CMJ Management Company, Inc. has hired an unaffiliated management agent to provide those services on its behalf. Total management fees paid for each of the years ended December 31, 1995, 1994 and 1993 were $17,052, $15,852, and $14,652, respectively. Effective September 1994, CMJ Management Company, Inc. receives 30% of the monthly fee which totaled $5,082 for the year ended December 31, 1995. In addition, for the years ended December 31, 1995 and 1994, incentive fees paid to CMJ Management Company, Inc. totalled $12,090 and $1,970, respectively, based on the prior years surplus cash, as defined.\nNOTE F - CONCENTRATION OF CREDIT RISK\nThe Partnership's real estate tax impound fund, replacement reserve fund, and insurance impound fund totalling $126,857 as of December 31, 1995 are on deposit with CHFA.\nINDEPENDENT AUDITORS' REPORT\nTo the Partners Colonial Farms, Ltd.\nWe have audited the accompanying balance sheets of Colonial Farms, Ltd. as of December 31, 1995 and 1994, and the related statements of operations, partners' deficit, and cash flows for each of the three years in the period ended December 31, 1995. 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 Colonial Farms, Ltd. as of December 31, 1995 and 1994, and the results of its operations, changes in its partners' deficit and its cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\n\/s\/ Reznick Fedder & Silverman REZNICK FEDDER & SILVERMAN\nBaltimore, Maryland January 27, 1996\nColonial Farms, Ltd.\nBALANCE SHEETS\nDecember 31, 1995 and 1994\nASSETS\n1995 1994 ---- ----\nCURRENT ASSETS Cash and cash equivalents $ 60,141 $ 145,241 Rents receivable 5,961 3,686 Prepaid expenses 8,789 8,205 --------- ----------\nTotal current assets 74,891 157,132 --------- ----------\nRESTRICTED FUNDS Tenants' security deposits 22,533 20,488 Real estate tax impound fund 14,518 13,511 Replacement reserve fund 232,164 212,730 Insurance impound fund 7,023 5,171 Reserve fund for operations 40,781 43,478 Interest income receivable - impounds 2,431 2,265 --------- ----------\n319,450 297,643 --------- ----------\nPROPERTY AND EQUIPMENT, less accumulated depreciation of $1,690,985 and $1,573,369 2,365,370 2,445,064 --------- ----------\nDEFERRED FINANCING COSTS, net of accumulated amortization of $31,309 and $29,032 44,458 46,735 --------- ----------\nTotal assets $ 2,804,169 $ 2,946,574 =========== ===========\nLIABILITIES AND PARTNERS' DEFICIT\nLIABILITIES Current maturities of mortgage payable $ 70,134 $ 64,024 Accounts payable 22,109 27,724 Accrued expenses 33,736 33,330 Deferred rental income 369 94 --------- ----------\nTotal current liabilities 126,348 125,172\nMortgage payable, less current maturities 2,789,928 2,860,062 Due to general partner 318,115 318,115 Tenants' security deposits 17,337 15,699 --------- ----------\nTotal liabilities 3,251,728 3,319,048\nPARTNERS' DEFICIT (447,559) (372,474) --------- ----------\nTotal liabilities and partners' deficit $ 2,804,169 $ 2,946,574 ============ ===========\nThe accompanying notes are an integral part of these financial statements.\nColonial Farms, Ltd.\nSTATEMENTS OF OPERATIONS\nYears ended December 31, 1995, 1994 and 1993\n1995 1994 1993 ---- ---- ----\nRevenue Rental income $785,378 $776,784 $ 762,473 Vacancies (24,535) (26,649) (11,925) Financial revenue 16,256 12,817 18,002 Other income 10,237 7,132 6,844 -------- -------- ---------\nTotal revenue 787,336 770,084 775,394 -------- -------- ---------\nExpenses Operating expenses Administration 22,779 19,504 23,655 Utilities 31,659 30,713 24,426 Management fee 39,600 38,435 37,200 Maintenance and repairs 144,185 139,278 169,881 Salaries 65,249 55,219 77,000 Insurance 12,074 12,067 10,888 Real estate taxes 39,762 39,272 38,860 -------- -------- ---------\nTotal operating expenses 355,308 334,488 381,910 -------- -------- ---------\nNonoperating expenses Interest 264,913 270,491 275,583 Depreciation and amortization 119,893 117,523 116,318 Incentive management fee 16,435 20,109 21,179 Earned surplus reimbursement 63,571 - 146,574 -------- -------- ---------\nTotal nonoperating expenses 464,812 408,123 559,654 -------- -------- ---------\nTotal expenses 820,120 742,611 941,564 -------- -------- ---------\nEXCESS (DEFICIENCY) OF REVENUE OVER EXPENSES $ (32,784) $ 27,473 $ (166,170) ========= ========= ==========\nThe accompanying notes are an integral part of these financial statements.\nColonial Farms, Ltd.\nSTATEMENTS OF PARTNERS' DEFICIT\nYears ended December 31, 1995, 1994 and 1993\nSpecial General Limited Limited Partner Partner Partner Total ------- ------- ------- -----\nBeginning, December 31, 1992 $(17,494) $(85,864) $ (33,187) $(136,545)\nDistributions (988) (1,483) (46,948) (49,419)\nExcess of expenses over revenue (3,323) (4,985) (157,862) (166,170) --------- -------- --------- ---------\nBalance, December 31, 1993 (21,805) (92,332) (237,997) (352,134)\nDistributions (956) (1,435) (45,422) (47,813)\nExcess of revenue over expenses 550 824 26,099 27,473 --------- -------- --------- ---------\nBalance, December 31, 1994 (22,211) (92,943) (257,320) (372,474)\nDistributions (846) (1,269) (40,186) (42,301)\nExcess of expenses over revenue (656) (983) (31,145) (32,784) --------- -------- --------- ---------\nBalance, December 31, 1995 $(23,713) $(95,195) $(328,651) $(447,559) ========= ======== ========= =========\nProfit and loss sharing percentage 2% 3% 95% 100% == == === ====\nThe accompanying notes are an integral part of these financial statements.\nColonial Farms, Ltd.\nSTATEMENTS OF CASH FLOWS\nYears ended December 31, 1995, 1994 and 1993\n1995 1994 1993 ---- ---- ----\nCash flows from operating activities Rental income received $ 751,795 $ 750,466 $ 750,550 Interest received 5,901 5,528 8,913 Other income received 10,237 7,132 6,844 Residual receipts reimbursement paid (63,571) - (146,574) Administration expenses paid (22,779) (19,504) (23,574) Management fees paid (39,500) (38,435) (37,200) Utilities paid (33,372) (30,713) (24,426) Salaries and wages paid (56,258) (47,327) (61,393) Maintenance and repairs expenses paid (141,608) (155,907) (152,303) Real estate taxes paid (39,762) (39,272) (38,860) Payroll taxes paid (8,116) (7,892) (15,607) Property and other insurance paid (12,658) (11,971) (11,918) Interest paid on mortgage (264,913) (270,491) (275,583) Incentive management fee paid (16,435) (20,109) (21,179) Decrease in residual receipts impound fund - - 12,884 Increase in reserve fund for operations 2,697 (1,816) (3,890) (Increase) decrease in real estate tax impound fund (1,007) (1,289) (1,025) Increase in insurance impound fund (1,852) (26) (565) Net security deposits received (paid) (407) 107 777 --------- -------- --------- Net cash provided by (used in) operating activities 68,392 118,481 (34,129) --------- -------- ---------\nCash flows from investing activities Purchases of equipment (37,922) - (19,934) Deposits to reserve for replacements (22,384) (22,139) (21,739) Withdrawals from reserve for replacements 13,139 46,506 39,161 --------- -------- --------- Net cash (used in) provided by investing activities (47,167) 24,367 (2,512) --------- -------- ---------\nCash flows from financing activities Repayment of mortgage payable (64,024) (58,446) (53,354) Distributions (42,301) (47,813) (49,419) --------- -------- ---------\nNet cash used in financing activities (106,325) (106,259) (102,773) --------- -------- ---------\nNET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (85,100) 36,589 (139,414)\nCash and cash equivalents, beginning 145,241 108,652 248,066 --------- -------- ---------\nCash and cash equivalents, ending $ 60,141 $ 145,241 $ 108,652 ========= ========= =========\nColonial Farms, Ltd.\nSTATEMENTS OF CASH FLOWS - CONTINUED\nYears ended December 31, 1995, 1994 and 1993\n1995 1994 1993 ---- ---- ---- Reconciliation of excess (deficiency) of revenue over expenses to net cash provided by (used in) operating activities Excess (deficiency) of revenue over expenses $ (32,784) $ 27,473 $(166,170) Adjustments to reconcile excess (deficiency) of revenue over expenses to net cash provided by operating activities Depreciation 117,616 115,246 114,041 Amortization of deferred financing costs 2,277 2,277 2,277 Interest earned on reserve for replacements (10,189) (9,847) (8,431) Changes in assets and liabilities (Increase) decrease in tenant accounts receivable (2,275) 504 931 (Increase) decrease in prepaid expenses (584) 96 (1,030) (Increase) decrease in interest income receivable - impounds (166) 2,558 (658) Net tenants' security deposits received (paid) (407) 107 777 Increase in real estate tax impound fund (1,007) (1,289) (1,025) Increase in insurance impound fund (1,852) (26) (565) Decrease in residual receipt fund - - 12,884 Increase (decrease) in reserve fund for operations 2,697 (1,816) (3,890) (Decrease) increase in accounts payable (5,615) (16,712) 17,577 Increase in accrued expenses 406 83 82 Increase (decrease) in rent deferred credits 275 (173) (929) --------- -------- --------- Net cash provided by (used in) operating activities $ 68,392 $ 118,481 $ (34,129) ========= ========= =========\nThe accompanying notes are an integral part of these financial statements.\nColonial Farms, Ltd.\nNOTES TO FINANCIAL STATEMENTS - CONTINUED\nDecember 31, 1995, 1994 and 1993\nNOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nColonial Farms, Ltd. (the Partnership) is a California Limited Partnership which commenced operations in February 1983. The Partnership owns and operates a 100-unit residential project (the project) located in Modesto, California. The project operates under Section 8 of the National Housing Act and, therefore, receives monthly rental subsidies from the U.S. Department of Housing and Urban Development (HUD). The agreement expires June 2002 and has two five-year renewal options. For the years ended December 31, 1995, 1994, and 1993, rental subsidies for the project totaled $586,267, $555,597, and $562,628, respectively. All leases between the Partnership and the tenants of the property are operating leases.\nCash distributions are limited by agreements between the Partner-ship and the California Housing Finance Agency (CHFA) to $35,299 per year to the extent of surplus cash and stated equity, as defined by CHFA. Undistributed amounts are cumulative and may be distributed in subsequent years if future operations provide surplus cash in excess of current requirements.\nUse of Estimates\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.\nCash and Cash Equivalents\nCash and cash equivalents include cash, money market accounts and U.S. Treasury bills, with a maturity of three months or less when acquired, stated at cost, which approximates market.\nProperty and Equipment\nProperty and equipment are carried at cost. The Partnership provides for depreciation by using the straight-line method over estimated useful lives as follows: buildings, 30 years and equipment, 8 years.\nDeferred Financing Costs\nDeferred financing costs are amortized by the straight-line method over the life of the related debt.\nRental Income\nRental income is recognized as rentals become due. Rental payments received in advance are deferred until earned.\nIncome Taxes\nNo provision or benefit for income taxes has been included in these financial statements since taxable income or loss passes through to, and is reportable by, the partners individually.\nNOTE B - CASH HELD IN TENANTS' SECURITY DEPOSIT FUND\nAt December 31, 1995 and 1994, the Partnership maintained tenants' security deposit fund balances of $22,533 and $20,488, respectively, in an interest bearing bank account and a certificate of deposit.\nNOTE C - MORTGAGE PAYABLE\nThe mortgage payable represents a permanent mortgage from the CHFA which is due on June 1, 2013 and is collateralized by a deed of trust on the rental property and the CHFA has been granted a security interest in rental subsidies. The terms of the mortgage require annual interest of 9.15% and monthly principal and interest payments of $27,411. Interest charged to operations during 1995, 1994, and 1993 amounted to $264,913, $270,491, and $275,583, respectively. Terms of the loan agreement require that monthly escrow deposits be made to fund real estate tax, insurance, and replacement reserve escrow accounts.\nThe liability of the Partnership under the mortgage is limited to the underlying value of the real estate, plus other amounts deposited with the lender.\nAggregate maturities of the mortgage payable for the five years following December 31, 1995 are as follows:\n1996 $ 70,134 1997 $ 76,827 1998 $ 84,159 1999 $ 92,191 2000 $110,990\nManagement believes it is not practical to estimate the fair value of the mortgage payable to CHFA because programs with similar characteristics are not currently available to the Partnership.\nNOTE D - RECONCILIATION OF FINANCIAL STATEMENT INCOME (LOSS) TO TAX BASIS INCOME (LOSS)\nThe reconciliation of the excess (deficiency) of revenue over expenses reported in the statements of operations with the income (loss) reported on a federal income tax return for the years ended December 31, 1995, 1994, and 1993 follows:\n1995 1994 1993 ---- ---- ---- Net income (loss) per state- ments of operations $(32,784) $ 27,473 $(166,170) Additional depreciation for tax purposes (17,603) (18,120) (49,454) Deferred rental income adjustments 275 (173) (929) ------- ------- ------- Income (loss) for federal income tax purposes $(50,112) $ 9,180 $(216,553) ======== ========= =========\nNOTE E - RELATED PARTY TRANSACTIONS\nAt December 31, 1995 and 1994, due to developer\/general partner consisted of development advances of $318,115. These advances are non-interest bearing and payable from proceeds upon sale or refinancing of the project after certain priority payments as defined in the Partnership agreement.\nThe Partnership has a contractual management agreement with CMJ Management Company, Inc., an affiliate of the general partner, to provide property management services for the project. CMJ Management Company, Inc. has hired an unaffiliated management agent to provide these services on its behalf.\nTotal management fees paid for the years ended December 31, 1995, 1994, and 1993 were $39,600, $38,435, and $37,200, respectively. Effective December 1994, CMJ Management Company, Inc. receives 30% of the monthly fee which totaled $11,850 for the year ended December 31, 1995. CMJ Management Company, Inc. also is entitled to receive an incentive management fee. For the years ended December 31, 1995, 1994, and 1993, incentive fees charged for the project totaled $16,435, $20,109, and $21,179, respectively, in accordance with the terms of the supplemental management agreement.\nNOTE F - CONCENTRATION OF CREDIT RISK\nThe Partnership's real estate tax impound fund, replacement reserve fund, insurance impound fund, and reserve fund for operations totalling $294,486 as of December 31, 1995 are on deposit with CHFA.\nINDEPENDENT AUDITORS' REPORT\nTo the Partners Holbrook Apartments Company\nWe have audited the accompanying balance sheets of Holbrook Apartments Company as of December 31, 1995 and 1994, and the related statements of operations, partners' deficit and cash flows for each of the three years in the period ended December 31, 1995. 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 Holbrook Apartments Company as of December 31, 1995 and 1994, and the results of its operations, changes in partners' deficit and its cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\n\/s\/ Reznick Fedder & Silverman REZNICK FEDDER & SILVERMAN\nBaltimore, Maryland January 27, 1996\nHolbrook Apartments Company\nBALANCE SHEETS\nDecember 31, 1995 and 1994\nASSETS 1996 1995 ---- ---- CURRENT ASSETS Cash and cash equivalents $ 486,602 $ 509,173 Accounts receivable 8,240 6,040 Accounts receivable - HAP - 570 Other receivables 16,803 9,700 Prepaid expenses 18,427 18,164 Other current assets 475 475 ---------- ---------- Total current assets 530,547 544,122 ---------- ----------\nRESTRICTED DEPOSITS AND FUNDED RESERVES Mortgage escrow deposits 42,895 53,225 Reserve for replacements 486,650 425,881 ---------- ----------\n529,545 479,106 ---------- ----------\nPROPERTY AND EQUIPMENT, less accumulated depreciation of $3,657,426 and $3,422,387 5,801,902 5,950,896 ---------- ----------\nDEFERRED FINANCING COSTS, net of accumulated amortization of $195,076 and $181,535 358,875 372,416 ---------- ----------\nTotal assets $7,220,869 $7,346,540 ========== ==========\nLIABILITIES AND PARTNERS' DEFICIT\nCURRENT LIABILITIES Current maturities of mortgage payable $ 88,328 $ 81,964 Accounts payable and accrued expenses 45,749 47,192 Accrued interest payable 47,095 47,608 Rent deferred credits 4,589 5,468 ---------- ---------- Total current liabilities 185,761 182,232\nLONG-TERM LIABILITIES Mortgage payable, less current maturities 7,446,966 7,535,294 ---------- ---------- Total liabilities 7,632,727 7,717,526 PARTNERS' DEFICIT (411,858) (370,986) ---------- ----------\nTotal liabilities and partners' deficit $7,220,869 $7,346,540 ========== ==========\nThe accompanying notes are an integral part of these financial statements.\nHolbrook Apartments Company\nSTATEMENTS OF OPERATIONS\nYears ended December 31, 1995, 1994 and 1993\n1995 1994 1993 ---- ---- ----\nRevenue Rental income $2,062,798 $2,060,656 $2,045,211 Vacancies (486) (3,458) (309) Financial revenue 34,734 26,487 11,817 Other income 6,381 5,588 5,128 --------- ---------- ----------\nTotal revenue 2,103,427 2,089,273 2,061,847 --------- ---------- ----------\nExpenses Operating expenses Marketing 208 329 476 Administration 120,673 123,390 113,219 Utilities 77,662 111,338 114,006 Management fee 98,221 97,710 97,136 Maintenance and repairs 195,276 192,998 206,502 Salaries 170,174 142,105 138,443 Insurance 40,196 41,951 44,768 Real estate taxes 197,441 139,335 122,181 --------- ---------- ---------- Total operating expenses 899,851 849,156 836,731 --------- ---------- ----------\nNonoperating expenses Interest 568,003 573,944 579,458 Mortgage insurance premium 37,865 38,261 38,629 Depreciation and amortization 248,580 243,525 234,770 Incentive management fee 137,695 165,684 129,347 --------- ---------- ----------\nTotal nonoperating expenses 992,143 1,021,414 982,204 --------- ---------- ----------\nTotal expenses 1,891,994 1,870,570 1,818,935 --------- ---------- ----------\nEXCESS OF REVENUE OVER EXPENSES $ 211,433 $ 218,703 $ 242,912 ========== ========== ==========\nThe accompanying notes are an integral part of these financial statements.\nHolbrook Apartments Company\nSTATEMENTS OF PARTNERS' DEFICIT\nYears ended December 31, 1995, 1994 and 1993\nGeneral Limited Partner Partner Total ------- ------- -----\nPartners' deficit, December 31, 1992 $(556,082) $ 257,523 $(298,559)\nDistributions (35,967) (203,816) (239,783)\nExcess of revenue over expenses 36,437 206,475 242,912 --------- --------- --------\nPartners' deficit, December 31, 1993 (555,612) 260,182 (295,430)\nDistributions (44,139) (250,120) (294,259)\nExcess of revenue over expenses 32,805 185,898 218,703 --------- --------- --------\nPartners' deficit, December 31, 1994 (566,946) 195,960 (370,986)\nDistributions (37,846) (214,459) (252,305)\nExcess of revenue over expenses 31,715 179,718 211,433 --------- --------- --------\nPartners' deficit, December 31, 1995 $(573,077) $ 161,219 $(411,858) ========= ========= =========\nProfit and loss sharing percentage 15% 85% 100% === === ====\nThe accompanying notes are an integral part of these financial statements.\nHolbrook Apartments Company\nSTATEMENTS OF CASH FLOWS\nYears ended December 31, 1995, 1994 and 1993\n1995 1994 1993 ---- ---- ----\nCash flows from operating activities Rental income received $2,059,803 $2,051,763 $2,035,812 Interest received 14,645 13,418 10,023 Other income received 9,418 6,046 6,677 Administration expenses paid (166,891) (164,640) (155,160) Management fees paid (98,221) (97,710) (97,136) Utilities paid (88,787) (118,133) (116,565) Maintenance and repairs expenses paid (303,582) (275,034) (290,539) Real estate taxes paid (197,441) (139,335) (122,181) Payroll taxes paid (16,316) (16,269) (15,721) Property insurance paid (18,192) (17,799) (20,618) Other taxes and insurance paid (22,335) (23,077) (24,888) Interest paid on mortgage (568,516) (574,419) (579,902) Mortgage insurance paid (37,797) (38,199) (38,572) Decrease (increase) in mortgage escrow deposits 10,330 12,966 (43,790) Mortgagor entity expenses paid (137,695) (165,684) (129,347) ---------- ---------- --------- Net cash provided by operating activities 438,423 453,894 418,093 ---------- ---------- ---------\nCash flows from investing activities Additions to property and equipment (86,045) (97,229) (23,938) Deposits to reserve for replacements (40,680) (40,776) (40,200) Net cash used in investing activities (126,725) (138,005) (64,138) ---------- ---------- ---------\nCash flows from financing activities Repayment of mortgage payable (81,964) (76,060) (70,580) Distributions paid to partners (252,305) (294,259) (239,783) ---------- ---------- --------- Net cash used in financing activities (334,269) (370,319) (310,363) ---------- ---------- ---------\nNET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (22,571) (54,430) 43,592\nCash and cash equivalents, beginning 509,173 563,603 520,011 ---------- ---------- ---------\nCash and cash equivalents, ending $ 486,602 $ 509,173 $ 563,603 ========== ========= ==========\nHolbrook Apartments Company\nSTATEMENTS OF CASH FLOWS - CONTINUED\nYears ended December 31, 1995, 1994 and 1993\n1995 1994 1993 ---- ---- ----\nReconciliation of excess of revenue over expenses to net cash provided by operating activities Excess of revenue over expenses $ 211,433 $ 218,703 $ 242,912 Adjustments to reconcile excess of revenue over expenses to net cash provided by operating activities Depreciation 235,039 229,984 221,229 Amortization of deferred financing costs 13,541 13,541 13,541 Interest earned on replacement reserves (20,089) (11,805) - Changes in assets and liabilities Increase in tenant accounts receivable (2,200) (194) (4,020) Decrease in accounts receivable - HAP 570 490 - Increase in accounts receivable - other (7,103) (806) (245) (Increase) decrease in prepaid expenses (263) 2,742 (2,286) Decrease (increase) in mortgage escrow deposits 10,330 12,966 (43,790) Decrease in accounts payable and accrued expenses (1,443) (5,521) (3,734) Decrease in accrued interest payable (513) (475) (444) Decrease in rent deferred credits (879) (5,731) (5,070) ---------- ---------- ---------\nNet cash provided by operating activities $ 438,423 $ 453,894 $ 418,093 ========== ========== ==========\nThe accompanying notes are an integral part of these financial statements.\nHolbrook Apartments Company\nNOTES TO FINANCIAL STATEMENTS - CONTINUED\nDecember 31, 1995, 1994 and 1993\nNOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nThe Partnership was formed as a limited partnership under the laws of the State of Massachusetts in July 1981, for the purpose of constructing and operating a rental housing project under Section 221(d)(4) of the National Housing Act. The project consists of 170 units located in Holbrook, Massachusetts and is currently operating under the name of Holbrook Apartments. All leases between the Partnership and the tenants of the property are operating leases.\nCash distributions are limited by agreements between the Partner-ship and HUD to the extent of surplus cash as defined by HUD.\nUse of Estimates\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.\nCash and Cash Equivalents\nCash and cash equivalents consist of cash and a repurchase agree-ments with a bank with maturities of three months or less when acquired, stated at cost, which approximates market.\nReserve for Replacements\nReserve for replacements includes investments in money market accounts which are held to maturity. The investments are carried at cost which approximates market value.\nProperty and Equipment\nProperty and equipment are carried at cost. Depreciation is provided for in amounts sufficient to relate the cost of depreciable assets to operations over their estimated service lives by use of the straight-line method for financial reporting purposes. For income tax purposes, accelerated lives and methods are used.\nDeferred Financing Costs\nDeferred financing costs are amortized over the term of the mortgage using the straight-line method.\nRental Income\nRental income is recognized as rentals become due. Rental payments received in advance are deferred until earned.\nNOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)\nIncome Taxes\nNo provision or benefit for income taxes has been included in these financial statements since taxable income or loss passes through to, and is reportable by, the partners individually.\nNOTE B - MORTGAGE PAYABLE\nThe mortgage is insured by the Federal Housing Administration (FHA) and collateralized by a deed of trust on the rental property. The mortgage, which is due February 1, 2023, is payable in equal monthly installments of principal and interest totalling $54,207 and bears interest at a rate of 7.5%. Interest incurred during December 31, 1995, 1994 and 1993, amounted to $568,003, $573,944, and $579,458, respectively.\nUnder agreements with the mortgage lender and FHA, the Partnership is required to make monthly escrow deposits for taxes, insurance and replacement of project assets, and is subject to restrictions as to operating policies, rental charges, operating expenditures and distributions to partners.\nThe liability of the Partnership under the mortgage is limited to the underlying value of the real estate, plus other amounts deposited with the lender.\nAggregate annual maturities of the mortgage payable for the five years following December 31, 1995 are as follows:\nDecember 31, 1996 $ 88,328 1997 $ 95,185 1998 $102,574 1999 $110,538 2000 $119,119\nManagement believes it is not practical to estimate the fair value of the mortgage payable insured by FHA because programs with similar characteristics are not currently available to the Partnership.\nNOTE C - HOUSING ASSISTANCE PAYMENT AGREEMENT\nFHA contracted with the Partnership under Section 8 of Title II of the Housing and Community Development Act of 1974, to make housing assistance payments to the Partnership on behalf of qualified tenants. The agreement expires July 1, 2001. Total housing assistance payments received during 1995, 1994, and 1993 were $1,587,132, $1,577,104, and $1,554,508, respectively.\nNOTE D - MANAGEMENT AGREEMENT\nManagement fees of 4.75% of gross receipts are paid to CMJ Management Company, Inc., an affiliate of the general partner, for its services as management agent to the project pursuant to a management agreement approved by HUD. Such fees amounted to $98,221, $97,710, and $97,136 for the years ended 1995, 1994, and 1993, respectively. In addition, CMJ Management Company, Inc., received incentive management fees of $137,695, $165,684, and $129,347 for the years ended December 31, 1995, 1994 and 1993, respectively.\nNOTE D - MANAGEMENT AGREEMENT (continued)\nCMJ Management Company, Inc., an affiliate of the general partner, makes monthly expenditures (primarily payroll, central office accounting, direct marketing and insurance costs) on behalf of the Partnership which are reimbursed the following month.\nNOTE E - TAX BASIS INCOME\nThe reconciliation of the excess of revenue and expenses in the accompanying statements of operations with the loss reported on a federal income tax basis follows:\n1995 1994 1993 ---- ---- ----\nExcess of revenue over expenses per statement of operations $ 211,433 $ 218,703 $ 242,912 Additional amortization of deferred costs 8,393 8,393 3,226 Decrease in deferred rental income (879) (5,731) (5,070) Additional depreciation (126,502) (139,140) (180,722) --------- --------- ----------\nIncome for federal income tax purposes $ 92,445 $ 82,225 $ 60,346 ========= ========= =========\nNOTE F - CONCENTRATION OF CREDIT RISK\nThe Partnership maintains its cash balances in one bank, which consists of an overnight repurchase agreement backed by government securities and an operating checking account. Account balances are insured by the Federal Deposit Insurance Corporation up to $100,000 by the bank. The Partnership also has a reserve for replacements and escrows totalling $529,545 on deposit with WMF\/Huntoon, Paige Associates Limited, including money market account totalling $400,441.","section_15":""}
{"filename":"773141_1995.txt","cik":"773141","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"Item 3. Legal Proceedings.\nExpansive Soils Cases.\nOn October 21, 1994, a complaint was served on several of the Company's subsidiaries in an action initiated by six homeowners in Highlands Ranch, Colorado. On January 26, 1995, counsel for the Company accepted service of two additional complaints by a homeowner in the Stonegate subdivision in Douglas County, Colorado and by a homeowner in the Rock Creek development located in Boulder County, Colorado. On September 12, 1995, the Company was served with a similar complaint relating to homeowners in Douglas County, Colorado. The complaints, each of which seek certification of a class action, purport to allege substantially identical claims relating to the construction of homes on lots with expansive soils, including negligence, breach of express and implied warranties, violation of the Colorado Consumer Protection Act, non-disclosure and a claim for exemplary damages. The homeowners in each complaint seek, individually and on behalf of the alleged class, recovery in unspecified amounts including actual damages, statutory damages, exemplary damages and treble damages. The Company has filed a response to each of the complaints and to initial discovery requests in the first filed case. The ultimate outcome of the cases is uncertain at this time; however, management does not believe that the outcome of these matters will have a material adverse effect on the financial condition or results of operations of the Company.\nThe Company has notified its insurance carriers of these complaints and currently is reviewing with the carriers how the Company will proceed. The insurance carriers providing primary coverage have agreed to defend the Company in the cases subject to reservations of rights.\nOther.\nThe Company and certain of its subsidiaries and affiliates have been named as defendants in various other claims, complaints and legal actions arising in the normal course of business. Because of the nature of the homebuilding business, and in the ordinary course of the Company's operations, the Company from time to time may be subject to product liability claims, including claims similar to those discussed under the description of the Expansive Soils Cases, above. In the opinion of management, the outcome of these matters will not have a material adverse effect upon the financial condition or results of operations of the Company.\nThe Company is not aware of any litigation, matter or pending claim against the Company which would result in material contingent liabilities related to environmental hazards or asbestos.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nNo meetings of the Company's shareowners were held during the fourth quarter of 1995.\n- -------------------------- [FN] Colescott, et al vs. Richmond Homes Limited, et al. in the District Court, Douglas County, State of Colorado, Civil Action No. 94 CV 352, Division 2. Moore vs. Richmond Homes Limited, et al. in the District Court, Douglas County, State of Colorado, Civil Action No. 95 CV 321, Division 2. Constantini vs. Richmond Homes Limited, et al. in the District Court, Boulder County, State of Colorado, Civil Action No. 95 CV 1052, Division 3. Rodenburg vs. Richmond Homes Limited, et al. in the District Court, Douglas County, State of Colorado, Civil Action No. 95 CV 298, Division 1.\nPART II\nItem 5.","section_5":"Item 5. Market Price of Common Stock and Related Security Holder Matters.\nThe shares of MDC Common Stock are traded on the New York and the Pacific Stock Exchanges. The following table sets forth, for the quarterly periods indicated, the high and low sale prices of the shares of MDC Common Stock as reported on the Composite Tape.\nHigh Low\nFirst quarter.................. $ 7.88 $ 5.38 Second quarter................. 6.00 5.00 Third quarter.................. 6.63 5.00 Fourth quarter................. 5.38 4.50\nFirst quarter.................. $ 5.88 $ 4.88 Second quarter................. 6.50 5.00 Third quarter.................. 8.13 6.13 Fourth quarter................. 8.13 6.13\nThe Company has declared dividends of three cents per share for each quarter in the year ended December 31, 1995 and two cents per share for each quarter in the year ended December 31, 1994. Prior to 1994, no dividends had been declared on the MDC Common Stock since 1988.\nIn connection with the declaration and payment of dividends, as well as the purchase, redemption or other acquisition of shares of MDC Common Stock, the Company is required to comply with certain covenants contained in the Senior Notes indenture (the \"Senior Notes Indenture\"). The Senior Notes Indenture allows the Company to pay dividends on its Common Stock in an amount, on a cumulative basis, not to exceed 50% of its Consolidated Net Income, as defined, after December 31, 1993, subject to certain other adjustments such as the value of MDC Common Stock issued after such date. Pursuant to the Senior Notes Indenture, the Company had a permitted capacity of approximately $20,473,000 for the payment of dividends at December 31, 1995.\nOn March 7, 1996, MDC had approximately 1,734 shareowners of record.\nItem 6.","section_6":"Item 6. Selected Financial and Other Data.\nThe data in this table 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 the notes thereto presented elsewhere herein (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.\nRESULTS OF OPERATIONS\nConsolidated Results.\n1995 Compared With 1994. MDC's revenues increased 6% for 1995 compared with 1994 primarily as a result of a 9% increase in home closings which more than offset a $5,700 decrease in the average selling price per housing unit. MDC's 1995 revenues of $865,856,000 represent the highest level of revenues in the Company's history.\nIncome before income taxes was lower for 1995 compared with 1994 primarily as a result of lower homebuilding segment operating profits, partially offset by higher mortgage lending and asset management segment operating profits, lower corporate and homebuilding interest expense and lower corporate general and administrative expenses. The reduction in homebuilding operating profits primarily resulted from a 13% decline in Home Gross Margins. The decline in Home Gross Margins largely was due to increased incentives offered to home buyers in order to counter weakening demand due to higher mortgage interest rates, particularly during the second half of 1994 and the first quarter of 1995, and increased competition in MDC's homebuilding markets.\nDuring 1995, the Company continued to strengthen its balance sheet and improve the efficiency of its operations. MDC reduced its homebuilding inventories significantly in 1995. Land and land under development inventories were $6,878,000 and $15,921,000, respectively, lower than the levels at December 31, 1994 and 1993. Land and land under development inventories at December 31, 1995 represented 21.4% of 1995 home sales revenues, the lowest ratio of land to home sales revenues in more than twelve years. The Company also reduced the level of its investment in unsold homes under construction to approximately $95,000,000 at December 31, 1995, an 18% improvement from the level of unsold homes under construction at December 31, 1994. In addition, the Company reduced its aggregate indebtedness in 1995 to $305,344,000, a reduction of 12%, from year-end 1994, and the lowest year-end debt level since 1984. All of these improvements contributed to a reduction in the Company's debt-to-equity ratio at December 31, 1995 to 1.49 to 1, its lowest year-end level since 1979.\n1994 Compared With 1993. MDC's revenues increased during 1994 compared with 1993 primarily as a result of a 26% increase in home closings and an $11,000 higher average selling price per housing unit.\nThe Company's income before income taxes and extraordinary gains increased in 1994 compared with 1993 due principally to (i) increased homebuilding segment operating profits from significantly higher home closings and higher Home Gross Margins; and (ii) lower corporate and homebuilding interest expense. These positive income effects partially were offset by lower operating profit from the asset management segment resulting primarily from lower mortgage interest rates in 1993 that enabled the Company to sell certain of its mortgage-related assets at a profit in 1993.\nDuring 1993, the Company recognized net extraordinary gains of $15,823,000, net of income taxes of $9,967,000, substantially all of which resulted from the early extinguishment of the Restructured Notes Payable with a portion of the net proceeds received in the 1993 Offering. No extraordinary gains or losses were recognized by the Company in 1994.\nImpact of Mortgage Interest Rates.\nThe Company's homebuilding and mortgage lending operations are dependent upon the availability and cost of mortgage financing. Increases in home mortgage interest rates (i) may reduce the demand for homes and home mortgages; and (ii) generally will reduce home mortgage refinancing activity.\nIn October 1993, home mortgage interest rates reached their lowest levels in 25 years, dropping to an average of 6.7% on a 30-year, fixed-rate mortgage. From October 1993 to December 1994, home mortgage interest rates increased to as high as 9.25%. During this period of rising interest rates, the Company experienced a general weakening in demand for new homes in most of its markets. This weakened demand, along with a general buildup in unsold homes under construction by the Company and other homebuilders, adversely affected the Company's home sales and Home Gross Margins in 1995, particularly in the first quarter. Since December 1994, home\nmortgage interest rates generally declined to 7.2% in December 1995 and to as low as 6.9% in February 1996. The decline during 1995 and early 1996, among other things, led to improved home sales levels in the last three quarters of 1995 and the first two months of 1996 compared with the same periods in the prior year. However, Home Gross Margins have not recovered as quickly, as the Company and other homebuilders in the Company's markets have continued to offer increased incentives to sell homes, especially unsold homes under construction.\nMortgage interest rates have recently increased to 8%. The Company is unable to predict the extent to which recent or future increases in home mortgage rates will affect adversely the Company's operating activities and results of operations.\nHomebuilding Segment.\nThe table below sets forth certain information with respect to the Company's homebuilding segment during each of the periods presented and at the end of such periods (dollars in thousands).\nHomebuilding Activities - 1995 Compared With 1994.\nHome Sales Revenues, Home Sales and Homes Closed and Delivered. Home sales revenues increased in 1995 compared with 1994 primarily as a result of increases in home closings, partially offset by an overall decrease in the average selling price per home closed, as discussed below. Home sales and closings increased in 1995 in (i) Arizona, primarily due to a significant expansion of the Company's operations in Phoenix where the Company has increased the number of active subdivisions to 16 at December 31, 1995 from nine at December 31, 1994;\n(ii) California, primarily due to the Company's acquisition and opening of several new subdivisions in Southern California after December 31, 1994 and the July 1995 acquisition of five active subdivisions in Paloma del Sol, a master-planned community in the city of Temecula, Riverside County; and (iii) Colorado due to, among other things, efforts to reduce the level of unsold homes under construction and a continuing emphasis on offering more affordable homes.\nIn its Mid-Atlantic market, the Company experienced lower home sales and closings per active subdivision in 1995 compared with 1994. The impact of lower home sales per active subdivision was partially offset by an increase in the number of the Company's active subdivisions in that market at December 31, 1995 compared with December 31, 1994. The lower home sales and closing levels per active subdivision were primarily the result of the Mid-Atlantic market, overall, experiencing (i) an increase in active subdivisions due to aggressive competition in this market; (ii) reduced consumer confidence due to reductions in the number of federal employees and government shutdowns, and the potential for further reductions in the number of federal employees as a result of deficit reduction plans; and (iii) a decline in total market home sales.\nThe Company's home sales in January and February 1996 increased by 38% (61% in February alone) to a total of 1,045 homes, compared with sales of 757 homes in the same two-month period in 1995. The Company is unable to predict if this trend of higher comparable sales from 1996 compared with 1995 will continue in the future, particularly in view of recent increases in mortgage interest rates.\nAverage Selling Price Per Housing Unit. The decrease in the average selling price per housing unit in 1995 compared with 1994 is the result of management's decision to increase the Company's emphasis on lower-priced, more affordable homes primarily marketed to first-time and first-time move-up home buyers. This strategic change in market mix resulted in lower average sales prices compared with prices in 1994 (i) in Colorado, Maryland and Tucson; and (ii) beginning in the third quarter of 1995, in Southern California as the Company began offering homes ranging in price from $105,000 to $170,000 in the Riverside County subdivisions acquired in July 1995. The Company anticipates that its average selling price will be lower in 1996 than in 1995.\nHome Gross Margins. Gross margins (home sales revenues less cost of goods sold, which primarily includes land and construction costs, capitalized interest, a reserve for warranty expense and financing costs) as a percent of home sales revenue (\"Home Gross Margins\") decreased to 13.4% in 1995 from 15.4% in 1994. This decline was due to (i) increased incentives offered to home buyers in order to counter weakening demand due to higher mortgage interest rates, particularly during the second half of 1994 and the first quarter of 1995; (ii) increased incentives used to reduce the Company's inventory of unsold homes under construction; and (iii) increased competition in MDC's homebuilding markets. Based on its estimated Home Gross Margins in Backlog at December 31, 1995, the Company believes that its average Home Gross Margins in the first quarter of 1996 will be comparable to the Company's average achieved in the year ended December 31, 1995. In addition, increases in, among other things, the costs of subcontracted labor, finished lots and building materials have affected adversely, and may affect adversely in the future, Home Gross Margins to the extent that market conditions prevent the recovery of increased costs through higher sales prices.\nInventory Valuation Reserves. Operating results during the year ended December 31, 1995 were impacted adversely by $3,677,000 in net realizable value adjustments. The adjustments primarily were related to certain under-performing projects in California, Arizona and the Mid-Atlantic region.\nMarketing. Marketing expenses (which include, among other things, amortization of deferred marketing costs, model home expenses and sales commissions) totalled $49,938,000 for 1995, compared with $44,588,000 for 1994. The increases reflect the impact of significant additional marketing-related salary, sales commission and model home operating expenses incurred to support the Company's expanded operations. Additionally, the Company has increased its marketing efforts in its markets to stimulate sales.\nGeneral and Administrative. General and administrative expenses totalled $26,694,000 in 1995 compared with $29,215,000 for 1994. General and administrative expenses as a percentage of home sales revenues decreased to 3.2% in 1995, compared with 3.7% in 1994 as the Company was able to deliver more homes in 1995 with a reduced level of overhead.\nHomebuilding Activities - 1994 Compared With 1993.\nHome Sales Revenues, Home Sales and Homes Closed and Delivered. Home sales revenues for 1994 were 33% higher than home sales revenues for 1993. This increase primarily was the result of increases in home closings in (i) Colorado, due to strong market conditions resulting from low interest rates in the second half of 1993 and the first quarter of 1994; (ii) Arizona, due to a significant expansion of the Company's operations, and continued strong demand for homes, in the Tucson and Phoenix markets; (iii) California, due to the Company's acquisition and opening of several new subdivisions, particularly in Southern California; and (iv) the Company's Mid-Atlantic market, due to improved market conditions in the first quarter of 1994 and an increase in the number of active subdivisions. The Company also realized an $11,000 increase in the average selling price per housing unit.\nSales increased in the year ended December 31, 1994 compared with 1993 in (i) Arizona (an increase of 82%) due to improved market conditions and an expansion of the Company's operations in the Phoenix and Tucson markets; and (ii) California (an increase of 49%) due to an expansion of the Company's operations in Northern California and the Company's re-entry into the Southern California market which began in the second half of 1993 and continued through 1994. Sales declined in the year ended December 31, 1994 compared with 1993 in (i) Colorado (a decline of 3%) as, among other things, new competitors entered the market and increased mortgage interest rates during the last three quarters of 1994 affected adversely the demand for new homes; and (ii) the Mid-Atlantic region (a decline of 7%) due to an overall slowing in this market which began in the second quarter of 1994 (the overall Mid-Atlantic market declined by approximately 10% in 1994 compared with 1993).\nAverage Selling Price Per Housing Unit. The increase in the average selling price per housing unit in 1994 compared with 1993 primarily was due to increases in average selling prices in all of the Company's markets except Phoenix and Northern California. The increases in selling prices principally were due to (i) the mix of homes closed; (ii) general price increases in most of the Company's markets to, among other things, offset increases in costs; and (iii) in certain markets, improved market conditions. These increases partially were offset by lower average selling prices in (i) Northern California primarily due to the introduction of more affordable homes during the latter part of 1993 in response to continuing consumer demand for lower-priced housing and softness in consumer demand for new homes; and (ii) Phoenix primarily due to the opening of new subdivisions which targeted the first-time and first-time move-up buyer.\nHome Gross Margins. The Company achieved higher Home Gross Margins in 1994 compared with 1993 in its Colorado, Southern California and Arizona markets primarily due to improved market conditions primarily resulting from lower interest rates. Home Gross Margins also were higher in the Company's Mid-Atlantic market in 1994 compared with 1993 due to improved market conditions through the first quarter of 1994 combined with home closings from a more profitable mix of subdivisions in 1994 compared with 1993. The increases partially were offset by lower Home Gross Margins in Northern California as the Company's profitability in this area was affected adversely by softness in consumer demand for new homes. To a substantially lesser extent, Home Gross Margins also were impacted negatively by builder competition in Nevada.\nInventory Valuation Reserves. Operating results during the fourth quarter of 1994 were impacted adversely by $4,000,000 in net realizable value adjustments related to, among other factors, several projects in Northern California which experienced significant slowing in sales and reduced selling prices during the fourth quarter due to softness in consumer demand which led to a general decline in home sales activity in this market.\nMarketing. Marketing expenses totalled $44,588,000 for 1994 compared with $34,820,000 for 1993. This 28% increase during 1994 principally was due to the 33% increase in home sales revenue and expanded operations in all of the Company's major regions.\nGeneral and Administrative. General and administrative expenses totalled $29,215,000 during 1994 compared with $27,497,000 in 1993. General and administrative expenses during 1993 were affected adversely by non-recurring charges totalling approximately $2,500,000. While general and administrative expenses increased in the aggregate primarily due to salary expense for the additional personnel needed for the Company's expanded operations, general and administrative expenses as a percentage of home sales revenues decreased to 3.7% for 1994 compared with 4.7% in 1993 because the Company was able to deliver more homes without a proportionate increase in overhead.\nLand Sales.\nRevenue from land sales totalled $10,396,000, $8,296,000 and $7,441,000, respectively, for the years 1995, 1994 and 1993. The land sales primarily were in Colorado and, to a lesser extent, in California. Gross profits (losses) from these land sales were $220,000, $319,000 and $(423,000), respectively, for the years 1995, 1994 and 1993.\nIncluded in the 1995 land sales was a sale of 45 acres of inactive land in its Rock Creek Ranch development in Colorado (\"Rock Creek\") for approximately $4,400,000, which was approximately equal to its book value. In accordance with the development plans of the metropolitan districts serving Rock Creek, the purchaser pre-paid approximately $3,400,000 of development fees to these districts. In connection with the sale, the purchaser acquired an option from the Company for the purchase of two adjacent parcels also served by the districts.\nLand Inventory.\nThe table below shows (in thousands) the carrying value of MDC's land and land under development in each of its homebuilding markets at December 31, 1995, 1994 and 1993.\nThe Company's net income, cash flow and returns on assets and stockholders' equity are affected adversely by the carrying costs (e.g., interest and property taxes) associated with land inventories held for future development or sale (inactive land inventories) and because the inventories do not earn any return. The decreases in inactive land inventories are due to the commencement of development and construction activity in certain subdivisions as well as land sales or other dispositions.\nCarrying costs on inactive land inventories are expensed, not capitalized. The Company is actively pursuing opportunities to further reduce, through sales, homebuilding activities, or other means, its inactive land inventories.\nMortgage Lending Segment.\nThe table below summarizes the results of HomeAmerican's operations during each of the periods presented (in thousands).\nThe table below sets forth certain information regarding HomeAmerican's portfolio of mortgage loans serviced (in thousands).\n1995 Compared With 1994. HomeAmerican's loan originations and purchases increased by 12% in 1995 compared with 1994 primarily due to an increase in the Company's home closings and an increase in the percentage of mortgage originations for buyers of the Company's homes, partially offset by a 48% decrease in the dollar amount of spot originations. HomeAmerican originated mortgages for 61% of MDC's home buyers in 1995 compared with 52% in 1994. HomeAmerican continues to benefit from the Company's home sales growth as MDC home buyers were the source of more than 80% of the principal amount of mortgage loans originated or purchased by HomeAmerican in 1995. By originating a mortgage loan for an MDC home buyer, the Company is able to recover a portion of the cost of the incentives provided by the Company to its home buyers through the future sale of the related mortgage servicing. During late 1995, HomeAmerican opened an origination facility in Southern California, and in February 1996, HomeAmerican opened an origination facility in Las Vegas, both of which positively will affect the percentage of HomeAmerican's originations for MDC's home buyers in 1996.\nSpot and correspondent originations mainly result from refinancings. Increased mortgage interest rates, particularly during the second half of 1994 and the first quarter of 1995, significantly decreased refinancing activity market-wide and resulted in a decrease in the Company's spot and correspondent originations in 1995 compared with 1994. However, during the second half of 1995, spot and correspondent originations and purchases increased compared with the same period in 1994, as interest rates in the second half of 1995 averaged approximately 131 basis points lower than in the second half of 1994.\nHomeAmerican's operating profit in 1995 was higher than in 1994 principally due to gains from sales of mortgage servicing totalling $8,336,000 in 1995 compared with gains totalling $6,770,000 in 1994. The Company sold approximately the same principal amount of servicing in 1995 as in 1994, but received approximately 10% more revenues on the sales in 1995 than in 1994 as, among other things, stronger market demand for mortgage servicing during 1995 resulted in more favorable prices than in 1994. Gains from mortgage servicing sales other than bulk sales comprised a larger percentage of total gains (24% for 1995 compared with 15% for 1994) primarily due to increased originations and purchases of adjustable rate mortgages, which generally are sold \"servicing released.\"\n1994 Compared With 1993. HomeAmerican's loan originations and purchases decreased by 35% in 1994 compared with 1993 primarily due to increased mortgage interest rates which resulted in lower mortgage loan originations market wide. The decrease partially was offset by a 5% increase in the dollar amount of originations for MDC's home buyers principally due to increased closings by MDC's homebuilding segment. HomeAmerican originated mortgages for 52% of MDC's home buyers in 1994 compared with 63% in 1993. The decline in the percentage of mortgages originated for MDC's home buyers was the result of, among other things, increased competition for mortgage loan originations and increases in closings in Southern California where HomeAmerican did not have an origination facility.\nHomeAmerican's operating profit of $6,951,000 during 1994 was lower than the operating profit of $7,508,000 for 1993 principally due to losses from sales of mortgage loans totalling $585,000 in 1994 (when mortgage rates were increasing) compared with gains totalling $2,864,000 in 1993 (when mortgage rates were decreasing), partially offset by higher gains from bulk sales of mortgage servicing in 1994. While loan origination fees were lower in 1994 compared with 1993, this reduction was offset by a decrease in general and administrative expenses as HomeAmerican was able to reduce its general and administrative costs in response to the decline in its mortgage lending operations.\nAsset Management Segment.\nThe table below summarizes the results of the asset management segment operations during each of the periods presented (in thousands).\nDuring the three years ended December 31, 1995, the Company has experienced a significant decrease in the amount of assets in its asset management segment primarily from (i) refinancing of mortgages by homeowners; (ii) the sale by the Company of mortgage-related assets; (iii) writedowns of mortgage-related assets due to\nprepayments; and (iv) certain investments reaching the end of their economic lives. As a result, future income from the asset management segment primarily will be dependent on management fees earned by FAMC from two publicly traded REITs, net of general and administrative costs. FAMC earned management fees from the REITs totalling $3,324,000, $2,780,000 and $2,180,000, respectively, in the years ending December 31, 1995, 1994 and 1993. See Note A - Summary of Significant Accounting Policies - Asset Management to the Company's Consolidated Financial Statements.\nAt December 31, 1995, FAMC had approximately $150 million in assets under management for the REITs.\nOther Operating Results.\nInterest Expense. Corporate and homebuilding interest incurred decreased by 5% to $33,909,000 in 1995 compared with $35,799,000 in 1994 primarily due to (i) lower average effective interest rates with respect to the Company's variable-rate bank lines of credit and project loans resulting from a decrease in the prime rate in 1995; and (ii) lower levels of borrowings resulting from the Company's reduction in homebuilding inventories and the increased usage of internally generated funds. Corporate and homebuilding interest incurred increased by 40% to $35,799,000 for 1994 compared with $25,505,000 for 1993 due to (i) higher average effective interest rates associated with the 11 1\/8% Senior Notes due 2003 (in part due to the repayment, in December 1993 and January 1994, of $132,496,000 of Restructured Notes Payable for approximately $100,701,000) compared with the debt outstanding for 1993; (ii) higher average effective interest rates with respect to the Company's variable-rate bank lines of credit and project loans due to an increase in the prime rate in 1994; and (iii) higher levels of borrowings resulting from the Company's expanded homebuilding operations.\nThe portion of corporate and homebuilding interest which was capitalized (the Company capitalizes interest on its homebuilding inventories during the period of active development and through the completion of construction) during 1995 totalled $26,136,000 compared with $26,345,000 and $14,051,000, respectively, during 1994 and 1993. The increase in interest capitalized for 1994 compared with 1993 primarily was due to (i) increased levels of active homebuilding inventories resulting from expanded operations; and (ii) higher capitalization rates resulting from higher average effective interest rates on the Company's debt, particularly with respect to Colorado.\nCorporate and homebuilding interest incurred but not capitalized is reflected as interest expense and totalled $7,773,000 for 1995 compared with $9,454,000 and $11,454,000, respectively, for 1994 and 1993. In addition to the factors discussed above, the declines in interest expense were attributable to the decreases in inactive land inventories.\nFor a reconciliation of interest incurred, capitalized and expensed, see Note H to the Company's Consolidated Financial Statements.\nCorporate General and Administrative Expenses. Corporate general and administrative expenses totalled $13,478,000 for 1995 compared with $15,132,000 and $14,890,000, respectively, for 1994 and 1993. The 11% decrease in 1995 compared with 1994 primarily was due to a reduction in insurance, legal expenses and professional fees, partially offset by an increase in salary expense and financing costs associated with the Company's expanded operations in 1995.\nIncome Taxes. M.D.C. Holdings, Inc. and its wholly owned subsidiaries file a consolidated federal income tax return (an \"MDC Consolidated Return\"). Richmond Homes and its wholly owned subsidiaries filed a separate consolidated federal income tax return (each a \"Richmond Homes Consolidated Return\") from its inception (December 28, 1989) through February 2, 1994, the date Richmond Homes became a wholly owned subsidiary of MDC.\nMDC's overall effective income tax rates of 35.3%, 37.9% and 36.6%, respectively, for 1995, 1994, and 1993, differed from the federal statutory rate of 35% primarily due to, among other things, (i) the impact of state income taxes; (ii) the realization of non-taxable income for financial reporting purposes for which no tax liability was recorded; and (iii) in 1994, adjustments of prior years' income taxes.\nAt December 31, 1995, the Company had a net deferred tax asset of $13,730,000, net of a valuation allowance of $3,000,000. Given present economic trends, particularly in the homebuilding industry, as evidenced by recent improvements in the Company's results of operations, management believes the net deferred tax asset to\nbe recoverable from future earnings. The valuation allowance has been provided to offset the related deferred income tax assets due to the uncertainty of realizing the benefit of certain future tax deductions. See Note I to the Company's Consolidated Financial Statements.\nIn April 1995, the Company and the Internal Revenue Service (the \"IRS\") reached final agreement on the IRS examinations of (i) the MDC Consolidated Returns for the years 1984 and 1985; and (ii) the Richmond Homes Consolidated Returns for the years 1989 and 1990. These agreements had no material impact upon the Company's financial position or results of operations.\nThe IRS has completed its examination of the MDC Consolidated Returns for the years 1986 through 1990 and has proposed adjustments that would shift the recognition of certain items of income and expense from one year to another (\"Timing Adjustments\"). To the extent taxable income in a prior year is increased by proposed Timing Adjustments, taxable income may be reduced by a corresponding amount in other years; however, the Company would incur an interest charge as a result of such adjustment. The Company currently is protesting many of these proposed adjustments through the IRS appeals process. In the opinion of management, adequate provision has been made for any additional income taxes and interest which may result from the proposed adjustments.\nThe IRS currently is examining the MDC and Richmond Homes Consolidated Returns for the years 1991, 1992 and 1993. No reports have been issued by the IRS in connection with these examinations. In the opinion of management, adequate provision has been made for additional income taxes and interest, if any, which may result from these examinations.\nLIQUIDITY AND CAPITAL RESOURCES\nMDC uses its liquidity and capital resources to, among other things, (i) support its operations, including its inventories of homes, home sites and land; (ii) provide working capital; and (iii) provide mortgage loans for its home buyers. Liquidity and capital resources are generated internally from operations and from external sources.\nCapital Resources.\nThe Company's capital structure is a combination of (i) permanent financing, represented by Stockholders' Equity; (ii) long-term financing, represented by publicly traded Senior Notes and subordinated notes due primarily in 2003 and 2005, respectively; and (iii) current financing, primarily lines of credit, as discussed below. The Company believes that its current financial condition is both balanced to fit its current operational structure and adequate to satisfy its current and near-term capital requirements.\nThe Company's debt to equity ratio improved to 1.49 to 1 at December 31, 1995 compared with 1.97 to 1 at December 31, 1993 and 1.81 to 1 at December 31, 1994. The improvement is primarily a result of (i) the earnings of the Company, which contributed to the increase in the Company's Stockholders' Equity to $205,033,000 at December 31, 1995; and (ii) the use of internally generated cash flow to reduce debt.\nBased upon its current business plan, MDC anticipates the acquisition of various parcels of finished lots and partially developed land for use in its future homebuilding operations during 1996. The Company currently intends to acquire a portion of the land inventories required in future periods through takedowns of lots subject to \"rolling\" options entered into in prior periods and under new \"rolling\" options. The use of \"rolling\" options lessens the Company's land-related risk and improves liquidity.\nBased upon its current capital resources and additional liquidity available under existing credit relationships, MDC anticipates that it has adequate financial resources to satisfy its current and near-term capital requirements. The Company believes that it can meet its long-term capital needs (including, among other things, meeting future debt payments and refinancing or paying off other long-term debt as it becomes due) from operations and external financing sources, assuming that no significant adverse changes in the Company's business occur as a result of the various risk factors described elsewhere herein, in particular, changes in interest rates.\nLines of Credit and Notes Payable.\nHomebuilding. MDC's homebuilding bank line of credit facilities at December 31, 1995 were $158,149,000 in the aggregate, a substantial increase over the $65,000,000 of similar facilities at December 31, 1993. Agreements governing significant portions of the present facilities were entered into during 1994 and 1995, and generally provide for final maturities from four to five years, including scheduled term-out periods (although the term-out periods may commence earlier under certain circumstances). The Company has expanded its bank lines of credit to, among other things, reduce the levels of its secured project financing, the cost of which is generally higher than the cost of bank lines of credit. Borrowings under the bank lines of credit are collateralized by homebuilding inventories and are limited to the value of \"eligible collateral\" (as defined in the credit agreements). At December 31, 1995, $43,490,000 was borrowed and an additional $112,693,000 was collateralized and available to be borrowed under the bank lines of credit.\nIn 1995, the Company modified and extended $105,000,000 in bank line of credit facilities. The modified agreements include, among other things, lower interest margins, lower fees and extensions of the final maturities.\nMortgage Lending. To provide funds to originate and purchase mortgage loans and to finance these mortgage loans on a short-term basis, HomeAmerican utilizes its mortgage lending bank line of credit (the \"Mortgage Line\"). These mortgage loans are pooled into GNMA, FNMA and FHLMC pools or retained as whole loans and subsequently are sold in the open market on a \"spot\" basis or pursuant to mortgage loan sale commitments. During 1995, 1994 and 1993, HomeAmerican sold $504,109,000, $480,485,000 and $695,635,000, respectively, principal amount of mortgage loans and mortgage certificates to unaffiliated purchasers.\nThe aggregate amount available under the Mortgage Line at December 31, 1995 was $51,000,000. Borrowings under the Mortgage Line are collateralized by mortgage loans and mortgage-backed certificates and are limited to the value of \"eligible collateral\" (as defined in the credit agreement). At December 31, 1995, $21,990,000 was borrowed and an additional $16,580,000 was collateralized and available to be borrowed under the Mortgage Line. The Company also has additional borrowing capability with available repurchase agreements.\nGeneral. The Company's lines of credit and notes payable require compliance with certain covenants, representations and warranties. Currently, the Company believes that it is in compliance with these covenants, representations and warranties.\nConsolidated Cash Flow.\nDuring 1995, the Company generated $28,687,000 in cash from operating activities. The Company used this cash, other internally generated funds and $22,769,000 of cash on hand to pay down lines of credit and notes payable by $46,639,000 and to repurchase, for $5,466,000, 865,600 shares of MDC Common Stock (at prices ranging from $5.88 to $6.50). The stock repurchases were made pursuant to an announced program to repurchase up to 1,100,000 shares of MDC Common Stock and up to 1% of the principal amount of each of its outstanding Senior Notes and Convertible Subordinated Notes.\nMDC used $19,439,000 of cash in 1994 principally due to increases in homebuilding inventories as a result of significantly increased levels of homebuilding activity, offset partially by a reduction in mortgage loans held in inventory and net increases in debt (primarily lines of credit) necessary to finance the substantial increases in homebuilding activities.\nIn 1993, cash generated of $1,975,000 principally was due to net cash provided by (i) net proceeds from borrowings in excess of payments made on notes; (ii) increases in accounts payable and accrued expenses; and (iii) proceeds from Investments and Marketable Securities, which was partially offset by cash used to increase homebuilding inventories and mortgage loans held in inventory and to repurchase MDC Common Stock.\nIMPACT OF INFLATION, CHANGING PRICES AND ECONOMIC CONDITIONS\nReal estate and residential housing prices are affected by inflation, which can cause increases in the price of land, raw materials and subcontracted labor. Unless costs are recovered through higher sales prices, Home Gross Margins can decrease. If interest rates increase, construction and financing costs, as well as the cost of borrowings, also increase, which can result in lower Home Gross Margins. Increases in home mortgage interest rates make it more difficult for MDC's customers to qualify for home mortgage loans, potentially decreasing home sales volume. Increases in interest rates also may affect adversely the volume of mortgage loan originations.\nThe volatility of interest rates could have an adverse effect on MDC's future operations and liquidity. Among other things, these conditions may (i) affect adversely the demand for housing and the availability of mortgage financing; and (ii) reduce the credit facilities offered to MDC by banks, investment bankers and mortgage bankers.\nMDC's business also is affected significantly by, among other things, general economic conditions and particularly the demand for new homes in the areas in which it builds.\nISSUANCE OF STATEMENTS OF FINANCIAL ACCOUNTING STANDARDS\nIn March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121 \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of\" (\"SFAS 121\"). The Company's adoption of SFAS 121 in the first quarter of 1996 is not anticipated to have a material impact on the results of operations or financial position of the Company upon adoption.\nIn May 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 122 \"Accounting for Mortgage Servicing Rights an Amendment of FASB Statement No. 65\" (\"SFAS 122\"). The Company's adoption of SFAS 122 in the first quarter of 1996 is not anticipated to have a material adverse impact on the results of operations or financial position of the Company upon adoption.\nIn October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation\", which establishes a fair value based method of accounting for stock-based compensation plans. The statement allows companies to continue to use the intrinsic value based approach, supplemented by footnote disclosure of the pro forma net income and earnings per share of the fair value based approach. The Company intends to follow this latter method and, as a result, adoption of this pronouncement in 1996 will have no effect on the Company's financial statements.\nOTHER\nForward-Looking Statements.\nCertain statements in this Form 10-K Annual Report, the Company's Summary Annual Report to Shareowners, as well as statements made by the Company in periodic press releases, oral statements made by the Company's officials to analysts and shareowners in the course of presentations about the Company and conference calls following quarterly earnings releases, constitute \"forward-looking statements\" within the meaning of the Private Securities Litigation Reform Act of 1995 (the \"Reform Act\"). Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. Such factors include, among other things, (i) general economic and business conditions; (ii) interest rate changes; (iii) competition; (iv) the availability and cost of land and other raw materials used by the Company in its homebuilding operations; (v) unanticipated demographic changes; (vi) shortages of labor; (vii) weather related slowdowns; (viii) slow growth initiatives; (ix) building moratoria; (x) governmental regulation including environmental laws; and (xi) other factors over which the Company has little or no control.\nProposed Tax Plans.\nCongressional considerations of major reform to the federal tax system have been increasing over the past year. Proposed tax plans currently being sponsored by various members of Congress, include variations of a consumption tax (sales tax) and flat tax. Under the current tax system, deductions are allowed for mortgage interest and property taxes. Tax reform may reduce or eliminate these deductions. The likelihood of major tax reform and the impact such reform would have on, among other things (i) the demand for, and the value of, new as well as existing homes; and (ii) the Company's financial position or results of operations, are not determinable.\nReorganization of FAMC.\nIn March 1996, M.D.C. Holdings, Inc.(\"Holdings\"), Mr. Spencer I. Browne (previously President, Co-Chief Operating Officer and a director of Holdings), M.D.C. Residual Holdings, Inc., a wholly owned subsidiary of Holdings (\"Residual\"), and Financial Asset Management Corporation (\"Management Corporation\") entered into an agreement (the \"Agreement\") effective as of April 1, 1996, pursuant to which Mr. Browne, Residual and Management Corporation formed FAMC. Mr. Browne owns 20% of FAMC, and Management Company and Residual own the remaining 80% of FAMC.\nPursuant to the Agreement, (i) Mr. Browne resigned as President, Co-Chief Operating Officer and a director of Holdings; (ii) Mr. Browne and Holdings entered into an employment agreement (the \"Employment Agreement\"); (iii) Mr. Browne was appointed President and Chief Executive Officer of FAMC; and (iv) FAMC assumed Management Corporation's business operations of managing Asset Investors and Commercial Assets and performing certain other asset management functions.\nAlso pursuant to the Agreement, Mr. Browne sold 473,142 shares of Holdings' Common Stock to the Company for $7.125 per share for a total of $3,371,137. A portion of the proceeds of this sale was used by Mr. Browne to repay all outstanding principal and interest borrowed from the Company pursuant to a Company option purchase program.\nMr. Browne acquired his 20% interest from FAMC by contributing to FAMC $400,000 cash and a $2,100,000 promissory note (the \"Promissory Note\"). The Promissory Note (i) has a maturity date of December 31, 1998; (ii) bears interest at Holdings' corporate borrowing rate (not to exceed 13% per annum); (iii) requires principal payments on April 1 of each year as specified in the Promissory Note; and (iv) is secured by a pledge of Mr. Browne's interest in FAMC.\nThe Agreement further provides that from January 1, 1997 through December 31, 1998, Mr. Browne shall have the right to cause FAMC to purchase his interest in FAMC at the \"Put\/Call Price\" as defined below. Similarly, at all times on and after January 1, 1997, FAMC shall have the right to purchase Mr. Browne's interest in FAMC at the Put\/Call Price. The Put\/Call Price shall equal the amount paid by Mr. Browne for his interest in FAMC increased by Mr. Browne's share of FAMC's earnings subsequent to March 31, 1996 and decreased by (i) Mr. Browne's share of FAMC's losses during the same period; (ii) all distributions to Mr. Browne in respect of his interest in FAMC during the same period; and (iii) the outstanding principal amount of, and accrued interest on, the Promissory Note described above.\nThe Employment Agreement provides that Mr. Browne remains an employee of Holdings. The term of the Employment Agreement is April 1, 1996 through December 31, 1998, unless terminated earlier, subject to annual renewals thereafter. The Employment Agreement provides (i) for Mr. Browne's compensation in the form of a base salary, annual incentive compensation primarily based on FAMC's pre-tax net income, subject to an annual limitation, and certain fringe benefits; (ii) severance payments in the event Mr. Browne's employment with the Company is terminated; and (iii) certain benefits in the event of a \"change in control\" as defined in the Employment Agreement.\nITEM 8.","section_7A":"","section_8":"ITEM 8. Financial Statements.\nM.D.C. HOLDINGS, INC. AND SUBSIDIARIES INDEX TO FINANCIAL STATEMENTS AND SCHEDULES\nPage ---- Consolidated Financial Statements: Report of Independent Accountants ................................ Consolidated Balance Sheets as of December 31, 1995 and December 31, 1994......................................... Consolidated Statements of Income for the Three Years Ended December 31, 1995........................... Consolidated Statements of Stockholders' Equity for the Three Years Ended December 31, 1995........................... Consolidated Statements of Cash Flows for the Three Years Ended December 31, 1995........................... Notes to Consolidated Financial Statements........................\nREPORT OF INDEPENDENT ACCOUNTANTS\nTO THE BOARD OF DIRECTORS AND SHAREOWNERS OF M.D.C. HOLDINGS, INC.\nIn our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, stockholders' equity and of cash flows present fairly, in all material respects, the financial position of M.D.C. Holdings, Inc. and its subsidiaries at December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995, 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.\n\/s\/ Price Waterhouse LLP - ------------------------ PRICE WATERHOUSE LLP\nLos Angeles, California\nFebruary 20, 1996\nM.D.C. HOLDINGS, INC. Consolidated Balance Sheets (In thousands)\nSee notes to consolidated financial statements.\nM.D.C. HOLDINGS, INC. Consolidated Balance Sheets (In thousands, except share amounts)\nSee notes to consolidated financial statements.\nM.D.C. HOLDINGS, INC. Consolidated Statements of Income (In thousands, except per share amounts)\nSee notes to consolidated financial statements.\nM.D.C. HOLDINGS, INC. Consolidated Statements of Stockholders' Equity (In thousands)\nSee notes to consolidated financial statements.\nM.D.C. HOLDINGS, INC. Consolidated Statements of Cash Flows (In thousands)\nSee notes to consolidated financial statements.\nM.D.C. HOLDINGS, INC. Consolidated Statements of Cash Flows (In thousands) (Continued)\nSee notes to consolidated financial statements.\nM.D.C. HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nA. Summary of Significant Accounting Policies\nPrinciples of Consolidation - The consolidated financial statements of M.D.C. Holdings, Inc. (\"MDC\" or the \"Company\", which, unless otherwise indicated, refers to M.D.C. Holdings, Inc. and its subsidiaries) include the accounts of MDC and its wholly owned and majority-owned subsidiaries. Investments in 50% or less owned limited partnerships, joint ventures and ownership interests in trusts are accounted for using the equity method. All significant intercompany balances and transactions have been eliminated in consolidation.\nGeneral. In the homebuilding segment of its operations, the Company (i) principally acquires finished lots and, to a lesser extent, acquires land and develops it for use in its homebuilding activities; and (ii) designs, constructs and sells single-family residential homes. The Company conducts its homebuilding operations in (i) metropolitan Denver and Colorado Springs, Colorado; (ii) northern Virginia and suburban Maryland; (iii) Northern and Southern California; (iv) Phoenix and Tucson, Arizona; and (v) Las Vegas, Nevada. Such operations are financed primarily with publicly traded Senior Notes (as hereinafter defined) and subordinated notes, bank lines of credit, internally-generated funds and, to a lesser extent, promissory notes and project loans.\nMDC's mortgage lending operations are conducted by HomeAmerican Mortgage Corporation (\"HomeAmerican\"), which primarily provides mortgage loans for MDC home buyers and, to a lesser extent, for others. Substantially all of the mortgage loans originated by HomeAmerican, as well as mortgage loans purchased from unaffiliated loan correspondents, subsequently are sold to private investors. Additionally, HomeAmerican sells mortgage loan servicing.\nIn MDC's asset management segment, Financial Asset Management LLC (an indirect subsidiary of M.D.C. Holdings, Inc., and the successor as of April 1, 1996 to Financial Asset Management Corporation, \"FAMC\") manages the operations of two publicly traded real estate investment trusts (each a \"REIT\"). MDC also owns other mortgage-related interests.\nHomebuilding.\nInventories - Inventories are stated at the lower of cost or net realizable value and include interest capitalized during the period of active development through the completion of construction. Construction-related overhead and salaries are capitalized and allocated proportionately to projects actively being developed. Land and related costs are transferred to housing inventory when construction commences.\nNet realizable value is based on the Company's plans for development and build-out of each project using estimated sales prices less estimated total costs of the project, which includes interest anticipated to be capitalized during development and anticipated costs to sell the project. Net realizable value does not represent, for a specific project, the current sales price that the Company could obtain from third parties for such properties and projects at their current stage of development. Management believes that its assumptions as to projected demand are reasonable based on present economic conditions and that financing will be available to enable the Company to realize the carrying value of its homebuilding inventories consistent with its plans for build-out and development. Depending upon, among other things, conditions in the Company's markets, it is reasonably possible that the amounts the Company will ultimately realize could differ materially in the near term from the amounts estimated to be realizable at December 31, 1995.\nRevenue Recognition - Revenues from real estate sales are recognized when a sufficient down payment has been received, financing has been arranged, title, possession and other attributes of ownership have been transferred to the buyer and the Company is not obligated to perform significant additional activities after sale and delivery.\nWarranty Costs - The Company's homes are sold with limited ten-year warranties from independent entities. Home buyer claims under these warranties generally are subject to a deductible payable by the Company.\nReserves, which are included in home cost of sales, are established by the Company on a per-house basis to cover anticipated costs of repairs during the Company's warranty period and a portion of the supplemental warranty deductible.\nMortgage Lending.\nMortgage Loans Held in Inventory - The Company generally purchases forward commitments to deliver mortgage loans held for sale. Mortgage loans held in inventory are stated at the lower of aggregate cost or market based upon such commitments for loans to be delivered into such commitments or prevailing market for uncommitted loans. Substantially all of the loans originated or purchased by the Company are sold to private investors within 45 days of origination or purchase. Gains or losses on mortgage loans held in inventory are realized when the loans are sold.\nRevenue Recognition - Loan origination fees in excess of origination costs incurred and loan commitment fees are deferred until the related loans are sold. Loan servicing fees are recorded as revenue when the mortgage loan payments are received. Revenues from the sale of mortgage loan servicing are recognized when title and all risks and rewards of ownership have irrevocably passed to the buyer and there are no significant unresolved contingencies.\nAsset Management.\nRestricted Cash - Restricted cash represents mortgage loan principal and interest receipts held pending distribution to holders of mortgage-backed bonds.\nMortgage Collateral and Mortgage-Backed Bonds - In prior periods, certain of the Company's ownership interests in Mortgage Collateral (as hereinafter defined) and the related mortgage-backed bonds were presented on a gross basis on the balance sheets and statements of income. Accordingly, the book values of the Mortgage Collateral and mortgage-backed bonds were presented separately as assets and liabilities, respectively, on the balance sheets, and interest income on Mortgage Collateral and interest expense on the related mortgage-backed bonds were presented separately as income and expenses, respectively, on the statements of income. Substantially all of such interests are at, or are nearing, the ends of their economic lives. Accordingly, the Company does not anticipate that such net assets will generate significant amounts of income or cash flow in the future. Beginning in the fourth quarter of 1995, the Company's balance sheets for all periods presented reflect its ownership interests in Mortgage Collateral net of the related mortgage-backed bonds, and the statements of income for all periods presented reflect earnings from such interests net of the related interest expense.\nGeneral.\nCash and Cash Equivalents - The Company periodically invests funds not immediately required for operating purposes in highly liquid, short-term investments with an original maturity of 90 days or less such as commercial paper and repurchase agreements which are included in cash and cash equivalents in the Consolidated Balance Sheet and Consolidated Statement of Cash Flows.\nProperty and Equipment - Property and equipment is carried at cost less accumulated depreciation and amortization. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the related assets.\nEarnings Per Share - Primary earnings per share are based on the weighted-average number of common and common equivalent shares outstanding during each period. For the years ended December 31, 1995 and 1994, fully diluted earnings per share also assumes the conversion into MDC Common Stock of all of the outstanding Convertible Subordinated Notes (as hereinafter defined) at the stated conversion price.\nEstimates in Financial Statements - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported\namounts 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.\nReclassifications - Certain amounts in the 1994 and 1993 consolidated financial statements have been reclassified to conform to the 1995 presentation.\nB. Information on Business Segments\nThe Company operates in three business segments: homebuilding, mortgage lending and asset management. A summary of the Company's segment information is shown below (in thousands).\nCorporate general and administrative expenses consist principally of salaries and other administrative expenses which are not identifiable to a specific segment. Transfers between segments are recorded at cost. Capital\nexpenditures and related depreciation and amortization for the years ended December 31, 1995, 1994 and 1993 were not material. Identifiable segment assets are shown on the face of the Consolidated Balance Sheet.\nC. Mortgage Loans Held in Inventory\nMortgage loans held in inventory consist of (in thousands):\nMortgage loans held in inventory consist primarily of loans collateralized by first mortgages and deeds of trust due over periods of up to 30 years. The weighted-average effective yield on mortgage loans held in inventory was approximately 7.4% and 8.4%, respectively, at December 31, 1995 and 1994.\nD. Mortgage Collateral, net of Mortgage-Backed Bonds, and Related Assets and Liabilities\nIn the past, mortgage-backed bonds were issued by limited-purpose subsidiaries of the asset management segment and other non-related entities. Payments are made on the bonds on a periodic basis as a result of, and in amounts related to, corresponding payments received on the underlying mortgage collateral (the \"Mortgage Collateral\"). Mortgage Collateral for mortgage-backed bonds payable consists of fixed-rate mortgage loans and mortgage-backed securities secured by first liens on single-family residential housing. Mortgage-backed securities consist of Government National Mortgage Association (\"GNMA\") certificates, Federal National Mortgage Association (\"FNMA\") mortgage pass-through certificates and conventional mortgage loans. All of the Mortgage Collateral and related assets are held by a trustee. All principal and interest on the collateral is remitted directly to a trustee and is available for payment on the bonds, all of which are rated \"AAA\" by Standard and Poor's Corporation or other national credit rating agencies. The Company has not guaranteed, nor is it otherwise obligated with respect to, these mortgage-backed bond issues.\nThe following assets and liabilities are held by trustees (in thousands):\nThe weighted-average effective yield on the Mortgage Collateral was approximately 9.4% and 9.5% at December 31, 1995 and 1994. Mortgage-backed bonds mature through 2019 and bear interest at weighted-average rates of 9.8% and 9.9%, respectively, at December 31, 1995 and 1994. The negative difference between the effective yield on the Mortgage Collateral and interest rates on the mortgage-backed bonds primarily is covered by the overcollateralization of the bonds.\nBecause the mortgage-backed bond indentures prohibit liquidation of the Mortgage Collateral, the Mortgage Collateral cannot be sold unless the corresponding mortgage-backed bonds payable are redeemed. The mortgage-backed bonds can be redeemed before maturity by the Company only under certain prescribed conditions. If those conditions are met, and the Company redeems the mortgage-backed bonds, the mortgage-backed bonds would be redeemed at par and any market appreciation or depreciation on the related Mortgage Collateral would accrue to the Company.\nIn 1995, 1994 and 1993, MDC sold, at a premium, Mortgage Collateral totalling $9,618,000, $19,088,000 and $44,735,000, respectively. The proceeds from these sales were utilized to redeem in full the related outstanding mortgage-backed bonds which totalled $8,547,000, $19,109,000 and $44,375,000, respectively. These sales, net of redemptions, resulted in pre-tax gains totalling $305,000, $295,000 and $2,129,000, respectively.\nE. Lines of Credit\nHomebuilding - The aggregate amount of MDC's homebuilding bank lines of credit at December 31, 1995 was $158,149,000 compared with $153,000,000 at December 31, 1994. Available borrowings under these bank lines of credit are collateralized by homebuilding inventories and are limited to the value of \"eligible collateral\" (as defined in the credit agreements). At December 31, 1995, $43,490,000 was borrowed and an additional $112,693,000 was collateralized and available to be borrowed. At December 31, 1995, the weighted-average interest rate of the lines of credit was 8.3%.\nMortgage Lending - The aggregate amount available under MDC's mortgage lending bank line of credit at December 31, 1995, was $51,000,000. Available borrowings under this bank line of credit are collateralized by mortgage loans and mortgage-backed certificates and are limited to the value of \"eligible collateral\" (as defined in\nthe credit agreement). At December 31, 1995, $21,990,000 was borrowed and an additional $16,580,000 was collateralized and available to be borrowed. The mortgage lending line of credit is cancellable upon 90 days' notice. At December 31, 1995, the weighted-average interest rate of the line was 6.9%.\nGeneral - The agreements for the Company's bank lines of credit include representations, warranties and covenants, the most restrictive of which require that the Company maintain certain minimum defined stockholders' equity. Currently, the Company believes that it is in compliance with these covenants, representations and warranties.\nF. Notes Payable\nSenior Notes and Subordinated Notes - The Senior Notes (as hereinafter defined) and the subordinated notes consist of (in thousands):\nIn December 1993, the Company completed an offering (the \"1993 Offering\") of $190,000,000 principal amount of 11 1\/8% senior notes due 2003 (the \"Senior Notes\") and $28,000,000 principal amount of 8 3\/4% convertible subordinated notes due 2005 (the \"Convertible Subordinated Notes\"). The Senior Notes were sold at 98.525% of par value. The Convertible Subordinated Notes were sold at par value and are convertible into MDC Common Stock at an initial conversion price of $7.75 per share, subject to adjustment upon certain events. A portion of the proceeds of the 1993 Offering was utilized to redeem $51,816,000 principal amount of 11 1\/4% senior subordinated notes due May 1996 at par value, resulting in an extraordinary loss on the early extinguishment of debt of $885,000, net of an income tax benefit of $559,000. A portion of the proceeds of the 1993 Offering was also used to repurchase certain notes payable resulting in an extraordinary gain on the early extinguishment of debt in 1993 of $16,708,000, net of income taxes of $10,526,000.\nThe Senior Notes are guaranteed, fully and unconditionally, and jointly and severally on an unsecured subordinated basis (the \"Guaranties\") by most of the Company's homebuilding segment subsidiaries (the \"Guarantors\"). The Guaranties are subordinated to all Guarantor Senior Indebtedness as defined in the indenture pursuant to which the Senior Notes are issued (the \"Senior Notes Indenture\"). In addition, the Senior Notes are secured by a first priority pledge of the capital stock of most of the Guarantors plus the capital stock of HomeAmerican. The Senior Notes Indenture contains certain covenants which, among other things, limit (i) the incurrence of additional Indebtedness (as defined) by the Company and Restricted Subsidiaries (as defined); (ii) the payment of dividends; (iii) the repurchase of capital stock or subordinated indebtedness; and (iv) the ability to enter into transactions with Affiliates (as defined) or merge, consolidate or transfer substantially all of the Company's or a Guarantor's assets. At December 31, 1995, the Company was in compliance with all covenants.\nOther Notes Payable - Notes payable other than the notes discussed above consist principally of loans collateralized by real estate. These notes bear interest at rates ranging from 8.0% to 11.0%. The aggregate net carrying value of the assets collateralizing the other notes payable totalled approximately $20,000,000 at December 31, 1995.\nGeneral - The following table sets forth the scheduled principal payments on the Senior Notes, subordinated notes and notes payable at December 31, 1995 (in thousands).\n1996............. $ 3,758 1997............. 4,074 1998............. 10,740 1999............. 516 2000............. 523 Thereafter....... 222,728\nG. Stockholders' Equity\nStock Option Plans - In 1993, the Company adopted incentive plans (the \"Plans\") to replace the 1983 Incentive Stock Option Plan and the 1983 Non-Qualified Stock Option Plan, each of which expired in January 1993. A summary of the Plans follows:\nEmployee Equity Incentive Plan - The Employee Equity Incentive Plan (the \"Employee Plan\") provides for an initial authorization of 2,100,000 shares of MDC Common Stock for issuance thereunder plus an additional annual authorization equal to 10% of the then authorized shares of MDC Common Stock under the Employee Plan as of each succeeding annual anniversary of the effective date of the Employee Plan. Under the Employee Plan, the Company may grant awards of restricted stock, incentive and non-statutory stock options and dividend equivalents, or any combination thereof, to officers and employees of the Company or any of its subsidiaries. The incentive stock options granted under this plan are exercisable at prices greater than or equal to the market value on the date of grant over periods of up to six years. Non-statutory options granted under this plan have discretionary exercise prices and are exercisable over periods of up to six years.\nDirector Equity Incentive Plan - Under the Director Equity Incentive Plan (the \"Director Plan\"), non-employee directors of the Company will be entitled to receive stock options. The Director Plan provides for an initial authorization of 300,000 shares of MDC Common Stock for issuance thereunder plus an additional annual authorization of shares equal to 10% of the then authorized shares of MDC Common Stock under the Director Plan. Each option granted under the Director Plan will expire five years from the date of grant. The option exercise price must be equal to 100% of the fair market value of the MDC Common Stock on the date of grant of the option.\nA summary of the changes in options during each of the three years ended December 31, 1995 is as follows (in shares of MDC Common Stock):\nOutstanding - January 1, 1993 2,598,437 Exercised at prices ranging from $.28 to $1.88............. (489,938) Granted at prices ranging from $3.88 to $6.60.............. 1,185,000 Cancelled.................................................. (92,125) -----------\nOutstanding - December 31, 1993............................... 3,201,374 Exercised at prices ranging from $.28 to $1.88............. (271,974) Granted at prices ranging from $4.75 to $6.38.............. 635,000 Cancelled.................................................. (3,000) -----------\nOutstanding - December 31, 1994............................... 3,561,400\nExercised at prices ranging from $.28 to $3.125............ (1,418,900) Granted at prices ranging from $6.63 to $6.75.............. 105,000 Cancelled.................................................. (100,000) -----------\nOutstanding - December 31, 1995............................... 2,147,500 ===========\nExercise prices of outstanding options at December 31, 1995... $3.00 to $6.75 ===========\nExercisable at December 31, 1995.............................. 888,327 ===========\nReserved for issuance at December 31, 1995.................... 1,029,000 ===========\nExecutive Option Purchase Program - Pursuant to the terms of the Executive Option Purchase Program (the \"Option Purchase Program\"), which was authorized by the MDC Board of Directors, the Company is authorized to lend eligible executives of the Company up to two-thirds of the aggregate exercise price and state and federal taxes payable in connection with their exercise of stock purchase options, subject to certain maximum amounts as set forth under the Option Purchase Program. During 1995, certain eligible executives of the Company exercised options to purchase 824,414 shares of MDC Common Stock and borrowed $1,361,000 in the aggregate under the Option Purchase Program. Notes receivable under the Option Purchase Program are recourse and secured by 100% of the shares of MDC Common Stock issued in connection with options exercised. The $1,361,000 in notes receivable are deducted from stockholders' equity.\nCommon Stock Repurchase Plan - During 1995, the Company repurchased 865,600 shares of MDC Common Stock at prices ranging from $5.88 to $6.50 ($6.32 average, including commissions) pursuant to a program authorized by the MDC Board of Directors to repurchase up to 1,100,000 shares of MDC Common Stock and up to 1% of the principal amount of each of its outstanding Senior Notes and Convertible Subordinated Notes. On January 19, 1996, the Company repurchased an additional 230,000 shares at $7.13 pursuant to such repurchase plan.\nExchange of Common Stock - Prior to February 2, 1994, Larry A. Mizel (Chairman of the Board, Chief Executive Officer and President of the Company) and David D. Mandarich (Executive Vice President-Real Estate, Chief Operating Officer and a director of the Company) owned 35% of the outstanding shares of Richmond Homes, Inc. I (the Company's consolidated subsidiary which conducts substantially all of the Company's home building activities in Colorado, \"Richmond Homes\") common stock. In furtherance of the Company's desire to own all of the outstanding shares of Richmond Homes common stock, in December 1993, a special committee of the Board of Directors of the Company negotiated on behalf of the Company terms of an option agreement with Messrs. Mizel and Mandarich to acquire the shares of Richmond Homes common stock owned by them in exchange for MDC Common Stock with a value of up to $3,500,000 in the aggregate. For purposes of the exchange, the shares of MDC Common Stock were valued at $5.75 per share, the closing price of MDC Common Stock on the date of the option agreement. The special committee engaged a financial advisor to perform a business enterprise valuation of\nRichmond Homes. In February 1994, based on the results of the valuation, the maximum value of $3,500,000 of MDC Common Stock (an aggregate of 608,695 shares) was issued to Messrs. Mizel and Mandarich in exchange for their shares of Richmond Homes common stock. As of February 2, 1994, MDC owns 100% of the equity of Richmond Homes.\nAs the transaction with Messrs. Mizel and Mandarich was between related parties, the issuance of the MDC Common Stock was recorded based on the net book value of Richmond Homes, which had approximately zero common stockholders' equity at the date of the acquisition. Accordingly, the value of the shares of MDC Common Stock issued to Messrs. Mizel and Mandarich was recorded at zero.\nH. Interest\nInterest activity is set forth below (in thousands):\nI. Income Taxes\nTotal income taxes has been allocated as follows (in thousands):\nThe significant components of income tax expense on income before income taxes and extraordinary gain consist of the following (in thousands):\nThe provision for income tax expense differs from the amount which would be computed by applying the statutory federal income tax rate of 35% to pre-tax income before extraordinary gain as a result of the following (in thousands):\nThe tax effects of the temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are presented below (in thousands).\nM.D.C. Holdings, Inc. and its wholly owned subsidiaries file a consolidated federal income tax return (an \"MDC Consolidated Return\"). Richmond Homes and its wholly owned subsidiaries filed a separate consolidated federal income tax return (each a \"Richmond Homes Consolidated Return\") from its inception (December 28, 1989) through February 2, 1994, the date Richmond Homes became a wholly owned subsidiary of MDC.\nIn April 1995, the Company and the Internal Revenue Service (the \"IRS\") reached final agreement on the IRS examinations of (i) the MDC Consolidated Returns for the years 1984 and 1985; and (ii) the Richmond Homes Consolidated Returns for the years 1989 and 1990. These agreements had no material impact upon the Company's financial position or results of operations.\nThe IRS has completed its examination of the MDC Consolidated Returns for the years 1986 through 1990 and has proposed adjustments to taxable income reflected in such returns which would shift the recognition of certain items of income and expense from one year to another (\"Timing Adjustments\"). To the extent taxable income in a prior year is increased by proposed Timing Adjustments, taxable income may be reduced by a corresponding amount in other years; however, the Company would incur an interest charge as a result of such adjustment. The Company currently is protesting certain of these proposed adjustments through the IRS appeals process. In the opinion of management, adequate provision has been made for the additional income taxes and interest which may result from the proposed adjustments; however, it is reasonably possible that the ultimate resolution could result in amounts which differ materially in the near term from amounts provided.\nThe IRS currently is examining the MDC and Richmond Homes Consolidated Returns for the years 1991, 1992 and 1993. No reports have been issued by the IRS in connection with these examinations. In the opinion of management, adequate provision has been made for additional income taxes and interest, if any, which may result\nfrom these examinations; however, it is reasonably possible that the ultimate resolution could result in amounts which differ materially in the near term from amounts provided.\nJ. Earnings Per Share\nPrimary earnings per share are based on the weighted-average number of common and common equivalent shares outstanding during each period. In 1995 and 1994, the computation of fully diluted earnings per share also assumes the conversion into MDC Common Stock of all of the $28,000,000 outstanding principal amount of the 8 3\/4% Convertible Subordinated Notes at a conversion price of $7.75 per share of MDC Common Stock. The primary and fully diluted earnings per share calculations are shown below (in thousands, except per share amounts).\nK. Legal Proceedings\nExpansive Soils Cases.\nOn October 21, 1994, a complaint was served on several of the Company's subsidiaries in an action initiated by six homeowners in Highlands Ranch, Colorado. On January 26, 1995, counsel for the Company accepted service of two additional complaints by a homeowner in the Stonegate subdivision in Douglas County, Colorado and by a homeowner in the Rock Creek development located in Boulder County, Colorado. On September 12, 1995, the Company was served with a similar complaint relating to homeowners in Douglas County, Colorado. The complaints, each of which seek certification of a class action, purport to allege substantially identical claims relating to the construction of homes on lots with expansive soils, including negligence, breach of express and implied warranties, violation of the Colorado Consumer Protection Act, non-disclosure and a claim for exemplary damages. The homeowners in each complaint seek, individually and on behalf of the alleged class, recovery in unspecified amounts including actual damages, statutory damages, exemplary damages and treble damages. The Company has filed a response to each of the complaints and to initial discovery requests in the first filed case. The ultimate outcome of the cases is uncertain at this time; however, management does not believe that the outcome of these matters will have a material adverse effect on the financial condition or results of operations of the Company.\nThe Company has notified its insurance carriers of these complaints and currently is reviewing with the carriers how the Company will proceed. The insurance carriers providing primary coverage have agreed to defend the Company in the cases subject to reservations of rights.\nOther.\nThe Company and certain of its subsidiaries and affiliates have been named as defendants in various other claims, complaints and legal actions arising in the normal course of business. Because of the nature of the homebuilding business, and in the ordinary course of the Company's operations, the Company from time to time may be subject to product liability claims, including claims similar to those discussed under the description of the Expansive Soils Cases, above. In the opinion of management, the outcome of these matters will not have a material adverse effect upon the financial condition or results of operations of the Company.\nThe Company is not aware of any litigation, matter or pending claim against the Company which would result in material contingent liabilities related to environmental hazards or asbestos.\nL. Disclosures About Fair Value of Financial Instruments\nThe following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate such value.\nCash and Cash Equivalents - For cash and cash equivalents, the carrying value is a reasonable estimate of fair value.\nInvestments and Marketable Securities, Net - Investments in marketable equity securities are carried on the balance sheet at cost, which approximates market value. Accordingly, the carrying value of the investments is a reasonable estimate of the fair value.\nMortgage Loans Held in Inventory - The Company generally purchases forward commitments to deliver mortgage loans held for sale. For loans which have no forward commitments, loans in inventory are stated at the lower of cost or market. Accordingly, the carrying value is a reasonable estimate of fair value.\nNotes Payable and Lines of Credit - The Company's notes payable and lines of credit are at floating rates or at fixed rates which approximate current market rates and have relatively short-term maturities. Accordingly, the carrying value is a reasonable estimate of fair value.\nSenior Notes and Subordinated Notes - Senior Notes and subordinated notes are valued based on dealer quotes.\nThe estimated fair values of the Company's financial instruments are as follows (in thousands):\nM. Commitments and Contingencies\nTo reduce exposure to fluctuations in interest rates, HomeAmerican makes commitments to originate (buy) and sell loans and mortgage-backed securities. At December 31, 1995, commitments by HomeAmerican to originate mortgage loans totalled $25,808,000, at market rates of interest. At December 31, 1995, unexpired forward commitments to sell loans totalled $52,448,000.\nMDC leases office space, equipment and certain of its model show homes under noncancellable operating leases. Future minimum rental payments for leases with initial terms in excess of one year total $1,476,000 in 1996, $1,080,000 in 1997, $940,000 in 1998, $451,000 in 1999 and $183,000 in 2000. Rent expense under cancellable and noncancellable leases totalled $2,662,000, $3,250,000 and $2,956,000 in 1995, 1994 and 1993, respectively.\nMDC has entered into agreements to guarantee payment of principal and interest on $30,080,000 principal amount of bonds issued by municipal agencies to fund the development of project infrastructure for a master-planned community in Colorado.\nN. Supplemental Guarantor Information\nThe Senior Notes are unconditionally guaranteed on an unsecured subordinated basis, jointly and severally, by Richmond American Homes of California, Inc., Richmond American Homes of Maryland, Inc., Richmond American Homes of Nevada, Inc., Richmond American Homes of Virginia, Inc., Richmond American Homes, Inc., Richmond Homes, Inc. I and Richmond Homes, Inc. II (collectively, the \"Guarantors\"). The Guaranties are subordinated to all Guarantor Senior Indebtedness (as defined in the Senior Notes Indenture).\nSupplemental combining financial information follows.\nSupplemental Combining Balance Sheet December 31, 1995 (In thousands)\nSupplemental Combining Balance Sheet December 31, 1995 (In thousands)\n(continued)\nSupplemental Combining Balance Sheet December 31, 1994 (In thousands)\nSupplemental Combining Balance Sheet December 31, 1994 (In thousands)\n(continued)\nSupplemental Combining Statements of Income (In thousands)\nYear Ended December 31, 1995\nSupplemental Combining Statements of Income (In thousands)\nSupplemental Combining Statement of Cash Flows Year Ended December 31, 1995 (In thousands)\nSupplemental Combining Statement of Cash Flows Year Ended December 31, 1994 (In thousands)\nSupplemental Combining Statement of Cash Flows Year Ended December 31, 1993 (In thousands)\nSummary of Significant Accounting Policies:\nInvestments in subsidiaries are accounted for on the equity method for purposes of the supplemental information. The Guarantors follow the accounting policies set forth in Note A.\nRelated Parties. The Guarantors are members of a group of affiliated companies and have transactions and relationships with members of the group.\nMDC charges the Guarantors for a share of its general and administrative expenses, which amounted to $4,332,000, $3,926,000 and $2,654,000, respectively, in 1995, 1994 and 1993.\nMDC pays costs associated with certain litigation and other significant claims against the Guarantors which it considers to be general corporate expenses. Amounts paid by MDC on behalf of the Guarantors amounted to approximately $270,000, $769,000, and $3,481,000, respectively, in 1995, 1994 and 1993. In 1995, MDC recovered a portion of such payments.\nAdvances and notes receivable\/payable - Parent (M.D.C. Holdings, Inc.) and subsidiaries consists, among other things, of ongoing activities relating to the Guarantors' participation in MDC's cash management system and current and deferred income taxes.\nIncome taxes. The Guarantors report their results of operations as if they were separate taxpayers. The current tax liabilities and deferred income tax assets and liabilities of the Guarantors are reported in the financial statements in the Advances and notes receivable\/payable -Parent and subsidiaries accounts.\nO. Related Party Transactions\nMDC has transacted business with related or affiliated companies and with certain officers and directors of the Company.\nFAMC has agreements with Asset Investors Corporation and Commercial Assets, Inc., each a publicly-traded REIT, to advise them on various facets of their business and to manage their day-to-day operations subject to the supervision of their respective boards of directors. FAMC earned fees from management and administration, including from acquisitions and incentives from these agreements which are included in asset management revenues of $3,324,000, $2,780,000 and $2,180,000 during 1995, 1994 and 1993 respectively.\nThe Company acquired certain assets from Messrs. Mizel and Mandarich in February 1994. See Note G.\nOn December 28, 1989, MDC granted loans to Messrs. Mizel and Mandarich for purposes of purchasing shares of common stock of Richmond Homes. On February 2, 1994, in conjunction with MDC's acquisition of Richmond Homes common stock from Messrs. Mizel and Mandarich as discussed in Note G, MDC exchanged these loans for new loans of equal amount. Each of the notes evidencing the new loans now provides that, upon sale of any of the MDC Common Stock acquired by Messrs. Mizel and Mandarich in exchange for their respective Richmond Homes common stock, the cash proceeds shall be remitted to the Company in payment of accrued interest and principal under the notes. The new loans, which mature in 1999, bear interest at 8.0% and are unsecured. At both December 31, 1995 and 1994, $840,000 of such loans were outstanding. Interest income of $67,200 was recognized on these loans in each of 1995, 1994 and 1993.\nDuring 1995, certain eligible executives of the Company exercised options to purchase 824,414 shares of MDC Common Stock and borrowed $1,361,000 in aggregate under the Option Purchase Program. See Note G.\nThe Company utilizes the services of companies owned by two former employees of the Company, one of whom is the brother-in-law of a current officer and director of the Company. During 1995, 1994 and 1993, the Company paid $7,372,000, $11,880,000 and $11,557,000, respectively, for plumbing, door and millwork services provided by these companies.\nThe Company leases office space and furniture to certain organizations in which certain officers and\/or directors of the Company have an ownership interest. The rental revenue from those leases totalled $320,000 $250,000 and $259,000, respectively, in 1995, 1994 and 1993.\nThe Company utilizes in the ordinary course of business the services of a marketing and communications firm which is owned by the brother-in-law of an officer and director of the Company. Total fees paid for advertising and marketing design services were $188,000, $275,000 and $246,000, respectively, in 1995, 1994 and 1993.\nP. Summarized Quarterly Consolidated Financial Information (Unaudited)\nUnaudited summarized quarterly consolidated financial information for the two years ended December 31, 1995 is as follows (in thousands, 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.\nInformation required to be set forth hereunder has been omitted and will be incorporated by reference, when filed, from the Company's Proxy Statement for its 1996 Annual Meeting of Shareowners to be held on or about May 3, 1996.\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, from the Company's Proxy Statement for its 1996 Annual Meeting of Shareowners to be held on or about May 3, 1996.\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, from the Company's Proxy Statement for its 1996 Annual Meeting of Shareowners to be held on or about May 3, 1996.\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, from the Company's Proxy Statement for its 1996 Annual Meeting of Shareowners to be held on or about May 3, 1996.\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 its subsidiaries are included in Part II, Item 8:\nPage ---- M.D.C. Holdings, Inc. and Subsidiaries Report of Independent Accountants............................... Consolidated Balance Sheets as of December 31, 1995 and 1994.... Consolidated Statements of Income for the Three Years Ended December 31, 1995............................................. Consolidated Statements of Stockholders' Equity for the Three Years Ended December 31, 1995........................... Consolidated Statements of Cash Flows for the Three Years Ended December 31, 1995....................................... Notes to Consolidated Financial Statements......................\nAll schedules are omitted because they are not applicable, not material, not required or the required information is included in the applicable financial statements or notes thereto.\nFinancial statements for certain unconsolidated partnerships and joint ventures owned 50% or less by the Company or its subsidiaries, which are accounted for on the equity method, have been omitted because they do not, individually, or in the aggregate, constitute a significant subsidiary.\n(a) 3. Exhibits.\n3.1(a) Form of Amendment to the Certificate of Incorporation of M.D.C. Holdings, Inc. (hereinafter sometimes referred to as \"MDC\", the \"Company\" or the \"Registrant\") regarding director liability, filed with the Delaware Secretary of State on July 1, 1987 (incorporated by reference to Exhibit 3.1(a) of the Company's Quarterly Report on Form 10-Q dated June 30, 1987). *\n3.1(b) Form of Certificate of Incorporation of MDC, as amended (incorporated herein by reference to Exhibit 3.1(b) of the Company's Quarterly Report on Form 10-Q dated June 30, 1987).*\n3.2(a) Form of Amendment to the Bylaws of MDC regarding indemnification adopted by its Board of Directors and effective as of March 20, 1987 (incorporated herein by reference to Exhibit 3.2(a) of the Company's Quarterly Report on Form 10-Q dated June 30, 1987). *\n3.2(b) Form of Bylaws of MDC, as amended (incorporated herein by reference to Exhibit 3.2(b) of the Company's Quarterly Report on Form 10-Q dated June 30, 1987). *\n4.1 Form of Certificate for shares of the Company's common stock (incorporated herein by reference to Exhibit 4.1 of the Company's Registration Statement on Form S-3, Registration No. 33-426). *\n4.2(a) Form of Indenture, dated as of June 15, 1984, between the Company and The Royal Bank and Trust Company, with respect to the Company's Subordinated Exchangeable Variable Rate Notes (the \"1984 RBTC Indenture\") (incorporated herein by reference to Exhibit 4.3 of the Company's Registration Statement on Form S-2, Registration No. 2-90744). *\n4.2(b) First Supplemental Indenture, dated as of June 20, 1985, to the 1984 RBTC Indenture (incorporated herein by reference to Exhibit 4.13(a) of the Company's Registration Statement on Form S-3, Registration No. 33-426). *\n4.2(c) Form of the Company's Subordinated Exchangeable Variable Rate Notes (filed as Exhibits A and B to Exhibit 4.13 and incorporated herein by reference to Exhibit 4.3 of the Company's Registration Statement on Form S-2, Registration No. 2-90744). *\n4.3(a) Form of Senior Notes Indenture, dated as of December 15, 1993, by and among the Company, the Guarantors and Pledgors named therein and First Bank National Association, a National Association, as Trustee, with respect to the Company's 11 1\/8% Senior Notes due 2003, including form of Senior Note (the \"Senior Notes Indenture\") (incorporated herein by reference to Exhibit 4.1 of the Company's Form 8-K dated January 11, 1994). *\n4.3(b) First Supplemental Indenture, dated as of February 2, 1994, to the Senior Notes Indenture (incorporated herein by reference to Exhibit 4.4(b) of the Company's Annual Report on Form 10-K for the year ended December 31, 1993). *\n4.4 Form of Convertible Notes Indenture, dated as of December 15, 1993, by and between the Company and First Bank National Association, a National Association, as Trustee, with respect to the Company's 8 3\/4% Convertible Subordinated Notes due 2005, including form of Convertible Note (incorporated herein by reference to Exhibit 4.2 of the Company's Form 8-K dated January 11, 1994). *\n4.5 Loan Agreement and related Promissory Note between Richmond American Homes, Inc., Richmond American Homes of California, Inc., Richmond Homes, Inc. I, Richmond Homes, Inc. II and Richmond American Homes of Nevada, Inc., all wholly owned subsidiaries of the Company and Bank One, Arizona, N.A. (\"Bank One\") dated June 13, 1994 (incorporated herein by reference to Exhibit 4.5 of the Company's Annual Report on Form 10-K for the year ended December 31, 1994).*\n4.6 Guaranty of Payment between the Company and Bank One dated June 13, 1994 (incorporated herein by reference to Exhibit 4.6 of the Company's Annual Report on Form 10-K for the year ended December 31, 1994).*\n4.9 Guaranty Agreement between the Company as guarantor and Bank One, Denver, N.A., as Trustee under Indenture of Trust dated as of June 1, 1994 between it and Superior Metropolitan District No. 1 dated as of June 1, 1994 (incorporated herein by reference to Exhibit 10.1 of the Company's Quarterly Report on Form 10-Q dated September 30, 1994). *\n4.10 Guaranty Agreement between the Company as guarantor and Bank One, Denver, N.A., as Trustee under Indenture of Trust dated as of June 1, 1994 between it and Superior Metropolitan District No. 2, dated as of June 1, 1994 (incorporated herein by reference to Exhibit 10.2 of the Company's Quarterly Report on Form 10-Q dated September 30, 1994). *\n10.1(a) The Company's 1983 Incentive Stock Option Plan (incorporated herein by reference to Exhibit 10.4 of the Company's Annual Report on Form 10-K for the year ended December 31, 1982). *\n10.1(b) 1987 Amendments to the Incentive Stock Option Plan of MDC (incorporated herein by reference to Exhibit 10.1(a) of the Company's Annual Report on Form 10-K for the year ended December 31, 1986). *\n10.1(c) 1988 Amendment to the 1983 Incentive Stock Option Plan of MDC (incorporated herein by reference to Exhibit 19.3(a) of the Company's Quarterly Report on Form 10-Q dated June 30, 1988).*\n10.2(a) The Company's 1983 Non-Qualified Stock Option Plan (incorporated herein by reference to Exhibit 10.5 of the Company's Annual Report on Form 10-K for the year ended December 31, 1983). *\n10.2(b) 1988 Amendment to the 1983 Non-Qualified Stock Option Plan of MDC (incorporated herein by reference to Exhibit 10.2(b) of the Company's Quarterly Report on Form 10-Q dated June 30, 1988). *\n10.3 The Company's Employee Equity Incentive Plan (incorporated herein by reference to Exhibit A of the Company's Proxy Statement dated May 14, 1993 relating to the 1993 Annual Meeting of Stockholders).*\n10.4 The Company's Director Equity Incentive Plan (incorporated herein by reference to Exhibit B of the Company's Proxy Statement dated May 14, 1993 relating to the 1993 Annual Meeting of Stockholders).*\n10.5(a) Amended Management Agreement between Asset Investors Corporation (\"AIC\") and Financial Asset Management Corporation (\"FAMC\") dated as of January 1, 1990 (incorporated herein by reference to Exhibit 10.8(d) to the Company's Annual Report on Form 10-K for the year ended December 31, 1989). *\n10.5(b) Amended Management Agreement between AIC and FAMC dated as of January 1, 1991 (incorporated herein by reference to Exhibit 19 of the Company's Quarterly Report on Form 10-Q dated June 30, 1991). *\n10.5(c) Amended Management Agreement between AIC and FAMC dated as of January 1, 1992 (incorporated herein by reference to Exhibit 10.3(c) of the Company's Annual Report on Form 10-K for the year ended December 31, 1991). *\n10.5(d) Management Agreement between AIC and FAMC dated as of January 1, 1993 (incorporated herein by reference to Exhibit 10.5(d) of the Company's Annual Report on Form 10-K for the year ended December 31, 1994).*\n10.5(e) Amendment to Management Agreement dated as of January 1, 1993 between AIC and FAMC dated as of October 12, 1993 (incorporated herein by reference to Exhibit 10.5(e) of the Company's Annual Report on Form 10-K for the year ended December 31, 1994).*\n10.5(f) Management Agreement between AIC and FAMC dated as of January 1, 1994 (incorporated herein by reference to Exhibit 10.5(f) of the Company's Annual Report on Form 10-K for the year ended December 31, 1994).*\n10.5(g) Management Agreement between Commercial Assets, Inc. (\"CAI\") and FAMC dated as of August __, 1993 (incorporated herein by reference to Exhibit 10.5(g) of the Company's Annual Report on Form 10-K for the year ended December 31, 1994).*\n10.5(h) Management Agreement between CAI and FAMC dated as of October 12, 1993 (incorporated herein by reference to Exhibit 10.5(h) of the Company's Annual Report on Form 10-K for the year ended December 31, 1994).*\n10.5(i) Management Agreement Amendment between AIC and FAMC dated as of January 1, 1996.\n10.5(j) Management Agreement Amendment between CAI and FAMC dated as of January 1, 1996.\n10.6 CMO Participation Agreement among the Company, M.D.C. Asset Investors, Inc. and Yosemite Financial, Inc. (incorporated herein by reference to Exhibit 10.6 of M.D.C. Asset Investors, Inc.'s Registration Statement on Form S-11, Registration No. 33-9557). *\n10.7(a) Form of Indemnity Agreement entered into between the Registrant and each member of its Board of Directors as of March 20, 1987 (incorporated herein by reference to Exhibit 19.1 of the Company's Quarterly Report on Form 10-Q dated June 30, 1987). *\n10.7(b) Form of Indemnity Agreement entered into between the Registrant and certain officers of the Registrant on various dates during 1988 and early 1989 (incorporated herein by reference to Exhibit 10.18(b) to the Company's Annual Report on Form 10-K for the year ended December 31, 1988). *\n10.7(c) Form of Indemnity Agreement entered into between the Registrant and John J. Heaney dated as of May 12, 1989 (incorporated herein by reference to Exhibit 10.17 to the Company's Annual Report on Form 10-K for the year ended December 31, 1990). *\n10.7(d) Form of Agreement, relating to the advancement of expenses and indemnification, entered into between the Registrant and each of its current and former officers and directors named in certain securities litigation (incorporated herein by reference to Exhibit 10.18(c) to the Company's Annual Report on Form 10-K for the year ended December 31, 1988). *\n10.8 Indemnification Agreement by and among the Company and Larry A. Mizel (\"Mizel\") and David D. Mandarich (\"Mandarich\") dated December 21, 1989 (incorporated herein by reference to Exhibit 9 of the Company's Form 8-K dated December 28, 1989). *\n10.9 Promissory Note in the amount of $559,920 from Mizel to the Company dated February 2, 1994 (incorporated herein by reference to Exhibit 10.9 of the Company's Annual Report on Form 10-K for the year ended December 31, 1993). *\n10.10 Promissory Note in the amount of $280,080 from Mandarich to the Company February 2, 1994 (incorporated herein by reference to Exhibit 10.10 of the Company's Annual Report on Form 10-K for the year ended December 31, 1993). *\n10.11 Fifth Amendment to Piney Creek Development Co. Joint Venture Agreement dated June 13, 1991 by and between Commercial Federal Bank and Land (incorporated herein by reference to Exhibit 10.25 to the Company's Annual Report on Form 10-K for the year ended December 31, 1991). *\n10.12 Letter Agreement effective October 1, 1994 by and between Gilbert Goldstein, P.C. and the Company (incorporated herein by reference to Exhibit 10.12 of the Company's Annual Report on Form 10-K for the year ended December 31, 1994).*\n10.13 MDC 401(k) Savings Plan (incorporated herein by reference to Exhibit 10.31(a) to the Company's Annual Report on Form 10-K for the year ended December 31, 1992).* 10.16 M.D.C. Holdings, Inc. Executive Officer Performance-Based Compensation Plan (incorporated herein by reference to Exhibit A to the Company's Proxy Statement dated May 25, 1994 related to the 1994 Meeting of Shareowners). *\n10.17 Employment Agreement between the Company and Michael Touff dated December 31, 1994 (incorporated herein by reference to Exhibit 10.17 of the Company's Form 10-K for the year ended December 31, 1994).*\n10.18 M.D.C. Holdings, Inc. Executive Option Purchase Program, including form of Promissory Note and Pledge Agreement (incorporated herein by reference to Exhibit 10.1 of the Company's Quarterly Report on Form 10-Q dated March 31, 1995).*\n10.19 (a) Agreement effective April 1, 1996 between M.D.C. Holdings, Inc., M.D.C. Residual Holdings, Inc., Financial Asset Management Corporation, Financial Asset Management LLC and Spencer I. Browne.\n10.19 (b) Employment Agreement effective April 1, 1996 between M.D.C. Holdings, Inc. and Spencer I. Browne.\n10.19 (c) Non-Negotiable Promissory Note of Spencer I. Browne payable to Financial Asset Management LLC dated April 1, 1996.\n10.19 (d) Pledge Agreement effective April 1, 1996 between Financial Asset Management LLC and Spencer I. Browne.\n21 Subsidiaries of the Company.\n23 Consent of Price Waterhouse LLP.\n27 Financial Data Schedule.\n- -------------------\n* Incorporated herein by reference.\n(b) Reports on Form 8-K.\nNo reports on Form 8-K were filed during the last quarter of the year ended December 31, 1995.\n` SIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on this 27th day of March, 1996 on its behalf by the undersigned, thereunto duly authorized. M.D.C. HOLDINGS, INC. (Registrant)\nBy: \/s\/ LARRY A. MIZEL ------------------------- Larry A. Mizel Chief Executive Officer\nBy: \/s\/ PARIS G. REECE III ------------------------- Paris G. Reece III Senior Vice President, Chief Financial Officer and Principal Accounting Officer\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned officers and\/or directors of the Registrant, by virtue of their signatures to this report, appearing below, hereby constitute and appoint Larry A. Mizel, Spencer I. Browne and Paris G. Reece III, or any one of them, with full power of substitution, as attorneys-in-fact in their names, places and steads to execute any and all amendments to this report in the capacities set forth opposite their names and hereby ratify all that said attorneys-in-fact do 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\/ LARRY A. MIZEL Chairman of the Board of Directors March 27, 1996 - ------------------------ and Chief Executive Officer Larry A. Mizel\n\/s\/ SPENCER I. BROWNE Director, President and March 27, 1996 - ------------------------ Co-Chief Operating Officer Spencer I. Browne\n\/s\/ DAVID D. MANDARICH Director, Executive Vice March 27, 1996 - ------------------------ President - Real Estate and David D. Mandarich Co-Chief Operating Officer\n\/s\/ STEVEN J. BORICK Director March 27, 1996 - ------------------------ Steven J. Borick\n\/s\/ GILBERT GOLDSTEIN Director March 27, 1996 - ------------------------ Gilbert Goldstein\n\/s\/ WILLIAM B. KEMPER Director March 27, 1996 - ------------------------ William B. Kemper\n\/s\/ HERBERT T. BUCHWALD Director March 27, 1996 - ------------------------ Herbert T. Buchwald\n(A Majority of the Board of Directors)","section_15":""}
{"filename":"36104_1995.txt","cik":"36104","year":"1995","section_1":"ITEM 1 Business General............................................................79 Distribution of Assets, Liabilities and Stockholders' Equity; Interest Rates and Interest Differential..............................18-20, 74-75 Investment Portfolio........................................27-28, 71 Loan Portfolio.........................24-27, 29-33, 45-46, 50-51, 77 Summary of Loan Loss Experience.............................20, 29-33 Deposits................................................28, 74-75, 77 Return on Equity and Assets........................................76 Short-Term Borrowings..............................................77\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2 Properties.........................................................80\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 Equity and Related Stockholder Matters...................38, 68, 76\nITEM 6","section_6":"ITEM 6 Selected Financial Data............................................15\nITEM 7","section_7":"ITEM 7 Management's Discussion and Analysis of Financial Condition and Results of Operations.................14-40\nITEM 8","section_7A":"","section_8":"ITEM 8 Financial Statements and Supplementary Data....................73, 80\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................82*\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......................*\nPART IV\nITEM 14","section_14":"ITEM 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K..........................................80\n*First Bank System's definitive proxy statement for the 1996 Annual Meeting of Shareholders is incorporated herein by reference, other than the sections entitled \"Report of the Compensation and Human Resources Committee on Executive Compensation\" and \"Comparative Stock Performance.\"\n78 First Bank System, Inc. and Subsidiaries\nGENERAL -- First Bank System, Inc. (the \"Company\") is a regional, multi-state bank holding company headquartered in Minneapolis, Minnesota. The Company was incorporated in Delaware in 1929 and owns more than 99 percent of the capital stock of each of nine banks, a savings association and seven trust companies, having 324 banking offices in Minnesota, Colorado, Wisconsin, Illinois, Montana, North Dakota, South Dakota, Iowa, Kansas, Nebraska, and Wyoming. The Company also has various nonbank subsidiaries engaged in financial services, principally in the Upper Midwest.\nThe banks are engaged in general commercial banking business, principally in domestic markets. They range in size from $36 million to $10.5 billion in deposits and provide a wide variety of services to individuals, businesses, industry, institutional organizations, governmental entities, and other financial institutions. Depository services include checking accounts, savings accounts, and time certificate contracts. Ancillary services such as treasury management and receivable lockbox collection are provided for corporate customers. Nine banks, a savings association, and seven trust companies provide a full range of fiduciary activities for individuals, estates, foundations, business corporations, and charitable organizations.\nThe Company provides banking services through its subsidiary banks to both domestic and foreign customers and correspondent banks. These services include consumer banking, commercial lending, financing of import\/export trade, foreign exchange, and investment services.\nThe Company, through its subsidiaries, also provides services in mortgage banking, trust, commercial and agricultural finance, data processing, leasing, and brokerage services.\nOn a full-time equivalent basis, employment during 1995 averaged a total of 13,231 employees.\nCOMPETITION -- The commercial banking business is highly competitive. Subsidiary banks compete with other commercial banks and with other financial institutions, including savings and loan associations, mutual savings banks, finance companies, mortgage banking companies, credit unions, and investment companies. In recent years, competition has increased from institutions not subject to the same regulatory restrictions as domestic banks and bank holding companies.\nGOVERNMENT POLICIES -- The operations of the Company's various operating units are affected by state and federal legislative changes and by policies of various regulatory authorities, including those of the several states in which they operate, the United States and foreign governments. These policies include, for example, statutory maximum legal lending rates, domestic monetary policies of the Board of Governors of the Federal Reserve System, United States fiscal policy, international currency regulations and monetary policies, and capital adequacy and liquidity constraints imposed by bank regulatory agencies.\nSUPERVISION AND REGULATION -- The Company is a registered bank holding company under the Bank Holding Company Act of 1956 (the \"Act\") and is subject to the supervision of, and regulation by, the Board of Governors of the Federal Reserve System (the \"Board\").\nUnder the Act, a bank holding company may engage in banking, managing or controlling banks, furnishing or performing services for banks it controls, and conducting activities that the Board has determined to be closely related to banking. The Company must obtain approval of the Board before acquiring control of a bank or acquiring more than 5 percent of the outstanding voting shares of a company engaged in a \"bank-related\" business. Under the Act and state laws, the Company is subject to certain restrictions as to states in which the Company can acquire a bank.\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.\nNational banks are subject to the supervision of, and are examined by, the Comptroller of the Currency. All subsidiary banks of the Company are members of the Federal Deposit Insurance Corporation (\"FDIC\"), and as such, are subject to examination thereby. In practice, the primary federal regulator makes regular examinations of each subsidiary bank subject to its regulatory review or participates in joint examinations with other federal regulators. Areas subject to regulation by federal authorities include the allowance for credit losses, investments, loans, mergers, issuance of securities, payment of dividends, establishment of branches and other aspects of operations.\nThe Company and its saving association subsidiary are subject to the supervision of and are examined by the OTS. The savings association is a member of SAIF, which is administered and is subject to examination by the FDIC. As a saving association, the Company's subsidiary must meet the requirements of a qualified thrift lender to avoid certain restrictions relating to dividends, branching and certain new activities. As of December 31, 1995, the savings association was a \"qualified thrift lender.\" Similar to its banking subsidiaries, the savings association is also subject to regulation by the OTS in the areas of credit losses, investments, loans, mergers, issuance of securities, payment of dividends, establishment of branches, and other aspects of operations.\nFirst Bank System, Inc. and Subsidiaries 79\nPROPERTIES -- At December 31, 1995, the Company's subsidiaries owned and operated a total of 252 facilities and leased an additional 214 facilities, all of which are well maintained.\nThe Company's three largest facilities are located in Denver, Minneapolis and St. Paul. In Denver, Colorado National Bank occupies approximately 70 percent of the Colorado National Bank Tower and 100 percent of the Colorado National Bank building. In Minneapolis, First Bank National Association and the Company's corporate offices occupy parts of five buildings, leasing 31 floors in First Bank Place, part of the second floor in the Pillsbury Center, and two floors in the Fifth Street Towers. The Company also occupies 10 floors in the Sixth and Marquette bank building, and six floors of the 1010 Building in Minneapolis. The Company's primary St. Paul presence is the Energy Park Operations Center, and in downtown St. Paul, where it occupies approximately one-fourth of the First National Bank Building, four floors in the First Trust Center, and approximately 70 percent of the space in the Pioneer\/ Endicott building complex.\nThe Company is currently constructing a 150,000 square foot service center in Fargo, North Dakota. The Center will be owned by FBS, is scheduled to open in mid-1996, and will provide space for the growth of service operations.\nAdditional information with respect to premises and equipment is presented in Notes G and O of Notes to Consolidated Financial Statements.\nSchedules to the consolidated financial statements required by Article 9 of Regulation S-X are omitted since the required information is included in the footnotes or is not applicable.\nDuring the three months ended December 31, 1995, the Company filed the following reports on Form 8-K:\nForm 8-K filed November 13, 1995, relating to the Company's announcement that it had signed a purchase agreement to merge with First Interstate Bancorp (\"First Interstate\").\nForm 8-K\/A filed on November 15, 1995, amending Form 8-K filed on August 18, 1995, which includes unaudited financial statements of FirsTier Financial, Inc. filed pursuant to Item 7(a).\nForm 8-K filed November 16, 1995, which discussed the updating of the description of the Rights contained in Item 1 of the FBS Registration Statement on Form 8-A dated December 21, 1988, as amended.\nForm 8-K filed November 16, 1995, which includes First Interstate's unaudited financial statements and pro forma financial information filed pursuant to Item 7.\nForm 8-K filed December 13, 1995, discussing the Company's stock repurchase program.\nForm 8-K filed December 15, 1995, regarding the complaint filed by the Company and Eleven Acquisition Corp. against Wells Fargo & Company.\nThe following Exhibit Index lists the Exhibits to Annual Report on Form 10-K.\n(1)3A Restated Certificate of Incorporation, as amended. Filed as Exhibit 2.1 to Form 8-A\/A-2 dated October 6, 1994.\n3B By-laws.\n4 [Pursuant to Item 601(b)(4)(iii)(A) of Regulation S-K, copies of instruments defining the rights of holders of long-term debt are not filed. First Bank System, Inc. agrees to furnish a copy thereof to the Securities and Exchange Commission upon request.]\n(1)4A Certificate of Designation for First Bank System, Inc. Series 1990A Preferred Stock. Filed as Exhibit 4.4 to Amendment No.1 to Registration Statement on Form S-3, File No.33-42650.\n(1)4B Certificate of Designation for First Bank System, Inc. Series 1991A Convertible Preferred Stock. Filed as Exhibit 4.3 to Registration Statement on Form S-4, File No. 33-50700.\n(1)4C Certificate of Designation for First Bank System, Inc. Series A Junior Participating Preferred Stock, as amended. Filed as Exhibit 2.4 to Form 8-A\/A-2 dated October 6, 1994.\n(1)4D Rights Agreement dated as of December 21, 1988, between First Bank System, Inc. and Morgan Shareholder Services Trust Company (now known as First Chicago Trust Company of New York), as amended by Amendment No. 1 dated as of May 30, 1990, Amendment No. 2 dated as of February 17, 1993, and Amendment No. 3 dated November 9, 1995. Filed as Exhibit 4.6 to Registration Statement on Form S-4, File No. 333-0029.\n(1)10A Stock Purchase Agreements dated as of May 30, 1990, among Corporate Partners, L.P.; Corporate Offshore Partners, L.P.; The State Board of Administration of Florida and First Bank System, Inc. and related documents. Filed as Exhibits 4.8-4.15 to Registration Statement on Form S-3, File No. 33-42650.\n(1)(2)10B First Bank System, Inc. 1987 Stock Option Plan. Filed as Exhibit 10E to report on Form 10-K for fiscal year ended December 31, 1991.\n(1)(2)10C First Bank System, Inc. Nonqualified Supplemental Executive Retirement Plan. Filed as Exhibit 10C to report on Form 10-Q for quarter ended March 31, 1995.\n(1)(2)10D First Bank System, Inc. Executive Deferral Plan. Filed as Exhibit 10G to report on Form 10-K for fiscal year ended December 31, 1991.\n(1)(2)10E First Bank System, Inc. Annual Incentive Plan. Filed as Exhibit 10H to report on Form 10-K for fiscal year ended December 31, 1992.\n(1)(2)10F First Bank System, Inc. Independent Director Retirement and Death Benefit Plan. Filed as Exhibit 10I to report on Form 10-K for fiscal year ended December 31, 1992.\n(1)(2)10G First Bank System, Inc. Deferred Compensation Plan for Directors. Filed as Exhibit 10J to report on Form 10-K for fiscal year ended December 31, 1992.\n(1)(2)10H First Bank System, Inc. 1995 Executive Incentive Plan. Filed as Exhibit 10B to report on Form 10-Q for quarter ended March 31,1995.\n(1)(2)10I First Bank System, Inc. Restated Employee Stock Purchase Plan. Filed as Exhibit 10L to report on Form 10-K for fiscal year ended December 31, 1991.\n80 First Bank System, Inc. and Subsidiaries\n(1)(2)10J Form of Change-in-Control Agreement between First Bank System, Inc. and certain officers of the Company. Filed as Exhibit 10M to report on Form 10-K for fiscal year ended December 31, 1991.\n(1)(2)10K First Bank System, Inc. 1991 Stock Incentive Plan, as amended. Filed as Exhibit 10A to report on Form 10-Q for quarter ended March 31, 1995.\n(1)(2)10L First Bank System, Inc. 1994 Stock Incentive Plan. Filed as Exhibit 10M to report on Form 10-K for fiscal year ended December 31, 1993.\n(1)(2)10M Agreement between First Bank System, Inc. and John F. Grundhofer dated January 18, 1995. Filed as Exhibit 10O to report on Form 10-K for fiscal year ended December 31, 1994.\n(1)(2)10N Deferred Income Agreement between First Bank System, Inc. and John F. Grundhofer dated November 1, 1993. Filed as Exhibit 10O to report on Form 10-K for fiscal year ended December 31, 1993.\n(1)(2)10O Description of First Bank System, Inc. Stock Option Loan Policy. Filed as Exhibit 10P to report on Form 10-K for fiscal year ended December 31, 1993.\n(1)(2)10P Employment Agreement dated as of April 30, 1993, by and between First Bank System, Inc. and Will F. Nicholson, Jr. Filed as Exhibit 10R to report on Form 10-K for fiscal year ended December 31, 1994.\n(1)(2)10Q Employment Agreement dated as of December 31, 1994 by and between First Bank System, Inc. and Will F. Nicholson, Jr. Filed as Exhibit 10S to report on Form 10-K for fiscal year ended December 31, 1994.\n(1)(2)10R Consulting Agreement dated as of January 23, 1995, by and between First Bank System, Inc. and Norman M. Jones. Filed as Exhibit 10T to report on Form 10-K for fiscal year ended December 31, 1994.\n(1)10S Agreement of Merger and Consolidation, dated July 21, 1994, by and between First Bank System, Inc. and Metropolitan Financial Corporation. Filed as Exhibit 2.1 to Form 8-K filed August 5, 1994.\n(1)10T Agreement of Merger and Consolidation dated August 6, 1995 by and between First Bank System, Inc. and FirsTier Financial, Inc. Filed as Exhibit 2.1 to Registration Statement on Form S-4, File No. 333-00299.\n(1)10U Settlement Agreement, dated as of January 23, 1996, between First Bank System, Inc., First Interstate Bancorp and Wells Fargo & Co. Filed as Exhibit 2.1 to Form 8-K filed January 26, 1996.\n11 Statement re: Computation of Primary and Fully Diluted Net Income per Common Share.\n12 Statement re: Computation of Ratio of Earnings to Fixed Charges.\n13 Annual Report to Shareholders for the year ended December 31, 1995.\n21 Subsidiaries of the Registrant.\n23 Consent of Ernst & Young LLP.\n27 Financial Data Schedule.\nCopies of the Exhibits will be furnished upon request and payment of the Company's reasonable expenses in furnishing the Financial Statement Schedule and Exhibits.\n(1) Exhibit has heretofore been filed with the Securities and Exchange Commission and is incorporated herein as an exhibit by reference.\n(2) Items that are management contracts or compensatory plans or arrangements required to be filed as an exhibit pursuant to Item 14(c) 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 February 21, 1996, on its behalf by the undersigned thereunto duly authorized.\nFirst Bank System, Inc. John F. Grundhofer Chairman, President and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on February 21, 1996, by the following persons on behalf of the registrant and in the capacities indicated.\nJOHN F. GRUNDHOFER Chairman, President, Chief Executive Officer, and Director (principal executive officer)\nRICHARD A. ZONA Vice Chairman-Finance\nSUSAN E. LESTER Executive Vice President and Chief Financial Officer (principal financial officer)\nDAVID J. PARRIN Senior Vice President and Controller (principal accounting officer)\nARTHUR D. COLLINS, JR. Director\nPETER H. COORS Director\nROGER L. HALE Director\nDELBERT W. JOHNSON Director\nNORMAN M. JONES Director\nJOHN H. KAREKEN Director\nRICHARD L. KNOWLTON Director\nJERRY W. LEVIN Director\nKENNETH A. MACKE Director\nMARILYN CARLSON NELSON Director\nEDWARD J. PHILLIPS Director\nJAMES J. RENIER Director\nS. WALTER RICHEY Director\nRICHARD L. ROBINSON Director\nRICHARD L. SCHALL Director\nLYLE E. SCHROEDER Director\nFirst Bank System, Inc. and Subsidiaries 81\nEXECUTIVE OFFICERS\nJOHN F. GRUNDHOFER Mr. Grundhofer, 57, has been Chairman of the Board, President and Chief Executive Officer of First Bank System since 1990.\nPHILIP G. HEASLEY Mr. Heasley, 46, has served as Vice Chairman since 1993. He is responsible for retail bank products, Payment Systems, and operations and technology. In February 1996, Mr. Heasley assumed additional responsibility for consumer and small business sales and services carried out through bank branches.\nRICHARD A. ZONA Mr. Zona, 51, was named Vice Chairman-Finance in February 1996, and assumed responsibility for private financial services and business banking. Mr. Zona previously served as Vice Chairman and Chief Financial Officer.\nJ. ROBERT HOFFMANN Mr. Hoffmann, 50, has been Executive Vice President and Chief Credit Officer since 1990.\nSUSAN E. LESTER Ms. Lester, 39, was named Executive Vice President and Chief Financial Officer in February 1996. She had served as Executive Vice President, Finance, since December 1995. From May 1994 to November 1995, Ms. Lester was Executive Vice President and Chief Financial Officer of Shawmut National Corporation. Before that, she served as Executive Vice President and Controller at First Bank System.\nLEE R. MITAU Mr. Mitau, 47, was named Executive Vice President, General Counsel and Secretary in 1995. Previously, he was a Senior Partner at Dorsey & Whitney P.L.L.P.\nJOHN M. MURPHY, JR. Mr. Murphy, 54, has been Chairman and Chief Investment Officer, First Trust National Association, since 1990.\nDANIEL C. ROHR Mr. Rohr, 49, has served as Executive Vice President of the Commercial Banking Group since 1990.\nROBERT H. SAYRE Mr. Sayre, 56, has served as Executive Vice President of Human Resources since 1990.\nDAVID R. EDSTAM Mr. Edstam, 48, was named Executive Vice President and Treasurer in 1995. He previously served as Senior Vice President and Treasurer.\nELIZABETH A. MALKERSON Ms. Malkerson, 46, has been Senior Vice President of Corporate Relations since 1990.\nDAVID J. PARRIN Mr. Parrin, 40, has been Senior Vice President and Controller since 1994. Previously, he was a Partner at Ernst & Young LLP.\nDIRECTORS\nJOHN F. GRUNDHOFER Chairman, President and Chief Executive Officer First Bank System, Inc. Minneapolis, Minnesota\nARTHUR D. COLLINS, JR.* Chief Operating Officer Medtronic, Inc. Minneapolis, Minnesota\nPETER H. COORS* Vice Chairman and Chief Executive Officer Coors Brewing Company Golden, Colorado\nROGER L. HALE President and Chief Executive Officer TENNANT Minneapolis, Minnesota\nDELBERT W. JOHNSON Chairman and Chief Executive Officer Pioneer Metal Finishing, Inc. Minneapolis, Minnesota\nNORMAN M. JONES Chairman of the Board First Bank, fsb Minneapolis, Minnesota\nJOHN H. KAREKEN Professor Emeritus of Banking and Finance Curtis L. Carlson School of Management University of Minnesota Minneapolis, Minnesota\nRICHARD L. KNOWLTON Chairman The Hormel Foundation Austin, Minnesota\nJERRY W. LEVIN** Chairman and Chief Executive Officer Revlon, Inc. New York, New York\nKENNETH A. MACKE Macke Partners Golden Valley, Minnesota\nMARILYN CARLSON NELSON Vice Chair Carlson Holdings, Inc. Minneapolis, Minnesota\nEDWARD J. PHILLIPS Chairman and Chief Executive Officer Phillips Beverage Company Minneapolis, Minnesota\nJAMES J. RENIER Retired Chairman of the Board and Chief Executive Officer Honeywell Inc. Minneapolis, Minnesota\nS. WALTER RICHEY President and Chief Executive Officer Meritex, Inc. Minneapolis, Minnesota\nRICHARD L. ROBINSON Chairman and Chief Executive Officer Robinson Dairy, Inc. Denver, Colorado\nRICHARD L. SCHALL Retired Vice Chairman of the Board Dayton Hudson Corporation Minneapolis, Minnesota\nLYLE E. SCHROEDER President and Chief Executive Officer Sioux Valley Hospital Sioux Falls, South Dakota\n*Elected effective February 21, 1996\n**Elected effective July 19, 1995\n82 First Bank System, Inc. and Subsidiaries\nFBS LOCATIONS*\nMINNESOTA Albert Lea Alexandria (2) Amboy Anoka (2) Apple Valley Austin Babbitt Blaine Blooming Prairie Bloomington (4) Brainerd Brooklyn Center Brooklyn Park Burnsville Chisago City Cloquet Columbia Heights Cottage Grove Duluth (7) Eagan (2) East Grand Forks Eden Prairie (2) Edina (3) Elk River Fairmont Fergus Falls Forest Lake Grand Rapids Hibbing Hopkins Lamberton Little Canada Mankato (2) Maple Grove Minneapolis (15) Minnetonka (2) Monticello Moorhead New Prague Oakdale Owatonna Pine City Pine River Plymouth (2) Princeton Prior Lake Ramsey Robbinsdale Rochester (4) Sauk Rapids Shoreview St. Anthony St. Cloud (2) St. Louis Park St. Paul (6) Stillwater Virginia Wayzata West St. Paul White Bear Lake (2) Willmar Woodbury\nCOLORADO Arvada (2) Aspen Aurora (4) Boulder (2) Broomfield Canon City Colorado Springs (6) Denver (18) Englewood (3) Evergreen Fort Collins (2) Glenwood Springs Golden Grand Junction (2) Greeley Highlands Ranch La Junta Lakewood (4) Littleton (4) Longmont Loveland Northglenn Parker Pueblo (4) Westminster (2) Wheat Ridge\nILLINOIS Chicago (6) Des Plaines (3) Downers Grove\nIOWA Altoona Alvord Ankeny Carlisle Clear Lake Council Bluffs (4) Des Moines (6) Doon Hampton Iowa Falls Knoxville Mason City (2) Nevada Pella Red Oak Rock Valley Wellman West Des Moines (2) Williamsburg\nKANSAS Andover Augusta Clay Center El Dorado Emporia (2) Eureka Gardner Holton Iola Lawrence (2) Manhattan Overland Park Prairie Village Pratt Topeka (2) Wichita (4)\nMONTANA Billings (2) Bozeman Butte Great Falls (3) Havre Helena Miles City Missoula (2)\nNEBRASKA Beatrice Bellevue Blair Columbus David City Elkhorn Fremont (2) Gering Grand Island (2) Hastings Kearney (2) La Vista Lincoln (10) Millard Norfolk (2) North Platte Omaha (21) Scottsbluff (3)\nNORTH DAKOTA Beulah Bismarck (4) Devils Lake Dickinson Fargo (5) Grafton Grand Forks (4) Jamestown Langdon Lisbon Mandan Minot (2) Valley City Wahpeton West Fargo Williston\nSOUTH DAKOTA\nAberdeen Colton Hartford Humboldt Mitchell Pierre Rapid City (4) Sioux Falls (7)\nWISCONSIN Brookfield Brown Deer Hudson LaCrosse Milwaukee (2) Onalaska\nWYOMING Casper Cheyenne (2) Cody Evanston Gillette Green River Lander Laramie Riverton Rock Springs Sheridan Torrington Worland\nCORPORATE TRUST OFFICES Billings, MT Cheyenne, WY Chicago, IL Denver, CO Des Plaines, IL Duluth, MN Fargo, ND Grand Junction, CO Los Angeles, CA Milwaukee, WI Minneapolis, MN New York, NY Portland, OR Pueblo, CO Rochester, MN San Francisco, CA Seattle, WA Sioux Falls, SD St. Paul, MN\nREPUBLIC ACCEPTANCE CORP. OFFICES Des Plaines, IL Lakewood, CO Milwaukee, WI Minneapolis, MN St. Louis, MO\n*First Bank System, Inc. primarily serves Minnesota, Colorado, Illinois, Iowa, Kansas, Montana, Nebraska, North Dakota, South Dakota, Wisconsin, and Wyoming through 356 banking locations and 18 nonbank offices. This includes the offices of FirsTier Financial, Inc., which FBS acquired February 16, 1996.\nFirst Bank System, Inc. and Subsidiaries 83\nCORPORATE DATA\nEXECUTIVE OFFICES First Bank Place 601 Second Avenue South Minneapolis, Minnesota 55402-4302 (612) 973-1111\nANNUAL MEETING The annual meeting of shareholders will be held at the Minneapolis Convention Center, 1301 Second Avenue South, Minneapolis, Minnesota 55403, at 2 p.m. on Wednesday, April 17, 1996.\nSECURITIES INFORMATION First Bank System Common Stock is traded on the New York Stock Exchange under the ticker symbol FBS and also may be found under the listing FtBkSy. The transfer agent and registrar for First Bank System is First Chicago Trust Company of New York, P.O. Box 2500, Jersey City, New Jersey 07303-2500.\nDIVIDEND REINVESTMENT First Bank System shareholders can take advantage of a plan that provides automatic reinvestment of dividends and\/or optional cash purchases of additional shares at market price of up to $5,000 per quarter. If you would like more information, contact First Chicago Trust Company of New York, P.O. Box 2598, Jersey City, New Jersey 07303-2598, (800) 446-2617.\nINVESTMENT COMMUNITY CONTACTS John R. Danielson Senior Vice President, Investor Relations (612) 973-2261\nGeneral Information, Investor Relations (612) 973-2263 First Bank System, Inc. P.O. Box 522 Minneapolis, Minnesota 55480\nFINANCIAL INFORMATION FBS news and financial results are available by fax, mail, or on-line.\nFax. To access our fax on demand service, call 1-800-758-5804. When asked, enter FBS's extension number, 312402. Enter \"1\" for the most current news release or \"2\" for a menu of recent releases. Enter your fax and phone numbers as directed. The information will be faxed to you immediately.\nMail. If you don't have access to a fax machine or prefer not to use FSB's fax- on-demand service, we will be glad to automatically mail to you our quarterly earnings news release. To get on our mailing list, please contact Corporate Relations, First Bank System, First Bank Place, Minneapolis, Minnesota 55402, (612) 973-2434.\nInternet. To access information about FBS, including news releases, product information, and a list of service locations, visit our home page on the world wide web. Our address is www.fbs.com.\nFor additional annual reports, quarterly financial data on Form 10-Q, or information about the 1996 annual meeting of shareholders, please contact Corporate Relations, First Bank System, First Bank Place, Minneapolis, Minnesota 55402, (612) 973-2434.\nCOMMUNITY RESPONSIBILITY REPORT For information about FBS's community reinvestment activities, call FBS Community Relations, (612) 973-2440.\nFirst Bank System is an Equal Employment Opportunity\/Affirmative Action employer.\n84 First Bank System, Inc. and Subsidiaries\nDesign and Typography: The Nancekivell Group \/ Printing: Banta Direct Marketing Group: The Press\n[LOGO] First Bank System\nP.O. Box 522 Minneapolis, Minnesota\nGRAPHICS APPENDIX\nInside Front Cover - ------------------\nMap of the United States. The 11 Midwest and Rocky Mountain states (Montana, Wyoming, Colorado, North Dakota, South Dakota, Nebraska, Kansas, Minnesota, Iowa, Wisconsin, and Illinois) in which FBS has retail banking offices are shaded.\nPage 1: - -------\nGraphs illustrate the following information:\nReturn on average common equity (percent) 1991: 14.7 1992: 12.6 1993: 15.8 1994: 17.6 1995: 21.3\nReturn on average assets (percent) 1991: 0.95 1992: 1.02 1993: 1.28 1994: 1.40 1995: 1.73\nEarnings per share (dollars and fully diluted) 1991: 1.92 1992: 2.08 1993: 2.82 1994: 3.32 1995: 4.11\nEfficiency ratio (percent) 1991: 68.3 1992: 65.2 1993: 60.4 1994: 58.1 1995: 53.3\nShareholders' equity to assets ratio (percent) 1991: 7.5 1992: 8.4 1993: 8.2 1994: 7.7 1995: 8.0\nAllowance coverage of nonperforming loans ratio (percent) 1991: 120 1992: 149 1993: 208 1994: 283 1995: 401\nGraphs before merger-related items and nonrecurring items.\n- ------\nPhotograph of John F. Grundhofer, chairman, president and chief executive officer\nGraph illustrates the following information: Six-year total return* (percent)\nIndex: 12\/31\/89 = 100 FBS = FBS Common Stock S&P500 = Standard & Poor's Index of 500 Stocks KBW 50 = Keefe Bruyette & Woods 50-bank index\n1989: FBS\/100, S&P500\/100, KBW 50\/100 1990: FBS\/83, S&P500\/97, KBW 50\/72 1991: FBS\/159, S&P500\/126, KBW 50\/114 1992: FBS\/193, S&P500\/136, KBW 50\/145 1993: FBS\/217, S&P500\/150, KBW 50\/153 1994: FBS\/243, S&P500\/152, KBW 50\/145 1995: FBS\/375, S&P500\/209, KBW 50\/232\n* Capital appreciation plus dividends\n$100 invested in FBS stock in 1989 would have been worth $375 at year-end 1995, compared with $232 for the KBW index of 50 banks and $209 for the S&P 500.\n- ------\nTable entitled \"Recent Acquisitions\" (assets in Millions)\nBankAmerica Corporate Trust, closing date: 1Q96, location: National, assets: N\/A FirsTier Financial, Inc., closing date: 1Q96, location: Nebraska, assets: 3,700 Midwestern Services, Inc., closing date: 4Q95, location: Nebraska, assets: 229 Southwest Holdings, Inc., closing date: 4Q95, location: Nebraska, assets: 195 Metropolitan Financial Corporation, closing date: 1Q95, location: Midwest, assets: 7,900 First Western Corporation, closing date: 1Q95, location: South Dakota, assets: 317\n- ------\nGraphs illustrate the following information:\nPie chart shows that the Retail and Community Banking Group accounts for 57 percent of FBS net income.\nNet Income (Millions) 1993: 202 1994: 252 1995: 322\nNet Interest Income (Millions) 1993: 949 1994: 1,021 1995: 1,052\nNoninterest Income (Millions) 1993: 228 1994: 237 1995: 221\nEfficiency Ratio (percent) 1993: 69.4 1994: 64.9 1995: 56.8\nGraphs before merger-related items and nonrecurring items. - ------\nGraphs illustrate the following information:\nPie chart shows that the Payment Systems group accounts for 15 percent of FBS net income.\nNet Income (Millions) 1993: 68 1994: 78 1995: 85\nNet Interest Income (Millions) 1993: 148 1994: 172 1995: 156\nNoninterest Income (Millions) 1993: 157 1994: 195 1995: 261\nEfficiency Ratio (percent) 1993: 43.6\n1994: 46.2 1995: 49.2\nGraphs before merger-related items and nonrecurring items. - -------\nGraphs illustrate the following information:\nPie chart shows that the Commercial Banking group accounts for 19 percent of FBS net income.\nNet Income (Millions) 1993: 105 1994: 106 1995: 111\nNet Interest Income (Millions) 1993: 227 1994: 216 1995: 218\nNoninterest Income (Millions) 1993: 60 1994: 58 1995: 60\nEfficiency Ratio (percent) 1993: 33.7 1994: 32.8 1995: 31.9\nGraphs before merger-related items and nonrecurring items. - -------\nGraphs illustrate the following information:\nPie chart shows that the Trust and Investment group accounts for 9 percent of FBS net income.\nNet Income (Millions) 1993: 36 1994: 35 1995: 50\nNet Interest Income (Millions) 1993: 32 1994: 25 1995: 29\nNoninterest Income (Millions) 1993: 173 1994: 180 1995: 211\nEfficiency Ratio (percent) 1993: 71.2 1994: 71.9 1995: 66.4\nGraphs before merger-related items and nonrecurring items.","section_15":""}
{"filename":"20104_1995.txt","cik":"20104","year":"1995","section_1":"ITEM 1. BUSINESS\nAt June 30, 1995, Christiana is engaged in providing public refrigerated and non-refrigerated warehousing and logistic services; renting, refurbishing and selling of residential housing in San Diego; and owning 1,948,731 shares of Energy Ventures, Inc. common stock representing 13.1% ownership of the then outstanding shares.\nREFRIGERATED WAREHOUSING AND LOGISTICS\nOperations in this line of business are conducted through two wholly owned subsidiaries, Wiscold, Inc. and The TLC Group, Inc.\nWISCOLD, INC.\nOn September 1, 1992, Christiana acquired the assets of Wiscold, Inc., a Wisconsin corporation, formed in 1915, which is engaged in providing public refrigerated warehousing services, vegetable processing and individual quick freeze (IQF) services and automated vegetable poly bag and bulk services. Customers include food processors, wholesalers, distributors and retailers servicing the central United States.\nWiscold owns and operates four facilities serving separate and distinct markets. In total, Wiscold's frozen storage capacity is approximately 200 million pounds. All of the Company's facilities with the exception of the downtown Milwaukee facility are single story concrete buildings constructed at dock height elevation and fully insulated. The downtown Milwaukee facility is a 10 story building. Wiscold's refrigerated warehouse facilities are:\n- Rochelle Cold Storage is located in Rochelle, Illinois. This is Wiscold's newest and largest facility, initially constructed in 1986. Currently this facility is comprised of 10,600,000 cubic feet of capacity after undergoing three capacity expansions in 1988, 1990 and 1993. All space is capable of temperatures of -20 degree F to ambient. Rochelle Cold Storage is strategically located at the intersection of two main line railroads and two interstate highways.\n- Badger Cold Storage is located in Beaver Dam, Wisconsin. The facility was constructed in 1975. Since 1975, this facility has undergone three freezer additions, the most recent in 1991, and today is comprised of 7,200,000 cubic feet of freezer storage space. Badger Cold Storage serves distribution related customers as well as vegetable and cranberry processors. This facility's unique capabilities involve value added services including IQF, blanching, slicing, dicing and packaging operations. Badger's IQF tunnels have the capacity to freeze 85,000 pounds of product per hour.\n- Mohawk Cold Storage is located in Wauwatosa, Wisconsin. This facility was originally constructed in 1954. There have been six expansions of this facility and today the Mohawk facility comprises 4,300,000 cubic feet of which 3,754,000 cubic feet is freezer capacity and 546,000 cubic feet is cooler space. This facility has multi-temperature refrigerated storage ranging from -20 degree F to +40 degree F and daily blast freezing capacity of 750,000 pounds. This location has a 7-car private rail siding. An additional 3 million cubic feet of refrigerated and processing space owned by Wiscold\nadjacent to the Mohawk facility is leased on a long term basis to a third party retail grocery company.\n- Wisconsin Cold Storage is located in Milwaukee, Wisconsin. Constructed between 1900 and 1915, it has 1,000,000 cubic feet of storage capacity comprised of 900,000 cubic feet of freezer space and 100,000 cubic feet of cooler space.\nWiscold is the nation's seventh largest provider of public refrigerated warehouse services. In addition to providing full service multi-temperature storage, other supplemental services related to the refrigerated storage business include fully computerized inventory management, production services such as blanching and blast freezing, packaging and repackaging, and logistic services, including services via company owned motor carrier, consolidated shipping services via common carriers, and intermodal services with the Burlington Northern and Chicago & Northwestern railroads.\nWiscold's customers consist primarily of national, regional and local frozen food processing firms, wholesalers and large retailers. Wiscold serves approximately 600 customers. In fiscal 1995, Wiscold's three largest customers accounted for approximately 33% of revenues. Wiscold had no single customer accounting for more than 15% of its total revenues.\nCompetition in the public refrigerated warehouse industry in the United States is on a national, regional and local basis. In the United States, there are four public refrigerated warehouse companies which compete on a national level. On a regional and local level there are many small warehouse operators. Wiscold's competitive edge is the ability to provide its customers with significantly reduced distribution costs through its consolidation and distribution center concept as well as a unique capacity to process and IQF freeze large volumes of vegetables and cranberries.\nWiscold holds no patents, trademarks, licenses, franchises or concessions which are material to its business.\nExpenditures for research and development and compliance with environmental regulations have not been, and are not anticipated to be, significant.\nTHE TLC GROUP, INC.\nChristiana acquired The TLC Group, Inc. (\"TLC\") a Zeeland, Michigan-based firm on January 3, 1994. TLC provides fully integrated third party logistic services that include warehouse, distribution and transportation services. TLC also markets and provides these services individually. Customers can utilize TLC's fully integrated services to handle their product from the point of manufacture to its final destination. The full spectrum of integrated services also includes picking, repackaging, freight consolidation, just-in-time (\"JIT\") production supply, electronic data interchange (\"EDI\") transmissions and customized inventory management reporting of inventory quantity and shipments.\nWarehouse services include full service public and contract warehousing in both the refrigerated and ambient temperature ranges. In addition, TLC provides ancillary warehouse services such as kitting, rail transloading and cross dock services. TLC's transportation and distribution services include full service truckload and less-than-truckload temperature controlled and dry freight, dedicated fleet service, and specialized store-door delivery. These services are provided utilizing its own fleet as well as brokered carrier equipment. The\nCompany's other services include truck part sales and repairs and international freight management.\nTLC's customers consist of national, regional and local firms, mainly in the food, office equipment and health and beauty aid channels. During fiscal 1995, TLC's three largest customers accounted for approximately 40% of its revenue. TLC's largest customer accounted for approximately 27% of its total revenues.\nTLC's competition in all sectors of its business is on a national and local basis. Each of TLC's individual business segments is in highly fragmented industries with many local and regional competitors and a few companies that have national presence. In most cases, except for long haul truckload and less-than-truckload freight, services are marketed on a local or regional basis. TLC's competitive edge is its ability to provide fully integrated innovative and flexible solutions to meet its customers' distribution needs and to improve efficiency within customers' supply chains. TLC is unique in its ability to provide its wide array of service offerings from one source utilizing its own facilities and equipment.\nTLC holds a perpetual license to its current warehouse software programs. TLC also holds a trademark on its name and logo. TLC holds no other patents, trademarks, licenses, franchises or concessions which are material to its business.\nExpenditures for research and development and compliance with environmental regulations have not been, and are not anticipated to be, significant.\nREAL ESTATE\nAt June 30, 1995, Christiana owned 82 condominium homes in Villa Martinique located in the Tierrasanta section of San Diego, California. Tierrasanta is approximately 10 miles northeast of downtown San Diego. It is essentially a suburban community built during the 1970s and early 1980s with a present population of about 20,000.\nVilla Martinique consists of 55 two-story, wood-frame and stucco, eight-plex condominium structures, for a total of 440 residential units. The project is between 15-20 years old. At June 30, 1995, Christiana owned 82 homes and, other than those offered for sale and those scheduled for refurbishment the homes were leased out through an onsite rental office. Tenants are required to sign a month-to-month lease agreement. This technique has enabled Christiana to maintain rents at current market rates and keeps the units not offered for sale fully occupied.\nAt June 30, 1995, 25 of these units are available for rental and are leased. The other 57 units are either models, in escrow or offered for sale.\nDuring fiscal 1995, the Company completed sales of 48 condominium units generating pre-tax gains of $3,083,000 or $64,000 per unit. These sales were part of a phased program to refurbish and sell company-owned condominium homes. Since commencement of the sales program in August 1991 through June 30, 1995, sales of 284 homes have been completed and an additional 10 homes were under contract for sale pending scheduled closings. Completion of the sales program is expected in fiscal 1996.\nPARTNERSHIP AND JOINT VENTURES\nAs discussed in Note A Other Assets, the Company holds a partnership interest which represented 5% ownership of a 1.15 million square foot Class A office building in\ndowntown Chicago. Ownership in the building was surrendered by the partnership for payment in the amount of $2,300,000 and in lieu of foreclosure. The amount of the payment attributable to Christiana's interest was approximately equal to its carrying value of $230,000. Due to the book\/tax difference in the basis of this holding, deferred taxes in the amount of $1,730,000 are included in current accrued liabilities and are expected to be paid in fiscal 1996.\nPRIDECO\nUntil June 30, 1995, Prideco was a 60% owned subsidiary of the Company. Prideco manufacturers downhole tubular products used in the exploration and production of oil and gas wells. These products which include drill pipe, drill collars, heavy weight pipe and premium casing are sold worldwide.\nOn June 30, 1995, Christiana completed a tax free merger of Prideco with Grant Acquisition Company, a wholly owned subsidiary of Energy Ventures, Inc. (\"EVI\"), a New York Stock Exchange listed firm. In the merger transaction Christiana exchanged its ownership in Prideco for 1,035,858 shares of EVI common stock which had a market value at June 30, 1995 of $18,645,000.\nEMPLOYEES\nThe following table shows the number of fulltime Christiana, Wiscold and TLC employees at the dates indicated.\n*In addition, Wiscold employs approximately 80 seasonal workers working varying hours.\n**On June 30, 1995 Prideco was merged with an operating unit of Energy Ventures, Inc. (NYSE:EVI).\nThe decrease in Christiana employees from 30 in 1994 to 23 in 1995 is due to the slower pace of home refurbishment activities in fiscal 1995. At August 31, 1995, Wiscold had 46 more fulltime employees then at the same date a year ago due to higher handling and order selection activities at Rochelle Cold Storage and Mohawk Cold Storage. The increase in employees at TLC is related to increased handling and order selection activities at various warehouses and increases in the transportation fleet.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nREFRIGERATED WAREHOUSING FACILITIES\nAt the end of fiscal 1995, Wiscold owned and operated four public refrigerated warehouse facilities located in Wisconsin (3) and Illinois (1). Other than Wisconsin Cold Storage, located in downtown Milwaukee, Wiscold's facilities are large single-story buildings constructed at dock height with full insulation and vapor barrier protection. Refrigeration is provided by screw-type compressors in ammonia-based cooling systems. The facilities are strategically located and well served by rail and truck.\nWiscold's refrigerated warehouse facilities are described on the following table:\nAt both the Rochelle and Beaver Dam facilities the Company owns substantial additional acreage available for expansion.\nAt the end of fiscal 1995, TLC operated 13 public refrigerated and dry warehouse (general merchandise) facilities located in Michigan (8), Georgia (1), Indiana (1), Nevada (1), New Jersey (1) and Puerto Rico (1). The newest dry warehouse located in the Company's headquarters in Zeeland, Michigan is owned. All other facilities are under short or long term leases. With the exception of the Taylor Freezer Plant, the refrigerated facilities are single story buildings constructed at dock height with full insulation and vapor barrier protection. Refrigeration is provided by screw-type compressors in ammonia-based cooling systems. The dry facilities (10) are single story block or metal construction buildings. All dry facilities are constructed at dock height and are approved as food grade storage facilities. The Michigan Distribution Center I is a multi-temperature facility that encompasses freezer (1.1 million cubic feet), cooler (0.4 million cubic feet) and dry (88 thousand square feet) space. One refrigerated and three dry facilities are served by rail.\nTLC's warehouse facilities are described on the following table:\nREFRIGERATED FACILITIES\n* Serviced by rail.\nDRY FACILITIES\n* Serviced by rail.\nTLC owns and operates a 10,000 square foot truck maintenance facility. This facility is used primarily for the maintenance of TLC transportation equipment. In addition, the facility is used to perform outside maintenance on non-TLC vehicles as well as sales of truck parts to the public.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\n(Not Applicable)\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\n(Not Applicable) PART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS.\nThe common stock of the Company is listed on the New York Stock Exchange. The table below sets forth the reported high and low sales prices as reported by the New York Stock Exchange for Christiana Companies common stock for quarters ended March 31, 1991 through September 15, 1995.\n* Ten weeks ended September 15, 1995.\nAt September 15, 1995 there were approximately 1,015 shareholders of record. There have been no dividends paid since 1981 and based on the Company's strategic business plan of reinvesting cash flow none are anticipated in the foreseeable future.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe material under \"Five Year Financial Information\" is included on page 32.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nNet earnings, after adjusting for minority interest, for each of the past three fiscal years are shown in the table below:\nFISCAL YEAR ENDED JUNE 30, 1995\nChristiana Companies consolidated revenues for fiscal 1995 increased 40.7% from $90,153,000 to $126,881,000 due primarily to higher volume in Refrigerated Warehousing and Logistics operations which in fiscal 1995 included The TLC Group for a full twelve month period versus six months in fiscal 1994, as well as increased demand for Prideco's downhole premium tubular products. Within the Refrigerated Warehousing and Logistics business segment in fiscal 1995 both Wiscold and TLC increased revenues on a comparable period basis through higher utilization of warehousing facilities, vegetable processing and IQF operations. Revenues within this segment increased 67.7%. Warehousing, rental and related expenses increased primarily due to increased volume at both Wiscold and The TLC Group as well as the inclusion of TLC for a full 12 month period. Prideco's revenues increased 19% in fiscal 1995 to $55,239,000 as it operated at virtually full capacity for much of the year. Increased demand for all of Prideco's products resulted from a sustained level of drilling activity throughout the year and the depletion of surplus inventories of used tubular products. Selling prices of Prideco's products were modestly higher, however increased steel prices more than offset these gains. Prideco's gross margin increased marginally from 14.2% in fiscal 1994 to 14.7% in fiscal 1995 due entirely to higher absorption factors resulting from near full capacity production levels. Product pricing in Prideco's industry remained intensely competitive throughout fiscal 1995 reflecting the continued existence of significant excess manufacturing capacity. Rental revenues from Christiana's real estate operations were lower in fiscal 1995 due entirely to fewer units being available for rent as a result of planned vacating of units in preparation for sale.\nConsolidated earnings from operations were $10,324,000 in fiscal 1995 compared to $6,422,000 in fiscal 1994, reflecting a 60.8% increase. Growth in operating earnings was primarily attributable to higher volume in Refrigerated Warehousing and Logistics. Within this business segment both Wiscold and TLC had higher utilization of warehousing,\nvegetable processing and IQF capacity all of which generate high marginal contribution with increased volume once breakeven levels have been surpassed. During the year Wiscold commenced a new poly bag vegetable packaging operation at its Beaver Dam facility. Focused marketing and sales strategies within this segment resulted in increased revenues derived from integrated logistic services which generally produce higher margins than discrete warehousing or transportation services. At Prideco, earnings from operations increased 31.2% compared to the previous year as a result of higher volume.\nOn June 30, 1995 Christiana completed a tax free merger of Prideco, a 60% owned subsidiary, Energy Ventures, Inc. In the merger transaction Christiana received 1,035,858 shares of EVI common stock in exchange for its ownership in Prideco. This transaction resulted in Christiana recognizing a pretax gain of $10,050,000. After providing for deferred taxes, the Prideco merger contributed net earnings of $5,383,000 or $1.02 per share.\nInterest income was marginally higher in fiscal 1995 due to higher rates available on short term investments. Interest expense increased 30.5% in fiscal 1995 to $4,842,000 due primarily to the inclusion of TLC's operations for the full twelve months this year and to a lesser extent higher short-term interest rates during the year which impacted Prideco's borrowings, most of which were priced on a floating rate basis indexed to prime.\nConsolidated net earnings for the year ended June 30, 1995 were $10,445,000 or $1.98 per share compared to $3,121,000 or $0.59 per share for the previous fiscal year. Refrigerated Warehousing and Logistics contributed $2,563,000 or $0.49 per share versus $994,000 or $0.19 per share in fiscal 1994. The improvement in net earnings in fiscal 1995 was primarily attributable to improved utilization of Wiscold's warehousing, vegetable processing and IQF operations and to a lesser extent the inclusion of The TLC Group for a full twelve month period.\nPrideco contributed net earnings, after minority interest, of $971,000 or $0.18 per share compared to $741,000 or $0.14 per share contributed in fiscal 1994. As previously discussed, the Prideco merger transaction contributed net earnings of $5,383,000 or $1.02 per share after providing for deferred taxes.\nReal estate sales in fiscal 1995 totaled 48 homes and contributed net earnings of $1,850,000 or $0.35 per share versus 84 home sales in fiscal 1994 which contributed net earnings of $3,369,000 or $0.63 per share.\nChristiana's effective tax rate increased in fiscal 1995 to 42% from 38% last year as a result of deferred taxes related to the Prideco merger. The higher rate is primarily attributable to the book\/tax difference of Christiana's basis in Prideco.\nThe following summarizes the unaudited consolidated pro forma operating results of the Company as if the merger of Prideco, the acquisition of EVI shares and the acquisition of The TLC Group had occurred at the beginning of the fiscal year ended June 30, 1994.\nInflation in fiscal 1995 was a meaningful factor at Prideco which experienced a substantial increase in steel prices throughout the period. Due to competitive industry conditions these increases were not able to be entirely recovered in the selling price of Prideco's products.\nFISCAL YEAR ENDED JUNE 30, 1994\nChristiana Companies consolidated financial results in fiscal year 1994 included the full year operations of Wiscold, Prideco, real estate and those of The TLC group for the six month period commencing January 4, 1994, the date of its acquisition.\nConsolidated revenues for fiscal 1994 increased 93% to $90,153,000 due primarily to the inclusion of TLC and improvement in the demand for Prideco's products and, to a lesser extent, a full twelve month period for Wiscold versus 10 months of operations in fiscal 1993. Rental revenues from Christiana's residential real estate were lower, due entirely to volume as fewer units were available for rent as a result of condominium home sales and refurbishment activities preparing homes for sale. Prideco's revenues increased 72% to $46,428,000 due principally to volume related factors resulting from increased levels of drilling activity, particularly in the Gulf of Mexico, and the near full consumption of surplus used tubular products. Selling prices for Prideco's products remained virtually unchanged from 1993 and reflected highly competitive conditions.\nConsolidated earnings from operations in fiscal 1994 increased to $6,422,000 due primarily to the improvement and return to consistently profitable operations at Prideco as higher capacity utilization and continued tight cost control facilitated improved margins, and to a lesser extent, increased volume at Refrigerated Warehousing and Logistics attributable to the inclusion of The TLC Group for six months and Wiscold's full twelve month period of operations.\nInterest income declined 22% in fiscal 1994 due primarily to the use of $5,630,000 of Christiana's cash resources in the acquisition of The TLC Group, and to a lesser extent, lower rates on short-term high quality investments. Interest expense increased $427,000, or 13%, due primarily to higher borrowings at Prideco used to fund additional investment in working capital needed to support its growth and the assumption of interest bearing liabilities at TLC. Interest expense at Wiscold and Christiana's real estate operations declined due to lower debt levels as free cash flow from each operation was allocated to reduce acquisition and mortgage-related obligations, respectively.\nOther income (expense), net included a non-operating writedown in the amount of $2,562,000 to value a 5% interest in a Chicago office building at its realizable value of $230,000.\nThe Company's effective tax rate decreased to 38% from 42% in fiscal 1993 due principally to the inclusion of the TLC Group which operated in states with lower tax rates.\nFINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES\nOperating activities provided cash of $12,439,000. Concurrently with the Prideco merger, Christiana invested $13,291,000 of cash to purchase additional shares of Energy Ventures. Capital expenditures in fiscal 1995 totaled $10,931,000, and were largely concentrated in Refrigerated Warehousing and Logistics. Major expenditures in 1995 included: at TLC a new warehouse facility and related equipment ($2.3 million) and replacement and additions of transportation equipment ($2.9 million); at Wiscold a new poly\nbag vegetable packaging operation was completed ($1.1 million); at Prideco equipment upgrades and maintenance related investment ($0.7 million); and refurbishments of condominium homes at Martinique totaled $1.8 million.\nFinancing activities in fiscal 1995 used $10,290,000 which consisted primarily of debt reduction in the amount of $6,000,000 at Wiscold and $3,170,000 at Prideco; TLC increased borrowings $2,252,000 in fiscal 1995 primarily to fund a new distribution facility in Zeeland, Michigan; and at Christiana corporate, $3,805,000 was used to fund the repurchase of stock.\nChristiana's consolidated balance sheet at June 30, 1995 reflects the effect of the Prideco merger which resulted in the elimination of Prideco's assets and liabilities, the additional purchase of Energy Ventures shares, the continuing process of converting real estate holdings to cash, and the operating cash flows attributable to the Refrigerated Warehousing and Logistics business unit.\nAt June 30, 1995 Christiana's holdings in Energy Ventures totaled 1,948,731 shares of which 1,035,858 shares were received in exchange for its ownership in Prideco and 912,873 shares were purchased for $13,291,000 directly from EVI and Prideco's minority shareholders. The average price of these shares at financial statement cost is $16.40 per share although the Company's cash cost of these shares is $9.74 per share. The financial statement cost will be adjusted quarterly based on the market value of the shares. The market value of these shares at June 30, 1995 was $18.00 per share or $35,077,000 resulting in an unrealized investment gain for financial statement purposes of $1,909,000, net of tax.\nAccounts receivable, inventories and prepaids were lower year to year due to the Prideco merger. The increase in deferred taxes is primarily the result of deferred taxes related to the Prideco transaction.\nAs otherwise described in this report, the Company is engaged in the phased refurbishment and sale of its condominium homes to individual buyers. Sale of the remaining 82 homes is expected to be completed in the next fiscal year. This program is a net provider of cash, and due to the full retirement of mortgage-related debt, increased levels of liquidity and capital resources are expected to be derived from these sales over the next fiscal year.\nAs discussed in Item 1, in fiscal 1996 Christiana anticipates liquidating a partnership interest which represented 5% of the ownership of a downtown Chicago office building for approximately its carrying value of $230,000. As a result, deferred taxes of approximately $1,730,000 are classified as currently payable.\nAs of fiscal year end, the Company had no material capital commitments and believes with its cash reserves, earnings, cash flow together with existing lines of credit and the capability of debt or equity issuance, that it will have sufficient resources to pursue its strategic plan, fund internal business expansion and future acquisitions. The Company anticipates building at least two new facilities in fiscal 1996 to support customer growth. However, no firm commitments have been made at this time.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENT AND SUPPLEMENTARY DATA.\nSee Index to Financial Information on page 15.\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 REGISTRANT.\nThe material in Section III of the 1995 Proxy Statement is incorporated herein by reference. All of Registrant's executive officers are also nominees for directors of Registrant.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe material in Section IV of the 1995 Proxy Statement is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe material in Section II and III of the 1995 Proxy Statement is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe material in Section IV 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.\nFinancial Statement and Schedules:\nSee Index on page 15.\nExhibits:\nSee Index on page 35.\nReports on Form 8-K:\nRegistrant filed a report on Form 8-K dated June 30, 1995 with respect to the merger of Prideco, Inc., a majority-owned subsidiary of the Registrant, with Grant Acquisition Company, a wholly-owned subsidiary of Energy Ventures, Inc. The items reported therein were Item 2. (Acquisition of Disposition of Assets) and Item 7 (Financial Statements). The latter included pro forma consolidated balance sheet as of March 31, 1995; pro forma consolidated statement of earnings for the year ended June 30, 1995; and pro forma consolidated statement of earnings for the nine months ended March 31, 1995.\nSIGNATURES\nPursuant to the requirement 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.\nChristiana Companies, Inc.\nDate: September 15, 1995 By: \/s\/ Sheldon B. Lubar ------------------------- Sheldon B. Lubar, Chairman\nPursuant to the requirements of the Securities Exchange Act of 1934 this 10-K report has been signed below on September 15, 1995 by the following persons on behalf of the Registrant and in the capacity indicated.\nSignature\nCHRISTIANA COMPANIES, INC.\nFINANCIAL INFORMATION\nFOR INCLUSION IN ANNUAL REPORT ON FORM 10-K\nFISCAL YEAR ENDED JUNE 30, 1995\nCHRISTIANA COMPANIES, INC. Index to financial information\nPage No. Consolidated Statements of Earnings for the years ended June 30, 1995, 1994 and 1993 . . . . . . . . . . . . . . . . . . . 16\nConsolidated Balance Sheets as June 30, 1995 and June 30, 1994 . . . . . 17\nConsolidated Statements of Shareholders' Equity for the years ended June 30, 1995, 1994 and 1993 . . . . . . . . . . . . . . . 18\nConsolidated Statements of Cash Flows for the years ended June 30, 1995, 1994 and 1993 . . . . . . . . . . . . . . . . . . 19\nReport of Independent Public Accountants . . . . . . . . . . . . . . . . 20\nNotes to Consolidated Financial Statements . . . . . . . . . . . . . . . 21\nSelected Financial Data . . . . . . . . . . . . . . . . . . . . . . . . . 32\nCHRISTIANA COMPANIES, INC. CONSOLIDATED STATEMENTS OF EARNINGS\nSee notes to consolidated financial statements.\nCHRISTIANA COMPANIES, INC. CONSOLIDATED BALANCE SHEETS\nSee notes to consolidated financial statements.\nCHRISTIANA COMPANIES, INC. CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (1) (2)\n(1) Preferred stock: $10 par value, 1,000,000 shares authorized, none issued.\n(2) Common stock: $1 par value, 12,000,000 shares authorized.\nSee notes to consolidated financial statements.\nCHRISTIANA COMPANIES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS\nSee notes to consolidated financial statements.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nBOARD OF DIRECTORS AND SHAREHOLDERS OF CHRISTIANA COMPANIES, INC.:\nWe have audited the accompanying consolidated balance sheets of Christiana Companies, Inc. (a Wisconsin corporation) as of June 30, 1995 and 1994, and the related consolidated statements of earnings, shareholders' equity and cash flows for each of the years in the three-year period ended June 30, 1995. 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 general accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as 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 Christiana Companies, Inc. as of June 30, 1995 and 1994, and the results of its consolidated operations and cash flows for each of the years in the three-year period ended June 30, 1995, in conformity with generally accepted accounting principles.\nAs explained in Note A to the consolidated financial statements, effective July 1, 1994, the Company changed its method of accounting for investment securities.\nARTHUR ANDERSEN LLP Milwaukee, Wisconsin August 4, 1995\nCHRISTIANA COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Three years ended June 30, 1995)\nA. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:\nPRINCIPLES OF CONSOLIDATION: The consolidated financial statements include the accounts of Christiana Companies, Inc., (\"Christiana\") and its majority-owned subsidiaries (together with Christiana referred to as the \"Company\"). All material intercompany transactions have been eliminated.\nSHORT-TERM INVESTMENTS: As of June 30, 1995 short-term investments are classified as \"available for sale\" and include U.S. Treasury securities maturing in less than one year. These investments are carried at market value. At June 30, 1994 short-term investments include U.S. Treasury securities maturing in less than one year and are carried at cost which approximates market.\nACCOUNTS RECEIVABLE: Accounts receivable are presented net of a reserve for bad debts of $120,000, $94,000 and $128,000 at June 30, 1995, 1994, and 1993 respectively. The provision for bad debts was $85,000, $88,000 and $8,000 for the years ended June 30, 1995, 1994, and 1993, respectively. Deductions from the reserve were $59,000, $122,000 and $25,000 for the years ended June 30, 1995, 1994, and 1993, respectively.\nINVESTMENT IN EVI: At June 30, 1995, Investment in EVI consists of 1,948,731 shares of Energy Ventures, Inc. common stock which is classified as \"available for sale\". Effective August 1, 1994, the Company adopted Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" The impact of adoption was not material. Accordingly, investment securities classified as available for sale at June 30, 1995 are carried at fair value with fair value adjustments, net of their related income tax effects, reported as a component of shareholders' equity. The gross unrealized gain on these securities was $3,141,000 at June 30, 1995.\nINVENTORIES: Inventories are stated at cost, principally determined on a first-in, first-out (FIFO) basis but not in excess of net realizable value. Inventory cost includes material, labor and manufacturing overhead. Inventories are comprised of the following:\nMORTGAGE NOTES RECEIVABLE: At June 30, 1995 mortgage notes receivable, derived principally from condominium sales, totaled $3,205,000 and accrue interest at rates ranging from 6.5% to 9.25%.\nThe principal balance of mortgage notes receivable matures as follows:\nDuring the years ended June 30, 1995 and 1994, $928,000 and $1,459,000, respectively, of mortgage notes receivable were sold or prepaid.\nRENTAL PROPERTIES AND FIXED ASSETS: Rental properties, consisting principally of residential condominium homes, and fixed assets are carried at cost less accumulated depreciation, which is computed using both straight-line and accelerated methods for financial reporting purposes. The cost of major renewals and improvements are capitalized; repair and maintenance costs are expensed. A summary of the cost of rental properties and fixed assets and the estimated useful lives for financial reporting purposes is as follows:\nGOODWILL: Goodwill is amortized on a straight-line basis over 40 years ($214,000 in 1995 and $141,000 in 1994). The accumulated amortization at June 30, 1995 and 1994 was $252,000 and $362,000, respectively. The Company continually evaluates whether events and circumstances, subsequent to its acquisition, have occurred that indicate the remaining estimated useful life may warrant revision or that the remaining balance of goodwill may not be recoverable.\nOTHER ASSETS: At June 30, 1995, Other Assets includes a partnership which represented a 5% interest in a Class A office building in Chicago. This asset was written down to $230,000 in 1994 to reflect its realizable value. The balance of Other Assets primarily represents deferred charges and cash surrender value of officer's life insurance.\nINCOME TAXES: Deferred income taxes are provided on the temporary differences in the carrying values of assets and liabilities for financial reporting and income tax purposes.\nEARNINGS PER SHARE: Earnings per share is computed on the basis of the weighted average number of common shares outstanding.\nCASH FLOWS: For purposes of the Statements of Cash Flows, the Company considers all highly liquid debt instruments, principally U.S. Treasury bills, municipal bonds and commercial paper which mature in less than ninety days to be cash equivalents.\nThe operating activities of Prideco are included in the Company's Statements of Cash Flows through June 30, 1995, the date of the merger, while the effects of the merger are excluded as non-cash transactions. Also in 1995, the Company issued a three year note in the amount of $2,286,000 as partial consideration for the acquisition of treasury stock.\nRECLASSIFICATIONS: Certain reclassifications have been made in the 1994 statements to conform to 1995 presentation.\nB. ACQUISITIONS:\nOn June 30, 1995, Prideco, Inc. (\"Prideco\"), a majority-owned subsidiary of the Company, merged with Grant Acquisition Company, a wholly-owned subsidiary of Energy Ventures, Inc. (\"EVI\"). In the merger, the Company's shares of Prideco were converted into 1,035,858 shares of Common Stock, $1.00 par value, of EVI. EVI's common stock is listed and traded on the New York Stock Exchange. Accordingly, the individual accounts of Prideco have been eliminated from the Company's June 30, 1995 Balance Sheet which reflects the effect of the merger. Prideco's results of operations are included in the Company's Consolidated Statement of Earnings through June 30, 1995, the date of the merger. Concurrently with the merger, the Company acquired an additional 912,873 shares of EVI common stock directly from EVI and the minority shareholders of Prideco for an aggregate cash price of $13,291,000. The 1,948,731 shares of EVI common stock acquired by the Company in the transactions referred to above represented 13.1% of the then outstanding shares of EVI common stock.\nOn January 3, 1994, the Company acquired, by way of merger, The TLC Group, Inc. (\"TLC), a Zeeland, Michigan-based firm which provides fully integrated logistic services including warehousing, transportation and information services. The purchase price consisted of approximately $5,630,000, the issuance of 234,269 shares of Christiana common stock, an 8% subordinated note in the amount of $1,764,000 and the assumption of its liabilities. As part of this acquisition, the assets of The TLC Group were revalued to their fair market value with the excess of purchase price over fair value amounting to $5,991,000 being recorded as goodwill. This acquisition was accounted for as a purchase and accordingly, the results of TLC's operations are included in the consolidated financial statements of the Company since the date of acquisition.\nDuring fiscal 1995, the Company repurchased the 234,269 shares issued in the TLC acquisition for $3,805,000 and a three year note in the amount of $2,286,000.\nThe following summarizes the unaudited consolidated pro forma operating results of the Company as if the merger of Prideco, the acquisition of EVI shares and the acquisition of The TLC Group had occurred at the beginning of the fiscal year ended June 30, 1994.\nPro forma results are not necessarily indicative of results that would have occurred had the purchase been made at the beginning of the respective periods, or of results which may occur in the future.\nC. INDEBTEDNESS:\nThe following is a summary of consolidated indebtedness:\nThe Company has a $15,000,000 unsecured line of credit, renewable annually. Borrowings under this line bear interest at prime. No amounts were drawn on this line during the year. No compensating balances are required under the terms of this credit facility.\nNotes payable attributable to Christiana Corporate relate to amounts due as a result of the repurchase of common stock.\nWiscold has a step down revolving credit agreement that provides for borrowings at June 30, 1995 up to $34,750,000. This credit facility was organized in conjunction with the acquisition of Wiscold. Borrowings under this agreement mature on December 31, 1997 and bear interest, payable monthly at either the London Interbank Offered Rate (\"LIBOR\") plus 1.75% or a floating rate at the bank's prime rate (7.10% and 7.07% at June 30, 1995 and 1994, respectively) and are secured by Wiscold's assets. Under the terms of this agreement, the interest rate decreases as Wiscold's leverage ratio declines. It requires, among other things, that Wiscold maintain defined levels of net worth and debt service coverage and restricts certain of Wiscold's activities including limitation on new indebtedness and the disposition of assets. No compensating balances are required under the terms of this credit facility.\nIn connection with this agreement Wiscold entered into an interest rate swap agreement (\"Swap\") which effectively fixed the interest rate payable by Wiscold at 5.3% plus the LIBOR spread which is subject to reduction based on decreases in Wiscold's leverage ratio. The Swap was issued with respect to principal in the original amount of $30,000,000 declining pro rata with scheduled principal reductions of this agreement and matures on December 31, 1997.\nThe TLC Group has a bank line of credit which permits borrowings up to $5,000,000. Borrowings bear interest at either a LIBOR-based rate plus 2.00% or the bank's prime rate, at TLC's option (8.06% and 7.25% at June 30, 1995 and 1994, respectively), and are secured by TLC accounts receivable. Notes payable relate to specific equipment purchases, primarily transportation and material handling equipment and a new distribution facility, and are secured by specified assets. These notes bear interest on both fixed and floating terms ranging from 6.375% to 9.75%. No compensating balances are required under the terms of these credit arrangements. TLC's subordinated note bears interest at 8% and was incurred in the redemption of a former shareholder's ownership coincident with the sale to Christiana. This obligation is guaranteed by Christiana.\nThe 1994 consolidated balance sheet includes borrowings related to Prideco. As discussed in Note B, the Company disposed of its investment in Prideco on June 30, 1995.\nFuture maturities of consolidated long-term indebtedness are as follows:\nThe weighted average interest rate paid on short term borrowings, all of which was attributable to TLC, was 7.69% and 6.62% for fiscal 1995 and 1994, respectively.\nD. INCOME TAXES:\nThe Income Tax Provision consists of the following:\nThe components of Deferred Income Taxes are:\nA reconciliation of the statutory Federal income tax rate to the Company's effective tax rate follows:\nE. EMPLOYEE BENEFIT PLANS:\nThe Company has 295,000 shares of its common stock reserved for issuance under a stock option plan, which permits the granting of options as well as appreciation rights and awards. During fiscal 1995, options for a total of 5,000 shares were granted to a Christiana employee at an exercise price of $28.8125. During fiscal 1994, options for a total of 35,000 shares were granted to seven TLC, Wiscold and Christiana executives at exercise prices ranging from $26.00 to $27.125 per share. At June 30, 1995 and 1994, 27.4% and 15.4%, respectively, of total options granted were exercisable. The remaining options are exercisable over the next nine years.\nChanges in stock options outstanding are summarized as follows:\nThe Company has 401(k) plans covering Christiana, Wiscold and TLC employees. The costs under these plans have not been material. The Company does not provide post employment medical or life insurance benefits.\nF. COMMITMENTS:\nThe TLC Group has operating leases for warehousing and office facilities. Rental expense under these leases was $5,100,000 in 1995. At June 30, 1995, future minimum lease payments under these operating leases are as follows:\nG. MARKET SEGMENT INFORMATION\nThe Company was engaged in primarily two distinct lines of business, namely, the manufacture of industrial products and the operation of warehousing, logistic services and rental properties.\n* On June 30, 1995 Prideco was merged with a unit of Energy Ventures, Inc.\nThere were no intersegment sales. Corporate assets consist primarily of cash equivalents, short-term investments and marketable securities.\nCHRISTIANA COMPANIES, INC.\nH. PARENT COMPANY ONLY STATEMENTS\nFollowing are the Parent Company only condensed Balance Sheet, Statement of Operations and Statement of Cash Flows:\nPARENT COMPANY ONLY STATEMENTS CONDENSED BALANCE SHEET AS OF JUNE 30, 1995 AND 1994\nCHRISTIANA COMPANIES, INC.\nPARENT COMPANY ONLY STATEMENTS CONDENSED STATEMENT OF OPERATIONS FOR THE YEAR ENDED JUNE 30, 1995, 1994 AND 1993\nCHRISTIANA COMPANIES, INC.\nPARENT COMPANY ONLY STATEMENTS STATEMENT OF CASH FLOWS FOR THE YEARS ENDED JUNE 30, 1995, 1994 AND 1993\nCHRISTIANA COMPANIES, INC. QUARTERLY FINANCIAL INFORMATION (unaudited)\n(1) On June 30, 1995 Prideco was merged with a unit of Energy Ventures, Inc. (2) Includes the non-operating writedown of $2,562,000 on a Chicago office building.\nFIVE YEAR FINANCIAL INFORMATION\n(1) On June 30, 1995 Prideco was merged with a unit of Energy Ventures, Inc.\nCHRISTIANA COMPANIES, INC. CORPORATE INFORMATION\nCHRISTIANA COMPANIES, INC.\nEXHIBITS\nFOR INCLUSION IN ANNUAL REPORT ON FORM 10-K\nFISCAL YEAR ENDED JUNE 30, 1995\nINDEX TO EXHIBITS\nEXHIBIT NO. BRIEF DESCRIPTION OF EXHIBIT\n3A Registrant's Articles of Incorporation as modified by Articles of Merger. Incorporated by reference to Exhibit 19 of Registrant's Form 10-Q for the quarter ended September 30, 1992.\n3B Registrant's current bylaws. Incorporated by reference to Exhibit 19A of Registrant's Form 10-Q for the quarter ended September 30, 1992.\n9 Voting Trust Agreement dated December 29, 1992 among Sheldon B. Lubar, as voting trustee, et al. Incorporated by reference to Exhibit 9 of Registrant's Form 10-K for the year ended June 30, 1993.\n10A The Wiscold Asset Purchase Agreement, dated August 12, 1992, by and among The Christiana Companies, Inc., Tierrasanta, Inc., WI Acquisition Corp., Wiscold, Inc. and the equity holders of Wiscold, Inc. Incorporated by reference to Exhibit 2.1 of Registrant's Form 8-K dated September 15, 1992.\n10B The Wiscold Amendment No. 1 to Asset Purchase Agreement, dated August 18, 1992, by and among The Christiana Companies, Inc., Tierrasanta, Inc., WI Acquisition Corp., Wisconsin Refrigerated Services, Inc., Wiscold, Inc. and the equity holders of Wiscold, Inc. Incorporated by reference to Exhibit 2.2 of Registrant's Form 8-K dated September 15, 1992.\n10C The Wiscold Revolving Credit Agreement, dated as of September 1, 1992, by and among the WI Acquisition Corp., Tierrasanta, Inc., The Christiana Companies, Inc., Bank One, Milwaukee, N.A., Harris Trust and Savings Bank, First Bank Milwaukee, N.A. and Firstar Bank Milwaukee, N.A., as agent for the Banks.\n10D Registrant's 1985 Stock Option Plan, as amended to date. Incorporated by reference to Exhibit 10B to Registrant's Form 10-Q for quarter ended December 31, 1992.\n10E The TLC Group Agreement and Plan of Reorganization dated as of November 24, 1994 by and among Christiana Companies, Inc., TLC Acquisition Corp., TLC Group, Inc. and certain equity holders of TLC Group, Inc. Incorporated by reference to Exhibit 2.1 of Registrant's Form 8-K dated January 18, 1994.\n10F The Prideco, Inc. Agreement and Plan of Merger dated May 22, 1995 by and among Prideco, Inc., the equity holders of Prideco, Inc., Energy Ventures, Inc. and Grant Acquisition Company and Amendment No. 1 thereto. Incorporated by reference to Exhibits 2.1 and 2.2 of Registrant's Form 8-K dated July 17, 1995.\n19 Letter Agreement dated August 24, 1993 between Registrant and Raymond F. Logan. Incorporated by reference to Exhibit 19 of Registrant's Form 10-K for the year ended June 30, 1993.\n21 Registrant's Subsidiaries.\n27 Financial Data Schedule.\n28 Form 10-K of Energy Ventures, Inc. *\n* To be filed when available.","section_15":""}
{"filename":"799903_1995.txt","cik":"799903","year":"1995","section_1":"ITEM 1. BUSINESS. - -------------------- GENERAL\nDuramed Pharmaceuticals, Inc. (the \"Company\" or \"Duramed\") currently manufactures and sells a limited line of prescription generic drug products in tablet, capsule and liquid forms to customers throughout the United States. Products sold by the Company include those of its own manufacture and those which it markets under certain arrangements with other drug manufacturers. The Company sells its products to drug wholesalers, private label distributors, drug store chains, health maintenance organizations, hospitals, nursing homes, retiree organizations, mail order distributors, other drug manufacturers, mass merchandisers and governmental agencies.\nGeneric drugs are the chemical and therapeutic equivalents of brand name drugs which have gained market acceptance while under patent protection. In general, prescription generic drug products are required to meet the same governmental standards as brand name pharmaceutical products and must receive Food and Drug Administration (\"FDA\") approval prior to manufacture and sale. Generic drug products are marketed after expiration of patents held by the innovator company, generally on the basis of FDA approved Abbreviated New Drug Applications (\"ANDAs\") submitted by the generic manufacturers. Generic drug products typically sell at prices substantially below those of the equivalent brand name products. The increasing emphasis on controlling health care costs, the growth of managed care organizations and the significant number of drugs for which patents will expire in the next few years are expected to create an opportunity for continued growth in the generic drug market.\nRECENT DEVELOPMENTS\nPrivate Placement of Series C Convertible Preferred Stock\nIn November 1995, the Company issued $12.0 million of 8% Cumulative Convertible Preferred Stock, Series C (the \"Series C Preferred Stock\") and obtained commitments for an additional $12.0 million. The Company's Common Stock trades on the Nasdaq National Market (\"Nasdaq\") under the symbol DRMD. Nasdaq regulations required stockholder approval for the second stage, which was obtained on January 24, 1996. The Company closed on the issuance of the $12.0 million second stage of the offering in February 1996.\nEach share of Series C Preferred Stock is convertible at the option of the holder, with respect to its stated value of $100, into shares of the Company's Common Stock at a price which is 15% below the average closing price of the Common Stock over the 10-day trading period ending two days prior to the date of conversion (the \"conversion price\"). The conversion price may not be less than $7.50 or more than $20.00. Half of the shares of Series C Preferred Stock became convertible on February 12, 1996; the remaining half became convertible on March 13, 1996.\n- 2 - Any shares of Series C Preferred Stock remaining outstanding on November 14, 1997 will automatically be converted into shares of Common Stock on such date. The Series C Preferred Stock pays a dividend of 8% annually, payable quarterly in arrears, on all unconverted shares.\nThrough March 25, 1996, $17.0 million of the Series C Preferred Stock had been converted to 1,175,794 shares of the Company's Common Stock at an average conversion price of $14.46 per common share.\nFinancial Arrangements\nDuring the third and fourth quarters of 1995, the Company reorganized the terms of certain borrowing arrangements with its bank, which resulted in expanded borrowing capacity under the Company's revolving credit facility and modified repayment due dates on a term note. The amended terms of the revolving credit facility permit the Company to borrow up to $12.5 million, based upon eligible collateral, through March 30, 1997 when the principal balance is due. The expressed intention of the Company and its bank is to review quarterly the Company's financial condition and, if appropriate, extend the due date of the revolving credit facility in order to maintain a fifteen month term. The Company made a $1.0 million principal payment on its term note in December 1995. As amended, the $4.5 million balance of the term note at December 31, 1995 required a principal payment of $1.5 million on March 1, 1996, with the remaining $3.0 million due on June 1, 1996. In February 1996 the Company made the $1.5 million term note principal payment due on March 1, 1996. In March 1996, the bank made available to the Company an additional $1.5 million of term financing collateralized by existing equipment. See \"Notes to Consolidated Financial Statements - Note D\" for additional information on these obligations.\nMergers\/Acquisitions\nIn October 1995, the Company signed a letter of intent to acquire Hallmark Pharmaceuticals, Inc. (\"Hallmark\"), a privately held pharmaceutical development company headquartered in Somerset, N.J. The Company believes that Hallmark's technical expertise and capabilities with respect to advanced drug delivery systems would contribute significantly to the long term success of the Company's product development program. The Company is continuing discussions with Hallmark directed toward the signing of a definitive acquisition agreement. If the acquisition is consummated, it is probable that a substantial non-cash charge will be recorded for the recognition of purchased research and development.\nSTRATEGIC ALLIANCES\/PRODUCT DEVELOPMENT STATUS\nThe Company's research and development efforts have been primarily focused on the development of conjugated estrogens tablets, the generic equivalent for the brand name product Premarin(R) marketed by the Wyeth-Ayerst Division of American Home Products (\"Wyeth-Ayerst\"). FDA approval is required for Duramed to market conjugated estrogens. On September\n- 3 - 27, 1994, the Company filed with the FDA an ANDA for the .625 mg strength of conjugated estrogens. This product is formulated and designed to meet the conjugated estrogens product composition standards and bioequivalency guidance established by the FDA in 1991.\nSince 1991, Wyeth-Ayerst has made several submissions to the FDA requesting changes in the FDA's 1991 conjugated estrogens product composition standards and bioequivalency guidance. Among other things, Wyeth-Ayerst requested that the FDA change the product composition standards for conjugated estrogens by requiring the generic version to include a specific equine estrogenic substance, delta(8,9) dehydroestrone sulfate (Delta(8,9) DHES). In response to each submission, the FDA determined that the information submitted by Wyeth-Ayerst was insufficient to justify changes in the standards or guidance. In so responding, the FDA let stand the 1991 product composition standards, which established Delta(8,9) DHES as an impurity and not a necessary ingredient.\nOn November 30, 1994, Wyeth-Ayerst filed a Citizen Petition with the FDA which reiterated some of its earlier arguments and again requested that the FDA require the inclusion of Delta(8,9) DHES in generic conjugated estrogens. On July 27-28, 1995, the FDA's Fertility and Maternal Health Drugs and Generic Drugs Advisory Committees met to address this issue. The outcome of this meeting was a unanimous vote by the advisory committees that there was insufficient data presented to assess whether any individual component (including Delta(8,9) DHES) or combination of components other than estrone sulfate and equilin sulfate need to be present to achieve clinical safety and efficacy in conjugated estrogens.\nDuramed believes that the conclusions of the advisory committees reaffirm the product composition standards for conjugated estrogens established by the FDA in 1991, and that the FDA review of the Company's ANDA is continuing. In support of its position, on October 6, 1995 the Company filed with the FDA an extensive response to the Citizen Petition. Duramed 's filing includes scientific and medical data, as well as the opinions of renowned experts, all to the effect that Delta(8,9) DHES has no impact on the safety or efficacy of conjugated estrogens and should not be a required component in a generic equivalent to Premarin(R). Duramed further believes that its conjugated estrogens product as filed meets the current product composition standards and bioequivalency guidance established by the FDA in 1991. At this time, the Company is unable to determine when, or if, it will obtain FDA approval to market the .625 mg strength product. If approval is obtained and the product is successfully manufactured and marketed, the resulting favorable financial impact is expected to be significant. Work on other conjugated estrogens strengths is continuing and results to date are encouraging.\nThe Company has an agreement with Schein Pharmaceutical, Inc. (\"Schein\") with respect to the development, manufacture and marketing of its conjugated estrogens products. Under the terms of the agreement, Schein provides project funding and technical assistance while Duramed is responsible for the product development and manufacturing; both firms will participate in the marketing and distribution of the products.\n- 4 - The Company's business strategy includes enhancing its market position and research and development efforts by entering into strategic alliance agreements. In June 1994 the Company entered into marketing, distribution and related agreements with Ortho-McNeil Pharmaceutical Corporation (\"Ortho-McNeil\"). Under the terms of these agreements Duramed received the non-exclusive distribution rights to the Ortho-McNeil products Acetaminophen with Codeine, Tolmetin sodium, Tolmetin sodium DS and Oxycodone with Acetaminophen as well as an extension of the distribution term for Estropipate originally received from Ortho-McNeil pursuant to an agreement reached in November 1993. The Company commenced marketing Estropipate in November 1993 and the four additional products during the fourth quarter of 1994. In addition to the distribution rights for the products, Ortho-McNeil provided $2 million in cash and other financial assistance. In exchange for the financial assistance provided to the Company under the agreements, Ortho-McNeil will receive a royalty on the future sales of the Company's conjugated estrogens products. In addition, Ortho-McNeil will participate in marketing the conjugated estrogens products, and share in the profits if the Company is successful in bringing the products to market.\nThe Company has an agreement with Invamed, Inc. (\"Invamed\") for the exclusive marketing rights of Verapamil S.R. (sustained release), which is the generic equivalent to Isoptin S.R.(R) and Calan S.R.(R). Verapamil S.R. has been formulated and will be manufactured by Invamed if an ANDA is filed with the FDA and approval is received. The Company will market the product on a variable profit basis with Invamed.\nFor the years ended December 31, 1995, 1994 and 1993, respectively, the percentages of the Company's sales comprised of products marketed for others were 31%, 28% and 36%. The gross profit generated by these sales was approximately $3.3, $3.6 and $4.0 million in 1995, 1994 and 1993, respectively. For additional information with respect to the Company's strategic alliance agreements see \"Notes to Consolidated Financial Statements - Note B.\"\nREGULATORY\nFrom May 1993 until January 1996, the Company operated under a consent decree, which was established as part of a plea agreement between the Company and the Department of Justice and the United States Attorney's Office (collectively \"Department\"). Under the consent decree, among other things, the Company agreed for a period of four years not to violate certain applicable laws, to cooperate with the Department in any investigation of former or present directors, officers or employees of the Company, and to cooperate with the FDA with regard to\n- 5 - future inspections of the Company's facilities or products. On January 2, 1996, the Company's petition to dissolve the consent decree was granted by the United States District Court for the District of Maryland.\nPRODUCTS\nA summary by therapeutic classification of the products currently manufactured or marketed by the Company is included below:\nMethylprednisolone, which is manufactured by Duramed, accounted for approximately 53%, 55% and 39%, respectively, of the Company's sales in 1995, 1994 and 1993. Metoclopramide, to which the Company has marketing rights, accounted for approximately 18% of sales in 1993.\nThe Company does not have patent protection for any of its products and trademarks are of relatively minor importance at this time. The Company's operating strategy includes developing brand identity for certain of its products. Certain of the Company's products have a degree of seasonality, the effect of which the Company is attempting to mitigate by adding complimentary products to its line.\n- 6 - PRODUCT DEVELOPMENT\nThe Company's product development activities have increased during the past year, but the principal focus has been on the development of conjugated estrogens products. The Company intends to increase significantly its investment in product development activities based upon available resources. The proposed acquisition of Hallmark is expected to significantly increase the Company's technical capabilities with respect to more complex drug delivery systems. Generic drug products with complex drug delivery systems typically experience limited competition due to the technical barriers to developing these products, and therefore generate higher margins.\nThe Company's product development strategy consists of three separate but related components; (i) an internal research and development staff, (ii) joint product development efforts with, or purchasing new product formulations from, other parties and (iii) engaging outside experts to develop specified products on a consulting basis. The Company's product development strategy has been to focus its development activities primarily on generic hormone replacement therapy (\"HRT\") opportunities and on other prescription drugs with attractive market opportunities and potentially limited competition due to technological barriers of entry. The Company will typically seek to develop products that are either (i) soon to be off patent, (ii) not yet been developed generically even though patents have expired (usually because of technological barriers), or (iii) are logical extensions of the Company's existing product line due to their marketing or production characteristics.\nThe successful introduction of new products depends upon favorable test results and, where required, FDA approvals. During the fiscal years ended December 31, 1995, 1994 and 1993, product development expenditures were $5,953,000, $1,861,000 and $859,000, respectively. Product development expenses in 1995 included a charge of approximately $1.5 million of product development costs that the Company has advanced to Hallmark Pharmaceuticals, in exchange for product marketing rights to Captopril and in anticipation of completing the acquisition of Hallmark. Additionally, in 1995 product development expenditures included approximately $1.6 million of certain costs incurred in preparation for manufacturing the conjugated estrogens product in commercial quantities. Product development expenditures are net of reimbursements received from Schein under the agreement for the development of a new formulation of conjugated estrogens tablets (see \"Notes to Consolidated Financial Statements - Note B\").\nFormulations for all new products are subjected to laboratory testing and stability studies, and when required or desirable, are tested for bioequivalence to the reference product by qualified laboratories. Bio-studies, used to demonstrate that the rate and extent of absorption of a generic drug are not significantly different from the corresponding innovator product, currently cost in the range of $250,000 to $700,000. Bio-studies for certain product classes exceed that range. If the accumulated data demonstrates bioequivalency, submission is then made to the FDA for its review and approval to manufacture and market.\n- 7 - The development of new generic products, including formulation, stability testing and obtaining FDA approval, generally takes at least 18-24 months. Development of sustained release prescription products typically requires at least two bioequivalence studies for most products and, therefore, total development time, including FDA approval, may be at least two or three years. Liquid product development frequently does not require bioequivalence studies and, including formulation, stability testing and FDA approval, generally takes at least 12-18 months.\nSALES AND MARKETING\nDuramed sells its products to a broad range of over 200 customers located throughout the United States. These customers include drug wholesalers, private label distributors, direct buying retail chains, health maintenance organizations, hospitals, nursing homes, retiree organizations, mail order distributors, other drug manufacturers, mass merchandisers and government agencies. The Company markets its products under the Duramed label as well as under private label; on all prescription products which it manufacturers, the Company is named on the label as the manufacturer. All marketing and sales efforts are conducted principally by Duramed employees. Duramed promotes its products through catalogs, trade shows, publications, telemarketing and direct sales.\nAlthough the highest profit margins are realized generally by the first generic manufacturers to enter the market for a product, the Company's marketing efforts are not dependent upon the Company being the first manufacturer to develop generic equivalents of innovator products. Instead, the Company's marketing expertise has enabled it to market products successfully even after their introduction by several competitors.\nThe Company has continued to expand its sales and marketing activities and increase its sales force in order to prepare for the commercial launch of conjugated estrogens, develop strategic alliance opportunities, enhance service to its existing customers and provide the resources to contact additional prospective customers.\nIn 1995, 1994 and 1993, no single customer accounted for more than 10% of the Company's net sales.\nORDER BACKLOG\nThe dollar amount of the Company's open orders at March 1, 1996 was approximately $2.3 million as compared to approximately $2.0 million at March 1, 1995. Although open orders are subject to cancellation without penalty, management expects to fill substantially all of such open orders within the current fiscal year. The Company's backlog may not be indicative of net sales during the following reporting period.\n- 8 -\nCOMPETITION\nCompetition in the generic prescription pharmaceutical industry is intense. The Company competes with other generic drug product manufacturers, brand name pharmaceutical companies which manufacture generic drug products and the original manufacturers of brand name drug products which continue to produce those products after patent expirations.\nThe Company believes that the primary competitive factors are the ability to develop new products on a timely basis, price, product quality, customer service, breadth of product line and reputation. Many of the Company's competitors have greater financial and other resources than the Company and are able to expend more for product development and marketing.\nGOVERNMENT REGULATION\nAll pharmaceutical manufacturers are subject to extensive regulation by the federal government, principally by the FDA and, to a lesser extent, by the Drug Enforcement Administration and by state governments. The Federal Food, Drug and Cosmetic Act, the Controlled Substance Act, the Generic Drug Enforcement Act of 1992 and other federal statutes and regulations govern or influence the testing, manufacture, safety, labeling, storage, recordkeeping, approval, pricing, advertising and promotion of the Company's products. Noncompliance with applicable requirements can result in fines, seizure of products, total or partial suspension of production, refusal of the government to enter into supply contracts or to approve new drug applications, criminal prosecution and corporate debarment. The FDA also has the authority to institute proceedings to revoke previous approvals of drug products.\nFDA approval is required before most prescription drug products can be marketed. Each dosage form of a specific generic drug product, whether a different form of administration or a different strength, is typically treated as a separate drug product by the FDA and requires separate submission. There are two types of applications currently used to obtain FDA approval of a new drug product.\n1. New Drug Application (\"NDA\"). With respect to drug products with active ingredients not previously approved by the FDA or new uses for previously approved active ingredients, a prospective manufacturer must conduct and submit to the FDA complete clinical studies to prove that product's safety and efficacy. An NDA may also be submitted for a drug product with previously approved active ingredients if the abbreviated procedure discussed below is not available.\n2. Abbreviated New Drug Application (\"ANDA\"). The Drug Price Competition and Patent Term Restoration Act of 1984 (the \"Waxman-Hatch Act\") established an abbreviated procedure for obtaining FDA approval for those generic drug products which are bioequivalent to brand name drugs. In contrast to the NDA procedure, this procedure does not require conducting complete animal and clinical studies for safety and efficacy, and instead requires data illustrating that the generic drug formulation is bioequivalent to a\n- 9 - previously approved drug. \"Bioequivalence\" indicates that the rate of absorption and the levels of concentration of a generic drug in the body are substantially equivalent to those of the previously approved equivalent brand name drug and, therefore, that the drug will produce an equivalent therapeutic effect.\nThe Company's product development pursuits are primarily focused on products which can obtain regulatory approval through the ANDA submission process.\nAmong the requirements for new drug approval is that the prospective manufacturer's methods conform to the FDA's Current Good Manufacturing Practices (\"CGMP Regulations\"). The CGMP Regulations must be followed at all times during which the approved drug is manufactured. To ensure compliance with the standards set forth in these regulations, the Company must continue to expend time, money and effort in the areas of production and quality control. Failure to comply risks possible FDA action such as the suspension of manufacturing or the seizure of drug products.\nThe Company also is subject to environmental protection laws and regulations of federal, state and local governmental authorities, including the Clean Air Act and Occupational Safety and Health Administration (\"OSHA\") requirements. Under the Clean Air Act, the Company is required to meet certain air emissions standards. Under OSHA, the Company is required to meet certain safety standards, including those relating to equipment and procedures, indoor air quality and data sheets on material used at the Company's facilities. Compliance with these laws had no material effect on the Company's capital expenditures, operating results or competitive position during fiscal 1995, and the Company anticipates no such material effect during fiscal 1996.\nRAW MATERIALS\nThe drugs and other raw materials used in the Company's products are purchased through United States distributors for foreign and domestic manufacturers of bulk pharmaceutical chemicals and are generally available from numerous sources. The federal drug application process requires specification and approval of raw material suppliers. If raw materials from all specified suppliers become unavailable, FDA approval of a new supplier is required, which can cause a delay of six months or more in the manufacture of the drug involved. To date, the Company has not experienced any significant delays and generally specifies two or more suppliers in all drug applications.\nLIABILITY INSURANCE\nDuramed's business exposes it to the potential liability which is inherent in the production of drugs for human use. Although the Company makes every effort to maintain strict quality control programs and carries product liability insurance of $5.0 million per incident and $5.0 million in the aggregate per year (with a deductible amount of $25,000 per claim and $250,000 in\n- 10 - the aggregate per year), it cannot be fully protected from potential liability in this area by any reasonable amount of insurance. Additionally, there can be no assurance that the Company's product liability insurance can be renewed or renewed at a rate comparable to that now being paid by the Company.\nEMPLOYEES\nAs of March 25, 1996, the Company had approximately 353 full-time employees. There are no collective bargaining agreements in effect at the Company.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES. - --------------------\nDuramed's manufacturing, laboratory, and product development activities are conducted primarily in a 190,000 square foot plant located on 17 acres in Cincinnati, Ohio, which includes a 38,000 square foot expansion designed to meet the initial projected manufacturing requirements of conjugated estrogens and other HRT products under development. The facility is collateral for certain of the Company's borrowings.\nThe Company's executive offices, certain corporate support groups and distribution activities are conducted from a 28,200 square foot facility in Cincinnati, Ohio. The lease for this facility extends to February 28, 2000, and contains options to renew for up to an additional three years.\nThe Company leases an approximately 7,200 square foot facility in Cincinnati, Ohio which is used for sales, marketing and certain other corporate functions. The lease for this facility expires May 31, 1996.\nThe Company also has two leased warehouses in Cincinnati, Ohio. One is approximately 28,000 square feet and is being leased on a month to month basis. The other facility is approximately 10,000 square feet and is leased through March 16, 1997.\nThe Company believes its facilities and equipment are well maintained, in good operating condition and, in general, suitable for the Company's purposes. The Company is currently reviewing its facility requirements and will likely need additional space and equipment to execute its business plan (see \"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\" for a discussion of anticipated facility and equipment resource requirements).\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS. - ---------------------------\nThe Company is involved in various lawsuits and claims which arise in the ordinary course of business. Although the outcome of such lawsuits and claims cannot be predicted with certainty, the disposition thereof will not, in the opinion of management, result in a material adverse effect on the Company.\n- 11 - ITEM 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 STOCKHOLDER MATTERS. - -------------------------------------------------------------------------------\nDuring the 1994 period prior to September 16, 1994, the Common Stock was traded in the over-the-counter market due to the Company's inability to meet certain listing requirements of the Nasdaq National Market. On September 16, 1994, trading of the Common Stock on the Nasdaq recommenced under a listing exception from the Nasdaq's tangible net asset requirements. On December 12, 1995 the Company was notified that it was found to be in compliance with all Nasdaq requirements, and the exception was removed. The table below sets forth the high and low bid quotations for the Common Stock as reported by the Nasdaq. Quotations prior to September 16, 1994 are the high and low bid quotations as reported by the National Quotation Bureau, Inc. and reflect inter-dealer prices, without retail mark-up, mark-down or commission, and may not necessarily represent actual transactions.\nHigh Low 1994: First Quarter . . . . . . . . . . . . . $ 7.88 $ 5.50 Second Quarter . . . . . . . . . . . . 9.17 6.50 Third Quarter . . . . . . . . . . . . . 18.25 7.38 Fourth Quarter. . . . . . . . . . . . . 17.25 11.75 1995: First Quarter. . . . . . . . . . . . . . $ 20.50 $ 14.25 Second Quarter . . . . . . . . . . . . . 18.75 12.00 Third Quarter. . . . . . . . . . . . . . 25.50 14.00 Fourth Quarter . . . . . . . . . . . . . 17.25 12.75\nAs of December 31, 1995, the Company had 1043 stockholders of record. The Company has not paid any cash dividends on its Common Stock since its inception and does not intend to pay cash dividends in the foreseeable future. Under the terms of the Company's current loan agreements with its bank, no dividend declaration is permitted. In addition, the terms of the Company's loan agreement with the State of Ohio require that the Company not pay any dividends to stockholders unless an amount equal to 30% of such dividends is paid to the State of Ohio as an additional principal reduction.\n- 12 -\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA. - ----------------------------------\nThe following table sets forth selected financial data, derived from the audited financial statements of the Company, for the five years ended December 31, 1995. This information should be read in conjunction with \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" elsewhere herein.\n- 13 -\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND - ------------------------------------------------------------------------ RESULTS OF OPERATIONS. - ----------------------\nRESULTS OF OPERATIONS - ---------------------\nThe table below sets forth the components of the Company's results of operations as a percentage of net sales, as well as the percentage change in each item from year to year.\nNET SALES Net sales increased by $4.3 million (9.6%), and $15.0 million (49.5%) in 1995 and 1994, respectively. The sales increase in 1995 was primarily attributable to continued growth in sales of the Ortho-McNeil products, which the Company commenced marketing in the fourth quarter of 1994, and recognition of $1.5 million of deferred revenue (see \"Notes to Consolidated Financial Statements - Note D\"). The marketing agreement under which the Company distributed products manufactured by Invamed was discontinued in 1995. The Company has subsequently obtained most of the products previously supplied by Invamed from alternative sources. Net sales in the fourth quarter of 1995 were $10.4 million (excluding $500,000 in incremental deferred revenue recognized in the fourth quarter). Sales in the fourth quarter were lower by approximately $2.5 million than the average of the prior quarters in 1995, primarily as a result of lower sales of the Company's Methylprednisolone product. Net sales in the first quarter of 1996 are expected to be at a similar level as the fourth quarter of 1995. The Company anticipates the sales level will increase in the second and third quarters of 1996 as a result of entering the seasonal high sales period for certain of its products and continued growth in sales of certain other products. The increase in 1994 sales compared to 1993, resulted primarily from increased sales of the Company's Methylprednisolone product and increased sales resulting from the first full year's shipment of the Ortho-McNeil product, Estropipate.\n- 14 - Methylprednisolone accounted for 53% of sales in 1995, 55% in 1994 and 39% in 1993. No other product accounted for more than 10% of net sales in 1995.\nGROSS MARGIN Gross margins, and the corresponding percentages of net sales for 1995, 1994 and 1993, were $19.9 million (40.1%), $20.0 million (44.4%) and $10.5 million (34.6%), respectively. The lower gross margin in 1995 compared to 1994 is attributable to the product sales mix and price erosion on certain of the Company's products. The gross margin in 1995 was favorably impacted by the recognition of $1.5 million in deferred revenues. The Company generated a substantially lower gross margin in the fourth quarter compared to prior quarters in 1995 as a result of lower sales and product mix. While gross margin in the first quarter of 1996 is expected to be similar to the fourth quarter of 1995, gross margin in the second and third quarters of 1996 is expected to increase as a result of the expected increase in sales. In 1994, the increases in the Company's gross margin were due primarily to increased sales of Methylprednisolone along with the effects of higher overhead absorption due to volume increases and manufacturing efficiencies. There can be no assurance that, with the Company's current limited product line, the present gross margin levels can be maintained if the Company's products, particularly Methylprednisolone, should experience increased competition.\nOPERATING EXPENSES\nProduct Development Product development expenditures for the years ended December 31, 1995, 1994 and 1993 were approximately $5,953,000, $1,861,000 and $859,000, respectively. Product development expenses in the fourth quarter of 1995 included a charge of $1,459,000 to record the estimated net exposure associated with funds advanced to Hallmark (see \"Notes to Consolidated Financial Statements - Note B\"). Additionally, in 1995 product development expenditures include approximately $1.6 million of certain costs incurred in preparation for manufacturing the conjugated estrogens product in commercial quantities. Product development expenditures are net of reimbursements received from Schein pursuant to the terms of the contractual agreement in connection with the development of a new formulation of conjugated estrogens tablets. The increase in product development expenditures reflects the Company's commitment to expanding its product development activities.\nThe Company intends to significantly increase its investment in product development as its available resources permit.\nSelling Selling expenses increased $782,000 in 1995 and $1,216,000 in 1994 as a result of increased sales and marketing activities and expansion of the Company's sales force in order to prepare for the commercial launch of conjugated estrogens, develop strategic alliance opportunities, enhance service to existing customers and provide additional resources to contact prospective customers.\n- 15 - General and Administrative In 1995, general and administration expenses increased by $1,242,000 due in part to staff increases and professional fees associated with an increased emphasis on business development activities. Additionally, in 1995 the Company incurred expenses of approximately $756,000 in connection with responding to various regulatory and legal issues associated with its pending ANDA for conjugated estrogens. In 1994, general and administrative expenses increased by $2,718,000 due primarily to increases in staffing and attendant costs necessary to support and execute the Company's business plans and address the requirements of its current and anticipated increased operating levels.\nInterest Expense The Company's borrowings are primarily variable rate facilities. The increase in interest expense in 1995 compared to 1994 resulted from an increase in average borrowings. The increase in interest expense in 1994 over 1993 was attributable to increasing interest rates during the period.\nPreferred Dividends The preferred dividends of $122,739 in 1995 represent the dividend provision associated with the $12.0 million of Series C Preferred Stock issued in November 1995 (see \" Notes to Consolidated Financial Statements - Note G\").\nOther Matters As noted above, a conscious decision was made in early 1995 to increase expenditures for manufacturing and other launch activities in anticipation of the approval of the Company's conjugated estrogens product and to provide the additional personnel and capital resources needed to implement the Company's business plan. This planned investment in the future contributed substantially to increased expenses, and therefore reduced levels of performance, in the fourth quarter and the year ended December 31, 1995. This commitment has increased through the first quarter of 1996 which could result in a first quarter 1996 loss in excess of the reported loss for the fourth quarter of 1995, exclusive of the charge pertaining to Hallmark. The Company remains optimistic regarding the approval of its conjugated estrogens product. However, management also recognizes the importance of balancing the needs between a strong product development commitment and conserving resources. In keeping with this combined commitment, steps have been taken recently to implement operational changes consistent with these two corporate goals (see \"Item 7. Management's Discussion and Analysis of Financial Condition And Results of Operations\/Liquidity and Capital Resources\").\nINCOME TAXES\nAt December 31, 1995 the Company had cumulative net operating loss carryforwards of approximately $28.2 million for federal income tax purposes which expire in the years 2004 to 2010. Additionally, the Company had cumulative losses from Duramed Europe that amounted to approximately $1.8 million which are not deductible for U.S. tax purposes. In 1994, based upon a forecast of future operating results, the Company concluded that it would, more likely than not, be able to realize a portion of the benefit of its net deferred tax assets. Accordingly, in the fourth quarter of 1994 the valuation allowance was reduced and a $3.9 million deferred tax benefit was recorded. The carrying value of the deferred tax asset and the related valuation allowance are based on a forecast of future operating results, which excludes potential revenues associated with products that are under development or have not yet obtained regulatory approval. Full utilization of this $3.9 million deferred tax benefit will require future taxable income of approximately $10.3 million. As of December 31, 1995, the Company had a $8.3 million valuation allowance, which it deems appropriate, associated with the net value of the operating loss carryforwards. Adjustments to the valuation allowance may be required if circumstances change.\nIn 1995 the Company did not record a provision for income taxes. In 1994, the Company recorded a current alternative minimum tax provision of $115,000.\n- 16 - IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS\nIn March 1995, the FASB issued Statement No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,\" which requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amount. Statement No. 121 also addresses the accounting for long-lived assets that are expected to be disposed of. The Company will adopt Statement No. 121 in the first quarter of 1996 and, based on current circumstances, does not believe the effect of adoption will be material.\nStatement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation,\" requires the Company either to adopt the fair value method of accounting for stock options in its financial statements or to retain its existing method and disclose the pro forma effects of using the fair value method beginning in 1996. The Company intends to retain its existing method of accounting for stock options and to include pro forma disclosures in the notes to its consolidated financial statements. Accordingly, the standard will have no effect on the Company's financial condition or results of operations.\nINFLATION Inflation has not had, and is not expected to have, a material impact upon the Company's business.\nLIQUIDITY AND CAPITAL RESOURCES - -------------------------------\nAs explained in \"Item 1. Business - Private Placement of Series C Convertible Preferred Stock\" the Company successfully raised $24.0 million through an offering of Series C Preferred Stock, of which the first $12.0 million ($10.8 million net of issuance costs) was received in November 1995. As a result, the Company had a capital surplus of $8.9 million at December 31, 1995 compared to a capital deficiency of $1.2 million at December 31, 1994. The Company's working capital situation also improved to a surplus of $4.6 million at December 31, 1995 compared to a working capital deficiency of $2.5 million at December 31, 1994. The Company closed on the second stage of the private placement, which provided net proceeds of $11.1 million, in February 1996.\nDuring the third and fourth quarters of 1995, the Company reorganized the terms of certain borrowing arrangements with its bank, which resulted in expanded borrowing capacity under the Company's revolving credit facility and modified repayment due dates on the term note. The amended terms of the revolving credit facility permit the Company to borrow up to $12.5 million, based upon eligible collateral, through March 30, 1997 when the principal balance is due. The expressed intention of the Company and its bank is to review quarterly the Company's financial condition and, if appropriate, extend the due date of the revolving credit facility in order to maintain a fifteen month term. The Company made a $1.0 million principal payment on its\n- 17 - term note in December 1995. As amended, the $4.5 million balance of the term note at December 31, 1995 required a principal payment of $1.5 million on March 1, 1996, with the remaining $3.0 million due on June 1, 1996. In February 1996 the Company made the $1.5 million term note principal payment due on March 1, 1996. Under a separate agreement in March 1996, the bank made available to the Company an additional $1.5 million of term financing collateralized by existing equipment. At March 25, 1996 the Company's borrowings on the revolving credit facility were $2.3 million. Based on the eligible collateral value of $10.2 million on that date, the Company could borrow an additional $7.9 million under this facility.\nThe current terms of the note payable to the State of Ohio require a balloon payment of $1,021,000 in November 1996.\nThe Company's capital expenditures were $5.2 million in 1995 and $5.7 million in 1994. The majority of these expenditures relate to a project which commenced in 1994 to expand the Company's manufacturing facility by approximately 38,000 square feet in order to meet the initial projected manufacturing requirements of its HRT products, primarily its anticipated conjugated estrogens products. The facility expansion and related facility testing were completed in the second quarter of 1995. Investment in facility and equipment with respect to the HRT facility is approximately $11.0 million, approximately $9.5 million of which was satisfied under the Company's agreement with Ortho-McNeil (see \"Notes to Consolidated Financial Statements - Note B\"). The Company funded the balance of the project with borrowings on its revolving credit facility.\nOperating activities in 1995 used approximately $6.0 million in cash primarily as a result of an increase in accounts receivable associated with strong sales in the latter part of the fourth quarter and extended payment terms offered to certain customers. Inventory increased by approximately $1.0 million, principally as a result of purchases of conjugated estrogens raw materials in anticipation of the commercial launch of the product.\nAs a result of a reduction in sales and continued expenditures associated with the anticipated commercial launch of conjugated estrogens the Company recorded a net loss of $2.1 million (excluding the $1.5 million reserve against amounts advanced to Hallmark and the $500,000 incremental deferred revenue recognized in the fourth quarter) in the fourth quarter of 1995. The Company expects net sales in the first quarter of 1996 to be at a similar level as the fourth quarter of 1995. Net sales in the second and third quarters of 1996 are expected to increase over the levels projected for the first quarter of 1996, as a result of entering the seasonal high sales period for certain of the Company's products and continued growth in sales of certain other products.\nThe Company continues to prepare for the anticipated commercial launch of conjugated estrogens and, accordingly, is maintaining a higher level of operational and corporate infrastructure than would otherwise be required. The Company is monitoring the status of its conjugated estrogens application closely and continues to remain optimistic on ultimate approval of the product;\n- 18 - however, approval is not assured. Pending approval of the product, management of the Company is implementing steps designed to balance the merits of continued preparedness for the launch of conjugated estrogens with the resulting impact on the Company's operating results and financial condition.\nIf the Company receives approval from the FDA for its ANDA filing for the .625 mg. strength of conjugated estrogens and this product is successfully manufactured and marketed, the resulting favorable financial impact is expected to be significant. Accordingly, the Company's longer term operating plan is significantly impacted by this event. If, however, conjugated estrogens is ultimately not approved by the FDA, the Company will incur certain write offs related to investments made to date in inventory and other pre-launch activities, and provisions of certain of the Company's contractual agreements would become applicable. (See \"Notes to Consolidated Financial Statements - Note B\").\nThe Company is currently pursuing several business development opportunities, which could result in additional products and profit contributions. On a longer term basis, if Invamed is ultimately successful with its Verapamil S.R. product development pursuits, or the Company is successful with certain of its other product development pursuits, the availability of these products could significantly improve the Company's operating results. Again, success is not assured. The Company intends to increase its resource commitment to product development pursuits as its resources permit. Continued expansion of the Company's product development efforts will necessitate capital investment in equipment and facility to provide the capabilities to produce the resulting products in commercial quantities. While the Company has not finalized the capital requirements related to its business plan, the resources required are significant. To the extent the necessary capital is not available, either from operations or other sources, implementation of the Company's plans will be restricted or delayed. In addition, as described under \"Results of Operation - Operating Expenses,\" the Company's general and administrative expenses have increased as needed to support and execute the Company's business plan and to address the requirements of the Company's current and anticipated increased operating levels. Management recognizes the importance of both the future benefits from continuing these increased expenditures and the current necessity of conserving the Company's resources. Accordingly, management is implementing steps designed to balance these dual concerns. These steps will result in reductions in operating expenses pending approval of the Company's conjugated estrogens products or success in other pending business development opportunities.\nThe need to balance the questions of spending for the future and conserving current resources may become even more significant if the Company completes its acquisition of Hallmark. The Company believes that Hallmark's technical expertise and its capabilities with respect to advanced drug delivery systems will contribute significantly to the long-term success of the Company's product development program. However, the only commercial product currently manufactured by Hallmark is Captopril. With the highly competitive market conditions associated with this product, the Company does not anticipate that Captopril will make a significant contribution to sales or profits. Therefore, if the Company proceeds with the Hallmark acquisition and the Company's revenue base is not\n- 19 - enhanced by the approval and marketing of the Company's conjugated estrogens product or through other products, the Company expects that it will need to execute certain restructurings and other additional cost-cutting efforts to curtail operating expenses in order to support the Company's and Hallmark's product development activities.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data. - -----------------------------------------------------\nThe following financial statements are included in this 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\nThis information required by Items 10, 11, 12 and 13 of Part III is incorporated by reference from the Company's definitive Proxy Statement for its 1996 Annual Meeting of Stockholders filed or to be filed with the Securities and Exchange Commission pursuant to Regulation 14A.\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. All financial statements filed as a part of this report on Form 10-K are listed under Item 8, above.\n- 20 - 2. The following financial statement schedule is filed herewith:\nAll other schedules are omitted because of the absence of conditions under which they are required or because the information is shown in the financial statements or notes thereto.\n(b) Reports on Form 8-K On November 17, 1995 the Company filed a current report on Form 8-K (date of report: November 15, 1995) announcing the completion of the first stage of the private placement offering of Series C Convertible Preferred Stock.\n(c) Exhibits\n- 21 -\n_________________\n(a) Filed as an Exhibit to Registration Statement No. 33-8215-C and incorporated herein by reference.\n- 22 -\nThe Company will furnish to the Commission, upon request, its long-term debt instruments not listed in this Item.\n- 23 - 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, as of the 29th day of March 1996.\nDURAMED PHARMACEUTICALS, INC.\nBY: \/s\/ E. Thomas Arington ------------------------------ E. Thomas Arington, 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 as of the 29th day of March 1996.\n- 24 - ERNST & YOUNG LLP 1300 Chiquita Center Phone 513 621 6454 250 East Fifth Street Cincinnati, Ohio 45302\nReport of Independent Auditors\nThe Board of Directors Duramed Pharmaceuticals, Inc.\nWe have audited the accompanying consolidated balance sheets of Duramed Pharmaceuticals, Inc. as of December 31, 1995 and 1994, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1995. 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 Duramed Pharmaceuticals, Inc. at December 31, 1995 and 1994, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, 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 therin.\n\/s\/ ERNST & YOUNG\nCincinnati, Ohio March 27, 1996\nErnst & Young LLP is a member of Ernst & Young International, Ltd.\nDURAMED PHARMACEUTICALS, INC.\nCONSOLIDATED BALANCE SHEETS\nASSETS\nSee accompanying notes.\nDURAMED PHARMACEUTICALS, INC.\nCONSOLIDATED BALANCE SHEETS\nLIABILITIES AND STOCKHOLDERS' EQUITY\nSee accompanying notes.\nDURAMED PHARMACEUTICALS, INC.\nCONSOLIDATED STATEMENTS OF OPERATIONS\nSee accompanying notes.\nSee accompanying notes.\nDURAMED PHARMACEUTICALS, INC.\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nDURAMED PHARMACEUTICALS, INC.\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nSee accompanying notes.\nDURAMED PHARMACEUTICALS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE A. ACCOUNTING POLICIES\nThe Company's Business - ---------------------- Duramed Pharmaceuticals, Inc. (the \"Company\") develops, manufactures and markets generic prescription pharmaceutical products in tablet, capsule and liquid forms to customers throughout the United States.\nA summary of the principal accounting policies followed in preparation of the consolidated financial statements is set forth below.\nPrinciples of Consolidation - --------------------------- The consolidated financial statements include the accounts of the Company and its subsidiaries, all of which are wholly owned. Significant intercompany accounts and transactions have been eliminated in consolidation. Goodwill related to acquisitions is being amortized over ten years.\nCash - ---- The Company's cash balance represents only the balance maintained in the petty cash funds. The Company's day to day operations are funded and financed through its revolving credit facility (see Note D).\nInventories - ----------- Inventories are stated at the lower of cost (first-in, first-out) or market. Components of inventories include:\nAs of December 31, 1995, inventories include approximately $1.3 million of inventory costs, principally raw materials, relating to the conjugated estrogens product, for which the Company is awaiting regulatory approval. The drugs and other raw materials used in the Company's products are purchased through United States distributors for foreign and domestic manufacturers of bulk pharmaceutical chemicals and are generally available from numerous sources. The federal drug application process requires specification and approval of raw material suppliers. If raw materials from all specified suppliers become unavailable, Food and Drug Administration (\"FDA\")\napproval of a new supplier is required, which can cause a delay of six months or more in the manufacture of the drug involved. To date, the Company has not experienced any significant delays and generally specifies two or more suppliers in all drug applications.\nProperty, Plant and Equipment - ----------------------------- Property, plant and equipment are stated at cost. Depreciation and amortization is provided using principally the straight-line method. Major renewals and improvements are capitalized, while ordinary maintenance and repairs are expensed. Property, plant and equipment consists of the following:\nProduct Development Costs - ------------------------- Product development costs are charged to expense when incurred, net of reimbursements received per the contractual agreement described in Note B. The reported costs include specifically identifiable expenses and an allocation of certain expenses shared with the other departments within the Company.\nRevenue Recognition - ------------------- The Company recognizes revenue at the time it ships product and provides for returns and allowances based upon historical trends.\nConcentration of Risk - --------------------- The financial instrument that potentially subjects the Company to credit risk is accounts receivable. The Company sells its products to drug wholesalers, private label distributors, drug store chains, health maintenance organizations, hospitals, nursing homes, retiree organizations, mail order distributors, other drug manufacturers, mass merchandisers and governmental agencies. The credit risk associated with this financial instrument is believed by the Company to be limited due to the large number of customers (no single customer accounts for more than 10% of the Company's sales), their geographic dispersion and the performance of certain credit evaluation procedures.\nThe Company's current product line is limited and the Company's current operating results are heavily dependent on the performance of its Methylprednisolone product. If the Company receives approval from the FDA on its ANDA filing for the .625 mg strength of conjugated estrogens, the resulting favorable financial impact is expected to be significant; however, approval is not assured. See Note B.\nIn the absence of resources provided by new product sales, the additional capital which will be required in order to execute the Company's expanded business plan, which includes significantly expanded product development and business development activities to broaden the Company's current product lines, will have to be acquired from other sources or the business plan will have to be scaled back.\nEarnings (Loss) Per Share - ------------------------- The fully diluted and primary earnings per share calculations are computed using weighted average common shares outstanding and common equivalent shares, which include dilutive options, warrants and convertible preferred stock. Loss per share is computed using the weighted average of common shares outstanding only. Recognition of outstanding options and warrants in computing loss per share is not required as their effect would be antidilutive.\nUse of Estimates - ---------------- The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.\nReclassification - ---------------- Certain accounts from 1994 and 1993 have been reclassified to correspond to the classification for the 1995 fiscal year.\nRecently Issued Accounting Standards - ------------------------------------ In March 1995, the FASB issued Statement No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,\" which requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amount. Statement No. 121 also addresses the accounting for long-lived assets that are expected to be disposed of. The Company will adopt Statement No. 121 in the first quarter of 1996 and, based on current circumstances, does not believe the effect of adoption will be material.\nStatement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation,\" requires the Company either to adopt the fair value method of accounting for stock options in its financial statements or to retain its existing method and disclose the pro forma effects of using the fair value method beginning in 1996. The Company intends to retain\nits existing method of accounting for stock options and to include pro forma disclosures in the notes to its consolidated financial statements. Accordingly, the standard will have no effect on the Company's financial condition or results of operations.\nNOTE B. STRATEGIC ALLIANCES\nThe Company has an agreement with Invamed, Inc. (\"Invamed\") for the marketing rights to Verapamil S.R.,which has been formulated and will be manufactured by Invamed if an ANDA is filed and FDA approval is obtained. As part of the consideration, the Company issued 150,000 shares of common stock to Invamed. The value of the 150,000 shares ($997,200) is included in Other Assets and will be amortized over the estimated useful life of the product commencing with approval by the FDA. At this time, to the Company's best knowledge, three companies have received FDA approval to manufacture this generic product. Although there can be no assurance Invamed's product will receive FDA approval, based on current market conditions and the Company's sales projections, there appears to have been no impairment of the value of the marketing rights held by the Company for this product.\nOn June 26, 1992, the Company signed an agreement with Schein Pharmaceutical, Inc. (\"Schein\") for the development, manufacture and marketing of a new formulation of conjugated estrogens tablets, the generic equivalent of the brand name product Premarin(R). Under the agreement, Schein provides project funding and technical assistance while Duramed is responsible for product development and manufacturing; both firms will participate in the marketing and distribution of the products. The conjugated estrogens products have been formulated and are designed to meet the bioequivalence guidance established by the FDA in late 1991. On September 27, 1994 the Company filed an Abbreviated New Drug Application (\"ANDA\") for the .625 mg strength of conjugated estrogens. In order to market the .625 mg strength product as well as other dosage strengths, FDA approval is required. At this time, the Company is unable to determine when, or if, it will obtain FDA approval to market the .625 mg strength product. If approval is obtained and the product is successfully manufactured and marketed, the resulting favorable financial impact is expected to be significant. Product development expenditures in 1995, 1994 and 1993 are net of reimbursements received from Schein pursuant to this agreement.\nOn June 2, 1994 the Company executed distribution, marketing and related agreements with Ortho-McNeil Pharmaceutical Corporation (\"Ortho- McNeil\"). Under the terms of the agreements Duramed received the non-exclusive distribution rights to the Ortho-McNeil products Acetaminophen with Codeine, Tolmetin sodium, Tolmetin sodium DS and Oxycodone with Acetaminophen as well as an extension of the distribution term for the Ortho-McNeil product Estropipate. The term of the distribution agreement for these products is ten years, subject to reduction to three years from date of first sale, if certain requirements are not met. The Company commenced marketing the new products during the fourth quarter of 1994, and has been selling the Estropipate product since the fourth quarter of 1993. In addition to the distribution rights for the products, Ortho-\nMcNeil provided $2 million in cash and the use of $4 million in equipment for the Company's hormone replacement therapy (\"HRT\") facility expansion and Ortho-McNeil's parent, Johnson & Johnson, guaranteed a $5.5 million construction loan for the HRT facility expansion. Under the terms of the agreement, if certain requirements are met, title to the equipment will transfer to the Company over a specified period. If these requirements are not met, the Company will be required, at Ortho-McNeil's option, either to return the equipment or to purchase it at its fair market value at that time. If the Company is required to purchase the equipment, the purchase price plus interest at the current prime rate will be payable on a quarterly basis over three years. In exchange for the financial assistance provided to the Company under the agreements, Ortho-McNeil will receive a royalty on the future sales of the conjugated estrogens products. In addition, Ortho-McNeil will participate in marketing of the Company's conjugated estrogens products and share in the profits if the Company is successful in bringing the products to market.\nIn October 1995, the Company signed a letter of intent to acquire Hallmark Pharmaceuticals, Inc. (\"Hallmark\"), a privately held pharmaceutical development company headquartered in Somerset, N.J. The Company believes that Hallmark's technical expertise and capabilities with respect to advanced drug delivery systems would contribute significantly to the long term success of the Company's product development program. The Company is continuing discussions with Hallmark directed toward the signing of a definitive acquisition agreement. If the acquisition is consummated, it is probable that a substantial non-cash charge will be recorded for the recognition of purchased research and development.\nIn exchange for the exclusive North American marketing rights to Hallmark's Captopril product, and in anticipation of completing the acquisition, Duramed has advanced certain funds to Hallmark. Advances to Hallmark were $900,000 at December 31, 1995 and $2.0 million as of March 25, 1996. If the acquisition is not completed, the primary anticipated source for repayment of these advances is the net profits from the sales of the Captopril product. The Company commenced marketing Captopril in February 1996 in a highly competitive marketplace. Based on activity to date, it is unlikely that the short term net profits for the Captopril product will be sufficient to recover fully the advances. Accordingly, in the fourth quarter of 1995 the Company recorded a charge of $1,459,000 to recognize this exposure, net of associated Captopril receivables and inventories. If the acquisition is consummated, the funds advanced are, in effect, part of the purchase price for the acquisition of Hallmark.\nFor the years ended December 31, 1995, 1994 and 1993, respectively, the percentages of the Company's sales comprised of products marketed for others were 31%, 28%, and 36%. The gross profit generated by these sales was approximately $3.3 million in 1995, $3.6 million in 1994 and $4.0 million in 1993.\nNOTE C. ACCRUED LIABILITIES\nThe Company's accrued liabilities consist of the following:\nNOTE D. DEBT AND OTHER LONG-TERM LIABILITIES\nThe Company's debt consists of the following:\nUntil mid-November 1995 the funds used by the Company in its operations had been primarily provided through borrowings against its revolving credit facility, additional extensions of credit granted by the Company's bank and funds received from the issuance of a convertible debt security. In November 1995 the Company reached agreement and closed on the first $12.0 million ($10.8 million net of issuance costs) of a private placement offering of Series C Preferred Stock (see Note G). With the additional capital, the Company renegotiated terms of certain borrowing arrangements with its bank, which included the elimination of penalty interest charges which were scheduled to commence in January 1996. Under the terms of the amended and restated bank agreement dated December 31, 1994 two facilities were established, a revolving\ncredit facility with a maximum borrowing limit of $10.5 million and a term note in the amount of $9.5 million. These facilities, and the amendments thereto, are collateralized by substantially all assets of the Company including inventory, receivables and a mortgage interest on the manufacturing facility. During both the third and fourth quarters of 1995 the Company reorganized the terms of certain borrowing arrangements with its bank which resulted in expanded borrowing capacity on the revolving credit facility and modified repayment due dates on the term note.\nThe amended terms of the revolving credit facility permit the Company to borrow up to $12.5 million based upon eligible collateral ($11.1 million as of December 31, 1995) through March 31, 1997 when the principal balance is due. The expressed intention of the Company and its bank is to review quarterly the Company's financial condition and, if appropriate, extend the due date of its revolving credit facility in order to maintain a fifteen month term. This facility requires monthly interest payments at a rate of prime plus 1% (9.50% at December 31, 1995). The weighted average interest rate in effect on the revolving credit facility in 1995 was 9.8%.\nThe $9.5 million term note, prior to the amendments renegotiated in the second half of 1995, had required quarterly principal payments in the amount of $2.0 million payable on the first day of March, June, September and December of 1995 with the remaining balance due on March 31, 1996. Through June 30, 1995, two principal payments totalling $4.0 million had been made on the term note. In December 1995 the Company repaid an additional $1.0 million of principal on the term note. The amendments to the borrowing agreement extended the due dates for the outstanding $4.5 million balance of the term note to $1.5 million due on March 1, 1996 and the remaining $3.0 million due on June 1, 1996. In February 1996 the Company made the $1.5 million term note principal payment due on March 1, 1996. The term note requires monthly interest payments and bears interest at the rate of prime plus 1%.\nIn consideration of the expanded borrowing arrangements, the Company granted to the bank warrants to purchase 200,000 shares of common stock of the Company at $18.125 per share.\nThe note payable to the State of Ohio is secured by the Company's manufacturing facility. The loan bears interest at 7.5% and requires minimum monthly payments of $20,394 and certain other payments as defined by the agreement. The final balloon payment of approximately $1,021,000, is due November 1, 1996. This debt is personally guaranteed by a former officer and by a director.\nDuring 1985, Hamilton County, Ohio issued Industrial Revenue Bonds in the amount of $995,000, the proceeds of which were used by the Company to purchase new machinery and equipment. The balance was paid in April 1995 with the proceeds of a $185,000 bank note. The interest rate of the note is prime plus 1%. The term of the note is three years and requires monthly payments of principal and interest in the amount of $6,400.\nThe construction loan is a ten year $5.5 million facility which provided a portion of the financing for the expansion of the Company's manufacturing facility and is supported by a loan guaranty from Johnson & Johnson. Under the terms of the construction loan, principal payments do not commence until the occurrence of certain defined events or January 1, 1997, whichever occurs first. Interest is payable monthly based upon the prime rate.\nThe equipment line of credit is a $1.5 million facility provided by the Company's bank for financing equipment which is collateralized by the assets financed. The term of the facility is five years at an interest rate of prime plus 1%.\nThe $2.0 million convertible note represents funds advanced from a joint venture partner. The note bears interest at a variable rate approximating prime rate + 3% (initially 12%), and matures on July 10, 1998. Upon the occurrence of certain events, or at the option of the lender, the principal amount of the note and accrued interest may be convertible to shares of Duramed common stock at a conversion price of $15.00 per share. If the Company repays this obligation prior to maturity, the note holder is entitled to receive warrants, in an amount equal to the principal amount plus accrued interest that is paid, to purchase shares of the Company's common stock. The exercise price of such warrants would be $15.00 per share.\nOther long-term debt also includes facilities of varying amounts and terms which are generally collateralized by the assets financed.\nThe carrying value of the Company's's debt approximates fair market value.\nThe Company's other long-term liabilities consist of the following:\nThe abandoned facility obligation represents the amounts due, net of sublease income, under terms of a lease which extends through September 30, 1998. Due to the Company's financial condition at the time, the Company was unable to meet its commitments under the lease and vacated the facility in 1991. The facility was sublet for a period of five years in 1992. In 1994 the Company commenced payment of its current net obligations under the lease and also commenced quarterly payments on the accumulated outstanding balance.\nThe $500,000 in deferred revenue at December 31, 1995 represents the unamortized balance from the $2.0 million cash received from Ortho-McNeil pursuant to the terms of distribution and marketing agreements entered into in 1994 (see Note B). In order to match the performance of certain activities pursuant to the terms of the agreement, the Company amortized $250,000 a quarter for the first three quarters of 1995 and $750,000 in the fourth quarter. As of December 31, 1995, the remaining $500,000 of deferred revenue is classified as current.\nMaturities of long-term indebtedness and obligations for the abandoned facility obligation for the ensuing five years are as follows:\nNOTE E. LEASES\nIn December 1994, the Company entered into a lease for approximately 28,200 square feet of a facility in Cincinnati, Ohio which is used for executive offices, certain corporate support groups and distribution. The lease term for this facility extends to February 28, 2000, with a provision for three one-year renewals. Annual rents are $256,000 through 1997, and escalate to $265,000 during the final year of the lease.\nIn 1993, the Company entered into a lease for an approximately 7,200 square foot facility in Cincinnati, Ohio, which is used for sales, marketing and certain other corporate functions. The lease term extends through May 31, 1996 at an annual rate of $54,540.\nThe Company also has two leased warehouses in Cincinnati, Ohio. One is approximately 28,000 square feet and is being leased on a month to month basis. The other facility is approximately 10,000 square feet and is leased through March 16, 1997, with an annual rent of $48,000.\nThe Company leases various equipment, offices, warehouse and distribution facilities. Rental expense for the years ended December 31, 1995, 1994, 1993 was approximately $694,000, $286,000, and $222,000, respectively. The following summarizes minimum future lease payments as of December 31, 1995:\nAssets under capital leases amounted to approximately $5.4 million and $3.0 million in 1995 and 1994, respectively, with related amortization of $2.6 million and $1.9 million.\nNOTE F. EMPLOYEE RETIREMENT PLAN\nThe Company has a defined contribution plan, the \"Duramed Pharmaceuticals, Inc. 401(k)\/Profit Sharing Plan,\" available to eligible employees. Under the Plan the Company matches 50% of employee contributions to a maximum of 2% of each employee's compensation. The Company match of $206,000 and $150,000 in 1995 and 1994, respectively, was made with the Company's common stock, as permitted by the Plan. The Plan also has a profit sharing provision at the discretion of the Company's Board of Directors. The Company has not made a profit sharing contribution to the Plan. All full-time employees are eligible to participate in the deferred compensation and Company matching provisions of the Plan. Employees who have completed one year of service with the Company and have attained the age of 21 are eligible to participate in the profit sharing provisions of the Plan. Employees are immediately vested with respect to the Company matching provisions of the Plan. Employees vest in the profit sharing provisions of the Plan at 20% after 3 years of service, with additional vesting at a rate of 20% per year of service and full vesting after 7 years of service.\nNOTE G. COMMON AND PREFERRED STOCK\nCommon Stock - ------------ On May 19, 1995, the Company's stockholders approved an amendment to the Company's Restated Certificate of Incorporation which increased the number of authorized shares of common stock from 20,000,000 to 50,000,000 shares.\nPreferred Stock - --------------- The Company's Restated Certificate of Incorporation authorizes the Board of Directors (the \"Board\") to provide for the issuance of up to 500,000 shares of Preferred Stock in one or more series, with such designated preferences, rights, qualifications, powers, restrictions and limitations as may be determined by the Board.\nOn July, 8, 1993, as part of an agreement with its bank, the Company issued 74,659 shares of Series B Convertible Preferred Stock. The Series B Preferred Stock is non-voting and is convertible at any time into 746,590 shares of the Company's common stock. Subsequent to December 31, 1995 the bank converted 42,130 shares of Series B Convertible Preferred Stock into 421,300 shares of the Company's common stock.\nOn November 6, 1995, the Board authorized the issuance of up to 250,000 shares of 8% Cumulative Convertible Preferred Stock, Series C (the \"Series C Preferred Stock\"), having a stated value of $100 per share. In November 1995, the Company issued $12.0 million (120,000 shares) of Series C Preferred Stock and obtained commitments for the purchase of an additional 120,000 shares. Nasdaq National Market (\"Nasdaq\") regulations required stockholder approval for the second stage, which was obtained on January 24, 1996. The Company closed on the issuance of the $12.0 million second stage of the offering in February 1996.\nEach share of Series C Preferred Stock is convertible at the option of the holder, with respect to its stated value of $100, into shares of the Company's common stock at a price which is 15% below the average closing price of the common stock over the 10-day trading period ending two days prior to the date of conversion (the \"conversion price\"). The conversion price may not be less than $7.50 or more than $20.00. Half of the shares of Series C Preferred Shares became convertible on February 12, 1996; the remaining half became convertible on March 13, 1996. Any shares of Series C Preferred Stock remaining outstanding on November 14, 1997 will automatically be converted into shares of common stock on such date. The Series C Preferred Stock pays a dividend of 8% annually, payable quarterly in arrears, on all unconverted shares.\nThrough March 25, 1996, $17.0 million of the Series C Preferred Stock had been converted to 1,175,794 shares of the Company's common stock, at an average conversion price of $14.46 per common share.\nThe Company has authorized the issuance of 100,000 shares of Series A Preferred Stock, none of which has been issued.\nThe remaining 75,341 shares of authorized preferred stock are undesignated.\nNOTE H. STOCK OPTIONS AND WARRANTS\nStock Option Plans - ------------------ The Company has three stock option plans which have been approved by the Company's stockholders. The 1986 Stock Option Plan (the \"1986 Plan\") permits the granting of options for up to 160,000 shares of the Company's common stock. The 1988 Stock Option Plan (the \"1988 Plan\") permits the granting of options for up to 2,360,000 shares of common stock. Options may be granted under both Plans to employees on the regular payroll of the Company. Options granted under the 1986 and 1988 Plans become exercisable based upon the terms and conditions established at the time of the grant. The 1991 Stock Option Plan for Nonemployee Directors (the \"Directors Plan\") provides for the issuance of non-qualified options for up to 150,000 shares of common stock. The Directors Plan is a \"formula plan\" under which each new nonemployee director is granted, at the close of business on the date he or she first becomes a director, options to purchase 10,000 shares of common stock. Annually, each then serving nonemployee director, other than a new director, is also automatically granted options to purchase 5,000 shares of common stock at a price equal to the closing market price on the date of grant.\nAs of December 31, 1995, options for 85,878 shares of common stock were outstanding under the 1986 Plan and options for 62,891 shares had been exercised; options for 1,572,205 shares of common stock were outstanding under the 1988 Plan and options for 691,941 shares had been exercised; and options for 65,000 shares of common stock were outstanding under the Directors Plan and options for 25,000 shares had been exercised.\nOther Options and Warrants - -------------------------- In connection with an agreement terminating the employment of a former officer and director, the Company exchanged stock options for 15,000 shares of common stock previously granted under the 1986 and 1988 Plans for non-qualified stock options. Of these, options for 10,000 shares (at $6.60) expire September 22, 1996 and options for 5,000 shares (at $5.75) expire January 2, 1998.\nPursuant to various provisions of an agreement with a consultant, the Company granted options to purchase 10,000 shares (at $1.00), 50,000 shares (at $1.50), and 60,000 shares (at $1.50) on August 1, 1991, June 1, 1992, and December 31, 1993, respectively. All options granted are fully vested at December 31, 1995 and expire five years from the date of grant.\nOn December 18, 1992, in consideration for certain defined business arrangements, the Company granted options to Invamed to purchase 135,000 shares of the Company's common stock at an exercise price of $3.25 per share. On December 20, 1993, the Company granted additional options to purchase 300,000 shares of the Company's common stock at an exercise price of $6.5625 per share as compensation for certain defined business arrangements. Options granted on both dates vested immediately upon grant and expire five years from the date of grant.\nOn August 22, 1995, in consideration of modifications to the Company's borrowing arrangements and additional extensions of credit, the Company granted to its bank warrants to purchase 200,000 shares of the Company's common stock at an exercise price of $18.125 per share. These warrants vested immediately upon grant and expire ten years from the date of grant.\nAt December 31, 1995, an aggregate of 5,402,874 shares of common stock were reserved for issuance, which includes 1,600,000 shares of common shares in connection with the $12.0 million of Series C Preferred Stock that was issued and outstanding at December 31, 1995.\nThe following summarizes the activity in the 1986, 1988 and Directors Plans:\nNOTE I. INCOME TAXES\nEffective January 1, 1993 the Company adopted Statement of Financial Accounting Standards No. 109 \"Accounting for Income Taxes\" (\"FAS 109\"). The standard requires the use of the liability method to recognize deferred income tax assets and liabilities, using expected future tax rates. In 1993, a valuation allowance was provided for the total amount of deferred tax assets, due to the Company's limited historical profitability and other uncertainties. In 1994, based upon a forecast of future operating results, the Company concluded that it would, more likely than not, be able to realize a portion of the benefit of its net deferred tax assets. Accordingly, in the fourth quarter of 1994 the valuation reserve was reduced, and a $3.9 million deferred tax benefit was recorded. At December 31, 1995 the Company continued to maintain the net deferred tax asset at $3.9 million. Full utilization of this $3.9 million deferred tax benefit will require future taxable income of approximately $10.3 million. The carrying value of the deferred tax asset and related valuation allowance are based on a forecast of future operating results, which excludes revenues associated with products that are under development or that have not yet obtained regulatory approval. Adjustments to the valuation allowance may be required if circumstances change.\nDeferred income taxes provided under FAS 109 are determined based upon the temporary differences between the financial statements and the tax basis of assets and liabilities. The tax effects of temporary differences that give rise to deferred income tax assets and liabilities at December 31, 1995 and January 1, 1995 are presented below:\nThe components of the provision (benefit) for income taxes follow:\n*This credit represents the benefit of recognizing a portion of the Company's net operating loss carryforward as required by FAS 109.\nAt December 31, 1995 the Company had cumulative net operating loss carryforwards of approximately $28.2 million for federal income tax purposes which expire in the years 2004 to 2010. Additionally, the Company had cumulative losses from Duramed Europe that amounted to approximately $1.8 million which are not deductible for U.S. tax purposes. As of December 31, 1995, the Company had a valuation allowance of $8.3 million which it deems appropriate, on the net value of the operating loss carryforwards.\nThe Company recorded no income tax provision in 1995. In 1994, the Company recorded a current alternative minimum tax provision of $115,000.\nThe reconciliation of income tax at the U.S. federal statutory rate to income tax (benefit expense) is:\nNOTE J. COMMITMENTS AND CONTINGENCIES\nThe Company is involved in various lawsuits and claims which arise in the ordinary course of business. Although the outcome of such lawsuits and claims cannot be predicted with certainty, the disposition thereof will not, in the opinion of management, result in a material adverse effect on the Company.\nThe Company has entered into commitments of approximately $1.8 million to fund certain strategic product development pursuits.\nSCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS\nDURAMED PHARMACEUTICALS, INC. AND SUBSIDIARIES\n(1) Uncollectible accounts written off, net of recoveries.\n(2) Reversal due to change in status of product.\nS-1","section_15":""}
{"filename":"351717_1995.txt","cik":"351717","year":"1995","section_1":"ITEM 1. BUSINESS --------\nHISTORY -------\nThe Company was formed on March 27, 1969 as a New York Corporation under the name of Computerized Pollution Abatement Corporation. Its name was shortened to CPAC, Inc. (pronounced \"seapack\") by an amendment to its Certificate of Incorporation filed March 29, 1976. The Certificate of Incorporation, as amended, authorizes the issuance of 5,000,000 shares of Common Stock with a par value of $0.01 per share.\nThomas N. Hendrickson left Eastman Kodak Company to become the founder, President and Chief Executive Officer of CPAC, and has remained President and Chief Executive Officer throughout the Company's history.\nThe basic premise underlying the formation of the Company was the founder's belief that it would become necessary for photofinishers to remove pollutants from photographic processing effluent in order to meet environmental standards, and that most of the pollutants could be recovered in a cost effective manner. Silver was the primary recoverable material initially addressed by the Company.\nAs a primary supplier of equipment for the recovery of silver from spent photographic solutions, CPAC sought to expand its service to customers by providing refining services for the recovered silver. On July 1, 1981, CPAC entered into a joint venture agreement, forming a 50% owned subsidiary company called Profit Recovery Systems, Inc. (later shortened to \"PRS, Inc.\"). The purpose of the joint venture was to provide silver refining services and to exclusively market the products of CPAC, Inc. in the domestic marketplace, acting as a commissioned sales agency. In June 1988, PRS, Inc. became a wholly- owned subsidiary of CPAC, Inc.\nIn an effort to expand its product line beyond the sale of equipment, and to enhance its strategy of providing consumable products to an established customer base, CPAC acquired Trebla Chemical Company on October 1, 1984. Trebla was founded in 1982 as a wholly-owned subsidiary of Fotomat Corporation, St. Petersburg, Florida, and was subsequently sold to four private investors in early 1984.\nTrebla produces high quality photographic processing chemicals and has successfully positioned itself as the \"high quality, low cost producer.\" Many of its products are unique formulations, optimized for use with CPAC desilvering and chemical recycling equipment.\nContinuing with its successful strategy of emphasizing the growth of its consumable product lines and seeking expanded marketing avenues, in April, 1988, CPAC acquired Allied Photo Products Co., Inc. from Allied Products Co., Inc. In fiscal 1994 Allied Photo Products Co., Inc. changed its name to Allied Diagnostic Imaging Resources, Inc.\nAllied Diagnostic Imaging Resources, Inc. produces processing chemistries for the medical, dental and industrial X-ray, microfilm, and graphic arts markets. Allied operates two strategically located plants and has several well-known registered and trademarked product lines.\nIMG Photo Products, acquired by CPAC, Inc. on March 31, 1989, was founded in 1978. A quality manufacturer of silver recovery equipment and chemical mixers and blenders, IMG was purchased to boost Allied's chemical sales to the graphic arts and medical X-ray industries. IMG's operations were consolidated at CPAC Equipment Division, Leicester, New York, in 1990.\nPursuing a strategic plan to become a worldwide chemical manufacturer, CPAC Europe, N.V. was formed in late December, 1989, as a joint venture. A manufacturing plant was constructed in Herentals, Belgium and opened in June, 1991. Initially, Trebla chemicals were packaged to European standards and sold from this location.\nIn July, 1991, CPAC, Inc. purchased the joint venture partner's interest in CPAC Europe, N.V. to obtain 98% ownership of the company. This action was taken to expedite the achievement of CPAC, Inc.'s international goals. During fiscal 1994, additional manufacturing equipment was added allowing on-site mixing capabilities.\nOn January 21, 1992, CPAC, Inc. announced the acquisition of Fotoprocesos de Venezuela C.A. (Fotus) in Caracas, Venezuela. Prior to the acquisition, CPAC worked under a royalty agreement with Fotus which allowed them to manufacture black-and-white chemicals using CPAC's formulations. As a wholly-owned subsidiary, Fotus also re-sells various Trebla and Allied chemicals. CPAC's long range plan is to expand the distribution of its full product line in Latin American countries.\nOn June 8, 1992, the Company purchased substantially all of the operating assets and assumed certain liabilities from Chimifoto Ornano S.p.A. in Milan, Italy. The transaction was completed through a newly formed entity, CPAC Italia, S.r.l. Now operating as a wholly-owned subsidiary under the name Chimifoto Ornano, the new company continues to manufacture color and black-and- white chemicals similar to those produced by the Company's domestic chemical subsidiaries.\nCPAC's strategic goal is to become a world leader in the manufacture, packaging, and distribution of specialty chemicals. In 1994, CPAC began its diversification strategy by acquiring The Fuller Brush Company of Great Bend, Kansas. Fuller makes a wide variety of specialty chemicals and cleaning products for the industrial and household consumer markets. In January 1995, CPAC signed an agreement to license the trademarks and formulas of Stanley Home Products. Similar to the Fuller Brush line, Stanley also has expanded personal care products.\nCPAC, Inc. utilizes a profit center system to capitalize on its internal and acquired management strengths and to assure the continued customer benefits produced by its complementary product lines. CPAC, Inc. is now considered a holding company for the operations of: Trebla Chemical Company; Allied Diagnostic Imaging Resources, Inc.; CPAC Europe, N.V.; CPAC Equipment Division; PRS, Inc. (a sales and marketing organization); Fotoprocesos de Venezuela C.A.; CPAC Italia, S.r.l.; The Fuller Brush Company, Inc.; and Stanley Home Products. Each of the operations will be described separately in the following sections.\nNATURE OF BUSINESS ------------------\nBUSINESS SEGMENTS - -----------------\nPrior to the acquisition of Fuller, the Company classified its operations into one industry segment -- the manufacture and sale of prepackaged chemical formulations, supplies, and equipment systems to the imaging industry. Following the acquisition of Fuller and the signing of the Stanley Home Products license agreement, the Company has added a new segment for financial reporting purposes. In addition to the Imaging segment, the Company also operates in the Cleaning and Personal Care Products segment which includes specialty chemical cleaning products and related accessories (brushes, brooms, mops) for industrial and consumer use, as well as personal products such as soaps, shampoos, and skin care. The products of each segment are manufactured and marketed both in the U.S. and in other parts of the world. For additional financial information on these two segments, refer to Footnote 9 of Notes to Consolidated Financial Statements.\nCPAC EQUIPMENT DIVISION\nAs photographic materials are processed, either the exhausted chemicals must be replaced by fresh chemicals, or the solutions must be treated to extend their useful lives. CPAC Equipment Division designs and manufactures systems to accomplish this by removing the silver from these solutions so that they can be mixed with fresh chemicals and reused. These systems also reduce pollutant discharge.\nCPAC Equipment Division innovated two principal technologies for silver recovery -- electrolytic and ion exchange. Under the registered trademark SilvPAC(R), the Equipment Division manufactures silver recovery systems for image processing facilities using these technologies.\nThe company also produces a broad line of IMG silver recovery systems and chemical mixers and blenders, as well as units that recirculate fixer to help customers save on chemistry usage and expense.\nTREBLA CHEMICAL COMPANY\nChemicals are used in the developing process of both photographic film and paper. The exhausted chemicals must be replaced by fresh chemicals or regenerated. Trebla manufactures a complete line of chemical replenishment and chemical regeneration kits for the photographic industry, as well as chemicals for any process that develops a silver halide emulsion.\nTrebla's Trecon(R) and Trelux(R) brand paper and film chemistries enhance the recovery efficiencies of CPAC silver and chemical recovery systems, to reduce chemical usage and minimize pollutant discharge. The company believes it is the leading manufacturer of recyclable chemistries. Trebla pioneered the industry's first line of developer regeneration kits, to allow photo labs to reuse color developer without purchasing recycling equipment.\nTrebla continues to develop and introduce chemical products specifically to cut pollutant discharge, reduce chemistry costs, and eliminate odors. The company also does contract manufacturing for several major manufacturers.\nALLIED DIAGNOSTIC IMAGING RESOURCES, INC.\nMedical, dental and industrial X-rays, and graphic arts pre-press plates all require processing of an exposed image in chemical solutions to produce an image. Allied produces a complete line of high quality chemical solutions for these purposes.\nIn Allied's primary market, medical X-ray, the company's Autex(R) processing chemicals are widely recognized for their quality and versatility. Allied pioneered the popular Quadrapak(R) and BiPak(R) packaging of chemistries.\nIn the dental X-ray industry, Allied's second largest market, its trademarked Redi-Chem A & B(R) chemistry has the majority marketshare for automatic-type processing chemicals.\nAllied also produces high quality microfilm and pre-press chemicals for use in graphic arts applications. This represents the smallest portion of Allied's business.\nAs in photofinishing, X-ray and graphic arts processing produces silver in its effluent. Increasingly, operations employing such processes are undergoing closer environmental scrutiny. It is anticipated that the customer base within Allied will continue to yield new business for CPAC Equipment Division's pollution control systems.\nCPAC EUROPE, N.V.\nCPAC Europe, N.V. manufactures Trebla chemicals and markets CPAC silver recovery equipment for sale in Europe, northern Africa, and the Middle East. CPAC Europe also has begun distributing Allied chemistry, and is pursuing new opportunities to supply photofinishers in Eastern Europe. Recently CPAC Europe introduced a line of competitively priced photofinishing chemistry for the Latin America market.\nFOTOPROCESOS DE VENEZUELA C.A. (FOTUS)\nFotus was acquired to position CPAC for market opportunities in Latin America, and to establish a chemical manufacturing and distribution point for further market expansion of CPAC, Inc. product lines. Due to political and economic instability, Fotus currently is operating only as a distribution center.\nCPAC ITALIA, S.R.L. (CHIMIFOTO ORNANO S.P.A.)\nChimifoto was acquired to increase CPAC's market position in Europe, and to establish an additional chemical manufacturing and distribution point for further expansion of CPAC product lines within the European, Middle East, and North African photographic markets. Chimifoto manufactures processing solutions for photofinishing, medical, and graphic arts applications.\nPRS, INC.\nAs the exclusive sales and marketing company for CPAC equipment, Trebla chemistry, and silver refining services, PRS utilizes a direct field sales force, mail order, dealers, and distributors to sell and service certain CPAC products in the photographic industry.\nPRS has expanded its marketing role on behalf of the CPAC companies by assuming responsibility for international sales excluding sales made by CPAC Europe, N.V.; Fotoprocesos de Venezuela C.A.; and CPAC Italia, S.r.l.\nTHE FULLER BRUSH COMPANY, INC.\nCPAC acquired The Fuller Brush Company as a major step toward diversification into new specialty chemicals. Fuller makes over 425 different products, including household and commercial cleaning chemicals, brushes, brooms, mops, and personal care products.\nThe business is divided into industrial and consumer divisions. In addition, Fuller manufactures its products on a contract basis, and has a relationship with roughly 400 O.E.M. companies. Fuller has more than 100 trademarks in the U.S., Canada, and Puerto Rico, and sells products under the brand names ``Fuller Life'' and ``Oceanesce.''\nSTANLEY HOME PRODUCTS\nCPAC's license agreement to take over the domestic operations of Stanley Home Products was the Company's second step toward diversification into new specialty chemical products. The move was designed to reinforce the direct selling element of Fuller Brush, as well as to promote and economize manufacturing in the Great Bend plant.\nStanley's products include 250 different cleaning and personal care items, sold through a network of 16,000 distributors via the ``hostess'' or ``party plan.'' Stanley has over 50 trademarks in the U.S., Canada, and Puerto Rico. Roughly 75% of Stanley's sales are in chemicals and 25% in hard goods. Products are marketed under the brand names ``Naturals,'' ``Selectives,'' and ``Creations.''\nMARKETING AND SALES -------------------\nPRS, INC. (Sales and Marketing Organization)\nPRS currently acts as a ``commissioned sales agency'' for Trebla Chemical and the CPAC Equipment Division, providing sales and customer service. PRS, in its sales and marketing capacity, is free to draw upon the various technical resources within the CPAC organization. PRS uses the family of complementary products and services available to establish and maintain vendor relations with its customers. In addition, PRS obtains a commission for silver refined by Pioneer Refining Services, Inc., Salt Lake City, Utah.\nPRS maintains a network of distributors who are authorized to sell selected products on a non-exclusive regional basis. Internationally, there are a number of exclusive and non-exclusive distributive arrangements in addition to the CPAC Europe, Fotus, and CPAC Italia organizations. All PRS-appointed distributorships may be canceled without cause upon ninety days written notice.\nCPAC EQUIPMENT DIVISION\nThe Equipment Division markets its products domestically through both PRS, Inc. and Allied Diagnostic Imaging Resources, Inc., and through CPAC international subsidiaries. Overall sales and marketing direction is managed within each organization.\nThe Equipment Division ships products to these foreign customers against sight drafts, irrevocable letters of credit, or on open account.\nPRS acts as a commissioned sales agency in its relationship with CPAC's Equipment Division, and provides customer service activities, including minor product maintenance and installation work.\nCPAC equipment is sold directly, under private label, to Allied for resale to its marketplace.\nThe Equipment Division markets IMG products through a network of dealers. The Company's silver recovery products and chemical mixers and blenders are sold through approximately 300 X-ray and solution service dealers in the United States, and through approximately 190 graphic arts and equipment dealers serving the newspaper and printing industries. Some IMG products are sold on a private label basis.\nTREBLA CHEMICAL COMPANY\nPRS also provides sales and marketing representation for Trebla Chemical Company. Chemical products are primarily sold through the PRS field sales force. In 1990, in order to increase sales penetration in the rapidly growing minilab market segment, an extensive dealer organization was established. At present, there are over 45 independent dealers marketing Trebla products, accounting for over 26% of Trebla's sales in fiscal year 1995.\nThe major areas of sales concentration include amateur, school, professional, commercial, and government photofinishers. Trebla chemical sales have been predominantly in the U.S., although some sales have been made directly to major photofinishers in Latin America, Australia, and the Far East. The foreign market is highly competitive and only a few companies are owned by U.S. interests -- the biggest being Eastman Kodak. The foreign-owned companies and Kodak are in contention for the world market. (See also CPAC Europe, N.V. on page 6 and CPAC Italia, S.r.l. on page 7.)\nALLIED DIAGNOSTIC IMAGING RESOURCES, INC.\nAllied markets its products through various channels. Since 1989, medical X-ray products have been sold to dealers by Allied field sales personnel, as well as through contract manufacturing. Through extensive marketing in recent years, Allied gained a greater percentage of the medical market share. The company believes it is the third largest supplier of medical X-ray chemistry, behind Kodak and DuPont, although no statistical data exists to substantiate this belief. Allied also uses the complementary products of CPAC, Inc. companies to promote chemistry sales.\nDental X-ray products are sold through an extensive dealer and commissioned sales representative organization. A number of distributors also warehouse the Allied product line. Certain dental X-ray processing chemicals are manufactured on a private label basis.\nThe company's graphic arts chemical products are sold to dealers through Allied's sales staff and independent representatives.\nTHE FULLER BRUSH COMPANY, INC.\nFuller Brush uses three sales methods to market its chemical and hard goods products to consumers:\n1) Direct Sales ------------\nFuller Brush pioneered the direct selling industry and at one point, earned almost all of its revenue from this sales method. Now, the 10,000 independent Fuller Brush salespeople nationwide are responsible for about 20% of Fuller's total sales.\n2) Mail Order\/Catalog Sales ------------------------\nIn addition to the hundreds of thousands of catalogs Fuller prints for use by the sales force and distributors, the company also advertises select products in other specialized manufacturers' publications. Promoting its high quality product line through nationally recognized catalogs has helped this part of the business grow to represent approximately 5% of total sales.\n3) Retail Outlet Stores --------------------\nFuller's retail outlet stores feature discontinued inventory, surplus products, and seconds merchandise, and provide the company with an opportunity to meet its inventory control objectives. Fuller presently has seven retail outlet stores nationwide. Currently, the retail business represents about 3% of Fuller's total sales.\nFuller's industrial business is comprised of:\n1) Commercial ----------\nIn the commercial area of the business, Fuller manufactures high quality, industrial strength cleaning and janitorial products for use in restaurant and food service establishments, restroom sanitation, and other specialty cleaning applications. These products are sold exclusively through janitorial supply, paper supply, and food distributors. It is estimated that Fuller has less than 1% of the commercial cleaning market and competes with six national players in the chemical area -- the largest and most well-known of which is S.C. Johnson. Fuller holds approximately 30 trademarks on products for this market.\n2) Custom Brush ------------\nThe custom brush division produces high quality, engineered brushes for O.E.M. production processes and other uses. Fuller currently has a relationship with approximately 400 national O.E.M. companies. Including Fuller Brush, about eight companies compete for marketshare. Fuller's engineering and design expertise in custom brush manufacturing places the company in a highly competitive position in this market.\n3) Contract Manufacturing ----------------------\nFuller has the capability of manufacturing any of its products on a private label basis, and currently has contracts to supply other large companies in the household and personal care industries. Fuller's contract manufacturing business will be a major focus for CPAC, Inc. to take advantage of underutilized manufacturing capacity and equipment in Great Bend.\nSTANLEY HOME PRODUCTS\nStanley Home Products' distributors utilize the hostess or party plan sales method, in which a hostess invites friends and family to her home to view a demonstration of Stanley products by an SHP distributor. After the demonstration, the distributor solicits orders from the guests. For sponsoring the demonstration, the hostess may select a premium (gift) from a wide range of home enhancement items, aromatics, holiday products, collectibles, and personal accessories. Premiums represent roughly 10% of SHP's sales.\nIn April, 1995, Fuller Brush opened a marketing office for Stanley Home Products in Easthampton, Massachusetts.\nAt the time of CPAC's license agreement, Stanley Home Products outsourced its manufacturing to numerous major suppliers and smaller manufacturers. Because the product lines of Fuller Brush and SHP are similar, Fuller began absorbing some of the manufacturing for Stanley products in May, 1995. By January, 1996, CPAC expects to convert most of SHP manufacturing to the Fuller Brush facility in Great Bend. Stanley Home Products also operated four distribution centers in the U.S. Recently, all centers were closed and totally consolidated at Fuller Brush.\nRESEARCH AND DEVELOPMENT - ------------------------\nThe amount spent on Company-sponsored research and development totaled $412,269, $269,563, and $239,324 for the years ended March 31, 1995, 1994, and 1993 respectively. Primary research and development for all CPAC chemical operations in the Imaging segment, is carried out in St. Louis at the Trebla facilities. All research and development for the Cleaning and Personal Care Products is carried out at Fuller, in Great Bend.\nSALES AND CUSTOMERS - -------------------\nThe Company's net sales for the fiscal years ended March 31, 1995, 1994, and 1993 were $58.6 million, $43.8 million, and $39.9 million, respectively during which periods total foreign sales were $9,187,215, $8,311,687, and $7,288,821, respectively.\nTrebla Chemical Company; Allied Diagnostic Imaging Resources, Inc.; CPAC Europe, N.V.; Fotoprocesos de Venezuela C.A.; CPAC Italia, S.r.l.; The Fuller Brush Company, Inc.; and Stanley Home Products generally work without a backlog and usually ship any order within 24 hours of receipt. Backlog for the Equipment Division is not material. Fuller has some commercial business in contract manufacturing and production of custom brushes where orders are generally placed for longer term delivery cycles. The majority of such orders are filled within 60 to 90 days and backlog is not material.\nCOMPETITION - -----------\n1) Imaging -------\nEastman Kodak Company remains the photofinishing chemistry market leader in the U.S. with Fuji-Hunt, Agfa, Russell, and Trebla all competing for a share of the market. Trebla has positioned itself as a quality manufacturer of specialized chemistries, and is in a good position to take advantage of market opportunities.\nThe Company provides systems for use in the imaging industry, which industry is dependent upon processing techniques developed by such major industrial firms as Eastman Kodak, DuPont, Fuji Photo, Konica and Agfa. Those firms are constantly changing and seeking to improve their processing techniques.\n2) Cleaning and Personal Care Products -----------------------------------\nThe total domestic market for cleaning and personal care products is estimated at $37 billion. The personal care products market alone is estimated at $21.5 billion annually. The size of the commercial cleaning market is roughly $6 billion annually. Sales of consumer (household) cleaning products are approximately $10 billion, and brushes and brooms comprise roughly $.2 billion in sales.\nCompetition for Fuller Brush and Stanley Home Products is at two levels -- for distributors and consumers. The key competitors in both areas are Avon and Amway, whose combined worldwide volume is $3.9 billion and $3.2 billion respectively, followed by Tupperware at $1.2 billion, and Mary Kay at $600 million.\nEMPLOYEES - ---------\nThe Company currently employs 553 people (March 31, 1995). CPAC Equipment Division has 38 employees; PRS employs 5; Trebla Chemical Company employs 42; Allied Diagnostic Imaging Resources, Inc. employs 85; CPAC Europe employs 8; Fotus employs 13; CPAC Italia employs 28; The Fuller Brush Company employs 322; and 12 persons are assigned to the CPAC Corporate staff.\nEffective May 1, 1986, the Company established a Profit Sharing and Retirement Plan under Provision 401(k) of the Internal Revenue Code. This plan covers all eligible employees of CPAC, Inc. and its domestic subsidiaries. Subject to certain qualifications (employees must be over 21 years of age and have completed one year of service), the plan has the following features:\n(a)Contributions to the plan may be made for each plan year out of current or accumulated earnings to all eligible employees in such amounts as the Board of Directors may, in its discretion, determine. (To date, no discretionary payments have been made.)\n(b)The Company will match each contribution made by a plan participant for the plan year in an amount equal to $0.50 for each $1.00 of participant contribution. While a participant may contribute up to 15% of compensation to the plan each year, the Company will limit matching contributions to 3% of compensation.\nThe Company has appointed Manning & Napier Advisors, Inc., Rochester, New York, as Investment Managers and Exeter Trust Company, Portsmouth, New Hampshire, as Trustee of the plan.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES ----------\nCPAC, Inc. owns the land and building located on Route 20A, immediately west of the Village of Leicester and approximately 20 miles from Rochester, New York, where the offices and manufacturing operations of the Equipment Division, corporate staff, telemarketing and international employees are housed. This plant is located on 4.2 acres and consists of a two-story basement building and other secondary buildings, comprising a total of 30,330 square feet.\nThe 40,000 sq. ft. Trebla plant, located at 8417 Chapin Industrial Drive in St. Louis, Missouri, was purchased on October 29, 1993. The Trebla offices, laboratories, and major chemical manufacturing operations are housed in a one- story, concrete-block building on three (3) acres of land. Trebla has direct access to both truck and rail transportation for shipping purposes. There is a mortgage outstanding on this property.\nIn May 1989, Trebla signed a 12-year lease for an additional 20,480 sq. ft. of office and warehouse space in the same industrial complex as its existing facility. In November, 1993 Trebla leased 14,800 sq. ft. of additional warehouse space immediately adjacent to the current warehouse facilities.\nCPAC Europe, N.V. owns approximately 5 acres of land in Industriepark Herentals (near Antwerp), Belgium. The first phase of the building construction, completed during fiscal 1992, was 15,500 sq. ft. with expansion capability to approximately 50,000 sq. ft. There is a mortgage outstanding on the property.\nAllied Diagnostic Imaging Resources, Inc. leases its two strategically located plants in Irwindale, California and Atlanta, Georgia. The east and west geographic locations enable Allied to control shipping costs while delivering fresh products in a timely manner. In fiscal year 1989, Allied signed a 10-year lease and relocated its Los Angeles operation to a 28,000 sq. ft. plant in Irwindale, California (a suburb of Los Angeles). Allied's main plant at its headquarters in Atlanta, Georgia, is approximately 84,000 sq. ft. The lease on the Atlanta facilities expires September 30, 1996.\nThe Fotus plant is situated on 35,920 square feet of industrially zoned property, with access to all major transportation. CPAC, Inc. owns the land and the 20,930 sq. ft. facility near Caracas, Venezuela. At March 31, 1995, there is a mortgage outstanding on the property.\nCPAC Italia leases its office and industrial manufacturing space in Milan, Italy under a six-year operating lease agreement with the former owners of Chimifoto Ornano, expiring in 1998. The lease contains options for an additional six-year renewal term.\nThe Fuller Brush Company, Inc.'s 450,000 square foot facility is located in Great Bend, Kansas. The single story building contains manufacturing, distribution, and office facilities, and has access to both truck and rail transportation for shipping purposes. The facility was financed through an Industrial Revenue Bond which is outstanding until 2009. Fuller also leases seven retail outlet stores located in Kansas, Maine, New York, Tennessee, Wisconsin, and West Virginia.\nIn February, 1995, the Company signed a lease for office space in Easthampton, Massachusetts, for the Stanley Home Products' sales and marketing headquarters.\nIn management's estimation, all facilities are adequate to allow the Company to continue operations.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS -----------------\nNo material litigation is pending to which the Registrant and\/or its subsidiary(ies) is a party or of which property of the Registrant and\/or its subsidiary(ies) is the subject.\nPART II -------\nITEM 5.","section_4":"","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SECURITY HOLDER ---------------------------------------------------------------------\nMATTERS -------\nThe principal market on which the Registrant's Common Stock is being traded is the national Over-The-Counter (OTC) market in the NASDAQ National Market System.\nThe range of high and low bid information for CPAC, Inc. Common Stock by quarters for the past two fiscal years has been adjusted for the five for four common stock split declared on November 18, 1994, and paid on January 12, 1995, and the 5% stock dividend distributed in June, 1993.\n1995 1994 ---- ----\n4th Q 3rd Q 2nd Q 1st Q 4th Q 3rd Q 2nd Q 1st Q ----- ----- ----- ----- ----- ----- ----- -----\nPrice per share:\nHigh bid $13.50 $13.00 $11.40 $8.80 $8.80 $7.40 $7.40 $7.80 Low bid 10.25 10.20 7.60 6.80 6.20 5.40 5.80 5.80\nThe source of such quotations is The National Association of Securities Dealers Daily Statistical Report. Such over-the-counter market quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.\nThe approximate number of holders of record of the Common Stock of the Registrant as of March 31, 1995 is 850. This number includes only holders of record, and beneficial holders who have disclosed that they are recordholders.\nOn November 18, 1994, the Board of Directors announced that it had discontinued its cash dividend indefinitely. Prior to that, dividends had been maintained on a quarterly basis at $0.065 per share since May 31, 1991, and at $0.06 per share since May 31, 1990.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND ---------------------------------------------------------------\nRESULTS OF OPERATIONS ---------------------\nLIQUIDITY AND CAPITAL RESOURCES -------------------------------\nThe Company uses a variety of measures of liquidity for internal management purposes. These measures include working capital, asset turnover, profitability and leverage ratios which are set forth below. Internally, review of these ratios on a quarterly and annual basis allows management to set and measure goals for performance by the various operations of the Company. These ratios, on a consolidated basis, help to measure the Company's ability to meet its short-term obligations and are a part of the loan covenants with our primary lending institution.\nWORKING CAPITAL RATIOS - ----------------------\nWorking capital is the excess of current assets over current liabilities. The working capital ratio is calculated by dividing current assets by current liabilities.\nFor the Years Ended March 31, -----------------------------\n1995 1994 1993 ---- ---- ---- Working capital (in thousands) $16,074.1 $13,296.8 $12,589.7\nWorking capital ratio 2.4 to 1 3.2 to 1 3.5 to 1\nThe Company's acquisition of The Fuller Brush Company (Fuller) was financed in part under a new $2.5 million term loan agreement which calls for 50 fixed monthly payments including principal and interest at 9.65% per year. At the same time, added working capital financing was made available through an amendment and modification to the existing promissory note agreement for the revolving line of credit facility. This amendment increased the available line of credit from $3 million to $4.5 million with interest at prime plus one- quarter of one percent (0.025%). The maturity date of this agreement was extended from August 31, 1995, to October 31, 1996. The agreement contains a variety of covenants, including specific working capital and net worth covenants, which are customary in such a credit facility. At March 31, 1995, there was $1,516,155 outstanding under this line of credit and the Company was in compliance with the covenants or appropriate waivers were obtained.\nAdditional financing for the Fuller acquisition was obtained through an unsecured loan of $1 million from a private individual, requiring repayment on the first anniversary. This new short-term debt, coupled with the current portion of the new-term debt, is primarily responsible for the decline in the working capital ratio at March 31, 1995.\nIn addition, the Company has a line of credit facility with a major Belgian bank. As of March 31, 1995, the Company has the full available amount (approximately $886,000) outstanding against this line, to finance the Company's investment in CPAC Europe.\nManagement believes that the existing available lines of credit and cash flows from operations should be adequate to meet normal working capital needs based on operations as of March 31, 1995. The addition of Stanley Home Products (SHP) sales as of April 1, 1995, coupled with plans to take on production of various SHP items during the 1996 fiscal year, may result in the need for additional equipment to be installed in Great Bend and may result in the need for additional working capital. Management will continue to evaluate the need for new or increased financing during the 1996 fiscal year.\nASSET TURNOVER RATIOS - ---------------------\nFor the Years Ended March 31, -----------------------------\n1995 1994 1993 ---- ---- ----\n(1) Receivables-days outstanding 77.1 days 81.6 days 64.1 days\n(2) Annual inventory turns 3.3 times 3.3 times 3.3 times\nThe number of days outstanding can be attributed to:\na. the continued expanded use of dealers with extended payment terms;\nb. the general economic and competitive domestic sales environment, particularly in the medical chemistry market of the Imaging segment; and\nc. the increasing volume of foreign sales in the Imaging segment which generally have payment terms of 60 to 90 days.\nAt March 31, 1995, the decline in days outstanding results from the inclusion of The Fuller Brush Company receivables since October 13, 1994, which generally have short-term payment terms. On a consolidated basis, days outstanding should continue to improve as Fuller sales increase and SHP cash sales enter the formula in fiscal 1996.\nInventory turns remained stable for the periods presented.\nPROFITABILITY RATIOS - --------------------\nReturn on net sales is the result of dividing operating income by net sales. Net income on net sales is calculated by dividing net income by net sales. Net income to net worth is calculated by dividing net income by the amount of shareholders' equity.\nFor the Years Ended March 31, -----------------------------\n1995 1994 1993 ---- ---- ----\nReturn on net sales 10% 10% 11%\nNet income on net sales 5% 6% 6%\nNet income to net worth 14% 16% 17%\nThe decrease in these ratios from 1995 versus 1994 is primarily the result of the addition of $3,360,000 of equity issued in connection with the acquisition of The Fuller Brush Company. Also, continuing pressure on pricing and margins at Allied in the medical chemistry industry negatively impacted the ratio of net income on net sales. Management has invested almost $800,000 in new manufacturing equipment at Allied to help improve operating and production efficiency and hold these margins in the next fiscal year.\nThe decrease in these ratios in 1994 versus 1993 was primarily the result of the sudden bankruptcy of a major dental customer, as previously reported to Shareholders.\nLEVERAGE RATIOS - ---------------\nDebt to debt-plus-equity is calculated by dividing all liabilities by the sum of all liabilities plus shareholders' equity. Total debt to equity is calculated by dividing all liabilities by the amount of shareholders' equity.\nThese ratios measure the extent to which the Company has been financed by debt and are an important measure to our lending institution.\nFor the Years Ended March 31, -----------------------------\n1995 1994 1993 ---- ---- ----\nDebt to debt-plus-equity 54% 40% 37%\nTotal debt to equity 1.16 to 1 0.7 to 1 0.6 to 1\nThe increase in these ratios at March 1995 versus 1994 is primarily the result of the acquisition of The Fuller Brush Company and the related debt necessary to finance this acquisition coupled with the addition of $3,360,000 of equity, as previously disclosed.\nThe change in these ratios at March 31, 1994, versus 1993 was primarily the result of the new mortgage in connection with the purchase of the Trebla building in October 1993, and increased borrowings on the domestic line of credit.\nRESULTS OF OPERATIONS --------------------- Prior to the acquisition of The Fuller Brush Company, the Company classified its operations into one industry segment -- the manufacture and sale of prepackaged chemical formulations, supplies, and equipment systems to the imaging industry. Following the acquisition of Fuller and the signing of the Stanley Home Products license agreement, the Company has added a new segment for financial reporting purposes. In addition to the Imaging segment, the Company also operates in the Cleaning and Personal Care Products segment which includes specialty chemical cleaning products and related accessories (brushes, brooms, mops) for industrial and consumer use, as well as personal products such as soaps, shampoos, and skin care. The products of each segment are manufactured and marketed both in the U.S. and in other parts of the world. Sales between segments are not material.\nNET SALES AND NET INCOME - ------------------------\nThe Company's net sales increased from fiscal year end March 31, 1994, to fiscal year end March 31, 1995, by 34%; March 31, 1993, to fiscal year end March 31, 1994, by 10%; and March 31, 1992, to fiscal year end March 31, 1993, by 23%.\nSales increased by 6% for the Imaging segment overall, and the remaining sales increase is a result of the addition of $12 million of sales from Fuller in Cleaning and Personal Care Products since October 13, 1994.\nTrebla Chemical has continued to expand market penetration despite extreme pressure on prices. Successful expansion of the domestic independent dealer network and increased foreign sales helped to achieve an increase in sales of 8% in 1995. The rate of sales growth at Allied Diagnostic has been reduced as a result of very competitive pricing pressure, as well as the consolidation taking place within the medical industry.\nNet sales from our combined foreign operations have grown at approximately 4% for the fiscal year 1995.\nThe impact of acquisitions and growth in sales volume for the three years since 1992, coupled with an emphasis on controlling expenses, has increased net income by 80%, from $1,773,457 in fiscal 1992, to $3,188,924 in fiscal 1995.\nFOREIGN OPERATIONS - ------------------\nWhile the economies of Italy and Belgium have been suffering from serious general economic slowdowns, sales volumes of CPAC subsidiaries in these countries have improved and market share is increasing.\nThe political situation in Venezuela and Italy continues to be very unstable, and management therefore continues to be concerned about the short- term operating results. It is difficult to predict the economic situation at these foreign locations, but at the present time, management expects the combined foreign operations to show continued modest growth for the 1996 fiscal year.\nThe Company has exposure to currency fluctuations and has utilized conservative hedging programs (primarily forward foreign currency exchange contracts), to help minimize the impact of these fluctuations on results of operations. The Company does not hold or issue derivatives for trading purposes and is not a party to leveraged derivatives transactions. The acquisition of Chimifoto increased the potential financial statement exposure to currency fluctuations. Although the Italian lira has been erratic, it has settled into a more stable range over the past fiscal year. On a consolidated basis, foreign currency exchange losses are not material to the results of operations.\nGROSS MARGINS - ------------- Gross margins (net sales less cost of sales expressed as a percentage of net sales), were 41%, 40%, and 40% for the years ended March 31, 1995, 1994, and 1993, respectively.\nConsolidated gross margins continued relatively stable from 1993 to 1995. Improvements in margins at Trebla, CPAC Europe, and Chimifoto were offset by lower margins at Allied as a result of the continuing market competition in medical chemistry. The addition of Fuller has also contributed to consolidated margin improvement.\nSELLING, ADMINISTRATION AND ENGINEERING EXPENSES - ------------------------------------------------\nThis category amounted to 30.3%, 29.4%, and 28.5% of net sales in fiscal years 1995, 1994, and 1993, respectively.\nThe increase in 1995 versus 1994 is primarily the result of increased marketing expenditures related to the medical chemistry market, as well as the inclusion of Fuller's expenses since the acquisition date.\nThe increase in 1994 versus 1993 was primarily attributable to the $317,000 charge to bad debts arising from the sudden bankruptcy of a major dental customer, as previously reported.\nRESEARCH AND DEVELOPMENT EXPENSES - ---------------------------------\nFrom inception, the Company has engaged in research and development activities in the Imaging segment with the primary goal of improving existing products. In addition, the Company has engaged in research of new compatible products and responds to customer needs as necessary. There were no significant changes in this area during fiscal 1995 with expense increasing approximately 4%. Research and development in Cleaning and Personal Care Products since October, 1994, accounts for the majority of the increased expenses in 1995 versus 1994.\nINTEREST EXPENSE - ----------------\nThe increase in interest expense at March 31, 1995, versus 1994 is primarily the result of increased borrowings on the NationsBank line of credit, the new term loan, Industrial Revenue Bonds, and other debt assumed in connection with the Fuller acquisition, coupled with higher interest rates.\nThe increase in interest expense at March 31, 1994, versus 1993 is primarily the result of increased borrowings on the NationsBank line of credit and the new mortgage on the Trebla manufacturing facility.\nAs a result of the issuance of 616,000 shares of treasury stock in a private placement during February 1992, the Company raised approximately $3,600,000 of net additional capital. This capital increase provided the Company with additional funds to finalize the acquisitions of Fotoprocesos de Venezuela C.A. (Fotus) and Chimifoto Ornano S.p.A. In addition, the funds provided additional working capital for operations while helping to control interest expense in 1993 versus 1992 by minimizing the need for borrowings against the NationsBank line of credit. Subsequent to the acquisition of Fotus, the Company re-negotiated a significant portion of the short and long-term bank financing in South America and was also able to reduce Fotus' interest expenses during fiscal 1993.\nIMPACT OF INFLATION - -------------------\nDue to increased competitive sales pressure, the Company has not been able to pass on all inflation related cost increases in the Imaging segment. However, the adverse impacts of inflation have been partially offset through productivity improvements and cost cutting efforts. Inflation has generally not had an adverse impact on Cleaning and Personal Care Products.\nENVIRONMENTAL CONTINGENCY - -------------------------\nIn connection with the Fuller Brush acquisition, certain environmental contamination issues were discovered at the Great Bend, Kansas facility during the due diligence process. As a result of findings generated by environmental assessments of the facility, the Seller and the Department of Health and Environment of the State of Kansas entered into a Consent Order pursuant to which the Seller developed and submitted for the Department's approval, a comprehensive work plan for remediation of the environmental problems at the site. Upon the approval of its work plan by the Department, the Seller will undertake the remediation called for in the work plan.\nThe Consent Order does not apply, by its terms, to The Fuller Brush Company, Inc. as the new purchaser of the assets of the Seller as long as the Seller is performing its obligations under the Consent Order. Estimates of the costs of the remediation as set forth in the work plan submitted by the Seller range from $150,000 to $200,000. In order to secure the performance of such obligations by the Seller and to provide a fund from which the costs of the required remediation are to be paid, the Company and the Seller established a cash escrow account in the total amount of $700,000, the first $250,000 of which was provided by the Seller, with the balance provided by the Company.\nITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA -------------------------------------------\nREPORT OF INDEPENDENT ACCOUNTANTS ---------------------------------\nBoard of Directors and Shareholders CPAC, Inc. and Subsidiaries\nWe have audited the consolidated financial statements and the financial statement schedule of CPAC, Inc. and Subsidiaries listed in Item 14 (a) 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 CPAC, Inc. and Subsidiaries as of March 31, 1995 and 1994, and the consolidated results of their operations and their cash flows for each of the three years in the period ended March 31, 1995, 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.\n\/s\/ Coopers & Lybrand L.L.P. COOPERS & LYBRAND L.L.P.\nRochester, New York June 2, 1995\n1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ------------------------------------------\nBasis of Consolidation - ----------------------\nThe consolidated financial statements of CPAC, Inc., and Subsidiaries (\"the Company\") include the accounts of the Company and its wholly-owned subsidiary companies and its 98% owned subsidiary, (CPAC Europe, N.V.). The Company's foreign subsidiaries are included in the consolidated financial statements utilizing a December 31 fiscal year to facilitate prompt reporting of financial results. All significant intercompany accounts and transactions have been eliminated.\nInventory - ---------\nInventory is stated at the lower of cost, on a first-in, first-out basis, or market.\nProperty, Plant and Equipment - -----------------------------\nProperty, plant and equipment are stated at cost and are depreciated over their estimated useful lives on the straight-line and accelerated methods. Leasehold improvements are amortized over the shorter of the lease period or the expected useful lives of the improvements using the straight-line method. At the time of retirement or other disposition of property, the cost and accumulated depreciation are removed from the accounts and any gain or loss is reflected in income.\nResearch and Development - ------------------------\nThe Company charges research and development expenditures to income as incurred.\nForeign Currency Translation - ----------------------------\nAll assets and liabilities of the Company's wholly-owned and majority-owned foreign subsidiaries are translated at year end exchange rates. Translation gains and losses are not included in determining net income, but are accumulated as a separate component of shareholders' equity. Foreign currency transaction gains and losses are included in the determination of net income.\nIncome Per Common Share - -----------------------\nPrimary and fully diluted income per common share are computed based on the weighted average number of common shares outstanding, including the shares issuable upon the exercise of the common stock options as required by the \"treasury stock\" method. Weighted average shares outstanding as of March 31, 1995, 1994 and 1993 have been restated to reflect the five for four common stock split declared on November 18, 1994 (See Note 6). The weighted average number of common shares outstanding is:\n1995 1994 1993 ---- ---- ----\nPrimary 4,189,990 3,896,755 3,892,763 ========= ========= =========\nFully diluted 4,197,166 3,908,089 3,896,595 ========= ========= =========\n1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED ------------------------------------------\nStatements of Cash Flows - ------------------------\nFor purposes of the statements of cash flows, the Company considers marketable securities with a maturity of three months or less at the time of purchase to be cash equivalents. The Company paid interest of $679,000, $382,000, and $338,000 in fiscal 1995, 1994 and 1993, respectively. In addition, the Company paid income taxes of $2,283,000, $1,546,000, and $1,573,000 in fiscal 1995, 1994 and 1993, respectively.\nAmortization of Goodwill and Intangible Assets - ----------------------------------------------\nGoodwill and intangible assets are amortized on the straight-line method over periods ranging from five to fifteen years. Cost and related amortization are written off when fully amortized.\nBusiness and Credit Concentrations - ----------------------------------\nThe Company is required by SFAS No. 105, \"Disclosure of Information about Financial Instruments with Off Balance Sheet Risk and Financial Instruments with Concentrations of Credit Risk,\" to disclose significant off balance sheet and credit risk concentrations regardless of the degree of such risk.\nFinancial instruments which potentially subject the Company to concentration of credit risk consist principally of temporary cash investments and trade accounts receivable. The Company places its temporary cash investments with high credit quality financial institutions. The Company's customers are not concentrated in any specific geographic region, but are broadly concentrated in the imaging and cleaning and personal care products industries. In 1995 and 1994, sales to one customer in the Imaging segment amounted to $6,594,000 and $5,099,000, respectively. No single customer accounted for a significant amount of the Company's business during 1993. Concentrations of credit risk with respect to trade receivables are limited due to the large number of domestic and foreign customers comprising the Company's customer base, and their dispersion across several different business sectors participating in different facets of the imaging and cleaning and personal care products industries.\nIncome Taxes - ------------\nOn April 1, 1993, the Company changed its method of accounting for income taxes to comply with the provisions of Statement of Financial Accounting Standards No. 109 - \"Accounting for Income Taxes,\" issued in February, 1992, (SFAS No. 109). The cumulative effect of this change was not material. Therefore, the cumulative effect adjustment has not been separately disclosed in the Statements of Operations for the year ended March 31, 1994. Prior year financial statements were not restated to apply the provisions of SFAS No. 109.\nUnder SFAS No. 109, deferred income taxes are recognized for the tax consequences of \"temporary differences\" by applying enacted statutory tax rates applicable in future years to differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities. It also allows recognition of future tax benefits of net operating loss carryforwards to the extent that realization of such benefits is more likely than not.\n2 - ACQUISITIONS ------------\nOn January 16, 1995, the Company signed an agreement with Stanhome Inc. to license the domestic operations of Stanhome Inc.'s Worldwide Direct Selling Group, known as Stanley Home Products. The agreement allows the Company to manufacture and distribute products through the use of the trademarks and formulas of Stanley Home Products in the U.S., Puerto Rico, and Canada, over the life of the agreement, commencing April 1, 1995; the agreement expires, unless terminated earlier under the terms of the agreement, on March 31, 2010, subject to any extension which may be negotiated between the parties. The agreement also allowed the Company to purchase inventory on a consignment basis through September 30, 1996, and copies of historical business files, current customer and supplier lists, and corresponding databases were obtained. The Company also had the option of purchasing various machinery and equipment at book value, as well as offering employment to various Stanhome Inc. employees. The Company is required to pay Stanhome Inc., royalties equal to an increasing percentage (ranging from 1% in the first year to 7.5% in the last six years) of the net selling price of products sold under the licensing agreement. Based on these terms, at March 31, 1995, the Company has made a preliminary allocation of the purchase price and has recorded a liability equal to the net present value of the estimated minimum royalty payments. In addition, the Company has capitalized the value of the license agreement and will amortize it over the contract period. For purposes of the Statement of Cash Flows, this transaction has been treated as a non-cash transaction. Stanley Home Products will operate as a division of The Fuller Brush Company, Inc. (Fuller), and its sales and related expenses will be included with the results of operations of the Company beginning April, 1, 1995.\nOn October 13, 1994, the Company acquired substantially all of the assets of The Fuller Brush Company, a Kansas corporation, in exchange for payment of $1,719,000 in cash, 300,000 restricted shares of the Company's $.01 par value common stock with a fair market value of $3,360,000, the assumption of certain of Seller's liabilities, and acquisition related costs of $747,000 for a total asset purchase price of approximately $15,883,000. For purposes of the Statement of Cash Flows, the issuance of 300,000 restricted shares has been treated as a non-cash transaction.\nThe acquisition has been accounted for as a purchase transaction. Fuller's results of operations from the October 13, 1994, acquisition date have been consolidated into the financial results for the year ended March 31, 1995.\nThe Company has made a preliminary allocation of purchase price of Fuller based on the estimated respective fair values of the acquired assets and liabilities, and expects to finalize the acquisition accounting during the next fiscal year. The final allocation is not expected to have a significant impact upon the results of operations as previously reported. The preliminary purchase price has been allocated as follows:\nAccounts receivable $ 1,950,000 Inventory 3,593,000 Other current assets 830,000 Property, plant and equipment 9,134,000 Patents and trademarks 25,000 Other long-term assets 351,000 -----------\nTotal assets acquired 15,883,000 Less: Liabilities assumed 10,057,000 -----------\n$ 5,826,000 ===========\n2 - ACQUISITIONS - CONTINUED ------------\nOn a pro forma (unaudited) basis, if the license agreement with Stanhome Inc. and the acquisition of Fuller had occurred as of April 1, 1993, the consolidated results of operations of the Company including Stanley Home Products and Fuller would have been approximately:\nYear-Ended Year-Ended March 31, 1995 March 31, 1994 -------------- --------------\n(unaudited) (unaudited)\nNet sales $107,403,000 $103,103,000 Net income $ 3,247,000 $ 2,235,000 Net income per share $ 0.74 $ 0.52 (both primary and fully diluted)\nThe pro forma information has been prepared on the basis of preliminary assumptions and estimates which are subject to adjustment and may not be indicative of actual or future results. Preliminary, unaudited net sales information for Stanley Home Products during 1995 indicate that sales may be significantly lower than historical levels. The reduction is partially attributable to the peso devaluation which has significantly impacted sales at the United States\/Mexican border, as well as the elimination of credit sales and implementation of an `all cash'' sales term policy. While it is unknown whether these factors will continue to impact the Stanley Home Products' operations during the Company's fiscal 1996 year, it is probable that the proforma sales presented will be reduced.\n3 - INVENTORY ---------\nInventory as of March 31,1995 and 1994 is summarized as follows: 1995 1994 ---- ----\nRaw materials and purchased parts $ 6,036,693 $3,682,467 Work-in-process 708,143 225,272 Finished goods 5,500,090 3,498,509 Promotional supplies 491,402 691,305 ----------- ----------\n$12,736,328 $8,097,553 =========== ==========\n4 - PROPERTY, PLANT AND EQUIPMENT -----------------------------\nProperty, plant and equipment are comprised of the following at March 31: 1995 1994 ---- ----\nLand $ 625,442 $ 463,871 Buildings and improvements 8,163,036 3,176,069 Machinery and equipment 9,586,115 3,634,351 Furniture and fixtures 424,829 254,874 Leasehold improvements 1,065,169 1,009,016 Leased equipment 241,264 56,660 ----------- -----------\n20,105,855 8,594,841 Less: Accumulated depreciation and amortization 4,990,279 3,842,262 ----------- -----------\n$15,115,576 $ 4,752,579 =========== ===========\n5 - DEBT - CONTINUED ----\nThe revolving credit and term loan agreements contain restrictive covenants, the more significant of which relate to indebtedness, net worth, working capital, financial ratios, and cash flow. At March 31, 1995, the Company was in compliance with the covenants or appropriate waivers were obtained.\nAnnual maturities of debt are as follows:\n1997 $2,456,955 1998 1,727,569 1999 787,157 2000 162,407 2001 129,617 Thereafter 6,651,170 ----------\n$11,914,875 ===========\n6 - SHAREHOLDERS' EQUITY --------------------\nStock Split and Dividend - ------------------------\nOn November 18, 1994, the Board of Directors declared a stock split of five shares of CPAC, Inc. common stock for each four shares of stock held by shareholders of record on December 22, 1994, payable on January 12, 1995. Accordingly, since the par value of the common stock remains unchanged, an amount equal to the par value of the additional shares issued has been charged to additional paid-in capital and credited to common stock at March 31, 1995. All earnings per share and weighted average, primary and fully diluted shares outstanding for each of the quarters in the years ended March 31, 1995 and 1994, have been restated to reflect the five for four stock split. Earnings per share for the years ended March 31, 1995, 1994, and 1993 would have been $0.95, $0.84, and $0.81, respectively, without the impact of this five for four stock split.\nOn November 18, 1994, the Company also announced that it had discontinued its cash dividend indefinitely.\nOn April 21, 1993, the Board of Directors declared a 5% stock dividend on the Company's common stock payable June 11, 1993, to shareholders of record as of May 21, 1993. Shareholders received one additional share of stock for each 20 shares held. Accordingly, amounts equal to the fair market value (based on quoted market price, as adjusted) of the additional shares issued, have been charged to retained earnings and credited to common stock and additional paid-in capital at March 31, 1993. Earnings per share and weighted average shares outstanding as of March 31, 1993, were restated to reflect this 5% stock dividend.\nStock Options - -------------\nIn fiscal 1995, shareholders of the Company approved an Executive Long-Term Stock Investment Plan (the Plan) for key employees, which allows issuance of incentive stock options, nonqualified stock options, reload options, and restricted performance shares. As part of the Plan, 350,000 shares of the Company's $.01 par value common stock have been reserved for issuance. Under the Plan, shares of common stock are reserved for issuance to key employees. Upon exercise, an employee granted an option under the Plan may pay for the Company's stock either with cash or with Company stock already owned by the\nemployees, valued at the fair market value of the stock on the exercise date. The term of each option is determined by the Stock Option Committee. On November 18, 1994, the Company issued 48,750 incentive stock options (as adjusted for the five for four stock split), pursuant to the Plan.\n6 - SHAREHOLDERS' EQUITY - CONTINUED --------------------\nBecause `incentive stock options'' constitute a feature of the Plan, the 1991 Employees' Incentive Stock Option Plan was terminated as to the grant of future options thereunder. The termination of the 1991 plan did not have any effect on the remaining options outstanding under this plan. As of March 31, 1995, options outstanding under all plans are summarized as follows:\nOPTION PRICE SHARES PER SHARE ------ ---------\nOptions outstanding - March 31, 1992 104,395 $ 0.833 to 6.905 Exercised (7,000) 0.833 to 6.905 Expired Granted 66,150 7.857 to 8.750 ---------- -----------------\nOptions outstanding - March 31, 1993 163,545 0.833 to 8.750 Exercised (70,805) 0.833 to 7.857 Expired (8,925) 5.238 to 7.857 Granted 97,125 7.938 to 9.000 ---------- -----------------\nOptions outstanding - March 31, 1994 180,940 $ 2.738 to 9.000 Exercised (25,140) 6.350 to 7.938 Expired Granted 48,750 11.00 Stock split 40,625 2.190 to 7.200 ---------- -----------------\nOptions outstanding - March 31, 1995 245,175 $ 2.190 to 11.00 ========== =================\nOptions exercisable:\nMarch 31, 1995 104,872 $ 2.190 to 7.200 ========== =================\nMarch 31, 1994 64,753 $ 2.738 to 9.000 ========== =================\nOn October 12, 1994, 18,750 shares of common stock of the Company were reserved for sale to a private individual as consideration for a loan obtained in connection with the acquisition of The Fuller Brush Company. This option was granted at an option price of $8.80 (as adjusted for the five for four stock split). This option is exercisable at any time through October 12, 1997, on which date the option expires.\nOn October 12, 1994, 18,750 shares of common stock of the Company were reserved for sale to J. E. Sheehan & Company, Inc. under a stock option, granted at an option price of $8.80 (as adjusted for the five for four stock split), exercisable at any time through October 12, 1997, at which time the option expires. The Company continues to reserve 26,251 common stock shares under a June, 1990, stock option, at an option price of $6.048 per share (as adjusted for the five for four stock split and the 5% June, 1993, stock dividend) which is exercisable at any time through June 13, 1997, on which date the option expires.\nOn June 13, 1991, 6,563 shares of common stock of the Company were reserved for sale to an outside director of the Company under a stock option. This option was granted at an option price of $5.428 per share, (the fair market value as of the date the option was granted, as adjusted for the five for four stock split and the 5% stock dividend). This option is exercisable at any time through June 13, 1996, on which date the option expires.\n6 - SHAREHOLDERS' EQUITY - CONTINUED --------------------\nThere have been no charges to income in any of the three years in connection with these options other than incidental expenses related to issuance of options.\nEmployee Benefits - -----------------\nOn April 13, 1994, the Company entered into a deferred compensation agreement with an executive officer of the Company pursuant to which 18,750 shares (post- split) of the Company's $.01 par value common stock were issued subject to certain conditions and restrictions. For the year ended March 31, 1995, 6,250 shares vested and were recognized as expense. The expense relating to the remaining 12,500 shares will be recognized over a five year period as it is earned, at which time the restrictions will lapse. Total expense recognized for the year ended March 31, 1995, was $81,875. The unearned balance, which has been grouped with additional paid-in capital, amounted to $112,500.\nOn November 18, 1994, in connection with the issuance of incentive stock options, the Board of Directors awarded 12,187 shares (post-split) of the Company's $.01 par value common stock as `restricted performance shares'' to\ncertain employees pursuant to the 1994 Executive Long-Term Stock Investment Plan. Restrictions on these shares will lapse over a five year period, if performance objectives have been met during the period. Shares may be forfeited if their related incentive stock options are exercised. At March 31, 1995, the unearned balance, which has been grouped with additional paid-in capital, amounted to $127,388. The expense recognized for the year ended March 31, 1995, was not significant.\nThe Company maintains a contributory profit sharing plan [401(k)] for the benefit of substantially all employees. Contributions to the plan may be made for each plan year in such amounts as the Board of Directors may, at its discretion, determine. In addition, the Company will also match to a maximum of 3% of the participant's compensation each contribution made by a plan participant for the plan year in an amount equal to $.50 for each $1.00 of participant contribution. A participant may contribute up to 15% of compensation to the plan. The amount charged to expense in connection with this plan was $125,000, $113,000, and $121,000 for the years ended March 31, 1995, 1994 and 1993, respectively.\n7 - PROVISION FOR INCOME TAX EXPENSE --------------------------------\nThe provision for income taxes is summarized as follows: 1995 1994 1993 ---- ---- ----\nCurrent tax expense: Federal $ 2,000,000 $ 1,427,000 $ 1,513,000 State 443,000 221,000 217,000 ------------ ------------ ------------\n2,443,000 1,648,000 1,730,000 Deferred taxes (benefit): Federal (318,000) (45,000) (92,000) State (47,000) (7,000) ------------ ------------ ------------\n(365,000) (52,000) (92,000) $ 2,078,000 $ 1,596,000 $ 1,638,000 ============ ============ ============\n7 - PROVISION FOR INCOME TAX EXPENSE - CONTINUED --------------------------------\nThe differences between the provision for income taxes and income taxes computed using the U.S. federal income tax rate are as follows: 1995 1994 1993 ---- ---- ----\nIncome tax expense using statutory rates $1,791,000 $1,436,000 $1,417,000\nState income tax effect 261,000 141,000 143,000\nOther items, net 26,000 19,000 78,000 ---------- ---------- ----------\n$2,078,000 $1,596,000 $1,638,000 ========== ========== ==========\nTemporary differences and carryforwards which give rise to a significant portion of deferred tax assets and liabilities at March 31, 1995 and 1994 are as follows:\nMarch 31, 1995 March 31, 1994 -------------- --------------\nDeferred tax assets: Current: Accounts receivable $ 188,000 $ 172,000 Inventory 352,000 109,000 Other 190,000 37,000 ---------- ----------\n730,000 318,000 Noncurrent: Property, plant and equipment 1,000 Other 15,000 Deferred compensation 106,000 106,000 Net operating loss carryforwards 120,000 ---------- ----------\n121,000 227,000 Valuation allowance (120,000) ---------- ----------\n851,000 425,000 Deferred tax liabilities: Noncurrent: Property, plant and equipment (44,000) Other (17,000) ---------- ----------\n(61,000) ---------- ----------\nTotal $ 790,000 $ 425,000 ========== ==========\nDuring the year ended March 31, 1995, the Company utilized its remaining net operating loss carryforwards related to its foreign subsidiaries to offset the taxable income of the applicable foreign subsidiary.\nThe Company has not provided for U.S. taxes on the undistributed earnings of foreign subsidiaries that are considered to be reinvested indefinitely. Calculation of the unrecognized deferred tax liability for temporary differences related to these earnings is not practicable.\n8 - COMMITMENTS -----------\nEnvironmental Contingency - -------------------------\nIn connection with the Fuller Brush acquisition, certain environmental contamination issues were discovered at the Great Bend, Kansas facility during the due diligence process. As a result of findings generated by environmental assessments of the facility, the Seller and the Department of Health and Environment of the State of Kansas entered into a Consent Order pursuant to which the Seller developed and submitted for the Department's approval, a comprehensive work plan for remediation of the environmental problems at the site. Upon the approval of its work plan by the Department, the Seller will undertake the remediation called for in the work plan.\nThe Consent Order does not apply, by its terms, to The Fuller Brush Company, Inc. as the new purchaser of the assets of the Seller as long as the Seller is performing its obligations under the Consent Order. Estimates of the costs of the remediation as set forth in the work plan submitted by the Seller range from $150,000 to $200,000. In order to secure the performance of such obligations by the Seller and to provide a fund from which the costs of the required\nremediation are to be paid, the Company and the Seller established a cash escrow account in the total amount of $700,000, the first $250,000 of which was provided by the Seller, with the balance provided by the Company.\nLease Agreements - ----------------\nThe Company leases certain facilities under operating leases which expire at various dates through 2001. Some of the leases contain renewal options. Rent expense for the years ended March 31, 1995, 1994 and 1993 was $1,103,000, $855,000, and $943,000, respectively.\nThe above leases have been classified as operating leases in accordance with the provisions of the Statement of Financial Accounting Standards No. 13. The future minimum rental payments required under the leases for the fiscal years ended subsequent to March 31, 1995 are as follows:\n1996 $ 1,334,176 1997 1,027,012 1998 810,118 1999 398,292 2000 184,773 Thereafter 162,912 ------------\n$ 3,917,283 ============\n9 - SEGMENT INFORMATION -------------------\nBusiness Segments - -----------------\nPrior to the acquisition of Fuller, the Company classified its operations into one industry segment -- the manufacture and sale of prepackaged chemical formulations, supplies, and equipment systems to the imaging industry. Following the acquisition of Fuller and the signing of the Stanley Home Products license agreement, the Company has added a new segment for financial reporting purposes. In addition to the Imaging segment, the Company also operates in the Cleaning and Personal Care Products segment which includes specialty chemical cleaning products and related accessories (brushes, brooms, mops) for industrial and consumer use, as well as personal products such as soaps, shampoos, and skin care. The products of each segment are manufactured and marketed both in the U.S. and in other parts\n9 - SEGMENT INFORMATION - CONTINUED -------------------\nof the world. Sales between segments are not material. Information concerning the Company's business segments for 1995, 1994 and 1993 are as follows:\nOperating income represents net sales less operating expenses and excludes minority interest, interest expense, and income taxes.\nGeographic Segment - ------------------\nForeign operations are located in Belgium, Italy, and Venezuela. Included in consolidated net income are foreign currency transaction losses of $41,000, $125,000, and $43,000, realized during fiscal 1995, 1994, and 1993, respectively. Information concerning the Company's foreign operations after translation into U.S. dollars are summarized as follows for fiscal years ended March 31: 1995 1994 1993 ---- ---- ----\nNet sales: United States $ 52,345,205 $ 37,731,242 $ 34,474,232 Foreign 6,284,820 6,066,921 5,396,968 ------------- ------------ ------------\n$ 58,630,025 $ 43,798,163 $ 39,871,200 ============= ============ ============\nOperating income (loss): United States $ 5,801,070 $ 4,299,998 $ 4,608,354 Foreign 179,723 273,390 (166,122) ------------- ------------ ------------\n$ 5,980,793 $ 4,573,388 $ 4,442,232 ============= ============ ============\nIdentifiable assets: United States $ 43,069,211 $ 21,077,713 $ 16,962,232 Foreign 5,925,250 5,942,957 6,065,436 ------------- ------------ ------------\n$ 48,994,461 $ 27,020,670 $ 23,027,668 ============= ============ ============\n9 - SEGMENT INFORMATION - CONTINUED -------------------\nOperating income excludes minority interest in consolidated foreign subsidiary, interest expense (income) net, and income tax expense. Foreign interest expense for the years ended March 31, 1995, 1994 and 1993 amounted to $125,877, $156,259, and $188,687, respectively. Identifiable assets are those assets employed in an area's operations, including an allocated value to each area of cost in excess of net assets acquired. Inter-area transfers are not material.\nIn addition, the Company's U.S. operations had total export sales for the years ended March 31, 1995, 1994 and 1993 of $2,902,395, $2,244,766, and $1,891,853, respectively.\n10 - QUARTERLY FINANCIAL DATA (UNAUDITED) ------------------------------------\nThe following table sets forth the unaudited quarterly results of operations for each of the fiscal quarters in the years ended March 31, 1995 and 1994:\nAs described in Note 6, per share income for each of the quarters has been restated to reflect the five for four common stock split. Amounts above reflect what per share income, primary, and fully diluted would have been with and without the impact of this stock split.\nPART III --------\nITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT --------------------------------------------------\nCertain information concerning the directors and executive officers of the Company is incorporated by reference to the caption \"Directors and Executive Officers\" in the Proxy Statement of the Company, dated June 23, 1995, (the \"1995 Proxy Statement\").\nIn addition to the executive officers named in the Proxy Statement, the Registrant employs the following key persons:\nBRIAN C. BARBO, age 38, is Vice President and General Manager of Trebla Chemical Company, and has served in that capacity since October 1988. He was formerly Manager of Manufacturing for Trebla Chemical Co. Mr. Barbo, a chemical engineer, has been with the Company since July 1979.\nPEDRO P. BONILLA, age 43, was named President of Trebla Chemical Company on April 24, 1995, and has also served as acting President of Allied Diagnostic Imaging Resources, Inc. since October 1994. Mr. Bonilla joined Trebla in February, 1993 as Vice President, Latin America\/Caribbean. Prior to joining Trebla, Mr. Bonilla was previously General Manager of Technolab in Santo Domingo, and more recently as an independent consultant in Florida and the Caribbean. In this capacity, he also represented Trebla as an independent representative to these territories.\nJ. ROBERT DUDIK, age 63, is President of Allied's Dental Division, a position he assumed in January, 1990. He was formerly Vice President of the Dental Division (1988-90), and, prior to that, National Sales Manager. Mr. Dudik has been an employee of Allied since 1982 and serves on the Board of Directors of Allied Diagnostic Imaging Resources, Inc.\nFRANK J. MANFRE, age 38, is currently Vice President of Sales and Marketing for Allied Diagnostic Imaging Resources, Inc., a position he has held since May 1993. Mr. Manfre has been with CPAC, Inc. since 1984, formerly serving as Operations Manager, then General Manager, for the Equipment Group, Director of Marketing Communications for PRS, and PRS Northeast Regional Sales Manager.\nTHOMAS F. RIORDEN, President, PRS, Inc., is 51 years old and has served in that position since May 1988. Prior to that he served as PRS Vice President, Chemical Sales. Mr. Riorden also serves on the Board of Directors for both the CPAC Equipment Group and PRS, Inc. As President of PRS, Mr. Riorden is responsible for the coordination of nationwide sales activities for all products, exclusive of dental, medical and graphics chemistry, presently being marketed by the Company. He has been with CPAC since 1979.\nEDWARD E. SCHILLER, 48, is Vice President and Technical Director for Trebla Chemical Company, a position he has held since February, 1985. From May, 1982 to January, 1985, he was Operations Manager at Trebla Chemical Co. Mr. Schiller is currently responsible for all research and development for CPAC, Inc. and its subsidiaries; he is also responsible for the technical service representatives at Trebla Chemical Company, and is the Registrant's Environmental Compliance Officer.\nERNEST E. THOMPSON III, age 43, joined the Company in 1974. He was named Vice President of Sales and Marketing for CPAC Equipment Division in March, 1994. Formerly, he served as International Sales Manager for PRS, Inc., and\nService Manager for the CPAC Equipment Division. Mr. Thompson started his career with CPAC as an R & D Chemist.\nITEM 11. EXECUTIVE COMPENSATION ----------------------\nInformation regarding executive compensation is incorporated by reference to the caption \"Executive Compensation\" in the 1995 Proxy Statement.\nITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT --------------------------------------------------------------\nThe stock ownership of each person known to CPAC to be the beneficial owner of more than 5% of its Common Stock and the stock ownership of all directors and officers of CPAC as a group are incorporated by reference to the caption \"Security Ownership of Certain Beneficial Owners and Management\" in the 1995 Proxy Statement. The beneficial ownership of CPAC Common Stock of all directors of the Company is incorporated by reference to the caption \"Security Ownership of Certain Beneficial Owners and Management\" in the 1995 Proxy Statement.\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ----------------------------------------------\nInformation regarding certain relationships and related transactions is incorporated by reference to the caption \"Information About The Board and Its Committees\" in the 1995 Proxy Statement.\nPART IV -------\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K ----------------------------------------------------------------\n(a)The following financial statements of the Registrant are included as part of the report:\n1.FINANCIAL STATEMENTS: --------------------\nReport of Independent Accountants\nConsolidated Balance Sheets as of March 31, 1995 and 1994\nConsolidated Statements of Operations for the Years Ended March 31, 1995, 1994, and 1993\nConsolidated Statements of Changes in Shareholders' Equity for the Years Ended March 31, 1995, 1994, and 1993\nConsolidated Statements of Cash Flows for the Years Ended March 31, 1995, 1994, and 1993\nNotes to Consolidated Financial Statements\n2.FINANCIAL STATEMENT SCHEDULES: -----------------------------\nSchedule II, Valuation and Qualifying Accounts and Reserves\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.\n(b) Reports on Form 8-K -------------------\n1.On January 30, 1995, the Company filed a Current Report (Form 8-K) reporting the signing of a Licensing Agreement with Stanhome Inc. of Westfield, Massachusetts, pursuant to which the Company acquired the exclusive right to manufacture, sell, advertise, and distribute the home care and personal care products of Stanhome's U.S. Direct Selling Division, known as ``Stanley Home Products.''\n2.On March 31, 1995, the Company filed Amendment No. 1 to its January 30, 1995, Current Report on Form 8-K(A) to provide certain financial statements as required by Form 8-K, Items 7(A) and 7 (B) with respect to the Stanhome Licensing Agreement.\nITEM 14. FINANCIAL STATEMENT SCHEDULE SCHEDULE II ----------------------------\nCPAC, INC. ----------\nVALUATION AND QUALIFYING ACCOUNTS AND RESERVES ----------------------------------------------\nFOR THE FISCAL YEARS ENDED MARCH 31, 1995, 1994 AND 1993 --------------------------------------------------------\nBALANCE AT BALANCE BEGINNING AT END OF OF PERIOD ADDITIONS DEDUCTIONS PERIOD --------- --------- ---------- ------\n1995: Allowance for doubtful accounts $ 509,000 $ 454,000 $ (362,000) $ 601,000 Inventory reserve 252,000 608,000 (96,000) 764,000\n1994: Allowance for doubtful accounts $ 528,000 $ 396,000 $ (415,000) $ 509,000 Inventory reserve 152,000 110,000 (10,000) 252,000\n1993: Allowance for doubtful accounts $ 251,000 $ 328,000 $ (51,000) $ 528,000 Inventory reserve 171,000 77,000 (96,000) 152,000\nEXHIBIT INDEX -------------\nExhibit Page - ------- ----\n2. Plan of acquisition, reorganization, arrangement, liquidation, or succession\n2.2 Licensing Agreement with Stanhome Inc. incorporated by reference to Form 8-K (Current Report) filed January 30, 1995 N\/A\n3. Articles of Incorporation, By-Laws\n3.1 Certificate of Incorporation, as amended, incorporated by reference to Form 10-K, filed for period ended March 31, 1989 N\/A\n3.2 By-laws, as amended, incorporated by reference to Form 10-K, filed for period ended March 31, 1989 N\/A\n4. Instruments defining the rights of security holders, including indentures\n4.1 Loan Agreement dated February 9, 1994, and Letter of Commitment dated December 16, 1993, incorporated by reference to Form 10-K filed for period ended March 31, 1994, as amended by Exhibits 99.1 to 99.3 filed as Exhibits to the Form 10-Q for the quarter ended December 31, 1994. N\/A\n9. Voting Trust Agreement N\/A\n10. Material Contracts N\/A\n11. Statement re: Computation of Per Share Earnings (Loss) N\/A\n12. Statement re: Computation of Ratios N\/A\n13. Annual Report to Security Holders N\/A\n16. Letter re: Change of Certifying Accountant N\/A\n18. Letter re: Change in Accounting Principles N\/A\n21. Subsidiaries of the Registrant\n21.1 Subsidiaries of the Registrant 44\n22. Published report regarding matters submitted to vote of security holders N\/A\n23. Consent of Experts and Counsel\n23.1 Consent of Coopers & Lybrand L.L.P. 45\n24. Power of Attorney N\/A\n27. Financial Data Schedule 46\n28. Information from reports furnished to state insurance regulatory authorities N\/A\n99. Additional Exhibits N\/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.\nCPAC, INC.\nDate June 27, 1995 By \/s\/ Thomas N. Hendrickson ---------------------------- ------------------------------ Thomas N. Hendrickson, 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 June 27, 1995 By \/s\/ Thomas N. Hendrickson ---------------------------- ------------------------------ Thomas N. Hendrickson, President, Chief Executive Officer, Treasurer, and Director\nDate June 27, 1995 By \/s\/ Robert Oppenheimer ---------------------------- ------------------------------ Robert Oppenheimer, Secretary and Director\nDate June 27, 1995 By \/s\/ Robert C. Isaacs ---------------------------- ------------------------------ Robert C. Isaacs, Senior Vice President and Director\nDate June 27, 1995 By \/s\/ Seldon T. James, Jr. ---------------------------- ------------------------------ Seldon T. James, Jr., Director\nDate June 27, 1995 By \/s\/ John C. Burton ---------------------------- ------------------------------ John C. Burton, Director\nDate June 27, 1995 By \/s\/ Thomas J. Weldgen ---------------------------- ------------------------------ Thomas J. Weldgen Chief Financial Officer\nDate June 27, 1995 By \/s\/ Wendy F. Clay ---------------------------- ------------------------------ Wendy F. Clay Vice President, Administration","section_6":"","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND ---------------------------------------------------------------\nRESULTS OF OPERATIONS ---------------------\nLIQUIDITY AND CAPITAL RESOURCES -------------------------------\nThe Company uses a variety of measures of liquidity for internal management purposes. These measures include working capital, asset turnover, profitability and leverage ratios which are set forth below. Internally, review of these ratios on a quarterly and annual basis allows management to set and measure goals for performance by the various operations of the Company. These ratios, on a consolidated basis, help to measure the Company's ability to meet its short-term obligations and are a part of the loan covenants with our primary lending institution.\nWORKING CAPITAL RATIOS - ----------------------\nWorking capital is the excess of current assets over current liabilities. The working capital ratio is calculated by dividing current assets by current liabilities.\nFor the Years Ended March 31, -----------------------------\n1995 1994 1993 ---- ---- ---- Working capital (in thousands) $16,074.1 $13,296.8 $12,589.7\nWorking capital ratio 2.4 to 1 3.2 to 1 3.5 to 1\nThe Company's acquisition of The Fuller Brush Company (Fuller) was financed in part under a new $2.5 million term loan agreement which calls for 50 fixed monthly payments including principal and interest at 9.65% per year. At the same time, added working capital financing was made available through an amendment and modification to the existing promissory note agreement for the revolving line of credit facility. This amendment increased the available line of credit from $3 million to $4.5 million with interest at prime plus one- quarter of one percent (0.025%). The maturity date of this agreement was extended from August 31, 1995, to October 31, 1996. The agreement contains a variety of covenants, including specific working capital and net worth covenants, which are customary in such a credit facility. At March 31, 1995, there was $1,516,155 outstanding under this line of credit and the Company was in compliance with the covenants or appropriate waivers were obtained.\nAdditional financing for the Fuller acquisition was obtained through an unsecured loan of $1 million from a private individual, requiring repayment on the first anniversary. This new short-term debt, coupled with the current portion of the new-term debt, is primarily responsible for the decline in the working capital ratio at March 31, 1995.\nIn addition, the Company has a line of credit facility with a major Belgian bank. As of March 31, 1995, the Company has the full available amount (approximately $886,000) outstanding against this line, to finance the Company's investment in CPAC Europe.\nManagement believes that the existing available lines of credit and cash flows from operations should be adequate to meet normal working capital needs based on operations as of March 31, 1995. The addition of Stanley Home Products (SHP) sales as of April 1, 1995, coupled with plans to take on production of various SHP items during the 1996 fiscal year, may result in the need for additional equipment to be installed in Great Bend and may result in the need for additional working capital. Management will continue to evaluate the need for new or increased financing during the 1996 fiscal year.\nASSET TURNOVER RATIOS - ---------------------\nFor the Years Ended March 31, -----------------------------\n1995 1994 1993 ---- ---- ----\n(1) Receivables-days outstanding 77.1 days 81.6 days 64.1 days\n(2) Annual inventory turns 3.3 times 3.3 times 3.3 times\nThe number of days outstanding can be attributed to:\na. the continued expanded use of dealers with extended payment terms;\nb. the general economic and competitive domestic sales environment, particularly in the medical chemistry market of the Imaging segment; and\nc. the increasing volume of foreign sales in the Imaging segment which generally have payment terms of 60 to 90 days.\nAt March 31, 1995, the decline in days outstanding results from the inclusion of The Fuller Brush Company receivables since October 13, 1994, which generally have short-term payment terms. On a consolidated basis, days outstanding should continue to improve as Fuller sales increase and SHP cash sales enter the formula in fiscal 1996.\nInventory turns remained stable for the periods presented.\nPROFITABILITY RATIOS - --------------------\nReturn on net sales is the result of dividing operating income by net sales. Net income on net sales is calculated by dividing net income by net sales. Net income to net worth is calculated by dividing net income by the amount of shareholders' equity.\nFor the Years Ended March 31, -----------------------------\n1995 1994 1993 ---- ---- ----\nReturn on net sales 10% 10% 11%\nNet income on net sales 5% 6% 6%\nNet income to net worth 14% 16% 17%\nThe decrease in these ratios from 1995 versus 1994 is primarily the result of the addition of $3,360,000 of equity issued in connection with the acquisition of The Fuller Brush Company. Also, continuing pressure on pricing and margins at Allied in the medical chemistry industry negatively impacted the ratio of net income on net sales. Management has invested almost $800,000 in new manufacturing equipment at Allied to help improve operating and production efficiency and hold these margins in the next fiscal year.\nThe decrease in these ratios in 1994 versus 1993 was primarily the result of the sudden bankruptcy of a major dental customer, as previously reported to Shareholders.\nLEVERAGE RATIOS - ---------------\nDebt to debt-plus-equity is calculated by dividing all liabilities by the sum of all liabilities plus shareholders' equity. Total debt to equity is calculated by dividing all liabilities by the amount of shareholders' equity.\nThese ratios measure the extent to which the Company has been financed by debt and are an important measure to our lending institution.\nFor the Years Ended March 31, -----------------------------\n1995 1994 1993 ---- ---- ----\nDebt to debt-plus-equity 54% 40% 37%\nTotal debt to equity 1.16 to 1 0.7 to 1 0.6 to 1\nThe increase in these ratios at March 1995 versus 1994 is primarily the result of the acquisition of The Fuller Brush Company and the related debt necessary to finance this acquisition coupled with the addition of $3,360,000 of equity, as previously disclosed.\nThe change in these ratios at March 31, 1994, versus 1993 was primarily the result of the new mortgage in connection with the purchase of the Trebla building in October 1993, and increased borrowings on the domestic line of credit.\nRESULTS OF OPERATIONS --------------------- Prior to the acquisition of The Fuller Brush Company, the Company classified its operations into one industry segment -- the manufacture and sale of prepackaged chemical formulations, supplies, and equipment systems to the imaging industry. Following the acquisition of Fuller and the signing of the Stanley Home Products license agreement, the Company has added a new segment for financial reporting purposes. In addition to the Imaging segment, the Company also operates in the Cleaning and Personal Care Products segment which includes specialty chemical cleaning products and related accessories (brushes, brooms, mops) for industrial and consumer use, as well as personal products such as soaps, shampoos, and skin care. The products of each segment are manufactured and marketed both in the U.S. and in other parts of the world. Sales between segments are not material.\nNET SALES AND NET INCOME - ------------------------\nThe Company's net sales increased from fiscal year end March 31, 1994, to fiscal year end March 31, 1995, by 34%; March 31, 1993, to fiscal year end March 31, 1994, by 10%; and March 31, 1992, to fiscal year end March 31, 1993, by 23%.\nSales increased by 6% for the Imaging segment overall, and the remaining sales increase is a result of the addition of $12 million of sales from Fuller in Cleaning and Personal Care Products since October 13, 1994.\nTrebla Chemical has continued to expand market penetration despite extreme pressure on prices. Successful expansion of the domestic independent dealer network and increased foreign sales helped to achieve an increase in sales of 8% in 1995. The rate of sales growth at Allied Diagnostic has been reduced as a result of very competitive pricing pressure, as well as the consolidation taking place within the medical industry.\nNet sales from our combined foreign operations have grown at approximately 4% for the fiscal year 1995.\nThe impact of acquisitions and growth in sales volume for the three years since 1992, coupled with an emphasis on controlling expenses, has increased net income by 80%, from $1,773,457 in fiscal 1992, to $3,188,924 in fiscal 1995.\nFOREIGN OPERATIONS - ------------------\nWhile the economies of Italy and Belgium have been suffering from serious general economic slowdowns, sales volumes of CPAC subsidiaries in these countries have improved and market share is increasing.\nThe political situation in Venezuela and Italy continues to be very unstable, and management therefore continues to be concerned about the short- term operating results. It is difficult to predict the economic situation at these foreign locations, but at the present time, management expects the combined foreign operations to show continued modest growth for the 1996 fiscal year.\nThe Company has exposure to currency fluctuations and has utilized conservative hedging programs (primarily forward foreign currency exchange contracts), to help minimize the impact of these fluctuations on results of operations. The Company does not hold or issue derivatives for trading purposes and is not a party to leveraged derivatives transactions. The acquisition of Chimifoto increased the potential financial statement exposure to currency fluctuations. Although the Italian lira has been erratic, it has settled into a more stable range over the past fiscal year. On a consolidated basis, foreign currency exchange losses are not material to the results of operations.\nGROSS MARGINS - ------------- Gross margins (net sales less cost of sales expressed as a percentage of net sales), were 41%, 40%, and 40% for the years ended March 31, 1995, 1994, and 1993, respectively.\nConsolidated gross margins continued relatively stable from 1993 to 1995. Improvements in margins at Trebla, CPAC Europe, and Chimifoto were offset by lower margins at Allied as a result of the continuing market competition in medical chemistry. The addition of Fuller has also contributed to consolidated margin improvement.\nSELLING, ADMINISTRATION AND ENGINEERING EXPENSES - ------------------------------------------------\nThis category amounted to 30.3%, 29.4%, and 28.5% of net sales in fiscal years 1995, 1994, and 1993, respectively.\nThe increase in 1995 versus 1994 is primarily the result of increased marketing expenditures related to the medical chemistry market, as well as the inclusion of Fuller's expenses since the acquisition date.\nThe increase in 1994 versus 1993 was primarily attributable to the $317,000 charge to bad debts arising from the sudden bankruptcy of a major dental customer, as previously reported.\nRESEARCH AND DEVELOPMENT EXPENSES - ---------------------------------\nFrom inception, the Company has engaged in research and development activities in the Imaging segment with the primary goal of improving existing products. In addition, the Company has engaged in research of new compatible products and responds to customer needs as necessary. There were no significant changes in this area during fiscal 1995 with expense increasing approximately 4%. Research and development in Cleaning and Personal Care Products since October, 1994, accounts for the majority of the increased expenses in 1995 versus 1994.\nINTEREST EXPENSE - ----------------\nThe increase in interest expense at March 31, 1995, versus 1994 is primarily the result of increased borrowings on the NationsBank line of credit, the new term loan, Industrial Revenue Bonds, and other debt assumed in connection with the Fuller acquisition, coupled with higher interest rates.\nThe increase in interest expense at March 31, 1994, versus 1993 is primarily the result of increased borrowings on the NationsBank line of credit and the new mortgage on the Trebla manufacturing facility.\nAs a result of the issuance of 616,000 shares of treasury stock in a private placement during February 1992, the Company raised approximately $3,600,000 of net additional capital. This capital increase provided the Company with additional funds to finalize the acquisitions of Fotoprocesos de Venezuela C.A. (Fotus) and Chimifoto Ornano S.p.A. In addition, the funds provided additional working capital for operations while helping to control interest expense in 1993 versus 1992 by minimizing the need for borrowings against the NationsBank line of credit. Subsequent to the acquisition of Fotus, the Company re-negotiated a significant portion of the short and long-term bank financing in South America and was also able to reduce Fotus' interest expenses during fiscal 1993.\nIMPACT OF INFLATION - -------------------\nDue to increased competitive sales pressure, the Company has not been able to pass on all inflation related cost increases in the Imaging segment. However, the adverse impacts of inflation have been partially offset through productivity improvements and cost cutting efforts. Inflation has generally not had an adverse impact on Cleaning and Personal Care Products.\nENVIRONMENTAL CONTINGENCY - -------------------------\nIn connection with the Fuller Brush acquisition, certain environmental contamination issues were discovered at the Great Bend, Kansas facility during the due diligence process. As a result of findings generated by environmental assessments of the facility, the Seller and the Department of Health and Environment of the State of Kansas entered into a Consent Order pursuant to which the Seller developed and submitted for the Department's approval, a comprehensive work plan for remediation of the environmental problems at the site. Upon the approval of its work plan by the Department, the Seller will undertake the remediation called for in the work plan.\nThe Consent Order does not apply, by its terms, to The Fuller Brush Company, Inc. as the new purchaser of the assets of the Seller as long as the Seller is performing its obligations under the Consent Order. Estimates of the costs of the remediation as set forth in the work plan submitted by the Seller range from $150,000 to $200,000. In order to secure the performance of such obligations by the Seller and to provide a fund from which the costs of the required remediation are to be paid, the Company and the Seller established a cash escrow account in the total amount of $700,000, the first $250,000 of which was provided by the Seller, with the balance provided by the Company.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA -------------------------------------------\nREPORT OF INDEPENDENT ACCOUNTANTS ---------------------------------\nBoard of Directors and Shareholders CPAC, Inc. and Subsidiaries\nWe have audited the consolidated financial statements and the financial statement schedule of CPAC, Inc. and Subsidiaries listed in Item 14 (a) 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 CPAC, Inc. and Subsidiaries as of March 31, 1995 and 1994, and the consolidated results of their operations and their cash flows for each of the three years in the period ended March 31, 1995, 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.\n\/s\/ Coopers & Lybrand L.L.P. COOPERS & LYBRAND L.L.P.\nRochester, New York June 2, 1995\n1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ------------------------------------------\nBasis of Consolidation - ----------------------\nThe consolidated financial statements of CPAC, Inc., and Subsidiaries (\"the Company\") include the accounts of the Company and its wholly-owned subsidiary companies and its 98% owned subsidiary, (CPAC Europe, N.V.). The Company's foreign subsidiaries are included in the consolidated financial statements utilizing a December 31 fiscal year to facilitate prompt reporting of financial results. All significant intercompany accounts and transactions have been eliminated.\nInventory - ---------\nInventory is stated at the lower of cost, on a first-in, first-out basis, or market.\nProperty, Plant and Equipment - -----------------------------\nProperty, plant and equipment are stated at cost and are depreciated over their estimated useful lives on the straight-line and accelerated methods. Leasehold improvements are amortized over the shorter of the lease period or the expected useful lives of the improvements using the straight-line method. At the time of retirement or other disposition of property, the cost and accumulated depreciation are removed from the accounts and any gain or loss is reflected in income.\nResearch and Development - ------------------------\nThe Company charges research and development expenditures to income as incurred.\nForeign Currency Translation - ----------------------------\nAll assets and liabilities of the Company's wholly-owned and majority-owned foreign subsidiaries are translated at year end exchange rates. Translation gains and losses are not included in determining net income, but are accumulated as a separate component of shareholders' equity. Foreign currency transaction gains and losses are included in the determination of net income.\nIncome Per Common Share - -----------------------\nPrimary and fully diluted income per common share are computed based on the weighted average number of common shares outstanding, including the shares issuable upon the exercise of the common stock options as required by the \"treasury stock\" method. Weighted average shares outstanding as of March 31, 1995, 1994 and 1993 have been restated to reflect the five for four common stock split declared on November 18, 1994 (See Note 6). The weighted average number of common shares outstanding is:\n1995 1994 1993 ---- ---- ----\nPrimary 4,189,990 3,896,755 3,892,763 ========= ========= =========\nFully diluted 4,197,166 3,908,089 3,896,595 ========= ========= =========\n1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED ------------------------------------------\nStatements of Cash Flows - ------------------------\nFor purposes of the statements of cash flows, the Company considers marketable securities with a maturity of three months or less at the time of purchase to be cash equivalents. The Company paid interest of $679,000, $382,000, and $338,000 in fiscal 1995, 1994 and 1993, respectively. In addition, the Company paid income taxes of $2,283,000, $1,546,000, and $1,573,000 in fiscal 1995, 1994 and 1993, respectively.\nAmortization of Goodwill and Intangible Assets - ----------------------------------------------\nGoodwill and intangible assets are amortized on the straight-line method over periods ranging from five to fifteen years. Cost and related amortization are written off when fully amortized.\nBusiness and Credit Concentrations - ----------------------------------\nThe Company is required by SFAS No. 105, \"Disclosure of Information about Financial Instruments with Off Balance Sheet Risk and Financial Instruments with Concentrations of Credit Risk,\" to disclose significant off balance sheet and credit risk concentrations regardless of the degree of such risk.\nFinancial instruments which potentially subject the Company to concentration of credit risk consist principally of temporary cash investments and trade accounts receivable. The Company places its temporary cash investments with high credit quality financial institutions. The Company's customers are not concentrated in any specific geographic region, but are broadly concentrated in the imaging and cleaning and personal care products industries. In 1995 and 1994, sales to one customer in the Imaging segment amounted to $6,594,000 and $5,099,000, respectively. No single customer accounted for a significant amount of the Company's business during 1993. Concentrations of credit risk with respect to trade receivables are limited due to the large number of domestic and foreign customers comprising the Company's customer base, and their dispersion across several different business sectors participating in different facets of the imaging and cleaning and personal care products industries.\nIncome Taxes - ------------\nOn April 1, 1993, the Company changed its method of accounting for income taxes to comply with the provisions of Statement of Financial Accounting Standards No. 109 - \"Accounting for Income Taxes,\" issued in February, 1992, (SFAS No. 109). The cumulative effect of this change was not material. Therefore, the cumulative effect adjustment has not been separately disclosed in the Statements of Operations for the year ended March 31, 1994. Prior year financial statements were not restated to apply the provisions of SFAS No. 109.\nUnder SFAS No. 109, deferred income taxes are recognized for the tax consequences of \"temporary differences\" by applying enacted statutory tax rates applicable in future years to differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities. It also allows recognition of future tax benefits of net operating loss carryforwards to the extent that realization of such benefits is more likely than not.\n2 - ACQUISITIONS ------------\nOn January 16, 1995, the Company signed an agreement with Stanhome Inc. to license the domestic operations of Stanhome Inc.'s Worldwide Direct Selling Group, known as Stanley Home Products. The agreement allows the Company to manufacture and distribute products through the use of the trademarks and formulas of Stanley Home Products in the U.S., Puerto Rico, and Canada, over the life of the agreement, commencing April 1, 1995; the agreement expires, unless terminated earlier under the terms of the agreement, on March 31, 2010, subject to any extension which may be negotiated between the parties. The agreement also allowed the Company to purchase inventory on a consignment basis through September 30, 1996, and copies of historical business files, current customer and supplier lists, and corresponding databases were obtained. The Company also had the option of purchasing various machinery and equipment at book value, as well as offering employment to various Stanhome Inc. employees. The Company is required to pay Stanhome Inc., royalties equal to an increasing percentage (ranging from 1% in the first year to 7.5% in the last six years) of the net selling price of products sold under the licensing agreement. Based on these terms, at March 31, 1995, the Company has made a preliminary allocation of the purchase price and has recorded a liability equal to the net present value of the estimated minimum royalty payments. In addition, the Company has capitalized the value of the license agreement and will amortize it over the contract period. For purposes of the Statement of Cash Flows, this transaction has been treated as a non-cash transaction. Stanley Home Products will operate as a division of The Fuller Brush Company, Inc. (Fuller), and its sales and related expenses will be included with the results of operations of the Company beginning April, 1, 1995.\nOn October 13, 1994, the Company acquired substantially all of the assets of The Fuller Brush Company, a Kansas corporation, in exchange for payment of $1,719,000 in cash, 300,000 restricted shares of the Company's $.01 par value common stock with a fair market value of $3,360,000, the assumption of certain of Seller's liabilities, and acquisition related costs of $747,000 for a total asset purchase price of approximately $15,883,000. For purposes of the Statement of Cash Flows, the issuance of 300,000 restricted shares has been treated as a non-cash transaction.\nThe acquisition has been accounted for as a purchase transaction. Fuller's results of operations from the October 13, 1994, acquisition date have been consolidated into the financial results for the year ended March 31, 1995.\nThe Company has made a preliminary allocation of purchase price of Fuller based on the estimated respective fair values of the acquired assets and liabilities, and expects to finalize the acquisition accounting during the next fiscal year. The final allocation is not expected to have a significant impact upon the results of operations as previously reported. The preliminary purchase price has been allocated as follows:\nAccounts receivable $ 1,950,000 Inventory 3,593,000 Other current assets 830,000 Property, plant and equipment 9,134,000 Patents and trademarks 25,000 Other long-term assets 351,000 -----------\nTotal assets acquired 15,883,000 Less: Liabilities assumed 10,057,000 -----------\n$ 5,826,000 ===========\n2 - ACQUISITIONS - CONTINUED ------------\nOn a pro forma (unaudited) basis, if the license agreement with Stanhome Inc. and the acquisition of Fuller had occurred as of April 1, 1993, the consolidated results of operations of the Company including Stanley Home Products and Fuller would have been approximately:\nYear-Ended Year-Ended March 31, 1995 March 31, 1994 -------------- --------------\n(unaudited) (unaudited)\nNet sales $107,403,000 $103,103,000 Net income $ 3,247,000 $ 2,235,000 Net income per share $ 0.74 $ 0.52 (both primary and fully diluted)\nThe pro forma information has been prepared on the basis of preliminary assumptions and estimates which are subject to adjustment and may not be indicative of actual or future results. Preliminary, unaudited net sales information for Stanley Home Products during 1995 indicate that sales may be significantly lower than historical levels. The reduction is partially attributable to the peso devaluation which has significantly impacted sales at the United States\/Mexican border, as well as the elimination of credit sales and implementation of an `all cash'' sales term policy. While it is unknown whether these factors will continue to impact the Stanley Home Products' operations during the Company's fiscal 1996 year, it is probable that the proforma sales presented will be reduced.\n3 - INVENTORY ---------\nInventory as of March 31,1995 and 1994 is summarized as follows: 1995 1994 ---- ----\nRaw materials and purchased parts $ 6,036,693 $3,682,467 Work-in-process 708,143 225,272 Finished goods 5,500,090 3,498,509 Promotional supplies 491,402 691,305 ----------- ----------\n$12,736,328 $8,097,553 =========== ==========\n4 - PROPERTY, PLANT AND EQUIPMENT -----------------------------\nProperty, plant and equipment are comprised of the following at March 31: 1995 1994 ---- ----\nLand $ 625,442 $ 463,871 Buildings and improvements 8,163,036 3,176,069 Machinery and equipment 9,586,115 3,634,351 Furniture and fixtures 424,829 254,874 Leasehold improvements 1,065,169 1,009,016 Leased equipment 241,264 56,660 ----------- -----------\n20,105,855 8,594,841 Less: Accumulated depreciation and amortization 4,990,279 3,842,262 ----------- -----------\n$15,115,576 $ 4,752,579 =========== ===========\n5 - DEBT - CONTINUED ----\nThe revolving credit and term loan agreements contain restrictive covenants, the more significant of which relate to indebtedness, net worth, working capital, financial ratios, and cash flow. At March 31, 1995, the Company was in compliance with the covenants or appropriate waivers were obtained.\nAnnual maturities of debt are as follows:\n1997 $2,456,955 1998 1,727,569 1999 787,157 2000 162,407 2001 129,617 Thereafter 6,651,170 ----------\n$11,914,875 ===========\n6 - SHAREHOLDERS' EQUITY --------------------\nStock Split and Dividend - ------------------------\nOn November 18, 1994, the Board of Directors declared a stock split of five shares of CPAC, Inc. common stock for each four shares of stock held by shareholders of record on December 22, 1994, payable on January 12, 1995. Accordingly, since the par value of the common stock remains unchanged, an amount equal to the par value of the additional shares issued has been charged to additional paid-in capital and credited to common stock at March 31, 1995. All earnings per share and weighted average, primary and fully diluted shares outstanding for each of the quarters in the years ended March 31, 1995 and 1994, have been restated to reflect the five for four stock split. Earnings per share for the years ended March 31, 1995, 1994, and 1993 would have been $0.95, $0.84, and $0.81, respectively, without the impact of this five for four stock split.\nOn November 18, 1994, the Company also announced that it had discontinued its cash dividend indefinitely.\nOn April 21, 1993, the Board of Directors declared a 5% stock dividend on the Company's common stock payable June 11, 1993, to shareholders of record as of May 21, 1993. Shareholders received one additional share of stock for each 20 shares held. Accordingly, amounts equal to the fair market value (based on quoted market price, as adjusted) of the additional shares issued, have been charged to retained earnings and credited to common stock and additional paid-in capital at March 31, 1993. Earnings per share and weighted average shares outstanding as of March 31, 1993, were restated to reflect this 5% stock dividend.\nStock Options - -------------\nIn fiscal 1995, shareholders of the Company approved an Executive Long-Term Stock Investment Plan (the Plan) for key employees, which allows issuance of incentive stock options, nonqualified stock options, reload options, and restricted performance shares. As part of the Plan, 350,000 shares of the Company's $.01 par value common stock have been reserved for issuance. Under the Plan, shares of common stock are reserved for issuance to key employees. Upon exercise, an employee granted an option under the Plan may pay for the Company's stock either with cash or with Company stock already owned by the\nemployees, valued at the fair market value of the stock on the exercise date. The term of each option is determined by the Stock Option Committee. On November 18, 1994, the Company issued 48,750 incentive stock options (as adjusted for the five for four stock split), pursuant to the Plan.\n6 - SHAREHOLDERS' EQUITY - CONTINUED --------------------\nBecause `incentive stock options'' constitute a feature of the Plan, the 1991 Employees' Incentive Stock Option Plan was terminated as to the grant of future options thereunder. The termination of the 1991 plan did not have any effect on the remaining options outstanding under this plan. As of March 31, 1995, options outstanding under all plans are summarized as follows:\nOPTION PRICE SHARES PER SHARE ------ ---------\nOptions outstanding - March 31, 1992 104,395 $ 0.833 to 6.905 Exercised (7,000) 0.833 to 6.905 Expired Granted 66,150 7.857 to 8.750 ---------- -----------------\nOptions outstanding - March 31, 1993 163,545 0.833 to 8.750 Exercised (70,805) 0.833 to 7.857 Expired (8,925) 5.238 to 7.857 Granted 97,125 7.938 to 9.000 ---------- -----------------\nOptions outstanding - March 31, 1994 180,940 $ 2.738 to 9.000 Exercised (25,140) 6.350 to 7.938 Expired Granted 48,750 11.00 Stock split 40,625 2.190 to 7.200 ---------- -----------------\nOptions outstanding - March 31, 1995 245,175 $ 2.190 to 11.00 ========== =================\nOptions exercisable:\nMarch 31, 1995 104,872 $ 2.190 to 7.200 ========== =================\nMarch 31, 1994 64,753 $ 2.738 to 9.000 ========== =================\nOn October 12, 1994, 18,750 shares of common stock of the Company were reserved for sale to a private individual as consideration for a loan obtained in connection with the acquisition of The Fuller Brush Company. This option was granted at an option price of $8.80 (as adjusted for the five for four stock split). This option is exercisable at any time through October 12, 1997, on which date the option expires.\nOn October 12, 1994, 18,750 shares of common stock of the Company were reserved for sale to J. E. Sheehan & Company, Inc. under a stock option, granted at an option price of $8.80 (as adjusted for the five for four stock split), exercisable at any time through October 12, 1997, at which time the option expires. The Company continues to reserve 26,251 common stock shares under a June, 1990, stock option, at an option price of $6.048 per share (as adjusted for the five for four stock split and the 5% June, 1993, stock dividend) which is exercisable at any time through June 13, 1997, on which date the option expires.\nOn June 13, 1991, 6,563 shares of common stock of the Company were reserved for sale to an outside director of the Company under a stock option. This option was granted at an option price of $5.428 per share, (the fair market value as of the date the option was granted, as adjusted for the five for four stock split and the 5% stock dividend). This option is exercisable at any time through June 13, 1996, on which date the option expires.\n6 - SHAREHOLDERS' EQUITY - CONTINUED --------------------\nThere have been no charges to income in any of the three years in connection with these options other than incidental expenses related to issuance of options.\nEmployee Benefits - -----------------\nOn April 13, 1994, the Company entered into a deferred compensation agreement with an executive officer of the Company pursuant to which 18,750 shares (post- split) of the Company's $.01 par value common stock were issued subject to certain conditions and restrictions. For the year ended March 31, 1995, 6,250 shares vested and were recognized as expense. The expense relating to the remaining 12,500 shares will be recognized over a five year period as it is earned, at which time the restrictions will lapse. Total expense recognized for the year ended March 31, 1995, was $81,875. The unearned balance, which has been grouped with additional paid-in capital, amounted to $112,500.\nOn November 18, 1994, in connection with the issuance of incentive stock options, the Board of Directors awarded 12,187 shares (post-split) of the Company's $.01 par value common stock as `restricted performance shares'' to\ncertain employees pursuant to the 1994 Executive Long-Term Stock Investment Plan. Restrictions on these shares will lapse over a five year period, if performance objectives have been met during the period. Shares may be forfeited if their related incentive stock options are exercised. At March 31, 1995, the unearned balance, which has been grouped with additional paid-in capital, amounted to $127,388. The expense recognized for the year ended March 31, 1995, was not significant.\nThe Company maintains a contributory profit sharing plan [401(k)] for the benefit of substantially all employees. Contributions to the plan may be made for each plan year in such amounts as the Board of Directors may, at its discretion, determine. In addition, the Company will also match to a maximum of 3% of the participant's compensation each contribution made by a plan participant for the plan year in an amount equal to $.50 for each $1.00 of participant contribution. A participant may contribute up to 15% of compensation to the plan. The amount charged to expense in connection with this plan was $125,000, $113,000, and $121,000 for the years ended March 31, 1995, 1994 and 1993, respectively.\n7 - PROVISION FOR INCOME TAX EXPENSE --------------------------------\nThe provision for income taxes is summarized as follows: 1995 1994 1993 ---- ---- ----\nCurrent tax expense: Federal $ 2,000,000 $ 1,427,000 $ 1,513,000 State 443,000 221,000 217,000 ------------ ------------ ------------\n2,443,000 1,648,000 1,730,000 Deferred taxes (benefit): Federal (318,000) (45,000) (92,000) State (47,000) (7,000) ------------ ------------ ------------\n(365,000) (52,000) (92,000) $ 2,078,000 $ 1,596,000 $ 1,638,000 ============ ============ ============\n7 - PROVISION FOR INCOME TAX EXPENSE - CONTINUED --------------------------------\nThe differences between the provision for income taxes and income taxes computed using the U.S. federal income tax rate are as follows: 1995 1994 1993 ---- ---- ----\nIncome tax expense using statutory rates $1,791,000 $1,436,000 $1,417,000\nState income tax effect 261,000 141,000 143,000\nOther items, net 26,000 19,000 78,000 ---------- ---------- ----------\n$2,078,000 $1,596,000 $1,638,000 ========== ========== ==========\nTemporary differences and carryforwards which give rise to a significant portion of deferred tax assets and liabilities at March 31, 1995 and 1994 are as follows:\nMarch 31, 1995 March 31, 1994 -------------- --------------\nDeferred tax assets: Current: Accounts receivable $ 188,000 $ 172,000 Inventory 352,000 109,000 Other 190,000 37,000 ---------- ----------\n730,000 318,000 Noncurrent: Property, plant and equipment 1,000 Other 15,000 Deferred compensation 106,000 106,000 Net operating loss carryforwards 120,000 ---------- ----------\n121,000 227,000 Valuation allowance (120,000) ---------- ----------\n851,000 425,000 Deferred tax liabilities: Noncurrent: Property, plant and equipment (44,000) Other (17,000) ---------- ----------\n(61,000) ---------- ----------\nTotal $ 790,000 $ 425,000 ========== ==========\nDuring the year ended March 31, 1995, the Company utilized its remaining net operating loss carryforwards related to its foreign subsidiaries to offset the taxable income of the applicable foreign subsidiary.\nThe Company has not provided for U.S. taxes on the undistributed earnings of foreign subsidiaries that are considered to be reinvested indefinitely. Calculation of the unrecognized deferred tax liability for temporary differences related to these earnings is not practicable.\n8 - COMMITMENTS -----------\nEnvironmental Contingency - -------------------------\nIn connection with the Fuller Brush acquisition, certain environmental contamination issues were discovered at the Great Bend, Kansas facility during the due diligence process. As a result of findings generated by environmental assessments of the facility, the Seller and the Department of Health and Environment of the State of Kansas entered into a Consent Order pursuant to which the Seller developed and submitted for the Department's approval, a comprehensive work plan for remediation of the environmental problems at the site. Upon the approval of its work plan by the Department, the Seller will undertake the remediation called for in the work plan.\nThe Consent Order does not apply, by its terms, to The Fuller Brush Company, Inc. as the new purchaser of the assets of the Seller as long as the Seller is performing its obligations under the Consent Order. Estimates of the costs of the remediation as set forth in the work plan submitted by the Seller range from $150,000 to $200,000. In order to secure the performance of such obligations by the Seller and to provide a fund from which the costs of the required\nremediation are to be paid, the Company and the Seller established a cash escrow account in the total amount of $700,000, the first $250,000 of which was provided by the Seller, with the balance provided by the Company.\nLease Agreements - ----------------\nThe Company leases certain facilities under operating leases which expire at various dates through 2001. Some of the leases contain renewal options. Rent expense for the years ended March 31, 1995, 1994 and 1993 was $1,103,000, $855,000, and $943,000, respectively.\nThe above leases have been classified as operating leases in accordance with the provisions of the Statement of Financial Accounting Standards No. 13. The future minimum rental payments required under the leases for the fiscal years ended subsequent to March 31, 1995 are as follows:\n1996 $ 1,334,176 1997 1,027,012 1998 810,118 1999 398,292 2000 184,773 Thereafter 162,912 ------------\n$ 3,917,283 ============\n9 - SEGMENT INFORMATION -------------------\nBusiness Segments - -----------------\nPrior to the acquisition of Fuller, the Company classified its operations into one industry segment -- the manufacture and sale of prepackaged chemical formulations, supplies, and equipment systems to the imaging industry. Following the acquisition of Fuller and the signing of the Stanley Home Products license agreement, the Company has added a new segment for financial reporting purposes. In addition to the Imaging segment, the Company also operates in the Cleaning and Personal Care Products segment which includes specialty chemical cleaning products and related accessories (brushes, brooms, mops) for industrial and consumer use, as well as personal products such as soaps, shampoos, and skin care. The products of each segment are manufactured and marketed both in the U.S. and in other parts\n9 - SEGMENT INFORMATION - CONTINUED -------------------\nof the world. Sales between segments are not material. Information concerning the Company's business segments for 1995, 1994 and 1993 are as follows:\nOperating income represents net sales less operating expenses and excludes minority interest, interest expense, and income taxes.\nGeographic Segment - ------------------\nForeign operations are located in Belgium, Italy, and Venezuela. Included in consolidated net income are foreign currency transaction losses of $41,000, $125,000, and $43,000, realized during fiscal 1995, 1994, and 1993, respectively. Information concerning the Company's foreign operations after translation into U.S. dollars are summarized as follows for fiscal years ended March 31: 1995 1994 1993 ---- ---- ----\nNet sales: United States $ 52,345,205 $ 37,731,242 $ 34,474,232 Foreign 6,284,820 6,066,921 5,396,968 ------------- ------------ ------------\n$ 58,630,025 $ 43,798,163 $ 39,871,200 ============= ============ ============\nOperating income (loss): United States $ 5,801,070 $ 4,299,998 $ 4,608,354 Foreign 179,723 273,390 (166,122) ------------- ------------ ------------\n$ 5,980,793 $ 4,573,388 $ 4,442,232 ============= ============ ============\nIdentifiable assets: United States $ 43,069,211 $ 21,077,713 $ 16,962,232 Foreign 5,925,250 5,942,957 6,065,436 ------------- ------------ ------------\n$ 48,994,461 $ 27,020,670 $ 23,027,668 ============= ============ ============\n9 - SEGMENT INFORMATION - CONTINUED -------------------\nOperating income excludes minority interest in consolidated foreign subsidiary, interest expense (income) net, and income tax expense. Foreign interest expense for the years ended March 31, 1995, 1994 and 1993 amounted to $125,877, $156,259, and $188,687, respectively. Identifiable assets are those assets employed in an area's operations, including an allocated value to each area of cost in excess of net assets acquired. Inter-area transfers are not material.\nIn addition, the Company's U.S. operations had total export sales for the years ended March 31, 1995, 1994 and 1993 of $2,902,395, $2,244,766, and $1,891,853, respectively.\n10 - QUARTERLY FINANCIAL DATA (UNAUDITED) ------------------------------------\nThe following table sets forth the unaudited quarterly results of operations for each of the fiscal quarters in the years ended March 31, 1995 and 1994:\nAs described in Note 6, per share income for each of the quarters has been restated to reflect the five for four common stock split. Amounts above reflect what per share income, primary, and fully diluted would have been with and without the impact of this stock split.\nPART III --------\nITEM 10.","section_9":"","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT --------------------------------------------------\nCertain information concerning the directors and executive officers of the Company is incorporated by reference to the caption \"Directors and Executive Officers\" in the Proxy Statement of the Company, dated June 23, 1995, (the \"1995 Proxy Statement\").\nIn addition to the executive officers named in the Proxy Statement, the Registrant employs the following key persons:\nBRIAN C. BARBO, age 38, is Vice President and General Manager of Trebla Chemical Company, and has served in that capacity since October 1988. He was formerly Manager of Manufacturing for Trebla Chemical Co. Mr. Barbo, a chemical engineer, has been with the Company since July 1979.\nPEDRO P. BONILLA, age 43, was named President of Trebla Chemical Company on April 24, 1995, and has also served as acting President of Allied Diagnostic Imaging Resources, Inc. since October 1994. Mr. Bonilla joined Trebla in February, 1993 as Vice President, Latin America\/Caribbean. Prior to joining Trebla, Mr. Bonilla was previously General Manager of Technolab in Santo Domingo, and more recently as an independent consultant in Florida and the Caribbean. In this capacity, he also represented Trebla as an independent representative to these territories.\nJ. ROBERT DUDIK, age 63, is President of Allied's Dental Division, a position he assumed in January, 1990. He was formerly Vice President of the Dental Division (1988-90), and, prior to that, National Sales Manager. Mr. Dudik has been an employee of Allied since 1982 and serves on the Board of Directors of Allied Diagnostic Imaging Resources, Inc.\nFRANK J. MANFRE, age 38, is currently Vice President of Sales and Marketing for Allied Diagnostic Imaging Resources, Inc., a position he has held since May 1993. Mr. Manfre has been with CPAC, Inc. since 1984, formerly serving as Operations Manager, then General Manager, for the Equipment Group, Director of Marketing Communications for PRS, and PRS Northeast Regional Sales Manager.\nTHOMAS F. RIORDEN, President, PRS, Inc., is 51 years old and has served in that position since May 1988. Prior to that he served as PRS Vice President, Chemical Sales. Mr. Riorden also serves on the Board of Directors for both the CPAC Equipment Group and PRS, Inc. As President of PRS, Mr. Riorden is responsible for the coordination of nationwide sales activities for all products, exclusive of dental, medical and graphics chemistry, presently being marketed by the Company. He has been with CPAC since 1979.\nEDWARD E. SCHILLER, 48, is Vice President and Technical Director for Trebla Chemical Company, a position he has held since February, 1985. From May, 1982 to January, 1985, he was Operations Manager at Trebla Chemical Co. Mr. Schiller is currently responsible for all research and development for CPAC, Inc. and its subsidiaries; he is also responsible for the technical service representatives at Trebla Chemical Company, and is the Registrant's Environmental Compliance Officer.\nERNEST E. THOMPSON III, age 43, joined the Company in 1974. He was named Vice President of Sales and Marketing for CPAC Equipment Division in March, 1994. Formerly, he served as International Sales Manager for PRS, Inc., and\nService Manager for the CPAC Equipment Division. Mr. Thompson started his career with CPAC as an R & D Chemist.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION ----------------------\nInformation regarding executive compensation is incorporated by reference to the caption \"Executive Compensation\" in the 1995 Proxy Statement.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT --------------------------------------------------------------\nThe stock ownership of each person known to CPAC to be the beneficial owner of more than 5% of its Common Stock and the stock ownership of all directors and officers of CPAC as a group are incorporated by reference to the caption \"Security Ownership of Certain Beneficial Owners and Management\" in the 1995 Proxy Statement. The beneficial ownership of CPAC Common Stock of all directors of the Company is incorporated by reference to the caption \"Security Ownership of Certain Beneficial Owners and Management\" in the 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 to the caption \"Information About The Board and Its Committees\" in the 1995 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 of the Registrant are included as part of the report:\n1.FINANCIAL STATEMENTS: --------------------\nReport of Independent Accountants\nConsolidated Balance Sheets as of March 31, 1995 and 1994\nConsolidated Statements of Operations for the Years Ended March 31, 1995, 1994, and 1993\nConsolidated Statements of Changes in Shareholders' Equity for the Years Ended March 31, 1995, 1994, and 1993\nConsolidated Statements of Cash Flows for the Years Ended March 31, 1995, 1994, and 1993\nNotes to Consolidated Financial Statements\n2.FINANCIAL STATEMENT SCHEDULES: -----------------------------\nSchedule II, Valuation and Qualifying Accounts and Reserves\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.\n(b) Reports on Form 8-K -------------------\n1.On January 30, 1995, the Company filed a Current Report (Form 8-K) reporting the signing of a Licensing Agreement with Stanhome Inc. of Westfield, Massachusetts, pursuant to which the Company acquired the exclusive right to manufacture, sell, advertise, and distribute the home care and personal care products of Stanhome's U.S. Direct Selling Division, known as ``Stanley Home Products.''\n2.On March 31, 1995, the Company filed Amendment No. 1 to its January 30, 1995, Current Report on Form 8-K(A) to provide certain financial statements as required by Form 8-K, Items 7(A) and 7 (B) with respect to the Stanhome Licensing Agreement.\nITEM 14. FINANCIAL STATEMENT SCHEDULE SCHEDULE II ----------------------------\nCPAC, INC. ----------\nVALUATION AND QUALIFYING ACCOUNTS AND RESERVES ----------------------------------------------\nFOR THE FISCAL YEARS ENDED MARCH 31, 1995, 1994 AND 1993 --------------------------------------------------------\nBALANCE AT BALANCE BEGINNING AT END OF OF PERIOD ADDITIONS DEDUCTIONS PERIOD --------- --------- ---------- ------\n1995: Allowance for doubtful accounts $ 509,000 $ 454,000 $ (362,000) $ 601,000 Inventory reserve 252,000 608,000 (96,000) 764,000\n1994: Allowance for doubtful accounts $ 528,000 $ 396,000 $ (415,000) $ 509,000 Inventory reserve 152,000 110,000 (10,000) 252,000\n1993: Allowance for doubtful accounts $ 251,000 $ 328,000 $ (51,000) $ 528,000 Inventory reserve 171,000 77,000 (96,000) 152,000\nEXHIBIT INDEX -------------\nExhibit Page - ------- ----\n2. Plan of acquisition, reorganization, arrangement, liquidation, or succession\n2.2 Licensing Agreement with Stanhome Inc. incorporated by reference to Form 8-K (Current Report) filed January 30, 1995 N\/A\n3. Articles of Incorporation, By-Laws\n3.1 Certificate of Incorporation, as amended, incorporated by reference to Form 10-K, filed for period ended March 31, 1989 N\/A\n3.2 By-laws, as amended, incorporated by reference to Form 10-K, filed for period ended March 31, 1989 N\/A\n4. Instruments defining the rights of security holders, including indentures\n4.1 Loan Agreement dated February 9, 1994, and Letter of Commitment dated December 16, 1993, incorporated by reference to Form 10-K filed for period ended March 31, 1994, as amended by Exhibits 99.1 to 99.3 filed as Exhibits to the Form 10-Q for the quarter ended December 31, 1994. N\/A\n9. Voting Trust Agreement N\/A\n10. Material Contracts N\/A\n11. Statement re: Computation of Per Share Earnings (Loss) N\/A\n12. Statement re: Computation of Ratios N\/A\n13. Annual Report to Security Holders N\/A\n16. Letter re: Change of Certifying Accountant N\/A\n18. Letter re: Change in Accounting Principles N\/A\n21. Subsidiaries of the Registrant\n21.1 Subsidiaries of the Registrant 44\n22. Published report regarding matters submitted to vote of security holders N\/A\n23. Consent of Experts and Counsel\n23.1 Consent of Coopers & Lybrand L.L.P. 45\n24. Power of Attorney N\/A\n27. Financial Data Schedule 46\n28. Information from reports furnished to state insurance regulatory authorities N\/A\n99. Additional Exhibits N\/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.\nCPAC, INC.\nDate June 27, 1995 By \/s\/ Thomas N. Hendrickson ---------------------------- ------------------------------ Thomas N. Hendrickson, 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 June 27, 1995 By \/s\/ Thomas N. Hendrickson ---------------------------- ------------------------------ Thomas N. Hendrickson, President, Chief Executive Officer, Treasurer, and Director\nDate June 27, 1995 By \/s\/ Robert Oppenheimer ---------------------------- ------------------------------ Robert Oppenheimer, Secretary and Director\nDate June 27, 1995 By \/s\/ Robert C. Isaacs ---------------------------- ------------------------------ Robert C. Isaacs, Senior Vice President and Director\nDate June 27, 1995 By \/s\/ Seldon T. James, Jr. ---------------------------- ------------------------------ Seldon T. James, Jr., Director\nDate June 27, 1995 By \/s\/ John C. Burton ---------------------------- ------------------------------ John C. Burton, Director\nDate June 27, 1995 By \/s\/ Thomas J. Weldgen ---------------------------- ------------------------------ Thomas J. Weldgen Chief Financial Officer\nDate June 27, 1995 By \/s\/ Wendy F. Clay ---------------------------- ------------------------------ Wendy F. Clay Vice President, Administration","section_15":""}
{"filename":"73076_1995.txt","cik":"73076","year":"1995","section_1":"Item 1. Business - ------------------\n(a) General development of business.\nThere have been no material changes or developments since the beginning of the fiscal year in the business done or intended to be done by the registrant and its subsidiaries.\n(b) Financial information about industry segments.\nThe registrant is a mutual life insurance company whose principal product is life insurance. The registrant also sells annuity contracts, including variable annuity contracts.\n(c) Description of business.\nThe Registrant is the seventh largest life insurance company in the United States with total assets in excess of $54 billion on December 31, 1995.\nThe registrant's principal products are life insurance contracts distributed by approximately 5,600 full-time producing agents. Sales of life insurance contracts as a percentage of total sales is as follows:\nAs of December 31 1995, the registrant had 3,344 employees.\n(d) Not applicable.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties - --------------------\nThe principal properties used in the business are located at 720 East Wisconsin Avenue and 818 East Mason Avenue, Milwaukee, Wisconsin. The properties, which house the registrant's home office, include approximately three and one-half square blocks improved with three office buildings and a parking structure. Title to land and buildings is held in fee.\nItem 3","section_3":"Item 3 is on page 3.\nThe Northwestern Mutual Life Insurance Company ---------------------------------------------- Form 10-K ---------\nItem 3. Legal Proceedings - --------------------------\nThe Northwestern Mutual Life Insurance Company is engaged in litigation of various kinds, which in its judgement is not of material importance in relation to its total assets. The litigation includes various administrative or judicial proceedings, relating to investments of the Registrant, arising under Federal, State or local provisions that have been enacted or adopted regulating the discharge of materials into the environment or primarily for the purpose of protecting the environment. The Registrant believes that these proceedings, singularly and in the aggregate, are not material. In addition, NML Variable Annuity Accounts A and C are not engaged in any litigation which is considered material to their total assets.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders - ------------------------------------------------------------\n(a) Not applicable. The Registrant is a mutual life insurance company and has no stockholders as such.\n(b) Not applicable.\n(c) Not applicable.\n(d) Not applicable.\nItem 5","section_5":"Item 5 is on page 4.\nThe Northwestern Mutual Life Insurance Company ---------------------------------------------- Form 10-K ---------\nPART II -------\nItem 5. Market for the Registrant's Common Stock and Related Stockholder Matters - -------------------------------------------------------------------------\n(a) Not applicable. The Registrant is a mutual life insurance company and has no equity securities or stockholders as such.\n(b) Not applicable.\n(c) Not applicable.\nItem 6","section_6":"Item 6 is on page 5.\nThe Northwestern Mutual Life Insurance Company ---------------------------------------------- Form 10-K ---------\nItem 6. Selected Financial Data 5 - --------------------------------\nResults of Operations for NML Variable Annuity Account A for each of the five years ending December 31, follows:\n** Represents operations through April 29, 1993. # Commenced operations on April 30, 1993. ## Commenced operations on May 3, 1994.\nSee Notes to Financial Statements on page 22-23.\nThe Northwestern Mutual Life Insurance Company ---------------------------------------------- Form 10-K ---------\nItem 6. (continued) 6 - --------------------\nChanges in Equity for NML Variable Annuity Account A for each of the five years ending December 31, follows:\nSee Notes to Financial Statements on page 22-23.\nThe Northwestern Mutual Life Insurance Company ---------------------------------------------- Form 10-K ---------\nItem 6. (continued) 7 - --------------------\nTotal Assets of NML Variable Annuity Account A for each of the five following years at December 31, follows:\n** Capital Appreciation Stock Fund was merged into Index 500 Stock Fund on April 30, 1993. # Commenced operations on April 30, 1993. ## Commenced operations on May 3, 1994.\nSee Notes to Financial Statements on page 22-23.\nThe Northwestern Mutual Life Insurance Company ---------------------------------------------- Form 10-K ---------\nItem 6. (continued) 8 - --------------------\nResults of Operations for NML Variable Annuity Account C for each of the five years ending December 31, follows:\n** Represents operations through April 29, 1993. # Commenced operations on April 30, 1993. ## Commenced operations on May 3, 1994. See Notes to Financial Statements on page 31-32.\nThe Northwestern Mutual Life Insurance Company ---------------------------------------------- Form 10-K ---------\nItem 6. (continued) 9 - --------------------\nChanges in Equity for NML Variable Annuity Account C for each of the five years ending December 31, follows:\nSee Notes to Financial Statements on page 31-32.\nThe Northwestern Mutual Life Insurance Company ---------------------------------------------- Form 10-K ---------\nItem 6. (continued) 10 - --------------------\nTotal Assets of NML Variable Annuity Account C for each of the five following years at December 31, follows:\n** Capital Appreciation Stock Fund was merged into Index 500 Stock Fund on April 30, 1993. # Commenced operations on April 30, 1993. ## Commenced operations on May 3, 1994.\nSee Notes to Financial Statements on page 31-32.\nItem 7","section_7":"Item 7 is on page 11.\nThe Northwestern Mutual Life Insurance Company ---------------------------------------------- Form 10-K ---------\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - ------------------------------------------------------------------------\n(a) Liquidity ---------\nThe assets of the Northwestern Mutual Life Insurance Company Variable Annuity Accounts A and C are invested solely in shares of Northwestern Mutual Series Fund, Inc. Index 500 Stock Portfolio, Northwestern Mutual Series Fund, Inc. Aggressive Growth Stock Portfolio, Northwestern Mutual Series Fund, Inc. International Equity Portfolio, Northwestern Mutual Series Fund, Inc. Select Bond Portfolio, Northwestern Mutual Series Fund, Inc. Money Market Portfolio, Northwestern Mutual Series Fund, Inc. Balanced Portfolio, Northwestern Mutual Series Fund, Inc. Growth Stock Portfolio, Northwestern Mutual Series Fund, Inc. Growth and Income Stock Portfolio, and Northwestern Mutual Series Fund, Inc. High Yield Bond Portfolio (the \"Funds\"). The Funds are open-end investment companies registered under the Investment Act of 1940. In order to pay annuity benefits and expenses, the Accounts redeem shares in these Funds. The registrant's liquidity is not expected to change in a material way.\n(b) Capital Resources -----------------\nAll payments from contract owners of NML Variable Annuity Accounts A and C are invested in shares of the Funds. The capital resources of NML Variable Annuity Accounts A and C are the equity in the respective Accounts. This consists of payments from the contract owners, plus unrealized and realized appreciation on the investment of these payments, plus investment income received from the Funds, minus payment of annuity benefits and expenses.\n(c) Results of Operations ---------------------\nNML Variable Annuity Account A ------------------------------\nAccumulation Unit Values Contracts Issued Prior to December 17, 1981:\nThe Northwestern Mutual Life Insurance Company ---------------------------------------------- Form 10-K ---------\nItem 7. (Continued) - --------------------\nAccumulation Unit Values Contracts Issued On or After December 17, 1981 and before March 31, 1995:\nAccumulation Unit Values Contracts Issued On or After March 31, 1995: Front Load Version\n# Growth Stock, Growth and Income Stock, and High Yield Bond Divisions began operations on May 3, 1994. The percentage change in unit value reflects performance from May 3, 1994.\nThe Northwestern Mutual Life Insurance Company ---------------------------------------------- Form 10-K ---------\nAccumulation Unit Values Contracts Issued On or After March 31, 1995: Back Load Version\nThe change in equity for each period is largely derived from investment activities within the Account: A $29,681,098 increase for the year ended December 31, 1993, a $2,579,179 decrease for the year ended December 31, 1994, and a $96,695,584 increase for the year ended December 31, 1995. Net contributions (surrenders)from contract owners amounted to $17,380,160 for the year ended December 31, 1993, $18,651,028 for the year ended December 31, 1994, and $(13,795,319) for the year ended December 31, 1995.\nNML Variable Annuity Account C ------------------------------\nAccumulation Unit Values Contracts Issued Prior to December 17, 1981 or between April 30, 1984 and December 31, 1991:\nThe Northwestern Mutual Life Insurance Company ---------------------------------------------- Form 10-K ---------\nItem 7. (Continued) - --------------------\nAccumulation Unit Values Contracts Issued On or After December 17, 1981 or before May 1, 1984:\nAccumulation Unit Values Contracts Issued After December 31, 1991 - Front Load Version:\n# Growth Stock, Growth and Income Stock, and High Yield Bond Divisions began operations on May 3, 1994. The percentage change in unit value reflects performance from May 3, 1994.\nThe Northwestern Mutual Life Insurance Company ---------------------------------------------- Form 10-K ---------\nItem 7. (Continued) - --------------------\nAccumulation Unit Values Contracts Issued After December 31, 1991 - Simplified Load Version:\n# Growth Stock, Growth and Income Stock, and High Yield Bond Divisions began operations on May 3, 1994. The percentage change in unit value reflects performance from May 3, 1994.\nThe change in equity for each period is largely derived from investment activities within the Account: A $20,222,278 increase for the year ended December 31, 1993, a $946,478 increase for the year ended December 31, 1994, and a $68,906,233 increase for the year ended December 31, 1995. Net contributions (surrenders) from contract owners amounted to $17,414,485 for the year ended December 31, 1993, $21,988,786 for the year ended December 31, 1994, and $(1,482,462) for the year ended December 31, 1995.\nItem 8","section_7A":"","section_8":"Item 8 is on page 16.\nThe Northwestern Mutual Life Insurance Company ---------------------------------------------- Form 10-K ---------\nItem 8. Financial Statements and Supplementary Data - ----------------------------------------------------\nNML VARIABLE ANNUITY ACCOUNT A STATEMENT OF ASSETS AND LIABILITIES\n# Growth Stock, Growth and Income Stock, and High Yield Bond Portfolios began operations on May 3, 1994.\nThe Accompanying Notes are an Integral Part of the Financial Statements.\nThe Northwestern Mutual Life Insurance Company ---------------------------------------------- Form 10-K ---------\nItem 8. (Continued) - -------------------- NML VARIABLE ANNUITY ACCOUNT A STATEMENT OF ASSETS AND LIABILITIES\nThe Accompanying Notes are an Integral Part of the Financial Statements.\nThe Northwestern Mutual Life Insurance Company ---------------------------------------------- Form 10-K ---------\nItem 8. (Continued) - -------------------- NML VARIABLE ANNUITY ACCOUNT A STATEMENT OF ASSETS AND LIABILITIES\n# Growth Stock, Growth and Income Stock, and High Yield Bond Divisions began operations on May 3, 1994.\nThe Accompanying Notes are an Integral Part of the Financial Statements.\nThe Northwestern Mutual Life Insurance Company ---------------------------------------------- Form 10-K ---------\nItem 8. (Continued) - -------------------- NML VARIABLE ANNUITY ACCOUNT A STATEMENT OF ASSETS AND LIABILITIES\nThe Accompanying Notes are an Integral Part of the Financial Statements.\nThe Northwestern Mutual Life Insurance Company ---------------------------------------------- Form 10-K ---------\nItem 8. (Continued) - -------------------- NML VARIABLE ANNUITY ACCOUNT A STATEMENT OF ASSETS AND LIABILITIES\nThe Accompanying Notes are an Integral Part of the Financial Statements.\nThe Northwestern Mutual Life Insurance Company ---------------------------------------------- Form 10-K ---------\nItem 8. (continued) - --------------------\nNML VARIABLE ANNUITY ACCOUNT A COMBINED STATEMENT OF OPERATIONS AND CHANGES IN EQUITY For the Years Ended December 31\nThe Accompanying Notes are an Integral Part of the Financial Statements.\nThe Northwestern Mutual Life Insurance Company ---------------------------------------------- Form 10-K ---------\nItem 8. (continued) - --------------------\nNML VARIABLE ANNUITY ACCOUNT A NOTES TO FINANCIAL STATEMENTS\nNote 1--NML Variable Annuity Account A (the \"Account\") is a segregated asset account of The Northwestern Mutual Life Insurance Company (\"Northwestern Mutual Life\") used to fund variable annuity contracts (\"contracts\") for HR-10 and corporate pension and profit-sharing plans which qualify for special tax treatment under the Internal Revenue Code. Beginning March 31, 1995, two versions of the contract are offered: Front Load contracts with a sales charge up to 4% of purchase payments and Back Load contracts with a withdrawal charge of 0-8%.\nNote 2--The preparation of the 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. Principal accounting policies are summarized below.\nNote 3--All assets of each Division of the Account are invested in shares of the corresponding Portfolio of Northwestern Mutual Series Fund, Inc. (the \"Fund\"). The shares are valued at the Fund's offering and redemption price per share.\nOn May 3, 1994, five new portfolios commenced operations in the Fund: Aggressive Growth Stock Portfolio (formerly Northwestern Mutual Aggressive Growth Stock Fund, Inc.), International Equity Portfolio (formerly Northwestern Mutual International Equity Fund, Inc.), Growth Stock Portfolio, Growth and Income Stock Portfolio and High Yield Bond Portfolio. Additionally, on May 3, 1994, the assets of Northwestern Mutual Life's Variable Annuity funds were merged into the respective portfolio of the Fund in a tax-free exchange of shares.\nThe Fund is an open-end investment company registered under the Investment Company Act of 1940.\nNote 4--Annuity reserves are based on published annuity tables with age adjustment and benefit payments which reflect actual investment experience. For variable payment plans issued prior to January 1, 1974, annuity reserves are based on the 1955 American Annuity Table with assumed interest rates of 3%, 3 1\/2% or 5%. For variable payment plans issued on or after January 1, 1974 and before January 1, 1985, annuity reserves are based on the 1971 Individual Annuity Table with assumed interest rates of 3 1\/2% or 5%. For variable payment plans issued on or after January 1, 1985, annuity reserves are based on the 1983 Table a with assumed interest rates of 3 1\/2% or 5%.\nNote 5--Dividend income from the Fund is recorded on the record date of the dividends. Transactions in Fund shares are accounted for on the trade date. The basis for determining cost on sale of Fund shares is identified cost. Purchases and sales of Fund shares for the years ended December 31 by each Division are shown below:\nThe Northwestern Mutual Life Insurance Company ---------------------------------------------- Form 10-K ---------\nItem 8. (continued) - --------------------\nNML VARIABLE ANNUITY ACCOUNT A NOTES TO FINANCIAL STATEMENTS\nNote 6--On April 30, 1993, Northwestern Mutual Capital Appreciation Stock Fund was merged into the Northwestern Mutual Index 500 Stock Fund in a tax-free exchange of fund shares. 21,689,286 shares of Northwestern Mutual Capital Appreciation Stock Fund, Inc. were exchanged for 22,749,651 shares of Northwestern Mutual Index 500 Stock Fund, Inc. The shares exchanged were valued at $30,719,638 for each Division.\nNote 7--A deduction for annuity rate and expense guarantees is determined daily and paid to Northwestern Mutual Life as compensation for assuming the risk that annuity payments will continue for longer periods than anticipated because the annuitants as a group live longer than expected, and the risk that the charges made by Northwestern Mutual Life may be insufficient to cover the actual costs incurred in connection with the contracts.\nFor contracts issued on or after March 31, 1995, for the Front Load version and the Back Load version, the deduction for annuity rate and expense guarantees is determined daily at annual rates of 4\/10 of 1% and 1 1\/4%, respectively, of the net assets of each Division attributable to these contracts and is paid to Northwestern Mutual Life. For these contracts, the rates may be increased or decreased by the Board of Trustees of Northwestern Mutual Life not to exceed 3\/4 of 1% and 1 1\/2%, respectively.\nFor contracts issued on or after December 17, 1981 and before March 31, 1995, the deduction is at an annual rate of 1 1\/4% of the net assets of each Division attributable to these contracts. For these contracts, the rate may be increased or decreased by the Board of Trustees of Northwestern Mutual Life not to exceed a 1 1\/2% annual rate.\nFor contracts issued prior to December 17, 1981, the deduction is at an annual rate of 3\/4 of 1% of the net assets of each Division attributable to these contracts. For these contracts, the rate may be increased or decreased by the Board of Trustees of Northwestern Mutual Life not to exceed a 1% annual rate.\nBeginning in 1995, Northwestern Mutual Life paid a dividend to certain contracts. The dividend was reinvested in the Account and has been reflected as a Contract Owners' Net Payment in the accompanying financial statements.\nNote 8--Northwestern Mutual Life is taxed as a \"life insurance company\" under the Internal Revenue Code and the operations of the Account form a part of and are taxed with those of Northwestern Mutual Life. Under current law, no federal income taxes are payable with respect to the Account. Accordingly, no provision for any such liability has been made.\nPrice Waterhouse LLP Letterhead\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo The Northwestern Mutual Life Insurance Company and Contract Owners of NML Variable Annuity Account A\nIn our opinion, the statements appearing on pages 16 through 23 present fairly, in all material respects, the financial position of NML Variable Annuity Account A at December 31, 1995 and 1994, and the results of its operations and the changes in its equity for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles. These financial statements are the responsibility of The Northwestern Mutual Life Insurance 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.\nPrice Waterhouse LLP Milwaukee, Wisconsin January 24, 1996\nThe Northwestern Mutual Life Insurance Company ---------------------------------------------- Form 10-K ---------\nItem 8. (continued) Financial Statements and Supplementary Data - --------------------------------------------------------------------\nNML VARIABLE ANNUITY ACCOUNT C STATEMENT OF ASSETS AND LIABILITIES\n# Growth Stock, Growth and Income Stock, and High Yield Bond Portfolios began operations on May 3, 1994.\nThe Accompanying Notes are an Integral Part of the Financial Statements.\nThe Northwestern Mutual Life Insurance Company ---------------------------------------------- Form 10-K ---------\nItem 8. (continued) - -------------------- NML VARIABLE ANNUITY ACCOUNT C STATEMENT OF ASSETS AND LIABILITIES\nThe Accompanying Notes are an Integral Part of the Financial Statements.\nThe Northwestern Mutual Life Insurance Company ---------------------------------------------- Form 10-K ---------\nItem 8. (continued) - -------------------- NML VARIABLE ANNUITY ACCOUNT C STATEMENT OF ASSETS AND LIABILITIES\nThe Accompanying Notes are an Integral Part of the Financial Statements.\nThe Northwestern Mutual Life Insurance Company ---------------------------------------------- Form 10-K ---------\nItem 8. (continued) - -------------------- NML VARIABLE ANNUITY ACCOUNT C STATEMENT OF ASSETS AND LIABILITIES\n# Growth Stock, Growth and Income Stock, and High Yield Bond Divisions began operations on May 3, 1994.\nThe Accompanying Notes are an Integral Part of the Financial Statements.\nThe Northwestern Mutual Life Insurance Company ---------------------------------------------- Form 10-K ---------\nItem 8. (continued) - -------------------- NML VARIABLE ANNUITY ACCOUNT C STATEMENT OF ASSETS AND LIABILITIES\n# Growth Stock, Growth and Income Stock, and High Yield Bond Divisions began operations on May 3, 1994.\nThe Accompanying Notes are an Integral Part of the Financial Statements.\nThe Northwestern Mutual Life Insurance Company ---------------------------------------------- Form 10-K ---------\nItem 8. (continued) - -------------------- NML VARIABLE ANNUITY ACCOUNT C COMBINED STATEMENT OF OPERATIONS AND CHANGES IN EQUITY For the Years Ended December 31\nThe Accompanying Notes are an Integral Part of the Financial Statements.\nThe Northwestern Mutual Life Insurance Company ---------------------------------------------- Form 10-K ---------\nItem 8. (continued) - --------------------\nNML VARIABLE ANNUITY ACCOUNT C NOTES TO FINANCIAL STATEMENTS\nNote 1--NML Variable Annuity Account C (the \"Account\") is a segregated asset account of The Northwestern Mutual Life Insurance Company (\"Northwestern Mutual Life\" or \"Sponsor\") used to fund variable annuity contracts (\"contracts\") for HR-10 and corporate pension and profit- sharing plans which qualify for special tax treatment under the Internal Revenue Code. Beginning December 31, 1991, two versions of the contract are offered: Front Load contracts with a sales charge up to 4.5% of purchase payments and Simplified Load contracts with an installation fee of $750.\nNote 2--The preparation of the 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. Principal accounting policies are summarized below.\nNote 3--All assets of each Division of the Account are invested in shares of the corresponding Portfolio of Northwestern Mutual Series Fund, Inc. (the \"Fund\"). The shares are valued at the Fund's offering and redemption price per share.\nOn May 3, 1994, five new portfolios commenced operations in the Fund: Aggressive Growth Stock Portfolio (formerly Northwestern Mutual Aggressive Growth Stock Fund,Inc.), International Equity Portfolio (formerly Northwestern Mutual International Equity Fund, Inc.), Growth Stock Portfolio, Growth and Income Stock Portfolio and High Yield Bond Portfolio. Additionally, on May 3, 1994, the assets of Northwestern Mutual Life's Variable Annuity funds were merged into the respective portfolio of the Fund in a tax-free exchange of shares.\nThe Fund is an open-end investment company registered under the Investment Company Act of 1940.\nNote 4--Annuity reserves are based on published annuity tables with age adjustment and benefit payments which reflect actual investment experience. Annuity reserves are based on the 1983 Table a with assumed interest rates of 3 1\/2% or 5%.\nNote 5--Dividend income from the Fund is recorded on the record date of the dividends. Transactions in Fund shares are accounted for on the trade date. The basis for determining cost on sale of Fund shares is identified cost. Purchases and sales of Fund shares for the years ended December 31 by each Division are shown below:\nThe Northwestern Mutual Life Insurance Company ---------------------------------------------- Form 10-K ---------\nItem 8. (continued) - --------------------\nNML VARIABLE ANNUITY ACCOUNT C NOTES TO FINANCIAL STATEMENTS\nNote 6--On April 30, 1993, Northwestern Mutual Capital Appreciation Stock Fund was merged into the Northwestern Mutual Index 500 Stock Fund in a tax-free exchange of fund shares. 23,586,477 shares of Northwestern Mutual Capital Appreciation Stock Fund, Inc. were exchanged for 24,739,593 shares of Northwestern Mutual Index 500 Stock Fund, Inc. The shares exchanged were valued at $33,406,725 for each Division.\nNote 7--A deduction for annuity rate and expense guarantees is determined daily and paid to Northwestern Mutual Life as compensation for assuming the risk that annuity payments will continue for longer periods than anticipated because the annuitants as a group live longer than expected and the risk that the charges made by Northwestern Mutual Life may be insufficient to cover the actual costs incurred in connection with the contracts.\nGenerally, for contracts issued on or after December 31, 1991, for the Front Load Version and the Simplified Load Version, the deduction for annuity rate and expense guarantees is determined daily at annual rates of 6.5\/10 of 1% and 1 1\/4%, respectively, of the net assets of each Division attributable to these contracts and is paid to Northwestern Mutual Life. For these contracts, the rates may be increased or decreased by the Board of Trustees of Northwestern Mutual Life not to exceed 1% and 1 1\/2% annual rates, respectively.\nGenerally, the deduction for contracts issued before December 17, 1981 or between April 30, 1984 and December 31, 1991 as provided for in the contracts has been waived by the Board of Trustees of Northwestern Mutual Life. For these contracts, the rate may be determined by the Board of Trustees of Northwestern Mutual Life not to exceed a 1\/4 of 1% annual rate.\nFor contracts issued on or after December 17, 1981, and before May 1, 1984, the deduction is determined daily at an annual rate of 1\/2 of 1% of the net assets of each Division attributable to these contracts and is paid to Northwestern Mutual Life. For these contracts, the rate may be increased or decreased by the Board of Trustees of Northwestern Mutual Life not to exceed a 3\/4 of 1% annual rate.\nNote 8--Northwestern Mutual Life is taxed as a \"life insurance company\" under the Internal Revenue Code and the operations of the Account form a part of and are taxed with those of Northwestern Mutual Life. Under current law, no federal income taxes are payable with respect to the Account. Accordingly, no provision for any such liability has been made.\nItem 9","section_9":"Item 9 is on page 34.\n[PRICE WATERHOUSE LLP LOGO]\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo The Northwestern Mutual Life Insurance Company and Contract Owners of NML Variable Annuity Account C\nIn our opinion, the statements appearing on pages 25 through 32 present fairly, in all material respects, the financial position of NML Variable Annuity Account C at December 31, 1995 and 1994, and the results of its operations and the changes in its equity for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles. These financial statements are the responsibility of The Northwestern Mutual Life Insurance 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.\nPRICE WATERHOUSE LLP Milwaukee, Wisconsin January 24, 1996\nThe Northwestern Mutual Life Insurance Company ---------------------------------------------- Form 10-K ---------\nItem 9. Disagreements on Accounting and Financial Disclosure - -------------------------------------------------------------\nNot applicable.\nItem 10","section_9A":"","section_9B":"","section_10":"Item 10 is on page 35.\nThe Northwestern Mutual Life Insurance Company 35 ---------------------------------------------- Form 10-K ---------\nPART III --------\nItem 10. Directors and Executive Officers of the Registrant - ------------------------------------------------------------\n(a) The following information as of March 1, 1996 is provided with respect to each director, including persons chosen to become directors, of the Registrant. The Registrant uses the title of Trustee to denote the directors.\n(1) Candidate proposed for re-election by the Board of Trustees for the election to be held at the May 1996 meeting of policyholders. If re-elected, these Trustees' terms will expire in May of 2000.\n* Retiring on May 22, 1996.\nThe Northwestern Mutual Life Insurance Company 36 ---------------------------------------------- Form 10-K ---------\n(1) Candidate proposed for re-election by the Board of Trustees for the election to be held at the May 1996 meeting of policyholders. If re-elected, these Trustees' terms will expire in May of 2000.\nThe Northwestern Mutual Life Insurance Company ---------------------------------------------- Form 10-K ---------\nItem 10. (continued) - ---------------------\n(b) The following information as of March 1, 1996 is provided with respect to each Executive Officer of the Registrant.\nAll of the Executive Officers, except Susan A. Lueger, have been associated with the Registrant, although not necessarily in their present positions, for more than five years.\nSusan A. Lueger has been Vice President of NML since May, 1994; Vice President of Human Resources at Wisconsin Electric Power Company 1992-1994; prior thereto with WEPC in the following positions: Assistant Vice President-Human Resources 1\/92 to 11\/92; Director-Human Resources 5\/91 to 1\/92; Manager-Compensation & Benefits Division 7\/90 to 5\/91; Project Specialist-Employment and Training Division 2\/88 to 7\/90.\nThe Northwestern Mutual Life Insurance Company 38 ---------------------------------------------- Form 10-K ---------\nItem 10. (continued) - ---------------------\nTerm of office for all Executive Officers is one year expiring May 31, 1996.\n(c) Not applicable\n(d) No one of the Executive Officers or Trustees is related to any other to the best of our knowledge.\n(e) Business experience and directorships of Trustees are as follows:\nThe Northwestern Mutual Life Insurance Company 39 ---------------------------------------------- Form 10-K ---------\nThe Northwestern Mutual Life Insurance Company 40 ---------------------------------------------- Form 10-K ---------\n* Note: Prior to 2\/15\/95, this company was known as Systematics Information Services, Inc.\nThe Northwestern Mutual Life Insurance Company ---------------------------------------------- Form 10-K ---------\nItem 10. (continued)\n(f) To the best of the Registrant's knowledge, none of the Registrant's Executive Officers or Trustees have been involved in any of the items required to be reported in response to Item 401(f) of Regulation S-K.\n(g) Not applicable.\nItem 11","section_11":"Item 11 is on page 42.\nThe Northwestern Mutual Life Insurance Company ---------------------------------------------- Form 10-K ---------\nItem 11. Executive Compensation - ---------------------------------\nNot applicable. NML Variable Annuity Accounts A and C have no directors or executive officers, the Executive Officers and Trustees of The Northwestern Mutual Life Insurance Company spend no substantial portion of their time on matters relating to NML Variable Annuity Accounts A and C, and the amounts of compensation received by the Executive Officers and Trustees of The Northwestern Mutual Life Insurance Company have no bearing on the values associated with variable annuity contracts issued in connection with Northwestern Mutual Variable Annuity Accounts A and C.\nThe Northwestern Mutual Life Insurance Company ---------------------------------------------- Form 10-K ---------\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management - ------------------------------------------------------------------------\n(a) Not applicable. The Registrant is a mutual life insurance company and has no stockholders as such.\n(b) Not applicable.\n(c) Not applicable.\nItem 13","section_13":"Item 13 is on page 44.\nThe Northwestern Mutual Life Insurance Company ---------------------------------------------- Form 10-K ---------\nItem 13. Certain Relationships and Related Transactions - ---------------------------------------------------------------\n(a) (1) The Registrant's second-tier subsidiary, Northwestern Mutual Investment Services, Inc.(\"NMIS\"), serves as the investment adviser to Northwestern Mutual Series Fund, Inc. (the \"Fund\"), a series company registered as an open-end management company under the Investment Company Act of 1940 and consisting of nine portfolios; and the Registrant is a party to an investment advisory agreement with each of these portfolios: the Index 500 Stock Portfolio, the Select Bond Portfolio, the Money Market Portfolio, the Balanced Portfolio, the Growth and Income Stock Portfolio, the Growth Stock Portfolio, the Aggressive Growth Stock Portfolio, the High Yield Bond Portfolio and the International Equity Portfolio. The investment advisory agreements with each portfolio were renewed during the fiscal year. Various Trustees and Officers of the Registrant serve as directors and officers of the Fund and may be deemed to have a direct or indirect material interest in the existence of the investment advisory agreements.\n(2) Various Trustees and Officers of the Registrant have securities accounts with Robert W. Baird and Co. Incorporated (\"Baird\") and effected transactions through such accounts during the fiscal year. Baird is a regional broker-dealer firm and a member of the New York Stock Exchange. Baird is a majority-owned indirect subsidiary of the Registrant.\nThe Northwestern Mutual Life Insurance Company ---------------------------------------------- Form 10-K ---------\nItem 13. (continued) - ---------------------\n(b) The Registrant, during 1995, retained the law firm of Monroe & Lemann, of which J. Thomas Lewis, a Trustee of the Registrant, is a member. The firm was retained to perform certain legal services for the Registrant.\n(c) Loans are made to Trustees and Officers in accordance with the provisions of insurance policies which they may own. Such loans are made in the ordinary course of business and are administered solely according to the terms of the policy.\n(d) Not applicable. The Registrant was not organized within the past five years.\nItem 14","section_14":"Item 14 is on page 46.\nThe Northwestern Mutual Life Insurance Company ---------------------------------------------- Form 10-K ---------\nTHE NORTHWESTERN MUTUAL LIFE - ---------------------------- INSURANCE COMPANY - ----------------- CONSOLIDATED FINANCIAL STATEMENTS - --------------------------------- DECEMBER 31, 1995, 1994 AND 1993 - --------------------------------\nREPORT OF INDEPENDENT ACCOUNTANTS ---------------------------------\nTo the Board of Trustees and Policyowners of The Northwestern Mutual Life Insurance Company\nIn our opinion, the accompanying consolidated statement of financial position and the related consolidated summary of operations, statement of general contingency reserve and statement of cash flows present fairly, in all material respects, the financial position of The Northwestern Mutual Life Insurance Company and its subsidiary at December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles (practices prescribed or permitted by insurance regulatory authorities - see Note 1). These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.\nPrice Waterhouse LLP January 24, 1996\nTHE NORTHWESTERN MUTUAL LIFE INSURANCE COMPANY ---------------------------------------------- CONSOLIDATED STATEMENT OF FINANCIAL POSITION -------------------------------------------- (In millions)\nThe accompanying notes are an integral part of the financial statements.\nTHE NORTHWESTERN MUTUAL LIFE INSURANCE COMPANY ---------------------------------------------- CONSOLIDATED SUMMARY OF OPERATIONS ---------------------------------- (In millions)\nThe accompanying notes are an integral part of the financial statements.\nTHE NORTHWESTERN MUTUAL LIFE INSURANCE COMPANY ---------------------------------------------- CONSOLIDATED STATEMENT OF GENERAL CONTINGENCY RESERVE ----------------------------------------------------- (In millions)\nThe accompanying notes are an integral part of the financial statements.\nTHE NORTHWESTERN MUTUAL LIFE INSURANCE COMPANY ---------------------------------------------- CONSOLIDATED STATEMENT OF CASH FLOWS ------------------------------------ (In millions)\nThe accompanying notes are an integral part of the financial statements.\nTHE NORTHWESTERN MUTUAL LIFE INSURANCE COMPANY ---------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------ DECEMBER 31, 1995, 1994 AND 1993 --------------------------------\nNOTE 1 - PRINCIPAL ACCOUNTING POLICIES - --------------------------------------\nThe accompanying consolidated financial statements include the accounts of The Northwestern Mutual Life Insurance Company (the \"Company\") and its wholly-owned life insurance subsidiary. The Company offers life, annuity and disability income products to the personal, business, estate and tax-qualified markets.\nThe consolidated financial statements have been prepared using accounting policies prescribed or permitted by the Insurance Departments of the states in which the Company and its subsidiary are domiciled. These policies are considered generally accepted accounting principles for mutual life insurance companies. 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 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.\nIn April 1993, the Financial Accounting Standards Board issued Interpretation No. 40, \"Applicability of Generally Accepted Accounting Principles to Mutual Life Insurance and Other Enterprises,\" which establishes a different definition of generally accepted accounting principles for mutual life insurance companies. Under the Interpretation, financial statements of mutual life insurance companies for periods beginning after December 15, 1995 which are prepared on the basis of statutory accounting will no longer be characterized as in conformity with generally accepted accounting principles.\nIn order to continue to present financial statements in accordance with generally accepted accounting principles for general purpose distribution in 1996, the Company is considering presenting its financial statements in accordance with the requirements of the Interpretation. Management believes that financial statements prepared on this basis would result in an increase to its general contingency reserve. The effects of this change in accounting basis would be reported retroactively through restatement beginning with the earliest year presented.\nInvestments - -----------\nThe Company's investments are valued on the following bases:\nSeparate Account Business - -------------------------\nThis business consists of annuities funded by specific assets held in separate accounts. The assets in these accounts are carried at market value. The policy values reflect the investment performance of the respective accounts.\nInsurance, Annuity and Disability Income Reserves - -------------------------------------------------\nLife insurance reserves on substantially all policies issued since 1978 are based on the Commissioner's Reserve Valuation Method with interest rates ranging from 3-1\/2% to 5-1\/2%. Other policy reserves are based primarily on the net level premium method employing various mortality tables at interest rates ranging from 2% to 4-1\/2%.\nDeferred annuity reserves on policies issued since 1985 are valued using the Commissioner's Annuity Reserve Valuation Method with interest rates ranging from 3-1\/2% to 6-1\/4%. Other deferred annuity reserves are based on the contract value. Immediate annuity reserves are present values of expected benefit payments at interest rates ranging from 3-1\/2% to 7-1\/2%.\nActive life reserves for disability income (\"DI\") policies issued since 1987 are primarily based on the two-year preliminary term method using a 4% interest rate and the 1985 Commissioner's Individual Disability Table A (\"CIDA\") for morbidity. Previous DI business used the net level premium method, using a 3% or 4% interest rate and the 1964 Commissioner's Disability Table for morbidity. Disabled life reserves for DI policies are based on the present values of expected benefit payments using primarily the 1985 CIDA (modified for Company experience in first two years of disability) with interest rates ranging from 3% to 5 1\/2%.\nUse of these actuarial tables and methods involves estimation of future mortality and morbidity based on past experience. Actual future experience could differ from these estimates.\nInterest Maintenance Reserve - ----------------------------\nThe Company is required to maintain an interest maintenance reserve (\"IMR\"). The IMR establishes a reserve for realized gains and losses, net of tax, resulting from changes in interest rates on short and long-term fixed income investments. Net realized gains and losses charged to the IMR are amortized into investment income over the approximate remaining life of the investment sold.\nAsset Valuation Reserve - -----------------------\n- 2 -\nThe Company is also required to maintain an asset valuation reserve (\"AVR\"). The AVR establishes a reserve for certain invested assets held by the Company. In the aggregate, AVR was 82% and 84% of the allowable maximum at December 31, 1995 and 1994, respectively.\nPremium Income - --------------\nLife insurance premiums are recognized as income at the beginning of each policy year.\nReinsurance - -----------\nIn the normal course of business, the Company seeks to limit its exposure to loss on any single insured and to recover a portion of benefits paid by ceding business to other insurance enterprises or reinsurers under excess coverage and co-insurance contracts. As of December 31, 1995 and 1994, total life insurance inforce approximated $380 billion and $347 billion, respectively, of which approximately $113 billion and $104 billion, respectively, comprised principally of term insurance, had been ceded to various reinsurers. The Company retains a maximum of $10 million of coverage per individual life.\nOperating Costs - ---------------\nOperating costs, including costs of acquiring new policies, are charged to operations as incurred.\nIncome Taxes - ------------\nProvisions for income taxes are based on current income tax returns without recognition of deferred taxes due to timing differences. The portion of the federal income tax based on mutual life insurance company equity is reflected as a component of income tax expense, including related adjustments for prior years.\nThe Company files a consolidated life-nonlife federal income tax return. Federal income tax returns for years through 1988 are closed as to further assessment of taxes. Adequate provision has been made in the financial statements for any additional taxes which may become due with respect to the open years.\nThe Company's effective tax rate on savings from operations before income tax expense (after dividends) in 1995, 1994 and 1993 was approximately 60%, 50% and 39%, respectively. Two significant factors cause the Company's effective rate to exceed the federal corporate rate of 35%. First, the Company pays a tax that is assessed only on mutual life insurance companies, which is an amount that purports to equate a portion of policyholder dividends with nondeductible dividends paid to shareholders of stock companies. Second, the Company must capitalize and amortize (as opposed to immediately deducting) an amount deemed to represent the cost of acquiring new business (\"DAC tax\").\nPolicyowner Dividends - ---------------------\nDividends payable in the following year on participating policies are charged to current operations. All life insurance policies issued by the Company are participating.\nNOTE 2 - DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS - --------------------------------------------------------------\nThe following summarizes the bases used by the Company in estimating its fair value disclosures for financial instruments:\nBonds and preferred stocks - Fair values are based upon quoted market prices, if available. For securities not actively traded, fair values are estimated using independent pricing services or internally developed pricing models.\nMortgage loans - Fair values are derived by discounting the future estimated cash flows using current interest rates for debt securities with similar credit risk and maturities, or utilizing net realizable values.\nLoans on policies - The carrying amount reported in the statement of financial position approximates fair value since loans on policies reduce the amount payable at death or at surrender of the contract.\nCash and temporary investments and due and accrued investment income - The carrying amounts reported in the statement of financial position approximate fair value.\nAnnuity reserves (without mortality\/morbidity features) - Fair values are derived by discounting the future estimated cash flows using current interest rates with similar maturities.\nOther deposit liabilities - The carrying amounts reported in the statement of financial position approximate fair value.\nNOTE 3 - INVESTMENTS - --------------------\nNet Investment Income - ---------------------\nThe Company's net investment income for the years ended December 31, 1995, 1994 and 1993 consists of the following:\n- 3 -\nRealized Gains and Losses - -------------------------\nDuring 1995, 1994 and 1993, the Company, in its normal course of business, sold certain invested assets realizing gains and losses before transfer to the IMR and capital gains tax from such sales as follows:\nDebt Securities - ---------------\nDebt securities consist of all bonds, fixed maturity preferred stocks and short term fixed income investments.\nThe statement values, which principally represent amortized cost, and estimated market values of the Company's debt securities at December 31, 1995 and 1994 are as follows:\n- 4 -\nThe amortized cost and estimated market value of debt securities at December 31, 1995 and 1994, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.\nThe fair value of perpetual preferred stocks as of December 31, 1995 and 1994 approximates $578 million and $440 million, respectively, compared to the statement values of $439 million and $440 million, respectively.\n- 5 -\nMortgage Loans - --------------\nAs of December 31, 1995 and 1994, the mortgage loan portfolio was distributed as follows:\nThe fair value of mortgage loans as of December 31, 1995 and 1994 approximates $8,983 million and $6,879 million, respectively. Decreases in current interest rates were a major reason for the increase in fair value relative to statement value in 1995.\nAffiliates - ----------\nThe Company has a 19.87% investment in MGIC Investment Corporation (\"MGIC\"), an affiliate. At December 31, 1995, the Company's investment in MGIC (11.7 million shares) exceeded the statement value by $420 million.\nIn July 1995, the Company entered into a forward contract with a brokerage firm to deliver 4.4 million to 5.4 million shares of MGIC (or cash) in August 1998 for a price determined by the market value of the MGIC shares at that time in exchange for a fixed cash payment of $247 million ($48 per share). The Company's objective in entering into the forward contract is to hedge against depreciation in the value of its MGIC holdings during the contract period below the initial spot price of $48, while partially participating in appreciation, if any, during the forward contract's duration.\nReal Estate - -----------\nFor real estate and joint venture properties acquired subsequent to December 1990, the Company calculates depreciation using the straight-line method in accordance with guidelines established by the National Association of Insurance Commissioners. For properties acquired prior to December 1990, the Company calculates depreciation using either the straight-line method or the constant-yield method. Home office real estate is depreciated using the straight-line method.\nAt December 31, 1995 and 1994, investment real estate includes $175 million and $146 million, respectively, of real estate acquired through foreclosure. In 1995, the Company recorded writedowns of $8 million and $28 million for the excess of carrying value over fair value of certain real estate investments and mortgage loans, respectively. Valuation allowances for real estate and mortgage loans with fair values that are less than statement values are adequately covered by normal AVR reserves and by a $90 million special investment reserve established by the Company for real estate, mortgage loans and other invested assets.\nDerivative Financial Instruments - --------------------------------\nThe Company's current utilization of derivative financial instruments is limited. Most of the Company's derivative transactions are used to reduce or modify risks of volatility related to currency or interest rate movements. These hedging strategies use forwards, futures and swaps. At December 31, 1995 and 1994, the Company held foreign currency forward contracts with a notional value of $889 million and $605 million, respectively, as a partial hedge against foreign currency exposure of foreign denominated investments. Changes in the market value of these contracts offset currency gains and losses on the hedged investments. The capital gains or losses are unrealized before contract settlement and realized on settlement. These currency hedges and the MGIC forward contract described above represent most of the\n- 6 -\nCompany's derivative positions. The effect of derivative transactions is not significant to the Company's results from operations or financial position.\nNOTE 4 - ANNUITIES AND OTHER DEPOSIT LIABILITIES - ------------------------------------------------\nThe fair value of annuities and other deposit liabilities as of December 31, 1995 and 1994 are as follows:\nNOTE 5 - BENEFIT PLANS - ----------------------\nThe Company maintains non-contributory defined benefit retirement plans for all eligible employees and agents as well as a 401(k) plan for eligible employees and a non-contributory defined contribution plan for all full-time agents. These plans are funded currently and plan assets of $1,152 million at December 31, 1995 are primarily included in the separate accounts of the Company. In 1995, the Company made a contribution of $13 million to the employee retirement plan; as of January 1, 1995, the most recent actuarial valuation date available, the defined benefit plans were fully funded.\nIn addition to pension benefits, the Company provides certain health care and life insurance benefits (\"postretirement benefits\") for retired employees. Substantially all employees may become eligible for these benefits if they reach retirement age while working for the Company.\nPostretirement benefit expenses, which includes the expected cost of postretirement benefits for newly eligible and vested employees and interest costs, were $7 million, $7 million and $9 million for the years ended December 31, 1995, 1994 and 1993, respectively. At December 31, 1995 and 1994, the unfunded postretirement benefit obligation for retirees and other fully eligible or vested employees was $49 million and $47 million, respectively. The estimated postretirement benefit obligation for active non-vested employees was $46 million and $44 million at December 31, 1995 and 1994, respectively. The discount rate used to determine the postretirement benefit obligation was 7% and the health care cost trend rate was 12% in 1995, declining by 1% per year to an ultimate rate of 5% over 7 years. If the health care cost trend rate assumptions were increased by 1%, the postretirement benefit obligation as of December 31, 1995 would be increased by $6 million.\nAt December 31, 1995 and 1994, plan assets attributable to postretirement health care benefits totaled $31 million and $25 million, respectively.\nNOTE 6 - REINSURANCE - --------------------\nThe amounts shown in the accompanying consolidated financial statements are net of reinsurance activity. The effect of reinsurance on premiums and benefits for the years ended December 31, 1995, 1994 and 1993 are as follows (in millions):\nIn addition, during 1995, 1994 and 1993, the Company received credits of $67 million, $63 million and $59 million, respectively, from reinsurers representing reimbursements of commissions and other expenses. These credits are included in other income in the consolidated summary of operations.\nReinsurance contracts do not relieve the Company from its obligations to policyholders. Failure of reinsurers to honor their obligations could result in losses to the Company; consequently, allowances are established for amounts deemed uncollectible. The Company evaluates the financial condition of its reinsurers and monitors concentrations of credit risk arising from similar geographic regions, activities, or economic characteristics of the reinsurers to minimize its exposure to significant losses from reinsurer insolvencies.\nNOTE 7 - CONTINGENCIES - ----------------------\nIn the normal course of business, the Company enters into transactions to reduce its exposure to fluctuations in interest rates and market volatility. These instruments may involve credit risk and may also be subject to risk of loss due to interest rate fluctuations.\n- 7 -\nThe Company has guaranteed certain obligations of its affiliates. These guarantees totaled approximately $126 million and $83 million at December 31, 1995 and 1994, respectively, and are generally supported by the underlying net asset values of the affiliates.\nThe Company is engaged in various legal actions in the normal course of its investment and insurance operations. In the opinion of management, any losses resulting from such actions would not have a material effect on the Company's financial condition.\nThe Northwestern Mutual Life Insurance Company ---------------------------------------------- Form 10-K ---------\nEXHIBIT I\nReference is made to a form of deferred compensation agreement filed as Exhibit B-2 with Form 10-K for 1970 and The Northwestern Mutual Employee Savings Plan filed as Exhibit II for 1985. Pursuant to such contracts the following amounts were deferred in 1995:\nThe Northwestern Mutual Life Insurance Company ---------------------------------------------- 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.\nTHE NORTHWESTERN MUTUAL LIFE INSURANCE COMPANY (Registrant)\nBy James D. Ericson --------------------------------------------- James D. Ericson President and Chief Executive Officer\nBy Gary E. Long --------------------------------------------- Gary E. Long Vice President and Controller\nDate: March 20, 1996 --------------\nPursuant to the requirements of the Securities Exchange Act of 1934, 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 20, 1996\nThe Northwestern Mutual Life Insurance Company ---------------------------------------------- Form 10-K ---------\nSIGNATURES (continued)\nThe Northwestern Mutual Life Insurance Company ---------------------------------------------- Form 10-K ---------\nSIGNATURES (continued)","section_15":""}
{"filename":"719497_1995.txt","cik":"719497","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's principal office, which is owned by the Company, is located at 11039 E. Lansing Circle, Meridian Office Park, in Douglas County, Colorado. This facility consists of 88,000 square feet and houses all of the Company's manufacturing activities. The building also houses certain warehousing functions and most administrative functions of the Company. During Fiscal 1995, the Company leased 71,500 square feet of warehouse space in Aurora, Colorado. Effective May 1995, the Company reduced its leased warehouse space to approximately 45,000 square feet. The Company believes its owned and leased facilities are adequate for its operations in the foreseeable future. See Notes 5 and 10 to the Consolidated Financial Statements regarding encumbrances on the Company's manufacturing and office facility.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nAs of April 1, 1995, the Company was involved in various litigation matters. See Note 11 to the Consolidated Financial Statements for a description of current legal proceedings.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SHAREHOLDERS\nNo matter was submitted to a vote of shareholders during the fourth quarter of the fiscal year covered by this report.\nEXECUTIVE OFFICERS\nThe executive officers of the Company as of June 1, 1995 are listed below:\nThe officers serve until their successors have been elected and qualified.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS:\nOn July 1, 1983, the Common Stock of the Company commenced trading in the over-the-counter market and was quoted on the NASDAQ system. On March 20, 1984, the Company's stock was accepted into the National Market System of NASDAQ. Effective October 14, 1994, the Company's Common Stock was included in the Nasdaq SmallCap Market. The Company's Common Stock is quoted under the symbol MMPI. The table below shows, for the period indicated, the range of high and low sales prices for Fiscal 1995 and 1994. All quotations were reported to the Company by the National Association of Securities Dealers and represent actual transactions and not inter-dealer quotations.\nThe closing sale price of the Company's Common Stock on June 14, 1995, as reported on NASDAQ, was $.4375.\nAs of June 14, 1995, the Company had 482 holders of record of its Common Stock. It is estimated that the total number of holders of the Common Stock is approximately 3,000.\nThe Company has not paid dividends on its Common Stock in the two most recent fiscal years. Under a Term Loan Agreement dated June 30, 1994, between the Company and Colorado National Bank (the \"Bank\"), the Company may not, without the prior written consent of the Bank, pay or declare any dividends on its Common Stock. The Company does not anticipate payment of dividends for the foreseeable future.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA:\nAll amounts in thousands of dollars except per share amounts.\nThe substantial decline in net revenues and the related operating results for since Fiscal 1991 is a result of the temporary suspension of the Company's operations by the FDA in the third quarter of Fiscal 1992 and its continuing impact on the Company's operations See Notes 3 and 8 to the Company's Consolidated Financial Statements and Management's Discussion and Analysis of Financial Condition and Results of Operations.\nEffective July 3, 1993, the Company effected a quasi-reorganization as discussed in Note 13 to the Consolidated Financial Statements. The Company has segregated its Consolidated Statements of Operations into the three-month period prior to and the nine-month period subsequent to the quasi-reorganization.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS:\nFOOD AND DRUG ADMINISTRATION\nThe impact of the United States Food and Drug Administration's (\"FDA\") action against the Company in August 1991 has had a significant and pervasive effect on the Company.\nOn August 8, 1991, the United States Attorney's Office for the District of Colorado filed a complaint seeking an injunction against the Company and three of its officers. The complaint alleged that the Company was manufacturing products in violation of the FDA's Current Good Manufacturing Practice Regulations (\"GMP\"). The complaint also alleged that certain of the devices were misbranded and adulterated for violating other relevant sections of the Federal Food, Drug and Cosmetic Act. On October 1, 1991, the Company and one of the named individual defendants entered into a five-year Consent Decree. The two other individuals originally named in the complaint for injunction were dismissed as defendants.\nBy letter dated October 8, 1991, the District Director of the FDA's Denver district informed the Company that, pursuant to the Consent Decree of October 1, 1991, the Company's medical device manufacturing operations were not in substantial compliance with GMP. The FDA informed the Company that it, therefore, was not in compliance with the terms of the Consent Decree and ordered the Company to cease all manufacturing and distribution.\nBased upon agreements with the FDA in November and December 1991, the Company was allowed to recondition inventories of components, sub-assemblies and finished products which were produced prior to the October 8th shut down. This was done in close cooperation with the FDA by the use of higher sampling levels and tightened acceptable quality limits . The Company's facilities were reinspected by the FDA in December, 1991 and found to have adequate processes in place to insure devices would be manufactured in compliance with GMP. As a result of that inspection, on January 9, 1992, the Company was given authorization to renew its operations, including production and distribution of all products.\nThe suspension of the Company's domestic operations during late 1991 and early 1992, as a result of the Consent Decree, resulted in the layoff of 350 personnel from the Company's manufacturing work force and created a significant decrease in revenue resulting in cash flow deficits. In order to remain in operation, the Company was forced to sell subsidiaries and other assets to raise sufficient operating funds to sustain ongoing operations. During and after the suspension of operations, the Company incurred substantial expenses and devoted valuable resources to the restart of operations that previously were devoted to research and development projects.\nThe Denver District Director has noted that the Company has fully cooperated with the FDA in all respects and has maintained constant communication regarding the status of the Company. During the first quarter of Fiscal 1994, the FDA conducted a routine inspection of the Company's Englewood, Colorado manufacturing facilities. The Company was issued an inspection report with only two deficiency observations noted, which were corrected. The results of the inspection also indicated that Marquest had made significant improvements in its systems and procedures. During Fiscal 1995, there were no additional FDA compliance inspections.\nFINANCIAL CONDITION\nTRADE ACCOUNTS RECEIVABLE, NET: The decrease in accounts receivable is due to the lower level of sales in the fourth quarter of Fiscal 1995 versus Fiscal 1994. There have been no significant changes in the composition or aging of receivables or in the sales terms between years.\nINVENTORIES, NET: The decrease in inventory from April 2, 1994 reflects management's continued efforts to reduce inventory levels to reduce costs and maximize cash flow.\nNOTE FROM RELATED PARTY: The note from related party at April 2, 1994 consisted of an 8% note due from Seabrook Medical, Inc., 10% owned by the Company. This note was paid off during Fiscal 1995.\nPROPERTY, PLANT, AND EQUIPMENT: In Fiscal 1995, the Company has included in construction in progress the down payment on three pieces of automation equipment in process of being constructed for the Company at April 1, 1995. The Company sold equipment no longer used in the business with a book value of $175,000.\nNOTE PAYABLE TO BANK: During Fiscal 1995, the Company refinanced its Industrial Revenue Bonds which were issued to build the Company's manufacturing facility in Englewood, Colorado. The Bonds were due December 31, 1993, however the bank extended the debt. The Bonds were refinanced by the same bank who held the Bonds. The Company refinanced $1,300,000 of the outstanding $1,389,000.\nSWISS DEBT PRINCIPAL: During Fiscal 1994, the holders of 96% of the Company's Swiss Franc denominated bonds exchanged the bonds for cumulative convertible preferred stock of Scherer Healthcare, Inc.; unsecured, 8% U.S. dollar denominated notes of the Company; and warrants to purchase the Company's common stock. The Company has taken no action with respect to the approximately $636,000 principal balance of Swiss bonds which were not tendered for exchange. If such bonds are tendered for redemption, the Company plans to attempt to exchange securities for them in a manner similar to the previous exchanges.\nNOTE PAYABLE TO SCHERER: During Fiscal 1995, Scherer Healthcare, Inc. converted $2,500,000 of debt to common equity of the Company. In accordance with the note, Scherer received 3,333,333 shares of common stock at a conversion price of $0.75 per share.\nSHAREHOLDERS' EQUITY: During Fiscal 1995, in addition to the debt conversion by Scherer described above, 263,921 warrants held by the former Swiss bondholders were converted to equity at $0.75 per share. In accordance with the warrant agreement, Swiss Notes Payable were used instead of cash.\nDuring the first quarter of Fiscal 1994, the Company completed significant changes to its operations and, at the end of the first quarter, determined that it was appropriate to effect a quasi-reorganization. In accordance with the rules for a quasi-reorganization, the balance sheet amounts were restated to fair values and the accumulated deficit was eliminated against the paid-in-capital accounts. See Note 13 to the Consolidated Financial Statements for a detailed discussion of the entries to effect the quasi-reorganization.\nRESULTS OF OPERATIONS\nFISCAL 1995 VERSUS FISCAL 1994\nREVENUE, COST OF SALES AND GROSS PROFIT: Sales decreased 8.4% from Fiscal 1994 to Fiscal 1995. The Company entered the first quarter of Fiscal 1994 with a backorder due to the closing of the Company's manufacturing plant in Nogales, Mexico and its distribution center in Nogales, Arizona. Many of the Company's distributors purchased high levels of product during the fourth quarter of Fiscal 1994, which depressed sales in the first quarter of Fiscal 1995. This purchasing pattern by distributors did not occur in the fourth quarter of Fiscal 1995. During Fiscal 1995, the Company implemented a territorial reorganization of its distributors. This reorganization expanded certain distributors' sales territories and dropped other distributors from the Company's network, resulting in a decrease in sales as not all business to customers of the dropped distributors has been retained by the Company. Sales also decreased in Fiscal 1995 due to a decline in hospital census which the Company's believes is due to the uncertainties surrounding healthcare reform.\nThe gross margin continued to increase to 24% in Fiscal 1995 from 20% in Fiscal 1994. During Fiscal 1994, the cost of sales and gross margin were negatively impacted by the closing and relocation of the Company's manufacturing and distribution facilities in Mexico, Arizona and Colorado to its principal location in Englewood, Colorado. During Fiscal 1995, the Company reduced manufacturing costs through reductions in personnel, improved operational efficiencies and increased vertical integration of the manufacturing process. During Fiscal 1995, the Company produced internally a larger portion of the molded components used in the Company's products than was done in Fiscal 1994. Internally manufactured components are less expensive than the same components purchased from outside vendors.\nSALES AND MARKETING EXPENSES: Selling expenses increased 12.5% during 1995. In Fiscal 1994, the Company reduced its sales and marketing management to preserve cash. During Fiscal 1995, the Company strategically hired additional sales and marketing personnel to support the Company's distributor network and refocus its marketing efforts. During Fiscal 1995, the Company increased its spending for trade advertising, sales training, sales tools and attendance at trade shows.\nINTEREST INCOME: Interest and other income for Fiscal 1995 declined 77% from Fiscal 1994 primarily due to a $200,000 decrease in the gain on the sale of assets no longer used in the business plus descreases in interest income on the Company's money market account due to lower cash balances and the pay off during Fiscal 1995 of a note receivable on which the Company was earning 8% interest.\nINTEREST EXPENSE: Interest expense decreased 37% during Fiscal 1995 due to the conversion by Scherer Healthcare, Inc. of $2,500,000 of debt to equity in the Company in May 1994.\nFISCAL 1994 VERSUS FISCAL 1993\nAt the end of the first quarter of Fiscal 1994, the Company effected a quasi-reorganization as described above. The Company's Consolidated Statement of Operations for Fiscal 1994 has been separated between operations pre- and post-quasi-reorganization. When appropriate for a more complete understanding, the results of operations discussed below for Fiscal 1994 delineates operations in the first quarter separate from the remainder of the year.\nREVENUE, COST OF SALES AND GROSS PROFIT: In October 1991, the sale of the Company's products practically ceased due to the actions of the FDA. The sales volume for the remainder of Fiscal 1992 was substantially reduced and remained at reduced levels through Fiscal 1993. Sales volumes in Fiscal 1994 increased 2.4% over Fiscal 1993. The Company has completed its validation process of products and has concentrated its marketing efforts on rebuilding market share.\nThe volume of the Company's sales in Fiscal 1993 was marginally sufficient to fully absorb and cover the amount of overhead related to the Company's production and the costs of revalidating its products. Validation costs included additional engineering, inspection and quality control costs to ensure compliance with FDA regulations. Smaller production runs resulted in smaller purchasing volumes and lost volume discounts. In addition, the Company was purchasing components that it once manufactured, resulting in increased material costs. During Fiscal 1994, the gross margin was 15% for the first quarter and 22% for the remaining three quarters. The cost of sales and gross margin for the first quarter were impacted by the closing and relocation of the Company's Mexico; Nogales, Arizona; and Parker, Colorado, manufacturing and warehouse facilities to its Englewood, Colorado facility. The relocation caused downtime in the Englewood facility and it had to be modified to accommodate the relocated equipment and manufacturing lines. During Fiscal 1994, the Company began manufacturing a limited number of molded components which were purchased during Fiscal 1993. This manufacturing of components, the efficiencies achieved by the consolidation of manufacturing and warehouse facilities, reductions in personnel and the Company's continued emphasis to improve operations and reduce costs favorably impacted cost of sales and gross margin during Fiscal 1994.\nSALES AND MARKETING EXPENSES: Sales expense decreased 31% during Fiscal 1994 from Fiscal 1993 due to restructuring of the sales and marketing function. The reorganization trimmed upper level sales and marketing management to reflect the lower sales levels and focused on the strengthening of the Company's existing distributor network.\nGENERAL AND ADMINISTRATIVE EXPENSES: General and administrative expenses in Fiscal 1993 were high due to the Company's ongoing revalidation and remarketing efforts, as well as its attempts to obtain refinancing. Such efforts resulted in additional consulting fees ($953,000), legal fees ($763,000) and investment banking and advisory fees ($942,000). During Fiscal 1994, general and administrative expenses decreased 54% due to the Company's completion of its product revalidation and the consummation of its successful refinancing as described in Note 12 to the Consolidated Financial Statements.\nLOSS ON SALE\/DISPOSAL: Fiscal 1993 losses on the sales or disposition of assets can be summarized as follows:\nDuring Fiscal 1994, the Company experienced no losses on the sales of assets.\nEXTRAORDINARY ITEM: In the first quarter of Fiscal 1994, the Company exchanged 91% of its Swiss Franc denominated bonds as discussed above, and recorded a gain of approximately $706,000 on the early extinguishment of debt. In the fourth quarter of Fiscal 1994, the Company exchanged an additional 5% of its Swiss bonds and recorded a similar gain on the exchange of approximately $282,000. See Note 12 to the Consolidated Financial Statements for a detailed discussion of the Swiss bond exchange.\nLIQUIDITY AND CAPITAL RESOURCES\nDuring Fiscal 1995, the Company has incurred continuing losses, and $994,000 of cash was used to fund operations. Liquidity was provided during Fiscal 1995 by cash on hand at the beginning of the fiscal year, obtained primarily from the sale of the Company's Arterial Blood Gas product line to Scherer Healthcare, Inc. during Fiscal 1994. Cash was also provided by proceeds of $245,000 from the sale of assets no longer used in the business and $375,000 of proceeds from the repayment of a note receivable.\nAt April 1, 1995, the Company had approximately $600,000 of cash on hand. Subsequent to year end, the following events occurred:\n(i) The Company sold its 10% investment in Seabrook Medical Systems, Inc., realizing proceeds of $200,000;\n(ii) During Fiscal 1994, the Company received an assessment of approximately $745,000 for additional taxes and interest from the Internal Revenue Service (\"IRS\"), as discussed in Note 10 to the Consolidated Financial Statements. In June, 1995, the Company negotiated a repayment plan with the IRS whereby the Company paid $400,000 in June 1995, with the remaining balance due in equal monthly installments over a two-year period. The Company must use best efforts to obtain third-party financing for all or a portion of the remaining balance by January 2, 1996;\n(iii) In May, 1995, the Company settled a lawsuit with the former President and former Chairman of the Company as discussed in Note 11 to the Consolidated Financial Statements, whereby the Company agreed to pay a total of $725,000 plus interest at 9%. A total of $200,000 was paid in May 1995 and the remainder will be paid in monthly installments through September 1998.\nThe Company has taken several steps in Fiscal 1996 to preserve cash and increase profitability on sales, including (i) the addition of independent manufacturer's representatives to supplement the Company's sales force; (ii) cost reductions in all departments; and (iii) equipment has been ordered which will increase the automation of the Company's manufacturing process.\nThe Company's planned capital investment during Fiscal 1996 is approximately $720,000 for new molds and betterments to existing molds, and for equipment to automate the Company's manufacturing process. Management believes that approximately $390,000 of this investment can be funded with internally generated funds and the Company has a financing commitment for the remaining $330,000.\nDue to the factors discussed above, there remains substantial doubt about the Company's ability to continue as a going concern. Management of the Company believes that it can fund its current operating levels and meet its obligations as they come due for the first half of Fiscal 1996 from existing cash on hand at April 1, 1995. Thereafter, the viability of the Company will be dependent on increasing operating income and, if necessary, the successful completion of external financing arrangements, which the Company is currently negotiating. However, there can be no assurance that external financing will be available to meet operating requirements as needed by the Company.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA:\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo Marquest Medical Products, Inc. and Subsidiaries:\nWe have audited the accompanying consolidated balance sheets of MARQUEST MEDICAL PRODUCTS, INC. (a Colorado corporation) and subsidiaries as of April 1, 1995 and April 2, 1994 (post quasi-reorganization), and the related consolidated statements of operations, stockholders' equity (deficit) and cash flows for the fiscal year ended April 1, 1995 and the nine months ended April 2, 1994 (post quasi-reorganization--Note 13), and for the three months ended July 3, 1993, and the fiscal year ended April 3, 1993 (pre quasi-reorganization). 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 Marquest Medical Products, Inc. and subsidiaries as of April 1, 1995 and April 2, 1994 (post quasi-reorganization) and the results of their operations and their cash flows for the fiscal year ended April 1, 1995 and the nine months ended April 2, 1994 (post quasi-reorganization) and for the three months ended July 3, 1993 and the fiscal year ended April 3, 1993 (pre quasi-reorganization), in conformity with generally accepted accounting principles.\nThe accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 3 to the Consolidated Financial Statements, the Company has incurred continuing losses during the fiscal year ended April 1, 1995. Operations continue to use cash and subsequent to year end, the Internal Revenue Service required partial payment of taxes due (Note 10). During Fiscal 1995, the Company completed several transactions to improve its cash requirements. First, the Company refinanced its Industrial Revenue Bonds with a ten-year agreement due in monthly installments through June 2004 (Note 5). Second, the beneficial owner of the Company converted $2,500,000 of notes due from the Company into 3,333,333 shares of the Company's common stock (Note 12). The Company has taken several further steps in Fiscal 1996 to preserve cash and increase profitability on sales as discussed in Note 3. Nevertheless, there remains substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 3 to the Consolidated Financial Statements. The Consolidated Financial Statements do not include any adjustments that might result from the outcome of these uncertainties.\nARTHUR ANDERSEN LLP\nDenver, Colorado, June 30, 1995.\nMARQUEST MEDICAL PRODUCTS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (THOUSANDS OF DOLLARS)\nASSETS\nThe accompanying notes to Consolidated Financial Statements are an integral part of these consolidated balance sheets.\nMARQUEST MEDICAL PRODUCTS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (THOUSANDS OF DOLLARS, EXCEPT SHARE AMOUNTS)\nLIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)\nThe accompanying notes to Consolidated Financial Statements are an integral part of these consolidated balance sheets.\nMARQUEST MEDICAL PRODUCTS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)\nMARQUEST MEDICAL PRODUCTS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (Continued on next page) (THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)\nThe accompanying notes to Consolidated Financial Statements are an integral part of these consolidated statements.\nMARQUEST MEDICAL PRODUCTS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT) (THOUSANDS OF DOLLARS EXCEPT SHARE AMOUNTS)\nThe accompanying Notes to Consolidated Financial Statements are an integral part of these consolidated statements.\nMARQUEST MEDICAL PRODUCTS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (THOUSANDS OF DOLLARS)\n(Continued on next page)\nMARQUEST MEDICAL PRODUCTS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (THOUSANDS OF DOLLARS)\n(Continued on next page)\nMARQUEST MEDICAL PRODUCTS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (THOUSANDS OF DOLLARS)\n(Continued on next page)\nMARQUEST MEDICAL PRODUCTS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (THOUSANDS OF DOLLARS)\nThe accompanying notes to Consolidated Financial Statements are an integral part of these consolidated statements.\nMARQUEST MEDICAL PRODUCTS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. DESCRIPTION OF BUSINESS:\nMarquest Medical Products, Inc. (the \"Company\") was incorporated in Colorado on March 28, 1979, for the purpose of developing, manufacturing and distributing medical and related products and services. The Company operates in the United States and has one line of business - it manufactures and distributes medical devices and equipment to the healthcare provider sector. During Fiscal 1995, 1994, and 1993, the Company had one distributor, Tri-Anim Health Services, Inc. of Sylmar, California, who accounted for 19%, 18%, and 16%, respectively, of the Company's sales. The Company's fiscal year ends on the Saturday closest to March 31.\nThe Company's export sales for the latest three fiscal years are presented in the table below. Profits on export sales have been comparable to those associated with domestic sales.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:\nQUASI-REORGANIZATION. On June 11, 1993, the Company's Board of Directors approved quasi-reorganization procedures which were effective July 3, 1993, the end of the Company's first quarter of Fiscal 1994. The Company has segregated its Consolidated Statements of Operations and Cash Flows for Fiscal 1994 into the three-month period prior to and the nine-month period subsequent to the quasi-reorganization.\nPRINCIPLES OF CONSOLIDATION. The Consolidated Financial Statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany transactions and balances have been eliminated.\nREVENUE RECOGNITION. Revenue is recognized at the time the product is shipped.\nINVENTORIES. Inventories are stated at the lower of cost (first-in, first-out basis) or market. Work in process and finished goods include material costs, labor and manufacturing overhead. The Company has expensed all inventories that cannot be used in the Company's operations.\nMARQUEST MEDICAL PRODUCTS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nInventories consist of the following:\nFOREIGN CURRENCY EXCHANGE GAIN\/(LOSS). The Company had SFr 720,000, 720,000 and 17,040,000 of Swiss Franc denominated bonds outstanding at April 1,1995, April 2, 1994 and April 3, 1993, respectively. The foreign currency gain\/(loss) is the result of the difference in the exchange rate between the Swiss Franc and the U.S. Dollar at the beginning and end of the related period for Swiss Francs outstanding during the period. The annual interest payments on the bonds are accrued and recorded as interest expense with the appropriate adjustments made to reflect the current exchange rate.\nPROPERTY, PLANT AND EQUIPMENT. Property, plant and equipment are recorded at acquisition cost. Depreciation and amortization are provided using the straight-line method over the estimated useful lives of the assets as follows:\nExpenditures for maintenance and repairs are charged to operations as incurred, whereas expenditures for renewals and betterments are capitalized and depreciated.\nRESEARCH AND DEVELOPMENT EXPENSE. Research and development expenditures for the creation and application of new products and processes are expensed as incurred.\nINCOME TAXES. As discussed in Note 10, effective April 4, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS 109\"). Under SFAS 109, deferred tax assets or liabilities are computed based on the difference between the financial reporting and income tax bases of assets and liabilities, as measured by the statutory tax rates in effect when such differences are expected to reverse. SFAS 109 requires recognition of deferred tax assets for the expected future effects of all deductible temporary differences, loss carryforwards and tax credit carryforwards. Deferred tax assets are then reduced, if deemed necessary, by a valuation allowance for the amount of any tax benefits which, more likely than not, based on current circumstances, are not expected to be realized (see Note 10).\nGOODWILL. The difference between direct costs of acquisitions accounted for by the purchase method and the estimated fair value of the net assets of acquired companies is recorded as goodwill and amortized over the remaining useful life. The Company periodically assesses the realizability of its recorded goodwill and makes any appropriate adjustments. During Fiscal 1994, as part of the quasi-reorganization discussed in Note 13, the Company reduced the remaining goodwill at July 3, 1993 of $4,283,000 to zero.\nMARQUEST MEDICAL PRODUCTS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nEARNINGS PER COMMON SHARE. Earnings per common share is based on the weighted average number of common and common stock equivalent shares outstanding during each period. Common stock equivalent shares were anti-dilutive in Fiscal 1995, 1994 and 1993 and are therefore excluded from the computation.\nCONSOLIDATED STATEMENTS OF CASH FLOWS. For purposes of reporting cash flows, the Company considers all highly liquid investments with an original maturity of three months or less to be cash and cash equivalents.\n3. BASIS OF PRESENTATION:\nThe Company's Consolidated Financial Statements have been presented on the basis that it will continue as a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The conditions and uncertainty associated with this basis of presentation, as well as management's plans concerning these matters, are described in the following paragraphs.\nFDA ACTIONS. The Company is subject to oversight and regulation by the U.S. Food and Drug Administration (\"FDA\") for substantially all of its manufactured products. On August 8, 1991 the Company was named in a civil complaint filed by the FDA alleging that the Company violated Good Manufacturing Practices (\"GMP\") and other FDA regulations. This dispute was resolved through the execution of a consent decree by the Company on October 1, 1991.\nThe consent decree provided for a series of inspections on the part of the FDA in the Company's U.S. manufacturing facilities. Following the first of these inspections, the Company was directed on October 8, 1991, to suspend its U. S. manufacturing and distribution operations until certain issues had been resolved to the satisfaction of the FDA. This suspension lasted until January 9, 1992 and had a significant impact on the operations of the Company.\nDuring Fiscal 1993, the Company's operations continued to be impacted by significantly lower sales volumes and higher operating costs as products were revalidated in accordance with GMP and reintroduced to the market. During Fiscal 1994, the Company completed the revalidation of its products, and in July, 1993, the FDA completed a routine inspection of the Company's compliance with the FDA's GMP. The results of the inspection indicated that the Company had made significant improvements in its systems and procedures. The Company was issued an inspection report with only two deficiency observations noted, which were corrected. During Fiscal 1995, there were no FDA compliance inspections.\nFINANCING. During Fiscal 1995, the Company refinanced its Industrial Revenue Bonds to a 10-year Term Loan Agreement due in monthly installments through June 2004 (See Note 5 to the Consolidated Financial Statements). Also during Fiscal 1995, Scherer Healthcare, Inc. elected to convert $2,500,000 of its Marquest debt to Marquest common stock.\nOPERATIONS. Cash used in operations has decreased from $7,547,000 in Fiscal 1993 and $3,585,000 in Fiscal 1994 to $994,000 in Fiscal 1995. Liquidity was provided during Fiscal 1995 by cash on hand at the beginning of the fiscal year, obtained primarily from the sale of the Company's Arterial Blood Gas product line to Scherer Healthcare, Inc. during Fiscal 1994.\nAt April l, 1995, the Company had approximately $600,000 of cash on hand. Subsequent to year end, the following events occurred:\n(i) The Company sold its 10% investment in Seabrook Medical Systems, Inc., realizing proceeds of $200,000;\nMARQUEST MEDICAL PRODUCTS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(ii) During Fiscal 1995, the Company received an assessment of approximately $745,000 for additional taxes plus interest from the Internal Revenue Service (\"IRS\"), as discussed in Note 10 to the Consolidated Financial Statements. In June 1995, the Company negotiated a repayment plan with the IRS whereby the Company paid $400,000 in June 1995, with the remaining balance due in equal monthly installments of approximately $20,000 over a two-year period. The Company must use best efforts to obtain third-party financing for all or a portion of the remaining balance by January 2, 1996; and\n(iii) In May 1995, the Company settled a lawsuit with the former President and former Chairman of the Company as discussed in Note 11 to the Consolidated Financial Statements, whereby the Company agreed to pay a total of $725,000 plus interest at 9%. A total of $200,000 was paid in May 1995 and the remainder will be paid in monthly installments through September 1998.\nThe Company has taken several steps in Fiscal 1996 to preserve cash and increase the gross margin on its sales: (i) independent manufacturer's representatives have been added to supplement the Company's sales force; (ii) effective in the first quarter of 1996, the Company has increased prices of its products; (iii) operating expenses in all departments have been reduced; and (iv) equipment has been ordered which will further automate the Company's manufacturing process. The Company has a financing commitment to fund $330,000 for the capital investment in automation equipment.\nManagement of the Company believes that it can fund its current operating levels and meet its obligations as they come due for the first half of Fiscal 1996 from improving profitability as discussed above and existing cash on hand at April 1, 1995. Thereafter, the viability of the Company will be dependent on increasing profitability and, if necessary, the successful completion of external financing arrangements, which the Company is currently negotiating. However, there can be no assurance that external financing will be available to meet operating requirements as needed by the Company. Nevertheless, there remains doubt about the Company's ability to continue as a going concern. The accompanying consolidated financial statements do not include any adjustments that might result from the outcome of these uncertainties.\n4. INVESTMENTS:\nSEABROOK MEDICAL SYSTEMS, INC. In Fiscal 1991 the Company acquired 10% of the issued and outstanding Class A and Class B common shares of Seabrook Medical Systems, Inc. (\"Seabrook\"). As part of this transaction, the Company entered into a private label distribution agreement with Seabrook that gave the Company worldwide distribution rights of certain products for a period of five years. In exchange for the 10% ownership interest, a private label distribution agreement and a license agreement to manufacture those same products, the Company paid approximately $608,000 in cash and agreed to loan Seabrook an additional $600,000 at an interest rate of 8% per annum. In Fiscal 1993, the Company determined that these products no longer played a part in its strategic direction and wrote off its remaining investment of $368,000. The note was paid off by Seabrook during Fiscal 1995. Subsequent to year end the Company sold its 10% investment back to Seabrook for $200,000.\nINVESTMENT IN SUBSIDIARY. In Fiscal 1993, the Company sold its investment in a subsidiary in exchange for a $300,000 note receivable. During Fiscal 1994, $100,000 was received and a reserve was established for the remainder of the receivable.\nDIVERSICARE, INC. The Company acquired 343,750 shares of common stock of Diversicare, Inc. in February, 1992 as part of the sale of the Company's Home Healthcare Division. At that time, due to certain restrictions and put and call provisions, it was the Company's intent to hold the stock until it could be realized at $16 per share.\nDuring Fiscal 1992, the Company became critically short of cash. Product validation costs and remarketing costs in excess of those previously anticipated had resulted in significant liquidity problems. As a result, the Company's\nMARQUEST MEDICAL PRODUCTS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nmanagement determined that sales of nonoperating assets were required to fund operations. The nonmarketable nature of the Diversicare, Inc. stock and the Company's critical need for cash resulted in the Company accepting a significant discount from the carrying amount of the stock to provide needed cash for operations. Accordingly, in Fiscal 1993, the Company entered into an agreement to sell the common stock for approximately $3,000,000 and recorded a loss of approximately $2,494,000.\nPROPERTY HELD FOR LEASE. As a result of a plant consolidation in Fiscal 1989, certain real property owned by the Company had been leased to a third party. Prior to Fiscal 1994, the Company had recorded $350,000 in writedowns to this investment. During Fiscal 1994, the Company sold the property and recorded a $50,000 gain on the sale.\n5. DEBT:\nMARQUEST MEDICAL PRODUCTS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nThe scheduled maturities of long-term debt for the next five fiscal years are as follows: 1996 - $1,126,000; 1997 - $103,000; 1998 - $112,000; 1999 - $4,651,000; 2000 - $132,000; thereafter - $670,000.\nSWISS BONDS. On January 14, 1992, the Company was notified that the holders of the majority of its Swiss bonds had exercised their right to put the bonds for redemption as of March 11, 1992. The Company was not able to honor this put, and accordingly defaulted on these obligations. The Company did not make any payments of principal or interest on the Swiss bonds in Fiscal 1993. During Fiscal 1994, the Company refinanced a significant portion of the Swiss bonds outstanding (see Note 12). The Swiss bonds outstanding at April 1, 1995, including the accrued interest on these bonds, have been classified as current maturities of long-term debt.\nNOTE PAYABLE TO BANK\/INDUSTRIAL REVENUE BONDS. The Industrial Revenue Bonds (the \"Bonds\"), which were due on December 31, 1993, were refinanced in Fiscal 1995 with a term loan from the same bank holding the Bonds. The Term Loan Agreement dated June 30, 1994, between the Company and Colorado National Bank (the \"Bank\"), imposes certain conditions and financial covenants on the Company. At April l, 1995, the Company was not in compliance with covenants requiring a specified current ratio and ratio of total liabilities to tangible net worth. The Company was also not in compliance with a covenant that the Company will pay and discharge all claims which might become a lien on the Company's property (see Note 10). The Bank has subsequently waived the requirement of compliance with these covenants.\nAlso, pursuant to the Term Loan Agreement, the Company cannot, without the written prior approval of the Bank, (1) make any expenditures for capital assets in excess of $1 million in any fiscal year subsequent to April l, 1995 and (2) pay or declare any dividends or purchase, redeem or otherwise acquire any of its capital stock, or make any other distribution of any property to any of its shareholders.\nNOTE PAYABLE TO SCHERER. The note payable to Scherer was issued during Fiscal 1994 to purchase Scherer's preferred stock which was used in connection with exchange offers for the Company's defaulted Swiss Bonds (see Note 12).The Company has not made its semi-annual interest payment to Scherer since September 30, 1993, due to the Company's cash flow deficit. Scherer has waived this event of noncompliance. The total interest accrued on the note payable is $347,000 at April l, 1995.\nNOTES PAYABLE. At April 1, 1995, the Company has three notes payable outstanding to a leasing company, aggregating $220,000. These notes represent the down payments funded by the leasing company on three pieces of equipment which are being constructed for the Company. The notes are recorded as current liabilities as the notes will be paid by the execution of long-term capital leases upon delivery and acceptance of the equipment by the Company during Fiscal 1996. The notes bear interest at 18% which is paid monthly. The remaining amount of the capital equipment to be funded by the leasing company will be approximately $330,000.\n6. INCENTIVE AND NON-QUALIFIED STOCK OPTION PLAN AND WARRANTS:\nSTOCK OPTION PLAN. The Company has an Incentive and Non-Qualified Stock Option Plan for executives and key employees, which is administered by the Compensation Committee of the Board of Directors. Shares approved for the plan total 1,250,000, of which 633,400 are available for grant at April 1, 1995. At April 1, 1995, 299,026 options are vested. Options expire seven years from the date of the grant.\nMARQUEST MEDICAL PRODUCTS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nThe activity in the stock option plan for the years ended April 1, 1995, April 2, 1994 and April 3, 1993 is as follows:\nSTOCK PURCHASE PLAN. During Fiscal 1990, shareholders approved the adoption of an Employee Stock Purchase Plan to benefit all full-time, permanent employees of the Company with more than one year of service. The shares approved for the 1990 Plan totaled 500,000. During Fiscal 1994, 1993 and 1992, shares in the amount of 934, 12,838 and 12,317, respectively, were issued under this plan. During Fiscal 1994, the Board of Directors terminated the Employee Stock Purchase Plan.\nCOMMON STOCK PURCHASE RIGHTS. On August 18, 1991, the Board of Directors of the Company declared a dividend distribution of one right (a \"Right\") for each outstanding share of the Company's Common Stock to shareholders of record at the close of business on August 20, 1991 (the \"Record Date\"). Each Right entitles the registered holder to purchase from the Company a unit consisting of one-half of a share (a \"Unit\") of Common Stock at a purchase price of $25.00 per Unit, subject to adjustment.\nThe Rights are attached to all Common Stock certificates representing shares outstanding, and no separate Rights Certificates have been distributed. The Rights will separate from the Common Stock and a \"Distribution Date\" will occur so that the Rights become exercisable no later than ten business days following (1) the public announcement that a person or group (other than Scherer Healthcare, Inc.) has acquired, or obtained the right to acquire, 15% or more of the Company's outstanding shares or (2) the commencement of a tender or exchange offer that would result in a person or entity (other than Scherer Healthcare, Inc.) owning 15% or more of the Company's outstanding Common Stock. In the event that 15% or more of the stock is actually held by a person or group, each right not owned by such person or group allows the holder to buy $50.00 worth of the Company's Common Stock, based on the then-current market price, for $25.00. The Company can redeem the rights at any time until 10 days following the above events at a price of $.01 per Right. The Rights are not exercisable until the Distribution Date and will expire at the close of business on August 20, 2001.\nMARQUEST MEDICAL PRODUCTS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nThe following table summarizes the total number of the Company's common shares which may be issued upon exercise of existing stock options and warrants, or conversion of debt.\nMARQUEST MEDICAL PRODUCTS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n7. LEASES:\nOPERATING LEASES. The Company leases warehouse space as well as office and manufacturing equipment under non-cancelable operating leases. The following is a schedule of future minimum rental payments required under these leases that expire after April 1, 1995.\nTotal rent expense, related to continuing operations, under all operating leases for Fiscal 1995, 1994, and 1993 was $560,000, $1,088,000 and $1,472,000, respectively.\nDuring Fiscal 1994, the Company consolidated its warehousing and administration facility in Nogales, Arizona into its primary facility in Englewood, Colorado. The facility in Nogales, Arizona, which was sold under a sale\/leaseback arrangement in Fiscal 1993, has a lease commitment until 2002 with monthly lease payments of approximately $14,000. The Company is currently negotiating with the owner of the building for a settlement of the obligation, as well as pursuing sublease arrangements with potential sublessors. At April 1, 1995, the Company has accrued approximately $240,000 for the estimated cost to settle the lease obligation.\nCAPITAL LEASE. In December, 1993, the Company refinanced certain production equipment rentals under a capital lease agreement. The present value of the future minimum capital lease payments as of April 2, 1994 are (in thousands of dollars):\nThe gross amount of equipment and related accumulated depreciation recorded under the capital lease was $591,000 and $185,000, respectively, at April 1, 1995.\nMARQUEST MEDICAL PRODUCTS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n8. FOOD AND DRUG ADMINISTRATION:\nThe Company is subject to regulation by the United States Food and Drug Administration (\"FDA\"). The FDA provides regulations governing the manufacture and sale of the Company's products and regularly inspects the Company and other manufacturers to determine their compliance with these regulations.\nOn August 8, 1991, the United States Attorney's Office for the District of Colorado filed a complaint for injunction against the Company and certain of its officers. The complaint alleged that the Company was manufacturing products in violation of the FDA's Current Good Manufacturing Practice Regulations (\"GMP\"). The complaint also alleged that certain of the devices were misbranded and adulterated for violating other relevant sections of the Federal Food, Drug and Cosmetic Act. On October 1, 1991, the Company and a former officer entered into a five-year Consent Decree. The two other individuals originally named in the complaint for injunction were dismissed as defendants.\nBy letter dated October 8, 1991, the District Director of the FDA's Denver district informed the Company that, pursuant to the consent decree of October l, 1991, the Company's medical device manufacturing operations were not in substantial compliance with the terms of the consent decree and ordered the Company to cease all manufacturing and distribution.\nBased upon agreements with the FDA in November and December 1991, the Company was allowed to recondition inventories of components, sub-assemblies and finished products which were produced prior to the October 8th shut down. This was done in close cooperation with the FDA by the use of higher sampling levels and tightened acceptable quality limits. After the FDA reviewed the Company's records of this reprocess\/rework, the FDA allowed the distribution of these products. The Company was also allowed to manufacture products following the new, documented procedures.\nBy letter dated January 9, 1992, the FDA's Denver district office informed the Company that it was authorized to renew its operations, including production and distribution of all products.\nThe Company has made substantial efforts to take appropriate corrective action and implement changes in order to respond to the FDA's concerns. These changes and corrective actions have been presented to the FDA in detail in the various submissions made by the Company. Included in those submissions also are the steps taken to prevent future recurrence of the problems identified by the FDA during its inspections. During Fiscal 1994, the FDA completed a routine inspection of the Company's compliance with the FDA's Good Manufacturing Practices. The Company was issued an inspection report with only two deficiency observations noted, which have been corrected. During Fiscal 1995, there have been no additional FDA compliance inspections.\n9. RELATED PARTY TRANSACTIONS:\nAt April 3, 1993, the Company had accrued $325,000 of severance expense which was paid after year end to the former CEO and member of the Board of Directors.\nIn Fiscal 1993 the Company paid, through monthly retainers, an amount of $314,000 to former members of the Board of Directors for additional services of a consulting nature.\nIn connection with a sale of the Company's Arterial Blood Gas (\"ABG\") product line to Scherer Healthcare, Inc. (\"Scherer\"), the Company pays a monthly royalty to Scherer of 3.25% of the Company's net sales of ABG products. During Fiscal 1995 and 1994, these royalties totaled $287,000 and $262,000, respectively. During Fiscal 1995 and\nMARQUEST MEDICAL PRODUCTS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1994, the Company expensed $180,000 and $263,000 of interest related to the Company's note payable to Scherer (see Note 5), and expensed $304,000 in Fiscal 1995 related to marketing and financial consulting provided by Scherer.\n10. INCOME TAXES:\nDuring Fiscal 1995, the nine months ended April 2, 1994, the three months ended July 3, 1993 and Fiscal 1993, the Company did not record any provision\/(benefit) for income taxes.\nEffective April 4, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS 109\"). The adoption of SFAS 109 did not have a material effect on the Company's financial position or results of operations.\nThe differences between the provision\/(benefit) for income taxes at the Federal statutory rate and that shown in the Consolidated Statements of Operation are as follows (in thousands of dollars):\nMARQUEST MEDICAL PRODUCTS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nUnder SFAS 109, deferred taxes are determined based on estimated future tax effects on differences between the amounts reflected in the financial statements and the tax basis of assets and liabilities given the provisions of the enacted tax laws. The net deferred tax assets and liabilities as of April 1, 1995 and April 2, 1994 are comprised of the following (in thousands of dollars):\nDuring recent fiscal years, the Company has experienced losses for financial reporting and tax purposes. Because of the uncertainty of realization of any future tax benefits, the Company has determined that, on a more likely than not basis, it is appropriate to reflect a valuation allowance for the entire net deferred tax asset. At April 1, 1995, the Company had tax net operating loss carryforwards of approximately $19,000,000, and capital loss carryforwards of approximately $4,100,000. Tax net operating losses expire at varying dates through 2010, and capital loss carryforwards expire at varying dates through 1998. Due to the transactions discussed in Notes 12 and 13, the future benefits associated with the utilization of net operating loss carryforwards may be substantially limited.\nDuring Fiscal 1994, the Company received a refund of federal income taxes of approximately $745,000 due to the carryback to prior years of losses incurred during the temporary suspension of operations by the FDA. The Internal Revenue Service (\"IRS\") has completed an audit, and in July 1994, determined that the losses could not be carried back and issued an assessment to the Company for the taxes plus interest. In June 1995, the Company negotiated a repayment plan with the IRS whereby the Company paid $400,000 in June, 1995 and the remaining balance will be paid in equal monthly installments over a two-year period. The Company must use best efforts to obtain third-party financing for all or a portion of the remaining balance by January 2, 1996. The IRS has placed a lien on the Company's facility in Englewood, Colorado to secure payment of the taxes. The tax assessment and interest has been accrued as of April 1, 1995.\n11. LITIGATION:\nAs of April 1, 1995, the Company was involved in various litigation matters. Certain of the more significant matters are discussed below.\nIn July, 1993, the Company filed suit in the United States District Court in Colorado against a former President and a former Chairman of the Board of Directors of the Company seeking a declaratory judgment that their termination\nMARQUEST MEDICAL PRODUCTS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nagreements were void and for damages. The Company discontinued making payments on these termination agreements in April, 1993. The former President and the former Chairman counterclaimed for payments allegedly due them under the termination agreements and the former Chairman counterclaimed for repayment of an alleged loan made by him to a third party for the benefit of the Company. Subsequent to year end, the Company entered into a settlement agreement with the counterclaimants to pay them a total of $725,000 plus interest at 9% in monthly payments through September 1998. This settlement is included in accrued liabilities in the accompanying Consolidated Financial Statements.\nA products liability action was filed against the Company in California in 1990 which was defended and settled during the trial by the Company's insurance company. Under the insurance policy, the Company may be responsible for a $250,000 self-insured retention plus the cost of defense. The Company has claimed that the insurance company mishandled the lawsuit and has declined to pay. The Company was sued by the insurance company in District Court, Arapahoe County, Colorado in February, 1994 alleging damages of either $540,000 or $290,000.\nThe Company has provided reserves on these issues. In Management's opinion, the resolution of the remaining proceeding is not expected to have a significant effect on the Company's reported financial condition or results of operations.\n12. REFINANCING TRANSACTIONS:\nDuring Fiscal 1994, the Company consummated two related transactions to provide the Company with necessary liquidity and to refinance the Swiss Bonds.\nSALE OF ARTERIAL BLOOD GAS PRODUCT LINE. The Company sold its Arterial Blood Gas product line, including $245,000 of net book value of property connected with the product line, to Scherer Healthcare, Inc. (\"Scherer') for $4.5 million in cash and agreed to a six year lease back of the product line for a royalty of 3.25% of net product line sales. The Company has the option to repurchase the product line at any time on or prior to May 31, 1996, for $4.5 million plus $22,500 for each month elapsed between the sale and repurchase. The Company granted Scherer 5,780,000 warrants to purchase common stock of the Company at $.75 per share as consideration for the repurchase option. These warrants were valued at $0.50 each. Of these, 1,530,000 and 4,250,000 will expire if not exercised by March 31, 1999 and March 31, 2003, respectively. The warrants are exercisable for cash or, if exercised by Scherer or a Scherer affiliate, for common stock of Scherer. Scherer may elect to exercise these options for no cash if a corresponding concession is granted to the Company in the product line repurchase price. Scherer may elect to receive the product line repurchase price in the form of 5,780,000 shares of the Company's common stock, based on a value of $.75 per share, plus the balance of the purchase price in cash. If Scherer makes this election, the number of warrants issued in consideration for the Company's repurchase option as described above will be reduced by a corresponding number.\nPrior to the above transaction, Scherer had advanced the Company $1,750,000. In consideration for this advance, the Company also granted to Scherer warrants to purchase 800,000 shares of the Company's common stock at $0.75 per share exercisable until March 31, 1999. These warrants were also valued at $0.50 each. The advance was repaid with the proceeds from the sale and leaseback transaction.\nThe Company recorded $3,290,000 related to the value of the warrants issued to Scherer and a deferred gain on the sale leaseback of $965,000, representing the amount of the sale proceeds, less the value assigned to the warrants, less the net book value of the property sold. The deferred gain was eliminated in the quasi-reorganization discussed in Note 13.\nMARQUEST MEDICAL PRODUCTS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nSWISS BOND REFINANCING. During Fiscal 1986, the Company issued 25,000,000 Swiss Francs of bonds due March 11, 1994. On January 14, 1992, the Company was notified that holders of the majority of its Swiss bonds had exercised their right to put the bonds for redemption as of March 11, 1992. The Company was not able to honor this put, and, accordingly, defaulted on these obligations.\nDuring Fiscal 1994, the Company acquired approximately $4,352,000 of 5% cumulative convertible preferred stock of Scherer (an amount equal to approximately 35% of the outstanding Swiss bond principal and accrued interest tendered in the transaction described below). This preferred stock was acquired in exchange for an 8% note, maturing on March 31, 1999. The note is convertible, in whole or in part, at Scherer's option, into Marquest common stock at a value of $.75 per share. The Scherer preferred stock is convertible into Scherer common stock. In May 1994, Scherer converted $2,500,000 of the principal balance of the 8% note into 3,333,333 shares of the Company's common stock.\nIn three exchange offers, the bondholders exchanged 16,320,000 Swiss Francs in bonds, 96% of the total bonds outstanding. The bondholders were offered a combination of Marquest debt, warrants to purchase common stock of the Company, and the convertible preferred stock of Scherer in exchange for the outstanding Swiss debt principal and interest. In the exchanges, the Swiss bondholders received (1) cumulative convertible preferred stock of Scherer for 35% of the principal and accrued interest of the tendered bonds; (2) unsecured, 8% U.S. dollar denominated notes of the Company maturing March 31, 1999 with an aggregate principal amount of $2,875,000, and (3) warrants to purchase 165,000 and 1,432,416 shares of Marquest common stock at $.25 and $.75 per share, respectively, exercisable until March 31, 1999. These warrants were also valued at $.50 each.\nThe Company recorded approximately $798,000 for the value assigned to the warrants given to the Swiss bondholders, a gain of approximately $988,000 on the extinguishment of the Swiss bonds and, because this transaction was considered a troubled debt restructuring under Statement of Financial Accounting Standards Number 15, the Company also accrued $3,246,000 in prospective interest on the notes. The prospective interest was eliminated in the quasi-reorganization described in Note 13.\nAs a result of the sale of the Arterial Blood Gas product line and the Swiss bond refinancing, Scherer has the right to acquire approximately 65% of the outstanding common stock of the Company through the exercise of all warrants and conversion of the note. Also as a result of the agreement with Scherer, Scherer acquired the right to, and has elected to, name a majority of the members of the Company's Board of Directors.\n13. QUASI-REORGANIZATION:\nDuring the first quarter of Fiscal 1994, the Company completed significant changes to its operations: (l) the reintroduction of substantially all of its product lines into the market after ceasing operations after an FDA shutdown in Fiscal 1992, (2) the consolidation of its manufacturing facilities in Mexico and Parker, Colorado into its primary facility in Englewood, Colorado; (3) the changes in management of the Company, including a new President and CEO, Vice President of Sales and Senior Vice President of Regulatory Affairs; and (4) the successful completion of the first exchange offer to the Swiss bondholders in which 91% of the bonds were exchanged. Considering these changes and management's expections of future operating profits, the Company determined that it was appropriate to effect a quasi-reorganization. On June 11, 1993, the Company's Board of Directors approved quasi-reorganization accounting procedures which were effective July 3, 1993, the end of the Company's first quarter of Fiscal 1994.\nQuasi-reorganization rules require that the balance sheet amounts be restated to fair values and that the accumulated deficit be eliminated against the paid-in-capital accounts. Therefore, the Company (1) wrote off the remaining amount of goodwill, totaling $4,283,000 at July 3, 1993; (2) eliminated the prospective interest on the Swiss bonds of $3,226,000 discussed in Note 12; (3) eliminated the deferred gain on the sale leaseback transaction of $965,000\nMARQUEST MEDICAL PRODUCTS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\ndiscussed in Note 12; (4) valued the treasury stock at its market value of $70,000; (5) eliminated the retained deficit of $20,434,000; and (6) reduced common stock by $17,125,000 and warrants by $3,456,000.\nThe Company has presented its Consolidated Statements of Operations and Cash Flows for the three-month period prior to and the nine-month period subsequent to the accounting for the quasi-reorganization.\n14. QUARTERLY FINANCIAL DATA (UNAUDITED)\nAll amounts are in thousands of dollars, except per share amounts\nSince the Company had net income for the fourth quarter of Fiscal 1994, earnings per share for that quarter have been calculated using a weighted average share calculation in accordance with Accounting Principles Board Opinion No. 15, \"Earnings Per Share.\"\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULE\nTo Marquest Medical Products, Inc. and Subsidiaries:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements of Marquest Medical Products, Inc. and subsidiaries included in this Form 10-K and have issued our report thereon dated June 30, 1995. Our audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole, which included an explanatory paragraph with respect to going concern issues as discussed in Note 3 to the consolidated financial statements. The following schedule listed in the index above is the responsibility of the Company's management and is presented for the purpose of complying with the Securities and Exchange Commission's rule and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\nARTHUR ANDERSEN LLP\nDenver, Colorado, June 30, 1995.\nMARQUEST MEDICAL PRODUCTS, INC. AND SUBSIDIARIES\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS (AMOUNTS IN THOUSANDS OF DOLLARS)\nITEM 9.","section_9":"ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThere have been no disagreements with accountants on any accounting or financial disclosure matters during the applicable period.\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 relating to nominees for Directors of the Company set forth under the caption \"Election of Directors\" and the information relating to compliance with Section 16(a) set forth under the caption \"Committees and Meetings of the Board of Directors\" in the Company's definitive proxy statement in connection with the Annual Meeting of Stockholders to be held on August 24, 1995 is incorporated herein by reference. Information regarding the executive officers of the Company required by Item 401(b) of Regulation S-K is set forth under the caption \"Executive Officers\" 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 relating to executive compensation set forth under the caption \"Compensation of Executive Officers\" in the Company's definitive proxy statement in connection with the Annual Meeting to be held on August 24, 1995 is incorporated herein by reference; such incorporation by reference shall not be deemed to include or incorporated by reference the information referrred to in Item 402(a)(8) of Regulation S-K.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nIn accordance with General Instruction G(3) of Form 10-K, the information relating to security ownership by certain persons set forth under the captions \"Principal Stockholders\" in the Company's definitive proxy statement for the Annual Meeting of Stockholders to be held on August 24, 1995 is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nIn accordance with General Instruction G(3) of Form 10-K, the information relating to certain relationships and related transactions set forth under the caption \"Related Party Transactions\" in the Company's definitive proxy statement in connection with the Annual Meeting of Stockholders to be held on August 24, 1995 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) The following represents a listing of all financial statement, financial statement schedules and exhibits filed as part of this report.\n(1) Financial Statements: See Table of Contents to the Consolidated Financial Statements included herein in Item 8.\n(2) Financial Statement Schedules: See Table of Contents to the Consolidated Financial Statements included herein in Item 8.\nSchedules I, III, IV and V, for which provision is made in the applicable regulations of the Securities and Exchange Commission have been omitted because they are not applicable or the information is elsewhere disclosed in the notes to the financial statements.\n(3) Exhibits: Exhibits identified in parentheses below are on file with the Securities and Exchange Commission and are incorporated herein by such references.\n3.1 Articles of Incorporation of Registrant, as amended through August 25, 1994 (Exhibit 3(i) of Registration Statement on Form S-2, Registration No. 33-85564)\n3.2 By-laws of Registrant, as amended (Exhibit 2 to Form 8-K dated April 9, 1993)\n4.1 The outside and inside front cover pages and the information set forth under the heading \"Terms of the Bonds\" excerpted from the Prospectus of the Registrant dated February 10, 1985 with respect to the 25,000,000 Swiss Franc Bonds offered pursuant thereto (Exhibit 4(b) to Form 10-K dated April 1, 1989)\n4.2 Rights Agreement dated as of August 8, 1991 between Marquest Medical Products, Inc and Bank of America National Trust & Savings Association (Exhibit 4.5 to Registration Statement on Form S-2, Registration Statement No. 33-85564)\n10.1 Master Equipment Lease Agreement dated December 8, 1993 between Marquest Medical Products, Inc. and Financing for Science International, Inc. (Exhibit 4(c) to Form 10-K dated April 2, 1994)\n10.2 Term Loan Agreement dated June 30, 1994 between Marquest Medical Products, Inc. and Colorado National Bank (Exhibit 4(d) to Form 10-Q dated July 2, 1994)\n10.3 Letter Agreement between Marquest Medical Products, Inc. and Norman Dreyfuss dated August 1, 1989 (Exhibit 10(a) to Form 10-K dated March 31, 1990)\n10.4 Letter Agreement between Marquest Medical Products, Inc. and Robert J. McKinnon dated August 19, 1991 (Exhibit 10(b) to Form 10-K dated March 28, 1992)\n10.5 Marquest Medical Products, Inc. Incentive and Non-Qualified Stock Option Plan effective November 14, 1987, as amended (Exhibit 10(c) to Form 10-K dated April 1, 1989)\n10.6 Consent Decree between Marquest Medical Products, Inc. and the Food and Drug Administration (\"FDA\") dated October 1, 1992 (Exhibit 10(d) to Form 10-K dated March 28, 1992)\n10.7 Letter from FDA approving resumption of manufacturing and distribution activities of Marquest Medical Products, Inc. dated January 9, 1992 (Exhibit 10(e) to Form 10-K dated March 28, 1992)\n10.8 Management Agreement between Marquest Medical Products, Inc. and Scherer Healthcare, Inc. dated June 1, 1994 (Exhibit 10(f) to Form 10-Q dated June 2, 1994)\n10.9 Omnibus Agreement between Scherer Healthcare, Inc. and Marquest Medical Products, Inc. dated April 12, 1993 (Exhibit 3 to Form 8-K dated April 9, 1993)\n10.10 Promissory Note dated January 13, 1995 between Marquest Medical Products, Inc. and Financing for Science International, Inc.\n10.11 Promissory Note dated January 13, 1995 between Marquest Medical Products, Inc. and Financing for Science International, Inc.\n10.12 Promissory Note dated January 13, 1995 between Marquest Medical Products, Inc. and Financing for Science International, Inc.\n21. Subsidiaries of Registrant\n27 Financial Data Schedule\n(b) Reports on Form 8-K:\nReport on Form 8-K dated February 24, 1995 regarding change in directors and officers effective February, 24, 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, in the County of Douglas, State of Colorado, on July 11, 1995.\nMARQUEST MEDICAL PRODUCTS, INC.\n\/s\/ Robert P. Scherer, Jr. By______________________________________ Robert P. Scherer, Jr., Chairman and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.","section_15":""}
{"filename":"919226_1995.txt","cik":"919226","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL Jefferson Smurfit Corporation, hereinafter referred to as the \"Company\" or \"JSC\", owns 100% of the equity interest in JSCE, Inc., hereinafter referred to as \"JSCE\". The Company has no operations other than its investment in JSCE. JSCE owns a 100% equity interest in Jefferson Smurfit Corporation (U.S.) (\"JSC (U.S.)\"). JSC (U.S.) has extensive operations throughout the United States. JSCE has no operations other than its investment in JSC (U.S.).\nThe Company operates in two business segments, Paperboard\/Packaging Products and Newsprint. The Company believes it is one of the nation's largest producers of paperboard and packaging products and is the largest producer of recycled paperboard and recycled packaging products and the largest processor of wastepaper. In addition, the Company believes it is one of the nation's largest producers of recycled newsprint.\nThe Company's Paperboard\/Packaging Products segment includes a system of paperboard mills that, in 1995, produced 1,905,000 tons of virgin and recycled containerboard, 773,000 tons of coated and uncoated recycled boxboard and solid bleached sulfate (\"SBS\") and 192,000 tons of recycled cylinderboard, which were sold to the Company's own converting operations and to third parties. The Company's converting operations consist of 51 corrugated container plants, 18 folding carton plants, and 22 industrial packaging plants located across the country, with three plants located outside the U.S. In 1995, the Company's container plants converted 1,925,000 tons of containerboard, an amount equal to approximately 101.1% of the amount it produced, its folding carton plants converted 529,000 tons of SBS, recycled boxboard and coated natural kraft, an amount equal to approximately 68.3% of the amount it produced, and its industrial packaging plants converted 148,000 tons of recycled cylinderboard, an amount equal to approximately 77.2% of the amount it produced. The paperboard\/packaging products operations also include 14 consumer packaging plants. The Company's Paperboard\/Packaging Products segment contributed 90.5% of the Company's net sales in 1995.\nThe Company's paperboard operations are supported by its reclamation division, which processed or brokered 4.3 million tons of wastepaper in 1995, and by its timber division which manages approximately one million acres of owned or leased timberland located in close proximity to its virgin fiber mills.\nThe Company's Newsprint segment includes two newsprint mills in Oregon, which produced 620,000 tons of recycled newsprint in 1995, and two facilities that produce Cladwood, a construction material produced from newsprint and wood by-products. The Company's newsprint mills are also supported by the Company's reclamation division.\nExcept for the historical information contained in this Annual Report on Form 10-K, certain matters discussed herein, including (without limitation) in particular under Part I, Item 3, \"Legal Proceedings\" and under Part II, Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations,\" are forward looking statements. The matters referred to in such statements could be affected by the risks and uncertainties involved in the Company's business, including (without limitation) the effect of economic and market conditions, the level and volatility of interest rates and currency values, wastepaper prices, costs related to environmental matters, and the impact of current or pending legislation and regulation.\nPRODUCTS\nPAPERBOARD\/PACKAGING PRODUCTS SEGMENT\nCONTAINERBOARD AND CORRUGATED SHIPPING CONTAINERS The Company's containerboard operations are highly integrated. Tons of containerboard produced and converted for the last three years were:\nThe Company's mills produce a full line of containerboard, including unbleached kraft linerboard, mottled white linerboard and recycled medium. Unbleached kraft linerboard is produced at the Company's mills located in Fernandina Beach and Jacksonville, Florida and mottled white linerboard is produced at its Brewton, Alabama mill. Recycled medium is produced at the Company's mills located in Alton, Illinois, Carthage, Indiana, Circleville, Ohio and Los Angeles, California. In 1995, the Company produced 1,057,000, 316,000 and 532,000 tons of unbleached kraft linerboard, mottled white linerboard and recycled medium, respectively. The Company's sales of containerboard in 1995 were $1,054 million (including $559 million of intracompany sales). Sales of containerboard to the Company's container plants are at market prices.\nCorrugated shipping containers, manufactured from containerboard in converting plants, are used to ship such diverse products as home appliances, electric motors, small machinery, grocery products, produce, books, tobacco and furniture, and for many other applications, including point of purchase displays. The Company stresses the value added aspects of its corrugated containers, such as labeling and multi-color graphics, to differentiate its products and respond to customer requirements. The Company's 51 container plants serve local customers and large national accounts and are located nationwide, generally in or near large metropolitan areas. The Company's total sales of corrugated shipping containers in 1995 were $1,570 million (including $109 million of intracompany sales). Total corrugated shipping container sales volumes for 1993, 1994 and 1995 were 29,394, 30,822 and 29,382 million square feet, respectively.\nRECYCLED BOXBOARD, SBS AND FOLDING CARTONS The Company's recycled boxboard, SBS and folding carton operations are also integrated. Tons of recycled boxboard and SBS produced and converted for the last three years were:\nThe Company's mill produce recycled coated and uncoated boxboard and SBS. Coated recycled boxboard is produced at the Company's mills located in Middletown, Ohio, Philadelphia, Pennsylvania, Santa Clara, California and Wabash, Indiana. The Company produces uncoated recycled boxboard at its Los Angeles, California mill and SBS at its Brewton, Alabama mill. The table above excludes production of approximately 85,000 tons in 1993 from the Lockland, Ohio boxboard mill that was closed in January 1994. In 1995, the Company produced 595,000 and 178,000 tons of recycled boxboard and SBS, respectively. The Company's total sales of recycled boxboard and SBS in 1995 were $461 million (including $231 million of intracompany sales).\nThe Company's folding carton plants offer a broad range of converting capabilities, including web and sheet litho, rotogravure and flexo printing and a full line of structural and design graphics services. The Company's 18 facilities convert recycled boxboard and SBS into folding cartons. Folding cartons are used primarily to protect customers' products while providing point of purchase advertising. The Company makes folding cartons for a wide variety of applications, including food and fast foods, detergents, paper products, beverages, health and beauty aids and other consumer products. Customers range from small local accounts to large national and multinational accounts. The Company's folding carton plants are located nationwide, generally in or near large metropolitan areas. The Company's sales of folding cartons in 1995 were $686 million (none of which were intracompany sales). Folding carton sales volumes for 1993, 1994 and 1995 were 475,000, 486,000 and 469,000 tons, respectively.\nThe Company has focused its capital expenditures in these operations and its marketing activities to support a strategy of enhancing product quality as it relates to packaging graphics, increasing flexibility while reducing customer lead time and assisting customers in innovative package designs.\nThe Company provides marketing consultation and research activities through its Design and Market Research (DMR) center. It provides customers with graphic and product design tailored to the specific technical requirements of lithographic, rotogravure and flexographic printing, as well as photography for packaging, sales promotion concepts, and point of purchase displays.\nRECYCLED CYLINDERBOARD AND INDUSTRIAL PACKAGING The Company's recycled cylinderboard and industrial packaging operations are also integrated. Tons of recycled cylinderboard produced and converted for the last three years were:\nThe Company's recycled cylinderboard mills are located in Tacoma, Washington, Monroe, Michigan, Lafayette, Indiana, and Cedartown, Georgia. The table above excludes production of approximately 49,000, 43,000 and 28,000 tons in 1993, 1994 and 1995 from a cylinderboard mill located in Monroe, Michigan that was closed in September 1995. In 1995, total sales of recycled cylinderboard were $80 million (including $34 million of intracompany sales).\nThe Company's 22 industrial packaging plants convert recycled cylinderboard, including a portion of the recycled cylinderboard produced by the Company, into papertubes and cores. Papertubes and cores are used primarily for paper, film and foil, yarn carriers and other textile products and furniture components. The Company also produces solid fiber partitions for the pharmaceutical, electronics, glass, cosmetics and plastics industries. In addition, the Company produces a patented self-locking partition especially suited for automated packaging and product protection. Also, the Company manufactures corrugated pallets that are made entirely from corrugated components and are lightweight yet extremely strong and are fully recyclable. The Company's industrial packaging sales in 1995 were $114 million (including $5 million in intracompany sales).\nCONSUMER PACKAGING The Company manufactures a wide variety of products at its 14 consumer products facilities. These products include flexible packaging, paper and metallized paper labels and labels that are heat transferred to plastic containers for a wide range of industrial and consumer product applications. The contract packaging plants provide a wide variety of custom contract packaging services including cartoning, bagging, liquid- or powder- filling and high-speed overwrapping. Fragranced advertising products and related specialty items are produced by the scented products facility. The Company produces high-quality rotogravure cylinders and has a full-service organization experienced in the production of color separations and lithographic film for the commercial printing, advertising and packaging industries. Total sales of consumer packaging products and services in 1995 were $191 million (including $15 million of intracompany sales).\nRECLAMATION OPERATIONS; FIBER RESOURCES AND TIMBER PRODUCTS The raw materials essential to the Company's business are reclaimed fiber and virgin wood fiber. The Brewton, Circleville, Jacksonville and Fernandina mills use primarily wood fibers, while the other paperboard mills use reclaimed fiber exclusively. The newsprint mills use approximately 47% wood fiber and 53% reclaimed fiber.\nThe use of recycled products in the Company's operations begins with its reclamation division which operates 27 facilities that collect, sort, grade and bale wastepaper, as well as collect aluminum and glass. The reclamation division also operates a nationwide brokerage system whereby it purchases and resells wastepaper (including wastepaper for use in its recycled fiber mills) on a regional and national contract basis. Such contracts provide bulk purchasing, resulting in lower prices and cleaner wastepaper. The reclamation division provides valuable fiber resources to both the paperboard and newsprint segments of the Company as well as to other producers. Many of the reclamation facilities are located in close proximity to the Company's recycled paperboard and newsprint mills, assuring availability of supply, when needed, with minimal shipping costs. Total sales of recycled materials in 1995 were $736 million (including $292 million of intracompany sales).\nIn 1995, the Company processed 4.3 million tons of wastepaper. The amount of wastepaper collected and the proportions sold internally and externally by the Company's reclamation division for the last three years were:\nWhile there has been unprecedented demand for reclaimed fiber during 1994 and 1995, the Company does not, however, anticipate any significant problems satisfying its need for this material in the foreseeable future. During 1995, the wastepaper which was reclaimed by the Company's reclamation plants and brokerage operations satisfied all of the Company's mill requirements for reclaimed fiber.\nThe Company's timber division manages approximately one million acres of owned and leased timberland. In 1995, approximately 59% of the timber harvested by the Company was used in its Jacksonville, Fernandina and Brewton Mills. The Company harvested 893,000 cords of timber which would satisfy approximately 35% of the Company's requirements for wood fibers. The Company's wood fiber requirements not satisfied internally are purchased on the open market or under long-term contracts. In the past, the Company has not experienced difficulty obtaining an adequate supply of wood through its own operations or open market purchases. The Company is not aware of any circumstances that would adversely affect its ability to satisfy its wood requirements in the foreseeable future. In recent years, a shortage of wood fiber in the spotted owl regions in the Northwest has resulted in increases in the cost of virgin wood fiber. In 1995, the Company's total sales of timber products were $260 million (including $201 million of intracompany sales).\nNEWSPRINT SEGMENT\nNEWSPRINT MILLS The Company's newsprint mills are located in Newberg and Oregon City, Oregon. During 1993, 1994 and 1995, the Company produced 615,000, 615,000 and 620,000 tons of newsprint, respectively. In 1995, total sales of newsprint were $361 million (none of which were intracompany sales).\nFor the past three years, an average of approximately 55% of the Company's newsprint production has been sold to The Times Mirror Company (\"Times Mirror\") pursuant to a long-term newsprint agreement (the \"Newsprint Agreement\") entered into in connection with the Company's acquisition of Smurfit Newsprint Corporation (\"SNC\") stock in February 1986. Under the terms of the Newsprint Agreement, the Company supplies newsprint to Times Mirror generally at prevailing West Coast market prices. Sales of newsprint to Times Mirror in 1995 amounted to $189 million.\nCLADWOOD Cladwood is a wood composite panel used by the housing industry, manufactured from sawmill shavings and other wood residuals and overlaid with recycled newsprint. The Company has two Cladwood plants located in Oregon. Total sales for Cladwood in 1995 were $26 million (none of which were intracompany sales).\nMARKETING\nThe marketing strategy for the Company's mills is to maximize sales of products to manufacturers located within an economical shipping area. The strategy in the converting plants focuses on both specialty products tailored to fit customers' needs and high volume sales of commodity products. The Company also seeks to broaden the customer base for each of its segments rather than to concentrate on only a few accounts for each plant. These objectives have led to decentralization of marketing efforts, such that each plant has its own sales force, and many have product design engineers, who are in close contact with customers to respond to their specific needs. National sales offices are also maintained for customers who purchase through a centralized purchasing office. National account business may be allocated to more than one plant because of production capacity and equipment requirements.\nCOMPETITION\nThe paperboard and packaging products markets as well as the newsprint markets are highly competitive and are comprised of many participants. Although no single company is dominant, the Company does face significant competitors in each of its businesses. The Company's competitors include large vertically integrated companies as well as numerous smaller companies. The industries in which the Company competes are particularly sensitive to price fluctuations as well as other competitive factors including design, quality and service, with varying emphasis on these factors depending on product line.\nBACKLOG\nDemand for the Company's major product lines is relatively constant throughout the year and seasonal fluctuations in marketing, production, shipments and inventories are not significant. The Company does not have a significant backlog of orders, as most orders are placed for delivery within 30 days.\nRESEARCH AND DEVELOPMENT\nThe Company's research and development center uses state-of-the-art technology to assist all levels of the manufacturing and sales process from raw materials supply through finished packaging performance. Research programs have provided improvements in coatings and barriers, stiffeners, inks and printing. The technical staff conducts basic, applied and diagnostic research, develops processes and products and provides a wide range of other technical services.\nThe Company actively pursues applications for patents on new inventions and designs and attempts to protect its patents against infringement. Nevertheless, the Company believes that its success and growth are dependent on the quality of its products and its relationships with its customers, rather than on the extent of its patent protection. The Company holds or is licensed to use certain patents, but does not consider that the successful continuation of any important phase of its business is dependent upon such patents.\nEMPLOYEES\nThe Company had approximately 16,200 employees at December 31, 1995, of which approximately 10,900 employees (67%), are represented by collective bargaining units. The expiration date of union contracts for the Company's major facilities are as follows: the Oregon City mill, expiring March 1997; the Brewton mill, expiring October 1997; the Fernandina mill, expiring June 1998; a group of 11 properties, including 4 paper mills and 7 corrugated container plants, expiring June 1998; the Jacksonville mill, expiring June 1999; the Alton mill, expiring June 2000 and the Newberg mill, expiring March 2002. The Company believes that its employee relations are generally good and is currently in the process of bargaining with unions representing production employees at a number of its other operations.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's properties at December 31, 1995 are summarized in the table below. Approximately 58% of the Company's investment in property, plant and equipment is represented by its paperboard and newsprint mills.\nIn addition to its manufacturing facilities, the Company owns and leases approximately 758,000 acres and 226,000 acres of timberland, respectively, and also operates wood harvesting facilities.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nLitigation In June 1993, the Company filed suit against Otis B. Ingram, as executor of the estate of Naomi M. Ingram, and Ingram-LeGrand Lumber Company in the United States District Court, Middle District of Georgia, seeking declaratory and injunctive relief and damages in excess of $3 million arising out of the defendants' alleged breach and anticipatory repudiation of certain timber purchase agreements and timber management agreements between the Company and such parties dated November 22, 1967 pertaining to approximately 30,000 acres of property in Georgia (the \"Agreements\"). The defendants filed an answer and counterclaim seeking damages in excess of $14 million based on allegations that the Company breached the Agreements and failed to pay for timber allegedly stolen or otherwise removed from the property by the Company or third parties. A jury trial commenced in October 1995 and the case was subsequently settled before completion of the trial.\nThe Company is a defendant in a number of other lawsuits which have arisen in the normal course of business. While any litigation has an element of uncertainty, the management of the Company believes that the outcome of such suits will not have a material adverse effect on its financial condition or results of operations.\nEnvironmental Matters\nFederal, state and local environmental requirements, particularly relating to air and water quality, are a significant factor in the Company's business. The Company employs processes in the manufacture of pulp, paperboard and other products, resulting in various discharges and emissions that are subject to numerous federal, state and local environmental control statutes, regulations and ordinances. The Company operates and expects to operate under permits and similar authorizations from various governmental authorities that regulate such discharges and emissions.\nOccasional violations of permit terms have occurred from time to time at the Company's facilities, resulting in administrative actions, legal proceedings or consent decrees and similar arrangements. Pending proceedings include the following:\nSweet Home, Oregon On May 11, 1995, the United States Environmental Protection Agency (\"EPA\") executed a search warrant at the Sweet Home, Oregon manufacturing facility of SNC, at which Cladwood, a wood composite panel manufactured from sawmill shavings, is produced. According to the search warrant, the U.S. Attorney's office for the District of Oregon and the EPA are investigating whether this facility violated the Clean Water Act or other federal laws in connection with its waste water discharges. The Company has been advised that the government has presented, or intends to present, evidence to a grand jury in connection with the investigation. SNC and certain of its employees could be charged, and SNC could be assessed significant fines and penalties if an indictment and conviction follows as a result of the grand jury proceeding.\nDuval County, Florida In March 1992, the Company entered into an administrative consent order with the Florida Department of Environmental Regulation to carry out any necessary assessment and remediation of Company- owned property in Duval County, Florida that was formerly the site of a sawmill that dipped lumber into a chemical solution. Assessment data with respect to this site indicates soil and groundwater contamination that will likely require nonroutine remediation. Management believes that the probable costs of this site, taken alone or with potential costs at other Company-owned properties where some contamination has been found, will not have a material adverse effect on its financial condition or results of operations.\nJacksonville, Florida In October 1994, the Company voluntarily reported possible noncompliance with certain provisions of its construction\/operation permit at its D-Graphics labels plant located in Jacksonville, Florida to state and local environmental authorities, and subsequently entered into a settlement agreement with such authorities to resolve all civil and administrative issues regarding this matter. The Company has recently been advised by the United States Department of Justice that it will not pursue any criminal action against the Company in connection with this matter.\nThe Company also faces potential liability as a result of releases, or threatened releases, of hazardous substances into the environment from various sites owned and operated by third parties at which Company-generated wastes have allegedly been deposited. Generators of hazardous substances sent to off-site disposal locations at which environmental problems exist, as well as the owners of those sites and certain other classes of persons (generally referred to as \"potentially responsible parties\" or \"PRPs\"), are, in most instances, subject to joint and several liability for response costs for the investigation and remediation of such sites under the Comprehensive Environmental Response, Compensation and Liability Act (\"CERCLA\") and analogous state laws, regardless of fault or the legality of original disposal. The Company has received notice that it is or may be a PRP at a number of federal and\/or state sites where remedial action may be required, and as a result may have joint and several liability for cleanup costs at such sites. However, liability of CERCLA sites is typically shared with the other PRPs and costs are commonly allocated according to relative amounts of waste deposited. Because the Company's relative percentage of waste deposited at a majority of these sites is quite small, management of the Company believes that its probable liability under CERCLA, taken on a case by case basis or in the aggregate, will not have a material adverse effect on its financial condition or operations. Pending CERCLA proceedings include the following:\nMiami County, Ohio Site In 1995, pursuant to a consent decree previously entered into with the United States, the Company paid $3.1 million in satisfaction of its alleged and\/or potential liability for past and future response costs under CERCLA in connection with a site in Miami County, Ohio and, pursuant to a second consent decree with the United States, paid $1.2 million in settlement of a cause of action previously commenced by the government against the Company for alleged failures to properly respond to document and information requests by the EPA with respect to such site. A criminal inquiry was commenced in 1993 relating to the Company's responses to the EPA's document and information requests, and it is uncertain whether any criminal action will be forthcoming.\nMonterey Park, California Site The Company has paid approximately $768,000 pursuant to two partial consent decrees entered into in 1990 and 1991 with respect to cleanup obligations at the Operating Industries site in Monterey Park, California. It is anticipated that there will be further remedial measures beyond those covered by these partial settlements.\nBaltimore, Maryland Site The Company entered into a consent decree and settlement agreement in full settlement of its obligations in connection with a superfund site in Baltimore, Maryland. The Company paid approximately $171,000 in 1995 as part of this settlement, and may be required to pay an additional amount up to approximately $80,000 for future cleanup costs.\nIn addition to other Federal and State laws regarding hazardous substance contamination at sites owned or operated by the Company, the New Jersey Industrial Site Recovery Act (\"ISRA\") requires that a \"Negative Declaration\" or a \"Cleanup Plan\" be filed and approved by the New Jersey Department of Environmental Protection and Energy (\"DEPE\") as a precondition to the \"transfer\" of an \"industrial establishment\". The ISRA regulations provide that a transferor may close a transaction prior to the DEPE's approval of a negative declaration if the transferor enters into an administrative consent order with the DEPE. The Company is currently a signatory to administrative consent orders with respect to two formerly leased or owned industrial establishments and to a facility that was sold in 1995 and received a negative declaration with respect thereto. Management believes that any requirements that may be imposed by the DEPE with respect to these sites will not have a materially adverse effect on the financial condition or results of operations of the Company.\nThe Company's paperboard and newsprint mills are large consumers of energy, using either natural gas or coal. Approximately 68% of the Company's total paperboard tonnage is produced by mills which have coal-fired boilers. The cost of energy is dependent, in part, on environmental regulations concerning sulfur dioxide and particulate emissions.\nBecause various pollution control standards are subject to change, it is not possible at this time to predict the amount of capital expenditures that will ultimately be required to comply with future standards. In particular, the EPA has proposed a comprehensive rule governing the pulp, paper and paperboard industry, which could require substantial expenditures to achieve compliance on the part of the Company. For the past three years, the Company has spent an average of approximately $10 million annually on capital expenditures for environmental purposes. Further sums may be required in the future, although, in the opinion of management, such expenditures will not have a material effect on its financial condition or results of operations. The anticipated spending for such capital projects for fiscal 1996 is approximately $30 million. Since the Company's competitors are, or will be, subject to comparable pollution control standards, including the proposed rule discussed above, if implemented, management is of the opinion that compliance with future pollution standards will not adversely affect the Company's competitive position.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matters were submitted to a vote of security holders of the registrant during the fourth quarter of 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nMARKET INFORMATION At December 31, 1995 the Company's common stock was held by approximately 12,000 stockholders, including stockholders of record and shares owned beneficially through nominee or street name accounts with brokers. The Company's common stock trades on The Nasdaq Stock Market under the symbol \"JJSC\". The high and low trading prices of the stock for 1995 were:\nDIVIDENDS The Company has not paid cash dividends on its common stock and does not intend to pay dividends on its common stock in the foreseeable future. The ability of the Company to pay dividends in the future is restricted by certain provisions contained in the 1994 Credit Agreement and the indentures relating to JSC (U.S.)'s outstanding indebtedness.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA (In millions, except per share and statistical data)\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nGeneral Market conditions and demand for containerboard, corrugated shipping containers and newsprint, three of the Company's most important products, are generally subject to cyclical changes in the economy and changes in industry capacity, both of which can significantly impact selling prices and the Company's profitability. Containerboard markets, which were depressed in the early 1990's, began to recover in late 1993 and the strong growth in the U.S. economy in the second half of 1994 and the first half of 1995 propelled containerboard prices through a series of rapid increases. Linerboard prices in 1993 were at a low of $280\/ton prior to the recovery and, by April of 1995, had reached a record high of $535\/ton. Market conditions were strong until the third quarter of 1995, when the economy began to weaken, causing excess inventories in the industry. Many paper companies, including the Company, took downtime at paper mills during the fourth quarter of 1995 in response to the slowdown in the economy. Linerboard prices softened by the end of 1995 to $490\/ton, but were still high compared to historical levels.\nNewsprint markets were also depressed in the early 1990's. Demand for newsprint began to improve in the second half of 1994 and prices steadily increased during the second half of 1994 and 1995.\nIncreases in demand for recycled paperboard products and recycled newsprint during 1994 and 1995 created unprecedented demand for reclaimed fiber, causing shortages of this material and prices escalated at a dramatic rate. While the effect of the reclaimed fiber price increases is favorable to the Company's reclamation products division, it is unfavorable to the Company overall because reclaimed fiber is a key raw material for certain of its paper mills. The demand for and price of reclaimed fiber dropped dramatically in the fourth quarter of 1995 as a result of the significant downtime taken by containerboard mills throughout the country. Although reclaimed fiber prices are currently low in comparison to the record highs reached earlier in 1995, the Company believes it is likely that the cost of reclaimed fiber will increase again in 1996. The Company does not, however, anticipate any significant problems satisfying its need for this material in the foreseeable future. Results of Operations\n1995 Compared to 1994 Price recovery coupled with productivity gains and cost reduction programs implemented in recent years provided record sales and earnings for the Company in 1995. Net sales were $4.1 billion, an increase of 26.6% over 1994 and income from operations was $630 million, more than double the 1994 amount. Increases (decreases) in sales for each of the Company's segments are discussed below.\nPaperboard\/Packaging Products Segment Sales Net sales of the Paperboard\/Packaging Products segment increased 24.6% compared to 1994, to $3.71 billion, primarily as a result of sales prices and product mix.\nNet sales of containerboard and corrugated shipping containers increased 25.9% compared to 1994, to $1.96 billion. Corrugated shipping container prices increased 28.0% on average compared to 1994. In view of the reduced demand in the second half of 1995, several of the Company's containerboard mills took downtime in order to reduce inventories. As a result of this downtime, shipments of containerboard in 1995 were down 2.0% compared to 1994. Shipments of corrugated shipping containers were down 4.2% compared to 1994.\nNet sales of recycled boxboard, SBS and folding cartons increased 9.6% compared to 1994, to $916 million. Recycled boxboard prices were increased during the first half of 1995 to cover higher reclaimed fiber cost, but declined later in the year in response to lower reclaimed fiber cost. On average, prices of recycled boxboard and SBS rose 19.4% and 18.9%, respectively, compared to 1994. Folding carton prices increased 9.4% on average compared to 1994. Shipments of recycled boxboard and SBS decreased 2.1% and shipments of folding cartons decreased by 2.8% compared to 1994.\nNet sales for the reclamation and timber products operations increased 74.7% compared to 1994, to $503 million, due primarily to escalating prices of reclaimed fiber. Reclaimed fiber prices were higher by 62.0% on average compared to 1994 and shipments increased 4.1% compared to 1994.\nNet sales of recycled cylinderboard and industrial packaging increased 18.3% compared to 1994, to $155 million, due primarily to higher prices. Net sales of consumer packaging increased 6.0% compared to 1994, to $176 million.\nNewsprint Segment Sales Net sales of the Newsprint segment increased 49.4% compared to 1994, to $387 million, primarily as a result of sales prices and product mix.\nCosts and Expenses Cost of goods sold as a percent of net sales declined from 82.5% in 1994 to 77.6% in 1995 in the Paperboard\/Packaging Products segment and declined from 102.2% in 1994 to 89.5% in 1995 in the Newsprint segment. Selling and administrative expenses as a percent of net sales declined for both segments from 6.9% in 1994 to 5.9% in 1995. The sales price increases implemented during 1995 were the primary reason for the improvements in each of cost of goods sold and selling and administrative expenses as a percent of net sales.\nIn 1993, the Company recorded a pretax charge of $96 million for a restructuring program (the \"Restructuring Program\") to improve its long- term competitive position. The Restructuring Program provided for plant closures, asset write-downs, reductions in workforce, relocation of employees and consolidation of certain plant operations, expected to be completed over an approximate three year period. Major activities relating to the Restructuring Program in 1995 included the sale of a corrugated shipping container plant in August and the shutdown in September of the East mill in Monroe, Michigan, which produced approximately 50,000 tons per year of recycled cylinderboard. Since 1993, the Company has written down the assets of closed facilities and other nonproductive assets totalling $35 million and made cash expenditures of $33 million relating to the Restructuring Program. Proceeds of $5 million from sale of fixed assets and asset transfers to other plants of $2 million were used to offset additional expenses and anticipated expenses related to shutdowns. The remaining balance of the restructuring liability, the majority of which is for anticipated cash expenditures in 1996, will continue to be funded through operations. Based on expenditures to date and those anticipated by the original plan, no significant adjustment to the reserve balance is expected at this time.\nThe Company decreased its weighted average discount rate in measuring its pension obligations from 8.5% to 7.25% and its rate of increase in compensation levels from 5.0% to 4.0% at December 31, 1995. The net effect of changing these assumptions was the primary reason for the increase in projected benefit obligations. In addition, the Company changed its expected long-term rate of return on assets from 10.0% to 9.5% at December 31, 1995. The net effect of these changes is expected to increase pension cost in 1996 by approximately $14 million.\nIn the fourth quarter of 1995, the Company recorded a pretax charge totalling $25 million related to product quality matters and failure to follow proper manufacturing and internal procedures in an immaterial non-core product line. The Company is continuing to further evaluate this issue and expects to conclude its review during the second fiscal quarter. Based upon the information currently available to management, the Company believes the reserve is adequate but intends to reevaluate the adequacy of the reserve at the conclusion of its review.\nInterest expense for 1995 declined $35 million compared to 1994 due primarily to lower average debt levels outstanding and lower effective interest rates. The lower average interest rate in 1995 resulted primarily from the retirement in December 1994 of the Company's high yield subordinated debt in conjunction with the Company's 1994 Recapitalization as defined in the JSC 1994 Annual Report on Form 10-K (the \"1994 Recapitalization\").\nThe Company will adopt Statement of Financial Accounting Standards (\"SFAS\") No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of\", in the first quarter of 1996. Based on current circumstances, the Company does not believe the effect of such adoption will be material.\nThe provision for income taxes in 1995 was $156 million compared to $16 million in 1994. The Company's effective tax rate of 38.7% in 1995 was substantially lower than the 1994 effective tax rate of 57.1%, primarily due to the effect of permanent differences from applying purchase accounting. The Company has net operating loss carryforwards for federal income tax purposes of approximately $98 million (expiring in the year 2009), none of which are available for utilization against alternative minimum taxes. Federal income tax returns for 1989 through 1991 are currently under examination. While the ultimate results of such examination cannot be predicted with certainty, the Company's management believes that the examination will not have a material adverse effect on its consolidated financial condition or results of operations.\n1994 Compared to 1993 Results for 1994 reflected increased demand for the Company's products. Net sales of $3.2 billion for 1994 were up 9.7% compared to 1993. Increases (decreases) in sales for each of the Company's segments are discussed below.\nPaperboard\/Packaging Products Segment Sales Net sales in the Paperboard\/Packaging Products segment for 1994 increased 10.2% compared to 1993, to $2.97 billion. The increase was due to higher sales prices and increased sales volume. Sales growth for this segment was mitigated by the shutdown of several operating facilities in late 1993 and early 1994, including a coated recycled boxboard mill, five converting plants and two reclamation products facilities in connection with the Company's Restructuring Program.\nNet sales of containerboard and corrugated shipping containers increased 12.5% compared to 1993, to $1.55 billion. Containerboard prices increased from approximately $300\/ton at the end of 1993 to $435\/ton in October 1994. Corrugated shipping container prices increased 4.7% on average compared to 1993. Shipments of containerboard and corrugated shipping containers were higher in 1994 compared to 1993 by 3.9% and 4.7%, respectively.\nNet sales of recycled boxboard, SBS and folding cartons decreased 2.6% compared to 1993, to $836 million. On average, recycled boxboard prices were comparable to 1993, but SBS prices, although rising in the second half of 1994, were 4.8% lower on average compared to 1993. Folding carton prices were lower on average by 2.2% in 1994 compared to 1993. Shipments of folding cartons increased by 1.8% compared to 1993, but shipments of recycled boxboard decreased 10.0%, due primarily to the recycled boxboard mill shutdown referred to above. Shipments of SBS increased 6.8% compared to 1993.\nNet sales for the reclamation and timber products operations increased 74.5% compared to 1993, to $288 million, due primarily to higher prices for reclaimed fiber. Reclaimed fiber prices in 1994 were higher by 62.9% on average compared to 1993 and shipments increased 5.8% compared to 1993.\nNet sales of recycled cylinderboard and industrial packaging increased .8% compared to 1993, to $131 million and net sales of consumer packaging increased .6% compared to 1993, to $166 million.\nNewsprint Segment Sales Net sales in the Newsprint segment for 1994 increased $11 million, up 4.4% compared to 1993, to $259 million. The increase was due primarily to higher sales prices in the second half of 1994.\nCosts and Expenses Costs and expenses in both segments in 1994 were favorably impacted by cost reduction initiatives and by the Restructuring Program. Cost of goods sold as a percent of net sales in the Paperboard\/Packaging Products segment declined from 85.6% in 1993 to 82.5% in 1994, primarily as a result of higher sales prices and improved capacity utilization. Cost of goods sold as a percent of net sales in the Newsprint segment improved modestly from 102.8% in 1993 to 102.2% in 1994, primarily as a result of higher sales prices. Selling and administrative expenses as a percent of net sales declined from 8.1% in 1993 to 6.9% in 1994 as a result of higher sales prices.\nThe Company increased its weighted average discount rate in measuring its pension obligations from 7.6% to 8.5% and its rate of increase in compensation levels from 4.0% to 5.0% at December 31, 1994. The net effect of changing these assumptions was the primary reason for the decrease in projected benefit obligations and the changes decreased pension cost in 1995 by approximately $5 million.\nAverage debt levels outstanding decreased in 1994 as a result of the 1994 Recapitalization, however, interest expense of $269 million for 1994 increased 5.9% compared to 1993 due to the impact of higher effective interest rates in 1994.\nThe tax provision for 1994 was $16 million compared to a tax benefit for 1993 of $83 million. The Company's effective tax rate for 1994 was higher than the U.S. Federal statutory tax rate due to several factors, the most significant of which was the effect of permanent differences between book and tax accounting.\nThe Company recorded an extraordinary loss from the early extinguishment of debt (net of income tax benefits) amounting to $55 million ($.55 per share) in 1994 and $38 million ($.59 per share) in 1993. The Company adopted SFAS No. 112 \"Employers' Accounting for Postemployment Benefits\" in 1994, the effect of which was not material.\nLiquidity and Capital Resources Net cash provided by operating activities was significantly higher in 1995 compared to 1994 due primarily to the higher earnings level. Net cash provided by operating activities of $411 million and excess cash at the end of 1994 was used primarily to fund capital investments and acquisitions of $188 million and to reduce debt by $264 million.\nThe ratio of current assets to current liabilities was 1.1 at December 31, 1995 compared to 1.0 at December 31, 1994. Accounts receivable were higher at December 31, 1995, primarily as a result of significantly higher product pricing. Accounts payable were lower at December 31, 1995, primarily as a result of lower fiber cost at the end of 1995 compared to 1994.\nIn February 1995, JSC (U.S.) entered into a $315 million accounts receivable securitization program (the \"1995 Securitization\") consisting of a $300 million trade receivables-backed commercial paper program and a $15 million term loan, which matures in December 1999. Proceeds of the 1995 Securitization were used to extinguish JSC (U.S.)'s borrowings under its previous accounts receivable securitization program and for general corporate purposes. Interest rates on borrowings under the 1995 Securitization are at a variable rate (5.78% at December 31, 1995).\nIn conjunction with the Company's 1994 Recapitalization, the Company entered into a new bank credit facility (the \"1994 Credit Agreement\") consisting of a $450 million revolving credit facility, a $900 million Tranche A Term Loan and a $300 million Tranche B Term Loan. In October 1995, the 1994 Credit Agreement was amended to reduce the interest rates payable on the revolving credit facility and the Tranche A Term Loan. Net debt reduction for 1995 included $64 million of mandatory and $192 million of optional payments in respect of the Tranche A and Tranche B Term Loans. The Company recorded an extraordinary loss from the early extinguishment of debt (net of income tax benefits) amounting to $4 million ($.04 per share) in 1995. In January 1996, the 1994 Credit Agreement was amended to give greater flexibility to the Company in applying optional prepayments toward installments due within the next twelve months.\nThe 1994 Credit Agreement contains various business and financial covenants including, among other things, (i) limitations on dividends, redemptions and repurchases of capital stock, (ii) limitations on the incurrence of indebtedness, liens, leases and sale-leaseback transactions, (iii) limitations on capital expenditures, (iv) maintenance of minimum levels of consolidated earnings before depreciation, interest, taxes and amortization and (v) maintenance of minimum interest coverage ratios. Such restrictions, together with the highly leveraged position of the Company, could restrict corporate activities, including the Company's ability to respond to market conditions, to provide for unanticipated capital expenditures or to take advantage of business opportunities.\nThe 1994 Credit Agreement imposes an annual limit on future capital expenditures of $150 million. The capital spending limit is subject to increase in any year by an amount equal to the Company's portion of excess cash flow and an amount up to $75 million if the prior year's spending was less than the maximum amount allowed. The Company has a carryover of approximately $66 million for 1996. Because the Company has invested heavily in its core businesses in prior years, management believes the annual limitation for capital expenditures does not impair its plans for maintenance, expansion and continued modernization of its facilities.\nCapital investments and acquisitions in 1995 include $154 million of property and timberland additions and $34 million of investments in affiliates and acquisitions. The investments in affiliates primarily include (i) the purchase of the 20% minority interest of Smurfit Newsprint Corporation previously owned by Times Mirror, the primary assets of which are two mills located near Portland, Oregon producing approximately 620,000 tons of newsprint annually, and (ii) a joint venture, the primary asset of which is a linerboard mill near Shanghai, China.\nThe Company expects internally generated cash flows and existing financing resources will be sufficient for the next several years to meet its needs to pay interest, amortize term loans and fund capital expenditures. Scheduled payments due in 1996 and 1997 under the 1994 Credit Agreement are $62 million and $133 million, with increasing amounts thereafter. Capital expenditures for 1996 are estimated to be comparable to 1995. The Company expects to use any excess cash provided by operations to make further debt reductions. At December 31, 1995, the Company had $301 million of unused borrowing capacity under its 1994 Credit Agreement and $95 million of unused borrowing capacity under the 1995 Securitization subject to JSC (U.S.)'s level of eligible accounts receivable.\nThe Company's earnings are significantly affected by the amount of interest on its indebtedness. The Company enters into interest rate swap, cap and option agreements to manage interest rate exposure on its indebtedness. Management's objective is to protect the Company from interest rate volatility and reduce or cap interest expense within acceptable levels of risk. Periodic amounts to be paid or received under interest rate swap and cap agreements are accrued and recognized as adjustments to interest expense. Premiums paid on cap agreements are included in interest payable and amortized to interest expense over the life of the agreements. The Company amends existing agreements or enters into agreements with offsetting effects when necessary to change its net position. In 1995, interest rate swap agreements with a notional value of $925 million expired and a cap agreement with a notional amount of $100 million was terminated. Also in 1995, the Company entered into an interest rate swap agreement with a notional amount of $100 million. The table below shows interest rate swap agreements outstanding at December 31, 1995, the related maturities for the years thereafter and the contracted pay and receive rates for such agreements.\nThe Company has a cap agreement with a notional amount of $100 million, which matures in 1996, on variable rate debt which limits the Company's interest payments to a range of 5.5-7.0% on the notional amount.\nEnvironmental Matters\nIn 1993, the Company recorded a provision of $54 million, of which $39 million relates to environmental matters, representing asbestos and PCB removal, solid waste cleanup at existing and former operating sites, and expenses for response costs at various sites where the Company has received notice that it is a potentially responsible party (\"PRP\"). The Company made payments of $9 million and $4 million related to PRP sites and other environmental cleanup in 1995 and 1994, respectively. The Company, as well as other companies in the industry, faces potential environmental liability related to various sites at which wastes have allegedly been deposited. The Company has received notice that it is or may be a PRP at a number of federal and state sites (the \"Sites\") where remedial action may be required. Because the laws that govern the cleanup of waste disposal sites have been construed to authorize joint and several liability, government agencies or other parties could seek to recover all response costs for any Site from any one of the PRPs for such Site, including the Company, despite the involvement of other PRPs. Although the Company is unable to estimate the aggregate response costs in connection with the remediation of all Sites, if the Company were held jointly and severally liable for all response costs at some or all of the Sites, it would have a material adverse effect on the financial condition and results of operations of the Company. However, joint and several liability generally has not in the past been imposed on PRPs, and, based on such past practice, the Company's past experience and the financial conditions of other PRPs with respect to the Sites, the Company does not expect to be held jointly and severally liable for all response costs at any Site. Liability at waste disposal sites is typically shared with other PRPs and costs generally are allocated according to relative volumes of waste deposited. At most Sites, the waste attributed to the Company is a very small portion of the total waste deposited at the Site (generally significantly less than 1%). There are approximately ten Sites where final settlement has not been reached and where the Company's potential liability is expected to exceed de minimis levels. Accordingly, the Company believes that its estimated total probable liability for response costs at the Sites was adequately reserved at December 31, 1995. Further, the estimate takes into consideration the number of other PRPs at each site, the identity, and financial position of such parties, in light of the joint and several nature of the liability, but does not take into account possible insurance coverage or other similar reimbursement.\nEffects of Inflation\nWith the exception of recycled fiber, the moderate level of inflation during the past few years has not had a material impact on the Company's financial position or operating results. The Company uses the last-in, first-out method of accounting for approximately 80% of its inventories. Under this method, the cost of products sold reported in the financial statements approximates current cost and thus reduces the distortion in reported income due to increasing costs.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Page No.\nThe following consolidated financial statements of Jefferson Smurfit Corporation are included in this report:\nConsolidated balance sheets - December 31, 1995 and 1994. . . . . .25 For the years ended December 31, 1995, 1994 and 1993: Consolidated statements of operations. . . . . . .. . . . . . .26 Consolidated statements of stockholders' deficit . . . . . . .27 Consolidated statements of cash flows . . . . . . . . . . . . .28 Notes to consolidated financial statements . . . . . . . . . . . . .29\nThe following consolidated financial statement schedule of Jefferson Smurfit Corporation is included in Item 14(a):\nII: Valuation and Qualifying Accounts . . . . . . . . . . . . .54\nAll other schedules specified under Regulation S-X for Jefferson Smurfit Corporation have been omitted because they are either not applicable, not required or because the information required is included in the financial statements or notes thereto.\nMANAGEMENT'S RESPONSIBILITY FOR FINANCIAL STATEMENTS\nThe management of the Company is responsible for the information contained in the consolidated financial statements and in other parts of this report. The consolidated financial statements have been prepared by the Company in accordance with generally accepted accounting principles appropriate in the circumstances, and necessarily include certain amounts based on management's best estimate and judgment.\nThe Company maintains a system of internal accounting control, which it believes is sufficient to provide reasonable assurance that in all material respects transactions are properly authorized and recorded, financial reporting responsibilities are met and accountability for assets is maintained. In establishing and maintaining any system of internal control, judgment is required to assess and balance the relative costs and expected benefits. Management believes that through the careful selection of employees, the division of responsibilities and the application of formal policies and procedures, the Company has an effective and responsive system of internal accounting controls. The system is monitored by the Company's staff of internal auditors, who evaluate and report to management on the effectiveness of the system.\nThe Audit Committee of the Board of Directors is composed of three directors who meet with the independent auditors, internal auditors and management to discuss specific accounting, reporting and internal control matters. Both the independent auditors and internal auditors have full and free access to the Audit Committee.\nJames E. Terrill President, Chief Executive Officer\nJohn R. Funke Vice President and Chief Financial Officer (Principal Accounting Officer)\nREPORT OF INDEPENDENT AUDITORS\nBoard of Directors Jefferson Smurfit Corporation\nWe have audited the accompanying consolidated balance sheets of Jefferson Smurfit Corporation as of December 31, 1995 and 1994, and the related consolidated statements of operations, stockholders' deficit and cash flows for each of the three years in the period ended December 31, 1995. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Jefferson Smurfit Corporation at December 31, 1995 and 1994, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.\nAs discussed in Note 5 and Note 6 to the financial statements, in 1993, the Company changed its method of accounting for income taxes and postretirement benefits.\nErnst & Young LLP\nSt. Louis, Missouri January 24, 1996\nSee notes to consolidated financial statements.\nSee notes to consolidated financial statements.\nSee notes to consolidated financial statements.\nSee notes to consolidated financial statements.\nJEFFERSON SMURFIT CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Tabular amounts in millions, except share data)\n1. -- Basis of Presentation\nJefferson Smurfit Corporation (formerly SIBV\/MS Holdings, Inc.) hereafter referred to as the \"Company\" owns 100% of the equity interest in JSCE, Inc. The Company has no operations other than its investment in JSCE, Inc. On December 31, 1994 Jefferson Smurfit Corporation (U.S.), a wholly-owned subsidiary of the Company, merged into its wholly-owned subsidiary, Container Corporation of America (\"CCA\"), with CCA surviving and changing its name to Jefferson Smurfit Corporation (U.S.) (\"JSC (U.S.)\"). JSCE, Inc. owns 100% of the equity interest in JSC (U.S.). JSCE, Inc. has no operations other than its investment in JSC (U.S.). Prior to May 4, 1994, 50% of the voting stock of the Company was owned by Smurfit Packaging Corporation (\"SPC\") and Smurfit Holdings B.V. (\"SHBV\"), indirect wholly-owned subsidiaries of Jefferson Smurfit Group plc (\"JS Group\"), a public corporation organized under the laws of the Republic of Ireland. The remaining 50% was owned by The Morgan Stanley Leveraged Equity Fund II, L.P. (\"MSLEF II\") and certain other investors.\nIn 1994, the Company completed a recapitalization plan (the \"Recapitalization\") to repay and refinance a substantial portion of its indebtedness. In connection with the Recapitalization, (i) the Company issued and sold 19,250,000 shares of common stock pursuant to a registered public offering at an initial public offering price of $13.00 per share, (ii) JS Group, through its wholly-owned subsidiary Smurfit International B.V. (\"SIBV\"), purchased an additional 11,538,462 shares of common stock for $150 million, and (iii) JSC (U.S.) issued and sold $300 million aggregate principal amount of unsecured 11.25% Series A Senior Notes due 2004 and $100 million aggregate principal amount of unsecured 10.75% Series B Senior Notes due 2002 (the \"1994 Senior Notes\") pursuant to a registered public offering.\nImmediately prior to the consummation of the 1994 initial public offerings, the Company effected a reclassification (the \"Reclassification\") whereby the Company's previous five classes of common stock were converted into one class on a basis of ten shares of common stock for each outstanding share of each of the old classes. The effect of the Reclassification was to transfer $1 million from the additional paid-in capital account to the common stock account.\nThe deficit in stockholders' equity is primarily due to the Company's 1989 purchase of JSC (U.S.)'s common equity owned by JS Group and the acquisition by JSC (U.S.) of its common equity owned by MSLEF I, which were accounted for as purchases of treasury stock.\n2. -- Significant Accounting Policies\nNature of Operations: The Company's major operations are in paper products, newsprint production, recycling, and consumer packaging. Paper product operations procure virgin or recycled fiber and produce paperboard for conversion into corrugated containers at the Company's own facilities and third party converting operations. Paper product operations customers represent a diverse range of industries including paperboard and paperboard packaging, wholesale trade, retailing and agri-business. The Company's newsprint operations produce newsprint\nfrom virgin or recycled fiber primarily for the newspaper industry. Recycling collects wastepaper which is then resold to paper product operations of the Company and third parties for conversion into boxboard, corrugated containers, and other paper products. Consumer packaging produces labels and flexible packaging for use in industrial, medical, and consumer product applications. Customers and operations are principally located in the United States. Credit is extended to customers based on an evaluation of their financial condition. Principles of Consolidation: The consolidated financial statements include the accounts of the Company and its majority-owned subsidiaries. Significant intercompany accounts and transactions are eliminated in consolidation.\nCash Equivalents: The Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents. At December 31, 1995, cash and cash equivalents of $27 million are pledged as collateral for obligations associated with the accounts receivable securitization program (See Note 4).\nRevenue Recognition: Revenue is recognized at the time products are shipped.\nInventories: Inventories are valued at the lower of cost or market, principally under the last-in, first-out (\"LIFO\") method except for $54 million in 1995 and $55 million in 1994 which are valued at the lower of average cost or market. First-in, first-out costs (which approximate replacement costs) exceed the LIFO value by $84 million and $58 million at December 31, 1995 and 1994, respectively.\nProperty, Plant and Equipment: Property, plant and equipment are carried at cost. Provisions for depreciation and amortization are made using straight-line rates over the estimated useful lives of the related assets and the terms of the applicable leases for leasehold improvements.\nTimberland: The portion of the costs of timberland attributed to standing timber is charged against income as timber is cut, at rates determined annually, based on the relationship of unamortized timber costs to the estimated volume of recoverable timber. The costs of seedlings and reforestation of timberland are capitalized.\nDeferred Debt Issuance Costs: Deferred debt issuance costs are amortized over the terms of the respective debt obligations using the interest method.\nGoodwill: The excess of cost over the fair value assigned to the net assets acquired is recorded as goodwill and is being amortized using the straight-line method over 40 years.\n2. -- Significant Accounting Policies (cont)\nUse of Estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nInterest Rate Swap and Cap Agreements: The Company enters into interest rate swap and cap agreements to reduce the impact of interest rate fluctuations. Swap agreements involve the exchange of fixed and floating rate interest payments without the exchange of the underlying principal amount. Cap agreements provide that the Company will receive a certain amount when short-term interest rates exceed a threshold rate. Periodic amounts to be paid or received under interest rate swap and cap agreements are accrued and recognized as adjustments to interest expense. Premiums paid on cap agreements are included in interest payable and amortized to interest expense over the life of the agreements. Gains and losses realized upon settlement of these agreements are deferred and amortized to interest expense over a period relevant to the agreement if the underlying hedged instrument remains outstanding, or immediately if the underlying hedged instrument is settled.\nEarnings (Loss) Per Common Share: The computations of earnings (loss) per common share are based on the weighted average number of common shares outstanding during the periods presented. Outstanding stock options are common equivalent shares but are not included since the dilutive effect is not material.\nFully diluted earnings per share amounts are not applicable because the effect of the conversion of the stock options is not dilutive in 1995 and 1994 and antidilutive in 1993.\nHad the Recapitalization occurred on January 1, 1994, the income before extraordinary item would have been $42 million or $.38 per common share, and the net loss would have been $15 million or $.13 per common share, for 1994.\nEarnings per share amounts and weighted average shares outstanding have been restated to reflect the results of the Reclassification.\nEmployee Stock Options: The Company accounts for its stock-based compensation awards under Accounting Principles Board Opinion No. 25, \"Accounting for Stock Issued to Employees\" (\"APB 25\"). Under APB 25, because the exercise price of the Company's employee stock options equal the market price of the underlying stock on the date of grant, no compensation expense is recognized.\n2. -- Significant Accounting Policies (cont)\nRecently Issued Accounting Standards: In March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (\"SFAS\") No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of\", which requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amount. SFAS No. 121 also addresses the accounting for long-lived assets that are expected to be disposed of. The Company will adopt SFAS No. 121 in the first quarter of 1996 and, based on current circumstances, does not believe the effect of adoption will be material.\nReclassifications: Certain reclassifications of prior year presentations have been made to conform to the 1995 presentation.\n3. -- Property, Plant and Equipment\n4. -- Long-Term Debt\nAggregate annual maturities of long-term debt at December 31, 1995, for the next five years are $81 million in 1996, $142 million in 1997, $146 million in 1998, $154 million in 1999, and $397 million in 2000.\n4. -- Long-Term Debt (cont)\n1994 Credit Agreement In connection with the Recapitalization, JSC (U.S.) entered into a bank credit facility (the \"1994 Credit Agreement\") which consists of a $450 million revolving credit facility (the \"Revolving Credit Facility\") of which up to $150 million may consist of letters of credit, a $900 million Tranche A Term Loan and a $300 million Tranche B Term Loan. The Revolving Credit Facility matures in 2001. The Tranche A Term Loan matures in various installments through 2001. The Tranche B Term Loan matures in various installments through 2002.\nOutstanding loans under the Tranche A Term Loan and the Revolving Credit Facility bear interest at rates selected at the option of JSC (U.S.) equal to the alternate base rate (\"ABR\") plus .75% per annum or the adjusted LIBOR Rate plus 1.75% per annum (7.82% at December 31, 1995). Interest on outstanding loans under the Tranche B Term Loan is payable at a rate per annum selected at the option of JSC (U.S.), equal to the prime rate plus 2% per annum or the adjusted LIBOR Rate plus 3% per annum (8.91% at December 31, 1995). ABR is defined as the highest of Chemical Bank's prime lending rate, 1\/2 of 1% in excess of the Federal Funds Rate or 1% in excess of the base certificate of deposit rate. The Tranche A and Tranche B Term Loans and the Revolving Credit Facility may be prepaid at any time, in whole or in part, at the option of JSC (U.S.).\nA commitment fee of .375% per annum is assessed on the unused portion of the Revolving Credit Facility. At December 31, 1995, the unused portion of this facility, after giving consideration to outstanding letters of credit, was $301 million.\nThe obligations under the 1994 Credit Agreement are unconditionally guaranteed by the Company, JSCE, Inc. and its subsidiaries and are secured by a security interest in substantially all of the assets of JSC (U.S.) and its material subsidiaries, with the exception of cash, cash equivalents and trade receivables. The 1994 Credit Agreement is also secured by a pledge of all the capital stock of each material subsidiary of the Company and by certain intercompany notes.\nThe 1994 Credit Agreement contains various business and financial covenants including, among other things, (i) limitations on dividends, redemptions and repurchases of capital stock, (ii) limitations on the incurrence of indebtedness, liens, leases and sale-leaseback transactions, (iii) limitations on capital expenditures, (iv) maintenance of minimum levels of consolidated earnings before depreciation, interest, taxes and amortization and (v) maintenance of minimum interest coverage ratios. The 1994 Credit Agreement also requires prepayments if JSC (U.S.) has excess cash flows, as defined, or receives proceeds from: certain asset sales, insurance, issuance of equity securities, or incurrence of certain indebtedness.\n4. -- Long-Term Debt (cont)\nAccounts Receivable Securitization Program Loans During 1995, JSC (U.S.) entered into a $315 million accounts receivable securitization program (the \"1995 Securitization\"). The proceeds of the 1995 Securitization were used to extinguish JSC (U.S.)'s borrowings of $230 million under the 1991 Securitization Program. The 1995 Securitization provides for the sale of certain of the Company's trade receivables to a wholly-owned, bankruptcy remote, limited purpose subsidiary, Jefferson Smurfit Finance Corporation (\"JS Finance\"), which finances its purchases of eligible JSC (U.S.) receivables through the issuance of commercial paper or the proceeds of borrowings under a revolving liquidity facility and a term loan. JS Finance borrowed $15 million under the term loan, and may issue up to $300 million trade receivables-backed commercial paper or borrow up to $300 million under a revolving liquidity facility.\nUnder the 1995 Securitization, JS Finance has granted a security interest in all its assets, principally cash and cash equivalents of $27 million and trade accounts receivable of $217 million at December 31, 1995. Interest rates on borrowings under the 1995 Securitization are at a variable rate (5.78% at December 31, 1995). At December 31, 1995, $95 million was available for additional borrowing, subject to JSC (U.S.)'s level of eligible accounts receivable. Borrowings under the Securitization Program, which expires December 1999, have been classified as long-term debt 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 the program.\n1994 Senior Notes In connection with the Recapitalization, JSC (U.S.) issued and sold $300 million aggregate principal amount of unsecured 11.25% Series A Senior Notes due 2004 and $100 million aggregate principal amount of unsecured 10.75% Series B Senior Notes due 2002. The Series A Senior Notes are redeemable in whole or in part at the option of JSC (U.S.), at any time on or after May 1, 1999 with premiums of 5.625% and 2.813% of the principal amount if redeemed during the 12-month periods commencing May 1, 1999 and 2000, respectively. In addition, up to $100 million aggregate principal amount of Series A Senior Notes are redeemable at 110% of the principal amount prior to May 1, 1997 in connection with certain stock issuances. The Series B Senior Notes are not redeemable prior to maturity.\nThe 1994 Senior Notes, which are unconditionally guaranteed on a senior basis by JSCE, Inc., rank pari passu with the 1994 Credit Agreement and the 1993 Senior Notes. The 1994 Senior Notes agreement contains business and financial covenants which are less restrictive than those contained in the 1994 Credit Agreement.\nHolders of the 1994 Senior Notes have the right, subject to certain limitations, to require JSC (U.S.) to repurchase their securities at 101% of the principal amount plus accrued and unpaid interest, upon the occurrence of a change of control or in certain events from proceeds of major asset sales, as defined.\n4. -- Long-Term Debt (cont)\n1993 Senior Notes In April 1993, JSC (U.S.) issued $500 million of unsecured 9.75% Senior Notes (the \"1993 Senior Notes\") due 2003 which are not redeemable prior to maturity. The 1993 Senior Notes, which are unconditionally guaranteed on a senior basis by JSCE, Inc., rank pari passu with the 1994 Credit Agreement and the 1994 Senior Notes. The 1993 Senior Notes agreement contains business and financial covenants which are substantially less restrictive than those contained in the 1994 Credit Agreement and substantially similar to those contained in the 1994 Senior Notes agreement.\nHolders of the 1993 Senior Notes have the right, subject to certain limitations, to require JSC (U.S.) to repurchase their securities at 101% of the principal amount plus accrued and unpaid interest, upon the occurrence of a change in control or in certain events, from proceeds of major asset sales, as defined.\nOther Debt Other long-term debt at December 31, 1995, is payable in varying installments through the year 2029. Interest rates on these obligations averaged approximately 8.81% at December 31, 1995.\nInterest Rate Swap and Cap Agreements The Company utilizes interest rate swap and cap agreements to manage its interest rate exposure on long-term debt. At December 31, 1995, the Company has interest rate swap agreements with a notional amount of $483 million which effectively fix (for remaining periods up to 2 years) the interest rate on variable rate borrowings. The Company is currently paying a weighted average fixed interest rate of 6.52% and receiving a weighted average variable interest rate of 5.80%, calculated on the notional amount. In addition, the Company has a cap agreement with a notional amount of $100 million (through 1996) on variable rate debt which limits the Company's interest payments to a range of 5.5-7.0% on the notional amount.\nThe Company is exposed to credit loss in the event of non-performance by the other parties to the interest rate swap agreements. However, the Company does not anticipate non-performance by the counterparties.\nOther Interest costs capitalized on construction projects in 1995, 1994, and 1993 totalled $4 million, $4 million, and $3 million, respectively. Interest payments on all debt instruments for 1995, 1994, and 1993 were $228 million, $247 million, and $226 million, respectively.\n5. -- Income Taxes\nAt December 31, 1995, the Company has net operating loss carryforwards for federal income tax purposes of approximately $98 million (expiring in the year 2009), none of which are available for utilization against alternative minimum taxes.\nThe Company increased its deferred tax assets and liabilities in 1993 as a result of legislation enacted during 1993 increasing the corporate federal statutory tax rate from 34% to 35% effective January 1, 1993.\n5. -- Income Taxes (cont)\nThe federal income tax returns for 1989 through 1991 are currently under examination. While the ultimate results of such examination cannot be predicted with certainty, the Company's management believes that the examination will not have a material adverse effect on its consolidated financial condition or results of operations.\nA reconciliation of the difference between the statutory federal income tax rate and the effective income tax rate as a percentage of income (loss) before income taxes, extraordinary item, and cumulative effect of accounting changes is as follows:\nThe Company made income tax payments of $41 million, $3 million, and $33 million, in 1995, 1994, and 1993, respectively.\nEffective January 1, 1993, the Company changed its method of accounting for income taxes from the deferred method to the liability method required by SFAS No. 109, \"Accounting for Income Taxes\".\nThe cumulative effect of adopting SFAS No. 109 as of January 1, 1993 was to increase net income by $21 million. For 1993, application of SFAS No. 109 increased the pretax loss by $14 million because of increased depreciation expense as a result of the requirement to report assets acquired in prior business combinations at pretax amounts.\n6. -- Employee Benefit Plans\nPension Plans The Company sponsors noncontributory defined benefit pension plans covering substantially all employees not covered by multi-employer plans. Plans that cover salaried and management employees provide pension benefits that are based on the employee's five highest consecutive calendar years' compensation during the last ten years of service. Plans covering non-salaried employees generally provide benefits of stated amounts for each year of service. These plans provide reduced benefits for early retirement. The Company's funding policy is to make minimum annual contributions required by applicable regulations. The Company also participates in several multi-employer pension plans, which provide defined benefits to certain union employees.\nAssumptions used in the accounting for the defined benefit plans were:\nThe components of net pension income for the defined benefit plans and the total contributions charged to pension expense for the multi- employer plans follow:\nThe following table sets forth the funded status and amounts recognized in the consolidated balance sheets at December 31 for the Company's and its subsidiaries' defined benefit pension plans:\n6. -- Employee Benefit Plans (cont)\nApproximately 41% of plan assets at December 31, 1995 are invested in cash equivalents or debt securities and 59% are invested in equity securities, including common stock of JS Group having a market value of $78 million.\nSavings Plans The Company sponsors voluntary savings plans covering substantially all salaried and certain hourly employees. The Company match, which is paid in Company stock, is 50% of each participant's contributions up to an annual maximum. The Company's expense for the savings plans totalled $6 million, $5 million, and $5 million in 1995, 1994, and 1993, respectively.\nPostretirement Health Care and Life Insurance Benefits The Company provides certain health care and life insurance benefits for all salaried and certain hourly employees. The Company has various plans under which the cost may be borne either by the Company, the employee or partially by each party. The Company does not currently fund these plans. These benefits are discretionary and are not a commitment to long-term benefit payments. The plans were amended effective January 1, 1993 to allow employees who retire on or after January 1, 1994 to become eligible for these benefits only if they retire after age 60 while working for the Company.\nEffective January 1, 1993, the Company adopted SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\", which requires companies to accrue the expected cost of retiree benefit payments, other than pensions, during employees' active service period. The Company elected to immediately recognize the accumulated liability, measured as of January 1, 1993. The cumulative effect of this change in accounting principle resulted in a charge of $37 million (net of income tax benefits of $22 million). The Company had previously recorded an obligation of $36 million in connection with prior business combinations.\nThe following table sets forth the accumulated postretirement benefit obligation (\"APBO\") with respect to these benefits as of December 31:\nNet periodic postretirement benefit cost included the following components:\n6. -- Employee Benefit Plans (cont)\nA weighted-average discount rate of 7.25% and 8.5% was used in determining the APBO at December 31, 1995 and 1994, respectively. The weighted-average annual assumed rate of increase in the per capita cost of covered benefits (\"health care cost trend rate\") was 9.5%, with an annual decline of 1% until the rate reaches 4.25% in the year 2001. The effect of a 1% increase in the assumed health care cost trend rate would increase the APBO as of December 31, 1995 by $2 million and have no effect on the annual net periodic postretirement benefit cost for 1995.\n1992 Stock Option Plan Under the 1992 Stock Option Plan (the \"Plan\"), selected employees of the Company and its affiliates and subsidiaries are granted non-qualified stock options to acquire shares of common stock of the Company. The stock options are exercisable at a price equal to the fair market value, as defined, of the Company's common stock on the date of grant. The options vest pursuant to the schedule set forth for each option and expire upon the earlier of twelve years from the date of grant or termination of employment, death or disability. At December 31, 1995, 8,049,306 shares of common stock were reserved for issuance under the Plan, including 2,417,838 shares available for the granting of options. The stock options become exercisable upon the earlier of the occurrence of certain trigger dates, as defined, or eleven years from the date of grant. At December 31, 1995, 486,103 options were exercisable, and no options were exercisable at December 31, 1994.\nAdditional information relating to the Plan restated to reflect the results of the Reclassification is as follows:\n7. -- Related Party Transactions\nTransactions with JS Group Transactions with JS Group, its subsidiaries and affiliated companies were as follows:\nProduct sales to and purchases from JS Group, its subsidiaries, and affiliates are consummated on terms generally similar to those prevailing with unrelated parties.\nThe Company provides certain subsidiaries and affiliates of JS Group with general management and elective management services under separate Management Services Agreements. In consideration for general management services, the Company is paid a fee up to 2% of the subsidiaries' or affiliates' gross sales. In consideration for elective services, the Company is reimbursed for its direct cost of providing such services.\nAn affiliate of JS Group owns the No. 2 paperboard machine that is located in the Company's Fernandina Beach, Florida paperboard mill (the \"Fernandina Mill\"). Pursuant to an operating agreement between the Company and the affiliate, the Company operates and manages the No. 2 paperboard machine and is compensated for its direct production and manufacturing costs and indirect manufacturing, selling and administrative costs incurred by the Company for the entire Fernandina Mill. The compensation is determined by applying various formulas and agreed upon amounts to the subject costs. The amounts reimbursed to the Company are reflected as reductions of cost of goods sold and selling and administrative expenses in the accompanying consolidated statements of operations.\nTransactions with Times Mirror In July 1995, under the terms of a shareholder agreement, JSC (U.S.) acquired the remaining 20% minority interest of Smurfit Newsprint Corporation (\"SNC\") from The Times Mirror Company (\"Times Mirror\"). SNC supplies newsprint to Times Mirror at amounts which approximate prevailing market prices under the terms of a long-term agreement. The obligations of the Company and Times Mirror to supply and purchase newsprint are wholly or partially terminable upon the occurrence of certain defined events. Sales to Times Mirror for 1995, 1994, and 1993 were $189 million, $113 million, and $115 million, respectively.\nTransactions with Morgan Stanley & Co. In connection with the Recapitalization, Morgan Stanley & Co., in its capacity as underwriter of public equity and debt securities, received fees from the Company of $16 million in 1994.\n8. -- Leases\nThe Company leases certain facilities and equipment for production, selling and administrative purposes under operating leases. Future minimum lease payments at December 31, 1995, required under operating leases that have initial or remaining noncancelable lease terms in excess of one year are $29 million in 1996, $22 million in 1997, $15 million in 1998, $11 million in 1999, $9 million in 2000 and $20 million thereafter.\nNet rental expense was $48 million, $46 million, and $45 million, for 1995, 1994, and 1993, respectively.\n9. -- Fair Value of Financial Instruments\nThe estimated fair values of the Company's financial instruments are as follows:\nThe carrying amount of cash equivalents approximates fair value because of the short maturity of those instruments. The fair value of the Company's long-term debt is estimated based on the quoted market prices for the same or similar issues or on the current rates offered to the Company for debt of the same remaining maturities. The fair value of the interest rate swap agreements is the estimated amount the Company would pay or receive, net of accrued interest expense, to terminate the agreements at December 31, 1995 and 1994, taking into account current interest rates and the current creditworthiness of the swap counterparties.\n10. -- Restructuring Charge\nDuring 1993, the Company recorded a pretax charge of $96 million to recognize the effects of a restructuring program designed to improve the Company's long-term competitive position. Since 1993, the Company has written down the assets of closed facilities and other nonproductive assets totalling $35 million, and made cash expenditures of $33 million relating to direct expenses associated with plant closures, reductions in workforce, realignment and consolidation of various manufacturing operations. The remaining balance of the restructuring liability at December 31, 1995 was $28 million, the majority of which is expected to be paid in 1996. The restructuring program is proceeding as originally planned, and no significant adjustment to the reserve is anticipated at this time.\n11. -- Contingencies\nThe Company's past and present operations include activities which are subject to federal, state and local environmental requirements, particularly relating to air and water quality. The Company faces potential environmental liability as a result of violations of permit terms and similar authorizations that have occurred from time to time at its facilities. The Company faces potential liability for response costs at various sites with respect to which the Company has received notice that it may be a potentially responsible party (\"PRP\") as well as contamination of certain Company-owned properties, under the Comprehensive Environmental Response, Compensation and Liability Act (\"CERCLA\") concerning hazardous substance contamination. In estimating its reserves for environmental remediation and future costs, the Company's estimated liability reflects only the Company's expected share. In determining the liability, the estimate takes into consideration the number of other PRP's at each site, the identity and financial condition of such parties and experience regarding similar matters. No amounts have been recorded for potential recoveries from insurance carriers.\nDuring 1993, the Company recorded a pretax charge of $54 million of which $39 million represents asbestos and PCB removal, solid waste cleanup at existing and former operating sites and expenses for response costs at various sites where the Company has received notice that it is a potentially responsible party. The Company made payments of $9 million and $4 million related to PRP sites and other environmental cleanup in 1995 and 1994, respectively.\nThe Company is a defendant in a number of lawsuits and claims arising out of the conduct of its business, including those related to environmental matters. While the ultimate results of such suits or other proceedings against the Company cannot be predicted with certainty, the management of the Company believes that the resolution of these matters will not have a material adverse effect on its consolidated financial condition or results of operation.\nIn the fourth quarter of 1995, the Company recorded a pretax charge totalling $25 million related to product quality matters and failure to follow proper manufacturing and internal procedures in an immaterial non-core product line. The Company is continuing to further evaluate this issue and expects to conclude its review during the second fiscal quarter. Based upon the information currently available to management, the Company believes the reserve is adequate but intends to reevaluate the adequacy of the reserve at the conclusion of its review.\n12. -- Business Segment Information\nThe Company's principal lines of business are paperboard\/packaging products and newsprint. The paperboard\/packaging products segment includes the manufacture and distribution of containerboard, boxboard and cylinderboard, corrugated containers, folding cartons, fiber partitions, spiral cores and tubes, labels and flexible packaging. The newsprint segment includes the manufacture and distribution of newsprint. A summary by business segment of net sales, income (loss) from operations, identifiable assets, capital expenditures and depreciation, depletion and amortization follows:\nSales and transfers between segments are not material. Export sales are less than 10% of total sales. Corporate assets consist principally of cash and cash equivalents, deferred income taxes, deferred debt issuance costs and other assets which are not specific to a segment.\n13. -- Quarterly Results (Unaudited)\nThe following is a summary of the unaudited quarterly results of operations:\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nDirectors\nThe following table sets forth the names and ages of the directors of the Company.\nName Age Michael W.J. Smurfit 59 Howard E. Kilroy 60 James E. Terrill 62 James R. Thompson 59 Donald P. Brennan 55 Alan E. Goldberg 41 David R. Ramsay 32 G. Thompson Hutton 40\nThe Board of Directors currently consists of eight directors. The directors are classified into three groups: three directors having terms expiring in 1996 (Messrs. Kilroy, Goldberg and Thompson), two directors having terms expiring in 1997 (Messrs. Smurfit and Brennan) and three directors having terms expiring in 1998 (Messrs. Terrill, Ramsay and Hutton).\nExecutive Officers\nThe following table sets forth the names, ages and positions of the executive officers of the Company.\nBiographies\nDonald P. Brennan has been a Director of the Company since 1989. Mr. Brennan is an Advisory Director of Morgan Stanley & Co. Inc. (\"MS&Co.\"). He was Managing Director of MS&Co. from 1984 to February 1996, responsible for MS&Co.'s Merchant Banking Division. He is Chairman and President of Morgan Stanley Leveraged Equity Fund II, Inc. (\"MSLEF II, Inc.\") and Morgan Stanley Capital Partners III, Inc. (\"MSCP III, Inc.\"). Mr. Brennan serves as Director of Fort Howard Corporation, PSF Finance Holdings, Inc. and SITA Telecommunications Holdings N.V.\nJames P. Davis was appointed Vice President and General Manager - Consumer Packaging Division in November 1995. He served as Division Director of Operations from August 1995 to November 1995. Prior to that time, he held various management positions in the Container Division since joining the Company in 1977.\nRaymond G. Duffy has been Vice President - Planning since July 1983 and served as Director of Corporate Planning from 1980 to 1983.\nJohn R. Funke has been Vice President and Chief Financial Officer since April 1989 and was Corporate Controller and Secretary from 1982 to April 1989.\nAlan E. Goldberg has been a Director of the Company since 1989. Mr. Goldberg joined MS&Co. in 1979 and has been a member of MS&Co.'s Merchant Banking Division since its formation in 1985 and a Managing Director of MS&Co. since 1988. Mr. Goldberg is a Director and a Vice Chairman of MSCP III, Inc. and MSLEF II, Inc. Mr. Goldberg also serves as Director of Amerin Guaranty Corporation, CIMIC Holdings Limited, Centre Cat Limited, Hamilton Services Limited and Risk Management Solutions, Inc.\nRichard J. Golden has been Vice President - Purchasing since January 1985 and was Director of Corporate Purchasing from October 1981 to January 1985. In January 1994, he was assigned responsibility for world-wide purchasing for Jefferson Smurfit Group plc (\"JS Group\"), a public company organized under the laws of the Republic of Ireland.\nRichard W. Graham was appointed Senior Vice President in February 1994. He served as Vice President and General Manager - Folding Carton and Boxboard Mill Division from February 1991 to January 1994. Mr. Graham was Vice President and General Manager - Folding Carton Division from October 1986 to February 1991.\nMichael F. Harrington was appointed Vice President - Personnel and Human Resources in January 1992. Prior to joining the Company, he was Corporate Director of Labor Relations\/Safety and Health with Boise Cascade Corporation for more than 5 years. Charles A. Hinrichs was appointed Vice President and Treasurer in April 1995. Prior to joining the Company, he was employed by The Boatmen's National Bank of St. Louis for 13 years where most recently he was Senior Vice President and Chief Credit Officer.\nG. Thompson Hutton was elected to the Board of Directors in December 1994. Mr. Hutton has been President and Chief Executive Officer of Risk Management Solutions, Inc., an information services company based in Menlo Park, California, since 1991. Prior to that he was a management consultant with McKinsey & Company, Inc. from 1986 to 1991. He also serves as a Trustee of Colorado Outward Bound School.\nHoward E. Kilroy has been a Director of the Company since 1989. Mr. Kilroy was Chief Operations Director of JS Group from 1978 until March 1995 and President of JS Group from October 1986 until March 1995. He was a member of the Supervisory Board of Smurfit International B.V. (\"SIBV\") from January 1978 to January 1992. He was Senior Vice President of the Company for over 5 years. He retired from his executive positions with JS Group and the Company at the end of March 1995, but remains a Director of JS Group and the Company. In addition, he is Governor (Chairman) of Bank of Ireland and a Director of CRH plc.\nF. Scott Macfarlane was appointed Vice President and General Manager - Folding Carton and Boxboard Mill Division in November 1995. He served as Vice President and General Manager of the Folding Carton Division from December 1993 to November 1995. Since joining the Company in 1971, he has held increasingly responsible positions within the Folding Carton Division.\nEdward F. McCallum has been Vice President and General Manager - Container Division since October 1992. He served as Vice President and General Manager of the Industrial Packaging Division from January 1991 to October 1992. Prior to that time, he served in various positions in the Container Division since joining the Company in 1971.\nLyle L. Meyer has been Vice President since April 1989. He served as President of Smurfit Pension and Insurance Services Company (\"SPISCO\") from 1982 until 1992, when SPISCO was merged into the Company.\nPatrick J. Moore has been Vice President and General Manager - Industrial Packaging Division since December 1994. He served as Vice President and Treasurer from February 1993 to December 1994 and was Treasurer from October 1990 to February 1993. Prior to joining the Company in 1987 as Assistant Treasurer, Mr. Moore was with Continental Bank in Chicago where he served in various corporate lending, international banking and administrative capacities.\nDavid R. Ramsay has been a Director of the Company since 1989. Mr. Ramsay joined MS&Co. in 1989 and is a Vice President of MS&Co.'s Merchant Banking Division. Mr. Ramsay also serves as a Director of ARM Financial Group Inc., Integrity Life Insurance Company, National Integrity Life Insurance Company, Consolidated Hydro, Inc., Hamilton Services Limited, Risk Management Solutions, Inc. and PSF Finance Holdings, Inc.\nMichael W.J. Smurfit has been Chairman and Chief Executive Officer of JS Group since 1977. Dr. Smurfit has been Chairman of the Board of the Company since 1989. He was Chief Executive Officer of the Company prior to July 1990.\nDavid C. Stevens has been Vice President and General Manager - Reclamation Division since January 1993. He joined the Company in 1987 as General Sales Manager and was named Vice President later that year. He held various management positions with International Paper and was President of Mead Container Division prior to joining the Company.\nTruman L. Sturdevant has been Vice President and General Manager of SNC since August 1990. Mr. Sturdevant joined the Company in 1984 as Vice President and General Manager of the Oregon City newsprint mill.\nJames E. Terrill was named a Director and President and Chief Executive Officer in February 1994. He served as Executive Vice President - Operations from August 1990 to February 1994. He also served as Executive Vice President of SNC from February 1993 to February 1994 and was President of SNC from February 1986 to February 1993.\nJames R. Thompson was elected to the Board of Directors in July 1994. He is Chairman of Winston & Strawn, a law firm that regularly represents the Company on numerous matters. He served as Governor of the State of Illinois from 1977 to 1991. Mr. Thompson also serves as a Director of FMC Corporation, the Chicago Board of Trade, International Advisory Council of the Bank of Montreal, Prime Retail, Inc., Pechiney International, Wackenhut Corrections Corporation, Hollinger International, Inc. and Union Pacific Resources, Inc.\nMichael E. Tierney has been Vice President, General Counsel and Secretary since January 1993. He served previously as Senior Counsel and Assistant Secretary since joining the Company in 1987.\nRichard K. Volland has been Vice President - Physical Distribution since 1978.\nWilliam N. Wandmacher has been Vice President and General Manager - Containerboard Mill Division since January 1993. He served as Division Vice President - Medium Mills from October 1986 to January 1993. Since joining the Company in 1966, he has held increasingly responsible positions in production, plant management and planning, both domestic and foreign.\nGary L. West has been Vice President - Sales and Marketing since December 1994. He was Vice President and General Manager - Industrial Packaging Division from October 1992 to December 1994. He served as Vice President - Converting and Marketing for the Industrial Packaging Division from January 1991 to October 1992. Prior to that time, he held various management positions in the Container and Consumer Packaging divisions since joining the Company in 1980.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required in response to this item is set forth under the captions \"Executive Compensation\", \"Report of the Compensation Committee on Executive Compensation\" and \"Appointment Committee Interlocks and Insider Participation\" in JSC's proxy statement in connection with the Annual Meeting of Stockholders to be held on May 9, 1996, which will be filed with the Securities and Exchange Commission on or before April 30, 1996 (the \"Proxy Statement\"), and is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required in response to this item is set forth under the caption \"Principal Stockholders\" in JSC's Proxy Statement and is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required in response to this item is set forth under the caption \"Certain Transactions\" in JSC's Proxy Statement and is incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.\n(a) (1) and (2) The list of Financial Statements and Financial Statement Schedules required by this item are included in Item 8 on page 22. (3) Exhibits. 3.1 Restated Certificate of Incorporation of the Company (incorporated by reference to Exhibit 4.1 to the Company's Registration Statement on Form S-8 (File No. 33-57085)). 3.2 By-laws of the Company (incorporated by reference to Exhibit 4.2 to the Company's Registration Statement on Form S-8 (File No. 33-57085)). 4.1 Certificate for the Company's Common Stock (incorporated by reference to Exhibit 4.3 to the Company's Registration Statement on Form S-8 (File No. 33-57085)). 10.1 Second Amended and Restated Organization Agreement, as of August 26, 1992, among JSC (U.S.), Container Corporation of America (\"CCA\"), MSLEF II, Inc., SIBV, the Company and The Morgan Stanley Leveraged Equity Fund II, L.P). (\"MSLEF II\") (incorporated by reference to Exhibit 10.1(d) to JSC (U.S.)'s quarterly report on Form 10-Q for the quarter ended September 30, 1992). 10.2 Stockholders Agreement among the Company, SIBV, MSLEF II and certain related entities (incorporated by reference to Exhibit 10.2 to the Company's quarterly report on Form 10-Q for the quarter ended March 31, 1994). 10.3 Registration Rights Agreement among the Company, MSLEF II and SIBV (incorporated by reference to Exhibit 10.3 to the Company's quarterly report on Form 10-Q for the quarter ended March 31, 1994). 10.4 Subscription Agreement among the Company, JSC (U.S.), CCA and SIBV (incorporated by reference to Exhibit 10.4 to the Company's quarterly report on Form 10-Q for the quarter ended March 31, 1994). 10.5(a) Restated Newsprint Agreement, dated January 1, 1990, by and between SNC and The Times Mirror Company (incorporated by reference to Exhibit 10.39 to JSC (U.S.)'s Annual Report on Form 10-K for the fiscal year ended December 31, 1990). Portions of this exhibit have been excluded pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended. 10.5(b) Amendment No. 1 to the Restated Newsprint Agreement (incorporated by reference to Exhibit 10.6(b) to the Company's Registration Statement on Form S-1 (File No. 33- 75520)). 10.6 Operating Agreement, dated as of April 30, 1992, by and between CCA and Smurfit Paperboard, Inc. (incorporated by reference to Exhibit 10.42 to JSC (U.S.)'s quarterly report on Form 10-Q for the quarter ended March 31, 1992). 10.7 Deferred Compensation Agreement, dated January 1, 1979, between JSC (U.S.) and James B. Malloy, as amended and effective November 10, 1983 (incorporated by reference to Exhibit 10(m) to JSC (U.S.)'s Registration Statement on Form S-1 (File No. 2-86554)).\n10.8(a) JSC (U.S.) Deferred Compensation Capital Enhancement Plan (incorporated by reference to Exhibit 10(r) to JSC (U.S.)'s quarterly report on Form 10-Q for the quarter ended September 30, 1985). 10.8(b) Amendment No. 1 to the Deferred Compensation Capital Enhancement Plan (incorporated by reference to Exhibit 10.37 to JSC (U.S.)\/CCA's Annual Report on Form 10-K for the fiscal year ended December 31, 1989). 10.9(a) JSC (U.S.) Deferred Director's Fee Plan (incorporated by reference to Exhibit 10.33 to JSC (U.S.)\/CCA's Annual Report on Form 10-K for the fiscal year ended December 31, 1989). 10.9(b) Amendment No. 1 to JSC (U.S.) Deferred Director's Fee Plan (incorporated by reference to Exhibit 10.34 to JSC (U.S.)\/CCA's Annual Report on Form 10-K for the fiscal year ended December 31, 1989). 10.10 Jefferson Smurfit Corporation (U.S.) Management Incentive Plan. 10.11 Jefferson Smurfit Corporation (U.S.) 1994 Long-Term Incentive Plan (incorporated by reference to Exhibit 10.13 to the Company's Registration Statement on Form S-1 (File No. 33- 75520)). 10.12 Rights Agreement, dated as of April 30, 1992, among CCA, Smurfit Paperboard, Inc. and Bankers Trust Company, as collateral trustee (incorporated by reference to Exhibit 10.43 to JSC (U.S.)'s quarterly report on Form 10-Q for the quarter ended March 31, 1992). 10.13(a) 1992 SIBV\/MS Holdings, Inc. Stock Option Plan (incorporated by reference to Exhibit 10.48 to JSC (U.S.)'s quarterly report on Form 10-Q for the quarter ended September 30, 1992). 10.13(b) Amendment No. 1 to 1992 SIBV\/MS Holdings, Inc. Stock Option Plan (incorporated by reference to Exhibit 10.16(b) to the Company's Registration Statement on Form S-1 (File No. 33-75520)). 10.14 Credit Agreement, among JSCE, JSC (U.S.) and the banks parties thereto (incorporated by reference to Exhibit 10.1 to the Company's quarterly report on Form 10-Q for the quarter ended March 31, 1994). 10.14(a) Consent and Amendment No. 1 dated as of February 23, 1995 to the Credit Agreement among JSCE, JSC (U.S.) and the banks parties thereto. 10.14(b) Waiver and Amendment No. 2 dated as of June 9, 1995 to the Credit Agreement among JSCE, JSC (U.S.) and the banks parties thereto. 10.14(c) Waiver and Amendment No. 3 dated as of July 14, 1995 to the Credit Agreement among JSCE, JSC (U.S.) and the banks parties thereto. 10.14(d) Amendment No. 4 dated as of October 16, 1995 to the Credit Agreement among JSCE, JSC (U.S.) and the banks parties thereto. 10.14(e) Amendment No. 5 dated as of January 31, 1996 to the Credit Agreement among JSCE, JSC (U.S.) and the banks parties thereto. 11.1 Calculation of Historical Per Share Earnings. 18.1 Letter regarding change in accounting for pension plans (incorporated by reference to Exhibit 18.1 to JSC (U.S.)'s quarterly report on Form 10-Q for the quarter ended September 30, 1993). 21.1 Subsidiaries of the Company. 23.1 Consent of Independent Auditors. 24.1 Powers of Attorney. 27.1 Financial Data Schedule.\n(b) Report on Form 8-K. The Company did not file any reports on Form 8-K during the three months ended December 31, 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 8, 1996 JEFFERSON SMURFIT CORPORATION (Registrant)\nBY \/s\/ John R. Funke John R. Funke Vice-President and Chief Financial Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the date indicated.\nSIGNATURE TITLE DATE\n* Chairman of the Board Michael W. J. Smurfit and Director\n* President, Chief Executive Officer James E. Terrill and Director (Principal Executive Officer)\n\/s\/ John R. Funke Vice-President and Chief March 8, 1996 John R. Funke Financial Officer (Principal Accounting Officer)\n* Director Howard E. Kilroy\n* Director Donald P. Brennan\n* Director Alan E. Goldberg\n* Director David R. Ramsay\n* Director James R. Thompson\n* Director G. Thompson Hutton\n* By \/s\/ John R. Funke , pursuant to Powers of Attorney John R. Funke filed as part of the Form 10-K. As Attorney in Fact","section_15":""}
{"filename":"64310_1995.txt","cik":"64310","year":"1995","section_1":"ITEM 1. BUSINESS - ------- --------\nORGANIZATION - ------------\nMcNeil Real Estate Fund V, Ltd. (the \"Partnership\") was organized September 12, 1974, as a limited partnership under the provisions of the California Uniform Limited Partnership Act. The general partner of the Partnership is McNeil Partners, L.P. (the \"General Partner\"), a Delaware limited partnership, an affiliate of Robert A. McNeil (\"McNeil\"). The General Partner was elected at a meeting of limited partners on March 26, 1992. Prior to March 26, 1992, Pacific Investors Corporation (the prior \"Corporate General Partner\"), a wholly-owned subsidiary of Southmark Corporation (\"Southmark\"), and McNeil were the general partners of the Partnership which was governed by an agreement of limited partnership dated September 12, 1974 (the \"Partnership Agreement\"). The principal place of business for the Partnership and the General Partner is 13760 Noel Road, Suite 700, LB70, Dallas, Texas 75240.\nOn February 21, 1975, a Registration Statement on Form S-11 was declared effective by the Securities and Exchange Commission whereby the Partnership offered for sale $20,000,000 of limited partnership units (\"Units\"). The Units represent equity interests in the Partnership and entitle the holders thereof to participate in certain allocations and distributions of the Partnership. The sale of Units closed on February 16, 1976, with 18,213 Units sold at $1,000 each, or gross proceeds of $18,213,000 to the Partnership. In addition, the original general partners purchased a total of 10 Units for $10,000.\nSOUTHMARK BANKRUPTCY AND CHANGE IN GENERAL PARTNER - --------------------------------------------------\nOn July 14, 1989, Southmark filed a voluntary petition for reorganization under Chapter 11 of the U.S. Bankruptcy Code. Neither the Partnership, McNeil nor the Corporate General Partner were included in the filing. Southmark's reorganization plan became effective August 10, 1990. Under the plan most of Southmark's assets, which included Southmark's interest in the Corporate General Partner, are being sold or liquidated for the benefit of the creditors.\nIn accordance with Southmark's reorganization plan, Southmark, McNeil and various of their affiliates entered into an asset purchase agreement on October 12, 1990, providing for, among other things, the transfer of control to McNeil or his affiliates of 34 limited partnerships (including the Partnership) in the Southmark portfolio.\nOn February 14, 1991, pursuant to the asset purchase agreement as amended on that date: (a) an affiliate of McNeil purchased the Corporate General Partner's economic interest in the Partnership; (b) McNeil became the managing general partner of the Partnership pursuant to an agreement with the Corporate General Partner that delegated management authority to McNeil; (c) McNeil Real Estate Management, Inc. (\"McREMI\"), an affiliate of McNeil, acquired the assets relating to the property management and partnership administrative business of Southmark and its affiliates and commenced management of the Partnership's property pursuant to an assignment of the existing property management agreement from the Southmark affiliates; and (d) an affiliate of McNeil purchased all Units owned by the Corporate General Partner or its affiliates.\nOn March 26, 1992, the limited partners approved a restructuring proposal providing for (i) the replacement of the Corporate General Partner and McNeil with the General Partner and (ii) the approval of a new property management agreement with McREMI, the Partnership's property manager.\nSettlement of Claims:\nThe Partnership filed claims with the United States Bankruptcy Court for the Northern District of Texas, Dallas Division (the \"Bankruptcy Court\") against Southmark for damages relating to improper overcharges, breach of contract and breach of fiduciary duty. The Partnership settled these claims in 1991, and such settlement was approved by the Bankruptcy Court.\nAn Order Granting Motion to Distribute Funds to Class 8 Claimants dated April 14, 1995 was issued by the Bankruptcy Court. In accordance with the Order, in May 1995 the Partnership received in full satisfaction of its claims, $3,325 in cash, and common and preferred stock in the reorganized Southmark, which represents the Partnership's pro-rata share of Southmark assets available for Class 8 Claimants. The Partnership sold the Southmark common and preferred stock in May 1995 for $1,073, which combined with the cash proceeds from Southmark, resulted in a gain on legal settlement of $4,398.\nCURRENT OPERATIONS - ------------------\nGeneral:\nThe Partnership is engaged in real estate activities, including the ownership, operation and management of residential real estate and other real estate related assets. At December 31, 1995, the Partnership owned one income-producing property as described in Item 2","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES - ------- ----------\nThe following table sets forth the remaining investment portfolio of the Partnership at December 31, 1995. The buildings and the land on which they are located are owned by the Partnership in fee, subject to a first lien deed of trust as set forth more fully in Item 8 - Note 5 - \"Mortgage Note Payable.\" During 1992, the Partnership exercised its option to purchase the land. See Item 8 - Note 4 - \"Real Estate Investment\" and Schedule III - \"Real Estate Investments and Accumulated Depreciation.\" In the opinion of management, the property is adequately covered by insurance.\nOccupancy rate represents all units leased divided by the total number of units of the property as of December 31 of the given year. Rent per square foot represents all revenue, except interest, derived from the property's operations divided by the leasable square footage of the property.\nCompetitive Conditions at Sycamore Valley\nSycamore Valley has been affected by the declining California economy over the past three years. Average market rental rates have remained flat or declined, however, as a result of the capital renovation program, occupancy rates have risen from 91% in 1992 to 95% at the end of 1995. Occupancy rates for the local area average 90%. The renovation program, which addressed the dated appearance of the property, has made the property much more competitive in its market.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS - ------- -----------------\nThe Partnership is not party to, nor is the Partnership's property the subject of, any material pending legal proceedings, other than ordinary, routine litigation incidental to the Partnership's business, except for the following:\n1) High River Limited Partnership v. McNeil Partners, L.P., McNeil Investors, Inc., McNeil Pacific Investors 1972, Ltd., McNeil Real Estate Fund V, Ltd., McNeil Real Estate Fund IX, Ltd., McNeil Real Estate Fund X, Ltd., McNeil Real Estate Fund XI, Ltd., McNeil Real Estate Fund XIV, Ltd., McNeil Real Estate Fund XV, Ltd., McNeil Real Estate Fund XX, L.P., McNeil Real Estate Fund XXIV, L.P., McNeil Real Estate Fund XXV, L.P., Robert A. McNeil and Carole J. McNeil (L95012) - High River (\"HR\") filed this action in the United States District Court for the Southern District of New York against McNeil Partners, L.P., McNeil Investors, Inc. and Mr. and Mrs. McNeil (as defined in this Section 1, collectively, the \"Defendants\") requesting, among other things, names and addresses of the limited partners in the partnerships referenced above (as defined in this Section 1, the \"Partnerships\"). The District Court issued a preliminary injunction against the Partnerships requiring them to commence mailing materials relating to the HR tender offer on August 14, 1995.\nOn August 18, 1995, the Defendants filed an Answer and Counterclaim. The Counterclaim principally asserts (1) the HR tender offers have been undertaken in violation of the federal securities laws, on the basis of material, non-public, and confidential information, and (2) that the HR offer documents omit and\/or misrepresent certain material information about the HR tender offers. The Counterclaim seeks a preliminary and permanent injunction against the continuation of the HR tender offers and, alternatively, ordering corrective disclosure with respect to allegedly false and misleading statements contained in the tender offer documents.\nThis action was dismissed without prejudice in November 1995.\n2) High River Limited Partnership v. McNeil Partners, L.P., McNeil Investors, Inc., McNeil Pacific Investors 1972, Ltd., McNeil Real Estate Fund V, Ltd., McNeil Real Estate Fund IX, Ltd., McNeil Real Estate Fund X, Ltd., McNeil Real Estate Fund XI, Ltd., McNeil Real Estate Fund XIV, Ltd., McNeil Real Estate Fund XV, Ltd., McNeil Real Estate Fund XX, L.P., McNeil Real Estate Fund XXIV, L.P., McNeil Real Estate Fund XXV, L.P., Robert A. McNeil and Carole J. McNeil - United States District Court for the Southern District of New York, (Case No. 95 Civ. 9488) (Second Action).\nOn November 7, 1995, High River filed a second complaint with the District Court which alleges, inter alia, that McNeil Partners, L.P.'s (the \"General Partner\") Schedule 14D-9 filed in connection with the High River tender offers was materially false and misleading, in violation of Sections 14(d) and 14(e) of the Securities Exchange Act of 1934, 15 U.S.C. Section 78n(d) and (e), and the SEC Regulations promulgated thereunder; and that High River further alleges that the General Partner has wrongfully refused to admit High River as a limited partner to the ten partnerships referenced above. Additionally, High River purports to assert claims derivatively on behalf of McNeil Real Estate Fund IX, Ltd., McNeil Real Estate Fund XI, Ltd., McNeil Real Estate Fund XV, Ltd., McNeil Real Estate Fund XXIV, L.P. and McNeil Real Estate Fund XXV, L.P., for breach of contract and breach of fiduciary duty, asserting that the General Partner has charged these partnerships excessive fees. High River's complaint seeks, inter alia,\npreliminary injunctive relief requiring the General Partner to admit High River as a limited partner in each of the ten partnerships referenced above and to transfer the tendered units of interest in the partnerships to High River; an unspecified award of damages payable to High River and an additional unspecified award of damages payable to certain of the partnerships; an order that defendants must discharge their fiduciary duties and must account for all fees they have received from certain of the partnerships; and attorneys' fees.\nOn January 31, 1996, this action was dismissed without prejudice.\n3) Robert Lewis v. McNeil Partners, L.P., McNeil Investors, Inc., Robert A. McNeil et al - In the District Court of Dallas County, Texas, A-14th Judicial District, Cause No. 95-08535 (Class Action) - Plaintiff, Robert Lewis, is a limited partner with McNeil Pacific Investors Fund 1972, Ltd., McNeil Real Estate Fund X, Ltd. and McNeil Real Estate Fund XV, Ltd.\nPlaintiff brings this action on his own behalf and as a class action on behalf of the class of all limited partners of McNeil Pacific Investors Fund 1972, Ltd., McNeil Real Estate Fund V, Ltd., McNeil Real Estate Fund IX, Ltd., McNeil Real Estate Fund X, Ltd., McNeil Real Estate Fund XI, Ltd., McNeil Real Estate Fund XIV, Ltd., McNeil Real Estate Fund XV, Ltd., McNeil Real Estate Fund XX, L.P., McNeil Real Estate Fund XXIV, L.P. and McNeil Real Estate Fund XXV, Ltd. (as defined in this Section 3, the \"Partnerships\") as of August 4, 1995.\nPlaintiff alleges that McNeil Partners, L.P., McNeil Investors, Inc., Robert A. McNeil and other senior officers (as defined in this Section 3, collectively, the \"Defendants\") breached their fiduciary duties by, among other things, (1) failing to attempt to sell the properties owned by the Partnerships (as defined in this Section 3, the \"Properties\") and extending the lives of the Partnerships indefinitely, contrary to the Partnerships' business plans, (2) paying distributions to themselves and generating fees for their affiliates, (3) refusing to make significant distributions to the class members, despite the fact that the Partnerships have positive cash flows and substantial cash balances, and (4) failing to take steps to create an auction market for equity interests of the Partnerships, despite the fact that a third party bidder filed tender offers for approximately forty-five percent (45%) of the outstanding units of each of the Partnerships. Plaintiff also claims that Defendants have breached the partnership agreements of the Partnerships by failing to take steps to liquidate the Properties and by their alteration of the Partnerships' primary purposes, their acts in contravention of these agreements, and their use of the assets of the Partnerships for their own benefit instead of for the benefit of the Partnerships.\nThe Defendants deny that there is any merit to Plaintiff's allegations and intend to vigorously defend this action.\n4) James F. Schofield, Gerald C. Gillett and Donna S. Gillett v. McNeil Partners, L.P., McNeil Investors, Inc., McNeil Real Estate Management, Inc., Robert A. McNeil, Carole J. McNeil, McNeil Real Estate Fund V, Ltd., McNeil Real Estate Fund IX, Ltd., McNeil Real Estate Fund X, Ltd., McNeil Real Estate Fund XI, Ltd., McNeil Real Estate Fund XIV, Ltd., McNeil Real Estate Fund XV, Ltd., McNeil Real Estate Fund XX, L.P., McNeil Real Estate Fund XXIV, L.P., McNeil Real Estate Fund XXV, L.P. et al - Superior Court of the State of California for the County of Los Angeles, Case No. BC133799 (Class and Derivative Action Complaint) and United States District Court, Southern District of New York, Case No. 95CIV.6711 (Class and Derivative Action Complaint)\nThese are corporate\/securities class and derivative actions brought in state and federal court by limited partners of each of the nine (9) limited partnerships that are named as nominal defendants as listed above (as defined in this Section 4, the \"Partnerships\"). Plaintiffs allege that McNeil Investors, Inc., its affiliate McNeil Real Estate Management, Inc. and four (4) of their senior officers and\/or directors (as defined in this Section 4, collectively, the \"Defendants\") have breached their fiduciary duties. Specifically, Plaintiffs allege that Defendants have caused the Partnerships to enter into several wasteful transactions that have no business purpose or benefit to the Partnerships and which have rendered such units highly illiquid and artificially depressed the prices that are available for units on the limited resale market. Plaintiffs also allege that Defendants have engaged in a course of conduct to prevent the acquisition of units by Carl Icahn by disseminating false, misleading and inadequate information. Plaintiffs further allege that Defendants have acted to advance their own personal interests at the expense of the Partnerships' public unit holders by failing to sell Partnership properties and failing to make distributions to unitholders and, thereby, have breached the partnership agreements.\nThe Defendants deny that there is any merit to Plaintiff's allegations and intend to vigorously defend these actions.\n5) Alfred Napoletano v. McNeil Partners, L.P., McNeil Investors, Inc., Robert A. McNeil, Carole J. McNeil, McNeil Pacific Investors Fund 1972, Ltd., McNeil Real Estate Fund V, Ltd., McNeil Real Estate Fund IX, Ltd., McNeil Real Estate Fund X, Ltd., McNeil Real Estate Fund XI, Ltd., McNeil Real Estate Fund XIV, Ltd., McNeil Real Estate Fund XV, Ltd., McNeil Real Estate Fund XX, L.P., McNeil Real Estate Fund XXIV, L.P., McNeil Real Estate Fund XXV, L.P. - Superior Court of the State of California, County of Los Angeles, Case No. BC133849 (Class Action Complaint)\nPlaintiff brings this class action on behalf of a class of all persons and entities who are current owners of units and\/or are limited partners in one or more of the partnerships referenced above (as defined in this Section 5, the \"Partnerships\"). Plaintiff alleges that McNeil Partners, L.P., McNeil Investors, Inc., Robert A. McNeil and other senior officers (as defined in this Section 5, collectively, the \"Defendants\") have breached their fiduciary duties to the class members by, among other things, (1) taking steps to prevent the consummation of the High River tender offers, (2) failing to take steps to maximize unitholders' or limited partners' values, including failure to liquidate the properties owned by the Partnerships, (3) managing the Partnerships so as to extend indefinitely the present fee arrangements, and (4) paying itself and entities owned and controlled by the general partner excessive fees and reimbursements of general and administrative expenses.\nThe Defendants deny that there is any merit to Plaintiff's allegations and intend to vigorously defend this action.\n6) Warren Heller v. McNeil Partners, L.P., McNeil Investors, Inc., Robert A. McNeil, Carole J. McNeil, McNeil Pacific Investors Fund 1972, Ltd., McNeil Real Estate Fund V, Ltd., McNeil Real Estate Fund IX, Ltd., McNeil Real Estate Fund X, Ltd., McNeil Real Estate Fund XI, Ltd., McNeil Real Estate Fund XIV, Ltd., McNeil Real Estate Fund XV, Ltd., McNeil Real Estate Fund XX, L.P., McNeil Real Estate Fund XXIV, L.P., McNeil Real Estate Fund XXV, L.P. - Superior Court of the State of California, County of Los Angeles, Case No. BC133957 (Class Action Complaint)\nPlaintiff brings this class action on behalf of a class of all persons and entities who are current owners of units and\/or are limited partners in one or more of the partnerships referenced above (as defined in this Section 6, the \"Partnerships\"). Plaintiff alleges that McNeil Partners, L.P., McNeil Investors, Inc., Robert A. McNeil and other senior officers (as defined in this Section 6, collectively, the \"Defendants\") have breached their fiduciary duties to the class members by, among other things, (1) taking steps to prevent the consummation of the High River tender offers, (2) failing to take steps to maximize unitholders' or limited partners' values, including failure to liquidate the properties owned by the Partnerships, (3) managing the Partnerships so as to extend indefinitely the present fee arrangements, and (4) paying itself and entities owned and controlled by the general partner excessive fees and reimbursements of general and administrative expenses.\nThe Defendants deny that there is any merit to Plaintiff's allegations and intend to vigorously defend this action.\nFor a discussion of the Southmark bankruptcy, see Item 1 - Business and Item 8 - Note 7 - \"Gain on Legal Settlement.\"\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 UNITS OF LIMITED PARTNERSHIP AND - ------- ------------------------------------------------------------ RELATED SECURITY HOLDER MATTERS -------------------------------\n(A) There is no established public trading market for limited partnership units, nor is one expected to develop.\n(B) Title of Class Number of Record Unit Holders\nLimited partnership units 1,797 as of February 16, 1996\n(C) Distributions to the limited partners totaled $760,009 in 1995 and $570,008 in 1994. No distributions were made to the General Partner. The distributions consisted of funds generated from operations. For further discussion of distributions and likelihood of their continuation, see Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA - ------- -----------------------\nThe following table sets forth a summary of certain financial data for the Partnership. This summary should be read in conjunction with the Partnership's financial statements and notes thereto appearing in Item 8.\nDuring 1992, the Partnership exercised its option to purchase the land underlying Sycamore Valley Apartments. The Partnership financed the purchase by obtaining a mortgage loan secured by Sycamore Valley Apartments. See Item 7","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION - ------- ----------------------------------------------------------- AND RESULTS OF OPERATIONS -------------------------\nFINANCIAL CONDITION - -------------------\nThe Partnership was formed to acquire, operate and ultimately dispose of a portfolio of income-producing real properties. At the end of 1995, the Partnership owned one apartment property which is subject to a mortgage note.\nOn February 5, 1996, the Partnership executed a purchase agreement dated January 23, 1996 with BRE Properties, Inc. to sell to BRE the Sycamore Valley Apartments which represents substantially all of the assets of the Partnership. The gross purchase price for Sycamore Valley is $23,300,000, subject to certain adjustments. Consummation of the sale is subject to the satisfaction of certain conditions, including the approval of the limited partners of the Partnership for the sale of Sycamore Valley. The Partnership presently anticipates submitting the sale and the subsequent dissolution and termination of the Partnership for limited partner approval at a future meeting.\nIf the limited partners approve and the sale of Sycamore Valley is consummated, the General Partner will commence the dissolution and termination of the Partnership. In connection with such dissolution and termination, the General Partner will liquidate any remaining assets, repay creditors, pay to the General Partner a brokerage fee and subordinated incentive fee (See Note 2), and authorize distributions to the limited partners of the Partnership, including distributions of net proceeds from the sale of Sycamore Valley, in accordance with the terms of the Partnership Agreement of the Partnership. Neither the amount nor timing of any such distributions has been determined. The financial statements have not been prepared on the liquidation basis of accounting, as the sale is subject to limited partner approval.\nDuring the three year period ended December 31, 1995, the Partnership experienced net income of $2,869,840 and has generated cash from operations of $4,220,969. The Partnership's only property, Sycamore Valley, continues to operate profitably and the Partnership's assets and liabilities have not changed significantly from their balances at December 31, 1994.\nRESULTS OF OPERATIONS - ---------------------\n1995 compared to 1994\nRevenues:\nTotal Partnership revenues for 1995 increased by $230,158 or 6% as compared to 1994 revenues. Rental revenue and interest income increased $177,399 and $48,361, respectively. The Partnership also recognized a gain on legal settlement of $4,398 as a result of the settlement with Southmark received in 1995.\nRental revenue for 1995 was $4,051,346 as compared to $3,873,947 for 1994. This increase is due to an increase in average occupancy of 2%, from 93% in 1994 to 95% in 1995. In addition to the increase in occupancy there was a decrease in discounts and concessions offered to the residents.\nInterest income increased by $48,361 or 74% due to an increase in the interest rates and to greater average cash balances being invested in interest-bearing accounts.\nExpenses:\nTotal Partnership expenses increased by $266,319 or 9% for the year ended December 31, 1995 as compared to the year ended 1994. Factors contributing to the increase in 1995 include increases in mortgage interest, depreciation, other operating expenses, general and administrative, and general and administrative-affiliates. The increases are offset only slightly by decreases in property taxes.\nMortgage interest expense increased $98,052 or 13% in 1995 as compared to 1994. The increase is due to increases in the variable interest rate on the mortgage note payable. The average interest rate during 1995 was 7.6% compared to 6.5% in 1994.\nDepreciation expense increased $62,609 or 13% in 1995 as compared to 1994. This increase is due to the increase in capital improvements made at the property over the past few years. The Partnership made $397,178 and $406,397 in capital improvements in 1995 and 1994, respectively.\nOther operating expenses increased 21% or $45,852 in 1995 as compared to 1994. The increase is primarily due to increases in earthquake insurance expense. Hazard insurance increased to $167,248 in 1995 from $98,449 in 1994. Decreases in other operating expenses were reflected in decreases in bad debt expense and marketing and leasing.\nGeneral and administrative expenses increased $49,591 in 1995 as compared to the same period in 1994. The increase was due to costs incurred by the Partnership in the third quarter of 1995 to evaluate and disseminate information regarding an unsolicited tender offer.\nGeneral and administrative-affiliates increased by $10,000 or 33% in 1995 as compared to the same period in 1994 due to an increase in Partnership management fees. These fees are based on distributions made to the limited partners which increased in 1995.\n1994 compared to 1993\nRevenues:\nTotal Partnership revenues for 1994 increased by $46,992 as compared to 1993. Rental revenue and interest income increased $33,691 and $13,301, respectively.\nRental revenue for 1994 was $3,873,947 as compared to $3,840,256 for 1993. This increase of $33,691 is due to an increase in average occupancy from 91% in 1993 to 93% in 1994.\nInterest income increased by $13,301 during 1994 as compared to 1993 due to an increase in the interest rates and to greater average cash balances being invested in interest-bearing accounts.\nExpenses:\nTotal Partnership expenses increased by $27,294 for the year ended December 31, 1994 as compared to the same period in 1993. Several factors contributed to the increase including increases in depreciation, property taxes and personnel expenses. These increases were offset by decreases in interest, repairs and maintenance, general and administrative, and general and administrative-affiliates expenses.\nDepreciation expense increased $85,024 or 22% in 1994 as compared to 1993. This increase is due to the increase in capital improvements made at the property. During 1994, the Partnership made $406,397 in capital improvements.\nProperty taxes increased $37,794 or 18% during 1994 due to an increase in the assessed land value which taxes are based.\nRepairs and maintenance decreased by $22,014 or 5% in 1994 as compared to 1993. During the last few years, the property underwent major renovations which in turn reduced the need for interior and exterior repairs. The property also experienced a reduction in plumbing repairs and supplies during 1994 as compared to 1993.\nGeneral and administrative expense decreased $21,340 or 38% in 1994 as compared to 1993 due to legal expenses incurred in 1993 which related to the 1992 purchase of land. No such expenses were incurred in 1994.\nGeneral and administrative - affiliates decreased by $30,450 or 50% in 1994 as compared to 1993 due to a decrease in Partnership management fees. These fees are based on distributions made to the limited partners which decreased in 1994 compared to 1993.\nLIQUIDITY AND CAPITAL RESOURCES - -------------------------------\nThe Partnership's primary source of cash flows is from operating activities, which generated $1,448,315 in 1995 as compared to $1,473,245 in 1994. The decrease in operating cash flow in 1995 was due to the increase in the cash paid to suppliers and the amount of interest paid, which increased by $90,087 due to the increase in mortgage interest rates. The decrease in operating cash flow was partially offset by the increase in cash received from tenants.\nDuring 1994, cash provided by operating activities increased to $1,473,245 as compared to $1,299,409 in 1993. The increase in 1994 was partially due to the increase in cash received from tenants and interest income as well as a reduction in the cash paid to suppliers and mortgage interest paid.\nThe Partnership expended $397,178, $406,397 and $621,842 for capital improvements to Sycamore Valley in 1995, 1994 and 1993, respectively.\nShort-term liquidity:\nAt December 31, 1995, the Partnership held $2,025,005 of cash and cash equivalents, up $225,415 since December 31, 1994. This balance provides for the working capital needs of the Partnership and allows for distributions to the limited partners. As discussed in Financial Conditions, the General Partner will seek limited partner approval for the sale of Sycamore Valley and to commence dissolution and termination of the Partnership. Until such approval is received, management will perform routine repairs and maintenance on the property to preserve and enhance its value in the market.\nMcNeil has established a revolving credit facility not to exceed $5,000,000 in the aggregate which will be available on a \"first-come, first-served\" basis to the Partnership and other affiliated partnerships if certain conditions are met. Borrowings under the facility may be used to fund deferred maintenance, refinancing obligations and working capital needs. There is no assurance that the partnership will receive funds under the facility because no amounts will be\nreserved for any particular partnership. As of December 31, 1995, $2,662,819 remained available for borrowing under the facility; however, additional funds could become available as other partnerships repay existing borrowings. This commitment will terminate March 30, 1997.\nLong-term liquidity:\nIf operations should deteriorate and present resources not be adequate for current needs, the Partnership has no established lines of credit on which to draw for its working capital needs other than any available portion of the $5,000,000 revolving credit facility discussed above, and thus would require other sources of working capital. No such other sources have been identified.\nDistributions:\nDuring 1995, the limited partners received a cash distribution of $760,009. The distribution consisted of funds from operations. Any cash not required for current operations is expected to continue to be distributed to the Partners on the semi-annual schedule presently followed. In February 1996, a distribution of approximately $475,000 was made to the limited partners. Distributions will be subject to maintenance of adequate levels of cash reserves, and such distributions will only be available from cash generated from operations. See Financial Condition.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - ------- -------------------------------------------\nPage Number ------\nFinancial Statements:\nReport of Independent Public Accountants......................... 13\nBalance Sheets at December 31, 1995 and 1994..................... 14\nStatements of Income for each of the three years in the period ended December 31, 1995................................ 15\nStatements of Partners' Equity for each of the three years in the period ended December 31, 1995......................... 16\nStatements of Cash Flows for each of the three years in the period ended December 31, 1995................................ 17\nNotes to Financial Statements.................................... 19\nFinancial Statement Schedule -\nSchedule III - Real Estate Investment and Accumulated Depreciation............................................... 20\nAll other schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Partners of McNeil Real Estate Fund V, Ltd.:\nWe have audited the accompanying balance sheets of McNeil Real Estate Fund V, Ltd. (a California limited partnership) as of December 31, 1995 and 1994, and the related statements of income, partners' equity and cash flows for each of the three years in the period ended December 31, 1995. These 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 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.\nAs further discussed in Note 8 to the financial statements, in February 1996, the Partnership executed a purchase agreement to sell the Sycamore Valley Apartments, which represents substantially all of the assets of the Partnership. Consummation of the sale is subject to the satisfaction of certain conditions, including the approval of the Partnership's limited partners. If the sale of Sycamore Valley Apartments is consummated, the Partnership's general partner will commence the dissolution and termination of the Partnership. The accompanying financial statements have not been prepared on the liquidation basis of accounting, as the sale of Sycamore Valley Apartments is subject to limited partner approval.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of McNeil Real Estate Fund V, Ltd. as of December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\nOur audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule listed in the index to financial statements is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in our audits of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\n\/s\/ Arthur Andersen LLP\nDallas, Texas March 6, 1996\nMcNEIL REAL ESTATE FUND V, LTD.\nBALANCE SHEETS\nSee accompanying notes to financial statements.\nMcNEIL REAL ESTATE FUND V, LTD.\nSTATEMENTS OF INCOME\nSee accompanying notes to financial statements.\nMcNEIL REAL ESTATE FUND V, LTD.\nSTATEMENTS OF PARTNERS' EQUITY\nFor the Years Ended December 31, 1995, 1994, and 1993\nSee accompanying notes to financial statements.\nMcNEIL REAL ESTATE FUND V, LTD.\nSTATEMENTS OF CASH FLOWS\nIncrease (Decrease) in Cash and Cash Equivalents\nSee accompanying notes to financial statements.\nMcNEIL REAL ESTATE FUND V, LTD.\nSTATEMENTS OF CASH FLOWS\nReconciliation of Net Income to Net Cash Provided by Operating Activities\nSee accompanying notes to financial statements.\nMcNEIL REAL ESTATE FUND V, LTD.\nNOTES TO FINANCIAL STATEMENTS December 31, 1995\nNOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - --------------------------------------------------------------------\nOrganization\nMcNeil Real Estate Fund V, Ltd. (the \"Partnership\") was organized September 12, 1974, as a limited partnership under the provisions of the California Uniform Limited Partnership Act. The general partner of the Partnership is McNeil Partners, L.P. (the \"General Partner\"), a Delaware limited partnership, an affiliate of Robert A. McNeil (\"McNeil\"). The General Partner was elected at a meeting of limited partners on March 26, 1992. Prior to March 26, 1992, Pacific Investors Corporation, a wholly-owned subsidiary of Southmark Corporation (\"Southmark\"), and McNeil were the general partners of the Partnership which was governed by an agreement of limited partnership dated September 12, 1974 (the \"Partnership Agreement\"). The principal place of business for the Partnership and the General Partner is 13760 Noel Road, Suite 700, LB70, Dallas, Texas 75240.\nThe Partnership is engaged in real estate activities, including the ownership, operation and management of residential real estate and other real estate related assets. At December 31, 1995, the Partnership owned one income-producing property as described in Note 4 - Real Estate Investment.\nBasis of Presentation - ---------------------\nThe accompanying financial statements have been prepared in conformity with generally accepted accounting principles (\"GAAP\"). The preparation of financial statements in conformity with GAAP 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.\nReal Estate Investment - ----------------------\nThe real estate investment is generally stated at the lower of cost or net realizable value. The real estate investment is monitored on an ongoing basis to determine if the property has sustained a permanent impairment in value. At such time, a write-down is recorded to reduce the basis of the property to its net realizable value. A permanent impairment is determined to have occurred when a decline in property value is considered to be other than temporary based upon management's expectations with respect to projected cash flows and prevailing economic conditions.\nImprovements and betterments are capitalized and expensed through depreciation charges. Repairs and maintenance are charged to operations as incurred.\nIn March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of.\" This statement requires that long-lived assets and certain identifiable intangibles to be held and used by an entity be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. This statement is effective for financial statements for fiscal years beginning after December 15, 1995. The Partnership has not adopted the principles of this statement within the accompanying financial statements; however, it is not anticipated that adoption will have a material effect on the carrying value of the Partnership's long-lived assets.\nAsset Held for Sale - -------------------\nAsset held for sale is stated at the lower of cost or estimated realizable value.\nDepreciation - ------------\nBuildings and improvements are depreciated using the straight-line method over the estimated useful lives of the assets, ranging from 3 to 25 years.\nCash and Cash Equivalents - -------------------------\nCash and cash equivalents include cash on hand and cash on deposit with financial institutions with original maturities of three months or less. Carrying amounts for cash and cash equivalents approximate fair value.\nDeferred Borrowing Costs - ------------------------\nLoan fees and other related costs incurred to obtain long-term financing on real property are capitalized and amortized using a method that approximates the effective interest method over the term of the related mortgage note payable. Amortization of deferred borrowing costs is included in interest expense on the Statements of Income.\nRental Revenue - --------------\nThe Partnership leases its residential property under short-term operating leases. Lease terms generally are less than one year in duration. Rental income is recognized as earned.\nIncome Taxes - ------------\nNo provision for Federal income taxes is necessary in the financial statements of the Partnership because, as a partnership, it is not subject to Federal income tax and the tax effect of its activities accrues to the partners.\nAllocation of Net Income and Net Loss - -------------------------------------\nNet income from Partnership operations is allocated to the partners in the same priorities as cash distributions from operations. Net income arising from the sale or other disposition of the Partnership's property is allocated to the partners in the same priorities as cash distributions arising from the sale of Partnership properties. Net losses of the Partnership are allocated 95% to the limited partners and 5% to the General Partner.\nFederal income tax law provides that the allocation of loss to a partner will not be recognized unless the allocation is in accordance with a partner's interest in the partnership or the allocation has substantial economic effect. Internal Revenue Code Section 704(b) and accompanying Treasury Regulations establish criteria for allocations of Partnership deductions attributable to debt. The Partnership's tax allocations for 1995, 1994 and 1993 have been made in accordance with these provisions.\nDistributions - -------------\nAt the discretion of the General Partner, distributions to the partners are paid from operations of the Partnership's property, from sales or refinancing of the property, or from excess cash reserves maintained by the Partnership.\nDistributions from operations of the Partnership's property are paid 100% to the limited partners.\nDistributions from sales or refinancing of the Partnership's property or from excess cash reserves held by the Partnership are made in the following order:\n(a) First to the limited partners in an amount that, when added to all prior distributions to the limited partners, equals (i) a 7% per annum cumulative return on the limited partners' adjusted invested capital and (ii) the limited partners' original invested capital; then,\n(b) Second to an affiliate of the General Partner in payment of the real estate brokerage commission (see Note 2); then,\n(c) Third to the limited partners in an amount equal to an additional 5% per annum cumulative return on their adjusted invested capital; then,\n(d) Fourth to the General Partner in an amount equal to the subordinated incentive fee; then,\n(e) All the remaining distributions are paid to the limited partners.\nDuring 1995, 1994 and 1993, the Partnership distributed cash from operations of $760,009, $570,008 and $1,148,553, respectively, to the limited partners. In February 1996, a distribution of approximately $475,000 was made to the limited partners.\nNo distributions were paid to the General Partner during the three years ended December 31, 1995.\nNet Income Per Limited Partnership Unit - ---------------------------------------\nNet income per limited partnership unit (\"Units\") is computed by dividing net income allocated to the limited partners by the number of Units outstanding. Per unit information has been computed based on 18,223 units outstanding for 1995, 1994, and 1993.\nNOTE 2 - TRANSACTIONS WITH AFFILIATES - -------------------------------------\nThe Partnership pays property management fees equal to 5% of the gross rental receipts of Sycamore Valley, the Partnership's residential property, to McNeil Real Estate Management, Inc. (\"McREMI\"), an affiliate of the General Partner, for providing property management and leasing services.\nAs compensation for administering the affairs of the Partnership, the General Partner receives a partnership management fee equal to 5% of cash from operations, as defined, but only if the limited partners receive distributions of cash from operations equal to a 6% per annum non-cumulative return on their adjusted invested capital. As shown in the table below, such fees were paid to or accrued for the General Partner in each of the three years ended December 31, 1995.\nThe Partnership is obligated to pay commissions for real estate brokerage services to an affiliate of the General Partner in connection with the sale of the Partnership's property. Such commissions shall not exceed the lesser of (i) the normal and competitive rate for similar services in the locality where the services are performed, (ii) 50% of the standard commission or (iii) one-half of the total acquisition fees which could have been paid to the General Partner under the terms of the Partnership Agreement. There were no such fees in 1995, 1994 and 1993.\nUnder the terms of the Partnership Agreement, the General Partner is also entitled to receive a subordinated incentive fee. This fee is an amount equal to 10% of the remaining cash from sales or refinancings, as defined, in excess of the cost of all partnership properties, as defined. The cash from sales or refinancing distributed to the limited partners has exceeded the subordination requirement. There were no such fees in 1995, 1994 and 1993. See Note 8.\nCompensation and reimbursements paid to or accrued for the benefit of the General Partner or its affiliates are as follows:\nPayable to affiliates - General Partner consists primarily of unpaid property management fees at December 31, 1995 and 1994. These payables are due and payable from current operations.\nNOTE 3 - TAXABLE INCOME - -----------------------\nMcNeil Real Estate Fund V, Ltd. is a partnership and is not subject to Federal and state income taxes. Accordingly, no recognition has been given to income taxes in the accompanying financial statements of the Partnership since the income or loss of the Partnership is to be included in the tax returns of the individual partners. The tax returns of the Partnership are subject to examination by Federal and state taxing authorities. If such examinations result in adjustments to distributive shares of taxable income or loss, the tax liability of the partners could be adjusted accordingly.\nThe Partnership's net assets and liabilities for tax purposes exceeded the net assets and liabilities for financial reporting purposes by $741,161 in 1995, $648,409 in 1994 and $625,886 in 1993.\nNOTE 4 - REAL ESTATE INVESTMENT - -------------------------------\nThe basis and accumulated depreciation of the Partnership's real estate investment at December 31, 1995 and 1994 is set forth in the following table:\n(a) Sycamore is on the market for sale and therefore, at December 31, 1995, is recorded as an asset held for sale. See Note 8 - Subsequent Event.\nNOTE 5 - MORTGAGE NOTE PAYABLE - ------------------------------\nOn August 14, 1992, the Partnership borrowed $12,000,000 by mortgaging its Sycamore Valley property. The mortgage note is non-recourse and bears interest at a monthly variable rate equal to the Eleventh Federal Reserve District's Cost of Funds Index plus 2.5%. The mortgage note specifies that the interest rate may not go below a floor rate of 6.502% nor above a ceiling rate of 13.502%. The actual interest rate at December 31, 1995, 1994 and 1993 was 7.611%, 6.539% and 6.502%, respectively. Monthly debt service payments are adjusted annually to an amount necessary to fully amortize the loan over a thirty-year period. The monthly payment was adjusted from $74,166 to $79,728 effective October 1, 1995. The note matures on August 14, 2022.\nScheduled principal maturities of the mortgage note payable are as follows:\nBased on borrowing rates currently available to the Partnership for a mortgage loan with similar terms and average maturities, the fair value of the mortgage note payable was approximately $9,605,000 as of December 31, 1995.\nNOTE 6 - LEGAL PROCEEDINGS - --------------------------\nThe Partnership is not party to, nor is the Partnership's property the subject of, any material pending legal proceedings, other than ordinary, routine litigation incidental to the Partnership's business, except for the following:\n1) High River Limited Partnership v. McNeil Partners, L.P., McNeil Investors, Inc., McNeil Pacific Investors 1972, Ltd., McNeil Real Estate Fund V, Ltd., McNeil Real Estate Fund IX, Ltd., McNeil Real Estate Fund X, Ltd., McNeil Real Estate Fund XI, Ltd., McNeil Real Estate Fund XIV, Ltd., McNeil Real Estate Fund XV, Ltd., McNeil Real Estate Fund XX, L.P., McNeil Real Estate Fund XXIV, L.P., McNeil Real Estate Fund XXV, L.P., Robert A. McNeil and Carole J. McNeil (L95012) - High River (\"HR\") filed this action in the United States District Court for the Southern District of New York against McNeil Partners, L.P., McNeil Investors, Inc. and Mr. and Mrs. McNeil (as defined in this Section 1, collectively, the \"Defendants\") requesting, among other things, names and addresses of the limited partners in the partnerships referenced above (as defined in this Section 1, the \"Partnerships\"). The District Court issued a preliminary injunction against the Partnerships requiring them to commence mailing materials relating to the HR tender offer on August 14, 1995.\nOn August 18, 1995, the Defendants filed an Answer and Counterclaim. The Counterclaim principally asserts (1) the HR tender offers have been undertaken in violation of the federal securities laws, on the basis of material, non-public, and confidential information, and (2) that the HR offer documents omit and\/or misrepresent certain material information about the HR tender offers. The Counterclaim seeks a preliminary and permanent injunction against the continuation of the HR tender offers and, alternatively, ordering corrective disclosure with respect to allegedly false and misleading statements contained in the tender offer documents.\nThis action was dismissed without prejudice in November 1995.\n2) High River Limited Partnership v. McNeil Partners, L.P., McNeil Investors, Inc., McNeil Pacific Investors 1972, Ltd., McNeil Real Estate Fund V, Ltd., McNeil Real Estate Fund IX, Ltd., McNeil Real Estate Fund X, Ltd., McNeil Real Estate Fund XI, Ltd., McNeil Real Estate Fund XIV, Ltd., McNeil Real Estate Fund XV, Ltd., McNeil Real Estate Fund XX, L.P., McNeil Real Estate Fund XXIV, L.P., McNeil Real Estate Fund XXV, L.P., Robert A. McNeil and Carole J. McNeil - United States District Court for the Southern District of New York, (Case No. 95 Civ. 9488) (Second Action).\nOn November 7, 1995, High River filed a second complaint with the District Court which alleges, inter alia, that McNeil Partners, L.P.'s (the \"General Partner\") Schedule 14D-9 filed in connection with the High River tender offers was materially false and misleading, in violation of Sections 14(d) and 14(e) of the Securities Exchange Act of 1934, 15 U.S.C. Section 78n(d) and (e), and the SEC Regulations promulgated thereunder; and that High River further alleges that the General Partner has wrongfully refused to admit High River as a limited partner to the ten partnerships referenced above. Additionally, High River purports to assert claims derivatively on behalf of McNeil Real Estate Fund IX, Ltd., McNeil Real Estate Fund XI, Ltd., McNeil Real Estate Fund XV, Ltd., McNeil Real Estate Fund XXIV, L.P. and McNeil Real Estate Fund XXV, L.P., for breach of contract and breach of fiduciary duty, asserting that the General Partner has charged these partnerships excessive fees. High River's complaint seeks, inter alia, preliminary injunctive relief requiring the General Partner to admit High River as a limited partner in each of the ten partnerships referenced above and to transfer the tendered units of interest in the partnerships to High River; an unspecified award of damages payable to High River and an additional unspecified award of damages payable to certain of the partnerships; an order that defendants must discharge their fiduciary duties and must account for all fees they have received from certain of the partnerships; and attorneys' fees.\nOn January 31, 1996, this action was dismissed without prejudice.\n3) Robert Lewis v. McNeil Partners, L.P., McNeil Investors, Inc., Robert A. McNeil et al - In the District Court of Dallas County, Texas, A-14th Judicial District, Cause No. 95-08535 (Class Action) - Plaintiff, Robert Lewis, is a limited partner with McNeil Pacific Investors Fund 1972, Ltd., McNeil Real Estate Fund X, Ltd. and McNeil Real Estate Fund XV, Ltd.\nPlaintiff brings this action on his own behalf and as a class action on behalf of the class of all limited partners of McNeil Pacific Investors Fund 1972, Ltd., McNeil Real Estate Fund V, Ltd., McNeil Real Estate Fund IX, Ltd., McNeil Real Estate Fund X, Ltd., McNeil Real Estate Fund XI, Ltd., McNeil Real Estate Fund XIV, Ltd., McNeil Real Estate Fund XV, Ltd., McNeil Real Estate Fund XX, L.P., McNeil Real Estate Fund XXIV, L.P. and McNeil Real Estate Fund XXV, Ltd. (as defined in this Section 3, the \"Partnerships\") as of August 4, 1995.\nPlaintiff alleges that McNeil Partners, L.P., McNeil Investors, Inc., Robert A. McNeil and other senior officers (as defined in this Section 3, collectively, the \"Defendants\") breached their fiduciary duties by, among other things, (1) failing to attempt to sell the properties owned by the Partnerships (as defined in this Section 3, the \"Properties\") and extending the lives of the Partnerships indefinitely, contrary to the Partnerships' business plans, (2) paying distributions to themselves and generating fees for their affiliates, (3) refusing to make significant distributions to the\nclass members, despite the fact that the Partnerships have positive cash flows and substantial cash balances, and (4) failing to take steps to create an auction market for equity interests of the Partnerships, despite the fact that a third party bidder filed tender offers for approximately forty-five percent (45%) of the outstanding units of each of the Partnerships. Plaintiff also claims that Defendants have breached the partnership agreements of the Partnerships by failing to take steps to liquidate the Properties and by their alteration of the Partnerships' primary purposes, their acts in contravention of these agreements, and their use of the assets of the Partnerships for their own benefit instead of for the benefit of the Partnerships.\nThe Defendants deny that there is any merit to Plaintiff's allegations and intend to vigorously defend this action.\n4) James F. Schofield, Gerald C. Gillett and Donna S. Gillett v. McNeil Partners, L.P., McNeil Investors, Inc., McNeil Real Estate Management, Inc., Robert A. McNeil, Carole J. McNeil, McNeil Real Estate Fund V, Ltd., McNeil Real Estate Fund IX, Ltd., McNeil Real Estate Fund X, Ltd., McNeil Real Estate Fund XI, Ltd., McNeil Real Estate Fund XIV, Ltd., McNeil Real Estate Fund XV, Ltd., McNeil Real Estate Fund XX, L.P., McNeil Real Estate Fund XXIV, L.P., McNeil Real Estate Fund XXV, L.P. et al - Superior Court of the State of California for the County of Los Angeles, Case No. BC133799 (Class and Derivative Action Complaint) and United States District Court, Southern District of New York, Case No. 95CIV.6711 (Class and Derivative Action Complaint)\nThese are corporate\/securities class and derivative actions brought in state and federal court by limited partners of each of the nine (9) limited partnerships that are named as nominal defendants as listed above (as defined in this Section 4, the \"Partnerships\"). Plaintiffs allege that McNeil Investors, Inc., its affiliate McNeil Real Estate Management, Inc. and four (4) of their senior officers and\/or directors (as defined in this Section 4, collectively, the \"Defendants\") have breached their fiduciary duties. Specifically, Plaintiffs allege that Defendants have caused the Partnerships to enter into several wasteful transactions that have no business purpose or benefit to the Partnerships and which have rendered such units highly illiquid and artificially depressed the prices that are available for units on the limited resale market. Plaintiffs also allege that Defendants have engaged in a course of conduct to prevent the acquisition of units by Carl Icahn by disseminating false, misleading and inadequate information. Plaintiffs further allege that Defendants have acted to advance their own personal interests at the expense of the Partnerships' public unit holders by failing to sell Partnership properties and failing to make distributions to unitholders and, thereby, have breached the partnership agreements.\nThe Defendants deny that there is any merit to Plaintiff's allegations and intend to vigorously defend these actions.\n5) Alfred Napoletano v. McNeil Partners, L.P., McNeil Investors, Inc., Robert A. McNeil, Carole J. McNeil, McNeil Pacific Investors Fund 1972, Ltd., McNeil Real Estate Fund V, Ltd., McNeil Real Estate Fund IX, Ltd., McNeil Real Estate Fund X, Ltd., McNeil Real Estate Fund XI, Ltd., McNeil Real Estate Fund XIV, Ltd., McNeil Real Estate Fund XV, Ltd., McNeil Real Estate Fund XX, L.P., McNeil Real Estate Fund XXIV, L.P., McNeil Real Estate Fund XXV, L.P. - Superior Court of the State of California, County of Los Angeles, Case No. BC133849 (Class Action Complaint)\nPlaintiff brings this class action on behalf of a class of all persons and entities who are current owners of units and\/or are limited partners in one or more of the partnerships referenced above (as defined in this Section 5, the \"Partnerships\"). Plaintiff alleges that McNeil Partners, L.P., McNeil Investors, Inc., Robert A. McNeil and other senior officers (as defined in this Section 5, collectively, the \"Defendants\") have breached their fiduciary duties to the class members by, among other things, (1) taking steps to prevent the consummation of the High River tender offers, (2) failing to take steps to maximize unitholders' or limited partners' values, including failure to liquidate the properties owned by the Partnerships, (3) managing the Partnerships so as to extend indefinitely the present fee arrangements, and (4) paying itself and entities owned and controlled by the general partner excessive fees and reimbursements of general and administrative expenses.\nThe Defendants deny that there is any merit to Plaintiff's allegations and intend to vigorously defend this action.\n6) Warren Heller v. McNeil Partners, L.P., McNeil Investors, Inc., Robert A. McNeil, Carole J. McNeil, McNeil Pacific Investors Fund 1972, Ltd., McNeil Real Estate Fund V, Ltd., McNeil Real Estate Fund IX, Ltd., McNeil Real Estate Fund X, Ltd., McNeil Real Estate Fund XI, Ltd., McNeil Real Estate Fund XIV, Ltd., McNeil Real Estate Fund XV, Ltd., McNeil Real Estate Fund XX, L.P., McNeil Real Estate Fund XXIV, L.P., McNeil Real Estate Fund XXV, L.P. - Superior Court of the State of California, County of Los Angeles, Case No. BC133957 (Class Action Complaint)\nPlaintiff brings this class action on behalf of a class of all persons and entities who are current owners of units and\/or are limited partners in one or more of the partnerships referenced above (as defined in this Section 6, the \"Partnerships\"). Plaintiff alleges that McNeil Partners, L.P., McNeil Investors, Inc., Robert A. McNeil and other senior officers (as defined in this Section 6, collectively, the \"Defendants\") have breached their fiduciary duties to the class members by, among other things, (1) taking steps to prevent the consummation of the High River tender offers, (2) failing to take steps to maximize unitholders' or limited partners' values, including failure to liquidate the properties owned by the Partnerships, (3) managing the Partnerships so as to extend indefinitely the present fee arrangements, and (4) paying itself and entities owned and controlled by the general partner excessive fees and reimbursements of general and administrative expenses.\nThe Defendants deny that there is any merit to Plaintiff's allegations and intend to vigorously defend this action.\n7) HCW Pension Real Estate Fund, Ltd. et al. v. Ernst & Young, BDO Seidman et al (Case #92-06560-A). This suit was filed on behalf of the Partnership and other affiliated partnerships (the \"Affiliated Partnerships\") on May 26, 1992, in the 14th Judicial District Court of Dallas County. The petition sought recovery against the Partnership's former auditors, BDO Seidman, for negligence and fraud in failing to detect and\/or report overcharges of fees\/expenses by Southmark, the former general partner. The former auditors asserted counterclaims against the Affiliated Partnerships based on alleged fraudulent misrepresentations made to the auditors by the former management of the Affiliated Partnerships (Southmark) in the form of client representation letters executed and delivered to the auditors by Southmark management. The counterclaims sought recovery of attorneys' fees and costs\nincurred in defending this action. The original petition also alleged causes of action against certain former officers and directors of the Partnership's original general partner for breach of fiduciary duty, fraud and conspiracy relating to the improper assessment and payment of certain administrative fees\/expenses. On January 11, 1994 the allegations against the former officers and directors were dismissed.\nThe trial court granted summary judgment in favor of Ernst & Young and BDO Seidman on the fraud and negligence claims based on the statute of limitations. The Affiliated Partnerships appealed the summary judgment to the Dallas Court of Appeals. In August 1995, the Appeals Court upheld all of the summary judgments in favor of BDO Seidman. In exchange for the plaintiff's agreement not to file any motions for rehearing or further appeals, BDO Seidman agreed that it will not pursue the counterclaims against the Partnership.\nNOTE 7 - GAIN ON LEGAL SETTLEMENT - ---------------------------------\nThe Partnership filed claims with the United States Bankruptcy Court for the Northern District of Texas, Dallas Division (the \"Bankruptcy Court\") against Southmark Corporation (\"Southmark\"), an affiliate of a previous general partner, for damages relating to improper overcharges, breach of contract and breach of fiduciary duty. The Partnership settled these claims in 1991, and such settlement was approved by the Bankruptcy Court.\nAn Order Granting Motion to Distribute Funds to Class 8 Claimants dated April 14, 1995 was issued by the Bankruptcy Court. In accordance with the Order, in May 1995 the Partnership received in full satisfaction of its claims, $3,325 in cash, and common and preferred stock in the reorganized Southmark, which represents the Partnership's pro-rata share of Southmark assets available for Class 8 Claimants. The Partnership sold the Southmark common and preferred stock in May 1995 for $1,073, which combined with the cash proceeds from Southmark, resulted in a gain on legal settlement of $4,398.\nNOTE 8 - SUBSEQUENT EVENTS - --------------------------\nOn February 5, 1996, the Partnership executed a purchase agreement dated January 23, 1996 with BRE Properties, Inc. to sell to BRE the Sycamore Valley Apartments which represents substantially all of the assets of the Partnership. The gross purchase price for Sycamore Valley is $23,300,000, subject to certain adjustments. Consummation of the sale is subject to the satisfaction of certain conditions, including the approval of the limited partners of the Partnership for the sale of Sycamore Valley. The Partnership presently anticipates submitting the sale and the subsequent dissolution and termination of the Partnership for limited partner approval at a future meeting.\nIf the limited partners approve and the sale of Sycamore Valley is consummated, the General Partner will commence the dissolution and termination of the Partnership. In connection with such dissolution and termination, the General Partner will liquidate any remaining assets, repay creditors, pay to the General Partner a brokerage fee and subordinated incentive fee (See Note 2), and authorize distributions to the limited partners of the Partnership, including distributions of net proceeds from the sale of Sycamore Valley, in accordance with the terms of the Partnership Agreement of the Partnership. Neither the amount nor timing of any such distributions has been determined. The financial statements have not been prepared on the liquidation basis of accounting, as the sale is subject to limited partner approval.\nMcNEIL REAL ESTATE FUND V, LTD. SCHEDULE III REAL ESTATE INVESTMENT AND ACCUMULATED DEPRECIATION December 31, 1995\nSee accompanying notes to Schedule III.\nMcNEIL REAL ESTATE FUND V, LTD. SCHEDULE III REAL ESTATE INVESTMENT AND ACCUMULATED DEPRECIATION December 31, 1995\n(a) For Federal income tax purposes, the property is depreciated over lives ranging from 15-25 years using ACRS or MACRS methods. The aggregate cost of the real estate investment for Federal income tax purposes was approximately $20,218,809 and accumulated depreciation was $6,373,332 December 31, 1995.\n(b) Asset held for sale is stated at the lower of cost or net realizable value. Historical cost, net of accumulated depreciation and cumulative write-downs, becomes the new cost basis when the asset is classified as \"Held for Sale.\"\nSee accompanying notes to Schedule III.\nMcNEIL REAL ESTATE FUND V, LTD. SCHEDULE III REAL ESTATE INVESTMENT AND ACCUMULATED DEPRECIATION December 31, 1995\nSee accompanying notes to Schedule III.\nMcNEIL REAL ESTATE FUND V, LTD.\nNotes to Schedule III\nReal Estate Investment and Accumulated Depreciation\nA summary of activity for real estate investment and accumulated depreciation is as follows:\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING - ------- ----------------------------------------------------------- AND FINANCIAL DISCLOSURE ------------------------\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - -------- --------------------------------------------------\nNeither the Partnership nor the General Partner has any directors or executive officers. The names and ages of, as well as the positions held by, the officers and directors of McNeil Investors, Inc., the general partner of the General Partner, are as follows:\nOther Principal Occupations and Other Name and Position Age Directorships During the Past 5 Years - ----------------- --- -------------------------------------\nEach director shall serve until his successor shall have been duly elected and qualified.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION - -------- ----------------------\nNo direct compensation was paid or payable by the Partnership to directors or officers (since it does not have any directors or officers) for the year ended December 31, 1995, nor was any direct compensation paid or payable by the Partnership to directors or officers of the general partner of the General Partner for the year ended December 31, 1995. The Partnership has no plans to pay any such remuneration to any directors or officers of the general partner of the General Partner in the future.\nSee Item 13 - Certain Relationships and Related Transactions for amounts of compensation and reimbursements paid by the Partnership to the General Partner and its affiliates.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - -------- --------------------------------------------------------------\n(A) Security ownership of certain beneficial owners.\nNo individual or group, as defined by Section 13(d) (3) of the Securities Exchange Act of 1934, known to the Partnership, is the beneficial owner of more than 5% of the Partnership's securities other than a group comprised of 13 limited partnerships which owns 1,078 Units (approximately 5.92% of the outstanding limited partnership units). The sole general partner of each partnership is Liquidity Financial Group, L.P., a California limited partnership whose sole general partner is Liquidity Financial Corporation, all of whose outstanding stock is owned by Richard G. Wollack and Brent R. Donaldson. The business address for each of the partnerships in the group is 2200 Powell Street, Suite 700, Emeryville, California, 94068.\n(B) Security ownership of management.\nThe General Partner and the officers and directors of its general partner collectively own 105 Units, which is less than 1% of the outstanding Units.\n(C) Change in control.\nNone.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - -------- ----------------------------------------------\nThe Partnership pays property management fees equal to 5% of the gross rental receipts to McREMI, an affiliate of the General Partner, for providing property management services for the residential property. For the year ended December 31, 1995, the Partnership paid or accrued for McREMI $200,509 in property management fees.\nAs compensation for administering the affairs of the Partnership, the General Partner receives a partnership management fee equal to 5% of cash from operations, as defined, but only if the limited partners receive distributions of cash from operations equal to a 6% per annum non-cumulative return on their adjusted invested capital. For the year ended December 31, 1995, the Partnership paid to or accrued for the General Partner $40,000 in partnership management fees.\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K - -------- -----------------------------------------------------------------\nSee accompanying Index to Financial Statements at Item 8.\n(A) Exhibits\n(B) Reports on Form 8-K. There were no reports on Form 8-K filed during the quarter ended December 31, 1995.\nMcNEIL REAL ESTATE FUND V, LTD. A Limited Partnership\nSIGNATURE PAGE\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.","section_15":""}
{"filename":"46216_1995.txt","cik":"46216","year":"1995","section_1":"Item 1. Business\nGTE Hawaiian Telephone Company Incorporated (the Company) (formerly Hawaiian Telephone Company) was incorporated under the laws of the Kingdom of Hawaii in 1883. The Company is a wholly-owned subsidiary of GTE Corporation (GTE) and provides communications services in Hawaii and in the Pacific and Asia.\nThe Company owns a majority interest in the Micronesian Telecommunications Corporation (MTC). MTC, which is headquartered on Saipan in the Commonwealth of the Northern Marianas, provides local and international telecommunications services on the islands of Saipan, Tinian and Rota. In addition, the Company has a wholly-owned subsidiary, GTE Hawaiian Tel Insurance Company Incorporated, which provides auto liability, general liability and workers' compensation insurance to the Company on a direct basis.\nThe Company's principal line of business is providing communications services ranging from local telephone service for the home and office to highly complex voice and data services for various industries. The Company provides local telephone service on each island in Hawaii and provides intraLATA (Local Access and Transport Area) toll service among the islands. InterLATA toll services between Hawaii and domestic points within the United States are provided by interexchange carriers (IXCs) which connect to the Company's local facilities for call origination and termination. The IXCs are charged fees (access charges) for interconnection to the Company's local facilities. Business and residential customers also pay access charges to connect to the local network to obtain long distance service. The Company also provides interLATA toll service between Hawaii and international termination points in competition with interLATA common carriers. These international revenues are settled between the Company and interLATA common carriers through revenue sharing arrangements. The Company earns other revenues by leasing interexchange plant facilities and providing such services as billing and collection and operator services to interexchange carriers. At December 31, 1995, the Company served 780,580 access lines in its service territories.\nAt December 31, 1995, the Company had 3,025 employees.\nThe Company has written agreements with the International Brotherhood of Electrical Workers (IBEW) covering substantially all non-management employees. In 1994, the contracts with the IBEW expired. An agreement has not yet been reached and negotiations will continue during 1996.\nREGULATORY AND COMPETITIVE TRENDS\nThe Company is subject to regulation by the Public Utilities Commission (PUC) of the State of Hawaii as to its intrastate business operations and by the Federal Communications Commission (FCC) as to its interstate and international operations.\nAdvances in technology, together with a number of regulatory, legislative and judicial actions, continue to accelerate and expand the level of competition and opportunities available to the Company. Presently, the Company is subject to competition from numerous sources, including competitive access providers (CAPs) for network access services and specialized communications companies that have constructed new systems in certain markets to bypass the local-exchange network. In addition, competition from alternative local-exchange carriers (ALECs), interexchange carriers (IXCs), wireless and cable TV companies, as well as more recent entry by media and computer companies, is expected to increase in the rapidly changing telecommunications marketplace.\nOn February 8, 1996, the Telecommunications Act of 1996 (the Telecommunications Act) became law. This comprehensive telecommunications reform legislation addresses a wide range of competitive and regulatory issues that will affect the future development of local and long distance services, cable television and information services. The Telecommunications Act overhauls 62 years of telecommunications law, replacing government regulation with competition as the chief way of assuring that telecommunications services are delivered to customers. The new law\nremoves many of the statutory and court-ordered barriers to competition between segments of the industry, enabling local-exchange, long distance, wireless and cable companies to compete in offering voice, video and information services.\nThe Telecommunications Act requires the FCC and state commissions to set new guidelines to open local-exchange markets and to set new guidelines for interconnection, loosens restrictions barring local telephone companies from entering the cable television market, and preserves Universal Service while equalizing the responsibility for contribution among all carriers.\nA key provision of the Telecommunications Act also eliminates the legal restraints of the GTE Consent Decree which has kept the Company from providing interLATA services. This action will simplify GTE's ability to market local intraLATA and interLATA service to its customers as a bundled service. In February 1996, GTE executed an agreement whereby WorldCom, Inc. will provide, on a non-exclusive basis, a full array of telecommunications services in support of GTE's entry into the interLATA long distance market. In March 1996, GTE, through a separate subsidiary, began offering long distance service to its customers in selected markets. GTE plans to offer the service, marketed under the name GTE Easy Savings Plan(sm), in all 28 states where it currently offers local telephone service by December 1996.\nThe Telecommunications Act forbids states from imposing any barriers to entry into local and toll competition. Through 1995, local competition has been authorized in fifteen states, including Hawaii. During the first quarter of 1995, the PUC authorized AT&T and Sprint Communications Company, L.P., d.b.a. Long Distance\/USA (Sprint) to provide interisland toll service on a 10XXX basis, effective March 1, 1995. The PUC reserves the right to modify or rescind the authority depending on the impact to the Company. On February 14, 1995, the PUC approved the Company's request to lower its toll rates and make changes to its various calling plans to keep them competitive with AT&T's rates. On February 22, 1995, the PUC granted MCI Communications Corporations' application to provide interisland toll service on a 10XXX basis.\nFederal and state regulatory activity continued to change the traditional cost-based, rate-of-return regulatory framework for intrastate and interstate telephone service. Regulatory authorities have adopted various forms of alternative regulation, which provide economic incentives to telephone service providers to improve productivity and provide the foundation for implementing pricing flexibility necessary to address competitive entry into GTE markets.\nFor the provision of interstate and international access 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 local-exchange carrier (LEC) may charge are increased or decreased each year by a price index based upon inflation less a predetermined productivity target. LECs have limited pricing flexibility provided they do not exceed the allowed price cap. The FCC is considering how the price cap plan should be modified in the future in order to adapt the system to the emergence of competition.\nFurther information regarding the Company's activities with the various regulatory agencies and revenue arrangements with other telephone companies is discussed in Note 10 of the Company's consolidated financial statements included in Item 8.\nThe Company continues to support greater competition in telecommunications, provided that, overall, the actions to eliminate existing legal and regulatory barriers benefit consumers by allowing an opportunity for all service providers to participate equally in a competitive marketplace under comparable conditions.\nThe 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 telephone networks. However, it is likely that such improvements will be offset, in part, by continued strategic pricing reductions and the effects of increased competition.\nINITIATIVES\nIn 1995, the Company continued to position itself to respond aggressively to competitive developments and benefit from new opportunities.\nRestructuring and Cost Control\nDuring 1995, the Company continued the implementation of its $78.3 million re-engineering program. Since the program began in 1994, costs of $38.9 million have been charged to the restructuring reserve --$28.5 million related to customer service processes, $3.9 million related to administrative processes and $6.5 million related to the consolidation of facilities and operations and other related costs. These costs were primarily associated with the closure and relocation of various centers, software enhancements and separation benefits associated with workforce reductions. The continued implementation of this program positions 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.\nWorld Class Network\nDuring 1995, the Company deployed its ISDN-based World Class Network in Honolulu, Hawaii, 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 the Company to provide advanced services such as high-speed data transmission and video conferencing.\nENVIRONMENTAL MATTERS\nGTE maintains monitoring and compliance programs related to environmental matters. The Company's annual expenditures for environmental compliance have not been and are not expected to be material. Costs incurred include outlays required to keep existing operations in compliance with environmental regulations and an underground storage tank replacement program.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company's property consists of land, structures and equipment required to provide various telecommunications services. All of the aforementioned properties, located in the state of Hawaii and islands of Saipan, Tinian and Rota, are generally in good operating condition and adequate to satisfy the needs of the business. Substantially all of the Company's property is subject to liens of its respective mortgages securing funded debt. From January 1, 1991 to December 31, 1995, the Company made capital expenditures of $788 million for new plant and facilities required to meet telecommunications service needs and to modernize plant and facilities. These additions were equal to 39% of gross plant of $2 billion at December 31, 1995.\nIn response to recently enacted and pending legislation and the increasingly competitive environment, the Company discontinued the use of Statement of Financial Accounting Standards No. 71, \"Accounting for the Effects of Certain Types of Regulation\" (FAS 71) in the fourth quarter of 1995.\nIn general, FAS 71 required the Company to depreciate its telephone plant and equipment over lives approved by regulators which, in many cases, extended beyond the assets' economic lives. FAS 71 also required the deferral of certain costs based upon approvals received from regulators to recover such costs in the future. As a result of these requirements, the recorded net book value of certain assets and liabilities, primarily telephone plant and equipment, were in many cases higher than that which would otherwise have been recorded based on their economic lives. See Note 2 to the Company's consolidated financial statements included elsewhere herein for further detail.\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 consolidated financial statements.\nPART II\nItem 5.","section_4":"","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 (GTE).\nSHAREHOLDER SERVICES\nThe First National Bank of Boston, Transfer Agent and Registrar for GTE and the Company's common stock, should be contacted with any questions relating to shareholder accounts. This includes the following:\n- - Account information - - Dividends - - Market prices - - Transfer instructions - - Statements and reports - - Change of address\nShareholders may call toll-free at 1-800-225-5160 anytime, seven days a week. Customer Service Representatives are available Monday through Friday between the hours of 8 a.m. and 5 p.m. Eastern Time. Outside the United States call 1-617-575-2990.\nOr write to: Bank of Boston c\/o Boston EquiServe, L.P. P.O. Box 9121 Mail Stop 45-02-60 Boston, MA 02205-9121\nFor overnight delivery services, use the following address: Bank of Boston c\/o Boston EquiServe, L.P. Blue Hills Office Park 150 Royall Street Canton, MA 02021\nThe Bank of Boston address where shareholders, banks and brokers may deliver certificates is One Exchange Place, 55 Broadway in New York City.\nPARENT COMPANY ANNUAL REPORT To obtain a copy of the 1995 annual report of our parent company or the annual Form 10-K filed with the Securities and Exchange Commission, call 1-800-225-5160.\nINFORMATION VIA THE INTERNET Internet World Wide Web users can access information on GTE Corporation through the following universal resource: http:\/\/www.gte.com\nItem 7.","section_6":"","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (Dollars in Millions)\nBUSINESS OPERATIONS\nGTE Hawaiian Telephone Company Incorporated (the Company), a wholly-owned subsidiary of GTE Corporation (GTE), provides a full range of telecommunications products and services in Hawaii and in the Pacific and Asia. The Company's majority-owned subsidiary, Micronesian Telecommunications Corporation (MTC), is headquartered on Saipan and provides local and international telecommunications services on the islands of Saipan, Tinian and Rota. In addition, the Company has a wholly-owned subsidiary, GTE Hawaiian Tel Insurance Company Incorporated, which provides auto liability, general liability and workers' compensation insurance to the Company on a direct basis. At December 31, 1995, the Company served 780,580 access lines in its service territories.\nRESULTS OF OPERATIONS\nThe net loss for 1995 includes an extraordinary after-tax charge of $263.4 for the discontinuance of Statement of Financial Accounting Standards No. 71, \"Accounting for the Effects of Certain Types of Regulation\" (FAS 71) in the fourth quarter of 1995. Excluding this charge, net income increased 27% or $8.1 in 1995. The 1995 increase is primarily due to higher revenues and sales resulting from continued customer growth and lower operating costs and expenses, partially offset by increased depreciation and amortization expenses.\nREVENUES AND SALES\nTotal revenues and sales increased 1% or $7.6 in 1995.\nLocal service revenues are based on fees charged to customers for providing local-exchange service within designated franchise areas. The Company has not had a rate increase since 1985. For further discussion of rate matters, see Note 10 of the Company's consolidated financial statements included in Item 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nGTE Hawaiian Telephone Company Incorporated and Subsidiaries CONSOLIDATED STATEMENTS OF INCOME\n(a) Includes billings to affiliates of $41,958, $38,420 and $38,198 for the years 1995-1993, respectively.\n(b) Includes billings from affiliates of $45,446, $37,322 and $33,174 for the years 1995-1993, respectively.\nSee Notes to Consolidated Financial Statements.\nGTE Hawaiian Telephone Company Incorporated and Subsidiaries CONSOLIDATED BALANCE SHEETS\nSee Notes to Consolidated Financial Statements.\nGTE Hawaiian Telephone Company Incorporated and Subsidiaries CONSOLIDATED STATEMENTS OF CASH FLOWS\nSee Notes to Consolidated Financial Statements.\nGTE Hawaiian Telephone Company Incorporated and Subsidiaries CONSOLIDATED STATEMENTS OF SHAREHOLDER'S EQUITY\nSee Notes to Consolidated Financial Statements.\nGTE Hawaiian Telephone Company Incorporated and Subsidiaries\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nDESCRIPTION OF BUSINESS\nGTE Hawaiian Telephone Company Incorporated (the Company) provides a wide variety of communications services, in Hawaii and in the Pacific and Asia, ranging from local telephone service for the home and office to highly complex voice and data services for various industries. The Company owns a majority interest in the Micronesian Telecommunications Corporation (MTC), headquartered in Saipan, which provides local and international telecommunications services to the islands of Saipan, Tinian and Rota. In addition, the Company has a wholly-owned subsidiary, GTE Hawaiian Tel Insurance Company Incorporated, which provides auto liability, general liability and workers' compensation insurance to the Company on a direct basis. At December 31, 1995 the Company served 780,580 access lines in its service territories. The Company is a wholly-owned subsidiary of GTE Corporation (GTE).\nBASIS OF PRESENTATION\nThe Company prepares its consolidated financial statements in accordance with generally accepted accounting principles which require that management make estimates and assumptions that affect reported amounts. Actual results could differ from those estimates.\nThe consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany items have been eliminated.\nThe Company discontinued applying the provisions of Statement of Financial Accounting Standards No. 71, \"Accounting for the Effects of Certain Types of Regulation\" (FAS 71), in the fourth quarter of 1995 (see Note 2). The 1995 financial presentation reflects account classifications consistent with unregulated enterprises operating in a competitive environment. Specifically, uncollectible revenue accounts have been reclassified from revenues and sales to selling, general and administrative expenses. Reclassifications of prior-year data have been made, where appropriate, to conform to the 1995 presentation.\nTRANSACTIONS WITH AFFILIATES\nCertain affiliated companies, which are not subsidiaries of the Company, supply construction and maintenance equipment, supplies and electronic repair services to the Company. These purchases and services amounted to $27.7 million, $27.1 million and $42.4 million for the years 1995-1993, respectively. Such purchases and services 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 $45.4 million, $37.3 million and $33.2 million for the years 1995-1993, respectively. The amounts charged for these affiliated transactions are based on a proportional cost allocation method.\nThe Company's consolidated financial statements include allocated expenses based on the sharing of certain executive, administrative, financial, accounting, marketing, personnel, engineering, and other support services being performed at consolidated work centers among the domestic GTE Telephone Operating Companies. The amounts charged for these affiliated transactions are based on a proportional cost allocation method as filed with the Federal Communications Commission.\nThe Company has an agreement with GTE Directories Corporation (Directories) (100% owned by GTE), whereby the Company provides its subscriber lists, billing and collection and other services to Directories. Revenues from these activities amounted to $42 million, $38.4 million and $38.2 million for the years 1995-1993, respectively.\nDEPRECIATION AND AMORTIZATION\nThe Company has historically provided for depreciation on a straight-line basis over asset lives approved by regulators. Beginning in 1996, the Company will provide for depreciation on a straight-line basis over the estimated economic lives of its assets (see Note 2). Maintenance and repairs of property 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 or extraordinary retirements of property where profit or loss is recognized.\nFranchises, goodwill and other intangibles are amortized on a straight-line basis over the periods to be benefited, or 40 years, whichever is less.\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, revenues are generally recognized when services are rendered or products are delivered to customers.\nINVENTORIES AND SUPPLIES\nInventories and supplies are stated at the lower of cost, determined principally by the average cost method, or net realizable value.\nEMPLOYEE BENEFIT PLANS\nPension and postretirement health care and life insurance benefits earned during the year as well as interest on accumulated benefit obligations are accrued currently. Prior service costs and credits resulting from changes in plan benefits are amortized over the average remaining service period of the employees expected to receive benefits. Material curtailment\/settlement gains and losses associated with employee separations are recognized in the period in which they occur.\nThe Company adopted Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits\" (FAS 112), effective January 1, 1993. FAS 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\nThe Company's results are included in GTE's consolidated federal income tax return. The Company participates in a tax-sharing agreement with GTE and remits tax payments to GTE based on its tax liability on a separate company basis.\nDeferred tax assets and liabilities are established for temporary differences between financial and tax reporting bases and are subsequently adjusted to reflect changes in tax rates expected to be in effect when the temporary differences reverse. A valuation allowance is established for any deferred tax asset for which realization is not likely. Deferred income taxes are not provided on undistributed earnings of the Company's foreign subsidiary, approximately $27 million at December 31, 1995, as such earnings are expected to be permanently reinvested in the foreign subsidiary.\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.\nCASH AND TEMPORARY INVESTMENTS\nCash and temporary investments include investments in short-term, highly liquid securities, which have maturities when purchased of three months or less.\nRECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS\nThe Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of\" (FAS 121) in March 1995, which is effective January 1, 1996. FAS 121 requires that an impairment loss be recognized when circumstances indicate that the carrying amount of an asset may not be recoverable. In discontinuing the application of FAS 71, the Company used a methodology similar to FAS 121 in determining the amount of asset impairments. Accordingly, the issuance of FAS 121 will not have a significant impact on the Company's consolidated financial statements.\nIn October 1995, the FASB issued Statement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation\" (FAS 123). As permitted by FAS 123, the Company will continue to apply the recognition and measurement provisions of Accounting Principles Board Opinion No. 25 \"Accounting for Stock Issued to Employees\" and adopt the disclosure requirements of FAS 123 beginning in 1996. Accordingly, the issuance of FAS 123 will not impact the Company's financial position or results of operations.\n2. EXTRAORDINARY CHARGE\nIn response to recently enacted and pending legislation (see Note 10) and the increasingly competitive environment, the Company discontinued the use of FAS 71 in the fourth quarter of 1995.\nIn general, FAS 71 required the Company to depreciate its telephone plant and equipment over lives approved by regulators which, in many cases, extended beyond the assets' economic lives. FAS 71 also required the deferral of certain costs based upon approvals received from regulators to recover such costs in the future. As a result of these requirements, the recorded net book value of certain assets and liabilities, primarily telephone plant and equipment, were in many cases higher than that which would otherwise have been recorded based on their economic lives.\nAs a result of the decision to discontinue FAS 71, the Company recorded a non-cash, after-tax extraordinary charge of $263.4 million (net of tax benefits of $167.8 million) in the fourth quarter of 1995. The charge primarily represents a reduction in the net book value of telephone plant and equipment through an increase in accumulated depreciation. The amount of the charge was based on an analysis of the discounted cash flows expected to be generated by the embedded telephone plant and equipment over their remaining economic lives. In addition to the one-time charge, the Company, beginning in 1996, will shorten the depreciable lives of its telephone plant and equipment as follows as a result of the discontinuance of FAS 71:\n3. RESTRUCTURING COSTS\nAs previously reported, results for 1993 included a one-time pre-tax restructuring charge of $78.3 million, which reduced net income by $48.2 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 major components of the estimated cost to implement the re-engineering plan and activity since inception are as follows (dollars in millions):\nImplementation of the re-engineering plan began during 1994 and is expected to be substantially completed by the end of 1996. Costs of $38.9 million have been incurred since the plan's inception. These expenditures were primarily associated with the closure and relocation of various service centers, software enhancements and separation benefits related to employee reductions.\n4. COMMON STOCK\nThe authorized common stock of the Company consists of 18,000,000 shares with a par value of $25 per share. The Company issued $40 million in common stock to GTE in 1993. 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.\n5. DEBT\nLong-term debt as of December 31 was as follows:\nIn August 1995, the Company issued $150 million of 7% Series A Debentures, due 2006, toward the repayment of short-term debt incurred for the purpose of financing the Company's construction program.\nThe aggregate principal amount of bonds and debentures that may be issued is subject to the restrictions and provisions of the Company's indentures. None of the securities shown above were held in sinking or other special funds of the Company or pledged by the Company. Debt discount and premium on the Company's outstanding long-term debt are amortized over the lives of the respective issues. Substantially all of the Company's telephone plant is subject to the liens of the indentures under which the bonds listed above were issued.\nEstimated payments of long-term debt during the next five years are: $37.8 million in 1996; $18.6 million in 1997; $22 million in 1998; $2.1 million in 1999; and $77.2 million in 2000.\nOn March 1, 1996, the Company redeemed prior to stated maturity the $35 million 8 3\/4% Series T first mortgage bond.\nA $3.5 billion credit line is available to the Company through shared lines of credit with GTE and other affiliates. Most of these arrangements require payment of annual commitment fees of .1% of the unused lines of credit.\n6. FINANCIAL INSTRUMENTS\nThe fair values of financial instruments, other than long-term debt, closely approximate their carrying value. As of December 31, 1995, the estimated fair value of long-term debt based on either quoted market prices or an option pricing model, exceeded the carrying value by approximately $12 million. The estimated fair value of long-term debt as of December 31, 1994 was lower than the carrying value by approximately $26 million.\n7. INCOME TAXES\nThe income tax provision (benefit) is as follows:\nA reconciliation between taxes computed by applying the statutory federal income tax rate to pre-tax income and income taxes provided in the consolidated statements of income is as follows:\nThe tax effects of temporary differences that give rise to the current deferred income tax benefits and deferred income tax liabilities at December 31 are as follows:\n8. EMPLOYEE BENEFIT PLANS\nRETIREMENT PLANS\nThe Company sponsors noncontributory defined benefit 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 1995-1993 were as follows:\nThe expected long-term rate of return on plan assets was 8.5% for 1995 and 1994, and 8.25% for 1993.\nThe funded status of the plans and the net prepaid pension costs at December 31, were as follows:\nAssumptions used to develop the projected benefit obligations at December 31, were as follows:\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\" (FAS 106). FAS 106 requires that the expected costs of these 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 FAS 106, the cost of these benefits was charged to expense as paid.\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 1995-1993 included the following components:\nThe following table sets forth the plans' funded status and the accrued postretirement benefit obligations as of December 31:\nThe assumed discount rates used to measure the accumulated postretirement benefit obligations were 7.5% at December 31, 1995 and 8.25% at December 31, 1994. The assumed health care cost trend rates in 1995 and 1994 were 11% and 12%, respectively, for pre-65 participants and 8.5% and 9.0%, 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 1995 costs by $3 million and the accumulated postretirement benefit obligations at December 31, 1995 by $35.5 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 resulting unrecognized prior service benefits are being amortized over the remaining service lives of the employees.\nSAVINGS PLANS\nThe Company sponsors employee savings plans under section 401(k) of the Internal Revenue Code. The plans cover substantially all full-time employees. Under the plans, the Company provides matching contributions in GTE common stock based on qualified employee contributions. Matching contributions charged to income were $3 million, $3 million and $3.5 million in 1995-1993, respectively.\n9. PROPERTY, PLANT AND EQUIPMENT\nThe Company's property, plant and equipment is summarized as follows at December 31:\nDepreciation provisions in 1995-1993 were equivalent to a composite average percentage of 6.3%, 6.5% and 6.2%, respectively.\n10. REGULATORY AND COMPETITIVE MATTERS\nThe Company is subject to regulation by the Public Utilities Commission (PUC) of the State of Hawaii with respect to intrastate business operations and by the Federal Communications Commission (FCC) for its interstate and international business operations, earth station ownership and the use of authorized radio frequencies.\nINTRASTATE SERVICES\nRate Matters\nOn May 11, 1993, the Company filed a general rate increase application with the PUC, requesting approval to increase intrastate revenues by $50.4 million. This represented a 15.9% increase over intrastate revenues for 1993 at current rates, and was the first rate increase application the Company has filed since 1985. The Company's rate restructure proposal and earnings investigation which were in progress were incorporated into the rate case docket. Hearings took place in March and April 1994. On June 14, 1994, the PUC ordered that the Company continue its rates at existing levels and denied the Consumer Advocate's recommendation for an interim revenue decrease.\nOn October 14, 1994, the Company filed a Notice of Intent to file another rate case with the PUC. The Company also filed a Motion for Waiver of Commission Rules and for approval of 1995 to be the test year. The waiver requested that the Company be allowed the option to file its rate case application in early 1995 without having to use a split 1995\/1996 test year. On November 29, 1994, the PUC approved the Company's request for the waiver of its test year rules.\nOn November 29, 1994, the PUC issued an order approving the adoption of accrual accounting for Postretirement Benefits Other Than Pensions (FAS 106) for ratemaking purposes. The PUC's order directed the Company to file plans for reflecting the full impact of FAS 106 in rates to be effective January 1, 1995. The PUC approved on January 19, 1995, the Company's plan to reflect an additional $10.7 million of Postretirement Benefits Other Than Pensions in its rates, retroactive to January 1, 1995.\nOn June 9, 1995, the PUC issued a decision on the Company's 1993 Rate Case. The PUC ordered that the Company's existing rate of return, rate base, and rate structure remain unchanged until the next rate case. The Company notified the PUC on July 10, 1995 that it would appeal the decision to the Supreme Court and the Intermediate Court of Appeals of the State of Hawaii. It is anticipated that the PUC may take up to one year to prepare the record for the court, from which time the Company will have forty days to file its brief. Anticipated resolution will take approximately one to two years.\nOn September 29, 1995, the Company filed an application to increase its rates by $74 million in its 1995 Rate Case. The PUC approved bifurcation of the proceeding into a revenue requirement phase (Phase I) and a rate design phase (Phase II). The PUC held public hearings on Phase I in late 1995. The Department of Defense (DOD), AT&T Communications of Hawaii (AT&T) and Pacwest Telecommunications Corporation (Pacwest) filed motions to intervene in this proceeding. On January 12, 1996, the PUC granted the DOD intervention in both phases but limited AT&T and Pacwest to participating in the formulation of issues for Phase I. The PUC indicated that after the issues are approved, AT&T and Pacwest may file motions to intervene if it appears that the issues will significantly impact their interests. They will also have the opportunity to file for intervention in Phase II after public hearings for that phase are held. The Company anticipates that it will file its Phase II proposal in mid-1996.\nOther\nOn May 11, 1993, the PUC initiated a communications infrastructure proceeding which was intended to investigate such issues as: what markets should be opened to competition; who should be allowed to compete in those markets; and what rules, if any, should apply. Parties filed opening testimony on these matters on March 24, 1995 and rebuttal testimony on April 28, 1995. Evidentiary hearings were held beginning May 22, 1995 and concluding on June 7, 1995. A\nposition statement and reply were filed on June 22, 1995 and July 7, 1995, respectively. On October 26, 1995, the PUC issued draft rules that will govern the introduction of and transition to competition in the intrastate telecommunications market, and the implementation of a state universal service fund, under the PUC's direction and oversight. Parties submitted suggested revisions and comments on the draft rules on November 15, 1995. Public hearings on the proposed rules occurred during the first quarter of 1996. A final resolution is expected in 1996.\nDuring the first quarter of 1995, the PUC authorized AT&T and Sprint Communications Company, L.P., d.b.a. Long Distance\/USA (Sprint) to provide interisland toll service on a 10XXX basis, effective March 1, 1995. The PUC reserves the right to modify or rescind the authority depending on the impact to the Company. On February 14, 1995, the PUC approved the Company's request to lower its toll rates and make changes to its various calling plans to keep them competitive with AT&T's rates. On February 22, 1995, the PUC granted MCI Communication Corporations' application to provide interisland toll service on a 10XXX basis.\nOn March 20, 1995, the PUC authorized the expansion of the operating authority of Pacwest to allow Pacwest to provide both data and voice digital transmission services on a point-to-point basis. Pacwest is now seeking approval to provide intrastate telecommunications services within the state. On August 17, 1995, the PUC granted the application of Time Warner Communications of Hawaii, L.P., d.b.a. Oceanic Communications (Oceanic) to provide digital and analog intrastate dedicated transport in the City & County of Honolulu. Thereafter, on November 27, 1995, the PUC granted Oceanic's request to expand its geographic authority to provide dedicated transport services within the entire state. On September 29, 1995, Oceanic submitted an application to expand its authority to provide direct and resold local-exchange services within the state. After granting the Company's motion to intervene, the PUC stayed the proceedings until further notice.\nIn September 1992, the PUC initiated an investigation of the Company's provision of telephone service in the rural areas in the state. On November 2, 1994, the PUC issued its ruling in this proceeding, requesting the Company to convert all existing rural multi-party lines to single-party over a three-year period. The ruling further allowed the Company to collect one-half of the cost of conversion from existing multi-party customers choosing to convert to single-party service. The estimated remaining costs of up to $20.2 million will be recovered from general ratepayers statewide through a three-year monthly surcharge. On February 24, 1995, the PUC approved the Company's Rural Service Plan (RSP). On September 1, 1995, the Company began assessing a three-year general ratepayer surcharge, while issuing its first offers to convert customers to single-line service in those rural areas that were upgraded pursuant to the RSP 1995 construction schedule. Construction activities under the RSP will continue through 1997.\nThe PUC opened a docket on December 12, 1994, and ordered the Company to show cause why the PUC should not authorize an alternate telecommunications provider for the rural areas of the state. On December 13, 1995, the PUC issued a decision allowing a telecommunications carrier other than the Company to seek authorization to provide service in the Ka'u area on the island of Hawaii. The PUC plans to accept bid proposals through May 15, 1996 from carriers -- including the Company -- who are interested in serving the first rural area for which an alternative telecommunications provider may be authorized. A provider for the Ka'u area will be selected by the PUC shortly thereafter.\nINTERSTATE AND INTERNATIONAL SERVICES\nFor the provision of interstate and international 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 LEC may charge is increased or decreased each year by a price index based upon inflation less a predetermined productivity target. LECs have limited pricing flexibility provided they do not exceed the allowed price cap.\nIn March 1995, the FCC adopted interim rules to be utilized by LECs including the Company for their 1995 Annual Price Cap Filing. The interim rules allowed LECs to select from three productivity\/sharing options for each tariff entity. Each of the three options required an increase to the 3.3% productivity factor elected by the Company since 1991. The Company selected the following productivity factors and sharing thresholds for use in the 1995-1996 tariff year:\nSince the Company's access fees were priced below the FCC's maximum price, the near-term impact of productivity increases are not expected to be significant. Under the interim rules, the Company filed tariffs to reduce rates by $5 million annually, effective August 1, 1995. On September 20, 1995, the FCC released its proposed rulemaking proceeding on price caps which proposes specific changes to reflect and encourage emerging competition in local and access service markets and to establish the path towards decreased regulation of LECs' services. On September 27, 1995, the FCC solicited comments on a number of specific issues regarding methods for establishing the price caps, such as productivity measurements, sharing, the common line formula, and exogenous costs. The Company anticipates the FCC will issue an order prior to the July 1996 annual filing.\nOn February 8, 1996, the Telecommunications Act of 1996 (the Telecommunications Act) became law. This comprehensive telecommunications reform legislation addresses a wide range of competitive and regulatory issues that will affect the future development of local and long distance services, cable television and information services. The Telecommunications Act overhauls 62 years of telecommunications law, replacing government regulation with competition as the chief way of assuring that telecommunications services are delivered to customers. The new law removes many of the statutory and court-ordered barriers to competition between segments of the industry, enabling local-exchange, long distance, wireless and cable companies to compete in offering voice, video and information services.\nThe Telecommunications Act requires the FCC and state commissions to set new guidelines to open local-exchange markets and to set new guidelines for interconnection, loosens restrictions barring local telephone companies from entering the cable television market, and preserves Universal Service while equalizing the responsibility for contribution among all carriers.\nA key provision of the Telecommunications Act also eliminates the legal restraints of the GTE Consent Decree which has kept the Company from providing interLATA services. This action will simplify GTE's ability to market local intraLATA and interLATA service to its customers as a bundled service. In February 1996, GTE executed an agreement whereby WorldCom, Inc. will provide, on a non-exclusive basis, a full array of telecommunications services in support of GTE's entry into the interLATA long distance market. In March 1996, GTE, through a separate subsidiary, began offering long distance service to its customers in selected markets. GTE plans to offer the service, marketed under the name GTE Easy Savings Plan(sm), in all 28 states where it currently offers local telephone service by December 1996.\nSIGNIFICANT CUSTOMER\nRevenues received from AT&T Corp. include amounts for access, billing and collection and interexchange leased facilities during the years 1995-1993 under various arrangements and amounted to $47.5 million, $46 million, and $44 million, respectively.\n11. COMMITMENTS AND CONTINGENCIES\nThe Company has noncancelable leases covering certain buildings, office space and equipment. Rental expense was $12.8 million, $15.7 million, and $14 million in 1995-1993, respectively. Minimum rental commitments under noncancelable leases through 2000 do not exceed $3.1 million annually and aggregate $43.8 million thereafter.\nThe Company is subject to a number of proceedings arising out of the conduct of its business, including those relating to regulatory actions, commercial transactions and\/or environmental, safety and health matters. Management believes that the ultimate resolution of these matters will not have a material adverse effect on the results of operations or the financial position of the Company.\nRecent judicial and regulatory developments, as well as the pace of technological change, have continued to influence industry trends, including accelerating and expanding the level of competition. As a result, the Company's operations face increasing competition in virtually all aspects of its business. The Company supports greater competition in telecommunications provided that, overall, the actions to eliminate existing legal and regulatory barriers allow an opportunity for all service providers to participate equally in a competitive marketplace under comparable conditions.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Board of Directors of GTE Hawaiian Telephone Company Incorporated:\nWe have audited the accompanying consolidated balance sheets of GTE Hawaiian Telephone Company Incorporated (a Hawaii corporation and wholly-owned subsidiary of GTE Corporation) and subsidiaries as of December 31, 1995 and 1994, 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, 1995. These financial statements and the schedule and exhibit 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 and exhibit based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as 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 Hawaiian Telephone Company Incorporated and subsidiaries as of December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\nAs discussed in Note 2 to the consolidated financial statements, in 1995, the Company discontinued applying the provisions of Statement of Financial Accounting Standards No. 71, \"Accounting for the Effects of Certain Types of Regulation\".\nOur audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. The supporting schedule and exhibit listed under Item 14 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. The supporting schedule and exhibit 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\nDallas, Texas January 24, 1996\nMANAGEMENT REPORT\nTo Our Shareholder:\nThe management of the Company is responsible for the integrity and objectivity of the financial and operating information contained in this Annual Report on Form 10-K, including the consolidated financial statements covered by the Report of Independent Public Accountants. These statements were prepared in conformity with generally accepted accounting principles and include amounts that are based on the best estimates and judgments of management.\nThe Company has a system of internal accounting controls which provides management with reasonable assurance that transactions are recorded and executed in accordance with its authorizations, that assets are properly safeguarded and accounted for, and that financial records are maintained so as to permit preparation of financial statements in accordance with generally accepted accounting principles. This system includes written policies and procedures, an organizational structure that segregates duties, and a comprehensive program of periodic audits by the internal auditors. The Company has also instituted policies and guidelines which require employees to maintain the highest level of ethical standards.\nWARREN H. HARUKI 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 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 - See GTE Hawaiian Telephone Company 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, 1995-1993 (as required):\nII - Valuation and Qualifying Accounts\nNote: Schedules other than the one listed above are omitted as not applicable, not required, or the information is included in the consolidated financial statements or notes thereto.\n(3) Exhibits - Included in this report or incorporated by reference.\n3.1* Articles of Incorporation and Bylaws (Exhibit 3.2 of the 1987 Form 10-K, File No. 2- 33059)\n3.2* Amended By-laws (Exhibit 3.2 of the 1994 Form 10-K, File No. 2-33059)\n10 Material Contracts - Agreements Between GTE and Certain Executive Officers\n12 Statements re: Calculation of the Consolidated Ratio of Earnings to Fixed Charges\n23 Consent of Independent Public Accountants\n26 Revised Form of Invitation for Bids pertaining to Registration Statement on Form S-3 (File No. 33-57743)\n27 Financial Data Schedule\n(b) Reports on Form 8-K\nOn November 13, 1995, the Company filed a report on Form 8-K dated November 9, 1995, under Item 5 \"Other Events\". Financial information was filed with this report.\n* Denotes exhibits incorporated herein by reference to previous filings with the Securities and Exchange Commission as designated.\nGTE Hawaiian Telephone Company Incorporated and Subsidiaries\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS\nFor the Years Ended December 31, 1995, 1994 and 1993 (Thousands of Dollars)\nNOTES:\n(1) Charges for purpose for which reserve was created. (2) Recoveries of previously written-off amounts. (3) See Note 3 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 HAWAIIAN TELEPHONE COMPANY INCORPORATED ------------------------------ (Registrant)\nDate March 26, 1996 By Warren H. Haruki --------------------- ------------------------------ Warren H. Haruki 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","section_15":""}
{"filename":"80718_1995.txt","cik":"80718","year":"1995","section_1":"ITEM 1. BUSINESS - --------------------------------------------------------------------------------\nProperty Capital Trust (the \"Trust\") is an unincorporated business trust organized under the laws of the Commonwealth of Massachusetts pursuant to a Declaration of Trust dated June 9, 1969, as amended. The Trust has qualified and has elected to be taxed as a real estate investment trust (\"REIT\") under Sections 856-860 of the Internal Revenue Code since 1969. It intends to continue to qualify as a REIT. On May 24, 1995, the Board of Trustees of the Trust adopted, subject to shareholder ratification, a new business plan, which provides for the orderly disposition of the Trust's assets, on a property-by-property basis, over a period estimated to be between three and five years. See \"New Business Plan.\"\nREAL ESTATE INVESTMENTS\nThe Trust's real estate portfolio (\"Real Estate Investments\") is comprised primarily of equity investments in office buildings, shopping centers, apartment complexes and hotels located throughout the United States. The Trust's investments are either made directly (including through wholly owned subsidiaries) or through limited partnerships or a participation agreement (classified as and referred to herein as \"Investment Partnerships\") in which the Trust is general partner or lead lender and other institutional investors are the limited partners or participating lenders.\nFor financial reporting purposes, the Trust categorizes its investments into four groups, Owned Properties held directly by the Trust (which includes investments held by wholly owned subsidiaries), Structured Transactions held directly by the Trust, Asset Held for Sale directly by the Trust (which currently consist only of one Owned Property), and interests in Investment Partnerships (which hold Owned Properties, Structured Transactions and Assets Held for Sale). Investments in land leasebacks and\/or mortgage loans are classified as Structured Transactions. Investments constituting ownership of improved income producing properties are classified as Owned Properties. Owned Properties involve operational and management responsibilities with on-site property management delegated to independent contractors. Owned Properties which have been approved for sale by the Trustees (and if applicable the limited partners of an Investment Partnership) that are currently being marketed for sale are classified as Assets Held for Sale.\nAt July 31, 1995, the Trust's portfolio of Real Estate Investments included eight Owned Properties, consisting of four held directly by the Trust and four held by Investment Partnerships; 14 Structured Transactions, consisting of ten held directly by the Trust and four held by Investment Partnerships; and five Assets Held for Sale, one of which is classified as an Asset Held for Sale directly by the Trust (previously classified as an Owned Property held directly by the Trust) and four of which are classified as Assets Held for Sale in Investment Partnerships (previously classified as Owned Properties held by Investment Partnerships).\nFor a description of the Trust's individual investments and developments relating to such investments during the year, see Item 2, Item 7, Note 2 of the Notes to Consolidated Financial Statements of the Trust, and Schedule III, Schedule IV, Exhibit A and Exhibit B included in Item 14 hereof.\nNEW BUSINESS PLAN\nThe Trust's business plan has focused on maximizing shareholder values through asset, portfolio and liability management and the selective disposition of investments. The business plan was in large part a response to the impact of the recent recession on the real estate industry. During the time this plan was in effect, the Trust retained much of its portfolio, disposing of four investments in fiscal 1994 and two investments in fiscal 1995.\nFollowing improvements in rental rates and occupancies throughout the Trust's portfolio attributable to improving economic conditions and considerable progress made by management in resolving problems affecting the portfolio, the Trustees undertook a reevaluation of the Trust's business plan in the context of developing a new long-term strategy that would seek to maximize shareholder values. The Trustees initiated such a review of the Trust's long-term strategy because of their belief that the Trust's stock price has not been reflective of the true value of the Trust's assets. The result of this reevaluation was the adoption by the Trustees on May 24, 1995, subject to shareholder ratification, of a new business plan which provides for the orderly disposition of the Trust's investments over an estimated period of three to five years.\nIn implementing the new business plan, the Trustees envision two different approaches, one relating to the Structured Transactions and the other to the Owned Properties.\nWith respect to the Structured Transactions, the Trust has commenced discussions with many of its lessees\/mortgagors regarding repurchasing or repaying the Trust's investments. Since management is intent on realizing full value for the\nITEM 1. BUSINESS (continued) Structured Transactions, negotiations with these logical purchasers are likely to extend over a considerable period of time. Management believes that this period could last from three to five years.\nWith respect to the disposition of Owned Properties, the Trust will base its decision with respect to timing of sales on such factors as the physical condition of a property and the occupancy and cash flow status of a property. The Trust anticipates using brokers to handle most sales of Owned Properties. It is expected that once a decision to sell an Owned Property is made, the process of broker selection, marketing contract negotiations and closing should normally take between six and nine months.\nIt is not expected that any property will be sold to persons deemed to be affiliates of the Trust. Each offer to purchase Trust assets must be acted upon by the Board of Trustees, which Board is comprised of seven Trustees, five of whom are unaffiliated with the Trust or its former investment advisor.\nIt is difficult to predict the exact timing of, or the amount of net proceeds from, the sale of the Trust's assets. No prices have been established for the portfolio. Accordingly, it is not possible to determine at this time the aggregate net proceeds that may ultimately be available for distribution to the Trust's shareholders. That amount will depend upon a variety of factors, including the timing of and the net proceeds realized from the sale of the Trust's assets, as well as the ultimate amount of expenses and other obligations and liabilities that must be satisfied out of the Trust's assets.\nProceeds from dispositions may be used during the course of the implementation of the new business plan to retire debt, repurchase outstanding Common Shares and\/or make distributions to shareholders. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\" Distributions to shareholders will be made periodically at such times and upon such terms as determined by the Trustees. Following the sale of all of the Trust's assets and satisfaction by the Trust, through payment or establishment of reserves, of all of its liabilities and obligations, the Trust will distribute to its shareholders the balance of available proceeds. The Trustees may from time to time fix a date in respect of any distribution for the determination of the persons to be treated as shareholders of record entitled to receive such distributions.\nBefore the final distributions of the Trust's remaining assets to the shareholders, the Common Shares will continue to be transferable and the Trust's shareholders will continue to have such rights as applicable law confers upon shareholders. It is the intention of the Trustees to maintain the listing of the Common Shares on the American Stock Exchange until such time as the American Stock Exchange causes the Common Shares to be delisted. Once all of the Trust's assets have been sold and the net proceeds are distributed to the Trust's shareholders, legal formalities of terminating the Trust will be completed in accordance with the Declaration of Trust and with Massachusetts law.\nAt the 1995 Annual Meeting of Shareholders the Trustees intend to seek ratification of the new business plan and approval of certain amendments to the Trust's Declaration of Trust that are necessary for the implementation of the plan. In the event of the failure of the shareholders to ratify the new business plan and to approve the proposed amendments, the Trust intends to continue to transact business as a REIT and to consider alternative courses of action.\nCOMPETITION, REGULATION AND OTHER FACTORS\nThe success of the Trust depends, among other factors, upon general economic conditions and trends, including real estate trends and population trends, interest rates, government regulations and legislation, income tax laws and zoning laws. The Trust does not consider its real estate business to be seasonal in nature.\nThe Trust's real estate investments are located in markets in which they face significant competition for the revenues they generate. Many of the Trust's investments, particularly the office buildings and hotels, are located in markets which have a substantial supply of available space, resulting in significant competition on the basis of price and amenities.\nTENANTS\nSpaces in the Owned Properties are leased to 2,997 tenants, including 83 retail tenants, 195 office tenants and 2,719 apartment tenants. The lease terms range from tenancies-at-will to 20 years.\nPROPERTY MANAGEMENT\nAll Owned Properties are managed by professional property management firms that are independent of the Trust and report directly to the Trust's management. Property management fees range from 2.5% to 5% of annual gross receipts from the operations of the properties and each property management agreement may be terminated upon 30 days' notice.\nINSURANCE\nThe Owned Properties, which include properties that are owned directly by the Trust (or its subsidiaries) and by the Investment Partnerships, have commercial general liability coverage, with limits of $76,000,000 per occurrence and $89,000,000 in the aggregate except for PCA Southwest Associates Limited Partnership, which is subject to a $77,000,000 aggregate limit. This\nITEM 1. BUSINESS (continued)\ncoverage protects the Trust and, where applicable, the Investment Partnerships against liability claims as well as the costs of defense. Property insurance on the Owned Properties is maintained on a replacement value basis covering both the cost of direct physical damage and the loss of rental income, subject to a limit of $50,000,000 at any one location except Loehmann's Fashion Island, which is subject to a $21,000,000 limit, and the Houston apartments owned by PCA Southwest Associates Limited Partnership, which are subject to a $79,005,600 limit. Separate flood and earthquake insurance is provided with an annual aggregate limit of $10,000,000 for each peril, with the exception of the Houston apartments which are subject to a $17,500,000 limit with a $500,000 per building deductible (for flood coverage only). Liability and property insurance for Structured Transactions is carried by the Trust's lessees\/mortgagors.\nAs of the end of fiscal 1995, two Investment Partnerships - Property Capital Midwest Associates, L.P. and PCA Southwest Associates Limited Partnership - held Owned Properties. Subsequent to the fiscal year end, a third Investment Partnership - PCA Canyon View Associates Limited Partnership - converted its investments in Phase II to an Owned Property (see Item 3, \"Legal Proceedings\"). The Trust, as general partner, is liable for all obligations of and claims made against Property Capital Midwest Associates, L.P. and PCA Canyon View Associates Limited Partnership beyond the net worth of such partnerships and, in the case of claims covered by the Investment Partnership's liability insurance, the amount of such insurance. The Trust has sought to obviate such liability with respect to PCA Southwest Associates Limited Partnership by transferring its general partnership interest to a limited partnership of which a wholly owned subsidiary of the Trust is the general partner and the Trust is the limited partner.\nTHE ADVISOR; INTERNALIZATION OF MANAGEMENT\nEffective August 1, 1992, the Trust internalized the investment and day-to-day administrative services previously performed by its former investment advisor, Property Capital Advisors, Inc. (the \"Advisor\"), under its advisory contract with the Trust (the \"Advisory Contract\") which expired on July 31, 1992 and was not renewed. No consideration was paid to the Advisor in connection with the expiration and non-renewal of the Advisory Contract. For additional information relating to the Advisory Contract and the internalization of management, see Note 6 of the Notes to Consolidated Financial Statements of the Trust.\nGOVERNMENT REGULATIONS\nA number of jurisdictions have laws and regulations relating to the ownership of real estate, such as local building and similar codes. From time to time, capital expenditures on Owned Properties may be required to comply with changes in these laws. No material expenditures are contemplated at this time in order to comply with any such laws or regulations.\nUnder various Federal, state and local laws, ordinances and regulations, a current or previous owner or operator of real estate may be liable for the costs of removal or remediation of certain hazardous or toxic substances released on, under or in its property. The costs of such removal or remediation can be substantial. Such laws often impose such liability without regard to whether the owner or operator knew of, or was responsible for, the release or presence of such hazardous or toxic substances. The presence of such substances, or the failure to remediate such substances properly, may adversely affect the owner's ability to sell or lease such real estate or to borrow using such property as collateral. Management is not aware of any material violation of applicable environmental requirements with respect to any of its real estate investments, nor does it contemplate having to make any material expenditures in order to comply with any current environmental laws or regulations.\nCUSTOMERS\nAs of July 31, 1995, the Trust's most significant relationship with any single third-party owner of real estate was with National Housing Partnerships (\"NHP\") which, through affiliates, is the lessee\/mortgagor in two of the Trust's apartment investments. The Trust's investments consist of a $5,400,000 land leaseback in Sandpiper Cove Apartments and investments totaling $9,770,000 in Elm Creek Apartments (a $2,230,000 land leaseback and a $7,540,000 leasehold mortgage loan). These investments accounted for approximately 9% of the Trust's real estate portfolio as of July 31, 1995 and approximately 6% of the Trust's total revenues from its real estate portfolio during fiscal 1995. Neither NHP nor any other lessee or borrower is affiliated with the Trust or its Trustees.\nANTICIPATED CAPITAL EXPENDITURES\nIn accordance with the Trust's new business plan, no new investments in properties are anticipated. The Owned Properties, pending sale, will continue to be managed aggressively to maximize performance and values. For fiscal 1996, the aggregate amount of anticipated capital expenditures at Owned Properties held directly by the Trust and Asset Held for Sale directly by the Trust is $1,900,000, primarily for tenant improvements and leasing commissions. The funds necessary for capital expenditures are anticipated to be available from cash flow provided by operations, through borrowings under the Trust's line of credit and from proceeds from the sale of properties.\nITEM 1. BUSINESS (continued)\nAdditionally, the Trust's share of anticipated tenant improvements, leasing commissions and other capital expenditures at Owned Properties held in Investment Partnerships and Assets Held for Sale in Investment Partnerships is approximately $900,000. These funds are anticipated to be available from the Investment Partnerships' cash flows.\nBORROWING\nAt July 31, 1995, the Trust had $71,816,000 of debt outstanding as follows:\nFor additional information, see Item 7 and Note 3 of the Notes to Consolidated Financial Statements of the Trust.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES - --------------------------------------------------------------------------------\nThe Trust's Real Estate Investments (net of accumulated depreciation) consist of the following:\n* Includes Assets Held for Sale in Investment Partnerships.\nMany of the investments in the portfolio are subject to first mortgage financing, which aggregated $182,686,000 as of July 31, 1995. Included in this amount is $40,145,000 of debt on three of the Owned Properties held directly by the Trust and $25,420,000 of debt on Owned Properties held in Investment Partnerships. The balance represents mortgage debt on Structured Transactions, which is not presented as a liability in the Trust's financial statements because the obligation to pay such debt is that of the Trust's lessees\/mortgagors. All of the first mortgage financing, with the exception of $15,000,000 of debt on Loehmann's Fashion Island, is non-recourse to the Trust. For additional information, see Note 3 of the Notes to Consolidated Financial Statements of the Trust and Schedule III and Exhibit A included in Item 14 hereof.\nITEM 2. PROPERTIES (continued)\nAs of July 31, 1995, the Trust's Real Estate Investments (net of accumulated depreciation and before the allowance for possible investment losses) were diversified by type of property as follows:\nAs of July 31, 1995, the Trust's Real Estate Investments (net of accumulated depreciation and before the allowance for possible investment losses) were diversified by geographic region as follows:\nThe Trust has investments in 27 properties (including those held in Investment Partnerships) located throughout the United States. Four properties are owned by the Trust (or wholly owned subsidiaries) and are classified as Owned Properties held directly by the Trust. Ten properties are investments in which the Trust owns and leases back land and\/or holds a mortgage loan and are classified as Structured Transactions held directly by the Trust. One property owned by the Trust is classified as an Asset Held for Sale directly by the Trust, a property which was previously classified as an Owned Property held directly by the Trust.\nThe Trust has investments in five Investment Partnerships. Two of such Investment Partnerships own an aggregate of eight properties, four of which are classified as Owned Properties held in Investment Partnerships and four of which are classified as Assets Held for Sale in Investment Partnerships. The remaining three Investment Partnerships hold an aggregate of four properties all of which are classified as Structured Transactions held in Investment Partnerships.\nITEM 2. PROPERTIES (continued)\nThe following is a schedule of the 27 properties in which the Trust has investments.\nINVESTMENTS HELD DIRECTLY BY THE TRUST\nITEM 2. PROPERTIES (continued) INVESTMENT PARTNERSHIPS\n(1) Average occupancy for fiscal 1995\nThe four Owned Properties held directly by the Trust total $83,985,000 at July 31, 1995 (48% of Real Estate Investments before the allowance for possible investment losses). Three of the properties are office buildings located in suburban markets and the remaining property is a retail center located in Aventura, Florida. Each property accounts for more than 5% of either Real Estate Investments (before the allowance for possible investment losses) or total revenues, and is described below.\nITEM 2. PROPERTIES (continued)\nONE PARK WEST - CHEVY CHASE, MARYLAND\nOne Park West is a 128,500 square foot, five story, multi-tenant office building with underground parking, built in 1980. The property is located in suburban Washington, D.C. At July 31, 1995, the property was encumbered by a $9,898,000 first mortgage which bears interest at 9.5%, due June 2000. The building is tenanted by the federal government, a publisher and general and medical offices. Four tenants each occupy more than 10% of the building, with space aggregating 34,883 square feet, 22,925 square feet, 15,901 square feet and 14,400 square feet, and lease expiration dates of December 31, 1996, October 31, 2000, March 31, 1998 (with an early termination option at March 31, 1997) and March 31, 1996, respectively. At July 31, 1995, 1994 and 1993, the property was 98%, 100% and 83% leased, respectively.\nCITIBANK OFFICE PLAZA - SCHAUMBURG, ILLINOIS\nCitibank Office Plaza - Schaumburg is a 105,400 square foot, five story, multi-tenant office building, built in 1978. The property is located in suburban Chicago, Illinois and is not encumbered by mortgage financing. The building is tenanted by the headquarters of a regional hardware retailer, an accounting firm, a stockbroker, a bank and general office tenants. Three tenants each occupy more than 10% of the building, with space aggregating 29,421 square feet, 18,394 square feet and 11,909 square feet and lease expiration dates of October 31, 2001 (with an early termination option at October 31, 1998), August 18, 2001 and December 31, 2003 (with an early termination option at December 31, 1996), respectively. In October 1995, an involuntary Chapter 11 proceeding was filed against the building's second largest tenant, the hardware retailer. At this time, it is unclear what action the tenant will take concerning its lease. At July 31, 1995, 1994 and 1993, the property was 90%, 88% and 80% leased, respectively.\nPARK PLACE - CLAYTON, MISSOURI\nPark Place is a 72,000 square foot, five story, multi-tenant office building with a parking garage, built in 1984. The property is located in suburban St. Louis, Missouri. At July 31, 1995, the property was encumbered by an $8,515,000 Industrial Revenue Bond mortgage with an average interest rate of 5.65%, due in May 2008. The building is tenanted by insurance, banking and professional service businesses. Three tenants each occupy more than 10% of the building, with space aggregating 12,836 square feet, 11,876 square feet and 9,934 square feet, and lease expiration dates of May 31, 2000, March 31, 1996 and October 31, 1997, respectively. At July 31, 1995, 1994 and 1993, the property was 99%, 100% and 100% leased, respectively.\nLOEHMANN'S FASHION ISLAND - AVENTURA, FLORIDA\nLoehmann's Fashion Island is a 282,000 square foot open mall specialty shopping center located in Aventura, Dade County, Florida, which underwent a major redevelopment that was substantially completed in fiscal 1994. The property is owned by a partnership whose partners are wholly owned subsidiaries of the Trust. At July 31, 1995, the property was encumbered by a $21,732,000 mortgage, which is due in July 1998. The loan bears interest at the lender's floating prime rate plus 1\/4%. The borrower, however, has the option, at no cost to it, to fix the rate from time to time at 2.25% over comparable term LIBOR or U.S. Treasury rates, for a specified number of times. The borrower made such an election as to the then outstanding principal balance in July 1995, and through December 1996 the interest rate is fixed at 7.97%. The shopping center is tenanted by a 16 screen movie theatre, a super market, three restaurants and other retailers. Two tenants each occupy more than 10% of the shopping center, with space aggregating 47,813 square feet and 47,220 square feet and lease expirations of May 3, 2013 and May 30, 2013, respectively. At July 31, 1995, 1994 and 1993, the property was 90%, 90% and 80% leased, respectively.\nFor additional information on the Trust's Owned Properties held directly by the Trust, see Item 7, Note 2 of the Notes to Consolidated Financial Statements of the Trust and Schedule III of Item 14.\nThe ten properties classified as Structured Transactions held directly by the Trust total $32,571,000 at July 31, 1995 (19% of Real Estate Investments before the allowance for possible investment losses). Two of the Structured Transactions held directly by the Trust each account for more than 5% of either Real Estate Investments (before the allowance for possible investment losses) or total revenues, and are described below.\nELM CREEK APARTMENTS - ELMHURST, ILLINOIS\nElm Creek Apartments is a 372 unit luxury apartment complex built in 1988, located in suburban Chicago, Illinois. The Trust's total investment in this property is $9,770,000 and is comprised of a $2,230,000 land leaseback and a $7,540,000 leasehold mortgage loan. The land lease, including renewal options, expires in December 2063 and provides for fixed monthly rental payments to the Trust aggregating $189,500 annually and overage rent of 40% of increases in revenues (as defined) of the property over specified amounts. In fiscal 1995, the Trust received overage rent (in excess of the fixed monthly payments) of $93,400. The lessee has the right to sell the land and improvements to a third party at any time (subject to the Trust's leasehold mortgage being repaid in full at that time); if the lessee so elects, the purchase price shall be determined at that time by a previously agreed upon formula based on the sales price of the project, but not less than $2,230,000. The Trust's leasehold\nITEM 2. PROPERTIES (continued)\nmortgage bears interest at the rate of 8.5% per annum through March 31, 1996 and 10% per annum thereafter and matures in November 2018. No amortization payments are required under this loan prior to maturity. The Trust's investments in this property are subordinated to a third party first mortgage loan of $21,104,000, bearing interest at 9.50% and due in 1997. At July 31, 1995, 1994 and 1993, the property was 97%, 97% and 99% leased, respectively.\nCITY CENTRE HOLIDAY INN - CHICAGO, ILLINOIS\nCity Centre Holiday Inn, located in downtown Chicago, is a 500 room hotel built in 1976. The Trust holds a $2,000,000 land leaseback interest in this property. The land lease, including renewal options, expires in December 2052 and provides for fixed monthly rent payments of $220,000 per annum. In addition, the Trust is entitled to receive overage rent annually equal to 1% of gross receipts and 15% of gross room revenues over specified amounts. In fiscal 1995 the overage rent earned by the Trust from this investment was $1,289,000. The lessee has an option to repurchase the Trust's land in 1996 and every five years thereafter for the sum of $2,000,000, plus the product of the average annual overage rent earned by the Trust in the three years immediately preceding the repurchase multiplied by 12.50. The Trust's investment is subordinated to a third-party first mortgage loan of $10,140,000, bearing interest at 9.13% and due in 1997. For fiscal 1995, 1994 and 1993, the average occupancy was 67%, 71% and 68%, respectively.\nNo other Structured Transaction held directly by the Trust constitutes 5% or more of either the Trust's Real Estate Investments (before the allowance for possible investment losses) or represents more than 5% of total revenues. For additional information on the Structured Transactions held directly by the Trust see Item 7, Note 2 of the Notes to Consolidated Financial Statements of the Trust and Schedules III and IV of Item 14.\nThe Trust's five Investment Partnerships own an aggregate of four Owned Properties, four Structured Transactions and four Assets Held for Sale. The Trust's equity investment in these five Investment Partnerships totals $48,299,000 at July 31, 1995 (28% of Real Estate Investments before the allowance for possible investment losses). The Trust's two most significant partnership investments each account for more than 5% of either Real Estate Investments (before allowance for possible investment losses) or total revenues, and are discussed below.\nPROPERTY CAPITAL MIDWEST ASSOCIATES, L.P.\nProperty Capital Midwest Associates, L.P. is the Investment Partnership in which the Trust has its largest partnership investment. The Trust owns 53.3% of this Investment Partnership which owns a complex of four office buildings totaling 300,600 square feet, built in 1984-1987, an office building totaling 50,900 square feet, built in 1982, and a 98,000 square foot shopping center building, built in 1988, all of which are classified as Assets Held for Sale, and one office building totaling 37,700 square feet, built in 1979, which is classified as an Owned Property. The properties are located in Overland Park, Kansas, a suburb of Kansas City, Missouri, and are owned free and clear of mortgage debt. At July 31, 1995, the Trust's equity investment in this partnership was $25,140,000. No single tenant occupies 10% or more of the 487,200 square feet rentable space owned by this Investment Partnership. At July 31, 1995, the Investment Partnership reclassified the complex of four office buildings, the 50,900 square foot office building and the shopping center to Assets Held For Sale and wrote the properties down to net realizable value (the Trust's share of the write-downs was $2,311,000, which had been previously provided for in the Trust's allowance for possible investment losses). At July 31, 1995, 1994 and 1993, the office buildings were 97%, 95% and 93% leased, respectively. At July 31, 1995, 1994 and 1993, the shopping center was 100%, 93% and 63% leased, respectively. The office buildings are tenanted by a large variety of businesses including banking and financial services firms, regional sales offices, an office furniture retailer and two restaurants. The shopping center is a mixed use office and retail center tenanted by various retail tenants, a realtor and a restaurant. For further information on this Investment Partnership, please see the separate financial statements attached to this Form 10-K as part of Item 14.\nPCA SOUTHWEST ASSOCIATES LIMITED PARTNERSHIP\nThe Trust's other significant partnership investment is a 45.45% interest in PCA Southwest Associates Limited Partnership. This partnership owns four separate apartment complexes consisting of 2,848 apartment units in Houston, Texas. The apartments were built from 1965 through 1978. The properties were encumbered by 11 mortgage loans totaling $25,420,000 at July 31, 1995, at an average interest rate of 8.27% and maturities ranging between October 1997 and October 1998. The Investment Partnership assumed full title to these complexes by exercising an option to terminate its land lease related to these properties and paying $427,000 to its lessee, an affiliate of Harold Farb, the original owner of the properties. At July 31, 1995, 1994 and 1993 the apartments were 95%, 85% and 93% leased, respectively.\nOne phase of the complexes owned by this Investment Partnership is Telegraph Hill Phase B, 259 units. The Investment Partnership ceased making payments to the first mortgagee in November 1994. The Investment Partnership attempted to restructure the loan without success. The principal amount due on the mortgage is $2,487,000. Management anticipates that the title to the property will be transferred to the first mortgagee by a deed in lieu of foreclosure.\nAt July 31, 1995 the Investment Partnership reclassified one of the complexes, Chimney Rock, consisting of 714 units, to an Asset\nITEM 2. PROPERTIES (continued)\nHeld for Sale and wrote the property down to net realizable value (the Trust's share of the write down was $54,000, which had been previously provided for in the Trust's allowance for possible investment losses). The property was sold on September 29, 1995. No further loss was incurred.\nFor further information on all of the Investment Partnerships, see Item 7, Note 2 of the Notes to Consolidated Financial Statements of the Trust and Exhibits A and B of Item 14.\nThe Trust has one property classified as an Asset Held for Sale directly by the Trust at July 31, 1995, Citibank Office Plaza - Oakbrook, which is described below.\nCITIBANK OFFICE PLAZA - OAKBROOK\nCitibank Office Plaza - Oakbrook (6% of Real Estate Investments before the allowance for possible investment losses) is a 100,400 square foot, five story, multi-tenant office building built in 1979. Previously this asset had been classified as an Owned Property held directly by the Trust. The property is located in suburban Chicago, Illinois and is not encumbered by mortgage financing. At July 31, 1995, 1994 and 1993 the property was 100%, 99% and 93% leased, respectively. The building is tenanted by an educational service firm and other professional and banking service businesses. Three tenants each occupy more than 10% of the building with spaces aggregating 29,202 square feet, 17,121 square feet and 10,352 square feet and lease expiration dates of January 31, 2001 (of which 7,943 square feet has an early termination option of July 31, 1996), August 31, 2002 (with an early termination option of September 1, 1998) and November 30, 1998, respectively.\nThe Owned Properties, Structured Transactions and Investment Partnerships described above constitute 80% of the Trust's Real Estate Investments (before the allowance for possible investment losses) and 79% of the Trust's revenues from real estate.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS - --------------------------------------------------------------------------------\nAt July 31, 1995, two Structured Transactions held by PCA Canyon View Associates Limited Partnership, an Investment Partnership, were in default. The properties are known as Canyon View I and Canyon View II (248 and 188 units, respectively), and the Investment Partnership's sublessee\/mortgagor had failed to make the required payments due to the Investment Partnership and the ground lessor since July 1994. In addition, beginning in August 1994, the sublessee\/mortgagor failed to make the required mortgage payment to the first mortgagee of Phase I. The Investment Partnership's Equity was $13,765,000 at July 31, 1995, of which the Trust's share was $3,277,000, and the outstanding balance of the first mortgage secured by Phase I was $12,000,000.\nAs a result of the defaults by the sublessee\/mortgagor during August 1994, litigation was commenced in Superior Court of the State of California, County of Contra Costa. On December 2, 1994 the Investment Partnership filed for protection under Chapter 11 of the U.S. Bankruptcy Code in the United States Bankruptcy Court for the Northern District of California. Following the close of Fiscal 1995, all such outstanding litigation was settled and the Chapter 11 proceedings were dismissed. As a result, the Investment Partnership now has full ownership to Canyon View II and permitted Canyon View I to be foreclosed by the first mortgagee. The Trust incurred a $530,000 loss on Canyon View I, which amount had previously been provided for in the Trust's allowance for possible investment losses. Additionally, the Trust wrote down by $961,000 its investment in Canyon View II to its net realizable value, which amount had previously been provided for in the Trust's allowance for possible investment losses.\nIn November 1994, a tenant that occupies approximately 19,315 square feet of College Hills 3, a 37,700 square foot office building located in Overland Park, Kansas, and owned by Property Capital Midwest Associates, L.P. (an Investment Partnership), filed an action in the District Court of Johnson County, Kansas, in which the tenant claims that the Trust and the Investment Partnership have violated the terms of the tenant's space lease. The tenant has alleged that it had an oral agreement with the Investment Partnership's predecessor-in-interest to the building, the Trust and the Investment Partnership granting the tenant the right to lease additional space that might become available in the building, which allegation the Trust and Investment Partnership have denied. After the filing of the action, negotiations for the possible sale of the building to the tenant ensued, but were not finalized. In March 1995, a settlement agreement granting the tenant the expansion rights it had requested in its original pleading in the litigation was entered into with the tenant but the tenant is currently arguing that the settlement agreement did not in fact constitute a full and final settlement among the parties to the litigation. In a pleading filed by the tenant, the tenant has also asserted that it is entitled to damages in excess of $1,000,000, which assertion is denied by the Trust and the Investment Partnership. Although it is not possible to predict with certainty the outcome of the litigation, the Trust and the Investment Partnership do not believe that they have any material liability to the tenant.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - --------------------------------------------------------------------------------\nNo matters were submitted to a vote of the Trust's security holders during the last quarter of its fiscal year ended July 31, 1995.\nITEM 4A. EXECUTIVE OFFICERS OF THE TRUST - --------------------------------------------------------------------------------\nThere is no family relationship among any of the officers listed above, nor any arrangement or understanding between any such officers and any other person pursuant to which he or she was selected as an officer. Each officer will hold office until the next Annual Meeting of Trustees or until his or her successor has been elected and has qualified.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE TRUST'S COMMON SHARES AND RELATED SECURITY HOLDER MATTERS - --------------------------------------------------------------------------------\n(A) PRICE RANGE OF COMMON SHARES\nThe Trust's Common Shares are traded on the American Stock Exchange (\"ASE\") - symbol PCT. The high and low prices on the ASE for each quarter during the past two fiscal years and dividends declared for such quarters are shown below:\n(B) APPROXIMATE NUMBER OF EQUITY SECURITY HOLDERS\nThe computation of the approximate number of holders includes record holders and individual participation security listing positions.\n(C) DIVIDENDS DECLARED ON COMMON SHARES\nCash dividends have usually been at least 100% of income (loss) before gain on sale of real estate investments and extraordinary item and increases to the Trust's allowance for possible investment losses. The Trust pays dividends approximately 55 days following the end of each fiscal quarter. To maintain its status as a REIT, the Trust is required each year to distribute to its shareholders at least 95% of its taxable income (excluding net capital gains and after certain other adjustments). In addition, the Trust will be subject to a 4% nondeductible excise tax on the amount, if any, by which certain distributions paid by it with respect to any calendar year are less than the sum of 85% of its ordinary income for the calendar year, 95% of its capital gain income for the calendar year, and any amount of such income that was not distributed in prior years. The Trust did not incur any such excise tax liability with respect to calendar 1994 or 1993. In fiscal 1995 and 1994, the Trust's net income per share was $.59 and $.45, respectively and dividends declared were $.41 and $.30, respectively. In connection with the implementation of the Trust's new business plan, the Trust may make additional distributions to its shareholders periodically as the Trust's assets are sold. The timing and amount of such distributions will depend on a number of factors determined by the Board of Trustees, see Item 1, \"Business - New Business Plan.\"\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA - --------------------------------------------------------------------------------\n* Restated for change in accounting method to the equity method for Investment Partnerships. The change did not affect net income (loss) or shareholders' equity. See Note 1 of the Notes to Consolidated Financial Statements of the Trust which describes the Trust's previous method of accounting and the reasons for the change.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - --------------------------------------------------------------------------------\nOn May 24, 1995, the Board of Trustees of the Trust adopted, subject to shareholder ratification, a new business plan, which provides for the orderly disposition of the Trust's assets, on a property-by-property basis, over a period of time estimated to be three to five years. See Item 1 \"Business - New Business Plan.\" Proceeds from dispositions may be used during the course of implementation of the new business plan to retire debt, repurchase outstanding Common Shares and\/or make distributions to shareholders. In accordance with its new business plan, the Trust does not anticipate any new acquisitions and Owned Properties, pending sale, will continue to be managed aggressively to maximize performance and values.\nFINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES\nThe Trust has reviewed its short-term and long-term liquidity needs in view of its new business plan and the adequacy of cash provided by operating activities and other liquidity sources to meet these needs. The Trust's principal short-term liquidity needs are normal operating expenses, debt service requirements, capital expenditures at Owned Properties (including Assets Held for Sale) and the minimum dividend distributions required to maintain the Trust's REIT status under the Internal Revenue Code. The Trust expects to fund these short-term liquidity needs from cash flows provided by operating activities and, if needed, available borrowings under its existing demand line of credit. The Trust expects to fund its longer-term liquidity requirements for scheduled debt maturities from property sales and its existing demand line of credit.\nThe Trust's debt to equity ratio was .77x at July 31, 1995, .89x at July 31, 1994, and .96x at July 31, 1993. The Trust's debt at July 31, 1995 was $71,816,000, as compared to $81,479,000 at July 31, 1994 and, $86,492,000 at July 31, 1993, and was composed of $31,671,000 in long-term fixed rate Convertible Subordinated Debentures and $40,145,000 of mortgage notes payable. The Trust's bank note payable had no outstanding balance at July 31, 1995.\nThe Trust's long-term 10% Convertible Subordinated Debentures decreased to $29,125,000 at July 31, 1995 from $30,823,000 at July 31, 1994 due to the Trust's repurchase of $1,698,000 aggregate principal amount of the debentures at a discount. Additionally, subsequent to the end of the fiscal year, the Trust called $4,000,000 of these debentures for redemption at par as of September 1, 1995 and $8,000,000 of these debentures for redemption at par as of December 1, 1995.\nThe Trust's mortgage notes payable of $40,145,000 at July 31, 1995 was comprised of three mortgages on three Owned Properties held directly by the Trust. In March 1993, the Trust acquired its lessee's interest in One Park West, an office building in Chevy Chase, Maryland, subject to a non-recourse mortgage loan which had a balance of $9,898,000 at July 31, 1995. The loan carries an annual interest rate of 9 1\/2%, requires monthly payments of principal and interest and matures in June 2000.\nIn January 1991, the Trust acquired its lessee's interest in Park Place, an office building located in Clayton, Missouri, subject to an $8,600,000 non-recourse mortgage loan. In November 1993, the Trust refinanced the first mortgage, resulting in a reduction in the annual effective interest rate from 8.25% to 5.65%. Interest is payable semi-annually. The mortgage balance was $8,515,000 at July 31, 1995 and amortizes $85,000 each year through May 2003, and $430,000 annually in May 2004 through May 2007. The remaining balance of $6,115,000 matures in May 2008.\nThe Loehmann's Fashion Island Shopping Center refinanced its then existing first mortgage on June 30, 1994 with an initial advance of $18,000,000. The loan commitment was for $30,000,000 with additional advances to be made through June 1996 based upon property performance. The first mortgage loan (of which $15,000,000 is with recourse to the Trust) matures in July 1998 and bears interest at the lender's floating prime rate plus 1\/4% with the Trust having the option to fix the interest rate from time to time at 2.25% above comparable term LIBOR or U.S. Treasury rates for a specified number of times. This option may be exercised at no cost or additional liability to the Trust. The loan also required mandatory amortization payments. During fiscal 1995 the Trust borrowed an additional $6,000,000, of which $2,000,000 was subsequently prepaid, eliminating the required monthly amortization payments prior to maturity in July 1998. In July 1995, the Trust elected to fix the interest rate on the total outstanding borrowings of $21,732,000 at 7.97% (2.25% over comparable term U.S. Treasury notes) until December 1996.\nThe Trust's bank note payable, which as noted above has no outstanding balance, is a revolving bank line of credit that provided available credit of $20,000,000 at July 31, 1994. In January 1995, when the Trust borrowed an additional $4,000,000 under the first mortgage secured by Loehmann's Fashion Island, the amount available under the bank line was reduced to $16,000,000. In February 1995, following the sale of 6110 Executive Boulevard, the Trust agreed to reduce further its borrowing capacity under its bank line to $10,000,000, an amount which the Trust believes is adequate to meet its working capital requirements for the foreseeable future.\nFor additional information regarding the Trust's indebtedness, see Note 3 of the Notes to Consolidated Financial Statements of the Trust.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)\nManagement believes that with its cash provided by operating activities retained after dividend distributions, and borrowings under the existing bank line, it will be able to meet its cash requirements for anticipated capital expenditures at Owned Properties held directly by the Trust. The Trust currently expects that these cash requirements will total approximately $1,900,000 during fiscal 1996.\nREVIEW OF REAL ESTATE INVESTMENTS\nThe Trust's principal asset is its $160,963,000 portfolio of Real Estate Investments, which is carried at cost, net of accumulated depreciation and the allowance for possible investment losses, and includes Assets Held for Sale (which are carried at the lower of cost or net realizable value). At July 31, 1995, the portfolio consisted of investments in 27 properties, comprised of investments in 11 apartment complexes, seven office buildings, five shopping centers and four hotels. Set forth below is a discussion of significant changes in the portfolio during the year.\nAPARTMENTS\nThe Trust's real estate investments include 11 apartment investments, consisting of five Structured Transactions held directly by the Trust, three Owned Properties held in an Investment Partnership, one Asset Held for Sale in an Investment Partnership and two Structured Transactions held in an Investment Partnership.\nOn March 31, 1994, PCA Southwest Associates Limited Partnership, the Investment Partnership which held mortgages on and the land under five Structured Transactions, acquired its lessee's interest in the properties for $427,000. The properties consisted of 3,000 apartment units in Houston, Texas. Braes Hill apartments, a 152 unit complex, was sold in March 1995 at a gain, of which the Trust's share was $110,000. At July 31, 1995, Chimney Rock apartments, (a 714 unit complex) was reclassified to an Asset Held for Sale and was written down to its net realizable value. The Trust's share of the write-down ($54,000) was charged against the Trust's previously established allowance for possible investment losses. Subsequent to the end of the fiscal year, the property was sold and no further loss was incurred. With regard to Telegraph Hill-Phase B, (a 259 unit complex) the Investment Partnership is in default under the terms of the first mortgage loan on this phase. Since November 1994 the Investment Partnership has not made the scheduled principal and interest payments. Management attempted to restructure this $2,487,000 mortgage loan without success, and anticipates transferring the title to the first mortgage lender by a deed in lieu of foreclosure. Additionally, during the year the Investment Partnership consolidated the property management and leasing agents\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)\nfor the portfolio to one firm. Since then a more aggressive leasing strategy has been implemented and the apartments were 95% leased at July 31, 1995 versus 85% leased at July 31, 1994 and 93% at July 31, 1993. On July 31, 1995, the Trust's equity investment in this Investment Partnership was $8,878,000.\nAt July 31, 1995 the Trust had a $3,277,000 investment in an Investment Partnership that held Structured Transactions in Phases I and II of the Canyon View apartments in San Ramon, California. The Investment Partnership's Phase I investments were subject to a $12,000,000 first mortgage which had a scheduled maturity of August 1, 1993, but was extended to August 1, 1994 in anticipation of a proposed sale. Both phases are also subject to non-subordinated land leases held by a third party.\nIn August 1994, when it became apparent that a sale was unlikely to occur, the first mortgagee initiated a court proceeding for the appointment of a receiver for Phase I and commenced foreclosure proceedings. Shortly thereafter the Investment Partnership initiated a court proceeding for the appointment of a receiver for Phase II and commenced foreclosure proceedings on Phases I and II. The Investment Partnership was successful in having a receiver appointed for Phase II. In December 1994 the Investment Partnership filed for protection under Chapter 11 of the U.S. Bankruptcy Code. Extensive negotiations then ensued with the Investment Partnership's lessee and the first mortgagee on Phase I. Subsequent to the end of the fiscal year the litigation was settled. The Investment Partnership, of which the Trust owns a 23.8% interest, received $300,000 from the first mortgagee of Phase I for permitting it to take full title to Phase I and the Investment Partnership took title to Phase II and received the proceeds from two letters of credit aggregating $1,750,000. The Trust's share of the loss due to the settlement of the litigation ($1,491,000) had been previously provided for in the Trust's allowance for possible investment losses. The Trust's total investment in Phase I was $840,000 at July 31, 1995 and the property was 100% leased at July 31, 1995, 99% leased at July 31, 1994 and 97% leased at July 31, 1993. The Trust's total investment in Phase II was $2,437,000 at July 31, 1995, and the property was 100% leased at July 31, 1995, 97% leased at July 31, 1994 and 96% leased at July 31, 1993. For a further discussion see Item 3, \"Legal Proceedings.\"\nThe remaining apartment investments are all current with respect to payments due the Trust at September 30, 1995.\nOFFICE BUILDINGS\nThe Trust currently has seven office building investments, consisting of three Owned Properties held directly by the Trust, one Asset Held for Sale directly by the Trust, one Owned Property held in an Investment Partnership and two Assets Held for Sale in an Investment Partnership (previously classified as Owned Properties held in an Investment Partnership). 6110 Executive Boulevard, an Owned Property held directly by the Trust, was sold in January 1995 at a gain of $3,099,000. In fiscal 1994, the Trust utilized a portion of its previously established allowance for possible investment losses to write down this investment by $2,000,000. Previously, in fiscal 1992, the Trust had written down this investment by $4,000,000.\nAt July 31, 1995 Citibank Office Plaza - Oak Brook, located in suburban Chicago, Illinois, previously classified as an Owned Property held directly by the Trust, was reclassified to an Asset Held for Sale directly by the Trust and was written down to its net realizable value of $10,185,000. The resulting loss of $971,000 was charged against the Trust's previously established allowance for possible investment losses. The property has been listed for sale with a broker and no further loss is anticipated. The property is not subject to first mortgage financing and was 100% leased at July 31, 1995 versus 99% at July 31, 1994 and 93% at July 31, 1993.\nAt July 31, 1995, two office properties held in an Investment Partnership, Financial Plaza and College Hills 8, were reclassified by the Investment Partnership to Assets Held for Sale and were written down by the Investment Partnership to their net realizable values. The Trust's share of the loss was $1,320,000, which was charged against the Trust's previously established allowance for possible investment losses. The properties are located in Overland Park, Kansas, and are not encumbered by mortgage financing. At July 31, 1995 the Trust's investments in Financial Plaza and College Hill 8 were $15,670,000 and $1,728,000, respectively. Financial Plaza was 98% leased at July 31, 1995 versus 94% leased at July 31, 1994 and 92% at July 31, 1993. College Hills 8 was 98% leased at July 31, 1995 versus 97% leased at July 31, 1994 and 90% at July 31, 1993.\nSHOPPING CENTERS\nThe Trust has five shopping center investments, one Owned Property held directly by the Trust, two Structured Transactions held directly by the Trust and two held in Investment Partnerships (an Owned Property classified as an Asset Held for Sale and a Structured Transaction).\nLoehmann's Fashion Island in Aventura, Florida, an Owned Property held directly by the Trust, is the Trust's largest investment. Its redevelopment, which included the expansion and renovation of two existing anchor tenant spaces (Loehmann's and AMC Theatres), the demolition of an existing building to permit construction of a new 48,000 square foot Publix market and new facades, walkways, signage, landscaping and tenant improvements for the entire center, was substantially completed during fiscal 1994. In May 1995, the Trust hired a new property management and leasing agent for the property. The Trust\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)\nanticipates more aggressive leasing efforts and a reduction in the operating costs of the property. Management has been disappointed with the leasing performance of the center and in the spring of 1996 intends to reevaluate its strategy based on leasing performance and expectations at that time. The Trust's investment in the property (net of depreciation) was approximately $43,603,000 at July 31, 1995. The property was 90% leased at July 31, 1995 and 1994 and 80% leased at July 31, 1993.\nThe Trust's other retail property, Plaza West Retail Center, is in Overland Park, Kansas. The property is held in an Investment Partnership, Property Capital Midwest Associates, L.P., which also owns three office properties in Overland Park. All properties held by this partnership are owned free and clear of debt. At July 31, 1995, Plaza West Retail Center, an Owned Property held in an Investment Partnership, was reclassified to an Asset Held for Sale and the property was written down to its net realizable value. The Trust's share of the loss was $991,000, which was charged against the Trust's previously established allowance for possible investment losses. The Trust's equity investment in this property after the write-down was $6,529,000 at July 31, 1995. The property was 100% leased at July 31, 1995, as compared to 93% leased at July 31, 1994 and 63% leased at July 31, 1993.\nSubsequent to the end of the fiscal year the Investment Partnership which owned the land under Crossroads Mall in Boulder, Colorado, sold its investment back to its lessee. The Trust received approximately $5,500,000 from the sale of which approximately $3,500,000 constitutes a gain to the Trust. The property was 91% leased at July 31, 1995 as compared to 97% at July 31, 1994 and 94% at July 31, 1993.\nThe remaining two shopping center investments are all current with respect to their payments due to the Trust at September 30, 1995.\nHOTELS\nThe Trust has four hotel investments, three of which are Structured Transactions held directly by the Trust and one of which is a Structured Transaction held in an Investment Partnership. As previously reported, the Trust has granted its lessee\/mortgagor an option to purchase the Trust's $4,000,000 Structured Transaction investments in Grosvenor Airport Inn, a 206 room hotel in South San Francisco, California, for $2,500,000. Subsequent to the end of the fiscal year, the Trust agreed to grant an extension of the option through November 1, 1995. The lessee\/mortgagor has given the Trust a non-refundable deposit of $350,000 and, commencing April 1, 1995, has been paying additional rent and interest of $10,600 per month pursuant to the option. There can be no assurance that the lessee\/mortgagor of the Grosvenor Airport Inn will exercise its option. The Trust had previously restructured this transaction to provide for a reduced annual return of $160,000. The anticipated loss on sale has been provided for in the Trust's allowance for possible investment losses. In the event this sale does not close the Trust does not contemplate that it will seek another buyer in the near future.\nThe Trust's three other hotel investments are current with respect to payments due the Trust or the Investment Partnership at September 30, 1995.\nALLOWANCE FOR POSSIBLE INVESTMENT LOSSES\nThe Trust's $14,077,000 allowance for possible investment losses at July 31, 1995 was based upon management's estimate of net realizable value of each investment and, to the extent such value is less than carrying value, an allowance for possible investment losses for each investment was established. In estimating net realizable value, consideration was given to many factors, such as income to be earned from the investment, the cost to hold the property to a hypothetical time of sale, the selling price the property would bring at such time, the cost of improving the property to the condition contemplated in determining the selling price, the cost of disposing of the property and prevailing economic conditions, including availability of credit. In the opinion of both the Trustees and Management, this allowance adequately reflects the extent of the estimated impairment that existed at July 31, 1995 in the net realizable value of each of the assets in the portfolio.\nRESULTS OF OPERATION - 1995 VS. 1994\nREVENUES\nRents from Owned Properties held directly by the Trust (base rent plus expense reimbursement) increased 12% from fiscal 1994 primarily due to an increase in rental revenues from the redeveloped Loehmann's Fashion Island and $404,000 of nonrecurring revenues related to the settlement of a bankruptcy claim filed by the Trust against a former tenant at Loehmann's Fashion Island. Additionally, the increase is attributable to increased occupancy at One Park West. This increase was offset in part by a decrease in rental revenue due to the sale of Eagle apartments (March 1994). Rents from Owned Properties held directly by the Trust includes rents from the Citibank Office Plaza - Oakbrook, which was reclassified to an Asset Held for Sale directly by the Trust at July 31, 1995.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)\nBase income from Structured Transactions held directly by the Trust (land rent and\/or mortgage interest) decreased 12% from fiscal 1994, primarily due to the conversion of 6110 Executive Boulevard and One Park West to Owned Properties held directly by the Trust, the sale of the land underlying the Village Oaks apartments (March 1994), the prepayment of the loan on and sale of the land underlying the Brown County Inn (January 1994) and the prepayment of the mortgage loan investment in Rapids Mall (June 1994). This decrease was offset in part by an increase in base income from the restructured Cincinnati Marriott Inn investment (April 1994).\nOverage income decreased 3% from fiscal 1994 primarily due to the sale of the Village Oaks and Brown County Inn investments. These decreases were offset in part by the receipt of increased overage income in fiscal 1995 from two apartment investments and one hotel investment.\nThe Trust's share of income from unconsolidated Investment Partnerships decreased 18% from fiscal 1994 primarily due to depreciation expense recorded by the Trust from PCA Southwest Associates Limited Partnership, the Partnership which owns 2,848 apartment units in Texas. The apartments were converted to Owned Properties in March 1994 and since that date the Trust's share of income from this Investment Partnership is reported net of depreciation expense. Previously, as a Structured Transaction held in an Investment Partnership, the Partnership incurred no depreciation expense. The decrease in income from unconsolidated Investment Partnerships was also due to the cessation of rent and interest payments from the sublessee\/mortgagor of the Canyon View apartment investments and the associated legal and professional fees incurred during negotiations. (See Item 3. \"Legal Proceedings,\" for a discussion of the bankruptcy filing of the Investment Partnership that holds the Canyon View investments.)\nEXPENSES\nExpenses on Owned Properties held directly by the Trust decreased by 1% from fiscal 1994 primarily due to the sale of Eagle apartments (March 1994), offset in part by an increase in operating expenses at the redeveloped Loehmann's Fashion Island. Expenses on Owned Properties held directly by the Trust include expenses from Citibank Office Plaza - Oakbrook, which was reclassified to Asset Held for Sale directly by the Trust at July 31, 1995.\nInterest expense decreased by 1% from fiscal 1994 primarily due to a reduction in interest expense due to the sale of Eagle apartments which was encumbered by a mortgage loan, the refinancing of Park Place at a lower interest rate and the repurchase of 10% Convertible Subordinated Debentures. These decreases were offset in part by the expensing of interest related to Loehmann's Fashion Island (which had been capitalized during construction).\nDepreciation expense increased 18% from fiscal 1994 primarily due to the increase in depreciation on Loehmann's Fashion Island (portions of the redeveloped center were in service for the entire fiscal 1995 as compared to only a part of the prior year) and an increase in depreciation of the office buildings due to capital expenditures made in conjunction with the lease-up of these properties. These increases were offset in part by the elimination of depreciation on Eagle apartments which was sold.\nGeneral and administrative expenses increased 5% as compared to fiscal 1994 primarily due to accrual of expenses related to employee severance plans associated with the Trust's proposed new business plan.\nTrustee fees decreased 15% due to reduction in the size of the Board of Trustees from 9 Trustees to 7 Trustees.\nINCOME (LOSS) BEFORE GAIN ON SALE OF REAL ESTATE INVESTMENTS AND EXTRAORDINARY ITEM\nIncome (loss) before gain on sale of real estate investments and extraordinary item increased to $2,016,000 ($.23 per share) from the prior year's $1,579,000 ($.17 per share) for the reasons noted above.\nGAIN ON SALE OF REAL ESTATE INVESTMENTS\nThe Trust sold two investments in fiscal 1995 resulting in a gain on real estate investments of $3,209,000 ($.35 per share). The Trust's 6110 Executive Boulevard office building was sold for $16,380,000, resulting in a gain of $3,099,000. The Investment Partnership, PCA Southwest Associates Limited Partnership, sold its investment in Braes Hill apartments at a gain, of which the Trust's share was $110,000.\nEXTRAORDINARY GAIN FROM EXTINGUISHMENT OF DEBT\nThe Trust purchased $1,698,000 of its 10% Convertible Subordinated Debentures at less than the Trust's carrying value, producing an extraordinary gain of $88,000 ($.01 per share).\nDIVIDENDS\nDividends declared for fiscal 1995 were $.41 per share versus $.30 per share for fiscal 1994. The Trust pays dividends approximately 55 days following the end of each fiscal quarter.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)\nRESULTS OF OPERATIONS - 1994 VS. 1993\nREVENUES\nRents from Owned Properties held directly by the Trust (base rent plus expense reimbursement) increased 71% in fiscal 1994 from fiscal 1993, primarily as a result of the Trust's acquisition of it's lessees' interests in 6110 Executive Boulevard (February 1994) and One Park West (March 1993). When the Trust acquires the interest of its lessee in a property, the Trust becomes the owner and operator of that property. As such, the Trust receives all tenant rents and expense reimbursements which are classified as Rents from Owned Properties held directly by the Trust and no longer receives income classified as Base Income from Structured Transactions held directly by the Trust (land rent and or mortgage interest) as it did when the investment was a Structured Transaction. Additionally, the increase is attributable to an increase in rental revenues from the redeveloped Loehmann's Fashion Island as new tenants took occupancy. This increase was offset in part by a decrease in rental revenue due to the sale of Eagle apartments (March 1994).\nBase income from Structured Transactions held directly by the Trust (land rent and\/or mortgage interest) decreased 29% in fiscal 1994 from fiscal 1993, primarily due to the conversion of 6110 Executive Boulevard and One Park West to Owned Properties held directly by the Trust, the prepayment of the loan on and sale of the land underlying Brown County Inn (January 1994), the sale of the land underlying Village Oaks apartments (March 1994) and the prepayment of the mortgage loan investment in Rapids Mall (June 1994). This decrease was offset in part by an increase in base income from the restructured Cincinnati Marriott Inn investment (April 1994).\nOverage income decreased 12% in fiscal 1994 from fiscal 1993 primarily due to the recognition in the prior year of additional overage income from a certain hotel investment as a result of an audit of the hotel's records and to the sale of the Village Oaks and Brown County Inn investments. This decrease was offset in part by the receipt of overage income in fiscal 1994 from two apartment investments which did not pay overage income in the prior year.\nThe Trust's share of income from unconsolidated Investment Partnerships increased 49% in fiscal 1994 from fiscal 1993 primarily due to improved operating results of the Investment Partnership which owns the Overland Park, Kansas, properties and the completion of the lessee's bankruptcy proceedings and the resumption of earnings with regard to the Investment Partnership which owns the Houston apartments.\nEXPENSES\nExpenses on Owned Properties held directly by the Trust increased 54% in fiscal 1994 from fiscal 1993 primarily due to the conversion of 6110 Executive Boulevard and One Park West to Owned Properties held directly by the Trust and an increase in operating expenses at the redeveloped Loehmann's Fashion Island.\nInterest expense increased 29% in fiscal 1994 from fiscal 1993 primarily due to the interest expense incurred on the first mortgages on 6110 Executive Boulevard and One Park West and the expensing of interest related to Loehmann's Fashion Island (which had been capitalized during construction). These increases were offset in part by a reduction in interest expense due to the sale of Eagle apartments and the refinancing of Park Place at a lower interest rate.\nDepreciation expense increased 46% in fiscal 1994 as compared to fiscal 1993 primarily due to the additions to Owned Properties held directly by the Trust noted above and the increase in depreciation on Loehmann's Fashion Island as portions of the redeveloped center were placed in service, offset in part by the elimination of depreciation on Eagle apartments which was sold.\nGeneral and administrative expenses increased 12% in fiscal 1994 as compared to fiscal 1993 as the Trust incurred certain expenses that had previously been shared with an affiliate of the former advisor to the Trust. Prior to August 1992, services related to investment matters and day-to-day administration were provided by an independent advisor which shared certain expenses with the Trust such as rent, errors & omissions insurance and computer maintenance. In August 1992, the Trust became self-managed and the Trust's contract with its independent advisor was not renewed. In fiscal 1993, although the former advisor did not provide services to the Trust, it shared offices with the Trust and continued to share certain expenses. In fiscal 1994 the former advisor relocated and these expenses could no longer be shared.\nProfessional fees decreased 23% in fiscal 1994 from fiscal 1993 due to reduced legal fees related to litigation in respect to certain investments.\nThere was no addition to the Trust's allowance for possible investment losses in fiscal 1994. During fiscal 1993 the Trust increased its allowance for possible investment losses by $10,000,000 ($1.11 per share).\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)\nINCOME (LOSS) BEFORE GAIN ON SALE OF REAL ESTATE INVESTMENTS\nIncome (loss) before gain on sale of real estate investments increased to $1,579,000 ($.17 per share) in fiscal 1994 from fiscal 1993's ($8,330,000) ($(.93) per share) for the reasons noted above.\nGAIN ON SALE OF REAL ESTATE INVESTMENTS\nThe Trust sold three investments in fiscal 1994 resulting in a gain on real estate investments of $2,510,000 ($.28 per share). The Trust's Village Oaks apartments investment was sold to the Trust's lessee for $3,500,000, producing a gain of $2,500,000. The Trust's Eagle apartments were sold to an unrelated third party for approximately $12,570,000, resulting in a net loss of $90,000. The Trust's Brown County Inn land investment was sold to the Trust's lessee for $600,000, producing a gain of $100,000. In fiscal 1993 the Trust sold its investment in Lakeside apartments for $9,500,000, which produced a gain of $7,700,000 ($.85 per share).\nDIVIDENDS\nDividends declared for fiscal 1994 were $.30 as compared to $.28 for fiscal 1993. During fiscal 1994 the Trust paid dividends approximately 55 days following each fiscal quarter.\nINFLATIONARY AND ECONOMIC FACTORS\nThe effect of inflation upon the Trust's operations and real estate investments has varied. For several years prior to fiscal 1995 rental rates did not increase by the rate of inflation as competitive market conditions existed at most of the Trust's properties. The Trust believes that many of the real estate markets in which the Trust operates have improved. Though not applicable to all properties in the Trust's portfolio, at many of these properties in fiscal 1995 rental rates have increased by or in excess of inflation. Although operating expenses are impacted by inflation, increases in operating expenses in the past year caused by inflation have not been material.\nITEM 8.","section_7A":"","section_8":"ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - --------------------------------------------------------------------------------\nThe consolidated financial statements and supplementary data of the Trust are included under Item 14 of this Annual Report.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE - --------------------------------------------------------------------------------\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. TRUSTEES AND EXECUTIVE OFFICERS OF THE REGISTRANT - --------------------------------------------------------------------------------\nThe information required to be furnished pursuant to this item with respect to Trustees of the Trust is set forth under the caption \"Election of Trustees\" in the Trust's proxy statement (the \"Proxy Statement\") to be furnished to shareholders in connection with the solicitation of proxies by the Trust's Board of Trustees for use at the 1995 Annual Meeting of Shareholders to be held on December 15, 1995 and is incorporated herein by reference; the information with respect to Executive Officers is set forth, pursuant to General Instruction G of Form 10-K, under Part I of this Report.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION - --------------------------------------------------------------------------------\nThe information required to be furnished pursuant to this item is set forth under the caption \"Executive Compensation\" in the Proxy Statement, other than information set forth under the subcaptions \"Compensation Committee's Report on Compensation\" and \"Performance Graphs\", and is incorporated herein by reference.\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 set forth under the captions \"Voting Securities and Principal Shareholders\" and \"Election of Trustees\" in the Proxy Statement, and is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - --------------------------------------------------------------------------------\nThe information required to be furnished pursuant to this item is set forth under the caption \"Certain Relationships and Related Transactions\" in the Proxy Statement, and is incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, CONSOLIDATED FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K - --------------------------------------------------------------------------------\n(a) 1. CONSOLIDATED FINANCIAL STATEMENTS\nThe consolidated financial statements listed in the accompanying index to financial statements on Page 28 are filed as part of this Annual Report.\n2. CONSOLIDATED FINANCIAL STATEMENT SCHEDULES\nThe consolidated financial statement schedules listed in the accompanying index to financial statements on Page 28 are filed as part of this Annual Report.\n3. EXHIBITS\nThe exhibits listed in the accompanying index to exhibits on Pages 23 and 24 are filed as part of the Annual Report.\n(b) REPORTS ON FORM 8-K\nNone.\nSIGNATURES - --------------------------------------------------------------------------------\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Trust has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nPROPERTY CAPITAL TRUST (Registrant)\nBy \/S\/ ROBERT M. MELZER October 30, 1995 - ------------------------------------------------- ------------------------ Robert M. Melzer Date Trustee, 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 Trust and in the capacities and on the dates indicated:\nAnnual Report on Form 10-K ITEM 8 AND ITEM 14(a) (1), (2) AND (d)\nINDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES Year Ended July 31, 1995\nPROPERTY CAPITAL TRUST Boston, Massachusetts\nITEM 14(a)(1), AND (2) INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES - --------------------------------------------------------------------------------\nREPORT OF INDEPENDENT AUDITORS\nThe Trustees and Shareholders Property Capital Trust\nWe have audited the accompanying consolidated balance sheets of Property Capital Trust (a real estate investment trust) as of July 31, 1995 and 1994, and the related consolidated statements of operations, cash flows and shareholders' equity for each of the three years in the period ended July 31, 1995. 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 Trust's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Property Capital Trust at July 31, 1995 and 1994, and the consolidated results of its operations and its cash flows for each of the three years in the period ended July 31, 1995, 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 consolidated financial statements, in 1994 the Trust changed its method of accounting for certain of its real estate investments.\nERNST & YOUNG LLP\nBoston, Massachusetts August 25, 1995\nProperty Capital Trust\nSee accompanying notes\nProperty Capital Trust\nSee accompanying notes\nProperty Capital Trust\nSee accompanying notes\nProperty Capital Trust\nSee accompanying notes\nProperty Capital Trust NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1. SIGNIFICANT ACCOUNTING POLICIES\nBUSINESS\nThe Trust is an owner of and investor in income producing real estate located throughout the United States. For the past several fiscal years, the Trust's business plan has focused on maximizing shareholder value through asset, portfolio and liability management and the selective disposition of investments. This business plan was in large part a response to the impact of the recent recession on the real estate industry. During the time this plan has been in effect, the Trust retained much of its portfolio. Following improvements in rental rates and occupancies throughout the portfolio attributable to improving economic conditions and considerable progress made by management in resolving problems affecting the portfolio, the Trustees reevaluated the business plan. The Trustees have concluded that the best means to maximize shareholder value is to provide for an orderly disposition of the Trust's investments. The Trustees also considered and rejected other strategies, such as a business combination or expanding the Trust, as being unlikely to be consummated or inappropriate given their belief that the stock price is not reflective of the value of the Trust's assets. The Trustees anticipate that the new business plan will involve dispositions of Owned Properties and Structured Transactions on a property-by-property basis, over a period estimated to be between three and five years, although the Trust will consider bulk sales and other opportunities that may arise which expedite the disposition process. The new business plan is subject to ratification by the shareholders of the Trust at the next Annual Meeting of Shareholders.\nCONSOLIDATION\nThe consolidated financial statements of the Trust include the accounts of its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.\nFEDERAL INCOME TAXES\nThe Trust has qualified and has elected to be taxed as a real estate investment trust under Sections 856-860 of the Internal Revenue Code. The Trust intends to continue to qualify as a real estate investment trust. Accordingly, no provision has been made for Federal income taxes in the consolidated financial statements.\nINVESTMENT PARTNERSHIPS\nCertain of the Trust's investments have been made through partnerships or a participation agreement in which the Trust or one of its subsidiaries is the general partner or lead lender and other institutional investors are limited partners or participants (\"Investment Partnerships\"). During the third quarter of fiscal 1994, the Trust changed its method of accounting for its Investment Partnerships to the equity method and prior period financial statements were restated to reflect the change as if it had occurred at the beginning of the period. Previously, the Trust consolidated its share of the Investment Partnerships' results of operations and related assets and liabilities. Although the change in accounting did not affect the Trust's net income (loss) or shareholders' equity, the change is to a preferable method based upon generally accepted accounting principles and is more consistent with current accounting practices in the real estate industry.\nVALUATION OF REAL ESTATE INVESTMENTS\nReal estate investments are carried at cost, net of accumulated depreciation and less an allowance for possible investment losses. When the Trust acquires a property from its lessee\/mortgagor it records the acquired property improvements at the lesser of cost or net realizable value at the time of acquisition. The Trust's allowance for possible investment losses is based upon management's estimate of the net realizable value of each investment and to the extent this is less than the carrying value of an investment, an allowance for possible investment losses is established. In determining estimated net realizable value, consideration is given to many factors, such as income to be earned from the investment, the cost to hold the property to the hypothetical time of sale, the selling price a property would bring at such time, the cost of improving the property to the condition contemplated in determining the selling price, the cost of disposing of the property and prevailing economic conditions including availability of credit.\nDepreciation and amortization have been calculated under the straight-line method, based upon the estimated useful lives of the assets. Properties and property improvements are depreciated over 25 to 39 years. Leasing commissions and tenant improvements are amortized under the straight-line method over the terms of the related leases. Expenditures for maintenance, repairs and betterments which do not materially prolong the normal useful life of an asset are charged to operations as incurred.\nProperty Capital Trust NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1. SIGNIFICANT ACCOUNTING POLICIES (continued)\nASSETS HELD FOR SALE\nThe Trust defines an \"Asset Held for Sale\" as an asset that has been approved for sale by the Trustees and, if applicable, the Investment Partnership and either is being marketed for sale or is soon to be marketed by a broker who has already been selected by the Trust. Assets Held for Sale are written down to the lower of cost or net realizable value and, in the case of investments held directly by the Trust, are reclassified to a separate line on the balance sheet. Depreciation is no longer recorded on these assets. The revenues and expenses from an Asset Held for Sale are not reclassified, and continue to be recorded as they were prior to the reclassification.\nREVENUE RECOGNITION\nFor financial reporting purposes, the Owned Properties held directly by the Trust and the Investment Partnerships are accounted for on a one-month lag. Certain space leases at the Owned Properties held directly by the Trust provide for free rent periods and stepped minimum rents which are accounted for on a straight-line basis over the terms of the leases. Rental income recognized under the straight-line method was greater (less) than rent received or receivable by the Trust for financial reporting purposes by $280,000, ($32,000) and ($67,000) for the years ended July 31, 1995, 1994 and 1993, respectively.\nNET INCOME (LOSS) PER SHARE\nNet income (loss) per share is calculated by dividing net income (loss) by the weighted average Common Shares outstanding during the year. Net income (loss) per share on a quarterly basis may not total to the annual net income (loss) per share due to rounding.\nRECLASSIFICATION\nCertain items in the 1994 and 1993 financial statements have been reclassified to conform to the 1995 presentation.\nNEW ACCOUNTING STANDARDS\nFASB Statement No. 114, \"Accounting by Creditors for Impairment of a Loan,\" as amended by FASB Statement 118, was issued in May 1993. The statement requires impairment losses to be recorded, when 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 requires impaired loans to 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 collateral dependent. The Trust will adopt Statement 114 in the first quarter of fiscal 1996. Based on current circumstances, including the availability of the previously established loss allowance, the Trust does not believe the effect of adoption of this new Standard will be material.\nIn March 1995, the FASB issued Statement No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed of, which requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amount. Statement 121 also addresses the accounting for long-lived assets that are expected to be disposed of. The Trust will adopt Statement 121 in the first quarter of fiscal 1997. Based on current circumstances, including uncertainties regarding the effects of implementing the new business plan referred to above, the financial statement impact of adoption of Statement 121 has not been determined. The availability of the previously established loss allowance is expected to mitigate any adverse impact.\nNOTE 2. REAL ESTATE INVESTMENTS\nThe Trust's real estate investments consist primarily of equity investments in completed, income-producing properties located throughout the United States. Investments consisting of land leasebacks and\/or mortgage loans are classified as Structured Transactions. Operating properties are classified as Owned Properties. Owned Properties which have been approved for sale and are being marketed for sale are classified as Assets Held for Sale. Investments made through partnerships or participation agreements in which the Trust or its subsidiary is the general partner or lead lender and other institutional investors are the limited partners or participating lenders are classified as Investment Partnerships. Two of the Investment Partnerships hold Owned Properties and Assets Held for Sale and three hold Structured Transactions. As of July 31, 1995, the Trust had ten Structured Transactions held directly by the Trust, four Owned Properties held directly by the Trust and one Asset Held for Sale directly by the Trust. The Trust had investments in five Investment Partnerships, three of which held four Structured Transactions and two of which held eight investments of which four are Owned Properties and four are Assets Held for Sale.\nProperty Capital Trust NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 2. REAL ESTATE INVESTMENTS (continued)\nProperty Capital Trust NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 2. REAL ESTATE INVESTMENTS (continued)\nProperty Capital Trust NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 2. REAL ESTATE INVESTMENTS (continued)\nThe Trust's Real Estate Investments (net of accumulated depreciation) including Assets Held for Sale and before allowance for possible investment losses are diversified, as of July 31, 1995, by geographic region as follows:\nOWNED PROPERTIES HELD DIRECTLY BY THE TRUST\nOwned Properties held directly by the Trust (which include those held in wholly owned subsidiaries) include land, buildings, tenant improvements, construction in progress, and other. Tenant improvements represent the cost of constructing or finishing tenant space under the terms of a lease for that space. Material disbursements that constitute new assets or improvements to existing assets that extend their useful lives and\/or substantially increase their value are capitalized.\nProperty Capital Trust NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 2. REAL ESTATE INVESTMENTS (continued)\nDuring fiscal 1995, the Trust sold the 6110 Executive Boulevard office building. An unrelated party purchased the property for $16,380,000 resulting in a gain of approximately $3,099,000.\nDuring fiscal year 1994, the Trust sold Eagle apartments. The property was purchased by an unrelated third party for approximately $12,570,000, resulting in a loss of $90,000. Effective February 1, 1994, a wholly owned subsidiary of the Trust acquired the equity interest of its lessee in 6110 Executive Boulevard, an office building in Rockville, Maryland, subject to a non-recourse first mortgage loan of $6,478,000. During the quarter ended January 31,1994, the Trust wrote down its investment in 6110 Executive Boulevard by $2,000,000. This write-down was charged against the Trust's allowance for possible investment losses.\nIn fiscal year 1993, a wholly owned subsidiary of the Trust acquired the equity interest of its lessee in One Park West, an office building in Chevy Chase, Maryland, subject to a first mortgage loan of $10,227,000. Upon acquisition the Trust utilized the applicable portion of its previously established allowance for possible investment losses to write down this investment by $6,000,000.\nASSET HELD FOR SALE\nAt July 31, 1995 the Trust had one Asset Held for Sale directly by the Trust, Citibank Office Plaza-Oakbrook. This investment, which had a net book value of $11,156,000, had previously been classified as an Owned Property held directly by the Trust. At July 31, 1995, the Trust wrote down its investment in this property by $971,000 to $10,185,000. This loss was charged against the Trust's previously established allowance for possible investment losses. In addition, the Investment Partnerships reclassified certain of their real estate investments to Assets Held for Sale and wrote down these assets to estimated net realizable value, which the Trust then charged against its previously established allowance for possible investment losses.\nSTRUCTURED TRANSACTIONS HELD DIRECTLY BY THE TRUST\nLand leasebacks consist of land purchased under income-producing properties and leased back under long-term net lease arrangements. These leases, which are classified as operating leases, have remaining initial terms of 22 to 69 years, with a weighted average term of 53 years. The leases require fixed monthly base rental payments to the Trust and generally also provide for overage rental payments, which are typically computed as a percentage of property gross receipts in excess of base amounts.\nBase rental income contractually due under land leasebacks existing at July 31, 1995 is approximately $1,541,000 per year for the next five years.\nCertain land leasebacks contain options whereby the lessees may repurchase the land at prices typically based on fair market value, but not less than the Trust's cost, or may cause the land and improvements to be sold to third parties. When a property is sold to a third party, the Trust typically receives the greater of a percentage of total sales proceeds of the property or its cost. During the next five years, repurchase or similar options covering $3,575,000 of land leasebacks become exercisable.\nThe mortgage loan investments are generally long-term loans that require fixed monthly base interest payments and, when not payable on a self-liquidating basis, require principal payments at maturity. Mortgage loans are generally owned in conjunction with land leaseback transactions and are subordinate to and have cross-default provisions with the land leasebacks. The loans allow for prepayment prior to maturity, and during the next five years all loans may be prepaid.\nBecause the mortgage loans were made and continue to be held in conjunction with land leaseback transactions and these loans were not originally structured to be considered separately from the land leaseback transactions it is not practicable to estimate the fair values of these mortgage loans. A determination of the fair values of these mortgage loans as a separate component would be too subjective and would not result in a meaningful estimate.\nDuring fiscal year 1994 the Trust disposed of three Structured Transactions held directly by the Trust. The Trust's $1,000,000 Village Oaks apartments investment was purchased by the Trust's lessee for $3,500,000. The Trust's Brown County Inn $500,000 land investment was purchased by the Trust's lessee for $600,000 and its $973,000 leasehold mortgage was prepaid at par. The Trust's $500,000 Rapids Mall mortgage loan was prepaid for $350,000, with the resulting loss of $150,000 being charged against the Trust's allowance for possible investment losses.\nDuring fiscal 1993 the Trust disposed of three Structured Transactions held directly by the Trust. The $1,800,000 Lakeside apartments investment was sold for $9,500,000. The $4,000,000 Town and Country office investment was sold for $70,000 and the $2,991,000 Stouffers Bedford Glen Hotel investment was sold for $350,000. Losses incurred in connection with such sales were charged against the Trust's allowance for possible investment losses. Additionally, during the year the Trust reduced its\nProperty Capital Trust NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 2. REAL ESTATE INVESTMENTS (continued)\nallowance for possible investment losses by $2,300,000 due to a write-off of the Trust's Sandpiper Cove mortgage loan, which was forgiven.\nProperty Capital Trust NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 2. REAL ESTATE INVESTMENTS (continued)\nProperty Capital Trust NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 2. REAL ESTATE INVESTMENTS (continued)\nProperty Capital Trust NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 2. REAL ESTATE INVESTMENTS (continued)\nThe Structured Transactions held in Investment Partnerships are similar to those held directly by the Trust. The land leaseback leases have remaining initial terms of 17 to 67 years, with a weighted average term of 62 years. The leases require fixed monthly base rental payments to the Investment Partnerships and also provide for overage rental payments. The Trust's share of base rental income contractually due under existing land leasebacks held in Investment Partnerships at July 31, 1995 is approximately $268,000 per year for the next five years.\nThe mortgage loans held in Investment Partnerships are generally long-term loans that require fixed monthly base interest payments and, when not payable on a self-liquidating basis, require principal payments at maturity. Except for the Lisle Hilton Inn loan participation, mortgage loans are owned in conjunction with land leaseback transactions and are subordinate to and have cross-default provisions with the land leasebacks. The Lisle Hilton Inn loan participation, although not owned in conjunction with a land leaseback transaction, also requires overage interest payments, similar to the land leasebacks. The loans allow for prepayment prior to maturity and during the next five years all loans may be prepaid.\nDuring fiscal 1995, PCA Southwest Associates Limited Partnership (\"Southwest\"), an Investment Partnership which owned 3,000 apartments in Houston, Texas, sold the Braes Hill project (152 units) to an unrelated party resulting in a gain to the Trust of $110,000. At July 31, 1995, Southwest reclassified its investment in the Chimney Rock apartments to Assets Held for Sale resulting in a write down by the Trust of $54,000, which was charged against the Trust's previously established allowance for possible investment losses. The Trust's investment in Southwest had a net book value of $8,932,000 prior to the Chimney Rock property write-down. The Trust's wholly owned subsidiary has a 45.45% general partner's interest in Southwest. At July 31, 1995, Property Capital Midwest Associates, L.P. (\"Midwest\"), an Investment Partnership which owns seven buildings in Overland Park, Kansas, reclassified its investments in Financial Plaza, Plaza West Retail Center and College Hills 8 to Assets Held for Sale, resulting in a write-down by the Trust of $2,311,000. The Trust's investment in Midwest had a net book value of $27,451,000 prior to the Financial Plaza, College Hills 8 and Plaza West Retail Center's write-downs. The Trust has a 53.30% general partner's interest in Midwest and the Trust's share of the loss was charged against the Trust's previously established allowance for possible investment losses.\nSubsequent to the end of the fiscal year, PCA Canyon View Associates Limited Partnership settled certain litigation. The Investment Partnership, of which the Trust owns a 23.8% interest, received $300,000 from the first mortgagee of Phase I for permitting it to take title to Phase I and the Investment Partnership took title to Phase II and received the proceeds from two letters of credit aggregating $1,750,000.\nOn March 31, 1994, Southwest acquired for $427,000 its lessee's interest in five properties subject to first mortgages aggregating $25,989,000. During the quarter ended July 31, 1994, the Trust wrote down its investment in this partnership by $566,000. This write-down was charged against the Trust's allowance for possible investment losses.\nNOTE 3. INDEBTEDNESS\nThe Trust has available a total of $10,000,000 under a revolving line of credit from a major New England bank. Borrowings under the line of credit are repayable on demand by the lender. At July 31, 1995 there were no outstanding borrowings under the line. Interest is at the bank's prime rate (8.75% at July 31, 1995) plus 1\/4%.\nA majority of the real estate investments are subject to long-term first mortgage financing which aggregated $182,686,000 at July 31, 1995 and $188,080,000 at July 31, 1994. At July 31, 1995 long-term first mortgage financing consisted of $40,145,000 of debt on Owned Properties held directly by the Trust and $25,420,000 of debt on Owned Properties held in Investment Partnerships. The balance of $117,121,000 represents debt on Structured Transactions which is not reflected on the Trust's balance sheet because the obligation to pay such debt is that of the Trust's lessees\/mortgagors.\nProperty Capital Trust NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 3. INDEBTEDNESS (continued)\nAt July 31, 1995 three of the Trust's Owned Properties held directly by the Trust were encumbered by first mortgages aggregating $40,145,000 and at July 31, 1994 four of the Trust's Owned Properties held directly by the Trust were encumbered by first mortgages aggregating $43,110,000.\nThe Loehmann's Fashion Island Shopping Center refinanced its then existing first mortgage on June 30, 1994 with an initial advance of $18,000,000. The loan commitment was for $30,000,000 with additional advances to be made through June 1996 based upon property performance. The first mortgage loan (of which $15,000,000 is with recourse to the Trust) matures in July 1998 and bears interest at the lender's prime rate plus 1\/4% with the Trust having the option to fix the interest rate from time to time at 2.25% above comparable term LIBOR or U.S. Treasury rates for a specified number of times. This option may be exercised at no cost or additional liability to the Trust. The loan also required mandatory amortization payments. During fiscal 1995 the Trust borrowed an additional $6,000,000 of which $2,000,000 was subsequently prepaid and eliminated the required monthly amortization payments prior to maturity in July 1998. In July 1995 the Trust elected to fix the interest rate on the total outstanding borrowings of $21,732,000 at 7.97% until December 1996 which, at that time, was 2.25% over comparable term U.S. Treasury rates.\nIn November 1993, the Trust refinanced the $8,600,000 first mortgage on the Park Place office building located in Clayton, Missouri, resulting in a reduction in the annual effective interest rate from 8.25% to 5.65%.\nThe Trust issued $40,000,000 of 9 3\/4% Convertible Subordinated Debentures in May 1983, maturing May 15, 2008, and $40,000,000 of 10% Convertible Subordinated Debentures in December 1984, maturing December 15, 2009. As of July 31, 1995, $2,546,000 and $29,125,000 of the 9 3\/4% and 10% Debentures, respectively, were outstanding. During fiscal 1995 the Trust repurchased $1,698,000 principal amount of the 10% Debentures at a discount. The 9 3\/4% and 10% Debentures are subordinated to all debt of the Trust and are convertible into Common Shares at $19.00 and $21.70 per share, respectively. Conversion of all Debentures outstanding at July 31, 1995 would add an additional 1,476,166 Common Shares. Due to conversions in prior years, sinking fund payments on the 10% Debentures will not commence until fiscal 2000, with a payment of $1,125,000. There are no sinking fund requirements on the 9 3\/4% Debentures due to conversions in prior years.\nProperty Capital Trust NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 3. INDEBTEDNESS (continued)\nFor the years ended July 31, 1995, 1994 and 1993, cash paid for interest on all of the Trust's debt was $6,818,000, $6,961,000, and $5,579,000, respectively, net of capitalized interest of $0, $858,000 and $1,311,000, respectively.\nThe fair values of the Trust's mortgage notes payable and Convertible Subordinated Debentures at July 31, 1995 are $40,256,000 and $30,783,000, respectively. The fair values were estimated using discounted cash flow analyses on the mortgage notes and quoted market prices on the convertible subordinated debentures. The mortgage notes payable are assumed to be held to maturity.\nNOTE 4. RENTS UNDER OPERATING LEASES\nThe minimum future base rents do not include contingent rentals, such as tenant reimbursements which are received under certain leases based upon property operating costs, or percentage rents which are based on the level of a tenant's sales.\nNOTE 5. RENTAL EXPENSE\nThe Trust leases office space under an operating lease which expires on May 31, 1997, although the Trust and the landlord each have the option to cancel the lease as of May 31, 1996 by giving six months' prior notice. Rental expense under this lease was $132,000, $128,000 and $111,000 in fiscal years 1995, 1994 and 1993, respectively. Future minimum rental payments will be $147,000 and $122,500 for fiscal years 1996 and 1997, respectively.\nNOTE 6. ADVISORY SERVICES\nPrior to August 1, 1992, services related to investment matters and day-to-day administration of the Trust were provided by Property Capital Advisors, Inc. (the \"Advisor\"). Effective August 1, 1992 the Trust commenced management of its affairs through an internal staff. Services related to the day-to-day administration of the Investment Partnerships were provided by PCA Institutional Advisors (\"PCAIA\"), an affiliate of the Advisor. In connection with the internalization of the Trust's management, the Trust entered into an agreement with PCAIA pursuant to which the Trust assumed responsibility for rendering services under advisory agreements (the \"Advisory Agreements\") between PCAIA and the five Investment Partnerships.\nThe Trust receives annually the first $150,000 of amounts payable pursuant to the Advisory Agreements as compensation for providing such services, which amount generally corresponds to the additional expenses incurred by the Trust in performance of such tasks, plus 50% of additional amounts payable pursuant to the Advisory Agreements, which additional amounts aggregated $175,000, $140,000 and $119,000 in fiscal years 1995, 1994 and 1993, respectively. PCAIA receives the remaining 50% of such payments in excess of $150,000. Excluded from the foregoing arrangement is the termination fee provided for in the PCA Crossroads Associates, Ltd. (\"Crossroads\") advisory agreement, which fee, was paid subsequent to year-end, solely to PCAIA.\nCommencing on August 1, 1997, the Trust may terminate the foregoing agreement and thereafter receive 100% of all payments under the Advisory Agreements (other than the termination fee payable pursuant to the Crossroads advisory agreement) by paying PCAIA three times PCAIA's share of the average of the annual payments, (the \"Buy-Out Amount\") that it received under such sharing arrangement during the two prior fiscal years, calculated without reference to payments attributable to properties sold or otherwise disposed of during such fiscal years. The Buy-Out Amount is payable to PCAIA in three annual\nProperty Capital Trust NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 3. ADVISORY SERVICES (continued)\ninstallments, in arrears, with interest accruing on the unpaid principal amount of such payment at the prime rate of the Trust's primary bank lender. The Buy-Out Amount is reduced in the event that properties are sold or otherwise disposed of during the three years over which such amount is payable.\nNOTE 7. RELATED PARTY TRANSACTIONS\nDuring fiscal 1995, 1994 and 1993, the Trust incurred legal fees in the amount of $224,000, $346,000 and $347,000, respectively (exclusive of additional amounts paid by the Trust's lessees and borrowers, if any), from the law firm of Paul, Weiss, Rifkind, Wharton & Garrison, of which Walter F. Leinhardt, Secretary and Trustee of the Trust, is a partner. Not included in the above amount is the Trust's share of legal fees incurred by the Investment Partnerships in the amount of $17,000, $46,000, and $66,000 for fiscal 1995, 1994 and 1993, respectively.\nDuring fiscal 1993, the Trust purchased for approximately $85,000 certain personal property from the Trust's former Advisor used in the conduct of the Trust's business. Also during fiscal 1993, an affiliate of the Trust paid approximately $68,000 to Boston Properties, Inc. of which Edward H. Linde, a Trustee of the Trust, is the President, for certain consulting services provided by an employee of Boston Properties, Inc. in connection with the redevelopment of one of the Trust's Owned Properties held directly by the Trust.\nNOTE 8. ANTICIPATED CAPITAL EXPENDITURES\nAmounts aggregating approximately $1,900,000 may be required during fiscal 1996 for capital expenditures on the Trust's Owned Properties held directly by the Trust. Additionally, the Trust's share of capital expenditures which may be required by the Investment Partnerships during 1996 is approximately $900,000.\nNOTE 9. SHAREHOLDERS' EQUITY\n1992 EMPLOYEE STOCK OPTION PLAN\nThe Property Capital Trust 1992 Employee Stock Option Plan (the \"Plan\") for key employees of the Trust and its subsidiaries is a plan under which options for 400,000 shares may be granted to purchase Common Shares for a purchase price equal to, at a minimum, the fair market value of the shares on the date of grant, subject to certain adjustments. The Compensation Committee of the Board of Trustees administers the Plan and is responsible for selecting the individuals eligible to receive options and for determining the number of options to be granted to such individuals and the purchase price of the shares. Under the plan 20% of the options become exercisable on each anniversary of the date of grant. The options are subject to termination under certain circumstances.\nProperty Capital Trust NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 9. SHAREHOLDERS' EQUITY (continued)\n1994 STOCK OPTION PLAN FOR NON-EMPLOYEE TRUSTEES\nThe Property Capital Trust 1994 Stock Option Plan for Non-Employee Trustees, approved by the shareholders of the Trust in November 1994, is a plan under which options for 100,000 shares may be granted to purchase Common Shares for a purchase price equal to the fair market value of such Common Shares at the time the option is granted, subject to certain adjustments.\nEach non-employee Trustee receives automatically upon election or re-election as a Trustee at an Annual Meeting of Shareholders an option to purchase 4,000 Common Shares. The option vests on the day immediately preceding the Annual Meeting of Shareholders next succeeding the date of grant of such option.\nAMENDED AND RESTATED DEFERRED STOCK PLAN FOR NON-EMPLOYEE TRUSTEES\nIn November 1994, the Amended and Restated Deferred Stock Plan for Non-Employee Trustees was approved by the shareholders of the Trust. If a Trustee elects to defer payment of Trustee fees, share units are allocated to such Trustee's account based upon the closing price for the Common Shares on the date the fees would have been earned. Share units are also allocated to reflect dividends that would have been paid on such share units. Payments to a Trustee are made upon death, disability or ceasing to serve as a Trustee. There are 250,000 Common Shares available under this Plan.\nThis plan replaced a previous plan whose shares were transferred to this plan on November 30, 1994.\nSHAREHOLDER RIGHTS PLAN\nOn September 28, 1990 (the \"Declaration Date\"), the Trustees adopted a Shareholder Rights Plan (the \"Plan\") and, in connection therewith, declared a dividend distribution of one right for each of the Trust's outstanding Common Shares to shareholders of record at the close of business on October 12, 1990. Each right entitles the holder thereof, upon the occurrence of certain events making such rights exercisable, to exercise the right to buy one Common Share at a purchase price of $27.00. The rights become exercisable (i) 10 business days following the announcement that a person or group of persons has acquired or obtained the right to acquire 9.8% or more of the Common Shares (with certain exceptions for persons who were shareholders on the Declaration Date) or (ii) upon the closing of a tender offer resulting in ownership of 9.8% or more of the Common Shares (any person acquiring in excess of 9.8% of the Common Shares being an \"Acquiror\"). On the twenty-first business day after the acquisition of 9.8% or more of the Common Shares by an Acquiror, or upon the closing of a tender offer for 9.8% or more of the Common Shares by an Acquiror, each right will entitle its holder to purchase, at the right's exercise price, that number of Common Shares having a market value at that time of twice the right's exercise price. Each right will also become exercisable to purchase Common Shares at a 50% discount in the event that an Acquiror engages in self-dealing transactions with the Trust. If, at any time after the rights become exercisable, the Trust is involved in a merger or other business combination in which the Trust is not the surviving entity, each right will entitle its holder to purchase, at the right's exercise price, that number of shares of the acquiring company's common stock having a market value at that time of twice the right's exercise price. The rights will expire on the earlier of (i) September 28, 2000 or (ii) their redemption by the Trustees at any time prior to the date that they become exercisable, as described above, at a price of $.01 per right.\nProperty Capital Trust NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 10. DIVIDENDS\nThe Trust pays dividends approximately 55 days following each fiscal quarter, normally equal to at least 100% of income before gains (losses) on real estate investments.\nOn August 25, 1995, the Trustees declared a dividend of $.12 per share, payable on September 22, 1995 to shareholders of record on September 11, 1995, which dividend is included in the above table.\nIn order to qualify as a real estate investment trust, Property Capital Trust must distribute substantially all of its taxable income to shareholders not later than twelve months following the end of its fiscal year.\nProperty Capital Trust\nProperty Capital Trust\nThe allowance for possible investment losses represents the excess of the carrying value of individual real estate investments over their estimated net realizable value. Based upon a review and evaluation of each real estate investment in the Trust's portfolio, management believes the allowance was adequate as of each date presented.\n[THIS PAGE INTENTIONALLY LEFT BLANK]\nProperty Capital Trust SCHEDULE III July 31, 1995 (thousands of dollars)\nLAND LEASEBACKS HELD DIRECTLY BY THE TRUST\nFor information on Land Leasebacks Held in Investment Partnerships see Exhibit A\nProperty Capital Trust\nSCHEDULE III (continued) July 31, 1995 (thousands of dollars)\nProperty Capital Trust\nSCHEDULE III (continued) July 31, 1995 (thousands of dollars)\nProperty Capital Trust NOTES TO SCHEDULE III\n(a) This amount represents the cost of each land investment and the amount at which each investment is carried on the balance sheet at July 31, 1995. There are no differences between the cost of each land investment for financial reporting purposes and the cost of each land investment for federal income tax purposes, except as follows:\n(b) The Trust also holds a leasehold mortgage on this property (see Schedule IV).\n(c) The base land rent rate was renegotiated, effective April 1, 1993, from a base payment rate of 10% to a base payment rate of 6.3% until March 31, 1996, and 7.4% thereafter.\n(d) The base land rent rate was renegotiated, effective April 1, 1993, from a base payment rate of 10% to a base payment rate of 8.5% until March 31, 1996, and 10% thereafter.\n(e) The base land rent rate was renegotiated, effective September 1, 1991, from a base payment rate of 13% to a base payment rate of the greater of 4.0% per annum or property cash flow. The unpaid amount, the difference between 13% and actual payments received, is payable at maturity but has not been accrued for financial reporting purposes.\n(f) Changes in the Trust's investment in land leasebacks held directly by the Trust are summarized below (thousands of dollars).\n(g) The Trust acquired the equity interests in these properties from its lessees. The date of the acquisition reflects the date on which the Trust converted its land leaseback investment to an Owned Property held directly by the Trust.\n(h) Rent receivable includes rents accrued but not yet due under leases with stepped minimum rents which have been accounted for on a straight line basis for financial reporting purposes in the amount of $308,000, $940,000, $339,000 and $118,000 for Citibank Office Plaza - Oakbrook, Citibank Office Plaza - Schaumburg, Loehmann's Fashion Island and One Park West, respectively.\nProperty Capital Trust NOTES TO SCHEDULE III (continued)\n(i) Changes in the Trust's investment in Owned Properties held directly by the Trust are summarized below (thousands of dollars).\n(j) This total does not include rental income earned in fiscal 1995 of $1,596,000 from 6110 Executive Boulevard which was sold during the year and $1,868,000 from Citibank Office Plaza - Oakbrook which was reclassified to Asset Held for Sale directly by the Trust at July 31, 1995.\n(k) This total does not include operating expenses incurred in fiscal 1995 of $746,000 from 6110 Executive Boulevard which was sold during the year and $782,000 from Citibank Office Plaza - Oakbrook which was reclassified to Asset Held for Sale directly by the Trust at July 31, 1995.\n(l) This total does not include depreciation expense in fiscal 1995 of $143,000 from 6110 Executive Boulevard which was sold during the year and $694,000 from Citibank Office Plaza - Oakbrook which was reclassified to Asset Held for Sale directly by the Trust at July 31, 1995.\n(m) Changes in the Trust's investment in Asset Held for Sale directly by the Trust is summarized below (thousands of dollars).\n(n) In March 1993, the Trust acquired the equity interest of its lessee in One Park West, a 128,500 square foot office building in Chevy Chase, Maryland. Upon acquisition, the Trust utilized a portion of its allowance for possible investment losses to write down this investment by $6,000,000.\nProperty Capital Trust\nSCHEDULE IV July 31, 1995 (thousands of dollars)\nFor information on Mortgage Loans held in Investment Partnerships see Exhibit B.\nProperty Capital Trust NOTES TO SCHEDULE IV\n(a) The Trust also has land leaseback investments in these properties. First mortgage indebtedness and rentable space are shown with those investments (see Schedule III).\n(b) The interest rate on this mortgage was renegotiated, effective April 1, 1993, from a payment rate of 10% to a payment rate of 8.5% until March 31, 1996, and 10% thereafter.\n(c) Monthly payments of interest only, with the entire principal due at maturity. Commencing July 1, 1996 the loan may be prepaid without penalty.\n(d) Monthly payments of interest and principal amortizing over a 27-year schedule. The loan may be prepaid at a premium of 104% through September 30, 1995. Thereafter the prepayment premium declines 1\/2% annually.\n(e) The interest rate on this mortgage was renegotiated, effective April 1, 1994, from a cash flow basis to 5.65% through March 31, 1997, 7% through April 30, 1999 and 7% thereafter. Amortization commences in May 1999. The loan may be prepaid at any time.\n(f) Monthly payments of interest only until April 30, 1999. Commencing May 1, 1999 payments of principal and interest.\n(g) The interest rate on this mortgage was renegotiated, effective September 1, 1991, from the stated interest rate of 13% to the greater of 4.0% per annum or property cash flow. The unpaid amount (the difference between 13% and actual payments) is payable at maturity.\n(h) Monthly payments of interest and, to the extent there is sufficient cash flow, principal. The loan is prepayable at any time without penalty.\n(i) Changes in the Trust's investment in mortgage loans held directly by the Trust are summarized below (thousands of dollars).\n[THIS PAGE INTENTIONALLY LEFT BLANK]\nProperty Capital Trust EXHIBIT A July 31, 1995 (thousands of dollars)\nLAND LEASEBACKS HELD IN INVESTMENT PARTNERSHIPS\nProperty Capital Trust EXHIBIT A (continued) July 31, 1995 (thousands of dollars)\nProperty Capital Trust EXHIBIT A (continued) July 31, 1995 (thousands of dollars)\nProperty Capital Trust NOTES TO EXHIBIT A\n(a) These investments are held by PCA Canyon View Associates Limited Partnership, a partnership in which the Trust participates as the sole general partner with a 23.81% interest and other institutional investors as the limited partners.The Partnership also has mortgage loan investments in these properties (see Exhibit B).\n(b) This third party first mortgage has matured but was not repaid. The first mortgagee commenced foreclosure on this property. Subsequent to the end of the year this property was transferred to the first mortgagee.\n(c) This investment is held by PCA Crossroads Associates, L.P., a partnership in which the Trust participates as the sole general partner with a 25% interest and other institutional investors as the limited partners. Subsequent to the end of the fiscal year, the Investment Partnership sold its investment back to its lessee. The Trust received approximately $5,500,000 from the sale of which approximately $3,500,000 constitutes a gain to the Trust.\n(d) Includes 231,000 square feet which are not part of the Partnership's security.\n(e) Changes in land leasebacks held in Investment Partnerships are summarized below (thousands of dollars).\n(f) The Partnerships acquired the equity interests in these properties from their lessees. The date of the acquisition reflects the date on which each Partnership converted its land leaseback\/mortgage loan investment to an Owned Property held in an Investment Partnership.\n(g) These investments are held by Property Capital Midwest Associates, L.P., a partnership in which the Trust participates as the sole general partner with a 53.3% interest and other institutional investors as the limited partners.\n(h) These investments are held by PCA Southwest Associates Limited Partnership, a partnership in which an affiliate of the Trust participates as the sole general partner with a 45.45% interest and other institutional investors as the limited partners.\n(i) Certain of the apartment complexes held by PCA Southwest Associates Limited Partnership are encumbered by third party senior indebtedness as follows.\nProperty Capital Trust NOTES TO EXHIBIT A (continued)\n(j) Changes in Owned Properties held in Investment Partnerships are summarized below (thousands of dollars).\n(k) This total does not include rental income earned in fiscal 1995 of $452,000 from PCA Southwest Associates Limited Partnership's Braes Hill apartments investment which was sold during the year and $11,603,000 from Assets Held for Sale in Investment Partnerships, see Exhibit A on pages 68 and 69.\n(l) This total does not include expenses other than depreciation incurred in fiscal 1995 of $312,000 from PCA Southwest Associates Limited Partnership's Braes Hill apartments investment which was sold during the year and $6,112,000 from Assets Held for Sale in Investment Partnerships, see Exhibit A on pages 68 and 69.\n(m) This total does not include depreciation expense in fiscal 1995 of $50,000 from PCA Southwest Associates Limited Partnership's Braes Hill apartments investment which was sold during the year and $2,836,000 from Assets Held for Sale in Investment Partnerships, see Exhibit A on pages 68 and 69.\n(n) Changes in Assets Held for Sale in Investment Partnerships are summarized below (thousands of dollars).\nProperty Capital Trust\nEXHIBIT B July 31, 1995 (thousands of dollars)\nProperty Capital Trust\nNOTES TO EXHIBIT B\n(a) The Partnership that holds this mortgage loan also has a land leaseback investment in this property. The first mortgage indebtedness and rentable space are shown with that investment (see Exhibit A).\n(b) Amortizing on a 30-year schedule. The loan may be prepaid without penalty commencing July 1, 1997. The loan is in default. Subsequent to the end of the fiscal year this property was transferred to the first mortgagee.\n(c) Amortizing on a 30-year schedule. Interest up to 2% may be deferred for any year in which cash flow is insufficient to fully pay interest at 11% annum ($493,397 has been deferred and added to the investment as of July 31, 1995). The loan may be prepaid without penalty commending August 1, 1998. The loan is in default. Subsequent to the end of the fiscal year this investment was converted to an Owned Property held in Investment Partnerships.\n(d) These loans are held by PCA Canyon View Associates Limited Partnership a partnership in which the Trust participates as the sole general partner with a 23.81% interest and other institutional investors as the limited partners.\n(e) The hotel has 313 rooms.\n(f) A modification of the loan terms was negotiated in May 1991 and was executed in September 1991. This modification calls for interest to be paid, commencing January 1, 1991, on the original principal plus all accrued and unpaid interest through December 31, 1990, at a stated annual interest rate of 7% through December 31, 1993; 8% through December 31, 1995; and 9% through the extended maturity date of March 1997. In addition, the borrower is required to pay participation interest to the extent room and food and beverage revenues exceed base amounts.\n(g) Monthly payments of interest only. In addition, an annual amortization payment equal to 100% of the property's cash flow (as defined) is required. Maturity has been extended from December 1993 to March 1997. The loan may be prepaid without penalty at any time.\n(h) This loan is held by the Trust and a group of institutional investors through a loan participation agreement. The Trust is the lead participant with a 41.67% interest.\n(i) Changes in mortgage loans held in Investment Partnerships are summarized below (thousands of dollars).\n(j) See Exhibit A for the information on the first mortgage indebtedness on this property.\nAnnual Report on Form 10-K ITEM 8 AND ITEM 14(D)\nFINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE Year Ended December 31, 1994\nPROPERTY CAPITAL MIDWEST ASSOCIATES, L.P. Boston, Massachusetts\nREPORT OF INDEPENDENT AUDITORS\nTo the Partners Property Capital Midwest Associates, L.P.\nWe have audited the accompanying balance sheets of Property Capital Midwest Associates, L.P. as of December 31, 1994 and 1993, and the related statements of operations, cash flows and partners' equity for each of the three years in the period ended December 31, 1994. Our audits also included the financial statement schedule listed in the Index at Item 14(a). 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 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 Property Capital Midwest Associates, L.P. at December 31, 1994 and 1993, and the results of its operations and its cash flows for each of three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles. Also, in our opinion, 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 February 23, 1995, except for Note 6, as to which the date is August 25, 1995\nSee accompanying notes\nSee accompanying notes\nSee accompanying notes\nSee accompanying notes\nProperty Capital Midwest Associates, L.P. NOTES TO FINANCIAL STATEMENTS\nNOTE 1. SIGNIFICANT ACCOUNTING POLICIES\nORGANIZATION\nProperty Capital Midwest Associates, L.P. (the \"Partnership\") was organized on April 20, 1983 as a Delaware limited partnership (under the name PCA Executive Hills Associates, L.P.) and is qualified to do business in the State of Kansas. Property Capital Trust is the sole general partner (the \"General Partner\") of the partnership and six institutional investors are limited partners. In September 1991, the General Partner purchased a 5.4945% limited partnership interest bringing the general partner interest to 53.2967%.\nBASIS OF PRESENTATION\nThe accompanying financial statements have been prepared in conformity with generally accepted accounting principles.\nREAL ESTATE INVESTMENTS\nReal estate investments are carried at cost, net of accumulated depreciation. Depreciation has been calculated under the straight-line method, based upon the estimated useful lives of the assets. Properties and property improvements are depreciated over 25 to 39 years. Leasing commissions and tenant improvements are amortized under the straight-line method over the term of the related leases. Expenditures for maintenance, repairs and betterments which do not materially prolong the normal useful life of an asset are charged to operations as incurred.\nCASH AND CASH EQUIVALENTS\nFor purposes of the Statement of Cash Flows, the Partnership considers all highly liquid investments with a maturity of three months or less to be cash equivalents.\nREVENUE RECOGNITION\nCertain space leases at the properties provide for stepped minimum rents which are accounted for on a straight-line basis over the terms of the leases. The difference between rental income accrued under the straight-line method and rent received or receivable by the Partnership for financial reporting purposes was $18,300, $54,000 and $108,500 for the years ended December 1994, 1993 and 1992, respectively.\nINCOME TAXES\nThe Partnership is not subject to Federal or state income taxes and, accordingly, no provisions have been made for such taxes in the financial statements.\nRECLASSIFICATION\nCertain items in the 1993 and 1992 financial statements have been reclassified to conform to the 1994 presentation.\nProperty Capital Midwest Associates, L.P. NOTES TO FINANCIAL STATEMENTS (continued)\nThe Partnership acquired the equity interest in these properties from its lessee in May 1989. The former owner is entitled to a deferred residual payment in an amount equal to 5% of the cash flow from the properties over an 11% imputed return on the Partnership's investment, at cost, plus 5% of the gain, as defined, on each property sold by 1999. If any property is not sold by 1999, the calculation of gain will be based upon an independent appraiser's estimate of current market value for such property.\nNOTE 3. MANAGEMENT AGREEMENT\nServices related to investment matters and day-to-day administration have been provided to the Partnership under a contract, dated May 24, 1989, with PCA Institutional Advisors (the \"Advisor\"). The contract had an initial term of five years and is extended automatically on a year-to-year basis unless terminated by the Partnership or the Advisor. The contract provides for a base advisory fee equal to 8% of the Partnership's cash flow (as defined) and for a disposition fee equal to 8% of the gain from the sale of the Partnership's properties. The Partnership paid PCA Institutional Advisors management fees aggregating $114,091, $74,297 and $204,020 in 1994, 1993 and 1992, respectively. Management fees payable are $13,213, $30,832 and $5,641 at December 31, 1994, 1993 and 1992, respectively.\nEffective August 1, 1992, Property Capital Trust, the General Partner of the Partnership, assumed responsibility for managing the affairs of the Partnership pursuant to a subcontract and option agreement with PCA Institutional Advisors. This change was approved by the Partners.\nNOTE 4. DISTRIBUTIONS\nThe Partnership makes monthly cash distributions to its Partners equal to approximately 100% of available cash flow from investments, including returns of capital, if any. For the years ended December 31, 1994, 1993 and 1992, the Partnership distributed $1,827,649, $1,228,133 and $2,554,886, respectively.\nProperty Capital Midwest Associates, L.P. NOTES TO FINANCIAL STATEMENTS (continued)\nProperty Capital Midwest Associates, L.P. SCHEDULE III December 31, 1994 (thousands of dollars)\nOWNED PROPERTIES\n[LOGO] Printed on Recycled Paper","section_15":""}
{"filename":"35214_1995.txt","cik":"35214","year":"1995","section_1":"ITEM 1 - BUSINESS\nFerro Corporation (\"Ferro\"), which was incorporated under the laws of Ohio in 1919, is a worldwide producer of specialty materials for industry by organic and inorganic chemistry. It operates (either directly or through wholly-owned subsidiaries or partially-owned affiliates) in 21 countries worldwide. Ferro produces a variety of specialty coatings, colors, ceramics, plastics, chemicals, and related products and services. Ferro's most important product is frit produced for use in porcelain enamels and ceramic glazes.\nMost of the products produced by Ferro are classified as specialty materials, rather than commodities, because they are formulated or designed to perform a specific and important function in the manufacturing processes of Ferro customers or in their end products. These specialty materials are not sold in the high volume normally associated with commodity businesses.\nFerro specialty materials require a high degree of technical service on an individual customer basis. The value of these specialty materials stems not just from their raw materials composition, but from the result and performance they achieve in actual use.\nA further description of Ferro's business, its principal products, their markets and applications is contained under all headings on pages 6 through 13 of its 1995 Annual Report to Shareholders, which is attached hereto as Exhibit 13 (the \"Annual Report\"). The information contained under the aforementioned headings on pages 6 through 13 of the Annual Report (excluding pages 8, 10 and 12 on which only pictures and text describing such pictures appear and the pictures and text describing such pictures on pages 9, 11 and 13) is incorporated herein by reference. Information concerning Ferro's business during 1995, 1994, and 1993 and certain transactions consummated during those years is included under the heading \"Management's Discussion and Analysis\" on pages 14 through 18 of the Annual Report and in Note 6 to Ferro's Consolidated Financial Statements, which are included in the Annual Report. Note 6 appears at pages 26 and 27 of the Annual Report. Such information is incorporated herein by reference. Additional information about Ferro's industry segments, including financial information relating thereto, is set forth in Note 11 to Ferro's Consolidated Financial Statements, which appears on pages 30 and 31 of the Annual Report and is incorporated herein by reference.\nRAW MATERIALS\nFor the most part the raw materials essential to Ferro's operations both in the United States and overseas are obtainable from multiple sources worldwide. Ferro did not encounter significant raw material shortages in 1995 and does not anticipate such shortages in 1996.\nPATENTS AND LICENSES\nFerro owns a substantial number of patents relating to its various products and their uses. While these patents are of importance to Ferro, it does not consider that the invalidity or expiration of any single patent or group of patents would have a material adverse effect on its business. Ferro patents expire at various dates through the year 2016.\nFerro does not hold any licenses, franchises or concessions which it considers to be material.\nCUSTOMERS\nFerro does not consider that a material part of its Coatings, Colors and Ceramics or its Plastics businesses are dependent on any single customer or group of customers. In the Chemicals segment however, the loss of two or three of the largest customers could have a materially adverse effect on this segment.\nBACKLOG OF ORDERS\nIn general there is no significant lead time between order and delivery in any of Ferro's business segments. As a result, Ferro does not consider that the dollar amount of backlog of orders believed to be firm as of any particular date is material for an understanding of its business. Ferro does not regard any material part of its business to be seasonal.\nCOMPETITION\nWith respect to most of its products, Ferro competes with a substantial number of companies, none of which is dominant. Exceptions to this are frit and powder coatings markets, where Ferro believes that it is the largest worldwide supplier. The details of foreign competition necessarily vary with respect to each foreign market.\nBecause of the specialty nature of Ferro's products, product performance characteristics and customer service are the most important components of the competition which Ferro encounters in the sale of nearly all of its products. However, in some of the markets served by Ferro, strong price competition is encountered from time to time.\nRESEARCH AND DEVELOPMENT\nA substantial number of Ferro's employees are involved in technical activities concerned with products required by the ever-changing markets of its customers. Laboratories are located at each of Ferro's major subsidiaries around the globe, where technical efforts are applied to the customer and market needs of that geographical area. In the United States, laboratories are maintained in each of its divisions. Backing up these divisional customer services laboratories is corporate research activity involving approximately 57 scientists and support personnel in the Cleveland area.\nExpenditures for research and development activities relating to the development or significant improvement of new and\/or existing products, services and techniques were approximately $23,150,000, $22,919,000 and $19,334,000 in 1995, 1994 and 1993, respectively. Expenditures for individual customer requests for research and development were not material.\nENVIRONMENTAL MATTERS\nFerro's manufacturing facilities, like those of industry generally, are subject to numerous laws and regulations designed to protect the environment, particularly in regard to plant wastes and emissions. In general, Ferro believes that it is in substantial compliance with the environmental regulations to which its operations are subject and that, to the extent Ferro may not be in compliance with such regulations, such non-compliance has not had a material adverse effect on Ferro. Moreover, while Ferro has not generally experienced substantial difficulty in complying with environmental requirements, compliance has required a continuous management effort and significant expenditures.\nFerro and its international subsidiaries authorized approximately $2,789,000, $6,040,000 and $8,970,000 in capital expenditures for environmental control during 1995, 1994 and 1993, respectively.\nTwo projects accounted for the majority of the environmental control capital expenditures in 1995:\na. Wastewater treatment plant expansion at Ferro chemical facility in Baton Rouge, Louisiana $ 750,000\nb. EDA removal from wastewater system at Ferro chemical facility in Hammond, Indiana $ 660,000 ---------\nTotal -- Major Projects (1995) $1,410,000\nTwo major projects accounted for the high level of environmental control capital expenditures in 1994:\na. EDC collection and recovery system at a Ferro chemical facility in Hammond, Indiana $3,250,000\nb. Zinc oxide production effluent treatment system in Portugal 1,370,000 ---------\nTotal -- Major Projects (1994) $4,620,000\nThree major projects accounted for the high level of environmental control capital expenditures in 1993:\na. Wastewater treatment plant at a Ferro chemical facility in France $2,300,000\nb. Replacement of underground tank farms at a Ferro chemical facility in Bedford, Ohio 1,600,000\nc. Scrubbers at a Ferro facility in Brazil 1,400,000 ---------\nTotal -- Major Projects (1993) $5,300,000\nDuring 1995 the Company reached an agreement in principle to settle a suit filed in August 1993 by the United States Environmental Protection Agency alleging violation of the Clean Water Act and the Rivers and Harbors Act by Keil Chemical, a production facility owned and operated by Ferro in Hammond, Indiana. The Company had been named as one of several defendants, including three local municipalities, one local government agency (a sewer district) and four other area industrial concerns. Subject to the negotiation of an acceptable consent decree, the Company will agree to pay a civil penalty of $0.4 million and to pay $1.4 million into a fund to be established to help clean up sediment in the West Branch of the Grand Calumet River. Terms of the consent decree are still being negotiated.\nDuring 1994, the Company signed an Agreed Order with the Indiana Department of Environmental Management and the Hammond Department of Environmental Management (the \"Agencies\") settling the Agencies' claims that the Keil Chemical facility had violated various air emission regulations. Subject to satisfactory compliance with the terms of the Agreed Order, the United States Environmental Protection Agency has concluded its Notice of Violations against the Keil facility. Under the Agreed Order, the Company paid a civil cash penalty of $1.5 million, constructed a supplemental environmental project and commenced reduction of air emissions to reach compliance with federal and state air emission regulations under compliance schedules as contained in the Agreed Order.\nEMPLOYEES\nAt December 31, 1995, Ferro employed approximately 6,914 full-time employees, including 4,059 employees in its foreign subsidiaries and affiliates and 2,855 in the United States.\nApproximately 25% of the domestic workforce is covered by labor agreements, and approximately 4% is affected by union agreements which expire in 1996.\nFOREIGN OPERATIONS\nFinancial information about Ferro's domestic and foreign operations is set forth on page 31 of the Annual Report and is incorporated herein by reference.\nFerro's products are produced and distributed in foreign as well as domestic markets. Ferro commenced its international operations in 1927.\nWholly-owned subsidiaries operate manufacturing facilities in Argentina, Australia, Brazil, Canada, England, France, Germany, Holland, Italy, Mexico, Spain, Taiwan and Thailand. Partially-owned affiliates manufacture in Ecuador, Indonesia, Japan, Portugal, Taiwan, Turkey and Venezuela.\nForeign operations (excluding Canada) accounted for 50% of the consolidated net sales and 53% of Ferro's consolidated operating income for the fiscal year 1995; comparable amounts for the fiscal year 1994 were 50% and 60% and for fiscal year 1993 were 50% and 53%.\nExcept for the sales of Ferro Enamel Espanola S.A. (Spain), Ferro France, S.a.R.L. (France), Ferro Chemicals S.A. (France), Ferro (Holland) B.V., Ferro Mexicana S.A. de C.V. (Mexico), Ferro (Great Britain) Ltd., Ferro Industrial Products Limited (Taiwan), Ferro Toyo Co., Ltd. (Taiwan) and Metal Portuguesa S.A. (Portugal), the sales of each of Ferro's subsidiaries are principally for delivery in the country in which the subsidiary is located. Ferro's European Community subsidiaries continue to reduce and eliminate, to the extent practical, duplication of product lines with the intended result being that only one subsidiary will be the primary provider of each line of Ferro specialty products to the entire European Community market.\nFerro receives technical service fees and\/or royalties from many of its foreign subsidiaries. Historically, as a matter of general corporate policy, the foreign subsidiaries have been expected to remit a portion of their annual earnings to the parent as dividends. Several of the countries where Ferro has subsidiaries control the transfer of currency out of the country, but in recent years Ferro has been able to receive such remittances without material hindrance from foreign government restrictions. To the extent earnings of foreign subsidiaries are not remitted to Ferro, such earnings are intended to be indefinitely invested in those subsidiaries.\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2 - PROPERTIES\nFerro's Research and Development Center is located in leased space in Independence, Ohio. The corporate headquarters office is located at 1000 Lakeside Avenue, Cleveland, Ohio and such property is owned by the Company. The business segments in which Ferro's plants are used and the locations of the principal manufacturing plants it owns in the United States are as follows:\nCOATINGS, COLORS AND CERAMICS -- Cleveland, Ohio; Nashville, Tennessee; Pittsburgh, Pennsylvania; Toccoa, Georgia; Orrville, Ohio; Shreve, Ohio; Penn Yan, New York; East Liverpool, Ohio; Crooksville, Ohio and East Rochester, New York. PLASTICS -- Plymouth, Indiana; Evansville, Indiana; Stryker, Ohio; Edison, New Jersey and South Plainfield, New Jersey. CHEMICALS -- Bedford, Ohio; Hammond, Indiana and Baton Rouge, Louisiana.\nIn addition, Ferro leases manufacturing facilities in Cleveland, Ohio (Chemicals); Fort Worth, Texas (Chemicals); Santa Barbara, California (Coatings) and San Marcos, California (Coatings).\nOutside the United States, Ferro or its subsidiaries own manufacturing plants in Argentina, Australia, Brazil, Canada, France, Germany, Indonesia, Italy, Japan, Mexico, the Netherlands, Portugal, Spain, Taiwan, Thailand and the United Kingdom. Ferro or its subsidiaries lease manufacturing plants in Portugal, Germany and the Netherlands. In many instances, the manufacturing facilities outside of the United States are used in multiple business segments of Ferro.\nFerro believes that all of the foregoing facilities are generally well maintained and adequate for their present use. During the past year, several of Ferro's plants have been operating near capacity.\nITEM 3","section_3":"ITEM 3 - LEGAL PROCEEDINGS\nInformation set forth in Note 7 to Ferro's Consolidated Financial Statements on page 27of the Annual Report is incorporated herein by reference.\nInformation regarding certain legal proceedings with respect to environmental matters is contained under Part I of this Annual Report on Form 10-K.\nThe law firm of Squire, Sanders & Dempsey, of which Mark A. Cusick is a partner, provided legal services to Ferro in 1995 and Ferro plans to continue the use of such firm in 1996. Mr. Cusick is the Secretary of Ferro.\nITEM 4","section_4":"ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matters were submitted to a vote of Ferro's security holders during the fourth quarter of the fiscal year covered by this report.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThere is set forth below the name, age, positions and offices held by each individual serving as executive officer as of March 15, 1996 as well as their business experience during the past five years. Years indicate the year the individual was named to the indicated position. There is no family relationship between any of Ferro's executive officers.\nAlbert C. Bersticker - 61 Chairman of the Board and Chief Executive Officer, 1996 President and Chief Executive Officer, 1991 President and Chief Operating Officer, 1988\nWerner F. Bush - 56 Executive Vice President and Chief Operating Officer, 1993 Senior Vice President, Coatings, Colors and Ceramics, 1991 Group Vice President, Coatings, Colors and Electronic Materials, 1988\nDavid G. Campopiano - 46 Vice President, Corporate Development, 1989\nR. Jay Finch - 54 Vice President, Specialty Plastics, 1991 Vice President and General Manager, Plastics & Rubber Division, Mobay Corporation, 1984\nJames B. Friederichsen - 53 Vice President, Specialty Chemicals, 1994 President, MTM Americas, 1990\nD. Thomas George - 48 Treasurer, 1991 Director, Treasury Operations, 1989\nJ. Larry Jameson - 58 Vice President, Powder Coatings, 1996 Self Employed, Coatings Consultant, 1993 Chief Executive Officer, Pirelli Cable Corporation, 1993 President, Coatings and Colorants Division, BASF Corporation,\nCharles M. Less - 46 Vice President, Marketing, 1995 Group Market Manager, Rohm and Haas, 1992 Business Manager Coatings, Europe, Rohm and Haas, 1987\nHector R. Ortino - 53 President, 1996 Executive Vice President and Chief Financial-Administrative Officer, 1993 Senior Vice President and Chief Financial Officer, 1991 Vice President, Finance and Chief Financia Officer, 1987\nRichard C. Oudersluys - 56 Vice President, Inorganic Coatings and Colorants, 1994 Vice President, Pigments and Glass\/Ceramics Colorants, 1992 General Manager, Color Division, 1987\nThomas O. Purcell, Jr. - 51 Vice President, Research and Development, 1991 Associate Director Research, Plastics, 1990\nGary H. Ritondaro - 49 Vice President and Chief Financial Officer, 1996 Vice President, Finance, 1993 Vice President, Controller, 1991 Controller, 1986\nPART II - --------------------------------------------------------------------------------\nITEM 5","section_5":"ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nInformation regarding the recent price and dividend history of Ferro's Common Stock, the principal market for its Common Stock and the number of holders thereof is set forth under the heading \"Quarterly Data\" on page 34 of the Annual Report. Said information is incorporated herein by reference. Information concerning dividend restrictions is contained in Note 3 to Ferro's Consolidated Financial Statements on pages 24 and 25 of the Annual Report and said information is incorporated herein by reference.\nITEM 6","section_6":"ITEM 6 - SELECTED FINANCIAL DATA\nThe summary of selected financial data for each of the last five years set forth under the heading \"Selected Financial Data \" on pages 32 and 33 of the Annual Report is incorporated herein by reference.\nITEM 7","section_7":"ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS\nThe information contained under the heading \"Management's Discussion and Analysis\" on pages 14 through 18 of the 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 Ferro and its subsidiaries contained on pages 19 through 31, inclusive, of the Annual Report, including the Notes to Consolidated Financial Statements, are incorporated herein by reference.\nITEM 9","section_9":"ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThere are no such changes or disagreements.\nPART III - --------------------------------------------------------------------------------\nITEM 10","section_9A":"","section_9B":"","section_10":"ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information regarding directors of Ferro contained under the headings \"Election of Directors\" and \"Certain Matters Pertaining to the Board of Directors\" on pages 1 through 9, inclusive, of Ferro's Proxy Statement dated March 12, 1996, is incorporated herein by reference. Information regarding executive officers of Ferro is contained under Part I of this Annual Report on Form 10-K.\nITEM 11","section_11":"ITEM 11 - EXECUTIVE COMPENSATION\nThe information required by this Item 11 is set forth under the heading \"Information Concerning Executive Officers\" on pages 14 through 28, inclusive, of Ferro's Proxy Statement dated March 12, 1996, 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 12 is set forth under the headings \"Election of Directors\" and \"Security Ownership of Directors, Officers and Certain Beneficial Owners\" on pages 1 through 8 of Ferro's Proxy Statement dated March 12, 1996 and is incorporated herein by reference.\nITEM 13","section_13":"ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThere are no relationships or transactions that are required to be reported.\nPART IV - --------------------------------------------------------------------------------\nITEM 14","section_14":"ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n1. DOCUMENTS FILED AS PART OF THIS ANNUAL REPORT ON FORM 10-K:\n(a) THE FOLLOWING CONSOLIDATED FINANCIAL STATEMENTS OF FERRO CORPORATION AND ITS SUBSIDIARIES, CONTAINED ON PAGES 19 THROUGH 31, INCLUSIVE, OF THE ANNUAL REPORT ARE INCORPORATED HEREIN BY REFERENCE:\nConsolidated Statements of Income for the years ended December 31, 1995, 1994 and 1993\nConsolidated Balance Sheets at December 31, 1995 and 1994\nConsolidated Statements of Shareholders' Equity for the years ended December 31, 1995, 1994 and 1993\nConsolidated Statements of Cash Flows for the years ended December 31, 1995, 1994 and 1993\nNotes to Consolidated Financial Statements\n(b) THE FOLLOWING ADDITIONAL INFORMATION FOR THE YEARS 1995, 1994 AND 1993, IS SUBMITTED HEREWITH:\nIndependent Auditors' Report on Financial Statement Schedule\nSchedule VIII - Valuation and Qualifying Accounts and Reserves\nAll other schedules have been omitted because the material is not applicable or is not required as permitted by the rules and regulations of the Securities and Exchange Commission, or the required information is included in notes to consolidated financial statements.\nFinancial statements of foreign affiliates in which Company ownership exceeds 20 percent, accounted for on the equity method, are not included herein since, in the aggregate, these companies do not constitute a significant subsidiary.\nFinancial Statement Schedule VIII, together with the independent Auditors' Report thereon, are contained on pages and of this Annual Report on Form 10-K.\n(c) EXHIBITS:\n(3) Articles of Incorporation and by-laws\n(a) Eleventh Amended Articles of Incorporation. (Reference is made to Exhibit 3 to Ferro Corporation's Quarterly Report on Form 10-Q for the three months ended September 30, 1989, which Exhibit is incorporated herein by reference.)\n(b) Certificate of Amendment to the Eleventh Amended Articles of Incorporation of Ferro Corporation filed December 28, 1994. (Reference is made to Exhibit (3)(b) to Ferro Corporation's Annual Report on Form 10-K for the year ended December 31, 1994, which Exhibit is incorporated herein by reference.)\n(c) Amended Code of Regulations. (Reference is made to Exhibit (3)(b) to Ferro Corporation's Quarterly Report on Form 10-Q for the three months ended June 30, 1987, which Exhibit is incorporated herein by reference.)\n(4) Instruments defining rights of security holders, including indentures\n(a) Revolving Credit Agreement by and between Ferro and four commercial banks dated August 22, 1990. (Reference is made to Exhibit 10 to Ferro Corporation's Form 10-Q for the three months ended September 30, 1990, which Exhibit is incorporated herein by reference.)\n(b) Amendment Number 1 dated May 31, 1991, to the Revolving Credit Agreement by and between Ferro and four commercial banks. (Reference is made to Exhibit 4(b)(1) to Ferro Corporation's Quarterly Report on Form 10-Q for the three months ended June 30, 1991, which Exhibit is incorporated herein by reference.)\n(c) Amendment Number 2 dated July 30, 1991, to the Revolving Credit Agreement by and between Ferro and four commercial banks. (Reference is made to Exhibit 4(b)(2) to Ferro Corporation's Form 10-Q for the three months ended June 30, 1991, which Exhibit is incorporated herein by reference.)\n(d) Amendment Number 3 dated December 31, 1991, to the Revolving Credit Agreement by and between Ferro and four commercial banks. (Reference is made to Exhibit 4 to Ferro Corporation's Form 10-K for the year ended December 31, 1991, which Exhibit is incorporated herein by reference.)\n(e) Amendment Number 4 dated July 21, 1992, to the Revolving Credit Agreement by and between Ferro and four commercial banks. (Reference is made to Exhibit 4 to Ferro Corporation's Form 10-Q for the three months ended June 30, 1992, which Exhibit is incorporated herein by reference.)\n(f) Amendment Number 5 dated April 20, 1993, to the Revolving Credit Agreement by and between Ferro and four commercial banks. (Reference is made to Exhibit 4(b)(4) to Ferro Corporation's Form 10-Q for the three months ended June 30, 1993, which Exhibit is incorporated herein by reference.)\n(g) Amendment Number 6 dated June 22, 1995, to the Revolving Credit Agreement by and between Ferro and four commercial banks. (Reference is made to Exhibit 4(b)(4) to Ferro Corporation's Form 10-Q for the three months ended June 30, 1995, which Exhibit is incorporated herein by reference.)\n(h) Amendment Number 7 dated October 25, 1995 to the Revolving Credit Agreement by and between Ferro Corporation and four commercial banks. (Reference is made to Exhibit 4(b)(4) to Ferro Corporation's Form 10-Q for the three months ended September 30, 1995, which Exhibit is incorporated herein by reference.)\n(i) Rights Agreement between Ferro Corporation and National City Bank, Cleveland, Ohio, as Rights Agent, dated as of March 21, 1986. (Reference is made to Exhibit 1.2 to the Registration Statement on Form 8-A dated March 26, 1986, which Exhibit is incorporated herein by reference.)\n(j) Amendment No. 1 to Rights Agreement between Ferro Corporation and National City Bank, Cleveland, Ohio, as Rights Agent, dated as of March 31, 1989. (Reference is made to Exhibit 1 to Form 8-K filed with the Commission on March 31, 1989, which Exhibit is incorporated herein by reference.)\n(k) The rights of the holders of Ferro's Debt Securities issued and to be issued pursuant to an Indenture between Ferro and Society National Bank, as Trustee, are described in the form of Indenture dated May 1, 1993 filed as Exhibit 4(j) to Ferro Corporation's Form\n10-Q for the three months ended June 30, 1993. Said Exhibit is incorporated herein by reference.\n(10) Material Contracts\n(a) Key elements of Ferro's Incentive Compensation Plan are set forth under the heading \"Report of the Compensation and Organization Committee\" on pages 14 through 18 of the Proxy Statement dated March 20, 1995. Said description is incorporated herein by reference.\n(b) Ferro's 1995 Performance Share Plan. (Reference is made to Exhibit A of Ferro Corporation's Proxy Statement dated March 20, 1995, which exhibit is incorporated herein by reference.)\n(c) Ferro Corporation Savings and Stock Ownership Plan. (Reference is made to Exhibit 4.3 to Ferro Corporation's Quarterly Report on Form 10-Q for the three months ended March 31, 1989, which Exhibit is incorporated herein by reference.)\n(d) Ferro's 1985 Employee Stock Option Plan for Key Personnel (Amended and Restated). (Reference is made to Exhibit A to Ferro Corporation's Proxy Statement dated March 11, 1991, which Exhibit is incorporated by reference.) Reference is also made to pages 13 and 14 of Ferro Corporation's Proxy Statement dated March 20, 1995, for an amendment to the plan and to pages 10 through 13 of Ferro Corporation's Proxy Statement dated March 12, 1996 regarding proposed amendments to the Plan, subject to shareholder approval at the 1996 annual meeting.\n(e) Form of Indemnification Agreement (adopted January 25, 1991 for use from and after that date). (Reference is made to Exhibit 10 to Ferro Corporation's Form 10-K for the year ended December 31, 1990, which Exhibit is incorporated herein by reference.)\n(f) Agreement between Ferro Corporation and Frank A. Carragher dated October 18, 1993. (Reference is made to Exhibit 10.1 to Ferro Corporation's Form 10-K for the year ended December 31, 1993, which Exhibit is incorporated herein by reference.)\n(g) Amended and Restated Executive Employment Agreement dated July 28, 1995. (Reference is made to Exhibit 10 (b) of Ferro Corporation's Form 10-Q for the three months ended September 30, 1995, which Exhibit is incorporated herein by reference.)\n(h) Schedule I listing the officers with whom Ferro has entered into currently effective executive employment agreements. A copy of such Schedule I is attached hereto as Exhibit 10.\n(i) Various agreements relating to an Asset Defeasance Financing including a Participation Agreement dated as of October 31, 1995 among Ferro Corporation, State Street Bank and Trust Company (not in its individual capacity but solely as Trustee), the financial institutions named as Purchasers, and Citibank N.A, as Agent, and a Lease dated October 31, 1995 between State Street Bank and Trust Company (not in its individual capacity but solely as Trustee) as Lessor and Ferro Corporation as Lessee.\nThe additional agreements are available upon request. (Reference is made to Exhibit 10(a) of Ferro Corporation's Form 10-Q for the three months ended September 30, 1995, which Exhibit is incorporated herein by reference.)\n(j) Separation Agreement between Ferro Corporation and James F. Fisher dated March 22, 1995 is attached hereto as Exhibit 10.1.\n(11) Statement Regarding Computation of Earnings per Share.\n(12) Ratio of Earnings to Fixed Charges.\n(13) Annual Report to Shareholders for the year ended December 31, 1995.\n(21) List of Subsidiaries.\n(23) Consent of KPMG Peat Marwick LLP to the incorporation by reference of their audit report on the Consolidated Financial Statements contained in the Annual Report into Ferro's Registration Statements on Form S-8 Registration Nos. 2-61407, 33-28520 and 33-45582 and Ferro's Registration Statement on Form S-3 Registration No. 33-51284 and Registration No. 33-63855.\n2. REPORTS ON FORM 8-K:\nNo reports on Form 8-K were filed for the three months ended December 31,\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.\nFERRO CORPORATION\nBy \/s\/Albert C. Bersticker ------------------------- Albert C. Bersticker, Chairman 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 their indicated capacities and as of this 27th day of March, 1996.\n\/s\/Adolph Posnick Director Adolph Posnick\n\/s\/Rex A. Sebastian Director Rex A. Sebastian\n\/s\/Dennis W. Sullivan Director Dennis W. Sullivan\nINDEPENDENT AUDITORS' REPORT ON FINANCIAL STATEMENT SCHEDULE ------------------------------------------------------------\nThe Shareholders and Board of Directors Ferro Corporation\nUnder date of January 24, 1996, we reported on the consolidated balance sheets of Ferro Corporation and subsidiaries as of December 31, 1995 and 1994, 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, 1995, as contained in the 1995 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 1995. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related financial statement Schedule VIII, Valuation and Qualifying Accounts and Reserves. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement schedule based on our audits.\nIn our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.\n\/s\/ KPMG Peat Marwick LLP KPMG Peat Marwick LLP Cleveland, Ohio January 24, 1996\nFERRO CORPORATION AND SUBSIDIARIES\nSchedule VIII - Valuation and Qualifying Accounts and Reserves\nYears ended December 31, 1995, 1994 and 1993\n(thousands of dollars)\nNotes: (A)Accounts written off, less recoveries (B)Adjustment in respect of differences in rates of exchange (C)Acquisitions and divestitures, net\nEXHIBIT INDEX -------------\nExhibit (10) Schedule I\nExhibit (10.1) Separation Agreement Between Ferro Corporation and James F. Fisher\nExhibit (11) Statement Regarding Computation of Earnings per Share\nExhibit (12) Ratio of Earnings to Fixed Charges\nExhibit (13) Annual Report to Shareholders\nExhibit (21) List of Subsidiaries\nExhibit (23) Consent of KPMG Peat Marwick LLP\nExhibit (27) Financial Data Schedule (Electronic Filing Only)","section_15":""}
{"filename":"764241_1995.txt","cik":"764241","year":"1995","section_1":"ITEM 1. BUSINESS\nNational City Bancshares, Inc., (hereinafter referred to as the \"Corporation\"), is an Indiana Corporation organized in 1985 to engage in the business of a bank holding company. Based in Evansville, Indiana, the Corporation has eleven wholly owned subsidiaries, including nine commercial banks and one savings bank serving twenty-three communities with a total of thirty-two banking centers, one leasing corporation, and one insurance agency (which is a subsidiary of a subsidiary bank). Each subsidiary, its locations, number of offices, year founded, and date of merger is shown below.\nThe Corporation's subsidiary banks provide a wide range of financial services to the communities they serve in Southwestern Indiana, Western Kentucky and Southeastern Illinois. These services include various types of deposit accounts; safe deposit boxes; safekeeping of securities; automated teller machines; consumer, mortgage, and commercial loans; mortgage loan sales and servicing; letters of credit; accounts receivable management (financing, accounting, billing and collecting); and complete personal and corporate trust services. All banks are members of the Federal Deposit Insurance Corporation.\nThe Corporation's nonbank subsidiary, NCBE Leasing Corp., operates as a full service equipment and real property leasing company offering its services to all commercial clients of the Corporation's subsidiary banks.\nUniFed, Inc., a wholly owned nonbank subsidiary of Pike County Bank (which is a wholly owned subsidiary of the Corporation), operates as an insurance agency offering various insurance products through several insurance companies or underwriters and sells the following types of insurance: casualty, property, homeowners, business, and automobile.\nAt December 31, 1995, the Corporation and its subsidiaries had 445 full-time equivalent employees. The subsidiaries provide a wide range of employee benefits and consider employee relations to be excellent.\nCOMPETITION\nThe Corporation has active competition in all areas in which it presently engages in business. Each subsidiary bank competes for commercial and individual deposits and loans with commercial banks, savings and loan associations, credit unions connected with local businesses, and other non-banking institutions. The Corporation's leasing company competes with bank and nonbank leasing companies as well as finance subsidiaries of major equipment vendors.\nFOREIGN OPERATIONS\nThe Corporation and its subsidiaries have no foreign branches or significant business with foreign obligers or depositors.\nREGULATION AND SUPERVISION\nThe following is a summary of certain statutes and regulations affecting the Corporation and its subsidiaries. This summary is qualified in its entirety by such statutes and regulations.\nThe Corporation\nThe Corporation is a registered bank holding company under the Bank Holding Company Act as amended (\"BHC Act\") and as such is subject to regulation by the Board of Governors of the Federal Reserve Board (\"FRB\"). A bank holding company is required to file with the FRB quarterly reports and other information regarding its business operations and those of its subsidiaries. A bank holding company and its subsidiary banks are also subject to examination by the FRB.\nThe BHC Act requires every bank holding company to obtain the prior approval of the FRB before acquiring substantially all the assets of any bank or bank holding company or ownership or control of any voting shares of any bank or bank holding company, if, after such acquisition, it would own or control, directly or indirectly, more than 5% of the voting shares of such bank or bank holding company. Bank holding companies are also prohibited from acquiring shares of any bank located outside the state in which the operations of the bank holding company's banking subsidiaries are principally conducted, unless such an acquisition is specifically authorized by statute of the state in which the bank whose shares are to be acquired is located. However, the BHC Act does not place territorial restrictions on the activities of nonbank subsidiaries of a bank holding company.\nIn approving acquisitions by bank holding companies of companies engaged in banking-related activities, the FRB considers whether the performance of any such activity by a subsidiary of the holding company reasonably can be expected to produce benefits to the public, such as greater convenience, increased competition, or gains in efficiency, which outweigh possible adverse effects, such as over concentration of resources, decrease of competition, conflicts of interest, or unsound banking practices.\nBank holding companies are restricted in, and subject to, limitations regarding transactions with subsidiaries and other affiliates.\nIn addition, bank holding companies and their subsidiaries are prohibited from engaging in certain \"tie in\" arrangements in connection with any extensions of credit, leases, sales of property or furnishing of services.\nIn connection with its acquisition of United Federal Savings Bank (\"UFSB\"), the Corporation became subject to supervision and regulation by the Office of Thrift Supervision (\"OTS\"), as a registered thrift holding company under the provision of the Home Owners Loan Act. The OTS has regulatory and supervisory jurisdiction over UFSB as well as the Corporation.\nSubsidiaries of the Corporation\nThe Corporation operates two national banks, The National City Bank of Evansville and The Peoples National Bank of Grayville. As national banks, these banks are supervised and regulated by the Comptroller of the Currency (\"OCC\"), and subject to laws and regulations applicable to national banks.\nIn addition to its national bank subsidiaries, the Corporation operates five Indiana state chartered banks; The Farmers and Merchants Bank, Lincolnland Bank, The Bank of Mitchell, Pike County Bank, and The State Bank of Washington; a Kentucky state chartered bank, First Kentucky Bank; and an Illinois state chartered bank, White County Bank. As state banks, they are supervised and regulated by their state banking supervisor and the Federal Deposit Insurance Corporation (\"FDIC\") as their primary federal banking regulatory agency.\nFinally, the Corporation operates a federal savings bank, United Federal Savings Bank, which is supervised and regulated by the OTS.\nCapital\nThe FRB, OCC, OTS, and FDIC require banks and holding companies to maintain minimum capital ratios.\nThe FRB has adopted final \"risk-adjusted\" capital guidelines for bank holding companies. The new guidelines became fully implemented as of December 31, 1992. The OCC, OTS, and FDIC have adopted substantially similar risk-based capital guidelines. These ratios involve a mathematical process of assigning various risk weights to different classes of assets, then evaluating the sum of the risk-weighted balance sheet structure against the Corporation's capital base. The rules set the minimum guidelines for the ratio of capital to risk-weighted assets (including certain off-balance sheet activities, such as standby letters of credit) at 8%. At least half of the total capital is to be composed of common equity, retained earnings, and a limited amount of perpetual preferred stock less certain goodwill items (\"Tier I Capital\"). The remainder may consist of a limited amount of subordinated debt, other preferred stock, or a limited amount of loan loss reserves.\nIn addition, the federal banking regulatory agencies have adopted leverage capital guidelines for banks and bank holding companies. Under these guidelines, banks and bank holding companies must maintain a minimum ratio of 3% Tier 1 Capital (as defined for purposes of the year-end 1992 risk-based capital guidelines) to total assets. The FRB has indicated, however, that banking organizations that are experiencing or anticipating significant growth, are expected to maintain capital ratios well in excess of the minimum levels.\nRegulatory authorities may increase such minimum requirements for all banks and bank holding companies or for specified banks or bank holding companies. Increases in the minimum required ratios could adversely affect the Corporation and the subsidiary banks, including the ability to pay dividends.\nAdditional Regulation\nThe Corporation's banks are also subject to federal regulation as to such matters as required reserves, limitation as to the nature and amount of its loans and investments, regulatory approval of any merger or consolidation, issuance or retirement of their own securities, limitations upon the payment of dividends and other aspects of banking operations. In addition, the activities and operations of the Corporation's banks are subject to a number of additional detailed, complex and sometimes overlapping laws and regulations. These include state usury and consumer credit laws, state laws relating to fiduciaries, the Federal Truth-in-Lending Act and Regulation Z, the Federal Equal Credit Opportunity Act and Regulation B, the Fair Credit Reporting Act, the Truth in Savings Act, the Community Reinvestment Act, anti-redlining legislation and antitrust laws.\nDividend Regulation\nThe ability of the Corporation to obtain funds for the payment of dividends and for other cash requirements is largely dependent on the amount of dividends which may be declared by the Corporation's banks. Generally, the Corporation's banks may not declare a dividend, without the approval of the appropriate federal and state regulatory agencies if the total of dividends declared by such subsidiary bank in a calendar year exceeds the total of its net profits for that year combined with its retained profits of the preceding two years.\nGovernment Policies and Legislation\nThe policies of regulatory authorities, including the FRB, OCC, FDIC, OTS and the Depository Institutions Deregulation Committee, have had a significant effect on the operating results of commercial banks and thrifts in the past and are expected to do so in the future. An important function of the Federal Reserve System is to regulate aggregate national credit and money supply through such means as open market dealings in securities, establishment of the discount rate on member bank borrowings, and changes in reserve requirements against member bank deposits. Policies of these agencies may be influenced by many factors, including inflation, unemployment, short-term and long-term changes in the international trade balance and fiscal policies of the United States government.\nThe United States Congress has periodically considered and adopted legislation which has resulted in further deregulation of both banks and other financial institutions, including mutual funds, securities\nbrokerage firms and investment banking firms. No assurance can be given as to whether any additional legislation will be adopted or as to the effect such legislation would have on the business of the Corporation or the Corporation's banks.\nIn addition to the relaxation or elimination of geographic restrictions on banks and bank holding companies, a number of regulatory and legislative initiatives have the potential for eliminating many of the product line barriers presently separating the services offered by commercial banks from those offered by nonbanking institutions. For example, Congress recently has considered legislation which would expand the scope of permissible business activities for bank holding companies (and in some cases banks) to include securities underwriting, insurance services, and various real estate related activities as well as allowing interstate branching.\nDeposit Insurance\nThe Federal Deposit Insurance Corporation Improvement Act of 1991 (\"FDICIA\") was enacted in 1991. Among other things, FDICIA requires federal bank regulatory authorities to take \"prompt corrective action\" with respect to banks that do not meet minimum capital requirements. For these purposes, FDICIA established five capital tiers: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. The Corporation and each of the Corporation's banks currently exceed the regulatory definition of a \"well capitalized\" financial institution.\nThe FRB, OCC, OTS, and FDIC have adopted regulations to implement the prompt corrective action provisions of FDICIA, effective December 19, 1992. Among other things, the regulations define the relevant capital measures for the five capital categories. An institution is deemed to be \"well capitalized\" if it has a total risk-based capital ratio (total capital to risk-weighted assets) of 10% or greater, a Tier 1 risk-based capital ratio (Tier 1 Capital to risk-weighted assets) of 6% or greater, and a Tier 1 leverage capital ratio (Tier 1 Capital to total assets) of 5% or greater, and is not subject to a regulatory order, agreement or directive to meet and maintain a specific capital level for any capital measure. An institution is deemed to be \"adequately capitalized\" if it has a total risk-based capital ratio of 8% or greater, a Tier 1 risk-based capital of 4% or greater, and (generally) a Tier 1 leverage capital ratio of 4% or greater, and the institution does not meet the definition of a \"well capitalized\" institution. An institution is deemed to be \"critically undercapitalized\" if it has a ratio of tangible equity (as defined in the regulations) to total assets that is equal to or less than 2%. \"Undercapitalized\" banks are subject to growth limitations and are required to submit a capital restoration plan. If an \"undercapitalized\" bank fails to submit an acceptable plan, it is treated as if it is significantly undercapitalized. \"Significantly undercapitalized\" banks may be subject to a number of\nrequirements and restrictions, including orders to sell sufficient voting stock to become adequately capitalized, requirements to reduce total assets, and cessation of receipt of deposits from correspondent banks. \"Critically undercapitalized\" institutions may not, beginning 60 days after becoming \"critically undercapitalized\", make any payment of principal or interest on their subordinated debt.\nAs an FDIC-insured institution, each of the Corporation's banks is required to pay deposit insurance premium assessments to the FDIC. Pursuant to FDICIA, the FDIC adopted a transitional risk-based assessment system, effective January 1, 1993, under which all insured depository institutions were placed into one of nine categories and assessed insurance premiums, ranging from .23% to .31% of deposits, based upon their level of capital and supervisory evaluation. Institutions classified as well-capitalized (as defined by the FDIC) and considered healthy pay the lowest premium while institutions that are less than adequately capitalized (as defined by the FDIC) and considered of substantial supervisory concern pay the highest premium. Risk classification of all insured institutions is made by the FDIC for each semiannual assessment period.\nOn June 17, 1993, the FDIC issued regulations establishing a permanent risk-based assessment system. These regulations took effect October 1, 1993, and were first used to determine assessments for the assessment period commencing January 1, 1994. Although the FDIC previously requested comments on whether the range of risk-based premiums should be expanded so that institutions posing the least risk to the deposit insurance funds would pay less than .23% of deposits and institutions posing the highest risk would pay more than .31% of deposits, the FDIC did not change the premium range and the permanent risk-based assessment system adopted by the FDIC is substantially the same as the transitional system. During 1994, the Corporation's banks were assessed at the rate of .23% of deposits under the transitional assessment system.\nEffective July 1, 1995, the FDIC implemented a change to the insurance premium rates charged by the Bank Insurance Fund (BIF) and reduced the rates charged to those institutions posing the least risk to the deposit insurance fund to .04% of deposits. Effective January 1, 1996, the FDIC further reduced the BIF rates applicable to those institutions posing the least risk to the deposit insurance fund to a flat fee of $2,000, regardless of the amount of deposits of such institution. In institutions posing the least risk, deposits continue to be insured by Savings Association Insurance Fund (SAIF) at the rate of .23% of deposits. The Corporation's banking and thrift subsidiaries are all insured by the BIF and SAIF at the lowest premium rates charged.\nThe FDIC may terminate the deposit insurance of any insured depository institution if the FDIC determines, after a hearing, that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue\noperations, or has violated any applicable law, regulation, order, or any condition imposed in writing by, or written agreement with, the FDIC. The FDIC may also suspend deposit insurance temporarily during the hearing process for a permanent termination of insurance if the institution has no tangible capital. Management of the Corporation is not aware of any activity or condition that could result in termination of the deposit insurance of the Corporation's banks.\nRecent Legislation\nOn September 29, 1994, the Reigle\/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 FRB may not be granted for a proposed interstate acquisition if after the acquisition, the acquiror on a consolidated basis would control more than 10% of the total deposits nationwide or would control more than 30% of deposits in the state where the acquiring institution is located. The deposit concentration state limit does not apply for initial acquisitions in a state and in every case, may be waived by 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.\nBranching between states may be accomplished either by merging separate banks located in different states into one legal entity, or by establishing de novo branches in another state. Consolidation of banks is not permitted until June 1, 1997, provided that the state has not passed legislation \"opting-out\" of interstate branching. If a state opts-out prior to June 1, 1997, then banks located in that state may not participate in interstate branching. A state may opt-in to interstate branching by bank consolidation or by de novo branching by passing appropriate legislation earlier than June 1, 1997. Interstate branching is also subject to a 30% statewide deposit concentration limit on a consolidated basis, and a 10% nationwide deposit concentration limit. The laws of the host state regarding community reinvestment, fair lending, consumer protection (including usury limits) and establishment of branches shall apply to the interstate branches.\nDe novo branching by an out-of-state bank is not permitted unless the host state expressly permits de novo branching by banks from out-of-state. The establishment of an initial de novo branch in a state is subject to the same conditions as apply to initial acquisition of a bank in the host state other than the deposit concentration limits.\nEffective one year after enactment, the Interstate Act permits bank subsidiaries of a bank holding company to act as agents for affiliated depository institutions in receiving deposits, renewing time deposits, closing loans, servicing loans, and receiving payments on loans and other obligations. A bank acting as 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 savings associations which were affiliated with banks as of June 1, 1994, may act as agents for such banks. An affiliate bank or savings association may not conduct any activity as an agent which such institution is prohibited from conducting as 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.\nTo ensure that interstate branching does not result in taking deposits without regard to a community's credit needs, the regulatory agencies are directed to implement regulations prohibiting interstate branches from being used as \"deposit production offices\". The regulations to implement its provisions are due by June 1, 1997. The regulations must include a provision to the effect that if loans made by an interstate branch are less than fifty percent of the average of all depository institutions in the state, then the regulator must review the loan portfolio of the branch. If the regulator determines that the branch is not meeting the credit needs of the community, it has the authority to close the branch and to prohibit the bank from opening new branches in that state.\nWhen the interstate banking provisions become effective in one year, the Corporation 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, the Corporation 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 the Corporation's affiliate banks to act as agents for each other in accepting deposits or servicing loans should make it more convenient for customers of one of the Corporation's bank to transact their banking business at a Corporation's affiliate in another state provided that operations are in place to facilitate these out-of-state transactions.\nOn November 18, 1993, the FDIC, together with the FRB, OCC, and OTS, published for comment proposed rules implementing the FDICIA\nrequirement that the federal banking agencies establish operational and managerial standards to promote the safety and soundness of federally insured depository institutions. The proposal would establish standards for internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, and compensation, fees and benefits. In general, the standards set forth in the proposal consist of the goals to be achieved in each area, and each institution would be responsible for establishing its own procedures to achieve those goals. Additionally, the proposal would establish a maximum permissible ratio of classified assets to capital and a minimum required earnings ratio. If an institution failed to comply with any of the standards set forth in the proposal, the institution would be required to submit to its primary federal regulator a plan for achieving and maintaining compliance. Failure to submit an acceptable plan, or failure to comply with a plan that has been accepted by the appropriate regulator, would constitute grounds for further enforcement action. Based upon a review of the proposal, management of the Corporation believes that the proposal, if adopted in substantially the form proposed, will not have a material adverse effect on the Corporation.\nOn May 17, 1995, the FDIC, together with the FRB, OCC, and OTS issued new regulations under the Community Reinvestment Act (\"CRA\"). Under the regulations, an institution's performance in meeting the credit needs of its entire community, including low and moderate income areas, as required by the CRA, are evaluated under three tests: the \"lending test\", which considers the extent to which the institution makes loans in the low and moderate income areas of its market; the \"service test,\" which considers the extent to which the institution makes branches accessible to low and moderate income areas of its market and provides other services that promote credit availability; and the \"investment test\", considers the extent to which the institution invests in community and economic development activities.\nProposed Legislation\nIn addition to the above, there have been proposed a number of legislative and regulatory proposals designed to strengthen the federal deposit insurance system and to improve the overall financial stability of the U.S. banking system. It is impossible to predict whether or in what form these proposals may be adopted in the future, and if adopted, what their effect would be on the Corporation.\nSTATISTICAL DISCLOSURE\nThe statistical disclosure on the Corporation and its subsidiaries, on a consolidated basis, included on pages 1, 4 through 14 and 33 of the Corporation's Annual Report to Shareholders for the fiscal year ended December 31, 1995, is hereby incorporated by reference herein.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe net investment of the Corporation and its subsidiaries in real estate and equipment at December 31, 1995, was $14,739,000. The Corporation's offices are located in a building owned by The National City Bank of Evansville (hereinafter referred to as the Bank), in which the Bank's main office is located. The main office of the Bank is located at 227 Main Street in downtown Evansville, Indiana. This building is owned in fee by the Bank. The other subsidiary banks, all branches, the leasing company, and the insurance company are located on premises either owned or leased. None of the property is subject to any major encumbrance. The National City Bank of Evansville committed in 1995 to build an addition to its main office to be completed in 1997 with an approximate cost of $6,000,000. It is anticipated that the project will be financed internally. There are no other material commitments for capital expenditures.\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 SHAREHOLDER MATTERS\nPages 1 and 33 of the Corporation's Annual Report to Shareholders for the fiscal year ended December 31, 1995, is hereby incorporated by reference herein. Dividends are restricted by earnings and the need to maintain adequate capital. Management intends to continue its current dividend policy subject to these restrictions.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nPage 1 of the Corporation's Annual Report to Shareholders for the fiscal year ended December 31, 1995, is hereby incorporated by reference herein.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION\nPages 1, 4 through 14, and 33 of the Corporation's Annual Report to Shareholders for the fiscal year ended December 31, 1995, are incorporated by reference herein.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nPages 15 through 29 of the Corporation's Annual Report to Shareholders for the fiscal year ended December 31, 1995, are incorporated by reference 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\n(a) Directors of the Corporation\nThis information under the heading \"Election of Directors and Information with Respect to Directors and Officers\" on pages 3 to 5 of the Corporation's Proxy Statement for its Annual Meeting of Shareholders to be held April 16, 1996, is hereby incorporated by reference herein.\n(b) Executive Officers of the Corporation\nThe Executive Officers of the Corporation, some of whom are also Executive Officers of The National City Bank of Evansville (hereinafter referred to as the \"Bank\") are as follows:\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information under the heading \"Compensation of Executive Officers\" on pages 7 through 12 of the Corporation's Proxy Statement for its Annual Meeting of Shareholders to be held April 16, 1996, is hereby incorporated by reference herein.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information under the heading \"Voting Securities\" on pages 1 through 3 of the Corporation's Proxy Statement for its Annual Meeting of Shareholders to be held April 16, 1996, is hereby incorporated by reference herein.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information under the heading \"Transactions with Management\" on page 13 of the Corporation's Proxy Statement for its Annual Meeting of Shareholders to be held April 16, 1996, is hereby incorporated by reference herein.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\nFINANCIAL STATEMENTS\nThe following consolidated financial statements of the Corporation and its subsidiaries, included on pages 15 through 29 of the Corporation's Annual Report to Shareholders for the fiscal year ended December 31, 1995, are hereby incorporated by reference:\nIndependent Auditor's Report Consolidated Statements of Financial Position, at December 31, 1995 and 1994 Consolidated Statements of Income, for years ended December 31, 1995, 1994 and 1993 Consolidated Statements of Cash Flows, for years ended December 31, 1995, 1994 and 1993 Consolidated Statements of Shareholders' Equity, for years ended December 31, 1995, 1994 and 1993 Notes to Consolidated Financial Statements\nFINANCIAL STATEMENT SCHEDULES\nAll schedules are omitted because they are not applicable or not required or because the required information is included in the consolidated financial statements or related notes.\nEXHIBITS\nThe following exhibits are submitted herewith or incorporated by reference:\n3(i) Articles of Incorporation, as amended 13 Annual Report to Shareholders for the year ended December 31, 1995 21 Subsidiaries of the Registrant 23 Consent of McGladrey & Pullen, LLP\nREPORTS ON FORM 8-K\nCURRENT REPORT dated October 25, 1995, for event of October 18, 1995, regarding the five percent stock dividend and an increase in the cash dividend.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on the dates indicated.\nNATIONAL CITY BANCSHARES, INC.\nBy \/s\/ JOHN D. LIPPERT 3\/20\/96 John D. Lippert Date Chairman of the Board and Chief Executive Officer\nBy \/s\/ ROBERT A. KEIL 3\/20\/96 Robert A. Keil Date President and Chief Financial Officer\nBy \/s\/ HAROLD A. MANN 3\/20\/96 Harold A. Mann Date Secretary and Treasurer (Chief Accounting Officer)\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\n----------------------- ------- Janice L. Beesley Date Director\n\/s\/ MICHAEL F. ELLIOTT 3\/20\/96 Michael F. Elliott Date Director\n----------------------- ------- Susanne R. Emge Date Director\n\/s\/ DONALD G. HARRIS 3\/20\/96 Donald G. Harris Date Director\n\/s\/ ROBERT A. KEIL 3\/20\/96 Robert A. Keil Date Director\n\/s\/ JOHN D. LIPPERT 3\/20\/96 John D. Lippert Date Director\n\/s\/ RONALD G. REHERMAN 3\/20\/96 Ronald G. Reherman Date Director\n\/s\/ LAURENCE R. STEENBERG 3\/20\/96 Laurence R. Steenberg Date Director\nEXHIBIT INDEX\nEXHIBIT NUMBER DESCRIPTION OF EXHIBIT\n3(i) Articles of Incorporation, as amended\n13 Annual Report to Shareholders for the year ended December 31, 1995\n21 Subsidiaries of the Registrant\n23 Consent of McGladrey & Pullen, LLP\n27 Financial Data Schedule","section_15":""}
{"filename":"202375_1995.txt","cik":"202375","year":"1995","section_1":"Item 1. The Company\nLazare Kaplan International Inc., which began its business in 1903, is principally engaged in the cutting, polishing and selling of ideally proportioned diamonds which it markets internationally under the brand name 'Lazare Diamonds'r''. Ideally proportioned diamonds are distinguished from commercial cut diamonds by the symmetrical relationship of their facets, which maximizes brilliance, sparkle and fire. Due to these characteristics, Lazare Diamonds command a premium in the marketplace. The Company believes there are only a few other companies worldwide engaged solely in the production of ideally proportioned diamonds and that it is the largest producer in this segment of the diamond industry. Additionally, the Company is engaged in the buying and selling of rough uncut diamonds.\nThe Company's sales strategy is directed primarily toward quality conscious consumers throughout the United States, the Far East and Europe. The Company generally sells to select retail jewelers in each geographic market in order to maintain an image of selectivity and prestige consistent with its overall marketing strategy. The Company has developed a comprehensive grading system for its ideal cut diamonds which allows jewelers to order inventory by category rather than through the more cumbersome process of visual selection. In addition, the Company designs, manufactures and sells a line of high quality jewelry which features Lazare Diamonds.\nAn important element of the Company's strategy is the promotion of the Lazare Diamonds brand name. Every Lazare Diamond bears a laser inscription on its outer perimeter containing the Lazare Kaplan logo and an identification number unique to the stone. This patented laser 'signature', which is invisible to the naked eye but visible when magnified at least ten times, serves as the purchaser's assurance that he is buying an authentic Lazare Diamond. This laser signature also allows consumers to register their Lazare Diamonds with the Company under its unique program, The Lazare Diamond Registry'r', thereby providing proof of ownership in case of loss or theft.\nEach rough diamond purchased by the Company and considered for sale as a polished diamond is evaluated against strict management standards designed to maximize its potential economic contribution to the Company's profitability. Expert technicians, assisted by proprietary computer software, determine whether to cut the stone to ideal proportions, cut the stone as a commercial diamond for sale through alternative distribution channels, or resell the stone as rough. The shape of the rough stone, its color, clarity and overall potential economic contribution, are among the criteria used in making such a determination.\nThe Company's involvement in the purchase and sale of rough diamonds, through its Antwerp, Belgium office, provides it with the ability to dispose of those diamonds not selected for cutting and polishing, as well as access to supplemental sources of supply. This activity allows the Company to maintain quantities and qualities of inventory which best meet its customers' needs.\nThe Company's principal stockholder is Maurice Tempelsman, the Chairman of the Board. Mr. Tempelsman and his son, Leon Tempelsman, are the sole general partners of Leon Tempelsman & Son ('LTS'), a New York limited partnership. LTS is the holder of 1,528,416 shares of common stock, all of which\nare deemed to be owned indirectly by each of Leon Tempelsman and Maurice Tempelsman. In addition, Maurice Tempelsman is the direct beneficial holder of 2,385,014 shares of common stock. The aggregate number of common shares held by Maurice Tempelsman, directly and indirectly, is 3,913,430 constituting 63.7% of the Company's issued and outstanding common stock.\nLazare Kaplan International Inc. was incorporated in 1972 under the laws of the State of Delaware as the successor to a business which originated in 1903.\nDiamond Supply\nRough Diamonds\nThe Company's business is dependent upon the availability of rough diamonds, the world's known sources of which are highly concentrated. Angola, Australia, Botswana, Brazil, Ghana, Guinea, Namibia, Sierra Leone, South Africa, Russia and Zaire account for more than 90% of present world rough gem diamond production. The Central Selling Organization (the 'CSO'), which is affiliated with De Beers Centenary AG, a Swiss company, is the primary world-wide marketing mechanism of the diamond industry. The CSO seeks to maintain an orderly and stable market for diamonds by regulating the quantity and selection of diamonds that reach the market. Sales for the CSO are made in London by the Diamond Trading Company (the 'DTC') to a select group of clients, including the Company. Based upon published reports, the Company believes that approximately 80% of the world diamond output is purchased for resale by the DTC and its affiliated companies. In order to maintain their purchasing relationship, the DTC's clients have traditionally been expected to purchase all of the diamonds offered to them by the DTC. Non-clients of the DTC must either purchase their requirements from clients of the DTC or seek access to that limited portion of the world supply not marketed by the DTC.\nHistorically, the Company's principal supplier of rough diamonds has been the DTC, which periodically invites its clients to submit their requirements as to the amount and type of stones they wish to purchase. Employees of the Company attend offerings ('sights') held by the DTC periodically during the year in London. At sights, the Company purchases, at the DTC's stated price, an assortment of stones known as a 'series', the composition of which attempts to take into account the market in which the Company operates and the Company's quantity requirements. The Company has been a client of the DTC for more than 50 years.\nIn order to diversify its sources of supply, the Company has entered into arrangements with other primary source suppliers, and has established an office in Antwerp to supplement its rough diamond needs by making purchases in the secondary market. For each of the past three years ended May 31, the Company purchased not more than 60% of its diamond purchases from the DTC.\nIn November 1993, the Company reached an agreement with the Ghanaian Government, Ghana Consolidated Diamonds Limited and De Beers Centenary pursuant to which, the parties would, subject to a feasibility study, form a new company to acquire, expand and operate the Akwatia\/Birim Diamond and Gold Concessions now owned by Ghana Consolidated Diamonds. In June, 1995 DeBeers Centenary announced that\nits feasibility study was complete. During the feasibility period, output at the mine increased significantly as a result of changes made to operations and revenue increased. The improved performance suggests that the project has the potential to generate positive cash flows subject to further cost reductions and the maintenance of current production levels. However, DeBeers has informed the Company and the Ghanaian Government that it will be withdrawing from the project later this year stating its belief that the cost of its participation will likely outweigh the economic potential it may realize. The Company anticipates maintaining its position as marketing agent and plans to seek another mining company to replace DeBeers in this project, however, should the Company not be able to maintain its position as marketing agent its ability to recoup certain pre-operating costs may not be assured.\nIn 1990, the Company and the Government of the Republic of Botswana, through its Ministry of Mineral Resources and Water Affairs, reached a long term agreement for the establishment of a diamond cutting and polishing factory in Botswana. In 1992, the Government issued to the Company a long term license for the construction and operation of the facility. On August 31, 1994, the Botswana Development Corporation ('BDC') made an investment in Lazare Kaplan Botswana (Pty) Limited. As a result of that investment, Lazare Kaplan Botswana (Pty) Limited is owned by the Company (60%), the Government of Botswana (5.1%) and the Botswana Development Corporation (34.9%). Lazare Kaplan Botswana moved into its new permanent manufacturing facility in January 1993, which it owns and operates in Molepolole, Botswana. The factory is a state-of-the-art facility using both automated and manual equipment, and will ultimately employ 500 skilled employees. The facility currently operates with approximately 463 local employee\/trainees and 14 expatriates. Lazare Kaplan Botswana has been given its own sight allocation from the DTC from which it selects rough diamonds for manufacture in its facility. Botswana is widely regarded today as the most important rough gem diamond producing country in the world.\nIn December 1994 the Company reached an agreement with the National Diamond Company of Angola, Endiama, U.E.E., pursuant to which the Company may purchase rough diamonds from local Angolan suppliers and export such diamonds for resale. The agreement entitles the Company to establish buying offices in Angola, the first of which has been set up in Luanda, the capital of Angola. The Company intends to establish additional buying offices in the future. The agreement will run for a renewable term of 5 years.\nPolished Diamonds\nIn addition to its purchase of rough diamonds, the Company also purchases polished diamonds from a number of sources. These diamonds are purchased with the intention either to resell them or to recut them to ideal proportions at the Company's manufacturing facility in Puerto Rico.\nAvailability of Sources of Supply\nThe Company believes that it has good relations with its suppliers, that its trade reputation and established customer base will continue to assure access to primary sources of diamonds and that its sources of supply are sufficient to enable the Company to meet its present and foreseeable needs. However, the\nCompany's sources of supply could be affected by political and economic developments over which the Company has no control. While the Company believes that alternative sources of supply may be available, any significant disruption of the Company's access to its primary source suppliers could have a material adverse effect on its ability to purchase rough diamonds.\nCutting and Polishing\nThe Company has two primary cutting and polishing operations: Lazare Kaplan Puerto Rico, located in Puerto Rico and Lazare Kaplan Botswana (Pty) Ltd., located in Botswana. In addition, the Company recently began a diamond polishing effort in cooperation with Roskomdragmet, the Russian Government organization responsible for diamond policy. Under this arrangement, rough diamonds supplied by Roskomdragmet are polished by Russian technicians in Moscow, supervised by Company technical personnel and marketed by the Company. The diamonds, which are non-ideal cut, commercial quality diamonds, are sold through the Company's worldwide distribution network.\nThe Company's factory in Puerto Rico is believed to be the largest cutting facility in the United States. Each stone received in Puerto Rico is evaluated against strict management standards designed to maximize its potential economic contribution to the Company. Expert technicians, assisted by proprietary computer software, determine whether to cut the stone to ideal proportions, cut the stone as a commercial diamond or resell the stone as rough. The shape of the rough stone, its color and clarity and overall potential economic contribution, are among the criteria used in making such determinations. The Company has an incentive program that rewards its factory managers and supervisors based on maximizing the manufactured results of the following criteria: gross margin, yield (rough weight to polished weight conversion) and efficiency.\nRough stones selected for cutting are analyzed and where desirable are sorted for sawing or cleaving to achieve the desired shape and to eliminate imperfections. They are then cut and polished into finished gems. Each finished ideal cut gemstone (weighing .18 carats and larger) which is marketed as a Lazare Diamond is then inscribed with the Lazare Kaplan logo and its own identification number by the Company's patented laser inscription process. All of these operations are performed by the Company's employees. The Company believes its work force in Puerto Rico is the most highly skilled in the diamond industry. The Company has undertaken a worker training program at its facility in Puerto Rico to ensure a constant flow of skilled labor to satisfy its needs for further growth.\nThe Lazare Kaplan Botswana diamond cutting and polishing factory in Molepolole, Botswana began operations in its newly constructed facility in early 1993. The factory, which is a state-of-the-art facility, uses both automated and manual equipment and is committed to train and employ Batswana workers. The Company expects to employ up to 500 skilled technicians at the facility. As of July 31, 1995, there were 477 employees, of which 116 were trainees.\nThis new factory cuts and polishes rough diamonds to ideal proportions in sizes which are presently not processed by the Company's facility in Puerto Rico. The factory, which is still in the beginning stages, is concentrating on the manufacture of rough stones of somewhat smaller size. The size range manufactured will be expanded as the skills of its employees are developed. Lazare Kaplan Botswana purchases rough on its own account directly from the DTC for manufacture in the Botswana factory.\nThe Company believes that it is recognized in the diamond industry for the high quality and brilliance of the gems it cuts and that it also enjoys a reputation as an imaginative and innovative cutter of large and difficult stones.\nPricing\nRough Diamond Prices\nThrough its control of approximately 80% of the world diamond output, the DTC can exert significant control over the pricing of rough and polished diamonds to maintain an orderly market by adjusting supplies in the marketplace. Rough diamond prices established by the DTC have been characterized historically by steady increases over the long term; however, prices in the secondary market have experienced a greater degree of volatility, particularly during the late 1970's. Traditionally, the Company has been able to pass along such price increases to its customers. From time to time, however, the Company has absorbed these price increases in the short term to maintain an orderly pricing relationship with its customers. This has, in the past, caused temporary adverse effects on the Company's earnings. However, a large rapid increase in rough diamond prices could adversely affect the Company's revenue and operating margins if the increased cost of rough diamonds could not be passed along to its customers in a timely manner.\nPolished Diamond Prices\nOver the past 60 years, increases in the price of rough diamonds have generally resulted in a corresponding increase in the price of polished diamonds. During the period of high inflation in the late 1970's, investors speculated in hard assets, driving polished diamond prices to exceptionally high levels which in turn caused significant increases in the cost of rough diamonds. However, the moderation of inflation during the 1980's resulted in a sudden and massive shift of investments from hard assets to financial instruments, resulting in dramatic price declines for polished diamonds which caused a market liquidity crisis as prices of some categories of polished diamonds fell below the inventory costs of such diamonds. Since this period in the early 1980's, the Company believes the pricing of polished diamonds has returned to its historical pattern of responding to increases in the pricing of rough diamonds. However, there can be no assurance that volatility in the price of polished diamonds could not occur again. Any rapid decrease in the price of polished diamonds could have a material adverse effect on the Company in terms of inventory losses, lower sales and lower margins.\nThe Company has implemented strict inventory, pricing and purchasing controls which it believes could lessen the impact of fluctuations in the price of rough and polished diamonds. These include computerized rough stone evaluation programs, automatic economic order quantity models and inventory utilization programs.\nMarketing, Sales and Distribution\nMarketing Strategy\nThe Company's sales strategy is directed primarily toward quality conscious consumers throughout the United States, the Pacific Rim and Europe. The Company generally sells to select retail jewelers in each geographic market in order to maintain an image of selectivity and prestige consistent with its overall marketing strategy. The Company also sells to certain jewelry and diamond manufacturers and wholesalers. The Company has developed a comprehensive grading system for its diamonds which allows jewelers to order inventory by category rather than through the more cumbersome process of visual selection. In addition, the Company designs, manufactures and sells a line of high quality jewelry which features Lazare Diamonds.\nA key element of the Company's strategy is the promotion of the Lazare Diamonds brand name directly to consumers. The Company believes that ideal cutting presents a clear competitive advantage over other diamonds in the marketplace by providing the Company with the opportunity to establish a brand name and to market its diamonds under this name through retailers. The Company's decision to pursue the brand name strategy is reinforced by two factors - a rising trend among informed consumers to purchase quality, brand name products, and the need among upscale jewelers to set themselves apart in an increasingly competitive market by carrying and promoting a highly differentiated product. Each Lazare Diamond is inscribed with the Company's logo and identification number using the Company's unique laser inscription process, thus authenticating the diamond as a Lazare Diamond. This 'labelling' enables the Company to pursue the brand name diamond strategy. The Company holds various domestic and international patents for this process.\nBuilding awareness and acceptance of Lazare Diamonds is accomplished through a comprehensive marketing program which includes co-op advertising, sales promotion and public relations. The advertising includes a toll-free number which consumers may call to receive additional information about the product and to be referred to jewelers carrying Lazare Diamonds and Lazare Diamond jewelry in their geographic area. A wide assortment of sales promotion materials has been designed to facilitate jewelers' sales of the Company's diamonds and fine jewelry line to consumers. Public relations events are offered which help build traffic in retail stores. The Company believes these marketing programs have been and will continue to be instrumental in increasing sales. The Company does not intend to sell its diamonds directly to consumers and plans to continue concentrating its marketing efforts towards the quality retail jeweler.\nThe Lazare Diamond Registry program has been established by the Company to enable consumers to register their Lazare Diamonds with the Company using the laser inscribed identification number, thereby providing proof of ownership in case of loss or theft.\nWhile the purchase and sale of rough diamonds is concentrated among relatively few parties, industry wide retailing of polished diamonds occurs through over 39,000 jewelry stores in the United States, over 26,000 retailers in Japan and over 48,000 retail stores in Europe. The Company's efforts for its polished diamonds are directed primarily toward the fine quality segment of these retailers (the majority of which are independently owned and operated) and, to a lesser extent, to jewelry manufacturers and wholesalers. Full time regional sales representatives located throughout the United States and in Hong Kong and Antwerp, who are compensated on a commission basis, handle sales throughout the United States, the Pacific Rim and Europe.\nThe Company's sales force is supported by a New York based telemarketing department. Sales to certain of the Company's largest accounts are handled by headquarters personnel. Most of the Company's major accounts are customers of long standing.\nThe Company has been expanding its activities abroad, particularly in the Pacific Rim countries of Japan, Hong Kong, Singapore, Taiwan, Thailand, Korea, Malaysia, Indonesia and Brunei. In Japan, the Company has had a marketing relationship since 1972 with Aiwa Co., Ltd., the Japanese importer-marketer of Lazare Diamonds. Aiwa Co., with a distribution network of over 200 retailers and wholesalers, is an important customer of the Company's polished diamonds. Additionally, the Company continues to believe there is significant growth opportunity in the European market and has expanded in this area.\nThe Company uses a comprehensive sorting and inventory classification system for grading color and clarity of its ideal cut polished diamonds. This system, combined with the fact that the Company's stones are uniformly cut to ideal proportions, reduces and in some cases eliminates the need for customers to view stones before placing orders. The system enables customers to standardize their inventories, order by mail or telephone and minimize their inventory investment.\nThe percentages of the Company's total domestic and foreign net sales to its customers, which include a combination of both rough diamonds and polished diamonds sales taken together, for the past three fiscal years are set forth below:\nThe domestic sales increase in 1995 as compared to the prior two years was a result of the decrease in rough diamond sales in 1995 as compared to 1994 and 1993. Historically, the majority of the Company's rough diamond sales have been to foreign customers. The Company believes that due to the possible international resale of diamonds by its customers, the above percentages may not represent the final location of retail sales of its product. As all foreign sales are denominated in United States dollars, the Company does not experience any foreign currency exposure on its foreign revenue. A portion of all foreign polished sales are accompanied by bank guarantees or are shipped on a C.O.D. basis. The profitability of foreign sales of either polished or rough diamonds is consistent with that of domestic sales of similar merchandise.\nCompetition\nThe polished and rough diamond business is highly competitive. While the Company believes that it has achieved a reputation as a leading cutter and distributor of high quality diamonds, it faces competition in sales to its customers in the United States and abroad from many other suppliers. A substantial number of cutters and merchants, some of which the Company believes to be larger or to have greater financial resources than the Company, sell diamonds of all qualities to the Company's customers. The Company also sells rough diamonds, primarily through its Antwerp office, in the competitive world market.\nThe Company believes there are significant barriers to entry by potential competitors into the business of manufacturing ideally proportioned diamonds. Among the most important of these barriers are the need for significant capital, the limited number of persons with the skills necessary to cut ideally proportioned diamonds, the difficulty in obtaining access to upscale channels of distribution, the importance of public recognition of an established brand name and the establishment of computer systems to gauge and monitor the manufacturing and distribution network.\nEmployees\nAt July 31, 1995, the Company had 658 full-time employees, which includes 116 trainees in Botswana. The Company also has 7 regional sales representatives. The Company maintains an apprenticeship program at its facilities in Caguas, Puerto Rico, through which it trains its cutters, who are highly skilled workmen. The Company also has a program in Botswana through which it trains cutters and polishers to work at the Company's new facility. The Company provides paid vacations, sick leave, group life, disability, hospitalization and medical insurance for its employees. The Company has a 401(k) plan for its U.S. and Puerto Rico employees. The Company believes that it has satisfactory relationships with its employees. None of the Company's employees is represented by a union.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company leases office space, a portion of which is devoted to sales rooms, at 529 Fifth Avenue, New York City, for a term expiring September 30, 2003 at an annual rental rate of approximately $278,000 (subject to escalations). The Company also subleases space at the same address to LTS for a like term at a rental rate per square foot which is the same as the Company is paying to the landlord.\nThe Company also owns a manufacturing facility in Caguas, Puerto Rico. The Caguas facility consists of approximately 7,500 square feet.\nThe Company leases office space in Antwerp, Belgium for a term expiring May 31, 2003 at an annual rental rate of approximately $53,000 (1,500,000 Belgian francs).\nThe Company also has a 40% ownership interest in a 330 square meter office in Antwerp, Belgium, a portion of which is devoted to sales rooms.\nThe Company leases office space in Hong Kong for a term expiring April 30, 1997 at an annual rental rate of approximately $67,000 (514,800 Hong Kong dollars).\nThe Company leases land in Botswana for a nominal amount for a term of fifty years with the right to renew for an additional fifty years. The Company has constructed its cutting and polishing factory on such land. The facility is approximately 4,300 square meters.\nThe Company believes that its facilities are fully equipped and adequate to fulfill its operating and manufacturing needs.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe Company is not involved in any significant legal proceedings.\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 information regarding executive officers of the Company.\nAll officers were elected at the Annual Meeting of the Board of Directors held in November 1994, and hold office until the next Annual Meeting of the Board of Directors and until their respective successors have been duly elected and qualified.\nMaurice Tempelsman, Chairman of the Board and a director of the Company, is a general partner of Leon Tempelsman & Son, a partnership with interests in the international diamond and mining industries, positions he has held since 1984. Maurice Tempelsman is the father of Leon Tempelsman and the father-in-law of Robert Speisman.\nLeon Tempelsman, Vice Chairman of the Board, President and a director of the Company, is a general partner of Leon Tempelsman & Son, positions he has held since 1984. Leon Tempelsman is the son of Maurice Tempelsman and the brother-in-law of Robert Speisman.\nThe Company believes that neither the Tempelsmans nor LTS currently engages directly or indirectly in any activities competitive with those of the Company.\nGeorge R. Kaplan has been Vice Chairman of the Board since 1984 and a director of the Company since 1972.\nSheldon L. Ginsberg has been Vice President and Chief Financial Officer since April 1991. He was the Vice President-Finance from January 1986 until April 1991. Mr. Ginsberg has been a director of the Company since 1989.\nRobert Speisman has been the Vice President - Sales of the Company since 1986. Mr. Speisman has been a director of the Company since 1989. Mr. Speisman is the son-in-law of Maurice Tempelsman and the brother-in-law of Leon Tempelsman.\nPart II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters\nThe Registrant's common stock (par value $1 per share) is traded on the American Stock Exchange.\nMarket prices and other information with respect to the Registrant's common stock are hereby incorporated by reference from page 1 of the Registrant's Annual Report.\nItem 6.","section_6":"Item 6. Selected Financial Data\nSelected financial data are hereby incorporated by reference from page 4 of the Registrant's Annual 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 financial condition and results of operations is hereby incorporated by reference from pages 5 to 7 of the Registrant's Annual Report.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\n(a) The following financial statements and supplementary data are hereby incorporated by reference from pages 8 to 18 of the Registrant's Annual Report.\n(i) Report of Ernst & Young LLP\n(ii) Consolidated Statements of Operations for each of the three years in the period ended May 31, 1995.\n(iii) Consolidated Statements of Stockholders' Equity for each of the three years in the period ended May 31, 1995.\n(iv) Consolidated Balance Sheets as at May 31, 1995 and May 31, 1994.\n(v) Consolidated Statements of Cash Flows for each of the three years in the period ended May 31, 1995.\n(vi) Notes to Consolidated Financial Statements.\n(b) Report on Financial Statements and Financial Statement Schedule of Deloitte & Touche LLP for each of the two years in the period ended May 31, 1994.\nINDEPENDENT AUDITORS' REPORT\nBoard of Directors and Stockholders Lazare Kaplan International Inc.\nWe have audited the accompanying consolidated balance sheet of Lazare Kaplan International Inc. and subsidiaries as of May 31, 1994, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the two years in the period ended May 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 Lazare Kaplan International Inc. and subsidiaries at May 31, 1994, and the results of their operations and their cash flows for each of the two years in the period ended May 31, 1994 in conformity with generally accepted accounting principles. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.\nDELOITTE & TOUCHE LLP\nNew York, New York July 13, 1994 (August 31, 1994 as to note 11)\nItem 9.","section_9":"Item 9. Change in and Disagreements with Accountants on Accounting and Financial Disclosure\nDuring the fiscal year ended May 31, 1994, the Board of Directors of the Company considered changing the Company's independent certified public accountants and, effective September 16, 1994, Ernst & Young LLP was appointed in replacement of Deloitte & Touche LLP to serve as the Company's independent certified public accountants for the Company's fiscal year ending May 31, 1995. In connection with the audits of the two most recent fiscal years of the Company and all subsequent interim periods preceding such dismissal, there was no disagreement between the Company and Deloitte & Touche LLP 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 Deloitte & Touche LLP would have caused them to make reference thereto in their report on the financial statements for such period. The reports of Deloitte & Touche LLP for such period did not contain an adverse opinion or disclaimer of opinion nor were they qualified as to uncertainty, audit scope, or accounting principles. The decision to replace Deloitte & Touche LLP with Ernst & Young LLP as the Company's independent certified accountants was unanimously approved by the Audit Committee of the Board of Directors of the Company and ratified by the stockholders of the Company at the 1994 Annual Meeting of Stockholders.\nPart III\nExcept for information regarding Executive Officers of the Registrant, which, in accordance with Instruction G to Form 10-K, is included in Part I hereof, the information called for by Part III (Items 10, 11, 12 and 13) is incorporated by reference herein from the Registrant's definitive proxy statement to be filed with the Commission within 120 days after the close of its fiscal year ended May 31, 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. The response to this portion of Item 14 is set forth in Item 8 of Part II hereof.\n2. Financial Statement Schedules\nReport on Financial Statement Schedule and Consent of Ernst & Young LLP for the year ended May 31, 1995\nReport on Financial Statements and Financial Statement Schedule of Deloitte & Touche LLP for each of the two years in the period ended May 31, 1994 (included in their report filed under Item 8(b) of this Report on Form 10-K).\nSchedule VIII - Valuation and Qualifying Accounts\nAll other schedules are omitted because they are not applicable, or not required, or because the required information is included in the consolidated financial statements or notes thereto.\nREPORT AND CONSENT OF INDEPENDENT AUDITORS\nWe have audited the consolidated financial statements of Lazare Kaplan International Inc. and subsidiaries as of May 31, 1995, and for the year then ended, and have issued our report thereon dated July 12, 1995 (August 25, 1995 as to Note 6); such consolidated financial statements and report are included in the Company's 1995 Annual Report to Stockholders and are incorporated herein by reference. Our audit also included the consolidated financial statement schedule of Lazare Kaplan International Inc. and subsidiaries for the year ended May 31, 1995, listed in the accompanying index at Item 14(a)(2). This consolidated financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audit. In our opinion, this consolidated financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects, the information set forth therein.\nWe consent to the incorporation by reference in Registration Statement No. 33-20528 of Lazare Kaplan International Inc. on Form S-8, of our reports dated July 12, 1995 (August 25, 1995 as to Note 6), with respect to the consolidated financial statements and schedule of Lazare Kaplan International Inc. included and incorporated by reference in the Annual Report on Form 10-K for the year ended May 31, 1995.\nErnst & Young LLP New York, New York August 25, 1995\nLAZARE KAPLAN INTERNATIONAL INC.\nAND SUBSIDIARIES\nSCHEDULE VIII-VALUATION AND QUALIFYING ACCOUNTS\n(A) Recoveries of previously written off accounts\n(B) Adjustments to reserve balance\n(C) Amounts written off\n(b) Reports on Form 8-K - No reports on Form 8-K were filed during the fourth quarter of the fiscal year ended May 31, 1995.\n(c) Exhibits\n(3) (a) Certificate of Incorporation, as amended - incorporated herein by reference to Exhibit 3(a) to Report on Form 10-K of the Registrant for the fiscal year ended May 31, 1987 filed with the Commission on August 26, 1987, as amended on January 14, 1988.\n(b) Certificate of Amendment of Certificate of Incorporation filed with the Secretary of State of the State of Delaware on November 1, 1990 - incorporated herein by reference to Exhibit (3)(b) to Report on Form 10-K of the Registrant for the fiscal year ended May 31, 1992 filed with the Commission on August 28, 1992.\n(c) By-laws, as amended - incorporated herein by reference to Exhibit 3(b) to Report on Form 10-K of the Registrant for the fiscal year ended May 31, 1987 filed with the Commission on August 26, 1987, as amended on January 14, 1988.\n(10) Material Contracts\n(a) Lazare Kaplan International Inc. Amended and Restated 1988 Stock Option Incentive Plan - incorporated herein by reference to Exhibit 4.1 to Registration Statement on Form S-8 of the Registrant filed with the Commission on November 5, 1990.\n(b) Note Agreement dated as of May 15, 1991 by and between the Registrant, Allstate Life Insurance Company, Monumental Insurance Company and PFL Life Insurance Company - incorporated herein by reference to Exhibit 28 to Report on Form 8-K dated May 23, 1991 filed with the Commission on June 4, 1991.\n(c) First Amendment to Note Agreement, dated as of February 28, 1992, by and between the Registrant, Allstate Life Insurance Company, Monumental Life Insurance Company and PFL Life Insurance Company incorporated herein by reference to Exhibit 10(d) to Report on Form 10-K of the Registrant for the fiscal year ended May 31, 1992 filed with the Commission on August 28, 1992.\n(d) Second Amendment to Note Agreement, dated as of March 25, 1992 by and between the Registrant, Allstate Life Insurance Company, Monumental Life Insurance Company and PFL Life Insurance Company incorporated herein by reference to Exhibit 10(e) to Report on Form 10-K of the Registrant for the fiscal year ended May 31, 1992 filed with the Commission on August 28, 1992.\n(e) Third Amendment to the Note Agreement, dated as of December 1, 1992 by and between the Registrant, Allstate Life Insurance Company, Monumental Life Insurance Company and PFL Life Insurance Company incorporated herein by reference to Exhibit 10(f) to Report on Form 10-K of the Registrant for the fiscal year ended May 31, 1993 filed with the Commission on August 30, 1993.\n(f) Agreement, dated December 5, 1990, by and between the Registrant and the Government of the Republic of Botswana - incorporated herein by reference to Exhibit 10(f) to Report on Form 10-K of the Registrant for the fiscal year ended May 31, 1992 filed with the Commission on August 28, 1992.\n(g) Subscription Agreement, dated August 24, 1994 among the Registrant and the Botswana Development Corporation incorporated herein by reference to Exhibit 10(h) to Report on Form 10-K of the Registrant for the fiscal year ended May 31, 1994 filed with the Commission on August 31, 1994.\n(13) 1995 Annual Report to Security Holders - incorporated herein by reference to the 1995 Annual Report to Stockholders of the Registrant to be filed with the Commission. (21) Subsidiaries\n(24)(a) Consent of Deloitte & Touche LLP\n(24)(b) Consent of Ernst & Young LLP (Included in their report filed under Item (14)(a)(2) of this 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.\nLAZARE KAPLAN INTERNATIONAL INC.\nBy\/s\/ Leon Tempelsman ---------------------------- Leon Tempelsman, Vice Chairman and President (principal executive officer)\nBy\/s\/ Sheldon L. Ginsberg ---------------------------- Sheldon L. Ginsberg, Vice President and Chief Financial Officer (principal financial officer)\nDated: August 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.\nLAZARE KAPLAN INTERNATIONAL INC.\nANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934\nFor the fiscal year ended Commission File No. 1-7848 May 31, 1995\nEXHIBIT INDEX\nExhibit Page No. ------- -------- (3) (a) Certificate of Incorporation, as amended - incorporated herein by reference to Exhibit 3(a) to Report on Form 10-K of the Registrant for the fiscal year ended May 31, 1987 filed with the Commission on August 26, 1987, as amended on January 14, 1988.\n(b) Certificate of Amendment of Certificate of Incorporation filed with the Secretary of State of the State of Delaware on November 1, 1990 - incorporated herein by reference to Exhibit (3)(b) to Report on Form 10-K of the Registrant for the fiscal year ended May 31, 1992 filed with the Commission on August 28, 1992.\n(c) By-laws, as amended - incorporated herein by reference to Exhibit 3(b) to Report on Form 10-K of the Registrant for the fiscal year ended May 31, 1987 filed with the Commission on August 26, 1987, as amended on January 14, 1988.\n(10) Material Contracts\n(a) Lazare Kaplan International Inc. Amended and Restated 1988 Stock Option Incentive Plan - incorporated herein by reference to Exhibit 4.1 to Registration Statement on Form S-8 of the Registrant filed with the Commission on November 5, 1990.\nExhibit Page No. ------- --------\n(b) Note Agreement dated as of May 15, 1991 by and between the Registrant, Allstate Life Insurance Company, Monumental Insurance Company and PFL Life Insurance Company - incorporated herein by reference to Exhibit 28 to Report on Form 8-K dated May 23, 1991 filed with the Commission on June 4, 1991.\n(c) First Amendment to Note Agreement, dated as of February 28, 1992, by and between the Registrant, Allstate Life Insurance Company, Monumental Life Insurance Company and PFL Life Insurance Company incorporated herein by reference to Exhibit 10(d) to Report on Form 10-K of the Registrant for the fiscal year ended May 31, 1992 filed with the Commission on August 28, 1992.\n(d) Second Amendment to Note Agreement, dated as of March 25, 1992 by and between the Registrant, Allstate Life Insurance Company, Monumental Life Insurance Company and PFL Life Insurance Company incorporated herein by reference to Exhibit 10(e) to Report on Form 10-K of the Registrant for the fiscal year ended May 31, 1992 filed with the Commission on August 28, 1992.\n(e) Third Amendment to the Note Agreement, dated as of December 1, 1992 by and between the Registrant, Allstate Life Insurance Company, Monumental Life Insurance Company and PFL Life Insurance Company incorporated herein by reference to Exhibit 10(f) to Report of Form 10-K of the Registrant for the fiscal year ended May 31, 1993 filed with the Commission on August 30, 1993.\nExhibit Page No. ------- --------\n(f) Agreement, dated December 5, 1990, by and between the Registrant and the Government of the Republic of Botswana - incorporated herein by reference to Exhibit 10(f) to Report on Form 10-K of the Registrant for the fiscal year ended May 31, 1992 filed with the Commission on August 28, 1992.\n(g) Subscription Agreement, dated August 24, 1994 among the Registrant and the Botswana Development Corporation incorporated herein by reference to Exhibit 10(h) to Report on Form 10-K of the Registrant for the fiscal year ended May 31, 1994 filed with the Commission on August 31, 1994.\n(13) 1995 Annual Report to Security Holders - incorporated herein by reference to the 1995 Annual Report to Stock holders of the Registrant to be filed with the Commission. 26\n(21) Subsidiaries 46\n(24)(a) Consent of Deloitte & Touche LLP. 47\n(24)(b) Consent of Ernst & Young LLP (included in their report filed under Item (14)(a)(2) of this Report on Form 10-K).","section_15":""}
{"filename":"822076_1995.txt","cik":"822076","year":"1995","section_1":"Item 1. BUSINESS\nGENERAL\nThe Registrant (\"Company\") is a multi-store retail chain engaged in the retail sales and service of recreational vehicles (\"RV's) and recreational boats. The Company currently operates eight sales and service dealerships, one in the heart of the Walt Disney World tourist area in Orlando, Florida, two in the Gulf Coast tourist areas of Tampa and Ft. Myers, Florida, one in Atlanta, Georgia adjacent to Interstate 75, one in Greer, South Carolina adjacent to Interstate 85, two in California's central valley cities of Sacramento and Bakersfield and one adjacent to Interstate 10 in Las Cruces, New Mexico. The Las Cruces facility was purchased in October, 1995.\nAll dealerships offer a full line of both new and used recreational vehicles and maintain full parts and service facilities, body repair shops and are equipped to repair virtually any type of recreational vehicle. The Greer and Las Cruces dealerships sell and service boats and related marine products.\nRECREATIONAL VEHICLE INDUSTRY\nThe recreational vehicle industry is approximately a $14.5 billion dollar a year industry in the United States, (Recreational Vehicle Industry Association, \"RVIA\", Reston, Virginia), catering to the travel and leisure-time needs of the general public through the sale and service of recreational vehicles. According to the RVIA, (RV TRADE DIGEST, December 1995) 441,000 new RVs were shipped by manufacturers to dealers in 1994 compared to 420,200 RVs in 1993 and 389,400 in 1992. Industry shipment peaked in 1976 through 1978 with 526,000 to 534,000 units.\nOne in ten American families own a recreational vehicle in the United States, and over 20,000 public and privately owned campgrounds operate nationwide, according to the RVIA, (RV TRADE DIGEST, October, 1992). There are over 9 million RVs on the road and an estimated 25 million Americans travel in RVs (RVIA). According to the US Census Bureau, there were 2,648 RV dealers in the U.S. in 1992 (RVDA News, September 1995).\nThe types of recreational vehicles sold by the company consist primarily of travel trailers and fifth wheels, designed to be towed by another vehicle, and motorized self-propelled units, built on automotive chassis (motorized vehicles).\nTowable recreational vehicles consist of travel trailers, including fifth wheel travel trailers, folding camping trailers and truck campers (a recreational camping unit designed to be loaded\non to, or affixed to, the bed or chassis of a truck). Motorized recreational vehicles consist of conventional motor homes (Class \"A\"), van campers (Class \"B\"), mini motor homes, low profile motor homes and compact motor homes (all referred to as Class \"C\") and van conversions. Class \"A\" motor homes are constructed by the recreational vehicle manufacturer on chassis that already have the engine and drive components. Van campers (Class \"B\") are panel type vans to which the recreational vehicle manufacturer adds sleeping facilities, kitchen and toilet facilities, fresh water storage, 110 volt hook up and other items. Class \"C\" units are built on an automotive manufactured van frame with an attached cab section, or on an automotive manufactured cab and chassis. The recreational vehicle manufacturer completes the body section containing the living area and attaches it to the cab section. For the van conversion, the recreational vehicle manufacturer modifies a completed van chassis aesthetically or decoratively in appearance for transportation and recreational purposes.\nCurrently, there are many manufacturers of both towable and motorized recreational vehicles. Although there are several sources for manufactured conventional vans including Ford, GMC, and Chrysler, Japanese imports and other foreign manufacturers, there are only four major manufacturers in the United States supplying chassis with engine and drive components to the recreational vehicle manufacturers: General Motors Company, Ford Motor Company, Oshkosh Truck Corporation and Spartan Motors Corporation. General Motors Company is the largest supplier of chassis to RV manufacturers.\nFuel consumption for motorized recreational vehicles has improved substantially over the last several years. Diesel engines are growing in popularity over gasoline engines, primarily in the larger vehicles.\nMARKETING\nADVERTISING AND PROMOTIONS. The Company has a year around advertising campaign utilizing newspaper, direct mail, billboards, yellow pages, and consumer magazine advertising. The advertising program is supplemented by on-lot promotions and off-lot consumer shows, organized by trade groups and private companies, primarily during the peak selling season. The Company participates in 20 to 25 consumer RV shows annually, attended by up to 40,000 consumers each. Smaller product shows are also promoted by the company at RV parks where by existing RV owners are targeted for \"trade-ups\" selling opportunities. The Company utilizes the services of a professional marketing firm to assist in implementing their advertising and promotion campaign.\nThe Company's Management believes that the Company was the first recreational vehicle retailer to promote sales through a national tele-marketing sales program. The Company promotes several recreational vehicle clubs and rallies for owners and prospective owners of recreational vehicles.\nPRICING. The Company's Management believes that pricing is an important element of its marketing strategy and occasionally makes volume purchases at reduced prices from some manufacturers. These purchases enable the Company to advertise and achieve a competitive pricing position over many of its competitors.\nCUSTOMER BASE. The Company's customer base demographic characteristics vary from dealership to dealership but primarily are represented as the following. The age group of 35 years and older represent 82% of the customers, with ages 45 and older representing 58%. Eighty six percent (86%) are married, 49% are retired, 21% have \"blue collar\" occupations, and 30% are \"white collar\" and professionals. The primary income group is $20,000 to $40,000 comprising 53%. Twenty six percent (26%) earn $40,000 to $60,000, and 10% earn over $60,000. Sixty two percent (62%) of the customers are prior owners of RVs, and 63% need to trade their RV, automobile or boat to make a purchase.\nIn summary, the Company's primary customer base is 45 years old or older, retired, earns between $20,000 and $40,000 annually, is a previous owner of an RV needing to trade to make a purchase.\nDEALERSHIP OPERATIONS\nThe Company, previously Holiday of Orlando, Inc., was incorporated in July 1978, in the State of Florida. In 1984, a second dealership was opened in Tampa, Florida, to sell and service new and used RVs. In 1988, the Company opened three new sales and service dealerships, one in Ft. Myers, Florida, one in Jacksonville, Florida and the third in Atlanta, Georgia. The Atlanta dealership operates as Holiday RV Superstores of South Atlanta, Inc.\nIn February 1990, the Company formed Holiday RV Superstores of South Carolina, Inc. which acquired an existing dealership in Greer, South Carolina formally, operating as Ledford's RV and Marine World.\nFrom October 1992 through January 1993 the Company operated a temporary sales location in Homestead, Florida, marketing travel trailers to the victims of Hurricane Andrew needing temporary housing. In December of 1992, the Jacksonville, Florida dealership was closed.\nIn January 1994, the Company formed Holiday RV Superstores West, Inc. which acquired two existing dealerships located in Bakersfield and Roseville (Sacramento), California, formerly operating as Venture Out, and an office location in Campbell, California. The Campbell office closed in November, 1995.\nIn September 1995, the Company formed Holiday RV Superstores of New Mexico, Inc. which acquired a vacant RV dealership facility in Las Cruces, New Mexico. The dealership began operations in November of 1995.\nThe Company currently markets approximately 40 brands of recreational vehicles and 10 brands of recreational boats. The Company purchases 79% or more of its new recreational vehicles from Fleetwood Enterprises Inc., and Thor Industries, Inc. In addition, the Company sells new recreational vehicles and recreational boats purchased from a number of other manufacturers including Winnebago Industries, Cobra Industries, Bayliner Marine Corporation, and Coachmen Industries, Inc. In the opinion of Management, the loss of any one brand of new recreational vehicle would not materially affect the Company. However, the loss of all the\nbrands sold by either of the two largest manufacturers, i.e. Fleetwood Enterprises, Inc., or Thor Industries, Inc., would have a material effect on the Company's sales. The Company's Management feels the loss of all brands from either of these two manufacturers to be highly unlikely. Dealer representation decisions for Fleetwood Enterprises, Inc. and Thor Industries, Inc. manufactured brands are made at the manufacturer's plants on a brand-by-brand basis, rather than centrally at each respective company's corporate headquarters.\nMANUFACTURERS REPURCHASE AGREEMENTS TO COMPANY'S FLOOR PLAN CREDITORS\nSubstantially all new vehicles and boats held in inventory for sale are pledged as security under floor plan contracts with financial institutions. Under such contracts, the sale of a pledged vehicle to a consumer requires payment to the lender of the amount attributable to such vehicle under the floor plan contract. Manufacturers have their respective repurchase agreements in force with the commercial lending institutions with limited repurchase indemnification to the lenders against any Company default under the floor plan contracts.\nSERVICE AND PARTS\nThe Company maintains fully equipped service facilities equipped to handle virtually any type of recreational vehicle. The Company is a factory designated chassis warranty service center for Gillig, Chevrolet Division of General Motors, and Oshkosh, who reimburse the Company for such warranty services. The Greer and Las Cruces facilities are fully equipped to repair all brands of boats and motors it sells.\nThe Company's service facilities are equipped to make engine and drive train repairs, as well as repairs to refrigerators, ovens and ranges, air conditioning systems, plumbing and electrical systems of each recreational vehicle it sells. In addition, the Company is an authorized service center for most manufacturers of recreational vehicle components, including generators, roof air conditioners, refrigerators, heaters, ovens and ranges (including microwave ovens), hot water heaters, toilets, furnaces, furniture, ice makers, awnings, TV antennas, metal framing, water pumps, hitches, suspension systems, brakes, windows and axles used in recreational vehicles sold and serviced by the Company. The Company's service and repair facilities are also used by commercial customers, including the Federal Emergency Management Agency of the United States Government (FEMA), Lockheed Martin Aerospace Corporation, Sea World, Walt Disney World, Universal Studios in Florida and the Department of Defense.\nThe Company maintains service agreements with those companies whose new recreational vehicles and marine products it sells at retail. These service agreements allow the Company to purchase parts and obtain technical assistance needed to repair and service vehicles, boats and equipment manufactured by these companies. The Company also has a supply of propane gas for resale to recreational vehicle owners for non-chassis use at all locations.\nThe parts departments of each dealership supports the Company's sales and service functions. In addition to a parts inventory department, each dealership stocks accessory items, usually sold to recreational vehicle owners, and maintains a computerized point-of-purchase inventory\ncontrol and customer tracking system. The Greer and Las Cruces dealerships maintain inventories of marine parts and accessories for marine products sold.\nPRINCIPAL PRODUCTS AND SERVICES\nThe Company's principal products and services for the last three years are listed below, by major revenue source, as a percentage of total revenue.\nPrincipal Products or Services as a Percentage of Total Revenue\nEMPLOYEE RELATIONS\nAs of October 31, 1995 and 1994, the Company had 182 and 198 full time employees, respectively. The Company has no contracts or collective bargaining agreements with labor unions and has never experienced work stoppages. The Company's Management considers its relations with employees to be good. The Company maintains internal training programs at every level and has a well developed internal quality control program and customer satisfaction feedback system for all its dealerships. The Company maintains a nation-wide recruitment program for sales, service and management personnel. Support personnel are usually hired from the local labor force. Factory training programs are available to the employees of the Company and the Company generally takes full advantage of these programs by sending its employees to manufacturer supervised schools. Most full time employees are provided with paid annual vacations, medical and hospitalization insurance premium reimbursement, sick leave, paid holidays and other fringe benefits. After one year of employment, employees are eligible to participate in the profit sharing and 401(k) investment plan.\nBUSINESS EXPANSION AND DIVERSIFICATION\nThe Company intends to continue its primary expansion by acquisition of existing compatible businesses. Existing RV dealerships with a minimum annual revenue of $5.0 million will be considered for acquisition. The Company's primarily focus is the Sunbelt areas of the U.S. and\nthe western states. Availability of product lines and dealership location on a major interstate highway is the primary criteria.\nThe Company's expansion plan also includes diversification into a compatible business that would enhance the margins of the Company. The diversified \"targeted business\" would be an acquisition or merger candidate with an existing business, whereby the Company could capitalize on its existing multi-store management structure and utilize its existing financial resources. The Company is also considering vehicle leasing, in-house sub-prime retail financing and \"niche\" market product manufacturing.\nCOMPETITION AND BUSINESS RISK\nBased upon statistics supplied by the Recreational Vehicle Dealers Association, the recreational vehicle industry in North America includes approximately 2,650 retail dealerships nationally. Competition in the sale of new and used recreational vehicles is intense. The Company competes with a large number of firms, some of which operate in more than one location, although most of the Company's competitors operate from a single location. The Company believes it is one of the most competitive RV dealers in the nation offering approximately 50 brands of new recreational vehicles and new boats, supported by extensive service facilities.\nSignificant competitive factors in the recreational vehicle sales and service industry include: vehicle availability, price, service, reliability, quality of service and convenience. The Company's management is of the opinion that it is competitive in all factors listed above. Nevertheless, the Company's management anticipates it will continue to face strong competition in the future.\nThe recreational vehicle business is heavily dependent upon the availability and terms of financing for the retail purchase of its products. Consequently, changes in interest rates and the tightening or loosening of credit by government agencies and financial institutions have dramatically affected the Company's business in the past and are likely to do so in the future.\nINSURANCE\nThe Company has had little difficulty in obtaining insurance coverage for its dealership operations. Such insurance has been obtained by the Company annually on a competitive bid basis, at what it believes to be reasonable premium rates. The applicable premium rates have been increasing slightly, however, Management does not believe that such increases will have a material adverse effect on the business of the Company for the foreseeable future.\nGOVERNMENT REGULATIONS\nThe Company's service facilities are subject to federal, state and local laws and regulations concerning environmental matters. These laws and regulations affect the storing, dispensing and discharge of petroleum based products and other waste, and affect the Company in the securing of permits for its full service dealership operations and in the ongoing conduct of such operations.\nThe securing of permits and compliance with all laws and regulations can be costly, and could affect the Company's earnings. Further, each dealership of the Company must comply with the requirements of local governmental bodies concerning zoning, land use, and environmental factors. State and local laws and regulations also require each dealership to obtain licenses to operate as a dealer in recreational vehicles. The Company has obtained all necessary licenses and permits and Management believes the Company is in full compliance with all federal, state and local laws and regulations. Furthermore, Management is not aware of any material capital expenditures necessary for compliance with any federal, state or local laws and regulations.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nThe Company leases the Orlando dealership from its principal stockholders, officers, and directors, Newton C. Kindlund and Joanne M. Kindlund. The dealership is located one half mile from Interstate 4, on Sand Lake Road and is approximately 2.5 miles from the Interstate 4 entrance to Walt Disney World. These facilities include 30,000 square feet of buildings on approximately 4 acres of land.\nThe Tampa, Florida dealership is owned by the Company and is approximately 3.5 miles from the intersection of Interstate 4 and Interstate 75, on Highway 301. These facilities include 5.2 acres of land with a 13,000 square foot building.\nThe Ft. Myers, Florida dealership is leased from a non-affiliated party. The facility is located six tenths of a mile west of Interstate 75, on the north side of the city and includes 9,700 square feet of buildings on approximately 2.7 acres of land.\nThe Atlanta, Georgia dealership is owned by the Company and is located adjacent to Interstate 75, south of Interstate 285 in Forest Park, Georgia. The facility includes 13,600 square feet of buildings and was expanded in 1995 from 2.2 acres to 5 acres.\nThe Greer, South Carolina dealership is leased from a non-affiliated party. The facility is located adjacent to Interstate 85 between Greenville and Spartanburg, South Carolina. The facility includes a 31,000 square foot building on 9 acres of land.\nThe Roseville, California dealership is subleased from a non-affiliated party. The facility is located adjacent to Interstate 5 and includes 24,000 square feet of buildings on 3.6 acres of land.\nThe Bakersfield, California dealership is owned by the Company and is located adjacent to State Road 99 and includes 17,400 square feet of building on 4.9 acres of land.\nThe Las Cruces, New Mexico dealership is owned by the Company and is located adjacent to Interstate 10. The facility includes 14,000 square feet of building on 7 acres of land.\nThe corporate office is leased from a non-affiliated party and is located approximately one quarter of a mile from the Orlando dealership on Sand Lake Road. The facilities include 3,750 square feet of office and conference room accommodations.\nThe Company believes that its facilities are adequate for the foreseeable future for the business carried on at these locations. Properties at Orlando, Tampa, Fort Myers, and Roseville are being fully utilized. Properties at Greer, Bakersfield and Las Cruces are not being fully utilized and have area for limited expansion\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nThe Company is party to various legal proceedings arising from its ordinary course of operations. The Company's Management believes, based upon the opinion of the Company's legal counsel, none of these proceedings, individually or in the aggregate, will result in a material adverse effect on the Company's consolidated financial position.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matters were submitted during the fourth quarter of the fiscal year covered by this report to a vote of security holders, through the solicitation of proxies or otherwise.\nPART II\nItem 5.","section_5":"Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nMARKET INFORMATION ON COMMON STOCK\nThe Company's common stock trades on The NASDAQ Stock Market, National Market System, under the symbol: \"RVEE\".\nThe table below gives the market high and low sales prices of the Company's common stock for the quarters in the fiscal years ended October 31, 1995 and 1994. The prices were furnished by the NASDAQ Stock Market.\nDIVIDENDS\nNo cash dividends have been paid by the Company nor does the Company anticipate paying cash dividends in the near future.\nHOLDERS OF RECORD\nAs of January 9, 1996, there were 625 holders of record of the Company's Common Stock.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA:\n---------------------------------------------------------------------\n(1) See Management's Discussion and Analysis of Financial Condition and Results of Operations. (2) Includes 400 RVs sold to the Federal Emergency Management Agency for $4.34 million. (3) Cumulative effect of change in accounting for income taxes. (4) The dealerships listed for 1995 include the newly acquired Las Cruces facility which became operational in November 1995.\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company continued to maintain a strong financial position and high liquidity throughout Fiscal 1995. $1.7 million of cash generated from net income and non cash expenses was used to finance other operating activities, primarily inventories not financed by floor plan sources, resulting in net cash provided by operating activities of $116,000.\nThe acquisition of new dealership facilities for the relocation of the Bakersfield, California dealership, acquisition of a dealership in Las Cruces, New Mexico and the expansion of the Atlanta dealership, used $1.8 million cash. The Company's decision to discontinue its rental operation and the sale of its rental fleet generated $472,000, resulting in $1.3 million net cash used for investing activities. The Company has a $1.0 million credit facility available for financing expansion but elected not to use the facility in Fiscal 1995.\nThe net result of all operating, investing and financing activities was the use of $1.23 million of cash, reducing the Company's cash and cash equivalents to $4.01 million as of October 31, 1995 compared to $5.24 million as of October 31, 1994.\nNet working capital increased slightly to $9.4 million as of the end of Fiscal 1995 compared to $9.3 million as of the end of Fiscal 1994.\nThe Company's liquidity ratios continue to compare favorably to the recreational vehicle dealers industry averages, as reported by 1995 Annual Statement Studies, Robert Morris Associates, Philadelphia, Pa. (\"RMA\"). The Company's current ratio, as of the end of Fiscal 1995 and Fiscal 1994, was 1.59 and 1.63 with the industry average of 1.3 both years.\nThe Company's quick ratio, as of the end of Fiscal 1995, and Fiscal 1994, was 0.37 and 0.46. The Company's quick ratio at the end of Fiscal 1995, a measure of the ability to pay off current liabilities without relying on the sale of inventories, was approximately 4 times greater than the industry average (RMA) of 0.1 both years.\nThe Company's debt to worth ratio, a measure of the financing provided by the Company's creditors as compared to the contribution by shareholders, as of the end of Fiscal 1995 was 1.2. The industry average (RMA) was 3.6 for 1995.\nThe Company's principal long term commitments, as of the end of Fiscal 1995, consist of obligations under operating leases. The Company also has a contingent liability to repay a portion of agency commission (referral fees) received principally from some lending institutions whereby the Company referred customers to one or more third party financing sources and earned referral fees (agency commissions) if the lender consummated a loan contract with the\ncustomer. In some cases the Company is required to pay back (chargeback) a pro rata amount of the referral fee to the lender if the loan does not reach maturity for various reasons such as foreclosure, refinancing, or loan pay-off, and only if the charge back amount exceeds reserves retained by the lender. The Company records commission income based upon the amount earned less allowances for chargebacks. In determining the allowance, the Company takes into consideration the total customer loans outstanding and estimates the exposure for potential chargebacks associated with these loans. The Company estimates the probability for loan pay offs and the potential chargebacks to the Company related thereto. The Company also considers the current and predicted future economic conditions, the effects of changes in consumer interest rates and the aging of all it's customer loans outstanding representing potential chargebacks to the Company.\nThe Company's chargeback allowance was $152,000, $193,000, and $603,000 as of the end of Fiscal 1995, Fiscal 1994 and Fiscal 1993 respectively. Chargebacks were $40,000, $588,000, $111,000 for Fiscal 1995, Fiscal 1994 and Fiscal 1993, respectively. The $588,000 chargebacks in Fiscal 1994 was primarily the result of negotiated settlements with third party financing sources reducing future chargeback potential. Management expects the current allowance for chargebacks to be sufficient to repay this contingency and does not expect the ultimate liability to have a significant impact on the liquidity of the Company.\nThe Company's Board of Directors, in Fiscal 1993, set specific strategic targets for the expansion and\/or diversification of the Company's operations, primarily through acquisition, with the ultimate goal of increasing the Company's value to its shareholders. These targets, if obtained, will mostly likely require the Company to seek additional capital. Since its initial public offering in 1987 the Company has funded its expansion plan with internally generated cash, debt from financial institutions for flooring RVs, and a issuing limited amount of common stock.\nThe Company's Management is currently evaluating alternative sources of capital, its cost and its ultimate effect on the capitalization of the Company. The Company currently has $25.0 million maximum borrowing under floor plan contracts of which $11 million was not used as of the end of Fiscal 1995. In addition, the Company has a $1.0 million credit facility available for financing this expansion of dealership real property. The Company's Management feels it can obtain additional debt financing at reasonable interest rates for expansion and\/or diversification of its operations. Currently Management has no expansion or diversification prospects requiring a secondary stock offering or a conversion of the financing debt to common stock. Management does intend to continue to issue common stock and\/or options on common stock as a partial payment for acquisitions when cost effective. However, Management expects the dilutive effect on the common stockholders of the Company resulting from issuing such common stock or options to be minimal.\nManagement believes that during the next twelve months cash generated by operating activities, cash and cash equivalents on deposit with financial institutions and financing currently available from floor plan financing companies will be sufficient for its capital and operating needs for its existing operations.\nRESULTS OF OPERATIONS\nRESULTS OF OPERATIONS FOR FISCAL 1995 COMPARED TO FISCAL 1994.\nSales and service revenue increased 31.6 % to $70.0 million in Fiscal 1995 from $53.2 in Fiscal 1994 primarily due to revenue from two RV dealerships acquired on August 1, 1994 (Sacramento and Bakersfield, California). Revenue increased 2.3%, on a same store basis. This increase, on a same store basis, compares favorably to the National RV shipment data, according to the Recreation Vehicle Industry Association (RV Business, January, 1996) reporting total RV unit shipments to dealers for the ten months ended October 1995 decreased 8.3%. Even though this data is not totally comparable, it does indicate the Company's change in RV sales were significantly better than the industries national average.\nHowever, the Company's total revenue decreased (on a same store basis) 6.2% in the fourth quarter of Fiscal 1995, as compared to the same quarter of Fiscal 1994. The Company's management believes this decrease was the beginning of a trend whereby the Company's revenue will follow more closely the national downward trend due to decreased consumer sentiment over concern about the national economy. Furthermore, the Company's management believes this downward trend will extend at least through the first quarter of Fiscal 1996, unless the consumer confidence in the national economy increases.\nCost of sales and service, as a percentage of revenue, decreased to 81.2% in Fiscal 1995 from 83.9% in Fiscal 1994.\nGross profit increased 53.8% in Fiscal 1995 to $13.2 million from $8.6 million in Fiscal 1994. On a same store basis gross profit increased 9.0%.\nAs a percentage of revenue, gross profit increased to 18.8% in Fiscal 95 from 16.1% in Fiscal 94. This increase resulted from increases from every major revenue categories due to two factors; significantly higher gross profit percentages from the two new California dealerships and slightly higher gross profits from the eastern dealerships. The California higher percentages were primarily due to a greater mix of towable RVs sold verses motorized RVs sold. Towables historically are sold at a higher gross profit percentage than motorized. The higher eastern dealership's gross profits resulted from a managerial effort to increase gross profits in all revenue categories. The eastern dealerships gross profits increased to 16.1% from 15.1%.\nSelling, general and administrative expenses (SG&A) increased 42.1% to $9.76 million in Fiscal 1995 from $6.87 million in Fiscal 1994. As a percentage of revenue, SG&A increased to 13.9% from 12.9%. These increases were primarily due to two factors; increased expenses from the\ntwo new California dealerships, and increased marketing and personnel expenses resulting from increased revenue.\nIncome from operations increased 101% to $3.40 million in Fiscal 1995 from $1.69 million in Fiscal 1994. As a percentage of revenue, income from operations increased to 4.9% from 3.2%.\nInterest income increased 41.9% to $376,000 in Fiscal 1995 from $265,000 in Fiscal 1994 due to higher yields on invested cash. Interest expense increased 86.3% to $1.34 million in Fiscal 1995 from $717,000 in Fiscal 1994. This increase resulted from higher floor plan balances due to increased new RV inventories at the two newly acquired California dealerships, and to increased interest rates resulting from increases in the prime lending rate.\nIncome before income taxes increased 97.2% to $2.44 million in Fiscal 1995 from $1.24 million in Fiscal 1994. As a percentage of revenue, income before income taxes increased to 3.4% from 2.3%.\nThe combined Federal and State income tax rate was 40.2% in Fiscal 1995 compared to 38.8% in Fiscal 1994. Income tax rates varied from Federal statutory rates due to state income taxes. See Note 11 of the notes to the consolidated financial statements for components of the income taxes and the reconciliation of the provision for income taxes to the federal statutory rates.\nNet income increased 92.7% to $1,458,993 in Fiscal 1995 from $757,054 in Fiscal 1994. As a percentage of revenue, net income increased to 2.1% in Fiscal 1995 from 1.4% in Fiscal 1994.\nEarnings per share was 20 cents in Fiscal 1995 compared to 10 cents in Fiscal 1994.\nThe dramatic increase in earnings resulted primarily from the two newly acquired California dealerships. The Company's management does not expect this level of continued increases in the Company's net income in Fiscal 1996. Although the Company acquired the Las Cruces property in October, 1995, management does not expect the Las Cruces dealership will make a significant contribution to the net income of the Company in Fiscal 1996. Furthermore, management believes the trend of decreasing revenue the Company experienced in the fourth quarter of Fiscal 1995, will continue at least through the first quarter in Fiscal 1996.\nRESULTS OF OPERATIONS FOR FISCAL 1994 COMPARED TO FISCAL 1993.\nSales and service revenue increased 16.2% to $53.2 million in Fiscal 1994 from $45.8 million in Fiscal 1993. The Company acquired selected assets from Venture Out, a California corporation, on August 1, 1994, consisting primarily of the assets of two RV dealerships operating in Roseville (Sacramento) and Bakersville, California. Revenue from these two dealerships accounted for 9.2% of the increase revenue in Fiscal 1995 and Fiscal 1994.\nRevenue increased in all the Company's markets resulting primarily from increased sales of both new and used recreational vehicles. On a same store basis, a 3% decease in new RV unit sales was offset by a 22% increase in the average selling price, resulting in a 6% net increase in revenue from the sale of new RVs. The average selling price increase of new RVs resulted from\nthe continuation of a shift in demand, beginning in Fiscal 1993, from lower priced towables to higher priced motorized. Used RV revenue increased 23%, on a same store basis, as a result of a 16% increase in unit sales and a 7% increase in the average price of used RVs sold.\nOn a same store basis net revenue from agency commissions decreased 10% to $1.45 million in Fiscal 1994 from $1.6 million in Fiscal 1993. This decrease was a result of $340,000 chargeback by one of the financial institutions the Company refers customers to for RV loans. The chargeback resulted from a negotiated settlement with the financial institution whereby the Company reduced its future chargeback liability. The total chargeback amount exceeded the Company's allowance (provision) for the chargebacks from the institution by $239,000. Without the Company's allowance (provision) for the chargebacks from the institution by $239,000. Without the chargeback, net agency commissions would have increased 5%.\nRevenue from service, parts increased 9% on a same store basis. Rental revenue decreased 48% due to high demand for rentals in the first quarter of Fiscal 1993 from Hurricane Andrew victims, not experienced in Fiscal 1994, and additional competition in the Orlando market, the only market in which the Company markets rentals.\nGross profit increased 12.3% to $8.56 million in Fiscal 1994 from $7.62 million in Fiscal 1993. On a same store basis gross profit increased 4%.\nAs a percentage of revenue, gross profit decreased to 16.1% in Fiscal 1994 from 16.6% in Fiscal 1993. This decrease resulted from the decrease in net agency commissions. There were no significant changes in the gross profit, as a percent of revenue, for any other revenue source.\nSelling, general and administrative expenses (SG&A) increased 19.8% to $6.9 million in Fiscal 1994 from $5.7 million in Fiscal 1993. On a same store basis, SG&A increased 7% due to increased marketing and personnel expenses resulting from increased revenue, and expenses associated with the Company's acquisition activities.\nIncome from operations decreased 9.7% to $1.69 million in Fiscal 1994 from $1.87 million in Fiscal 1993. As a percentage of revenue, income from operations decreased to 3.2% in Fiscal 1994 from 4.1% in Fiscal 1993.\nInterest income increased slightly to $264,000 in Fiscal 1994 from $246,000 in Fiscal 1993. Interest expense increased 31% to $717,000 in Fiscal 1994 from $547,000 in Fiscal 1993. This increase resulted from higher floor plan contract balances due to increased new RV inventories associated with the acquisition, and to increased rates resulting from increases in the prime lending rate.\nIncome before income taxes decreased 21.2% to $1,237,000 in Fiscal 1994 from $1,570,000 in Fiscal 1993.\nThe combined Federal and State income tax rate was 38.9%, in Fiscal 1994 compared to 38.2% in Fiscal 1993. Income taxes for both years varied from the Federal statutory rates due to state\nincome taxes. See Note 11 of the Notes to consolidated financial statements for components of income taxes and a reconciliation of the provision for income taxes to the Federal Statutory rate.\nNet income decreased 22% to $757,054 in Fiscal 1994 from $970,311 net income before the cumulative effect of a change in accounting for income taxes in Fiscal 1993. As a percentage of revenue, net income decreased 1.4% in Fiscal 1994 from 2.1% in Fiscal 1993. The Company elected the early adoption of Statement of Financial Accounting Standards No. 109 \"Accounting for Income Taxes\" (\"FAS 109\"), in Fiscal 1993. The cumulative effect of this change in method increased the Company's net income in Fiscal 1993 by $77,000. Including the cumulative effect, net income in Fiscal 1993 was $1,047,311.\nEarnings per share were 10 cents in Fiscal 1994 compared to 13 cents in Fiscal 1993. Without the cumulative effect, earnings per share in Fiscal 1993 were 14 cents.\nINFLATION\nThe Company's Management believes that increases in the cost of new vehicles and boats that may result from increases in inflation can be offset by higher resale prices for used retail vehicles and boats as well as higher retail prices for new vehicles and boats although there may be a lag in the ability of the Company to pass such increases on to its customers.\nHistorically, increases in operating costs are passed on to the consumer when the market allows. The Company's Management believes that its business has not been significantly affected by inflation despite increased chassis and manufacture conversion costs experienced.\nSEASONALITY\nAlthough the recreational vehicle business is a year round business in the Southeastern United States and California, the recreational vehicle industry is seasonal. The Company has significantly higher sales in the second quarter of its fiscal year, and significantly lower sales in its first and fourth quarters. During slack seasons at a particular dealership, the Company reduces inventory of both new and used RVs and introduces other cutbacks in operations minimizing the impact of the seasonality on the results of operations. Because a substantial portion of the Company's expenses are fixed, operating income tends to be lower in the first quarter and fourth quarter of the Company's Fiscal Year and higher in the second and third quarters.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe response to Part II, Item 8, is submitted as a separate section of this Form 10-K.\nItem 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThere has been no change of accountants or reported disagreement on any matter of accounting principles or procedures or financial statement disclosure in Fiscal 1995.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe directors and executive officers of the Company as of January 9, 1996 were as follows:\nAll Directors hold office until the next annual meeting of the Company's shareholders and until their successors are elected and qualified. Executive officers serve at the discretion of the Board of Directors.\nINDEMNIFICATION\nIn May, 1991, the Company's Shareholders amended the Company's Articles of Incorporation to provide for the automatic mandatory indemnification of the Company's Officers and Directors to the full extent permitted by Florida Law and for the indemnification of every Company Employee and Agent upon a vote of its Board of Directors. Prior to the adoption of such amendment to the Company's Articles of Incorporation and pursuant to authority then set forth in its by-laws, and upon authorization of its Board of Directors, the Company executed indemnification agreements with its Officers and Directors in November, 1990, which agreements were ratified by the Shareholders in May, 1991.\nUnder such indemnification agreements, indemnification of the Company's Officers and Directors extends to any and all costs and expenses (including trial, appellate and other attorneys' fees), judgments, fines, penalties and amounts paid in settlement, actually and reasonable incurred by the Indemnitee in connection with any such action. Indemnification is available in any action unless a judgment (after exhaustion of all appeals) or other final adjudication determines that the Indemnitee's actions, or omissions to act, were material to the cause of action so adjudicated and constitute: (i) a violation of criminal law, unless the Indemnitee had reasonable cause to believe his conduct was lawful; or, had no reasonable cause to believe his conduct was unlawful; (ii) a transaction from which the Indemnitee received an improper personal benefit within the meaning of Florida Statute Section 607.0850(7)(b); (iii) in the case of a Director, circumstances under which the liability provisions of Florida Statute Section 607.0834, concerning unlawful distributions made by the Company are applicable; or, (iv) willful misconduct or a conscious disregard for the best interest of the Company in a proceeding by or in the right of the Company to procure a judgment in its favor or in a proceeding by or in the right of a shareholder of the Company. Further, Florida Statute Section 607.0831 provides that a Director is not personally liable for monetary damages to the Company or any other person for any statement, vote, decision, or failure to act, regarding Company management or policy unless the Director breached or failed to perform his duties as Director; and, the Director's breach or failure to perform his duties constitutes an act within the meaning of the aforesaid clauses (i) - (iv), inclusive.\nThe indemnification agreements represent an enlargement of the indemnification rights as specifically set forth in the Florida Statutes; however, as permitted by Florida Statutes, because the agreements provide that in all proceedings to determine whether an individual is entitled to indemnification, the persons making such determination shall presume that such entitlement exists and the Company has the burden of proof that the indemnification is not available. Regardless of whether a person is ultimately found to be entitled to indemnification, the Company is responsible for all costs incurred by such person in the determination proceedings in addition to all costs incurred by the person in defending in the original action.\nFurther, the indemnification agreements' provisions, being similar to Florida Statutory Law, require indemnification of Officers and Directors if such persons have been successful on the merits or otherwise in the defense of any action, the Company being required to indemnify such\npersons against expenses (including attorneys' fees) actually and reasonably incurred by them in such actions. However, the indemnification agreements expand the Indemnitee provisions of the Florida Statutes as is authorized by such Statutes, by expressly defining the term \"successful on the merits or otherwise\" to include, among other things, termination's of actions on procedural grounds (e.g., the statute of limitations or disqualification of the plaintiff). The agreement also provides that settlements with a cost to the Indemnitee of less that $15,000.00 and the failure to bring actions within a specified period of time after the making of any claim or threat of an action will constitute, for purposes of the agreements, success on the merits or otherwise. Further, the indemnification agreements provide that persons will be deemed to have satisfied the requisite standard of care for indemnification if their actions were based on (i) financial statements, books or account or other records of the Company; (ii) information supplied to them by the Officers of the Company or another enterprise in the course of their duties; or, (iii) advice of legal counsel, outside accountants or appraisers. This provision of the indemnification agreement is comparable to that found in Florida Statute Section 607.0830.\nDIRECTORS AND EXECUTIVE OFFICERS' BUSINESS EXPERIENCE\nThe following is a brief account of the educational and business experience of each Director and Officer of the Company:\nNEWTON C. KINDLUND\nMr. Kindlund and his wife, Joanne M. Kindlund, are co-founders of the Company. He has served as President and Chairman since its inception in July 1978. He is a graduate of Michigan State University having received his BA in 1963. He has done postgraduate studies at the Wharton School of the University of Pennsylvania, Boston College and Indiana University. From 1975 to 1977 he was a regional Vice President of Recreational Vehicle Industry Association, Elkhart, Indiana. He was a founder of the Florida RV Trade Association and served on the Board of Directors of the National Recreational Vehicle Rental Dealers Association and the Central Florida World Trade Council. Recently Mr. Kindlund has served a four year term as an Executive Board member and on the Executive Committee of the Greater Orlando Florida Chamber of Commerce. Currently Mr. Kindlund is a member of the National Dealer Advisory Council for Airstream, Inc. and is a past Chairman of the Board of Directors of the Recreational Vehicle Rental Dealers Association. Mr. Kindlund was recognized as the RV News RV Executive of the Year for 1995.\nJOANNE M. KINDLUND\nMrs. Kindlund, a co-founder of the Company, has served as Executive Vice President, Secretary and Treasurer and as a Director since its inception in July, 1978. She graduated from the University of Florida in 1971 with a B.S. Degree in Advertising and has done postgraduate work at the University of Florida in accounting and finance. From 1984 to 1985, she assisted Gorman Planning and Associates, Virginia Beach, Virginia with the creation of software\nmanagerial systems including accounting systems and inventory control systems for retail recreational vehicle sales dealerships.\nW. HARDEE MCALHANEY\nMr. McAlhaney joined the Company as Corporate Comptroller in 1988 and is currently a Vice President and Chief Financial Officer of the Company. He graduated from the University of Tennessee in 1970 with a B.S.B.A. Degree, and from the University of Florida in 1972 with an MBA Mr. McAlhaney served as Chief Financial Officer for two national retail chains; The Athletic Attic and The Athlete's Foot, prior to joining Drexel, Burnham, Lambert as an investment consultant.\nFRANKLIN J. HITT\nMr. Hitt has served on the Board of Directors of the Company since August of 1987. He received his MBA in 1966 to complement his B.S. in Industrial Management from Ohio State University in 1965. From 1969 to 1982 he was Assistant Professor of Finance at the University of Central Florida. From 1969 to 1975 he was Assistant Dean of the College of Business Administration. From 1982 to current date, Mr. Hitt has been an active real estate broker in Central Florida and currently is President of Franklin J. Hitt Real Estate Enterprise. He is a licensed general contractor in the State of Florida.\nLAWRENCE H. KATZ\nMr. Katz has served as a Director of the Company since August 1987. He has practiced law, specializing in corporate, business, tax and real property since 1969. His firm acts as special counsel to the Company on SEC corporate matters. Mr. Katz earned a Juris Doctorate from Stetson University College of Law in 1969. In 1966 he earned an MBA in General Management to complement his Bachelor of Science in Chemistry earned in 1963, both from Rollins College.\nJAMES P. WILLIAMS\nMr. Williams has served on the Board of Directors of the Company since August of 1987. He received his Bachelor of Science Degree in Business in 1961 from Stetson University. Mr. Williams, since graduation from college has been a practicing accountant having become a Certified Public Accountant in 1967. He is the senior partner of Williams, Gryzich and Company, CPAs.\nAVIE N. ABRAMOWITZ\nMr. Abramowitz has been a Director of the Company since August of 1987. He received his B.S. degree from the University of Maryland in 1952. He was a member of the Million Dollar Round Table for 25 years, qualifying for the prestigious Top of the Table in 1985. From 1957 to current date Mr. Abramowitz has been a life insurance representative with the Equitable Life\nCorporation. From college graduation until 1957, Mr. Abramowitz was active in the citrus industry. He is also active in international real estate acquisitions and developments.\nPAUL G. CLUBBE\nMr. Clubbe attended St. Dunstans College, England, Lisgar Collegiate, Ottawa, Ontario Canada and Pickering College, Toronto, Ontario Canada. From 1982 to present he has been President and Chief Executive Officer of Rotex Canada, Inc., of Scarborough, Canada (a joint venture with P.C.M., Ltd., and International Rotex, Inc.) manufacturer of label makers, vinyl embossing tape and office products. From 1963 to 1964 Mr. Clubbe was a sales representative for Morgan Paper Co., Ltd., Toronto, Canada. He is Chairman of the Board of Directors of Rotex Canada, Inc., and a member of the Board of Directors of Flesherton Concrete Products, Inc., Paulaurier Sales, Inc. and is active in the international market of Imports\/Exports.\nROY W. PARKER\nMr. Parker is Chief Executive Officer and Owner of Parker Boat Company, Incorporated, the Sea Ray boat dealer for Orlando, Florida. Parker Boats was founded in 1927 Mr. Parker joined the business in 1964, and became the sole owner in 1980. Parker Boats has ranked consistently as a top 25 dealer in sales nationally for Sea Ray. Mr. Parker serves as the current President of the Central Florida Marine Trade Association, and is on the Lakes and Advisory Board for the City of Maitland, Florida.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION\nThe table below sets forth the cash compensation including salaries, bonuses, contributions to retirement plans, premium paid on health and dental insurance plans and disability insurance plans, paid by the Company for the years ended October 31, 1995, 1994, and 1993, to, or for the benefit of, each executive officer whose total annual salary and bonus exceeded $100,000, and the CEO regardless of compensation level.\n(1) Includes contributions by the Company pursuant to an employee benefit plan established under Section 401 (k) of the Internal Revenue Code in the amounts of $3,964, $2,746 and $4,283 for Mr. Kindlund for 1995, 1994 and 1993 respectively, and $5,803, $2,780 and $4,678 for Mr. McAlhaney for 1995, 1994 and 1993 respectively.\n(2) Mr. McAlhaney's bonus is based on the Company's net income before taxes.\n(3) One (1) option each year for 25,000 shares of common each.\n(4) The Company pays the premiums on two (2) term life insurance policies for Mr. McAlhaney whose sole beneficiary is designated by the insured. The policies have no cash surrender value provisions.\nOPTION GRANTS IN LAST FISCAL YEAR\nThe following table sets forth information concerning stock option grants made in the fiscal year ended October 31, 1995, to the individuals named in the Summary Compensation Table. There were no grants of options or SARs to said individuals during the year.\nAGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION VALUES\nThe following table sets forth information concerning the number and value realized as to options exercised during Fiscal 1995 and options held at October 31, 1995, by the individuals named in the Summary Compensation Table and the value of those options held at such date. There were no options exercised during Fiscal 1995 and no SARs were held at year end.\n(1) Based on a price of $3.00 per share, being the closing price of Common Stock on October 31, 1995.\nDISCRETIONARY AND INCENTIVE BONUSES\nThe Board of Directors awards discretionary cash bonuses to executive officers and other employees each year. Bonuses have been paid under various informal arrangements that have provided for the payment of stipulated amounts to certain executive officers ratably during the fiscal year, fiscal year end bonuses to certain executive officers and to marketing and sales support personnel.\nThe Company has established an incentive bonus program for its employees with bonuses generally paid monthly or annually. Bonuses are primarily based upon net pre-tax profits from the various profit centers within each dealership and is contingent upon continued employment with the company.\nDIRECTORS FEES\nDirectors, who are not salaried employees of the Company, receive $500 for their attendance at each meeting of the Board of Directors, Annual Shareholders Meeting and $175 for each committee meeting. The Directors are reimbursed for their travel, lodging and food expense incurred when attending such meetings, if such meetings are held in a location in excess of twenty five (25) miles from the principal place of business of the Company in Orlando, Florida. Directors are also reimbursed for their travel, lodging and food expenses incurred when traveling on behalf of the Company when requested to do so by an officer of the Company or by the Board of Directors.\nDIRECTORS OPTIONS\nEach outside Director, serving on the board as of February 20, 1993, was granted an option for 10,000 shares of common stock of the Company, exercisable after February 20, 1995. The exercise price is $1.81 per share, the price of the Company's common stock at the time of the grant. A total of five options were granted, one to each of the five Directors (total of 50,000 shares).\nEMPLOYEE BENEFIT PLANS\nThe Company maintains a tax qualified, integrated Profit Sharing and 401(k) Employee Investment Plan, (\"Plan\"). All employees who have attained 21 years of age and complete one year of service are eligible to participate in the Plan. Plan participants must complete at least two (2) years of service to begin partial vesting with total vesting occurring when a Plan participant has completed six (6) years of service to the Company. Normal retirement age under the retirement Plan is 65 years. The Plan fiscal year ends October 31st.\nIn Fiscal 1995 $94,204 was contributed to the Plan for the benefit of 113 Plan participants. In Fiscal 1994 $46,883 was contributed to the Plan for the benefit of 74 Plan participants.\nNations Bank of Florida's Trust Group, (Nations Bank of Florida, PO Box 1469, Tampa, Florida, 33601, 813-224-5313), serves as trustee, fund manager and fund administrator.\nThe Plan documents provide for contributions at the discretion of the Board of Directors, to be allocated to each Plan participant in an amount not greater than 10% of each participant's compensation subject to the annual contribution limitation of the top heavy rules. Under the Plan, compensation is broadly defined to include wages, salaries, bonuses, overtime and commissions. Amounts contributed to the Plan by the Company for the 1995, 1994 and 1993 Plan years on behalf of the named individuals are included in the Executive Compensation Table, of this report are included in said table.\n1987 INCENTIVE STOCK OPTION PLAN\nIn August 1987, the Board of Directors of the Company adopted the 1987 Incentive Stock Option Plan (the \"ISO Plan\") which provides that the Company may grant to officers and managerial employees of the Company and its subsidiaries incentive stock options. The purpose of the ISO Plan is to provide the Company with a means of attracting, retaining and increasing the incentive of officers and managerial employees by offering them the opportunity to invest in, or increase their investment in, the Company. Options under the ISO Plan are designed to qualify under Section 422A of the Internal Revenue Code of 1986.\nThe ISO Plan is administered by the Compensation Advisory Committee of the Board of Directors (the \"Committee\") which may grant options to purchase up to an aggregate of 280,000 shares of Common Stock. The option exercise price must be at least 100% of the fair market value per share of Common Stock on the date of grant, except that such price must be at least 110% of the fair market value per share for employees who own more than 10% of the outstanding Shares of the Company. The options are exercisable, as determined by the Committee, over a period of time, but not more than ten years from the date of grant and will be subject to such other terms and conditions as the Committee may determine. Any option granted to an employee shall lapse following his termination of employment; provided, however, that in the discretion of the Committee, the employee shall have up to three (3) months following his termination of employment to exercise his options and provided, further, that upon the employee's permanent and total disability, any option granted to him may be exercised within twelve months following his termination of employment because of such disability. The ISO Plan provides for certain anti-dilution adjustments upon the occurrence of certain events.\nFive separate options for 25,000 shares each have been granted to an Officer of the Company, the Vice President and Chief Financial Officer, Mr. McAlhaney. The options were approved by the Board of Directors on the following dates and at the following option exercise prices:\nBONUS STOCK\nIn September 1987, the Company issued 250,000 Shares of Common Stock to various individuals including officers, directors and employees of the Company for services rendered. These shares have certain restrictions and forfeiture provisions attached to them. Since September 1987, a number of recipients of such shares have terminated their employment with the Company resulting in their bonus shares of Common Stock being forfeited to the Company. After September 1987, the Company made additional awards of bonus shares to employees; however, no shares in excess of the initial 250,000 shares have been issued since forfeited shares equaled or exceeded the number of bonus shares issued by the Company to employees subsequent to such date. Beginning with the year ended October 31, 1987, and over a period of two to five years the value of these shares will be a charge against earnings of the Company. The Company valued the shares initially issued at 50% of the initial public offering price of its shares of common stock or $1.25. Shares issued subsequent to September 1987 were valued at 100% of the market value on the day of issue.\nThe amount of shares awarded and fair market value assigned to the shares for the last three Fiscal years are as follows:\nThe bonus stock awards listed above require a two (2) year vesting and employment period. As of October 31, 1995, 234,700 shares had been granted pursuant to the plan.\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\nThe Company's Board of Directors Compensation Advisory Committee membership for Fiscal 1995 included Messrs. Newton C. Kindlund, Lawrence H. Katz, and James P. Williams. Mr. Kindlund is the President and Chief Executive Officer of the Company.\nCUMULATIVE TOTAL SHAREHOLDER RETURN\nThe cumulative total shareholder return performance graph as of October 31, 1991, 1992, 1993, 1994 and 1995, for the Company, the S&P 500 Index, and for the Company's peer group, is submitted as a separate section of this Form 10-K.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following table sets forth as of January 9, 1996, the number of shares, of Common Stock of the Company, owned and the percent so owned (i) each person known to the Company to be the beneficial owner of more than 5% of the outstanding Common Stock, (ii) each director and\/or officer of the Company, and (iii) all directors and officers of the Company as a group. The number of shares owned are those \"beneficially owned\" as determined under the rules of the Securities and Exchange Commission, including any shares of Common Stock as to which a person has sole or shared voting power or investment power and any shares of Common Stock which the person has the right to acquire within 60 days through the exercise of any option, warrant or right.\n(1) Newton C. Kindlund and Joanne M. Kindlund, husband and wife, each disclaims any right to control the others exercise of shareholders' rights, with respect to the Shares, including voting the shares of the Common Stock of the Company set out in the above Table.\n(2) Includes options exercisable for 100,000 shares of Common Stock issued under the 1987 Incentive Stock Option Plan.\n(3) Includes options exercisable for 10,000 shares of Common Stock underlying an option granted February 20, 1993. A total of five (5) options, each for 10,000 shares (50,000 total shares), were granted to five Directors of the Company.\n* Less than 1% of Class\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nIn November 1994, the Company renewed a five year lease agreement with Newton C. Kindlund and Joanne M. Kindlund, husband and wife, whereby the Company leases the real property upon which its dealership is located in Orlando, Florida. The annual rent is currently $144,000 and, in addition thereto, the Company pays the real estate taxes, insures the interest of Mr. and Mrs. Kindlund against casualty loss, pays for all repairs to the property and names Mr. and Mrs. Kindlund as co-insured under its general liability insurance policy. The lease provides for a cost of living increase for each year of the lease beginning with the second lease year. The term of the lease agreement expires on October 31, 1999. In fiscal year 1995, the Company paid to or for the benefit of Mr. and Mrs. Kindlund $144,000 for the use of these premises.\nBased on current market rates for properties similar to those listed above, transactions with Mr. and Mrs. Kindlund related to the lease for the Orlando property were on terms comparable to those which would have been reached with unaffiliated parties.\nSince 1987, Lawrence H. Katz, a Director of the Company has served as special counsel of the Company on corporate and SEC matters as a senior partner or Katz, Jaeger and Blankner. In 1992 Mr. Katz continued his services to the Company representing the firm of Lawrence H. Katz.\nPART IV\nItem 14.","section_14":"Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8K\nINDEX TO EXHIBITS\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange\nAct of 1934, the registrant has duly caused this report to be signed on its\nbehalf by the undersigned, thereto duly authorized.\nHOLIDAY RV SUPERSTORES, INCORPORATED Registrant\nBy: \/s\/NEWTON C. KINDLUND, PRESIDENT ------------------------------------ Newton C. Kindlund, President and Chairman\nDATED: JANUARY 21, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, this\nreport has been signed by the following persons on behalf of the registrant\nand in the capacities and on the dates indicated.\nANNUAL REPORT ON FORM 10-K\nITEM 8, ITEM 14(a)(1) and (2)\nFINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nLIST OF FINANCIAL STATEMENTS AND\nFINANCIAL STATEMENT SCHEDULES\nAS OF OCTOBER 31, 1995 AND 1994\nAND FOR THE YEARS ENDED OCTOBER 31, 1995, 1994 AND 1993\nHOLIDAY RV SUPERSTORES, INCORPORATED\nAND SUBSIDIARIES\nORLANDO, FLORIDA\nHOLIDAY RV SUPERSTORES, INCORPORATED AND SUBSIDIARIES\nCONTENTS\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nTo the Shareholders of Holiday RV Superstores, Incorporated Orlando, Florida\nWe have audited the consolidated balance sheets of Holiday RV Superstores, Incorporated and subsidiaries as of October 31, 1995 and 1994, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended October 31, 1995. 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 Holiday RV Superstores, Incorporated and subsidiaries at October 31, 1995 and 1994, and the consolidated results of their operations and their cash flows for each of the three years in the period ended October 31, 1995 in conformity with generally accepted accounting principles.\nAs discussed in the summary of accounting policies, effective November 1, 1992, the Company changed its method of accounting for income taxes by adopting Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\"\nBDO SEIDMAN, LLP Orlando, Florida December 19, 1995\nHOLIDAY RV SUPERSTORES, INCORPORATED AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\nSee accompanying summary of significant accounting policies and notes to consolidated financial statements.\nHOLIDAY RV SUPERSTORES, INCORPORATED AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\nSee accompanying summary of significant accounting policies and notes to consolidated financial statements.\nHOLIDAY RV SUPERSTORES, INCORPORATED AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF INCOME\nSee accompanying summary of significant accounting policies and notes to consolidated financial statements.\nHOLIDAY RV SUPERSTORES, INCORPORATED AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY\nSee accompanying summary of significant accounting policies and notes to consolidated financial statements.\nHOLIDAY RV SUPERSTORES, INCORPORATED AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY\nSee accompanying summary of significant accounting policies and notes to consolidated financial statements.\nHOLIDAY RV SUPERSTORES, INCORPORATED AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nSee accompanying summary of significant accounting policies and notes to consolidated financial statements.\nHOLIDAY RV SUPERSTORES, INCORPORATED AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nSee accompanying summary of significant accounting policies and notes to consolidated financial statements.\nHOLIDAY RV SUPERSTORES, INCORPORATED AND SUBSIDIARIES\nSUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF The consolidated financial statements include CONSOLIDATION the accounts of Holiday RV CONSOLIDATION Superstores, Incorporated and its subsidiaries (the \"Company\"), which include Holiday RV Rental\/Leasing, Inc., Holiday RV Superstores of South Atlanta, Inc., Holiday RV Superstores of South Carolina, Inc., Holiday RV Superstores West, Inc. and Holiday RV Superstores of New Mexico, Inc. All material intercompany accounts and transactions are eliminated.\nINVENTORIES Inventories are valued at the lower of cost or market on an aggregate basis. New and used vehicles are accounted for using specific identification. Cost of parts and accessory inventories is determined by the first-in, first-out (FIFO) method.\nCOVENANT NOT The covenant not to compete is being amortized on a TO COMPETE straight-line basis over seven years. Accumulated amortization totaled $86,000 and $17,000 as of October 31, 1995 and 1994, respectively.\nPROPERTY, Property, equipment and rental fleet are stated at cost. EQUIPMENT, Depreciation is computed EQUIPMENT, over the estimated RENTAL FLEET AND useful lives of the assets by the straight-line method DEPRECIATION for financial reporting and by accelerated methods for income tax purposes. Amortization of leasehold improvements is computed by the straight-line method over the estimated useful lives of the assets. Gains on sales of rental vehicles are recorded as gross profit.\nCHANGE IN METHOD During the fourth quarter of fiscal 1993, the Company OF ACCOUNTING FOR elected the early adoption, effective November 1, 1992, INCOME TAXES of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"FAS 109\") which requires recognition of estimated income taxes payable or refundable on income tax returns for the current year and for the estimated future tax effect attributable to temporary differences and carryforwards. Measurement of deferred income tax is based on enacted tax laws including tax rates, with the measurement of deferred income tax assets being reduced by available tax benefits not expected to be realized.\nHOLIDAY RV SUPERSTORES, INCORPORATED AND SUBSIDIARIES\nSUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nIn accordance with FAS 109, the initial application of the statement has been made as of the beginning of the Company's fiscal year, and the effect of applying this new method to years prior to fiscal 1993 have been presented in the statements of income as the cumulative effect of the change in accounting method. The cumulative effect of this change in method for fiscal 1993 was to increase net income by $77,000 ($.01 per share).\nREVENUE Retail sales and related costs of vehicles, parts and RECOGNITION service are recognized in operations upon delivery of products or services to customers or, in the case of recreational vehicles, when title passes to the customer. Factory incentives and rebates are recorded as a reduction in the related product cost as earned.\nDeferred compensation consists of the unamortized portion of the value of shares of common stock which were awarded to various individuals, including certain employees of the Company. The awards provide for vesting of the shares over periods of two to five years. Amortization of the deferred compensation is computed by the straight-line method over the vesting periods. Unvested shares forfeited to the Company are recorded as treasury stock based on the value of the shares at their original issuance date.\nEARNINGS PER SHARE Earnings per share is based upon the weighted average shares of common stock and common stock equivalents outstanding during the respective period.\nHOLIDAY RV SUPERSTORES, INCORPORATED AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. ORGANIZATION, The Company is a multi-state retail chain of dealerships BUSINESS AND engaged in the retail sales and service of recreational BUSINESS vehicles and recreational boats and the rental BUSINESS ACQUISITION of recreational vehicles in the Southeastern United States, New Mexico and California. During 1995, the Company dissolved its rental operations and transferred all rental units to used vehicle inventory to be sold in the ordinary course of business. Each dealership offers a full line of new and used recreational vehicles, and each dealership maintains a parts, service and body repair facility. Recreational vehicle rental activity was, and recreational boat sales are, carried on at selected dealerships.\nApproximately 79% of the Company's new vehicle sales for the year ended October 31, 1995 consist of vehicles purchased from two manufacturers.\nThe Company was incorporated in July 1978 in the State of Florida. In May 1981, the Company formed Holiday RV Rental\/Leasing, Inc., a Florida corporation to engage in the business of recreational vehicle rentals. In July 1988, the Company formed Holiday RV Superstores of South Atlanta, Inc., a Georgia Corporation which acquired an existing recreational vehicle sales location in Atlanta, Georgia. In February 1990, the Company formed Holiday RV Superstores of South Carolina, Inc., a South Carolina corporation which acquired an existing recreational vehicle and marine sales location in Greer, South Carolina. In January 1994, the Company formed Holiday RV Superstores West, Inc., a California corporation which acquired existing recreational vehicle sales locations in Bakersfield and Roseville, California in August 1994 (the \"California acquisition\"). In September 1995, the Company formed Holiday RV Superstores of New Mexico, Inc., a New Mexico corporation which purchased land and a building in Las Cruces, New Mexico to be used as a recreational vehicle and marine sales location.\nThe California acquisition has been accounted for by the purchase method of accounting, and the purchase price of $4,731,000 approximates the fair value of the net assets acquired. The operating results of this acquisition are included in the Company's consolidated results of operations from the date of acquisition.\nHOLIDAY RV SUPERSTORES, INCORPORATED AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nThe following unaudited pro-forma summary presents the consolidated results of operations of the Company as if the acquisition had occurred at the beginning of periods presented and do not purport of be indicative of what would have occurred had the acquisition been made as of these dates or of results which may occur in the future.\n2. SUPPLEMENTAL For purposes of the statements of cash flows, the CASH FLOW Company considers all highly liquid debt instruments INFORMATION purchased with a maturity of three months or less to be cash equivalents. Cash and cash equivalents include checking accounts, money market funds and repurchase agreements.\nThe following summarizes noncash investing and financing transactions:\nHOLIDAY RV SUPERSTORES, INCORPORATED AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n3. ACCOUNTS The Company evaluates the collectibility of all accounts RECEIVABLE receivable and establishes an allowance for doubtful accounts as deemed necessary. At October 31, 1995 and 1994, all accounts receivable were evaluated and deemed collectible.\n4. INVENORIES Inventories are summarized as follows:\n5. PROPERTY AND Property and equipment are summarized as follows: EQUIPMENT\nHOLIDAY RV SUPERSTORES, INCORPORATED AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n6. RENTAL FLEET Rental fleet is summarized as follows:\n7. FLOOR PLAN Substantially all inventories, accounts receivable and CONTRACTS AND equipment are pledged as security under floor plan NOTE PAYABLE contracts. Floor plan contracts are due upon sale of the related vehicle.\nInterest rates and interest expense are as follows for the years ended October 31:\nMaximum borrowings available under the contracts were $26,000,000 as of October 31, 1995. The following summarizes certain information about the borrowings under the floor plan contracts:\nHOLIDAY RV SUPERSTORES, INCORPORATED AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n8. STOCK OPTION In August 1987, the Company adopted an Incentive PLAN Stock Option Plan (the \"Plan\"). The Plan provides for the issuance of up to 280,000 shares of common stock. The option exercise price must be at least 100% of the fair market value per share of common stock on the date of grant, except that such price must be at least 110% of the fair market value per share for employees who own more than 10% of the outstanding shares of the Company. The options are exercisable, as determined by the Compensation Committee, over a period of time, but not more than ten years from the date of grant and will be subject to such other terms and conditions as the Committee may determine. Changes in options are summarized as follows:\nAt October 31, 1995, 100,000 of the above options were exercisable.\nUnder a separate plan, the Company granted options during 1993 for 50,000 shares to certain directors with an exercise price of $1.81 per share. All of these options were exercisable at October 31, 1995. None were exercised during the year.\n9. RESTRICTED In August 1994, as part of the California acquisition, STOCK OPTIONS the Company granted options for 125,000 shares at an exercise price equal to the average closing price of the Company's common stock for the 30 days prior to the acquisition, $1.70 per share. These options expire on July 31, 2004. Of these options, 100,000 are exercisable as of October 31, 1995. The remaining options become exercisable on August 1, 1996.\nIn connection with the purchase of the Greer, South Carolina dealership, the Company granted an option to the sellers to purchase 20,000 shares of the\nHOLIDAY RV SUPERSTORES, INCORPORATED AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nCompany's unregistered common stock. This option was granted on April 2, 1991 at an exercise price of $3.44 per share. The option is exercisable, in whole or in part, at anytime within five (5) years from the date of the grant of the option. As of October 31, 1995, the option was not exercised.\n10. SALES AND The following is a summary of sales and service and SERVICE cost of sales and service:\nHOLIDAY RV SUPERSTORES, INCORPORATED AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n11. INCOME TAXES The components of income taxes are as follows:\nHOLIDAY RV SUPERSTORES, INCORPORATED AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nThe components of deferred tax assets and liabilities consist of the following:\nHOLIDAY RV SUPERSTORES, INCORPORATED AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nThe following summary reconciles differences from taxes at the federal statutory rate with the effective rate before the cumulative effect of change in accounting:\nAt October 31, 1995, the Company has net operating loss carryforwards of approximately $115,000 for state income tax purposes that expire in 2004.\n12. EMPLOYEES The Company adopted a Profit-Sharing and Employee BENEFIT Investment Plan in 1992 which covers substantially all PLAN employees meeting certain minimum age and service Plans requirements. Contributions to the plan, included in selling, general and administrative expenses, were $94,204, $46,883 and $59,659 for 1995, 1994 and 1993, respectively.\n13. LEASES AND The Company conducts its operations from leased RELATED PARTY facilities including land and buildings in Orlando and TRANSACTIONS Fort Myers, Florida; Greer, South Carolina; and Bakersfield and Roseville, California. The Orlando (excluding the corporate facility) facility is leased from the principal stockholders. The leases which are classified as operating leases, expire on various dates from 1994 through 2000 and include renewal options.\nThe Company also leases computer equipment which is included in property and equipment in the amount of $391,580. The lease, which is classified as a capital lease, expires in 2002, at which time the Company will have an option to purchase the computer equipment for a nominal amount.\nHOLIDAY RV SUPERSTORES, INCORPORATED AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nAs of October 31, 1995, future minimum rental payments required under the capital lease and operating leases that have initial or remaining noncancelable lease terms in excess of one year are as follows:\nRental expense under all operating leases was as follows:\n14. COMMITMENTS Concentration of Risk AND CONTINGENCIES Due to the nature of its business and the volume of sales activity, the Company accumulates, from time to time, bank balances in excess of the insurance provided by Federal and\/or other insurance sources. At October 31, 1995, such excess balances totaled approximately $4,580,000.\nHOLIDAY RV SUPERSTORES, INCORPORATED AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nThird-Party Financing\nThe Company uses third-party banks and\/or finance companies to assist its customers in locating financing for vehicle purchases. The Company refers customers to one or more of these third-party financing sources and earns a referral fee if the third-party lender consummates a loan contract with the customer. These contracts represent third-party financing, and the Company provides no underwriting or credit approval services for the lender. The Company's referral fees are in fact a commission and are typically based upon the difference between the interest rate the customer pays under the contract with the lender and an interest rate designated by the lender. The Company does not service the collection of these loans or receivables either initially or in the future. The Company is charged back a pro rata amount of the commission by the lender if the loan does not reach maturity for various reasons such as foreclosure, refinancing or loan pay-off, if this amount exceeds reserves retained by the lender.\nThe Company records this commission income based upon the amount earned less allowances for chargebacks. In determining the allowance for chargebacks, the Company takes into consideration the total customer loans outstanding and estimates the exposure for potential chargebacks associated with these loans. The Company estimates the probability for loan payoffs and estimates potential chargebacks to the Company related thereto. The Company also considers the current and future economic conditions, the effects of the change in consumer interest rates and the aging of all loans outstanding. The chargeback allowance was approximately $152,000 and $193,000 at October 31, 1995 and 1994, respectively. Finance chargebacks were approximately $40,000, $588,000 and $111,000 for 1995, 1994 and 1993, respectively.\n15. FUTURE The Company is required to adopt the provisions of ACCOUNTING Statement of Financial Accounting Standards No. 123, CHANGE (\"SFAS No. 123\"), Accounting for Stock Based Compensation for or before its fiscal year ending October 31, 1997. SFAS No. 123, among other things, requires certain added disclosures regarding the fair value of equity instruments, such as stock options, issued by\nHOLIDAY RV SUPERSTORES, INCORPORATED AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nthe Company. In addition, SFAS No. 123 encourages the recognition of expense for the fair value of equity instruments issued by the Company.\nThe Company has not yet determined whether the optional expense recognition provisions of SFAS No. 123 will be adopted, and therefore, the effects of adopting SFAS No. 123 cannot be determined.\nSCHEDULE VIII\nHOLIDAY RV SUPERSTORES, INCORPORATED AND SUBSIDIARIES\nVALUATION AND QUALIFYING ACCOUNTS\nFOR THE FISCAL YEARS ENDED OCTOBER 31, 1995, 1994, 1993\n(a) Finance income chargebacks paid. (b) Finance reserves balance includes an allowance for disputed chargeback claims of $343,465 for the year ended 1993.\nS-1\nANNUAL REPORT ON FORM 10-K\nITEM 11\nCUMULATIVE TOTAL SHAREHOLDER RETURN\nPERFORMANCE GRAPH AS OF OCTOBER 31,\n1991, 1992, 1993, 1994 AND 1995\nFOR\nHOLIDAY RV SUPERSTORES, INC., THE S&P 500 INDEX, AND\nINDEX OF HOLIDAY RV SUPERSTORES, INC.'S PEER GROUP\nDISCLOSURE REQUIRED FOR\nITEM 402(L) FOR FORM 10-K (ANNUAL REPORT)\nPERFORMANCE GRAPH\nHere in displays a line graph plotting three (3) series of points, whereby the Y axis is the total cumulative shareholder return, and the X axis is the year, being 1990 through 1995.\nThe plotted points (cumulative shareholder return by year) are listed in the table below.\nThe performance graph above illustrates the cumulative yearly shareholder return for the past five years, assuming a $100 investment on October 31, 1990, in (1) the Company; (RVEE) (2) The Standard and Poor's 500 composite index, assuming reinvestment of dividends; (3) a Company determined Market Capitalization Peer Group composite index, assuming reinvestment of dividends.\nThe Peer Group consist of twenty publicly owned retail companies with similar market capitalization as Holiday RV Superstores, Inc., whose common stocks are traded on exchanges. The market capitalization criteria in determining a peer group was selected by the Company for shareholder return comparative purposes, as there is no published industry or line-of-business index comparable to the industry or line-of-business as that of the Company.\nThe peer group consist of the following companies:\nAudio King Corp., Brendles Inc., Eagle Holding Inc., Evans Inc., FFP Partners LP-CL, A., Foodarama Supermarkets, Harold's Stores Inc., Hills Department Stores Inc., Holiday RV Superstores, Inc., Huffman Koos Inc., Michaels (J.) Inc., Pubco Corp., Seaway Food Town Inc., Sound Advice Inc., Spec's Music Inc., Strober Organization Inc., Sunshine-Jr Stores, Uni-Marts Inc. CL A, Village Super Market CL A, Warehouse Club Inc.","section_15":""}
{"filename":"718077_1995.txt","cik":"718077","year":"1995","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 one 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 two wholly owned subsidiaries: The Peoples First National Bank & Trust Company of Paducah (\"Peoples Bank\") in McCracken, Marshall, Ballard, Livingston, Calloway and Graves Counties; and, First Kentucky Federal Savings Bank of Central City in Muhlenberg, Ohio, McLean and Butler Counties. 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 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, Bank of Murray in 1992 and Liberty Bank and Trust in 1994. 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 1,025,098 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 bank.\nDividends from Peoples Bank and First Kentucky FSB (collectively the \"banks\") are the principal source of cash flow 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 $896.9 million at December 31, 1995 and is the first or second largest commercial banking operation in each of the five counties it operates. At December 31, 1995, Peoples Bank had 426 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\nthe primary source of operating income. First Kentucky FSB had total deposits of $151.3 million at December 31, 1995 and is largest financial institution headquartered in their immediate West-Central Kentucky market area. At December 31, 1995, First Kentucky FSB had 64 full-time equivalent 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 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 Bank Insurance Fund of the Federal Deposit Insurance Corporation (FDIC). As such, they are subject to regulation by these federal agencies. First 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) 1995 1994 1993 _______________________________________________________________________________\nINTEREST-EARNING ASSETS Short-term investments $2,877 $3,831 $10,579 Taxable securities 251,107 285,242 318,861 Non-taxable securities 64,835 69,731 71,001 Loans (1) 865,707 755,314 660,345 --------- --------- --------- 1,184,526 1,114,118 1,060,786 NONINTEREST-EARNING ASSETS Cash and due from banks 33,515 34,878 33,974 Allowance for loan losses (12,691) (11,524) (9,827) Other assets 40,582 40,800 41,542 --------- --------- --------- $1,245,932 $1,178,272 $1,126,475 ========= ========= =========\nINTEREST-BEARING LIABILITIES Transaction accounts $253,689 $235,918 $228,146 Savings deposits 87,618 106,891 105,191 Time deposits 598,514 567,438 555,689 Short-term borrowings 86,400 51,489 31,761 Long-term borrowings 7,946 13,644 17,956 Other liabilities 1,292 1,201 944 --------- --------- --------- 1,035,459 976,581 939,687\nNONINTEREST-BEARING LIABILITIES Demand deposits 82,752 85,307 78,178 Other liabilities 9,176 8,391 9,471\nSTOCKHOLDERS' EQUITY 118,545 107,993 99,139 --------- --------- --------- $1,245,932 $1,178,272 $1,126,475 ========= ========= =========\n(1) Nonperforming loans are included in average loans\nB. ANALYSIS OF NET INTEREST EARNINGS For the Year Ended December 31, (in thousands) 1995 1994 1993 _______________________________________________________________________________\nINTEREST INCOME Short-term investments $160 $169 $335 Taxable securities 16,082 17,493 20,006 Non-taxable securities (TE) (2) 5,847 6,302 6,487 Loans (TE) (2) 78,573 62,520 56,178 ------ ------ ------ 100,662 86,484 83,006\nINTEREST EXPENSE Transaction accounts 9,101 6,970 5,854 Saving deposits 2,460 2,996 3,980 Time deposits 34,047 25,744 25,927 Short-term borrowings 4,939 2,169 1,026 Long-term borrowings 515 900 1,150 Other liabilities 90 76 60 ------ ------ ------ 51,152 38,855 37,997 ------ ------ ------ NET INTEREST INCOME (TE) (2) 49,510 47,629 45,009 TE Basis Adjustment (1,916) (2,080) (2,161) ------ ------ ------ NET INTEREST EARNINGS $47,594 $45,549 $42,848 ====== ====== ======\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, 1995 1994 1993 _______________________________________________________________________________\nAVERAGE YIELDS FOR INTEREST-EARNING ASSETS Short-term investments 5.56% 4.41% 3.17% Taxable securities 6.40% 6.13% 6.27% Non-taxable securities (TE) (2) 9.02% 9.04% 9.14% Loans (TE) (1) (2) 9.08% 8.28% 8.51% All interest-earning assets 8.50% 7.76% 7.82%\nAVERAGE RATES FOR INTEREST-BEARING LIABILITIES Transaction accounts 3.59% 2.95% 2.57% Saving deposits 2.81% 2.80% 3.78% Time deposits 5.69% 4.54% 4.67% Short-term borrowings 5.72% 4.21% 3.23% Long-term borrowings 6.48% 6.60% 6.40% Other liabilities 6.97% 6.33% 6.36% All interest-bearing liabilities 4.94% 3.98% 4.04% ---- ---- ---- NET INTEREST-RATE SPREAD (TE) (2) 3.56% 3.78% 3.78% ==== ==== ====\nNET YIELD ON INTEREST-EARNING ASSETS 4.18% 4.28% 4.24% ==== ==== ====\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) 1995\/1994 Volume Rate (3) _______________________________________________________________________________\nINTEREST INCOME Short-term investments ($9) ($42) $33 Taxable securities (1,411) (2,093) 682 Non-taxable securities (TE) (2) (455) (442) (13) Loans (1) (2) 16,053 9,138 6,915 ------ 14,178 5,465 8,713 INTEREST EXPENSE Transaction accounts 2,131 525 1,606 Saving deposits (536) (540) 4 Time deposits 8,303 1,410 6,893 Short-term borrowings 2,770 1,471 1,299 Long-term borrowings (385) (376) (9) Other liabilities 14 6 8 ------ 12,297 2,343 9,954 ------ ------ ------ NET INTEREST EARNINGS (TE) (2) $1,881 $3,122 ($1,241) ====== ====== ======\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) 1994\/1993 Volume Rate (3) _______________________________________________________________________________\nINTEREST INCOME Short-term investments ($166) ($214) $48 Taxable securities (2,513) (2,109) (404) Non-taxable securities (TE) (2) (185) (116) (69) Loans (TE) (1) 6,342 8,079 (1,737) ------ 3,478 4,173 (695)\nINTEREST EXPENSE Transaction accounts 1,116 199 917 Saving deposits (984) 64 (1,048) Time deposits (183) 548 (731) Short-term borrowings 1,143 637 506 Long-term borrowings (250) (276) 26 Other liabilities 16 16 (0) ------ 858 1,492 (634) ------ ------ ------ NET INTEREST INCOME (TE) (2) $2,620 $2,681 ($61) ====== ====== ======\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. Security Portfolios\nA. Footnote 4 to the Consolidated Financial Statements included herein on page 41 presents the book value as of the end of 1995 and 1994 of securities by type of security.\nB. Footnote 4 to the Consolidated Financial Statements included herein on page 41 presents the amortized cost, estimated market value and the weighted average yield of securities at December 31, 1995, by contractual maturity range.\nC. As of December 31, 1995, 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 19 presents the amount of all loans in various categories as of the end of 1995 and 1994.\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, 1995:\nLoan Portfolio Maturities 1 year 1 to 5 Over December 31, 1995 or less years 5 years Total _______________________________________________________________________________ (in thousands)\nCommercial, financial and agricultural $56,579 $33,956 $23,394 $113,929 Real estate construction 17,989 555 842 19,386 ------- ------- ------- ------- $74,568 $34,511 $24,236 $133,315 ======= ======= ======= =======\nThe amounts of these loans due after one year which have predetermined rates and adjustable rates are $19.0 million and $39.7 million, respectively.\nC. Risk Elements\n1. The table of Nonperforming Assets in MDA included herein on page 21 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, 1991 through 1995, 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, 1995, loans with a total principal balance of $14.3 million had been identified that may become nonperforming in the future, compared to $14.8 million at December 31, 1994. 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, 1995, a total of $3.5 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, 1995, 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, 1995, 1994, 1993, 1992 and 1991:\nB. The following tables present a breakdown of the allowance for loan losses at December 31, 1995, 1994, 1993, 1992 and 1991:\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 5 and 7 present the average amount of and the average rate paid for the years ended December 31, 1995, 1994 and 1993.\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, 1995, of $100,000 or more by maturity:\nMaturity of $100,000 Time Deposits December 31, 1995 _______________________________________________________________________________ (in thousands)\nMaturing 3 months or less $19,379 Maturing over 3 months through 6 months 13,580 Maturing over 6 months through 12 months 22,713 Maturing over 12 months 40,423 ------ $96,095 ======\nFor the Year Ended December 31, VI. RETURN ON EQUITY AND ASSETS 1995 1994 1993 _______________________________________________________________________________\n1. Return on average assets 1.19% 1.11% 1.14% 2. Return on average equity 12.46% 12.15% 12.92% 3. Dividend payout ratio 31.85% 29.08% 26.28% 4. Equity to assets ratio 9.51% 9.17% 8.80%\nVII. SHORT-TERM BORROWINGS\nA. Footnote 7 to the Consolidated Financial Statements included herein on page 47 presents for each category of short-term borrowings, the amounts outstanding at the end of the reported periods, the weighted average interest rate, the maximum 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 bank.\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\". Share and per share information have been adjusted to give effect to the two-for-one stock split on January 4, 1994 and 5% stock dividends declared on April 19, 1995 and January 17, 1996. The high and low stock prices and the quarterly dividends declared on the Company's common stock for each quarter of 1995 and 1994 are as follows:\nHigh and Low Stock Prices First Second Third Fourth Dividends Declared quarter quarter quarter quarter _______________________________________________________________________________\nHigh 1995 $18.14 $18.33 $21.67 $22.38 Low 1995 15.65 15.95 17.38 20.00 Cash dividends declared 0.109 0.109 0.143 0.143\nHigh 1994 $25.85 $23.13 $22.22 $19.73 Low 1994 21.32 19.95 19.05 14.74 Cash dividends declared 0.095 0.095 0.109 0.109\nHolders The approximate number of holders of registrant's only class of common stock as of February 16, 1996, was 2,827.\n______________________________________________________________________________ Shares outstanding and per share amounts have been adjusted for a two-for-one stock split on January 4, 1994 and 5% stock dividends on April 19, 1995 and January 17, 1996.\nAs more fully explained in Note 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. 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 Company operates principally in a single business segment offering general commercial and savings bank services. The following table provides certain subsidiary, parent company and consolidated information for 1995:\nEARNING ASSETS Average earning assets of the Company for 1995, increased 6.3%, or $70.4 million to $1,184.5 million from $1,114.1 million for 1994. This compares to growth of earning assets, excluding the purchase of three branch bank locations in 1992, of 5.0% and 3.4%, for 1994 and 1993, respectively. Loan growth during the last three years has been partially funded with reductions in 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 95.1% for 1995, compared to 94.6% and 94.2% for 1994 and 1993, respectively. Loans are the Company's primary earning asset. Management believes the Company should be a prominent lender. Average loans for 1995 increased 14.6%, or $110.4 million, to $865.7 million. Internal average loan growth for 1994 and 1993 was 14.4% and 8.6%, respectively. The changing mix of earning assets was favorable during the last two years. Average loans for 1995 were 73.1% of\nof total average earning assets, compared to 67.8% and 62.2% during 1994 and 1993, respectively. Prior to 1993, loans had been a decreasing portion of earning assets. Management's desire for promininence in area lending and a slowed growth of deposits used for investment in securities has lead to the improved earning asset composition.\nTable 2 Average Earning Assets Year ended December 31, 1995 1994 1993 _______________________________________________________________________________ (dollars in thousands)\nTotal average earning assets $1,184,526 $1,114,118 $1,060,786 Percent of average earning assets Average loans 73.1% 67.8% 62.2% Average securities 26.7 31.9 36.8 Average other earning assets 0.2 0.3 1.0\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 securities and the principal collected on mortgage-backed securities was used to fund loan growth. Average securities decreased $39.0 million during 1995 and $34.9 million during 1994. The Company maintains a portfolio of securities held for sale as an available source of funding for loan growth. U. S. treasury and agency obligations represent approximately 75.5% of the securities portfolios at December 31, 1995.\nAt December 31, 1995, mortgage-backed securities which included Real Estate Mortgage Investment Conduit (REMIC) and CMO instruments were approximately 51.8% of the securities portfolios, compared to approximately 46.0% at December 31, 1994. The REMIC issues are 100% U. S. agencies issues. The CMO issues are marketable, collateralized mortgage obligations backed by agency-pooled collateral or whole-loan collateral. All nonagency issues held are currently rated AA or AAA by either Standard & Poors or Moody's. Approximately 19.4% of the mortgage-backed securities are floating-rate issues, the majority being indexed to the Constant Maturity Treasury index. Management's normal practice is to purchase securities at or near par value to reduce risk of premium write-offs resulting from unexpected prepayments.\nAt December 31, 1995, the Company did not have any structured notes (as currently defined by regulatory agencies) in the securities portfolios since management believes the uncertainty of cash flows from these securities, which are driven by interest-rate movements, could expose the Company to greater market risk than traditional securities.\nFUNDING Average 1995 deposits increased 2.7%, or $27.0 million to $1,022.6 million from $995.6 million for 1994. Local markets for deposits are competitive. Core deposits, the Company's most important and stable funding source, are a decreasing portion of average interest-bearing liabilities. The core deposit base is supplemented with brokered deposits, short-term and long-term borrowings to fully fund loan growth. Average brokered deposits amounted to $24.7 million, $22.1 million and $8.0 million for the years ended December 31, 1995, 1994 and 1993, respectively. Average short-term and long-term borrowings were $94.3 million for 1995, up from $65.1 million for 1994 and $49.7 million for 1993.\nTable 4 Average Interest-bearing Liabilities 1995 1994 1993 _______________________________________________________________________________ (dollars in thousands)\nTotal average interest-bearing liabilities $1,035.5 $976.6 $939.7 Percent of average total interest- bearing liabilities Average core deposits 88.4% 90.9% 93.8% Average short-term borrowings 8.3 5.3 3.4 Average long-term borrowings 0.8 1.4 1.9\nManagement anticipates an increasing need to rely on more volatile purchased liabilities. The Company's subsidiary banks have obtained various short-term and long-term advances from the Federal Home Loan Bank (FHLB) under Blanket Agreements for Advances and Security Agreements (Agreements). The Agreements entitle the subsidiary banks to borrow additional funds from the FHLB to fund mortgage loan programs and satisfy other funding needs.\nNONPERFORMING ASSETS AND RISK ELEMENTS As illustrated in Table 5, nonperforming assets, which include nonperforming loans and foreclosed property, have generally declined over the last three years. Nonperforming assets as a percentage of total loans and other real estate declined to 0.58% at December 31, 1995 compared to 0.60% and 0.86% at December 31, 1994 and 1993, respectively. A small number of loans and one tract of undeveloped land, portions of which have been sold, represent most of the nonperforming balance for the last three years. The decline in nonperforming assets reflects good economic conditions in the area and the Company's comphrehensive loan administration and workout procedures. Also, diversification within the loan portfolio is an important means of reducing inherent lending risks. At December 31, 1995, 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 even though the nonperforming totals are significantly lower than peer bank holding company ratios. A significant focus on underwriting standards is maintained by management and the subsidiary bank boards. Internal credit review procedures are designed to alert management of possible credit problems which\nwould create serious doubts as to the future ability of borrowers to comply with loan repayment terms. At December 31, 1995, loans with a total principal balance of $14.3 million have been identified that may become nonperforming in the future, compared to $14.8 million at December 31, 1994 and $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.\nCAPITAL RESOURCES AND DIVIDENDS The Company's strong capital position and overall financial strength provide flexibility when management evaluates opportunities to improve stockholder value. Stockholders' equity was 10.0% of assets at December 31, 1995, an increase from 9.1% at December 31, 1994. Exclusive of unrealized net gain and loss on securities held for sale, net of applicable income taxes, stockholders' equity increased $12.4 million, or 10.8%, during 1995, and increased $10.4 million, or 9.9%, during 1994. The capital base has been strengthened through earnings retention and issuance of common stock through various shareholder and employee plans. The earnings retention rate, which the board of directors adjusts through declaration of cash dividends, was 68.2% for 1995, 70.9% for 1994 and 73.7% for 1993. Proceeds from the sale of common stock through shareholder and employee plans amounted to $2.2 million in 1995, $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 1995 stockholders' equity was increased by $5.6 million, for 1994 was decreased by $6.5 million and for 1993 was increased by $1.9 million to record the change during the year in the fair value of securities held for sale. The board of directors develops and reviews the capital goals and policies of the consolidated entity and each of the subsidiary banks. The Company's capital policies are designed to retain sufficient amounts for healthy financial ratios, considering future planned asset growth and to leverage stockholders' equity to a desirable degree. Subsidiary bank dividends are the principal source of funds for the Company's payment of dividends to its stockholders. At December 31, 1995, approximately $23.9 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.\nThe board of directors raised the quarterly dividend to $0.109 per share in the third quarter of 1994 and to $0.143 per share in the third quarter of 1995. Stock dividends of 5% were declared in April 1995 and in Janaury 1996. On Janaury 17, 1996, the board of directors approved the purchase of up to 400,000 shares of the Company's common stock in the open market during the following eighteen to twenty-four month period. Shares acquired may be used in conjunction with the Company's stock dividend program.\nAn important measure of capital adequacy of a banking institution is its risk-based capital ratios. Bank regulatory agencies' minimum capital guidelines assign relative measures of credit risk to balance sheet assets and off-balance sheet exposures. Based upon the nature and makeup of their current businesses and growth expectations, management expects all of the reporting entities' risk-based capital ratios to continue to exceed regulatory minimums. At December 31, 1995 and 1994, the Company and the subsidiary banks' ratios were as follows:\nRESULTS OF OPERATIONS Net income increased 13.0% in 1995, reaching a record level of $14.8 million, compared to an increase of 2.3% in 1994 when net income totaled $13.1 million. On a per common share basis, net income increased 11.3% to $1.57 per share for the year ended December 31, 1995, compared to an increase of 2.9% to $1.41 per share for the year ended December 31, 1994. Net income per common share for the fourth quarter of 1995 increased 18.9% to $0.44 from $0.37 for the fourth quarter of 1994. The earnings increases were primarily due to increased interest income due in part to strong loan demand in 1995 and 1994. Reductions in deposit insurance expense due to the level of FDIC capitalization and the absence of acquisition related expense contributed to the 1995 earnings increase. Earnings performance for 1994 was negatively impacted by transaction costs of approximately $0.06 per share related to two acquisitions completed during the year.\nReturn on average stockholders' equity for the years ended December 31, 1995, 1994 and 1993 was 12.46%, 12.15% and 12.92%, respectively. Return on average assets for the years ended 1995, 1994 and 1993 was 1.19%, 1.11% and 1.14%, respectively.\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. Measured on a fully taxable equivalent (TE) basis, net interest income for the year ended December 31, 1995, increased 4.0%, or $1.9 million to $49.5 million compared to $47.6 million for 1994. For the year ended December 31, 1994, net interest income (TE) increased 5.8%, or $2.6 million from $45.0 million for 1993. As expected, 1995's increase is attributable to growth in the volume of average earning assets while the net interest margin decreased 10 basis points from 1994. Substantially all of 1994's increase is attributable to growth in the volume of average earning assets. Net interest income (TE) as a percent of average earning assets was 4.18%, 4.28% and 4.24% for the years ended December 31, 1995, 1994 and 1993, respectively.\nThe Company's concentration in residential real estate loans, competition for increased loan volumes and reliance on time deposits and non-core funding results in narrower interest spreads. The subsidiary banks generally maintain a relatively balanced position between volumes of rate-repricing assets and\nliabilities to guard to some degree against adverse effects to net interest income from possible fluctuations in interest rates. 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. The provision for loan losses amounted to $2.2 million for 1995, an increase of 29.4% compared to $1.7 million in 1994, which was a decrease of 32.0% compared to $2.5 million in 1993. The 1995 increase was required to reflect the growth in outstanding loans and chargeoffs. The 1994 decrease was influenced by declines in net charge-offs, nonperforming assets and potential problem loans. The provision for loan losses as a percentage of average loans was 0.25% for the year ended December 31, 1995, up from 0.23% for the year ended December 31, 1994 and compared to 0.38% for the year ended December 31, 1993.\nNet loan chargeoffs over the last three years were at levels below historical trends. Net chargeoffs for 1995 were $1.0 million compard to $0.3 million for 1994 and $0.4 million for 1993. As a percentage of average loans, net chargeoffs were 0.11% for 1995, up from 0.03% for 1994 and 0.07% for 1993, periods of unusually low net chargeoffs. Net chargeoffs as a percent of average loans were 0.21% for the five-year period ended December 31, 1995. The allowance for loan losses 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. At December 31, 1995, the allowance for loan losses is 1.46% of outstanding loans compared 1.51% of outstanding loans at December 31, 1994. The December 31, 1995 allowance is 251% of nonperforming assets compared to 252% at December 31, 1994.\nNONINTEREST INCOME Fees from traditional deposit services as well as revenues from insurance, brokerage activities and other commission business have been increased by management's focus on improving all areas of noninterest income during the last three years. Noninterest income amounted to $8.0 million in 1995, a 12.7% increase compared to $7.1 million in 1994 which was an increase of 6.0% compared to $6.7 million in 1993. Excluding net securities gains, the 1995 and 1994 increases were more comparable and were 11.6% and 9.1%, repectively.\nService charges on deposit accounts, the largest component of noninterest income, increased 4.1% in 1995 and 11.2% in 1994. Net gains of $178,143, $62,309 and $230,642, were recognized in 1995, 1994 and 1993, respectively. Securities held for sale, primarily mortgage-backed securities, totaling $12.1 million, $11.9 million and $21.9 million, respectively, 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.\nThe Company has shown small growth in the amount of trust assets managed. Fees from personal and pension lines of business for the last three years have been relatively the same. The 41.3% and 48.3% increases in insurance commissions in 1995 and 1994, over prior respective years, are 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 1995 and 1994 were lower than 1993 due to the unusually large amount of home refinancing in 1993. In 1995, the Company sold its student loan portfolio and changed to a fee income program from the previous practice of originating and holding the loans. The Company made available two new financial services during 1994 to bank customers. Management believes that investment brokerage services and property and casualty insurance products made available in 1994 will generate a higher level of fees in 1996 than in the first two introductory years. The relative improvement in fee income is slightly more than the growth in net interest income. Noninterest income excluding securities gains was 13.7% of total net tax-equivalent interest income plus noninterest income for 1995, compared to 12.9% for 1994 and 12.5% for 1993. Management expects this trend to continue into 1996.\nNONINTEREST EXPENSE After rising in 1994, the ratio of noninterest expense net of noninterest income exclusive of securities gains to average total assets fell in 1995. The ratio was 1.96% for 1995, 2.15% for 1994 and 2.03% for 1993. Since internal asset growth has slowed, management continues to focus on controlling the rate of increase of noninterest expense by reconfiguring certain functions to gain more employee productivity. The Company consolidated six of the previously separate corporate subsidiaries into one bank during 1995 and 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.\nNoninterest expense decreased 0.3% in 1995 due to reduced deposit insurance rates and the absence of merger-related professional fees. This compares to an increase of 10.1% in 1994 when all categories of noninterest expense rose. Salaries and employee benefits increased 6.0% in 1995, compared to 6.3% in 1994. Staffing levels were approximately the same at December 31, 1995 and 1993. The Company has made investments in facilities and equipment of approximately $6.9 million during the last three years as technology has advanced and the need to leverage personnel costs has intensified. Occupancy expense increased 5.5% in 1995 and 6.2% in 1994. Equipment expense increased 13.2% in 1995 and 16.2% in 1994 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 a five year or shorter period. Management plans to continue to invest in techology for new product delivery systems.\nThe Federal Deposit Insurance Corporation (FDIC) currently administers two separate deposit insurance funds, the Bank Insurance Fund (BIF) and the Savings Association Insurance Fund (SAIF). The BIF and SAIF were established primarily\nto insure the depositors of insured banks and savings associations and to finance the resolution of failed institutions. The Company's lead bank subsidiary pays deposit insurance premiums to the BIF and the Company's other subsidiary pays deposit insurance premiums to the SAIF based on a rate applied to their respective assessable deposits. Beginning in 1993, the assessments were based not only on deposits but also on the risk characteristics of the individual financial institutions. Both of the Company's subsidiaries received the lowest applicable deposit assessment rates from the FDIC.\nAssessments for deposit insurance were $1.3 million, $2.3 million and $2.1 million in 1995, 1994 and 1993, respectively. The decrease in FDIC insurance expense is attributable to a BIF refund and rate reduction. During September 1995, as a result of the stability of the commercial bank industry and the level of insurance fund reserves, the FDIC refunded the lead bank a portion of the deposit-insurance premiums paid and reduced rates. The Company accounted for the BIF refund in the third quarter when received as a component of operating income.\nCongress is considering a variety of legislation that will recapitalize the SAIF through a special assessment on the assessable deposits of SAIF member institutions such as the Company's savings association subsidiary. At December 31, 1995, the Company had not accrued a liability for the potential special assessment. The expense for any special assessment will be recorded as a component of operating income in the period of the enacted legislation. Management estimates the special assessment will be between $1.2 million and $1.5 million and payable in the second quarter of 1996. The legislation may provide for lower premiums following the special assessment. For 1996, management currently believes lower BIF and SAIF rates will generally offset the expense of the anticipated special SAIF assessment.\nIncreased data processing expense is attributable to a greater volume of activ- ity, the outsourcing of a portion of some functions and one-time system conversion costs incurred mainly in 1994. The increase was 5.7% in 1995 and 13.2% in 1994. Some reduction in Kentucky Bankshare taxes occurred in 1995 due to the consolidation of the six separate banking corporations. Kentucky has raised the assessment level and has been attempting to significantly increase this taxation, which is based upon net income and capital of the subsidiaries. The Company's bank subsidiaries are required to to maintain significant noninterest-bearing balances with the Federal Reserve and to pay fees to regulatory agencies for periodic examinations by the agencies.\nDuring 1994, the Company completed two pooling-of-interest acquisitions. Included in other noninterest expense for 1994 and 1993 is approximately $561,000 and $145,000, respectively, of professional fees related to these acquisitions.\nINCOME TAXES Increases in income tax expense are attributable to higher operating earnings and higher effective tax rates. The Company's effective income tax rate was 30.4%, 29.4% and 27.3%, for the years ended December 31, 1995, 1994 and 1993,\nrespectively. The 1% federal income tax rate increase mandated by the Omnibus Budget Reconciliation Act of 1993 and a continued decline in the amount of tax-exempt income as a percentage of operating income has increased the effective rate. Also increasing the rate for 1994 was nondeductible organizational costs associated with two mergers. 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 of liquidity for the banks, in addition to loan repayments, is their debt securities portfolios. 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 locations in twelve 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. 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. A balance-sheet analysis is conducted to determine the impact on net interest income for the following twelve months under several interest-rate scenarios. One scenario uses current rates at December 31, 1995 and holds the rates and volumes constant for the simulation. When this projection is subjected to immediate and parallel shifts in interest rates (rate shocks) of 200 basis points, both rising and falling, the annual impact of the rate shock at December 31, 1995 on the Company's projected net interest income margin was less than five basis points. Currently, the Company does not employ interest rate swaps, financial futures or options to affect interest rate risks.\nManagement made the following assumptions in preparing the Interest Rate Sensitivity Analysis:\n1 Assets and liabilities are generally scheduled according to their earliest repricing dates regardless of their contractual maturities. 2 Nonaccrual loans are included in the rate-sensitive category. 3 The scheduled maturities of mortgage-backed securities assume principal prepayments on dates estimated by management, relying primarily on current and concensus interest-rate forecasts in conjunction with historical prepayment schedules. 4 Transaction and savings deposits that have no contractual maturities are scheduled according to management's best estimate of their re- pricing in response to changes in market rates.\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 are 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, the 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. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nIndependent Auditors' Reports _______________________________________________________________________________\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, 1995 and 1994, 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, 1995. 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, 1995 and 1994, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1995, in conformity with generally accepted accounting principles.\n\/s\/ KPMG Peat Marwick LLP\nSt. Louis, Missouri January 26, 1996\nDecember 31, December 31, CONSOLIDATED BALANCE SHEETS 1995 1994 ________________________________________________________________________________ (in thousands)\nASSETS Cash and due from banks $37,524 $39,333 Securities held for sale 146,322 129,682 Securities held for investment 160,320 203,845 Loans 914,497 805,947 Allowance for loan losses (13,371) (12,188) --------- --------- Loans, net 901,126 793,759 Excess of cost over net assets of purchased subsidiaries 9,248 10,077 Premises and equipment 18,226 16,980 Other assets 14,830 16,880 --------- --------- $1,287,596 $1,210,556 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Deposits Demand deposits $86,360 $87,985 Interest-bearing transaction accounts 291,539 243,910 Savings deposits 83,607 98,571 Time deposits 585,598 568,117 --------- --------- 1,047,104 998,583 Short-term borrowings 93,469 84,567 Long-term borrowings 7,757 9,536 Other liabilities 11,094 7,607 --------- --------- Total liabilities 1,159,424 1,100,293\nStockholders' Equity Common stock 7,207 6,422 Surplus 53,269 34,859 Retained earnings 66,878 73,739 Unrealized net gain (loss) on securities held for sale 926 (4,624) Debt on ESOP shares (108) (133) --------- --------- 128,172 110,263 --------- --------- $1,287,596 $1,210,556 ========= =========\nFair value of securities held for investment $165,042 $200,092 Common shares issued and outstanding 9,225 9,062\nSee accompanying notes to consolidated financial statements. 31\nYear Ended December 31, CONSOLIDATED STATEMENTS OF INCOME 1995 1994 1993 ________________________________________________________________________________ (in thousands except per share data)\nINTEREST INCOME Interest on short-term investments $160 $169 $335 Taxable interest on securities 16,082 17,493 20,006 Nontaxable interest on securities 4,017 4,305 4,413 Interest and fees on loans 78,487 62,437 56,091 ------ ------ ------ 98,746 84,404 80,845 INTEREST EXPENSE Interest on deposits 45,608 35,710 35,761 Other interest expense 5,544 3,145 2,236 ------ ------ ------ 51,152 38,855 37,997 ------ ------ ------ Net Interest Income 47,594 45,549 42,848 Provision for Loan Losses 2,167 1,723 2,541 ------ ------ ------ Net Interest Income after Provision for Loan Losses 45,427 43,826 40,307\nNoninterest Income 8,037 7,101 6,683 Noninterest Expense 32,251 32,337 29,373 ------ ------ ------ Income Before Income Tax Expense 21,213 18,590 17,617 Income Tax Expense 6,446 5,465 4,807 ------ ------ ------ NET INCOME $14,767 $13,125 $12,810 ====== ====== ======\nNet Income per Common Share $1.57 $1.41 $1.37\nCash Dividends per Common Share 0.50 0.41 0.36\nSee accompanying notes to consolidated financial statements. 32\nSee accompanying notes to consolidated financial statements. 33\nSee accompanying notes to consolidated financial statements. 35\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Peoples First Corporation (Company) through its subsidiaries, Peoples First National Bank and Trust Company and First Kentucky Federal Savings Bank, operates principally in a single business segment offering 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. Estimates and assumptions involve future events and may change.\nThe more significant accounting 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 acquired subject to purchase accounting are included from the dates of acquisition. In accordance with purchase accounting, assets and liabilities of purchased companies are stated at fair values, less accumulated amortization and depreciation since the dates 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\nother 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 separate component of stockholders' equity until realized. Securities for which the Company has the ability and positive intent to hold until maturity are classified as securities held for investment 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.\nCertain changes in circumstances and other events that are isolated, nonrecurring and unusual for the Company that could not have been reasonably anticipated may cause the Company to change its intent to hold a certain security to maturity without necessarily calling into question its intent to hold other securities for investment.\nRealized gains or losses on securities held for sale or investment are accounted for using the specific security. A decline in the fair value of any security held for sale or investment below cost that is deemed other than temporary results in a charge to earnings and the establishment of a new cost basis for the security. 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.\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 loss recognition. 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. 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.\nThe Company recognizes interest income on nonaccrual impaired loans equal to the amount of interest received, if any, in cash. All changes in the present value of estimated future cash flows are recorded as an adjustment to the allowance for loan losses and ultimately the provision for loan losses. No interest income is recognized for changes in present value attributable to the passage of time.\nDuring May 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 122, \"Accounting for Mortgage Servicing Rights\", (FAS 122) which requires that a mortgage banking enterprise recognize as separate assets the rights to service mortgage loans for others at the orgination or purchase date of the loans when the enterprise has definitive plans to sell or securitize the loans and retain the mortgage servicing rights, assuming the fair value of the loans and servicing rights may be practically estimated. Otherwise, servicing rights should be recognized when the underlying loans are sold or securitized, using an allocation of total cost of the loans based on the relative fair values at the date of sale. FAS 122 also requires an assessment of capitalized mortgage servicing rights for impairment to be based on the current fair value of those rights. FAS 122 is required to be applied prospectively in fiscal years beginning after December 15, 1995. The Company does not believe FAS 122 will have a material effect on its financial position.\nALLOWANCE FOR LOAN LOSSES The allowance for loan losses 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. The allowance for loan losses is decreased by charge offs, net of recoveries. 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 loan loss experience, 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.\nThe Company adopted Statement of Financial Accounting Standards No. 114, \"Accounting by Creditors for Impairment of a Loan\", (FAS 114) and Statement of Financial Accounting Standards No. 118, \"Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures\", (FAS 118) effective for the year beginning January 1, 1995. As a result of applying FAS 114, as amended by FAS 118, certain impaired loans subject to the statements are reported 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, by allocating a portion of the allowance for loan losses to such loans. If these allocations cause the allowance for loan losses to be increased, such increase is recorded as provision for loan losses. No adjustment to the provision for loan losses was required due to the adoption of FAS 114 and FAS 118 in the first quarter of 1995.\nEXCESS OF COST OVER NET ASSETS OF PURCHASED SUBSIDIARIES Net assets of subsidiaries acquired in purchase transactions are recorded at fair value at the date of acquisition. The excess of cost over net assets acquired is amortized by systematic charges in the statement of income over the period benefited. Management evaluates the periods of amortization continually to determine whether later events and circumstances warrant revised estimates. Currently, amortization is provided on a straight-line basis over fifteen years. Accumulated amortization was $3.2 million at December 31, 1995 and $2.4 million at December 31, 1994 and amortization expense was $829,884 for each of the years ended December 31, 1995, 1994 and 1993.\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.\nFINANCIAL INSTRUMENTS During 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\" (FAS 119). FAS 119 requires disclosure about the amounts, nature and terms of derivative financial instruments that are not subject to FAS 105, \"Disclosure of Information about Financial Instruments with Off-Balance Sheet Risks and Financial Instruments with Concentrations of Credit Risk\". FAS 119 requires that a distinction be made between financial instruments held or issued for trading purposes and financial instruments held or issued for purposes other than trading.\nFAS 119 was effective for financial statements issued for fiscal years after December 31, 1994. The Company's adoption of FAS 119 had no effect on the consolidated financial statements other than the required disclosure with respect to fixed rate loan commitments.\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\ndifferences between the carrying values of assets and liabilities for financial reporting purposes and the values 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, provision 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.\nPER COMMON SHARE DATA Share and per share information have been adjusted to give effect to stock splits and stock dividends in the three years ended December 31, 1995, including the 5% stock dividend declared in Janaury 1996, and payable in March 1996. Net income per common share is determined by dividing net income by the weighted average number of common shares actually outstanding and common stock equivalents pertaining to common stock options. The average number of shares outstanding including common stock equivalents for 1995, 1994 and 1993 were 9,382,546, 9,302,057 and 9,321,178, 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 cash and due from banks and highly liquid securities puchased with a maturity of three months or less to be cash equivalents.\nRECLASSIFICATIONS Certain amounts in the 1994 and 1993 consolidated financial statements have been reclassified to conform with the 1995 presentation. The reclassifications had no effect on previously reported stockholders' equity or net income.\n2. BUSINESS COMBINATIONS During the three year period ended December 31, 1995, the Company was a party to two business combinations.\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 1,025,098 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 consolidated financial satements for December 31, 1993 include the accounts of First Kentucky for their fiscal year ended September 30, 1993. For the year ended December 31, 1994, consolidated retained earnings were increased $334,814 due to the change in First Kentucky's year end to 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. Immediately prior the acquisition, First Kentucky had total assets of approximately $176.8 million.\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 1,188,333 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. During 1995, Liberty Bank & Trust was merged into Peoples First National Bank and Trust Company. Immediately prior to the acquisition, Libsab had total assets of approximately $141.9 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 period prior to combination: First Results of Operations Company Libsab Kentucky Combined _______________________________________________________________________________ (in thousands)\nTotal revenue $37,586 $5,911 $6,034 $49,531 Net income 9,534 1,520 1,756 12,810\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 $0.06 and $0.02 for 1994 and 1993, respectively.\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, 1995 and 1994 were $11.5 million and $8.2 million, respectively.\n4. SECURITIES HELD FOR SALE AND INVESTMENT The amortized cost and fair value of securities held for sale as of December 31, 1995 and 1994 are summarized as follows:\nGross Gross Securities Held For Sale Amortized unrealized unrealized Fair December 31, 1995 cost gains losses value _______________________________________________________________________________ (in thousands)\nU.S. treasury and agencies $48,370 $467 ($116) $48,721 Mortgage-backed securities 84,591 1,220 (273) 85,538 Federal Home Loan Bank stock 10,534 105 0 10,639 Federal Reserve Bank stock 1,424 0 0 1,424 ------- ------- ------- ------- $144,919 $1,792 ($389) $146,322 ======= ======= ======= =======\nGross Gross Securities Held For Sale Amortized unrealized unrealized Fair December 31, 1994 cost gains losses value _______________________________________________________________________________ (in thousands)\nU.S. treasury and agencies $58,891 $0 ($3,321) $55,570 Mortgage-backed securities 69,304 39 (3,663) 65,680 Federal Home Loan Bank stock 8,248 0 (60) 8,188 Federal Reserve Bank stock 244 0 0 244 ------- ------- ------- ------- $136,687 $39 ($7,044) $129,682 ======= ======= ======= =======\nThe amortized cost and fair value of securities held for investment as of December 31, 1995 and 1994 are summarized as follows:\nSecurities Gross Gross Held for Investment Amortized unrealized unrealized Fair December 31, 1995 cost gains losses value _______________________________________________________________________________ (in thousands)\nU.S. treasury and agencies $23,894 $187 ($13) $24,068 Mortgage-backed securities 73,357 891 (88) 74,160 State and political subdivisions 62,569 3,843 (102) 66,310 Other 500 4 0 504 ------- ------- ------- ------- $160,320 $4,925 ($203) $165,042 ======= ======= ======= =======\nSecurities 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 (3,481) 84,355 State and political subdivisions 67,334 1,579 (1,329) 67,584 Other 2,999 3 (22) 2,980 ------- ------- ------- ------- $203,845 $1,618 ($5,371) $200,092 ======= ======= ======= =======\nProceeds from sales of securities during 1995, 1994 and 1993 were $12,085,690, $11,885,303 and $21,897,188, respectively. Gross gains of $178,143, $62,309 and $252,056 and gross losses of $0, $0 and $21,414 were realized on those sales during 1995, 1994 and 1993, respectively.\nThe amortized cost, estimated fair value and the weighted average yield of securities held for sale and held for investment at December 31, 1995, 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 presented for mortgage-backed securities, as these securities are particularly exposed to prepayments. Management evaluates, on an ongoing 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 Weighted Maturity Distribution Amortized Fair average December 31, 1995 cost value yield _______________________________________________________________________________ (in thousands)\nU.S. treasury and agencies 1 year or less $19,931 $20,001 6.04% Over 1 through 5 years 28,439 28,720 5.70 Mortgage-backed securities 84,591 85,538 6.53 Federal Home Loan Bank stock 10,534 10,639 7.13 Federal Reserve Bank stock 1,424 1,424 6.00 ------- ------- $144,919 $146,322 6.29% ======= =======\nSecurities Held for Investment Weighted Maturity Distribution Amortized Fair average December 31, 1995 cost value yield _______________________________________________________________________________ (in thousands)\nU.S. treasury and agencies 1 year or less $18,860 $18,998 6.46% Over 1 through 5 years 5,034 5,070 6.00 Mortgage-backed securities 73,357 74,160 6.62 State and political sudivisions 1 year or less 3,779 3,803 6.18 Over 1 through 5 years 18,976 19,979 6.13 Over 5 through 10 years 25,389 27,385 6.54 Over 10 years 14,425 15,143 5.75 Other 1 year or less 100 100 8.25 Over 10 years 400 404 8.65 ------- ------- $160,320 $165,042 6.43% ======= =======\nAt December 31, 1995 and 1994, securities with carrying values of approxi- mately $145.1 million and $135.4 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 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, 1995 and 1994, total loans to any group of customers engaged in similar activities and having similar economic characteristics, 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, 1995 1994 _______________________________________________________________________________ (in thousands)\nCommercial, financial and agricultural $113,929 $111,929 Real estate Construction 19,386 19,421 Residential mortgage 364,607 318,551 Commercial mortgage 158,429 139,629 Consumer, net of unearned income of $12,980 and $11,340 at December 31, 1995 and 1994 255,975 214,309 Loans held for sale 708 156 Other 1,463 1,952 ------- ------- $914,497 $805,947 ======= =======\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 borrower. Collateral varies but may include accounts receivable, inventory, property, plant and equipment, income producing commercial properties, real estate and other property owned by the borrowers.\nActivity in the allowance for loan losses was as follows for the three-year period ended December 31, 1995:\nAllowance for Loan Losses Year Ended December 31, 1995 1994 1993 _______________________________________________________________________________ (in thousands)\nBalance at beginning of year $12,188 $10,715 $8,606 Provision charged to expense 2,167 1,723 2,541 Loans charged off (1,307) (686) (1,044) Recoveries of loans previously charged off 323 436 612 ------ ------ ------ Net loans charged off (984) (250) (432) ------ ------ ------ Balance at end of year $13,371 $12,188 $10,715 ====== ====== ======\nNonaccrual and renegotiated loans totaled $4.7 million and $3.3 million at December 31, 1995 and 1994, respectively. Beginning in 1995, loans except, large groups of smaller-balance homogeneous loans, for which the full collection of principal and interest is not probable, or a delay in payments is expected, are evaluated for impairment. The Company measures and reports impaired loans that are within the scope of FAS 114 at either the present value of expected future cash flows discounted at the loan's effective rate, the market price of the loan, or fair value of the underlying collateral if the loan is collateral dependent. Prior accounting did not discount cash flows and only considered loss of principal, not loss of interest, when measuring troubled loans. Information regarding impaired loans at December 31, 1995 is as follows:\nImpaired Loans December 31, 1995 __________________________________________________________________ (in thousands)\nBalance of impaired loans $4,109 Less portion for which no allowance for loan losses is alloacated 308 ------ Portion of impaired loan balance for which an allowance for loan losses is allocated $3,801 ====== Portion of allowance for loan losses allocated to the impaired loan balance $829 ======\nInformation regarding impaired loans is as follows for the year ended December 31, 1995:\nImpaired Loans Year Ended December 31, 1995 __________________________________________________________________ (in thousands)\nAverage investment in impaired loans $4,258 Interest income recognized on impaired loans 378 Interest income recognized on impaired loans on cash basis 0\nCertain officers and directors of the Company 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 time for comparable transactions with other customers and did not involve more than the normal risk of collectibility. The activity of these loans during the years ended December 31, 1995 and 1994 is summarized below:\nLoans to Officers and Directors Year Ended December 31, 1995 1994 _______________________________________________________________________________ (in thousands)\nBalance at beginning of year $11,825 $20,663 Additions 2,165 4,230 Repayments (631) (1,087) Changes in officer and director status 86 (11,981) ------ ------ Balance at end of year $13,445 $11,825 ====== ======\n6. PREMISES AND EQUIPMENT A summary of premises and equipment is as follows:\nDecember 31, 1995 1994 _______________________________________________________________________________ (in thousands)\nLand $2,394 $2,264 Buildings 18,421 17,502 Equipment 12,432 11,157 Leasehold improvements 985 1,084 Construction in progress 764 156 ------ ------ 34,996 32,163 Accumulated depreciation and amortization (16,770) (15,183) ------ ------ $18,226 $16,980 ====== ======\nThe amount of depreciation and amortization related to premises and equipment that was charged to operating expenses in 1995, 1994 and 1993 was $1,857,202, $1,650,659 and $1,426,263, 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 1995 1994 1993 ________________________________________________________________________________ (dollars in thousands)\nFederal funds purchased Average balance $13,414 $21,171 $10,980 Year end balance 15,100 41,500 12,600 Highest month-end balance 35,000 41,500 23,700 Average interest rate 6.07% 4.63% 3.23% Year end interest rate 5.60% 6.12% 3.30% Repurchase agreements Average balance $25,794 $22,702 $20,781 Year end balance 23,869 21,567 19,902 Highest month-end balance 32,120 24,090 22,883 Average interest rate 4.64% 3.50% 3.23% Year end interest rate 4.05% 4.08% 3.27% Short-term FHLB advances Average balance $46,733 $7,581 $0 Year end balance 54,500 21,500 0 Highest month-end balance 54,500 21,500 0 Average interest rate 6.19% 5.18% -- Year end interest rate 5.85% 6.16% --\nAt December 31, 1995, the subsidiary banks had total lines-of-credit for Federal funds purchased from unaffiliated banks of $54.0 million, of which $38.9 million was undrawn and available.\n8. LONG-TERM BORROWINGS Information pertaining to long-term borrowings is summarized below:\nDecember 31, 1995 1994 __________________________________________________________________ (in thousands)\nParent Company Bank loan for subsidiary acquisition $0 $1,530 Subsidiaries Federal Home Loan Bank advances 7,649 7,873 Employee Stock Ownership Plan debt 108 133 ------ ------ $7,757 $9,536 ====== ======\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, payable quarterly at the lender's prime rate, was adjustable on a daily basis (8.50% at December 31, 1994). The note provided for quarterly principal payments of $261,604 and a final maturity in May 2004. The Company retired the debt during 1995.\nThe subsidiary banks obtain various short-term and long-term advances from the FHLB under Blanket Agreements for Advances and Security Agreements (Agreements). The Agreements entitle the subsidiary 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, 1995, all 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, other securities in the approximate amount of $13.0 million and certain single-family first mortgage loans in the approximate amount of $269.0 million. 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 $7.5 million at December 31, 1995. 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 an unaffiliated 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 stock of the subsidiary. Interest is payable quarterly at the lender's prime rate less 0.50% which can be adjusted daily (9.75% at December 31, 1995 and 9.50% at December 31, 1994). 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 1996 through 2000 are $435,350, $470,913, $426,343, $459,106 and $468,359, 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, 1995 and 1994 are summarized as follows:\nFinancial Instruments with Off-Balance-Sheet Risk December 31, 1995 1994 _______________________________________________________________________________ (in thousands)\nContractual commitments to extend credit $115,788 $101,132 Standby letters of credit 10,894 4,327\nOf the total commitments to extend credit at December 31, 1995 and 1994, $99,072 and $0, respectively, 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 $215,360, $201,696 and $208,983 for the years ended 1995, 1994 and 1993, respectively. The ESOP's investments include 307,142 and 281,348 shares of the Company's common stock at December 31, 1995 and 1994, respectively.\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, 1995, 1994 and 1993, the Company's required matching contribution amounted to $243,924, $225,583 and $184,472, respectively. Employees have several investment options in which 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) and First Kentucky Federal Savings Bank (First Federal) as soon as reasonably practicable. Liberty's and First Federal's defined benefit retirement plans will be terminated. Liberty's employees became 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 Service and Department of Labor requirements are met. The plan terminations should have no material 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 retired employee's expense. There was no cost for employee benefits for retired employees in 1995, 1994 and 1993.\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 1,146,600 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 payment month. At December 31, 1995 and 1994, 791,189 shares and 859,625 shares were reserved for issuance under the DRIP. Shares issued under the DRIP totaled 68,436, 44,781 and 37,388 shares in 1995, 1994 and 1993, 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. Currently, no compensation cost is recognized for the Company's Option Plan. Outstanding stock options are considered common stock equivalents in the computation of net income per common share.\nDuring October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation\" (FAS 123). For fiscal years beginning after December 15, 1995, FAS 123 requires new footnote disclosures about stock compensation awards based upon their fair value on the date granted. FAS 123 also permits companies to switch to the fair value method to record compensation costs for new and modified employee stock options. The footnote disclosure requirements include provisions to show pro forma net income and net income per share as if the fair value accounting had been adopted. The Company plans to continue its current\naccounting practices and not elect to recognize compensation costs in the consolidated statements of income. Pro forma disclosures will be provided in 1996.\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 cash dividends by the Company to its shareholders, are subject to various national and\/or state regulatory restrictions. At December 31, 1995, total retained earnings of the Company's direct subsidiaries was approximately $75.1 million, of which $23.9 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, 1995 and 1994, 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, 1995 1994 1993 _______________________________________________________________________________ (in thousands)\nCurrent taxes $6,762 $6,397 $6,119 Deferred taxes (316) (932) (1,312) ----- ----- ----- Income tax expense $6,446 $5,465 $4,807 ===== ===== =====\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, 1995 1994 1993 _______________________________________________________________________________ (in thousands)\nTax computed at statutory rates $7,425 $6,407 $6,020 Increase (decrease) in taxes resulting from: Tax-exempt income (1,328) (1,413) (1,562) Goodwill amortization 290 290 290 Other, net 59 181 59 ----- ----- ----- Income tax expense $6,446 $5,465 $4,807 ===== ===== =====\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, 1995 1994 _______________________________________________________________________________ (in thousands)\nDeferred tax assets: Allowance for loan losses $4,272 $3,824 Deferred compensation 431 424 Other real estate owned 181 171 Unrealized security loss -- 1,650 Other 74 105 ----- ----- 4,958 6,174 Deferred tax liabilities: Unrealized security gain (125) -- Accrued interest income (89) (93) Premises and equipment (1,335) (1,314) Other (453) (352) ----- ----- (2,002) (1,759) ----- ----- Net deferred tax assets $2,956 $4,415 ===== =====\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\ntaxes have been provided for approximately $2.6 million of income at December 31, 1995 and 1994 which represents allocations for bad debt deductions for tax purposes only. Under existing tax regulations, 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. CONTINGENCIES\nLEGAL PROCEEDINGS In the ordinary course of business, there are various legal proceedings pending against the Company and its subsidiaries. Management, after consultation with legal counsel, is of the opinion that the ultimate resolution of these precedings will have no material effect on the consolidated financial condition or results of operations of the Company.\n14. SUPPLEMENTAL INCOME STATEMENT INFORMATION Details of noninterest income and noninterest expense are as follows:\nYear Ended December 31, 1995 1994 1993 _______________________________________________________________________________ (in thousands)\nNoninterest Income Service charges on deposits $3,831 $3,680 $3,308 Net securities gains 178 62 231 Trust department fees 1,220 1,181 1,199 Insurance commissions 664 470 317 Bankcard fees 658 546 533 Other income 1,486 1,162 1,095 ----- ----- ----- $8,037 $7,101 $6,683 ===== ===== =====\nYear Ended December 31, 1995 1994 1993 _______________________________________________________________________________ (in thousands)\nNoninterest Expense Salaries $13,302 $12,370 $11,591 Employee benefits 2,411 2,450 2,348 Occupancy expense 1,769 1,677 1,579 Equipment expense 1,885 1,665 1,433 FDIC insurance expense 1,338 2,250 2,135 Data processing expense 2,338 2,212 1,954 Bankshare taxes 1,349 1,365 1,253 Goodwill amortization 830 830 830 Other expense 7,029 7,518 6,250 ------ ------ ------ $32,251 $32,337 $29,373 ====== ====== ======\n15. PARENT COMPANY FINANCIAL INFORMATION Following are condensed balance sheets of Peoples First Corporation (parent company only) as of December 31, 1995 and 1994, and the related condensed statements of income and cash flows for the years ended 1995, 1994 and 1993:\nCondensed Balance Sheets December 31, 1995 1994 __________________________________________________________________ (in thousands)\nASSETS Cash in subsidiary bank $797 $492 Investment in subsidiaries 127,105 111,302 Other assets 556 276 ------- ------- $128,458 $112,070 ======= ======= LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities Note payable $0 $1,530 Other liabilities 286 277 ------- ------- Total liabilities 286 1,807\nStockholders' equity Common stock 7,207 6,422 Surplus 53,269 34,859 Retained earnings 66,878 73,739 Unrealized net gain (loss) on securities held for sale 926 (4,624) Debt on ESOP shares (108) (133) ------- ------- 128,172 110,263 ------- ------- $128,458 $112,070 ======= =======\nCommon shares issued and outstanding 9,225 9,062\nCondensed Statements of Income Year Ended December 31, 1995 1994 1993 _______________________________________________________________________________ (in thousands)\nINCOME Dividends from subsidiaries $5,078 $10,878 $5,752 Other income 3 11 7 ------ ------ ------ 5,081 10,889 5,759 EXPENSE Interest expense 44 385 745 Legal and accounting fees 284 571 335 Other expense 378 654 450 ------ ------ ------ 706 1,610 1,530 ------ ------ ------ Income before income tax benefit and equity in undistributed income of subsidiaries 4,375 9,279 4,229 Income tax benefit 164 385 434 Income before equity in ------ ------ ------ undistributed income of subsidiaries 4,539 9,664 4,663 Equity in undistributed income of subsidiaries 10,228 3,461 8,147 ------ ------ ------ NET INCOME $14,767 $13,125 $12,810 ====== ====== ======\nCondensed Statement of Cash Flows Year Ended December 31, 1995 1994 1993 _______________________________________________________________________________ (in thousands)\nOPERATING ACTIVITIES Net income $14,767 $13,125 $12,810 Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed income of subsidiaries (10,228) (3,461) (8,147) Amortization and other, net (271) 134 (16) Net Cash Provided by ------ ------ ------ Operating Activities 4,268 9,798 4,647\nFINANCING ACTIVITIES Proceeds from notes payable 0 3,800 6,200 Repayments of notes payable (1,530) (11,859) (8,712) Proceeds from issuance of common stock 1,418 495 299 Cash dividends paid (3,851) (2,698) (2,012) ------ ------ ------ Net Cash Used by Financing Activities (3,963) (10,262) (4,225)\nNet Increase (Decrease) in Cash 305 (464) 422 and Cash Equivalents Cash and Cash Equivalents at Beginning of Year 492 956 534 ------ ------ ------ Cash and Cash Equivalents at End of Year $797 $492 $956 ====== ====== ======\nSUPPLEMENTAL DISCLOSURES Cash paid for interest expense $53 $405 $716 Cash received for income taxes (345) (711) (365)\nNONCASH INVESTING AND FINANCING TRANSACTIONS Dividends reinvested 753 542 438\n16. 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, ACCRUED INTEREST PAYABLE AND SHORT-TERM BORROWINGS The carrying amount reported for cash, due from banks, accrued interest receiv- able, 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 Loan balances are 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.\nDEPOSITS The fair value for demand deposits and interest-bearing deposits with no fixed maturity date is considered to be equal to the amount payable on demand or maturity 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 The fair value of long-term borrowings is based on a 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 $100,000 for 1995 and 1994.\nThe book values and estimated fair values for financial instruments as of December 31, 1995 and 1994 are reflected below.\nFinancial Instruments December 31, 1995 Book value Fair value _______________________________________________________________________________ (in thousands)\nFinancial Assets Cash and due from banks $37,524 $37,524 Securities held for sale 146,322 146,322 Securities held for investment 160,320 165,042 Loans, net 901,126 944,922 Accrued interest receivable 9,392 9,392\nFinancial Liabilities Deposits 1,047,104 1,055,235 Short-term borrowings 93,469 93,469 Long-term borrowings 7,757 7,721 Accrued interest payable 6,875 6,875\nFinancial Instruments December 31, 1994 Book value Fair value _______________________________________________________________________________ (in thousands)\nFinancial Assets Cash and due from banks $39,333 $39,333 Securities held for sale 129,682 129,682 Securities held for investment 203,845 200,092 Loans, net 793,759 777,877 Accrued interest receivable 8,627 8,627\nFinancial Liabilities Deposits 998,583 996,989 Short-term borrowings 84,567 84,567 Long-term borrowings 9,536 9,536 Accrued interest payable 4,454 4,454\nItem 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nDuring the years ended December 31, 1995, 1994 and 1993 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. DIRECTORS AND EXECUTIVE 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 25, 1996, is incorporated herein by reference.\nThe following table provides information as of December 31, 1995, 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 201,407(1) age 55 President and Chief Executive of the registrant; Chairman of the Board of Peoples Bank\nAllan B. Kleet, Principal Accounting Officer, 1986 67,616(2) age 47 Treasurer and Director of the registrant\nGeorge Shaw, Director, President and Chief 1993 5,181(3) age 50 Executive Officer of Peoples Bank; formerly President and Chief Executive Officer of Bowling Green Bank & Trust Company (1982-05\/93)\n(1) Represents 2.2% of the class of stock. Includes 119,621 shares subject to currently exercisable stock options and 20,463 shares held in Mr. Lippert's ESOP account for which he has voting but no dispositive power.\n(2) Represents less than 1.0% of the class of stock. Includes 675 shares held individually by Mr. Kleet's wife, 62,511 shares subject to currently exercisable stock options and 2,917 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 4,961 shares subject to currently exercisable stock options.\nItem 11. EXECUTIVE COMPENSATION\nThe information concerning compensation appearing on pages 9 through 13 of Peoples First Corporation's definitive proxy statement, filed with the Securities and Exchange Commission on March 25, 1996, is incorporated herein by reference.\nItem 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 25, 1996, is incorporated herein by reference.\nItem 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information on page 7 and 8 of Peoples First Corporation's definitive proxy statement, filed with the Securities and Exchange Commission on March 25, 1996, is incorporated herein by reference.\nPART IV\nItem 14. EXHIBITS, FINANCIAL STATEMENTS 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 are incorporated herein by reference to Exhibit 3(1) to the Registrant's Form 10-K for the year ended December 31, 1994.\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(10.2)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(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(10.4)Employment agreement among the Company, Liberty Bank & Trust Co. and Steve Story is herein incorporated by reference to Exhibit 99.1 of Form S-4, registration #33-54535 as filed with the Securities and Exchange Commission on July 12, 1994.\n(21) Subsidiaries of Registrant.\n(23) Consent of KPMG Peat Marwick LLP, independent public accountants.\n(27) Financial Data Schedules (SEC use only).\n(99) Undertakings.\n(b) Reports on Form 8-K\nPeoples First Corporation filed a current report on Form 8-K dated January 17, 1996 on January 17, 1996 to report the Board of Director's declaration of a 5% stock dividend payable March 18, 1996 to shareholders of record on March 18, 1996; and, the Board of Director's approval of the purchase of up to 400,000 shares of the Company's common stock in the open market.\nPeoples First Corporation filed a current report on Form 8-K dated February 20, 1996 on February 22, 1996 to report the February 20, 1996 signing of a definitive Acquisition Agreement with Guaranty Federal Savings Bank (Guaranty FSB). The agreement provides for the acquisition by the Company of 100% of Guaranty FSB's outstanding capital stock, subject to approval of the shareholders of Guaranty FSB and regulators.\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\/20\/96 \/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\/20\/96 Aubrey W. Lippert of the Board\n\/s\/ Allan B. Kleet Principal Accounting Officer 03\/20\/96 Allan B. Kleet\n\/s\/ William R. Dibert Director 03\/20\/96 William R. Dibert\n\/s\/ Joe Dick Director 03\/20\/96 Joe Dick\n\/s\/ Richard E. Fairhurst, Jr. Director 03\/20\/96 Richard E. Fairhurst, Jr.\n\/s\/ William Rowland Hancock Director 03\/20\/96 William Rowland Hancock\n\/s\/ Dennis W. Kirtley Director 03\/20\/96 Dennis W. Kirtley\nSignature Title Date _____________________ ______________________ ________\n\/s\/ Jerry L. Page Director 03\/20\/96 Jerry L. Page\n\/s\/ Rufus E. Pugh Director 03\/20\/96 Rufus E. Pugh\n\/s\/ Victor F. Speck, Jr. Director 03\/20\/96 Victor F. Speck, Jr.\nINDEX TO EXHIBITS Page _______________________________________________________________________________\n(21) Subsidiaries of Registrant 67\n(23) Consent of KPMG Peat Marwick LLP, independent public accountants 68\n(27) Financial Data Schedules (SEC only) 69\n(99) Undertakings 71","section_6":"","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 Company operates principally in a single business segment offering general commercial and savings bank services. The following table provides certain subsidiary, parent company and consolidated information for 1995:\nEARNING ASSETS Average earning assets of the Company for 1995, increased 6.3%, or $70.4 million to $1,184.5 million from $1,114.1 million for 1994. This compares to growth of earning assets, excluding the purchase of three branch bank locations in 1992, of 5.0% and 3.4%, for 1994 and 1993, respectively. Loan growth during the last three years has been partially funded with reductions in 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 95.1% for 1995, compared to 94.6% and 94.2% for 1994 and 1993, respectively. Loans are the Company's primary earning asset. Management believes the Company should be a prominent lender. Average loans for 1995 increased 14.6%, or $110.4 million, to $865.7 million. Internal average loan growth for 1994 and 1993 was 14.4% and 8.6%, respectively. The changing mix of earning assets was favorable during the last two years. Average loans for 1995 were 73.1% of\nof total average earning assets, compared to 67.8% and 62.2% during 1994 and 1993, respectively. Prior to 1993, loans had been a decreasing portion of earning assets. Management's desire for promininence in area lending and a slowed growth of deposits used for investment in securities has lead to the improved earning asset composition.\nTable 2 Average Earning Assets Year ended December 31, 1995 1994 1993 _______________________________________________________________________________ (dollars in thousands)\nTotal average earning assets $1,184,526 $1,114,118 $1,060,786 Percent of average earning assets Average loans 73.1% 67.8% 62.2% Average securities 26.7 31.9 36.8 Average other earning assets 0.2 0.3 1.0\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 securities and the principal collected on mortgage-backed securities was used to fund loan growth. Average securities decreased $39.0 million during 1995 and $34.9 million during 1994. The Company maintains a portfolio of securities held for sale as an available source of funding for loan growth. U. S. treasury and agency obligations represent approximately 75.5% of the securities portfolios at December 31, 1995.\nAt December 31, 1995, mortgage-backed securities which included Real Estate Mortgage Investment Conduit (REMIC) and CMO instruments were approximately 51.8% of the securities portfolios, compared to approximately 46.0% at December 31, 1994. The REMIC issues are 100% U. S. agencies issues. The CMO issues are marketable, collateralized mortgage obligations backed by agency-pooled collateral or whole-loan collateral. All nonagency issues held are currently rated AA or AAA by either Standard & Poors or Moody's. Approximately 19.4% of the mortgage-backed securities are floating-rate issues, the majority being indexed to the Constant Maturity Treasury index. Management's normal practice is to purchase securities at or near par value to reduce risk of premium write-offs resulting from unexpected prepayments.\nAt December 31, 1995, the Company did not have any structured notes (as currently defined by regulatory agencies) in the securities portfolios since management believes the uncertainty of cash flows from these securities, which are driven by interest-rate movements, could expose the Company to greater market risk than traditional securities.\nFUNDING Average 1995 deposits increased 2.7%, or $27.0 million to $1,022.6 million from $995.6 million for 1994. Local markets for deposits are competitive. Core deposits, the Company's most important and stable funding source, are a decreasing portion of average interest-bearing liabilities. The core deposit base is supplemented with brokered deposits, short-term and long-term borrowings to fully fund loan growth. Average brokered deposits amounted to $24.7 million, $22.1 million and $8.0 million for the years ended December 31, 1995, 1994 and 1993, respectively. Average short-term and long-term borrowings were $94.3 million for 1995, up from $65.1 million for 1994 and $49.7 million for 1993.\nTable 4 Average Interest-bearing Liabilities 1995 1994 1993 _______________________________________________________________________________ (dollars in thousands)\nTotal average interest-bearing liabilities $1,035.5 $976.6 $939.7 Percent of average total interest- bearing liabilities Average core deposits 88.4% 90.9% 93.8% Average short-term borrowings 8.3 5.3 3.4 Average long-term borrowings 0.8 1.4 1.9\nManagement anticipates an increasing need to rely on more volatile purchased liabilities. The Company's subsidiary banks have obtained various short-term and long-term advances from the Federal Home Loan Bank (FHLB) under Blanket Agreements for Advances and Security Agreements (Agreements). The Agreements entitle the subsidiary banks to borrow additional funds from the FHLB to fund mortgage loan programs and satisfy other funding needs.\nNONPERFORMING ASSETS AND RISK ELEMENTS As illustrated in Table 5, nonperforming assets, which include nonperforming loans and foreclosed property, have generally declined over the last three years. Nonperforming assets as a percentage of total loans and other real estate declined to 0.58% at December 31, 1995 compared to 0.60% and 0.86% at December 31, 1994 and 1993, respectively. A small number of loans and one tract of undeveloped land, portions of which have been sold, represent most of the nonperforming balance for the last three years. The decline in nonperforming assets reflects good economic conditions in the area and the Company's comphrehensive loan administration and workout procedures. Also, diversification within the loan portfolio is an important means of reducing inherent lending risks. At December 31, 1995, 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 even though the nonperforming totals are significantly lower than peer bank holding company ratios. A significant focus on underwriting standards is maintained by management and the subsidiary bank boards. Internal credit review procedures are designed to alert management of possible credit problems which\nwould create serious doubts as to the future ability of borrowers to comply with loan repayment terms. At December 31, 1995, loans with a total principal balance of $14.3 million have been identified that may become nonperforming in the future, compared to $14.8 million at December 31, 1994 and $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.\nCAPITAL RESOURCES AND DIVIDENDS The Company's strong capital position and overall financial strength provide flexibility when management evaluates opportunities to improve stockholder value. Stockholders' equity was 10.0% of assets at December 31, 1995, an increase from 9.1% at December 31, 1994. Exclusive of unrealized net gain and loss on securities held for sale, net of applicable income taxes, stockholders' equity increased $12.4 million, or 10.8%, during 1995, and increased $10.4 million, or 9.9%, during 1994. The capital base has been strengthened through earnings retention and issuance of common stock through various shareholder and employee plans. The earnings retention rate, which the board of directors adjusts through declaration of cash dividends, was 68.2% for 1995, 70.9% for 1994 and 73.7% for 1993. Proceeds from the sale of common stock through shareholder and employee plans amounted to $2.2 million in 1995, $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 1995 stockholders' equity was increased by $5.6 million, for 1994 was decreased by $6.5 million and for 1993 was increased by $1.9 million to record the change during the year in the fair value of securities held for sale. The board of directors develops and reviews the capital goals and policies of the consolidated entity and each of the subsidiary banks. The Company's capital policies are designed to retain sufficient amounts for healthy financial ratios, considering future planned asset growth and to leverage stockholders' equity to a desirable degree. Subsidiary bank dividends are the principal source of funds for the Company's payment of dividends to its stockholders. At December 31, 1995, approximately $23.9 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.\nThe board of directors raised the quarterly dividend to $0.109 per share in the third quarter of 1994 and to $0.143 per share in the third quarter of 1995. Stock dividends of 5% were declared in April 1995 and in Janaury 1996. On Janaury 17, 1996, the board of directors approved the purchase of up to 400,000 shares of the Company's common stock in the open market during the following eighteen to twenty-four month period. Shares acquired may be used in conjunction with the Company's stock dividend program.\nAn important measure of capital adequacy of a banking institution is its risk-based capital ratios. Bank regulatory agencies' minimum capital guidelines assign relative measures of credit risk to balance sheet assets and off-balance sheet exposures. Based upon the nature and makeup of their current businesses and growth expectations, management expects all of the reporting entities' risk-based capital ratios to continue to exceed regulatory minimums. At December 31, 1995 and 1994, the Company and the subsidiary banks' ratios were as follows:\nRESULTS OF OPERATIONS Net income increased 13.0% in 1995, reaching a record level of $14.8 million, compared to an increase of 2.3% in 1994 when net income totaled $13.1 million. On a per common share basis, net income increased 11.3% to $1.57 per share for the year ended December 31, 1995, compared to an increase of 2.9% to $1.41 per share for the year ended December 31, 1994. Net income per common share for the fourth quarter of 1995 increased 18.9% to $0.44 from $0.37 for the fourth quarter of 1994. The earnings increases were primarily due to increased interest income due in part to strong loan demand in 1995 and 1994. Reductions in deposit insurance expense due to the level of FDIC capitalization and the absence of acquisition related expense contributed to the 1995 earnings increase. Earnings performance for 1994 was negatively impacted by transaction costs of approximately $0.06 per share related to two acquisitions completed during the year.\nReturn on average stockholders' equity for the years ended December 31, 1995, 1994 and 1993 was 12.46%, 12.15% and 12.92%, respectively. Return on average assets for the years ended 1995, 1994 and 1993 was 1.19%, 1.11% and 1.14%, respectively.\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. Measured on a fully taxable equivalent (TE) basis, net interest income for the year ended December 31, 1995, increased 4.0%, or $1.9 million to $49.5 million compared to $47.6 million for 1994. For the year ended December 31, 1994, net interest income (TE) increased 5.8%, or $2.6 million from $45.0 million for 1993. As expected, 1995's increase is attributable to growth in the volume of average earning assets while the net interest margin decreased 10 basis points from 1994. Substantially all of 1994's increase is attributable to growth in the volume of average earning assets. Net interest income (TE) as a percent of average earning assets was 4.18%, 4.28% and 4.24% for the years ended December 31, 1995, 1994 and 1993, respectively.\nThe Company's concentration in residential real estate loans, competition for increased loan volumes and reliance on time deposits and non-core funding results in narrower interest spreads. The subsidiary banks generally maintain a relatively balanced position between volumes of rate-repricing assets and\nliabilities to guard to some degree against adverse effects to net interest income from possible fluctuations in interest rates. 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. The provision for loan losses amounted to $2.2 million for 1995, an increase of 29.4% compared to $1.7 million in 1994, which was a decrease of 32.0% compared to $2.5 million in 1993. The 1995 increase was required to reflect the growth in outstanding loans and chargeoffs. The 1994 decrease was influenced by declines in net charge-offs, nonperforming assets and potential problem loans. The provision for loan losses as a percentage of average loans was 0.25% for the year ended December 31, 1995, up from 0.23% for the year ended December 31, 1994 and compared to 0.38% for the year ended December 31, 1993.\nNet loan chargeoffs over the last three years were at levels below historical trends. Net chargeoffs for 1995 were $1.0 million compard to $0.3 million for 1994 and $0.4 million for 1993. As a percentage of average loans, net chargeoffs were 0.11% for 1995, up from 0.03% for 1994 and 0.07% for 1993, periods of unusually low net chargeoffs. Net chargeoffs as a percent of average loans were 0.21% for the five-year period ended December 31, 1995. The allowance for loan losses 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. At December 31, 1995, the allowance for loan losses is 1.46% of outstanding loans compared 1.51% of outstanding loans at December 31, 1994. The December 31, 1995 allowance is 251% of nonperforming assets compared to 252% at December 31, 1994.\nNONINTEREST INCOME Fees from traditional deposit services as well as revenues from insurance, brokerage activities and other commission business have been increased by management's focus on improving all areas of noninterest income during the last three years. Noninterest income amounted to $8.0 million in 1995, a 12.7% increase compared to $7.1 million in 1994 which was an increase of 6.0% compared to $6.7 million in 1993. Excluding net securities gains, the 1995 and 1994 increases were more comparable and were 11.6% and 9.1%, repectively.\nService charges on deposit accounts, the largest component of noninterest income, increased 4.1% in 1995 and 11.2% in 1994. Net gains of $178,143, $62,309 and $230,642, were recognized in 1995, 1994 and 1993, respectively. Securities held for sale, primarily mortgage-backed securities, totaling $12.1 million, $11.9 million and $21.9 million, respectively, 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.\nThe Company has shown small growth in the amount of trust assets managed. Fees from personal and pension lines of business for the last three years have been relatively the same. The 41.3% and 48.3% increases in insurance commissions in 1995 and 1994, over prior respective years, are 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 1995 and 1994 were lower than 1993 due to the unusually large amount of home refinancing in 1993. In 1995, the Company sold its student loan portfolio and changed to a fee income program from the previous practice of originating and holding the loans. The Company made available two new financial services during 1994 to bank customers. Management believes that investment brokerage services and property and casualty insurance products made available in 1994 will generate a higher level of fees in 1996 than in the first two introductory years. The relative improvement in fee income is slightly more than the growth in net interest income. Noninterest income excluding securities gains was 13.7% of total net tax-equivalent interest income plus noninterest income for 1995, compared to 12.9% for 1994 and 12.5% for 1993. Management expects this trend to continue into 1996.\nNONINTEREST EXPENSE After rising in 1994, the ratio of noninterest expense net of noninterest income exclusive of securities gains to average total assets fell in 1995. The ratio was 1.96% for 1995, 2.15% for 1994 and 2.03% for 1993. Since internal asset growth has slowed, management continues to focus on controlling the rate of increase of noninterest expense by reconfiguring certain functions to gain more employee productivity. The Company consolidated six of the previously separate corporate subsidiaries into one bank during 1995 and 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.\nNoninterest expense decreased 0.3% in 1995 due to reduced deposit insurance rates and the absence of merger-related professional fees. This compares to an increase of 10.1% in 1994 when all categories of noninterest expense rose. Salaries and employee benefits increased 6.0% in 1995, compared to 6.3% in 1994. Staffing levels were approximately the same at December 31, 1995 and 1993. The Company has made investments in facilities and equipment of approximately $6.9 million during the last three years as technology has advanced and the need to leverage personnel costs has intensified. Occupancy expense increased 5.5% in 1995 and 6.2% in 1994. Equipment expense increased 13.2% in 1995 and 16.2% in 1994 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 a five year or shorter period. Management plans to continue to invest in techology for new product delivery systems.\nThe Federal Deposit Insurance Corporation (FDIC) currently administers two separate deposit insurance funds, the Bank Insurance Fund (BIF) and the Savings Association Insurance Fund (SAIF). The BIF and SAIF were established primarily\nto insure the depositors of insured banks and savings associations and to finance the resolution of failed institutions. The Company's lead bank subsidiary pays deposit insurance premiums to the BIF and the Company's other subsidiary pays deposit insurance premiums to the SAIF based on a rate applied to their respective assessable deposits. Beginning in 1993, the assessments were based not only on deposits but also on the risk characteristics of the individual financial institutions. Both of the Company's subsidiaries received the lowest applicable deposit assessment rates from the FDIC.\nAssessments for deposit insurance were $1.3 million, $2.3 million and $2.1 million in 1995, 1994 and 1993, respectively. The decrease in FDIC insurance expense is attributable to a BIF refund and rate reduction. During September 1995, as a result of the stability of the commercial bank industry and the level of insurance fund reserves, the FDIC refunded the lead bank a portion of the deposit-insurance premiums paid and reduced rates. The Company accounted for the BIF refund in the third quarter when received as a component of operating income.\nCongress is considering a variety of legislation that will recapitalize the SAIF through a special assessment on the assessable deposits of SAIF member institutions such as the Company's savings association subsidiary. At December 31, 1995, the Company had not accrued a liability for the potential special assessment. The expense for any special assessment will be recorded as a component of operating income in the period of the enacted legislation. Management estimates the special assessment will be between $1.2 million and $1.5 million and payable in the second quarter of 1996. The legislation may provide for lower premiums following the special assessment. For 1996, management currently believes lower BIF and SAIF rates will generally offset the expense of the anticipated special SAIF assessment.\nIncreased data processing expense is attributable to a greater volume of activ- ity, the outsourcing of a portion of some functions and one-time system conversion costs incurred mainly in 1994. The increase was 5.7% in 1995 and 13.2% in 1994. Some reduction in Kentucky Bankshare taxes occurred in 1995 due to the consolidation of the six separate banking corporations. Kentucky has raised the assessment level and has been attempting to significantly increase this taxation, which is based upon net income and capital of the subsidiaries. The Company's bank subsidiaries are required to to maintain significant noninterest-bearing balances with the Federal Reserve and to pay fees to regulatory agencies for periodic examinations by the agencies.\nDuring 1994, the Company completed two pooling-of-interest acquisitions. Included in other noninterest expense for 1994 and 1993 is approximately $561,000 and $145,000, respectively, of professional fees related to these acquisitions.\nINCOME TAXES Increases in income tax expense are attributable to higher operating earnings and higher effective tax rates. The Company's effective income tax rate was 30.4%, 29.4% and 27.3%, for the years ended December 31, 1995, 1994 and 1993,\nrespectively. The 1% federal income tax rate increase mandated by the Omnibus Budget Reconciliation Act of 1993 and a continued decline in the amount of tax-exempt income as a percentage of operating income has increased the effective rate. Also increasing the rate for 1994 was nondeductible organizational costs associated with two mergers. 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 of liquidity for the banks, in addition to loan repayments, is their debt securities portfolios. 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 locations in twelve 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. 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. A balance-sheet analysis is conducted to determine the impact on net interest income for the following twelve months under several interest-rate scenarios. One scenario uses current rates at December 31, 1995 and holds the rates and volumes constant for the simulation. When this projection is subjected to immediate and parallel shifts in interest rates (rate shocks) of 200 basis points, both rising and falling, the annual impact of the rate shock at December 31, 1995 on the Company's projected net interest income margin was less than five basis points. Currently, the Company does not employ interest rate swaps, financial futures or options to affect interest rate risks.\nManagement made the following assumptions in preparing the Interest Rate Sensitivity Analysis:\n1 Assets and liabilities are generally scheduled according to their earliest repricing dates regardless of their contractual maturities. 2 Nonaccrual loans are included in the rate-sensitive category. 3 The scheduled maturities of mortgage-backed securities assume principal prepayments on dates estimated by management, relying primarily on current and concensus interest-rate forecasts in conjunction with historical prepayment schedules. 4 Transaction and savings deposits that have no contractual maturities are scheduled according to management's best estimate of their re- pricing in response to changes in market rates.\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 are 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, the 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' Reports _______________________________________________________________________________\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, 1995 and 1994, 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, 1995. 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, 1995 and 1994, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1995, in conformity with generally accepted accounting principles.\n\/s\/ KPMG Peat Marwick LLP\nSt. Louis, Missouri January 26, 1996\nDecember 31, December 31, CONSOLIDATED BALANCE SHEETS 1995 1994 ________________________________________________________________________________ (in thousands)\nASSETS Cash and due from banks $37,524 $39,333 Securities held for sale 146,322 129,682 Securities held for investment 160,320 203,845 Loans 914,497 805,947 Allowance for loan losses (13,371) (12,188) --------- --------- Loans, net 901,126 793,759 Excess of cost over net assets of purchased subsidiaries 9,248 10,077 Premises and equipment 18,226 16,980 Other assets 14,830 16,880 --------- --------- $1,287,596 $1,210,556 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Deposits Demand deposits $86,360 $87,985 Interest-bearing transaction accounts 291,539 243,910 Savings deposits 83,607 98,571 Time deposits 585,598 568,117 --------- --------- 1,047,104 998,583 Short-term borrowings 93,469 84,567 Long-term borrowings 7,757 9,536 Other liabilities 11,094 7,607 --------- --------- Total liabilities 1,159,424 1,100,293\nStockholders' Equity Common stock 7,207 6,422 Surplus 53,269 34,859 Retained earnings 66,878 73,739 Unrealized net gain (loss) on securities held for sale 926 (4,624) Debt on ESOP shares (108) (133) --------- --------- 128,172 110,263 --------- --------- $1,287,596 $1,210,556 ========= =========\nFair value of securities held for investment $165,042 $200,092 Common shares issued and outstanding 9,225 9,062\nSee accompanying notes to consolidated financial statements. 31\nYear Ended December 31, CONSOLIDATED STATEMENTS OF INCOME 1995 1994 1993 ________________________________________________________________________________ (in thousands except per share data)\nINTEREST INCOME Interest on short-term investments $160 $169 $335 Taxable interest on securities 16,082 17,493 20,006 Nontaxable interest on securities 4,017 4,305 4,413 Interest and fees on loans 78,487 62,437 56,091 ------ ------ ------ 98,746 84,404 80,845 INTEREST EXPENSE Interest on deposits 45,608 35,710 35,761 Other interest expense 5,544 3,145 2,236 ------ ------ ------ 51,152 38,855 37,997 ------ ------ ------ Net Interest Income 47,594 45,549 42,848 Provision for Loan Losses 2,167 1,723 2,541 ------ ------ ------ Net Interest Income after Provision for Loan Losses 45,427 43,826 40,307\nNoninterest Income 8,037 7,101 6,683 Noninterest Expense 32,251 32,337 29,373 ------ ------ ------ Income Before Income Tax Expense 21,213 18,590 17,617 Income Tax Expense 6,446 5,465 4,807 ------ ------ ------ NET INCOME $14,767 $13,125 $12,810 ====== ====== ======\nNet Income per Common Share $1.57 $1.41 $1.37\nCash Dividends per Common Share 0.50 0.41 0.36\nSee accompanying notes to consolidated financial statements. 32\nSee accompanying notes to consolidated financial statements. 33\nSee accompanying notes to consolidated financial statements. 35\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Peoples First Corporation (Company) through its subsidiaries, Peoples First National Bank and Trust Company and First Kentucky Federal Savings Bank, operates principally in a single business segment offering 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. Estimates and assumptions involve future events and may change.\nThe more significant accounting 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 acquired subject to purchase accounting are included from the dates of acquisition. In accordance with purchase accounting, assets and liabilities of purchased companies are stated at fair values, less accumulated amortization and depreciation since the dates 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\nother 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 separate component of stockholders' equity until realized. Securities for which the Company has the ability and positive intent to hold until maturity are classified as securities held for investment 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.\nCertain changes in circumstances and other events that are isolated, nonrecurring and unusual for the Company that could not have been reasonably anticipated may cause the Company to change its intent to hold a certain security to maturity without necessarily calling into question its intent to hold other securities for investment.\nRealized gains or losses on securities held for sale or investment are accounted for using the specific security. A decline in the fair value of any security held for sale or investment below cost that is deemed other than temporary results in a charge to earnings and the establishment of a new cost basis for the security. 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.\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 loss recognition. 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. 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.\nThe Company recognizes interest income on nonaccrual impaired loans equal to the amount of interest received, if any, in cash. All changes in the present value of estimated future cash flows are recorded as an adjustment to the allowance for loan losses and ultimately the provision for loan losses. No interest income is recognized for changes in present value attributable to the passage of time.\nDuring May 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 122, \"Accounting for Mortgage Servicing Rights\", (FAS 122) which requires that a mortgage banking enterprise recognize as separate assets the rights to service mortgage loans for others at the orgination or purchase date of the loans when the enterprise has definitive plans to sell or securitize the loans and retain the mortgage servicing rights, assuming the fair value of the loans and servicing rights may be practically estimated. Otherwise, servicing rights should be recognized when the underlying loans are sold or securitized, using an allocation of total cost of the loans based on the relative fair values at the date of sale. FAS 122 also requires an assessment of capitalized mortgage servicing rights for impairment to be based on the current fair value of those rights. FAS 122 is required to be applied prospectively in fiscal years beginning after December 15, 1995. The Company does not believe FAS 122 will have a material effect on its financial position.\nALLOWANCE FOR LOAN LOSSES The allowance for loan losses 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. The allowance for loan losses is decreased by charge offs, net of recoveries. 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 loan loss experience, 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.\nThe Company adopted Statement of Financial Accounting Standards No. 114, \"Accounting by Creditors for Impairment of a Loan\", (FAS 114) and Statement of Financial Accounting Standards No. 118, \"Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures\", (FAS 118) effective for the year beginning January 1, 1995. As a result of applying FAS 114, as amended by FAS 118, certain impaired loans subject to the statements are reported 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, by allocating a portion of the allowance for loan losses to such loans. If these allocations cause the allowance for loan losses to be increased, such increase is recorded as provision for loan losses. No adjustment to the provision for loan losses was required due to the adoption of FAS 114 and FAS 118 in the first quarter of 1995.\nEXCESS OF COST OVER NET ASSETS OF PURCHASED SUBSIDIARIES Net assets of subsidiaries acquired in purchase transactions are recorded at fair value at the date of acquisition. The excess of cost over net assets acquired is amortized by systematic charges in the statement of income over the period benefited. Management evaluates the periods of amortization continually to determine whether later events and circumstances warrant revised estimates. Currently, amortization is provided on a straight-line basis over fifteen years. Accumulated amortization was $3.2 million at December 31, 1995 and $2.4 million at December 31, 1994 and amortization expense was $829,884 for each of the years ended December 31, 1995, 1994 and 1993.\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.\nFINANCIAL INSTRUMENTS During 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\" (FAS 119). FAS 119 requires disclosure about the amounts, nature and terms of derivative financial instruments that are not subject to FAS 105, \"Disclosure of Information about Financial Instruments with Off-Balance Sheet Risks and Financial Instruments with Concentrations of Credit Risk\". FAS 119 requires that a distinction be made between financial instruments held or issued for trading purposes and financial instruments held or issued for purposes other than trading.\nFAS 119 was effective for financial statements issued for fiscal years after December 31, 1994. The Company's adoption of FAS 119 had no effect on the consolidated financial statements other than the required disclosure with respect to fixed rate loan commitments.\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\ndifferences between the carrying values of assets and liabilities for financial reporting purposes and the values 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, provision 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.\nPER COMMON SHARE DATA Share and per share information have been adjusted to give effect to stock splits and stock dividends in the three years ended December 31, 1995, including the 5% stock dividend declared in Janaury 1996, and payable in March 1996. Net income per common share is determined by dividing net income by the weighted average number of common shares actually outstanding and common stock equivalents pertaining to common stock options. The average number of shares outstanding including common stock equivalents for 1995, 1994 and 1993 were 9,382,546, 9,302,057 and 9,321,178, 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 cash and due from banks and highly liquid securities puchased with a maturity of three months or less to be cash equivalents.\nRECLASSIFICATIONS Certain amounts in the 1994 and 1993 consolidated financial statements have been reclassified to conform with the 1995 presentation. The reclassifications had no effect on previously reported stockholders' equity or net income.\n2. BUSINESS COMBINATIONS During the three year period ended December 31, 1995, the Company was a party to two business combinations.\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 1,025,098 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 consolidated financial satements for December 31, 1993 include the accounts of First Kentucky for their fiscal year ended September 30, 1993. For the year ended December 31, 1994, consolidated retained earnings were increased $334,814 due to the change in First Kentucky's year end to 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. Immediately prior the acquisition, First Kentucky had total assets of approximately $176.8 million.\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 1,188,333 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. During 1995, Liberty Bank & Trust was merged into Peoples First National Bank and Trust Company. Immediately prior to the acquisition, Libsab had total assets of approximately $141.9 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 period prior to combination: First Results of Operations Company Libsab Kentucky Combined _______________________________________________________________________________ (in thousands)\nTotal revenue $37,586 $5,911 $6,034 $49,531 Net income 9,534 1,520 1,756 12,810\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 $0.06 and $0.02 for 1994 and 1993, respectively.\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, 1995 and 1994 were $11.5 million and $8.2 million, respectively.\n4. SECURITIES HELD FOR SALE AND INVESTMENT The amortized cost and fair value of securities held for sale as of December 31, 1995 and 1994 are summarized as follows:\nGross Gross Securities Held For Sale Amortized unrealized unrealized Fair December 31, 1995 cost gains losses value _______________________________________________________________________________ (in thousands)\nU.S. treasury and agencies $48,370 $467 ($116) $48,721 Mortgage-backed securities 84,591 1,220 (273) 85,538 Federal Home Loan Bank stock 10,534 105 0 10,639 Federal Reserve Bank stock 1,424 0 0 1,424 ------- ------- ------- ------- $144,919 $1,792 ($389) $146,322 ======= ======= ======= =======\nGross Gross Securities Held For Sale Amortized unrealized unrealized Fair December 31, 1994 cost gains losses value _______________________________________________________________________________ (in thousands)\nU.S. treasury and agencies $58,891 $0 ($3,321) $55,570 Mortgage-backed securities 69,304 39 (3,663) 65,680 Federal Home Loan Bank stock 8,248 0 (60) 8,188 Federal Reserve Bank stock 244 0 0 244 ------- ------- ------- ------- $136,687 $39 ($7,044) $129,682 ======= ======= ======= =======\nThe amortized cost and fair value of securities held for investment as of December 31, 1995 and 1994 are summarized as follows:\nSecurities Gross Gross Held for Investment Amortized unrealized unrealized Fair December 31, 1995 cost gains losses value _______________________________________________________________________________ (in thousands)\nU.S. treasury and agencies $23,894 $187 ($13) $24,068 Mortgage-backed securities 73,357 891 (88) 74,160 State and political subdivisions 62,569 3,843 (102) 66,310 Other 500 4 0 504 ------- ------- ------- ------- $160,320 $4,925 ($203) $165,042 ======= ======= ======= =======\nSecurities 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 (3,481) 84,355 State and political subdivisions 67,334 1,579 (1,329) 67,584 Other 2,999 3 (22) 2,980 ------- ------- ------- ------- $203,845 $1,618 ($5,371) $200,092 ======= ======= ======= =======\nProceeds from sales of securities during 1995, 1994 and 1993 were $12,085,690, $11,885,303 and $21,897,188, respectively. Gross gains of $178,143, $62,309 and $252,056 and gross losses of $0, $0 and $21,414 were realized on those sales during 1995, 1994 and 1993, respectively.\nThe amortized cost, estimated fair value and the weighted average yield of securities held for sale and held for investment at December 31, 1995, 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 presented for mortgage-backed securities, as these securities are particularly exposed to prepayments. Management evaluates, on an ongoing 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 Weighted Maturity Distribution Amortized Fair average December 31, 1995 cost value yield _______________________________________________________________________________ (in thousands)\nU.S. treasury and agencies 1 year or less $19,931 $20,001 6.04% Over 1 through 5 years 28,439 28,720 5.70 Mortgage-backed securities 84,591 85,538 6.53 Federal Home Loan Bank stock 10,534 10,639 7.13 Federal Reserve Bank stock 1,424 1,424 6.00 ------- ------- $144,919 $146,322 6.29% ======= =======\nSecurities Held for Investment Weighted Maturity Distribution Amortized Fair average December 31, 1995 cost value yield _______________________________________________________________________________ (in thousands)\nU.S. treasury and agencies 1 year or less $18,860 $18,998 6.46% Over 1 through 5 years 5,034 5,070 6.00 Mortgage-backed securities 73,357 74,160 6.62 State and political sudivisions 1 year or less 3,779 3,803 6.18 Over 1 through 5 years 18,976 19,979 6.13 Over 5 through 10 years 25,389 27,385 6.54 Over 10 years 14,425 15,143 5.75 Other 1 year or less 100 100 8.25 Over 10 years 400 404 8.65 ------- ------- $160,320 $165,042 6.43% ======= =======\nAt December 31, 1995 and 1994, securities with carrying values of approxi- mately $145.1 million and $135.4 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 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, 1995 and 1994, total loans to any group of customers engaged in similar activities and having similar economic characteristics, 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, 1995 1994 _______________________________________________________________________________ (in thousands)\nCommercial, financial and agricultural $113,929 $111,929 Real estate Construction 19,386 19,421 Residential mortgage 364,607 318,551 Commercial mortgage 158,429 139,629 Consumer, net of unearned income of $12,980 and $11,340 at December 31, 1995 and 1994 255,975 214,309 Loans held for sale 708 156 Other 1,463 1,952 ------- ------- $914,497 $805,947 ======= =======\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 borrower. Collateral varies but may include accounts receivable, inventory, property, plant and equipment, income producing commercial properties, real estate and other property owned by the borrowers.\nActivity in the allowance for loan losses was as follows for the three-year period ended December 31, 1995:\nAllowance for Loan Losses Year Ended December 31, 1995 1994 1993 _______________________________________________________________________________ (in thousands)\nBalance at beginning of year $12,188 $10,715 $8,606 Provision charged to expense 2,167 1,723 2,541 Loans charged off (1,307) (686) (1,044) Recoveries of loans previously charged off 323 436 612 ------ ------ ------ Net loans charged off (984) (250) (432) ------ ------ ------ Balance at end of year $13,371 $12,188 $10,715 ====== ====== ======\nNonaccrual and renegotiated loans totaled $4.7 million and $3.3 million at December 31, 1995 and 1994, respectively. Beginning in 1995, loans except, large groups of smaller-balance homogeneous loans, for which the full collection of principal and interest is not probable, or a delay in payments is expected, are evaluated for impairment. The Company measures and reports impaired loans that are within the scope of FAS 114 at either the present value of expected future cash flows discounted at the loan's effective rate, the market price of the loan, or fair value of the underlying collateral if the loan is collateral dependent. Prior accounting did not discount cash flows and only considered loss of principal, not loss of interest, when measuring troubled loans. Information regarding impaired loans at December 31, 1995 is as follows:\nImpaired Loans December 31, 1995 __________________________________________________________________ (in thousands)\nBalance of impaired loans $4,109 Less portion for which no allowance for loan losses is alloacated 308 ------ Portion of impaired loan balance for which an allowance for loan losses is allocated $3,801 ====== Portion of allowance for loan losses allocated to the impaired loan balance $829 ======\nInformation regarding impaired loans is as follows for the year ended December 31, 1995:\nImpaired Loans Year Ended December 31, 1995 __________________________________________________________________ (in thousands)\nAverage investment in impaired loans $4,258 Interest income recognized on impaired loans 378 Interest income recognized on impaired loans on cash basis 0\nCertain officers and directors of the Company 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 time for comparable transactions with other customers and did not involve more than the normal risk of collectibility. The activity of these loans during the years ended December 31, 1995 and 1994 is summarized below:\nLoans to Officers and Directors Year Ended December 31, 1995 1994 _______________________________________________________________________________ (in thousands)\nBalance at beginning of year $11,825 $20,663 Additions 2,165 4,230 Repayments (631) (1,087) Changes in officer and director status 86 (11,981) ------ ------ Balance at end of year $13,445 $11,825 ====== ======\n6. PREMISES AND EQUIPMENT A summary of premises and equipment is as follows:\nDecember 31, 1995 1994 _______________________________________________________________________________ (in thousands)\nLand $2,394 $2,264 Buildings 18,421 17,502 Equipment 12,432 11,157 Leasehold improvements 985 1,084 Construction in progress 764 156 ------ ------ 34,996 32,163 Accumulated depreciation and amortization (16,770) (15,183) ------ ------ $18,226 $16,980 ====== ======\nThe amount of depreciation and amortization related to premises and equipment that was charged to operating expenses in 1995, 1994 and 1993 was $1,857,202, $1,650,659 and $1,426,263, 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 1995 1994 1993 ________________________________________________________________________________ (dollars in thousands)\nFederal funds purchased Average balance $13,414 $21,171 $10,980 Year end balance 15,100 41,500 12,600 Highest month-end balance 35,000 41,500 23,700 Average interest rate 6.07% 4.63% 3.23% Year end interest rate 5.60% 6.12% 3.30% Repurchase agreements Average balance $25,794 $22,702 $20,781 Year end balance 23,869 21,567 19,902 Highest month-end balance 32,120 24,090 22,883 Average interest rate 4.64% 3.50% 3.23% Year end interest rate 4.05% 4.08% 3.27% Short-term FHLB advances Average balance $46,733 $7,581 $0 Year end balance 54,500 21,500 0 Highest month-end balance 54,500 21,500 0 Average interest rate 6.19% 5.18% -- Year end interest rate 5.85% 6.16% --\nAt December 31, 1995, the subsidiary banks had total lines-of-credit for Federal funds purchased from unaffiliated banks of $54.0 million, of which $38.9 million was undrawn and available.\n8. LONG-TERM BORROWINGS Information pertaining to long-term borrowings is summarized below:\nDecember 31, 1995 1994 __________________________________________________________________ (in thousands)\nParent Company Bank loan for subsidiary acquisition $0 $1,530 Subsidiaries Federal Home Loan Bank advances 7,649 7,873 Employee Stock Ownership Plan debt 108 133 ------ ------ $7,757 $9,536 ====== ======\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, payable quarterly at the lender's prime rate, was adjustable on a daily basis (8.50% at December 31, 1994). The note provided for quarterly principal payments of $261,604 and a final maturity in May 2004. The Company retired the debt during 1995.\nThe subsidiary banks obtain various short-term and long-term advances from the FHLB under Blanket Agreements for Advances and Security Agreements (Agreements). The Agreements entitle the subsidiary 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, 1995, all 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, other securities in the approximate amount of $13.0 million and certain single-family first mortgage loans in the approximate amount of $269.0 million. 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 $7.5 million at December 31, 1995. 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 an unaffiliated 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 stock of the subsidiary. Interest is payable quarterly at the lender's prime rate less 0.50% which can be adjusted daily (9.75% at December 31, 1995 and 9.50% at December 31, 1994). 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 1996 through 2000 are $435,350, $470,913, $426,343, $459,106 and $468,359, 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, 1995 and 1994 are summarized as follows:\nFinancial Instruments with Off-Balance-Sheet Risk December 31, 1995 1994 _______________________________________________________________________________ (in thousands)\nContractual commitments to extend credit $115,788 $101,132 Standby letters of credit 10,894 4,327\nOf the total commitments to extend credit at December 31, 1995 and 1994, $99,072 and $0, respectively, 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 $215,360, $201,696 and $208,983 for the years ended 1995, 1994 and 1993, respectively. The ESOP's investments include 307,142 and 281,348 shares of the Company's common stock at December 31, 1995 and 1994, respectively.\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, 1995, 1994 and 1993, the Company's required matching contribution amounted to $243,924, $225,583 and $184,472, respectively. Employees have several investment options in which 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) and First Kentucky Federal Savings Bank (First Federal) as soon as reasonably practicable. Liberty's and First Federal's defined benefit retirement plans will be terminated. Liberty's employees became 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 Service and Department of Labor requirements are met. The plan terminations should have no material 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 retired employee's expense. There was no cost for employee benefits for retired employees in 1995, 1994 and 1993.\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 1,146,600 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 payment month. At December 31, 1995 and 1994, 791,189 shares and 859,625 shares were reserved for issuance under the DRIP. Shares issued under the DRIP totaled 68,436, 44,781 and 37,388 shares in 1995, 1994 and 1993, 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. Currently, no compensation cost is recognized for the Company's Option Plan. Outstanding stock options are considered common stock equivalents in the computation of net income per common share.\nDuring October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation\" (FAS 123). For fiscal years beginning after December 15, 1995, FAS 123 requires new footnote disclosures about stock compensation awards based upon their fair value on the date granted. FAS 123 also permits companies to switch to the fair value method to record compensation costs for new and modified employee stock options. The footnote disclosure requirements include provisions to show pro forma net income and net income per share as if the fair value accounting had been adopted. The Company plans to continue its current\naccounting practices and not elect to recognize compensation costs in the consolidated statements of income. Pro forma disclosures will be provided in 1996.\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 cash dividends by the Company to its shareholders, are subject to various national and\/or state regulatory restrictions. At December 31, 1995, total retained earnings of the Company's direct subsidiaries was approximately $75.1 million, of which $23.9 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, 1995 and 1994, 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, 1995 1994 1993 _______________________________________________________________________________ (in thousands)\nCurrent taxes $6,762 $6,397 $6,119 Deferred taxes (316) (932) (1,312) ----- ----- ----- Income tax expense $6,446 $5,465 $4,807 ===== ===== =====\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, 1995 1994 1993 _______________________________________________________________________________ (in thousands)\nTax computed at statutory rates $7,425 $6,407 $6,020 Increase (decrease) in taxes resulting from: Tax-exempt income (1,328) (1,413) (1,562) Goodwill amortization 290 290 290 Other, net 59 181 59 ----- ----- ----- Income tax expense $6,446 $5,465 $4,807 ===== ===== =====\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, 1995 1994 _______________________________________________________________________________ (in thousands)\nDeferred tax assets: Allowance for loan losses $4,272 $3,824 Deferred compensation 431 424 Other real estate owned 181 171 Unrealized security loss -- 1,650 Other 74 105 ----- ----- 4,958 6,174 Deferred tax liabilities: Unrealized security gain (125) -- Accrued interest income (89) (93) Premises and equipment (1,335) (1,314) Other (453) (352) ----- ----- (2,002) (1,759) ----- ----- Net deferred tax assets $2,956 $4,415 ===== =====\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\ntaxes have been provided for approximately $2.6 million of income at December 31, 1995 and 1994 which represents allocations for bad debt deductions for tax purposes only. Under existing tax regulations, 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. CONTINGENCIES\nLEGAL PROCEEDINGS In the ordinary course of business, there are various legal proceedings pending against the Company and its subsidiaries. Management, after consultation with legal counsel, is of the opinion that the ultimate resolution of these precedings will have no material effect on the consolidated financial condition or results of operations of the Company.\n14. SUPPLEMENTAL INCOME STATEMENT INFORMATION Details of noninterest income and noninterest expense are as follows:\nYear Ended December 31, 1995 1994 1993 _______________________________________________________________________________ (in thousands)\nNoninterest Income Service charges on deposits $3,831 $3,680 $3,308 Net securities gains 178 62 231 Trust department fees 1,220 1,181 1,199 Insurance commissions 664 470 317 Bankcard fees 658 546 533 Other income 1,486 1,162 1,095 ----- ----- ----- $8,037 $7,101 $6,683 ===== ===== =====\nYear Ended December 31, 1995 1994 1993 _______________________________________________________________________________ (in thousands)\nNoninterest Expense Salaries $13,302 $12,370 $11,591 Employee benefits 2,411 2,450 2,348 Occupancy expense 1,769 1,677 1,579 Equipment expense 1,885 1,665 1,433 FDIC insurance expense 1,338 2,250 2,135 Data processing expense 2,338 2,212 1,954 Bankshare taxes 1,349 1,365 1,253 Goodwill amortization 830 830 830 Other expense 7,029 7,518 6,250 ------ ------ ------ $32,251 $32,337 $29,373 ====== ====== ======\n15. PARENT COMPANY FINANCIAL INFORMATION Following are condensed balance sheets of Peoples First Corporation (parent company only) as of December 31, 1995 and 1994, and the related condensed statements of income and cash flows for the years ended 1995, 1994 and 1993:\nCondensed Balance Sheets December 31, 1995 1994 __________________________________________________________________ (in thousands)\nASSETS Cash in subsidiary bank $797 $492 Investment in subsidiaries 127,105 111,302 Other assets 556 276 ------- ------- $128,458 $112,070 ======= ======= LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities Note payable $0 $1,530 Other liabilities 286 277 ------- ------- Total liabilities 286 1,807\nStockholders' equity Common stock 7,207 6,422 Surplus 53,269 34,859 Retained earnings 66,878 73,739 Unrealized net gain (loss) on securities held for sale 926 (4,624) Debt on ESOP shares (108) (133) ------- ------- 128,172 110,263 ------- ------- $128,458 $112,070 ======= =======\nCommon shares issued and outstanding 9,225 9,062\nCondensed Statements of Income Year Ended December 31, 1995 1994 1993 _______________________________________________________________________________ (in thousands)\nINCOME Dividends from subsidiaries $5,078 $10,878 $5,752 Other income 3 11 7 ------ ------ ------ 5,081 10,889 5,759 EXPENSE Interest expense 44 385 745 Legal and accounting fees 284 571 335 Other expense 378 654 450 ------ ------ ------ 706 1,610 1,530 ------ ------ ------ Income before income tax benefit and equity in undistributed income of subsidiaries 4,375 9,279 4,229 Income tax benefit 164 385 434 Income before equity in ------ ------ ------ undistributed income of subsidiaries 4,539 9,664 4,663 Equity in undistributed income of subsidiaries 10,228 3,461 8,147 ------ ------ ------ NET INCOME $14,767 $13,125 $12,810 ====== ====== ======\nCondensed Statement of Cash Flows Year Ended December 31, 1995 1994 1993 _______________________________________________________________________________ (in thousands)\nOPERATING ACTIVITIES Net income $14,767 $13,125 $12,810 Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed income of subsidiaries (10,228) (3,461) (8,147) Amortization and other, net (271) 134 (16) Net Cash Provided by ------ ------ ------ Operating Activities 4,268 9,798 4,647\nFINANCING ACTIVITIES Proceeds from notes payable 0 3,800 6,200 Repayments of notes payable (1,530) (11,859) (8,712) Proceeds from issuance of common stock 1,418 495 299 Cash dividends paid (3,851) (2,698) (2,012) ------ ------ ------ Net Cash Used by Financing Activities (3,963) (10,262) (4,225)\nNet Increase (Decrease) in Cash 305 (464) 422 and Cash Equivalents Cash and Cash Equivalents at Beginning of Year 492 956 534 ------ ------ ------ Cash and Cash Equivalents at End of Year $797 $492 $956 ====== ====== ======\nSUPPLEMENTAL DISCLOSURES Cash paid for interest expense $53 $405 $716 Cash received for income taxes (345) (711) (365)\nNONCASH INVESTING AND FINANCING TRANSACTIONS Dividends reinvested 753 542 438\n16. 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, ACCRUED INTEREST PAYABLE AND SHORT-TERM BORROWINGS The carrying amount reported for cash, due from banks, accrued interest receiv- able, 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 Loan balances are 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.\nDEPOSITS The fair value for demand deposits and interest-bearing deposits with no fixed maturity date is considered to be equal to the amount payable on demand or maturity 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 The fair value of long-term borrowings is based on a 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 $100,000 for 1995 and 1994.\nThe book values and estimated fair values for financial instruments as of December 31, 1995 and 1994 are reflected below.\nFinancial Instruments December 31, 1995 Book value Fair value _______________________________________________________________________________ (in thousands)\nFinancial Assets Cash and due from banks $37,524 $37,524 Securities held for sale 146,322 146,322 Securities held for investment 160,320 165,042 Loans, net 901,126 944,922 Accrued interest receivable 9,392 9,392\nFinancial Liabilities Deposits 1,047,104 1,055,235 Short-term borrowings 93,469 93,469 Long-term borrowings 7,757 7,721 Accrued interest payable 6,875 6,875\nFinancial Instruments December 31, 1994 Book value Fair value _______________________________________________________________________________ (in thousands)\nFinancial Assets Cash and due from banks $39,333 $39,333 Securities held for sale 129,682 129,682 Securities held for investment 203,845 200,092 Loans, net 793,759 777,877 Accrued interest receivable 8,627 8,627\nFinancial Liabilities Deposits 998,583 996,989 Short-term borrowings 84,567 84,567 Long-term borrowings 9,536 9,536 Accrued interest payable 4,454 4,454\nItem 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nDuring the years ended December 31, 1995, 1994 and 1993 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 EXECUTIVE 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 25, 1996, is incorporated herein by reference.\nThe following table provides information as of December 31, 1995, 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 201,407(1) age 55 President and Chief Executive of the registrant; Chairman of the Board of Peoples Bank\nAllan B. Kleet, Principal Accounting Officer, 1986 67,616(2) age 47 Treasurer and Director of the registrant\nGeorge Shaw, Director, President and Chief 1993 5,181(3) age 50 Executive Officer of Peoples Bank; formerly President and Chief Executive Officer of Bowling Green Bank & Trust Company (1982-05\/93)\n(1) Represents 2.2% of the class of stock. Includes 119,621 shares subject to currently exercisable stock options and 20,463 shares held in Mr. Lippert's ESOP account for which he has voting but no dispositive power.\n(2) Represents less than 1.0% of the class of stock. Includes 675 shares held individually by Mr. Kleet's wife, 62,511 shares subject to currently exercisable stock options and 2,917 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 4,961 shares subject to currently exercisable stock options.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION\nThe information concerning compensation appearing on pages 9 through 13 of Peoples First Corporation's definitive proxy statement, filed with the Securities and Exchange Commission on March 25, 1996, 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 25, 1996, is incorporated herein by reference.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information on page 7 and 8 of Peoples First Corporation's definitive proxy statement, filed with the Securities and Exchange Commission on March 25, 1996, is incorporated herein by reference.\nPART IV\nItem 14.","section_14":"Item 14. EXHIBITS, FINANCIAL STATEMENTS 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 are incorporated herein by reference to Exhibit 3(1) to the Registrant's Form 10-K for the year ended December 31, 1994.\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(10.2)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(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(10.4)Employment agreement among the Company, Liberty Bank & Trust Co. and Steve Story is herein incorporated by reference to Exhibit 99.1 of Form S-4, registration #33-54535 as filed with the Securities and Exchange Commission on July 12, 1994.\n(21) Subsidiaries of Registrant.\n(23) Consent of KPMG Peat Marwick LLP, independent public accountants.\n(27) Financial Data Schedules (SEC use only).\n(99) Undertakings.\n(b) Reports on Form 8-K\nPeoples First Corporation filed a current report on Form 8-K dated January 17, 1996 on January 17, 1996 to report the Board of Director's declaration of a 5% stock dividend payable March 18, 1996 to shareholders of record on March 18, 1996; and, the Board of Director's approval of the purchase of up to 400,000 shares of the Company's common stock in the open market.\nPeoples First Corporation filed a current report on Form 8-K dated February 20, 1996 on February 22, 1996 to report the February 20, 1996 signing of a definitive Acquisition Agreement with Guaranty Federal Savings Bank (Guaranty FSB). The agreement provides for the acquisition by the Company of 100% of Guaranty FSB's outstanding capital stock, subject to approval of the shareholders of Guaranty FSB and regulators.\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\/20\/96 \/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\/20\/96 Aubrey W. Lippert of the Board\n\/s\/ Allan B. Kleet Principal Accounting Officer 03\/20\/96 Allan B. Kleet\n\/s\/ William R. Dibert Director 03\/20\/96 William R. Dibert\n\/s\/ Joe Dick Director 03\/20\/96 Joe Dick\n\/s\/ Richard E. Fairhurst, Jr. Director 03\/20\/96 Richard E. Fairhurst, Jr.\n\/s\/ William Rowland Hancock Director 03\/20\/96 William Rowland Hancock\n\/s\/ Dennis W. Kirtley Director 03\/20\/96 Dennis W. Kirtley\nSignature Title Date _____________________ ______________________ ________\n\/s\/ Jerry L. Page Director 03\/20\/96 Jerry L. Page\n\/s\/ Rufus E. Pugh Director 03\/20\/96 Rufus E. Pugh\n\/s\/ Victor F. Speck, Jr. Director 03\/20\/96 Victor F. Speck, Jr.\nINDEX TO EXHIBITS Page _______________________________________________________________________________\n(21) Subsidiaries of Registrant 67\n(23) Consent of KPMG Peat Marwick LLP, independent public accountants 68\n(27) Financial Data Schedules (SEC only) 69\n(99) Undertakings 71","section_15":""}
{"filename":"23249_1995.txt","cik":"23249","year":"1995","section_1":"Item 1. Business Registrant's principal business is developing, designing and producing, in its own facilities and through unaffiliated contractors, woven and knitted fabrics of natural and synthetic fibers in a wide variety of colors and patterns, for sale to manufacturers (primarily of women's apparel) and to retailers (including chains, department stores and independently owned fabric stores) for resale to the home sewing market. In the fiscal year ended September 3, 1995 (\"fiscal 1995\") 68% of Registrant's fabric sales was to manufacturers and 32% was to retail stores. In the fiscal year ended August 28, 1994 (\"fiscal 1994\") 71% of Registrant's fabric sales was to manufacturers and 29% was to retail stores.\nManufacture and Sale of Fabrics Woven Fabrics Woven fabrics accounted for 69% of fabric sales in fiscal 1995, compared with 70% in fiscal 1994 and 72% in fiscal 1993. All of Registrant's supply of unfinished woven fabrics (\"greige goods\") are made from natural and\/or synthetic fibers by unaffiliated companies, who frequently produce the greige goods to Registrant's specifications. In fiscal 1995, Registrant was able to obtain adequate supplies of greige goods at competitive prices. Registrant purchased substantially all of its greige goods from about 85 suppliers; the five largest suppliers accounted for 36% of Registrant's purchases of greige goods and the largest supplied 13%. In fiscal 1994, Registrant purchased substantially all of its greige goods from about 100 suppliers; the five largest suppliers accounted for 37% of Registrant's purchases of greige goods and the single largest supplied 11%. In fiscal 1993, Registrant purchased its greige goods from about 105 suppliers of which the single largest supplied 12%\nof Registrant's needs. Registrant's greige cloth purchases derive from domestic and imported sources.\nGreige goods purchased by Registrant are printed or dyed and finished by unaffiliated finishers in accordance with Registrant's specifications, or until October, 1995, by Registrant in its Washington, Georgia plant. On October 6, 1995 the Washington Plant was closed (See Item 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties Registrant owns a 23 1\/2-year-old knitting and finishing plant, consisting of approximately 130,000 square feet on one floor, situated on approximately 60 acres of land in Milledgeville, Georgia. The plant generally operates at full productive capacity, which is adequate for Registrant's requirements. Registrant, in fiscal 1986, purchased a 140,000-square foot building on approximately 55 acres of land in Washington, Georgia. On October 6, 1995 Registrant closed this facility and it is currently being offered for sale. See Part I, Item 1. Business for more information concerning this location. Registrant, in fiscal 1987, purchased a 93,000-square foot building on approximately three acres of land in Chino, California. In February, 1994 Registrant sold the machinery and equipment in that facility, and leased the building to a non-affiliated contract dyeing and finishing company for a five year term. See Part I, Item 1. Business and Management's Discussion and Analysis for more information concerning this location. Registrant's Washington facility was closed because Registrant could not secure sufficient business at acceptable margins to adequately fill its capacity. Registrant believes that its Milledgeville, Georgia facility will provide substantially all of its knitting and dyeing and finishing of knitted fabrics requirements.\nRegistrant has entered into leases expiring in 2003 for two floors at 1359 Broadway, New York, New York, consisting of approximately 40,000 square feet which it uses for its executive offices and showrooms. Kat-Em International, Inc. has a lease for office and warehouse space in Los Angeles, California comprised of 40,000 square feet; the lease expires in 1999. (See Note H of Notes to Financial Statements).\nItem 3.","section_3":"Item 3. Legal Proceedings None.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders Not applicable.\nExecutive Officers of Registrant\nThe following table shows the executive officers of Registrant, their respective ages, and all positions presently held with Registrant by each such person.\nName Age Position - ---- --- -------- Alvin Weinstein 70 Chairman of the Board and Director Frank Weinstein 65 Vice Chairman of the Board and Director Earl Kramer 62 President and Director Martin Wolfson 59 Senior Vice President, Treasurer and Director Mark Neugeboren 45 Vice President Joan Weinstein 63 Secretary\nAlvin Weinstein has been Chairman of the Board of Registrant since 1969. Frank Weinstein has been Vice Chairman of the Board since 1979. Alvin and Frank Weinstein are brothers.\nMr. Kramer joined Registrant in June 1972 as President of its Knit Division, with responsibility for supervising and coordinating the various aspects of Registrant's knit operations. In March 1976, Mr. Kramer was\nelected a Vice President of Registrant and was given the additional executive responsibility of supervising the operation of Registrant's dyeing and finishing plant in Washington, Georgia. Mr. Kramer has served as President of Registrant since August 1979.\nMr. Wolfson was elected Senior Vice President in 1995 after having been Vice President since 1981 and Treasurer and a Director of Registrant since 1973. Formerly he had served as Controller of Registrant. He served as Secretary of Registrant from January 1973 to October 1981. Mr. Wolfson is the principal financial officer of Registrant.\nIn January 1985, Mr. Neugeboren was elected a Vice President in Charge of Production. Mr. Neugeboren joined Registrant in 1972 and has held various positions in its production departments.\nIn October 1982, Joan Weinstein (the wife of Alvin Weinstein) was elected Secretary of Registrant. She has been Registrant's Fashion Director since joining Registrant in 1973.\nAll of Registrant's officers hold office until the next annual meeting of Registrant's Board of Directors (scheduled for January 9, 1996) and the election of their successors.\nPART II Item 5.","section_5":"Item 5. Market for the Registrant's Common Stock and Related Security\nHolder Matters\nOn May 27, 1988 Registrant exchanged one share each of Class A and Class B stock of Concord Fabrics Inc. (a Delaware Corporation) for each share of stock previously issued of Concord Fabrics Inc. (a New York Corporation). As of September 3, 1995, the number of record holders of the Registrant's Class A Common Stock was 400 and the number of record holders of Registrant's Class B Common Stock was 374. The principal market on which both classes of\nRegistrant's Common Stock is traded is the American Stock Exchange. The table below sets forth information on the high and low sales prices for such Common Stock for each quarter of fiscal 1995 and 1994.\nRegistrant has not paid cash dividends for many years and has no present intention to do so. The payment of dividends by Registrant is subject to restrictions under the terms of the Note Agreement between Registrant and John Hancock Mutual Life Insurance Company (the \"Note Agreement\"). Under the Note Agreement, cumulative payments for cash dividends and redemption of capital stock are limited to $3,000,000 plus 50% of Consolidated Net Income (as defined) subsequent to August 28, 1994 plus net cash proceeds from the sale of stock; $2,025,000 was available for such payments as of September 3, 1995.\nITEM 6","section_6":"ITEM 6 CONCORD FABRICS INC. AND SUBSIDIARIES\nSELECTED FINANCIAL DATA\nThe year ended September 3, 1995 comprised 53 weeks; the other years presented each comprised 52 weeks.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nFiscal 1995 vs. Fiscal 1994 Fiscal 1995 comprised 53 weeks; fiscal 1994 comprised 52 weeks. Fiscal 1995 results include the operations of Kat-Em International Inc. for a full year. Fiscal 1994 results include the operations of Kat-Em from April 18, 1994, the date it was acquired by Registrant, through August 28, 1994. Net sales decreased 9% from $197,804,544 to $180,152,779. This resulted from a decline in unit sales of 8% and a 1% decline in average selling price. Registrant believes that the decrease in sales reflected decreased consumer spending on domestically manufactured apparel. Gross margins fell from 24.7% in fiscal 1994 to 20.1% in fiscal 1995. This resulted from price competition stemming from reduced consumer demand, inefficiencies and lack of productivity in Registrant's Washington, Georgia manufacturing facility (the plant was closed in October, 1995), higher raw material costs, and inventory mark-downs predominantly in the Kat-Em subsidiary. Registrant expects that the closing of the Washington plant will lead to lower sales but higher gross margins in fiscal 1996. Merchandising expenses increased by approximately $945,000 or 11%. About $700,000 of this was due to the inclusion of the Kat-Em operation for a full year in fiscal 1995 versus a four and one half month period in fiscal 1994. The balance resulted from higher engraving costs associated with the production of more intricate designs on Registrant's printed fabrics. Selling and shipping expenses declined about 2% as a result of the decrease in Registrant's sales. The decrease was less than the actual sales decrease because some of Registrant's selling and shipping expenses do not vary directly with sales but represent sales management cost which are more fixed in nature.\nGeneral and administrative expenses declined almost 7% primarily due to decreased performance related compensation and profit sharing. Registrant's provision for doubtful accounts declined from $1,321,000 in fiscal 1994 to $633,000 in fiscal 1995 because they were no significant customer failures in contrast with fiscal 1994. However, Registrant is continuously exposed to bad debt risk with respect to its wholesale customers when such customers may have significant concentration of business with retailers who may become financially unstable. Registrant attempts to monitor this situation and adjust its credit policies accordingly. Interest expense increased by 36%. In November, 1994 Registrant secured $20,000,000 of long term financing which replaced $9,000,000 of long term debt and added to working capital. The additional $11,000,000 of long term borrowing, although at a lower fixed rate than the debt it replaced in part accounted for substantially all of the increase in interest cost for the year. Average short term debt declined by almost $2,000,000 but average short term borrowing rates were higher in fiscal 1995 so that interest cost on short term debt was marginally higher. In fiscal 1995 Registrant incurred a loss of $2,686,000 (net of an income tax credit of $1,414,000) before an extraordinary item. The loss principally reflected weak demand for Registrant's imported and domestic woven fabrics marketed to apparel manufacturers. The loss included $660,000 (net of tax credit) provision for the shut down of the Washington, Georgia plant. An extraordinary loss of $297,000 (net of income tax credit of $198,000) in connection with a penalty incurred on Registrant's early repayment of a term loan brought the net loss to $2,984,000. In fiscal 1994 Registrant earned $6,444,000 (net of $4,332,000 income taxes). The results included an $860,000 after tax gain from the sale of machinery and equipment.\nFiscal 1994 vs. Fiscal 1993\nFiscal 1994 and fiscal 1993 comprised 52 weeks. Fiscal 1994 results include the operations of Kat-Em from April 18, 1994 (the date it was acquired by Registrant). Net sales increased less than 1% from $197,047,714 to $197,804,544. A decline in unit sales by approximately 3 1\/2% was offset by an increase in average selling price of about 4%. Gross margins rose from 22.2% in fiscal 1993 to 24.7% in fiscal 1994 primarily due to a more favorable product mix comprised of proprietary printed fabric lines and a favorable greige goods market. Increasing greige goods costs are expected to put pressure on future gross margins and may adversely affect operating results. However, Registrant believes that the disposition of the Chino facility will lead to improved operating efficiencies at its Washington, Georgia plant as its solid woven fabric dyeing and finishing needs are concentrated there. Accordingly, gross margins for certain of Registrant's products may improve. In February, 1994 Registrant sold the operating assets of its Chino, California plant for $2,000,000 cash and recognized a pre-tax gain of $1,420,606. Registrant also leased the land and building for a five year period to the buyer. The lessee has an option to purchase the real estate for $2,900,000. Merchandising expenses increased by approximately 8% reflective of higher costs associated with designing and engraving print patterns and 4% due to the acquisition of Kat-Em. Selling and shipping expenses increased by almost 12% as a result of the payment of higher performance related compensation and 3% due to the acquisition of Kat-Em.\nGeneral and administrative expenses increased by almost 10% reflective of higher performance related compensation and 6% due to the acquisition of Kat- Em. Registrant's provision for doubtful accounts declined from $1,777,000 in fiscal, 1993 to $1,321,000 in fiscal, 1994. Interest expense declined by 23% reflective of lower average short term borrowing requirements permitted by cash flow generation from earnings and reduced long term debt as a result of Registrant's scheduled amortization payment thereon. In fiscal 1994 Registrant earned $6,444,000 (net of $4,332,000 income taxes) in fiscal 1993 Registrant earned $4,626,000 (net of $3,133,000 income taxes). The 1994 results included a pre-tax gain of $1,421,000 ($860,000 after tax) from the sale of the Chino, California plant's operating assets. Liquidity and Capital Resources During fiscal 1995, Registrant met its cash needs from cash flow from operations ($1,460,000), issuance and sale of notes ($20,000,000) and the sale of capital stock ($38,000), which it used to invest in plant and equipment ($4,113,000), reduce short term debt ($7,600,000), and repay long term debt ($9,000,000). Cash increased by $785,000. Working capital increased by $6,779,000. Under individual credit line arrangements with several New York banks, Registrant may borrow up to $20,000,000 at the prime lending rate. In addition, the Registrant has a facility of $5,000,000 for letters of credit in connection with the operations of Kat-Em. The credit lines are unsecured. Registrant is generally expected to maintain compensating bank balances. The banks have advised that Registrant has been in substantial compliance with its compensating balance arrangements, and that withdrawal of bank balances is not legally restricted. Amounts borrowed are generally due in 30 to 90 days. Although the lending arrangements are informal and are cancelable at each\nbank's option, Registrant has no reason to believe that the lines of credit will not be available during fiscal 1996. Registrant's actual borrowing fluctuates from month to month. The average outstanding debt during fiscal 1995 was $9,538,000 and the maximum outstanding at any time during the year was $18,000,000. $2,000,00 was outstanding at September 3, 1995. Registrant expects its lines of credit, together with cash management and cash flow from operations, to be adequate to finance operations for fiscal 1996. Registrant's long-term lending agreement with an insurance company which is unsecured, prohibits pledging of assets, and requires (among other things - See Note G to Financial Statements) maintenance of minimum working capital, tangible net worth of $36,166,868 and maintenance of a minimum working capital ratio of 1.5 to 1. The unpaid principal balance is $20,000,000. At September 3, 1995, tangible net worth approximated $39,450,000 and Registrant's working capital ratio was 3.7 to 1. Registrant has met all of the requirements specified in the loan agreement. The loan bears interest at 9.31% a year, and is repayable in seven equal annual installments beginning November, 1998.\nInflation Registrant's operating costs are subject to the general inflationary trends of the rest of the economy; in fiscal 1995 such trends were modest; inflation has not been a significant factor in Registrant's costs for the last three fiscal years.\nITEM 8","section_7A":"","section_8":"ITEM 8 CONCORD FABRICS INC. AND SUBSIDIARIES\n- I N D E X -\nFINANCIAL STATEMENTS\nINDEPENDENT AUDITORS' REPORT\nCONSOLIDATED BALANCE SHEET AS AT SEPTEMBER 3, 1995 AND AUGUST 28, 1994\nCONSOLIDATED STATEMENT OF OPERATIONS AND RETAINED EARNINGS FOR THE YEARS ENDED SEPTEMBER 3, 1995, AUGUST 28, 1994 AND AUGUST 29, 1993\nCONSOLIDATED STATEMENT OF CASH FLOWS FOR THE YEARS ENDED SEPTEMBER 3, 1995, AUGUST 28, 1994 AND AUGUST 29, 1993\nNOTES TO FINANCIAL STATEMENTS\nFINANCIAL STATEMENT SCHEDULE\nSchedule II - Valuation and Qualifying Accounts\nSchedules other than those referred to above have been omitted as the conditions requiring their filing are not present or the information has been presented elsewhere in the financial statements.\n[LETTERHEAD]\nIndependent Auditors' Report\nTo the Board of Directors and Stockholders Concord Fabrics Inc.\nWe have audited the accompanying consolidated balance sheets of Concord Fabrics Inc. and Subsidiaries as at September 3, 1995 and August 28, 1994, and the related consolidated statements of operations and retained earnings and cash flows for each of the three years in the period ended September 3, 1995. 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 Concord Fabrics Inc. and Subsidiaries as at September 3, 1995 and August 28, 1994, and the results of its operations and its cash flows for each of the three years in the period ended September 3, 1995 in conformity with generally accepted accounting principles.\nThe audits of the financial statements were made for the purpose of forming an opinion on those statements taken as a whole. The schedule listed in the index of financial statement schedules 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.\nEISNER & LUBIN ---------------------------- CERTIFIED PUBLIC ACCOUNTANTS\nNew York, New York November 20, 1995\nCONCORD FABRICS INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEET\nThe notes to financial statements are made a part hereof.\nCONCORD FABRICS INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENT OF OPERATIONS AND RETAINED EARNINGS\nThe notes to financial statements are made a part hereof.\nCONCORD FABRICS INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENT OF CASH FLOWS\nThe notes to financial statements are made a part hereof.\nCONCORD FABRICS INC. AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS\n(Note A) - Summary of Significant Accounting Policies:\n(1) Principles of Consolidation - The financial statements include the accounts of Concord Fabrics Inc. and its wholly-owned subsidiaries (the Company); intercompany investments, advances and transactions have been eliminated (Note N).\n(2) Inventories - Inventories are stated at lower of cost or market, first-in, first-out; obsolete inventory items are carried at net realizable value. Inventory costs comprise material, direct labor and overhead (Note B).\n(3) Property and Depreciation - Property, plant and equipment is recorded at cost. Profits and losses on dispositions are reflected in current operations. Fully depreciated assets are written off against accumulated depreciation.\nDepreciation for financial accounting purposes is computed substantially by the straight-line method to amortize the cost of various classes of assets over their estimated useful lives. Leasehold improvements are amortized over the shorter of the life of the related asset or the life of the lease.\nFor income tax purposes, accelerated methods of depreciation are generally used; deferred income taxes are provided for the difference between depreciation expense for financial accounting purposes and for income tax purposes.\n(4) Earnings (loss) Per Share - Earnings (loss) per share is computed by dividing net earnings by the weighted average number of common shares outstanding during the year. Outstanding options to purchase common shares (Note K) did not have a material effect on earnings per share for the years ended August 28, 1994 and August 29, 1993.\n(5) For purposes of the statement of cash flows, the Company considers all highly liquid debt investments purchased with a maturity of three months or less to be cash equivalents.\n(6) The Company operates on a 52-53 week year ending on the Sunday closest to August 31. The year ended September 3, 1995 comprised fifty-three weeks; the other two years in the period ended September 3, 1995 each comprised fifty-two weeks.\n(Continued)\nCONCORD FABRICS INC. AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS - Sheet 2 -\n(Note B) - Inventories:\nInventories are summarized by categories as follows:\nAt September 3, 1995, the Company had outstanding commitments to purchase greige goods aggregating approximately $6,500,000.\n(Note C) - Property, Plant and Equipment:\nProperty, plant and equipment is summarized as follows:\n(Continued)\nCONCORD FABRICS INC. AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS - Sheet 3 -\n(Note D) - Income Taxes:\n(1) Income tax provision (credit) on the consolidated statement of operations and retained earnings is analyzed as follows:\n(2) Income taxes computed at the statutory federal income tax rate are reconciled to income tax provision (credit) on the consolidated statement of operations and retained earnings as follows:\n*The tax benefit related to the extraordinary item on retirement of debt was $198,000 in the year ended September 3, 1995.\n(Continued)\nCONCORD FABRICS INC. AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS - Sheet 4 -\n(Note D) - Income Taxes (Continued):\n(3) Deferred tax assets and liabilities are comprised of the following elements:\n(4) Concord Fabrics Inc. files a consolidated federal income tax return with its domestic subsidiary; separate returns are filed for state and local income tax purposes.\n(Continued)\nCONCORD FABRICS INC. AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS - Sheet 5 -\n(Note E) - Notes Payable - Banks:\n(1) The Company has total bank lines of credit aggregating $20,000,000; $2,000,000 of loans were outstanding at September 3, 1995. Amounts borrowed are generally due in 30 to 90 days. The line of credit arrangements are informal and are cancelable at the banks' option and provide for borrowings at the prime lending rate. The Company is generally expected to maintain average annual compensating bank balances in consideration of average annual bank borrowings. The banks have advised that the Company has been in substantial compliance with its compensating balance arrangements and that withdrawals of bank balances are not legally restricted. The average interest rates on amounts outstanding were 8.75% and 7.75% at September 3, 1995 and August 28, 1994, respectively.\n(2) A subsidiary of the Company had approximately $450,000 of letters of credit outstanding at September 3, 1995 for merchandise scheduled for future receipts.\n(Note F) - Profit-Sharing Plan:\nThe Company's noncontributory profit-sharing plan, approved by the Treasury Department, for the benefit of eligible full time employees, provides for a minimum annual contribution to a trust fund based on percentages of pre-tax profits (as defined); the Board of Directors may increase such minimum annual contribution at its sole discretion but all contributions are limited to the maximum amount deductible for federal income tax purposes. Contributions of $500,000 and $420,000 were made for the years ended August 28, 1994 and August 29, 1993, respectively; no contribution was made for the year ended September 3, 1995.\n(Note G) - Notes Payable - Insurance Company:\nOn November 30, 1994, the Company borrowed $20,000,000 from an insurance company. The unsecured loan bears interest at 9.31% a year and is repayable in seven equal annual installments commencing on the fourth anniversary date of the borrowing. A portion of the loan proceeds was used to prepay the $9,000,000 loan outstanding to The Prudential Insurance Company of America. A prepayment penalty of $495,266 was also paid; this amount has been reflected as an extraordinary item (net of $198,000 income tax benefit) on the statement of operations and retained earnings for the year ended September 3, 1995.\n(Continued)\nCONCORD FABRICS INC. AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS - Sheet 6 -\n(Note G) - Notes Payable - Insurance Company (Continued):\nThe new loan agreement requires maintenance of tangible net worth of approximately $36,000,000. The Company must also maintain, at each fiscal quarter end, ratios of current assets to current liabilities and current assets to total liabilities of not less than 1.5 to 1 and 1.4 to 1, respectively, and may not permit debt for borrowed money to exceed 55% of capitalization (as defined). The agreement also prohibits the pledging of assets and restricts dividends and redemptions of capital stock to $3,000,000 plus 50% of consolidated net income (as defined) subsequent to August 28, 1994; at September 3, 1995, $2,025,000 was available for such payments.\n(Note H) - Leases:\nThe Company leases showroom and office space and various equipment under leases expiring at various dates to 2003.\nMinimum rental payments under long-term leases in effect at September 3, 1995 are as follows:\nRent expense aggregated $2,300,000 in 1995, $2,200,000 in 1994 and $2,380,000 in 1993.\n(Continued)\nCONCORD FABRICS INC. AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS - Sheet 7 -\n(Note I) - Interest Expense:\nInterest expense (net) on the consolidated statement of operations and retained earnings comprises the following:\n(Note J) - Common Stock:\nThe Class A and Class B shares principally differ as follows:\n(1) The Class A shares have a 15% dividend preference and a 10% liquidation preference with respect to the Class B shares.\n(2) Holders of Class A shares are entitled to one vote a share whereas holders of Class B shares are entitled to ten votes a share.\n(3) Holders of Class A shares, voting as a separate class, are entitled to elect 25% of the Company's directors and holders of Class B shares, voting as a separate class, are entitled to elect the remaining directors.\n(4) Class B shares are convertible into Class A shares on the basis of one share of Class A shares for each share of Class B shares; Class A shares have no conversion rights. During the year ended August 28, 1994, 11,650 Class B shares were converted to an equal number of Class A shares; no conversions took place during the year ended September 3, 1995.\n(Note K) - Stock Options:\nPursuant to an Incentive Program adopted on January 10, 1989, awards (as defined) may be granted to key employees of the Company up to a maximum of 500,000 shares of the Company's Class A common stock.\n(Continued)\nCONCORD FABRICS INC. AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS - Sheet 8 -\n(Note K) - Stock Options (Continued):\nOn January 10, 1989, options to purchase an aggregate of 150,000 shares of the Company's Class A common stock at $3 a share (fair market value at such date) were granted to three employees. The options become exercisable in four annual installments com- mencing January 10, 1994 and expire ten years from the date of grant.\nOn March 1, 1994, an option to purchase 10,000 shares of the Company's Class A common stock at $9.50 a share (fair market value at such date) was granted to an employee. The option was cancelled upon the employee's termination of employment during the year ended September 3, 1995.\nOption activity is summarized as follows:\n(1) Subsequent to September 3, 1995, 10,045 and 2,455 options were exercised and cancelled, respectively, by an employee who retired.\n(2) The $31,250 and $93,750 excess of the exercise price over the par value of the Class A common stock issued has been credited to additional paid-in capital in the years ending September 3, 1995 and August 28, 1994, respectively.\n(Note L) - Business of the Company:\nThe Company's principal business is the manufacturing and purchasing of woven and knitted fabrics for sale to manufacturers (primarily of women's apparel) and to retailers (including chains, department stores and independently owned fabric stores) for resale to the home sewing market.\n(Continued)\nCONCORD FABRICS INC. AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS - Sheet 9 -\n(Note M) - Chino, California Facility:\nIn February 1994, the Company sold its Chino, California machinery and equipment for $2,000,000 cash and recognized a gain before income taxes of $1,420,606 on its statement of operations for the year ended August 28, 1994. The Company also leased the land and building for a five year period at an annual net rental of $297,000; the lessee was also granted the option to purchase the land and building during the lease period for $2,900,000.\n(Note N) - Acquisition of Kat-Em International, Inc.\nOn April 18, 1994, the Company purchased all of the capital stock of Kat-Em International, Inc. (Kat-Em), an importer of printed and solid finished fabrics used in the apparel industry, for $1,150,482 cash, which includes acquisition costs. In connection therewith, the former sole shareholder is being employed by Kat-Em pursuant to a five year employment contract.\nThe acquisition was accounted for as a purchase and, accordingly, the acquired assets and liabilities were recorded at their estimated fair values at the acquisition date and the operations of Kat-Em are included in the consolidated statement of operations and retained earnings from April 18, 1994.\n(Note O) - Plant Shut-Down Costs:\nThe Company has decided to dispose of its Washington, Georgia dyeing and finishing plant and is actively searching for a buyer; manufacturing operations ceased October 6, 1995. The loss of $1,100,000 (before income tax benefit of $440,000) reflected on the statement of operations and retained earnings for the fiscal year ended September 3, 1995 comprises estimated expenses during the disposition period. The Company estimates that the net proceeds of sale will approximate the facility's depreciated cost.\n(Continued)\nCONCORD FABRICS INC. AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS - Sheet 10 -\n(Note P) - Supplemental Information to Consolidated Statement of Cash Flows:\nNoncash investing activity:\nDuring the year ended August 28, 1994, the Company purchased all of the capital stock of Kat-Em International, Inc. for $1,150,482. In conjunction with the acquisition, liabilities were assumed as follows:\n(Note Q) - Concentration of Credit Risk:\n(1) Cash in banks, based on bank balances, exceeded federally insured limits by $3,800,000 and $2,700,000 at September 3, 1995 and August 28, 1994, respectively.\n(2) Accounts receivable from manufacturers and retailers aggregated approximately $19,368,000 and $6,447,000 at September 3, 1995, respectively, and $23,554,000 and $8,855,000 at August 28, 1994, respectively. The Company performs ongoing credit evaluations of its customers' financial condition and, generally, requires no collateral from its customers.\n(3) Accounts receivable at September 3, 1995 and August 28, 1994 also includes $3,320,000 and $4,765,000, respectively, of due from factors.\nCONCORD FABRICS INC. SCHEDULE II AND SUBSIDIARIES\nVALUATION AND QUALIFYING ACCOUNTS\n*Deductions from estimated doubtful accounts represent accounts written off, net of recoveries of accounts written off in prior years.\nThe notes to financial statements are made a part hereof.\nItem 9.","section_9":"Item 9. Disagreements on Accounting and Financial Disclosure. Not applicable. PART III Item 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant. This information is incorporated by reference from the Registrant's definitive Proxy Statement for the Annual Meeting of Stockholders to be held on January 9, 1996, to be filed pursuant to Section 14 of the Exchange Act within 120 days after the end of Registrant's 1995 fiscal year.\nItem 11.","section_11":"Item 11. Executive Compensation. This information is incorporated by reference from the Registrant's definitive Proxy Statement for the Annual Meeting of Stockholders to be held on January 9, 1996, to be filed pursuant to Section 14 of the Exchange Act within 120 days after the end of Registrant's 1995 fiscal year.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners of Management. This information is incorporated by reference from the Registrant's definitive Proxy Statement for the Annual Meeting of Stockholders to be held on January 9, 1996, to be filed pursuant to Section 14 of the Exchange Act within 120 days after the end of Registrant's 1995 fiscal year.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions. This information is incorporated by reference from the Registrant's definitive Proxy Statement for the Annual Meeting of Stockholders to be held on January 9, 1996, to be filed pursuant to Section 14 of the Exchange Act within 120 days after the end of Registrant's 1995 fiscal year.\nPART IV Item 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K. (a) (1) and (2) The following financial statements and schedules are filed as part of this Report. See Item 8 -- Index of Financial Statements and Schedules.\n(a) (3) Exhibits. *3.1 Delaware Certificate of Incorporation of the Registrant incorporated by reference from Appendix B to Registrant's Proxy Statement dated January 26, 1988. *3.2 Delaware bylaws of the Registrant incorporated by reference from Exhibit 3.2 to Registrant's Annual Report on Form 10-K for the year ended August 28, 1988. *4.1 Note Agreement between Registrant and John Hancock Mutual Life Insurance Company dated November 30, 1994 (the \"Note Agreement\"), incorporated by reference from exhibit 4.1 to Registrant's Report on Form 8-K dated December 15, 1994. *10.1 Employment Agreement dated August 27, 1992 between Registrant and George Gleitman incorporated by reference from exhibit 10.1 to Registrant's Annual Report on Form 10-K for the year ended August 30, 1992. *10.2 Employment Agreement dated as of March 2, 1994 between Registrant and Earl Kramer, incorporated by reference from exhibit 10.2 to Registrant's annual report on form 10-K for the year ended August 28, 1994. *10.3 Deferred Compensation Agreement dated June 14, 1977, as amended on February 5, 1986 between Registrant and Martin Wolfson incorporated by reference to exhibit 10.5 to Registrant's Annual Report on Form 10-K for the fiscal year ended August 31, 1986. *10.4 Lease Agreement dated August 1, 1994 between 1359 Broadway Associates and Concord Fabrics Inc., incorporated by reference from exhibit\n- -------------------\n* Document is available at Public Reference Section of the Securities and Exchange Commission, Commission File No. 1-5960.\n10.4 to Registrant's Annual Report on form 10-K for the year ended August 29, 1994. *10.5 Lease Agreement dated October 1, 1994 between 1359 Broadway Associates and Concord Fabrics Inc., incorporated by reference from exhibit 10.5 to Registrant's Annual Report on form 10-K for the year ended August 28, 1994. *10.8 Employment Agreement dated December 6, 1993 between Registrant and Mark Neugeboren incorporated by reference from exhibit 10.8 to Registrant's Annual Report on form 10-K for the year ended August 28, 1994. 22 Subsidiaries of the Registrant: Concord FSC Inc., Trilogy Fabrics Inc., and Kat-Em International, Inc. (b) Report on Form 8-K dated December 15, 1994 in connection with the issuance and sale $20,000,000 in notes to John Hancock Mutual Life Insurance Company. (c) See item 14(a)(3), above. (d) See item 14(a)(2), above.\n- -------------------\n* Document is available at Public Reference Section of the Securities and Exchange Commission, Commission File No. 1-5960.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the 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 20, 1995 CONCORD FABRICS INC.\n\/s\/ Earl Kramer ---------------------- Earl Kramer President and Director\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.","section_15":""}
{"filename":"757189_1995.txt","cik":"757189","year":"1995","section_1":"Item 1. BUSINESS - ----------------- General - ------- Delaware Otsego Corporation, a New York corporation, is a railroad holding company. The Company's principal executive offices are located at 1 Railroad Avenue, Cooperstown, New York 13326, and its telephone number is (607) 547-2555. As used in this Form 10-K, unless the context requires otherwise, the term \"Company\" or \"DOC\" refers to Delaware Otsego Corporation and its wholly-owned subsidiaries: Susquehanna Properties, Inc. (SPI); Fonfulco, Inc. (Fonfulco); Lackawaxen and Stourbridge Railroad Corporation (LASB); Syracuse, Binghamton and New York Railroad Corporation (SBNY); The New York, Susquehanna and Western Railway Corporation (NYS&W); Cooperstown and Charlotte Valley Railway Corporation (CACV); Delta Warehousing Corporation (DWC); Central New York Railroad Corporation (CNY); Delaware Otsego Equipment Corporation (DOE); Susquehanna Bulk Systems, Inc. (SBS); Staten Island Railway Corporation (SIRY); Rahway Valley Company, Lessee (RVC); and Rahway Valley Railroad Company (RVRR).\nThe Company operates in one business segment - railroad transportation. DOC's rail system provides rail service for customers along its routes and access to the national rail system through interchange facilities with two of the major northeastern railroads, Conrail, Inc. (\"Conrail\") and the CP Rail System (\"CP\"). Additionally, pursuant to a Haulage Agreement with CP, the Company has direct access with the Norfolk Southern rail system and other carriers in Buffalo, NY. DOC's railroad system is devoted principally to carrying freight, but also generates revenue through the operation of passenger excursion trains. DOC seeks to encourage development on and near, and utilization of, its real estate and rights-of-way by potential shippers and as a possible source of additional revenue. The Company also generates revenues by granting to various entities, such as utilities, pipeline and communication companies and non-industrial tenants, the right to occupy its railroad right-of-way and other real property. The Company also hires rail equipment to, and repairs rail equipment owned by, others, provides services related to the transfer of bulk commodities from railcar to truck, and provides administrative services related to railroad operations.\nIn January, 1996, the Company acquired a 40% interest in The Toledo, Peoria and Western Railroad Corporation (\"TP&W\"). The investment will be accounted for under the provisions of APB 18, The Equity Method of Accounting for Investments in Common Stock. TP&W owns a 284 mile Class III regional railroad which provides rail service on a generally East-West route from Fort Madison, Iowa through Central Illinois (approximately 70 miles south of Chicago) to Logansport, Indiana. TP&W hauls agricultural products, chemicals, coal, fertilizer, food products, steel and manufactured goods and consumer products, and operates two intermodal facilities. The TP&W's geographic location and connections with over 20 rail carriers, including seven Class I railroads, present opportunities for growth, and the acquisition provides the Company with an opportunity to diversify its rail holdings and to provide improved service to its intermodal customers.\n- 2 -\nRailroad Operations - ------------------- The Company operates a 500 mile regional railroad in New York, New Jersey and Pennsylvania, of which 200 miles consist of trackage rights over the lines of other railroads. The Company's rail lines have been integrated into a coordinated rail system which connects upstate New York with the Northern New Jersey - New York City metropolitan area and provides rail service via two Class I carriers (through its connections with Conrail and CP).\nThe Company presently serves over 110 customers in its railroad operations, two of which accounted for approximately 72% of its traffic volume. In 1995, the Company earned approximately $17.2 million from CSX Intermodal, Inc., representing 50% of operating revenues, on traffic moving to CSXI's owned facility located adjacent to the NYS&W at Little Ferry, NJ. 1995 revenues for container traffic moved on behalf of Hanjin Shipping Lines to the Resources Warehousing and Consolidation Services, Incorporated facility (\"RWCS\"), were approximately $7.5 million, representing 22% of operating revenues. No assurance can be given that such revenue levels will be attained in the future. The principal freight carried by the Company consists of manufactured goods, industrial raw materials, paper products, and agricultural commodities.\nThe operation of a railroad requires significant expenditures for maintenance-of-way and equipment, the availability of railcars in diverse locations for the carriage of customer freight, and reliance upon other carriers who participate in the transportation of almost all freight transported by the Company.\nThe Company, as a substantial property owner, is subject to potential liability for personal injury and property damages to trespassers and others present on its property. Additionally, attendant to the Company's railroad operations is potential liability for personal injury and property damage arising from derailments, collisions at highway-rail grade crossings, and from job-related employee injuries pursuant to Federal Employer Liability Act.\nReal Estate Activities & Other Operations - ----------------------------------------- Through its subsidiaries, the Company seeks to maximize utilization of and revenues from its real estate holdings. Leasing and right-of-way agreements, sales where favorable prices can be obtained for property that is deemed unnecessary for the Company's rail operations, and the encouragement of industrial development are the focus of the Company's activities in this regard.\nMarketing - --------- The Company markets its services primarily through its sales and customer service personnel, under the supervision of its Executive Vice President and Vice President-Marketing and Sales of its NYS&W subsidiary. In addition, the Company's executive officers are occasionally involved in formulating and making presentations to customers and potential customers.\n- 3 -\nSuppliers - --------- The Company is able to acquire the equipment, parts and other materials it needs in the operation of its business from several suppliers. The Company does not believe that the loss of any supplier would have a material adverse effect on its business, as there are alternative suppliers available.\nCompetition - ----------- The Company's regional rail system is relatively small in an industry dominated by carriers with far greater resources and facilities. In the Company's area of operation, it competes with Conrail, particularly with respect to bulk and intermodal traffic, and with both long-haul and short-haul trucking companies which may be able to offer more extensive facilities and resources than the Company. Deregulation of the railroad industry has intensified competition and will likely continue to do so, placing pressure on pricing and routing schedules of the Company. The Company believes that it is able to compete for railroad business on the basis of its quality of customer service, pricing, scheduling and concentration on its principal rail corridors. There can be no assurance, however, that the Company will be able to maintain its present competitive position.\nThe Company relies on, and its ability to compete is dependent upon, its rail connections with CP and Conrail for a substantial portion of its rail traffic. Changes in the operations of either of these carriers could have a material adverse impact on the Company.\nWith respect to its real estate activities, the Company competes with other railroads, developers and real estate businesses for purchasers, tenants and users of its real property. For example, other railroads seek some of the same customers for fiber optics cable installation, and real estate developers and other railroads seek the same type of industrial user as is sought by the Company. Such competitors may have greater financial resources, more experience in real estate development or a greater ability to offer incentives than does the Company. No assurance can be given that the Company's efforts to develop, lease or sell its real estate resources will be successful.\nRegulation - ---------- The Company is subject to regulation by the Surface Transportation Board, the Federal Railroad Administration, and certain state and local authorities, including state Departments of Transportation, in connection with some aspects of its railroad operations. Such regulation affects rates, safety rules, maintenance of track, other facilities, and rights-of-way, and may affect the Company's revenues and expenses.\n- 4 -\nEnvironmental Matters - --------------------- The Company transports hazardous materials on behalf of certain of its customers, and uses certain hazardous materials in the normal course of the repair and maintenance of its locomotives, rail cars and other equipment. The operation of a railroad includes the risk of derailments which could result in the release or spillage of diesel fuel and hazardous materials from locomotives and rail cars to property of the Company and adjoining properties. The Company is not aware of any such spills or releases which have not been remediated in compliance with applicable statutes and regulations.\nThe Company, as the owner of real estate, may be responsible under certain circumstances for remediation of environmental conditions on its property, whether or not such conditions arose from the Company's operations. The Company has, with one exception, no knowledge of the existence of any such conditions, but cannot assure that such will not arise or occur in the future. During 1993, The New York, Susquehanna and Western Railway Corporation, a Company railroad operating subsidiary, received notice from the Environmental Protection Agency (EPA) that it is a potentially responsible party under the Comprehensive Environmental Response, Compensation and Liability Act (Superfund) and may be required to share in the cost to clean up a certain site identified by the EPA. The information presently available to the Company indicates that the estimated liability is less than ten thousand dollars and, therefore, will not have a material effect on the consolidated financial condition or results of operation.\nEmployees - --------- At December 31, 1995, the Company employed 191 people, of whom 115 were operating personnel, 12 were supervisors, 46 were office and sales personnel, and 18 were executive officers and managerial personnel. 33 of the Company's operating personnel are subject to a collective bargaining agreement with the Brotherhood of Locomotive Engineers (BLE) which sets their general level of compensation and working conditions through December 31, 1996. In 1995, the Company reached a collective bargaining agreement with the Brotherhood of Maintenance of Way Employes (\"BMWE\") covering 49 employees of the Company's Track Department which sets the general level of compensation and working conditions through December 31, 2000. The Company considers its employee relations to be good.\nAt January 31, 1996, TP&W employed 117 people of whom 81 were operating personnel, 21 were supervisors and officers, and 15 were sales and office personnel. 44 of TP&W operating personnel are subject to collective bargaining agreement with the United Transportation Union which sets their general level of compensation and working conditions through December 31, 1999. 19 of TP&W operating personnel are subject to a collective bargaining agreement with the BMWE, which is currently in the process proscribed by the Railway Labor Act for renegotiation.\n- 5 -\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES - -------------------\nThe Company's executive offices are located in approximately 4,500 square feet of space at 1 Railroad Avenue, Cooperstown, New York, a property owned by the Company. The Company also owns the Edgewater Executive Offices in Cooperstown. This structure, containing 10,000 square feet of space, presently is used for offices, conferences, and facilities for overnight accommodations for Company guests.\nThe Company owns 140 route miles of track and right-of-way and owns jointly with the County of Sussex, New Jersey an additional 8.8 miles of line. The Company leases 186.2 miles of line. Included in this total are 164.35 miles of line leased from several Industrial Development Agencies at nominal cost, which leases expire in April, 1997, at which time ownership of the lines revert to the Company for nominal consideration. As these Industrial Development Agency lease agreements result in real estate tax savings, the Company intends to request that they be extended past their current expiration date. Additionally, the Company has agreements enabling it to use track owned by other railroads including trackage rights from Warwick, New York to Binghamton, New York of 175 miles. Although unlikely, such trackage rights may be terminated if their use is abandoned by its owners upon compliance with certain statutory procedures which may require approval of the Surface Transportation Board.\nThe properties of the Company are subject to various easements, occupations, licenses, leases and rights-of-way. The trackage and other operating rights pursuant to which the Company is authorized to carry freight over track belonging to others are subject to contractual agreements which may be subject to termination or restriction, either of which may have a significant adverse effect on the railroad operations of the Company.\nSubstantially all the Company's properties are subject to lien, or mortgage, in connection with obligations of the Company to Manufacturers and Traders Trust Company, New Jersey Economic Development Authority, and Federal Railroad Administration.\nA description of the Company's railroad properties, by subsidiary, is as follows:\na) NYS&W. The NYS&W is the main operating subsidiary of the Company, and consists of two divisions. The Southern Division consists of 82.6 miles of Company-owned track which, together with 8.8 miles of track owned jointly with the County of Sussex, NJ, run from Jersey City, NJ to Warwick, NY. NYS&W has trackage and other operating rights to run over track owned by Conrail from Warwick, NY to Binghamton, NY and, alternatively, from Passaic Junction, NJ to Binghamton, NY. The Northern Division consists of track from Binghamton, NY to Chenango Forks, NY, and then to Jamesville, NY (the Syracuse Branch) and Utica, NY (the Utica Branch), a total of 164.35 miles. The Northern Division properties were acquired pursuant to a lease purchase agreement with the industrial development agencies of the counties of location. NYS&W also has trackage rights to run over approximately 11 miles of trackage from Jamesville, NY to interchange with Conrail at Syracuse, NY on tracks leased by SBNY. The Southern Division and the Syracuse\n- 6 -\nBranch of the Northern Division of NYS&W consist mainly of Class II track in accordance with Federal Railroad Administration (\"FRA\") standards, allowing operation at speeds of up to 40 mph. Generally, all other trackage owned or leased by the Company, with the exception of industrial spurs and sidings, are designated Class III tracks, thereby allowing speeds of up to 25 mph. While existing track conditions and speeds allow the Company to adequately serve all its existing customers, maintenance and rehabilitation of rail facilities is an ongoing project.\nb) CNY. The CNY consists of 21.7 miles of Company-owned track from its connection with NYS&W in Richfield Junction, NY to Richfield Springs, NY. Rail operations on all but 2.3 miles of this track were abandoned in 1995, and the Company intends to begin to dispose of this property in 1996. The remaining 2.3 miles are operated by NYS&W.\nc) SBNY. SBNY operates passenger excursion and shuttle trains on 11 miles of track located in Syracuse, NY and owned by Onondaga County Industrial Development Agency.\nd) CACV. CACV consists of 15.9 miles of Company-owned track from an interchange with D&H at Cooperstown Junction, NY to Cooperstown, NY. The Company abandoned all rail operations on CACV in 1995, and intends to dispose of substantially all of CACV's assets in 1996.\ne) RVC, RVRR. The RVC and RVRR are related companies which owned 11.6 miles of track running from Cranford Junction, NJ to Summit, NJ. The Company sold these assets to the New Jersey Department of Transportation in 1995 and intends to dissolve RVC and RVRR in 1996.\nThe Company owns 14 locomotives of various manufacture, age and size, three of which were acquired new in 1995, and leases an additional 9 locomotives. The Company believes it has an adequate supply of locomotives for its current needs. The Company owns fewer than 50 railcars of various types and manufacture, and depends on connecting rail lines and customers to provide cars for outbound loadings.\nTP&W owns approximately 195 miles of railroad and has operating rights over approximately 90 miles of track owned by other railroads as part of its integrated railroad system between Fort Madison, Iowa and Logansport, Illinois. TP&W owns 22 locomotives of various age, manufacture and size, and believes it has an adequate supply of locomotives for its current needs. Substantially all the assets of TP&W are subject to lien or mortgage in connection with obligations of TP&W to Creditanstalt Corporate Finance, Inc.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS - --------------------------\nThere are no material pending legal proceedings other than ordinary routine litigation, incidental to the Company's business, to which the Company or any of its subsidiaries is a party or of which any of its or their property is the subject.\n- 7 -\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - ------------------------------------------------------------\nNone.\nExecutive Officers and Key Employees of the Registrant - ------------------------------------------------------\nEach of the following officers of the Company has been elected by the Board of Directors and serves at the discretion of the Board.\nPosition with Officer Name Age the Registrant Since - -------------------------- --- ---------------------------- ------------ Walter G. Rich 50 President, Chief Executive 1968 Officer & Director\nC. David Soule 45 Executive Vice President 1981 & Director\nWilliam B. Blatter 61 Senior Vice President & 1988 Chief Financial Officer\nNathan R. Fenno 37 Vice President-Law, General 1988 Counsel & Secretary\nRobert E. Pierce 49 Vice President\/Controller 1982\nFrank Quattrocchi 46 Vice President & Treasurer 1993\nMr. Rich has been a member of the Board of Directors of the Company since 1968, and has been President and Chief Executive Officer since 1971. Mr. Rich is also a director of Norwich Aero Products, Inc., New York State Business Development Corporation, and Security Mutual Life Insurance Company of New York. Mr. Rich was appointed in 1993 to the New York State Public Transportation Safety Board.\nMr. Soule has been Executive Vice President of the Company since June, 1983. He was elected to the Board of Directors in June, 1984.\nMr. Blatter joined the Company as Vice President-Finance and Chief Financial Officer in April, 1988, and was named Senior Vice President and Chief Financial Officer in June, 1990.\nMr. Fenno joined the Company as Attorney in July, 1987. Mr. Fenno was appointed General Counsel and Corporate Secretary in July, 1988, and Vice President-Law in September, 1991.\nMr. Pierce joined the Company in September, 1981 and has served as Vice President\/Controller since February 1, 1986.\nMr. Quattrocchi joined the NYS&W in June, 1983. Mr. Quattrocchi was promoted to Vice President & Treasurer of the Company in April, 1993.\n- 8 -\nThe following are other key employees of the Registrant's operating subsidiaries:\nMr. Joseph G. Senchyshyn became Vice President-Operations of NYS&W on September 3, 1985.\nMr. Robert A. Kurdock was appointed Vice President of NYS&W in June of 1985. He has been employed by the Company since September, 1980, serving in increasingly responsible positions.\nMr. Richard J. Hensel became Vice President-Engineering of NYS&W in April, 1987.\nMr. Paul Garber joined the NYS&W in 1989, and was appointed Vice President-Marketing & Sales in October, 1990.\nMr. Phillip England joined the NYS&W as Vice President-Mechanical in August, 1994. He was previously employed by Consolidated Rail Corporation for over five years in various positions in its Mechanical Department.\nMr. Gordon Fuller joined NYS&W as an Executive Vice President in January, 1996 and will be active in the areas of railroad sales and marketing, governmental relations, industrial development and similar executive level functions. He previously was President of Toledo, Peoria & Western Railway Corporation for over five years.\nPART II -------\nItem 5.","section_5":"Item 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS - -------------------------------------------------------------\nMarket Information - ------------------\nThe Company's common stock trades in the over-the-counter market and is quoted on the Nasdaq National Market (\"Nasdaq\"). The symbol for the common stock is \"DOCP\". The following table sets forth the quarterly high and low sale prices of the Company's common stock as reported by NASDAQ for the two years ending December 31, 1995.\n1995 High Low ------------------- --------- --------- First Quarter $11 $9 3\/4 Second Quarter $10 1\/4 $9 1\/4 Third Quarter $10 1\/2 $9 1\/2 Fourth Quarter $10 $9\n- 9 -\n1994 High Low ------------------- --------- --------- First Quarter $ 10 3\/4 $ 9 1\/2 Second Quarter $ 10 3\/4 $ 9 1\/2 Third Quarter $ 10 3\/4 $ 9 1\/2 Fourth Quarter $ 11 $ 10 1\/4\nHolders of Record - ----------------- As of December 31, 1995, the approximate number of record holders of the Company's common stock was 1,519.\nDividends - --------- During 1995, the Company paid a 5% stock dividend payable to stockholders of record February 17, 1995. The dividend was paid on March 20, 1995, resulting in the issuance of an additional 72,518 shares. Subsequent to year-end, the Company declared a 5% stock dividend payable to stockholders of record February 17, 1996. The dividend was paid on March 20, 1996 and 82,297 shares were issued accordingly.\nThe Company's loan with Manufacturers and Traders Trust Company provides that the Company may not declare any cash dividends in any fiscal year in excess of 40% of Consolidated Net Income in such fiscal year, and that cumulative dividends paid during the term of the loan may not exceed 10% of cumulative retained earnings. In addition, the Financing Agreement between the Company and its subsidiary NYS&W, and the Federal government through the FRA 505 Redeemable Preference Share Program provides that yearly dividends may not exceed 50% of the total additions to retained earnings of the Company for the previous year, nor 50% of the total additions to retained earnings for 1985 and each year thereafter.\n- 10 -\n[FN] (1) Revenue from the Company's temporary operations over lines of the Delaware & Hudson Railway. (2) See Management's Discussion and Analysis for discussion of the 1994 extraordinary item. The 1992 extraordinary item relates to a debt forgiveness transaction in connection with the termination of a land lease. (3) All data in the accompanying financial statements and related notes have been restated to give effect to a 5% stock dividend declared on January 26, 1996.\n- 11 -\nItem 7.","section_6":"","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - --------------------------------------------------------- RESULTS OF OPERATIONS (In thousands) - --------------------- Recent Acquisition - ------------------ Subsequent to the balance sheet date, the Company completed the purchase of a 40% interest in The Toledo, Peoria and Western Railroad Corporation (\"TP&W\") for consideration totalling $2.25 million, including 25,000 shares of the Company's common stock. The non-stock portion of the consideration for the acquisition was funded through a $1 million loan and the private placement of 100,000 shares of the Company's common stock. Additionally, the Company issued warrants to purchase 60,000 common shares to another party involved in the transaction. The Company will perform administrative services which will have a positive impact on general and administrative expenses for 1996 and beyond. At December 31, 1995, the Company had incurred $592 of advances related to the purchase which were recorded in other current assets. The $592 was reimbursed at closing on January 31, 1996. The investment will be accounted for under the provisions of APB 18, The Equity Method of Accounting for Investments in Common Stock.\nThe TP&W owns a 284 mile Class III regional railroad which provides rail service on a generally East-West route across one of the top grain producing regions in the world from Fort Madison, Iowa through Central Illinois (approximately 70 miles south of Chicago) to Logansport, Indiana. The TP&W hauls agricultural products, chemicals, coal, fertilizer, food products, steel and manufactured goods and consumer products for such customers as ADM, Cilco, Witco, Lonza and Caterpillar and to two company-operated intermodal facilities. The TP&W's geographic location and connections with over 20 rail carriers, including seven Class I railroads, present opportunities for growth, and the acquisition provides the Company with an opportunity to diversify its rail holdings and to provide improved service to its intermodal customers.\nThe following Management's Discussion and Analysis of Financial Condition and Results of Operations relates to the continuing operations of the Company.\n1995 COMPARED TO 1994 - --------------------- Operating Revenues - ------------------ 1995 railway operating revenues, which include intermodal, carload and all other rail operating revenues, were $32,484 compared with railway operating revenues of $24,981 for 1994.\nTwo major customers account for approximately 72% and 64% of the Company's 1995 and 1994 operating revenues, respectively. During 1995 and 1994, the Company earned approximately $17.2 million and\n- 12 -\n$9.8 million , respectively from CSX Intermodal, Inc. During the same periods, the Company earned approximately $7.5 million and $7.7 million, respectively from Hanjin Shipping Lines. The loss of either customer or a material reduction in their operations would have a material adverse effect on the Company's results of operations.\nThe Company relies on, and its ability to compete is dependent upon, its rail connections with CP and with Conrail for a substantial portion of its rail traffic. Changes in the operations of either of these carriers could have a material adverse impact on the Company.\nIntermodal revenues for 1995 increased $7,230 compared to 1994. Intermodal revenues from CSX Intermodal, Inc. (\"CSXI\") increased $7,438 due to two new intermodal services that began in the second and third quarters of 1994. Both services transport containerized traffic to CSXI's Little Ferry Terminal in New Jersey. Intermodal revenues derived from shipments on behalf of Hanjin Shipping Lines to the Resources facility declined $208, due mainly to market re-distribution factors and a general softness in international business in the fourth quarter.\n1995 carload revenues improved by $162 compared to 1994, due principally to volume improvements in newsprint and printing paper, contaminated soil, liquid food-grade commodities and automobiles.\nOther railway operating revenues in the aggregate for 1995 improved $112 compared to 1994, due mostly to improved auto terminal and passenger revenues of $210, offset by declines in demurrage and other incidental revenues of $98.\nReal property revenues for 1995 were $165 greater than 1994, due mostly to unearned rent revenues recognized as earned when certain property was sold by a Company subsidiary in the second quarter.\nOther operating revenues in 1995 declined $607 compared to 1994, due mostly to declines in construction activity.\nOperating Expenses - ------------------ Maintenance of way and structures expenses in the aggregate for 1995 were $663 greater than 1994 due to a $126 bonus paid to employees in the second quarter, and an increase of $780 in trackage rights expenses due to increased intermodal traffic. Partially offsetting the increased expenses was a $243 decrease in expenses relating to litigation settlements, snow removal, environmental clean-up, insurance, professional services and utilities.\nMaintenance of equipment expenses in the aggregate were $520 higher during 1995 as compared to 1994 due to increased locomotive maintenance expenses necessary to meet power requirements of the Company's increased intermodal business. The principal components of the increase were: $170 for compensation and benefits; $312 for\n- 13 -\nmaterials and supplies; and $28 for independent contractors. Railcar and other equipment expenses in the aggregate for 1995 declined insignificantly.\nTransportation expenses in the aggregate for 1995 exceeded 1994 by $3,733, due principally to the increase in the Company's intermodal business. The most significant increases were: $603 for compensation and benefits; $590 for fuel; $2,237 for haulage and terminal expenses; $123 for security; and $50 for operations administration. Derailment and other transportation expenses for 1995 declined approximately $270 compared to 1994. Increased activity during 1995 for the Company's passenger shuttle and scenic excursion business resulted in approximately $400 of additional expenses compared to 1994.\nCar hire expenses for 1995 were $261 greater than 1994, due mostly to the increase in intermodal traffic.\nDepreciation and amortization expense for 1995 exceeded 1994 by $301, due principally to additional property, plant and equipment. General, administrative and other expenses for 1995 were $673 greater than 1994, due principally to the following: $624 for compensation and benefits of which $337 represents a company wide bonus paid during the second quarter; $161 for professional fees; $36 for telephones and other communications expense; offset by declines of approximately $148 in other overhead expenses.\nAs a result of the foregoing, operating expenses increased $6,164 in 1995 compared to 1994. For the twelve month period ended December 31, 1995, the operating loss declined by $897 compared to the 1994 period. The operating ratio for 1995 was 104.5% compared to 108.9% for 1994.\nOther Income (Expense) - ---------------------- Interest expense net, comprised of interest expense (net of capitalized interest) and interest income, for 1995 increased $50 compared to 1994. Total interest expense for 1995 increased insignificantly compared to 1994.\nGain on sale of property, equipment and other for 1995 increased $4,994 compared to 1994, due principally to the sale of an 8.8 mile railroad line located in Union County, New Jersey to the State of New Jersey for $6.2 million resulting in gain of $5.2 million.\nTaxes - ----- The Company provides for income taxes in accordance with the liability method as set forth in Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes. The Company's provision for income taxes on income (loss) before extraordinary item resulted in a $878 tax expense in 1995 compared to a tax benefit of $1,128 for 1994. See Note 7 to financial statements for further information concerning income taxes.\n- 14 -\n1994 COMPARED TO 1993 - --------------------- Operating Revenues - ------------------ Railway operating revenues, which include intermodal, carload and all other rail operating revenues, were $4,117 greater in 1994 than 1993.\nTwo major customers account for approximately 64% and 60% of the Company's 1994 and 1993 operating revenues, respectively. During 1994 and 1993, the Company earned approximately $9.8 million and $6.3 million, respectively from CSX Intermodal, Inc. During the same periods, the Company earned approximately $7.7 million and $7.2 million, respectively from Hanjin Shipping Lines. The loss of either customer or a material reduction in their operations would have a material adverse effect on the Company's results of operations.\nIntermodal revenues in the aggregate for 1994 increased $4,011 compared to 1993. Intermodal revenues from CSX Intermodal, Inc. (\"CSXI\") increased $3,475 due to two new intermodal services that began in June and August, respectively in 1994. Both services transport containerized traffic to CSXI's Little Ferry Terminal in New Jersey. Revenue from intermodal shipments on behalf on Hanjin shipping lines to the Resources facility in New Jersey improved $536 compared to 1993.\nCarload revenues were $116 higher in 1994 compared with 1993, due mainly to greater commodity shipments for paper, lumber and stone ballast, combined with favorable shipper rebate arrangements.\nOther railway operating revenues in the aggregate declined insignificantly in 1994 compared to 1993. Components include passenger revenues, which were $78 greater in 1994 than 1993 due to the initiation of the passenger shuttle service in Syracuse, New York. Demurrage, switching and other incidental railway operating revenue for 1994 declined approximately $87 compared to 1993.\nReal property revenues for 1994 improved $120 compared to 1993.\nOther operating revenues in 1994 were $616 greater than 1993.\nOperating Expenses - ------------------ Maintenance of way and structures expenses for 1994 were $459 greater than 1993, due mainly to $360 of increased trackage rights costs attributable to additional business over Conrail track and approximately $99 of increased expenses for compensation and benefits, utilities and independent contractors.\nMaintenance of equipment expenses for 1994 were $233 higher than 1993, due mainly to greater expenses for labor costs, increased maintenance of locomotives and railcars resulting from increased traffic and increased maintenance of track equipment due to higher levels of construction activity.\n- 15 -\nTransportation expenses in the aggregate for 1994 rose by $3,407 over 1993 levels, due principally to increases in traffic levels from two new intermodal services. The principal components of the increase were: $384 in compensation and benefits, which reflects a 5% scheduled wage increase for contract employees; $210 in diesel fuel; $155 for increased costs of road locomotive utilization; haulage costs of $1,665; $263 in terminal operating expenses; $147 in drayage charges and $68 for additional security at terminal facilities. Derailment expenses in 1994 exceeded 1993 by $280; the 1993 period included a favorable adjustment of $130 necessary to reduce a previously established reserve for a major derailment in which all claims had been settled. Passenger expenses for 1994 exceeded 1993 amounts by $134, due to start-up and other operating expenses from initiating the shuttle service in Syracuse, New York.\nCar hire expenses for 1994 increased by $195 compared to 1993.\nDepreciation and amortization expenses for 1994 increased $175 compared with 1993.\nAs a result of the foregoing, operating expenses increased $4,333 in 1994 compared to 1993. For the twelve month period ended December 31, 1994, the operating loss declined $520 from the 1993 period. The operating ratio for 1994 improved to 108.9% compared to 113.2% in 1993.\nOther Income (Expense) - ---------------------- Interest expense net, comprised of interest expense (net of capitalized interest) and interest income, for 1994 increased $128 compared to 1993. Total interest expense for 1994 was $1,444 compared to $1,246 for 1993, due principally to higher interest rates, additional interest from the issuance of $3,580 of 6.5% convertible subordinated notes in September, 1993 and increased borrowings from the construction line of credit.\nThe Company's gain on sale of property, equipment and other declined $1,859 in 1994 compared to 1993, due principally to gain of $1,911 recognized in the 1993 period from the sale of a permanent easement to Public Service Electric and Gas Company.\nTaxes - ----- The Company provides for income taxes in accordance with the liability method as set forth in Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes. The Company's provision for income taxes on income (loss) before extraordinary item resulted in a $1,128 tax benefit in 1994 compared to a benefit of $603 for 1993. See Note 7 to the financial statements for further information concerning income taxes.\nExtraordinary Item - ------------------ During 1994, the Company completed the refinancing of its major bank debt with Manufacturers and Traders Trust Company. In\n- 16 -\nconjunction with this refinancing, the Company wrote-off $334, representing the unamortized balance of deferred financing costs incurred in 1990 in conjunction with its prior loans. The write-off was recorded as an extraordinary item in the statement of earnings, net of applicable income taxes of $106.\nLIQUIDITY AND CAPITAL RESOURCES (In thousands, except share amounts) - ------------------------------- At December 31, 1995, the Company had a working capital deficit of $5,284 compared to a deficit of $7,149 at December 31, 1994. The improved working capital was due principally to a real estate sale for $6,203 that occurred in the second quarter of 1995.\nLiquidity refers to the ability of an organization to generate adequate amounts of cash, principally from operating results or through borrowing power to meet its short-term and long-term cash requirements. At December 31, 1995, the Company had cash and cash equivalents of $1,213 compared to $1,308 at December 31, 1994.\nTotal long-term liabilities at December 31, 1995 were $26,780, an increase of $4,433 compared to December 31, 1994. Long-term debt exclusive of current maturities, as a percentage of equity at December 31, 1995, was 39.5% compared to 34.1% at December 31, 1994, and total capitalization (long-term debt, 6.5% convertible subordinated notes and equity) was $48,828 at December 31, 1995, compared to $43,157 at December 31, 1994.\nSubsequent to year-end, the Company entered into an equipment line of credit with Key Bank of New York, whereby it may borrow up to $500. The interest rate is the lender's base rate plus three quarters percent (3\/4%.) The line expires on April 30, 1997.\nProperty, plant and equipment additions for 1995 were $9,879 of which $2,021 was funded by grants from the New York and New Jersey Departments of Transportation. The $7,858 balance was provided by additional debt and sales of real property.\nDuring the fourth quarter of 1995, the Company entered into a contract to sell certain parcels of railroad property of a non-operating Company subsidiary for $500, which is anticipated to close during 1996. The carrying amount is estimated at $110. A portion of the purchase price is subject to the buyers obtaining government funding. The proceeds will be used for working capital purposes.\nThe Company's capital spending program for 1996, including commit- ments, is projected at approximately $14 million, of which $9 million will be for railway projects and $5 million for acquisition of land for terminals and improvements to locomotives and other rolling stock. (Refer to Note 11 - Commitments to the consolidated financial statements.) The expenditures are expected to be funded from grants from participating state governments which are expected to continue beyond 1996, cash from operations, debt financing and\n- 17 -\nproceeds from sales of non-operating property.\nDuring 1995, the Company paid a 5% stock dividend payable to stockholders of record February 17, 1995. The dividend was paid on March 20, 1995, resulting in the issuance of an additional 72,518 shares. Subsequent to year end, the Company declared a 5% stock dividend payable to stockholders of record February 17, 1996. The dividend will be paid on March 20, 1996 and 82,297 shares will be issued accordingly.\nSEASONALITY AND EFFECTS OF INFLATION - ------------------------------------ The Company's container revenues are affected by seasonal demands for consumer goods, generally resulting in higher intermodal revenues in the third quarter. The effects of inflation have not had a material effect on the Company's operating expenses in the aggregate.\nThe Company enters into a diesel fuel supply agreement to hedge its exposure to price fluctuations on approximately 27% of its anticipated fuel requirements during a seven month period, generally late fall - early spring, for its freight transportation business. The nature of the hedging transaction does not result in any significant risk to the Company.\nGenerally accepted accounting principles require the use of historical costs in preparing financial statements. This approach disregards the effects of inflation on the replacement cost of property and equipment. The Company is a capital-intensive company and has approximately $92.4 million invested in such assets. The replacement costs of these assets, as well as the related depreciation expense, would be substantially greater than the amounts reported on the basis of historical costs.\nENVIRONMENTAL MATTERS - --------------------- During 1993, The New York, Susquehanna and Western Railway Corporation, a Company railroad operating subsidiary, received notice from the Environmental Protection Agency (EPA) that it is a potentially responsible party under the Comprehensive Environmental Response, Compensation and Liability Act (Superfund) and may be required to share in the cost to clean up a certain site identified by the EPA. The information presently available to the Company indicates that the estimated liability is less than ten thousand dollars and therefore, will not have a material affect on the consolidated financial condition or results of operations.\n- 18 -\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe Financial Statements and Supplementary Data begin on the next page.\n- 19 -\nREPORT OF INDEPENDENT AUDITORS\nBoard of Directors and Stockholders Delaware Otsego Corporation\nWe have audited the accompanying consolidated balance sheets of Delaware Otsego Corporation and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1995. 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 Delaware Otsego Corporation and subsidiaries at December 31, 1995 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, 1995, in conformity with generally accepted accounting principles.\nErnst & Young LLP\nSyracuse, New York February 26, 1996\n- 20 -\n[FN] See notes to consolidated financial statements\n- 21 -\n[FN] See notes to consolidated financial statements\n- 22 -\n[FN] See notes to consolidated financial statements\n- 23 -\n[FN] See notes to consolidated financial statements\n- 24 -\n[FN] See notes to consolidated financial statements\n- 25 -\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS DELAWARE OTSEGO CORPORATION AND SUBSIDIARIES December 31, 1995, 1994 and 1993 - --------------------------------------------\nNOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - --------------------------------------------------- Business: The Company operates a 500 mile regional railroad system extending into the states of New York, Pennsylvania and New Jersey. The principal freight carried by the Company consists of manufactured goods, industrial raw materials, paper products and agricultural commodities. The principal markets for this freight are the New York City metropolitan area, Northern New Jersey and Central New York. The Company relies on, and its ability to compete is dependent upon, its rail connections with the CP Rail System and Consolidated Rail Corporation. Changes in the operations of either of these carriers could have a material adverse impact on the Company.\nTwo major customers account for approximately 72%, 64% and 60% of the Company's operating revenues for 1995, 1994 and 1993, respectively. During 1995, 1994 and 1993, the Company earned approximately $17.2 million, $9.8 million and $6.3 million from CSX Intermodal, Inc. During the same periods, the Company earned $7.5 million, $7.7 million and $7.2 million from Hanjin Shipping Lines. The loss of either customer or a material reduction in their operations would have a material adverse effect on the Company's results of operations.\nPrinciples of Consolidation: The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries, all of which are wholly-owned. All significant intercompany transactions and balances have been eliminated in consolidation.\nAccounts Receivable and Revenue Recognition: Accounts receivable and accounts payable in the consolidated balance sheet reflect interline transactions with other railroads which the Company is required to enter into as part of settling freight payments received from customers. The system follows Railway Accounting Rules as adopted by member railroads of The Association of American Railroads, of which the Company is a member. At year end, in accordance with industry practice, accrued revenue on a completed service basis is reflected in the consolidated statements of operations for unsettled freight not yet part of the interline accounting system.\nAt December 31, 1995 and 1994, the Company's trade receivables include approximately $4.1 million and $3.4 million, respectively of total receivables, representing balances due from two major customers. The December 31, 1995 and 1994 receivables from the two customers constitute 75.8% and 55.3%, respectively of total receivables. The Company does not require collateral. The credit risk associated with this concentration is not deemed significant.\nAllowances for doubtful accounts of $171 thousand and $190 thousand have been applied as a reduction of accounts receivable at December\n- 26 -\nNOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued - --------------------------------------------------- 31, 1995 and 1994, respectively.\nMaterials and Supplies: Materials and supplies are stated at the lower of cost or market determined by the average cost method.\nMaterials and supplies are charged to expense, construction- in-progress or property, plant and equipment at the time of use.\nProperty, Plant and Equipment: Property, plant and equipment is recorded at cost including capitalized interest during periods of construction. Depreciation is provided over the estimated useful lives of the related assets and is computed principally by the straight-line method for financial statement purposes.\nCosts of reimbursable rehabilitation projects not yet complete are recorded in reimbursable construction costs. Charges incurred during the project phase are billed to the respective state or federal government agency. The proceeds from these subsidies are recorded in the consolidated statement of stockholders' equity as contributed capital at the time of receipt, net of applicable income taxes.\nThe cost of property retired or sold and related accumulated depreciation are removed from the asset and allowance accounts. Gain or loss on disposition of property is reflected in earnings. Maintenance and repairs are charged to earnings as incurred. Renewals and betterments are capitalized.\nLeasehold improvements are amortized on the straight-line method over the remaining life of the lease or the estimated life of the improvement, whichever is shorter.\nImpact of Recently Issued Accounting Standards: In March, 1995 the Financial Accounting Standards Board issued Statement No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of. The statement requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amount. Statement No. 121 also addresses the accounting for long-lived assets that are expected to be disposed of. The Company adopted Statement No. 121 in the fourth quarter of 1995 without any material effect.\nIntangible Assets: Intangibles are amortized by the straight-line method over a period of 5 to 40 years. Accumulated amortization was $1.1 million and $1.4 million at December 31, 1995 and 1994, respectively.\nEstimated Self-Insurance Liability: The Company is self-insured to various limits for public liability and property loss. The liability for self-insurance is generally accrued based on occurrence, with liability for possible escalation on unsettled claims being estimated based on individual situations. The Company does not accrue an estimated liability for unasserted claims unless\n- 27 -\nNOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued - --------------------------------------------------- (i) it is aware of the possibility of such claim; (ii) it is considered probable such claim will be asserted at a future date; and (iii) it has a basis to estimate its potential exposure and there is a reasonable possibility of an unfavorable outcome. In the opinion of management, after review with attorneys for the Company, such claims are of a nature that they will not have a material adverse effect on the financial position of the Company.\nIncome Taxes: The Company provides for income taxes in accordance with the liability method as set forth in Statement of Financial Accounting Standards No. 109, Accounting For Income Taxes. Under the liability method, deferred taxes are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. (See Note 7.)\nPer Share Amounts: Primary net income per share is computed by dividing net income by the weighted average number of shares outstanding of 1,612,817 in 1995, 1994 and 1993, respectively, including the effects of a 5% stock dividend declared January 26, 1996. Fully diluted net income per share is computed by dividing net income plus after tax interest incurred on the convertible debentures by the weighted average number of common shares outstanding after giving effect to dilutive stock options and shares assumed to be issued on conversion of the convertible debentures of approximately 1,951,000 shares in 1995. Reported fully diluted and primary net income per share are the same for 1994 and 1993 as dilution from the assumed conversion of the convertible debentures issued in 1993 is antidilutive.\nCash Equivalents: The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents.\nUse of Estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.\nStock Based Compensation: The Company accounts for its stock compensation arrangements under the provisions of APB 25, Accounting for Stock Issued to Employees and intends to continue with this accounting treatment.\nPrior-Year Data: Certain amounts in the 1994 and 1993 financial statements have been reclassified to conform to the 1995 presentation.\n- 28 -\nNOTE 2 - PROPERTY, PLANT AND EQUIPMENT - -------------------------------------- A summary of property, plant and equipment balances by major classes at December 31, 1995 and 1994, is as follows: (in thousands)\n1995 1994 --------- --------- Land $ 1,658 $ 2,373 Buildings and bridges 6,527 6,337 Machinery, equipment and roadway 83,604 74,989 Leasehold improvements 612 486 --------- --------- 92,401 84,185 Less allowance for depreciation and amortization (29,414) (25,961) --------- ---------\nPROPERTY, PLANT AND EQUIPMENT, NET $62,987 $58,224 ========= =========\nNOTE 3 - NOTES PAYABLE TO BANK - ------------------------------ Notes payable at December 31, 1995 and 1994 consist of a secured advance under a $5 million line of credit with Manufacturers and Traders Trust Company. Interest on these borrowings is at Prime plus 1%. (Prime at December 31, 1995 was 8.5%.) Available borrowings are based on and secured by eligible accounts receivable. At December 31, 1995 and 1994, eligible accounts receivable were $3.6 million and $3.8 million, respectively. At December 31, 1995 and 1994, borrowings on the line were $2.1 million and $3.4 million, respectively. The weighted average interest rate on the borrowings is 9.7% and 7.9% for 1995 and 1994, respectively.\nNOTE 4 - LONG-TERM DEBT - ----------------------- Long-term debt obligations at December 31 are summarized as follows: (in thousands) 1995 1994 ---------- ---------- Term loan payable to Manufacturers and Traders Trust Company with $50 thousand of principal due in the last quarter of 1996 and thirty quarterly principal installments of approximately $91.7 thousand plus interest due thereafter through 2004, with a balloon payment of $1.33 million due in the same year. During 1995, two quarterly payments of $91.7 and a $1 million prepayment of principal was made. Interest on portions of the term loan are based on the prime rate plus 1.5% or LIBOR, and the greater of a 3.5% fixed rate above the yield on United States Treasury Obligations, or 8%. (Prime at 8.5% on December 31, 1995.) $ 4,133 $ 5,317 - 29 -\nNOTE 4 - LONG-TERM DEBT - Continued - ----------------------- Loan payable to the New Jersey Economic Development Authority due in monthly installments of $18 - $20 thousand plus interest, through 1999, with interest at a rate between 2% and 9% (6% at December 31, 1995) secured by a mortgage on real property. 927 1,125\nLoan payable to the federal government through the Federal Railroad Administration (FRA) due in quarterly installments of $88 thousand, including interest at 6.276% with a balloon payment of $1.5 million on March 31, 2000, secured by a mortgage on real property. 2,356 2,552\nLoan payable to the federal government through the Federal Railroad Administration (FRA) due in quarterly installments of $93 thousand, including interest at 6.4% through 2015, secured by railway equipment. 4,143 -\nVarious promissory notes, mortgage notes and capital leases payable, due in monthly installments, with interest varying from 4.9% - 9.4% at December 31, 1995. The notes are secured by land, buildings or equipment. 2,318 2,192 ---------- ---------- 13,877 11,186 Less current portion (1,075) (1,120) ---------- ---------- Long-term debt $12,802 $10,066 ========== ==========\nDuring 1994, the Company completed the refinancing of its major bank debt with Manufacturers and Traders Trust Company. In conjunction with this refinancing, the Company wrote-off $334 thousand, representing the unamortized balance of deferred financing costs incurred in 1990 in conjunction with its prior loans. The write-off was recorded as an extraordinary item net of applicable income taxes of $106.\nSubstantially all assets of the Company are pledged as collateral under debt agreements. In addition to other requirements, the Company is required to meet certain minimum tangible net worth, working capital, and current ratio requirements under certain debt agreements. At December 31, 1995, the Company met all the minimum requirements.\nThe Company's loan with Manufacturers and Traders Trust Company provides that the Company may not declare any cash dividends in any fiscal year in excess of 40% of Consolidated Net Income in such fiscal year, and that cumulative dividends paid during the term of the loan may not exceed 10% of cumulative retained earnings.\n- 30 -\nNOTE 4 - LONG-TERM DEBT - Continued - ----------------------- In addition, the financing agreements between the Company and its subsidiary, NYS&W, and the federal government provide that yearly dividends may not exceed 50% of the total additions to retained earnings of the Company for the previous year, nor 50% of the total additions to retained earnings for 1985 and each year thereafter.\nInterest expense, net (in thousands) is comprised of interest expense of $1,465, $1,444 and $1,246 for 1995, 1994 and 1993 respectively, net of respective amounts for capitalized interest of $104, $147 and $91, and interest income of $85, $71 and $57. Interest paid (in thousands) was $1,455, $1,332 and $1,131 for the 1995, 1994 and 1993 periods.\nA summary of maturities of long-term debt at December 31, 1995 is as follows (in thousands):\n1996 $ 1,075 1997 1,415 1998 1,301 1999 1,269 2000 2,201 Thereafter 6,616 ------- $13,877 =======\nNOTE 5 - 6.5% CONVERTIBLE SUBORDINATED NOTES - -------------------------------------------- During 1993, the Company completed a private placement of $3.6 million of 6.5% convertible subordinated notes due September 1, 2003. The notes are convertible into shares of the Company's presently authorized common stock at a conversion price of $10.58 per share, after giving effect to stock dividends. Interest on the notes is payable semi-annually on the first day of March and September of each year. The notes may be converted into shares anytime prior to maturity. The Company has reserved 338 thousand shares of authorized common stock for the conversion of the notes. Directors of the Company purchased $850 thousand of the notes.\nNOTE 6 - DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS - -------------------------------------------------------------- The estimated fair values of the Company's financial instruments at December 31, 1995 and the methods and assumptions used to estimate the fair value of each class of financial instruments held by the Company were as follows:\nCash and Cash Equivalents: The carrying amount approximated fair value because of the short maturity of these instruments.\nLong-Term Debt: The fair value of the Company's long-term debt is estimated using discounted cash flow analyses, based on the\n- 31 -\nNOTE 6 - DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS - Continued - ---------------------------------------------------------------- Company's current incremental borrowing rates for similar types of borrowing arrangements. The carrying amount reported in the balance sheet approximates its fair value.\nNOTE 7 - INCOME TAXES - --------------------- The components of the provision for federal and state income taxes are as follows (in thousands):\n1995 1994 1993 -------- -------- -------- Current tax (expense) benefit ($ 49) ($ 218) $ 244 Deferred tax (expense) benefit (829) 1,346 359 -------- -------- -------- TOTAL INCOME TAX (EXPENSE) BENEFIT ($878) $1,128 $ 603 ======== ======== ========\nA reconciliation of the statutory U.S. federal income tax rate to the effective income tax rate follows:\n1995 1994 1993 -------- -------- -------- Statutory income tax rate 34.00% 34.00% 34.00% State taxes, net of federal tax benefit 1.28 (2.72) (1.53) Other (.06) 2.41 ( .40) -------- -------- -------- EFFECTIVE TAX RATE 35.22% 33.69% 32.07% ======== ======== ========\nState taxes are based on a combination of pre-tax earnings, allocated capital and gross transportation receipts. Amounts included in current tax expense were $49 thousand, $218 thousand and $44 thousand for 1995, 1994 and 1993 respectively.\nThe Company has general business credit carryovers of approximately $1.5 million which expire at various dates through the year 2003, net operating loss carryforwards of $11.6 million which expire at various dates through 2010 and alternative minimum tax credits of $983 thousand available to reduce income taxes otherwise currently payable.\nNet income tax payments (refunds) amounted to $237 thousand, $28 thousand, and ($211 thousand) in 1995, 1994 and 1993, respectively.\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\n- 32 -\nNOTE 7 - INCOME TAXES - Continued - --------------------- liabilities and assets as of December 31 are as follows: (in thousands)\n1995 1994 ------- ------- Deferred tax liabilities: Book basis in excess of tax basis of property, plant & equipment $16,811 $14,127 ------- -------\nDeferred tax assets: Vacation reserve $ 142 $ 115 Bad debt reserve 58 65 Litigation reserve 55 82 Other-net 59 35 Net operating loss carryforwards 3,929 3,065 General business credit carryforwards 1,519 1,519 AMT credit carryforwards 983 981 ------- ------- Total deferred tax assets 6,745 5,862 ------- ------- Net deferred tax liabilities $10,066 $ 8,265 ======= ======= Classification of deferred taxes:\nNon-current liabilities $10,398 $ 8,582 Current assets (332) (317) ------- ------- $10,066 $ 8,265 ======= =======\nNOTE 8 - LEASES - --------------- The Company leases certain equipment and real estate under operating lease agreements for periods ranging from one to eight years. The annual rental expenses were $2.9 million, $2.9 million and $2.8 million for 1995, 1994 and 1993, respectively.\nFuture minimum lease payments for noncancelable operating leases as of December 31, 1995, are as follows (in thousands):\nYear ending December 31, 1996 $ 711 1997 628 1998 626 1999 652 2000 652 Thereafter 1,534 ------ TOTAL MINIMUM OPERATING LEASE PAYMENTS $4,803 ======\n- 33 -\nNOTE 9 - STOCK OPTIONS - ---------------------- The Stockholders of the Company have approved stock option plans for officers, directors and key employees. At December 31, 1995, there are 175,208 exercisable shares under option, which includes 6,300 options granted to certain directors during the fourth quarter of 1995. 62,104 options are available for future grants. The exercise price of options granted is equal to the fair market value of the common stock on the date of grant adjusted for stock dividends. The options expire ten years from the date of grant.\nThe status of these plans at December 31, is as follows (the stock option data has been restated to reflect the effects of the 1996 5% stock dividend): Shares Option Under Price Option Range --------- ------------- 1995 175,208 $8.43 - $9.50\nOptions Exercise Exercised Price --------- ------------- 1995 - - 1994 - - 1993 525 $10.50\nNOTE 10 - EMPLOYEE BENEFIT PLAN - ------------------------------- On August 1, 1990, the Company established a defined contribution plan covering substantially all employees. Employees can contribute a portion of their salary or wages as prescribed under section 401(k) of the Internal Revenue Code and, subject to certain limitations, the Company will match a portion of the employees' contribution. The amounts of employer contributions were $91 thousand in 1995, $78 thousand in 1994 and $75 thousand in 1993.\nNOTE 11 - COMMITMENTS - --------------------- The Company has outstanding commitments of approximately $4.8 million in connection with the completion of various rehabilitation projects and construction in progress. Completion dates range from six months to three years. The commitments are expected to be partially offset by government agency funding of approximately $4.4 million.\nThe Company entered into an agreement in August, 1992 to purchase certain property currently under lease for a total inflation adjusted purchase price of approximately $3.5 million. During the second quarter, the Company deposited $500 thousand towards the purchase. The Company will be required to pay an additional $500 thousand at closing, which is anticipated to occur during the first half of 1996. Subsequent to year-end, the Company received a\n- 34 -\nNOTE 11 - COMMITMENTS - Continued - --------------------- commitment for a credit facility from Manufacturers and Traders Trust Company for $2.5 million to finance the purchase. The commitment expires on May 31, 1996. The property is presently being used for relocation and expansion of its bulk distribution operations.\nDuring the fourth quarter of 1995, the Company entered into a contract to sell certain parcels of railroad property of a non- operating Company subsidiary for $500 thousand, which is anticipated to close during 1996. The carrying amount is estimated at $110 thousand. A portion of the purchase price is subject to the buyers obtaining government funding. The proceeds will be used for working capital purposes.\nCertain claims have been filed against the Company or its subsidiaries and have not been finally adjudicated. These claims when finally concluded and determined, will not, in the opinion of management based upon information that it presently possesses, have a material adverse effect on the consolidated financial position and results of operations.\nNOTE 12 - SUBSEQUENT EVENTS - Unaudited - --------------------------- Subsequent to the balance sheet date, the Company completed the purchase of a 40% interest in The Toledo, Peoria and Western Railroad Corporation (\"TP&W\") for consideration totalling $2.25 million, including 25,000 shares of the Company's common stock. The non-stock portion of the consideration for the acquisition was funded through a $1 million loan and the private placement of 100,000 shares of the Company's common stock. Additionally, the Company issued warrants to purchase 60,000 common shares to another party involved in the transaction. The Company will perform administrative services which will have a positive impact on general and administrative expenses for 1996 and beyond. At December 31, 1995, the Company had incurred $592 of advances related to the purchase which were recorded in other current assets. The $592 was reimbursed at closing on January 31, 1996. The investment will be accounted for under the provisions of APB 18, The Equity Method of Accounting for Investments in Common Stock.\nThe TP&W owns a 284 mile Class III regional railroad which provides rail service on a generally East-West route across one of the top grain producing regions in the world from Fort Madison, Iowa through Central Illinois (approximately 70 miles south of Chicago) to Logansport, Indiana. The TP&W hauls agricultural products, chemicals, coal, fertilizer, food products, steel and manufactured goods and consumer products for such customers as ADM, Cilco, Witco, Lonza and Caterpillar and to two company-operated intermodal facilities. The TP&W's geographic location and connections with over 20 rail carriers, including seven Class I railroads, present opportunities for growth, and the acquisition provides the Company with an opportunity to diversify its rail holdings and to provide improved service to its intermodal customers.\n- 35 -\nItem 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE - --------------------------------------------------------------------\nNone.\nPART III --------\nThe information required in Item 10","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) (1) Financial Statements\nThe following financial statements of Delaware Otsego Corporation are included in Part II, Item 8: Page ---- Report of Independent Auditors 20\nConsolidated Statements of Operations for the Years Ended December 31, 1995, 1994 and 1993 21\nConsolidated Balance Sheets at December 31, 1995 and 1994 22\nConsolidated Statements of Stockholders' Equity for the Years Ended December 31, 1995, 1994, and 1993 24\nConsolidated Statements of Cash Flows for the Years Ended December 31, 1995, 1994, and 1993 25\nNotes to Consolidated Financial Statements 26\nSchedules 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.\n(b) Reports on Form 8-K\n- 36 -\nNo reports on Form 8-K were filed by the Company in the fourth quarter.\n(c) Exhibits\nFiled herewith (-) or Incorporated by Reference to ------------------------------- 3.1 Restated Certificate of Incorporation Exhibit 3.1 to Registrant's of the Delaware Otsego Corporation Annual Report on Form 10-K dated dated June 1, 1991 December 31, 1991\n3.2 By-Laws of DOC dated April 5, 1988 Exhibit 3.8 to Registrant's Annual Report on Form 10-K dated December 31, 1988\n10.1 Employment Agreement between DOC Exhibit 10.1 to Registrant's and Walter Rich dated June 3, 1995 Quarterly Report on Form 10-Q dated June 30, 1995\n10.2 Direct Loan Agreement between New Exhibit 10(g) to Registration Jersey Economic Development Authority Statement on Form S-1, and NYS&W dated August 6, 1982 No. 2-94319\n10.3 Agreement between Conrail and NYS&W Exhibit 10(p) to Registration dated March 30, 1982 relating to Statement on Form S-1, trackage rights over line of Conrail No. 2-94319 from Binghamton, New York to Warwick, New York via Campbell Hall and Maybrook, New York\n10.4 Financing Agreement between NYS&W Exhibit 19.11 to Form 10-Q dated and FRA dated September 30, 1985 November 13, 1986\n10.5 Agreement Amending Financing Exhibit 19.12 to Form 10-Q dated Agreement between FRA and NYS&W November 13, 1986 dated July 30, 1986\n10.6 Amendment to Direct Loan Agreement Exhibit 19.18 to Form 10-Q between New Jersey Economic dated November 13, 1986 Development Authority and NYS&W dated July 15, 1986\n10.7 Amendment to Direct Loan Agreement Exhibit 19.19 to Form 10-Q dated between New Jersey Economic November 13, 1986 Development Authority and NYS&W dated September 2, 1986\n- 37 -\n10.8 Amended and Restated Credit Agreement Exhibit 10.8 to Form 10-Q dated between Manufacturers and Traders November 11, 1994 Trust Company and DOC dated May 27, 1994\n10.9 Agreement between NYS&W and Exhibit 10.9 to Registrant's Brotherhood of Locomotive Engineers Annual Report on Form 10-K dated March 30, 1994 dated March 27, 1995\n10.10 Agreement between NYS&W and - Brotherhood of Maintenance of Way Employes dated October 13, 1995\n10.11 Modification to Direct Loan Agreement Exhibit 10(hh) to Registration and Direct Loan Promissory Note dated Statement on Form S-1, as of August 6, 1982 between the New No. 2-94319 Jersey Economic Development Authority and NYS&W dated July 17, 1984\n10.12 Amendment to Operating Agreement Exhibit 10(qq) to Registration Under Branchline Assistance Program Statement on Form S-1, between NYS&W and New York State No. 2-94319 Department of Transportation dated January 10, 1984\n10.22 Delaware Otsego Corporation Exhibit B to Definitive Proxy 1987 Stock Option Plan Statement Dated October 7, 1987\n10.23 Delaware Otsego Corporation Exhibit B to Definitive Proxy 1993 Stock Option Plan Statement Dated May 5, 1993\n10.27 Form of Delaware Otsego Corporation Exhibit 1 to Registrant's 6.5% Convertible Subordinated Note Form 8-K dated October 19, 1993 Due on September 1, 2003\n10.28 Guarantee Commitment between the Exhibit 10.28 to Registrant's Federal Railroad Administration and Annual Report on Form 10-K DOC dated September 29, 1994 dated March 27, 1995\n10.29 Warrant Agreement between DOC and - Creditanstalt Corporate Finance, Inc. dated January 31, 1996\n10.30 Deficiency Guarantee among DOC and - others and Creditanstalt Corporate Finance, Inc. dated January 31, 1996\n- 38 -\n10.31 Cash Collateral Agreement among DOC - and others and Creditanstalt Corporate Finance, Inc. dated January 31, 1996\n21 Subsidiaries of Registrant -\n23 Consent of Ernst & Young LLP -\n- 39 -\nSIGNATURES ----------\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Delaware Otsego Corporation has duly caused this Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nDELAWARE OTSEGO CORPORATION - --------------------------- Registrant\nBy: s\/ Walter G. Rich ------------------------------------- Walter G. Rich, Director President and Chief Executive Officer\nDate: March 24, 1996\nBy: s\/ William B. Blatter ------------------------------------- William B. Blatter, Senior Vice President and Chief Financial Officer\nDate: March 24, 1996\nBy: s\/ Robert E. Pierce ------------------------------------- Robert E. Pierce, Vice President, Controller & Chief Accounting Officer\nDate: March 24, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, 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\/ Albert B. Aftoora s\/ Richard A. White - ------------------------------ ------------------------------ Albert B. Aftoora, Director Richard A. White, Director March 24, 1996 March 24, 1996\ns\/ Robert L. Marcalus s\/ David B. Common - ------------------------------ ------------------------------ Robert L. Marcalus, Director David B. Common, Director March 24, 1996 March 24, 1996\ns\/ Charles S. Brenner s\/ Malcolm C. Hughes - ------------------------------ ------------------------------ Charles S. Brenner, Director Malcolm C. Hughes, Director March 24, 1996 March 24, 1996\ns\/ Niles F. Curtis s\/ Gerald D. Groff - ------------------------------ ------------------------------ Niles F. Curtis, Director Gerald D. Groff, Director March 24, 1996 March 24, 1996\n- 40 -\nEXHIBIT INDEX -------------\nPage ----\n10.10 Agreement between NYS&W and Brotherhood of Maintenance of Way Employes dated October 13, 1995 42\n10.29 Warrant Agreement between DOC and Creditanstalt Corporate Finance, Inc. dated January 31, 1996 121\n10.30 Deficiency Guarantee among DOC and others and Creditanstalt Corporate Finance, Inc. dated January 31, 1996 151\n10.31 Cash Collateral Agreement among DOC and others and Creditanstalt Corporate Finance, Inc. dated January 31, 1996 162\n21 Subsidiaries of Registrant 166\n23 Consent of Ernst & Young LLP 167\n- 41 -","section_15":""}
{"filename":"312812_1995.txt","cik":"312812","year":"1995","section_1":"ITEM 1. BUSINESS - ------- --------\nORGANIZATION - ------------\nMcNeil Real Estate Fund X, Ltd. (the \"Partnership\") was organized June 1, 1979 as a limited partnership under provisions of the California Uniform Limited Partnership Act. The general partner of the Partnership is McNeil Partners, L.P. (the \"General Partner\"), a Delaware limited partnership, an affiliate of Robert A. McNeil (\"McNeil\"). The Partnership is governed by an amended and restated partnership agreement of limited partnership dated October 9, 1991, as amended (the \"Amended Partnership Agreement\"). Prior to October 9, 1991, Pacific Investors Corporation (the prior \"Corporate General Partner\"), a wholly-owned subsidiary of Southmark Corporation (\"Southmark\"), and McNeil were the general partners of the Partnership, which was governed by an agreement of limited partnership (the \"Original Partnership Agreement\") dated June 1, 1979. The principal place of business for the Partnership and the General Partner is 13760 Noel Road, Suite 700, LB70, Dallas, Texas, 75240.\nOn December 14, 1979, a Registration Statement on Form S-11 was declared effective by the Securities and Exchange Commission whereby the Partnership offered for sale $67,500,000 of limited partnership units (\"Units\"). The Units represent equity interests in the Partnership and entitle the holders thereof to participate in certain allocations and distributions of the Partnership. The sale of Units closed on July 17, 1980, with 135,000 Units sold at $500 each, or gross proceeds of $67,500,000 to the Partnership. The original general partners purchased an additional 200 Units for $100,000. Limited partners relinquished 80, 30 and 60 Units in 1993, 1994 and 1995, respectively, leaving 135,030 Units outstanding at December 31, 1995.\nSOUTHMARK BANKRUPTCY AND CHANGE IN GENERAL PARTNER - --------------------------------------------------\nOn July 14, 1989, Southmark filed a voluntary petition for reorganization under Chapter 11 of the U.S. Bankruptcy Code. Neither the Partnership, McNeil nor the Corporate General Partner were included in the filing. Southmark's reorganization plan became effective August 10, 1990. Under the plan, most of Southmark's assets, which included Southmark's interest in the Corporate General Partner, are being sold or liquidated for the benefit of creditors.\nIn accordance with Southmark's reorganization plan, Southmark, McNeil and various of their affiliates entered into an asset purchase agreement on October 12, 1990, providing for, among other things, the transfer of control to McNeil or his affiliates of 34 limited partnerships (including the Partnership) in the Southmark portfolio.\nOn February 14, 1991, pursuant to the asset purchase agreement as amended on that date: (a) an affiliate of McNeil purchased the Corporate General Partner's economic interest in the Partnership; (b) McNeil became the managing general partner of the Partnership pursuant to an agreement with the Corporate General Partner that delegated management authority to McNeil; and (c) McNeil Real Estate Management, Inc. (\"McREMI\"), an affiliate of McNeil, acquired the assets relating to the property management and partnership administrative business of Southmark and its affiliates and commenced management of the Partnership's properties pursuant to an assignment of the existing property management agreements from the Southmark affiliates.\nOn October 11, 1991, the limited partners approved a restructuring proposal providing for (i) the replacement of the Corporate General Partner and McNeil with the General Partner; (ii) the adoption of the Amended Partnership Agreement, which substantially alters provisions of the Original Partnership Agreement relating to, among other things, compensation, reimbursement of expenses, and voting rights; and (iii) the approval of a new property management agreement with McREMI, the Partnership's property manager.\nThe Amended Partnership Agreement provides for a Management Incentive Distribution (\"MID\") to replace all other forms of general partner compensation other than property management fees and reimbursement of certain costs. Additional Units may be issued in connection with the payment of the MID pursuant to the Amended Partnership Agreement. See Item 8 - Note 2 - \"Transactions with Affiliates.\" For a discussion of the methodology for calculating and distributing the MID see Item 13 - Certain Relationships and Related Transactions.\nSettlement of Claims:\nThe Partnership filed claims with the United States Bankruptcy Court for the Northern District of Texas, Dallas Division (the \"Bankruptcy Court\") against Southmark for damages relating to improper overcharges, breach of contract and breach of fiduciary duty. The Partnership settled these claims in 1991, and such settlement was approved by the Bankruptcy Court.\nAn Order Granting Motion to Distribute Funds to Class 8 Claimants dated April 14, 1995 was issued by the Bankruptcy Court. In accordance with the Order, in May 1995, the Partnership received in full satisfaction of its claims, $69,234 in cash, and common and preferred stock in the reorganized Southmark. The cash and stock represent the Partnership's pro-rata share of Southmark assets available for Class 8 Claimants. The Partnership sold the Southmark common and preferred stock in May 1995 for $22,283 which, when combined with the cash proceeds from Southmark, resulted in a gain on settlement of litigation of $91,517.\nCURRENT OPERATIONS - ------------------\nGeneral:\nThe Partnership is engaged in diversified real estate activities, including the ownership, operation and management of residential and commercial real estate and other real estate related assets. At December 31, 1995, the Partnership owned twelve income-producing properties as described in Item 2","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES - ------- ----------\nThe following table sets forth the real estate investment portfolio of the Partnership at December 31, 1995. The buildings and the land on which they are located are owned by the Partnership in fee, subject in each case to a first lien deed of trust as set forth more fully in Item 8 - Note 5 - \"Mortgage Notes Payable\" and Note 6 - \"Mortgage Note Payable - Affiliate.\" See also Item 8 - Note 4 - \"Real Estate Investments\" and Schedule III - \"Real Estate Investments and Accumulated Depreciation and Amortization.\" In the opinion of management, the properties are adequately covered by insurance.\n- ----------------------------------------- Total: Apartments - 2,383 units Retail Centers - 610,247 sq. ft. Office Building - 104,230 sq. ft.\n(1) Briarwood Apartments is owned by Briarwood Fund X Limited Partnership, which is wholly-owned by the Partnership.\n(2) Coppermill Apartments is owned by Coppermill Fund X Limited Partnership, which is wholly-owned by the Partnership.\n(3) Orchard Apartments is owned by Orchard Fund X Limited Partnership, which is wholly-owned by the Partnership.\n(4) Quail Meadows Apartments is owned by Quail Meadows Fund X Limited Partnership, which is wholly-owned by the Partnership.\n(5) Regency Park Apartments is owned by Regency Park Fund X Associates, L.P. which is wholly-owned by the Partnership and the General Partner.\n(6) Sandpiper Apartments is owned by Sandpiper Fund X Limited Partnership, which is wholly-owned by the Partnership.\n(7) Subsequent to year end, the Partnership transferred Spanish Oaks Apartments to Spanish Fund X, Ltd. See Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations and Item 8 - Note 13 - \"Subsequent Event.\" Spanish Fund X, Ltd. is wholly-owned by the Partnership.\nThe following table sets forth the occupancy rate and rent per square foot of the Partnership's properties for each of the last five years:\nOccupancy rate represents all units or square footage leased divided by the total number of units or square footage of the property as of December 31 of the given year. Rent per square foot represents all revenue, except interest, derived from the properties' operations divided by the leasable square footage of the property.\nCompetitive Conditions at Properties - ------------------------------------\nStudents at nearby University of Arizona make up 91% of the tenants at Briarwood Apartments. The property commands rents $100 to $150 higher per month than its competition due to its excellent location near the university and a bike route to the university. Due to the heavy student-tenant profile, occupancy at the property typically drops during the summer months, giving Briarwood an average occupancy rate four to five percentage points below market averages. Planned developments in the area may have a short-term impact on the property, but long-term impact is expected to be negligible due to Briarwood's excellent location.\nThe major exterior renovation currently underway at Cave Spring Corners Shopping Center has allowed the Partnership to increase market rental rates up to area averages. Occupancy remains high due to a good location. Competing properties have also been renovated during the past five to six years. The economic outlook for the Roanoke area is expected to be positive, and should allow Cave Spring Corners to maintain its high occupancy through 1997.\nThe average occupancy rate at Coppermill Apartments mirrors the local area average of 92%. Area occupancy rates are expected to be stable in the 92% to 93% range. Most properties in the immediate area, including Coppermill, were built by the same developer using identical floor plans. Thus, the local market is very price-sensitive. The average monthly rent per square foot city-wide is $.54 per square foot. Because Coppermill's monthly rental rates average $.48 per square foot, there is some room for rental rate increases, but usually only with units that have upgraded amenities that differentiate the units from the competition's.\nIberia Plaza gained a new anchor tenant during 1995. The property remained 97% leased, but the proportion of the space that was \"dark\" or vacant decreased from 84% to 19% during 1995. The new tenant, a grocery store, has greatly increased the amount of traffic into the property. In connection with the new anchor tenant lease, the Partnership invested over $700,000 in capital improvements to replace the asphalt, roof, exterior lighting and HVAC equipment. The primary competition for the property is a retail center constructed in 1991 across the street from Iberia Plaza. The new retail center charges an average rental rate of $8 to $10 per square foot as opposed to $6 at Iberia Plaza.\nLa Plaza Business Center had two major tenants vacate or down-size their space requirements during 1995. Occupancy fell from 97% at the beginning of 1995 to 77% at the end of 1995. The decrease in occupancy has prompted the Partnership to update the appearance of the property. Additional substantial tenant improvement costs are expected to be incurred to convert the property to a more leasable configuration and to bring the property into compliance with local building codes. The Partnership intends to fund the tenant improvements as lease negotiations proceed with new tenants. Demand for office space in Las Vegas is expected to be strong in 1996. New construction is aimed at the high-end of the market, and is not expected to compete with La Plaza.\nLakeview Plaza is 98% leased. However, one of the property's anchor tenants vacated its space in mid-1995. The tenant anticipates sub-leasing its space by mid-1996. The local market area appears to be strong, with several national retailers looking for sites for additional stores in the area. There are also several, newer competing properties in very close proximity to Lakeview Plaza that have adversely affected sales of Lakeview Plaza's tenants.\nIn 1993, the Partnership invested $660,000 of capital improvements at Orchard Apartments. The property, as a result, has benefited from improved curb appeal and improved financial performance. Orchard's occupancy rate is usually two percentage points above the 93% average occupancy rate of competitors in the Indianapolis submarket where Orchard is located. Rental rates at Orchard are comparable to its competitors. Recent and impending layoffs by major area employers are a concern.\nParkway Plaza has a good location on the north side of Lafayette, Louisiana. There is no room for additional development in the immediate area; consequently, new developments are located across town from Parkway Plaza. The property is 100% leased, but the property's main anchor tenant has vacated its space. Although lease payments continue to be made, the vacant space generates no percentage rents and does not pull in shoppers to the property. The Partnership placed Parkway Plaza on the market for sale in December 1994.\nQuail Meadows Apartments is one of the nicer properties in the Wichita area. Both interiors and exteriors of the property are above average relative to the competition. However, the market in the Wichita area is soft. Area occupancy rates have decreased for the past three years and rental rates have been flat. Quail Meadows has maintained occupancy rates higher than market averages, but has not been able to increase rental rates despite significant capital improvements. The property relies on tenants from nearby McConnell Air Force Base, which has recently constructed new housing facilities and faces the possibility of congressional military cutbacks.\nOccupancy rates in the Regency Park Apartments market area average 94%, slightly better than Regency Park's occupancy rate. Rental rates realized at Regency Park are also lower than its competitors. The property competes with numerous properties, some of which are newer or have more appeal to prospective tenants. Capital improvements made by the Partnership during 1993, 1994 and 1995 have allowed the property to close some of the gap between Regency Park and its competitors. The rental market in the area, however, remains price sensitive. Improvements in operating results generally are coming through improved occupancy rather than rate increases.\nCapital improvements placed in service since 1992 have allowed Sandpiper Apartments to increase its rent per square foot by 41% in the past four years. Occupancy and rental rates are above market averages. Since 1992, the income level of Sandpiper's tenants has increased substantially. There is significant new construction under development in the market area. It is expected that the new construction will put downward pressure on market rent levels, but management expects that well-maintained Sandpiper will continue to compete effectively.\nAverage occupancy rates at Spanish Oaks Apartments have decreased two percentage points during the past two years due to competition with new construction, older properties that have been renovated, and rate hikes at Spanish Oaks. Net income from the property has continued to rise due to increased rental rates, but rental rates at Spanish Oaks remain below market averages. The interiors at Spanish Oaks will need to be updated to allow the property to raise its rents to current market levels. Also of concern is the reliance upon personnel employed or stationed at Fort Sam Houston Army Base for many of the property's tenants.\nThe following schedule shows lease expirations for each of the Partnership's commercial properties for 1996 through 2005:\nNo residential tenant leases 10% or more of the available rental space. The following schedule reflects information on commercial tenants occupying 10% or more of the leasable square feet for each property:\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS - ------- -----------------\nThe Partnership is not party to, nor are any of the Partnership's properties the subject of, any material pending legal proceedings, other than ordinary, routine litigation incidental to the Partnership's business, except as noted below.\n1) High River Limited Partnership v. McNeil Partners, L.P., McNeil Investors, Inc., McNeil Pacific Investors 1972, Ltd., McNeil Real Estate Fund V, Ltd., McNeil Real Estate Fund IX, Ltd., McNeil Real Estate Fund X, Ltd., McNeil Real Estate Fund XI, Ltd., McNeil Real Estate Fund XIV, Ltd., McNeil Real Estate Fund XV, Ltd., McNeil Real Estate Fund XX, L.P., McNeil Real Estate Fund XXIV, L.P., McNeil Real Estate Fund XXV, L.P., Robert A. McNeil and Carole J. McNeil (L95012) - High River (\"HR\") filed this action in the United States District Court for the Southern District of New York against McNeil Partners, L.P., McNeil Investors, Inc. and Mr. and Mrs. McNeil (as defined in this Section 1, collectively, the \"Defendants\") requesting, among other things, names and addresses of the limited partners in the partnerships referenced above (as defined in this Section 1, the \"Partnerships\"). The District Court issued a preliminary injunction against the Partnerships requiring them to commence mailing materials relating to the HR tender offer on August 14, 1995.\nOn August 18, 1995, the Defendants filed an Answer and Counterclaim. The Counterclaim principally asserts (1) the HR tender offers have been undertaken in violation of the federal securities laws, on the basis of material, non-public, and confidential information, and (2) that the HR offer documents omit and\/or misrepresent certain material information about the HR tender offers. The Counterclaim seeks a preliminary and permanent injunction against the continuation of the HR tender offers and, alternatively, ordering corrective disclosure with respect to allegedly false and misleading statements contained in the tender offer documents.\nThis action was dismissed without prejudice in November 1995.\n2) High River Limited Partnership v. McNeil Partners, L.P., McNeil Investors, Inc., McNeil Pacific Investors 1972, Ltd., McNeil Real Estate Fund V, Ltd., McNeil Real Estate Fund IX, Ltd., McNeil Real Estate Fund X, Ltd., McNeil Real Estate Fund XI, Ltd., McNeil Real Estate Fund XIV, Ltd., McNeil Real Estate Fund XV, Ltd., McNeil Real Estate Fund XX, L.P., McNeil Real Estate Fund XXIV, L.P., McNeil Real Estate Fund XXV, L.P., Robert A. McNeil and Carole J. McNeil - United States District Court for the Southern District of New York, (Case No. 95 Civ. 9488) (Second Action).\nOn November 7, 1995, High River filed a second complaint with the District Court which alleges, inter alia, that McNeil Partners, L.P.'s (the \"General Partner\") Schedule 14D-9 filed in connection with the High River tender offers was materially false and misleading, in violation of Sections 14(d) and 14(e) of the Securities Exchange Act of 1934, 15 U.S.C. Section 78n(d) and (e), and the SEC Regulations promulgated thereunder; and that High River further alleges that the General Partner has wrongfully refused to admit High River as a limited partner to the ten partnerships referenced above. Additionally, High River purports to assert claims derivatively on behalf of McNeil Real Estate Fund IX, Ltd., McNeil Real Estate Fund XI, Ltd., McNeil Real Estate Fund XV, Ltd., McNeil Real Estate Fund XXIV, L.P. and McNeil Real Estate Fund XXV, L.P., for breach of contract and breach of fiduciary duty, asserting that the General Partner has charged these partnerships excessive fees. High River's complaint seeks, inter alia, preliminary injunctive relief requiring the General Partner to admit High River as a limited partner in each of the ten partnerships referenced above and to transfer the tendered units of interest in the partnerships to High River; an unspecified award of damages payable to High River and an additional unspecified award of damages payable to certain of the partnerships; an order that defendants must discharge their fiduciary duties and must account for all fees they have received from certain of the partnerships; and attorneys' fees.\nOn January 31, 1996, this action was dismissed without prejudice.\n3) Robert Lewis v. McNeil Partners, L.P., McNeil Investors, Inc., Robert A. McNeil et al - In the District Court of Dallas County, Texas, A-14th Judicial District, Cause No. 95-08535 (Class Action) - Plaintiff, Robert Lewis, is a limited partner with McNeil Pacific Investors Fund 1972, Ltd., McNeil Real Estate Fund X, Ltd. and McNeil Real Estate Fund XV, Ltd.\nPlaintiff brings this action on his own behalf and as a class action on behalf of the class of all limited partners of McNeil Pacific Investors Fund 1972, Ltd., McNeil Real Estate Fund V, Ltd., McNeil Real Estate Fund IX, Ltd., McNeil Real Estate Fund X, Ltd., McNeil Real Estate Fund XI, Ltd., McNeil Real Estate Fund XIV, Ltd., McNeil Real Estate Fund XV, Ltd., McNeil Real Estate Fund XX, L.P., McNeil Real Estate Fund XXIV, L.P. and McNeil Real Estate Fund XXV, Ltd. (as defined in this Section 3, the \"Partnerships\") as of August 4, 1995.\nPlaintiff alleges that McNeil Partners, L.P., McNeil Investors, Inc., Robert A. McNeil and other senior officers (as defined in this Section 3, collectively, the \"Defendants\") breached their fiduciary duties by, among other things, (1) failing to attempt to sell the properties owned by the Partnerships (as defined in this Section 3, the \"Properties\") and extending the lives of the Partnerships indefinitely, contrary to the Partnerships' business plans, (2) paying distributions to themselves and generating fees for their affiliates, (3) refusing to make significant distributions to the class members, despite the fact that the Partnerships have positive cash flows and substantial cash balances, and (4) failing to take steps to create an auction market for equity interests of the Partnerships, despite the fact that a third party bidder filed tender offers for approximately forty-five percent (45%) of the outstanding units of each of the Partnerships. Plaintiff also claims that Defendants have breached the partnership agreements of the Partnerships by failing to take steps to liquidate the Properties and by their alteration of the Partnerships' primary purposes, their acts in contravention of these agreements, and their use of the assets of the Partnerships for their own benefit instead of for the benefit of the Partnerships.\nThe Defendants deny that there is any merit to Plaintiff's allegations and intend to vigorously defend this action.\n4) James F. Schofield, Gerald C. Gillett and Donna S. Gillett v. McNeil Partners, L.P., McNeil Investors, Inc., McNeil Real Estate Management, Inc., Robert A. McNeil, Carole J. McNeil, McNeil Real Estate Fund V, Ltd., McNeil Real Estate Fund IX, Ltd., McNeil Real Estate Fund X, Ltd., McNeil Real Estate Fund XI, Ltd., McNeil Real Estate Fund XIV, Ltd., McNeil Real Estate Fund XV, Ltd., McNeil Real Estate Fund XX, L.P., McNeil Real Estate Fund XXIV, L.P., McNeil Real Estate Fund XXV, L.P. et al - Superior Court of the State of California for the County of Los Angeles, Case No. BC133799 (Class and Derivative Action Complaint) and United States District Court, Southern District of New York, Case No. 95CIV.6711 (Class and Derivative Action Complaint)\nThese are corporate\/securities class and derivative actions brought in state and federal court by limited partners of each of the nine (9) limited partnerships that are named as nominal defendants as listed above (as defined in this Section 4, the \"Partnerships\"). Plaintiffs allege that McNeil Investors, Inc., its affiliate McNeil Real Estate Management, Inc. and four (4) of their senior officers and\/or directors (as defined in this Section 4, collectively, the \"Defendants\") have breached their fiduciary duties. Specifically, Plaintiffs allege that Defendants have caused the Partnerships to enter into several wasteful transactions that have no business purpose or benefit to the Partnerships and which have rendered such units highly illiquid and artificially depressed the prices that are available for units on the limited resale market. Plaintiffs also allege that Defendants have engaged in a course of conduct to prevent the acquisition of units by Carl Icahn by disseminating false, misleading and inadequate information. Plaintiffs further allege that Defendants have acted to advance their own personal interests at the expense of the Partnerships' public unit holders by failing to sell Partnership properties and failing to make distributions to unitholders and, thereby, have breached the partnership agreements.\nThe Defendants deny that there is any merit to Plaintiff's allegations and intend to vigorously defend these actions.\n5) Alfred Napoletano v. McNeil Partners, L.P., McNeil Investors, Inc., Robert A. McNeil, Carole J. McNeil, McNeil Pacific Investors Fund 1972, Ltd., McNeil Real Estate Fund V, Ltd., McNeil Real Estate Fund IX, Ltd., McNeil Real Estate Fund X, Ltd., McNeil Real Estate Fund XI, Ltd., McNeil Real Estate Fund XIV, Ltd., McNeil Real Estate Fund XV, Ltd., McNeil Real Estate Fund XX, L.P., McNeil Real Estate Fund XXIV, L.P., McNeil Real Estate Fund XXV, L.P. - Superior Court of the State of California, County of Los Angeles, Case No. BC133849 (Class Action Complaint)\nPlaintiff brings this class action on behalf of a class of all persons and entities who are current owners of units and\/or are limited partners in one or more of the partnerships referenced above (as defined in this Section 5, the \"Partnerships\"). Plaintiff alleges that McNeil Partners, L.P., McNeil Investors, Inc., Robert A. McNeil and other senior officers (as defined in this Section 5, collectively, the \"Defendants\") have breached their fiduciary duties to the class members by, among other things, (1) taking steps to prevent the consummation of the High River tender offers, (2) failing to take steps to maximize unitholders' or limited partners' values, including failure to liquidate the properties owned by the Partnerships, (3) managing the Partnerships so as to extend indefinitely the present fee arrangements, and (4) paying itself and entities owned and controlled by the general partner excessive fees and reimbursements of general and administrative expenses.\nThe Defendants deny that there is any merit to Plaintiff's allegations and intend to vigorously defend this action.\n6) Warren Heller v. McNeil Partners, L.P., McNeil Investors, Inc., Robert A. McNeil, Carole J. McNeil, McNeil Pacific Investors Fund 1972, Ltd., McNeil Real Estate Fund V, Ltd., McNeil Real Estate Fund IX, Ltd., McNeil Real Estate Fund X, Ltd., McNeil Real Estate Fund XI, Ltd., McNeil Real Estate Fund XIV, Ltd., McNeil Real Estate Fund XV, Ltd., McNeil Real Estate Fund XX, L.P., McNeil Real Estate Fund XXIV, L.P., McNeil Real Estate Fund XXV, L.P. - Superior Court of the State of California, County of Los Angeles, Case No. BC133957 (Class Action Complaint)\nPlaintiff brings this class action on behalf of a class of all persons and entities who are current owners of units and\/or are limited partners in one or more of the partnerships referenced above (as defined in this Section 6, the \"Partnerships\"). Plaintiff alleges that McNeil Partners, L.P., McNeil Investors, Inc., Robert A. McNeil and other senior officers (as defined in this Section 6, collectively, the \"Defendants\") have breached their fiduciary duties to the class members by, among other things, (1) taking steps to prevent the consummation of the High River tender offers, (2) failing to take steps to maximize unitholders' or limited partners' values, including failure to liquidate the properties owned by the Partnerships, (3) managing the Partnerships so as to extend indefinitely the present fee arrangements, and (4) paying itself and entities owned and controlled by the general partner excessive fees and reimbursements of general and administrative expenses.\nThe Defendants deny that there is any merit to Plaintiff's allegations and intend to vigorously defend this action.\nFor discussion of the Southmark bankruptcy, see Item 1 - Business and Item 8 - Note 12 - \"Gain on Legal Settlement.\"\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 UNITS OF LIMITED PARTNERSHIP AND - ------- ------------------------------------------------------------ RELATED SECURITY HOLDER MATTERS -------------------------------\n(A) There is no established public trading market for limited partnership units, nor is one expected to develop.\n(B) Title of Class Number of Record Unit Holders\nLimited partnership units 6,971 as of February 16, 1996\n(C) No distributions were paid to the limited partners in 1995 or 1994 and none are anticipated in 1996. The Partnership accrued distributions of $1,064,257 and $634,802 for the benefit of the General Partner for the years ended December 31, 1995 and 1994, respectively. These distributions are the contingent portion of the MID pursuant to the Amended Partnership Agreement. See Item 8 - Note 2 - \"Transactions with Affiliates.\" See Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations for a discussion of the likelihood that the Partnership will resume distributions to the limited partners.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA - ------- -----------------------\nThe following table sets forth a summary of certain financial data for the Partnership. This summary should be read in conjunction with the Partnership's financial statements and notes thereto appearing in Item 8.\nSee Item 7","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION - ------- ----------------------------------------------------------- AND RESULTS OF OPERATIONS -------------------------\nFINANCIAL CONDITION - -------------------\nThe Partnership was formed to acquire, operate and ultimately dispose of a portfolio of income-producing real properties. At the end of 1995, the Partnership owned seven apartment buildings, four retail centers and one office building. All of the Partnership's properties are subject to mortgage indebtedness.\nOn September 14, 1995, the Partnership sold The Courts Apartments, a 382-unit apartment complex located in Kent, Washington. The unaffiliated buyer purchased the property for a cash purchase price of $8,050,000 and assumed the $140,358 improvement district liens encumbering the property. The Partnership recorded a gain of $3,183,698 on the sale. After retiring the mortgage note on the property and paying for closing costs, the sale provided $1,289,573 of cash proceeds that the Partnership added to its cash reserves.\nSubsequent to year end, on January 26, 1996, the Partnership refinanced the Spanish Oaks mortgage note. The interest rate on the new $4,000,000 mortgage note is 7.71%; monthly payments of principal and interest are $28,546. Proceeds from the new mortgage note, after retiring the previous mortgage note, totaled $475,775. The Partnership used $129,273 of the net loan proceeds to pay for deferred borrowing costs associated with the new mortgage note, and $165,291 to fund various escrow accounts held by the mortgagee for the payment of property taxes, hazard insurance and deferred maintenance.\nRESULTS OF OPERATIONS - ---------------------\n1995 compared to 1994\nRevenue:\nThe Partnership reported two non-recurring items of revenue in 1995. First was the $3,183,698 gain on the sale of The Courts Apartments. Second was a $91,517 gain on a legal settlement pertaining to cash proceeds received from Southmark, the parent of the Partnership's former general partner, in settlement of the Partnership's claims in the Southmark bankruptcy filing.\nThe Partnership's rental revenue decreased $497,828 or 2.9% in 1995 compared to 1994. Most of the decrease is attributable to the sale of The Courts Apartments in September 1995. However, rental revenue, excluding rental revenue from The Courts Apartments for 1995 and 1994, also decreased by $79,997 or 0.5%. Eight of the Partnership's properties reported steady increases in rental revenue ranging from 3 to 4.5 percent. One property, Regency Park Apartments, reported a 7.0% increase in rental revenue, the result of a 5% increase in base rental rates combined with a decrease in vacancy losses.\nDecreases in rental revenue were reported at Iberia Plaza, La Plaza Office Building and Lakeview Plaza. Behind the 3.8% decrease in rental revenue at Iberia Plaza was a decrease in percentage rents from the property's tenants. 78% of the property's leasable space was \"dark\" (space that is under lease, but vacant) for some period of time during 1995. Tenants who have vacated their space, but are still paying base rent do not provide the Partnership with any percentage rents. Expense recoveries also decreased at Iberia Plaza. A new anchor tenant (a grocery store) is now in place at Iberia Plaza. The General Partner anticipates that expense recoveries will improve in 1996 due to the new anchor tenant. Rental revenue at La Plaza Office Building decreased 28% as two of the property's major tenants either moved to a competing property, or reduced their space requirements by half. The Partnership is reconfiguring space arrangements at La Plaza Office Building to take advantage of the shortage of smaller office suites in the Las Vegas market. Rental revenue will likely remain depressed at La Plaza for 1996, before improving in 1997. Lakeview Plaza also had difficulty with dark space in 1995. Rental revenue at the Lexington, Kentucky property decreased 17.3% principally due to decreases in expense recoveries from tenants no longer operating businesses at the property.\nExpenses:\nTotal Partnership expenses decreased $562,961 or 3.0% in 1995 compared to 1994. Excluding the effect of expenses incurred at The Courts Apartments reveals an $8,949 decrease in expenses.\nProperty tax expense decreased at six of the Partnership's properties. The most significant decrease was reported at Lakeview Plaza. A preliminary reduction in the assessed value of Lakeview Plaza resulted in a $78,000 reduction in property tax expense for 1995. Property taxes were also reduced by lesser amounts at Cave Spring Corners Shopping Center, Orchard Apartments, Regency Park Apartments, Sandpiper Apartments and Spanish Oaks Apartments.\nOther property operating expenses, excluding other property operating expenses incurred at The Courts Apartments, increased $86,128 or 9.3% in 1995 compared to 1994. The increase is principally attributable to increased insurance expense for the Partnership's properties. Also included in this category are advertising and marketing expenses, bad debt expense, and office and administrative expenses.\nPartnership general and administrative expenses increased $167,761 or 83% in 1995 compared to 1994. The Partnership incurred $242,486 of expenses related to the evaluation and dissemination of information with regards to an unsolicited tender offer. No such expenses were incurred in 1994.\nInterest incurred on loans from affiliates increased to $78,822 in 1995 from $5,206 in 1994. This expense represents interest on the $800,000 loan from an affiliate of the General Partner secured by Lakeview Plaza. Only one month of affiliate interest expense was incurred in 1994 as opposed to twelve months of such expense during 1995.\nGeneral and administrative expenses incurred for the benefit of affiliates increased $61,400 or 10.1% in 1995 compared to 1994. These expenses are the reimbursable expenses incurred by affiliates of the General Partner. These costs increased due to a reduction in the number of properties managed by McREMI over which such costs are allocated.\n1994 compared to 1993\nRevenue:\nRental revenues for 1994 increased $1,158,015 or 7.1% compared to 1993. Rental revenue increased at all of the partnership's properties except The Courts Apartments. Rental revenues increased greater than 10% at Briarwood Apartments, Cave Spring Corners Shopping Center, La Plaza Office Building and Orchard Apartments. Average occupancy rates increased at nine of the Partnership's properties. Layoffs in the military and aerospace industry and a generally flat local economy contributed to a decrease in rental and average occupancy rates at The Courts Apartments.\nThe Partnership benefited from a $292,539 extraordinary gain during 1994. The gain relates to the discounted payoff of the Iberia Plaza second mortgage note. The General Partner was able to negotiate a release of the $477,016 mortgage note for a $100,000 payment. See Item 8","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - ------- -------------------------------------------\nAll other schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Partners of McNeil Real Estate Fund X, Ltd.:\nWe have audited the accompanying balance sheets of McNeil Real Estate Fund X, Ltd. (a California limited partnership) as of December 31, 1995 and 1994, and the related statements of operations, partners' equity (deficit) and cash flows for each of the three years in the period ended December 31, 1995. These 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 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 McNeil Real Estate Fund X, Ltd. as of December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\nOur audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule listed in the index to financial statements is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in our audits of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\n\/s\/ Arthur Andersen LLP\nDallas, Texas March 13, 1996\nMcNEIL REAL ESTATE FUND X, LTD.\nBALANCE SHEETS\nSee accompanying notes to financial statements.\nMcNEIL REAL ESTATE FUND X, LTD.\nSTATEMENTS OF OPERATIONS\nSee accompanying notes to financial statements.\nMcNEIL REAL ESTATE FUND X, LTD.\nSTATEMENTS OF PARTNERS' EQUITY (DEFICIT)\nFor the Years Ended December 31, 1995, 1994 and 1993\nSee accompanying notes to financial statements.\nMcNEIL REAL ESTATE FUND X, LTD.\nSTATEMENTS OF CASH FLOWS\nIncrease (Decrease) in Cash and Cash Equivalents\nSee discussion of noncash investing activity in Note 10 - \"Gain on Involuntary Conversion.\"\nSee accompanying notes to financial statements.\nMcNEIL REAL ESTATE FUND X, LTD.\nSTATEMENTS OF CASH FLOWS\nReconciliation of Net Income (Loss) to Net Cash Provided by Operating Activities\nSee accompanying notes to financial statements.\nMcNEIL REAL ESTATE FUND X, LTD.\nNOTES TO FINANCIAL STATEMENTS\nDECEMBER 31, 1995\nNOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - --------------------------------------------------------------------\nOrganization - ------------\nMcNeil Real Estate Fund X, Ltd. (the \"Partnership\") was organized June 1, 1979, as a limited partnership under the provisions of the California Uniform Limited Partnership Act. The general partner of the Partnership is McNeil Partners, L.P. (the \"General Partner\"), a Delaware limited partnership, an affiliate of Robert A. McNeil. The Partnership is governed by an amended and restated partnership agreement of limited partnership dated October 9, 1991, as amended (the \"Amended Partnership Agreement\"). The principal place of business for the Partnership and the General Partner is 13760 Noel Road, Suite 700, LB70, Dallas, Texas, 75240.\nThe Partnership is engaged in diversified real estate activities, including the ownership, operation and management of residential and commercial real estate and other real estate related assets. At December 31, 1995, the Partnership owned twelve income-producing properties as described in Note 4 - Real Estate Investments.\nBasis of Presentation - ---------------------\nThe accompanying financial statements have been prepared in conformity with generally accepted accounting principles (\"GAAP\"). The preparation of financial statements in conformity with GAAP 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.\nThe Partnership's financial statements include the accounts of the following listed tier limited partnerships. These single asset tier limited partnerships were formed to accommodate the refinancing of the respective properties. The Partnership's and the General Partner's ownership interest in each tier limited partnership are detailed below. The Partnership retains effective control of each tier limited partnership. The General Partner's minority interest is not presented as it is immaterial.\n(a) The general partner of these limited partnerships is a corporation whose stock is 100% owned by the Partnership.\n(b) Included in financial statements for years ended December 31, 1995, 1994 and 1993.\n(c) Included in financial statements for years ended December 31, 1995 and 1994.\n(d) Spanish Fund X, Ltd. commenced business activity on January 26, 1996.\nReal Estate Investments - -----------------------\nReal estate investments are generally stated at the lower of cost or net realizable value. Real estate investments are monitored on an ongoing basis to determine if the property has sustained a permanent impairment in value. At such time, a write-down is recorded to reduce the basis of the property to its net realizable value. A permanent impairment is determined to have occurred when a decline in property value is considered to be other than temporary based upon management's expectations with respect to projected cash flows and prevailing economic conditions.\nImprovements and betterments are capitalized and expensed through depreciation charges. Repairs and maintenance are charged to operations as incurred.\nIn March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of.\" This statement requires that long-lived assets and certain identifiable intangibles to be held and used by an entity be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. This statement is effective for financial statements for fiscal years beginning after December 15, 1995. The Partnership has not adopted the principles of this statement within the accompanying financial statements; however, it is not anticipated that adoption will have a material effect on the carrying value of the Partnership's long-lived assets.\nAssets Held for Sale - --------------------\nAssets held for sale are stated at the lower of cost or net realizable value.\nDepreciation - ------------\nBuildings and improvements are depreciated using the straight-line method over the estimated useful lives of the assets, ranging from 3 to 38 years. Tenant improvements are amortized over the terms of the related tenant leases using the straight-line method.\nCash and Cash Equivalents - -------------------------\nCash and cash equivalents include cash on hand and cash on deposit with financial institutions with original maturities of three months or less. Carrying amounts for cash and cash equivalents approximate fair value.\nEscrow Deposits - ---------------\nThe Partnership is required to maintain escrow accounts in accordance with the terms of various mortgage indebtedness agreements. These escrow accounts are controlled by the mortgagee and are used for payment of property taxes, hazard insurance, capital improvements and\/or property replacements. Carrying amounts for escrow deposits approximate fair value.\nDeferred Borrowing Costs - ------------------------\nLoan fees and other related costs incurred to obtain long-term financing on real property are capitalized and amortized using a method that approximates the effective interest method over the terms of the related mortgage notes payable. Amortization of deferred borrowing costs is included in interest expense on the Statements of Operations.\nDiscounts on Mortgage Notes Payable - -----------------------------------\nDiscounts on mortgage notes payable are amortized over the remaining terms of the related mortgage notes using the effective interest method. Amortization of discounts on mortgage notes payable is included in interest expense on the Statements of Operations.\nRental Revenue - --------------\nThe Partnership leases its residential properties under short-term operating leases. Lease terms generally are less than one year in duration. Rental revenue is recognized as earned.\nThe Partnership leases its commercial properties under non-cancelable operating leases. Certain leases provide concessions and\/or periods of escalating or free rent. Rental revenue is recognized on a straight-line basis over the term of the related leases. The excess of the rental revenue recognized over the contractual rental payments is recorded as accrued rent receivable and included in accounts receivable on the Balance Sheets.\nIncome Taxes - ------------\nNo provision for Federal income taxes is necessary in the financial statements of the Partnership because, as a partnership, it is not subject to Federal income tax and the tax effect of its activities accrues to the partners.\nAllocation of Net Income and Net Loss - -------------------------------------\nThe Amended Partnership Agreement provides for net income or net loss of the Partnership for both financial statement and income tax reporting purposes to be allocated as indicated below. For allocation purposes, net income and net loss of the Partnership is determined prior to deductions for depreciation.\n(a) First, 5% of all deductions for depreciation shall be allocated to the General Partner, and 95% of all deductions for depreciation shall be allocated to the limited partners;\n(b) then, an amount of net income equal to the cumulative amount of the contingent portion of the Management Incentive Distribution (\"MID\") paid to the General Partner for which no income has previously been allocated (see Note 2 - \"Transactions with Affiliates\") shall be allocated to the General Partner; provided, however, that if all or a portion of such payment consists of limited partnership units (\"Units\"), the amount of net income allocated to the General Partner shall be equal to the amount of cash the General Partner would have otherwise received;\n(c) then, any remaining net income shall be allocated to the General Partner and to the limited partners so that the total amount of net income allocated to the General Partner pursuant to (b) above and this paragraph (c) and to the limited partners pursuant to this paragraph (c) shall be in the ratio of 5% to the General Partner and 95% to the limited partners.\n(d) Net loss shall be allocated 5% to the General Partner and 95% to the limited partners.\nFederal income tax law provides that the allocation of loss to a partner will not be recognized unless the allocation is in accordance with a partner's interest in the partnership or the allocation has substantial economic effect. Internal Revenue Code Section 704(b) and accompanying Treasury Regulations establish criteria for allocations of Partnership deductions attributable to debt. The Partnership's tax allocations for 1995, 1994 and 1993 have been made in accordance with these provisions.\nDistributions - -------------\nPursuant to the Amended Partnership Agreement and at the discretion of the General Partner, distributions during each taxable year shall be made as follows:\n(a) first, to the General Partner, an amount equal to the contingent portion of the MID, and\n(b) any remaining distributable cash, as defined, shall be distributed 100% to the limited partners.\nNo distributions were made to the limited partners in 1995, 1994 or 1993. The Partnership accrued distributions of $1,064,257, $634,802 and $824,487 for the benefit of the General Partner for the years ended December 31, 1995, 1994 and 1993, respectively. These distributions are the contingent portion of the MID pursuant to the Amended Partnership Agreement.\nNet Income (Loss) Per Limited Partnership Unit - ----------------------------------------------\nNet income (loss) per Unit is computed by dividing net income (loss) allocated to the limited partners by the weighted average number of Units outstanding. Per Unit information has been computed based on 135,030, 135,090 and 135,120 Units outstanding in 1995, 1994 and 1993, respectively.\nReclassifications - -----------------\nCertain reclassifications have been made to prior year amounts to conform with the current year presentation.\nNOTE 2 - TRANSACTIONS WITH AFFILIATES - -------------------------------------\nThe Partnership pays property management fees equal to 5% of the gross rental receipts of the Partnership's properties to McNeil Real Estate Management, Inc. (\"McREMI\"), an affiliate of the General Partner, for providing property management services for the Partnership's residential and commercial properties and leasing services for its residential properties. McREMI may choose to perform leasing services for the Partnership's commercial properties, in which case McREMI will receive a property management fee equal to 3% of the gross rental receipts of the Partnership's commercial properties plus a commission for performing leasing services equal to the prevailing market rate for such services in the area where the property is located.\nThe Partnership reimburses McREMI for its costs, including overhead, of administering the Partnership's affairs.\nThe Partnership reimbursed an affiliate of the General Partner for costs incurred in connection with the 1993 refinancing and modification of mortgage notes. These costs are capitalized as deferred borrowing costs and amortized over the remaining term of the related mortgage notes.\nUnder terms of the Amended Partnership Agreement, the Partnership is paying the MID to the General Partner. The maximum MID is calculated as 1% of the tangible asset value of the Partnership. The maximum MID percentage decreases subsequent to 1999. Tangible asset value is determined by using the greater of (i) an amount calculated by applying a capitalization rate of 9% of the annualized net operating income of each property or (ii) a value of $10,000 per apartment unit for residential property and $50 per gross square foot for commercial property to arrive at the property tangible asset value. The property tangible asset value is then added to the book value of all other assets excluding intangible assets. Prior to July 1, 1993, the MID consisted of two components: (i) the fixed portion which was payable without respect to the net income of the Partnership and was equal to 25% of the maximum MID (the \"Fixed MID\") and (ii) a contingent portion which was payable only to the extent of the lesser of the Partnership's excess cash flow, as defined, or net operating income (the \"Entitlement Amount\") and was equal to up to 75% of the maximum MID (the \"Contingent MID\").\nEffective July 1, 1993, the General Partner amended the Amended Partnership Agreement as a settlement to a class action complaint. This amendment eliminates the Fixed MID and makes the entire MID payable to the extent of the Entitlement Amount. In all other respects, the calculation and payment of the MID remain the same.\nFixed MID was payable in Units unless the Entitlement Amount exceeded the amount necessary to pay Contingent MID, in which case, at the General Partner's option, the Fixed MID was paid in cash to the extent of such excess.\nContingent MID will be paid to the extent of the Entitlement Amount, and may be paid (i) in cash, unless there is insufficient cash to pay the distribution in which event any unpaid portion not taken in Units will be deferred and is payable, without interest, from the first available cash and\/or (ii) in Units. The General Partner has deferred collection of the MID since January 1, 1994. A maximum of 50% of the MID may be paid in Units. The number of Units issued in payment of the MID is based on the greater of $50 per Unit or the net tangible asset value, as defined, per Unit. During 1995, 1994 and 1993, no Units were issued as payment for the MID.\nDuring 1991, the Partnership amended its capitalization policy and began capitalizing certain costs of improvements and betterments which under policies of prior management had been expensed when incurred. The purpose of the amendment was to more properly recognize items which were capital in nature. The effect of the amendment standing alone was evaluated at the time the change was made and determined not to be material to the financial statements of the Partnership in 1991, nor was it expected to be material in any future year. However, the amendment does have a material effect on the calculation of the Entitlement Amount which determines the amount of Contingent MID earned and the amount of Fixed MID payable in cash. Capital improvements are excluded from cash flow, as defined. The majority of the base period cash flow was measured under the previous capitalization policy, while incentive period cash flow is determined using the amended policy. Under the amended policy, more items are capitalized, and cash flow increases. If base period cash flow had been measured on a basis comparable with incentive period cash flow, Contingent MID would have been reduced by $256,656 for the year ended December 31, 1994. The amendment of the capitalization policy did not materially affect MID for 1995 or 1993 as the Entitlement Amount was sufficient to pay Contingent MID notwithstanding the amendment to the capitalization policy.\nAny amount of the MID which is paid to the General Partner in Units will be treated as if cash is distributed to the General Partner and is then contributed to the Partnership by the General Partner. The Fixed MID was treated as a fee payable to the General Partner by the Partnership for services rendered. The Contingent MID represents a return of equity to the General Partner for increasing cash flow, as defined, and accordingly is treated as a distribution.\nCompensation and reimbursements paid to or accrued for the benefit of the General Partner or its affiliates are as follows:\nPayable to affiliates - General Partner at December 31, 1995 and 1994 consists of Contingent MID, reimbursable costs and property management fees which are due and payable from current operations.\nNOTE 3 - TAXABLE LOSS - ---------------------\nMcNeil Real Estate Fund X, Ltd. is a partnership and is not subject to Federal and state income taxes. Accordingly, no recognition has been given to income taxes in the accompanying financial statements of the Partnership since the income or loss of the Partnership is to be included in the tax returns of the individual partners. The tax returns of the Partnership are subject to examination by Federal and state taxing authorities. If such examinations result in adjustments to distributive shares of taxable income or loss, the tax liability of the partners could be adjusted accordingly.\nThe Partnership's net assets and liabilities for tax purposes exceeded the net assets and liabilities for financial reporting purposes by $13,571,531, $11,156,745 and $9,454,176 at December 31, 1995, 1994 and 1993, respectively.\nNOTE 4 - REAL ESTATE INVESTMENTS - --------------------------------\nThe basis and accumulated depreciation of the Partnership's real estate investments held at December 31, 1995 and 1994 are set forth in the following tables:\nDuring 1994, the General Partner placed The Courts Apartments and Parkway Plaza on the market for sale. The Courts Apartments was sold September 14, 1995. See Note 7 - \"Disposition of Real Estate.\" The Courts Apartments is classified as an asset held for sale at December 31, 1994. Parkway Plaza is classified as an asset held for sale at December 31, 1995 and 1994.\nThe Partnership leases its commercial properties under various non-cancelable operating leases. In most cases, the Partnership expects that in the normal course of business these leases will be renewed or replaced by other leases. Future minimum rents to be received from commercial properties as of December 31, 1995, are as follows:\nFuture minimum rents do not include contingent rents based on sales volume of tenants. Contingent rents amounted to $86,571, $99,514 and $77,899 for the years ended December 31, 1995, 1994 and 1993, respectively. Future minimum rents also do not include expense reimbursements for common area maintenance, property taxes, and other expenses. The expense reimbursements amounted to $177,095, $399,360 and $318,444 for the years ended December 31, 1995, 1994 and 1993, respectively.\nThe Partnership's real estate investments are encumbered by mortgage indebtedness as discussed in Note 5 - \"Mortgage Notes Payable\" and Note 6 - \"Mortgage Note Payable - Affiliates.\"\nNOTE 5 - MORTGAGE NOTES PAYABLE - -------------------------------\nThe following table sets forth the mortgage notes payable of the Partnership at December 31, 1995 and 1994. All mortgage notes payable are secured by real estate investments.\n(a) The debt is non-recourse to the Partnership.\n(b) The Partnership refinanced the Coppermill mortgage note on December 8, 1994. See Note 8 - \"Refinancing of Mortgage Notes.\"\n(c) The Partnership sold The Courts Apartments on September 14, 1995, and the related first lien was retired using proceeds from the sale. See Note 7 - \"Disposition of Real Estate.\"\n(d) The Courts Apartments were subject to several improvement district liens. The Partnership sold The Courts Apartments on September 14, 1995, and the improvement district liens were assumed by the purchaser. See Note 7 - \"Disposition of Real Estate.\"\n(e) The holder of the Parkway Plaza mortgage note had an option to call the Parkway Plaza mortgage note, upon giving 180 days notice to the Partnership, for a period of one year beginning November 1995. On December 1, 1995, the holder exercised the option and set the maturity date of the Parkway Plaza mortgage note at August 1, 1996.\n(f) The Spanish Oaks mortgage note matured in August 1995. Subsequent to August 1995, the Partnership continued to make monthly debt service payments, which were accepted by the holder of the Spanish Oaks mortgage note, while the Partnership negotiated a refinancing of the Spanish Oaks mortgage note. The Partnership succeeded in refinancing the Spanish Oaks mortgage note on January 26, 1996. See Note 13 - \"Subsequent Event.\"\n(g) Discounts for the Iberia Plaza, Parkway Plaza and Spanish Oaks mortgage notes are based on effective interest rates of 10% to 13%. The discount for the Regency Park mortgage note is based on an effective interest rate of 10.375%. Discounts for the Briarwood, Orchard, Quail Meadows and Sandpiper mortgage notes are based on an effective interest rate of 8.622%.\n(h) Balloon payments on the Partnership's mortgage notes, including the new Spanish Oaks mortgage note (see Note 13 - \"Subsequent Event\"), are due as follows:\nScheduled principal maturities of the Partnership's mortgage notes, including the new Spanish Oaks mortgage note (see Note 13 - \"Subsequent Event\"), but before consideration of discounts of $1,284,580, are as follows:\nBased on borrowing rates currently available to the Partnership for mortgage loans with similar terms and average maturities, the fair value of the Partnership's mortgage notes payable was approximately $45,756,000 at December 31, 1995.\nNOTE 6 - MORTGAGE NOTE PAYABLE - AFFILIATE - ------------------------------------------\nThe following table sets forth the mortgage note payable - affiliate of the Partnership at December 31, 1995 and 1994. The affiliate mortgage note is secured by real estate investments of the Partnership.\n(a) The debt is non-recourse to the Partnership.\n(b) On August 1, 1994, the Partnership obtained a mortgage loan commitment from an affiliate of the General Partner for an amount up to $1,000,000. An initial amount of $800,000 was funded on December 6, 1994.\n(c) The note requires monthly payments of interest only equal to the prime lending rate plus 1%. At December 31, 1995, the prime rate equaled 8.5%.\nUnder terms of the Amended Partnership Agreement, borrowings from affiliates approximate fair market value.\nNOTE 7 - DISPOSITION OF REAL ESTATE - -----------------------------------\nOn September 14, 1995, the Partnership sold The Courts Apartments to an unaffiliated buyer for a cash sales price of $8,050,000. The buyer also assumed the improvement district liens that encumbered the property. Cash proceeds from this transaction, as well as the gain on sale of The Courts Apartments are detailed below.\nNOTE 8 - REFINANCING OF MORTGAGE NOTES - --------------------------------------\nDuring 1994, the Partnership and the holder of the former Coppermill mortgage note agreed to extend the maturity date of the former Coppermill mortgage note from May 1, 1994, to August 1, 1994, and again to December 31, 1994. In consideration for the maturity date extensions, the Partnership paid four balloon payments totaling $400,000. In addition to the balloon payments, the interest rate on the former Coppermill mortgage note increased to 10.0% from 9.25% effective August 22, 1994.\nOn December 8, 1994, the Partnership refinanced the Coppermill mortgage note. See Note 5 - \"Mortgage Notes Payable.\" The new mortgage note, in the amount of $5,046,000, bears interest at 10.405%, requires monthly principal and interest payments of $45,800, and matures on January 1, 2002. Cash used to close the refinancing transaction is as follows:\nThe Partnership incurred $165,912 of deferred borrowing costs related to the refinancing of the Coppermill mortgage note. The Partnership was also required to fund $146,573 into various escrows for capital improvements, property taxes and insurance.\nOn June 24, 1993, the General Partner refinanced a portfolio of properties via a Real Estate Mortgage Investment Conduit (\"REMIC\"). See Note 5 - \"Mortgage Notes Payable.\" This REMIC consists of a pool of properties from various partnerships affiliated with the General Partner. Four of the Partnership's properties, Briarwood Apartments, Orchard Apartments, Quail Meadows Apartments and Sandpiper Apartments, were included in the REMIC. The properties in the REMIC are not cross-collateralized between the various partnerships, but are cross-collateralized within the same partnership. The new mortgage loans bear an interest rate of 8.15%, discounted to yield an effective interest rate of 8.622%, and mature in July 2003. A summary of the cash proceeds from the refinancings follows on the next page.\nThe Partnership incurred $1,017,123 of deferred borrowing costs related to the REMIC refinancings. The Partnership was also required to use $934,739 of the loan proceeds to fund various escrows for capital improvements, property taxes and insurance. The Partnership recognized an extraordinary loss on extinguishment of debt in the amount of $1,078,519 that is attributable to prepayment penalties and the write-off of unamortized mortgage discounts and unamortized deferred borrowing costs related to the retired mortgage notes.\nNOTE 9 - GAIN ON EXTINGUISHMENT OF DEBT - ---------------------------------------\nOn May 18, 1994, the Partnership paid off the Iberia Plaza second mortgage note for a cash payment of $100,000. This transaction resulted in an extraordinary gain on extinguishment of debt as set forth in the following schedule.\nNOTE 10 - GAIN ON INVOLUNTARY CONVERSION - ----------------------------------------\nOn August 26, 1992, Hurricane Andrew caused approximately $475,200 of damage to Iberia Plaza. The Partnership received $468,434 from its insurance carrier to repair property damages at Iberia Plaza, and an additional $54,000 to reimburse the Partnership for lost rents while repairs were under way. Insurance reimbursements received in excess of the basis of the property damaged were recorded as gain on involuntary conversion on the Statements of Operations. The gain on involuntary conversion equaled $268,434 and $192,168 for the years ended December 31, 1993 and 1992, respectively.\nNOTE 11 - LEGAL PROCEEDINGS - ---------------------------\nThe Partnership is not party to, nor are any of the Partnership's properties the subject of, any material pending legal proceedings, other than ordinary, routine litigation incidental to the Partnership's business, except for the following:\n1) High River Limited Partnership v. McNeil Partners, L.P., McNeil Investors, Inc., McNeil Pacific Investors 1972, Ltd., McNeil Real Estate Fund V, Ltd., McNeil Real Estate Fund IX, Ltd., McNeil Real Estate Fund X, Ltd., McNeil Real Estate Fund XI, Ltd., McNeil Real Estate Fund XIV, Ltd., McNeil Real Estate Fund XV, Ltd., McNeil Real Estate Fund XX, L.P., McNeil Real Estate Fund XXIV, L.P., McNeil Real Estate Fund XXV, L.P., Robert A. McNeil and Carole J. McNeil (L95012) - High River (\"HR\") filed this action in the United States District Court for the Southern District of New York against McNeil Partners, L.P., McNeil Investors, Inc. and Mr. and Mrs. McNeil (as defined in this Section 1, collectively, the \"Defendants\") requesting, among other things, names and addresses of the limited partners in the partnerships referenced above (as defined in this Section 1, the \"Partnerships\"). The District Court issued a preliminary injunction against the Partnerships requiring them to commence mailing materials relating to the HR tender offer on August 14, 1995.\nOn August 18, 1995, the Defendants filed an Answer and Counterclaim. The Counterclaim principally asserts (1) the HR tender offers have been undertaken in violation of the federal securities laws, on the basis of material, non-public, and confidential information, and (2) that the HR offer documents omit and\/or misrepresent certain material information about the HR tender offers. The Counterclaim seeks a preliminary and permanent injunction against the continuation of the HR tender offers and, alternatively, ordering corrective disclosure with respect to allegedly false and misleading statements contained in the tender offer documents.\nThis action was dismissed without prejudice in November 1995.\n2) High River Limited Partnership v. McNeil Partners, L.P., McNeil Investors, Inc., McNeil Pacific Investors 1972, Ltd., McNeil Real Estate Fund V, Ltd., McNeil Real Estate Fund IX, Ltd., McNeil Real Estate Fund X, Ltd., McNeil Real Estate Fund XI, Ltd., McNeil Real Estate Fund XIV, Ltd., McNeil Real Estate Fund XV, Ltd., McNeil Real Estate Fund XX, L.P., McNeil Real Estate Fund XXIV, L.P., McNeil Real Estate Fund XXV, L.P., Robert A. McNeil and Carole J. McNeil - United States District Court for the Southern District of New York, (Case No. 95 Civ. 9488) (Second Action).\nOn November 7, 1995, High River filed a second complaint with the District Court which alleges, inter alia, that McNeil Partners, L.P.'s (the \"General Partner\") Schedule 14D-9 filed in connection with the High River tender offers was materially false and misleading, in violation of Sections 14(d) and 14(e) of the Securities Exchange Act of 1934, 15 U.S.C. Section 78n(d) and (e), and the SEC Regulations promulgated thereunder; and that High River further alleges that the General Partner has wrongfully refused to admit High River as a limited partner to the ten partnerships referenced above. Additionally, High River purports to assert claims derivatively on behalf of McNeil Real Estate Fund IX, Ltd., McNeil Real Estate Fund XI, Ltd., McNeil Real Estate Fund XV, Ltd., McNeil Real Estate Fund XXIV, L.P. and McNeil Real Estate Fund XXV, L.P., for breach of contract and breach of fiduciary duty, asserting that the General Partner has charged these partnerships excessive fees. High River's complaint seeks, inter alia, preliminary injunctive relief requiring the General Partner to admit High River as a limited partner in each of the ten partnerships referenced above and to transfer the tendered units of interest in the partnerships to High River; an unspecified award of damages payable to High River and an additional unspecified award of damages payable to certain of the partnerships; an order that defendants must discharge their fiduciary duties and must account for all fees they have received from certain of the partnerships; and attorneys' fees.\nOn January 31, 1996, this action was dismissed without prejudice.\n3) Robert Lewis v. McNeil Partners, L.P., McNeil Investors, Inc., Robert A. McNeil et al - In the District Court of Dallas County, Texas, A-14th Judicial District, Cause No. 95-08535 (Class Action) - Plaintiff, Robert Lewis, is a limited partner with McNeil Pacific Investors Fund 1972, Ltd., McNeil Real Estate Fund X, Ltd. and McNeil Real Estate Fund XV, Ltd.\nPlaintiff brings this action on his own behalf and as a class action on behalf of the class of all limited partners of McNeil Pacific Investors Fund 1972, Ltd., McNeil Real Estate Fund V, Ltd., McNeil Real Estate Fund IX, Ltd., McNeil Real Estate Fund X, Ltd., McNeil Real Estate Fund XI, Ltd., McNeil Real Estate Fund XIV, Ltd., McNeil Real Estate Fund XV, Ltd., McNeil Real Estate Fund XX, L.P., McNeil Real Estate Fund XXIV, L.P. and McNeil Real Estate Fund XXV, Ltd. (as defined in this Section 3, the \"Partnerships\") as of August 4, 1995.\nPlaintiff alleges that McNeil Partners, L.P., McNeil Investors, Inc., Robert A. McNeil and other senior officers (as defined in this Section 3, collectively, the \"Defendants\") breached their fiduciary duties by, among other things, (1) failing to attempt to sell the properties owned by the Partnerships (as defined in this Section 3, the \"Properties\") and extending the lives of the Partnerships indefinitely, contrary to the Partnerships' business plans, (2) paying distributions to themselves and generating fees for their affiliates, (3) refusing to make significant distributions to the class members, despite the fact that the Partnerships have positive cash flows and substantial cash balances, and (4) failing to take steps to create an auction market for equity interests of the Partnerships, despite the fact that a third party bidder filed tender offers for approximately forty-five percent (45%) of the outstanding units of each of the Partnerships. Plaintiff also claims that Defendants have breached the partnership agreements of the Partnerships by failing to take steps to liquidate the Properties and by their alteration of the Partnerships' primary purposes, their acts in contravention of these agreements, and their use of the assets of the Partnerships for their own benefit instead of for the benefit of the Partnerships.\nThe Defendants deny that there is any merit to Plaintiff's allegations and intend to vigorously defend this action.\n4) James F. Schofield, Gerald C. Gillett and Donna S. Gillett v. McNeil Partners, L.P., McNeil Investors, Inc., McNeil Real Estate Management, Inc., Robert A. McNeil, Carole J. McNeil, McNeil Real Estate Fund V, Ltd., McNeil Real Estate Fund IX, Ltd., McNeil Real Estate Fund X, Ltd., McNeil Real Estate Fund XI, Ltd., McNeil Real Estate Fund XIV, Ltd., McNeil Real Estate Fund XV, Ltd., McNeil Real Estate Fund XX, L.P., McNeil Real Estate Fund XXIV, L.P., McNeil Real Estate Fund XXV, L.P. et al - Superior Court of the State of California for the County of Los Angeles, Case No. BC133799 (Class and Derivative Action Complaint) and United States District Court, Southern District of New York, Case No. 95CIV.6711 (Class and Derivative Action Complaint)\nThese are corporate\/securities class and derivative actions brought in state and federal court by limited partners of each of the nine (9) limited partnerships that are named as nominal defendants as listed above (as defined in this Section 4, the \"Partnerships\"). Plaintiffs allege that McNeil Investors, Inc., its affiliate McNeil Real Estate Management, Inc. and four (4) of their senior officers and\/or directors (as defined in this Section 4, collectively, the \"Defendants\") have breached their fiduciary duties. Specifically, Plaintiffs allege that Defendants have caused the Partnerships to enter into several wasteful transactions that have no business purpose or benefit to the Partnerships and which have rendered such units highly illiquid and artificially depressed the prices that are available for units on the limited resale market. Plaintiffs also allege that Defendants have engaged in a course of conduct to prevent the acquisition of units by Carl Icahn by disseminating false, misleading and inadequate information. Plaintiffs further allege that Defendants have acted to advance their own personal interests at the expense of the Partnerships' public unit holders by failing to sell Partnership properties and failing to make distributions to unitholders and, thereby, have breached the partnership agreements.\nThe Defendants deny that there is any merit to Plaintiff's allegations and intend to vigorously defend these actions.\n5) Alfred Napoletano v. McNeil Partners, L.P., McNeil Investors, Inc., Robert A. McNeil, Carole J. McNeil, McNeil Pacific Investors Fund 1972, Ltd., McNeil Real Estate Fund V, Ltd., McNeil Real Estate Fund IX, Ltd., McNeil Real Estate Fund X, Ltd., McNeil Real Estate Fund XI, Ltd., McNeil Real Estate Fund XIV, Ltd., McNeil Real Estate Fund XV, Ltd., McNeil Real Estate Fund XX, L.P., McNeil Real Estate Fund XXIV, L.P., McNeil Real Estate Fund XXV, L.P. - Superior Court of the State of California, County of Los Angeles, Case No. BC133849 (Class Action Complaint)\nPlaintiff brings this class action on behalf of a class of all persons and entities who are current owners of units and\/or are limited partners in one or more of the partnerships referenced above (as defined in this Section 5, the \"Partnerships\"). Plaintiff alleges that McNeil Partners, L.P., McNeil Investors, Inc., Robert A. McNeil and other senior officers (as defined in this Section 5, collectively, the \"Defendants\") have breached their fiduciary duties to the class members by, among other things, (1) taking steps to prevent the consummation of the High River tender offers, (2) failing to take steps to maximize unitholders' or limited partners' values, including failure to liquidate the properties owned by the Partnerships, (3) managing the Partnerships so as to extend indefinitely the present fee arrangements, and (4) paying itself and entities owned and controlled by the general partner excessive fees and reimbursements of general and administrative expenses.\nThe Defendants deny that there is any merit to Plaintiff's allegations and intend to vigorously defend this action.\n6) Warren Heller v. McNeil Partners, L.P., McNeil Investors, Inc., Robert A. McNeil, Carole J. McNeil, McNeil Pacific Investors Fund 1972, Ltd., McNeil Real Estate Fund V, Ltd., McNeil Real Estate Fund IX, Ltd., McNeil Real Estate Fund X, Ltd., McNeil Real Estate Fund XI, Ltd., McNeil Real Estate Fund XIV, Ltd., McNeil Real Estate Fund XV, Ltd., McNeil Real Estate Fund XX, L.P., McNeil Real Estate Fund XXIV, L.P., McNeil Real Estate Fund XXV, L.P. - Superior Court of the State of California, County of Los Angeles, Case No. BC133957 (Class Action Complaint)\nPlaintiff brings this class action on behalf of a class of all persons and entities who are current owners of units and\/or are limited partners in one or more of the partnerships referenced above (as defined in this Section 6, the \"Partnerships\"). Plaintiff alleges that McNeil Partners, L.P., McNeil Investors, Inc., Robert A. McNeil and other senior officers (as defined in this Section 6, collectively, the \"Defendants\") have breached their fiduciary duties to the class members by, among other things, (1) taking steps to prevent the consummation of the High River tender offers, (2) failing to take steps to maximize unitholders' or limited partners' values, including failure to liquidate the properties owned by the Partnerships, (3) managing the Partnerships so as to extend indefinitely the present fee arrangements, and (4) paying itself and entities owned and controlled by the general partner excessive fees and reimbursements of general and administrative expenses.\nThe Defendants deny that there is any merit to Plaintiff's allegations and intend to vigorously defend this action.\n7) HCW Pension Real Estate Fund, Ltd. et al. v. Ernst & Young BDO Seidman et al (Case #92-06560-A). This suit was filed on behalf of the Partnership and other affiliated partnerships (the \"Affiliated Partnerships\") on May 26, 1992, in the 14th Judicial District Court of Dallas County. The petition sought recovery against the Partnership's former auditors, BDO Seidman, for negligence and fraud in failing to detect and\/or report overcharges of fees\/expenses by Southmark, the former general partner. The former auditors asserted counterclaims against the Affiliated Partnerships based on alleged fraudulent misrepresentations made to the auditors by the former management of the Affiliated Partnerships (Southmark) in the form of client representation letters executed and delivered to the auditors by Southmark management. The counterclaims sought recovery of attorneys' fees and costs incurred in defending this action. The original petition also alleged causes of action against certain former officers and directors of the Partnership's original general partner for breach of fiduciary duty, fraud and conspiracy relating to the improper assessment and payment of certain administrative fees\/expenses. On January 11, 1994 the allegations against the former officers and directors were dismissed.\nThe trial court granted summary judgment in favor of Ernst & Young and BDO Seidman on the fraud and negligence claims based on the statute of limitations. The Affiliated Partnerships appealed the summary judgment to the Dallas Court of Appeals. In August 1995, the Appeals Court upheld all of the summary judgments in favor of BDO Seidman. In exchange for the plaintiff's agreement not to file any motions for rehearing or further appeals, BDO Seidman agreed that it will not pursue the counterclaims against the Partnership.\nNOTE 12 - GAIN ON LEGAL SETTLEMENT - ----------------------------------\nThe Partnership filed claims with the United States Bankruptcy Court for the Northern District of Texas, Dallas Division (the \"Bankruptcy Court\") against Southmark Corporation (\"Southmark\"), an affiliate of a previous general partner, for damages relating to improper overcharges, breach of contract and breach of fiduciary duty. The Partnership settled these claims in 1991, and such settlement was approved by the Bankruptcy Court.\nAn Order Granting Motion to Distribute Funds to Class 8 Claimants dated April 14, 1995 was issued by the Bankruptcy Court. In accordance with the Order, in May 1995, the Partnership received in full satisfaction of its claims, $69,234 in cash, and common and preferred stock in the reorganized Southmark. The cash and stock represent the Partnership's pro-rata share of Southmark assets available for Class 8 Claimants. The Partnership sold the Southmark common and preferred stock in May 1995, for $22,283 which, when combined with the cash proceeds from Southmark, resulted in a gain on legal settlement of $91,517.\nNOTE 13 - SUBSEQUENT EVENT (UNAUDITED) - --------------------------------------\nOn January 26, 1996, the Partnership refinanced the Spanish Oaks mortgage note. The new mortgage note, in the amount of $4,000,000, bears interest at 7.71%, requires monthly principal and interest payments of $28,546, and matures on January 26, 2003. Cash proceeds from the refinancing transaction are as follows:\nThe Partnership incurred $129,273 of deferred borrowing costs related to the refinancing of the Spanish Oaks mortgage note. The Partnership was also required to fund $165,291 into various escrows for property taxes, hazard insurance and deferred maintenance.\nMcNEIL REAL ESTATE FUND X, LTD. SCHEDULE III REAL ESTATE INVESTMENTS AND ACCUMULATED DEPRECIATION December 31, 1995\nAsset Held for Sale:\nParkway Plaza Lafayette, LA $ 2,362,750 --------------\n$ 2,362,750 ==============\n(b) The encumbrances reflect the present value of future loan payments discounted, if appropriate, at a rate estimated to be the prevailing interest rate at the date of acquisition or refinancing.\nSee accompanying notes to Schedule III.\nMcNEIL REAL ESTATE FUND X, LTD. SCHEDULE III REAL ESTATE INVESTMENTS AND ACCUMULATED DEPRECIATION December 31, 1995\n(a) For Federal income tax purposes, the properties are depreciated over lives ranging from 15-25 years using ACRS or MACRS methods. The aggregate cost of real estate investments for Federal income tax purposes was approximately $100,274,995 and accumulated depreciation was $57,593,126 December 31, 1995.\n(c) Assets held for sale are carried at the lower of cost or net realizable value. Historical cost, net of accumulative depreciation and cumulative write-downs, becomes the new cost basis when the asset is classified as \"Asset Held for Sale\".\nSee accompanying notes to Schedule III.\nMcNEIL REAL ESTATE FUND X, LTD. SCHEDULE III REAL ESTATE INVESTMENTS AND ACCUMULATED DEPRECIATION December 31, 1995\nSee accompanying notes to Schedule III.\nMcNEIL REAL ESTATE FUND X, LTD.\nNotes to Schedule III\nReal Estate Investments and Accumulated Depreciation and Amortization\nA summary of activity for the Partnership's real estate investments, accumulated depreciation and amortization, and assets held for sale is as follows:\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING - ------- ----------------------------------------------------------- AND FINANCIAL DISCLOSURE ------------------------\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - -------- --------------------------------------------------\nNeither the Partnership nor the General Partner has any directors or executive officers. The names and ages of, as well as the positions held by, the officers and directors of McNeil Investors, Inc., the general partner of the General Partner, are as follows:\nEach director shall serve until his successor shall have been duly elected and qualified.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION - -------- ----------------------\nNo direct compensation was paid or payable by the Partnership to directors or officers (since it does not have any directors or officers) for the year ended December 31, 1995, nor was any direct compensation paid or payable by the Partnership to directors or officers of the general partner of the General Partner for the year ended December 31, 1995. The Partnership has no plans to pay any such remuneration to any directors or officers of the general partner of the General Partner in the future.\nSee Item 13 - Certain Relationships and Related Transactions for amounts of compensation and reimbursements paid by the Partnership to the General Partner and its affiliates.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - -------- --------------------------------------------------------------\n(A) Security ownership of certain beneficial owners.\nNo individual or group, as defined by Section 13(d)(3) of the Securities Exchange Act of 1934, known to the Partnership is the beneficial owner of more than 5 percent of the Partnership's securities except as noted below:\n1. High River Limited Partnership, 100 S. Bedford Road, Mount Kisco, New York, 10549, owns 7,452 Units (5.52%) as of February 29, 1996.\n(B) Security ownership of management.\nThe General Partner and the officers and directors of its general partner, collectively, own 1,732 Units (1.28%).\n(C) Change in control.\nNone.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - -------- ----------------------------------------------\nUnder terms of the Amended Partnership Agreement, the Partnership is paying the MID to the General Partner. The maximum MID is calculated as 1% of the Partnership's tangible asset value. The maximum MID percentage decreases subsequent to 1999. Tangible asset value is determined by using the greater of (i) an amount calculated by applying a capitalization rate of 9% to the annualized net operating income of each property or (ii) a value of $10,000 per apartment unit for residential property and $50 per gross square foot for commercial property to arrive at the property tangible asset value. The property tangible asset value is then added to the book value of all other assets excluding intangible items. Prior to July 1, 1993, the MID consisted of two components: (i) the fixed portion which was payable without respect to the net income of the Partnership and was equal to 25% of the maximum MID (the \"Fixed MID\") and (ii) a contingent portion which was payable only to the extent of the lesser of the Partnership's excess cash flow, as defined, or net operating income (the \"Entitlement Amount\") and was equal to up to 75% of the maximum MID (the \"Contingent MID\").\nEffective July 1, 1993, the General Partner amended the Amended Partnership Agreement as a settlement to a class action complaint. This amendment eliminates the Fixed MID and makes the entire MID payable to the extent of the Entitlement Amount. In all other respects, the calculation and payment of the MID will remain the same.\nContingent MID will be paid to the extent of the Entitlement Amount, and may be paid (i) in cash, unless there is insufficient cash to pay the distribution in which event any unpaid portion not taken in Units will be deferred and is payable, without interest, from the first available cash and\/or (ii) in Units. A maximum of 50% of the MID may be paid in Units. The number of Units issued in payment of the MID is based on the greater of $50 per Unit or the net tangible asset value, as defined, per Unit. For the year ended December 31, 1995, the Partnership accrued Contingent MID in the amount of $1,064,257.\nDuring 1991, the Partnership amended its capitalization policy and began capitalizing certain costs of improvements and betterments which under policies of prior management had been expensed when incurred. The purpose of the amendment was to more properly recognize items which were capital in nature. The effect of the amendment standing alone was evaluated at the time the change was made and determined not to be material to the financial statements of the Partnership in 1991, nor was it expected to be material in any future year. However, the amendment does have a material effect on the calculation of the Entitlement Amount which determines the amount of Contingent MID earned and the amount of Fixed MID payable in cash. Capital improvements are excluded from cash flow, as defined. The majority of the base period cash flow was measured under the previous capitalization policy, while incentive period cash flow is determined using the amended policy. Under the amended policy, more items are capitalized, and cash flow increases. If base period cash flow had been measured on a basis comparable with incentive period cash flow, Contingent MID would have been reduced by $256,656 for the year ended December 31, 1994. The amendment of the capitalization policy did not materially affect the MID for 1995 or 1993 as the Entitlement Amount was sufficient to pay Contingent MID notwithstanding the amendment to the capitalization policy.\nAny amount of the MID which is paid to the General Partner in Units will be treated as if cash is distributed to the General Partner and is then contributed to the Partnership by the General Partner. The Fixed MID was treated as a fee payable to the General Partner by the Partnership for services rendered. The Contingent MID represents a return of equity to the General Partner for increasing cash flow, as defined, and accordingly is treated as a distribution.\nThe Partnership pays property management fees equal to 5% of gross rental receipts of the Partnership's properties to McREMI for providing property management and leasing services for the Partnership's residential properties and property management services for the Partnership's commercial properties. The Partnership reimburses McREMI for its costs, including overhead, of administering the Partnership's affairs. For the year ended December 31, 1995, the Partnership paid or accrued $1,517,079 in property management fees and reimbursements.\nSee Item 1 - Business, Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations and Item 8 - Note 2 - \"Transactions with Affiliates.\"\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K - -------- -----------------------------------------------------------------\nSee accompanying index to Financial Statements at Item 8.\n(A) The following documents are incorporated by reference and are an integral part of this report:\nExhibits\nThe Partnership has omitted instruments with respect to long-term debt where the total amount of the securities authorized thereunder does not exceed 10% of the total assets of the Partnership. The Partnership agrees to furnish a copy of each such instrument to the Commission upon request.\n(B) Reports on Form 8-K. There were no reports on Form 8-K filed during the quarter ended December 31, 1995.\nMcNEIL REAL ESTATE FUND X, LTD. A Limited Partnership\nSIGNATURE PAGE\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.","section_15":""}
{"filename":"316253_1995.txt","cik":"316253","year":"1995","section_1":"ITEM 1. BUSINESS\nINTRODUCTION\nEnzo Biochem, Inc. (the \"Company\" or \"Enzo\") employing biotechnology, develops, manufactures and markets health care products, and also provides medical diagnostic services to the medical community. Each of the three business activities of the Company is performed by one of the Company's three wholly-owned subsidiaries--Enzo Diagnostics, Inc., Enzo Therapeutics, Inc., and Enzo Clinical Labs, Inc. (\"Enzo Diagnostics\", \"Enzo Therapeutics\" and \"Enzo Clinical Labs\", respectively). These activities are: (1) diagnostic and research product development, manufacture and marketing through Enzo Diagnostics, (2) therapeutic product research and development through Enzo Therapeutics, and (3) the operation of a clinical reference laboratory through Enzo Clinical Labs. For information relating to the Company's business segments, see Note 11 of the Notes to Consolidated Financial Statements.\nFor the fiscal year ended July 31, 1995 (fiscal 1995), approximately 30% of the Company's operating revenues was derived from product sales and approximately 70% was derived from clinical reference laboratory services. For the fiscal years ended July 31, 1994 and 1993 (fiscal 1994 and fiscal 1993, respectively), approximately 23% and 11%, respectively, of the Company's operating revenues were derived from product sales and approximately 77% and 89%, respectively, were derived from clinical reference laboratory services.\nPRODUCT DEVELOPMENT ACTIVITIES\nThe Company's product development programs incorporate various scientific areas of expertise, including recombinant DNA, monoclonal antibody development, enzymology, microbiology, biochemistry, organic chemistry, and fermentation. The Company's activities in research and development are performed by the Company's professional and scientific staff. To a lesser extent, research and development is pursued in collaboration with outside consultants at research and academic institutions.\nThe primary focus of the Company's current research is the development of products based on gene labeling and gene regulation. The Company is funding its research programs through its operating cash flows and cash and cash equivalents, as well as seeking joint ventures and collaborative relationships.\nThrough Enzo Diagnostics, the Company has devoted a major portion of its research and development activities to develop simple and reliable test formats and protocols for the commercialization of nucleic acid-based diagnostics as well as other diagnostic products. A key system for Enzo is its non-radioactive BIOPROBE-Registered Trademark- nucleic acid probe system and the Company continued to introduce new products based on this technology into the research market during fiscal 1995.\nThe product development programs of the Company include developing BIOPROBE-Registered Trademark- nucleic acid probe products to detect sexually transmitted diseases, such as AIDS, herpes, chlamydia, gonorrhea, and other infectious diseases, such as tuberculosis, cytomegalovirus, hepatitis and Epstein-Barr virus (implicated in mononucleosis). The Company markets several product lines containing BIOPROBE-Registered Trademark- nucleic acid probe products.\nThe Company, through Enzo Therapeutics, is developing therapeutic applications of nucleic acids. In May 1987, the Company entered into an agreement with the Research Foundation of the State University of New York which grants the Company certain exclusive rights to a genetic engineering technology for generating antisense RNA repressors. As a result of the technology covered by such agreement, the Company has obtained three (3) patents. Although the Company has not derived revenues from any of the foregoing three antisense patents, the Company believes that these patents will be the basis for the Company to derive meaningful revenues in the future.\nWhenever the Company complements its internal research and development activities with collaborative research arrangements with academic and private research institutions or consultants on specific projects, the Company typically supplies funds to cover salaries, materials, certain laboratory equipment and a portion of the overhead. In all such collaborative research arrangements, the Company reserves the commercial rights to any product or process developed, subject to a royalty payment to the institution or consultant involved over a period of years. The location of the Company in the greater New York area affords the Company access to and interaction with a large number of research institutions and qualified scientists.\nIn the fiscal years ended July 31, 1995, 1994 and 1993, the Company incurred costs of approximately $2,366,000, $ 1,764,000 and $ 1,486,000 respectively, for research and development activities.\nCLINICAL REFERENCE LABORATORY\nThe Company, through Enzo Clinical Labs, operates a clinical reference laboratory which offers full diagnostic services to the greater New York medical community. The services Enzo Clinical Labs provides include chemistry, blood tests, cytology studies, tissue pathology, hormone studies, and diagnostic procedures which seek to detect precancerous conditions, cancers in cervical specimens and sexually transmitted diseases. Enzo Clinical Labs provides these services primarily to physicians as well as to clinics, nursing homes and other clinical laboratories. The Company,\nthrough Enzo Clinical Labs operates a regional clinical reference laboratory on Long Island and also operates twelve satellite patient service centers in the greater New York area. In addition, the Company utilizes its clinical reference laboratory to evaluate and demonstrate the benefits of the Company's diagnostic products (see Note 11 of the Notes to Consolidated Financial Statements for segment information and operating revenues and profits).\nBUSINESS OBJECTIVES\nThe current business objectives of the Company are (1) to develop, manufacture and market on a worldwide basis diagnostic and therapeutic products based on the Company's research activities in biotechnology and molecular biology, and (2) to perform diagnostic tests for the U.S. health care community. The Company's research and development efforts are directed to both short and long-term projects. Diagnostic products require less time to commercialize than therapeutic products because the procedures required for attaining government clearance are less time consuming. Therapeutic products, once developed, require extensive clinical testing and compliance. This process can range from three to five years and, in some instances, longer.\nAt such time as the Company's initial self-funded research demonstrates technical feasibility and potential commercial importance, the Company will have the option to pursue the opportunity on its own or to associate with another entity for development and ultimate marketing of the product. Unless there is a business reason to license products or processes developed by the Company, the Company intends to retain ownership with respect to development and marketing of a product or process.\nMARKETING STRATEGY\nEnzo's initial commercialization program for the BIOPROBE-Registered Trademark- nucleic acid probe systems included filing major U.S. and foreign patent applications, clinical evaluation, and Food and Drug Administration (FDA) submissions. The Company has obtained clearance for a number of FDA approved diagnostics for sale to clinical reference laboratories and researchers through Enzo Diagnostics. BIOPROBE-Registered Trademark- nucleic acid probe products are also sold to the research market, where FDA clearance is not required. The Company has been successful in obtaining FDA clearance for four totally Enzo- developed DNA probe products. The Company believes that significant delays will not be encountered with any future probe product submissions to the FDA since products based on the BIOPROBE-Registered Trademark- nucleic acid probe system have been FDA cleared. However, there can be no assurance that delays will not be incurred.\nThrough Enzo Diagnostics, the Company manufactures and markets its BIOPROBE-Registered Trademark- nucleic acid probe products for research applications. These BIOPROBE-Registered Trademark- research products include products which allow researchers to make their own non-radioactive DNA probes as well as complete DNA probe kits which contain all reagents necessary for detecting various disease pathogens in clinical samples.\nEnzo Diagnostics markets a variety of IN SITU hybridization kits. PATHOGENE-Registered Trademark- DNA probe kits detect specific pathogens including human papillomavirus (HPV), herpes simplex virus, cytomegalovirus, Epstein-Barr virus, adenovirus, hepatitis B virus and CHLAMYDIA TRACHOMATIS. Its BIOPAP-Registered Trademark- DNA probe kits detect certain types of HPV in Pap smear samples. An enhanced detection procedure that will enable the pathologist to identify the presence of fewer virus particles by increasing the sensitivity of the assay was developed by the Company. These products compete directly with products labeled with various radioactive isotopes. In addition to the IN SITU hybridization kits, Enzo Diagnostics also markets kits based on its proprietary microplate hybridization format. Microplate Hybridization Assays have been developed for the detection of the AIDS-causing virus (HIV-1). Kits are also available to detect HIV-2, another strain of the AIDS virus, hepatitis virus, the bacteria causing tuberculosis (TB) and members of the MYCOBATERIUM TUBERCULOSIS (MTB) complex.\nEnzo's HIV test was the first commercial DNA probe test for this pathogen in this format. Unlike most AIDS tests which detect antibodies for HIV, Enzo's HIV Microplate Hybridization Assay detects DNA unique to HIV. Since individuals can carry the HIV infection for up to 12 months before developing antibodies to it, a test directed at the virus can provide earlier detection. Because this product also can measure virus concentrations, it is easier for researchers to determine HIV levels in patients and look for relationships between these levels and other disease indicators such as antibody production or appearance of symptoms. This product is currently marketed to the research community. During fiscal 1995, an enhanced, version of the Microplate Hybridization Assay, was developed to detect the hepatitis virus directly in serum and is aimed at the blood bank market.\nIn early stages of infection, the pathogen may be present in very small amounts and may be difficult to detect. Samples, however, can be treated in a way that produces copies of targeted DNA, if it is present. This amplification process is one possible approach to detect very low levels of infection. All of Enzo's Microplate Assays can be used to detect these pathogens in amplified as well as unamplified samples. In order to fully integrate its technology, Enzo has developed a new simplified amplification process for multicopy production of nucleic acid. A patent application was filed in January 1994. During fiscal 1995, this proprietary amplification process was incorporated into the microplate assay format, thus providing a totally integrated assay system. This approach is being developed for use with the hepatitis assay system and will form the basis for all Enzo's microplate assays.\nIn addition to nucleic acid-based products, the Company also produces and sells other types of research products, such as monoclonal antibodies. The products are marketed through direct sales, an extensive product catalog, advertising in scientific and trade journals and U.S. and foreign distributors. In fiscal 1993, Enzo Diagnostics began to expand its non-exclusive distribution arrangements for its proprietary products in both the U.S. and foreign markets with various companies having worldwide distribution and with companies having local foreign distribution. In fiscal 1994, the Company continued\nto expand these distribution arrangements and began a policy of using joint labels on all products marketed by its distributors. In April, 1994, the Company signed a non-exclusive worldwide distribution and supply agreement with Boehringer Mannheim Biochemicals. Under the terms of this agreement, Boehringer Mannheim distributes to the global medical research market, a broad range of biochemical products and reagents manufactured and supplied by Enzo. The agreement includes products based on nonradioactive DNA probe technology and includes products that were developed and marketed by Boehringer Mannheim prior to the agreement, as well as products developed by the Company, all of which are covered by Enzo patents. The agreement took effect in April 1994 and extends for the life of the last patent to expire for products involved.\nDuring fiscal 1995, two additional distribution agreements were signed. In February 1995, a distribution agreement was signed with Amersham International and includes a broad group of products developed and marketed by Amersham, as well as products developed by Enzo Diagnostics. All products are based on nonradioactive DNA labeling technologies covered by Enzo patents. The second agreement, also covering the Company's line of proprietary DNA labeling products and reagents was concluded in May 1995 with Dako A\/S, a privately-held international company with headquarters in Copenhagen, Denmark and subsidiaries worldwide, including the Dako Corporation based in the Carpinteria, California.\nThe Company had previously entered into distribution agreements with certain Johnson & Johnson, Inc. (J&J) subsidiaries in Europe, one of which continues to be in effect. Ortho Diagnostics continues to be the Company's distributor for marketing, distribution and sale in Italy for the Company's BIOPROBE-Registered Trademark- and other products.\nThe Company, because of its various proprietary diagnostic technologies, may enter into joint ventures with other biotechnology companies or other health care companies with marketing resources and\/or complementary technology or products to more fully take advantage of market opportunities.\nEnzo Clinical Labs is a major regional clinical reference laboratory offering full service diagnostic testing in the greater New York marketplace. Its services are marketed by a professional sales force who serve client physicians, clinics, nursing homes and other clinical laboratories in the area. A key marketing strategy has been the strategic placement of a network of patient service centers, where patients can go to have samples taken upon the request of their physicians. The Company operates a stat laboratory at its Manhattan patient service center, affording its client physicians rapid test turnaround. The diagnostic service business provides Enzo Diagnostics with a practical application of its products, making it possible to more appropriately tailor diagnostic products to the end-user. The Company's BIOPROBE-Registered Trademark- nucleic acid probe products offer Enzo Clinical Labs a marketing tool by establishing it among the first to offer nucleic acid based tests.\nTECHNOLOGY AND PRODUCT DEVELOPMENT\nThe major focus of the Company's product development program has been toward the commercialization of nucleic acid probe-based IN VITRO diagnostics for specific\npathogens. Initially, nucleic acid probes were radioactive and required complex protocols to perform. To develop them into useful commercial products required making such products easy-to-use, easy to interpret, readily automatable and sensitive enough to detect the presence of low levels of pathogen. As a result of this product development effort, the Company has developed a broad technology base for the labeling, detection, sensitivity enhancement, signal amplification and testing formats of nucleic acid probe products. Patent protection has been aggressively pursued for this technology base. At the end of fiscal 1995 some 198 patents issued worldwide had been granted to or licensed by the Company in this area of technology. In fiscal 1995 the Company began to receive significant revenues from the distribution agreements related to these patents and believes that the patents have positioned the Company to derive considerably more revenues in the future as the markets for these products continue to develop. These patents cover a variety of BIOPROBE-Registered Trademark- nucleic acid probe products, chelation technology for easy radioactive labeling, signal amplification methods, sensitivity enhancements, and automatable formats.\nBIOPROBE-Registered Trademark- Nucleic Acid Probe Labeling and Signal Generating Systems\nNucleic acid probes used traditionally in biomedical research and recombinant DNA technology have been radioactively labeled with isotopes of hydrogen, phosphorous, carbon or iodine. Radioactive materials have historically provided researchers with the most sensitive and, in many cases, the only means to perform many important experimental or analytical tests. However, limitations and drawbacks are associated with the use of radioactive compounds. For example, radioactive materials are often very unstable and have a limited shelf-life. Because of the potentially hazardous nature of radioactive materials, their use must be licensed and elaborate safety precautions must be maintained during the preparation, utilization and disposal of radioisotopes. In addition, radioactive nucleotides are extremely expensive and their instability increases usage cost.\nTo overcome the limitations of radioactively labeled probes, the Company, starting with basic technology licensed from Yale University (\"Yale\"), has developed a proprietary technology which allows DNA probes to be used effectively without the use of radioactivity. This development permits the application of genetic analysis in a clinical setting without the shelf-life, licensing and disposal problems associated with radioactively labeled probes.\nIn December 1987, a primary patent for the technology that is essential to the development of nonradioactive DNA probe diagnostics was issued to Yale. In July 1994 and in September 1995 additional patents, broadening the coverage of the primary patent were also issued to Yale. The Company has an exclusive license for both patents from Yale for the life of the patents. Pursuant to such license agreement, the Company is obligated to pay Yale royalties equal to a percentage of sales. The Company is obligated to pay Yale an annual minimum royalty fee of $200,000 which shall continue through the end of the term of the exclusive license.\nThe near term application of the BIOPROBE-Registered Trademark- nucleic acid probe system in the human health care area is in bacterial and viral diagnostics. Nucleic acid probe diagnostics can be developed for any organism. Advantages of the nucleic acid probes for the direct detection of pathogens in human diagnostics are speed (less than an hour for test results as compared to days), greater specificity, and the capability of diagnosing a disease in an early or latent stage of development.\nRadioactive Labeling Systems\nThe Company has developed a new method for labeling molecules with radioisotopes that is safer, faster, simpler and more cost effective than traditional methods of radiolabeling. This method is to be used in those applications requiring more sensitivity than non-radioactive materials permit. This method permits radiolabeling of a wide range of molecules for use in a variety of applications, including IN VIVO imaging, therapeutics, and clinical assays.\nWith this technology stable products are radiolabeled just prior to use, thereby overcoming inherent limitations of classical radiolabeling technologies. The Company's method for radiolabeling maximizes the sensitivity while minimizing radiation exposure and radioactive waste.\nIn November 1987, the Company received two U.S. patents protecting aspects of its versatile technology for linking radioactive ions or biotin to various biologically active molecules for diagnostic and therapeutic uses. Since that time additional patents covering aspects of this technology have been issued to the Company.\nAutomatable Test Formats\nIn February 1991, the Company was granted a U.S. patent for its nucleic acid probe testing technology that generates a signal in solution. This technology allows the development of nucleic acid probe-based tests that can be readily automated and measured or identified instrumentally. Using this technology, probes can be detected with either chemiluminescent, fluorescent or colorimetric methods. The Company is developing test kits employing this technology and launched two of them to the research market during fiscal 1992. These included a test for the HIV virus which causes AIDS, and a test for the bacteria causing tuberculosis. In fiscal 1993 tests for other viruses, including HIV-2, and hepatitis, were introduced to researchers. In fiscal 1994 a more sensitive assay that can detect hepatitis B virus directly in serum and geared to the blood banking market was developed and in fiscal 1995 the Company's amplification technology was integrated with the enhanced hepatitis assay. The Company is developing an instrument-based automatable system employing this and other proprietary Enzo technologies.\nRapid, On-Site Diagnostics\nThe Company also has developed a diagnostic test technology which makes possible accurate, rapid and one-step tests. The ease of performing and interpreting tests\nusing this proprietary gel technology suits them well for at-home and doctor office use. Using the gel technology, the Company has developed a fecal occult blood test used to screen for colorectal cancer. The Company has received FDA clearance to market this occult blood test to physician offices and plans to develop other tests utilizing the gel technology for aiding consumer health maintenance.\nMonoclonal Antibodies\nThe Company markets a panel of monoclonal antibodies that are being used in pathology laboratories to help identify the original source of a metastatic cancer and the type of cancer in undifferentiated cancer cells. The ability to identify the origin and type of cancer aids in the diagnosis of cancer and assists physicians in prescribing therapy. In order to offer a full line of state-of-the-art research products, the Company is actively engaged in expanding its line of monoclonal antibodies.\nTherapeutic Technology and Product Development\nThrough Enzo Therapeutics, the Company is applying its technological capabilities for manipulating genetic material towards the development of therapeutic treatments for a variety of cancers and infections. Enzo is exploring applications of antisense nucleic acids employing various proprietary technologies. Also, the Company has developed techniques for stably attaching drugs and radioisotopes to proteins and DNA. The Company is working towards, INTER ALIA, the development of products relating to HIV, certain cancers and hepatitis, however, no products have been finalized.\nIn May 1987, Enzo entered into an agreement with The Research Foundation of the State of New York (SUNY) granting the Company certain exclusive rights to a genetic antisense technology. Because this antisense technology offers a way to control the expression of any gene in any organism, the Company believes it has broad therapeutic and agricultural applications. For example, this technology should make possible a new approach to controlling viral diseases and cancers in humans. It may also be used to control viral diseases in animals and agriculturally important plants and may lead to a variety of other desirable traits in agricultural crops and animals. This technology has been proven to be effective in a variety of organisms, including plants, animals and bacteria. For example, researchers have developed transgenic mice that are resistant to murine leukemia virus and tomato plants which produce tomatoes that do not spoil upon ripening. However, to date the Company has not developed any commercial products utilizing this technology. Because this technology has such broad application, the Company is exploring collaborative business relationships of various types with other companies to develop the applications which Enzo is not interested in retaining for its own activities. Three U.S. patent applications were subsequently issued as patents by the U.S. Patent and Trademark Office. The first patent issued in March 1993; a second patent issued in May 1993; the third patent issued in December 1993.\nIn January 1995, the Company signed a collaborative research agreement with Cornell University on behalf of its Medical College, aimed at evaluating the Company's genetic antisense technology for use in managing the treatment of HIV, the AIDS-causing virus. Research results at Enzo indicate on a preliminary basis, that this technology could be applied to inhibiting the function of genes necessary for the HIV virus to grow. Upon completion of this research, the Company plans to move into human clinical studies.\nMANUFACTURING\nThe Company's BIOPROBE-Registered Trademark- nucleic acid probe products contained in its PATHOGENE-Registered Trademark- and BIOPAP-TM- product lines are manufactured by using recombinant DNA techniques and traditional chemical synthesis methods. The DNA sequence which codes for a specific infectious agent or particular trait is isolated by cloning. The sequence is then introduced into a plasmid, commonly one that grows in E.COLI bacteria, and the bacteria serves as a reproduction vehicle with the application of standard fermentation procedures. The reproduced quantities of the specific DNA sequences are purified from the bacteria and then labeled so they can be detected. The detection system usually employs a non-radioactive visualization molecule, such as a color-changing enzyme-substrate or a fluorescent substance. The production of DNA probes does not require large manufacturing facilities because the yields from the bacteria are high and only small quantities of nucleic acids are required.\nMonoclonal antibodies specific to certain substances are produced by fusing a type of mouse cancer cell with certain antibody-producing white blood cells from the spleens of mice that had been immunized with the targeted substance. The hybrid cells which make antibodies with the desired characteristics are then cultured to produce large quantities of that one discrete type of antibody. Monoclonal antibody production does not require extensive facilities.\nThe Company's manufacturing operation uses exempt quantities of tritium (3H) in its research and development activities and manufacturing operations. For the fiscal year ended July 31, 1995 the Company had accumulated two (2) millicuries of tritium. This was disposed of in the regular course of the Company's business at a cost of $1,200 during the 1995 fiscal year by a licensed carrier (Radiac Research Corporation, Brooklyn, New York). The Company has not historically had any problems disposing of such quantities and does not anticipate any such problems in the future.\nREGULATION\nThe Company's present and proposed activities are regulated by the federal government to a significant extent. This regulation applies not only to research and development and manufacturing, but also to the marketing of products, particularly those involving diagnostic or therapeutic applications.\nIn order to test clinically, manufacture and market diagnostic or therapeutic products, the Company (and\/or its marketer) must obtain the approval and comply with the standards of the FDA in the United States and comparable agencies in other countries. The FDA has established mandatory procedures and safety standards which apply to the clinical testing, manufacture and marketing of all diagnostic and therapeutic products. FDA approval is not required for the sale of certain products for research use only.\nThe process of seeking and obtaining FDA approval of a new therapeutic product generally takes a number of years and may require substantial funding. The process of seeking FDA clearance and corresponding foreign approvals is significantly less for IN VITRO diagnostic tests.\nThe Company has in-house personnel to expedite the preparation and filing of documentation necessary for FDA clearances and approvals, patent issuances and licensing agreements. The Company has received clearance from the FDA to market five of its diagnostic products. The Company also has several products in various stages of clinical trial evaluation which, if successful, are expected to be submitted to the FDA for clearance.\nThe Company's clinical reference laboratories are subject to various federal, state and local licensing, permits and regulatory certifications.\nIn addition to the foregoing, the Company's present and future business may be subject to regulation under the Occupational Safety and Health Act, Environmental Protection Act, Resource Conservation and Recovery Act and other present or possible future legislation, as well as by governmental agencies with regulatory authority relating to the Company's business. From time to time, legislation has been introduced to regulate various aspects of the technology, but the Company is unaware of any proposed actions by federal, state or local authorities which might materially impair its ability to conduct its business.\nPROPRIETARY TECHNOLOGY - PATENTS\nAs novel techniques, processes, products or microorganisms are developed during the course of its research and development activities, the Company will seek U.S. and, if deemed necessary, foreign patents. At the end of fiscal 1995 the Company owned or licensed 32 U.S. and some 145 foreign patents and had filed approximately 169 U.S. and foreign patent applications covering products, methods and procedures resulting from the Company's research projects. In fiscal 1995 the Company began to receive significant revenues from the distribution agreements related to these patents and believes that the patents have positioned the Company to derive considerably more revenues in the future as the markets for these products continue to develop. Patents relating to the BIOPROBE-Registered Trademark- nucleic acid probe system have issued in the U.S. and Europe. Management believes that additional patents will issue shortly and over the next several years with respect to the Company's pending applications. There can be no assurance, however, that patents will issue on pending applications or that any issued patents will have commercial benefit. The Company does not intend to rely on patent protection as the sole basis for protecting\nits proprietary technology. It also relies on its trade secrets and continuing technological innovation. All employees involved in the clinical reference division and the manufacturing operations sign a confidentiality agreement prohibiting the employee from disclosing any confidential information about the Company, including the Company's technology or trade secrets.\nIn some instances, the Company may enter into royalty agreements with collaborating research parties in consideration for the commercial use by the Company of the developments of their joint research. In other instances a patent may be obtained by the collaborating party with the Company receiving a license to use the patented subject matter. In such cases, the Company will seek to secure exclusive licenses.\nIn other instances, the Company may have an obligation to pay royalties to, or reach a royalty arrangement with, a third party in consideration of the Company's use of developments of such third party. The Company has an exclusive licensing agreement with Yale for the technology used in the BIOPROBE-Registered Trademark- nucleic acid probe products. The agreement covers licensed patents owned by Yale and licensed to the Company for the life of the patents which expire not earlier than 2004.\nIn fiscal 1987, the Company entered into an agreement with The Research Foundation of the State University of New York giving the Company exclusive rights to a genetic engineering technology using antisense nucleic acid control methodologies. This technology is covered by three U.S. patents applications subsequently issued as patents by the U.S. Patent and Trademark Office. The first patent issued in March 1993; a second patent issued in May 1993; the third patent issued in December 1993. (See \"Therapeutic Technology and Product Development\" section, page 10). The term of the license agreement extends through the life of such patents as may issue therefrom.\nHUMAN RESOURCES\nAs of July 31, 1995, the Company employed 184 full-time and 35 part-time employees. Of the full-time employees, 30 were engaged in research, development, manufacturing and marketing of research products and 154 at the clinical reference laboratories. The scientific staff of the Company possesses a wide range of experience and expertise in the areas of recombinant DNA, nucleic acid chemistry, molecular biology and immunology. The Company believes that relations with its employees are good.\nCOMPETITION\nThe Company's biotechnology activities compete with pharmaceutical, chemical, energy, and food companies which are diversifying into biotechnology, and with specialized biotechnology firms in the United States and elsewhere. Competition from existing companies and from newly formed private enterprises is expected to increase.\nMost of the Company's competitors in the biotechnology industry are performing research in many of the same areas as the Company. Many of these competitors are larger and have greater financial and other resources than the Company. The primary competitive factors in the biotechnology field are the ability to create and maintain scientifically advanced technology during a period of rapid technological development, to attract and retain a breadth and depth of human resources, to develop proprietary products or processes and to have available adequate financial resources for bridging the often substantial time lag between technical concept and commercial implementation.\nThe Company's clinical reference laboratories activity, which is conducted in the New York metropolitan area, competes with numerous national and local entities, some of which are larger and have greater financial resources than the Company. The laboratories compete based on the specialized nature of the services performed, as well as on the reliability and speed in which they perform the diagnostic tests.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe following are the principal facilities of the Company:\nEffective December 1, 1985, the Company entered into a lease with the City of New York and the New York City Health and Hospitals Corporation for the Company to lease, over a fifty-year term, a building containing approximately 146,000 square feet of rentable space. The building, which has landmark designation, is located in the Bellevue Hospital Center Campus, First Avenue and East 29th Street, in Manhattan. The Company has recorded the fair value of the real property in the amount of $3,000,000 as a capital lease obligation due in installment payments through 2036. The construction was financed through Company funds.\nThe Company has negotiated with the City of New York to restructure past and future leasehold commitments. The renegotiated lease provides that payments for the period from March 1, 1991 through December 31, 1992 be deferred for a period of eight years. In addition, the annual rental was reduced by $260,000 per annum for the period from January 1, 1993 through December 31, 1997. The Company's carrying value of the leasehold asset is recorded at its estimated fair market value as of July 31, 1995 which resulted in a writedown of approximately $11,400,000 for the fourth quarter of fiscal 1995 due to management's decision to seek alternative uses for the property.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIn March 1993, the Company filed suit in the United States District Court for the District of Delaware charging patent infringement and acts of unfair competition against Calgene, Inc. and seeking a declaratory judgment of invalidity concerning Calgene, Inc.'s plant antisense patent. On February 9, 1994 the Company filed a second suit in the United States District Court for the District of Delaware charging Calgene with infringement of a second antisense patent owned by the Company. Calgene has filed a counterclaim in the second Delaware action seeking a declaration that a third patent belonging to the Company is invalid. The two Delaware actions have been consolidated and were tried to the Court in April 1995. The parties are awaiting the Court's decision. In addition, the Company filed suit on March 22, 1994 in the United States District Court for the Western District of Washington against Calgene and the Fred Hutchinson Cancer Research Center, alleging that the defendants had conspired to issue a false and misleading press release regarding a supposed \"patent license\" from Hutchinson to Calgene, and conspired to damage the Company's antisense patents by improperly using confidential information to challenge them in the Patent Office. The Complaint further charges that Hutchinson is infringing and inducing Calgene to infringe the Company's antisense patents. There can be no assurance that the Company will be successful in any of the foregoing matters or that Calgene, Inc. and\/or Hutchinson will not be successful. However, even if the Company is not successful management does not believe there will be a significant monetary impact.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matters were brought to a vote of the Company's stockholders in the fourth fiscal quarter ended July 31, 1995.\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 American Stock Exchange (Symbol:ENZ). The following table sets forth the high and low price of the Company's Common Stock for the periods indicated as reported on the American Stock Exchange. High Low ---- ---\n1994 Fiscal Year (August 1, 1993 to July 31, 1994): 1st Quarter $21 3\/4 $ 9 3\/8 2nd Quarter $19 3\/8 $15 3rd Quarter $19 7\/8 $10 1\/4 4th Quarter $12 1\/8 $ 7 5\/8\n1995 Fiscal Year (August 1, 1994 to July 31, 1995): 1st Quarter $15 3\/8 $ 9 1\/8 2nd Quarter $13 7\/8 $10 3rd Quarter $11 3\/8 $ 9 1\/2 4th Quarter $17 1\/8 $ 9 1\/2\nOn October 19, 1995, the last sale price of the Common Stock of the Company as reported on the American Stock Exchange was $17 1\/8.\nOn October 19, 1995, the Company had approximately 1,526 shareholders of record.\nThe Company has not paid a cash dividend on its Common Stock and intends to continue to follow a policy of retaining future earnings to finance its operations. Accordingly, the Company does not anticipate the payment of cash dividends to holders of Common Stock in the foreseeable future.\nThe Company declared a 5% stock dividend in June 1995 payable July 31, 1995 to shareholders of record as of July 3, 1995. The stock price on the date of declaration was $10.125.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA (IN THOUSANDS, EXCEPT PER SHARE DATA) FOR THE YEARS ENDED JULY 31, -------------------------------------\n- - ----------------\n(1) In fiscal years 1991 through 1993, common stock equivalents have not been included because the effect of their inclusion would have been anti- dilutive. (2) For the purpose of calculating the ratio of earnings to fixed charges and deficiency of earnings to cover fixed charges, earnings consist of income (loss) before provision for taxes plus extraordinary items and fixed charges (interest expense, amortization of deferred financing costs, and one-third of rental expense).\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ---------------------------------------------------------------\nLIQUIDITY AND CAPITAL RESOURCES\nNet cash provided by operating activities increased by approximately $12.3 million over the previous fiscal year principally as the result of a non cash writedown of the Company's leasehold of approximately $11.4 million and deferred income tax provision of $2.8 million offset by the increase in note receivable litigation settlement of $17.6 million in fiscal 1995 in addition to changes in other operating assets and liabilities.\nNet cash used by investing activities decreased by approximately $136,000 as a result of a decrease in capital expenditures related to the Company's clinical reference laboratory operations.\nNet cash provided by financing activities decreased by $9.1 million primarily from the proceeds of approximately $7.5 million from the issuance of stock in fiscal 1994.\nIn fiscal 1995, the Company exchanged approximately $2.9 million of legal fees and patent costs for approximately 286,000 shares of the Company's Common Stock.\nOn October 19, 1994 the Company executed a settlement agreement with Johnson & Johnson, Inc. (J&J) pursuant to which the Company received $15.0 million and a promissory note requiring J&J and its subsidiary, Ortho Diagnostics, Inc., to pay $5.0 million a year for each of the four successive anniversaries of said date. These future payments are recorded at net present value discounted using an interest rate of 5.25%. The litigation settlement amounted to approximately $21,860,000, net of legal fees. Pursuant to the terms of the settlement, all of the Company's grants, licenses and intellectual property have been returned to the Company in totality.\nThe Company's internal source of cash generated by operations and equity financing was sufficient to meet the Company's cash needs for investing and other financing activities.\nAs of July 31, 1995, the Company has a working capital of approximately $24,449,000.\nEffective December 1, 1985, the Company entered into an agreement with the City of New York to lease, over a fifty-year term, a six-story building located in New York City. During 1992 this lease was renegotiated. (See Item 2.) The Company has recorded the fair market value of the real property in the amount of $3,000,000 as a capital lease obligation due in installments through 2036. Financing for the renovation and equipping of such facility came principally from the Company's own funds. The Company is carrying the capital leasehold interest at its estimated fair market value as of July 31, 1995. During the fourth quarter of fiscal 1995, the Company wrote down the leasehold property by approximately $11,400,000 due to management's decision to seek alternative uses for the property.\nThe Company will use its remaining net operating loss of $19,244,000 to partially offset its taxable income for fiscal 1995.\nRESULTS OF OPERATIONS\nFISCAL 1995 COMPARED TO FISCAL 1994\nRevenues from operations for the fiscal year ended July 31, 1995 (\"fiscal 1995\") increased by $8,901,000 over revenues from operations for the fiscal year ended July 31, 1994 (\"fiscal 1994\"). This increase was due to increases of $4,365,000 in revenues from research product sales over revenue for the similar activity in fiscal 1994 and by a $4,536,000 increase in revenues for the clinical reference laboratory operations. The increase in revenues from the clinical laboratory operations resulted primarily from an increase in volume of screening tests. The increase in research product sales resulted primarily from the Company's non-exclusive contract with Boehringer Mannheim and Amersham to distribute the Company's products.\nR&D expenses increased by approximately $602,000 as a result of an increase in research programs and the amortization of patent costs. Cost of sales increased by approximately $3,099,000 as a result of increased revenue from the sale of research products and from the clinical reference laboratory. This increase resulted primarily from the Company's non- exclusive contract with Boehringer Mannheim and Amersham to distribute products. Included in the general and administrative expenses are legal fees of $2,977,000 and $1,663,000 for fiscal years 1995 and 1994, respectively.\nThe provision for uncollectable accounts receivable increased by $341,000 primarily from an increase in operating revenues at the clinical reference laboratory operations. Selling expenses increased by approximately $701,000 due to an increase in marketing programs and personnel costs for the clinical reference laboratory operations.\nOn October 19, 1994, the Company executed a settlement agreement with J&J pursuant to which the Company received $15.0 million in cash and a promissory note requiring J&J to pay a total of $5.0 million a year for each of the four successive anniversaries of said date. These future payments are recorded at net present value discounted using an interest rate of 5.25%. The litigation settlement amounted to approximately $21,860,000, net of legal fees.\nThe Company has recorded a writedown of the leasehold in the amount of $11,400,000 against earnings to its estimated fair market value in the fourth quarter of fiscal 1995 due to management's decision to seek alternative uses for the property.\nThe operating profit from the research and development activities and related costs amounted to $479,000 in fiscal 1995 as compared to an operating loss of $493,000 in fiscal 1994. The increase in this profit is principally related to the Company's nonexclusive agreement with Boehringer Mannheim and Amersham to distribute products. The operating profit from the clinical reference laboratories activities amounted to a profit of $2,146,000 as compared to an operating loss of $659,000 in fiscal 1994. This increase resulted principally from an increase in the volume of screening tests.\nThe provision for income taxes of $4,131,000 results from current income taxes due and utilization of net operating loss carryforwards related to taxable income recognized in connection with the J&J lawsuit.\nNet income for the fiscal year ended July 31, 1995 increased to approximately $5,618,000 compared with approximately $5,251,000 for the fiscal year ended July 31, 1994.\nRESULTS OF OPERATIONS\nFISCAL 1994 COMPARED TO FISCAL 1993\nRevenues from operations for the fiscal year ended July 31, 1994 (\"fiscal 1994\") increased by $2,773,000 over revenues from operations for the fiscal year ended July 31, 1993 (\"fiscal 1993\"). This increase was due to increases of $2,906,000 in revenues from research product sales over revenue for the similar activity in fiscal 1993 and by a $133,000 decrease in revenues for the clinical reference laboratory operations. The decrease in revenues from the clinical laboratory operations resulted primarily from a decrease in volume of higher priced screening tests. The increase in research product sales resulted primarily from the Company's non-exclusive contract with Boehringer Mannheim to distribute the Company's products.\nR&D expenses increased by approximately $278,000 as a result of an increase in research programs and the amortization of patent costs. Cost of sales increased by approximately $2,626,000 as a result of increased revenue from the sale of research products. This increase resulted primarily from the Company's non-exclusive contract with Boehringer Mannheim to distribute products. Included in the general and administrative expenses are legal fees of $1,663,000 and $1,357,000 for fiscal years 1994 and 1993, respectively.\nThe provision for uncollectable accounts receivable increased by $365,000 primarily from a decrease in reimbursement rates from third party insurance carriers and a decline in collections from third parties. Other than through its normal collection procedures, the Company has no control over the percentage of bills that are reimbursable. In the fourth quarter of fiscal 1994, the Company recorded a recovery of a previously reserved research contract receivable of $6,500,000 due from Johnson and Johnson, Inc. Selling expenses increased by approximately $218,000 due to an increase in marketing programs and personnel costs for the clinical reference laboratory operations.\nThe Company has expensed certain costs in the amount of $600,000 against earnings for the writedown of the leasehold to its estimated fair market value.\nThe operating loss on the research and development activities and related costs amounted to $493,000 in fiscal 1994 as compared to an operating loss of $610,000 in fiscal 1993. The decrease in this loss is principally related to an increase in research product sales. The operating loss from the clinical reference laboratories activities increased to an operating loss of $659,000 as compared to an operating loss of $319,000 in fiscal 1993. This increase resulted principally from a decrease in reimbursement rates from third party insurance carriers and a decline in collections from third parties\nThe benefit for taxes on income of $2,945,000 in fiscal 1994 is primarily due to the decrease in the valuation allowance for deferred tax assets of $4,084,000 related to the expected tax utilization of deferred tax assets from the Johnson & Johnson, Inc. settlement, net of a deferred income tax provision of $1,035,000 in fiscal 1994.\nNet income (loss) for the fiscal year ended July 31, 1994 increased to approximately $5,251,000 compared with approximately $(6,842,000) for the fiscal year ended July 31, 1993.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe response to this item is submitted in a separate section 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\n(a) DIRECTORS - The following sets forth certain information regarding directors of the Company who are not executive officers of the Company. Information with respect to directors of the Company who are also executive officers of the Company appears below under the subcaption \"Executive Officers.\" The Company has a classified Board of Directors consisting of three classes.\nJOHN B. SIAS (age 68) has been Director of the Company since January 1982. Mr. Sias has been President and Chief Executive Officer of Chronicle Publishing Company since April 1993. From January 1986 until April 1993, Mr. Sias was President of ABC Network Division, Capital Cities\/ABC, Inc. From 1977 until January 1986 he was the Executive Vice President, President of the Publishing Division (which includes Fairchild Publications) of Capital Cities Communications, Inc.\nJOHN J. DELUCCA (age 52) has been a Director of the Company since January 1982. Since October 1993 Mr. Delucca has been Senior Vice President and Treasurer of RJR Nabisco, Inc. From January 1992 until October 1993 he was managing director and Chief Financial Officer of Hascoe Associates, Inc. From October 1, 1990 to January 1992 he was President of The Lexington Group. From September 1989 until September 1990 he was Senior Vice President-Finance of the Trump Group. From May 1986 until August 1989, he was senior Vice President- Finance at International Controls Corp. From February 1985 until May 1986, he was a Vice President and Treasurer of Textron, Inc. Prior to that he was a Vice President and Treasurer of the Avco Corporation, which was acquired by Textron.\nDuring the fiscal year ended July 31, 1995, there were four (4) formal meetings of the Board of Directors, several actions by unanimous consent and several informal meetings. The Board of Directors has an Audit Committee and Stock Option Committee. The Audit Committee had one (1) formal meeting and the Stock Option Committee had three (3) formal meetings in fiscal 1995.\nThe Audit Committee is authorized to review proposals of the Company's auditors regarding annual audits, recommend the engagement or discharge of the auditors, review recommendations of such auditors concerning accounting principles and the adequacy of internal controls and accounting procedures and practices, to review the scope of the annual audit, to approve or disapprove each professional service or type of service other than standard auditing services to be provided by the auditors, and to review and discuss the audited financial statements with the auditors. Its members are Shahram K. Rabbani and Messrs. Sias and Delucca.\nThe Stock Option Committee has the plenary authority in its discretion to determine the purchase price of the Common Stock issuable upon the exercise of each option, to\ndetermine the employees to whom, and the time or times at which, options shall be granted and the number of shares to be issuable upon the exercise of each option, to interpret the plans, to prescribe, amend and rescind rules and regulations relating to them, to determine the term and provisions of the respective option agreements and to make all other determinations deemed necessary or advisable for the administration of the plans. Its members are Messrs. Sias and Delucca.\nThe Company does not have a formal Executive Committee or Nominating Committee of the Board of Directors.\n(b) EXECUTIVE OFFICERS - The following table sets forth the names and positions of all of the current executive officers of the Company:\nNAME POSITION ---- --------\nElazar Rabbani, Ph.D. President, Chairman of the Board of Directors and Chief Executive Officer Shahram K. Rabbani Executive Vice President, Treasurer, Director Barry W. Weiner Executive Vice President, Secretary and Director Norman E. Kelker, Ph.D. Senior Vice President Dean Engelhardt, Ph.D. Senior Vice President Herbert B. Bass Vice President of Finance Barbara E. Thalenfeld, Ph.D. Vice President, Corporate Development David C. Goldberg Vice President, Business Development\nDR. ELAZAR RABBANI (age 51) has served as President and a Director of the Company since its organization in 1976. Dr. Rabbani received his B.A. degree from New York University in Chemistry and his Ph.D. degree in Biochemistry from Columbia University. He is a member of the American Society for Microbiology.\nSHAHRAM K. RABBANI (age 43) has been an Executive Vice President of the Company since September 1981 and a Vice President, Treasurer and a Director of the Company since its organization. Mr. Rabbani received a B.A. degree in chemistry from Adelphi University.\nBARRY W. WEINER (age 45) has been an Executive Vice President since September 1981, a Vice President and Director of the Company since its organization and Secretary since March 1980. He was employed by Colgate- Palmolive Company, New York, New York from August 1974 until March 1980, when he joined the Company on a full-time basis. Mr. Weiner received his B.S. degree in Economics from New York University and a M.B.A. from Boston University.\nDR. NORMAN E. KELKER (age 56) has been a Vice President of the Company since September 1981. Effective January 1, 1989, he was promoted to Senior Vice President. From 1975 until he joined the Company, Dr. Kelker was an Associate Professor in the Department of Microbiology of the New York University School of Medicine. He holds a Ph.D. from Michigan State University.\nDR. DEAN ENGELHARDT (age 55) has been Vice President since September 1981. Effective January 1, 1989, he was promoted to Senior Vice President. Prior to joining the Company he was Associate Professor of Microbiology at Columbia University College of Physicians and Surgeons. He obtained his Ph.D. from Rockefeller University.\nHERBERT B. BASS (age 47) is Vice President of Finance of the Company. Prior to his promotion, Mr. Bass was the Corporate Controller of Enzo. Before joining Enzo in 1988, Mr. Bass held various positions at Danziger & Friedman, Certified Public Accountants, from 1979 to 1986, the most recent of which was audit manager. For the preceding seven years he held various positions at Berenson & Berenson, C.P.A.'s. Mr. Bass holds a Bachelor degree in Business Administration from Baruch College.\nDR. BARBARA E. THALENFELD (age 55) is Vice President of Corporate Development and has been with Enzo since 1982. Prior to joining the Company she held an NIH research fellowship at Columbia University. She received a Ph.D. from Hebrew University-Hadassah Medical Center and an MS from Yale University.\nDAVID C. GOLDBERG (age 38) is Vice President of Business Development. Prior to joining Enzo in 1985, he was employed at DuPont NEN Products. He received an MS from Rutgers University and an MBA from New York University.\nDr. Elazar Rabbani and Shahram K. Rabbani are brothers and Barry W. Weiner is their brother-in-law.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required under this item will be set forth in the Company's proxy statement to be filed with the Securities and Exchange Commission on or before November 28, 1995 and is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required under this item will be set forth in the Company's proxy statement to filed with the Securities and Exchange Commission on or before November 28, 1995 and is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required under this item will be set forth in the Company's proxy statement to be filed with the Securities and Exchange Commission on or before November 28, 1995 and is incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K -----------------------------------------------------\n(a) (1) Consolidated Financial Statements Consolidated Balance Sheet - July 31, 1995 and 1994 Consolidated Statement of Operations- Years ended July 31, 1995, 1994 and 1993 Consolidated Statement of Stockholders' Equity- Years ended July 31, 1995, 1994 and 1993 Consolidated Statement of Cash Flows- Years ended July 31, 1995, 1994 and 1993 Notes to Consolidated Financial Statements.\n(2) Financial Statement Schedule Schedule II - Valuation and Qualifying Accounts\nAll other schedules have been omitted because the required information is included in the consolidated financial statements or the notes thereto or because they are not required.\n(3) Exhibits\nThe following documents are filed as Exhibits to this Annual Report on Form 10-K:\nEXHIBIT DESCRIPTION NO ------- -----------\n3(a) Certificate of Incorporation, as amended March 17, 1980. (1)\n3(b) June 16, 1981 Certificate of Amendment of the Certificate of Incorporation. (2)\n3(c) Certificate of Amendment to the Certificate of Incorporation. (11)\n3(d) Bylaws. (1)\n4(a) Indenture dated as of March 15, 1986, between registrant and The First National Bank of Boston, as Trustee. (3)\n4(b) Form of Purchase Agreement dated as of March 24, 1986, between registrant and the Purchasers. (3)\n4(c) Form of Registration Rights Agreement made and entered into as of March 24, 1986 by and among registrant and the Purchasers. (3)\n4(d) Form of Note Indenture. (3)\n10(a) 1980 Stock Option Plan. (1)\n10(b) Investment Agreement between the registrant and Johnson & Johnson Development Corp., dated June 25, 1982. (4)\n10(c) Agreement between the registrant and Ortho Diagnostic System, Inc. dated June 25, 1982. (5)\n10(d) 1983 Incentive Stock Option Plan. (6)\n10(e) Letter Agreement between the Company and Ortho Diagnostic Systems, Inc. dated as of January 1, 1985. (7)\n10(f) Lease Agreement dated as of December 1, 1985. (8)\n10(g) Indenture of Mortgage and Trust dated as of December 1, 1985. (8)\n10(h) Letter of Credit Agreement dated as of December 1, 1985. (8)\n10(i) Leasehold Mortgage and Security Agreement dated as of February 5, 1986. (8)\n10(j) Loan Agreement dated as of December 31, 1985. (8)\n10(k) Restricted Stock Plan. (8)\n10(l) Letter Agreement dated October 27, 1987 between the registrant and the First National Bank of Boston. (9)\n10(m) Supplemental Collateral Security Agreement between the registrant and The First National Bank of Boston. (12)\n10(n) Bio Health Laboratories Inc. Stock Purchase Agreement. (10)\n10(o) Extension Agreement dated October 31, 1990 between the registrant and The First National Bank of Boston filed herewith. (13)\n10(p) Agreement with First New York Bank for Business filed herewith. (14)\n10(q) Agreement with BioHealth Laboratories, Inc. shareholders filed herewith. (15)\n10(r) Agreement with Johnson & Johnson, Inc. filed herewith. (16)\n10(s) 1993 Incentive Stock Option Plan. (16)\n10(t) Employment Agreement with Elazar Rabbani. (16)\n10(u) Employment Agreement with Shahram Rabbani. (16)\n10(v) Employment Agreement with Barry Weiner. (16)\n10(w) 1994 Stock Option Plan filed herewith.\n11 Computation of per-share earnings filed herewith.\n12 Computation of ratio of earnings to fixed charges filed herewith.\n21 Subsidiaries of the registrant: Enzo Clinical Labs, Inc., a New York corporation. Enzo Diagnostics, Inc., a New York corporation. Enzo Therapeutics, Inc., a New York corporation.\n23 Consent of Independent Auditors filed herewith.\n- - --------------- NOTES TO (a)(3)\n(1) The exhibits were filed as exhibits to the Company's Registration Statement on Form S-18 (File No. 2-67359) and are incorporated herein by reference.\n(2) This exhibit was filed as an exhibit to the Company's Form 10-K for the year ended July 31, 1981 and is incorporated herein by reference.\n(3) These exhibits were filed as exhibits to the Company's Current Report on Form 8-K dated April 4, 1986 and are incorporated herein by reference.\n(4) This exhibit was filed as an exhibit to the Company's Current Report on Form 8-K dated June 29, 1982 and is incorporated herein by reference.\n(5) This exhibit was filed as an exhibit to the Company's Annual Report on Form 10-K for the year ended July 31, 1983 and is incorporated herein by reference.\n(6) This exhibit was filed with the Company's definitive proxy statement dated February 4, 1983 and is incorporated herein by reference.\n(7) This exhibit was filed with the Company's Annual Report on Form 10-K for the year ended July 31, 1985 and is incorporated herein by reference.\n(8) These exhibits were filed as exhibits to the Company's Quarterly Report on Form 10-Q for the quarter ended January 31, 1986 and are incorporated herein by reference.\n(9) This exhibit was filed as an exhibit to the Company's Registration Statement on Form S-2(33-7657) and is incorporated herein by reference.\n(10) This exhibit was filed as an exhibit to the Company's Current Report on Form 8-K dated July 12, 1990 and is incorporated herein by reference.\n(11) This exhibit was filed with the Company's Annual Report on Form 10-K for the year ended July 31, 1989 and is incorporated herein by reference.\n(12) This exhibit was filed with the Company's Annual Report on Form 10-K for the year ended July 31, 1990 and is incorporated herein by reference.\n(13) This exhibit was filed with the Company's Annual Report on Form 10-K for the year ended July 31, 1991 and is incorporated herein by reference.\n(14) This exhibit was filed with the Company's Annual Report on Form 10-K for the year ended July 31, 1992 and is incorporated herein by reference.\n(15) This exhibit was filed as an exhibit to the Company's Registration Statement on Form S-3 (33-72170) and is incorporated herein by reference.\n(16) This exhibit was filed with the Company's Annual Report on Form 10-K for the year ended July 31, 1994 and is incorporated herein by reference.\n- - --------------- (b) The Company's Current Reports on Form 8-K filed during the quarter ended July 31, 1995 -- none (c) See Item 14(a)(3), above. (d) See Item 14(a)(2), above.\n*************\nS I G N A T U R E S\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nENZO BIOCHEM, INC.\nDate: October 25, 1995 By: \/s\/ Elazar Rabbani ----------------------- President\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\n\/s\/ Elazar Rabbani October 25, 1995 - - ------------------------------------- Elazar Rabbani, President and Chairman of Board of Directors (Principal Executive Officer)\n\/s\/ Shahram K. Rabbani October 25, 1995 - - ------------------------------------- Shahram K. Rabbani, Executive Vice President, Treasurer and Director (Principal Financial and Accounting Officer)\n\/s\/ Barry W. Weiner October 25, 1995 - - -------------------------------------- Barry W. Weiner, Executive Vice President, Secretary and Director\n- - ------------------------------------- John B. Sias, Director\n- - ------------------------------------- John J. Delucca, Director\nFORM 10-K, ITEM 14(a) (1) AND (2) ENZO BIOCHEM, INC.\nLIST OF CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nThe following consolidated financial statements and financial statement schedules of Enzo Biochem, Inc. are included in Item 14(a):\nReport of Independent Auditors\nConsolidated Balance Sheet -- July 31, 1995 and 1994\nConsolidated Statement of Operations -- Years ended July 31, 1995, 1994 and 1993\nConsolidated Statement of Stockholders' Equity -- Years ended July 31, 1995, 1994 and 1993\nConsolidated Statement of Cash Flows -- Years ended July 31, 1995, 1994 and 1993\nNotes to Consolidated Financial Statements\nSchedule II - Valuation and Qualifying Accounts --Years ended July 31, 1995, 1994 and 1993\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 and Stockholders Enzo Biochem, Inc.\nWe have audited the accompanying consolidated balance sheets of Enzo Biochem, Inc. (the \"Company\") as of July 31, 1995 and 1994, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended July 31,1995. 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 present fairly, in all material respects, the consolidated financial position of Enzo Biochem, Inc. at July 31, 1995 and 1994 and the consolidated results of its operations and its cash flows for each of the three years in the period ended July 31, 1995, 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 herein.\nErnst & Young LLP\nMelville, New York October 12, 1995\nENZO BIOCHEM, INC. CONSOLIDATED BALANCE SHEET July 31, 1995 and 1994\nSee accompanying notes\nENZO BIOCHEM, INC. CONSOLIDATED STATEMENT OF OPERATIONS Years ended July 31, 1995, 1994 and 1993\nSee accompanying notes\nENZO BIOCHEM, INC. CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY Years ended July 31, 1995, 1994 and 1993\nSee accompanying notes\nENZO BIOCHEM, INC. CONSOLIDATED STATEMENT OF CASH FLOWS Years ended July 31, 1995, 1994 and 1993 (Note 2)\nSee accompanying notes\nENZO BIOCHEM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nJuly 31, 1995, 1994 and 1993\nNote 1 - BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBUSINESS\nEnzo Biochem, Inc. (the \"Company\") is engaged in research, development, manufacturing and marketing of diagnostic and research products based on genetic engineering, biotechnology and molecular biology. These diagnostic products will allow for the diagnosis of and\/or screening for infectious diseases, cancers, genetic defects and other medically pertinent diagnostic information. The Company operates a clinical reference laboratory which offers and provides diagnostic medical testing services to the health care community. The Company also is conducting research and development activities in the development of therapeutic products.\nSUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION\nThe accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany transactions and balances have been eliminated.\nCASH AND CASH EQUIVALENTS\nThe Company considers all highly liquid debt instruments purchased with maturities of three months or less to be cash equivalents.\nCash equivalents consist of short-term debt securities of the U.S. government that the Company intends to hold to maturity. The market values of these securities approximated cost at July 31, 1995.\nENZO BIOCHEM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nJuly 31, 1995, 1994 and 1993\nNote 1 - BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT'D)\nCONCENTRATION OF CREDIT RISK\nApproximately 85% and 60% at July 31, 1995 and 1994, respectively, of the Company's net accounts receivable relate to its clinical reference laboratory business which operates in the New York Metropolitan area. The accounts receivable are primarily from public and private insurance carriers and individuals. The Company recorded an additional provision for uncollectable accounts receivable of $400,000 in the fourth quarter of fiscal 1995 based on its evaluation of accounts receivable at the clinical reference laboratory. Management believes that collectability of the accounts receivable will be within its expectations. At July 31, 1995, 13% of the Company's net accounts receivable relate to amounts due under nonexclusive distribution agreements with Boehringer Mannheim and Amersham. At July 31, 1994, 35% of the Company's net accounts receivable related to amounts due from Boehringer Mannheim. In fiscal 1995 sales to Boehringer Mannheim represented approximately 22% of consolidated operating revenues.\nINVENTORIES\nInventories are stated at the lower of cost (first-in, first-out method) or market.\nPROPERTY AND EQUIPMENT\nEquipment is being depreciated on the straight-line and accelerated methods over the estimated useful lives of the assets. Leasehold improvements are amortized over the term of the related leases or estimated useful lives of the assets, whichever is shorter.\nAMORTIZATION OF INTANGIBLE ASSETS\nThe cost in excess of fair value of net tangible assets acquired is being amortized on the straight-line method over periods of twenty or forty years.\nPATENT COSTS\nThe Company has filed applications for United States and foreign patents covering certain aspects of its technology. The costs incurred in filing such applications have been deferred and are amortized over the estimated useful lives of the patents beginning upon issue. Costs related to unsuccessful patent applications are expensed.\nENZO BIOCHEM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nJuly 31, 1995, 1994 and 1993\nNote 1 - BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT'D)\nREVENUE RECOGNITION\nRevenues from services from the clinical reference laboratory are recognized when services are provided. Revenues from research product sales are recognized when the merchandise is shipped.\nNET INCOME (LOSS) PER SHARE\nNet income (loss) per share has been computed based upon the weighted average number of common shares and dilutive common stock equivalents outstanding during the year. The net income (loss) per share amounts for fiscal 1994 and 1993 have been retroactively adjusted to reflect the 5% stock dividend declared in fiscal 1995 (see Note 14).\nCommon stock equivalents which result from employee stock options and common stock purchase warrants have not been included in the calculation of net loss per share in fiscal 1993 because the effect would be antidilutive. Shares issuable upon conversion of the 9% convertible subordinated debentures are not common stock equivalents, are antidilutive and, therefore, are also excluded from the computation of net loss per share.\nENZO BIOCHEM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nJuly 31, 1995, 1994 and 1993\nNote 2 - SUPPLEMENTAL DISCLOSURE FOR STATEMENT OF CASH FLOWS\nCash paid for interest reconciled to interest expense for the years ended July 31, 1995, 1994 and 1993 is as follows:\nIn the years ended July 31, 1995, 1994 and 1993, the Company paid cash for income taxes of approximately $232,000, $94,000 and $63,000, respectively, and received refunds of income taxes previously paid of approximately $27,000 in fiscal 1994.\nENZO BIOCHEM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nJuly 31, 1995, 1994 and 1993\nNOTE 2 - SUPPLEMENTAL DISCLOSURE FOR STATEMENT OF CASH FLOWS (CONT'D)\nOTHER NONCASH ITEMS:\nDuring fiscal 1995, 1994 and 1993, the Company acquired property and equipment in the amount of $129,300, $76,400 and $63,900, respectively, which was financed through capital lease obligations.\nDuring fiscal 1995, 1994 and 1993, approximately $1,082,000, $282,000 and $1,334,000, respectively, has been accrued for construction costs, rent and legal fees related to the New York City leasehold. Interest accretion on the capital lease obligation for the New York City leasehold was approximately $318,000, $331,000 and $360,000 for fiscal 1995, 1994 and 1993, respectively.\nThe conversion of the Debentures during 1993 included accrued interest of $122,900 and accretion of redemption premium of $43,500, offset by deferred financing costs of $26,000 associated with the issuance of the Debentures, and net of conversion costs of $75,000, all of which were written off and included in the extraordinary loss. The extraordinary loss on the conversion of the Debentures to 167,600 shares of the Company's Common Stock was based upon the Company's stock price, as quoted on the American Stock Exchange, of $7.00 - $8.50 per share for the period from December 23, 1992 to July 31, 1993. During fiscal 1994, Debentures of $262,000 were converted into 50,000 shares of the Company's Common Stock. On January 13, 1995, the Company paid in full the outstanding balance of the Debentures.\nIn fiscal 1993, the Company accrued approximately $10,000 of deferred patent costs and $150,000 of legal and professional fees for registration filing fees.\nIn fiscal 1993, the Company exchanged approximately $5.1 million of accrued legal fees, construction costs and other expenses for approximately 600,000 shares of the Company's Common Stock. In fiscal 1994, the Company exchanged approximately $2.6 million of accrued legal fees, construction costs and patent costs for approximately 205,000 shares of the Company's Common Stock. The Company also settled a lawsuit against the former owners of its subsidiary, Enzo Clinical Labs, Inc., by issuing approximately 190,000 shares with a market value of approximately $3,000,000. In fiscal 1995, the Company issued approximately 286,000 shares of common stock in exchange for approximately $2.9 million in legal fees of which approximately $1,456,000 related to legal fees incurred in fiscal 1995.\nENZO BIOCHEM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nJuly 31, 1995, 1994 and 1993\nNOTE 3 - INVENTORIES\nAt July 31, 1995 and 1994 inventories consist of:\n1995 1994 ---- ----\nRaw materials $ 60,800 $ 68,600 Work in process 1,508,200 1,349,700 Finished products 628,500 684,400 ---------- ---------- $2,197,500 $2,102,700 ---------- ---------- ---------- ----------\nNOTE 4 - PROPERTY AND EQUIPMENT\nAt July 31, 1995 and 1994 property and equipment consist of:\n1995 1994 ---- ----\nLaboratory machinery and equipment $ 1,941,500 $ 1,664,900 Leasehold improvements 2,146,200 2,162,800 Office furniture and equipment 3,422,400 2,856,000 ----------- ----------- 7,510,100 6,683,700\nAccumulated depreciation and amortization 3,893,800 3,234,800 ----------- ----------- 3,616,300 3,448,900\nBuilding under capital lease and related construction costs, including capitalized interest of $4,364,700 in 1995 and 1994 and net of cumulative writedown to estimated fair market value of $19,901,000 in 1995 and $8,501,000 in 1994. 10,275,900 20,167,400 ----------- ----------- $13,892,200 $23,616,300 ----------- ----------- ----------- -----------\nIn fiscal 1995, 1994 and 1993 the Company wrote down the capital lease asset by $11,400,000, $600,000 and $3,000,000, respectively to its estimated fair market value. In the fourth quarter of fiscal 1995 management decided to seek alternative uses for the building under the capital lease.\nENZO BIOCHEM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nJuly 31, 1995, 1994 and 1993\nNOTE 5 - LOANS PAYABLE AND LONG-TERM DEBT\nAt July 31, 1995 and 1994, long-term debt consists of the following:\n1995 1994 ---- ----\n9% Convertible Subordinated Debentures due March 15, 2001 $ -- $ 68,600\n8.75% loan payable to bank at $3,360 per month through 1998 112,900 162,800 -------- -------- 112,900 231,400 Less current portion 31,700 95,800 -------- -------- Total long-term debt $ 81,200 $135,600 -------- -------- -------- --------\nIn 1993, the Company converted $649,000 in principal of the Company's outstanding Debentures into 167,600 shares of Common Stock which resulted in an extraordinary loss of $466,000. During fiscal 1994, the Company converted an additional $37,300 in principal into 5,000 shares of Common Stock. On January 13, 1995, the Company paid in full the outstanding balance of the Debentures.\nDuring fiscal 1994, the 9% convertible debentures of $225,000 were converted into 45,000 shares of common stock.\nOn September 17, 1991, the Company entered into a financing agreement from The First New York Bank for Business. In fiscal 1994, the outstanding principal on the line of credit was paid and the Company negotiated a 10% reduction in the outstanding balance on the term loan which also was paid and resulted in an extraordinary gain of $150,000 on the extinguishment of bank debt.\nIn March 1994, the Company entered into a $2 million line of credit with a bank. Interest was being charged at a rate of 1% above bank's prime rate (8.1% at July 31, 1994). In October 1994, the Company paid in full the line of credit.\nAs of July 31, 1995, the Company has a $2,000,000 line of credit available with a bank.\nENZO BIOCHEM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nJuly 31, 1995, 1994 and 1993\nNOTE 6 - LEASE OBLIGATIONS\nCAPITAL LEASES\nEffective December 1, 1985, the Company entered into an agreement with the City of New York to lease, over a fifty-year term, a six-story building located in New York City. The cost of the renovation was financed principally through the use of Company funds.\nThe Company recorded the fair value of the real property in the amount of $3,000,000 as a capital lease obligation due in installments through 2036. The minimum lease payments began in fiscal 1987, increasing (and in some years decreasing) through the twentieth year, when the payment is $825,000. The payments from the twenty-first through fiftieth years will be based on an appraisal of the fair market value of the property, excluding the value of improvements made by the Company, but will not be less than $579,000 per annum. Through 1998, payments will be applied to interest only which accrues at 12.05% per annum. The capital lease obligation will increase to approximately $5,525,000 before payments begin to be applied to both principal and interest in 1999.\nIn January 1992, the City of New York amended the lease payment schedule by deferring current payments and reducing future rentals for a period of five years. This amendment was in consideration of excess renovation costs incurred by the Company. The overall reduction in the capital lease obligation of $770,000 has been offset against the carrying value of the building under capital lease in the accompanying consolidated balance sheet. In connection with the amended lease payment schedule, the Company began to make monthly payments of $12,150 beginning January 1993. The Company incurred $1,400,000 in related building costs in fiscal 1995, but did not make these payments of rent or payment in lieu of taxes pending discussions with the City of New York concerning certain leasehold issues.\nThe cost and accumulated amortization of assets acquired under capitalized leases is approximately $3,529,000 and $94,000 at July 31, 1995 and $3,824,000 and $650,000 at July 31, 1994, respectively.\nENZO BIOCHEM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nJuly 31, 1995, 1994 and 1993\nNOTE 6 - LEASE OBLIGATIONS (CONT'D)\nMinimum annual rentals under capital lease obligations for fiscal years ending July 31 are as follows:\nReal property Equipment leases leases Total ------------- --------- -----------\n1996 $ 258,000 $ 53,000 $ 311,000 1997 280,000 29,000 309,000 1998 445,000 27,000 472,000 1999 568,000 31,000 599,000 2000 582,000 8,000 590,000 Thereafter 21,525,000 -- 21,525,000 ----------- -------- ----------- Total of future annual minimum lease payments $23,658,000 $148,000 $23,806,000 ----------- -------- ----------- -------- Less amount representing interest 19,136,000 -----------\nPresent value of minimum lease payments $ 4,670,000 ----------- -----------\nOPERATING LEASES\nEnzo Clinical Labs, Inc., (\"Enzo Clinical Labs\"), a wholly-owned subsidiary of the Company, leases its office and laboratory space under several leases which expire between September 1, 1994 and November 30, 2004. Certain officers of the Company own the building which Enzo Clinical Labs uses as its main facility. In addition to the minimum annual rentals of space, this lease is subject to an escalation clause. Rent expense under this lease approximated $684,000, $683,000 and $648,000 in fiscal 1995, 1994 and 1993, respectively.\nENZO BIOCHEM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nJuly 31, 1995, 1994 and 1993\nNOTE 6 - LEASE OBLIGATIONS (CONT'D)\nTotal consolidated rent expense incurred by the Company during fiscal 1995, 1994 and 1993 was approximately $1,132,000, $1,108,000 and $1,038,000, respectively. Minimum annual rentals under operating lease commitments for fiscal years ending July 31 are as follows:\n1996 882,000 1997 1,021,000 1998 1,129,000 1999 1,092,000 2000 1,094,000 Thereafter 2,478,000 ---------- $7,696,000 ---------- ----------\nNOTE 7 - LITIGATION\nORTHO DIAGNOSTIC SYSTEMS, INC.\nOn January 1, 1985, the Company entered into a follow-on agreement with Ortho Diagnostic Systems, Inc. (\"Ortho\"), a subsidiary of Johnson and Johnson, Inc. (\"J&J\") pursuant to the 1982 agreement, whereby Ortho agreed to pay the Company $11,000,000 over a four and one-half year period on a cost recovery basis in support of research and development projects. Ortho paid $4,500,000 to the Company under this agreement up to January 1987 at which time Ortho indicated its intention to suspend future scheduled payments under the agreements pending resolution of certain matters. At July 31, 1994, the Company had a receivable from Ortho of approximately $6,500,000. Even though the Company continued to perform its obligations under the agreements, it provided a total of $6,500,000 in prior years for the potentially uncollectable receivable from Ortho pending resolution of the disputed items and the outcome of the civil suit filed by the Company against Ortho and J&J. This allowance for uncollectable receivable of $6,500,000 was reversed in the fourth quarter of fiscal 1994 due to the resolution of this matter, as discussed below.\nENZO BIOCHEM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nJuly 31, 1995, 1994 and 1993\nNOTE 7 - LITIGATION (CONT'D)\nDuring 1992, the outside legal counsel went on a contingency basis and, therefore, no fees were incurred. In fiscal 1993 and 1994, the Company exchanged 22,736 and 6,121 shares of its common stock for reimbursable legal expenses, approximating $200,000 and $101,800, respectively. During fiscal 1995, the Company issued approximately 110,000 shares in exchange for $1.1 million in accrued legal fees.\nOn October 19, 1994, the Company executed a settlement agreement with J&J pursuant to which the Company received $15.0 million in cash, of which $6.5 million related to amounts due under the agreements referred to above, and a promissory note requiring J&J Ortho to pay a total of $5.0 million a year for each of the four successive anniversaries of said date. Pursuant to the terms of the settlement, all of the Company's grants, licenses and intellectual property have been returned to the Company in totality. These future payments are recorded at their net present value of $18,121,000 at July 31, 1995 in the accompanying consolidated balance sheet, using a discount rate of 5.25%.\nCALGENE, INC.\nIn March 1993, the Company filed suit in the United States District Court for the District of Delaware charging patent infringement and acts of unfair competition against Calgene, Inc. and seeking a declaratory judgment of invalidity concerning Calgene, Inc.'s plant antisense patent. On February 9, 1994 the Company filed a second suit in the United States District Court for the District of Delaware charging Calgene with infringement of a second antisense patent owned by the Company. Calgene has filed a counterclaim in the second Delaware action seeking a declaration that a third patent belonging to the Company is invalid. The two Delaware actions have been consolidated and were tried to the Court in April 1995. The parties are awaiting the Court's decision. In addition, the Company filed suit on March 22, 1994 in the United States District Court for the Western District of Washington against Calgene and the Fred Hutchinson Cancer Research Center, alleging that the defendants had conspired to issue a false and misleading press release regarding a supposed \"patent license\" from Hutchinson to Calgene, and conspired to damage the Company's antisense patents by improperly using confidential information to challenge them in the Patent Office. The Complaint further charges that Hutchinson is infringing and inducing Calgene to infringe the Company's antisense patents. There can be no assurance that the Company will be successful in any of the foregoing matters or that Calgene, Inc. and\/or Hutchinson will not be successful. However, even if the Company is not successful management does not believe there will be a significant monetary impact.\nENZO BIOCHEM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nJuly 31, 1995, 1994 and 1993\nNOTE 8 - INCOME TAXES\nThe tax provision (benefit) is calculated under the provisions in Statement of Financial Accounting Standards (SFAS) No. 109 \"Accounting for Income Taxes\".\n1995 1994 1993 ---- ---- ---- Current Federal $ 400,000 -- -- State and local 881,900 $104,300 $52,400\nDeferred Federal 5,650,000 -- -- State and local 1,799,300 (49,300) -- Change in deferred tax asset valuation reserve related to net operating losses (4,600,000) (3,000,000) -- ---------- ----------- -------\nProvision (benefit) for income taxes $4,131,200 $(2,945,000) $52,400 ---------- ----------- ------- ---------- ----------- -------\nENZO BIOCHEM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nJuly 31, 1995, 1994 and 1993\nNOTE 8 - INCOME TAXES (CONT'D)\nDeferred income taxes arise from temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements. The components of deferred income taxes are as follows:\n1995 1994 1993 ---- ---- ----\nDeferred tax liability: Deferred patent costs $(2,076,000) $(2,110,000) $(2,136,000) Other (310,000) (310,000) -- ----------- ----------- ------------ Total deferred tax liabilities (2,386,000) (2,420,000) (2,136,000)\nDeferred tax assets: Writedown of leasehold interest 7,573,000 3,390,000 3,138,000 Provision for uncollectable accounts receivable and research contract 574,000 490,000 3,240,000 Net operating loss carryforwards 36,000 8,199,000 6,447,000 Alternative minimum tax 600,000 -- -- Other 352,000 282,000 287,000 ----------- ----------- ------------ 9,135,000 12,361,000 13,112,000\nValuation allowance for deferred tax assets (6,749,000) (7,092,000) (11,176,000) ----------- ----------- ------------ Net deferred tax asset (liability) $ 0 $ 2,849,000 $ (200,000) ----------- ----------- ------------ ----------- ----------- ------------\nCurrent income taxes of approximately $1.3 million provided for in the fourth quarter of fiscal 1995 are primarily calculated on the alternative minimum tax method. The decrease in the valuation allowance for deferred tax assets of $4,084,000 in fiscal 1994 relates primarily to the expected utilization of net operating loss carryforwards and deferred tax assets related to the Johnson & Johnson, Inc. settlement (see Note 7).\nENZO BIOCHEM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nJuly 31, 1995, 1994 and 1993\nNOTE 8 - INCOME TAXES (CONT'D)\nThe provision (benefit) for income taxes were at rates different from U.S. federal statutory rates for the following reasons:\n1995 1994 1993 ---- ---- ----\nFederal statutory rate 34% 34% (34%)\nExpenses not deductible for income tax return purposes 2% 7% 2%\nState income taxes, net of federal 10% 2% 1%\nNo benefit for operating losses 44% (41%) 32%\nChange in valuation reserve related to benefits from operating losses (48%) (139%) -- ---- ----- --- 42% (137%) 1% ---- ----- --- ---- ----- ---\nNOTE 9 - STOCK OPTIONS AND WARRANTS\nThe Company has a nonqualified stock option plan, an incentive stock option plan and a restricted stock incentive plan and has issued other options and warrants, as described below. All share information has been adjusted to reflect the 5% stock dividend declared in fiscal 1995.\nNONQUALIFIED STOCK OPTION PLAN\nThe Company has a nonqualified stock option plan (the \"Plan\") under which options for up to 756,000 shares of Common Stock may be issued. No additional options may be granted under such plan. The exercise price of options granted under the terms of the Plan will be determined by the Board of Directors.\nENZO BIOCHEM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nJuly 31, 1995, 1994 and 1993\nNOTE 9 - STOCK OPTIONS AND WARRANTS (CONT'D)\nA summary of nonqualified stock option transactions for the three years ended July 31, 1995 is as follows:\nNumber of shares Exercise price --------- --------------\nOutstanding - July 31, 1992 161,784 $3.22\nExercised (1,418) $3.22 --------\nOutstanding - July 31, 1993 160,366 $3.22\nExercised (13,230) $3.22 --------\nOutstanding - July 31, 1995 and 1994 147,136 $3.22 -------- --------\nThe options granted are generally exercisable at 25% per year after one year and expire ten years after the date of grant and, at July 31, 1995 all nonqualified options were exercisable.\nINCENTIVE STOCK OPTION PLAN\nThe Company has an incentive stock option plan (\"1983 plan\") under which the Company may grant options for up to 945,000 shares of common stock. No additional options may be granted under the 1983 plan. The exercise price of options granted under such plan is equal to or greater than fair market value of the common stock on the date of grant. The Company has stock option plans (\"1993 plan\" and \"1994 plan\") under which the Company may grant options for up to 1,575,000 shares (1993 plan) and for up to 997,500 shares (1994 plan) of common stock. The options granted pursuant to the plans may be either incentive stock options or nonstatutory options. To date, the Company has only granted incentive stock\nENZO BIOCHEM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nJuly 31, 1995, 1994 and 1993\nNOTE 9 - STOCK OPTIONS AND WARRANTS (CONT'D)\noptions under these plans. A summary of incentive stock option transactions for the three years ended July 31, 1995 is as follows:\nNumber of shares Exercise price --------- --------------\nOutstanding July 31, 1992 755,589 $1.43 - 3.54\nExercised (43,969) $1.43 - 3.22\nCanceled (56,831) $1.43 - 6.19\nIssued 410,025 $4.29 - 7.38 ---------\nOutstanding July 31, 1993 1,064,814 $1.43 - 7.38\nExercised (40,530) $1.43 - 4.29\nCanceled (133,409) $1.43 - 7.38\nIssued 722,459 $9.41 - 15.25 ---------\nOutstanding July 31, 1994 1,613,334 $1.43 - 15.25\nExercised (110,417) $1.43 - 7.38\nCanceled (2,625) $3.22\nIssued 284,550 $9.17 - 10.83 ---------\nOutstanding July 31, 1995 1,784,842 $1.43 - 15.25 --------- ---------\nIncentive stock options generally become exercisable at 25% per year after one year and expire ten years after the date of grant. At July 31, 1995, under the incentive stock option plans 827,175 options were exercisable.\nRESTRICTED STOCK INCENTIVE PLAN\nThe Company has a restricted stock incentive plan whereby the Company may award up to 210,000 shares of its common stock. Under the terms of the plan, any shares issued are restricted in regard to sales and transfers for a period of five years after award. Such restrictions begin to expire at 25% per year after the second year of ownership. As of July 31, 1995, the Company has not awarded any shares of common stock under this plan.\nENZO BIOCHEM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nJuly 31, 1995, 1994 and 1993\nNOTE 9 - STOCK OPTIONS AND WARRANTS (CONT'D)\nOTHER OPTIONS AND WARRANTS\nIn fiscal 1982, the Company issued 32,130 warrants in connection with the sale of stock. These warrants were exercisable at $8.73 per share through June 1994 of which 16,065 warrants were exercised in fiscal 1994 and the remaining 16,065 warrants expired in fiscal 1995. As part of the restructuring of the Debenture in November 1991, the Company issued additional warrants to purchase 269,850 shares of common stock with an exercise price of $1.90 per share expiring ten years after the date of issue. In fiscal 1995 and 1994, 4,200 and 87,675 of these warrants were exercised, respectively. In connection with the issuance of newly issued shares of the Company's Common Stock to a private investor in fiscal 1994, the Company issued warrants to purchase 262,500 shares of common stock with an exercise price ranging from $7.62 to $11.43 per share. In fiscal 1995 and 1994, 105,000 and 42,000 of these warrants were exercised, respectively.\n* * * * *\nAs of July 31, 1995, the Company has reserved 4,331,485 shares under the arrangements described above and shares issuable upon conversion of debt as described in Note 5.\nENZO BIOCHEM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nJuly 31, 1995, 1994 and 1993\nNOTE 10 - COMMITMENTS\nThe Company has an exclusive licensing agreement to an invention covered by licensed patents. Under this agreement, the Company is required to make certain minimum royalty payments of $200,000 per year through the life of the patents.\nENZO BIOCHEM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nJuly 31, 1995, 1994 and 1993\nNOTE 11 - LINES OF BUSINESS\nThe Company operates two lines of business: (i) conducting research and development activity and selling products derived from such research and (ii) operating clinical reference laboratories which provide diagnostic services to the health care community. The following financial information (in thousands) with respect to such lines of business (industry segments) is based on the guidelines contained in Statement of Financial Accounting Standards No. 14.\n(a) Includes cost in excess of fair value of net tangible assets acquired of $10,046 in 1995, $10,391 in 1994 and $11,210 in 1993.\nENZO BIOCHEM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nJuly 31, 1995, 1994 and 1993\nNOTE 12 - EMPLOYEE BENEFIT PLAN\nThe Company has a qualified Salary Reduction Profit Sharing Plan (the \"Plan\") for eligible employees under Section 401(k) of the Internal Revenue Code. The Plan provides for voluntary employee contributions through salary reduction and voluntary employer contributions at the discretion of the Company. For the years ended July 31, 1995 and 1994, the Company has authorized employer contributions of 25% of the employees' contribution up to 6% of the employees' compensation in Enzo Biochem, Inc. common stock and such contribution was not material in fiscal 1995 and 1994.\nNOTE 13 - SUPPLEMENTARY EARNINGS PER SHARE\nThe Company converted $649,000 and $262,000 in principal of the Company's outstanding Debentures into 167,600 and 50,000 shares of Common Stock in 1993 and 1994, respectively. Pro forma earnings per share information as if the conversion had occurred at the beginning of the period would be as follows:\n1994 1993 ---- ----\nIncome (loss) before extraordinary items $.23 ($.34) Extraordinary items .01 -- ---- ----- Net income (loss) $.24 ($.34) ---- ----- ---- ----- Weighted average common shares 21,513,535 18,651,400 ---------- ---------- ---------- ----------\nNOTE 14 - STOCK DIVIDEND\nThe Company declared a 5% stock dividend on July 3, 1995 to shareholders of record as of July 3, 1995. The stock price on the date of declaration was $10.125. The dividend has been charged against accumulated deficit to the extent of net income in fiscal 1995.\nENZO BIOCHEM, INC. SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS\nYears ended July 31, 1995, 1994 and 1993\n(1) Write-off of uncollectable accounts receivable. (2) Offset by increase in net deferred tax assets. (3) Recovery of research contract receivable\nINDEX\nOF\nEXHIBITS FILED WITH\nFORM 10-K FOR FISCAL YEAR ENDED\nJULY 31, 1995\nOF\nENZO BIOCHEM, INC.\nEXHIBIT EXHIBIT NUMBER PAGE - - ------- -------------- ----\n1994 Stock Option Plan 10(w) E-2\nComputation of per-share earnings 11 E-15\nComputation of ratio of earnings to fixed charges 12 E-16\nConsent of Ernst & Young LLP 23 E-17\nE-1","section_15":""}
{"filename":"38195_1995.txt","cik":"38195","year":"1995","section_1":"ITEM 1. BUSINESS\nTHE COMPANY\nFounded in 1919, Fort Howard is a leading manufacturer, converter and marketer of sanitary tissue products, including specialty dry form products, in the United States and the United Kingdom. Its principal products, which are sold in the commercial (away-from-home) and consumer (at-home) markets, include paper towels, bath tissue, table napkins, wipers and facial tissue manufactured from virtually 100% recycled fibers. The Company believes that it has the leading market share of tissue products in the domestic commercial market of approximately 26% and has focused approximately 60% of its capacity on this segment of the tissue market. In the domestic consumer market, where the Company has an approximate 10% market share, its principal brands include Mardi Gras printed napkins (which hold the leading domestic market position) and paper towels, Soft'n Gentle bath and facial tissue, So-Dri paper towels, and Green Forest, the leading domestic line of environmentally positioned, recycled tissue paper products. Fort Howard also manufactures and distributes its products in the United Kingdom where it currently has the third largest market share primarily in the consumer segment of the market.\nDOMESTIC TISSUE OPERATIONS\nProducts\nCommercial Products. Fort Howard's commercial tissue products include folded and roll towels, bath and facial tissue, bulk and dispenser napkins, disposable wipers, specialty printed merchandise and dispensers. Competition in this market is based upon attaining a competitive level of product attributes at prices which provide a good value to customers. Another competitive factor is the ability to provide reliable and timely service.\nIn addition, the Company also produces parent rolls for sale to converters in international markets, including Latin America and the Middle East.\nConsumer Products. Fort Howard's consumer product growth strategy has targeted the value brand and private label segments of the market. The Company's value brand products such as Mardi Gras, Soft'n Gentle and Green Forest offer a high level of softness, absorbency and brightness at a substantial price savings versus the premium brands. The appeal of Mardi Gras napkins and paper towels is enhanced by their multi-color prints with changing patterns and special seasonal designs.\nFort Howard is the leading tissue producer in the growing consumer private label business with an estimated market share of approximately 40% in 1995. Many national grocery chains have focused on the development of private label tissue products to support the positioning of the chain with their shoppers as well as to enhance margins. Typically offered on a limited supplier basis, private label products enable the Company to form close relationships with many of the nation's fastest growing, leading grocery chains and mass merchandisers and afford opportunities for sales of Fort Howard's branded products with these same customers.\n- 2 - Marketing\nCommercial Market. Approximately 60% of the Company's products are sold through paper, institutional food and janitorial distributors into the commercial market. These products are produced in a broad range of weights, textures, sizes, colors and package configurations providing Fort Howard with distinct advantages as a full-line manufacturer. The Company also creates and prints logos, commercial messages and artistic designs on paper napkins and place mats for commercial customers and party goods and specialty print merchandisers. The Company sells its commercial products under its own brand names which include Envision, Generation II and Preference Ultra and under the Fort Howard name.\nFort Howard's commercial sales force of approximately 200 salaried representatives combines broad geographical reach and frequency of contact with the Company's major commercial customers, including large distributors, national accounts and club warehouses. Because the commercial sales force is dedicated to the sale of the Company's commercial tissue products, the Company's sales representatives are able to devote substantial time to developing end user demand, an important selling point for the Company's distributors. In addition, the Company's sales force includes specialized sales teams focused on selling wiper products and its premium quality products.\nConsumer Market. Approximately 40% of the Company's products are sold through independent brokers to major food store chains and wholesale grocers or directly to mass merchandisers for at-home use. Most consumer products are sold under Company-owned brand names, with a significant percentage of products being sold under private labels. Principal brand names of consumer products include Mardi Gras, Soft'n Gentle, So-Dri and Green Forest. Regional sales managers focus on maintaining close relationships with brokers and retailers by emphasizing Fort Howard's historic strengths--attractive product attributes at a good value for the consumer and enhanced margins for retailers. The Company's national accounts sales force focuses on mass merchandisers and on implementing their \"everyday low pricing\" strategies. The private label sales team markets directly to national accounts and through food brokers to their customers. In contrast to tissue producers who emphasize marketing of their consumer products through advertising and promotion to the end consumer, Fort Howard incurs minimal advertising expense. Rather, the Company focuses its marketing efforts for consumer products on trade promotion and incentive programs targeted to grocery and mass merchandising retailers.\nINTERNATIONAL TISSUE OPERATIONS\nThe Company's international tissue operations principally consist of its tissue business in the United Kingdom, Fort Sterling Limited (\"Fort Sterling\"). The Company also entered into a small joint venture to convert parent rolls into finished products in the People's Republic of China in 1995 which will begin operations in the first half of 1996, and opened direct sales operations in Mexico in 1995. For an analysis of net sales, operating income (loss) and identifiable operating assets in the United States and internationally, see Note 12 to the audited consolidated financial statements.\n- 3 - Products\nFort Sterling's primary thrust has been in the larger consumer segment of the United Kingdom tissue market where approximately 85% of its converted product sales are targeted. In a market where private label represents about one-half of all tissue sales, the Company believes that Fort Sterling maintains a leading share of the consumer private label market. Approximately two-thirds of Fort Sterling's consumer business in 1995 was sold under private labels to large grocers and convenience stores. Fort Sterling's principal brand is its Nouvelle line of tissue paper products. Overall, Fort Sterling's consumer market share approximated 16% in 1995.\nFort Sterling has approximately 5% of the market share in the commercial segment.\nMarketing\nFort Sterling maintains a direct sales force serving large national grocers, independent grocers and mass merchandisers in the consumer market. Fort Sterling has a commercial sales force which markets the Company's products via a network of independent distributors. A separate national accounts sales team targets commercial foodservice, health care and national industrial accounts.\nCAPITAL EXPENDITURES\nThe Company has invested heavily in its manufacturing operations. Capital expenditures in the Company's tissue business were approximately $674 million for the five year period ended December 31, 1995, $476 million of which was incurred for capacity expansion projects. In addition, the Company's annual capital spending program includes significant investments for the ongoing modernization of each of its mills. For example, as new deinking technologies and converting equipment are developed, the Company adds such technology and equipment at each mill to maintain its low cost structure.\nIn 1994, the Company completed the installation of a fifth tissue paper machine, environmental protection equipment and associated facilities at its Muskogee tissue mill. Total expenditures for the expansion were approximately $140 million. In 1993, the Company completed an expansion of its Green Bay tissue mill, including the addition of a new tissue paper machine and related environmental protection, pulp processing, converting, and steam generation equipment. The new tissue paper machine at the Green Bay mill commenced production in August 1992. Total expenditures for the expansion project were $180 million. Also in 1993, Fort Sterling completed a $96 million expansion which doubled the capacity of its paper mill. The expansion project added a 206-inch tissue paper machine and related deinking and pulp processing plants.\nRAW MATERIALS AND ENERGY SOURCES\nThe principal raw materials and supplies used to manufacture tissue products are wastepaper (which is processed to reclaim fiber), chemicals, corrugated shipping cases and packaging materials. Fort Howard uses 100% wastepaper for all but a limited number of dry form and specialty products representing approximately 3% of its volume. Currently, Fort Howard recycles over 1.4 million tons of wastepaper annually into tissue products. Beginning\n- 4 - in July 1994, wastepaper prices for the grades of wastepaper used in Fort Howard's products have been volatile. See Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations. The deinking technology employed by the Company allows it to use a broad range of wastepaper grades, which effectively increases both the number of sources and the quantity of wastepaper available for its manufacturing process.\nThe Company manufactures some of the process chemicals required for the Company's tissue production at each of its domestic mill locations. The balance of its chemical requirements is purchased from outside sources. The Company also purchases significant quantities of coal and petroleum coke for generation of electrical power and steam at all three of its domestic tissue mills. The Company seeks to maintain inventories of wastepaper, other raw materials and supplies which are adequate to meet its anticipated manufacturing needs.\nThe Company's major sources of energy for its domestic tissue mills are coal, petroleum coke and, to a lesser extent, natural gas. These fuels are burned to provide steam and electrical power to process wastepaper, operate machinery and dry paper. Coal is received in Green Bay in self-unloading vessels during the Great Lakes shipping season and at the Muskogee and Savannah mills by rail. Petroleum coke is received in Green Bay and Savannah by rail. The Company maintains adequate inventories of these fuels at each of its domestic mills. The Savannah mill can also generate electrical power by burning natural gas or fuel oil in combustion turbines. The primary sources of energy for the Company's United Kingdom tissue facilities are purchased electrical power and natural gas.\nCOMPETITION\nAll the markets in which the Company sells its products are extremely competitive. The Company's tissue products compete directly with those of a number of large diversified paper companies, including Chesapeake Corporation, Georgia-Pacific Corporation, James River Corporation of Virginia, Kimberly-Clark Corporation, Pope & Talbot, Inc. and the Procter & Gamble Company, as well as regional manufacturers, including converters of tissue into finished products who buy tissue directly from tissue mills. Many of the Company's competitors are larger and more strongly capitalized than the Company which may enable them to better withstand periods of declining prices and adverse operating conditions in the tissue industry. Customers generally take into account price, quality, distribution and service as factors when considering the purchase of products from the Company.\nCUSTOMERS AND BACKLOG\nThe Company principally markets its products to customers in the United States and the United Kingdom, and to a lesser extent, Mexico, Canada and the Middle East. The business of the Company is not dependent on a single customer.\nThe Company's products are manufactured with relatively short production time from basic materials. Products marketed under the Company's trademarks and stock items are sold from inventory. The backlog of customer orders is not significant in relation to sales.\n- 5 - RESEARCH AND DEVELOPMENT\nThe Company maintains laboratory facilities with a permanent staff of engineers, scientists and technicians who are responsible for improving existing products, developing new products and processes, product quality, process control and providing technical assistance in adhering to regulatory standards. Continuing emphasis is being placed upon expanding the Company's capability to deink a broader range of wastepaper grades, designing new products, further automating manufacturing operations and developing improved manufacturing and environmental processes.\nPATENTS, LICENSES, TRADEMARKS AND TRADE NAMES\nWhile the Company owns or is a licensee of a number of patents, its operations and products are not materially dependent on any patent. The Company relies on trade secret protection for its proprietary deinking technology which is not covered by patent. The Company's domestic tissue products for at-home use are sold under the principal brand names Mardi Gras, Soft'n Gentle, So-Dri and Green Forest. For the Company's domestic commercial tissue business, principal brand names include Envision, Generation II and Preference. All brand names are registered trademarks of the Company. A portion of the Company's tissue products are sold under private labels or brand names owned by customers.\nEMPLOYEES\nAt December 31, 1995, the Company's worldwide employment was approximately 6,800, of which 5,800 persons were employed in the United States and 1,000 persons were employed in the United Kingdom. There is no union representation at any of the Company's domestic facilities. The Company's employees at its facilities in the United Kingdom are unionized and the union contracts generally require annual renegotiation of employee wage awards. The Company considers its relationship with its employees to be good.\nENVIRONMENTAL MATTERS\nThe Company is subject to substantial regulation by various federal, state and local authorities in the U.S., and by national and local authorities in the United Kingdom concerned with the impact of the environment on human health, the limitation and control of emissions and discharges to the air and waters, the quality of ambient air and bodies of water and the handling, use and disposal of specified substances and solid waste at, among other locations, the Company's process waste landfills.\nCompliance with existing laws and regulations presently requires the Company to incur substantial capital expenditures and operating costs. In addition, environmental legislation and regulations and the interpretation and enforcement thereof are expected to become increasingly stringent. Such further environmental regulation is likely to limit the operating flexibility of the Company's manufacturing operations. Because other paper manufacturers are generally subject to similar environmental restrictions, the Company believes that compliance with environmental laws and regulations is not likely to have a material adverse effect on its competitive position.\n- 6 - In 1995, the Company made capital expenditures of $4 million with respect to pollution abatement and environmental compliance. The Company expects to commit to approximately $9 million of capital expenditures to maintain compliance with environmental control standards and enhance pollution control at its mills during 1996 and 1997. Because the impact of further environmental regulation cannot be determined with certainty at this time, it is possible that there will be additional capital expenditures during these years, including but not limited to those described below.\nThe U.S. Environmental Protection Agency (the \"U.S. EPA\") has proposed new air emission and revised wastewater discharge standards for the pulp and paper industry which are commonly known as the \"Cluster Rules.\" U.S. EPA has not formally indicated when the components of the Cluster Rules that deal with wastewater discharges are to be finalized. If the final rules on wastewater discharges are substantially the same as the proposed rules, the Company estimates that it will incur additional aggregate capital expenditures of approximately $1.2 million.\nComponents of the currently proposed Cluster Rules that address air emissions will have little impact on deinking paper mills such as the Company's mills. However, additional installments of the Cluster Rules, expected to be proposed during 1996 with expected compliance deadlines as late as the year 2000, are expected to specifically address air emissions from deinking mills and likely will have a greater impact on the Company. The Company is presently unable to estimate that impact since the applicable rules have not been proposed and therefore no assurances can be given as to whether the impact will be material to the Company.\nThe Comprehensive Environmental Response, Compensation and Liability Act (\"CERCLA\") imposes liability, without regard to fault or to the legality of the original action, on certain classes of persons (referred to as potentially responsible parties or PRPs) associated with a release or threat of a release of hazardous substances into the environment. Financial responsibility for the clean-up or other remediation of contaminated property or for natural resource damages can extend to previously owned or used properties, waterways and properties owned by third parties, as well as to properties currently owned and used by the Company even if contamination is attributable entirely to prior owners. The Company is involved in a voluntary investigation and potential clean-up of the Lower Fox River and has been named a PRP for alleged natural resource damages to the Fox River, both of which are discussed in \"Legal Proceedings\" below. Other than the United States Department of Interior, Fish and Wildlife Service (\"FWS\") assessment of the Fox River described in \"Legal Proceedings,\" the Company is currently named as a PRP at only one CERCLA-related site. The Company believes its liability, if any, at such site is de minimis. However, there can be no certainty that the Company will not be named as a PRP at any other sites in the future or that the costs associated with additional sites would not be material to the Company's financial condition or results of operations.\nThe Company has $20 million of accrued liabilities as of December 31, 1995 for estimated or anticipated liabilities and legal and consulting costs relating to environmental matters arising from past operations. The Company expects these costs to be incurred over an extended number of years. While the accrued liabilities reflect the Company's current estimate of the cost of these environmental matters, there can be no assurance that the amount accrued will be adequate.\n- 7 -\nITEM 2. PROPERTIES\nFort Howard produces its domestic tissue products at three mills: its original mill in Green Bay, Wisconsin; its Muskogee, Oklahoma mill constructed as a greenfield site which commenced papermaking production in 1978; and its greenfield mill near Savannah, Georgia, which commenced production in 1987. Each of these mills is a world-class, fully integrated tissue mill that can deink and process fiber from low cost wastepaper to provide virtually all of the mill's tissue fiber. Each mill is geographically located to minimize distribution costs to its regional markets.\nIn Green Bay, Wisconsin, the Company operates nine tissue paper machines, including two world-class 270-inch tissue paper machines completed in 1984 and 1992. In addition, the Green Bay mill contains two dry form machines which commenced operation in 1978 and 1989. Although the Green Bay mill is the Company's original mill, having commenced production in 1920, it is well maintained, includes virtually all of Fort Howard's latest technologies and equipment and is cost competitive with the Company's newer mills. The Company's Muskogee, Oklahoma mill contains a new 270-inch tissue paper machine which was added during the first quarter of 1994, and another 270-inch and three 200-inch tissue paper machines which were installed between 1978 and 1985. Fort Howard's greenfield mill located near Savannah, Georgia contains four 270-inch tissue paper machines that commenced production in 1987, 1988, 1989 and 1991.\nEach of the Company's domestic mills also includes a coal-fired cogeneration power plant capable of producing all of the mill's steam and electricity, a modern deinking and pulp processing plant that processes virtually all of the mill's fiber requirements from wastepaper, a chemical plant that produces high volume chemicals used in whitening fibers, high speed converting equipment for cutting, folding, printing and packaging paper into the Company's finished products and related facilities and warehousing. The Muskogee mill also includes a polywrap manufacturing plant that processes approximately one-half of the polywrap required by the Company's domestic mills and the Green Bay mill includes a large machine shop that services all the Company's domestic mills.\nFort Sterling currently operates three tissue paper machines and a deinking and wastepaper processing plant at its Ramsbottom paper mill. The Company cuts, folds, prints and packages paper into finished tissue products at its Bolton and Wigan converting facilities. All of Fort Sterling's locations are in Greater Manchester, England.\nExcept for certain facilities and equipment constructed or acquired in connection with sale and leaseback transactions pursuant to which the Company continues to possess and operate such facilities and equipment, substantially all the Company's manufacturing facilities and equipment are owned in fee. The Company's domestic and United Kingdom tissue manufacturing facilities are pledged as collateral under the terms of the Company's debt agreements. See Note 5 to the audited consolidated financial statements.\nThe Green Bay, Muskogee, Savannah, and United Kingdom facilities generally operate tissue paper machines at full capacity seven days per week, except for downtime for routine maintenance. Converting facilities are generally operated on a 24-hour per day, 5-day per week basis or a 7-day per week schedule. Converting capacity could be expanded by working additional hours and\/or adding converting equipment.\n- 8 - ITEM 3. LEGAL PROCEEDINGS\nIn December 1994, the Company was notified by the U.S. Department of Justice of a civil antitrust investigation into possible agreements in restraint of trade in connection with sales of sanitary paper products. The Company has cooperated in the investigation and in the first and second quarters of 1995 responsed to the Civil Investigative Demand served on the Company.\nSince July 1992, the Company has been participating with a coalition consisting of industry, local government, Wisconsin Department of Natural Resources (\"WDNR\") and public interest members studying the nature and extent of PCB (polychlorinated biphenyl) and other sediment contamination of the Lower Fox River in northeast Wisconsin. The objective of the coalition is to identify, recommend and implement cost effective remediation of contaminated deposits which can be implemented on a voluntary basis. The Company anticipates that any remediation of sediment contamination will begin in an area approximately 35 miles upstream of the Company's Green Bay mill. The Company's participation in the studies undertaken by the coalition is voluntary and its contributions to funding those activities to date have not been significant. The Company's participation in the coalition is not an admission of liability for any portion of any remediation and the Company does not believe its participation will prejudice any defenses available to the Company. In addition to its participation in the activities of the coalition, the Company, together with four other companies with facilities along the Fox River (the \"Five Companies\"), is engaged in discussions with the WDNR regarding their liability in connection with the remediation and restoration of sediment contamination caused by alleged PCB releases to the Fox River. Based upon available information, the Company believes the WDNR has identified other parties, some of whom have substantial resources, whose manufacturing practices allegedly resulted in the release of PCBs to the Fox River.\nOn June 20, 1994, the FWS, a federal natural resources trustee, informed each of the Five Companies that they had been identified as PRPs for purposes of federal claims for natural resources damages under CERCLA, commonly known as the \"Superfund Act,\" and the Federal Water Pollution Control Act arising from alleged releases of PCBs to the Fox River and Green Bay system (the \"Federal Claims\"). The FWS alleges that natural resources including endangered species, fish, birds and tribal lands or lands held by the United States in trust for various tribes have been exposed to PCBs that were released from facilities located along the Fox River. The FWS has stated that it is undertaking an assessment to determine and quantify the nature and extent of injury to natural resources. The FWS has invited the Five Companies to participate in the development of the type and scope of the assessment and in the performance of the assessment, pursuant to federal regulations. The Five Companies are engaged in discussions with the FWS concerning the nature of their participation in assessment. Based upon presently available information, the Company believes that there are additional parties, some of which may have substantial resources, who may be identified as PRPs for alleged natural resource damages.\nOn July 15, 1992, Region V of the U.S. EPA issued a Finding of Violation to the Company concerning the No. 8 boiler at its Green Bay mill. The Finding alleged violation of regulations issued by the U.S. EPA under the Clean Air Act relating to New Source Performance Standards for Fossil Fuel Fired Steam Generators. On October 5, 1994, the Company and the U.S. EPA, with concurrence from the U.S. Department of Justice, reached an agreement in principle whereby the Company, without admitting any wrongdoing, has agreed to\n- 9 - make certain modifications to the boiler which will limit its physical capacity to the level specified in the alleged relevant New Source Performance Standards. The physical modifications, which require expenditures of approximately $40,000, will not affect the utility of the No. 8 boiler. In addition, the Company has agreed to pay $350,000 to settle this matter. The Company anticipates that the settlement will be completed in 1996.\nThe Company has $20 million of accrued liabilities as of December 31, 1995 for estimated or anticipated liabilities and legal and consulting costs relating to environmental matters arising from past operations. The Company expects these costs to be incurred over an extended number of years. While the accrued liabilities reflect the Company's current estimate of the cost of these environmental matters, there can be no assurance that the amount accrued will be adequate.\nIn 1992, the Internal Revenue Service (the \"IRS\") disallowed income tax deductions for the 1988 tax year which were claimed by the Company for fees and expenses, other than interest, related to 1988 debt financing and refinancing transactions. The Company deducted the balance of the disallowed fees and expenses related to the 1988 debt instruments during the tax years 1989 through 1995. In disallowing these deductions, the IRS relied on Code Section 162(k) (which denies deductions for otherwise deductible amounts paid or incurred in connection with stock redemptions). The Company is contesting the disallowance. In August 1994, the U.S. Tax Court issued its opinion in which it essentially adopted the interpretation of Code Section 162(k) advanced by the IRS and disallowed the deductions claimed by the Company.\nAt present, the U.S. Tax Court is preparing to enter its decision in which it will determine the amount of the tax deficiency owed by the Company. The Company intends to appeal the U.S. Tax Court decision as it bears on the interpretation of Code Section 162(k) to the U.S. Court of Appeals for the Seventh Circuit.\nIn anticipation of its appeal, the Company has paid to the IRS tax of approximately $5 million potentially due for its 1988 tax year pursuant to the U.S. Tax Court opinion along with $4 million for the interest accrued on such tax. If the decision of the U.S. Tax Court is ultimately sustained, the Company estimates that the potential amount of additional taxes due on account of such disallowance for the period 1989 through 1995 would be approximately $38 million exclusive of interest. While the Company is unable to predict the final result of its appeal of the U.S. Tax Court decision with certainty, it has accrued for the potential tax liability as well as for the interest charges thereon for the period 1989 through 1995 and thus the Company believes that the ultimate resolution of this case will not have a material adverse effect on the Company's financial condition or on its results of operations.\nThe Company and its subsidiaries are parties to other lawsuits and state and federal administrative proceedings in connection with their businesses. Although the final results in all suits and proceedings cannot be predicted with certainty, the Company presently believes that the ultimate resolution of all such lawsuits and proceedings, after taking into account the liabilities accrued with respect to such matters, will not have a material adverse effect on the Company's financial condition or results of operations.\nITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThere were no matters submitted to a vote of the security holders during the fourth quarter of 1995.\n- 10 -\nITEM 1a.","section_1A":"ITEM 1a. EXECUTIVE OFFICERS OF THE REGISTRANT\nThe following table provides certain information about each of the current executive officers of the Company. All executive officers are elected by, and serve at the discretion of, the Board of Directors. None of the executive officers of the Company are related by blood, marriage or adoption to any other executive officer or director of the Company.\nPresent Principal Occupation or Name and Position Employment; Five-Year Employment With the Company Age History and other Directorships ----------------- --- -------------------------------- Donald H. DeMeuse .............. 59 Chairman of the Board of Directors and Chairman of the Board and Chief Executive Officer since March Chief Executive Officer 1992; President and Chief Executive Officer from July 1990 to March 1992. Director of Associated Bank Green Bay. Kathleen J. Hempel ............. 45 Vice Chairman and Chief Financial Vice Chairman and Officer since March 1992; Senior Chief Financial Officer Executive Vice President and Chief Financial Officer prior to that time. Director of Whirlpool Corporation. Michael T. Riordan ............. 45 President and Chief Operating Officer President and since March 1992; Vice President Chief Operating Officer prior to that time. Andrew W. Donnelly ............. 53 Executive Vice President for more than Executive Vice President five years. John F. Rowley ................. 55 Executive Vice President for more than Executive Vice President five years. James C. Bowen, Jr.............. 50 Vice President since July 1995; Director Vice President of Consumer Sales prior to that time. George F. Hartmann, Jr. ........ 53 Vice President for more than five years. Vice President R. Michael Lempke .............. 43 Vice President since September 1994; Vice President and Treasurer Treasurer since November 1989. James W. Nellen II ............. 48 Vice President and Secretary for more Vice President and Secretary than five years. Daniel J. Platkowski ........... 44 Vice President for more than five years. Vice President Timothy G. Reilly .............. 45 Vice President for more than five years. Vice President James H. Riehl, Jr.............. 43 Vice President since July 1995; Director Vice President of Consumer Marketing prior to that time. Donald J. Schneider ............ 59 Vice President for more than five years. Vice President Charles L. Szews ............... 39 Vice President since September 1994; Vice President and Controller Controller since November 1989. Charles D. Wilson .............. 50 Vice President since June 1994; Director Vice President of Government Affairs prior to that time. David K. Wong .................. 46 Vice President since June 1993; Director Vice President of Personnel prior to that time. David A. Stevens ............... 46 Assistant Vice President for more than Assistant Vice President five years.\n- 11 -\nITEM 1b.","section_1B":"ITEM 1b. STATEMENT REGARDING FORWARD LOOKING DISCLOSURE\nExcept for the historical information contained in this Annual Report on Form 10-K, certain matters discussed herein, including (without limitation) in particular under Part I, Item 1, \"Business -- Environmental Matters,\" Item 3, \"Legal Proceedings\" and under Part II, Item 7, \"Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations,\" are forward looking statements that involve risks and uncertainties, including (without limitation) the effect of economic and market conditions, wastepaper prices, costs related to environmental matters, and the impact of current or pending legislation and regulation.\nPART II\nITEM 5.","section_2":"","section_3":"","section_4":"","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS\nDuring the fiscal year ended December 31, 1994, there was no market for the Company's Common Stock. The Company's Common Stock began trading under the symbol FORT on the Nasdaq National Market on March 10, 1995. The range of high and low trade prices of the Company's stock during quarters in which there was an active public trading market is as follows:\nCommon Stock Trade Prices ------------------------- High Low Close ---- --- ----- Quarter Ended -------------\nMarch 31, 1995.................... $12.875 $12.00 $12.625 June 30, 1995..................... 15.00 12.00 14.125 September 30, 1995................ 16.25 13.375 15.375 December 31, 1995................. 23.25 14.375 22.50\nThe number of holders of record of the Company's Common Stock at December 31, 1995 was approximately 800.\nThe Company anticipates that all its earnings in the near future will be used for the repayment of indebtedness and for the development and expansion of its business and, therefore, does not anticipate paying dividends on its Common Stock in the foreseeable future. The 1995 Bank Credit Agreement and the Company's outstanding debt obligations limit, in each case with certain exceptions, the ability of the Company to pay dividends on the Common Stock. Subject to such restrictions, any determination to pay cash dividends in the future will be at the discretion of the Company's Board of Directors and will be dependent upon the Company's results of operations, financial condition, contractual restrictions and other factors deemed relevant at the time by the Board of Directors.\n- 12 -\nITEM 6.","section_6":"ITEM 6. SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA\n- 13 -\n(a) Effective January 1, 1992, the Company prospectively changed its estimates of the depreciable lives of certain machinery and equipment. The change had the effect of reducing depreciation expense by approximately $38 million and net loss by $24 million in 1992.\n(b) Selling, general and administrative expense in 1993 reflects an $8 million reduction for the reversal of all employee stock compensation expense accrued prior to 1993. See Note 9 of the Company's audited consolidated financial statements.\n(c) During the third quarter of 1993, the Company wrote off the remaining unamortized balance of its goodwill of $1.98 billion and, accordingly, there is no amortization of goodwill for periods subsequent to September 30, 1993. See \"Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations\" and Note 3 of the Company's audited consolidated financial statements.\n(d) During the fourth quarter of 1994, the Company recorded an environmental charge totaling $20 million. Excluding the effects of the environmental charge, the Company's operating income, loss before taxes, net loss and loss per share in 1994 would have been $297 million, $41 million, $56 million and $1.47 per share, respectively.\n(e) As of December 31, 1991, the Company had sold all its international cup operations and had discontinued recording equity in net losses of its residual interest in its former domestic cup operations because the Company's carrying value of such residual investment was reduced to zero.\n(f) Reflects the cumulative effect on years prior to 1992 of adopting SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" This change in accounting principle, excluding the cumulative effect, decreased operating income for 1992 by $1 million.\n(g) The computation of earnings (loss) per share is based on the weighted average number of shares of Common Stock outstanding during the period plus (in periods in which they have a dilutive effect) the effect of shares of Common Stock contingently issuable upon the exercise of stock options.\n(h) EBITDA represents operating income plus depreciation of property, plant and equipment, amortization of goodwill, the goodwill write-off, the 1994 environmental charge and the effects of 1993 employee stock compensation (credits). EBITDA is presented here as a measure of the Company's debt service ability. Certain financial and other restrictive covenants in the 1995 Bank Credit Agreement and other instruments governing the Company's indebtedness are based on the Company's EBITDA, subject to certain adjustments.\n- 14 -\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS Year Ended December 31, ---------------------------- 1995 1994 1993 ---- ---- ---- (In millions, except percentages) Net sales: Domestic tissue......................... $1,320 $ 1,060 $ 1,004 International operations................ 164 131 143 Harmon.................................. 137 83 40 ------ ------- ------- Consolidated............................ $1,621 $ 1,274 $ 1,187 ====== ======= ======= Operating income (loss): Domestic tissue (a)(b)(c)............... $ 337 $ 264 $(1,715) International operations (a)............ 18 8 (1) Harmon (a).............................. 5 5 (1) ------ ------- ------- Consolidated (a)(b)(c).................. 360 277 (1,717) Amortization of goodwill and goodwill write-off (a)........................... -- -- 2,023 Depreciation.............................. 99 96 89 Environmental charge (b).................. -- 20 -- Employee stock compensation (c)........... -- -- (8) ------ ------- ------- EBITDA(d)............................... $ 459 $ 393 $ 387 ====== ======= ======= Consolidated net income (loss)............ $ 15 $ (70) $(2,052) ====== ======= ======= EBITDA as a percent of net sales(d)....... 28.3% 30.8% 32.6%\n_____________________\n(a) During the third quarter of 1993, the Company wrote off the remaining unamortized balance of its goodwill of $1.98 billion. See Note 3 to the Company's audited consolidated financial statements.\n(b) During the fourth quarter of 1994, operating income for domestic tissue operations was reduced by a $20 million environmental charge. See Note 11 to the Company's audited consolidated financial statements.\n(c) Selling, general and administrative expense in 1993 reflects an $8 million reduction for the reversal of all employee stock compensation expense accrued prior to 1993. See Note 9 to the Company's audited consolidated financial statements.\n(d) EBITDA represents operating income plus depreciation of property, plant and equipment, amortization of goodwill, the goodwill write-off, the 1994 environmental charge and the effects of 1993 employee stock compensation (credits). EBITDA is presented here as a measure of the Company's debt service ability. Certain financial and other restrictive covenants in the 1995 Bank Credit Agreement and other instruments governing the Company's indebtedness are based on the Company's EBITDA, subject to certain adjustments.\n- 15 - FISCAL YEAR 1995 COMPARED TO FISCAL YEAR 1994\nNet Sales. Consolidated net sales for 1995 increased 27.2% compared to 1994. Domestic tissue net sales for 1995 increased 24.6% compared to 1994 due to net selling price increases of 22.4%, converted products volume increases of 4.4% and reduced parent roll export volume. The significant increase in domestic net selling prices in 1995 reflects commercial market price increase announcements effective January 1995, April 1995, July 1995 and September 1995 and consumer market price increase announcements effective January 1995 and July 1995, all in response to rising raw material costs and improving operating rates in the tissue industry. Domestic volume of the Company's commercial products was flat for the full year 1995 compared to 1994. Significant volume growth in the first quarter of 1995 was offset by volume declines in succeeding quarters. The Company's firm implementation of price increases led to the commercial volume declines beginning in the second quarter of 1995. Domestic consumer volume was significantly higher throughout 1995 compared to 1994 due to strong consumer market demand for the Company's products.\nNet sales of the Company's international operations increased 24.8% for 1995 compared to 1994 due to a significant increase in net selling prices, slightly higher volume of converted products and the benefit from the change in foreign exchange rates, while parent roll volume was reduced. Net sales of the Company's wastepaper brokerage subsidiary, Harmon Associates Corp. (\"Harmon\"), increased 63.8% for 1995 due to higher selling prices and slightly higher volume.\nGross income. For 1995, consolidated gross income increased 18.3% due to higher selling prices and to a much lesser degree, higher domestic volume, partially offset by higher raw material costs. Consolidated gross margins decreased to 29.7% for 1995 from 31.9% for 1994 and 34.0% for 1993 as a result of significant raw material cost increases that began in mid-1994 and continued until mid-1995. However, beginning in the second quarter of 1995, as net selling price increases began to offset raw material cost increases, consolidated gross margins began to recover and reached 34.0% in the fourth quarter of 1995, the same rate achieved in full year 1993. Domestic tissue gross margins in 1995 exhibited trends similar to consolidated gross margins. Beginning in July 1994, domestic wastepaper prices rose sharply until flattening in the second and third quarters of 1995. Average wastepaper prices in the fourth quarter of 1995 were higher than average wastepaper prices in the fourth quarter of 1994. However, wastepaper prices fell significantly in the fourth quarter of 1995 from the third quarter of 1995 and by December 1995 were significantly below wastepaper prices in December 1994. Wastepaper price trends are expected to remain positive for the first quarter of 1996, however, the direction of wastepaper price trends in succeeding quarters is uncertain due to general economic factors, virgin market pulp price trends and expected increases in demand for wastepaper arising from scheduled start-ups of deinked market pulp mills and from export markets. Costs of other raw materials also increased during 1995 compared to 1994 but to a much lesser extent, while all other costs were flat or declined due to efficiencies achieved from higher volumes.\nGross margins of international operations increased in 1995 compared to 1994 in spite of significantly higher wastepaper prices due to the benefits achieved from product rationalization in 1994 and the success of 1995 price increases. Wastepaper price trends in the U.K. were similar to those in the U.S. in 1995.\n- 16 - Consolidated gross margins were negatively affected in 1995 by the increased proportion of net sales represented by the Company's wastepaper brokerage subsidiary which typically has very low margins compared to domestic tissue operations.\nSelling, General and Administrative Expenses. Selling, general and administrative expenses, as a percent of net sales, decreased to 7.5% for 1995 compared to 8.6% for 1994. The decrease occurred principally due to the effects of significantly higher net sales.\nOperating Income. Operating income increased to $360 million in 1995 compared to $277 million in 1994. Excluding the environmental charge from 1994 results, operating income would have been $297 million in 1994. Operating income as a percent of net sales decreased to 22.2% in 1995 compared to 23.3% in 1994, as adjusted for the environmental charge. Domestic tissue operating income as a percent of net sales decreased to 25.5% in 1995 from 26.9% in 1994, also as adjusted for the environmental charge. The decreases are due to significantly higher raw material costs in 1995 partially offset by significantly higher net selling prices and higher domestic volume. Operating income as a percent of net sales began to recover beginning in the second quarter of 1995, similar to gross margin trends, such that consolidated and domestic tissue operating income as a percent of net sales reached 25.5% and 27.9%, respectively, in the fourth quarter of 1995.\nExtraordinary Loss. The Company's net income in 1995 was decreased by an extraordinary loss of $19 million (net of income taxes of $12 million) representing the redemption premiums and write-offs of deferred loan costs associated with the Recapitalization (see below).\nNet Income. The Company reported net income of $15 million for 1995 compared to a net loss of $70 million for 1994.\nFISCAL YEAR 1994 COMPARED TO FISCAL YEAR 1993\nNet Sales. Consolidated net sales for 1994 increased 7.3% compared to 1993 due to increases in domestic tissue net sales and a significant net sales increase by the Company's wastepaper brokerage subsidiary. Domestic tissue net sales increased 5.5% for 1994 compared to 1993 due to higher net selling prices principally in the commercial market and higher sales volume in the consumer and parent roll export markets that were partially offset by a volume decrease in the commercial market. Overall, domestic tissue sales volume for 1994 increased slightly over 1993. The Company's decision to implement net selling price increases in the commercial market during each of the first three quarters of 1993 and to follow with a price increase in the second quarter of 1994 led to the decline in commercial volume during 1994.\nNet sales of the Company's international operations decreased 8.4% for 1994 compared to 1993. The decrease in international net sales in 1994 was due to significantly lower net selling prices on flat volume. The international net selling price declines were attributable to product mix changes and continued competitive conditions. The significant increase in net sales of the Company's wastepaper brokerage subsidiary during 1994 compared to 1993 principally reflects higher net selling prices.\n- 17 - Gross income. For 1994, consolidated gross margins decreased to 31.9% from 34.0% in 1993, principally due to lower margins in domestic tissue operations where unit manufacturing cost increases exceeded net selling price increases. Such cost increases primarily resulted from higher wastepaper and other raw material costs, lower converting volume, higher depreciation expense resulting from the start-up of a new paper machine at the Muskogee mill late in the first quarter of 1994 and higher maintenance costs. From July to December 1994, wastepaper prices for the grades of wastepaper used in Fort Howard's products more than doubled.\nGross margins of international operations declined in 1994 compared to 1993 principally due to the lower net selling prices and the effects of product rationalization. In addition, from July to December 1994, wastepaper prices for the grades of wastepaper used by international operations increased approximately 65%. Consolidated gross margins also were negatively affected in 1994 by the increased proportion of net sales represented by the Company's wastepaper brokerage subsidiary which typically has lower margins than domestic tissue operations.\nSelling, General and Administrative Expenses. In the third quarter of 1993, the Company reversed all previously accrued employee stock compensation expense resulting in a reduction of selling, general and administrative expenses of $8 million for 1993. Excluding the effects of the reversal, selling, general and administrative expenses, as a percent of net sales, were 8.6% for 1994 compared to 8.8% for 1993. The decrease resulted principally from the increased proportion of net sales represented by the Company's wastepaper brokerage subsidiary and, to a lesser degree, cost containment.\nAmortization of Goodwill. As a result of the goodwill write-off in the third quarter of 1993, there was no amortization of goodwill in 1994 compared to $43 million for 1993.\nEnvironmental Charge. The Company recorded a $20 million charge in the fourth quarter of 1994 for estimated or anticipated liabilities and legal and consulting costs relating to environmental matters arising from past operations. The Company expects these costs to be incurred over an extended number of years. See \"Environmental Matters\" and \"Legal Proceedings\" and Note 11 of the Company's audited consolidated financial statements.\nOperating Income (Loss). Operating income increased to $277 million in 1994 compared to an operating loss of $1,717 million in 1993. The operating loss in 1993 resulted entirely from the goodwill write-off in the third quarter of 1993. Excluding the environmental charge from 1994 results and amortization of goodwill, the goodwill write-off and the reversal of employee stock compensation expense from 1993 results, operating income would have declined to $297 million in 1994 from $299 million in 1993.\nExtraordinary Losses. The Company's net loss in 1994 was increased by an extraordinary loss of $28 million (net of income taxes of $15 million) representing the redemption premiums and the write off of deferred loan costs associated with the repayment of long-term debt from the proceeds of the issuance of the 8 1\/4% Notes and 9% Notes in 1994.\nNet Loss. The Company reported a net loss of $70 million for 1994 compared to a net loss of $2,052 million in 1993. The significant net loss for 1993 resulted principally from the goodwill write-off in the third quarter of 1993.\n- 18 - FINANCIAL CONDITION\nYear Ended December 31, 1995\nDuring 1995, cash increased $524,000. Capital additions of $47 million, debt repayments of $1,811 million, including the prepayment or repurchase of all of the 1988 Term Loan, the 1988 Revolving Credit Facility, the 1993 Term Loan and the Senior Secured Notes, repayment of the 1995 Receivables Facility and the redemption of all the outstanding 12 5\/8% Debentures and 14 1\/8% Debentures, were funded principally by cash provided from operations of $157 million (including proceeds of $63 million from the sale of certain domestic tissue receivables), net proceeds of $284 million from the sale of Common Stock and borrowings of $1,418 million (net of $50 million of debt issuance costs) pursuant to the Recapitalization (see below).\nReceivables decreased $25 million during 1995 due principally to the sale of certain domestic tissue receivables of $63 million, which was largely offset by the effects of an increase in net sales and significantly higher net selling prices in all the Company's businesses. Inventories increased by $32 million principally due to an increase in inventory quantities. Parent roll and wastepaper inventories were increased to reflect currently lower priced wastepaper and to maximize the flexibility of existing productive capacity. The liability for interest payable decreased $20 million due to the early payment of interest in connection with the Recapitalization. Principally as a result of all these changes and the $53 million reduction in the current portion of long-term debt, the net working capital deficit decreased to $35 million at December 31, 1995, from a deficit of $98 million at December 31, 1994.\nYear Ended December 31, 1994\nDuring 1994, cash increased $195,000. Capital additions of $84 million and debt repayments of $759 million, including the prepayment of $100 million of the 1988 Term Loan, the repurchases of all outstanding 12 3\/8% Notes and of $238 million of the 12 5\/8% Debentures, a reduction in the 1988 Revolving Credit Facility and the purchase of interest rate cap agreements for $10 million were funded by cash provided from operations of $125 million and net proceeds of the sale of 8 1\/4% Notes and 9% Notes of $728 million in February 1994.\nReceivables increased $17 million during 1994 due principally to higher net selling prices in the domestic tissue and wastepaper brokerage operations and sales volume increases in domestic tissue operations in the fourth quarter of 1994. The $13 million increase in inventories in 1994 resulted from increases in inventory quantities to improve service levels and the revaluation of inventories to reflect higher manufacturing costs. The liability for interest payable increased $29 million due to a change in interest payment schedules resulting from the 1994 debt repurchases from the net proceeds of the sale of the 8 1\/4% Notes and 9% Notes in 1994 and for the liability with respect to the 14 1\/8% Debentures for interest accruing in cash commencing on November 1, 1994. Principally as a result of all these changes, the net working capital deficit increased to $98 million at December 31, 1994, from a deficit of $92 million at December 31, 1993. The $15 million increase in long-term other liabilities in 1994 principally reflects the classification of $18 million of the environmental charge taken in the fourth quarter as a long-term liability. Deferred and other long-term income taxes declined\n- 19 - $34 million from 1993 to 1994 principally due to the reversal of deferred income taxes related to continuing operations and the extraordinary item.\nCash provided from operations declined in 1994 compared to 1993 principally due to increased interest payments resulting from the 1993 repurchases of all outstanding 14 5\/8% Debentures (which accrued interest in kind) from the net proceeds of the sale of the 9 1\/4% Notes and 10% Notes in 1993 (which accrue interest in cash) and higher floating interest rates. Cash provided from operations was further impacted by the increases in receivables and inventories.\nLiquidity and Capital Resources\nThe Company's principal uses of cash for the next several years will be interest and principal payments on its indebtedness and capital expenditures.\nOn April 15, 1995, the Company completed a recapitalization plan (the \"Recapitalization\") to prepay or redeem a substantial portion of its indebtedness in order to reduce the level and overall cost of its debt, extend certain debt maturities, increase shareholders' equity and enhance its access to capital markets. The Recapitalization included the following components: (1) the offer and sale by the Company of 25,269,555 shares of Common Stock in March and April 1995, at $12.00 per share (the \"Offering\"); (2) entering into a bank credit agreement (the \"1995 Bank Credit Agreement\") consisting of a $300 million revolving credit facility (the \"1995 Revolving Credit Facility\"), an $810 million term loan and a $330 million term loan and entering into a receivables credit agreement consisting of a $60 million term loan (the \"1995 Receivables Facility\"); (3) the application in March and April 1995 of the net proceeds of the Offering, together with borrowings under the 1995 Bank Credit Agreement and the 1995 Receivables Facility, to prepay or redeem all the Company's indebtedness outstanding under the 1988 Bank Credit Agreement, 1993 Term Loan, Senior Secured Notes, 14 1\/8% Debentures (at par) and 12 5\/8% Debentures (at 102.5% of the principal amount thereof); and (4) the payment of transaction costs. Following the Recapitalization, the Company has payment obligations of $63 million in 1996, $114 million in 1997, $138 million in 1998, $152 million in 1999 and $158 million in 2000.\nIn September 1995, the Company entered into receivables sales agreements which segregate certain domestic tissue receivables from the Company's other assets and liabilities for the purpose of effecting the sales of such receivables in order to achieve a lower cost of borrowing based on the credit quality of the receivables. As a result, receivables were reduced by $60 million, the 1995 Receivables Facility was repaid and the interest cost on the 1995 Receivables Facility of 2.5% over LIBOR has been effectively replaced by financing costs equal to 0.25% to 0.65% over LIBOR on $60 million. In connection with these agreements, additional revolving funds of up to $25 million may be available to the Company, resulting in further decreases in receivables and interest costs. At December 31, 1995, the Company had drawn $3 million against the additional revolving funds under these agreements.\nCapital expenditures were $47 million, $84 million and $166 million in 1995, 1994 and 1993, respectively, including an aggregate of $175 million during those periods for capacity expansions. Subject to market conditions, the Company's current plans to support growth in domestic tissue shipments include adding one world-class (270-inch) tissue paper machine over the next five years. The 1995 Bank Credit Agreement imposes limits for domestic\n- 20 - capital expenditures, with certain exceptions, of $75 million per year. The Company is also permitted to spend up to $250 million for domestic expansion projects including, without restriction, an additional tissue paper machine at one of its existing domestic mills. Other domestic expansion projects are restricted unless certain conditions are met. In addition, the Company is permitted to make capital expenditures for international expansion of up to $40 million through June 30, 1996, and up to $100 million in the aggregate after June 30, 1996 if certain conditions are met. Under the 1995 Bank Credit Agreement, the Company may carry over to one or more years (thereby increasing the scheduled permitted limit for capital expenditures in respect of such year) the amount by which the scheduled permitted limit for each year (beginning with fiscal year 1995) exceeded the capital expenditures actually made in respect of such prior year. At December 31, 1995, the capital expenditures carryover available to the Company totaled $31 million. The Company does not believe such limitations will impair its plans for capital expenditures. Capital expenditures are projected to approximate $90 to $100 million annually for the next several years, plus domestic expansion capital spending that is subject to market conditions. The portions of the above capital expenditures which are attributable to environmental matters are described in \"Environmental Matters.\"\nThe Company's 1995 Revolving Credit Facility, which may be used for general corporate purposes, has a final maturity of March 16, 2002. At December 31, 1995, the Company had $221 million in available capacity under the 1995 Revolving Credit Facility.\nThe Company believes that cash provided from operations, unused borrowing capacity under the 1995 Revolving Credit Facility and access to financing in public and private markets will be sufficient to enable it to fund capital expenditures (including planned capital expenditures for environmental matters) and to meet its debt service requirements for the foreseeable future.\nRefer to Note 4 to the audited consolidated financial statements for a description of certain matters related to income taxes. Also see \"Legal Proceedings.\"\nSeasonality\nHistorically, a slightly higher amount of the Company's revenues and operating income have been recognized during the second and third quarters. The Company expects to fund seasonal working capital needs from the 1995 Revolving Credit Facility.\n- 21 -\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nMANAGEMENT'S RESPONSIBILITY FOR FINANCIAL REPORTING\nThe management of Fort Howard Corporation is responsible for the preparation, integrity and fair presentation of the following financial statements. These financial statements have been prepared by management in accordance with generally accepted accounting principles and where necessary include amounts based on management's judgments and estimates. Management also prepared the other information in this annual report and is responsible for its integrity and consistency with the financial statements.\nFort Howard Corporation is committed to conducting its business with integrity and in accordance with all applicable laws, rules and regulations. This commitment is reflected in the Company's Code of Conduct. The Code of Conduct is annually communicated to employees and compliance is monitored regularly to provide reasonable assurance that the Company's business is being conducted in accordance with the Code of Conduct.\nThe Company maintains a system of internal accounting controls designed to provide reasonable assurance that the Company's assets are safeguarded and that transactions are executed and recorded according to management's authorizations in order to create financial records reliable for the preparation of financial statements. Management continuously evaluates its system of internal accounting controls in response to changes in business conditions and operations, staff turnover and development of new technologies and, as a result, enhances existing controls with the objective of maintaining a strong internal control environment. In addition, the Company's internal audit staff monitors the effectiveness of internal controls through operational audits of this system, reporting their findings and recommendations for improvement to management.\nThe financial statements of the Company have been audited by Arthur Andersen LLP. The independent accountants were provided with unrestricted access to all financial records and related data in order to perform their tests and other procedures. Their opinion on the fairness of the Company's financial statements appears on the next page.\nThe Audit Committee of the Board of Directors, composed solely of outside directors, meets periodically with the Company's management, internal auditors and independent accountants to review the adequacy of significant internal control systems, the nature, extent and results of internal and external audits and reported financial results. The Audit Committee maintains direct and independent access with the independent accountants.\nIn conclusion, management believes that as of December 31, 1995, the Company's internal control systems over financial reporting are adequate and operating effectively in all material respects.\nDonald H. DeMeuse, Chairman and Kathleen J. Hempel, Vice Chairman Chief Executive Officer and Chief Financial Officer\n- 22 -\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Board of Directors of FORT HOWARD CORPORATION:\nWe have audited the accompanying consolidated balance sheets of Fort Howard Corporation (a Delaware corporation) and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of income and cash flows for the years ended December 31, 1995, 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 audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Fort Howard Corporation and subsidiaries as of December 31, 1995 and 1994, and the consolidated results of their operations and their cash flows for the years ended December 31, 1995, 1994 and 1993, in conformity with generally accepted accounting principles.\nARTHUR ANDERSEN LLP\nMilwaukee, Wisconsin, January 30, 1996.\n- 23 -\nFORT HOWARD CORPORATION CONSOLIDATED STATEMENTS OF INCOME (In thousands, except per share data)\nFor the Years Ended December 31, -------------------------------- 1995 1994 1993 ---- ---- ----\nNet sales............................. $1,620,903 $ 1,274,445 $ 1,187,387 Cost of sales......................... 1,139,378 867,357 784,054 ---------- ----------- ----------- Gross income.......................... 481,525 407,088 403,333 Selling, general and administrative... 121,406 110,285 96,966 Amortization of goodwill.............. -- -- 42,576 Goodwill write-off.................... -- -- 1,980,427 Environmental charge.................. -- 20,000 -- ---------- ----------- ----------- Operating income (loss)............... 360,119 276,803 (1,716,636) Interest expense...................... 309,915 337,701 342,792 Other (income) expense, net........... (1,662) 118 (2,996) ---------- ----------- ----------- Income (loss) before taxes............ 51,866 (61,016) (2,056,432) Income taxes (credit)................. 18,401 (18,891) (16,314) ---------- ----------- ----------- Income (loss) before extraordinary items............................... 33,465 (42,125) (2,040,118) Extraordinary items--losses on debt repurchases (net of income taxes of $11,986 in 1995, $14,731 in 1994 and $7,333 in 1993)......... (18,748) (28,170) (11,964) ---------- ----------- ----------- Net income (loss)..................... $ 14,717 $ (70,295) $(2,052,082) ========== =========== ===========\nEarnings (loss) per share: Net income (loss) before extraordinary items............... $ 0.57 $ (1.11) $ (53.54) Extraordinary items................. (0.32) (0.74) (0.31) ---------- ----------- ----------- Net income (loss)................... $ 0.25 $ (1.85) $ (53.85) ========== =========== ===========\nThe accompanying notes are an integral part of these consolidated financial statements.\n- 24 -\nFORT HOWARD CORPORATION CONSOLIDATED BALANCE SHEETS (In thousands)\nDecember 31, ------------------- 1995 1994 ---- ----\nAssets Current assets: Cash and cash equivalents.................. $ 946 $ 422 Receivables, less allowances of $2,883 in 1995 and $1,589 in 1994............... 97,707 123,150 Inventories................................ 163,076 130,843 Deferred income taxes...................... 29,000 20,000 Income taxes receivable.................... 700 5,200 ----------- ----------- Total current assets..................... 291,429 279,615 Property, plant and equipment................ 1,971,641 1,932,713 Less: Accumulated depreciation............. 706,394 611,762 ----------- ----------- Net property, plant and equipment........ 1,265,247 1,320,951 Other assets................................. 95,761 80,332 ----------- ----------- Total assets........................... $ 1,652,437 $ 1,680,898 =========== ===========\nLiabilities and Shareholders' Deficit Current liabilities: Accounts payable........................... $ 112,384 $ 100,981 Interest payable........................... 64,375 84,273 Income taxes payable....................... 1,339 224 Other current liabilities.................. 85,351 75,450 Current portion of long-term debt.......... 62,720 116,203 ----------- ----------- Total current liabilities................ 326,169 377,131 Long-term debt............................... 2,903,299 3,189,644 Deferred and other long-term income taxes.... 225,043 209,697 Other liabilities............................ 36,355 41,162 Common Stock with put right.................. -- 11,711 Shareholders' deficit: Common Stock............................... 634 381 Additional paid-in capital................. 895,652 600,090 Cumulative translation adjustment.......... (2,844) (2,330) Retained deficit........................... (2,731,871) (2,746,588) ----------- ----------- Total shareholders' deficit.............. (1,838,429) (2,148,447) ----------- ----------- Total liabilities and shareholders' deficit.............................. $ 1,652,437 $ 1,680,898 =========== ===========\nThe accompanying notes are an integral part of these consolidated financial statements.\n- 25 -\nFORT HOWARD CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) For the Year Ended December 31, ------------------------------- 1995 1994 1993 ---- ---- ---- Cash provided from (used for) operations: Net income (loss)........................ $ 14,717 $(70,295) $(2,052,082) Depreciation and amortization............ 98,882 95,727 130,671 Goodwill write-off....................... -- -- 1,980,427 Non-cash interest expense................ 12,925 74,238 100,844 Deferred income taxes (credit)........... 4,418 (33,832) (17,874) Environmental charge..................... -- 20,000 -- Employee stock compensation.............. -- -- (7,832) Pre-tax loss on debt repurchases......... 30,734 42,901 19,297 (Increase) decrease in receivables....... 25,443 (17,316) (2,343) Increase in inventories.................. (32,233) (12,574) (17,294) (Increase) decrease in income taxes receivable............................. 4,500 4,300 (7,000) Increase (decrease) in accounts payable.. 11,403 (684) (2,740) Increase (decrease) in interest payable.. (19,898) 29,419 21,797 Increase (decrease) in income taxes payable................................ 1,115 102 (1,670) All other, net........................... 4,930 (6,799) 6,854 ---------- -------- ----------- Net cash provided from operations.... 156,936 125,187 151,055\nCash used for investment activities: Additions to property, plant and equipment.............................. (47,296) (83,559) (165,539)\nCash provided from (used for) financing activities: Proceeds from long-term borrowings....... 1,467,800 750,000 887,088 Repayment of long-term borrowings........ (1,810,966) (759,202) (841,399) Debt issuance costs...................... (50,054) (32,134) (31,160) Issuance (repurchase) of Common Stock, net of offering costs........... 284,104 (97) (6) ---------- -------- ----------- Net cash provided from (used for) financing activities............... (109,116) (41,433) 14,523 ---------- -------- ----------- Increase (decrease) in cash................ 524 195 39 Cash, beginning of year.................... 422 227 188 ---------- -------- ----------- Cash, end of year.................... $ 946 $ 422 $ 227 ========== ======== ===========\nSupplemental Cash Flow Disclosures: Interest paid............................ $ 317,866 $237,650 $ 228,360 Income taxes paid (refunded), net........ (5,728) 2,483 4,432\nThe accompanying notes are an integral part of these consolidated financial statements.\n- 26 -\nFORT HOWARD CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1995\n1. SIGNIFICANT ACCOUNTING POLICIES\n(A) OPERATIONS -- The Company operates in one industry segment as a manufacturer, converter and marketer of a diversified line of single-use tissue products for the commercial and consumer markets, primarily in the United States and United Kingdom.\n(B) PRINCIPLES OF CONSOLIDATION -- The consolidated financial statements include the accounts of Fort Howard Corporation and all domestic and foreign subsidiaries and are prepared in conformity with U.S. 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. Assets and liabilities of foreign subsidiaries are translated at the rates of exchange in effect at the balance sheet date. Income amounts are translated at the average of the monthly exchange rates. The cumulative effect of translation adjustments is deferred and classified as a cumulative translation adjustment in the consolidated balance sheet. The Company currently does not hedge its translation exposure. The Company does not engage in material hedging activity with respect to foreign currency transaction risks. All significant intercompany accounts and transactions have been eliminated. Certain reclassifications have been made to conform prior years' data to the current format.\n(C) CASH AND CASH EQUIVALENTS -- The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. The carrying amount of cash equivalents approximates fair value due to the short maturity of the investments.\n(D) INVENTORIES -- Inventories are carried at the lower of cost or market. Cost is principally determined on a first-in, first-out basis, with a lesser portion determined on an average cost by specific lot method.\n(E) PROPERTY, PLANT AND EQUIPMENT -- Effective with the Acquisition (as defined below), property, plant and equipment were adjusted to their estimated fair values and are being depreciated on a straight-line basis over useful lives of 30 to 50 years for buildings and 2 to 25 years for equipment. In 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of\" (\"SFAS No. 121\"). The Company's adoption of SFAS No. 121 effective January 1, 1995 had no effect on the 1995 consolidated financial statements.\nAssets under capital leases principally arose in connection with sale and leaseback transactions as described in Note 6 and are stated at the present value of future minimum lease payments. These assets are amortized over the respective periods of the leases which range from 15 to 25 years. Amortization of assets under capital leases is included in depreciation expense.\n- 27 - The Company follows the policy of capitalizing interest incurred in conjunction with major capital expenditure projects. The amounts capitalized in 1995, 1994 and 1993 were $2,096,000, $4,230,000 and $8,369,000, respectively.\n(F) REVENUE RECOGNITION -- Sales of the Company's tissue products are recorded upon shipment of the products.\n(G) ENVIRONMENTAL EXPENDITURES -- Environmental expenditures that relate to current operations are expensed or capitalized as appropriate. Expenditures that relate to an existing condition caused by past operations, and which do not contribute to current or future revenue generation, are expensed. Liabilities are recorded when material environmental assessments and\/or remedial efforts are probable, and the cost can be reasonably estimated. Recoveries of environmental remediation costs from other potentially responsible parties and recoveries from insurance carriers are not recorded as assets until such time as their receipt is deemed probable and the amounts are reasonably estimable.\n(H) GOODWILL -- In 1988, FH Acquisition Corp., a company organized on behalf of The Morgan Stanley Leveraged Equity Fund II, L.P. (\"MSLEF II\"), acquired the Company in a leveraged buyout and was subsequently merged with and into the Company (the \"Acquisition\"). Goodwill (the acquisition costs in excess of the fair value of net assets of acquired businesses) acquired in connection with the Acquisition and the purchases of other businesses was amortized on a straight-line basis over 40 years through the third quarter of 1993 when the Company wrote off its remaining goodwill balance (see Note 3).\n(I) EMPLOYEE BENEFIT PLANS -- A substantial majority of the Company's employees are covered under defined contribution plans. The Company makes annual discretionary contributions under the plans. Participants may also contribute a certain percentage of their wages to the plans. Costs charged to operations for defined contributions plans were approximately $13,231,000, $12,716,000 and $12,725,000 for 1995, 1994 and 1993, respectively.\nThe Company follows SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" which requires that the expected cost of postretirement health care benefits be charged to expense during the years that employees render service (see Note 7). Employees retiring prior to February 1, 1990 from the Company's U.S. tissue operations who had met certain eligibility requirements are entitled to postretirement health care benefit coverage. These benefits are subject to deductibles, copayment provisions, a lifetime maximum benefit and other limitations. In addition, employees who retire after January 31, 1990 and meet certain age and years of service requirements may purchase health care benefit coverage from the Company up to age 65. The Company has reserved the right to change or terminate this benefit for active employees at any time. Employees of the Company's U.K. tissue operations are not entitled to Company-provided postretirement benefit coverage.\n(J) INTEREST RATE CAP AGREEMENTS -- The costs of interest rate cap agreements are amortized over the respective lives of the agreements.\n- 28 - (K) INCOME TAXES -- The Company follows SFAS No. 109, \"Accounting for Income Taxes.\" As a result, deferred income taxes are provided to recognize temporary differences between the financial reporting basis and the tax basis of the Company's assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. The principal difference relates to depreciation expense. Deferred income tax expense represents the change in the deferred income tax asset and liability balances, excluding the deferred tax benefit related to extraordinary losses.\n(L) EARNINGS (LOSS) PER SHARE -- Earnings (loss) per share has been computed on the basis of the average number of common shares outstanding during the years, after giving retroactive effect to a 6.5-for-one stock split on January 31, 1995. The average number of shares used in the computation was 58,227,712, 38,103,215 and 38,107,154 for 1995, 1994 and 1993, respectively. The assumed exercise of all outstanding stock options has been excluded from the computation of earnings (loss) per share in 1995, 1994 and 1993 because the result was not material or was antidilutive.\n2. BALANCE SHEET INFORMATION\nDecember 31, ------------------ 1995 1994 ---- ---- (In thousands) Inventories\nRaw materials and supplies........................ $ 80,134 $ 63,721 Finished and partly-finished products............. 82,942 67,122 ---------- ---------- $ 163,076 $ 130,843 ========== ==========\nProperty, Plant and Equipment\nLand.............................................. $ 45,523 $ 44,422 Buildings......................................... 326,207 325,395 Machinery and equipment........................... 1,586,627 1,527,865 Construction in progress.......................... 13,284 35,031 ---------- ---------- $1,971,641 $1,932,713 ========== ==========\nCapital Lease Assets (Included in Property, Plant and Equipment Totals Above)\nBuildings......................................... $ 4,008 $ 4,012 Machinery and equipment........................... 187,007 186,281 ---------- ---------- Total assets under capital leases............. $ 191,015 $ 190,293 ========== ==========\n- 29 - December 31, ------------------- 1995 1994 ---- ---- (In thousands) Other Assets\nDeferred loan costs, net of accumulated amortization.. $89,180 $76,640 Prepayments and other................................. 6,581 3,692 ------- ------- $95,761 $80,332 ======= ======= Other Current Liabilities\nSalaries and wages.................................... $51,797 $41,959 Contributions to employee benefit plans............... 13,226 12,816 Taxes other than income taxes......................... 6,442 5,615 Other accrued expenses................................ 13,886 15,060 ------- ------- $85,351 $75,450 ======= =======\n3. GOODWILL\nLow industry operating rates and aggressive competitive activity among tissue producers resulting from a recession, additions to capacity and other factors adversely affected tissue industry operating conditions and the Company's operating results from 1991 through September 30, 1993. The Company determined that its projected results would not support the future amortization of the Company's remaining goodwill balance at September 30, 1993. Accordingly, the Company wrote-off its remaining goodwill balance of $1.98 billion in the third quarter of 1993.\n4. INCOME TAXES\nYear Ended December 31, ---------------------------- 1995 1994 1993 ---- ---- ---- (In thousands) Income Tax Provision\nCurrent Federal.................................. $ (304) $ 1,800 $ (6,012) State.................................... 768 509 465 Foreign.................................. 1,533 (2,099) (225) ------- -------- -------- Total current........................ 1,997 210 (5,772) Deferred Federal.................................. 17,227 (18,826) (7,731) State.................................... (2,739) (2,793) (2,956) Foreign.................................. 1,916 2,518 145 ------- -------- -------- Total deferred....................... 16,404 (19,101) (10,542) ------- -------- -------- $18,401 $(18,891) $(16,314) ======= ======== ========\n- 30 - Year Ended December 31, ----------------------------- 1995 1994 1993 ---- ---- ---- (In thousands) Effective Tax Rate Reconciliation\nU.S. federal tax rate...................... 35.0% (34.0)% (34.0)% Amortization of intangibles................ -- -- 33.4 State income taxes, net.................... 2.1 (4.1) (0.1) Interest on long-term income taxes......... -- 3.3 -- Permanent differences related to accruals.. -- 3.3 -- Other, net................................. (1.6) 0.5 (0.1) ------- -------- -------- Effective tax rate......................... 35.5% (31.0)% (0.8)% ======= ======== ========\nIncome (Loss) Before Income Taxes\nDomestic................................... $39,067 $(62,711) $(2,048,746) Foreign.................................... 12,799 1,695 (7,686) ------- -------- ----------- $51,866 $(61,016) $(2,056,432) ======= ======== ===========\nThe net deferred income tax liability at December 31, 1995 includes $242 million related to property, plant and equipment offset by the recognition of federal and state loss and tax credit carryforwards totaling $71 million. All other components of the gross deferred income tax assets and gross deferred income tax liabilities are individually not significant. The Company has not recorded a valuation allowance with respect to any deferred income tax asset.\nIn 1992, the Internal Revenue Service (the \"IRS\") disallowed income tax deductions for the 1988 tax year which were claimed by the Company for fees and expenses, other than interest, related to 1988 debt financing and refinancing transactions. The Company deducted the balance of the disallowed fees and expenses related to the 1988 debt instruments during the tax years 1989 through 1995. In disallowing these deductions, the IRS relied on Code Section 162(k) (which denies deductions for otherwise deductible amounts paid or incurred in connection with stock redemptions). The Company is contesting the disallowance. In August 1994, the U.S. Tax Court issued its opinion in which it essentially adopted the interpretation of Code Section 162(k) advanced by the IRS and disallowed the deductions claimed by the Company.\nAt present, the U.S. Tax Court is preparing to enter its decision in which it will determine the amount of the tax deficiency owed by the Company. The Company intends to appeal the U.S. Tax Court decision as it bears on the interpretation of Code Section 162(k) to the U.S. Court of Appeals for the Seventh Circuit.\nIn anticipation of its appeal, the Company has paid to the IRS tax of approximately $5 million potentially due for its 1988 tax year pursuant to the U.S. Tax Court opinion along with $4 million for the interest accrued on such tax. If the decision of the U.S. Tax Court is ultimately sustained, the Company estimates that the potential amount of additional taxes due on account\n- 31 - of such disallowance for the period 1989 through 1995 would be approximately $38 million exclusive of interest. While the Company is unable to predict the final result of its appeal of the U.S. Tax Court decision with certainty, it has accrued for the potential tax liability as well as for the interest charges thereon for the period 1989 through 1995 and thus the Company believes that the ultimate resolution of this case will not have a material adverse effect on the Company's financial condition or on its results of operations, and could result in a reversal of previously provided income taxes in the event of a resolution of the matter in the favor of the Company. It is possible that certain legislative activities could bring resolution to this matter in 1996. Should the matter proceed to the U.S. Court of Appeals, it is likely that it will not be resolved until 1997 or later.\nAssuming a favorable resolution of the U.S. Tax Court decision, the Company will have approximately $137 million of net operating loss carryforwards as of December 31, 1995 for federal income tax purposes which expire as follows: $8 million in 2007, $47 million in 2008, $69 million in 2009 and $13 million in 2010. The aggregate amount of net operating loss carryforwards available to the Company as of December 31, 1995 could be reduced to approximately $66 million if the U.S. Tax Court decision is affirmed. During 1994, the Company reclassified $11 million from the liability for other long-term income taxes to the liability for current income taxes principally to reflect the payments totaling $9 million made to the IRS with respect to the 1988 tax year.\n- 32 - 5. LONG-TERM DEBT\nLong-term debt and capital lease obligations, including amounts payable within one year, are summarized as follows:\nDecember 31, ---------------- 1995 1994 ---- ---- (In thousands) 1995 Term Loan A, due in varying semi-annual repayments with a final maturity of March 16, 2002 (a).................................. $ 810,000 $ -- 1995 Term Loan B, due in varying semi-annual repayments with a final maturity of December 31, 2002 (b)............................... 330,000 -- 1995 Revolving Credit Facility, due March 16, 2002 (i).................................. 79,400 -- Senior Unsecured Notes, 9 1\/4%, due March 15, 2001.... 450,000 450,000 Senior Unsecured Notes, 8 1\/4%, due February 1, 2002.. 100,000 100,000 Senior Subordinated Notes, 9%, due February 1, 2006... 650,000 650,000 Subordinated Notes, 10%, due March 15, 2003........... 300,000 300,000 Capital lease obligations, at interest rates approximating 10.9%................................. 175,161 182,936 Pollution Control Revenue Refunding Bonds, 7.90%, due October 1, 2005................................. 42,000 42,000 Debt of foreign subsidiaries, at rates ranging from 7.60% to 8.66%, due in varying annual installments through March 2001.................................. 29,458 47,193 1988 Term Loan, repaid in 1995........................ -- 224,534 1988 Revolving Credit Facility, repaid in 1995........ -- 196,500 1993 Term Loan, repaid in 1995........................ -- 100,000 Senior Secured Notes, repaid in 1995.................. -- 300,000 Subordinated Debentures, 12 5\/8%, redeemed in 1995.... -- 145,815 Junior Subordinated Discount Debentures, interest payable in kind at 14 1\/8%, redeemed in 1995........ -- 566,869 ---------- ---------- 2,966,019 3,305,847 Less: Current portion of long-term debt............... 62,720 116,203 ---------- ---------- $2,903,299 $3,189,644 ========== ========== _____________________\n(a) Interest on the 1995 Term Loan A and the 1995 Revolving Credit Facility is payable at prime plus 1.5% or, subject to certain limitations, at a reserve adjusted LIBOR rate plus 2.5% subject to downward adjustment if certain financial criteria are met (at a weighted average rate of 8.26% at December 31, 1995).\n(b) Interest on the 1995 Term Loan B is payable at prime plus 1.5% or at a reserve adjusted LIBOR rate plus 3.0% (at a weighted average rate of 8.74% at December 31, 1995).\nAs a part of the Recapitalization and Offering (see Note 8), the Company entered into a bank credit agreement (the \"1995 Bank Credit Agreement\") consisting of a $300 million revolving credit facility and $1,140 million of\n- 33 - term loans; and entered into a receivables credit agreement consisting of a $60 million term loan (the \"1995 Receivables Facility\"). The net proceeds of the Offering, together with borrowings of $1,414 million under the 1995 Bank Credit Agreement and 1995 Receivables Facility, were used to prepay or repurchase all the outstanding indebtedness under the 1988 Bank Credit Agreement, the 1993 Term Loan and the Senior Secured Notes, to redeem all outstanding 14 1\/8% Debentures (at par) and 12 5\/8% Debentures (at 102.5% of the principal amount thereof) and to pay transaction costs.\nThe Company incurred extraordinary losses of $19 million, $28 million and $12 million, net of income taxes of $12 million, $15 million and $7 million, in the first quarters of 1995, 1994 and 1993, respectively, representing redemption premiums and write-offs of deferred loan costs associated with refinancing transactions in each of those years.\nAmong other restrictions, the 1995 Bank Credit Agreement, the debt of foreign subsidiaries and the Company's indentures: (1) restrict payments of dividends, repayments of subordinated debt, purchases of the Company's Common Stock, additional borrowings and acquisition of property, plant and equipment; (2) require that certain financial ratios be maintained at prescribed levels; (3) restrict the ability of the Company to make fundamental changes and to enter into new lines of business, the pledging of the Company's assets and guarantees of indebtedness of others and (4) limit dispositions of assets and investments which might be made by the Company. The Company believes that such limitations should not impair its plans for continued maintenance and modernization of facilities or other operating activities.\nThe Company is charged a 0.5% fee with respect to any unused balance available under its $300 million 1995 Revolving Credit Facility, and a 2.75% fee with respect to any letters of credit issued under the 1995 Revolving Credit Facility. At December 31, 1995, $79 million of borrowings reduced available capacity under the 1995 Revolving Credit Facility to $221 million.\nThe aggregate annual maturities of long-term debt and capital lease obligations for the five years succeeding December 31, 1995, are as follows: 1996-$62,720,000; 1997-$114,353,000; 1998-$137,687,000; 1999-$152,342,000 and 2000-$158,371,000.\nIn September 1995, the Company entered into agreements expiring in July 2000 (the \"1995 Receivables Sales Agreements\") whereby substantially all the Company's domestic tissue receivables are sold. The Company has retained substantially the same credit risk as if the receivables had not been sold. The Company received $60 million from such initial sales which was applied to the repayment of the 1995 Receivables Facility and may receive up to $25 million of additional proceeds on a revolving basis. The Company retains a residual interest in the receivables sold, thus receivables in the accompanying consolidated balance sheet are only reduced by the net proceeds from the sales which totaled $63 million as of December 31, 1995. Under the terms of the 1995 Receivables Sales Agreements, the ongoing costs to the Company from this program are based on LIBOR, plus 0.25% to 0.65%, on the net proceeds received.\nAt December 31, 1995, receivables totaling $94 million, inventories totaling $163 million and property, plant and equipment with a net book value of $1,258 million were pledged as collateral or held in trust under the terms of the 1995 Bank Credit Agreement, the 1995 Receivables Sales Agreements, the debt of foreign subsidiaries and under the indentures for sale and leaseback transactions.\n- 34 -\nFair Market Value Disclosures\nThe aggregate fair values of the Company's long-term debt and capital lease obligations approximated $2,975 million and $3,152 million compared to aggregate carrying values of $2,966 million and $3,306 million at December 31, 1995 and 1994, respectively. The fair values of the long-term debt and capital lease obligations have been determined principally based on secondary market transactions or trading activity in the securities.\nObligations under the 1995 Bank Credit Agreement and debt of foreign subsidiaries bear interest at floating rates. The Company's policy is to enter into interest rate cap agreements as a hedge to effectively fix or limit its exposure to floating interest rates to, at a minimum, comply with the terms of its senior secured debt agreements. The Company is a party to LIBOR- based interest rate cap agreements which limit the interest cost to the Company with respect to $500 million of floating rate obligations to 6% plus the Company's borrowing margin until June 1, 1996 and to 8% plus the Company's borrowing margin from June 1, 1996 until June 1, 1999. At current market rates at December 31, 1995, the fair value of the Company's interest rate cap agreements is $2 million compared to a carrying value of $11 million. The counterparties to the Company's interest rate cap agreements consist of major financial institutions. While the Company is exposed to credit risk to the extent of nonperformance by these counterparties, management monitors the risk of default by the counterparties and believes that the risk of incurring losses due to nonperformance is remote.\n6. SALE AND LEASEBACK TRANSACTIONS\nCertain buildings and machinery and equipment at the Company's tissue mills were sold and leased back from various financial institutions. These leases are treated as capital leases in the accompanying consolidated financial statements. Future minimum lease payments at December 31, 1995, are as follows:\nYear Ending December 31, Amount ------------------------ ------ (In thousands)\n1996................................... $ 22,540 1997................................... 23,649 1998................................... 23,649 1999................................... 23,272 2000................................... 22,980 2001 and thereafter.................... 333,467 -------- Total payments......................... 449,557 Less imputed interest at rates approximating 10.9%............ 274,396 -------- Present value of capital lease obligations.................... $175,161 ========\n- 35 - 7. EMPLOYEE POSTRETIREMENT BENEFIT PLANS\nEffective January 1, 1995, the Company revised the eligibility requirements for postretirement medical benefits resulting in a reduction in the number of active employees eligible to receive these benefits. An additional change was made to freeze the amount of the monthly postretirement medical benefit at the 1995 amount. As a result of these changes, the accumulated postretirement benefit obligation as of December 31, 1995 was reduced by $10.6 million and the Company recognized a curtailment gain of $3.4 million in 1995. The decrease in the obligation is being amortized over 12 years, the average remaining service period of active employees.\nYear Ended December 31, ----------------------- 1995 1994 1993 ---- ---- ---- (In thousands) Net Periodic Postretirement Benefit Cost\nService cost...................................... $ 82 $1,138 $1,140 Interest cost..................................... 871 1,719 1,800 Curtailment gain recognized....................... (3,389) -- -- Amortization of prior service cost (benefit)...... (671) 85 99 ------- ------ ------ Net periodic postretirement benefit cost (gain). $(3,107) $2,942 $3,039 ======= ====== ======\nDecember 31, ---------------- 1995 1994 ---- ---- (In thousands) Unfunded Accumulated Postretirement Benefit Obligation\nAccumulated postretirement benefit obligation: Retirees............................................ $ 8,127 $ 7,068 Fully eligible active plan participants............. 1,305 3,411 Other active plan participants...................... 1,980 11,505 ------- ------- 11,412 21,984 Unrecognized prior service benefit.................... 7,385 -- Unrecognized actuarial gains (losses)................. (435) 457 ------- ------- Accrued postretirement benefit cost................... $18,362 $22,441 ======= =======\nThe medical trend rate assumed in the determination of the accumulated postretirement benefit obligation at December 31, 1995 begins at 10.5% in 1996, decreases 1% per year to 6.5% for 2000 and remains at that level thereafter. Increasing the assumed medical trend rates by one percentage point in each year would have no material effect on the accumulated postretirement benefit obligation as of December 31, 1995 or net periodic postretirement benefit cost.\nThe discount rate used in determining the accumulated postretirement benefit obligation was 7.5% and 8% compounded annually with respect to the 1995 and 1994 valuations, respectively.\n- 36 - 8. SHAREHOLDERS' DEFICIT\nIn March 1995, the Certificate of Incorporation was restated to create two classes of stock and eliminate the formerly authorized nonvoting Common Stock.\nThe Company is authorized to issue up to 100,000,000 shares of $.01 par value Common Stock. At December 31, 1995, 63,377,326 shares were issued and 63,370,794 shares were outstanding. At December 31, 1994, 38,107,778 shares were issued and 38,101,239 shares were outstanding (after giving retroactive effect to a 6.5-for-one stock split on January 31, 1995). The Company is authorized to issue up to 50,000,000 shares of $.01 par value Preferred Stock none of which were issued or outstanding at December 31, 1995. At December 31, 1994, 600,000 shares of $.01 par value nonvoting Common Stock had been authorized, of which none were issued or outstanding.\nIn March and April of 1995, the Company issued 25,269,555 shares of Common Stock at $12.00 per share in a public offering (the \"Offering\"). Proceeds from the Offering, net of underwriting commissions and other related expenses totaling $19 million, were $284 million. The Offering was part of a recapitalization plan (the \"Recapitalization\") implemented by the Company to prepay or redeem a substantial portion of its indebtedness in order to reduce the level and overall cost of its debt, extend certain debt maturities, increase shareholders' equity and enhance its access to capital markets (see Note 5).\nThe balance of Common Stock with put right outstanding at the date of the Offering of approximately $12 million was reclassified to Common Stock and Additional Paid-In Capital in the accompanying consolidated financial statements because the put right terminated effective with the consummation of the Offering.\n- 37 -\nChanges in Shareholders' Deficit Accounts\nAdditional Cumulative Common Paid-in Translation Retained Stock Capital Adjustment Deficit ------ ---------- ----------- -------- (In millions)\nBalance, December 31, 1992..... $0.4 $600.1 $(3.9) $ (625.6) Net loss....................... -- -- -- (2,052.1) Decrease in fair market value of Common Stock with put right......... -- -- -- 1.4 Foreign currency translation adjustment................... -- -- (1.2) -- ---- ------ ----- --------- Balance, December 31, 1993..... 0.4 600.1 (5.1) (2,676.3) Net loss....................... -- -- -- (70.3) Foreign currency translation adjustment................... -- -- 2.8 -- ---- ------ ----- --------- Balance, December 31, 1994..... 0.4 600.1 (2.3) (2,746.6) Net income..................... -- -- -- 14.7 Common Stock offering.......... 0.2 283.9 -- -- Reclass of Common Stock with put right.................... 0.0 11.7 -- -- Foreign currency translation adjustment................... -- -- (0.5) -- ---- ------ ----- --------- Balance, December 31, 1995..... $0.6 $895.7 $(2.8) $(2,731.9) ==== ====== ===== =========\n9. STOCK OPTIONS\nOn January 31, 1995, the Company's shareholders approved the 1995 Stock Incentive Plan under which a total of 3,359,662 shares of Common Stock are reserved for awards to officers and key employees as stock options, stock appreciation rights, restricted stock, performance shares, stock equivalents and dividend equivalents and approved the 1995 Stock Plan for Non-Employee Directors under which a total of 80,000 shares of Common Stock are reserved for grant to non-employee directors. In addition, 3,740,158 stock options were granted and remain outstanding at December 31, 1995 under predecessor stock plans. All options issued or to be issued subject to the 1995 Stock Incentive Plan will expire not later than ten years after the date on which they are granted. The vesting schedule and exercisability of stock options under the 1995 Stock Incentive Plan will be determined by the compensation and nominating committee of the Board of Directors. In December 1995, 1,231 shares were granted pursuant to the 1995 Stock Plan for Non-Employee Directors.\n- 38 - Prior to the Offering, the Company amortized the excess of the fair market value of its Common Stock over the strike price of options granted to employees over the periods the options vested. Subsequent to the Offering, no amortization is required because the options are not putable to the Company. There was no employee stock compensation expense in 1995 or 1994. Due to the effects of adverse tissue industry operating conditions on its long-term earnings forecast as of September 30, 1993, the Company decreased the estimated fair market valuation of its Common Stock and, as a result, reversed all previously accrued employee stock compensation expense in 1993. The reversal of the accrued employee stock compensation expense resulted in a credit to operations of $8 million for 1993.\nChanges in Stock Options Outstanding\nExercise Number Of Price Options Per Option --------- --------------- Balance, December 31, 1992..................... 3,737,506 $15.38 to 18.46 Options Granted.............................. 98,800 18.46 Options Cancelled............................ (10,660) 15.38 to 18.46 --------- --------------- Balance, December 31, 1993..................... 3,825,646 15.38 to 18.46 Options Cancelled............................ (82,888) 15.38 to 18.46 --------- --------------- Balance, December 31, 1994..................... 3,742,758 15.38 to 18.46 Options Granted.............................. 743,000 19.75 Options Cancelled............................ (2,600) 18.46 --------- --------------- Balance, December 31, 1995..................... 4,483,158 $15.38 to 19.75 ========= =============== Exercisable at December 31, 1995............... 3,740,158 $15.38 to 18.46 ========= =============== Shares available for future grant at December 31, 1995............................ 2,616,662 =========\nIn October 1995, SFAS No. 123, \"Accounting for Stock-Based Compensation\" was issued. Beginning in 1996, the Company will begin to make pro forma disclosures of stock-based compensation cost utilizing the fair value based method of accounting pursuant to SFAS No. 123, but currently intends to continue to report stock-based compensation expense in its consolidated financial statements for years following 1995 under the intrinsic value based method permitted under Accounting Principles Board Opinion No. 25 and SFAS No. 123.\n10. RELATED PARTY TRANSACTIONS\nMorgan Stanley Group Inc. (\"Morgan Stanley Group\") and an affiliate acquired a substantial majority equity interest in the Company to effect the Acquisition. At December 31, 1995, Morgan Stanley Group and certain of its affiliates controlled 37.8% of the Company's Common Stock.\n- 39 - Morgan Stanley & Co. Incorporated (\"MS&Co\") has served as lead underwriter with respect to the Offering and periodic public debt offerings and has received underwriting fees of $7 million in 1995, $20 million in 1994 and $20 million in 1993 in connection with such public offerings. Since the Acquisition, MS&Co has also been a market maker with respect to the Company's public debt securities. Pursuant to an agreement terminated effective December 31, 1994, MS&Co provided financial advisory services to the Company for which the Company paid MS&Co $1 million in each of 1994 and 1993. The Company is a party to several interest rate cap agreements (see Note 5) including one such agreement with MS&Co which was purchased in 1994 for $2 million.\n11. COMMITMENTS AND CONTINGENCIES\nThe Company is subject to substantial regulation by various federal, state and local authorities in the U.S. and national and local authorities in the U.K. concerned with the impact of the environment on human health, the limitation and control of emissions and discharges to the air and waters, the quality of ambient air and bodies of water and the handling, use and disposal of specified substances and solid wastes. Financial responsibility for the clean-up or other remediation of contaminated property or for natural resource damages can extend to previously owned or used properties, waterways and properties owned by third parties as well as to prior owners. The Company is involved in a voluntary investigation and potential clean-up of the Lower Fox River in Wisconsin and has been named as a potentially responsible party for alleged natural resource damages related to the Lower Fox River and Green Bay system. In addition, the Company makes capital expenditures and incurs operating expenses for clean-up obligations and other environmental matters arising in its on-going operations.\nThe Company recorded a $20 million charge in the fourth quarter of 1994 for estimated or anticipated liabilities and legal and consulting costs relating to environmental matters arising from past operations. The Company expects these costs to be incurred over an extended number of years and as of December 31, 1995 continues to have accrued liabilities for environmental matters of approximately $20 million. The ultimate cost to the Company for environmental matters cannot be determined with certainty due to the often unknown magnitude of the contamination to be addressed, the varying cost of remediation methods that could be employed, the evolving nature of remediation technologies and government regulations and the inability to determine the Company's share of multiparty obligations or the extent to which contributions will be available from other parties. While the accrued liabilities reflect the Company's current estimate of the cost of these environmental matters, there can be no assurance that the amount accrued will be adequate.\nThe Company and its subsidiaries are parties to other lawsuits and state and federal administrative proceedings in connection with their businesses. Although the final results in all such suits and proceedings cannot be predicted with certainty, the Company currently believes that the ultimate resolution of all of such lawsuits and proceedings, after taking into account the liabilities accrued with respect to such matters, will not have a material adverse effect on the Company's financial condition or on its results of operations.\n- 40 - 12. GEOGRAPHIC INFORMATION\nUnited United States Kingdom Consolidated ------ ------- ------------ (In thousands) Net sales........................ $ 1,457,136 $163,767 $ 1,620,903 Operating income................. 342,534 17,585 360,119 Identifiable operating assets.... 1,490,426 162,011 1,652,437 Net sales........................ $ 1,143,205 $131,240 $ 1,274,445 Operating income................. 268,620 8,183 276,803 Identifiable operating assets.... 1,517,992 162,906 1,680,898 Net sales........................ $ 1,044,174 $143,213 $ 1,187,387 Operating loss................... (1,715,777) (859) (1,716,636) Identifiable operating assets.... 1,486,166 163,621 1,649,787\nIntercompany sales and charges between geographic areas and export sales are not material.\nIn 1993, the Company determined that its projected results would not support the future amortization of the Company's remaining goodwill balance. Accordingly, the Company wrote off its remaining goodwill balance of $1,980 million in the third quarter of 1993, resulting in charges of $1,968 million and $12 million to the operating income of the United States and United Kingdom operations, respectively.\n13. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)\nFirst Second Third Fourth Total Quarter Quarter Quarter Quarter Year ------- ------- ------- ------- ----- (In millions, except per share data) Net sales................ $ 367 $ 412 $ 426 $ 416 $ 1,621 Gross income............. 100 115 126 141 482 Operating income......... 71 88 95 106 360 Net income (loss) before extraordinary item..... (9) 7 15 21 34 Extraordinary item-loss on debt repurchases.... (19) -- -- -- (19) Net income (loss)........ (28) 7 15 21 15 Earnings (loss) per share: Net income (loss) before extraordinary item... (0.22) 0.12 0.23 0.33 0.57 Extraordinary item-loss on debt repurchases.. (0.44) -- -- -- (0.32) Net income (loss) per share............ (0.66) 0.12 0.23 0.33 0.25 Dividends per share...... -- -- -- -- --\n- 41 -\nFirst Second Third Fourth Total Quarter Quarter Quarter Quarter Year ------- ------- ------- ------- ----- (In millions, except per share data) Net sales................ $ 275 $ 315 $ 340 $ 344 $ 1,274 Gross income............. 87 107 113 100 407 Operating income......... 60 79 85 53 277 Net loss before extraordinary item..... (15) (2) -- (25) (42) Extraordinary item-loss on debt repurchases.... (28) -- -- -- (28) Net loss................. (43) (2) -- (25) (70) Loss per share: Net (loss) before extraordinary item... (0.40) (0.05) 0.01 (0.65) (1.11) Extraordinary item-loss on debt repurchases.. (0.74) -- -- -- (0.74) Net loss per share..... (1.14) (0.05) 0.01 (0.65) (1.85) Dividends per share...... -- -- -- -- --\n- 42 -\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 REGISTRANT\nFor information regarding executive officers see Item 1a. on this form.\nFor information regarding directors and compliance with Section 16(a) of the Securities and Exchange Act of 1934, see the Proxy Statement for the Annual Meeting of Shareholders to be held on May 14, 1996, under the captions \"Election of Directors\" and \"Compliance with Section 16(a) of the Securities Exchange Act of 1934\" which are incorporated by reference herein.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nSee the Proxy Statement for the Annual Meeting of Shareholders to be held on May 14, 1996, under the captions \"Committees of the Board of Directors; Meetings and Compensation of Directors,\" \"Executive Compensation,\" \"Committee Report on Executive Compensation\" and \"Performance Graph,\" which are incorporated by reference herein.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nSee the Proxy Statement for the Annual Meeting of Shareholders to be held on May 14, 1996, under the captions \"Ownership of Common Stock by Management,\" \"Principal Stockholders\" and \"Executive Compensation--Management Incentive Plan and 1995 Stock Incentive Plan,\" which are incorporated by reference herein.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nSee the Proxy Statement for the Annual Meeting of Shareholders to be held on May 14, 1996, under the caption \"Certain Transactions,\" which is 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 of Fort Howard Corporation\nIncluded in Part II, Item 8:\nReport of Independent Public Accountants.\nConsolidated Statements of Income for the years ended December 31, 1995, 1994 and 1993.\n- 43 - Consolidated Balance Sheets as of December 31, 1995 and 1994.\nConsolidated Statements of Cash Flows for the years ended December 31, 1995, 1994 and 1993.\nNotes to Consolidated Financial Statements.\nSeparate financial statements and supplemental schedules of the Company and its consolidated subsidiaries are omitted since the Company is primarily an operating corporation and its consolidated subsidiaries included in the consolidated financial statements being filed do not have a minority equity interest or indebtedness to any other person or to the Company in an amount which exceeds five percent of the total assets as shown by the consolidated financial statements as filed herein.\na. 2. Financial Statement Schedules\nReport of Indendent Public Accountants\nSchedule II -- Valuation and Qualifying Accounts\nAll other schedules are omitted because they are not applicable, or not required, or because the required information is included in the audited consolidated financial statements or notes thereto.\na. 3. Exhibits\nExhibit No. Description ----------- -----------\n3.1 Restated Certificate of Incorporation of the Company. (Incorporated by reference to Exhibit 3.1 as filed with the Company's Annual Report on Form 10-K for the year ended December 31, 1994.)\n3.2 Amended and Restated By-Laws of the Company. (Incorporated by reference to Exhibit 3.2 as filed with the Company's Annual Report on Form 10-K for the year ended December 31, 1994.)\n4.1 Credit Agreement dated as of March 8, 1995 among the Company, the lenders named therein, and Bankers' Trust Company, Bank of America National Trust and Savings Association and Chemical Bank as arrangeers, and Bankers' Trust Company as administrative agent. (Incorporated by reference to Exhibit 4.0 as filed with the Company's Annual Report on Form 10-K for the year ended December 31, 1994.)\n4.2 Form of 9 1\/4% Senior Note Indenture dated as of March 15, 1993 between the Company and Norwest Bank Wisconsin, N.A., Trustee. (Incorporated by reference to Exhibit 4.1 as filed with the Company's Amendment No. 2 to Form S-2 on March 4, 1993.)\n4.3 Form of 10% Subordinated Note Indenture dated as of March 15, 1993 between the Company and the United States Trust Company of New York, Trustee. (Incorporated by reference to Exhibit 4.2 as filed with the Company's Amendment No. 2 to Form S-2 on March 4, 1993.)\n- 44 -\n4.4 Form of 9% Senior Subordinated Note Indenture dated as of February 1, 1994 between the Company and The Bank of New York, Trustee. (Incorporated by reference to Exhibit 4.2 as filed with the Company's Form S-2 on December 17, 1993.)\nRegistrant agrees to provide copies of instruments defining the rights of security holders, including indentures, upon request of the Commission.\n*10.1 Employment Agreements dated October 15, 1993 with the Company's Chief Executive Officer, Chief Operating Officer and Chief Financial Officer. (Incorporated by reference to Exhibit No. 10 as filed with the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993.)\n*10.1(A) Amendments dated January 1, 1995 to Employment Agreements dated October 15, 1993, with the Company's Chief Executive Officer, Chief Operating Officer and Chief Financial Officer. (Incorporated by reference to Exhibit No. 10.6(A) as filed with the Company's Amendment No. 1 to Form S-1 on February 8, 1995.)\n*10.2 Employment Agreements dated December 10, 1993 with certain executive officers of the Company. (Incorporated by reference to Exhibit 10.13 as filed with the Company's Form S-2 on December 17, 1993.)\n*10.2(A) Amendments to Employment Agreements with certain executive officers of the Company. (Incorporated by reference to Exhibit No. 10.13(A) as filed with the Company's Amendment No. 1 to Form S-1 on February 8, 1995.)\n*10.3 Amended and Restated Stockholders Agreement dated as of March 1, 1995, among the Company, Morgan Stanley Group, MSLEF II, certain institutional investors and the Management Investors which amends and restates the Stockholders Agreement dated as of December 7, 1990, as amended. (Incorporated by reference to Exhibit 10.3(A) as filed with the Company's Form 10-K for the year ended December 31, 1994.)\n*10.4 Management Incentive Plan as amended and restated as of December 19, 1994. (Incorporated by reference to Exhibit No. 10.2 as filed with the Company's Amendment No. 1 to Form S-1 on February 8, 1995.)\n*10.5 Supplemental Retirement Plan. (Incorporated by reference to Exhibit No. 10.7 as filed with Amendment No. 2 to the Company's Form S-1 on October 25, 1988.)\n*10.5(A) Amendment No. 1 to the Supplemental Retirement Plan. (Incorporated by reference to Exhibit 10.P as filed with the Company's Annual Report on Form 10-K for the year ended December 31, 1988.)\n*10.6 Form of Supplemental Retirement Agreement for the Company's Chief Executive Officer as Amended. (Incorporated by reference to Exhibit 10.M as filed with the Company's Annual Report on Form 10-K for the year ended December 31, 1988.)\n- 45 -\n*10.7 Supplemental Retirement Agreements for certain directors and officers. (Incorporated by reference to Exhibit 10.T as filed with the Company's Annual Report on Form 10-K for the year ended December 31, 1989.)\n*10.7(A) Form of Amendment No. 1 to Supplemental Retirement Agreements for certain directors and officers. (Incorporated by reference to Exhibit 10.U as filed with the Company's Form 10-K for the year ended December 31, 1990.)\n*10.8 Amended and Restated Management Equity Participation Agreement dated as of August 1, 1988. (Incorporated by reference to Exhibit No. 10.9 as filed with the Company's Amendment No. 2 to Form S-1 on October 25, 1988.)\n*10.8(A) Letter Agreement dated June 27, 1990, which modifies Amended and Restated Management Equity Participation Agreement. (Incorporated by reference to Exhibit 10.V as filed with the Company's Form 10-K for the year ended December 31, 1990.)\n*10.8(B) Letter Agreement dated July 31, 1990, among the Company and the Principal Management Investors which amends Amended and Restated Management Equity Participation Agreement. (Incorporated by reference to Exhibit 10.W as filed with the Company's Form 10-K for the year ended December 31, 1990.)\n*10.8(C) Letter Agreement dated July 31, 1990, between the Company and the Management Investor Committee which amends Amended and Restated Management Equity Participation Agreement. (Incorporated by reference to Exhibit 10.X as filed with the Company's Form 10-K for the year ended December 31, 1990.)\n*10.8(D) Letter Agreement dated February 7, 1991, between the Company and the Management Investors Committee which amends the Amended and Restated Management Equity Participation Agreement. (Incorporated by reference to Exhibit 10.GG as filed with the Company's Form 10-K for the year ended December 31, 1990.)\n*10.8(E) Form of Letter Agreement dated February 7, 1991, among the Company, the Management Investors Committee and Management Investors which cancels certain stock options, grants new stock options and amends the Amended and Restated Management Equity Participation Agreement. (Incorporated by reference to Exhibit 10.HH as filed with the Company's Form 10-K for the year ended December 31, 1990.)\n*10.8(F) Letter Agreement dated March 1, 1995, between the Company and the Management Investors Committee which amends the Amended and Restated Management Equity Participation Agreement. (Incorporated by reference to Exhibit 10.8(F) as filed with the Company's Annual Report on Form 10-K for the year ended December 31, 1994.)\n*10.9 Management Equity Plan. (Incorporated by reference to Exhibit 10.H as filed with the Company's Form 10-K for the year ended December 31, 1991.)\n- 46 -\n*10.9(A) Amendment dated December 28, 1993 to Management Equity Plan. (Incorporated by reference to Exhibit 10.9(A) as filed with the Company's Form 10-K for the year ended December 31, 1993.)\n*10.9(B) Amendment dated March 1, 1995 to the Management Equity Plan. (Incorporated by reference to Exhibit 10.9(B) as filed with the Company's Annual Report on Form 10-K for the year ended December 31, 1994.)\n*10.10 Form of Management Equity Plan Agreement. (Incorporated by reference to Exhibit 10.I as filed with the Company's Form 10-K for the year ended December 31, 1991.)\n10.11 Participation Agreement dated as of October 20, 1989, among the Company, Philip Morris Credit Corporation, the Loan Participants listed therein, the Connecticut National Bank, Owner Trustee, and Wilmington Trust Company, Indenture Trustee. (Incorporated by reference to Exhibit 10.15 as filed with the Company's Post-Effective Amendment No. 2 to Form S-1 on February 8, 1990.)\n10.12 Facility Lease Agreement dated as of October 20, 1989, between the Connecticut National Bank in its capacity as Owner Trustee, the Lessor and the Company as Lessee. (Incorporated by reference to Exhibit 10.16 as filed with the Company's Post-Effective Amendment No. 2 to Form S-1 on February 8, 1990.)\n10.13 Power Installation Lease Agreement dated as of October 20, 1989, between The Connecticut National Bank, not in its individual capacity but solely as Owner Trustee, and the Company. (Incorporated by reference to Exhibit 10.HH as filed with the Company's Form 10-K for the year ended December 31, 1991.)\n10.14 Equipment Lease Agreement dated as of October 20, 1989, between The Connecticut National Bank, not in its individual capacity but solely as Owner Trustee, and the Company. (Incorporated by reference to Exhibit 10.II as filed with the Company's Form 10-K for the year ended December 31, 1991.)\n10.15 Participation Agreement dated as of December 23, 1990, among the Company, Bell Atlantic Tricon Leasing Corporation, Bankers Trust Company, The Connecticut National Bank, Owner Trustee, and Wilmington Trust Company, Indenture Trustee. (Incorporated by reference to Exhibit 10.BB as filed with the Company's Form 10-K for the year ended December 31, 1990.)\n10.16 Amended and Restated Equipment Lease Agreement [1990] dated as of December 19, 1991, between The Connecticut National Bank, not in its individual capacity but solely as Owner Trustee under the Trust Agreement, as Lessor, and the Company, as Lessee. (Incorporated by reference to Exhibit 10.W as filed with the Company's Form 10-K for the year ended December 31, 1991.)\n10.17 Facility Lease Agreement dated as of December 19, 1991, between The Connecticut National Bank, not in its individual capacity but solely as Owner Trustee, and the Company. (Incorporated by reference to Exhibit 10.EE as filed with the Company's Form 10-K for the year ended December 31, 1991.)\n- 47 -\n10.18 Equipment Lease Agreement [1991] dated as of December 19, 1991, between The Connecticut National Bank, not in its individual capacity but solely as Owner Trustee, and the Company. (Incorporated by reference to Exhibit 10.FF as filed with the Company's Form 10-K for the year ended December 31, 1991.)\n10.19 Power Plant Lease Agreement dated as of December 19, 1991, between The Connecticut National Bank, not in its individual capacity but solely as Owner Trustee, and the Company. (Incorporated by reference to Exhibit 10.GG as filed with the Company's Form 10-K for the year ended December 31, 1991.)\n10.20 Amended and Restated Participation Agreement dated as of October 21, 1991, among the Company, Bell Atlantic Tricon Leasing Corporation, Bankers Trust Company, The Connecticut National Bank, Owner Trustee, and Wilmington Trust Company, Indenture Trustee and the Form of the First Amendment thereto dated as of December 13, 1991. (Incorporated by reference to Exhibit 4.3 as filed with the Company's Amendment No. 3 to Form S-3 on December 13, 1991).\n*10.21 Deferred Compensation Plan for Non-Employee Directors. (Incorporated by reference to Exhibit No. 10.14 as filed with the Company's Amendment No. 1 to Form S-1 on February 8, 1995).\n*10.22 1995 Stock Incentive Plan. (Incorporated by reference to Exhibit No. 10.15 as filed with the Company's Amendment No. 1 to Form S-1 on February 8, 1995).\n+*10.22(A) Form of Nonqualified Stock Option Agreement dated December 6, 1995.\n*10.23 1995 Stock Plan for Non-Employee Directors. (Incorporated by reference to Exhibit No. 10.16 as filed with the Company's Amendment No. 1 to Form S-1 on February 8, 1995).\n+12.1 Statement of Deficiency of Earnings Available to Cover Fixed Charges.\n+12.2 Statement of Computation of Ratio of Earnings to Fixed Charges.\n+21 Subsidiaries of Fort Howard Corporation.\n+23 Consent of Arthur Andersen LLP (included in Part IV at page 51).\n+25 Powers of Attorney (included as part of signature page).\n+27 Financial Data Schedule for year ended December 31, 1995.\n- -------------------- *Management contract or compensatory plan or arrangement. +Filed herewith.\nb. Reports on Form 8-K\nNo reports on Form 8-K were filed during the quarter ended December 31, 1995.\n- 48 -\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nFORT HOWARD CORPORATION Green Bay, Wisconsin February 6 1996 By \/s\/ Donald H. DeMeuse ---------------------------------- Donald H. DeMeuse, Chairman of the Board and Chief Executive Officer\nPOWER OF ATTORNEY\nThe undersigned directors and officer of Fort Howard Corporation hereby constitute and appoint Donald H. DeMeuse, Kathleen J. Hempel and James W. Nellen II and each of them, with full power to act without the other and with full power of substitution and resubstitution, our true and lawful attorneys- in-fact with full power to execute in our name and behalf in the capacities indicated below any and all amendments to this Annual Report on Form 10-K and to file the same, with all exhibits thereto and other documents in connection therewith with the Securities and Exchange Commission and hereby ratify and confirm all that such attorneys-in-fact, or any of them, or their substitutes shall lawfully do or cause to be done by virtue hereof.\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on behalf of the registrant and in the capacities on the dates indicated:\n\/s\/ Donald H. DeMeuse Chairman of the Board, February 6, 1996 Donald H. DeMeuse Chief Executive Officer and Director\n\/s\/ Kathleen J. Hempel Vice Chairman, Chief February 6, 1996 Kathleen J. Hempel Financial Officer and Director\n\/s\/ Michael T. Riordan President, Chief February 6, 1996 Michael T. Riordan Operating Officer and Director\n\/s\/ Donald Patrick Brennan Director February 2, 1996 Donald Patrick Brennan\n\/s\/ James L. Burke Director February 2, 1996 James L. Burke\n\/s\/ Dudley J. Godfrey Director February 2, 1996 Dudley J. Godfrey\n\/s\/ David I. Margolis Director February 1, 1996 David I. Margolis\n- 49 -\n\/s\/ Robert H. Niehaus Director February 2, 1996 Robert H. Niehaus\n\/s\/ Frank V. Sica Director February 2, 1996 Frank V. Sica\n\/s\/ Charles L. Szews Vice President and February 6, 1996 Charles L. Szews Controller and Principal Accounting Officer\n- 50 -\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements of Fort Howard Corporation included in this Form 10-K and have issued our report thereon dated January 30, 1996. Our audits were made for the purpose of forming an opinion on those 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 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\nMilwaukee, Wisconsin, January 30, 1996.\n______________________\nCONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS\nAs independent public accountants, we hereby consent to the incorporation of our reports included in this Form 10-K, into the Company's previously filed Registration Statement Nos. 33-63099, 33-64841 and 333-00019.\nARTHUR ANDERSEN LLP\nMilwaukee, Wisconsin February 5, 1996.\n- 51 -\nSchedule II\nFORT HOWARD CORPORATION\nVALUATION AND QUALIFYING ACCOUNTS (In thousands)\nFor the Years Ended December 31, --------------------------------- ALLOWANCE FOR DOUBTFUL ACCOUNTS: 1995 1994 1993 ---- ---- ----\nBalance at beginning of year.......... $1,589 $2,366 $1,376 Additions charged to earnings......... 1,209 (92) 1,633 Charges for purpose for which reserve was created............... 85 (685) (643) ------ ------ ------ Balance at end of year................ $2,883 $1,589 $2,366 ====== ====== ======\n- 52 -\nINDEX TO EXHIBITS\nExhibit No. - -----------\n*3.1 Restated Certificate of Incorporation of the Company. (Incorporated by reference to Exxhibit 3.1 as filed with the Company's Annual Report on Form 10-K for the year ended December 31, 1994.)\n3.2 Amended and Restated By-Laws of the Company. (Incorporated by reference to Exhibit 3.2 as filed with the Company's Annual Report on Form 10-K for the year ended December 31, 1994.)\n4.1 Credit Agreement dated as of March 8, 1995 among the Company, the lenders named therein, and Bankers' Trust Company, Bank of America National Trust and Savings Association and Chemical Bank as arrangeers, and Bankers' Trust Company as administrative agent. (Incorporated by reference to Exhibit 4.0 as filed with the Company's Annual Report on Form 10-K for the year ended December 31, 1994.)\n4.2 Form of 9 1\/4% Senior Note Indenture dated as of March 15, 1993 between the Company and Norwest Bank Wisconsin, N.A., Trustee. (Incorporated by reference to Exhibit 4.1 as filed with the Company's Amendment No. 2 to Form S-2 on March 4, 1993.)\n4.3 Form of 10% Subordinated Note Indenture dated as of March 15, 1993 between the Company and the United States Trust Company of New York, Trustee. (Incorporated by reference to Exhibit 4.2 as filed with the Company's Amendment No. 2 to Form S-2 on March 4, 1993.)\n4.4 Form of 9% Senior Subordinated Note Indenture dated as of February 1, 1994 between the Company and The Bank of New York, Trustee. (Incorporated by reference to Exhibit 4.2 as filed with the Company's Form S-2 on December 17, 1993.)\nRegistrant agrees to provide copies of instruments defining the rights of security holders, including indentures, upon request of the Commission.\n*10.1 Employment Agreements dated October 15, 1993 with the Company's Chief Executive Officer, Chief Operating Officer and Chief Financial Officer. (Incorporated by reference to Exhibit No. 10 as filed with the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993.)\n*10.1(A) Amendments dated January 1, 1995 to Employment Agreements dated October 15, 1993, with the Company's Chief Executive Officer, Chief Operating Officer and Chief Financial Officer. (Incorporated by reference to Exhibit No. 10.6(A) as filed with the Company's Amendment No. 1 to Form S-1 on February 8, 1995.)\n- 53 -\n*10.2 Employment Agreements dated December 10, 1993 with certain executive officers of the Company. (Incorporated by reference to Exhibit 10.13 as filed with the Company's Form S-2 on December 17, 1993.)\n*10.2(A) Amendments to Employment Agreements with certain executive officers of the Company. (Incorporated by reference to Exhibit No. 10.13(A) as filed with the Company's Amendment No. 1 to Form S-1 on February 8, 1995.)\n*10.3 Amended and Restated Stockholders Agreement dated as of March 1, 1995, among the Company, Morgan Stanley Group, MSLEF II, certain institutional investors and the Management Investors which amends and restates the Stockholders Agreement dated as of December 7, 1990, as amended. (Incorporated by reference to Exhibit 10.3(A) as filed with the Company's Form 10-K for the year ended December 31, 1994.)\n*10.4 Management Incentive Plan as amended and restated as of December 19, 1994. (Incorporated by reference to Exhibit No. 10.2 as filed with the Company's Amendment No. 1 to Form S-1 on February 8, 1995.)\n*10.5 Supplemental Retirement Plan. (Incorporated by reference to Exhibit No. 10.7 as filed with Amendment No. 2 to the Company's Form S-1 on October 25, 1988.)\n*10.5(A) Amendment No. 1 to the Supplemental Retirement Plan. (Incorporated by reference to Exhibit 10.P as filed with the Company's Annual Report on Form 10-K for the year ended December 31, 1988.)\n*10.6 Form of Supplemental Retirement Agreement for the Company's Chief Executive Officer as Amended. (Incorporated by reference to Exhibit 10.M as filed with the Company's Annual Report on Form 10-K for the year ended December 31, 1988.)\n*10.7 Supplemental Retirement Agreements for certain directors and officers. (Incorporated by reference to Exhibit 10.T as filed with the Company's Annual Report on Form 10-K for the year ended December 31, 1989.)\n*10.7(A) Form of Amendment No. 1 to Supplemental Retirement Agreements for certain directors and officers. (Incorporated by reference to Exhibit 10.U as filed with the Company's Form 10-K for the year ended December 31, 1990.)\n*10.8 Amended and Restated Management Equity Participation Agreement dated as of August 1, 1988. (Incorporated by reference to Exhibit No. 10.9 as filed with the Company's Amendment No. 2 to Form S-1 on October 25, 1988.)\n*10.8(A) Letter Agreement dated June 27, 1990, which modifies Amended and Restated Management Equity Participation Agreement. (Incorporated by reference to Exhibit 10.V as filed with the Company's Form 10-K for the year ended December 31, 1990.)\n- 54 -\n*10.8(B) Letter Agreement dated July 31, 1990, among the Company and the Principal Management Investors which amends Amended and Restated Management Equity Participation Agreement. (Incorporated by reference to Exhibit 10.W as filed with the Company's Form 10-K for the year ended December 31, 1990.)\n*10.8(C) Letter Agreement dated July 31, 1990, between the Company and the Management Investor Committee which amends Amended and Restated Management Equity Participation Agreement. (Incorporated by reference to Exhibit 10.X as filed with the Company's Form 10-K for the year ended December 31, 1990.)\n*10.8(D) Letter Agreement dated February 7, 1991, between the Company and the Management Investors Committee which amends the Amended and Restated Management Equity Participation Agreement. (Incorporated by reference to Exhibit 10.GG as filed with the Company's Form 10-K for the year ended December 31, 1990.)\n*10.8(E) Form of Letter Agreement dated February 7, 1991, among the Company, the Management Investors Committee and Management Investors which cancels certain stock options, grants new stock options and amends the Amended and Restated Management Equity Participation Agreement. (Incorporated by reference to Exhibit 10.HH as filed with the Company's Form 10-K for the year ended December 31, 1990.)\n*10.8(F) Letter Agreement dated March 1, 1995, between the Company and the Management Investors Committee which amends the Amended and Restated Management Equity Participation Agreement. (Incorporated by reference to Exhibit 10.8(F) as filed with the Company's Annual Report on Form 10-K for the year ended December 31, 1994.)\n*10.9 Management Equity Plan. (Incorporated by reference to Exhibit 10.H as filed with the Company's Form 10-K for the year ended December 31, 1991.)\n*10.9(A) Amendment dated December 28, 1993 to Management Equity Plan. (Incorporated by reference to Exhibit 10.9(A) as filed with the Company's Form 10-K for the year ended December 31, 1993.)\n*10.9(B) Amendment dated March 1, 1995 to the Management Equity Plan. (Incorporated by reference to Exhibit 10.9(B) as filed with the Company's Annual Report on Form 10-K for the year ended December 31, 1994.)\n*10.10 Form of Management Equity Plan Agreement. (Incorporated by reference to Exhibit 10.I as filed with the Company's Form 10-K for the year ended December 31, 1991.)\n10.11 Participation Agreement dated as of October 20, 1989, among the Company, Philip Morris Credit Corporation, the Loan Participants listed therein, the Connecticut National Bank, Owner Trustee, and Wilmington Trust Company, Indenture Trustee. (Incorporated by reference to Exhibit 10.15 as filed with the Company's Post-Effective Amendment No. 2 to Form S-1 on February 8, 1990.)\n- 55 -\n10.12 Facility Lease Agreement dated as of October 20, 1989, between the Connecticut National Bank in its capacity as Owner Trustee, the Lessor and the Company as Lessee. (Incorporated by reference to Exhibit 10.16 as filed with the Company's Post-Effective Amendment No. 2 to Form S-1 on February 8, 1990.)\n10.13 Power Installation Lease Agreement dated as of October 20, 1989, between The Connecticut National Bank, not in its individual capacity but solely as Owner Trustee, and the Company. (Incorporated by reference to Exhibit 10.HH as filed with the Company's Form 10-K for the year ended December 31, 1991.)\n10.14 Equipment Lease Agreement dated as of October 20, 1989, between The Connecticut National Bank, not in its individual capacity but solely as Owner Trustee, and the Company. (Incorporated by reference to Exhibit 10.II as filed with the Company's Form 10-K for the year ended December 31, 1991.)\n10.15 Participation Agreement dated as of December 23, 1990, among the Company, Bell Atlantic Tricon Leasing Corporation, Bankers Trust Company, The Connecticut National Bank, Owner Trustee, and Wilmington Trust Company, Indenture Trustee. (Incorporated by reference to Exhibit 10.BB as filed with the Company's Form 10-K for the year ended December 31, 1990.)\n10.16 Amended and Restated Equipment Lease Agreement [1990] dated as of December 19, 1991, between The Connecticut National Bank, not in its individual capacity but solely as Owner Trustee under the Trust Agreement, as Lessor, and the Company, as Lessee. (Incorporated by reference to Exhibit 10.W as filed with the Company's Form 10-K for the year ended December 31, 1991.)\n10.17 Facility Lease Agreement dated as of December 19, 1991, between The Connecticut National Bank, not in its individual capacity but solely as Owner Trustee, and the Company. (Incorporated by reference to Exhibit 10.EE as filed with the Company's Form 10-K for the year ended December 31, 1991.)\n10.18 Equipment Lease Agreement [1991] dated as of December 19, 1991, between The Connecticut National Bank, not in its individual capacity but solely as Owner Trustee, and the Company. (Incorporated by reference to Exhibit 10.FF as filed with the Company's Form 10-K for the year ended December 31, 1991.)\n10.19 Power Plant Lease Agreement dated as of December 19, 1991, between The Connecticut National Bank, not in its individual capacity but solely as Owner Trustee, and the Company. (Incorporated by reference to Exhibit 10.GG as filed with the Company's Form 10-K for the year ended December 31, 1991.)\n10.20 Amended and Restated Participation Agreement dated as of October 21, 1991, among the Company, Bell Atlantic Tricon Leasing Corporation, Bankers Trust Company, The Connecticut National Bank, Owner Trustee, and Wilmington Trust Company, Indenture Trustee and the Form of the First Amendment thereto dated as of December 13, 1991. (Incorporated by reference to Exhibit 4.3 as filed with the Company's Amendment No. 3 to Form S-3 on December 13, 1991).\n- 56 -\n*10.21 Deferred Compensation Plan for Non-Employee Directors. (Incorporated by reference to Exhibit No. 10.14 as filed with the Company's Amendment No. 1 to Form S-1 on February 8, 1995).\n*10.22 1995 Stock Incentive Plan. (Incorporated by reference to Exhibit No. 10.15 as filed with the Company's Amendment No. 1 to Form S-1 on February 8, 1995).\n+*10.22(A) Form of Nonqualified Stock Option Agreement dated December 6, 1995.\n*10.23 1995 Stock Plan for Non-Employee Directors. (Incorporated by reference to Exhibit No. 10.16 as filed with the Company's Amendment No. 1 to Form S-1 on February 8, 1995).\n+12.1 Statement of Deficiency of Earnings Available to Cover Fixed Charges.\n+12.2 Statement of Computation of Ratio of Earnings to Fixed Charges.\n+21 Subsidiaries of Fort Howard Corporation.\n+23 Consent of Arthur Andersen LLP (included in Part IV at page 51).\n+25 Powers of Attorney (included as part of signature page).\n+27 Financial Data Schedule for year ended December 31, 1995.\n- -------------------- *Management contract or compensatory plan or arrangement. +Filed herewith.\nb. Reports on Form 8-K\nNo reports on Form 8-K were filed during the quarter ended December 31, 1995.\n- 57 -","section_15":""}
{"filename":"793499_1995.txt","cik":"793499","year":"1995","section_1":"ITEM 1. BUSINESS\n(A) GENERAL DESCRIPTION OF BUSINESS\nThrough its direct and indirect subsidiaries, FHP International Corporation, a Delaware corporation (the \"Company\"), delivers managed health care services and sells indemnity health, group life and workers' compensation insurance. The Company's oldest subsidiary, FHP, Inc., a California corporation (\"FHP\"), is a federally qualified multi-state licensed health maintenance organization (\"HMO\"), which has been operating managed health care programs since 1961. Unless the context otherwise requires, the term \"Company\" as used in this Form 10-K Annual Report refers to FHP International Corporation and its direct and indirect subsidiaries.\nAt June 30, 1995, the Company provided a broad range of managed health care services to more than 1,779,000 HMO members, comprised of commercial and governmental employees and Medicare beneficiaries, in 11 states and Guam. These managed health care services include ambulatory and outpatient physician care, hospital care, pharmacy, dental care, eye care, home health nursing, skilled nursing, physical therapy, psychological counseling and health education.\nThe Company also offers group term life and health insurance products through its insurance subsidiaries. At June 30, 1995, the Company provided group term life insurance coverage for more than 75,000 insureds and group health and accident indemnity insurance coverage for more than 55,000 insureds. In its 24 Hour Managed Care ProgramSM the Company offers in a single package workers' compensation coverage, HMO plans and group indemnity medical, dental and life insurance benefit plans through several of its subsidiaries. The Company also offers third party administration and utilization review services and several PPO networks.\nAs a result of its June, 1994, acquisition of TakeCare, Inc. (\"TakeCare\"), the Company owned three separately licensed HMOs in both Colorado and California. On December 31, 1994, the three separately licensed Colorado HMO subsidiaries were merged with each other and the sole surviving Colorado HMO subsidiary, Comprecare Health Care Services, Inc., changed its name to FHP of Colorado, Inc. On March 31, 1995, the three separately licensed California HMO subsidiaries merged with each other and the sole surviving California HMO subsidiary is FHP.\nRestructuring of Staff Model Operations\nAt June 30, 1995, the Company provided staff model HMO services to over 350,000 enrollees in 58 medical centers and dental centers located in southern California, Arizona, Utah, New Mexico, Nevada and Guam. On June 27, 1995, the Company announced that its Board of Directors had approved a plan to restructure its staff model HMO operations by creating a physician practice management company (the \"PPMC\"). Subject to the receipt of requisite regulatory approvals, the PPMC will become the owner and manager of most of the Company's 58 medical and dental centers and will employ all the personnel in those centers, with the exception of the physicians, dentists and certain other licensed professionals. The physicians, dentists and other professionals will become employees of several newly formed professional corporations (\"PCs\") and the PCs will enter into long-term management agreements with the PPMC. Under the management agreements, the PPMC will provide the facilities, equipment and support personnel to enable the physicians and dentists to continue their practices with no interruption in service to patients. It is the intention of the Company that the PPMC and PCs will become fully operational on or around January 1, 1996, and that the PCs will continue to provide health care to the Company's HMO members. The PPMC and the PCs also will seek to do business with non-affiliated HMOs and other payors and will provide fee-for-service health care to patients.\nTogether, the PPMC and PCs will include all the Company's current staff model operations in California, Utah, Arizona, New Mexico and Nevada. In connection with the restructuring, the Company also announced its intention to sell the Company's two acute care hospitals and to sublease or otherwise dispose of the Company's two skilled nursing facilities.\nAs a part of the restructuring, the Company has reduced the number of its employees by approximately 700 positions. At September 1, 1995, the Company had approximately 13,000 full and part-time employees.\nThe Company's primary business activities consist of two business segments: HMO services and group life, health and accident and workers' compensation insurance. Information concerning revenue, operating profit or loss and identifiable assets of the Company's two business segments is set forth in the financial statements and related notes included in Part II of this Form 10-K.\n(B) HMO DELIVERY MODELS\nThe Company delivers health care services through independent practice association and group model HMOs in which the Company contracts with individual medical and dental providers, provider networks and multi-specialty medical groups to provide health care in facilities not operated by the Company. The term \"IPA\" used hereafter in this Form 10-K Annual Report refers to both of these contract HMO models. Each IPA model centers around one or more contract hospitals where IPA physicians maintain practice privileges. The Company's members receive health care through the offices of approximately 51,000 independent contract providers and approximately 600 contract hospitals.\nAs described above, the Company is undergoing a restructuring of its staff model operation which will result in the redeployment of those operations through the PPMC and PCs. Currently, in its staff model, the Company delivers health care services through an employed staff of primary health care physicians, physician specialists, dentists, nurses and other health care providers. These providers deliver health care to members in Company-operated facilities rather than in the offices of private doctors and dentists. At June 30, 1995, the Company employed approximately 800 primary care physicians and physician specialists, 200 dentists and 5,000 other health care professionals. Company-operated facilities currently include 58 medical and dental centers ranging in size from approximately 2,000 to 95,000 square feet, three acute care hospitals and two sub-acute skilled nursing facilities. With the transfer of these assets and personnel to the PPMC and the PCs, the Company will cease to operate as a staff model. The Company's former staff model HMO members will continue to receive health care services from the PPMC and PCs.\n(C) HMO MEMBERSHIP\nCommercial Members. As used herein, the term commercial members means all HMO members except Senior Plan\/SM\/ members. The Company acquires most of its commercial members by contracting with employers that offer health benefits to their employees. These employers generally offer a selection of indemnity and managed health care plans, pay for all or part of the monthly costs thereof and make payroll deductions for any costs payable by the employee. Supplemental benefits such as dental and eye care are often included as part of employer health benefit plans. During a designated open enrollment period, employees may select their desired health care coverage. Monthly premiums are negotiated between the Company and the employers, and are typically fixed for a one-year period. Commercial members comprised approximately 79% of the Company's total membership at June 30, 1995.\nSenior Plan Members. The Company also delivers managed health care services to Medicare beneficiaries under its Senior Plan pursuant to contracts with the Health Care Financing Administration (\"HCFA\") of the United States Department of Health and Human Services (\"DHHS\"). These contracts entitle the Company to a fixed fee per member premium, and are subject to adjustment annually based on certain demographic information relating to the Medicare population, and the cost of providing health care in a particular geographic area. Senior Plan membership comprised approximately 21% of the Company's total membership at June 30, 1995, but accounted for approximately 47% of the Company's total revenue for the fiscal year. The Company receives substantially more revenue for each Senior Plan member than it receives for each commercial member.\nIn addition to physician care, hospitalization and other benefits covered by Medicare, Senior Plan benefits also include prescription drugs, routine physical exams, hearing tests, immunizations, eye examinations, counseling and health education services. Senior Plan members are enrolled on an individual basis and may disenroll with 30 days notice. Medicare beneficiaries also can choose to enroll in the Senior Plan PlusSM program which offers more comprehensive medical and dental benefits. Seniors who enroll in this plan pay a monthly premium.\nThe Company anticipates further growth opportunities for its Senior Plan, based in part on demographic trends that show that the senior population is growing faster than any other segment of the nation's population. The Company is currently one of the largest providers of health care services to Medicare beneficiaries in the United States.\nThe following table shows an approximate breakdown of the Company's HMO membership at June 30, 1995:\n- -------- (1) Includes government employees and Medicaid recipients. (2) Includes mixed model membership in Arizona, New Mexico, Nevada and portions of southern California, where members may choose to receive care in an IPA or staff model setting. (3) Includes approximately 6,000 members located in northwest Indiana. (4) Includes approximately 1,000 members located in southeast Indiana and approximately 16,000 members located in northern Kentucky.\n(D) INSURANCE OPERATIONS\nThe Company also offers group health and life insurance products through its insurance subsidiaries. At June 30, 1995, the Company provided group term life insurance coverage for approximately 75,000 individuals and group health and accident indemnity coverage (including its preferred provider organization) for approximately 55,000 individuals.\n24 Hour Managed Care Program. The Company operates a 24 Hour Managed Care Program, which provides HMO and preferred provider organization\/indemnity medical coverage and workers' compensation coverage in one coordinated managed care system. Through this program, both occupational and nonoccupational injuries and illnesses are covered by products offered in a single package and administered on a coordinated basis. As of June 30, 1995, the 24 Hour Managed Care Program provided services to approximately 189 employer groups for approximately 24,000 insured employees.\n(E) GOVERNMENT REGULATION\nMost of the Company's HMO subsidiaries are qualified under the federal Health Maintenance Organization Act of 1973, as amended (the \"HMO Act\"). In addition, each of the states in which the Company does business has enacted statutes regulating or affecting the HMO subsidiaries. As a result, the\nCompany is subject to extensive regulation regarding the scope of benefits provided to HMO members and the terms of group benefit agreements, the Company's financial condition, including minimum tangible net equity, quality assurance and utilization review procedures, enrollment requirements, manner of structuring member premiums, member grievance procedures, provider contracts, marketing and advertising. Changes in governmental regulations could adversely affect the operations, profitability and business prospects of the HMO subsidiaries.\nAn example of such regulations is the Knox-Keene Health Care Service Plan Act of 1975, as amended (the \"Knox-Keene Act\"), under which the Company's California HMO is licensed. The Knox-Keene Act mandates that the Company's California HMO satisfy California regulatory authorities that it has fiscally sound operations, adequate provision for the risk of insolvency, and working procedures for the prompt payment or denial of claims for payment by health care providers. In addition, the Knox-Keene Act empowers California regulatory authorities to limit the administrative expense of the Company's California HMO to 15% of total revenue. Nearly all of the Company's HMOs outside of California are subject to state regulation similar to the Knox-Keene Act.\nCalifornia law requires all HMOs and health insurers that offer health care benefit plans to \"small groups\" in California (employers with 5 to 50 employees) to offer such benefit plans to any small group seeking coverage, and to renew the health coverage of any small group that purchases coverage from the HMO or insurer and desires to renew it, regardless of the health status of the individuals in the group. This legislation also limits the amount by which the premium rates charged to a specific small group by an HMO or insurer can vary from the average community rate charged by such HMO or insurer to other small groups in California. The law also places various other requirements on HMOs and insurers participating in the California small group market, including a requirement to file premium rate information with the state and various restrictions on the terms under which health care coverage can be provided to small groups.\nCertain minimum tangible net equity and other financial viability requirements are imposed on the Company's HMO and insurance subsidiaries by regulatory authorities in each state in which these subsidiaries operate and restrict the Company's ability to transfer cash and short-term investments from such subsidiaries to the Company. While the Company currently believes its regulated subsidiaries are in compliance with these minimum tangible net equity and other financial viability requirements, a change in these requirements or an adverse determination by one or more regulatory authorities could have a material adverse effect on the Company's ability to make timely payments on preferred stock dividend obligations and principal and interest obligations under its Credit Agreement and its 7% Senior Notes due 2003. In order to obtain approvals for HMO and insurance company expansions into additional states, the regulated subsidiaries are required to meet certain minimum capital, surplus and deposit requirements which may require the Company to make additional capital contributions to such subsidiaries.\nThe Company's Senior Plan services are provided under contracts with, and are subject to regulation by, HCFA and certain state agencies. HCFA requires that an HMO be federally qualified in order to be eligible for Medicare fixed fee per member contracts. Under the Company's Medicare contracts and HCFA regulations, if the premiums received for Medicare-covered health care services provided to Senior Plan members are more than the premiums received for the same health care services provided to non-Senior Plan members, then the Company must provide its Senior Plan members with additional benefits beyond those required by Medicare or reduce any of the premiums, deductibles or co-payments that it may charge. The Company's Senior Plan is not permitted to account for more than one-half of the Company's total HMO members in each of the Company's geographic markets as those markets are defined by HCFA. HCFA has the right to audit HMOs operating under Medicare contracts to determine the quality of care being rendered and the degree of compliance with HCFA's contracts and regulations.\nThe Company's Medicare contracts are renewed annually unless the Company or HCFA elects to terminate the contracts. HCFA also may unilaterally terminate the Company's Medicare contracts if the Company fails to continue to meet compliance and eligibility standards. While the federal government may\nimplement changes in the Medicare risk-based program, the Company believes that the HMO will continue to be an important factor in the federal government's overall efforts to control medical costs. However, the loss of Medicare contracts or termination or modification of the HCFA risk-based Medicare program could have a material adverse effect on the revenue, profitability and business prospects of the Company. The services reimbursed by Medicare and Medicaid are subject to various requirements and restrictions imposed by contract law and regulation. Non-compliance with government regulations could subject the Company to adverse action by the government. To maintain compliance, the Company will take such action, or modify its practices, as it deems necessary.\nSection 9313(c) of the Omnibus Budget Reconciliation Act of 1986 (\"OBRA '86\") prohibits HMOs with Medicare risk contracts from knowingly making incentive payments to a physician as an inducement to reduce or limit services to Medicare beneficiaries. Sections 4204(a) and 4731 of OBRA '90 repealed the prohibition on all such physician incentive plans, and enacted requirements for regulating these plans. Under these sections, an HMO must: (1) not operate a physician incentive plan that directly or indirectly makes specific payments to a physician or physician group as an inducement to limit or reduce medically necessary services to a specific individual enrolled with the organization; (2) disclose to HCFA their incentive plan arrangements in such detail as to allow HCFA to determine compliance of the arrangements with the DHHS regulations; and (3) provide certain protections to physicians and enrollees where a physician incentive plan places a physician or physician group at \"substantial financial risk\" for services not provided directly by them.\nThe Company's Medicare contracts subject it to numerous other federal regulations governing the Medicare program, including the so-called \"Medicare and Medicaid anti-kickback statute.\" The Medicare and Medicaid anti-kickback statute (Section 1128B of the Social Security Act, as amended) provides both civil and criminal penalties for individuals or entities that knowingly and willfully offer, pay, solicit or receive remuneration in return for referrals of business reimbursed under Medicare or Medicaid. Civil penalties include exclusion from participation in the Medicare or Medicaid programs. In 1991, DHHS promulgated a \"safe harbor\" regulation that defined certain payment practices between providers of Medicare or Medicaid covered services and entities or individuals in a position to refer patients or business to these providers, which would not constitute violations of the statute. On November 5, 1992, DHHS promulgated interim final regulations establishing two new safe harbors and amending one existing safe harbor to provide protection from criminal prosecution and civil sanctions for certain payment practices engaged in by health care plans, including HMOs. This new regulation provides that certain incentives offered to HMO enrollees, such as a reduction or waiver of Medicare coinsurance or deductible amounts paid by the HMO; the waiver of Part A deductible and coinsurance amounts pursuant to an agreement between a hospital and a Medicare insurer; and price reductions or discounts offered to HMOs by contracting health care providers as part of agreements by those providers to furnish Medicare covered services will be deemed not to violate the anti-kickback statute. The Company believes that its payment practices either come within one or more of the safe harbors promulgated in 1991 and 1992, or are not in violation of the anti-kickback statute in any event.\nThe HMO and insurance subsidiaries of the Company must file periodic reports with, and their operations are subject to periodic examination by, federal and state licensing authorities. To remain licensed and accredited, it is necessary for the Company's HMO and insurance subsidiaries to comply with various fiscal standards imposed by regulatory authorities and to make changes from time to time in their services, procedures, structure and marketing methods. Such changes may be required as a result of amendment to, or other significant modification of, federal and state laws and regulations controlling the subsidiaries' operations.\nThe Company contracts with the United States Office of Personnel Management (\"OPM\") to provide or arrange managed health care services under the Federal Employees Health Benefits Program (\"FEHBP\") for federal employees, annuitants and their dependents. These contracts with OPM and applicable government regulations establish premium rating requirements for the FEHBP. OPM conducts periodic audits of its contractors to, among other things, verify that the premiums established under the OPM contracts are established in compliance with the community rating and other requirements under the FEHBP.\nIn May 1993, after conducting a periodic audit of the Company's FEHBP contracts covering primarily the years 1988 through 1991, OPM sent a draft audit report to the Company alleging certain defects in the Company's rating practices under applicable regulatory and contractual requirements and invited the Company to comment. Following its evaluation of additional information and comments provided by the Company, the OPM auditors will issue a final report; the OPM Audit Resolution Division will then be responsible for resolving the audit findings. As part of the resolution process, the Audit Resolution Division may reconsider the findings of the auditors and the information provided by the Company.\nIt is likely that the final audit report will recommend that OPM seek a monetary recovery from the Company and that such recommended recovery could be a substantial amount. At this time, the Company's management and legal counsel are unable to determine the amounts that may be required to be refunded to OPM to resolve the audit findings. Management currently believes, however, that after application of available offsets and consideration of established reserves, amounts ultimately required to be refunded to OPM will not have a material adverse effect on the consolidated financial position or results of operations or cash flows of the Company. In addition, the Company's management currently does not believe that the audit will have a material effect on future relations with OPM.\nHCFA has notified the Company and other risk-based contractors that HCFA believes it has erroneously made overpayments over the last three years for health care services provided to dually eligible Medicaid\/Medicare (\"Medi\/Medi\") beneficiaries. HCFA began to recoup the alleged overpayments on a quarterly basis from the Company beginning April 1, 1995. The aggregate withholds by HCFA are expected to be approximately $23.5 million. The Company is contesting HCFA's legal authority to recoup such sums as well as the amount of the purported Medi\/Medi overpayments. Most of the Company's capitation contracts permit the Company to retroactively reduce payments to providers to reflect changes in payments from HCFA. The Company's contracted providers have been notified that the Company will be recouping overpayments from them as a result of HCFA's recoupments from the Company.\nThe Company has established reserves based on its best estimate of the amounts it will be unable to recoup from contracted providers. Management currently believes that after consideration of established reserves and the amounts of overpayments which are currently expected to be borne by the contracted providers, amounts ultimately to be recouped by HCFA will not have a material adverse effect on the consolidated financial position or results of operations or cash flows of the Company.\nThe Company's insurance subsidiaries are regulated by the department of insurance in each of the states in which they operate. These regulations relate to, among other things, the terms, administration and marketing of the products offered and the financial condition of these subsidiaries, and subject these subsidiaries to periodic audits and continuing oversight. In addition, the offering of certain new insurance products may require the approval of these regulatory agencies.\nThe Company believes that it is in substantial compliance with all governmental regulations affecting its business, the violation of which could have a material adverse effect on its consolidated financial position or results of operations or cash flows.\n(F) HEALTH CARE REFORM\nThere have been diverse legislative and regulatory initiatives at both the federal and state levels to address, among other aspects of the nation's health care system, the continuing increases in health care costs and the lack of health care coverage for a significant segment of the population. Several bills have been introduced in Congress to reform the nation's health care system. These bills include elements such as guaranteed issuance and renewability of health insurance; subsidies for individuals who are uninsured or underinsured; mandates on employers to provide health coverage for their employees; medical savings accounts; mandatory or voluntary regional health alliances or purchasing cooperatives; minimum or standardized health benefit packages; limitations on premiums; medical liability reforms; amendment of the antitrust laws to benefit providers; mandatory or optional single-payer systems for all or part of the\npopulation; and changes in federal tax, Medicare and Medicaid laws and the Employee Retirement Income Security Act of 1974. To varying degrees, many of the bills contemplate the involvement of state governments in the regulation and implementation of federal health care reform legislation.\nVarious states are considering forms of single-payer systems, restructuring of Medicaid programs and \"any willing provider\" legislation that could require managed care companies to contract with any medical provider who agrees to the terms of the company's standard provider contract and payment schedule. All or any of these potential forms of legislation could adversely affect the Company's business.\nThe Company is unable to predict how existing federal or state laws and regulations may be changed or interpreted, what additional laws or regulations affecting its businesses may be enacted or proposed, when and which of the proposed laws will be adopted or what effect the new laws and regulations will have on its businesses. However, certain of the proposals, if adopted, could have a material adverse effect on the Company's business, while others, if adopted, could potentially benefit the Company's business. Although the effects of these activities cannot yet be determined, the Company remains committed to participate in the debate over health care reform and in the restructuring of the health care system.\n(G) COMPETITION\nThe health care and insurance industries are highly competitive. The Company believes that among the most significant competitive factors in the market are the quality and location of the health care providers, the comprehensiveness of coverage and the pricing of services. The Company has a number of competitors, including commercial insurance carriers and other HMOs, some of which have substantially larger memberships and are better capitalized than the Company. In addition to insurance carriers and other HMOs, the Company also competes with fee-for-service physicians, hospitals, and preferred provider organizations which contract directly with employers, thus by-passing HMOs.\nThe Company's largest HMO competitor in California is Kaiser Foundation Health Plan, Inc. (\"Kaiser\"), which served approximately 4.7 million members in California at January 1, 1995. In addition to Kaiser, there are at least two other HMOs with more members than the Company in California at January 1, 1995. At June 30, 1995, the Company served approximately 894,000 HMO members in California.\nAt June 30, 1995, the Company served approximately 314,000 and 179,000 HMO members in Colorado and Utah, respectively, more members than any other HMO in these States. The Company believes that Kaiser is its largest competitor in Colorado and that Intermountain Health Care is its largest competitor in Utah. At June 30, 1995, the Company served approximately 174,000, 47,000 and 40,000 HMO members in Arizona, Nevada and New Mexico, respectively. The Company believes that its largest competitors in Arizona are Intergroup Prepaid Health Services of Arizona and CIGNA Healthplan of Arizona-Phoenix, that its largest competitor in Nevada is Health Plan of Nevada and that its largest competitor in New Mexico is Lovelace Healthplan, Inc.\nAt June 30, 1995, the Company served approximately 48,000 and 42,000 HMO members in Illinois and Ohio, respectively. The Company believes its largest competitor in Illinois is United HealthCare of Illinois, Inc. and that its largest competitor in Ohio is ChoiceCare. At June 30, 1995, the Company served approximately 38,000 HMO members in Guam. The Company believes its largest competitor in Guam is Guam Memorial Health Plan. At June 30, 1995, the Company served approximately 3,000 members in Texas. The Company believes that Sanus Health Plan, Inc. is its largest competitor in Texas. The Company also believes that Blue Cross and Blue Shield carriers serve a substantial portion of the total health care markets in its service areas.\nAll membership data for other HMOs is obtained from \"The InterStudy Competitive Edge, 1995 Volume 5.2, Number 1,\" published by InterStudy Center for Managed Care Research, a research organization.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company currently operates medical and dental centers ranging in size from approximately 2,000 to 95,000 square feet.\nThe Company currently operates (i) 26 medical and dental centers in southern California, of which 10 are owned and 16 are leased; (ii) 7 medical and dental centers in Utah, of which 6 are owned and 1 is leased; (iii) 14 medical centers in Arizona, of which 4 are owned and 10 are leased; (iv) 3 owned and 2 leased medical centers in New Mexico; (v) 2 medical centers in Nevada, of which one is owned and one is leased; and (vi) 1 owned and 3 leased medical centers in Guam and a neighboring island. The Company also leases two 99-bed sub-acute skilled nursing facilities, owns a hospital licensed for 239 beds and manages another hospital licensed for 150 beds in southern California. The Company also owns a hospital currently licensed for 117 beds in Salt Lake City, Utah. As described in Item 1, the Company has announced its intention to sell the Company's two acute care hospitals and to sublease or otherwise dispose of its two sub-acute skilled nursing facilities.\nThe Company owns a 40,000 square foot administrative office building in southern California and a 58,000 square foot administrative office building in Utah. The Company also leases administrative offices in more than one dozen states and a public affairs office in California.\nOn June 30, 1995, the Company owned buildings totaling approximately 1.6 million square feet in size, all but one of which was free of outstanding encumbrances. The Company has a single medical center in southern California which is subject to an encumbrance of approximately $2.5 million. During the fiscal year ended June 30, 1995, the Company leased approximately 2.1 million square feet of buildings subject to annual lease obligations of approximately $27.4 million. In addition, the Company owns nonproductive acreage in California, Utah, Arizona, New Mexico, Nevada and Guam most of which it is planning to sell.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nDuring the ordinary course of business, the Company has become a party to pending and threatened legal actions and proceedings, a significant number of which involve claims of medical malpractice. Management of the Company is of the opinion, taking into account its insurance coverage and reserves that have been established, that the outcome of currently known legal actions and proceedings will not, singly or in the aggregate, have a material effect on the consolidated financial position or results of operations or cash flows 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, through the solicitation of proxies or otherwise, during the three months ended June 30, 1995.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nSet forth below are the names of the executive officers of the Company as of September 15, 1995. The executive officers of the Company are chosen 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.\nWestcott W. Price III, age 56, has been Vice Chairman of the Board of Directors of the Company since 1986, and has been a Director of the Company since 1984. Mr. Price was a Vice President of the Company from 1987 to 1989 and was elected President in 1989. Mr. Price joined FHP in 1981, first serving as Senior Vice President and later as Executive Vice President, and was elected President in 1987. Mr. Price became Chief Executive Officer of the Company in 1990.\nGloria Austin, age 41, joined FHP in 1978 and served in several executive capacities in FHP's Utah and California regional operations, including Associate Vice President, Utah Region Administration and Regional Vice President, Los Angeles. In February 1995, Ms. Austin became the Company's Senior Vice President, Health Care Delivery. In July 1995, Ms. Austin was appointed Senior Vice President, California of the Company's PPMC Division.\nValerie A. Fletcher, age 48, joined FHP in 1989 as Associate Vice President, Finance. In 1992, Ms. Fletcher was appointed Corporate Vice President, Accounting of FHP and in 1993 was elected Controller of the Company. In 1994, Ms. Fletcher became Vice President, Accounting of the Company.\nNick Franklin, age 52, joined FHP in 1990 and served as Vice President, Government Affairs before being appointed Senior Vice President, Public Affairs in 1993. In 1994, Mr. Franklin became Senior Vice President, Public Affairs of the Company.\nJohn F. Fritz, age 51, joined FHP in 1991 and served as Vice President and Chief Actuary of FHP and FHP Life Insurance Company before becoming President of FHP Life Insurance Company and a Senior Vice President of the Company in 1994. From 1976 to 1991, Mr. Fritz was a Vice President and Principal of Tillinghast, a Towers Perrin Co., in Irvine, California.\nGary E. Goldstein, M.D., age 45, joined FHP in 1982 from private practice and has held the positions of Regional Medical Director, Corporate Medical Director, and California Regional Vice President. He was appointed Corporate Vice President of Medical Affairs in 1990 and in 1992, a Senior Vice President of FHP. In 1994, Dr. Goldstein was appointed Senior Vice President, Medical Affairs of the Company. In July 1995, Dr. Goldstein was appointed Senior Vice President and Chief Medical Officer of the Company's PPMC Division.\nBurke F. Gumbiner, age 44, has been a Director of the Company since 1984 and was a Vice President from 1986 to November 1989, when he was appointed Senior Vice President. He joined FHP in 1977 and served in several executive capacities before being appointed a Senior Vice President in 1986. In 1994, Burke Gumbiner was appointed Senior Vice President and Chief Operating Officer, Insurance and Support Services of the Company. In August 1995, Mr. Gumbiner was appointed President of the Company's Insurance Division.\nR. Judd Jessup, age 47, joined the Company in 1994 as President of its Health Plans Division. In July 1995, Mr. Jessup was appointed President of the Company's HMO Division. Mr. Jessup was TakeCare Health Plan, Inc.'s Executive Director from June 1987 to January 1990 and was its President from January 1990 to March 1995. He served as President of TakeCare, Inc. from 1991 until June of 1994 when it was acquired by the Company.\nJeffrey H. Margolis, age 32, joined the Company in 1994 as Vice President, Information Services and Chief Information Officer. From 1993 to 1994, Mr. Margolis was Vice President and Chief Information Officer of TakeCare, Inc. From 1989 to 1991, Mr. Margolis was Director of Information Services of Comprecare, Inc. and from 1991 to 1993 he was Vice President and Chief Information Officer of Comprecare, Inc. In June 1995, Mr. Margolis was appointed a Senior Vice President of the Company.\nJack D. Massimino, age 46, first joined FHP in 1975 and served in several executive capacities, including Utah Regional General Manager, before leaving FHP in 1979 to join a health care consulting firm. He later served as President, CEO and a Director of Texas Health Plans from 1987 to 1988. In 1988, he returned to FHP as Vice President of Corporate Development and in 1990 was appointed a Senior Vice President of FHP. From 1994 to 1995 he served as the Company's Executive Vice President and Chief Operating Officer. In July 1995, Mr. Massimino was appointed President of the Company's PPMC Division.\nMichael A. Montevideo, age 41, joined FHP in 1985, became Treasurer of the Company and FHP in 1989 and was appointed an Associate Vice President of FHP in 1990 and a Vice President of FHP in 1993. In 1994, Mr. Montevideo became a Vice President of the Company.\nKenneth S. Ord, age 49, joined the Company in 1994 as Senior Vice President and Chief Financial Officer. From 1982 to 1994, he was employed by Kelly Services, Inc. in Troy, Michigan most recently as Vice President of Finance, Controller and Treasurer.\nEric D. Sipf, age 46, joined the Company in 1994 as Senior Vice President of Health Plans of the Company's Eastern Division. From 1985 to 1993, he was President and Chief Executive Officer of Comprecare, Inc. and from 1993 to 1994 was President of Comprecare Health Care Services, Inc. and TakeCare of Colorado, Inc.\nMichael J. Weinstock, age 54, has been General Counsel and Secretary of the Company and FHP since 1987. He became a Vice President of the Company and FHP in 1989 and a Senior Vice President of the Company and FHP in 1993.\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 traded over-the-counter on the National Association of Securities Dealers Automated Quotation (\"NASDAQ\") National Market System under the symbol \"FHPC.\" The following table sets forth the range of high and low closing bid prices per share for the fiscal periods indicated, as reported on the NASDAQ National Market System. Quotations represent prices between dealers and do not reflect retail markups, mark-downs or commissions and may not necessarily represent actual transactions.\nAs of September 15, 1995, the reported closing bid price per share was $23.00.\n(B) HOLDERS\nThe approximate number of holders of record of the Company's Common Stock as of August 31, 1995 was 730. This number did not include individual participants in security position listings. Based on available information, the Company believes there are several thousand beneficial holders of its Common Stock.\n(C) DIVIDENDS\nThe Company has retained its fiscal year 1995 earnings for use in its business and anticipates, for the foreseeable future, that no cash dividends will be paid on its Common Stock. The Company's Amended Credit Agreement restricts the payment of cash dividends on the Company's Common Stock.\nITEM 6.","section_6":"ITEM 6.SELECTED FINANCIAL DATA\nInformation with respect to this item is located at page 14 herein.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nInformation with respect to this item is located at pages 15 through 19 herein.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe following documents are 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\nThere have been no changes in the Company's independent auditors or disagreements with such auditors 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\nInformation with respect to Directors of the Company is incorporated by reference from the Company's 1995 Proxy Statement. Certain information relating to Executive Officers of the Company appears on pages 9 through 10 herein.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation with respect to this item is incorporated by reference from the Company's 1995 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 Company's 1995 Proxy Statement.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation with respect to this item is incorporated by reference from the Company's 1995 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 Form 10-K Annual Report:\n(a) Exhibits:\nSee the Exhibit Index on pages 43 through 45 herein.\n(b) Financial Statement Schedules:\nNone.\n(c) Reports on Form 8-K:\nNone filed during the three months ended June 30, 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.\nFHP INTERNATIONAL CORPORATION\nBy \/s\/ Westcott W. Price III ------------------------------ Westcott W. Price III, Chief Executive Officer and President\nDate: September 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.\nFHP INTERNATIONAL CORPORATION\nSELECTED FINANCIAL DATA\n- -------- (a) The Company acquired all of the outstanding common stock of TakeCare on June 17, 1994, as explained in Note 12 of the Notes to Consolidated Financial Statements. The Consolidated Financial Statements include the operations of TakeCare beginning June 17, 1994.\n(b) Earnings per share were computed as explained in Note 11 of the Notes to Consolidated Financial Statements.\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF\nFINANCIAL CONDITION AND RESULTS OF OPERATIONS\nBUSINESS RESTRUCTURING\nIn June, 1995, FHP International Corporation (\"FHP\" or the \"Company\") announced an internal restructuring (the \"Restructuring Plan\") of its operations. The Restructuring Plan was formulated in response to the intensely competitive environment in the HMO industry and continued declining membership in its Company-operated medical facilities. The Restructuring Plan consists of the sale of the Company's owned and operated hospitals, certain nonproductive real estate and other assets; a reduction in the Company's work force; and the creation of three distinct business segments: 1) a physician practice management company (\"PPMC\"); 2) the contract model health maintenance organization (\"HMO\"); and3) the Company's group life, health and accident and workers' compensation insurance and related products (collectively, the \"Insurance Group\").\nThe Restructuring Plan provides for sale of the Company's two acute care hospitals located in Fountain Valley, California and Salt Lake City, Utah (with a combined total of 356 licensed beds), sublease of two sub-acute facilities, disposal of certain nonproductive real estate and other assets, discontinuance of the Company's consulting product line and a reduction of the Company's work force. Accordingly, the Company recorded a pretax charge against earnings in the fourth quarter of $75.1 million. The charge primarily includes the write- down to the estimated net realizable value of the hospitals and other assets held for sale and costs associated with a reduction in work force of approximately 500 employees which took place in June, 1995. The Company further reduced its work force by approximately 200 employees in the first quarter of fiscal year 1996. Further reductions in the work force are likely. The costs of fiscal year 1996 work force reductions, together with costs associated with establishing the PPMC, will result in an additional provision for restructuring in fiscal year 1996 of up to $10 million. All asset sales that are part of the Restructuring Plan are expected to be completed by June 30, 1996. Net proceeds available from the sale of assets will be used to reduce indebtedness and for other corporate purposes.\nThe Restructuring Plan includes the creation of the PPMC, as a new subsidiary of the Company and the transfer of the Company's medical centers and related assets (located in California, Arizona, Utah, Nevada, and New Mexico) into the PPMC. Approximately 7,000 of the Company's employees, including health care professionals, will become employees of the PPMC or of several newly created professional corporations (the \"PCs\"). The PCs will enter into long-term practice management agreements with the PPMC, thereby enabling the PCs and PPMC to do business with other payors and HMOs, as well as with the Company's HMO. The PCs and PPMC are expected to be operational by January 1, 1996, subject to obtaining all necessary regulatory approvals.\nThe Company's HMO will be responsible for all the Company's HMO membership. The HMO will contract with the PCs to provide health care services for approximately 20% of the Company's HMO members who are already receiving health care in the Company's medical centers. The Company's contractual arrangements between the HMO and PCs will be financially similar to existing contracts between the HMO and other contract health care providers.\nThe Company will continue to operate its Insurance Group. The Insurance Group accounted for 3.7% of the Company's revenue and incurred an operating loss in fiscal year 1995. The products offered by the Insurance Group enable the Company to offer a full complement of health care products to employer groups.\nTAKECARE ACQUISITION\nThe Company acquired TakeCare, Inc. and its subsidiaries (\"TakeCare\") on June 17, 1994. The Company acquired all of the outstanding stock of TakeCare, for approximately $1,054.4 million. The acquisition was paid for by the issuance of approximately 21 million shares of Series A Cumulative Convertible Preferred Stock, 6.3 million shares of Common Stock, 79.2 thousand shares of Series B Adjustable Rate Cumulative Preferred Stock and approximately $360 million of cash.\nREVENUE AND MEMBERSHIP\nThe Company generates approximately 96% of its revenue from premiums received for health care services provided to the HMO members of its wholly-owned subsidiaries. The Company experienced significant revenue growth during the three-year period ended June 30, 1995, primarily due to the acquisition of TakeCare in June, 1994, and to growth in its HMO membership. Total revenue for the year endedJune 30, 1995, was $3,909.4 million, increasing 58.1% over revenue of $2,473.0 million for the previous year. The Company's year-over-year revenue growth was primarily due to the TakeCare acquisition. During fiscal year 1995, revenue growth was slowed by modest enrollment growth and intense pricing competition.\nTotal HMO membership grew 17.0%, 104.3%, and 3.9% in the three years ended June 30, 1993, 1994, and 1995, respectively. Membership growth in fiscal year 1994 was primarily due to the acquisition of TakeCare on June 17, 1994. Excluding TakeCare membership, total HMO membership growth in fiscal year 1994 was 10.5%. During fiscal year 1995, the Company experienced slower membership growth than in prior years, due primarily to intense competition in all its key markets. Membership growth in fiscal year 1995 resulted from contiguous expansion of HMO operations into new market areas, together with growth in existing markets. The Company's membership in fiscal year 1995 grew primarily in the Company's contract model plans. As FHP and TakeCare merged their California operations, the Company lost approximately 14,000 former TakeCare plan members in fiscal year 1995. Also, membership in Company-operated medical centers continued to decline. Continued slow membership growth may adversely impact the Company's operating results in fiscal year 1996.\nCommercial HMO membership grew 15.4%, 152.6%, and 2.9% for the years ended June 30, 1993, 1994, and 1995, respectively. Commercial HMO membership growth in fiscal year 1994 was primarily due to the acquisition of TakeCare. Excluding TakeCare commercial membership, commercial HMO membership growth in fiscal year 1994 was 10.7%. Senior membership grew 20.2%, 16.8%, and 7.8% for the fiscal years ended June 30, 1993, 1994, and 1995, respectively. Excluding TakeCare senior membership, senior HMO membership growth in fiscal year 1994 was 10.1%. During fiscal year 1995, regulatory approvals necessary for senior membership expansion in northern California were delayed, causing lower than expected senior growth. Regulatory approvals were completed in the fourth quarter of fiscal year 1995.\nThe Company generates approximately 51% of its HMO revenue from sales to the commercial market. The Company's ability to increase its commercial membership and commercial premium rates during the fiscal years ended June 30, 1994 and 1995, was adversely impacted by intense competition in all the Company's major markets, particularly in California. In addition, certain large employer groups and other purchasers of health care services continue to demand minimal increases or reductions in premium rates. Downward pressure on premium rates is expected to continue into fiscal year 1996 in all of the Company's major service areas. A substantial portion of the Company's HMO commercial premium rate increases becomes effective in January of each year.\nAlmost all of the Company's senior HMO revenue is generated from premiums paid to the Company by the Health Care Financing Administration (\"HCFA\"). The Company receives senior premium rate increases from HCFA on January 1 of each year. For calendar year 1995, the Company received an average 5.8% rate increase. Revenue per senior member is substantially higher than revenue per commercial plan member because senior members use substantially more health care services. In September of each year, HCFA announces the annual Medicare rate increases that will become effective on January 1 of the subsequent year. These rate increases vary geographically and become the basis for determining the amounts that HCFA will pay to the Company. Based upon the September, 1995, announcement, the Company currently estimates that it will receive an average 3.5% senior premium rate increase on January 1, 1996.\nFor the year ended June 30, 1995, the Company generated approximately 3.7% of its revenue from the sale of indemnity health, group life and workers' compensation insurance, and related lines of business. This compares to 4.4% for the previous fiscal year. In fiscal year 1994, the Company increased its investment in\nthe Insurance Group by approximately $25.0 million. During fiscal year 1995, the Company was faced with rate deregulation for workers' compensation insurance in California resulting in substantial rate decreases and loss of business in the state. Also, the Company's indemnity health subsidiaries have been facing an increasingly competitive market. The Company does not anticipate that its Insurance Group will represent a material portion of revenues or profits in fiscal year 1996.\nCOST OF HEALTH CARE\nA significant factor affecting the Company's profitability is its ability to manage and control its health care costs. Since the Company receives fixed monthly premiums, an unusually high number of catastrophic claims (such as organ transplants and costly premature births) may cause substantial additional health care costs. Periodically, the Company's results of operations may be affected by such costs. Management believes that the Company's cost control measures, which include risk-sharing arrangements with its contract medical providers along with administrative and medical review of its health care delivery services, help to mitigate the effects of rising health care costs.\nDuring the last three years, certain Company-operated medical centers in California have experienced high operating costs relative to declining enrollment. The economic recession has resulted in permanent job losses in certain industries in southern California whose employees were traditionally enrolled in Company-operated medical centers. Also, the competitive environment and the proliferation of managed care health plan choices have contributed further to a decline in membership in Company-operated medical centers. This has created excess capacity and therefore, higher health care costs as a percentage of revenue.\nThe following table sets forth the percentage relationships of various income statement items to revenue for the periods indicated:\nFiscal Year 1995 Compared to Fiscal Year 1994\nRevenue increased 58.1% to $3,909.4 million for fiscal year 1995 from $2,473.0 million for fiscal year 1994, primarily due to the acquisition of TakeCare.\nHealth care costs increased 57.4% to $3,238.5 million for fiscal year 1995 from $2,057.7 million for fiscal year 1994, primarily due to the TakeCare acquisition. Health care costs decreased to 82.8% of revenue in 1995 from 83.2% in 1994, primarily due to the lower average cost of health care in the former TakeCare health plans. Notwithstanding the year-over-year improvement, the Company's cost of health care was adversely impacted by excess capacity in Company-operated medical centers.\nGeneral, administrative, and marketing (\"G&A\") expenses increased 57.0% to $521.7 million for fiscal year 1995 from $332.2 million for fiscal year 1994, primarily as a result of the acquisition of TakeCare. G&A expenses as a percentage of revenue were 13.3% in fiscal year 1995, down slightly from 13.4% in fiscal year 1994. Fiscal year 1995 G&A expenses included approximately $26.7 million of goodwill amortization arising from the TakeCare transaction on June 17, 1994. In fiscal year 1994, goodwill amortization relating to the TakeCare transaction was approximately $1.0 million.\nNet interest income was $6.1 million for fiscal year 1995 as compared to $13.8 million for the previous year. Net interest income declined year-over- year, primarily because of additional interest expense due to an increase in debt related to the acquisition of TakeCare.\nFiscal Year 1994 Compared to Fiscal Year 1993\nRevenue increased 23.3% to $2,473.0 million for fiscal year 1994 from $2,005.9 million for fiscal year 1993. Approximately 67.3% of revenue was generated by contract model membership, and approximately 28.3% of revenue was generated by membership in Company-operated medical centers during fiscal year 1994. Approximately 4.4% of the Company's revenue was generated by the Insurance Group.\nHealth care costs increased 22.4% to $2,057.7 million for fiscal year 1994 from $1,681.1 million for fiscal year 1993, primarily due to membership growth during the period. Health care costs decreased to 83.2% of revenue in 1994 from 83.8% in 1993, primarily due to improvement in the Company's health administration and health operations costs. In addition, pharmacy costs in Arizona, as well as optometry costs in California and Nevada, were significantly reduced. The Company experienced certain health care cost increases during the year. In Utah, the Company opened its own acute care hospital in August, 1993. The hospital did not reach break-even occupancy by the end of the fiscal year. California and Nevada experienced higher physician services costs as a percent of revenue in fiscal year 1994 than in fiscal year 1993.\nG&A expenses increased 23.2% to $332.2 million for fiscal year 1994 from $269.6 million for the fiscal year 1993, primarily as a result of growth in the Company's operations. G&A expenses as a percentage of revenue were 13.4% in fiscal year 1994, unchanged from 13.4% in fiscal year 1993. Cost control measures included hiring freezes, reductions in the Company's work force, and administrative reorganizations.\nNet interest income was $13.8 million for fiscal year 1994 as compared to $14.7 million for the previous year. The decrease in net interest income was primarily the result of interest expense on $100 million of 7% Senior Notes due 2003 (the \"Notes\") issued in September, 1993, and a decrease in capitalized interest of approximately $2 million, due to the completion of several major construction projects including the Company's Utah hospital. The decreases were partially offset by higher average invested cash balances during the period.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company's consolidated cash, cash equivalents, and short-term investments increased by $209.6 million to $456.4 million at June 30, 1995, from $246.8 million at June 30, 1994. The increase includes the early receipt in June, 1995, of approximately $152.0 million of premiums from HCFA due on July 1, 1995, for medical services to be provided to senior members in July, 1995. Other major sources of cash during the fiscal year ended June 30, 1995, included cash generated from operations (net of the early receipt of HCFA premiums) of $135.0 million and net transfers of $37.4 million from long-term investments. Uses of cash during fiscal year 1995 included $72.1 million for capital expenditures, $26.3 million for Preferred Stock dividends, and $35.2 million net reductions in borrowings.\nIn order to fund a major portion of the cash required for the TakeCare acquisition, the Company entered into a $350 million Credit Agreement (the \"Credit Agreement\") in March, 1994. The Credit Agreement originally provided for a $250 million five-year Term Loan facility (the \"Term Loan\") and a $100 million five-year Revolving Credit facility (the \"Revolving Credit Loan\"). The Credit Agreement was amended in March, 1995, and currently provides a $200 million Revolving Credit Loan and a $150 million Term Loan. The Term Loan and Revolving Credit Loan carry interest rates currently ranging from 6.1% to 6.9% based on LIBOR rate borrowings. The Term Loan is repayable at the rate of $15 million every six months, commencing on September 29, 1995. The final payment is due March 31, 2000. The Credit Agreement contains financial and other covenants, including limitations on indebtedness, liens, dividends, sale and lease-back transactions, and certain other transactions.\nThe Company's ability to make a payment on, or repayment of, its obligations under the Notes, the Credit Agreement, and dividends on its preferred stock is significantly dependent upon the receipt of funds by the Company from the Company's direct and indirect subsidiaries. These subsidiary payments represent: (a) fees for management services rendered by the Company to the subsidiaries; and (b) cash dividends by the subsidiaries to the Company. Nearly all of the subsidiaries are subject to HMO regulations or insurance regulations and may be subject to substantial supervision by one or more HMO regulators and insurance regulators (the \"Regulated Subsidiaries\"). Each of the Regulated Subsidiaries must meet or exceed various fiscal standards imposed by HMO regulations or insurance regulations. These fiscal standards may, from time to time, impact the amount of funds paid by one or more of the Regulated Subsidiaries to the Company.\nThe Company believes the payments referred to above by the Regulated Subsidiaries, together with other financing sources, including the Credit Agreement, should be sufficient to enable the Company to meet its payment obligations (totaling approximately $80 million annually) under the Notes, the Credit Agreement and the Company's Preferred Stock. The Company believes that cash flow from operations, the Credit Agreement and existing cash balances will be sufficient to continue to fund operations and capital expenditures for the foreseeable future. Also, sales of real property under the Restructuring Plan are expected to generate net cash to the Company in fiscal year 1996 which is intended to be used to reduce indebtedness and for other corporate purposes.\nEffects of Regulatory Changes and Inflation\nRecently, the Company has been informed by HCFA that effective January 1, 1996, it will receive an annual premium rate increase of approximately 3.5% for its Senior Plan members. Over calendar years 1994 and 1995, annual Senior Plan premium increases granted by HCFA were approximately 2.0% and 5.8%, respectively. Periodically, the Company evaluates the effects of HCFA premium adjustments on its liquidity and capital resources, and incorporates the actual and anticipated impact of such adjustments into its planning process.\nThe Company has been experiencing significant downward pressures on commercial HMO membership growth and premium rates due to competition and measures by large employer groups and other purchasers of health care services attempting to hold their costs down. The Company may not be able to obtain premium rate increases and may see some premium rate reductions in its commercial HMO business in the short term. Also in recent years health care costs have been rising at a rate higher than that for consumer goods as a whole, as a result of inflation, new technology, and medical advances. There can be no assurance that these trends will be reversed in the short term.\nFHP INTERNATIONAL CORPORATION\nCONSOLIDATED BALANCE SHEETS\nASSETS\nSee accompanying Notes to Consolidated Financial Statements.\nFHP INTERNATIONAL CORPORATION\nCONSOLIDATED STATEMENTS OF INCOME\nSee accompanying Notes to Consolidated Financial Statements.\nFHP INTERNATIONAL CORPORATION\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY\nSee accompanying Notes to Consolidated Financial Statements.\nFHP INTERNATIONAL CORPORATION\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (CONTINUED)\nSee accompanying Notes to Consolidated Financial Statements.\nFHP INTERNATIONAL CORPORATION\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nSee accompanying Notes to Consolidated Financial Statements.\nFHP INTERNATIONAL CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1--ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES\nOrganization\nFHP International Corporation (the \"Company\"), through its direct and indirect subsidiaries, delivers managed health care services and sells indemnity medical, group life, and workers' compensation insurance.\nOn June 17, 1994, the Company completed its acquisition of TakeCare, Inc. (\"TakeCare\") in exchange for cash, Common Stock, and Preferred Stock. The acquisition was accounted for as a purchase business combination, and consequently, all balances and results of operations of TakeCare since the date of acquisition have been included in the accompanying financial statements (Note 12).\nMost of the Company's subsidiaries are federally qualified, licensed health maintenance organizations (\"HMO\") which provide comprehensive health care to their members for a fixed monthly fee per member. In the course of providing health care services to commercial and governmental employees, the Company extends credit to various federal government agencies and hospitals, independent physician groups, and to other health care providers and intermediaries located in California, Colorado, Arizona, Utah, Guam, New Mexico, Texas, Illinois, Nevada, Ohio, Indiana, and Kentucky.\nPrinciples of Consolidation\nThe accompanying consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany accounts and transactions have been eliminated.\nRegulatory Requirements\nThe Company's regulated subsidiaries must comply with certain minimum capital or tangible net equity requirements in each of the states in which they operate. As of June 30, 1995, all of the Company's regulated subsidiaries were in compliance with these requirements.\nRevenue Recognition and Health Care Costs\nMedicare risk contracts with the Health Care Financing Administration (\"HCFA\") provided 45%, 63%, and 65% of revenue in fiscal years 1995, 1994, and 1993, respectively. The Company's HMOs are paid a prospectively determined per capita monthly payment for each Medicare beneficiary enrolled in the HMOs. This capitated payment is the projected actuarial equivalence of 95% of the amount Medicare would have paid for the Medicare beneficiaries if they had received services from a fee for service Medicare provider or supplier. The HMOs must absorb any difference between the Medicare prepaid amounts and the actual costs the HMOs incur for providing services and are therefore at risk.\nPremiums from enrolled groups for prepaid health care are recognized as revenue in the month in which the enrollees are entitled to care. Unearned premiums represent cash received from employer groups and HCFA in advance of the applicable period of coverage. Health care costs are recorded in the period when services are provided to enrolled members, including estimates for contracted medical specialists and hospital costs which have been incurred as of the balance sheet date but not yet reported. The estimates for accrued health care costs are based on historical studies of claims paid. The methods for making such estimates and for establishing the resulting reserves are continually reviewed and updated, and any adjustments resulting therefrom are reflected in current operations. While the ultimate amount of claims and the related expenses paid are dependent on future developments, management is of the opinion that the liability for medical claims payable is adequate to cover such medical claims and expenses.\nFHP INTERNATIONAL CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nAdvertising Costs\nThe Company recognizes advertising costs in accordance with the American Institute of Certified Public Accountants' Statement of Position 93-7, \"Reporting on Advertising Costs.\"\nAdvertising expense was $37,018,000, $23,800,000, and $17,018,000 for the fiscal years ended June 30, 1995, 1994, and 1993, respectively.\nCash Equivalents\nThe Company considers all highly-liquid investments with a maturity of three months or less when purchased to be cash equivalents. The carrying value of cash and cash equivalents approximates fair value based on their short-term maturity.\nShort-term, Long-term, and Restricted Investments\nEffective June 30, 1994, the Company adopted Statement of Financial Accounting Standards No. 115 (\"SFAS 115\"), \"Accounting for Certain Investments in Debt and Equity Securities.\" The Company has classified all of its investment portfolio as \"available-for-sale.\" In accordance with SFAS 115, investments classified as available-for-sale are carried at fair value, and unrealized gains or losses (net of applicable income taxes) are reported in a separate caption of stockholders' equity.\nShort-term, long-term, and restricted investments consist of U.S. Treasury securities, certificates of deposit, and other marketable debt securities. Long-term investments have maturities in excess of one year. Restricted investments primarily include investments placed on deposit with various state regulatory agencies to comply with regulatory requirements.\nIncome Taxes\nThe Company utilizes the asset and liability method of accounting for income taxes. Under this method, income taxes are recognized for (a) the amount of taxes payable or refundable for the current year and (b) deferred tax liabilities and assets for the future tax consequences of events that have been recognized in the Company's financial statements or tax returns. The effects of income taxes are measured based on enacted tax law and rates. Deferred tax assets and liabilities are established for temporary differences between the financial reporting basis and 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.\nAccounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of\nIn March, 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121 (\"SFAS 121\"), \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of.\" As permitted by SFAS 121, the Company elected to adopt the statement as of June 30, 1995. In accordance with SFAS 121, long-lived assets to be held will be reviewed for events or changes in circumstances which would indicate that the carrying value may not be recoverable. Assets held for sale are accounted for at the lower of carrying amount or fair value, less costs to sell, since management has committed to a plan to dispose of the assets. The adoption of SFAS 121 had no effect on the consolidated financial statements for fiscal year 1995. In accordance with SFAS 121, prior period financial statements have not been restated.\nFHP INTERNATIONAL CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nProperty and Equipment\nProperty and equipment are recorded at cost. Depreciation and amortization are provided principally by the straight-line method over the estimated useful lives of the respective classes of assets as follows: buildings, 20 to 40 years; leasehold improvements, lesser of the useful lives (three to ten years) or the lease term; and equipment and fixtures, three to ten years. Property and equipment also includes capitalized interest expense of approximately $471,000, $596,000, and $2,597,000 in fiscal years 1995, 1994, and 1993, respectively, associated with the Company's major construction projects.\nGoodwill and Other Intangibles\nGoodwill arose primarily from the purchase of TakeCare (Note 12). Amortization is provided on a straight-line basis over periods not exceeding 40 years. In addition to goodwill, other intangible assets resulting from business acquisitions consist of the economic value of purchased membership, customer contracts, and covenants not-to-compete. Intangibles are amortized on a straight-line basis over their estimated useful lives ranging from 3 to 30 years. The Company periodically evaluates whether events and circumstances have occurred which may affect the estimated useful life or the recoverability of the remaining balance of its intangibles. At June 30, 1995, the Company's management believed that no material impairment of goodwill or other intangible assets existed. Amortization charged to continuing operations amounted to $31,506,000, $5,284,000, and $1,163,000 for fiscal years 1995, 1994, and 1993, respectively. Accumulated amortization was $34,738,000, $6,685,000, and $1,401,000 for the fiscal years ended June 30, 1995, 1994, and 1993, respectively.\nOther Assets\nThe principal components of other assets are as follows:\nReclassifications\nCertain prior year amounts have been reclassified to conform to the 1995 financial statement presentation.\nFHP INTERNATIONAL CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 2--PROPERTY AND EQUIPMENT\nProperty and equipment consist of the following:\nIn June, 1995, the Company's Board of Directors authorized the sale of the Company's two acute care hospitals and other nonproductive real estate (Note 13). Property and equipment with an estimated net realizable value of $136,477,000 have been reclassified to assets held for sale in the Consolidated Balance Sheets as of June 30, 1995.\nTotal depreciation and amortization expense related to property and equipment was $48,559,000, $39,987,000, and $28,749,000 for fiscal years 1995, 1994, and 1993, respectively.\nNOTE 3--OTHER LIABILITIES\nFrom January, 1984, through March, 1986, the Company maintained commercial insurance on a claims occurrence basis with nominal deductibles. Since April, 1986, the Company has maintained commercial insurance on a claims made basis. The Company currently carries $50,000,000 of professional liability insurance with annual deductibles of $2,000,000 per occurrence and $12,000,000 in the aggregate.\nAn estimate of the Company's liability for professional liability claims, including deductibles, was actuarially computed on a present value basis using a discount rate of 7%, and amounted to approximately $35,525,000 and $31,400,000 at June 30, 1995 and 1994, respectively. Such amounts are allocated between other current liabilities and other liabilities based on estimates of the amounts of claims which will be paid during the subsequent fiscal year (Note 8).\nOther liabilities also include approximately $30,001,000 and $40,785,000 of reserves for losses and loss adjustment expenses at June 30, 1995 and 1994, respectively, associated with the Company's insurance operations. These reserves are estimates based on actuarial computations and industry standards for the eventual costs of claims incurred but not settled, less reinsurance recoverable from other companies.\nAs claims are settled, as amounts required to settle become known, and as anticipated claims are actuarially revised, the professional liability and loss reserve expenses and liabilities are adjusted accordingly.\nFHP INTERNATIONAL CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 4--LONG-TERM OBLIGATIONS\nLong-term obligations consist of the following:\nScheduled maturities of long-term obligations are as follows:\nIn March, 1994, in connection with the acquisition of TakeCare (Note 12), the Company entered into a $350 million credit agreement with a group of banks which provided for a $250 million term loan facility and a $100 million revolving credit facility (the \"Credit Agreement\"). The Credit Agreement was amended in March, 1995, and currently provides a $200 million revolving credit facility and a $150 million term loan facility. The amended Credit Agreement expires March 31, 2000. Prime rate, LIBOR based, and competitive bid (revolving credit facility only) interest rate options are available for borrowings under the Credit Agreement. In addition, a facility fee of 0.125% is payable, regardless of usage, on the $200 million revolving credit facility portion of the Credit Agreement.\nThe Credit Agreement contains financial and other covenants. The Company was in compliance with these covenants as of June 30, 1995.\nFHP INTERNATIONAL CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 5--INCOME TAXES\nThe components of the provision for income taxes are summarized as follows:\nThe deferred (benefit) provision for income taxes results from reporting the following items in different periods for financial statement and income tax purposes:\nThe provision for income taxes differs from the amount of tax determined by applying the Federal statutory rate to pretax income. The components of this difference are summarized as follows:\nFHP INTERNATIONAL CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nThe tax effects of significant items comprising the Company's net deferred tax assets are as follows:\nThere was no change in the valuation allowance during the years ended June 30, 1995 and 1994.\nNOTE 6--INVESTMENTS AND FAIR VALUE OF OTHER FINANCIAL INSTRUMENTS\nGross unrealized gains and losses and a comparison of amortized cost and estimated fair value are presented in the table below:\nFHP INTERNATIONAL CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nRealized gains or (losses) on available-for-sale investments are calculated on the specific identification method and were $5,232,000 and ($880,000), respectively, in fiscal year 1995.\nThe contractual maturities of short-term, long-term, and restricted investments at June 30, 1995, were as follows:\nThe Company also determined that investments, classified as short-term, are available for use in current operations and, accordingly, classified such investments as current assets without regard to the investments' contractual maturity dates.\nThe fair value of short-term, long-term, and restricted investments is estimated based on quoted market prices. The fair value of the Company's long- term obligations are estimated to be equivalent to its carrying value.\nFHP INTERNATIONAL CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 7--EMPLOYEE BENEFITS\nThe Company has a defined contribution pension plan (\"Pension Plan\") and an Employee Stock Ownership Plan (\"ESOP\") covering substantially all employees. Under the provisions of these plans, the Company contributed into trusts for the benefit of employees an amount equal to 12% of eligible annual compensation, as defined, of all plan participants. Effective January 1, 1995, the contribution rate was reduced to 8% of eligible annual compensation, as defined. Participants do not vest until they have completed five years of service with the Company. Nonvested contributions, which are forfeited upon an employee's termination, are treated as a reduction in the amount of the Company's contribution. The combined contribution expenses for the Pension Plan and ESOP were $32,844,000, $35,020,000, and $32,970,000 for fiscal years 1995, 1994, and 1993, respectively.\nUnder an Executive Incentive Plan (the \"Plan\"), the Company is authorized to grant restricted stock awards, incentive stock options, nonqualified stock options, and bonus awards to directors, officers, key employees, consultants, and other agents. Under the terms of the Plan, the exercise price of the stock options must be equal to the fair market value of the Company's Common Stock at the date of grant. All stock options granted by the Company through June 30, 1995, were nonqualified.\nBeginning July 1, 1992, the first of a series of four annual stock option grants were made to certain executives under the Plan. These grants are intended to provide a strong linkage between long-term incentives and the Company's financial performance. Accelerated vesting of each of these stock options is tied directly to growth in the Company's earnings per share (\"EPS\"). Total stock options for 300,000, 435,000, and 1,085,000 shares were granted under this plan on July 1, 1994, 1993, and 1992, respectively. Each year's stock option grant allows the optionee up to six consecutive annual opportunities for accelerated vesting of portions of the employee's stock options only if the Company's EPS exceeds both: (1) EPS for the previous fiscal year and (2) average EPS for the two previous fiscal years. The terms of accelerated vesting for 25% of the stock options granted on July 1, 1992, and 10% of the stock options granted on July 1, 1993, have been met. The terms of accelerated vesting for stock options granted July 1, 1994, have not been met. If a stock option in the series does not become subject to accelerated vesting by the sixth anniversary of its grant, the stock option automatically becomes vested on the seventh anniversary of its grant. The Company may periodically issue stock options under similar terms and conditions as those above.\nIn addition to the options described above, the Company has granted other options. All options granted are included in the following summary of stock option activity for fiscal years 1995, 1994, and 1993:\nAt June 30, 1995, 1,179,000 shares remained available under the Plan for future grants of stock awards and stock options. Outstanding stock options at June 30, 1995, expire at the earlier of the date the stock option holder ceases to be an employee or a director, or ten years after the date of grant, based on the date of grant of the original stock options.\nFHP INTERNATIONAL CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nThe Company established a deferred compensation plan in July, 1991, for certain of its executives and physicians which is designed to provide supplemental retirement income benefits by enabling the participants to defer receipt of up to 50% of their gross annual salaries and 100% of their gross annual bonuses. Amounts deferred by employees are included in other liabilities and these deferred amounts are deemed to be invested in one or more mutual funds selected by the participants. The Company pays premiums on individual life insurance policies whose policy benefits are equal to the deferred amounts. Account balances, including earnings from investments, are distributed to a participant upon two years' advance request or upon a participant's termination of employment, death, or disability. Such distributions are substantially offset by any values in the cash surrender value of the life insurance policies provided by the Company which are included in other assets.\nIn fiscal year 1995, the Company's Board of Directors and shareholders approved the Employee Stock Purchase Plan, effective January 1, 1995. The plan provides employees of the Company with an opportunity to purchase the Company's Common Stock once annually with after tax income set aside through payroll deductions. Eligible employees may defer up to a specified amount from annual compensation to purchase shares of the Company's Common Stock at 85% of the market price on the last day of each annual offering period. No shares were purchased in fiscal year 1995, as the first purchase date is December 18, 1995.\nOn November 1, 1989, 187,000 shares of Common Stock were issued as restricted stock awards at a purchase price of $0.02 per share. Compensation expense was determined based on the excess of the estimated market value of the stock over the purchase price on the date of the grant and was recognized ratably over the vesting period which ended on October 31, 1992.\nNOTE 8--COMMITMENTS AND CONTINGENCIES\nOperating Leases\nThe Company leases certain buildings and equipment under operating leases. Future minimum rental payments required under operating leases that have initial or remaining noncancellable lease terms in excess of one year as of June 30, 1995, are as follows:\nTotal rental expense on operating leases aggregated $34,956,000, $28,663,000, and $23,579,000 for fiscal years 1995, 1994, and 1993, respectively.\nOPM Audit\nThe Company contracts with the United States Office of Personnel Management (\"OPM\") to provide or arrange managed health care services under the Federal Employees Health Benefits Program (\"FEHBP\") for federal employees, annuitants, and their dependents. OPM is the Company's largest commercial customer. These contracts with OPM and applicable government regulations establish premium rating requirements\nFHP INTERNATIONAL CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nfor the FEHBP. OPM conducts periodic audits of its contractors to, among other things, verify that the premiums established under the OPM contracts are established in compliance with the community rating and other requirements under the FEHBP. In May, 1993, after conducting a periodic audit of the Company's FEHBP contracts covering primarily the years 1988 through 1991, OPM sent a draft audit report to the Company alleging certain defects in the Company's rating practices under applicable regulatory and contractual requirements and invited the Company to comment. Following its evaluation of the additional information and comments provided by the Company, the OPM auditors will issue a final report; the OPM Audit Resolution Division will then be responsible for resolving the audit findings. As part of the resolution process, the Audit Resolution Division may reconsider the findings of the auditors and the information provided by the Company.\nIt is likely that the final audit report will recommend that OPM seek a monetary recovery from the Company and that such recommended recovery could be a substantial amount. At this time, the Company's management and legal counsel are unable to determine the amounts that may be required to be refunded to OPM to resolve the audit findings. Management currently believes, however, that after application of available offsets and consideration of established reserves, amounts ultimately required to be refunded to OPM will not have a material adverse effect on the consolidated financial position or results of operations or cash flows of the Company. In addition, the Company's management currently does not believe that the audit will have a material effect on future relations with OPM.\nLitigation\nDuring the ordinary course of business, the Company and its subsidiaries have become a party to pending and threatened legal actions and proceedings, a significant number of which involve alleged claims of medical malpractice. Management of the Company is of the opinion, taking into account its insurance coverage and reserves that have been established, that the outcome of the currently known legal actions and proceedings will not, singly or in the aggregate, have a material effect on the consolidated financial position or results of operations or cash flows of the Company and its subsidiaries.\nNOTE 9--NOTES RECEIVABLE FROM EMPLOYEE STOCK OWNERSHIP PLAN\nDuring fiscal year 1993, the ESOP repaid to the Company amounts previously loaned of $4,150,000. The loans were made to enable the ESOP to purchase the Company's Common Stock on a periodic basis and were repaid from periodic contributions to the ESOP received from the Company (Note 7).\nThe Company currently makes quarterly contributions (pursuant to the annual contribution described in Note 7) to the ESOP to fund quarterly purchases by the ESOP on the open market. For fiscal years 1995, 1994, and 1993, the Company contributed $9,315,000, $9,140,000, and $6,870,000, respectively for this purpose.\nNOTE 10--STOCKHOLDERS' EQUITY\nIn June, 1994, the Company amended its Certificate of Incorporation to increase the authorized number of shares of Common Stock from 70,000,000 to 100,000,000 and the authorized number of shares of Preferred Stock from 5,000,000 to 40,000,000. As the Company issues Preferred Stock, it is designated as either Series A Cumulative Convertible Preferred Stock (\"Series A Preferred Stock\") or Series B Adjustable Rate Cumulative Preferred Stock (\"Series B Preferred Stock\"). The Company issued 6,311,781 shares of Common Stock, 21,031,733 shares of Series A Preferred Stock, and 32,850 shares of Series B Preferred Stock as merger consideration in the acquisition of TakeCare as of June 17, 1994 (Note 12). An additional 3,876 shares of Common Stock, 8,574 shares of Series A Preferred Stock, and 46,368 shares of Series B Preferred Stock were issued during fiscal year 1995 to TakeCare shareholders for shares unpresented at the acquisition date.\nFHP INTERNATIONAL CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nHolders of the Series A Preferred Stock are entitled to receive cumulative cash dividends of 5.0% per annum. Dividends are payable quarterly in arrears when and if declared by the Company's Board of Directors. Dividends declared during fiscal year 1995 were $26,230,000. On or after the fourth anniversary of the acquisition, the Company may, at its option, redeem all or part of the outstanding shares of Series A Preferred Stock, at fixed redemption prices per share plus an amount equal to any accrued and unpaid dividends. Each share of Series A Preferred Stock may be convertible at the option of the holder into the Company's Common Stock at any time commencing six months after the acquisition date. The conversion price for the Series A Preferred Stock is $31 per share.\nHolders of Series B Preferred Stock are entitled to receive cumulative cash dividends of not less than 5.0% per annum or greater than 11.0% per annum. The actual dividend rate is determined quarterly based upon prevailing market interest rates. During fiscal year 1995, the dividend rate ranged from 6.245% to 7.454%. Dividends are payable quarterly in arrears when and if declared by the Company's Board of Directors. Dividends declared during fiscal year 1995 were $139,000. The Company may, at its option, redeem all or part of the outstanding shares of Series B Preferred Stock at $25 per share plus an amount equal to accrued and unpaid dividends.\nIn June, 1990, the Board of Directors of the Company declared a dividend of one common share purchase right (a \"Right\") for each outstanding share of common stock to the holders of record on June 29, 1990, and authorized and directed the issuance of one Right with respect to each share of common stock that shall become outstanding prior to the occurrence of certain terminating events. Each Right entitles the registered holder to purchase from the Company one-fourth of a share of common stock at a price which varies based on the market price of a share of the Company's stock ($23.00 at June 30, 1995), subject to adjustment (the \"Purchase Price\"). Upon the occurrence of certain events associated with an unsolicited takeover attempt of the Company, the Rights will become exercisable and will cease to automatically trade with the common stock. Thereafter, upon the occurrence of certain further triggering events, each Right will become exercisable, at an adjusted Purchase Price (the \"Adjusted Purchase Price\") equal to four times the Purchase Price immediately prior to such adjustment, for that number of shares of common stock having a market value of two times such Adjusted Purchase Price. The Rights have certain anti-takeover effects that will cause substantial dilution to a person or group that attempts to acquire the Company in a manner which causes the Rights to become exercisable. The terms of the Rights may be amended by the Board of Directors of the Company without the consent of the holders of the Rights. At June 30, 1995, there was one Right outstanding for each share of common stock outstanding and a sufficient number of authorized but unissued shares of common stock available for issuance upon (i) the exercise of the Rights, (ii) the issuance of common stock (and associated Rights) in connection with the future exercise of outstanding stock options, and (iii) the issuance of common stock (and associated Rights) in connection with the future conversion of the Series A Preferred Stock.\nNOTE 11--EARNINGS PER SHARE ATTRIBUTABLE TO COMMON STOCK\nEarnings per share for fiscal years 1995, 1994, and 1993, were computed by dividing net income attributable to Common Stock by 41,057,000, 34,051,000, and 33,270,000 shares, respectively, which represent the weighted average number of outstanding common shares and common share equivalents during the respective periods. Common share equivalents include the effect of dilutive stock options calculated using the treasury stock method.\nPrimary and fully diluted earnings per share are the same for each year presented.\nFHP INTERNATIONAL CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 12--ACQUISITIONS\nThe Company acquired all of the outstanding common stock of TakeCare on June 17, 1994, in a transaction treated as a purchase for accounting purposes. The consolidated financial statements include the operations of TakeCare beginning June 17, 1994. The purchase price was approximately $1,054.4 million, net of acquisition costs.\nThe following table summarizes the unaudited pro forma consolidated results of operations of the Company as though the acquisition of TakeCare had occurred on July 1, 1992. The unaudited pro forma consolidated results of operations shown below do not necessarily represent what the consolidated results of operations of the Company would have been if the acquisition had actually occurred on July 1, 1992, nor do they represent a forecast of the consolidated results of operations of the Company for any future period.\nIn January, 1995, the Company acquired a third party administrator located in Nevada for approximately $1.9 million. The acquisition, which has been accounted for as a purchase, was consummated through the issuance of approximately 73,000 shares of the Company's Common Stock. As a result of the purchase, the Company recorded goodwill of approximately $1.4 million.\nIn October, 1993, the Company acquired an approximately 4,700 member HMO located in Denver, Colorado, for approximately $3.5 million. The Company also obtained a covenant not-to-compete for which it paid $0.5 million (Note 1). The acquisition, which has been accounted for as a purchase, was financed through cash generated from operations of the Company. During fiscal year 1995, under a contract clause tied to retained membership on the first anniversary of the transaction, the Company made an additional payment of approximately $0.8 million. As a result of the purchase, the Company recorded goodwill of approximately $1.8 million.\nIn March, 1993, the Company acquired an insurance carrier and its subsidiaries for approximately $21.7 million, net of cash acquired. Through its subsidiaries, it offers workers' compensation insurance in California and Arizona and provides various claims administration services. The acquisition, which has been accounted for as a purchase, was financed through cash generated from operations of the Company. As a result of the purchase, the Company recorded goodwill of approximately $2.5 million. The Company also obtained a covenant not-to-compete for which it paid $4.0 million (Note 1).\nNOTE 13--RESTRUCTURING CHARGE\nIn June, 1995, the Company's Board of Directors approved a restructuring plan involving the discontinuance of services and programs that do not meet the Company's strategic and economic return objectives, a reduction in workforce, and the creation of a physician practice management company (\"PPMC\"), which will be operated as a subsidiary of the Company. The PPMC will encompass all of FHP's Company-operated medical facilities in California, Utah, Arizona, New Mexico, and Nevada. In addition, the Board of Directors decided to sell the Company's two acute care hospitals and other nonproductive real\nFHP INTERNATIONAL CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) estate. The formation of the PPMC, anticipated for January 1, 1996, will entail added operating costs during the first six months of fiscal 1996. These costs include duplicate employees during the transition period, separation expenses for displaced employees, and the cost of developing new computer systems to handle fee for service business and other HMO and preferred provider organization customers. The restructuring plan was announced to the affected employees prior to the Company's fiscal year end.\nAccordingly, the Company recorded a pretax restructuring charge of $75.1 million ($46.6 million, net of tax) in the accompanying Consolidated Statements of Income for the fiscal year ended June 30, 1995. Included in this charge are the expected costs of employee separations ($6.8 million), asset write-downs to estimated net realizable values ($58.9 million), and certain other costs associated with the Company's restructuring of its operations ($9.4 million). Assets identified as those to be sold as part of the restructuring have been reclassified as assets held for sale in the accompanying Consolidated Balance Sheets as of June 30, 1995, and are expected to be disposed of by the end of fiscal year 1996 (Notes 1 and 2).\nThe restructuring charge is based on the Company's estimate and will continue to be refined until the restructuring plan is complete.\nNOTE 14--INFORMATION REGARDING THE COMPANY'S OPERATIONS IN DIFFERENT SEGMENTS\nThe Company offers a full range of products to achieve its strategic goal of becoming a sole source provider of health care services. These products can be classified into two principal segments of business: HMO and insurance services. The HMO offers a full range of related products to consumers and employers in the direct delivery of managed health care services, either through contracted health care providers or through Company-operated medical centers. Complementing the operations of the HMO are the products offered by the insurance segment. These products include traditional indemnity health and life insurance, workers' compensation, and third party administration of self- insured employer programs. Often, the products offered by the HMO and insurance segments are sold to the same account; that is, an employer is able to offer a \"dual choice\" to employees of enrollment in either the HMO or the indemnity product provided through group health insurance coverage.\nFHP INTERNATIONAL CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nInformation regarding the two segments is summarized below:\nFHP INTERNATIONAL CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 15--UNAUDITED QUARTERLY INFORMATION\n- -------- (a) The net loss for the fourth quarter ended June 30, 1995, included an unfavorable net adjustment due to a restructuring charge of approximately $46.6 million, net of tax, relating primarily to the costs of employee separations, asset write-downs to estimated net realizable values, and certain other costs associated with the restructuring of the Company's operations (Note 13).\n(b) Fully diluted earnings per share is not presented if it is anti-dilutive.\n(c) Net income for the fourth quarter ended June 30, 1994, included TakeCare's operations from the date of acquisition (June 17, 1994) and other favorable net adjustments of approximately $838,000, resulting primarily from changes of estimates with respect to certain fiscal year 1994 compensation and benefit related accruals and reserves for professional liability claims. Management's estimates were based on the most recent information available, including events and changes in circumstances which occurred during the period.\nINDEPENDENT AUDITORS' REPORT\nFHP International Corporation:\nWe have audited the accompanying consolidated balance sheets of FHP International Corporation and its subsidiaries as of June 30, 1995 and 1994, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended June 30, 1995. 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, such consolidated financial statements present fairly, in all material respects, the financial position of FHP International Corporation and its subsidiaries at June 30, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 1995, in conformity with generally accepted accounting principles.\nDeloitte & Touche LLP\nCosta Mesa, California September 7, 1995\nINDEX TO EXHIBITS\n- -------- * Document has previously been filed with the Commission and is incorporated by reference and made a part hereof.\nThe Registrant will furnish any of the foregoing exhibits upon the payment of a reasonable fee based upon the Registrant's expenses in furnishing such exhibit(s). Written inquiries should be addressed to FHP International Corporation, Investor Relations Department, 9900 Talbert Avenue, Fountain Valley, California 92708.","section_15":""}
{"filename":"811641_1995.txt","cik":"811641","year":"1995","section_1":"ITEM 1. Business .....................................................1 ITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2 - PROPERTIES\nIn November 1993, the Company purchased the 10,000 square foot office and laboratory building that it had been renting at 56 Evergreen Drive in Portland, Maine for $350,000. The Company financed the acquisition through an $85,000 cash payment, a $220,000 first mortgage loan from a bank and a $45,000 second mortgage loan from the seller. The Company uses the space for its office and laboratory needs. In the purchase of the building, the Company assumed a lease to a tenant to approximately 3,720 of the 10,000 square feet. The Company received annual income of rent and taxes aggregating approximately $21,000 through October 1995 under this lease agreement.\nThe Company leases 3,500 square feet of manufacturing and warehouse space in a building located at 987 Riverside Street in Portland, Maine. This lease expires in March 1996. The Company's obligation to pay rent and taxes under the lease totals approximately $24,000 per year. This facility has been approved by the USDA for manufacture of FIRST DEFENSE{R}.\nThe Company intends to consolidate its manufacturing and warehouse operations into the current office and laboratory building that it owns at 56 Evergreen Drive in March 1996. Facility modifications necessary to complete this consolidation are expected to cost approximately $200,000.\nThe Company also maintains certain animals, primarily cows, through contractual relationships with several farms. The Company believes that these facilities are adequate for all current and projected needs.\nITEM 3","section_3":"ITEM 3 - LEGAL PROCEEDINGS\nNone ITEM 4","section_4":"ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None\nPART II ITEM 5","section_5":"ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Company's common stock trades on The Nasdaq SmallCap Market tier of The Nasdaq Stock Market under the symbol: ICCC. Additionally, as of April 1994, the Company's common stock was registered for trading on the Boston Stock Exchange under the symbol: IMU. No dividends have been declared or paid on the common stock since its inception, and the Company does not contemplate the payment of cash dividends in the foreseeable future.\nThe following table sets forth the high and low sales price information for ImmuCell's common stock as reported by The Nasdaq Stock Market during the period January 1, 1994 through December 31, 1995:\nSuch over-the-counter market quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission. As of March 22, 1996, the Company had 8,000,000 ($.10 per share par value) common shares authorized and 2,291,981 common shares outstanding, and there were approximately 1,800 shareholders of record. The mean between the bid and asked prices of the Company's common stock on March 22, 1996, as quoted on The Nasdaq Stock Market, was $4.53 and the last sales price of the Company's common stock on March 22, 1996 was $4.44.\nITEM 6","section_6":"ITEM 6 - SELECTED FINANCIAL DATA\nThe selected financial data set forth below has been derived from the audited financial statements of the Company. The information should be read in conjunction with the audited financial statements and related notes appearing elsewhere in this Form 10-K.\nYear Ended December 31,\nITEM 7","section_7":"ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nResults of Operations\nFISCAL 1995 COMPARED TO FISCAL 1994\nTotal revenues for the year ended December 31, 1995 of $4,938,000 increased by $499,000 (11%) from $4,439,000 in 1994. Product sales for the year ended December 31, 1995 of $4,350,000 were $365,000 (9%) greater than the product sales recorded in 1994. While product selling prices have generally increased in line with inflation, the increase in total product sales is principally due to an increased volume of product sold.\nSales of the KAMAR HEATMOUNT DETECTOR totaled approximately $2,058,000 (47% of total product sales) for the year ended December 31, 1995 as compared to approximately $2,146,000 (54% of total product sales) for the year ended December 31, 1994. Royalties paid to Kamar, Inc. of Steamboat Springs, Colorado on these sales equaled approximately $178,000 and $192,000 for 1995 and 1994, respectively. The Company owns an exclusive world-wide license from Kamar, Inc. to sell this product through December 31, 1999, which license is cancelable by either party upon twelve months written notice. (See Item 1 - \"BUSINESS - DAIRY AND BEEF ANIMAL HEALTH PRODUCTS\").\nSales of FIRST DEFENSE{R} totaled approximately $1,603,000 (37% of total product sales) for the twelve months ended December 31, 1995 as compared to approximately $1,298,000 (33% of total product sales) for the twelve months ended December 31, 1994. The Company obtained USDA approval to sell this product in September 1991. The sales of this product are seasonal with highest sales expected in the winter months. (See Item 1 - \"BUSINESS - DAIRY AND BEEF ANIMAL HEALTH PRODUCTS).\nSales of the Company's human infectious disease diagnostic reagents increased to approximately $553,000 (13% of total product sales) for the year ended December 31, 1995 from approximately $367,000 (9% of total product sales) for the year ended December 31, 1994.\nCollaborative research and development revenue decreased to approximately $10,000 (less than 1% of total revenues) in 1995 as compared to $250,000 (6% of total revenues) in 1994. The 1995 revenue supported a small portion of the Company's effort to purify specialty proteins from cheese whey. The 1994 revenue contributed to the funding of the Company's research program intended to develop a passive antibody product to prevent cryptosporidiosis in AIDS patients.\nGrant income increased to approximately $577,000 (12% of total revenues) in 1995 as compared to $204,000 in 1994 principally as the result of revenue recognized under two federal government research grants obtained by the Company in 1994. These two grants provide aggregate funding of $935,000 over two years. Funding aggregating $273,000 under these two grants will be recognized as the work is completed in 1996. The first grant is intended to partially fund development of a recombinant vaccine to CRYPTOSPORIDIUM PARVUM for animals and humans, utilizing several cloned antigens of CRYPTOSPORIDIUM PARVUM to which the Company holds an exclusive world-wide license from the Regents of the University of California. The second grant supports further research and development of ImmuCell's passive antibody product to prevent and\/or treat cryptosporidiosis in AIDS patients. The 1995 grant income was also increased due to the receipt of a $100,000 federal government research grant to support an epidemiology study related to the Company's passive antibody product to prevent Travelers' Diarrhea. (See Item 1 - \"BUSINESS - PRIMARY PRODUCTS UNDER DEVELOPMENT\").\nInterest and other income exceeded interest expense by approximately $33,000 in 1995 as compared to a $27,000 excess in 1994. Other income is comprised primarily of rental income for space leased to a tenant in the building that the Company owns. Interest expense increased as the result of additional interest expense incurred under a $500,000 bank note entered into in October 1994 and a $200,000 bank note entered into in September 1995.\nProduct costs as a percentage of product sales decreased to 45% in 1995 from 49% in 1994. The Company expects its product sales mix to continue to shift to more internally developed products which tend to have higher gross margin percentages than licensed-in products and expects to achieve incremental efficiencies in the manufacturing processes, as it continues to implement process development improvements. The increase in sales of human infectious disease diagnostic reagents also contributed to the improved gross margin, as the gross margin experienced on these reagents is better than the gross margin on the Company's animal health products.\nThe Company increased its expenditures for research and development to approximately $1,578,000 in 1995 as compared to $1,366,000 in 1994. Research and development expenses exceeded collaborative research and development revenue and grant income by approximately $991,000 in 1995 and by $912,000 in 1994. The 1995 spending on research and development aggregated 32% of total revenues as compared to 31% in 1994.\nThe primary focus of the Company's research and development programs is on the development of passive antibody products to prevent gastrointestinal diseases. The Company has one product, CRYPTOGAM{TM}, in clinical trials to prevent and\/or treat cryptosporidiosis in AIDS patients and a second product, TRAVELGAM{TM}, in clinical trials to prevent diarrhea caused by E. COLI (commonly known as Travelers' Diarrhea). The Company intends to file an Investigational New Drug (\"IND\") application by early 1997 for a third product, DIFFGAM{TM}, to prevent CLOSTRIDIUM DIFFICILE associated colon diseases that commonly occur after broad spectrum antibiotic usage. (See Item 1 - \"BUSINESS - - PRIMARY PRODUCTS UNDER DEVELOPMENT\"). The Company has also invested in the development of a test intended to detect the presence of CRYPTOSPORIDIUM PARVUM in drinking water. Additionally, the Company has conducted significant development of a milk purification process that may have commercial utility for certain food ingredient applications.\nResearch and development expenses that are not supported by an outside source of revenue are the primary cause of the Company's limited profit in 1995 and operating losses in prior years. The Company believes that a net operating loss may be incurred in 1996 and that this expected loss can be funded internally. The Company believes that advancing its research and development programs and incurring the resulting loss is necessary to create value in its product portfolio by performing early stage validation of its technology. However, for product development to proceed into more expensive clinical trials in 1997, potential partners or new sources of capital would be required to fund much of the continued research and development expenses.\nSales and marketing expenses increased by $44,000 (a 6% increase) to $766,000 (18% of total product sales) in 1995 from $721,000 (18% of total product sales) in 1994. The Company continues to leverage its small sales force through wholesale distribution channels. General and administrative expenses were approximately $640,000 in 1995 as compared to $567,000 in 1994. The Company has continued its efforts to control its general and administrative expenses while incurring all the necessary expenses associated with being a publicly held company.\nFISCAL 1994 COMPARED TO FISCAL 1993\nTotal revenues for the year ended December 31, 1994 of $4,439,000 increased by $497,000 (13%) from $3,941,000 in 1993. Product sales for the year ended December 31, 1994 of $3,985,000 were $585,000 (17%) greater than the product sales recorded in 1993. While product selling prices have generally increased in line with inflation, the increase in total product sales is principally due to an increased volume of product sold.\nSales of the KAMAR HEATMOUNT DETECTOR totaled approximately $2,146,000 (54% of total product sales) for the year ended December 31, 1994 as compared to approximately $1,949,000 (57% of total product sales) for the year ended December 31, 1993. Royalties paid to Kamar, Inc. of Steamboat Springs, Colorado on these sales equaled approximately $192,000 and $160,000 for 1994 and 1993, respectively. The Company owns an exclusive world-wide license from Kamar, Inc. to sell this product through December 31, 1999, which license is cancelable by either party upon twelve months written notice. (See Item 1 - \"BUSINESS - MARKETING AND SALES\").\nSales of FIRST DEFENSE{R} totaled approximately $1,298,000 (33% of total product sales) for the twelve months ended December 31, 1994 as compared to approximately $1,164,000 (34% of total product sales) for the twelve months ended December 31, 1993. The Company obtained USDA approval to sell this product in September 1991. The sales of this product are seasonal with highest sales expected in the winter months. (See Item 1 - \"DAIRY AND BEEF ANIMAL HEALTH PRODUCTS\").\nSales of the Company's human infectious disease diagnostic reagents increased to approximately $367,000 (9% of total product sales) for the year ended December 31, 1994 from approximately $102,000 (3% of total product sales) for the year ended December 31, 1993.\nCollaborative research and development revenue decreased to approximately $250,000 (6% of total revenues) in 1994 as compared to $435,000 (11% of total revenues) in 1993. All of this revenue except for $175,000 in 1993 contributed to the funding of the Company's research program intended to develop a passive antibody product to prevent cryptosporidiosis in AIDS patients. The $175,000 in 1993 revenue went towards the development of a test kit to diagnose candidiasis, a human fungal disease, which development work has been terminated by the Company.\nGrant income increased to approximately $204,000 (5% of total revenues) in 1994 as compared to $6,000 in 1993 principally as the result of revenue recognized under two federal government research grants obtained by the Company in 1994. These two grants provide aggregate funding of $954,000 over two years. Funding aggregating $756,000 under these two grants will be recognized as the work is completed in 1995 and into 1996. The first grant is intended to partially fund development of a recombinant vaccine to CRYPTOSPORIDIUM PARVUM for animals and humans, utilizing several cloned antigens of CRYPTOSPORIDIUM PARVUM to which the Company holds an exclusive world-wide license from the Regents of the University of California. The second grant supports further research and development of ImmuCell's passive antibody product to prevent cryptosporidiosis in AIDS patients. (See Item 1 - \"BUSINESS - PRIMARY PRODUCTS UNDER DEVELOPMENT\").\nTotal revenues in 1993 included $100,000 in income from the licensing of technology to a third party. No comparable sale was made in 1994.\nInterest and other income exceeded interest expense by approximately $27,000 in 1994 as compared to a $29,000 excess in 1993. Other income increased primarily as the result of the receipt of rental income for a full twelve months in 1994 for space leased to a tenant in the building that the Company purchased in November 1993. Interest expense increased accordingly due to the related mortgage interest for the full twelve months in 1994 and as the result of additional interest expense incurred under a $500,000 bank note entered into in October 1994.\nProduct costs as a percentage of product sales decreased to 49% in 1994 from 53% in 1993. The Company expects its product sales mix to continue to shift to more internally developed products which tend to have higher gross margin percentages than licensed-in products and expects to achieve incremental efficiencies in the manufacturing processes, as it continues to implement process development improvements. The increase in sales of human infectious disease diagnostic reagents also contributed to the improved gross margin, as the gross margin experienced on these reagents is better than the gross margin on the Company's animal health products.\nThe Company increased its expenditures for research and development to approximately $1,366,000 in 1994 as compared to $879,000 in 1993. Increased grant income partially funded this increase in research and development expenses. Research and development expenses exceeded collaborative research and development revenue and grant income by approximately $912,000 in 1994 and $438,000 in 1993.\nThe primary focus of the Company's research and development programs is on the development of passive antibody products to prevent gastrointestinal diseases. The Company has one product, CRYPTOGAM{TM}, in clinical trials to prevent cryptosporidiosis in AIDS patients. The Company intends to file an Investigational New Drug (\"IND\") application in 1995 for a milk-derived passive antibody product to prevent diarrhea caused by E. COLI (commonly known as Travelers' Diarrhea). In 1996, the Company expects to file an additional IND\nfor a product to prevent CLOSTRIDIUM DIFFICILE associated colon diseases that commonly occur after broad spectrum antibiotic usage over a prolonged period of time. (See Item 1 - \"BUSINESS - PRIMARY PRODUCTS UNDER DEVELOPMENT\"). Additionally, the Company has conducted significant development of a milk purification process that may lead to a new lower cost manufacturing process for these gastrointestinal disease prevention products and that may also have commercial utility for certain food ingredient applications.\nResearch and development expenses that are not supported by an outside source of revenue are the primary cause of the Company's net operating loss. The Company believes that its net operating loss may increase in 1995 and that this expected loss can be funded internally. The Company believes that advancing its research and development programs and incurring the resulting loss is necessary to create value in its product portfolio by performing early stage validation of its technology. However, for product development to proceed into more expensive clinical trials in 1996, potential partners or new sources of capital would be required to fund much of the continued research and development expenses.\nGeneral and administrative expenses were approximately $567,000 in 1994 as compared to $530,000 in 1993 and $601,000 in 1992. The Company has continued its efforts to control its general and administrative expenses while incurring all the necessary expenses associated with being a publicly held company. Sales and marketing expenses were reduced by $59,000 (an 8% decrease) to $721,000 (18% of total product sales) in 1994 from $780,000 (23% of total product sales) in 1993. The Company continues to leverage its small sales force through wholesale distribution channels.\nFINANCIAL POSITION, LIQUIDITY AND CAPITAL RESOURCES\nThe Company's total assets increased to $3,234,000 at December 31, 1995 from $3,075,000 at December 31, 1994. The Company's cash balance as of December 31, 1995 increased to $1,550,000 from $1,295,000 at December 31, 1994. Net working capital increased by 7% to $1,850,000 at December 31, 1995 from $1,728,000 at December 31, 1994. Stockholders' equity at December 31, 1995 of $1,905,000 increased from $1,876,000 at December 31, 1994.\nAs is the case with most early stage biotechnology companies, the Company funds a large portion of its research and development expenses through strategic alliances with corporate partners and equity financing with the prospect of becoming profitable if products can be successfully commercialized. The size of the Company's research and development programs and the speed at which they are funded is, in large part, determined by the level of financing completed. However, during the year ended December 31, 1995, the gross margin from product sales was sufficient to contribute $988,000 to the research and development programs after covering all general, sales and administrative expenses. This $988,000 contribution compares favorably to a $737,000 contribution in 1994, a $287,000 contribution in 1993 and a $190,000 deficit in 1992. This growing contribution from the operating (non-research and development) side of the Company's business allows the Company to be less dependent on raising capital in the equity markets to fund its ongoing operations.\nLong term debt decreased from $630,000 at December 31, 1994 to $608,000 at December 31, 1995. The current portion of these long term debt obligations increased from $114,000 at December 31, 1994 to $169,000 at December 31, 1995. As of December 31, 1995, this current and long term debt was comprised of: 1) $212,000 under a $220,000 mortgage from a bank on the Company's office and laboratory facility that was purchased by the Company in November 1993, 2) $375,000 under a four year $500,000 note payable to a bank that was entered into in October of 1994 and 3) $190,000 under a four year $200,000 note payable to a bank that was entered into in September 1995. The mortgage bears interest at the rate of 9.5% per year and is amortized over twenty years with a balloon payment of approximately $183,000 due in November 2000. The $500,000 bank note bears interest at the rate of 10.27% per year and is being amortized in full over four years. The $200,000 bank note bears interest at the rate of 9.62% per year and is being amortized in full over four years. The Company is obligated to make monthly principal and interest payments aggregating $19,833 under the mortgage and the bank notes.\nIn connection with the consolidation of the Company's operations into the building that it owns, the Company has committed to incur approximately $200,000 in building improvement and modification costs. Additionally, the Company has entered into purchase commitments for certain manufacturing and research\nequipment aggregating approximately $200,000. Management believes that its current cash and investments balance will be sufficient to meet its operating and capital requirements in 1996. Management intends to keep expenditure levels in the appropriate relation to the amount of equity raised, expected revenues and the resulting amount of available cash.\nFORWARD LOOKING STATEMENTS\nThis document contains certain forward looking statements; there can be no assurance that actual results will not differ materially from those projected or suggested in such statements as a result of various factors including, but not limited to, the risk factors discussed below. The Company is heavily dependent on the successful development of new products for its future growth. These new products have the potential to make the Company significantly more profitable than it currently is. Retail markets for the human applications of the Company's passive antibody products that are currently in clinical trials have been estimated at between $50,000,000 to $150,000,000 and the market for the passive antibody product not yet in clinical trials has been estimated at approximately twice that size. (See Item 1 - \"BUSINESS - PRIMARY PRODUCTS UNDER DEVELOPMENT). If clinical trials are successful, sales would not be expected to begin until 1998 or 1999, due to the complex regulatory process required to obtain approval of these products. If the products are successfully developed, the Company intends to enter into marketing alliances with corporate partners to achieve its sales in these markets. The market for: 1) the Company's water test under development has been estimated up to $20,000,000 and 2) the first specialty protein being derived by the Company from cheese whey has been estimated at $2,000,000. (See Item 1 - \"BUSINESS - PRIMARY PRODUCTS UNDER DEVELOPMENT\"). Working with partners on both of these products, the Company has retained 50% ownership of each of these products. If further development proves positive, sales of these two products may begin by 1997.\nRISK FACTORS\nThe development of these new products is subject to financial, efficacy, regulatory and market risks. There can be no assurance that the Company will be able to finance the development of these new product opportunities nor that, if financed, the new products will be found to be efficacious and gain the appropriate regulatory approval. Furthermore, if regulatory approval is obtained, there can be no assurance that the market estimates will prove to be accurate or that market acceptance at a profitable price level can be achieved or that the products can be profitably manufactured.\nEFFECTS OF INFLATION AND INTEREST RATES\nThe Company believes that neither inflation nor interest rates have had a significant effect on revenues and expenses.\nITEM 8","section_7A":"","section_8":"ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe financial statements of the Company, together with the notes thereto and the report of the accountants thereon, are set forth on Pages through at the end 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\n(A) Information with respect to the Company's directors is incorporated herein by reference to the section of the Company's 1996 Proxy Statement titled \"Election of the Board of Directors\", which is intended to be filed with the Securities and Exchange Commission within 120 days after the end of the Company's fiscal year.\n(B) The Company's executive officers are as follows:\nMICHAEL F. BRIGHAM (Age: 35, Officer Since: October 1991) was elected Chief Financial Officer and Treasurer of the Company in October 1991 and was appointed Secretary in December 1995. Prior to that, he served as Director of Finance and Administration for the Company since September 1989. Prior to joining the Company, he was employed as an audit manager for the public accounting firm of Ernst & Young. Mr. Brigham earned his Masters in Business Administration from New York University in 1989.\nJOSEPH H. CRABB, PH.D. (Age: 41, Officer Since: March 1996) was elected Vice President of Research and Development of the Company in March 1996. Prior to that, he served as Director of Research and Development for the Company. Prior to joining the Company in 1988, Dr. Crabb earned his Ph.D. in Biochemistry from Dartmouth Medical School and completed postdoctoral studies in microbial pathogenesis at Harvard Medical School, where he also served on the faculty.\nTHOMAS C. HATCH (Age: 42, Officer Since: October 1991, Director Since: August 1992) was elected President and Chief Executive Officer of the Company in October 1991 and is a member of the Executive Committee of the Company's Board of Directors. Prior to that, he served as Manager of Commercial Development for the Company since May 1989. Prior to joining the Company, he held various product management and sales positions in the Animal Health and Crop Protection Chemical businesses of the American Cyanamid Company. Prior to that, he had been an Economic Analyst with the U.S. Department of Agriculture in Washington. Mr. Hatch earned his Masters in Business Administration from the University of Virginia in 1984.\nThere is no family relationship between any director, executive officer, or person nominated or chosen by the Company to become a director or executive officer.\nITEM 11","section_11":"ITEM 11 - EXECUTIVE COMPENSATION\nInformation regarding cash compensation paid to executive officers of the Company is incorporated herein by reference to the section of the Company's 1996 Proxy Statement titled \"Executive Compensation\", which is intended to be filed with the Securities and Exchange Commission within 120 days after the end of the Company's fiscal year.\nITEM 12","section_12":"ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation regarding ownership of the Company's common stock by certain owners and management is incorporated herein by reference to the section of the Company's 1996 Proxy Statement titled \"Security Ownership of Certain Beneficial Owners and Management\", which is intended to be filed with the Securities and Exchange Commission within 120 days after the end of the Company's fiscal year.\nITEM 13","section_13":"ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation regarding certain relationships and related transactions is incorporated herein by reference to the section of the Company's 1996 Proxy Statement titled \"Certain Relationships and Related Transactions\", which is intended to be filed with the Securities and Exchange Commission within 120 days after the end of the Company's fiscal year.\nPART IV ITEM 14","section_14":"ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (A) Exhibits 3.1 Certificate of Incorporation of the Registrant (incorporated by reference to Exhibit 3.1 of the Company's 1987 Registration Statement Number 33-12722 on Form S-1 as filed with the Commission). 3.2 Certificate of Amendment to the Company's Certificate of Incorporation (incorporated by reference to Exhibit 4.1 to the Company's quarterly report on Form 10-Q for the three months ended June 30, 1990). 3.3 Bylaws of the Registrant as amended. 3.4 Certificate of Amendment to the Company's Certificate of Incorporation effective August 24, 1992 (incorporated by reference to Exhibit 3.4 of the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1992). 4.1 Specimen of the Company's Common Stock Certificate (incorporated by reference to Exhibit 4.1 to the Company's quarterly report on Form 10-Q for the three months ended September 30, 1990). 4.2 $220,000 Note payable to Peoples Heritage Bank dated November 3, 1993 (incorporated by reference to Exhibit 4.1 to the Registrant's Current Report on Form 8-K dated November 4, 1993). 4.3 Mortgage deed, Security Agreement and Financing Statement dated November 3, 1993 in favor of Peoples Heritage Bank (incorporated by reference to Exhibit 4.3 to the Registrant's Current Report on Form 8-K dated November 4, 1993). 4.4 $500,000 Commercial Note to Peoples Heritage Bank dated October 7, 1994 (incorporated by reference to Exhibit 4.1 to the Registrant's Quarterly Report on Form 10-Q for the three months ended September 30, 1994). 4.5 Security Agreement dated October 7, 1994 in favor of Peoples Heritage Bank (incorporated by reference to Exhibit 4.2 to the Registrant's Quarterly Report on Form 10-Q for the three months ended September 30, 1994). 4.6 $200,000 Commercial Note payable to Peoples Heritage Bank dated September 28, 1995 (incorporated by reference to Exhibit 4.1 to the Registrant's Quarterly Report on Form 10-Q for the three months ended September 30, 1995). 4.7 Security Agreement dated September 28, 1995 in favor of Peoples Heritage Bank (incorporated by reference to Exhibit 4.2 to the Registrant's Quarterly Report on Form 10-Q for the three months ended September 30, 1995). 4.8 Rights Agreement dated as of September 5, 1995, between the Registrant and American Stock Transfer and Trust Co., as Rights Agent, which includes as Exhibit A thereto the form of Right Certificate and as Exhibit B thereto the Summary of Rights to Purchase Common Stock (incorporated by reference to Exhibit 4.1 to the Registrant's Current Report on Form 8-K dated September 5, 1995). 10.1{+} 1989 Stock Option and Incentive Plan of the Registrant (incorporated by reference to Exhibit 10.27 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1989). 10.2{+} Form of Incentive Stock Option Agreement (incorporated by reference to Exhibit 10.28 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1989). 10.3{+} 1990 Stock Option Plan for Outside Directors (incorporated by reference to Exhibit 10.29 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1989). 10.4{+} Form of Stock Option Agreement for Outside Directors (incorporated by reference to Exhibit 10.30 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1989). 10.5{+} Form of Indemnification Agreement entered into with each of the Company's directors and officers (incorporated by reference to Exhibit 10.32 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1989). 10.6* Technology Purchase and Supply Agreement effective December 15, 1990 between the Registrant and Hybritech, Inc., 11095 Torreyana Road, San Diego, California 92121 (incorporated by reference to Exhibit 10.31 to \tthe Registrant's Annual Report on Form 10-K for the fiscal year ended \tDecember 31, 1990). 10.7{+} Employment Agreement dated November 1991 between the Registrant and Michael F. Brigham (incorporated by reference to Exhibit 10.37 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1991). 10.8{+} Employment Agreement dated November 1991 between the Registrant and Thomas C. Hatch (incorporated by reference to \tExhibit 10.38 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1991). 10.9 Lease dated September 1, 1992 between Young's Electric, Inc., as Lessor, and the Registrant, as Lessee, for the premises located at 987 Riverside Street, Portland, Maine (incorporated by reference to Exhibit 10.20 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1992).\n10.10 First Amendment to Technology Purchase and Supply Agreement between Hybritech Incorporated and the Registrant effective December 23, 1992 (incorporated by reference to Exhibit 10.24 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1992). 10.11{+}Amendment, dated April 1992, to Employment Agreement dated November 1991, between the Registrant and Michael F. Brigham (incorporated by reference to Exhibit 10.26 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1992). 10.12{+}Amendment, dated April 1992, to Employment Agreement dated November 1991, between the Registrant and Thomas C. Hatch (incorporated by reference to Exhibit 10.29 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1992). 10.13 License and Supply Agreement between Bio-Vac, Inc. and the Registrant dated June 15, 1993 (incorporated by reference to Exhibit 10.25 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1993). 10.14** ImmuCell - Advanced Separation Technologies, Inc. Agreement for exclusivity in protein separation of milk or whey proteins, dated \tAugust 30, 1993 (incorporated by reference to Exhibit 10.27 to the \tRegistrant's Annual Report on Form 10-K for the fiscal year ended \tDecember 31, 1993). 10.15 Distribution and Licensing Agreement between Kamar, Inc. and the Registrant dated December 3, 1993 (incorporated by reference to Exhibit 10.30 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1993). 10.16 Second Amendment to Technology Purchase and Supply Agreement between Hybritech Incorporated and the Registrant effective December 15, 1993 (incorporated by reference to Exhibit 10.31 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1993). 10.17 Amendment No. 1 to Agreement for Exclusivity between Advanced Separation Technologies, Inc. and the Registrant dated January 14, 1994 (incorporated by reference to Exhibit 10.33 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1993). 10.18***Exclusive License Agreement between The Regents of the University of California of Alameda, California and the Registrant dated February 23, \t1994 (incorporated by reference to Exhibit 10.1 to the Registrant's \tQuarterly Report on Form 10-Q for the three months ended \tMarch 31, 1994). 10.19* Technology Purchase and Sale Renewal Agreement effective February 17, 1995 between the Registrant and Hybritech, Inc., 8958 Terman Court, San Diego, California 92121 (incorporated by reference to Exhibit 10.24 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1994). 10.20 Non-qualified Stock Option Agreement dated November 10, 1994 between the Registrant and Redwood MicroCap Fund, Inc (incorporated by reference to Exhibit 10.25 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1994). 10.21 Amendment No. 2 to Agreement for Exclusivity between Advanced Separation Technologies, Inc. and the Registrant dated December 16, 1994 (incorporated by reference to Exhibit 10.26 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1994). 10.22****License Agreement between Registrant and Wisconsin Alumni Research Foundation effective March 1, 1995 (incorporated by reference to Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q for the three months ended March 31, 1995). 10.23 1995 Stock Option Plan for Outside Directors (incorporated by reference to Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q for the three months ended June 30, 1995). 10.24 Form of Stock Option Agreement (incorporated by reference to Exhibit 10.2 to the Registrant's Quarterly Report on Form 10-Q for the three months ended June 30, 1995). 10.25 Research Agreement dated April 19, 1995 between the Registrant and Membrex, Inc. of Fairfield, New Jersey (incorporated by reference to Exhibit 10.3 to the Registrant's Quarterly Report on Form 10-Q for the three months ended June 30, 1995). 10.26 Term Letter dated April 19, 1995 between the Registrant and Membrex, Inc. of Fairfield, New Jersey (incorporated by reference to Exhibit 10.4 to the Registrant's Quarterly Report on Form 10-Q for the three months ended June 30, 1995). 10.27 Amendment No. 3 to Agreement for Exclusivity between Advanced Separation Technologies, Inc. and the Registrant dated May 3, 1995 (incorporated by reference to Exhibit 10.5 to the Registrant's Quarterly Report on Form 10-Q for the three months ended June 30, 1995). 10.28 Amendment No. 4 to Agreement for Exclusivity between Advanced Separation Technologies, Inc. and the Registrant dated November 15, 1995.\n10.29 Option Agreement dated November 22, 1995 between the Registrant and Agri-Mark, Inc. of Methuen, Massachusetts. 10.30{+ }Employment Agreement dated November 1991 between the Registrant and Joseph H Crabb. 10.31{+}Amendment, dated March 1992, to Employment Agreement dated November 1991, between the Registrant and Joseph H. Crabb. 10.32{+}Amendment, dated April 1992, to Employment Agreement dated November 1991, between the Registrant and Joseph H. Crabb. 21.1 Subsidiaries of the Registrant (incorporated by reference to Exhibit 22.1 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1990). 27.1 Financial Data Schedule.\n*Confidential Treatment as to certain portions obtained effective until December 14, 2002. The copy filed as an exhibit omits the information subject to the Confidential Treatment.\n**Confidential Treatment as to certain portions obtained effective until December 31, 2000. The copy filed as an exhibit omits the information subject to the Confidential Treatment.\n***Confidential Treatment as to certain portions obtained effective until March 31, 1999. The copy filed as an exhibit omits the information subject to the Confidential Treatment.\n****Confidential Treatment as to certain portions has been requested effective until March 1, 2005. The copy filed as an exhibit omits the information subject to the confidentiality request.\n+ Management contract or compensatory plan or arrangement.\n(B) INDEX TO FINANCIAL STATEMENT SCHEDULES Report of Coopers & Lybrand L.L.P., Independent Accountants Consolidated Balance Sheets - December 31, 1995 and 1994 to Consolidated Statements of Operations for the years endedF-4 December 31, 1995, 1994 and 1993\nConsolidated Statements of Stockholders' Equity for the yearsF-5 ended December 31, 1995, 1994 and 1993\nConsolidated Statements of Cash Flows for the years endedF-6 December 31, 1995, 1994 and 1993\nNotes to Consolidated Financial Statements to\nAll financial statement schedules have been omitted as they are not required, are not applicable, or the information is included in the consolidated financial statements or otherwise.\n(C) REPORTS ON 8-K None\nREPORT OF INDEPENDENT ACCOUNTANTS\nBoard of Directors ImmuCell Corporation\nWe have audited the accompanying consolidated balance sheets of ImmuCell Corporation and Subsidiary as of December 31, 1995 and 1994, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1995. 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 consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of ImmuCell Corporation and Subsidiary as of December 31, 1995 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, 1995 in conformity with generally accepted accounting principles.\n\/s\/ Coopers & Lybrand\nPortland, Maine February 9, 1996\nIMMUCELL CORPORATION AND SUBSIDIARY\nCONSOLIDATED BALANCE SHEETS DECEMBER 31, 1995 AND 1994\nASSETS\nThe accompanying notes are an integral part of the financial statements.\nIMMUCELL CORPORATION AND SUBSIDIARY\nCONSOLIDATED BALANCE SHEETS DECEMBER 31, 1995 AND 1994\nLIABILITIES AND STOCKHOLDERS' EQUITY\nThe accompanying notes are an integral part of the financial statements.\nIMMUCELL CORPORATION AND SUBSIDIARY\nCONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31,\nThe accompanying notes are an integral part of the financial statements.\nIMMUCELL CORPORATION AND SUBSIDIARY\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY\nFOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nThe accompanying notes are an integral part of the financial statements.\nIMMUCELL CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31,\nThe accompanying notes are an integral part of the financial statements.\nIMMUCELL CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (1) BUSINESS OPERATIONS\nImmuCell Corporation (the \"Company\") is a biotechnology company that primarily develops, manufactures and markets milk-derived passive antibody products to prevent and\/or treat gastrointestinal infections in both humans and animals.\nThe Company was originally incorporated in Maine in 1982 and reincorporated in Delaware in March 1987. In May 1987, the Company raised approximately $5,300,000 in net proceeds from its initial public offering. In September 1992, the Company raised $600,000 from the sale of 342,857 shares of the Company's common stock, which shares were repurchased by the Company for the aggregate consideration of $308,571 in December 1994 (see Note 6(a)). In December 1993, the Company sold 300,000 shares of common stock for $562,500 to an investment group lead by the Redwood MicroCap Fund of Colorado Springs, Colorado.\nThe Company is subject to certain risks associated with its stage of development including dependence on key individuals, competition from other larger companies, the successful marketing of existing products and the development of additional commercially viable products.\n(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\n(A) CONSOLIDATION PRINCIPLES\nThe consolidated financial statements of the Company include the accounts of the Company and its wholly-owned subsidiary, the Kamar Marketing Group, Inc. All intercompany accounts and transactions have been eliminated in consolidation. Certain amounts in the 1993 financial statements have been reclassified to conform with the 1995 and 1994 financial statement presentation.\n(B) CASH AND CASH EQUIVALENTS\nThe Company considers all highly liquid investment instruments purchased with an original maturity of three months or less to be cash equivalents.\n(C) INVENTORIES\nInventories include raw materials, work-in-process and finished goods and are recorded at the lower of standard cost which approximates cost on the first-in, first-out method or market (net realizable value). Work-in- process and finished goods inventories include materials, labor and manufacturing overhead.\nInventories consist of the following:\n(D) EQUIPMENT, BUILDING AND IMPROVEMENTS\nThe Company provides for depreciation and amortization on the straight- line method by charges to operations in amounts estimated to allocate the cost of the assets over their estimated useful lives, generally equal to five to ten years for equipment and ten years for building improvements. The cost of the building is being depreciated over 30 years.\n(E) REVENUE RECOGNITION\nRevenues related to the sale of manufactured products are recorded at the time of shipment to the customer. Collaborative research and development revenue and income on government research grants is recognized under the percentage-of-completion method. Percentages of completion are determined by relating the actual cost of work performed to date to the estimated total cost that the Company is obligated to incur under the applicable agreement. Indirect costs which are billed to the government are subject to their review. All related research and development costs are expensed as incurred, as are all patent costs.\n(F) NET PROFIT (LOSS) PER COMMON SHARE\nThe 1994 and prior net losses per common share have been computed by dividing the net loss by the weighted average number of common shares outstanding during the year. Common stock equivalents outstanding have not been included in the computation, as the effect would be antidilutive, thereby decreasing the net loss per common share. The 1995 net profit per common share has been computed by dividing the net profit by the weighted average number of common shares outstanding during the year. The effect of including common stock equivalents outstanding in this computation was less than $.01 per share.\n(G) USE OF ESTIMATES\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the period. Actual amounts could differ from those estimates.\n(3)ACCRUED EXPENSES\nAccrued expenses consisted of the following:\n(4) DEBT OBLIGATIONS\nThe Company has long term debt obligations, net of current maturities, as follows:\nPrincipal payments under the above debt obligations due subsequent to December 31, 1995 are approximately as follows: $169,000 (1996); $187,000 (1997); $181,000 (1998); $50,000 (1999); and $190,000 (2000).\n(5) INCOME TAXES\nThe Company adopted Financial Accounting Standards Board (FASB) Statement No. 109 effective January 1, 1993. Adoption of the Statement had no impact on the financial statements as the Company provided a valuation allowance for its net deferred tax assets at January 1, 1993.\nThe Company has no net deferred taxes at December 31, 1995 as the net deferred tax assets (consisting of the tax effect of net operating loss carryforwards amounting to approximately $2,108,000, the tax credit carryforwards of approximately $207,000 and temporary differences relating principally to depreciation) have been fully reserved for due to the uncertainty of future taxable income.\nAt December 31, 1995, the Company had available net operating loss carryforwards of approximately $5,270,000. The Company also had available at December 31, 1995 approximately $207,000 of tax credits to reduce future federal income taxes, if any. The operating loss and tax credit carryforwards expire in 1998 through 2008. These carryforwards are subject to review and possible adjustment by the Internal Revenue Service. The Tax Reform Act of 1986 contains provisions which may limit the net operating loss carryforwards available to be used in any given year in the event of certain significant changes in ownership interests. The Company does not believe that the cumulative effect of all ownership changes to date will reduce the availability of its net operating loss carryforwards.\n(6) STOCKHOLDERS' EQUITY\n(A) ACQUISITION OF TREASURY STOCK\nIn December 1994, The Company repurchased the 342,857 shares of its common stock held by Cambridge Biotech Corporation for the aggregate consideration of $308,571. These shares represented approximately 13% of the Company's common stock prior to the repurchase.\n(B) STOCK WARRANTS AND OPTIONS\nIn April 1992, a total of 200,000 nonqualified stock options were issued to three employees of the Company at $1.05 per share, the then current market price of the Company's common stock. These options, which were granted outside of the stock option plans described below, expire in April 2002. Half of these options became exercisable in April 1993, and the remaining half became exercisable in April 1994.\nIn November 1994, the Company entered into a non-exclusive investment banking contract with Redwood MicroCap Fund of Colorado Springs, Colorado (\" Redwood\"). As compensation for services provided under this contract, the Company issued 30,000 non-qualified stock options to Redwood, which are exercisable at $1.45 per share as to 10,000 shares on and after November 2, 1995, an additional 10,000 shares on and after November 2, 1996, and the remaining 10,000 shares on and after November 2, 1997. The options expire completely to the extent not exercised on or before November 2, 1999.\n(C) STOCK OPTION PLANS\nIn May 1989, the stockholders approved the 1989 Stock Option and Incentive Plan (the \"1989 Plan\") pursuant to the provisions of the Internal Revenue Code of 1986, under which employees may be granted options to purchase shares of the Company's common stock at i) no less than fair market value on the date of grant in the case of incentive stock options and ii) no less than 85% of fair market value on the date of grant in the case of non-qualified stock options. 90,000 shares of common stock were originally reserved for issuance under the 1989 Plan; the stockholders of the Company approved an increase in this number to 190,000 shares at the August 1992 Annual Meeting and a further increase in this number to 290,000 shares at the June 1994 Annual Meeting. All options granted under the 1989 Plan expire no later than ten years from the date of grant.\nIn February 1990, the Board of Directors adopted the 1990 Stock Option Plan for Outside Directors (the \"1990 Plan\"). The 1990 Plan was approved by the stockholders of the Company on July 23, 1990. Under the 1990 Plan, each director who was not an employee of the Company on the date the Plan was adopted was automatically granted a non-qualified stock option to purchase 2,250 shares of common stock at fair market value on the day preceding the date of the grant. Directors who were newly elected to the Board subsequent to that date received an automatic grant of an option to purchase 2,250 shares, at the fair market value on the day preceding the date of the grant. All options granted under the 1990 Plan expire no later than five years from the date of grant. The 1990 Plan expired on February 2, 1995, and no further grants of options maybe made under the 1990 Plan.\nIn February 1995, the Board of Directors adopted the 1995 Stock Option Plan for Outside Directors (the \"1995 Plan\"). The 1995 Plan was approved by the stockholders of the Company on June 23, 1995. Under the 1995 Plan, each director who was not an employee of the Company on the date the Plan was adopted was automatically granted a non-qualified stock option to purchase 8,000 shares of common stock at its fair market value on the date of the grant. Directors who are newly elected to the Board subsequent to February 1995 receive an automatic grant of an option to purchase 8,000 shares, at fair market value on the date when such directors are first elected to the Board by the stockholders. As of February 1995, 64,000 shares of common stock were reserved for issuance under the 1995 Plan. Options to purchase an aggregate of 40,000 shares were automatically granted on the date the Plan was adopted by the Board of Directors. Of these 40,000 options,\n8,000 terminated in September 1995. Options to purchase another 8,000 shares were automatically granted on June 23, 1995. One half of the shares subject to the options will become exercisable after the 1996 Annual Meeting of Stockholders, and the remaining half of the shares subject to the options will become exercisable after the 1997 Annual Meeting of Stockholders. All options granted under the 1995 Plan expire no later than five years from the date of grant.\nActivity under the stock option plans described above, was as follows:\nAt December 31, 1995, approximately 586,250 common shares were reserved for future issuance under all warrants, stock options and stock option plans described above.\n(D) COMPLIANCE WITH FINANCIAL ACCOUNTING STANDARDS BOARD NEW ACCOUNTING STANDARD\nIn 1995, the Financial Accounting Standards Board issued \"Statement of Financial Accounting Standard (SFAS) No. 123 - Accounting for Stock Based Compensation\". This statement requires a fair value based method of accounting for employee stock options and similar equity instruments. It also permits a Company to continue to measure compensation expense for such plans using the intrinsic value based method as prescribed by APB Opinion No. 25, \"Accounting for Stock Issued to Employees\". Companies electing to continue following the accounting rules of APB No. 25 must make pro forma disclosures of net income and earnings per share, as if the fair value based method for accounting as defined in SFAS No. 123 had been applied. The Company has elected to continue to measure its cost using APB No. 25 and, as required, will disclose the impact of SFAS No. 123 with its 1996 financial statements.\n(E) COMMON STOCK RIGHTS PLAN\nOn September 5, 1995, the Board of Directors of the Company adopted a Common Stock Rights Plan and declared a dividend of one common share purchase right (a \"Right\") for each of the then outstanding shares of the common stock of the Company. The dividend was distributed to the shareholders of record as of the close of business on September 19, 1995. Each Right entitles the registered holder to purchase from the Company one share of common stock at an initial purchase price of $70.00 per share, subject to adjustment. The description and terms of the Rights are set forth in a Rights Agreement between the Company and American Stock Transfer & Trust Co., as Right Agent.\nThe Rights become exercisable and transferrable apart from the common stock upon the earlier of (i) 10 days following a public announcement that a person or group (acquiring person) has, without the prior consent of the Continuing Directors (as such term is defined in the Rights Agreement), acquired beneficial ownership of 15 percent or more of the outstanding common stock, or (ii) 10 days following commencement of a tender offer or exchange offer the consummation of which would result in ownership by a person or group of 20% or more of the outstanding common stock (the earlier of such dates being called the \"Distribution Date\").\nUpon the acquisition of 15% or more of the Company's common stock by an acquiring person, the holder of each Right not owned by the acquiring person would be entitled to purchase common stock having a market value equal to two times the exercise price of the Right (i.e., at a 50 percent discount). If, after the Distribution Date, the Company should consolidate or merge with any other entity and the Company were not the surviving company, or, if the Company were the surviving company, all or part of the Company's common stock were changed or exchanged into the securities of any other entity, or if more than 50% of the Company's assets or earning power were sold, each Right would entitle its holder to purchase, at the Rights' then-current purchase price, a number of shares of the acquiring company's common stock having a market value at that time equal to twice the Right's exercise price.\nAt any time after a person or group becomes an acquiring person and prior to the acquisition by such person or group of 50% or more of the outstanding common stock, the Board of Directors of the Company may exchange the Rights (other than Rights owned by such person or group which have become void), in whole or in part, at an exchange ratio of one share of common stock per Right (subject to adjustment).\nAt any time prior to fourteen days following the date that any person or group becomes an acquiring person, the Board of Directors of the Company may redeem the then outstanding Rights in whole, but not in part, at a price of $.005 per Right, subject to adjustment. The Rights will expire on the earlier of (i) the close of business on September 19, 2005, or (ii) the time at which the Rights are redeemed by the Company.\n(7) SEGMENT AND SIGNIFICANT CUSTOMER INFORMATION\nThe Company operates in the single business segment described in Note 1. The Company's primary customers for the majority of its current product sales (67%) are in the United States dairy and beef industries. Revenues derived from foreign customers, who are also in the dairy and beef industries, were approximately $862,000, $952,000 and $820,000 during the years ended December 31, 1995, 1994 and 1993, respectively.\nCollaborative research and development revenue comprised less than 1%($10,000), 6% ($250,000) and 7% ($260,000) of total revenues in the years ended December 31, 1995, 1994 and 1993, respectively. Government grant income amounted to approximately 12% ($577,000), 5% ($204,000) and less than 1% ($6,000) of total revenues in the years ended December 31, 1995, 1994 and 1993, respectively.\n(8) COMMITMENTS AND CONTINGENCIES\nThe Company currently leases a manufacturing and warehouse facility and had leased office and research space in a second building prior to purchasing that building in November 1993, both under operating leases. Costs incurred under operating lease (primarily rent and real estate taxes) totaled approximately $24,000, $24,000 and $56,000 in 1995, 1994, and 1993, respectively. The lease for the manufacturing and warehouse facility expires in March 1996. Minimum non-cancelable rental payments under the lease total approximately $6,000 in 1996. In connection with the consolidation of the Company's operations into the building that it owns, the Company has committed to incur approximately $200,000 in building improvement and modification costs. Additionally, the Company has entered into purchase commitments for certain manufacturing and research equipment aggregating approximately $200,000.\nIn order to maintain an exclusive world-wide license to the use of a certain milk whey purification machine for all milk purification applications, the Company must meet certain performance requirements, including the purchase of a machine valued at approximately $450,000 by June 1996.\nThe Company has entered into employment contracts with its three executive officers which could require the Company to pay from two to four months' salary as severance pay depending upon the circumstances of any termination of employment of these key employees.\nIn December 1993, the Company entered into a renewal of its service and license agreement effective through December 31, 1999 with Kamar, Inc. whereby Kamar will continue to provide the Company warehousing, distribution and certain other services and the Company will continue to market a certain bovine heat detection device under an exclusive world-wide license. The renewal agreement is cancelable by either party upon twelve months written notice. The Company is committed to pay Kamar a monthly fee for distribution services and related license fees of $19,630 until the license agreement is canceled. Royalties paid on sales made during the years ended December 31, 1995, 1994 and 1993 were $178,000, $192,000 and $159,000, respectively.\nThe research, manufacturing and marketing of human and animal health care products by the Company entail an inherent risk that liability claims will be asserted against the Company. The Company feels it has adequate levels of liability insurance to support its operations.\n(9) EMPLOYEE BENEFITS\nThe Company has a 401(k) savings plan in which all employees completing one year of service with the Company (working at least 1,000 hours) are eligible to participate. Participants may contribute up to 20% of their annual compensation to the plan, subject to certain limitations. In 1993, the Company implemented a dollar-for-dollar match of the first $400 contributed by each employee to the plan. Under this matching contribution program, the Company paid the aggregate of $5,600 to the plan in December 1993. Beginning January 1, 1994, the Company has matched 50% of each employee's contribution to the plan up to a maximum match of 3% of each employee's compensation. Under this matching contribution program, the Company paid the aggregate of $23,000 and $21,000 to the plan for the years ended December 31, 1995 and 1994, respectively. The Company intends to continue this same matching contribution program in 1996.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nIMMUCELL CORPORATION\nDate: March 27, 1996 By: \/s\/ Thomas C. Hatch Thomas C. Hatch President, \t\t\t\t\t\t Chief Executive Officer and Director\nPOWER OF ATTORNEY\nWe, the undersigned directors and officers of ImmuCell Corporation hereby severally constitute and appoint Thomas C. Hatch and Michael F. Brigham, and each of them (with full power to each of them to act alone), our true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, for us and in our stead, in any and all capacities, to sign any and all amendments to this report and all documents relating thereto, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing necessary or advisable to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys- in-fact and agents, or any of them, or their substitute or substitutes, may lawfully do or 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.\nDate: March 27, 1996 By: \/s\/ Michael F. Brigham Michael F. Brigham Chief Financial Officer, \t\t\t\t\t Treasurer & Secretary\nDate: March 27, 1996 By: \/s\/ Anthony B. Cashen Anthony B. Cashen, Director\nDate: March 27, 1996 By: \/s\/ Thomas C. Hatch Thomas C. Hatch President, \t\t\t\t\t Chief Executive Officer & Director\nDate: March 27, 1996 By: \/s\/ George W. Masters George W. Masters, Director\nDate: March 27, 1996 By: \/s\/ William H. Maxwell William H. Maxwell, M.D., Director Date: March 27, 1996 By: \/s\/ John R. McKernan, Jr. John R. McKernan, Jr., Director\nDate: March 27, 1996 By: \/s\/ Mitchel Sayare Mitchel Sayare, Director\nIMMUCELL CORPORATION AND SUBSIDIARY Exhibit Index\n3.3 Bylaws of the Registrant as amended.\n10.28 Amendment No. 4 to Agreement for Exclusivity between Advanced Separation Technologies, Inc. and the Registrant dated \t November 15, 1995.\n10.29 Option Agreement dated November 22, 1995 between the Registrant and Agri-Mark, Inc. of Methuen, Massachusetts.\n10.30{+} Employment Agreement dated November 1991 between the Registrant and Joseph H. Crabb.\n10.31{+} Amendment, dated March 1992, to Employment Agreement dated November 1991, between the Registrant and Joseph H. Crabb.\n10.32{+} Amendment, dated April 1992, to Employment Agreement dated November 1991, between the Registrant and Joseph H. Crabb.\n27.1 Financial Data Schedule.\nIMMUCELL CORPORATION AND SUBSIDIARY Exhibit 3.3\nBylaws of the Registrant as amended.\nBy-Laws of\nIMMUCELL CORPORATION\nA Delaware Corporation\nAs amended through March 8, 1996\nPage\nARTICLE I MEETINGS OF STOCKHOLDERS ...................................1\nSection 1. Place of Meetings ..........................................1 Section 2. Annual Meeting .............................................1 Section 3. Special Meetings ...........................................1 Section 4. Notice of Meetings .........................................1 Section 5. Voting List ................................................2 Section 6. Quorum .....................................................2 Section 7. Adjournments ...............................................2 Section 8. Action at Meetings .........................................2 Section 9. Voting and Proxies .........................................2 Section 10. Action Without Meeting .....................................3 Section 11. Nomination of Directors ....................................3 Section 12. Notice of Stockholder Business .............................4\nARTICLE II DIRECTORS ..........................................5\nSection 1. Number, Election, Tenure and Qualification .........5 Section 2. Enlargement ........................................5 Section 3. Vacancies ..........................................5 Section 4. Resignation and Removal ............................5 Section 5. General Powers .....................................6 Section 6. Chairman of the Board ..............................6 Section 7. Place of Meetings ..................................6 Section 8. Regular Meetings ...................................6 Section 9. Special Meetings ...................................6 Section 10. Quorum, Action at Meeting, Adjournments ............6 Section 11. Action by Consent ..................................7 Section 12. Telephonic Meetings ................................7 Section 13. Committees .........................................7 Section 14. Compensation .......................................7\nARTICLE III OFFICERS ...........................................8\nSection 1. Enumeration ................................................8 Section 2. Election ...........................................8 Section 3. Tenure .............................................8 Section 4. President ..........................................8 Section 5. Vice-Presidents ....................................9 Section 6. Secretary ..........................................9 Section 7. Assistant Secretaries ..............................9 Section 8. Treasurer ..........................................9 Section 9. Assistant Treasurers ..............................10 Section 10. Bond ..............................................10\nARTICLE IV NOTICES ...........................................10\nSection 1. Delivery ..........................................10 Section 2. Waiver of Notice ..................................11 \t ARTICLE V INDEMNIFICATION ...........................................11\nSection 1. Actions other than by or in the Right of the \t\t\tCorporation ......................................11 Section 2. Actions by or in the Right of the Corporation .....11 Section 3. Success on the Merits .............................12 Section 4. Specific Authorization ............................12 Section 5. Advance Payment ...................................12 Section 6. Non-Exclusivity ...................................12 Section 7. Insurance .........................................12 Section 8. Continuation of Indemnification and Advancement \t of Expenses ......................................12 Section 9. Intent of Article .................................13\nARTICLE VI CAPITAL STOCK .....................................13\nSection 1. Certificates of Stock .............................13 Section 2. Lost Certificates .................................13 Section 3. Transfer of Stock .................................13 Section 4. Record Date .......................................14 Section 5. Registered Stockholders ...........................15\nARTICLE VII CERTAIN TRANSACTIONS ......................................15\nSection 1. Transactions with Interested Parties ..............15 Section 2. Quorum ............................................15\nARTICLE VIII GENERAL PROVISIONS ........................................16\nSection 1. Dividends .........................................16 Section 2. Reserves ..........................................16 Section 3. Checks ............................................16 Section 4. Fiscal Year .......................................16 Section 5. Seal ..............................................16\nARTICLE IX AMENDMENTS ........................................16\nIMMUCELL CORPORATION\n* * * * *\nBY- LAWS\n* * * * *\nARTICLE I\nMEETINGS OF STOCKHOLDERS\nSection 1. Place of Meetings. All meetings of the stockholders shall he held at such place within or without the State of Delaware as may be fixed from time to time by the board of directors or the chief executive officer, or if not so designated, at the registered office of the corporation.\nSection 2. Annual Meeting. Commencing in calendar year 1988, annual meetings of stockholders shall be held on the third Tuesday in May in each year if not a legal holiday, and if a legal holiday, then on the next secular day following, at 10:00 a.m., or at such other date and time as shall be designated from time to time by the board of directors or the chief executive officer, at which meeting the stockholders shall elect by a plurality vote a board of directors and shall transact such other business as may properly be brought before the meeting. If no annual meeting is held in accordance with the foregoing provisions, the board of directors shall cause the meeting to be held as soon thereafter as convenient, which meeting shall be designated a special meeting in lieu of annual meeting.\nSection 3. Special Meetings. Special meetings of the stockholders, for any purpose or purposes, may, unless otherwise prescribed by statute or by the certificate of incorporation, be called by the board of directors or the chief executive officer and shall be called by the chief executive officer or secretary at the request in writing of a majority of the board of directors, or at the request in writing of stockholders owning a majority in amount of the entire capital stock of the corporation issued and outstanding and entitled to vote. Such request shall state the purpose or purposes of the proposed meeting. Business transacted at any special meeting shall be limited to matters relating to the purpose or purposes stated in the notice of meeting.\nSection 4. Notice of Meetings. Except as otherwise provided by law, written notice of each meeting of stockholders, annual or special, stating the place, date and hour of the meeting and, in the case of a special meeting, the purpose or purposes for which the meeting is called, shall be given not less than ten or more than sixty days before the date of the meeting, to each stockholder entitled to vote at such meeting.\nSection 5. Voting List. The officer who has charge of the stock ledger of the corporation shall prepare and make, at least ten days before every meeting of stockholders, a complete list of the stockholders entitled to vote at the meeting, arranged in alphabetical order, and showing the address of each stockholder and the number of shares registered in the name of each stockholder. Such list shall be open to the examination of any stockholder, for any purpose germane to the meeting, during ordinary business hours, for a period of at least ten days prior to the meeting, either at a place within the city or town where the meeting is to be held, which place shall be specified in the notice of the meeting, or, if not so specified, at the place where the meeting is to be held. The list shall also be produced and kept at the time and place of the meeting during the whole time thereof, and may be inspected by any stockholder who is present.\nSection 6. Quorum. The holders of one-third of the stock issued and outstanding and entitled to vote thereat, present in person or represented by proxy, shall constitute a quorum at all meetings of the stockholders for the transaction of business, except as otherwise provided by statute, the certificate of incorporation or these by-laws.\nSection 7. Adjournments. Any meeting of stockholders may be adjourned from time to time to any other time and to any other place at which a meeting of stockholders may be held under these by-laws, which time and place shall be announced at the meeting, by a majority of the stockholders present in person or represented by proxy at the meeting and entitled to vote, though less than a quorum, or, if no stockholder is present or represented by proxy, by any officer entitled to preside at or to act as secretary of such meeting, without notice other than announcement at the meeting, until a quorum shall be present or represented. At such adjournment meeting at which a quorum shall be present or represented, any business may be transacted which might have been transacted at the original meeting. If the adjournment is for more than thirty days, or if after the adjournment a new record date is fixed for the adjourned meeting, a notice of the adjourned meeting shall be given to each stockholder of record entitled to vote at the meeting.\nSection 8. Action at Meetings. Except with respect to the election of directors, when a quorum is present at any meeting, the vote of the holders of a majority of the stock present in person or represented by proxy and entitled to vote on the question shall decide any question brought before such meeting, unless the question is one upon which by express provision of law, the certificate of incorporation or these bylaws, a different vote is required, in which case such express provision shall govern and control the decision of such question. Unless otherwise provided in the certificate of incorporation or by express provision of law, directors shall be elected by a plurality of the votes of the shares present in person or represented by proxy at the meeting and entitled to vote on the election of directors.\nSection 9. Voting and Proxies. Unless otherwise provided in the certificate of incorporation, each stockholder shall at every meeting of the stockholders be entitled to one vote for each share of capital stock having voting power held of record by such stockholder. Each stockholder entitled to vote at a meeting of stockholders, or to express consent or dissent to corporate action in writing without a meeting, may authorize another person or persons to act for him by proxy, but no such proxy shall be voted or acted upon after three years from its date, unless the proxy provides for a longer period.\nSection 10. Action Without Meeting. Unless otherwise provided in the certificate of incorporation, any action required to be taken at any annual or special meeting of such stockholders, may be taken without a meeting, without prior notice and without a vote, if a consent or consents in writing, setting forth the action so taken, shall be signed by the holders of outstanding stock having not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting at which all shares entitled to vote thereon were present and voted and shall be delivered to the corporation by delivery to its registered office in Delaware, its principal place of business, or an officer or agent of the corporation having custody of the book in which proceedings of meetings of stockholders are recorded. Delivery made to a corporation's registered office shall be by hand or certified or registered mail, return receipt requested. Every written consent shall bear the date of signature of each stockholder or member who signs the consent and no written consent shall be effective to take the corporate action referred to therein unless, within sixty days of the earliest dated consent delivered in the manner provided for herein to the corporation, written consents signed by a sufficient number of holders or members to take action are delivered to the corporation by delivery to its registered office in Delaware, its principal place of business, or an officer or agent of the corporation having custody of the book in which proceedings of meetings of stockholders are recorded. Delivery made to a corporation's registered office shall be by hand or by certified or registered mail, return receipt requested. Prompt notice of the taking of the corporate action without a meeting by less than unanimous written consent shall be given to those stockholders or members who have not consented in writing.\nSection 11. Nomination of Directors. (a) Only persons who are nominated in accordance with the procedures set forth in this Section 11 shall be eligible for election as directors. Nominations of persons for election to the board of directors of the corporation may be made at a meeting of stockholders (i) by or at the direction of the board of directors or (ii) by any stockholder of the corporation entitled to vote for the election of directors at the meeting who complies with the notice procedures set forth in this Section 11.\n(b) Nominations by stockholders shall be made pursuant to timely notice in writing to the secretary of the corporation. To be timely, a stockholder's notice shall be delivered to or mailed and received at the principal executive offices of the corporation (i) in the case of an annual meeting, not less than 60 days nor more than 90 days prior to the first anniversary of the preceding year's annual meeting; provided, however, that in the event that the date of the annual meeting is changed by more than 30 days from such anniversary date, notice by the stockholder to be timely must be so received not later than the close of business on the 10th day following the earlier of the day on which notice of the date of the meeting was mailed or public disclosure was made, and (ii) in the case of a special meeting at which directors are to be elected, not later than the close of business on the 10th day following the earlier of the day on which notice of the date of the meeting was mailed or public disclosure was made. Such stockholder's notice shall set forth (i) as to each person whom the stockholder proposes to nominate for election or re-election as a director, (1) the name, age, business address and residence address of such person, (2) the principal occupation or employment of such person, (3) the class and number of shares of the corporation which are beneficially owned by such person and (4) any other information relating to such person that is required to be disclosed in solicitations of proxies for election of directors, or is otherwise required, in each case pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended (including without limitation such persons' written consent to being named in the proxy statement as a nominee and to serving as a director if elected); and (ii) as to the stockholder giving the notice (1) the name and address, as they appear on the corporation's books, of such stockholder and (2) the class and number of shares of the corporation which are beneficially owned by such stockholder. At the request of the board of directors any person nominated by the board of directors for election as a director shall furnish to the secretary of the corporation that information required to be set forth in a stockholder's notice of nomination which pertains to the nominee.\n(c) No person shall be eligible for election as a director of the corporation unless nominated in accordance with the procedures set forth in this Section 11. The chairman of the meeting shall, if the facts warrant, determine and declare to the meeting that a nomination was not made in accordance with the procedures prescribed by these by-laws, and if he should so determine, he shall so declare to the meeting and the defective nomination shall be disregarded. Notwithstanding the foregoing provisions of this by-law, a stockholder shall also comply with all applicable requirements of the Securities Exchange Act of 1934, as amended, and the rules and regulations thereunder with respect to the matters set forth in this by-law.\nSection 12. Notice of Stockholder Business.(a) At an annual meeting of the stockholders, only such business shall be conducted as shall have been properly brought before the meeting. To be properly brought before an annual meeting business must be (i) specified in the notice of meeting (or any supplement thereto) given by or at the direction of the board of directors, (ii) otherwise properly brought before the meeting by or at the direction of the board of directors, or (iii) otherwise properly brought before the meeting by a stockholder. For business to be properly brought before an annual meeting by a stockholder, the stockholder must have given timely notice thereof in writing to the secretary of the corporation. To be timely, a stockholder's notice must be delivered to or mailed and received at the principal executive offices of the corporation, not less than 60 days nor more than 90 days prior to the first anniversary of the preceding year's annual meeting; provided, however, that in the event that the date of the meeting is changed by more than 30 days from such anniversary date, notice by the stockholder to be timely must be so received not later than the close of business on the 10th day following the earlier of the day on which notice of the date of the annual meeting was mailed or public disclosure was made. A stockholder's notice to the secretary shall set forth as to each matter the stockholder proposes to bring before the annual meeting (i) a brief description of the business desired to be brought before the annual meeting and the reasons for conducting such business at the annual meeting, (ii) the name and address, as they appear on the corporation's books, of the stockholder proposing such business, (iii) the class and number of shares of the corporation which are beneficially owned by the stockholder, and (iv) any material interest of the stockholder in such business.\n(b) Notwithstanding anything in these by-laws to the contrary, no business shall be conducted at any annual meeting except in accordance with the procedures set forth in this Section 12. The chairman of the annual meeting shall, if the facts warrant, determine and declare to the meeting that business was not properly brought before the meeting and in accordance with the provisions of this Section 12, and if he should so determine, he shall so declare to the meeting and any such business not properly brought before the meeting shall not be transacted. Notwithstanding the foregoing provisions of this by-law, a stockholder shall also comply with all applicable requirements of the Securities Exchange Act of 1934, as amended, and the rules and regulations thereunder with respect to the matters set forth in this by-law.\nARTICLE II\nDIRECTORS\nSection 1. Number, Election, Tenure and Qualification. The corporation shall have not less than three (3) nor more than fifteen (15) directors. The number of directors may be increased or decreased from time to time by resolution of the board of directors but no decrease shall have the effect of shortening the term of any incumbent director. The directors shall be elected at the annual meeting or at any special meeting of the stockholders, except as provided in Section 3 of this Article, and each director elected shall hold office until his successor is elected and qualified, unless sooner displaced. Directors need not be stockholders.\nSection 2. Enlargement. The number of the board of directors may be increased at any time by vote of a majority of the directors then in office.\nSection 3. Vacancies. Vacancies and newly created directorships resulting from any increase in the authorized number of directors may be filled by a majority of the directors then in office, though less than a quorum, or by a sole remaining director, and the directors so chosen shall hold office until the next annual election and until their successors are duly elected and shall qualify, unless sooner displaced. If there are no directors in office, then an election of directors may be held in the manner provided by statute. In the event of a vacancy in the board of directors, the remaining directors, except as otherwise provided by law or these by-laws, may exercise the powers of the full board until the vacancy is filled.\nSection 4. Resignation and Removal. Any director may resign at any time upon written notice to the corporation at its principal place of business or to the chief executive officer or secretary. Such resignation shall be effective upon receipt unless it is specified to be effective at some other time or upon the happening of some other event. Any director or the entire board of directors may be removed, with or without cause, by the holders of a majority of the shares then entitled to vote at an election of directors, unless otherwise specified by law or the certificate of incorporation.\nSection 5. General Powers. The business and affairs of the corporation shall be managed by its board of directors, which may exercise all powers of the corporation and do all such lawful acts and things as are not by statute or by the certificate of incorporation or by these by-laws directed or required to be exercised or done by the stockholders.\nSection 6. Chairman of the Board. If the board of directors appoints a chairman of the board, he shall, when present, preside at all meetings of the stockholders and the board of directors. He shall perform such duties and possess such powers as are customarily vested in him by the board of directors.\nSection 7. Place of Meetings. The board of directors may hold meetings, both regular and special, either within or without the State of Delaware.\nSection 8. Regular Meetings. Regular meetings of the board of directors may be held without notice at such time and at such place as shall from time to time be determined by the board; provided that any director who is absent when such a determination is made shall be given prompt notice of such determination. A regular meeting of the board of directors may be held without notice immediately after and at the same place as the annual meeting of stockholders.\nSection 9. Special Meetings. Special meetings of the board may be called by the chief executive officer, secretary, or on the written request of two or more directors, or by one director in the event that there is only one director in office. Two days' notice to each director, either personally or by telegram, cable, telecopy, commercial delivery service, telex or similar means sent to his business or home address, or three days' notice by written notice deposited in the mail, shall be given to each director by the secretary or by the officer or one of the directors calling the meeting. A notice or waiver of notice of a meeting of the board of directors need not specify the purposes of the meeting.\nSection 10. Quorum, Action at Meeting, Adjournments. At all meetings of the board a majority of directors then in office, but in no event less than one third of the entire board, shall constitute a quorum for the transaction of business and the act of a majority of the directors present at any meeting at which there is a quorum shall be the act of the board of directors, except as may be otherwise specifically provided by law or by the certificate of incorporation. For purposes of this section, the term \"entire board\" shall mean the number of directors last fixed by the stockholders or directors, as the case may be, in accordance with law and these by-laws; provided, however, that if less than all the number so fixed of directors were elected, the \"entire board\" shall mean the greatest number of directors so elected to hold office at any one time pursuant to such authorization. If a quorum shall not be present at any meeting of the board of directors, a majority of the directors present thereat may adjourn the meeting from time to time, without notice other than the announcement at the meeting, until a quorum shall be present.\nSection 11. Action by Consent. Unless otherwise restricted by the certificate of incorporation or these by-laws, any action required or permitted to be taken at any meeting of the board of directors or of any committee thereof may be taken without a meeting, if all members of the board or committee, as the case may be, consent thereto in writing, and the writing or writings are filed with the minutes of proceedings of the board or committee.\nSection 12. Telephonic Meetings. Unless otherwise restricted by the certificate of incorporation or these by-laws, members of the board of directors or of any committee thereof may participate in a meeting of the board of directors or of any committee, as the case may be, by means of conference telephone or similar communications equipment by means of which all persons participating in the meeting can hear each other, and such participation in a meeting shall constitute presence in person at the meeting.\nSection 13. Committees. The board of directors may, by resolution passed by a majority of the whole board, designate one or more committees, each committee to consist of one or more of the directors of the corporation. The board may designate one or more directors as alternate members of any committee, who may replace any absent or disqualified member at any meeting of the committee. Any such committee, to the extent provided in the resolution of the board of directors, shall have and may exercise all the powers and authority of the board of directors in the management of the business and affairs of the corporation, and may authorize the seal of the corporation to be affixed to all papers which may require it; but no such committee shall have the power or authority in reference to amending the certificate of incorporation, adopting an agreement of merger or consolidation, recommending to the stockholders the sale, lease or exchange of all or substantially all of the corporation's property and assets, recommending to the stockholders a dissolution of the corporation or a revocation of a dissolution, or amending the by-laws of the corporation; and, unless the resolution designating such committee or the certificate of incorporation expressly so provide, no such committee shall have the power or authority to declare a dividend or to authorize the issuance of stock. Such committee or committees shall have such name or names as may be determined from time to time by resolution adopted by the board of directors. Each committee shall keep regular minutes of its meetings and make such reports to the board of directors as the board of directors may request. Except as the board of directors may otherwise determine, any committee may make rules for the conduct of its business, but unless otherwise provided by the directors or in such rules, its business shall be conducted as nearly as possible in the same manner as is provided in these by-laws for the conduct of its business by the board of directors.\nSection 14. Compensation. Unless otherwise restricted by the certificate of incorporation or these by-laws, the board of directors shall have the authority to fix from time to time the compensation of directors. The directors may be paid their expenses, if any, of attendance at each meeting of the board of directors and the performance of their responsibilities as directors and may be paid a fixed sum for attendance at each meeting of the board of directors and\/or a stated salary as director. No such payment shall preclude any director from serving the corporation or its parent or subsidiary corporations in any other capacity and receiving compensation therefor. The board of directors may also allow compensation for members of special or standing committees for service on such committees.\nARTICLE III\nOFFICERS\nSection 1. Enumeration. The officers of the corporation shall be chosen by the board of directors and shall be a president, a secretary and a treasurer and such other officers with such titles, terms of office and duties as the board of directors may from time to time determine, including a chairman of the board, one or more vice-presidents, and one or more assistant secretaries and assistant treasurers. If authorized by resolution of the board of directors, the chief executive officer may be empowered to appoint from time to time assistant secretaries and assistant treasurers. Any number of offices may be held by the same person, unless the certificate of incorporation or these by-laws otherwise provide.\nSection 2. Election. The board of directors at its first meeting after each annual meeting of stockholders shall choose a president, a secretary and a treasurer. Other officers may be appointed by the board of directors at such meeting, at any other meeting, or by written consent.\nSection 3. Tenure. The officers of the corporation shall hold office until their successors are chosen and qualify, unless a different term is specified in the vote choosing or appointing him, or until his earlier death, resignation or removal. Any officer elected or appointed by the board of directors or by the chief executive officer may be removed at any time by the affirmative vote of a majority of the board or directors or a committee duly authorized to do so, except that any officer appointed by the chief executive officer may also be removed at any time by the chief executive officer. Any vacancy occurring in any office of the corporation may be filled by the board of directors, at its discretion. Any officer may resign by delivering his written resignation to the corporation at its principal place of business or to the chief executive officer or the secretary. Such resignation shall be effective upon receipt unless it is specified to be effective at some other time or upon the happening of some other event.\nSection 4. President. The president shall be the chief operating officer of the corporation. He shall also be the chief executive officer unless the board of directors otherwise provides. The president shall, unless the board of directors provides otherwise in specific instance or generally, preside at all meetings of the stockholders and the board of directors, have general and active management of the business of the corporation and see that all orders and resolutions of the board of directors are carried into effect. The president shall execute bonds, mortgages, and other contracts requiring a seal, under the seal of corporation, except where required or permitted by law to be otherwise signed and executed and except where the signing and execution thereof shall be expressly delegated by the board of directors to some other officer or agent of the corporation.\nSection 5. Vice-Presidents. In the absence of the president or in the event of his inability or refusal to act, the vice-president, or if there be more than one vice-president, the vice-presidents in the order designated by the board of directors or the chief executive officer (or in the absence of any designation, then in the order determined by their tenure in office) shall perform the duties of the president, and when so acting, shall have all the powers of and be subject to all the restrictions upon the president. The vice- presidents shall perform such other duties and have such other powers as the board of directors or the chief executive officer may from time to time prescribe.\nSection 6. Secretary. The secretary shall have such powers and perform such duties as are incident to the office of secretary. He shall maintain a stock ledger and prepare lists of custodian of corporate records. The secretary shall attend all meetings of the board of directors and all meetings of the stockholders and record all the proceedings of the meetings of the corporation and of the board of directors in a book to be kept for that purpose and shall perform like duties for the standing committees when required. He shall give, or cause to be given, notice of all meetings of the stockholders and special meetings of the board of directors, and shall perform such other duties as may be from time to time prescribed by the board of directors or chief executive officer, under whose supervision he shall be. He shall have custody of the corporate seal of the corporation and he, or an assistant secretary, shall have authority to affix the same to any instrument requiring it and when so affixed, it may be attested by his signature or by the signature of such assistant secretary. The board of directors may give general authority to any other officer to affix the seal of the corporation and to attest the affixing by his signature.\nSection 7. Assistant Secretaries. The assistant secretary, or if there be more than one, the assistant secretaries in the order determined by the board of directors, the chief executive officer or the secretary (or if there be no such determination, then in the order determined by their tenure in office), shall, in the absence of the secretary or in the event of his inability or refusal to act, perform the duties and exercise the powers of the secretary and shall perform the duties and exercise the powers of the secretary and shall perform such other duties and have such other powers as the board of directors, the chief executive officer or the secretary may from time to time prescribe. In the absence of the secretary or any assistant secretary at any meeting of stockholders or directors, the person presiding at the meeting shall designate a temporary or acting secretary to keep a record of the meeting.\nSection 8. Treasurer. The treasurer shall perform such duties and shall have such powers as may be assigned to him by the board of directors or the chief executive officer. In addition, the treasurer shall perform such duties and have such powers as are incident to the office of treasurer shall keep full and accurate accounts of receipts and disbursements in books belonging to the corporation and shall deposit all moneys and other valuable effects in the name and to the credit of the corporation in such depositories as may be designated by the board of directors. He shall disburse the funds of the corporation as may be ordered by the board of directors, taking proper vouchers for such disbursements, and shall render to the chief executive officer and the board of directors, when the chief executive officer or board of directors so requires, an account of all his transactions as treasurer and of the financial condition of the corporation.\nSection 9. Assistant Treasurers. The assistant treasurer, or if there shall be more than one, the assistant treasurers in the order determined by the board of directors, the chief executive officer or the treasurer (or if there be no such determination, then in the order determined by their tenure in office), shall, in the absence of the treasurer or in the event of his inability or refusal to act, perform the duties and exercise the powers of the treasurer and shall perform such other duties and have such other powers as the board of directors, the chief executive officer or the treasurer may from time to time prescribe.\nSection 10. Bond. If required by the board of directors, any officer shall give the corporation a bond in such sum and with such surety or sureties and upon such terms and conditions as shall be satisfactory to the board of directors, including without limitation a bond for the faithful performance of the duties of his office and for the restoration to the corporation of all books, papers, vouchers, money and other property of whatever kind in his possession or under his control and belonging to the corporation.\nARTICLE IV\nNOTICES\nSection 1. Delivery. Whenever, under the provisions of law, or of the certificate of incorporation or these by-laws, written notice is required to given to any director or stockholder, such notice may be given by mail, addressed to such director or stockholder, at his address as it appears on the records of the corporation, with postage thereon prepaid, and such notice shall be deemed to be given at the time when the same shall be deposited in the United States mail. Unless written notice by mail is required by law, written notice may also be given by telegram, cable, telecopy, commercial delivery service, telex or similar means, addressed to such director or stockholder at his address as it appears on the records of the corporation, in which case such notice shall be deemed to be given when delivered into the control of the persons charged with effecting such transmission, the transmission charge to be paid by the corporation or the person sending such notice and not by the addressee. Oral notice or other in-hand delivery (in person or by telephone) shall be deemed given at the time it is actually given.\nSection 2. Waiver of Notice. Whenever any notice is required to be given under the provisions of law or of the certificate of incorporation or of these by-laws, a waiver thereof in writing, signed by the person or persons entitled to said notice, whether before or after the time stated therein, shall be deemed equivalent thereto.\nARTICLE V\nINDEMNIFICATION\nSection 1. Actions other than by or in the Right of the Corporation. The corporation shall indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative (other than an action by or in the right of the corporation) by reason of the fact that he is or was a director, officer, employee or agent of the corporation, or is or was serving at the request or the corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, against expenses (including attorneys' fees), judgments, fines and amounts paid in settlement actually and reasonably incurred by him in connection with such action, suit or proceeding if he acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the corporation, and, with respect to any criminal action or proceedings, had no reasonable cause to believe his conduct was unlawful. The termination of any action, suit or proceeding by judgment, order, settlement, conviction, or upon a plea of nolo contendere or its equivalent, shall not, of itself, create a presumption that the person did not act in good faith and in a manner which he reasonably believed to be in or not opposed to the best interests of the corporation, and, with respect to any criminal action or proceeding, had reasonable cause to believe that his conduct was unlawful.\nSection 2. Actions by or in the Right of the Corporation. The corporation shall indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action or suit by or in the right of the corporation to procure a judgment in its favor by reason of the fact that he is or was a director, officer, employee or agent of the corporation, or is or was serving at the request of the corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprises against expenses (including attorney's fees) actually and reasonably incurred by him in connection with the defense or settlement of such action or suit if he acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the corporation and except that no indemnification shall be made in respect of any claim, issue or matter as to which such person shall have been adjudged to be liable for negligence or misconduct in the performance of his duties to the corporation unless and only to the extent that the Court of Chancery of the State of Delaware or the court in which such action or suit was brought shall determine upon application that, despite the adjudication of liability but in view of all the circumstances of the case, such person is fairly and reasonably entitled to indemnity for such expenses which the Court of Chancery of the State of Delaware or such other court shall deem proper.\nSection 3. Success on the Merits. To the extent that any person described in Section 1 or 2 of this Article V has been successful on the merits or otherwise in defense of any action, suit or proceeding referred to in said Sections, or in defense of any claim, issue or matter therein, he shall be indemnified against expenses (including attorneys' fees) actually and reasonably incurred by him in connection therewith.\nSection 4. Specific Authorization. Any indemnification under Section 1 or 2 of this Article V (unless ordered by a court) shall be made by the corporation only as authorized in the specific case upon a determination that indemnification of any person described in said Sections is proper in the circumstances because he has met the applicable standard of conduct set forth in said Sections. Such determination shall be made (1) by the board of director by a majority vote of a quorum consisting of directors who were not parties to such action, suit or proceeding, or (2) if such a quorum is not obtainable, or even if obtainable a quorum of disinterested directors so directs, by independent legal counsel in a written opinion, or (3) by the stockholders of the corporation.\nSection 5. Advance Payment. Expenses incurred in defending a civil or criminal action, suit or proceeding may be paid by the corporation in advance of the final disposition of such action, suit or proceeding upon receipt of an undertaking by or on behalf of any person described in said Section to repay such amount if it shall ultimately be determined that he is not entitled to indemnification by the corporation as authorized in this Article V.\nSection 6. Non-Exclusivity. The indemnification and advancement of expenses provided by, or granted pursuant to, the other Sections of this Article V shall not be deemed exclusive of any other rights to which those provided indemnification or advancement of expenses may be entitled under any by-law, agreement, vote of stockholders or disinterested directors or otherwise, both as to action in his official capacity and as to action in another capacity while holding such office.\nSection 7. Insurance. The board of directors may authorize, by a vote of the majority of the full board, the corporation to purchase and maintain insurance on behalf of any person who is or was a director, officer, employee or agent of the corporation, or is or was serving at the request of the corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise against any liability asserted against him and incurred by him in any such capacity, or arising out of his status as such, whether or not the corporation would have the power to indemnify him against such liability under the provisions of this Article V.\nSection 8. Continuation of Indemnification and Advancement of Expenses. The indemnification and advancement of expenses provided by, or granted pursuant to, this Article V shall continue as to a person who has ceased to be a director, officer, employee or agent and shall inure to the benefit of the heirs, executors and administrators of such a person.\nSection 9. Intent of Article. The intent of this Article V is to provide for indemnification and advancement of expenses to the fullest extent permitted by Section 145 of the General Corporation Law of Delaware. To the extent that such Section or any successor section may be amended or supplemented from time to time, this Article V shall be amended automatically and construed so as to permit indemnification and advancement of expenses to the fullest extent from time to time permitted by law.\nARTICLE VI\nCAPITAL STOCK\nSection 1. Certificates of Stock. Every holder of stock in the corporation shall be entitled to have a certificate, signed by, or in the name of the corporation by, the chairman or vice-chairman of the board of directors, or the president or a vice-president and the treasurer or an assistant treasurer, or the secretary or an assistant secretary of the corporation, certifying the number of shares owned by him in the corporation. Any or all of the signatures on the certificate may be a facsimile. In case any officer, transfer agent or registrar who has signed or whose facsimile signature has been placed upon a certificate shall have ceased to be such officer, transfer agent or registrar before such certificate is issued, it may be issued by the corporation with the same effect as if he were such officer, transfer agent or registrar at the date of issue. Certificates may be issued for partly paid shares and in such case upon the face or back of the certificates issued to represent any such partly paid shares, the total amount of the consideration to be paid therefor, and the amount paid thereon shall be specified.\nSection 2. Lost Certificates. The board of directors may direct a new certificate or certificates to be issued in place of any certificate or certificates theretofore issued by the corporation alleged to have been lost, stolen or destroyed. When authorizing such issue of a new certificate or certificates, the board of directors may, in its discretion and as a condition precedent to the issuance thereof, require the owner of such lost, stolen or destroyed certificate or certificates, or his legal representative, to give reasonable evidence of such loss, theft or destruction, to advertise the same in such manner as it shall require and\/or to give the corporation a bond in such sum as it may direct as indemnity against any claim that may be made against the corporation with respect to the certificate alleged to have been lost, stolen or destroyed or the issuance of such new certificate.\nSection 3. Transfer of Stock. Upon surrender to the corporation or the transfer agent of the corporation of a certificate for shares, duly endorsed or accompanied by proper evidence of succession, assignment or authority to transfer, and proper evidence of compliance with other conditions to rightful transfer, it shall be the duty of the corporation to issue a new certificate to the person entitled thereto, cancel the old certificate and record the transaction upon its books.\nSection 4. Record Date. (a) In order that the corporation may determine the stockholders entitled to notice of or to vote at any meeting of stockholders or any adjournment thereof, the board of directors may fix a record date, which record date shall not precede the date upon which the resolution fixing the record date is adopted by the board of directors, and which record date shall not be more than sixty nor less than ten days before the date of such meeting. If no record date is fixed by the board of directors, the record date for determining stockholders entitled to notice of or to vote at a meeting of stockholders shall be at the close of business on the day next preceding the day on which notice is given, or, if notice is waived, at the close of business on the day next preceding the day on which the meeting is held. A determination of stockholders of record entitled to notice of or to vote at a meeting of stockholders shall apply to any adjournment of the meeting; provided, however, that the board of directors may fix a new record date for the adjourned meeting.\n(b) In order that the corporation may determine the stockholders entitled to consent to corporate action in writing without a meeting, the board of directors may fix a record date, which record date shall not precede the date upon which the resolution fixing the record date is adopted by the board of directors, and which date shall not be more than ten days after the date upon which the resolution fixing the record date is adopted by the board of directors. If no record date has been fixed by the board of directors, the record date for determining stockholders entitled to consent to corporate action in writing without a meeting, when no prior action by the board of directors is required by this chapter, shall be the first date on which a signed written consent setting forth the action taken or proposed to be taken is delivered to the corporation by delivery to its registered office in Delaware, its principal place of business, or an officer or agent of the corporation having custody of the book in which proceedings of meetings of stockholders are recorded. Delivery made to a corporation's registered office shall be by hand or by certified or registered mail, return receipt requested. If no record date has been fixed by the board of directors and prior action by the board of directors is required by this chapter, the record date for determining stockholders entitled to consent to corporate action in writing without a meeting shall be at the close of business on the day on which the board of directors adopts the resolution taking such prior action.\n(c) In order that the corporation may determine the stockholders entitled to receive payment of any dividend or other distribution or allotment of any rights or the stockholders entitled to exercise any rights in respect of any change, conversion or exchange of stock, or for the purpose of any other lawful action, the board of directors may fix a record date, which record date shall not precede the date upon which the resolution fixing the record date is adopted, and which record date shall be not more than sixty days prior to such action. If no record date is fixed, the record date for determining stockholders for any such purpose shall be at the close of business on the day on which the board of directors adopts the resolution relating thereto.\nSection 5. Registered Stockholders. The corporation shall be entitled to recognize the exclusive right of a person registered on its books as the owner of shares to receive dividends, and to vote as such owner, and to hold liable for calls and assessments a person registered on its books as the owner of shares, and shall not be bound to recognize any equitable or other claim to or interest in such share or shares on the part of any other person, whether or not it shall have express or other notice thereof, except as otherwise provided by the laws of Delaware.\nARTICLE VII\nCERTAIN TRANSACTIONS\nSection 1. Transactions with Interested Parties. No contract or transaction between the corporation and one or more of its directors or officers, or between the corporation and any other corporation, partnership, association, or other organization in which one or more of its directors or officers are directors or officers, or have a financial interest, shall be void or voidable solely for this reason, or solely because the director or officer is present at or participates in the meeting of the board or committee thereof which authorizes the contract or transaction or solely because his or their votes are counted for such purpose, if:\n(a) The material facts as to his relationship or interest and as to the contract or transaction are disclosed or are known to the board of directors or the committee, and the board or committee in good faith authorizes the contract or transaction by the affirmative votes of a majority of the disinterested directors, even though the disinterested directors be less than a quorum; or\n(b) The material facts as to his relationship or interest and as to be contract or transaction are disclosed or are known to the stockholders entitled to vote thereon, and the contract or transaction is specifically approved in good faith by vote of the stockholders; or\n(c) The contract or transaction is fair as to the corporation as of the time it is authorized, approved or ratified, by the board of directors, a committee thereof, or the stockholders.\nSection 2. Quorum. Common or interested directors may be counted in determining the presence of a quorum at a meeting of the board of directors or of a committee which authorizes the contract or transaction.\nARTICLE VIII\nGENERAL PROVISIONS\nSection 1. Dividends. Dividends upon the capital stock of the corporation, if any, may be declared by the board of directors at any regular or special meeting or by written consent, pursuant to law. Dividends may be paid in cash, in property, or in shares of the capital stock, subject to the provisions of the certificate of incorporation.\nSection 2. Reserves. The directors may set apart out of any funds of the corporation available for dividends a reserve or reserves for any proper purpose and may abolish any such reserve.\nSection 3. Checks. All checks or demands for money and notes of the corporation shall be signed by such officer or officers or such other person or persons as the board of directors may from time to time designate.\nSection 4. Fiscal Year. The fiscal year of the corporation shall be fixed by resolution of the board of directors.\nSection 5. Seal. The board of directors may, by resolution, adopt a corporate seal. The corporate seal shall have inscribed thereon the name of the corporation, the year of its organization and the word \"Delaware\". The seal may be used by causing it or a facsimile thereof to be impressed or affixed or reproduced or otherwise. The seal may be altered from time to time by the board of directors.\nARTICLE IX\nAMENDMENTS\nThese by-laws may be altered, amended or repealed or new bylaws may be adopted by the stockholders or by the board of directors, when such power is conferred upon the board of directors by the certificate of incorporation, at any regular meeting of the stockholders or of the board of directors or at any special meeting of the stockholders or of the board of directors provided, however, that in the case of a regular or special meeting of stockholders, notice of such alteration, amendment, repeal or adoption of new by-laws be contained in the notice of such meeting.\nRegister of Amendments to the By-laws\nIMMUCELL CORPORATION AND SUBSIDIARY Exhibit 10.28\nAmendment No. 4 to Agreement for Exclusivity between Advanced Separation Technologies, Inc. and the Registrant dated November 15, 1995.\nAMENDMENT TO AGREEMENT\nFOR EXCLUSIVITY\nNOVEMBER 15, 1995\nTHIS AMENDMENT (\"The Amendment\") to AGREEMENT FOR EXCLUSIVITY IN PROTEIN SEPARATION OF MILK OR WHEY PROTEINS (the \"Agreement\" dated August 30, 1993) is made this 15th day of November, 1995 by and between ImmuCell Corporation, a Delaware Corporation with its principal place of business at 56 Evergreen Drive, Portland, Maine 04103 (\"ImmuCell\") and Advanced Separation Technologies, Inc., a Florida corporation with its principal place of business at 5315 Great Oak Drive, Lakeland, Florida 33801 (\"AST\").\nRECITALS\nA.) ImmuCell and AST have entered into an Agreement for Exclusivity, dated August 30, 1993 (Agreement), pursuant to which AST granted ImmuCell certain rights in return for meeting certain purchase requirements.\nB.) ImmuCell and AST have amended the Agreement on November 5, 1993, January 14, 1994, December 16, 1994 and May 3, 1995.\nC.) ImmuCell and AST desire to amend the Agreement again.\nNOW THEREFORE, in consideration of the mutual convents and conditions contained herein, the parties hereto agree as follows:\n1.) Article II, Section 2.0 on page four of the Agreement is deleted in its entirety and replaced with the following:\n2.0 AST agrees to grant ImmuCell the exclusive rights to buy ISEP(r) Systems and the right to use ISEP Systems\/ISEP Technology throughout the Territory for the purification of milk and whey proteins included in the Field of Use, provided the following conditions are met:\n2.) Article II, Section 2.4 on page four of the Agreement is deleted in its entirety and replaced with the following:\n2.4 Commercial ISEP-ImmuCell will place order for a commercial ISEP System as defined in Proposal No. 24-95289B and C. Rev. 1 within twenty-four months of receipt of the ISEP(r) defined in Proposal No. 42-95289-A and purchased by ImmuCell under P.O. #A0463 on September 28, 1993. ImmuCell will pay AST One Thousand Dollars ($1,000) per month for each month the order is delayed past the twelth month from receipt of the ISEP defined in\nPage 2. AST\/ImmuCell Agreement\nProposal No. 42-952889-A. The date by which\n\t\t\t ImmuCell must place an orderper this Section 2.4 \t\t\t will be extended to June 30, 1996 if the following \t\t\t two conditions are met: i) an agreement between \t\t\t ImmuCell and Agri-Mark toenter into a pilot \t\t\t development project is signed by November 22, \t\t\t 1995, and ii) the pilot ISEP unit owned by \t\t\t ImmuCell will be shipped to the Middlebury \t\t\t cheese plant of Agri-Mark on or before \t\t\t December 15, 1995. \t\t\t\n3.) The following Section 2.11 is added to Article II of the Agreement:\n2.11 ImmuCell may grant written sublicenses to third parties; except that no sublicense may be granted by ImmuCell to any competitor of AST. Any agreement in which ImmuCell grants a sublicense to buy and use ISEP Systems in the Field of Use shall state that the sublicense is subject to the terms and conditions of this Agreement.\n4.) The following Section 4.3 is added to Article IV of the Agreement:\n4.3 If ImmuCell does not order an ISEP System as contemplated in Section 2.4, ImmuCell shall grant AST a perpetual non-exclusive, royalty free license with rights to sublicense, to data from and process steps employing the continuous absorption or adsorption and chromatography capabilities of the ISEP System as developed by ImmuCell in its pilot plant programs in Fond du Lac, WI and Middlebury, Vermont. ImmuCell shall provide such data and process information to AST by August 30, 1996. Any data and processes developed by ImmuCell after June 30, 1996 shall not be included in this license. If ImmuCell or an ImmuCell sublicensee orders an ISEP per the terms of Section 2.4, ImmuCell will be under no obligation to grant the license described in this Section 4.3.\n5.) The following Article V, Section 5.0 is added to the Agreement:\n5.0 Sections 2.11, 3.4, 3.5, 4.1 and 4.3 shall survive termination of the Agreement.\n6.) All other provision of the Agreement remain unchanged and in full force and effect.\nIN WITNESS WHEREOF, the parties hereto have executed this amendment as of the day and year first above written.\nIMMUCELL CORPORATION ADVANCED SEPARATION TECHNOLOGIES, INC.\nBy: \/s\/ Thomas C. Hatch By: \/s\/ Steven Weiss\nNovember 17, 1995 November 30, 1995\nIMMUCELL CORPORATION AND SUBSIDIARY Exhibit 10.29\nOption Agreement dated November 22, 1995 between the Registrant and Agri-Mark, Inc. of Methuen, Massachusetts.\nOPTION AGREEMENT\nTHIS OPTION AGREEMENT (the \"Agreement\") is made as of this 22nd day of November, 1995, by and between ImmuCell Corporation, a Delaware corporation with its principal place of business at 56 Evergreen Drive, Portland, Maine 04103 (\"ImmuCell\"), and Agri-Mark, Inc., a Delaware corporation with its principal place of business at 100 Milk Street Office Park, Methuen, Massachusetts 01944 (\"AgriMark\").\nRECITALS\nWHEREAS, ImmuCell owns or controls certain proprietary and other rights (the \"Lactoferrin Technology\") relating to the production of lactoferrin from cows' milk (the \"Lactoferrin Product\"); and\nWHEREAS, ImmuCell and AgriMark desire to further develop the process of producing the Lactoferrin Product using the Lactoferrin Technology for commercial sale; and\nWHEREAS, ImmuCell and AgriMark recognize the goal of the Option Period (as hereinafter defined) is to determine whether it is possible: (i) to make lactoferrin using the Lactoferrin Technology, (ii) to fully equip a commercial plant at AgriMark's Middlebury, Vermont facility to make lactoferrin using the Lactoferrin Technology for a maximum capital investment of $800,000, (iii) to locate buyers willing to purchase lactoferrin for a least $200 per pound; and whether the Lactoferrin Technology and ISEP System (as hereinafter defined) will meet all USDA, USPH and other applicable regulatory standards.\nWHEREAS, ImmuCell desires to have AgriMark provide certain funding for the development and commercialization efforts, and\nWHEREAS, AgriMark desires to purchase an option to form a joint venture with ImmuCell in the form of a limited liability company to use the Lactoferrin Technology in the commercial production and production and sale of the Lactoferrin Product on the terms and conditions set forth below, and\nWHEREAS, ImmuCell has agreed that during the term of the Agreement ImmuCell will not enter into another option agreement on Lactoferrin Product with similar material terms with any other party;\nNOW THEREFORE, in consideration of the mutual covenants and conditions contained herein, the parties hereto agree as follows:\nARTICLE 1 - DEFINITIONS\n1.1 Affiliate shall mean any corporation or business entity controlled by, controlling, or under common control with, a party to this Agreement. For this purpose, \"control\" shall mean direct or indirect beneficial ownership of at least fifty percent (50%) of the voting stock or income interest in such corporation or other business entity, or such other relationship as, in fact, constitutes actual control.\n1.2 Confidential Information shall mean any know-how, technology, expertise and information, whether or not patented or patentable, copyrighted or copyrightable and any designs, processes, procedures, formulae, or improvements which relate to the development, formulation, production, manufacture or marketing of the Lactoferrin Product and which are confidential and commercially valuable in the sense that their confidentiality affords the disclosing party a competitive advantage over its competitors.\n1.3 Lactoferrin Product shall mean lactoferrin which is derived from the milk of dairy cows using the Lactoferrin Technology, together with any Improvements thereto.\n1.4 Lactoferrin Technology shall mean know-how, technology, information and processes owned by and\/or licensed to ImmuCell and used in deriving lactoferrin from whey using the ISEP System, together with all improvements thereto, except as restricted by Section 4.3 below.\n1.5 Effective Date shall mean the date set forth above.\n1.6 Improvements shall mean any and all inventions, modifications, discoveries, ideas, developments and enhancements related to the manufacture of the Lactoferrin Product, which inventions, etc., are conceived or first reduced to practice prior to the expiration or termination of this Agreement.\n1.7 AST shall mean Advanced Separation Technologies, Inc. a Florida corporation located in Lakeland, Florida, which owns the ISEP System and which has granted an exclusive license, with the right of sublicense, to ImmuCell to use the ISEP System as part of the Lactoferrin Technology.\n1.8 The ISEP System shall mean certain patented process and equipment technology owned by AST relating to the design, manufacture and operation of equipment for use in continuous chromatography described in U.S. Patent Nos. 4,522,726, 4,764.276, 4,808,317 and 5,069,883, attached to this agreement as Exhibit C.\n1.9 LLC shall have the encasing set forth in Section 3.1.\n1.10 Option Period shall mean the period of time which shall begin on the Effective Date of this Agreement and shall end on the earlier of (i) the formation of the LLC per the terms of Appendix A, (ii) June 15, 1996, or on any date before June 15, 1996 in which early termination is given per the terms of Section 7.1 or 7.2. In no event will the option be extended past June 15, 1996.\nARTICLE 2 - REPRESENTATIONS AND WARRANTIES\n2.1 By ImmuCell. ImmuCell hereby represents and warrants to AgriMark the following:\n(a) It is a corporation validly formed and existing under the laws of the State of Delaware.\n(b) It has an exclusive, worldwide license to use the ISEP System for the purification of milk or whey proteins and produce the Lactoferrin Product, and has full power and authority to sublicense the ISEP System for such use to AgriMark and the LLC as provided and contemplated in this Agreement. Except with respect to the ISEP System, and to the best of its knowledge, ImmuCell is the sole owner of all Lactoferrin Technology and does not know of any other person or entity who claims any right, title or interest in or to any of the Lactoferrin Technology.\n(c) There are no prior or contemporaneous assignments, grants, licenser, encumbrances, obligations or agreements, either written or oral, express or implied, to which it is a party, that are inconsistent with this Agreement.\n(d) To the best of ImmuCell's knowledge, the production, use and sale of the Lactoferrin Product, does not violate or infringe upon any patent or proprietary rights of any third party and ImmuCell has no knowledge of any claim of any kind pending, threatened or anticipated that alleges any such violation or infringement,\n(e) Immucell knows of no legal impediment to the license and option granted or to be granted in this Agreement and ImmuCell is aware of no pending or threatened claims or litigation that might create a legal impediment in the future.\n(f) The execution, delivery and performance of this Agreement and the consummation of the joint venture contemplated herein (i) have been duly and effectively authorized by all necessary corporate or other actions; (ii) do not violate, conflict with, or result in the breach of any provision of its Certificate of Incorporation. Bylaws or any comparable document, or of any agreement to which it is a party; (iii) do not require any consent, waiver or authorization of any third party; and (iv) do not result in the creation of any lien, charge or encumbrance upon the Lactoferrin Technology.\n(g) This Agreement is binding on and enforceable against ImmuCell in accordance with its terms.\n(h) ImmuCell makes no representations or warranties, that the Lactoferrin Technology or ISEP System can meet 3A dairy standards. Information collected by ImmuCell as it relates to system and process design are available for examination by AgriMark and appropriate regulatory personnel in Vermont.\n(i) To the best of ImmuCell's knowledge, the Lactoferrin Technology is free and clear of any mortgage, security interest, lien or encumbrance.\n(j) The representation and warranties made by ImmuCell in this Agreement or any document provided in connection with this Agreement are true and correct at and as of the date of this Agreement.\n2.2 By AgriMark. AgriMark hereby represents and warrants to ImmuCell the following:\n(a) It is a corporation validly formed and existing under the laws of the State of Delaware.\n(b) There are no prior or contemporaneous assignments, grants, licenses, encumbrances, obligations or agreements, either written or oral, express or implied, to which it is a party, that are inconsistent with this Agreement.\n(c) The execution, delivery and performance of this Agreement, but not consummation of the joint venture contemplated herein, (i) have been duly and effectively authorized by all necessary corporate or other actions and (ii) do not violate, conflict with, or result in the breach of any provision of its Certificate of Incorporation, Bylaws or any comparable document, or of any agreement to which it is a party.\n(d) This Agreement is binding on and enforceable against AgriMark in accordance with its terms.\n(e) The representation and warranties made by AgriMark in this Agreement or any document provided in connection with this Agreement are true and correct at and as of the date of this Agreement.\nARTICLE 3 - GRANT OF OPTION\n3.1 Option. ImmuCell hereby grants to AgriMark an option to jointly form, fund, own and operate a joint venture entity with ImmuCell, which option may be exercised by AgriMark by written notice thereof to ImmuCell during the Option Period, in the form of a Delaware Limited Liability Company (\"LLC'), for the purpose of commercializing the production and sale of the Lactoferrin Product. The LLC would be formed under the general terms outlined in Appendix A. ImmuCell further agrees to grant to the LLC a non- exclusive license to use the Lactoferrin Technology and a non-exclusive sublicense to buy and use a single commercial size ISEP System to manufacture Lactoferrin Product on a royalty free basis. The non-exclusive sublicense to buy and use an ISEP System to manufacture Lactoferrin Product is subject to the terms and conditions in the license agreement between AST and ImmuCell dated August 30, 1993 and all subsequent amendments up to and including the amendment of November 16, 1995.\nARTICLE 4 - PILOT PLANT DEVELOPMENT\n4.1 Product Development: ImmuCell\n(a) During the first four months of the Option Period, ImmuCell will use its best efforts to contract for services from a service provider or will use its own employees for between three and four days per week of personnel time to assist in the assembly, set up and operation of the pilot plant. ImmuCell will also provide one additional full time employee to the pilot plant development efforts during the first four months of the Option Period. ImmuCell agrees to provide all appropriate support for the conduct of the pilot plant development being conducted by AgriMark, including, without limitation, all testing and analysis necessary to characterize the Lactoferrin Product. ImmuCell shall make available the fixed assets and equipment detailed in Appendix B to the pilot plant, F.O.B. the pilot plant location. ImmuCell will provide all consumables and supplies needed by the pilot plant during the Option Period with the exception of the neat whey which is to be supplied by AgriMark as defined in Section 4.2.\n(b) ImmuCell shall pay all license fees required to maintain its exclusive rights to all Lactoferrin Technology except that ImmuCell will not be required to meet any purchase requirement for the ISEP System needed to maintain its exclusive license to use the ISEP System.\n(c) ImmuCell will perform marketing and technical sales support during the Option Period and during the first year of operation of the LLC.\n(d) ImmuCell hereby grants to AgriMark a non-exclusive license to use the Lactoferrin Technology during the Option Period.\n4.2 Product Development - AgriMark. During the Option Period, AgriMark will initiate and diligently pursue and supply, at its own expense: (i) the construction or acquisition of an adequate pilot facility by AgriMark personnel containing approximately 1,500 square feet of floor space with required utilities, (ii) one employee to assist in process operations, and (iii) a supply of neat whey representative of the eventual production whey (up to 1,000 - 2,000 gallons of neat whey or equivalent per day needed during the Option Period).\n4.3 Rights to ImmuCell's Improvement. Any Improvements to the Lactoferrin Technology developed during the Option Period and thereafter solely by Immucell, or which ImmuCell otherwise has the right to license, shall be automatically included in the license to be granted to the LLC by ImmuCell, with no right to sublicense.\n4.4 Rights to AgriMark's Improvements. AgriMark hereby grants to ImmuCell and shall cause its Affiliates to grant to ImmuCell, and ImmuCell hereby accepts, a perpetual, non-exclusive, royalty-free license, to use any improvements developed during the Option Period and thereafter solely by AgriMark, or which AgriMark otherwise has the right to license, to make or have made the Lactoferrin Product with no right of sublicense.\n4.5 Publicity. With the exception of required filings by the Securities and Exchange Commission, the parties shall absolutely refrain from any disclosures to any third parties regarding this Agreement without the consent of the other.\nARTICLE 5 - OPTION PURCHASE PRICE, EXERCISE AND COMPETITIVE PROTECTION\n5.1 Option Purchase Payment. In consideration of ImmuCell granting\nAgriMark the Option contemplated in Section 3.1 to form an LLC with ImmuCell for the manufacture of the Lactoferrin Product, AgriMark agrees to pay ImmuCell $75,000 upon execution of this Agreement. ImmuCell will refund this $75,000 fee to AgriMark if the pilot ISEP unit is not shipped to Middlebury on or before December 15, 1995.\n5.2 Option Exercise Payment. If AgriMark elects to exercise the option to form an LLC with ImmuCell, AgriMark will capitalize the LLC with a maximum of $800,000 Invested Capital, approximately $400,000 of which investment shall be for the purchase of a commercial size ISEP System. The balance will be used to purchase other needed equipment as mutually determined by ImmuCell and AgriMark. The ISEP System must be ordered no later than June 15, 1996.\n5.3 Additional Lactoferrin Production. If AgriMark exercises its option to form an LLC, ImmuCell at its sole discretion will either:\n(a) not commission additional lactoferrin production capacity until AgriMark has recovered double its Invested Capital in the LLC; or\n(b) for a period of ten years, pay AgriMark 2.5% of net sales derived from all subsequent lactoferrin production business arrangements in which ImmuCell is involved; or\n(c) not commission any additional lactoferrin production capacity until the LLC has contracted with a customer under a full output supply contract that guarantees a price of $200 per pound or higher for a sufficient period of time to return to AgriMark double the amount of its Invested Capital.\nARTICLE 6 - PATENT PROTECTION\n6.1 Patent Protection. ImmuCell will own and shall be responsible for seeking patent protection for any improvements discovered in the pilot plant during the Option Period.\nARTICLE 7 - TERM AND TERMINATION\n7.1 Termination by AgriMark. (a) AgriMark may terminate this Agreement without cause and without penalty at any time by giving ImmuCell written notice. If AgriMark so terminates this Agreement, all rights and future obligations shall cease as of the date written notice is given to terminate the Agreement, except that the rights provided under Section 9.11 shall survive any termination by AgriMark under this Section 7.1; (b) upon termination in accordance with this Section 7.1, AgriMark agrees to transfer to ImmuCell, at no cost, all data and analysis pertaining to the Lactoferrin Product in its possession at the termination date.\n7.2 Termination by ImmuCell. ImmuCell may terminate this Agreement at any time upon thirty (30) days' advance notice to AgriMark if AgriMark breaches any material term, provision or covenant hereof which is not cured by AgriMark within the thirty (30) day notice period provided above. In the event AgriMark disputes any ImmuCell claim of an event of breach under this Section. and such dispute is submitted to arbitration under Section 9.10, the cure period for the alleged breach shall be extended until the earlier of (a) an agreement by the parties to settle the matter in dispute without further arbitration, or (b) a final decision of the arbitration panel. If ImmuCell so terminates this Agreement, except for Section 9.11 hereof, all rights and future obligations of the parties shall cease as of the effective date of termination.\nARTICLE 8 - INDEMNITY AND INSURANCE\n8.1 General Indemnification. Each party agrees to indemnify and hold the other party harmless against any and all losses, liabilities, damages, claim, judgments, demands, and expenses, reasonable attorneys' fees and all other costs (hereinafter collectively or individually referred to as a \"Loss\") arising out of or in connection with (i) the breach by the indemnifying party of any of its representations or warranties contained in this Agreement, or (ii) the nonperformance, partial or total, of any covenants of the indemnifying party contained in this Agreement. As a condition to the indemnified party's right to indemnification under this Section 8.1, the indemnified party shall give prompt notice to the indemnifying party of any suits, claims or demands by third parties which may give rise to any Loss for which indemnification may be required under this Section. The indemnifying party shall be entitled to assume the defense and control of any suit, claim or demand of any third party at its own cost and expense.\n8.2 Specific Indemnification. Without limiting the general indemnity provisions of Section\n8.1: (a) AgriMark shall indemnify ImmuCell for any Loss arising out of or connected with any negligence or willful misconduct of AgriMark and ImmuCell shall indemnify AgriMark for any Loss arising out of any negligence or willful misconduct of ImmuCell connected with their respective responsibilities under this Agreement during the Option Period, (b) ImmuCell shall indemnify and hold harmless AgriMark from and against all losses, liabilities and expenses including reasonable attorneys fees arising out of any claim against AgriMark by any third party for infringement of any patent, trade secret, copyright or other intellectual property right relating to AgriMark's use of the Lactoferrin Technology, unless the claim results from any Improvement created by AgriMark in which case AgriMark shall indemnify ImmuCell.\n8.3 Insurance. AgriMark and ImmuCell agree to maintain during the Option Period liability insurance against loss or damage related during the Option Period in the minimum amount of $1,000,000 per occurrence and in a minimum aggregate of $1,000,000. Each party will name the other as an additional insured on Said policy(ies), and will, upon written request, provide a certificate of insurance evidencing such coverage.\nARTICLE 9 - GENERAL PROVISIONS\n9.1 Notices. Except as otherwise specified herein, any notices permitted or required by this Agreement shall be sent by telephonically confirmed telecopy, by recognized overnight mail service or by certified or registered mail, return receipt requested except that normal correspondence not related to termination, defaults, or rights to manufacture may be sent by first class mail. Any such notice shall be effective when received if sent and addressed as follows or to such other address as may be designated by such party in writing and delivered in accordance with this Section 9.1:\nIf to ImmuCell: ImmuCell Corporation 56 Evergreen Drive Portland, Maine 04103 Telephone: (207) 878-2770 Telefax: (207) 878-2117 Attention: Thomas Hatch\nwith a copy to:\nJeffrey A. Clopeck, Esq. Day, Berry & Howard 260 Franklin Street Boston, Massachusetts 02110-3109 Telephone: (617) 345-4600 Telefax: (617) 439-4453\nIf to AgriMark: AgriMark, Incorporated P.O. Box 5800 Lawrence, Massachusetts 01842 Telephone: (508) 689-4442 Telefax: (508) 685-8716 Attention: Richard 0. Langworthy\nwith a copy to:\nEileen Brogan AgriMark, Incorporated P.O. Box 5800 Lawrence, Massachusetts 01842 Telephone: (508) 689-4442 Telefax: (508) 685-8716\n9.2 Entire Agreement: Amendment. The parties acknowledge that this Agreement sets forth the entire agreement and understanding of the parties and supersedes all prior written or oral agreements or understandings with respect to the subject matter hereof. No modification or amendment of any of the terms of this Agreement shall be deemed to be valid unless in writing and signed by both parties hereto.\n9.3 Waiver. No waiver by any party of any default shall operate as a waiver of any other default or of the same default on a future occasion.\n9.4 Assignment. Neither party shall assign or transfer this Agreement without the other party's prior written consent. This Agreement shall be binding on and inure to the benefit of each party's permitted successors and assigns.\n9.5 Governing Law. This Agreement shall be governed by and construed under the substantive and procedural laws of the State of Maine without giving effect to choice of law principles.\n9.6 Severability. If any term, provision or condition of this Agreement, or the application thereof to any person or circumstance, shall be invalid, illegal or unenforceable in any respect, the remainder of this Agreement shall be construed without such provision and the application of such term or provision to persons or circumstances other than those as to which it is held invalid, illegal or unenforceable, as the case may be, shall not be affected thereby, and each term and provision of this Agreement shall be valid and enforced to the fullest extent permitted by law.\n9.7 Counterparts. This Agreement may be executed in any number of duplicate originals and each such duplicate original shall be deemed to constitute one and the same instrument.\n9.8 Headings. The headings of the paragraphs of this Agreement are for convenience only and have no meaning with respect to this Agreement or the rights or obligations of the parties.\n9.9 Independent Contractor. The parties are each independent contractors and nothing herein shall be deemed to establish a relationship of principal and agent between them, nor any of their agents or employees for any purpose whatsoever. This Agreement shall not be construed as constituting the parties as partners, or as creating any other form of legal association or arrangement which would impose liability upon one party for the act or failure to act of the other party.\n9.10 Arbitration and Jurisdiction.\n(a) All disputes arising between ImmuCell and AgriMark under this Agreement shall be settled by arbitration conducted in accordance with the procedures of the commercial Arbitration Rules of the American Arbitration Association, before a panel of three arbitrators, one of whom shall be selected by AgriMark, one of whom shall be selected by ImmuCell, and one of whom shall be selected by AgriMark and ImmuCell (or by the other two arbitrators, if the parties cannot agree). The parties will request an expedited hearing for any dispute related to a nonpayment hereunder, and will otherwise cooperate with each other in causing the arbitration to be held in as efficient and expeditious a manner as practicable. Any arbitration proceeding initiated by AgriMark shall be brought and conducted in Portland, Maine. Any arbitration proceeding initiated by ImmuCell shall be brought and conducted in the Boston, MA metropolitan area.\n(b) Any award rendered by the arbitrators shall be binding upon the parties hereto and shall be final, subject to review by a court of competent jurisdiction under the statutory standard of review applicable to arbitrations. Judgement upon the award may be entered in any court of competent jurisdiction. Each party shall pay its own expenses of arbitration and the expenses of the arbitrators shall be equally shared except that if, in the opinion of the arbitrators, any claim by a party hereto or any defenses or objection thereto by the other party was unreasonable, the arbitrators may in their discretion assess as part of their award all or any part of the arbitration expenses of the other party (including reasonable attorneys fees) and expenses of the arbitrators against the party raising such unreasonable claim, defense or objection. Nothing herein shall prevent the parties from settling any dispute by mutual agreement at any time.\n(c) The parties irrevocably and unconditionally (i) agree that any suit, action or other legal proceeding for the review of any arbitration proceeding under this Agreement may be brought in the United States District Court located in the opposing party's jurisdiction, or, if such court does not have jurisdiction or will not accept jurisdiction, in any court of general jurisdiction in the state of the opposing party; (ii) consents to the jurisdiction of any such court in any such suit, action or proceedings; and (iii) waives any objection that it may have to the laying of venue of any such suit, action or proceeding in any such court.\n9.11 Confidential. AgriMark and ImmuCell shall not disclose any Confidential Information of the other party received pursuant to this Agreement or otherwise, or use any such Confidential Information in any manner, or for any purpose, that is not expressly or implicitly permitted hereby, without the prior written consent of such other party. These obligations shall not apply to: (a) information which is known to the receiving party at the time of disclosure or independently developed by the receiving party, and documented by written records; (b) information disclosed to the receiving party by a third party which has a right to make such disclosure; (c) information which becomes patented, published or otherwise part of the public domain as a result of acts by the disclosing party; or (d) disclosures of such Confidential Information to the Affiliates or employees of the disclosing party on a need to know basis, provided the disclosing party takes reasonable precautions to preclude any further disclosures of such Confidential Information. Upon request by the party providing the Confidential Information, at the expiration or earlier termination of this Agreement, the other party shall return all Confidential Information and all copies thereof that are in its possession.\n9.12 Force Majeure Events. Failure of either party to perform its obligations under this Agreement (except the obligation to make payments) shall not subject such party to any liability to the other party if such failure is caused by any cause beyond the reasonable control of such nonperforming party, including, but not limited to, acts of God, fire, explosion, flood, drought, war, riot, sabotage, embargo, strikes or other labor trouble, failure in whole or in part of suppliers to deliver on schedule materials, equipment or machinery, interruption of or delay in transportation, a national health emergency or compliance with any order or regulation of any government entity acting with color of right.\n9.13 ImmuCell shall not use AgriMark's name and AgriMark shall not use ImmuCell's name in any sales promotion advertising or any other form of publicity without the prior written approval of the entity or person whose name is being used, which approval shall not be unreasonably withheld.\nIN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed as of the date first above written.\nIMMUCELL CORPORATION\nBy: \/s\/ Thomas C. Hatch\nName: Thomas C. Hatch\nTitle: President and CEO\nDate: November 22, 1995\nAGRIMARK, INC.\nBy: \/s\/ Richard Langworthy\nName: Richard Langworthy Title: Sr. V.P. Manufacturing Operations Date: November 22, 1995\nAppendix A\nOUTLINE HEADS OF AGREEMENT APPLYING TO THE FORMATION, OWNERSHIP AND OPERATION OF AN INTENDED LLC BETWEEN IMMUCELL AND AGRIMARK\n1. GRANT OF LICENSE\nUpon the formation of an LLC between ImmuCell and AgriMark, ImmuCell shall grant the LLC the right to purchase a single ISEP System from AST and a non- exclusive, non-terminable, royalty free license to use the Lactoferrin Technology including a non-exclusive sublicense to use the ISEP System, as well as all improvements conceived or reduced to practice or obtained at any time by ImmuCell, to which ImmuCell has the right to license or sublicense, in order for the LLC to manufacture Lactoferrin Product using whey produced as a result of cheesemaking operations at the Middlebury, Vermont cheese plant plus an additional amount of 250,000 lbs. of neat whey per day from other sources.\n2. INVESTED CAPITAL BY AGRIMARK\nAgriMark will capitalize the LLC with a maximum of $800,000 (\"Invested Capital\"), $400,000 of this amount must be contributed upon formation of the LLC and will be spent principally purchasing an ISEP System. The remaining amount will be contributed as needed to equip the production plant to manufacture Lactoferrin Product on a commercial basis.\n3. ASSET CONTRIBUTION BY IMMUCELL\nImmuCell will contribute applicable equipment from the pilot plant to the LLC (\"the Contributed Assets\"). This explicitly excludes the pilot ISEP System and associated pumps and hardware.\n4. ECONOMIC INTERESTS IN THE LLC\nAgriMark and ImmuCell shall have equal economic interests in the LLC to be formed except that 90% of the net income before taxes from the LLC shall go to AgriMark until twice the amount of its Invested Capital is returned to AgriMark. The other 10% of net income before taxes from the LLC shall go to ImmuCell during the same period. After such time as twice the Invested Capital is returned to AgriMark, all subsequent net income before taxes of the LLC shall be divided between ImmuCell and AgriMark on the basis of their equal economic interests in the LLC. All tax obligations will accrue to each party on the basis of their interests in the income from the LLC.\nS. FREEZE DRYING\nImmuCell shall freeze dry all Lactoferrin Product produced by the LLC at a 30% discount to the next best quote from a commercial freeze dryer.\n6. WHEY SUPPLY\nAgriMark will provide whey to the LLC at no cost. AgriMark's economic interest in providing whey at no cost is to earn a return on its economic interest in the LLC.\n7. LIFE OF LLC AND RETURN OF CAPITAL\nThe LLC will have a thirty year life. Upon expiration or earlier termination the Contributed Assets and all documents related to Lactoferrin Technology will be returned to ImmuCell. The assets purchased with Invested Capital will be returned to AgriMark. Other assets will be distributed according to the parties' ownership shares in the LLC, which are expected to be equal. Section 8 notwithstanding, upon expiration of the 30 year term, the license granted by Immucell to use the Lactoferrin Technology will terminate and AgriMark will at that time have no right to use the Lactoferrin Technology for any purpose.\n8. DISPOSITION AND USE OF ISEP SYSTEM\nIf the LLC is terminated, ImmuCell grants AgriMark the right to sell the ISEP System described in Paragraph 2 to ImmuCell any time within one year of installation of the ISEP System in the Middlebury plant at half the purchase price. AgriMark will be under no obligation to make such a sale but ImmuCell will be obligated to make such a purchase within ninety (90) days of notification by AgriMark of its desire to make such a sale. AgriMark will provide seller financing for the purchase price with terms of three years and twelve percent interest, payments of principal and interest to be made monthly. If ImmuCell terminates or causes the termination of the LLC, AgriMark shall be permitted by ImmuCell to use the ISEP System and the Lactoferrin Technology to manufacture Lactoferrin Product and will pay a royalty rate equal to royalty rates ImmuCell has entered into with other parties for the manufacture of Lactoferrin Product in arm's length negotiations. If no other license agreements are in place on Lactoferrin Product, ImmuCell and AgriMark shall negotiate a reasonable royalty rate to apply to sales. Upon termination of the LLC without cause by AgriMark, AgriMark shall be prohibited from manufacturing Lactoferrin Product for a period of five years, and all documents, material, information, procedures, processes and know-how related to Lactoferrin Technology will be returned to ImmuCell within ninety days.\n9. PATENTS AND IMPROVEMENTS\nOnce formed, the LLC shall be responsible for seeking patent protection for any Improvements made in the manufacture or use of the Lactoferrin Product if deemed patentable. Any such patent shall be licensed to ImmuCell and to AgriMark, and to no others, on a royalty-free basis for the life of the patent with no rights to sublicense. Improvements shall mean any and all inventions, modifications, discoveries, ideas, developments and enhancements related to the manufacture of the Lactoferrin Product.\n10. FORMATION COSTS AND WORKING CAPITAL REQUIREMENTS\nImmuCell and AgriMark will share equally in the legal costs of forming the LLC and in providing necessary working capital to fund initial production and sales of Lactoferrin Product.\n11. AgriMark and ImmuCell agree to negotiate in good faith all remaining terms needed to form the LLC if AgriMark exercises itS option to proceed.\n12. AgriMark will have 51% voting control in the management and operation of the business of the LLC; ImmuCell will have 49%. In accordance with Section 4 of this Appendix A, AgriMark will have the right to annual distribution of the income to which it is entitled until it receives twice the amount of its Invested Capital. Each party will then have rights to annual distributions of income based on economic interests in the LLC.\n13. ADDITIONAL LACTOFERRIN PRODUCTION ImmuCell at its sole discretion will either: (a) not commission additional lactoferrin production capacity until AgriMark has recovered double its Invested Capital in the LLC; or\n(b) for a period of ten years, pay AgriMark 2.5% of net sales derived from any subsequent lactoferrin production business arrangements in which ImmuCell is involved; or\n(c) not commission any additional lactoferrin production capacity until the LLC has contracted with a customer under a full output supply contract at a price of $200 per pound for a sufficient period of time to return to AgriMark double the amounts of its Capital Investment.\n14. INDEMNIFICATION\nImmuCell shall indemnify and hold harmless LLC and AgriMark from and against all losses, liabilities and expenses including reasonable attorneys fees arising out of any claim against LLC by any third party for infringement of any patent, trade secret, copyright or other intellectual property right relating to LLC's use of the Lactoferrin Technology. In the case of infringement, ImmuCell shall have the right to defend against any suit and to obtain a license to use the Lactoferrin Technology. Any royalties or license fees are to be paid only from sale of product and will be deducted only from ImmuCell's portion of net income before taxes. AgriMark will indemnify ImmuCell against any claims resulting from any improvement created by AgriMark.\nAPPENDIX B IMMUCELL PILOT LAB EQUIPMENT\n1. ISEP - 30 x 7.85 liter - 235 lit. bed volume\n2. ISEP Data acquisition Equipment (Gateway 386 Computer LabTech Control Software & Flow Cell Sensors)\n3. Niro, Pilot UF Unit - 4 stages\/8 elements\n4. Hollow Fiber UF Module - UFP-30-75C. (AG Technology)\n5. Positive Displacement Pumps\n- Tri-Clover PRO10 (0.75-6.0 gpm) (3) - Waukashau 18U (0.3-3.0 gpm)\n6. Centrifugal Pumps (2)\n7. Shell & Tube Heat Exchanger\n8. Niro Reverse Osmosis Unit - three elements\n9. UV Liquid Sterilizer\n10. Bulk Tanks - refrigerated\n- 500 gal with stirrer & compressor - 300 gal with stirrer & compressor\n11. Holding Tank - jacketed (45 gal)\n12. Lyophilizer - Viritis Freezemobile 6\n13. Sanitary tubing and tri-clover connectors\n14. Analytical lab equipment (HPLC, UV-Vis Spectrophotometer)\nAPPENDIX C U.S. Patent Nos. 4,522,726 4,764,276 4,808,317 5,069,883\nIMMUCELL CORPORATION AND SUBSIDIARY Exhibit 10.30\nEmployment Agreement dated November 1991 between the Registrant and Joseph H. Crabb.\nEMPLOYMENT AGREEMENT\nAGREEMENT made this 8th day of November, 1991 between IMMUCELL CORPORATION, a Delaware Corporation (the \"Company\"), and Joseph Crabb, of Newfield, Maine (\"Crabb\").\nWITNESSETH:\nIn consideration of the mutual promises hereinafter contained, the parties hereto agree as follows:\n1. EMPLOYMENT AND TERM. The Company hereby employs Crabb and Crabb hereby accepts employment by the Company subject to the provisions of this Agreement for a term commencing on October 18, 1991 and ending upon June 30, 1992. The Company shall notify Crabb in writing by March 1, 1992 if the Company will renew or extend this Agreement.\n2. DUTIES OF CRABB. Crabb shall be employed by the Company as Director of Research and Development to perform such duties consistent with such a position as Director of Research and Development as its Chief Executive Officer shall assign Crabb from time to time. Crabb shall serve the Company faithfully and diligently, use his best efforts to promote the interests of the Company, and shall devote his full time and efforts to the business and affairs of the Company.\n3. COMPENSATION.\n(a) Base salary. As compensation for his services hereunder, the Company shall pay Crabb $5,166.67 per month, beginning on 1 November, 1991. During the entire term of this agreement, Crabb's salary shall be subject to periodic review and adjustment by the Chief Executive Officer, which Chief Executive Officer may in his sole discretion change the salary to an amount greater than that provided for therein; provided, however, that in no event may the Company decrease Crabb's salary below that which is provided for herein.\n(b) Employee Benefits. During the term of this Agreement the Company shall provide Crabb with the standard health, life, and disability insurance coverage that is provided to the Company's other non-officer employees. Crabb shall also be entitled to all other employee benefits of the Company in the same manner and to the same extent as other employees of the Company in accordance with the Company's policies, including, without limitation, any incentive pay programs offered by the Company to all of its non-executive employees.\n(c) Bonus. A cash bonus of up to 20% of the base salary in 3(a) above will be paid to Crabb by the Company if certain performance objectives are met during the Company's 1992 fiscal year. These objectives will be specified by the Chief Executive Officer no later than 1 December, 1991.\n4. TERMINATION OF EMPLOYMENT.\n(a) Voluntary Termination. Should Crabb voluntarily terminate his employment with the company, Crabb hereby covenants that, for a period of one (1) year he will not, directly or indirectly, render assistance to any person, firm, or corporation in the same line of business as, or in any line of business kindred or similar to, the business of the Company. Crabb furthermore agrees that for this same period of one year after termination of employment he will not accept employment in which he would engage in research or development or any business activity identical to those previously carried out, in progress, or planned by the Company. For the same period he will not at any place or through any medium whatever, either on behalf of himself or another, directly or indirectly solicit business in a line of business which is the same as, kindred, to, or similar to that of the Company, from any person or persons who were customers of the Company.\n(b) Other Termination. Should Crabb's employment with the Company terminate for any reason except through Crabb's voluntary act or by termination for \"just cause\" as provided by subsection (c) of this Section 4 or (ii) should the Company terminate Crabb's employment at any time prior to the end of the term of this Agreement, Crabb shall receive from the Company salary and benefits in the same manner as if Crabb's employment had not been terminated.\nIn consideration for the payments to be made to him pursuant to this subsection (b), Crabb shall be bound by the provisions of subsection (a) of this Section in the same manner as if his termination had been voluntary, and Crabb shall not compete with the Company as provided therein for a period of one (1) year from the date of termination of Crabb's employment by the Company.\n(c) Termination for Just Cause. Notwithstanding the forgoing provisions of this Section 4, the Chief Executive officer may at any time terminate the employment of Crabb for just cause (as hereinafter defined) upon fourteen (14) days' written notice to Crabb. Upon the expiration of such fourteen (14) day period, Crabb's employment with the Company shall cease, and from and after such date the Company shall have no further liability or obligation to make any payments or provide any benefits which would otherwise be paid to Crabb hereunder, except as such have accrued on or before such date. In the event of the termination of Crabb's employment for just cause as provided herein, Crabb shall be bound by the provisions of subsection (a) of this Section in the same manner as if his termination had been voluntary, and Crabb shall not compete with the Company as provided therein for a period of one (1) year from the date of termination of Crabb's employment.\nAs used in this subsection (c), \"just cause\" shall be deemed to include only the following:\n(i) Crabb's conviction of a felony involving moral turpitude or dishonesty; or\nii) Crabb's persistent failure to comply with the reasonable directives or assignments of the Company's Chief Executive Officer; or\n(iii) Crabb's persistent failure to devote his full time and efforts to the business and affairs of the Company in the manner contemplated by Section 2 of this Agreement.\n(d) Certain Events. In the event that (i) following the termination of Crabb's employment pursuant to subsection (b) of this Section 4 the Company shall fail to pay Crabb when due, or within ten (10) business days thereafter, all current sums payable to Crabb pursuant to said subsection (b), or (ii) following the termination of Crabb's employment for any reason whatsoever, the Company or any successor or assignee of the Company\nentitled to the benefits of this Agreement shall cease to conduct the business of the company engaged in by the Company at the times of such termination, then, and in either such event, the covenants against competition set forth in subsections (a), (b), and (c) of this Section 4 shall be terminated and Crabb shall thereafter not be bound by the provisions thereof. The termination of said covenants against competition shall not alter or affect the obligation of the Company to make any payments required to be made to Crabb pursuant to the provisions of subsection (b) of this Section 4.\n5. COVENANT CONCERNING OTHER EMPLOYEES. Should Crabb voluntarily terminate his employment with the Company for any reason whatsoever, Crabb hereby covenants that, for a period of one (1) year, Crabb will not directly or indirectly persuade, induce or otherwise encourage any other employee of the Company to leave the employ of the Company to join or form any other firm, corporation, partnership, association, joint venture, trust or business entity of any kind engaged in, or to be engaged in future in, any business which is similar to or competitive with the business now or at any time hereafter engaged in by the Company.\n6. MISCELLANEOUS.\n(a) Notice.Any notice required to be given hereunder shall be given in writing and shall be delivered by hand or sent by registered or certified mail, postage prepaid, return receipt requested, or by Federal Express, if to the Company, at the address of its principal offices on the date upon which such notice is given, and if to Crabb, at the then current residential address of Crabb (as reflected on the records of the Company) by any of the aforesaid means. Any such notice shall be effective when delivered in person or deposited in the United States mails in accordance with the provisions of this subsection.\nb) Death. In the event of the death of Crabb during the term of this Agreement while he shall be an employee of the Company, Crabb's compensation pursuant to Section 3 hereof shall cease as of the last day of the month in which Crabb's death occurs. Any remaining amounts owing to Crabb pursuant to Section 3 hereof in respect to such month shall be paid to his estate or shall pass by applicable laws of descent and\ndistribution. In the event of the death of Crabb after he has terminated his employment with the Company, but prior to the payment of all amounts payable to him pursuant to the provisions of subsection (b) of Section 4 hereof, the remaining such amounts shall be paid to the representatives of Crabb's estate.\n(c) Injunctive Relief. The parties agree that the extent of damage to the Company in the event of the breach by Crabb of the noncompetition covenants contained in the agreement attached hereto as Exhibit A would be difficult or impossible to ascertain and that there would be no adequate remedy at law available to the Company in the event of such breach. Therefore, in the event of any such breach, the Company shall be entitled to enforce any or all of such covenants by injunction or other equitable relief in addition to receiving damages or other relief to which the Company may be entitled.\n(d) Binding Effect; Assignment. The provision of this Agreement shall be binding upon and shall inure to the benefit of the Company and its successors and assigns and to the benefit of Crabb and his heirs and legal representative. This Agreement is a personal contract and the rights and interest of Crabb herein may not be sold, transferred, assigned, pledged, or hypothecated and any such attempted sale, transfer, assignment, pledge or hypothecation shall be null, void and of no effect.\n(e) Entire Agreement. This Agreement contains the entire agreement between the parties hereto with respect to the transactions contemplated herein and supersedes all prior agreements and understandings, written and oral with respect to the subject matter hereof, and may not be amended or modified except by an instrument in writing signed by both parties hereto.\n(f) No Inconsistent Obligations. Crabb hereby represents and warrants to the Company that he is not now under any obligation to any person, firm, corporation or other entity which is inconsistent or in conflict with this Agreement or which would prevent, limit or repair in any way the performance by him of his obligations hereunder.\n(g) Severability. If any provision of this Agreement is declared invalid, illegal or unenforceable, such provision shall be severed and all remaining provisions shall continue in full force and effect.\n(h) Law Governing. This Agreement shall be governed by and enforced in accordance with the laws of the State of Maine.\nIN WITNESS WHEREOF, the parties hereto have executed this Agreement, intending the same to take effect as a sealed instrument, as of the date first above written.\nIMMUCELL CORPORATION\n\/s\/ Joseph H. Crabb By \/s\/ Thomas C. Hatch Joseph H. Crabb\nIts: President\nIMMUCELL CORPORATION AND SUBSIDIARY Exhibit 10.31\nAmendment, dated March 1992, to Employment Agreement dated November 1991, between the Registrant and Joseph H. Crabb.\nAMENDMENT TO EMPLOYMENT AGREEMENT\nTHIS AMENDMENT made this 17th day of March, 1992, between IMMUCELL CORPORATION, a Delaware Corporation (the \"Company\"), and Joseph Crabb, of Newfield, Maine (\"Crabb\").\nWHEREAS, the Company and Crabb entered into an employment agreement, dated November 8, 1991; and\nWHEREAS, Section 6 (e) of the Agreement provides that it \"may not be amended or modified except by an instrument in writing signed by both parties\"; and\nWHEREAS, the Company and Crabb desire to amend the Agreement to modify the term;\nNOW THEREFORE, in consideration of the mutual promises hereinafter contained, IT IS AGREED:\n1. Section 1 of the Agreement is hereby amended by replacing \"June 30, 1992\" with \"July 31, 1992\"; deleting the second sentence; and inserting the following two sentences: \"The ending date of this Agreement shall be extended on a rolling four month basis until such time as the Company gives notice of termination to Crabb, at which time the term of the employment agreement will be fixed at four months from date of notification (the termination period). The Company will not require Crabb to perform any duties during the fourth month of the termination period.\"\nIN WITNESS WHEREOF, the parties hereto have executed this Amendment as of the date first above written.\n\/s\/ Thomas C. Hatch Thomas C. Hatch President, IMMUCELL\n\/s\/ Joseph H. Crabb Joseph H. Crabb\nIMMUCELL CORPORATION AND SUBSIDIARY Exhibit 10.32\nAmendment, dated April 1992, to Employment Agreement dated November 1991, between the Registrant and Joseph H. Crabb.\nAMENDMENT TO EMPLOYMENT AGREEMENT\nTHIS AMENDMENT made this 13th day of April, 1992, between IMMUCELL CORPORATION, a Delaware Corporation (the \"Company\"), and JOSEPH H. CRABB, of Portland, Maine (\"Crabb\").\nWHEREAS, the Company and Crabb entered into an employment agreement, dated November 8, 1991 (\"Agreement\"); and\nWHEREAS, Section 6 (e) of the Agreement provides that it \"may not be amended or modified except by an instrument in writing signed by both parties\"; and\nWHEREAS, the Company and Crabb desire to amend the Agreement to grant Crabb a nonqualified stock option to purchase twenty-five thousand (25,000) shares of the Company's common stock on the terms and conditions hereinafter set forth;\nNOW THEREFORE, in consideration of the mutual promises hereinafter contained, IT IS AGREED:\n1. The terms used in this Amendment shall have the meanings set forth in the Agreement, unless the context clearly indicates otherwise.\n2. Section 3 of the Agreement is hereby amended by adding at the end thereof a new subsection (d) to read as follows:\n(d) Nonqualified Stock Options.\n(1) Grant. The Company grants to Crabb an option ('Option') to purchase twenty-five thousand (25,000) shares of ImmuCell common stock ('Shares') at a price equal to the fair market value of a share of such common stock on the date of this Amendment, as determined under the Company's 1989 Stock Option and Incentive Plan ('Fair Market Value').\n(2) Vesting. Crabb's right to purchase the Shares subject to this Option shall vest as follows: fifty percent (50%) one year from signing of this Amendment, and fifty percent (50%) on the second anniversary of the signing of this Amendment.\n(3) Exercise. Except as hereinafter provided, the Option may be exercised in full or in part at any time to the extent vested in accordance with subsection (2). In the event any exercise of the Option would, in the opinion of the Company's independent auditors, cause the Company's quarterly earnings to be reduced by more than twenty-five percent (25%), such exercise shall be limited to that number of Shares the purchase of which shall cause quarterly earnings to be reduced by twenty-five percent (25%). The foregoing limit shall not apply to the extent that the Option would otherwise terminate or expire. In no event may the Option be exercised to purchase fewer than one hundred (100) Shares, unless fewer than one hundred (100) Shares are subject to the Option.\nThe purchase price for the Shares acquired upon exercise of the Option shall be paid (i) in cash or certified check, or (ii) at the direction of the Stock Option Committee of the Board of Directors of the Company by delivery of one or more stock certificates, duly endorsed, evidencing other Shares with a Fair Market Value on the date of exercise equal to\nthe option price, or (iii) by a combination of the methods described in (i) or (ii). As soon as practicable after Crabb has tendered payment of the purchase price to the Company, the Company shall provide Crabb with a Certificate evidencing the Shares purchased. Such certificate shall include any legends required under federal or state securities laws.\nIn the event of Crabb's termination of employment with the Company, disability or death, the Option shall be exercisable \t to the extent provided in Section III.2 (c) (ii), (iii) or (iv) \t of the Company's 1989 Stock option and Incentive Plan.\n(4) Expiration of Option This Option shall expire ten (10) years from the date of this Amendment and may not be exercised thereafter.\n(5) Nontransferability. Crabb may not transfer the Option other than by will or the laws of descent and \t distribution. During Crabb's lifetime, only Crabb may exercise \t the Option.\n(6) Change in ControlIn the event of a change in control of the Company, Crabb's right to purchase Shares subject to the Option shall vest immediately. For purposes of this Amendment, 'change in control' shall mean any one of the following events:\n(a) Any person shall become beneficial owner, directly or indirectly, of securities representing forty percent (40%) or more of the combined voting power of the Company's then outstanding stock.\nAs used in this Paragraph 6 (a), 'beneficial owner' shall have the meaning ascribed to it from time to time under rules promulgated by the Securities and Exchange Commission pursuant to Section 13 (d) of the Securities Exchange Act of 1934, or any similar successor statute or rule; and a 'person' shall include any natural person, corporation, partnership, trust, association, or any group or combination thereof, whose ownership of the Company stock would be reportable pursuant to such provision of the Securities Exchange Act of 1934 and the rules and regulations promulgated thereunder;\n(b) The Company's stockholders approve (i) any consolidation or merger of the Company in which the Company is not the continuing or surviving corporation or pursuant to which shares of Company common stock would be converted into cash, securities or other property, or (ii) any sale, lease, exchange, liquidation or other transfer (in one transaction or a series of transactions) of all or substantially all of the assets of the Company.\n(e) Any other event which a majority of all the Company's Outside Directors determines constitutes a change in control.\nFor purposes of this Section 3, 'Outside Directors' shall mean those members of the Company's Board, at the time a determination is to be made hereunder by the Outside Directors, who were not Company employees and who were directors of the Company six (6) months prior to the Change in Control.\n(7) No Registration of Securities. The parties agree that the Company intends to rely or the securities registration exemption contained in Section 1052 (1) (L) of the Revised Maine Securities Act and that, accordingly, no registration or exemption filing shall be made by the Company under such Act with respect to the Shares. Crabb acknowledges that transfer of the Shares may be restricted by applicable federal and state securities laws and that the Shares when issued shall contain an appropriate legend to that effect.\"\nIN WITNESS WHEREOF, the parties hereto have executed this Amendment as of the date first above written.\n\/s\/ Thomas C. Hatch \/s\/ Joseph H. Crabb Joseph H. Crabb\nIMMUCELL CORPORATION\n\/s\/ Lisa DeTera By \/s\/ William J. Reidy Its\nIMMUCELL CORPORATION AND SUBSIDIARY Exhibit 27.1\nFinancial Data Schedule THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE COMPANY'S AUDITED FINANCIAL STATEMENTS FOR THE YEAR ENDED DECEMBER 31, 1995 AS REPORTED ON FORM 10-K AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS\nItem Number Item Description\n5-02(1) cash and cash items $1,550,011 5-02(2) marketable securities 0 5-02(3)(a)(1) notes and accounts receivable-trade $408,533 5-02(4) allowances for doubtful accounts $51,000 5-02(6) inventory $636,203 5-02(9) total current assets $2,570,347 5-02(13) property, plant and equipment $1,402,680 5-02(14) accumulated depreciation $740,751 5-02(18) total assets $3,234,426 5-02(21) total current liabilities $720,767 5-02(22) bonds, mortgages and similar debt $608,343 5-02(28) preferred stock-mandatory redemption 0 5-02(29) preferred stock-no mandatory redemption 0 5-02(30) common stock $268,159 5-02(31) other stockholders' equity $1,637,157 5-02(32) total liabilities and stockholders' equity $3,234,426 5-03(b)1(a) net sales of tangible products $4,350,340 5-03(b)1 total revenues $4,937,529 5-03(b)2(a) cost of tangible goods sold $1,957,095 5-03(b)2 total costs and expenses applicable to sales and revenues $4,940,811 5-03(b)3 other costs and expenses $72,531 5-03(b)5 provision for doubtful accounts and notes $(2,000) 5-03(b)(8) interest and amortization of debt discount $105,624 5-03(b)(10) income before taxes and other items $29,811 5-03(b)(11) income tax expense 0 5-03(b)(14) income (loss) continuing operations $29,811 5-03(b)(15) discontinued operations 0 5-03(b)(17) extraordinary items 0 5-03(b)(18) cumulative effect-changes in accounting principles 0 5-03(b)(19) net income or (loss) $29,811 5-03(b)(20) earnings per share-primary $.01 5-03(b)(20) earnings per share-fully diluted $.01","section_15":""}
{"filename":"727621_1995.txt","cik":"727621","year":"1995","section_1":"ITEM 1. BUSINESS\nZycad Corporation-Registered Trademark- (the \"Company\")(1) designs, manufactures and markets a broad array of high performance tools and services for design verification of electronic systems and components. Zycad's products, include hardware and software simulation acceleration tools, emulation\/rapid prototyping systems, partitioning software and, recently introduced, high-density field programmable gate arrays (FPGAs) and related desktop foundry design tools, that enable electronic designers to verify their designs prior to production. This process of verification throughout the design cycle ensures that a design produces a final delivered product that meets the customer's requirements. The high-density FPGAs also provide designers with an alternative to using ASICs (Application Specific Integrated Circuit) for their more complex, higher-density designs.\nZycad's business emphasis is on providing both the highest performance simulation and emulation verification product offerings in the EDA (Electronic Design Automation) market and the highest density FPGAs to the ASIC designer for both design verification and programmable component use. All development activities are focused on bringing these technologies together to solve the customer's high-end complex verification problems.\nCustomers benefit from Zycad's solutions by:\n- - GETTING TO MARKET FASTER at the lowest possible cost.\n- - IMPROVING PRODUCT QUALITY through more comprehensive verification.\n- - REDUCING RISK and MANAGING COMPLEXITY through the effective application of advanced verification tools, methodologies and services.\nZycad Corporation, founded in 1981, designs, develops, and markets products and services that provide design verification, rapid prototyping, test analysis and programmable silicon components to customers designing high-performance, electronic systems. These allow customers to quickly logic simulate, fault simulate, emulate, or rapidly prototype their designs. Logic simulation is used to verify accuracy, completeness, and quality of designs before building hardware. Fault simulation is used to verify the quality and completeness of tests developed for the design once it is manufactured. Emulation is the ability to replicate the operation of a portion of a design by programming a series of FPGAs to behave like the target circuit. Rapid prototyping also uses FPGAs, but takes a more flexible approach to replicating behavior of a system by allowing other system components, like processors, memory, and software, to be included in the emulation environment.\nZycad's corporate offices, product development operations and its GateField division are located in Fremont, California. The services operations, which provide consulting, engineering and design management services is located in Rockaway, New Jersey. Sales and support offices are located throughout the United States, Europe, Japan and Asia.\n- -------------------------- (1) As used herein, the term \"Company\" includes Zycad Corporation and its wholly-owned subsidiaries listed in Exhibit 21.1 hereto, unless the context requires otherwise.\nZycad Corporation Page 2 3\/26\/96 2:44 PM\nSTRATEGY\nZYCAD'S STRATEGY IS TO PROVIDE HIGH PERFORMANCE VERIFICATION SOLUTIONS TO DEVELOPERS OF COMPLEX ELECTRONIC PRODUCTS AND TO PROVIDE HIGH-DENSITY FPGAS AS AN ALTERNATIVE TO USING CUSTOM OR SEMI-CUSTOM ASICS IN END-USER PRODUCTS\nIn the development of today's electronic systems, the market pressures of creating increasingly more complex products, in constantly decreasing time frames, forces design engineers to seek improved methods of development. The primary challenge during the mid to late 1990's will be how to integrate all the components of a system so that it works right the first time and meets the customers' expectations - the two greatest concerns among system designers. The available tools have solved many of the problems of getting the individual components of the system to work right the first time, but fall short in solving the problem for an entire system. In particular, challenges for system developers include:\n- Design complexity that increases dramatically each year.\n- This complexity then permeates the design cycle, making traditional end-of-process methods of verification obsolete.\n- This complexity also increases the risk that designs will fail to meet customer expectations for performance, functionality, ruggedness, and other issues of quality.\nZycad will continue to provide high performance, verification solutions to address the problem of complexity by enabling developers to verify their complex electronic systems prior to productization. Verification has the goal of minimizing downstream problems and risks (i.e., avoiding the expensive and time- consuming process of redesign should a final design not work or the manufactured product does not meet customer requirements). As with all development strategies, the ultimate objective is to produce the best product, at the lowest cost, as early as possible.\nMARKET\nCompanies who market electronic products must overcome the shorter product life cycles, and yet increasing design complexity for these products. System architects, system engineers, hardware and software design engineers, and test engineers in all electronic industries confront a similar set of problems in evolving new products from concept to physical reality. This has made the product development cycle more difficult to control and manage.\nIncreasing complexity of electronic system and circuit design is a key trend which will continue to require companies to make extensive changes to their organizations and design methodologies over the next few years. Recent market surveys from Dataquest Inc. show that approximately 50% of new electronic design starts will comprise gate complexity of more than 50,000 gates, and more than half of those will be greater than 100,000-gate designs. Within our customer base, some design sizes already reach beyond one million gates.\nWith this growth in electronic systems design size and complexity comes an increasing need to know whether the system will work as intended before fabrication. The problem of redesigning a product or coping with widespread field failures can be catastrophic. In addition, being late to market can cause dire consequences for products and the companies developing them. Designers are challenged with bringing increasingly advanced, higher quality products to market faster in order to remain competitive.\nZycad Corporation Page 3 3\/26\/96 2:44 PM\nZycad's customers include:\n- SEMICONDUCTOR MANUFACTURERS with architecture compatibility, fast time-to-volume and high quality requirements. - MILITARY\/AEROSPACE COMPANIES with the need to integrate increasingly complex avionics in reduced budget and schedule environments. - TELECOMMUNICATIONS EQUIPMENT MANUFACTURERS with zero fault tolerance requirements and reduced market windows. - MULTI-MEDIA COMPANIES that need to make real-time subjective measurements of their designs in order to fine-tune their products before submitting to manufacturing. - COMPUTER VENDORS with rapidly shortening product life cycles, requiring a predictable development process and efficient system integration.\nASIC\/FPGA\nCharacteristics of today's $7 billion ASIC market include non-recurring engineering costs in the several hundred thousands of dollars to incorporate electronic designs into ASICs for complex designs, lead times of 16 weeks or more from completion of design verification to receiving the ASIC and 65% of design starts result in unit volume of less than 1,000 units. Where product life cycles are short, waiting 16 weeks can have a dramatic influence on time to market and profitability results, and if the ASIC doesn't meet the component or system requirements, even further costs, delays, and profit consequences.\nAn alternative is using reprogrammable FPGAs. Where design corrections are needed, designers simply reprogram the part and proceed with the verification process until satisfied. Then, instead of waiting 16 or more weeks, the FPGA is included in the final system and shipped to customers. When increasing volume justifies it, the design can then be mapped to an ASIC for unit cost savings. But, this can be done while the product is generating revenues and profits.\nToday's FPGA vendors cannot meet the density requirements of designs greater than 12,000 to 15,000 gates on a single FPGA. Furthermore, because their tools are not sufficiently compatible with \"Top Down\" design tools used by ASIC designers, use of these FPGAs requires additional effort and time to complete the design and get the product to market, exactly the opposite of what is needed.\nThe Company's GateField 100,000 gate family of FPGAs, together with its \"Top Down\" methodology compatible software tools, provide a desktop foundry system that allows ASIC designers to easily work within their current design environment to verify their design and get their product to market more quickly.\nZYCAD'S PRODUCTS\nZycad products provide high-performance solutions for concurrent verification of complex electronic system designs. These products include Paradigm XP simulation accelerators, Paradigm RP rapid prototyping\/emulation systems and the Desktop Foundry system of GateField FPGAs and Desktop Foundry Tools. These verification products are enhanced by the Zycad Service Division's consulting and engineering services business.\nZycad's products and services are complementary. Figure 1 shows the tasks that a typical design engineer must take to develop a product, and the areas in which Zycad's products are used. The segments defined as dark blocks with white letters are those that Zycad products can accelerate. The figure demonstrates that all the products are needed and can be an important part in the verification of a complex electronic system.\nZycad Corporation Page 4 3\/26\/96 2:44 PM\n[FLOW CHART]\nFig. 1: Designing a Complex Product Requires Regular Verification with Zycad's Products\nEach block in Figure 1 above represents the process of designing an electronic product. The tasks occur in time from left to right. Block 1 shows requirements definition and Block 2 shows high-level system analysis. Once the system analysis is complete the process splits into parallel hardware and software tasks.\nOn the software track, Block 3b, the software code is constructed at a high level, then divided into different processes for further development. On the hardware side, Block 3a, a behavioral or RTL description is created and, then synthesized into gates. The gate structure, the real building blocks of a system, is developed and simulated on the Paradigm XP, Block 4a, until the designer is satisfied with the results. At that point, the design can be defined at the physical implementation level, Block 5a, in order to prepare for manufacturing. During this process, fault simulation can be run on the Paradigm XP, Block 5, in order to grade the tests that will be used to verify the finished product. Before sending off the ASICs to be manufactured, it is wise to test them along with the software and other system components on the Paradigm RP, Block 5b, in order to ensure compatibility. Now, when the chips come back, it is easy to perform a final hardware\/software integration and productization, Block 6, before shipping to customers.\nZycad and its products are unique in many ways, which helps the company maintain a strong technical lead in the industry. A few of these features include:\nPERFORMANCE - A criteria for all development at Zycad is that the products provide at least an order of magnitude performance improvement over other methods available in the marketplace. This performance is critical to both simulation and emulation applications required for system verification.\nARCHITECTURE - The Company's hardware products' advantage over software-based simulators on traditional workstations is achieved by building products that have a much different architecture. Zycad's development emphasis is on developing high performance simulation and emulation\/rapid prototyping products, not general purpose machines as the workstations manufacturers are designing. With this main focus, Zycad employs specialized techniques, technology and architectures that produce systems that provide an order, to orders of magnitude greater performance over workstations.\nAN EDA COMPANY THAT DESIGNS HARDWARE - Zycad is an EDA company that actually uses its own tools and methodologies to design its hardware. We are our own end user and, therefore, have the opportunity to debug our tools and services in a real world environment before taking them to our customers. Our Services business is dramatically enhanced by the on-going real world experience that our engineers obtain through the development of our products.\nZycad Corporation Page 5 3\/26\/96 2:44 PM\nSpecifically, Zycad incorporates these features into its main product lines:\nPARADIGM XP SIMULATION ACCELERATOR\nThe Paradigm XP family is the world's leading line of structural logic and fault simulation accelerators that meet the verification challenges of complex ASIC and large system designs. They range in price from approximately $50,000 for an entry-level model with 256,000 gate capacity to several hundred thousand dollars for expansion to multi-million gate capacity. The Paradigm XP provides powerful features that address ASIC, integrated circuit, and system logic and fault verification problems including modular compilation and hardware assisted toggle test.\nTransparent interfaces are provided to popular simulation environments and to VHDL via third party tools. This allows the Paradigm XP product line to transparently integrate into these environments, making it easy for the design engineer to access the XP accelerators in their design environment. Interfaces include:\n- - QuickSim II-TM- - VHDL System (Mentor Graphics-TM-) Simulator-TM-(Synopsys-Registered Trademark-) - ViewSim-TM- (Viewlogic) - - Verilog-Registered Trademark- (Cadence) - MDE-Registered - - VantageSpreadSheet-TM- (Viewlogic) Trademark-\/C-MDE-TM-(LSI Logic) - - VLSI Link (Compass)\nLibraries are always a main concern with our customers. In order to ease the creation of accurate libraries, Zycad has developed automated tools that will accept multiple sources for library translation.\nThe Paradigm XP is available in three basic system configurations. The Paradigm XP 2001 Desktop Accelerator is a single-board, entry-level system that supports up to 256,000 gates for logic simulation and 64,000 gates for fault simulation. The Paradigm XP 2004 Design Team Accelerator is a four-board, office environment system expandable to one million gates for logic and 256,000 gates for fault simulation. And the Paradigm XP 2016 System Design Accelerator is a 16-board configuration which offers capacity expansion to 16 million gates for logic simulation and four million gates for fault simulation.\nLIGHTSPEED SIMULATION SERVER\nThe Company has recently announced its next generation accelerator, LightSpeed, which is expected to be 10 to 40 times faster than the Paradigm XP and will be available to beta customers in June 1996, with production quantities in Q3 1996.\nPARADIGM RP RAPID PROTOTYPING SYSTEM\nThe Paradigm RP, starting at below $100,000, was the industry's first low-cost rapid prototyping system, and is currently offered as a series of application- specific rapid prototyping solutions. It became part of Zycad's product line with the acquisition of InCA, Ltd. and its VA-II product in September of 1993. The first Paradigm RP systems are geared to digital signal processor (DSP) based design, and speed DSP time-to-market cycles by enabling developers to emulate and rapid prototype complex DSP-based designs before committing them to silicon.\nThe Paradigm RP provides the performance and flexibility required for the near- real-time testing of DSP designs with complexities up to 120,000 gates and with clock rates exceeding 10MHz. The system is based on a 30,000 gate module containing high speed, electrically reprogrammable FPGAs.\nZycad Corporation Page 6 3\/26\/96 2:44 PM\nAn intuitive yet powerful graphical user environment, Concept Silicon, allows the importing, partitioning, and mapping of designs to the system's emulation hardware. Concept Silcon supports both standard Paradigm RP emulation hardware and user-defined prototype hardware.\nThe partitioning software within the Concept Silicon promotes fast concept-to- production by taking a netlist from a computer-aided engineering (CAE) system and automatically partitioning it across multiple FPGAs, thereby providing device programming data and a manufacturing database for printed circuit board (PCB) design. The partitioner software is designed to minimize the connectivity between FPGAs while optimizing high gate utilization, thus achieving an emulated system on a par with a production board.\nBy incorporating the GateField family of 100K gate FPGAs into its RP product offering, the Company expects to significantly improve its capacity and value to rapid prototyping customers.\nGATEFIELD FPGAs\nThe GateField GF100K series of field-programmable FPGAs use a unique architecture and switch technology to provide a device that is comparable to a gate array in capacity and usable density, while offering all the advantages of non-volatility and field re-programmability. The revolutionary Sea-of-Tiles-TM- architecture coupled with GateField's Desktop Foundry software, provides the ASIC designer with unparalleled gate capacity and automation.\nWith the wide acceptance of top-down design methodologies, the average size of ASIC designs is approaching 30K gates and countinues to grow. CMOS gate arrays are the dominant ASIC technology. They are highly integrated, flexible, and well supported by EDA tools. But they also have high initial costs, slow turnaround time and require zero design defects. Current FPGA products avoid these drawbacks, but do not provide the high gate density, the flexibility, nor the support for top-down design methodologies needed for ASIC design.\nZYCAD'S SERVICES DIVISION\nZycad's Services Division offers consulting, engineering and process management services with an emphasis on complex system design verification methodologies. The services engineering staff leverage Zycad products to achieve customers' goals of increasing design productivity, reducing development costs and improving product quality.\nConsulting services are comprised of assessment\/recommendation and implementation planning. These services include:\n- DESIGN AND VERIFICATION METHODOLOGY CONSULTING. Zycad recommends design methodologies and verification tools (e.g. simulation, emulation, rapid prototyping) for determining the completeness of a system design in the shortest time frame with minimal cost.\n- FAULT SIMULATION AND TEST GENERATION CONSULTING. Customers leverage Zycad's expertise in fault simulating highly complex circuits. Zycad recommends optimal fault grading and vector generation methodologies to help customers meet strict quality requirements.\nZycad's engineering services include both packaged and custom engineering services executed by expert design, test and software engineers to enhance customer development teams and\/or increase design environment productivity. These services include:\n- FAULT GRADING AND TEST VECTOR GENERATION -- Perform fault vector grading and increase fault coverage by developing additional vectors.\n- SYSTEM SIMULATION -- Perform complex system simulations to help customers debug functional designs.\n- ASIC DESIGN -- Develop ASICs from customer specifications.\n- RAPID PROTOTYPING -- Develop FPGA-based rapid prototypes of customer-specific systems within the context of additional system entities, including processors, memories, and software.\n- MODEL DEVELOPMENT -- Develop behavioral\/specification models using VHDL and\/or Verilog.\nProcess management services involve managing a critical segment of a customer's design and\/or verification process. This can include managing the modeling, system simulation, rapid prototyping, fault grading, and\/or test generation activities on a project.\nZycad Corporation Page 7 3\/26\/96 2:44 PM\nPRODUCT DEVELOPMENT\nZycad is regularly engaged in ongoing research and development to further enhance and improve its family of high-performance design verification products. The Company will introduce its next generation simulation accelerator, LightSpeed, in June 1996 and will also introduce several other FPGA products ranging in densities from 23K up to 100K. In fiscal year 1995, the Company expensed $11,263,000 on research and development, compared to $11,172,000 in 1994 and $9,339,000 in 1993.\nMARKETING & SALES\nZycad markets its products directly, through a worldwide product and service sales organization. The Company has direct sales offices in North America, Europe, Japan, Korea, and Taiwan. To complement its direct organization, the Company also has international distributors in the Far East, Israel and Europe.\nThe Company highlights the economic benefits that can be gained from use of its high performance verification products and services. In addition, demonstration of the products' capacity and speed to individual potential customers through the use of benchmark comparisons against software alternatives is an important element of the selling cycle. The Company's applications engineers, consulting engineers, and sales force are involved in the sales process in order to provide pre-sale technical assistance, technical credibility, and continuity with post- sale installation and servicing. The Company's general policy is to sell and not to lease its products; however, leasing arrangements are available for customers who prefer that option.\nThe rate at which orders are received by the Company may vary from month to month. In addition, customers' lead times for placing purchase orders have varied substantially. For these reasons, the Company's backlog as of any particular date may not be indicative of its actual sales for any succeeding period.\nThe Company offers a maintenance agreement to its customers under which its applications engineers provide diagnostic, repair or replacement and maintenance service.\nZycad will market its GateField FPGA products both directly through its worldwide sales organization, as well as through manufacturing representatives. In addition, the manufacturer of the GateField FPGAs, Rohm Co. LTD. located in Kyoto Japan, will also market and sell the GF100K series of FPGAs and the Desktop Foundry design software tools in Japan on a non-exclusive basis. Rohm has strong marketing and sales presence in Japan through its seven design centers and its direct sales force of 350 people. This partnership provides Zycad the opportunity to quickly penetrate the Japanese market, which according to the market research from Dataquest, constitutes 36 percent of the world's gate array market.\nFor Export Sales Information for the three years ended December 31, 1995, see Note 10 to the Company's Consolidated Financial Statements in the Company's Annual Report to its stockholders for the year ended December 31, 1995, which Note has been incorporated herein by reference in Item 8.\nCOMPETITION\nThe EDA market is a dynamic market characterized by advancing technologies in both hardware and software. The advancing technologies frequently result in new product introductions, increased product capabilities and relative product improvements in price\/performance ratios. The Company recognizes that rapid technological changes could impair its competitive position.\nIndirect competition for the Company's system verification products consists primarily of software simulators that run on general purpose workstations. Software simulators currently hold a large share of the logic simulation market. However, the Company's strategy is to leverage this large installed base of software simulators through selling accelerators as a complementary point tool into the large installed base of EDA vendors whose customers require increased simulation performance.\nZycad Corporation Page 8 3\/26\/96 2:44 PM\nDirect competition to the Paradigm XP comes from one other company with a hardware-assisted simulator, IKOS Systems, Inc. Zycad believes that the combined features, speed, and capacity of its current and future products offer competitive performance and functionality advantages over Ikos. Competition in the emulation\/rapid prototyping arena, versus the Paradigm RP, comes mainly from Quickturn Design Systems, Inc., although their products are mostly targeted at the small number of customers that need very large capacities. The Paradigm RP, on the other hand, is targeted at the many telecom, audio, and multi-media companies that may not have huge circuits to prototype, but need a machine that can provide a real-time test of their product. There are other companies that recently have bought products they intend to market in the emulation\/system rapid prototyping arena, including Synopsys and Mentor Graphics.\nIndirect competition for the Company's services, comes primarily from customers accomplishing the activity with their own personnel. The Company's strategy is to demonstrate our expertise to accomplish the objectives more rapidly and extensively than less experienced individuals might achieve.\nDirect competition for the Company's services comes from other EDA vendors including Cadence Design Systems, Inc. and Mentor Graphics. The EDA vendors services are primarily focused on the tools they provide. Zycad offers a significant advantage through its ability to work with many tools and its experience in real hardware design. The Company's focus on the contribution of the systems engineering process to systems integration success is not addressed by the EDA vendors.\nManagement believes that its superior products, consulting services, and customer support will enable the Company to compete effectively in the EDA market based on the breadth, quality, features, performance and price of its product offerings and the neutrality, flexibility, and technological prowess of its services offerings.\nThe FPGA market is a fast growing and dynamic market with several large established vendors including Xilinx, Altera and Actel. These companies offer broad product lines but have not yet been very successful in providing high-density FPGA solutions to gate array designers. Their penetration into this market has been limited, both by their lack of high gate count devices, and by the mismatch between the top down design methodologies used by gate array designers and the design tools required to use their FPGAs effectively. The revolutionary flash switch technology utilitied by the GF100K family provides a 7X size advantage over switches used by SRAM-based devices offered by the market leaders in higher gate count devices. This switch technology is used in a Sea-of-Tiles architecture to create devices that have a 2X-4X density advantage over the competitive offerings. Unlike competing devices the Sea-of-Tiles architecture has been designed specifically to work seamlessly in the top down design flow used by today's ASIC designers. The GateField devices offer the gate array designer not only high density but also allow the designer to remain within his established design environment.\nPATENTS AND TRADEMARKS\nDue to the rapid pace of technological advance, the Company believes that, while the protection of proprietary information is important, it must continue to develop and market new products to remain competitive. The Company protects its proprietary product information through issuance of patents, use of employee nondisclosure agreements and by limiting access to sensitive information. On July 2, 1985, United States Patent No. 4,527,249 was issued to the Company for a \"Concurrent Fault Simulation for Logic Designs\", and on April 5, 1988, United States Patent No. 4,736,338 was issued to the Company for a \"Programmable Look Up System\". These patents are effective for a period of 17 years from the issue date and the Company believes that these patents are an important factor in the protection of its proprietary information. On May 17, 1989, the Company signed a Patent Cross License Agreement with IKOS Systems, Inc., under which both companies granted to each other a perpetual non-exclusive license for logic or fault simulation products utilizing inventions covered by its respective patents issued through May 1, 1994.\nOn October 10, 1995, United States Patent No. 5.457,653 was isssued to the Company for a \"Technique To Prevent Deprogramming A Floating Gate Transistor Used To Directly Switch A Large Electrical Signal\". This is the first patent issued for the GateField FPGA technology and several more patent applications are on file and are pending at this time.\nZycad Corporation Page 9 3\/26\/96 2:44 PM\nThe Company has obtained federal trademark registration for its trademark \"Zycad Corporation\" from the United States Patent and Trademark Office.\nEMPLOYEES\nAt December 31, 1995, the Company had 219 employees. The employees are not represented by a labor organization, and the Company considers its relations with its employees to be good.\nMANUFACTURING\nThe Company's accelerator and rapid prototyping hardware products utilize a technology which has significant impact upon its manufacturing activities. The efficient use of full custom IC's dramatically reduces both assembly and test time. In addition, custom IC's tend to operate more reliably than a functionally equivalent printed circuit board due to a number of factors including the reduction of solder points and external contacts.\nProduct configurations include standard computer components such as a controller, CPU and main memory which are selected from various independent suppliers on the basis of cost, reliability and performance properties. These standard components are connected utilizing proprietary bus structures and controlled using operating systems with proprietary extensions as they interact with the Company's custom IC-based, application-specific subsystems.\nThe Company contracts out certain manufacturing steps, including printed circuit fabrication and assembly, circuit board wiring, cabinet fabrication and assembly, sheet metal fabrication and painting, and performs final assembly, configuration, testing and quality control procedures itself. Circuit boards are wired by automated equipment on computerized instructions generated on the Company's own CAE system, which is used extensively in order design and test phases. Manufacturing efficiency is enhanced by testing each circuit board on the Company's test equipment. After final assembly and configuration, each simulation system undergoes additional \"burn in\" testing.\nThe company's FPGA products are manufactured by Rohm CO. LTD, located in Kyoto, Japan under a manufacturing and development partnership agreement. GateField and Rohm have built a strong working alliance that dates back to October 1993. ROHM is widely recognized for its expertise in large scale integration (LSI) manufacturing and as one of the pioneers in flash technology. As part of the agreement, the company has secured guaranteed wafer capacity sufficient to meet the expected product needs for the foreseeable future. Packaging for the Gatefield parts is done by third-party companies located in the Philippines and in Korea. The company performs wafer sort and final test at its facilities in Fremont California, but, as volume dictates these activities may be moved off shore.\nCurrently, Zycad has sufficient capacity to meet its present manufacturing requirements through 1996 and the foreseeable future.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company occupies approximately 61,000 square feet of office space in Fremont, California for its headquarters, manufacturing, and engineering operations. The total lease payments remaining amount to approximately $2.3 million. The lease expires July 31, 1999. The Company's Service Division in New Jersey, occupies approximately 25,000 square feet of office space. Total lease payments remaining through February, 1998 amount to approximately $1.8 million. For additional information, see Note 6 of \"Notes to Consolidated Financial Statements\" included in the Company's 1995 Annual Report to Stockholders.\nThe Company leases sales and support office space in seven domestic locations, three European locations, one Taiwanese, one Korean and one Japanese location on a short-term or intermediate-term basis.\nZycad Corporation Page 10 3\/26\/96 2:44 PM\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS None.\nITEM 4:","section_4":"ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nA special meeting of the stockholders was held on December 18, 1995 for the purpose of voting on the following proposals with the following votes cast:\nEXECUTIVE OFFICERS OF THE REGISTRANT\nSet forth below is information regarding executive officers of the Company:\nDr. Smith was named President, Chief Executive Officer and a Director of Zycad Corporation in June 1990. He had been an industry consultant after leaving his post as Chairman and CEO of Edgecore Technology, Inc., after its September 1989 acquisition by Arix Corporation. Previously, Dr. Smith had served as President and CEO and a director of CAE Systems, which was sold to Tektronix in March 1985, and prior to that, he was Vice President, Marketing for Computervision. Dr. Smith holds a Ph.D. in business administration from St. Louis University, an M.B.A. from Michigan State and a B.S. from the U.S. Military Academy at West Point.\nMr. Cassidy joined the Company in July 1990 from Sharebase Corporation, where he served as Executive Vice President, Operations and CFO. Before joining Sharebase in October 1987, he held a similar position at NCA Corporation, a supplier of computer software for manufacturing resource planning. He holds a B.S. in Accounting from the University of Dayton.\nMr. Klint joined the Company in December 1984 as Director of Contracts, was named Corporate Secretary in June 1986, and was promoted to Vice President and General Counsel in November 1987. Mr. Klint holds a J.D. degree from William Mitchel College of Law and a B.A. degree from Gustavus Adolphus College.\nMr. Olson joined the Company in 1982 and, except for a 2 year separation from 1986 to 1988, has been employed at the Company since that time. He has served in his current position since January 1995 and prior to January 1995 held several management positions including, Vice President\nMr. Sandfort joined the Company in September 1995 after serving ten years at LSI Logic, his most recent position being Executive Vice President for Geographic Markets. He also held other senior management positions at LSI including General Manager, Germany; Vice President Marketing, Sales and Engineering LSI Europe; and President, LSI Europe.\nZycad Corporation Page 11 3\/26\/96 2:44 PM\nWorldwide Sales -GateField Division, Vice President and General Manager - ViP Division and Director of Sales - Western area.\nThere are no family relationships among the officers listed, and there are no arrangements or understandings pursuant to which any of them were elected as officers.\nZycad Corporation Page 12 3\/26\/96 2:44 PM\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe information under the heading \"Stock Listing\" on page 17 of the Company's 1995 Annual Report to Stockholders is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe information under the heading \"Selected Financial Data\" on page 1 of the Company's 1995 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\nThe information under the heading \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" on pages 4 and 5 of the Company's 1995 Annual Report to Stockholders is incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe Independent Auditors' Report, the consolidated financial statements and the notes to consolidated financial statements on pages 6 to 15 of the Company's 1995 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\nNot applicable.\n(THE REMAINDER OF THIS PAGE IS INTENTIONALLY LEFT BLANK)\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nDIRECTORS\nSet forth below is information regarding the Directors of the Company, including information furnished by them as to their principal occupation for the last five years, certain other directorships held by them, and their ages as of March 29, 1996:\nExcept as set forth below, each of the nominees has been engaged in his principal occupation set forth above during the past five years. There is no family relationship between any of the directors and executive officers of the Company.\nDr. Smith was named President, Chief Executive Officer and director of the Company in June 1990. He had been an Independent industry consultant from October 1989 to June 1990 after leaving his post as Chairman and Chief Executive Officer of Edgecore Technology, Inc., a computer manufacturer, after it was acquired by Arix Corporation in September 1989. Previously, Dr. Smith had been President and Chief Executive Officer and a director of CAE Systems, Inc.\nMr. Cassidy was appointed a director of the Company in November 1991. He has held the position of Executive Vice President and Chief Financial Officer of Zycad Corporation since July 1990. From October 1987 to July 1990, he was Executive Vice President, Operations and Chief Financial Officer for Sharebase Corporation, a relational data base system supplier.\nDr. Fiebiger was appointed a director of the Company in February 1994. Dr., Fiebiger has been a Consultant for the semiconductor industry since serving as President and Chief Operating Officer of VLSI Technology, Inc., a manufacturer of semiconductors, from February 1988 to August 1993. Previous positions include President and CEO of Thomson-Mostek and Senior Vice President and Assistant General Manager of Motorola's Worldwide Semiconductor Sector. Dr. Fiebiger is also a member of the board of directors of Mentor Graphics Corporation, Cooper & Chyan Technology, Inc., and Chairman and Managing Director, Thunderbird Technology, Inc.\nMr. Huberman was appointed a director of the Company in September 1990. He has served as President of the Huberman Consulting Group, a technology consulting firm, since 1990. Prior to that, he served as Vice president of Consultants International from 1981 to 1988 and as President from 1988\nto 1990. Mr. Huberman is currently a member of the Chief of Naval Operations' Executive Panel. From 1988 to mid-1990, he also served as the first chairman of the Technical Advisory Panel to the U.S. Space Command. Mr. Huberman is also a member of the board of directors of Silicon Valley Research, Inc.\nMr. Sandfort was appointed a director of the Company in September 1995. He held the position of Executive Vice President for Geographic Markets at LSI Logic, where he had worldwide responsibilities for Sales, Marketing, and Engineering in Asia, Canada, Europe and the U.S.A. During his ten years at LSI, he was also employed in a variety of other senior management positions including General Manager, Germany; Vice President Marketing, Sales and Engineering LSI Europe; and President, LSI Europe.\nCOMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT\nSection 16(a) of the Securities Exchange Act of 1934 requires the Company's officers and directors, and persons who own more than ten percent of a registered class of the Company's equity securities, to file reports of ownership on Form 3 and changes in ownership on Form 4 or 5 with the SEC. Such officers, directors and ten-percent stockholders are also required by SEC rules to furnish the Company with copies of all Section 16(a) forms that they file.\nBased solely on its review of the copies of such forms received by it, or representations from certain reporting persons that no Forms 5 were required for such persons, the Company believes that, during the last fiscal year, all Section 16(a) filing requirements applicable to its officers, directors, and ten-percent stockholders were complied with.\n(The remainder of this page is intentionally left blank)\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nEXECUTIVE COMPENSATION\nThe following table shows, as to the Chief Executive Officer and each of the three other executive officers, information concerning compensation paid for services to the Company in all capacities during the fiscal year ended December 31, 1995 as well as the Company's two previous fiscal years (if such person was the Chief Executive Officer or an executive officer, as the case may be, during any part of such fiscal year).\nSUMMARY COMPENSATION TABLE\n(1) Messrs. Smith, Cassidy and Klint are paid bonuses based on the Company's profitability. Mr. Olson is paid incentive compensation based on the Accelerator Division revenues and gross profit margin. Mr. Sandfort had a one-time guaranteed bonus of $15,000. (2) Represents $44,048 in cost of living adjustments for California housing. (3) Includes $10,000 contributed by the Company to a cafeteria benefit plan and $2,310 contributed by the Company to a 401K plan and $3,030 for term life insurance premium reimbursement. (4) Represents $25,937 in cost of living adjustments for California housing and $38,975 in tax gross up rembursement payments for 1993 and 1994. (5) Includes $10,000 contributed by the Company to a cafeteria benefit plan and $2,310 contributed by the Company to a 401 (K) plan, and $7,680 for term life insurance premium reimbursement. (6) Represents $25,732 in cost of living adjustments for California housing. (7) Represents Company contributions to defined benefit plans. (8) Mr. Olson became an Executive Officer in June 1995. His annual base salary in 1995 was $150,000. (9) Mr. Sandfort hire date was September 6, 1995 and his annual base salary is $240,000. He was actually paid $80,000 in salary in 1995.\n(The remainder of this page is intentionally left blank)\nOPTION GRANTS TO EXECUTIVE OFFICERS\nThe following table sets forth further information regarding individual grants of stock options pursuant to the 1993 Stock Option Plan during 1995 to each of the executive officers named in the Summary Compensation Table above.\nNote: All option shave an exercise price equal to the fair market value of the Company's common stock on the date of grant.\n(1) All 20,000 options are time based with vesting over 4 years with annual vesting for the first two years and monthly vesting thereafter.\n(2) Options for 90,000 shares are time based with annual vesting over 3 years. Options for 60,000 shares are performance based with vesting upon achievement of certain performance goals.\n(3) Options for 240,000 shares are time based with vesting over 4 years with annual vesting for the first two years and monthly vesting thereafter. Options for 160,000 shares are performance based with vesting upon achievement of certain performance goals.\nOPTIONS EXERCISED AND HELD\nThe following table shows, as to the individuals named in the Summary Compensation Table above, information concern in stock options exercised during the fiscal year ended December 31, 1995 and options held at fiscal year end.\nAGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR END OPTION VALUES\n(1) Market value of underlying securities, based on the last sale price of the Companies Common Stock on the National Association of Securities Dealers, Inc. Automated Quotation (\"NASDAQ\") National Market System on the date of exercise, minus the exercise price.\n(2) Market value of underlying securities, based on the last sale price of the Company's Common Stock on the NASDAQ National Market System on December 29, 1995 ($8.38 per share), minus the exercise price.\nDIRECTOR COMPENSATION\nMembers of the Board of Directors who are not employees of the Company receive a retainer of $2,500 per quarter plus a fee of $1,000 for attendance at each Board and Board Committee meetings and are reimbursed for their expenses in attending meetings of the Board of Directors. On September 10, 1990, Mr. Huberman received warrants from the Company entitling him to purchase 50,000 shares of the Company's Common Stock at an exercise price of $1.00 per share, the then market value. In August 1993 Mr. Huberman received warrants from the Company entitling him to purchase 30,000 shares of the Company's Common Stock at an exercise price of $2.06 per share. In February 1994 Dr. Fiebiger received warrants from the Company entitling him to purchase 50,000 shares of the Company's Common Stock at an exercise price of $3.63 per share. Both of these warrants are exercisable for 10,000 shares on each anniversary date.\nAll warrants expire six years after their respective issue dates or 90 days after resignation from the Board of Directors, whichever occurs first.\nREPORT OF THE COMPENSATION COMMITTEE OF THE BOARD OF DIRECTORS\nThe Compensation Committee of the Board of Directors is comprised of two non-employee directors of the Board of Directors. No member of the Committee is a former or current officer or employee of the Company.\nThe Compensation Committee is responsible for setting and administering the policies governing annual compensation of executive officers, including the annual management incentive plans and the Company's stock option plans. In addition, The Committee reviews compensation levels of executive officers and evaluates their performance.\nIt is the compensation policy of the Committee that a substantial portion of the annual compensation opportunities of each executive officer be contingent upon the performance of the Company. The Committee also believes that employee equity ownership is highly motivating, provides a major incentive to employees in building stockholder value and serves to align the interests of employees with stockholders.\nThe salaries for executive officers generally are based on a review of salaries for comparable positions among competing companies, and are adjusted annually to take into account cost of living increases, merit increases and adjustments deemed necessary to continue to attract and retain highly qualified executive officers.\nUnder the Company's annual incentive plan, incentive compensation is paid based on the performance of the Company as a whole. Bonuses for Messrs. Smith, Cassidy and Klint are paid based on attainment of Company profitability goals and incentive compensation for Mr. Olson is paid based on attainment of Accelerator Division revenues and gross profit margin. Mr. Sandfort's bonus is based on revenue and expense goals for the Gatefield Division. Annual incentive compensation at targeted levels of performance represents approximately 50% of total cash compensation for the CEO and 25% to 45% for the executive officers. The targeted amounts of incentive compensation are established in the Company's annual operating plan, which is approved by the Board annually.\nThe Company's performance is measured for purposes of compensation decisions under the annual incentive plan against goals established by the Committee in consultation with management prior to the fiscal year based on the Company's annual operating plan.\nThe financial goals for fiscal 1995 which related to Company revenue and net profit before tax were partially achieved. No bonuses were paid to Messrs. Smith and Cassidy for 1995 performance. Mr. Sandfort was guaranteed a one time bonus of $15,000 for Fourth Quarter 1995. Mr. Olson was paid incentive compensation of $93,400 related to revenue and gross profit attainment in 1995. In 1995 stock options for 20,000 shares, 150,000 shares and 400,000 shares were granted to Messrs. Klint, Olson and Sandfort, respectively.\nJames Fiebiger Chairman, Compensation Committee\nBenjamin Huberman Member, Compensation Committee\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\nThe Compensation Committee currently consists of outside directors James Fiebiger and Benjamin Huberman. None of these individuals was at any time during the fiscal year ended December 31, 1995 or at any other time an officer or employee of the Company.\nDuring fiscal year ended December 31, 1995 the Company paid Mr.. Benjamin Huberman, a member of the Board of Directors, $80,000 in consulting fees. Mr. Huberman has worked closely with the Company in developing and marketing the Company's consulting services. Management believes that this arrangement is at least as favorable as could be negotiated with outside consultants.\nDuring fiscal year ending December 31, 1995 the Company paid Dr. James Fiebiger, a member of the Board of Directors, consulting fees in the amount of $77,788. Dr. Fiebiger's consulting services were rendered for product development, strategic planning and marketing consulting services for Field Programmable Gate Array Products developed by the Company's GateField Division. Management believes that this arrangement is at least as favorable as could be negotiated with outside consultants.\nNo executive officer of the Company serves as a member of the board of directors or compensation committee of any entity which has one or more executive officers serving as a member of the Company's Board of Directors or Compensation Committee.\nCOMPANY STOCK PRICE PERFORMANCE\nThe following graph shows a five-year comparison of cumulative total stockholder returns (on a dividend reinvestment basis) for the Company's Common Stock, NASDAQ Stock Market (U.S.) and Hambrecht and Quist (\"H&Q\") Technology Index. Note that the historic stock price performance is not necessarily indicative of future stock price performance.\nZYCAD CORPORATION\nCOMPARISON OF FIVE-YEAR CUMULATIVE TOTAL RETURN\nAssumes $100 invested on December 31, 1990 in the Company's Common Stock, NASDAQ Stock Market (U.S.) and Hambrecht and Quist Technology Index.\n*Total return assumes reinvestment of dividends.\n(The remainder of this page is intentionally left blank)\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nSHARE OWNERSHIP\nThe following persons or entities were known to the Company to be the beneficial owners of more than 5% of the Company's Common Stock.\nSECURITY OWNERSHIP OF MANAGEMENT\nThe following table sets forth certain information regarding ownership of the Company's Common Stock as of March 29, 1995, by each director, by each of the executive officers, and all executive officers named in the summary Compensation Table and directors of the Company as a group.\nSHARES OF COMMON STOCK BENEFICIALLY OWNED\n*Less than (1) percent.\n(1) Represents 300,000 shares subject to options held by Mr. Cassidy that are exercisable within 60 days of the Record Date.\n(2) Includes 20,000 shares subject to warrants held by Dr. Fiebiger that are exercisable within 60 days of the Recorded Date.\n(3) Includes 70,000 shares subject to warrants held by Mr. Huberman that are exercisable within 60 days of the Record Date.\n(4) Includes 6,042 shares subject to options held by Mr. Klint that are exercisable within 60 days of the Recorded Date.\n(5) Includes 4,896 shares subject to options held by Mr. Olson that are exercisable within 60 days of the record date.\n(6) Includes 400,938 share subject to options and warrants held by five persons that are exercisable within 60 days of the Record Date.\nITEM 13.","section_13":"ITEM 13. CERTAIN TRANSACTIONS\nCERTAIN TRANSACTIONS\nThe following table sets forth information with respect to all executive officers of the Company who had indebtedness in excess of $60,000 outstanding during the past fiscal year.\nThese Loans were paid in full in August and September, 1995. These loans were made in connection with the purchase and financing of real property by Dr. Smith and in connection with the exercise of stock options by Dr. Smith. Both loans are documented with full recourse Promissory Notes signed by Dr. Smith. These loans are secured by certain real property including Dr. Smith's personal residence; as well as 1,200,000 shares of Common Stock of the Company owned by Dr. Smith of which 900,000 shares were issued pursuant to the exercise of his stock options and 300,000 shares were previously purchased by him in the open market.\n(The remainder of this page is intentionally left blank)\nPART IV\n- -------------------------------------------------------------------------------- ITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K - --------------------------------------------------------------------------------\n(a) 1. Financial Statements\nIndependent Auditors' Report (page 15 of the Company's 1995 Annual Report to Stockholders).\nConsolidated Balance Sheets as of December 31, 1995 and 1994 (page 6 of the Company's 1995 Annual Report to Stockholders).\nConsolidated Statements of Operations for Years Ended December 31, 1995, 1994 and 1993 (page 7 of the Company's 1995 Annual Report to Stockholders).\nConsolidated Statements of Stockholders' Equity for Years Ended December 31, 1995, 1994 and 1993 (page 8 of the Company's 1995 Annual Report to Stockholders).\nConsolidated Statements of Cash Flows for Years Ended December 31, 1995, 1994 and 1993 (page 9 of the Company's 1995 Annual Report to Stockholders).\nNotes to Consolidated Financial Statements (pages 10 to 14 of the Company's 1995 Annual Report to Stockholders).\n2. The following financial statement schedules is included herein: Schedule II: Valuation and Qualifying Accounts and Reserves\nAll other schedules are omitted because they are not required, inapplicable or the information is otherwise included.\n3. Exhibits:\nEXHIBIT NUMBER DESCRIPTION\n3.1 Certificate of Incorporation of the Company, as amended (incorporated by reference to Exhibit 3.1 to the Company's Annual Report on Form 10-K for the year ended December 31, 1987).\n3.2 Bylaws of the Company, as amended (incorporated by reference to Exhibit 3.2 to the Company's Annual Report on Form 10-K for the year ended December 31, 1988).\n3.3 Amendment to the Certificate of Incorporation of the Company\n10.1 * 1984 Stock Option Plan as amended (incorporated by reference to Exhibit 10.2 of the Company's Annual Report on Form 10-K for the year ended December 31, 1987).\n10.2 Patent Agreement dated October 28, 1985 with Control Data Corporation (incorporated by reference to Exhibit 10.12 to the Company's Annual Report on Form 10-K for the year ended December 31, 1985).\n10.3 Employee Stock Purchase Plan (incorporated by reference to Exhibit 10.12 to the Company's Annual Report on Form 10-K for the year ended December 31, 1986).\n10.4 Warrant Certificate for the purchase of 15,000 shares of Common Stock executed with Douglas E. Johnson and John A. Fahlberg (incorporated by reference 10.22 to the Company's Annual Report on Form 10-K for the year ended December 31, 1989).\n10.5 Patent Cross License Agreement dated May 17, 1989 with IKOS Systems, Inc. (incorporated by reference 10.25 to the Company's Annual Report on Form 10-K for the year ended December 31, 1989).\n10.6 Warrant Certificate for the purchase of 50,000 shares of Common Stock executed with Benjamin Huberman dated September 19, 1990 (incorporated by reference 10.22 to the Company's Annual Report on Form 10-12 for the year ended December 31, 1991).\n10.7 Consulting Agreement dated October 1, 1990 with Benjamin Huberman (incorporated by reference 10.24 to the Company's Annual Report on Form 10-12 for the year ended December 31, 1991).\n10.8 Warrant Certificate for the purchase of 50,000 shares of Common Stock executed with Yoshikazu Hori dated July 18, 1991 (incorporated by reference 10.25 to the Company's Annual Report on Form 10-12 for the year ended December 31, 1991).\n10.9 Asset Purchase Agreement between Zycad Corporation and Synopsys Technology Inc., a wholly-owned subsidiary of Synopsys, Inc. dated as October 19, 1990 (incorporated by reference 10.26 to the Company's Annual Report on Form 10-12 for the year ended December 31, 1991).\n10.10 Agreement regarding non-compete and payments dated January 15, 1992 between Synopsys, Inc. and Synopsys Technology, Inc. and Zycad Corporation (incorporated by reference 10.27 to the Company's Annual Report on Form 10-12 for the year ended December 31, 1991).\n10.11 Lease dated March 6, 1992 relating to premises at 47100 Bayside Parkway, Fremont, California (incorporated by reference 10.22 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992).\n10.12 Promissory Note dated August 27, 1992 in the amount of $600,000 from Phillips W. Smith (incorporated by reference 10.24 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992).\n10.13 * 1993 Stock Option Plan (incorporated by reference 10.13 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993).\n10.14 Lease dated October 23, 1992 relating to premises at 100 Enterprise Drive, Rockaway, New Jersey (incorporated by reference 10.14 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993).\n10.15 Form of Warrant Certificate for the purchase of 30,000 shares of Common Stock executed with Benjamin Huberman and Yoshikazu Hori dated August 16, 1993 (incorporated by reference 10.15 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993).\n10.16 Promissory Note (full recourse) dated September 1, 1993 in the amount of $900,000 from Phillips W. Smith and Patricia Smith (incorporated by reference 10.16 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993).\n10.17 Share Exchange and Allotment Agreement dated September 7, 1993, for the purchase of Integrated Circuit Applications, Ltd. (incorporated by reference 10.17 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993).\n10.18 SICAN\/Zycad Technology Agreement dated September 23, 1993, between SICAN GmbH and Zycad Corporation (incorporated by reference 10.18 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993).\n10.19 Private Placement Distribution Agreement dated March 4, 1994 with Rosehouse, Ltd. (incorporated by reference 10.19 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994).\n10.20 Warrant Certificate for purchase of 50,000 shares of Common Stock executed with James Fiebiger dated February 4, 1994 (incorporated by reference 10.20 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994).\n10.21 Warrant Certificate for purchase of 5,918 shares of Common Stock executed with James Fiebiger dated November 11, 1994 (incorporated by reference 10.21 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994).\n10.22 First Amendment to Rockaway New Jersey Lease dated January 13, 1995 (incorporated by reference 10.22 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994).\n11.1 Computation of Earnings Per Share.\n13.1 The Company's 1995 Annual Report to Stockholders.\n21.1 Subsidiaries of the Registrant.\n23.1 Independent Auditors' Consent -- Deloitte & Touche LLP.\n- -------------------------------------\n* Denotes a compensation plan in which an executive officer participates.\n(b) REPORTS ON FORM 8-K. None.\n(c) EXHIBITS. See response to Item 14(a) (3).\n(d) FINANCIAL STATEMENTS SCHEDULES. See response to Item 14 (a) (2).\nFor the purposes of complying with the amendments to the Rules governing Form S- 8 (effective July 13, 1990) under the Securities and Exchange Act of 1933, the undersigned hereby undertakes as follows, which undertaken shall be incorporated by reference into the Registrant's Registration Statements on Form S-8 (File Nos. 13244):\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.\n(The remainder of this page is intentionally left blank)\n---------- 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 to be signed on its behalf by the undersigned, thereunto duly authorized.\nZYCAD CORPORATION\nBy \/s\/Phillips W. Smith ------------------------- Phillips W. Smith President and Chief Executive Officer\nBy \/s\/Peter J. Cassidy ------------------------ Peter J. Cassidy Executive Vice President and Chief Financial Officer\nDate: March 29, 1996\nPursuant 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 their respective capacities as directors of the Company.\n\/s\/Phillips W. Smith Director March 29, 1996 - ----------------------------- Phillips W. Smith\n\/s\/Peter J. Cassidy Director March 29, 1996 - ----------------------------- Peter J. Cassidy\n\/s\/Horst G. Sandfort Director March 29, 1996 - ----------------------------- Horst G. Sandfort\n\/s\/Benjamin Huberman Director March 29, 1996 - ----------------------------- Benjamin Huberman\n\/s\/James R. Fiebiger Director March 29, 1996 - ----------------------------- James R. Fiebiger\nINDEX TO EXHIBITS SEQUENTIALLY EXHIBIT NUMBERED NUMBER DESCRIPTION PAGE 3.1 Certificate of Incorporation of the Company, as amended (incorporated by reference to Exhibit 3.1 to the Company's Annual Report on Form 10-K for the year ended December 31, 1987).\n3.2 Bylaws of the Company, as amended (incorporated by reference to Exhibit 3.2 to the Company's Annual Report on Form 10-K for the year ended December 31, 1988).\n3.3 Amendment to the Certificate of Incorporation of the Company\n10.1 1984 Stock Option Plan as amended (incorporated by reference to Exhibit 10.2 of the Company's Annual Report on Form 10-K for the year ended December 31, 1987).\n10.2 Patent Agreement dated October 28, 1985 with Control Data Corporation (incorporated by reference to Exhibit 10.12 to the Company's Annual Report on Form 10-K for the year ended December 31, 1985).\n10.3 Employee Stock Purchase Plan (incorporated by reference to Exhibit 10.12 to the Company's Annual Report on Form 10-K for the year ended December 31, 1986).\n10.4 Warrant Certificate for the purchase of 15,000 shares of Common Stock executed with Douglas E. Johnson and John A. Fahlberg (incorporated by reference 10.22 to the Company's Annual Report on Form 10-K for the year ended December 31, 1989).\n10.5 Patent Cross License Agreement dated May 17, 1989 with IKOS Systems, Inc. (incorporated by reference 10.25 to the Company's Annual Report on Form 10-K for the year ended December 31, 1989).\n10.6 Warrant Certificate for the purchase of 50,000 shares of Common Stock executed with Benjamin Huberman dated September 19, 1990 (incorporated by reference 10.22 to the Company's Annual Report on Form 10-12 for the year ended December 31, 1991).\n10.7 Consulting Agreement dated October 1, 1990 with Benjamin Huberman (incorporated by reference 10.24 to the Company's Annual Report on Form 10-12 for the year ended December 31, 1991).\n10.8 Warrant Certificate for the purchase of 50,000 shares of Common Stock executed with Yoshikazu Hori dated July 18, 1991 (incorporated by reference 10.25 to the Company's Annual Report on Form 10-12 for the year ended December 31, 1991).\n10.9 Asset Purchase Agreement between Zycad Corporation and Synopsys Technology Inc., a wholly-owned subsidiary of Synopsys, Inc. dated as October 19, 1990 (incorporated by reference 10.26 to the Company's Annual Report on Form 10-12 for the year ended December 31, 1991).\n10.10 Agreement regarding non-compete and payments dated January 15, 1992 between Synopsys, Inc. and Synopsys Technology, Inc. and Zycad Corporation (incorporated by reference 10.27 to the Company's Annual Report on Form 10-12 for the year ended December 31, 1991).\n10.11 Lease dated March 6, 1992 relating to premises at 47100 Bayside Parkway, Fremont, California (incorporated by reference 10.22 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992).\n10.12 Promissory Note dated August 27, 1992 in the amount of $600,000 from Phillips W. Smith (incorporated by reference 10.24 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992).\n10.13 1993 Stock Option Plan (incorporated by reference 10.13 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993).\n10.14 Lease dated October 23, 1992 relating to premises at 100 Enterprise Drive, Rockaway, New Jersey (incorporated by reference 10.14 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993).\n10.15 Form of Warrant Certificate for the purchase of 30,000 shares of Common Stock executed with Benjamin Huberman and Yoshikazu Hori dated August 16, 1993 (incorporated by reference 10.15 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993).\n10.16 Promissory Note (full recourse) dated September 1, 1993 in the amount of $900,000 from Phillips W. Smith and Patricia Smith (incorporated by reference 10.16 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993).\n10.17 Share Exchange and Allotment Agreement dated September 7, 1993, for the purchase of Integrated Circuit Applications, Ltd. (incorporated by reference 10.17 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993).\n10.18 SICAN\/Zycad Technology Agreement dated September 23, 1993, between SICAN GmbH and Zycad Corporation (incorporated by reference 10.18 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993).\n10.19 Private Placement Distribution Agreement dated March 4, 1994 with Rosehouse, Ltd. (incorporated by reference 10.19 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994).\n10.20 Warrant Certificate for purchase of 50,000 shares of Common Stock executed with James Fiebiger dated February 4, 1994 (incorporated by reference 10.20 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994).\n10.21 Warrant Certificate for purchase of 5,918 shares of Common Stock executed with James Fiebiger dated November 11, 1994 (incorporated by reference 10.21 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994).\n10.22 First Amendment to Rockaway New Jersey Lease dated January 13, 1995 (incorporated by reference 10.22 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994).\n11.1 Computation of Earnings Per Share.\n13.1 The Company's 1995 Annual Report to Stockholders.\n21.1 Subsidiaries of the Registrant.\n23.1 Independent Auditors' Consent -- Deloitte & Touche LLP.\nINDEPENDENT AUDITORS' REPORT\nTo the Board of Directors and Stockholders of Zycad Corporation:\nWe have audited the consolidated financial statements of Zycad Corporation as of December 31, 1995 and 1994, and for each of the three years in the period ended December 31, 1995, and have issued our report thereon dated March 27, 1996. Our audits also included the consolidated financial statement schedule of Zycad Corporation, listed in the Index at Item 14. This consolidated financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such consolidated financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.\nDELOITTE & TOUCHE LLP\nSan Jose, California March 27, 1996","section_15":""}
{"filename":"78853_1995.txt","cik":"78853","year":"1995","section_1":"Item 1. Business\nGeneral\nPitt-Des Moines, Inc. and its subsidiaries (PDM or the Company) began conducting business in 1892. PDM was incorporated in Pennsylvania on February 14, 1916. The Company's principal executive offices are located at 3400 Grand Avenue, Pittsburgh, Pennsylvania 15225, telephone number (412) 331-3000.\nEffective with the disposition of CVI's operations during the fourth quarter of 1994 (see Discontinued Operation note accompanying the consolidated financial statements), the Company is comprised of three business segments: Engineered Construction Division, Steel Construction and Steel Service Centers. Each segment is a profit center except the Steel Construction business segment which is divided into three profit centers as noted below.\nA summary of the Company's products and services by business segment is set forth below.\nEngineered Construction Division\nIn 1994, the Engineered Construction Division was reorganized into three project groups: Water, Industrial, and International and Technology. These market groups provide:\na) The capability to design, fabricate and erect many types of facilities and structures; services offered include research and design, material selection, preparation of detailed drawings, shop fabrication, field erection and subcontract management.\nb) The capability to design, fabricate and erect elevated and flat bottom water storage tanks for water service and fire protection requirements and treatment tanks for the purification, filtration and softening of water. The principal purchasers of the Company's water storage tanks and wastewater treatment facilities are government agencies and private industry.\nc) The capability to design, fabricate and erect oil and chemical storage tanks used for storing crude oil, petroleum, gasoline and other petroleum derivatives and chemicals. The Company has developed and patented certain systems, parts and sealing devices which help to reduce the hazards of fire and explosion from the stored products, as well as to decrease air pollution and vapor loss. Additionally, the Company fabricates and erects various vessels used in the processing of a variety of oil and chemical products. The oil and chemical tanks, sealing devices and process vessels are produced principally for the petroleum, petrochemical, chemical and food processing industries as well as government agencies.\nItem 1. Business (Cont'd)\nd) The capability to fabricate and erect miscellaneous plate work which includes penstocks and breechings, stacks and stack liners, scrubbers, absorbers, flow conductors and heat exchangers for utilities and private industry.\ne) The capability to design, fabricate and erect high speed wind tunnels, altitude test chambers, hydrospace test facilities and high vacuum and thermal test facilities for use in connection with energy, aerospace and defense research.\nf) The capability to design and build supercritical fluid extraction facilities for the food processing industry.\ng) The capability to design and build anaerobic digesters for the wastewater treatment industry.\nSteel Construction\nOn September 1, 1994, the Company acquired the bridge fabricating assets of Phoenix Steel, Inc., located in Eau Claire, Wisconsin. These assets were combined with the bridge fabricating assets of Hartwig Mfg. Corp. (which was merged with and into the Company on December 31, 1994) to form the PDM Bridge Division. PDM Bridge, PDM Strocal, Inc. and PDM Chicago Steel Construction comprise the three profit centers of Steel Construction which provide:\na) The capability to fabricate and erect structural steel for commercial, institutional and public sector buildings for government agencies, private developers and general contractors.\nb) The capability to fabricate structural steel for new bridges and fabricate and erect structural steel for bridge rehabilitation for government agencies and general contractors.\nSteel Service Centers\nThe Steel Service Centers operate six steel service centers and three culvert facilities located in the West and Midwest regions of the United States. This Division processes and distributes to the end users, a general line of carbon steel products including plates, sheets, structural shapes, bars, tubes, pipe and other miscellaneous metal products. This Division also manufactures and markets to the end users, corrugated metal culvert pipe and accessories. The Steel Service Centers' primary markets include steel fabricators, original equipment manufacturers and the mining, logging, agricultural and road construction industries.\nItem 1. Business (Cont'd)\nSteel Service Centers (Cont'd)\nThe Company and the industry as a whole deem the maintenance of adequate levels of inventory to be integral to the Service Center business. The Company believes that it has adequate levels of inventory on hand to meet current and anticipated customer demand.\nOther\nSeveral large companies compete nationally in some product lines with the Company and there are several local and regional companies that compete in certain product lines in specific geographic areas. The majority of the Company's business is secured through open competitive bidding or through direct negotiations with industry or government agencies. Competition is based primarily on performance including the ability to provide design, engineering and on-site field construction services in a cost-effective, timely manner. The Steel Service Centers' volume of business is based on the price, delivery and credit terms, and first stage preprocessing operations offered to its customers as well as its reputation.\nEarned revenue was $461 million in 1995, compared with $408 million in 1994 and $324 million in 1993. For further financial information refer to Consolidated Financial Statements in PDM's 1995 Annual Report to Stockholders which are incorporated herein by reference.\nThe principal raw materials essential to the Company's business are steel, alloys and other metal plates and structural sections. The Company procures these raw materials from various domestic and foreign sources including, the mills of USX Corporation, Bethlehem Steel Corporation, Northwestern Steel and Wire Company, Nucor Steel, British Steel and Mitsubishi International Corporation.\nThe Company has a license and technical assistance agreement with Roediger, a German corporation, which gives the Company exclusive rights in North America and other selected countries worldwide to use the Roediger technology, a process which utilizes anaerobic digestion in the treatment of wastewater. Revenues to date from this technology have not been material to the Company.\nSome components of the other products made and erection techniques used by the Company are covered by patents owned or licensed by the Company. None of these are deemed to be material to the Company from an overall financial viewpoint.\nThe Company had a backlog of uncompleted contracts of $183 million on December 31, 1995 compared to $194 million on December 31, 1994. Substantially all backlog is expected to be completed during 1996.\nFactors such as the type and scope of operations in progress at any given time, including weather conditions at field sites, create fluctuations in the employment level at PDM. On December 31, 1995, the Company employed 2,082 persons, of which 635 were salaried personnel and 1,447 were hourly personnel.\nItem 1. Business (Cont'd)\nThe financial information for business segments is included in the Business Segment Information section in PDM's 1995 Annual Report to stockholders, which section is incorporated herein by reference.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nOperations of the Company are conducted at both owned and leased properties. In addition, certain owned properties of the Company are leased to third party tenants. The following table indicates each of the Company's facilities in the United States by: segment, location, type of facility, year operations began, and square footage of property owned or leased on December 31, 1995:\nItem 2. Properties (Cont'd)\n__________ (1) Company leases land from outside third party. Lease will expire March 31, 1999. (2) Company leases land and building from outside third party. Lease will expire July 1, 1997. (3) Company leases land from outside third party. Lease will expire January 31, 2003. (4) Company pursues the sale or development of all idle facilities and regularly evaluates similar opportunities for facilities not fully utilized.\nThe properties listed above are utilized by the Company's business segments as indicated. The Company's production capacity is adequate for its present needs. The Company believes that its properties have been adequately maintained, are generally in good condition and are suitable for the Company's business as now conducted.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThere are various claims and legal proceedings against the Company arising in the normal course of business. Although counsel is unable to predict with certainty the ultimate outcome, management and counsel believe the Company has significant and meritorious defenses to any claims, and intend to pursue them vigorously.\nAs previously reported, in May 1984, Washington Public Power Supply System (WPPSS) filed a complaint against the Company and its surety in the United States District Court for the Eastern District of Washington. All of WPPSS' claims against the Company and its surety have been dismissed.\nOn November 3, 1993, an accident occurred at the construction site of a new United States Post Office in Chicago where the Company's Steel Construction business segment was in the process of fabricating and erecting the steel structure of the building. Two men were killed and five seriously injured when a portion of the erected steel collapsed. An investigation is being conducted by the Federal Occupational Safety and Health Administration (OSHA) and the Justice Department as required by OSHA law. See Accrued Liabilities note accompanying the consolidated financial statements in PDM's 1995 Annual Report to Stockholders, which note is incorporated herein by reference.\nItem 3. Legal Proceedings (Cont'd)\nThe Company's operations, including idle facilities and other property, are subject to and affected by federal, state and local laws and regulations regarding the protection of the environment. The Company accrues for environmental costs where such obligations are either known or considered probable and can be reasonably estimated.\nThe Company is participating as a potentially responsible party (PRP) at three different sites pursuant to proceedings under the Comprehensive Environmental Response, Compensation and Liability ACT (CERCLA). Other parties have also been identified as PRP's at the sites. Investigative and\/or remedial activities are ongoing. The Company believes, based upon information presently available to it, that such future costs will not have a material effect on the Company's financial position, results of operations or liquidity. However, the imposition of more stringent requirements under environmental laws or regulations, new developments or changes regarding site cleanup costs or the allocation of such costs amount PRP's or a determination that the Company is potentially responsible for the release of hazardous substances at sites other than those currently identified, could result in additional costs.\nManagement believes it is improbable that the ultimate outcome of any matter currently pending against the Company will 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\nExecutive Officers of the Registrant\nInformation regarding executive officers of the Registrant is presented in Part III following and incorporated herein by reference.\nPART II\nInformation for Items 5, 6 and 7 is included in PDM's 1995 Annual Report to Stockholders and is incorporated herein by reference (and except for these sections, and sections incorporated herein by reference in Items 1 and 8 of this report, PDM's Annual Report to Stockholders is not deemed to be filed as part of this report):\nThe financial statements consisting of Consolidated Statements of Income, Consolidated Statements of Financial Condition, Consolidated Statements of Cash Flows, Consolidated Statements of Stockholders' Equity, Notes to Consolidated Financial Statements, and Business Segment Information are included in the Consolidated Financial Statements section of PDM's 1995 Annual Report to Stockholders, which are incorporated herein by reference. The report of independent auditors on PDM's consolidated financial statements is in the Reports of Independent Auditors and Management section of PDM's 1995 Annual Report to Stockholders which is incorporated herein by reference.\nThe unaudited Two-Year Quarterly Results of Operations in PDM's 1995 Annual Report to Stockholders is incorporated herein by reference.\nItem 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 (1)\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 April 1, 1996 (Proxy Statement) which information is incorporated herein by reference.\nThe principal executive officers of the Company and their recent business experience are as follows:\nW. R. Jackson, age 87\nDirector since 1940; Chairman Emeritus since 1988; formerly Chairman of the Board since 1971. Mr. Jackson has been with the Company since 1936.\nP. O. Elbert, age 65 (2)\nDirector since 1988; Chairman of the Board of the Company since 1990; formerly President of the Company since 1988 and President, PDM Structural Group since 1987. Mr. Elbert joined the Company in 1987. Prior to 1987, Mr. Elbert was Vice Chairman of Chicago Steel Corporation since 1986; formerly a partner of Elbert and McKee Company since 1984; formerly President and Chief Executive Officer of Flint Steel Corporation since 1979; and formerly Group Vice President of Inryco, Inc., a subsidiary of Inland Steel Company since 1969.\nWm. W. McKee, age 57 (3)\nDirector since 1988; President and Chief Executive Officer of the Company since 1990; formerly President, PDM Plate Group since May 1987 and formerly Executive Vice President, PDM Structural Group since April 1987. Mr. McKee joined the Company in 1987. Prior to 1987, Mr. McKee was Secretary of Chicago Steel Corporation since 1986; formerly a partner of Elbert and McKee Company since 1984; formerly a consultant with McKee and Associates since 1983; formerly President of Hogan Manufacturing since 1980; and formerly President of Herrick Corporation since 1973.\nR. A. Byers, age 48 (3)\nTreasurer since 1988 and Vice President, Finance and Administration since 1987; formerly Vice President, Finance since 1984; formerly Controller since 1982; formerly Assistant Controller since 1981; formerly Manager of Financial Reporting since 1979; and formerly with Ernst & Young LLP for ten years.\nItem 10. Directors and Executive Officers of the Registrant (Cont'd)\nT. R. Lloyd, age 47 (3)\nSecretary and General Counsel since 1990; formerly Senior Attorney of Buchanan Ingersoll Professional Corporation, since 1989; formerly Vice President, Secretary and General Counsel for Arch Mineral Corporation since 1984; and formerly Director and Secretary of U.S. Steel Mining Co., Inc. since 1979. ____________________ (1) Except where otherwise indicated, all references are to positions held with Pitt-Des Moines, Inc. Each executive officer of the Company is elected annually by the Board of Directors until his successor is elected and qualified, and each has served continually as an officer since first elected.\n(2) The Company has a severance agreement with Mr. Elbert.\n(3) The Company has agreements with each of Messrs. McKee, Byers and Lloyd covering, among other things, their positions as executive officers of the Company after a change of control.\nRegarding Section 16 compliance, reference is made to the information set forth under the caption \"Compliance with Section 16 of the Exchange Act\" in the Company's definitive Proxy Statement anticipated to be dated April 1, 1996 which information is incorporated herein by reference.\nItem 11. Executive Compensation\nReference is made to the information set forth under the captions \"Board of Directors and Committees of the Board,\" \"Executive Compensation and Other Information,\" \"Compensation Committee Interlocks and Insider Participation\" appearing in the Company's Proxy Statement, which information is incorporated herein by reference; provided, however, that the information set forth under the captions \"Compensation Committee Report on Executive Compensation\" and \"Performance Graph\" in the proxy Statement shall not be deemed to be soliciting material or to be \"filed\" with the Commission or subject to Regulation 14A or 14C (other than as provided in Item 402 of Regulation S-K) or to the liabilities of Section 18 of the Securities Exchange Act of 1934, as amended.\nItem 12. Security Ownership of Certain Beneficial Owners and Management\nReference is made to the information contained under the captions \"Stockholdings of Management\" and \"Principal Holders of Common Stock\" in the Company's Proxy Statement which information is incorporated herein by reference.\nItem 13. Certain Relationships and Related Transactions\nReference is made to the information contained under the caption \"Compensation Committee Interlocks and Insider Participation\" in the Company's Proxy Statement which information is incorporated herein by reference.\nPART IV\nItem 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\n(a) 1. Financial Statements\nThe following consolidated financial statements and Report of Independent Auditors previously incorporated by reference in Part II, Item 8 of this report are incorporated herein by reference:\nReport of Independent Auditors\nConsolidated Statements of Income -- Years Ended December 31, 1995, 1994 and 1993\nConsolidated Statements of Financial Condition as of December 31, 1995 and 1994\nConsolidated Statements of Cash Flows -- Years Ended December 31, 1995, 1994 and 1993\nConsolidated Statements of Stockholders' Equity -- Years Ended December 31, 1995, 1994 and 1993\nNotes To Consolidated Financial Statements\n2. Financial Statement Schedules\nThe following consolidated financial statement schedule of Pitt-Des Moines, Inc. and subsidiaries is included in Item 14(d):\nSchedule II. Valuation and Qualifying Accounts for years ended December 31, 1995, 1994 and 1993\nAll other schedules are omitted because they are not applicable or the required information is shown in the consolidated financial statements or notes thereto.\n3. Exhibits:\n3.1 Articles of Incorporation, as amended to date (filed as Exhibit 3.1 to the Company's quarterly report on Form 10-Q for the quarter ended September 30, 1989 and incorporated herein by reference)\n3.2 Bylaws, as amended to date (filed as Exhibit 3.2 to the Company's quarterly report on Form 10-Q for the quarter ended September 30, 1989 and incorporated herein by reference)\nItem 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K (Cont'd)\n4.1 Amended and Restated Credit Agreement dated as of June 30, 1992 by and among Pitt-Des Moines, Inc. and Pittsburgh National Bank, Wells Fargo Bank, N.A. and American National Bank (filed as Exhibit 4.1 to the Company's annual report on Form 10-K for the year ended December 31, 1992 and incorporated herein by reference)\n4.2 First Amendment dated November 23, 1992 to Credit Agreement filed as Exhibit 4.1 hereto (filed as Exhibit 4.2 to the Company's annual report on Form 10-K for the year ended December 31, 1992 and incorporated herein by reference)\n4.3 Second Amendment dated June 10, 1993 to Credit Agreement filed as Exhibit 4.1 hereto (filed as Exhibit 4.1 to the Company's quarterly report on Form 10-Q for the quarter ended June 30, 1992 and incorporated herein by reference)\n4.4 Third Amendment dated December 16, 1993 to Credit Agreement filed as Exhibit 4.1 hereto (filed as Exhibit 4.4 to the Company's annual report on Form 10-K for the year ended December 31, 1993 and incorporated herein by reference)\n4.5 Fourth Amendment dated June 14, 1994 to Credit Agreement filed as Exhibit 4.1 hereto (filed as Exhibit 4.1 to the Company's quarterly report on Form 10-Q for the quarter ended June 30, 1994 and incorporated herein by reference)\n4.6 Fifth Amendment dated December 8, 1994 to Credit Agreement filed as Exhibit 4.1 hereto (filed as Exhibit 4.6 to the Company's annual report on Form 10-K for the year ended December 31, 1994 and incorporated herein by reference)\n4.7 Sixth Amendment dated May 31, 1995 to Credit Agreement filed as Exhibit 4.1 hereto (filed as Exhibit 4.1 to the company's quarterly report on Form 10-Q for the quarter ended June 30, 1995 and incorporated herein by reference)\n10.1* Agreement executed by and between the Company and Wm. W. McKee (filed as Exhibit 10.1 to the Company's annual report on Form 10-K for the year ended December 31, 1990 and incorporated herein by reference)\n10.2* Agreement executed by and between the Company and R. A. Byers (filed as Exhibit 10.1 to the Company's quarterly report on Form 10-Q for the quarter ended June 30, 1991 and incorporated herein by reference)\n10.3* Agreement executed by and between the Company and T. R. Lloyd (filed as Exhibit 10.2 to the Company's quarterly report on Form 10-Q for the quarter ended June 30, 1991 and incorporated herein by reference)\nItem 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K (Cont'd)\n10.4* Management Incentive Plan (filed as Exhibit 10.5 to the Company's annual report on Form 10-K for the year ended December 31, 1992 and incorporated herein by reference)\n10.5* Summary of Company's 1995 Management Incentive Plan (MIP) (filed herewith)\n10.6* Retirement Plan for PDM Outside Directors as amended, effective May 26, 1994 (filed as Exhibit 10.7 to the Company's annual report on Form 10-K for the year ended December 31, 1994 and incorporated herein by reference)\n10.7* Retirement Plan for PDM Outside Directors as amended on September 14, 1995, effective May 26, 1994 (filed herewith)\n10.8* Stock Option Plan of 1990 (filed as Exhibit 4.01 to the Company's Registration Statement No. 33-34787 on Form S-8 filed May 7, 1990 and incorporated herein by reference)\n10.9* Investment Letter and Registration Rights Agreement dated September 21, 1993 by and between Pitt-Des Moines, Inc. and William W. McKee, Jr. (filed as Exhibit 10.1 to the Company's quarterly report on Form 10-Q for the quarter ended September 30, 1993 and incorporated herein by reference)\n10.10* Investment Letter and Registration Rights Agreement dated September 21, 1993 by and between Pitt-Des Moines, Inc. and Phillip O. Elbert (filed as Exhibit 10.2 to the Company's quarterly report on Form 10-Q for the quarter ended September 30, 1993 and incorporated herein by reference)\n11 Computation of Per Share Earnings (filed herewith)\n13 Those portions of the Annual Report to Stockholders for fiscal year ended December 31, 1995, which are incorporated herein by reference (filed herewith)\n21 Subsidiaries of Pitt-Des Moines, Inc. (filed herewith)\n23 Consent of Independent Auditors, Ernst & Young LLP (filed herewith)\n27 Financial Data Schedule\n(b) Reports on Form 8-K:\nA Form 8-K dated December 7, 1995 was filed under Item 5.","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":"833054_1995.txt","cik":"833054","year":"1995","section_1":"ITEM 1. BUSINESS\nGeneral\nThe Geodyne Energy Income Limited Partnership II-A (the \"II-A Partnership\"), Geodyne Energy Income Limited Partnership II-B (the \"II-B Partnership\"), Geodyne Energy Income Limited Partnership II-C (the \"II-C Partnership\"), Geodyne Energy Income Limited Partnership II-D (the \"II-D Partnership\"), Geodyne Energy Income Limited Partnership II-E (the \"II-E Partnership\"), Geodyne Energy Income Limited Partnership II-F (the \"II-F Partnership\"), Geodyne Energy Income Limited Partnership II-G (the \"II-G Partnership\"), and Geodyne Energy Income Limited Partnership II-H (the \"II-H Partnership\") (collectively, the \"Partnerships\") are limited partnerships formed under the Oklahoma Revised Uniform Limited Partnership Act. Each Partnership is composed of Geodyne Properties, Inc., a Delaware corporation, as the general partner, and Geodyne Depositary Company, a Delaware corporation, as the sole initial limited partner and public investors as substitute limited partners.\nOn the dates set forth below, investors who made the aggregate capital contributions set forth below were admitted as limited partners (the \"Limited Partners\") to the Partnerships and the Partnerships commenced operations.\nLimited Partner Date of Capital Partnership Activation Contributions ----------- ----------------- -------------\nII-A July 22, 1987 $48,428,300 II-B October 14, 1987 36,171,900 II-C January 14, 1988 15,462,100 II-D May 10, 1988 31,487,800 II-E September 27, 1988 22,882,100 II-F January 5, 1989 17,140,000 II-G April 10, 1989 37,218,900 II-H May 17, 1989 9,171,100\nImmediately following activation of each Partnership and in accordance with its Agreement and Certificate of Limited Partnership (the \"Partnership Agreement\"), each Partnership invested as a general partner in a separate Oklahoma general partnership (sometimes collectively referred to herein as the \"Production Partnership\"). Geodyne Production Company, a Delaware corporation, is the managing partner of the Production Partnerships. Each Partnership's investment in its related Production Partnership is the sole business and purpose of each Partnership. Unless the context indicates otherwise, all references to any single Partnership or all of the Partnerships in this Annual Report on Form 10-K (the \"Annual Report\") are references to the Partnership and the Production Partnership, collectively. In addition, unless the context indicates otherwise, all references to the \"General Partner\" in this Annual Report are references to Geodyne Properties, Inc., the general partner of the Partnerships, and Geodyne Production Company, the managing partner of the Production Partnerships.\nThe General Partner currently serves as general partner of 29 limited partnerships including the Partnerships. The General Partner is a wholly-owned subsidiary of Geodyne Resources, Inc. (\"Geodyne Resources\"). Geodyne Resources is a wholly-owned subsidiary of Samson Investment Company. Samson Investment Company and its various corporate subsidiaries, including the General Partner (collectively, the \"Samson Companies\"), are engaged in the production and development of and exploration for oil and gas reserves and the acquisition and operation of producing properties. At December 31, 1995, the Samson Companies owned interests in approximately 18,000 oil and gas wells located in 19 states of the United States and 3 provinces of Canada. At December 31, 1995, the Samson Companies operated approximately 3,100 oil and gas wells located in 15 states of the United States, 2 provinces of Canada, Venezuela, and Russia.\nThe Partnerships are currently engaged in the business of owning interests in producing oil and gas properties located in the continental United States. The Partnerships may also engage to a limited extent in development drilling on producing oil and gas properties as required for the prudent management of the Partnerships.\nAs limited partnerships, the Partnerships have no officers, directors, or employees. They rely instead on the personnel of the General Partner and the other Samson Companies. As of March 15, 1996, the Samson Companies employed approximately 830 persons. No employees are covered by collective bargaining agreements, and management believes that the Samson Companies provide a sound employee relations environment. For information regarding the executive officers of the General Partner, see \"Item 10. Directors and Executive Officers of the General Partner.\"\nThe General Partner's and the Partnerships' principal place of business is located at Samson Plaza, Two West Second Street, Tulsa, Oklahoma 74103, and their telephone number is (918) 583-1791 or (800) 283-1791.\nFunding\nAlthough the Partnership Agreements permit the Partnerships to incur borrowings, the Partnerships' operations and expenses are currently funded out of each Partnership's revenues from oil and gas sales. The General Partner may, but is not required to, advance funds to a Partnership for the same purposes for which Partnership borrowings are authorized.\nPrincipal Products Produced and Services Rendered\nThe Partnerships' sole business is the production of, and related incidental development of, oil and natural gas. The Partnerships do not refine or otherwise process crude oil and condensate. The Partnerships do not hold any patents, trademarks, licenses, or concessions and are not a party to any government contracts. The Partnerships have no backlog of orders and do not participate in research and development activities. The Partnerships are not presently encountering shortages of oilfield tubular goods, compressors, production material, or other equipment.\nCompetition and Marketing\nThe oil and gas industry is highly competitive, with a large number of companies and individuals engaged in the exploration and development of oil and gas properties. The ability of the Partnerships to produce and market oil and gas profitably depends on a number of factors that are beyond the control of the Partnerships. These factors include worldwide political instability (especially in oil-producing regions), the supply and price of foreign imports of oil and gas, the level of consumer product demand (which is heavily influenced by weather patterns), government regulations and taxes, the price and availability of alternative fuels, the overall economic environment, and the availability and capacity of transportation and processing facilities. The effect of these factors cannot be accurately predicted or anticipated.\nAs a general rule, in recent years, worldwide oil production capacity and gas production capacity in the United States exceeded demand and resulted in a decline in the average price of oil and gas in the United States. During the later part of 1994 and 1995, however, average oil prices in the United States increased. Oil prices increased from approximately $16.50 per barrel at December 31, 1994 to approximately $18.50 per barrel at December 31, 1995. Management is unable to predict whether future oil prices will (i) stabilize, (ii) increase, or (iii) decrease.\nGas sales contract prices have generally declined significantly since the mid-1980s due to a number of factors, including a nationwide surplus of gas and increased competition. Competition has increased among United States gas marketers due to the gas surplus, the partial deregulation of gas prices, the conversion by major pipelines to open access transportation, and the lack of strong residential demand for natural gas during the winter months for the last few years as a result of warm winters in much of the United States. However, spot gas prices in the areas where the Partnership's gas is marketed increased during the later part of 1995 compared to prices received in the later part of 1994 and the first several months of 1995.\nSubstantially all of the Partnerships' natural gas reserves are being sold in the \"spot market.\" Due to the highly competitive nature of the spot market, prices on the spot market are subject to wide seasonal and regional pricing fluctuations. In addition, such spot market sales are generally short-term in nature and are dependent upon the obtaining of transportation services provided by pipelines.\nThe Partnerships' spot gas prices increased from approximately $1.67 per Mcf at December 31, 1994 to approximately $2.00 per Mcf at December 31, 1995. Such prices were on an MMBTU basis and differ from the prices actually received by the Partnerships due to transportation and marketing costs, BTU adjustments, and regional price and quality differences. Future prices will likely be different from (and may be lower than) the prices in effect on December 31, 1995. In many past years, year-end prices have tended to be higher, and in some cases significantly higher, than the yearly average price actually received by the Partnerships for at least the year following the year-end valuation date. Management is unable to predict whether future gas prices will (i) stabilize, (ii) increase, or (iii) decrease.\nSignificant Customers\nThe following customers accounted for ten percent or more of the Partnerships' oil and gas sales during the year ended December 31, 1995:\nPartnership Purchaser Percentage - ----------- ---------------------------------- ----------\nII-A Premier Gas Company (\"Premier\")(1) 17.7% Hallwood Petroleum, Inc. (\"Hallwood\") 15.5% Amoco Production Company 14.3%\nII-B Hallwood 21.0% Premier 11.7%\nII-C Premier 14.9%\nII-D Premier 17.5%\nII-E Premier 25.8%\nII-F Premier 18.1% Texaco Exploration & Producing, Inc. (\"Texaco\") 14.1%\nII-G Premier 17.9% Texaco 13.9%\nII-H Premier 17.5% Texaco 13.7%\n- ---------------\n(1) Premier was an affiliate of the Partnerships until December 6, 1995. See \"Item 11. Executive Compensation.\"\nIn the event of interruption of purchases by one or more of the Partnerships' significant customers or the cessation or material change in availability of open access transportation by the Partnerships' pipeline transporters, the Partnerships may encounter difficulty in marketing their gas and in maintaining historic sales levels. Management does not expect any of its open access transporters to seek authorization to terminate their transportation services. Even if the services were terminated, management believes that alternatives would be available whereby the Partnerships would be able to continue to market their natural gas.\nThe Partnerships' principal customers for crude oil production are refiners and other companies which have pipeline facilities near the producing properties of the Partnerships. In the event pipeline facilities are not conveniently available to production areas, crude oil is usually trucked by purchasers to storage facilities.\nOil, Gas, and Environmental Control Regulations\nRegulation of Production Operations -- The production of oil and gas is subject to extensive federal and state laws and regulations governing a wide variety of matters, including the drilling and spacing of wells, allowable rates of production, prevention of waste and pollution, and protection of the environment. In addition to the direct costs borne in complying with such regulations, operations and revenues may be impacted to the extent that certain regulations limit oil and gas production to below economic levels.\nRegulation of Sales and Transportation of Oil and Natural Gas -- Sales of crude oil and condensate are made by the Partnerships at market prices and are not subject to price controls. The sale of natural gas may be subject to both federal and state laws and regulations, including, but not limited to, the Natural Gas Act of 1938 (the \"NGA\"), the Natural Gas Policy Act of 1978 (the \"NGPA\"), and regulations promulgated by the Federal Energy Regulatory Commission (the \"FERC\") under the NGA, the NGPA, and other statutes. The provisions of the NGA and the NGPA, as well as the regulations thereunder, are complex and affect all who produce, resell, transport, or purchase natural gas, including the Partnerships. Although virtually all of the Partnerships' gas production is not subject to price regulation, the NGA, NGPA, and FERC regulations affect the availability of gas transportation services and the ability of gas consumers to continue to purchase or use gas at current levels. Accordingly, such regulations may have a material effect on the Partnerships' operations and projections of future oil and natural gas production and revenues.\nFuture Legislation -- Legislation affecting the oil and gas industry is under constant review for amendment or expansion. Because such laws and regulations are frequently amended or reinterpreted, management is unable to predict what additional energy legislation may be proposed or enacted or the future cost and impact of complying with existing or future regulations.\nRegulation of the Environment -- The Partnerships' operations are subject to numerous laws and regulations governing the discharge of materials into the environment or otherwise relating to environmental protection. Compliance with such laws and regulations, together with any penalties resulting from noncompliance therewith, may increase the cost of the Partnerships' operations or may affect the Partnerships' ability to complete, in a timely fashion, existing or future activities. Management anticipates that various local, state, and federal environmental control agencies will have an increasing impact on oil and gas operations.\nInsurance Coverage\nThe Partnerships are subject to all of the risks inherent in the exploration for and production of oil and gas including blowouts, pollution, fires, and other casualties. The Partnerships maintain insurance coverage as is customary for entities of a similar size engaged in operations similar to that of the Partnerships, but losses can occur from uninsurable risks or in amounts in excess of existing insurance coverage. The occurrence of an event which is not fully covered by insurance could have a material adverse effect on the Partnerships' financial position and results of operations.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nWell Statistics\nThe following table sets forth the number of gross and net productive wells of the Partnerships as of December 31, 1995. The designation of a well as an oil well or gas well is made by the General Partner based on the relative amount of oil and gas reserves for the well. Regardless of a well's oil or gas designation, it may produce oil, gas, or both oil and gas. As used in this Annual Report, \"Gross Well\" refers to a well in which a working interest is owned, accordingly, the number of gross wells is the total number of wells in which a working interest is owned. As used in this Annual Report, \"Net Well\" refers to the sum of the fractional working interests owned in gross wells expressed as whole numbers and fractions thereof. For example, a 15% leasehold interest in a well represents one Gross Well, but 0.15 Net Well.\nWell Statistics As of December 31, 1995\nNumber of Gross Wells Number of Net Wells ----------------------- --------------------------- P\/ship Total Oil Gas N\/A(1) Total Oil Gas N\/A(1) - ------ ----- --- --- ------ ----- ----- ----- ------\nII-A 1,052 297 680 75 68.45 39.18 23.49 5.78 II-B 349 181 118 50 40.38 22.04 13.73 4.61 II-C 448 182 234 32 16.70 4.78 11.37 .55 II-D 351 160 180 11 59.77 27.74 29.76 2.27 II-E 1,353 721 564 68 35.24 16.62 16.93 1.69 II-F 1,288 679 542 67 21.49 6.76 12.72 2.01 II-G 1,288 679 542 67 48.27 14.58 29.29 4.40 II-H 1,288 679 542 67 12.66 3.56 7.97 1.13\n- --------------- (1) Wells which have not been designated as oil or gas.\nDrilling Activities\nThe following table sets forth the number of gross and net wells in which the Partnerships had an interest that were drilled during the year ended December 31, 1995. All such wells were development wells and were completed as producing wells during the year ended December 31, 1995.\nTotal Oil Gas N\/A(1) ----- --- --- ------ II-A Partnership: ---------------- Gross Wells 1 - 1 - Net Wells .01 - .01 -\nII-E Partnership: ---------------- Gross Wells 2 1 - 1 Net Wells .10 .04 - .06\n- ---------------\n(1) Wells which have not been designated as oil or gas.\nThe II-B, II-C, II-D, II-F, II-G, and II-H Partnerships did not drill any wells during the year ended December 31, 1995. The data included in this table should not be considered indicative of future performance, nor should it be assumed that there is necessarily any correlation between the number of productive wells drilled and the oil and gas reserves generated thereby.\nOil and Gas Production, Revenue, and Price History\nThe following tables set forth certain historical information concerning the oil (including condensates) and natural gas production, net of all royalties, overriding royalties, and other third party interests, of the Partnerships, revenues attributable to such production, and certain price and cost information. Where applicable, the amounts in the following tables are after the impact of any net profits interest conveyances the Partnerships may have entered into with an affiliated partnership. As used in the tables, direct operating expenses include lease operating expenses and production taxes. In addition, gas production is converted to oil equivalents at the rate of six Mcf per barrel, representing the estimated relative energy content of gas and oil, which rate is not necessarily indica- tive of the relationship of oil and gas prices. The respective prices of oil and gas are affected by market and other factors in addition to relative energy content.\nNet Production Data\nII-A Partnership ----------------\nYear Ended December 31, ---------------------------------- 1995 1994 1993 ---------- ---------- ---------- Production: Oil (Bbls) 120,420 150,281 141,868 Gas (Mcf) 1,768,316 2,226,658 1,488,837\nOil and gas sales: Oil $2,030,710 $2,272,594 $2,378,461 Gas 2,640,845 4,099,355 3,067,171 ---------- --------- --------- Total $4,671,555 $6,371,949 $5,445,632 ========= ========= ========= Total direct operating expenses $1,846,264 $2,383,367 $2,646,187 ========= ========= =========\nDirect operating expenses as a percentage of oil and gas sales 39.5% 37.4% 48.6%\nAverage sales price: Per barrel of oil $16.86 $15.12 $16.77 Per Mcf of gas 1.49 1.84 2.06\nDirect operating expenses per equivalent Bbl of oil $ 4.45 $ 4.57 $ 6.78\nNet Production Data\nII-B Partnership ----------------\nYear Ended December 31, ---------------------------------- 1995 1994 1993 ---------- ---------- ---------- Production: Oil (Bbls) 81,304 111,099 106,685 Gas (Mcf) 1,205,296 1,649,869 1,329,860\nOil and gas sales: Oil $1,351,079 $1,683,529 $1,831,941 Gas 1,853,715 3,020,100 2,783,443 --------- --------- --------- Total $3,204,794 $4,703,629 $4,615,384 ========= ========= ========= Total direct operating expenses $1,524,778 $2,014,972 $1,880,059 ========= ========= =========\nDirect operating expenses as a percentage of oil and gas sales 47.6% 42.8% 40.7%\nAverage sales price: Per barrel of oil $16.62 $15.15 $17.17 Per Mcf of gas 1.54 1.83 2.09\nDirect operating expenses per equivalent Bbl of oil $ 5.40 $ 5.22 $ 5.73\nNet Production Data\nII-C Partnership ----------------\nYear Ended December 31, ---------------------------------- 1995 1994 1993 ---------- ---------- ---------- Production: Oil (Bbls) 26,383 34,074 32,568 Gas (Mcf) 737,277 975,652 675,399\nOil and gas sales: Oil $ 446,522 $ 533,966 $ 564,653 Gas 1,073,415 1,755,200 1,331,912 --------- --------- --------- Total $1,519,937 $2,289,166 $1,896,565 ========= ========= ========= Total direct operating expenses $ 698,645 $ 819,854 $ 731,716 ========= ========= =========\nDirect operating expenses as a percentage of oil and gas sales 46.0% 35.8% 38.6%\nAverage sales price: Per barrel of oil $16.92 $15.67 $17.34 Per Mcf of gas 1.46 1.80 1.97\nDirect operating expenses per equivalent Bbl of oil $ 4.68 $ 4.17 $ 5.04\nNet Production Data\nII-D Partnership ----------------\nYear Ended December 31, ---------------------------------- 1995 1994 1993 ---------- ---------- ---------- Production: Oil (Bbls) 88,913 93,610 92,253 Gas (Mcf) 1,906,303 2,000,016 1,545,516\nOil and gas sales: Oil $1,457,580 $1,415,937 $1,523,763 Gas 2,443,936 3,433,223 2,829,861 --------- --------- --------- Total $3,901,516 $4,849,160 $4,353,624 ========= ========= ========= Total direct operating expenses $2,136,244 $1,735,761 $1,921,386 ========= ========= =========\nDirect operating expenses as a percentage of oil and gas sales 54.8% 35.8% 44.1%\nAverage sales price: Per barrel of oil $16.39 $15.13 $16.52 Per Mcf of gas 1.28 1.72 1.83\nDirect operating expenses per equivalent Bbl of oil $ 5.25 $ 4.07 $ 5.49\nNet Production Data\nII-E Partnership ----------------\nYear Ended December 31, ---------------------------------- 1995 1994 1993 ---------- ---------- ---------- Production: Oil (Bbls) 63,680 66,656 68,723 Gas (Mcf) 937,469 853,317 752,689\nOil and gas sales: Oil $1,070,217 $1,029,794 $1,131,063 Gas 1,227,192 1,450,912 1,441,501 --------- --------- --------- Total $2,297,409 $2,480,706 $2,572,564 ========= ========= ========= Total direct operating expenses $1,148,507 $ 943,898 $ 991,225 ========= ========= =========\nDirect operating expenses as a percentage of oil and gas sales 50.0% 38.0% 38.5%\nAverage sales price: Per barrel of oil $16.81 $15.45 $16.46 Per Mcf of gas 1.31 1.70 1.92\nDirect operating expenses per equivalent Bbl of oil $ 5.22 $ 4.52 $ 5.10\nNet Production Data\nII-F Partnership ----------------\nYear Ended December 31, ---------------------------------- 1995 1994 1993 ---------- ---------- ---------- Production: Oil (Bbls) 54,773 63,723 61,194 Gas (Mcf) 845,804 833,628 883,094\nOil and gas sales: Oil $ 882,021 $ 946,186 $ 979,194 Gas 1,146,571 1,370,378 1,657,110 --------- --------- --------- Total $2,028,592 $2,316,564 $2,636,304 ========= ========= ========= Total direct operating expenses $ 661,659 $ 777,636 $ 681,972 ========= ========= =========\nDirect operating expenses as a percentage of oil and gas sales 32.6% 33.6% 25.9%\nAverage sales price: Per barrel of oil $16.10 $14.85 $16.00 Per Mcf of gas 1.36 1.64 1.88\nDirect operating expenses per equivalent Bbl of oil $ 3.38 $ 3.84 $ 3.27\nNet Production Data\nII-G Partnership ----------------\nYear Ended December 31, ---------------------------------- 1995 1994 1993 ---------- ---------- ---------- Production: Oil (Bbls) 115,206 134,034 128,280 Gas (Mcf) 1,832,915 1,921,696 1,879,891\nOil and gas sales: Oil $1,855,886 $1,991,144 $2,053,146 Gas 2,492,201 3,125,632 3,528,075 --------- --------- --------- Total $4,348,087 $5,116,776 $5,581,221 ========= ========= ========= Total direct operating expenses $1,455,357 $1,827,558 $1,481,029 ========= ========= =========\nDirect operating expenses as a percentage of oil and gas sales 33.5% 35.7% 26.5%\nAverage sales price: Per barrel of oil $16.11 $14.86 $16.01 Per Mcf of gas 1.36 1.63 1.88\nDirect operating expenses per equivalent Bbl of oil $ 3.46 $ 4.02 $ 3.35\nNet Production Data\nII-H Partnership ----------------\nYear Ended December 31, ---------------------------------- 1995 1994 1993 ---------- ---------- ---------- Production: Oil (Bbls) 26,870 31,241 29,861 Gas (Mcf) 449,854 452,661 471,281\nOil and gas sales: Oil $ 433,226 $ 464,290 $ 478,012 Gas 609,509 744,596 889,502 --------- --------- --------- Total $1,042,735 $1,208,886 $1,367,514 ========= ========= ========= Total direct operating expenses $ 358,984 $ 427,693 $ 370,067 ========= ========= =========\nDirect operating expenses as a percentage of oil and gas sales 34.4% 35.4% 27.1%\nAverage sales price: Per barrel of oil $16.12 $14.86 $16.01 Per Mcf of gas 1.35 1.64 1.89\nDirect operating expenses per equivalent Bbl of oil $ 3.52 $ 4.01 $ 3.41\nProved Reserves and Net Present Value\nThe following table sets forth each Partnership's estimated proved oil and gas reserves and net present value therefrom as of December 31, 1995. The schedule of quantities of proved oil and gas reserves was prepared by the General Partner in accordance with the rules prescribed by the Securities and Exchange Commission (the \"SEC\"). Certain reserve information was reviewed by Ryder Scott Company Petroleum Engineers (\"Ryder Scott\"), an independent petroleum engineering firm. As used throughout this Annual Report, \"proved reserves\" refers to those 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 oil and gas reservoirs under existing economic and operating conditions.\nNet present value represents estimated future gross cash flow from the production and sale of proved reserves, net of estimated oil and gas production costs (including production taxes, ad valorem taxes, and operating expenses) and estimated future development costs, discounted at 10% per annum. Net present value attributable to the Partnerships' proved reserves was calculated on the basis of current costs and prices at December 31, 1995. Such prices were not escalated except in certain circumstances where escalations were fixed and readily determinable in accordance with applicable contract provisions. The prices used in calculating the net present value attributable to the Partnerships' proved reserves do not necessarily reflect market prices for oil and gas production subsequent to December 31, 1995. Furthermore, gas prices at December 31, 1995 were higher than the price used for determining the Partnerships' net present value of proved reserves for the year ended December 31, 1994. There can be no assurance that the prices used in calculating the net present value of the Partnerships' proved reserves at December 31, 1995 will actually be realized for such production.\nThe process of estimating oil and gas reserves is complex, requiring significant subjective decisions in the evaluation of available geological, engineering, and economic data for each reservoir. The data for a given reservoir may change substantially over time as a result of, among other things, additional development activity, production history, and viability of production under varying economic conditions; consequently, it is reasonably possible that material revisions to existing reserve estimates may occur in the near future. Although every reasonable effort has been made to ensure that the reserve estimates reported herein represent the most accurate assessment possible, the significance of the subjective decisions required and variances in available data for various reservoirs make these estimates generally less precise than other estimates presented in connection with financial statement disclosures.\nProved Reserves and Net Present Values From Proved Reserves As of December 31, 1995(1)\nII-A Partnership: - ---------------- Estimated proved reserves: Natural gas (Mcf) 9,603,075 Oil and liquids (Bbls) 700,254\nNet present value (discounted at 10% per annum) $12,394,737\nII-B Partnership: - ---------------- Estimated proved reserves: Natural gas (Mcf) 5,729,103 Oil and liquids (Bbls) 495,525\nNet present value (discounted at 10% per annum) $ 8,117,351\nII-C Partnership: - ---------------- Estimated proved reserves: Natural gas (Mcf) 3,983,315 Oil and liquids (Bbls) 205,669\nNet present value (discounted at 10% per annum) $ 4,529,550\nII-D Partnership: - ---------------- Estimated proved reserves: Natural gas (Mcf) 10,910,460 Oil and liquids (Bbls) 553,578\nNet present value (discounted at 10% per annum) $11,725,897\nII-E Partnership: - ---------------- Estimated proved reserves: Natural gas (Mcf) 6,401,259 Oil and liquids (Bbls) 297,934\nNet present value (discounted at 10% per annum) $ 7,413,484\nII-F Partnership: - ---------------- Estimated proved reserves: Natural gas (Mcf) 4,738,716 Oil and liquids (Bbls) 355,007\nNet present value (discounted at 10% per annum) $ 6,702,912\nII-G Partnership: - ---------------- Estimated proved reserves: Natural gas (Mcf) 10,303,283 Oil and liquids (Bbls) 746,479\nNet present value (discounted at 10% per annum) $14,307,715\nII-H Partnership: - ---------------- Estimated proved reserves: Natural gas (Mcf) 2,553,664 Oil and liquids (Bbls) 173,521\nNet present value (discounted at 10% per annum) $ 3,425,489\n- ----------\n(1) Includes certain gas balancing adjustments which cause the gas volumes and net present values to differ from the reserve reports prepared by the General Partner and reviewed by Ryder Scott.\nNo estimates of the proved reserves of the Partnerships compara- ble to those included herein have been included in reports to any federal agency other than the SEC. Additional information relating to the Partnerships' proved reserves is contained in Note 4 to the Partnerships' financial statements, included in Item 8 of this Annual Report.\nSignificant Properties\nII-A Partnership ----------------\nAs of December 31, 1995, the II-A Partnership's properties consisted of 1,052 gross (68.45 net) wells. The II-A Partnership owned a non-working interest in an additional 174 wells. Affiliates of the II-A Partnership operate 75 (6.1%) of its total wells. As of December 31, 1995, the II-A Partnership's net interest in its properties resulted in estimated total proved reserves of 700,254 barrels of crude oil and 9,603,075 Mcf of natural gas, with a present value (discounted at 10% per annum) of estimated future net cash flow of $12,394,737. The II-A Partnership's properties are located primarily in the Anadarko Basin of western Oklahoma and the Texas Panhandle and the Gulf Coast Basin of southern Louisiana and southeast Texas.\nAs of December 31, 1995, the II-A Partnership's properties in the Anadarko Basin consisted of 194 gross (11.07 net) wells. The II-A Partnership owned a non-working interest in an additional 82 wells in the Anadarko Basin. As of December 31, 1995, the II-A Partnership's net interest in its properties in the Anadarko Basin resulted in estimated total proved reserves of approximately 55,200 barrels of crude oil and 4,850,500 Mcf of natural gas, with a present value (discounted at 10% per annum) of estimated future net cash flow of approximately $4,899,200.\nAs of December 31, 1995, the II-A Partnership's properties in the Gulf Coast Basin consisted of 143 gross (12.20 net) wells. The II-A Partnership owned a non-working interest in an additional 6 wells in the Gulf Coast Basin. As of December 31, 1995, the II-A Partnership's net interest in its properties in the Gulf Coast Basin resulted in estimated total proved reserves of approximately 200,100 barrels of crude oil and 1,817,200 Mcf of natural gas, with a present value (discounted at 10% per annum) of estimated future net cash flow of approximately $2,638,000.\nII-B Partnership ----------------\nAs of December 31, 1995, the II-B Partnership's properties consisted of 349 gross (40.38 net) wells. The II-B Partnership owned a non-working interest in an additional 81 wells. Affiliates of the II-B Partnership operate 50 (11.6%) of its total wells. As of December 31, 1995, the II-B Partnership's net interest in its properties resulted in estimated total proved reserves of 495,525 barrels of crude oil and 5,729,103 Mcf of natural gas, with a present value (discounted at 10% per annum) of estimated future net cash flow of $8,117,351. The II-B Partnership's properties are located primarily in the Anadarko Basin of western Oklahoma and the Texas Panhandle, the Southern Oklahoma Folded Belt Basin of southern Oklahoma, the Gulf Coast Basin of southern Louisiana and southeast Texas, and the Permian Basin of west Texas and southeast New Mexico.\nAs of December 31, 1995, the II-B Partnership's properties in the Anadarko Basin consisted of 52 gross (6.77 net) wells. The II-B Partnership owned a non-working interest in an additional 17 wells in the Anadarko Basin. As of December 31, 1995, the II-B Partnership's net interest in its properties in the Anadarko Basin resulted in estimated total proved reserves of approximately 22,000 barrels of crude oil and 2,598,100 Mcf of natural gas, with a present value (discounted at 10% per annum) of estimated future net cash flow of approximately $2,602,400.\nAs of December 31, 1995, the II-B Partnership's properties in the Southern Oklahoma Folded Belt Basin consisted of 21 gross (4.99 net) wells. The II-B Partnership owned a non-working interest in an additional 4 wells in the Southern Oklahoma Folded Belt Basin. Affiliates operate 19 (76.0%) of such wells. As of December 31, 1995, the II-B Partnership's net interest in its properties in the Southern Oklahoma Folded Belt Basin resulted in estimated total proved reserves of approximately 135,200 barrels of crude oil and 790,200 Mcf of natural gas, with a present value (discounted at 10% per annum) of estimated future net cash flow of approximately $1,789,100.\nAs of December 31, 1995, the II-B Partnership's properties in the Gulf Coast Basin consisted of 63 gross (1.84 net) wells. The II-B Partnership owned a non-working interest in an additional 35 wells in the Gulf Coast Basin. As of December 31, 1995, the II-B Partnership's net interest in its properties in the Gulf Coast Basin resulted in estimated total proved reserves of approximately 50,900 barrels of crude oil and 921,200 Mcf of natural gas, with a present value (discounted at 10% per annum) of estimated future net cash flow of approximately $1,463,800.\nAs of December 31, 1995, the II-B Partnership's properties in the Permian Basin consisted of 26 gross (3.37 net) wells. The II-B Partnership owned a non-working interest in an additional 7 wells in the Permian Basin. Affiliates operate 21 (63.6%) of such wells. As of December 31, 1995, the II-B Partnership's net interest in its properties in the Permian Basin resulted in estimated total proved reserves of approximately 51,900 barrels of crude oil and 1,139,200 Mcf of natural gas, with a present value (discounted at 10% per annum) of estimated future net cash flow of approximately $1,138,500.\nII-C Partnership ----------------\nAs of December 31, 1995 the II-C Partnership's properties consisted of 448 gross (16.70 net) wells. The II-C Partnership owned a non-working interest in an additional 102 wells. Affiliates of the II-C Partnership operate 62 (11.3%) of its total wells. As of December 31, 1995, the II-C Partnership's net interest in its properties resulted in estimated total proved reserves of 205,669 barrels of crude oil and 3,983,315 Mcf of natural gas, with a present value (discounted at 10% per annum) of estimated future net cash flow of $4,529,550. The Partnership's properties are located primarily in the Anadarko Basin of western Oklahoma and the Texas Panhandle and the Southern Oklahoma Folded Belt Basin of southern Oklahoma.\nAs of December 31, 1995, the II-C Partnership's properties in the Anadarko Basin consisted of 129 gross (8.69 net) wells. The II-C Partnership owned a non-working interest in an additional 35 wells in the Anadarko Basin. As of December 31, 1995, the II-C Partnership's net interest in its properties in the Anadarko Basin resulted in estimated total proved reserves of approximately 18,600 barrels of crude oil and 2,165,600 Mcf of natural gas, with a present value (discounted at 10% per annum) of estimated future net cash flow of approximately $1,928,100.\nAs of December 31, 1995, the II-C Partnership's properties in the Southern Oklahoma Folded Belt Basin consisted of 19 gross (2.03 net) wells. The II-C Partnership owned a non-working interest in an additional 2 wells in the Southern Oklahoma Folded Belt Basin. Affiliates operate 16 (76.2%) of such wells. As of December 31, 1995, the II-C Partnership's net interest in its properties in the Southern Oklahoma Folded Belt Basin resulted in estimated total proved reserves of approximately 57,800 barrels of crude oil and 464,300 Mcf of natural gas, with a present value (discounted at 10% per annum) of estimated future net cash flow of approximately $826,300.\nII-D Partnership ----------------\nAs of December 31, 1995, the II-D Partnership's properties consisted of 351 gross (59.77 net) wells. The II-D Partnership owned a non-working interest in an additional 39 wells. Affiliates of the II-D Partnership operate 69 (17.7%) of the its total wells. As of December 31, 1995, the II-D Partnership's net interest in its properties resulted in estimated total proved reserves of 553,578 barrels of crude oil and 10,910,460 Mcf of natural gas, with a present value (discounted at 10% per annum) of estimated future net cash flow of $11,725,897. The II-D Partnership's properties are located primarily in the Anadarko Basin of western Oklahoma and the Texas Panhandle, the Gulf Coast Basin of southern Louisiana and southeast Texas, the Permian Basin of west Texas and southeast New Mexico, and the Williston Basin of North Dakota, South Dakota, and eastern Montana.\nAs of December 31, 1995, the II-D Partnership's properties in the Anadarko Basin consisted of 86 gross (14.26 net) wells. The II-D Partnership owned a non-working interest in an additional 17 wells in the Anadarko Basin. As of December 31, 1995, the II-D Partnership's net interest in its properties in the Anadarko Basin resulted in estimated total proved reserves of approximately 40,900 barrels of crude oil and 4,116,500 Mcf of natural gas, with a present value (discounted at 10% per annum) of estimated future net cash flow of approximately $3,790,300.\nAs of December 31, 1995, the II-D Partnership's properties in the Gulf Coast Basin consisted of 24 gross (5.20 net) wells. The II-D Partnership owned a non-working interest in an additional 2 wells in the Gulf Coast Basin. Affiliates operate 15 (57.7%) of such wells. As of December 31, 1995, the II-D Partnership's net interest in its properties in the Gulf Coast Basin resulted in estimated total proved reserves of approximately 85,900 barrels of crude oil and 985,700 Mcf of natural gas, with a present value (discounted at 10% per annum) of estimated future net cash flow of approximately $1,421,400.\nAs of December 31, 1995, the II-D Partnership's properties in the Permian Basin consisted of 11 gross (2.12 net) wells. The II-D Partnership owned a non-working interest in one additional well in the Permian Basin. As of December 31, 1995, the II-D Partnership's net interest in its properties in the Permian Basin resulted in estimated total proved reserves of approximately 34,500 barrels of crude oil and 1,688,400 Mcf of natural gas, with a present value (discounted at 10% per annum) of estimated future net cash flow of approximately $1,421,400.\nAs of December 31, 1995, the II-D Partnership's properties in the Williston Basin consists of 48 gross (2.18 net) wells. The II-D Partnership owned a non-working interest in one additional well in the Williston Basin. As of December 31, 1995, the II-D Partnership's net interest in its properties in the Williston Basin resulted in estimated total proved reserves of approximately 193,500 barrels of crude oil and 239,300 Mcf of natural gas, with a present value (discounted at 10% per annum) of estimated future net cash flow of approximately $1,184,500.\nII-E Partnership ----------------\nAs of December 31, 1995, the II-E Partnership's properties consisted of 1,353 gross (35.24 net) wells. The II-E Partnership owned a non-working interest in an additional 2,165 wells. Affiliates of the II-E Partnership operate 73 (2.1%) of its total wells. As of December 31, 1995, the II-E Partnership's net interest in its properties resulted in estimated total proved reserves of 297,934 barrels of crude oil and 6,401,259 Mcf of natural gas, with a present value (discounted at 10% per annum) of estimated future net cash flow of $7,413,484. The II-E Partnership's properties are located primarily in the Anadarko Basin of western Oklahoma and the Texas Panhandle, the Permian Basin of west Texas and southeast New Mexico, and the Gulf Coast Basin of southern Louisiana and southeast Texas.\nAs of December 31, 1995, the II-E Partnership's properties in the Anadarko Basin consisted of 44 gross (2.29 net) wells. The II-E Partnership owned a non-working interest in an additional 28 wells in the Anadarko Basin. As of December 31, 1995, the II-E Partnership's net interest in its properties in the Anadarko Basin resulted in estimated total proved reserves of approximately 7,900 barrels of crude oil and 2,622,200 Mcf of natural gas, with a present value (discounted at 10% per annum) of estimated future net cash flow of approximately $2,474,600.\nAs of December 31, 1995, the II-E Partnership's properties in the Permian Basin consisted of 959 gross (5.82 net) wells. The II-E Partnership owned a non-working interest in an additional 1,813 wells in the Permian Basin. As of December 31, 1995, the II-E Partnership's net interest in its properties in the Permian Basin resulted in estimated total proved reserves of approximately 107,800 barrels of crude oil and 1,597,000 Mcf of natural gas, with a present value (discounted at 10% per annum) of estimated future net cash flow of approximately $2,099,600.\nAs of December 31, 1995, the II-E Partnership's properties in the Gulf Coast Basin consisted of 53 gross (4.66 net) wells. The II-E Partnership owned a non-working interest in an additional 16 wells in the Gulf Coast Basin. As of December 31, 1995, the II-E Partnership's net interest in its properties in the Gulf Coast Basin resulted in estimated total proved reserves of approximately 70,900 barrels of crude oil and 485,300 Mcf of natural gas, with a present value (discounted at 10% per annum) of estimated future net cash flow of approximately $824,900.\nII-F Partnership ----------------\nAs of December 31, 1995, the II-F Partnership's properties consisted of 1,288 gross (21.49 net) wells. The II-F Partnership owned a non-working interest in an additional 2,164 wells. Affiliates of the II-F Partnership operate 50 (1.4%) of its total wells. As of December 31, 1995, the II-F Partnership's net interest in its properties resulted in estimated total proved reserves of 355,007 barrels of crude oil and 4,738,716 Mcf of natural gas, with a present value (discounted at 10% per annum) of estimated future net cash flow of $6,702,912. The II-F Partnership's properties are located primarily in the Anadarko Basin of western Oklahoma and the Texas Panhandle and the Permian Basin of west Texas and southeast New Mexico.\nAs of December 31, 1995, the II-F Partnership's properties in the Anadarko Basin consisted of 54 gross (2.62 net) wells. The II-F Partnership owned a non-working interest in an additional 31 wells in the Anadarko Basin. As of December 31, 1995, the II-F Partnership's net interest in its properties in the Anadarko Basin resulted in estimated total proved reserves of approximately 8,900 barrels of crude oil and 1,887,800 Mcf of natural gas, with a present value (discounted at 10% per annum) of estimated future net cash flow of approximately $1,614,300.\nAs of December 31, 1995, the II-F Partnership's properties in the Permian Basin consisted of 954 gross (12.21 net) wells. The II-F Partnership owned a non-working interest in an additional 1,812 wells in the Permian Basin. As of December 31, 1995, the II-F Partnership's net interest in its properties in the Permian Basin resulted in estimated total proved reserves of approximately 242,700 barrels of crude oil and 1,723,900 Mcf of natural gas, with a present value (discounted at 10% per annum) of estimated future net cash flow of approximately $3,430,400.\nII-G Partnership ----------------\nAs of December 31, 1995, the II-G Partnership's properties consisted of 1,288 gross (48.27 net) wells. The II-G Partnership owned a non-working interest in an additional 2,164 wells. Affiliates of the II-G Partnership operate 50 (1.4%) of its total wells. As of December 31, 1995, the II-G Partnership's net interest in its properties resulted in estimated total proved reserves of 746,479 barrels of crude oil and 10,303,283 Mcf of natural gas, with a present value (discounted at 10% per annum) of estimated future net cash flow of $14,307,715. The II-G Partnership's properties are located primarily in the Permian Basin of west Texas and southeast New Mexico, the Anadarko Basin of western Oklahoma and the Texas Panhandle, and the Southern Oklahoma Folded Belt Basin of southern Oklahoma.\nAs of December 31, 1995, the II-G Partnership's properties in the Permian Basin consisted of 954 gross (25.47 net) wells. The II-G Partnership owned a non-working interest in an additional 1,812 wells in the Permian Basin. As of December 31, 1995, the II-G Partnership's net interest in its properties in the Permian Basin resulted in estimated total proved reserves of approximately 507,700 barrels of crude oil and 3,604,800 Mcf of natural gas, with a present value (discounted at 10% per annum) of estimated future net cash flow of approximately $7,179,100.\nAs of December 31, 1995, the II-G Partnership's properties in the Anadarko Basin consisted of 54 gross (5.56 net) wells. The II-G Partnership owned a non-working interest in an additional 31 wells in the Anadarko Basin. As of December 31, 1995, the II-G Partnership's net interest in its properties in the Anadarko Basin resulted in estimated total proved reserves of approximately 19,000 barrels of crude oil and 3,987,200 Mcf of natural gas, with a present value (discounted at 10% per annum) of estimated future net cash flow of approximately $3,446,000.\nAs of December 31, 1995, the II-G Partnership's properties in the Southern Oklahoma Folded Belt Basin consisted of 38 gross (5.86 net) wells. Affiliates operate 27 (71.1%) of such wells. As of December 31, 1995, the II-G Partnership's net interest in its properties in the Southern Oklahoma Folded Belt Basin resulted in estimated total proved reserves of approximately 25,800 barrels of crude oil and 1,610,600 Mcf of natural gas, with a present value (discounted at 10% per annum) of estimated future net cash flow of approximately $1,435,800.\nII-H Partnership ----------------\nAs of December 31, 1995, the II-H Partnership's properties consisted of 1,288 gross (12.66 net) wells. The II-H Partnership owned a non-working interest in an additional 2,157 wells. Affiliates of the II-H Partnership operate 50 (1.5%) of its total wells. As of December 31, 1995, the II-H Partnership's net interest in its properties resulted in estimated total proved reserves of 173,521 barrels of crude oil and 2,553,664 Mcf of natural gas, with a present value (discounted at 10% per annum) of estimated future net cash flow of $3,425,489. The II-H Partnership's properties are located primarily in the Permian Basin of west Texas and southeast New Mexico, the Anadarko Basin of western Oklahoma and the Texas Panhandle, and the Southern Oklahoma Folded Belt Basin of southern Oklahoma.\nAs of December 31, 1995, the II-H Partnership's properties in the Permian Basin consisted of 954 gross (5.90 net) wells. The II-H Partnership owned a non-working interest in an additional 1,809 wells in the Permian Basin. As of December 31, 1995, the II-H Partnership's net interest in its properties in the Permian Basin resulted in estimated total proved reserves of approximately 117,500 barrels of crude oil and 834,100 Mcf of natural gas, with a present value (discounted at 10% per annum) of estimated future net cash flow of approximately $1,702,800.\nAs of December 31, 1995, the II-H Partnership's properties in the Anadarko Basin consisted of 54 gross (1.32 net) wells. The II-H Partnership owned a non-working interest in an additional 27 wells in the Anadarko Basin. As of December 31, 1995, the II-H Partnership's net interest in its properties in the Anadarko Basin resulted in estimated total proved reserves of approximately 3,500 barrels of crude oil and 938,600 Mcf of natural gas, with a present value (discounted at 10% per annum) of estimated future net cash flow of approximately $799,300.\nAs of December 31, 1995, the II-H Partnership's properties in the Southern Oklahoma Folded Belt Basin consisted of 38 gross (1.55 net) wells. Affiliates operate 27 (71.1%) of such wells. As of December 31, 1995, the II-H Partnership's net interest in its properties in the Southern Oklahoma Folded Belt Basin resulted in estimated total proved reserves of approximately 6,800 barrels of crude oil and 425,600 Mcf of natural gas, with a present value (discounted at 10% per annum) of estimated future net cash flow of approximately $382,300.\nTitle to Oil and Gas Properties\nManagement believes that the Partnerships have satisfactory title to their oil and gas properties. Record title to all of the Partnerships' properties is held by either the Partnerships or Geodyne Nominee Corporation, an affiliate of the General Partner.\nTitle to the Partnerships' properties is subject to customary royalty, overriding royalty, carried, working, and other similar interests and contractual arrangements customary in the oil and gas industry, to liens for current taxes not yet due, and to other encumbrances. Management believes that such burdens do not materially detract from the value of such properties or from the Partnerships' interest therein or materially interfere with their use in the operation of the Partnerships' business.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nOn September 12, 1988 Wolverine Exploration Company and certain other parties filed a lawsuit against Natural Gas Pipeline Company of America, Inc. and certain other parties in which the plaintiffs sought to recover damages as a result of an alleged breach of a gas contract. (Wolverine Exploration Company et al. vs. Natural Gas Pipeline Company of America, et al., Case No. CJ-88-5522, District Court, Tulsa County, Oklahoma). The II-A, II-B, II-C, II-D, and II-E Partnerships own an interest in certain oil and gas properties which are subject to said lawsuit, and there is a possibility that said Partnerships may recover damages as a result of the alleged breach of the gas contract. The lawsuit involves legal and factual issues concerning alleged (i) take- or-pay deficiencies and (ii) gas pricing claims. In June 1995, a hearing was conducted before a three person arbitration panel and on September 6, 1995 the panel issued its determination and awarded damages to the plaintiffs in the matter.\nThe Partnerships' estimated share of the awarded damages would increase the following Partnerships' assets by the following approximate amounts:\nPartnership Total Per Unit ----------- ---------- --------\nII-A $1,300,000 $ 2.50 II-B 2,100,000 5.50 II-C 900,000 5.50 II-D 2,300,000 7.00 II-E 4,700,000 19.50\nThe above estimates may change for a number of reasons, including, but not limited to, an appeal of the award by the one remaining defendant, Texaco Inc. (\"Texaco\").\nGeodyne Resources has filed a petition with the Tulsa County District Court seeking confirmation of the arbitration award. A hearing has been set on such petition for May 1, 1996. Texaco, on the other hand, has sought to reopen its Chapter 11 bankruptcy proceedings in an effort to avoid enforcement of the arbitration award through the bankruptcy court; however, as of the date of this Annual Report, no hearing has been set by the bankruptcy court with respect to Texaco's motion. It is not expected that the legal expenses to defend the award will be as significant as the expenses incurred by the Partnerships during the year ended December 31, 1995.\nIn the event the Partnerships ultimately receive any or all of the damages awarded, the funds will be included in the Partnerships' revenues for the quarter in which they are received. Limited Partners who hold Units at the time any related cash distribution is made, then, will benefit from any recovery associated with the litigation.\nOn October 26, 1994, Geodyne Resources and the Partnerships, among other parties, were named as defendants in a lawsuit alleging causes of action based on fraud, negligent misrepresentation, breach of fiduciary duty, breach of implied covenant, and breach of contract in connection with the offer and sale of limited partnership interests (\"Units\") in the Partnerships (Sidney Neidick et al. v. Geodyne Resources, Inc., et al., Case No. 94-052860, District Court of Harris County, Texas). The plaintiffs' petition alleged that the lawsuit was being brought as a class action on behalf of investors who purchased Units in the Partnerships. On June 7, 1995, Geodyne Resources and the Partnerships were dismissed without prejudice as defendants in the matter. In addition, on June 7, 1995, the matter was certified as a class action. A class action notice was mailed on June 7, 1995 to all Limited Partners who are members of the class. PaineWebber Incorporated (\"PaineWebber\") has agreed to indemnify Geodyne Resources and the Partnerships and their affiliates with respect to all claims asserted by the plaintiffs in the lawsuit pursuant to that certain Indemnification Agreement dated November 24, 1992 by and between PaineWebber and Samson Investment Company (the \"Indemnification\nAgreement\") in the event Geodyne Resources or the Partnerships are rejoined in the matter at a later time.\nOn November 23 and 25, 1994, Geodyne Resources, PaineWebber, and certain other parties were named as defendants in two related lawsuits alleging misrepresentations made to induce investments in the Partnerships and asserting causes of action for common law fraud and deceit and unjust enrichment (Romine v. PaineWebber, Inc. et al., Case No. 94-CIV-8558, U. S. District Court, Southern District of New York and Romine v. PaineWebber, Inc. et al., Case No. 94-132844, Supreme Court of the State of New York, County of New York). The federal court case was later consolidated with other similar actions (to which Geodyne Resources is not a party) under the title In Re: PaineWebber Limited Partnerships Litigation and was certified as a class action on May 30, 1995 (the \"PaineWebber Partnership Class Action\"). A class action notice was mailed on June 7, 1995 to all members of the class. The PaineWebber Partnerships Class Action also alleges violations of 18 U.S.C. Section 1962(c) and the Securities Exchange Act of 1934. Compensatory and punitive damages, interest, and costs have been requested in both matters. PaineWebber has agreed to indemnify Geodyne Resources with respect to all claims asserted by the plaintiff in the lawsuits pursuant to the Indemnification Agreement. The amended complaint in the PaineWebber Partnership Class Action no longer asserts any claim directly against Geodyne Resources.\nOn January 18, 1996, PaineWebber issued a press release indicating that it has reached an agreement to settle both the pending PaineWebber Partnership Class Action matter referred to above and the Neidick matter referred to above, along with a settlement with the SEC and an agreement to settle with various state securities regulators. The press release issued by PaineWebber indicates that the parties have agreed to a class action settlement of $125 million and other non-cash consideration; a SEC administrative order creating a capped $40 million fund, a civil penalty of $5 million leveled by the SEC; and payments aggregating $5 million to state securities administra- tors. The dollar amounts referred to in the press release apply to both the Partnerships and other direct investment programs sold by PaineWebber. As of the date of this Annual Report, PaineWebber has not informed management of the Partnerships of the portion of such settlement that would be applicable to the Partnerships. In any event, such settlement is not an obligation of either the Partnerships or the General Partner and, accordingly, would not affect the financial statements of the Partnerships. As a result of both the dismissal and the Indemnification Agreement, management does not believe that either the Partnerships or Geodyne Resources will be required to pay any damages or expenses in any of the matters set forth herein.\nTo the knowledge of the General Partner, neither the General Partner nor the Partnerships or their properties are subject to any litigation, the results of which would have a material effect on the Partnerships' or the General Partner's financial condition or operations.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF LIMITED PARTNERS\nThere were no matters submitted to a vote of the Limited Partners of any Partnership during 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR UNITS AND RELATED LIMITED PARTNER MATTERS\nAs of February 20, 1996, the number of Units outstanding and the approximate number of Limited Partners of record in the Partnerships were as follows:\nNumbers of Numbers of Partnership Units Limited Partners ----------- ---------- ----------------\nII-A 484,283 4,561 II-B 361,719 2,915 II-C 154,621 1,504 II-D 314,878 3,186 II-E 228,821 2,427 II-F 171,400 1,811 II-G 372,189 2,778 II-H 91,711 1,321\nUnits were initially sold for a price of $100. The Units are not traded on any exchange and there is no public trading market for them. The General Partner is aware of certain transfers of Units between unrelated parties, some of which are facilitated by secondary trading firms and matching services. However, the General Partner believes that these transfers have been limited and sporadic in number and volume. Other than trades facilitated by certain secondary trading firms and matching services, no organized trading market for Units exists and none is expected to develop. Due to the nature of these transactions, the General Partner has no verifiable information regarding prices at which Units have been transferred. Further, a transferee may not become a substitute Limited Partner without the consent of the General Partner.\nPursuant to the terms of the Partnership Agreements, the General Partner is obligated to annually offer a repurchase offer which is based on the estimated future net revenues from the Partnerships' reserves and is calculated pursuant to the terms of the Partnership Agreements. Such repurchase offer is recalculated monthly in order to reflect cash distributions to the Limited Partners and other extraordinary events. The following table sets forth the General Partner's repurchase offer per Unit as of the periods indicated. For purposes of this Annual Report, a Unit represents an initial subscription of $100 to the Partnership.\nRepurchase Offer Prices -----------------------\n1994 1995 1996 ------------------- ------------------ ---- 1st 2nd 3rd 4th 1st 2nd 3rd 4th 1st P\/ship Qtr. Qtr. Qtr. Qtr. Qtr. Qtr. Qtr. Qtr. Qtr. - ------ ---- ---- ---- ---- ---- ---- ---- ---- ----\nII-A $21 $20 $17 $16 $14 $15 $14 $13 $12 II-B 21 19 17 15 14 14 13 13 12 II-C 24 22 21 18 16 18 17 17 16 II-D 25 23 21 19 17 22 21 20 19 II-E 27 26 19 18 17 18 18 17 17 II-F 32 29 29 28 26 24 23 21 19 II-G 32 30 30 28 27 24 22 21 19 II-H 31 29 30 28 27 23 22 21 19\nCash Distributions\nCash distributions are primarily dependent upon a Partnership's cash receipts from the sale of oil and gas production and cash requirements of the Partnership. Distributable cash is determined by the Limited Partners at the end of each calendar quarter and distributed to the Limited Partners within 45 days after the end of the quarter. Distributions are restricted to cash on hand less amounts required to be retained out of such cash as determined in the sole judgment of the General Partner to pay costs, expenses, or other Partnership obligations whether accrued or anticipated to accrue. In other instances, the General Partner may not distribute the full amount of cash receipts which might otherwise be available for distribution in an effort to equalize or stabilize the amounts of quarterly distributions. Any available amounts not distributed are invested and the interest or income thereon is for the accounts of the Limited Partners.\nThe following is a summary of cash distributions paid to the Limited Partners for the years ended December 31, 1994 and 1995 and the first quarter of 1996:\nCash Distributions ------------------\n---------------------------------- 1st 2nd 3rd 4th P\/ship Quarter Quarter Quarter Quarter ------ ------- ------- ------- -------\nII-A $1.34 $1.24 $1.29 $1.62 II-B 1.31 1.45 1.31 1.91 II-C 1.42 1.46 1.75 2.43 II-D 1.51 1.37 1.75 1.62 II-E 1.31 1.09 1.31 1.07 II-F 2.92 2.33 1.98 1.98 II-G 2.49 2.15 2.15 1.93 II-H 2.45 2.13 2.07 1.74\n1995 1996 ---------------------------------- ------- 1st 2nd 3rd 4th 1st P\/ship Quarter Quarter Quarter Quarter Quarter ------ ------- ------- ------- ------- -------\nII-A $1.35 $1.03 $ .64 $ .81 $ .97 II-B 1.37 1.09 .47 .28 .46 II-C 2.10 1.33 .81 .39 .59 II-D 1.62 1.41 .64 1.02 1.08 II-E 1.07 .57 .33 .35 .80 II-F 1.52 1.31 1.52 1.58 1.71 II-G 1.48 1.33 1.54 1.45 1.64 II-H 1.47 1.31 1.47 1.36 1.60\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following tables present selected financial data for the Partnerships. This data should be read in conjunction with the financial statements of the Partnerships, and the respective notes thereto, included elsewhere in this Annual Report. See \"Item 8. Financial Statements and Supplementary Data.\"\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nGeneral\nThe following general discussion should be read in conjunction with the analysis of results of operations provided below. The Partnerships are engaged in the business of operating producing oil and gas properties located in the continental United States. In management's view, it is not possible to predict accurately either the short-term or long-term prices for oil, gas, or refined petroleum products. Specifically, due to the oversupply of natural gas in recent years, certain of the Partnerships' gas producing properties have suffered, and continue to suffer during portions of the year, production curtailments and seasonal reductions in the prices paid by purchasers. Additional curtailments and seasonal or regional price reductions will adversely affect the operations and financial condition of the Partnerships. Gas sales prices, which have generally declined significantly since the mid-1980s, increased during the fourth quarter of 1995. See \"Item 1. Business - Competition and Marketing.\" Actual future prices received by the Partnerships will likely be different from (and may be lower than) the prices in effect on December 31, 1995. In many past years, year-end prices have tended to be higher, and in some cases significantly higher, than the yearly average price actually received by the Partnerships for at least the year following the year-end valuation date. Management is unable to predict whether future gas prices will (i) stabilize, (ii) increase, or (iii) decrease. The amount of the Partnerships' cash flow, however, is dependent on such future gas prices.\nLiquidity and Capital Resources\nNet proceeds from operations less necessary operating capital are distributed to the Limited Partners on a quarterly basis. See \"Item 5. Market for Units and Related Limited Partner Matters.\" The net proceeds from production are not reinvested in productive assets, except to the extent that producing wells are improved, or where methods are employed to permit more efficient recovery of reserves, thereby resulting in a positive economic impact. Assuming production levels for the year ended December 31, 1995, the Partnerships proved reserve quantities at December 31, 1995 would have the following lives:\nPartnership Gas-Years Oil-Years ----------- --------- ---------\nII-A 5.4 5.8 II-B 4.8 6.1 II-C 5.4 7.8 II-D 5.7 6.2 II-E 6.8 4.7 II-F 5.6 6.5 II-G 5.6 6.5 II-H 5.7 6.5\nThere should be no further material capital resource commitments for the Partnerships in the future. The Partnerships have no debt commitments. Cash for operational purposes will be provided by current oil and gas production.\nThere can be no assurance as to the amount of the Partnerships' future cash distributions. The Partnerships' ability to make cash distributions depends primarily upon the level of available cash flow generated by the Partnerships' operating activities, which will be affected (either positively or negatively) by many factors beyond the control of the Partnerships, including the price of and demand for oil and gas and other market and economic conditions. Even if prices and costs remain stable, the amount of cash available for distributions will decline over time (as the volume of production from producing properties declines) since the Partnerships are not replacing production through acquisitions of producing properties and drilling.\nInflation and Changing Prices\nPrices obtained for oil and gas production depend upon numerous factors, including the extent of domestic and foreign production, foreign imports of oil, market demand, domestic and foreign economic conditions in general, and governmental regulations and tax laws. The general level of inflation in the economy did not have a material effect on the operations of the Partnerships in 1995. Oil and natural gas prices have fluctuated during recent years and generally have not followed the same pattern as inflation. See \"Item 2. Properties - Oil and Gas Production, Revenue, and Price History.\"\nResults of Operations\nAn analysis of the change in net oil and gas operations (oil and gas sales, less lease operating expenses and production taxes), is presented in the tables following \"Results of Operations\" under the heading \"Average Sales Prices, Production Volumes, and Average Production Costs.\"\nGenerally, the Partnerships' operations during the year ended December 31, 1995 reflected a decline in oil and gas sales compared to the same period in 1994. Management believes this decline resulted from a number of factors including, but not limited to, (i) a normal decline in production from certain of the Partnerships' mature properties and (ii) a decline in natural gas prices. Refer to \"Liquidity and Capital Resources\" above for a discussion of factors impacting prices and production volumes.\nDuring 1994, a few of the Partnerships experienced an increase in oil and gas sales compared to the year ended December 31, 1993. Management believes this increase resulted primarily from gas balancing adjustments which occurred in 1993 in order to reflect such Partnerships' overproduced status on some properties. The adjustments were partially offset by a decline in oil and natural gas prices.\nEffective October 1, 1995, the Partnerships adopted the requirements of Statement of Financial Accounting Standards (\"SFAS\") No. 121, \"Accounting for the Impairment of Long Lived Assets and Assets Held for Disposal\", which is intended to establish more consistent accounting standards for measuring the recoverability of long-lived assets. SFAS No. 121 requires successful efforts companies, like the Partnerships, to evaluate the recoverability of the carrying costs of their proved oil and gas properties for each field, rather than for the Partnerships' properties as a whole as previously allowed by the SEC. See Note 1 to the Partnerships' financial statements, included in Item 8","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe financial statements and supplementary data are indexed 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.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE GENERAL PARTNER\nThe Partnerships have no directors or executive officers. The following individuals are directors and executive officers of the General Partner. The business address of such directors and executive officers is Two West Second Street, Tulsa, Oklahoma 74103.\nName Age Position with General Partner ---------------- --- -------------------------------- C. Philip Tholen 47 President and Chairman of the Board of Directors\nDennis R. Neill 44 Senior Vice President and Director\nJack A. Canon 46 Senior Vice President - General Counsel\nDrew S. Phillips 37 Vice President - Controller\nPatrick M. Hall 37 Director\nAnnabel M. Jones 42 Secretary\nJudy F. Hughes 49 Treasurer\nThe directors will hold office until the next annual meeting of shareholders of the General Partner and until their successors have been duly elected and qualified. All executive officers serve at the discretion of the Boards of Directors.\nC. Philip Tholen joined the Samson Companies in 1977 and has served as President, Chief Executive Officer, and Director of the General Partner since March 3, 1993. Prior to joining the Samson Companies, he was an audit manager for Arthur Andersen & Co. in Tulsa where he specialized in oil and natural gas industry audits and contract audits. He holds a Bachelor of Science degree in accounting from the University of Tulsa and is a Certified Public Accountant. Mr. Tholen is also Executive Vice President, Chief Financial Officer, Treasurer, and Director of Samson Investment Company; President, Chief Executive Officer, and Chairman of the Board of Directors of Samson Natural Gas Company, Dyco Petroleum Corporation, and Samson Resources Company; President of two Divisions of Samson Natural Gas Company, Samson Exploration Company and Samson Production Services Company; Senior Vice President, Treasurer, and Director of Samson Properties Incorporated; and Director of Circle L Drilling Company and Samson Industrial Corporation.\nDennis R. Neill joined the Samson Companies in 1981 and was named Senior Vice President and Director of the General Partner on March 3, 1993. Prior to joining the Samson Companies, he was associated with a Tulsa law firm, Conner and Winters, where his principal practice was in the securities area. He received a Bachelor of Arts degree in political science from Oklahoma State University and a Juris Doctorate degree from the University of Texas. Mr. Neill also serves as Senior Vice President, Chief Operating Officer, and Director of Samson Properties Incorporated; Senior Vice President of Samson Hydrocarbons Company; Senior Vice President and Director of Dyco Petroleum Corporation; and President and Chairman of the Board of Directors of Samson Securities Company.\nJack A. Canon joined the Samson Companies in 1983 and has served as Senior Vice President - General Counsel of the General Partner since March 3, 1993. Prior to joining the Samson Companies, he served as a staff attorney for Terra Resources, Inc. and was associated with the Tulsa law firm of Dyer, Powers, Marsh, Turner and Armstrong. He received a Bachelor of Science degree in accounting from Quincy College and a Juris Doctorate degree from the University of Tulsa. Mr. Canon also serves as Secretary of Samson Investment Company; Director of Samson Natural Gas Company, Samson Properties Incorporated, Circle L Drilling Company, and Samson Securities Company; Senior Vice President - General Counsel of Samson Production Services Company and Dyco Petroleum Corporation; and Vice President - General Counsel of Samson Industrial Corporation.\nDrew S. Phillips joined the Samson Companies in 1984 and has served as Vice President - Controller of the General Partner since March 3, 1993. Prior to joining the Samson Companies, Mr. Phillips was a senior accountant for Arthur Andersen & Co. He received a Bachelor of Science degree in business administration from the University of Arkansas and a Juris Doctorate degree from the University of Tulsa. A certified public accountant, Mr. Phillips is also Vice President - Financial and Tax Accounting of Samson Production Services Company.\nPatrick M. Hall joined the Samson Companies in 1983 and was named Director of the General Partner on March 3, 1993. Prior to joining the Samson Companies he was a senior accountant with Peat Marwick Main & Co. in Tulsa. He holds a Bachelor of Science degree in accounting from Oklahoma State University and is a Certified Public Accountant. Mr. Hall is also a Director of Samson Natural Gas Company; Senior Vice President - Controller and Director of Samson Properties Incorporated; and Senior Vice President - Controller of Samson Production Services Company and Dyco Petroleum Corporation.\nAnnabel M. Jones joined the Samson Companies in 1982 and was named Secretary of the General Partner on March 3, 1993. Prior to joining the Samson Companies she served as associate general counsel of the Oklahoma Securities Commission. She holds Bachelor of Arts (in political science) and Juris Doctorate degrees from the University of Oklahoma. Ms. Jones serves as Assistant General Counsel - Corporate Affairs for Samson Production Services Company and is also Secretary of Samson Properties Incorporated, Samson Natural Gas Company, Dyco Petroleum Corporation, and Samson Industrial Corporation; Vice-President, Secretary, and Director of Samson Securities Company; and Assistant Secretary of Samson Investment Company.\nJudy F. Hughes joined the Samson Companies in 1978 and was named Treasurer of the General Partner on March 3, 1993. Prior to joining the Samson Companies, she performed treasury functions with Reading & Bates Corporation. She attended the University of Tulsa and also serves as Treasurer of Samson Natural Gas Company, Dyco Petroleum Corporation, and Samson Securities Company and Assistant Treasurer of Samson Investment Company and Samson Industrial Corporation.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe General Partner and its affiliates are reimbursed for actual general and administrative costs and operating costs incurred and attributable to the conduct of the business affairs and operations of the Partnerships, computed on a cost basis, determined in accordance with generally accepted accounting principles. Such reimbursed costs and expenses allocated to the Partnerships include office rent, secretarial, employee compensation and benefits, travel and communication costs, fees for professional services, and other items generally classified as general or administrative expense. The amount of general and administrative expense allocated to the General Partner and its affiliates which was charged to each Partnership for the years ended December 31, 1995, 1994, and 1993 is set forth in the table below.\nPartnership 1995 1994 1993 ----------- -------- -------- --------\nII-A $509,772 $509,772 $509,772 II-B 380,760 380,757 380,761 II-C 162,756 162,759 162,683 II-D 331,452 331,451 330,685 II-E 240,864 240,864 240,864 II-F 180,420 180,421 180,420 II-G 391,776 391,778 391,788 II-H 96,540 96,358 96,540\nNone of the officers or directors of the General Partner receive compensation directly from the Partnerships. The Partnerships reimburse the General Partner or its affiliates for that portion of such officers' and directors' salaries and expenses attributable to time devoted by such individuals to the Partnerships' activities. The following tables indicate the approximate amount of general and administrative expense reimbursement attributable to the salaries of the directors, officers, and employees of the General Partner and its affiliates for the years ended December 31, 1995, 1994, and 1993:\nPremier Gas Company (\"Premier\"), an affiliate of the Partnerships until December 6, 1995, purchased a portion of the Partnerships' gas at market prices and resold such gas at market prices directly to end users and local distribution companies. Premier performs this function for both the Partnerships and unrelated third parties. The table below summarizes the dollar amount of gas sold by the Partner- ships to Premier for the years ended December 31, 1995, 1994, and 1993.\nPartnership 1995 1994 1993 ----------- -------- ---------- ----------\nII-A $825,515 $1,085,911 $1,063,966 II-B 374,717 595,951 422,202 II-C 225,948 365,980 267,852 II-D 682,346 909,348 707,391 II-E 593,218 618,067 456,173 II-F 367,527 543,786 309,628 II-G 776,211 1,150,665 656,517 II-H 182,878 272,053 155,801\nSee \"Item 13. Certain Relationships and Related Transactions.\"\nAffiliates of the Partnerships serve as operator of some of the Partnerships' wells. The General Partner contracts with such affiliates for services as operator of the wells. As operator, such affiliates are compensated at rates provided in the operating agreements in effect and charged to all parties to such agreement. Such compensation may occur both prior and subsequent to the commencement of commercial marketing of production of oil or gas. The dollar amount of such compensation paid by the Partnerships to the affiliates is impossible to quantify as of the date of this Annual Report.\nIn addition to the compensation\/reimbursements noted above, the Samson Companies were in the business of supplying field and drilling equipment and services to affiliated and unaffiliated parties in the industry. These companies may have provided equipment and services for wells in which the Partnerships have an interest. These equipment and services were provided at prices or rates equal to or less than those normally charged in the same or comparable geographic area by unaffiliated persons or companies dealing at arm's length. The operators of these wells bill the Partnerships for a portion of such costs based upon the Partnerships' interest in the well.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following table provides information as to the beneficial ownership of the Units as of February 29, 1996 by (i) each beneficial owner of more than 5% of the issued and outstanding Units, (ii) the directors and officers of the General Partner, and (iii) the General\nPartner and its affiliates. The address of each of such persons is Samson Plaza, Two West Second Street, Tulsa, Oklahoma 74103.\nNumber of Units Beneficially Owned (Percent Beneficial Owner of Outstanding) - ------------------------------------ ------------------\nII-A Partnership: - ---------------- Samson Properties Incorporated 45,645 ( 9.4%) All affiliates, directors, and officers of the General Partner as a group and the General Partner (10 persons) 45,645 ( 9.4%)\nII-B Partnership: - ---------------- Samson Properties Incorporated 38,393 (10.6%) All affiliates, directors, and officers of the General Partner as a group and the General Partner (10 persons) 38,393 (10.6%)\nII-C Partnership: - ---------------- Samson Properties Incorporated 16,399 (10.6%) All affiliates, directors, and officers of the General Partner as a group and the General Partner (10 persons) 16,399 (10.6%)\nII-D Partnership: - ---------------- Samson Properties Incorporated 28,241.5 ( 9.0%) All affiliates, directors, and officers of the General Partner as a group and the General Partner (10 persons) 28,241.5 ( 9.0%)\nII-E Partnership: - ---------------- Samson Properties Incorporated 22,968 (10.0%) All affiliates, directors, and officers of the General Partner as a group and the General Partner (10 persons) 22,968 (10.0%)\nII-F Partnership: - ---------------- Samson Properties Incorporated 15,680 ( 9.1%) All affiliates, directors, and officers of the General Partner as a group and the General Partner (10 persons) 15,680 ( 9.1%)\nII-G Partnership: - ---------------- Samson Properties Incorporated 27,773 ( 7.5%) All affiliates, directors, and officers of the General Partner as a group and the General Partner (10 persons) 27,773 ( 7.5%)\nII-H Partnership: - ---------------- Samson Properties Incorporated 10,776 (11.7%) All affiliates, directors, and officers of the General Partner as a group and the General Partner (10 persons) 10,776 (11.7%)\nTo the best knowledge of the Partnerships and the General Partner, there were no officers, directors, or 5% owners who were delinquent filers of reports required under Section 16 of the Securities Exchange Act of 1934.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe General Partner and certain of its affiliates engage in oil and gas activities independently of the Partnerships which result in conflicts of interest that cannot be totally eliminated. The allocation of acquisition and drilling opportunities and the nature of the compensation arrangements between the Partnerships and the General Partner also create potential conflicts of interest. Affiliates of the Partnerships own some of the Partnerships' Units and therefore have an identity of interest with other Limited Partners with respect to the operations of the Partnerships.\nIn order to attempt to assure limited liability for Limited Partners as well as an orderly conduct of business, management of the Partnerships is exercised solely by the General Partner. The Partnership Agreements grant the General Partner broad discretionary authority with respect to the Partnerships' participation in drilling prospects and expenditure and control of funds, including borrowings. These provisions are similar to those contained in prospectuses and partnership agreements for other public oil and gas partnerships. Broad discretion as to general management of the Partnerships involves circumstances where the General Partner has conflicts of interest and where it must allocate costs and expenses, or opportunities, among the Partnerships and other competing interests.\nThe General Partner does not devote all of its time, efforts, and personnel exclusively to the Partnerships. Furthermore, the Partnerships do not have any employees, but instead rely on the personnel of the Samson Companies. The Partnerships thus compete with the Samson Companies (including other currently sponsored oil and gas partnerships) for the time and resources of such personnel. The Samson Companies devote such time and personnel to the management of\nthe Partnerships as are indicated by the circumstances and as are con- sistent with the General Partner's fiduciary duties.\nAs a result of Samson Investment Company's (\"Samson\") acquisition of Geodyne Resources, Samson, PaineWebber, Geodyne Resources, and the General Partner entered into an advisory agreement which relates primarily to the Partnerships. PaineWebber served as the dealer manager of the original offering of Units. The Advisory Agreement became effective on March 3, 1993 and will generally continue in effect for a period of five years from the date thereof. The Advisory Agreement provides that: (i) Samson, Geodyne Resources, and the General Partners will comply, and will cause the Partnerships to comply, with provisions of the Partnership Agreements (including all restrictions, prohibitions, and other provisions of such agreements concerning transactions in which Samson or its affiliates purchase or sell properties from or to, or render services to, the Partnerships and the terms of such agreements relating to farmouts of oil and gas properties), and Samson and Geodyne Resources will cause the General Partner to comply with all applicable fiduciary duties; (ii) Samson will review periodically with PaineWebber on a retrospective basis the general operations and performance of the Partnerships and the terms of any material transaction by a Partnership, including any transaction that involves participation by the Samson Companies; and (iii) Samson will review with PaineWebber on a prospective basis, and will allow PaineWebber to advise Samson and to comment on, (A) any General Partner-initiated amendment to a Partnership Agreement which requires a vote of the Limited Partners of such Partnership and (B) any proposal initiated by the General Partner or any of its affiliates that would involve a reorganization, merger, or consolidation of a Partnership, a sale of all or substantially all of the assets of a Partnership (including a roll-up or corporate stock exchange), the liquidation or dissolution of a Partnership, or the exchange of cash, securities, or other assets for all or any outstanding Units.\nIn addition, the Advisory Agreement provides that: (i) Samson will cause Geodyne Resources to offer to repurchase Units at a price to be calculated in accordance with certain guidelines and to be paid in cash or a combination of cash and certain securities, all subject to certain limitations and restrictions; (ii) for a 24-month period beginning on March 1, 1993, the aggregate annual maximum amount chargeable to the Partnerships for direct administrative costs and general and administrative costs (as defined in the Partnership Agreements) will be reduced by an aggregate $800,000 from current levels for all partnerships sponsored by Geodyne Resources' subsidiaries and that certain other limits on amounts charged to the Partnerships for general and administrative costs will be observed; (iii) Samson will provide PaineWebber certain information relating to the Partnerships and the Limited Partners; (iv) Samson and Geodyne Resources will maintain an \"800\" investor services telephone number; (v) Samson and Geodyne Resources will take certain actions with respect to oil and gas properties held by nominees, insurance maintained by the Partnerships, approval as to transfers of interests in the Partnerships and the selection of independent reserve engineers; (vi) Samson and Geodyne Resources acknowledge the standing\nof PaineWebber to institute actions, subject to certain limitations, in connection with the Advisory Agreement on behalf of the Limited Partners; and (vii) if Samson proposes a consolidation, merger, or exchange offer involving any limited partnership managed by Samson (other than Samson Energy Company Limited Partnership), it will propose to include all of the Partnerships in such transaction or provide a statement to PaineWebber as to the reasons why some or all of the Partnerships are not included in such transaction.\nPursuant to the Advisory Agreement, Geodyne Resources has agreed to reimburse PaineWebber for all reasonable expenses incurred by it in connection with the matters contemplated by the Advisory Agreement, and Samson has agreed to indemnify PaineWebber and certain related parties from certain liabilities incurred in connection with the Advisory Agreement.\nAffiliates of the Partnerships are solely responsible for the negotiation, administration, and enforcement of oil and gas sales agreements covering the Partnerships' leasehold interests. Until December 6, 1995, the General Partner had delegated the negotiation, administration, and enforcement of its gas sales agreements to Premier. In addition to providing such administrative services, Premier purchased and resold gas directly to end-users and local distribution companies. Because affiliates of the Partnership who provide services to the Partnership have fiduciary or other duties to other members of the Samson Companies, contract amendments and negotiating positions taken by them in their effort to enforce contracts with purchasers may not necessarily represent the positions that the Partnership would take if it were to administer their own contracts without involvement with other members of the Samson Companies. On the other hand, management believes that the Partnerships's negotiating strength and contractual positions have been enhanced by virtue of their affiliation with the Samson Companies. For a description of certain of the relationships and related transactions see \"Item 11. Executive Compensation.\"\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: The following financial statements for the\nGeodyne Energy Income Limited Partnership II-A Geodyne Energy Income Limited Partnership II-B Geodyne Energy Income Limited Partnership II-C Geodyne Energy Income Limited Partnership II-D Geodyne Energy Income Limited Partnership II-E Geodyne Energy Income Limited Partnership II-F Geodyne Energy Income Limited Partnership II-G Geodyne Energy Income Limited Partnership II-H\nas of December 31, 1995 and 1994 and for each of the three years in the period ended December 31, 1995 are filed as part of this report:\nReport of Independent Accountants Combined Balance Sheets Combined Statements of Operations Combined Statements of Changes in Partners' Capital (Deficit) Combined Statements of Cash Flows Notes to Combined Financial Statements\n(2) Financial Statement Schedules:\nNone. These schedules have been omitted since the required information is presented in the financial statements or is not applicable.\n(3) Exhibits:\n4.1 The Certificate and Agreements of Limited Partnership for the following Partnerships have been previously filed with the Securities and Exchange Commission as Exhibit 2.1 to Form 8-A filed by each Partnership on the dates shown below and are hereby incorporated by reference.\nPartnership Filing Date File No. ----------- ------------ --------\nII-A November 18, 1987 0-16388 II-B November 19, 1987 0-16405 II-C August 5, 1988 0-16981 II-D August 5, 1988 0-16980 II-E November 17, 1988 0-17320 II-F June 5, 1989 0-17799 II-G June 5, 1989 0-17802 II-H February 20, 1990 0-18305\n4.2 The Agreements of Partnership for the following Production Partnerships have been previously filed with the Securities and Exchange Commission as Exhibit 2.2 to Form 8-A filed by the related Partnerships on the dates shown below and are hereby incorporated by reference.\nPartnership Filing Date ----------- -----------\nII-A November 18, 1987 II-B November 19, 1987 II-C August 5, 1988 II-D August 5, 1988 II-E November 17, 1988 II-F June 5, 1989 II-G June 5, 1989 II-H February 20, 1990\n4.3 Advisory Agreement dated as of November 24, 1992 between Samson, PaineWebber, Geodyne Resources, Geodyne Properties, Inc., Geodyne Production Company, and Geodyne Energy Company filed as Exhibit 28.3 to Registrant's Current Report on Form 8-K on December 24, 1992 and is hereby incorporated by reference.\n4.4 Second Amendment to Amended and Restated Agreement and Certificate of Limited Partnership of Geodyne Energy Income Limited Partnership II-A, filed as Exhibit 4.1 to Registrant's Current Report on Form 8-K dated August 2, 1993 and filed with the Securities and Exchange Commission on August 10, 1993 and is hereby incorporated by reference.\n4.5 Second Amendment to Amended and Restated Agreement and Certificate of Limited Partnership of Geodyne Energy Income Limited Partnership II-B, filed as Exhibit 4.2 to Registrant's Current Report on Form 8-K dated August 2, 1993 and filed with the Securities and Exchange Commission on August 10, 1993 and is hereby incorporated by reference.\n4.6 Second Amendment to Amended and Restated Agreement and Certificate of Limited Partnership of Geodyne Energy Income Limited Partnership II-C, filed as Exhibit 4.3 to Registrant's Current Report on Form 8-K dated August 2, 1993 and filed with the Securities and Exchange Commission on August 10, 1993 and is hereby incorporated by reference.\n4.7 Second Amendment to Amended and Restated Agreement and Certificate of Limited Partnership of Geodyne Energy Income Limited Partnership II-D, filed as Exhibit 4.4 to Registrant's Current Report on Form 8-K dated August 2, 1993 and filed with the Securities and Exchange Commission on August 10, 1993 and is hereby incorporated by reference.\n4.8 Second Amendment to Amended and Restated Agreement and Certificate of Limited Partnership of Geodyne Energy Income Limited Partnership II-E, filed as Exhibit 4.5 to Registrant's Current Report on Form 8-K dated August 2, 1993 and filed with the Securities and Exchange Commission on August 10, 1993 and is hereby incorporated by reference.\n4.9 Second Amendment to Amended and Restated Agreement and Certificate of Limited Partnership of Geodyne Energy Income Limited Partnership II-F, filed as Exhibit 4.6 to Registrant's Current Report on Form 8-K dated August 2, 1993 and filed with the Securities and Exchange Commission on August 10, 1993 and is hereby incorporated by reference.\n4.10 Second Amendment to Amended and Restated Agreement and Certificate of Limited Partnership of Geodyne Energy Income Limited Partnership II-G, filed as Exhibit 4.7 to Registrant's Current Report on Form 8-K dated August 2, 1993 and filed with the Securities and Exchange Commission on August 10, 1993 and is hereby incorporated by reference.\n4.11 Second Amendment to Amended and Restated Agreement and Certificate of Limited Partnership of Geodyne Energy Income Limited Partnership II-H, filed as Exhibit 4.8 to Registrant's Current Report on Form 8-K dated August 2, 1993 and filed with the Securities and Exchange Commission on August 10, 1993 and is hereby incorporated by reference.\n* 4.12 Third Amendment to Agreement and Certificate of Limited Partnership of Geodyne Energy Income Limited Partnership II-E.\n* 4.13 Third Amendment to Agreement and Certificate of Limited Partnership of Geodyne Energy Income Limited Partnership II-F.\n* 4.14 Third Amendment to Agreement and Certificate of Limited Partnership of Geodyne Energy Income Limited Partnership II-G.\n* 4.15 Third Amendment to Agreement and Certificate of Limited Partnership of Geodyne Energy Income Limited Partnership II-H.\n* 23.1 Consent of Ryder Scott Company Petroleum Engineers for Geodyne Energy Income Limited Partnership II- A.\n* 23.2 Consent of Ryder Scott Company Petroleum Engineers for Geodyne Energy Income Limited Partnership II- B.\n* 23.3 Consent of Ryder Scott Company Petroleum Engineers for Geodyne Energy Income Limited Partnership II- C.\n* 23.4 Consent of Ryder Scott Company Petroleum Engineers for Geodyne Energy Income Limited Partnership II- D.\n* 23.5 Consent of Ryder Scott Company Petroleum Engineers for Geodyne Energy Income Limited Partnership II- E.\n* 23.6 Consent of Ryder Scott Company Petroleum Engineers for Geodyne Energy Income Limited Partnership II- F.\n* 23.7 Consent of Ryder Scott Company Petroleum Engineers for Geodyne Energy Income Limited Partnership II- G.\n* 23.8 Consent of Ryder Scott Company Petroleum Engineers for Geodyne Energy Income Limited Partnership II- H.\n* 27.1 Financial Data Schedule containing summary financial information extracted from the Geodyne Energy Income Limited Partnership II-A's financial statements as of December 31, 1995 and for the year ended December 31, 1995.\n* 27.2 Financial Data Schedule containing summary financial information extracted from the Geodyne Energy Income Limited Partnership II-B's financial statements as of December 31, 1995 and for the year ended December 31, 1995.\n* 27.3 Financial Data Schedule containing summary financial information extracted from the Geodyne Energy Income Limited Partnership II-C's financial statements as of December 31, 1995 and for the year ended December 31, 1995.\n* 27.4 Financial Data Schedule containing summary financial information extracted from the Geodyne Energy Income Limited Partnership II-D's financial statements as of December 31, 1995 and for the year ended December 31, 1995.\n* 27.5 Financial Data Schedule containing summary financial information extracted from the Geodyne Energy Income Limited Partnership II-E's financial statements as of December 31, 1995 and for the year ended December 31, 1995.\n* 27.6 Financial Data Schedule containing summary financial information extracted from the Geodyne Energy Income Limited Partnership II-F's financial statements as of December 31, 1995 and for the year ended December 31, 1995.\n* 27.7 Financial Data Schedule containing summary financial information extracted from the Geodyne Energy Income Limited Partnership II-G's financial statements as of December 31, 1995 and for the year ended December 31, 1995.\n* 27.8 Financial Data Schedule containing summary financial information extracted from the Geodyne Energy Income Limited Partnership II-H's financial statements as of December 31, 1995 and for the year ended December 31, 1995.\nAll other Exhibits are omitted as inapplicable.\n----------\n*Filed herewith.\n(b) Reports on Form 8-K for the fourth quarter of 1995:\nNone.\nSIGNATURES\nPursuant to the requirements of Sections 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly organized.\nGEODYNE ENERGY INCOME LIMITED PARTNERSHIP II-A\nBy: GEODYNE PROPERTIES, INC. General Partner\nApril 4, 1996\nBy: \/s\/C. Philip Tholen ------------------------------ C. Philip Tholen 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 the dates indicated.\nBy: \/s\/C. Philip Tholen President and April 4, 1996 ------------------- Chairman of the C. Philip Tholen Board (Principal Executive Officer)\n\/s\/Dennis R. Neill Senior Vice April 4, 1996 ------------------- President and Dennis R. Neill Director\n\/s\/Jack A. Canon Senior Vice April 4, 1996 ------------------- President - Jack A. Canon General Counsel\n\/s\/Drew S. Phillips Vice-President - April 4, 1996 ------------------- Controller Drew S. Phillips (Principal Accounting Officer)\n\/s\/Patrick M. Hall Director April 4, 1996 ------------------- Patrick M. Hall\n\/s\/Annabel M. Jones Secretary April 4, 1996 ------------------- Annabel M. Jones\n\/s\/Judy F. Hughes Treasurer April 4, 1996 ------------------- Judy F. Hughes\nSIGNATURES\nPursuant to the requirements of Sections 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly organized.\nGEODYNE ENERGY INCOME LIMITED PARTNERSHIP II-B\nBy: GEODYNE PROPERTIES, INC. General Partner\nApril 4, 1996\nBy: \/s\/C. Philip Tholen ------------------------------ C. Philip Tholen 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 the dates indicated.\nBy: \/s\/C. Philip Tholen President and April 4, 1996 ------------------- Chairman of the C. Philip Tholen Board (Principal Executive Officer)\n\/s\/Dennis R. Neill Senior Vice April 4, 1996 ------------------- President and Dennis R. Neill Director\n\/s\/Jack A. Canon Senior Vice April 4, 1996 ------------------- President - Jack A. Canon General Counsel\n\/s\/Drew S. Phillips Vice-President - April 4, 1996 ------------------- Controller Drew S. Phillips (Principal Accounting Officer)\n\/s\/Patrick M. Hall Director April 4, 1996 ------------------- Patrick M. Hall\n\/s\/Annabel M. Jones Secretary April 4, 1996 ------------------- Annabel M. Jones\n\/s\/Judy F. Hughes Treasurer April 4, 1996 ------------------- Judy F. Hughes\nSIGNATURES\nPursuant to the requirements of Sections 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly organized.\nGEODYNE ENERGY INCOME LIMITED PARTNERSHIP II-C\nBy: GEODYNE PROPERTIES, INC. General Partner\nApril 4, 1996\nBy: \/s\/C. Philip Tholen ------------------------------ C. Philip Tholen 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 the dates indicated.\nBy: \/s\/C. Philip Tholen President and April 4, 1996 ------------------- Chairman of the C. Philip Tholen Board (Principal Executive Officer)\n\/s\/Dennis R. Neill Senior Vice April 4, 1996 ------------------- President and Dennis R. Neill Director\n\/s\/Jack A. Canon Senior Vice April 4, 1996 ------------------- President - Jack A. Canon General Counsel\n\/s\/Drew S. Phillips Vice-President - April 4, 1996 ------------------- Controller Drew S. Phillips (Principal Accounting Officer)\n\/s\/Patrick M. Hall Director April 4, 1996 ------------------- Patrick M. Hall\n\/s\/Annabel M. Jones Secretary April 4, 1996 ------------------- Annabel M. Jones\n\/s\/Judy F. Hughes Treasurer April 4, 1996 ------------------- Judy F. Hughes\nSIGNATURES\nPursuant to the requirements of Sections 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly organized.\nGEODYNE ENERGY INCOME LIMITED PARTNERSHIP II-D\nBy: GEODYNE PROPERTIES, INC. General Partner\nApril 4, 1996\nBy: \/s\/C. Philip Tholen ------------------------------ C. Philip Tholen 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 the dates indicated.\nBy: \/s\/C. Philip Tholen President and April 4, 1996 ------------------- Chairman of the C. Philip Tholen Board (Principal Executive Officer)\n\/s\/Dennis R. Neill Senior Vice April 4, 1996 ------------------- President and Dennis R. Neill Director\n\/s\/Jack A. Canon Senior Vice April 4, 1996 ------------------- President - Jack A. Canon General Counsel\n\/s\/Drew S. Phillips Vice-President - April 4, 1996 ------------------- Controller Drew S. Phillips (Principal Accounting Officer)\n\/s\/Patrick M. Hall Director April 4, 1996 ------------------- Patrick M. Hall\n\/s\/Annabel M. Jones Secretary April 4, 1996 ------------------- Annabel M. Jones\n\/s\/Judy F. Hughes Treasurer April 4, 1996 ------------------- Judy F. Hughes\nSIGNATURES\nPursuant to the requirements of Sections 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly organized.\nGEODYNE ENERGY INCOME LIMITED PARTNERSHIP II-E\nBy: GEODYNE PROPERTIES, INC. General Partner\nApril 4, 1996\nBy: \/s\/C. Philip Tholen ------------------------------ C. Philip Tholen 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 the dates indicated.\nBy: \/s\/C. Philip Tholen President and April 4, 1996 ------------------- Chairman of the C. Philip Tholen Board (Principal Executive Officer)\n\/s\/Dennis R. Neill Senior Vice April 4, 1996 ------------------- President and Dennis R. Neill Director\n\/s\/Jack A. Canon Senior Vice April 4, 1996 ------------------- President - Jack A. Canon General Counsel\n\/s\/Drew S. Phillips Vice-President - April 4, 1996 ------------------- Controller Drew S. Phillips (Principal Accounting Officer)\n\/s\/Patrick M. Hall Director April 4, 1996 ------------------- Patrick M. Hall\n\/s\/Annabel M. Jones Secretary April 4, 1996 ------------------- Annabel M. Jones\n\/s\/Judy F. Hughes Treasurer April 4, 1996 ------------------- Judy F. Hughes\nSIGNATURES\nPursuant to the requirements of Sections 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly organized.\nGEODYNE ENERGY INCOME LIMITED PARTNERSHIP II-F\nBy: GEODYNE PROPERTIES, INC. General Partner\nApril 4, 1996\nBy: \/s\/C. Philip Tholen ------------------------------ C. Philip Tholen 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 the dates indicated.\nBy: \/s\/C. Philip Tholen President and April 4, 1996 ------------------- Chairman of the C. Philip Tholen Board (Principal Executive Officer)\n\/s\/Dennis R. Neill Senior Vice April 4, 1996 ------------------- President and Dennis R. Neill Director\n\/s\/Jack A. Canon Senior Vice April 4, 1996 ------------------- President - Jack A. Canon General Counsel\n\/s\/Drew S. Phillips Vice-President - April 4, 1996 ------------------- Controller Drew S. Phillips (Principal Accounting Officer)\n\/s\/Patrick M. Hall Director April 4, 1996 ------------------- Patrick M. Hall\n\/s\/Annabel M. Jones Secretary April 4, 1996 ------------------- Annabel M. Jones\n\/s\/Judy F. Hughes Treasurer April 4, 1996 ------------------- Judy F. Hughes\nSIGNATURES\nPursuant to the requirements of Sections 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly organized.\nGEODYNE ENERGY INCOME LIMITED PARTNERSHIP II-G\nBy: GEODYNE PROPERTIES, INC. General Partner\nApril 4, 1996\nBy: \/s\/C. Philip Tholen ------------------------------ C. Philip Tholen 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 the dates indicated.\nBy: \/s\/C. Philip Tholen President and April 4, 1996 ------------------- Chairman of the C. Philip Tholen Board (Principal Executive Officer)\n\/s\/Dennis R. Neill Senior Vice April 4, 1996 ------------------- President and Dennis R. Neill Director\n\/s\/Jack A. Canon Senior Vice April 4, 1996 ------------------- President - Jack A. Canon General Counsel\n\/s\/Drew S. Phillips Vice-President - April 4, 1996 ------------------- Controller Drew S. Phillips (Principal Accounting Officer)\n\/s\/Patrick M. Hall Director April 4, 1996 ------------------- Patrick M. Hall\n\/s\/Annabel M. Jones Secretary April 4, 1996 ------------------- Annabel M. Jones\n\/s\/Judy F. Hughes Treasurer April 4, 1996 ------------------- Judy F. Hughes\nSIGNATURES\nPursuant to the requirements of Sections 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly organized.\nGEODYNE ENERGY INCOME LIMITED PARTNERSHIP II-H\nBy: GEODYNE PROPERTIES, INC. General Partner\nApril 4, 1996\nBy: \/s\/C. Philip Tholen ------------------------------ C. Philip Tholen 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 the dates indicated.\nBy: \/s\/C. Philip Tholen President and April 4, 1996 ------------------- Chairman of the C. Philip Tholen Board (Principal Executive Officer)\n\/s\/Dennis R. Neill Senior Vice April 4, 1996 ------------------- President and Dennis R. Neill Director\n\/s\/Jack A. Canon Senior Vice April 4, 1996 ------------------- President - Jack A. Canon General Counsel\n\/s\/Drew S. Phillips Vice-President - April 4, 1996 ------------------- Controller Drew S. Phillips (Principal Accounting Officer)\n\/s\/Patrick M. Hall Director April 4, 1996 ------------------- Patrick M. Hall\n\/s\/Annabel M. Jones Secretary April 4, 1996 ------------------- Annabel M. Jones\n\/s\/Judy F. Hughes Treasurer April 4, 1996 ------------------- Judy F. Hughes\nITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nREPORT OF INDEPENDENT ACCOUNTANTS\nTO THE PARTNERS\nGEODYNE ENERGY INCOME LIMITED PARTNERSHIP II-A GEODYNE PRODUCTION PARTNERSHIP II-A\nWe have audited the combined balance sheets of the Geodyne Energy Income Limited Partnership II-A, an Oklahoma limited partnership, and Geodyne Production Partnership II-A, an Oklahoma general partnership, as of December 31, 1995 and 1994 and the related combined statements of operations, changes in partners' capital (deficit), and cash flows for the years ended December 31, 1995, 1994, and 1993. These financial statements are the responsibility of the Partnerships' 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 combined financial statements referred to above present fairly, in all material respects, the combined financial position of the Geodyne Energy Income Limited Partnership II-A and Geodyne Production Partnership II-A at December 31, 1995 and 1994 and the combined results of their operations and cash flows for the years ended December 31, 1995, 1994, and 1993, in conformity with generally accepted accounting principles.\nAs disclosed in Note 1 to the combined financial statements, the Geodyne Energy Income Limited Partnership II-A and Geodyne Production Partnership II-A changed their method of accounting for impairment of their oil and gas properties as of October 1, 1995.\nCOOPERS & LYBRAND L.L.P.\nTulsa, Oklahoma March 25, 1996\nGEODYNE ENERGY INCOME LIMITED PARTNERSHIP II-A GEODYNE ENERGY INCOME PRODUCTION PARTNERSHIP II-A Combined Balance Sheets December 31, 1995 and 1994\nASSETS ------\n1995 1994 ------------- ------------- CURRENT ASSETS: Cash and cash equivalents $ 508,024 $ 793,694 Accounts receivable: Oil and gas sales, including $153,461 and $107,036 due from related parties 765,075 829,056 ---------- ---------- Total current assets $ 1,273,099 $ 1,622,750\nNET OIL AND GAS PROPERTIES, utilizing the successful efforts method 7,390,812 10,069,976\nDEFERRED CHARGE 1,169,277 980,772 ---------- ---------- $ 9,833,188 $12,673,498 ========== ==========\nLIABILITIES AND PARTNERS' CAPITAL (DEFICIT) -------------------------------------------\nCURRENT LIABILITIES: Accounts payable $ 213,126 $ 289,391 Gas imbalance payable 164,837 217,949 ---------- ---------- Total current liabilities $ 377,963 $ 507,340\nACCRUED LIABILITY $ 272,667 $ 398,669\nPARTNERS' CAPITAL (DEFICIT): General Partner ($ 311,994) ($ 297,741) Limited Partners, issued and outstanding, 484,283 Units 9,494,552 12,065,230 ---------- ---------- Total Partners' capital $ 9,182,558 $11,767,489 ---------- ---------- $ 9,833,188 $12,673,498 ========== ==========\nThe accompanying notes are an integral part of these combined financial statements.\nGEODYNE ENERGY INCOME LIMITED PARTNERSHIP II-A GEODYNE ENERGY INCOME PRODUCTION PARTNERSHIP II-A Combined Statements of Operations For the Years Ended December 31, 1995, 1994, and 1993\n1995 1994 1993 ------------ ---------- ------------\nREVENUES: Oil and gas sales, including $825,515, $1,085,911, and $1,063,966 of sales to related parties $4,671,555 $6,371,949 $5,445,632 Interest income 20,126 31,747 20,151 Gain on sale of oil and gas properties 12,179 21,991 3,298 Other income - 72,028 1,423 --------- --------- --------- $4,703,860 $6,497,715 $5,470,504\nCOSTS AND EXPENSES: Lease operating $1,564,012 $2,023,881 $2,291,270 Production tax 282,252 359,486 354,917 Depreciation, depletion, and amortization of oil and gas properties 1,841,159 3,135,128 2,917,145 Impairment provision 994,919 - - General and administrative 655,449 567,466 545,460 --------- --------- --------- $5,337,791 $6,085,961 $6,108,792 --------- --------- --------- NET INCOME (LOSS) ($ 633,931) $ 411,754 ($ 638,288) ========= ========= =========\nGENERAL PARTNER - NET INCOME $ 81,747 $ 145,993 $ 84,771 ========= ========= =========\nLIMITED PARTNERS - NET INCOME (LOSS) ($ 715,678) $ 265,761 ($ 723,059) ========= ========= =========\nNET INCOME (LOSS) per Unit ($ 1.48) $ .55 ($ 1.49) ========= ========= =========\nUNITS OUTSTANDING 484,283 484,283 484,283 ========= ========= =========\nThe accompanying notes are an integral part of these combined financial statements.\nGEODYNE ENERGY INCOME LIMITED PARTNERSHIP II-A GEODYNE ENERGY INCOME PRODUCTION PARTNERSHIP II-A Combined Statements of Changes in Partners' Capital (Deficit) For the Years Ended December 31, 1995, 1994, and 1993\nLimited General Partners Partner Total ------------- ---------- -------------\nBalance, Dec. 31, 1992 $17,956,097 ($240,427) $17,715,670 Net income (loss) ( 723,059) 84,771 ( 638,288) Cash distributions ( 2,773,569) ( 148,078) ( 2,921,647) ---------- ------- ---------- Balance, Dec. 31, 1993 $14,459,469 ($303,734) $14,155,735 Net income 265,761 145,993 411,754 Cash distributions ( 2,660,000) ( 140,000) ( 2,800,000) ---------- ------- ----------\nBalance, Dec. 31, 1994 $12,065,230 ($297,741) $11,767,489 Net income (loss) ( 715,678) 81,747 ( 633,931) Cash Distributions ( 1,855,000) ( 96,000) ( 1,951,000) ---------- ------- ----------\nBalance, Dec. 31, 1995 $ 9,494,552 ($311,994) $ 9,182,558 ========== ======= ==========\nThe accompanying notes are an integral part of these combined financial statements.\nGEODYNE ENERGY INCOME LIMITED PARTNERSHIP II-A GEODYNE ENERGY INCOME PRODUCTION PARTNERSHIP II-A Combined Statements of Cash Flows For the Years Ended December 31, 1995, 1994, and 1993\n1995 1994 1993 ------------ ------------ ------------\nCASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) ($ 633,931) $ 411,754 ($ 638,288) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation, depletion, and amortization of oil and gas properties 1,841,159 3,135,128 2,917,145 Impairment provision 994,919 - - Gain on sale of oil and gas properties ( 12,179) ( 21,991) ( 3,298) Decrease in accounts receivable 63,981 163,316 86,829 Increase in deferred charge ( 188,505) ( 159,357) ( 821,415) Increase (decrease) in accounts payable ( 76,265) ( 9,190) 115,934 Increase (decrease) in gas imbalance payable ( 53,112) ( 755,225) 643,300 Increase (decrease) in accrued liability ( 126,002) 53,007 345,662 --------- --------- --------- Net cash provided by operating activities $1,810,065 $2,817,442 $2,645,869 --------- --------- ---------\nCASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures ($ 168,118) ($ 305,300) ($ 215,092) Proceeds from sale of oil and gas properties 23,383 34,826 485,634 --------- --------- --------- Net cash provided (used) by investing activities ($ 144,735) ($ 270,474) $ 270,542 --------- --------- ---------\nCASH FLOWS FROM FINANCING ACTIVITIES: Cash distributions ($1,951,000) ($2,800,000) ($2,921,647) --------- --------- --------- Net cash used by financing activities ($1,951,000) ($2,800,000) ($2,921,647) --------- --------- ---------\nNET DECREASE IN CASH AND CASH EQUIVALENTS ($ 285,670) ($ 253,032) ($ 5,236)\nCASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 793,694 1,046,726 1,051,962 --------- --------- ---------\nCASH AND CASH EQUIVALENTS AT END OF PERIOD $ 508,024 $ 793,694 $1,046,726 ========= ========= =========\nThe accompanying notes are an integral part of these combined financial statements.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTO THE PARTNERS\nGEODYNE ENERGY INCOME LIMITED PARTNERSHIP II-B GEODYNE PRODUCTION PARTNERSHIP II-B\nWe have audited the combined balance sheets of the Geodyne Energy Income Limited Partnership II-B, an Oklahoma limited partnership, and Geodyne Production Partnership II-B, an Oklahoma general partnership, as of December 31, 1995 and 1994 and the related combined statements of operations, changes in partners' capital (deficit), and cash flows for the years ended December 31, 1995, 1994, and 1993. These financial statements are the responsibility of the Partnerships' 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 combined financial statements referred to above present fairly, in all material respects, the combined financial position of the Geodyne Energy Income Limited Partnership II-B and Geodyne Production Partnership II-B at December 31, 1995 and 1994 and the combined results of their operations and cash flows for the years ended December 31, 1995, 1994, and 1993 in conformity with generally accepted accounting principles.\nAs disclosed in Note 1 to the combined financial statements, the Geodyne Energy Income Limited Partnership II-B and Geodyne Production Partnership II-B changed their method of accounting for impairment of their oil and gas properties as of October 1, 1995.\nCOOPERS & LYBRAND L.L.P.\nTulsa, Oklahoma March 25, 1996\nGEODYNE ENERGY INCOME LIMITED PARTNERSHIP II-B GEODYNE ENERGY INCOME PRODUCTION PARTNERSHIP II-B Combined Balance Sheets December 31, 1995 and 1994\nASSETS ------\n1995 1994 ------------ ------------ CURRENT ASSETS: Cash and cash equivalents $ 168,239 $ 623,450 Accounts receivable: Oil and gas sales, including $81,240 and $64,669 due from related parties 584,133 572,547 --------- --------- Total current assets $ 752,372 $1,195,997\nNET OIL AND GAS PROPERTIES, utilizing the successful efforts method 5,258,752 6,932,761\nDEFERRED CHARGE 226,303 173,300 --------- --------- $6,237,427 $8,302,058 ========= =========\nLIABILITIES AND PARTNERS' CAPITAL (DEFICIT) -------------------------------------------\nCURRENT LIABILITIES: Accounts payable $ 211,226 $ 222,404 Gas imbalance payable 15,048 18,793 --------- --------- Total current liabilities $ 226,274 $ 241,197\nACCRUED LIABILITY $ 301,684 $ 369,296\nPARTNERS' CAPITAL (DEFICIT): General Partner ($ 246,438) ($ 222,879) Limited Partners, issued and outstanding, 361,719 Units 5,955,907 7,914,444 --------- --------- Total Partners' capital $5,709,469 $7,691,565 --------- --------- $6,237,427 $8,302,058 ========= =========\nThe accompanying notes are an integral part of these combined financial statements.\nGEODYNE ENERGY INCOME LIMITED PARTNERSHIP II-B GEODYNE ENERGY INCOME PRODUCTION PARTNERSHIP II-B Combined Statements of Operations For the Years Ended December 31, 1995, 1994, and 1993\n1995 1994 1993 ------------ ------------ ------------ REVENUES: Oil and gas sales, including $374,717, $595,951, and $422,202 of sales to related parties $3,204,794 $4,703,629 $4,615,384 Interest income 9,960 20,907 11,162 Gain (loss) on sale of oil and gas properties 10,869 14,693 ( 7,270) --------- --------- --------- $3,225,623 $4,739,229 $4,619,276\nCOSTS AND EXPENSES: Lease operating $1,315,780 $1,720,223 $1,596,910 Production tax 208,998 294,749 283,149 Depreciation, depletion, and amortization of oil and gas properties 1,436,788 2,787,591 2,570,101 Impairment provision 450,601 - - General and administrative 574,552 424,373 408,406 --------- --------- --------- $3,986,719 $5,226,936 $4,858,566 --------- --------- --------- NET LOSS ($ 761,096) ($ 487,707) ($ 239,290) ========= ========= =========\nGENERAL PARTNER - NET INCOME $ 37,441 $ 87,118 $ 90,840 ========= ========= =========\nLIMITED PARTNERS - NET LOSS ($ 798,537) ($ 574,825) ($ 330,130) ========= ========= =========\nNET LOSS per Unit ($ 2.21) ($ 1.59) ($ .91) ========= ========= =========\nUNITS OUTSTANDING 361,719 361,719 361,719 ========= ========= =========\nThe accompanying notes are an integral part of these combined financial statements.\nGEODYNE ENERGY INCOME LIMITED PARTNERSHIP II-B GEODYNE ENERGY INCOME PRODUCTION PARTNERSHIP II-B Combined Statements of Changes in Partners' Capital (Deficit) For the Years Ended December 31, 1995, 1994, and 1993\nLimited General Partners Partner Total ------------- ---------- ------------- Balance, Dec. 31, 1992 $13,387,529 ($179,762) $13,207,767 Net income (loss) ( 330,130) 90,840 ( 239,290) Cash distributions ( 2,403,130) ( 108,075) ( 2,511,205) ---------- ------- ----------\nBalance, Dec. 31, 1993 $10,654,269 ($196,997) $10,457,272 Net income (loss) ( 574,825) 87,118 ( 487,707) Cash distributions ( 2,165,000) ( 113,000) ( 2,278,000) ---------- ------- ----------\nBalance, Dec. 31, 1994 $ 7,914,444 ($222,879) $ 7,691,565 Net income (loss) ( 798,537) 37,441 ( 761,096) Cash distributions ( 1,160,000) ( 61,000) ( 1,221,000) ---------- ------- ----------\nBalance, Dec. 31, 1995 $ 5,955,907 ($246,438) $ 5,709,469 ========== ======= ==========\nThe accompanying notes are an integral part of these combined financial statements.\nGEODYNE ENERGY INCOME LIMITED PARTNERSHIP II-B GEODYNE ENERGY INCOME PRODUCTION PARTNERSHIP II-B Combined Statements of Cash Flows For the Years Ended December 31, 1995, 1994, and 1993\n1995 1994 1993 ------------ ------------ ------------\nCASH FLOWS FROM OPERATING ACTIVITIES: Net loss ($ 761,096) ($ 487,707) ($ 239,290) Adjustments to reconcile net loss to net cash provided by operating activities: Depreciation, depletion, and amortization of oil and gas properties 1,436,788 2,787,591 2,570,101 Impairment provision 450,601 - - (Gain) loss on sale of oil and gas properties ( 10,869) ( 14,693) 7,270 Increase in deferred charge ( 53,003) ( 48,827) - Increase (decrease) in accrued liability ( 67,612) 166,378 - (Increase) decrease in accounts receivable ( 11,586) 233,588 189,788 Increase (decrease) in accounts payable ( 11,178) 22,788 92,594 Increase (decrease) in gas imbalance payable ( 3,745) ( 184,769) 92,210 --------- --------- --------- Net cash provided by operating activities $ 968,300 $2,474,349 $2,712,673 --------- --------- ---------\nCASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures ($ 217,765) ($ 203,350) ($ 138,546) Proceeds from sale of oil and gas properties 15,254 33,230 680 --------- --------- --------- Net cash used by investing activities ($ 202,511) ($ 170,120) ($ 137,866) --------- --------- ---------\nCASH FLOWS FROM FINANCING ACTIVITIES: Cash distributions ($1,221,000) ($2,278,000) ($2,511,205) --------- --------- --------- Net cash used by financing activities ($1,221,000) ($2,278,000) ($2,511,205) --------- --------- ---------\nNET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS ($ 455,211) $ 26,229 $ 63,602\nCASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 623,450 597,221 533,619 --------- --------- ---------\nCASH AND CASH EQUIVALENTS AT END OF PERIOD $ 168,239 $ 623,450 $ 597,221 ========= ========= =========\nThe accompanying notes are an integral part of these combined financial statements.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTO THE PARTNERS\nGEODYNE ENERGY INCOME LIMITED PARTNERSHIP II-C GEODYNE PRODUCTION PARTNERSHIP II-C\nWe have audited the combined balance sheets of the Geodyne Energy Income Limited Partnership II-C, an Oklahoma limited partnership, and Geodyne Production Partnership II-C, an Oklahoma general partnership, as of December 31, 1995 and 1994 and the related combined statements of operations, changes in partners' capital (deficit), and cash flows for the years ended December 31, 1995, 1994, and 1993. These financial statements are the responsibility of the Partnerships' 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 combined financial statements referred to above present fairly, in all material respects, the combined financial position of the Geodyne Energy Income Limited Partnership II-C and Geodyne Production Partnership II-C at December 31, 1995 and 1994 and the combined results of their operations and cash flows for the years ended December 31, 1995, 1994, and 1993, in conformity with generally accepted accounting principles.\nAs disclosed in Note 1 to the combined financial statements, the Geodyne Energy Income Limited Partnership II-C and Geodyne Production Partnership II-C changed their method of accounting for impairment of their oil and gas properties as of October 1, 1995.\nCOOPERS & LYBRAND L.L.P.\nTulsa, Oklahoma March 25, 1996\nGEODYNE ENERGY INCOME LIMITED PARTNERSHIP II-C GEODYNE ENERGY INCOME PRODUCTION PARTNERSHIP II-C Combined Balance Sheets December 31, 1995 and 1994\nASSETS ------\n1995 1994 ------------ ------------\nCURRENT ASSETS: Cash and cash equivalents $ 82,353 $ 380,901 Accounts receivable: Oil and gas sales, including $46,202 and $41,709 due from related parties 291,365 288,238 --------- --------- Total current assets $ 373,718 $ 669,139\nNET OIL AND GAS PROPERTIES, utilizing the successful efforts method 2,572,284 3,411,988\nDEFERRED CHARGE 259,941 210,793 --------- --------- $3,205,943 $4,291,920 ========= =========\nLIABILITIES AND PARTNERS' CAPITAL (DEFICIT) -------------------------------------------\nCURRENT LIABILITIES: Accounts payable $ 67,293 $ 56,341 Gas imbalance payable 59,892 104,939 --------- --------- Total current liabilities $ 127,185 $ 161,280\nACCRUED LIABILITY $ 138,658 $ 122,531\nPARTNERS' CAPITAL (DEFICIT): General Partner ($ 99,615) ($ 84,153) Limited Partners, issued and outstanding, 154,621 Units 3,039,715 4,092,262 --------- --------- Total Partners' capital $2,940,100 $4,008,109 --------- --------- $3,205,943 $4,291,920 ========= =========\nThe accompanying notes are an integral part of these combined financial statements.\nGEODYNE ENERGY INCOME LIMITED PARTNERSHIP II-C GEODYNE ENERGY INCOME PRODUCTION PARTNERSHIP II-C Combined Statements of Operations For the Years Ended December 31, 1995, 1994, and 1993\n1995 1994 1993 ------------ ------------ ------------ REVENUES: Oil and gas sales, including $225,948, $365,980, and $267,852 of sales to related parties $1,519,937 $2,289,166 $1,896,565 Interest income 6,475 13,099 4,832 Gain (loss) on sale of oil and gas properties 13,807 11,076 ( 11,756) Other income - 180 - --------- --------- --------- $1,540,219 $2,313,521 $1,889,641\nCOSTS AND EXPENSES: Lease operating $ 594,932 $ 663,437 $ 585,676 Production tax 103,713 156,417 146,040 Depreciation, depletion, and amortization of oil and gas properties 664,376 1,295,299 973,115 Impairment provision 245,324 - - General and administrative 248,883 183,693 180,094 Other - - 2,203 --------- --------- --------- $1,857,228 $2,298,846 $1,887,128 --------- --------- --------- NET INCOME (LOSS) ($ 317,009) $ 14,675 $ 2,513 ========= ========= =========\nGENERAL PARTNER - NET INCOME $ 20,538 $ 52,546 $ 39,050 ========= ========= =========\nLIMITED PARTNERS - NET LOSS ($ 337,547) ($ 37,871) ($ 36,537) ========= ========= =========\nNET LOSS per Unit ($ 2.18) ($ .24) ($ .24) ========= ========= =========\nUNITS OUTSTANDING 154,621 154,621 154,621 ========= ========= =========\nThe accompanying notes are an integral part of these combined financial statements.\nGEODYNE ENERGY INCOME LIMITED PARTNERSHIP II-C GEODYNE ENERGY INCOME PRODUCTION PARTNERSHIP II-C Combined Statements of Changes in Partners' Capital (Deficit) For the Years Ended December 31, 1995, 1994, and 1993\nLimited General Partners Partner Total ------------ --------- ------------\nBalance, Dec. 31, 1992 $6,407,337 ($64,354) $6,342,983 Net income (loss) ( 36,537) 39,050 2,513 Cash distributions ( 1,150,667) ( 54,895) ( 1,205,562) --------- ------ --------- Balance, Dec. 31, 1993 $5,220,133 ($80,199) $5,139,934 Net income (loss) ( 37,871) 52,546 14,675 Cash distributions ( 1,090,000) ( 56,500) ( 1,146,500) --------- ------ ---------\nBalance, Dec. 31, 1994 $4,092,262 ($84,153) $4,008,109 Net income (loss) ( 337,547) 20,538 ( 317,009) Cash distributions ( 715,000) ( 36,000) ( 751,000) --------- ------ ---------\nBalance, Dec. 31, 1995 $3,039,715 ($99,615) $2,940,100 ========= ====== =========\nThe accompanying notes are an integral part of these combined financial statements.\nGEODYNE ENERGY INCOME LIMITED PARTNERSHIP II-C GEODYNE ENERGY INCOME PRODUCTION PARTNERSHIP II-C Combined Statements of Cash Flows For the Years Ended December 31, 1995, 1994, and 1993\n1995 1994 1993 ------------ ------------ ------------\nCASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) ($ 317,009) $ 14,675 $ 2,513 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation, depletion, and amortization of oil and gas properties 664,376 1,295,299 973,115 Impairment provision 245,324 - - (Gain) loss on sale of oil and gas properties ( 13,807) ( 11,076) 11,756 (Increase) decrease in accounts receivable ( 3,127) 72,543 13,316 Increase (decrease) in accounts payable 10,952 ( 8,557) 28,455 Increase in deferred charge ( 49,148) ( 27,159) ( 183,634) Increase (decrease) in gas imbalance payable ( 45,047) ( 104,745) 209,684 Increase in accrued liability 16,127 50,653 71,878 --------- --------- --------- Net cash provided by operating activities $ 508,641 $1,281,633 $1,127,083 --------- --------- ---------\nCASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures ($ 77,297) ($ 58,552) ($ 52,946) Proceeds from sale of oil and gas properties 21,108 4,143 111,780 --------- --------- --------- Net cash provided (used) by investing activities ($ 56,189) ($ 54,409) $ 58,834 --------- --------- ---------\nCASH FLOWS FROM FINANCING ACTIVITIES: Cash distributions ($ 751,000) ($1,146,500) ($1,205,562) --------- --------- --------- Net cash used by financing activities ($ 751,000) ($1,146,500) ($1,205,562) --------- --------- ---------\nNET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS ($ 298,548) $ 80,724 ($ 19,645)\nCASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 380,901 300,177 319,822 --------- --------- ---------\nCASH AND CASH EQUIVALENTS AT END OF PERIOD $ 82,353 $ 380,901 $ 300,177 ========= ========= =========\nThe accompanying notes are an integral part of these combined financial statements.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTO THE PARTNERS\nGEODYNE ENERGY INCOME LIMITED PARTNERSHIP II-D GEODYNE PRODUCTION PARTNERSHIP II-D\nWe have audited the combined balance sheets of the Geodyne Energy Income Limited Partnership II-D, an Oklahoma limited partnership, and Geodyne Production Partnership II-D, an Oklahoma general partnership, as of December 31, 1995 and 1994 and the related combined statements of operations, changes in partners' capital (deficit), and cash flows for the years ended December 31, 1995, 1994, and 1993. These financial statements are the responsibility of the Partnerships' 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 combined financial statements referred to above present fairly, in all material respects, the combined financial position of the Geodyne Energy Income Limited Partnership II-D and Geodyne Production Partnership II-D at December 31, 1995 and 1994 and the combined results of their operations and cash flows for the years ended December 31, 1995, 1994, and 1993, in conformity with generally accepted accounting principles.\nAs disclosed in Note 1 to the combined financial statements, the Geodyne Energy Income Limited Partnership II-D and Geodyne Production Partnership II-D changed their method of accounting for impairment of their oil and gas properties as of October 1, 1995.\nCOOPERS & LYBRAND L.L.P.\nTulsa, Oklahoma March 25, 1996\nGEODYNE ENERGY INCOME LIMITED PARTNERSHIP II-D GEODYNE ENERGY INCOME PRODUCTION PARTNERSHIP II-D Combined Balance Sheets December 31, 1995 and 1994\nASSETS ------\n1995 1994 ------------ ------------\nCURRENT ASSETS: Cash and cash equivalents $ 317,368 $ 563,613 Accounts receivable: Oil and gas sales, including $124,908 and $121,780 due from related parties 630,370 697,345 --------- --------- Total current assets $ 947,738 $1,260,958\nNET OIL AND GAS PROPERTIES, utilizing the successful efforts method 5,394,199 7,261,978\nDEFERRED CHARGE 949,227 1,048,947 --------- --------- $7,291,164 $9,571,883 ========= =========\nLIABILITIES AND PARTNERS' CAPITAL (DEFICIT) -------------------------------------------\nCURRENT LIABILITIES: Accounts payable $ 146,808 $ 195,236 Gas imbalance payable 117,523 208,023 --------- --------- Total current liabilities $ 264,331 $ 403,259\nACCRUED LIABILITY $ 285,420 $ 222,635\nPARTNERS' CAPITAL (DEFICIT): General Partner ($ 143,473) ($ 111,528) Limited Partners, issued and outstanding, 314,878 Units 6,884,886 9,057,517 --------- --------- Total Partners' capital $6,741,413 $8,945,989 --------- --------- $7,291,164 $9,571,883 ========= =========\nThe accompanying notes are an integral part of these combined financial statements.\nGEODYNE ENERGY INCOME LIMITED PARTNERSHIP II-D GEODYNE ENERGY INCOME PRODUCTION PARTNERSHIP II-D Combined Statements of Operations For the Years Ended December 31, 1995, 1994, and 1993\n1995 1994 1993 ------------ ------------ ------------ REVENUES: Oil and gas sales, including $682,346, $909,348, and $707,391 of sales to related parties $3,901,516 $4,849,160 $4,353,624 Interest income 14,424 9,816 10,592 Gain (loss) on sale of oil and gas properties 27,963 2,133 ( 5,164) Other income - - 31,217 --------- --------- --------- $3,943,903 $4,861,109 $4,390,269\nCOSTS AND EXPENSES: Lease operating $1,854,632 $1,296,072 $1,552,331 Production tax 281,612 439,689 369,055 Depreciation, depletion, and amortization of oil and gas properties 1,548,167 2,812,182 2,201,884 Impairment provision 370,172 - - General and administrative 542,896 398,240 320,137 --------- --------- --------- $4,597,479 $4,946,183 $4,443,407 --------- --------- --------- NET LOSS ($ 653,576) ($ 85,074) ($ 53,138) ========= ========= =========\nGENERAL PARTNER - NET INCOME $ 44,055 $ 108,234 $ 85,418 ========= ========= =========\nLIMITED PARTNERS - NET LOSS ($ 697,631) ($ 193,308) ($ 138,556) ========= ========= =========\nNET LOSS per Unit ($ 2.22) ($ .61) ($ .44) ========= ========= =========\nUNITS OUTSTANDING 314,878 314,878 314,878 ========= ========= =========\nThe accompanying notes are an integral part of these combined financial statements.\nGEODYNE ENERGY INCOME LIMITED PARTNERSHIP II-D GEODYNE ENERGY INCOME PRODUCTION PARTNERSHIP II-D Combined Statements of Changes in Partners' Capital (Deficit) For the Years Ended December 31, 1995, 1994, and 1993\nLimited General Partners Partner Total ------------- ---------- -------------\nBalance, Dec. 31, 1992 $14,278,065 ($107,460) $14,170,605 Net income (loss) ( 138,556) 85,418 ( 53,138) Cash distributions ( 2,923,684) ( 113,220) ( 3,036,904) ---------- ------- ---------- Balance, Dec. 31, 1993 $11,215,825 ($135,262) $11,080,563 Net income (loss) ( 193,308) 108,234 ( 85,074) Cash distributions ( 1,965,000) ( 84,500) ( 2,049,500) ---------- ------- ----------\nBalance, Dec. 31, 1994 $ 9,057,517 ($111,528) $ 8,945,989 Net income (loss) ( 697,631) 44,055 ( 653,576) Cash distributions ( 1,475,000) ( 76,000) ( 1,551,000) ---------- ------- ----------\nBalance, Dec. 31, 1995 $ 6,884,886 ($143,473) $ 6,741,413 ========== ======= ==========\nThe accompanying notes are an integral part of these combined financial statements.\nGEODYNE ENERGY INCOME LIMITED PARTNERSHIP II-D GEODYNE ENERGY INCOME PRODUCTION PARTNERSHIP II-D Combined Statements of Cash Flows For the Years Ended December 31, 1995, 1994, and 1993\n1995 1994 1993 ------------ ------------ ------------\nCASH FLOWS FROM OPERATING ACTIVITIES: Net loss ($ 653,576) ($ 85,074) ($ 53,138) Adjustments to reconcile net loss to net cash provided by operating activities: Depreciation, depletion, and amortization of oil and gas properties 1,548,167 2,812,182 2,201,884 Impairment provision 370,172 - - Gain on sale of oil and gas properties ( 27,963) ( 2,133) ( 5,164) (Increase) decrease in deferred charge 99,720 ( 506,260) - Increase in accrued liability 62,785 41,723 - Decrease in accounts receivable 66,975 321,203 280,576 Increase (decrease) in accounts payable ( 48,428) 31,666 ( 13,874) Increase (decrease) in gas imbalance payable ( 90,500) ( 54,864) 262,887 --------- --------- --------- Net cash provided by operating activities $1,327,352 $2,558,443 $2,673,171 --------- --------- ---------\nCASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures ($ 58,694) ($ 100,082) ($ 178,362) Proceeds from sale of oil and gas properties 36,097 7,537 10,475 --------- --------- --------- Net cash used by investing activities ($ 22,597) ($ 92,545) ($ 167,887) --------- --------- ---------\nCASH FLOWS FROM FINANCING ACTIVITIES: Cash distributions ($1,551,000) ($2,049,500) ($3,036,904) --------- --------- --------- Net cash used by financing activities ($1,551,000) ($2,049,500) ($3,036,904) --------- --------- ---------\nNET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS ($ 246,245) $ 416,398 ($ 531,620)\nCASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 563,613 147,215 678,835 --------- --------- ---------\nCASH AND CASH EQUIVALENTS AT END OF PERIOD $ 317,368 $ 563,613 $ 147,215 ========= ========= =========\nThe accompanying notes are an integral part of these combined financial statements.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTO THE PARTNERS\nGEODYNE ENERGY INCOME LIMITED PARTNERSHIP II-E GEODYNE PRODUCTION PARTNERSHIP II-E\nWe have audited the combined balance sheets of the Geodyne Energy Income Limited Partnership II-E, an Oklahoma limited partnership, and Geodyne Production Partnership II-E, an Oklahoma general partnership, as of December 31, 1995 and 1994 and the related combined statements of operations, changes in partners' capital (deficit), and cash flows for the years ended December 31, 1995, 1994, and 1993. These financial statements are the responsibility of the Partnerships' 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 combined financial statements referred to above present fairly, in all material respects, the combined financial position of the Geodyne Energy Income Limited Partnership II-E and Geodyne Production Partnership II-E at December 31, 1995 and 1994 and the combined results of their operations and cash flows for the years ended December 31, 1995, 1994, and 1993, in conformity with generally accepted accounting principles.\nAs disclosed in Note 1 to the combined financial statements, the Geodyne Energy Income Limited Partnership II-E and Geodyne Production Partnership II-E changed their method of accounting for impairment of their oil and gas properties as of October 1, 1995.\nCOOPERS & LYBRAND L.L.P.\nTulsa, Oklahoma March 25, 1996\nGEODYNE ENERGY INCOME LIMITED PARTNERSHIP II-E GEODYNE ENERGY INCOME PRODUCTION PARTNERSHIP II-E Combined Balance Sheets December 31, 1995 and 1994\nASSETS ------\n1995 1994 ------------ ------------\nCURRENT ASSETS: Cash and cash equivalents $ 201,042 $ 260,348 Accounts receivable: Oil and gas sales, including $122,758 and $90,940 due from related parties 409,630 355,365 --------- --------- Total current assets $ 610,672 $ 615,713\nNET OIL AND GAS PROPERTIES, utilizing the successful efforts method 5,293,979 7,062,612\nDEFERRED CHARGE 374,745 438,881 --------- --------- $6,279,396 $8,117,206 ========= =========\nLIABILITIES AND PARTNERS' CAPITAL (DEFICIT) -------------------------------------------\nCURRENT LIABILITIES: Accounts payable $ 90,392 $ 97,077 Gas imbalance payable 84,265 41,780 --------- --------- Total current liabilities $ 174,657 $ 138,857\nACCRUED LIABILITY $ 134,283 $ 180,097\nPARTNERS' CAPITAL (DEFICIT): General Partner ($ 122,950) ($ 104,398) Limited Partners, issued and outstanding, 228,821 Units 6,093,406 7,902,650 --------- --------- Total Partners' capital $5,970,456 $7,798,252 --------- --------- $6,279,396 $8,117,206 ========= =========\nThe accompanying notes are an integral part of these combined financial statements.\nGEODYNE ENERGY INCOME LIMITED PARTNERSHIP II-E GEODYNE ENERGY INCOME PRODUCTION PARTNERSHIP II-E Combined Statements of Operations For the Years Ended December 31, 1995, 1994, and 1993\n1995 1994 1993 ------------ ------------ ------------\nREVENUES: Oil and gas sales, including $593,218, $618,067, and $456,173 of sales to related parties $2,297,409 $2,480,706 $2,572,564 Interest income 5,942 5,481 8,726 Gain (loss) on sale of oil and gas properties 15,120 1,475 ( 3,053) Other income - 4,361 2,944 --------- --------- --------- $2,318,471 $2,492,023 $2,581,181\nCOSTS AND EXPENSES: Lease operating $ 965,824 $ 725,707 $ 785,782 Production tax 182,683 218,191 205,443 Depreciation, depletion, and amortization of oil and gas properties 1,358,410 2,075,423 1,830,465 Impairment provision 465,045 - - General and administrative 616,305 271,833 233,659 --------- --------- --------- $3,588,267 $3,291,154 $3,055,349 --------- --------- --------- NET LOSS ($1,269,796) ($ 799,131) ($ 474,168) ========= ========= =========\nGENERAL PARTNER - NET INCOME $ 9,448 $ 43,060 $ 49,510 ========= ========= =========\nLIMITED PARTNERS - NET LOSS ($1,279,244) ($ 842,191) ($ 523,678) ========= ========= =========\nNET LOSS per Unit ($ 5.59) ($ 3.68) ($ 2.29) ========= ========= =========\nUNITS OUTSTANDING 228,821 228,821 228,821 ========= ========= =========\nThe accompanying notes are an integral part of these combined financial statements.\nGEODYNE ENERGY INCOME LIMITED PARTNERSHIP II-E GEODYNE ENERGY INCOME PRODUCTION PARTNERSHIP II-E Combined Statements of Changes in Partners' Capital (Deficit) For the Years Ended December 31, 1995, 1994, and 1993\nLimited General Partners Partner Total ------------- ---------- -------------\nBalance, Dec. 31, 1992 $12,151,338 ($ 80,783) $12,070,555 Net income (loss) ( 523,678) 49,510 ( 474,168) Cash distributions ( 1,787,819) ( 63,685) ( 1,851,504) ---------- ------- ---------- Balance, Dec. 31, 1993 $ 9,839,841 ($ 94,958) $ 9,744,883 Net income (loss) ( 842,191) 43,060 ( 799,131) Cash distributions ( 1,095,000) ( 52,500) ( 1,147,500) ---------- ------- ----------\nBalance, Dec. 31, 1994 $ 7,902,650 ($104,398) $ 7,798,252 Net income (loss) ( 1,279,244) 9,448 ( 1,269,796) Cash distributions ( 530,000) ( 28,000) ( 558,000) ---------- ------- ----------\nBalance, Dec. 31, 1995 $ 6,093,406 ($122,950) $ 5,970,456 ========== ======= ==========\nThe accompanying notes are an integral part of these combined financial statements.\nGEODYNE ENERGY INCOME LIMITED PARTNERSHIP II-E GEODYNE ENERGY INCOME PRODUCTION PARTNERSHIP II-E Combined Statements of Cash Flows For the Years Ended December 31, 1995, 1994, and 1993\n1995 1994 1993 ------------ ------------ ------------\nCASH FLOWS FROM OPERATING ACTIVITIES: Net loss ($1,269,796) ($ 799,131) ($ 474,168) Adjustments to reconcile net loss to net cash provided by operating activities: Depreciation, depletion, and amortization of oil and gas properties 1,358,410 2,075,423 1,830,465 Impairment provision 465,045 - - (Gain) loss on sale of oil and gas properties ( 15,120) ( 1,475) 3,053 (Increase) decrease in accounts receivable ( 54,265) 223,408 117,099 Decrease in accounts payable ( 6,685) ( 13,503) ( 12,573) Increase (decrease) in gas imbalance payable 42,485 ( 3,938) 45,718 Increase (decrease) in accrued liability ( 45,814) 60,855 119,242 (Increase) decrease in deferred charge 64,136 ( 322,362) ( 116,519) --------- --------- --------- Net cash provided by operating activities $ 538,396 $1,219,277 $1,512,317 --------- --------- ---------\nCASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures ($ 82,764) ($ 44,274) ($ 62,161) Proceeds from sale of oil and gas properties 43,062 2,308 1,749 --------- --------- --------- Net cash used by investing activities ($ 39,702) ($ 41,966) ($ 60,412) --------- --------- ---------\nCASH FLOWS FROM FINANCING ACTIVITIES: Cash distributions ($ 558,000) ($1,147,500) ($1,851,504) --------- --------- --------- Net cash used by financing activities ($ 558,000) ($1,147,500) ($1,851,504) --------- --------- ---------\nNET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS ($ 59,306) $ 29,811 ($ 399,599)\nCASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 260,348 230,537 630,136 --------- --------- ---------\nCASH AND CASH EQUIVALENTS AT END OF PERIOD $ 201,042 $ 260,348 $ 230,537 ========= ========= =========\nThe accompanying notes are an integral part of these combined financial statements.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTO THE PARTNERS\nGEODYNE ENERGY INCOME LIMITED PARTNERSHIP II-F GEODYNE PRODUCTION PARTNERSHIP II-F\nWe have audited the combined balance sheets of the Geodyne Energy Income Limited Partnership II-F, an Oklahoma limited partnership, and Geodyne Production Partnership II-F, an Oklahoma general partnership, as of December 31, 1995 and 1994 and the related combined statements of operations, changes in partners' capital (deficit), and cash flows for the years ended December 31, 1995, 1994, and 1993. These financial statements are the responsibility of the Partnerships' 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 combined financial statements referred to above present fairly, in all material respects, the combined financial position of the Geodyne Energy Income Limited Partnership II-F and Geodyne Production Partnership II-F at December 31, 1995 and 1994 and the combined results of their operations and cash flows for the years ended December 31, 1995, 1994, and 1993, in conformity with generally accepted accounting principles.\nAs disclosed in Note 1 to the combined financial statements, the Geodyne Energy Income Limited Partnership II-F and Geodyne Production Partnership II-F changed their method of accounting for impairment of their oil and gas properties as of October 1, 1995.\nCOOPERS & LYBRAND L.L.P.\nTulsa, Oklahoma March 25, 1996\nGEODYNE ENERGY INCOME LIMITED PARTNERSHIP II-F GEODYNE ENERGY INCOME PRODUCTION PARTNERSHIP II-F Combined Balance Sheets December 31, 1995 and 1994\nASSETS ------\n1995 1994 ------------ ------------ CURRENT ASSETS: Cash and cash equivalents $ 325,816 $ 237,397 Accounts receivable: Oil and gas sales, including $66,788 and $61,777 due from related parties 352,473 321,964 --------- --------- Total current assets $ 678,289 $ 559,361\nNET OIL AND GAS PROPERTIES, utilizing the successful efforts method 4,936,055 6,309,820\nDEFERRED CHARGE 119,115 98,251 --------- --------- $5,733,459 $6,967,432 ========= =========\nLIABILITIES AND PARTNERS' CAPITAL (DEFICIT) -------------------------------------------\nCURRENT LIABILITIES: Accounts payable $ 79,348 $ 65,394 Gas imbalance payable 23,373 43,583 --------- --------- Total current liabilities $ 102,721 $ 108,977\nACCRUED LIABILITY $ 23,330 $ 40,102\nPARTNERS' CAPITAL (DEFICIT): General Partner ($ 84,377) ($ 80,063) Limited Partners, issued and outstanding, 171,400 Units 5,691,785 6,898,416 --------- --------- Total Partners' capital $5,607,408 $6,818,353 --------- --------- $5,733,459 $6,967,432 ========= =========\nThe accompanying notes are an integral part of these combined financial statements.\nGEODYNE ENERGY INCOME LIMITED PARTNERSHIP II-F GEODYNE ENERGY INCOME PRODUCTION PARTNERSHIP II-F Combined Statements of Operations For the Years Ended December 31, 1995, 1994, and 1993\n1995 1994 1993 ------------ ---------- ---------- REVENUES: Oil and gas sales, including $367,527, $543,786, and $309,628 of sales to related parties $2,028,592 $2,316,564 $2,636,304 Interest income 9,818 8,634 8,936 Gain on sale of oil and gas properties 27,433 1,130 874\n--------- --------- --------- $2,065,843 $2,326,328 $2,646,114\nCOSTS AND EXPENSES: Lease operating $ 522,525 $ 582,556 $ 496,440 Production tax 139,134 195,080 185,532 Depreciation, depletion, and amortization of oil and gas properties 1,036,058 1,269,912 1,591,424 Impairment provision 312,270 - - General and administrative 200,801 204,758 176,202 Other - - 1,037 --------- --------- --------- $2,210,788 $2,252,306 $2,450,635 --------- --------- --------- NET INCOME (LOSS) ($ 144,945) $ 74,022 $ 195,479\n========= ========= =========\nGENERAL PARTNER - NET INCOME $ 46,686 $ 54,498 $ 73,431 ========= ========= =========\nLIMITED PARTNERS - NET INCOME (LOSS) ($ 191,631) $ 19,524 $ 122,048\n========= ========= =========\nNET INCOME (LOSS) per Unit ($ 1.12) $ .11 $ .71 ========= ========= =========\nUNITS OUTSTANDING 171,400 171,400 171,400 ========= ========= =========\nThe accompanying notes are an integral part of these combined financial statements.\nGEODYNE ENERGY INCOME LIMITED PARTNERSHIP II-F GEODYNE ENERGY INCOME PRODUCTION PARTNERSHIP II-F Combined Statements of Changes in Partners' Capital (Deficit) For the Years Ended December 31, 1995, 1994, and 1993\nLimited General Partners Partner Total ------------ --------- ------------\nBalance, Dec. 31, 1992 $9,857,985 ($49,422) $9,808,563 Net income 122,048 73,431 195,479 Cash distributions ( 1,521,141) ( 76,570) ( 1,597,711) --------- ------ ---------\nBalance, Dec. 31, 1993 $8,458,892 ($52,561) $8,406,331 Net income 19,524 54,498 74,022 Cash distributions ( 1,580,000) ( 82,000) ( 1,662,000) --------- ------ ---------\nBalance, Dec. 31, 1994 $6,898,416 ($80,063) $6,818,353 Net income (loss) ( 191,631) 46,686 ( 144,945) Cash distributions ( 1,015,000) ( 51,000) ( 1,066,000) --------- ------ ---------\nBalance, Dec. 31, 1995 $5,691,785 ($84,377) $5,607,408 ========= ====== =========\nThe accompanying notes are an integral part of these combined financial statements.\nGEODYNE ENERGY INCOME LIMITED PARTNERSHIP II-F GEODYNE ENERGY INCOME PRODUCTION PARTNERSHIP II-F Combined Statements of Cash Flows For the Years Ended December 31, 1995, 1994, and 1993\n1995 1994 1993 ------------ ------------ ------------\nCASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) ($ 144,945) $ 74,022 $ 195,479 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation, depletion, and amortization of oil and gas properties 1,036,058 1,269,912 1,591,424 Impairment provision 312,270 - - Gain on sale of oil and gas properties ( 27,433) ( 1,130) ( 874) (Increase) decrease in accounts receivable ( 30,509) 89,992 39,952 Increase (decrease) in accounts payable 13,954 4,291 ( 62,727) Increase in deferred charge ( 20,864) ( 52,880) ( 45,371) Increase (decrease) in gas imbalance payable ( 20,210) 2,965 ( 242) Increase (decrease) in accrued liability ( 16,772) 4,006 36,096 --------- --------- --------- Net cash provided by operating activities $1,101,549 $1,391,178 $1,753,737 --------- --------- ---------\nCASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures ($ 18,171) ($ 38,920) ($ 48,016) Proceeds from sale of oil and gas properties 71,041 2,412 12,531 --------- --------- --------- Net cash provided (used) by investing activities $ 52,870 ($ 36,508) ($ 35,485) --------- --------- ---------\nCASH FLOWS FROM FINANCING ACTIVITIES: Cash distributions ($1,066,000) ($1,662,000) ($1,597,711) --------- --------- --------- Net cash used by financing activities ($1,066,000) ($1,662,000) ($1,597,711) --------- --------- ---------\nNET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS $ 88,419 ($ 307,330) $ 120,541\nCASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 237,397 544,727 424,186 --------- --------- ---------\nCASH AND CASH EQUIVALENTS AT END OF PERIOD $ 325,816 $ 237,397 $ 544,727 ========= ========= =========\nThe accompanying notes are an integral part of these combined financial statements.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTO THE PARTNERS\nGEODYNE ENERGY INCOME LIMITED PARTNERSHIP II-G GEODYNE PRODUCTION PARTNERSHIP II-G\nWe have audited the combined balance sheets of the Geodyne Energy Income Limited Partnership II-G, an Oklahoma limited partnership, and Geodyne Production Partnership II-G, an Oklahoma general partnership, as of December 31, 1995 and 1994 and the related combined statements of operations, changes in partners' capital (deficit), and cash flows for the years ended December 31, 1995, 1994, and 1993. These financial statements are the responsibility of the Partnerships' 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 combined financial statements referred to above present fairly, in all material respects, the combined financial position of the Geodyne Energy Income Limited Partnership II-G and Geodyne Production Partnership II-G at December 31, 1995 and 1994 and the combined results of their operations and cash flows for the years ended December 31, 1995, 1994, and 1993, in conformity with generally accepted accounting principles.\nAs disclosed in Note 1 to the combined financial statements, the Geodyne Energy Income Limited Partnership II-G and Geodyne Production Partnership II-G changed their method of accounting for impairment of their oil and gas properties as of October 1, 1995.\nCOOPERS & LYBRAND L.L.P.\nTulsa, Oklahoma March 25, 1996\nGEODYNE ENERGY INCOME LIMITED PARTNERSHIP II-G GEODYNE ENERGY INCOME PRODUCTION PARTNERSHIP II-G Combined Balance Sheets December 31, 1995 and 1994\nASSETS ------\n1995 1994 ------------- ------------- CURRENT ASSETS: Cash and cash equivalents $ 661,921 $ 492,117 Accounts receivable: Oil and gas sales, including $141,036 and $130,572 due from related parties 748,457 687,939 ---------- ---------- Total current assets $ 1,410,378 $ 1,180,056\nNET OIL AND GAS PROPERTIES, utilizing the successful efforts method 10,851,397 14,057,651\nDEFERRED CHARGE 257,374 219,078 ---------- ---------- $12,519,149 $15,456,785 ========== ==========\nLIABILITIES AND PARTNERS' CAPITAL (DEFICIT) -------------------------------------------\nCURRENT LIABILITIES: Accounts payable $ 176,095 $ 139,970 Gas imbalance payable 50,501 94,414 ---------- ---------- Total current liabilities $ 226,596 $ 234,384\nACCRUED LIABILITY $ 50,802 $ 90,341\nPARTNERS' CAPITAL (DEFICIT): General Partner ($ 197,620) ($ 181,500) Limited Partners, issued and outstanding, 372,189 Units 12,439,371 15,313,560 ---------- ---------- Total Partners' capital $12,241,751 $15,132,060 ---------- ---------- $12,519,149 $15,456,785 ========== ==========\nThe accompanying notes are an integral part of these combined financial statements.\nGEODYNE ENERGY INCOME LIMITED PARTNERSHIP II-G GEODYNE ENERGY INCOME PRODUCTION PARTNERSHIP II-G Combined Statements of Operations For the Years Ended December 31, 1995, 1994, and 1993\n1995 1994 1993 ------------ ------------ ---------- REVENUES: Oil and gas sales, including $776,211, $1,150,665, and $656,517 of sales to related parties $4,348,087 $5,116,776 $5,581,221 Interest income 20,378 19,121 19,559 Gain on sale of oil and gas properties 51,339 1,377 1,882 Other income - - 31,784 ---------- --------- ---------\n$4,419,804 $5,137,274 $5,634,446\nCOSTS AND EXPENSES: Lease operating $1,152,908 $1,396,694 $1,085,377 Production tax 302,449 430,864 395,652 Depreciation, depletion, and amortization of oil and gas properties 2,306,915 2,809,502 3,491,609 Impairment provision 839,228 - - General and administrative 437,613 441,568 377,079 Other - 32,648 - --------- --------- --------- $5,039,113 $5,111,276 $5,349,717 --------- --------- ---------\nNET INCOME (LOSS) ($ 619,309) $ 25,998 $ 284,729 ========= ========= =========\nGENERAL PARTNER - NET INCOME $ 94,880 $ 113,680 $ 153,901 ========= ========= =========\nLIMITED PARTNERS - NET INCOME (LOSS) ($ 714,189) ($ 87,682) $ 130,828 ========= ========= =========\nNET INCOME (LOSS) per Unit ($ 1.92) ($ .24) $ .35 ========= ========= =========\nUNITS OUTSTANDING 372,189 372,189 372,189 ========= ========= =========\nThe accompanying notes are an integral part of these combined financial statements.\nGEODYNE ENERGY INCOME LIMITED PARTNERSHIP II-G GEODYNE ENERGY INCOME PRODUCTION PARTNERSHIP II-G Combined Statements of Changes in Partners' Capital (Deficit) For the Years Ended December 31, 1995, 1994, and 1993\nLimited General Partners Partner Total ------------- ---------- -------------\nBalance, Dec. 31, 1992 $21,770,067 ($104,626) $21,665,441 Net income 130,828 153,901 284,729 Cash distributions ( 3,254,653) ( 171,455) ( 3,426,108) ---------- ------- ----------\nBalance, Dec. 31, 1993 $18,646,242 ($122,180) $18,524,062 Net income (loss) ( 87,682) 113,680 25,998 Cash distributions ( 3,245,000) ( 173,000) ( 3,418,000) ---------- ------- ----------\nBalance, Dec. 31, 1994 $15,313,560 ($181,500) $15,132,060 Net income (loss) ( 714,189) 94,880 ( 619,309) Cash distributions ( 2,160,000) ( 111,000) ( 2,271,000) ---------- ------- ----------\nBalance, Dec. 31, 1995 $12,439,371 ($197,620) $12,241,751 ========== ======= ==========\nThe accompanying notes are an integral part of these combined financial statements.\nGEODYNE ENERGY INCOME LIMITED PARTNERSHIP II-G GEODYNE ENERGY INCOME PRODUCTION PARTNERSHIP II-G Combined Statements of Cash Flows For the Years Ended December 31, 1995, 1994, and 1993\n1995 1994 1993 ------------ ------------ ------------\nCASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) ($ 619,309) $ 25,998 $ 284,729 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation, depletion, and amortization of oil and gas properties 2,306,915 2,809,502 3,491,609 Impairment provision 839,228 - - Gain on sale of oil and gas properties ( 51,339) ( 1,377) ( 1,882) (Increase) decrease in accounts receivable ( 60,518) 217,929 58,369 Increase (decrease) in accounts payable 36,125 9,959 ( 131,587) Increase in deferred charge ( 38,296) ( 122,766) ( 96,312) Increase (decrease) in gas imbalance payable ( 43,913) 2,370 16,380 Increase (decrease) in accrued liability ( 39,539) 10,876 79,465 --------- --------- --------- Net cash provided by operating activities $2,329,354 $2,952,491 $3,700,771 --------- --------- ---------\nCASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures ($ 40,899) ($ 114,454) ($ 101,498) Proceeds from sale of oil and gas properties 152,349 5,546 23,883 --------- --------- --------- Net cash provided (used) by investing activities $ 111,450 ($ 108,908) ($ 77,615) --------- --------- ---------\nCASH FLOWS FROM FINANCING ACTIVITIES: Cash distributions ($2,271,000) ($3,418,000) ($3,426,108) --------- --------- --------- Net cash used by financing activities ($2,271,000) ($3,418,000) ($3,426,108) --------- --------- ---------\nNET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS $ 169,804 ($ 574,417) $ 197,048\nCASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 492,117 1,066,534 869,486 --------- --------- ---------\nCASH AND CASH EQUIVALENTS AT END OF PERIOD $ 661,921 $ 492,117 $1,066,534 ========= ========= =========\nThe accompanying notes are an integral part of these combined financial statements.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTO THE PARTNERS\nGEODYNE ENERGY INCOME LIMITED PARTNERSHIP II-H GEODYNE PRODUCTION PARTNERSHIP II-H\nWe have audited the combined balance sheets of the Geodyne Energy Income Limited Partnership II-H, an Oklahoma limited partnership, and Geodyne Production Partnership II-H, an Oklahoma general partnership, as of December 31, 1995 and 1994 and the related combined statements of operations, changes in partners' capital (deficit), and cash flows for the years ended December 31, 1995, 1994, and 1993. These financial statements are the responsibility of the Partnerships' 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 combined financial statements referred to above present fairly, in all material respects, the combined financial position of the Geodyne Energy Income Limited Partnership II-H and Geodyne Production Partnership II-H at December 31, 1995 and 1994 and the combined results of their operations and cash flows for the years ended December 31, 1995, 1994, and 1993, in conformity with generally accepted accounting principles.\nAs disclosed in Note 1 to the combined financial statements, the Geodyne Energy Income Limited Partnership II-H and Geodyne Production Partnership II-H changed their method of accounting for impairment of their oil and gas properties as of October 1, 1995.\nCOOPERS & LYBRAND L.L.P.\nTulsa, Oklahoma March 25, 1996\nGEODYNE ENERGY INCOME LIMITED PARTNERSHIP II-H GEODYNE ENERGY INCOME PRODUCTION PARTNERSHIP II-H Combined Balance Sheets December 31, 1995 and 1994\nASSETS ------\n1995 1994 ------------ ------------ CURRENT ASSETS: Cash and cash equivalents $ 158,812 $ 124,102 Accounts receivable: Oil and gas sales, including $33,220 and $30,807 due from related parties 179,505 166,834 --------- --------- Total current assets $ 338,317 $ 290,936\nNET OIL AND GAS PROPERTIES, utilizing the successful efforts method 2,624,277 3,449,374\nDEFERRED CHARGE 62,062 49,839 --------- --------- $3,024,656 $3,790,149 ========= =========\nLIABILITIES AND PARTNERS' CAPITAL (DEFICIT) -------------------------------------------\nCURRENT LIABILITIES: Accounts payable $ 45,404 $ 33,996 Gas imbalance payable 11,211 18,690 --------- --------- Total current liabilities $ 56,615 $ 52,686\nACCRUED LIABILITY $ 12,779 $ 22,681\nPARTNERS' CAPITAL (DEFICIT): General Partner ($ 47,635) ($ 42,167) Limited Partners, issued and outstanding, 91,711 Units 3,002,897 3,756,949 --------- --------- Total Partners' capital $2,955,262 $3,714,782 --------- --------- $3,024,656 $3,790,149 ========= =========\nThe accompanying notes are an integral part of these combined financial statements.\nGEODYNE ENERGY INCOME LIMITED PARTNERSHIP II-H GEODYNE ENERGY INCOME PRODUCTION PARTNERSHIP II-H Combined Statements of Operations For the Years Ended December 31, 1995, 1994, and 1993\n1995 1994 1993 ------------ ------------ ------------ REVENUES: Oil and gas sales, including $182,878, $272,053, and $155,801 of sales to related parties $1,042,735 $1,208,886 $1,367,514 Interest income 4,721 4,315 4,346 Gain (loss) on sale of oil and gas properties 11,436 4,175 ( 4,271) --------- --------- ---------\n$1,058,892 $1,217,376 $1,367,589\nCOSTS AND EXPENSES: Lease operating $ 284,635 $ 322,897 $ 271,395 Production tax 74,349 104,796 98,672 Depreciation, depletion, and amortization of oil and gas properties 550,384 699,724 843,501 Impairment provision 259,808 - - General and administrative 107,236 110,634 96,260 Other - - 361 --------- --------- --------- $1,276,412 $1,238,051 $1,310,189 --------- --------- --------- NET INCOME (LOSS) ($ 217,520) ($ 20,675) $ 57,400 ========= ========= =========\nGENERAL PARTNER - NET INCOME $ 21,532 $ 26,955 $ 36,610 ========= ========= =========\nLIMITED PARTNERS - NET INCOME (LOSS) ($ 239,052) ($ 47,630) $ 20,790 ========= ========= =========\nNET INCOME (LOSS) per Unit ($ 2.61) ($ .52) $ .23 ========= ========= =========\nUNITS OUTSTANDING 91,711 91,711 91,711 ========= ========= =========\nThe accompanying notes are an integral part of these combined financial statements.\nGEODYNE ENERGY INCOME LIMITED PARTNERSHIP II-H GEODYNE ENERGY INCOME PRODUCTION PARTNERSHIP II-H Combined Statements of Changes in Partners' Capital (Deficit) For the Years Ended December 31, 1995, 1994, and 1993\nLimited General Partners Partner Total ------------ --------- ------------\nBalance, Dec. 31, 1992 $5,349,318 ($26,477) $5,322,841 Net income 20,790 36,610 57,400 Cash distributions ( 795,529) ( 39,255) ( 834,784) --------- ------ --------- Balance, Dec. 31, 1993 $4,574,579 ($29,122) $4,545,457 Net income (loss) ( 47,630) 26,955 ( 20,675) Cash distributions ( 770,000) ( 40,000) ( 810,000) --------- ------ ---------\nBalance, Dec. 31, 1994 $3,756,949 ($42,167) $3,714,782 Net income (loss) ( 239,052) $21,532 ( 217,520) Cash distributions ( 515,000) ( 27,000) ( 542,000) --------- ------ ---------\nBalance, Dec. 31, 1995 $3,002,897 ($47,635) $2,955,262 ========= ====== =========\nThe accompanying notes are an integral part of these combined financial statements.\nGEODYNE ENERGY INCOME LIMITED PARTNERSHIP II-H GEODYNE ENERGY INCOME PRODUCTION PARTNERSHIP II-H Combined Statements of Cash Flows For the Years Ended December 31, 1995, 1994, and 1993\n1995 1994 1993 ---------- ---------- ----------\nCASH FLOWS FROM OPERATING ACTIVITIES:\nNet income (loss) ($217,520) ($ 20,675) $ 57,400 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation, depletion, and amortization of oil and gas properties 550,384 699,724 843,501 Impairment provision 259,808 - - (Gain) loss on sale of oil and gas properties ( 11,436) ( 4,175) 4,271 (Increase) decrease in accounts receivable ( 12,671) 46,724 17,824 Increase (decrease) in accounts payable 11,408 1,874 ( 30,118) Increase in deferred charge ( 12,223) ( 25,782) ( 24,057) Decrease in gas imbalance payable ( 7,479) ( 1,905) ( 10,490) Increase (decrease) in accrued liability ( 9,902) 2,727 19,954 ------- ------- ------- Net cash provided by operating activities $550,369 $698,512 $878,285 ------- ------- -------\nCASH FLOWS FROM INVESTING ACTIVITIES:\nCapital expenditures ($ 10,563) ($ 21,559) ($ 24,059) Proceeds from sale of oil and gas properties 36,904 1,585 5,830 ------- ------- ------- Net cash provided (used) by investing activities $ 26,341 ($ 19,974) ($ 18,229) ------- ------- -------\nCASH FLOWS FROM FINANCING ACTIVITIES:\nCash distributions ($542,000) ($810,000) ($834,784) ------- ------- ------- Net cash used by financing activities ($542,000) ($810,000) ($834,784) ------- ------- -------\nNET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS $ 34,710 ($131,462) $ 25,272\nCASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 124,102 255,564 230,292 ------- ------- -------\nCASH AND CASH EQUIVALENTS AT END OF PERIOD $158,812 $124,102 $255,564 ======= ======= ======\nThe accompanying notes are an integral part of these combined financial statements.\nGEODYNE ENERGY INCOME PROGRAM II Notes to Combined Financial Statements For the Years Ended December 31, 1995, 1994, and 1993\n1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nOrganization and Nature of Operations\nThe Geodyne Energy Income Limited Partnerships (the \"Partner- ships\") were formed pursuant to a public offering of depositary units (\"Units\"). Upon formation, investors became limited partners (the \"Limited Partners\") and held Units issued by each Partnership. Geodyne Properties, Inc. is the general partner of each Partnership. Each Partnership is a general partner in the related Geodyne Production Partnership (the \"Production Partnership\") in which Geodyne Production Company serves as the managing partner. Geodyne Properties, Inc. and Geodyne Production Company are both wholly-owned subsidiaries of Geodyne Resources, Inc. Limited Partner capital contributions were contributed to the related Production Partnerships for investment in producing oil and gas properties. The Partnerships were activated on the following dates with the following Limited Partner capital contributions.\nLimited Date of Partner Capital Partnership Activation Contributions ----------- ------------------ ---------------\nII-A July 22, 1987 $48,428,300 II-B October 14,1987 36,171,900 II-C January 14, 1988 15,462,100 II-D May 10, 1988 31,487,800 II-E September 27, 1988 22,882,100 II-F January 5, 1989 17,140,000 II-G April 10, 1989 37,218,900 II-H May 17, 1989 9,171,100\nFor purposes of these financial statements, the Partnerships and Production Partnerships are collectively referred to as the \"Partnerships\" and the general partner and managing partner are collectively referred to as the \"General Partner\".\nThe General Partner and its affiliates owned the following Units at December 31, 1995:\nNumber of Percent of Partnership Units Owned Outstanding Units ----------- ----------- ----------------- II-A 45,222.0 9.3% II-B 36,166.0 10.0% II-C 15,997.0 10.3% II-D 27,295.5 8.7% II-E 22,900.0 10.0% II-F 15,370.0 9.0% II-G 26,846.0 7.2% II-H 10,767.0 11.7%\nThe Partnerships' sole business is the development and production of oil and natural gas. Substantially all of the Partnerships' natural gas reserves are being sold regionally in the \"spot market.\" Due to the highly competitive nature of the spot market, prices on the spot market are subject to wide seasonal and regional pricing fluctuations. In addition, such spot market sales are generally short-term in nature and are dependent upon the obtaining of transportation services provided by pipelines.\nAllocation of Costs and Revenues\nThe combination of the allocation provisions in each Partner- ship's limited partnership agreement and each Production Partnership's partnership agreement (collectively, the \"Partnership Agreement\") results in allocations of costs and income between the Limited Partners and General Partner as follows:\nBefore Payout After Payout ------------------ ------------------ General Limited General Limited Partner Partners Partner Partners -------- -------- -------- -------- Costs(1) - ------------------------ Sales commissions, pay- ment for organization and offering costs and management fee 1% 99% - - Property acquisition costs 1% 99% 1% 99% Identified development drilling 1% 99% 1% 99% Development drilling(2) 5% 95% 15% 85% General and administra- tive costs, direct administrative costs and operating costs(2) 5% 95% 15% 85%\nIncome(1) - ----------------------- Temporary investments of Limited Partners' subscriptions 1% 99% 1% 99% Income from oil and gas production(2) 5% 95% 15% 85% Gain on sale of produc- ing properties(2) 5% 95% 15% 85% All other income(2) 5% 95% 15% 85%\n- ----------\n(1) The allocations in the table result generally from the combined effect of the allocation provisions in the Partnership Agreements. For example, the costs incurred in development drilling are allocated 95.9596% to the limited partnership and 4.0404% to the managing partner. The 95.9596% portion of these costs allocated to the limited partnership, when passed through the limited partnership, is further allocated 99% to the limited partners and 1% to the general partner. In this manner the Limited Partners are allocated 95% of such costs and the General Partner is allocated 5% of such costs. (2) If at payout, the Limited Partners have received distributions at an annual rate less than 12% of their subscriptions, the percentage of income and costs allocated to the general partner and managing partner will increase to only 10% and the Limited Partners will decrease to only 90%. Thereafter, if the distribution to Limited Partners reaches an average annual rate of 12% the allocation will change to 15% to the general partner and managing partner and 85% to the Limited Partners.\nBasis of Presentation\nThese financial statements reflect the combined accounts of each Partnership after the elimination of all inter-partnership transactions and balances.\nCash and Cash Equivalents\nThe Partnerships consider all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. Cash equivalents are not insured, which cause the Partnerships to be subject to risk.\nCredit Risks\nAccrued oil and gas sales which are due from a variety of oil and natural gas purchasers subject the Partnerships to a concentration of credit risk. Some of these purchasers are discussed in Note 3 - Major Customers. Subsequent to year-end, all oil and gas sales accrued as of December 31, 1995 have been collected.\nOil and Gas Properties\nThe Partnerships follow the successful efforts method of accounting for their oil and gas properties. Under the successful efforts method, the Partnerships capitalize all property acquisition costs and development costs incurred in connection with the further development of oil and gas reserves. Property acquisition costs include costs incurred by the Partnerships or the General Partner to acquire producing properties, including related title insurance or examination costs, commissions, engineering, legal and accounting fees, and similar costs directly related to the acquisitions, plus an allocated portion of the General Partners' property screening costs. The acquisition cost to the Partnership of properties acquired by the General Partner is adjusted to reflect the net cash results of operations, including interest incurred to finance the acquisition, for the period of time the properties are held by the General Partner. Leasehold impairment for unproved properties is based upon an individual property assessment and exploratory experience. Upon discovery of commercial reserves, leasehold costs are transferred to producing properties.\nDepletion of the cost of producing oil and gas properties, amortization of related intangible drilling and development costs, and depreciation of tangible lease and well equipment are computed on the units-of-production method. The depreciation, depletion, and amortization rates per equivalent barrel of oil produced during the years ended December 31, 1995, 1994, and 1993 were as follows:\nPartnership 1995 1994 1993 ----------- ----- ----- -----\nII-A $4.44 $6.01 $7.48 II-B 5.09 7.22 7.83 II-C 4.45 6.59 6.70 II-D 3.81 6.59 6.29 II-E 6.18 9.94 9.43 II-F 5.29 6.27 7.64 II-G 5.48 6.18 7.91 II-H 5.40 6.56 7.78\nWhen complete units of depreciable property are retired or sold, the asset cost and related accumulated depreciation are eliminated with any gain or loss reflected in income. When less than complete units of depreciable property are retired or sold, the difference between asset cost and salvage value is charged or credited to accumulated depreciation.\nEffective October 1, 1995, the Partnerships adopted the requirements of Statement of Financial Accounting Standards (\"SFAS\") No. 121, \"Accounting for the Impairment of Long Lived Assets and Assets Held for Disposal,\" which is intended to establish more consistent accounting standards for measuring the recoverability of long-lived assets. SFAS No. 121 requires successful efforts companies, like the Partnerships, to evaluate the recoverability of the carrying costs of their proved oil and gas properties at the lowest level for which there are identifiable cash flows that are largely independent of the cash flows of other groups of oil and gas properties. With respect to the Partnerships' oil and gas properties, this evaluation was performed for each field, rather than for the Partnership's properties as a whole as previously allowed by the Securities and Exchange Commission (\"SEC\"). SFAS No. 121 provides that if the unamortized costs of oil and gas properties exceed the expected undiscounted future cash flows from such properties, the cost of the properties is written down to fair value, which is determined by using the discounted future cash flows from the properties. As a result of the Partnerships' adoption of SFAS No. 121, the Partnerships recorded a non-cash charge against earnings (impairment provision) during the fourth quarter of 1995 as follows:\nPartnership Amount ----------- -------- II-A $994,919 II-B 450,601 II-C 245,324 II-D 370,172 II-E 465,045 II-F 312,270 II-G 839,228 II-H 259,808\nNo such charge was recorded for any Partnership during the years ended December 31, 1994 and 1993 pursuant to the Partnerships' prior impairment policy. Impairment provisions do not impact the Partnerships' cash flows from operating activities; however, they do impact the amount of General Partner and Limited Partner capital. The risk that the Partnerships will be required to record such impairment provisions in the future increases when oil and gas prices are depressed. Accordingly, the II-A and II-D Partnerships have eleven fields, the II-B Partnership has four fields, the II-C Partnership has ten fields, the II-E Partnership has thirteen fields, the II-F and II- G Partnerships have nine fields, and the II-H Partnership has seven fields in which it is reasonably possible that a write-down will be incurred in the near term if gas prices decrease below December 31, 1995 levels.\nDeferred Charge\nDeferred Charge represents costs deferred for lease operating expenses incurred in connection with the Partnerships' underproduced gas imbalance positions. At December 1995 and 1994, cumulative total gas sales volumes for underproduced wells were less than the Partnerships' pro-rata share of total gas production from these wells by the following amounts:\n1995 1994 --------------------- --------------------- Partnership Mcf Amount Mcf Amount ----------- --------- ---------- --------- ----------\nII-A 1,100,703 $1,169,277 1,025,162 $ 980,772 II-B 189,899 226,303 178,402 173,300 II-C 305,202 259,941 321,380 210,793 II-D 1,069,431 949,227 1,203,887 1,048,947 II-E 370,778 374,745 387,636 438,881 II-F 179,850 119,115 129,721 98,251 II-G 383,282 257,374 275,328 219,078 II-H 91,013 62,062 64,650 49,839\nAccrued Liability\nAccrued liability represents charges accrued for direct operating expenses incurred in connection with the Partnerships' overproduced gas imbalance positions. At December 31, 1995 and 1994, cumulative total gas sales volumes for overproduced wells exceeded the Partnerships' pro-rata share of total gas production from these wells by the following amounts:\n1995 1994 ----------------- ----------------- Partnership Mcf Amount Mcf Amount ----------- ------- -------- ------- --------\nII-A 342,978 $272,667 416,713 $398,669 II-B 261,201 301,684 380,169 369,296 II-C 194,491 138,658 186,814 122,531 II-D 382,457 285,420 255,521 222,635 II-E 176,074 134,283 159,068 180,097 II-F 47,211 23,330 52,947 40,102 II-G 101,552 50,802 113,537 90,341 II-H 24,489 12,779 29,421 22,681\nOil and Gas Sales and Gas Imbalance Payable\nThe Partnerships' oil and condensate production is sold, title passed, and revenue recognized at or near the Partnerships' wells under short-term purchase contracts at prevailing prices in accordance with arrangements which are customary in the oil industry. Sales of natural gas applicable to the Partnerships' interest in producing oil and gas leases are recorded as income when the gas is metered and title transferred pursuant to the gas sales contracts covering the Partnerships' interest in natural gas reserves. During such times as a Partnership's sales of gas exceed its pro rata ownership in a well, such sales are recorded as income unless total sales from the well have exceeded the Partnership's share of estimated total gas reserves underlying the property, at which time such excess is recorded as a liability. At December 31, 1995 and 1994 total sales exceeded the Partnerships' share of estimated total gas reserves as follows:\n1995 1994 ----------------- ------------------- Partnership Mcf Amount Mcf Amount ----------- ------- -------- ------- ----------\nII-A 86,302 $164,837 139,711 $217,949 II-B 8,047 15,048 12,446 18,793 II-C 31,689 59,892 68,142 104,939 II-D 60,893 117,523 136,857 208,023 II-E 43,213 84,265 27,487 41,780 II-F 11,986 23,373 27,584 43,583 II-G 25,898 50,501 59,380 94,414 II-H 5,749 11,211 11,681 18,690\nThese amounts were recorded as gas imbalance payables in accordance with the sales method.\nGeneral and Administrative Overhead\nThe General Partner and its affiliates are reimbursed for actual general and administrative costs incurred and attributable to the conduct of the business affairs and operations of the Partnerships.\nUse of Estimates in Financial Statements\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Further, the deferred charge, the gas imbalance payable, and the accrued liability all involve estimates which could materially differ from the actual amounts ultimately realized or incurred in the near term. Oil and gas reserves (see Note 4) also involve significant estimates which could materially differ from the actual amounts ultimately realized.\nIncome Taxes\nIncome or loss for income tax purposes is includable in the income tax returns of the partners. Accordingly, no recognition has been given to income taxes in these financial statements.\n2. TRANSACTIONS WITH RELATED PARTIES\nThe Partnerships reimburse the General Partner for the general and administrative overhead applicable to the Partnerships, based on an allocation of actual costs incurred. The following is a summary of payments made to the General Partner or its affiliates by the Partnerships for general and administrative costs for the years ended December 31, 1995, 1994, and 1993:\nPartnership 1995 1994 1993 ----------- -------- -------- --------\nII-A $509,772 $509,772 $509,772 II-B 380,760 380,757 380,761 II-C 162,756 162,759 162,683 II-D 331,452 331,451 330,685 II-E 240,864 240,864 240,864 II-F 180,420 180,421 180,420 II-G 391,776 391,778 391,788 II-H 96,540 96,358 96,540\nAffiliates of the Partnerships operate certain of the Partnerships' properties and their policy is to bill the Partnerships for all customary charges and cost reimbursements associated with these activities, together with any compressor rentals, consulting, or other services provided.\nThe Partnerships sell gas at market prices to Premier Gas Company (\"Premier\") and other similar gas marketing firms. Such firms may then resell such gas to third parties at market prices. Premier was an affiliate of the Partnerships until December 6, 1995. The following table summarizes the total amount of the Partnerships' sales to Premier during the years ended December 31, 1995, 1994, and 1993:\nPartnership 1995 1994 1993 ----------- ---------- ---------- ----------\nII-A $ 825,515 $1,085,911 $1,063,966 II-B 374,717 595,951 422,202 II-C 225,948 365,980 267,852 II-D 682,346 909,348 707,391 II-E 593,218 618,067 456,173 II-F 367,527 543,786 309,628 II-G 776,211 1,150,665 656,517 II-H 182,878 272,053 155,801\nThe following table summarizes the amount of the Partnerships' accrued oil and gas sales due from Premier at December 31, 1995 and 1994:\nPartnership 1995 1994 ----------- -------- --------\nII-A $153,461 $107,036 II-B 81,240 64,669 II-C 46,202 41,709 II-D 124,908 121,780 II-E 122,758 90,940 II-F 66,788 61,777 II-G 141,036 130,572 II-H 33,220 30,807\n3. MAJOR CUSTOMERS\nThe following table sets forth purchasers who individually accounted for more than ten percent of the Partnerships' combined oil and gas sales for the years ended December 31, 1995, 1994, and 1993:\nPartnership Purchaser Percentage - ----------- ------------------------ --------------------- 1995 1994 1993 ----- ----- -----\nII-A Premier 17.7% 17.0% 19.5% Hallwood Petroleum, Inc. (\"Hallwood\") 15.5% 14.4% - % Amoco Production Company (\"Amoco\") 14.3% 12.9% 15.8%\nII-B Hallwood 21.0% 18.0% - % Premier 11.7% 12.7% - % Amoco - % - % 11.2%\nII-C Premier 14.9% 16.0% 14.1% Amoco - % - % 11.8%\nII-D Premier 17.5% 18.8% 16.2%\nII-E Premier 25.8% 24.9% 17.7%\nII-F Premier 18.1% 23.5% 11.7% Texaco Exploration and Production, Inc. (\"Texaco\") 14.1% - % - % Chevron U.S.A., Inc. (\"Chevron\") - % - % 19.7%\nII-G Premier 17.9% 22.5% 11.8% Texaco 13.9% - % - % Chevron - % - % 18.2%\nII-H Premier 17.5% 22.5% 11.4% Texaco 13.7% - % - % Chevron - % - % 15.6%\nIn the event of interruption of purchases by one or more of these significant customers or the cessation or material change in availability of open access transportation by the Partnerships' pipeline transporters, the Partnerships may encounter difficulty in marketing their gas and in maintaining historic sales levels. Alternative purchasers or transporters may not be readily available.\n4. SUPPLEMENTAL OIL AND GAS INFORMATION\nThe following supplemental information regarding the oil and gas activities of the Partnerships is presented pursuant to the disclosure requirements promulgated by the SEC.\nCapitalized Costs\nThe capitalized costs and accumulated depreciation, depletion, amortization, and valuation allowance at December 31, 1995 and 1994 were as follows:\nII-A Partnership ---------------\n1995 1994 ------------- -------------\nProved properties $36,017,026 $37,179,981 Unproved properties, not subject to depreciation, depletion, and amortization 461,419 461,419 ---------- ---------- $36,478,445 $37,641,400\nLess accumulated depreciation, depletion, amorti- zation, and valua- tion allowance ( 29,087,633) ( 27,571,424) ---------- ---------- Net oil and gas properties $ 7,390,812 $10,069,976 ========== ==========\nII-B Partnership ---------------\n1995 1994 ------------- -------------\nProved properties $26,611,424 $27,066,713 Unproved properties, not subject to depreciation, depletion, and amortization 396,985 396,985 ---------- ---------- $27,008,409 $27,463,698 Less accumulated depreciation, depletion, amorti- zation, and valua- tion allowance ( 21,749,657) ( 20,530,937) ---------- ---------- Net oil and gas properties $ 5,258,752 $ 6,932,761 ========== ==========\nII-C Partnership ----------------\n1995 1994 ------------- -------------\nProved properties $11,807,787 $11,924,367 Unproved properties, not subject to depreciation, depletion, and amortization 30,441 30,444 ---------- ---------- $11,838,228 $11,954,811\nLess accumulated depreciation, depletion, amorti- zation, and valua- tion allowance ( 9,265,944) ( 8,542,823) ---------- ---------- Net oil and gas properties $ 2,572,284 $ 3,411,988 ========== ==========\nII-D Partnership ----------------\n1995 1994 ------------- -------------\nProved properties $22,632,078 $23,473,118 Unproved properties, not subject to depreciation, depletion, and amortization 16 16 ---------- ---------- $22,632,094 $23,473,134 Less accumulated depreciation, depletion, amorti- zation, and valua- tion allowance ( 17,237,895) ( 16,211,156) ---------- ---------- Net oil and gas properties $ 5,394,199 $ 7,261,978 ========== ==========\nII-E Partnership ----------------\n1995 1994 ------------- -------------\nProved properties $17,520,680 $18,113,344 Unproved properties, not subject to depreciation, depletion, and amortization 680,978 680,978 ---------- ---------- $18,201,658 $18,794,322 Less accumulated depreciation, depletion, amorti- zation, and valua- tion allowance ( 12,907,679) ( 11,731,710) ---------- ---------- Net oil and gas properties $ 5,293,979 $ 7,062,612 ========== ==========\nII-F Partnership ----------------\n1995 1994 ------------- -------------\nProved properties $13,331,175 $13,951,294 Unproved properties, not subject to depreciation, depletion, and amortization 1,168,905 1,168,905 ---------- ---------- $14,500,080 $15,120,199 Less accumulated depreciation, depletion, amorti- zation, and valua- tion allowance ( 9,564,025) ( 8,810,379) ---------- ---------- Net oil and gas properties $ 4,936,055 $ 6,309,820 ========== ==========\nII-G Partnership ----------------\n1995 1994 ------------- -------------\nProved properties $28,899,424 $30,209,795 Unproved properties, not subject to depreciation, depletion, and amortization 2,612,125 2,612,125 ---------- ---------- $31,511,549 $32,821,920 Less accumulated depreciation, depletion, amorti- zation, and valua- tion allowance ( 20,660,152) ( 18,764,269) ---------- ---------- Net oil and gas properties $10,851,397 $14,057,651 ========== ==========\nII-H Partnership ----------------\n1995 1994 ------------- -------------\nProved properties $ 7,097,729 $ 7,417,430 Unproved properties, not subject to depreciation, depletion, and amortization 660,832 660,832 ---------- ---------- $ 7,758,561 $ 8,078,262 Less accumulated depreciation, depletion, amorti- zation, and valua- tion allowance ( 5,134,284) ( 4,628,888) ---------- ---------- Net oil and gas properties $ 2,624,277 $ 3,449,374 ========== ==========\nCosts Incurred\nThe Partnerships incurred no costs in connection with oil and gas acquisition or exploration activities during the years ended December 31, 1995, 1994, or 1993. Costs incurred by the Partnerships in connection with their oil and gas property development activities for the years ended December 31, 1995, 1994, and 1993 were as follows:\nPartnership 1995 1994 1993 ----------- -------- -------- --------\nII-A $168,118 $305,300 $215,092 II-B 217,765 203,350 138,546 II-C 77,297 58,552 52,946 II-D 58,694 100,082 178,362 II-E 82,764 44,274 62,161 II-F 18,171 38,920 48,016 II-G 40,899 114,454 101,498 II-H 10,563 21,559 24,059\nQuantities of Proved Oil and Gas Reserves - Unaudited\nThe following tables summarize changes in net quantities of the Partnerships' proved reserves, all of which are located in the United States, for the periods indicated. The proved reserves at December 31, 1995, 1994, and 1993 were estimated by petroleum engineers employed by affiliates of the Partnerships. Certain reserve information was reviewed by Ryder Scott Company Petroleum Engineers, an independent petroleum engineering firm.\nII-A Partnership ----------------\nCrude Natural Oil Gas (Barrels) (Mcf) --------- ------------\nProved reserves, Dec. 31, 1992 979,300 13,090,000 Production (141,868) ( 1,488,837) Sales of minerals in place ( 700) ( 14,000) Revision of previous estimates (141,723) ( 1,085,925) ------- ----------\nProved reserves, Dec. 31, 1993 695,009 10,501,238 Production (150,281) ( 2,226,658) Sales of minerals in place ( 2,147) ( 3,261) Revision of previous estimates 133,406 1,715,644 ------- ----------\nProved reserves, Dec. 31, 1994 675,987 9,986,963 Production (120,420) ( 1,768,316) Sales of minerals in place ( 422) ( 19,550) Extensions and discoveries 11,099 42,427 Revisions of previous estimates 134,010 1,361,551 ------- ----------\nProved reserves, Dec. 31, 1995 700,254 9,603,075 ======= ==========\nPROVED DEVELOPED RESERVES:\nDecember 31, 1993 694,955 10,500,601 ======= ==========\nDecember 31, 1994 675,948 9,816,017 ======= ==========\nDecember 31, 1995 700,254 9,603,075 ======= ==========\nII-B Partnership ----------------\nCrude Natural Oil Gas (Barrels) (Mcf) --------- ------------\nProved reserves, Dec. 31, 1992 813,000 9,265,200 Production (106,685) ( 1,329,860) Sales of minerals in place ( 1,000) ( 17,000) Revision of previous estimates (146,634) ( 1,454,245) ------- ----------\nProved reserves, Dec. 31, 1993 558,681 6,464,095 Production (111,099) ( 1,649,869) Sales of minerals in place ( 1,745) ( 19,087) Revision of previous estimates 39,239 1,321,885 ------- ----------\nProved reserves, Dec. 31, 1994 485,076 6,117,024 Production ( 81,304) ( 1,205,296) Sales of minerals in place ( 756) ( 61,925) Extensions and discoveries 13,810 18,726 Revisions of previous estimates 78,699 860,574 ------- ----------\nProved reserves, Dec. 31, 1995 495,525 5,729,103 ======= ==========\nPROVED DEVELOPED RESERVES:\nDecember 31, 1993 558,671 6,463,486 ======= ==========\nDecember 31, 1994 485,076 5,884,070 ======= ==========\nDecember 31, 1995 495,525 5,729,103 ======= ==========\nII-C Partnership ----------------\nCrude Natural Oil Gas (Barrels) (Mcf) --------- ------------\nProved reserves, Dec. 31, 1992 324,600 5,466,900 Production ( 32,568) ( 675,399) Sales of minerals in place ( 400) ( - ) Revision of previous estimates ( 39,542) ( 528,066) ------- ----------\nProved reserves, Dec. 31, 1993 252,090 4,263,435 Production ( 34,074) ( 975,652) Sales of minerals in place ( 73) ( 3,673) Revision of previous estimates 2,314 751,118 ------- ----------\nProved reserves, Dec. 31, 1994 220,257 4,035,228 Production ( 26,383) ( 737,277) Sales of minerals in place ( 1,141) ( 5,265) Extensions and discoveries 2,810 9,289 Revisions of previous estimates 10,126 681,340 ------- ----------\nProved reserves, Dec. 31, 1995 205,669 3,983,315 ======= ==========\nPROVED DEVELOPED RESERVES:\nDecember 31, 1993 252,090 4,263,090 ======= ==========\nDecember 31, 1994 220,257 3,935,386 ======= ==========\nDecember 31, 1995 205,669 3,983,315 ======= ==========\nII-D Partnership ----------------\nCrude Natural Oil Gas (Barrels) (Mcf) --------- ------------\nProved reserves, Dec. 31, 1992 735,800 11,821,900 Production ( 92,253) ( 1,545,516) Sales of minerals in place - - Revision of previous estimates (247,068) 1,675,748 ------- ----------\nProved reserves, Dec. 31, 1993 396,479 11,952,132 Production ( 93,610) ( 2,000,016) Sales of minerals in place ( 20) ( 13,563) Revision of previous estimates 137,228 1,588,157 ------- ----------\nProved reserves, Dec. 31, 1994 440,077 11,526,710 Production ( 88,913) ( 1,906,303) Sales of minerals in place ( 1,286) ( 13,896) Extensions and discoveries 292 28,447 Revisions of previous estimates 203,408 1,275,502 ------- ----------\nProved reserves, Dec. 31, 1995 553,578 10,910,460 ======= ==========\nPROVED DEVELOPED RESERVES:\nDecember 31, 1993 396,479 11,952,132 ======= ==========\nDecember 31, 1994 440,077 11,526,710 ======= ==========\nDecember 31, 1995 553,578 10,910,460 ======= ==========\nII-E Partnership ----------------\nCrude Natural Oil Gas (Barrels) (Mcf) --------- ------------\nProved reserves, Dec. 31, 1992 495,800 7,687,800 Production ( 68,723) ( 752,689) Sales of minerals in place - - Revision of previous estimates (123,903) ( 771,972) ------- ----------\nProved reserves, Dec. 31, 1993 303,174 6,163,139 Production ( 66,656) ( 853,317) Sales of minerals in place ( 94) ( 748) Revision of previous estimates 7,232 559,970 ------- ----------\nProved reserves, Dec. 31, 1994 243,656 5,869,044 Production ( 63,680) ( 937,469) Sales of minerals in place ( 1,574) ( 23,318) Extensions and discoveries 10,194 48,960 Revisions of previous estimates 109,338 1,444,042 ------- ----------\nProved reserves, Dec. 31, 1995 297,934 6,401,259 ======= ==========\nPROVED DEVELOPED RESERVES:\nDecember 31, 1993 303,173 6,163,123 ======= ==========\nDecember 31, 1994 243,656 5,856,457 ======= ==========\nDecember 31, 1995 297,934 6,401,259 ======= ==========\nII-F Partnership ----------------\nCrude Natural Oil Gas (Barrels) (Mcf) --------- ------------\nProved reserves, Dec. 31, 1992 518,800 6,783,200 Production ( 61,194) ( 883,094) Sales of minerals in place ( 1,600) ( 3,000) Revision of previous estimates ( 52,800) ( 340,369) ------- ----------\nProved reserves, Dec. 31, 1993 403,206 5,556,737 Production ( 63,723) ( 833,628) Sales of minerals in place ( 264) ( 741) Revision of previous estimates 13,322 ( 33,656) ------- ----------\nProved reserves, Dec. 31, 1994 352,541 4,688,712 Production ( 54,773) ( 845,804) Sales of minerals in place ( 4,031) ( 28,284) Extensions and discoveries 829 108,943 Revisions of previous estimates 60,441 815,149 ------- ----------\nProved reserves, Dec. 31, 1995 355,007 4,738,716 ======= ==========\nPROVED DEVELOPED RESERVES:\nDecember 31, 1993 402,203 5,556,698 ======= ==========\nDecember 31, 1994 352,541 4,657,944 ======= ==========\nDecember 31, 1995 355,007 4,738,716 ======= ==========\nII-G Partnership ----------------\nCrude Natural Oil Gas (Barrels) (Mcf) ----------- ------------\nProved reserves, Dec. 31, 1992 1,095,200 15,186,600 Production ( 128,280) ( 1,879,891) Sales of minerals in place ( 3,500) ( 7,000) Revision of previous estimates ( 101,365) ( 1,085,933) --------- ----------\nProved reserves, Dec. 31, 1993 862,055 12,213,776 Production ( 134,034) ( 1,921,696) Sales of minerals in place ( 562) ( 2,026) Revision of previous estimates 14,538 ( 30,956) --------- ----------\nProved reserves, Dec. 31, 1994 741,997 10,259,098 Production ( 115,206) ( 1,832,915) Sales of minerals in place ( 8,413) ( 66,454) Extensions and discoveries 1,737 227,933 Revisions of previous estimates 126,364 1,715,621 --------- ----------\nProved reserves, Dec. 31, 1995 746,479 10,303,283 ========= ==========\nPROVED DEVELOPED RESERVES:\nDecember 31, 1993 862,050 12,213,695 ========= ==========\nDecember 31, 1994 741,997 10,194,757 ========= ==========\nDecember 31, 1995 746,479 10,303,283 ========= ==========\nII-H Partnership ----------------\nCrude Natural Oil Gas (Barrels) (Mcf) --------- ------------\nProved reserves, Dec. 31, 1992 256,100 3,847,000 Production ( 29,861) ( 471,281) Sales of minerals in place ( 900) ( 2,000) Revision of previous estimates ( 26,654) ( 293,205) ------- ----------\nProved reserves, Dec. 31, 1993 198,685 3,080,514 Production ( 31,241) ( 452,661) Sales of minerals in place ( 142) ( 512) Revision of previous estimates 6,580 ( 59,390) ------- ----------\nProved reserves, Dec. 31, 1994 173,882 2,567,951 Production ( 26,870) ( 449,854) Sales of minerals in place ( 2,006) ( 18,719) Extensions and discoveries 401 52,767 Revisions of previous estimates 28,114 401,519 ------- ----------\nProved reserves, Dec. 31, 1995 173,521 2,553,664 ======= ==========\nPROVED DEVELOPED RESERVES:\nDecember 31, 1993 198,684 3,080,495 ======= ==========\nDecember 31, 1994 173,882 2,555,068 ======= ==========\nDecember 31, 1995 173,521 2,553,664 ======= ==========\nStandardized Measure of Discounted Future Net Cash Flows of Proved Oil and Gas Reserves - Unaudited\nThe following tables set forth each of the Partnerships' estimated future net cash flows as of December 31, 1995 relating to proved oil and gas reserves based on the standardized measure as pre- scribed in SFAS No. 69:\nPartnership ------------------------------ II-A II-B ------------- -------------\nFuture cash inflows $31,406,635 $20,046,479 Future production and development costs ( 13,349,516) ( 8,252,665) ---------- ----------\nFuture net cash flows $18,057,119 $11,793,814\n10% discount to reflect timing of cash flows ( 5,662,382) ( 3,676,463) ---------- ----------\nStandardized measure of discounted future net cash flows $12,394,737 $ 8,117,351 ========== ==========\nPartnership ------------------------------ II-C II-D ------------- -------------\nFuture cash inflows $11,384,094 $31,038,959 Future production and development costs ( 4,543,061) ( 13,158,836) ---------- ----------\nFuture net cash flows $ 6,841,033 $17,880,123\n10% discount to reflect timing of cash flows ( 2,311,483) ( 6,154,226) ---------- ----------\nStandardized measure of discounted future net cash flows $ 4,529,550 $11,725,897 ========== ==========\nPartnership ------------------------------ II-E II-F ------------- -------------\nFuture cash inflows $17,878,894 $15,674,089 Future production and development costs ( 5,936,666) ( 4,463,134) ---------- ----------\nFuture net cash flows $11,942,228 $11,210,955\n10% discount to reflect timing of cash flows ( 4,528,744) ( 4,508,043) ---------- ----------\nStandardized measure of discounted future net cash flows $ 7,413,484 $ 6,702,912 ========== ==========\nPartnership ------------------------------ II-G II-H ------------- -------------\nFuture cash inflows $33,629,734 $ 8,132,254 Future production and development costs ( 9,731,423) ( 2,420,275) ---------- ----------\nFuture net cash flows $23,898,311 $ 5,711,979\n10% discount to reflect timing of cash flows ( 9,590,596) ( 2,286,490) ---------- ----------\nStandardized measure of discounted future net cash flows $14,307,715 $ 3,425,489 ========== ==========\nThe process of estimating oil and gas reserves is complex, requiring significant subjective decisions in the evaluation of available geological, engineering, and economic data for each reservoir. The data for a given reservoir may change substantially over time as a result of, among other things, additional development activity, production history, and viability of production under varying economic conditions; consequently, it is reasonably possible that material revisions to existing reserve estimates may occur in the near future. Although every reasonable effort has been made to ensure that the reserve estimates reported herein represent the most accurate assessment possible, the significance of the subjective decisions required and variances in available data for various reservoirs make these estimates generally less precise than other estimates presented in connection with financial statement disclosures.\nINDEX TO EXHIBITS -----------------\nNumber Description - ------ -----------\n4.1 The Certificate and Agreements of Limited Partnership for the following Partnerships have been previously filed with the Securities and Exchange Commission as Exhibit 2.1 to Form 8-A filed by each Partnership on the dates shown below and are hereby incorporated by reference.\nPartnership Filing Date File No. ----------- ------------ --------\nII-A November 18, 1987 0-16388 II-B November 19, 1987 0-16405 II-C August 5, 1988 0-16981 II-D August 5, 1988 0-16980 II-E November 17, 1988 0-17320 II-F June 5, 1989 0-17799 II-G June 5, 1989 0-17802 II-H February 20, 1990 0-18305\n4.2 The Agreements of Partnership for the following Production Partnerships have been previously filed with the Securities and Exchange Commission as Exhibit 2.2 to Form 8-A filed by the related Partnerships on the dates shown below and are hereby incorporated by reference.\nPartnership Filing Date ----------- -----------\nII-A November 18, 1987 II-B November 19, 1987 II-C August 5, 1988 II-D August 5, 1988 II-E November 17, 1988 II-F June 5, 1989 II-G June 5, 1989 II-H February 20, 1990\n4.3 Advisory Agreement dated as of November 24, 1992 between Samson, PaineWebber, Geodyne Resources, Geodyne Properties, Inc., Geodyne Production Company, and Geodyne Energy Company filed as Exhibit 28.3 to Registrant's Current Report on Form 8-K on December 24, 1992 and is hereby incorporated by reference.\n4.4 Second Amendment to Amended and Restated Agreement and Certificate of Limited Partnership of Geodyne Energy Income Limited Partnership II-A, filed as Exhibit 4.1 to Registrant's Current Report on Form 8-K dated August 2, 1993 and filed with the Securities and Exchange Commission on August 10, 1993 and is hereby incorporated by reference.\n4.5 Second Amendment to Amended and Restated Agreement and Certificate of Limited Partnership of Geodyne Energy Income Limited Partnership II-B, filed as Exhibit 4.2 to Registrant's Current Report on Form 8-K dated August 2, 1993 and filed with the Securities and Exchange Commission on August 10, 1993 and is hereby incorporated by reference.\n4.6 Second Amendment to Amended and Restated Agreement and Certificate of Limited Partnership of Geodyne Energy Income Limited Partnership II-C, filed as Exhibit 4.3 to Registrant's Current Report on Form 8-K dated August 2, 1993 and filed with the Securities and Exchange Commission on August 10, 1993 and is hereby incorporated by reference.\n4.7 Second Amendment to Amended and Restated Agreement and Certificate of Limited Partnership of Geodyne Energy Income Limited Partnership II-D, filed as Exhibit 4.4 to Registrant's Current Report on Form 8-K dated August 2, 1993 and filed with the Securities and Exchange Commission on August 10, 1993 and is hereby incorporated by reference.\n4.8 Second Amendment to Amended and Restated Agreement and Certificate of Limited Partnership of Geodyne Energy Income Limited Partnership II-E, filed as Exhibit 4.5 to Registrant's Current Report on Form 8-K dated August 2, 1993 and filed with the Securities and Exchange Commission on August 10, 1993 and is hereby incorporated by reference.\n4.9 Second Amendment to Amended and Restated Agreement and Certificate of Limited Partnership of Geodyne Energy Income Limited Partnership II-F, filed as Exhibit 4.6 to Registrant's Current Report on Form 8-K dated August 2, 1993 and filed with the Securities and Exchange Commission on August 10, 1993 and is hereby incorporated by reference.\n4.10 Second Amendment to Amended and Restated Agreement and Certificate of Limited Partnership of Geodyne Energy Income Limited Partnership II-G, filed as Exhibit 4.7 to Registrant's Current Report on Form 8-K dated August 2, 1993 and filed with the Securities and Exchange Commission on August 10, 1993 and is hereby incorporated by reference.\n4.11 Second Amendment to Amended and Restated Agreement and Certificate of Limited Partnership of Geodyne Energy Income Limited Partnership II-H, filed as Exhibit 4.8 to Registrant's Current Report on Form 8-K dated August 2, 1993 and filed with the Securities and Exchange Commission on August 10, 1993 and is hereby incorporated by reference.\n4.12* Third Amendment to Agreement and Certificate of Limited Partnership of Geodyne Energy Income Limited Partnership II- E.\n4.13* Third Amendment to Agreement and Certificate of Limited Partnership of Geodyne Energy Income Limited Partnership II- F.\n4.14* Third Amendment to Agreement and Certificate of Limited Partnership of Geodyne Energy Income Limited Partnership II- G.\n4.15* Third Amendment to Agreement and Certificate of Limited Partnership of Geodyne Energy Income Limited Partnership II- H.\n23.1* Consent of Ryder Scott Company Petroleum Engineers for Geodyne Energy Income Limited Partnership II-A.\n23.2* Consent of Ryder Scott Company Petroleum Engineers for Geodyne Energy Income Limited Partnership II-B.\n23.3* Consent of Ryder Scott Company Petroleum Engineers for Geodyne Energy Income Limited Partnership II-C.\n23.4* Consent of Ryder Scott Company Petroleum Engineers for Geodyne Energy Income Limited Partnership II-D.\n23.5* Consent of Ryder Scott Company Petroleum Engineers for Geodyne Energy Income Limited Partnership II-E.\n23.6* Consent of Ryder Scott Company Petroleum Engineers for Geodyne Energy Income Limited Partnership II-F.\n23.7* Consent of Ryder Scott Company Petroleum Engineers for Geodyne Energy Income Limited Partnership II-G.\n23.8* Consent of Ryder Scott Company Petroleum Engineers for Geodyne Energy Income Limited Partnership II-H.\n27.1* Financial Data Schedule containing summary financial information extracted from the Geodyne Energy Income Limited Partnership II-A's financial statements as of December 31, 1995 and for the year ended December 31, 1995.\n27.2* Financial Data Schedule containing summary financial information extracted from the Geodyne Energy Income Limited Partnership II-B's financial statements as of December 31, 1995 and for the year ended December 31, 1995.\n27.3* Financial Data Schedule containing summary financial information extracted from the Geodyne Energy Income Limited Partnership II-C's financial statements as of December 31, 1995 and for the year ended December 31, 1995.\n27.4* Financial Data Schedule containing summary financial information extracted from the Geodyne Energy Income Limited Partnership II-D's financial statements as of December 31, 1995 and for the year ended December 31, 1995.\n27.5* Financial Data Schedule containing summary financial information extracted from the Geodyne Energy Income Limited Partnership II-E's financial statements as of December 31, 1995 and for the year ended December 31, 1995.\n27.6* Financial Data Schedule containing summary financial information extracted from the Geodyne Energy Income Limited Partnership II-F's financial statements as of December 31, 1995 and for the year ended December 31, 1995.\n27.7* Financial Data Schedule containing summary financial information extracted from the Geodyne Energy Income Limited Partnership II-G's financial statements as of December 31, 1995 and for the year ended December 31, 1995.\n27.8* Financial Data Schedule containing summary financial information extracted from the Geodyne Energy Income Limited Partnership II-H's financial statements as of December 31, 1995 and for the year ended December 31, 1995.\nAll other Exhibits are omitted as inapplicable.\n----------\n* Filed herewith.","section_15":""}
{"filename":"43837_1995.txt","cik":"43837","year":"1995","section_1":"ITEM 1. BUSINESS.\n(a) General\nGreenman Bros. Inc., a New York corporation organized in 1946 (herein together with its wholly-owned subsidiaries called \"Registrant\" or \"Company\"), is engaged in the wholesale distribution of general merchandise with emphasis on housewares, toys and stationery. The principal consumer products distributed by Registrant are housewares products, consisting of cookware, kitchen gadgets and utensils, cleaning aids, household chemicals, plastics and glassware; toys, games, and related products; and stationery products and school supplies. The Company is also engaged in the retail toy business including a retail concept developed by Registrant that offers a broad range of educationally oriented children's toys and other products such as books, video and audio tapes, computer software, crafts and science. (b) Financial Information About Industry Segments Registrant's operations fall into two industry segments. The larger segment includes the wholesale distribution of general merchandise. The other segment includes the retail sales of childrens toys and other products. The sales, operating profit and the identifiable assets attributable to each segment for the three years ended January 28, 1995 are set forth in Note 9 (Industry Segments) of the Notes to Consolidated Financial Statements, which Note is incorporated herein by reference. (c) Narrative Description of Business Wholesale Operations Registrant's wholesale operations are conducted from warehouses located in Farmingdale, New York; Phillipsburg, New Jersey and West Haven, Connecticut. Registrant services virtually every class\n- 1 -\nof retail trade from small independent stores to drug stores, supermarkets, variety stores, discount stores, department stores, home improvement centers and college bookstores. Registrant believes that its broad and diversified customer base helps protect it against the peaks and valleys that occur in any particular segment of the retail business. There is a continuing trend of consolidation in manufacturing, wholesaling and retailing in all commodities distributed by Registrant. Registrant believes that its financial strength, buying power and market share are significant benefits both in the current marketplace and for the future. Retail Operations Registrant's current retail operations include the Noodle Kidoodle TM (TM is purposely omitted everywhere else) and Playworld Toy store divisions. The Company is shifting its emphasis towards development and expansion of its Noodle Kidoodle concept. The Company opened its first Noodle Kidoodle store in Nassau County, New York in November 1993 and opened three more stores, located in Nassau County, New York and Bergen and Passaic Counties in New Jersey, during fiscal 1995. The Company opened its fifth store in Essex County, New Jersey early in fiscal 1996, and plans to open fifteen more stores during the year. Currently these openings are planned to include additional locations in Long Island, New York, New Jersey and locations in new markets including Connecticut, upstate New York and Chicago, Illinois. Noodle Kidoodle stores have to date been located in strip centers and their size is approximately 10,000 square feet. Several of the stores expected to open in fiscal 1996 will be located in large regional enclosed malls. These stores focus on educationally oriented products for children, merchandised in an entertaining and interactive environment.\n- 2 -\nBooks, video and audio tapes, computer software, arts and crafts, science and construction are major merchandise categories. The majority of their merchandise is delivered from the Company's warehouses with the rest drop shipped by manufacturers. The buying and merchandising management operates independently from the wholesale toy business and the other retail businesses of the Company. The Playworld division currently consists of two stores operating under the name of Playworld Toys which are located in Nassau County, New York, one store operating under the name Toy Park which is located in Manhattan, New York and one licensed store operating under the name Toy Park, which is located in Huntington, New York. On August 10, 1994 the Company announced that it would be closing its retail stores operating under the name Playworld Toys and one leased department operation by the end of fiscal 1995. Due to leasing issues it is now expected that two of these stores will remain open indefinitely and consideration is being given to changes in their format. The Playworld Stores and leased department that were closed represented 8.0% of consolidated sales for fiscal 1995 and 7.9% for fiscal 1994. The remaining Playworld Toy Stores are approximately 10,000 square feet. One store is located in a strip center while the second store is situated in a neighborhood shopping district. Stores are primarily serviced by Registrant's warehouses located in Farmingdale, New York and Phillipsburg, New Jersey. A relatively small amount of merchandise is drop shipped by manufacturers directly to the stores. The Toy Park locations are situated in neighborhood shopping districts and are 4,000 and 7,000 square feet for the Huntington and Manhattan stores, respectively. Toy Park carries more upscale and educationally oriented toys and related products than the Playworld stores.\n- 3 -\nThe majority of their merchandise is delivered from the Company's warehouses with the rest drop shipped by manufacturers. The merchandise management for both the Playworld and Toy Park stores are independent of the wholesale toy and the Noodle Kidoodle businesses. However, a significant portion of the Toy Park merchandise assortment and virtually all of the Playworld assortment is purchased by the wholesale toy business and transferred at cost to these retail stores.\nGeneral Backlog is not considered relevant to an understanding of any of Registrant's businesses. Registrant is required to carry substantial amounts of inventory in the months of June through September of each year in order to meet pre-Christmas delivery requirements, particularly in its toy wholesale and retail businesses. Registrant does not have any customers that represented more than 10% of the Company's consolidated revenues for the year ended January 28, 1995 (\"fiscal 1995\"). The following chart sets forth, for Registrant's last three fiscal years, the approximate percentage of Registrant's total revenues from operations contributed by each class of similar products:\nRegistrant's wholesale and retail sales of toys, games and related products are highly seasonal. During the 1995 fiscal year, 35% of such sales were made in November and December.\n- 4 -\nCompetition All phases of Registrant's business are highly competitive. In its wholesale business, Registrant competes with other distributors and, to some extent, with certain manufacturers (including some of Registrant's own suppliers) which sell directly to retailers. Registrant believes that it is one of the largest wholesale distributors of housewares, toys and stationery products in the United States. Price, service and selling terms are the key competitive factors in the wholesale operation. At the retail level, Registrant is in competition with all specialty retailers of toys, educationally oriented childrens' products, video games, traditional games, books, computer software and related products; discount chains, large department stores and small single unit retail shops which do business in the areas where Registrant operates. Certain of these competitors are customers of Registrant's wholesale operation. In retail operations, price, service, environment, variety of merchandise, location and convenience are all key competitive factors.\nEmployees Registrant employed approximately 595 persons at the end of the 1995 fiscal year, 124 of whom were in administrative and clerical positions, 156 in sales positions, 248 in warehouse positions and the balance in its retail units. A substantial number of additional personnel are employed by Registrant on a temporary basis, particularly during the pre- Christmas season. Approximately 152 of Registrant's employees (primarily warehouse personnel) are covered by contracts with various unions.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES. Registrant operates three major distribution centers, located in three states, containing a total of approximately 629,000 square feet. Two of these distribution centers, located in Farmingdale, New York and\n- 5 -\nPhillipsburg, New Jersey, containing a total of approximately 569,000 square feet, are owned by Registrant and one distribution center located in West Haven, Connecticut, containing approximately 60,000 square feet, is held under lease. The lease expires March 31, 1996 with options to extend it for up to eight additional years. Retail stores are leased in all cases. A substantial number of leases for Noodle Kidoodle stores have been signed to date. Registrant also subleases one former distribution center (a 105,810 square foot warehouse in Birmingham, Alabama), and two former retail stores to unaffiliated third parties. Registrant's executive offices are located at its Farmingdale, New York owned facility. Registrant believes that each of the foregoing facilities is adequate for its present operations and such facilities are maintained in a good state of repair. Significant increases in Registrant's wholesale or retail operations might require additions to existing facilities or new facilities. Reference is made in Note 4 (Commitments and Contingencies) of the Notes to Consolidated Financial Statements for additional information concerning the lease obligations of Registrant.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS. Registrant is currently involved in only ordinary and routine litigation incidental to the Company's business, none of which is material with respect to the Company's operations taken as a whole.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. There were no matters submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this report.\n- 6 -\nPART II ITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS. The Company's common stock is traded on the American Stock Exchange (Symbol GMN). The range of high and low sales prices for the common stock for each quarterly period during the fiscal years ended January 28, 1995 and January 29, 1994 were:\nAs of January 28, 1995 there were 600 holders of record of the Company's common stock. The Company has followed a policy of reinvesting earnings in the business and consequently has not paid any cash dividends. At the present time, no change in this policy is under consideration by the Board of Directors. The payment of cash dividends in the future will be determined by the Board of Directors based on conditions then existing, including the Company's earnings, financial requirements and condition, opportunities for reinvesting earnings, business conditions and other factors. Such payment is also subject to certain restrictions on the payment of dividends pursuant to certain covenants in its revolving credit agreement. See Note 3 (Long-Term Debt) of the Notes to Consolidated Financial Statements. - 7 -\nOn February 4, 1993, Registrant's Board of Directors authorized the repurchase by Registrant of up to 500,000 shares of its common stock in the open market or in privately negotiated transactions from time to time depending upon prices and market conditions. As of April 13, 1995 the Company had repurchased 413,600 of the authorized shares. The Board, at that time, decided to rescind its authorization for the remainder of the shares.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nRESULTS OF OPERATIONS In the fiscal year ended January 28, 1995 (\"fiscal 1995\") the Company reported a net loss of $3.4 million ($.65 per share) compared to net income of $.7 million ($.13 per share) and $1.8 million ($.32 per share) for fiscal 1994 and 1993, respectively. The net loss for fiscal 1995 versus net income for fiscal 1994 was primarily attributable to the net charge for Playworld Toy Stores closings of $2.3 million ($.45 per share) and lower wholesale earnings resulting from the decline in wholesale revenues. The decrease in fiscal 1994 versus fiscal 1993 was primarily attributable to lower wholesale earnings resulting from decline in revenues and slightly lower margins and a loss on retail operations versus income in the 1993 fiscal year.\nRevenues Sales in fiscal 1995 were $136.5 million versus $142.9 million and $154.7 million in fiscal 1994 and 1993, respectively. Wholesale sales decreased $8.9 million or 7.3% to $113.2 million in fiscal 1995 versus fiscal 1994. The decline reflects lower volume to our existing customer base in all merchandise categories offset by increased business and customer base in the chain drug, deep discount drug and supermarket channels of distribution. Wholesale sales are expected to continue to decline in fiscal 1996 at a similar rate. Retail sales of our Playworld Toy Stores and Noodle Kidoodle operation represented 17.1% of total sales in fiscal 1995 compared to 14.5% in fiscal 1994. Overall retail sales increased 12.5% to $23.3 million in fiscal 1995 versus fiscal 1994. Comparable store sales decreased 3.4% as a result of the announcement on August 10, 1994 that the Company was closing its retail stores operating under the name Playworld Toy Stores and one\nleased department operation. The improvement in overall sales resulted from the opening of three Noodle Kidoodle stores during fiscal 1995 and full year results for our first Noodle Kidoodle store opened in the latter part of fiscal 1994. Retail sales are expected to be over 60% higher for fiscal 1996 due to the combination of expected openings of approximately sixteen additional Noodle Kidoodle stores, a full year for the three new stores opened in fiscal 1995 and increases in existing stores partially offset by the closing of the Playworld Toy Stores and one leased department. Sales for the closed Playworld stores were $10,923, $11,257 and $10,955 for fiscal 1995, 1994 and 1993, respectively. The decrease in the Company's sales of 7.7% in fiscal 1994 versus fiscal 1993 resulted from a 10.5% decline in our wholesale business partially offset by higher retail sales. The decline in wholesale sales resulted from a combination of factors, including weak retail sales in our product lines, bankruptcies and more direct purchases from manufacturers by certain of our customers. The improvement in overall retail sales resulted from the opening of our first Noodle Kidoodle store, two additional Playworld holiday stores and full year results for two Playworld and two leased departments which were opened in the latter part of fiscal 1993.\nGross Profit The Company's gross profit as a percentage of sales for fiscal 1995 was 24.1% versus 23.8% and 24.3% for fiscal 1994 and fiscal 1993, respectively. The increase in the overall gross profit percentage of .3% in fiscal 1995 versus fiscal 1994 was primarily attributable to higher margins in the retail segment and an increase in the sales mix of higher margin retail sales in relation to the total business partially offset by lower margins in the wholesale segment.\nMargins in the wholesale segment decreased to 21.7% in fiscal 1995 from 21.9% in fiscal 1994. The decrease resulted primarily from the decline in the wholesale business sales in product lines (primarily housewares) that have traditionally carried higher margins offset by a LIFO benefit of $.2 million or .2% in fiscal 1995 versus a LIFO charge of $.2 million or .2% in fiscal 1994. Margins in the retail segment increased .8% to 35.9% in fiscal 1995 versus 35.1% in fiscal 1994. The improvement resulted primarily from increased sales in the Noodle Kidoodle stores which operate with higher margins. The decrease of .5% in the Company's gross profit in fiscal 1994 versus fiscal 1993 was primarily attributable to lower margins in the wholesale segment partially offset by an increase in sales mix of higher margin retail sales in relation to the total business. Margins in the wholesale segment decreased .9% primarily from the decline in product lines (primarily housewares) that have traditionally carried higher margins with .2% of the decrease was attributable to the LIFO charge in fiscal 1994. Retail segment margins remained flat at 35.1% in both fiscal 1994 and 1993, respectively.\nOperating Expenses Expenses other than interest and provision for store closings and restructured operations totalled $34.9 million in fiscal 1995 versus $33.1 million and $34.0 million in fiscal 1994 and 1993, respectively. Operating expenses as a percent of sales were 25.5%, 23.2% and 22.0% for fiscal 1995, 1994 and 1993, respectively. Wholesale expenses as a percent of sales for fiscal 1995 were 20.2% versus 19.3% in fiscal 1994. The increase resulted primarily from revenue decreases where selling and distribution expense reductions did not keep pace with revenue reductions. The operating expenses for the\n- 12 -\nretail segment increased 4.0% as a percent of sales in fiscal 1995 versus fiscal 1994. The increase resulted from higher selling expenses due to lower comparable store sales in the Playworld operation and costs associated with the opening of Noodle Kidoodle stores that did not reach maturity by the end of fiscal 1995. The increase of .9% in the Company's operating expenses as a percent of sales for fiscal 1994 versus fiscal 1993 resulted primarily from higher selling expenses as percent of sales in the retail segment due to lower comparable Playworld Toy Store sales and costs associated with the development of the concept and the opening of the first Noodle Kidoodle store. In the wholesale segment expenses remained virtually flat which is substantially attributable to the steps that the Company took through the first phases of the reorganization and consolidation of its wholesale segment which was reported in fiscal 1993.\nProvision for Store Closings and Restructured Operations The Company recorded a pre-tax provision for closing the stores operating under the name Playworld Toy Stores in the amount of $3.9 million ($2.3 million or $.45 per share net of income taxes) in fiscal 1995 of which $3.5 million was recorded during the second quarter and $.4 million was provided during the fourth quarter. The provision reflects a one time charge to cover losses from store operations from the date of announcement until closing, employee severance costs, estimated lease liabilities, losses on liquidation of inventories and disposition of assets and other related restructuring costs. Due to leasing issues it is now expected that two of the Playworld stores will remain open indefinitely and consideration is being given to changes in their format.\nThe Company recorded a pre-tax provision for restructured wholesale operations in the amount of $1.1 million in fiscal 1993 ($.6 million or $.12 per share net of income taxes). The provision included anticipated severance and relocation costs, as well as costs resulting from realigning the distribution of merchandise among the Company's warehouses. The restructuring resulted in the consolidation of the three divisional commodity-based organizations into a single general merchandise distribution company in order to lower costs by streamlining the administrative, sales and purchasing functions and by enhancing the ability to market multiple commodities to the customer base that we expect to serve in the future.\nInterest Expense and Income Pre-tax interest expense was $.08 million in fiscal 1995 and $.1 million in both fiscal 1994 and 1993, respectively. The Company did not require any seasonal borrowings in fiscal 1995 or 1994. Pre-tax interest income was $.4 million in both fiscal 1995 and 1994 versus $.6 million for fiscal 1993. Interest income is derived from the Company's investment of cash in high grade commercial paper, U.S. Treasury bills and tax exempt money market funds as well as additional vendor cash discounts for early payment of dated invoices. The decrease in interest income for fiscal 1994 versus fiscal 1993 resulted primarily from lower average rates of 2.7% versus 4.3% on the investments.\nIncome Taxes The Company recorded a tax benefit based on an effective income tax rate of 38.2% for fiscal 1995. In fiscal 1994 and 1993 the Company recorded a tax provision based on an effective income tax rate of 40.4% and 38.7%, respectively. The Company adopted SFAS 109 in fiscal 1994 which resulted in no material impact on the Company's results of operations or financial position.\nLIQUIDITY AND SOURCES OF CAPITAL The Company's cash position (including cash equivalents) was $10.9 million at January 28, 1995, $5.8 million at January 29, 1994 and $10.5 million at January 30,1993. Cash flows provided from operating activities for the year ended January 28, 1995 were $7.6 million versus cash flows used of $3.0 million for the year ended January 29, 1994. Net loss before non-cash expenditures of depreciation, provision for doubtful accounts, restructuring charges and deferred income taxes used $1.3 million of cash offset by changes in working capital components which contributed $8.9 million of cash for fiscal 1995. The working capital contribution to cash was primarily from decreases in inventory levels of $10.4 million. In fiscal 1994, net earnings before non-cash expenditures contributed cash of $1.9 million less cash required for working capital components of $4.9 million. The working capital requirements included a $1.6 million prepayment of dated invoices to vendors, increased inventories of $1.5 million and a decrease in income tax liability of $1.2 million. In fiscal 1995, a total of $2.5 million of cash was used for investing activities. Approximately $4.0 million was utilized for property additions offset by proceeds from the sale of marketable securities of $1.0 million and proceeds from a life insurance policy of $.5 million. In fiscal 1994, investing activities provided cash of $.2 million of which approximately $3.0 million was provided from the redemption of certain U.S. Treasury securities offset by $1.0 million of cash used to purchase a Treasury bill in the same year and $2.0 million was utilized for property additions. The 1995 property additions resulted primarily from the opening of three Noodle Kidoodle stores and construction in progress on a fourth store, installation of a warehouse management system and an upgrade to the data processing system.\n- 15 -\nThe Company has budgeted approximately $10.0 million for various capital additions in fiscal 1996, primarily relating to the opening of sixteen additional Noodle Kidoodle stores. The balance of the additions are for the distribution facilities and data processing. Cash used in financing activities of $1.9 million in fiscal 1994 was primarily due to the repurchase of 413,600 shares of the Company's common stock at an average price of $4.52 per share. The Company had no additional repurchases of stock in fiscal 1995 and expects none for fiscal 1996. The Company has an unsecured revolving credit facility from a bank which currently provides for maximum borrowing of $10.0 million that expires in June, 1995. There were no borrowings under this agreement in fiscal 1995 and 1994. The Company is currently negotiating a new credit agreement which is expected to be in place upon the expiration of the prior agreement. The Company anticipates capital expenditures of approximately $10.0 million for fiscal 1996. These expenditures and the working capital requirements for the expected new stores will result in the need for capital in excess of existing cash and cash to be generated from operations. We are reviewing various options at this time, however it is likely that the Company will utilize bank borrowings for several months during the second half of the year.\nIMPACT OF INFLATION Inflation has not been a significant factor to the Company for many years. The Company attempts to pass on increased costs by increasing product prices over time.\n- 16 -\nThe Company utilizes the LIFO method of accounting for certain of its inventories which results in a better matching of costs and revenues by reporting the cost of products sold in the financial statements at a level which approximates current costs.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. Reference is made to Item 14.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNONE.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. Information with respect to directors and executive officers of the Company is incorporated herein by reference to the information set forth under the captions \"Election of Directors\", \"Executive Officers\" and \"Compliance with Section 16(a) of the Exchange Act\" in the Company's Proxy Statement for its 1995 Annual Meeting of Stockholders (the \"1995 Proxy Statement\").\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION. Information with respect to executive compensation is incorporated herein by reference to the information set forth under the captions \"Committees, Meetings and Director Compensation\" and \"Executive Compensation\", excluding the information under the captions \"Executive Compensation - Compensation Committee Report on Executive Compensation\" and \"Executive Compensation - Performance Graph\", in the Company's 1995 Proxy Statement.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. Information with respect to security ownership is incorporated herein by reference to the information set forth under the caption \"Security Ownership\" in the Company's 1995 Proxy Statement.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. Information with respect to certain relationships and related transactions is incorporated herein by reference to the information, if any, set forth under the caption \"Certain Relationships and Related Transactions\" in the Company's 1995 Proxy Statement.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(a) 1. Financial Statements Page\nReport of independent certified public accountants . . . 23\nConsolidated balance sheets at January 28, 1995 and January 29, 1994 . . . . . . . . . . . . . . . . . . . 24\nConsolidated statements of income for the years ended January 28, 1995, January 29, 1994 and January 30, 1993 . . . . . . . . . . . . . . . . . . . 25\nConsolidated statements of stockholders' equity for the years ended January 28, 1995, January 29, 1994 and January 30, 1993 . . . . . . . . . . . . . . . . . 26\nConsolidated statements of cash flows for the years ended January 28, 1995, January 29, 1994 and January 30, 1993 . . . . . . . . . . . . . . . . . 27\nNotes to consolidated financial statements . . . . . 28-35\n2. Schedules\nVIII Valuation and qualifying accounts. . . . . . . 36\nAll other schedules have been omitted because they are not applicable or the required information is shown in the financial statements or the notes thereto.\nThe individual financial statements and schedules of Registrant have been omitted since consolidated financial statements have been filed and Registrant is primarily an operating company and all subsidiaries included in the consolidated financial statements filed are wholly-owned subsidiaries.\nShareholders may obtain a copy of any exhibit not contained herein by writing to William A. Johnson Jr., Vice President, Chief Financial Officer and Secretary, Greenman Bros. Inc., 105 Price Parkway, Farmingdale, New York 11735.\n3. Index to Exhibits Page\n3.01 Restated Certificate of Incorporation of Registrant, with all amendments (Incorporated by reference to Exhibits 3.01,3.02, 3.03, 3.04 to Registrant's Annual Report on Form 10-K for the fiscal year ended January 29, 1983 and Exhibit 3.01 to Registrant's Annual Report on Form 10-K for the fiscal year ended January 28, 1989). . . **\n3.02 By-Laws of Registrant, as amended through July 9, 1991 (Incorporated by reference to Registrant's Report on Form 10-K for the fiscal year ended January 29, 1994) . . . . . **\n4.01 Rights Agreement, dated as of May 6, 1988, between Registrant and Manufacturers Hanover Trust Company, as Rights Agent (Incorporated by reference to Registrant's Report on Form 8-K dated May 6, 1988 and the exhibits filed therewith). . . . . . . . . . . . . . . . . . . . . **\n4.02 First Amendment to Rights Agreement dated as of November 22, 1991 (Incorporated by reference to Registrant's Report on Form 8-K, dated November 22, 1991, and the exhibits filed therewith) . . . . . . . . . . . . . . . . **\n4.03 Credit Agreement, dated as of April 16, 1992, between Registrant and Chemical Bank as successor by merger to Manufacturers Hanover Trust Company (the \"Credit Agreement\")(Incorporated by reference to Item 6(a) to Registrant's quarterly report on Form 10-Q for the period ended May 2, 1992 and the exhibits filed therewith) . . . **\n4.04 Amendment to the Credit Agreement dated August 13, 1992 (Incorporated by reference to Exhibit 4.04 to Registrant's Annual Report on Form 10-K for the fiscal year ended January 30, 1993) . . . . . . . . . . . . . . . . . . . . **\n4.05 Second Amendment and Waiver to the Credit Agreement dated September 1, 1993 (Incorporated by reference to Item 6(a) to Registrant's quarterly report on Form 10-Q for the period ended October 3, 1993 and the exhibits filed therewith) . **\n10.01 Stock Incentive Plan and Outside Directors Stock Option Plan, dated April 26, 1994 (Incorporated by reference to Registrant's Form S-8 Registration Statement (Commission File No. 33-82104), effective July 26, 1994 and the exhibits filed therewith)*. . . . . . . . . . . . . . . . **\n10.02 Employment Agreement by and between Registrant and Stanley Greenman dated as of February 1, 1995* . . . . . 37-51\n10.03 Employment Agreement by and between Registrant and Stewart Katz dated as of February 1, 1995*. . . . . . . . 52-66\n10.04 Non-Contributory Insured Medical Reimbursement Plan (Incorporated by reference to Exhibit 10.05 to Registrant's Annual Report on Form 10-K for the fiscal year ended January 30, 1993)*. . . . . . . . . . . . . . . . . . . . **\n10.05 Short Term Executive Incentive Bonus Plan for the fiscal year ended January 29, 1994 (Incorporated by reference to Exhibit 10.06 to Registrant's Annual Report on Form 10-K for fiscal year ended January 29, 1994)*. . . . . . . . . **\n10.06 Long Term Executive Incentive Bonus Plan for the fiscal year ended January 29, 1994 (Incorporated by reference to Exhibit 10.07 to Registrant's Annual Report on Form 10-K for fiscal year ended January 29, 1994)*. . . . . . . . . **\n10.07 Agreement and Plan of Merger dated February 1, 1994 by and between Registrant and certain wholly-owned subsidiaries of the Registrant (Incorporated by reference to Exhibit 10.08 to Registrant's Annual Report on Form 10-K for fiscal year ended January 29, 1994) . . . . . . . . . **\n11.01 Computation of Earnings Per Share . . . . . . . . . . . . 67\n21 Subsidiaries of Registrant . . . . . . . . . . . . . . . 68\n* Management Contract or Compensation Plan or Agreement required to be filed as an Exhibit pursuant to Item 14(c) of Form 10-K.\n** Previously filed.\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 caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nGREENMAN BROS. INC. (Registrant)\nApril 19, 1995 BY:Stanley Greenman Stanley Greenman, Chairman of the Board, Chief Executive Officer, 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 in the capacities and on the date indicated.\nStanley Greenman Joshua Biblowitz Stanley Greenman,Chairman of the Joshua Biblowitz, Director Board, Chief Executive Officer, Director (Principal Executive Officer) Robin Farkas Robin Farkas, Director\nStewart Katz Stewart Katz, President, Chief Lester Greenman Operating Officer, Director Lester Greenman, Director\nJoseph Madenberg William A. Johnson Jr. Joseph Madenberg, Director William A. Johnson Jr., Vice- President, Chief Financial Officer and Secretary (Principal Financial Barry W. Ridings and Accounting Officer) Barry W. Ridings, Director\nRobert Stokvis Robert Stokvis, Director\nBenjamin Zdatny Benjamin Zdatny, Director\nINDEPENDENT AUDITORS' REPORT\nTo the Stockholders and Board of Directors of Greenman Bros. Inc.:\nWe have audited the accompanying consolidated balance sheets of Greenman Bros. Inc. and Subsidiaries as of January 28, 1995 and January 29, 1994 and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended January 28, 1995. Our audits also include the financial statement schedules 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 Greenman Bros. Inc. and Subsidiaries as of January 28, 1995 and January 29, 1994, and the results of their operations and cash flows for each of the years in the three year period ended January 28, 1995 in conformity with generally accepted accounting principles. Further, 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.\nJanover Rubinroit & Co. Certified Public Accountants New York, New York April 18, 1995\n- 24 -\n- 27 -\nGREENMAN BROS. INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1 - SIGNIFICANT ACCOUNTING POLICIES:\nThe following summary of the Company's major accounting policies is presented to assist in the interpretation of the financial statements.\nPrinciples of consolidation\nThe consolidated financial statements include the accounts of the parent company and all subsidiary companies. Intercompany balances and material transactions are eliminated in consolidation. The Company and its consolidated subsidiaries are on a 52-53 week accounting period ending on the Saturday closest to January 31. Fiscal 1995, 1994 and 1993 each contained 52 weeks.\nCash equivalents and short-term investments\nAll highly liquid investments purchased with a maturity of three months or less are considered to be cash equivalents; investments with maturities between three and twelve months are considered to be short-term investments. These investments are stated at cost which approximates market value.\nConcentration of credit risk\nThe Company grants credit to its customers, who are primarily retailers operating under numerous retail formats. Sales are made primarily in the northeastern United States. The Company places its temporary cash investments in high grade instruments with high credit quality financial institutions and, by policy, limits the amount of credit exposure to any one financial institution.\nInventories\nInventories are stated at the lower of cost or market. Inventory costs have been determined by the last-in, first-out (LIFO) method for approximately 31% and 40% of inventories in fiscal 1995 and 1994, respectively. Costs of other inventories have been determined by the first-in, first-out (FIFO) method. The accumulated LIFO provision amounted to $570 and $763 at January 28, 1995 and January 29, 1994, respectively. The effect of LIFO upon income was to (decrease) increase cost of products sold by $(193), $225 and $(51) in fiscal 1995, 1994 and 1993, respectively.\nEarnings per share\nThe computation of earnings per share is based on the weighted average number of outstanding common shares and equivalents (stock options) of 5,220, 5,338, and 5,575 for fiscal 1995, 1994 and 1993, respectively. The inclusion of common stock equivalents had no significant dilutive effect or were antidilutive and therefore were not utilized in the computations of net income (loss) per share.\nProperty, plant and equipment\nPlant and equipment is stated at cost and is depreciated on a straight-line basis over estimated useful lives. Repairs and maintenance are charged to expense as incurred; renewals and betterments, which significantly extend the useful lives of existing plant and equipment, are capitalized.\n- 28 -\nNOTE 1 - SIGNIFICANT ACCOUNTING POLICIES: (Continued)\nLeasehold improvements are amortized over the terms of the respective leases or over their useful lives, whichever is shorter. Useful lives vary among the classifications, but generally fall within the following ranges:\nBuildings and improvements 10-40 years Fixtures and equipment 4-10 years\nPre-opening expenses\nCosts incurred in the opening of new stores are amortized over the first twelve months of operations. These costs were not material.\nIncome taxes\nIn fiscal 1994, the Company adopted Statement of Financial Accounting Standards (\"SFAS\") No. 109. Deferred taxes provided under SFAS No. 109 result principally from temporary differences in depreciation, capitalized inventory costs, restructuring charges and allowance for doubtful accounts. Upon implementation of SFAS No. 109, there was no material impact on the Company's results of operations or financial position. The Company previously accounted for income taxes based upon SFAS No. 96.\nNOTE 2 - PROPERTY, PLANT AND EQUIPMENT:\nNOTE 3 - LONG-TERM DEBT:\nThe Company has an unsecured revolving credit agreement with a bank which provides for maximum borrowings of $10 million until June 30, 1995. Interest on borrowings is at the lesser of the bank's prime rate or at a rate of 3\/4% in excess of the Eurodollar Lending Office rate of the bank for U.S. dollar deposits. The agreement provides for a commitment fee of 1\/4% per annum on the average daily amount of the unused portion of the commitment. The revolving credit agreement contains various restrictive covenants which, among other items, require the maintenance of minimum levels of working capital and net worth. The payment of cash dividends is limited to 25% of the preceding year's net income. The Company had no borrowings under this agreement during fiscal 1995 and 1994.\n- 29 -\nNOTE 4 - COMMITMENTS AND CONTINGENCIES:\nOperating leases\nMinimum annual commitments under non-cancellable leases in effect at January 28, 1995 are as follows:\nAt January 28, 1995, the Company and its subsidiaries were lessees of stores, a warehouse, vehicles and warehouse equipment under various leases. In addition to fixed rents and rentals based on sales, certain of the leases require the payment of taxes and other costs. Some leases include renewal options.\nRental expense (income) for operating leases was as follows:\nLetters of credit\nThe Company and its subsidiaries are contingently liable for open letters of credit in the aggregate amount of $.6 million. These letters of credit relate to specific contracts for the purchase of merchandise.\nLitigation\nSeveral lawsuits are pending against the Company. In the opinion of management, the Company has meritorious defenses or is covered by insurance and the Company's liability, if any, when ultimately determined will not be significant.\n- 30 -\nNOTE 4 - COMMITMENTS AND CONTINGENCIES (Continued)\nEmployment and consulting agreements\nThe Company has employment and consulting agreements with certain directors, officers and employees. Certain agreements provide for minimum salary levels as well as for incentive bonuses which are payable if specified management goals are attained.\nNOTE 5 - CAPITAL STOCK:\nStockholders' Rights Plan\nEach outstanding share of the Company's Common Stock carries a stock purchase right. Under certain circumstances, as defined in a rights agreement, each right may be exercised to purchase 1\/100 of a share of Series A Junior Participating Preferred Stock for $25, subject to certain anti-dilution adjustments. The rights are redeemable by the Company or, under certain circumstances, by a third party to whom the Company assigns its rights at $.01 each until a person or group acquires twenty percent of the Company's Common Stock or until they expire on May 15, 1998.\nTreasury Stock\nOn February 4, 1993, the Company's Board of Directors authorized the repurchase from time to time of up to 500,000 shares of its common stock. As of January 29, 1994, the Company purchased 413,600 shares of common stock at an average price of $4.52 per share.\nNOTE 6 - STOCK OPTIONS:\nIn 1994, the Company's shareholders adopted a Stock Incentive Plan for key employees and consultants and a Stock Option Plan for eligible directors who are not employees of the Company. The Stock Incentive Plan reserves 500,000 shares of common stock for the issuance of stock options, stock appreciation rights (SARs), dividend equivalent rights, restricted stock, unrestricted stock and performance shares and is administered by the Stock Option Committee (the \"Committee\") of the board of directors of the Company. The outside directors Stock Option Plan reserves 75,000 shares of common stock for the issuance of stock options.\nUnder the terms of the Stock Incentive Plan (the Plan)options granted may be either nonqualified or incentive stock options and the exercise price, determined by the Committee, shall be at least 75% (100% in the case of an incentive stock option) of the fair market value of a share on the date of grant. SARs may be granted in connection with all or any part of, or independently of, any option granted under the Plan. SARs granted in connection with a nonqualified stock option may be granted at or after the time of grant of such option. SARs granted in connection with an incentive stock option may be granted only at the time of grant of such option. Other than restrictions which limit the sale and transfer of restricted stock awards and performance share awards, grantees are entitled to all the rights of a shareholder. No SARs, dividend equivalent rights, restricted stock, unrestricted stock or performance shares were granted during fiscal 1995. Options granted under the Stock Incentive Plan are exercisable in installments; however, no options are exercisable within one year or later than ten years from the date of grant.\n- 31 -\nNOTE 6 - STOCK OPTIONS (Continued)\nThe outside directors Stock Option Plan provides that upon the initial election to the Board, each eligible director is granted an option to purchase 5,000 shares of common stock and 1,000 shares each year thereafter at the fair market value on the date of grant. The options have a term of five years and become exercisable 50% on the first anniversary of the date of grant and 50% on the second anniversary of the date of grant.\nThe Company's 1984 Stock Option Plan expired in April 1994 and the remaining options available but not granted under the Plan were cancelled.\nThe following summary sets forth the activity under the Company's stock incentive plans:\nNOTE 7 - TAXES ON INCOME:\nIncome taxes consist of the following:\nNOTE - 7 TAXES ON INCOME: (Continued)\nThe components of deferred tax assets (liabilities) consist of the following:\nDeferred income taxes result from temporary differences in the recognition of revenue and expense for tax and financial statement purposes. Principal items resulting in deferred income tax liabilities or assets are differences in depreciation, inventory valuations, restructuring charges and allowance for doubtful accounts. Management has determined, based on the Company's history of prior operating earnings and its expectations for the future, that operating income of the Company will more likely than not be sufficient to recognize fully these net deferred tax assets. There can be no assurance, however, that the Company will generate taxable income or any specific level of continuing earnings in the future.\nNOTE 8 - EMPLOYEE RETIREMENT PLANS:\nThe Company has a 401-k savings plan designed to provide additional financial security during retirement by providing eligible employees with an incentive to make regular savings. The Company matches 10% of the first 4% of compensation contributed by the employee.\nCertain employees are covered by union sponsored, multi-employer pension plans. Contributions and costs are determined in accordance with the provisions of negotiated labor contracts or terms of the plans. The Company does not administer nor control the plans. One of the plans, to which the Company and many other employers make contributions, is having financial difficulties. The Employee Retirement Income Security Act (\"ERISA\") imposes certain liabilities upon employers who are contributors to multi-employer pension plans in the event of withdrawal or termination of such a plan. The union has advised the Company that they will no longer accept contributions to the plan. The Company has been advised that cessation of contributions will result in a withdrawal liability. The Company provided for an estimated settlement cost in the fourth quarter of fiscal 1995.\n- 33 -\nNOTE 9 - INDUSTRY SEGMENTS:\nThe Company operates substantially in two industry segments which consist of the wholesale distribution of housewares, toys, and stationery products and the retail distribution of toys. Two customers in fiscal 1994 and 1993 represented sales in excess of 10% of consolidated sales 1994-13.5% and 10.3%; 1993- 12.7% and 10.1%.\nFinancial information by reportable business segments for fiscal 1995, 1994, and 1993 is included in the following summary:\n- 34 -\nNOTE 10 - PROVISION FOR STORE CLOSINGS AND RESTRUCTURING CHARGES:\nOn August 10, 1994 the Company announced the closing of stores operating under the name Playworld Toy Stores and one leased department operation. Provision of $3,900 was recorded for store closings represents losses from store operations from the date of announcement until closing, employee severance costs, estimated lease liabilities, losses on liquidation of inventories and disposition of assets and other related restructuring costs. This charge increased the net loss for fiscal 1995 by $2,340 ($.45 per share). Revenues for these operations amounted to $10,923, $11,257, and $10,955 during fiscal 1995, 1994 and 1993, respectively.\nDuring fiscal 1993 the Company recorded a restructuring charge of $1,050 for severance and relocation costs resulting from the realignment of its wholesale distribution business. The effect of the restructuring enabled the Company to reduce costs and improve operating efficiency. This charge resulted in a decrease in fiscal 1993 net income of $644 ($.12 per share).\nNOTE 11 - INTERIM FINANCIAL DATA (UNAUDITED):\nDuring the second quarter of fiscal 1995, the Company provided a pre-tax charge of $3,500,000 ($2,100,000, $.40 per share after taxes) to cover the unusual costs of the decision to close its Playworld Toy Stores. An additional pre-tax charge of $400,000 ($240,000, $.05 per share after taxes) was provided during the fourth quarter. The Company's wholesale and retail sales are highly seasonal. During fiscal 1995 and 1994, 58% and 57%, respectively, of such sales were made in the second half of the year.\nIncome (loss) per share calculations for each of the quarters are based on the weighted average number of shares outstanding for each period and the sum of the quarters may not necessarily be equal to the full year income (loss) per share amount. The fourth quarter of fiscal 1994 includes the dilutive effect of common stock equivalents. The inclusion of common stock equivalents were either antidilutive or had no significant dilutive effect in the other quarters and therefore were not utilized in the above computations of income (loss) per share.\n- 35 -\n- 36 -\n- 67 -\nEXHIBIT 21\nSubsidiaries of the Registrant\n1. Martin Zippel Co. Inc., Incorporated in New Jersey, doing business as same. (a)\n2. Kleban Distribution Services, Inc., Incorporated In Delaware, doing business as same. (a)\n3. C.W.P.W. Inc., Incorporated in Michigan, doing business as Playworld, Toy Park, Hudson Berlind Sales Associates, Martin Zippel Sales Associates and Noodle Kidoodle.\n4. M.Z. Catalogue Services, Inc., Incorporated in New Jersey, doing business as same.\n(a) As of April 1, 1994, Martin Zippel Co. Inc., and Kleban Distribution Services, Inc., were merged into Greenman Bros. Inc.\n- 68 -","section_15":""}
{"filename":"820736_1995.txt","cik":"820736","year":"1995","section_1":"ITEM 1. BUSINESS\nBACKGROUND\nOrbital Sciences Corporation (together with its subsidiaries, \"Orbital\" or the \"Company\") is a space technology and satellite services company that designs, manufactures, operates and markets a broad range of space-related products and services. Orbital's products and services are grouped into four categories: Launch Systems, Space and Electronics Systems, Ground Systems and Software, and Communications and Information Services. Launch Systems include space and suborbital launch vehicles, and orbit transfer and other advanced vehicles; Space and Electronics Systems include satellites, spacecraft platforms, space sensors and instruments, space payloads and experiments, as well as advanced electronics and data management systems; Ground Systems and Software products include commercial satellite remote sensing ground station and related information processing software, automated aeronautical information and air traffic management systems, defense system software and network systems consulting services; and Communications and Information Services include satellite-based two-way mobile data communications systems and services, satellite-based navigation and communications products and remote sensing services.\nOrbital was incorporated in Delaware in 1987 to consolidate the assets, liabilities and operations of Space Systems Corporation (formerly named Orbital Sciences Corporation) (\"SSC\") and Orbital Research Partners, L.P. (the \"Partnership\") through an exchange offer to the Partnership and to the stockholders of SSC (the \"Consolidation\"). As a result of the consummation of the Consolidation in 1988, SSC became a wholly owned subsidiary of Orbital, and Orbital acquired substantially all the assets and liabilities of the Partnership. The Company acquired Space Data Corporation (\"Space Data\") in 1988, thereby expanding its product lines and increasing its vertical integration in production and testing. In late 1992, SSC and Space Data were merged into Orbital, with the Company being the surviving corporation. In September 1993, Orbital acquired all the assets of the Applied Science Operation, a division of The Perkin-Elmer Corporation (\"ASO\"). This operation designs, develops and produces satellite-borne scientific sensors for space and terrestrial research and in situ atmospheric monitoring equipment for human space flight programs. In August 1994 and December 1994, Orbital acquired Fairchild Space and Defense Corporation (\"Fairchild\") and Magellan Corporation (\"Magellan\"), respectively. The Fairchild acquisition enhanced Orbital's satellite system and subsystem development and production capabilities and expanded Orbital's existing product lines by adding various sophisticated electronics products. Magellan designs, manufactures and markets hand-held receivers for Global Positioning System (\"GPS\") satellite-based navigation and positioning for commercial and consumer markets, along with portable satellite communications equipment. In November 1995, Orbital acquired MacDonald, Dettwiler and Associates, Ltd. (\"MDA\"), a leading supplier of commercial space remote sensing ground stations and related information processing software headquartered in Vancouver, British Columbia. MDA complements Orbital's satellite information collection businesses and has strengthened Orbital's ability to offer a broader range of space-based information services.\nDESCRIPTION OF ORBITAL'S PRODUCTS AND SERVICES\nThe space products and services provided by the Company are grouped into four categories: Launch Systems, Space and Electronics Systems, Ground Systems and Software, and Communications and Information Services. Orbital's business is not seasonal to any significant extent.\nLAUNCH SYSTEMS\nThe Company's Launch Systems Group's products include space and suborbital launch vehicles and orbit transfer and other advanced vehicles.\nSPACE LAUNCH VEHICLES. The Company has developed three space launch vehicles: the Pegasus(R) launch vehicle; the Pegasus XL(TM) launch vehicle; and the Taurus(R) launch vehicle. Orbital's Pegasus and Pegasus XL vehicles are launched from beneath a modified large aircraft such as the Company's leased Lockheed L-1011 to deploy satellites weighing up to 1,000 pounds into low-Earth orbit. Through December 1995, the Company had conducted a total of seven standard Pegasus missions, all of which were fully or partially successful. Whether a mission is fully or partially successful depends on the particular mission requirements designated by the customer. Prior to its first successful flight in March 1996, the modified Pegasus XL, developed to deploy heavier satellites into orbit, had two unsuccessful flights, one occurring in June 1994 and the other in June 1995. The first Pegasus XL failure was caused by inaccurate aerodynamic modeling of the vehicle. The second Pegasus XL failure resulted from human assembly error involving the improper installation of a small component that prevented the Stage 1\/Stage 2 interstage from properly separating from Stage 2. Following a comprehensive review of design, assembly, test and operations procedures, the Pegasus XL returned to flight on March 8, 1996, successfully launching a satellite for the U.S. Air Force to its targeted orbit.\nCustomers for Pegasus launch vehicles include the National Aeronautics and Space Administration (\"NASA\"), the U.S. Air Force, the Defense Advanced Research Projects Agency (\"DARPA\"), the Ballistic Missile Defense Organization (\"BMDO\"), Spain's National Institute of Aerospace Technology, the Company's affiliated partnership, ORBCOMM Global L.P. (\"ORBCOMM Global\") and the Company's wholly owned subsidiary, Orbital Imaging Corporation (\"ORBIMAGE\").\nThe higher capacity Taurus vehicle is a ground-launched derivative of the Pegasus vehicle that can carry payloads weighing up to 3,000 pounds to low-Earth orbit and payloads weighing up to 800 pounds to geosynchronous orbit. In March 1994, Orbital successfully launched the first Taurus vehicle, deploying two satellites for DARPA. The Company received several new Taurus orders in 1995, including a commercial launch for Ball Corporation (\"Ball\") carrying a U.S. Navy satellite scheduled for late 1996, a launch for the U.S. Air Force in 1997, and options for up to 11 Taurus missions pursuant to a contract award under NASA's Med-Lite program. The Taurus mission for Ball is also expected to launch two satellites for ORBCOMM Global as a secondary payload.\nDuring 1995, Orbital and Rockwell International Corporation (\"Rockwell\") teamed together to develop and construct the X-34 reusable launch vehicle in a project to be jointly funded by Orbital, Rockwell and NASA. The X-34 was intended as a next-generation space launch vehicle that would significantly reduce the costs of placing a satellite in orbit. Following an assessment that the design of the vehicle would not achieve the economic and performance goals of the project, development efforts on the vehicle were terminated in early 1996. Orbital continues to explore new, longer-term research and development opportunities for more affordable and flexible space launch vehicles.\nSUBORBITAL LAUNCH VEHICLES. Suborbital launch vehicles place payloads into a variety of high-altitude trajectories but, unlike space launch vehicles, do not place payloads into orbit around the Earth. The Company's suborbital launch products include suborbital vehicles and their principal subsystems, payloads carried by such vehicles and related launch support installations and systems used in their assembly and operation. The Company offers its customers customized vehicle and payload design, manufacturing and integration, launch and mission support and tracking and recovery services, as well as construction and activation of launch pads and other infrastructure elements. Customers typically use the Company's suborbital launch vehicles to launch scientific and other payloads and for defense-related applications such as target and interceptor experiments. Primary customers of the Company's suborbital launch vehicles include the U.S. Army, the U.S. Navy and BMDO.\nOrbital's primary programs in 1995 for suborbital launch vehicles and related systems included the STORM contract pursuant to which Orbital provided ballistic and maneuvering tactical target suborbital vehicles for use with the PATRIOT and Theater High Altitude Area Defense Interceptor anti-missile defense systems for target and interceptor experiments for the U.S. Army, the Navy LEAP\ncontract with BMDO and the High-Gear contract with the Massachusetts Institute of Technology - Lincoln Laboratory pursuant to which Orbital provided suborbital vehicles to serve as targets for U.S. Air Force testing of anti-missile defense systems. Orbital conducted ten suborbital launches in 1995, all of which were successful. Since January 1993, the Company has conducted a total of 26 launches of suborbital vehicles, all of which were successful.\nSPACE AND ELECTRONICS SYSTEMS\nThe Company's Space and Electronics Systems Group's products enable Orbital to provide its customers fully integrated, low-cost space systems, networks and related services. The Company's most significant Space and Electronics Systems products are satellite systems and payloads, space sensors and instruments, defense electronics and sensors, and transit management systems.\nThe Company designs and produces small and medium class satellites for scientific, military and commercial applications. The Company's small satellite platforms such as PegaStar(TM), MicroStar(TM) and PicoStar(TM) are designed and produced to be launched by the Pegasus or Taurus launch vehicle. The PegaStar spacecraft is a general purpose spacecraft that has successfully performed one mission for the U.S. Air Force measuring space radiation and carrying out related experiments. It will also be used for certain of the Company's satellite-based remote sensing systems, such as the SeaStar(TM) ocean and land surface environmental monitoring satellite system. Orbital's MicroStar spacecraft platform, which is placed into orbit by the Pegasus launch vehicle, is designed for use in ORBCOMM Global's satellite-based two-way data communications network (the \"ORBCOMM System\") and also for a variety of small space science and remote sensing projects, including some of those being pursued by ORBIMAGE. In April 1995, the first three MicroStar spacecraft were deployed, two for the ORBCOMM System, and the other for ORBIMAGE to monitor lightning and severe weather patterns for NASA. Customers for the Company's small spacecraft include NASA, the U.S. Air Force and ORBCOMM Global. In late 1995, DARPA selected the Company for a contract to develop a specialized MicroStar communications satellite.\nOrbital's medium class satellites, such as NASA's TOPEX\/Poseidon, NASA's Upper Atmosphere Research satellite, and the National Oceanic and Atmospheric Administration's Landsat 4 and Landsat 5 have been in space for several years, and are used to gather various scientific data, such as ocean topography and Earth imaging information. In August 1995, Orbital was selected to become the spacecraft supplier to Johns Hopkins University, which is leading NASA's Far Ultraviolet Spectroscopy Explorer (FUSE) program to measure the early universe's radiation. The FUSE spacecraft is presently scheduled for launch in 1998.\nIn addition, Orbital designs and manufactures satellite command and data handling, attitude control and structural subsystems for a variety of government and commercial customers, and provides a broad range of spacecraft design and engineering services as well as specialized analytical engineering services for NASA, the Department of Defense (\"DoD\"), the Department of Energy and other customers. Orbital provided engineering support and services for the first repair mission for the orbiting Hubble Space Telescope, and will provide similar services on a second repair mission currently scheduled for early 1997.\nThe Company also develops, manufactures and markets defense electronics, including advanced avionics and data management systems for aircraft flight operations and ground support. These systems collect, process and store mission-critical data for, among other things, mission planning and flight operations, and manage on-board equipment for strategic and tactical military aircraft, helicopters, satellites and surface vehicles. The primary customers for data management systems are the U.S. Navy, the U.S. Air Force, and various DoD prime contractors and foreign governments. The Company is the leading supplier of certain avionics systems and products, including mission data loaders for the U.S. Navy and data transfer equipment and digital terrain systems for the U.S. Air Force. In addition, the\nCompany provides stores management systems, including weapons arming and firing functions for use on tactical aircraft and helicopters. The avionics systems and products are deployed on a number of aircraft, including the,,, and and the LAMPS Helicopter.\nIn addition, Orbital produces electronics and data management systems that have been applied to the development and manufacture of \"intelligent transportation systems,\" primarily for metropolitan mass transit operators, that provide GPS-based tracking of vehicles and allow for communications and schedule management. Customers for Orbital's intelligent transportation systems include several metropolitan mass transit operators, such as the Chicago Transit Authority.\nOrbital's Pomona, California operations produce satellite-borne scientific sensors and instruments, such as atmospheric ozone monitoring instruments and environmental sensors. For example, the Total Ozone Mapping Spectrometer (\"TOMS\") instrument is being produced by the Company for launch on a Pegasus vehicle for NASA. TOMS measures ozone concentrations around the world for the purpose of monitoring the effect of man-made chemicals and atmospheric conditions on the ozone layer. In addition, Orbital is currently developing and producing various in situ monitoring products for space and defense applications. These products include an atmospheric monitoring system for use on the Space Station called the Atmospheric Composition Monitoring Assembly (\"ACMA\"). The ACMA, developed under a contract with The Boeing Company, will measure various atmospheric gases in the crew's living quarters on the Space Station for the purpose of ensuring a healthy environment for astronauts. The Company also produces the Central Atmospheric Monitoring System for the U.S. Navy for use on submarines.\nGROUND SYSTEMS AND SOFTWARE\nAs a result of the Company's November 1995 acquisition of MDA, Orbital's Ground Systems and Software Group is a leading supplier of commercial satellite remote sensing ground stations and a provider of advanced space-qualified software, air navigation systems, and network communications training and consulting services. The Company's defense electronics systems have also expanded to include software-intensive systems designed for naval operations, artillery command and control, radar deception systems and logistics support.\nThe Company develops, provides and upgrades commercial satellite remote sensing ground stations and related information processing software. Of the 27 major non-military satellite ground stations around the world, MDA has built or been involved in the construction of 23 ground stations in 20 countries. These ground stations are designed to receive and process data from the eight major civil and commercial Earth observation satellites currently in operation. In 1995, the Company completed the ground station and mission control and management systems for the Canadian Space Agency's RADARSAT-1 remote sensing satellite that was launched successfully in November 1995. MDA also develops and markets software that generates and processes imagery and mapping products from satellites and airborne sensors. Customers for the Company's ground stations and Earth information systems include the European and Canadian Space Agencies as well as Canadian and foreign government customers.\nThe Company's aviation systems products include automated aeronautical information and air traffic management systems. The Company has developed the Pegasus-AIS(TM) (not related to the Pegasus launch vehicle), an off-the shelf, automated aeronautical information management system that delivers weather and route information directly to a pilot by computer. These systems are designed to address a growing trend toward commercialization and automation of air traffic control systems. Faster and less expensive to operate than traditional manual systems, automated aeronautical information systems provide pilots and other users with aeronautical and meteorological information on a timely basis. Customers for the Company's aviation systems products include the military and civil aviation authorities in various countries such as Australia, Belgium, Canada, Norway and Switzerland.\nThe Ground Systems and Software Group also provides computer network communications consulting, training and other services to network equipment vendors and telecommunications carriers in Canada, the United States, Australia and Asia.\nCOMMUNICATIONS AND INFORMATION SERVICES\nOrbital's Communications and Information Services include products and services provided by Magellan, the Company's majority owned subsidiary Orbital Communications Corporation (\"ORBCOMM\"), and ORBIMAGE. Magellan manufactures GPS satellite-based navigation and communications products for commercial and consumer markets including commercial and recreational marine and aviation markets, outdoor recreational users such as hunters and hikers, and professional users such as geologists, geographers, surveyors, natural resource managers and contractors. ORBCOMM and ORBIMAGE are developing satellite-based services to address the expanding markets for global two-way data communications and information derived from remote sensing of the atmosphere, oceans and land surfaces. The ORBCOMM and ORBIMAGE systems will require significant capital investments and market development. Although the Company believes the long-term profit potential of such service businesses, developed and supported by the Company's proprietary product technologies, is significant, there can be no assurance that the Company will be able to successfully develop these businesses.\nSATELLITE-BASED NAVIGATION AND COMMUNICATIONS PRODUCTS. The Company's Magellan subsidiary designs, manufactures and markets hand-held GPS navigators that provide users with precise positioning and location information. The need for positioning and location information is central to a broad range of personal and professional activities including marine navigation, outdoor recreation (e.g., hiking and hunting), surveying and general aviation. Magellan focuses its research, design and engineering activities on the development of GPS navigators that are reliable, portable, easy to use and highly affordable, targeting the growing recreational market. During 1995, Magellan introduced the low-cost GPS 2000(TM) personal navigation unit that is widely distributed in mass merchandising outlets and mail order catalogs. Magellan has also started production of the microCOM-M(TM), a small, lightweight and low-priced INMARSAT satellite telephone for worldwide voice, fax and data communications. Magellan is also expected to be a significant supplier of personal communicators for the ORBCOMM System and to be involved in the continued development of satellite-based communications and tracking technology that is compatible with the ORBCOMM System.\nORBCOMM COMMUNICATIONS SERVICES. The ORBCOMM System is designed to provide virtually continuous mobile data communications coverage over much of the Earth's surface. Under this system, subscribers are able to use inexpensive communicators to send and receive short messages, high priority alerts and other information, such as the location and condition of automobiles, trucks, shipping vessels and other remote assets. The Company expects that the ability to send and receive messages and data without the geographic limitations of existing data communications systems will stimulate the growth of new markets for satellite-based data communications and will be used to supplement terrestrial-based communications systems by providing relatively low-cost coverage in areas outside the range of such tower-based systems.\nThe global ORBCOMM System design consists of a constellation of small low-Earth orbit satellites, a satellite control center operating and positioning the satellites, the mobile communicators used by subscribers to transmit and receive messages to and from the satellites, and the gateways that transmit and control the flow of data and message communications and other information for the system. A gateway generally will consist of gateway Earth stations and a software-based gateway message switching system that processes the message traffic and provides the interconnection to terrestrial networks. The U.S. gateway, for example, includes four gateway Earth stations located in New York, Washington, Arizona and Georgia with the message switching system located at ORBCOMM Global's network operations center in\nDulles, Virginia. Gateways are planned to be owned and operated by ORBCOMM Global licensees in strategic locations around the world.\nIn April 1995, the Company successfully launched the first two satellites that will comprise the ORBCOMM System constellation. Certain technical problems with both spacecraft resulted in a delay of several months in the completion of on-orbit testing. The Company believes that it has identified and implemented the appropriate corrective actions with respect to these problems, and does not believe that they will impact continued development of the ORBCOMM System. During 1995, in addition to the launch of the first two satellites, the Company completed construction and testing of various network management systems including the satellite control center and the network operations center, and substantially completed the four United States gateway Earth stations. Prototype communicators also transmitted hundreds of thousands of messages. Following comprehensive testing of the space and ground network during 1995, intermittent commercial service in the United States commenced in February 1996. Several consumer electronics manufacturers are developing communicators that monitor fixed assets and hand-held communicators for personal use for shipment during 1996, and the Company expects that the number of users of the ORBCOMM System will grow significantly as subscriber unit production rates increase.\nThe two ORBCOMM System satellites currently in orbit and the U.S. gateway provide communications availability in the United States approximately 10% of each 24-hour period, with maximum outages of approximately nine hours. With the launch of additional satellites, such as the two scheduled to be launched as a secondary payload on a Taurus mission scheduled for late 1996, communications availability will also increase. The Company expects that, with a planned constellation of at least 26 satellites and appropriately situated gateways, the ORBCOMM System will provide communications availability generally exceeding 95% of each 24-hour period in the United States and other temperate zones in the Northern and Southern hemispheres and exceeding 75% of each 24-hour period in the equatorial region. Equatorial region availability could be improved to generally exceed 90% with an additional plane of eight satellites. Outside the United States, the ORBCOMM System will only be available in countries and regions where appropriate licenses have been obtained and where there is a gateway that can serve the applicable market.\nDEVELOPMENT AND FINANCING. In 1993, ORBCOMM and Teleglobe Mobile Partners (\"Teleglobe Mobile\"), an affiliate of Teleglobe Inc., formed a partnership, ORBCOMM Global (formerly known as ORBCOMM Development Partners, L.P.) for the two-phased design, development, construction, integration, testing and operation of the ORBCOMM System. ORBCOMM and Teleglobe Mobile also formed two marketing partnerships, ORBCOMM USA, L.P. (\"ORBCOMM USA\") and ORBCOMM International Partners, L.P. (\"ORBCOMM International\"), each with the exclusive right to market the ORBCOMM System in the United States and internationally, respectively. ORBCOMM has retained control over applicable licenses issued by the Federal Communications Commission (\"FCC\"), consistent with FCC regulations.\nAlso in 1993, Orbital entered into an agreement with ORBCOMM Global whereby Orbital had responsibility for the overall design, construction and integration for the first phase of the ORBCOMM project, which was completed during 1995. In September 1995, Orbital and ORBCOMM Global executed the ORBCOMM System Procurement Agreement (the \"Procurement Agreement\"), which provides that Orbital will, among other things, construct and launch an additional 26 satellites, and construct an additional eight satellites. Under the Procurement Agreement, Orbital is providing satellites and launch services on a fixed-price basis. Consistent with industry practice for many launch contracts, the Procurement Agreement contains certain performance incentives with respect to the satellites and their launch.\nUnder ORBCOMM Global's partnership agreement, action by the partnership generally requires the approval of general partners holding a majority of the participating interests (i.e., interests participating in profits and losses). ORBCOMM and Teleglobe Mobile are each 50% general partners in\nORBCOMM Global, with the result that ORBCOMM and Teleglobe Mobile share equal responsibility for the operational and financial affairs of ORBCOMM Global and the approval of both ORBCOMM and Teleglobe Mobile is necessary for ORBCOMM Global to act. ORBCOMM holds indirectly a 51% participating interest in ORBCOMM USA and Teleglobe Mobile holds indirectly a 51% participating interest in ORBCOMM International, with the result that ORBCOMM acting alone can generally control the operational and financial affairs of ORBCOMM USA, and Teleglobe Mobile acting alone can generally control the operational and financial affairs of ORBCOMM International.\nIn September 1995, Teleglobe Mobile exercised its option to participate in the second phase of the ORBCOMM System and, accordingly, Orbital and Teleglobe Mobile's total capital commitments to ORBCOMM Global are approximately $75 million and $85 million, respectively, of which approximately $62 million and $35 million, respectively, had been contributed through December 31, 1995. Although construction of the first phase of the ORBCOMM System is completed, development and construction of the second phase is in an early stage, and the actual cost of the system and the amount and structure of anticipated investment in ORBCOMM Global may vary significantly from current estimates. Orbital expects that the total estimated required capital for the ORBCOMM System will be approximately $225-$250 million. ORBCOMM Global intends to seek additional equity contributions and\/or bank or other debt financing to fund the remaining requirements. ORBCOMM Global already obtained asset-based financing of $5 million to fund a portion of its development costs for the first phase of the ORBCOMM System. The Company has guaranteed ORBCOMM Global's outstanding indebtedness, and may be required to guarantee or provide credit support in connection with additional indebtedness incurred by ORBCOMM Global.\nIn the event that ORBCOMM Global does not otherwise receive the necessary capital, full development and implementation of the ORBCOMM System may be delayed, significantly restricted or possibly abandoned, and the Company could be required to expense part or all of its investment in the ORBCOMM System. In addition, start-up of the ORBCOMM System will produce significant ORBCOMM Global operating losses for several years. Even if the ORBCOMM System is fully constructed and operational, there can be no assurance that an adequate market will develop for ORBCOMM System services, that ORBCOMM Global will achieve profitable operations or that Orbital will recover any of its past or anticipated investment in the ORBCOMM System. Because Orbital (through ORBCOMM) has a 50% participating interest in ORBCOMM Global, Orbital expects to recognize its pro rata share of ORBCOMM Global profits and losses.\nAs of March 1, 1996, certain officers and employees of ORBCOMM Global and Orbital held options to acquire 555,100 shares of ORBCOMM's common stock (or approximately 12 percent of ORBCOMM's outstanding common stock) at option exercise prices ranging from $1.50 to $17.00 per share. On an annual basis, holders of ORBCOMM common stock acquired on exercise of these options may, subject to certain conditions, require ORBCOMM to purchase such ORBCOMM common stock at its then fair market value. As of March 1, 1996, there were 52,286 shares of ORBCOMM common stock outstanding that were acquired in connection with option exercises by current or former ORBCOMM and Orbital employees.\nREGULATORY APPROVALS. In October 1994, ORBCOMM became the first company to be awarded full FCC authority to construct, launch and operate a low-Earth orbit satellite-based messaging and data communications network in the United States. This license, which provides that the ORBCOMM System must be constructed within six years from the date the license was granted, extends for a period of ten years from the date the first ORBCOMM System satellite was operational. At the end of the seventh year of the ten-year term, a renewal application must be filed with the FCC. As with any such license, the ORBCOMM System license may be revoked and a license renewal application may be denied for cause. In October 1995, ORBCOMM requested a modification of its FCC license with respect to ORBCOMM's channel plan for purposes of facilitating frequency coordination of the ORBCOMM System with foreign governments. This request has completed the public comment cycle and\nORBCOMM believes its request will be granted within the next several months. In addition, for the ORBCOMM System to be operated in other countries throughout the world, the Company or the foreign licensees must obtain from the appropriate foreign regulatory bodies authority to do so. The Company anticipates that the cost of these activities will be borne primarily by foreign licensees. ORBCOMM International has entered into a definitive license agreement with ORBCOMM Canada Inc., which is expected to begin providing ORBCOMM service in Canada in Spring 1996. ORBCOMM has signed preliminary agreements with 19 candidate licensees serving 71 other countries to seek such regulatory approvals and to initiate territory-specific market development in such countries. There can be no assurance that ORBCOMM or its foreign licensees will be granted all licenses or approvals necessary to operate the ORBCOMM System in any other country.\nORBIMAGE REMOTE SENSING AND IMAGING SERVICES. The Company is currently seeking to develop and market a broad range of information services that involve identifying and monitoring global environmental changes and weather patterns and collecting and disseminating digital land maps and other remote sensing information. Small Earth-viewing satellites and related sensors and instruments to be placed in relatively low orbits are planned to offer cost-efficient data collection, daily global coverage and high-resolution imaging services.\nIn April 1995, ORBIMAGE's first MicroStar satellite, MicroLab-1, was successfully launched to monitor lightning and severe weather patterns for NASA. In 1991, Orbital entered into a contract with NASA to provide worldwide, daily ocean imagery using Orbital's SeaStar environmental monitoring satellite system, based on the PegaStar spacecraft. The Company plans to develop, produce, launch and operate the SeaStar system to deliver high-quality multi-spectral ocean imagery and land surface imagery for up to five years. The SeaStar launch has been delayed several years, primarily due to technical challenges associated with the development of the spacecraft and launch delays relating to the Pegasus XL failures in 1994 and 1995. The SeaStar satellite is currently scheduled to be launched in late 1996 or early 1997. In addition to providing unprocessed real-time ocean data to NASA, ORBIMAGE plans to market the SeaStar data directly and through value-added resellers and other marketing agents to other U.S. Government users and to potential domestic and international customers such as commercial fishing fleets, oil and gas companies, ocean transportation operators, oceanographers and agricultural companies.\nORBIMAGE is developing and marketing other small satellite-based Earth observation, remote sensing and environmental monitoring services using, among other things, the Company's PegaStar and MicroStar spacecraft platforms, Pegasus and Taurus launch vehicles, space sensors and instruments and other space products. Services to be provided by ORBIMAGE could include high-resolution optical imaging of land surfaces for geographic information services, mapping, sensing of ocean and atmospheric conditions and measuring of ozone and other gaseous concentrations in the atmosphere. The Company is currently exploring potential strategic arrangements for development of the high-resolution remote sensing business, with Orbital providing launch services, spacecraft, ground stations and other related products. During 1995, ORBIMAGE signed preliminary agreements with several potential imagery distributors and initiated preliminary discussions with potential strategic partners. There can be no assurance that the Company will be able to conclude such strategic arrangements or develop profitable commercial Earth observation, remote sensing or environmental monitoring businesses.\n* * * *\nFinancial information about the Company's products and services, foreign and domestic operations and export sales is included in Management's Discussion and Analysis of Financial Condition and Results of Operations and Notes to the Company's Consolidated Financial Statements set forth in the Company's Annual Report, and is incorporated herein by reference.\nCOMPETITION\nOrbital believes that competition for sales of its products and services is based on performance and other technical features, price, reliability, scheduling and customization.\nThe primary competition to the Pegasus and Taurus vehicles is expected to come from the smaller and larger classes, respectively, of LMLV launch vehicles currently being developed by Lockheed Martin Corporation (\"Lockheed Martin\"). The LMLV had an unsuccessful first flight in August 1995. Potential competition to the Pegasus may also come from launch systems derived from surplus ballistic missiles that are primarily being made available by the U.S. Government and Russia. The National Space Transportation Policy (the \"NSTP\") authorizes U.S. Government agencies to use excess ballistic missiles to launch payloads into orbit on a case-by-case basis. While Lockheed Martin currently has a contract with the DoD to convert excess Minuteman missiles into space launch vehicles, the NSTP established that such use may only be permitted after the DoD has determined, among other things, that such use would meet the agency's needs and would result in a cost savings to the U.S. Government compared to a commercial launch service. Competition for Taurus could also come from surplus Titan II launch vehicles, although Titan II production has been discontinued and only a very limited inventory remains. In addition, in 1995 the Japanese space agency successfully launched a booster that directly competes with Taurus in terms of launch capacity, but is more expensive than the Taurus. Indirect competition to Pegasus and Taurus vehicles also exists in the form of secondary or \"piggyback\" payload capacity on large boosters such as the Ariane, Titan, Long March and Proton launch vehicles. While secondary payloads offer a low-cost method of launching satellites in some cases, the secondary status of the payload often requires customers to accept less desirable orbits, \"standby\" launch scheduling and potentially more complicated and costly payload integration procedures.\nWhile several companies design and manufacture suborbital launch vehicles, Orbital's primary competitor in this product line is Coleman Research Corp. Satellite systems and payloads and space support products compete with products and services produced or provided by numerous companies and government entities, including TRW Inc. and CTA, Inc. The Company's space instruments and airborne and ground-based electronics, data management systems, defense-oriented avionics products and software systems, and aviation systems face competition from several established manufacturers. The Company's space sensors and instruments face competition from a number of companies and university research laboratories capable of designing and producing space instruments. The Company's main competition in the area of ground stations include Datron Systems Inc. and Hughes-STX Corp.\nMagellan's marine and outdoor recreation GPS satellite-based navigation products primarily face competition from Garmin International. Magellan competes with a larger number of producers of GPS navigation and communications products in its other markets. The Company believes that Magellan's success will depend on its ability to continue to develop new lower-cost and enhanced performance products and to enter into and develop new markets for GPS navigators.\nThe ORBCOMM System will face competition from numerous existing and potential alternative communications products and services provided by various large and small companies, including sophisticated two-way satellite-based data and voice communications services. For specific markets, the ORBCOMM System may complement existing tower-based services such as one-way and two-way paging, cellular data, specialized mobile radio and private networks. ORBIMAGE may face competition from U.S. and foreign government and private entities that provide or are seeking to provide satellite-based and other land imaging, environmental monitoring and atmospheric sensing products.\nMany of the Company's competitors are larger and have substantially greater resources than the Company. Furthermore, the possibility exists that other domestic or foreign companies or governments, some with greater experience in the space industry and greater financial resources than Orbital, will seek to produce products or services that compete with those of the Company. Any such foreign competitor could benefit from subsidies from, or other protective measures by, its home country.\nRESEARCH AND DEVELOPMENT\nThe Company expects to continue to invest in product-related research and development, to conceive and develop new products and services, to enhance existing products and to seek customer and, where appropriate, strategic partner investments in these products. Orbital's research and development expenses, excluding direct customer-funded development, were approximately $25.5 million, $17.3 million, and $19.7 million, respectively, for the fiscal years ended December 31, 1995, 1994 and 1993. It is expected that the Company's research and development expenses during 1996 will be primarily for satellite programs, possible ORBIMAGE projects, new or modified launch systems, and satellite-based navigation and communications products.\nPATENTS AND TRADEMARKS\nOrbital relies, in part, on patents, trade secrets and know-how to develop and maintain its competitive position and technological advantage. The Company holds U.S. and foreign patents relating to the Pegasus vehicle and U.S. patents relating to the ORBCOMM System as well as for other components and products produced by the Company. The Company also has various pending patent applications relating to Pegasus and the ORBCOMM System along with other products. Certain of the trademarks and service marks used in connection with the Company's products and services have been registered with the U.S. Patent and Trademark Office and the Canadian Intellectual Property Office.\nCOMPONENTS AND RAW MATERIALS\nOrbital purchases a significant percentage of its product components, including rocket propulsion motors, structural assemblies and electronic equipment, from third parties. Orbital also occasionally obtains from the U.S. Government parts and equipment that are used in the production of the Company's products or in the provision of the Company's services. Orbital has not experienced material difficulty in obtaining product components or necessary parts and equipment and believes that alternative sources of supply would be available, although increased costs could be incurred in securing alternative sources of supply. The Company's ability to launch its Pegasus and Pegasus XL vehicles depends on the availability of an aircraft with the capability of carrying and launching such space launch vehicles. Orbital entered into a 10-year lease in 1992 for a Lockheed L-1011 for the air-launch of the Pegasus and Pegasus XL vehicles.\nU.S. GOVERNMENT CONTRACTS\nDuring 1995, 1994 and 1993, approximately 40 percent, 45 percent and 45 percent, respectively, of the Company's total annual revenues were derived from contracts with the U.S. Government and its agencies or from subcontracts with the U.S. Government's prime contractors. Orbital's government contracts are subject to regular audit and periodic reviews and may be modified, increased, reduced or terminated in the event of changes in government requirements or policies, Congressional appropriations and program progress and scheduling. U.S. Government curtailment of expenditures for space research and development and related products and services could have a material adverse effect on Orbital's revenues and results from operations. Agencies within the U.S. Government and commercial customers to which sales by the Company accounted for ten percent or more of the Company's consolidated 1995 revenues were NASA, DoD and ORBCOMM Global.\nOrbital's major contracts with the U.S. Government fall into three categories: firm fixed-price contracts, fixed-price incentive fee contracts and cost-plus-fee contracts. Under firm fixed-price contracts,\nwork performed and products shipped are paid for at a fixed price without adjustment for actual costs incurred in connection with the contract. Risk of loss due to increased cost, therefore, is borne by the Company although some of this risk may be passed on to subcontractors. Under fixed-price government contracts, Orbital may receive progress payments, generally in an amount equal to between 80 and 95 percent of monthly costs, or it may receive milestone payments upon the occurrence of certain program achievements. Fixed-price incentive fee contracts provide for sharing by the customer and the Company of unexpected costs incurred or savings realized within specified limits, and may provide for adjustments in price depending on actual contract performance other than costs. Costs in excess of the negotiated maximum (ceiling) price and the risk of loss by reason of such excess costs are borne by the Company, although some of this risk may be passed on to subcontractors. Under a cost-plus-fee contract, Orbital recovers its actual allowable costs incurred and receives a fee consisting of a base amount that is fixed at the inception of the contract and\/or an award amount that is based on the Government's subjective evaluation of the contractor's performance in terms of the criteria stated in the contract.\nAll of Orbital's U.S. Government contracts and, in general, its subcontracts with the U.S. Government's prime contractors provide that such contracts may be terminated at will by the U.S. Government or the prime contractor, respectively. Furthermore, any of these contracts may become subject to a government-issued stop work order under which the Company is required to suspend production. In the event of a termination at will, Orbital is normally entitled to recognize the purchase price for delivered items, reimbursement for allowable costs for work in process, and an allowance for reasonable profit thereon or adjustment for loss if completion of performance would have resulted in a loss. The Company has experienced several contract suspensions and terminations in the past.\nBACKLOG\nThe Company's backlog at December 31, 1995 and 1994 was approximately $530 million and $419 million, respectively. As of December 31, 1995, approximately 60 percent of the Company's backlog was with the U.S. Government and its agencies or from subcontracts with the U.S. Government's prime contractors. Backlog consists of aggregate contract values for firm product orders, excluding the portion previously included in operating revenues on the basis of percentage of completion accounting, and including government contracts awarded but not signed and orders not yet funded in the amounts of approximately $355 million and $171 million as of December 31, 1995 and 1994, respectively. Approximately $303 million of backlog is currently scheduled to be performed beyond 1996. Backlog excludes unexercised and undefinitized contract options having an aggregate potential contract value at December 31, 1995 of approximately $910 million.\nEMPLOYEES\nAs of December 31, 1995, Orbital had 2, 729 full-time permanent employees.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nIn 1993, Orbital entered into a 12-year lease agreement for approximately 100,000 square feet of office and engineering space in Dulles, Virginia, which serves as its corporate headquarters. The Company owns an approximately 30,000 square-foot satellite engineering and manufacturing facility on land adjacent to the Dulles office facility. Orbital also leases approximately 320,000 square feet of office, engineering and manufacturing space in Germantown, Maryland; 305,000 square feet of office, engineering and manufacturing space in Chandler, Arizona; approximately 212,000 square feet of office and engineering space in Richmond, British Columbia; approximately 135,000 square feet of office, engineering and manufacturing space in Pomona, California; approximately 40,000 square feet of office, engineering and manufacturing space in San Dimas, California. The Company leases or owns other\nsmaller facilities, offices or manufacturing space around the United States, including Huntsville, Alabama; Edwards Air Force Base, California; Vandenberg Air Force Base, California and Greenbelt, Maryland; in other locations in Canada such as Ottawa, Ontario, as well as in England, Malaysia, Mexico and Australia. Although completion of the Company's existing and pending contracts may in the future require additional manufacturing capacity, Orbital believes that its existing facilities are adequate for its near- and medium-term requirements.\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\nThere was no matter submitted to a vote of the Company's security holders during the fourth quarter of 1995.\nITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT\nThe following table sets forth the name, age and position of each of the Executive Officers of Orbital as of March 1, 1996. All Executive Officers are elected annually and serve at the discretion of the Board of Directors.\nDavid W. Thompson is a founder of Orbital and has been Chairman of the Board, President and Chief Executive Officer of the Company since 1982.\nBruce W. Ferguson is a founder of Orbital and has been Executive Vice President and General Manager\/Communications and Information Services Group since October 1993 and a Director of the Company since 1982. Mr. Ferguson was Executive Vice President and Chief Operating Officer of Orbital from 1989 to October 1993 and Senior Vice President\/Finance and Administration and General Counsel of Orbital from 1985 to 1989.\nJames R. Thompson (who is not related to David W. Thompson) has been Executive Vice President and General Manager\/Launch Systems Group since October 1993 and a Director since January 1992. Mr. Thompson was Executive Vice President and Chief Technical Officer of Orbital from 1991 to\nOctober 1993. He was Deputy Administrator of NASA from 1989 to 1991. From 1986 until 1989, Mr. Thompson was Director of the Marshall Space Flight Center. He was Deputy Director for Technical Operations at Princeton University's Plasma Physics Laboratory from 1983 through 1986. Before that, he had a 20-year career with NASA at the Marshall Space Flight Center.\nJack A. Frohbieter has been a Director of the Company since August 1994, and Executive Vice President and General Manager\/Space and Electronics Systems since September 1994. From 1990 until August 1994, Mr. Frohbieter was President and Chief Operating Officer of Fairchild. From 1988 to 1990, he was Vice President and General Manager of General Electric Company's Government Electronics Systems Division, and from 1966 to 1987, he held a variety of positions at RCA's Astro Space Division, including Vice President and General Manager from 1986 to 1987.\nDaniel E. Friedmann has been Executive Vice President and General Manager\/Ground Systems and Software since January 1996. He continues to serve as President and Chief Executive Officer of MDA, a position he has held since March 1995. From 1992 to March 1995, he served as Executive Vice President and Chief Operating Officer of MDA. Between 1979 and 1992, he held a variety of positions at MDA, including serving as Vice President of various divisions.\nMichael D. Griffin has been Executive Vice President\/Advanced Systems Group since January 1996. Dr. Griffin joined Orbital in August 1995 when he was appointed Senior Vice President and Chief Technical Officer. From 1994 to August 1995, he was Senior Vice President for Program Development at Space Industries International. From September 1991 to January 1994 he served as Chief Engineer of NASA and was Deputy Director for Technology at the Strategic Defense Initiative Organization from 1989 to 1991.\nCarlton B. Crenshaw has been Executive Vice President and Chief Financial Officer since February 1996. He was Senior Vice President\/Finance and Administration from August 1995 to January 1996 and was Senior Vice President\/Finance and Administration and Treasurer of Orbital from January 1993 to August 1995. From 1989 to January 1993, he was Vice President\/Finance and Administration and Treasurer of the Company. From 1985 to 1989, Mr. Crenshaw was Vice President\/Finance and Administration and Chief Financial Officer of Software AG Systems, Inc.\nAntonio L. Elias has been Senior Vice President and Chief Technical Officer since January 1996. From May 1993 through December 1995 he was Senior Vice President for Advanced Projects and was Senior Vice President\/Space Systems Division from 1990 to April 1993. He was Vice President\/Engineering of Orbital from 1989 to 1990 and was Chief Engineer from 1986 to 1989. From 1980 to 1986, Dr. Elias was an Assistant Professor of Aeronautics and Astronautics at Massachusetts Institute of Technology.\nJohn H. Mehoves has been Senior Vice President\/Corporate Strategy since January 1996. From October 1993 to December 1995, he was Senior Vice President, from 1990 to October 1993, he was Executive Vice President\/Space Systems Division of Orbital, from 1987 to 1989, he was Vice President\/Space Transportation and from 1985 to 1987, he was Vice President\/Operations.\nLeslie C. Seeman has been Senior Vice President of the Company since October 1993 and General Counsel and Secretary of the Company since 1989. From 1989 to October 1993, she was Vice President of the Company, and from 1987 to 1989, Ms. Seeman was Assistant General Counsel of Orbital. From 1984 to 1987, she was General Counsel of Source Telecomputing Corporation, a telecommunications company. Prior to that, she was an associate with the law firm of Wilmer, Cutler & Pickering.\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 under the captions \"Market Information\" and \"Corporate Information - Dividends\" of the 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 \"Selected Consolidated Financial Data\" of the Annual Report and is incorporated herein by reference.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe information required by this Item is included under the caption \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" of the Annual Report and is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe information required by this Item is included in pages 34 through 55 of the Annual Report and is incorporated herein by reference.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information required by this Item and not given in Item 4A, Executive Officers of the Registrant, is included under the caption \"Election of Directors -- Directors to be Elected at the 1996 Annual Meeting, -- Directors Whose Term Expires in 1997, and -- Directors Whose Term Expires in 1998\" and \"Compliance with Section 16(a) of the Exchange Act\" of the Proxy Statement filed pursuant to Regulation 14A on March 28, 1996 and is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by this Item is included under the captions \"Election of Directors -- Summary Compensation Table,\" \"Election of Directors - -- Option Grants in Last Fiscal Year,\" \"Election of Directors -- Aggregated Option Exercises in Last Fiscal Year and Fiscal Year-End Option Values,\" \"Election of Directors -- Indemnification Agreements,\" \"Election of Directors - -- Executive Employment Agreements\" and \"Election of Directors - Information Concerning the Board and Its Committees\" of the Proxy Statement filed pursuant to Regulation 14A on March 28, 1996 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 under the caption \"Ownership of Common Stock\" of the Proxy Statement filed pursuant to Regulation 14A on March 28, 1996 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) Documents filed as part of this Report:\n1. FINANCIAL STATEMENTS. The following financial statements, together with the report of KPMG Peat Marwick LLP, appearing in the portions of the Annual Report, filed as Exhibit 13, are filed as a part of this report:\nA. Independent Auditors' Report (Annual Report page 34) B. Consolidated Statements of Operations (Annual Report page 35) C. Consolidated Balance Sheets (Annual Report page 36) D. Consolidated Statements of Stockholders' Equity (Annual Report page 37) E. Consolidated Statements of Cash Flows (Annual Report page 38) F. Notes to Consolidated Financial Statements (Annual Report pages 39 through 55)\n2. FINANCIAL STATEMENT SCHEDULES. The following additional financial data are transmitted with this report and should be read in conjunction with the Consolidated Financial Statements in the Annual Report. Schedules other than those listed below have been omitted because they are inapplicable or are not required.\nIndependent Auditors' Report on Consolidated Financial Statement Schedule\nII Valuation and Qualifying Accounts\n3. EXHIBITS. A complete listing of exhibits required is given in the Exhibit Index that precedes the exhibits filed with this report.\n(b) Reports on Form 8-K\n1. On November 2, 1995, the Company filed a Form 8-K reporting its potential acquisition of MacDonald, Dettwiler and Associates, Ltd. (\"MDA\") pursuant to Item 5. The following financial statements were filed as part of that report:\nConsolidated Financial Statements of MDA, together with report of the independent auditors, as of March 31, 1995, 1994 and 1993;\nUnaudited Consolidated Financial Statements of MDA, as of June 30, 1995 and for the three-month periods ended June 30, 1995 and 1994;\nPro Forma Financial Information of Orbital Sciences Corporation as of and for the six-month period ended June 30, 1995, and for the years ended December 31, 1994, 1993 and 1992.\n2. On December 4, 1995, the Company filed a Form 8-K reporting the consummation of its acquisition of MDA pursuant to Item 2.\n(c) See Item 14(a)(3) of this report.\n(d) See Item 14(a)(2) of this report.\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.\nORBITAL SCIENCES CORPORATION\nDATED: March 28, 1996 By \/s\/ David W. Thompson ----------------------------------------- David W. Thompson, Chairman of the Board, President and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated.\nDATED: March 28, 1996\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Stockholders Orbital Sciences Corporation\nUnder date of February 5, 1996, we reported on the consolidated balance sheets of Orbital Sciences Corporation and subsidiaries (the \"Company\") as of December 31, 1995 and 1994, and the related statements of operations, stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1995, as contained in the 1995 annual report to stockholders. These consolidated financial statements and our report thereon are incorporated by reference in the Company's annual report on Form 10-K for the year 1995. In connection with our audits of the aforementioned consolidated financial statements, we also have audited the related consolidated financial statement schedule as listed in Item 14(a)2 in the Company's Form 10-K for the year 1995. This consolidated financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on the consolidated financial statement schedule based on our audits.\nIn our opinion, based on our audits and the reports of other auditors, 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.\nKPMG Peat Marwick LLP\nWashington, D.C. February 5, 1996\nORBITAL SCIENCES CORPORATION\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS (AMOUNTS IN THOUSANDS)\n(1) - All historical balances have been restated to reflect the Company's acquisitions of Magellan Corporation and MacDonald, Dettwiler and Associates, Ltd. The acquisitions were accounted for using the pooling of interests method of accounting.\n(2) - Amounts charged\/credited to other accounts represent valuation and qualifying accounts recorded pursuant to purchase business combinations as described in Note (4) to the consolidated financial statements incorporated by reference elsewhere herein, adjustments required to recast pooled company's year end as described in Note (4) to the consolidated financial statements incorporated by reference elsewhere herein, and certain reclassifications of deferred tax accounts.\n(3) - Deduction for revaluation of allowance account.\n(4) - The deferred income tax valuation reserve at December 31, 1993 and 1992 has been provided based on estimated deferred tax assets and liabilities in a foreign taxing jurisdiction, converting to generally accepted accounting principles as applied in the U.S. (SFAS 109), after recasting pooled company's year end as described in Note (4) to the consolidated financial statements incorporated by reference elsewhere herein.\nEXHIBIT INDEX\nThe following exhibits are filed as part of this report. Where such filing is made by incorporation by reference to a previously filed statement or report, such statement or report is identified in parentheses. In addition, the registrant has executed certain instruments reflecting long-term debt, the total amount of which does not exceed 10% of the total assets of the registrant and its subsidiaries on a consolidated basis. In accordance with section 4(iii) of Item 601 under Regulation S-K, the registrant agrees to furnish to the Securities and Exchange Commission copies of each instrument relating to such long-term debt not otherwise filed herewith or incorporated herein by reference.\n- ---------------------- * Confidential treatment requested pursuant to Rule 24b-2 of the Exchange Act.\n+ Confidential treatment previously granted by the Commission.\n** Management Contract or Compensatory Plan or Arrangement.","section_15":""}
{"filename":"95779_1995.txt","cik":"95779","year":"1995","section_1":"Item 1. Business.\nSwank, Inc. (the \"Company\") was incorporated on April 17, 1936. The Company is engaged in the manufacture, sale and distribution of men's and women's fashion accessories under the names \"Swank\", \"L'Aiglon\", \"Pierre Cardin\", \"Anne Klein\", \"Anne Klein II\", \"Guess?\" and \"Colours by Alexander Julian\", among others.\nProducts\nThe Company's principal product categories are described below:\nMen's jewelry consists principally of cuff links, tie klips, chains and tacs, bracelets, neck chains, vest chains, collar pins, key rings, money klips and watches distributed under the names \"Swank\", \"Guess?\", \"Pierre Cardin\", \"Colours by Alexander Julian\" and \"L'Aiglon\". Women's jewelry consists principally of necklaces, earrings, pendants, chokers, bracelets, hair ornaments and scarf clips distributed under the names \"Pierre Cardin\", \"Anne Klein\" and \"Anne Klein II\", and \"Guess?\". The Company also manufactures women's jewelry (principally necklaces, brooches, hair accessories and earrings) for private label distribution.\nLeather accessories consist primarily of belts, billfolds, wallets, key cases, card holders and suspenders distributed under the names \"Swank\", \"Guess?\", \"L'Aiglon\", \"Pierre Cardin\" and \"Colours by Alexander Julian\". The Company also manufactures leather items for private label distribution.\nAs is customary in the fashion accessories industry, substantial percentages of the Company's sales and earnings occur in the months of September, October and November, during which the Company makes significant shipments of its products to retailers for sale during the holiday season. The Company's short-term bank borrowings are at a peak during the months of August, September, October and November to enable the Company to (a) carry significant amounts of inventory and (b) provide more favorable payment terms to its customers during this season.\nThe relative contributions to total net sales and gross profit from the Company's principal product categories for the last three fiscal years and the relative year-to-year changes in such contributions during such period are shown in the following table:\n- -------------------------\n* The Company's gift lines were discontinued during the fourth quarter of fiscal 1995.\nSales and Distribution\nThe Company's customers are primarily major retailers within the United States. The Company does not believe it is dependent upon any single customer. In 1995, sales to the Company's two largest customers accounted for 18.7% and 11.8%, respectively, of consolidated net sales. Sales to one customer amounted to 10.6% and 10.8% of consolidated net sales during 1994 and 1993, respectively. No other customer accounted for more than 10% of consolidated net sales during such fiscal years. Exports to foreign countries accounted for 7%, 5% and 5% of consolidated net sales in each of the Company's fiscal years ended December 31, 1995, 1994 and 1993.\nApproximately 110 salespeople and district managers are engaged in the sale of products of the Company, working out of sales offices located in five major cities throughout the United States. The Company has established separate sales forces to handle the distribution to retailers of (a) women's jewelry and (b) the remaining products of the Company. In certain foreign countries, the Company has licensed or sub-licensed the production and sale of certain of its lines under royalty arrangements.\nIn addition to the sale of the Company's products through wholesale channels, the Company sells certain of its products at retail in 38 Company-operated factory outlet stores and one kiosk located in 24 states.\nManufacturing\nItems manufactured by the Company accounted for approximately 65% of total sales in 1995.\nSubstantially all jewelry products are manufactured and\/or assembled at the Company's plant in Attleboro, Massachusetts. Leather goods are manufactured at the Company's plant in Norwalk, Connecticut. Raw materials are purchased in the open market from a number of suppliers and are readily available.\nItems not manufactured by the Company include certain jewelry and leather items, watches, wallets and other accessories which are purchased domestically or imported from countries in Europe, South America and the Far East.\nAdvertising Media and Promotion\nSubstantial expenditures on advertising and promotions are an integral part of the Company's business. Approximately 8% of net sales was expended on promotions in 1995, of which approximately 1% was for advertising media, principally in national consumer magazines, trade publications, newspapers, radio and television, and approximately 7% was for fixtures, displays, point-of-sale materials, cooperative advertising and other in-store promotions.\nCompetition\nThe businesses in which the Company is engaged are highly competitive. The Company competes with, among others, David Donahue in men's jewelry; Rolfs, Mundy and retail private label programs in small leather goods; Salant, Humphrey, Textan and private label programs in men's belts; and Crystal Brands, Napier and Victoria Creations in women's jewelry. The ability of the Company to continue to compete will depend largely upon its ability to create new designs and products, to make improvements on its present products and to offer the public high quality merchandise at popular prices.\nPatents, Trademarks and Licenses\nThe Company owns the rights to various patents, trademarks, trade names and copyrights and has exclusive licenses in the United States for, among other things, (i) men's and women's leather accessories and costume jewelry under the name \"Pierre Cardin\", (ii) leather accessories under the name \"L'Aiglon\", (iii) women's jewelry under the names \"Anne Klein\" and \"Anne Klein II\", and (iv) men's jewelry and leather accessories under the name \"Colours by Alexander Julian\" and (v) leather accessories and men's and women's jewelry under the name \"Guess?\". The Company's \"Pierre Cardin\", \"Anne Klein\", \"Anne Klein II\" and \"Guess?\" licenses may be considered material to the Company's business. The \"Pierre Cardin\" and \"Anne Klein\" licenses provide for royalty payments not exceeding 5% of sales. The \"Anne Klein II\" license provides for royalty payments not exceeding 6% of sales. The \"Guess?\" license provides for royalty payments not exceeding 7% of sales. The Company's licenses to distribute \"Pierre Cardin\" jewelry and leather accessories expire December 31, 2000. The Company's \"Anne Klein\" and \"Anne Klein II\" licenses expire December 31, 1996. The Company is currently negotiating an extension to these licenses and presently expects to continue its relationship beyond December 31, 1996. The Company's \"Guess?\" license expires June 30, 1997.\nEmployees\nThe Company has approximately 1,500 employees, of whom approximately 1,000 are production employees. None of the Company's employees are represented by labor unions and management believes its relationship with its employees to be satisfactory.\nRecent Developments\nDuring the fourth quarter of 1995, the Company discontinued its gift lines, which consisted primarily of accessories such as mugs, tie racks, sunglasses, travel kits and clothes and hair brushes distributed under the names \"Swank\" and \"Pierre Cardin\". The Company has determined to streamline operations and reduce operating costs. In that connection, the Company noted that these lines, while providing incremental revenues, involved the maintenance of significant inventory levels that, in a volatile and competitive retail environment with quickly shifting consumer preferences, would not be the best use of the Company's resources. Accordingly, the Company discontinued the manufacture and sale of its gift lines.\nOn May 24, 1996 the Company obtained new working capital financing from IBJ Schroder Bank & Trust Company, as agent, for the lenders thereunder (the \"New Lenders\"), for up to $25,000,000 with a sublimit of $3,000,000 in letters of credit (the \"New Agreement\"). The proceeds of the New Agreement were used, in part, to repay all but $4 million of the outstanding balance under the previous facility.\nThe New Agreement is available through April 1999 and is collateralized by all of the Company's assets. The New Lenders have a senior lien position on all assets other than real property, improvements and certain fixtures, in which the Company's other institutional lenders maintain a senior position to collateralize a $4,000,000 term loan, as described below, and in which the New Lenders have a subordinate lien. The New Agreement permits the Company to borrow against a percentage of eligible accounts receivable and inventory and its loans bear an interest rate of 1.5% over the New Lenders' prime lending rate. The New Agreement also contains a facility fee of 1\/2% per annum on the unused portion of the revolving credit facility.\nThe terms of the New Agreement include covenants requiring the Company to maintain certain financial ratios including interest coverage, leverage and quarterly inventory turnovers. The New Agreement also includes covenants pertaining to profitability, limiting capital expenditures and additional indebtedness. The Company believes the inventory turnover covenant to be the most restrictive, requiring minimum inventory turnover, as defined, up to 2.25 times annually. The New Agreement also prohibits the payment of dividends. Management believes this credit facility will meet its working capital needs until April 1999.\nIn connection with the refinancing, The Chase Manhattan Bank, N.A. and Fleet National Bank (the \"Banks\") amended and restated the existing credit facility (the \"Agreement\") to provide the Company with a $4,000,000 term loan (the \"Term Loan\") in lieu of a like amount of revolving credit debt. The Term Loan will be repaid in $200,000 quarterly increments starting in June 1997 with a final payment of $2,600,000 due May 1999. The Term Loan bears interest at 2.5% over the Banks' prime lending rate and is collaterialized by a senior lien on real property, improvements and certain fixtures, and a subordinate lien on all other assets. The Term Loan also contains an annual facility fee of 2% of the term loan and a maximum success fee of $450,000 payable as follows; $225,000 on final maturity with the balance payable subsequently in six equal monthly installments of $37,500.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nThe Company's main administrative office is located in a three-story building, containing approximately 193,000 square feet, on a seven-acre site owned by the Company in Attleboro, Massachusetts. The Company's jewelry products are manufactured and\/or assembled at this facility.\nThe Company's executive, national and international sales offices are located in leased premises at 90 Park Avenue, New York City. The leases of such premises expire in 2000. Branch offices are also located in leased premises in New York, Beverly Hills, Chicago, Atlanta and Dallas; the leases for such premises expire from 1996 to 2000.\nThe Company leases a warehouse in Taunton, Massachusetts which is used for the distribution of men's and women's jewelry, leather goods and other accessories and consists of 242,000 square feet. The lease for these premises expires in 2001.\nMen's belts and other leather accessories are manufactured in premises consisting of a manufacturing plant and office space in a 126,500 square foot building, located on approximately seven and one-half acres, owned by the Company in Norwalk, Connecticut.\nThe Company's manufacturing and distribution facilities are equipped with modern machinery and equipment, substantially all of which is owned by the Company. In management's opinion, the Company's properties, machinery and equipment are adequate for the conduct of the respective businesses to which they relate.\nDuring 1995, the Company operated 38 factory outlet stores and one kiosk at locations other than those described above. These stores have leases with terms not in excess of five years and contain in the aggregate approximately 96,000 square feet.\nItem 3.","section_3":"Item 3. Legal Proceedings.\n(a) On June 7, 1990, the Company received notice from the United States Environmental Protection Agency (\"EPA\") that it, along with fifteen others, had been identified as a Potentially Responsible Party (\"PRP\") in connection with the release of hazardous substances at a Superfund site located in Massachusetts. The Company, together with six others, has entered into an Administrative Order on Consent pursuant to which, inter alia, they have undertaken to conduct a remedial investigation\/feasibility study (the \"RI\/FS\") with respect to the alleged contamination at the site. This notice does not constitute the commencement of a proceeding against the Company nor necessarily indicate that a proceeding against the Company is contemplated.\nIt is the position of the PRPs who have undertaken to perform the RI\/FS at the Massachusetts Superfund site that the remedial investigation has been substantially completed. Based upon available information, it is estimated that the feasibility study may be completed in approximately one year; the most recent estimate of costs for completion of the feasibility study is approximately $250,000. The estimates are subject to change since the scope of work is within the discretion of the EPA. The PRP group's accountant's records reflect group expenses, independent of legal fees, in the amount of $1,910,618 as of December 31, 1995. The Company's share of costs for the RI\/FS is being allocated on an interim basis at 12.5177%.\nThe Massachusetts Superfund site is adjacent to a municipal landfill that is in the process of being closed under Massachusetts law. Due to the proximity of the municipal landfill to the site and the composition of waste at this site, the issues are under discussion regarding the site among state and federal agencies and the United States Department of Energy.\nIn September 1988, the Company received notice from the Department of Pollution Control and Ecology of the State of Arkansas that the Company, together with numerous other companies, had been identified as a PRP in connection with the release or threatened release of hazardous substances from the Diaz Refinery, Incorporated site in Diaz, Arkansas. The Company has advised the State of Arkansas that it intends to participate in negotiations with the Department of Pollution Control and Ecology through the committees formed by the PRPs.The Company has not received further communications regarding the Diaz site.\nIn September 1991, the Company entered into a judicial consent decree relating to the Western Sand and Gravel site located in Burrillville and North Smithfield, Rhode Island. The consent decree was entered on August 28, 1992 by the United States District Court for the District of Rhode Island. Cost estimates for remediation of the ground water at the site range from approximately $2.8 million to approximately $7.8 million. Based on current participation, the Company's share is 7.98% of approximately 75% of the costs. The Company and certain other participants have commenced litigation against non-settling PRPs to seek to obtain reimbursement for their respective shares of the remediation costs.\n(b) No material pending legal proceedings were terminated during the three-month period ended December 31, 1995.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nNot applicable.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters.\nThe Company's Common Stock is traded in the over-the-counter market under the Nasdaq symbol SNKI. The following table sets forth the range of high bid prices and low bid prices of the Company's Common Stock as reported by the National Quotation Bureau Incorporated for the fiscal quarters indicated. These quotations represent prices between dealers without adjustment for retail mark-ups, mark-downs, or commissions and may not necessarily represent actual transactions.\n1995 1994 ------------ ------------ Quarter High Low High Low ------------ ------------ First................................. $1.69 $1.06 $1.22 $1.00 Second................................ 1.56 1.06 1.06 .94 Third................................. 1.38 1.00 1.19 .94 Fourth................................ 1.06 .75 1.38 1.00 For the Year.......................... $1.69 $ .75 $1.38 $ .94\nAt May 20, 1996 there were 1,898 holders of record of the Company's Common Stock.\nThe New Agreement and the Agreement each prohibit the payment of cash dividends on the Company's Common Stock (see \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" included elsewhere in this Report).\nItem 6.","section_6":"Item 6. Selected Financial Data.\nThe following selected financial data should be read in conjunction with the Company's consolidated financial statements, the accompanying notes thereto and \"Management's Discussion and Analysis of Financial Condition and Results of Operation\" included elsewhere in this Report.\nFinancial Highlights For each of the Five Years Ended December 31\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\n* The Company's gift lines were discontinued during the fourth quarter of fiscal 1995.\nThe table above indicates the contribution to total net sales and total gross profit by major product categories for each of the three years ended December 31. The components of net sales are gross sales and royalty income less cash discounts and customer returns.\nResults of Operations\nThe following discussion and analysis provides information which management believes is relevant to an assessment and understanding of the Company's consolidated results of operations and financial condition. The discussion should be read in conjunction with the consolidated financial statements and notes thereto.\n1995 vs. 1994\nThe Company's net sales decreased $3,394,000 or 2% in 1995 compared to the prior year.\nNet sales decreased in Men's and Women's Jewelry $3,813,000 or 6% and Gift lines $5,603,000 or 48%. The decreased net sales in Men's and Women's Jewelry were primarily attributable to a lackluster retail environment combined with a change in the sales mix. The change in sales mix was caused by a shift in emphasis on women's jewelry from higher margin fashion products to more competitively priced career oriented products. This resulted in heavier than anticipated returns due to the necessity of changing the merchandise presentation at the store level. The higher than anticipated returns in 1995 compared to lower than anticipated returns in 1994 combined for a decrease in net sales of $4,263,000. The Men's and Women's Jewelry decrease accounted for $3,477,000 of the total with the balance being comprised of Men's Leather Accessories $370,000, and Gift lines $416,000. The Company anticipates fewer returns in 1996 and has reduced its reserve accordingly. The decreased net sales in the Gift lines resulted from the Company's decision to discontinue the sale and distribution of those lines at the end of 1995. The Company noted that these lines, while providing incremental revenues, involved the maintenance of significant inventory levels that, in a volatile and competitive retail environment with quickly shifting consumer preferences, would not be the best use of the Company's resources These decreases were offset, in part, by increased net sales from Men's Leather Accessories $6,022,000 or 9%. The increased net sales in Men's Leather Accessories were attributable to an expanded customer base for the Company's special market lines and private label belt programs along with the continued success of Guess? Leather Accessories.\nIncluded in the net sales figures noted above were sales from the Company's factory outlets, which declined 20% from 1994. Sales declines of 12% and 9% were experienced in same store sales and closed store sales, offset in part by a 1% increase in new store sales. The Company continues to monitor this declining trend and is assessing the profitability of each store location.\nGross profit decreased $10,046,000 or 16% compared to the prior year. Gross profit expressed as a percentage of net sales declined 6.1 percentage points from 44.9% to 38.8%. The erosion of the Company's margins was caused principally by higher inventory markdowns needed to dispose of excess inventory, higher production costs and an unfavorable product mix.\nThe decreased gross profit was attributable to Men's and Women's Jewelry $6,354,000 or 20%, Men's Leather Accessories $827,000 or 3%, and Gifts line $2,865,000 or 63%. The decreased gross profit in Men's and Women's Jewelry was attributable to lower sales volume, higher production costs and the shift in emphasis on women's jewelry from higher margin fashion products to more competitively priced career oriented products. As discussed above, this change caused heavier than anticipated returns due to the necessity of changing merchandise at the store level. The higher than anticipated returns in 1995 compared to lower than anticipated returns in 1994 combined for a decrease in total gross profit of $2,553,000. The Men's and Women's Jewelry decrease accounted for $2,126,000 of the total with the balance being comprised of Men's Leather Accessories $231,000, and Gift lines $196,000. The higher returns of women's jewelry also contributed to excess inventory balances which resulted in higher markdown expense. The decreased gross profit in Men's Leather Accessories was primarily the result of higher production costs and lower margins on current line items offset in part by increased volume. The decreased gross profit in the Gift lines resulted principally from the Company's decision to discontinue the sale and distribution of those lines.\nInventory levels increased $3,021,000 or 12% primarily as a result of holiday sales being less than expected. The increased inventory levels, corresponding carrying costs and loss from operations strained the Company's working capital. In order to fund projected working capital requirements in July 1995 the Company amended its revolving credit facility from $21 million to $32 million. The lower holiday sales also contributed to the Company's inability to reduce its revolving credit facility to the required levels stated in the agreement (see note C).\nSelling and administrative expenses increased $2,041,000 or 4%. When expressed as a percentage of net sales the rate increased from 41% to 43%.\nThe increased selling and administrative expenses were attributable principally to increased costs for advertising, promotion and sample lines and provision for bad debts. These costs were offset in part by decreased compensation and related fringe benefits. Advertising and promotion increased $1,041,000 primarily from display and refixturing costs needed to adjust to the change of merchandise from fashion to competitively priced products at the store level as well as the Company's efforts to penetrate new markets and expand market share. Also contributing were increased in-store markdowns given to retailers demanding more promotional activity in the sluggish retail environment in the apparel and accessories sector. The provision for bad debts increased $592,000 primarily from recognizing the exposure that arose from one of the Company's customers filing reorganization proceedings in January 1996. Expenditures relating to sample charges increased $309,000 in order to change the style of merchandise from fashion to career oriented, as mentioned previously. Compensation and related fringe benefits decreased $1,424,000 as a result of staff reductions, the elimination of estimated bonuses and the reduction of the contribution to the Company's retirement plan during fiscal 1995, offset by increased expenses associated with workman's compensation, group insurance and severance benefits.\nInterest charges increased $393,000 or 23% primarily from increased short term borrowing combined with a higher monthly average interest rate, offset in part by reduced long term bank debt.\nThe Company recognized a provision of $994,000 for income taxes, principally as a result of reestablishing a valuation allowance eliminated in 1994. A valuation allowance is provided to reduce the deferred tax assets to a level which management believes more likely than not will be realized. The net effect of establishing this valuation allowance was to decrease net income approximately $4,764,000 in the fourth quarter.\n1994 vs. 1993\nThe Company's net sales increased $16,726,000 or 13% in 1994 compared to the prior year.\nNet sales increased primarily from the Company's Men's Leather Accessories lines, $11,558,000 or 20%, and Men's and Women's Jewelry lines, $6,590,000 or 12%. These increases are attributable to overall growth in the Company's established product lines and the successful introduction of the Guess? label in the fall of 1994. Belt sales increased $8,411,000 or 22% due primarily to expanding the Company's lines to incorporate the growing trend towards more \"corporate casual wear\" while maintaining traditional lines and aggressively servicing the marketplace. Leather goods contributed sales gains of $2,534,000 or 17% due primarily to the improved quality and consistency of the product coupled with our ability to ship goods in a more timely fashion. The Company's Anne Klein and Anne Klein II lines for women's jewelry continue to be successful with increased sales of approximately $2,570,000 or 6%. These increases were offset in part, by sales declines in the Company's gift lines of $1,422,000 or 11%. This decrease resulted from the Company taking a more conservative approach towards this business and placing more emphasis on inventory management.\nIncluded in the net sales figures noted above were sales from the Company's factory outlets which declined 13% from 1993. Sales declines of 13% and 7% were experienced in same store sales and closed store sales, offset in part by a 7% increase in new store sales. The Company continues to monitor this declining trend and is assessing the profitability of each store location as its lease term expires. Management continues to believe, however, that the factory outlets play a significant role in the Company's overall cash and inventory management strategies.\nGross profit increased $6,606,000 or 11% primarily as a result of increased sales volume. Gross profit expressed as a percentage of net sales declined less than 1% from 45.6% to 44.9%. The decrease in margins was caused principally from an unfavorable product mix within women's jewelry and gifts. The increase in gross profit was attributable to Men's and Women's Jewelry, $2,514,000 or 9%, and Men's Leather Accessories, $4,670,000 or 20%, offset in part, by declines in the Company's Gift lines of $578,000 or 11%.\nInventory levels increased $1,132,000 or 5% primarily as a result of adding the new Guess? lines in Men's and Women's Jewelry and Men's Leather Accessories. This increase combined with an effort by the Company to change the timing of production, principally in men's leather accessories, to improve the response to our customer needs, contributed to increased working capital needs during the year. The Company temporarily increased its revolving credit facility by $3 million in September. Cash provided by operations enabled the Company to repay all of its short term borrowings by January 18, 1995. The Company continues to balance the strategy of better responding to our customer needs while maintaining appropriate inventory levels.\nSelling and administrative expenses increased $5,007,000 or 9%, however, when expressed as a percentage of net sales the rate declined from 42% to 41%.\nThis was principally the result of increases in in-store markdowns and compensation costs. Increases in in-store markdown expense of $2,380,000 or 71% reflect the intense competition being exhibited at the retail level. In addition, 1993 benefited from favorable adjustments to customer allowances for in-store markdowns of $700,000 as a result of actual activity being lower than anticipated at December 31, 1992. Compensation costs and related fringe benefits contributed an increase of $1,916,000 or 6% relating primarily to higher commission costs associated with the growth in sales, additional personnel required for the new Guess? lines, and general wage increases.\nInterest charges increased $118,000 or 7% primarily as a result of increased short term borrowings combined with a higher monthly average interest rate, offset in part, by reduced long term debt.\nThe Company recognized a net benefit of $1,042,000 for income taxes, principally as a result of eliminating the valuation allowance established in 1993 when adopting Statement of Financial Accounting Standards (SFAS) No. 109 \"Accounting for Income Taxes\". Based on the earnings exhibited in 1994 and in recent years, management believed a valuation allowance against its net deferred tax asset was no longer warranted. The Company has eliminated its valuation allowance and recognized the benefit against 1994's tax provision. The net effect of this was to increase net income approximately $2,453,000 in the fourth quarter.\nPromotional Expenses\nSubstantial expenditures for advertising and promotion are considered necessary to enhance the Company's business. The table below indicates the various promotional expenses incurred by the Company during its last three fiscal years. Advertising and promotion increased $1,041,000 primarily from display and refixturing costs needed to adjust to the change of merchandise from fashion to competitively priced products at the store level as well as the Company's efforts to penetrate new markets and expand market share. Also contributing were increased in-store markdowns given to retailers demanding more promotional activity in the sluggish retail environment in the apparel and accessories sector. - -------------------------------------------------------------------------- 1995 1994 1993 - -------------------------------------------------------------------------- In-store markdowns........ $6,121 $5,741 $3,361 Co-op advertising........... 1,227 1,314 1,002 Displays.......................... 1,966 1,124 1,246 National advertising & other 1,755 1,849 1,485 - -------------------------------------------------------------------------- $11,069 $10,028 $7,094 Percentage of net sales... 7.9% 7.0% 5.6% - --------------------------------------------------------------------------\nInterest Charges\nThe average monthly amount of short-term borrowings and related weighted average interest rates were $18,266,000 and 10.32% in 1995, $12,971,000 and 9.43% in 1994 and $6,214,000 and 8.00% in 1993.\nThe increased short term borrowings were a result of less cash generated from operations due to reduced margins and lower sales combined with the need to fund higher inventory balances.\nLiquidity and Capital Resources\nWorking capital decreased by $9,566,000 in 1995.\nAs is customary in the fashion accessories industry, substantial percentages of the Company's sales and earnings occur in the months of September, October and November, during which the Company makes significant shipments of its products to retailers for sale during the holiday season. As a result, receivables increase during the year and peak during the fourth quarter. The Company builds its inventory during the first three quarters of the year to respond to the holiday season. Cash required is provided by a revolving credit facility. Historically, cash generated from operations has been used to pay down the credit facility during the months of December and January.\nCash used in operations totaled $6,509,000 caused primarily by a $8,944,000 net loss, increased inventory balances of $3,021,000 and increases in prepaid and other assets of $2,826,000, which includes refundable income taxes of $1,665,000, offset in part by decreased accounts receivable of $3,557,000 and related reserves of $387,000, increased accounts payable and accrued other of $996,000, as well as recognizing a valuation allowance against deferred taxes of $4,764,000. Cash provided from financing totaled $6,140,000, consisting primarily of a net increase in short-term borrowings of $9,800,000, offset in part by payments of long term debt of $2,920,000. Cash used in investing activities was $663,000 for replacement of used machinery and equipment.\nAccounts receivable decreased primarily as a result of decreased sales in the fourth quarter offset in part by decreased allowances. The decreased allowances primarily reflect decreased sales volume, write-offs of disputed customer claims, and fewer returns anticipated in 1996.\nOn July 20, 1995 the Company modified and extended the Agreement with The Chase Manhattan Bank, N.A. and Fleet National Bank (the \"Banks\"). The Agreement provided for loans and letters of credit in an amount up to $32,000,000, with a sublimit of $7,000,000 for letters of credit (see Note C). Loans under the Agreement had been amended to bear interest at the prime plus 2.5%. These loans and letters of credit were collateralized by all of the Company's assets. The terms of the Agreement required the Company to maintain certain financial ratios, limited capital expenditures, prohibited additional indebtedness over a specified amount and contained other covenants normally associated with such agreements.\nPursuant to the Agreement, certain financial ratios were required to be met. These included a leverage ratio not to exceed 1.0 to 1 and a current ratio of at least 1.0 to 1. As of December 31, 1995 the actual leverage and debt ratios were 1.8 to 1 and 1.5 to 1, respectively. The Company was not in compliance with the leverage ratio at December 31, 1995. The Company was not in compliance with certain other covenants under the Agreement including a $800,000 limit on indebtedness to other lenders (including capital leases). The Company exceeded this limit by $543,000. The Company was also not in compliance with a covenant for interest coverage wherein earnings before interest and taxes (\"EBIT\") equal or exceed 200% of interest expense and an institutional debt ratio of a rolling four quarter average of EBIT to total institutional indebtedness equal or exceed 5.5 to 1. The loss before interest and taxes of $5,840,000 placed the Company in default of these covenants. The Company was unable to reduce the outstanding balance as required under the Agreement to $2 million for a 30 day period within the first six months of 1996.\nDue primarily to the Company's net loss in fiscal 1995 and the resulting failure of the Company to meet the financial ratios required by the Agreement, the Banks requested that the Company investigate alternative sources of working capital. The Company obtained revolving credit financing on May 24, 1996 from IBJ Schroder Bank & Trust Company, as agent for the lenders thereunder (the \"New Lenders\") for up to $25,000,000 with a sublimit of $3,000,000 in letters of credit (the \"New Agreement\"). The proceeds of the New Agreement were used, in part, to repay all but $4 million of the outstanding balance under the Agreement.\nThe New Agreement is available through April 1999 and is collateralized by all of the Company's assets. The New Lenders have senior lien position on all assets other than real property, improvements and certain fixtures, in which the Company's other institutional lenders maintain a senior position to collateralize a $4,000,000 term loan, as described below, and in which the New Lenders have a subordinate lien. The New Agreement permits the Company to borrow against a percentage of eligible accounts receivable and inventory and its loans bear an interest rate of 1.5% over the New Lenders' prime lending rate. The New Agreement also contains a facility fee of 1\/2% per annum on the unused portion of the revolving credit facility. . The terms of the New Agreement include covenants requiring the Company to maintain certain financial ratios including interest coverage, leverage and quarterly inventory turnovers. The New Agreement also includes covenants pertaining to profitability, limiting capital expenditures and additional indebtedness. The Company believes the inventory turnover covenant to be the most restrictive, requiring minimum inventory turnover, as defined, up to 2.25 times annually. The New Agreement also prohibits the payment of dividends. Management believes this credit facility will meet its working capital needs until May 1999.\nIn connection with the refinancing, the Banks amended and restated the Agreement to provide the Company with a $4,000,000 term loan (the \"Term Loan\") in lieu of a like amount of revolving credit debt. The Term Loan will be repaid in $200,000 quarterly increments starting in June 1997 with a final payment of $2,600,000 due May 1999. The Term Loan bears interest at 2.5% over the Banks prime lending rate and is collaterialized by a senior lien on real property and certain improvements and a subordinate lien. The Term Loan also contains an annual facility fee of 2% of the term loan and a maximum success fee of $450,000 payable as follows; $225,000 on final maturity with the balance payable subsequently in six equal monthly installments of $37,500. The Term Loan covenants are the same as those in the New Agreement.\nThe financing agreements include provisions specifying that a material adverse effect, as determined by the lenders, in the financial position or results of operations of the Company is an event of default. As such, the Term Loan, which would otherwise be classified as long-term, has been classified as current on the balance sheet at December 31, 1995.\nBased upon present information and the Company's operating plans for fiscal 1996, the Company expects that it will meet the financial covenants contained in the New Agreement and that eligible assets will provide a sufficient borrowing base to meet the Company's seasonal working capital needs. However, should the Company fail to meet those covenants, or the borrowing base should prove insufficient to support required borrowings, the Company would be required to obtain a waiver or amendment to the New Agreement or, in the alternative, secure other financing. There can be no assurance that the Company would be able to obtain a waiver or amendment or that alternative financing would be available. In such circumstances, liquidity would be adversely affected.\nThe preceding paragraph contains \"forward looking statements\" under the securities laws of the United States. Actual results may vary from anticipated as a result of various risks and uncertainties, including sales patterns, overall economic conditions, competition, pricing, consumer buying trends and other factors.\nEnvironmental Matters\nEnvironmental expenditures that relate to current operations are expensed or capitalized as appropriate. Expenditures that relate to an existing condition caused by past operations, and which do not contribute to current or future revenue generation, are expensed. Liabilities are recorded when environmental assessments and\/or remedial efforts are probable, and the costs can be reasonably estimated. Generally, the timing of these accruals coincides with the completion of a feasibility study or the Company's commitment to a formal plan of action. The liabilities for costs associated with environmental sites (described in footnote I) recorded in Other Liabilities at December 31, 1995 and 1994 were $1,286,000 and $991,000 respectively.\nCapital Expenditures\nThe Company is continuing the policy of replacing aging machinery and equipment to maintain operating efficiencies. Internally generated working capital is anticipated to provide the funding required. The Company has entered into a capital lease obligation for computer hardware and software. The Company believes it will enhance its information gathering process significantly as a result of this investment and will enjoy cost savings from operating efficiencies in future years.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nThe following financial statements are annexed to this Report:\n* Report of Independent Accountants on the Financial Statements and Financial Schedule\n* Consolidated Balance Sheets as of December 31, 1995 and 1994.\n* Consolidated Statements of Operations for each of the three years ended December 31, 1995, 1994 and 1993.\n* Consolidated Statements of Changes in Stockholders'Equity for each of the three years ended December 31,1995, 1994 and 1993.\n* Consolidated Statements of Cash Flows for each of the three years ended December 31, 1995, 1994 and 1993.\n* Notes to Consolidated Financial Statements.\nSupplementary financial information is incorporated herein by reference to Note L of the Notes to Consolidated Financial Statements contained in this Report.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.\nNot Applicable.\nExecutive Officers of the Registrant - ------------------------------------\nName Age Title - --------------- --- ------------------------------------\nMarshall Tulin 78 Chairman of the Board and Director\nJohn A. Tulin 49 President and Director\nRichard S. Blum 60 Senior Vice President - International Sales\nAndrew C. Corsini 60 Senior Vice President, Chief Financial Officer, Treasurer and Secretary\nMelvin Goldfeder 59 Senior Vice President - Special Markets Division\nJames E. Tulin 45 Senior Vice President - Merchandising and Director\nLewis Valenti 56 Senior Vice President - Women's Division\nEric P. Luft 40 Senior Vice President - Men's Division\nPaul Duckett 55 Senior Vice President - Distribution and Retail Store Operations\nRichard V. Byrnes, Jr. 36 Senior Vice President - Operations\nWilliam B, MacLeod 83 Direstor\nMark Abramowitz 60 Direstor\nJohn J. Macht 83 Direstor\nRaymond Vise 60 Direstor\nThere are no family relationships among any of the persons listed above or among such persons and the directors of the Company except that John A. Tulin and James E. Tulin are the sons of Marshall Tulin.\nMarshall Tulin has served as Chairman of the Board since October 1995. He joined the Company in 1940, was elected a Vice President in 1954 and President in 1957. Mr. Tulin has served as a director of the Company since 1956.\nJohn A. Tulin has served as President and Chief Executive Officer of the Company since October 1995. Mr. Tulin joined the Company in 1971, was elected a Vice President in 1974, Senior Vice President in 1979 and Executive Vice President in 1982. He has served as a director since 1975.\nRichard S. Blum has been Senior Vice President-International Sales since October 1995. For more than five years prior to October 1985, Mr. Blum served as a Senior Vice President of the Company.\nAndrew C. Corsini has been Senior Vice President, Chief Financial Officer, Treasurer and Secretary for more than the past five years.\nMelvin Goldfeder has been Senior Vice President-Special Markets Division since October 1995. For more than five years prior to October 1995, Mr. Goldfeder served as a Senior Vice President of the Company.\nJames E. Tulin has been Senior Vice President-Merchandising since October 1995. For more than five years prior to October 1995, Mr. Tulin served as a Senior Vice President of the Company. Mr. Tulin has been a director of the Company since 1985.\nLewis Valenti has been Senior Vice President-Women's Division since October 1995. For more than five years prior to October 1995, Mr. Valenti served as a Senior Vice President of the Company.\nEric P. Luft has been Senior Vice President-Men's Division since October 1995. Mr. Luft served as a Divisional Vice President of the Men's Products Division from June 1989 until January 1993, when he was elected a Senior Vice President of the Company.\nPaul Duckett has been Senior Vice President-Distribution and Retail Store Operations since October 1995. For more than five years prior to October 1995, Mr. Duckett served as a Senior Vice President of the Company.\nRichard V. Byrnes, Jr. has been Senior Vice President-Operations since October 1995. Mr. Byrnes joined the Company in December 1991 as a Divisional Vice President of the Crestline Division and was elected a Vice President in April 1994. Prior to joining the Company, Mr. Byrnes was a consultant with the accounting firm of Coopers & Lybrand L.L.P.\nWilliam B. MacLeod has been a director of the Company since 1967. Mr. MacLeod served as Executive Vice President and Chief Financial Officer or as a Senior Vice President of the Company prior to his retirement in 1982.\nMark Abramowitz has been a director of the Company since 1987. Mr. Abramowitz has been a partner in the law firm of Parker Chapin Flattau & Klimpl, LLP for more than the past five years.\nJohn J. Macht was appointed as a director of the Company in December 1995. Since July 1992, Mr. Macht has been President of The Macht Group, a marketing and retail consulting firm. From April 1991 until July 1992, Mr. Macht served as Senior Vice President of Jordan Marsh department stores, a division of Federated Department Stores.\nRaymond Vise has been a director of the Company since 1963. Mr. Vise served as Senior Vice President of the Company for more than five years prior to his retirement in 1987.\nThe Company's Board of Directors presently consists of seven directors divided into three classes. William B. MacLeod and James Tulin serve as Class I directors, Mark Abramowitz, John J. Macht and John Tulin serve as Class II directors and Marshall Tulin and Raymond Vise serve as Class III directors. The term of office of Class I directors continues until the Company's 1996 Annual Meeting of Stockholders, the term of office of Class II directors continues until the 1997 annual meeting of stockholders and the term of office of Class III directors continues until the 1998 annual meeting of stockholders and, in each case, until their respective successors are elected and qualified. Directors are elected at each annual meeting to succeed those in the class whose term expires at that meeting.\nEach officer of the Company serves, at the pleasure of the Board of Directors, for a term of one year and until his successor is elected and qualified.\nItem 11.","section_9A":"","section_9B":"","section_10":"","section_11":"Item 11. Executive Compensation.\nSummary Compensation Table.\n(1) Marshall Tulin served as President and Chief Executive Officer until October 25, 1995, when he was elected Chairman of the Board. Mr. Tulin has an employment agreement with the Company which terminates on June 30, 1998 providing for a salary at the rate of $360,000 per annum.\n(2) John Tulin served as Executive Vice President of the Company until October 25, 1995, when he was elected President and Chief Executive Officer. Mr. Tulin has an employment agreement with the Company which terminates on December 31, 1998 providing for a salary at the rate of $220,000 per annum.\n(3) The bonus amounts shown for Lewis Valenti include sales commissions in the amounts of $139,214, $234,110 and $213,479 for the years 1995, 1994 and 1993, respectively.\n(4) The bonus amounts shown for Melvin Goldfeder include sales commissions in the amounts of $130,661, $109,856 and $94,990 for the years 1995, 1994 and 1993, respectively.\n(5) The bonus amounts shown for Richard S. Blum include sales commissions in the amounts of $99,279, $68,240 and $58,420 for the years 1995, 1994 and 1993, respectively.\n(6) The bonus amounts shown for Eric P. Luft include sales commissions in the amounts of $110,352, $107,527 and $74,135 for the years 1995, 1994 and 1993, respectively.\n(7) This amount includes automobile lease payments of $18,929 and a travel allowance of $9,450. Except as set forth for John Tulin for fiscal 1995, perquisites and other personal benefits did not exceed the lessor of $50,000 or 10% of reported annual salary and bonus for any of the executive officers named in the Summary Compensation Table.\n(8) The amounts set forth for 1995, 1994 and 1993 represent allocations under certain benefit plans of the Company as follows:\nIn 1983, the Company terminated its pension plans covering salaried employees and salesmen and purchased annuities from the assets of those plans to provide for the payment (commencing at age 62) of accrued benefits of those employees who were not entitled to or did not elect to receive lump sum payments. The accrued annual benefits for Messrs. John Tulin, Lewis Valenti, Melvin Goldfeder, and Richard S. Blum are $13,116, $12,731, $10,991, and $13,208, respectively. Marshall Tulin has heretofore received amounts to which he has to date been entitled in respect of such pension plans. Eric P. Luft was not employed by the Company at the time of termination of such pension plans and is not entitled to receive amounts in respect thereof.\nRemuneration of Directors.\nEach director who is not also an employee of, or counsel or a consultant to, the Company, receives a fee of $2,000 per meeting of the Board and of committees of the Board attended by him. In addition, pursuant to the terms of the 1994 Plan, each director who is not also an employee of the Company or any subsidiary of the Company in office immediately following each annual meeting of stockholders at which directors are elected will, effective on the date such annual meeting is held, automatically be granted an option to purchase 5,000 shares of Common Stock. During the fiscal year ended December 31, 1995, Messrs. Abramowitz, MacLeod and Vise were each granted an option to purchase 5,000 shares of Common Stock at an exercise price per share of $1.28125, the fair market value per share of Common Stock on the date of the grant.\nJohn Macht was granted an option to purchase 5,000 shares of Common Stock on December 12, 1995, the date he was elected a director, at an exercise price per share of $.804675, the fair market value per share of Common Stock on that date.\nTermination Agreements.\nThe Company has entered into termination agreements with Messrs. Marshall Tulin, John Tulin, Lewis Valenti, Melvin Goldfeder, Richard S. Blum and Eric P. Luft which expire on December 31, 1998. In the event of a change of control (as defined in such agreements) of the Company during the term of such agreements followed by a significant change in the duties, powers or conditions of employment of any such officer, the officer may within two years thereafter terminate his employment and receive a lump sum payment equal to 2.99 times such officer's \"base amount\" (as defined in Section 280G(b)(3) of the Internal Revenue Code of 1986, as amended (the \"Code\")).\nStock Options.\nCompensation Committee Interlocks and Insider Participation\nThe Company's Executive Compensation Committee consists of William B. MacLeod, a former Executive Vice President and Chief Financial Officer of the Company, Raymond Vise, a former Senior Vice President of the Company, and Mark Abramowitz. The members of the Company's Stock Option Committee and the Company's Incentive Share Committee are Mr. MacLeod and Mr. Vise. Ronald Vise (who is the son of Raymond Vise) was employed by the Company during 1995 as a commissioned salesman. Aggregate compensation paid to Ronald Vise for services rendered during 1995 amounted to $183,419. Mark Abramowitz is a partner in the law firm of Parker Chapin Flattau & Klimpl, LLP, which is retained by the Company to provide legal services.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nThe following table sets forth information as of May 20, 1996 with respect to each person (including any \"group\" of persons as that term is used in Section 13(d)(3) of the Securities Exchange Act of 1934, as amended) who is known to the Company to be the beneficial owner of more than 5% of the Common Stock:\n(1) The Company has merged its Employee Stock Ownership Plan No. 1 (\"ESOP I\"), Employee Stock Ownership Plan No. 2 (\"ESOP II\") and Savings Plan into one plan, The New Swank, Inc. Retirement Plan (the \"Retirement Plan\"). This amount includes (a) 5,659,632 shares of Common Stock allocated to participants' ESOP I accounts in the Retirement Plan and as to which such participants may direct the trustees of the Retirement Plan as to voting on all matters, (b) an additional 193,014 shares of Common Stock allocated to participants' ESOP I accounts in the Retirement Plan as to which such participants may direct the trustees, as described below, as to voting on certain significant corporate events such as mergers, consolidations, recapitalizations, reclassifications, liquidations, dissolutions or sales of substantially all of a trade or business of the Company (collectively, \"Significant Corporate Events\"), (c) an additional 67,403 of such shares allocated to the accounts of former employees, subject to forfeiture, and able to be voted by the trustees on all matters on which stockholders may vote and (d) 1,126,881 shares of Common Stock not allocated to participants in ESOP I, which the trustees may vote in their sole discretion on all matters on which stockholders may vote, except that, in the case of voting on Significant Corporate Events, the trustees will vote such shares in the same proportion as shares as to which voting instructions are received.\n(2) This amount also includes 2,764,891 shares of Common Stock allocated to participants' ESOP II accounts in the Retirement Plan as to which participants may direct the trustees as to voting only on Significant Corporate Events and as to which the trustees may vote on all other matters in their discretion. Shares allocated to ESOP II accounts as to which no voting instructions are received are required to be voted in the same proportion as shares allocated to ESOP II accounts as to which voting instructions are received. This amount also includes 664,721 shares held in the 401(k) accounts under the Retirement Plan, as to which participants may direct the trustees as to voting on all matters and may be disposed of in the discretion of the trustees.\n(3) The trustees of the Retirement Plan are Marshall Tulin, Chairman of the Board and a director of the Company, John A. Tulin, President and a director of the Company and Raymond Vise, a director of the Company. This amount includes (a) 1,126,881 shares of Common Stock not allocated to participants in ESOP I, (b) 193,014 allocated shares held in ESOP I accounts as to which the trustees have sole voting power (see footnote 1 above), (c) 67,403 shares of Common Stock allocated to the accounts of former employees but voted by the trustees (see footnote 1 above), (d) 2,764,891 shares held in ESOP II accounts as to which the trustees have sole voting power (see footnote 2 above) and (e) 664,721 shares held in the 401(k) accounts (see footnote 2 above).\n(4) This amount includes 343,022 shares owned by Mr. Tulin's wife. Mr. Tulin disclaims beneficial ownership of these shares. This amount also includes 211,209 shares which Mr. Tulin has the right to acquire within 60 days through the exercise of stock options granted under the Company's 1981 Stock Option Plan (the \"1981 Plan\") and its 1987 Incentive Stock Option Plan (the \"1987 Plan\") (collectively, the \"Plans\").\n(5) This amount includes 3,180 shares owned by Mr. Tulin's wife. Mr. Tulin disclaims beneficial ownership of these shares. This amount also includes 192,209 shares which Mr. Tulin has the right to acquire within 60 days through the exercise of stock options granted under the Plans.\n(6) This amount includes 10,000 shares which Mr. Vise has the right to acquire within 60 days through the exercise of stock options granted under 1994 Non-Employee Director Stock Option Plan (the \"1994 Plan\").\n(1) Includes 10,000, 5,000, and 10,000 shares which Messrs. Abramowitz, Macht and MacLeod, respectively, have the right to acquire within 60 days through the exercise of stock options granted under the 1994 Plan.\n(2) Includes 184,325 shares which Mr. Tulin has the right to acquire within 60 days through the exercise of stock options granted under the Plans and 60,105 shares of Common Stock allocated to his ESOP I account and 401(k) account under the Retirement Plan.\n(3) This amount includes the shares referred to in footnotes 3 and 5 to the first table above in this Item 12.\n(4) This amount includes the shares referred to in footnotes 3 and 4 to the first table above in this Item 12.\n(5) This amount includes the shares referred to in footnotes 3 and 6 to the first table above in this Item 12.\n(6) This amount includes 171,825 shares which Mr. Valenti has the right to acquire within 60 days through the exercise of stock options granted under the Plans and 53,014 shares of Common Stock allocated to his ESOP I account and 401(k) account under the Retirement Plan.\n(7) This amount includes 184,325 shares which Mr. Goldfeder has the right to acquire within 60 days through the exercise of stock options granted under the Plans and 47,250 shares of Common Stock allocated to his ESOP I account and 401(k) account under the Retirement Plan.\n(8) This amount includes 169,325 shares which Mr. Blum has the right to acquire within 60 days through the exercise of stock options granted under the Plans and 42,542 shares of Common Stock allocated to his ESOP I account and 401(k) account under the Retirement Plan.\n(9) This amount includes 15,000 shares which Mr. Luft has the right to acquire within 60 days through the exercise of stock options granted under the Plans and 43,414 shares of Common Stock allocated to his ESOP I account and 401(k) account under the Retirement Plan.\n(10) This amount includes the shares referred to in footnote 3 to the first table above under \"Ownership of Voting Securities.\" This amount also includes 1,414,725 shares of Common Stock which directors and executive officers as a group have the right to acquire within 60 days through the exercise of stock options granted under the plans and the 1994 Plan.\nPursuant to Section 16 of the Securities Exchange Act of 1934, as amended, officers, directors and holders of more than 10% of the outstanding shares of Common Stock are required to file periodic reports of their ownership of, and transactions involving, the Common Stock with the Securities and Exchange Commission. Based solely on its review of copies of such reports received by the Company or written representations from certain reporting persons that no Form 5 was required for those person, the Company believes that its reporting persons have complied with all Section 16 filing requirements applicable to them with respect to the Company's fiscal year ended December 31, 1995. The Company is not aware of any filing delinquencies from prior fiscal years.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nRobert Tulin (who is the brother of Marshall Tulin and an uncle of John Tulin and James Tulin) was employed by the Company during 1995. Robert Tulin is the director of advertising and is responsible for coordinating the production of the Company's merchandise catalogs. Aggregate compensation paid Robert Tulin by the Company for services rendered during 1995 amounted to $90,000.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.\n(a) Financial Statements and Schedules\n1. The financial statements listed under Item 8 of this Annual Report on Form 10-K are filed as part of this Annual Report.\n2. Financial Statement Schedules filed as part of this Report:\nThe following financial statement schedule is submitted herewith in response to Item 14(d) of Part IV of this Annual Report on Form 10-K:\nNo reports on Form 8-K were filed by the Company during the last fiscal quarter of the period covered by this Report.\nReport of Independent Accountants\nTo the Stockholders of Swank, Inc. Attleboro, Massachusetts\nWe have audited the accompanying consolidated balance sheets of Swank, Inc. as of December 31, 1995 and 1994, and related consolidated statements of operations, changes in stockholders' equity, and cash flows for each of the three years in the period then ended December 31, 1995. We also audited the financial statement schedule listed in the index on page 30 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 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 Swank, Inc. as of December 31, 1995 and 1994, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1995 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 February 22, 1996 (except as to the information presented in Note C for which the date is May 24, 1996) Coopers & Lybrand L.L.P.\nII. Valuation and Qualifying Accounts ---------------------------------\nSWANK, INC. SCHEDULE VII - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES\n(A) BAD DEBTS CHARGED OFF AS UNCOLLECTIBLE, NET OF RECOVERIES (B) CASH DISCOUNTS TAKEN BY CUSTOMERS (C) CUSTOMER RETURNS (D) CREDITS ISSUED TO CUSTOMERS FOR COOPERATIVE ADVERTISING (E) CREDITS ISSUED TO CUSTOMERS FOR IN-STORE MARKDOWNS (F) LOCATED IN COST OF SALES (G) LOCATED IN SELLING AND ADMINISTRATIVE (H) LOCATED IN NET SALES\nConsolidated Balance Sheets as of December 31 (Dollars in thousands)\nConsolidated Statements of Operations\nFor Each of the Three Years Ended December 31\nConsolidated Statements of Changes in Stockholders' Equity\nConsolidated Statements of Cash Flows\nSwank, Inc. Notes to Consolidated Financial Statements A. The Company\nThe Company is engaged in the manufacture, sale and distribution of men's jewelry, belts, leather accessories, suspenders and women's jewelry. Its products are sold both domestically and internationally through department and specialty stores as well as mass merchandisers. The Company also operates a number of factory outlet stores primarily to distribute excess and out of line merchandise.\nB. Summary of Significant Accounting Policies\nBasis of Presentation\nThe Consolidated Financial Statements include the accounts of Swank and a wholly owned foreign sales corporation. All significant intercompany accounts and profits have been eliminated.\nUse of Estimates\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.\nRevenue Recognition\nNet sales are comprised of gross sales and royalty income less cash discounts and customer returns. Sales are recorded upon shipment and royalty income is accrued based on contract minimums. Cash discounts and returns are accrued based upon experience.\nAllowances for Accounts Receivable\nThe Company's allowances for receivables are comprised of cash discounts, doubtful accounts, in-store markdowns, cooperative advertising and customer returns. Cash discounts are reflected as a reduction of sales. Provisions for doubtful accounts, in-store markdowns and cooperative advertising are reflected in selling and administrative expenses. The reserve for customer returns results from the reversal of sales for estimated returns and associated costs. These reserve balances are at their highest level on December 31. Reductions of these reserves occur principally in the first and second quarters when the reserve balances are adjusted to reflect actual charges as processed. These reserves are based on estimates made by management and may differ from actual results. The provision for bad debts for 1995, 1994 and 1993 were $805,000, $213,000 and $510,000, respectively.\nSwank, Inc Notes to Consolidated Financial Statements (continued)\nCash Equivalents\nFor purposes of the consolidated statements of cash flows, the Company considers all highly liquid instruments purchased with original maturities of three months or less to be cash equivalents.\nInventories\nInventories are stated at the lower of cost (principally average cost which approximates FIFO) or market. The Company's inventory is considered fashion oriented and as a result is subject to risk of rapid obsolescence. At December 31, 1995 a portion of the Company's inventory is in excess of its current requirements based on recent sales. Management is developing programs emphasizing asset management and believes that inventory has been adequately marked down, where appropriate, and that no material loss will be incurred upon disposition of excess quantities. Management believes it has adequate channels to dispose of excess and obsolete inventory.\nIn connection with the purchase of gold for manufacturing requirements, the Company enters into commodity forward contracts to reduce the risk of future price fluctuations. These contracts are accounted for as hedges and, accordingly, gains and losses are deferred and recognized in cost of sales as part of the product cost. At December 31, 1995, the Company had no outstanding gold contracts.\nProperty, Plant and Equipment\nProperty, plant and equipment are stated at cost. The Company provides for depreciation of plant and equipment by charges against income which are sufficient to write off the cost of the assets on a straight-line or double declining-balance basis over estimated useful lives of 10-45 years for building and improvements and 3-12 years for machinery and equipment.\nImprovements to leased premises are amortized on a straight-line basis over the shorter of the useful life of the improvement or the term of the lease.\nThe Company has capitalized lease obligations for computer hardware and software and for water treatment equipment. The cost of equipment held under capital leases is equal to the lesser of the present value of the minimum lease payments or the fair market value of the leased equipment at the inception of the leases. The cost of the leased assets is amortized on a straight line basis over the lesser of the term of the lease obligation or the life of the asset.\nExpenditures for maintenance and repairs and minor renewals are charged to expense; betterments and major renewals are capitalized. Upon disposition, cost and related accumulated depreciation are removed from the accounts with any related gain or loss reflected in results of operations.\nSwank, Inc Notes to Consolidated Financial Statements (continued)\nIncome Taxes\nThe Company utilizes the liability method of accounting for income taxes as set forth in FAS 109, Accounting for Income Taxes. Under the liability method, deferred taxes are 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.\nEnvironmental Costs\nEnvironmental expenditures that relate to current operations are expensed or capitalized as appropriate. Expenditures that relate to an existing condition caused by past operations, and which do not contribute to current or future revenue generation, are expensed. Liabilities are recorded when environmental assessments and\/or remedial efforts are probable and the costs can be reasonably estimated. Generally, the timing of these accruals coincides with the completion of a feasibility study or the Company's commitment to a formal plan of action.\nLong-Term Assets\nIn March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121 (\"FAS 121\"), \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of.\" FAS 121 requires that long-lived assets be reviewed for impairment by comparing the fair value of the assets with their carrying amount. Any write-downs are to be treated as permanent reductions in the carrying amount of the assets. The Company was not required to adopt FAS 121 during fiscal 1995 and has not determined the impact on its financial statements.\nFair Value of Financial Instruments\nIn 1995 the Company adopted Statement of Financial Accounting Standards No. 107, \"Disclosures about Fair Value of Financial Instruments.\" The carrying value of notes payable to banks approximates fair value because these financial instruments have variable interest rates.\nConcentrations of Credit Risk\nThe Company sells products primarily to major retailers within the United States. The Company performs ongoing credit evaluations of its customers and maintains reserves for potential credit losses. Any such losses have been within management's expectations.\nThe Company does not believe that it is dependent upon any single customer. In 1995, sales to the Company's two largest customers accounted for 18.7% and 11.8%, respectively, of consolidated net sales and 22.4% and 15.3%, respectively, of consolidated trade receivables. Sales to one customer amounted to 10.6% and 10.8% of consolidated net sales during 1994 and 1993, respectively.\nSwank, Inc Notes to Consolidated Financial Statements (continued)\nC. Short-Term Borrowings\nData on short-term borrowing arrangements are as follows:\nThe average amounts outstanding and weighted average interest rates during each year are based on average monthly balances outstanding. On July 20, 1995 the Company modified and extended its revolving Credit Agreement (the \" Agreement\") with The Chase Manhattan Bank, N.A. and Fleet National Bank (the \"Banks\"). The Agreement provided for loans and letters of credit in an amount up to $32,000,000, with a sublimit of $7,000,000 for letters of credit, available through June 30, 1998. Loans under the Agreement bore interest at the Banks' prime rate plus 2.5%. The maximum amount available is determined under a formula based on eligible accounts receivable and inventory. Borrowings under the Agreement were collateralized by all of the Company's assets.\nPursuant to the Agreement, certain financial ratios were required to be met. These included a leverage ratio not to exceed 1.0 to 1 and a current ratio of at least 1.0 to 1. As of December 31, 1995 the actual leverage and debt ratios were 1.8 to 1 and 1.5 to 1, respectively. The Company was not in compliance with the leverage ratio at December 31, 1995. The Company was not in compliance with certain other covenants under the Agreement including a $800,000 limit on indebtedness to other lenders (including capital leases). The Company exceeded this limit by $543,000. The Company was also not in compliance with a covenant for interest coverage wherein earnings before interest and taxes (\"EBIT\") equal or exceed 200% of interest expense and an institutional debt ratio of a rolling four quarter average of EBIT to total institutional indebtedness equal or exceed 5.5 to 1. The loss before interest and taxes of $5,840,000 placed the Company in default of these covenants. The Company was unable to reduce the outstanding balance as required under the Agreement to $2 million for a 30 day period within the first six months of the calendar year.\nDue primarily to the Company's net loss in fiscal 1995 and the resulting failure of the Company to meet the financial ratios required by the Agreement, the Banks requested that the Company investigate alternative sources of working capital. The Company obtained revolving credit financing on May 24, 1996 from IBJ Schroder Bank & Trust Company, as agent (the \"Lenders\") for up to $25,000,000 with a sublimit of $3,000,000 in letters of credit (the \"New\nSwank, Inc Notes to Consolidated Financial Statements (continued)\nAgreement\"). The proceeds of the New Agreement were used, in part, to repay all but $4 million the outstanding balance under the Agreement.\nThe New Agreement is available through April 1999 and is collateralized by all of the Company's assets. The New Lenders have senior lien position on all assets other than real property, improvements and certain fixtures, in which the Company's other institutional lenders maintain a senior position to collateralize a $4,000,000 term loan, as described below, and in which the New Lenders have a subordinate lien. The New Agreement permits the Company to borrow against a percentage of eligible accounts receivable and inventory and its loans bear an interest rate of 1.5% over the New Lenders' prime lending rate. The New Agreement also contains a facility fee of 1\/2% per annum on the unused portion of the revolving credit facility and a closing fee of $500,000 payable at the closing date.\nThe terms of the New Agreement include covenants requiring the Company to maintain certain financial ratios including interest coverage, leverage and quarterly inventory turnovers. The New Agreement also includes covenants pertaining to profitability, limiting capital expenditures and additional indebtedness. The Company believes the inventory turnover covenant to be the most restrictive, requiring minimum inventory turnovers, as defined, up to 2.25 times annually. The New Agreement also prohibits the payment of dividends. Management believes this credit facility will meet its working capital needs until May 1999.\nIn connection with the refinancing, the Banks amended and restated the Agreement to provide the Company with a $4,000,000 term loan (the \"Term Loan\") in lieu of a like amount of revolving credit debt. The Term Loan will be repaid in $200,000 quarterly increments starting in June 1997 with a final payment of $2,600,000 due May 1999. The Term Loan bears interest at 2.5% over the Banks' prime lending rate and is collaterialized by a senior lien on real property and certain improvements and a subordinate lien on all other assets. The Term Loan also contains an annual facility fee of 2% of the term loan and a maximum success fee of $450,000 payable as follows; $225,000 on final maturity with the balance payable subsequently in six equal monthly installments of $37,500. The Term Loan covenants are the same as those in the New Agreement.\nThe financing agreements include provisions specifying that a material adverse effect, as determined by the lenders, in the financial position or results of operations of the Company is an event of default. As such, the Term Loan, which would otherwise be classified as long-term, has been classified as current on the balance sheet at December 31, 1995.\nBased upon present information and the Company's operating plans for fiscal 1996, the Company expects that it will meet the financial covenants contained in the New Agreement and that eligible assets will provide a sufficient borrowing base to meet the Company's seasonal working capital needs. However, should the Company fail to meet those covenants, or the borrowing base should prove insufficient to support required borrowings, the Company would be required to obtain a waiver or amendment to the New Agreement or, in the alternative, secure other financing. There can be no assurance that the Company would be able to obtain a waiver or amendment or that alternative financing would be available. In such circumstances, liquidity would be adversely affected.\nSwank, Inc Notes to Consolidated Financial Statements (continued)\nD. Income Taxes\nThe Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS 109\") during 1993. In 1993, the Company recognized a cumulative effect from this adoption of $477,000 and, in addition, increased net income by $467,000.\nSwank, Inc Notes to Consolidated Financial Statements (continued)\nSwank, Inc Notes to Consolidated Financial Statements (continued)\nA valuation allowance is provided to reduce the deferred tax assets to a level which management believes more likely than not to be realized. Realization of approximately $800,000 of the net deferred tax asset is dependent upon generating sufficient future taxable income. Although realization is not assured management believes that it is more likely than not that this portion of the net deferred tax asset will be realized.\nThe Company has alternative minimum tax credit carryforwards of approximately $1,010,000 which are available to reduce future regular Federal income taxes over an indefinite period and net operating loss carryfowards for state income tax purposes of approximately $365,000 which are available to offset future state taxable income.\nSwank, Inc Notes to Consolidated Financial Statements (continued)\nE. Long-Term Obligations\nThe Company's lease agreements for computer hardware and software and for water treatment equipment have been classified as capital leases for financial reporting purposes. Under these leases, future minimum lease payments and the present value of the minimum lease payments as of December 31, 1995 were:\nAs of December 31, 1995 $235,000 has been classified in current portion of long-term debt.\nF. Employee Benefits and Bonus Plans\nEffective January 1, 1994 the Company amended and restated the Swank, Inc. Employees' Stock Ownership Plan to be merged with the Swank, Inc. Employees' Stock Ownership Plan No. 2 and the Swank, Inc. Savings Plan. This amended and restated plan, called The New Swank, Inc. Retirement Plan, incorporates the characteristics of the three separate plans and reflects the Company's continued desire to provide added incentives and enable employees to acquire shares of the Company's Common Stock. The cost of the Plan has been borne by the Company through contributions in amounts determined by the Board of Directors. Shares of Common Stock acquired by the Plan are allocated to each participating employee and are vested on a prescribed schedule.\nAs part of The New Swank Inc. Retirement Plan, the Company will continue to maintain a Savings (401(k)) Plan covering substantially all full time employees that allows Swank, Inc Notes to Consolidated Financial Statements (continued)\nemployer cash contributions of a discretionary nature and employee contributions resulting from their election to reduce taxable compensation.\nAt December 31, 1995 The New Swank Inc. Retirement Plan held a total of 10,697,003 shares of the Company's outstanding stock. Interest bearing loans (8% per annum) from the Company to the Plans and predecessor plans were $771,000, $0 and $519,000 in 1995, 1994 and 1993, respectively. These loans are collateralized by the unallocated shares of the plans. In accordance with Statement of Position 93-6, \"Employers' Accounting for Employees' Stock Ownership Plans,\" the loan in 1995 has been classified as deferred employee benefits and is deducted from stockholders' equity. Prior to 1994, the loan balances were classified as current assets.\nThe Company provides postretirement life insurance, supplemental pension and medical benefits for certain groups of retired employees. The post retirement medical plan is contributory, with contributions adjusted annually; the death benefit is noncontributory. In 1993, the Company adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other than Pensions\" (\"SFAS 106\"). SFAS 106 has no effect on cash flow but changes the method of accounting for other postretirement benefits by requiring that the cost of these benefits be accrued by the date employees become eligible for them. In accordance with SFAS 106, the Company has elected to amortize the transition obligation for all plan participants on a straight-line basis over a 20 year period.\nSwank, Inc Notes to Consolidated Financial Statements (continued)\nFor measurement purposes, a 9% annual rate of increase in the per capita cost of covered health care benefits was assumed for 1995; the rate was assumed to decrease gradually to 5.5% for 1999 and remain at that level thereafter. The effect of increasing the assumed health care cost trend rate by one percentage point in each year would not significantly increase the accumulated postretirement benefit obligation as of December 31, 1995 or the net periodic postretirement benefit cost for the year then ended.\nLife insurance contracts have been purchased on the lives of certain employees in order to fund the postretirement death benefits. The net cost included in selling and administrative expenses was $97,000, $103,000 and $189,000 in 1995, 1994 and 1993, respectively. The weighted-average discount rate used in determining the accumulated postretirement obligation was 7.0% and 7.5% on December 31, 1995 and 1994, respectively. Swank, Inc Notes to Consolidated Financial Statements (continued)\nIn 1987 the Company adopted a deferred compensation plan for certain key executives that provides for payments upon retirement, death or other termination of employment. Amounts payable to participants of this plan aggregated $3,176,000, $3,275,000 and $3,322,000 at December 31, 1995, 1994 and 1993, respectively, of which $507,000 and $498,000 have been classified in other current liabilities in 1995 and 1994, respectively. The balance of the liability has been included in long-term obligations in 1995 and 1994. Life insurance contracts have been purchased on the lives of the plan participants and certain other employees in order to fund the benefits.\nIn 1993 the Company established an additional deferred compensation plan for certain key executives that provides for payments upon retirement, death or other termination of employment. Amounts payable to participants of this plan aggregated $1,300,000 and $835,000 at December 31, 1995 and 1994, respectively, of which $191,000 has been classified in other current liabilities in 1995. The balance of the liability has been included in long term obligations. Variable annuity life insurance contracts have been purchased on the lives of the plan participants and certain other employees in order to fund the benefit obligations.\nThe net charges related to these plans are included in selling and administrative expense, and aggregated $1,153,000, $1,278,000 and $1,205,000 in 1995, 1994 and 1993, respectively.\nThe benefits under each plan are paid directly by the Company and are indirectly funded by life insurance. The Company has corporate owned life insurance policies on current and former salaried employees. It is expected that the net proceeds from death benefits will provide the necessary monies to fund future payments to participants of the deferred compensation plans and postretirement death benefits to beneficiaries of salaried employees who reach age sixty with ten years of service. The Company is the owner and sole beneficiary of the policies and, as such, is able to use loans against the policy cash values to pay part or all of the annual premiums.\nOther assets include cash surrender value of insurance policies, net of loans. The aggregate cash surrender value of these policies was $29,981,000, $23,240,000 and $20,0176,000, offset by policy loans aggregating $25,920,000, $20,210,000 and $18,407,000 in 1995, 1994 and 1993, respectively. The Company has no intention to repay these loans and expects that they will be liquidated from future life insurance proceeds. Interest on policy loans amounted to $2,128,000, $1,621,000 and $1,717,000 in 1995, 1994 and 1993, respectively, and is included in the net costs of each plan described above. The weighted average interest rate was 8.7%, 9.4% and 8.6% at December 31, 1995, 1994 and 1993, respectively.\nG. Stock Options\nUnder the Company's Stock Option Plans, options may be granted to key employees to purchase shares of Common Stock at the market value on the date of grant. Options to purchase shares of Common Stock were granted under these Plans and are exercisable beginning one year after the date of grant and continuing for an additional nine years.\nDuring 1994 the Company established an additional Stock Option Plan. Options may be granted to non-employee directors to purchase 150,000 shares of Common Stock at market value on the date of grant. Options to purchase 20,000 and 15,000 shares of Common Stock Swank, Inc Notes to Consolidated Financial Statements (continued)\nwere granted under this plan in 1995 and 1994, respectively, and are immediately exercisable and continuing for an additional five years. At December 31, 1995, 1,785,615 shares of Common Stock were reserved for future grants under these Plans.\nAt December 31, 1995 options for 2,203,160 shares of Common Stock were exercisable under the Plans at an aggregate option price of approximately $2,354,000. Options expire at various dates through 2002.\nIn October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123 (\"FAS 123\"), \"Accounting for Stock-Based Compensation,\" which is effective for fiscal year 1996. The Company has determined that it will elect to disclose pro forma net income or loss and per share amounts in the notes to the financial statements using the fair value based method beginning in fiscal 1996 with comparable disclosures for fiscal 1995. The Company was not required to adopt FAS 123 during fiscal 1995 and has not determined the impact of these pro forma adjustments.\nSwank, Inc Notes to Consolidated Financial Statements (continued)\nH. Capital\nThe difference between shares for primary and fully diluted earnings per share was not significant in any year. Effective January 1, 1994 the Company adopted Statement of Position 93-6 \"Employers' Accounting for Employee Stock Ownership Plans\" and, accordingly, has reflected the unallocated ESOP shares maintained in the Company's Plan (described in Note F) as a reduction of outstanding shares for earnings per share purposes until such shares were committed to be allocated. At December 31, 1995 the Company has 664,461 unallocated shares remaining in its Plan. There were no unallocated shares at December 31, 1994.\nI. Commitments and Contingencies\nThe Company leases certain of its warehousing, sales and office facilities, automobiles and equipment under noncancelable long-term operating leases. Certain of the leases provide renewal options ranging from one to ten years and escalation clauses covering increases in various costs. The Company is also contingently liable for premises leased by an unrelated third party. This contingency totals $225,000 per year until March 31, 1998.\nTotal rental expenses amounted to $4,017,000, $4,109,000 and $3,979,000 in 1994, 1993 and 1992, respectively.\nSwank, Inc Notes to Consolidated Financial Statements (continued)\nOn June 7, 1990 the Company received notice from the United States Environmental Protection Agency (\"EPA\") that it, along with fifteen others, had been identified as a Potentially Responsible Party (\"PRP\") in connection with the release of hazardous substances at a Superfund Site located in Massachusetts. The Company, along with six others, has voluntarily entered into an Administrative Order pursuant to which, inter alia, they have undertaken to conduct a remedial investigation\/feasibility study (\"RI\/FS\") with respect to the alleged contamination at the site. This notice does not constitute the commencement of a proceeding against the Company or necessarily indicate that a proceeding against the Company is contemplated.\nIt is the position of the potentially responsible parties that the remedial investigation has been completed. Based upon available information, it is estimated that the feasibility study may be completed in approximately one year; the most recent estimate of costs for completion of the feasibility study is approximately $250,000. The estimates are subject to change since the scope of work is within the discretion of the EPA. Accordingly, it is reasonably possible that the Company's potential obligation may change in the near term. The PRP group's accountant's records reflect group expenses, independent of legal fees, in the amount of $1,910,618 as of December 31, 1995. The Company's share of costs for the RI\/FS is being allocated on an interim basis at 12.5177%.\nThis Superfund site is adjacent to a municipal landfill that is in the process of being closed under Massachusetts law. Due to the proximity of the site to the landfill and the composition of waste at the site, the issues are under discussion regarding the site among state and federal agencies and the United States Department of Energy.\nIn September 1988 the Company received notice from the Department of Pollution Control and Ecology of the State of Arkansas that the Company, together with numerous other companies, had been identified as a PRP in connection with the release or threatened release of hazardous substances from the Diaz Refinery, Incorporated site in Diaz, Arkansas. The Company has advised the State of Arkansas that it intends to participate in negotiations with the Department of Pollution Control and Ecology through the committees formed by the PRPs. The Company has not received any further communications regarding the Diaz site.\nIn September, 1991, the Company signed a judicial consent decree relating to the Western Sand and Gravel site located in Burrillville and North Smithfield, Rhode Island. The consent decree was entered on August 28, 1992 by the U.S. District Court for the District of Rhode Island. The most likely scenario cost estimates for remediation of the ground water at the site range from approximately $2.8 million to approximately $7.8 million. Based on current participation, the Company's share is 7.98% of approximately 75% of the costs. The Company and certain other participants have commenced litigation against non-settling potentially responsible parties to seek to obtain reimbursement for their share of the remediation costs.\nThe liabilities for costs associated with environmental sites recorded in Other Liabilities at December 31, 1995, 1994 and 1993 were $1,286,000, $991,000 and $850,000, respectively. Management believes it has provided adequately for the above environmental exposures.\nSwank, Inc Notes to Consolidated Financial Statements (continued)\nJ. Promotional Expenses\nK. Patents, Trademarks and Licenses\nThe Company owns the rights to various patents, trademarks and trade names and has exclusive licenses in the United States. The Company's \"Pierre Cardin\", \"Anne Klein\", \"Anne Klein II', and \"Guess?\" licenses may be considered material to the Company's business. The Company's license to distribute \"Anne Klein\" and \"Anne Klein II\" expire December 31, 1996. The Company is currently negotiating an extension to the licenses and presently expects to continue its relationship beyond December 31, 1996. The Company's licenses for \"Guess?\" expire in 1997 and \"Pierre Cardin\" expire in the year 2000.\nL. Quarterly Financial Data (unaudited)\nSwank, Inc Notes to Consolidated Financial Statements (continued)\nThe Company incurred a net loss in the fourth quarter primarily as a result of a charge of $4,764,000 to reestablish a valuation allowance against its deferred tax asset (see note D). In the fourth quarter of 1994, the Company recognized a reduction in its deferred tax valuation allowance resulting in a net tax benefit of approximately $2,453,000. Also during the fourth quarter of 1995, the Company implemented a program designed to enhance the overall competitiveness, productivity and efficiency through the reduction of overhead costs. Costs associated with the program of $822,000, primarily severance and related benefits, were recognized in the fourth quarter.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nDate: May 24, 1996 SWANK, INC. (Registrant)\nBy: \/s\/ Andrew C. Corsini Andrew C. Corsini, Senior Vice President, Chief Financial Officer, Treasurer 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\/ John A. Tulin President and Director John A. Tulin (principal executive officer) May 24, 1996\n\/s\/ Andrew C. Corsini Senior Vice President, Andrew C. Corsini Chief Financial Officer, Treasurer and Secretary May 24, 1996 (principal financial and accounting officer)\n\/s\/ Mark Abramowitz Director May 24, 1996 Mark Abramowitz\n\/s\/ John J. Macht Director May 24, 1996 John J. Macht\n\/s\/ William B. MacLeod Director May 24, 1996 William B. MacLeod\nSignature Title Date\n\/s\/ James E. Tulin Director May 24, 1996 James E. Tulin\n\/s\/ Marshall Tulin Director May 24, 1996 Marshall Tulin\n\/s\/ Raymond Vise Director May 24, 1996 Raymond Vise\n- ------------------------------------------------------------------------------\nSECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549\n----------------------------\nEXHIBITS to ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 1995\n---------------------------------------\nSWANK, INC.\n- ------------------------------------------------------------------------------\nEXHIBIT INDEX\n- ------- ------ Exhibit Page No. Description No. - ------ ------\n3.01 Restated Certificate of Incorporation of the Company dated May 1, 1987, as amended to date. (The first exhibit to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1995, File No. 1- 5354, is incorporated herein by reference).\n3.02 By-Laws of the Company, as amended to date.*\n4.01 Form of Certificate of Designation of the Series A Participating Preferred Stock and Series B Participating Preferred Stock. (Exhibit A to Annex 1 to the Proxy Statement\/Prospectus contained in the Company's Registration Statement, File No.33-19501, filed on January 4, 1988, is incorporated herein by reference).\n4.02 Seocnd Amended and Restated Credit Agreement dated as of May 24, 1995 (\"Credit Agreement\") between the Company, each of the banks which is a signatory thereto and The Chase Manhattan Bank (National Associations), as Agent (in such capacity, the \"Agent\").*\n4.03 Security Agreement dated as of May 24, 1996 between between the Company and the Agent.*\n4.04 Security Agreement dated as of May 24, 1996 between Swank Sales International(V.I.), Inc. and the Agent.*\n4.05 Open End Indenture of Mortgage, Assignment of Rents, Security Agreement and Fixture Filing (Connecticut) dated as of December 22, 1992 (\"Connecticut Mortgage\") between the Company and the Agent. (Exhibit 4.06 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1992, File No. 1-5354, is incorporated herein by reference).\n4.05.1 Modification and Confirmation of the Connecticut Mortgage dated as of July 20, 1995. (The fourth exhibit to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1995, File No. 1-5354, is incorporated herein by reference).\n4.05.2 Second Modification and Confirmation of the Connecticut Mortgage dated as of May 24, 1996.*\n4.06 Open End Indenture of Mortgage, Assignment of Rents, Security Agreement and Fixture Filing (Massachusetts) dated as of December 22, 1992 (\"Massachusetts Mortgage\")between the Company and the Agent. (Exhibit 4.07 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1992, File No. 1-5354, is incorporated herein by reference).\n4.06.1 Modification and Confirmation of the Massachusetts Mortgage dated as of July 20, 1995. (The fifth exhibit to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1995, File No. 1-5354, is incorporated herein by reference).\n4.06.2 Second Modification and Confirmation of the Massachusetts Mortgage dated as of May 24, 1996.*\n4.07 Revolving Credit and Security Agreement dated as of May 24, 1996 (\"New Agreement\") between the Company, each of the lenders which is a signatory thereto and IBJ Schroder Bank & Trust Company, as Lender, ACM Agent and Co-Agent.*\n4.08.1 Mortgage abd Security Agreement (Massachusetts), dated as of May 24,1996, in the maximum principal amount of $25,000,000, made by Swank, Inc to IBJ Schroder Bank & Trust Company, as ACM Agent for itself and as agent for ratable benefit of the Lenders.*\n4.08.2 Open End Mortgage, Assignment of Rents and Security Agreement (Connecticut), dated as of May 24, 1996, in the maximum principal amount of $25,000,000, made by Swank, Inc to IBJ Schroder Bank & Trust Company, as ACM Agent for itself and as agent for ratable benefit of the Lenders.*\n4.08.3 FSC Security Agreement dated May 24, 1996 between Swank International (V.I.), Inc. and IBJ Schroder Bank & Trust Company, as Agent.*\n4.08.4 Pledge and Security Agreement dated as of May 24,1996 between the Company and IBJ Schroder Bank & Trust Company, as Agent.*\n10.01 Employment Agreement dated June 20, 1991 between the Company and Marshall Tulin. (Exhibit 10.01 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991, File No. 1-5354, is incorporated herein by reference).+\n10.01.1 Amendment dated as of September 1, 1993 to Employment Agreement between the Company and Marshall Tulin. (Exhibit 10.01.1 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993, File No. 1-5354, is incorporated herein by reference).+\n10.02 Employment Agreement dated as of January 1, 1990 between the Company and John Tulin. (Exhibit 10-03 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989, File No. 1-5354, is incorporated herein by reference).+\n10.02.1 Amendments dated as of September 1, 1993 and September 2, 1993, respectively, between the Company and John Tulin. (Exhibit 10.02.1 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993, File No. 1-5354, is incorporated herein by reference).+\n10.03 Employment Agreement dated as of March 1, 1989 between the Company and James Tulin. (Exhibit 10.05 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1988, File No. 1-5354, is incorporated herein by reference).+\n10.03.1 Amendment dated as of January 4, 1990 to Employment Agreement between the Company and James Tulin. (Exhibit 10.05 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989, File No. 1-5354, is incorporated herein by reference).+\n10.03.2 Amendment dated as of September 1, 1993 to Employment Agreement between the Company and James Tulin. (Exhibit 10.03.2 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993, File No. 1-5354, is incorporated herein by reference).+\n10.04 Amended and Restated 1981 Incentive Stock Option Plan of the Company. (Exhibit 10.08 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1987, File No.1-5354, is incorporated herein by reference).+\n10.05 1987 Incentive Stock Option Plan of the Company. (Annex 3 to the Proxy Statement\/ Prospectus contained in the Company's Registration Statement, File No.33-19501, filed on January 4, 1988, is incorporated herein by reference).+\n10.06 1987 Incentive Share Plan of the Company. (Annex 2 to the Proxy Statement\/Prospectus contained in the Company's Registration Statement, File No.33-19501, filed on January 4, 1988, is incorporated herein by reference).+\n10.07 Form of Termination Agreement effective January 1, 1996 between the Company and each of the Company's officers listed on Schedule A thereto.*+\n10.09 Deferred Compensation Plan of the Company dated as of January 1, 1987. (Exhibit 10.12 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1988, File No. 1-5354, is incorporated herein by reference).+\n10.10 Employment Agreement dated as of January 15, 1992, as amended, between the Company and Richard Byrnes. (Exhibit 10.10 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, File No. 1-5354, is incorporated herein by reference).+\n10.11 Agreement dated as of July 14, 1981 between the Company and Marshall Tulin, John Tulin and Raymond Vise as investment managers of the Company's pension plans. (Exhibit 10.12(b) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1981, File No. 1-5354, is incorporated herein by reference).\n10.12 The New Swank, Inc. Retirement Plan Trust Agreement dated as of January 1, 1994 among the Company and Marshall Tulin, John Tulin and Raymond Vise, as co-trustees. (Exhibit 10.12 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, File No. 1-5354, is incorporated herein by reference).\n10.13 Plan of Recapitalization of the Company dated as of September 28, 1987, as amended (Exhibit 2.01 to Post-Effective Amendment No.1 to the Company's S-4 Registration Statement, File No.33-19501, filed on February 9, 1988, is incorporated herein by reference).\n10.14 Key Employee Deferred Compensation Plan. (Exhibit 10.17 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993, File No. 1-5354, is incorporated herein by reference).+\n10.15 1994 Non-Employee Director Stock Option Plan. (Exhibit 10.15 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, File No. 1-5354, is incorporated herein by reference).\n10.15.1 Stock Option Contracts dated as of December 31, 1994 between the Company and each of Mark Abramowitz, William B. MacLeod and Raymond Vise. (Exhibit 10.15.1 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, File No. 1- 5354, is incorporated herein by reference).+\n10.15.2 Stock Option Contract dated as of April 20, 1995 between the Company and Raymond Vise. (The third exhibit to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1995, File No. 1-5354, is incorporated herein by reference).+\n10.15.3 Stock Option Contract dated as of April 20, 1995 between the Company and William B. MacLeod. (The fourth exhibit to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1995, File No. 1-5354, is incorporated herein by reference).+\n10.15.4 Stock Option Contract dated as of April 20, 1995 between the Company and Mark Abramowitz. (The fifth exhibit to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1995, File No. 1-5354, is incorporated herein by reference).+\n10.15.5 Stock Option Contract between the Company and John J. Macht.*+\n11.01 Statement Re Computation of Earnings Per Share.*\n21.01 Subsidiaries of the Company. (Exhibit 22.01 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1992, File No. 1-5354, is incorporated herein by reference).\n23.01 Consent of independent accountants.*\n27 Financial Data Schedule.*\n- --------------------------- *Filed herewith. +Management contract or compensatory plan or arrangement.","section_15":""}
{"filename":"36703_1995.txt","cik":"36703","year":"1995","section_1":"ITEM 1. BUSINESS OF FIRST OF AMERICA BANK CORPORATION\nGENERAL\nFirst of America Bank Corporation (herein after referred to as First of America or the Registrant) is a multi-bank holding company headquartered in Kalamazoo, Michigan. The Registrant was incorporated as a Michigan corporation in May 1971. Its principal activity consists of owning and supervising four affiliate financial institutions which operate general, commercial banking businesses from 613 banking offices and facilities located in Michigan, Florida, Illinois and Indiana. The Registrant also has divisions and non-banking subsidiaries which provide mortgage, trust, data processing, pension consulting, revolving credit, securities brokerage and investment advisory services. At December 31, 1995, the Registrant had assets of $23.6 billion, deposits of $19.3 billion and shareholders' equity of $1.8 billion.\nThe Registrant has responsibility for the overall conduct, direction and performance of its affiliates. The Registrant establishes direction and policies for the entire organization and monitors compliance with these policies. The Registrant also provides capital funds to affiliates as required and assists affiliates in asset and liability management, marketing, planning, accounting, tax, internal audit, loan review, and human resource management for its 12,690 full time equivalent employees. The operational responsibilities of each affiliate rest with its officers and directors. The Registrant derives its income principally from dividends upstreamed from its subsidiaries.\nSUBSIDIARY BANKS\nAs of December 31, 1995, the Registrant had two wholly owned subsidiaries, First of America Bank-Michigan, N.A. and First of America Bank-Illinois, N.A. which met the conditions for \"significant subsidiary.\" First of America Bank-Michigan, N.A., is a general commercial bank based in Kalamazoo, Michigan, and at December 31, 1995, had $13.1 billion in assets and $11.2 billion in deposits. First of America Bank-Illinois, N.A., is a general commercial bank based in Bannockburn, Illinois, and at December 31, 1995, had $7.2 billion in assets and $5.9 billion in deposits. Similar to all of the Registrant's banking and thrift subsidiaries, these subsidiaries offer a broad range of lending, depository and related financial services to individual, commercial, industrial, financial, and governmental customers, including demand, savings and time deposits, secured and unsecured loans, lease financing, letters of credit, money transfers, corporate and personal trust services, cash management, and other financial services.\nNo material part of the business of the Registrant and its subsidiaries is dependent upon a single customer, or a very few customers, where the loss of any one would have a materially adverse effect on the Registrant.\nNON-BANKING SUBSIDIARIES\nFirst of America Loan Services, Inc. is a wholly owned subsidiary of First of America Bank -- Michigan, N.A. First of America Loan Services, Inc. engages in the servicing of both commercial and residential real estate loans for institutional investors and certain affiliates of the Registrant and secondary market sales.\nFirst of America Mortgage Company is a wholly owned subsidiary of First of America Bank -- Michigan, N.A. and provides mortgage loan origination services.\nFirst of America Insurance Company is a wholly owned subsidiary of the Registrant. The insurance company reinsures credit life and disability insurance provided by an unaffiliated insurer for customers of the Registrant's affiliates.\nFirst of America Brokerage Service, Inc., is a wholly owned subsidiary of First of America Bank -- Michigan, N.A. It is a registered broker-dealer and provides retail securities brokerage services through a clearing broker to customers of the Registrant's affiliate banks and others.\nFirst of America Investment Corporation is a wholly owned subsidiary of First of America Bank -- Michigan, N.A. First of America Investment Corporation is a registered investment adviser which provides comprehensive investment advisory services to the trust division of the Registrant and to individual and institutional investors. It also serves as investment adviser for The Parkstone Group of Funds, First of America's proprietary mutual funds.\nFirst of America Securities, Inc. is a wholly owned subsidiary of the Registrant. It is a registered broker-dealer and engages in limited securities underwriting and dealing as well as other capital market activities.\nFirst of America Trust Company is a wholly owned subsidiary of the Registrant. It provides trust services to customers of the Registrant's Illinois affiliate.\nNew England Trust Company, based in Providence, Rhode Island, is a wholly owned subsidiary of the Registrant and provides investment advisory services to individual and institutional investors.\nFirst of America Community Development Corporation is a wholly owned subsidiary of the Registrant. It invests in qualifying businesses or housing projects, as allowed by federal law, to address the needs of low to moderate income neighborhoods.\nUnderwriting Consultants, Inc. is a wholly owned subsidiary of First of America Bank -- Michigan, N.A. and First of America Insurance Group -- Illinois, Inc. is a wholly owned subsidiary of First of America Bank -- Illinois, N.A. These affiliates provide personal and commercial insurance products.\nCOMPETITION\nBanking and related financial services are highly competitive businesses and have become increasingly so during the past few years. The banking subsidiaries of the Registrant compete primarily with other banks and savings and loan associations for loans, deposits and trust accounts. They are also faced with increasing competition from other financial intermediaries including consumer finance companies, leasing companies, credit unions, retailers and investment banking firms.\nTechnological changes have resulted in computer and communication applications intended to meet the needs of First of America's business and consumer customers in a convenient, efficient and reliable manner. Affiliate banks of the Registrant have 675 automated teller machines (ATM's) located on bank premises to handle banking transactions 24 hours per day and on off-premise sites located in high volume retail and service locations.\nSUPERVISION AND REGULATION\nThe Registrant and its subsidiary banks are subject to supervision, regulation and periodic examination by various federal and state banking regulatory agencies, including the Board of Governors of the Federal Reserve Board (the \"FRB\"), the Office of the Comptroller of the Currency (the \"OCC\"), the Federal Deposit Insurance Corporation (the \"FDIC\"), the Office of Thrift Supervision (the \"OTS\"), the Florida Commissioner, the Illinois Commissioner of Banks and Trust Companies (the \"Illinois Commissioner\"), the Michigan Financial Institutions Bureau (the \"Michigan FIB\") and the Indiana Department of Financial Institutions (the \"Indiana DFI\"). Since it is a bank holding company, the Registrant's activities and those of its affiliates are limited to the business of banking and activities closely related to banking.\nThe following is a summary of certain statutes and regulations affecting First of America and its affiliate financial institutions. This summary is qualified in its entirety by such statutes and regulations, which are subject to change based on pending and future legislation and action by regulatory agencies.\nBANK HOLDING COMPANIES. As a bank holding company, First of America is subject to regulation under the Bank Holding Company Act of 1956, as amended (the \"BHCA\") and by the FRB. Among other things, the BHCA imposes requirements for the maintenance of capital adequate to support a bank holding company's operations. The BHCA also restricts the geographic and product range of bank holding companies by circumscribing the types and locations of institutions bank holding companies may own or acquire. The BHCA limits bank holding companies to owning and managing banks or companies engaged in activities determined by the FRB to be closely related to banking. The BHCA requires bank holding companies to obtain the prior approval of the FRB before acquiring substantially all the assets of any bank or bank holding company or direct or indirect ownership or control of more than 5% of the voting shares of a bank or bank holding company. Under the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the \"Interstate Act\"), commencing on September 29, 1995, bank holding companies are permitted to acquire banks located in any state regardless of the state law in effect at the time. The Interstate Act also provides for the nationwide interstate branching of banks. Under the Interstate Act, both national and state-chartered banks will be permitted to merge across state lines (and thereby create interstate branches) commencing June 1, 1997. States are\npermitted to \"opt out\" of the 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 branching provisions.\nSAVINGS AND LOAN HOLDING COMPANIES. Its acquisition of thrift institutions subjects First of America to regulation as a savings and loan holding company by the OTS. A savings and loan holding company that is also a bank holding company may engage only in activities permissible for a bank holding company, and may, in certain circumstances, be required to obtain approval from the OTS, as well as the FRB, before acquiring new subsidiaries or commencing new business activities. Further, a savings and loan holding company's acquisitions of savings associations and other savings and loan holding companies are subject to prior approval by the OTS comparable to the extent to which bank holding company acquisitions of banks and other bank holding companies are subject to the prior approval of the FRB.\nUnder the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (\"FIRREA\"), the OTS is granted broad power to impose restrictions on savings and loan holding company activities, including the payment of dividends to the holding company by and transactions with affiliated savings associations, if the OTS determines that there is reasonable cause to believe that the continuation by the holding company of any activity constitutes a serious risk to the financial safety, soundness or stability of a subsidiary savings association.\nBANKS. First of America's affiliate banks are subject to regulation, supervision and periodic examination by the bank regulatory agency of the state under the laws of which the affiliate bank is chartered or, in the case of national banks, the OCC. Additionally, its two affiliate national banks are members of the Federal Reserve System, and as such are subject to applicable provisions of the Federal Reserve Act and regulations thereunder. These regulations relate to reserves and other aspects of banking operations. First of America's one affiliate state bank is not a member of the Federal Reserve System and is subject to federal regulation, supervision and examination by the FDIC. Deposits held by all affiliate banks of First of America are insured, to the extent permitted by law, by the FDIC. Applicable federal and state law govern, among other things, the scope of First of America's affiliate banks' businesses, maintenance of adequate capital, investments and loans they may make, transactions with affiliates and their activities with respect to mergers and establishing branches.\nSAVINGS ASSOCIATIONS. First of America Bank -- Florida, FSB is a federally chartered savings association subject to regulation, supervision and regular examination by the OTS. Federal law governs, among other things, the scope of the savings association's business, required reserves against deposits, the investments and loans the savings association may make, and transactions with the savings association's affiliates. Deposits held by such savings associations are insured, to the extent permitted by law, by the FDIC.\nNON-BANKING SUBSIDIARIES. First of America has non-banking subsidiaries that are broker-dealers, a securities underwriter and investment advisers, each registered and subject to regulation by the Securities and Exchange Commission under federal securities laws. These subsidiaries are also subject to regulation under various state securities laws. Because they are affiliated with First of America's subsidiary banks, these subsidiaries are subject to certain limitations on their securities activities imposed by federal banking laws.\nECONOMIC CONDITIONS AND GOVERNMENTAL POLICY. First of America's earnings are affected not only by the extensive regulation described above, but also by general economic conditions. These economic conditions influence and are influenced by the monetary and fiscal policies of the United States government and its various agencies, particularly the FRB. The Registrant cannot predict changes in monetary policies or their impact on its operations and earnings.\nSTATISTICAL DATA\nThe statistical data as required is presented with \"Item 7. Management's Discussion and Analysis\" and in certain of the Notes to Consolidated Financial Statements and Supplemental Data included with \"Item 8. Financial Statements and Supplementary Data\" appearing later in this document.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe executive officers of the Registrant, their ages and their positions for the last five years are shown in the following table. There are no family relationships between the executive officers or between the executive officers and the Registrant's directors.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Registrant is headquartered in Kalamazoo, Michigan.\nThe Registrant's subsidiaries operate a total of 613 offices, a majority of which are owned by the respective banks with the remaining offices under lease agreements. Reference is made to Note 9 of the Notes to Consolidated Financial Statements included under \"Item 8. Financial Statements and Supplementary Data\" included later in this document for further information regarding the terms of these leases. All of these offices are considered by management to be well maintained and adequate for the purpose intended.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe subsidiaries of the Registrant are routinely engaged in litigation, both as plaintiff and defendant, which is incident to their business, and in certain proceedings, claims or counter-claims have been asserted against the Registrant's subsidiaries. Management, after consultation with legal counsel, does not currently anticipate that the ultimate liability, if any, arising out of such litigation and threats of litigation will have a material effect on the financial position, results of operations or liquidity of the Registrant.\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 three months ended December 31, 1995.\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 listed for trading on the New York Stock Exchange (NYSE). The range of high and low sales prices appear under the caption \"Market Price of Common Stock\" under Supplemental Information included with \"Item 8. Financial Statements and Supplementary Data\" included later in this document.\nCommon stock dividends, payable in cash, were declared on a quarterly basis during 1995 and 1994. The dividends declared per common share totaled $1.72 during 1995 and $1.64 during 1994. Restrictions on the Registrant's ability to pay dividends are described in Note 11 in the paragraph beginning \"The various loan agreements\" and in Note 14 of the Registrant's \"Notes to Consolidated Financial Statements\" included under \"Item 8. Financial Statements and Supplementary Data\" included later in this document.\nThe number of record holders of the Registrant's common stock as of December 31, 1995 was 31,300.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nReference is made to the following information included in \"Item 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe following financial review discusses the performance of First of America, on a consolidated basis, for the three years ended December 31, 1995, and should be read in conjunction with the consolidated financial statements and notes thereto.\nMERGERS AND ACQUISITIONS\nTable I below and Note 2 of the Notes to Consolidated Financial Statements, included later in this document, summarize First of America's business combinations for the past three years.\nBUSINESS COMBINATIONS TABLE I ($ in thousands) - --------------------------------------------------------------------------------\nOn January 1, 1995, First of America acquired New England Trust Company, an investment management firm based in Providence, Rhode Island, with $600 million in assets under management. Also during 1995, First of\nAmerica acquired Underwriting Consultants, Inc. and West Suburban Financial Corporation (renamed First of America Insurance Group - Illinois, Inc.), insurance companies which specialize in personal and commercial life and casualty insurance. These acquisitions provide opportunities for further diversification of revenue sources.\n1995 HIGHLIGHTS\nNet income for 1995 was $236.7 million, up 7.3 percent compared with the $220.5 million earned in 1994, and earnings per share were $3.73 versus $3.69. The current year's results reflected the impact of increased non-interest income, $16.3 million in branch sale gains, and controlled expense levels. Non-interest expense was virtually level with a year ago, as benefits achieved from the internal restructuring and reduced FDIC premiums offset additional expense from acquisitions completed on December 31, 1994, and $13.2 million in restructuring charges. In 1993 record gains on the sale of mortgages and securities contributed to that year's net income of $247.4 million, or $4.14 per fully diluted share.\nReturn on average assets was 1.00 percent for full year 1995 and improved as the year progressed, beginning at 0.79 percent for the first quarter and ending the year at 1.13 percent for the fourth quarter. Return on average assets for 1994 was 0.98 percent and 1.20 percent for 1993. Return on average equity was down for the year-over-year comparison, 13.89 percent compared with 14.44 percent, as growth in equity offset the higher earnings. Return on average equity was 17.50 percent in 1993.\nAsset quality remained strong, showing only slight deterioration from 1994's record measures. Nonperforming assets were 0.63 percent of total assets, up slightly from 0.57 percent at December 31, 1994, but lower than the 0.86 percent reported at year-end 1993. Net charge-offs as a percent of average loans followed the same trend and was 0.47 percent, 0.39 percent and 0.53 percent, respectively, for 1995, 1994 and 1993. The allowance for loan losses as a percent of total loans did increase, however, to 1.50 percent at year-end 1995 compared with 1.36 percent at year-end 1994, as the provision for loan loss expense covered net charge-offs by 117 percent and total loans decreased 4.5 percent. The allowance as a percent of total loans was 1.31 percent at December 31, 1993.\nTotal assets were $23.6 billion at December 31, 1995, a 3.9 percent decrease compared with the $24.6 billion reported at December 31, 1994. The decrease can be attributed to strategies aimed at trimming the balance sheet and to the securitization of $500 million in credit card receivables during June 1995. Total assets were $21.2 billion at December 31, 1993. Excluding the credit card securitization, total loans decreased 1.5 percent due to pricing strategies implemented to improve the profitability of the installment and residential mortgage portfolios. The commercial and commercial mortgage portfolios, however, experienced steady growth during 1995, up 11.0 percent from the previous year.\nTotal shareholders' equity increased 15.8 percent to $1.8 billion at December 31, 1995. The increase resulted from earnings retention of $128.0 million and the $118.2 million positive change in the adjustment to equity for Available for Sale securities. The higher equity level resulted in an increase in the book value per share, which was $28.89 at December 31, 1995 compared with $25.12 and $25.60 for year-ends 1994 and 1993. The risk-based capital ratio of 12.89 percent at year-end 1995 was the highest reported by First of America since it began computing risk-based ratios in 1989. The regulatory requirement for this ratio is 8 percent.\nIn August 1995, the Board of Directors increased the annual cash dividend paid per common share by 5 percent to $1.76. This increase indicated the Board's continued confidence in First of America's profitability and represents the thirteenth year in a row that the dividend was increased.\nSELECTED FINANCIAL DATA TABLE II ($ in thousands, except per share data)\n(a) Fully taxable equivalent based on a marginal federal income tax rate of 35% for 1995, 1994 and 1993, and 34% for prior years.\nINCOME ANALYSIS\nNET INTEREST INCOME. Net interest income on a fully taxable equivalent (FTE) basis was $940.0 million, down 2.0 percent from $955.7 million in 1994. The lower net interest margin for 1995, 4.28 percent versus 4.58 percent, offset the 5.2 percent increase in average earning assets which was primarily the result of the acquisitions completed at year-end 1994. Net interest income for 1995 was also reduced by the securitization of $500 million in credit card receivables during June 1995, which shifted revenue from interest income to non-interest fee revenue. For 1994 compared with 1993, net interest income FTE increased 3.3 percent due to a higher level of average earning assets offsetting the impact of a lower net interest margin.\nTotal interest income FTE grew 12.0 percent in 1995. As illustrated in Table III, the increase resulted from both a higher volume of earning assets and higher asset yields. On the other hand, interest expense was up 31.8 percent mainly as a result of increased rates on interest-bearing liabilities. The combination of the changes in interest income FTE and interest expense resulted in the 2.0 percent decrease in net interest income FTE.\nTable III presents a summary of the changes in net interest income resulting from changes in volumes and rates for 1995 and 1994. Net interest income, average balance sheet amounts, and the corresponding yields and costs for the years 1990 through 1995 are shown in Table IV.\nVOLUME\/RATE TABLE III ($ in thousands)\n* Any variance attributable jointly to volume and rate changes is allocated to volume and rate in proportion to the relationship of the absolute dollar amount of the change in each. Non-taxable income has been adjusted to a fully taxable equivalent basis.\n- -------------------------------------------------------------------------------- AVERAGE BALANCES\/NET INTEREST INCOME\/AVERAGE RATES TABLE IV ($ in thousands)\n(1) Interest income on obligations of states and political subdivisions and on tax exempt commercial loans has been adjusted to a fully taxable equivalent basis using a marginal federal tax rate of 35% for 1995, 1994 and 1993, and 34% for prior years.\n(2) Non-accrual loans are included in average loan balances.\n(3) In 1995, 1994 and 1993, money market checking accounts are included in \"Savings and NOW accounts\"; in prior years, they are included in \"Money market savings accounts.\"\nNET INTEREST MARGIN. The net interest margin was 4.28 percent in 1995 lower than the 4.58 percent reported in 1994, due in part to the acquisition of higher priced thrift deposits at December 31, 1994. The margin was also reduced by approximately 6 basis points as a result of the securitization of $500 million in credit card receivables completed in June 1995. During 1995 management implemented specific strategies to improve the core margin, such as steps to increase the interest spread on newly originated installment and residential mortgage loans, changes to deposit product pricing and mix and decreased reliance on short-term borrowings. As a result of these strategies, the core margin showed improvement during the last six months of 1995. If the first and second quarter margins are normalized for the impact of the credit card securitization, the margins would have been as follows: first quarter, 4.17 percent; second quarter, 4.16 percent; third quarter, 4.23 percent; fourth quarter, 4.32 percent.\nPROVISION FOR LOAN LOSSES. The provision for loan losses is based on the current level of net charge-offs and management's assessment of the credit risk inherent in the loan portfolio. For 1995, the provision for loan losses was increased 5.7 percent to $91.5 million from $86.6 million in 1994 to adequately cover net charge-offs and the higher risk of loss beginning to be experienced in the credit card and installment loan portfolios. The 1993 provision was $84.7 million. The 117 percent coverage of net charge-offs by the provision for loan losses and the securitization of the $500 million in credit card receivables contributed to the higher allowance as a percent of total loans ratio which was 1.50 percent, up from 1.36 percent at December 31, 1994 and 1.31 percent at December 31, 1993.\nAs a percent of average assets, the 1995 provision was 0.39 percent compared with the 0.38 percent and 0.41 percent reported for 1994 and 1993, respectively. Additional information on the provision for loan losses, net charge-offs and nonperforming assets is provided in Tables IX and XI and under the caption,\"Credit Risk Profile,\" presented later in this discussion.\nNON-INTEREST REVENUE. Non-interest revenue of $346.1 million was up 21.7 percent over 1994. Included in this total were $16.3 million in branch sale gains related to internal restructuring and $17.6 million in net servicing fees from the credit card securitization. Excluding these two components, total non-interest revenue would have increased 9.8 percent over 1994. Non-interest revenue totaled $284.4 million in 1994 and $292.2 million in 1993. Record gains on the sale of securities and mortgages during 1993 were the primary reasons for the higher level of non-interest revenue in 1993 compared with 1994. Table V presents the trends in the major components of non-interest revenue from 1991 to 1995.\nNON-INTEREST INCOME AND NON-INTEREST EXPENSE TABLE V ($ in thousands)\nService charges on deposit accounts remained the largest component of non-interest revenue in 1995. New fee structures initiated during the year and a slightly higher volume of non-interest transaction deposits, accounted for the 12.5 percent increase over a year ago.\nIn total, trust and financial services revenue increased 15.3 percent over a year ago. Traditional trust fees increased 12.6 percent as a result of the additional $600 million in managed assets acquired with the New England Trust Company and the higher market value of managed assets upon which fees are assessed. Other financial services fees, derived from brokerage services and investment advisory services, increased 22.4 percent as investment activity rebounded from 1994. Total revenue from the sale of Parkstone and other mutual funds and annuities was $9.6 million compared with $8.7 million in 1994.\nNet gains on the sales of investment securities totaled $0.1 million compared with $5.3 million in 1994 and $16.8 million in 1993. During December 1995, First of America transferred all of its Held to Maturity securities into the Available for Sale classification. More detail on that reclassification is provided in Note 4 of the Notes to Consolidated Financial Statements included later in this document. At December 31, 1995, the amortized cost of Available for Sale securities totaled $5.0 billion and had a corresponding market value of $5.1 billion which resulted in a $25.9 million positive adjustment to shareholders' equity.\nBank card revenue totaled $60.4 million, up 39.9 percent over the $43.2 million earned in 1994. The 1995 total included $17.6 million in net fees from the credit card securitization. Excluding these fees, bank card revenue would have been level with a year ago. The securitization, completed during June, shifted revenue from interest income to fee revenue but had minimal impact on net income; its benefit was that the funds it provided allowed the company to reduce short-term borrowings. Bank card revenue totaled $40.0 million in 1993. The managed credit card portfolio,\nwhich includes the $835 million in receivables remaining on the balance sheet and the securitized receivables, was $1.3 billion at December 31, 1995, level with a year ago as fewer promotional initiatives were implemented in 1995.\nMortgage banking revenue of $31.5 million increased 30.5 percent over 1994. The main reasons for the increase were a $4.1 million gain on the sale of servicing rights and $3.5 million in additional gains on the sale of mortgage loans from the adoption of Financial Accounting Standards Board Statement No. 122, \"Accounting for Mortgage Servicing Rights an amendment of FASB Statement No. 65\" (FAS 122). Impairment expense on the capitalized originated mortgage servicing rights was $95,700. Mortgage originations totaling $1.6 billion were down 24.8 percent from 1994, but increased each quarter throughout 1995. Despite the sale of servicing rights, First of America's outside servicing portfolio was up slightly over a year ago totaling $3.2 billion and added $9.2 million in servicing revenue.\nOther operating revenue increased 46.2 percent over 1994. The largest component of this category, gains on branch sales, totaled $16.3 million and added $0.16 to earnings per share. The review of branch offices to determine their fit with the company's marketing strategies is an ongoing activity, but such scrutiny was intensified during the internal restructuring effort. Excluding branch sale gains, other operating revenue increased 6.3 percent over a year ago. Included in this total were nonaffiliate corporate services at $10.6 million, up 6.6 percent; ATM network fees at $6.6 million, up 7.6 percent; and credit life income at $4.8 million, up 19.8 percent.\nNON-INTEREST EXPENSE. As detailed in Table V, non-interest expense was $815.3 million in 1995, up only 0.2 percent from 1994. Operating efficiencies generated by the internal restructuring and reduced FDIC premiums, down $13.7 million for the year, offset the additional operating expense from acquisitions completed at year-end 1994 and $13.2 million in restructuring charges incurred during 1995. Non-interest expense was 3.61 percent of average assets for 1994 and 3.72 percent for 1993.\nTotal personnel cost was $431.0 million in 1995 compared with $430.6 million in 1994 and $403.1 million in 1993. Excluding severance charges, personnel costs were down 1.7 percent from 1994 and represented 1.77 percent of average assets compared with 1.89 percent in 1994. This improvement demonstrates the positive impact the restructuring had on personnel cost, the largest component of non-interest expense. Total full time equivalent employees (FTEs) were 12,690 at December 31, 1995 compared with 14,500 in August 1994 when the restructuring was announced. The lower level of FTEs was achieved even with the addition of 340 FTEs from acquisitions completed since September 30, 1994. Two ratios which measure the progress made through internal efficiencies are the number of FTEs per one million dollars of average assets and net income per FTE. For 1995, there were 0.53 FTEs per one million dollars of average assets compared with 0.56 a year ago, and $18,653 of net income per FTE versus $16,570 a year ago. These ratios were 0.63 and $18,559 for 1993.\nNet occupancy and equipment costs increased 5.9 percent in 1995 to $123.4 million compared with $116.6 million in 1994 and $108.5 million in 1993. The 1995 growth in this expense was largely the result of acquisitions completed late in 1994 and early in 1995.\nOther operating expense, which includes all the other costs of doing business such as advertising, supplies, travel, telephone, professional fees and outside services purchased, was $192.5 million in 1995, up 1.3 percent from 1994's total of $190.1 million. As a percent of average assets, other operating expense was 0.81 percent compared with 0.84 percent in 1994 and 0.92 percent in 1993.\nEFFICIENCY RATIO AND BURDEN RATIO. The efficiency ratio measures non-interest expense as a percent of the sum of net interest income FTE and non-interest income. The lower the ratio, the more efficiently a company's resources produce revenue. Table V presents the efficiency ratio over the last five years. The improvement in this ratio to 63.39 percent for 1995 compared with 65.59 percent a year ago is directly related to revenue growth since total non-interest expense was basically level with a year ago. The growth in non-interest revenue offset the impact of a lower net interest margin and resulting lower net interest income.\nThe higher level of non-interest revenue also directly impacted the burden ratio as non-interest revenue was 1.46 percent of average total assets compared with 1.26 percent a year ago. The lower FDIC premiums in 1995 also served to improve the burden ratio to 1.97 percent; one of First of America's long term goals is to maintain this ratio at or below 2.00 percent.\nINCOME TAX EXPENSE. Income tax expense was $126.6 million in 1995 compared with $102.6 million in 1994 and $98.6 million in 1993. The increased income tax expense was primarily related to the 12.4 percent increase in\nincome before taxes. A summary of significant tax components is provided in Note 18 of the Notes to Consolidated Financial Statements included later in this document.\nPRO FORMA RESULTS -- CASH APPROACH The calculation of \"cash earnings\" provides an alternative analysis of First of America's results. \"Cash earnings\" adds back the amortization of intangibles and assumes that all intangibles were charged off against retained earnings upon the original acquisition date of all mergers accounted for as purchases. These pro forma results, as detailed below, indicate that First of America's underlying return on equity for the last two years would have been within the 17 to 18 percent range, which has been the company's stated long term goal. Also earnings per share and return on assets would have been higher than reported. The book value per share, while lower than the reported $28.89 for year-end 1995, would be the equivalent of a reported tangible book value per share. In fact, the tier I leverage ratio, the strictest regulatory capital ratio, remains unchanged under these assumptions since it already excludes intangibles from its computation.\nLINE OF BUSINESS FINANCIAL PERFORMANCE TABLE VI ($ in thousands)\n(a) The consolidated results by quarter include gains on branch sales and charges for severance and other restructuring costs.\nLINE OF BUSINESS ANALYSIS\nAn objective of First of America's recent restructuring effort was to define specific lines of business which would cross legal entity lines and focus its management and accounting systems accordingly. As a result, First of America now measures the individual performance of four business lines -- community banking, bank card, mortgage banking and trust and financial services -- as well as the performance of certain product lines within those businesses.\nIn developing the management accounting system for line of business reporting, certain assumptions and allocations were necessary. Equity was allocated on the basis of required regulatory levels, inherent operational risk or market-determined factors as evidenced by similar independent single business line companies. Support services which were centrally provided were allocated on a per-unit cost basis or in proportion to the balances of assets and liabilities associated with a particular business line. Funds transfer pricing was used to allocate a cost of funds used or a credit for funds provided from market-determined indices. Because of the assumptions and allocations utilized, the financial results of the individual business lines might vary from the actual results if those lines were in fact separate operating entities. While no comparative results from previous years are available, Table VI presents a summarized income statement, performance ratios and selected quarterly information from 1995 for the four business lines identified above.\nCOMMUNITY BANKING. The community banking business line is responsible for gathering and managing deposits, lending to commercial and consumer installment customers, and managing the four state branch networks for the delivery of First of America's products and services. It also provides customers with home equity and student loans, international banking services and other general banking services, such as ATM operations and safety deposit boxes.\nCommunity banking is the core of First of America's business activities, and its contribution to the consolidated net income is the largest of the business lines. In 1995 community banking benefited from the reduction of FDIC premiums at mid-year as evidenced by the increase in its net income from second to third quarter and by the improvement in its efficiency ratio between those same quarters. For the full year, community banking earned a return on allocated equity of 12.01 percent. Excluding the indirect lending product line and the start-up effort in Florida, it would have earned 15.47 percent on its allocated equity. Investment in Florida's physical franchise, advertising and other developmental activities significantly affected its 1995 results; however, progress was made on re-mixing its customer base and changing its product offerings. The performance of the indirect lending product line was lowered by the lingering effect of pricing competition in 1994 and the deterioration of credit quality during 1995 which necessitated a higher provision for loan losses particularly in the fourth quarter. Further credit quality problems are not anticipated, and management has taken steps to improve the interest spreads on newly originated indirect installment loans.\nCommunity banking's non-interest expense included virtually all of the goodwill amortization included in the corporation's consolidated financial results, a total of $21.1 million in 1995. Without that amortization, its efficiency ratio and return on allocated equity would have been 63.99 percent and 13.62 percent, respectively.\nBANK CARD. Bank card is responsible for managing and servicing First of America's $1.5 billion managed portfolio of credit card and other revolving loans, as well as the merchant services operation. In addition to the managed portfolio of VISA\/Mastercard credit cards, bank card manages affinity cards for 30 groups and offers a FirstAir card. The revolving portfolio remained relatively level with 1994 as fewer customer promotions were initiated than in previous years. In 1996, renewed emphasis will be placed on promoting the VISA\/Mastercard portfolio.\nThis business line was a strong performer during 1995 with an efficiency ratio of 37.53 percent and a return on allocated equity of 31.93 percent. As the year progressed, the provision for loan losses was increased in order to provide for net charge-offs which also rose. This reflected a trend in consumer debt which was generally experienced across the industry. As a result, the bank card's quarterly net income and return on allocated equity declined over the second half of the year as indicated in Table VI.\nMORTGAGE BANKING. Mortgage banking originates all residential mortgages across First of America's four community banking states and in separate origination offices in Arizona, Missouri, North Carolina and South Carolina. The loans are originated both for portfolio retention and sale to the secondary market. Mortgage banking also provides\nservicing for First of America's entire portfolio and a $3.2 billion portfolio for external investors. Since mortgage banking is responsible for originating, servicing and managing First of America's residential loan portfolio, the portfolio's interest income and related funds transfer charge are included in mortgage banking's net income.\nMortgage banking earned the lowest return on allocated equity of the four business lines in 1995. Its results can vary substantially from period to period since origination activity is rate-sensitive, and gains on loan sales vary directly with the volume of originations. Some seasonality was evident in the 1995 results with net income highest during the second and third quarters when origination activity was at its peak. FAS 122 added $3.5 million in pre-tax gains during the year and a sale of servicing rights contributed $4.1 million in pre-tax gains during the second quarter.\nTRUST AND FINANCIAL SERVICES. Trust and financial services provides traditional trust services to individuals and institutions, as well as investment management and brokerage services. It also manages First of America's proprietary mutual funds, The Parkstone Group of Funds and recently began offering certain insurance services and annuity products.\nThis business line earned the highest return on allocated equity at 49.69 percent. The nature of its business activity -- fee generating and personnel intensive -- will generally result in comparatively higher returns on equity and higher efficiency ratios. Net income climbed steadily over the year, in part due to the increasing market value of its managed assets upon which fees are assessed. Its managed assets totaled $15.6 billion at year-end 1995, up 18.3 percent from the previous year.\nCREDIT RISK PROFILE\nFirst of America's community banking structure helps minimize its credit risk exposure. Community banking means that loans are made in local markets to consumers and small to mid-sized businesses from deposits gathered in the same market. A centralized, independent loan review staff evaluates the loan portfolio of each line of business on a regular basis and shares its evaluation with the management of the business line as well as corporate management.\nFirst of America's loan portfolio includes a large percentage of loans with balances less than $100,000 which effectively reduces total portfolio risk. At year-end 1995, consumer installment and revolving loans totaled 28.0 percent of the total portfolio, one-to-four family residential mortgages and home equity loans accounted for 32.2 percent, commercial loans totaled 16.1 percent, and commercial mortgages totaled 23.7 percent. First of America does not have any concentrations of credit to any specific borrower or within any geographic area. The total loan portfolio, as presented in Table VII, was $16.1 billion at year-end 1995, down slightly from the $16.8 billion a year ago.\nCOMPONENTS OF THE LOAN PORTFOLIO TABLE VII ($ in thousands)\nCONSUMER LOANS. First of America's consumer loan portfolio, which includes indirect and direct installment loans, credit cards and other revolving loans, declined 22.3 percent from 1994's level. The managed credit card portfolio at $1.3 billion remained level with 1994. First of America offers its credit card products in all fifty states; the largest portion of the portfolio, 56 percent, was to customers in its four operating states. As a percent of average loans, the net charge-offs for the managed portfolio were 3.23 percent in 1995 compared with 2.14 percent in 1994.\nThe consumer installment portfolio was $3.5 billion at December 31, 1995, down 17.9 percent from the previous year due to the combination of intense competition within the industry and First of America's more stringent pricing policies. First of America's consumer installment loans originate primarily from its four state operating area. The net charge-offs as a percent of average consumer installment loans were 0.91 percent in 1995 and 0.36 percent in 1994. Management increased the provision for loan losses in 1995 to adequately cover the estimated risk of loss in this\nportfolio and, unless there is a serious economic downturn, does not expect further significant deterioration in its credit quality.\nRESIDENTIAL MORTGAGE LOANS. At December 31, 1995, residential mortgage loans totaled $5.2 billion compared with $5.3 billion at year-end 1994. Originations of residential mortgage loans during 1995 were $1.6 billion compared with $2.2 billion in 1994. The average loan size in the balance sheet portfolio was $57,200, and the loans in portfolio were originated within First of America's four home states. First of America's portfolio continued to have excellent credit quality measurements. Net charge-offs as a percent of average residential mortgage loans were 0.01 percent in 1995 and 0.02 in 1994.\nAt December 31, 1995, residential mortgage loans held for sale, originated at prevailing market rates, totaled $101.3 million with a market value of $104.1 million. These residential mortgages are closed and therefore included in outstandings on the balance sheet. In addition, First of America has entered into commitments to originate residential mortgage loans, at prevailing market rates, totaling $48.9 million. Mandatory commitments to deliver mortgage loans to investors, at prevailing market rates, totaled $125.0 million as of December 31, 1995.\nCOMMERCIAL AND COMMERCIAL MORTGAGE LOANS. First of America's commercial and commercial mortgage loan portfolio is comprised primarily of loans to small and mid-sized businesses within the local markets of its four operating states. Evidence of this philosophy is the average loan size within this portfolio at year-end which was $48,000 for commercial loans and $235,000 for commercial mortgages, allowing for a more diverse customer base and limiting the exposure from any one borrower. First of America has no foreign loans, no highly leveraged transactions and no syndicated purchase participations. Maturity and rate sensitivity of selected loan categories is presented in Table VIII.\nFirst of America's commercial and commercial mortgages demonstrated the highest growth of any of the portfolios during 1995. This portfolio grew 11.0 percent to $6.4 billion compared with $5.8 billion at year-end 1994. Total non-performing commercial and commercial mortgage loans as a percent of outstandings decreased to 1.38 percent from 1.44 percent a year ago, and net charge-offs as a percent of average loans was 0.09 percent compared with 0.22 percent for 1994.\nMATURITY AND RATE SENSITIVITY OF SELECTED LOANS TABLE VIII ($ in thousands)\nASSET QUALITY. Non-performing assets, including nonaccrual loans, renegotiated loans and other real estate owned, totaled $147.6 million or 0.63 percent of total assets. Non-performing assets were 0.57 percent and 0.86 percent of total assets at year-end 1994 and 1993, respectively. Total non-performing loans, other real estate owned and other loans of concern for the past five years are detailed in Table IX.\nRISK ELEMENTS IN THE LOAN PORTFOLIO TABLE IX ($ in thousands)\nOther loans of concern which represent loans where known information about possible credit problems of borrowers causes management concern about the ability of such borrowers to comply with the present loan terms totaled $17.7 million at year-end 1995, a decrease of 44.2 percent from 1994's year-end total of $31.7 million. While management has identified these loans as requiring additional monitoring, they do not necessarily represent future non-performing loans.\nThe allowance for loan losses is determined by management taking into consideration past charge-off experience, estimated loss exposure on specific loans and the current and projected economic climate. Management evaluates the adequacy of the allowance for loan losses quarterly based on information compiled by the corporate loan review area. Management's allocation of the allowance for loan losses over the last five years is presented in Table X. The amounts indicated for each loan type include amounts allocated for specific loans as well as a general allocation.\nThe allowance coverage of non-performing loans at year-end 1995 was 207.02 percent compared with 224.38 percent at year-end 1994 and 142.86 percent at year-end 1993. It was management's determination that the level of the allowance was adequate to absorb potential loan losses. Other ratios measuring asset quality and the adequacy of the allowance for loan losses are presented in Table XI.\nOn January 1, 1995, First of America identified $82.8 million of impaired loans under the guidelines of Financial Accounting Standards Board Statement No. 114, \"Accounting by Creditors for Impairment of a Loan,\" as amended by Statement No. 118, \"Accounting by Creditors for Impairment of a Loan -- Income Recognition and Disclosures\" (FAS 114). This resulted in a specifically identified allowance for impaired loan losses of $17.4 million which was transferred from the general allowance. At year-end 1995, the allowance for impaired loan losses was $17.6 million. The adoption of FAS 114 did not significantly impact the comparability of the allowance related tables included in this report.\nALLOCATION OF ALLOWANCE FOR LOAN LOSSES TABLE X ($ in thousands)\n* Allowance as a percent of year-end loans outstanding by type. Unallocated ratio is the unallocated portfolio allowance as a percent of total loans at year-end.\nSUMMARY OF LOAN LOSS EXPERIENCE TABLE XI ($ in thousands)\nFUNDING, LIQUIDITY AND INTEREST RATE RISK\nLiquidity is measured by a financial institution's ability to raise funds through deposits, borrowed funds, capital or the sale of assets. Funding is achieved through growth in core deposits and accessibility to the money and capital markets.\nDEPOSITS. First of America's primary source of funding is its core deposits which include all deposits except negotiated certificates of deposit. As a percent of total deposits, core deposits were 95.5 percent at year-end 1995 and 94.8 percent at year-end 1994. First of America does not issue negotiated CD's in the national money markets, and the level of purchased funds is strictly limited by corporate policy to less than 10 percent of assets. The majority of negotiated CD's and purchased funds originate from the core deposit customer base, including downstream correspondents.\nThe loans to deposits ratio measures how well a company is using its lowest cost source of funding which is typically its deposit base. As a percent of total deposits, total loans were 83.1 percent compared with 83.3 percent and 78.9 percent for 1994 and 1993, respectively. Since loans are generally a higher yielding asset than securities, this is a positive trend and represents a more efficient use of funds.\nThe average deposit balances outstanding and the rates paid on those deposits for the three years ended December 31, 1995, are presented in Table XII. The maturity distribution of time deposits of $100,000 or more at year-end 1995 is detailed in Table XIII.\nIn addition to deposits, First of America's sources of funding include money market borrowings, capital funds, securitizations and long term debt. First of America entered into a Three-Year Competitive Advance and Revolving Credit Facility Agreement dated as of March 25, 1994 and amended by its First Amendment dated December 9, 1995 and the Second Amendment dated February 15, 1996 (collectively, the Credit Agreement). The Credit Agreement allows First of America to borrow up to $350,000,000 on a standby revolving credit basis and an uncommitted competitive advance basis. The proceeds of all borrowings made pursuant to the Credit Agreement will be used to provide working capital and for other general corporate purposes. At December 31, 1995, there was no outstanding balance under the Credit Agreement.\nIn June 1995, First of America securitized $500 million in credit card receivables. This transaction was an effective management balance sheet tool since it had no impact on net income, but released funds which were used to reduce short-term borrowings.\nOn July 26, 1994, First of America issued $200 million of 7 3\/4% Subordinated Notes Due July 15, 2004, which are not subject to redemption prior to maturity and which qualify as tier II capital under the Federal Reserve Board's capital guidelines. The proceeds received from the Notes were used to discharge indebtedness incurred to fund the acquisition of the Goldome Federal branches, to fund the repurchase of common stock and for other general corporate purposes.\nDuring August 1994, certain First of America bank subsidiaries began issuing Bank Notes due from 30 days to 10 years from date of issue. The proceeds from the sale of the notes were used for general corporate purposes by the issuing banks. Total outstanding for all bank notes at December 31, 1995 was $699.9 million, of which $105.0 million was included in long term debt.\nDEPOSITS TABLE XII ($ in thousands)\nMATURITY DISTRIBUTION OF TIME DEPOSITS OF $100,000 OR MORE TABLE XIII ($ in thousands)\nINTEREST RATE RISK. First of America's interest rate risk policy is to attempt to minimize the effect on net income resulting from a change in interest rates through asset\/liability management at all levels in the company. Each banking affiliate completes an interest rate analysis every month using an asset\/liability model, and a consolidated analysis is then completed using the affiliates' data. The Asset and Liability Committees, which exist at each banking affiliate and at the consolidated level, review the analysis and as necessary, appropriate action is taken to maintain the net interest spread, even in periods of rapid interest rate movement.\nInterest rate swap transactions generally involve the exchange of fixed and floating rate interest payment obligations without the exchange of the underlying financial instrument. The company becomes a principal in the exchange of interest payments with other parties and, therefore, is exposed to the loss of future interest payments should the counterparty default. The company minimizes this risk by performing normal credit reviews of its counterparties and collateralizing its exposure when it exceeds a predetermined limit.\nFirst of America had outstanding interest rate swap agreements at December 31, 1995, totaling $105.5 million in notional amounts versus $707.9 million at December 31, 1994. This total included notional amounts of $75.0 million as a hedge against the parent company's 8.50% Subordinated Notes Due February 1, 2004, $10.0 million against various fixed rate bank notes, $12.0 million against certain FirstRate Fund deposits, and $8.5 million as a hedge against certain Market Rate certificates of deposit. First of America had swaps of variable rate instruments for fixed rate instruments with notional amounts totaling $22.0 million, $75.0 million of fixed rate instruments for variable rate instruments and $8.5 million representing basis swaps.\nThe aggregate market value of interest rate swaps at year-end was a positive $499 thousand. The full year 1995 impact from swap activity on net interest income was a negative $4.0 million versus a negative $1.2 million impact for 1994. If interest rates increased one hundred basis points, First of America would increase net interest income $173 thousand over the next twelve months from its current interest rate swap agreements. Note 20 of the Notes to Consolidated Financial Statements included later in this document provides further detail on First of America's interest rate swap agreements.\nDuring 1994, First of America also entered into interest rate cap agreements as a means of managing interest rate risk. These caps were agreements to receive payments for interest rate differentials between an index rate and a specified maximum rate, computed on notional amounts. At December 31, 1995, First of America had no outstanding interest rate caps compared with $125 million in interest rate cap agreements at year-end 1994.\nInterest rate sensitivity of assets and liabilities is represented in a Gap report, Gap being the difference between rate sensitive assets and liabilities and includes the impact of off-balance sheet interest rate swap and cap agreements. Table XVI presents First of America's Gap position at December 31, 1995, for one year and shorter periods, and Table XVII details the company's five year Gap position. The Gap reports' reliability in measuring the risk to income from a change in interest rates is tested through the use of simulation models. At year-end 1995 simulation models showed that less than two percent of First of America's annual net income was at risk if interest rates were to move up or down by one percent in a parallel fashion. However, changing economic conditions affect results, therefore, the management of First of America's interest rate sensitivity is an ongoing process. Management has determined that these simulations provide a more meaningful measurement of the company's interest rate risk positions than the following Gap tables.\nINTEREST RATE SENSITIVITY -- SHORT TERM TABLE XIV ($ in millions)\n(1) Maturities of rate sensitive securities are based on contractual maturities and estimated prepayments. (2) Maturities of rate sensitive loans are based on contractual maturities, estimated prepayments and estimated repricing. (3) Maturities of rate sensitive liabilities and interest rate swaps are based on contractual maturities and estimated repricing.\nINTEREST RATE SENSITIVITY -- LONG TERM TABLE XVII ($ in millions)\n(1) Maturities of rate sensitive securities are based on contractual maturities and estimated prepayments. (2) Maturities of rate sensitive loans are based on contractual maturities, estimated prepayments and estimated repricing. (3) Maturities of rate sensitive liabilities and interest rate swaps are based on contractual maturities and estimated repricing.\nCAPITAL STRENGTH\nREGULATORY REQUIREMENTS. First of America's capital policy is to maintain its capital levels above minimum regulatory guidelines. At December 31, 1992, the Federal Reserve required a tier I risk based capital ratio of 4.00 percent and a total risk based capital ratio of 8.00 percent. In 1991, the Federal Reserve also adopted a new leverage capital adequacy standard. This ratio compares tier I capital to reported total assets and requires a minimum ratio of 4.00 percent in order to be categorized as adequately capitalized. As shown in Table XVIII, at December 31, 1995, First of America's capital ratios exceeded required regulatory minimums with a tier I risk based ratio of 9.52 percent, a total risk based ratio of 12.89 percent and a tier I leverage ratio of 6.70 percent. Capital ratios exclude the mark-to-market adjustment for Available for Sale securities in accordance with the Federal Reserve's regulations.\nThe long term debt which qualified as tier II capital at December 31, 1995, consisted of $150 million in 8.5% Subordinated Notes Due February 1, 2004, a $10.0 million 6.35% Subordinated Note which matures ratably over a five year period beginning December 31, 2003, $3.1 million in 10.675% Subordinated Notes due in equal installments through 1998 and the above mentioned $200 million in 7.75% Subordinated Notes Due July 15, 2004. This debt is included in tier II capital on a weighted maturity basis. Additional information relating to First of America's various long term debt agreements is provided in Note 11 of the Notes to Consolidated Financial Statements included later in this document.\nRISK-BASED CAPITAL TABLE XVIII ($ in thousands)\n* Limited to 1.25% of total risk-weighted assets.\nTOTAL SHAREHOLDERS' EQUITY. First of America's total shareholders' equity increased 15.8 percent to $1.8 billion at year-end 1995. The increase in equity was the result of $128.0 million in earnings retention and the $118.2 million positive change in the adjustment to equity for available for sale securities.\nIN CONCLUSION\nIn the effort to fully fund the Savings Association Insurance Fund (SAIF), the U.S. Congress has been considering legislation which would assess a one-time premium on thrift deposits insured by SAIF of which First of America has approximately $4.5 billion. When this legislation is finally enacted which is expected during 1996, First of America will accrue the required liability which could result in a maximum, one-time expense of $38 million, or $0.39 per share. After the one-time charge, the premium rate on thrift deposits is expected to match the lower bank deposit rate.\nFirst of America's management remains committed to its long term goals of a return on assets of 1.25 percent, an efficiency ratio below 60 percent and a return on equity of 17 to 18 percent. The benefits of its internal restructuring effort, combined with a company-wide emphasis on pricing products by market and customer type and a focus on the business lines which drive higher profitability, provide the fundamentals for the achievement of these goals in the future.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nSTATEMENT OF MANAGEMENT RESPONSIBILITY\nThe following consolidated financial statements and accompanying notes to the consolidated financial statements of First of America have been prepared by management, which has the responsibility for their integrity and objectivity. The statements have been prepared in accordance with generally accepted accounting principles to reflect, in all material respects, the substance of financial events and transactions occurring during the respective periods.\nIn meeting its responsibility, management relies on First of America's accounting systems and related internal controls. These systems are designed to provide reasonable assurance that assets are safeguarded and that transactions are properly recorded and executed in accordance with management's authorization. Augmenting these systems are written policies and procedures and audits performed by First of America's internal audit staff.\nThe consolidated financial statements and notes to the consolidated financial statements of First of America, have been audited by the independent certified public accounting firm, KPMG Peat Marwick LLP, which was engaged to express an opinion as to the fairness of presentation of such financial statements.\nDaniel R. Smith Thomas W. Lambert Daniel R. Smith Thomas W. Lambert Chairman and Executive Vice President and Chief Executive Officer Chief Financial Officer\nLETTER OF AUDIT COMMITTEE CHAIRMAN\nThe audit committee of the Board of Directors is composed of six independent directors with Robert L. Hetzler as chairman. The committee held five meetings during fiscal year 1995.\nThe audit committee oversees First of America's financial reporting process on behalf of the Board of Directors. In fulfilling its responsibility, the committee recommended to the Board of Directors, subject to shareholder approval, the selection of First of America's independent auditor. The audit committee discussed with the internal auditor and the independent auditor the overall scope and specific plans for their respective audits. The committee additionally discussed First of America's consolidated financial statements and the adequacy of First of America's internal controls. The committee also met with First of America's internal auditor and independent auditor, without management present, to discuss the results of their audits, their evaluations of First of America's internal controls and the overall quality of First of America's financial reporting. This meeting was designed to facilitate private communications between the committee, the internal auditor and the independent auditor.\nThe audit committee believes that, for the period ended December 31, 1995, its duties, as indicated, were satisfactorily discharged and that First of America's system of internal controls is adequate.\nRobert L. Hetzler Robert L. Hetzler Chairman Audit Committee\nREPORT OF INDEPENDENT AUDITORS\nTo the Shareholders and Board of Directors, First of America Bank Corporation:\nWe have audited the accompanying consolidated balance sheets of First of America Bank Corporation and its subsidiaries as of December 31, 1995 and 1994 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, 1995. 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 First of America Bank Corporation and its subsidiaries as of December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1995, in conformity with generally accepted accounting principles.\nKPMG Peat Marwick LLP KPMG Peat Marwick LLP Chicago, Illinois January 17, 1996\nCONSOLIDATED BALANCE SHEETS ($ in thousands)\nSee accompanying notes to consolidated financial statements.\nCONSOLIDATED STATEMENTS OF INCOME ($ in thousands, except per share data)\nSee accompanying notes to consolidated financial statements.\nCONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY ($ in thousands, except per share data)\nSee accompanying notes to consolidated financial statements.\nCONSOLIDATED STATEMENTS OF CASH FLOWS ($ in thousands)\nSee accompanying notes to consolidated financial statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1: ACCOUNTING POLICIES\nThe consolidated financial statements have been prepared in conformity with generally accepted accounting principles and reporting practices prescribed for the banking industry. The significant accounting and reporting policies of First of America Bank Corporation and its subsidiaries follow.\nNATURE OF BUSINESS:\nFirst of America Bank Corporation is a multi-bank holding company headquartered in Kalamazoo, Michigan and was incorporated as a Michigan corporation in May 1971. Its principal activity consists of owning and supervising four affiliate financial institutions which operate general, commercial banking businesses from 613 banking offices and facilities located in Michigan, Florida, Illinois and Indiana. The Registrant also has divisions and non-banking subsidiaries which provide mortgage, trust, data processing, pension consulting, revolving credit, securities brokerage and investment advisory services.\nCONSOLIDATION:\nThe consolidated financial statements include the accounts of First of America and its subsidiaries, after elimination of significant intercompany transactions and accounts. Goodwill, the cost over the fair value of assets acquired, is amortized on a basis which matches the periods estimated to be benefitted. First of America's policy is to amortize goodwill generated from acquisitions over a fifteen year period and core deposit intangibles over their estimated lives, not to exceed ten years.\nBASIS OF PRESENTATION:\nCertain amounts in the prior years' financial statements have been reclassified to conform with current financial statement presentation. First of America uses the accrual basis of accounting for financial reporting purposes, except for immaterial sources of income and expenses which are recorded when received or paid.\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make certain 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.\nSECURITIES:\nIn accordance with Financial Accounting Standards Board Statement No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" Securities Held to Maturity include only those securities which First of America has the positive intent and ability to hold until maturity. Such securities are carried at cost adjusted for amortization of premium and accretion of discount, computed in a manner which approximates the interest method. Using the specific identification method, the adjusted cost of each security sold is used to compute realized gains or losses on the sales of these securities.\nIn accordance with Statement No. 115, Securities Available for Sale include those securities which would be available to be sold prior to final maturity in response to asset-liability management needs. Using the specific identification method such securities are carried at market value with a corresponding market value adjustment carried as a separate component of the equity section of the balance sheet on a net of tax basis. The adjusted cost of each security sold is used to compute realized gains or losses on the sales of these securities.\nLOANS HELD FOR SALE:\nLoans held for sale consist of fixed rate and variable rate residential mortgage loans with maturities of fifteen to thirty years. Such loans are recorded at the lower of aggregate cost or estimated fair value.\nALLOWANCE FOR LOAN LOSSES:\nLosses on loans are charged to the allowance for loan losses. The allowance is increased by recoveries of principal and interest previously charged to the allowance and by a provision charged against income. Management determines the adequacy of the allowance based on reviews of individual loans, recent loss experience, current economic conditions, risk characteristics of various categories of loans and such other factors which, in management's judgement, deserve recognition in estimating possible loan losses.\nOn January 1, 1995, First of America adopted Financial Accounting Standards Board Statement No. 114, \"Accounting by Creditors for Impairment of a Loan,\" as amended by Statement No. 118, \"Accounting by Creditors for Impairment of a Loan - -- Income Recognition and Disclosures.\" Under the provisions of Statement No. 114, a separate allowance for loan losses was identified for impaired loans as defined by the statement. On January 1, 1995, First of America identified $82.8 million of impaired loans under the guidelines of Statement No. 114. This resulted in an allowance for impaired loan losses of $17.4 million which was transferred from the general allowance on that date.\nNON-PERFORMING LOANS:\nLoans are considered non-performing when placed in non-accrual status or when terms are renegotiated meeting the definition of troubled debt restructuring of Financial Accounting Standards Board Statement No. 15, \"Accounting by Debtors and Creditors for Troubled Debt Restructuring.\"\nCommercial, commercial mortgage and residential mortgage loans are placed in non-accrual status when, in the opinion of management, there is doubt as to collectibility of interest or principal, or when principal or interest is past due 90 days or more and the loan is either not well secured or in the process of collection. Consumer and revolving loans are generally charged off when payments are 120 days past due; therefore, they are not included in non-performing loans.\nLoans are considered to be renegotiated when concessions have been granted, such as reduction of interest rates or deferral of interest or principal payments, as a result of the borrower's financial condition.\nManagement has determined that First of America's non-accrual and renegotiated commercial and commercial mortgage loans meet the definition for impaired loans under Statement No. 114. Payments received on non-accrual loans are applied to the principal balance.\nOTHER REAL ESTATE OWNED:\nOther real estate owned includes, primarily, properties acquired through foreclosure or deed in lieu of foreclosure. Other real estate is recorded in other assets at the lower of the amount of the loan balance plus unpaid accrued interest or the current fair value. Any write-down of the loan balance to fair value when the property is acquired is charged to the allowance for loan losses. Subsequent market write-downs, operating expenses, and gains or losses on the sale of other real estate are charged or credited to other operating expense.\nORIGINATED MORTGAGE SERVICING RIGHTS:\nEffective January 1, 1995, First of America adopted Financial Accounting Standards Board Statement No. 122, \"Accounting for Mortgage Servicing Rights an amendment of FASB Statement No. 65,\" which requires the recognition as separate assets the rights to service mortgage loans for others, however those rights are acquired. After the residential mortgage loan portfolio is stratified by servicing type, loan type, rate type and interest rate type, the fair value of the Originated Mortgage Servicing Rights (OMSRs) is determined using the present value of estimated expected future cash flows assuming a market discount rate and certain forecasted prepayment rates based on industry experience. The OMSRs are amortized in proportion to and over the period of the estimated net servicing income.\nAt December 31, 1995, First of America had capitalized $3.3 million in OMSRs with a fair market value of $3.2 million, resulting in an impairment allowance and impairment expense of $95.7 thousand. Amortization expense of $193.5 thousand had also been incurred.\nPREMISES AND EQUIPMENT:\nPremises and equipment are stated at cost, less accumulated depreciation, and include capital leases, expenditures for new facilities and additions which materially extend the useful lives of existing premises and equipment. Expenditures for normal repairs and maintenance are charged to operations as incurred. The cost of assets retired or otherwise disposed of and the related accumulated depreciation are eliminated from the accounts in the year of disposal, and the resulting gains or losses are reflected in operations.\nDepreciation is computed principally by the straight-line method and is charged to operations over the estimated useful lives of the assets. Capital leases and leasehold improvements are being amortized over the lesser of the remaining term of the respective lease or the estimated useful life of the asset.\nLONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE DISPOSED OF:\nOn January 1, 1996, First of America adopted Financial Accounting Standards Board Statement No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,\" which requires that long-lived assets and certain identifiable intangibles be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. The impairment is measured based on the present value of expected future cash flows from the use of the asset and its eventual disposition. If the expected future cash flows are less than the carrying amount of the asset, an impairment loss is recognized based on current fair values. Because First of America regularly reviews its long-lived assets for impairment and adjusts the carrying amounts as appropriate, the adoption of this statement did not have a material impact on the financial statements of the corporation.\nINTEREST INCOME ON LOANS:\nInterest income on loans is recognized over the terms of the loans based on the unpaid principal balance. Interest accrual on loans is discontinued when, in the opinion of management, the ultimate full collection of both principal and interest is in doubt, unless the loan is well secured and in the process of collection. Interest previously accrued on charged off loans is reversed, by charging interest income, to the extent of the amount included in current year income. The excess, if any, is charged to the allowance for loan losses.\nLOAN FEES:\nNon-refundable loan origination fees and direct loan origination costs are deferred and amortized as an adjustment of yield by a method that approximates the interest method. The deferred fees and costs are netted against outstanding loan balances. When a loan is placed into non-accrual status, amortization of the loan fees and costs is stopped until the loan returns to accruing status.\nDeferred fees and costs related to credit card loans are included in other assets and other liabilities and are amortized to non-interest income over a twelve month period.\nINCOME TAX:\nIncome taxes are accounted for under the asset and liability method in accordance with Financial Accounting Standards Board Statement No. 109, \"Accounting for Income Taxes.\" 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 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.\nINTEREST RATE CAPS AND INTEREST RATE SWAPS:\nAt December 31, 1994, First of America adopted the provisions of Financial Accounting Standards Board Statement No. 119, \"Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments.\"\nIn accordance with Statement No. 119, for all derivative financial instruments, an entity is required to disclose the following for each category: the face or contract amount and the nature and terms, including, the credit and market risk, cash requirements and related accounting policies. The corporation and its subsidiaries have entered into interest rate caps and interest rate swaps as a hedge against certain deposit and debt liabilities in an attempt to manage interest rate sensitivity.\nInterest rate caps are agreements to make payments for interest rate differentials between an index rate and a specified maximum rate, computed on notional amounts. Interest rate swaps are contracts that represent an exchange of interest payments and the underlying principal balances of the assets or liabilities are not affected. Net settlement amounts are reported as adjustments to interest income or interest expense. Gains and losses from the termination of interest rate swaps are deferred and amortized over the remaining lives of the designated balance sheet liability. When the swap becomes uncovered during the swap agreement period, the swap is immediately marked-to-market with a corresponding charge to current earnings.\nNOTE 2: BUSINESS COMBINATIONS\nInformation relating to mergers and acquisitions for the three year period ended December 31, 1995 follows.\n* Includes direct acquisition costs on all purchased affiliates. ** Accounted for as a pooling of interests with no restatement of prior periods as the amounts involved were not material to First of America.\nOn February 28, 1995, First of America Investment Corporation purchased for $4,742,000 in cash a 49 percent interest in Gulfstream Global Investors LTD, an investment management firm based in Dallas, Texas. Gulfstream Global Investors LTD acts as the investment advisor for the Parkstone International Discovery Fund.\nGoodwill, the cost over the fair value of assets acquired, is amortized on a basis which matches the periods estimated to be benefitted. Core deposit premiums are amortized over ten years approximating the benefitted periods. All intangible assets are reviewed annually for permanent impairment using a discounted cash flow analysis. Total intangibles, which is included in other assets in the Consolidated Balance Sheets, amounted to $226,979,000 at December 31, 1995 and $252,979,000 at December 31, 1994.\nNOTE 3: RESTRICTIONS ON CASH AND DUE FROM BANKS\nFederal regulations require First of America to maintain as reserves, minimum cash balances based on deposit levels at subsidiary banks. Cash balances restricted from usage due to these requirements were $359,319,000 and $296,840,000 at December 31, 1995 and 1994, respectively.\nNOTE 4: CASH FLOW\nFor the purpose of reporting cash flows, cash and cash equivalents include only cash and due from banks. The following schedule presents noncash investing activities for the years 1995, 1994 and 1993.\nThe following schedule details supplemental disclosures for the cash flow statements:\nIn conjunction with the Financial Accounting Standards Board's (\"FASB\") issuance of A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities, FASB approved the transfer of securities from the Held to Maturity to the Available for Sale classification during the period from November 15, 1995, to December 31, 1995, with no recognition of any related unrealized gain or loss in current earnings. On December 1, 1995, First of America's portfolio of Securities Held to Maturity was transferred, in its entirety, to the classification of Securities Available for Sale. The unrealized gain related to the transferred securities was $3.9 million (after tax) and was recognized as a component of shareholders' equity.\nNOTE 5: SECURITIES\nAt December 31, 1995, First of America had no Securities Held to Maturity. Refer to Note 4 for a discussion of the transfer of Securities Held to Maturity to the Securities Available for Sale classification. The amortized cost and estimated market value of Securities Held to Maturity at December 31, 1994 and their gross unrealized gains and losses for 1994 follow.\nThe amortized cost and estimated market value of Securities Available for Sale at December 31, 1995 and 1994 follow.\nThe following table details the gross unrealized gains and losses on Securities Available for Sale at December 31, 1995 and 1994.\nExcept as indicated below, total securities of no individual state, political subdivision or other issuer exceeded 10% of shareholders' equity at December 31, 1995. At December 31, 1995 and 1994, the book value of securities issued by the State of Michigan and all of its political subdivisions totaled approximately $126,225,000 and $150,978,000, respectively, with a market value of approximately $130,570,000 and $151,074,000, respectively. The securities at December 31, 1995, represent a wide range of ratings, all of \"investment grade\" with a substantial portion rated A-1 or higher. First of America has no concentration of credit risk in its investment portfolio.\nAssets, principally securities, carried at approximately $1,516,639,000 at December 31, 1995, and $1,467,386,000 at December 31, 1994, were pledged to secure public deposits, exercise trust powers and for other purposes required or permitted by law.\nSECURITIES AVAILABLE FOR SALE MATURITY DISTRIBUTION AND PORTFOLIO YIELDS ($ in millions)\n* Yields on state and political obligations have been adjusted to a taxable equivalent basis using a 35% tax rate. Yields are calculated on the basis of cost and weighted for the scheduled maturity and dollar amount of each issue. - --------------------------------------------------------------------------------\nSECURITIES HELD TO MATURITY ($ in thousands)\nSECURITIES AVAILABLE FOR SALE ($ in thousands)\nNOTE 6: RISK ELEMENTS IN THE LOAN PORTFOLIO AND OTHER REAL ESTATE OWNED\nAssets earning at less than normal interest rates include (1) non-accrual loans, (2) restructured loans (loans for which the interest rate or principal balance has been reduced because of a borrower's financial difficulty) and (3) other real estate owned which has been acquired in lieu of loan balances due. Information concerning these assets, loans past due 90 days or more and other loans of concern (loans where known information about possible credit problems of borrowers causes management concern about the ability of such borrowers to comply with the present loan terms) at December 31, 1995 and 1994 follows:\nInterest income of $3,052,000 and $3,801,000 during 1995 and 1994, respectively, was recognized as income on non-accrual and restructured loans. Had these loans been performing under the original contract terms, an additional $10,090,000 and $8,520,000 of interest would have been reflected in interest income during 1995 and 1994, respectively.\nFirst of America has no significant concentrations of credit risk. Its loan portfolio is well balanced both by type and by geographical area.\nNOTE 7: LOANS TO RELATED PARTIES\nFirst of America's subsidiary banks have extended loans to directors and executive officers of the corporation and their associates and to the directors and executive officers of the corporation's significant subsidiaries and their associates (other than members of their immediate families). In conformance with First of America's written corporate policy and applicable laws and regulations, these loans to related parties were made in accordance with sound business and banking practices on non-preferential terms and rates available to non-insiders of comparable credit worthiness under similar circumstances. The loans do not involve more than the normal risk of collectibility or present other unfavorable features. All such extensions of credit must be properly documented as complying with this corporate policy. The aggregate loans outstanding as reported by the directors and executive officers of the corporation and its significant subsidiaries which exceeded $60,000 during 1995 totaled less than 5 percent of total shareholders' equity at year-end 1995. First of America relies on its directors and executive officers for identification of loans to their associates.\nFirst of America maintains a line of credit for First of America Securities, Inc. and First of America Community Development Corporation; at December 31, 1995 only First of America Community Development Corporation had any borrowings outstanding in the amount of $613,400. In conformance with First of America's corporate policy and applicable law, such extensions of credit to subsidiaries are made in accordance with sound banking practices and on non-preferential terms and rates.\nIn the opinion of management, the amount and nature of these loans to related parties and subsidiaries do not materially affect the financial condition of First of America.\nNOTE 8: ALLOWANCE FOR LOAN LOSSES\nAn analysis of the transactions in the allowance for loan losses for 1995, 1994 and 1993 follows.\nManagement has evaluated the loan portfolio and determined that the balance in the allowance for loan losses is adequate in light of the composition of the loan portfolio, economic conditions and other pertinent factors.\nAs of December 31, 1995, the recorded investment in loans considered to be impaired under Statement No. 114 was $88.6 million with an average recorded investment in impaired loans during 1995 of approximately $81.9 million. Included in the impaired loans total were $42.6 million of impaired loans for which the related specific allowance for loan losses was $17.6 million. The remaining $46.0 million of impaired loans did not require a specific allowance for loan losses due to the net realizable value of loan collateral, guarantees and other factors.\nNOTE 9: PREMISES AND EQUIPMENT\nA summary of premises and equipment at December 31, 1995 and 1994 follows.\nFirst of America and certain of its subsidiaries have capital and operating leases for premises and equipment under agreements expiring at various dates through 2034. These leases, in general, provide for renewal options and options to purchase certain premises at fair values, and require the payment of property taxes, insurance premiums and maintenance costs. Total rental expense for all operating leases was $17,554,000 in 1995, $16,100,000 in 1994, and $10,936,000 in 1993.\nThe future minimum payments by year, and in the aggregate, under capital leases and noncancelable operating leases with initial or remaining terms of one year or more consisted of the following at December 31, 1995.\nNOTE 10: SHORT TERM BORROWINGS\nInformation relating to securities sold under agreement to repurchase follows:\nSecurities sold under agreements to repurchase are secured transactions with customers, generally maturing within thirty days. As of December 31, 1995, First of America did not have repurchase agreements which exceeded 10 percent of total assets.\nNOTE 11: LONG TERM DEBT\nInformation relating to long term debt at December 31, 1995 and 1994 follows.\nFirst of America entered into a Three-Year Competitive Advance and Revolving Credit Facility Agreement dated as of March 25, 1994 and amended by the First Amendment dated December 9, 1994, and by the Second Amendment dated February 15, 1996 (collectively, the Credit Agreement). The Credit Agreement allows First of America to borrow on a standby revolving credit basis and an uncommitted competitive advance basis up to $350,000,000. The proceeds of all borrowings made pursuant to the Credit Agreement will be used to provide working capital and for other general corporate purposes.\nOn July 26, 1994, First of America issued $200 million of 7 3\/4% Subordinated Notes Due July 15, 2004, which are not subject to redemption prior to maturity and which qualify as tier II capital under the Federal Reserve Board's capital guidelines. The proceeds received from the Notes were used to discharge indebtedness incurred to fund the acquisition of the Goldome Federal branches, the repurchase of common stock and for other general corporate purposes.\nDuring August 1994, certain First of America bank subsidiaries began issuing Bank Notes Due from 30 Days to 10 Years from Date of Issue. The Bank Notes which are long term are included in the preceding table. The proceeds from the sale of the notes were used for general operating purposes by the issuing banks.\nThe various loan agreements include restrictions on consolidated capital. First of America's net worth, under the most restrictive loan covenant, may not be less than $1,421,141,000. The indebtedness of subsidiary banks is subordinated to the claims of their depositors and certain other creditors. Management has determined that First of America is in compliance with all of its loan covenants.\nMaturities of outstanding indebtedness at December 31, 1995 follow.\nNOTE 12: PREFERRED STOCK\nFirst of America has reserved 500,000 shares of preferred stock for issuance as Series A Junior Participating Preferred Stock (\"Series A Preferred\") upon the exercise of certain preferred stock purchase rights (each a \"Right\") issued to holders of and in tandem with shares of First of America Common Stock.\nIf issued, each share of Series A Preferred is entitled to 100 votes on all matters submitted to a vote of the shareholders of First of America. Additionally, in the event First of America fails to pay dividends on the Series A Preferred for four full quarters, holders of the Series A Preferred have certain rights to elect additional directors of the company. Except as described in the Rights Agreement, holders of the Series A Preferred have no preemptive rights to subscribe for additional securities which the company may issue. The Series A Preferred will not be redeemable. Each share of Series A Preferred will, subject to the rights of any other preferred stock the company may issue ranking senior to the Series A Preferred, if any, be entitled to preferential quarterly dividends equal to the greater of $10.00, or subject to certain adjustments, 100 times the dividend declared per share of First of America Common Stock. Upon liquidation of the company, holders of Series A Preferred will, subject to the rights of senior securities, be entitled to a preferential liquidation payment equal to $190.00 per share, plus accrued and unpaid dividends. In the event of any merger, consolidation, or other transaction in which shares of First of America Common Stock are exchanged, each share of Series A Preferred will, subject to the rights of senior securities, be entitled to receive 100 times the amount received per share common stock. The rights of the Series A Preferred are protected by customary antidilution provisions.\nNOTE 13: STOCK OPTION PLAN\nThe First of America Bank Corporation Restated 1987 Stock Option Plan is administered by the Nominating and Compensation Committee of the Board of Directors, none of whom is eligible to participate therein. Under the Plan options to purchase up to 1,700,000 authorized but unissued shares of First of America Common Stock may be granted through December 9, 1997.\nThe stock options are exercisable during a 10 year period, beginning on the date of grant and may be granted at prices not less than the fair market value on the date of grant.\nThe following is a summary of transactions which occurred during 1993, 1994 and 1995:\nNOTE 14: DIVIDENDS FROM BANKING SUBSIDIARIES\nDividends paid to First of America by its bank subsidiaries amounted to $337,407,000 in 1995, $173,350,000 in 1994 and $200,700,000 in 1993. Unless prior regulatory approval is obtained, banking regulations limit the amount of dividends that First of America's banking subsidiaries can declare during 1996, to the 1996 net profits, as defined in the Federal Reserve Act, plus retained net profits for 1995 and 1994, which amounted to $50,187,000. Under the FDIC Improvement Act of 1993, there is incentive to maintain banks' capital at the \"well-capitalized\" level. This may further restrict dividends in the future.\nNOTE 15: EMPLOYEE PENSION PLAN\nFirst of America and its subsidiaries have a defined benefit pension plan that covers substantially all of its full-time employees. Benefits are based on years of service and the employee's compensation.\nPension costs for the years 1995 and 1994 were calculated based on Financial Accounting Standards Board Statement No. 87 \"Employers' Accounting for Pensions.\" Pension costs for the years ended December 31, 1995, 1994, and 1993 equaled $3,980,000, $8,073,000, and $5,920,000, respectively.\nThe following table presents the plan's funded status and amounts recognized in the consolidated balance sheets at December 31, 1995 and 1994.\nFirst of America's weighted-average discount rate was 7.50 percent at December 31, 1995 and 8.00 percent at December 31, 1994. The rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligation was 5.50 percent at year-end 1995 and 6.00 percent at year-end 1994. The expected long term rate of return on assets was 9.50 percent and 9.00 percent at December 31, 1995 and 1994, respectively. The assumed rates in place at each year-end are used to determine the net periodic pension cost for the following year.\nNOTE 16: OTHER POSTRETIREMENT BENEFITS\nFirst of America and its subsidiaries have a Retiree Medical Plan which provides a portion of retiree medical care premiums. First of America's level of contribution is based on an age and service formula.\nThe following table presents the plan's funded status reconciled with amounts recognized in First of America's Consolidated Balance Sheet at December 31, 1995 and 1994:\nFor measurement purposes of the accrued postretirement benefit cost included in other liabilities, 10.03 percent and 10.36 percent annual rates of increase in the per capita cost of covered benefits (i.e., health care cost trend rate) were assumed at December 31, 1995 and 1994, respectively; the 1995 rate was further assumed to decline evenly to 6.0 percent in 2004. The weighted-average discount rate used in determining the accumulated postretirement benefit obligation was 7.5 percent at December 31, 1995 and 8.00 percent at December 31, 1994. To determine First of America's net periodic postretirement benefit cost for 1995 and 1994, a weighted average discount rate of 8.0 percent and 7.25 percent, respectively, and the health care trend rate of 10.36 percent and 10.95 percent, respectively, were used. 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, 1995 by 2.1 percent and the aggregate of the service and interest cost components of net periodic postretirement benefit cost for the year ended December 31, 1995 by 1.5 percent.\nNOTE 17: SUPPLEMENTARY INCOME STATEMENT INFORMATION\nOther than the items listed below, other operating income and other operating expenses did not include any accounts that exceeded one percent of total revenue, which is the sum of total interest income and total non-interest income.\nNOTE 18: INCOME TAXES\nTotal income tax expense (benefit) for the years ended December 31, 1995, 1994 and 1993, respectively, was allocated as follows:\nIncome tax expense (benefit) attributable to income from continuing operations consists of:\nIncome tax expense attributable to income from continuing operations differed from the amounts computed by applying the U.S. federal income tax rate of 35 percent to pretax income from operations as a result of the following:\nThe significant components of deferred income tax expense (benefit) attributable to income from continuing operations for the years ended December 31, 1995, 1994 and 1993 were as follows:\nThe tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities at December 31, 1995 and 1994 are presented below:\nThe valuation allowance for deferred tax assets as of January 1, 1995 was $22,524,000. The net change in the total valuation allowance for the year ended December 31, 1995 was a decrease of $22,524,000.\nThe valuation allowance for deferred tax assets at January 1, 1995 was related entirely to market value adjustments on Securities Available for Sale which would have resulted in capital losses that could be recognized only when offset against capital gains. During 1995, the market value adjustment on Securities Available for Sale resulted in an overall capital gain position, and accordingly, the reduction in the valuation allowance of $22,524,000 has been allocated to shareholders' equity.\nNOTE 19: EARNINGS PER SHARE CALCULATION\nThe weighted average number of shares used in the determination of earnings per share were:\nCommon and common equivalents per share amounts were calculated by dividing net income applicable to common shares by the weighted average number of common shares outstanding during the respective periods adjusted for the portion of stock options which were considered common equivalents, 279,856 in 1995, 281,498 in 1994 and 305,240 in 1993. Fully diluted earnings per share calculations were based on the assumption that all outstanding preferred stock was converted into common stock and the preferred dividends on these shares eliminated. In addition, the average fully diluted earnings per share included the portion of stock options which were considered common equivalents, 279,856 in 1995, 281,498 in 1994 and 305,240 in 1993.\nOn December 31, 1995 and 1994, there were 63,283,857 and 62,849,209 common shares outstanding, respectively. At the same dates there were 100,000,000 authorized shares of $10 par value common stock.\nNOTE 20: COMMITMENTS AND CONTINGENT LIABILITIES\nFirst of America and its subsidiaries are parties to routine litigation arising in the normal course of their respective businesses. In the opinion of management after consultation with counsel, liabilities arising from these proceedings, if any, are not expected to be material to First of America's financial position.\nFINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK:\nIn First of America's normal course of business, there are various conditional obligations outstanding which are not reflected in the financial statements. These financial instruments include commitments to extend credit, standby letters of credit, commercial letters of credit, when issued securities, securities lent and commitments to purchase foreign currency.\nFirst of America's exposure to credit loss in the event of nonperformance by other parties to the financial instruments with off-balance sheet risk is represented by the contractual notional amount of these instruments. First of America uses the same credit policies in making these commitments and conditional obligations as it does for on-balance sheet instruments.\nUnless noted otherwise, First of America does not require collateral or other security to support financial instruments with off-balance sheet credit risk.\nA summary of the contract or notional amounts of these financial instruments at December 31, is 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 and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the commitment amounts included in the preceding table does not necessarily represent future cash requirements. At December 31, 1995, other commitments to extend credit were comprised of $1,983,159,000 in unused commercial loan commitments, $947,465,000 in commitments to fund commercial real estate, construction and land development of which $445,643,000 was secured by real estate, and $464,953,000 in home equity lines of credit. Collateral held on these instruments varies but may include accounts receivable, inventory, property, plant and equipment and income-producing commercial properties.\nFirst of America has sold mortgage loans to the Federal National Mortgage Association (FNMA), Government National Mortgage Association (GNMA), Federal Home Loan Mortgage Corporation (FHLMC), and other savings institutions with full recourse. The total unpaid principal balances of these loans were $80.0 million at December 31, 1995 and are not included in the accompanying consolidated balance sheets. Mortgage loan sale commitments represent agreements to deliver mortgage loans to investors in future periods.\nStandby letters of credit and commercial letters of credit are conditional commitments issued to secure performance of a customer to a third party and are subject to the same credit review and approval process as loans. Losses to date have not been material.\nForeign exchange contracts are entered into for trading activities which enable customers to transfer or reduce their foreign exchange risk. Foreign exchange forward contracts represent First of America's largest activity in this specialized area. Forward contracts are commitments to buy or sell at a future date a currency at a contracted price and are settled in cash or through delivery. The risk in foreign exchange trading arises from the potential inability of the counterparties to deliver under the terms of the contract and the possibility that the value of a foreign currency might change in relation to the U.S. dollar. In the event of a default by a counterparty, the cost to First of America would be the replacement of the contract at the current market rate. Such credit losses to date have not been material. The risk of loss from changes in market rate is substantially lessened because First of America limits its risk by entering into offsetting contracts.\nAt December 31, 1994, First of America had outstanding interest rate caps which totaled $125 million and were designated to certain FirstRate Fund deposits. First of America also had interest rate swaps with a total notional value of $707.9 million of which $530.9 million was a hedge against certain certificates of deposit, $125.0 million as a hedge against long term debt with the remainder as a hedge against certain other deposits and borrowings. Although the notional amounts are often used to express the volume of these transactions, the amounts potentially subject to credit risk are much smaller. The company minimizes this risk by performing normal credit reviews of its counterparties and collateralizing its exposure when it exceeds a predetermined limit. The following table outlines First of America's interest rate caps and interest rate swaps at December 31, 1995.\nINTEREST RATE SWAPS ($ in thousands)\n* This represents a basis swap.\nAt December 31, 1995, there were no deferred losses included in other assets from the termination of interest rate swaps. During 1995, no losses were recognized in earnings related to interest rate swaps which were marked-to- market.\nInterest rate caps are agreements to make payments for interest rate differentials between an index rate and a specified maximum rate, computed on notional amounts. First of America utilized interest rate caps in an attempt to manage its interest rate risk. As of December 31, 1995, First of America had no outstanding interest rate caps.\nNOTE 21: FAIR VALUE DISCLOSURE\nSFAS No. 107, \"Disclosure about Fair Value of Financial Instruments,\" requires disclosure of fair value information for 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 were not available, fair values were based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of First of America.\nFor purposes of this disclosure, the estimated fair value of financial instruments with short-term maturities is assumed to equal the recorded book value. These financial instruments include cash and short term investments, accrued interest receivable and payable and short term borrowings. Estimated fair values for other financial instruments were determined as follows:\nSECURITIES:\nFair values for Held to Maturity and Available for Sale securities were based on quoted market prices where available. If a quoted market price was not available, fair value was estimated using quoted market prices for similar securities.\nLOANS RECEIVABLE:\nFor variable rate loans that reprice frequently and for which there has been no significant change in credit risk, fair values equal carrying values. The fair values for fixed rate loans were based on estimates using discounted cash flow analyses and current interest rates being offered for loans with similar terms to borrowers of similar credit quality.\nLOANS HELD FOR SALE:\nFair values for loans held for sale were based on quoted market prices where available. If a quoted market price was not available, fair value was estimated using market prices for similar assets.\nDEPOSIT LIABILITIES:\nThe fair values disclosed for demand deposits with no stated maturity (e.g., interest and non-interest checking, passbook savings and certain types of money market accounts) were, by definition, equal to the amount payable on demand at the reporting date. The carrying amounts for variable rate, fixed-term money market accounts and certificates of deposits with less than twelve months maturities approximate their fair values at the reporting date. Fair values for fixed-rate certificates of deposit with maturities greater than twelve months are estimated using a discounted cash flow calculation that applied interest rates being offered on the same or similar certificates at the reporting date to a schedule of aggregated expected maturities on the certificates of deposits.\nLONG TERM BORROWINGS:\nFair values for First of America's long term debt (other than deposits) were 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.\nOFF BALANCE SHEET INSTRUMENTS:\nFair values for unused commitments were estimated using the fees charged to enter into similar agreements at the reporting date, taking into account the remaining terms of the agreements and the present credit worthiness of the counterparties. Fair values for guarantees and letters of credit were based on fees charged for similar agreements.\nThe fair value of forward delivery commitments, foreign exchange contracts, interest rate swaps and interest rate caps is estimated, using dealer quotes, as the amount that the corporation would receive or pay to execute a new agreement with terms identical to those remaining on the current agreement, considering current interest rates.\nThe estimated fair values of First of America's financial instruments for which the fair value differs from the recorded book value for December 31, 1995 and 1994 were as follows:\n* SFAS No. 107 defines the fair value of demand deposits as the amount payable on demand and prohibits adjusting fair value for any value derived from retaining those deposits for an expected future period of time.\nNOTE 22: CONDENSED FINANCIAL INFORMATION -- PARENT COMPANY ONLY\nThe balance sheets for December 31, 1995 and 1994, and the statements of income and statements of cash flows for the three years ended December 31, 1995 follow.\nSUPPLEMENTAL INFORMATION (Unaudited)\n* Prior years numbers not restated.\nQUARTERLY INFORMATION (Unaudited) ($ in millions except per share data)\nITEM 9.","section_9":"ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURES\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nReference is made to the information under the headings \"Election of Directors\" on pages 1 through 4 and \"Other Matters\" on page 24 of the Registrant's definitive Proxy Statement for the Annual Meeting of Shareholders to be held in 1996. Such information is incorporated herein by reference. The information concerning executive officers of the Registrant appears on page 5 in Part I of this document.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nReference is made to those portions of the information under the heading \"Executive Compensation,\" other than the \"Compensation Committee Report on Executive Compensation\" and the \"Performance Graph,\" on pages 6 through 17 of the Registrant's definitive Proxy Statement for the Annual Meeting of Shareholders to be held in 1996. Such 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 in the Registrant's definitive Proxy Statement for the Annual Meeting of Shareholders to be held in 1996 under the headings \"Principal Shareholders\" on page 1, and \"Election of Directors\" on pages 1 through 4 regarding ownership of the Registrant's securities. Such information in incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nReference is made to the information under the heading \"Interest of Management in Certain Transactions\" on page 17 of the Registrant's definitive Proxy Statement for the Annual Meeting of Shareholders to be held in 1996. Such information is incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) The following documents are filed as a part of this report:\n1. Financial Statements\nReport of Independent Auditors Consolidated Balance Sheets -- December 31, 1995 and 1994 Consolidated Statements of Income -- three years ended December 31, Consolidated Statements of Changes in Shareholders' Equity -- three years ended December 31, 1995 Consolidated Statements of Cash Flows -- three years ended December 31, 1995 Notes to Consolidated Financial Statements\nThe above listed auditor's report, consolidated financial statements and notes to consolidated financial statements are included under \"Item 8. Financial Statements and Supplementary Data\" of this document.\n2. Financial statement schedules required by Article 9 of Regulation S-X are inapplicable.\n3. Exhibits required by Item 601 of Regulation S-K.\n(2) Plan of acquisition, reorganization, arrangement, liquidation or succession.\nNot applicable.\n(3) Articles of Incorporation and Bylaws\nA. A copy of the Restated Articles of Incorporation of the Registrant was filed as an Exhibit to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1992, and is incorporated herein by reference.\nB. A copy of the Bylaws of the Registrant as currently in effect was filed as an Exhibit to the Registrant's Registration Statement on Form S-4 (Registration No. 33-53983) filed June 6, 1994 and is incorporated herein by reference.\n(4) Instruments defining the rights of security holders, including indentures\nA. Instruments defining the rights of security holders are included in the Registrant's Articles of Incorporation and Bylaws. See (3) A and B above.\nB. A copy of the Rights Agreement between the Registrant and First of America Bank -- Michigan, N.A., as Rights Agent, dated as of July 18, 1990, was filed as an Exhibit to the Registrant's Current Report on Form 8-K, dated July 18, 1990, and is incorporated herein by reference.\nC. A copy of the Subordinated Indenture between the Registrant, as Issuer, and First Trust National Association, as Trustee, dated as of November 1, 1991, was filed as an Exhibit to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1991, and is incorporated herein by reference.\nD. The Registrant is a party to various other instruments defining the rights of holders of long term debt, none of which authorizes securities in excess of 10 percent of the total assets of the Registrant and its subsidiaries on a consolidated basis. None of such instruments (except such as may be filed under (10) Material Contracts) are filed with this Report. The Registrant hereby agrees to furnish a copy of any such instrument to the Commission upon request.\n(9) Voting trust agreement\nNot applicable.\n(10) Material contracts\n* Denotes management contracts and compensatory arrangements required to be filed as Exhibits and in which the Registrant's executive officers participate.\nA. A copy of the Three-Year Competitive Advance and Revolving Credit Facility Agreement dated March 25, 1994, among the Registrant and the several lenders named therein was filed as an Exhibit to the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 1994 and is incorporated herein by reference. That Agreement which was amended by the First Amendment dated December 9, 1994, was filed as an Exhibit to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994 and is incorporated herein by reference. The Agreement was also amended by the Second Amendment dated February 15, 1996, which is filed herewith as an Exhibit.\nB.* A copy of the First of America Bank Corporation Annual Incentive Compensation Plan for Key Corporate and Affiliate Executives, in which the Registrant's executive officers participate, was filed as an Exhibit to the Registrant's Annual Report to the Commission on Form 10-K for the year ended December 31, 1988 and is incorporated herein by reference, and a copy of the Amendment to this document was filed as an Exhibit to the Registrant's Quarterly Report on Form 10-Q dated September 30, 1990, and is incorporated herein by reference.\nC.* A copy of the Registrant's Unfunded Deferred Excess Benefit Plan as adopted during 1990, in which the Registrant's executive officers participate, was filed as an Exhibit to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1990, and is incorporated herein by reference.\nD.* A copy of the Registrant's Supplemental Retirement Plan to Compensate for Nonqualified Savings Deferrals, in which the Registrant's executive officers participate, was filed as an Exhibit to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993 and is incorporated herein by reference.\nE.* A copy of the Registrant's Supplemental Savings Plan and the Amendment to this document, in which the Registrant's executive officers participate, were filed as an Exhibit to the Registrant's Annual Report to the Commission on Form 10-K for the year ended December 31, 1992 and is incorporated herein by reference.\nF.* A copy of the Restated First of America Bank Corporation 1987 Stock Option Plan, as amended and in which the Registrant's executive officers participate, was filed, as an Exhibit to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993 and is incorporated herein by reference.\nG.* A copy of First of America's Long-Term Incentive Plan as amended and restated for performance periods commencing July 1, 1988, and thereafter, in which the Registrant's executive officers participate, was filed as an Exhibit to the Registrant's Registration Statement on Form S-4 filed July 28, 1988 (Reg. No. 33-23365) and is incorporated herein by reference, and a copy of the Amendment to this document was filed as an Exhibit to the Registrant's Quarterly Report on Form 10-Q dated September 30, 1990, and is incorporated herein by reference.\nH.*A copy of the composite form of the Management Continuity Agreement dated February 15, 1995, entered into by the Registrant and its executive and certain other senior officers of the Registrant was filed as an Exhibit to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994 and is incorporated herein by reference.\nI.* A copy of First of America's Executive Management Trust Agreement, intended to fund benefits under the Management Continuity Agreements (see Exhibit (10)H above) was filed as an Exhibit to the Registrant's Annual Report on Form 10-K dated December 31, 1989, and is incorporated herein by reference.\n(11) Statement re computation of per share earnings\nThe computation of common and common equivalents and fully diluted earnings per share is described in Note 19 of the Registrant's Notes to Consolidated Financial Statements included in \"Item 8. Financial Statements and Supplementary Data\" of this document.\n(12) Statement re computation of ratios\nNot applicable.\n(13) Annual Report to Security Holders, Form 10-Q or Quarterly Report to Security Holders.\nNot applicable.\n(16) Letter re change in certifying accountant\nNot applicable.\n(18) Letter re change in accounting principles\nNot applicable.\n(21) Subsidiaries of the Registrant\nThe subsidiaries of the Registrant as of the date of this document are as follows:\n(22) Published report regarding matters submitted to a vote of security holders.\nNot applicable.\n(23) Consents of experts\nConsent of KPMG Peat Marwick\n(24) Power of Attorney\nPower of Attorney signed by various directors of the Registrant authorizing Daniel R. Smith or Richard F. Chormann or Thomas W. Lambert to sign this Report on their behalf.\n(27) Financial Data Schedule\nFinancial Data Schedule is filed herewith an Exhibit.\n(28) Information from reports furnished to state insurance regulatory authorities.\nNot applicable.\n(99) Additional exhibits\nNot applicable.\n(b) Reports on Form 8-K\nNo Reports on Form 8-K were filed by the Registrant during the three months ended December 31, 1995.\n(c) Exhibits\nAn Exhibit Index and Exhibits are attached to this Report.\n(d) Financial Statement Schedules\nFinancial Statement Schedules are inapplicable. See Item 14 (a) 2 above.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nFIRST OF AMERICA BANK CORPORATION\nBy: \/s\/ DANIEL R. SMITH --------------------------------------- Daniel R. Smith, Chairman and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\n*DIRECTORS\nEXHIBIT INDEX","section_15":""}
{"filename":"108721_1995.txt","cik":"108721","year":"1995","section_1":"ITEM 1. BUSINESS\nWynn's International, Inc., through its subsidiaries, is engaged primarily in the automotive components business and the specialty chemicals business. The Company designs, produces and sells O-rings and other seals and molded elastomeric and thermoplastic polymer products and automotive air conditioning systems and components. The Company also formulates, produces and sells specialty chemical products and automotive service equipment and distributes, primarily in southern California, locks and hardware products manufactured by others.\nO-rings and other molded polymer products are marketed under the trade name \"Wynn's-Precision.\" Air conditioning systems for the automotive aftermarket are marketed by the Company under the trademark FROSTEMP-Registered Trademark- and installation centers are operated under the trademarks MAXAIR-Registered Trademark- and FROSTEMP-Registered Trademark-. Specialty chemical products and automotive service equipment are marketed under various trademarks, including WYNN'S-Registered Trademark-, FRICTION PROOFING-Registered Trademark-, X-TEND-Registered Trademark-, SPIT FIRE-Registered Trademark-, DU-ALL-Registered Trademark- and TRANSERVE-TM-.\nThe Company's executive offices are located at 500 North State College Boulevard, Suite 700, Orange, California 92668. Its telephone number is (714) 938-3700. The terms \"Wynn's International, Inc.,\" \"Wynn's,\" \"Company\" and \"Registrant\" herein refer to Wynn's International, Inc. and its subsidiaries unless the context indicates otherwise.\nFINANCIAL INFORMATION BY BUSINESS SEGMENT AND GEOGRAPHIC DATA\nThe Company's operations are conducted in three industry segments: Automotive Components; Specialty Chemicals; and Builders Hardware. Financial information relating to the Company's business segments for the five years ended December 31, 1995 is incorporated by reference from Note 14 of \"Notes to Consolidated Financial Statements\" on pages 29 through 31 of the Company's Annual Report to Stockholders for the year ended December 31, 1995 (the \"1995 Annual Report\").\nAUTOMOTIVE COMPONENTS\nThe Automotive Components Division consists of Wynn's-Precision, Inc. (\"Precision\") and Wynn's Climate Systems, Inc. (\"Wynn's Climate Systems\"). During 1995, sales of the Automotive Components Division were $166,012,000, or 55% of the Company's total net sales, as compared with $176,346,000 and 60% in 1994. The operating profit of the division in 1995 was $19,872,000, or 61% of the Company's total operating profit, as compared with $18,566,000 and 65% in 1994. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and \"Business Segment and Geographical Information\" on pages 16 through 19 and 29 through 31, respectively, of the 1995 Annual Report, which are hereby incorporated by reference. See also \"Other Factors Affecting the Business.\"\nWYNN'S-PRECISION, INC. (O-RINGS, SEALS AND OTHER MOLDED ELASTOMERIC AND THERMOPLASTIC POLYMER PRODUCTS)\nPRODUCTS\nPrecision and its affiliated companies design, manufacture and market a variety of static and dynamic sealing products. The principal products of Precision are O-rings, composite gaskets, engineered seals and convoluted boots and seals that are reinforced with plastic, metal and fabric. These products are made from elastomeric and thermoplastic polymers. The products are used for a variety of sealing applications that include engines, transmissions, steering pumps and assemblies, fuel handling, suspension\/brake systems, refrigeration and electronics. Precision's primary customers are manufacturers of automobiles, trucks, off-highway vehicles, fluid handling equipment, aircraft\/aerospace components, and the military.\nDISTRIBUTION\nPrecision sells its products primarily through a direct sales force to original equipment manufacturer (\"OEM\") customers. Precision also markets its products throughout the United States through independent distributors and through Company-operated regional service centers located in California, Illinois, Indiana, Kansas, Michigan, Minnesota, New York, North Carolina, Ohio, Pennsylvania and Texas. Precision's Canadian operation distributes products principally through a direct sales force to OEM customers, through independent distributors and through Precision-operated service centers in Canada and England.\nPRODUCTION\nPrecision's manufacturing facilities are located in Arizona, Tennessee, Texas, Virginia and Ontario, Canada. Precision's administrative headquarters are located at the site of its main manufacturing facility in Lebanon, Tennessee. Also located in Lebanon, Tennessee are Precision's own tool production facility and a facility dedicated exclusively to injection molding. Over the past several years, Precision has made significant investments in modern computerized production equipment and facilities. In 1995, Precision continued to invest in new production equipment, which expanded production capacity primarily at Precision's Lebanon, Tennessee and Virginia facilities.\nThe principal raw materials used by Precision are elastomeric and thermoplastic polymers. These raw materials generally have been available from numerous sources in sufficient quantities to meet Precision's requirements. Adequate supplies of raw materials were available in 1995 and are expected to continue to be available in 1996.\nWYNN'S CLIMATE SYSTEMS, INC. (AUTOMOTIVE AIR CONDITIONING SYSTEMS AND COMPONENTS)\nPRODUCTS AND SERVICES\nWynn's Climate Systems designs, manufactures and markets automotive air conditioning systems and components for both automotive OEMs and the automotive aftermarket. The components include condensers, evaporator coils, injection-molded and vacuum-formed plastic parts, steel brackets, adapter kits and hose and tube assemblies. In 1994, Wynn's Climate Systems also manufactured and sold refrigerant recovery and recycling equipment (\"A\/C-R Equipment\"). In January 1995, Wynn's Climate Systems sold substantially all of its inventory of A\/C-R Equipment and discontinued the manufacture of such equipment in April 1995. Wynn's Climate Systems also operates ten installation centers in Arizona, California, Colorado and North Carolina that install air conditioners and accessories for automobile dealers and retail customers.\nDISTRIBUTION\nWynn's Climate Systems sells its air conditioning components to OEM customers and distributors. It sells its air conditioning systems to OEM customers and their distributors and dealers, and to distributors in the automotive aftermarket. In addition, through its installation centers, Wynn's Climate Systems sells air conditioning systems and accessories to automobile dealers and retail customers.\nPRODUCTION\nWynn's Climate Systems manufactures its products in its 185,000 square foot facility located in Fort Worth, Texas. Wynn's Climate Systems manufactures many of the components that it uses in the production of its air conditioning systems. Outside vendors supply certain finished components such as compressors, accumulators and receiver\/dryers. Adequate supplies of raw materials and components provided by outside vendors are available at present and are expected to continue to be available for the foreseeable future.\nSPECIALTY CHEMICALS\nThe Specialty Chemicals Division consists of Wynn Oil Company and its subsidiaries (\"Wynn Oil\"). During 1995, net sales at Wynn Oil were $132,173,000, or 43% of the Company's total net sales, as compared to $110,867,000 and 38% for 1994. The operating profit of the division during 1995 was $12,426,000, or 38% of the Company's total operating profit, compared with $9,564,000 and 34% for 1994. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and \"Business Segment and Geographical Information\" on pages 16 through 19 and 29 through 31, respectively, of the 1995 Annual Report, which are hereby incorporated by reference. See also \"Other Factors Affecting the Business.\"\nPRODUCTS\nThe principal business of Wynn Oil is the development, manufacture and marketing of a wide variety of specialty chemical car care products and related service programs under the WYNN'S-Registered Trademark- and X-TEND-Registered Trademark- trademarks. Wynn Oil's car care products are formulated to provide preventive or corrective maintenance for automotive engines, transmissions, steering systems, fuel delivery systems, differentials, engine cooling systems and other automotive mechanical parts. Wynn Oil also manufactures industrial specialty chemical products, including forging compounds, lubricants, cutting fluids and multipurpose coolants for precision metal forming and machining operations. Wynn Oil also manufactures the patented DU-ALL-Registered Trademark- antifreeze power drain and fill and recycling system, which is a portable machine used in conjunction with proprietary chemicals to service a vehicle's cooling system and recycle the used antifreeze. The DU-ALL-Registered Trademark- system has been approved by General Motors and Chrysler. In December 1995, Wynn Oil launched the sale of its TRANSERVE-TM- transmission flush and fill system, which is a portable machine used in conjunction with proprietary chemicals to flush and refill the transmission fluid in a vehicle. Wynn Oil also sells its WYNN'S EMISSION CONTROL-Registered Trademark- product, a patented organic fuel combustion catalyst for spark ignition and diesel engines which helps reduce exhaust emissions and improve fuel economy.\nWynn Oil also markets the WYNN'S PRODUCT WARRANTY-Registered Trademark- program, which, in general, consists of kits containing a specially formulated line of automotive additive products, accompanied by a special product warranty. The warranty kits are sold through distributors, sales representatives and automobile dealers primarily to purchasers of used automobiles. The Wynn's Product Warranty program provides reimbursement of the costs of certain parts and labor and, in some instances, the costs of towing and a rental car, incurred by vehicle owners who use the special products to treat their vehicles in accordance with the terms and conditions of the warranty and who experience certain types of damage which the special products are designed to help prevent. See \"Other Factors Affecting the Business.\"\nDISTRIBUTION\nWynn Oil's car care products are sold in the United States and in approximately 90 foreign countries. See \"Foreign Operations.\"\nWynn Oil distributes its products through a wide range of distribution channels. Domestically, Wynn Oil distributes its products primarily through independent distributors, sales representatives and warehouse distributors, and also through mass merchandisers and chain stores. Wynn Oil also uses internal sales management in the sale and distribution of its products. Foreign sales are made principally through wholly-owned subsidiaries, which sell primarily through independent distributors or manufacturers' representative organizations, with a direct sales force in France. Wynn Oil also engages in direct export sales from the U.S. to independent distributors in Asia and Latin America, and from Belgium to independent distributors in Scandinavia, Europe, North Africa, the Middle East and former republics of the USSR. See \"Other Factors Affecting the Business.\"\nPRODUCTION\nWynn Oil has manufacturing facilities in California and Belgium. Other foreign subsidiaries either purchase products directly from the manufacturing facilities in the United States or Belgium or have the products manufactured locally by outside contract suppliers according to Wynn Oil's specifications and formulae. Wynn Oil periodically reviews its production and sourcing locations in light of fluctuating foreign currency rates.\nWynn Oil utilizes a large number of chemicals in the production of its various specialty chemical products. Primary raw materials necessary for the production of these products, as well as the finished products, generally have been available from several sources. An adequate supply of materials was available in 1995 and is expected to continue to be available for the foreseeable future.\nBUILDERS HARDWARE\nThe Builders Hardware Division consists of Robert Skeels & Company (\"Skeels\"), a wholesale distributor of builders hardware products, including lock sets and locksmith supplies. During 1995, Skeels' net sales were $5,602,000, or 2% of the Company's total net sales, as compared with $5,438,000 and 2% for 1994. The operating profit of the division during 1995 was $297,000, or 1% of the Company's total operating profit, compared with $392,000 and 1% for 1994. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and \"Business Segment and Geographical Information\" on pages 16 through 19 and 29 through 31, respectively, of the 1995 Annual Report, which are hereby incorporated by reference.\nSkeels' main facility is located in Compton, California. In addition, Skeels has a leased satellite sales facility located in Fullerton, California.\nSkeels supplies approximately 35,000 items to retail hardware, locksmith and lumberyard outlets in southern California, Arizona, and Nevada. Skeels also sells directly to large institutional customers. Most of Skeels' sales are derived from replacement items used by industry, institutions and in-home remodeling and repair.\nSkeels has been a distributor of Schlage lock products since 1931. Skeels also distributes other well-known brands such as Lawrence, Kwikset and Master. Skeels' distributorship arrangements generally are cancelable by the manufacturers without cause.\nOTHER FACTORS AFFECTING THE BUSINESS\nCOMPETITION\nAll phases of the Company's business have been and remain highly competitive. The Company's products and services compete with those of numerous companies, some of which have financial\nresources greater than those of the Company. Sales by the Automotive Components Division are in part related to the sales of vehicles by its OEM customers.\nPrecision has a large number of competitors in the market for static and dynamic sealing products, some of which competitors are substantially larger than Precision. The markets in which Precision competes are also sensitive to changes in price. Requests for price reductions are not uncommon. Precision attempts to work with its customers to identify ways to lower costs and prices. Precision focuses on high technology, high quality sealing devices and has made significant investments in advanced equipment and other means to raise productivity. In 1995, Precision invested approximately $5 million in new production equipment, which expanded its production capacity primarily at its Lebanon, Tennessee and Virginia facilities. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\" Precision's major focus is to be the low cost producer of superior quality products within its industry. Precision believes it must expand into additional areas of sealing technology in order to continue to be an effective competitor.\nWynn's Climate Systems has a number of competitors that manufacture air conditioning systems and components, some of which competitors are substantially larger than Wynn's Climate Systems. Automotive air conditioning manufacturers compete in the areas of price, service, warranty and product performance. Wynn's Climate Systems' focus is to manufacture high quality products. Over time there has been a gradual increase in the number of air conditioning systems installed on the automotive factory line. The increase in the number of factory-installed systems has reduced the size of the market for aftermarket sales.\nCompetition with respect to Wynn Oil's specialty chemical products consists principally of other automotive aftermarket chemical and industrial fluid companies. Some major oil companies also market their own additive products through retail service stations, independent dealers and garages. Certain national retailers and car manufacturers market private label brands of specialty chemical products. Wynn Oil's DU-ALL-Registered Trademark- antifreeze recycling equipment and chemicals compete against other antifreeze recycling processes, some of which also have been approved by General Motors and Chrysler. Similarly, Wynn Oil's TRANSERVE-TM- transmission fluid flush and fill equipment and chemicals compete against other transmission flush equipment. The principal methods of competition vary by geographic locale and by the relative market share held by the Company compared to other competitors.\nSkeels continues to face intense price competition from numerous cash-and-carry discount retailers. Skeels also has observed some manufacturers selling directly to retailers to increase volume.\nKEY CUSTOMERS\nSales to General Motors constituted approximately 10.1% of the total net sales of the Company in 1995. No other customer represented more than 10% of total net sales of the Company in 1995.\nGOVERNMENT REGULATIONS\nThe number of governmental rules and regulations affecting the Company's business and products continues to increase.\nWynn Oil markets the Wynn's Product Warranty program in approximately forty-four states in the U.S. and also in Canada. Questions have been raised by certain state insurance regulators as to whether the product warranty that accompanies the kit is in the nature of insurance. Wynn Oil attempts to resolve these questions to the satisfaction of each state insurance regulator. At times, it has elected to withdraw the Wynn's Product Warranty program from certain states. No assurance can be given that governmental regulations will not significantly affect the marketing of the Wynn's Product Warranty in the United States or other countries in the future. Over the past few years, sales of the Wynn's Product Warranty have become an increasingly important element of Wynn Oil's domestic business.\nENVIRONMENTAL MATTERS\nThe Company has used various substances in its past and present manufacturing operations which have been or may be deemed to be hazardous, and the extent of its potential liability, if any, under applicable environmental statutes, rules, regulations and case law is unclear. Under the Comprehensive Environmental Response, Compensation and Liability Act, as amended (\"CERCLA\"), a responsible party may be jointly liable for the entire cost of remediating contaminated property even if it contributed only a small portion of the total contamination. At December 31, 1995, the Company had consolidated accrued reserves of approximately $4.8 million relating to environmental matters. Although the effect of resolution of environmental matters on results of operations cannot be predicted, the Company believes, based on information presently known to the Company, that any liability that may result from environmental matters in excess of accrued reserves should not materially affect the Company's financial position or annual results of operations or cash flows. See Note 11 of \"Notes to Consolidated Financial Statements\" on page 28 of the 1995 Annual Report, which is hereby incorporated by reference.\nAll potentially significant environmental matters presently known to the Company are described below.\n(a) In 1988, the Los Angeles County Department of Health Services (the \"LADHS\") directed Wynn Oil to conduct a site assessment of the Wynn Oil manufacturing facility in Azusa, California (the \"Azusa Facility\"). In April 1989, regulatory jurisdiction over this matter was transferred from the LADHS to the California Regional Water Quality Control Board- Los Angeles Region (the \"RWQCB\"). In July 1990, Wynn Oil received a general notice letter from the United States Environmental Protection Agency (the \"EPA\") stating that it may be a potentially responsible party (\"PRP\") with respect to the San Gabriel Valley, California Superfund Sites regional groundwater problem. The EPA letter included an information request pursuant to Section 104(e) of CERCLA to which Wynn Oil responded within the specified time period.\nSince October 1989, Wynn Oil and its consultants have been working with representatives of the RWQCB to conduct a comprehensive site assessment of the Azusa Facility. In January 1992, at the request of the EPA and the RWQCB, Wynn Oil agreed to expand the scope of its investigation of the Azusa Facility to include three soil gas monitoring wells and one groundwater monitoring well. The monitoring wells were installed in 1992, and the results of ongoing sampling have been reported to the RWQCB. In the fall of 1993, the\nRWQCB requested Wynn Oil to install a groundwater monitoring well located upgradient of the existing Azusa Facility well. Wynn Oil reached agreement with another PRP located on an approximately upgradient property. The agreement provided for this PRP to install the groundwater monitoring well on its property and for Wynn Oil to share the costs of installation. The well was installed, and the RWQCB has accepted this well as meeting its request for Wynn Oil to install a well upgradient of the Azusa Facility. Wynn Oil continues to monitor the well located at the Azusa Facility in accordance with RWQCB requirements. During 1995, the RWQCB sent letters to Wynn Oil and certain other facilities in the general area asking them to submit remedial action plans for vadose zone remediation at their respective facilities. In December 1995, Wynn Oil's consultants responded to the RWQCB stating that such remediation was neither warranted nor cost effective at the Azusa Facility. Wynn Oil may at some later date elect or be required to take specific remedial actions with respect to soils conditions at the Azusa Facility.\nIn March 1994, the EPA issued its Record of Decision (\"ROD\") with respect to the Baldwin Park Operable Unit (\"BPOU\") of the San Gabriel Valley Superfund Sites. The Azusa Facility is located within the BPOU. In the ROD, the EPA selected an interim groundwater remedial action (the \"Interim Remedial Action\") for the BPOU that is estimated to cost in the range of $100 to $120 million. Wynn Oil has joined with approximately ten other companies, each of which has been identified as a PRP in EPA General Notice letters, to form the BPOU Steering Committee (\"Steering Committee\"). The Steering Committee has been negotiating with several local, state and federal entities regarding implementation of the ROD with partial funding from the Metropolitan Water District Groundwater Recovery Program and funds from the federal Bureau of Reclamation available for conjunctive use projects in the San Gabriel Basin. This approach is generally known as the \"Consensus Plan.\" If agreement is reached among these entities, the PRP costs of implementing the ROD reportedly could be reduced to approximately $35 million, excluding any of EPA's past costs. However, no assurance can be given that such agreements will be reached or the Consensus Plan will be implemented.\nIn January 1995, the EPA issued \"pre-Special Notice\" letters to sixteen companies, including Wynn Oil, requesting them to install up to ten regional monitoring wells and complete other pre-design work needed before the remedy can be implemented (the \"Pre-Design Work\"). The Steering Committee members have funded the costs of the Pre-Design Work on an interim basis subject to reallocation among all of the PRPs which ultimately share the costs of implementing the ROD. The cost of the Pre-Design Work paid by the Steering Committee members was approximately $2 million. In recognition of the Steering Committee's commitment to perform the Pre-Design Work, the EPA has deferred issuance of Special Notice letters for implementation of the ROD. The EPA has indicated that it considers Wynn Oil to be one of the four largest contributors to the regional groundwater problem in the BPOU. Wynn Oil disagrees with the views expressed by the EPA.\nThe Steering Committee has begun the process of allocating among its members the cost for implementing the ROD. There is no assurance that a negotiated allocation of responsibility will be reached. Wynn Oil's ultimate share of the total remedial costs cannot be estimated with certainty at this time. In establishing appropriate reserves for this matter, Registrant has assumed\nthat the total PRP costs of implementing the ROD plus the Steering Committee's share of EPA's past costs, if any, will be in the range of $30 to $40 million.\n(b) In February 1992, an inactive subsidiary of the Company received a letter from the then lessee (the \"Lessee\") of a parcel of real property in Compton, California formerly leased by the subsidiary. The letter stated that the Lessee had discovered soil contamination at the site and asserted that the subsidiary may be liable for the cost of clean-up. The letter stated that the Lessee was investigating the nature and extent of the soil contamination. In July 1993, the Company received a letter from the owner of the real property (the \"Property Owner\") stating that the Property Owner had asserted a claim against the Lessee to pay the cost of remediation and that the Property Owner may assert a claim against the Company. In February 1995, the Property Owner filed a lawsuit in federal court against the Lessee and its principal, the inactive subsidiary, Wynn's International, Inc. and Wynn Oil. The complaint alleges that the defendants stored solid and hazardous wastes at the site and that the storage devices for the wastes leaked, causing contamination of the soils and groundwater. The complaint seeks relief under CERCLA, the Resource Conservation Recovery Act of 1976 and common law, including an unspecified amount of damages and an injunction to compel the defendants to clean up the property. After the Wynn's parties were served with the lawsuit in June 1995, the parties filed various cross claims and counter claims against each other. In September 1995, all parties met to review the possibility of an early settlement. As a result of this meeting, the Wynn's parties and the Property Owner agreed to fund equally a joint investigation of the site, with each party being responsible for half of the cost of the investigation. In exchange, the Property Owner stayed the litigation pending completion of the joint investigation. As of March 13, 1996, the Company had not received the results of the investigation. The Company does not know the extent of the contamination or the estimated cost of cleanup at this site.\n(c) In January 1991, Wynn's Climate Systems received a letter from the Texas Natural Resources Conservation Commission (the \"TNRCC\") alleging that soil adjacent to one of its leased manufacturing facilities was contaminated with hazardous substances. The TNRCC directed Wynn's Climate Systems to determine the extent of such contamination and then take appropriate remedial measures. Wynn's Climate Systems retained environmental consultants to conduct soil sampling and otherwise comply with the directive of the TNRCC. Performance of this work was completed in late 1991. Wynn's Climate Systems submitted a copy of the report of its consultants to the TNRCC in February 1992. In 1994, Wynn's Climate Systems received a request from the TNRCC for additional information. Wynn's Climate Systems furnished the requested information to the TNRCC. Wynn's Climate Systems also voluntarily conducted additional investigation activities at this facility. Wynn's Climate Systems ceased leasing this facility at the end of 1994. Since the expiration of the lease, Wynn's Climate Systems has been attempting to obtain written consent from the property owner to gain access to the facility for purposes of continuing the additional investigation. As of March 13, 1996, Wynn's Climate Systems had not yet obtained such consent and had so informed the TNRCC.\n(d) In May 1989, Wynn's Climate Systems received notice that it had been identified as a generator of hazardous waste that had been shipped to the Chemical Recycling, Inc. (\"CRI\") site in Wylie, Texas (the \"CRI Site\") for treatment. CRI was engaged in the business of\nrecycling and reclaiming spent solvents and other hazardous wastes at the CRI Site until it ceased operations in February 1989. Wynn's Climate Systems is one of approximately 100 hazardous waste generators that have been identified as potentially responsible parties for the CRI Site. A PRP Steering Committee (the \"Committee\") was formed to negotiate with the EPA on behalf of its members an agreement to take remedial measures voluntarily at the CRI Site. As of March 1996, approximately 85 PRPs, including Wynn's Climate Systems, had agreed to participate in the Committee for the CRI Site. PRPs that have agreed to participate in the Committee have signed Consent Agreements with the EPA with respect to the CRI Site. Remediation efforts have begun at the CRI Site under the guidance of the Committee. No significant developments occurred in 1995. As of March 1996, Wynn's Climate Systems' proportionate share of the total volume of waste contributed to the CRI Site by Committee members was approximately two-tenths of one percent (0.2%).\nThe foregoing \"Environmental Matters\" section and Note 11 of \"Notes to Consolidated Financial Statements\" on page 28 of the 1995 Annual Report (which is incorporated by reference herein) contain various \"forward looking statements\" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which represent the Company's expectations or beliefs concerning future events, including statements regarding estimates of the Company's liabilities associated with identified environmental matters and the likelihood that any liability in excess of reserves for such matters will not materially affect the Company's financial position or annual results of operations or cash flows. The Company cautions that these statements are further qualified by important factors that could cause actual results to differ materially from those in the forward looking statements, including, without limitation, the following: (i) the actual nature and extent of the contamination, (ii) the remedial action selected, (iii) the cleanup level required, (iv) changes in regulatory requirements, (v) with respect to the San Gabriel Valley Superfund Sites, the PRP costs of implementing the ROD and the amount of EPA past costs required to be paid by the PRPs, (vi) the ability of other responsible parties, if any, to pay their respective shares, and (vii) any insurance recoveries. Results actually achieved thus may differ materially from expected results included in these and any other forward looking statements contained herein.\nFOREIGN CURRENCY FLUCTUATIONS\nIn 1995, the United States dollar generally decreased in value compared to 1994 in the currencies of most countries in which the Company does business. This decrease in the value of the U.S. dollar caused aggregate foreign sales and operating profit to be translated into higher dollar values than what would have been reported if exchange rates had remained the same as in 1994. In 1995, the Equity Adjustment from Foreign Currency Translation account on the Consolidated Balance Sheet increased by $1,068,000, which caused a corresponding increase in Total Stockholders' Equity. See \"Foreign Operations.\"\nPATENTS AND TRADEMARKS\nThe Company holds a number of patents and trademarks which are used in the operation of its businesses. There is no known challenge to the Company's rights under any material patents or material trademarks. In 1989, Wynn Oil filed a lawsuit in the federal district court in Detroit, Michigan against another company and its principal stockholder for infringement of Wynn Oil's X-TEND-Registered Trademark- trademark. In February 1994, the court awarded Wynn Oil $2.0 million in damages. Additionally, in May 1994, the court awarded Wynn Oil approximately $1.2 million in prejudgment interest and attorneys' fees. Defendants filed a timely appeal of the District Court ruling to the United States Court of Appeals for the Sixth Circuit, but did not file the required bond to stay execution of the judgment. Prior to Wynn Oil executing upon the defendants' assets, the defendants filed Chapter 11 bankruptcy proceedings in late 1994 in Florida. The bankruptcy filing resulted in an automatic stay of all pending collection efforts. In 1995, the Court of Appeals determined that the District Court had erred in part in determining the damage award and remanded the case to the District Court for a final determination of the damage award. The District Court subsequently awarded Wynn Oil damages and attorneys' fees of approximately $1.8 million. Wynn Oil and its counsel are working through the bankruptcy process to maximize Wynn Oil's ultimate recovery against the defendants. See \"Legal Proceedings.\"\nSEASONALITY OF THE BUSINESS\nAlthough sales at the Company's divisions are somewhat seasonal, the consolidated results of operations generally do not reflect seasonality.\nRESEARCH AND DEVELOPMENT\nPrecision maintains research and engineering facilities in Tennessee, Virginia and Canada. Research and development is an important aspect of Precision's business as Precision has developed and continues to develop numerous specialized compounds to meet the specific needs of its various customers. Precision also has technical centers in Tennessee, Virginia and Canada to design sealing solutions, construct prototype products and to perform comprehensive testing of materials and products. Precision maintains extensive research, development and engineering facilities to provide outstanding service to its customers.\nWynn Oil maintains research and product performance centers in California, Belgium, France and South Africa. The main activities of the research staff are the development of new specialty chemicals and other products, improvement of existing products, including finding new applications for their use, evaluation of competitive products and performance of quality control procedures.\nFOREIGN OPERATIONS\nThe following table shows sales to foreign customers for the years 1995, 1994 and 1993:\nConsolidated operating results are reported in United States dollars. Because the Company's foreign subsidiaries conduct operations in the currencies of the countries in which they are based, all financial statements of the foreign subsidiaries must be translated into United States dollars. As the value of the United States dollar increases or decreases relative to these foreign currencies, the United States dollar value of items on the financial statements of the foreign subsidiaries is reduced or increased, respectively. Consequently, changes in dollar sales of the foreign subsidiaries from year to year are not necessarily indicative of changes in actual sales recorded in local currency. See Note 3 and Note 14 of \"Notes to Consolidated Financial Statements\" on page 25 and 29 through 31, respectively, of the 1995 Annual Report, which are hereby incorporated by reference.\nThe value of any foreign currency relative to the United States dollar is affected by a variety of factors. It is exceedingly difficult to predict what such value may be at any time in the future. Consequently, the ability of the Company to control the impact of foreign currency fluctuations is limited.\nA material portion of the Company's business is conducted outside the United States. Consequently, the Company's ability to continue such operations or maintain their profitability is to some extent subject to control and regulation by the United States government and foreign governments.\nEMPLOYEES\nAt December 31, 1995, the Company had 2,023 employees.\nA majority of the production and maintenance employees at the Lebanon, Tennessee plant of Precision are represented by a local lodge of the International Association of Machinists and Aerospace Workers. The collective bargaining agreement for this facility will expire in April 1998. The production and maintenance employees at the Orillia, Ontario, Canada plant of Precision are represented by a local unit of the United Rubber, Cork, Linoleum and Plastic Workers of America. The collective bargaining agreement for the unit will expire in February 1997.\nA majority of the production and maintenance employees at the Lynchburg, Virginia plant of Dynamic Seals, Inc., an affiliate of Precision, are represented by a local of the International Chemical Workers Union. The collective bargaining agreement for this facility expires in February 1999.\nThe Company considers its relations with its employees to be good.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe executive officers of the Company, who are appointed annually, are as follows:\nThe principal occupations of Messrs. Carroll, Schlosser and Gibbons for the past five years have been their current respective positions with the Company. There is no arrangement or understanding between any executive officer and any other person pursuant to which he was selected as an officer. There is no family relationship between any executive officers of the Company.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe following is a summary description of the Company's facilities, all of which the Company believes to be of adequate construction, as of March 13, 1996:\nThe Company believes that all of its operating properties are adequately maintained, fully utilized and suitable for the purposes for which they are used. With respect to those leases expiring in 1996 and 1997, the Company believes it will be able to renew such leases on acceptable terms or find suitable alternative facilities.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nVarious claims and actions, considered normal to Registrant's business, have been asserted and are pending against Registrant and its subsidiaries. Registrant believes that such claims and actions should not have any material adverse effect upon the results of operations or the financial position of Registrant based on information presently known to Registrant.\nIn February 1994, the United States District Court for the Eastern District of Michigan, Southern Division, in the case of WYNN OIL COMPANY V. AMERICAN WAY SERVICE CORPORATION AND THOMAS A. WARMUS, Case No. 89-CV-71777-DT, awarded Wynn Oil approximately $2.0 million in damages in an action brought by Wynn Oil in 1989 asserting trademark infringement by the defendants. In May 1994, the court awarded Wynn Oil approximately $1.2 million in prejudgment interest and attorneys' fees. Subsequently, the defendants filed a timely appeal to the United States Court of Appeals for the Sixth Circuit, but did not file a bond to stay execution of the judgment. Between May and December 1994, Wynn Oil sought out assets of the defendants to satisfy the judgment. Prior to Wynn Oil executing upon the defendants' assets, the defendants filed Chapter 11 bankruptcy proceedings in late 1994 in Florida. The bankruptcy filing resulted in an automatic stay of all pending collection efforts. In July 1995, the Court of Appeals upheld the District Court's award of damages and attorneys' fees, but held that the District Court erred when it awarded (i) both investment income and prejudgment interest and (ii) reasonable investment income instead of actual investment income. The Court of Appeals remanded the case to the District Court for a final determination of the damage award. In November 1995, the District Court awarded Wynn Oil damages and attorneys' fees of $1.8 million. The District Court also ordered the defendants to show the investment income earned by them during the period in question, which, if any, the court indicated it would award to Wynn Oil. The bankruptcy court has lifted the automatic stay for purposes of determining the applicable investment income and finalizing Wynn Oil's judgment. In 1995, the bankruptcy court appointed separate trustees to take control of the assets of both defendants. The bankruptcy court also affirmed that Wynn Oil had a liquidated claim in the amount of approximately $1.8 million. Wynn Oil and its counsel are continuing to work through the bankruptcy process to maximize Wynn Oil's ultimate recovery against the defendants. No portion of the judgment has been included in the results of operations of the Company and all of Registrant's costs relating to this case have been expensed as incurred.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThere were no matters submitted to a vote of security holders during the fourth quarter of 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe information appearing under \"Cash Dividends and Common Stock Price Per Share: 1994-1995\" on page 32 of the 1995 Annual Report and \"Number of Stockholders\" and \"Stock Exchange Listing\" on page 33 of the 1995 Annual Report is hereby incorporated by reference.\nOn February 14, 1996, the Board of Directors of Registrant declared a cash dividend of $0.10 per share payable March 29, 1996 to stockholders of record on March 13, 1996.\nRegistrant currently expects that it will continue to pay dividends in the future, in amounts per share at least comparable to dividends paid during the past two years.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nIncorporated by reference from page 15 of the 1995 Annual Report.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nIncorporated by reference from the 1995 Annual Report, pages 16 through 19.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nConsolidated financial statements of Registrant at December 31, 1995 and 1994 and for each of the three years in the period ended December 31, 1995 (including unaudited supplementary data) and the report of independent auditors thereon are incorporated by reference from the 1995 Annual Report, pages 20 through 32.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information appearing under \"Election of Directors\" on pages 4 and 5 of Registrant's definitive proxy statement for the Annual Meeting of Stockholders to be held on May 8, 1996 (\"Registrant's 1996 Proxy Statement\") is hereby incorporated by reference. A list of executive officers of Registrant is provided in Item 1 of Part I of this report.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information appearing under \"Board of Directors and Committees of the Board--Compensation of Directors\" and \"--Compensation Committee Interlocks and Insider Participation,\" and \"Executive Compensation\" on pages 6 through 10 of Registrant's 1996 Proxy\nStatement is hereby incorporated by reference. The Report of the Compensation Committee on pages 11 and 12 of Registrant's 1996 Proxy Statement shall not be deemed to be incorporated by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information appearing under \"Security Ownership of Certain Beneficial Owners and Management\" on pages 2 and 3 of Registrant's 1996 Proxy Statement is hereby incorporated by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information appearing under \"Election of Directors--Certain Relationships and Related Transactions\" on page 5 of Registrant's 1996 Proxy Statement is hereby incorporated by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) 1. See Index to Financial Statements and Financial Statement Schedules Covered By Report of Independent Auditors.\n2. See Index to Financial Statements and Financial Statement Schedules Covered By Report of Independent Auditors.\n3. See Index to Exhibits.\n(b) No Reports on Form 8-K were filed by Registrant during the last quarter of 1995.\nWYNN'S INTERNATIONAL, INC.\nINDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES COVERED BY REPORT OF INDEPENDENT AUDITORS\n(ITEM 14(a))\nAll other schedules are omitted since the required information is not present or is not present in amounts sufficient to require submission of the schedule, or because the information required is included in the consolidated financial statements, including the notes thereto.\nThe consolidated financial statements listed in the above index, which are included in the 1995 Annual Report, are hereby incorporated by reference. With the exceptions of the pages listed in the above index and the items referred to in Items 1, 5, 6, 7 and 8, the 1995 Annual Report is not deemed to be filed as part of this report.\nWYNN'S INTERNATIONAL, INC.\nSCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS\nTHREE YEARS ENDED DECEMBER 31, 1995\n____________________\n(1) Represents accounts written off against the reserve.\nPOWER OF ATTORNEY\nEach person whose signature appears below hereby authorizes each of James Carroll, Seymour A. Schlosser and Gregg M. Gibbons as attorney-in-fact to sign on his behalf, individually and in each capacity stated below, and to file all amendments and\/or supplements to this Annual Report on Form 10-K.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on March 25, 1996.\nWYNN'S INTERNATIONAL, INC.\nBy \/S\/ JAMES CARROLL ------------------------------------------- James Carroll President Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nDATE\nMarch 25, 1996 By \/S\/ WESLEY E. BELLWOOD ------------------------------------------- Wesley E. Bellwood Chairman of the Board\nMarch 25, 1996 By \/S\/ JAMES CARROLL ------------------------------------------- James Carroll President Chief Executive Officer Director\nDATE\nMarch 25, 1996 By \/S\/ SEYMOUR A. SCHLOSSER ------------------------------------------- Seymour A. Schlosser Vice President-Finance (Principal Financial and Accounting Officer)\nMarch 25, 1996 By \/S\/ BARTON BEEK ------------------------------------------- Barton Beek Director\nMarch 25, 1996 By \/S\/ JOHN D. BORIE ------------------------------------------- John D. Borie Director\nMarch 25, 1996 By \/S\/ BRYAN L. HERRMANN ------------------------------------------- Bryan L. Herrmann Director\nMarch 25, 1996 By \/S\/ ROBERT H. HOOD, JR. ------------------------------------------- Robert H. Hood, Jr. Director\nMarch 25, 1996 By \/S\/ RICHARD L. NELSON ------------------------------------------- Richard L. Nelson Director\nMarch 25, 1996 By \/S\/ JAMES D. WOODS ------------------------------------------- James D. Woods Director\nWYNN'S INTERNATIONAL, INC.\nINDEX TO EXHIBITS (Item 14(a))\nExhibit Number Description - ------- -----------\n3.1 Certificate of Incorporation, as amended, of Registrant (incorporated herein by reference to Exhibit 3.1 to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1987)\n3.2 Certificate of Designations of Junior Participating Preferred Stock (incorporated herein by reference to Exhibit 4.2 to Registrant's Report on Form 8-K dated March 3, 1989)\n3.3 By-Laws, as amended, of Registrant (incorporated herein by reference to Exhibit 3.3 to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1993)\n4.1 Note Agreement, dated March 5, 1986, between Registrant and Metropolitan Life Insurance Company (incorporated herein by reference to Exhibit 4.1 to Registrant's Report on Form 8-K dated March 5, 1986)\n4.2 Shareholder Rights Agreement, dated as of March 3, 1989, between Registrant and First Interstate Bank of California, as Rights Agent (incorporated by reference to Exhibit 4.1 to Registrant's Report on Form 8-K dated March 3, 1989)\n4.3 Amendment No. 1 to Shareholder Rights Agreement, dated June 11, 1990 (incorporated by reference to Exhibit 28.2 to Registrant's Report on Form 8-K dated June 11, 1990)\n10.1 Employment Agreement, dated February 15, 1995, between Registrant and James Carroll (incorporated by reference to Exhibit 10.1 to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1994)\n10.2 Employment Agreement, dated January 1, 1995, between Registrant and Gregg M. Gibbons (incorporated by reference to Exhibit 10.3 to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1994)\nExhibit Number Description - ------- -----------\n10.3 Employment Agreement, dated January 1, 1995, between Registrant and Seymour A. Schlosser (incorporated by reference to Exhibit 10.3 to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1994)\n10.4 Wynn's International, Inc. Amended and Restated 1980 Stock Option and Appreciation Rights Plan (incorporated herein by reference to Exhibit 4.1 to Registrant's Registration Statement on Form S-8, Registration No. 2-68157)\n10.5 Wynn's International, Inc. Amended and Restated 1982 Incentive Stock Option Plan (incorporated herein by reference to Exhibit 4.2 to Registrant's Registration Statement on Form S-8, Registration No. 2-68157)\n10.6 Wynn's International, Inc. Stock-Based Incentive Award Plan (incorporated herein by reference to Exhibit 28.1 to Registrant's Registration Statement on Form S-8, Registration No. 33-30296 and Exhibit 28.2 to Registrant's Registration Statement on Form S-8, Registration No. 33-64090)\n10.7 Wynn's International, Inc. 1996 Corporate Management Incentive Plan\n10.8 Deferred Compensation Agreement, dated November 30, 1990, between Registrant and James Carroll (incorporated herein by reference to Exhibit 10.9 to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1990)\n10.9 Deferred Compensation Agreement, dated February 15, 1993, between Registrant and James Carroll (incorporated herein by reference to Exhibit 10.11 to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1992)\n10.10 Deferred Compensation Agreement, dated April 23, 1993, between Registrant and James Carroll (incorporated herein by reference to Exhibit 10.10 to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1993)\n10.11 Deferred Compensation Agreement, dated August 5, 1994, between Registrant and James Carroll (incorporated herein by reference to Exhibit 10.11 to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1994)\nExhibit Number Description - ------- -----------\n10.12 Deferred Compensation Agreement, dated November 21, 1995, between Registrant and James Carroll\n10.13 Deferred Compensation Agreement, dated November 28, 1995, between Registrant and James Carroll\n10.14 Form of Indemnification Agreement between Registrant and a director of Registrant (incorporated herein by reference to Exhibit 10.11 to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1993)\n10.15 Wynn's International, Inc. Non-Employee Directors' Stock Option Plan (incorporated herein by reference to Exhibit C of Registrant's Definitive Proxy Statement relating to its Annual Meeting of Stockholders held on May 11, 1994, filed with the Commission on March 25, 1994)\n11 Computation of Net Income Per Common Share -- Primary and Assuming Full Dilution\n13 Portions of Registrant's Annual Report to Stockholders for the fiscal year ended December 31, 1995 that have been expressly incorporated by reference as a part of this Annual Report on Form 10-K\n21 Subsidiaries of Registrant\n23 Consent of Independent Auditors\n27 Financial Data Schedule","section_15":""}
{"filename":"100320_1995.txt","cik":"100320","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nConsumers Financial Corporation (the \"Company\") is an insurance holding company which, through its subsidiaries, is a leading provider of credit life and credit disability insurance in the Middle Atlantic region of the United States. The Company also owns and administers a small block of universal life insurance business, but no longer markets those products. The insurance subsidiaries are licensed in 33 states and the District of Columbia and currently conduct the majority of their business in the states of Pennsylvania, Delaware, Maryland, Nebraska, Ohio and Virginia. Credit insurance, which accounted for $33.1 million, or 85%, of the Company's total premium revenues in 1995, is marketed primarily through approximately 900 automobile dealers. In connection with its credit insurance operations, the Company also markets, as an agent, an automobile extended service warranty contract and, to a lesser extent, reinsures certain underwriting risks on warranty business. Universal life insurance, which accounted for $5.1 million of premium and policy charge revenues, or 13% of the Company's total premiums and policy charges in 1995, was marketed, until 1992, through general agents, personal producing general agents and independent brokers. Additional information regarding the termination of marketing activities in the Individual Life Division and the sale of the majority of the Division s in-force business appears below under \"Operations.\"\nThe Company, through its wholly-owned subsidiary, Interstate Auto Auction, Inc. (\"Interstate\"), conducts wholesale and retail automobile auctions of used vehicles for automobile dealers, banks and leasing companies.\nThe Company was formed in 1966 as 20th Century Corporation (a Pennsylvania business corporation) and adopted its present name on May 30, 1980. The Company operates through its wholly-owned subsidiaries, principally Consumers Life Insurance Company (a Delaware life insurance company), Consumers Car Care Corporation (a Pennsylvania business corporation) and Interstate Auto Auction, Inc. (a Pennsylvania business corporation). Consumers Life Insurance Company of North Carolina (a North Carolina life insurance company) and Investors Fidelity Life Assurance Corp. (an Ohio life insurance company) are subsidiaries of Consumers Life Insurance Company.\nThe term \"Company\" when used herein refers to Consumers Financial Corporation and its subsidiaries unless the context requires otherwise. The Company's executive offices are located at 1200 Camp Hill By-Pass, Camp Hill, Pennsylvania 17011. Its telephone numbers are (717) 761-4230 and (800) 933- 3018.\nThe Company operates in three industry segments: the Automotive Resource Division, which markets credit insurance and other products and services to its automobile dealer customers, the Individual Life Insurance Division and the Auto Auction Division. These segments exclude the corporate activities of Consumers Financial Corporation which are insignificant in relation to the three segments. The Automotive Resource segment consists principally of credit life and credit disability insurance which is sold primarily through automobile dealers and, to a limited extent, through banks and other financial institutions. This segment also generates commission revenues on sales of automobile warranty contracts and revenues from other related products and services. The Individual Life segment emphasized the sale of universal life products which were introduced in 1985, and had previously marketed whole- life, term, endowment and annuity products. The Auto Auction segment operates an automobile auction of used vehicles for automobile dealers, banks and leasing companies.\nIn March of 1992, the Company announced its decision to terminate the operations of its Individual Life Insurance Division. The phase-out plan included discontinuing the sale of insurance policies and the sale of the Company s existing block of individual business. Effective October 1, 1992, the Company sold its block of whole life, term and annuity products to an unaffiliated insurer but continued to administer the block of universal life policies. As of December 31, 1994, the Company sold its in-force block of direct universal life insurance business to an unaffiliated insurer. As part of that transaction, the Company irrevocably assigned to the same insurer, all of its right, title and interest to a block of universal life business which had been assumed previously from another unaffiliated insurer. The Company will continue to administer these blocks of universal life business until May 1, 1995 unless the arrangement is terminated earlier by the reinsurer. The Company continues to own and administer an assumed block of universal life business issued by an unaffiliated insurer.\nIn March of 1996, the Company announced that it had retained a financial advisor to assist management in evaluating various alternatives to best serve the interests of its shareholders. The recent losses incurred in the Company's core credit insurance operation have lead to this action in order to preserve shareholder value. The various alternatives being considered include the sale of the insurance operations (either the existing business and the marketing organization or only the marketing organization), the sale of the auto auction business, the sale of the entire Company or a combination of the Company with another organization. Bids are currently being solicited for both the insurance operations and the auto auction business. There can be no assurance that any one of these alternatives can be completed in 1996; however, the Company believes that it is reasonably possible that one of the alternatives outlined above may be consummated in 1996.\nThe following table sets forth for the periods indicated the contribution to revenues, which are comprised of premiums written (before reinsurance ceded), policy charges, net investment income, realized investment gains and other revenues, of each of the product lines within the Company's three industry segments:\n(1) Includes $3.2 million in policy charge revenues which relate to business which was 100% coinsured to another insurer as of December 31, 1994. The coinsurance arrangement will be replaced by an assumption and novation agreement following approval by the appropriate regulatory authorities.\nThe following table sets forth for the periods indicated the contribution to pre-tax income (loss) of each of the product lines within the Company's three industry segments:\nThe following table sets forth certain information pertaining to the Company's industry segments:\n(1) See footnote on page 4 of this Form 10-K.\nAdditional segment information is contained in Note 18 of the Notes to Consolidated Financial Statements appearing elsewhere in this Form 10-K.\nOPERATIONS\nThe Company's principal subsidiaries, which are engaged in the credit insurance and, until 1992, the individual life insurance business, are Consumers Life Insurance Company, Consumers Life Insurance Company of North Carolina and Investors Fidelity Life Assurance Corp. Together these companies are licensed in 33 states and the District of Columbia. As noted in Item I. - General, the Company disposed of a significant portion of its individual life business in October 1992 and December 1994. The following table sets forth the amounts of life insurance in force at the dates indicated:\nFor information concerning future policy benefits and unearned premiums, see Notes 1 and 9 of the Notes to Consolidated Financial Statements appearing elsewhere in this Form 10-K. Reserves for life insurance are developed using generally accepted actuarial principles which are widely recognized in the insurance industry. Methods of developing credit disability insurance claims reserves vary widely in the industry. The Company's methods of establishing credit disability claims reserves are based on its prior claims experience. During the last three years, the difference between actual claims on credit disability policies and amounts reserved has not been significant.\nAutomotive Resource Division\nThe Company sells credit insurance in connection with consumer credit transactions, substantially all of which are automobile purchases. Credit life insurance provides funds in the event of the insured's death for payment of a specified loan or loans owed by the insured. Similarly, credit disability insurance provides for the periodic paydown of such loans during the term of the insured's disability. In most cases, the entire premium is paid at the time the insurance is issued. Premiums collected are remitted to the Company net of commissions. Credit insurance generally is written on a decreasing term basis with the policy benefit initially being the full amount of the loan and thereafter decreasing in amounts corresponding to the repayment schedule. The primary beneficiary under credit insurance is the lender, with any proceeds in excess of the unpaid portion of the loan payable to a named second beneficiary or the insured's estate.\nThe Company underwrites all of its credit insurance certificates as to certain health matters including cancer, heart disease, AIDS and AIDS related complex (ARC). The Company also establishes maximum age limits beyond which individuals are not eligible for coverage. The Company believes that its comprehensive training programs increase the ability of its automobile dealer accounts to sell insurance to a significant percentage of automobile purchasers, which creates a larger and more diverse pool of insureds, thereby reducing its mortality and morbidity risk. The Company typically experiences a higher level of claims on disability policies during the first quarter of each year.\nThe Company has concentrated credit insurance sales efforts mainly in seven states, and was ranked for 1994 (the most recent year for which statistics are available) by A.M. Best Company according to the volume of direct written premiums as shown in the following table:\nThe Company's success in selling credit insurance is dependent upon establishing and maintaining favorable relationships with automobile dealers. To accomplish these goals, the Company provides finance and insurance training programs which assist dealers in arranging financing and increasing sales of credit insurance; it offers certain dealers the opportunity to participate in profits of the credit insurance business generated by them through reinsurance arrangements; and it provides administrative support and claims handling procedures to dealers. The Company also seeks the endorsement of local and state automobile dealer and other credit insurance producing member associations. To assist the Company in developing dealer relationships, the Company employs two home office sales managers, three finance and insurance training specialists and 17 salaried field representatives who solicit and service accounts. The Company's dealer relationships may be terminated by the Company or the dealers at any time without penalty. In addition to its direct sales efforts, the Company also purchases closed blocks of credit insurance from unaffiliated companies and administers the purchased business until all coverages expire.\nThe credit insurance business is the major source of the Company's revenues and, until 1991, provided the majority of its profits as well. As indicated above, approximately 85% of the Company's premium revenues during 1995 were derived from its credit insurance business. Automobile sales account for substantially all of the credit insurance sold by the Company, and have been and will continue to be affected, directly and indirectly, by automobile prices, interest rates, the availability of consumer credit and general economic conditions. The credit insurance industry and the Company s credit business have both been adversely affected in recent years by the increase in the number of automobiles which are leased instead of purchased. This is principally due to the lack of availability of approved credit insurance products applicable to leases and to a reluctance on the part of automobile dealers to emphasize the sale of credit insurance products on lease transactions. The Company has credit insurance products available for lease transactions in most of the states in which it actively markets.\nThe Company's ability to retain credit insurance premiums written is limited by applicable statutory surplus requirements. For this reason, the Company reinsures substantial percentages of its credit insurance premiums on a written basis under quota share agreements with unaffiliated insurance companies. These reinsurance agreements provide statutory surplus relief, thereby increasing the Company's capacity to write credit insurance. An effect of this reinsurance is, however, to reduce the profit that the Company might otherwise realize on its credit insurance business. The agreements contain an experience adjustment computation which results in the ultimate cost of this reinsurance being a stated percentage of the amount of statutory surplus provided. Security funds are maintained by the Company in amounts which are generally proportional to the ceded unearned premiums. This reinsurance does not discharge the Company's primary liability as the original insurer.\nThe Company also markets, in an agency capacity, extended service automobile warranty products through its wholly-owned subsidiary, Consumers Car Care Corporation. These products are underwritten by unaffiliated insurance companies, administered by unaffiliated third party administrators and sold primarily through automobile dealers, who also sell the Company's credit insurance. The Company, through another subsidiary, also assumes a portion of the risks on these extended service contracts pursuant to a reinsurance arrangement with one of the unaffiliated insurers who underwrite the business. Other related products and services are also offered to the Company's automobile dealer customers.\nIndividual Life Insurance Division\nIn March of 1992, the Company announced the termination of this Division's marketing activities and announced its intent to sell its existing blocks of whole-life, term, annuity and universal life business. Effective October 1, 1992, the traditional whole-life, term and annuity business was sold for $5.6 million to the Londen Insurance Group of Phoenix, Arizona. In early 1993, the Company rejected offers it received for the sale of its universal life business after determining that the offers were too low in relation to the projected future profits on that block of business.\nEffective December 31, 1994, the Company sold its direct universal life business and irrevocably assigned all its right, title and interest in a block of assumed universal life business (coinsured from AMEX Life Assurance Company on a 90% quota share basis) to American Merchants Life Insurance Company, Jacksonville, Florida, for $5.5 million. The Company continued to provide all policyholder administrative functions for this business pursuant to a service agreement until May 1, 1995.\nThe Company had experienced continuing losses in its individual life operation due to insufficient premium levels to support the cost of operations. With the sale of the direct universal life business and the AMEX business to American Merchants and the termination of operations of CLMC Insurance Agency, Inc. (a general agency which marketed life insurance and annuity products through unaffiliated insurers), significant reductions have been made in various direct and indirect costs. Although the remaining block of assumed universal life business has generally been profitable, the Company is exploring opportunities to sell this business to the direct writer or another purchaser as part of its plan to sell its insurance operations.\nThe table below sets forth for the periods indicated the amount of policy charge revenues (for universal life products) and premiums written (for other individual life insurance products).\n(1) See footnote on page 4 of this Form 10-K.\nAuto Auction Division\nThe Company's wholly-owned subsidiary, Interstate Auto Auction, Inc., conducts wholesale automobile auctions of used vehicles at its facility in Mercer, Pennsylvania (about 50 miles north of Pittsburgh). The Youngstown Auto Auction business acquired in July of 1993 to expand the Company s auction operations, relocated to Lordstown, Ohio in 1994 in order to attract additional accounts and business to the auction. The Company subsequently ceased all operations at Lordstown effective December 31, 1994 and transferred a portion of its business operations to Interstate. In January 1995, Interstate began conducting the bi-weekly bank repossession auction previously held at Lordstown. This resulted in the termination, as of the end of 1994, of all of Lordstown's expenses while maintaining a portion of its revenue base at Interstate with virtually no incremental costs. Interstate s customers include automobile dealers and leasing companies. In connection with its weekly auctions, Interstate provides a body shop repair and conditioning service and an arbitration service through which disputes between buyers and sellers can be resolved.\nIn 1995, approximately 35,000 cars were registered for sale at Interstate through the regular weekly consignment auction, and approximately 56% of all vehicles registered were sold. In 1994, approximately 32,000 cars were registered and 59% of the cars registered were sold. Auction fees are generally paid by the seller for each vehicle sold and an additional fee is paid by the purchaser. The purchaser s fees vary according to the price paid for the automobile.\nBetween 1986 and 1992, significant revenues and profits were generated in connection with a contract with Ford Motor Company wherein Ford's executive and fleet lease vehicles were sold through special monthly auctions held by Interstate. The purchasers at these sales were limited to Ford's new car dealers. In November 1992, Ford terminated its contract with Interstate.\nInterstate is a member of the National Automobile Auction Association. It is also bonded and maintains an Auction House License with the Pennsylvania Department of Motor Vehicles.\nBEST'S RATINGS\nIn 1995, Consumers Life Insurance Company received a C rating (Marginal) from A.M. Best Company, principally because of its substantial amount of financial reinsurance and its relatively small capital base. In 1994 Consumers had a C- rating (Marginal). In 1992 and 1993, Consumers had an NA-9 rating (Not Rated at Company Request), which is assigned to any company which is otherwise eligible for a letter rating, but has requested that the rating not be published. The NA-9 designation was requested by Consumers while it completed the restructuring of its individual life insurance operations. In 1991, Consumers was rated \"B\" (Good). Consumers Life Insurance Company of North Carolina is currently rated \"NA-3\" (Insufficient Operating Experience), while Investors Fidelity Life Assurance Corp. is classified as \"NA-9.\" Best's letter ratings range from A++ (Superior) to D (Below Minimum Standards), with letters E and F assigned to companies under state supervision or in liquidation. Best's ratings are based on a comparative analysis of the statutory financial condition and operating performance of the companies, rated as determined by their publicly available reports.\nINVESTMENTS\nThe Company's general investment policy with respect to assets of its insurance subsidiaries has been to invest in both fixed maturity securities and mortgages with intermediate terms (generally not more than seven years). Investments in mortgages have allowed the Company to obtain higher yields while maintaining maturities in the five to seven year range. Prior to the sale of most of the Company s universal life business, the Company's investment policy also included investing in certain mortgage-backed securities which provided competitive yields on assets supporting these interest sensitive products.\nThe Company's mortgage loan portfolio, which relates primarily to commercial real estate, is concentrated in the central Pennsylvania area. Specifically, about 75% of the $7 million in mortgage loan balances at December 31, 1995 are secured by properties within a 60 mile radius of Harrisburg. The Company considers this strategy to be conservative because this region has historically not been particularly susceptible to wide economic swings in recessionary times, due to the diversity of industries throughout the area and the presence of government operations and military installations. See the Management's Discussion and Analysis of Financial Condition and Results of Operations appearing elsewhere in this Form 10-K for further information concerning mortgage loans and investments.\nInvestments in government and corporate bonds are limited to those with a Moody s or Standard & Poors rating of A or better. The Company buys U.S. Treasury Notes for their yield and superior liquidity features. The Company also purchases U.S. Government agency bonds and corporate bonds provided such bonds are part of large liquid issues (over $100 million) and, in the case of corporate bonds, represent economic balance and diversification. The Company may also buy foreign bonds denominated in U.S. dollars (Yankee Bonds), thereby avoiding exposure to foreign currency risk. Short-term investments are maintained primarily to meet anticipated cash requirements arising from operations. As of December 31, 1995, the fixed maturities portfolio did not contain any non-investment grade securities. The Company defines a non- investment grade security as any security rated below Baa3 by Moody s Investors Service and below BBB by Standard and Poor s Rating Service. The assets of the Company's non-insurance subsidiaries generally have been invested in short-term instruments.\nThe following table sets forth the Company's investment results for the periods indicated:\n(1) Includes $27,000 in interest which should have been included in 1994 income. If this income had been included in 1994, the yield in 1995 would have been 7.4% and the 1994 yield would have been 7.3%. (2) Includes $170,000 in rental income related to a property classified as non- investment real estate. Excluding this income, the real estate yield is 6.8%.\nCOMPETITION\nThe Company competes with numerous other credit insurance companies, many of which are larger than the Company and have greater financial and marketing resources. The principal competitive factors in the automobile credit insurance industry are commission levels, the quality of training for dealers, the variety of related products, the availability of dealer incentive programs and the level of administrative support and efficiency of claims handling procedures. The Company believes that it is able to compete successfully on the basis of these factors.\nThe Company pays relatively high commissions in order to remain competitive in states that do not mandate maximum commissions. In states which have established maximum commissions by regulation, there is generally no commission competition among companies. The elimination of the existing commission limits in Pennsylvania, Maryland and Nebraska, the only states where the Company has any significant amount of business which regulate commission levels, could have a detrimental effect on the Company's business because agents could negotiate for higher commissions on the sale of credit insurance without a corresponding increase in premiums. The Company is not aware that any of these states is considering elimination of maximum commission regulations.\nBecause the Company markets its extended service warranty products primarily in connection with its marketing of credit insurance to automobile dealers, its ability to sell this product is a function of its ability to compete in the credit insurance market. The availability of financially sound insurance underwriters and capable third party warranty administrators are additional factors which affect the Company's ability to market its extended service warranty products effectively.\nThe marketing areas for the auto auction include western Pennsylvania, western New York, eastern Ohio and the West Virginia panhandle. Interstate competes with five automobile auctions in its market areas. The principal competitive factors are the quality of management, the amount of auction fees charged, location in relation to major metropolitan markets, the quality of the physical plant and facilities and other services offered, such as title guarantees. The Company believes that it is able to compete effectively on the basis of these factors.\nREGULATION\nThe Company's insurance operations are subject to regulation and supervision in the states in which it is licensed. The extent of such regulation varies from state to state, but, in general, each state has statutory restrictions and a supervisory agency which has broad discretionary administrative powers. Such regulation is designed primarily to protect policyholders and relates to the licensing of insurers and their agents, the approval of policy forms, the methods of computing financial statement reserves, the form and content of financial reports and the type and concentration of permitted investments. The Company's insurance subsidiaries are subject to periodic examination by the insurance departments in the states of their formation and are also subject to joint regulatory agency examination and market conduct examinations in the other states in which they are authorized to do business.\nCertain states in which the Company is licensed have regulations limiting the credit insurance premium rates or the commissions payable to agents or, in some cases, limiting both rates and commissions payable. In addition, some states have regulations that require credit insurance claims ratios to be a specified percentage of earned premiums. If an insurer's claims ratio is below the prescribed benchmark, it is required to reduce premium rates and, conversely, if the claims ratio is higher than the benchmark, the insurer may request an increase in premium rates.\nThe dividends which a life insurance company may distribute are subject to regulatory requirements based upon minimum statutory capital and surplus and\/or statutory earnings. In addition to regulatory considerations, the overall financial strength of each operating entity is considered before dividends are paid. Additionally, the amount of dividends a life insurance company can pay is subject to certain tax considerations. See Notes 2 and 16 of the Notes to Consolidated Financial Statements appearing elsewhere in this Form 10-K.\nThe Company is also subject to regulation under the insurance holding company laws of various states in which it does business. These laws vary from state to state, but generally require insurance holding companies and insurers that are subsidiaries of holding companies to register and file certain reports, including information concerning their capital structures, ownership, financial condition and general business operations, and require prior regulatory agency approval of changes in control of an insurer, most dividends and intercorporate transfers of assets within the holding company structure. The purchase of more than 10% of the outstanding shares of the Company's Common Stock by one or more affiliated parties would require the prior approval of certain state insurance departments which regulate the Company.\nEMPLOYEES AND AGENTS\nAs of December 31, 1995, the Company had approximately 97 full-time employees, including its management and sales personnel. In addition, as of that date there were approximately 900 licensed agents selling credit insurance and vehicle extended service contracts, most of whom were full-time employees of automobile dealers, banks and other financial institutions.\nThe Company has adequate insurance coverage against employee dishonesty, theft, forgery and alteration of checks and similar items. The Company does not have similar coverage for its agents. There can be no assurance that the Company will be able to continue to obtain such coverage in the future or that it will not experience uninsured losses.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nSince September 1989, the Company has maintained its executive and business offices in a leased building located at 1200 Camp Hill By-Pass, Camp Hill, Pennsylvania. The office building contains approximately 44,500 square feet of office space. Prior to 1993, the Company leased the entire facility at an annual rental of $421,000, plus insurance, taxes and utilities. As a result of the termination in 1992 of all new business functions in the Individual Life Insurance Division, the Company now occupies approximately 67% of the available office space. The Company has leased about 85% of the remaining space to third party tenants. Annual rental income to the Company under these sub-leases totals $105,000. In March of 1994, the Company exercised its option to acquire a 50% interest in its home office building, which reduced the Company s annual rent to $204,000. The option price was approximately $1.75 million. Except as otherwise noted, the business operations of the Company and all of the subsidiaries are conducted at the above address in Camp Hill, Pennsylvania.\nIn connection with its insurance operations, Consumers Life Insurance Company maintains a branch office in leased facilities in Philadelphia, Pennsylvania. The branch office primarily provides supervision, sales and service for credit insurance agents doing business in the eastern Pennsylvania, Delaware and New Jersey areas. Annual rental for this office is $27,000.\nInvestors Fidelity Life Assurance Corp. maintains an office in leased facilities in Columbus, Ohio. This office primarily provides sales support and supervision for credit insurance agents in the State of Ohio. Annual rental for this office is $12,000 plus insurance, taxes and utilities. Interstate's auction facilities are situated on approximately 50 acres of land owned by Interstate. The auction building contains approximately 44,500 square feet which includes seven auction lanes, a restaurant and various lounges and other amenities.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is a party to various lawsuits which are ordinary and routine litigation incidental to its business. None of these lawsuits is expected to have a materially adverse effect on the Company's financial condition or operations. See Note 13 of the Notes to Consolidated Financial Statements appearing elsewhere in this Form 10-K for additional information concerning litigation matters.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matters were submitted during the Fourth Quarter of 1995 to the shareholders of the Company for their consideration through the solicitation of proxies or otherwise.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nConsumers Financial Corporation common stock and Convertible Preferred Stock, Series A, are traded on the NASDAQ, National Market System. Ticker symbols are CFIN and CFINP, respectively.\nDirectors, officers and employees of Consumers Financial Corporation have a sizeable ownership position in Consumers, which is derived from the Company s belief that this provides a strong incentive for all parties involved to enhance shareholder value. At December 31, 1995, the Company s Employee Stock Ownership Plan held 10.7% of the total common stock outstanding.\nAs of December 31, 1995, there were 7,054 shareholders of record who collectively held 2,621,090 common shares and 161 shareholders of the Convertible Preferred Stock, Series A, who held 481,461 shares. Seven institutions held approximately 138,700 shares of common stock at year end.\nDividends on both the Company s common stock and Convertible Preferred Stock, Series A, are declared by the Board of Directors. A common stock dividend was not declared in 1995; however, common stock dividends had been paid for 14 consecutive years through 1994. The 1994 common stock cash dividend was $.05 per share. The Convertible Preferred Stock, Series A, dividends are paid quarterly on the first day of January, April, July and October. The annual Convertible Preferred Stock, Series A, cash dividend is $.85 per share.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA","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":"791449_1995.txt","cik":"791449","year":"1995","section_1":"ITEM 1. BUSINESS\nBACKGROUND AND CORPORATE ORGANIZATION\nGENERAL\nHerbalife International, Inc. (the \"Company\") markets weight control products, food and dietary supplements and a new line of personal care products worldwide through a network marketing system. Herbalife uses network marketing as a way to describe its marketing and sales programs as opposed to multi-level marketing because multi-level marketing has had a negative connotation in certain countries in which Herbalife does business. The Company emphasizes the herbs and other natural ingredients in its 62 products in order to appeal to consumer demand for products including such ingredients. The Company currently conducts business in 32 countries located in The Americas, Europe and Asia\/Pacific Rim. Retail sales derived from The Americas, Europe and Asia\/Pacific Rim represented 44.0%, 40.5% and 15.5%, respectively, of the Company's total retail sales for the year ended December 31, 1995.\nThe Company's products are marketed exclusively through a network marketing system in which independent distributors purchase products for resale to retail consumers and other distributors. Management believes that its network marketing system is ideally suited to marketing its products, which emphasize \"lifestyle\", because sales of such products are strengthened by ongoing personal contact between retail consumers and distributors, many of whom use the Company's products themselves. The Company's network marketing system appeals to a broad cross-section of people worldwide, particularly those looking to supplement family income or who are unable or choose not to devote full-time to more conventional employment.\nHISTORY AND ORGANIZATION\nThe Company began operations in February 1980 as a California limited partnership and operated in that form through December 1985, with the exception of an interim period from October 1981 through August 1983 when the business was operated through a California corporation. In January 1986, the Company's business was transferred from the California limited partnership to its corporate general partner, Herbalife International of America, Inc. (\"Herbalife of America\"). In November 1986, Herbalife of America was acquired in a stock-for-stock reorganization by Sage Court Ventures, Inc. (\"Sage Court\"). As a result of the acquisition, Herbalife of America became a wholly-owned subsidiary of Sage Court and the former stockholders of Herbalife of America acquired a controlling interest in Sage Court. Sage Court's name was formally changed to Herbalife International, Inc. in December 1986.\nIn October 1993, the Company and certain selling stockholders sold a total of 6,047,000 shares of Common Stock in a Public Offering (the \"1993 Offering\"). The Company issued and sold 2,647,000 shares as part of this transaction.\nHerbalife International, Inc. operates through 37 wholly-owned domestic and foreign subsidiaries. Except as the context otherwise requires, references to the \"Company\" include Herbalife International, Inc. and its operating subsidiaries.\nEXECUTIVE OFFICES\nThe Company's executive offices are located at 1800 Century Park East, Los Angeles, California 90067. The Company's telephone number is (310) 410-9600.\nBUSINESS STRATEGY\nThe Company's business strategy consists of three principal elements: (1) expansion into new markets, (2) continued growth in existing markets, and (3) management initiatives designed to support future growth and increase operating efficiencies.\nEXPANSION INTO NEW MARKETS\nThe opening of new markets is an important part of the Company's business strategy. Since the beginning of 1989, the Company has commenced operations in 27 countries, which in 1995 accounted for 57.3% of the Company's total retail sales. From the beginning of 1992 to date, the Company entered 21 countries, and these markets, while certain of them are still in the early stages of their development, are already contributing significantly to retail sales and net income. The Company currently plans to enter between three to five new countries in 1996.\nAn important factor in the success of the Company's recent market openings has been its international sponsorship program. This program permits distributors in any country to sponsor distributors in other countries and earn royalties and bonuses on sales by those distributors. International sponsorship provides distributors with an incentive to build distributor organizations in each of the Company's new markets. The Company has permitted international sponsorship since the commencement of operations in its first international market in 1982. In deciding which countries to enter and the timing of entry, the Company considers, among other things, the contacts its distributors may have in potential new markets. Through its experience in starting operations in new countries, the Company's approach generally is to introduce as many of its four principal weight control and nutritional products as possible upon commencing operations in a new market and thereafter to introduce additional products over time.\nGROWTH IN EXISTING MARKETS\nThe Company attempts to expand its business in each of its markets by introducing additional products, attracting new distributors and further motivating existing distributors. The continued introduction of products is designed to generate additional revenue, encourage growth in the number of distributors and serve as an important promotional tool to assist distributors in selling products and recruiting new distributors.\nIn May 1992 a new product, Thermojetics-Registered Trademark-, was introduced in the United States. This weight control system, which includes herbal tablets, has resulted in an expansion of the Company's United States business by generating significant sales itself, stimulating sales of the Company's other products and contributing to an increase in the number of active distributors. These initial Thermojetics-Registered Trademark- products were marketed during 1992 and 1993 in the United States, Canada and Mexico only, and helped U.S. retail sales increase almost six-fold in 1993 versus 1991 levels. In 1994, the second major product in the Thermojetics-Registered Trademark- family was introduced, Thermojetics-Registered Trademark- Instant Herbal Beverage, in a total of 18 countries. The Thermojetics-Registered Trademark- Instant Herbal Beverage introduction assisted in the increase in worldwide Thermojetics-Registered Trademark- products retail sales to $165.1 million, which represented 17.9% of total worldwide retail sales during 1995. Thermojetics-Registered Trademark- products represented 35.0%, 33.4% and 27.8% of total retail sales in the U.S. market in 1993, 1994 and 1995, respectively.\nIn May 1994, Herbalife began the development of a new product line, Personal Care. The Personal Care line is designed to complement Herbalife's traditional weight control and food and dietary products, by emphasizing personal lifestyle and health awareness. Significant development efforts in 1994 culminated in the January 1995 launch of The Skin Survival Kit, the first line of Personal Care products. Further personal care products were launched in 1995: the fragrances, Parfums Vitessence-TM- in April, and the facial products, Nature's Mirror-TM-in October. All personal care products developed by Herbalife are grouped under the name of Dermajetics-Registered Trademark-. The Company plans to emphasize the development of additional new products to supplement its existing product line.\nEXPANSION INTO CATALOG SALES\nIn March 1994, the Company expanded into catalog sales with the \"Art of Promotion\" catalog. Management believes that this strategic move is compatible with the existing network marketing system. This initiative involves marketing products that supplement existing product lines, and that can be used as tools to enable distributors to grow their businesses. Distributors are motivated to participate by earning commissions. Management believes that the diversification of the Company's product line and marketing systems resulting from the establishment of the catalog sales business should benefit the Company by providing, among other things, valuable marketing information regarding the retail consumers of existing products.\nPRODUCT DEVELOPMENT\nThe Company's products include weight control products and food and dietary supplements. In addition, supplementing its existing operations, in 1995 the Company expanded its business into personal care products. The Company currently markets 62 products, exclusive of variations in product flavors, reformulations of products to satisfy regulatory requirements or similar variations of the Company's basic product line.\nA majority of the Company's sales are derived from its four principal weight control products, which consist of Formula #1, a protein powder in five different flavors designed as a meal replacement, and Formulas #2, #3 and #4, all tablets that contain herbs, vitamins and minerals designed to assist in weight control and satisfy certain nutritional requirements, and from Thermojetics-Registered Trademark-, a weight control system that includes herbal tablets and a beverage. The Company's other food and dietary supplements include a variety of products, each containing herbs, vitamins, minerals and other natural ingredients. Such\nproducts are sold under various names, including Cell-U-Loss-Registered Trademark-, Activated Fiber, N.R.G. (Nature's Raw Guarana), Herbal-Aloe, Florafiber, Xtra-Cal, Herbalifeline-Registered Trademark-, and Schizandra Plus-Registered Trademark-.\nIn 1995, the company entered a new category of products - the Dermajetics-Registered Trademark- personal care line. Three initial phases of the new line of personal care products were introduced: Skin Survival Kit in January 1995, Parfums Vitessence-TM- in April, 1995, and Nature's Mirror-TM- in October, 1995. The Skin Survival Kit consists of four skin care products packaged in a vinyl cosmetic bag: a day moisturizer, a night moisturizer, a mask and an eye gel. Parfums Vitessence-TM- consist of six eau d'toilettes, three for men and three for women. The Nature's Mirror-TM- facial products consist of nine products: cleanser, toner and moisturizer for three skin types.\nIn September 1995, six Dermajetics-Registered Trademark- skin care products were launched specifically for the Japanese market. These products, which are a combination of the Skin Survival Kit products and Nature's Mirror-TM-, are manufactured in Japan and have been reformulated and re-packaged for the Japanese market.\nIn January 1996, eight new products for nutrition and weight management were launched as a part of a newly developed Health & Fitness Program and Bulk & Muscle Program. The two programs consist of a protein powder Multivitamin-Mineral, Herbal Tablet and a Cell Activator. Initially, the products have been introduced into the United States. The Company also introduced an A.M. Replenishing and a P.M. Cleansing formula as part of a 21-Day herbal cleaning program.\nWeight control products (including Thermojetics-Registered Trademark-), food and dietary supplements and personal care and all other products accounted for approximately 71%, 16% and 12% of total retail sales, respectively, for 1995, and approximately 77%, 17% and 4% of total retail sales, respectively, for 1994. In addition, the Company's educational and promotional materials accounted for approximately 1% and 2% of total retail sales in 1995 and 1994, respectively.\nThe Thermojetics-Registered Trademark- weight control system includes herbal tablets designed to aid in weight control in conjunction with the Herbalife Cellular Nutrition-Registered Trademark- Health and Weight Management System, the Thermojetics-Registered Trademark- Energy Guide or alternative weight control programs. The introduction of Thermojetics-Registered Trademark- into the United States has contributed significantly to the increase in United States sales. Following the introduction of Thermojetics-Registered Trademark- into the United States in May 1992, the product was introduced into Mexico and Canada. In 1994 Thermojetics-Registered Trademark- Instant Herbal Beverage was initially introduced in 18 countries, but in 1995 it was sold in 28 countries. Worldwide retail sales of the Thermojetics-Registered Trademark- family of products represented 17.9% of total retail sales in 1995.\nAn important ingredient in one of the tablets included in the Thermojetics-Registered Trademark- system is a Chinese herb known as \"Ma Huang,\" which contains naturally-occurring ephedrine in small quantities and which has been the subject of adverse publicity in the United States. As with the Company's other food and dietary supplements, the Company makes no therapeutic claims with respect to Thermojetics-Registered Trademark- or any of its ingredients, including Ma Huang. Accordingly, prior to initiating sales of the product in the United States, the Company did not, and believes it was not required to, obtain prior regulatory approval from the FDA or other regulatory agencies. While the Company was likewise not required to obtain prior approval in Canada, following the introduction of Thermojetics-Registered Trademark- in that country in February 1993, the Company received informal notice from a local regulatory authority that the Canadian Department of Health and Welfare was investigating the existence of ephedrine in food products. As a result, the Company suspended shipment of Thermojetics-Registered Trademark- into Canada in March 1993. The Company then reformulated the product to reduce its ephedrine level and upon obtaining notice that the reformulated product was acceptable to Canadian authorities, renewed sales of Thermojetics-Registered Trademark- in June 1993. In February 1994, Canadian authorities again suspended sales of products containing ephedrine. This suspension is indefinite and may be permanent. As a result, the Company has responded by selling in Canada only the Thermojetics-Registered Trademark- tablets that do not contain Ma Huang and otherwise comply with the new directions. There is a risk that Ma Huang may be subject to regulation in the United States in the future, as a result of FDA action or otherwise. The Company believes that the product could be reformulated, if necessary, with reduced ephedrine levels or with an acceptable substitute for Ma Huang, although there can be no assurance in this regard. In the event that a food product containing Ma Huang was found to be unacceptable for sale in additional markets in which Thermojetics-Registered Trademark- is currently sold and the Company was unable to effectively reformulate the product in those markets, there could be an adverse effect on the Company.\nIn April, 1995, in anticipation of upcoming FDA actions regarding Ma Huang, the Company decided to temporarily stop sales of Thermojetics-Registered Trademark-Green tablets in the United States. At that time the Company introduced its reformulated tablets that did not include Ma Huang. In the fourth quarter of 1995, the Company reintroduced the Thermojetics-Registered Trademark- Green tablets (containing Ma Huang), as no regulation had been enacted concerning Ma Huang.\nDuring the third quarter of 1995, the Company received inquiries from certain governmental agencies within Germany and Portugal relating to the Company's product, Thermojetics-Registered Trademark- Instant Herbal Beverage. Pending resolution of these inquiries, the sale of this product in these countries was suspended. The Company is engaged in ongoing consultation with the appropriate authorities, and the resumption of sales of this product is dependent upon the satisfactory outcome of these consultations.\nThe Company expands its product line through the development of new products. New product ideas are derived from a number of sources, including trade publications, scientific and health journals, the Company's executives and consultants and outside parties. When introducing products into its markets, local counsel and other representatives retained by the Company investigate product formulation matters as they relate to regulatory compliance and other issues. To the extent possible, the Company's products are then reformulated to suit both the regulatory and marketing requirements of the particular market.\nAll of the Company's nutritional products are manufactured by outside companies. Raven Industries Inc. (\"Raven\") manufactures the Company's powder products, and D&F Industries, Inc. (\"D&F\") manufactures substantially all of the Company's tablet and capsule products. The Company does not maintain its own product research, development and formulation staff and relies on Raven and D&F for such services. When the Company, one of its consultants or another party (including, in many instances, Raven or D&F) identifies a new product concept or when an existing product must be reformulated for introduction into a new or existing market, the new product concept or reformulation project is generally submitted to D&F or Raven for technological development and implementation. The Company does not own the proprietary rights to its weight management products and its food and dietary supplements. However, the developer and supplier of all these products has granted the Company the exclusive right to market any product which the Company purchases from the suppliers thereby granting the Company the practical equivalent of ownership of the formulations of these products during the term of the supply agreements. The Company has obtained or has applications pending for trademark registration of certain of its tradenames in certain jurisdictions. However, there can be no assurance that another company will not replicate one of the Company's products. In addition, Raven and D&F own certain product formulations and manufacturing processes relating to the Company's products.\nThe Company's business relationship with Raven and D&F represents an important source of income to these manufacturers, as sales to the Company comprise a substantial portion of the total sales of Raven and D&F. In addition, in May 1993, the Company entered into requirements contracts with Raven, D&F and Dynamic Products, Inc. (\"Dynamic,\" the licensor of one of the Company's tablet products), that extend to January 1998. Pursuant to these contracts, each manufacturer has agreed, among other things, not to sell the products sold to the Company to third parties, and the Company has agreed to purchase all of its requirements for powder products from Raven and all of its requirements for tablet, capsule, liquid, cream and lotion products from D&F or Dynamic, to the extent each such manufacturer is capable or becomes capable of manufacturing such products. The manufacturers have waived that requirement as it relates to the Skin Survival Kit, Parfums Vitessence-TM- and Nature's Mirror-TM-. The contracts also provide Raven, D&F and Dynamic a right of first refusal to establish any manufacturing facility outside of North America that the Company proposes to develop or acquire, and the right to receive certain royalty payments in the event that such a manufacturing facility were contracted or acquired and the right of first refusal was not exercised.\nTwo individuals (not affiliates of the Company) are principal stockholders of each of Raven, D&F, and Dynamic. Mark Hughes, the Company's principal stockholder, Chairman of the Board, Chief Executive Officer and President, owns a one-third ownership interest in Raven and a one-fifth ownership interest in Dynamic. Dr. David Katzin, an officer of the Company and member of the Company's Scientific Advisory Board, owns a 5% minority interest in Dynamic.\nAlthough the Company believes that its relationships with its outside manufacturers are good as a result of the foregoing factors, the Company's business could be adversely affected if its relationship with Raven or D&F were impaired, and there can be no assurance that Raven and D&F will continue to provide the product research, development and formulation services that they have in the past. However, the Company interacts regularly and extensively with (1) outside third party suppliers regarding new product introduction ideas, (2) the distributors regarding their receptivity to proposed product introductions and (3) the manufacturers and suppliers of new products regarding design, formulation and other specifications for new product introduction.\nThe Company owns all the formulas, processes and trade secrets with respect to the Personal Care Line. This information with respect to these products is made available to outside manufacturers on a strictly confidential basis and for the limited purpose of manufacturing these products for the Company. The Skin Survival Kit products are currently being\nmanufactured by BCM Cosmetiques S.A., formerly Croda Cosmetique France S.A. The Parfums Vitessence-TM- products are manufactured by Laboratoires Selecta S.A. and Abodino S.A. in France. Nature's Mirror-TM- products are manufactured by Thibiant International Inc. in the U.S.A. The Company provides specifications to the manufacturers. The European manufacturers are supplied components by Herbalife at no charge, then procure the raw materials, compound the products, and fill the supplied components. The U.S. manufacturer procures the raw materials and the components, compounds the product and fills the components. The Company's arrangement with the manufacturers can be terminated by either party upon the completion of any outstanding purchase orders.\nDISTRIBUTION AND MARKETING\nThe Company's products are distributed exclusively through a network marketing system consisting of an extensive network of distributors. Herbalife uses network marketing as a way to describe its marketing and sales programs as opposed to multi-level marketing because multi-level marketing has had a negative connotation in certain countries in which Herbalife does business. Distributors are generally independent contractors who purchase products directly from the Company or from other distributors for resale to retail consumers and other distributors. Distributors may elect to work on a full-time or part-time basis. The Company believes that its network marketing system appeals to a broad cross-section of people worldwide, particularly those looking to supplement family income or who are unable or choose not to devote full-time to more conventional employment, and that a majority of its distributors therefore, work on a part-time basis. The Company believes that its network marketing system is ideally suited to marketing weight control and personal care products because sales of such products are strengthened by ongoing personal contact between retail consumers and distributors, many of whom use the Company's products themselves. The Company encourages its distributors to use the Company's products and to communicate the results of their use of such products to their retail customers.\nDistributors' earnings are derived from several sources. First, distributors may earn profits by purchasing the Company's products at wholesale prices (which are discounted 25% to 50% from suggested retail prices depending on the distributor's level within the Company's distributor network) and selling the Company's products to retail customers at retail prices. Second, distributors may earn profits by selling products to other distributors who do not qualify for the same level of discount as the selling distributor. Third, distributors who sponsor other distributors and establish their own distributor organizations may earn royalties of 5% to 15% and production bonuses of up to 6% on sales generated by distributors within their organizations. Distributors earn the right to receive royalties and production bonuses upon attaining the level of supervisor and above. Distributors may earn royalties on sales generated by distributors within their organization and production bonuses on sales generated by any distributor within their organization who is at a lower level within the Company's distributor network. The Company believes that the right of distributors to earn royalties and production bonuses contributes significantly to the Company's ability to retain its productive distributors.\nTo become a distributor, a person must be sponsored by an existing distributor and must purchase a distributor kit from the Company. A distributor kit currently sells for an average of $80 and provides a sampling of the Company's products plus aids, brochures, order forms, cassette recordings and informational videotapes. Sales of distributor kits (including the samples of the Company's products contained therein) and other educational promotional materials accounted for 4.5% and 5.0% of the Company's total retail sales for 1994 and 1995, respectively.\nTo become a supervisor or qualify for a higher level, distributors must purchase a certain amount of the Company's products or earn certain amounts of royalties during specified time periods and must re-qualify for such levels once each year. Supervisors may then attain higher levels by earning increasing amounts of royalties based on purchases by distributors within their organizations. Supervisors contribute significantly to the Company's sales and certain key supervisors who have attained the highest levels within the Company's distributor network are responsible for generating a substantial portion of the Company's sales and for recruiting a substantial number of the Company's distributors. The following table sets forth the approximate number of the Company's supervisors at the dates indicated:\nAt February 28, * - ------------------------------------------------------------------------------ 1992 1993 1994 1995 1996 - ------------------------------------------------------------------------------ Approximate Number of 18,000 41,000 75,000 85,000 99,000 Supervisors - ------------------------------------------------------------------------------ *The Company determines the number of supervisors as of the end of February each year following the conclusion of the first supervisor qualification period of the year and deletes supervisors who fail to meet the supervisor qualifications at that time. The Company relies on distributors' certifications as to the amount and source of their product purchases from other distributors. Although the Company applies certain review procedures with respect to such certifications, they are not directly verifiable by the Company.\nThe Company seeks to expand its distributor base in each market by offering distributors attractive compensation opportunities. The Company believes its unique international sponsorship program provides a significant advantage to its\ndistributors as compared with distributors in other network marketing organizations because the program permits distributors in any country to sponsor distributors in other countries (where the Company is licensed to do business and where the Company has obtained required product approvals) and to earn the same level of royalties and bonuses on sales by those distributors as if both distributors resided in the same country.\nIn addition, in 1992 and 1993 the Company introduced two new compensation and incentive programs designed to motivate distributors at both the most senior and junior levels within the Company's distributor network. For the Company's most senior distributors, the President's Team (\"PT\"), the Company created the President's Council and President's Bonus. As of February 1996, there were approximately 250 members. The President's Council, comprising the most successful PT members, works closely with Mark Hughes to develop and implement new initiatives and strategies for increasing sales and distributor productivity throughout the Company's entire distributor organization. Qualifying PT members have the opportunity to participate in the President's Bonus which in 1995 consisted of a total available awards package of three-quarter of one percent of the Company's total product retail sales. The President's Bonus provides a direct incentive for the Company's most productive distributors. The distribution of the President's Bonus is determined by Mark Hughes.\nFor the Company's most junior distributors, those who have not yet attained supervisor status, the Company instituted a \"Success Builder\" program. This program establishes three levels of distributors below the supervisor level. By reaching specified retail sales levels during certain time periods, distributors become eligible to receive additional product discounts, training tapes, manuals and other productivity awards. The Success Builder program is designed to provide incentives to distributors who are in the initial stages of building distributor organizations and to encourage them to reach supervisor status.\nThe Company is constantly developing new programs and technologies to help facilitate distributor recruitment, and to provide distributors with the skills and tools to build their businesses. In March 1992, the Company introduced its \"International Success Training System\" (\"ISTS\") in the United States, Mexico, Canada, Australia and New Zealand. The ISTS supplements the Company's current training and education programs. It consists of a series of informational training messages, some live and some recorded, that are available through telephone conference calls. Among other things, it enables potential distributors to learn about the Company and its products and develop the skills necessary to build their own distributor organizations through a convenient format that can generally be accessed from their own home or office. In 1994, the Company tested several new technologies for communicating with, educating and motivating distributors. The first International Success Satellite Event (ISSE) was held in December 1994 in approximately 60 cities worldwide, in 22 countries. The ISSE represents a new cost-effective technique of disseminating information to large audiences of distributors simultaneously. Live distributor meeting venues are relayed via satellite to audiences worldwide. In 1995, the Company held five ISSE events with an audience of over 60 cities in 30 Countries. Another technology was launched in 1995 - The Herbalife Broadcast Network. This technology allows the Company to reach a large number of distributors, initially in North America and Europe, with over 10 hours of training and motivational programming per week. Throughout the year the company held leadership meetings in key cities in the Americas, Europe and Asia\/Pacific Rim. The meetings are designed to reward important sales achievements and to help distributors successfully build, manage and train their organization.\nIn August 1995, members of the top levels of distributors qualified for Worldwide Getaway Vacations. These vacations provide an opportunity for top producing distributors to share techniques, successes, and business advice.\nThe Company maintains a computerized system for processing distributor orders and calculating distributor royalties and bonus payments which enables it to remit such payments promptly to distributors. The Company believes that prompt remittance of royalties is vital to maintaining a motivated network of distributors, and that its distributors' loyalty to the Company has been enhanced by the Company's history of consistently making royalty and bonus payments on a scheduled basis.\nGEOGRAPHIC AREAS OF OPERATIONS\nThe following chart sets forth the countries in which the Company currently operates, the year operations were commenced in each country, and product and retail sales information by country during the past five years.\n(1) The Company records sales data based on the country from which distributor orders are shipped by the Company. Sales by distributors to other distributors or retail consumers may occur in other countries, although such sales generally violate geographic limitations imposed by the Company on product sales.\n(2) Throughout this annual report, \"entering\", \"opening\", \"commencing operations\" or \"doing business\" in a market or country means that the Company has obtained either regulatory approval of, or the favorable opinion of local legal counsel with respect to, its network marketing plan and has obtained all requisite regulatory approvals of at least one product and has commenced sales and shipment of that product within the market or country.\n(3) Sales in the Dominican Republic are shipped from the United States.\n(4) The Company initiated operations in Israel in 1989 through a licensing arrangement that was terminated in 1990. In 1991, the Company began operating in Israel through a wholly-owned subsidiary. Accordingly, sales data for Israel are reported only for 1991 and subsequent periods.\n(5) Because sales in South Africa are not large enough to be treated as a separate segment, they are included with sales from the European region.\n(6) In 1991 and 1992 the Company operated under a licensing arrangement in Japan. No retail sales revenue was recorded for those periods. A new wholly-owned Japanese subsidiary was formed in November 1993 whose results from that date are reported above.\nThe Company commenced operations in the United States in 1980 and, by 1983, had expanded its operations to three additional English speaking countries: Australia, Canada and the United Kingdom. Beginning in 1989, the Company began to expand to non-English speaking countries, starting with Spain and Mexico because of the substantial number of the Company's distributors who spoke Spanish and had friends, relatives and other acquaintances in those countries. Focusing on Europe, but expanding into other non-English speaking countries, the Company commenced operations in France and Germany in 1990 and 1991, respectively, in 1992 opened Italy, Portugal and The Czech Republic, in 1993 opened The Netherlands, in 1994 opened Belgium, Poland, Denmark and Sweden, and in 1995 opened Russia, Switzerland, Austria, Norway, Finland and South Africa. The Company's expansion into these countries contributed significantly to the Company's financial performance. The Company expanded its Asia\/Pacific Rim operations with the opening of Hong Kong in 1992, the formation of a new Japanese subsidiary in 1993, the opening of the Philippines in 1994, and Taiwan in 1995. The Americas saw expansion in 1994 with the opening of the Dominican Republic, Venezuela and Argentina, and Brazil in 1995.\nAs the Company's entry into Spain and France indicates, since 1989 the Company has generally experienced an initial period of rapid growth in sales after entering a country as new distributors were recruited and the Company's principal weight control products were introduced. Following this initial growth period, the Company has generally experienced a decline in the rate of growth and, in several instances, a decline in sales. The Company believes that a significant factor affecting these markets has been the opening of other new markets within the same geographic region or with the same or similar language or cultural bases, and the inclination of some distributors to focus their attention on business opportunities provided by new markets which can have a negative impact on existing markets.\nIn late 1994 through 1995 the sales of the Company were negatively impacted by an adverse business environment in France. That environment included the publication of reports that the Company's distributors are members of a disfavored religious group, and the negative impact from governmental action against distributors for allegedly failing to pay certain taxes. While the Company is taking steps to restore sales in France, at present, French sales and sales in other countries continue to be adversely affected. In July 1995 the sale of Thermojetics-Registered Trademark- Instant Herbal Beverage was suspended in Germany. This situation has led to an increase in product returns and distributor resignations, as well as a decline in the sale of other products.\nThe Company's business strategy continues to be to support growth in existing markets. This strategy includes increased compensation for the Company's distributors, increased emphasis on distributor training, as well as the product introduction strategies discussed above. In certain of its larger international markets, the Company has appointed sales managers responsible for providing ongoing assistance to distributors in the development, expansion and management of their distributor organizations. In addition, the Company has recruited and appointed vice presidents responsible for corporate marketing and business development, public relations, and sales incentive, premium and recognition programs. The Company also appointed new Regional Vice Presidents in Europe, responsible for marketing and sales, oversight of day-to-day operations, public relations (including advertising and media communications), and legal affairs. This European upper management team represents the first regional administrative center for the Company. The Company believes that the strategy of forming regional management teams will help sustain growth in existing markets, and it anticipates the creation of similar regional administrative centers in the future.\nThe Company's five largest markets (the United States, Germany, Japan, Italy and Israel), accounted for 70.4% and 66.9%, respectively, of the Company's total retail sales for 1994 and 1995.\nBeginning in the mid-1980's, the Company experienced a decline in United States sales that was attributable in large part to regulatory scrutiny related to claims and representations about the Company's products as well as increased competition from weight control products that were lower priced than the Company's four principal weight control products. In 1992, the Company sought to reverse this trend in United States sales by introducing the \"International Success Training System\" and new production bonuses for supervisors who attained certain levels of royalty earnings. These innovations resulted in increases both in the size of the Company's distributor base in the United States and in the productivity of the Company's most successful United States distributors. Subsequently, in 1992, the Company introduced Thermojetics-Registered Trademark-, which generated significant sales itself and stimulated sales of the Company's four principal weight control products despite continuing competition from lower-priced weight control products. In 1995 the Company introduced the personal care products grouped under the name of Dermajetics-Registered Trademark-, which further stimulated sales by $48.8 million in the United States. As a result of these initiatives, retail sales in the United States increased over eight-fold to $333.6 million in 1995 from $42.0 million in 1991. In 1995, retail sales in The Americas region grew $51.9 million, or 14.7% over 1994 retail sales. The U.S. accounted for $38.6 million of this retail sales growth, followed by Brazil, which opened in September of 1995, and accounted for $24.2 million of the growth.\nTotal retail sales in the European region declined $99.3 million or 21.0% in 1995 versus 1994. The sales decrease in Germany and Israel of $43.9 and $43.1 million respectively, together with sales decreases in Czech Republic, France, Italy, Spain and UK, were partially offset by sales in Denmark, Russia, South Africa and Sweden. In addition to the factors affecting sales in France and Germany discussed above, the Company believes this decline is attributable to the effect of new market openings in Europe, regulatory restrictions on herbal products that have impeded the introduction of additional products and the reduction in activity levels of certain key distributors in those markets. The Company has sought to stimulate sales in these countries by hiring sales managers and continuing its efforts to introduce additional products and has undertaken marketing assessments of the factors affecting sales. Furthermore, regional management personnel responsible for public relations, legal affairs and marketing have been hired.\nTotal retail sales in the Asia\/Pacific Rim region grew 153.9% in 1995 versus 1994. This $87.0 million increase included retail sales increases of $63.0 million in Japan and $13.1 million in the Philippines. 1995 was the first full year of operation of Herbalife business in the Philippines. The growth in Japan resulted from new products and marketing initiatives.\nWhen the Company decides to enter a new market, it first hires local legal counsel to help ensure that the Company's multilevel marketing system and products comply with all applicable regulations and that the Company's profits may be expatriated. In addition, local counsel helps to establish favorable public relations in the new market by acting as an intermediary between the Company and local regulatory authorities, public officials and business people. Local counsel is also responsible for explaining the Company's products and products ingredients to appropriate regulators and, when necessary, arranging for local technicians to conduct required ingredient analysis tests of the Company's products.\nWhere regulatory approval in a foreign market is required, the Company's local counsel work with regulatory agencies to confirm that all of the ingredients of the Company's products are permissible within the new market. During the regulatory compliance process, the Company may alter the formulation, packaging or labeling of its products to conform to applicable regulations as well as local variations in customs and consumer habits, and the Company may modify certain aspects of its network marketing system as necessary to comply with applicable regulations. Where reformulations of the Company's four principal weight control products are required, the Company has historically found substitute or replacement ingredients to be readily available, though there can be no assurance in this regard in the future. Where regulatory approval in a foreign market is not required, the Company obtains the favorable opinion of local counsel as to compliance with all applicable regulations.\nFollowing completion of the regulatory compliance phase, the Company undertakes the steps necessary to meet the operational requirements of the new market. In the majority of its markets, the Company establishes either a distribution center or a sales center; in countries without a distribution or sales center, the Company generally arranges for its products to be distributed from distribution or sales centers in the same region. In addition, the Company initiates plans to satisfy the inventory, personnel and transportation requirements of the new market, and the Company modifies its distributor manuals, cassette recordings, video cassettes and other training materials as necessary to be suitable for the new market.\nAlthough the Company intends to expand into new markets, there can be no assurance that the Company can open markets on a timely basis or that such new markets will prove to be profitable. Significant regulatory and legal barriers must be overcome before marketing can begin in any new market. Also, before marketing has commenced, it is difficult to assess the\nextent to which the Company's products and sales techniques will be successful in any given country. In addition, expansion of the Company's operations into new markets entails substantial working capital and capital expenditure requirements associated with both the regulatory compliance and operations phases of the process. The lead-time and costs associated with opening anticipated new markets may significantly exceed those of entering new markets in the past due to greater regulatory barriers, the necessity of adapting to entirely new regulatory systems and problems related to entering new markets with different cultural bases and political systems from those encountered in the past. The lead-time necessary to open a new market has generally been up to two years or more.\nPRODUCT DISTRIBUTION\nThe Company's weight control, nutritional, and some personal care products are distributed to foreign markets either from the facilities of the Company's manufacturers or from the Company's Los Angeles distribution center. Products are distributed in the United States market from one of those locations or from the Company's Memphis distribution center. Products are generally transported by cargo ship or plane to the Company's international markets and are warehoused in one of the Company's foreign distribution centers. After arrival of the products in a foreign market, distributors purchase the products from the local distribution center or the associated sales center. The Company's Dermajetics-Registered Trademark- personal care products, are predominantly manufactured in France. The products are shipped to the Company's Strasbourg distribution center, from which delivery by ship or plane to other international markets occurs.\nREGULATION\nIn both its United States and foreign markets, the Company may be subject to or affected by extensive laws, regulations, administrative determinations and similar constraints (as applicable, at the federal, state and local levels) (hereinafter \"regulations\") including, among other things, regulations pertaining to (i) product formulation, labeling and packaging, (ii) product claims and advertising, whether made by the Company or its distributors, (iii) the Company's network marketing system, and (iv) transfer pricing and similar regulations that affect the level of foreign taxable income and customs duties.\nPRODUCT FORMULATION, LABELING AND PACKAGING\nBecause the Company's products are food and dietary supplements and the Company makes no therapeutic claims for its products, the Company believes that its product formulations do not require approval by the FDA prior to sale. The Company continuously monitors FDA regulations with respect to the ingredients contained in its products. Based upon such regulations and communications with FDA staff members, on occasion the Company has reformulated a product to eliminate, substitute or modify an ingredient, and such reformulations may be required with respect to additional products in the future. Further, although the Company believes its product formulations comply with all applicable regulations, the FDA is authorized at any time to impose various restrictions on or affecting the Company and its products that may prohibit the Company from selling any one or more of its products in the United States, impair the production of the Company's products, or impede the importation of ingredients for the Company's products.\nCurrently, in order for the Company to market its products, such products must be \"safe\" within the meaning of the United States laws and regulations, including the Food, Drug and Cosmetic Act, as amended. The Company believes that all of its products are safe within that meaning. In particular, the Company believes that Thermojetics-Registered Trademark-, which includes a Chinese herb known as \"Ma Huang\" that contains naturally-occurring ephedrine in small quantities, is safe based upon the common use of Ma Huang in foods for many years. Under the applicable laws and regulations, the general recognition of a substance's safety can be based upon experience obtained through its common use in foods.\nIn October 1994, Congress passed the Dietary Supplement Health and Education Act. The Act established a commission on dietary supplement labels to study and make recommendations for the regulation of label claims and statements for dietary supplements.\nThe Company cannot determine the effect that future governmental regulations or administrative orders may have on the Company's business. However, such regulations and orders could require the reformulation of certain products to meet new standards, the recall or discontinuance of certain products not capable of reformulation, expanded documentation of the properties of certain products, expanded or different labeling, and scientific substantiation regarding product ingredients, safety or usefulness. Any or all such requirements could have an adverse effect on the Company.\nIn foreign markets, prior to commencing operations and prior to making or permitting sales of its products in the market, the Company may be required to obtain an approval, license or certification from the country's ministry of health or comparable\nagency. Where a formal approval, license or certification is not required, the Company nonetheless seeks a favorable opinion of counsel regarding the Company's compliance with applicable laws. Prior to entering a new market in which a formal approval, license or certificate is required, the Company works extensively with local authorities in order to obtain the requisite approvals. The approval process generally requires the Company to present each product and product ingredient to appropriate regulators and, in some instances, arrange for testing of products by local technicians for ingredient analysis. Such approvals may be conditioned on reformulation of the Company's products or may be unavailable with respect to certain products or certain ingredients. Product reformulation or the inability to introduce certain products or ingredients into a particular market may have an adverse effect on sales.\nThe Company must also comply with product labeling and packaging regulations that vary from country to country. The Company's failure to comply with such regulations can result in, among other things, a product being removed from sale in a particular market, either temporarily or permanently.\nAdvertisements and claims made with respect to the Company's products, whether by the Company or its distributors, are strictly regulated. The Company is affected by regulations applicable to the activities of its distributors because in some countries the Company is, or regulators may assert that the Company is, responsible for its distributors' conduct, or such regulators may request or require that the Company take steps to ensure its distributors' compliance with regulations. The types of regulated conduct include, among other things, representations concerning the Company's products (including therapeutic claims, which are generally prohibited), public media advertisements (which in foreign markets may require prior approval by regulators) and sales of products in markets in which such products have not been approved, licensed or certified for sale. In certain markets, it is possible that improper product claims by distributors could result in the Company's products being reviewed or re-reviewed by regulatory authorities and, as a result, being classified or placed into another category as to which stricter regulations are applicable. In addition, certain labeling changes might be required.\nThrough its manuals, seminars and other training materials and programs, the Company attempts to educate its distributors as to the scope of permissible and impermissible activities in each market. The Company also investigates allegations of distributor misconduct. However, the Company's distributors are generally independent contractors, and the Company is not able to monitor directly all distributor activities. As a consequence, there can be no assurance that the Company's distributors comply with applicable regulations. Misconduct by distributors has in the past and could again have a material adverse effect on the Company in a particular market or in general.\nNETWORK MARKETING SYSTEM\nThe Company's network marketing system is subject to a number of federal and state regulations administered by the Federal Trade Commission and various state agencies as well as regulations in foreign markets administered by foreign agencies.\nRegulations applicable to network marketing organizations are generally directed at ensuring that product sales are ultimately made to retail consumers (as opposed to other distributors) who consume the product and that advancement within such organizations be based on sales of the organizations' products rather than investments in the organizations or other non-retail sales related criteria. For instance, in certain markets there are limits on the extent to which distributors may earn royalties on sales generated by distributors that were not directly sponsored by the distributor. Where required by law, the Company obtains regulatory approval of its network marketing system or, where such approval is not required, the favorable opinion of local counsel as to regulatory compliance.\nHowever, the Company remains subject to the risk that, in one or more of its markets, its marketing system could be found not to be in compliance with applicable regulations. Failure by the Company to comply with these regulations could have an adverse material effect on the Company in a particular market or in general.\nTRANSFER PRICING AND SIMILAR REGULATIONS\nIn many foreign countries, the Company is subject to transfer pricing regulations, restrictions on management fees charged by the Company to its local subsidiary and similar regulations and restrictions designed to ensure that appropriate levels of income are reported as earned by the local subsidiary and taxed by the foreign governmental authorities. In addition, the Company's operations in foreign countries are subject to regulations designed to ensure that appropriate levels of customs duties are assessed on the importation of the Company's products.\nWhile the Company believes it is in compliance with all applicable regulations and restrictions, it is subject to the risk that foreign governmental authorities could audit its transfer pricing and related practices and assert that additional taxes are\nowed. In the event that such audits were concluded adversely to the Company, the Company believes that it could generally offset or mitigate the consolidated effect of foreign taxes required to be paid through the use of U.S. foreign tax credits. However, depending upon the years at issue, the Company might not be able to amend prior U.S. tax returns to obtain the benefit of such credits. Furthermore, because the laws and regulations governing U.S. foreign tax credits are complex and depend, among other things, on tax treaties with foreign nations in addition to U.S. tax laws, there can be no assurance that the Company would in fact be able to take advantage of any tax credits.\nOTHER REGULATIONS\nThe Company is also subject to a variety of other regulations in various foreign markets, including regulations pertaining to social security assessments and value added taxes, employment and severance pay requirements, import\/export regulations and antitrust issues. As an example, in many markets, the Company is substantially restricted in the amount and types of rules and termination criteria that it can impose on distributors without causing social security assessments to be payable by the Company on behalf of such distributors and without incurring severance obligations to terminated distributors. In some countries, the Company may be subject to such obligations in any event.\nFailure by the Company to comply with such regulations could have a material adverse effect on the Company in a particular market or in general. Such assertions or the effect of adverse regulations in one market could adversely affect the Company in other markets as well by causing increased regulatory scrutiny in those other markets or as a result of the negative publicity generated in those other markets.\nCOMPLIANCE PROCEDURES\nAs indicated above, the Company, its products and its network marketing system are subject, both directly and indirectly through distributors' conduct, to numerous federal, state and local regulations both in the United States and foreign markets. In the mid-1980's, the Company's products and network marketing system became the subject of regulatory scrutiny in the United States resulting in large part from claims and representations about the Company's products. In connection with such regulatory scrutiny by the California Attorney General and other state authorities that resulted in a lawsuit being filed by such authorities, in 1986 the Company voluntarily stipulated to a judgment and permanent injunction that, among other things, prevents the Company from making certain specified claims in future product advertisements and requires the Company to implement certain documentation systems with respect to payments to the Company's distributors. The Company believes that it is in compliance with the terms of the injunction.\nIn addition, beginning in 1985, the Company began to institute formal regulatory compliance measures by developing a system to identify specific complaints against distributors and to remedy any violations by distributors through appropriate sanctions, including warnings, suspensions and, when necessary, terminations. In its manuals, seminars and other training programs and materials, the Company emphasizes that distributors are prohibited from making therapeutic claims for the Company's products.\nThe Company's general policy regarding acceptance of distributor applications from individuals who do not reside in one of the Company's markets is to refuse to accept such individual's distributor application. From time to time, exceptions to the policy are made on a country by country basis.\nIn order to comply with regulations that apply to both the Company and its distributors, the Company conducts considerable research into the applicable regulatory framework (typically, with the assistance of local legal counsel and other representatives) prior to entering any new market to identify all necessary licenses and approvals and applicable limitations in the Company's operations in that market. The Company devotes substantial resources to obtaining such licenses and approvals and bringing its operations into compliance with such limitations. The Company also researches laws applicable to distributor operations and revises or alters its distributor manuals and other training materials and programs to provide distributors with guidelines for operating a business, marketing and distributing the Company's products and similar matters, as required by applicable regulations in each market. However, the Company is not able to monitor its distributors effectively to ensure that they refrain from distributing the Company's products in countries where the Company has not commenced operations, and the Company does not devote significant resources to such monitoring.\nIn addition, regulations in existing and new markets are often ambiguous and subject to considerable interpretive and enforcement discretion by the responsible regulators. Moreover, even when the Company believes that it and its distributors are initially in compliance with all applicable regulations, new regulations are regularly being added and the interpretation of existing regulations is subject to change. Further, the content and impact of regulations to which the Company is subject may\nbe influenced by public attention directed at the Company, its products or its network marketing system, so that extensive adverse publicity about the Company, its products or its network marketing system may result in increased regulatory scrutiny.\nIt is an ongoing part of the Company's business to anticipate and respond to such new and changing regulations and make corresponding changes in the Company's operations to the extent practicable. However, while the Company devotes considerable resources to maintaining its compliance with regulatory constraints in each of its markets, there can be no assurance that the Company would be found to be in full compliance with applicable regulations in all of its markets at any given time or that the regulatory authorities in one or more markets will not assert, either retroactively or prospectively or both, that the Company's operations are not in full compliance. Such assertions or the effect of adverse regulations in one market could negatively affect the Company in other markets as well by causing increased regulatory scrutiny in those other markets or as a result of the negative publicity generated in those other markets. Such assertions could have a material adverse effect on the Company in a particular market or in general. Furthermore, depending upon the severity of regulatory changes in a particular market and the changes in the Company's operations that would be necessitated to maintain compliance, such changes could result in the Company experiencing a material reduction in sales in such market or determining to exit such market altogether. In such event, the Company would attempt to devote the resources previously devoted to such market to a new market or markets or other existing markets, but there can be no assurance that such transition would not have an adverse effect on the Company's business and results of operations either in the short or long term.\nTRADEMARKS\nThe Company uses the umbrella trademarks Herbalife-Registered Trademark-, Thermojetics-Registered Trademark-, Dermajetics-Registered Trademark- and several other trademarks and tradenames in connection with its products and operations. Trademark registrations are either issued or pending in the United States Patent and Trademark Office and in comparable agencies in many other countries. The Company considers its trademarks and tradenames to be an important factor in its business. The Company's product formulations are not protected by patents and are generally not patentable.\nCOMPETITION\nThe Company is subject to significant competition from other network marketing organizations, including those that market food and dietary supplements, for the recruitment of distributors. Some of the Company's competitors are substantially larger and have available considerably greater financial resources than the Company. The Company's ability to remain competitive depends, in significant part, on the Company's success in recruiting and retaining distributors through an attractive compensation plan and other incentives. The Company believes that its production bonus program, international sponsorship program and other compensation and incentive programs provide its distributors with significant earning potential. However, there can be no assurance that the Company's programs for recruitment and retention of distributors will be successful.\nIn addition, the business of marketing food and dietary supplements, in particular weight control products, is highly competitive. This market segment includes numerous manufacturers, distributors and marketers that actively compete for the business of consumers both in the United States and abroad. The market is highly sensitive to the introduction of new products or weight control plans that may rapidly capture a significant share of the market. As a result, the Company's ability to remain competitive depends in part upon the successful introduction of new products, such as Thermojetics-Registered Trademark- and Dermajetics-Registered Trademark-.\nIn addition, the Company's ability to stimulate sales through new market expansion and new product introduction in existing markets is dependent upon the Company's ability to reformulate products from its existing product line in order to comply with applicable regulations in each market. The Company believes it has developed a sophisticated, systematic approach to new market expansion and new product introduction. However, there can be no assurance that the Company's new market expansion and new product introduction plans will be successful in the future.\nEMPLOYEES\nOn December 31, 1995, the Company had 1060 full-time employees. This number does not include the Company's distributors, who are generally independent contractors rather than employees of the Company. The Company considers its employee relationships to be satisfactory. Except for certain employees in Mexico, none of the Company's employees is a\nmember of any labor union, and the Company has never experienced any business interruption as a result of any labor disputes.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company leases all of its physical properties located in the United States. The Company's executive offices, re-located to Century City, California in February 1996, include approximately 81,000 square feet of general office space under a lease that expires in January 2006. The Company leases an aggregate of approximately 130,000 square feet of office space, computer facilities and conference rooms at the Operations Center in Inglewood, California, under leases that expire in October 1996, and approximately 96,000 square feet of warehouse space in two separate facilities located in Los Angeles and Memphis. The Los Angeles agreement has terms through August 1996 and the Memphis facility is leased on a month-to-month basis. The Company also leases warehouse and office space in a majority of its other geographic areas of operations. The Company believes that its existing facilities are adequate to meet its current requirements and that comparable space is readily available at each of these locations.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIn 1995, the Company and certain of its officers and directors were served with three complaints alleging violation of federal securities laws.\nPLATTUS V. GERRITY ET AL. USDC C.D. Cal. 95-0400 SVW (January 20, 1995)\nRESPLER V. HUGHES ET AL. USDC C.D. Cal. 95-0447 KN (January 24, 1995)\nALTMAN V. HUGHES ET AL. USDC C.D. Cal. 95-1027 ABC (February 17, 1995)\nGenerally, the plaintiffs in the lawsuits alleged that certain public reports and statements made by or attributable to the Company between October 1993 and January 1995 were materially false or misleading and thereby had the effect of artificially inflating the trading price of the Company's stock. Each of the lawsuits named, in addition to the Company, certain of the Company's officers and directors alleged to be responsible for, or to have knowledge of the false or misleading disclosures and to have sold stock at allegedly inflated prices with knowledge of material information not then known to the public. The Company has certain indemnity obligations to the named officers and directors. The Company has directors and officers liability insurance which, subject to certain customary exceptions and exclusions, is expected to cover a portion or all of any such obligations less the Company's self-retention amount. In March 1995, the court consolidated the three complaints. In January 1996, the court dismissed in its entirety the plaintiffs' consolidated complaint. In February 1996, the plaintiffs filed a Notice of Appeal of the court's order of dismissal.\nThe Company's French subsidiary has been subject to a tax audit by French tax authorities, who are proposing that significant value added, withholding, and income taxes are due. The Company and its tax advisors believe that the Company has substantial defenses and the Company is vigorously contesting these and other potential assessments. However, the ultimate resolution of this matter may take several years.\nFurthermore, the Company is from time to time engaged in routine litigation incident to the conduct of its business. The Company regularly reviews all pending litigation matters in which it is involved and establishes reserves deemed appropriate by management for such litigation matters. The Company believes that no litigation currently pending against it will have a material adverse effect on its consolidated financial position and results of operations.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Company's Common Stock has been quoted on the National Market System of the National Association of Securities Dealers Automated Quotation System (\"NASDAQ-NMS\") under the symbol \"HERB\" since April 21, 1992. The table below sets forth, for the periods indicated, the high and low closing bid prices of the Common Stock, as reported on NASDAQ-NMS.\n___________\n*The bid\/closing prices in the table were taken from a written summary provided to the Company by NASDAQ. Prices reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not represent actual transactions.\nAt February 29, 1996, 29,887,864 shares of the Company's Common Stock were issued and outstanding, and were held by 1348 stockholders of record.\nPrior to the third quarter of 1992, the Company had never paid a dividend on its Common Stock. In June 1992, the Company announced the adoption of a cash dividend practice. The Company paid quarterly dividends of $0.18 per share for the dividends paid on February 11, 1994, May 5, 1994 and August 4, 1994, increased the dividend to $0.22 per share for the dividends paid on November 3, 1994, February 2, 1995, May 4, 1995 and August 3, 1995, and reduced the dividend to $0.15 per share for the dividends paid on November 2, 1995 and February 15, 1996. The declaration of dividends in the future will be determined by the Board of Directors in its discretion and the amount of dividends declared and paid in future quarters will depend, among other factors, on increased levels of profitability, as well as other planned uses of the Company's cash resources.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe selected consolidated financial data set forth below for each of the years in the five-year period ended December 31, 1995 are derived from the audited consolidated financial statements of the Company. The selected financial and operating data should be read in conjunction with Management's Discussion and Analysis of Results of Operations and Financial Condition and the consolidated financial statements and related notes.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\nThroughout this report \"retail sales\" are determined as the gross sales amounts reflected on the Company's invoices to its distributors. The Company does not receive the amount reported as \"retail sales\", and the Company does not monitor the actual retail prices charged for the Company's products. \"Net sales\" represent the actual purchase prices paid to the Company by its distributors, after giving effect to distributor discounts (referred to as \"distributor allowances\"), which total approximately 50% of suggested retail sales prices. The Company receives its net sales price in cash or through credit card payments upon receipt of orders from distributors. The Company's \"operating margin\" consists of net sales less (i) \"cost of sales,\" consisting of the prices paid by the Company to its manufacturers for products and costs related to product shipments, foreign duties and tariffs and similar expenses, and (ii) \"royalty overrides,\" currently consisting of (a) royalties (5% to 15%) and bonuses (up to 6%) on the suggested retail sales prices of products earned by qualifying distributors on the sales of other distributors within their distributor organizations, and (b) the President's Team Bonus payable to certain of the Company's most senior distributors in the aggregate amount of up to an additional 1% of product retail sales. Royalty overrides as reported in the Consolidated Statements of Income are net of a handling fee (6% of retail sales effective April 1, 1994, previously 5%) charged by the Company to its distributors on purchases of products from the Company.\nThe Company's use of \"retail sales\" in reporting financial and operating data reflects the fundamental role of \"retail sales\" in the Company's accounting systems, internal controls and operations, including the basis upon which distributor bonuses are paid. The retail sales price of the Company's products is reflected in distributor invoices as the price charged to distributors together with, in most cases, a deduction for the corresponding distributor allowance. The retail sales price is used by the Company to calculate, among other things, royalty overrides and \"volume points\" earned by distributors. Volume points are point values assigned to each of the Company's products that are equal in all countries, and are used as a supervisor qualification criteria. In addition, management relies upon \"retail sales\" data reflected in daily sales reports to monitor results of operations in each of the Company's markets.\nThe significance of the Company's \"net sales\" is to reflect, generally, the prices actually received by the Company after deducting the basic distributor allowance, but before deducting royalty overrides and bonuses. The ratio of the Company's \"retail sales\" to \"net sales\" is relatively constant because distributor allowances historically total approximately 50% of suggested retail sales prices. Accordingly, factors that affect \"retail sales\" generally have a corresponding and proportionate effect on \"net sales.\" To the extent the ratio of \"retail sales\" to \"net sales\" varies from period to period, such variances have resulted principally from sales of the Company's distributor kits and other educational and promotional materials, for which there are no distributor allowances. Sales of such items initially decreased and thereafter stabilized as a percentage of total retail sales since 1991, but such decreases have not had a material impact on the ratio of the Company's \"retail sales\" to \"net sales\" or on the Company's operating margin.\nThe Company's results of operations for the periods described below are not necessarily indicative of results of operations for future periods, which depend upon numerous factors including the Company's ability in the future to enter new markets and introduce additional and new products into its markets.\n1995 COMPARED TO 1994\nRetail sales increased 4.5% to $923.6 million in 1995 from $884.1 million in 1994. Regionally, retail sales in the year ended December 31, 1995 compared to the year ended December 31, 1994 increased 153.9% and 14.7% in Asia\/Pacific Rim and The Americas, respectively; and decreased 21.0% in Europe. In The Americas, retail sales increased from $354.3 million in 1994 to $406.2 million in 1995. In Asia\/Pacific Rim, retail sales increased from $56.5 million in 1994 to $143.5 million in 1995. In Europe, retail sales decreased from $473.3 million in 1994 to $373.9 million in 1995. Contributing to 1995 consolidated retail sales was the introduction of the first three phases of products in the company's new line of personal care products, the Skin Care Kit in January 1995, the fragrances, Parfums Vitessence-TM-, in April 1995 and the facial products, Nature's Mirror-TM-, in October 1995. The new products accounted for $107.4 million of consolidated retail sales in 1995. The products were introduced extensively in Europe and The Americas where they accounted for $49.2 million and $50.7 million, or 13.2% and 12.5%, of those regions' retail sales in 1995. For the fourth quarter ended December 31,1995 retail sales rose to $257.4 million compared with $230.3 million for the comparable period in 1994, due primarily to increased sales in Japan and the start of operations in Brazil.\nIn The Americas, combined retail sales in 1995 increased $51.9 million, or 14.7% when compared to 1994, which was due to (i) sales increase in the U.S. of $38.6 million or 13.1% when compared to 1994, and (ii) the opening of Brazil in October 1995 which reported retail sales of $24.2 million. The increases were partly offset by a reduction in sales in Mexico resulting from devaluation of the Mexican peso. Within The Americas, U.S. retail sales accounted for $333.6 million or 36.1% of total worldwide retail sales in 1995, compared to $295.0 million or 33.4% of total worldwide retail sales in 1994. The increase in U.S. retail sales as a percentage of worldwide retail sales resulted from increased U.S. sales and approximately constant foreign sales in 1995 as compared to 1994. Also during the fourth quarter the Company reintroduced the sale of Thermojetics-Registered Trademark-Green tablets in the U.S. which contain, among other ingredients, the Chinese herb known as Ma Huang which contains small quantities of naturally occurring ephedrine.\nIn Europe, the decrease in German sales of $43.9 million, together with sales decreases in the Czech Republic, France, Israel, Italy, Spain and the U.K, were partially offset by sales in Belgium, Denmark, Poland, Sweden, all of which opened in the second half of 1994, and sales in Austria, Russia, South Africa and Switzerland which opened in the second and third quarters of 1995. The decrease in sales in Germany was part due to the suspension of sales of Thermojetics-Registered Trademark-Instant Herbal Beverage in that country in July 1995. The suspension led to an increase in product returns and distributor resignations, as well as a decline in sales of other products. Sales in France were negatively impacted by an adverse business environment in late 1994, while 1995 sales were stable but at lower levels. The Company believes that a significant factor affecting these markets has been the opening of other new markets within the same geographic region or with the same or similar language or cultural bases, and the inclination of some distributors to focus their attention on business opportunities provided by new markets which can have a negative impact on existing markets.\nThe Asia\/Pacific Rim growth was due to (i) sales increases in Japan of $63.0 million, or 335.7% when compared to 1994, and (ii) the opening of the Philippines in December 1994 and Taiwan in July 1995, which reported combined retail sales of $17.6 million for 1995.\nOperating margin decreased 1.8% to $206.5 million in 1995 from $210.4 million in 1994. As a percentage of retail sales, operating margin for 1995 decreased to 22.4% from 23.8% in 1994. The decreased operating margins are due to higher cost of sales and royalty overrides as a percentage of retail sales. The cost of sales percentage increased to 15.5% in 1995 from 14.8% in 1994. Such increase includes higher freight costs resulting from (i) redeployment of inventories to meet demand patterns and (ii) provisions made against slow moving inventory. Royalty overrides as a percentage of retail sales increased to 15.0% in 1995 from 14.2% in 1994. This increase includes primarily the effect of a modification to the marketing plan made in June 1995, which increased the royalties earned by distributors and increased bonuses payable to certain of the Company's senior distributors.\nMarketing, distribution and administrative expenses increased 26.1% to $176.0 million in 1995 from $139.6 million in 1994. As a percentage of retail sales, these expenses increased to 19.1% in 1995 from 15.8% in 1994. Selling expenses increased $5.1 million, corporate expenses increased $18.6 million and distribution expenses increased $12.7 million. The increased selling expenses were instrumental in an effort to increase International Business Package (distributor kit) sales, stimulate new distributor sponsoring rates and expand distributor training. The increase was also due to introductions of new technologies such as International Satellite Supervisor Training and The Herbalife Broadcast Network, a home based satellite television program. The corporate expenses increased due to (i) initiatives taken in new product introductions and marketing activities, (ii) intensified government and media relations and other business related functions and (iii) foreign exchange losses which increased $2.5 million in 1995, when compared to 1994. The increase in distribution expense was due to new country openings and facility and staff expansions in Japan and Germany.\nDuring 1995, the Company made a detailed study of its European warehousing and distribution systems to identify possible areas of cost savings. As a result, the Company will make a number of changes in its European infrastructure in order to enhance operating efficiencies. In connection with this change, the Company recorded a restructuring charge of $2.3 million, primarily relating to lease termination costs. Infrastructure modifications are scheduled to take place in the second half of 1996.\nIncome taxes decreased to $11.8 million in 1995 from $27.6 million in 1994. As a percentage of pre-tax income, income taxes remained constant at 37.5%.\nNet income decreased 57.1% to $19.7 million in 1995 from $46.0 million in 1994, as a result of the factors described above. However, net income in the quarter ended December 31, 1995 increased 11.8% to $5.0 million from $4.5 million in the quarter\nended December 31, 1994. The increase primarily resulted from decreased marketing, distribution and administrative expenses which were partly offset by higher corporate expenses.\n1994 COMPARED TO 1993\nRetail sales increased 27.6% to $884.1 million from $693.0 million for 1994 as compared to 1993. Regionally, retail sales in the year ended December 31, 1994 compared to the year ended December 31, 1993 increased 104.5%, 29.4% and 20.9% in Asia\/Pacific Rim, The Americas and Europe, respectively. In Asia\/Pacific Rim, retail sales in 1994 increased from $27.6 million to $56.5 million compared to 1993. This growth was due to the opening of Japan in late 1993, to the successful introduction of Thermojetics-Registered Trademark- products in a number of markets, and the positive impact that sales of Thermojetics-Registered Trademark- products had on sales of the Company's other principal weight control products. In The Americas, retail sales in 1994 increased from $273.9 million to $354.3 million compared to 1993. This growth was due to three factors: (i) the continued strength of the Thermojetics-Registered Trademark- family of products in North America, including the positive impact such sales have on sales of the Company's other weight control products, (ii) the successful opening of Argentina in mid-1994, resulting in sales of $19.1 million in that country, and (iii) improved distribution of product in Mexico with the opening of the Company's second distribution center in that country in 1994. In Europe, retail sales increased from $391.5 million in 1993 to $473.2 million in 1994. The most important factor impacting the growth in this region was the introduction of the first Thermojetics-Registered Trademark- product, Thermojetics-Registered Trademark- Instant Herbal Beverage, in 12 of the region's countries during 1994, and its positive effect on sales of the other weight control products. Partially offsetting this gain in Europe was an adverse business environment facing distributors in France. That environment included negative publicity regarding the Company's distributors and had the effect of reducing France's fourth quarter sales by approximately $9.8 million and $14.5 million compared to the third quarter of 1994 and the fourth quarter of 1993, respectively.\nWithin The Americas, U.S. retail sales grew to $295.0 million or 33.4% of total worldwide retail sales in 1994, compared to $247.0 million or 35.6% of total worldwide retail sales in 1993. The decrease in U.S. retail sales as a percentage of worldwide retail sales resulted from a greater increase in foreign sales, in relation to U.S. sales, in 1994 as compared to 1993.\nOperating margin increased 37.0% to $210.3 million in 1994 from $153.5 million in 1993. As a percentage of retail sales, operating margin for 1994 increased to 23.8% from 22.2% in 1993. The principal reasons for the improved operating margin were (i) a reduced royalty override expense effective April 1, 1994 as a result of increasing the handling fee (6% of retail product sales effective on that date, up from 5%), which fee is incorporated in royalty override expense, and (ii) a reduction in costs of sales expense as a percentage of retail sales from 15.0% in 1993 to 14.8% in 1994. The reduction in costs of sales as a percentage of retail sales reflects the favorable effects of a duty reduction initiative implemented by the Company in Europe in 1994 overcoming increased freight costs associated with (i) the increase in foreign sales as a percentage of total retail sales in 1994 when compared to 1993, and (ii) excess air freight usage for new product introductions and new country openings.\nMarketing, distribution and administrative expenses increased 57.0% to $139.6 million in 1994 from $88.9 million in 1993. As a percentage of retail sales, these expenses increased to 15.8% in 1994 from 12.8% in 1993. The increase is principally a result of (i) increased sales and marketing expenses in connection with various sales enhancement programs, and (ii) staffing and facilities' expansion to support new country opening initiatives and accelerated activities in introducing new products in existing markets.\nIncome taxes increased 9.8% to $27.6 million in 1994 from $25.2 million in 1993. As a percentage of pre-tax income, income taxes decreased to 37.5% in 1994 from 37.9% in 1993. This reduction is due to the implementation of tax strategies by the Company which offset the effect of a U.S. tax rate increase resulting from the 1993 Omnibus Budget Reconciliation Act.\nNet income increased 11.8% to $46.0 million in 1994 from $41.2 million in 1993, as a result of the factors described above. However, net income in the quarter ended December 31, 1994 decreased 54.7% to $4.5 million from $9.9 million in the quarter ended December 31, 1993. The decrease primarily resulted from the decline in sales in France in the quarter ended December 31, 1994, referred to above, and increased marketing, distribution and administrative expenses as a result of (i) expenditures made to counteract the France sales decline, and (ii) investment in sales enhancement programs to increase sales worldwide.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company has historically met its working capital and capital expenditure requirements, including funding for expansion of operations, through net cash provided by operating activities. For the year ended December 31, 1995, net cash provided by operating activities was $77.9 million, compared to $14.8 million and $36.5 million for the years ended December 31, 1994 and\n1993, respectively. Although net income in 1995 decreased $26.3 million when compared to 1994, net cash provided by operating activities increased by $63.0 million. This increase resulted primarily from reductions in inventories, prepaid expenses and other current assets, increases in advanced sales deposits and royalty override accruals and reduced taxable income and the timing of income tax payments.\nStockholders' equity decreased $0.3 million to $109.5 million at December 31, 1995 from $109.8 million at December 31,1994. In 1995, net income of $19.7 million was offset by $22.2 million of dividends declared. The dividend in the third and fourth quarters of 1995 was reduced to $0.15 per share from $0.22 per share in the prior four quarters. The payment of dividends is determined by the Board of Directors at its discretion and the amounts of dividends declared and paid in future quarters will depend, among other factors, on increased levels of profitability, as well as other planned uses of the Company's cash resources.\nCapital expenditures for the year ended December 31, 1995 were $7.2 million compared to $8.6 million and $4.1 million for the years ended December 31, 1994 and 1993, respectively. The majority of the 1995 expenditures were made to upgrade computer and office equipment, and to expand facilities to support growth. For 1996, the Company is planning to invest up to $7 million in management information systems including hardware and software. In connection with its entry into each new market, the Company funds inventory requirements and typically establishes either a full-service distribution center, sales office, a fulfillment center or compliance office, or a combination of the foregoing. While the capital requirements associated with entry into new markets vary, the Company estimates that approximately $7 million will be required for pre-opening expenses and capital expenditures associated with its 1996 new market expansion activities.\nOn January 12, 1996, the Company announced that its Board of Directors had approved a share repurchase program pursuant to which up to $5 million could be expended to repurchase shares of the Company's common stock. As of March 13, 1996, the Company had expended $1.7 million to make repurchases of its shares in the public market.\nIn total, cash and cash equivalents increased $34.9 million in 1995 to $69.2 million at December 31, 1995. At December 31, 1995, the Company's cash, cash equivalents and marketable securities aggregate balance was $104.2 million, which represents a $45.1 million increase from the balance as of December 31, 1994.\nThe Company has not been subjected to material price increases by its suppliers for several years. The Company believes that it has the ability to respond to a portion or possibly all of any price increases by raising the price of its products. Purchases by the Company from its suppliers are made in U.S. dollars, while sales to distributors are generally made in local currencies. Consequently, strengthening of the U.S. dollar versus a foreign currency can have a negative impact on operating margins and can generate transaction losses on intercompany transactions. The Company enters into forward exchange contracts to manage its foreign exchange risk on intercompany transactions. Transaction losses totaled $3.3 million, $0.1 million and $2.6 million in the years ended December 31, 1993, 1994 and 1995, respectively.\nFor a discussion of certain contingencies that may impact liquidity and capital resources, see \"Note 9, Contingencies,\" in the Company's consolidated financial statements included herein.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe consolidated financial statements of the Company, together with the Report thereon of Deloitte & Touche LLP, independent auditors, are included elsewhere herein on pages 25 through 40.\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 called for by Item 10 of Part III is incorporated by reference to the Company's definitive Proxy Statement for the 1996 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission within 120 days after the close of the year ended December 31, 1995.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation called for by Item 11 of Part III is incorporated by reference to the Company's definitive Proxy Statement for the 1996 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission within 120 days after the close of the year ended December 31, 1995.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation called for by Item 12 of Part III is incorporated by reference to the Company's definitive Proxy Statement for the 1996 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission within 120 days after the close of the year ended December 31, 1995.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation called for by Item 13 of Part III is incorporated by reference to the Company's definitive Proxy Statement for the 1996 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission within 120 days after the close of the year ended December 31, 1995.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K\n(a) Documents filed as part of this report:\n1. FINANCIAL STATEMENTS\nThe following financial statements of the Company are filed with this report and can be found on the pages indicated below:\n2. FINANCIAL STATEMENT SCHEDULES\nNone.\n3. EXHIBITS\n(1) Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1987.\n(2) Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1989.\n(3) Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1990.\n(4) Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1991.\n(5) Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1992.\n(6) Incorporated by reference to the Company's definitive Proxy Statement relating to its annual meeting of shareholders held May 20, 1993.\n(7) Incorporated by reference to the Company's Registration Statement on Form S-1 (No. 33-66576) declared effective by the Securities and Exchange Commission on October 8, 1993.\n(8) Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the three months ended June 30, 1994.\n(9) Incorporated by reference to the Company's Definitive Proxy Statement relating to its 1994 Annual Meeting of Stockholders.\n(10) Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1994.\n(11) Filed herewith\n(12) Form of the amended and restated plan, to be submitted for shareholder approval at the 1996 Annual Meeting of Shareholders, will be attached as an appendix to the Proxy Statement relating to such meeting.\n(b) REPORTS ON FORM 8-K:\nNone.\n(c) OTHER EXHIBITS:\nSee \"Item 14(a)3. Exhibits.\"\n(d) OTHER FINANCIAL STATEMENT SCHEDULES:\nNone.\nINDEPENDENT AUDITORS' REPORT\nTo the Stockholders of Herbalife International, Inc.:\nWe have audited the accompanying consolidated balance sheets of Herbalife International, Inc. and subsidiaries (the \"Company\") as of December 31, 1994 and 1995, and the related consolidated statements of income, changes in stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1995. 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 Herbalife International, Inc. and subsidiaries at December 31, 1994 and 1995, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles.\nDELOITTE & TOUCHE LLP Los Angeles, California February 12, 1996\nHERBALIFE INTERNATIONAL, INC.\nCONSOLIDATED BALANCE SHEETS\nDECEMBER 31, 1994 AND 1995\nASSETS\nSee the accompanying notes to consolidated financial statements\nHERBALIFE INTERNATIONAL, INC.\nCONSOLIDATED BALANCE SHEETS\nDECEMBER 31, 1994 AND 1995\nLIABILITIES AND STOCKHOLDERS' EQUITY\nSee the accompanying notes to consolidated financial statements\nHERBALIFE INTERNATIONAL, INC.\nCONSOLIDATED STATEMENTS OF INCOME\nFOR THE YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995\nSee the accompanying notes to consolidated financial statements\nHERBALIFE INTERNATIONAL, INC. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1993, 1994, AND 1995\nSee the accompanying notes to consolidated financial statements\nHERBALIFE INTERNATIONAL, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995\nSee the accompanying notes to consolidated financial statements.\nHERBALIFE INTERNATIONAL, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. GENERAL\nHerbalife International, Inc. (the Company) has thirty-seven active subsidiaries, which are wholly owned by the Company.\nThe Company markets weight control products, other food and dietary supplements and personal care products worldwide. The Company's products, which consist of herbs and other natural ingredients, are marketed through a network marketing system in which \"distributors\" who are generally independent contractors purchase products for resale to retail consumers and other distributors. As of December 31, 1995, the Company conducted business in thirty-two countries located in the Americas, Europe and Asia\/Pacific Rim. In the Company's foreign markets, distributors market the same (or essentially the same) products as those sold in the United States and in fundamentally the same manner.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nCONSOLIDATION POLICY\nThe consolidated financial statements include the accounts of the Company and its subsidiaries; all significant intercompany transactions and accounts have been eliminated.\nTRANSLATION OF FOREIGN CURRENCIES\nEach foreign subsidiary's asset and liability accounts, which are originally recorded in the appropriate local currencies, are translated, for consolidated financial reporting purposes, into U.S. dollar amounts at year-end exchange rates. Revenue and expense accounts are translated at the average rates during the year. Transaction losses, which totaled $3,299,000, $111,000 and $2,573,000 in the years ending December 31, 1993, 1994 and 1995, respectively, are included in marketing, distribution and administrative expenses. Foreign exchange translation adjustments are accumulated in a separate component of stockholders' equity.\nFORWARD EXCHANGE CONTRACTS\nThe Company enters into forward exchange contracts in managing its foreign exchange risk on intercompany transactions and does not use the contracts for trading purposes. Gain and losses on forward exchange contracts are recorded when incurred. Premiums on such contracts are amortized into income over the life of the contracts.\nCASH AND CASH EQUIVALENTS\nThe Company considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents. Cash and cash equivalents comprise primarily money market accounts, foreign and domestic bank accounts and tax-exempt municipal bonds with short-term maturities. To reduce its credit risk, the Company monitors the credit standing of the financial institutions that hold the Company's cash and cash equivalents.\nMARKETABLE SECURITIES\nThe Company's marketable securities are classified as \"available for sale\". Fluctuations in fair value are included in a separate component of stockholders' equity. Marketable securities comprise primarily tax-exempt municipal bonds with contractual maturities of up to five years.\nINVENTORIES\nInventories are stated at lower of cost (on the first-in, first-out basis) or market.\nADVERTISING COSTS\nThe Company expenses advertising costs in the period incurred. Literature and promotional items are sold to distributors to support them in their sales efforts. Such items are included in inventories and are charged to cost of sales as they are sold.\nHERBALIFE INTERNATIONAL, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nLONG-LIVED ASSETS\nDepreciation of furniture, fixtures and other equipment is computed on a straight-line basis over the estimated useful lives of the related assets, which range from three to six years. Leasehold improvements are amortized on a straight-line basis over the life of the related asset or the term of the lease whichever is shorter. Maintenance and repairs are charged to income as incurred while major improvements are capitalized.\nCosts incurred in advance of commencing operations in a new country are capitalized. These costs comprise direct, incremental costs such as incorporation fees, product licenses, business permits, and establishing facilities in advance of selling product. These costs are amortized over a period not exceeding twenty-four months.\nGoodwill is being amortized over periods ranging from fifteen to forty years.\nLong-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. Impairment losses would be recognized if the carrying amount of the asset exceeds the fair value of the asset.\nINCOME TAXES\nIncome tax expense includes income taxes payable for the current year and the change in deferred income tax assets and liabilities for the future tax consequences of events that have been recognized in the Company's financial statements or income tax returns. A valuation allowance is recognized to reduce the carrying value of the deferred tax assets if it is more likely than not that some portion or all of the deferred tax assets will not be realized.\nROYALTY OVERRIDES\nAn independent distributor may earn commissions called royalty overrides or production bonuses based on retail volume. Such commissions are based on the retail sales volume of certain other members of the independent sales force who are sponsored by the distributor.\nREVENUE RECOGNITION\nThe Company records its retail sales based upon suggested retail prices as reflected on the Company's sales invoices to its distributors. The Company does not receive the amount reported as retail sales, but generally receives the net sales price in cash or through credit card payments upon receipt of orders from distributors. The net sales price is the suggested retail price less a distributor allowance approximating 50%. Sales and related royalty overrides are recorded when the merchandise is shipped. Advance sales deposits represent prepaid orders for which the Company has not shipped the merchandise.\nSOURCES OF SUPPLY AND PRODUCT DEVELOPMENT\nA large majority of the Company's products are produced by two manufacturers, who also perform substantially all of the Company's research and development functions and own certain product formulations and manufacturing processes relating to the Company's products. The Company has requirements contracts with these companies that extend to January 1998, whereby the Company has agreed to purchase all of its requirements for these products from the manufacturers, and the manufacturers have agreed to sell these products only to the Company.\nSTOCK COMPENSATION\nIn October 1995, the Financial Accounting Standards Board issued SFAS No. 123, \"Accounting for Stock-Based Compensation\". As permitted by SFAS No. 123, the Company expects to continue to apply Accounting Principles Board Opinion 25 and related interpretations in accounting for its stock-based compensation. Accordingly, the adoption of SFAS\nHERBALIFE INTERNATIONAL, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNo. 123, which is required beginning in 1996, will expand disclosure of the Company's stock option plans but is not expected to have a material effect on the consolidated financial statements of the Company.\nUSE OF ESTIMATES\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions. Such estimates and assumptions affect the reported amounts of assets and liabilities, the 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.\n3. INVENTORIES\nInventories comprise the following:\n4. BANK LOANS AND CONTRACTS PAYABLE\nBank loans and contracts payable consist of the following:\nAnnual scheduled payments of bank loans and contracts payable are: $1,185,000 (1996), $752,000 (1997), $453,000 (1998), $324,000 (1999), and $250,000 (2000).\nHERBALIFE INTERNATIONAL, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n5. LEASE OBLIGATIONS\nThe Company has warehouse and office facilities, furniture and fixtures and equipment under leases which expire at various dates through 2009. Under the lease agreements, the Company is also obligated to pay property taxes, insurance, and maintenance costs. Certain of the leases contain renewal options. Future minimum rental commitments for non-cancelable operating leases and capital leases at December 31, 1995 were as follows:\nRental expense for the years ended December 31, 1993, 1994 and 1995 was $3,539,000, $5,120,000, and $7,126,000, respectively.\nProperty under capital leases is included in property in the accompanying balance sheets at December 31, 1994 and 1995 as follows:\n6. EMPLOYEE COMPENSATION PLANS\nThe Company adopted an incentive compensation and production bonus plan in 1992 for officers, directors and key employees. Bonuses were awarded in 1993 and 1994 within the framework of this plan, except for the bonus paid to the Chief Executive Officer in 1993, which was determined in accordance with the formula in his Compensation Agreement of $20,000 for each one percent increase in the Company's primary earnings per share in 1993 as compared to 1992, and except for 1994 bonuses paid to a number of senior executives, which were determined under the Plan described below. Under the plan, up to 20% of earnings before bonuses and income taxes could be awarded based on the attainment of certain sales goals and net income. The expenses under the plans for 1993 and 1994 totaled $4,965,000 and $830,000, respectively. No bonuses were awarded under these plans for 1995.\nIn 1994, the Company adopted the 1994 Performance Based Annual Incentive Compensation Plan (\"the Plan\"). The purpose of the Plan is to provide additional compensation as an incentive to key executives and consultants to attain certain specified performance objectives of the Company. The amount of the available awards to individual participants and the aggregate amount to all participants is determined based upon objective performance goals as determined by the Compensation Committee of the Board of Directors. The amounts awarded under the Plan for 1994 totaled $3,160,000. No amounts were awarded under this plan for 1995.\nHERBALIFE INTERNATIONAL, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nThe Company also maintains a savings plan pursuant to Sections 401 (k) and (m) of the Internal Revenue Code. The plan is available to substantially all employees who meet length and service requirements. Employees may elect to contribute 2% to 15% of their compensation, and the Company will match a portion of the participant's contribution. Participants are partially vested in contributions, made on their behalf by the Company, after three years, and fully vested after seven years. Employer contributions were $144,000, $203,000 and $284,000 for the years ended December 31, 1993, 1994 and 1995, respectively.\n7. TRANSACTIONS WITH RELATED PARTIES\nThe majority stockholder and director of the Company owns a one-third interest in Raven Industries, a major supplier of one of the Company's products, and a one-fifth interest in Dynamic Products, Inc., a supplier of one of the Company's products. Another director of the Company owns a five percent interest in Dynamic Products, Inc. Total purchases from Raven Industries under a contract which expires in 1998 were $42,436,000, $41,801,000 and $26,246,000 for the years ended December 31, 1993, 1994 and 1995, respectively. Total purchases from Dynamic Products, Inc. were $2,351,000, $5,768,000 and $3,094,000 for the years ended December 31, 1993, 1994 and 1995, respectively. At December 31, 1994 and 1995, the aggregate amounts due to these suppliers were $1,062,000 and $971,000, respectively.\nThe Company engages Nutrient Research Consultants, Ltd., which is wholly owned by an officer, to perform consulting services related to the formulation and testing of nutritional products. For the years ended December 31, 1993, 1994 and 1995, payments by the Company to this consulting firm amounted to $967,000, $1,294,000 and $1,003,000, respectively.\nDuring 1994 and 1995, the Company advanced amounts to officers and directors under promissory notes that bear interest at various rates ranging from 5.75% to 7.93% per annum and are due and payable two years from the date of issuance. At December 31, 1994 and 1995, the total amount receivable from officers and directors was $3,815,000 and $1,269,000, respectively. Such notes were reduced in 1995 by $3,160,000 following ratification by the Compensation Committee of the Board of Directors of awards under the Company's 1994 Performance Based Annual Incentive Compensation Plan (see Note 6).\n8. RESTRUCTURING EXPENSES\nIn connection with the Company's plan to modify its European infrastructure in order to enhance operating efficiencies, the Company recorded a restructuring charge of $2,300,000 in the year ended December 31, 1995. The restructuring charge included expected termination costs for certain leases and a reduction in certain asset carrying values. The plan to modify the infrastructure will be implemented in the second half of 1996.\n9. CONTINGENCIES\nIn January 1995, the Company and certain of its officers and directors were served with three complaints alleging violation of federal securities laws. In March 1995, the court consolidated the three complaints. In January 1996, the court dismissed in its entirety the plaintiffs' consolidated complaint. In February 1996, the plaintiffs filed a notice of appeal of the court's order of dismissal. The Company has certain indemnity obligations to the named officers and directors. The Company has directors' and officers' liability insurance which, subject to certain customary exceptions and exclusions, is expected to cover a portion or all of any such obligations less the Company's self-retention amount. Based upon a review of the allegations of the complaints, the court's dismissal of the complaints and analysis by litigation counsel, the Company believes that it has substantial and meritorious defenses to the asserted claims and is vigorously contesting these claims.\nThe Company's French subsidiary has been subject to a tax audit by French tax authorities, who are proposing that significant value added, withholding, and income taxes are due. The Company and its tax advisors believe that the Company has substantial defenses and the Company is vigorously contesting these and other potential assessments. However, the ultimate resolution of this matter may take several years.\nDuring the third quarter of 1995, the Company received inquiries from certain governmental agencies within Germany and Portugal relating to the Company's product, Thermojetics-Registered Trademark- Instant Herbal Beverage. Pending resolution of these inquiries, the sale of this product in these countries was suspended. The Company is engaged in ongoing consultation with the\nHERBALIFE INTERNATIONAL, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nappropriate authorities, and the resumption of sales of this product is dependent upon the satisfactory outcome of these consultations.\nFurthermore, the Company is from time to time engaged in routine litigation incident to the conduct of its business. The Company regularly reviews all pending litigation matters in which it is involved and, estimating the impact of such litigation matters, establishes reserves considered appropriate by management. The Company's estimates of the impact of these matters may change as the matters progress and are ultimately resolved.\n10. STOCKHOLDERS' EQUITY\nIn October 1993, the Company offered and sold 2,647,000 shares of Common Stock. Proceeds to the Company net of underwriting commissions were $31.1 million and, after cash offering costs, net proceeds were $29.6 million. In addition, 75,588 shares of Common Stock with a value of $1,314,000 were issued in January 1994 to the firm of Mallory Factor, Inc. for their work on the offering.\nThe Company's 1991 Stock Option Plan as amended permits the granting of non-qualified stock options to key employees and consultants to purchase 3,500,000 shares of the Company's Common Stock at prices not less than 85% of the fair market value of such shares on the date the option is granted. The options vest ratably over a maximum of 5 years in minimum installments of 20% of the number of shares covered by the option. Summarized information related to the Company's 1991 Stock Option Plan and other separate stock option agreements is as follows:\nIn 1992 and 1993, three key management employees were issued a total of 525,000 restricted shares of Common Stock. The employees are entitled to receive dividends, but assumption of full beneficial ownership vests ratably over five years and is contingent upon remaining in continuous employment for the vesting period. Paid-in Capital in Excess of Par Value and Unearned Compensation were recorded for the market value of the shares issued. Unearned Compensation is being amortized over the vesting period and is shown as a reduction of stockholders' equity.\nHERBALIFE INTERNATIONAL, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n11. OPERATIONS IN FOREIGN COUNTRIES\nThe Company has subsidiaries in Argentina, Australia, Austria, Belgium, Brazil, Canada, Czech Republic, Denmark, Dominican Republic, Finland, France, Germany, Hong Kong, Israel, Italy, Japan, Mexico, Netherlands, New Zealand, Norway, Philippines, Poland, Portugal, Russia, South Africa, Spain, Sweden, Switzerland, Taiwan, United Kingdom, Venezuela and the United States. The following is a summary of the financial activity of the Company by geographical area:\n12. INCOME TAXES\nThe components of income before income taxes were:\nIncome taxes are as follows:\nHERBALIFE INTERNATIONAL, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nThe tax effects of temporary differences which gave rise to deferred income tax assets and liabilities are as follows:\nAt December 31, 1995, the Company's deferred income tax asset for tax loss carryforwards of certain foreign subsidiaries totaling $2,635,000 was reduced by a valuation allowance of $2,232,000. The tax loss carryforwards expire in varying amounts between 1996 and 2005. Realization of the tax loss carryforwards is dependent on generating sufficient taxable income prior to expiration of the loss carryforwards. Although realization is not assured, management believes it is more likely than not that the net carrying value of the tax loss carryforwards will be realized. The amount of the tax loss carryforwards that is considered realizable, however, could be reduced in the near term if estimates of future taxable income during the carryforward period are reduced.\nThe tax expense differs from the \"expected\" income tax expense by applying the United States statutory rate of 35% as follows:\nCumulative undistributed earnings of foreign subsidiaries for which no deferred taxes have been provided approximated $14,405,000 at December 31, 1995. The additional taxes payable on the earnings of foreign subsidiaries, if remitted, would be substantially offset by U.S. tax credits for foreign taxes paid.\nHERBALIFE INTERNATIONAL, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n13. FINANCIAL INSTRUMENTS\nThe company enters into forward exchange contracts in managing its foreign exchange risk on intercompany transactions and does not use the contracts for trading purposes. The Company's goal is to protect the Company from the risk that the eventual dollar net cash inflows from the intercompany transactions will be adversely affected by changes in exchange rates. At December 31, 1995, the Company had $10,000,000 in notional amounts of foreign exchange contracts with short-term maturities through February 22, 1996. Gains and losses on the forward exchange contracts are recognized currently into income and, along with contract premiums, are included in marketing, distribution and administrative expenses. A summary of the forward exchange contracts is as follows:\nThe Company is exposed to credit losses in the event of nonperformance by counterparties to its foreign exchange contracts but has no off-balance-sheet credit risk of accounting loss. The Company anticipates, however, that the counterparties will be able to fully satisfy their obligations under the contracts. The Company does not obtain collateral or other security to support the foreign exchange contracts subject to credit risk but monitors the credit standing of the counterparties. The Company is required by the counterparty to provide $1,500,000 of collateral for the Company's obligations in the contracts.\nHERBALIFE INTERNATIONAL, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n14. QUARTERLY INFORMATION (UNAUDITED)\nQuarterly information presented here is unaudited.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereto duly authorized.\nDated: March 29, 1996 HERBALIFE INTERNATIONAL, INC.\nTIM GERRITY By:_______________________________________ Tim Gerrity Senior Vice President, Chief Financial Officer (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 date indicated.\nHERBALIFE INTERNATIONAL, INC.\nEXHIBITS TO ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1995\nHERBALIFE INTERNATIONAL, INC. EXHIBIT INDEX\n(1) Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1987.\n(2) Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1989.\n(3) Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1990.\n(4) Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1991.\n(5) Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1992.\n(6) Incorporated by reference to the Company's definitive Proxy Statement relating to its annual meeting of shareholders held May 20, 1993.\n(7) Incorporated by reference to the Company's Registration Statement on Form S-1 (No. 33-66576) declared effective by the Securities and Exchange Commission on October 8, 1993.\n(8) Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the three months ended June 30, 1994.\n(9) Incorporated by reference to the Company's Definitive Proxy Statement relating to its 1994 Annual Meeting of Stockholders.\n(10) Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1994.\n(11) Filed herewith\n(12) Form of the amended and restated plan, to be submitted for shareholder approval at the 1996 Annual Meeting of Shareholders, will be attached as an appendix to the Proxy Statement relating to such meeting.","section_15":""}
{"filename":"6071_1995.txt","cik":"6071","year":"1995","section_1":"Item 1. Description of Business\n(a) General\nAmes Department Stores, Inc. and its subsidiaries (collectively, \"Ames\" or the \"Company\") are retail merchandisers. As of April 1, 1995, Ames operates 305 discount department stores under the Ames name in 14 states in the Northeast, Middle Atlantic and Mid-West regions and the District of Columbia. The Company's stores are located in rural communities, some of which are not served by other large retail stores, high-traffic suburban sites, small cities and several major metropolitan areas. The stores largely serve middle and lower-middle income customers.\nAmes is a Delaware corporation organized in 1962 as a successor to a business originally founded in 1958. Ames was reorganized in December, 1992 under Chapter 11 of the United States Bankruptcy Code (\"Chapter 11\"). The principal executive offices are located at 2418 Main Street, Rocky Hill, Connecticut 06067, and the telephone number is (203) 257-2000.\nThe Company has changed its method of designating fiscal years. Previously, the year ended January 28, 1995 would have been referred to as fiscal 1995. Since the majority of retailers commonly refer to this year as fiscal 1994, and because 11 of the 12 months in the fiscal year were in 1994, Ames will now use this designation.\nFiscal 1994\nThe Company took several steps in the fiscal year ended January 28, 1995 (\"Fiscal 1994\") to improve operations and its long-term competitive position:\n- In-Season Opportunistic Purchases: In an attempt to further differentiate its merchandise selection from the competition, the Company began a special purchase program (\"Special Buys\") in the second half of Fiscal 1994 that includes, among other items, odd-lot and closeout products. Special Buys allow the Company to offer brand name merchandise for significantly less than the original retail prices, and to offer customers different merchandise each week. In addition, these Special Buys, especially in apparel, can be obtained closer to and during the selling season and later in the merchandise buying cycle than is true for many of the Company's competitors.\n- Deemphasis on Certain Long-Term Purchase Commitments: The Company has begun to deemphasize long-term merchandise purchase commitments for fashion merchandise. The Company believes it can respond more effectively to trends by buying closer to customer needs and reducing the merchandise flow cycle time. The Company will, however, continue to utilize imports, overseas sources and other long-term merchandise commitments for several hardlines areas.\n- Targeted Advertising and Micro-marketing: As an example of targeted advertising and micro-marketing, in September, 1994 Ames launched a new senior citizen discount program (\"55 Gold\") that offers customers aged 55 and older a ten percent discount each Tuesday on all merchandise, including all sale items and Special Buys. The 55 Gold program allows Ames to better serve this important and growing segment of its customer base, many of\nwhom may prefer to shop in the Company's stores rather than competitors' larger-size stores. To qualify for the discounts, shoppers are asked to complete a form and obtain a 55 Gold card. This process provides Ames with names and addresses for future targeted marketing. The Company believes micro-marketing, for example through the 55 Gold program and specific store location needs, can further differentiate Ames from its larger competitors.\n- Remodeling and New Stores: The first new store in more than four years was reopened in November, 1994 in Mt. Pocono, PA. This store, which has been very successful and will serve as a prototype store for future new and remodeled stores, includes, among other things, a wide variety and assortment of merchandise for the entire family; an easier-to-shop layout with \"soft corner concepts\" highlighting expanded domestics and furniture areas; an updated apparel presentation in the center of the store with more feature racks at different angles and plus-size items; large, bright signage; party, pets and crafts departments; and customer assistance phones, home delivery, gift wrapping, faxing and other services.\nAmes installed new apparel fixtures in all of its stores during Fiscal 1994 and continued the roll-out of party and pet departments within the stores. The Company also completed smaller scale remodels in 52 stores.\nThe Company believes its operating performance and the availability of its financing facilities will provide sufficient liquidity to allow the Company to meet its financial obligations. The Company continually reviews the profitability of its stores in the ordinary course of business and closes or sells stores whose performance is thought to be inadequate. The Company will consider relocating certain stores and opening new stores, particularly in selected markets that would reinforce marketing programs, enhance name recognition, and\/or achieve market penetration. Three new stores are currently expected to be opened by the Company in the fiscal year ending January 27, 1996 (\"Fiscal 1995\"). Ames announced in December, 1994 that the Camp Hill, PA store would close in the first quarter of Fiscal 1995.\n(b) Financial Information about Industry Segments.\nAmes operates self-service retail discount department stores selling a broad range of merchandise. There are no other reportable industry segments.\n(c) Narrative Description of Business.\n(i) Services, Markets and Distribution\nAmes sells primarily brand name general merchandise, including the following items: family apparel and accessories, shoes, housewares, home furnishings, crafts, hardware and automotive accessories, sporting goods, toys, small appliances and consumer electronics, pre-recorded tapes and compact discs, jewelry, health and beauty products, household products, camera and photographic supplies, pet products, party and paper products, and school and office supplies. Although Ames attempts to be competitive on everyday pricing, the Company primarily\nemploys a high\/low promotional pricing strategy with an emphasis on quality weekly circular advertising. The Company will continue to stress depth and breadth of products in selected merchandise categories; clean, neat and well-maintained facilities; appealing merchandise presentation; and customer service.\nMerchandise is purchased centrally by Ames associates at the Rocky Hill, CT headquarters for all stores and is shipped by vendors either directly to individual stores or to Ames' distribution centers\/warehouses in Massachusetts and Pennsylvania which then make deliveries to stores.\nFor the last three fiscal years, women's apparel has been the only class of product that exceeded 10% of total sales, accounting for an average of approximately 13% of total sales. An average of approximately 21% of sales for the last three fiscal years were made using third party credit cards and the remainder were made by cash or check.\nThe table below sets forth the number of retail stores in operation in each state at the end of each of the last three fiscal years.\nStores in Operation at Fiscal Year End -------------------------------------- 1994(a) 1993 1992 -------- -------- --------\nConnecticut 15 15 15 Delaware 4 4 4 District of Columbia 1 1 1 Maine 28 28 28 Maryland 25 25 25 Massachusetts 31 32 32 New Hampshire 18 19 19 New Jersey 5 5 5 New York 81 81 81 Ohio 11 11 11 Pennsylvania 54 54 55 Rhode Island 7 7 7 Vermont 13 13 13 Virginia 6 6 6 West Virginia 7 7 7 --- --- --- Total 306 308 309 === === ===\n(a) Includes one Pennsylvania store in the process of closing at year-end.\n(ii) New Products.\nAs discussed earlier, the Company began a special purchase program (see Item 1(a) - Fiscal 1994), and continued the roll-out of certain specialty departments during Fiscal 1994. These specialty departments included expanded party and paper products and expanded pet products. The Company intends to continue the expansion of successful specialty strategies to new and remodeled stores, as well as its offering of casual apparel and home products.\n(iii) Raw Materials.\nThe Company does not rely on any one or a few suppliers for a material portion of its purchases, and there is no current or anticipated problem with respect to the availability of merchandise.\n(iv) Patents, Trademarks and Licenses.\nThe mark \"Ames\" is registered with the United States Patent and Trademark Office. The Company considers this mark and the associated name recognition to be valuable to its business. The Company has a significant number of other trademarks, trade names, and service marks, some of which, such as \"Crafts & More,\" \"Pawsitively Pets,\" and \"Party Plaza,\" are used in connection with certain of the Company's specialty departments within the stores. Although the Company considers these additional marks and its patents and licenses to be valuable in the aggregate, none of them individually is currently considered to have a material impact on the Company's business.\n(v) Seasonality of Business.\nThe Company's sales are greater during the second half of the fiscal year as a result of the back-to-school and Christmas shopping seasons. Sales are highest in the last fiscal quarter.\n(vi) Working Capital.\nAs of January 28, 1995, the Company's current ratio (current assets divided by current liabilities) was 1.7 to 1. See Item 7(b) - Management's Discussion and Analysis - Liquidity and Capital Resources for discussion of liquidity and plans to meet future liquidity needs.\nThe demand for working capital is heaviest in April and May, and from August through November, when sufficient merchandise must be purchased for the spring, back-to-school and Christmas seasons, respectively.\n(vii) Customers.\nNo material part of the Company's business is dependent upon a single customer or a few customers. During Fiscal 1994, Ames had no single customer or affiliated group of customers to whom sales were made in an amount which accounted for 10% or more of the Company's total sales for such period.\nAs is customary in the discount store industry, the Company's retail operations allow merchandise to be returned by customers. In addition, the Company has a program that allows for the matching of its sales prices to the advertised sales prices of its local competitors upon presentation of proper proof of the competitor's advertised price on the same item. The Company also started a new senior citizen discount program in Fiscal 1994 (see Item 1(a) - Fiscal 1994). Merchandise may be purchased under the Ames' layaway plan.\n(viii) Backlog.\nBacklog is not a significant factor in the Company's business.\n(ix) Government Contracts.\nAmes has no material contracts with any government agency.\n(x) Competition.\nAmes operates in a highly competitive environment. Ames competes with other stores, including large national and regional chains, in the purchase and sale of merchandise, as well as for store locations. Ames currently anticipates a further increase in competition from other discount store chains and is continuing the modification of its store operations, advertising, merchandise mix, and merchandise presentation (see Item 1(a) - Fiscal 1994).\nMany of the Company's stores are located in smaller communities and are, in some cases, the largest non-food retail store in their market area. They compete, however, with many smaller stores offering a similar range of products. The Company's stores located in suburban sites and urban areas are in direct competition with other discount stores, including other large national and regional chains.\nThe policy of Ames is to compete with non-discount retail competitors primarily on the basis of price and selection of merchandise, and with all retail competitors primarily on the basis of convenience of location, price of merchandise, special purchases, depth and breadth of products in selected merchandise categories, and customer service.\n(xi) Research and Development.\nResearch and development activities are not a material aspect of the Company's business.\n(xii) Environmental Matters.\nTo date, compliance with federal, state and local laws and regulations enacted to regulate the discharge of materials into the environment has not had, and is not expected to have, a material effect upon the Company's business.\n(xiii) Employees.\nAt April 1, 1995, Ames employed approximately 22,200 people.\n(d) Foreign and Domestic Operations and Export Sales.\nThe information called for by this item is not relevant to the Company's business.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nAs of January 28, 1995, the Company's stores occupied a total of approximately 18,670,299 square feet. The average store size is approximately 61,000 square feet. On average, approximately 82% is selling area.\nThe construction of one store located in Monroeville, PA was financed with an industrial development bond. Ames has an option to purchase this location at nominal cost at the expiration of the lease term in May, 2003. The land and buildings for seven store locations are owned by Ames (one of which was being offered for sale at January 28, 1995). The seven owned locations (with operating stores) are: Woodsville, NH; Bethel Park, Ellwood City, Grove City, Irwin, and No. Huntingdon, PA; and Lewiston, ME. The Bethel Park and Huntingdon, PA locations are subject to mortgages. The remainder of the Company's stores are leased, with the leases expiring at various times between 1995 and 2018. The leases generally have renewal options permitting extensions for at least five years. In addition, the leases typically provide for fixed annual rentals, payment of certain taxes, insurance and other charges, and additional rentals based on a percentage of sales in excess of certain fixed amounts. Except for certain point-of-sale equipment that is leased, vendor-owned greeting card equipment and leased department equipment, Ames owns the fixtures and equipment in its stores, some of which are subject to various financing arrangements.\nThe Company's warehouse and distribution facilities in Leesport, PA, Clinton, MA, and Mansfield, MA are owned and occupy an aggregate of approximately 2,543,500 square feet. The construction of the facility in Clinton, MA was financed with industrial development bonds and the Mansfield, MA facility is subject to a mortgage. The Clinton, MA facility (459,000 square feet) is expected to be sold in the second quarter of Fiscal 1995. Transfer of the Clinton operations to the Company's distribution center in Leesport, PA began in January, 1995 and is expected to be completed by June, 1995. A former distribution center in McKeesport, PA is also currently being offered for sale or lease.\nAmes leases approximately 386,000 square feet of space in Rochester, NY under a lease expiring on December 31, 1997, with three ten-year renewal options. These premises have been subleased to an unaffiliated tenant for the remainder of the lease term. In early Fiscal 1995, Ames received payment for a lease and sublease to a 260,000 square foot warehouse in Indianapolis, IN for which it had assigned its interest in early 1993.\nAmes owns and occupies its 217,000 square foot corporate office in Rocky Hill, CT. The Company also has a lease for 135,000 square feet of combined storage, office and printing space in East Hartford, CT.\nItem 3.","section_3":"Item 3. Litigation\nAmes is involved in various litigation as detailed in Note 12 to the Consolidated Financial Statements included in this Form 10-K.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nThere were no matters submitted during the fourth quarter of Fiscal 1994 to a vote of security holders, through the solicitation of proxies or otherwise.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Stock and Related Matters Concerning Security Holders.\nThe Company's common stock is listed on the NASDAQ National Market System (\"NASDAQ\"; symbol: AMES). As of April 1, 1995, Ames had 5,529 shareholders of record. Certain restrictions applied to the purchase and trading of the common stock through December, 1994. Low and high prices of the Company's common stock for Fiscal 1994 and for the fiscal year ended January 29, 1994 (\"Fiscal 1993\"), as reported on NASDAQ, are shown in the table below:\nFiscal 1994 Fiscal 1993 Low High Low High ------------------ -----------------\n1st Quarter $2 6\/16 $6 1\/2 $2 5\/8 $4 5\/8 2nd Quarter 2 14\/16 5 1\/4 2 1\/8 3 7\/16 3rd Quarter 2 14\/16 4 5\/16 1 1\/2 2 3\/4 4th Quarter 2 1\/4 3 5\/8 1 9\/16 3 -\nThere were no quarterly dividends paid by Ames to the holders of its common stock during these periods. Dividends cannot be declared under the terms of the Company's revolving credit facility. On November 30, 1994, the Company adopted a Stock Purchase Rights Agreement as described in Note 7 to the Consolidated Financial Statements.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe following selected financial data of Ames should be read in conjunction with the Consolidated Financial Statements and related Notes appearing elsewhere in this Form 10-K.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\n(a) Results of Operations\nThe following discussion and analysis is based on the results of operations of the Company for Fiscal 1994 and 1993, the five-week period ended January 30, 1993 and the forty-eight week period ended December 26, 1992 (combined - \"Fiscal 1992\"). The Company's results of operations for Fiscal 1994 and 1993 and for the five-week period ended January 30, 1993 are not comparable in certain material respects to its results of operations for prior periods due to the Company's adoption of fresh-start reporting as of December 26, 1992 (Note 2 to the Consolidated Financial Statements). For purposes of the following discussion, comparison of the Company's results of operations for Fiscal 1994 and 1993 and for the five-week period ended January 30, 1993 to prior periods are made only when, in the Company's opinion, such comparisons are meaningful. The financial information set forth below should be read in conjunction with the Consolidated Financial Statements of Ames Department Stores, Inc. and its subsidiaries included elsewhere in this filing.\nThe Company's business is seasonal in nature, with a large portion (33% in Fiscal 1994) of its net sales occurring in the fourth quarter, which includes the Christmas selling season. Total sales, including sales from leased departments, for the last three fiscal years and the respective total sales percentage increases\/decreases and comparable store sales percentage increases\/decreases over the prior year for stores that have been open and operated by Ames for at least the prior full fiscal year were:\nResults of Operations for Fiscal 1994 Compared to Fiscal 1993\nThe Company reported improvements in Fiscal 1994 in sales, EBITDA (as defined in Note 5) and net earnings. The sales and EBITDA improvements reflected, in part, the beginning of the Company's efforts to generate customer excitement and sales through opportunistic purchases, targeted advertising and micro-marketing, remodeling, and maintaining an improved in-stock inventory position.\nTotal sales increased 0.6% from Fiscal 1993 due to an increase of 1.7% in comparable store sales, partially offset by the closing of three stores during Fiscal 1994 and a 4.1% decline in leased department (shoes) comparable store sales. The major causes for the improvement in comparable store sales were an improved in-stock inventory position, additional circular advertising, opportunistic purchases, and a new senior citizen discount program, partially offset by additional new discount store competition and a continued weak apparel sales market.\nThe following table sets forth the results of operations for the fiscal year ended January 28, 1995 and for the fiscal year ended January 29, 1994 in millions and as a percentage of net sales:\nGross margin declined $14.5 million or 0.9% as a percentage of net sales in Fiscal 1994 compared to Fiscal 1993. Sales of certain higher- margin items, such as ladies apparel, accessories, and crafts, declined; distribution center inventory shortage was higher; and purchase discounts were significantly lower in Fiscal 1994. In addition, advertising and clearance markdowns were both higher in Fiscal 1994 compared to Fiscal 1993. These factors were partially offset by strong performances in childrens apparel, domestics and housewares in Fiscal 1994. The Company expects the decline in gross margin as a percentage of net sales to continue in the first and second quarters of Fiscal 1995.\nSelling, general and administrative expenses decreased $16.7 million or 1.0% as a percentage of net sales in Fiscal 1994 compared to Fiscal 1993. Reductions in store non-payroll, advertising, home office and field support expenses were partially offset by an increase in store payroll expense in Fiscal 1994. This reflects the Company's commitment to reduce expenses and invest, where possible, in areas directly affecting customer service. The Company's self-insurance expense was lower in Fiscal 1994 compared to Fiscal 1993 due to a continued improved trend in claims experience.\nLeased department and other operating income declined $4.1 million or 0.2% as a percentage of net sales in Fiscal 1994 compared to Fiscal 1993. This decline was due, in part, to the decline in leased department sales.\nDepreciation and amortization expense increased $3.2 million or 0.1% as a percentage of net sales in Fiscal 1994 compared to Fiscal 1993. The adoption of fresh-start reporting at December 26, 1992 resulted in the write-off of all of the Company's noncurrent assets at that date, and therefore depreciation and amortization expense for Fiscal 1994 was for capital additions subsequent to December 26, 1992. The amortization of the excess of revalued net assets over equity under fresh-start reporting remained approximately the same. The Company is using a ten-year life for the period of amortization.\nInterest and debt expense declined $1.0 million or 0.1% of net sales in Fiscal 1994 compared to Fiscal 1993. The Company had a daily weighted average of $96.1 million in outstanding debt under its revolving credit facilities during Fiscal 1994 compared to $89.3 million in Fiscal 1993. In June, 1994, the Company prepaid approximately $69 million of debt utilizing a portion of the New Facility (Note 5) and the funds that were no longer required to be restricted for the collateralization of letters of credit. The favorable impact on interest expense from this prepayment has been partially offset by an increase in market interest rates and the amortization of the financing costs associated with the New Facility.\nDuring Fiscal 1994, the Company sold several properties (Note 15) for a combined total of $8.8 million in proceeds and recognized gains totalling $8.3 million.\nThe closing on the Wertheim Settlement Agreement (Note 12) occurred in June, 1994 and the Company recognized a nonrecurring gain for its $12 million portion of the settlement.\nDuring Fiscal 1994, the Company announced its decision to close the Clinton, MA distribution center in June, 1995 and recorded a provision of $1.3 million in Fiscal 1994 for the estimated costs associated with the closing (Note 16). Transfer of the Clinton operations to the Company's Leesport, PA distribution center is expected to be completed in June, 1995. This consolidation is part of the Company's continuing productivity enhancement and expense-reduction efforts. Use of enhanced automation capabilities in the Leesport facility will allow the Company to efficiently service its stores with fewer distribution centers. The Company currently anticipates this consolidation will result in future pre-tax savings of approximately $3 million per year.\nAs a consequence of fresh-start reporting and SFAS No. 109 (Note 9), the Company recorded a non-cash income tax provision of $8.2 million for Fiscal 1994 with an associated increase of $8.2 million in additional paid- in capital.\nAs a result of the debt refinancing and associated prepayment of certain debt, the Company recorded a non-cash extraordinary charge of $1.5 million, net of tax benefit of $0.7 million, in Fiscal 1994. The charge was primarily for the write-off of deferred financing costs and debt discounts related to the debt that was prepaid.\nResults of Operations for Fiscal 1993 Compared to Fiscal 1992\nDespite a continued difficult economic environment in the Northeast and a decline in comparable store sales, the Company reported improvements in Fiscal 1993 in its gross margin rate, operating earnings and net earnings, reflecting, in part, its emphasis on higher-margin sales and inventory and expense controls.\nTotal sales declined 12.4% from Fiscal 1992 due to the closing of 62 stores during Fiscal 1992, one less week in Fiscal 1993, and a decrease of 2.3% in comparable store sales. The major causes for the decline in comparable store sales were the Company's de-emphasis of several lower-margin hardline categories, reduced broadcast advertising, severe winter weather during the first and fourth quarters of Fiscal 1993, a weak apparel market, and increased discount store competition, partially offset by sales increases from remodeled stores, expansions of certain specialty departments, and additional circular advertising.\nSales of the Company's leased departments were $104.6 million or 4.7% of total sales for Fiscal 1993 compared to $117.2 million or 4.6% of total sales for Fiscal 1992. The decline of $12.6 million in leased department sales was due to the closing of the 62 stores, one less week, and a decrease of 1.2% in leased department comparable store sales.\nTo facilitate a comparison of the Company's operating results for Fiscal 1993 with results achieved in Fiscal 1992, including the predecessor's results, the following discussion and analysis incorporates certain pro forma data of the Company, which is summarized in the note titled \"Pro Forma Summary Information (Unaudited)\" in the Notes to the Consolidated Financial Statements. The pro forma data was prepared under the assumption that the closing of the 60 stores (announced in October, 1992) and the reorganization and related financing occurred at the beginning of Fiscal 1992.\nIn the Company's judgement, the pro forma data enhances the ability to understand the results of operations of the Company for the 52 weeks ended January 29, 1994 compared with those for the combined 53 weeks ended January 30, 1993. The pro forma data is for illustrative purposes only and should not be construed to be indicative of the Company's results of operations that actually would have resulted if the transactions were consummated on the date assumed and do not project the Company's results of operations or trends for any future date or period.\nThe following table sets forth the historical operating results for the 52 weeks ended January 29, 1994 and the unaudited pro forma operating results for the 53 weeks ended January 30, 1993 in millions and as a percentage of net sales:\nGross margin increased $18.1 million or 1.9% as a percentage of net sales in Fiscal 1993 compared to pro forma Fiscal 1992. The Company emphasized higher- margin products in its merchandise mix and in its advertising in Fiscal 1993. For example, Ames continued with the installation within the stores of certain specialty departments, such as Crafts & More, Party Plaza and Pawsitively Pets departments, and the remodeling and expansions of jewelry departments. Broadcast advertising, which resulted in higher sales but lower margins in Fiscal 1992, was reduced and more narrowly focused by limiting the percents-off primarily to specific merchandise departments. In addition, although advertising markdowns were significantly higher in Fiscal 1993, clearance markdowns and inventory shrink were significantly lower due primarily to tighter inventory (and other operating) controls. Inventory shortage was reduced by 0.6% of net sales. Pro forma gross profit for Fiscal 1992 included a LIFO credit of $5.8 million as compared to no LIFO charge or credit in Fiscal 1993.\nSelling, general and administrative expenses decreased $11.6 million but increased as a percentage of net sales by 0.5% in Fiscal 1993 compared to pro forma Fiscal 1992. The dollar decrease was primarily due to reductions in home office expenses and one less week in Fiscal 1993, while the increase as a percentage of net sales was primarily due to the lower sales base upon which the percentage is calculated. Advertising expense was slightly higher in Fiscal 1993 compared to pro forma Fiscal 1992 due to additional circular advertising, partially offset by less broadcast advertising. Store payroll expense was slightly higher but other store expenses were slightly lower in Fiscal 1993 compared to pro forma Fiscal 1992. The Company began a program to improve customer service in Fiscal 1993 by, among other things, increasing its investment in store payroll. The Company's self-insurance expense was significantly reduced in Fiscal 1993 due to an improved trend in claims experience. Field support expenses were constant between the two fiscal years.\nLeased department and other operating income declined $0.5 million in Fiscal 1993 compared to pro forma Fiscal 1992, but remained the same as a percentage of sales. The decline was primarily attributable to the decrease in leased department (shoes) sales.\nDepreciation and amortization expense increased $0.9 million but remained the same as a percentage of sales in Fiscal 1993 compared to pro forma Fiscal 1992. The adoption of fresh-start reporting at December 26, 1992 resulted in the write-off of all of the Company's noncurrent assets at that date, and therefore depreciation and amortization expense for Fiscal 1993 was for capital additions subsequent to December 26, 1992. The amortization of the excess of revalued net assets over equity under fresh-start reporting resulted in a $6.2 million credit to the Fiscal 1993 results. The Company is using a ten-year life for the period of amortization.\nInterest and debt expense increased $3.4 million or 0.3% of net sales in Fiscal 1993 compared to pro forma Fiscal 1992. Approximately $1.3 million of fees related to the Credit Agreement (Note 5) and the Letter of Credit Facility (Note 5) were charged to interest and debt expense in Fiscal 1993. The Company had a daily weighted average of $89.3 million in outstanding debt during Fiscal 1993 under the revolving credit portion of the Credit Agreement. These borrowings were utilized for seasonal inventory purchases and for the required cash collateralization of outstanding letters of credit.\nDuring Fiscal 1993, the Company sold a shopping plaza and its corporate jet for a combined total of $3.4 million in proceeds and recognized gains totalling $1.3 million.\nAs a consequence of the adoption of fresh-start reporting and SFAS No. 109, the Company recorded a non-cash income tax provision of $3.3 million for Fiscal 1993 with an associated increase of $3.3 million in additional paid-in capital.\nThe Company recorded an extraordinary gain of $.9 million, before and after income taxes, from the early settlement of certain tax notes during Fiscal 1993.\n(b) Liquidity and Capital Resources.\nCredit Facilities - Fiscal 1994 and Fiscal 1993\nThe Company's principal sources of liquidity are certain available credit facilities, cash from operations, and cash on hand. On April 28, 1994, the Company entered into an agreement with BankAmerica Business Credit, Inc., as agent, and a syndicate consisting of seven other banks and financial institutions, for a secured revolving credit facility of up to $300 million (the \"New Facility\") that contains terms, covenants and interest rates that the Company believes are generally more favorable than those in the prior Credit Agreement. The New Facility is in effect until June 22, 1997, is secured by substantially all of the assets of the Company, and requires the Company to meet certain quarterly financial covenants. Ames is in compliance with the financial covenants through January, 1995. Reference can be made to Note 5 for a further description of the New Facility.\nIn June, 1994, the Company used the funds that were no longer restricted for the collateralization of letters of credit, and funds from the New Facility, to prepay the then-outstanding Series A, B and D Notes, a $1.2 million term note, and the outstanding borrowings under the Credit Agreement. The Company's peak borrowing level in Fiscal 1994 under the New Facility was $177.5 million. Ames repaid all such borrowings by December, 1994, and fulfilled its \"clean-up\" requirement (Note 5) in January, 1995.\nUpon consummation of the plan of reorganization in December, 1992, Ames had obtained $210 million of post-emergence financing (the \"Credit Agreement\"), including approximately $176 million in the form of revolving credit financing (the \"Revolver\"). In addition, Ames obtained a $90 million letter of credit facility (the \"Letter of Credit Facility\") which was later increased to $120 million. The Company's historical borrowing patterns changed as a result of the Letter of Credit Facility. That facility required cash collateralization at 105% of outstanding letters of credit, which in turn required an average incremental increase of approximately $60 million in outstanding revolving credit borrowings in Fiscal 1993. The Company's peak borrowing level was $161.9 million under the Revolver in Fiscal 1993. Ames repaid all borrowings under the Revolver in December, 1993 before borrowing $15.4 million in January, 1994.\nBefore Reorganization\nOther than payments approved by the Bankruptcy Court made to secured creditors as adequate protection payments, or costs to cure defaults on leases and contracts assumed in the Chapter 11 case, principal and interest payments on indebtedness incurred prior to the filing of the petitions under Chapter 11 on April 25, 1990 (the \"Filing Date\") were not made during the Chapter 11 proceedings. Virtually all pre-petition indebtedness of Ames was subject to settlement under the reorganization case as a result of the filing of the petitions under Chapter 11.\nChemical Bank, as agent for a group of banks, initially provided the Company with a $250 million Debtor-in-Possession Revolving Credit Agreement (the \"DIP Facility\") during Chapter 11. The DIP Facility provided Ames, at variable interest rates, with a line of credit and letter of credit facility that could be used to purchase inventory and for other corporate purposes. The DIP Facility was lowered to $200 million in August, 1992 and expired, in accordance with its terms, on December 30, 1992, the consummation date of the Company's plan of reorganization (the \"Consummation Date\").\nReview of Cash Flows, Liquidity and Financial Condition\nThe Company's unrestricted cash position increased $11.9 million during Fiscal 1994. This increase was primarily due to $83.5 million in net cash provided by operations and $53.9 million of restricted cash withdrawals, partially offset by $24.5 million of fixed asset purchases, the paydown of $15.4 million in the outstanding balance under revolving credit facilities, and the payments of $87.8 million on debt and capital lease obligations, including the prepayments of $67.7 million on certain debt described above. Please see below for further discussions of activities affecting cash and liquidity for Fiscal 1994.\nAmes experienced a decline of $15.4 million in unrestricted cash during Fiscal 1993. This decline was primarily due to the payment of approximately $15.0 million of deferred distributions under the plan of reorganization, payments of $13.7 million of other debt and capital lease obligations, payments of $32.4 million of restructuring costs, purchases of $20.2 million of fixed assets, and the paydown of $7.6 million in the outstanding balance under the Revolver, partially offset by a combined $40.5 million of cash proceeds on sales of net assets held for disposition and other properties, $27.7 million of restricted cash withdrawals, and $7.3 million in net cash provided by operations prior to the payment of restructuring costs. Please see below for further discussions of activities affecting cash and liquidity for Fiscal 1993.\nAmes experienced a total cash decrease of $25.6 million for the forty-eight weeks ended December 26, 1992, prior to the consummation cash distributions. The Company's unrestricted cash position declined $21.2 million for the five weeks ended January 30, 1993. The 48-week decline was primarily due to the operating loss incurred, partially offset by the proceeds from the sale of assets held for disposition (primarily from the 77 store closings). The 48-week cash decline caused Ames to increase its peak borrowings by $40 million under the DIP Facility as compared to the prior year. The January cash decrease was primarily a result of the reduction of accounts payable and the operating loss incurred, partially offset by the initial proceeds from the sale of inventories at the 60 closing stores and short-term borrowings under the Revolver. Please see below for further discussions of activities affecting cash and liquidity for Fiscal 1992.\nThe New Facility does not require cash collateralization of letters of credit, except in limited instances. As of January 29, 1994 and January 30, 1993, approximately $55.0 and $57.4 million, respectively, was placed for collateral pledge and consignment with Republic National Bank of New York as a condition precedent to the issuance of letters of credit under the Letter of Credit Facility. This cash collateral was included in \"Restricted cash and short-term investments.\" Approximately $66.3 million had been placed as such collateral at the Consummation Date. The amounts of cash collateral changed as the balances outstanding under the Letter of Credit Facility changed, since the cash collateral had to equal 105% of the Company's outstanding obligations, including $5.5 and $6.5 million at January 29, 1994 and January 30, 1993, respectively, for future increases to standby letters of credit to cover expected workers' compensation claims. Ames earned interest on the invested cash collateral.\nAs of January 28, 1995, January 29, 1994 and January 30, 1993, Ames also restricted approximately $0.2, $1.0 and $26.3 million of cash, respectively, for expected payments of certain remaining administrative and priority claims under the plan of reorganization. This amount was also included in \"Restricted cash and short-term investments.\" The associated liability was included in \"Accrued expenses.\" Approximately $37.7 million had been placed on deposit for such claims at the Consummation Date. The Company earns interest on invested segregated funds. As of January 28, 1995, the Company also had $1.8 million of cash received in escrow from the December, 1994 sale of a store's lease interest. The cash was released from escrow in February, 1995.\nThe changes in working capital and other, net, in the consolidated statements of cash flows exclude reclassifications related to the restructuring and Chapter 11 proceedings. The following two paragraphs detail the components of restricted cash prior to the Company's emergence from Chapter 11 and the related cash flows from the sale of assets held for disposition through December 26, 1992.\nAmes received and segregated through December 26, 1992, pursuant to Bankruptcy Court orders or agreements with creditors, $244.9 million of proceeds from the sales of inventory, lease contracts, furniture and equipment pursuant to the closing of 221 stores and other asset sales and $27.1 million of interest on such proceeds. Pursuant to a Bankruptcy Court order and agreements with creditors, Ames was authorized to draw up to $51.0 million of such segregated proceeds and interest to pay for actual expenses incurred in connection with the closing of the 221 stores and related restructuring costs. Furthermore, Ames applied for and received Bankruptcy Court approval to use certain additional segregated proceeds. Through December 26, 1992, Ames had drawn $62.3 million of these funds ($41.4 million representing the reimbursement for actual expenses incurred in connection with the closing of the 221 stores). In addition, other funds totalling $21.8 million were segregated for payment of sales and payroll taxes and utilities incurred after the Filing Date, as well as for the payment of certain mortgages. Prior to distribution on the Consummation Date, Ames had on hand $231.5 million of cash and short-term investments related to the 221 stores and related escrow funds whose use was restricted and subject primarily to Bankruptcy Court approval.\nIn addition, Ames received and segregated through December 26, 1992, pursuant to Bankruptcy Court orders, $42.2 million of proceeds from the sales of inventory and other assets pursuant to the closing of 77 stores and $8.5 million from the sale of Mathews & Boucher, Inc. (\"M&B\"), the Company's former wholesale sporting goods distributor, and $1.0 and $.3 million of interest on such proceeds, respectively. Through December 26, 1992, Ames had drawn $17.6 and $.4 million from the 77 store funds and M&B funds, respectively, to pay for expenses incurred in connection with the closings and sale. Prior to the distribution on the Consummation Date, Ames had on hand $25.7 million and $8.3 million of cash and short-term investments related to the 77 stores and M&B, respectively, whose use was restricted and subject primarily to Bankruptcy Court approval.\nMerchandise inventories declined $12.0 million during Fiscal 1994 primarily due to strong fourth quarter sales. Inventories had declined $22.4 million during Fiscal 1993 primarily as a result of planned reductions and stringent inventory controls. Inventories had also declined $13.4 million during the five weeks ended January 30, 1993, primarily as a result of January clearance sales. Inventories had increased $38.0 million to $478.0 million at December 26, 1992 from $440.0 million at January 25, 1992 due primarily to the lower than planned Christmas season sales, the timing of inventory shipments and clearance sales, and the elimination of the LIFO reserve of $34.3 million at December 26, 1992, partially offset by the effect of the closing of the 60 stores, which contained approximately\n$67.9 million of inventory at January 25, 1992. Inventory shipments were unusually low immediately prior to January 25, 1992 and post-Christmas clearance sales took place after December 26, 1992. The LIFO reserve as of December 26, 1992 was eliminated in connection with the adoption of fresh-start reporting. Ames remained on the LIFO method after emergence from Chapter 11, but there was no LIFO charge or credit in Fiscal 1994, 1993 and January, 1993 because inventory levels declined, the Company's merchandise mix continued to change, and inflation was insignificant during those periods.\nAccounts payable increased $54.4 million during Fiscal 1994, due primarily to longer payment terms. During Fiscal 1994, the Company began a concerted effort to return to normal industry payment terms by lengthening its payment terms with merchandise vendors. Accounts payable had increased $4.8 million during Fiscal 1993, due primarily to the timing of inventory shipments prior to January 29, 1994, and declined $57.1 million during the five weeks ended January 30, 1993, primarily as a result of the timing of inventory shipments at December 26, 1992 and the curtailment of purchases at the 60 closing stores. Trade accounts payable at January 30, 1993 were almost twice the level at January 25, 1992 due to the unusually low level of inventory shipments prior to the previous year-end. Accounts payable had increased $57.9 million during the forty-eight weeks ended December 26, 1992 primarily due to the inventory build-up and the timing of inventory shipments discussed above, partially offset by the curtailment of purchases at the 60 closing stores. During Fiscal 1994, 1993 and 1992, the Company paid its trade payables within the terms negotiated with vendors.\nDuring Fiscal 1993 and January 1993, accrued expenses and the restructuring reserve both declined significantly as a result of payments out of the segregated account and payments associated with the 60 closing stores. Accrued expenses had increased significantly at December 26, 1992 from January 25, 1992 primarily due to the segregated account liability, which contained a larger accumulation of professional fees and assumed lease liabilities.\nThe Company and its pre-petition lenders agreed to a restructuring of the Company's obligations as part of the plan of reorganization. The new obligations consisted primarily of secured notes that certain banks elected to receive, which were prepaid in Fiscal 1994, and deferred cash distributions. The major component of the \"Current portion of long-term debt\" at January 28, 1995 and January 29, 1994 related primarily to cash distributions of $8.0 million paid on January 31, 1995 and January 31, 1994 pursuant to the plan of reorganization.\nThere were no outstanding borrowings under the New Facility as of January 28, 1995. The \"Note payable\" of approximately $15.4 million at January 29, 1994 was the amount outstanding under the Revolver. The \"Unfavorable lease liability\" was recorded as part of fresh-start reporting and \"Other long-term liabilities\" consist primarily of the long-term portion of unemployment tax reserves. The unemployment tax reserves were recorded at October 24, 1992 for the higher unemployment taxes to be paid as a result of the large number of store closings and associated reductions in work force during the Company's restructuring.\nNo dividends were paid while Ames was under the protection of Chapter 11, or since its emergence from Chapter 11. The Company is restricted from declaring dividends under the New Facility.\nCapital Expenditures\nCapital expenditures for Fiscal 1994 were $24.5 million and included, among other things, new apparel fixtures for all stores, small-scale remodeling of 52 stores, and the rollout of certain specialty departments to additional stores. The increase in capital expenditures from Fiscal 1993 was due primarily to the Fiscal 1994 expenditures for the new apparel fixtures. The decrease from the Fiscal 1992 expenditures of $29.0 million was due primarily to the Fiscal 1992 costs related to the complete remodeling of 18 stores.\nCapital spending is expected to be approximately $25.0 million for Fiscal 1995, primarily for small-scale remodels at 22 stores, complete remodels at 20 stores and the anticipated opening of three new stores. The Company expects to finance equipment purchases, new store fixtures and equipment, and the remodeling of existing stores through internally-generated funds. The Company adjusts the plans for making such expenditures depending on the amount of internally-generated funds available. Land, buildings and improvements are financed principally through either long-term capital or operating leases.\nSummary\nThe Company believes the ability to meet its financial obligations and make planned capital expenditures will depend on the Company's future operating performance, which will be subject to financial, economic and other factors affecting the industry and operations of the Company, including factors beyond its control. The Company believes its operating performance and the availability of its financing facilities will provide sufficient liquidity to allow the Company to meet its financial obligations.\nAmes currently anticipates the following investment and financing activities for Fiscal 1995: capital expenditures as described above, seasonal borrowings and payments under the New Facility, planned payments of debt and capital lease obligations, and the sale of certain properties and lease interests.\nThe Company believes the actions set forth above and the availability of its financing facilities, together with the Company's available cash and expected cash flows from Fiscal 1995 operations and beyond, will enable Ames to fund its expected needs for working capital, capital expenditures and debt service requirements. Achievement of expected cash flows from operations and compliance with the EBITDA covenant (Note 5) is dependent upon the Company's attainment of sales, gross profit, and expense levels that are reasonably consistent with its financial projections.\nThe Company expects from time to time to consider possible capital market transactions, debt refinancing, and other transactions to further enhance the Company's financial flexibility.\nThe significant net operating loss carryforwards remaining after Fiscal 1994, subject to limitations pursuant to Internal Revenue Code Sec. 382, should offset income on which taxes would otherwise be payable in future years.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nSee Index to Consolidated Financial Statements.\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. Officers and Directors of the Registrant\nInformation as to the directors of the registrant required by Item 10 is incorporated herein by reference from the information set forth under the caption \"ELECTION OF DIRECTORS\" of the Company's definitive proxy statement to be filed pursuant to Regulation 14A within 120 days after the close of its fiscal year.\nThe following table indicates the names of all executive officers of Ames and the offices held by each. Other than the employment contracts with Mr. Ettore and Mr. Lemire described in the Company's proxy statement, there are no other arrangements or understandings between any officer below and any other person pursuant to which he was selected as an officer.\nJoseph R. Ettore, age 55, joined Ames as President, Chief Executive Officer and Director in June, 1994. Prior to joining Ames, he was President, Chief Executive Officer and Director of Jamesway Corporation(\"Jamesway\") from July, 1993 to June, 1994; President, Chief Operating Officer and Director of Jamesway in June, 1993; Chairman of the Board and Chief Executive Officer of Stuarts Department Stores, Inc.(\"Stuarts\") from October, 1992 to June, 1993; and President, Chief Operating Officer and Director of Stuarts from October, 1989 to October, 1992. He remained a Director of Stuarts until May, 1994. Jamesway filed for protection under Chapter 11 of the Bankruptcy Code (\"Chapter 11\") in July, 1993 and emerged from the Chapter 11 case in January, 1995. Stuarts filed under Chapter 11 in December, 1990 and emerged from the Chapter 11 case in October, 1992.\nJohn F. Burtelow, age 47, joined Ames as Executive Vice President, Chief Financial Officer in August, 1994. Prior to joining Ames, he was Senior Vice President, Chief Financial Officer of Venture Stores, Inc. from March, 1989 to May, 1994. He held a number of increasingly senior financial positions with The May Department Stores Company between 1979 and 1989.\nJohn W. Hermsen, age 48, became Executive Vice President, Stores and Distribution in July, 1994. He joined Ames as Senior Vice President, Store Operations in June, 1993. Prior to joining Ames, he was employed at Shopko Stores, Inc. as Vice President for Store Operations, Loss Prevention and Health Services from 1986 to 1993.\nDenis T. Lemire, age 47, joined Ames as Executive Vice President, Merchandising in August, 1994. Prior to joining Ames, he was President and Chief Operating Officer of Stuarts Department, Inc. (\"Stuarts\") from November, 1993 to August, 1994 and Senior Vice President, Merchandising for Stuarts from April, 1990 to November, 1993. Stuarts filed for protection under Chapter 11 in December, 1990 and emerged from the Chapter 11 case in October, 1992. Mr. Lemire was a General Merchandise Manager at American Eagle Outfitters, Inc., a subsidiary of Retail Ventures, Inc., from July, 1989 to April, 1990.\nEugene E. Bankers, age 55, joined Ames as Senior Vice President, Marketing in December, 1993. Prior to joining Ames, he was employed at Shopko Stores, Inc. as Vice President, Communications and Investor Relations from 1991 to 1993, and Vice President of Advertising, Sales Promotions, Special Events and Public Relations from 1982 to 1991.\nRichard L. Carter, age 46, joined Ames as Senior Vice President, Human Resources in February, 1993. Prior to joining Ames, he was Senior Vice President, Human Resources at G. Fox & Co., Inc. from 1989 to 1993.\nDavid H. Lissy, age 51, became Senior Vice President, General Counsel and Corporate Secretary in December, 1992. He began work on the Ames Chapter 11 cases in June, 1990, and in July, 1990 was named Vice President, Legal Services. He was appointed Vice President, General Counsel and Corporate Secretary in October, 1991. He has been owner of Samuel Lehrer & Co., Inc., a wholesaler of fine quality fabrics, since 1988.\nCornelius F. Moses, III, age 36, became Senior Vice President, Treasury in December, 1992. He joined Ames in June, 1990 as Vice President, Special Projects. He became Vice President, Associate Treasurer in September, 1990 and Vice President and Treasurer in September, 1991. Prior to joining Ames, he served as Director-Project Development, Manager-Project Finance, and Financial Analyst for Wheelabrator Technologies, Inc. from 1985 to June, 1990.\nWilliam C. Najdecki, age 44, became Senior Vice President, Chief Accounting Officer in December, 1992. He joined Ames in April, 1991 as Vice President, Bankruptcy Administration and became Vice President, Controller in July, 1991. Prior to joining Ames, he was Hardlines Controller for Montgomery Ward from 1989 to 1991.\nJohn M. Pascucci, age 52, became Senior Vice President, Management Information Systems (MIS) in September, 1994. He joined Ames in April, 1994 as Vice President, System Development. Prior to joining Ames, he was Vice President, MIS for Shopko Stores, Inc. from September, 1991 to January, 1994 and Vice President, MIS at P.A. Bergner and Company from January, 1986 to August, 1991.\nRonald T. Raymond, age 51, became Senior Vice President, Asset Protection in April, 1993. Since joining Ames in 1987, he has served in a number of Loss Prevention positions, from Corporate Director to Assistant Vice President to Vice President, and became Vice President, Internal Audit and Loss Prevention in December, 1992.\nGrant C. Sanborn, age 43, became Senior Vice President, Store Operations in January, 1995. Since joining Ames in 1971, he has served in a number of store operations positions, including Assistant Regional Manager from July, 1989 to May, 1991; Regional Director from May, 1991 to July, 1991; Director, Store Operations from July, 1991 to October, 1993; and Vice President, Store Operations from October, 1993 to January, 1995.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe information required by Item 11 is incorporated herein by reference from the information set forth under the sections titled \"Executive Compensation,\" \"Board Meetings and Committees,\" \"Compensation of Directors,\" \"Employment Contracts, Termination, Severance and Change-of-Control Arrangements,\" \"Additional Information with respect to Board of Directors Interlocks and Insider Participation in Compensation Decisions,\" \"The Board of Directors Report on Executive Compensation,\" and \"Performance Graph\" of the Company's definitive proxy statement to be filed pursuant to Regulation 14A within 120 days after the close of its fiscal year.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThe information required by Item 12 is incorporated herein by reference from the information set forth under the sections titled \"Security Ownership of Management\" and \"Security Ownership of Certain Beneficial Owners\" of the Company's definitive proxy statement to be filed pursuant to Regulation 14A within 120 days after the close of its fiscal year.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThe information required by Item 13 is incorporated herein by reference from the information set forth under the section titled \"Transactions with Management\" of the Company's definitive proxy statement to be filed pursuant to Regulation 14A within 120 days after the close of its fiscal year.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedule and Reports on Form 8-K\n(a) Documents Filed as Part of this Form 10-K\n1. Financial Statements\nThe Financial Statements listed in the accompanying Index to Consolidated Financial Statements are filed as part of this Form 10-K.\n2. Financial Statement Schedule\nThe Financial Statement Schedule listed in the accompanying Index to Consolidated Financial Statements is filed as part of this Form 10-K.\n3. Exhibits\nThe Exhibits filed as part of this Form 10-K are listed on the Exhibit Index immediately preceding such Exhibits, incorporated herein by reference.\n(b) Reports on Form 8-K\nReports on Form 8-K were filed with the Securities and Exchange Commission during the fourth quarter as follows:\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nAMES DEPARTMENT STORES, INC. (Registrant)\nAMES DEPARTMENT STORES, INC. AND SUBSIDIARIES\n----------------------------------\nFINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE (FORM 10-K)\nEXHIBITS\nFor the Fiscal Years Ended January 28, 1995 and January 29, 1994, the Five Weeks Ended January 30, 1993, and the Forty-eight Weeks Ended December 26, 1992\n(With Report of Independent Public Accountants)\n-----------------------------------\nAMES DEPARTMENT STORES, INC. AND SUBSIDIARIES\nIndex to Consolidated Financial Statements and Financial Statement Schedule for the Fiscal Years Ended January 28, 1995 and January 29, 1994, the Five Weeks Ended January 30, 1993, and the Forty-eight Weeks Ended December 26, 1992\nFinancial Statements:\nReport of Independent Public Accountants.\nConsolidated Statements of Operations for the fiscal years ended January 28, 1995 and January 29, 1994, the five weeks ended January 30, 1993, and the forty-eight weeks ended December 26, 1992.\nConsolidated Balance Sheets as of January 28, 1995 and January 29, 1994.\nConsolidated Statements of Changes in Stockholders' Equity (Deficit) for the fiscal years ended January 28, 1995 and January 29, 1994, the five weeks ended January 30, 1993, and the forty-eight weeks ended December 26, 1992.\nConsolidated Statements of Cash Flows for the fiscal years ended January 28, 1995 and January 29, 1994, the five weeks ended January 30, 1993, and the forty-eight weeks ended December 26, 1992.\nNotes to Consolidated Financial Statements.\nSchedule:\nII. Valuation and Qualifying Accounts for the fiscal years ended January 28, 1995 and January 29, 1994, the five weeks ended January 30, 1993, and the forty-eight weeks ended December 26, 1992.\nSchedules Omitted:\nAll other schedules are omitted as they are not applicable or the information is shown in the consolidated financial statements or notes thereto.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Stockholders and Board of Directors of AMES DEPARTMENT STORES, INC.:\nWe have audited the accompanying consolidated balance sheets of Ames Department Stores, Inc. (a Delaware corporation) and subsidiaries as of January 28, 1995 and January 29, 1994, and the related consolidated statements of operations, changes in stockholders' equity (deficit) and cash flows for the fifty-two weeks ended January 28, 1995 and January 29, 1994, the five weeks ended January 30, 1993, and the forty-eight weeks ended December 26, 1992. These consolidated 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 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 financial statements referred to above present fairly, in all material respects, the financial position of Ames Department Stores, Inc. and subsidiaries as of January 28, 1995 and January 29, 1994, and the results of their operations and their cash flows for the fifty-two weeks ended January 28, 1995 and January 29, 1994, the five weeks ended January 30, 1993, and the forty-eight weeks ended December 26, 1992 in conformity with generally accepted accounting principles.\nOn December 30, 1992, the Company emerged from bankruptcy. As discussed in Note 2 to the financial statements, effective December 26, 1992, the Company accounted for the reorganization, adopted \"fresh-start reporting\" and changed its methods of accounting for post-retirement benefits other than pensions and income taxes. As a result of the reorganization and adoption of fresh-start reporting, the consolidated statements of operations and cash flows for the fifty-two weeks ended January 28, 1995 and January 29, 1994 and the five weeks ended January 30, 1993 are not comparable to the consolidated statements of operations and cash flows for the forty-eight weeks ended December 26, 1992 since they present the consolidated results of operations and cash flows of the reorganized entity.\nOur audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule listed in the index to the consolidated financial statements is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\n\/s\/ ARTHUR ANDERSEN LLP\nNew York, New York March 20, 1995\nAMES DEPARTMENT STORES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. Summary of Significant Accounting Policies:\n(a) Basis of Presentation:\nAmes Department Stores, Inc. (a Delaware corporation) and its subsidiaries (collectively \"Ames\" or the \"Company\") filed petitions under Chapter 11 of the U.S. Bankruptcy Code (\"Chapter 11\") on April 25, 1990. From that time until December 30, 1992, Ames operated its business as a debtor-in-possession subject to the jurisdiction of the United States Bankruptcy Court for the Southern District of New York (the \"Bankruptcy Court\"). On December 30, 1992, Ames emerged from bankruptcy (Note 2).\nCertain prior year items have been reclassified to conform to the current year presentation.\n(b) Fiscal year:\nThe Company's fiscal year ends on the last Saturday in January. The fiscal years ended January 28, 1995 (Fiscal 1994) and January 29, 1994 (Fiscal 1993) included 52 weeks. The fiscal year ended January 30, 1993 (Fiscal 1992) included 53 weeks and was comprised of the forty-eight weeks ended December 26, 1992 (pre-emergence) and the five weeks ended January 30, 1993 (post-emergence).\n(c) Principles of consolidation:\nThe consolidated financial statements include the accounts of Ames and its subsidiaries, all of which are wholly-owned. All material intercompany accounts and transactions have been eliminated.\n(d) Cash and short-term investments:\nAmes considers all highly liquid investments with a maturity of three months or less when purchased to be cash and short-term investments.\n(e) Inventory valuation:\nSubstantially all inventories are stated at the lower of cost, using the retail last-in, first-out (LIFO) method, or market and include transportation and distribution center costs.\n(f) Fixed assets:\nLand and buildings, fixtures and equipment, and leasehold improvements are recorded at cost. All fixed assets at December 26, 1992 were written-off under fresh-start reporting (Note 2). Major replacements and betterments are capitalized. Maintenance and repairs are charged to earnings as incurred. The cost of assets sold or retired and the related amounts of accumulated depreciation are eliminated from the accounts in the year of disposal, with the resulting gain or loss included in earnings.\n(g) Depreciation and amortization:\nBuildings, fixtures and equipment are recorded at cost and are depreciated on a straight-line basis over their estimated useful lives. Property under capital leases and leasehold improvements are depreciated over the shorter of their estimated useful lives or their related lease terms.\nThe unfavorable lease liability (recorded under fresh-start reporting) is being amortized on a straight-line basis over the applicable lease terms.\nThe excess of revalued net assets over equity under fresh-start reporting is being amortized over a 10 year period (Note 2).\n(h) Deferred charges:\nExpenses related to new store openings are expensed in the fiscal year in which the store opens.\nDebt transaction costs and related issue expenses are deferred and amortized over the term of the associated debt.\n(i) Leaseholds:\nAll leaseholds and accumulated amortization at December 26, 1992 were written-off under fresh-start reporting. Leaseholds represented the present value of the economic benefit of leases at stores acquired and were amortized on a straight-line basis over their average remaining lease lives. For the forty-eight weeks ended December 26, 1992, $9.7 million of net leaseholds were written-off or sold as part of the Company's restructuring. Amortization of leaseholds was approximately $3.5 million in the forty-eight weeks ended December 26, 1992.\n(j) Income taxes:\nAmes and its subsidiaries file a consolidated federal income tax return. Ames adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS No. 109\") under fresh-start reporting. Under this method, any deferred income taxes recorded are provided for at currently enacted statutory rates on the differences in the basis of assets and liabilities for tax and financial reporting purposes. If recorded, deferred income taxes are classified in the balance sheet as current or non-current based upon the expected future period in which such deferred income taxes are anticipated to reverse.\n(k) Self-insurance reserves:\nThe Company is self-insured for workers' compensation, general liability, property and casualty, and accident and health insurance claims, subject to certain limitations. The Company has insurance coverage for losses that may occur above certain levels. The Company determines its liability for claims incurred but not reported based on its historical claims experience. As of January 28, 1995, Ames had established a self-insurance reserve of $46.4 million, a major portion of which may not be paid within a year. As of January 29, 1994, Ames had established a self-insurance reserve of $48.5 million.\n(l) Leased department sales and income:\nAmes has an agreement with an independent contractor that allows the independent contractor to operate shoe departments within the Ames stores. Ames receives a percentage of the sales under the agreement.\n(m) Earnings per common share:\nNet income per common share for Fiscal 1994 and 1993 was determined by using the weighted average number of common and common equivalent shares outstanding during each fiscal year. Primary and fully-diluted earnings per share were the same in each year. Common stock equivalents represented the assumed exercise of the outstanding Series C Warrants.\nNet loss per common share for the five weeks ended January 30, 1993 was determined using the weighted average number of common shares outstanding. Common stock equivalents and fully- diluted loss per share were excluded for the five weeks ended January 30, 1993 as their inclusion would have had an anti-dilutive impact on the loss per share.\nNet earnings per share for the forty-eight weeks ended December 26, 1992 was not presented because such presentation would not be meaningful, as the old stock was cancelled under the plan of reorganization and the new stock was not issued until consummation.\n2. Reorganization Case and Fresh-Start Reporting:\nReorganization Case\nAs discussed in Note 1, Ames and its subsidiaries filed petitions for reorganization under Chapter 11 on April 25, 1990 (the \"Filing Date\"). The Company's disclosure statement relating to its Third Amended and Restated Joint Plan of Reorganization dated October 23, 1992 (the \"Amended Plan\") was approved by the Bankruptcy Court on October 29, 1992. The Amended Plan was confirmed by the Bankruptcy Court on December 18, 1992 and consummated on December 30, 1992 (the \"Consummation Date\").\nThe Amended Plan provided for, among other things, the payment of $303.5 million of cash (including $46.5 million in deferred cash distributions), $68.9 million in secured notes, the reinstatement of certain obligations, and the distribution of all of the new common stock of the reorganized Ames to creditors to settle approximately $1.6 billion of total estimated claims against the Company that existed as of the Filing Date.\nFresh-Start Reporting\nAs discussed above, the Company's Amended Plan was consummated on December 30, 1992 and Ames emerged from Chapter 11. Pursuant to the guidance provided by the American Institute of Certified Public Accountants in Statement of Position 90-7, \"Financial Reporting by Entities in Reorganization Under the Bankruptcy Code\" (\"SOP 90-7\"), the Company adopted fresh-start reporting and reflected the consummation distributions in the consolidated balance sheet as of December 26, 1992 (the fiscal month-end for December, 1992). The consummation distributions included the payment of certain fees related to the Credit Agreement (Note 5). Under fresh-start reporting, the reorganization value of the Company was allocated to the emerging Company's net assets on the basis of the purchase method of accounting.\nIn connection with the adoption of fresh-start reporting, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS No. 109\"), which had no impact on Ames. Also in connection with the adoption of fresh-start reporting, the Company adopted Statement of Financial Standard No. 106, \"Employers' Accounting for Post-retirement Benefits other than Pensions\" (\"SFAS No. 106\"), which requires that the cost of the these benefits be recognized in the financial statements over an employee's term of service with the Company.\nThe resulting charge of $391.2 million from all fresh-start adjustments, including the write-off of all revalued non-current assets but excluding the write-off of the old stock, was presented as \"Revaluation of assets and liabilities pursuant to adoption of fresh-start reporting\" in the consolidated statement of operations for the forty-eight weeks ended December 26, 1992.\nThe Company's reorganization value was less than the fair value of the current assets at the Consummation Date. In accordance with the purchase method of accounting, the excess of book value over fair value was allocated to reduce proportionately the values assigned to non-current assets in determining their fair values. Because this allocation reduced the non-current assets to zero value, the remainder was classified as a deferred credit (\"Excess of revalued net assets over equity under fresh-start reporting\" or \"negative goodwill\") and is being amortized systematically to income over the period estimated to be benefited (ten years). Depreciation and amortization of fixed assets is for capital additions after December 26, 1992.\nSince the purchase method of accounting was used to record the fair values of assets and assumed liabilities of the reorganized company at December 26, 1992, the consolidated statements of operations and the consolidated statements of cash flows for the fiscal years ended January 28, 1995 and January 29, 1994, and for the five weeks ended January 30, 1993, are not comparable in certain material respects to such predecessor statements for any prior periods. The consolidated financial statements for periods after December 26, 1992 are those of the reorganized entity (the registrant).\n3. Cash and Short-Term Investments:\nAs of January 28, 1995, the Company had $1.8 million of cash received in escrow from the December, 1994 sale of a store's lease interest. This cash was included in \"Restricted cash and short-term investments\" at January 28, 1995 and was released from escrow in February, 1995. In addition, as of January 28, 1995 and January 29, 1994, Ames restricted approximately $0.2 and $1.0 million of cash, respectively, for expected payments of certain remaining administrative and priority claims under the Amended Plan. These amounts are also included in \"Restricted cash and short-term investments.\" The associated liability is included in \"Accrued expenses.\"\nAs of January 29, 1994, approximately $55.0 million was placed for collateral pledge and consignment with Republic National Bank of New York as a condition precedent to the issuance of letters of credit under the Letter of Credit Facility (Note 5). This cash collateral was included in \"Restricted cash and short-term investments\" at January 29, 1994. The amount of cash collateral changed as the balance outstanding under the Letter of Credit Facility changed, since the cash collateral had to equal 105% of the Company's outstanding obligations, including $5.5 million at January 29, 1994 for future increases to standby letters of credit to cover expected workers' compensation claims. Ames earned interest on the invested cash collateral.\n4. Inventories:\nSubstantially all inventories are valued at the lower of cost or market. Cost is determined by the retail last-in, first-out (LIFO) cost method for all merchandise inventories. No LIFO reserve was necessary as of January 28, 1995 and January 29, 1994.\n5. Debt:\nThe New Facility\nOn April 28, 1994, the Company entered into an agreement with BankAmerica Business Credit, Inc., as agent, two financial institutions as co-agents (together with the agent, the \"Agents\"), and a syndicate consisting of five other banks and financial institutions, for a secured revolving credit facility of up to $300 million, with a sublimit of $100 million for letters of credit (the \"New Facility\"). The Company believes the New Facility contains terms, covenants and interest rates that are generally more favorable than those in the original post-emergence Credit Agreement. The New Facility is in effect until June 22, 1997, is secured by substantially all of the assets of the Company, and requires the Company to meet certain quarterly financial covenants. The New Facility has no requirement for cash collateralization of letters of credit, except in limited instances. The funds under the New Facility may only be used for working capital and for the payment of certain debt described below. The interest rate per annum on the New Facility is equal to the Reference Rate (as defined in the New Facility) plus 2% of the first $270 million of Advances (subject to downward adjustments) or 5% of the last $30 million of Advances. Alternatively, the first $270 million of Advances under the New Facility may be made at the interest rate per annum equal to the Eurodollar Rate (as defined in the New Facility) plus 3.75% (subject to downward adjustments).\nAs of January 28, 1995, the interest rate on the New Facility was 10.5%. For Fiscal 1994, the weighted average interest rate on the Company's revolving credit facilities was 9.1%. The peak borrowing level under the New Facility during Fiscal 1994 was $177.5 million. As of January 28, 1995, approximately $9.2 and $29.2 million was outstanding in trade and standby letters of credit, respectively, under the New Facility.\nThe amount of borrowing under the New Facility shall not exceed the sum of (i) an amount equal to 55% of inventory not covered by any outstanding letter of credit plus (ii) an amount equal to 50% of inventory covered by any outstanding letter of credit less (iii) a reserve for reinstated debt ($31.0 million as of January 28, 1995). In addition, the New Facility provides for the potential establishment of other reserves contingent upon the Company's financial performance. Each Agent, in addition, reserves the right in good faith, based upon such collateral consideration as such Agent may in its sole discretion deem necessary or appropriate to adjust the total available to be borrowed by establishing reserves, making determinations of eligible inventory, revising standards of eligibility or decreasing from time to time the percentages set forth above.\nThe quarterly financial covenants under the New Facility are limited to: capital expenditure limits; minimum earnings, without giving effect to any extraordinary gains\/losses or accounting changes, before interest expense, income tax provision, depreciation and amortization, LIFO expense, stock appreciation right accruals, restructuring charges, and other non-cash charges, plus or minus the amount of cash received or expended relating to stock appreciation right accruals or restructuring charges (\"EBITDA\"); and minimum\nEBITDA to cash interest expense. Compliance with the EBITDA covenant will be dependent upon the Company's attainment of results that are reasonably consistent with its financial projections reported on Form 8-K dated February 16, 1995. In addition, each year Ames must have no outstanding borrowings under the New Facility for a consecutive 30-day period between November 15th and February 15th of the following year (the \"clean-up\" requirement). The Company is in compliance with the financial covenants through January 28, 1995.\nFees required under the New Facility include: (1) quarterly commitment fees of .5% per annum on the unused portion of the facility during each quarter, (2) an initial facility fee of $5.4 million paid on the closing date and an additional facility fee of $3.0 million ($1.0 million paid at closing and the remainder due in quarterly installments of $250,000 each beginning in the second year), and (3) prepayment fees of 3.0%, 2.0%, and 1.0% of the amount of the Tranche A portion (as defined in the New Facility) reduced or terminated prior to the first, second, and third (six months or more prior to the maturity date) anniversary of the New Facility, respectively.\nIn June, 1994, the Company utilized the funds that were no longer restricted for the collateralization of letters of credit (Note 3), and funds from the New Facility, to prepay its then outstanding Series A, B and D Notes, a $1.2 million term note, and the outstanding borrowings under the Credit Agreement. As a result of the refinancing and associated commitment to prepay the above debt, a non-cash extraordinary charge of $1.5 million, net of tax benefit of $0.7 million, was recorded in the quarter ended April 30, 1994, primarily for the write-off of deferred financing costs and debt discounts related to the debt to be prepaid.\nOther Debt\nThe Company's outstanding debt as of January 28, 1995 and January 29, 1994 is listed and described below. Pursuant to the Amended Plan, the Company and its lenders agreed to a restructuring of the Company's obligations at December 26, 1992. The differences between the pre-consummation debt obligations and the present values of the new and reinstated debt obligations were included in the calculation of the \"Extraordinary gain on debt discharge\" in the forty-eight weeks ended December 26, 1992.\nNew and reinstated debt obligations that carried face interest rates significantly lower than market rates (for financing of a similar nature) as of the Consummation Date were discounted to their present values using estimated market rates. The discount amounts are being amortized to interest expense over the terms of the related obligations using the effective interest method. The determination of appropriate interest rates was based upon an evaluation of Ames' credit standing, the nature of the collateral, if any, and other terms pertaining to the debt, and the prevailing rates for similar instruments of issues with similar credit ratings. The market interest rates used to determine the present values at December 26, 1992 are shown in the table below.\nUpon consummation of the Amended Plan, Ames obtained $210 million of post-emergence financing. Of this amount, $175.9 million was in the form of a revolving credit facility (the \"Revolver\") and $1.2 million was in the form of a two-year term note. Citibank was the agent in the post-emergence credit agreement (the \"Credit Agreement\" - see below) which combined the $175.9 million Revolver and the $1.2 million term note. The balance of the $210 million post-emergence financing ($32.9 million) represented the two-year portion of the 8% Senior Secured Notes (the \"Series D Notes\") issued under an Indenture with Fleet Bank as indenture trustee.\nUpon consummation of the Amended Plan, the Company also entered into a one-year $90 million letter of credit facility with Republic National Bank of New York (the \"Letter of Credit Facility\" - see below). In September, 1993, the Letter of Credit Facility was increased to $120 million and extended to November 28, 1994.\nDuring Fiscal 1993, Ames recognized an extraordinary gain of approximately $0.9 million on the early extinguishment of certain tax obligations.\nAs of January 28, 1995, payments due on long-term debt for the next five years and thereafter were as follows:\n(000's Omitted) Fiscal Year Ending January Amount -------------------------- ---------------\n1996 $15,168 1997 14,024 1998 12,469 1999 3,152 2000 9,940 Thereafter 2,817\nOutstanding debt at January 28, 1995 and January 29, 1994 is listed below. Further explanations of certain of the obligations follow the table.\nThe Credit Agreement\nThe Credit Agreement was between Ames and Citibank, as agent, and a syndicate consisting of other banks and financial institutions and was terminated when the New Facility became effective in June, 1994. The Credit Agreement provided the $175.9 million Revolver and a $1.2 million term loan. The amount outstanding under the Revolver at the time of the funding of the New Facility, along with the term loan, were prepaid out of the funds from the New Facility.\nThe funds under the Credit Agreement had to be used for working capital, except that up to $10 million could be used for any purpose. The interest rate per annum on the Revolver was equal to the Base Rate (as defined in the Credit Agreement) plus 2 1\/2%. As of January 29, 1994, the interest rate on the Revolver was 8.5%. For the fiscal year ended January 29, 1994 and for the five weeks ended January 30, 1993, the weighted average interest rate was 8.6%. Approximately $15.4 million was outstanding under the Revolver at January 29, 1994. The peak borrowing level under the Revolver was approximately $161.9 and $32.8 million during Fiscal 1993 and during the five weeks ended January 30, 1993, respectively. The face interest rate on the term loan was 8% per annum.\nFees required under the Credit Agreement included: (1) a commitment fee of .5% per annum of the unused portion of the Revolver, (2) an initial facility fee of $4.0 million (paid on the Consummation Date and written-off in conjunction with the recording of the Amended Plan) and a subsequent facility fee of $.9 million paid in December, 1993, (3) a usage fee of $.8 million paid when the sum of advances under the Revolver plus a portion of the Series D Notes exceeded $100 million, and (4) an agent's fee of $1.0 million paid in December, 1993 (the initial agent's fee of $1.0 million was paid on the Consummation Date and written-off in conjunction with the recording of the Amended Plan).\nThe Credit Agreement was secured by substantially all of the assets of Ames and contained certain financial and operating covenants including current ratio; the maintenance of certain inventory levels; maximum capital expenditures; minimum interest and fixed charge coverages; and minimum EBITDA. In addition, Ames could not have any outstanding borrowings (other than borrowings used to cash collateralize letters of credit) under the Credit Agreement for a consecutive 30-day period beginning between November 15 of each fiscal year and the last day of such fiscal year.\nSeries A Notes\nCertain banks from the pre-petition Citibank syndicate elected to receive Series A Notes as part of their distribution under the Amended Plan. The total amount issued was $25.3 million and was due in installments at June 30, 1995, December 31, 1995, and December 31, 1996. The annual face interest rate on these notes was equal to the Base Rate (as defined in the Credit Agreement) plus 3 1\/2%. The Series A Notes were secured in the same manner as the Credit Agreement and contained the same financial covenants as in the Credit Agreement. The Series A Notes were prepaid at the time of the funding under the New Facility and, accordingly, were classified as a component of \"Long-term Debt Classified as Current\" as of January 29, 1994.\nSeries B Notes\nCertain banks from the pre-petition Citibank syndicate elected to receive Series B Notes as part of their distribution under the Amended Plan. The total amount issued was $4.2 million and was due December 31, 1996. These notes were non-interest bearing until December 31, 1995 when they would have begun to bear face interest at 8.0% per annum. The Series B Notes were secured in the same manner as the Credit Agreement and contained the same financial covenants as the Series A Notes. The Series B Notes were prepaid at the time of the funding under the New Facility and, accordingly, were classified as a component of \"Long-term Debt Classified as Current\" as of January 29, 1994.\nSeries D Notes\nCertain banks from the pre-petition Citibank syndicate elected to receive Series D Notes as part of their distribution under the Amended Plan and, for the two-year term note portion of the Series D Notes ($32.9 million), made a net cash contribution to the Company rather than providing the Company with revolving credit financing. The total amount issued was $38.2 million, $32.9 million of which was due on the earlier of June 30, 1995 or 45 days after the termination of the Credit Agreement. The remainder was due in installments at December 31, 1995 and December 31, 1996. The Series D Notes yielded a face interest rate of 8.0% per annum and were secured in the same manner as the obligations under the Credit Agreement. There were no financial covenants under the Indenture. The Series D Notes were prepaid at the time of the funding under the New Facility and, accordingly, were classified as a component of \"Long-term Debt Classified as Current\" as of January 29, 1994.\nThe Letter of Credit Facility\nThe $120 million Letter of Credit Facility with Republic National Bank of New York (\"Republic\") had sublimits of $60 million for trade letters of credit and $60 million for standby letters of credit. The Letter of Credit Facility was terminated when the New Facility became effective in June, 1994. As of January 29, 1994, approximately $11.3 and $35.6 million was outstanding in trade and standby letters of credit, respectively, under the Letter of Credit Facility. All letters of credit outstanding under the Letter of Credit Facility had to be cash collateralized at 105% from the date of issuance (Note 3).\nAllowed Priority Tax Obligations\nAllowed priority tax obligations consist of remaining claims entitled to priority under the Bankruptcy Code, including claims based on retail sales made by Ames (the proceeds of which are deemed to be held in trust by Ames for the benefit of various state taxing authorities). Unless otherwise agreed to in writing with Ames, the holder of an allowed priority tax claim receives deferred cash payments in a principal amount equal to the amount of such claim over a period not exceeding six years from the date of assessment of the tax on which the claim is based. The deferred cash payments may be made in annual installments equal to 10% of the allowed priority tax claim together with simple interest at the rate of 5% per annum. The remaining unpaid principal and accrued interest thereon will be paid on the first business day following the date that is the sixth anniversary of the date of assessment of the tax on which the claim is based. During Fiscal 1993, the Company paid approximately $1.9 million to certain state taxing authorities in early settlement of approximately $2.8 million of tax obligations (Note 21).\nDeferred Cash Distributions\nThe Amended Plan provided that approximately $46.5 million of cash distributions in respect to several classes of claims would be paid subsequent to the Consummation Date. Approximately $15.0, $8.0 and $8.0 million of these deferred cash distributions were paid as scheduled on January 31, 1993, January 31, 1994 and January 31, 1995, respectively, and the remaining unsecured amounts are due as follows, with interest that began on February 1, 1994 at 5% per annum: $8.0 million due January 31, 1996 and $7.5 million due January 31, 1997.\nBefore Reorganization\nContractual interest expense not recorded on certain pre- petition debt totaled approximately $76.2 million for the forty-eight weeks ended December 26, 1992.\nTo finance seasonal working capital requirements during the Chapter 11 period, Ames and Chemical Bank, as agent, were parties to a Debtor-in-Possession Revolving Credit Agreement (the \"DIP Facility\"), under which Ames was allowed to borrow up to $250 million ($200 million beginning in August, 1992) for general corporate purposes, working capital, letters of credit, and inventory purchases.\nThe maximum amount borrowed under the DIP Facility, exclusive of letters of credit, was $70.0 million during the forty-eight weeks ended December 26, 1992. The average interest rate on the DIP Facility was 7.6% in the forty-eight weeks ended December 26, 1992.\n6. Lease Commitments and Unfavorable Lease Liability:\nAmes is committed under long-term leases for various retail stores, warehouses and equipment expiring at various dates through 2018 with varying renewal options and escalating lease clauses. Some leases are classified as capital leases under Statement of Financial Accounting Standards No. 13. Capital lease obligations were revalued under fresh-start reporting. Ames generally pays for real estate taxes, insurance, and specified maintenance costs under real property leases. Certain leases also provide for contingent rentals based on percentages of sales in excess of specified amounts.\nFuture minimum lease payments for leases as of January 28, 1995 were as follows:\n(000's Omitted) Lease Payments ----------------------- Fiscal Year Capital Operating Ending January Leases Leases ------------------- --------- ---------\n1996 $8,356 $41,387 1997 7,757 39,922 1998 6,746 36,040 1999 5,745 33,132 2000 4,905 30,095 Thereafter 44,829 209,113 ------- --------\nTotal minimum lease payments 78,338 $389,689 ======== Less: amount representing estimated executory costs 1,105 ------- Net minimum lease payments 77,233 Less: amount representing interest 35,180 ------- Present value of net minimum lease payments 42,053 Less: currently payable 3,988 ------- Long-term capital lease obligations $38,065 =======\nTotal payments have not been reduced by minimum sublease rentals to be received in the aggregate under noncancellable subleases of capital leases and operating leases of approximately $3.5 and $3.1 million, respectively, as of January 28, 1995.\nAmortization of capital lease assets was approximately $0.1, $0.0, and $4.0 million for Fiscal 1994, Fiscal 1993, and for the forty-eight weeks ended December 26, 1992, respectively.\nRent expense (income), excluding the benefit from the amortization of the unfavorable lease liability, was as follows:\nThe unfavorable lease liability in the Consolidated Balance Sheet was recorded as part of fresh-start reporting and represents the estimated liability related to lease commitments that exceeded market rents for similar locations. This liability is being amortized as a reduction of rent expense in the Consolidated Statements of Operations over the remaining lease terms.\n7. Stockholder's Equity:\nCommon Stock and Priority Common Stock\nAs provided under the Amended Plan, the authorized capital stock of the reorganized Ames consisted of 40,000,000 shares of common stock (20,127,269 and 16,267,211 shares outstanding as of January 28, 1995 and January 29, 1994, respectively), par value $.01 per share (the \"Common Stock\"), and 12,000,000 shares of priority common stock (0 and 3,860,058 shares outstanding as of January 28, 1995 and January 29, 1994, respectively), par value $.01 per share (the \"Priority Common Stock\"). The outstanding shares of the Priority Common Stock as of December 30, 1994 were automatically converted into an equal number of fully paid and nonassessable shares of Common Stock. Such conversion was deemed to have occurred on such date without any notice or other action on the part of the Company or the holder of such Priority Common Stock.\nHolders of shares of Common Stock are entitled to one vote per share on all matters to be voted upon by stockholders and are entitled to receive dividends when, as and if declared by the Board of Directors. In the event of any liquidation, dissolution or winding up of the Company during the two years ended December 30, 1994, whether voluntary or involuntary, the holders of the Priority Common Stock were entitled to be paid out of the assets of the Company available for distribution to its stockholders an amount equal to $8.75 for each share outstanding. The holders of the previously outstanding shares of Priority Common Stock could at such holder's option, at any time and from time to time, convert any or all such shares into an equal number of fully paid and nonassessable shares of Common Stock.\nThe Common Stock does not have any preemptive right or subscription or redemption privilege. The Common Stock also does not have cumulative voting rights, which means the holder or holders of more than half of the shares voting for the election of directors can elect all the directors then being elected. All of the shares of Common Stock are fully paid and nonassessable.\nAll equity interests existing immediately prior to the consummation of the Amended Plan were cancelled pursuant to the Amended Plan and the accumulated deficit was eliminated under fresh-start reporting.\nWarrants\nAn aggregate of 200,000 Series B Warrants were issued under the Amended Plan. Each such warrant entitles the holder to purchase one share of the Common Stock at any time from six months after the Consummation Date through the eighth anniversary of the Consummation Date. The exercise price is $5.92 per share. No Series B Warrants have yet been exercised.\nAn aggregate of 2,120,000 Series C Warrants were issued (1,992,715 outstanding as of January 28, 1995) under the Amended Plan. Each such warrant entitles the holder to purchase one share of the Common Stock at any time from six months after the Consummation Date through January 31, 1999. The exercise price is $1.11 per share. There were no exercises of the Series C Warrants during Fiscal 1994.\nThe exercise prices of the above warrants are subject to adjustment upon the occurrence of certain events, including, among other things, the payment of a stock dividend with respect to the Company's Common Stock, the subdivision, combination or reclassification of Common Stock, the merger or consolidation of the reorganized Company, and the issuance for consideration of rights, options or warrants (other than rights to purchase Common Stock issued to shareholders generally) to acquire Common Stock of the Company. Rights, options or warrants distributed to holders of Common Stock prior to the warrant expiration dates will be distributed to holders of such warrants as if the warrants had been exercised immediately prior to the record date for such distribution. Upon the exercise of warrants, a holder of such warrants is entitled to receive any distributions (other than distributions described above, distributions in connection with the total liquidation, dissolution, or winding-up of the Company or dividends payable out of current earnings) made to holders of Common Stock prior to expiration of such warrants as if the holder had exercised such warrants prior to the record date of such distribution. In this case, the holder, upon conversion, would also receive interest at a rate of 10% per annum on any cash payable, as well as any income earned on distributed assets, property or securities from the distribution date to the date of exercise. The exercise prices and number of shares issuable upon exercise will also be adjusted in certain circumstances if the Company issues certain securities at below market prices.\nA holder of any of the warrants described above as such will not be entitled to any rights as a stockholder of the Company, including without limitation the right to vote with respect to the shares of Common Stock of the Company, until such holder has properly exercised the warrants in accordance with the terms of the respective warrant agreement.\nStock Purchase Rights Agreement\nOn November 30, 1994, the Company adopted a Stock Purchase Rights Agreement (the \"Agreement\"). Under the terms of the Agreement, one purchase right (\"Right\"), with an exercise price of $14.00, is attached to each share of the Company's Common Stock outstanding as of, or issued subsequent to, November 30, 1994 but prior to the occurrence of certain events (as more fully described in the Agreement). The Rights become exercisable in the event that a person or group (an \"Acquiring Person\") either acquires 15% or more of the Company's outstanding voting stock or announces an intention to acquire 20% or more of such stock. Once exercisable, each Right will, depending on the circumstances, entitle a holder, other than an Acquiring Person, to purchase shares of either the Company or an acquiring company having a market value equal to twice the exercise price. The Agreement was adopted to assure that all of the Company's shareholders receive full value for their investment in the event of stock accumulation by an Acquiring Person. Unless previously redeemed by the Company, the Rights will expire on November 29, 2004.\n8. Stock Options:\nPursuant to the 1994 Management Stock Option Plan (the \"Option Plan\") approved by shareholders in June, 1994, the Company may grant options with respect to an aggregate of up to 1,700,000 shares of Common Stock, with no individual optionee to receive in excess of 200,000 shares of Common Stock upon exercise of options granted under the Option Plan. The exercise prices of the options are equal to the fair market value of the Common Stock on the date the options are granted. The options become exercisable over three to five years and terminate after five to six years from the grant date.\nThe following table sets forth the stock option activity for Fiscal 1994.\n9. Income Taxes:\nFor reasons discussed below, the Company recorded income tax provisions of approximately $8.2 and $3.3 million for Fiscal 1994 and 1993, respectively. There were no provisions for income taxes for the five weeks ended January 30, 1993 and for the forty-eight weeks ended December 26, 1992.\nThe Company adopted SFAS No. 109 in conjunction with the adoption of fresh-start reporting. Under SFAS No. 109, deferred income taxes are recognized by applying the enacted statutory tax rates in future years to the changes in \"cumulative temporary differences\" (the differences between financial statement carrying values and the tax basis of assets and liabilities).\nAs a consequence of the adoption of fresh-start reporting and SFAS No. 109, any tax benefits realized for tax purposes after the Consummation Date for pre-consummation cumulative temporary differences, as well as for the pre-consummation net operating loss carryovers, are reported as additions to paid-in-capital (see Consolidated Statements of Changes in Stockholders' Equity) rather than as reductions in the tax provisions in the statements of operations. Tax benefits or liabilities realized for book purposes after the Consummation Date will be segregated from the pre-consummation deferred tax assets. Ames, although not likely to pay income taxes in the near future, is expecting to record tax provisions on any book income. However, the utilization of post- consummation deferred tax assets may reduce future income tax provisions. Such income tax provisions have no impact on the Company's taxes payable or cash flows.\nAmes has the following deferred tax assets from pre-consummation (\"Pre\") and post-consummation (\"Post\") periods, as of the following dates ($ in millions):\nThe Company has fully reserved for its deferred tax assets because of the current uncertainty of the future recognition of such deductions. In subsequent periods, Ames may reduce the valuation allowances, provided that the possibility of utilization of the deferred tax asset is more likely than not, as defined by SFAS No. 109. Any such reduction in the pre-consummation valuation allowance in the near future will result in a corresponding addition to paid-in-capital.\nThe Company has treated \"pre-emergence net operating losses\" (qualified losses incurred prior to the Consummation Date) under Section 382(l)(5) of the Internal Revenue Service (\"IRS\") Code (hereafter \"L-5\"). Under \"L-5,\" there is approximately $295 million in pre-emergence net operating losses currently available as carryovers without any annual limitation, which could result in future tax benefits of approximately $118 million at currently enacted tax rates.\nAmes also has a \"post-emergence net operating loss\" carryover (incurred after the Consummation Date) of approximately $162 million. Both pre and post emergence net operating loss carryovers will expire between 2007 and 2010. In addition, Ames has targeted jobs tax credit carryovers of approximately $7 million and alternative minimum tax credit carryovers of approximately $3 million, which will expire in 2007 and 2004, respectively. Federal net operating loss carryovers for fiscal years subsequent to January 27, 1990 are subject to future adjustments, if any, by the IRS.\nAmes has substantial potential state net operating loss carryovers. It is difficult, however, to quantify the utilizable amounts of such state operating losses because of the uncertainty related to the mix of future profits in specific states.\n10. Benefit and Compensation Plans:\nRetirement and Savings Plan\nAmes has a defined contribution retirement and savings plan (the \"Retirement and Savings Plan\") that is qualified under Sections 401(a) and 401(k) of the Internal Revenue Code of 1986, as amended, for employees who have reached the age of 21, and after one year of service, provided they have completed at least 1,000 hours of service in a 12-month period. For each participant's contribution (up to a maximum of 5% of such participant's total compensation), the Company contributes to the Retirement and Savings Plan an amount equal to 50% of such contribution. A participant may contribute to the plan from 1% to 18% of annual compensation on a pre-tax or after-tax basis, or a combination of both. Participants who terminate their employment with the Company are entitled to receive the full amount of their contributions and, depending on the length of the participant's service to Ames, a portion of the Company's matching contributions. Ames funds all administrative costs incurred by the plan. Ames' expense associated with this plan amounted to approximately $3.1, $2.6, $.2, and $2.5 million, in Fiscal 1994, Fiscal 1993, in the five weeks ended January 30, 1993, and in the forty-eight weeks ended December 26, 1992, respectively.\nIncome Continuation Plan\nCertain officers of Ames participate in an Income Continuation Plan (\"ICP\"), which guarantees up to one year's salary in the event of termination other than for cause. As of January 28, 1995, the Company has reserved for its known obligations under the ICP.\nStock Appreciation Rights\nIn connection with the Amended Plan, stock appreciation rights (\"SARs\") exercisable only for cash, equivalent to 1.2 million shares of the new Common Stock were granted to certain members of management as compensation for their efforts in restructuring Ames and enabling it to emerge from Chapter 11. After exercises and terminations, SARs equivalent to 228,367 shares were outstanding at January 28, 1995. One-third of the SARs vested on the Consummation Date, one-third vested on December 30, 1993, and the remaining one-third vested on December 30, 1994. Each SAR entitles the recipient, upon exercise (which may not be later than five years after the Consummation Date), to receive in cash the excess of the average closing price of a share of Common Stock during the ten trading days prior to the exercise date, over the average closing price of a share of Common Stock during the 60 trading days after the Consummation Date ($2.96). The average closing price for the last 10 trading days of Fiscal 1994 was $2.70 per share. Therefore, no reserve was necessary at January 28, 1995. During Fiscal 1994, a total of 594,965 SARs were exercised.\nKey Employee Continuity Benefit Plan\nAmes has a Key Employee Continuity Benefit Plan (the \"Continuity Plan\") that covers all officers, Vice President and above, and certain other employees of Ames. If the employment of any participant in the Continuity Plan is terminated, other than for death, disability, cause (as defined in the Continuity Plan) or by the participant other than for good reason (as defined in the Continuity Plan), within 18 months after a change of control of Ames, the participant will receive a lump sum cash severance payment. The severance payment is 2.99 times Base Compensation for the President and Executive Vice Presidents, 2 times Base Compensation for Senior Vice Presidents and selected Vice Presidents and 1 times Base\nCompensation for other Vice Presidents. Base Compensation is defined generally as the sum of the participant's annual base compensation in effect immediately prior to the participant's termination plus one-third of the value of the cash and stock bonuses paid to the participant during the 36 months ending on the date of termination. For purposes of the Continuity Plan, a change of control includes but is not limited to the acquisition by any person of beneficial ownership of 20% or more of Ames outstanding voting securities or the failure of the individuals who constituted the Board of Directors at the beginning of any period of 12 consecutive months to continue to constitute a majority of the Board during such period.\nAnnual Incentive Compensation Plan\nThe Company has an Annual Incentive Compensation Plan (the \"Annual Bonus Plan\") that is subject to annual review by the Board of Directors. The Annual Bonus Plan provides annual incentive cash bonuses based on the achievement of the Company's financial goals for the year (and customer service goals for store and field management). Bonus expense recorded under the plan was $1.6, $2.8 and $1.9 million for Fiscal 1994, 1993 and 1992, respectively.\nRetirement Plan\nAmes has an unfunded Retirement Plan for Officers\/Directors (the \"Retirement Plan\"). Every person who is employed by Ames when he or she retires, dies or becomes disabled and who (i) served as both a full-time officer and a director of Ames and has completed five years of service, not necessarily consecutive, in both of these capacities, or (ii) served as a director of Ames and has completed 10 years, not necessarily consecutive, of service to Ames, is eligible for benefits under the Retirement Plan.\nBenefits are payable upon termination of employment due to retirement, death or disability. The annual benefit is equal to two-thirds of the participant's average annual base salary during the five-year period of highest compensation preceding such termination of employment. The maximum annual benefit under the Retirement Plan is $100,000, reduced by an amount equal to certain of such participant's annual Social Security benefits. Each participant in the Retirement Plan is entitled to benefits for a period of 10 years. Upon the earlier death of the participant, at the Company's option, the future payments as scheduled or the then present value of all unpaid benefits will be paid to the participant's estate. The Company has a reserve established for potential payments under the Retirement Plan. No payments were made under this plan during the periods presented.\nThe G.C. Murphy Company Life Insurance Plan\nThe G.C. Murphy Company Life Insurance Plan granted a flat dollar amount (defined benefit) of group term life insurance at no cost to certain retired employees. This plan excludes G.C. Murphy Co. employees who retired from Ames after January 31, 1986. The amount of coverage varies by retiree, is payable only upon death, and has no loan or cash value. There were 2,209 retirees covered by this plan as of January 28, 1995. The Company has a reserve established for the projected payments under this plan.\n11. Commitments and Contingencies:\nAs part of the Company's settlement with TJX Companies, Inc. (\"TJX\") under the Amended Plan, Ames must reimburse TJX for various obligations, fees, and expenses that may be paid by TJX relating to various properties that were under leases rejected by Ames. The obligations, fees, and expenses are subject to certain maximum\namounts and the total reimbursement may not exceed $2.7 million and will be in the form of an unsecured note payable due on January 31, 1998 (the \"TJX Expense Note\"). TJX provides Ames with the amounts paid, if any, during each quarter and those amounts,after appropriate review, become the principal due under the TJX Expense Note. As of January 28, 1995, the amount claimed as due by TJX and recorded by Ames as the TJX Expense Note was approximately $.7 million (see Note 5). Interest is being accrued on the principal amounts due at 10% per annum and will be payable on January 31, 1998.\nThe Amended Plan states that portions of any \"Excess cash flow amount\" must be distributed to holders of claims in certain classes in the order set forth in the Amended Plan. \"Excess cash flow amount\" is defined as, with respect to the fiscal years ending January 27, 1996 and January 25, 1997, 50% of the excess of (i) EBITDA (as defined in the Credit Agreement) of reorganized Ames for such fiscal year over (ii)(a) $99.1 million with respect to the fiscal year ending January 27, 1996 and (b) $114.7 million with respect to the fiscal year ending January 25, 1997; provided, however, that excess cash flow amounts shall not be paid with respect to any fiscal year after the fiscal year ending January 25, 1997. There are a number of events that must occur before these classes will receive any payments from the excess cash flow amount. First, Ames must realize cash flows that exceed the level of projected cash flows in the Amended Plan. Second, if there is cash flow exceeding those projections, it will be allocated to pay the other distributions scheduled under the Amended Plan before any of the classes entitled to receive excess cash flow payments will receive any payments from the excess cash flow amount. Thus, if Ames has excess cash flow, some of the deferred distributions provided in the Amended Plan may be paid earlier than otherwise scheduled. Third, the excess will be measured at the end of each fiscal year through January 25, 1997. This means that if the required earnings levels are not reached during those years, no excess cash flow amount will ever be paid. There were no excess cash flow amounts through January 28, 1995 and none are anticipated in the Company's latest projections.\nThe Amended Plan further states that portions of any Wertheim Claim Proceeds (Note 12) and Litigation Claims (as defined in the Amended Plan) must be distributed to certain classes of claims. As to the Wertheim Claim Proceeds received in June, 1994, after distribution of $7 million to the Class AG-6A Trust, Ames retained the remaining $12 million. To the Company's knowledge, the relevant creditor groups have not formed the Litigation Trust which would be responsible for pursuing any Litigation Claims. Any future net proceeds from Litigation Claims would be distributed pursuant to the Amended Plan.\n12. Litigation:\nOn April 25, 1990, Ames filed for protection under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the Southern District of New York, Case Nos. 90B11233 through 11285. By Order dated as of December 18, 1992 (and modified subsequently) (the \"Confirmation Order\"), the Bankruptcy Court confirmed the Amended Plan. The Amended Plan was consummated on December 30, 1992.\nThe Confirmation Order, among other things, dismissed with prejudice all pending litigation, and released all claims that could have been brought in litigation, between the Company and the Citibank Group, TJX (to the extent provided in the Ames-TJX Release), and the creditors of the Company, including but not limited to Claims arising in (a) the Tax Refund Motion, (b) the Citibank Lift Stay Motion, (c)\nthe Ames Declaratory Judgment Action, (d) the Substantive Consolidation Motion (as terms (a) through (d) are defined on pages 24 and 25 of the October 23, 1992 Disclosure Statement and Restated Joint Plan of Reorganization of Ames Department Stores, Inc. and Other Members of the Ames Group), and (e) an action filed under seal in the Bankruptcy Court on April 24, 1992 by the members of the Ames Group as Adversary Proceeding No. 92-9016A (JAG).\nA number of claims filed in connection with the Ames Chapter 11 cases remain unresolved, only some of which are asserted to be administrative, priority or secured claims. To the extent that such claims are properly asserted or found to be unpaid administrative, priority or secured claims, they would be the responsibility of the Company. Based on its continuing review of these claims, the Company believes that some have, in fact, already been fully satisfied, others are pre-petition unsecured claims which are not the responsibility of the Company, and some will be without any validity. In the aggregate, the Company does not believe the remaining pre- petition claims for which it will be liable under the Amended Plan will be material.\nOn February 1, 1994, a civil complaint was filed against the Company in the Circuit Court for Prince George's County, Maryland, entitled Robert S. Wilson and Lillian Wilson vs Ames Department Stores, Inc. et. al. This complaint arose from an incident on February 15, 1993 in an Ames store in which one of the plaintiffs, Robert S. Wilson, was apprehended for allegedly shoplifting merchandise and was injured in a struggle with Ames store personnel. The complaint alleged that the plaintiff was permanently disabled and, among other things, that Ames personnel used excessive force. On February 1, 1995 Ames and its insurance carriers reached an out- of-court settlement with the plaintiffs, and on February 21, 1995 the case was dismissed with prejudice.\nWertheim Proceeding\nOn October 13, 1992, Ames commenced an adversary proceeding against Wertheim Schroder & Co., Inc. (\"Wertheim\") and James A. Harmon (\"Harmon\") (Wertheim & Harmon, collectively the \"Defendants\"). In this proceeding (the \"Wertheim Proceeding\"), Ames sought damages and equitable relief for breach of fiduciary duty, professional malpractice, fraudulent conveyance and transfer pursuant to the Bankruptcy Code and New York law, and other improper conduct relating to Ames' acquisition from Zayre Corporation (\"Zayre\") of Zayre's discount stores division in October 1988 (the \"Zayre Acquisition\"). Wertheim was investment advisor to both Ames and Zayre in connection with the Zayre Acquisition; Harmon at the time of the Zayre Acquisition served as Chairman of the Board of Directors of Ames and as Chairman of Wertheim.\nOn November 20, 1992, the Defendants answered the complaint, denied its material allegations and interposed ten counterclaims against Ames, asserting (i) contribution claims under common law and the 1933 Securities Act, and (ii) claims for indemnity under Ames' articles of incorporation, Ames' engagement letter with Wertheim, other agreements between Wertheim and Ames, Delaware law and common law.\nOn March 31, 1994, Ames entered into a settlement agreement with the Defendants (the \"Settlement Agreement\"), which was subject to the approval of the Bankruptcy Court. In summary, the Settlement Agreement provided for a $19 million settlement payment by the Defendants and dismissal of all claims and counterclaims in the Wertheim Proceeding. The Settlement Agreement also provided for the Bankruptcy Court to enter an order (the \"Bar Order\") barring the assertion of further claims arising out of the Zayre Acquisition\nagainst the Defendants by Ames and holders of Allowed Claims (as defined in the Amended Plan). The Settlement Agreement also required Ames to indemnify the Defendants in the event that the assertion of Zayre-related claims by Ames against any third party results in that third party bringing a claim over against either of the Defendants. A hearing on the motion to approve the Settlement Agreement and enter the Bar Order was held on April 26, 1994.\nSubsequent to the hearing, the Bankruptcy Court entered an order approving the Settlement Agreement, and the closing on the Wertheim Settlement Agreement took place in June, 1994. At that time, the Company recorded a nonrecurring gain for its $12 million portion of the settlement. The Class AG-6A Trust received $7 million for its portion of the settlement.\nOther Matters:\nBoth prior and subsequent to the Filing Date, various class action suits were commenced on behalf of certain prior stockholders and debenture holders of Ames Department Stores, Inc. A settlement of these class actions, dated May 14, 1993, was reached between the plaintiffs and defendants and was approved by the United States District Court, Southern District of New York, on July 14, 1993. Any claim against Ames arising out of these suits were discharged as part of and in accordance with the terms of the Amended Plan which was confirmed on December 18, 1992. Accordingly, the settlement of these cases has no financial impact on Ames beyond the terms of the Amended Plan.\nAmes has owned and\/or leased current and former facilities that are subject to several environmental laws relating to the operation and maintenance of those facilities, particularly with respect to the facilities' 200 or more underground storage tanks. The vast majority of those tanks have been cleanly removed. Some residual contamination exists at a limited number of facilities, the extent of which has not been determined at this time. Environmental liabilities associated with these facilities may be shared with facility landlords, tenants, subtenants, or other third parties. In some states, clean-ups may be eligible for financing from state funds. Based on currently available information, no liabilities material to the Company will result from any underground storage tank residual contamination. The Company believes that adequate liabilities have been recorded related to any potential costs.\nUnder the Comprehensive Environmental Response, Compensation and Liability Act of 1980 as amended by the Superfund Amendments and Reauthorization Act of 1986 (\"Superfund\"), liability may be imposed on waste generators, site owners and operators, and others regardless of fault or the legality of the original waste disposal activity. Ames may be liable for costs at several sites under Superfund or similar state laws either for generating wastes, including waste oils disposed of at those sites, or in connection with the assumption by Ames of certain Zayre Discount Division liabilities. Ames believes that it has been connected to most of these sites based on relatively small amounts of wastes and that many other parties are involved at these sites and may share in the ultimate liability. Ames does not have sufficient information to determine its relative responsibility for, or contribution to (if any), all of these sites at this time.\nAt the Peak Oil Superfund site in Florida, four Zayre stores were among a number of parties which received unilateral orders from the United States Environmental Protection Agency (\"EPA\") in 1990 requiring them to participate in an immediate removal action at that site. Subsequently, that removal action was performed by the EPA. In December 1994, the EPA notified the Company of its eligibility to participate in a deminimis settlement. In January 1995, the Company agreed to enter into the Deminimis Administrative Order on Consent.\nThe Company is a party to various claims and legal proceedings covering a wide range of matters that arise in the ordinary course of its business activities. The Company believes that its likely liability as to these matters will not have a material adverse effect on the consolidated financial position or results of operations of the Company.\n13. Supplemental Cash Flow Information:\nCash paid for interest and income taxes were as follows:\nAmes entered into other non-cash investing and financing activities as follows:\n14. Fair Values of Financial Instruments:\nThe Financial Accounting Standards Board requires disclosure of the fair value of financial instruments under Statement of Financial Accounting Standards No. 107, \"Disclosures About Fair Value of Financial Instruments\" (\"SFAS No. 107\"). The following methods and assumptions were used by the Company in estimating the fair value disclosures for its financial instruments.\nThe Company's financial instruments as of January 28, 1995 and January 29, 1994 were cash and short-term investments, long-term debt, and the Series C Warrants. For cash and short-term investments, the carrying amounts reported in the Consolidated Balance Sheets approximated fair values. For long-term debt obligations, the fair values were estimated using a discounted cash flow analysis (based upon the Company's incremental borrowing rates for similar types of borrowing arrangements). The fair values of those debt instruments at January 29, 1994 expected to be paid-off from the proceeds of the New Facility (Note 5) were stated at their face amounts. The estimates of the fair values of the other debt instruments at January 29, 1994 approximated their carrying amounts. The fair value of the Series C Warrants was based on the market trading price at year-end less the exercise price, times the number of such warrants that were outstanding.\nThe carrying amounts and fair values of the Company's financial instruments at January 28, 1995 and January 29, 1994 were as follows:\n15. Gain on Disposition of Properties:\nThe following is a summary of the major components of the \"Gain on disposition of properties\": (000's Omitted) ------------------------------------ Fiscal Year Fiscal Year Ended Ended January 28, 1995 January 29, 1994 ---------------- ---------------- Sales of lease interests at closed locations $2,965 $ - Sale of office building 2,870 - Sale of shopping center 1,649 844 Sale of corporate jet - 496 Insurance proceeds and other 771 - ------ ------ $8,255 $1,340 ====== ======\n16. Distribution Center Closing Costs:\nOn November 1, 1994, the Company announced it would close the distribution center in Clinton, Massachusetts in June, 1995 and recorded a provision of $2.5 million in the third quarter for the estimated costs associated with closing the facility. The Company has entered into an agreement to sell the Clinton facility in the second quarter of Fiscal 1995, earlier than originally anticipated. Due to this earlier-than-expected sale, the Company reduced the provision to $1.3 million in the fourth quarter to eliminate the reserve amounts established for real estate taxes and other estimated property holding costs. Transfer of the Clinton operations to the Company's distribution center in Leesport, Pennsylvania began in January, 1995.\nApproximately $0.6 million of estimated termination benefits was included in the provision. Approximately 330 employees will be affected by the closing. The following items represent the major components (in thousands) of the total provision for the Clinton closing costs:\nTermination benefits and other human resources costs $776 Asset write-off 145 Other closing costs 379 ------ $1,300 ======\n17. Restructuring:\nAs part of its restructuring prior to emergence from Chapter 11, the Company announced in October, 1992 that in early 1993 it would close 60 discount stores and the three remaining (freestanding) Crafts & More stores. All of these stores were closed as planned in March, 1993. In connection with the 60 store closings and related restructuring (including the closing of a distribution center\/warehouse and office consolidation), the Company recorded a restructuring charge of $72.5 million in October, 1992. The restructuring charge represented profits or losses from store operations from the date of announcement until closing, estimated lease liabilities (including amounts that were subject to settlement), employee payroll and severance costs, losses on liquidation of inventories, losses on disposition of owned assets and leasehold interests, and other related restructuring costs. In December, 1992, the Company recorded an additional restructuring charge of $16.0 million, primarily to provide a reserve for expected markdowns associated with the discontinuance of private-label children's apparel and for additional home office and field employee severance costs associated with the continued restructuring of the Company.\nThe non-cash decrease in merchandise inventories due to restructuring activities totalled $57.8 million for the forty-eight weeks ended December 26, 1992. The following items represent the major components of the total restructuring charge for the forty-eight weeks ended December 26, 1992: ($ in millions) ----------------- Forty-eight Weeks Ended Item December 26, 1992 ---- ----------------- Lease costs (a) $23.4 Net fixed asset and leasehold write-down 28.3 Write-down of inventories 9.3 Severance and other human resource costs 18.2 Reserve for discontinuance of private-label children's apparel 12.1 Various other (including post- announcement operating results for closing stores) (2.8) ------ $88.5 ======\n(a) The lease costs relate to the closing of stores\/facilities and rejected leases as part of the Chapter 11 case.\nNet assets held for disposition are recorded net of related anticipated costs associated with the sale of such assets. Assets other than merchandise inventories are sold as market conditions permit.\nIn December, 1992, the Company entered into an agreement (the \"60-Store Agency Agreement\") with an agent to assist the Company with the disposition of merchandise inventory in \"going-out-of-business\" (GOB) sales at the 60 discount stores and three Crafts & More stores. The GOB sales commenced in January, 1993, were completed in March, 1993, and the Company realized approximately $46 million in cash for the merchandise inventory after payment of all direct GOB expenses as defined in the 60-Store Agency Agreement. This represented approximately 52% of the beginning GOB retail inventory value at the closed stores.\n18. Pro Forma Summary Information (Unaudited):\nAs discussed in Note 17, during the forty-eight weeks ended December 26, 1992, Ames announced its plan to close 60 discount stores in early Fiscal 1993. The announcement was made on October 30, 1992 and the stores were closed in March, 1993. Results of closing stores' operations are applied against the restructuring reserve from the date of announcement. Therefore the operating results of the 60 stores were included in the statement of operations only through October, 1992.\nThe following unaudited pro forma summary information for the forty-eight weeks ended December 26, 1992 represents the estimated results of operations of the Company as if the Amended Plan was effective at the beginning of Fiscal 1992 and the 60 closed stores were excluded from operations for the forty-eight weeks ended December 26, 1992. The adjustments reflected in the information below include: (1) the estimated effects of the Amended Plan; (2) the reversal of the restructuring charge and operating results of the 60 stores; (3) interest expense and interest income adjustments related to inventory levels at the closed stores and additional funds on hand; (4) income tax expense for the forty-eight week period; and (5) adjustment to the earnings per common share based on the new common shares issued under the Amended Plan.\nPro Forma Summary Information (In Thousands, Except Per Share Amount) (Unaudited)\nForty-eight Weeks Ended December 26, 1992 ----------------- Total Sales $2,167,658 Net Income $8,594 Net Income Per Common Share $ .43\nAlthough reductions were made in corporate office and field expenses in connection with the store closings, no estimates of such reductions were included in any of the pro forma adjustments. Only expenses directly attributable to the closing stores' operations were removed from the historical expense totals. The pro forma data is for illustrative purposes only and should not be construed to be indicative of the Company's results of operations that actually would have resulted if the transactions were consummated on the date assumed and do not project the Company's results of operations or trends for any future date or period.\n19. Leased Department and Other Operating Income:\n20. Bankruptcy Expenses:\nBankruptcy expenses represented primarily professional fees and incremental internal costs incurred as a result of the Chapter 11 cases. Costs totalling $25.5 million were expensed during the forty-eight weeks ended December 26, 1992, relating primarily to accounting, legal and consulting services provided to Ames and various official creditors' committees (which were required to be paid by Ames while in Chapter 11).\n21. Extraordinary Items:\nThe Company prepaid certain debt (Note 5) during Fiscal 1994 and recorded a non-cash extraordinary charge of $1.5 million, net of tax benefit of $0.7 million, primarily for the write-off of deferred financing costs and debt discounts.\nDuring Fiscal 1993, the Company paid $1.9 million to certain state taxing authorities in early settlement of $2.8 million of tax obligations and recorded the difference of $0.9 million as an extraordinary gain.\nThe Company stated its liabilities at December 26, 1992 at the present value of the amounts to be paid pursuant to the Amended Plan. The resulting non-taxable gain of approximately $1.25 billion from the debt discharge was presented as an extraordinary gain in the accompanying consolidated statement of operations for the forty-eight weeks ended December 26, 1992.\n22. Quarterly Financial Data (Unaudited):\nSummarized unaudited quarterly financial data (in thousands except for per share amounts) for the last two fiscal years are shown below. The prior-year's fourth quarter gross margin amount includes certain reclassifications to conform to the current year presentation.\nExhibit 3(b)\nAMENDED AND RESTATED\nBY-LAWS\nOF\nAMES DEPARTMENT STORES, INC. (hereinafter called the \"Corporation\")\nARTICLE I\nOFFICES\nSECTION 1. REGISTERED OFFICE. The registered office of the Corporation shall be in the City of Wilmington, County of New Castle, State of Delaware.\nSECTION 2. OTHER OFFICES. The Corporation may also have offices at such other places both within and without the State of Delaware as the Board of Directors of the Corporation (the \"Board of Directors\") may from time to time determine.\nARTICLE II\nMEETINGS OF STOCKHOLDERS\nSECTION 1. PLACE OF MEETINGS. Meetings of the stockholders for the election of directors or for any other purpose shall be held at such time and place, either within or without the State of Delaware as shall be designated from time to time by the Board of Directors and stated in the notice of the meeting or in a duly executed waiver of notice thereof.\nSECTION 2. ANNUAL MEETINGS. The annual meeting of stockholders shall be held on such date and at such time as shall be designated from time to time by the Board of Directors. At the Annual Meeting the stockholders shall elect by a plurality vote the Board of Directors, and transact such other business as may properly be brought before the meeting. Written notice of the Annual Meeting stating the place, date and hour of the meeting shall be given to each stockholder entitled to vote at such meeting not less than ten nor more than sixty days before the date of the meeting.\nSECTION 3. SPECIAL MEETINGS. Unless otherwise prescribed by law or by the Certificate of Incorporation, special meetings of stockholders, for any purpose or purposes, may be called at any time by either (i) the Chairman, if there be one, (ii) the President, (iii) any Vice President, if there be one, (iv) the Secretary or (v) any Assistant Secretary, if there be one, and shall be called by any such officer at the request in writing of a majority of the Board of Directors or at the request in writing of stockholders owning a majority of the capital stock of the Corporation issued and outstanding and entitled to vote. Such request shall state the purpose or purposes of the proposed meeting. Written notice of a special meeting stating the place, date and hour of the meeting and the purpose or purposes for which the meeting is called shall be given not less than ten nor more than sixty days before the date of the meeting to each stockholder entitled to vote at such meeting.\nSECTION 4. QUORUM. Except as otherwise provided by law or by the Certificate of Incorporation, the holders of a majority of the capital stock issued and outstanding and entitled to vote thereat, present in person or represented by proxy, shall constitute a quorum at all meetings of the stockholders for the transaction of business. If, however, such quorum shall not be present or represented at any meeting of the stockholders, the stockholders entitled to vote thereat, present in person or represented by proxy, shall have the power to adjourn the meeting from time to time, without notice other than announcement at the meeting, until a quorum shall be present or represented. At such adjourned meeting at which a quorum shall be present or represented, any business may be transacted which might have been transacted at the meeting as originally noticed. If the adjournment is for more than thirty days, or if after the adjournment a new record date is fixed for the adjourned meeting, a notice of the adjourned meeting shall be given to each stockholder entitled to vote at the meeting.\nSECTION 5. VOTING. Unless otherwise required by law, the Certificate of Incorporation or these By-Laws, any question brought before any meeting of stockholders shall be decided by the vote of the holders of a majority of the stock represented and entitled to vote thereat. Each stockholder represented at a meeting of stockholders shall be entitled to cast one vote for each share of the capital stock entitled to vote thereat held by such stockholder. Such votes may be cast in person or by proxy but no proxy shall be voted on or after three years from its date, unless such proxy provides for a longer period. The Board of Directors, in its discretion, or the officer of the Corporation presiding at a meeting of stockholders, in his discretion, may require that any votes cast at such meeting shall be cast by written ballot.\nSECTION 6. CONSENT OF STOCKHOLDERS IN LIEU OF MEETING. Unless otherwise provided in the Certificate of Incorporation, any action required or permitted to be taken at any annual or special meeting of stockholders of the Corporation, may be taken without a meeting, without prior notice and without a vote, if a consent in writing setting forth the action so taken, shall be signed by the holders of outstanding stock have not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting at which all shares entitled to vote thereon were present and voted. Prompt notice of the taking of the corporate action without a meeting by less than unanimous written consent shall be given to those stockholders who have not consented in writing.\nSECTION 7. LIST OF STOCKHOLDERS ENTITLED TO VOTE. The officer of the Corporation who has charge of the stock ledger of the Corporation shall prepare and make, at least ten days before every meeting of stockholders, a complete list of the stockholders entitled to vote at the meeting, arranged in alphabetical order, and showing the address of each stockholder and the number of shares registered in the name of each stockholder. Such list shall be open to the examination of any stockholder, for any purpose germane to the meeting, during ordinary business hours, for a period of at least ten days prior to the meeting, either at a place within the city where the meeting is to be held, which place shall be specified in the notice of the meeting, or, if not so specified, at the place where the meeting is to be held. The list shall also be produced and kept at the time and place of the meeting during the whole time thereof, and may be inspected by any stockholder of the Corporation who is present.\nSECTION 8. STOCK LEDGER. The stock ledger of the Corporation shall be the only evidence as to who are the stockholders entitled to examine the stock ledger, the list required by Section 7 of this Article II or the books of the Corporation, or to vote in person or by proxy at any meeting of stockholders.\nARTICLE III\nDIRECTORS\nSECTION 1. NUMBER AND ELECTION OF DIRECTORS. The Board of Directors shall consist of seven members except as provided in Section 2 of this Article, directors shall be elected by a plurality of the votes cast at annual meetings of stockholders, and each director so elected shall hold office until his successor is elected and qualified or until his earlier death or resignation. Any director may resign at any time upon written notice to the Corporation. Directors need not be stockholders.\nSECTION 2. VACANCIES. Vacancies occurring on the Board of Directors for any reason may be filled by a majority of the directors then in office, though less than a quorum, or by a sole remaining director, and the directors so chosen shall hold office until the next annual election and until their successors are duly elected and qualified, or until their earlier resignation or removal.\nSECTION 3. DUTIES AND POWERS. The business of the Corporation shall be managed by or under the direction of the Board of Directors that may exercise all such powers of the Corporation and do all such lawful acts and things as are not by statute or by the Certificate of Incorporation or by these By-Laws directed or required to be exercised or done by the stockholders.\nSECTION 4. MEETINGS. The Board of Directors of the Corporation may hold meetings, both regular and special, either within or without the State of Delaware. Regular meetings of the Board of Directors may be held without notice at such time and at such place as may from time to time be determined by the Board of Directors. Special Meetings of the Board of Directors may be called by the Chairman, if there be one, the President, or any directors. Notice thereof stating the place, date and hour of the meeting shall be given to each director either by mail not less than forty-eight (48) hours before the date of the meeting, by telephone or telegram on twenty-four (24) hours' notice, or on such shorter notice as the person or persons calling such meeting may deem necessary or appropriate in the circumstances. Notice of a meeting of the Board of Directors need not be given to any director who submits a signed waiver of notice whether before or after the meeting, or who attends the meeting without protesting, prior thereto or at its commencement, the lack of notice to him. A notice, or waiver of notice, need not specify the business to be transacted at or purpose of any meeting of the Board of Directors.\nSECTION 5. QUORUM. Except as may be otherwise specifically provided by law, the Certificate of Incorporation or these By-Laws, at all meetings of the Board of Directors, a majority of the entire Board of Directors shall constitute a quorum for the transaction of business and the act of a majority of the directors present at any meeting at which there is a quorum shall be the act of the Board of Directors. If a quorum shall not be present at any meeting of the Board of Directors, the directors present thereat may adjourn the meeting from time to time, without notice other than announcement at the meeting, until a quorum shall be present.\nSECTION 6. ACTIONS OF BOARD BY WRITTEN CONSENT. Unless otherwise provided by the Certificate of Incorporation or these By-Laws, any action required or permitted to be taken at any meeting of the Board of Directors or of any committee thereof may be taken without a meeting, prior notice, or a vote, if all the members of the Board of Directors or committee, as the case may be, consent thereto in writing, and the writing or writings are filed with the minutes of proceedings of the Board of Directors or committee.\nSECTION 7. MEETINGS BY MEANS OF CONFERENCE TELEPHONE. Unless otherwise provided by the Certificate of Incorporation or these By-Laws, members of the Board of Directors of the Corporation, or any committee designated by the Board of Directors, may participate in a meeting of the Board of Directors or such committee by means of a conference telephone or similar communications equipment by means of which all persons participating in the meeting can hear each other, and participation in a meeting pursuant to this Section 7 shall constitute presence in person at such meeting.\nSECTION 8. COMMITTEES. The Board of Directors may, by resolution passed by a majority of the entire Board of Directors, designate one or more committees, each committee to consist of one or more of the directors of the Corporation. The Board of Directors may designate one or more directors as alternate members of any committee, who may replace any absent or disqualified member at any meeting of any such committee. In the absence or disqualification of a member of a committee, and in the absence of a designation by the Board of Directors of an alternate member to replace the absent or disqualified member, the member or members thereof present at any meeting and not disqualified from voting, whether or not he or they constitute a quorum, may unanimously appoint another member of the Board of Directors to act at the meeting in the place of any absent or disqualified member. Any committee, to the extent allowed by law and provided in the resolution establishing such committee, shall have and may exercise all the powers and authority of the Board of Directors in the management of the business and affairs of the Corporation. Each committee shall keep regular minutes and report to the Board of Directors when so requested by the Board of Directors.\nSECTION 9. COMPENSATION. The directors may be paid their expenses, if any, of attendance at each meeting of the Board of Directors and for the performance of their duties as directors and may be paid a fixed sum, determined by the Board of Directors, for attendance at each meeting of the Board of Directors or a stated salary as director. No such payment shall preclude any director from serving the Corporation in any other capacity and receiving compensation therefor. Members of special or standing committees may be allowed like compensation for attending committee meetings.\nSECTION 10. INTERESTED DIRECTORS. No contract or transaction between the Corporation and one or more of its directors or officers, or between the Corporation and any other corporation, partnership, association, or other organization in which one or more of its directors or officers are directors or officers, or have a financial interest, shall be void or voidable solely for this reason, or solely because the director or officer is present at or participates in the meeting of the Board of Directors or committee thereof that authorizes the contract or transaction, or solely because his or their votes are counted for such purpose if (i) the material facts as to his or their relationship or interest and as to the contract or transaction are disclosed or are known to the Board of Directors or the committee, and the Board of Directors or committee in good faith authorizes the contract or transaction by the affirmative votes of a majority of the disinterested directors, even though the disinterested directors be less than a quorum; or (ii) the material facts as to his or their relationship or interest and as to the contract or transaction are disclosed or are known to the stockholders entitled to vote thereon, and the contract or transaction is specifically approved in good faith by vote of the stockholders; or (iii) the contract or transaction is fair as to the Corporation as of the time it is authorized, approved or ratified, by the Board of Directors, a committee thereof or the stockholders. Common or interested directors may be counted in determining the presence of a quorum at a meeting of the Board of Directors or of a committee which authorizes the contract or transaction.\nARTICLE IV\nOFFICERS\nSECTION 1. GENERAL. The officers of the Corporation shall be chosen by the Board of Directors and shall be a President, a Secretary and a Treasurer. The Board of Directors, in its discretion, may also choose a Chairman of the Board of Directors (who must be a director) and one or more Vice Presidents, Assistant Secretaries, Assistant Treasurers and other officers. Any number of offices may be held by the same person, unless otherwise prohibited by law, the Certificate of Incorporation or these By-Laws. The officers of the Corporation need not be stockholders of the Corporation nor, except in the case of the Chairman of the Board of Directors, need such officers be directors of the Corporation.\nSECTION 2. ELECTION. The Board of Directors at its first meeting held after each annual meeting of stockholders shall elect the officers of the Corporation who shall hold their offices for such terms and shall exercise such powers and perform such duties as shall be determined from time to time by the Board of Directors; and all officers of the Corporation shall hold office until their successors are chosen and qualified, or until their earlier resignation or removal. Any officer elected by the Board of Directors may be removed at any time by the affirmative vote of a majority of the Board of Directors. Any vacancy occurring in any office of the Corporation shall be filled by the Board of Directors. The salaries of all officers of the Corporation shall be fixed by the Board of Directors.\nSECTION 3. VOTING SECURITIES OWNED BY THE CORPORATION. Powers of attorney, proxies, waivers of notice of meeting, consents and other instruments relating to securities owned by the Corporation may be executed in the name of and on behalf of the Corporation by the President or any Vice President and any such officer may, in the name of and on behalf of the Corporation, take all such action as any such officer may deem advisable to vote in person or by proxy at any meeting of security holders of any corporation in which the Corporation may own securities and at any such meeting shall possess and may exercise any and all rights and power incident to the ownership of such securities and which, as the owner thereof, the Corporation might have exercised and possessed if present. The Board of Directors may, by resolution, from time to time confer like powers upon any other person or persons.\nSECTION 4. CHAIRMAN OF THE BOARD OF DIRECTORS. The Chairman of the Board of Directors, if there be one, shall preside at all meetings of the stockholders and of the Board of Directors. Unless some other person is so designated by the Board of Directors, he shall be the Chief Executive Officer of the Corporation, and except where by law the signature of the President is required, the Chairman of the Board of Directors shall possess the same power as the President to sign all contracts, certificates and other instruments of the Corporation which may be authorized by the Board of Directors. During the absence or disability of the President, the Chairman of the Board of Directors shall exercise all the powers and discharge all the duties of the President. The Chairman of the Board of Directors shall also perform such other duties and may exercise such other powers as from time to time may be assigned to him by these By-Laws or by the Board of Directors.\nSECTION 5. PRESIDENT. The President shall, subject to the control of the Board of Directors and, if there be one, the Chairman of the Board of Directors, have general supervision of the business of the Corporation and shall see that all orders and resolutions of the Board of Directors are carried into effect. He shall execute all bonds, mortgages, contracts and other instruments of the Corporation requiring a seal, under the seal of the Corporation, except where required or permitted by law to be otherwise signed and executed and except that the other officers of the Corporation may sign and execute documents when so authorized by these By-Laws, the Board of Directors or the President. In the absence or disability of the Chairman of the Board of Directors, or if there be none, the President shall preside at all meetings of the stockholders and the Board of Directors. If there be no Chairman of the Board of Directors, the President shall be the Chief Executive Officer of the Corporation. The President shall also perform such other duties and may exercise such other powers as from time to time may be assigned to him by these By-Laws or by the Board of Directors.\nSECTION 6. VICE PRESIDENTS. At the request of the President or in his absence or in the event of his inability or refusal to act (and if there be no Chairman of the Board of Directors), the Vice President or the Vice Presidents if there is more than one (in the order designated by the Board of Directors) shall perform the duties of the President, and when so acting, shall have all the powers of and be subject to all the restrictions upon the President. Each Vice President shall perform such other duties and have such other powers as the Board of Directors from time to time may prescribe. If there be no Chairman of the Board of Directors and no Vice President, the Board of Directors shall designate the officer of the Corporation who, in the absence of the President or in the event of the inability or refusal of the President to act, shall perform the duties of the President, and when so acting, shall have all the powers of and be subject to all the restrictions upon the President.\nSECTION 7. SECRETARY. The Secretary shall attend all meetings of the Board of Directors and all meetings of stockholders and record all the proceedings thereat in a book or books to be kept for that purpose; the Secretary shall also perform like duties for the standing committees when required. The Secretary shall give, or cause to be given, notice of all meetings of the stockholders and special meetings of the Board of Directors, and shall perform such other duties as may be prescribed by the Board of Directors or President, under whose supervision he shall be. If the Secretary shall be unable or shall refuse to cause to be given notice of all meetings of the stockholders and special meetings of the Board of Directors, and if there be no Assistant Secretary, then either the Board of Directors or the President may choose another officer to cause such notice to be given. The Secretary shall have custody of the seal of the Corporation and the Secretary or any Assistant Secretary, if there be one, shall have authority to affix the same to any instrument requiring it and when so affixed, it may be attested by the signature of the Secretary or by the signature of any such Assistant Secretary. The Board of Directors may give general authority to any other officer to affix the seal of the Corporation and to attest the affixing by his signature. The Secretary shall see that all books, reports, statements, certificates and other documents and records required by law to be kept or filed are properly kept or filed, as the case may be.\nSECTION 8. TREASURER. The Treasurer shall have the custody of the corporate funds and securities and shall keep full and accurate accounts of receipts and disbursements in books belonging to the Corporation and shall deposit all moneys and other valuable effects in the name and to the credit of the Corporation in such depositories as may be designated by the Board of Directors. The Treasurer shall disburse the funds of the Corporation as may be ordered by the Board of Directors, taking proper vouchers for such disbursements, and shall render to the President and the Board of Directors, at its regular meetings, or when the Board of Directors so requests, an account of all his transactions as Treasurer and of the financial condition of the Corporation. If required by the Board of Directors, the Treasurer shall give the Corporation a bond in such sum and with such surety or sureties as shall be satisfactory to the Board of Directors for the faithful performance of the duties of his office and for the restoration to the Corporation, in case of his death, resignation, retirement or removal from office, of all books, papers, vouchers, money and other property of whatever kind in his possession or under his control belonging to the Corporation.\nSECTION 9. ASSISTANT SECRETARIES. Except as may be otherwise provided in these By-Laws, Assistant Secretaries, if there be any, shall perform such duties and have such powers as from time to time may be assigned to them by the Board of Directors, the President, any Vice President, if there be one, or the Secretary, and in the absence of the Secretary or in the event of his disability or refusal to act, shall perform the duties of the Secretary, and when so acting, shall have all the powers of and be subject to all the restrictions upon the Secretary.\nSECTION 10. ASSISTANT TREASURERS. Assistant Treasurers, if there be any, shall perform such duties and have such powers as from time to time may be assigned to them by the Board of Directors, the President, any Vice President, if there be one, or the Treasurer, and in the absence of the Treasurer or in the event of his disability or refusal to act, shall perform the duties of the Treasurer, and when so acting, shall have all the powers of and be subject to all the restrictions upon the Treasurer. If required by the Board of Directors, an Assistant Treasurer shall give the Corporation a bond in such sum and with such surety or sureties as shall be satisfactory to the Board of Directors for the faithful performance of the duties of his office and for the restoration to the Corporation, in case of his death, resignation, retirement or removal from office, of all books, papers, vouchers, money and other property of whatever kind in his possession or under his control belonging to the Corporation.\nSECTION 11. OTHER OFFICERS. Such other officers as the Board of Directors may choose shall perform such duties and have such powers as from time to time may be assigned to them by the Board of Directors. The Board of Directors may delegate to any other officer of the Corporation the power to choose such other officers and to prescribe their respective duties and powers.\nARTICLE V\nSTOCK\nSECTION 1. FORM OF CERTIFICATES. Every holder of stock in the Corporation shall be entitled to have a certificate signed, in the name of the Corporation (i) by the Chairman of the Board of Directors, the President or a Vice President and (ii) by the Treasurer or an Assistant Treasurer, or the Secretary or an Assistant Secretary of the Corporation, certifying the number of shares owned by him in the Corporation.\nSECTION 2. SIGNATURES. Where a certificate is countersigned by (i) a transfer agent other than the Corporation or its employee, or (ii) a registrar other than the Corporation or its employee, any other signature on the certificate may be a facsimile. In case any officer, transfer agent or registrar who has signed or whose facsimile signature has been placed upon a certificate shall have ceased to be such officer, transfer agent or registrar before such certificate is issued, it may be issued by the Corporation with the same effect as if he were such officer, transfer agent or registrar at the date of issue.\nSECTION 3. LOST CERTIFICATES. The Board of Directors may direct a new certificate to be issued in place of any certificate theretofore issued by the Corporation alleged to have been lost, stolen or destroyed, upon the making of an affidavit of that fact by the person claiming the certificate of stock to be lost, stolen or destroyed. When authorizing such issue of a new certificate, the Board of Directors may, in its discretion and as a condition precedent to the issuance thereof, require the owner of such lost, stolen or destroyed certificate, or his legal representative, to advertise the same in such manner as the Board of Directors shall require and\/or to give the Corporation a bond in such sum as it may direct as indemnity against any claim that may be made against the Corporation with respect to the certificate alleged to have been lost, stolen or destroyed.\nSECTION 4. TRANSFERS. Except as otherwise provided in the Certificate of Incorporation, stock of the Corporation shall be transferable in the manner prescribed by law and in these By-Laws. Transfers of stock shall be made on the books of the Corporation only by the person named in the certificate or by his attorney lawfully constituted in writing and upon the surrender of the certificate therefor, which shall be cancelled before a new certificate shall be issued.\nSECTION 5. RECORD DATE. In order that the Corporation may determine the stockholders entitled to notice of or to vote at any meeting of stockholders or any adjournment thereof, or entitled to express consent to corporate action in writing without a meeting, or entitled to receive payment of any dividend or other distribution or allotment of any rights, or entitled to exercise any rights in respect of any change, conversion or exchange of stock, or for the purpose of any other lawful action, the Board of Directors may fix, in advance, a record date, which shall not be more than sixty days nor less than ten days before the date of such meeting, nor more than sixty days prior to any other action. A determination of stockholders of record entitled to notice of or to vote at a meeting of stockholders shall apply to any adjournment of the meeting; provided, however, that the Board of Directors may fix a new record date for the adjourned meeting.\nSECTION 6. BENEFICIAL OWNERS. The Corporation shall be entitled to recognize the exclusive right of a person registered on its books as the owner of shares to receive dividends, and to vote as such owner, and to hold liable for calls and assessments a person registered on its books as the owner of shares, and shall not be bound to recognize any equitable or other claim to or interest in such share or shares on the part of any other person, whether or not it shall have express or other notice thereof, except as otherwise provided by law.\nARTICLE VI\nNOTICES\nSECTION 1. NOTICES. Whenever written notice is required by law, the Certificate of Incorporation or these By-Laws, to be given to any director, member of a committee or stockholder, such notice may be given by mail, addressed to such director, member of a committee or stockholder, at his address as it appears on the records of the Corporation, with postage thereon prepaid, and such notice shall be deemed to be given at the time when the same shall be deposited in the United States mail. Written notice may also be given personally or by telegram, telex or cable.\nSECTION 2. WAIVERS OF NOTICE. Whenever any notice is required by law, the Certificate of Incorporation or these By-Laws, to be given to any director, member of a committee or stockholder, a waiver thereof in writing, signed by the person or persons entitled to said notice, whether before or after the time stated therein, shall be deemed equivalent thereto. Attendance of a stockholder at a meeting in person or by proxy shall constitute a waiver of notice of such meeting, except when such stockholder attends such meeting for the express purpose of objecting at the beginning of such meeting, to the transaction of any business on the grounds that notice of such meeting was inadequate or improperly given.\nARTICLE VII\nGENERAL PROVISIONS\nSECTION 1. DIVIDENDS. Dividends upon the capital stock of the Corporation, subject to the provisions of the Certificate of Incorporation, if any, may be declared by the Board of Directors at any regular or special meeting, and may be paid in cash, in property, or in shares of the capital stock. Before payment of any dividend, there may be set aside out of any funds of the Corporation available for dividends such sum or sums as the Board of Directors from time to time, in its absolute discretion, deems proper as a reserve or reserves to meet contingencies, or for equalizing dividends, or for repairing or maintaining any property of the Corporation, or for any proper purpose, and the Board of Directors may modify or abolish any such reserve.\nSECTION 2. DISBURSEMENTS. All checks or demands for money and notes of the Corporation shall be signed by such officer or officers or such other person or persons as the Board of Directors may from time to time designate.\nSECTION 3. FISCAL YEAR. The fiscal year of the Corporation shall be fixed by resolution of the Board of Directors and may be changed from time to time in the same manner.\nSECTION 4. CORPORATE SEAL. The corporate seal shall have inscribed thereon the name of the Corporation, the year of its organization and the words \"Corporate Seal, Delaware.\" The seal may be used by causing it or a facsimile thereof to be impressed or affixed or reproduced or otherwise.\nARTICLE VIII\nINDEMNIFICATION\nSECTION 1. POWER TO INDEMNIFY IN ACTIONS, SUITS OR PROCEEDINGS OTHER THAN THOSE BY OR IN THE RIGHT OF THE CORPORATION. Subject to Section 3 of this Article VIII, the Corporation shall indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative (other than an action by or in the right of the Corporation) by reason of the fact that he is or was a director or officer of the Corporation, or is or was a director or officer of the Corporation serving at the request of the Corporation as a director or officer, employee or agent of another corporation, partnership, joint venture, trust, employee benefit plan or other enterprise, against expenses (including attorneys' fees), judgments, fines and amounts paid in settlement actually and reasonably incurred by him in connection with such action, suit or proceeding if he acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the Corporation, and, with respect to any criminal action or proceeding, had no reasonable cause to believe his conduct was unlawful. The termination of any action, suit or proceeding by judgment, order, settlement, conviction, or upon a plea of nolo contendere or its equivalent, shall not, of itself, create a presumption that the person did not act in good faith and in a manner which he reasonably believed to be in or not opposed to the best interests of the Corporation, and, with respect to any criminal action or proceeding, had reasonable cause to believe that his conduct was unlawful.\nSECTION 2. POWER TO INDEMNIFY IN ACTIONS, SUITS OR PROCEEDINGS BY OR IN THE RIGHT OF THE CORPORATION. Subject to Section 3 of this Article VIII, the Corporation shall indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action or suit by or in the right of the Corporation to procure a judgment in its favor by reason of the fact that he is or was a director or officer of the Corporation, or is or was a director or officer of the Corporation serving at the request of the Corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust, employee benefit plan or other enterprise against expenses (including attorneys' fees) actually and reasonably incurred by him in connection with the defense or settlement of such action or suit if he acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the Corporation; except that no indemnification shall be made in respect of any claim, issue or matter as to which such person shall have been adjudged to be liable to the Corporation unless and only to the extent that the Court of Chancery of the State of Delaware or the court in which such action or suit was brought shall determine upon application that, despite the adjudication of liability but in view of all the circumstances of the case, such person is fairly and reasonably entitled to indemnity for such expenses which the Court of Chancery or such other court shall deem proper.\nSECTION 3. AUTHORIZATION OF INDEMNIFICATION. Any indemnification under this Article VIII (unless ordered by a court) shall be made by the Corporation only as authorized in the specific case upon a determination that indemnification of the director or officer is proper in the circumstances because he has met the applicable standard of conduct set forth in Section 1 or Section 2 of this Article VIII, as the case may be. Such determination shall be made (i) by the Board of Directors by a majority vote of a quorum consisting of directors who were not parties to such action, suit or proceeding, or (ii) if such a quorum is not obtainable, or, even if obtainable a quorum of disinterested directors so directs, by independent legal counsel in a written opinion, or (iii) by the stockholders. To the extent that a director or officer of the Corporation has been successful on the merits or otherwise in defense of any action, suit or proceeding described above, or in defense of any claim, issue or matter therein, he shall be indemnified against expenses (including attorneys' fees) actually and reasonably incurred by him in connection therewith, without the necessity of authorization in the specific case.\nSECTION 4. GOOD FAITH DEFINED. For purposes of any determination under Section 3 of this Article VIII, a person shall be deemed to have acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the Corporation, or, with respect to any criminal action or proceeding, to have had no reasonable cause to believe his conduct was unlawful, if his action is based on the records or books of account of the Corporation or another enterprise, or on information supplied to him by the officers of the Corporation or another enterprise in the course of their duties, or on the advice of legal counsel for the Corporation or another enterprise or on information or records given or reports made to the Corporation or another enterprise by an independent certified public accountant or by an appraiser or other expert selected with reasonable care by the Corporation or another enterprise. The term \"another enterprise\" as used in this Section 4 shall mean any other corporation or any partnership, joint venture, trust, employee benefit plan or other enterprise of which such person is or was serving at the request of the Corporation as a director, officer, employee or agent. The provisions of this Section 4 shall not be deemed to be exclusive or to limit in any way the circumstances in which a person may be deemed to have met the applicable standard of conduct set forth in Section 1 or 2 of this Article VIII, as the case may be.\nSECTION 5. INDEMNIFICATION BY A COURT. Notwithstanding any contrary determination in the specific case under Section 3 of this Article VIII, and notwithstanding the absence of any determination thereunder, any director or officer may apply to any court of competent jurisdiction in the State of Delaware for indemnification to the extent otherwise permissible under Section 1 and 2 of this Article VIII. The basis of such indemnification by a court shall be a determination by such court that indemnification of the director or officer is proper in the circumstances because he has met the applicable standards of conduct set forth in Section 1 or 2 of this Article VIII, as the case may be. Neither a contrary determination in the specific case under Section 3 of this Article VIII nor the absence of any determination thereunder shall be a defense to such application or create a presumption that the director or officer seeking indemnification has not met any applicable standard of conduct. Notice of any application for indemnification pursuant to this Section 5 shall be given to the Corporation promptly upon the filing of such application. If successful, in whole or in part, the director or officer seeking indemnification shall also be entitled to be paid the expense of prosecuting such application.\nSECTION 6. EXPENSES PAYABLE IN ADVANCE. Expenses (including attorneys' fees) incurred by a director or officer in defending or investigating a threatened or pending action, suit or proceeding shall be paid by the Corporation in advance of the final disposition of such action, suit or proceeding upon receipt of an undertaking by or on behalf of such director or officer to repay such amount if it shall ultimately be determined that he is not entitled to be indemnified by the Corporation as authorized in this Article VIII.\nSECTION 7. NONEXCLUSIVITY OF INDEMNIFICATION AND ADVANCEMENT OF EXPENSES. The indemnification and advancement of expenses provided by or granted pursuant to this Article VIII shall not be deemed exclusive of any other rights to which those seeking indemnification or advancement of expenses may be entitled under any law, By-Law, agreement, contract, vote of stockholders or disinterested directors or pursuant to the direction (howsoever embodied) of any court of competent jurisdiction or otherwise, both as to action in his official capacity and as to action in another capacity while holding such office, it being the policy of the Corporation that indemnification of the persons specified in Sections 1 and 2 of this Article VIII shall be made to the fullest extent permitted by law. The provisions of this Article VIII shall not be deemed to preclude the indemnification of any person who is not specified in Section 1 or 2 of this Article VIII but whom the Corporation has the power or obligation to indemnify under the provisions of the General Corporation Law of the State of Delaware, or otherwise.\nSECTION 8. INSURANCE. The Corporation may purchase and maintain insurance on behalf of any person who is or was a director or officer of the Corporation, or is or was a director or officer of the Corporation serving at the request of the Corporation as a director, officer, employee or agent of an other corporation, partnership, joint venture, trust, employee benefit plan or other enterprise against any liability asserted against him and incurred by him in any such capacity, or arising out of his status as such, whether or not the Corporation would have the power or the obligation to indemnify him against such liability under the provisions of this Article VIII.\nSECTION 9. CERTAIN DEFINITIONS. For purposes of this Article VIII, references to \"the Corporation\" shall include, in addition to the resulting corporation, any constituent corporation (including any constituent of a constituent) absorbed in a consolidation or merger which, if its separate existence had continued, would have had power and authority to indemnify its directors or officers, so that any person who is or was a director or officer of such constituent corporation, or is or was a director or officer of such constituent corporation serving at the request of such constituent corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust, employee benefit plan or other enterprise, shall stand in the same position under the provisions of this Article VIII with respect to the resulting or surviving corporation as he would have with respect to such constituent corporation if its separate existence had continued. For purposes of this Article VIII, references to \"fines\" shall include any excise taxes assessed on a person with respect to an employee benefit plan; and references to \"serving at the request of the Corporation\" shall include any service as a director, officer, employee or agent of the Corporation which imposes duties on, or involves services by, such director or officer with respect to an employee benefit plan, its participants or beneficiaries; and a person who acted in good faith and in a manner he reasonably believed to be in the interest of the participants and beneficiaries of an employee benefit plan shall be deemed to have acted in a manner \"not opposed to the best interests of the Corporation\" as referred to in this Article VIII.\nSECTION 10. SURVIVAL OF INDEMNIFICATION AND ADVANCEMENT OF EXPENSES. The indemnification and advancement of expenses provided by, or granted pursuant to, this Article VIII shall, unless otherwise provided when authorized or ratified, continue as to a person who has ceased to be a director or officer and shall inure to the benefit of the heirs, executors and administrators of such a person.\nSECTION 11. LIMITATION ON INDEMNIFICATION. Notwithstanding anything contained in this Article VIII to the contrary, except for proceedings to enforce rights to indemnification (which shall be governed by Section 5 hereof), the Corporation shall not be obligated to indemnify any director or officer in connection with a proceeding (or part thereof) initiated by such person unless such proceeding (or part thereof) was authorized or consented to by the Board of Directors of the Corporation.\nSECTION 12. INDEMNIFICATION OF EMPLOYEES AND AGENTS. The Corporation may, to the extent authorized from time to time by the Board of Directors, provide rights to indemnification and to the advancement of expenses to employees and agents of the Corporation similar to those conferred in this Article VIII to directors and officers of the Corporation.\nARTICLE IX\nAMENDMENTS\nSECTION 1. These By-Laws may be altered, amended or repealed, in whole or in part, or new By-Laws may be adopted by the stockholders or by the Board of Directors, provided, however, that notice of such alteration, amendment, repeal or adoption of new By-Laws be contained in the notice of such meeting of stockholders or Board of Directors as the case may be. All such amendments must be approved by either the holders of a majority of the outstanding capital stock entitled to vote thereon or by a majority of the entire Board of Directors then in office.\nSECTION 2. ENTIRE BOARD OF DIRECTORS. As used in this Article IX and in these By-Laws generally, the term \"entire Board of Directors\" means the total number of directors which the Corporation would have if there were no vacancies.\nEXHIBIT 22\nAMES DEPARTMENT STORES, INC. AND SUBSIDIARIES SUBSIDIARIES OF THE REGISTRANT\nName State of Incorporation\nAmes Transportation Systems, Inc. Delaware AMD, Inc. Delaware Ames Realty II, Inc. Delaware Zayre New England Corp. * Delaware Zayre Central Corp.* Delaware\n* Holds a 50% interest in Ames Stores, a partnership.","section_15":""}
{"filename":"802971_1995.txt","cik":"802971","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nCitizens Security Group Inc. (the \"Company\") is a regional insurance holding company formed in 1986 and headquartered in Minnesota. The Company, through its subsidiaries, Citizens Fund Insurance Company (\"Citizens Fund\") and Insurance Company of Ohio (\"ICO\"), together with Citizens Security Mutual Insurance Company (\"Citizens Mutual\"), is engaged in the preferred risk property and casualty business.\nCitizens Mutual, Citizens Fund and ICO participate in a reinsurance pooling arrangement under which they combine all of their respective insurance business and Citizens Fund and ICO together assume 75% of the combined business. Citizens Mutual, Citizens Fund and ICO offer a broad line of personal and commercial property and casualty products. The personal insurance products offered include homeowner, automobile, tenant, inland marine and umbrella insurance, and the commercial insurance products offered include multi-peril, automobile, general liability, umbrella and workers' compensation insurance. These products are marketed in Minnesota, Wisconsin, Iowa, Ohio, North Dakota, South Dakota and Missouri through a network of approximately 500 independent agencies.\nPROPOSED ACQUISITION BY MERIDIAN\nEffective as of March 20, 1996, the Company and Citizens Mutual entered into an Acquisition and Affiliation Agreement (the \"Meridian Acquisition Agreement\") with Meridian Insurance Group, Inc. (\"Meridian\") providing for the acquisition of the Company by Meridian (the \"Meridian Acquisition\") and the affiliation of Citizens Mutual and Meridian. Pursuant to the Meridian Acquisition Agreement, a direct or indirect wholly-owned subsidiary of Meridian would be merged with and into the Company, with the result that the Company would become a wholly-owned subsidiary of Meridian or a Meridian subsidiary. In the Meridian Acquisition, each holder of shares of Common Stock of the Company would receive approximately $12.50 per share of Common Stock in cash (an aggregate of approximately $25 million), and Citizens Mutual, as the sole holder of shares of the Company's 7.95% Series A Preferred Stock (the \"Preferred Stock\"), would receive approximately $3.50 per share of Preferred Stock in cash (an aggregate of approximately $4.4 million).\nIn connection with the Meridian Acquisition, Meridian would assume control of the Citizens Mutual Board of Directors. In addition, Citizens Mutual, Citizens Fund, ICO and the insurance companies affiliated with Meridian would enter into a new reinsurance pooling arrangement under which they would combine all of their respective insurance business.\nThe Meridian Acquisition is conditioned upon approval by the holders of the Common Stock of the Company, Citizens Mutual, as the sole shareholder of the Preferred Stock, the policyholders of Citizens Mutual, and insurance company regulatory authorities in Minnesota, Ohio and Indiana, and certain other conditions. The Company anticipates that the Meridian Acquisition will be completed on or about June 30, 1996.\nINTERCOMPANY RELATIONSHIPS\nCitizens Mutual owns 1,250,000 shares of the Preferred Stock and 337,500 shares of the Company's Common Stock. The Preferred Stock and Common Stock vote together as one class on all matters submitted to a vote of the holders of the Company's Common Stock. Therefore, Citizens Mutual owns 54.5% of the Company's outstanding voting securities.\nThe Company, Citizens Mutual, Citizens Fund and ICO are parties to a reinsurance pooling agreement (the \"Pooling Agreement\") under which the insurance business of Citizens Mutual, Citizens Fund and ICO is pooled, and all premiums, losses, loss adjustment expenses and underwriting expenses (after deduction of amounts ceded to other insurance companies) are prorated among these companies on the basis of their participation in the pool. Since October 20, 1989, Citizens Fund, ICO and Citizens Mutual have participated in the pool 50%, 25% and 25%, respectively. From December 24, 1986 to October 20, 1989, Citizens Fund and Citizens Mutual participated in the pool 70% and 30%, respectively. Losses incurred prior to December 24, 1986 are paid solely by Citizens Mutual.\nThe percentages of participation in the pool were determined based on the relative amounts of statutory surplus of Citizens Mutual, Citizens Fund and ICO. If there are significant changes in the relative amounts of surplus, the participation of Citizens Fund and ICO in the pooled business may be adjusted to reflect such changes. The Pooling Agreement has a one-year term expiring December 31, 1996 and is subject to automatic renewal for additional one-year terms. Subject to approval by Minnesota and Ohio state regulatory authorities, the Pooling Agreement may be terminated by any party on December 31 of any year upon 180 days' prior notice. Any amendments to the Pooling Agreement must be approved by Minnesota and Ohio state regulatory authorities.\nThe operations of the Company are interrelated with the operations of Citizens Mutual, which provides facilities, employees and services required to conduct the business of the Company on a cost-allocated basis. See \"Business-Employees and Management Services\" below. All executive officers of the Company are officers of Citizens Mutual, and four members of the Company's seven-person Board of Directors are directors of Citizens Mutual. The Company is a publicly held stock company owned by its shareholders, and Citizens Mutual is a mutual insurance company owned by its policyholders. Conflicts of interest regarding business philosophy, profit objectives, determination of premium rates and other matters may arise between the Company and Citizens Mutual because of the potential varying interests of the Company's shareholders and Citizens Mutual's policyholders. An advisory committee of four persons is required to approve any changes in the Pooling Agreement and pass upon matters involving actual or potential conflicts of interest that may arise between the Company and Citizens Mutual. The advisory committee consists of two outside directors from each of the Company and Citizens Mutual, none of whom holds a seat on both Boards. The decisions of the advisory committee are binding on the two companies. The Company's advisory committee members must conclude that any intercompany transactions and compensation arrangements with the officers of Citizens Mutual and the Company are fair and equitable to the Company.\nLINES OF INSURANCE\nThe property and casualty insurance business underwritten by Citizens Fund is personal lines of insurance. Citizens Mutual and ICO offer personal and commercial lines of insurance. The personal insurance products offered by Citizens Mutual, Citizens Fund and ICO include homeowner, automobile, tenant, inland marine and umbrella insurance. The commercial insurance products offered by Citizens Mutual and ICO include multi-peril, automobile, general liability and umbrella insurance. Commercial insurance products offered by Citizens Mutual and ICO are oriented toward retail stores, restaurants, trade contractors and members of various trade associations, including funeral directors, newspaper publishers and veterinarians. Citizens Mutual's commercial insurance products also include workers' compensation insurance.\nThe following table sets forth by lines of insurance Citizens Fund's and ICO's 75% proportional share of the pool's direct premiums written under the Pooling Agreement in 1995, 1994 and 1993.\nUNDERWRITING\nCitizens Mutual, Citizens Fund and ICO apply a conservative underwriting approach and underwrite only standard lines of property and casualty insurance rather than those lines which are considered higher risk lines, such as aviation, pollution and liquor liability. In addition, Citizens Mutual, Citizens Fund and ICO generally write lines of insurance only for persons and businesses in the \"preferred risk\" category.\nIn general, the underwriting experience of a property and casualty insurer is indicated by its statutory combined ratio, which is the sum of (i) the loss ratio, calculated by dividing losses and loss adjustment expenses by premiums earned, and (ii) the expense ratio, calculated by dividing underwriting expenses, less miscellaneous income, by premiums written. A combined ratio below 100% indicates an underwriting profit, while a combined ratio above 100% indicates an underwriting loss. The following table sets forth statutory loss, expense and combined ratios for Citizens Fund and ICO for 1995, 1994 and 1993.\nMARKETING\nCitizens Mutual's insurance products are marketed through a network of approximately 400 independent insurance agencies located in Minnesota, Wisconsin, Iowa, North Dakota, South Dakota and Missouri. Citizens Fund's insurance products are marketed through approximately 45 independent insurance agencies located in Minnesota, Iowa, Wisconsin, North Dakota, Ohio and South Dakota. ICO's insurance products are marketed through a network of approximately 110 independent insurance agencies in Ohio.\nCitizens Mutual, Citizens Fund and ICO are selective in determining which independent agencies to retain. They generally retain only prominent agencies that employ full-time, professional agents. Because of the long period of time Citizens Mutual, Citizens Fund and ICO have been engaged in the property and casualty business, Citizens Mutual, Citizens Fund and ICO have long-standing relationships with the majority of their independent agencies.\nThe majority of the agencies retained by Citizens Mutual, Citizens Fund and ICO are located in the communities in which their customers reside, and, accordingly, they provide fast, fair and personalized service. Since the agents generally handle competing property and casualty insurance products, the ability of Citizens Mutual, Citizens Fund and ICO to market their products is dependent upon the extent to which their agents promote them.\nIn 1995, a hierarchy of agencies was established in order to deliver services that are consistent with each agency's performance. Citizens Mutual's, Citizens Fund's and ICO's marketing strategy is to sell its personal insurance products through certain select \"Partner\" agencies with the use of automation systems. The Company's goal is to electronically accept and transmit the majority of Citizens Mutual's, Citizens Fund's and ICO's business within the independent agency system. The Company has developed a microcomputer-based automation system to streamline underwriting, rating and policy production functions. This system, which has been installed in the offices of approximately 110 independent agencies in six states, enables agents to provide customers with rate quotations and electronically transfer information to Citizens Mutual, Citizens Fund or ICO. The Company believes the automation system will reduce the cost of processing business while making it easier for independent agents to place policies with Citizens Mutual, Citizens Fund and ICO.\nCitizens Mutual, Citizens Fund and ICO market their insurance products so that the products of one company are distinguishable from those of the other companies. Because all business is combined and allocated pursuant to the Pooling Agreement, such arrangements do not improve the operating results of one company to the detriment of the others.\nOne important aspect of Citizens Mutual's and ICO's marketing strategy is to sell commercial insurance products through various state trade associations. Citizens Mutual is the endorsed property and casualty insurance provider for various trade associations, including associations for funeral directors, newspaper publishers and veterinarians in Minnesota, Wisconsin, Iowa, North Dakota, South Dakota and Missouri. ICO is the endorsed property and casualty insurance provider for one trade association in Ohio and is currently pursuing additional association endorsements.\nTo encourage their agents to sell their products, Citizens Mutual, Citizens Fund and ICO emphasize policyholder service, multi-line insurance coverage packages and a policyholder-oriented premium payment plan. Citizens Mutual, Citizens Fund and ICO offer excellent service to their agents and policyholders by providing 24-hours-a-day claims service and rapid turnaround for rate quotations, policy issuances and policy endorsements. The Company believes the broad range of personal and commercial insurance products written by Citizens Mutual, Citizens Fund and ICO, and the ability to offer these products together in multi-line packages, provide Citizens Mutual, Citizens Fund and ICO with an important marketing tool. The personal insurance products offered by Citizens Mutual, Citizens Fund and ICO permit agencies to offer policyholders automobile, homeowner, inland marine and umbrella insurance together in a comprehensive package. In addition, the broad line of retail store, restaurant and trade contractor coverages offered by Citizens Mutual and ICO permit agents to tailor insurance policies to their customers' needs. The Company believes the availability of comprehensive insurance packages provides an incentive for the agent to sell Citizens Mutual's, Citizens Fund's and ICO's products because the agent is better able to retain all of the customer's insurance business.\nCitizens Mutual, Citizens Fund and ICO emphasize claims service as a marketing tool. Programs have been implemented to make the claims process easier for agents and insureds, while decreasing the claim cost. Programs include a catastrophe team, the Streamlined Auto Repair Program, a National Glass\nProgram, an Approved Contractor Repair Program and on-site loss prevention seminars.\nThe Citizens Account Plan, known as \"CAP\", is designed to offer policyholders convenience and flexibility in paying premiums. Policyholders are billed for premiums on a monthly basis and have the option of making a minimum monthly payment or prepaying all or a portion of the premiums. A single, easy-to-read bill covering the aggregate amount of premiums for all policies written by Citizens Mutual, Citizens Fund and ICO is sent to policyholders. In 1995, approximately 93% of all premium amounts were billed directly to policyholders by Citizens Mutual, Citizens Fund and ICO through an automated billing process.\nEach independent agency receives a percentage of direct premiums written as a commission. Citizens Mutual, Citizens Fund and ICO have various agency commission schedules. Citizens Mutual and ICO have a single profit sharing program under which agents may earn additional compensation. Citizens Fund also has a profit sharing program for its agents. Agency commissions are primarily based on direct premiums written by an agency. The agency profit sharing programs are based on the profitability, retention and growth of business obtained from the agencies and are intended to provide additional compensation to the agencies exceeding certain productivity levels.\nThe independent insurance agencies are currently retained under agency contracts. Under the agency contracts, agents are authorized to sell and bind insurance policies in accordance with procedures specified in the contracts. No one agency or group of related agencies accounted for more than 3.2% of direct premiums written by Citizens Mutual, Citizens Fund and ICO in 1995.\nREINSURANCE\nCitizens Mutual, Citizens Fund and ICO have reinsurance contracts with various reinsurers to reduce their liability on individual risks and to protect against catastrophic losses. Under a reinsurance contract, an insurance company cedes a portion of its exposure and premiums received to another insurance company. The ceding of insurance does not legally discharge the insurer from its primary liability for the full amount of the policies. Therefore, the ceding company remains liable to pay the loss if the reinsurer is unable to meet its obligation under the reinsurance contract.\nThe reinsurance agreements maintained by Citizens Mutual, Citizens Fund and ICO are of two general types, consisting of (i) excess of loss reinsurance, which covers losses in excess of a specified retained amount, and (ii) pro rata reinsurance, under which premiums and losses are shared on a proportionate basis up to a specified amount. Effective January 1, 1996, Citizens Mutual, Citizens Fund and ICO entered into a pro rata reinsurance contract covering 40% of each homeowner policy. Previously, this contract covered 50% of each homeowner policy. Under other reinsurance contracts currently in force, Citizens Mutual, Citizens Fund and ICO retain the first $300,000 (previous to January 1, 1996, this was set at $100,000) of loss on any one risk on property coverage. Citizens Mutual, Citizens Fund and ICO have pro rata reinsurance contracts for property risks covering losses between $300,000 (previously $100,000) and $4,600,000 (previously $3,600,000) per risk. For property risks in excess of $4,600,000 (previously $3,600,000), Citizens Mutual, Citizens Fund and ICO negotiate reinsurance arrangements for each risk on an individual basis. The casualty insurance written by Citizens Mutual, Citizens Fund and ICO is reinsured for losses in excess of $250,000 (previously $100,000) up to a maximum of $5,000,000 per occurrence.\nCitizens Mutual, Citizens Fund and ICO also maintain catastrophe reinsurance to protect against property loss occurrences that involve more than one risk. Citizens Mutual, Citizens Fund and ICO have a catastrophe reinsurance contract\nunder which they recover 95.0% of accumulated catastrophic losses in excess of $600,000 up to $1,250,000 and 97.5% of the next $18,750,000 of catastrophic losses. Effective January 1, 1996 Citizens Mutual, Citizens Fund and ICO also reinsure 100% of each umbrella policy up to and including $5,000,000. Prior to this time, Citizens Mutual, Citizens Fund and ICO reinsured 95% of the first $1,000,000 of risk on each umbrella policy and 100% of any umbrella risk in excess of $1,000,000.\nEffective January 1, 1996, Citizens Mutual, Citizens Fund and ICO entered into an aggregate excess of loss contract which reinsures losses and allocated loss adjusting expenses in excess of 62% in any accident year. The reinsurer's obligation is limited to 5% of accident year subject net earned premium. Losses and allocated adjusting expenses in excess of 67% are retained by Citizens Mutual, Citizens Fund and ICO.\nThe reinsurance contracts maintained by Citizens Mutual, Citizens Fund and ICO either have one-year terms or have indefinite terms and may be terminated by the reinsurer or Citizens Mutual, Citizens Fund and ICO on January 1 of any year upon 60 days' notice. The availability and rates of future reinsurance contracts are subject to future market conditions. If the reinsurance market were to become more expensive or restrictive, Citizens Mutual, Citizens Fund and ICO may face greater exposure and higher costs. The inability of Citizens Mutual, Citizens Fund and ICO to obtain reinsurance on acceptable terms or the insolvency of any of their principal reinsurers could have a material adverse effect on the Company.\nLOSS AND LOSS ADJUSTMENT EXPENSE RESERVES\nWhen claims are made by or against policyholders, any amounts paid or expected to be paid by Citizens Mutual, Citizens Fund or ICO to the claimant are referred to as losses. The costs of investigating, resolving and processing these claims are referred to as loss adjustment expenses (\"LAE\"). Citizens Mutual, Citizens Fund and ICO establish reserves which reflect the estimated unpaid total costs of losses and LAE. These reserves include estimates of the total costs of claims already reported but not yet settled and estimates of the costs of claims that have been incurred but which have not been reported. Among other things, these estimates are based on past claims experience of Citizens Mutual, Citizens Fund and ICO and consider current claim trends as well as changes in social and economic conditions. The effects of inflation are implicitly reflected in the reserving process through analysis of cost trends and review of historical reserve results. Citizens Mutual, Citizens Fund and ICO do not have an internal actuary, but management employs actuarial techniques to analyze and develop reserves. In addition, Citizens Mutual, Citizens Fund and ICO contract with outside actuarial consultants to certify reserves for losses and LAE.\nThe Company believes the reserves currently established by Citizens Fund and ICO for losses and LAE are adequate to cover the ultimate costs. Citizens Fund and ICO do not discount loss reserves. See the table in Part II, Item 8, \"Financial Statements and Supplementary Data\" concerning the reserves of Citizens Fund and ICO.\nThe following table shows the development of balance sheet reserves for unpaid losses and LAE for Citizens Fund from 1986 through 1995 and for ICO from October 20, 1989 through December 31, 1995 on a combined basis. The top line of the table represents the estimated amounts of net losses and LAE for claims arising in all prior years that were unpaid at the respective balance sheet dates, including losses that had been incurred but not yet reported. The next portion of the table shows the re-estimated amount of the previously recorded net reserves based on experience as of the end of each succeeding year. The estimate is modified as more information becomes known about the frequency and severity of claims for individual years. The \"cumulative redundancy\n(deficiency) on net liability\" represents the aggregate change in the estimates over all prior years. The last portion of the table shows gross balance sheet reserves less the reinsurance recoverable on unpaid losses as of the respective balance sheet dates and the gross re-estimated reserves less the reinsurance recoverable on unpaid losses as of the current year. This information is available for 1995, 1994, 1993 and 1992 and is a result of the implementation of Statement of Financial Accounting Standard No. 113, \"Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts.\" This statement requires the Company to report gross balances on the balance sheet before the effect of reinsurance transactions. The Company now records reinsurance recoverables on paid and unpaid losses and ceded unearned premiums as assets, in contrast to the Company's prior practice of netting these amounts against the corresponding liabilities.\n__________ (1) Reinsurance recoverables exclude $49, $55, $1 and $3 of paid recoverables as of December 31, 1995, 1994, 1993 and 1992, respectively.\nSEASONALITY OF BUSINESS\nIn the geographic region where Citizens Mutual and Citizens Fund operate, most weather-related claims, primarily those resulting from tornadoes and severe hailstorms, historically occur during the period from May to September. Most weather-related claims in ICO's geographic region historically occur during the period from March to June. Accordingly, greater losses have been incurred from claims in the second and third quarters of the year than during the rest of the year. Therefore, the Company expects to experience poorer results of operations during these quarters.\nINVESTMENTS\nAn important element of the financial results of the Company is the return on invested assets. The investment portfolios of Citizens Fund and ICO are managed by a professional investment management firm and are under the direction of the Company's Board of Directors. The Company's investment policy is to maximize current yield while maintaining safety of capital together with adequate liquidity for insurance operations.\nThe investment portfolios consist primarily of fixed maturity tax-exempt and taxable bonds, including United States Government and governmental agency securities and corporate, state and municipal bonds. The entire investment portfolios are classified as \"available-for-sale,\" and therefore, these investments are reported at estimated market value, with unrealized gains and losses, net of deferred taxes, recorded in shareholders' equity. In 1995, the investment portfolios were positively affected by an decrease in interest rates. The Company experienced an after-tax increase of approximately $2.1 million from December 31, 1994 to December 31, 1995 in the market value of its investments in fixed maturities and equity securities.\nThe following table sets forth the combined investment results of Citizens Fund's and ICO's investment portfolios for the years ended December 31, 1995, 1994 and 1993. Because of the inability to predict future investment yield, the following information should not be considered indicative of future investment results for the Company.\n__________\n(1) Average of the aggregate invested amounts at market at the beginning and end of the year.\n(2) After deduction of investment expenses, but before applicable income taxes.\n(3) Before applicable income taxes.\nThe following table sets forth the composition of the investment portfolios of Citizens Fund and ICO, based on estimated market values, as of the dates indicated.\n__________\n(1) Total cost adjusted for amortization of discount or premium of fixed maturities was $36,174,613 and $34,153,963 on December 31, 1995 and 1994, respectively.\n(2) Equity securities are valued at market. Total cost of equity securities was $649,278 and $646,597 on December 31, 1995 and 1994, respectively.\n(3) Short-term investments are valued at amortized cost, which approximates market.\nCOMPETITION\nThe property and casualty insurance industry is highly competitive. Price competition has been particularly intense during recent years and is expected to continue for the foreseeable future. Citizens Mutual, Citizens Fund and ICO compete with numerous insurance companies, many of which are substantially larger and have considerably greater financial resources. In addition, Citizens Mutual, Citizens Fund and ICO operate through independent agents which represent more than one company and therefore face competition within each agency.\nRATING\nAs a result of the proposed Meridian Acquisition, A. M. Best & Company, Inc., publisher of Best's Insurance Reports, Property-Casualty (\"Best's\"), has placed its rating of Citizens Mutual, Citizens Fund and ICO under review with positive implications. Best's rating of Citizens Mutual, Citizens Fund and ICO is currently \"B++ (Very Good)\". As is customary for pooled insurance companies, Citizens Mutual, Citizens Fund and ICO are rated as a group. Best's ratings are based in part on an analysis of the financial condition, operations and strategic plans of insurance companies. These ratings are not designed for investors and do not constitute recommendations to buy, sell or hold any security.\nINVESTIGATION AND SETTLEMENT OF CLAIMS\nIn the ordinary course of business, Citizens Mutual, Citizens Fund and ICO are regularly engaged in the defense of claims arising out of the conduct of their insurance business. Claims under insurance policies written by Citizens Mutual, Citizens Fund and ICO are investigated and settled either by claims adjusters employed by Citizens Mutual, by their independent agents who have the authority to settle small claims or by independent adjusters. Citizens Mutual, Citizens Fund and ICO currently utilize 14 full-time claims adjusters\nemployed by Citizens Mutual. If a claim or loss cannot be settled and results in litigation, Citizens Mutual, Citizens Fund and ICO retain outside counsel to represent them.\nIn 1995, Citizens Mutual, Citizens Fund and ICO entered into an agreement with a single adjusting company, Adjusting Unlimited (\"AU\"), covering claims inspection and loss control services. The Company's strategy is to reduce non-legal expenses and severity. AU has the ability to provide claim adjustment services more efficiently through the use of highly automated equipment and by strategically placing their employees in territories serviced by Citizens Mutual, Citizens Fund and ICO.\nGOVERNMENT REGULATION\nCitizens Fund and Citizens Mutual hold licenses to write property and casualty insurance in Minnesota, Wisconsin, Iowa, North Dakota and South Dakota. ICO and Citizens Fund each hold a license to write property and casualty insurance in Ohio. Citizens Mutual also holds licenses to reinsure property and casualty insurance in Ohio and to write property and casualty insurance in Missouri.\nCitizens Mutual, Citizens Fund and ICO are regulated by Minnesota, Ohio and the other states in which they are licensed. The purpose of such regulation is to protect policyholders rather than shareholders. The insurance laws of the various states establish regulatory agencies with broad administrative powers, including the power to grant or revoke licenses to transact business and to regulate trade practices, investments, premium rates, the form and content of financial statements and insurance policies, accounting practices and the maintenance of specified reserves and surplus.\nPursuant to Ohio insurance laws, ICO must maintain minimum statutory surplus of $5,000,000 in order to write commercial property and casualty insurance lines. As of December 31, 1995, ICO's statutory surplus was $5,287,053.\nCitizens Mutual and the Company have agreed that, without prior approval of Minnesota state regulatory authorities, neither of the two companies will engage in any transaction which would result in Citizens Mutual and the directors, officers and employees of, and employee benefit or stock ownership plans sponsored by, Citizens Mutual, the Company, and Citizens Fund owning less than 35.0% of the issued and outstanding voting stock of the Company. In addition, the Minnesota insurance statutes require that Citizens Mutual have \"voting control\" of the Company. Voting control is presumed to exist if Citizens Mutual owns at least 10% of the voting securities of the Company.\nUnder Minnesota and Ohio laws, dividends which may be paid by Citizens Fund and ICO to the Company are restricted. The information contained under Note 14 of Notes to Consolidated Financial Statements is incorporated herein by reference.\nIn addition to regulatory supervision of Citizens Mutual, Citizens Fund and ICO, the Company is subject to statutes governing insurance holding company systems. Typically, such statutes require the Company to periodically file information with the state insurance commissioner, including information concerning its capital structure, ownership, financial condition and general business operations and material intercompany transactions not in the ordinary course of business. In addition, these laws require administrative approval of a change in control of insurance companies.\nThe regulatory authorities of the states in which Citizens Mutual and Citizens Fund operate require them to deposit securities with the Minnesota Department of Commerce for the benefit of policyholders. ICO is required to deposit securities with the Ohio Insurance Department. Amounts deposited may only be\nused for the purpose of paying claims. At December 31, 1995, the securities on deposit by Citizens Fund with the Minnesota Department of Commerce had a market value of $705,671. At December 31, 1995, the securities on deposit by ICO with the Ohio Insurance Department had a market value of $259,140.\nUnder insolvency or guaranty laws in all states in which Citizens Mutual, Citizens Fund and ICO operate, insurers doing business in those states can be assessed up to prescribed limits for policyholder losses of insolvent insurance companies. Assessments are based on prior years' experience or prior years' direct premiums written. In addition, other state laws require Citizens Mutual, Citizens Fund and ICO to participate in various mandatory pools or underwriting associations in certain states in which they operate. During 1995, 1994 and 1993, Citizens Fund's and ICO's portion of total paid assessments was approximately $402,000, $287,000 and $290,000, respectively.\nIn 1994, Citizens Fund and ICO received refunds of $592,398 of excess ceded reinsurance premiums from the Minnesota Workers' Compensation Reinsurance Association. These refunds were required to be distributed to certain Workers' Compensation policyholders under legislation passed by the State of Minnesota in 1992. This legislation was challenged by a group of insurers and on January 31, 1995, the US Court of Appeals for the Eighth Circuit upheld a lower court ruling that found the legislation to be unconstitutional. Citizens Fund and ICO recorded such refunds as premiums earned in 1995 which were recognized in net income accordingly.\nIn December 1993, the National Association of Insurance Commissioners approved a model risk-based capital formula for property and casualty insurers to be effective with the 1994 statutory annual statement. Citizens Mutual, Citizens Fund and ICO have adequate surplus to meet these requirements.\nEMPLOYEES AND MANAGEMENT SERVICES\nThe Company, Citizens Fund and ICO have no employees, and Citizens Mutual provides the services of its employees to the Company, Citizens Fund and ICO under a management services agreement (the \"Management Services Agreement\"). Under the Management Services Agreement, Citizens Fund and ICO pay 75% of all salaries and related expenses of Citizens Mutual's employees. In addition, the Company pays Citizens Mutual for services that are performed specifically for the Company.\nPursuant to the Management Services Agreement, the employees will be transferred to the Company when Citizens Mutual owns shares of Common Stock and Preferred Stock that constitute less than 50% of the voting power of all outstanding voting securities of the Company. After the transfer of such employees, Citizens Mutual would pay 25% of all employee related expenses of the Company.\nCitizens Fund and ICO also pay 75% of the total expenses relating to data processing equipment and other employee support facilities. Prior to October 20, 1989, Citizens Fund paid 70% of such expenses. If the Pooling Agreement is amended, the Management Services Agreement provides that the percentage of expenses paid by Citizens Fund and ICO will change to equal the new percentages of the pool allocated to Citizens Fund and ICO. The Management Services Agreement expires on December 31, 1996 and is subject to automatic renewal on an annual basis.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe principal office of the Company in Red Wing, Minnesota, consists of approximately 30,000 square feet and is leased by Citizens Mutual under a lease expiring on December 31, 2002. Citizens Mutual may terminate the lease upon prior written notice of one year. Citizens Mutual also has the option to extend the lease for two periods of five years. Under the terms of the Management Services Agreement, Citizens Mutual and the Company have the right to occupy the premises jointly. Citizens Mutual also leases an additional office in Red Wing, Minnesota, consisting of approximately 3,300 square feet under a lease expiring on June 30, 1998. The lease is automatically extended for an additional 60 months. Although, Citizens Mutual may terminate the lease upon written notice prior to April 1, 1998. ICO leases an office in Mansfield, Ohio, which consists of approximately 2,700 square feet under a lease which expires on January 3, 1997. ICO is subleasing the Mansfield, Ohio office space.\nThe annual rent on offices is currently $314,412 plus the amount of real estate taxes, utility, insurance and common area maintenance expenses. Citizens Fund and ICO pay 75% of the rent and all other expenses under the leases. If the Pooling Agreement is amended, the Management Services Agreement provides that this percentage will change to equal the new percentage of the pool allocated to Citizens Fund and ICO.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nNone.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nMARKET INFORMATION\nThe Common Stock ($.01 par value) of the Company trades on The Nasdaq Small-Cap Market under the symbol \"CSGI\".\nThe following table sets forth the high and low bid quotations as reported by Nasdaq for each quarterly period during 1995 and 1994.\nHOLDERS\nThere were 115 holders of record of Common Stock as of March 19, 1996. The Company believes there were more than 1,000 beneficial owners of its Common Stock as of March 19, 1996.\nDIVIDENDS\nThe Company does not intend to pay cash dividends to holders of its Common Stock for the foreseeable future. As a result of changes in state insurance statutes and covenants contained in its bank loan agreement, the Company has not paid any cash dividends with respect to its Common Stock since 1992. As a holding company, the Company's source of cash is dividends from its subsidiaries and payments under a capital access fee agreement with Citizens Mutual, Citizens Fund and ICO. See Part III, Item 13, \"Certain Relationships and Related Transactions.\" These subsidiaries are subject to state laws and regulations which restrict their ability to pay dividends. See Note 14 of Notes to Consolidated Financial Statements in Part II, Item 8, \"Financial Statements and Supplementary Data.\"\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe selected financial data of the Company as of December 31, 1990 through 1995 and for the years then ended are derived from the consolidated financial statements of Citizens Security Group Inc. and subsidiaries, which financial statements have been audited by KPMG Peat Marwick LLP, independent auditors. The consolidated financial statements for 1995, 1994 and 1993 and KPMG Peat Marwick LLP's report thereon are included in Part II, Item 8, \"Financial Statements and Supplementary Data.\"\n- ------------------- * All per common share information for 1995 and 1994 reflects the March 1994 stock exchange transaction and the deduction of preferred stock dividends.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe consolidated financial statements and the related notes included in Part II, Item 8, \"Financial Statements and Supplementary Data\" should be read in conjunction with the following discussion as they contain important information for evaluation of the Company's financial condition and operating results.\nRESULTS OF OPERATIONS\nINDUSTRY OVERVIEW\nProperty and casualty insurance policies are priced before costs are known as premiums are determined before losses are reported. The profitability of insurers is affected by many factors, including the severity and frequency of claims, natural disasters, interest rates, crime rates, general business conditions, regulatory measures, and court decisions that define and expand the extent of coverage and amount of compensation due for injuries or losses.\nThe property and casualty insurance industry experienced record catastrophe losses in recent years as a result of hurricanes, floods, earthquakes and other natural disasters. While the Company was not adversely affected by these catastrophic losses, they will have a lasting effect on how the insurance industry evaluates exposures.\nYEAR ENDED DECEMBER 31, 1995 COMPARED TO YEAR ENDED DECEMBER 31, 1994\nDirect premiums written increased 7.9 percent in 1995 over the comparable amount in 1994 primarily because of growth in commercial lines of business. The growth is also attributable to an increase in policies written with agents that the Company has designated as \"Partner\" agencies. As anticipated, this growth was somewhat offset by the effect of the Company's decision not to write new business with certain agencies that do not fit within the Company's long-term marketing strategies.\nNet premiums earned increased 12.0 percent in 1995 over 1994. In the first quarter of 1995, net premiums earned were positively affected by a $592,398 refund of excess ceded premiums received from the Minnesota Workers' Compensation Reinsurance Association (\"MWCRA\").\nThe property and casualty insurance market continues to be competitive. Although revenues from the Company's association business grew approximately 32 percent in 1995 compared to association revenues during 1994, the workers' compensation market in Minnesota and Wisconsin is intensely competitive. The Company's current strategy is to maintain rate adequacy in order not to jeopardize underwriting results.\nNet investment income increased 11.8 percent in 1995 over 1994, primarily as a result of an increase in invested assets. Realized gains on investments were $76,880 in 1995 compared to a realized loss of $7,422 in 1994. The Company continued to shorten the duration of the investment portfolios in order to decrease exposure to interest rate volatility.\nThe Company's loss ratio was 62.0 percent in 1995 compared to 59.3 percent in 1994. The Company experienced a 12.7 percent decrease in the number of claims in 1995 compared to 1994; however, this decrease was offset by an increase in severe claims during 1995. The Company experienced an increase in the severity of claims mainly in the homeowners line of business as a result of catastrophe hailstorms in Iowa, North Dakota and South Dakota and in the personal automobile line due to major accidents. The increase in severity was partially offset by favorable development of prior years' workers' compensation losses in 1995.\nThe Company continued to decrease loss adjustment expenses in 1995. The Company's loss adjustment expense ratio (loss adjustment expenses to premiums earned) was 7.7 percent in 1995 compared to 8.6 percent in 1994. The majority of this decrease occurred as a result of utilizing one outside vendor to handle certain adjusting functions previously handled by many outside vendors.\nThe Company's expense ratio (total operating expenses to premiums earned) in 1995 was approximately the same as the expense ratio reported in 1994.\nIn evaluating its financial performance, the Company focuses on after-tax operating results before consideration of realized investment gains or losses. Management believes operating results are a better indicator of the Company's financial performance because it eliminates the variability associated with such gains or losses. After-tax operating income, excluding realized gains and losses, was $1,389,643 in 1995 compared to $1,386,961 in 1994. This resulted in operating earnings per common share of $.61 in 1995 (after deduction of Preferred Stock dividends) compared to $.57 in 1994. The MWCRA refund, in addition to accrued interest income associated with such refund, accounted for net income of approximately $410,000, or $.25 per common share, in the first quarter of 1995.\nNet income was $1,440,523, or $.64 per common share, in 1995 compared to net income of $1,381,538, or $.57 per common share, in 1994.\nYEAR ENDED DECEMBER 31, 1994 COMPARED TO YEAR ENDED DECEMBER 31, 1993\nDirect premiums written increased 13.5 percent in 1994 over the comparable amount in 1993. The growth was primarily attributable to an increase in the number of policies written for personal automobile, commercial multi-peril, workers' compensation and related commercial lines in Iowa, Minnesota and Wisconsin.\nNet premiums written in 1994 rose 16.3 percent over the comparable amount in 1993 mainly as the result of the increase in direct premiums written. The Company's net premiums written also increased by $592,398 due to a refund of excess ceded premiums from the MWCRA. Net written premiums and unearned premiums as of December 31, 1994 were increased by this amount. Net premiums earned in 1994 increased 11.7 percent over 1993.\nNet investment income was $2,194,372 for 1994 compared to $1,952,529 for 1993. This increase over 1993 results was primarily from an increase in invested assets. The Company experienced realized losses on investments of $7,422 in 1994 compared to realized gains of $606,031 in 1993. During the first quarter of 1993, the Company took advantage of favorable conditions in the bond market and repositioned a portion of its investment portfolio to reduce its exposure to fixed maturities being called before maturity.\nThe Company's loss ratio was 59.3 percent in 1994 compared to 54.5 percent in 1993. The Company experienced a 13.5 percent increase in the number of claims for the year ended December 31, 1994 compared to the same period in 1993. In addition, the Company experienced an increase in the severity of claims during 1994. The majority of the increase in claim frequency and severity occurred in the homeowners line of business as a result of a catastrophe hailstorm which occurred on August 18 and 19, 1994, in three separate locations in Iowa, Minnesota and North Dakota. The increase in claim frequency and severity was partially offset by favorable development primarily in commercial multi-peril, commercial automobile liability and homeowners lines of business related to claims incurred prior to 1994.\nThe Company aggressively decreased loss adjustment processing costs in 1994. The Company's loss adjustment expense ratio was 8.6 percent in 1994 compared to 12.5 percent in 1993. The majority of this decrease occurred as a result of adding in-house staff to handle certain adjusting functions previously handled by outside vendors. The Company also realized a decrease of approximately $169,000 in loss adjustment expenses during 1994 as a result of a reclassification of expenses into insurance operating expenses based on a recent study of the allocation of expenses between loss adjustment and underwriting.\nAs a result of the expense reallocation, the Company's expense ratio for 1994 increased nearly one percentage point as compared to the expense ratio for 1993.\nAfter-tax operating income, excluding realized gains and losses, increased 30 percent to $1,386,961 in 1994 from $1,062,887 in 1993. This increase resulted in operating earnings per common share of $.57 in 1994 (after effect of the March 1994 stock exchange of Common Stock for Preferred Stock by Citizens Mutual and the deduction of Preferred Stock dividends) compared to $.37 in 1993.\nNet income was $1,381,538, or $.57 per common share, in 1994 compared to net income of $1,501,918, or $.52 per common share, in 1993.\nLIQUIDITY AND CAPITAL RESOURCES\nOPERATING ACTIVITIES\nThe primary sources of liquidity for the Company's subsidiaries are funds generated from insurance premiums and net investment income. The principal outflows of cash are payments of claims, taxes and operating expenses. The amount of cash provided from operating activities was $2,557,371 in 1995 and $3,826,575 in 1994. The Company's subsidiaries generate sufficient cash to meet their operating requirements.\nIn December 1993, the National Association of Insurance Commissioners approved a model risk-based capital formula for property and casualty insurers to be effective with the 1994 statutory annual statement. The Company's subsidiaries have adequate surplus to meet these requirements.\nINVESTING ACTIVITIES\nIn addition to the cash provided from operations, the Company maintains liquidity in its subsidiaries' investment portfolios. At December 31, 1995, Citizens Fund and ICO had total investments, at market value, of $39,275,897 compared to $34,161,671 at December 31, 1994.\nIn 1995, the Company's subsidiaries' investment portfolios were effected by a change in economic conditions which led to a decrease in interest rates. The Company experienced an after-tax increase of approximately $2.1 million from December 31, 1994 to December 31, 1995 in the market value of its investments in fixed maturities and equity securities. The entire investment portfolio is classified as \"available-for-sale,\" and, therefore, these investments are reported at estimated market value, with unrealized gains and losses, net of deferred taxes, recorded in shareholders' equity. Citizens Fund's and ICO's investment portfolios consist almost entirely of fixed maturity bonds, of which 97% are rated \"A\" or higher by investment rating agencies. The Company does not own real estate, junk bonds or high-risk derivative products.\nThe Company's subsidiaries' investment portfolios are managed by an investment advisor under the direction of the Company's Board of Directors.\nAt December 31, 1995, the Company, Citizens Fund and ICO held cash and short- term investments of $2,753,621. Management believes these funds provide adequate liquidity for the payment of claims and other short-term cash needs.\nFINANCING ACTIVITIES\nOn November 3, 1989, the Company obtained a $6,000,000, seven-year bank loan to fund the purchase of ICO. On November 9, 1995, the bank loan was assigned by the lender to Goodhue County National Bank of Red Wing, Minnesota (\"GCNB\"). The principal balance of the bank loan remaining to be paid as of December 31, 1995 was $999,000. The current interest rate is 8.75 percent, but the rate is variable and is tied to the prime rate. Under the bank loan agreement, the Company agreed to certain restrictive covenants. See Note 9 of Notes to Consolidated Financial Statements included in Part II, Item 8, \"Financial Statements and Supplementary Data.\"\nOn March 31, 1994, Citizens Mutual exchanged 1,250,000 shares of Common Stock for 1,250,000 shares of Preferred Stock issued by the Company. Annual cumulative dividends totaling $347,813 ($.27825 per share) are payable with respect to the Preferred Stock.\nAs a holding company, the Company depends on cash dividends from its subsidiaries and fees payable under a capital access fee agreement to make principal and interest payments due under the loan agreement and provide funds for preferred stock dividends and other expenses. Citizens Fund and ICO are restricted under state insurance laws as to the amount of dividends that may be paid without the approval of such regulatory authorities. See Note 14 of Notes to Consolidated Financial Statements included in Part II, Item 8, \"Financial Statements and Supplementary Data.\"\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nCONSOLIDATED BALANCE SHEETS Citizens Security Group Inc. and Subsidiaries\nSEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.\nCONSOLIDATED STATEMENTS OF INCOME Citizens Security Group Inc. and Subsidiaries\nSEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.\nCONSOLIDATED STATEMENTS OF CHANGES IN EQUITY Citizens Security Group Inc. and Subsidiaries\nSEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.\nCONSOLIDATED STATEMENTS OF CASH FLOWS Citizens Security Group Inc. and Subsidiaries\nSEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS Citizens Security Group Inc. and Subsidiaries December 31, 1995, 1994 and 1993\n(1) BASIS OF PRESENTATION\nCitizens Security Group Inc. (the \"Company\") was incorporated on September 12, 1986 and is currently 54.5 percent owned by Citizens Security Mutual Insurance Company (\"Citizens Mutual\"). Citizens Fund Insurance Company (\"Citizens Fund\"), a wholly-owned subsidiary of the Company, was incorporated on September 15, 1986. Insurance Company of Ohio (\"ICO\"), a wholly-owned subsidiary of the Company, was acquired by the Company effective as of October 20, 1989. As used herein, \"Subsidiaries\" refers to Citizens Fund and ICO. The consolidated financial statements include the accounts of the Company and Subsidiaries. All significant intercompany balances have been eliminated in consolidation.\nThe Subsidiaries and Citizens Mutual provide personal and commercial insurance products throughout the states of Iowa, Minnesota, Missouri, North Dakota, Ohio, South Dakota, and Wisconsin.\nThe Subsidiaries and Citizens Mutual are parties to a reinsurance pooling agreement. Under the pooling agreement, all premiums, losses, loss adjustment expenses and underwriting expenses of the three companies are combined and prorated between the parties based on their participation in the pool. Since October 20, 1989, the Subsidiaries have been 75 percent participants in the pool and Citizens Mutual has been a 25 percent participant.\nCitizens Fund and Citizens Mutual losses incurred prior to October 20, 1989 (but not prior to December 24, 1986) are pooled 70 percent to Citizens Fund and 30 percent to Citizens Mutual. Losses incurred prior to December 24, 1986 are incurred solely by Citizens Mutual.\nPursuant to a loss and loss adjustment expense agreement between Prudential-LMI Commercial Insurance Company (\"Prudential-LMI\") and ICO, ICO losses incurred prior to October 20, 1989 are incurred solely by Prudential-LMI regardless of when such losses are reported or paid.\nUnder the terms of a management services agreement, Citizens Mutual provides the Company and Subsidiaries with facilities, employees and substantially all services required to conduct its business. In return, the Subsidiaries pay 75 percent of the related expenses of Citizens Mutual, which consist primarily of salaries, employee benefits, rent and depreciation of equipment. In addition, the Company pays Citizens Mutual for services that are performed specifically for the Company.\nThe Company entered into a capital access fee agreement on March 31, 1994 under which the Subsidiaries and Citizens Mutual pay a fee to the Company in consideration of its ability to raise capital for the combined insurance operations of the Subsidiaries and Citizens Mutual. The fee is paid monthly in an amount equal to one percent of the aggregate direct written premiums of the Subsidiaries and Citizens Mutual. Of the total monthly fee, 75 percent of the fee is paid by the Subsidiaries and 25 percent by Citizens Mutual. Citizens Mutual's obligation to pay its portion of the fee will terminate on the earlier of (i) the date on which the Company's currently outstanding bank loan (or any indebtedness incurred to refinance such loan) is repaid in full or (ii) the closing date of the Company's next public offering of securities.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS Citizens Security Group Inc. and Subsidiaries December 31, 1995, 1994 and 1993\nOn February 8, 1996, Meridian Insurance Group, Inc., (\"Meridian\") and the Company announced that they entered into a letter of intent providing for Meridian's acquisition of the Company for approximately $29 million in cash. Common shareholders of the Company would receive approximately $12.50 per common share, and the preferred shareholder, Citizens Mutual, would receive approximately $4.4 million for the Company's preferred stock. In conjunction with the transaction, Meridian would also assume control of Citizens Mutual and the Subsidiaries and Citizens Mutual would enter into arrangements with the Meridian Insurance Group companies relating to the pooling of insurance.\n(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nINVESTMENTS The Company implemented Statement of Financial Accounting Standards (\"SFAS\") No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" as of December 31, 1993. The Company classified its entire fixed maturity and equity investment portfolios as \"available-for-sale.\" Accordingly, these investments are reported at estimated market value with unrealized gains and losses, net of deferred taxes, recorded in shareholders' equity. Classifying these portfolios as \"available-for-sale\" does not impact net income. Estimated market value is based on quoted market prices where available. Where quoted market prices are not available, market value is estimated using values obtained from independent pricing services.\nShort-term investments include investments maturing within one year, money market instruments and mutual funds. Short-term investments with original maturities of three months or less are considered cash equivalents for purposes of the Consolidated Statements of Cash Flows. The carrying amount reported in the balance sheets for cash and short-term investments approximate their fair value.\nRealized gains or losses on sales of investments, based on specific identification of the investments sold, are credited or charged to income. Changes in unrealized appreciation or depreciation resulting from changes in the market value of investments are credited or charged to shareholders' equity, net of deferred income taxes, if any.\nPREMIUMS Premiums are recognized as revenue on a pro rata basis over the terms of the respective policies. Unearned premiums are calculated on the daily pro rata basis.\nDEFERRED POLICY ACQUISITION COSTS Policy acquisition costs such as commissions, premium taxes and certain other underwriting expenses, which vary with and are primarily related to the production of business, are deferred and amortized over the effective period of the related insurance policies. If deferred policy acquisition expenses were to exceed the sum of unearned premiums and related anticipated investment income less losses and loss adjustment expenses, the excess costs would be expensed immediately.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS Citizens Security Group Inc. and Subsidiaries December 31, 1995, 1994 and 1993\nRESERVES FOR LOSSES AND LOSS ADJUSTMENT EXPENSES The Company provides reserves for losses based upon aggregate case basis estimates for losses reported and estimates of unreported losses, less reductions for estimated amounts recoverable for salvage and subrogation. The estimated amounts recoverable for salvage and subrogation were $685,000 and $695,000 at December 31, 1995 and 1994, respectively. The Company provides reserves for loss adjustment expenses by estimating expenses to be incurred in settlement of the claims. Estimated losses and loss adjustment expenses recoverable from reinsurers are reflected as assets.\nThe reserves for losses and loss adjustment expenses are considered adequate to cover the ultimate net cost of losses and loss adjustment expenses. Since the reserves are necessarily based on estimates, the ultimate liability may be more or less than such reserves. Any adjustments made to reserves are reflected in the operating results of the year during which the adjustments are made.\nBANK LOAN PAYABLE The carrying amount reported in the Consolidated Balance Sheets for the bank loan payable approximates its fair value.\nEQUIPMENT Equipment is stated at cost less accumulated depreciation. Depreciation is computed on a straight-line basis over the estimated useful lives of the related assets.\nINCOME TAXES Deferred Federal income taxes are provided to recognize temporary differences between income determined for financial reporting purposes and income determined for Federal income tax purposes and changes during the year in cumulative temporary differences between the tax basis and book basis and liabilities.\nEARNINGS PER COMMON SHARE Earnings per common share are calculated based on the weighted average number of common and common equivalent shares outstanding and after net income is reduced by dividends on the Company's Series A preferred stock. Declared preferred stock dividends were $347,812 and $260,859 in 1995 and 1994, respectively.\nEXCESS OF COST OVER NET ASSETS ACQUIRED The excess of cost over net assets acquired of $1,184,550, less accumulated amortization of $875,253 and $733,033 as of December 31, 1995 and 1994, respectively, represents the unamortized excess of cost over underlying net tangible assets of ICO at the date of acquisition. The original amount is being amortized on a straight-line basis over an average life of approximately nine years. The Company monitors the value of goodwill and would reduce the carrying value against expenses if it was determined that goodwill had been impaired.\nUSE OF ESTIMATES The preparation of the consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS Citizens Security Group Inc. and Subsidiaries December 31, 1995, 1994 and 1993\nreported financial statement balances as well as the disclosure of contingent assets and liabilities. Actual results could differ from those estimates.\nSimilar to most companies with property and casualty insurance operations, the Company's gross and net reserves for losses and loss adjustment expenses and deferred acquisition costs, although supported by actuarial projections and other data, are ultimately based on management's reasoned expectations of future events. It is reasonably possible that the expectations associated with these accounts could change in the near term (i.e., within one year) and that the effect of such changes could be material to the consolidated financial statements.\nRECLASSIFICATIONS The Company reclassified some figures in prior years' financial statements to conform with the 1995 presentation.\n(3) INVESTMENTS\nThe following schedule summarizes information related to equity securities as of December 31:\nThe amortized cost, gross unrealized appreciation, gross unrealized depreciation and estimated market value of investments in fixed maturities available for sale as of December 31, 1995 and 1994 are as follows:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS Citizens Security Group Inc. and Subsidiaries December 31, 1995, 1994 and 1993\nThe amortized cost and estimated market value of fixed maturities at December 31, 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.\nRealized and unrealized gains (losses) from investments are summarized as follows:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS Citizens Security Group Inc. and Subsidiaries December 31, 1995, 1994 and 1993\nInvestment income is summarized as follows:\nAt December 31, 1995 and 1994, there were no investments, other than investments in U.S. Government or U.S. Government Agency securities, which exceeded 10 percent of shareholders' equity.\nAt December 31, 1995 and 1994, bonds carried at $705,671 and $602,064 respectively, were pledged to the Commerce Department of the State of Minnesota. At December 31, 1995 and 1994, bonds carried at $259,140 and $237,577, respectively, were pledged to the Insurance Department of the State of Ohio.\n(4) EQUIPMENT Equipment is summarized as follows:\n(5) FEDERAL INCOME TAXES\nThe Company implemented SFAS No. 109, \"Accounting for Income Taxes,\" in the first quarter of 1993. The cumulative effect of this change was a one-time increase to earnings of $38,000 or $.01 per share.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS Citizens Security Group Inc. and Subsidiaries December 31, 1995, 1994 and 1993\nSFAS No. 109 changed the way the Company calculates tax expense shown in the financial statements. Under prior rules, the primary objective was to match the tax expense with pretax operating income on the Consolidated Statements of Income. Under SFAS No. 109, the primary objective is to ensure the deferred tax asset or liability on the balance sheet properly reflects the amount due to or from the government in the future. As a consequence, the portion of the tax expense resulting from the change in the deferred tax asset or liability may not always be consistent with the income reported in the Consolidated Statements of Income.\nSome items of revenue and expense included in the Consolidated Statements of Income may not be currently taxable or deductible on income tax returns. Therefore, the income tax assets and liabilities are divided into a current portion, which is the amount attributable to the current year's tax return, and a deferred portion, which is the amount attributable to another year's tax return. The revenue and expense items not currently taxable or deductible are called temporary differences. Income tax expense or benefits are recorded in various places in the Company's financial statements. A summary of these amounts is as follows:\nThe components of income tax expense related to income before cumulative effect of accounting change are as follows:\nFederal income tax expense is less than the U.S. Federal income tax rate of 34 percent applied to income before income taxes. The reasons for this difference and the related tax effects are as follows:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS Citizens Security Group Inc. and Subsidiaries December 31, 1995, 1994 and 1993\nThe tax effects of temporary differences giving rise to significant portions of the deferred tax assets and deferred tax liabilities are presented as follows:\nThe Company has determined it is not necessary to establish a valuation allowance for the deferred tax asset as it is more likely than not the deferred tax asset will be realized principally through future reversal of existing taxable temporary differences, future taxable income and tax planning strategies related to its investment portfolios.\nIncome tax payments in 1995, 1994 and 1993 were $695,617, $678,710 and $700,491, respectively.\n(6) STOCK OPTION PLANS\nOn April 18, 1995, the Company amended the 1986 Stock Option Plan (a) to extend the term of such plan from September 16, 1996 to September 16, 2006, (b) to increase the number of shares of the Company's Common Stock authorized for issuance from 225,000 to 375,000 and (c) to satisfy the requirements of Section 162(m) of the Internal Revenue Code of 1986. The Company has reserved a maximum of 375,000 and 225,000 shares of common stock for issuance under the 1986 Stock Option Plan as of December 31, 1995 and December 31, 1994, respectively. At December 31, 1995 and 1994, options to purchase 285,000 and 196,500 shares, respectively, had been granted at exercise prices ranging from $3.13 to $4.00. No options have been exercised under this plan.\nIn 1991, the Company adopted a non-employee director stock option plan. The Company has reserved a maximum of 50,000 shares of common stock for issuance under such plan. As of December 31, 1995 and 1994, options to purchase 50,000 and 40,000 shares, respectively, had been granted at exercise prices ranging from $3.13 to $4.00. No options have been exercised under this plan.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS Citizens Security Group Inc. and Subsidiaries December 31, 1995, 1994 and 1993\n(7) POST RETIREMENT BENEFITS\nIn October 1992, Citizens Mutual established an Employee Stock Ownership Plan (\"ESOP\"). The ESOP borrowed $1,200,000 from Citizens Mutual. The loan will be repaid in monthly principal payments of $20,000. The current interest rate is 9.5 percent, but the rate is variable and is tied to the prime rate. On October 30, 1992, the ESOP purchased 349,090 shares of the Company's authorized but previously unissued shares of Common Stock for approximately $1,200,000. The stock held by the ESOP is released for allocation to the participants' accounts over the term of the loan as the Company and Citizens Mutual make contributions. The Company has reflected the principal portion of the loan it expects to repay as an unearned compensation liability and a corresponding reduction in shareholders' equity. These amounts will be reduced as the ESOP loan is repaid. The amount of the annual contribution is discretionary, except that it must be sufficient to enable the ESOP to meet its current obligations. The Company's portion of contribution expense related to the ESOP amounted to $221,988, $229,699 and $235,131 in 1995, 1994 and 1993, respectively, of which $41,988, $49,700 and $55,125, respectively, was payment of interest.\nCitizens Mutual had a defined benefit pension plan covering substantially all of its employees which was curtailed on June 20, 1992. The Company recognized a gain of $3,266 on the final settlement which occurred in early 1993.\n(8) COMMITMENTS AND CONTINGENCIES\nCitizens Mutual leases the home office, a branch office, automobiles and equipment under various agreements. Under the terms of the management services agreement, Citizens Mutual and the Company have the right to occupy the offices jointly, and the Company pays 75 percent of the rent and all other expenses under the leases. The Company's portion of rental expense for these leases was $316,729, $275,894 and $295,232 in 1995, 1994 and 1993, respectively. The Company's portion of future rentals under these leases are $328,320, $106,685, $37,852, $22,679 and $2,870 in the years 1996, 1997, 1998, 1999 and 2000, respectively. Lease payments include amounts paid to an affiliated company for the rental of computer software and equipment. The Company's annual portion of this lease is $81,795 in 1996 and 1997, $26,625 in 1998, $21,610 in 1999 and $1,801 in 2000. The future rentals do not include insurance and real estate taxes which are also payable by the Company. The home and branch office rentals also do not include utilities and maintenance expenses.\nThe Company is subject to claims and lawsuits that arise in the ordinary course of business. In the opinion of management, the ultimate resolution of such litigation will not have a material adverse effect on the Company's financial position.\nThe Company has not established a liability for environmental-related losses because it does not offer a pollution liability policy. The Company's commercial liability policies contain standard Insurance Services Office pollution exclusions and no claims have been reported to date.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS Citizens Security Group Inc. and Subsidiaries December 31, 1995, 1994 and 1993\n(9) BANK LOAN PAYABLE\nOn November 3, 1989, the Company obtained a $6,000,000, seven-year bank loan from First Bank National Association, which has subsequently been purchased on November 9, 1995 by Goodhue County National Bank, Red Wing, Minnesota. The principal balance of the bank loan remaining to be paid as of December 31, 1995, was $999,000. The current interest rate is 8.75 percent, but the rate is variable and is tied to the prime rate. On March 31, 1994, the Company and First Bank National Association amended the bank loan to change the debt repayment schedule and revise certain covenants. The Company is now required to make quarterly principal payments of $100,000 until October 1996 when the remaining principal amount of $699,000 is due. Principal may be prepaid. Principal payments of $519,920 were made in 1995. Interest payments in 1995, 1994 and 1993 totaled $121,669, $202,928 and $243,563, respectively.\nThe loan is secured by a pledge of the stock of the Subsidiaries. Additionally, the Company agreed to certain restrictive covenants which limit the amount of subsequent indebtedness, dividends payable to shareholders, capital expenditures and business acquisitions. The covenants also restrict any changes to the pooling agreement.\nThese restrictive covenants further require that the Subsidiaries maintain specified levels of capital and policyholders' surplus and that net written premiums to policyholders' surplus and combined trade ratios not exceed specified levels. The Company is currently in compliance with all requirements of the loan agreement.\n(10) REINSURANCE\nCeded reinsurance involves having other insurance companies agree to share certain risks with the Company. The primary purpose of ceded reinsurance is to protect the Company from potential losses in excess of the amount it is prepared to accept. Reinsurance may be on an individual policy basis or to protect against catastrophic losses.\nDuring 1993, the Company implemented SFAS No. 113, \"Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts.\" This statement requires the Company to report balances pertaining to reinsurance transactions \"gross\" on the balance sheet. The Company now records reinsurance recoverables on unpaid losses and ceded unearned premiums as assets, in contrast to the Company's prior practice of netting these amounts against the corresponding liabilities. Adoption of SFAS No. 113 had no impact on net income or shareholders' equity.\nThe Company expects the companies with whom reinsurance is placed to honor their obligations to the Company. In the event these companies are unable to honor their obligations, the Company will pay these amounts. As of December 31, 1995, approximately 74 percent of the prepaid reinsurance premiums was with Mutual Reinsurance Bureau. All business written with that company is automatically assumed on an equal and joint basis by its six owner\/assuming companies and the six\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS Citizens Security Group Inc. and Subsidiaries December 31, 1995, 1994 and 1993\ncompanies are rated from \"A\" to \"A++\" by A.M. Best Company. As of December 31, 1995, approximately 54 percent of the total reinsurance recoverable was with Swiss Reinsurance America Corporation, formerly known as the North American Reinsurance Corporation. Swiss Reinsurance America Corporation is rated \"A\" by A.M. Best Company and \"AAA\" by Standard and Poor's for its property\/liability claims-paying ability.\nIn 1994, the Company received refunds of $592,388 of excess ceded reinsurance premiums from the Minnesota Workers' Compensation Reinsurance Association (\"WCRA\"). These refunds were required to be distributed to certain workers' compensation policyholders under legislation passed by the State of Minnesota in 1992. This legislation was challenged by a group of insurers and on January 31, 1995 the U.S. Court of Appeals for the Eighth Circuit upheld a lower court ruling that found the legislation to be unconstitutional. At December 31, 1994 the Company recorded the refund as a reduction of ceded written premium and ceded unearned premium, with no effect on earned premium. The Company recorded these refunds as premiums earned in 1995.\nThe effect of assumed and ceded reinsurance on premiums written, premiums earned and insurance losses and loss adjustment expenses is reflected in the following table.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS Citizens Security Group Inc. and Subsidiaries December 31, 1995, 1994 and 1993\n(11) LIABILITY FOR UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES\nThe following table contains information concerning the reserves of Citizens Fund and ICO for losses and Loss Adjustment Expenses (\"LAE\").\nIn 1995, the majority of the decrease in estimated losses and LAE for claims occurring in prior years is the result of favorable development primarily in the workers' compensation line.\n(12) STATUTORY ACCOUNTING PRACTICES\nThe Subsidiaries are required to file statutory financial statements with state regulatory authorities. The Subsidiaries follow prescribed statutory accounting policies in all material respects. The accounting practices used to prepare statutory financial statements differ from generally accepted accounting principles (\"GAAP\").\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS Citizens Security Group Inc. and Subsidiaries December 31, 1995, 1994 and 1993\nA reconciliation of net income and shareholders' equity, as determined in accordance with GAAP on a consolidated basis, to statutory amounts reported to regulatory authorities by the Subsidiaries on an unconsolidated basis, is as follows:\nIn December 1993, the National Association of Insurance Commissioners approved a model risk-based capital formula for property and casualty insurers to be effective with the 1994 statutory annual statement. The Subsidiaries have adequate surplus to meet these requirements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS Citizens Security Group Inc. and Subsidiaries December 31, 1995, 1994 and 1993\n(13) STOCK EXCHANGE\nOn March 31, 1994, the Company's affiliate, Citizens Mutual, exchanged 1,250,000 shares of common stock for 1,250,000 shares of 7.95% Series A Preferred Stock (\"Preferred Stock\"). The Preferred Stock, which has an annual cumulative dividend of $.27825 per share and a liquidation preference of $3.50 per share, ranks senior to the Company's common stock as to payment of dividends and also as to the distribution of assets should there be a liquidation or dissolution of the Company. The Preferred Stock has one vote per share voting together with the Company's common stock on all matters submitted to a shareholders' vote. The Preferred Stock is not convertible by Citizens Mutual and is not subject to redemption at the option of the Company or the holder thereof.\nThe Preferred Stock was recorded at the liquidation preference of $3.50 per share which approximated the market of the common stock retired at the time of the exchange. Common stock and additional paid-in capital were decreased $4,524,814 for the common stock retired (including $149,814 of transaction costs).\n(14) DIVIDEND RESTRICTIONS\nAs a holding company, the Company depends on dividends from the Subsidiaries to make principal and interest payments with respect to its bank loan and to meet its other expenses. As members of an insurance holding company system, the Subsidiaries are restricted by law as to the amount of dividends they may pay to the Company without the approval of state regulatory authorities.\nGenerally, restrictions on Citizens Fund limit the amount of dividends paid during a twelve month period to an amount which does not exceed the greater of (i) 10 percent of Citizens Fund's statutory surplus at the end of the prior year or (ii) the statutory net income, not including realized gains, of Citizens Fund for the prior year. In addition, ordinary dividends may only be paid from the earned surplus of Citizens Fund, also known as unassigned funds, determined in accordance with the accounting procedures and practices used in the preparation of its statutory annual statement, minus 25 percent of earned surplus attributable to unrealized capital gains. As of December 31, 1995, Citizens Fund's unassigned surplus was $305,020. Citizens Fund's ordinary dividends are restricted to a maximum of $832,883 for 1996. Citizens Fund paid dividends of $789,000 in 1995.\nRestrictions on ICO limit the amount of dividends paid during a twelve month period to an amount which does not exceed the greater of (i) 10 percent of ICO's statutory surplus at the end of the prior year or (ii) the net income of ICO for the prior year. In addition, ordinary dividends may only be paid from earned surplus, which equals ICO's unassigned funds as set forth in its most recent statutory annual statement, including net unrealized capital gains and losses. As of December 31, 1995, ICO's unassigned surplus was $69,053. ICO's ordinary dividends are restricted to a maximum $528,705 for 1996. ICO paid dividends of $375,706 in 1995.\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Shareholders Citizens Security Group Inc.:\nWe have audited the consolidated balance sheets of Citizens Security Group Inc. and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of income, changes in equity and cash flows for each of the years in the three-year period ended December 31, 1995. 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 Citizens Security Group Inc. and subsidiaries as of December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1995 in conformity with generally accepted accounting principles.\nAs discussed in Notes 2 and 5 to the consolidated financial statements, the Company in 1993 adopted the provisions of the Financial Accounting Standards Board's Statements of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" and No. 109, \"Accounting for Income Taxes.\"\n\/s\/ KPMG PEAT MARWICK LLP ------------------------- Minneapolis, Minnesota March 15, 1996\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe directors and executive officers of the Company are as follows:\nSpencer A. Broughton has been Chairman of the Board, Chief Executive Officer and a director of the Company since its inception in September 1986 and of Citizens Mutual since 1965. Mr. Broughton was also President of the Company from its inception in September 1986 to April 1992 and President of Citizens Mutual from 1965 to April 1992. He joined Citizens Mutual as General Manager in 1962. Mr. Broughton is a director of BancInsure Company, an insurance company formed by national banks to provide directors' and officers' insurance and blanket bond coverage to member banks, and a director of the Independent Casualty Companies of America. Mr. Broughton is also a director and past President of the Insurance Federation of Minnesota, Minnesota Association of Mutual Insurance Companies and Minnesota Insurance Information Center. In addition, he is a director of the Alliance of American Insurers and a past President of the Twin Cities Underwriters Association.\nScott S. Broughton has been President and Chief Operating Officer of the Company and Citizens Mutual since April 1992 and Chief Financial Officer of the Company and Citizens Mutual since December 1994. Mr. Broughton has served as a director of the Company since April 1992 and a director of Citizens Mutual since April 1990. Mr. Broughton was Senior Vice President of the Company from April 1991 to April 1992 and Senior Vice President of Citizens Mutual from December 1990 to April 1992. He was Vice President, Sales of the Company from February 1989 to April 1991 and Vice President, Sales of Citizens Mutual from February 1989 to December 1990. From July 1986 to February 1989, Mr. Broughton was employed by Citizens Mutual as Assistant to the President. Mr. Broughton is on the Board of Trustees of the Ohio Insurance Institute. He is the son of Spencer A. Broughton.\nDavid A. Cairns was elected to the Board of Directors of the Company in 1994. Mr. Cairns is a private business consultant. He served as Vice President and Treasurer of SUPERVALU INC. a food wholesaler, from 1984 to February 1995.\nWilliam C. Ferril was elected to the Board of Directors of the Company in November 1986. Mr. Ferril is a private investor and consultant. He served as\nPresident and Chief Executive Officer of Ciatti's Inc., a company that operates full-service Italian restaurants, from May 1988 to May 1992 and as a director of Ciatti's Inc. from November 1986 to July 1992.\nS. B. Foot, III has served as a director of the Company since its inception in September 1986. He has been President and Chief Executive Officer of S. B. Foot Tanning Company since 1981. Mr. Foot has served as a director of Citizens Mutual since 1983.\nWilliam J. Haaland has been Vice President, Marketing (previously known as Sales and Underwriting) of the Company and Citizens Mutual since January 1994. Mr. Haaland was named a director of Citizens Mutual in March 1996. From February 1992 until January 1994, Mr. Haaland was the Assistant Vice President, Sales of Citizens Mutual. He was Sales Manager of Citizens Mutual from January 1991 until February 1992, and Agency Automation Manager of Citizens Mutual from January 1989 until January 1991. He is the son-in-law of Spencer A. Broughton.\nR. Scott Jones has served as a director of the Company since its inception in September 1986. He has been Chairman of the Board of GCNB since April 1993 and Chief Executive Officer of GCNB since 1984. He has been Co-Chairman of the Board, Co-Chief Executive Officer and a director of United Community Bancshares Inc. (\"United Bancshares\") since January 1994. Mr. Jones has served as a director of Citizens Mutual since 1982.\nTerry A. Lynner was elected to the Board of Directors of the Company in November 1986. He is a Managing Director of Goldsmith, Agio, Helms & Company, an investment banking firm, and has been employed by such firm since March 1989. From March 1985 until such time, he was a Vice President of Piper, Jaffray & Hopwood Incorporated (now Piper Jaffray Inc.), an investment banking firm. Mr. Lynner is also a director of the Minnesota Zoo Foundation.\nJerald K. Olson has been Vice President, People Services (previously known as Human Resources) of the Company and Citizens Mutual since December 1994. Mr. Olson has been Assistant Secretary of the Company since April 1992 and Secretary of Citizens Mutual since December 1991. From April 1990 until December 1994, Mr. Olson was the Human Resources Manager of the Company and Citizens Mutual. Mr. Olson was a Management Trainee at Citizens Mutual and Citizens Fund from March 1987 through April 1990 and a Management Trainee at ICO from October 1989 through April 1990. He is the son-in-law of Spencer A. Broughton.\nMary B. Plein has been Vice President, Financial Services (previously known as Accounting) and Treasurer of the Company and Citizens Mutual since April 1995. Ms. Plein was the Assistant to the President of the Company and Citizens Mutual from January 1993 to April 1995. Ms. Plein was named an Assistant Vice President of Citizens Mutual, Citizens Fund and ICO in February 1992. She joined Citizens Mutual as an accountant in April 1993.\nKirk D. Simmons has been Vice President, Insurance Operations (previously known as Claims and Information Services) of the Company and Citizens Mutual since October 1993. Mr. Simmons was a Regional Claims Analyst\/Manager of the CNA Insurance Group(\"CNA\") from January 1992 to October 1993 and a CNA Claims Supervisor from May 1988 to January 1992.\nBruce A. Tollefson has been Vice President, Product Services (previously known as Operations) of the Company since April 1991 and Vice President, Product Services of Citizens Mutual since December 1990. From April 1987 until December 1990, Mr. Tollefson was the Assistant Vice President, Research and Development of Citizens Mutual. Mr. Tollefson was the Research and Development Manager of Citizens Mutual from December 1985 through April 1987.\nMEETINGS OF THE BOARD OF DIRECTORS AND DIRECTOR FEES\nThe Board of Directors held six meetings in 1995. In 1995, all directors attended at least 75% of the total number of meetings of the Board of Directors and committees of the Board on which they served during 1995. Each nonemployee director receives an annual fee of $4,000 for serving as a director and a fee of $1,000 plus expenses for each Board meeting attended.\nCOMMITTEES\nThe Board of Directors has an Audit Committee that reviews, and makes recommendations to the Board with respect to, financial and accounting matters, including the activities of the Company's independent auditors and the Company's internal accounting controls. Messrs. R. Scott Jones (Chairman), Cairns, Ferril, Foot and Lynner are the members of the Audit Committee. The Audit Committee held two meetings in 1995.\nThe Board of Directors also has a Compensation Committee that reviews, and makes recommendations to the Board with respect to, executive compensation matters. Messrs. Ferril (Chairman), Cairns, Foot and R. Scott Jones are the members of the Compensation Committee. The Compensation Committee held four meetings in 1995.\nAn Advisory Committee of four persons has been established to approve any changes in the Pooling Agreement between the Company and Citizens Mutual (see Part III, Item 13, \"Certain Relationships and Related Transactions\" below), to pass upon any other matters involving actual or potential conflicts of interest between the two companies and to approve the compensation of officers of the Company and Citizens Mutual. The Advisory Committee consists of two outside directors from each of the Company and Citizens Mutual, none of whom holds seats on both Boards. Advisory Committee members must conclude that any intercompany transactions are fair and equitable to both companies. Decisions of the Advisory Committee are binding on the Company. Messrs. Ferril and Lynner are the Company's Advisory Committee members.\nThe Company's Board of Directors does not have a nominating committee. Each nonemployee member of a Board committee receives $300 plus expenses for each committee meeting attended. The Chairman of each Board committee receives $400 plus expenses for each committee meeting attended.\nNONEMPLOYEE DIRECTOR STOCK OPTION PLAN\nThe Company has a Nonemployee Director Stock Option Plan (\"Director Option Plan\") under which a total of 50,000 shares of Common Stock are reserved for issuance. Each director of the Company is eligible to participate in the Director Option Plan unless such director is an employee of Citizens mutual, the Company or a subsidiary of the Company. Under the Director Option Plan, each eligible director automatically is granted an option to purchase 2,000 shares of Common Stock at the time of each Annual Meeting of Shareholders at which such director is elected for the first time or re-elected to the Board.\nAll options granted under the Director Option Plan have an exercise price equal to the fair market value of the Company's Common Stock on the date of grant and become exercisable six months after the date of grant. The option exercise price is payable in cash. The options expire five years from the date of grant and are not transferable (except by will or the laws of descent and distribution).\nDuring the year ended December 31, 1995, Messrs. Cairns, Ferril, Foot, R. Scott Jones and Lynner each were granted an option under the Director Option Plan to purchase 2,000 shares of the Company's Common Stock at an exercise price of $4.00. No options granted under the Director Option Plan have been exercised to date.\nCOMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT\nSection 16(a) of the Securities Exchange Act of 1934 (the \"Exchange Act\") requires the Company's directors and executive officers, and persons who own more than 10% of the Company's Common Stock, to file with the Securities and Exchange Commission (the \"SEC\") initial reports of ownership and reports of changes in ownership of Common Stock and other equity securities of the Company. Officers, directors and greater than 10% shareholders are required by SEC regulation to furnish the Company with copies of all Section 16(a) reports they file. To the Company's knowledge, based solely on review of copies of such reports furnished to the Company relating to transactions during the fiscal year ended December 31, 1995, all Section 16(a) filing requirements applicable to its directors, officers and greater than 10% beneficial owners were complied with, except that (a) each of David A. Cairns, William C. Ferril, S.B. Foot, III, R. Scott Jones and Terry A. Lynner (who are directors of the Company) were late in filing a Form 5 (annual statement of changes in beneficial ownership) reporting the grant of a stock option pursuant to the Company's Nonemployee Stock Option Plan and (b) each of Spencer A. Broughton, Scott S. Broughton, William J. Haaland, Jerald K. Olson, Mary B. Plein, Kirk D. Simmons and Bruce A. Tollefson (who are executive officers of the Company) and Charles W. Bergher, Michael L. Halvorson and Gloria J. Reeck (former executive officers of the Company) were late in filing a Form 5 reporting the grant of options under the Company's Employee Stock Option Plan and certain indirect acquisitions of Common Stock of the Company through the Company's 401(k) Plan. All of the above transactions were exempt from Section 16(b) of the Exchange Act pursuant to Rule 16b-3 or Rule 16a-8 under the Exchange Act and have been reported on Form 5 reports filed with the SEC prior to the date of filing of this report.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nCOMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION\nOVERVIEW\nThe Compensation Committee of the Board of Directors of the Company (the \"Committee\") is responsible for developing and making recommendations to the Board with respect to the Company's executive compensation policies. In addition, the Committee makes annual recommendations to the Board concerning the compensation to be paid to the Chief Executive Officer and each of the other executive officers of the Company. The Committee is composed entirely of outside directors of the Company.\nEXECUTIVE COMPENSATION PROGRAM\nThe Company's executive compensation program is intended to reward executives for successful long-term strategic management and enhancement of shareholder value. In addition, it is intended to attract and retain highly qualified and motivated managers, recognize and reward outstanding performance, and foster a diverse and cohesive management team. The components of the Company's executive compensation program include (a) base salaries, (b) performance-based bonuses, (c) stock options, (d) participation in an employee stock ownership plan and (e) miscellaneous other fringe benefits.\nThe executive officers of the Company are employees of Citizens Mutual, and all salaries and cash bonuses of such officers are paid by Citizens Mutual. Pursuant to the Management Services Agreement, Citizens Mutual provides the services of its employees (including the Company's officers) to the Company in exchange for payments equal to 75% of the amount of such employees' cash compensation and other benefits. In addition, the Company pays Citizens Mutual for services that are performed specifically for the Company. The salaries and cash bonuses of the Company's executive officers are approved by the Boards of Directors of both the Company and Citizens Mutual.\nThe Chief Executive Officer and the Chief Operating Officer proposes to the Committee base salary amounts for the executive officers. The proposed salaries are based on factors such as the quality and achievement of the strategic plan produced for the executive officer's department, development of organizational and management skills, and industry and civic involvement. In 1995, the Company revised its internal performance management system. Job descriptions, compensation levels and performance evaluation processes were reviewed and revised.\nIn determining base salaries for executive officers, the Committee takes into account the Chief Executive Officer's and Chief Operating Officer's recommendations and considers subjective factors relating to each executive officer's performance. The Committee reviews the executive officers' compensation structures and the individual executive officers' proposed salaries within such structures. Based on this review, the Committee believes the base salaries for the Company's executive officers are comparable to the average salary levels of executive officers of other property and casualty insurance companies of similar size.\nCash bonuses are awarded only if the Company achieves or exceeds certain corporate performance objectives as determined by the Board at the beginning of each year based on the Committee's recommendations. Under the 1995 employee bonus plan for executive officers, the payment of bonuses was conditioned upon the achievement of a combined trade ratio goal (losses plus loss adjustment expenses to net earned premiums and underwriting expenses to net written premiums) for the Company's and Citizens Mutual's combined insurance operations and of certain Company department goals. No bonuses were awarded to executive officers because the combined trade ratio goal was not achieved.\nThe Committee believes that significant stock ownership by executive officers provides strong incentive to increase shareholder value and aligns the interest of executive officers and shareholders. Options are granted under the Company's Employee Option Plan, which is administered by the Committee. Options are granted to executive management employees based on recommendations made by the Chief Operating Officer involving subjective criteria. The size of option grants depend upon an executive officer's responsibility level. To date, the exercise prices of all stock options granted under the Employee Option Plan have been equal to the fair market value of the Common Stock on the date of grant.\nIn October 1992, Citizens Mutual established the Citizens Security Mutual Employee Stock Ownership Plan (the \"ESOP\"). The ESOP purchased 349,090 shares of the Company's authorized but unissued shares of Common Stock on October 30, 1992 for approximately $1,200,000. The ESOP borrowed such amount from Citizens Mutual. During the five years ending October 30, 1997, as the annual principal payments of $240,000 are paid by the Company and Citizens Mutual to the ESOP, the shares held by the ESOP are allocated to eligible employees proportionally based on their salaries.\nThe Company also provides miscellaneous fringe benefits. These benefits include a split-dollar life insurance program for executive officers. Under this plan, Citizens Mutual matches 100% of the officer's premiums paid for a life insurance policy up to a maximum of $3,000 per year.\nCOMPENSATION OF THE CHIEF EXECUTIVE OFFICER\nThe Chief Executive Officer's base salary is determined in accordance with the criteria discussed above. The Committee meets to evaluate the Chief Executive Officer's performance and reports on that evaluation to the other members of the Board. In determining Spencer A. Broughton's 1995 base salary, the Committee considered many factors, including the overall quality of management and leadership exhibited by Mr. Broughton as well as his tenure with the Company. The following factors were particularly important to the Committee in determining the amount of his base salary: (a) the achievement of the combined trade ratio goal, (b) the continued decrease in expenses to direct written premiums and (c) the substantial increase in productivity as measured by written premiums per employee. The determination of Mr. Broughton's base salary also took into account information relating to the salaries of chief executive officers of other similar sized regional property and casualty companies.\nMr. Broughton was not awarded a bonus for 1995 in accordance with the Company's annual bonus plan as described above. Option grants made to Mr. Broughton during 1995 were determined in the manner described above.\nTAX DEDUCTIBILITY OF EXECUTIVE COMPENSATION\nSection 162(m) of the Internal Revenue Code of 1986, as amended, should not affect the deductibility of compensation paid to the Company's executive officers for the foreseeable future. Accordingly, the Committee has not formulated any policy with respect to qualifying such compensation for deductibility under Section 162(m). However, the Board of Directors has amended the Employee Option Plan to comply with Section 162(m) in order that compensation resulting from stock options granted under the Employee Option Plan will not be counted toward the $1,000,000 limit on deductible compensation under Section 162(m).\nWilliam C. Ferril, Chairman David A. Cairns, S. B. Foot, III and R. Scott Jones Members of the Compensation Committee\nSUMMARY COMPENSATION TABLE\nThe executive officers of the Company are employees of Citizens Mutual, and all salaries and cash bonuses of such officers are paid by Citizens Mutual. Pursuant to the Management Services Agreement between the Company and Citizens Mutual, Citizens Mutual provides the services of its employees (including the Company's executive officers) to the Company in exchange for payments equal to 75% of the amount of such employees' cash compensation and other benefits. In addition, the Company pays Citizens Mutual for services that are performed specifically for the Company.\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 only other executive officer of the Company whose salary and bonus earned in 1995 exceeded $100,000.\n__________ (1) The Company does not grant stock appreciation rights.\n(2) The compensation reported represents (a) contributions (determined at cost) to the ESOP, (b) contributions to the Savings Plan, (c) premiums paid for split-dollar life insurance, (d) premiums paid for whole life insurance and (e) deferred compensation plan benefits. Company contributions during fiscal 1995 were as follows: ESOP contributions of $9,315 to both to Mr. Spencer A. Broughton and Mr. Scott S. Broughton; Savings Plan Contributions of $4,620 to both Mr. Spencer A. Broughton and Mr. Scott S. Broughton; premium payments on split-dollar life insurance of $3,000 and $2,750 for Mr. Spencer A. Broughton and Mr. Scott S. Broughton, respectively; $1,050 of premiums paid for term life insurance for Mr. Scott S. Broughton; and $7,000 of deferred compensation payments to Mr. Scott S. Broughton.\nOPTION GRANTS AND VALUE\nThe following tables summarize option grants during 1995 to the Chief Executive Officer and the other executive officer named in Summary Compensation table above, and the value of the options held by such persons at the end of 1995. No options were exercised by these officers during 1995.\nOPTION\/SAR GRANTS IN LAST FISCAL YEAR\n__________ (1) Each option (a) has a term of six years from the date of grant, (b) becomes exercisable to the extent of 20% of the shares subject to the option one year after the date of grant of the option with the balance of the option becoming exercisable in four cumulative installments of 20% of the shares subject to the option until five years after the date of grant, after which the option will be fully exercisable, (c) has an exercise price per share equal to the fair market value per share of the Common Stock on the date of grant, (d) is exercisable only by payment of the exercise price to the Company in cash, and (e) is an \"incentive stock option\" within the meaning of Section 422 of the Code.\nFISCAL YEAR-END OPTION\/SAR VALUES\n__________ (1) Value based on market value of the Company's Common Stock as of December 31, 1995 less the exercise price of the options.\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\nR. Scott Jones, a director of the Company, is the Chairman of the Board of GCNB and is a director and principal shareholder of United Bancshares, Inc.(\"UBI\"), GCNB's parent corporation. Mr. R. Scott Jones is also the Co-Chairman of the Board and Co-Chief Executive Officer of UBI. Mr. R. Scott Jones serves on the Compensation Committee of the Company's Board of Directors. Mr. Spencer A. Broughton, Chairman of the Board and Chief Executive Officer of the Company, serves on the Board of Directors of GCNB and UBI and also serves on the Audit, Loan\/Discount and Personnel Committees of GCNB. Mr. Spencer A. Broughton also owns less than 1% of the outstanding common stock of UBI.\nIn December 1993, Citizens Fund purchased 4,000 shares of common stock of UBI for its investment portfolio. The aggregate purchase price paid for such shares was $272,000.\nPursuant to a term loan agreement dated as of November 3, 1989, the Company obtained a $6,000,000 seven-year loan payable through 1996 to fund the purchase price of ICO, and certain acquisition expenses. On November 9, 1995, the lender assigned the bank loan, which as of December 31, 1995 had an outstanding principal balance of $999,000, to GCNB. The current interest rate on the loan is 8.75%, but the rate is variable and is tied to the prime rate.\nCOMPARATIVE STOCK PERFORMANCE GRAPH\nThe following table shows a five-year comparison of cumulative total returns for the Company, the Nasdaq Insurance Stocks and the Nasdaq Stock Market (U.S. Companies) over the same period (assuming the investment of $100 in each vehicle on January 1, 1991 and reinvestment of all dividends).\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following table sets forth certain information regarding the ownership of the Company's voting securities as of March 19, 1996 by each person beneficially owning at least five percent of such securities, by each director of the Company, by each executive officer named in the Summary Compensation Table above and by all executive officers and directors as a group.\n__________ * Less than one percent.\n(1) Shares allocated to the accounts of executive officers and reported as owned by the ESOP are also reported as beneficially owned by such executive officers. The shares of Common Stock owned by the ESOP are held by National City Bank of Minneapolis as trustee of the ESOP (the \"ESOP Trustee\"). Although the ESOP is required to invest primarily in the Common Stock of the Company, certain investment control is retained by the committee that administers the ESOP , which is composed of Scott S. Broughton and Gloria J. Reeck, who are officers of the Company. The shares held by the ESOP that are allocated to participants are voted by the ESOP Trustee in the manner directed by the participants, and the unallocated shares are voted by the ESOP Trustee in the same proportion as the allocated shares.\n(2) Shares reported as owned by the Citizens Mutual 401(k) Plan (the \"Savings Plan\") that are held in the accounts of executive officers of the Company are also reported as beneficially owned by such executive officers. The shares of Common Stock owned by the Savings Plan are held by Frontier Trust as trustee of the Savings Plan (the \"Savings Plan Trustee\"). The shares in the Savings Plan are voted by the Savings Plan Trustee in the manner directed by the participants.\n(3) Includes (a) 82,700 shares held in trust under the Savings Plan, (b) 10,661 shares held in trust under the ESOP and (c) 27,400 shares that may be purchased under currently exercisable options or options that will be come exercisable within 60 days after the date of this Form 10-K.\n(4) Includes (a) 8,116 shares held in trust under the Savings Plan, (b) 8,693 shares held in trust under the ESOP and (c) 38,150 shares that may be purchased under currently exercisable options or options that will be come exercisable within 60 days after the date of this Form 10-K.\n(5) Includes 10,000 shares that may be purchased under currently exercisable options.\n(6) Includes 2,000 shares that may be purchased under currently exercisable options.\n(7) Includes (a) 102,802 shares held in trust under the Savings Plan, (b) 38,013 shares held in trust under the ESOP for the benefits of certain officers of the Company, and (c) 144,700 shares that may be purchased under currently exercisable options or options that will be come exercisable within 60 days after the date of this Form 10-K.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe operations of the Company are directly interrelated with the operations of Citizens Mutual. Under the terms of the Pooling Agreement, all premiums, losses, loss adjustment expenses and underwriting expenses (after deducting all other reinsurance) are prorated between the Company and Citizens Mutual on the basis of their participation in the pool. Since October 20, 1989, the Company's and Citizens Mutual's participation in the pool have been 75% and 25%, respectively. During the year ended December 31, 1995, the Company assumed approximately $32,194,349 of gross premiums written from, and ceded approximately $1,869,665 of gross premiums written to Citizens Mutual under the Pooling Agreement.\nUnder the Management Services Agreement, Citizens Mutual provides the Company with facilities, employees and all services required to conduct its business on a cost allocated basis. Under the Management Services Agreement, the Company pays 75% of all expenses of Citizens Mutual relating to salaries, employee benefits, facilities and data processing equipment. In addition, the Company pays Citizens Mutual for services that are performed specifically for the Company. Pursuant to a second amended Management Services Agreement, the employees will be transferred to the Company when Citizens Mutual owns shares of Common Stock and Series A Preferred Stock with less than 50% of the voting power of all outstanding voting securities of the Company.\nPursuant to a capital access fee agreement, Citizens Mutual, Citizens Fund and ICO pay a fee to the Company in consideration of the Company's ability to raise capital for the combined insurance operations of Citizens Mutual, Citizens Fund and ICO. The fee is paid monthly in an amount equal to 1% of\nthe aggregate direct written premiums of Citizens Mutual, Citizens Fund and ICO. Of the total monthly fee, 25% of the fee is payable by Citizens Mutual. However, Citizens Mutual's obligation to pay its portion of the fee would terminate on the earlier of (i) the date on which the Company's currently outstanding bank loan (or any indebtedness incurred to refinance such loan) is repaid in full or (ii) the closing date of the next public offering of securities by the Company.\nIn March 1994, the Boards of Directors of the Company and Citizens Mutual approved a transaction in which the Company issued 1,250,000 shares of Series A Preferred Stock in exchange for 1,250,000 shares of Common Stock of the Company previously held by Citizens Mutual. Dividends (in an annual amount of $.27825 per share) are paid on the Series A Preferred Stock, when, as and if declared by the Company's Board of Directors, and such dividends are cumulative and payable quarterly. The Series A Preferred Stock has a liquidation preference of $3.50 per share, is not convertible by Citizens Mutual and is not subject to redemption at the option of the Company or Citizens Mutual.\nGoldsmith, Agio, Helms & Company (\"Goldsmith, Agio\"), an investment banking firm, is providing certain financial advisory services to the Company in connection with the Meridian Acquisition. The Company anticipates paying Goldsmith, Agio total fees of approximately $250,000, of which $62,500 has been paid to date. Terry A. Lynner, a director of the Company, is a Managing Director of Goldsmith, Agio.\nCitizens Fund holds an investment in UBI. See Part III, Item 11, \"Executive Compensation - Compensation Committee Interlocks and Insider Participation.\"\nThe Company is the borrower under a bank loan agreement with GCNB. See Part III, 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) List of documents filed as part of this report:\n(1) FINANCIAL STATEMENTS\nPage Description Number ----------------------------------------------------------- -------\nIndependent Auditors' Report............................... 38\nConsolidated Balance Sheets as of December 31, 1995 and................................................... 20\nConsolidated Statements of Income for the Years ended December 31, 1995, 1994 and 1993........................... 21\nConsolidated Statements of Changes in Equity for the Years ended December 31, 1995, 1994 and 1993..................... 22\nConsolidated Statements of Cash Flows for the Years ended December 31, 1995, 1994 and 1993........................... 23\nNotes to Consolidated Financial Statements................. 24\n(2) FINANCIAL STATEMENT SCHEDULES\nSchedule Page Number Description Number -------- ----------------------------------------- ------\nIndependent Auditors' Report.................... 56\nI. Summary Of Investments - Other Than Investments In Related Parties............................ 57\nII. Condensed Financial Information of Registrant... 58\nIII. Supplementary Insurance Information............. 64\nIV. Reinsurance..................................... 65\nVI. Supplemental Information Concerning Property- Casualty Insurance Operations................. 66\nAll other schedules not listed have been omitted since the required information is included in the consolidated financial statements or the notes thereto, or is not applicable or required.\n(3) LISTING OF EXHIBITS\nExhibit Number Description ------ ---------------------------------------------------------------\n(2) (.1) Plan of Stock Exchange between the Company and Citizens Security Mutual Insurance Company dated as of March 31, 1994(1) (.2) Acquisition and Affiliation Agreement dated as of March 20, 1996 by and among the Company, Citizens Security Mutual Insurance Company, and Meridian Insurance Group, Inc.\n(3) LISTING OF EXHIBITS - CONTINUED\nExhibit Number Description ------ ---------------------------------------------------------------\n(3) (.1) Articles of Incorporation(2)\n(.2) Bylaws(3)\n(4) (.1) Certificate of Designations, defining the rights of the holders of Series A Preferred Stock of the Company(1)\n(.2) Form of Common Stock certificate(4)\n(10) (.1a) Reinsurance Pooling Agreement dated as of September 22, 1986 and restated as of November 10, 1986 among Citizens Security Mutual Insurance Company, the Company and Citizens Fund Insurance(4)\n(.1b) First Amended Reinsurance Pooling Agreement dated as of October 20, 1989 among the Company, Citizens Fund Insurance Company, Citizens Security Mutual Insurance Company and Insurance Company of Ohio(5)\n(.2a) Management Services Agreement dated as of September 22, 1986 and restated as of November 10, 1986 among Citizens Security Mutual Insurance Company, the Company and Citizens Fund Insurance Company(4)\n(.2b) First Amended Management Services Agreement dated as of October 20, 1989 among the Company, Citizens Fund Insurance Company, Citizens Security Mutual Insurance and Insurance Company of Ohio(5)\n(.2c) Second Amended Management Services Agreement among the Company, Citizens Security Mutual Insurance Company, Citizens Fund Insurance Company and Insurance Company of Ohio, dated March 31, 1994(1)\n(.3) 1986 Stock Option Plan, as restated April 18, 1995(6)*\n(.4) Third Amended Stipulation dated April 9, 1993 among the Minnesota Department of Commerce, Citizens Security Mutual Insurance Company and Citizens Fund Insurance Company(7)\n(.5) Lease dated March 1, 1993 between Red Wing Hotel Corporation and Citizens Security Mutual Insurance Company(3)\n(.6a) Software License and Development Agreement dated as of August 25, 1988 between the Company and Programming Resources Company(2)\n(3) LISTING OF EXHIBITS - CONTINUED\nExhibit Number Description -----------------------------------------------------------------------\n(.6b) Amendment dated January 3, 1989 to Software License and Development Agreement dated as of August 25, 1988 between the Company and Programming Resources Company(5)\n(.6c) Addendum dated October 7, 1991 to Software License and Development Agreement between the Company and Programming Resources Company(5)\n(.6d) Addendum effective as of September 1, 1993 to Software License and Development Agreement dated as of August 25, 1988 between the Company and Programming Resources Company(2)\n(.7a) Amended and Restated Term Loan Agreement dated as of December 31, 1992 between the Company and First Bank National Association(3)\n(.7b) First Amendment dated as of March 31, 1993 to Amended and Restated Term Loan Agreement dated as of December 31, 1992 by and between the Company and First Bank National Association(7)\n(.7c) Waiver Letter dated March 1, 1994 to the Company from First Bank National Association(2)\n(.7d) Second Amendment, dated as of March 31, 1994 to Amended and Restated Term Loan Agreement, dated as of December 31, 1992 by and between the Company and First Bank National Association(1)\n(.7e) Third Amendment, dated as of August 1, 1994 to Amended and Restated Term Loan Agreement, dated as of December 31, 1992 by and between the Company and First Bank National Association(8)\n(.7f) Waiver letter dated February 28, 1995 to the Company from First Bank National Association(5)\n(.7g) Waiver letter dated November 9, 1995 to the Company from Goodhue County National Bank(9)\n(.7h) Fourth Amendment, dated as of November 9, 1995 to Amended and Restated Term Loan Agreement, dated as of December 31, 1992 by and between the Company and Goodhue County National Bank\n(.8) Pledge Agreement dated as of December 31, 1992 between the Company and First Bank National Association(3)\n(.9a) Letter Agreement dated as of November 2, 1989 among the Company, Insurance Company of Ohio and the Ohio Department of Insurance(5)\n(.9b) Letter dated October 7, 1993 to Insurance Company of Ohio from the Ohio Department of Insurance(10)\n(3) LISTING OF EXHIBITS - CONTINUED\nExhibit Number Description -----------------------------------------------------------------------\n(.10a) 1994 Employee Bonus Plan(2)*\n(.10b) 1995 Employee Bonus Plan(6)*\n(.11) Nonemployee Director Stock Option Plan(11)*\n(.12) Letter Agreement dated January 15, 1992 between Citizens Fund Insurance Company and the Minnesota Department of Commerce(12)\n(.13a) Lease dated September 16, 1993 between Engwiller Properties, Inc. and Insurance Company of Ohio(10)\n(.13b) Sublease Agreement dated July 5, 1995 between Insurance Company of Ohio and Tom Witkowski(12)\n(.14) Letter dated September 22, 1993 to State of Minnesota Department of Commerce from Citizens Fund Insurance Company(2)\n(.15) Capital Access Fee Agreement dated March 31, 1994 among the Company, Citizens Security Mutual Insurance Company, Citizens Fund Insurance Company and Insurance Company of Ohio(1)\n(.16) Order Approving Restructuring dated March 31, 1994 issued by the Minnesota Department of Commerce(1)\n(.17) Letter of Authority dated September 12, 1994 to Scudder, Stevens & Clark, Inc. from Citizens Fund Insurance Company(8)\n(.18) Letter of Authority dated September 12, 1994 to Scudder, Stevens & Clark, Inc. from Insurance Company of Ohio(8)\n(.19a) Agreement dated December 31, 1994 among Citizens Security Mutual Insurance Company, Citizens Fund Insurance Company, Insurance Company of Ohio and Adjusting Unlimited, Inc.(5)\n(.19b) Agreement dated December 31, 1995 between the Company and Adjusting Unlimited, Inc.\n(.20) Lease dated April 21, 1995 between Eagle Building, L.L.C. and Citizens Security Mutual Insurance Company(6)\n(.21) Deferred Compensation Plan Agreement dated August 1, 1995 between Citizens Security Mutual Insurance Company and Scott Broughton*\n(21) Subsidiaries of the Company(5)\n(24) Power of Attorney\n(27) Financial Data Schedule\n(3) LISTING OF EXHIBITS - CONTINUED\nExhibit Number Description -----------------------------------------------------------------------\n(28) (.1) Schedule P from Citizens Fund Insurance Company's 1995 Annual Statement filed with the Minnesota State Insurance Department\n(.2) Schedule P from Insurance Company of Ohio's 1995 Annual Statement filed with the Ohio Department of Insurance\n__________ * Denotes management contract or compensatory plan or arrangement.\n(1) Incorporated by reference to the Company's Form 8-K dated March 31, 1994.\n(2) Incorporated by reference to the Company's Form 10-K for the fiscal year ended December 31, 1993.\n(3) Incorporated by reference to the Company's Form 10-K for the fiscal year ended December 31, 1992.\n(4) Incorporated by reference to the Company's Registration Statement on Form S-1 (Registration No. 33-9096) which became effective on December 17, 1986.\n(5) Incorporated by reference to the Company's Form 10-K for the fiscal year ended December 31, 1994.\n(6) Incorporated by reference to the Company's Form 10-Q for the quarter ended March 31, 1995.\n(7) Incorporated by reference to the Company's Form 10-Q for the quarter ended March 31, 1993.\n(8) Incorporated by reference to the Company's Form 10-Q for the quarter ended September 30, 1994.\n(9) Incorporated by reference to the Company's Form 10-Q for the quarter ended September 30, 1995.\n(10) Incorporated by reference to the Company's Form 10-Q for the quarter ended September 30, 1993.\n(11) Incorporated by reference to the Company's Form 10-Q for the quarter ended March 31, 1991.\n(12) Incorporated by reference to the Company's Form 10-K for the fiscal year ended December 31, 1991.\n(13) Incorporated by reference to the Company's Form 10-Q for the quarter ended June 30, 1995.\n(b) Reports on Form 8-K\nNo reports on Form 8-K were filed during the quarter ended December 31, 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.\nCITIZENS SECURITY GROUP INC.\nMarch 19, 1996 By: \/s\/ Spencer A. Broughton ------------------------ Spencer A. Broughton Chairman of the Board, and Chief Executive Officer\nPursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nSpencer A. Broughton Chairman of ) the Board, ) Chief Executive ) Officer ) (principal ) executive ) officer) and ) Director ) ) Scott S. Broughton* President, Chief ) By: \/s\/ SPENCER A. BROUGHTON Operating Officer, ) ------------------------ Chief Financial ) Spencer A. Broughton Officer ) Pro Se and Attorney- (principal ) in-Fact financial and ) Date: March 19, 1996 accounting ) officer) and ) Director ) ) David A. Cairns* Director ) ) R. Scott Jones* Director ) ) S. B. Foot, III* Director ) ) Terry A. Lynner* Director ) ) William C. Ferril* Director )\n__________ * Executed on behalf of the indicated persons by Spencer A. Broughton pursuant to the Power of Attorney included as Exhibit 24 to this report.\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Shareholders Citizens Security Group Inc.:\nUnder date of March 15, 1996, we reported on the consolidated balance sheets of Citizens Security Group Inc. and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of income, changes in equity and cash flows for each of the years in the three-year period ended December 31, 1995, as contained in Part III, Item 8, \"Financial Statements and Supplementary Data\". 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 (see Item 14.(a)(2)). These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statement schedules based on our audits.\nIn our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.\nAs discussed in Notes 2 and 5 to the consolidated financial statements, the Company adopted the provisions of the Financial Accounting Standards Board's Statements of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" and No. 109, \"Accounting for Income Taxes,\" in 1993.\nKPMG Peat Marwick LLP\nMinneapolis, Minnesota March 15, 1996\nCitizens Security Group Inc. and Subsidiaries\nSchedule I. Summary Of Investments - Other Than Investments In Related Parties\nDecember 31, 1995\n__________ (1) Fixed maturities and short-term investments are at amortized cost and equity securities at original cost.\nCitizens Security Group Inc. (Parent Only)\nSchedule II. Condensed Financial Information of Registrant Condensed Balance Sheet Information\nSEE ACCOMPANYING NOTES TO CONDENSED FINANCIAL INFORMATION.\nCitizens Security Group Inc. (Parent Only)\nSchedule II. Condensed Financial Information of Registrant Condensed Statement of Income Information\nSEE ACCOMPANYING NOTES TO CONDENSED FINANCIAL INFORMATION.\nCitizens Security Group Inc. (Parent Only)\nSchedule II. Condensed Financial Information of Registrant Condensed Statement of Cash Flows Information\nSEE ACCOMPANYING NOTES TO CONDENSED FINANCIAL INFORMATION.\nCitizens Security Group Inc. (Parent Only)\nSchedule II. Condensed Financial Information of Registrant Notes To Condensed Financial Information December 31, 1995, 1994 and 1993\n1. Basis of presentation\nThe accompanying condensed financial information should be read in conjunction with the consolidated financial statements and notes as set forth in Part II, Item 8, \"Financial Statements and Supplementary Data.\"\nThe Company entered into a capital access fee agreement on March 31, 1994 under which Citizens Security Mutual Insurance Company (\"Citizens Mutual\"), Citizens Fund Insurance Company (\"Citizens Fund\") and Insurance Company of Ohio (\"ICO\") pay a fee to the Company in consideration of its ability to raise capital for the combined insurance operations of Citizens Mutual, Citizens Fund and ICO. The fee is paid monthly in an amount equal to one percent of the aggregate direct written premiums of Citizens Mutual, Citizens Fund and ICO. Citizens Mutual's obligation to pay its portion of the fee will terminate on the earlier of (i) the date on which the Company's currently outstanding bank loan (or any indebtedness incurred to refinance such loan) is repaid in full or (ii) the closing date of the Company's next public offering of securities.\nAs of March 20, 1996, Meridian Insurance Group, Inc., (\"Meridian\") and the Company executed a definitive acquisition agreement providing for Meridian's acquisition of the Company for approximately $29 million in cash. Common shareholders of the Company would receive approximately $12.50 per common share, and the preferred shareholder, Citizens Mutual, would receive approximately $4.4 million for the Company's preferred stock. In conjunction with the transaction, Meridian would also assume control of Citizens Mutual and Citizens Fund, ICO and Citizens Mutual would enter into arrangements with the Meridian Insurance Group companies relating to the pooling of insurance.\nThe acquisition is conditioned upon approval by the companies' Board of Directors, the Company's common and preferred shareholders, Citizen Mutual's policyholders and insurance regulators in Indiana, Minnesota, and Ohio, where the insurance companies are domiciled. It is anticipated that the acquisition will be completed by June 30, 1996.\n2. Bank loan payable\nOn November 3, 1989, the Company obtained a $6,000,000, seven-year bank loan from First Bank National Association, which has subsequently been assigned on November 9, 1995 to Goodhue County National Bank, Red Wing, Minnesota. The principal balance of the bank loan remaining to be paid as of December 31, 1995, was $999,000. The current interest rate is 8.75 percent, but the rate is variable and is tied to the prime rate. The Company is required to make quarterly principal payments of $100,000 until October 1996 when the remaining principal amount of $699,000 is due. Principal may be prepaid. Principal payments of $519,920 were made in 1995. Interest payments in 1995, 1994 and 1993 totaled $121,669, $202,928, and $243,563, respectively.\nThe loan is secured by a pledge of the stock of Citizens Fund and ICO. Additionally, the Company agreed to certain restrictive covenants which limit the amount of subsequent indebtedness, dividends payable to shareholders, capital expenditures and business acquisitions. The covenants also restrict any changes to the pooling agreement.\nThese restrictive covenants further require that Citizens Fund and ICO maintain specified levels of capital and policyholders' surplus and that net\nCitizens Security Group Inc. (Parent Only)\nSchedule II. Condensed Financial Information of Registrant Notes To Condensed Financial Information December 31, 1995, 1994 and 1993\nwritten premiums to policyholders' surplus and combined trade ratios not exceed specified levels. The Company is currently in compliance with all requirements of the loan agreement.\n3. Stock exchange\nOn March 31, 1994, Citizens Mutual exchanged 1,250,000 shares of common stock for 1,250,000 shares of 7.95% Series A Preferred Stock (\"Preferred Stock\"). The Preferred Stock, which has an annual cumulative dividend of $.27825 per share and a liquidation preference of $3.50 per share, ranks senior to the Company's common stock as to payment of dividends and also as to the distribution of assets should there be a liquidation or dissolution of the Company. The Preferred Stock is not convertible by Citizens Mutual and is not subject to redemption at the option of the Company or Citizens Mutual.\nThe Preferred Stock was recorded at the liquidation preference of $3.50 per share, which approximated the market value of the common stock retired at the time of the exchange. Common stock and additional paid-in capital were decreased $4,524,814 for the common stock retired (including $149,814 of transaction costs).\n4. Dividend restrictions\nAs a holding company, the Company depends on dividends from Citizens Fund and ICO to make principal and interest payments with respect to its bank loan and to meet its other expenses. During 1995, 1994 and 1993, the Company received dividends from Citizens Fund of $789,000, $811,754 and $682,845, respectively. During 1995, 1994 and 1993, the Company received dividends from ICO of $375,706, $645,735 and $542,057, respectively. As members of an insurance holding company system, Citizens Fund and ICO are restricted by law as to the amount of dividends they may pay to the Company without the approval of state regulatory authorities.\nGenerally, restrictions on Citizens Fund limit the amount of dividends paid during a twelve month period to an amount which does not exceed the greater of (i) 10 percent of Citizens Fund's statutory surplus at the end of the prior year or (ii) the statutory net income, not including realized gains, of Citizens Fund for the prior year. In addition, ordinary dividends may only be paid from the earned surplus of Citizens Fund, also known as unassigned funds, determined in accordance with the accounting procedures and practices used in the preparation of its statutory annual statement, minus 25 percent of earned surplus attributable to unrealized capital gains. As of December 31, 1995, Citizens Fund's unassigned surplus was $305,020. Citizens Fund's ordinary dividends are restricted to a maximum of $832,883 for 1996. Citizens Fund paid dividends of $789,000 in 1995.\nRestrictions on ICO limit the amount of dividends paid during a twelve month period to an amount which does not exceed the greater of (i) 10 percent of ICO's statutory surplus at the end of the prior year or (ii) the net income of ICO for the prior year. In addition, ordinary dividends may only be paid from earned surplus, which equals ICO's unassigned funds as set forth in its most recent statutory annual statement, including net unrealized capital gains and losses. As of December 31, 1995, ICO's unassigned surplus was $69,053. ICO's ordinary dividends are restricted to a maximum $528,705 for 1996. ICO paid dividends of $375,706 in 1995.\nCitizens Security Group Inc. (Parent Only)\nSchedule II. Condensed Financial Information of Registrant Notes To Condensed Financial Information December 31, 1995, 1994 and 1993\nPursuant to Ohio insurance laws, ICO must maintain statutory surplus of $5,000,000 in order to write commercial property and casualty insurance lines. As of December 31, 1995, ICO's statutory surplus was $5,287,053. The requirements for minimum capital and surplus may restrict ICO's ability to pay dividends to the Company.\nCitizens Security Group Inc. and Subsidiaries\nSchedule III. Supplementary Insurance Information\n__________ (1) Balance sheet information not applicable.\nCitizens Security Group Inc. and Subsidiaries\nSchedule IV. Reinsurance\nYears ended December 31, 1995, 1994 and 1993\n__________ (1) Pursuant to the Pooling Agreement, gross insurance premiums earned includes 75% of Citizens Fund's, ICO's and Citizens Mutual's gross premiums earned.\nCitizens Security Group Inc. and Subsidiaries\nSchedule VI. Supplemental Information Concerning Property-Casualty Insurance Operations\nEXHIBIT INDEX\nExhibit Number Description - ------ ---------------------------------------------------------------------\n(2) (.1) Plan of Stock Exchange between the Company and Citizens Security Mutual Insurance Company dated as of March 31, 1994(1)\n(.2) Acquisition and Affiliation Agreement dated as of March 20, 1996 by and among the Company, Citizens Security Mutual Insurance Company and Meridian Insurance Group, Inc.\n(3) (.1) Articles of Incorporation(2)\n(.2) Bylaws(3)\n(4) (.1) Certificate of Designations, defining the rights of the holders of Series A Preferred Stock of the Company(1)\n(.2) Form of Common Stock certificate(4)\n(10) (.1a) Reinsurance Pooling Agreement dated as of September 22, 1986 and restated as of November 10, 1986 among Citizens Security Mutual Insurance Company, the Company and Citizens Fund Insurance(4)\n(.1b) First Amended Reinsurance Pooling Agreement dated as of October 20, 1989 among the Company, Citizens Fund Insurance Company, Citizens Security Mutual Insurance Company and Insurance Company of Ohio(5)\n(.2a) Management Services Agreement dated as of September 22, 1986 and restated as of November 10, 1986 among Citizens Security Mutual Insurance Company, the Company and Citizens Fund Insurance Company(4)\n(.2b) First Amended Management Services Agreement dated as of October 20, 1989 among the Company, Citizens Fund Insurance Company, Citizens Security Mutual Insurance and Insurance Company of Ohio(5)\n(.2c) Second Amended Management Services Agreement among the Company, Citizens Security Mutual Insurance Company, Citizens Fund Insurance Company and Insurance Company of Ohio, dated March 31, 1994(1)\n(.3) 1986 Stock Option Plan, as restated April 18, 1995(6)*\n(.4) Third Amended Stipulation dated April 9, 1993 among the Minnesota Department of Commerce, Citizens Security Mutual Insurance Company and Citizens Fund Insurance Company(7)\nEXHIBIT INDEX - CONTINUED\nExhibit Description - ------- ----------------------------------------------------------------------\n(.5) Lease dated March 1, 1993 between Red Wing Hotel Corporation and Citizens Security Mutual Insurance Company(3)\n(.6a) Software License and Development Agreement dated as of August 25, 1988 between the Company and Programming Resources Company(2)\n(.6b) Amendment dated January 3, 1989 to Software License and Development Agreement dated as of August 25, 1988 between the Company and Programming Resources Company(5)\n(.6c) Addendum dated October 7, 1991 to Software License Development Agreement between the Company and Programming Resources Company(5)\n(.6d) Addendum effective as of September 1, 1993 to Software License and Development Agreement dated as of August 25, 1988 between the Company and Programming Resources Company(2)\n(.7a) Amended and Restated Term Loan Agreement dated as of December 31, 1992 between the Company and First Bank National Association(3)\n(.7b) First Amendment dated as of March 31, 1993 to Amended and Restated Term Loan Agreement dated as of December 31, 1992 by and between the Company and First Bank National Association(7)\n(.7c) Waiver Letter dated March 1, 1994 to the Company from First Bank National Association(2)\n(.7d) Second Amendment, dated as of March 31, 1994 to Amended and Restated Term Loan Agreement, dated as of December 31, 1992 by and between the Company and First Bank National Association(1)\n(.7e) Third Amendment, dated as of August 1, 1994 to Amended and Restated Term Loan Agreement, dated as of December 31, 1992 by and between the Company and First Bank National Association(8)\n(.7f) Waiver letter dated February 28, 1995 to the Company from First Bank National Association(5)\n(.7g) Waiver letter dated November 9, 1995 to the Company from Goodhue County National Bank(9)\n(.7h) Fourth Amendment, dated as of November 9, 1995 to Amended and Restated Term Loan Agreement, dated as of December 31, 1992 by and between the Company and Goodhue County National Bank\n(.8) Pledge Agreement dated as of December 31, 1992 between the Company and First Bank National Association(3)\nEXHIBIT INDEX - CONTINUED\nExhibit Description - ------- ----------------------------------------------------------------------\n(.9a) Letter Agreement dated as of November 2, 1989 among the Company, Insurance Company of Ohio and the Ohio Department of Insurance(5)\n(.9b) Letter dated October 7, 1993 to Insurance Company of Ohio from the Ohio Department of Insurance(10)\n(.10a) 1994 Employee Bonus Plan(2)*\n(.10b) 1995 Employee Bonus Plan(6)*\n(.11) Non-employee Director Stock Option Plan(11)*\n(.12) Letter Agreement dated January 15, 1992 between Citizens Fund Insurance Company and the Minnesota Department of Commerce(12)\n(.13a) Lease dated September 16, 1993 between Engwiller Properties, Inc. and Insurance Company of Ohio(10)\n(.13b) Sublease Agreement dated July 5, 1995 between Insurance Company of Ohio and Tom Witkowski(12)\n(.14) Letter dated September 22, 1993 to State of Minnesota Department of Commerce from Citizens Fund Insurance Company(2)\n(.15) Capital Access Fee Agreement dated March 31, 1994 among the Company, Citizens Security Mutual Insurance Company, Citizens Fund Insurance Company and Insurance Company of Ohio(1)\n(.16) Order Approving Restructuring dated March 31, 1994 issued by the Minnesota Department of Commerce(1)\n(.17) Letter of Authority dated September 12, 1994 to Scudder, Stevens & Clark, Inc. from Citizens Fund Insurance Company(8)\n(.18) Letter of Authority dated September 12, 1994 to Scudder, Stevens & Clark, Inc. from Insurance Company of Ohio(8)\n(.19a) Agreement dated December 31, 1994 among Citizens Security Mutual Insurance Company, Citizens Fund Insurance Company, Insurance Company of Ohio and Adjusting Unlimited, Inc.(5)\n(.19b) Agreement dated December 31, 1996 between the Company and Adjusting Unlimited, Inc.\n(.20) Lease dated April 21, 1995 between Eagle Building, L.L.C. and Citizens Security Mutual Insurance Company(6)\nEXHIBIT INDEX - CONTINUED\nExhibit Description - ------- ----------------------------------------------------------------------\n(.21) Deferred Compensation Plan Agreement dated August 1, 1995 between Citizens Security Mutual Insurance Company and Scott Broughton\n(21) Subsidiaries of the Company(5)\n(24) Power of Attorney\n(27) Financial Data Schedule\n(28) (.1) Schedule P from Citizens Fund Insurance Company's 1995 Annual Statement filed with the Minnesota State Insurance Department\n(.2) Schedule P from Insurance Company of Ohio's 1995 Annual Statement filed with the Ohio Department of Insurance\n__________ * Denotes management contract or compensatory plan or arrangement.\n(1) Incorporated by reference to the Company's Form 8-K dated March 31, 1994.\n(2) Incorporated by reference to the Company's Form 10-K for the fiscal year ended December 31, 1993.\n(3) Incorporated by reference to the Company's Form 10-K for the fiscal year ended December 31, 1992.\n(4) Incorporated by reference to the Company's Registration Statement on Form S-1 (Registration No. 33-9096) which became effective on December 17, 1986.\n(5) Incorporated by reference to the Company's Form 10-K for the fiscal year ended December 31, 1994.\n(6) Incorporated by reference to the Company's Form 10-Q for the quarter ended March 31, 1995.\n(7) Incorporated by reference to the Company's Form 10-Q for the quarter ended March 31, 1993.\n(8) Incorporated by reference to the Company's Form 10-Q for the quarter ended September 30, 1994.\n(9) Incorporated by reference to the Company's Form 10-Q for the quarter ended September 30, 1995.\n(10) Incorporated by reference to the Company's Form 10-Q for the quarter ended September 30, 1993.\n(11) Incorporated by reference to the Company's Form 10-Q for the quarter ended March 31, 1991.\n(12) Incorporated by reference to the Company's Form 10-K for the fiscal year ended December 31, 1991.\n(13) Incorporated by reference to the Company's Form 10-Q for the quarter ended June 30, 1995.","section_15":""}
{"filename":"715779_1995.txt","cik":"715779","year":"1995","section_1":"Item 1. Business\nGeneral\nDeb Shops, Inc. (the \"Company\") operates 330 women's specialty apparel retail stores (\"Deb\") offering moderately priced, fashionable, coordinated women's sportswear, dresses, coats, lingerie, accessories and shoes for junior sizes. Deb merchandise consists of clothing and accessories appealing primarily to the fashion-conscious junior-sized female consumers between the ages of 13 and 40. In addition to 324 stores operating under the name \"DEB\" and one operating under the name \"JOY\", the Company operates five outlet stores under the name \"CSO\". The outlet stores offer the same merchandise as DEB and JOY at reduced prices and serve as clearance stores for slow-moving inventory.\nThe Company also operates 11 apparel retail stores under the name Tops 'N Bottoms. Tops 'N Bottoms sells moderately priced men's and women's apparel. Thirty-four of the Deb stores contain Tops 'N Bottoms departments.\nMerchandising and Marketing\nDeb specializes in junior-sized merchandise and offers an extensive selection of colors and styles. The merchandise is attractively presented in groups coordinated by color and style to assist customers in locating items of their choice and in creating outfits of their own.\nTops 'N Bottoms caters primarily to young men and junior-sized women. Much of the merchandise is brand names and is unisex, capable of being worn by men or women.\nThe Company purchases its merchandise in volume, sells it at moderate prices, and has a policy of early mark-downs of slow-moving inventory. A special effort is made to select and present coordinated outfits on a rotating basis and featured merchandise is changed approximately twice a week.\nA computerized point of sale merchandise data system provides detailed daily information regarding sales and inventory levels by style, color, class and department, thereby permitting the Company to analyze market trends and changing store needs. Since merchandise control statistics are available on a daily basis, the Company can identify slow-moving merchandise and respond to customer buying trends when making repurchase decisions and mark-down adjustments. This permits the Company to maintain current and fresh merchandise in its stores.\nThe Company experiences the normal seasonal pattern of the retail apparel industry with its peak sales occurring during the Christmas, Back-to-School and Easter periods. To keep merchandise fresh and fashionable, slow-moving merchandise is marked down throughout the year. End-of-season sales are conducted twice a year (in the second and fourth quarters), in keeping\nwith the Company's policy of carrying a minimal amount of seasonal merchandise over from one year to another. If unsold at the end of the seasonal sales, merchandise is transferred to the Company's CSO stores.\nStores\nOriginally, the business of the Company was located in Pennsylvania and New Jersey. As the business grew and expanded into other states, the Company expanded its principal regional focus to include both the northeast and midwest sections of the United States. During the fiscal year ended January 31, 1995, Deb opened seven additional stores (while closing 34 stores). Tops 'N Bottoms opened one store and closed one store. Deb also opened sixteen Tops 'N Bottoms departments within Deb stores. At the present time the Company has scheduled one new store and one Tops 'N Bottoms department for the first half of fiscal 1996. The Company is currently scheduled to close eight stores in the first half of fiscal 1996. The Company plans to continue to carefully evaluate the profitability of individual stores and close those stores which it believes cannot become profitable or maintain profitability.\nThe following table shows store openings and closings for the last five fiscal years.\nYear Ended January 31, ------------------------------------------ 1991 1992 1993 1994 1995 ---- ---- ---- ---- ---- Open at beginning of fiscal year................ 316 342 365 373 368 Opened during fiscal year..... 37 32 24 11 8 Closed during fiscal year..... (11) (9) (16) (16) (35) --- --- --- --- --- Open at end of fiscal year.... 342 365 373 368 341 === === === === ===\nThe following table shows the states in which the Company's 341 existing stores are located.\nNew England East Midwest\nConnecticut 2 Delaware 1 Illinois 16 Maine 3 Maryland 6 Indiana 14 Massachusetts 13 New Jersey 15 Iowa 6 Rhode Island 1 New York 40 Kansas 3 -- Pennsylvania 50 Kentucky 6 19 Virginia 13 Michigan 24 West Virginia 7 Minnesota 10 --- Missouri 7 132 Nebraska 1 North Dakota 2 Ohio 30 South Dakota 1 Wisconsin 16 ---\nSouth West\nAlabama 1 California 3 Arkansas 1 Colorado 4 Georgia 2 Idaho 2 Louisiana 1 New Mexico 3 North Carolina 1 Oklahoma 5 South Carolina 1 Oregon 7 Tennessee 5 Texas 10 -- Utah 2 12 Washington 6 --\nDeb stores, which are typically 6,200 square feet, are located primarily in enclosed regional shopping malls and selected strip centers. Deb stores with Tops 'N Bottoms departments are typically 8,300 square feet and are all located in enclosed regional malls. Tops 'N Bottoms stores are all located in enclosed regional malls and range in size from 2,300 to 3,400 square feet. New stores are opened in existing malls, existing mall expansions, new malls and occasionally, strip centers. Factors considered in opening new stores include the availability of suitable locations and negotiation of satisfactory lease terms, both of which are considered essential to successful operations. Key considerations in selecting sites for new stores include the geographic location of the center, the demographics of the surrounding area, the principal specialty and \"anchor\" stores within the center, expected customer traffic within the center, and the location of the Company's store within the center itself.\nStores are distinctively designed for customer identification and are remodeled, when necessary. The stores are open generally from l0:00 A.M. to 9:30 P.M., Monday through Saturday, and from Noon to 5:00 P.M. on Sunday.\nOperations\nPayments for most of the Company's sales are made in cash, and the balance are made with MasterCard, Visa, Discover and the Company's private label credit cards. For customer convenience, the Company provides lay-away plans. The Company's policy is to permit returns of merchandise for exchange or for a full cash or credit refund, at the customer's preference.\nThe Company purchases its merchandise from a number of suppliers, both domestic and foreign, and is not materially dependent on any one supplier. All merchandise is shipped directly from vendors to the Company's central distribution facility, where it is received, inspected and price-marked before being shipped to the individual stores. The Company distributes its inventory by common carrier and leased trucks.\nThe responsibility for managing the Company's stores rests with the Vice President, Store Operations and a staff of forty-one employees consisting of Regional and District Supervisors. A District Supervisor is responsible for an average of ten stores, each of which is staffed by a Store Manager and an Assistant Store Manager and two Junior Assistant Store Managers. The District and Regional Supervisors visit the stores regularly to review merchandise levels, content and presentation, staff training and personnel issues, store security and cleanliness and adherence to standard operating procedures.\nThe merchandising department consists of thirty-six employees, including the Vice President, Merchandising, Merchandise Managers and Buyers. The department is responsible for purchasing, pricing (including mark-downs), inventory planning and allocating merchandise among the stores. The merchandising department's staff is organized in the following apparel categories: sportswear, dresses, coats, lingerie, hosiery and accessories.\nThe Company stresses promotion from within its organization. All of the current District and Regional Supervisors and the Vice President, Store Operations, have been promoted in this manner.\nAt January 31, 1995, the Company had approximately 3,000 employees, approximately 60% of whom were employed on a part-time basis. The Company has a collective bargaining agreement with the United Paperworkers International Union, Philadelphia Local 286 (UPIU) which expires on December 31, 1995. The UPIU represents the Company's warehouse employees. The collective bargaining agreement covers approximately 80 employees. The Company considers its employee relations to be good.\nCompetition\nThe retail sale of apparel is a highly competitive business with numerous individual and chain store competitors, including specialty shops as well as regional and national department store chains. Many of its competitors are considerably larger than the Company and have substantially greater financial and other resources.\nThe primary elements of competition are merchandise style, selection, quality, display and price, as well as store location and design. The Company believes that its strategy for the Deb stores of specializing in the junior\nsportswear market and its ability to effect volume purchases are important elements in its operations. Brand name merchandise is not a significant factor in the Company's sales.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company leases all of its stores. The internal layout and fixtures of each store are designed and constructed under contracts with third parties.\nUnder most leases, the Company is required to pay, in addition to fixed minimum rental payments, charges for real estate taxes, common area maintenance fees, utility charges, insurance premiums, mall association charges and contingent rentals based upon a percentage of sales in excess of specified amounts.\nThe following table shows the years in which executed store leases existing at January 31, 1995 expire.\nCalendar Years Number of Leases Expiring -------------- ------------------------- 1995 - 1996........................... 37 1997 - 1998........................... 60 1999 - 2000........................... 85 2001 - 2002........................... 73 2003 - 2004........................... 44 2005 - 2006........................... 23 2007 and thereafter................... 19 --- Total............................ 341 ===\nThe Company leases its warehouse, distribution and office space, aggregating 280,000 square feet, pursuant to a twenty year lease dated and effective June 15, 1982. This facility is a modern, one story industrial building situated on approximately 20 acres located in the northeast section of Philadelphia. See Item 13. Certain Relationships and Related Transactions.\nWith respect to the locations of present stores, see Item 1. Business-Stores.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe Company is involved in certain litigation incidental to the normal conduct of its business, none of which individually, or in the aggregate, appears likely to result in materially adverse consequences for the Company.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nNone.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nPursuant to General Instruction G(3) of Form 10-K, the following list is included as an un-numbered Item in Part I of this Report in lieu of being included in the Proxy Statement for the Annual Meeting of Shareholders to be held on May 24, 1995.\nThe executive officers of the Company, each of whom serves at the discretion of the Board of Directors, are as follows.\nName Age Position with Company Officer Since ---- --- --------------------- ------------- Marvin Rounick 55 Director, President and Chief Executive Officer 1973 Warren Weiner 51 Director, Executive Vice President, Secretary\/Treasurer 1973 Barry Vesotsky 49 Vice President, Merchandising 1981 Traci Jan Morrow 45 Vice President, Store Operations 1980 Stanley A. Uhr 49 Vice President, Real Estate Corporate Counsel 1988 Lewis Lyons 41 Vice President, Finance and Chief Financial Officer 1992 Marvin Waxman 50 Controller 1985\nMarvin Rounick has been employed by the Company since 1961. Since 1979, he has served as the President and Chief Executive Officer. Prior to that time, he served as Vice President, Operations and General Merchandise Manager.\nWarren Weiner was employed by the Company from 1965 until 1975. He rejoined the Company in January, 1982, as Executive Vice President, Secretary and Treasurer.\nBarry Vesotsky has been employed by the Company since 1970. Since 1981, he has served as Vice President, Merchandising. From 1978 to 1981, he was a Buyer and Merchandise Manager with the Company.\nTraci Jan Morrow has been employed by the Company since 1977. Since 1980, she has been Vice President, Store Operations.\nStanley A. Uhr has been employed by the Company since 1987, first as Director of Real Estate and Corporate Counsel and, from March 31, 1988, as Vice President, Real Estate and Corporate Counsel.\nLewis Lyons has been employed by the Company since 1990, first as Director of Taxes; from May 20, 1992, as Vice President, Finance; and from May 26, 1993, as Vice President, Finance and Chief Financial Officer. For more than five years prior thereto he was a Tax Manager in the accounting firm of Goldenberg\/Rosenthal, Philadelphia, Pennsylvania.\nMarvin Waxman has been employed by the Company in his present capacity since 1985.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters\nMarket Information\nThe Company's Common Stock is traded on the over-the-counter market (NASDAQ National Market). Symbol: DEBS.\nThe following table sets forth quarterly high and low sales prices for the two most recent fiscal years.\n1995 High Low - - ---- ---- --- First Quarter $7.250 $6.125 Second Quarter 7.375 6.625 Third Quarter 7.125 4.625 Fourth Quarter 5.375 3.000\n1994 High Low - - ---- ---- --- First Quarter $9.00 $7.25 Second Quarter 8.00 5.75 Third Quarter 7.50 5.50 Fourth Quarter 7.50 5.75\nHolders\nAs of April 7, 1995, there were 497 holders of record of the Company's Common Stock.\nDividends\nThe Company paid regular quarterly dividends for each of the fiscal quarters in the two most recent fiscal years. The per share amount of these dividends was $.05 for each of the fiscal quarters of fiscal 1994 and 1995. The company intends to follow a policy of regular quarterly cash dividends, subject to earnings, capital requirements and the operating and financial condition of the Company, among other factors.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe following selected financial data are derived from the consolidated financial statements of the Company. The data should be read in conjunction with the consolidated financial statements, related notes, and other financial information included herein.\nDeb Shops, Inc.\nConsolidated Financial Highlights\nNot covered by report of Independent Public Accountants.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Operations\nRESULTS OF OPERATIONS\nNet sales decreased $18,133,000 (8.2%) from fiscal 1994 to 1995 and decreased $8,388,000 (3.7%) from fiscal 1993 to 1994. The decrease in net sales in fiscal 1995 was principally attributable to continued customer resistance to product and pricing and a lack of fashion direction in the women's specialty apparel industry. The decrease in net sales in fiscal 1994 was attributable principally to adverse weather conditions in the first quarter of fiscal 1994 and a continued lack of customer confidence. The following table sets forth certain per store information.\nPer Store Data(1) Year Ended January 31, ---------------------- 1995 1994 1993\nStores open at end of the period 341 368 373 Average number in operation during the period 357 371 367 Average net sales per store (in thousands) $568 $596 $625 Average net (loss) income per store (in thousands) ($ 8) $ 14 $ 20 Comparable Store Sales(2) -- Percent Change (7.9%) (5.9%) (1.5%)\n- - ------------- (1) Includes Tops 'N Bottoms stores\n(2) Comparable store sales includes stores opened for both periods, in the current format and location. A store is added to the comparable store base in its 13th month of operation.\nSince fiscal 1993 the Company has trended toward lower sales and since fiscal 1991 the company has trended toward lower earnings. Sales have been lower principally due to lower demand as a result of increased customer resistance to product and pricing and a lack of fashion direction in the women's specialty apparel industry. Management has tried and continues to try to adjust the product mix and pricing philosophy in an attempt to stimulate sales. For fiscal 1996 the Company will introduce shoes into 200 of its locations, in an attempt to generate new business and multiple sales. In August 1993, the Company introduced its private label credit card as a means of attempting to stimulate sales. The credit card also serves as a vehicle for direct mail contact with the customer.\nNet income decreased $7,865,000 (152.8%) from fiscal 1994 to 1995 and decreased $2,105,000 (29.0%) from fiscal 1993 to 1994. As a percentage of net sales, the net (loss) income was (1.3%) in fiscal 1995, 2.3% in fiscal 1994, and 3.2% in fiscal 1993. The decrease in fiscal 1995 was primarily attributable to the decrease in total sales, as discussed above, along with decreased margins as a result of increased competitive pressures. Sales and margins at these levels are insufficient to cover fixed overhead. The net loss for fiscal 1995 was partially offset (to the extent of $600,000) by refunds of insurance premiums received during the quarter ended April 30, 1994. The decrease in fiscal 1994 was primarily attributable to the continued lack of consumer confidence and increased expenses as a percentage of sales. The decrease in 1993 was primarily attributable to a lack of consumer confidence, a decrease in other income (principally interest) and increased expenses. During the fourth quarter of fiscal 1995 margins decreased compared to a small increase in margins during the fourth quarter of fiscal 1994 and fiscal 1993. During the periods reported, comparable store sales decreased as noted in the table above. The primary reason for the decreases in comparable store sales was customer resistance to product and pricing and a lack of fashion direction in the women's specialty apparel industry. The trend toward lower sales and lower comparable store sales has continued into the first quarter of fiscal 1996.\nCost of sales, including buying and occupancy costs, decreased $4,570,000 (2.7%) from fiscal 1994 to 1995 and decreased $5,457,000 (3.2%) from fiscal 1993 to 1994. The principal reason for the dollar decrease from fiscal 1994 to 1995 and from fiscal 1993 and 1994 was the decrease in sales. As a percentage of net sales these costs were 79.8% during fiscal 1995, 75.3% during fiscal 1994, and 75.0% during fiscal 1993. The increased cost of sales percentage resulted principally from higher promotional activity as a result of increased competitive pressures. Buying and occupancy costs were 19.7%, 18.0% and 17.6% of sales for the fiscal years 1995, 1994 and 1993 respectively. These percentage increases resulted principally from decreased comparable store sales.\nSelling and administrative expenses decreased $2,255,000 (5.1%) from fiscal 1994 to 1995 and $112,000 (0.3%) from fiscal 1993 to 1994. The decrease in selling and administrative expenses from fiscal 1994 to 1995 was due, in part, to approximately $600,000 of refunds received for health and workers' compensation insurance as a result of favorable experience. In addition the decrease in selling and administrative expenses from fiscal 1994 to 1995 was due to a decrease in the number of stores and a decrease in sales.\nThe decrease in these expenses for fiscal 1994 was mainly due to cost controls. As a percentage of net sales, these expenses were 20.9% during fiscal 1995, 20.2% during fiscal 1994 and 19.5% during fiscal 1993. The percentage increases in fiscal 1994 and 1995 were the result of sales for the period being insufficient to cover fixed overhead.\nThe increase in depreciation expense in fiscal 1995 and 1994 is principally attributed to the remodeling and expanding of the Company's stores.\nLIQUIDITY AND CAPITAL RESOURCES\nDuring the past three fiscal years, the Company has funded internally all of its operating needs, including capital expenditures for the opening of new stores, the purchase of new cash registers, remodeling of existing stores, the purchase of computer equipment and the acquisition of Treasury Stock.\nTotal cash provided by operating activities for the fiscal years ended January 31, 1995, 1994, and 1993 was $65,000, $4,894,000 and $16,707,000, respectively derived principally from operating income for the fiscal years ended January 31, 1994 and 1993. For fiscal 1995 the net loss was offset by cash provided by operations as a result of non cash charges for depreciation and decreased merchandise inventories. For fiscal 1994 cash provided by operating activities was reduced by lower income and $5,000,000 from increased merchandise inventories.\nNet cash used in investing activities was $1,735,000, $928,000 and $6,295,000 for the fiscal years ended January 31, 1995, 1994 and 1993, respectively. These funds were principally used in the purchase of property, plant and equipment. During fiscal 1995 and 1994, these funds were net of proceeds from the sale of investments. During fiscal 1995, the Company expended $2.6 million for property and equipment additions to open 8 new stores and remodel existing stores. During fiscal 1994, the Company expended $2.7 million for property and equipment additions to open 11 new stores and remodel existing stores. During fiscal 1993, the Company expended $6.3 million for property and equipment additions to open 24 new stores, remodel existing stores and purchase new cash registers.\nNet cash used in financing activities was $19.3 million, $3.2 million and $3.2 million for the fiscal years ended January 31, 1995, 1994 and 1993, respectively. For the fiscal year ended January 31, 1995 these funds were used for the purchase of treasury stock and the payment of dividends on preferred and common stock. On April 4, 1994 the Company purchased the 2,761,800 shares of its Common Stock owned by Petrie Stores Corporation at a cash price of $6.05 per share, for a total cash outlay of approximately $16,800,000 including transaction costs. That price represented a substantial discount from book value of $6.98 per share. The purchase price was funded entirely from a portion of the Company's short-term investments. For the fiscal years ended January 31, 1994 and 1993 these funds were also used for the payment of dividends on preferred and common stock.\nAs of January 31, 1995, the Company had cash and cash equivalents of $50,610,000 compared with $71,614,000 at January 31, 1994 and $70,822,000 at January 31, 1993. Since fiscal 1993, the Company has trended toward lower sales and since fiscal 1991 the Company has trended toward lower earnings and these trends are continuing into the first quarter of fiscal 1996. There are no known other trends or commitments, events or other uncertainties that are reasonably likely to result in the Company's liquidity increasing or decreasing in any material way. The Company believes that internally generated funds will be sufficient to meet its anticipated capital expenditures, none of which are material, and current operating needs.\nINCOME TAXES\nThe effective income tax rate for fiscal 1995, 1994 and 1993 was (41.1%), 30.4% and 30.0% , respectively. The effective tax rate benefit for fiscal 1995 is higher than the statutory rate primarily as a result of tax-free interest income. The effective tax rate for fiscal 1994 and 1993 is lower than the statutory rate primarily as the result of tax-free interest income. Effective February 1, 1993, The Company adopted Financial Accounting Standard No. 109 (SFAS No. 109) ,\"Accounting for Income Taxes\". The impact of adopting SFAS No. 109 was not material to the fiscal 1994 or 1995 financial statements.\nINFLATION\nInflation has little impact on the operating results of the Company since inflation rates are relatively low and inventory turns are frequent. Inflation has had no meaningful effect on the other assets of the Company.\nSEASONAL NATURE OF OPERATIONS\nApproximately 55% and (4%) of the Company's net sales and net (loss) income respectively for fiscal 1995 occurred during the last six months as compared to 57% and 118% in the prior year. The last six months include the Back-to-School and Christmas selling seasons. See \"Quarterly Financial Information (Unaudited)\", and the preceding discussion on \"Results of Operations\".\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementory Data\nReport of Independent Public Accountants\nTo the Board of Directors of Deb Shops, Inc.:\nWe have audited the accompanying consolidated balance sheets of Deb Shops, Inc. (a Pennsylvania corporation) and subsidiaries as of January 31, 1995 and 1994, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended January 31, 1995. 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 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 Deb Shops, Inc. and subsidiaries as of January 31, 1995, and 1994, and the results of their operations and their cash flows for each of the three years in the period ended January 31, 1995 in conformity with generally accepted accounting principles.\n\/s\/ Arthur Andersen LLP ----------------------- ARTHUR ANDERSEN LLP\nPhiladelphia, PA February 27, 1995\nDeb Shops, Inc. CONSOLIDATED STATEMENTS OF OPERATIONS\nThe notes to consolidated financial statements are an integral part of these financial statements.\nDeb Shops, Inc. CONSOLIDATED BALANCE SHEETS\nThe notes to consolidated financial statements are an integral part of these financial statements.\nDeb Shops, Inc. CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY\nThe notes to consolidated financial statements are an integral part of these financial statements.\nDeb Shops, Inc. CONSOLIDATED STATEMENTS OF CASH FLOWS\nThe notes to consolidated financial statements are an integral part of these financial statements.\nDEB SHOPS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n- - - A -SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nConsolidation: The consolidated financial statements of Deb Shops, Inc. (the Company) include the accounts of the Company and its subsidiaries, after elimination of all inter-company transactions and accounts.\nInventories: Merchandise inventories are stated at the lower of cost (first-in, first-out method) or market, as determined by the retail inventory method.\nInvestments: In May, 1993, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\", (SFAS No. 115). 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. The Company adopted SFAS No. 115 effective February 1, 1994. The adoption of SFAS No. 115 did not have a material effect on the Company's financial condition or results of operations.\nIncome Taxes: The liability method is used in accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between the financial reporting and tax bases of assets and liabilities and are measured using enacted tax rates and laws that are expected to be in effect when the differences reverse. Deferred income taxes result principally from differences in the timing of recognition of overhead in inventory, deductibility of certain liabilities and depreciation expense.\nProperty, Plant and Equipment: The provisions for depreciation and amortization are computed using the straight-line method based upon estimated useful lives of the assets. Leasehold improvements are amortized over the initial term of the lease. Furniture and equipment is depreciated over seven years or the lease term, whichever is less. Gain or loss on disposition of property, plant and equipment is included in other income.\nNet (Loss) Income Per Common Share: Net (loss) income per common share and all per share amounts are based upon the weighted average common shares outstanding during each year including the dilutive effect of stock options and restricted incentive stock.\nStatements of Cash Flows: The Company considers all highly liquid investments with an original maturity of less than three months to be cash equivalents. Included in cash and cash equivalents at January 31, 1995 is $48,295,000 of investments in mutual funds, money markets and municipal bonds. They are carried at cost which approximates market.\n- - - B -INVESTMENTS\nAt January 31, 1994, the Company had investments in mutual funds of $857,672. During the year ended January 31, 1995, all investments were sold.\n- - - C -INCOME TAXES\nIncome tax provision (benefit) consists of the following components:\nYear Ended January 31, ---------------------------------- 1995 1994 1993 - - --------------------------------------------------------------------- Current: Federal........................($1,850,000) $2,075,000 $3,000,000 State.......................... 250,000 250,000 300,000 ----------- ---------- ---------- (1,600,000) 2,325,000 3,300,000 ----------- ---------- ---------- Deferred: Federal........................ (250,000) (25,000) (150,000) State.......................... (50,000) (50,000) (50,000) ----------- ---------- ---------- (300,000) (75,000) (200,000) ----------- ---------- ---------- ($1,900,000) $2,250,000 $3,100,000 =========== ========== ==========\nThe tax benefit generated during fiscal year 1995 will be realized by carrying back the loss to income generated during previous years.\nA reconciliation of the Company's effective income tax with the statutory federal rate follows:\nYear Ended January 31, ------------------------------------- 1995 1994 1993 - - ----------------------------------------------------------------------- Tax (benefit) at statutory rate.. $1,570,000) $2,515,000 $3,520,000 Tax-free income.................. (441,000) (563,000) (588,000) State income taxes, net of federal tax............. 132,000 132,000 165,000 Other............................ (21,000) 166,000 3,000 ----------- ---------- ---------- ($1,900,000) $2,250,000 $3,100,000 =========== ========== ==========\nEffective February 1, 1993, the Company adopted Financial Accounting Standards No. 109 (SFAS No. 109) \"Accounting for Income Taxes\". The impact of adopting SFAS No. 109 was not material to the fiscal 1995, 1994 or 1993 financial statements.\nThe deferred tax effect of temporary differences giving rise to the Company's deferred tax assets are:\nJanuary 31, ---------------------------------- 1995 1994 - - ------------------------------------------------------------------------------ Deferred Tax Asset - - ------------------ Uniform cost capitalization $ 443,000 $ 546,000 Capital lease obligation 423,000 446,000 Deferred rent 323,000 345,000 Depreciation 210,000 172,000 Accrued expenses 726,000 607,000 ---------- ---------- 2,125,000 2,116,000 Deferred Tax Liabilities - - ------------------------ Prepaid Expenses (264,000) ( 306,000) ---------- ---------- $1,861,000 $1,810,000 ========== ==========\n- - - D -LEASES\nThe Company leases all of its retail stores for periods ranging from one to 25 years, including renewal options. In most instances, the Company pays real estate taxes, insurance and maintenance costs on the leased properties and contingent rentals based upon a percentage of sales. The warehouse and office building occupied by the Company is leased from a partnership whose partners include three of the Company's directors including the President and Executive Vice President.\nUnder the terms of the warehouse and office building lease, the Company is required to pay annual rentals as reflected under \"Capital Lease\" in the lease table below. The lease term is 20 years and requires the Company to pay all real estate taxes, utilities and maintenance costs. The warehouse and office building lease has a net book value of $793,000 at January 31, 1995 and is accounted for as a capital lease. Resulting asset amounts are included in building and improvements and are depreciated over twenty years.\nInterest expense related to the capital lease obligation amounted to $444,000, $464,000, $475,000, for the years ended January 31, 1995, 1994 and 1993, respectively, and is included in selling and administrative expense.\nFuture minimum rental commitments for all noncancellable leases at January 31, 1995 are as follows:\nCapital Operating Lease Leases - - ---------------------------------------------------------------------- 1996.................................... $ 550,000 $ 19,156,000 1997.................................... 550,000 18,202,000 1998.................................... 550,000 16,786,000 1999.................................... 550,000 15,012,000 2000.................................... 550,000 12,417,000 Thereafter.............................. 1,330,000 35,353,000 ---------- ------------ Total minimum rental commitments........ 4,080,000 $116,926,000 ============ Imputed interest........................ (2,039,592) ---------- Present value of net minimum lease payments........................ $2,040,408 ==========\nTotal rental expense under operating leases amounted to $20,003,352, $20,290,486 and $21,383,050 in fiscal 1995, 1994 and 1993, respectively. Such amounts include contingent rentals based upon a percentage of sales of $730,171, $861,177 and $926,771 in fiscal 1995, 1994 and 1993, respectively.\n- - - E -STOCK OPTION PLAN\nIn January 1983, the Company adopted an Incentive Stock Option Plan. The plan is administered by a Stock Option Committee designated by the Board of Directors. Under the plan, a maximum of 1,000,000 shares of the Company's common stock, par value $.01 per share, may be issued by the Company and sold to selected key employees on the basis of contribution to the operations of the Company. The price payable for the shares of common stock under each stock option will be fixed by the Committee at the time of grant, but will be no less than 100% of the fair market value of the Company's common stock at the time the stock option is granted. Options are exercisable 50% per year cumulatively commencing after the first year after date of grant. There were 50,460 options outstanding on January 31, 1993 which expired during fiscal 1994. At January 31, 1995 there were 294,210 shares reserved for future grant.\n- - -F-RESTRICTED STOCK INCENTIVE PLAN\nEffective June 1, 1990, the Company adopted a Restricted Stock Incentive Plan (\"RSIP\") administered by the Company's Stock Option Committee. Under the RSIP a maximum 300,000 shares of the Company's common stock may be awarded as bonuses to key employees. No more than 100,000 shares may be issued under this plan during any calendar year. Upon grant, the shares shall be registered in the\nname of the recipient who shall have the right to vote the shares and receive cash dividends, but the right to receive the certificates and retain the shares does not vest until the grantee has remained in the employ of the Company for a period determined by the Stock Option Committee. At the time of the vesting, a portion of the shares may be withheld to cover withholding taxes due on the compensation income resulting from the grant.\nDuring each of fiscal 1995 and 1994, 20,000 shares were granted under the plan. Compensation expense in the years ended January 31, 1995 and 1994 was $100,000 and $125,000, respectively. At January 31, 1995 there were 206,000 shares reserved for future grant. During fiscal 1995 and 1994, 8,320 and 6,860 shares, respectively, of treasury stock were withheld to cover withholding taxes. These have been included in the issuance of restricted incentive stock, net on the consolidated statements of shareholders' equity.\n- - -G-COMMITMENTS\nThe Company has an unsecured line of credit aggregating $20,000,000 at January 31, 1995. Of this amount, $8,069,000 was outstanding as letters of credit for the purchase of inventory.\nThe Company entered into a five year agreement with a bank during fiscal 1994 for the use of a private label credit card bearing the Company's name. The Company pays a fee based on a percent of sales. Upon termination and under certain circumstances, the Company may be liable for excess losses incurred, as defined, on the collection of the then outstanding receivables.\nDeb Shops, Inc. Quarterly Financial Information (Unaudited)\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) Directors of the Registrant\nThe required information with respect to each director is contained in the Company's Proxy Statement in connection with its Annual Meeting to be held on May 24, 1995, which is incorporated in this Form 10-K Annual Report by reference.\n(b) Executive Officers of the Registrant\nThe required information with respect to each executive officer is contained at the end of Part I of this Form 10-K.\n(c) Family Relationships\nMarvin Rounick, President, Chief Executive Officer and a Director, and Jack A. Rounick, a Director, are brothers.\n(d) Other\nThere have been no events under any bankruptcy act, no criminal proceedings and no judgments or injunctions material to the evaluation of the ability and integrity of any director or executive officer during the past five years.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe required information with respect to executive compensation is contained in the Company's Proxy Statement in connection with its Annual Meeting to be held on May 24, 1995, which is incorporated in this Form 10-K Annual Report by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners & Management\nThe required information with respect to security ownership of certain beneficial owners and management is contained in the Company's Proxy Statement in connection with its Annual Meeting to be held on May 24, 1995, which is incorporated in this Form 10-K Annual Report by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThe required information with respect to certain relationships and related transactions is contained in the Company's Proxy Statement in connection with its Annual Meeting to be held on May 24, 1995, which is incorporated in this Form 10-K Annual Report by reference.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\nFinancial Statements and Financial Statement Schedules\nPage(s) -------\nDocument\nReport of independent public accountants............. 13\nConsolidated statements of operations for the years ended January 31, 1995, January 31, 1994 and January 31, 1993............................ 14\nConsolidated balance sheets as of January 31, 1995 and January 31, 1994............................ 15\nConsolidated statements of shareholders' equity for the years ended January 31, 1995, January 31, 1994 and January 31, 1993................ 16\nConsolidated statements of cash flows for the years ended January 31, 1995, January 31, 1994 and January 31, 1993................................. 17\nNotes to consolidated financial statements........... 18-22\nSelected quarterly financial data for the years ended January 31, 1995 and January 31, 1994..................................... 23\nAll schedules are omitted because they are not applicable or not required, or because the required information is included in the consolidated financial statements or notes thereto.\nEXHIBITS\nCertain of the following exhibits have been filed with the Securities and Exchange Commission pursuant to the requirements of the Acts administered by the Commission. Such exhibits are identified by the references following the listing of each such exhibit, and are incorporated herein by reference.\nExhibits identified with an asterisk below comprise executive compensation plans and arrangements.\nExhibit No. Description of Document - - ---------- ----------------------- 3-1 Restated articles of Incorporation of the Company, as amended through May 29, 1984 (1992 Form 10-K, Exhibit 3-1)\n3-2 By-Laws of the Company, as amended through July 19, 1990 (1993 Form 10-K, Exhibit 3-2)\n4-1 * Deb Shops, Inc. Restated Savings and Protection Plan (1992 Form 10-K, Exhibit 4-1)\n4-1.1 * Amendment No. I to Deb Shops, Inc. Restated Savings and Protection Plan (1992 Form 10-K, Exhibit 4-1.1)\n4-1.2 * Amendment No. II to Deb Shops, Inc. Restated Savings and Protection Plan (1992 Form 10-K, Exhibit 4-1.2)\n4-1.3 * Amendment No. III to Deb Shops, Inc. Restated Savings and Protection Plan (1992 Form 10-K, Exhibit 4-1.3)\n4-1.4 * Amendment No. IV to Deb Shops, Inc. Restated Savings and Protection Plan (1992 Form 10-K, Exhibit 4-1.4)\n4-1.5 * Amendment No. V to Deb Shops, Inc. Restated Savings and Protection Plan (1994 10-K Exhibit 4-1.5)\n4-1.6 * Amendment No. VI to Deb Shops, Inc. Restated Savings and Protection Plan (1994 Form 10-K, Exhibit 4-1.6)\n4-2 * Employee Savings and Protection Trust Agreement (Registration No. 2-99124, Exhibit 4-5)\n4-2.1 * Amendment No. I to Employee Savings and Protection Trust Agreement (Form 10-Q for quarter ended July 31, 1992)\n10-1 Lease Agreement for property located at 9401 Blue Grass Road, Philadelphia, Pennsylvania, 19114 (Registration No. 2-82222, Exhibit 10-1)\nExhibit No. Description of Document - - ---------- ----------------------- 10-8 Blue Grass Partnership Agreement dated June 15, 1982 (Registration No. 2-82222, Exhibit 10-8)\n10-9 Guarantee by Deb Shops, Inc. of payment of debt obligation of Blue Grass Partnership to Philadelphia Industrial Development Corporation Local Development Corporation dated December 16, 1982 (Registration No. 2-82222, Exhibit 10-9)\n10-10 Acceptance by Deb Shops, Inc. dated June l8, 1982 to guarantee the $500,000 loan to Blue Grass Partnership (Registration No. 2-82222, Exhibit 10-10)\n10-11 * Deb Shops, Inc. Incentive Stock Option Plan (Registration No. 2-82222, Exhibit 10-11)\n10-11(a) * First Amendment to the Incentive Stock Option Plan (Registration No. 33-11983, Exhibit 4-1(a))\n10-11(b) * Amendment dated February 1, 1988 to Incentive Stock Option Plan (1993 Form 10-K, Exhibit 10-11(b))\n10-14.1 * Insurance Policy for Marvin Rounick and Judy Rounick (1993 Form 10-K, Exhibit 10-14.1)\n10-14.2 * Split Dollar Insurance Agreement dated July 31, 1987 between the Company and Jack A. Rounick and Stuart Savett, Trustees under the Rounick Family Irrevocable Insurance Trust dated October 27, 1986 (1993 Form 10-K, Exhibit 10-14.2)\n10-14.3 * Collateral Assignment dated July 31, 1987 from Jack A. Rounick and Stuart Savett, Trustees under the Rounick Family Irrevocable Insurance Trust dated October 27, 1986, as assignor, and the Company, as assignee (1993 Form 10-K, Exhibit 10-14.3)\n10-15.1 * Life Insurance Policy for Warren Weiner and Penny Weiner (1993 Form 10-K, Exhibit 10-15.1)\n10-15.2 * Split Dollar Insurance Agreement dated July 31, 1987 between the Company and Barry H. Frank and Robert Shein, Trustees under the Weiner Family Irrevocable Insurance Trust dated October 27, 1986 (1993 Form 10-K, Exhibit 10-15.2)\nExhibit No. Description of Document - - ---------- ----------------------- 10-15.3 * Collateral Assignment dated July 31, 1987 from Barry H. Frank and Robert Shein, Trustees under the Weiner Family Irrevocable Insurance Trust dated October 27, 1986, as assignor, and the Company, as assignee (1993 Form 10-K, Exhibit 10-15.3)\n10-17 * Restricted Stock Incentive Plan as amended\n10-18 Stock Purchase Agreement dated April 4, 1994 between the Company and Petrie Stores Corporation (1994 Form 10-K Exhibit 10-18)\n11 Computation of Primary Earnings Per Share\n22 Subsidiaries of the Company\n24-1 Consent of Arthur Andersen LLP\n27 Financial Data Schedule\nReports on Form 8-K\nThere were no reports on Form 8-K for the quarter ended January 31, 1995.\nSIGNATURES\nPursuant to the requirements of Sections 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized in the City and County of Philadelphia, Commonwealth of Pennsylvania, on April 26, 1995.\nDEB SHOPS, INC. (Registrant)\nBy: \/s\/ Marvin Rounick ---------------------------- Marvin Rounick, President\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.\n\/s\/ Marvin Rounick April 26, 1995 - - ----------------------------------------- Marvin Rounick, President, Chief Executive Officer and Director (Principal Executive Officer)\n\/s\/ Warren Weiner April 26, 1995 - - ----------------------------------------- Warren Weiner, Executive Vice President, Secretary, Treasurer and Director\n\/s\/ Jack Rounick April 26, 1995 - - ----------------------------------------- Jack A. Rounick, Assistant Secretary and Director\n\/s\/ Paul Bachow April 26, 1995 - - ----------------------------------------- Paul S. Bachow, Director\n\/s\/ Barry Feinberg April 26, 1995 - - ----------------------------------------- Barry H. Feinberg, Director\n\/s\/ Barry Frank, Esq April 26, 1995 - - ----------------------------------------- Barry H. Frank, Esq., Director\n\/s\/ Lewis Lyons April 26, 1995 - - ----------------------------------------- Lewis Lyons, Vice President, Finance, Chief Financial Officer\n\/s\/ Marvin Waxman April 26, 1995 - - ----------------------------------------- Marvin Waxman, Controller","section_15":""}
{"filename":"6955_1995.txt","cik":"6955","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL DEVELOPMENT OF THE COMPANY\nApplied Power Inc. (the \"Company\"), a Wisconsin corporation incorporated in 1910, is a diversified global company engaged in the business of providing tools, equipment, systems and consumable items to a variety of end-users and original equipment manufacturers in the manufacturing, construction, transportation, natural resource, aerospace, defense and other industries.\nThe Company's operations are divided into three business segments:\nFinancial information by segment and geographic area, as well as information related to export sales, is included in Note M -- \"Segment Information\" in Notes to Consolidated Financial Statements, which is included as part of Item 8 of Part II of this report and is incorporated herein by reference.\nAll numbers in the report are in thousands of US Dollars unless otherwise indicated.\nDESCRIPTION OF BUSINESS SEGMENTS\nDISTRIBUTED PRODUCTS\nDistributed Products, which includes Enerpac and GB Electrical, is engaged in the manufacture and distribution of tools and consumables to the construction, retail and general industrial markets. Products are generally distributed through wholesale and retail distributors. Both Distributed Products businesses supply approximately 5,000 SKU's each to a broad customer base. Geographic expansion offers a source of growth potential for the Distributed Products businesses.\nENERPAC\nEnerpac is involved in the design, manufacture and sale, on a worldwide basis, of labor and cost saving products and systems for industrial and construction operations. The products can be grouped into three product lines: high force tools, production automation, and specially engineered or complementary systems.\nEnerpac's high force tool line consists of approximately 5,000 products that are used extensively in general industrial and construction applications. These hydraulic products allow users to apply controlled force and motion that increase productivity and make work safer and easier to perform. Hydraulic pumps, valves, cylinders and presses, as well as more specialized tools such as pipe benders, torque wrenches and electronically-controlled lifting systems are examples of Enerpac's high force tools.\nEnerpac's production automation products consist of workholding components and systems which enable a quick change of dies, molds and other equipment used in production and assembly operations. Hydraulic workholding components and systems utilized in metal-cutting machine tools hold parts in position during the machining process, and provide superior accuracy and flexibility to traditional mechanical clamping methods. Enerpac also designs and manufactures quick mold change systems that are used extensively in the injection molding industry.\nIn addition to its line of high force tools and production automation products, Enerpac custom engineers and assembles equipment and special modified products that are sold directly to original equipment manufacturers (\"OEMs\").\nEnerpac has engineering, manufacturing and warehousing operations in the United States, the Netherlands, Mexico, France, South Korea and Japan, with sales and service operations in a number of other countries. The manufacturing operations in the Netherlands were recently consolidated into the United States, with the Netherlands' location primarily serving as a European warehouse. Products are primarily distributed through a worldwide network of over 2,500 independent distributors as well as directly to certain OEM customers. Enerpac believes its strengths include the breadth of its product line, large distribution network, long operating history, reputation and technical expertise.\nGB ELECTRICAL\nAs a result of niche acquisitions, new product introductions, strong customer service and its expansion into new markets, GB Electrical has tripled its sales since being acquired by the Company in 1988. It has completed three acquisitions between October, 1993 and September, 1995, including Palmer Industries (a manufacturer of plastic and metal staples), New England Controls (an electrical switch manufacturer) and Vision Plastics (a plastic cable tie manufacturer). GB's major product groups include the following: tools and accessories used in industrial, commercial and residential construction, remodeling and maintenance; wire connectors and other wire termination devices; conduit fishing and pulling systems; conduit benders; fastening devices (including cable ties and plastic staples); digital and analog multitesters; and electrical switches.\nGB's products are sold through electrical wholesale distributors and mass merchandisers. This network includes approximately 4,000 electrical wholesale accounts as well as merchandisers including Sears, Ace Hardware, Builders Square, Payless Cashways, Wal-Mart, The Home Depot, Cotter & Co. and other major chains, which in total represent over 20,000 consumer outlets.\nGB operates manufacturing facilities in Wisconsin, Minnesota, North Carolina, California and Connecticut. GB's products are primarily distributed through its International Distribution Center located in Milwaukee, Wisconsin as well as a number of independent warehouses located throughout the United States. Although the majority of its business is generated in the United States, GB is aggressively pursuing opportunities in Canada, Mexico, Latin America and Asia.\nENGINEERED SOLUTIONS\nEngineered Solutions, consisting of Power-Packer, APITECH and Barry Controls, focuses on developing and marketing value-added solutions for OEMs in the transportation, construction, aerospace, defense and industrial markets. Technical sales force members from each of the Engineered Solutions units often work together to develop and market Engineered Solutions products in one technology solution package. These value-added technology solutions offer cost-effective systems to meet the needs of Engineered Solutions' global customer base.\nPOWER-PACKER\nPower-Packer custom designs hydraulic systems and components for OEM customers in the transportation, medical equipment and agricultural equipment markets. Although its principal engineering and assembly operations are based in the United States and the Netherlands, Power-Packer also markets its products\nthroughout Europe, Japan, South Korea, South America and North America. The majority of its products are sold direct by its technically-trained sales force.\nPower-Packer has three primary product applications in the transportation industry: the cab-tilt system, the air suspension system and the convertible top actuation system. The cab-tilt system is installed on heavy-duty, cab-over-engine trucks and tilts and retracts the cab for engine inspection and maintenance. The systems are customized to meet the needs of individual truck manufacturers which include virtually all of the major manufacturers of cab-over-engine trucks in the United States and Western Europe. Power-Packer also markets its cab-tilt systems in Japan through a license agreement. Air suspension systems improve the ride characteristics of trucks, enhance driver comfort and safety while reducing cab maintenance costs. Power-Packer has also developed a leading position in supplying electrically powered hydraulic actuator systems for convertible automobile tops. These systems, which are shipped to automotive OEMs fully assembled and tested, are presently used on many car models in Europe and the United States.\nPower-Packer supplies self-contained hydraulic actuators to medical equipment manufacturers that provide portable patient lifting and positioning capability for institutional or home use. Other manually operated products are supplied for hospital bed height adjustment. It also produces power driven systems, in some cases combined with fully integrated microprocessor control, to expand the multi-function capability of beds and examination tables.\nAPITECH\nThe Company formed APITECH to develop and market products that combine electronic control with hydraulic technologies to increase the control, safety and performance of end-user products. APITECH employs advanced electronic and software technology in its modular line of products, including electro-hydraulic control valves, microprocessor-based control circuitry, sensors and software. These products can be adapted to customers' control situations and span broad application areas without extensive redesign. The Company has a patented digital electro-hydraulic valve, marketed under the Pulsar ValveTM name, which can be directly controlled by a microprocessor to deliver performance comparable to servo valve technology at a significantly lower cost.\nThe Company markets APITECH products to a diversified mix of customers, primarily OEMs. The highest demand for electro-hydraulic APITECH products occurs in the off-highway mobile market, the on-highway transportation and maintenance vehicle market and the automotive market. In the off-highway market, APITECH's customers include John Deere, Hameck, F.W. McConnell, Palfinger, Snorkel and Altec. In the on-highway maintenance market, major state and municipal road fleets in the United States and Canada use APITECH's salt and sand spreader control products. In the automotive market, APITECH supplies small fast valves to GM Delphi that are part of the system that provides a semi-active suspension capability in certain Cadillac models. Sales to GM Delphi are a significant portion of APITECH's business.\nProducts are sold as components or turn-key systems, depending on customer specifications and design capability, typically with long-term supply arrangements. The Company primarily sells its APITECH products through its own sales engineering team as well as through a group of full service mobile equipment distributors in North America and Europe. Sales to the road maintenance equipment market take place through a national network of truck equipment dealers in the United States and Canada. APITECH's operations are based in Butler, Wisconsin.\nBARRY CONTROLS\nBarry Controls was acquired by Applied Power in 1989, along with Wright Line, in conjunction with the acquisition of Barry Wright Corporation. Barry Controls is engaged in the business of custom designing, manufacturing and marketing engineered products and systems that reduce vibration, shock and structure-borne noise. Products for the commercial aerospace and defense markets include engine vibration isolators for aircraft and vibration and shock isolators for defense and aerospace applications. Industrial products represent an important part of Barry Controls' business, and include vibration isolators and noise dampening\ncomponents for a variety of applications including computers, appliances, power tools, industrial equipment, heavy trucks, farm and construction equipment and many other diverse applications.\nPrincipal markets and customers served include OEMs of many types of machinery and equipment, (including computers), aircraft manufacturers, commercial airlines, defense and aerospace contractors, and users of equipment requiring noise or vibration reduction. Products are distributed through its sales engineers, independent sales engineering representatives and specialized distributors. Barry Controls' products are manufactured in two locations in the United States as well as in England.\nWRIGHT LINE\nIn the second quarter of 1994, the Company announced its decision to retain the remaining Wright Line business, which had been held for sale and included in discontinued operations since the third quarter of 1992. For further information, refer to Note B -- \"Discontinued Operations\" in Notes to Consolidated Financial Statements.\nDuring the past three years, Wright Line has shifted its strategy to respond to the application and storage demands posed by new and fast changing markets, including Local Area Networks (LAN's), multi-media, engineering test and development and scientific laboratory markets. Its customers require efficient and flexible work centers and equipment for professionals. In addition to these fast growing markets, Wright Line continues to provide cabinets, workstations and work surfaces used in the computerized office.\nWright Line products are primarily sold through its direct sales force in the United States, in addition to a network of independent distributors and value-added resellers. Its products are marketed in foreign markets through direct salespeople, sales representatives and dealers, depending on the country. Products are primarily sold to commercial and governmental end-users. Sales to the government, which have averaged approximately 30% of total Wright Line net sales over the past three years, are made pursuant to a contract between Wright Line and the US Government's General Services Administration.\nCOMPETITION\nThe Company competes on the basis of product design, quality, availability, performance, customer service and price. The Company believes that its technical skills, global presence, shared technology base, close working relationships with customers as well as its patents bolster its competitive position.\nApplied Power's businesses face competition to varying degrees in each of their markets. In general, each product line competes with a small group of different competitors. No one company competes directly with the Company across all of its businesses. Some competitors of the Enerpac, GB Electrical, APITECH, and Wright Line businesses are substantially larger than the Company and have greater financial resources. The competitors of Power-Packer are limited to a few specialized firms, which are generally privately held and operate in specific geographic markets. Barry Controls and its principal competitor, a segment of Lord Corporation, are the dominant suppliers in the shock, vibration and noise isolation markets.\nRESEARCH AND DEVELOPMENT\nThe Company maintains engineering staffs at several locations, which design new products and make improvements to existing product lines. Expenditures for research and development, which constitute a portion of the Company's engineering expense, were $8,725, $7,446 and $5,878 in fiscal years 1995, 1994 and 1993, respectively. Substantially all research, development and product improvement expenditures are Company funded.\nPATENTS AND TRADEMARKS\nThe Company has been issued a number of patents that provide protection of valuable designs and processes in its APITECH, Power-Packer and Barry Controls businesses. Numerous other United States and foreign patents and trademarks are owned by the Company, although no such individual patent or trademark\n(or group thereof) is believed to be of sufficient importance that its termination would have a materially adverse effect on the Company's business.\nMANUFACTURING, MATERIALS AND SUPPLIERS\nThe majority of the Company's manufacturing operations include the assembly of parts and components which have been purchased by the Company from a number of suppliers. In the absence of unusual circumstances, substantially all such products are normally available from a number of local and national suppliers.\nORDER BACKLOGS AND SEASONALITY\nAt August 31, 1995, the Company had approximately $88,200 in backlog orders, compared to approximately $81,200 at August 31, 1994. Substantially all orders are expected to be completed prior to August 31, 1996. The Company's sales are subject to minor seasonal fluctuations, with second quarter sales traditionally being the lowest of the year.\nEMPLOYEE RELATIONS\nAs of August 31, 1995, Applied Power employed 2,840 people on a full-time basis, none of which are subject to a collective bargaining agreement. In general, the Company enjoys good relationships with its employees.\nENVIRONMENTAL COMPLIANCE\nThe Company has facilities at numerous geographic locations, which are subject to a range of environmental laws and regulations. Compliance with these laws has, and will require expenditures on a continuing basis. Environmental expenditures are expensed or capitalized depending on their future economic benefit. The Company has been identified by the United States Environmental Protection Agency as a \"Potentially Responsible Party\" regarding seven multi-party Superfund sites. Based on its investigations, the Company believes it is a de minimis participant in each case, and that any liability which may be incurred as a result of its involvement with such Superfund sites, taken together with its expenditures for environmental compliance, will not have a material adverse effect on its financial position. Liabilities are recorded when environmental remediation is probable, and the costs can be reasonably estimated. Environmental remediation accruals of $573 and $567 were included in the Consolidated Balance Sheet at August 31, 1995 and 1994, respectively. For further information, refer to Note N -- \"Contingencies and Litigation\" in Notes to Consolidated Financial Statements.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe following table summarizes the principal manufacturing, warehouse and office facilities owned or leased by the Company:\nIn addition to these properties, the Company utilizes a number of smaller facilities in South Korea, Spain, Italy, Canada, Brazil, France, Germany, Australia, Russia, Singapore, India, China, the United Kingdom and the United States. The Company's headquarters are based in a 68,000 square foot leased office facility in Butler, Wisconsin, which is also utilized by Enerpac and Power-Packer.\nThe Company's strategy is to lease properties when available and economically advantageous. Leases for the majority of the Company's facilities include renewal options. For additional information, see Note H -- \"Leases\" in Notes to Consolidated Financial Statements. The Company believes its current properties are well maintained and in general, are adequately sized to house existing operations. The Company is currently making additions to the Wright Line facility in Worcester which are expected to be completed within the next year. The Company intends to construct, lease or acquire a larger manufacturing and warehousing facility in South Korea within the next two years to support its expansion in that emerging market. Funding for this project is expected to come from operating cash flow.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is a party to various legal proceedings which have arisen in the normal course of its business. These legal proceedings typically include product liability, environmental and patent claims. (For further information related to environmental claims, refer to \"Environmental Compliance\" on page 6). The Company has recorded reserves for loss contingencies based on the specific circumstances of each case. Such\nreserves are recorded when the loss is probable and can be reasonably estimated. In the opinion of management, the resolution of these contingencies will not have a materially adverse effect on the Company's financial condition or results of operations.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe names, ages and positions of all of the executive officers of the Company are listed below.\nRichard G. Sim was elected President and Chief Operating Officer in August, 1985, Chief Executive Officer effective September, 1986 and Chairman of the Board effective November, 1988. From January, 1982 through August, 1985, Mr. Sim was a General Manager in the General Electric Medical Systems Business Group. He is also a director of The Gehl Company, IPSCO Inc. and Falcon Building Products, Inc.\nWilliam J. Albrecht was named Senior Vice President of Engineered Solutions in May, 1994. Prior to that, he served as Vice President and President of Power-Packer and APITECH since January, 1991. He joined the Company in March, 1989 as General Manager of the APITECH Division in the United States. Prior to joining the Company, Mr. Albrecht was Director of National Accounts and Industrial Power Systems at Generac Corp. from 1987 to 1989 and Vice President-Sales at NP Marketing from 1985 to 1987.\nRobert G. Deuster was appointed Senior Vice President of Distributed Products in May, 1994. He had served as a Vice President since August, 1988, and was named President of Barry Controls in August, 1989. From March, 1987 to August, 1989, Mr. Deuster had responsibility for the APITECH business worldwide. From November, 1985 to March, 1987, he was Vice President Marketing and Sales for Enerpac in the United States. Prior to joining the Company in 1985, Mr. Deuster spent 10 years at General Electric in engineering and as Manager of Marketing in its Medical Systems Business Group.\nGustav H.P. Boel was elected Vice President of the Company and named President of Enerpac in November, 1995. From 1991 until that time, he was Managing Director of Power-Packer Europe. From 1990 to 1991, Mr. Boel was Technical Director for Groeneveld, located in Holland. Prior to 1990, he spent nineteen years with Enerpac in the Netherlands, where he last held the position of Managing Director.\nPhilip T. Burkart was elected Vice President of the Company in November, 1995 and named the President of Wright Line Inc. in August, 1994. From 1990 to 1994, Mr. Burkart held various positions within Wright Line Inc. including: General Manager, Vice President, Marketing and Operations and Director of Marketing. Prior to joining the Company, Mr. Burkart was a Marketing Manager for GE Medical Systems.\nTheodore M. Lecher has served as President of GB Electrical, Inc. (Gardner Bender, Inc. prior to its acquisition by the Company in February, 1988) since September, 1986, and as a Company Vice President\nsince August, 1988. He was Vice President-General Manager of Gardner Bender, Inc. from 1983 to 1986, and prior to that, Director of Sales and Marketing since 1980. Mr. Lecher has been associated with GB Electrical, Inc. since 1977.\nRobert C. Arzbaecher was named Vice President and Chief Financial Officer in October, 1994. He had served as Vice President, Finance of Distributed Products from August, 1993 to October, 1994. He joined the Company in January, 1992 as Controller. From May, 1988 to December, 1991, Mr. Arzbaecher was employed by Grabill Aerospace Industries LTD, where he last held the position of Chief Financial Officer. Prior to 1988, Mr. Arzbaecher held various financial positions at Farley Industries Inc. and at Grant Thornton and Company, a public accounting firm.\nLouis E. Font was elected Vice President, Human Resources in October, 1994. From March, 1994 to October, 1994, Mr. Font served as Vice President, Human Resources for Distributed Products. He served from May, 1992 to March, 1994 as Vice President, Human Resources for Enerpac Americas. Prior to joining the Company in 1992, Mr. Font was employed by General Electric for 12 years, holding various human resource positions.\nDale A. Knutson has served as Vice President, Technology since May, 1987. From 1982 until May, 1987, he held the position of Vice President, Product Engineering. Mr. Knutson has been associated with the Company since 1969.\nPhilip M. Van Praag was named Vice President and Chief Information Officer in November, 1995. Prior to joining the Company in 1994 as Chief Information Officer, Mr. Van Praag was with R.R. Donnelley & Sons since 1989, where he last held the position of Director of Information Systems. From 1979 to 1989, Mr. Van Praag held various positions with Hughes Aircraft Company.\nDouglas R. Dorszynski was appointed Vice President, Tax and Treasurer in July, 1994. Mr. Dorszynski joined the Company in 1983 as Corporate Tax Manager and was subsequently appointed Director, Tax and Special Project Planning in 1985. Prior to joining the Company, Mr. Dorszynski was employed by Arthur Young & Co., a public accounting firm, from 1978 to 1983.\nAndrew G. Lampereur was appointed Corporate Controller in May, 1994. He joined the Company in May, 1993 as Assistant Corporate Controller. Mr. Lampereur was employed by Terex Corporation from 1988 to May, 1993, where he held a number of financial positions, most recently Corporate Controller of its Fruehauf Trailer Corporation subsidiary. Prior to that, he was employed at Price Waterhouse, a public accounting firm, from 1985 to 1988.\nAnthony W. Asmuth III is a partner in the law firm of Quarles & Brady, Milwaukee, Wisconsin, having joined that firm in 1989. Quarles & Brady performs legal services for the Company and certain of its subsidiaries. Prior to joining Quarles & Brady, he was a partner with the law firm of Whyte & Hirschboeck Dudek S.C. Mr. Asmuth had previously served as Secretary of the Company from January, 1986 to January, 1993. He was re-elected Secretary in July, 1994.\nEach officer is appointed by the Board of Directors and holds office until he or she resigns, dies, is removed or a different person is appointed to the office. The Board of Directors generally appoints officers at its meeting following the Annual Meeting of 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 New York Stock Exchange under the symbol APW. At October 31, 1995, the approximate number of record shareholders of common stock was 468. The high and low sales prices of the common stock by quarter for each of the past two years are as follows:\nQuarterly dividends of $0.03 per share were declared and paid for each of the quarters above.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA (IN MILLIONS, EXCEPT PER SHARE AMOUNTS)\n- - ------------------------- (1) Earnings from Continuing Operations for 1993, 1992 and 1991 reflect after-tax restructuring charges of $5.0 ($0.38 per share), $3.1 ($0.24 per share) and $3.0 ($0.23 per share), respectively. In addition, 1992 includes a liquidation of LIFO inventory which had the effect of increasing earnings by $1.3 ($0.10 per share).\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)\nThe preceding table sets forth the results of continuing operations of the Company for the years ended August 31, 1995, 1994 and 1993.\nThe Company recorded restructuring charges, extraordinary losses and adopted new accounting pronouncements during the last three years which impact the comparability of financial information. The following table reconciles reported net earnings from continuing operations to net earnings from continuing operations excluding restructuring costs, extraordinary losses and the cumulative effect of accounting changes:\nEarnings have grown over the last three years as a result of higher sales volume, improved operating margins and lower financing costs.\nNET SALES\nNet sales increased 22% in 1995 with all three segments posting double-digit sales growth percentages. Ignoring the favorable impact on translated sales from the weaker US Dollar, sales increased 18% over 1994.\nImproving economic conditions experienced in the last half of fiscal 1994 carried into 1995, with significant strengthening in Europe and North America. Sales in Japan and Asia Pacific increased 27% in 1995, but were 14% higher in real terms. The weak US Dollar relative to the Japanese Yen during 1995 distorts this comparison. Conversely, Latin America sales growth in real terms was 23%, but the significant devaluation of the Mexican Peso in December, 1994 unfavorably impacted the translation into US Dollars.\nTotal sales from Distributed Products, which consists of Enerpac and GB Electrical, increased 19% in 1995, benefiting from improved economic conditions in North America and Europe, further expansion into developing markets in Southeast Asia, Latin America, and South America and approximately $4.0 million from minor acquisitions. The impact of the weaker US Dollar favorably impacted Distributed Products sales in 1995 relative to 1994, as sales generated by units outside the US translated into higher US Dollars in 1995. Ignoring currency rate changes, Distributed Products sales grew 16% in 1995.\nEngineered Solutions, consisting of Barry Controls, APITECH and Power-Packer, had an 18% increase in sales in 1995. Ignoring currency rate changes, sales grew 14%. The majority of the growth took place in Power-Packer which enjoyed a 45% increase in sales, resulting from strong demand from European OEM truck and automobile manufacturers. Barry Controls and APITECH had sales increases of 5% and 4%, respectively. In addition to improved economic conditions, Engineered Solutions sales grew from the sale of products introduced in recent years. Sales of the LAN Management System (\"LMS\") product line, which was introduced in the second half of 1993, continued to have a significant impact on Wright Line sales, which grew 42% in 1995. Sales to government agencies increased 25% in 1995, also having a considerable impact on Wright Line's growth.\nTotal sales in 1994 were 9% higher than 1993, reflecting geographic expansion and the start of improved economic conditions in North America. With the exception of the truck and automotive sectors in Europe, sales in Europe and Japan in 1994 were lower than the prior year due to weak economic conditions. Sales in 1994 of newly introduced products, such as Power-Packer's multi-cylinder convertible top actuation systems, Barry Control's Duo-Plexx and industrial products, APITECH's suspension and motion control systems and Wright Line's LMS product line more than offset declines in cyclical markets that Barry Controls competes in, including commercial aerospace and defense. Foreign currency translation did not materially impact the sales comparison between 1994 and 1993.\nPrice changes and acquisitions have not had a significant impact on the comparability of net sales during the last three years.\nGROSS PROFIT\nGross profit increased to $201.4 million in 1995, compared to $163.5 million and $151.0 million in 1994 and 1993, respectively. The improvement in gross profit resulted primarily from the sales increases in 1995 and 1994.\nItems influencing overall gross profit percentages include relative sales mix between Distributed Products, Engineered Solutions and Wright Line, as well as production levels. Engineered Solutions' gross profit percentages are lower than either Wright Line or Distributed Products because a much higher proportion of its sales are made to OEM customers (which generate lower margins than non-OEM customers). As a result, the lower the proportion of its sales to total Company sales, the higher the Company's overall gross profit percentage. Gross profit percentages from Distributed Products were lower in 1995 and 1994, relative to 1993, as a result of inefficiencies during the consolidation of Enerpac manufacturing, higher discounts to distributors and increased shipments to OEM customers. Engineered Solutions and Wright Line gross profit percentages improved in 1994 due to the benefits of prior year restructuring, as well as higher production levels. Both achieved additional improvement in 1995 due to favorable product mix and the impact of higher production levels on fixed manufacturing costs.\nOPERATING EXPENSES\nEngineering expense increased 39% over the last two years to $17.1 million due to new product development programs. The Company believes that its investment in technology in all businesses will continue to provide it with a competitive advantage.\nSelling and marketing expenses increased from $68.1 million in 1993 to $72.0 million in 1994 and $89.0 million in 1995. The majority of the increase since 1993 related to variable selling expenses, primarily commissions. Wright Line has a direct salesforce whose compensation is commission-based. As a result of its 83% sales growth over the last two years, its selling and marketing expenses have increased significantly. As Wright Line becomes a larger part of the total Company, it will exert more influence on the year-to-year growth in operating expenses. In addition to variable selling costs, total operating costs have increased as a result of expenditures for geographic expansion into emerging markets. During the last few years, the Company opened sales offices in Russia, India and China, and has significantly increased its presence in Latin America and Southeast Asia.\nAdministration expense increased 17% from 1993 to 1995. Geographic expansion expenditures, higher information technology, legal and bonus costs and the impact of minor acquisitions were the primary reasons for the increase.\nRESTRUCTURING EXPENSE\nThe Company recorded $7.7 million of pre-tax restructuring charges ($0.38 per share) in 1993, primarily related to consolidating certain manufacturing, distribution and administrative functions at Enerpac and Barry Controls operations in Europe, downsizing field sales and headquarters administrative staff at retained Wright Line operations, and idle facility costs at Barry Controls. Substantially all of the restructuring costs had been incurred as of August 31, 1995, consisting of severance and consolidation expenditures.\nOTHER EXPENSE(INCOME)\nThe reduction in financing costs during the last three years reflects lower market interest rates and reduced debt levels. The Company refinanced certain debt in 1995, which also had the impact of lowering its financing costs. For further information, see \"Liquidity and Capital Resources\" below.\nAmortization expense increased in 1994 due to incremental amortization of intangible assets added in 1993 and 1994 from acquisitions (see \"Liquidity and Capital Resources\" below), but declined in 1995 as certain intangible assets from the GB Electrical acquisition in 1988 became fully amortized.\n\"Other -- net\" includes foreign exchange (gains)losses and miscellaneous other (income)expense. A net foreign exchange gain was realized in 1993, while the Mexican Peso devaluation in 1995 caused a $1.3 million foreign exchange loss in 1995.\nINCOME TAX EXPENSE\nThe Company's effective income tax rate is largely impacted by the proportion of earnings generated inside and outside the US, as well as the utilization of foreign tax credits in the US. Higher US earnings, the utilization of foreign tax credits, deferred tax adjustments and lower pre-tax income also had a favorable impact on the effective tax rate in 1993.\nEXTRAORDINARY LOSS\nThe Company recorded an extraordinary loss of $4.9 million, or $0.36 per share, in 1995 in connection with the March 30, 1995 extinguishment of its $64.4 million 9.92% Senior Unsecured Notes. The pre-tax extraordinary loss of $7.3 million was comprised of an estimated make whole provision of $4.1 million, costs associated with the cancellation of underlying interest rate swap agreements of $3.0 million and the write-off of $0.2 million of deferred financing costs. For further information, see Note G -- \"Long-term Debt\" in Notes to Consolidated Financial Statements.\nADOPTION OF NEW ACCOUNTING PRONOUNCEMENTS\nThe Company adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other than Pensions\" (\"SFAS 106\"), on September 1, 1992, which requires the accrual of postretirement benefits (such as health care and life insurance) during the years an employee provides service. Previously, these costs were recognized as they were paid. The cumulative effect of adopting SFAS 106 was $4.4 million ($0.33 per share) in 1993. For further information, see Note K -- \"Postretirement Benefits\" in Notes to Consolidated Financial Statements.\nThe adoption of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS 109\") in 1993 had no material impact on net earnings or cash flows. Certain assets and liabilities at acquired companies that previously had been carried on a net-of-tax basis under prior accounting rules, were adjusted to a gross basis.\nDISCONTINUED OPERATIONS\nIn the second quarter of 1994, the Company announced its decision to retain the remaining Wright Line business, which had been reported as a discontinued operation since 1992. The Company completed the sale of Wright Line's German operation in 1993 and Wright Line's Datafile businesses in Canada, Australia, the UK and the US in 1994. The net assets and results of operations for the retained Wright Line business were reclassified from discontinued to continuing operations for the periods it was held for sale. However, the results of operations from June, 1992 to November, 1993 have remained offset against the reserve previously established for the estimated loss on disposition. For further information, see Note B -- \"Discontinued Operations\" in Notes to Consolidated Financial Statements.\nLIQUIDITY AND CAPITAL RESOURCES\nOutstanding debt at August 31, 1995 totaled $87.0 million, a reduction of $16.5 million since the beginning of the year. End-of-year debt to total capital was approximately 37%, its lowest point since 1989. Approximately $23.8 million of cash was generated from operating activities in 1995, $16.0 million of which was used to fund capital expenditures. Dividends of $1.6 million were paid during the year. The Company utilized approximately $2.8 million of cash during 1995 to acquire New England Controls, Inc., and Enerpac's master distributor in Brazil. The resulting cash flow was used to reduce debt.\nIncreases in primary working capital (net receivables plus net inventory less trade accounts payable) used approximately $22.4 million of cash during 1995 as a result of higher sales volume (receivables) and geographic expansion (inventory). The Company believes that primary working capital will grow further in 1996 as a result of anticipated business expansion.\nThe Company extinguished all $64.4 million of its 9.92% Senior Unsecured Notes on March 30, 1995. The funds used to retire the debt and disburse the make whole payments totaling $4.0 million were obtained from new borrowings, including those under a temporary expansion of the Company's then existing $40.0 million multi-currency revolving credit agreement. The Company replaced the original $40.0 million multi-currency credit agreement and the temporary $40.0 million expansion with the proceeds from a new $120.0 million multi-currency credit agreement in August, 1995. The new facility expires August, 2000. To reduce interest rate risk associated with the refinancing, the Company entered into interest rate caps on a notional $60.0 million in borrowings that limits the maximum applicable base rate (three month LIBOR) to 8.0%. Currently, the Company incurs interest at a rate of .45 of 1% above IBOR. The interest rate caps expire in March, 1997. For additional information, see Note G -- \"Long-term Debt\" in Notes to Consolidated Financial Statements.\nThe Company also replaced its former $25.0 million accounts receivable financing facility in 1995 with a new facility that expires in August, 1998 and provides up to $50.0 million of multi-currency accounts receivable financing. An incremental $11.2 million of receivables were financed in 1995, bringing the total balance financed to $36.2 million at August 31, 1995. Proceeds were used to reduce debt. For additional information, see Note D -- \"Accounts Receivable Financing\" in Notes to Consolidated Financial Statements.\nOutstanding indebtedness declined $14.4 million in 1994. The Company generated $22.5 million of cash in operating activities during the year and used $12.7 million on capital expenditures and $2.4 million for acquisitions. Dividends of $1.6 million were also paid. Total borrowings decreased $6.9 million in 1993. Cash of $12.7 million was generated from operations. Major expenditures included $12.2 million for fixed asset additions. Dividends totaling $1.6 million were also paid.\nIn order to minimize interest expense, the Company intentionally maintains low cash balances and uses available cash to reduce short-term bank borrowings. Funds available under unused non-committed lines and the $120.0 million multi-currency credit agreement totaled $41.0 million and $46.0 million, respectively, as of August 31, 1995. The Company believes that such availability, plus funds generated from operations will be adequate to fund operating activities, including modestly higher capital expenditures and working capital, for the foreseeable future.\nINFLATION\nNo meaningful measures of inflation are available because the Company has a significant number of small operations which operate in countries with diverse rates of inflation and currency rate movements.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (IN MILLIONS, EXCEPT PER SHARE AMOUNTS)\nQuarterly financial data for 1995 and 1994 is as follows:\nThe Consolidated Financial Statements are included on pages 20 to 34 and are incorporated by reference 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 information required by this item is incorporated by reference from the \"Election of Directors\" and \"Other Information -- Compliance with Section 16(a) of the Exchange Act\" sections of the Company's Proxy Statement for its Annual Meeting of Shareholders to be held on January 11, 1996 (the \"1996 Annual Meeting Proxy Statement\"). See also \"Executive Officers of the Registrant\" in Part I hereof.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by this item is incorporated by reference from the \"Board Meetings, Committees and Director Compensation\" and \"Executive Compensation\" sections of the 1996 Annual Meeting 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 from the \"Certain Beneficial Owners\" and \"Election of Directors\" sections of the 1996 Annual Meeting Proxy Statement.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nNone.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) Documents filed as part of this report:\n1. Consolidated Financial Statements\nSee \"Index to Consolidated Financial Statements and Financial Statement Schedules\" on page 18, the Independent Auditors' Report on page 19 and the Consolidated Financial Statements on pages 20 to 34, all of which are incorporated herein by reference.\n2. Financial Statement Schedules\nSee \"Index to Consolidated Financial Statements and Financial Statement Schedules\" on page 18 and the Financial Statement Schedule on page 35, all of which are incorporated herein by reference.\n3. Exhibits\nSee \"Index to Exhibits\" on pages 37 to 39, which is incorporated herein by reference.\n(b) Reports on Form 8-K:\nThe Company filed a Current Report on Form 8-K dated as of August 16, 1995 announcing that its GB Electrical unit had signed a letter of intent to acquire the business of Vision Plastics Manufacturing Company.\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nAll other schedules are omitted because they are not applicable, not required, or because the required information is included in the consolidated financial statements or notes thereto.\nINDEPENDENT AUDITORS' REPORT\nTo the Shareholders and Directors of Applied Power Inc.:\nWe have audited the accompanying consolidated balance sheets of Applied Power Inc. and subsidiaries as of August 31, 1995 and 1994, and the related consolidated statements of earnings, shareholders' equity, and cash flows for each of the three years in the period ended August 31, 1995. Our audits also included the consolidated financial statement schedule listed in the Index at Item 14. 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 Applied Power Inc. and subsidiaries at August 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended August 31, 1995 in conformity with generally accepted accounting principles. Also, 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.\nAs discussed in Note K to the consolidated financial statements, effective September 1, 1992 the Company changed its method of accounting for postretirement benefits other than pensions to conform with Statement of Financial Accounting Standards No. 106.\nDELOITTE & TOUCHE LLP Milwaukee, Wisconsin September 29, 1995\nAPPLIED POWER INC.\nCONSOLIDATED STATEMENT OF EARNINGS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\nThe accompanying notes are an integral part of these financial statements\nAPPLIED POWER INC.\nCONSOLIDATED BALANCE SHEET (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\nThe accompanying notes are an integral part of these financial statements\nAPPLIED POWER INC.\nCONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\nThe accompanying notes are an integral part of these financial statements\nAPPLIED POWER INC.\nCONSOLIDATED STATEMENT OF CASH FLOWS (DOLLARS IN THOUSANDS)\nThe accompanying notes are an integral part of these financial statements\nAPPLIED POWER INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\nNOTE A -- SIGNIFICANT ACCOUNTING POLICIES\nPrinciples of Consolidation: The consolidated financial statements include the accounts of Applied Power Inc. and its majority-owned subsidiaries (\"Applied Power\" or the \"Company\"). All significant intercompany balances, transactions and profits have been eliminated.\nCash and Cash Equivalents: The Company considers all highly liquid investments with original maturities of 90 days or less to be cash equivalents.\nInventories: Inventories are comprised of material, direct labor and manufacturing overhead, and are stated at the lower of cost or market.\nProperty, Plant and Equipment: Property, plant and equipment are stated at cost. Plant and equipment are depreciated over the estimated useful lives of the assets under the straight-line method for financial reporting purposes and both straight-line and accelerated methods for tax purposes. Expenditures for maintenance and repairs not expected to extend the useful life of an asset beyond its normal useful life are expensed.\nIntangible Assets: Goodwill is amortized on a straight-line basis over periods of fifteen to forty years. Other intangible assets, consisting primarily of purchased patents, trademarks and noncompete agreements, are amortized over periods from two to seventeen years. The Company periodically evaluates the carrying value of intangible assets in accordance with Statement of Financial Accounting Standards (\"SFAS\") No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of.\"\nRevenue Recognition: Revenues and costs of products sold are recognized as the related products are shipped.\nResearch and Development Costs: Research and development costs are generally expensed as incurred. Such costs incurred in the development of new products or significant improvements to existing products totaled approximately $8,725, $7,446 and $5,878 in 1995, 1994 and 1993, respectively.\nFinancing Costs: Net financing costs represents interest expense on debt obligations, investment income, and accounts receivable financing costs.\nIncome Taxes: The Company accounts for income taxes in accordance with Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\" For further information, see Note L -- \"Income Taxes.\"\nEarnings per Share: Earnings per share is based on the weighted average number of common and common equivalent shares outstanding during the year. The dilutive effect of stock options, which are considered common stock equivalents, is calculated using the treasury stock method.\nForeign Currency Translation: Foreign currency translation adjustments are generally excluded from the Consolidated Statement of Earnings and are included in Cumulative Translation Adjustments in the Consolidated Balance Sheet. Gains and losses resulting from foreign currency transactions are included in Other -- net in the Consolidated Statement of Earnings.\nFinancial Instruments: The Company utilizes interest rate swap and cap agreements to manage interest rate exposure. The differential to be paid or received is recorded as interest rates change. For further information, see Note G -- \"Long-term Debt.\" The Company also utilizes, in limited circumstances, foreign currency forward contracts. Gains and losses resulting from these instruments are recognized in the same period as the underlying transaction. At August 31, 1995, the Company had one immaterial forward contract expiring on September 1, 1995, which hedged an existing exposure. Other than foreign currency forward\ncontracts and interest rate swap and cap agreements, the Company does not utilize or trade derivative financial instruments.\nReclassifications: Certain amounts shown for 1994 and 1993 have been reclassified to conform to the current year presentation.\nNOTE B -- DISCONTINUED OPERATIONS\nIn the second quarter of 1994, the Company announced its decision to retain the remaining Wright Line business, which had been included in discontinued operations since the third quarter of 1992. The retained business has refocused its business strategy on technical furniture solutions for offices and laboratories.\nThe Company had originally intended to sell all of Wright Line in a single transaction in 1993. However, management subsequently determined that proceeds could be maximized by selling the assets in a series of separate transactions. The Company completed the sale of certain assets of Wright Line's German operation to an existing distributor in exchange for the assumption of certain liabilities. In early 1994, Wright Line's Datafile businesses in Canada, Australia, the UK and the US were sold, generating proceeds of $6,222. A short time later, Wright Line sold its Tapeseal product line to a third party for future compensation.\nThe operating results from the retained Wright Line operations have been reclassified from discontinued operations to continuing operations for all periods presented. However, the results of the retained operations for the period June, 1992 through November, 1993 have remained offset against the reserve previously established for operating losses until disposition. The Company had previously recorded provisions of $31,307 ($2.51 per share) and $5,400 ($0.41 per share) in 1992 and 1993, respectively, to accrue for the estimated loss on the sale of Wright Line and a small French subsidiary, the sale of a previously vacated Wright Line building (completed in 1992), estimated operating losses prior to disposition, and estimated disposition costs. Substantially all of the provisions were utilized for the operations, product lines and assets sold since 1992. The net assets of the retained operations were returned to the appropriate balance sheet captions based on their historical cost. After reviewing the value of such assets, the Company determined that no impairment had taken place.\nNOTE C -- ACQUISITIONS\nThe Company acquired all of the outstanding stock of New England Controls, Inc. (\"NECON\") on June 28, 1995 for approximately $2,059 in cash. Approximately $1,536 of the purchase price was assigned to Goodwill. NECON, based in Milford, Connecticut, manufactures electrical switches for the electrical wholesale, retail and OEM markets. The operating results of NECON subsequent to June 28, 1995 are included in the Consolidated Statement of Earnings.\nOn September 1, 1994, the Company acquired the assets of Enerpac's master distributor in Brazil for $699 in cash. Approximately $350 of the purchase price was assigned to Goodwill. The operating results of this business subsequent to such date are included in the Consolidated Statement of Earnings.\nThe Company completed the acquisition of certain assets of Palmer Industries, Inc. (\"Palmer\") on October 1, 1993 for approximately $1,534 in cash and a $350 note. Approximately $490 of the purchase price was assigned to Goodwill. Palmer, based in Alexandria, Minnesota, is a leading manufacturer of plastic and metal staples, fasteners and straps. The operating results of Palmer subsequent to October 1, 1993 are included in the Consolidated Statement of Earnings.\nOn March 21, 1994, the Company increased its ownership interest in Applied Power Korea from approximately 50% to 90%. Cash of $912 was used in the acquisition which resulted in Goodwill of $572. The operating results of this subsidiary have historically been included in the Consolidated Statement of Earnings.\nAll acquisitions were accounted for using the purchase method.\nNOTE D -- ACCOUNTS RECEIVABLE FINANCING\nAs a part of its overall financing strategy, the Company sells to financial institutions undivided participation interests in designated pools of accounts receivable, with limited recourse. Participation interests in new receivables may be sold as collections reduce previously sold participation interests. The sold accounts receivable are reflected as a reduction of receivables in the Consolidated Balance Sheet. The Company retains collection and administrative responsibilities on the participation interests sold as agent for the purchaser. In August, 1995, the Company entered into a new multi-currency accounts receivable financing agreement that allows up to the equivalent of $50,000 of sold receivables at any one time. Previously, the Company was a party to an agreement that provided up to $30,000 of accounts receivable financing for US Dollar denominated receivables. The new accounts receivable financing agreement expires in August, 1998.\nAt August 31, 1995 and 1994, accounts receivable were reduced by $36,200 and $25,000, respectively, representing receivable interests sold under this program.\nAccounts receivable financing costs totaling $1,892, $1,076 and $795 for the years ended August 31, 1995, 1994 and 1993, respectively, are included in the accompanying Consolidated Statement of Earnings.\nNOTE E -- NET INVENTORIES\nInventory cost is determined using the last-in, first-out (\"LIFO\") method for substantially all inventory in the United States (approximately 58% and 59% of total inventories in 1995 and 1994, respectively). The first-in, first-out or average cost methods are used for all other inventories. If the LIFO method was not used, inventory balances would be higher than the amounts in the Consolidated Balance Sheet by approximately $10,296 and $9,748 at August 31, 1995 and 1994, respectively.\nIt is not practical to segregate the amounts of raw materials, work-in-process or finished goods at the respective balance sheet dates, since the segregation is possible only as the result of physical inventories which are taken at dates different from the balance sheet dates. The systems at many of the Company's operating units have not been designed to capture this segregation due to the very short production cycle of their products and the minimal amount of work-in-process.\nNOTE F -- SHORT-TERM BORROWINGS\nThe Company had borrowings under unsecured non-committed lines of credit with banks aggregating approximately $12,620 and $14,707 at August 31, 1995 and 1994, respectively. Interest rates vary depending on the currency being borrowed. The weighted average interest rate on the short-term borrowings was 9.38% at August 31, 1995. The amount of unused available borrowings under such lines of credit was approximately $41,000 at August 31, 1995.\nNOTE G -- LONG-TERM DEBT\nRefinancing: During the second quarter of 1995, the Company recorded an extraordinary loss of $4,920 ($0.36 per share) in anticipation of the March 30, 1995 extinguishment of the outstanding $64,350 9.92%\nSenior Unsecured Notes. The pre-tax extraordinary loss of $7,343 was comprised of an estimated make whole provision of $4,050, costs associated with the cancellation of underlying interest rate swap agreements of $3,047, and the write-off of deferred financing costs of $246.\nFunds used to retire the Senior Unsecured Notes and pay the make whole obligation were obtained from new borrowings under an existing $40,000 Multi-currency revolving credit agreement and a temporary $40,000 expansion to the existing Multi-currency revolving credit agreement. These borrowings were extinguished on August 21, 1995, and all amounts outstanding were simultaneously reborrowed under a new $120,000 Multi-currency revolving credit agreement (the \"New Multi-currency Credit Agreement\").\nThe New Multi-currency Credit Agreement provides total unsecured credit availability of $120,000, bears interest at a floating rate of IBOR plus .3 - .5 of 1% annually, and expires in August, 2000. Interest is payable monthly. Pursuant to the agreement, borrowings may be denominated in various currencies at the Company's option. A commitment fee, currently computed at a rate of .175 of 1% annually, is payable quarterly on the average unused credit line. The unused credit line at August 31, 1995 was $46,007.\nThe New Multi-currency Credit Agreement contains customary restrictions concerning investments, liens on assets, sales of assets, dividend payments, maximum levels of debt and minimum levels of shareholders' equity. In addition, the agreement requires the Company to maintain certain financial ratios. As of August 31, 1995, the Company was in compliance with all debt covenants. Under the most restrictive covenant, approximately $35,795 of retained earnings was available for the payment of future dividends on common stock as of August 31, 1995.\nCommercial paper outstanding at August 31, 1995 and 1994 totaled $3,276 and $9,947, respectively, net of discount, and carried average interest rates of 5.94% and 4.73%, respectively. The Company has the ability and intent to maintain these commercial paper obligations, classified as long term, for more than one year. Amounts outstanding as commercial paper reduce the amount available for borrowing under the New Multi-currency Credit Agreement.\nInterest Rate Financial Instruments: As part of its interest rate management program, the Company periodically enters into interest rate swap and cap agreements with respect to portions of its outstanding debt. Interest rate swap agreements typically convert the variable nature of debt to fixed rate, or vice versa. Interest rate caps limit the maximum interest rate that is paid. As of August 31, 1995, the Company had interest rate caps in place on a notional $60,000 in borrowings that limits the maximum applicable base rate (three month LIBOR) to 8.0%. Currently, the Company incurs interest at .45 of 1% above IBOR. The interest rate caps expire in March, 1997, and were recorded at a value of $225 at August 31, 1995.\nFair Values: The fair value of the Company's short-term borrowings and long-term debt approximated book value as of August 31, 1995. The fair value of debt instruments is calculated by discounting the cash flow of such obligations using the market interest rates for similar instruments at August 31, 1995. The fair value of the Company's interest rate cap agreement and foreign currency forward exchange contract at August 31, 1995 approximated book value.\nAggregate Maturities: Aggregate maturities of long-term debt outstanding at August 31, 1995, were: $187 in 1996; $75 in 1997; $81 in 1998; $7 in 1999 and $73,993 in 2000.\nThe Company paid $10,363, $10,695 and $11,894 for financing costs in 1995, 1994 and 1993, respectively, excluding the make whole payments associated with refinancing the 9.92% Senior Unsecured Debt.\nNOTE H -- LEASES\nThe Company leases certain facilities, computers, equipment and vehicles under various lease agreements over periods of one to twenty years. Under most arrangements, the Company pays the property taxes, insurance, maintenance and expenses related to the leased property. Many of the leases include provisions which enable the Company to renew leases based upon the fair values on the date of expiration of the initial lease.\nFuture obligations on non-cancelable operating leases in effect at August 31, 1995 were: $10,941 in 1996; $9,745 in 1997; $7,491 in 1998; $4,992 in 1999; $4,530 in 2000; and $21,778 thereafter.\nTotal rental expense under operating leases was $11,076, $11,379 and $12,250 in 1995, 1994 and 1993, respectively.\nNOTE I -- INCENTIVE STOCK OPTION PLANS\nAt August 31, 1995, 2,127,835 shares of Class A common stock were reserved for issuance under the Company's stock option plans.\nEmployee Plans: The Company has three non-qualified stock option plans for employees -- the 1985, 1987 and 1990 Plans. No further options may be granted under the 1985 or 1987 Plans, although options previously issued and outstanding under these plans remain exercisable pursuant to the provisions of the plans. A total of 3,050,000 shares may be issued under all three stock option plans (equal to 950,000 shares authorized under the 1985 Plan, 1,200,000 shares under the 1987 Plan and 900,000 shares under the 1990 Plan). Any available unissued shares under the 1985 and 1987 Plans at the date of adoption of the 1990 Plan became available for issuance under the 1990 Plan.\nOptions may be granted to officers and key employees. Options generally have a maximum term of ten years and an exercise price equal to 100% of the fair market value of a share of the Company's common stock at the date of grant. Options vest 50% after 2 years and 100% after 5 years.\nA summary of option activity under the three plans is as follows:\nOutside Director Plan: Annually each outside director is automatically granted stock options to purchase 1,000 shares of common stock at a price equal to the market price of the underlying stock on the date of grant. A maximum of 60,000 shares may be issued under this plan. Options vest 100% after 11 months.\nA summary of option activity under this plan is as follows:\nNOTE J -- EMPLOYEE STOCK OWNERSHIP AND RETIREMENT PLANS\nUS Employees: All of the Company's full-time US employees are participants in the Applied Power Inc. Employee Stock Ownership Plan (the \"ESOP Plan\"). Under the provisions of the ESOP Plan, the plan administrator acquires shares of Class A common stock on the open market and allocates such shares to accounts set aside for Company employees' retirements. Contributions equal 3% of each employee's annual cash compensation except \"initial participants,\" who received no allocation of shares until 1995. During the years ended August 31, 1995, 1994 and 1993, pre-tax expense related to the ESOP Plan was $1,720, $534 and $450, respectively.\nThe Company also offers an employee 401(K) Savings Plan (the \"Savings Plan\") to encourage eligible employees to save on a regular basis for their retirements. All full-time US employees are eligible to participate in the Savings Plan, and generally may contribute up to 15% of their base compensation. Effective January 1, 1995, the Company's annual match equals approximately 25% of each participant's first 3% of earnings. Expense attributable to the Savings Plan was $643, $293 and $307 for 1995, 1994 and 1993, respectively.\nNon-US Employees: The Company contributes to a number of retirement programs for employees outside the US. Pension expense amounted to $821, $631 and $1,213 in 1995, 1994 and 1993, respectively. These plans are not required to report to US governmental agencies under ERISA and do not otherwise determine the actuarial value of accumulated plan benefits or net assets available for benefits.\nNOTE K -- POSTRETIREMENT BENEFITS\nThe Company adopted SFAS No. 106 -- \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" effective September 1, 1992. This new pronouncement requires the accrual of postretirement benefits (such as health care and life insurance) during the years an employee provides service. In connection with the adoption of SFAS No. 106, the Company elected to recognize as expense in 1993 the accumulated postretirement benefit obligation rather than amortizing such amount to expense over a 20-year period. The Company recorded a $4,355 charge (net of a $2,579 tax benefit) in 1993 for the cumulative effect of this accounting change.\nThe Company's current policy is not to offer postretirement health care and life insurance benefits to employees. However, certain employees of businesses previously acquired by the Company were entitled to such benefits upon retirement. The individuals receiving health care benefits under these programs are required to make monthly contributions to defray a portion of the cost. Retiree contributions are adjusted annually. Retirees currently do not contribute toward the cost of life insurance. The accounting for retiree health care benefits assumes retirees will continue to contribute toward the cost of such benefits.\nNet periodic postretirement benefit expense for 1995, 1994 and 1993 included the following components:\nThe Company's accumulated postretirement benefit obligation for such benefits is as follows:\nThe Company's postretirement benefit obligations are not funded. Benefits paid in 1995, 1994 and 1993 were $24, $202 and $420 lower than that expensed during those years, respectively.\nThe health care cost trend rate used in the actuarial calculations was 11.0%, trending downward to 6.5% by the year 2010, and remaining level thereafter. The discount rate used in determining the accumulated postretirement benefit obligation was 7.75% in both 1995 and 1994, and 8.0% in 1993. The effect of a one percentage-point change in health care cost trend rates would change the accumulated postretirement benefit obligation by approximately 10%.\nNOTE L -- INCOME TAXES\nIncome tax expense for continuing operations consists of the following:\nComponents of deferred income tax benefits include the following:\nIncome tax expense differs from the amounts computed by applying the Federal income tax rate to earnings before income tax expense. A reconciliation of income taxes at the US statutory rate to the effective tax rate follows:\nTemporary differences and carryforwards which gave rise to the deferred tax assets and liabilities included the following items:\nThe valuation allowance primarily represents foreign loss and foreign tax credit carryforwards for which utilization is uncertain. The majority of the foreign losses may be carried forward indefinitely; however, the foreign tax credit carryforwards expire in 1996 and 1997.\nIncome taxes paid during 1995, 1994 and 1993 were $12,280, $9,191 and $5,080, respectively.\nThe Company's policy is to remit earnings from foreign subsidiaries only to the extent any resultant foreign income taxes are creditable in the US. Accordingly, the Company does not currently provide for the additional US and foreign income taxes which would become payable upon remission of undistributed earnings of foreign subsidiaries. Undistributed earnings on which additional income taxes have not been provided amounted to approximately $33,000 at August 31, 1995. If all such undistributed earnings were remitted, an additional provision for income taxes of approximately $2,400 would have been necessary as of August 31, 1995.\nEarnings from continuing operations before income taxes from non-US operations were $16,156, $12,041 and $2,293 for 1995, 1994 and 1993, respectively.\nNOTE M -- SEGMENT INFORMATION\nThe Company's operations are classified into three business segments: Distributed Products, Engineered Solutions and Wright Line. Distributed Products, consisting of Enerpac and GB Electrical, is involved in the manufacture and distribution of tools and consumables to the construction, retail and general industrial markets. Engineered Solutions, which consists of Barry Controls, Power-Packer and APITECH, focuses on high-volume technology products for OEM customers in the transportation, industrial, defense and aerospace markets. Wright Line develops, manufactures and sells technical furniture solutions for offices and laboratories.\nSummarized financial information by business segment is as follows:\nSummarized financial information by geographic region is as follows:\nOperations before income taxes for each business and geographic segment do not include general corporate expenses, amortization expense, interest expense or currency exchange adjustments. Sales between business segments and geographic areas are insignificant and are accounted for at prices intended to yield a reasonable return to the selling affiliate. No single customer accounted for more than 10% of total sales in 1995, 1994 or 1993. Export sales from domestic operations were less than 10% in each of the periods presented.\nCorporate assets, which are not allocated, represent principally cash, prepaid taxes and investments.\nNOTE N -- CONTINGENCIES AND LITIGATION\nThe Company had outstanding letters of credit totaling $1,300 and $1,640 at August 31, 1995 and 1994, respectively. The letters of credit generally serve as collateral for liabilities included in the Consolidated Balance Sheet.\nThe Company is involved in various legal proceedings which have arisen in the normal course of its business. These legal proceedings typically include product liability and patent claims. The Company has recorded reserves for loss contingencies based on the specific circumstances of each case. Such reserves are\nrecorded when the occurrence of loss is probable and can be reasonably estimated. In the opinion of management, the resolution of these contingencies will not have a materially adverse effect on the Company's financial condition or results of operations.\nThe Company has facilities at numerous geographic locations, which are subject to a range of environmental laws and regulations. Environmental costs are expensed or capitalized depending on their future economic benefit. Expenditures that have no future economic value are expensed. Liabilities are recorded when environmental remediation is probable, and the costs can be reasonably estimated. Although the level of future expenditures for environmental remediation is impossible to determine with any degree of certainty, it is management's opinion that such costs will not have a material effect on the Company's financial position. Environmental remediation accruals of $573 and $567 were included in the Consolidated Balance Sheet at August 31, 1995 and 1994, respectively.\nNOTE O -- SUBSEQUENT EVENT\nOn September 29, 1995, the Company completed the acquisition of substantially all of the assets and certain liabilities of Vision Plastics Manufacturing Company (\"Vision\"). Certain proprietary technology rights and patents related to the business are to be acquired in a separate transaction that is expected to close in January, 1996. Total consideration for the two transactions is approximately $21,500, and will be funded by proceeds from borrowings under existing credit facilities. Vision, based in San Diego, California, manufactures plastic cable ties which are sold through electrical wholesale, retail and OEM channels.\nAPPLIED POWER INC. AND SUBSIDIARIES\nSCHEDULE VIII -- VALUATION AND QUALIFYING ACCOUNTS\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nAPPLIED POWER INC. (Registrant)\nBy: \/s\/ ROBERT C. ARZBAECHER ------------------------------------ Robert C. Arzbaecher Vice President and Chief Financial Officer\nDated: November 16, 1995\nPOWER OF ATTORNEY\nKNOWN ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Richard G. Sim and Robert C. Arzbaecher, and each of them, his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments to this report, and to file the same, with all and any other regulatory authority, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their substitutes, may lawfully do or cause to be done by virtue hereof.\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.*\n- - ------------------------- * Each of the above signatures is affixed as of November 16, 1995\nAPPLIED POWER INC.\nANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED AUGUST 31, 1995\nINDEX TO EXHIBITS\n- - ---------------\n+ Pursuant to Item 601(b)(4)(iii)(A) of Regulation S-K, the Registrant agrees to furnish to the Securities and Exchange Commission upon request a copy of any unfiled instruments, or any unfiled exhibits or schedules to filed instruments, defining the rights of security holders.\n- - ---------------\n* Management contracts and executive compensation plans and arrangements required to be filed as exhibits pursuant to Item 14(c) of Form 10-K.\n- - ---------------\n* Management contracts and executive compensation plans and arrangements required to be filed as exhibits pursuant to Item 14(c) of Form 10-K.","section_15":""}
{"filename":"788736_1995.txt","cik":"788736","year":"1995","section_1":"ITEM 1. BUSINESS\nNorthland Cable Properties Six Limited Partnership (the \"Partnership\") is a Washington limited partnership consisting of two general partners (the \"General Partners\") and approximately 1,880 limited partners as of December 31, 1995. Northland Communications Corporation, a Washington corporation, is the Managing General Partner of the Partnership (referred to herein as \"Northland\" or the \"Managing General Partner\"). FN Equities Joint Venture, a California general partnership, is the Administrative General Partner of the Partnership (the \"Administrative General Partner\").\nNorthland was formed in March 1981 and is principally involved in the ownership and management of cable television systems. Northland currently manages the operations and is the General Partner for 6 cable television systems owned by limited partnerships. Northland is also the parent company of Northland Cable Properties, Inc. which was formed in February 1995 and is principally involved in direct ownership of cable television systems. Northland is a subsidiary of Northland Telecommunications Corporation (\"NTC\"). Other subsidiaries of NTC include:\nNORTHLAND CABLE TELEVISION, INC. - formed in October 1985 and principally involved in the direct ownership of cable television systems. Owner of Northland Cable News, Inc.\nNORTHLAND CABLE NEWS, INC. - formed in May 1994 and principally involved in the production and development of local programming.\nNORTHLAND CABLE SERVICES CORPORATION - formed in August 1993 as the holding company for the following entities:\nCABLE TELEVISION BILLING, INC. - formed in June 1987 and principally involved in the development and production of computer software used in connection with the billing and financial recordkeeping for cable systems owned or managed by Northland or Northland Cable Television, Inc.\nNORTHLAND INVESTMENT CORPORATION - formed in 1988 and principally involved in the underwriting of Northland sponsored limited partnership securities offerings.\nCABLE AD-CONCEPTS, INC. - formed in November 1993 and principally involved in the production and development of video commercial advertisements.\nNORTHLAND MEDIA, INC. - formed in April 1995 as the holding company for the following entity:\nSTATESBORO MEDIA, INC. - formed in April 1995 and principally involved in acquiring and operating an AM radio station serving the community of Statesboro, GA and surrounding areas.\nThe Partnership was formed on January 22, 1986 and began operations in 1986 with the acquisition of the cable television systems serving the communities of and contiguous areas surrounding Starkville, Maben and Mathiston, Mississippi (the \"Starkville System\"), six additional communities in central Mississippi (the \"Philadelphia System\"), and the community of and contiguous areas surrounding Highlands, North Carolina (the \"Highlands System\"). In July 1988, the Partnership completed its purchase of the cable television systems serving Sandersville and Heidelberg, Mississippi and\ncertain areas of Jones County and Jasper County, Mississippi (the \"Sandersville System\"). In December 1995, the Partnership purchased the cable television system serving Sapphire Valley, Cedar Creek and certain areas of Jackson County, North Carolina (the \"Sapphire Valley System\")(collectively herein referred to as the \"Systems\"). As of December 31, 1995, the total number of basic subscribers served by the Systems was 24,430, and the partnership's penetration rate (basic subscribers as a percentage of homes passed) was approximately 78% as compared to an industry average of approximately 64%, as reported by the PAUL KAGAN ASSOCIATES, INC. The Partnership's properties are located in rural areas which, to some extent, do not offer consistently acceptable off-air network signals. This factor, combined with the existence of fewer entertainment alternatives than in large markets contributes to a larger proportion of the population subscribing to cable television (higher penetration).\nThe Partnership has 24 non-exclusive franchises to operate the Systems. These franchises, which will expire at various dates through the year 2017, have been granted by local, county, state and other governmental authorities in the areas in which the Systems currently operate. Annual franchise fees are paid to the granting governmental authorities. These fees vary between 2% and 5% of the respective gross revenues of the system in a particular community. The franchises may be terminated for failure to comply with their respective conditions.\nThe Partnership serves the communities and surrounding areas of Starkville and Philadelphia, Mississippi and Highlands, North Carolina. The following is a description of these areas:\nStarkville, MS: The City of Starkville is the home of Mississippi State University with an enrollment of approximately 12,000 students. The university's 10 colleges and schools comprise 58 departments that offer more than 120 majors. Mississippi State is also the largest employer in Starkville, with nearly 1,300 faculty members or professionals and 1,450 support staff. Also located in Starkville is the Mississippi Research and Technology Park, which is a long-range economic development project initiated through the joint efforts of the City of Starkville, Oktibbeha County, Mississippi State University and the local business community. The park is located on approximately 220 acres across from the entrance to the university and will enhance high-technology research for application to the economic sector. The developers and businesses that comprise the park intend to work hand in hand with research efforts at the university, and companies that locate in the park will have the benefit of university facilities and faculty. Certain information regarding the Starkville, MS system as of December 31, 1995 is as follows:\nPhiladelphia, MS and Sandersville, MS: The Philadelphia System and the Sandersville System encompass eight communities and six counties located in central Mississippi. These systems are operated as three separate profit centers grouped as follows:\nProfit Center #1 - Philadelphia, Mississippi Profit Center #2 - Kosciusko and Carthage, Mississippi Profit Center #3 - Forest, Morton, Raleigh and Sandersville, Mississippi\nThe local economies of the communities included in the Philadelphia System are based primarily in manufacturing. The region has excellent highway and\nrailroad transportation, a year-round mild climate, and the availability of a trained, cost-effective labor force. One of the main industries in the area is poultry. Nearly two million birds are dressed weekly in the city of Forest, which ranks as the second-largest producer of broilers in the nation. Other industries in the area include apparel, ready mix concrete, frozen food products, lumber, small appliances, electronic assembly, meat processing and steel. Certain information regarding the Philadelphia, MS and Sandersville, MS systems as of December 31, 1995 is as follows:\nHighlands, NC: Located on a high plateau of the Blue Ridge Mountains where the corners of Georgia, North Carolina and South Carolina meet, Highlands has long offered a cool and beautiful summer retreat for the affluent families from such southern cities as Atlanta, New Orleans and Tampa. The Highlands region is almost encircled by the 200,000 acres of the End National Forest, and boasts a lush mixture of hardwoods and evergreens because of an abundant rainfall. Highlands has an average altitude of over 4,000 feet, and thus maintains a temperate summer climate. The influx of tourists increases Highland's year-round population of approximately 2,000 to over 20,000 between May and October.\nThe Highlands area is perhaps best known for its exclusive golf clubs. There are three beautiful golf courses in the Highlands area, the oldest being the Highlands Country Club. About half the land in the Highlands area is under private ownership; the rest is part of the End National Forest, and is open for hiking, fishing, hunting, camping and other outdoor activities. The private land near the golf courses consists largely of exclusive housing developments, many of which feature rambling, ranch-style vacation homes with values ranging from $200,000 to a half million dollars. The Great Smokey Mountains National Park and the Blue Ridge Parkway are within easy driving distance of Highlands. Several lakes in the area offer swimming, boating, skiing, fishing and other water sports. Rafting is also popular in the area due to the close proximity of the Chattooga and Cullasaja Rivers. Certain information regarding the Highlands, NC System as of December 31, 1995 is as follows:\nThe Partnership had 35 employees as of December 31, 1995. Management of these systems is handled through offices located in the towns of Starkville, Forest, Sandersville, Kosciusko and Philadelphia, Mississippi and in Highlands, North Carolina. Pursuant to the Agreement of Limited Partnership, the Partnership reimburses the Managing General Partner for time spent by the Managing General Partner's accounting staff on Partnership accounting and bookkeeping matters. (See Item 13(a) below.)\nThe Partnership's cable television business is generally not considered seasonal. The business of the Partnership 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 business. No customer accounts for 10% or more of revenues. No material portion of the Partnership's business is subject to renegotiation of profits or termination of contracts or subcontracts at the election of any governmental unit, except that franchise agreements may be terminated or modified by the franchising authorities as noted above. During\nthe last year, the Partnership did not engage in any research and development activities.\nPartnership revenues are derived primarily from monthly payments received from cable television subscribers. Subscribers are divided into three categories: basic subscribers, tier subscribers and premium subscribers. \"Basic subscribers\" are households that subscribe to the basic level of service, which generally provides access to the three major television networks (ABC, NBC and CBS), a few independent local stations, PBS (the Public Broadcasting System) and certain satellite programming services, such as ESPN, CNN or The Discovery Channel. \"Tier subscribers\" are households that subscribe to an additional level of programming services, such as Cartoon Network, CNBC or American Movie Classics. \"Premium subscribers\" are households that subscribe to one or more \"pay channels\" in addition to the basic service. These pay channels include such services as Showtime, Home Box Office, Cinemax, Disney or The Movie Channel.\nCOMPETITION\nDue to factors such as the non-exclusivity of the Partnership's franchises, recent regulatory changes and Congressional action, the rapid pace of technological developments, and the adverse publicity received by the cable industry regarding the lack of competition, there is a substantial likelihood that the Partnership's systems will be subject to a greater degree of competition in the future.\nOther Entertainment Alternatives The Partnership's systems compete with other communications and entertainment media, including conventional over-the-air television broadcasting stations. Cable television service was first offered as a means of improving television reception in markets where terrain factors or remoteness from major cities limited the availability of over-the-air television broadcasts. In some of the areas served by the Partnership's systems, several of the broadcast television channels can be adequately received off-air. The extent to which cable television service is competitive with broadcast stations depends in significant part upon the cable television system's ability to provide an even greater variety of programming than available off-air.\nCable television systems also are susceptible to competition from other video programming delivery systems (discussed below), from other forms of home entertainment such as video cassette recorders, and, in varying degrees, from sources of entertainment in the communities served, including motion picture theaters, live theater and sporting events.\nOverbuilds Recent federal legislation and court decisions have increased the likelihood that incumbent cable operators will face instances of \"overbuilding\". Overbuilding occurs when a cable operator who is not affiliated with the incumbent franchise holder applies for and receives a second franchise from the local franchising authority and constructs a cable system in direct competition with that of the incumbent. None of the Partnership's franchises provide for exclusivity. Overbuilding typically occurs where the overbuilder believes it can attract a profitable share of the incumbent operator's customer base. Overbuilding also may occur if the local franchising authority authorizes construction of a governmentally owned and operated cable system. However, Management believes that given the current regulatory environment related to cable rates, the attractiveness of overbuilding may have been diminished.\nWireless Services A variety of services, often generically referred to as \"wireless\" cable, distribute video programming via omnidirectional low-power microwave signals from a stationary transmitter to customers at fixed locations. For many years such services faced governmental restrictions on\nthe types of programming they could distribute and were generally prevented, by regulatory and technological reasons, from distributing the quantity of programming distributed by cable operators. Wireless operators also faced difficulty in obtaining access to certain programming produced by vendors affiliated with the cable industry.\nIn recent years, the Federal Communications Commission (the \"FCC\") has adopted policies for authorizing new technologies and providing a more favorable regulatory environment for certain existing wireless technologies. Such policies have the potential to create additional competition for cable television systems. The FCC recently amended its regulations to enable multi-channel, multi-point distribution services (\"MMDS\"), to compete more effectively with cable television systems by making available additional channels to the MMDS industry.\nOn December 10, 1992, the FCC commenced a rulemaking in which a new wireless multichannel video service is proposed to be created. The proposed new service is called the Local Multichannel Distribution Service (\"LMDS\") and will operate in the 27.5 - 29.5 MHz frequency band. LMDS providers, as the FCC currently proposes, would have no restrictions on the kinds of service that may be offered. No major technological advances which would adversely affect the Partnership's business have been made during 1995.\nThere can be no assurance, however, that future competition brought about by MMDS, LMDS and other wireless technologies will not have a material adverse effect on Partnership operations. As noted below, the recent Congressional legislation, among other things, is designed to make programming that is currently available to the cable television industry available to other technologies to foster the growth of alternative video programming delivery services.\nSatellite Delivered Services Additional competition exists from private cable television systems serving condominiums, apartment complexes and other private residential developments. The operators of these private systems, generally referred to as Satellite Master Antenna Television (\"SMATV\") providers, often enter into exclusive agreements with apartment building owners or homeowner's associations that preclude operators of franchised cable television systems from serving residents of such private complexes. Due to the widespread availability of reasonably priced satellite signal reception dishes or earth stations, SMATV systems now can offer both improved reception of local televisions station and many of the same satellite-delivered programming services that are offered by franchised cable television systems. Moreover, SMATV systems generally are free of the regulatory burdens imposed on franchised cable television systems. Although a number of states and some municipalities have enacted laws and ordinances to afford operators of franchised cable television systems access to private complexes, several of such laws and ordinances have been challenged successfully in the courts, and others are under attack. Because the Partnership generally has been able to enter into access agreements with owners of private complexes, in Management's opinion, successful challenges to access statutes would not have a material adverse effect on the operations of the Partnership.\nReasonably priced earth stations designed for private home use now enable individual households to receive many of the satellite-delivered programming services formerly available only to cable television subscribers. Many satellite programmers now encode their signals in order to allow reception only by means of authorized decoding equipment.\nDirect broadcast satellite (\"DBS\") service consists of satellite services that focus on delivering programming services directly to homes using high-power signals transmitted by satellites to receiving facilities located on the premises of subscribers. With an antenna as small as 18 inches, a DBS customer can receive a hundred or more programming signals. Several companies\nare preparing to have high-powered DBS systems in place by the middle of this decade, and two, DirecTv, an affiliate of Hughes Communications, United States Satellite Broadcasting Co., an affiliate of Hubbard Broadcasting and Primestar, owned by a consortium of cable television operators, have launched their systems. It is expected that these DBS operators will use video compression technology to increase the channel capacity of their systems to provide a package of movies, broadcast stations and other programming services competitive with those of cable television systems.\nUsing a national base of subscribers, it is possible that DBS companies may be able to offer new and highly specialized services which may not be available to the cable television industry, but as channel capacity and penetration of cable television systems increase, the cable industry is expected to have the ability to offer additional services as well. Because DBS systems deliver their services using satellite technology, they may not be able to provide services that are of local interest to their subscribers, and may not be able to maintain a local presence, which is considered a significant advantage in developing and maintaining subscriber support. The extent to which DBS systems will be competitive with the services provided by cable television systems will depend, among other things, on the ability of DBS operators to finance substantial start-up costs and to create their own programming or to obtain access to existing programming. Recent federal legislation requires cable programmers under certain circumstances to offer their programming to operators of DBS, MMDS and other multi-channel video systems at not unreasonably discriminatory prices.\nDuring 1995, the Partnership did not experience any significant subscriber loss to DBS. There can be no assurance, however, that future competition brought about by DBS will not have a material adverse impact on Partnership operations.\nTelephone Companies Federal law, FCC regulations and the 1982 federal court consent decree (the \"Modified Final Judgment\") that settled the 1974 antitrust suit against AT&T all limit in various ways the provision of video programming and other information services by telephone companies. Federal law codifies FCC cross-ownership regulations which, among other things, prohibit local telephone exchange companies including the seven Regional Bell Operating Companies (\"RBOCs\"), from providing video programming directly to subscribers within their local exchange service areas, except in rural areas or by specific waiver of FCC rules. These statutory provisions and corresponding FCC regulations are of particular competitive importance because these telephone companies already own much of the plant necessary for cable television operations, such as poles, underground conduits, associated rights-of-way and connections to the home.\nIn July 1991, the U.S. District Court responsible for the Modified Final Judgment lifted the prohibition on the provision of information services by the RBOCs. As a result, the RBOCs were allowed to acquire or construct cable television systems outside of their own service areas. Another federal court held that the cable\/telco cross-ownership prohibitions unconstitutionally abridge the First Amendment rights of the RBOCs and other telephone companies. Several RBOCs have entered into agreements to purchase cable television systems outside their service areas. Management believes that such purchases of existing cable television systems do not represent a significant competitive threat to the Partnership\nIn July 1992, the FCC voted to authorize additional competition to cable television by video programmers using broadband common carrier facilities constructed by telephone companies. The FCC allowed telephone companies to take ownership interests of up to 5% in such programmers. Several telephone companies have sought approval from the FCC to build such \"video dialtone\" systems and several experimental systems have been approved by the FCC. No\nsuch systems were proposed in a community in which the Partnership holds a cable franchise.\nRecent Federal laws have significantly changed the restrictions on telephone companies with respect to their ability to own and operate video programming delivery systems within their own service areas. See \"Regulation - The 1996 Act.\"\nThere can be no assurance that future competition brought on by telephone company participation in the cable television industry will not have a material adverse effect on the Partnership's operations.\nREGULATION\nThe Partnership's business is subject to intensive regulation at the federal and local levels, and to a lesser degree, at the state level. The FCC, the principal federal regulatory agency with jurisdiction over cable television, is responsible for implementing federal policies such as rate regulation, cable system relations with other communications media, cross-ownership, signal carriage, equal employment opportunity and technical performance. Provisions of regulatory events that have impacted the Partnership's operations are summarized below.\nThe 1992 Cable Act. On October 5, 1992, Congress enacted the Cable Television Consumer Protection and Competition Act of 1992 (the \"1992 Cable Act\"), which significantly increased regulation of the cable television industry. The 1992 Cable Act became generally effective on December 4, 1992, although certain provisions became effective at later dates. The 1992 Cable Act represents a significant change in the regulatory framework under which cable television systems operate and has had and likely will continue to have a significant impact on the cable industry and the Partnership's business.\nSince the Cable Communications Policy Act of 1984 (the \"1984 Cable Act\") became effective, and prior to the enactment of the 1992 Cable Act, rates for cable services were unregulated for substantially all of the Partnership's systems. Effective September 1, 1993, rate regulation was instituted for certain cable television services and equipment in communities that are not subject to \"effective competition\" as defined in the legislation. Effective competition is defined by this law to exist only where (i) fewer than 30 percent of the households in the franchise area subscribe to the cable service of a cable system; (ii) there are at least two unaffiliated multichannel video programming distributors serving the franchise area meeting certain penetration criteria; or (iii) a multichannel video programming distributor is available to 50 percent of the homes in the franchise area and is operated by the franchising authority. Virtually all cable television systems in the United States, including all of the Partnership's systems, are not subject to effective competition under this definition and therefore are subject to rate regulation for basic service by local franchising authority officials under the oversight of the FCC and subject to rate regulation for their remaining programming services (other than those offered for a per-channel or per-program charge) by the FCC.\nThe 1992 Cable Act requires each cable system to establish a basic service tier consisting, at a minimum, of all local broadcast signals and all non-satellite delivered distant broadcast signals which the system wishes to carry, and all public, educational and governmental access programming. On April 1, 1993, the FCC adopted its initial regulations governing rates for the basic service tier. Under the regulations adopted by the FCC on April 1, 1993, local franchising authorities, after meeting certain requirements, can require cable operators to reduce the rates for the basic service tier by up to 10 percent from the rates in effect on September 30, 1992, if those rates exceed a per-channel benchmark established by the FCC. Local franchising\nauthorities also are empowered to regulate the rates charged for installation and lease of the equipment used by subscribers to receive the basic service tier and the installation and monthly use of connections for additional television sets. The FCC's regulations require franchising authorities to regulate these rates on the basis of actual cost standards developed by the FCC.\nA local franchising authority seeking to regulate basic service rates must certify to the FCC that, among other things, it has adopted regulations consistent with the FCC's rate regulation guidelines and criteria. If a local franchising authority's certification is deficient or subsequently is revoked, then the FCC is required to regulate the cable operator's basic service rates until the local franchising authority is properly certified or until such time as effective competition exists within the cable system's franchise area.\nUnder the initial regulations adopted by the FCC on April 1, 1993, the FCC, in response to complaints by a subscriber, franchising authority or other governmental entity, required cable operators to reduce the rates for tiers of service other than the basic service tier (\"CPST's\") by up to 10 percent from the rates in effect on September 30, 1992, if those rates were determined to exceed a per-channel benchmark established by the FCC. In response to complaints, the FCC also regulates, on the basis of actual cost, the rates for equipment used only to receive these higher service tiers.\nOnly the FCC may regulate CPST's. Neither the FCC nor a local franchising authority has jurisdiction over a cable system's rates for programming provided on a per-channel or per-program basis.\nAs part of the implementation of the new regulations, the FCC froze all rates in effect on April 5, 1993 until May 15, 1994, except rates for premium and pay-per-view programming services and equipment. On February 22, 1994, the FCC adopted rules that modify, among other things, the FCC's benchmark system for determining the maximum rates for regulated services on cable systems not subject to effective competition. In addition to adopting new, lower benchmark levels, the FCC's regulations (i) allow local franchising authorities to require cable operators to reduce the rate for the basic service tier by up to 17 percent from the rates in effect on September 30, 1992 if those rates exceed the new per-channel benchmarks by that amount, and (ii) allow the FCC, in response to a complaint, to require cable operators to reduce the rates for CPST's by up to 17 percent from the rates in effect on September 30, 1992 if those rates exceed the new per-channel benchmarks by that amount.\nIn late 1994, the FCC revised its regulations governing the manner in which cable operators may charge subscribers for new cable programming services. The FCC instituted a three-year flat fee mark-up plan for charges relating to new channels of cable programming services in addition to the present formula for calculating the permissible rate for new services. Commencing 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. Cable operators may charge an additional 20 cents in the third year only for channels added in that year plus the costs for the programming. Cable operators electing to use the 20 cents per channel adjustment may not also take a 7.5% mark-up on programming cost increases, which is permitted under the FCC's current rate regulations. The FCC indicated that it would request further comment on whether cable operators should continue to receive the 7.5% mark-up on increases in license fees on existing programming services.\nAdditionally, the FCC will permit cable operators to offer New Product Tiers (\"NPT\") at rates which they elect so long as, among other conditions,\nother channels that are subject to rate regulation are priced in conformity with applicable regulations and cable operators do not remove programming services from existing service tiers and offer them on the NPT.\nUnder the 1992 Cable Act, cable systems may not require subscribers to purchase any service tier other than the basic tier as a condition of access to video programming offered on a per-channel or per-program basis. Cable systems are allowed a 10-year phase-in period to the extent necessary to implement the required technology to facilitate such access. The FCC may grant extensions of the 10-year time period, if deemed necessary.\nThe 1992 Cable Act also provides that the consent of most television stations (except satellite-delivered television stations that were provided to the cable television industry as of May 1, 1991, and noncommercial stations) would be required before a cable system could retransmit their signals. Alternatively, a television station could elect to exercise must-carry rights. Must-carry rights entitle a local broadcast station to demand carriage on a cable system, and a system generally is required to devote up to one-third of its channel capacity for the carriage of local stations. Litigation challenging the constitutionality of the mandatory broadcast signal carriage requirements of the 1992 Cable Act is currently pending before the United States Supreme Court. The must-carry rules will remain in effect during the pendency of the proceedings before the United States Supreme Court. If must-carry requirements withstand judicial review, the requirements may cause displacement of more attractive programming. If retransmission consent requirements withstand judicial review and broadcast stations require significant monetary payments for cable system carriage of their signals, the cost of such signal carriage may adversely affect the Partnership's operations.\nIn addition, the 1992 Cable Act (i) requires cable programmers under certain circumstances to offer their programming to present and future competitors of cable television such as multichannel multipoint distribution services (\"MMDS\"), satellite master antenna systems (\"SMATV\") and direct broadcast satellite system operators; (ii) prohibits new exclusive contracts with program suppliers without FCC approval; (iii) bars municipalities from granting exclusive franchises and from unreasonably refusing to grant additional competitive franchises; (iv) permits municipal authorities to operate a cable system without a franchise; (v) regulates the ownership by cable operators of other media such as MMDS and SMATV; (vi) bars, subject to several stated exceptions, cable operators from selling or transferring ownership in a cable system for a three-year period following the acquisition or initial construction of the system; and (vii) prohibits a cable operator from charging a customer for any service or equipment that the subscriber has not affirmatively requested.\nIn response to the 1992 Cable Act, the FCC has imposed or will impose new regulations in the areas of customer service, technical standards, compatibility with other consumer electronic equipment such as \"cable ready\" television sets and video cassette recorders, equal employment opportunity, privacy, rates for leased access channels, obscene or indecent programming, limits on national cable system ownership concentration, standards for limiting the number of channels that a cable television system operator could program with programming services controlled by such operator and disposition of a customer's home wiring.\nThe 1992 Cable Act and subsequent FCC rulings have generally increased the administrative and operational expenses of cable television systems as a result of additional regulatory oversight by the FCC and local franchise authorities. There have been several lawsuits filed by cable operators and programmers in federal court challenging various aspects of the 1992 Cable Act. The litigation concerning the must-carry rules is described above. Appeals also have been filed in connection with litigation resulting from the\nFCC's rate regulation rulemaking decisions. The Partnership cannot determine at this time the outcome of pending FCC rulemakings, the litigation described herein, or the impact of any adverse judicial or administrative decisions on the Partnership's systems or business.\nOther Regulatory Developments In November 1991, the FCC released a Report and Order in which it concluded, among other things, that the 1984 Cable Act and the FCC's regulatory cross-ownership restrictions do not prohibit interexchange carriers (i.e., long distance telephone companies) from acquiring cable television systems or entering into joint ventures with cable operators in areas where such interexchange carriers provide their long distance telephone services. The FCC also concluded that a local exchange carrier (i.e., the local telephone company) that provides a common carrier-based system to distribute video programming to subscribers and a third party programmer using such common carrier services are not required by federal law to obtain a cable television franchise from the local franchising authority in order to provide such video programming services to the public. The FCC's decision described in the preceding sentence has been appealed and these appeals are currently pending.\nIn 1989, the FCC issued new syndicated exclusivity and network non-duplication rules which enable local television broadcasters to compel cable television operators to delete certain programming on distant broadcast signals. Those rules took effect January 1, 1990. Under the rules, all television broadcasters, including independent stations, can compel cable television operators to delete syndicated programming from distant signals if the local broadcaster negotiated exclusive rights to such programming. Local network affiliates may insist that a cable television operator delete a network broadcast on a distant signal. The rules made certain distant signals a less attractive source of programming for the Partnership's systems, since much of such distant signals' programming may have to be deleted.\nThe FCC currently regulates the rates and conditions imposed by public utilities for use of their poles, unless, under the Federal Pole Attachments Act, state public service commissions are able to demonstrate that they regulate the cable television pole attachment rates. In the absence of state regulation, the FCC administers pole attachment rates through the use of a formula which it has devised. The validity of this FCC function was upheld by the United States Supreme Court.\nTHE 1996 ACT\nOn February 8, 1996, the Telecommunications Act of 1996 (the \"1996 Act\") was enacted which dramatically changed federal telecommunications laws and the future competitiveness of the industry. Many of the changes called for by the 1996 Act will not take effect until the FCC issues new regulations which, in some cases, may not be completed for a few years. Because of this, the full impact of the 1996 Act on the Partnership's operations cannot be determined at this time. A summary of the provisions impacting the cable television industry, more specifically those impacting the Partnership's operations, follows:\nCPST Rate Regulation FCC regulation of rates for CPST's has been eliminated for small cable systems served by small companies. Small cable systems are those having 50,000 or fewer subscribers served by companies with fewer than one percent of national cable subscribers (approximately 600,000). All of the Partnership's cable systems qualify as small cable systems. Basic tier rates remain subject to regulation by the local franchising authority under most circumstances until effective competition exists. The 1996 Act expands the definition of effective competition to include the offering of video programming services directly to subscribers in a franchised area by the local exchange carrier, its affiliates, or any multichannel video programming distributor which uses the facilities of the local exchange carrier. No\npenetration criteria exists that triggers the presence of effective competition under these circumstances.\nTelephone Companies The 1996 Act allows telephone companies to offer video programming directly to customers in their service areas immediately upon enactment. They may provide video programming as a cable operator fully subject to the 1996 Act, or a radio-based multichannel programming distributor not subject to any provisions of the 1996 Act or through non-franchised \"open video systems\" offering non-discriminatory capacity to unaffiliated programmers, subject to selected provisions of the 1996 Act. Although management's opinion is that the probability of competition from telcos in rural areas is unlikely in the near future, there are no assurances such competition will not materialize.\nThe 1996 Act encompasses various other aspects of providing cable television service including prices for equipment, discounting of rates to multiple dwelling units, lifting of anti-trafficking restrictions, cable-telephone cross ownership provisions, pole attachment rate formulas, rate uniformity, program access, scrambling and censoring of PEG and leased access channels.\nCopyright Cable television systems are subject to federal copyright licensing, covering carriage of television broadcast signals. In exchange for paying a percentage of their revenues to a federal copyright royalty pool, cable television operators obtain a compulsory license to retransmit copyrighted materials from broadcast signals. Existing Copyright Office regulations require that compulsory copyright payments be calculated on the basis of revenue derived from any service tier containing broadcast retransmission. Although the FCC has no formal jurisdiction over this area, it has recommended to Congress to eliminate the compulsory copyright scheme altogether. The Copyright Office has similarly recommended such a repeal. Without the compulsory license, cable television operators would need to negotiate rights from the copyright owners for each program carried on each broadcast station in each cable system's channel lineup. Such negotiated agreements could increase the cost to cable television operators of carrying broadcast signals. Thus, given the uncertain but possible adoption of this type of copyright legislation, the nature or amount of the Partnership's future payments for broadcast signal carriage cannot be predicted at this time.\nLocal Regulation Cable television systems are generally operated pursuant to franchises, permits or licenses issued by a municipality or other local government entity. Each franchise generally contains provisions governing fees to be paid to the franchising authority, sale or transfer of the franchise, territory of the franchise, design and technical performance of the system, use and occupancy of public streets and number and types of cable television services provided. Franchises are usually issued for fixed terms and must periodically be renewed. There can be no assurance that the franchises for the Partnership's systems will be renewed as they expire, although the Partnership believes that its cable systems generally have been operated in a manner that satisfies the standards of the 1984 Cable Act, as amended by the 1992 Cable Act, for franchise renewal. In the event the franchises are renewed, the Partnership cannot predict the impact of any new or different conditions that might be imposed by the franchising authorities in connection with such renewals.\nSummary The foregoing does not purport to be a summary of all present and proposed federal, state and local regulations and legislation relating to the cable television industry. Other existing federal legislation and regulations, copyright licensing and, in many jurisdictions, state and local franchise requirements are currently the subject of a variety of judicial proceedings, legislative hearings and administrative and legislative proposals which could change, in varying degrees, the manner in which cable television\nsystems operate. Neither the outcome of these proceedings nor their impact upon the cable television industry or the Partnership can be predicted at this time.\nThe Partnership expects to adapt its business to adjust to the changes that may be required under any scenario of regulation. At this time, the Partnership cannot assess the effects, if any, that present regulation may have on the Partnership's operations and potential appreciation of its Systems. There can be no assurance, however, that the final form of regulation will not have a material adverse impact on partnership operations.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Partnership's cable television systems are located in and around Starkville, Philadelphia, Kosciusko, Carthage, Forest, Morton, Raleigh and Sandersville, Mississippi and in Highlands and Sapphire Valley, North Carolina. The principal physical properties of the Systems consist of system components (including antennas, coaxial cable, electronic amplification and distribution equipment), motor vehicles, miscellaneous hardware, spare parts and real property, including office buildings and land on which towers and antennas are located. The Partnership's cable plant passed approximately 31,210 homes as of December 31, 1995. Management believes that the Partnership's plant passes all areas which are currently economically feasible to service. Future line extensions depend upon the density of homes in the area as well as available capital resources for the construction of new plant. (See Part II. Item 7. Liquidity and Capital Resources.)\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nNone.\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 REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\n(a) There is no established public trading market for the Partnership's units of limited partnership interest.\n(b) The approximate number of equity holders as of December 31, 1995, is as follows:\n(c) During 1995, the Partnership made cash distributions of $298,161 to limited partners and $3,012 to the Managing General Partner. The limited partners have received in the aggregate in the form of cash distributions $3,743,458 on total initial contributions of $15,000,000 as of December 31, 1995. As of December 31, 1995, the Partnership had repurchased $84,475 of limited partnership units (141 units at $500 per unit and 43 units at $325 per unit). Future distributions depend upon results of operations, leverage ratios and compliance with financial covenants required by the Partnership's lender, but are expected to remain at their current level.\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\n1995 AND 1994\nTotal revenue reached $8,611,947 for the year ended December 31, 1995, representing an increase of approximately 9% over 1994. This increase is due to rate increases placed into effect the latter part of 1995, an approximate 4% increase in basic subscribers (December 31, 1995 as compared to December 31, 1994), significant increases in tier and premium service revenues as well as advertising revenues. Of the 1995 revenue, $6,151,203 (71%) is derived from subscriptions to basic services, $870,018 (10%) from subscriptions to premium services, $382,033 (5%) from advertising, $321,896 (4%) from subscriptions to tier services, $312,375 (4%) from service maintenance revenue, $294,802 (3%) from installation charges and $279,620 (3%) from other sources.\nThe following table displays historical average rate information for various services offered by the Partnership's systems (amounts per subscriber per month):\nOperating expenses totaled $844,840 for the year ended December 31, 1995, remaining relatively constant as compared to 1994. Increases in salary and benefit costs were offset by technician positions not being filled for portions of 1995. Salary and benefit costs are the major component of operating expenses. Employee wages are reviewed annually and, in most cases, increased based on cost of living adjustments and other factors. Therefore, Management expects operating expenses to increase in future years.\nGeneral and administrative expenses totaled $2,135,917 for the year ended December 31, 1995, representing an increase of approximately 7% over 1994. This is due to increases in revenue based expenses such as franchise fees and management fees as a result of revenue gains discussed above and increased salary and benefit expenses. Significant general and administrative expenses are based on revenues. Therefore, as the Partnership's revenue increases the trend of increased administrative expenses is expected to continue.\nProgramming expenses totaled $1,909,473 for the year ended December 31, 1995 representing an increase of approximately 25% over 1994. This is mainly the result of increased costs charged by various program suppliers. Programming expenses consist mainly of payments made to the suppliers of various cable programming services. Since these costs are based on the number of subscribers served, future subscriber increases will cause the trend of increasing programming costs to continue. Rate increases from program suppliers, as well as new fees associated with the launch of additional channels will also contribute to increased programming costs.\nDepreciation and amortization expense increased approximately 3% as compared to 1994. This is mainly due to certain assets being fully amortized offset by depreciation expense on new assets placed in service during 1995.\nInterest expense increased from $991,902 in 1994 to $1,027,088 in 1995 (approximately 4%). The Partnership's average senior debt balance decreased from approximately $14,842,500 during 1994 to $14,027,910 during 1995. The Partnership's effective interest rate increased to approximately 7.32% in 1995 compared to 6.68% in 1994.\n1994 AND 1993\nTotal revenue reached $7,888,216 for the year ended December 31, 1994, representing an increase of approximately 6% over 1993. This increase is due to rate increases placed into effect the latter part of 1994, an approximate 5% increase in basic subscribers (December 31, 1994 as compared to December 31, 1993), significant increases in advertising revenue, late charges for past due subscribers and service maintenance revenue offset by a decrease in additional outlet income. Of the 1994 revenue, $5,703,145 (72%) is derived from subscriptions to basic services, $803,300 (10%) from subscriptions to premium services, $304,831 (4%) from installation charges, $292,002 (4%) from advertising, $251,895 (3%) from subscriptions to tier services, $291,924 (4%) from service maintenance revenue and $241,119 (3%) from other sources.\nOperating expenses totaled $835,889 for the year ended December 31, 1994, representing an increase of approximately 8% as compared to 1993. Increases in salary and benefit costs and the addition of a system manager in the Starkville system were offset by a decrease in system maintenance related to an insurance reimbursement for costs from storm damage.\nGeneral and administrative expenses totaled $1,997,289 for the year ended December 31, 1994, representing an increase of approximately 7% over 1993. This is due to increases in discretionary incentive compensation during the current year and increases in revenue based expenses such as franchise fees, and management fees due to the revenue increases noted above.\nProgramming expenses totaled $1,531,220 for the year ended December 31, 1994, representing an increase of approximately 21% over 1993. This is mainly due to increased costs charged by various program suppliers and an increased number of subscribers. Programming expenses mainly consist of payments made to the suppliers of various cable programming services.\nDepreciation and amortization expense decreased approximately 2% as compared to 1993. This is mainly due to certain assets being fully amortized offset by depreciation expense on new assets placed in service during 1994.\nInterest expense decreased from $1,177,832 in 1993 to $991,902 in 1994 (approximately 16%). The Partnership's average debt balance decreased from approximately $15,956,000 during 1993 to approximately $14,842,500 during 1994. In addition, the Partnership's effective interest rate decreased from approximately 7.38% in 1993 to approximately 6.68% in 1994.\nEFFECTS OF REGULATION\nOn October 5, 1992, Congress enacted the Cable Television Consumer Protection and Competition Act of 1992 (the \"1992 Act\"). The 1992 Act and subsequent revisions and rulemakings substantially re-regulated the cable television industry. The regulatory aspects of the 1992 Act included giving the local franchising authorities and the FCC the ability to regulate rates for basic services, equipment charges and additional CPST's when certain conditions were met. All of the Partnership's cable systems were potentially\nsubject to rate regulation. The most significant impact of rate regulation was the inability to raise rates for regulated services as costs of operation rose during an FCC imposed rate freeze from April 5, 1993 to May 15, 1994. This has contributed to operating margins before depreciation and amortization declining from 48% for the twelve months ended December 31, 1993 to 46% for the same period in 1994.\nOn February 8, 1996, the Telecommunications Act of 1996 (the 1996 Act) became law. The 1996 Act will eliminate all rate controls on CPST's of small cable systems, defined by the 1996 Act as systems serving fewer than 50,000 subscribers owned by operators serving fewer than 1% of all subscribers in the United States (approximately 600,000 subscribers). All of the Partnership's cable systems qualify as small cable systems. Many of the changes called for by the 1996 Act will not take effect until the FCC issues new regulations, a process that could take from several months to a few years depending on the complexity of the required changes and the statutory time limits. Because of this the full impact of the 1996 Act on the Partnership's operations cannot be determined at this time.\nAs of the date of this filing, the Partnership has received notification that local franchising authorities with jurisdiction over approximately 36% of total subscribers have elected to certify. Based on Management's analysis, the rates charged by these systems are within the maximum rates allowed under current FCC rate regulations.\nLIQUIDITY AND CAPITAL RESOURCES\nDuring 1995, the Partnership's primary source of liquidity was cash provided from operations. The Partnership generates cash on a monthly basis through the monthly billing of subscribers for cable services. Losses from uncollectible accounts have not been material. During 1995, cash generated from monthly billings was sufficient to meet the Partnership's needs for working capital, capital expenditures (excluding acquisitions) and debt service. Management's projections for 1996 show that the cash generated from monthly subscriber billings should be sufficient to meet the Partnership's working capital needs, as well as meeting the debt service obligations of its bank loan.\nAs of the date of this filing, the Partnership's term loan balance was $13,870,821. As of the date of this filing, interest rates on the credit facility were as follows: $1,400,000 at Libor based rate of 7.41% expiring April 28, 1996; and $11,920,000 fixed at 7.61% under the terms of a swap agreement with the Partnership's lender expiring March 28, 1997. The balance of $550,821 bears interest at the prime rate plus 1\/2% (currently 8.75%). The above rates include a margin paid to the lender based on overall leverage, and may increase or decrease as overall leverage fluctuates.\nOn November 27, 1995, the Partnership amended its loan agreement in order to finance the acquisition of the Sapphire Valley System. Under the amendment, the Revolving Credit Facility was increased by $1,250,000 to $2,000,000. The maturity date was extended from September 30, 2000 to December 31, 2000.\nAt December 31, 1995, the Partnership was required under the terms of its credit agreement to maintain certain financial ratios including a maximum ratio of Senior Debt to Annualized Operating Cash Flow of 3.50 to 1, and a minimum rate of Annual Operating Cash Flow to Interest Expense of 3.00 to 1. At December 31, 1995, the Partnership was in compliance with all covenants of its loan agreement.\nECONOMIC CONDITIONS\nHistorically, the effects of inflation have been considered in determining to what extent rates will be increased for various services provided. It is expected that the future rate of inflation will continue to be a significant variable in determining rates charged for services provided, subject to the provisions of the 1996 Act. Because of the deregulatory nature of the 1996 Act, the Partnership does not expect the future rate of inflation to have a material adverse impact on operations.\nCAPITAL EXPENDITURES\nDuring 1995, the Partnership incurred approximately $1,100,000 in capital expenditures excluding the acquisition of the Sapphire Valley System. These expenditures included construction of a fiber network for data transmission, channel additions and headend equipment upgrades all in the Starkville, MS system, launch of new channels and vehicle replacements in the Forest, MS system, repairs to distribution plant damaged by storms in the Highlands, NC system and purchase of land for an office in the Philadelphia, MS system.\nManagement estimates that the Partnership will spend approximately $1,200,000 on capital expenditures during 1996. These expenditures include continuation of the fiber network for data transmission in the Starkville, MS system, construction of a new office in the Philadelphia, MS system, commercial insertion equipment and system upgrades in the Forest, MS system and line extensions throughout various systems.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe audited financial statements of the Partnership for the years ended December 31, 1995, 1994 and 1993 are included as a part of this filing (see Item 14(a)(1) 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 has no directors or officers. The Managing General Partner of the Partnership is Northland Communications Corporation, a Washington corporation; the Administrative General Partner of the Partnership is FN Equities Joint Venture, a California general partnership.\nCertain information regarding the officers and directors of Northland is set forth below.\nJOHN S. WHETZELL (AGE 54). Mr. Whetzell is the founder of Northland Communications Corporation and has been President since its inception and a Director since March 1982. Mr. Whetzell became Chairman of the Board of Directors in December 1984. He also serves as President and Chairman of the Board of Northland Telecommunications Corporation, Northland Cable Television, Inc., Northland Cable Services Corporation, Cable Ad-Concepts, Inc., Cable Television Billing, Inc. and Northland Cable News, Inc. He has been involved with the cable television industry for over 21 years and currently serves as a director on the board of the Cable Antenna Television Association, a national cable television association. Between March 1979 and February 1982 he was in charge of the Ernst & Whinney national cable television consulting services. Mr. Whetzell first became involved in the cable television industry when he served as the Chief Economist of the Cable Television Bureau of the Federal Communications Commission (FCC) from May 1974 to February 1979. He provided economic studies which support the deregulation of cable television both in federal and state arenas. He participated in the formulation of accounting standards for the industry and assisted the FCC in negotiating and developing the pole attachment rate formula for cable television. His undergraduate degree is in economics from George Washington University, and he has an MBA degree from New York University.\nJOHN E. IVERSON (AGE 59). Mr. Iverson is the Assistant Secretary of Northland Communications Corporation and has served on the Board of Directors since December 1984. He also serves on the Board of Directors of Northland Telecommunications Corporation, Northland Cable Television, Inc., Northland Cable Services Corporation, Cable Ad-Concepts, Inc. and Cable Television Billing, Inc., Northland Investment Corporation and Northland Cable News, Inc. He is currently a partner in the law firm of Ryan, Swanson & Cleveland, Northland's general counsel. He is a member of the Washington State Bar Association and American Bar Association and has been practicing law for more than 33 years. Mr. Iverson is the past president and a current Trustee of the Pacific Northwest Ballet Association. Mr. Iverson has a Juris Doctor degree from the University of Washington.\nARLEN I. PRENTICE (AGE 58). Since July 1985, Mr. Prentice has served on the Board of Directors of Northland Telecommunications Corporation, and he served on the Board of Directors of Northland Communications Corporation between March 1982 and July 1985. Since 1969, Mr. Prentice has been Chairman and Chief Executive Officer of Kibble & Prentice, a diversified financial services firm. Kibble & Prentice has four divisions, which include Estate Planning and Business Insurance, Financial Planning and Investments, Employee Benefit Services, and Property and Casualty Insurance. Mr. Prentice is a Chartered Life Underwriter, Chartered Financial Consultant, past President of the Million Dollar Round Table and a registered representative of Investment Management and Research. Mr. Prentice has a Bachelor of Arts degree from the University of Washington.\nMILTON A. BARRETT, JR. (AGE 61). Since April 1986, Mr. Barrett has served on the Board of Directors of NTC. In 1995, he retired from the Weyerhaeuser Company after thirty-four years of service. At the time of his retirement, Mr. Barrett was a Vice President of Sales and Marketing as well as chairman of Weyerhaeuser's business ethics committee. Mr. Barrett is a graduate of Princeton University magna cum laude and of the Harvard University Graduate School of Business Administration.\nRICHARD I. CLARK (AGE 38). Mr. Clark has served as Vice President of Northland since March 1982. He has served on the Board of Directors of both Northland Communications Corporation and Northland Telecommunications Corporation since July 1985. He also serves as Vice President and Director of Northland Cable Services Corporation, Cable Ad-Concepts, Inc., Cable Television Billing, Inc., and Northland Cable News, Inc. Mr. Clark was elected Treasurer in April 1987, prior to which he served as Secretary from March 1982. He also serves as a registered principal, President and director of Northland Investment Corporation. Mr. Clark was an original incorporator of Northland and is responsible for the administration and investor relations activities of Northland, including financial planning and corporate development. From July 1979 to February 1982, Mr. Clark was employed by Ernst & Whinney in the area of providing cable television consultation services and has been involved with the cable television industry for nearly 17 years. He has directed cable television feasibility studies and on-site market surveys. Mr. Clark has assisted in the design and maintenance of financial and budget computer programs, and he has prepared documents for major cable television companies in franchising and budgeting projects though the application of these programs. In 1979, Mr. Clark graduated cum laude from Pacific Lutheran University with a Bachelor of Arts degree in accounting.\nARTHUR H. MAZZOLA (AGE 73). Mr. Mazzola was elected to the Board of Directors of Northland Telecommunications Corporation in April 1987. From 1985 to 1990, he was Senior Vice President of Benjamin Franklin Leasing Company, Inc., an equipment lease financing company. Currently, Mr. Mazzola is serving as Business Development Coordinator at Bank of California. Prior to his association with Benjamin Franklin Leasing Company, Mr. Mazzola served as President of Federal Capital Corporation and Trans Pacific Lease Co., Inc. Both of these companies also engaged exclusively in equipment lease financing. Mr. Mazzola is a past Board Chairman and current Trustee of the Pacific Northwest Ballet Association and current Board Member of the Dante Alighieri Society. Mr. Mazzola attended Boston University School of Business in 1943 where he studied economics.\nTRAVIS H. KEELER (AGE 55). Mr. Keeler was elected to the Board of Directors of Northland Telecommunications Corporation in April 1987. Since May 1985, he has served as President of Overall Laundry Services, Inc., an industrial laundry and garment rental firm. Mr. Keeler received a Bachelor of Arts degree from the University of Washington in 1962.\nJAMES E. HANLON (AGE 62). Since June 1985, Mr. Hanlon has been a Divisional Vice President for Northland's Tyler, Texas regional office and is currently responsible for the management of systems serving approximately 92,900 basic subscribers in Texas, Alabama and Mississippi. He also serves as Vice President for Northland Cable News, Inc. Prior to his association with Northland, he served as Chief Executive of M.C.T. Communications, a cable television company, from 1981 to June 1985. His responsibilities included supervision of the franchise, construction and operation of a cable television system located near Tyler, Texas. From 1979 to 1981, Mr. Hanlon was President of the CATV Division of Buford Television, Inc., and from 1973 to 1979, he served as President and General Manager of Suffolk Cablevision in Suffolk County, New York. Mr. Hanlon has also served as Vice President and Corporate Controller of Viacom International, Inc. and Division Controller of New York\nYankees, Inc. Mr. Hanlon has a Bachelor of Science degree in Business Administration from St. Johns University.\nJAMES A. PENNEY (AGE 41). Mr. Penney is Vice President and General Counsel for Northland. He has served as Vice President and General Counsel for Northland Telecommunications Corporation, Northland Communications Corporation, Northland Cable Television, Inc. and Northland Cable News, Inc. since September 1985 and was elected Secretary in April 1987. He also serves as Vice President and General Counsel for Northland Cable Services Corporation, Cable Ad-Concepts, Inc. and Cable Television Billing, Inc. He is responsible for advising all Northland systems with regard to legal and regulatory matters, and also is involved in the acquisition and financing of new cable systems. From 1983 until 1985 he was associated with the law firm of Ryan, Swanson & Cleveland, Northland's general counsel. Mr. Penney holds a Bachelor of Arts Degree from the University of Florida and a Juris Doctor from The College of William and Mary, where he was a member of The William and Mary Law Review.\nGARY S. JONES (AGE 38). Mr. Jones is Vice President of Northland. Mr. Jones joined Northland in March 1986 as Controller and has been Vice President of Northland Telecommunications Corporation, Northland Communications Corporation and Northland Cable Television, Inc. since October 1986. He also serves as Vice President for Northland Cable Services Corporation, Cable Ad-Concepts, Inc., Cable Television Billing, Inc. and Northland Cable News, Inc. Mr. Jones is responsible for cash management, financial reporting and banking relations for Northland and is involved in the acquisition and financing of new cable systems. Prior to joining Northland, Mr. Jones was employed as a Certified Public Accountant with Laventhol & Horwath from 1980 to 1986. Mr. Jones received his Bachelor of Arts degree in Business Administration with a major in accounting from the University of Washington in 1979.\nRICHARD J. DYSTE (AGE 50). Mr. Dyste has served as Vice President-Technical Services of Northland Telecommunications Corporation, Northland Communications Corporation and Northland Cable Television, Inc. since April 1987. He also serves as Vice President for Cable Ad-Concepts, Inc. and Northland Cable News, Inc. He is currently responsible for the management of systems serving approximately 48,600 basic subscribers in California, Idaho, Oregon and Washington. Mr. Dyste is the past president and a current member of the Mount Rainier Chapter of the Society of Cable Television Engineers, Inc. Mr. Dyste joined Northland in 1986 as an engineer and served as Operations Consultant to Northland Communications Corporation from August 1986 until April 1987. From 1977 to 1985, Mr. Dyste owned and operated Bainbridge TV Cable. Mr. Dyste is a graduate of Washington Technology Institute.\nH. LEE JOHNSON (AGE 52). Mr. Johnson has served as Divisional Vice President for Northland's Statesboro, Georgia regional office since March 1994. Mr. Johnson is responsible for the management of systems serving over 50,400 subscribers located in South Carolina, North Carolina, Georgia and Mississippi. He also serves as Vice President for Northland Cable News, Inc. Mr. Johnson has been employed in the cable industry for nearly 27 years. Mr. Johnson has attended and received certificates of completion from numerous industry training seminars including courses sponsored by Jerrold Electronics, Scientific Atlanta, and the Society of Cable Television Engineers. Mr. Johnson also received a certificate of completion from CATA in public relations.\nCertain information regarding the officers and directors of FN Equities Joint Venture is set forth below:\nMILES Z. GORDON (AGE 48). Mr. Gordon, President and Chief Executive Officer of Financial Network Investment Corporation (FNIC), has a comprehensive background in both the securities industry and securities law\nand regulation. In 1972, he joined the Los Angeles office of the Securities and Exchange Commission (SEC), and in 1974 he was appointed Branch Chief of the Investment Company and Investment Advisors Examination Division. Mr. Gordon left the SEC in 1978 to practice law. Within one year, he accepted a position as Vice President of a major national securities broker\/dealer firm headquartered in Long Beach, California. He subsequently accepted the presidency of this firm in early 1980. In 1983, he helped form and became President and Chief Executive Officer of FNIC. This leading firm is now one of the largest independent broker\/dealers in the United States. A graduate of Michigan State University (and current board member of the Visitors for the College of Social Science for MSU), Mr. Gordon received his Juris Doctorate from the University of California at Los Angeles School of Law. He presently serves as Chairman of the Securities Industry Association Independent Contractor Firms Committee. Mr. Gordon was also Chairman and a member of the NASD District Business Conduct Committee and a former member of the NASD Board of Governors. He is past president of the California Syndication Forum and has also served on several committees for the Securities Industry Association. Mr. Gordon has appeared on television and radio programs, been featured in numerous magazine and newspaper articles as an industry spokesperson, and is a frequent speaker at many industry seminars and conventions.\nJOHN S. SIMMERS (AGE 45). Mr. Simmers, Executive Vice President and Chief Operating Officer of Financial Network Investment Corporation (FNIC), has an extensive background in the securities industry. He began his career as a reporter for Dunn and Bradstreet, then joined the National Association of Securities Dealers (NASD) in 1974. Knowledgeable in all aspects of broker\/dealer regulations, operations, and products, Mr. Simmers was responsible for reviewing the activities of member firms in twelve states. Mr. Simmers left the NASD seven years later to accept a position as Vice President of the securities broker\/dealer, retail, wholesale and investment advisory subsidiaries of a publicly held investment company headquartered in Long Beach, California. He left this firm in 1983 to help form and become Executive Vice President and Chief Operating Officer of FNIC. This full service broker\/dealer firm has offices located across the United States. Mr. Simmers is a graduate of Ohio State University. He served on the Board of Directors of the California Association of Independent Broker\/Dealers and was a member of the Real Estate Securities and Syndication Institute, the NASD District Business Conduct Committee (District 2 South), and the International Association for Financial Planning Due Diligence Steering Committee, which was organized to work toward improving the quality and consistency of due diligence in the securities industry. Mr. Simmers currently serves as a member of the NASD Direct Participation Programs Committee, and has spoken at numerous seminars and conventions.\nHARRY M. KITTER (AGE 40). Mr. Kitter has served as Controller for Financial Network Investment Corporation since 1983. Prior to this association from 1981 to 1983 he was employed as the Los Angeles Internal Audit Manager at the Pacific Stock Exchange. From 1978 to 1981, he was Senior Accountant at Arthur Young & Co., C.P.A. He holds an MBA from the University of Pittsburgh and a bachelor's degree in economics from Lafayette College, Easton, Pennsylvania.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe Partnership does not have executive officers. However, compensation was paid to the Managing General Partner during 1995 as indicated in Note 3 of the Notes to Financial Statements--December 31, 1995 (see Items 13(a) and 14(a)(1) below). In addition, cash distributions were made to the Managing General Partner in 1995 (see Item 5(c) above).\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\n(A) CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. Security ownership of management as of December 31, 1995 is as follows:\nNote A: Northland has a 1% interest in the Partnership, which increases to a 20% interest in the Partnership at such time as the limited partners have received 100% of their aggregate cash contributions. The natural person who exercises voting and\/or investment control over these interests is John S. Whetzell.\nNote B: FN Equities Joint Venture has no interest in the Partnership until such time as the limited partners have received 100% of their aggregate cash contributions, at which time FN Equities Joint Venture will have a 5% interest in the Partnership. The natural person who exercises voting and\/or investment control over these interests is John S. Simmers.\n(B) CHANGES IN CONTROL. Northland has pledged its ownership interest as Managing General Partner of the Partnership to its lender as collateral pursuant to the terms of the term loan agreement between Northland and its lender.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\n(A) TRANSACTIONS WITH MANAGEMENT AND OTHERS. The Managing General Partner receives a management fee equal to 6% of the gross revenues of the Partnership, not including revenues from any sale or refinancing of the Partnership's Systems. The Managing General Partner also receives reimbursement of normal operating and general and administrative expenses incurred on behalf of the Partnership.\nThe Partnership entered into an operating agreement with Northland Premier Cable Limited Partnership (\"Premier\"), an affiliated partnership organized and managed by Northland. Under the terms of this agreement, Premier serves as the exclusive managing agent for the Highlands NC system, and is reimbursed for certain operating and administrative costs.\nCable Television Billing, Inc. (\"CTB\"), an affiliate of Northland, provides software installation and billing services to the Partnership's Systems.\nNorthland Cable News, Inc. (\"NCN\"), an affiliate of Northland, provides programming to the Partnership's systems.\nCable Ad-Concepts, Inc. (\"CAC\"), an affiliate of Northland, provides the production and development of video commercial advertisements and advertising sales support.\nSee Note 3 of the Notes to Financial Statements--December 31, 1995 for disclosures regarding transactions with the General Partners and affiliates.\nThe following schedule summarizes these transactions:\nManagement believes that all of the above transactions are on terms as favorable to the Partnership as could be obtained from unaffiliated parties for comparable goods or services.\nAs disclosed in the Partnership's Prospectus (which has been incorporated by reference), certain conflicts of interest may arise between the Partnership and the General Partners and their affiliates. Certain conflicts may arise due to the allocation of management time, services and functions between the Partnership and existing and future partnerships as well as other business ventures. The General Partners have sought to minimize these conflicts by allocating costs between systems on a reasonable basis. Each limited partner may have access to the books and non-confidential records of the Partnership. A review of the books will allow a limited partner to assess the reasonableness of these allocations. The Agreement of Limited Partnership provides for any limited partner owning 10% or more of the Partnership units to call a special meeting of the Limited Partners, by giving written notice to the General Partners specifying in general terms the subjects to be considered. In the event of a dispute between the General Partners and Limited Partners which cannot be otherwise resolved, the Agreement of Limited Partnership provides steps for the removal of a General Partner by Limited Partners.\n(b) CERTAIN BUSINESS RELATIONSHIPS. John E. Iverson, a Director and Assistant Secretary of the Managing General Partner, is a partner of the law firm of Ryan, Swanson & Cleveland, which has rendered and is expected to continue to render legal services to the Managing General Partner and the Partnership.\n(c) INDEBTEDNESS OF MANAGEMENT. None.\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:\n(1) FINANCIAL STATEMENTS:\n(2) EXHIBITS:\n4.1 Amended and Restated Certificate and Agreement of Limited Partnership dated November 3, 1986(3)\n10.1 Agreement of Purchase and Sale with Highlands Community Cable Television, Inc.(2)\n10.2 Mississippi State University Contract(2)\n10.3 Mathiston Franchise(2)\n10.4 Maben Franchise(2)\n10.5 Starkville Franchise(2)\n10.6 Oktibbeha County Franchise(2)\n10.7 Raleigh Franchise(2)\n10.8 Philadelphia Franchise(2)\n10.9 Neshoba Franchise(2)\n10.10 Mississippi Band of Choctaw Indians Franchise(2)\n10.11 Carthage Franchise(2)\n10.12 Kosciusko Franchise(2)\n10.13 Morton Franchise(2)\n10.14 Forest Franchise(2)\n10.15 Scott County Franchise(2)\n10.16 Highlands Franchise(2)\n10.17 Macon County Franchise(2)\n10.18 Jackson County Franchise(2)\n10.19 Heidelberg Franchise(2)\n10.20 Jasper County Franchise(2)\n10.21 Jones County Franchise(2)\n10.22 Sandersville Franchise(2)\n10.23 Golf Properties Franchise(2)\n10.24 Management Agreement dated as of October 10, 1986(2)\n10.25 Credit Agreement with National Westminster Bank USA dated as of October 31, 1986 (\"Credit Agreement\")(1)\n10.26 First Amendment to Credit Agreement dated as of December 12, 1986(5)\n10.27 Second Amendment to Credit Agreement dated as of October 26, 1987(5)\n10.28 Third Amendment to Credit Agreement dated as of September 26, 1988(5)\n10.29 Agreement of Purchase and Sale with Starkville TV Cable Company(1)\n10.30 Agreement of Purchase and Sale between Northland Telecommunications Corporation and Seemore TV, Inc.(1)\n10.31 Agreement of Purchase and Sale between Northland Telecommunications Corporation and Central Cable TV, Inc.(1)\n10.32 Agreement of Purchase and Sale between Northland Telecommunications Corporation and Clear Vision TV Company of Kosciusko, A Corporation(1)\n10.33 Agreement of Purchase and Sale between Northland Telecommunications Corporation and Scott Cable TV, Inc.(1)\n10.34 Agreement of Purchase and Sale with SCAN, Inc. and South Central Antenna Network Inc. dated July 18, 1988(4)\n10.35 Fourth Amendment to Credit Agreement dated as of March 31, 1989(6)\n10.36 Fifth Amendment to Credit Agreement dated as of February 15, 1990(6)\n10.37 Leake County Franchise(7)\n10.38 Sixth Amendment to Credit Agreement dated as of May 28, 1992(8)\n10.39 Loan Agreement with First Union Bank of North Carolina dated as of February 16, 1993(8)\n(1) Incorporated by reference from the Partnership's Form S-1 Registration Statement declared effective on July 10, 1986 (No. 33-2928).\n(2) Incorporated by reference from the partnership's Form 10-K Annual Report for the fiscal year ended December 31, 1986.\n(3) Incorporated by reference from the partnership's Form 8-A Registration Statement filed July 24, 1987.\n(4) Incorporated by reference from the partnership's Form 10-Q Quarterly Report for the period ended September 30, 1988.\n(5) Incorporated by reference from the partnership's Form 10-K Annual Report for the fiscal year ended December 31, 1988.\n(6) Incorporated by reference from the partnership's Form 10-K Annual Report for the fiscal year ended December 31, 1989.\n(7) Incorporated by reference from the partnership's Form 10-K Annual Report for the fiscal year ended December 31, 1990.\n(8) Incorporated by reference from the partnership's Form 10-K Annual Report for the fiscal year ended December 31, 1992\n(b) REPORTS ON FORM 8-K. No Partnership reports on Form 8-K have been filed for the fourth quarter of the fiscal year ended December 31, 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.\nNORTHLAND CABLE PROPERTIES SIX LIMITED PARTNERSHIP\nBy: NORTHLAND COMMUNICATIONS CORPORATION (Managing General Partner)\nBy \/s\/ John S. Whetzell Date: 3\/28\/96 ----------------------- ------------- John S. Whetzell, 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.\nEXHIBITS INDEX\nNORTHLAND CABLE PROPERTIES SIX LIMITED PARTNERSHIP\nFINANCIAL STATEMENTS AS OF DECEMBER 31, 1995 AND 1994 TOGETHER WITH AUDITORS' REPORT\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Partners of Northland Cable Properties Six Limited Partnership:\nWe have audited the accompanying balance sheets of Northland Cable Properties Six Limited Partnership (a Washington limited partnership) as of December 31, 1995 and 1994, and the related statements of operations, changes in partners' capital (deficit) and cash flows for each of the three years in the period ended December 31, 1995. 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 Northland Cable Properties Six Limited Partnership as of December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles.\n\/s\/ Arthur Anderson LLP - ----------------------------- Seattle, Washington, February 9, 1996\nNORTHLAND CABLE PROPERTIES SIX LIMITED PARTNERSHIP\nBALANCE SHEETS -- DECEMBER 31, 1995 AND 1994\nASSETS\nThe accompanying notes are an integral part of these balance sheets.\nNORTHLAND CABLE PROPERTIES SIX LIMITED PARTNERSHIP\nSTATEMENTS OF OPERATIONS\nFOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nThe accompanying notes are an integral part of these financial statements.\nNORTHLAND CABLE PROPERTIES SIX LIMITED PARTNERSHIP\nSTATEMENTS OF CHANGES IN PARTNERS' CAPITAL (DEFICIT)\nFOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nThe accompanying notes are an integral part of these financial statements.\nNORTHLAND CABLE PROPERTIES SIX LIMITED PARTNERSHIP\nSTATEMENTS OF CASH FLOWS\nFOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nThe accompanying notes are an integral part of these financial statements.\nNORTHLAND CABLE PROPERTIES SIX LIMITED PARTNERSHIP\nNOTES TO FINANCIAL STATEMENTS\nDECEMBER 31, 1995\n1. ORGANIZATION AND PARTNERS' INTERESTS:\nFormation and Business\nNorthland Cable Properties Six Limited Partnership (the Partnership), a Washington limited partnership, was formed on January 22, 1986. The Partnership was formed to acquire, develop and operate cable television systems. The Partnership began operations on November 3, 1986 by acquiring a cable television system in Mississippi. Subsequently, additional cable television systems were acquired in Mississippi and North Carolina. The Partnership has 24 nonexclusive franchises to operate cable systems for periods which will expire at various dates through 2017.\nNorthland Communications Corporation is the Managing General Partner (the General Partner) of the Partnership. Certain affiliates of the Partnership also own and operate other cable television systems. In addition, the General Partner manages cable television systems for other limited partnerships for which it is General Partner.\nFN Equities Joint Venture, a California joint venture, is the Administrative General Partner of the Partnership.\nContributed Capital, Commissions and Offering Costs\nThe capitalization of the Partnership is set forth in the accompanying statements of changes in partners' capital (deficit). No limited partner is obligated to make any additional contribution to Partnership capital.\nThe general partners purchased their 1% interest in the Partnership by contributing $1,000 to Partnership capital.\nPursuant to the Partnership Agreement, brokerage fees paid to an affiliate of the Administrative General Partner and other offering costs paid to the General Partner were recorded as a reduction of limited partners' capital. The Administrative General Partner received a fee for providing certain administrative services to the Partnership.\nOrganization Costs\nOrganization costs originally included reimbursements of $126,661 to the General Partner for costs incurred on the Partnership's behalf and a fee of $975,000 as compensation for selecting and arranging for the purchase of the cable television systems. Amounts recorded as organization costs have been adjusted for subsequent acquisitions.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:\nDepreciation\nDepreciation of property and equipment is provided using the straight-line method over the following estimated service lives:\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 estimated fair value of net tangible assets acquired; then, to the franchise and other determinable intangible costs; then any excess would have been allocated to goodwill.\nIntangible Assets\nCosts assigned to franchise agreements, organization costs and noncompetition agreements and other intangibles are being amortized using the straight-line method over the following estimated useful lives:\nRevenue Recognition\nThe Partnership recognizes revenue in the month service is provided to customers and accounts for advance payments on services to be rendered as subscriber prepayments.\nReclassifications\nCertain reclassifications have been made to conform prior years' data with the current year presentation.\nEstimates Used in Financial Statement Presentation\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount 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.\n-3-\n3. TRANSACTIONS WITH GENERAL PARTNER AND AFFILIATES:\nManagement Fees\nThe General Partner receives a fee for managing the Partnership equal to 6% of the gross revenues of the Partnership, excluding revenues from the sale of cable television systems or franchises. The amount of management fees charged by the General Partner was $516,473, $473,293 and $444,566 in 1995, 1994 and 1993, respectively.\nIncome Allocation\nAll items of income, loss, deduction and credit are allocated 99% to the limited partners and 1% to the general partners until the limited partners have received aggregate cash distributions in an amount equal to aggregate capital contributions. Thereafter, the general partners receive 25% and the limited partners are allocated 75% of partnership income and losses. Prior to the general partners receiving a distribution in any year, the limited partners must receive distributions equal to at least 50% of their allocable share of net income for such year, based on projections by the Managing General Partner of the net income of the Partnership for the year. If cash distributions to the general partners are deferred because of this 50% limitation, those deferred cash distributions will be paid to the general partners in subsequent years or upon liquidation of the Partnership. Any distributions other than from cash flow, such as from the sale or refinancing of a system or upon dissolution of the Partnership, will be determined according to contractual stipulations in the Partnership Agreement.\nThe limited partners' total initial contributions to capital were $15,000,000 ($500 per partnership unit). As of December 31, 1995, $3,743,458 ($125 per partnership unit) has been distributed to the limited partners, and the Partnership has repurchased $84,475 of limited partnership units (141 units at $500 per unit and 43 units at $325 per unit).\nReimbursements\nThe General Partner provides certain centralized services to the Partnership and other affiliated entities. As set forth in the Partnership Agreement, the Partnership reimburses the General Partner for the cost of those services provided by the General Partner to the Partnership. These services include engineering, marketing, management services, accounting, bookkeeping, legal, copying, office rent and computer services.\nThe amounts billed to the Partnership for these services are based on the General Partner's cost. The cost of certain services is charged directly to the Partnership, based upon actual time spent by employees of the General Partner. The cost of other services is allocated to the Partnership, and other affiliated entities, based upon their relative size, revenue and other factors. The amount charged to the Partnership by the General Partner for these services was $488,303, $385,519 and $370,990 for 1995, 1994 and 1993, respectively.\nIn 1995, 1994 and 1993, the Partnership paid billing service fees to an affiliate, amounting to $56,672, $54,941 and $53,635, respectively.\n-4-\nThe Partnership has entered into an operating management agreement with an affiliate managed by the General Partner. Under the terms of the agreement, the affiliate serves as the executive managing agent for one of the Partnership's cable television systems and is reimbursed for certain operating and administrative expenses. The Partnership paid $119,398, $112,805 and $99,617 under the terms of this agreement during 1995, 1994 and 1993, respectively.\nIn July 1994, the Partnership began paying monthly program license fees to Northland Cable News, Inc. (NCN), an affiliate of the General Partner, for the rights to distribute programming developed and produced by NCN. Total license fees paid to NCN during 1995 and 1994 were $156,653 and $68,631, respectively.\nCable Ad Concepts, Inc. (CAC), an affiliate of the General Partner, was formed in 1993 and began operations in 1994. CAC was organized to assist in the development of local advertising markets and management and training of local sales staffs. CAC billed the Partnership $41,529 and $17,565 in 1995 and 1994, respectively, for these services.\nDue to General Partner and Affiliates\nThe liability to the General Partner and affiliates consists of the following:\n4. PROPERTY AND EQUIPMENT:\nProperty and equipment consist of the following:\n-5-\nReplacements, renewals and improvements are capitalized. Maintenance and repairs are charged to expense as incurred.\n5. NOTES PAYABLE:\nNotes payable consist of the following:\nThe Partnership has a revolving credit facility with its creditor allowing for borrowings not to exceed $2,000,000 until the maturity of the term loan agreement on December 31, 2000. At December 31, 1995, the Partnership had $1,235,821 outstanding on its revolving credit facility.\nAnnual maturities of notes payable after December 31, 1995 are as follows:\nUnder the terms of the revolving credit and term loan agreement, the Partnership has agreed to restrictive covenants which require the maintenance of certain ratios, including Annual Operating Cash Flow to Interest Expense of less than 3.00 to 1 and Senior Debt to Annualized Operating Cash Flow of 3.5 to 1, among other restrictions. The General Partner submits quarterly debt compliance reports to the Partnership's creditor under this agreement.\n6. INCOME TAXES:\nIncome taxes payable have not been recorded in the accompanying financial statements because they are obligations of the partners. The federal and state income tax returns of the Partnership are prepared and filed by the General Partner.\n-6-\nThe tax returns, the qualification of the Partnership as such for tax purposes, and the amount of distributable partnership income or loss are subject to examination by federal and state taxing authorities. If such examinations result in changes with respect to the Partnership's qualification or in changes with respect to the income or loss, the tax liability of the partners would likely be changed accordingly.\nTaxable income to the limited partners was approximately $298,000, $298,000 and $299,000 for the three years in the period ended December 31, 1995 and is different from that reported in the statements of operations due to the difference in depreciation expense allowed for tax purposes and that amount recognized under generally accepted accounting principles. There were no other significant differences between taxable income and the net income (loss) reported in the statements of operations.\nIn general, under current federal income tax laws, a partner's allocated share of tax losses from a partnership is allowed as a deduction on his individual income tax return only to the extent of the partner's adjusted basis in his partnership interest at the end of the tax year. Any excess losses over adjusted basis may be carried forward to future tax years and are allowed as a deduction to the extent the partner has an increase in his adjusted basis in the Partnership through either an allocation of partnership income or additional capital contributions to the Partnership.\nIn addition, the current tax law does not allow a taxpayer to use losses from a business activity in which he does not materially participate (a \"passive activity,\" e.g., a limited partner in a limited partnership) to offset other income such as salary, active business income, dividends, interest, royalties and capital gains. However, such losses can be used to offset income from other passive activities. In addition, disallowed losses can be carried forward indefinitely to offset future income from passive activities. Disallowed losses can be used in full when the taxpayer recognizes gain or loss upon the disposition of his entire interest in the passive activity.\n7. COMMITMENTS AND CONTINGENCIES:\nLease Arrangements\nThe Partnership leases certain tower sites, office facilities and pole attachments under leases accounted for as operating leases. Rental expense included in operations amounted to $122,178, $113,357 and $117,924 in 1995, 1994 and 1993, respectively. Minimum lease payments to the end of the lease terms are as follows:\n-7-\n8. CABLE TELEVISION SYSTEM ACQUISITION:\nIn December 1995, the Partnership completed its purchase of certain operating assets and franchises of the cable television systems owned by Phoenix Cable Income Fund (Phoenix). These systems currently serve the communities of Sapphire Valley, Cedar Creek and Cedar Ridge Estates and other nearby unincorporated areas of Jackson County, North Carolina. The purchase price was $1,276,000. At the time of closing, the Partnership paid $1,235,800 in cash to Phoenix and assumed certain liabilities. The remaining purchase price was in the form of a $31,500 unsecured, subordinated, non-interest bearing, hold-back note payable due April 19, 1996.\n9. EFFECTS OF REGULATION:\nOn October 5, 1992, Congress enacted the Cable Television Consumer Protection and Competition Act of 1992 (the 1992 Act). On April 1, 1993, the Federal Communications Commission (FCC) adopted rules implementing rate regulation and certain other provisions of the 1992 Act, which became effective September 1, 1993. On February 22, 1994, the FCC adopted further rate regulation rules requiring additional reductions, which became effective May 15, 1994, and revised the benchmarks and formulas used to calculate such rates. Also in February, the FCC's initial rules governing cost-of-service showings were adopted with an effective date of May 15, 1994. Cable operators may pursue cost-of-service showings to justify charging rates for regulated services in excess of those established by the FCC in its benchmark regulatory scheme.\nOn May 5, 1995, the FCC announced the adoption of a simplified set of rate regulation rules applicable to small cable systems, defined as a system serving 15,000 or fewer subscribers, owned by small companies, defined as a company serving 400,000 or fewer subscribers. Under the FCC's definition, the Partnership is a small company and each of the Partnership's cable systems are small systems. Maximum permitted rates under these revised rules are dependent on several factors including the number of regulated channels offered, the net asset basis of plant and equipment used to deliver regulated services, the number of subscribers served and a reasonable rate of return. It is management's opinion that, in all material respects, the rates in effect in the Partnership's cable systems are within the maximum allowable rates permitted under the FCC's small cable system rules.\nOn February 8, 1996, the Telecommunications Act of 1996 (the 1996 Act) became law. The 1996 Act will eliminate all rate controls on cable programming service tiers of small cable systems, defined by the 1996 Act as systems serving fewer than 50,000 subscribers owned by operators serving fewer than 1% of all subscribers in the United States (approximately 600,000 subscribers). All of the Partnership's cable systems qualify as small cable systems. Many of the changes called for by the 1996 Act will not take effect until the FCC issues new regulations, a process that could take from several months to a few years depending on the complexity of the required changes and the statutory time limits. Because of this the full impact of the 1996 Act on the Partnership's operations cannot be determined at this time.\n-8-\n10. SUBSEQUENT TRANSACTION:\nThe Partnership is currently in the process of negotiating the acquisition of cable television systems serving approximately 12,450 subscribers in central Georgia for an approximate purchase price of $23,840,000. This purchase is expected to be completed in April 1996.\nThe Partnership is currently negotiating an agreement with its current lender to provide a $38,000,000 term loan and $500,000 revolving credit facility to finance this acquisition, repay amounts outstanding under the current term loan and provide future working capital.","section_15":""}
{"filename":"46656_1995.txt","cik":"46656","year":"1995","section_1":"Item 1. Business.\nThe corporate headquarters of Regency Equities Corp. (the \"Company\") are located at 3660 Wilshire Boulevard, Suite 336, Los Angeles, California 90010. The Company shares this suite on a rent-free basis with the accounting firm of Engel & Kalvin, LLP. The Company's Chief Financial Officer, Morris Engel, is a partner in Engel & Kalvin, LLP. The Company has two employees: Mr. Engel and Allan L. Chapman, the Company's Chairman of the Board, Chief Executive Officer and President.\nIn February 1990, the Company acquired an $850,000 promissory note with a four-year term and an interest rate of 13% per annum. The note was secured by a second mortgage on a commercial building in Westchester County, New York. The obligor on the promissory note was Earl Reiss (\"Reiss\"), and the guarantor was Richard Siegal (\"Siegal\").\nDuring 1993, Reiss ceased making interest payments on the mortgage loan, and the Company ceased accruing interest on the loan. The Company also commenced an action for collection against Reiss and Siegal. In November 1994, the court awarded a summary judgment against Reiss in the amount of $1,341,093. In July 1995, the court awarded a summary judgment against Siegal in the amount of $1,564,753. On October 3, 1995, the Company entered into a settlement agreement with Siegal whereby the Company received $900,000 in cash in full settlement of all amounts outstanding owed by Reiss and Siegal.\nThe Company owns a shopping center in Grand Rapids, Michigan. Two tenants lease space in the shopping center. Net operating income on this property was approximately $160,480 in 1995. For further information regarding the Grand Rapids property, see the Company's financial statements and notes thereto that are included in this Annual Report on Form 10-K.\nDuring 1995 and the preceding several years, substantially all of the Company's remaining assets have consisted of cash which has been deposited with several major United States banks. For further information regarding the amount of revenue, operating profit or loss and identifiable assets attributable to the Company's various operations, reference is made to the Company's financial statements and notes thereto that are included in this Annual Report on Form 10-K.\nIn September 1991, the Company learned that it had been named as a defendant in two amended complaints filed by the Federal Deposit Insurance Corporation (the \"FDIC\") and Columbia Savings and Loan Association (\"Columbia Savings\"), respectively, against Michael Milken and several hundred other defendants. A third complaint was filed in late 1991 by American Savings of Florida which contained essentially the same allegations as the FDIC and Columbia Savings actions. The three actions collectively are referred to herein as the \"Milken Litigation.\"\nDuring 1991 and 1992, the Company was forced to devote substantial time and effort to the Milken Litigation, which involved complaints of enormous complexity and which sought billions of dollars of damages. A Stipulation of Settlement dated as of March 9, 1992 (the \"Stipulation\") was approved by the U.S. District Court for the Southern District of New York. Among other things, the Stipulation effected in large part a global settlement of the Milken Litigation. Pursuant to the Stipulation, the Company contributed the amount of $1,000,000 in settlement of the claims against it. The Company made this payment into an escrow fund in March 1992. According to the Stipulation, ultimate consummation of the settlement was contingent upon several conditions the satisfaction of which was contemplated to take in excess of one year. For a period of approximately one and one-half years, such conditions remained unsatisfied and the Company did not know whether the actions against it might be revived. Effective September 29, 1993, the global settlement contemplated under the Stipulation became effective and the Company was dismissed with prejudice from the Milken Litigation on or about that date.\nIn view of the uncertainties posed by the Milken Litigation, it was extremely difficult for the Company to commit its efforts or resources to any potential business opportunities between September 1991 and September 1993. Following the effectiveness in September 1993 of the global settlement of the Milken Litigation, the Board of Directors established an acquisition committee to consider a suitable business venture or ventures in which the Company could employ its liquid assets. The committee members devoted a substantial amount of time in 1994 to the analysis and negotiation of such potential investments, although the Company did not consummate any business venture.\nIn December 1994, the Board of Directors scheduled an annual meeting of the Company's stockholders for January 16, 1995. On approximately December 28, 1994, the Company mailed to its stockholders a notice of the annual meeting and a proxy statement which solicited proxies with respect to six persons nominated for election as directors by the Board of Directors. The proxy statement advised stockholders that the Board of Directors had nominated four current directors -- William J. Adams, Allan L. Chapman, Ira L. Gottshall and Martin Oliner -- for reelection as directors. The proxy statement also provided that two new nominees -- Peter A. Glicklich and Richard M. Pachulski -- had been nominated for election by the Board of Directors, and that two incumbent directors -- Peter M. Graham and Ronald LaBow -- had not been nominated for reelection.\nOn or about January 9, 1995, a group called the Regency Shareholders Committee (the \"Committee\") began distributing to the Company's stockholders a proxy statement in which the Committee solicited proxies with respect to the election of an opposing slate of six director nominees. The Committee's proxy statement identified Messrs. Graham and LaBow as two of the nominees. The other nominees were Lawrence Butler, Jack Howard, Warren G. Lichtenstein and Steven Wolosky. The Committee's proxy statement disclosed that the Committee members were Messrs. Butler, Howard, LaBow and Lichtenstein, and that the costs of the Committee's proxy solicitation efforts would be borne by Mr. LaBow, Richard Sandler and Steel Partners II, L.P., a Delaware Limited Partnership (\"Steel Partners\"). Among other things, the Committee's proxy statement disclosed that the Committee's six nominees, if elected, would attempt to liquidate the Company, in whole or in part.\nAs a related action, on January 13, 1995 the Committee filed with the Securities and Exchange Commission a preliminary consent statement pursuant to which the Committee sought to solicit written consents from stockholders for the purpose of removing the Company's directors and electing the Committee's six nominees identified in the preceding paragraph.\nOn January 12, 1995, the Company filed a complaint for injunctive relief in the Delaware federal district court against the members of the Committee. Among other things, the complaint sought to enjoin the Committee from soliciting and voting proxies in connection with the January 16 meeting through the use of a proxy statement that the Company alleged was misleading. The Company dismissed its complaint several days later in light of the events described below.\nOn January 16, 1995, the Company's Board of Directors conducted a meeting prior to the scheduled meeting of the stockholders. The Board of Directors approved a cash dividend of $.15 per share to stockholders of record as of January 30, 1995 and payable on February 7, 1995. The aggregate amount of the dividend was $13,092,549, which represented approximately 77.5% and 77.8% of the Company's total assets and stockholders' equity, respectively, as of December 31, 1994. At its meeting, the Board of Directors also postponed the January 16 annual meeting of stockholders and approved in principle the liquidation and distribution to stockholders of the Company's remaining assets.\nDuring the period subsequent to January 16, 1995, the Company, the Committee and the Company's largest stockholder, First Lincoln Holdings, Inc. and its wholly owned subsidiary, Evergreen Acceptance Corporation, have discussed various proposals regarding the future of the Company. The parties currently are negotiating the terms of a transaction pursuant to which, among other things: (a) Evergreen Acceptance Corporation would purchase the shares of the Company's common stock that are owned by the Committee and its affiliates (including Steel Partners and Richard Sandler) and by various other persons, including EJ Associates and RA Partnership; (b) the sellers would agree not to attempt to gain control of the Company in the future; (c) the Company would reimburse the Committee for up to $150,000 of its costs incurred in connection with the proxy contest and related matters; and (d) the Company would deliver to the sellers, the other members of the Committee, First Lincoln Holdings, Inc., Evergreen Acceptance Corporation and Martin Oliner (the Chairman of the Board of First Lincoln Holdings, Inc. and a director of the Company) a general release of claims related to the proxy contest, and the Company would receive a general release of such claims from certain of such persons.\nThe proposed sellers collectively own approximately 52% of the Company's outstanding common stock, and each of the Committee, EJ Associates and RA Partnership owns more than 10% of the Company's common stock. See \"Item 12. Security Ownership of Certain Beneficial Owners and Management.\" Because First Lincoln Holdings, Inc. and Evergreen Acceptance Corporation jointly own approximately 39% of the Company's outstanding common stock, the purchase by Evergreen Acceptance Corporation of the sellers' stock would give First Lincoln Holdings, Inc. and Evergreen Acceptance Corporation ownership of approximately 91% of the Company's outstanding common stock. It is not yet certain when, or if, this transaction will be consummated.\nAs a result of the cash dividend that was paid on February 7, 1995, the Company's total assets were reduced by almost 78%. The Company's Board of Directors has not yet determined the future direction of the Company, including whether or not all or part of the Company's remaining assets should be liquidated and distributed to stockholders. The Board's decision as to the future direction of the Company will depend in part upon the resolution of the negotiations described above among the Committee, First Lincoln Holdings, Inc. and Evergreen Acceptance Corporation.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nSee \"Item 1. Business.\" The Company does not own any real property other than the Grand Rapids shopping center described above.\nItem 3.","section_3":"Item 3. Legal Proceedings.\n(a) Olshan v. Regency Equities Corp., No. 16\/92 (Civ. Ct. N.Y. County). --------------------------------\nIn an action filed on January 2, 1992 by Marvin L. Olshan, a former President and director of the Company, Mr. Olshan sought $468,000 plus interest from December 31, 1989 for additional compensation over and above his salary, for services allegedly rendered during 1988 and 1989. Mr. Olshan asserted two causes of action, one for breach of contract and the other for implied contract\/quantum meruit. In his complaint, Mr. Olshan alleged that, in addition to the salary which he was paid, there was an understanding and agreement between Mr. Olshan and certain members of the Company's Board of Directors that he would be \"fairly compensated\" for services performed during 1988 and 1989.\nOn December 8, 1994, the Company paid Mr. Olshan $10,000 in full settlement of the litigation commenced by him.\n(b) Regency Equities Corp. v. Reiss and Siegal, 93 Civ. 8096 (S.D.N.Y) ------------------------------------------ (CSH).\nReference is made to \"Item 1. Business\" for a description of the Company's lawsuit against Reiss and Siegal and the settlement of the Company's judgment against them.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nNo matters were submitted to the Company's stockholders during the quarter ended December 31, 1995.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters.\n(a) Market Information.\nUntil February 8, 1995, the principal market for the Company's common stock was the Nasdaq National Market System. On that date, primarily as a result of the Company's February 7, 1995 cash dividend which represented approximately 77.5% of its total assets, the Company's stock was delisted from the Nasdaq National Market System. The common stock is now traded over-the-counter, and there is not an active market for such stock.\nThe following table reflects the highest and lowest per share prices for the Company's common stock as quoted for the periods indicated. Because there is no longer an established, active public trading market for the Company's common stock, the following prices may not be an accurate indication of the value of such stock.\n1995 High Low ---- ---- --- 1st quarter $0.030 $0.015 2nd quarter 0.025 0.015 3rd quarter 0.027 0.015 4th quarter 0.027 0.019\n1994 High Low ---- ---- --- 1st quarter $0.156 $0.094 2nd quarter 0.125 0.125 3rd quarter 0.125 0.125 4th quarter 0.156 0.156\n(b) Holders.\nThe approximate number of record holders of the Company's common stock on February 1, 1996 was 1,685.\n(c) Dividends.\nThe Company paid no dividends during 1993 or 1994. The Company has not historically paid regular dividends on its common stock and does not presently intend to do so in the future.\nOn February 7, 1995, the Company paid an extraordinary cash dividend of $.15 per share to stockholders of record as of January 30, 1995. The Company did not pay any other dividends during 1995.\nItem 6.","section_6":"Item 6. Selected Financial Data.\n(In thousands except per share data)\nYear ended December 31, ------------------------------------------------ 1995 1994 1993 1992 1991 -------- -------- -------- -------- --------- Total revenues $ 926 $ 773 $ 797 $ 900 $ 1,247 Income (loss) from continuing operations before income taxes 171 267 (260) 375 (615) Net income (loss) 292 (298) 277 368 (524) Income (loss) from continuing operations before income taxes per share .002 .003 (.003) .004 (.007) Income (loss) .003 (.003) .003 .004 (.006) per share Dividends per share .15 0 0 0 0 Total assets 4,240 16,893 17,181 16,925 17,585 Liabilities 213 66 56 77 1,104 Shareholders' equity 4,027 16,827 17,125 16,848 16,481 Book value per share .05 .19 .20 .19 .19 Weighted average shares 87,284 87,284 87,284 87,284 87,284 outstanding ______________________________\nThe 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 financial statements and notes thereto that are included elsewhere in this Annual Report on Form 10-K. On February 7, 1995, the Company paid a cash dividend of $.15 per share to stockholders of record as of January 30, 1995. The aggregate amount of the dividend was $13,092,549, which represented approximately 77.5% and 77.8% of the Company's total assets and stockholders' equity, respectively, as of December 31, 1994. The nature and direction of the future business plans and operations of the Company are uncertain. See \"Item 1. Business.\" As a result of these factors, the selected financial data are not necessarily indicative of the Company's future financial condition or results of operations.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nThe following discussion should be read in conjunction with the Company's financial statements and notes thereto that are included elsewhere in this Annual Report on Form 10-K. See \"Item 1. Business\" for a description of recent developments affecting the Company and the future direction of the Company.\n(a) Results of Operations.\n(i) Year Ended December 31, 1995 Compared with Year Ended December 31, 1994.\nThe Company recorded income (i) before income taxes (benefit) and (ii) the cumulative effect of a change in accounting of $170,849 in 1995 compared to $266,555 in 1994. The decrease resulted principally from (i) a decrease in interest income of $349,624 caused by the decrease in cash earning interest attributable to the $13,092,549 dividend (offset in part by an increase in interest rates of approximately 1.0%); (ii) an increase in administrative expenses of $70,127 primarily due to increases in stockholders' meeting costs and directors' fees attributable to a proxy contest between the Company and the Regency Shareholders Committee; and (iii) an increase in professional fees of $189,833 primarily attributable to legal fees incurred in connection with the proxy contest.\nThe decline in operating results was partially offset by a gain of $500,000, representing the recovery of amounts previously reserved, on the settlement of amounts due to the Company in connection with a mortgage note and related interest receivable. See \"Item 1. Business.\"\nThe Company's net income of $292,281 in 1995 compared to its net loss of $297,980 in 1994 resulted primarily from an income tax benefit of $121,432 in 1995 as compared with income tax expense of $564,535 in 1994. The income tax benefit for 1995 results from the recognition for income tax purposes of bad debt expense in connection with the settlement of amounts owing to the Company on a mortgage note and related interest receivable and the related deferred tax asset of the loss carryforward. The Company has recognized deferred tax assets of $246,380 in 1995 as compared to $125,612 in 1994. A 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 with reasonable certainty. The amount of the deferred tax asset considered realizable, however, could be reduced in the near term if estimates of future taxable income during the carryforward period are reduced. The net change in the total valuation allowance for the years ended December 31, 1995 and 1994 were ($630,603) and ($512,963), respectively. The decrease in 1995 results primarily from the expiration of loss carryforwards. The decrease in 1994 was due to the expiration of loss carryforwards and the anticipated reduction in estimated future taxable income resulting from the Company's payment in February 1995 of a $13,092,549 cash dividend.\n(ii) Year Ended December 31, 1994 Compared with Year Ended December 31, 1993.\nThe Company recorded income before (i) income taxes (benefit) and (ii) the cumulative effect of a change in accounting, of $266,555 in 1994 compared to a loss of $259,598 in 1993. The principal reason for the increase in operating results was that the Company provided in 1993 for a reserve of $187,937 against accrued interest on its $850,000 promissory note and for a reserve of $450,000 against the principal balance of the note. See \"Note C to the Company's Financial Statements.\"\nThis increase in income was offset in part by an increase in professional fees of $95,129 attributable to (i) expenses incurred in connection with the litigation involving the $850,000 promissory note and the litigation involving Marvin Olshan, as described above in \"Item 3. Legal Proceedings,\" and (ii) fees incurred in the performance of a due diligence examination in connection with a proposed business acquisition by the Company. The proposed acquisition subsequently was abandoned, in part because of the decrease in available cash resulting from the Company's February 7, 1995 dividend to its stockholders.\nThe Company's net income of $276,527 in 1993 compared to its net loss of $297,980 in 1994 resulted primarily from (i) a provision for income taxes in 1994 of $564,535 and (ii) an income benefit of $446,982 in 1993. Included in the provision for income taxes for 1994 is a decrease in the valuation allowance for deferred tax assets of $512,963. This decrease was attributable to the expiration of loss carryforwards and to the Company's February 7, 1995 dividend to its stockholders, which changed the amount of future income expected to be realized by the Company.\n(b) Liquidity, Capital Resources and Future Operations.\nAs of December 31, 1995, the Company had cash in the amount of $2,975,808 invested in interest-bearing demand deposit accounts with two major United States banks. The Company has sufficient cash for its current operating needs; the Company does not currently have any material commitments for capital expenditures, and it has no present plans to incur any indebtedness.\nThe direction of the Company is uncertain, although the Company's Board of Directors is in the process of addressing this issue. See \"Item 1. Business.\" As a result, the reported financial information contained in this Annual Report on Form 10-K is not necessarily indicative of future operating results or of future financial condition.\n(c) New Accounting Standard.\nStatement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed of\" (SFAS No. 121), issued by the Financial Accounting Standards Board (FASB) is effective for financial statements for fiscal years beginning after December 15, 1995. The new standard establishes guidelines regarding when impairment losses on long-lived assets, which include plant and equipment, and certain identifiable intangible assets should be recognized and how impairment losses should be measured. The Company does not expect adoption to have a material effect on its financial position or results of operations.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nThe information with respect to this item is set forth in the Company's financial statements and notes thereto included in this Annual Report on Form 10-K and listed in the Index to Financial Statements and Financial Statement Schedules set forth in Item 14 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 directors and executive officers of the Company are as follows:\nName Age Position with the Company ____ ___ _________________________\nWilliam J. Adams 66 Director and Secretary\nAllan L. Chapman 58 Chairman of the Board of Directors, Chief Executive Officer and President\nMorris Engel 69 Chief Financial Officer and Treasurer\nIra L. Gottshall 38 Director\nPeter M. Graham 41 Director\nRonald LaBow 61 Director\nMartin Oliner 48 Director\nWilliam J. Adams has served as Secretary and a director of the Company since June 1992 and is presently engaged in the private practice of law. Mr. Adams also serves as a director of Combined Broadcasting, Inc. Mr. Adams served as Vice President, Secretary and General Counsel of First Lincoln Holdings, Inc., an insurance holding company which was formerly called First Executive Corporation, from 1982 through May 1993, and as a director and as Secretary and General Counsel of Evergreen Acceptance Corporation, a subsidiary of First Lincoln Holdings, Inc., from 1982 through May 1993.\nAllan L. Chapman has served as Chairman of the Board of Directors, Chief Executive Officer and President of the Company since June 30, 1992. He has also served as President of the Sterling Group, an actuarial consulting firm, since March 1991. He served as a Senior Vice President and a director of Executive Life Insurance Company from 1980 until February 1991 and as a Vice President of First Executive Corporation (now called First Lincoln Holdings, Inc.), an insurance holding company, from 1980 until February 1991.\nMorris Engel has served as Chief Financial Officer of the Company since May 1991 and as Treasurer since March 1993. He has also been a partner in the accounting firm of Engel & Kalvin since November 1990. Mr. Engel was a partner in the accounting firm of Laventhol & Horwath from 1969 to 1990.\nIra L. Gottshall has served as a director of the Company since August 1992 and as President of The Southern Group, an insurance holding company, since October 1995. Mr. Gottshall served as Chief Operating Officer of Pierce Financial & Insurance Services from January 1994 until October 1995; as President and Chief Executive Officer of First Delaware Life Insurance Company from July 1991 until January 1994 and as manager of its life insurance operations from April 1986 through July 1991; as a Senior Vice President of First Landmark Life Insurance Company from late 1990 until January 1994; as a Vice President of Evergreen Acceptance Corporation from September 1992 until January 1994; as a Vice President of Rhodes Financial, Inc. from September 1992 until January 1994; as a Vice President of Flintridge Corporation from September 1992 until January 1994; as a Vice President of Lincoln Indemnity Company from January 1993 until January 1994; and as President and Chief Executive Officer of Lincoln Liberty Life Insurance Company from May 1993 until January 1994.\nPeter M. Graham has served as a director of the Company since March 1991. Mr. Graham has served as Chairman of the Executive Committee of Ladenburg, Thalmann & Co. Inc., an investment banking firm, since 1990, as its Director of Corporate Finance since 1989, as its President since 1995 and as a director of the firm since 1982. He also serves as a director of Rudy's Restaurant Group, Suspension & Parts Industries, Ltd., Seventh Generation, Inc. and Prism Entertainment Corporation.\nRonald LaBow has served as a director of the Company since May 1985. Mr. LaBow has served as Chairman of the Board of Directors of WHX Corp., a steel manufacturing company, since January 1991. Mr. LaBow was employed by Neuberger & Berman, a stock brokerage firm, from 1978 through early 1990, and as a Vice President from 1979 to May 1985 of Liberty Fund, a public mutual fund, to which an affiliate of Neuberger & Berman serves as investment adviser. He also serves as a director of Teledyne, Inc.\nMartin Oliner has served as a director of the Company since November 1993 and has been engaged in the private practice of law since 1972. Mr. Oliner serves as Chairman of the Board of Directors, President and Chief Executive Officer of First Lincoln Holdings, Inc., an insurance holding company, and as a director and\/or President of First Delaware Life Insurance Company, First Landmark Life Insurance Company, Evergreen Acceptance Corporation, Rhodes Financial, Inc., Flintridge Corporation, Lincoln Indemnity Company, Lincoln Liberty Life Insurance Company, NYRIB, Inc. and Hallworth Corporation, all of which are wholly owned subsidiaries of First Lincoln Holdings, Inc.\nApproximately 39% of the outstanding shares of the Company's common stock are owned by First Lincoln Holdings, Inc., a privately held corporation, and its wholly owned subsidiary, Evergreen Acceptance Corporation. First Lincoln Holdings, Inc. was known formerly as First Executive Corporation. In May 1991, First Executive Corporation filed a petition under Chapter 11 of the Bankruptcy Code. First Executive Corporation was reorganized, effective September 11, 1992, as First Lincoln Holdings, Inc. In addition, Executive Life Insurance Company, a former subsidiary of First Lincoln Holdings, Inc., was placed into conservatorship by the California Insurance Commissioner in April 1991.\nMessrs. Adams, Chapman, Gottshall and Oliner have served as executive officers and\/or directors of First Lincoln Holdings, Inc. and\/or one or more of its subsidiaries. Messrs. Adams, Chapman and Gottshall were appointed as directors of the Company in 1992 following a request made to the Company by First Lincoln Holdings, Inc. and Evergreen Acceptance Corporation that such persons be appointed as directors, and Mr. Oliner was appointed as a director in 1993 following a similar request made by First Lincoln Holdings, Inc. and Evergreen Acceptance Corporation. The Company's Board of Directors acquiesced to such requests in light of the relative size of the beneficial ownership of the Company's common stock by First Lincoln Holdings, Inc. and Evergreen Acceptance Corporation.\nDirectors are elected at the annual meeting of stockholders to serve during the ensuing year and until a successor is duly elected and qualified. Officers serve at the pleasure of the Board of Directors. There are no family relationships between or among any of the directors and executive officers of the Company.\nItem 11.","section_11":"Item 11. Executive Compensation.\n(a) Summary Compensation Table.\nThe following table sets forth all compensation paid or awarded by the Company for services rendered during the fiscal years ended December 31, 1995, December 31, 1994 and December 31, 1993 to its Chief Executive Officer. No executive officer or other employee of the Company had aggregate compensation for salary and bonus in excess of $100,000 during the most recently completed fiscal year.\n_____________________________\n(1) Represents Mr. Chapman's receipt of directors' fees.\n(b) Compensation of Directors.\nDuring 1995, the Company's directors received $1,000 per Board meeting and $500 per committee meeting, and their expenses incurred in attending such meetings were reimbursed by the Company.\n(c) Indemnification Agreements.\nThe Company has entered into an indemnification agreement with each of its current directors and executive officers. The indemnification agreements provide for the mandatory indemnification of each director and executive officer by the Company with respect to proceedings arising out of or related to actions taken or omitted to be taken by the individuals as directors, officers, employees or agents of the Company. Under the agreements, the Company is obligated to indemnify each of these individuals to the fullest extent permitted by Delaware law and, if requested, is obligated to advance the reasonable expenses of any such individual with respect to a proceeding, unless independent legal counsel determines that such payments are not permitted. The Company's obligations under these agreements continue notwithstanding the cessation of the individuals' tenure as directors and officers of the Company.\n(d) Compensation Committee Interlocks and Insider Participation.\nThe members of the Company's Stock Option\/Compensation Committee are William J. Adams and Ronald LaBow. Mr. Adams is the Company's Secretary, which is not a salaried position.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nWith respect to each person known by the Company to be the beneficial owner of more than five percent of its common stock, each director of the Company, each of the Company's executive officers named in the Summary Compensation Table presented above and all directors and executive officers of the Company as a group, the following table sets forth the number of shares of common stock beneficially owned as of March 1, 1996 by each such person or group and the percentage of the outstanding shares of the Company's common stock beneficially owned as of March 1, 1996 by each such person or group. Unless otherwise indicated, each of the following stockholders has, to the Company's knowledge, sole voting and investment power with respect to the shares beneficially owned, except to the extent that such authority is shared by spouses under applicable law or otherwise noted herein. Information presented below with respect to persons or groups owning more than five percent of the Company's common stock is based upon Schedule 13D or 13G filings made by such persons or groups with the Securities and Exchange Commission. The proposed transaction pursuant to which First Lincoln Holdings, Inc. and Evergreen Acceptance Corporation may acquire ownership of a majority of the Company's outstanding common stock is described above in \"Item 1. Business.\"\nApproximate Shares of Stock Percent Name of Beneficial Owner Beneficially Owned of Class - ----------------------- ------------------ ----------- Five Percent Shareholders\nFirst Lincoln Holdings, Inc. 34,122,125 39.1% Evergreen Acceptance Corporation 3 Christina Center, Suite 1004 201 North Walnut Street Wilmington, Delaware 19801\nRegency Shareholders Committee 9,666,500 11.1 Richard Sandler Robert Frome\nRA Partnership 9,408,000 10.8 9560 Wilshire Boulevard Beverly Hills, CA 90210\nEJ Associates 8,843,700 10.1 9560 Wilshire Boulevard Beverly Hills, CA 90210\nDirectors and Named Executive Officers\nWilliam J. Adams 20,000 *\nAllan L. Chapman 235,000 *\nIra L. Gottshall 0 0\nPeter M. Graham 0 0\nRonald LaBow 0 0\nMartin Oliner 0 0\nAll Directors and Executive Officers as a Group (7 persons) 255,000 *\n______________________________\n* Owns less than 1% of the Company's outstanding shares of common stock.\nEvergreen Acceptance Corporation is a wholly owned subsidiary of First Lincoln Holdings, Inc. Evergreen Acceptance Corporation is the record owner of 33,112,125 shares of the Company's common stock; Evergreen Acceptance Corporation and First Lincoln Holdings, Inc. share voting and investment power with respect to such shares. First Lincoln Holdings, Inc. is the record owner of 1,010,000 shares of the Company's common stock, as to which it has sole voting and investment power.\nAs described above in \"Item 1. Business,\" the Regency Shareholders Committee (the \"Committee\") engaged in a proxy contest with the Company in connection with the January 16, 1995 annual meeting of stockholders. The following information is based upon a Schedule 13D filed by the individuals and entities described below with the Securities and Exchange Commission on or about January 5, 1995, as amended by filings made on or about January 10, 13 and 17, 1995, respectively:\nThe Committee (through its members), Richard Sandler (individually and as trustee) and Robert Frome (individually and through his trust) beneficially own an aggregate of 9,666,500 shares of the Company's common stock, representing approximately 11.1% of the Company's outstanding common stock. Prior to January 1, 1995, such group owned less than 10% of the Company's outstanding common stock. The members of the Committee, which is not a formal legal entity, are Lawrence Butler, Jack Howard, Ronald LaBow and Warren G. Lichtenstein. Although the Schedule 13D, as amended, contains inconsistent statements, it appears that Messrs. Butler and Lichtenstein and Steel Partners II, L.P. (\"Steel Partners\"), a partnership with which they are affiliated, share voting and investment power with respect to 6,519,625 shares of the Company's common stock. Mr. LaBow is not listed as having voting or investment power with respect to any shares of the Company's common stock and Mr. Howard, the fourth Committee member, is listed as having sole voting and investment power with respect to 50,000 shares of the Company's common stock.\nAs described above in \"Item 1. Business,\" Mr. Sandler agreed to bear a portion of the Committee's proxy solicitation expenses. Mr. Sandler is listed in the Schedule 13D, as amended, as having beneficial ownership of 2,996,875 shares of the Company's common stock; with respect to such shares, Mr. Sandler has sole voting and investment power over 346,875 shares; the M&L 1981 Trust, of which Mr. Sandler is trustee, has sole voting and investment power over 1,765,000 shares; and the L&S 1981 Trust, of which Mr. Sandler is also the trustee, has sole voting and investment power over 885,000 shares. The Schedule 13D, as amended, also states that Robert Frome, who agreed to participate in the Committee's effort to remove the Company's directors through written consents from stockholders, has beneficial ownership of 100,000 shares of the Company's common stock; with respect to such shares, Mr. Frome has sole voting and investment power over 85,000 shares, and Mr. Frome's pension and profit-sharing trust has sole voting and investment power over 15,000 shares.\nThe business address of the Committee, Steel Partners and Messrs. Butler and Lichtenstein is 750 Lexington Avenue, 27th Floor, New York, New York 10022. The business address of Mr. Howard is 2927 Montecito Avenue, Santa Rosa, California 95404. The business address of Mr. LaBow is 110 East 59th Street, New York, New York 10019. The business address of Mr. Sandler and his trusts is 844 Moraga Drive, Los Angeles, California 90049. The business address of Mr. Frome is 505 Park Avenue, New York, New York 10022.\nThe Company believes that the partners of this partnership are Michael Milken and a member of his immediate family.\nThe Company believes that the partners of this partnership are Lowell Milken and a member of his immediate family. Lowell Milken and Michael Milken are brothers.\nMr. LaBow is not the record owner of any shares of the Company's common stock. Mr. LaBow is a member of the Committee. Information presented for Mr. LaBow does not include any shares of the Company's common stock that are owned by the Committee or any of its members, and Mr. LaBow disclaims beneficial ownership of such shares.\nInformation presented for Mr. Oliner does not include any shares of the Company's common stock that are owned by First Lincoln Holdings, Inc. or its wholly owned subsidiary, Evergreen Acceptance Corporation. Mr. Oliner serves as Chairman of the Board, Chief Executive Officer and President of First Lincoln Holdings, Inc. Mr. Oliner disclaims beneficial ownership of the shares of the Company's common stock that are owned by First Lincoln Holdings, Inc. and Evergreen Acceptance Corporation.\nSection 16(a) of the Securities Exchange Act of 1934 and regulations adopted thereunder require the Company's directors and officers and persons who own more than ten percent of the outstanding shares of the Company's Common Stock (collectively, the \"Reporting Persons\") to file with the Securities and Exchange Commission and the Company initial reports of ownership and reports of changes in ownership of the Company's Common Stock and other equity securities. Based solely upon (i) the Company's review of the Forms 3, 4 and 5 that were furnished by the Reporting Persons to the Company pursuant to Section 16(a) and applicable regulations during and with respect to the Company's most recent fiscal year and (ii) written representations received by the Company from its directors and officers, the Company believes that all applicable Section 16(a) filing requirements were complied with on a timely basis by the Reporting Persons during and with respect to the Company's most recent fiscal year.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nMorris Engel, the Company's Chief Financial Officer and Treasurer, is a partner in the accounting firm of Engel & Kalvin, LLP. The Company paid fees of $27,946 to Engel & Kalvin in 1995 in consideration for accounting and tax services rendered by that firm.\nReference is made to \"Item 1. Business\" for a description of a proposed transaction between the Company and several stockholders who each own more than ten percent of the Company's outstanding common stock.\nPart IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statements and Financial Statement Schedules and Reports on Form 8-K.\nIndex to Financial Statements and Financial Statement Schedules.\nPage No.\nReport of BDO Seidman, LLP. . . . . . . . . . . . . . . .\nBalance Sheets - December 31, 1995 and 1994 . . . . . . .\nStatements of Operations - Years Ended December 31, 1995, 1994 and 1993 . . . . . .\nStatements of Changes in Shareholders' Equity - Years Ended December 31, 1995, 1994 and 1993 . . . . . . . . . . . . . . . . . .\nStatements of Cash Flows - Years Ended December 31, 1995, 1994 and 1993 . . . . . . . . .\nNotes to Financial Statements . . . . . . . . . . . . . .\nReport of BDO Seidman, LLP on Schedules . . . . . . . . .\nSchedule II - Valuation and Qualifying Accounts . . . . .\nSchedule III - Real Estate and Accumulated Depreciation . . . . . . . . . . . . . . . . . . .\nSchedule IV - Mortgage Loan on Real Estate and Interest Earned on Mortgage . . . . . . . . . . . . . . . . . . . . .\nSchedules not listed above are omitted because they are inapplicable or the information required is presented in the financial statements or the footnotes thereto.\nExhibits.\n3.1 Certificate of Incorporation of the Company as amended and restated to date, incorporated herein by this reference to Exhibit 3.1 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991.\n3.2 By-laws of the Company, incorporated herein by this reference to Exhibit 3.2 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990.\n10.1 1986 Stock Option Plan, incorporated herein by this reference to Exhibit 10.1 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991.\n10.2 Incentive Stock Option Plan, incorporated herein by this reference to Exhibit 10.2 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991.\n10.3 Lease Agreement dated February 17, 1978 and amended by First Amendment of Lease dated September 1, 1984 and by Second Amendment of Lease dated as of June 1, 1990, incorporated herein by this reference to Exhibit 10.6 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990.\n10.4 Indemnification Agreement dated February 7, 1995, between the Company and William J. Adams, incorporated herein by this reference to Exhibit 10.4 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994.\n10.5 Indemnification Agreement dated February 7, 1995, between the Company and Allan L. Chapman, incorporated herein by this reference to Exhibit 10.5 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994.\n10.6 Indemnification Agreement dated February 7, 1995, between the Company and Morris Engel, incorporated herein by this reference to Exhibit 10.6 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994.\n10.7 Indemnification Agreement dated February 7, 1995, between the Company and Ira L. Gottshall, incorporated herein by this reference to Exhibit 10.7 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994.\n10.8 Indemnification Agreement dated February 7, 1995, between the Company and Peter M. Graham, incorporated herein by this reference to Exhibit 10.8 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994.\n10.9 Indemnification Agreement dated February 14, 1995, between the Company and Ronald LaBow, incorporated herein by this reference to Exhibit 10.9 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994.\n10.10 Indemnification Agreement dated February 7, 1995, between the Company and Martin Oliner, incorporated herein by this reference to Exhibit 10.10 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994.\n27.1 Financial Data Schedule (included only in the electronic filing)\nReports on Form 8-K.\nNo Current Reports on Form 8-K were filed by the Company during the quarter ended December 31, 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 27, 1996 REGENCY EQUITIES CORP.\nBy \/s\/ ALLAN L. CHAPMAN ________________________________________ Allan L. Chapman, Chairman of the Board, 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:\nDate: March 27, 1996 By \/s\/ ALLAN L. CHAPMAN ___________________________________________ Allan L. Chapman Chairman of the Board, Chief Executive Officer and President (Principal Executive Officer)\nDate: March 27, 1996 By \/s\/ MORRIS ENGEL __________________________________________ Morris Engel Chief Financial Officer and Treasurer (Principal Financial and Accounting Officer)\nDate: March 27, 1996 By \/s\/ WILLIAM J. ADAMS ___________________________________________ William J. Adams Secretary and Director\nDate: March 27, 1996 By \/s\/ RONALD LaBOW ___________________________________________ Ronald LaBow Director\nDate: March 27, 1996 By \/s\/ PETER M. GRAHAM ___________________________________________ Peter M. Graham Director\nDate: March 27, 1996 By \/s\/ IRA L. GOTTSHALL ____________________________________________ Ira L. Gottshall Director\nDate: March 27, 1996 By \/s\/ MARTIN OLINER ___________________________________________ Martin Oliner Director\nREGENCY EQUITIES CORP.\nANNUAL REPORT ON FORM 10-K\nITEM 8 AND ITEM 14(a)(1) and 14(a)(2)\nFINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nYEAR ENDED DECEMBER 31, 1995\nREPORT OF INDEPENDENT AUDITORS\nBoard of Directors Regency Equities Corp.\nWe have audited the accompanying balance sheets of Regency Equities Corp. as of December 31, 1995 and 1994 and the related statements of operations, changes in shareholders' equity and cash flows for each of the three years in the period ended December 31, 1995. 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 Regency Equities Corp. at December 31, 1995 and 1994 and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles.\nBDO SEIDMAN, LLP\nLos Angeles, California February 9, 1996\nREGENCY EQUITIES CORP.\nBALANCE SHEETS DECEMBER 31, ------------------------------\n1995 1994 ------------ ------------- ASSETS Cash (Note A and H) $ 2,975,808 $15,298,990 Rent receivable 100,989 105,441 Rental property owned, net of write down for possible loss of $215,000 and accumulated depreciation of $245,340 in 1995 and $196,272 in 1994 (Note B) 1,011,101 1,060,169 Deferred income taxes (Note D) 151,822 28,670 Mortgage receivable, net of reserve for collectibility of $450,000 in 1994 (Note C) 400,000 ----------- -----------\n$ 4,239,720 $16,893,270 =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY\nLIABILITIES Accounts payable and accrued expenses $ 211,778 $ 60,660 Income taxes payable (Note D) 1,320 5,720 ----------- -----------\n213,098 66,380 ----------- ----------- CONTINGENCIES (NOTES A and G)\nSHAREHOLDERS' EQUITY (Note H): Preferred stock, par value $.01 per share, authorized 5,000,000 shares; none issued Common stock, par value $.01 per share, authorized 125,000,000 shares; issued and outstanding 87,283,661 shares 872,836 872,836 Additional paid-in capital 47,660,331 47,660,331 Accumulated deficit ( 44,506,545) ( 31,706,277) ----------- -----------\n4,026,622 16,826,890 ----------- -----------\n$ 4,239,720 $16,893,270 =========== ===========\nSee accompanying notes to financial statements\nREGENCY EQUITIES CORP.\nSTATEMENTS OF OPERATIONS\nYEAR ENDED DECEMBER 31, ----------------------------------- 1 9 9 5 1 9 9 4 1 9 9 3 --------- --------- --------- REVENUES: Interest income (Note H) $ 160,946 $ 510,570 $ 516,863 Rental income 264,850 262,711 279,936 Recovery of reserve for collectibility of mortgage receivable (Note C) 500,000 ---------- ---------- ---------\nTOTAL REVENUES 925,796 773,281 796,799 ---------- ---------- ---------\nEXPENSES: Administrative expense 221,887 151,760 159,445 Professional fees (Note F) 428,690 238,857 143,727 Rental expense 104,370 106,031 115,185 Litigation settlement (Note G) 10,000 Provision for bad debts (Note C) 637,937 Other expenses 78 103 ---------- ---------- ----------\nTOTAL EXPENSES 754,947 506,726 1,056,397 ---------- ---------- ----------\nINCOME (LOSS) BEFORE INCOME TAXES (BENEFIT) 170,849 266,555 ( 259,598)\nPROVISION (BENEFIT) FOR INCOME TAXES (NOTE D) ( 121,432) 564,535 ( 89,143) --------- --------- --------\nINCOME (LOSS) BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING 292,281 ( 297,980) ( 170,455)\nCUMULATIVE EFFECT OF CHANGE IN ACCOUNTING: Tax benefit for change in accoun- ting for income taxes (NOTE D) 446,982 ---------- ---------- ---------- NET INCOME (LOSS) $ 292,281 ($ 297,980) $ 276,527 ========== =========== ==========\nWEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING 87,283,661 87,283,661 87,283,661 ========== ========== ========== INCOME (LOSS)PER SHARE:\nINCOME (LOSS) BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING $ .003 ($ .003) ($ .002) ========== ========== ==========\nNET INCOME (LOSS) $ .003 ($ .003) $ .003 ========== ========== ==========\nSee accompanying notes to financial statements\nREGENCY EQUITIES CORP.\nSTATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY\nTHREE YEARS ENDED DECEMBER 31, 1995\nCOMMON STOCK ADDITIONAL -------------------- NUMBER OF PAID-IN ACCUMULATED SHARES AMOUNT CAPITAL DEFICIT ---------- -------- --------- -----------\nBALANCE AT January 1, 1993 87,283,661 $872,836 $47,660,331 ($31,684,824)\nNet income 276,527 ---------- -------- ----------- ----------- BALANCE AT December 31, 1993 87,283,661 872,836 47,660,331 ( 31,408,297)\nNet loss ( 297,980) ---------- -------- ----------- -----------\nBALANCE AT December 31, 1994 87,283,661 872,836 47,660,331 ( 31,706,277)\nDividends paid (Note H) ( 13,092,549)\nNet income 292,281 ---------- -------- ------------ -----------\nBALANCE AT December 31, 1995 87,283,661 $872,836 $47,660,331 ($44,506,545) ========== ======== =========== ===========\nSee accompanying notes to financial statements\nREGENCY EQUITIES CORP.\nSTATEMENTS OF CASH FLOWS YEAR ENDED DECEMBER 31, --------------------------------------- 1 9 9 5 1 9 9 4 1 9 9 3 ------------ ----------- ----------- INCREASE (DECREASE) IN CASH\nOPERATING ACTIVITIES:\nNet income (loss) 292,281 ($ 297,980) $ 276,527\nAdjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation 49,068 49,069 49,068\nChanges in operating assets and liabilities: Rent receivable 4,453 8,984 ( 141) Interest receivable, net 40,228 99,824 Accounts payable and accrued expenses 151,117 5,553 ( 20,270) Mortgage receivable 850,000 Reserve for collectibility of mortgage receivable ( 450,000) 450,000 Refundable income taxes 1,900 Deferred income taxes ( 123,152) 557,865 ( 541,938) Income taxes payable ( 4,400) 4,460 180 ---------- ----------- ---------- NET CASH PROVIDED BY OPERATING ACTIVITIES 769,367 368,179 315,150 ----------- ----------- ---------- FINANCING ACTIVITIES: Dividends paid ( 13,092,549) ----------- NET CASH USED IN FINANCING ACTIVITIES ( 13,092,549) ---------- ---------- ----------- INCREASE (DECREASE) IN CASH ( 12,323,182) 368,179 315,150\nCASH BEGINNING OF YEAR 15,298,990 14,930,811 14,615,661 ----------- ----------- ----------- CASH END OF YEAR $ 2,975,808 $15,298,990 $14,930,811 =========== =========== =========== See accompanying notes to financial statements\nNOTES TO FINANCIAL STATEMENTS\nREGENCY EQUITIES CORP.\nDecember 31, 1995\nNOTE A - SIGNIFICANT ACCOUNTING POLICIES\nBUSINESS: The Company is incorporated in Delaware. The Company's business activity has been the operation of a shopping center in Grand Rapids, Michigan. The Company settled in 1995 the collection of a mortgage note (see Note C). The Company is considering exploring new investment opportunities or possible liquidation.\nCASH: Regency Equities Corp.'s (the \"Company\") cash at December 31, 1995 is deposited with two major U.S. banks. At December 31, 1995 and throughout the year the Company has maintained balances in its bank accounts in excess of the federally insured limit.\nDEPRECIATION: Rental property is depreciated over its estimated useful life of 25 years using the straight-line method. Tenant improvements are amortized over the life of the lease using the straight-line method.\nRENTAL INCOME: The Company recognizes minimum rents from leases on a straight-line basis over the lease term. Overage rentals are recognized in the period earned.\nINCOME TAXES: The Company provides for income taxes in accordance with the Financial Accounting Standards Board Statement of Financial Accounting Standards (\"SFAS\") No. 109, \"Accounting for Income Taxes\" effective January 1, 1993. SFAS No. 109 requires the asset and liability method of accounting for income taxes. Under the asset and liability method, deferred income taxes are recognized for the tax consequences of \"temporary differences\" by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities. In addition, the tax benefits from the future utilization of available \"Net Operating Loss Carryovers\" (computed at current enacted statutory tax rates) are treated as an asset. A valuation allowance is required for all or a portion of such asset based on the Company's determination of the amount of realization that is more likely than not to occur. Under SFAS No. 109, the effect on deferred taxes of a change in tax rates is recognized in the income statement in the period that includes the enactment date.\nNOTES TO FINANCIAL STATEMENTS\nREGENCY EQUITIES CORP.\nDecember 31, 1995\nNOTE A - SIGNIFICANT ACCOUNTING POLICIES (continued)\nMORTGAGE AND INTEREST RECEIVABLE: Effective December 31, 1993, the Company adopted Financial Accounting Standards Board Statement of Financial Accounting Standards (\"SFAS\") No. 114, \"Accounting by Creditors for Impairment of a Loan.\" In accordance with SFAS 114, the Company had provided an allowance for credit losses based upon the estimated fair value of the underlying collateral less estimated costs to sell. This allowance was reversed in 1995 (See Note C).\nACCOUNTING ESTIMATES: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures 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.\nNOTE B - RENTAL PROPERTY AND DEPRECIATION\nRental property consists of a shopping center in Grand Rapids, Michigan. Two tenants lease all of the space in the shopping center. The leases expire on July 10, 1997 and August 31, 1999. The future minimum rentals, excluding amounts contingent upon tenant sales levels, from these leases are as follows:\n1996 $230,000 1997 225,000 1998 204,000 1999 136,000 -------- $795,000 ======== NOTE C - MORTGAGE RECEIVABLE\nOn February 12, 1990, the Company entered into a second mortgage agreement on a commercial building in New York state. The $850,000 mortgage earned interest at a rate of 13% per annum and was due on March 1, 1994. Interest originally was payable annually at the rate of 8.5% per annum with the balance of the interest and principal due upon the maturity of the loan.\nNOTES TO FINANCIAL STATEMENTS\nREGENCY EQUITIES CORP.\nDecember 31, 1995\nNOTE C - MORTGAGE RECEIVABLE (continued)\nThe note was amended effective as of June 1, 1992 to provide that (a) interest was currently payable at an annual rate of 3%, (b) the additional 5.5% of annual interest to be deferred was to bear interest at 6% per annum compounded monthly, and, (c) the balance of the interest was due with the principal upon the maturity of the loan.\nDuring 1993, the borrower ceased making interest payments on the mortgage and the Company (a) ceased accruing interest on the mortgage, and (b) commenced an action for collection against the borrower and the guarantor of the mortgage. At December 31, 1994 the Company had provided a reserve of $187,937 against accrued interest and a reserve of $450,000 against the principal balance. The reserves totalling $637,937 were determined based upon management's estimate of the net realizable value of the underlying property.\nIn November 1994, the United States District Court for the Southern District of New York awarded a summary judgment against the borrower in the amount of $1,341,093, which included unpaid principal and accrued interest through October 28, 1994. In July 1995, the Court awarded a summary judgment against Siegal in the amount of $1,564,753. The Company vigorously pursued collection of the judgement and on October 3, 1995, entered into a settlement agreement whereby the Company received $900,000 in cash in full settlement of all amounts outstanding. The settlement resulted in a gain of $500,000 representing the recovery of amounts previously reserved.\nNOTE D - INCOME TAXES (BENEFIT)\nEffective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109 \"Accounting for Income Taxes\" (SFAS 109). SFAS 109 is an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Company's financial statements or tax returns. If it is more likely than not that some portion or all of a deferred tax asset will not be realized, a valuation allowance is recognized. In accordance with SFAS 109, the cumulative effect of\nNOTES TO FINANCIAL STATEMENTS\nREGENCY EQUITIES CORP.\nDecember 31, 1995\nNOTE D - INCOME TAXES (BENEFIT) (continued)\nadoption on prior years' results of operations totalling $446,982, has been shown in the Statement of Income for 1993, the year of change.\nThe provision (benefit) for income taxes consists of:\n1995 1994 1993 -------- -------- -------- Federal: Current ($157,115) $ 90,641 $ 128,939 Deferred 213,173 ( 7,006) (216,748) State: Current ( 23,533) 20,728 29,508 Deferred 29,506 ( 158) ( 30,842)\nIncrease (decrease) in valuation allowance of deferred tax assets ( 183,463) 460,330 -------- -------- ---------\nTotal ($121,432) $564,535 ($ 89,143) ======== ======== ========\nThe current benefit for 1995 results primarily from the deduction for income tax purposes of a bad debt provision provided for in 1993. The deferred benefit for 1993 results primarily from a provision for bad debt and litigation settlement, respectively, deducted for financial reporting purposes but not for income tax purposes.\nThe reconciliation of the provision for income taxes and the amount computed by applying the statutory federal income tax rate to earnings (loss) before income taxes is as follows: 1995 1994 1993 ------ ------ ------ Federal tax (benefit) at statutory rate 34.0% 34.0% (34.0%) State income tax (benefit), net of federal income tax benefit 2.3 5.1 ( .3) Increase (decrease) in valuation allowance of deferred tax assets (110.9) 172.7 ------ ------ ------- Provision (benefit) for income taxes ( 74.6%) 211.8% (34.3%) ====== ====== ======\nNOTES TO FINANCIAL STATEMENTS\nREGENCY EQUITIES CORP.\nDecember 31, 1995\nNOTE D - INCOME TAXES (BENEFIT) (continued)\nDeferred tax assets (liabilities) consist of:\n1995 1994 ---------- ----------\nDepreciation ($ 66,002) ($ 67,579) Rental income ( 28,556) ( 29,363) ---------- ----------\nGross deferred tax liabilities ( 94,558) ( 96,942) ---------- ----------\nBad debt provision 237,150 Rental property loss allowance 76,435 76,435 Loss carryforwards 6,752,704 7,025,389 ---------- ---------- Gross deferred tax assets 6,829,139 7,338,974\nValuation allowance ( 6,582,759) ( 7,213,362) ---------- ----------\nNet deferred tax assets 246,380 125,612 ---------- ---------\nDeferred taxes $ 151,822 $ 28,670 ========== ==========\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 assets reflects management's estimate of the amount which will be realized from future profitability with reasonable certainty. The amount of the deferred tax asset considered realizable, however, could be reduced in the near term if estimates of future taxable income during the carryforward period are reduced. The valuation allowance as of December 31, 1993, the year in which SFAS 109 was adopted, was $7,726,325. The net change in the total valuation allowance for the years ended December 31, 1995 and 1994 were ($630,603) and ($512,963), respectively. The decrease in 1995 results primarily from the expiration of loss carryforwards. The decrease in 1994 was due to the expiration of loss carryforwards and the anticipated reduction in estimated future taxable income resulting from the Company's payment in February 1995 of a $13,092,549 cash dividend.\nNOTES TO FINANCIAL STATEMENTS\nREGENCY EQUITIES CORP.\nDecember 31, 1995\nNOTE D - INCOME TAXES (BENEFIT) (concluded)\nThe Company had operating loss carryforwards at December 31, 1995 for federal tax purposes as follows:\nEXPIRES IN: 1996 $ 1,000,000 1997 1,700,000 1999 6,490,000 2000 8,700,000 2007 620,000 2010 460,000 ----------- $18,970,000 ===========\nThe Company also had significant Michigan state operating loss carryforwards at December 31, 1995.\nThe Company made income tax payments of $6,120, $2,210, and $6,433 during 1995, 1994 and 1993, respectively.\nNOTE E - INCENTIVE STOCK OPTION PLANS\nThe Company has incentive stock option plans for certain officers that provide for options to be granted at a price equal to fair market value at the date of the grant. Options cannot be exercised after ten years from the date of the grant or more than three months after the termination of an optionee's employment with the Company. No stock options were granted or exercised in 1993, 1994 or 1995. No options were outstanding at December 31, 1995; however, options were available to be granted for 5,450,000 shares.\nNOTE F - RELATED PARTY TRANSACTIONS\nThe current Chief Financial Officer is a partner in a certified public accounting firm which provides accounting and tax services to the Company. Fees paid by the Company to that firm were $27,946 in 1995, $56,238 in 1994 and $36,977 in 1993.\nNOTES TO FINANCIAL STATEMENTS\nREGENCY EQUITIES CORP.\nDecember 31, 1995\nNOTE G - LITIGATION SETTLEMENT\nIn an action commenced by Marvin L. Olshan, a former president and director of the Company, Mr. Olshan sought $468,000 plus interest from December 31, 1989 for additional compensation over and above his salary, for services allegedly rendered during 1988 and 1989. On December 8, 1994 the Company paid Mr. Olshan $10,000 in full settlement of the matter.\nNOTE H - DIVIDENDS PAID\nOn January 16, 1995, the Board of Directors declared a $13,092,549 ($.15 per share) dividend which was paid February 7, 1995 to shareholders of record as of January 30, 1995. The dividend represented approximately 77.5% and 77.8% of total assets and shareholders' equity at December 31, 1994, respectively. Included in interest income for the years ended December 31, 1994 and 1993 is $442,698 and $372,365, respectively earned on the $13,092,549 cash.\nThe Company's Board of Directors has not yet determined the future direction of the Company, although the Board intends to give careful consideration to a liquidation and distribution to shareholders of all or substantially all of the Company's remaining assets.\nREPORT OF INDEPENDENT AUDITORS ON FINANCIAL STATEMENT SCHEDULES\nBoard of Directors Regency Equities Corp.\nThe audits referred to in our report dated February 9, 1996 relating to the financial statements of Regency Equities Corp., which is contained in Item 8 of this Form 10-K included the audit of the financial statement schedules listed in the accompanying index. These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statement schedules based on our audits.\nIn our opinion such financial statement schedules present fairly, in all material respects, the information set forth therein.\nBDO SEIDMAN, LLP\nLos Angeles, California February 9, 1996\nREGENCY EQUITIES CORP.\nVALUATION AND QUALIFYING ACCOUNTS - SCHEDULE II\nDecember 31, 1995\nAdditions Additions Balance at (deductions)(deductions)Balance beginning charged to from at end of year operations reserve of year ---------- ---------- --------- ---------\nAllowance for credit losses: Year ended December 31, 1994$ 637,937 $ $ $ 637,937 ---------- ---------- --------- ---------- Year ended December 31, 1995$ 637,937 $ ($637,937) $ 0 ---------- ---------- -------- ----------\nDeferred tax valuation allowance deducted from deferred tax assets: Year ended December 31, 1994$7,726,325 $ 460,330 ($973,293) $7,213,362 ---------- --------- -------- ---------- Year ended December 31, 1995$7,213,362 ($ 183,463)($447,140) $6,582,759 ---------- --------- -------- ----------\nREGENCY EQUITIES CORP. REAL ESTATE AND ACCUMULATED DEPRECIATION - SCHEDULE III\nCosts capitalized Gross amount subsequent to at which carried (4) Life (years) Initial Cost acquisition at close of period Accumu- on which -------------- ------------ ------------------------- (1) Bldg. & Bldg. & lated deprecia- Descrip- Improve- Improve- Improve- (5) Deprecia- Date tion is tion Land ments ments Land ments Total tion acquired computed - ---------- ------ -------- -------- ------ --------- ----- --------- --------- --------\nDecember 31, 1995 $266,076 $794,337 $411,028 $266,076 $1,205,365 $1,471,441 $245,340 Oct 1976 25\n(1) The property is a shopping arcade in Grand Rapids, Michigan.\n(2) The property was not subject to encumbrance at December 31, 1995, 1994, or 1993.\n(3) An allowance for possible losses of $215,000 has been provided at December 31, 1995, 1994, and 1993 to adjust the carrying value of the property to estimated net realizable value.\n(4) Reconciliation of accumulated depreciation:\n1995 1994 1993 -------- -------- -------- Balance at beginning of period$196,272$147,204$ 98,136 Additions during period 49,068 49,068 49,068 -------- -------- --------\nBalance at close of period$245,340$196,272 $147,204\n======== ======== ========\n(5) The aggregate cost for federal income tax purposes of the property for each of the three years December 31, 1993, 1994 and 1995 was $1,297,309.\n\/TABLE\nREGENCY EQUITIES CORP.\nMORTGAGE LOAN ON REAL ESTATE AND INTEREST EARNED ON MORTGAGE\nSCHEDULE - IV\nPart 1 Part 2 Mortgage loan on Real Estate at close of period Interest earned on mortgage - ----------------------------------------------------------- ----------------------------\nAmount of principal Amount of Interest Carrying unpaid at mortgage Interest due income earned Prior amount of close of being and accrued at applicable Description liens mortgage period foreclosed end of period to period - ----------- ----- -------- --------- ---------- -------------- -------------\nDecember 31, 1995 $ 0 $ 0 $ 0 None $ 0 $ 0\nThe loan was a second mortgage on a commercial building in New York state.\nReconciliation of carrying amount of mortgage: 1995 1994 1993 -------- -------- -------- Balance at beginning of period$400,000$400,000$850,000 Deduction during period: Recovery (Reserve) for450,000 ( 450,000) uncollectibility Payment received( 850,000) -------- -------- --------\nBalance at close of period$ 0$400,000$400,000 ======== ======== ========\nReconciliation of interest due and accrued: Balance at beginning of period$ 0$ 0$140,052 Additions during period: Interest earned 56,385 -------- -------- -------- 0 0 196,437 -------- -------- -------- Deductions during period: Collections of interest( 50,000) ( 8,500) Recovery (reserve) for50,000 ( 187,937) ------- -------- -------- uncollectibility 0 0( 196,487) ------- -------- -------- Balance at close of period$ 0$ 0$ 0 ======= ======== ========\n\/TABLE\nREGENCY EQUITIES CORP.\nANNUAL REPORT ON FORM 10-K\nINDEX TO EXHIBITS Exhibit Number Description Page - ------- ----------- ----\n3.1 Certificate of Incorporation of the Company as amended and restated to date, incorporated herein by this reference to Exhibit 3.1 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991.\n3.2 By-laws of the Company, incorporated herein by this reference to Exhibit 3.2 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990.\n10.1 1986 Stock Option Plan, incorporated herein by this reference to Exhibit 10.1 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991.\n10.2 Incentive Stock Option Plan, incorporated herein by this reference to Exhibit 10.2 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991.\n10.3 Lease Agreement dated February 17, 1978 and amended by First Amendment of Lease dated September 1, 1984 and by Second Amendment of Lease dated as of June 1, 1990, incorporated herein by this reference to Exhibit 10.6 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990.\n10.4 Indemnification Agreement dated February 7, 1995, between the Company and William J. Adams, incorporated herein by this reference to Exhibit 10.4 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994.\n10.5 Indemnification Agreement dated February 7, 1995, between the Company and Allan L. Chapman, incorporated herein by this reference to Exhibit 10.5 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994.\n10.6 Indemnification Agreement dated February 7, 1995, between the Company and Morris Engel, incorporated herein by this reference to Exhibit 10.6 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994.\n10.7 Indemnification Agreement dated February 7, 1995, between the Company and Ira L. Gottshall, incorporated herein by this reference to Exhibit 10.7 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994.\n10.8 Indemnification Agreement dated February 7, 1995, between the Company and Peter M. Graham, incorporated herein by this reference to Exhibit 10.8 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994.\n10.9 Indemnification Agreement dated February 14, 1995, between the Company and Ronald LaBow, incorporated herein by this reference to Exhibit 10.9 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994.\n10.10 Indemnification Agreement dated February 7, 1995, between the Company and Martin Oliner, incorporated herein by this reference to Exhibit 10.10 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994.\n27.1 Financial Data Schedule (included only in the electronic filing)","section_15":""}
{"filename":"5103_1995.txt","cik":"5103","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nAmerican General Corporation (American General or the company) is the parent company of one of the nation's largest diversified financial services organizations. American General's operating subsidiaries are leading providers of retirement annuities, consumer loans, and life insurance. The company was incorporated as a general business corporation in Texas in 1980 and is the successor to American General Insurance Company, an insurance company incorporated in Texas in 1926.\nMuch of the information provided in response to this Item 1 is incorporated herein by reference to selected portions of American General's 1995 Annual Report to Shareholders (ARS). Appropriate references to such incorporated information are specified throughout the text of this Item 1. Portions of American General's 1995 ARS are provided as Exhibit 13 to this Form 10-K.\nACQUISITIONS AND DIVESTITURES. American General continued its corporate development efforts during 1995. On January 31, 1995, the company acquired American Franklin Company (AFC), the holding company of The Franklin Life Insurance Company (Franklin Life), for $1.17 billion. The purchase price consisted of $920 million paid in cash at closing and a $250 million cash dividend paid by AFC to its former parent prior to closing. On October 19, 1995, the company announced a definitive agreement to acquire Independent Insurance Group, Inc. (Independent) for total consideration of $362 million.\nOn February 29, 1996, the company completed the Independent acquisition. Prior to closing, Independent shareholders could elect to exchange each share of Independent stock for $27.50 in cash, .7480 share of American General common stock, or .7480 share of American General 7% mandatorily convertible preferred stock. The exchange ratio was based on $36.7625, the average market price of American General common stock during the ten trading days ending on and including the fifth trading day prior to closing. The consideration at closing was as follows: 1) $139 million of cash (38%), 2) 3.7 million shares of common stock (38%), and 3) 2.3 million shares of preferred stock (24%). Holders of the preferred stock are entitled to receive annual cumulative dividends of 7% and have the right to vote, together with holders of American General common stock, on the basis of four-fifths of one vote for each share of preferred stock. The preferred stock is non-callable for four years, and each share is mandatorily convertible into not more than one share of American General common stock during the fifth year.\nAdditional information regarding acquisition and divestiture activities is incorporated herein by reference to the section \"Acquisitions and Divestitures\" on page 16 of Management's Discussion and Analysis (MD&A) and Note 2 of Notes to Financial Statements in American General's 1995 ARS.\nBUSINESS SEGMENTS. American General's operations are classified into the following three business segments: Retirement Annuities, Consumer Finance, and Life Insurance. A description of each business segment, including principal products, methods of distribution, and principal markets, is incorporated herein by reference to Note 1.1 of Notes to Financial Statements in American General's 1995 ARS. Financial information for each business segment is incorporated herein by reference to the section \"Business Segments\" on pages 16-18 and the sections \"Asset\/Liability Management,\" \"Capital Requirements,\" and \"Liquidity\" on pages 21-24 of MD&A and Note 1.2 of Notes to Financial Statements in American General's 1995 ARS, and to Schedule III of Item 14 of this Form 10-K.\nEMPLOYEES. As of December 31, 1995, American General and its subsidiaries employed approximately 15,300 full-time salaried employees, compared to 12,900 at year-end 1994. This increase is principally due to growth in the Consumer Finance segment and the acquisition of Franklin Life.\nAMERICAN GENERAL CORPORATION\n- - --------------------------------------------------------------------------------\n[AMERICAN GENERAL LOGO]\nINSURANCE SALES AND IN FORCE. The following table summarizes the face amounts of life insurance sales and life insurance in force for the company's insurance subsidiaries for the past three years:\n(a) Includes Franklin Life from January 31, 1995. (b) Excludes life insurance company sold in 1994. (c) Before deductions for reinsurance ceded. (d) Includes reinsurance assumed before deductions for reinsurance ceded.\nINSURANCE DEPOSITS AND PREMIUMS. The following table lists deposits and premiums and other considerations of the company's insurance and annuity subsidiaries for the past three years:\n(a) Includes Franklin Life from January 31, 1995. (b) Represents premiums received for interest-sensitive and certain participating life insurance and annuity products.\nINVESTMENTS\nInformation regarding investments is incorporated here- in by reference to the sections \"Investments\" and \"Asset\/Liability Management\" on pages 18-22 of MD&A and Notes 3.2 and 5 of Notes to Financial Statements in American General's 1995 ARS, and to Schedule I of Item 14 of this Form 10-K.\nINSURANCE AND ANNUITY RESERVING METHODS\nIndividual life insurance reserves are based on assumptions similar to those used to establish premium rates. Further information regarding reserving methods is incorporated herein by reference to Note 3.8 of Notes to Financial Statements in American General's 1995 ARS.\nREINSURANCE\nInformation regarding reinsurance is incorporated herein by reference to Note 3.11 of Notes to Financial Statements in American General's 1995 ARS, and to Schedule IV of Item 14 of this Form 10-K.\nFACTORS AFFECTING PRICING OF PRODUCTS\nINSURANCE AND ANNUITY PRODUCTS. Premium rates are based on assumptions, which the company's insurance subsidiaries believe to be realistic, as to future mortality, investment yields, expenses, and lapses. In addition, the pricing is influenced by competition and the company's objectives for return on capital. Although a profit margin is included in the price of the products, the actual profitability of the products can be significantly affected by the variation between actual and assumed experience.\nCONSUMER FINANCE PRODUCTS. Pricing of consumer finance products is influenced by such factors as cost of borrowed funds, credit risk, competition, and the expense of operations. In addition, pricing is affected by state regulation of interest rates based on contractual terms and loan amounts, charges for individual loans, and insurance premium rates.\nCOMPETITION\nThe business of the company's subsidiaries is highly competitive with other financial institutions and mutual fund companies with respect to pricing, selection of products, and quality of service. No single competitor nor any small group of competitors dominates any of the markets in which the company's subsidiaries operate. Additional information is incorporated herein by reference to the section \"Competition\" on page 25 of MD&A in American General's 1995 ARS.\n1995 FORM 10-K\n- - --------------------------------------------------------------------------------\nPART I (Continued)\nREGULATION\nINSURANCE. American General's insurance subsidiaries are subject to state regulation in the jurisdictions in which they do business. Information concerning regulatory compliance is incorporated herein by reference to the sections \"Solvency Regulation\" and \"Market Conduct\" on page 25 of MD&A in American General's 1995 ARS. Information regarding statutory accounting practices is incorporated herein by reference to Note 16 of Notes to Financial Statements in American General's 1995 ARS.\nMost states also regulate affiliated groups such as American General and its subsidiaries under insurance holding company laws. Additional information regarding dividend restrictions is incorporated herein by reference to Note 19.1 of Notes to Financial Statements in American General's 1995 ARS.\nDiscussion of state guaranty associations is incorporated herein by reference to the section \"Guaranty Associations\" on page 25 of MD&A and Note 9 of Notes to Financial Statements in American General's 1995 ARS.\nCONSUMER FINANCE. The company's consumer finance subsidiaries are subject to various types of federal regulation including the Federal Consumer Credit Protection Act, the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Truth In Lending Act, certain Federal Trade Commission rules, and state laws that regulate the consumer loan and retail sales finance businesses. In addition, the company's thrift subsidiary, which engages in the consumer finance business and accepts insured deposits, is subject to regulation by and reporting requirements of the Federal Deposit Insurance Corporation and is subject to regulatory codes in the state of Utah.\nOTHER. Discussion of certain other regulatory factors is incorporated herein by reference to the sections \"Taxation\" and \"Environmental\" on page 25 of MD&A in American General's 1995 ARS.\nITEM 1A.","section_1A":"ITEM 1A. EXECUTIVE OFFICERS OF THE REGISTRANT\nInformation as of March 1, 1996 regarding the 15 executive officers of American General is as follows:\nAMERICAN GENERAL CORPORATION\n- - --------------------------------------------------------------------------------\n[AMERICAN GENERAL LOGO]\n1995 FORM 10-K\n- - --------------------------------------------------------------------------------\nPART I (Continued)\nITEM 2.","section_1B":"","section_2":"ITEM 2. PROPERTIES\nAmerican General's corporate headquarters is located in the American General Center, a complex of office buildings on a 45-acre tract near downtown Houston. American General or its subsidiaries either own or lease pursuant to a sale-leaseback arrangement all of the buildings in the complex. In addition, American General or its subsidiaries own all of the underlying land, except for a five-acre parcel that is leased pursuant to a long-term agreement. American General and its subsidiaries occupy approximately 45% of the total office space available in the American General Center.\nAmerican General's subsidiaries also own various other properties, including properties held for investment, branch office buildings, and the home office buildings of American General Finance, Inc. in Evansville, Indiana; Franklin Life in Springfield, Illinois; and The Independent Life and Accident Insurance Company in Jacksonville, Florida. Portions of certain of these buildings are rented to unaffiliated third parties. The home office building of American General Life and Accident Insurance Company was sold in 1994, and construction of a new building in Nashville, Tennessee is expected to be completed in late 1996.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nAVIA V. AMERICAN GENERAL REALTY. Two real estate subsidiaries of the company were defendants in a lawsuit, Avia Development Group et al. v. American General Realty Investment Corp., et al. (filed in the 61st District Court of Harris County, Texas, September 23, 1991), that alleged damages based on lost profits and related claims arising from certain loans and joint venture contracts. On July 16, 1993, a judgment was entered against the subsidiaries jointly for $47.3 million in compensatory damages and against one of the subsidiaries for $189.2 million in punitive damages. On September 17, 1993, a Texas state district court reduced the previously-awarded punitive damages by $60.0 million, resulting in a reduced judgment in the amount of $176.5 million plus post-judgment interest. On January 29, 1996, the Texas First Court of Appeals rendered a two-to-one decision that affirmed the trial court judgment. The company intends to vigorously contest the matter through the appellate process. Although substantial risks and uncertainties remain with respect to the ultimate outcome, legal counsel has advised the company that it is not probable within the meaning of Statement of Financial Accounting Standards (SFAS) 5, \"Accounting for Contingencies,\" that the company will ultimately incur a material liability in connection with this matter. Accordingly, no provision has been made in the consolidated financial statements related to this contingency.\nGULF LIFE V. IRS. In April 1992, the Internal Revenue Service (IRS) issued Notices of Deficiency for the 1977-1981 tax years of certain insurance subsidiaries. The basis of the dispute was the tax treatment of modified coinsurance agreements. The company elected to pay all related assessments plus associated interest, totaling $59 million. A claim for refund of tax and interest was disallowed by the IRS in January 1993. On June 30, 1993, a suit for refund was filed in the United States Court of Federal Claims (Gulf Life Insurance Co. v. United States, C.A. No. 93-404T). On February 7, 1996, the court ruled in favor of the company on all legal issues related to this contingency. The company does not yet know whether the IRS will appeal this decision; however, the company intends to pursue a full refund of the amounts paid. Accordingly, no provision has been made in the consolidated financial statements related to this contingency.\nAMERICAN GENERAL CORPORATION\n- - --------------------------------------------------------------------------------\n[AMERICAN GENERAL LOGO]\nCALIFORNIA V. OCHOA. In March 1994, two subsidiaries of the company were named as defendants in a lawsuit, The People of the State of California (California) v. Luis Ochoa, Skeeters Automotive, Morris Plan, Creditway of America, Inc. and American General Finance, filed in the Superior Court of California, County of San Joaquin, Case No. 271130. California is seeking injunctive relief, a civil penalty of not less than $5,000 per day or not less than $250,000 for violation of its Health and Safety Code in connection with the failure to register and remove underground storage tanks on property acquired through a foreclosure proceeding by a subsidiary of the company, and a civil penalty of $2,500 for each act of unfair competition prohibited by its Business and Professions Code, but not less than $250,000, plus costs.\nPEBBLE CREEK. Various violations of operating permits held by Pebble Creek Service Corporation (Pebble Creek), an indirect wholly-owned subsidiary of the company, are currently being addressed by Pebble Creek with the United States Environmental Protection Agency (EPA), the Florida Department of Environmental Protection, and the Environmental Protection Commission of Hillsborough County, Florida. These violations include inaccurate reporting of test results by a former plant operator and violations of effluent parameters in connection with its wastewater treatment plant. In May 1994, Pebble Creek attended a meeting to show cause why the EPA should not initiate enforcement proceedings against Pebble Creek. Pebble Creek has not yet been made aware of the EPA's decision. The company believes that penalties in excess of $100,000 could be assessed against Pebble Creek.\nThe company believes that the total amounts that would ultimately be paid, if any, arising from the environmental claims discussed in the two preceding paragraphs would have no material effect on the company's consolidated results of operations and financial position.\nOTHER. American General and certain of its subsidiaries are defendants in various other lawsuits and proceedings arising in the normal course of business. Some of these lawsuits and proceedings arise in jurisdictions such as Alabama that permit punitive damages disproportionate to the actual damages alleged. In light of the uncertainties inherent in any litigation, no assurances can be given as to the ultimate outcome of these lawsuits and proceedings. However, American General and its subsidiaries believe that there are meritorious defenses for all of these claims and are defending them vigorously.\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 fourth quarter 1995.\n1995 FORM 10-K\n- - --------------------------------------------------------------------------------\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe quarterly high and low market prices of American General's common stock as quoted by the New York Stock Exchange, the number of shareholders of record of common stock, and restrictions on retained earnings for the payment of dividends are incorporated herein by reference to Notes 20, 13.1, and 19.1, respectively, of Notes to Financial Statements in American General's 1995 ARS. The quarterly cash dividends paid on common stock are incorporated herein by reference to Note 20 of Notes to Financial Statements in American General's 1995 ARS.\nThe common stock of American General is traded in the United States on the New York Stock Exchange and the Pacific Stock Exchange. The common stock is also traded on the London Stock Exchange and the Swiss Stock Exchanges of Basel, Geneva, and Zurich.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following selected financial data is 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 or incorporated by reference herein.\n(a) Includes Franklin Life from January 31, 1995. (b) Includes aftertax charge of $140 million ($.67 per share) for an increase in the allowance for finance receivable losses in fourth quarter 1995. (c) 1994 includes realized investment losses of $114 million ($.55 per share). Realized investment gains for 1995, 1993, 1992, and 1991 were immaterial. (d) Includes $300 million ($1.39 per share) write-down of goodwill and $30 million ($.14 per share) tax rate related adjustment. Additional information is incorporated herein by reference to the section \"Acquisition-Related Goodwill\" on page 24 of MD&A and Note 11.2 of Notes to Financial Statements in American General's 1995 ARS. (e) Includes fair value adjustment related to securities. Additional information is incorporated herein by reference to the section \"Fair Value of Securities\" on pages 18-19 of MD&A in American General's 1995 ARS. (f) Includes $244 million of convertible and $485 million of non-convertible preferred securities of subsidiaries issued in 1995. Additional information is incorporated herein by reference to Note 12.1 of Notes to Financial Statements in American General's 1995 ARS.\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 herein by reference to \"Management's Discussion and Analysis\" on pages 16-25 in American General's 1995 ARS.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nFinancial statements and supplementary data are incorporated herein by reference to pages 26-44 in American General's 1995 ARS.\nThe ratios of earnings to fixed charges are incorporated herein by reference to Exhibit 12 of Item 14 of this Form 10-K.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nAMERICAN GENERAL CORPORATION\n- - --------------------------------------------------------------------------------\nPART III [AMERICAN GENERAL LOGO]\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information appearing in the section \"Election of Directors\" in American General's definitive Proxy Statement dated March 19, 1996 (1996 Proxy Statement), is incorporated herein by reference. Information regarding the 12 executive officers of American General who are not standing for election to the board of directors of American General is included in Part I, Item 1A of this Form 10-K.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information appearing in the sections \"Governance of the Company\" and \"Compensation of Executive Officers\" in American General's 1996 Proxy Statement is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information appearing in the sections \"Security Ownership of Certain Beneficial Owners\" and \"Security Ownership of Management\" in American General's 1996 Proxy Statement is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information appearing in the section \"Certain Relationships and Transactions\" in American General's 1996 Proxy Statement is incorporated herein by reference.\n1995 FORM 10-K\n- - --------------------------------------------------------------------------------\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.\nAll other financial statement schedules have been omitted because they are inapplicable.\n3. Exhibits\n(continued on next page)\nAMERICAN GENERAL CORPORATION\n- - --------------------------------------------------------------------------------\n[AMERICAN GENERAL LOGO]\n(continued on next page)\n1995 FORM 10-K\n- - --------------------------------------------------------------------------------\nPART IV (Continued)\nAny Exhibit not included with this Form 10-K will be furnished to any shareholder of record on written request and payment of up to $.25 per page plus postage. Such requests should be directed to American General Corporation, Investor Relations, P.O. Box 3247, Houston, Texas 77253-3247.\n(b) Reports on Form 8-K.\nThe following reports on Form 8-K were filed after September 30, 1995:\n1. Current Report on Form 8-K dated October 20, 1995, with respect to the issuance of a news release announcing the signing of a definitive agreement under which the company will acquire Independent for total consideration of $362 million, subject to approval by Independent's shareholders and requisite regulatory authorities.\n2. Current Report on Form 8-K dated October 26, 1995, with respect to the issuance of a news release announcing the adoption by the company's board of directors of a plan of succession for the Office of the Chairman.\n3. Current Report on Form 8-K dated November 13, 1995, with respect to the pro forma financial statements of the company including the acquisition of AFC and the proposed acquisition of Independent as of and for the nine months ended September 30, 1995, and for the year ended December 31, 1994.\nAMERICAN GENERAL CORPORATION\n- - --------------------------------------------------------------------------------\n[AMERICAN GENERAL LOGO]\nAMERICAN GENERAL CORPORATION\nSCHEDULE I - SUMMARY OF INVESTMENTS - OTHER THAN INVESTMENTS IN AFFILIATES\nIn millions\n* Net of applicable allowance for losses. See Schedule V of this Form 10-K.\n1995 FORM 10-K\n- - --------------------------------------------------------------------------------\nPART IV (Continued)\nAMERICAN GENERAL CORPORATION\nSCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT\nSTATEMENT OF INCOME OF AMERICAN GENERAL CORPORATION (PARENT ONLY)\n(a) To conform with the 1995 presentation, amount has been restated.\n(b) Reflects adoption of SFAS 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions;\" SFAS 109, \"Accounting for Income Taxes;\" and SFAS 112, \"Employers' Accounting for Postemployment Benefits,\" at January 1, 1993. Additional information is incorporated herein by reference to Note 4.2 of Notes to Financial Statements in American General's 1995 ARS.\nAMERICAN GENERAL CORPORATION\n- - --------------------------------------------------------------------------------\n[AMERICAN GENERAL LOGO]\nAMERICAN GENERAL CORPORATION\nSCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)\nBALANCE SHEET OF AMERICAN GENERAL CORPORATION (PARENT ONLY)\n(a) The five-year schedule of maturities of debt is as follows: 1996, $0; 1997, $136 million; 1998, $71 million; 1999, $103 million; and 2000, $203 million.\n(b) The principal amount of American General senior notes held by subsidiaries was $10 million at December 31, 1995, $11 million at December 31, 1994, and $11 million at December 31, 1993.\n(c) Information regarding American General's subordinated debentures issued in 1995 is incorporated herein by reference to Note 12.1 of Notes to Financial Statements in American General's 1995 ARS.\n(d) Includes fair value adjustment related to securities. Additional information is incorporated herein by reference to the section \"Fair Value of Securities\" on pages 18-19 of MD&A in American General's 1995 ARS.\n(e) Amounts include undistributed earnings of subsidiaries of $2.7 billion in 1995, $2.6 billion in 1994, and $2.4 billion in 1993.\n(f) Amounts for 1995, 1994, and 1993 include 699,614 shares at a cost of $8 million held by a subsidiary.\n1995 FORM 10-K\n- - --------------------------------------------------------------------------------\nPART IV (Continued) AMERICAN GENERAL CORPORATION\nSCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)\nSTATEMENT OF CASH FLOWS OF AMERICAN GENERAL CORPORATION (PARENT ONLY)\n* To conform with the 1995 presentation, amount has been restated.\nAMERICAN GENERAL CORPORATION\n- - --------------------------------------------------------------------------------\n[AMERICAN GENERAL LOGO]\nAMERICAN GENERAL CORPORATION\nSCHEDULE III - SUPPLEMENTARY INSURANCE INFORMATION\nIn millions\n(a) Includes fair value adjustment related to securities. Additional information is incorporated herein by reference to the section \"Fair Value of Securities\" on pages 18-19 of MD&A in American General's 1995 ARS.\n(b) Includes cost of insurance purchased.\n(c) Includes unearned premiums, other policy claims and benefits payable, and other policyholder funds, which are not significant relative to insurance and annuity liabilities.\n(d) Represents earnings and related expenses on those investments considered necessary to support the segment's business operations.\n(e) Net of accretion of interest.\n(f) Includes Franklin Life from January 31, 1995.\n(g) Represents Consumer Finance non-insurance operations, Corporate operations, and intersegment eliminations.\n1995 FORM 10-K\n- - --------------------------------------------------------------------------------\nPART IV (Continued) AMERICAN GENERAL CORPORATION\nSCHEDULE IV - REINSURANCE\nIn millions\n* To conform with the 1995 presentation, amounts have been restated.\nAMERICAN GENERAL CORPORATION\n- - --------------------------------------------------------------------------------\n[AMERICAN GENERAL LOGO]\nAMERICAN GENERAL CORPORATION\nSCHEDULE V - VALUATION AND QUALIFYING ACCOUNTS\nIn millions\n(a) Resulting from write-offs of uncollectible receivables and bonds, sales of bonds and real estate, mortgage loan payoffs, and foreclosures of real estate.\n(b) Includes $243 million reclassification to reduce cost basis on adoption of SFAS 121, \"Accounting for the Impairment of Long-Lived Assets and for Long- Lived Assets to Be Disposed Of.\"\n(c) Relates to operating loss carryovers not expected to be utilized charged to deferred tax expense.\n(d) Relates to unrealized losses on securities charged to net unrealized gains (losses) on securities.\n1995 FORM 10-K\n- - --------------------------------------------------------------------------------\nPART IV (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, on March 20, 1996.\nAMERICAN GENERAL CORPORATION\nBy: \/s\/ Pamela J. Penny ----------------------------------------\nPamela J. Penny (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 indicated on March 20, 1996.\n\/s\/ Harold S. Hook - - -----------------------------------------------------------------\nHarold S. Hook (Chairman of the Board, Chief Executive Officer, and Director - Principal Executive Officer)\n\/s\/ Austin P. Young - - -----------------------------------------------------------------\nAustin P. Young (Senior Vice President and Chief Financial Officer - Principal Financial Officer)\n\/s\/ Pamela J. Penny - - -----------------------------------------------------------------\nPamela J. Penny (Vice President and Controller - Principal Accounting Officer)\nJ. Evans Attwell* - - -----------------------------------------------------------------\nJ. Evans Attwell (Director)\nBrady F. Carruth* - - -----------------------------------------------------------------\nBrady F. Carruth (Director)\nW. Lipscomb Davis Jr.* - - -----------------------------------------------------------------\nW. Lipscomb Davis Jr. (Director)\nRobert M. Devlin* - - -----------------------------------------------------------------\nRobert M. Devlin (Director)\nLarry D. Horner* - - -----------------------------------------------------------------\nLarry D. Horner (Director)\nRichard J.V. Johnson* - - -----------------------------------------------------------------\nRichard J.V. Johnson (Director)\n\/s\/ Jon P. Newton - - -----------------------------------------------------------------\nJon P. Newton (Director)\nRobert E. Smittcamp* - - -----------------------------------------------------------------\nRobert E. Smittcamp (Director)\nAnne M. Tatlock* - - -----------------------------------------------------------------\nAnne M. Tatlock (Director)\n*By: \/s\/ Jon P. Newton - - -----------------------------------------------------------------\nJon P. Newton (Attorney-in-fact)\nAMERICAN GENERAL CORPORATION\nEXHIBIT INDEX\n(continued on next page)\n(continued on next page)\nAny Exhibit not included with this Form 10-K will be furnished to any shareholder of record on written request and payment of up to $.25 per page plus postage. Such requests should be directed to American General Corporation, Investor Relations, P.O. Box 3247, Houston, Texas 77253-3247.","section_15":""}
{"filename":"942788_1995.txt","cik":"942788","year":"1995","section_1":"ITEM 1. BUSINESS\nTHE COMPANY\nNeoPharm is a pharmaceutical company engaged in the research and development of drugs for the diagnosis and treatment of various forms of cancer. Phase II clinical trials have been completed by various parties under the sponsorship of the National Cancer Institute (the \"NCI\"), a unit of the National Institutes of Health, with respect to the Company's two primary drugs, BUdR (Broxuridine) and IUdR (Idoxuridine). In clinical trials involving brain cancer patients, patients receiving BUdR together with radiation therapy exhibited increased survival times as compared to patients receiving radiation therapy alone. Preliminary results of additional studies indicate that BUdR and IUdR may enhance the effectiveness of radiation therapy for other cancers, including cervical and gynecological cancers, soft tissue sarcomas, and head and neck cancers. BUdR and IUdR are also being used for diagnostic applications as indicators of cancer cell proliferation activity. The Company anticipates filing new drug applications (\"NDA\") with the United States Food and Drug Administration (\"FDA\") for BUdR in a diagnostic application, for IUdR in a diagnostic application and for BUdR in the treatment of brain cancer in the future.\nThe Company's BUdR and IUdR products are the subject of a Cooperative Research and Development Agreement (\"CRADA\") with the NCI. The CRADA provides the Company with exclusive access to all clinical data compiled in BUdR and IUdR studies conducted by various parties under the sponsorship of the NCI, involving more than 6,000 patients for diagnostic applications and 1,500 patients for therapeutic applications. Under the CRADA, NCI has agreed to provide the Company with exclusive access to all clinical data for the compounds from clinical trials sponsored by the NCI during the term of the CRADA pursuant to the CRADA Research Plan.\nThe incorporation of BUdR and IUdR into the DNA of actively dividing cancer cells weakens the DNA molecules in the cancerous cells, and renders them more sensitive to the lethal effects of radiation. These drugs, when coupled with radiation therapy, may therefore be a more effective treatment for certain forms of cancer than radiation therapy alone. In addition to their therapeutic applications, BUdR and IUdR administered in smaller doses have been used for diagnostic applications as indicators of cellular proliferation activity. Following the administration of BUdR and IUdR, biopsies of the tumor are taken and treated with specific monoclonal antibodies to highlight the presence of BUdR or IUdR in the cells, and the actively dividing cells can then be identified and counted. Clinical trials involving diagnostic use of BUdR and IUdR have indicated that this cell tumor behavior information provided by BUdR and IUdR can assist the oncologist in selecting appropriate therapeutic regimens and enable better monitoring of the effectiveness of the chosen therapy.\nThe Company also has developed proprietary liposome products (spheres of subcellular size composed primarily of phospholipids, certain of which are the primary components of living cell membranes). By encapsulating certain chemotherapeutic drugs in liposomes, the toxic side effects associated with the drug can be reduced and the dose increased, thereby potentially increasing the effectiveness of therapy through both increased drug action against cancer cells and reduced side effects. Unlike other liposome-encapsulated chemotherapeutic drugs, the Company believes its liposomes overcome the effects of MDR (multiple drug resistance), which is a common phenomenon in approximately 300,000 cancer patients each year. The Company has conducted one Phase II efficacy study of its liposome-encapsulated doxorubicin (\"LED\") product involving approximately 20 patients with breast cancer, in which 45% of the patients showed either a partial (minimum 50% shrinkage of the tumor) or complete (100% shrinkage of the tumor) response, as compared to a reported 22% partial or complete response observed with free doxorubicin in other studies. The study also demonstrated a significant reduction in side effects. In addition, the Company has developed a synthetically derived lipid source for making its liposomes, and plans to initiate Phase I\/II clinical trials using the synthetically derived formulation in 1996. During 1995 and the first quarter of 1996, the Company's liposome products were the subject of license and sponsored research agreements\nwith Georgetown University (\"Georgetown\"). Under these agreements, the Company was obligated to fund liposome related research activities at Georgetown in return for exclusive licenses to its liposome products then under development, and a right of first refusal to license additional liposome products developed by Georgetown. As of April 27, 1996 the Company's obligation to fund further supportive research under these agreements has ended.\nThe Company does not intend to acquire or establish its own dedicated manufacturing facilities for the foreseeable future. The Company's manufacturing strategy is to develop manufacturing relationships with established pharmaceutical manufacturers for production of BUdR and IUdR as well as its liposome products. The Company's primary market in the United States consists of approximately 3,500 oncologists, most of whom are affiliated with major cancer treatment centers. The Company believes it will be able to address this market with a direct sales force of relatively modest size. The Company intends to enter into collaborative arrangements with other companies to market its products elsewhere in the world. To date, the Company has been engaged primarily in research and development of its proposed products. The Company currently has no marketing or sales staff and, to date, has conducted its activities through consultants and at university research facilities. The Company will need to hire additional personnel and gain access to marketing and sales resources in order to continue the development and commercialization of its products.\nNeoPharm, Inc. was incorporated under the name OncoMed, Inc. in June 1990, and changed its name to NeoPharm, Inc. in March 1995. The Company's principal offices are located at 225 East Deerpath, suite 250, Lake Forest, Illinois 60045, and its telephone number is (847) 295-8678.\nNEOPHARM PRODUCTS\nThe Company has two primary areas of product focus, its BUdR and IUdR products and its proprietary liposome products. The Company is developing BUdR and IUdR for use as radiation sensitizers to improve the effectiveness of radiation therapy for certain types of cancers and as diagnostic agents in cancer therapy. The Company is also developing liposome encapsulated chemotherapeutic agents, including liposome encapsulated doxorubicin and liposome encapsulated vincristine. The Company has also acquired rights to liposome encapsulated taxol and liposome encapsulated antisense oligodeoxynucleotides.\nAll of the products currently being developed by the Company will require approval by the FDA before they can be sold commercially in the United States. This approval process is rigorous and time consuming. The products must be shown to be effective in preclinical studies involving animal models and must be shown to have acceptable levels of toxicity. The products are then subjected to controlled clinical trials involving hundreds of patients in order to prove safety and efficacy. These clinical trials are typically divided into Phase I and II trials in which the safety and appropriate therapeutic dose are determined, followed by Phase III trials, in which the efficacy is confirmed in larger numbers of patients. BUdR and IUdR, which the Company is focusing on for development of its initial products, have been shown to be safe and effective in Phase I and Phase II clinical trials. BUdR and IUdR are currently undergoing Phase III clinical trials. See \"Government Regulation\" below.\nThe table below sets forth the Company's principal products under development, the primary indications for these products and the development status for each product.\nNEOPHARM PRODUCT SUMMARY\nThere can be no assurance that any of the Company's products will receive necessary regulatory approvals, be successfully commercialized and achieve market acceptance, or that any products commercialized by the Company will not be rendered obsolete by other developments in the field of cancer treatment.\nBUDR AND IUDR PRODUCTS\nThe first commercial products for the Company are expected to be BUdR and IUdR. Under the sponsorship of the National Cancer Institute (\"NCI\"), a unit of the National Institutes of Health, these compounds have been evaluated as agents for improving the effectiveness of cancer therapy in academic and clinical studies for nearly 30 years, and the first IND application for BUdR and IUdR was filed with the FDA in 1964. During the course of clinical evaluation of these compounds, approximately 7,500 patients have been studied under NCI-approved and sponsored clinical protocols. Recent advancements in radiation therapy and cancer diagnostic techniques have increased the potential utility of BUdR and IUdR as therapeutic and diagnostic agents in cancer therapy. As a result of these advancements, in the early 1990s the NCI determined that BUdR and IUdR should be made available on a commercial basis. NCI chose NeoPharm as its development partner to bring these products to market. As a result, a Cooperative Research and Development Agreement (\"CRADA\") has been signed between NeoPharm and NCI. Under the terms of the CRADA, NeoPharm has exclusive rights to the data generated with BUdR and IUdR by NCI for certain indications contained in the CRADA including tumors metastatic to the brain, astrocytomas, gastrointestinal cancers, colon cancer, pancreatic cancer, lung cancer, soft tissue sarcomas, head and neck cancer and leukemia. The CRADA provides that the Company may sponsor and help support clinical studies, pay for the cost of producing BUdR and IUdR used in clinical trials and, to the extent supported by clinical results, file appropriate NDAs with the FDA. The term of the CRADA extends through May 1, 1997, although the agreement may be terminated by either party without cause upon 60 days notice; provided that in the event of such termination all clinical trials and protocols that have been scheduled, initiated, or otherwise included under the CRADA prior to the notification of termination shall be completed unless otherwise mutually agreed. All provisions of the CRADA shall continue in effect for such clinical trials and protocols. Although BUdR and IUdR are not covered by patents or patent applications, the Company believes that its exclusive access to the clinical data collected by NCI and its\ninvestigators and its other rights under the CRADA represent a significant competitive advantage for the Company in the development and eventual commercialization of BUdR and IUdR. There can be no assurance that the CRADA will remain in effect or that the collaboration provided for in the CRADA will be successfully completed. See \"Collaborative Relationships, Licenses and Commercialization Strategy\", below.\nLIPOSOME PRODUCTS\nLiposomes are spheres of subcellular size composed primarily of phospholipids, certain of which are the primary components of living cell membranes, and can be made to contain and deliver drugs. This membrane encapsulation feature of liposomes enables the entrapped drug to be circulated in the bloodstream in higher concentrations for longer periods of time than the free drug. When certain drugs, including chemotherapeutic agents, are administered in conjunction with liposomes, they have been shown to produce fewer and less severe local and systemic side effects. Although liposomes have been investigated and used for many years as drug delivery systems, the difficulty in producing liposomes on a large scale, as well as the limited shelf life of many liposomes, have limited their use in clinical settings.\nUnlike other liposomes-encapsulated chemotherapeutic drugs, the Company believes its liposomes overcome the effects of MDR (multiple drug resistance), which occurs in many chemotherapeutic regimens. In addition, these liposomes are easy to prepare at the clinical site. The Company's formulation is based on a lipid, cardiolipin, that is found in cardiac tissue. In addition, the Company has developed a synthetically derived cardiolipin, which it believes will provide a reliable lipid source for making the Company's liposomes to be used in upcoming clinical trials.\nCOLLABORATIVE RELATIONSHIPS, LICENSES AND COMMERCIALIZATION STRATEGY\nThe Company has entered into a CRADA with the NCI and has licensed certain technology relating to its liposome products from Georgetown. Dr. Aquilur Rahman, the Company's Chief Scientific Officer, is an Adjunct Professor of Pathology and Pharmacology at Georgetown. The principal terms of the NCI CRADA and the license and sponsored research agreements with Georgetown are summarized below.\nNCI CRADA. The Company has entered into a CRADA with the National Cancer Institute giving the Company the exclusive right to develop and commercialize BUdR and IUdR for use as diagnostic and therapeutic agents in the treatment of cancer. Under the CRADA, the Company is responsible for the co- development with the NCI of clinical trials and for obtaining regulatory approvals for BUdR and IUdR. NCI will provide NeoPharm with exclusive access to all clinical data for the compounds from clinical trials sponsored by NCI during the term of the CRADA pursuant to the CRADA Research Plan. NeoPharm has the right to use all such data for the purpose of obtaining regulatory approval for the compounds. NeoPharm is responsible for the preparation and submission of NDAs for the compounds and for supplying the BUdR and IUdR to be used in clinical trials. NCI has agreed, during the term of the CRADA, to refrain from assisting any other party in the development and commercialization of BUdR and IUdR; however, either the Company or the NCI may independently initiate clinical trials involving BUdR or IUdR that are not part of the research plan or clinical trial program under the CRADA. BUdR and IUdR are currently not the subject of any patent or patent application; however, in the event any NCI personnel develop any patentable inventions within the scope of the CRADA, NCI will offer NeoPharm a first option to a license to such inventions on industry standard terms. The term of the CRADA extends through May 1, 1997, although the agreement may be terminated by either party upon 60 days' notice; provided that in the event of such termination all clinical trials and protocols that have been scheduled, initiated, or otherwise included under the CRADA prior to the notification of termination shall be completed unless otherwise mutually agreed. All provisions of the CRADA shall continue in effect for such clinical trials and protocols. In addition, should NeoPharm fail to prepare and submit an NDA to the FDA within 18 months from the time the data are known to demonstrate reproducible results that would be sufficient to support an NDA, the NCI may terminate the CRADA but only if the Company fails to exercise reasonable diligence in pursuit of an NDA. The Company's preclinical and clinical research and development activities under the\nCRADA are conducted pursuant to guidelines established by a Steering Committee of three voting members from the NCI and three voting members from the Company. In the event the Steering Committee cannot reach agreement on an issue related to the CRADA, then the matter will be submitted to Dr. John Kapoor (or another individual designated by the Company) and the Director of the Division of Cancer Treatment at the NCI. If the matter cannot then be resolved, the Director of the NCI shall propose a resolution in writing. If NeoPharm elects not to accept the proposed resolution, either party may terminate the CRADA or make a new proposal for resolution of the matter. The Company has assumed responsibility for satisfying the supply requirements of BUdR and IUdR for conducting clinical trials. During 1994, the Company reimbursed NCI $45,000 for prior product production costs. The Company will also provide $120,000 per year for reasonable and necessary expenses incurred by the NCI in carrying out its responsibilities under the CRADA. Any excess funds not used by the NCI for incurred expenses will be refunded to the Company at the termination of the agreement. The Company is further obliged under the CRADA to provide sufficient staff to meet its obligations under the CRADA. Pursuant to the CRADA, the NCI will refrain from assisting any other party other than the Company in commercializing BUdR\/IUdR during the term of the CRADA. The Company may license any drug developed under the CRADA not made solely by NeoPharm's employees for which a patent or patent application is filed. The terms of the license for such jointly developed drugs will, according to the CRADA, reflect relative contributions of the parties to the invention, the risks incurred by the Company, and the costs of subsequent research and development needed to bring the invention to the marketplace. If NeoPharm does not accept the NIH proposals on the license terms, the NIH will be free to license such inventions to third parties.\nBecause BUdR and IUdR are not covered by patents or patent applications, the Company's exclusive access to the clinical data collected by NCI and its investigators and its other rights under the CRADA represent the principal competitive advantage for the Company in the development and eventual commercialization of BUdR and IUdR. The NCI may publish summary data from the clinical trials under the CRADA in its annual reports, which do not include individual patient data. Furthermore, the collaborative nature of the Company's relationship with the NCI is of significant importance for conduct of clinical trials and to assist the Company in gaining acceptance of its products among oncologists. Accordingly, termination of the CRADA would be materially adverse to the Company's BUdR and IUdR program, could require curtailment or termination of such program and could therefore have a material adverse effect on the Company's business, financial condition and results of operations.\nGeorgetown University. The Company previously entered into license and sponsored research agreements with Georgetown University relating to LED, LEVCR, LET and LE-AON. Under these agreements, the Company was obligated to sponsor certain research activities at Georgetown relating to liposome-encapsulated chemotherapeutic agents. As of April 27, 1996 the obligation to fund further supportive research ended. The research was previously conducted in the laboratory of Dr. Aquilur Rahman, the Company's Chief Scientific Officer and an Adjunct Professor at Georgetown University. Under the agreements with Georgetown, and in return for the sponsorship of this supportive research, the Company has exclusive licenses to manufacture and sell LED, LEVCR, LET and LE-AON. The Company also had a right of first refusal to obtain exclusive licenses to new liposome-encapsulated anticancer agents developed in Dr. Rahman's laboratory under the license and sponsored research agreement with Georgetown University. The Company will also be obligated to pay Georgetown royalties on commercial sales of the liposome products. In addition, the Company will be obligated to make certain advance royalty payments to Georgetown, which payments will be credited against future royalties payable under the Company's agreements with Georgetown. In the event the Company is unable to successfully commercialize its liposome products, it would be unable to recoup these advance royalty payments. The licenses are generally not terminable by Georgetown, except in the event of a default by the Company. Any such default and resulting termination of the licenses would be materially adverse to the Company's liposome program, could require curtailment or termination of such program and could therefore have a material adverse effect on the Company's business, financial condition and results of operations.\nThe Company's strategy for future development and commercialization of therapeutics will involve, where appropriate, the establishment of collaborative relationships with pharmaceutical industry partners.\nThe Company intends to seek collaborative relationships in certain targeted development areas, particularly in situations where the Company believes that the clinical testing, marketing, manufacturing and other resources of pharmaceutical collaborators will enable it to more effectively access particular product or geographic markets. There can be no assurance that any products which are developed by the Company and for which the Company obtains regulatory approvals could be manufactured at a cost or in quantities required to make them commercially viable. The Company's inability to contract, on acceptable terms and with qualified suppliers, for the manufacture of any products which it develops, or delays or difficulties in its relationships with manufacturers, would have a material adverse effect on the Company.\nMARKETING AND SALES\nThe treatment of cancer is a highly specialized activity in which the treating oncologists tend to be concentrated in major medical centers. The Company's marketing strategy is designed to enable the Company to operate with a relatively small direct sales force in the United States. As products receive regulatory approval, the Company plans to develop a sales force of modest size to service the over 3,500 practicing oncologists in the United States. The Company intends to seek collaborative agreements with other companies to market the products elsewhere in the world.\nThe marketing and sale of the Company's BUdR and IUdR will be subject to certain requirements imposed pursuant to the CRADA. These include requirements that the products not be sold at prices that may be deemed to be excessive.\nMANUFACTURING\nThe Company does not intend to acquire or establish its own dedicated manufacturing facilities for the foreseeable future. Rather, the Company's manufacturing strategy will be to develop manufacturing relationships with established pharmaceutical manufacturers for production of BUdR and IUdR as well as its liposomal products.\nThere are a number of FDA approved suppliers of raw materials used in the Company's products in existence. There are also a number of facilities with FDA Good Manufacturing Practice approval for contract manufacturing of the Company's proposed products. The Company has a source for the manufacture of BUdR and IUdR and is in the process of arranging for sources for the manufacture of certain of its planned liposomal products. The Company believes that, in the event of the termination of its existing sources for product supplies and manufacture, the Company will be able to enter into agreements with other suppliers and\/or manufacturers on similar terms. There can be no assurance that there will be manufacturing capacity available to the Company at the time the Company is ready to manufacture its products.\nPATENTS AND PROPRIETARY RIGHTS\nIt will be the Company's policy to, where possible, file patent applications to protect technology, inventions and improvements that are important to the development of its business. Under its agreements with Georgetown University, the Company has licensed rights to three United States patents and two pending United States patent applications relating to its liposome products under development. BUdR and IUdR are, however, not currently the subject of patents or patent applications, and the Company does not expect to obtain patent protection for its BUdR and IUdR products. The Company's principal advantage with respect to the development and planned commercialization of BUdR and IUdR is its exclusive access under the CRADA to NCI's clinical data regarding the compounds.\nThe patent position of participants in the pharmaceutical field generally is highly uncertain, involves complex legal and factual questions, and has recently been the subject of much litigation. There can be no assurance that any patent applications relating to the Company's potential products or processes will result in patents being issued, or that the resulting patents, if any, will provide protection against competitors who\nsuccessfully challenge the Company's patents, obtain patents that may have an adverse effect on the Company's ability to conduct business, or are able to circumvent the Company's patent position. It is possible that other parties have conducted or are conducting research and could make discoveries of compounds or processes that would precede any discoveries made by the Company, which could prevent the Company from obtaining patent protection for these discoveries. Finally, there can be no assurance that others will not independently develop pharmaceutical products similar to or obsoleting those that the Company is planning to develop, or duplicate any of the Company's products.\nThe Company's competitive position is also dependent upon unpatented trade secrets. In an effort to protect its trade secrets, the Company has a policy of requiring its employees, Scientific Advisory Board members, consultants and advisors to execute proprietary information and invention assignment agreements upon commencement of employment or consulting relationships with the Company. These agreements provide that all confidential information of the Company developed or made known to the individual during the course of their relationship with the Company must be kept confidential, except in specified circumstances. There can be no assurance, however, that these agreements will provide meaningful protection for the Company's trade secrets or other proprietary information in the event of unauthorized use or disclosure of confidential information. Invention assignment agreements executed by Scientific Advisory Board members, consultants and advisors may conflict with, or be subject to, the rights of third parties with whom such individuals have employment or consulting relationships. In addition, there can be no assurance that others will not independently develop substantially equivalent proprietary information and techniques or otherwise gain access to the Company's trade secrets, that such trade secrets will not be disclosed or that the Company can effectively protect its rights to unpatented trade secrets.\nThe Company may be required to obtain licenses to patents or proprietary rights of others. No assurance can be given that any licenses required under any such patents or proprietary rights would be made available on terms acceptable to the Company, or at all. If the Company does not obtain such licenses, it could encounter delays in product market introductions while it attempts to design around such patents, or could find that the development, manufacture or sale of products requiring such licenses could be foreclosed. Litigation may be necessary to defend against or assert such claims of infringement, to enforce patents issued to the Company, to protect trade secrets or know-how owned by the Company, or to determine the scope and validity of the proprietary rights of others. In addition, interference proceedings declared by the United States Patent and Trademark Office may be necessary to determine the priority of inventions with respect to patent applications of the Company or its licensors. Litigation or interference proceedings could result in substantial costs to and diversion of effort by, and may have a material adverse impact on, the Company. In addition, there can be no assurance that these efforts by the Company will be successful.\nGOVERNMENT REGULATION\nIntroduction. Regulation by governmental authorities in the United States and foreign countries is a significant factor in the development, manufacture and marketing of the Company's proposed products and in its ongoing research and product development activities. The nature and extent to which such regulation will apply to the Company will vary depending on the nature of any products which may be developed by the Company. It is anticipated that all of the Company's products will require regulatory approval by governmental agencies prior to commercialization. In particular, human therapeutic and some diagnostic products are subject to rigorous preclinical and clinical testing and other approval procedures of the FDA and similar regulatory authorities in foreign countries. Various Federal statutes and regulations also govern or influence testing, manufacturing, safety, labeling, storage and record-keeping related to such products and their marketing. The process of obtaining these approvals and the subsequent compliance with appropriate Federal statutes and regulations require the expenditure of substantial time and financial resources. Any failure by the Company or its collaborators to obtain, or any delay in obtaining, regulatory approval could adversely affect the marketing of any products developed by the Company, its ability to receive product revenues and its liquidity and capital resources.\nFDA Approval Process. Prior to commencement of clinical studies involving human beings, preclinical testing of new pharmaceutical products is generally conducted on animals in the laboratory to evaluate the potential efficacy and the safety of the product. The results of these studies are submitted to the FDA as a part of an investigational new drug (\"IND\") application, which must become effective before clinical testing in humans can begin. Typically, clinical evaluation involves a time consuming and costly three-phase process. In Phase I, clinical trials are conducted with a small number of subjects to determine the early safety profile, the pattern of drug distribution and metabolism. In Phase II, clinical trials are conducted with groups of patients afflicted with a specific disease in order to determine preliminary efficacy, optimal dosages and expanded evidence of safety. In Phase III, large-scale, multi-center, comparative trials are conducted with patients afflicted with a target disease in order to provide enough data to demonstrate the efficacy and safety required by the FDA. The FDA closely monitors the progress of each of the three phases of clinical testing and may, at its discretion, re-evaluate, alter, suspend or terminate the testing based upon the data which have been accumulated to that point and its assessment of the risk\/benefit ratio to the patient.\nThe results of the preclinical and clinical testing on a nonbiologic drug and certain diagnostic drugs are submitted to the FDA in the form of a new drug application (\"NDA\") for approval to commence commercial sales. In responding to an NDA, the FDA may grant marketing approval, request additional information or deny the application if the FDA determines that the application does not satisfy its regulatory approval criteria. There can be no assurance that approvals will be granted on a timely basis, if at all. Similar procedures are in place in countries outside the United States.\nIn 1988, the FDA issued \"fast-track\" regulations intended to accelerate the approval process for the development, evaluation and marketing of new therapeutic and diagnostic products used to treat life-threatening and severely debilitating illnesses, especially those for which no satisfactory alternative therapies exist. \"Fast-track\" designation affords the Company early interaction with the FDA in terms of protocol design and permits, although it does not require the FDA to grant approval after completion of Phase II clinical trials (although the FDA may require subsequent Phase III clinical trials or even post-approval Phase IV efficacy studies). The Company believes that a number of its product candidates may fall under these regulations, but there can be no assurance that any of the Company's products will receive this or other similar regulatory treatment.\nIn late 1992, legislation imposing FDA user fees on drug manufacturers was enacted. Such fees will be required for each commercial marketing drug application submitted by the Company for FDA approval, and annual product and establishment fees will also be imposed upon approval. The revenues raised from these fees are earmarked specifically to increase the resources of the FDA, and by doing so, to increase the speed with which the FDA reviews and approves drug marketing applications. Currently, the user fee for an NDA is approximately $150,000, and the statute provides for periodic fee increases. The statute currently provides small companies (defined as companies with less than 500 employees that are not marketing a prescription drug product) with a reduction in the initial application fee and contains limited provisions for fee waivers. The Company is unable to predict the impact of the current user fee legislation, as well as possible future changes in the law, upon its business.\nWaxman-Hatch Act. The Drug Price Competition and Patent Restoration Act of 1984, also known as the Waxman-Hatch Act, contains provisions pertaining to marketing exclusivity from generic competition for most non-biological drugs and patent restoration for most pharmaceutical products. These patent provisions will not be applicable to BUdR and IUdR because such compounds are not patented. A five-year marketing exclusivity period is provided for new chemical entities, and a three-year marketing exclusivity period is provided for approved drugs for which new clinical investigations are essential to the receipt of FDA approval to market the product. For purposes of the Waxman-Hatch Act, a new chemical entity is defined as a drug product that contains an active moiety not previously approved by the FDA for marketing. Accordingly, the Company believes that BUdR and IUdR would qualify as new chemical entities under the Waxman-Hatch Act. If the Company were to obtain FDA approval to market BUdR or IUdR, for a period of five years after such approval, no company could copy the approved product and\nobtain approval of a competitive version. The five year exclusivity period would not prevent a competitive product from being marketed based upon new preclinical and clinical studies conducted by the competitor. In the event that the Company receives approval of NDAs for BUdR and IUdR, there can, however, be no assurance that the Company would receive any or all of the benefits provided by the Waxman-Hatch Act as currently in effect.\nOrphan Drug Act. Under the Orphan Drug Act, the FDA may designate drug products as orphan drugs if there is no reasonable expectation of recovery of the costs of research and development from sales in the United States or if such drugs are intended to treat a rare disease or condition, which is defined as a disease or condition that affects less than 200,000 persons in the United States. If certain conditions are met, designation as an orphan drug confers upon the sponsor marketing exclusivity for seven years following FDA approval of the product, meaning that the FDA cannot approve another version of the \"same\" product for the same use during such seven year period. The market exclusivity provision does not, however, prevent the FDA from approving a different orphan drug for the same use or the same orphan drug for a different use. Although the Company received a letter from the FDA stating that BUdR qualifies for orphan drug designation as a radiation sensitizer in the treatment of primary brain tumors, there is no assurance that any of the Company's products will ultimately receive orphan drug designation or approval, or that the benefits currently provided by such designations or approvals will not hereafter be amended or eliminated. The Orphan Drug Act has been controversial, and many legislative proposals have from time to time been introduced in Congress to modify various aspects of the Orphan Drug Act, particularly the market exclusivity provisions. There can be no assurance that new legislation will not be introduced in the future that may adversely impact the availability or attractiveness of orphan drug status for any of the Company's products.\nOther Regulations. The Company is also subject to various Federal, state and local laws, regulations and recommendations relating to safe working conditions, laboratory manufacturing practices and the use and disposal of hazardous or potentially hazardous substances, including radioactive compounds and infectious disease agents, used in connection with the Company's research work. The extent of government regulation which might result from future legislation or administrative action cannot be predicted accurately.\nPRODUCT LIABILITY AND INSURANCE\nThe Company's business exposes it to potential product liability risks which are inherent in the testing, manufacturing and marketing of human therapeutic products. The Company does not currently have any product liability insurance. Although the Company plans to obtain product liability insurance, there can be no assurance that it will be able to obtain or maintain such insurance on acceptable terms or that any insurance obtained will provide adequate coverage against potential liabilities. Claims or losses in excess of any liability insurance coverage obtained by the Company could have a material adverse effect on the business, financial condition or results of operations of the Company.\nCOMPETITION\nCompetition in the discovery and development of methods for treating cancer is intense. Numerous pharmaceutical, biotechnology and medical companies and academic and research institutions in the United States and elsewhere are engaged in the discovery, development, marketing and sale of products for the treatment of cancer. These include surgical approaches, new pharmaceutical products and new biologically derived products. The Company expects to encounter significant competition for the principal pharmaceutical products it plans to develop. Companies that complete clinical trials, obtain regulatory approvals and commence commercial sales of their products before their competitors may achieve a significant competitive advantage. A number of pharmaceutical companies are developing new products for the treatment of the same diseases being targeted by the Company. In some instances, the Company's competitors already have products in clinical trials. In addition, certain pharmaceutical companies are\ncurrently marketing drugs for the treatment of the same diseases being targeted by the Company, and may also be developing new drugs to address these disorders.\nThe Company believes that its competitive success will be based on its ability to create and maintain scientifically advanced technology, develop proprietary products, attract and retain scientific personnel, obtain patent or other protection for its products, obtain required regulatory approvals, obtain orphan drug status for certain products and manufacture and successfully market its products either independently or through outside parties. Many of the Company's competitors have substantially greater financial, clinical testing, regulatory compliance, manufacturing, marketing, human and other resources. In addition, the Company will continue to seek licenses with respect to key technologies related to its fields of interest and may face competition with respect to such efforts.\nHUMAN RESOURCES\nAs of April 25, 1996, the Company had one full time employee, and two part-time employees, all of whom are officers. The Company currently has consulting agreements with 8 consultants, holding either Ph.D. or M.D. degrees. None of the Company's consultants are represented by a collective bargaining arrangement, and the Company believes its relationship with its consultants is satisfactory. The Company intends to continue to retain consultants and to add personnel in as the business strategy is implemented.\nSCIENTIFIC ADVISORY BOARD\nThe Company has assembled a six-member Scientific Advisory Board. The members of the Scientific Advisory Board together provide expertise in areas of scientific and medical interest to the Company. The Company has entered into agreements with the Scientific Advisors providing that all inventions made by the Advisors when working for the Company will belong to the Company; however, most of the members of the Company's Scientific Advisory Board are employed on a full-time basis by academic or research institutions. The members of the Scientific Advisory Board are permitted to share information among themselves regarding the projects that they are working on with the Company. The Company granted options to acquire an aggregate of 25,000 shares its Common Stock to members of the Scientific Advisory Board, and pays a retainer to compensate its Scientific Advisory Board members.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's administrative offices are located in 4470 square feet of leased office space in Lake Forest, Illinois. This leased space is provided to the Company as a part of a consulting agreement with EJ Financial.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is not a party to any litigation or other legal proceedings.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS\nNone.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nSince January 25, 1996, the Common Stock has been quoted on The NASDAQ Stock Market's Small Cap Issues under the trading symbol. Since trading opened on January 25, 1996, the stock has been a high of $17 and a low of $4.50. As of April 25, 1996, there were 19 holders of record of the Common Stock, and the Company estimates that as of such date there were more than 300 beneficial holders of the Common Stock. The Company has never paid a cash dividend on its Common Stock and has no present intention of paying cash dividends in the foreseeable future. Any determination in the future to pay dividends will depend on the Company's financial condition, capital requirements, results of operations, contractual limitations and other factors deemed relevant by the Board of Directors.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\n- - - ---------- (1) See Note 2 of Notes to Financial Statements for an explanation of pro forma net loss and shares used to compute pro forma net loss per share.\n(2) Adjusted to give effect to the receipt of the net proceeds of the Offering at the initial public offering price of $7.00 per Share and $.10 per Warrant (after deducting $ 1,110,175 in expenses and underwriting discounts payable by the Company in connection with the Offering), the reclassification of the accumulated deficit to additional paid-in capital as the result of the termination of the Company's S Corporation status, the conversion of the $1,500,000 loan and $523,385 of accrued interest payable at November 30, 1995 to a trust, the sole beneficiary of which is Dr. John N. Kapoor, the chairman of the Company, pursuant to the June 18, 1990 note issued to the trust (the \"Loan Repayment Note\") into 287,004 shares of Common Stock and 143,502 Warrants, and to reflect the retirement of the bank line of credit which had a balance of $2,007,652 at December 31, 1995.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nOVERVIEW\nSince the Company's inception in June 1990, NeoPharm has devoted its resources primarily to fund its research and product development programs. The Company has been unprofitable since inception and has had no revenues from the sale of products or other sources, and does not expect revenues in the near future. The Company expects to continue to incur losses as it expands its research and development activities and sponsorship of clinical trials. As of December 31, 1995, the Company's accumulated deficit was $4.5 million.\nRESULTS OF OPERATIONS\nYears Ended December 31, 1995, 1994 and 1993\nThe Company had no revenues during the three fiscal years ended December 31, 1995. The Company incurred research and development expenses of approximately $1,069,000 in 1995, as compared to $814,000 in 1994 and $233,000 in 1993. The increase in 1995 research and development expenses is primarily due to acceleration of gathering and analyzing clinical data relating to BUdR and IUdR. The increase in 1994 is primarily due to sponsored research initiated at Georgetown, spending to support clinical trials and payments associated with gathering and analyzing clinical data relating to BUdR and IUdR. 1995 and 1994 expenses include payments made by the Company to Georgetown and the NCI pursuant to the Company's license and sponsored research agreements with Georgetown and its CRADA with the NCI. The Company expects research and development spending to increase over the next several years. See \"Item 1 - Business -- Collaborative Relationships, Licenses and Commercialization Strategy.\"\nGeneral and administrative expenses increased to approximately $245,000 in 1995 from $107,000 for the same period of 1994. The increase was due primarily to professional fees on general corporate matters and consulting fees due to EJ Financial Enterprises, Inc. (\"EJ Financial\"), a health care consulting and investment company, accrued during 1995. General and administrative expenses decreased to approximately $107,000 in 1994 from $175,000 in 1993. This decrease was mainly due to the Company's efforts to better control its expenditures. Because the majority of the Company's research and development efforts are being conducted in university laboratories and at clinical sites, the Company concluded that a separate administrative facility was no longer necessary. Accordingly, the Company closed its Rockville, Maryland office in 1993. The Company expects to lease laboratory facilities in the Chicago, Illinois area during 1996 and to hire additional personnel. The Company will also incur salaries for key management personnel as well as expenses to support corporate development activities and costs resulting from becoming a public company. From its inception through June 30, 1994, the Company accrued management services charges to EJ Financial of $25,000 per year. These charges were not paid, but were instead treated as contributions to capital by the John N. Kapoor Trust, the sole beneficiary of which is Dr. John Kapoor, the sole stockholder of EJ Financial and the chairman of the Company. Effective July 1, 1994, EJ Financial increased its management services charge to $125,000 per year plus expenses incurred. The increased charges, which the Company believes are reasonable and reflect the cost of the services provided, reflect the increased need for EJ Financial's services in connection with operation as a publicly-held company. The management services agreement with EJ Financial expires in 1997. As a result of these factors, the Company expects general and administrative expenses to increase in the future. See \"Item 13 - Certain Relationships and Related Transactions\" and Note 7 of Notes to the Financial Statements attached as Exhibit 1.\nInterest expense increased to approximately $356,000 in 1995 from $163,000 in 1994 and $85,000 in 1993. These increases were due to additional borrowings on debt, owed to the Company's principal stockholder and Harris Bank and Trust N.A., under the Company's bank line of credit. The increase in\n1995 is due in part to the delay in the completion of the Offering until the first month in 1996. The proceeds of borrowings were used to fund the Company's operations during the period from 1993 to 1995. The Company's principal stockholder subsequently converted the principal of and accrued interest on the loan into shares of Common Stock and Warrants at $7.00 per share, the initial public offering price. In addition, a portion of the proceeds from the Offering were used to repay the outstanding balance under the bank line of credit. See \"Item 13 - Certain Relationships and Related Transactions\" and Note 3 of Notes to the Financial Statements.\nInception to December 31, 1995\nThe Company was taxed as an S corporation from inception through October 11, 1995 when the S corporation status was voluntarily terminated. Because the Company was taxed as an S Corporation, all of its net losses from inception through October 11, 1995 were passed through to its stockholders. Accordingly, the Company did not accumulate operating loss carryforwards prior to October 11, 1995. The Company uses the cash method to report tax losses. Due to the use of this method, the Company had tax expenses of approximately $437,000 at December 31, 1995, to be reported in future periods. The Company has commenced accruing net operating loss carryforwards.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company has funded its operations to date primarily through borrowings from its principal stockholder and under its bank line of credit, which is guaranteed by the Company's principal stockholder. At December 31, 1995, the Company had an outstanding principal balance of approximately $3.5 million under its debt financing arrangements. Of this amount, $1.5 million consisted of borrowings from the Company's principal stockholder and the remainder consisted of borrowings under the Company's bank line of credit. Borrowings under the stockholder loan bear interest at a rate equal to the lesser of 10% or the prime rate of Northern Trust Bank. Principal payments not paid when due are subject to additional interest at the rate of 15%. Approximately $193,000 of additional interest has been accrued through December 31, 1995. Borrowings under the bank line of credit have accrued interest at the prime rate of Harris Bank & Trust N.A., and such bank line of credit is payable upon demand and not on a revolving credit basis (that is, payments made on the line of credit by the Company are not available to be borrowed again by the Company). Because the Company has financed operations through debt financing, the Company has typically maintained minimal cash balances.\nThe Company's assets at December 31, 1995 increased to approximately $496,000 from $113,000 at December 31, 1994, principally due to $486,436 of deferred offering costs relating to its initial public offering (the \"Offering\"). The classification of these costs as an asset is in conformity with generally accepted accounting principles. Since these costs directly relate to the Offering, they should not be expensed when incurred. The costs were treated as a deferred cost and reflected on the balance sheet as an asset until the Offering was closed on January 30, 1996. Deferred offering costs will be offset against the net proceeds from the Offering.\nThe Company's liabilities at December 31, 1995 increased to approximately $4.9 million from $2.8 million at December 31, 1994. This increase is due to additional accrued expenses and borrowings under the Company's debt financing arrangements. These funds were used primarily for research and development costs incurred during the year.\nThe Company expects its cash requirements to increase significantly in future periods. In May 1995, the Company agreed to fund ongoing research at Georgetown through April 1996 for approximately $258,000. In addition, under the CRADA the Company is committed to pay NCI clinical trial costs of $120,000 per year as well as the cost to supply the BUdR and IUdR to be used in clinical trials. The Company may incur additional costs in supporting its agreements with NCI, as well as the continuation of its own research and development efforts. In the future, the Company will require funds for building a sales and marketing organization and development of distribution channels.\nBased on its currently planned research and product development programs, the Company anticipates that the net proceeds of the initial public offering and interest income earned thereon should be adequate to satisfy its capital and operational requirements for approximately 12 months. The net proceeds from the Offering were $8,662,092, including exercise of the Underwriters' over-allotment option. The Company's cash requirements may vary materially from those now planned because of results of research and development, results of clinical testing, relationships with possible strategic partners, changes in the focus and direction of the Company's research and development programs, competitive and technological advances, the FDA regulatory process and other factors. The Company has not yet submitted an NDA or received FDA approval for any of its products, and the Company has not realized any operating revenues. The Company's cumulative loss is approximately $4.5 million as of December 31, 1995.\nThe Company anticipates filing NDAs with the FDA for BUdR and IUdR for diagnostic and therapeutic applications for various cancers during 1996 and 1997. See \"Item - 1 Business -- NeoPharm Products -- NeoPharm Product Summary.\" All of the products currently being developed by the Company will require approval by the FDA before they can be sold commercially in the United States. The results of the preclinical and clinical testing on a nonbiologic drug and certain diagnostic drugs are submitted to the FDA in the form of an NDA for approval to commence commercial sales. In responding to an NDA, the FDA may grant marketing approval, request additional information or deny the application if the FDA determines that the application does not satisfy its regulatory approval criteria.\nThe Company may seek to satisfy its future funding requirements through public or private offerings of securities, with collaborative or other arrangements with corporate partners or from other sources. Additional financing may not be available when needed or on terms acceptable to the Company. If adequate financing is not available, the Company may be required to delay, scale back or eliminate certain of its research and development programs, to relinquish rights to certain of its technologies, therapeutic and diagnostic agents, product candidates or products, or to license third parties to commercialize products or technologies that the Company would otherwise seek to develop itself.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA\nThe Financial Statements and Supplementary Data are incorporated herein by reference to the Company's Financial Statements included as Exhibit 1. The information is contained as follows:\nPAGE ---- Report of Arthur Andersen LLP, Independent Public Accountants . . . . . . . . . . . . . . . . . . . . Balance Sheets . . . . . . . . . . . . . . . . . . Statements of Operations . . . . . . . . . . . . . Statements of Stockholders' Equity (Deficit) . . . Statements of Cash Flows . . . . . . . . . . . . . Notes to Financial Statements . . . . . . . . . . .\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe directors and executive officers of the Company are as follows:\n- - - ----------\n(1) Member of the Audit Committee.\n(2) Member of the Compensation Committee.\nAll directors hold office until the next annual meeting of the stockholders and until their successors are duly elected. Officers are appointed to serve, subject to the discretion of the Board of Directors, until their successors are appointed.\nJohn N. Kapoor, Ph.D., Chairman of the Board of Directors, has been a director of the Company since July 1990. Prior to forming the Company, Dr. Kapoor formed EJ Financial Enterprises, Inc., a health care consulting and investment company, in March 1990, of which Dr. Kapoor is currently President. Dr. Kapoor is presently Chairman and Chief Executive Officer of Option Care, Inc., an outpatient and home infusion health care company; Chairman of Unimed Pharmaceuticals, Inc., a developer and marketer of pharmaceuticals for cancer, endocrine disorders and infectious diseases; and Chairman of Akorn, Inc., a manufacturer, distributor, and marketer of generic ophthalmic products. Dr. Kapoor received his Ph.D. in medicinal chemistry from the State University of New York in 1970 and a B.S. in pharmacy from Bombay University in India.\nAquilur Rahman, Ph.D., joined the Company as Chief Scientific Officer and as a member of the Board of Directors in July 1990. Dr. Rahman is an adjunct professor of pathology and pharmacology at Georgetown University and has more than 15 years of research experience in developing methods of chemotherapy treatment for cancer. Dr. Rahman received his Masters of Science in Biochemistry from the University of Dacca (Bangladesh) in 1964 and his Ph.D. in Pharmaceutics from the University of Strathclyde (Glasgow, U.K.) in 1972.\nAnatoly Dritschilo, M.D., joined the Company as a Member of the Board of Directors in July 1990. Since August 1979, Dr. Dritschilo has been Chairman of the Department of Radiation Medicine and Medical Director of the Georgetown University Medical Center in Washington, D.C. Dr. Dritschilo received his B.S. in Chemical Engineering from the University of Pennsylvania, his M.S. in Engineering in 1969 from Newark College of Engineering, and his M.D. in 1973 from the College of Medicine of New Jersey.\nWilliam C. Govier, M.D., Ph.D., joined the Company in December 1993 as its President, Chief Executive Officer, and a member of the Board of Directors. Dr. Govier was a founder of Aegis Technology, Inc., a developer of pharmaceuticals for pulmonary disease therapy, and has been its President since June 1990. Prior to that time, Dr. Govier was Executive Vice President and Director of Research and Medical Affairs at Medco Research, Inc., a developer of drugs aimed at treating heart diseases. Dr. Govier received a B.A. in Chemistry and Biology in 1957 from Kalamazoo College, an M.D. in 1961 from McGill University in Montreal, Quebec, Canada, and a Ph.D. in Pharmacology in 1965 from the University of\nMississippi. From 1963 to 1968 he was a faculty member at the University of Mississippi, University of Texas Southwestern Medical School and Oxford University in England. From 1968 to 1970 Dr. Govier was associated with the Experimental Therapeutics Branch of the National Heart Institute, National Institutes of Health. Since that time, he has held management positions with major pharmaceutical companies, including Executive Director of Biological Research with CIBA-Geigy; Director of Pharmaceutical Research and Director of Medical Research with Lederle Laboratories, Division of American Cyanamid; and Director, Pharmaceuticals Research and Development Division of E.I. DuPont de Nemours & Co.\nMahendra G. Shah, Ph.D., has served as Vice President of Corporate and Business Development since October 1991. Dr. Shah is also a Vice President of EJ Financial Enterprises, Inc., a position he has held since October 1991. Prior to joining the Company, Dr. Shah was the Senior Director of New Business Development with Fujisawa USA from January 1987 to October 1991. Dr. Shah received his M.S. in 1978 and Ph.D. in 1984 in Industrial Pharmacy from St. John's University and an M.S. in 1969 and a B.S. in 1967 in Pharmaceutical Chemistry from Gujarat University in India.\nDavid E. Riggs has served as Chief Financial Officer since November 1995. Mr. Riggs is Senior Vice President, Chief Financial Officer, Secretary and Treasurer of Unimed Pharmaceuticals, Inc., a developer and marketer of pharmaceuticals for cancer, endocrine disorders and infectious diseases, since October 1994, and Vice President, Chief Financial Officer, Secretary and Treasurer of Unimed since May 1992. Prior to joining Unimed, Mr. Riggs was Chief Financial Officer of VideoCart, Inc., a micro-marketing media company, a company sold by Information Resources Inc., a market research company, from April 1990 to August 1991. Prior to working for VideoCart, Mr. Riggs held various positions from April 1986 until April 1990 with Fujisawa USA, serving finally as Treasurer. Mr. Riggs received a B.S. in accounting from the University of Illinois in 1979 and an M.B.A. from DePaul University in 1984. Mr. Riggs is a Certified Public Accountant.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nITEM 11. EXECUTIVE COMPENSATION.\nThe following table summarizes the compensation for services to the Company for the fiscal year ended December 31, 1995, of the Chief Executive Officer. No executive officer of the Company had total salary and bonus in excess of $100,000 in 1995:\nSummary Compensation Table\nDIRECTOR COMPENSATION\nDirectors are not paid any compensation for attendance at directors' meetings or for attending or participating in any committee. Directors are reimbursed for reasonable out-of-pocket expenses incurred in connection with attendance at such meetings. Non-employee directors are eligible to participate in the Company's 1995 Director Option Plan. See \"Employee Benefit Plans -- 1995 Director Option Plan.\"\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\nThe Compensation Committee is responsible for determining salaries, incentives and other forms of compensation for directors, officers and other employees of the Company and administers various incentive compensation and benefit plans. The Compensation Committee consists of Messrs. Kapoor and Dritschilo.\nINCENTIVE STOCK OPTION PLAN\nIn January 1995, the Board of Directors (the \"Board\") and the stockholders of the Company approved the 1995 Stock Option Plan (the \"Plan\"). The Plan provides for the granting to employees (including officers and employee directors) of \"incentive stock options\" within the meaning of Section 422 of the Internal Revenue Code of 1986, as amended, and the granting to employees (including officers, employees, directors, and consultants) of nonstatutory stock options. The purpose of the Plan is to attract and retain the best available personnel to the Company and to encourage stock ownership by employees, officers, directors and consultants of the Company to give them a greater personal stake in the success of the Company. A total of 450,000 shares of Common Stock were reserved for issuance under the Plan.\nThe Plan is currently administered by the Board of Directors, which determines the terms of the options granted under the Plan, including the exercise price, number of shares subject to the option and the exercisability thereof. Generally, options granted to employees and consultants under the Plan vest and become exercisable at a rate of 2.08% of the shares subject to the option per month but may not be exercised prior to one (1) year from the commencement of employment or the consultant relationship, but the Board of Directors of the Company has the discretion to determine the vesting of shares subject to each option. The terms of incentive stock options and nonstatutory stock options granted under the Plan may not exceed ten (10) years. The term of incentive stock options and nonstatutory stock options granted to an optionee who, at the time of grant, owns stock representing more than 10% of the Company's outstanding capital stock may not exceed five (5) years. No option granted under the Plan may be transferred by the optionee other than by will or the laws of descent or distribution and each option may be exercised, during the lifetime of the optionee, only by such optionee. In the event of a merger of the Company with or into another corporation or a sale of substantially all of the Company's assets, each option will be assumed or an equivalent option substituted by the successor corporation.\nIn the event any change is made in the Company's capitalization (other than the one for 1.28681 reverse stock split effected on October 4, 1995), such as a stock split or stock dividend, which results in a greater or lesser number of shares of Common Stock of the Company, appropriate adjustment shall be made in the option price and in the number of shares subject to the options. In the event of the proposed dissolution or liquidation of the Company, to the extent that an option has not been previously exercised, it will terminate immediately prior to the consummation of such proposed action. In the event of the merger or sale of substantially all of the assets of the Company, all outstanding options shall be assumed or substituted by the successor corporation, or if they are not assumed or substituted, they shall become fully vested unless the Board of Directors determines otherwise.\nThe exercise price of all incentive stock options granted under the Plan must be at least equal to the fair market value of the shares of Common Stock on the date of grant. With respect to any participant who owns stock possessing more than 10% of the voting rights of the Company's outstanding capital stock, the\nexercise price of any incentive stock option granted must equal at least 110% of the fair market value on the date of grant. No incentive stock options may be granted to a participant, that, when aggregated with all other incentive stock options granted to such participant would have an aggregate fair market value in excess of $100,000 becoming exercisable in any calendar year. The exercise price of all nonstatutory stock options granted under the Plan is determined by the Administrator but cannot be less than 85% of fair market value on the date of grant. No options have been granted to date at prices less than 100% of the fair market value on the date of grant.\nIn 1995, options to acquire 247,000 shares were granted under the Plan. The exercise price for all such option grants will be equal to the initial public offering price. No stock options nor SAR's were granted to named executives during 1995.\n1995 DIRECTOR OPTION PLAN\nThe 1995 Director Option Plan (the \"Director Plan\") was adopted by the Company's Board of Directors in January 1995 and approved by the Company's stockholders in January 1995. The Director Plan provides for the grant of nonstatutory stock options to non-employee directors of the Company who are not stockholders holding more than 5% of the Company's outstanding Common Stock (\"Outside Directors\") pursuant to an automatic, non-discretionary grant mechanism providing for a total of 50,000 shares of Common Stock. Currently one director is eligible to participate in the Director Plan in 1995.\nThe exercise price of options granted to Outside Directors must be 100% of the fair market value of the Company's Common Stock on the date of grant. The consideration for exercising options granted to Outside Directors may only consist of cash, check, previously owned shares of the Company's Common Stock or cashless exercise. Options granted to the Outside Directors have a five (5) year term, or shorter upon termination of their tenure as a director. Options granted to the Outside Directors vest at the rate of 25% of the shares subject to the option one year from the date of grant and 6.25% of the shares subject to the option at the end of each full quarter thereafter.\nThe Director Plan provides that each director who is an Outside Director on the date on which the Director Plan becomes effective will automatically be granted an option to purchase 1,000 shares of Common Stock of the Company. Each future Outside Director automatically will be granted an option to purchase 1,000 shares of Common Stock of the Company upon his or her initial election as a director. Subsequently, each Outside Director will be granted an additional option to purchase 500 shares of Common Stock on January 1 of each year thereafter (if, on such date, he or she has served as a director for at least six (6) months), so long as he or she remains an Outside Director. No option granted under the Plan may be transferred by the optionee other than by will or the laws of descent or distribution and each option may be exercised, during the lifetime of the optionee, only by such optionee.\nIn the event any change is made in the Company's capitalization (other than the one for 1.28681 reverse stock split effected on October 4, 1995), such as a stock split or stock dividend, which results in a greater or lesser number of shares of Common Stock of the Company, appropriate adjustment shall be made in the option price and in the number of shares subject to the options. In the event of the proposed dissolution or liquidation of the Company, to the extent that an option has not been previously exercised, it will terminate immediately prior to the consummation of such proposed action. In the event of the merger or sale of substantially all of the assets of the Company, all outstanding options shall be assumed or substituted by the successor corporation, or if they are not assumed or substituted, they shall become fully vested unless the Board of Directors determines otherwise.\nThe Board of Directors may amend the Director Plan at any time or may terminate it without approval of the stockholders. However, no such action by the Board of Directors may unilaterally alter or impair any option previously granted under the Director Plan without the consent of the optionee. In any event, the Director Plan will terminate in January 2005.\n1990 STOCK OPTION PLAN\nThe 1990 Stock Option Plan (the \"1990 Plan\") was terminated by the Company in January 1995. Upon termination of the 1990 Plan, there were 12,433 shares subject to options outstanding under such plan. The weighted average exercise price of such outstanding options is $.04 per share. Options for 8,547 shares are currently exercisable, and options for 3,886 shares are exercisable upon the filing with the FDA of the Company's first NDA.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following table sets forth certain information regarding the beneficial ownership of the Company's Common Stock as of April 25, 1996 for (i) each director, (ii) all of the Company's directors and executive officers as a group and (iii) each person known to the Company to be the beneficial owner of more than 5% of the Company's Common Stock. Except as otherwise indicated, based on information furnished by the beneficial owners of the Common Stock listed below, the Company believes that such owners have sole investment and voting power with respect to such shares, subject to community property laws where applicable.\n- - - ----------\n* As of December 31, 1995 35,618 of Dr. Govier's shares are subject to a Stock Repurchase Agreement.\n(1) Does not include the 287,004 shares of Common Stock, or 143,502 shares of Common Stock that may be acquired upon exercise of 143,502 Warrants issuable to the John N. Kapoor Trust upon conversion of the $1,500,000 loan and $523,385 of accrued interest thereon payable pursuant to the Loan Repayment Note (based upon interest accruing through November 30, 1995). Dr. John N. Kapoor disclaims beneficial ownership of 777,117 shares of Common Stock held by the John N. Kapoor 1994-A Annuity Trust, 38,856 shares of Common Stock held by the Christina Grace Kapoor Trust, 38,856 shares of Common Stock held by the Jonathan Nath Kapoor Trust, 38,856 shares of Common Stock held by the Olivia Jane Kapoor Trust, and 38,856 shares of Common Stock held by the Jules Alexander Kapoor Trust.\n(2) Includes the 287,004 shares of Common Stock the John N. Kapoor Trust may acquire upon conversion of the outstanding principal and accrued interest on the Loan Repayment Note, but does not include 143,502 shares of Common Stock that may be acquired at a price of $9.80 per share commencing upon exercise on or after January 25, 1997 of 143,502 Warrants issuable to the John N. Kapoor Trust\nupon conversion of the $1,500,000 loan and $523,385 of accrued interest thereon payable pursuant to the Loan Repayment Note (based upon interest accruing through November 30, 1995). See \"Risk Factors -- Litigation Involving Company's Chairman.\"\n(3) Includes an option immediately exercisable for 25,000 shares of Common Stock. Dr. Mahendra G. Shah disclaims beneficial ownership of 7,771 shares of Common Stock held by Nrupal Shah, 7,771 shares of Common Stock held by Shaily Shah, and 23,312 shares of Common Stock held by Indira Shah.\n(4) Includes an option immediately exercisable for 50,000 shares of Common Stock.\n(5) Does not include shares held by family members of officers and directors over which shares such officers and directors disclaim beneficial ownership.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nDr. Aquilur Rahman, the Company's Chief Scientific Officer and member of the Board of Directors, was until April 1, 1996 employed by Georgetown University on a full -time basis, an entity with which the Company had entered into license and sponsored research agreements. See \"Item 1 - Business--Collaborative Relationships, Licenses and Commercialization Strategy.\"\nA trust of which Dr. John N. Kapoor, Chairman of the Board of the Company, is the sole beneficiary has loaned the Company $1,500,000 pursuant to a Loan Repayment Note dated June 18, 1990. The amount outstanding on such Loan Repayment Note as of December 31, 1995 was $1,500,000 in principal amount and $545,379 in interest. Funds borrowed under the Loan Repayment Note incur interest at the lesser of 10% per annum or the prime rate, plus, if the Company is in default under the Loan Repayment Note, an additional 15% per annum accrues on the Loan Repayment Note from the date of default until the Loan Repayment Note is paid. The Company has been in default under the Loan Repayment Note since June 18, 1992. No payments have been made on the Loan Repayment Note. The Company is accruing interest at 15% per annum on the principal balances that are past due. The principal and accrued interest to November 30, 1995 under this Loan Repayment Note will convert into Common Stock and Warrants at the initial public offering price, and $54,834 in remaining unpaid interest accruing from November 30, 1995 through the date of the closing of the Offering was paid by the Company in cash, subsequent to year-end. An aggregate of 287,004 shares of Common Stock and 143,502 Warrants were issued upon conversion of the outstanding $1,500,000 in principal and $523,385 of accrued interest debt.\nThe Company's President and Chief Executive Officer (\"CEO\"), William C. Govier, has served as a consultant to the Company on clinical trials and NDA filing matters, both individually and as a consultant with Aegis Technology, Inc. (\"Aegis\"), an entity co-founded by Govier. As the Company's President and CEO, Govier received options in December 1993, to purchase 116,567 shares of Company stock at the fair market value on the date of grant, which were subsequently exercised. His colleague and co-founder of Aegis received options in December 1993 to purchase 7,771 shares of Company stock at the fair market value on the date of grant, of which 3,885 options were 100% vested and 3,886 options vest upon future performance of services. The Company has expensed approximately $442,000 since inception through December 31, 1995, related to work performed and expenses incurred by Govier, his colleague and Aegis. During 1994 and 1993, the Company expensed approximately $104,000 and $3,600 were expensed.\nOn July 1, 1994, the Company entered into a Consulting Agreement with EJ Financial Enterprises, Inc. (\"EJ Financial\"). The Consulting Agreement provides that the Company will pay EJ Financial $125,000 per year (paid quarterly) for certain business and financial services, including having certain officers of EJ Financial serve as officers of the Company. Dr. John Kapoor, the Company's Chairman of the Board is the president and a director of EJ Financial. Dr. Mahendra Shah, Vice President of the Company, is also a Vice President of EJ Financial. The Company believes that the charges provided for in the Agreement are reasonable and reflect the cost of the services provided. These charges reflect the increased need for EJ Financial's services in connection with future operation of NeoPharm as a publicly-held company. The management services agreement with EJ Financial expires in 1997.\nIn connection with the Offering, the Company has adopted a policy whereby any further transactions between the Company and its officers, directors, principal stockholders and any affiliates of the foregoing persons will be on terms no less favorable to the Company than could reasonably be obtained in arm's length transactions with independent third parties, and that any such transactions also be approved by a majority of the Company's disinterested outside directors.\nDuring 1995, John N. Kapoor extended his personal guarantee of a $1 million Harris Bank and Trust Company line of credit, and guaranteed a $1.5 million increase to the line. This line of credit was closed as of February 19, 1996.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.\n(a) Exhibits\n3.1 Certificate of Incorporation, as amended filed with the Commission as Exhibit 3.1 to the Company's Registration Statement on Form S-1 (File No. 33-90516), is incorporated by reference. 3.2 Bylaws of the Registrant, as amended filed with the Commission as Exhibit 3.2 to the Company's Registration Statement on Form S-1 (File No. 33- 90516), is incorporated by reference. 4.1 Specimen Common Stock Certificate filed with the Commission as Exhibit 4.1 to the Company's Registration Statement on Form S-1 (File No. 33- 90516), is incorporated by reference. 4.2 Specimen Warrant Certificate filed with the Commission as Exhibit 4.2 to the Company's Registration Statement on Form S-1 (File No. 33-90516), is incorporated by reference. 4.3 Form of Representative's Warrant Agreement between the Registrant and the Representative, including form of Representative's Warrant filed with the Commission as Exhibit 4.3 to the Company's Registration Statement on Form S-1 (File No. 33-90516), is incorporated by reference. 4.4 Form of Warrant Agreement between the Registrant, the Representative and Harris Trust and Savings Bank, including form of Warrant filed with the Commission as Exhibit 4.4 to the Company's Registration Statement on Form S-1 (File No. 33-90516), is incorporated by reference. 10.1 1995 Stock Option Plan, with forms of Incentive and Nonstatutory Stock Option Agreements filed with the Commission as Exhibit 10.1 to the Company's Registration Statement on Form S-1 (File No. 33-90516), is incorporated by reference. 10.2 1995 Director Option Plan, with form of Director Stock Option Agreement filed with the Commission as Exhibit 10.2 to the Company's Registration Statement on Form S-1 (File No. 33-90516), is incorporated by reference. 10.3 Form of Director and Officer Indemnification Agreement. filed with the Commission as Exhibit 10.3to the Company's Registration Statement on Form S-1 (File No. 33-90516), is incorporated by reference. 10.4 Cooperative Research and Development Agreement between the Company and the National Cancer Institute dated September 13, 1993 filed with the Commission as Exhibit 10.4 to the Company's Registration Statement on Form S-1 (File No. 33-90516), is incorporated by reference. 10.5 License Agreement between the Company and Georgetown University dated July, 1990 filed with the Commission as Exhibit 10.5 to the Company's Registration Statement on Form S-1 (File No. 33-90516), is incorporated by reference. 10.6 License Agreement between the Company and Georgetown University dated April 18, 1994 filed with the Commission as Exhibit 10.6 to the Company's Registration Statement on Form S-1 (File No. 33-90516), is incorporated by reference. 10.7 Loan Repayment Note, dated June 18, 1990, by and between the Company and the John N. Kapoor Trust filed with the Commission as Exhibit 10.7 to the Company's Registration Statement on Form S-1 (File No. 33-90516), is incorporated by reference. 10.8 Consulting Agreement, dated July 1, 1994, by and between the Company and EJ Financial Services, Inc. filed with the Commission as Exhibit 10.8 to the Company's Registration Statement on Form S-1 (File No. 33-90516), is incorporated by reference. 10.9 Stock Repurchase Agreement, dated November 17, 1994, between the Company and William C. Govier filed with the Commission as Exhibit 10.9 to the Company's Registration Statement on Form S-1 (File No. 33-90516), is incorporated by reference. 10.10 Harris Bank and Trust Company Loan Agreement dated March 16, 1995, as amended on October 5, 1995. filed with the Commission as Exhibit 10.10 to the Company's Registration Statement on Form S-1 (File No. 33-90516), is incorporated by reference. 11.1 Calculation of Earnings Per Share.\n- - - -----------\n(b) Financial Statements\n(1) Financial Statements\nThe financial statements filed as part of this Registration Statement are listed in the Index to Financial Statements of the Company on 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, ON THE 25TH DAY OF APRIL, 1996.\nNEOPHARM, INC.\nBy: \/s\/ WILLIAM C. GOVIER ---------------------------------------- William C. Govier, President and Chief Executive Officer\nPURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS ANNUAL REPORT HAS BEEN SIGNED BY THE FOLLOWING PERSONS IN THE CAPACITIES AND ON THE DATES INDICATED.\nNEOPHARM, INC. (A DELAWARE CORPORATION IN THE DEVELOPMENT STAGE)\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo Stockholders of NeoPharm, Inc.:\nWe have audited the accompanying balance sheets of NeoPharm, Inc. (a Delaware corporation in the development stage) as of December 31, 1994 and 1995, and the related statements of operations, stockholders' equity (deficit) and cash flows for each of the three years in the period ended December 31, 1995. 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 NeoPharm, Inc. as of December 31, 1994 and 1995, and the results of its operations and cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\nARTHUR ANDERSEN LLP\nChicago, Illinois April 12, 1996\nNEOPHARM, INC. (A DELAWARE CORPORATION IN THE DEVELOPMENT STAGE)\nBALANCE SHEETS\nThe accompanying notes are an integral part of these balance sheets.\nNEOPHARM, INC. (A DELAWARE CORPORATION IN THE DEVELOPMENT STAGE)\nSTATEMENTS OF OPERATIONS\nThe accompanying notes are an integral part of these statements.\nNEOPHARM, INC. (A DELAWARE CORPORATION IN THE DEVELOPMENT STAGE)\nSTATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)\nFOR THE PERIOD FROM INCEPTION (JUNE 15, 1990) THROUGH DECEMBER 31, 1995\nThe accompanying notes are an integral part of these statements.\nNEOPHARM, INC. (A DELAWARE CORPORATION IN THE DEVELOPMENT STAGE)\nSTATEMENTS OF CASH FLOWS\nSupplemental disclosure of non--cash transactions:\nThe Company received management services from a related party (Note 7) of $25,000 and $12,500 in 1993 and 1994, respectively, which were recorded as additional capital contributions.\nThe accompanying notes are an integral part of these statements.\nNEOPHARM, INC. (A DELAWARE CORPORATION IN THE DEVELOPMENT STAGE)\nNOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995\n1. ORGANIZATION AND BUSINESS:\nNeoPharm, Inc. (the \"Company\"), a Delaware corporation in the development stage, was incorporated on June 15, 1990, under the name of OncoMed, Inc. In March 1995, the Company changed its name to NeoPharm, Inc. The Company is developing products to provide therapeutic and diagnostic benefits in the treatment of various forms of cancer. The Company has two products which are the subject of a Cooperative Research and Development Agreement (\"CRADA\") with the National Cancer Institute (\"NCI\"), a unit of the National Institutes of Health. The Company also has rights to products developed under license and sponsored research agreements with Georgetown University (\"Georgetown\").\nThe Company is in the development stage which requires substantial capital for research, product development and market development activities. The Company has not yet initiated marketing of a commercial product. The Company's proposed products are in various stages of clinical trials, but the Company has not yet filed an NDA. These and other proposed products will require clinical testing, regulatory approval and substantial additional investment prior to commercialization. The future success of the Company is dependent on its ability to obtain additional working capital to develop, manufacture and market its products and, ultimately, upon its ability to attain future profitable operations. There can be no assurance that the Company will be able to obtain necessary financing or regulatory approvals to be able to successfully develop, manufacture and market its products, or attain successful future operations. Accordingly, the predictability of the Company's future success is uncertain.\nThe Company's rights to its products are subject to the terms of its agreements with NCI and Georgetown. Termination of either, or both, of these agreements would have a material adverse effect on the Company's business, financial condition and results of operations. In addition, uncertainty exists as to the Company's ability to protect its rights to patents and its proprietary information. There can also be no assurance that research and discoveries by others will not render some or all of the Company's programs or products noncompetitive or obsolete. Nor can there be any assurance that unforeseen problems will not develop with the Company's technologies or applications, or that the Company will be able to address successfully technological challenges it encounters in its research and development programs. Although the Company plans to obtain product liability insurance, it currently does not have any nor is there any assurance that it will be able to attain or maintain such insurance on acceptable terms or with adequate coverage against potential liabilities.\n2. SIGNIFICANT ACCOUNTING POLICIES:\nRESEARCH AND DEVELOPMENT\nResearch and development costs are expensed when incurred. These costs include, among other things, consulting fees and costs reimbursed to Georgetown pursuant to the agreements as described in Note 6. Payments related to the acquisition of technology rights, for which development work is in process, are expensed and considered a component of research and development costs. The Company also allocates indirect costs, consisting primarily of operational costs for administering research and development activities, to research and development expenses.\nEQUIPMENT AND FURNITURE\nEquipment and furniture are recorded at cost and are depreciated using an accelerated method over the estimated useful economic lives of the assets involved. The estimated useful lives employed in computing depreciation are five years for computer equipment and seven years for furniture. Maintenance and repairs that do not extend the life of assets are charged to expense when incurred.\nDEFERRED OFFERING COSTS\nDeferred offering costs represent costs incurred directly related to the initial public offering. Upon completion of the offering, these costs will be offset against the proceeds of the offering.\nMANAGEMENT'S USE OF ESTIMATES\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expense during the reporting period. Actual results could differ from those estimates.\nPRO FORMA FINANCIAL INFORMATION\nPro forma financial information is presented to reflect the impact of the conversion of the loan and interest payable to the principal stockholder into equity of the Company at the offering. Pro forma net loss differs from net loss due to the reduction of interest expense resulting from the assumed conversion of the $1,500,000 loan payable to the principal stockholder into equity. The interest expense reduction was $209,835 for the year ended December 31, 1995.\nPro forma net loss per share is computed using the weighted average number of common shares outstanding during the period, retroactively adjusted for the one-for-1.28681 reverse stock split effected in October 1995 (See Note 8). The calculation of the shares used in computing pro forma loss per share assumes the conversion of the $1,500,000 loan payable to the principal stockholder outstanding at December 31, 1995 into 212,766 shares of common stock. This conversion is assumed to have occurred at the beginning of the period. During all periods presented, outstanding options have been excluded from the computation as their effect was antidilutive. There were no option grants during the 12-month period prior to the proposed offering at prices below the expected initial public offering price. All stock issuances during the 12-month period prior to the proposed offering were pursuant to the exercise of options previously granted.\nSupplementary pro forma loss per share for the year ended December 31, 1995 (based on the weighted average number of common shares outstanding during the respective periods, assuming the conversion of the loan payable to the principal stockholder and the retirement of the line of credit with the bank occurred at the beginning of the period or the issue date, if later) was $(0.49).\nPro forma information in the accompanying balance sheet reflects the reclassification of the accumulated deficit to additional paid-in capital as a result of the termination of the Company's S Corporation status in connection with the proposed initial public offering, and the conversion of the $1,500,000 loan and $523,385 of accrued interest payable at December 31, 1995 to a trust, the sole beneficiary of which is Dr. John N. Kapoor, the Chairman of the Company, into 287,004 shares of common stock and 143,502 warrants.\n3. DEBT:\nOn June 18, 1990, the Company executed a loan agreement with Dr. John N. Kapoor, its principal stockholder. The loan agreement allows the Company to borrow up to $1,500,000. Funds borrowed under the agreement incur interest at the lesser of 10% or the prime rate as determined by the Northern Trust\nBank. The Company has borrowed funds up to the maximum of $1,500,000 at December 31, 1995 and December 31, 1994.\nInterest on borrowed funds accrues until the second anniversary of the funding. Thereafter, principal and interest are to be repaid in 12 quarterly installments. Any principal payment not paid within 5 days of the date when due is subject to additional interest of 15% per annum.\nFrom June 1990 through April 1994, the Company financed its operations by borrowing under this loan agreement. No payments of interest or principal were made during this period. Subsequent to year-end, in accordance with the agreement between the principal stockholder and the Company, with the completion of the proposed offering, the principal stockholder converted the outstanding loan balance, plus accrued interest through November 30, 1995, into shares of the Company's common stock and common stock purchase warrants at a per share conversion price equal to the offering price, $7.00 per share, $.10 per warrant. The Company issued 287,004 shares and 143,502 warrants.\nIn July 1994, the Company obtained a line of credit from Harris Bank. Maximum borrowings under this line were $1,000,000 and were subject to interest at the prime rate (8.5% at December 31, 1994, which is also the weighted average interest rate on all short term borrowings at December 31, 1994). In March 1995, the Company increased the Harris Bank line of credit from $1,000,000 to $2,500,000. The line was subject to interest at the prime rate (8.5% at December 31, 1995, which is also the weighted average interest rate on all short term borrowings). Funds were drawn on the line for any corporate purposes. Amounts borrowed were payable on demand.\nThe Harris Bank line of credit was personally guaranteed by Dr. Kapoor, the principal stockholder. The Company owed approximately $2,008,000 and $656,000 in principal under this agreement as of December 31, 1995 and December 31, 1994, respectively. The unused portion of the line of credit was approximately $492,000 and $344,000 at December 31, 1995 and December 31, 1994, respectively.\nOn January 31, 1996, the Company remitted principal of $2,007,652 and interest of $136,750 representing payment in full of the outstanding obligation under the line of credit.\n4. OPTIONS AND STOCK REPURCHASE AGREEMENTS\nOPTION AGREEMENTS\nThe Company adopted a stock plan in 1990. The Company granted options under the plan to purchase 730,489 shares. The options have an exercise price of $0.000429 per share with the exception of options to purchase 124,338 shares issued in December 1993, which have an exercise price of $.06434 per share. Effective January 1995, this plan has been terminated. No additional grants will be made under this plan.\nIncluded in the grants described above are options to purchase 147,652 shares granted to non-employees. The Company accounts for these options using a fair value method with the fair value of these options determined at the date of issuance. The Company has deemed the fair value for these options at their respective issuance dates to be nominal. Thus, no expense for these option grants has been recorded by the Company.\nA summary of stock option activity is as follows:\nOn January 25, 1995, the board of directors approved the NeoPharm, Inc. 1995 Stock Option Plan (the \"Plan\"), which provides for the grant of up to 450,000 options to acquire the Company's common stock. The option prices shall be not less than 85 percent of the fair market value of the stock as determined by the Administrator pursuant to the Plan. The board also approved the NeoPharm, Inc. 1995 Director Option Plan, which provides for the grant of up to 50,000 options to acquire the Company's common stock. The option prices shall be the fair market value on the date of grant.\nSTOCK REPURCHASE AGREEMENT\nIn December 1993, the Company granted an option to purchase 116,567 shares of its common stock to William C. Govier, President and Chief Executive Officer (See Note 7). The option had an exercise price of $.06434 per share and a three year monthly vesting schedule. On November 17, 1994, the Company agreed to allow Govier to exercise the option for all 116,567 shares in exchange for Govier agreeing to a Stock Repurchase Agreement. The Company has an option to repurchase the unreleased shares at $.06434 per share. The shares are released from the repurchase agreement one thirty-sixth ( 1\/36) per month starting from December 1, 1993. As of December 31, 1995 and December 31, 1994, 35,618 and 74,473 shares, respectively, are still subject to the terms of this repurchase agreement.\n5. FEDERAL INCOME TAXES:\nThe Company elected \"S\" Corporation status at inception. Losses incurred to date have been reported on the stockholders' tax returns and are not available to the Company as a net operating loss carryforward. During 1994, the Company adopted Statement of Financial Accounting Standards No. 109 (\"FAS 109\"), \"Accounting for Income Taxes.\" The Company reports certain income and expense items for income tax purposes on a basis different from that reflected in the accompanying financial statements. The principal differences are due to accruals which are accounted for on a cash basis for income tax purposes. The Company voluntarily terminated its S Corporation election on October 11, 1995. The Company has future tax deductions of approximately $383,000 and $437,000 as of December 31, 1994 and December 31, 1995, respectively, that have previously been expensed for financial reporting purposes. In accordance with the\nprovisions of FAS 109, the Company will record a 100% valuation reserve for the deferred tax asset related to the future tax expenses.\n6. COMMITMENTS AND CONTINGENCIES:\nLICENSE AND RESEARCH AGREEMENTS\nFrom time to time the Company enters into license and research agreements with third parties. At December 31, 1995, the Company has three agreements in effect as described below.\nNATIONAL CANCER INSTITUTE\nThe Company has entered into an agreement (\"CRADA\") with NCI. Pursuant to the agreement, the Company has committed to commercialize certain products received from NCI. The Company has agreed to provide product to support NCI sponsored clinical trials and will use its best efforts to file a New Drug Application (\"NDA\") with the Food and Drug Administration (\"FDA\"). NCI has agreed to collaborate on the clinical development of the products and to provide access to the data necessary to obtain pharmaceutic regulatory approval.\nDuring the years ended December 31, 1995 and 1994, the Company paid and expensed approximately $87,000 and $153,000, respectively, for product used in clinical trials. During 1994, the Company paid approximately $162,000 for current and prior product used in clinical trials. The Company expensed, as research and development costs, $45,000 in 1993 and $117,000 in 1994. In addition, the Company is committed to pay NCI $120,000 per year for reasonable and necessary expenses incurred by NCI in carrying out NCI's responsibilities under the CRADA. During 1995 and 1994, the Company expensed, as research and development costs, and paid $120,000 to NCI for these expenses. NCI is required to provide the Company an accounting of the use of funds. Any amounts not expended at the end of the agreement (May 1997) are refundable to the Company.\nThe CRADA will expire on May 1, 1997, if not earlier terminated. It may be terminated by mutual consent of NCI and the Company. Either Party may terminate if the other Party breaches a material term or condition and such breach is not cured within a certain period of time. Also, either Party may unilaterally terminate by giving 60 days notice. If unilaterally terminated by either party, all provisions of the CRADA shall continue in full force and effect during the completion of all clinical trials and clinical protocols included under the CRADA prior to the date of notification of intent to terminate. In such situation, the Company retains the rights to data from clinical trials conducted prior to, or in progress, at the time of the termination.\nGEORGETOWN UNIVERSITY\nThe Company has entered into two license and research agreements with Georgetown whereby the Company has obtained an exclusive worldwide license to use certain technology. In exchange for the grant of these exclusive licenses, the Company will pay Georgetown, beginning with the first commercial sale of a product incorporating the licensed technologies, a royalty on net sales by the Company of products incorporating any of such technologies. The royalty will be payable for the life of the related patents.\nDuring the years ended December 31, 1995 and 1994, the Company paid and expensed approximately $277,000 and $229,000, respectively, pursuant to the license and research agreements. No amounts were expensed under this agreement in 1993.\nOTHER\nThe Company has entered into consulting arrangements with members of its Scientific Advisory Board who are also employed on a full-time basis by academic or research institutions. Since inception through December 31, 1995, members of the Scientific Advisory Board have been issued options (see Note 4) to purchase an aggregate 43,313 shares of Company stock at the fair market value at the date of grant which vest over the consulting period. Additionally, the Scientific Advisory Board members have received aggregate payments of approximately $50,000 since the inception of these consulting arrangements for work performed and expenses incurred through December 31, 1995.\nThe Company is not a party to any litigation or other legal proceedings.\n7. TRANSACTIONS WITH RELATED PARTIES\nThe Company receives management services from EJ Financial Enterprises, Inc. (\"EJ Financial\"), a healthcare consulting and investment firm in which Dr. Kapoor is the principal stockholder. From inception through June 30, 1994, EJ Financial has charged the Company $25,000 per year for services provided plus actual expenses incurred. Through June 30, 1994, no payment for these services was made, but rather has been treated as additional capital contributions by Dr. Kapoor in the accompanying statements of stockholders' equity (deficit). Effective July 1, 1994, EJ Financial increased its charge for management services provided to $125,000 per year plus actual expenses. The agreement, which expires June 30, 1997, reflects an increase in the research and development activity of the Company, the increased need for EJ Financial's services and future operations as a public company. Charges are allocated to the Company based on estimated time spent by EJ Financial personnel on the Company's affairs. Management believes that the cost for management services allocated to the Company represents the cost of the services provided and that they are reasonable. Since inception through December 31, 1995, the Company has expensed approximately $187,500 for management services and $174,000 as reimbursement of actual expenses incurred by EJ Financial that directly related to the Company.\nThe Company's Chief Scientific Officer, Dr. Aquilur Rahman, is employed on a full-time basis by Georgetown with which the Company has entered into license and sponsored research agreements for product research and development (see Note 6). During 1995 and 1994, the Company expensed approximately $347,000 and $302,000 related to work performed and expenses incurred by Georgetown and Dr. Rahman. Since inception through December 31, 1995, the Company has expensed approximately $1,542,000. Additionally, Dr. Rahman received options in June 1990 (See Note 4) to purchase 466,270 shares of Company stock at the fair market value on the date of the grant of the options.\nThe Company's President and Chief Executive Officer (\"CEO\"), William C. Govier, has served as a consultant to the Company on clinical trials and NDA filing matters, both individually and as a consultant with Aegis Technology, Inc. (\"Aegis\"), an entity co-founded by Govier. As the Company's President and CEO, Govier received options in December 1993, to purchase 116,567 shares of Company stock at the fair market value on the date of grant, which were subsequently exercised (See Note 4). His colleague and co-founder of Aegis received options in December 1993 (see Note 4) to purchase 7,771 shares of Company stock at the fair market value on the date of grant, of which 3,885 options were 100% vested and 3,886 options vest upon future performance of services. The Company has expensed approximately $442,000 since inception through December 31, 1995, related to work performed and expenses incurred by Govier, his colleague and Aegis. During 1994 and 1993, the Company expensed approximately $104,000 and $3,600 were expensed.\nAs discussed in Note 3, the Company has a financing arrangement with its principal stockholder.\nIncluded as accrued expenses in the accompanying balance sheet is an accrual for management services and expense reimbursement due to EJ Financial of $206,366 and $62,500 at December 31, 1995 and 1994, respectively. Also, included as accrued expenses is an accrual for consulting services and expenses due to Dr. Rahman of $69,205 and 41,667, and due to Govier's colleague of $62,169 and $18,000 at December 31, 1995 and 1994, respectively.\n8. STOCKHOLDERS' EQUITY\nIn January 1995, the Company amended its Certificate of Incorporation to increase the number of authorized shares of common stock to 15,000,000 shares. In October 1995, the Company amended its Certificate of Incorporation to convert each 1.28681 shares of outstanding Common Stock into one share of Common Stock and to restate the par value of the Common Stock from $0.000333 per share to $0.000429 per share. The reverse stock split has been reflected retroactively in these financial statements for all periods presented.\n9. SUBSEQUENT EVENT -- INITIAL PUBLIC OFFERING\nOn January 30, 1996 the Company completed a public offering of newly issued 1,350,000 shares of common stock and 675,000 warrants for proceeds of approximately $8,435,000, net of expenses. On March 8, 1996 the Company issued 36,130 shares of common stock and 18,565 warrants related to the underwriter's over-allotment option for proceeds of approximately $267,000, net of expenses. The Company plans to use the proceeds for research and development, repayment of bank debt, sales and marketing, working capital and general corporate purposes (including payment of certain interest accrued on the Chairman's loan).\nPRO FORMA BALANCE SHEET","section_15":""}
{"filename":"72162_1995.txt","cik":"72162","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nNL Industries, Inc., organized as a New Jersey corporation in 1891, conducts its operations through its principal wholly-owned subsidiaries, Kronos, Inc. and Rheox, Inc. Valhi, Inc. and Tremont Corporation, each affiliates of Contran Corporation, hold 54% and 18%, respectively, of NL's outstanding common stock. Contran holds, directly or through subsidiaries, approximately 91% of Valhi's and 44% of Tremont's outstanding common stock. Substantially all of Contran's outstanding voting stock is held by trusts established for the benefit of the children and grandchildren of Harold C. Simmons of which Mr. Simmons is the sole trustee. Mr. Simmons, the Chairman of the Board of NL and the Chairman of the Board, President and Chief Executive Officer of each of Contran and Valhi and a director of Tremont, may be deemed to control each of such companies. NL and its consolidated subsidiaries are sometimes referred to herein collectively as the \"Company\".\nKronos is the world's fourth largest producer of titanium dioxide pigments (\"TiO2\") with an estimated 11% share of the worldwide market. Approximately one-half of Kronos' 1995 sales volume was in Europe, where Kronos is the second largest producer of TiO2. In 1995, Kronos accounted for 87% of the Company's sales and 81% of its operating income. Rheox is the world's largest producer of rheological additives for solvent-based systems.\nThe Company's objective is to maximize total shareholder returns by (i) focusing on continued cost control, (ii) deleveraging during the current upturn of the TiO2 industry and (iii) investing in certain cost effective debottlenecking projects to increase TiO2 production capacity.\nKRONOS\nINDUSTRY\nTitanium dioxide pigments are chemical products used for imparting whiteness, brightness and opacity to a wide range of products, including paints, plastics, paper, fibers and ceramics. TiO2 is considered to be a \"quality-of- life\" product with demand affected by the gross domestic product in various regions of the world.\nDemand, supply and pricing of TiO2 have historically been cyclical. The last cyclical peak for TiO2 prices occurred in early 1990, with a cyclical low in the third quarter of 1993. The Company believes the TiO2 industry continues to have long-term potential. During the last TiO2 downturn, industry capacity utilization dropped from almost 100% to approximately 85%. Industry utilization increased to about 91% in 1995, and Kronos' selling prices in fourth quarter of 1995 were about 24% above the 1993 low point. Although TiO2 demand in Europe and the U.S. is expected to be relatively flat during the first half of 1996, the Company expects industry capacity utilization rates will increase over the next several years. The Company's expectations as to the future prospects of the TiO2 industry are based upon several factors beyond the Company's control, principally continued worldwide growth of gross domestic product and the absence of technological advancements in or modifications to TiO2 processes that would result in material and unanticipated increases in production efficiencies. To the extent that actual developments differ from the Company's expectations, the Company's and the TiO2 industry's future performance could be unfavorably affected.\nKronos has an estimated 18% share of European TiO2 sales and an estimated 9% share of U.S. TiO2 sales. Consumption per capita in the United States and Western Europe far exceeds that in other areas of the world and these regions are expected to continue to be the largest geographic markets for TiO2 consumption. If the economies in Eastern Europe, the Far East and China continue to develop, a significant market for TiO2 could emerge in those countries. Kronos believes that, due to its strong presence in Western Europe, it is well positioned to participate in growth in the Eastern European market . Geographic segment information is contained in Note 3 to the Consolidated Financial Statements.\nPRODUCTS AND OPERATIONS\nThe Company believes that there are no effective substitutes for TiO2. However, extenders such as kaolin clays, calcium carbonate and polymeric opacifiers are used in a number of Kronos' markets. Generally, extenders are used to reduce to some extent the utilization of higher cost TiO2. The use of extenders has not significantly affected TiO2 consumption over the past decade because extenders generally have, to date, failed to match the performance characteristics of TiO2. The Company believes that the use of extenders will not materially alter the growth of the TiO2 business in the foreseeable future.\nKronos currently produces over 40 different TiO2 grades, sold under the Kronos and Titanox trademarks, which provide a variety of performance properties to meet customers' specific requirements. Kronos' major customers include international paint, plastics and paper manufacturers.\nKronos is one of the world's leading producers and marketers of TiO2. Kronos and its distributors and agents sell and provide technical services for its products to over 5,000 customers with the majority of sales in Europe, the United States and Canada. Kronos' international operations are conducted through Kronos International, Inc., a German-based holding company formed in 1989 to manage and coordinate the Company's manufacturing operations in Germany, Canada, Belgium and Norway, and its sales and marketing activities in over 100 countries worldwide. Kronos and its predecessors have produced and marketed TiO2 in North America and Europe for over 70 years. As a result, Kronos believes that it has developed considerable expertise and efficiency in the manufacture, sale, shipment and service of its products in domestic and international markets. By volume, one-half of Kronos' 1995 TiO2 sales were to Europe, with 36% to North America and the balance to export markets.\nKronos is also engaged in the mining and sale of ilmenite ore (a raw material used in the sulfate pigment production process), and the manufacture and sale of iron-based water treatment chemicals (derived from co-products of the pigment production processes). Water treatment chemicals are used as treatment and conditioning agents for industrial effluents and municipal wastewater and in the manufacture of iron pigments.\nMANUFACTURING PROCESS AND RAW MATERIALS\nTiO2 is manufactured by Kronos using both the chloride process and the sulfate process. Approximately two-thirds of Kronos' current production capacity is based on its chloride process which generates less waste than the sulfate process. The waste acid resulting from the sulfate process is either neutralized or reprocessed at Kronos or third party facilities. Although most end-use applications can use pigments produced by either process, chloride process pigments are generally preferred in certain coatings and plastics applications, and sulfate process pigments are generally preferred for paper, fibers and ceramics applications. Due to environmental factors and customer considerations, the proportion of TiO2 industry sales represented by chloride process pigments has increased relative to sulfate process pigments in the past few years, and chloride process production facilities currently represent approximately 55% of industry capacity.\nKronos produced a record 393,000 metric tons of TiO2 in 1995, compared to 357,000 metric tons in 1994 and 352,000 metric tons in 1993. Kronos believes its annual attainable production capacity is approximately 390,000 metric tons, including its one-half interest in the joint venture-owned Louisiana plant (see \"TiO2 manufacturing joint venture\"). Following the completion of the $25 million debottlenecking expansion of its Leverkusen, Germany chloride process plant in 1997, the Company expects its worldwide annual attainable production capacity to increase to approximately 400,000 metric tons.\nThe primary raw materials used in the TiO2 chloride production process are chlorine, coke and titanium-containing feedstock derived from beach sand ilmenite and natural rutile ore. Chlorine and coke are available from a number of suppliers. Titanium-containing feedstock suitable for use in the chloride process is available from a limited number of suppliers around the world, principally in Australia, Africa, India and the United States. Kronos purchases slag refined from beach sand ilmenite from Richards Bay Iron and Titanium (Proprietary) Limited (South Africa), approximately 50% of which is owned by Q.I.T. Fer et Titane Inc. (\"QIT\"), an indirect subsidiary of RTZ Corp., under a long-term supply contract that expires in 2000. Natural rutile ore, another chloride feedstock, is purchased primarily from RGC Mineral Sands Limited (Australia), under a long-term supply contract that expires in 2000. Raw materials under these contracts are expected to meet Kronos' chloride feedstock requirements over the next several years.\nThe primary raw materials used in the TiO2 sulfate production process are sulfuric acid and titanium-containing feedstock derived primarily from rock and beach sand ilmenite. Sulfuric acid is available from a number of suppliers. Titanium-containing feedstock suitable for use in the sulfate process is available from a limited number of suppliers around the world. Currently, the principal active sources are located in Norway, Canada, Australia, India and South Africa. As one of the few vertically-integrated producers of sulfate process pigments, Kronos operates a rock ilmenite mine near Hauge i Dalane, Norway, which provided all of Kronos' feedstock for its European sulfate process pigment plants in 1995. Kronos' mine is also a commercial source of rock ilmenite for other sulfate process producers in Europe. Kronos also purchases sulfate grade slag under contracts negotiated annually with QIT and Tinfos Titanium and Iron K\/S.\nKronos believes the availability of titanium-containing feedstock for both the chloride and sulfate processes is adequate through the remainder of the decade. Kronos does not anticipate experiencing any interruptions of its raw material supplies because of its long-term supply contracts, although political and economic instability in the countries from which the Company purchases its raw material supplies could adversely affect the availability.\nTIO2 MANUFACTURING JOINT VENTURE\nIn October 1993, Kronos formed a manufacturing joint venture with Tioxide Group, Ltd., a wholly-owned subsidiary of Imperial Chemicals Industries PLC (\"Tioxide\"). The joint venture, which is equally owned by subsidiaries of Kronos and Tioxide (the \"Partners\"), owns and operates the Louisiana chloride process TiO2 plant formerly owned by Kronos. Production from the plant is shared equally by Kronos and Tioxide pursuant to separate offtake agreements.\nA supervisory committee, composed of four members, two of whom are appointed by each Partner, directs the business and affairs of the joint venture, including production and output decisions. Two general managers, one appointed and compensated by each Partner, manage the day-to-day operations of the joint venture acting under the direction of the supervisory committee.\nThe manufacturing joint venture is intended to be operated on a break-even basis and, accordingly, Kronos' transfer price for its share of the TiO2 produced is equal to its share of the joint venture's production costs and interest expense. Kronos' share of the production costs are reported as cost of sales as the related TiO2 acquired from the joint venture is sold, and its share of the joint venture's interest expense is reported as a component of interest expense.\nCOMPETITION\nThe TiO2 industry is highly competitive. During the late 1980s worldwide demand approximated available supply and the major producers, including Kronos, were operating at or near available capacity and customers generally were served on an allocation basis. During the early 1990s, supply exceeded demand, primarily due to new chloride process capacity coming on-stream. Relative supply\/demand relationships, which had a favorable impact on industry-wide prices during the late 1980s, had a negative impact during the subsequent downturn. During 1994 and the first half of 1995, improved industry capacity utilization resulted in increases in worldwide TiO2 prices. Average TiO2 prices in the fourth quarter of 1995 were 14% higher than the fourth quarter of 1994, and were about 17% lower than the previous peak.\nCapacity additions that are the result of construction of grassroot plants in the worldwide TiO2 market require significant capital expenditures and substantial lead time (typically three to five years in the Company's experience) for, among other things, planning, obtaining environmental approvals and construction. No grassroot plants have been announced, but industry capacity in the next few years can be expected to increase as Kronos and its competitors complete debottlenecking projects at existing plants. Based on the factors described under the caption \"Kronos-Industry\" above, the Company expects that the average annual increase in industry capacity from announced debottlenecking projects will be less than the average annual demand growth for TiO2 during the next few years.\nKronos competes primarily on the basis of price, product quality and technical service, and the availability of high performance pigment grades. Although certain TiO2 grades are considered specialty pigments, the majority of grades and substantially all of Kronos' production are considered commodity pigments with price generally being the most significant competitive factor. Kronos has an estimated worldwide TiO2 market share of 11%, and believes that it is the leading marketer of TiO2 in a number of countries, including Germany and Canada.\nKronos' principal competitors are E.I. du Pont de Nemours & Co. (\"DuPont\"); Imperial Chemical Industries PLC (Tioxide); Hanson PLC (SCM Chemicals); Kemira Oy; Kerr-McGee Corporation; Ishihara Sangyo Kaisha, Ltd.; Bayer AG; and Thann et Mulhouse. These eight competitors have estimated individual worldwide market shares ranging from 4% to 21%, and an estimated aggregate 76% share. DuPont has over one-half of total U.S. TiO2 production capacity and is Kronos' principal North American competitor.\nRHEOX\nPRODUCTS AND OPERATIONS\nRheological additives control the flow and leveling characteristics for a variety of products, including paints, inks, lubricants, sealants, adhesives and cosmetics. Organoclay rheological additives are clays which have been chemically reacted with organic chemicals and compounds. Rheox produces rheological additives for both solvent-based and water-based systems. Rheox believes it is the world's largest producer of rheological additives for solvent-based systems and is also a supplier of rheological additives used in water-based systems. Rheological additives for solvent-based systems accounted for about 80% of Rheox's sales in 1995, with the remainder being principally rheological additives for water-based systems. Rheox introduced a number of new products during the past few years, the majority of which are for water-based systems, which represent a larger portion of the market than solvent-based systems. The Company believes water-based additives will account for an increasing portion of its sales in the long term.\nSales of rheological additives generally follow overall economic growth in Rheox's principal markets and are influenced by the volume of shipments of the worldwide coatings industry. Since Rheox's rheological additives are used in industrial coatings, plant and equipment spending has an influence on demand for this product line.\nMANUFACTURING PROCESS AND RAW MATERIALS\nThe primary raw materials utilized in the production of rheological additives are bentonite clays, hectorite clays, quaternary amines, polyethylene waxes and castor oil derivatives. Bentonite clays are currently purchased under a three-year contract, renewable through 2004, with a subsidiary of Dresser Industries, Inc. (\"Dresser\"), which has significant bentonite reserves in Wyoming. This contract assures Rheox the right to purchase its anticipated requirements of bentonite clays for the foreseeable future, and Dresser's reserves are believed to be sufficient for such purpose. Hectorite clays are mined from Company-owned reserves in Newberry Springs, California, which the Company believes are adequate to supply its needs for the foreseeable future. The Newberry Springs ore body contains the largest known commercial deposit of hectorite clays in the world. Quaternary amines are purchased primarily from a joint venture company 50%-owned by Rheox and are also generally available on the open market from a number of suppliers. Castor oil-based rheological additives are purchased from sources in the United States and abroad. Rheox has a supply contract with a manufacturer of these products which may not be terminated without 180 days notice by either party.\nCOMPETITION\nCompetition in the specialty chemicals industry is generally concentrated in the areas of product uniqueness, quality and availability, technical service, knowledge of end-use applications and price. Rheox's principal competitors for rheological additives for solvent-based systems are Laporte PLC and Sud-Chemie AG. Rheox's principal competitors for water-based systems are Rohm and Haas Company, Hercules Incorporated, The Dow Chemical Company and Union Carbide Corporation.\nRESEARCH AND DEVELOPMENT\nThe Company's expenditures for research and development and technical support programs have averaged approximately $10 million annually during the past three years with Kronos accounting for approximately three-quarters of the annual spending. Research and development activities related to TiO2 are conducted principally at the Leverkusen, Germany facility. Such activities are directed primarily toward improving both the chloride and sulfate production processes, improving product quality and strengthening Kronos' competitive position by developing new pigment applications. Activities relating to rheological additives are conducted primarily in the United States and are directed towards the development of new products for water-based systems, environmental applications and new end-use applications for existing product lines.\nPATENTS AND TRADEMARKS\nPatents held for products and production processes are believed to be important to the Company and contribute to the continuing business activities of Kronos and Rheox. The Company continually seeks patent protection for its technical developments, principally in the United States, Canada and Europe, and from time to time enters into licensing arrangements with third parties. In connection with the formation of the manufacturing joint venture with Tioxide, Kronos and certain of its subsidiaries exchanged proprietary chloride process and product technologies with Tioxide and certain of its affiliates. Use by each recipient of the other's technology in Europe is restricted until October 1996. The Company does not expect that the technology sharing arrangement with Tioxide will materially impact the Company's competitive position within the TiO2 industry. See \"Kronos - TiO2 manufacturing joint venture.\"\nThe Company's major trademarks, including Kronos, Titanox and Rheox, are protected by registration in the United States and elsewhere with respect to those products it manufactures and sells.\nFOREIGN OPERATIONS\nThe Company's chemical businesses have operated in international markets since the 1920s. Most of Kronos' current production capacity is located in Europe and Canada, and approximately one-third of Rheox's sales in each of the past three years have been from European production. Approximately three- quarters of the Company's 1995 consolidated sales were to non-U.S. customers, including 12% to customers in areas other than Europe and Canada. Foreign operations are subject to, among other things, currency exchange rate fluctuations and the Company's results of operations have in the past been both favorably and unfavorably affected by fluctuations in currency exchange rates. Effects of fluctuations in currency exchange rates on the Company's results of operations are discussed in Item 7 - \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nPolitical and economic uncertainties in certain of the countries in which the Company operates may expose it to risk of loss. The Company does not believe that there is currently any likelihood of material loss through political or economic instability, seizure, nationalization or similar event. The Company cannot predict, however, whether events of this type in the future could have a material effect on its operations. The Company's manufacturing and mining operations are also subject to extensive and diverse environmental regulation in each of the foreign countries in which they operate. See \"Regulatory and Environmental Matters.\"\nCUSTOMER BASE AND SEASONALITY\nThe Company believes that neither its aggregate sales nor those of any of its principal product groups are concentrated in or materially dependent upon any single customer or small group of customers. Neither the Company's business as a whole nor that of any of its principal product groups is seasonal to any significant extent. Due in part to the increase in paint production in the spring to meet the spring and summer painting season demand, TiO2 sales are generally higher in the second and third calendar quarters than in the first and fourth calendar quarters. Sales of rheological additives are influenced by the worldwide industrial protective coatings industry, where second calendar quarter sales are generally the strongest.\nEMPLOYEES\nAs of December 31, 1995, the Company employed approximately 3,200 persons, excluding the joint venture employees, with approximately 400 employees in the United States and approximately 2,800 at sites outside the United States. Hourly employees in production facilities worldwide, including the TiO2 joint venture, are represented by a variety of labor unions, with labor agreements having various expiration dates. The Company believes its labor relations are good.\nREGULATORY AND ENVIRONMENTAL MATTERS\nCertain of the Company's businesses are and have been engaged in the handling, manufacture or use of substances or compounds that may be considered toxic or hazardous within the meaning of applicable environmental laws. As with other companies engaged in similar businesses, certain past and current operations and products of the Company have the potential to cause environmental or other damage. The Company has implemented and continues to implement various policies and programs in an effort to minimize these risks. The policy of the Company is to achieve compliance with applicable environmental laws and regulations at all its facilities and to strive to improve its environmental performance. It is possible that future developments, such as stricter requirements of environmental laws and enforcement policies thereunder, could adversely affect the Company's production, handling, use, storage, transportation, sale or disposal of such substances.\nThe Company's U.S. manufacturing operations are governed by federal environmental and worker health and safety laws and regulations, principally the Resource Conservation and Recovery Act, the Occupational Safety and Health Act, the Clean Air Act, the Clean Water Act, the Safe Drinking Water Act, the Toxic Substances Control Act and the Comprehensive Environmental Response, Compensation and Liability Act, as amended by the Superfund Amendments and Reauthorization Act (\"CERCLA\"), as well as the state counterparts of these statutes. The Company believes that all of its U.S. plants and the Louisiana plant owned and operated by the joint venture are in substantial compliance with applicable requirements of these laws or compliance orders issued thereunder. From time to time, the Company's facilities may be subject to environmental regulatory enforcement under such statutes. Resolution of such matters typically involves the establishment of compliance programs. Occasionally, resolution may result in the payment of penalties, but to date such penalties have not involved amounts having a material adverse effect on the Company's consolidated financial position, results of operations or liquidity.\nThe Company's European and Canadian production facilities operate in an environmental regulatory framework in which governmental authorities typically are granted broad discretionary powers which allow them to issue operating permits required for the plants to operate. The Company believes that all its plants are in substantial compliance with applicable environmental laws.\nWhile the laws regulating operations of industrial facilities in Europe vary from country to country, a common regulatory denominator is provided by the European Union (the \"EU\"). Germany, Belgium and the United Kingdom, each members of the EU, follow the initiatives of the EU. Norway, although not a member, generally patterns its environmental regulatory actions after the EU. The Company believes that Kronos is in substantial compliance with agreements reached with European environmental authorities and with an EU directive to control the effluents produced by TiO2 production facilities. The Company also believes that Rheox is in substantial compliance with the environmental regulations in Germany and the United Kingdom.\nIn order to reduce sulfur dioxide emissions into the atmosphere consistent with applicable environmental regulations, Kronos is currently installing off- gas desulfurization systems at its Norwegian and German plants at an estimated cost of $30 million and expects to complete the systems in 1996 and 1997, respectively. The manufacturing joint venture has installed a $16 million off- gas desulfurization system at the Louisiana plant which commenced operation in 1995. In addition, Kronos expects to complete an $11 million water treatment chemical purification project at its Leverkusen, Germany facility in 1996.\nThe Quebec provincial government has environmental regulatory authority over Kronos' Canadian chloride and sulfate process TiO2 production facilities in Varennes, Quebec. The provincial government regulates discharges into the St. Lawrence River. In May 1992, the Quebec provincial government extended Kronos' right to discharge effluents from its Canadian sulfate process TiO2 plant into the St. Lawrence River until June 1994. Kronos completed a waste acid neutralization facility and discontinued discharging waste acid effluents into the St. Lawrence River in June 1994. Notwithstanding the foregoing, in March 1993 Kronos' Canadian subsidiary and two of its directors were charged by the Canadian federal government with five violations of the Canadian Fisheries Act relating to discharges into the St. Lawrence River from the Varennes sulfate process TiO2 production facility. The penalty for these violations, if proven, could be up to Canadian $15 million. Additional charges, if brought, could involve additional penalties. The Company believes that this charge is inconsistent with the extension granted by provincial authorities, referred to above, and is vigorously contesting the charge.\nThe Company's capital expenditures related to its ongoing environmental protection and improvement programs are currently expected to be approximately $23 million in 1996 and $5 million in 1997.\nThe Company has been named as a defendant, potentially responsible party (\"PRP\"), or both, pursuant to CERCLA and similar state laws in approximately 80 governmental enforcement and private actions associated with waste disposal sites and facilities currently or previously owned, operated or used by the Company, or its subsidiaries, or their predecessors, many of which are on the U.S. Environmental Protection Agency's (\"U.S. EPA\") Superfund National Priorities List or similar state lists. See Item 3 - \"Legal Proceedings\".\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nKronos currently operates four TiO2 facilities in Europe (Leverkusen and Nordenham, Germany; Langerbrugge, Belgium; and Fredrikstad, Norway). In North America, Kronos has a facility in Varennes, Quebec, Canada and, through the manufacturing joint venture described above, a one-half interest in a plant in Lake Charles, Louisiana. Certain of the Company's properties collateralize long-term debt agreements. See Note 10 to the Consolidated Financial Statements.\nKronos' principal German operating subsidiary leases the land under its Leverkusen TiO2 production facility pursuant to a lease expiring in 2050. The Leverkusen facility, with almost one-third of Kronos' current TiO2 production capacity, is located within an extensive manufacturing complex owned by Bayer AG, and Kronos is the only unrelated party so situated. Under a separate supplies and services agreement expiring in 2011, Bayer provides some raw materials, auxiliary and operating materials and utilities services necessary to operate the Leverkusen facility. Both the lease and the supplies and services agreement restrict Kronos' ability to transfer ownership or use of the Leverkusen facility.\nAll of Kronos' principal production facilities described above are owned, except for the land under the Leverkusen facility. Kronos has a governmental concession with an unlimited term to operate its ilmenite mine in Norway.\nSpecialty chemicals are produced by Rheox at facilities in Charleston, West Virginia; Newberry Springs, California; St. Louis, Missouri; Livingston, Scotland and Nordenham, Germany. All of such production facilities are owned.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nLEAD PIGMENT LITIGATION\nThe Company was formerly involved in the manufacture of lead pigments for use in paint and lead-based paint. The Company has been named as a defendant or third party defendant in various legal proceedings alleging that the Company and other manufacturers are responsible for personal injury and property damage allegedly associated with the use of lead pigments. The Company is vigorously defending such litigation. Considering the Company's previous involvement in the lead pigment and lead-based paint businesses, there can be no assurance that additional litigation, similar to that described below, will not be filed. In addition, various legislation and administrative regulations have, from time to time, been enacted or proposed that seek to (a) impose various obligations on present and former manufacturers of lead pigment and lead-based paint with respect to asserted health concerns associated with the use of such products and (b) effectively overturn court decisions in which the Company and other pigment manufacturers have been successful. Examples of such proposed legislation include bills proposed in Massachusetts and Ohio which would permit civil liability for damages on the basis of market share and, in the case of Massachusetts, extend certain statutes of limitations. No legislation or regulations have been enacted to date which are expected to have a material adverse effect on the Company's consolidated financial position, results of operations or liquidity. The Company has not accrued any amounts for the pending lead pigment litigation. Although no assurance can be given that the Company will not incur future liability in respect of this litigation in view of the inherent uncertainties involved in court and jury rulings in pending and possible future cases, based on, among other things, the results of such litigation to date, the Company believes that the pending lead pigment litigation is without merit. Liability that may result, if any, cannot reasonably be estimated.\nIn 1989 and 1990, the Housing Authority of New Orleans (\"HANO\") filed third-party complaints for indemnity and\/or contribution against the Company, other alleged manufacturers of lead pigment (together with the Company, the \"pigment manufacturers\") and the Lead Industries Association (the \"LIA\") in 14 actions commenced by residents of HANO units seeking compensatory and punitive damages for injuries allegedly caused by lead pigment. The actions in the Civil District Court for the Parish of Orleans, State of Louisiana were dismissed by the district court in 1990. Subsequently, HANO agreed to consolidate all the cases and appealed. In March 1992, the Louisiana Court of Appeals, Fourth Circuit, dismissed HANO's appeal as untimely with respect to three of these cases. With respect to the other cases included in the appeal, the court of appeals reversed the lower court decision dismissing the cases. These cases were remanded to the District Court for further proceedings. In November 1994, the District Court granted defendants' motion for summary judgment in one of the remaining cases and in June 1995 the District Court granted defendants' motion for summary judgment in several of the remaining cases. After such grant, only two cases remained pending.\nIn June 1989, a complaint was filed in the Supreme Court of the State of New York, County of New York, against the pigment manufacturers and the LIA. Plaintiffs seek damages, contribution and\/or indemnity in an amount in excess of $50 million for monitoring and abating alleged lead paint hazards in public and private residential buildings, diagnosing and treating children allegedly exposed to lead paint in city buildings, the costs of educating city residents to the hazards of lead paint, and liability in personal injury actions against the City and the Housing Authority based on alleged lead poisoning of city residents (The City of New York, the New York City Housing Authority and the New York City Health and Hospitals Corp. v. Lead Industries Association, Inc., et al., No. 89-4617). In December 1991, the court granted the defendants' motion to dismiss claims alleging negligence and strict liability and denied the remainder of the motion. In January 1992, defendants appealed the denial. The Company has answered the remaining portions of the complaint denying all allegations of wrongdoing, and the case is in discovery. In May 1993, the Appellate Division of the Supreme Court affirmed the denial of the motion to dismiss plaintiffs' fraud, restitution, conspiracy and concert of action claims. In August 1993, the defendants' motion for leave to appeal was denied. In May 1994, the trial court granted the defendants' motion to dismiss the plaintiffs' restitution and indemnification claims, and plaintiffs have appealed. Defendants' motion for summary judgment on the remaining fraud claim was denied in August 1995; defendants have noticed an appeal. In December 1995, defendants moved for summary judgment on the basis that the fraud claim was time-barred; the motion is pending.\nIn March 1992, the Company was served with a complaint in Skipworth v. Sherwin-Williams Co., et al. (No. 92-3069), Court of Common Pleas, Philadelphia County. Plaintiffs are a minor and her legal guardians seeking damages from lead paint and pigment producers, the LIA, the Philadelphia Housing Authority and the owners of the plaintiffs' premises for bodily injuries allegedly suffered by the minor from lead-based paint. Plaintiffs' counsel has asserted that approximately 200 similar complaints would be served shortly, but no such complaints have yet been served. In April 1994, the court granted defendants' motion for summary judgment and the dismissal was affirmed by the Superior Court in October 1995. Plaintiffs sought review in the Pennsylvania Supreme Court in November 1995 and the request for review is pending.\nIn August 1992, the Company was served with an amended complaint in Jackson, et al. v. The Glidden Co., et al., Court of Common Pleas, Cuyahoga County, Cleveland, Ohio (Case No. 236835). Plaintiffs seek compensatory and punitive damages for personal injury caused by the ingestion of lead, and an order directing defendants to abate lead-based paint in buildings. Plaintiffs purport to represent a class of similarly situated persons throughout the State of Ohio. The amended complaint identifies 18 other defendants who allegedly manufactured lead products or lead-based paint, and asserts causes of action under theories of strict liability, negligence per se, negligence, breach of express and implied warranty, fraud, nuisance, restitution, and negligent infliction of emotional distress. The complaint asserts several theories of liability including joint and several, market share, enterprise and alternative liability. In October 1992, the Company and the other defendants moved to dismiss the complaint with prejudice. In July 1993, the court dismissed the complaint. In December 1994, the Ohio Court of Appeals reversed the trial court dismissal and remanded the case to the trial court.\nIn November 1993, the Company was served with a complaint in Brenner, et al. v. American Cyanamid, et al., (No. 12596-93) Supreme Court, State of New York, Erie County alleging injuries to two children purportedly caused by lead pigment. The complaint seeks $24 million in compensatory and $10 million in punitive damages for alleged negligent failure to warn, strict products liability, fraud and misrepresentation, concert of action, civil conspiracy, enterprise liability, market share liability, and alternative liability. In January 1994, the Company answered the complaint, denying liability. Discovery is proceeding.\nIn January 1995, the Company was served with complaints in Wright (Alvin) and Wright (Allen) v. Lead Industries, et. al., (Nos. 94-363042 and 363043), Circuit Court, Baltimore City, Maryland. Plaintiffs are two brothers (one deceased) who allege injuries due to exposure to lead pigment. The complaints, as amended in April 1995, seek more than $100 million in compensatory and punitive damages for alleged strict liability, negligence, conspiracy, fraud and unfair and deceptive trade practices claims. In July 1995, the trial court granted, in part, the defendants' motion to dismiss, and dismissed the plaintiffs' fraud and unfair and deceptive trade practices claims. A trial date has been set in these consolidated cases for October 1996, and discovery is proceeding. In February 1996, the Company filed a motion for summary judgement, which is pending.\nIn November 1995, the Company was served with the complaint in Jefferson v. Lead Industry Association, et. al. (No. 95-2835), filed in the U.S. District Court for the Eastern District of Louisiana. The complaint asserts claims against the LIA and the lead pigment defendants on behalf of a putative class of allegedly injured children in Louisiana. The complaint purports to allege claims for strict liability, negligence, failure to warn, breach of alleged warranties, fraud and misrepresentation, and conspiracy, and seeks actual and punitive damages. The complaint asserts several theories of liability, including joint and several and market share liability. The Company moved to dismiss the complaint in February 1996.\nIn January 1996, the Company was served with a complaint on behalf of individual intervenors in German, et. al. v. Federal Home Loan Mortgage Corp., et. al., (U.S. Dist. Court, Southern District of New York, Civil Action No. 93 Civ. 6941 (RWS)). This class action lawsuit had originally been brought against the City of New York and other landlord defendants. The intervenors' complaint alleges claims against the Company and other former manufacturers of lead pigment for medical monitoring, property abatement, and other injunctive relief, based on various causes of action, including negligent product design, negligent failure to warn, strict products liability, fraud and misrepresentation, concert of action, civil conspiracy, enterprise liability, market share liability, breach of express and implied warranties, and nuisance. The intervenors purport to represent a class of children and pregnant women who reside in New York City.\nThe Company believes that the foregoing lead pigment actions are without merit and intends to continue to deny all allegations of wrongdoing and liability and to defend such actions vigorously.\nThe Company has filed actions seeking declaratory judgment and other relief against various insurance carriers with respect to costs of defense and indemnity coverage for certain of its environmental and lead pigment litigation. NL Industries, Inc. v. Commercial Union Insurance Cos., et al., Nos. 90-2124, - -2125 (HLS) (District Court of New Jersey). The action relating to lead pigment litigation defense costs filed in May 1990 against Commercial Union Insurance Company (\"Commercial Union\") seeks to recover defense costs incurred in the City of New York lead pigment case and two other cases which have since been resolved in the Company's favor. In July 1991, the court granted the Company's motion for summary judgment and ordered Commercial Union to pay the Company's reasonable defense costs for such cases. In June 1992, the Company filed an amended complaint in the United States District Court for the District of New Jersey against Commercial Union seeking to recover costs incurred in defending four additional lead pigment cases which have since been resolved in the Company's favor. In August 1993, the court granted the Company's motion for summary judgment and ordered Commercial Union to pay the reasonable costs of defending those cases. In July 1994, the court entered judgment on the order requiring Commercial Union to pay previously-incurred Company costs in defending those cases. In September 1995, the U.S. Court of Appeals for the Third Circuit reversed and remanded for further consideration the decision by the trial court that Commercial Union was obligated to pay the Company's reasonable defense costs in certain of the lead pigment cases. The trial court had made its decision applying New Jersey law; the appeals court concluded that New York and not New Jersey law applied and remanded the case to the trial court for a determination under New York law. Other than granting motions for summary judgment brought by two excess liability insurance carriers, which contended that their policies contained unique pollution exclusion language, and certain summary judgment motions regarding policy periods, the court has not made any final rulings on defense costs or indemnity coverage with respect to the Company's pending environmental litigation. The Court has not made any final ruling on indemnity coverage in the lead pigment litigation. No trial dates have been set. Other than rulings to date, the issue of whether insurance coverage for defense costs or indemnity or both will be found to exist depends upon a variety of factors, and there can be no assurance that such insurance coverage will exist in other cases. The Company has not considered any potential insurance recoveries for lead pigment or environmental litigation in determining related accruals.\nENVIRONMENTAL MATTERS AND LITIGATION\nThe Company has been named as a defendant, PRP, or both, pursuant to CERCLA and similar state laws in approximately 80 governmental and private actions associated with waste disposal sites and facilities currently or previously owned, operated or used by the Company, or its subsidiaries, or their predecessors, many of which are on the U.S. EPA's Superfund National Priorities List or similar state lists. These proceedings seek cleanup costs, damages for personal injury or property damage, or both. Certain of these proceedings involve claims for substantial amounts. Although the Company may be jointly and severally liable for such costs, in most cases it is only one of a number of PRPs who are also jointly and severally liable. In addition to the matters noted above, certain current and former facilities of the Company, including several divested secondary lead smelter and former mining locations, are the subject of environmental investigations or litigation arising out of industrial waste disposal practices and mining activities.\nThe extent of CERCLA liability cannot be determined until the Remedial Investigation and Feasibility Study (\"RIFS\") is complete, the U.S. EPA issues a record of decision and costs are allocated among PRPs. The extent of liability under analogous state cleanup statutes and for common law equivalents are subject to similar uncertainties. The Company believes it has provided adequate accruals for reasonably estimable costs for CERCLA matters and other environmental liabilities. At December 31, 1995, the Company had accrued $100 million with respect to those environmental matters which are reasonably estimable. The Company determines the amount of accrual on a quarterly basis by analyzing and estimating the range of possible costs to the Company. Such costs include, among other things, remedial investigations, monitoring, studies, clean-up, removal and remediation. It is not possible to estimate the range of costs for certain sites. The Company has estimated that the upper end of the range of reasonably possible costs to the Company for sites for which it is possible to estimate costs is approximately $169 million. No assurance can be given that actual costs will not exceed accrued amounts or the upper end of the range for sites for which estimates have been made, and no assurance can be given that costs will not be incurred with respect to sites as to which no estimate presently can be made. The imposition of more stringent standards or requirements under environmental laws or regulations, new developments or changes respecting site cleanup costs or allocation of such costs among PRPs, or a determination that the Company is potentially responsible for the release of hazardous substances at other sites could result in expenditures in excess of amounts currently estimated by the Company to be required for such matters. Further, there can be no assurance that additional environmental matters will not arise in the future. More detailed descriptions of certain legal proceedings relating to environmental matters are set forth below.\nThe Company has been identified as a PRP by the U.S. EPA because of its former ownership of three secondary lead smelters (battery recycling plants) in Pedricktown, New Jersey; Granite City, Illinois; and Portland, Oregon. In all three matters, the Company voluntarily entered into administrative consent orders with the U.S. EPA requiring the performance of a RIFS, a study with the objective of identifying the nature and extent of the hazards, if any, posed by the sites, and selecting a remedial action, if necessary.\nAt Pedricktown, the U.S. EPA divided the site into two operable units. Operable unit one covers contaminated ground water, surface water, soils and stream sediments. The Company submitted the final RIFS for operable unit one to the U.S. EPA in May 1993. In July 1994, the U.S. EPA issued the Record of Decision for operable unit one. The U.S. EPA estimates the cost to complete operable unit one is $18.7 million. The U.S. EPA recently issued a notice requesting that the PRPs enter into an agreement to perform the remedial design phase of operable unit one. In addition, the U.S. EPA incurred past costs in the estimated amount of $4 million to $5 million. The U.S. EPA issued an order with respect to operable unit two in March 1992 to the Company and 30 other PRPs directing immediate removal activities including the cleanup of waste, surface water and building surfaces. The Company has complied with the order, and the work with respect to operable unit two is completed. The Company has paid approximately 50% of operable unit two costs, or $2.5 million.\nAt Granite City, the RIFS is complete, and in 1990 the U.S. EPA selected a remedy estimated to cost approximately $28 million. In July 1991, the United States filed an action in the U.S. District Court for the Southern District of Illinois against the Company and others (United States of America v. NL Industries, Inc., et al., Civ. No. 91-CV 00578) with respect to the Granite City smelter. The complaint seeks injunctive relief to compel the defendants to comply with an administrative order issued pursuant to CERCLA, and fines and treble damages for the alleged failure to comply with the order. The Company and the other parties did not comply with the order believing that the remedy selected by the U.S. EPA was invalid, arbitrary, capricious and not in accordance with law. The complaint also seeks recovery of past costs of $.3 million and a declaration that the defendants are liable for future costs. Although the action was filed against the Company and ten other defendants, there are 330 other PRPs who have been notified by the U.S. EPA. Some of those notified were also respondents to the administrative order. In February 1992, the court entered a case management order directing that the remedy issues be tried before the liability aspects are presented. In August 1994, when the U.S. EPA reinitiated the residential yard soils remediation in Granite City after an agreed-upon stay of the cleanup pending completion of a health study and reopening of the administrative record, the PRPs and the City of Granite City sought an injunction against the U.S. EPA to prevent further cleanup until after the record was reopened for submittal of additional comments on the selected remedy. In September 1995, the U.S. EPA released its decision selecting cleanup remedies for the Granite City site. The cost of the remedies selected by the U.S. EPA aggregates, in its estimation, $40.8 million to $67.8 million, although its decision states that the higher amount is not considered to be representative of expected costs. The Company believes that certain components of the U.S. EPA's estimated costs may be erroneous and presently intends to challenge portions of the U.S. EPA's selection of the remedy. There is no allocation among the PRPs for these costs.\nHaving completed the RIFS at Portland, the Company conducted predesign studies to explore the viability of the U.S. EPA's selected remedy pursuant to a June 1989 consent decree captioned U.S. v. NL Industries, Inc., Civ. No. 89-408, United States District Court for the District of Oregon. Subsequent to the completion of the predesign studies, the U.S. EPA issued notices of potential liability to approximately 20 PRPs, including the Company, directing them to perform the remedy, which was initially estimated to cost approximately $17 million, exclusive of administrative and overhead costs and any additional costs, for the disposition of recycled materials from the site. In January 1992, the U.S. EPA issued unilateral administrative orders to the Company and six other PRPs directing the performance of the remedy. The Company and the other PRPs commenced performance of the remedy. Based upon site operations to date, the remedy is not proceeding in accordance with engineering expectations or cost projections; therefore, the Company and the other PRPs have met with the U.S. EPA to discuss alternative remedies for the site. The U.S. EPA authorized the Company and the other PRPs to cease performing most aspects of the selected remedy. In September 1994, the Company and the other PRPs submitted a focused feasibility study to the U.S. EPA, which proposes alternative remedies for the site. In January 1996, the Company and the other PRP's submitted to U.S. EPA the Amended Remedy Document (\"ARD\"), recommending selection of a new remedy for the site. The U.S. EPA has indicated that it intends to notice the ARD for public comment in 1996 and will thereafter select a new remedy for the site. Pursuant to an interim allocation, the Company's share of remedial costs is approximately 50%. In November 1991, Gould, Inc., the current owner of the site, filed an action, Gould Inc. v. NL Industries, Inc., No. 91-1091, United States District Court for the District of Oregon, against the Company for damages for alleged fraud in the sale of the smelter, rescission of the sale, past CERCLA response costs and a declaratory judgment allocating future response costs and punitive damages. The court granted Gould's motion to amend the complaint to add additional defendants (adjoining current and former landowners) and third party defendants (generators). The amended complaint deletes the fraud and punitive damages claims asserted against NL; thus, the pending action is essentially one for reallocation of past and future cleanup costs. Discovery is proceeding. A trial date has been tentatively set for September 1996.\nThe Company and other PRPs entered into an administrative consent order with the U.S. EPA requiring the performance of a RIFS at two sites in Cherokee County, Kansas, where the Company and others formerly mined lead and zinc. A former subsidiary of the Company mined at the Baxter Springs subsite, where it is the largest viable PRP. The final RIFS was submitted to the U.S. EPA in May 1993. In August 1994, the U.S. EPA issued its proposed plan for the cleanup of the Baxter Springs and Treece sites in Cherokee County. The proposed remedy is estimated by U.S. EPA to cost $6 million.\nIn January 1989, the State of Illinois brought an action against the Company and several other subsequent owners and operators of the former lead oxide plant in Chicago, Illinois (People of the State of Illinois v. NL Industries, et al., No. 88-CH-11618, Circuit Court, Cook County). The complaint seeks recovery of $2.3 million of cleanup costs expended by the Illinois Environmental Protection Agency, plus penalties and treble damages. In October 1992, the Supreme Court of Illinois reversed the Appellate Division, which had affirmed the trial court's earlier dismissal of the complaint, and remanded the case for further proceedings. In December 1993, the trial court denied the State's petition to reinstate the complaint, and dismissed the case with prejudice. In February 1996, the appeals court affirmed the dismissal. The time in which review by the state Supreme Court may be sought has not expired.\nIn 1980, the State of New York commenced litigation against the Company in connection with the operation of a plant in Colonie, New York formerly owned by the Company. Flacke v. NL Industries, Inc., No. 1842-80 (\"Flacke I\") and Flacke v. Federal Insurance Company and NL Industries, Inc., No. 3131-92 (\"Flacke II\"), New York Supreme Court, Albany County. The plant manufactured military and civilian products from depleted uranium and was acquired from the Company by the U.S. Department of Energy (\"DOE\") in 1984. Flacke I seeks penalties for alleged violations of New York's Environmental Conservation Law, and of a consent order entered into to resolve these alleged violations. Flacke II seeks forfeiture of a $200,000 surety bond posted in connection with the consent order, plus interest from February 1980. The Company denied liability in both actions. The litigation had been inactive from 1984 until July 1993 when the State moved for partial summary judgment for approximately $1.5 million on certain of its claims in Flacke I and for summary judgment in Flacke II. In January 1994, the Company cross-moved for summary judgment in Flacke I and Flacke II. All summary judgment motions have been denied and both parties have appealed.\nResidents in the vicinity of the Company's former Philadelphia lead chemicals plant commenced a class action allegedly comprised of over 7,500 individuals seeking medical monitoring and damages allegedly caused by emissions from the plant. Wagner, et al. v. Anzon, Inc. and NL Industries, Inc., No. 87- 4420, Court of Common Pleas, Philadelphia County. The complaint sought compensatory and punitive damages from the Company and the current owner of the plant, and alleged causes of action for, among other things, negligence, strict liability, and nuisance. A class was certified to include persons who resided, owned or rented property, or who work or have worked within up to approximately three-quarters of a mile from the plant from 1960 through the present. The Company answered the complaint, denying liability. In December 1994, the jury returned a verdict in favor of the Company. Plaintiffs have appealed. Residents also filed consolidated actions in the United States District Court for the Eastern District of Pennsylvania, Shinozaki v. Anzon, Inc. and Wagner and Antczak v. Anzon and NL Industries, Inc. Nos. 87-3441, 87-3502, 87-4137 and 87-5150. The consolidated action is a putative class action seeking CERCLA response costs, including cleanup and medical monitoring, declaratory and injunctive relief and civil penalties for alleged violations of the Resource Conservation and Recovery Act (\"RCRA\"), and also asserting pendent common law claims for strict liability, trespass, nuisance and punitive damages. The court dismissed the common law claims without prejudice, dismissed two of the three RCRA claims as against the Company with prejudice, and stayed the case pending the outcome of the state court litigation.\nIn July 1991, a complaint was filed in the United States District Court for the Central District of California, United States of America v. Peter Gull and NL Industries, Inc., Civ. No. 91-4098, seeking recovery of $2 million in costs incurred by the United States in response to the alleged release of hazardous substances into the environment from a facility located in Norco, California, treble damages and $1.75 million in penalties for the Company's alleged failure to comply with the U.S. EPA's administrative order No. 88-13. The order, which alleged that the Company arranged for the treatment or disposal of materials at the Norco site, directed the immediate removal of hazardous substances from the site. The Company carried out a portion of the remedy at the Norco site, but did not complete the ordered activities because it believed they were in conflict with California law. The Company answered the complaint denying liability. The government claims it expended in excess of $2.7 million for this matter. Trial was held in March and April 1993. In April 1994, the court entered final judgment in this matter directing the Company to pay $6.3 million plus interest. The court ruled that the Company was liable for approximately $2.7 million in response costs plus approximately $3.6 million in penalties for failure to comply with the administrative order. Both the Company and the government have appealed. In August 1994, this matter was referred to mediation, which is pending.\nAt a municipal and industrial waste disposal site in Batavia, New York, the Company and six others have been identified as PRPs. The U.S. EPA has divided the site into two operable units. Pursuant to an administrative consent order entered into with the U.S. EPA, the Company conducted a RIFS for operable unit one, the closure of the industrial waste disposal section of the landfill. The Company's RIFS costs are approximately $2 million. In June 1995, the U.S. EPA issued the record of decision for operable unit one, which is estimated by the U.S. EPA to cost approximately $12.3 million. In September 1995, the U.S. EPA and certain PRPs entered into an administrative order on consent for the remedial design phase of the remedy for operable unit one. The Company and other PRPs entered into an interim cost sharing arrangement for this phase of work. With respect to the second operable unit, the extension of the municipal water supply, the U.S. EPA estimated the costs at $1.2 million plus annual operation and maintenance costs. The Company and the other PRPs are performing the work comprising operable unit two. The U.S. EPA has also demanded approximately $.9 million in past costs from the PRPs.\nSee Item 1 - \"Business - Regulatory and Environmental Matters\".\nOTHER LITIGATION\nRhodes, et al. v. ACF Industries, Inc., et al. (Circuit Court of Putnam County, West Virginia, No. 95-C-261). Twelve plaintiffs brought this action against the Company and various other defendants in July 1995. Plaintiffs allege that they were employed by demolition and disposal contractors, and claim that as a result of the defendants' negligence they were exposed to asbestos during demolition and disposal of materials from defendants' premises in West Virginia. Plaintiffs allege personal injuries and seek compensatory damages totaling $18.5 million and punitive damages totaling $55.5 million. The Company has filed an answer denying plaintiffs' allegations. Discovery is proceeding.\nThe Company has been named as a defendant in various lawsuits alleging personal injuries as a result of exposure to asbestos in connection with formerly-owned operations. Various of these actions remain pending. One such case, In re: Monongalia Mass II, (Circuit Court of Monongalia County, West Virginia, Nos. 93-C-362, et al.), involving approximately 1,800 plaintiffs, is scheduled to begin trial in August 1996. The Company is aware that claims on behalf of approximately 400 additional plaintiffs have been filed, but the Company has not yet been served with those claims. The Company intends to defend these matters vigorously.\nThe Company is also involved in various other environmental, contractual, product liability and other claims and disputes incidental to its present and former businesses, and the disposition of past properties and former businesses.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matters were submitted to a vote of security holders during the quarter ended December 31, 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nNL's common stock is listed and traded on the New York and Pacific Stock Exchanges under the symbol \"NL\". As of February 29, 1996, there were approximately 9,500 holders of record of NL common stock. The following table sets forth the high and low sales prices for NL common stock on the New York Stock Exchange (\"NYSE\") Composite Tape. On February 29, 1996, the closing price of NL common stock according to the NYSE Composite Tape was $13 7\/8.\nThe Company's Senior Notes generally limit the ability of the Company to pay dividends to 50% of consolidated net income, as defined, subsequent to October 1993. The Company did not pay a dividend in 1993, 1994 or 1995. At December 31, 1995, $6 million was available for dividends. On February 15, 1996, the Company announced the resumption of a regular quarterly dividend by declaring a $.10 per share cash dividend to be paid to shareholders of record on March 1, 1996. The declaration and payment of future dividends and the amount thereof will be dependent upon the Company's results of operations, financial condition, contractual restrictions and other factors deemed relevant by the Company's Board of Directors.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe selected consolidated financial data set forth below should be read in conjunction with the Consolidated Financial Statements and Notes thereto, and Item 7","section_7":"Item 7 - \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\n(1) Net debt represents notes payable and long-term debt less cash, cash equivalents and current marketable securities.\n(2) EBITDA, as presented, represents operating income less corporate expense, net, plus depreciation, depletion and amortization. EBITDA is presented as a supplement to the Company's operating income and cash flow from operations because the Company believes that certain parties find EBITDA a useful tool for measuring the Company's performance and ability to service debt. EBITDA is not a substitute for either operating income or cash flow from operations.\n(3) Interest expense, net represents interest expense less general corporate interest and dividend income.\n(4) Cash interest expense, net represents interest expense, net less non-cash interest expense (deferred interest expense on the Senior Secured Discount Notes and amortization of deferred financing costs).\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\nGENERAL\nThe Company's operations are conducted in two business segments - TiO2 conducted by Kronos and specialty chemicals conducted by Rheox. As discussed below, TiO2 selling prices increased during 1994 and the first nine months of 1995 after four consecutive years of a declining price trend. Kronos' operating income and margins improved significantly during 1994 and 1995.\nNET SALES AND OPERATING INCOME\nThe improvement in Kronos' 1995 results was primarily due to higher average TiO2 selling prices and higher TiO2 production volumes, partially offset by lower TiO2 sales volumes. In billing currency terms, Kronos' 1995 average TiO2 selling prices were approximately 15% higher than in 1994 and were 3% higher in 1994 compared to 1993. However, the majority of the 1995 increase in average selling prices occurred during the first half of the year and average TiO2 selling prices in the fourth quarter of 1995 were 1% lower than the third quarter of 1995.\nSales volume of 366,000 metric tons of TiO2 in 1995 decreased 3% compared to the record level of 1994, with declines in both Europe and North America, due to softening demand in the second half of 1995 and customers building inventories during 1994 and early 1995. Kronos increased its production to 94% of its capacity in 1994 and to full capacity in 1995. Kronos has curtailed production rates in early 1996 in response to soft demand and its high inventory levels. Kronos anticipates TiO2 demand will remain soft during the first half of 1996, although industry capacity utilization rates are expected to increase over the next several years. Kronos' TiO2 sales volumes increased 9% in 1994 over 1993, with increases in all major regions. Approximately one-half of Kronos' 1995 TiO2 sales, by volume, were attributable to markets in Europe with approximately 36% attributable to North America and the balance to other regions.\nDemand, supply and pricing of TiO2 have historically been cyclical and the last cyclical peak for TiO2 prices occurred in early 1990. Kronos believes that its operating margins for 1996 could be lower than in 1995 due principally to the net effect of higher sales volumes, offset by increased raw material costs, lower production volumes and lower technology fee income.\nRheox's operating income improved in 1995 compared to 1994 due to higher sales volumes and selling prices. Operating income increased during 1994 over 1993 due to higher sales volumes and lower operating costs.\nThe Company has substantial operations and assets located outside the United States (principally Germany, Norway, Belgium and Canada). The U.S. dollar value of the Company's foreign sales and operating costs are subject to currency exchange rate fluctuations which may slightly impact reported earnings and may effect the comparability of period to period operating results. A significant amount of the Company's sales are denominated in currencies other than the U.S. dollar (64% in 1995), principally major European currencies and the Canadian dollar. Certain purchases of raw materials, primarily titanium- containing feedstocks, are denominated in U.S. dollars, while labor and other production costs are primarily denominated in local currencies. Fluctuations in the value of the U.S. dollar relative to other currencies increased 1995 sales by $54 million compared to 1994 and decreased 1994 sales by $2 million compared to 1993.\nGENERAL CORPORATE\nThe following table sets forth certain information regarding general corporate income (expense).\nSecurities earnings fluctuate in part based upon the amount of funds invested and yields thereon. Corporate expenses, net were significantly lower in 1995 compared to 1994 due to lower provisions for environmental remediation and litigation costs. Corporate expenses in 1994 were slightly higher than 1993 as a $20 million gain related to the settlement of a lawsuit was offset by increases in provisions for environmental remediation and litigation costs.\nINTEREST EXPENSE\nInterest expense in 1994 and 1995 declined compared to the respective prior-year periods due to lower levels of debt, principally Kronos' Deutsche mark-denominated debt, and lower interest rates on such DM-denominated debt.\nPROVISION FOR INCOME TAXES\nThe principal reasons for the difference between the U.S. federal statutory income tax rates and the Company's effective income tax rates are explained in Note 13 to the Consolidated Financial Statements. The Company's operations are conducted on a worldwide basis and the geographic mix of income can significantly impact the Company's effective income tax rate. In 1995, due to the Company's return to profitability, the Company recognized approximately $10 million of U.S. deferred tax assets which the Company believes satisfy the \"more-likely-than-not\" recognition criteria. During the fourth quarter of 1995, the Company recorded deferred tax benefits of $6.6 million due to the reduction in dividend withholding tax rates pursuant to ratification of the new U.S.\/Canada income tax treaty. In 1993 and 1994, the geographic mix of income, including losses in certain jurisdictions for which no current refund was available and recognition of a deferred tax asset was not considered appropriate, contributed to the Company's effective tax rate varying from a normally-expected rate. The Company's deferred income tax status at December 31, 1995 is discussed in \"Liquidity and Capital Resources\".\nExtraordinary item\nSee Note 16 to the Consolidated Financial Statements.\nCHANGE IN ACCOUNTING PRINCIPLE\nSee Notes 2 and 19 to the Consolidated Financial Statements.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company's consolidated cash flows provided by operating, investing and financing activities for each of the past three years are presented below.\nThe TiO2 industry is cyclical, with the previous peak in selling prices in early 1990 and the latest trough in the third quarter of 1993. During the last TiO2 downturn, the Company's operations used significant amounts of cash. Since the 1993 trough, the Company's cash provided by operating activities substantially improved as the Company's operating income improved. Changes in the Company's inventories, receivables and payables (excluding the effect of currency translation) also contributed to the cash provided by operations in 1993 and 1994; however, such changes used cash in 1995 primarily due to increased inventory levels. Receipt of the German tentative tax refund, discussed below, significantly increased the Company's cash flow from operating activities during 1994. A $30 million technology exchange fee received from Tioxide in October 1993, which is being recognized as a component of operating income over three years, also favorably impacted cash flow from operating activities in 1993.\nCash provided (used) by investing activities includes capital expenditures in each period, and in 1993 included $161 million net cash generated from the formation of the manufacturing joint venture with Tioxide. Cash provided by investing activities also included net sales of marketable securities of $68 million in 1993 primarily used to fund debt repayments. In 1994 and 1995, net proceeds of $15 million and $26 million, respectively, from the sale of trading securities are components of the cash provided from operations as a result of the adoption of SFAS No. 115.\nThe Company's capital expenditures during the past three years include an aggregate of $73 million ($26 million in 1995) for the Company's ongoing environmental protection and compliance programs, including a Canadian waste acid neutralization facility, a Norwegian onshore tailings disposal system and off-gas desulfurization systems. The Company's estimated 1996 and 1997 capital expenditures are $63 million and $56 million, respectively, and include $23 million and $5 million, respectively, in the area of environmental protection and compliance primarily related to the off-gas desulfurization systems and water treatment chemical purification project. The Company spent $9 million in 1995, and plans to spend an additional $11 million in 1996 and $5 million in 1997, in capital expenditures related to a debottlenecking project at its Leverkusen, Germany chloride process TiO2 facility that is expected to increase the Company's worldwide annual attainable production to approximately 400,000 metric tons in 1997. The capital expenditures of the manufacturing joint venture are not included in the Company's capital expenditures.\nNet repayments of indebtedness in 1995 included $30 million in payments on the Rheox bank term loan, including $10 million of prepayments, and $15 million in scheduled repayments on the joint venture term loan. In addition, the Company borrowed $51 million under DM-denominated short-term credit facilities of which $11 million was repaid. In 1994 the Company borrowed DM 75 million ($45 million when borrowed) under the DM credit facility. Repayments of indebtedness in 1994 included DM 225 million ($140 million when paid) paid on the DM credit facility, $15 million paid on the Rheox bank term loan and $15 million paid on the joint venture term loan. Net repayments of indebtedness in 1993 included payments on the DM credit facility of DM 552 million ($342 million when paid), a $110 million net reduction in indebtedness related to the Louisiana plant and $350 million proceeds from the Company's public offering of debt.\nAt December 31, 1995, the Company had cash and cash equivalents aggregating $141 million (25% held by non-U.S. subsidiaries) including restricted cash and cash equivalents of $10 million. In addition, the Company's subsidiaries had $5 million and $191 million available for borrowing at December 31, 1995 under existing U.S. and non-U.S. credit facilities, respectively, of which $87 million of the non-U.S. amount is available only for (i) permanently reducing the DM term loan or (ii) paying future German income tax assessments, as described below. In January 1996, the Company borrowed DM 30 million under the revolving credit portion of the DM credit facility.\nBased upon the Company's expectations for the TiO2 industry and anticipated demands on the Company's cash resources as discussed herein, the Company expects to have sufficient liquidity to meet its obligations including operations, capital expenditures and debt service. To the extent that actual developments differ from Company's expectations, the Company's liquidity could be adversely affected. On February 15, 1996, the Company announced the resumption of a regular quarterly dividend by declaring a $.10 per share cash dividend to be paid to shareholders of record on March 1, 1996.\nCertain of the Company's income tax returns in various U.S. and non-U.S. jurisdictions, including Germany, are being examined and tax authorities have proposed or may propose tax deficiencies. During 1994, the German tax authorities withdrew certain proposed tax deficiencies of DM 100 million and remitted tax refunds aggregating DM 225 million ($136 million when received), including interest, on a tentative basis while examination of the Company's German income tax returns continued. The Company recently reached agreement in principle with the German tax authorities regarding such examinations which will resolve certain significant tax contingencies for years through 1990. The Company expects to finalize assessments and pay tax deficiencies of approximately DM 50 million ($35 million at December 31, 1995), including interest, in settlement of these issues during the first half of 1996. The Company considers the agreement in principle to be a favorable resolution of the contingencies and the anticipated payment is within previously-accrued amounts for such matters.\nCertain other German tax contingencies remain outstanding and will continue to be litigated. No assurances can be given that this litigation will be resolved in the Company's favor in view of the inherent uncertainties involved in court rulings. Although the Company believes that it will ultimately prevail in the litigation, the Company has granted a DM 100 million ($70 million at December 31, 1995) lien on its Nordenham, Germany TiO2 plant in favor of the German tax authorities until the litigation is resolved. The Company believes that it has adequately provided accruals for additional income taxes and related interest expense which may ultimately result from all such examinations and believes that the ultimate disposition of such examinations should not have a material adverse effect on the Company's consolidated financial position, results of operations or liquidity.\nAt December 31, 1995, the Company had net deferred tax liabilities of $157 million. The Company operates in numerous tax jurisdictions, in certain of which it has temporary differences that net to deferred tax assets (before valuation allowance). The Company has provided a deferred tax valuation allowance of $196 million at December 31, 1995, principally related to the U.S. and Germany, partially offsetting deferred tax assets which the Company believes do not currently meet the \"more-likely-than-not\" recognition criteria.\nIn addition to the chemicals businesses conducted through Kronos and Rheox, the Company also has certain interests and associated liabilities relating to certain discontinued or divested businesses and other holdings of marketable equity securities including securities issued by Valhi and other Contran subsidiaries.\nThe Company has been named as a defendant, PRP, or both, in a number of legal proceedings associated with environmental matters, including waste disposal sites or facilities currently or formerly owned, operated or used by the Company, many of which disposal sites or facilities are on the U.S. EPA's Superfund National Priorities List or similar state lists. On a quarterly basis, the Company evaluates the potential range of its liability at sites where it has been named as a PRP or defendant. The Company believes it has provided adequate accruals for reasonably estimable costs of such matters, but the Company's ultimate liability may be affected by a number of factors, including changes in remedial alternatives and costs and the allocation of such costs among PRPs. The Company is also a defendant in a number of legal proceedings seeking damages for personal injury and property damage arising out of the sale of lead pigments and lead-based paints. The Company has not accrued any amounts for the pending lead pigment litigation. Although no assurance can be given that the Company will not incur future liability in respect of this litigation, based on, among other things, the results of such litigation to date, the Company believes that the pending lead pigment litigation is without merit. Liability, that may result, if any, cannot reasonably be estimated. The Company currently believes the disposition of all claims and disputes, individually or in the aggregate, should not have a material adverse effect on the Company's consolidated financial position, results of operations or liquidity. There can be no assurance that additional matters of these types will not arise in the future. See Item 3 - \"Legal Proceedings\" and Note 18 to the Consolidated Financial Statements.\nAs discussed above, the Company has substantial operations located outside the United States for which the functional currency is not the U.S. dollar. As a result, the reported amount of the Company's assets and liabilities related to its non-U.S. operations, and therefore the Company's consolidated net assets, will fluctuate based upon changes in currency exchange rates. The carrying value of the Company's net investment in its German operations is a net liability due principally to its DM credit facility, while its net investment in its other non-U.S. operations are net assets.\nThe Company periodically evaluates its liquidity requirements, alternative uses of capital, capital needs and availability of resources in view of, among other things, its debt service and capital expenditure requirements and estimated future operating cash flows. As a result of this process, the Company has in the past and may in the future seek to reduce, refinance or restructure indebtedness, raise additional capital, modify its dividend policy, restructure ownership interests, sell interests in subsidiaries or other assets, or take a combination of such steps or other steps to manage its liquidity and capital resources. In the normal course of its business, the Company may review opportunities for the acquisition of businesses and assets in the chemicals industry. In the event of any future acquisition, the Company may consider using available cash, issuing equity securities or increasing its indebtedness to the extent permitted by the agreements governing the Company's existing debt. See Note 10 to the Consolidated Financial Statements.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe information required by this Item is contained in a separate section of this Annual Report. See \"Index of Financial Statements and Schedules\" on page.\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 is incorporated by reference to NL's definitive proxy statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A within 120 days after the end of the fiscal year covered by this report (the \"NL Proxy Statement\").\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by this Item is incorporated by reference to the NL Proxy Statement.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required by this Item is incorporated by reference to the NL Proxy Statement.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by this Item is incorporated by reference to the NL Proxy Statement. See also Note 17 to the Consolidated Financial Statements.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES, AND REPORTS ON FORM 8-K\n(a) and (d) Financial Statements and Schedules\nThe consolidated financial statements and schedules listed by the Registrant on the accompanying Index of Financial Statements and Schedules (see page) are filed as part of this Annual Report.\n(b) Reports on Form 8-K\nReports on Form 8-K for the quarter ended December 31, 1995 and thereafter through the date of this report.\nOctober 19, 1995 - reported items 5 and 7. January 25, 1996 - reported items 5 and 7. February 15, 1996 - reported items 5 and 7.\n(c) Exhibits\nIncluded as exhibits are the items listed in the Exhibit Index. NL will furnish a copy of any of the exhibits listed below upon payment of $4.00 per exhibit to cover the costs to NL of furnishing the exhibits. Instruments defining the rights of holders of long-term debt issues which do not exceed 10% of consolidated total assets will be furnished to the Securities and Exchange Commission upon request.\nItem No. Exhibit Index\n3.1 By-Laws, as amended on June 28, 1990 - incorporated by reference to Exhibit 3.1 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1990.\n3.2 Certificate of Amended and Restated Certificate of Incorporation dated June 28, 1990 - incorporated by reference to Exhibit 1 to the Registrant's Proxy Statement on Schedule 14A for the annual meeting held on June 28, 1990.\n4.1 Registration Rights Agreement dated October 30, 1991, by and between the Registrant and Tremont Corporation - incorporated by reference to Exhibit 4.3 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1991.\n4.2 Indenture dated October 20, 1993 governing the Registrant's 11.75% Senior Secured Notes due 2003, including form of Senior Note - incorporated by reference to Exhibit 4.1 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993.\n4.3 Senior Mirror Notes dated October 20, 1993 - incorporated by reference to Exhibit 4.3 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993.\n4.4 Senior Note Subsidiary Pledge Agreement dated October 20, 1993 between Registrant and Kronos, Inc. - incorporated by reference to Exhibit 4.4 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993.\n4.5 Third Party Pledge and Intercreditor Agreement dated October 20, 1993 between Registrant, Chase Manhattan Bank (National Association) and Chemical Bank - incorporated by reference to Exhibit 4.5 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993.\n4.6 Indenture dated October 20, 1993 governing the Registrant's 13% Senior Secured Discount Notes due 2005, including form of Discount Note - incorporated by reference to Exhibit 4.6 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993.\n4.7 Discount Mirror Notes dated October 20, 1993 - incorporated by reference to Exhibit 4.8 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993.\n4.8 Discount Note Subsidiary Pledge Agreement dated October 20, 1993 between Registrant and Kronos, Inc. - incorporated by reference to Exhibit 4.9 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993.\n10.1 Amended and Restated Loan Agreement dated as of October 15, 1993 among Kronos International, Inc., the Banks set forth therein, Hypobank International S.A., as Agent and Banque Paribas, as Co- agent - incorporated by reference to Exhibit 10.17 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993.\n10.2 Amended and Restated Liquidity Undertaking dated October 15, 1993 by the Registrant, Kronos, Inc. and Kronos International, Inc. to Hypobank International S.A., as agent, and the Banks set forth therein - incorporated by reference to Exhibit 10.18 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993.\n10.3 Credit Agreement dated as of March 20, 1991 between Rheox, Inc. and Subsidiary Guarantors and The Chase Manhattan Bank (National Association) and the Nippon Credit Bank, Ltd., as Co-agents - incorporated by reference to Exhibit 10.4 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1990.\n10.4 Amendments 1 and 2 dated May 1, 1991 and February 15, 1992, respectively, to the Credit Agreement between Rheox, Inc. and Subsidiary Guarantors and the Chase Manhattan Bank (National Association) and the Nippon Credit Bank, Ltd. as Co-Agents- incorporated by reference to Exhibit 10.2 to the Registrant's Quarterly Report on form 10-Q for the quarter ended June 30, 1992.\n10.5 Third amendment to the Credit Agreement, dated March 5, 1993 between Rheox, Inc. and Subsidiary Guarantors and the Chase Manhattan Bank (National Association) and the Nippon Credit Bank, Ltd as Co-Agents - incorporated by reference to Exhibit 10.7 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1992.\n10.6 Fourth and Fifth Amendments to the Credit Agreement, dated September 23, 1994 and December 15, 1994, respectively, between Rheox, Inc. and Subsidiary Guarantors and the Chase Manhattan Bank (National Association) and the Nippon Credit Bank, Ltd. as Co-Agents - incorporated by reference to Exhibit 10.6 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994.\n10.7 Sixth and Seventh Amendments to the Credit Agreement, dated September 23, 1995 and February 2 1996, respectively, between Rheox, Inc. and Subsidiary Guarantors and the Chase Manhattan Bank (National Association) and the Nippon Credit Bank, Ltd. as Co- Agents.\n10.8 Credit Agreement dated as of October 18, 1993 among Louisiana Pigment Company, L.P., as Borrower, the Banks listed therein and Citibank, N.A., as Agent - incorporated by reference to Exhibit 10.11 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993.\n10.9 Security Agreement dated October 18, 1993 from Louisiana Pigment Company, L.P., as Borrower, to Citibank, N.A., as Agent - incorporated by reference to Exhibit 10.12 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993.\n10.10 Security Agreement dated October 18, 1993 from Kronos Louisiana, Inc. as Grantor, to Citibank, N.A., as Agent - incorporated by reference to Exhibit 10.13 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993.\n10.11 KLA Consent and Agreement dated as of October 18, 1993 between Kronos Louisiana, Inc. and Citibank, N.A., as Agent - incorporated by reference to Exhibit 10.14 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993.\n10.12 Guaranty dated October 18, 1993, from Kronos, Inc., as guarantor, in favor of Lenders named therein, as Lenders, and Citibank, N.A., as Agent - incorporated by reference to Exhibit 10.15 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993.\n10.13 Mortgage by Louisiana Pigment Company, L.P. dated October 18, 1993 in favor of Citibank, N.A. - incorporated by reference to Exhibit 10.16 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993.\n10.14 Lease Contract dated June 21, 1952, between Farbenfabrieken Bayer Aktiengesellschaft and Titangesellschaft mit beschrankter Haftung (German language version and English translation thereof) - incorporated by reference to Exhibit 10.14 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1985.\n10.15 Contract on Supplies and Services among Bayer AG, Kronos Titan-GmbH and Kronos International, Inc. dated June 30, 1995 (English translation from German language document) - incorporated by reference to Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1995.\n10.16 Agreement dated February 8, 1984, between Bayer AG and Kronos Titan GmbH (German language version and English translation thereof) - incorporated by reference to Exhibit 10.16 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1985.\n10.17 Richards Bay Slag Sales Agreement dated May 1, 1995 between Richards Bay Iron and Titanium (Proprietary) Limited and Kronos, Inc.\n10.18 Formation Agreement dated as of October 18, 1993 among Tioxide Americas Inc., Kronos Louisiana, Inc. and Louisiana Pigment Company, L.P. - incorporated by reference to Exhibit 10.2 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993.\n10.19 Joint Venture Agreement dated as of October 18, 1993 between Tioxide Americas Inc. and Kronos Louisiana, Inc. - incorporated by reference to Exhibit 10.3 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993.\n10.20 Amendment No. 1 to Joint Venture Agreement dated as of December 20, 1995 between Tioxide Americas Inc. and Kronos Louisiana, Inc.\n10.21 Kronos Offtake Agreement dated as of October 18, 1993 between Kronos Louisiana, Inc. and Louisiana Pigment Company, L.P. - incorporated by reference to Exhibit 10.4 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993.\n10.22 Amendment No. 1 to Kronos Offtake Agreement dated as of December 20, 1995 between Kronos Louisiana, Inc. and Louisiana Pigment Company, L.P.\n10.23 Tioxide Americas Offtake Agreement dated as of October 18, 1993 between Tioxide Americas Inc. and Louisiana Pigment Company, L.P. - incorporated by reference to Exhibit 10.5 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993.\n10.24 Amendment No. 1 to Tioxide Americas Offtake Agreement dated as of December 20, 1995 between Tioxide Americas Inc. and Louisiana Pigment Company, L.P.\n10.25 TCI\/KCI Output Purchase Agreement dated as of October 18, 1993 between Tioxide Canada Inc. and Kronos Canada, Inc. - incorporated by reference to Exhibit 10.6 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993.\n10.26 TAI\/KLA Output Purchase Agreement dated as of October 18, 1993 between Tioxide Americas Inc. and Kronos Louisiana, Inc. - incorporated by reference to Exhibit 10.7 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993.\n10.27 Master Technology Exchange Agreement dated as of October 18, 1993 among Kronos, Inc., Kronos Louisiana, Inc., Kronos International, Inc., Tioxide Group Limited and Tioxide Group Services Limited - incorporated by reference to Exhibit 10.8 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993.\n10.28 Parents' Undertaking dated as of October 18, 1993 between ICI American Holdings Inc. and Kronos, Inc. - incorporated by reference to Exhibit 10.9 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993.\n10.29 Allocation Agreement dated as of October 18, 1993 between Tioxide Americas Inc., ICI American Holdings, Inc., Kronos, Inc. and Kronos Louisiana, Inc. - incorporated by reference to Exhibit 10.10 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993.\n10.30* 1985 Long Term Performance Incentive Plan of NL Industries, Inc., as adopted by the Board of Directors on February 27, 1985 - incorporated by reference to Exhibit A to the Registrant's Proxy Statement on Schedule 14A for the annual meeting held on April 24, 1985.\n10.31 Form of Director's Indemnity Agreement between NL and the independent members of the Board of Directors of NL - incorporated by reference to Exhibit 10.20 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1987.\n10.32* 1989 Long Term Performance Incentive Plan of NL Industries, Inc. as adopted by the Board of Directors on February 14, 1989 - incorporated by reference to Exhibit A to the Registrant's Proxy Statement on Schedule 14A for the annual meeting held on May 2, 1989.\n10.33 Savings Plan for Employees of NL Industries, Inc. as adopted by the Board of Directors on February 14, 1989 - incorporated by reference to Exhibit B to the Registrant's Proxy Statement on Schedule 14A for the annual meeting held May 2, 1989.\n10.34* NL Industries, Inc. 1992 Non-Employee Director Stock Option Plan, as adopted by the Board of Directors on February 13, 1992 - incorporated by reference to Appendix A to the Registrant's Proxy Statement on Schedule 14A for the annual meeting held April 30, 1992.\n10.35 Intercorporate Services Agreement by and between Valhi, Inc. and the Registrant effective as of January 1, 1995 - incorporated by reference to Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 1995.\n10.36 Intercorporate Services Agreement by and between Contran Corporation and the Registrant effective as of January 1, 1995 -incorporated by reference to Exhibit 10.2 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 1995.\n10.37 Intercorporate Services Agreement by and between Tremont Corporation and the Registrant effective as of January 1, 1995.\n10.38 Insurance Sharing Agreement, effective January 1, 1990, by and between the Registrant, NL Insurance, Ltd. (an indirect subsidiary of Tremont Corporation) and Baroid Corporation - incorporated by reference to Exhibit 10.20 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1991.\n10.39* Description of terms of an executive severance agreement between the Registrant and Joseph S. Compofelice - incorporated by reference to the last paragraph of page 16 entitled \"Employment Agreements\" of the Registrant's definitive proxy statement dated March 30, 1994.\n10.40* Description of terms of an executive severance agreement between the Registrant and Lawrence A. Wigdor - incorporated by reference to the last paragraph on page 16 entitled \"Employment Agreements\" of the Registrant's definitive proxy statement dated March 29, 1995.\n10.41* Executive Severance Agreement effective as of December 31, 1991 by and between the Registrant and J. Landis Martin - incorporated by reference to Exhibit 10.22 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1991.\n10.42* Supplemental Executive Retirement Plan for Executives and Officers of NL Industries, Inc. effective as of January 1, 1991 - incorporated by reference to Exhibit 10.26 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1992.\n10.43* Agreement to Defer Bonus Payment dated December 28, 1995 between the Registrant and Lawrence A. Wigdor and related trust agreement.\n21.1 Subsidiaries of the Registrant.\n23.1 Consent of Independent Accountants.\n27.1 Financial Data Schedules for the year ended December 31, 1995.\n99.1 Annual Report of Savings Plan for Employees of NL Industries, Inc. (Form 11-K) to be filed under Form 10-K\/A to the Registrant's Annual Report on Form 10-K within 180 days after December 31, 1995.\n* Management contract, compensatory plan or arrangement. 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.\nNL Industries, Inc. (Registrant)\nBy \/s\/ J. Landis Martin J. Landis Martin, March 1, 1996 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\/ J. Landis Martin \/s\/ Harold C. Simmons\nJ. Landis Martin, Harold C. Simmons, March 1, 1996 March 1, 1996 Director, President and Chairman of the Board Chief Executive Officer\n\/s\/ Glenn R. Simmons \/s\/ Joseph S. Compofelice\nGlenn R. Simmons, Joseph S. Compofelice, March 1, 1996 March 1, 1996 Director Director, Vice President and Chief Financial Officer\n\/s\/ Kenneth R. Peak \/s\/ Dr. Lawrence A. Wigdor\nKenneth R. Peak, Dr. Lawrence A. Wigdor, March 1, 1996 March 1, 1996 Director Director, President and Chief Executive Officer of Kronos and Rheox\n\/s\/ Elmo R. Zumwalt, Jr. \/s\/ Dennis G. Newkirk\nElmo R. Zumwalt, Jr., Dennis G. Newkirk, March 1, 1996 March 1, 1996 Director Vice President and Controller (Principal Accounting Officer)","section_15":""}
{"filename":"736999_1995.txt","cik":"736999","year":"1995","section_1":"Item 1. BUSINESS (a) General Development of Business. Dean Witter Cornerstone Fund II (the \"Partnership\") is a New York limited partnership formed to engage in the speculative trading of commodity futures contracts and other commodity interests, including, but not limited to, forward contracts on foreign currencies. The Partnership's net asset value per unit, as of December 31, 1995, was $2,830.65, representing an increase of 26.50 percent from the net asset value per unit of $2,237.75 at December 31, 1994. (b) Financial Information about Industry Segments. The Partnership's business comprises only one segment for financial reporting purposes, speculative trading of commodity futures contracts and other commodity interests. The relevant financial information is presented in Items 6 and 8. (c) Narrative Description of Business. The Partnership is in the business of speculative trading in commodity futures contracts and other commodity interests, pursuant to trading instructions provided by independent trading advisors. For a detailed description of the different facets of the Partnership's business, see those portions of the Partnership's latest Prospectus, dated May 2, 1994 together with the Supplement to Prospectus and Disclosure Document dated August 7, 1995 (the \"Supplement\"), filed as part of the Registration Statement on Form S-1 (see \"Documents Incorporated by Reference\" Page 1), set forth on the next page.\nFacets of Business 1. Summary 1. \"Summary of the Prospectus\" (Pages 3-12 and the Prospectus and Page 1 of the Supplement).\n2. Commodity Markets 2. \"The Commodities Markets\" (Pages 164-172).\n3. Partnership's Commodity 3. \"Trading Policies\" (Pages Trading Arrangements and 68-69). \"The Trading Policies Managers\" (Pages 73-74 and 75-119 of the Prospectus and Pages 10-1 and Pages T-2- T-11 of the Supplement).\n4. Management of the Part- 4. \"The Cornerstone Funds\" nership (Pages 30-61 of the Prospectus and Pages 1-3 of the Supplement). \"The General Partner\" Pages 160- 162 of Page 14 of the Supplement and \"The Commodity Broker\" (Pages 162-164). \"The Limited Partnership Agreements\" (Pages 174-178).\n5. Taxation of the Partnership's 5. \"Federal Income Tax Limited Partners Aspects\" and \"State and Local Income Tax Aspects\" (Pages 182-189).\n(d) Financial Information About Foreign and Domestic Operations and Export Sales.\nThe Partnership has not engaged in any operations in foreign countries; however, the Partnership (through the commodity broker) enters into forward contract transactions where foreign banks are the contracting party and trades in commodity interest contracts on foreign exchanges.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nThe executive and administrative offices are located within the offices of Dean Witter Reynolds Inc. (\"DWR\"). The DWR offices utilized by the Partnership are located at Two World Trade Center, 62nd Floor, New York, NY 10048. Item 3.","section_3":"Item 3. LEGAL PROCEEDINGS The General Partner, Demeter Management Corporation (\"Demeter\"), is not aware of any material pending legal proceedings to which the Partnership is a party or to which any of its assets are subject. Item 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 PARTNERSHIP UNITS AND RELATED SECURITY HOLDER MATTERS\nThere is no established public trading market for the Units of Limited Partnership Interest in the Partnership. The number of holders of Units at December 31, 1995 was 3,828. No distributions have been made by the Partnership since it commenced operations on January 2, 1985. Demeter has sole discretion to decide what distributions, if any, shall be made to investors in the Partnership. No determination has yet been made as to future distributions. Limited Partnership Units were registered for sale to the public in certain Canadian provinces.\nItem 7.","section_6":"","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Liquidity. The Partnership's assets are deposited in separate commodity trading accounts with DWR, the commodity broker, and are used by the Partnership as margin to engage in trading commodity futures contracts and forward contracts on foreign currencies. DWR holds such assets in either designated depositories or in securities approved by the Commodity Futures Trading Commission (\"CFTC\") for investment of customer funds. The Partnership's assets held by DWR may be used as margin solely for the Partnership's trading. Since the Partnership's sole purpose is to trade in commodity futures contracts and other commodity interests, it is expected that the Partnership will continue to own such liquid assets for margin purposes. The Partnership's investment in commodity futures contracts and other commodity interests may be illiquid. If the price for a futures contract for a particular commodity has increased or decreased by an amount equal to the \"daily limit\", positions in the commodity can neither be taken nor liquidated unless traders are willing to effect trades at or within the limit. Commodity futures prices have occasionally moved the daily limit for several consecutive days with little or no trading. Such market conditions could prevent the Partnership from promptly liquidating its commodity futures positions. There is no limitation on daily price moves in trading forward contracts on foreign currencies. The markets for some world currencies have low trading volume and are illiquid which may prevent the Partnership from trading in potentially profitable markets or prevent the Partnership from promptly liquidating unfavorable positions in such markets and subjecting it to substantial losses.\nEither of these market conditions could result in restrictions on redemptions.\nMarket Risk. The Partnership trades futures, options and forward contracts in interest rates, stock indices, commodities and currencies. In entering into these contracts there exists a risk to the Partnership (market risk) that such contracts may be significantly influenced by market conditions, such as interest rate volatility, resulting in such contracts being less valuable. If the markets should move against all of the commodity interest positions held by the Partnership at the same time, and if the Trading Advisors were unable to offset commodity interest positions of the Partnership, the Partnership could lose all of its assets. The Partnership has established Trading Policies for liquidity and leverage which help control market risk. Both the Trading Advisors and Demeter monitor the Partnership's trading activities on a daily basis to ensure compliance with the Trading Policies. Demeter may (under terms of the Management Agreements) override the trading instructions of a Trading Advisor to the extent necessary to comply with the Partnership's Trading Policies. Credit Risk. In addition to market risk, the Partnership is subject to credit risk in that a counterparty may not be able to meet its obligations to the Partnership. The counterparty of the Partnership for futures contracts traded in the United States and most foreign exchanges on which the Partnership trades is the clearinghouse associated with such exchange. In general, clearinghouses are backed by the membership of the exchange and will act in the event of non-performance by one of its members or one of its members' customers, and as such, should significantly reduce this credit risk. In cases where the Partnership trades on exchanges where the clearinghouse is not backed by the\nmembership or when the Partnership enters into off-exchange contracts with a counterparty, the sole recourse of the Partnership will be the clearinghouse or the counterparty as the case may be. With respect to futures contracts, DWR, in its business as an international commodity broker, constantly monitors the credit-worthiness of the exchanges and clearing members of the foreign exchanges with which it does business for clients, including the Partnership. If DWR believes that there was a problem with the credit-worthiness of an exchange on which the Partnership deals, it would so advise Demeter. With respect to forward contract trading, the Partnership trades with only those counterparties which Demeter, together with DWR, have determined to be creditworthy. As set forth in the Partnership's Trading Policies, in determining credit- worthiness, Demeter and DWR consult with the Corporate Credit Department of DWR. Currently, the Partnership deals solely with DWR as its counterparty on forward contracts. While DWR and Demeter monitor credit- worthiness and risk involved in dealing on the various exchanges and with counterparties, there can be no assurance that an exchange or counterparty will be able to meet its obligations to the Partnership. Capital Resources. The Partnership does not have, nor does it expect to have, any capital assets. Redemptions of additional Units in the future will impact the amount of funds available for investments in commodity futures, forward contracts on foreign currencies and other commodity interests in subsequent periods. As redemptions are at the discretion of Limited Partners, it is not possible to estimate the amount and therefore, the impact of future redemptions.\nResults of Operations. As of December 31, 1995, the Partnership's total capital was $30,828,888 a decrease of $543,114 from the Partnership's total capital of $31,372,002 at December 31, 1994. For the year ended December 31, 1995, the Partnership generated net income of $7,882,659, total subscriptions aggregated $178,837 and total redemptions aggregated $8,604,610. For the year ended December 31, 1995, the Partnership's total trading revenues including interest income were $11,604,765. The Partnership's total expenses for the year were $3,722,106 resulting in net income of $7,882,659. The value of an individual unit in the Partnership increased from $2,237.75 at December 31, 1994 to $2,830.65 at December 31, 1995. As of December 31, 1994, the Partnership's total capital was $31,372,002 a decrease of $569,371 from the Partnership's total capital of $31,941,373 at December 31, 1993. For the year ended December 31, 1994, the Partnership incurred a net loss of $3,095,555, total subscriptions aggregated $7,098,104 and total redemptions aggregated $4,571,920. For the year ended December 31, 1994, the Partnership's total trading revenues including interest income were $830,882. The Partnership's total expenses for the year were $3,926,437 resulting in a net loss of $3,095,555. The value of an individual unit in the Partnership decreased from $2,457.22 at December 31, 1993 to $2,237.75 at December 31, 1994. As of December 31, 1993, the Partnership's total capital was $31,941,373 an increase of $5,362,208 from the Partnership's total capital of $26,579,165 at December 31, 1992. For the year ended December 31, 1993, the Partnership generated net income of $2,101,347, total subscriptions aggregated $7,100,239 and total redemptions aggregated $3,839,378.\nFor the year ended December 31, 1993, the Partnership's total trading revenues including interest income were $5,262,886. The Partnership's total expenses for the year were $3,161,539 resulting in net income of $2,101,347. The value of an individual unit in the Partnership increased from $2,279.17 at December 31, 1992 to $2,457.22 at December 31, 1993. The Partnership's overall performance record represents varied results of trading in different commodity markets. For a further description of trading results, refer to the letter to the Limited Partners in the accompanying 1995 Annual Report to Partners, incorporated by reference in this Form 10-K. The Partnership's gains and losses are allocated among its Limited Partners for income tax purposes. Item 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The information required by this Item appears in the attached 1995 Annual Report to Partners and is incorporated by reference in this Annual Report on Form 10-K. Item 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS OF THE REGISTRANT\nGeneral Partner Demeter, a Delaware corporation, was formed on August 18, 1977 to act as a commodity pool operator and is registered with the CFTC as a commodity pool operator and currently is a member of the National Futures Association (\"NFA\") in such capacity. Demeter is wholly-owned by Dean Witter, Discover & Co. (\"DWD\") and is an affiliate of DWR. DWD, DWR and Demeter may each be deemed to be \"promoters\" and\/or a \"parent\" of the Partnership within the meaning of the federal securities laws. Dean Witter Reynolds Inc. DWR is a financial services company which provides to its individual, corporate and institutional clients services as a broker in securities and commodity interest contracts, a dealer in corporate, municipal and government securities, an investment banker, an investment adviser and an agent in the sale of life insurance and various other products and services. DWR is a member firm of the New York Stock Exchange, the American Stock Exchange, the Chicago Board Options Exchange, and other major securities exchanges, and is a clearing member of the Chicago Board of Trade, the Chicago Mercantile Exchange, the Commodity Exchange Inc., and other major commodities exchanges. DWR is registered with the CFTC as a futures commission merchant and is a member of the NFA in such capacity. DWR is currently servicing its clients through a network of 350 branch offices with approximately 8,500 account executives servicing individual and institutional client accounts.\nDirectors and Officers of the General Partner The directors and officers of Demeter as of December 31, 1995 are as follows: Richard M. DeMartini, age 43, is the Chairman of the Board and a Director of Demeter. Mr. DeMartini is also the Chairman of the Board and a Director of Dean Witter Futures & Currency Management Inc. (\"DWFCM\"), a registered commodity trading advisor. Mr. DeMartini has served as President and Chief Operating Officer of Dean Witter Capital, a division of DWR since January 1989. From January 1988 until January 1989, Mr. DeMartini served as President and Chief Operating Officer of the Consumer Banking Division of DWD, and from May 1985 until January 1988 was President and Chief Executive Officer of the Consumer Markets Division of DWD. Mr. DeMartini currently serves as a Director of DWD and DWR, and has served as an officer of DWR for the past five years. Mr. DeMartini has been with DWD and its affiliates for 18 years. While Mr. DeMartini has extensive experience in the securities industry, he has no experience in commodity interests trading. Mark J. Hawley, age 52, is President and a Director of Demeter. Mr. Hawley joined DWR in February 1989 as Senior Vice President and Director of DWR's Managed Futures and Precious Metals Department. Mr. Hawley also serves as President of DWFCM. From 1978 to 1989, Mr. Hawley was a member of the senior management team at Heinold Asset Management, Inc., a commodity pool operator, and was responsible for a variety of projects in public futures funds. From 1972 to 1978, Mr. Hawley was a Vice President in charge of institutional block trading for the Mid-West at Kuhn Loeb & Co. Lawrence Volpe, age 48, is a Director of Demeter and DWFCM. Mr. Volpe joined DWR as a Senior Vice President and Controller in September\n1983, and currently holds those positions. From July 1979 to September 1983, he was associated with E.F. Hutton & Company Inc. and prior to his departure, held the positions of First Vice President and Assistant Controller. From 1970 to July 1979, he was associated with Arthur Anderson & Co. and prior to his departure he served as audit manager in the financial services division. Joseph G. Siniscalchi, age 50, is a Director of Demeter. Mr. Siniscalchi joined DWR in July 1984 as a First Vice President, Director of General Accounting. He is currently Senior Vice President and Controller of the Financial Markets Division of DWR. From February 1980 to July 1984, Mr. Siniscalchi was Director of Internal Audit at Lehman Brothers Kuhn Loeb, Inc. Laurence E. Mollner, age 54, is a Director of Demeter. Mr. Mollner joined DWR in May 1979 as Vice President and Director of Commercial Sales. He is currently Executive Vice President and Deputy Director of the Futures Markets Division of DWR. Edward C. Oelsner III, age 53, is a Director of Demeter. Mr. Oelsner joined DWR in March 1981 as a Managing Director in the Corporate Finance Department. He currently manages DWR's Retail Products Group within the Corporate Finance Department. While Mr. Oelsner has extensive experience in the securities industry, he has no experience in commodity interests trading. Robert E. Murray, age 35, is a Director of Demeter. Mr. Murray is currently a First Vice President of the DWR Managed Futures Division and is a Director and the Senior Administrative Officer of DWFCM. Mr. Murray graduated from Geneseo State University in May 1983 with a B.A. degree in Finance. Mr. Murray began at DWR in 1984 and is currently the Director of Product Development for the Managed Futures Division and is responsible\nfor the development and maintenance of the proprietary Fund Management System utilized by Demeter and DWFCM for organizing information and producing reports for monitoring investors' accounts. Patti L. Behnke, age 35, is Vice President and Chief Financial Officer of Demeter. Ms. Behnke joined DWR in 1991 as Assistant Vice President of Financial Reporting and is currently First Vice President and Director of Financial Reporting and Managed Futures Accounting in the Capital Markets division of DWR. From August 1988 to September 1990, Ms. Behnke was Assistant Controller of L.F. Rothschild & Co. and from September 1986 to August 1988, she was associated with Carteret Savings Bank as Assistant Vice President - Financial Analysis. From April 1982 to September 1986, Ms. Behnke was an auditor at Arthur Andersen & Co. Item 11.","section_11":"Item 11. EXECUTIVE COMPENSATION The Partnership has no directors and executive officers. As a limited partnership, the business of the Partnership is managed by Demeter which is responsible for the administration of the business affairs of the Partnership but receives no compensation for such services. Item 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT (a) Security Ownership of Certain Beneficial Owners - As of December 31, 1995, there were no persons as beneficial owners of more than 5 percent of the Units of Limited Partnership Interest in the Partnership. (b) Security Ownership of Management - At December 31, 1995, Demeter owned 217.400 Units of General Partnership Interest in the Partnership representing a 2.04 percent interest in the Partnership. (c) Changes in Control - None\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Refer to Note 2 - \"Related Party Transactions\" of \"Notes to Financial Statements\", in the accompanying 1995 Annual Report to Partners, incorporated by reference in this Form 10-K. In its capacity as the Partnership's retail commodity broker, DWR received commodity brokerage commissions (paid and accrued by the Partnership) of $1,864,093 for the year ended December 31, 1995.\nPART IV Item 14.","section_14":"Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) 1. Listing of Financial Statements The following financial statements and report of independent public accountants, all appearing in the accompanying 1995 Annual Report to Partners, are incorporated by reference in this Form 10-K: - Report of Deloitte & Touche LLP, independent auditors, for the years ended December 31, 1995, 1994 and 1993.\n- Statements of Financial Condition as of December 31, 1995 and 1994.\n- Statements of Operations, Changes in Partners' Capital, and Cash Flows for the years ended December 31, 1995, 1994 and 1993.\n- Notes to Financial Statements. With exception of the aforementioned information and the information incorporated in Items 7, 8, and 13, the 1995 Annual Report to Partners is not deemed to be filed with this report. 2. Listing of Financial Statement Schedules No financial statement schedules are required to be filed with this report. (b) Reports on Form 8-K No reports on Form 8-K have been filed by the Partnership during the last quarter of the period covered by this report. (c) Exhibits Refer to Exhibit Index on Page E-1.\nSIGNATURES\nPursuant to the requirement 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.\nDEAN WITTER CORNERSTONE FUND II (Registrant)\nBY: Demeter Management Corporation, General Partner\nMarch 21, 1996 BY: \/s\/ Mark J. Hawley Mark J. Hawley, 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.\nDemeter Management Corporation.\nBY: \/s\/ Mark J. Hawley March 21, 1996 Mark J. Hawley, Director and President\n\/s\/ Richard M. DeMartini March 21, 1996 Richard M. DeMartini, Director and Chairman of the Board\n\/s\/ Lawrence Volpe March 21, 1996 Lawrence Volpe, Director\n\/s\/ Laurence E. Mollner March 21, 1996 Laurence E. Mollner, Director\n\/s\/ Joseph G. Siniscalchi March 21, 1996 Joseph G. Siniscalchi, Director\n\/s\/ Edward C. Oelsner III March 21, 1996 Edward C. Oelsner III, Director\n\/s\/ Robert E. Murray, March 21, 1996 Robert E. Murray, Director\n\/s\/ Patti L. Behnke March 21, 1996 Patti L. Behnke, Chief Financial Officer\nEXHIBIT INDEX\nITEM METHOD OF FILING\n- - 3. Limited Partnership Agreement of the Partnership, dated as of December 7, 1983, as amended as (1) of May 11, 1984.\n- - 10. Management Agreement among the Partnership, Demeter Management Corporation and A.O. Management, Inc., dated as of November 18, 1983. (2)\n- - 10. Management Agreement among the Partnership, Demeter Management Corporation and John W. Henry & Co., Inc. dated November 15, 1983. (3)\n- - 10. Dean Witter Cornerstone Funds Exchange Agreement, dated as of May 31, 1984. (4)\n- - 10. Customer Agreement Between the Partnership and Dean Witter Reynolds Inc., dated as of May 31, 1984. (5)\n- - 13. December 31, 1995 Annual Report to Limited Partners. (6)\n(1) Incorporated by reference to Exhibit 3.01 of the Partnership's Annual Report on Form 10-K for the fiscal year ended September 30, 1984.\n(2) Incorporated by reference to Exhibit 10.01 of the Partnership's Annual Report on Form 10-K for the fiscal year ended September 30, 1984.\n(3) Incorporated by reference to Exhibit 10.03 of the Partnership's Annual Report on Form 10-K for the fiscal year ended September 30, 1984.\n(4) Incorporated by reference to Exhibit 10.04 of the Partnership's Annual Report on Form 10-K for the fiscal year ended September 30, 1984.\n(5) Incorporated by reference to Exhibit 10.05 of the Partnership's Annual Report on Form 10-K for the fiscal year ended September 30, 1984.\n(6) Filed herewith.\nE-1\nCornerstone Funds\nDecember 31, 1995 Annual Report\n[LOGO] DEAN WITTER\nDEAN WITTER Two World Trade Center 62nd Floor NEW YORK, NY 10048 TELEPHONE (212) 392-8899\nCORNERSTONE FUNDS ANNUAL REPORT\nDear Limited Partner:\nThis marks the eleventh annual report for Cornerstone Funds II and III and the ninth for Cornerstone Fund IV. The Net Asset Value per Unit for the three Cornerstone Funds on December 31, 1995 was as follows:\nCornerstone Fund IV, the currency Fund, recorded net losses during January as a decline in the value of the U.S. dollar relative to most major world currencies resulted in losses. As January progressed, the advisors to the Fund reversed positions only to experience additional losses when the U.S. dollar strengthened sharply on January 31. Significant gains were recorded during February and March due to a trend higher in the value of the Japanese yen and most major European currencies relative to the U.S. dollar. As a result, trading gains were recorded from long positions in the Japanese yen, German mark, as well as the Swiss and French francs and Norwegian krone.\nIn April, Fund IV continued to record gains from the upward trend in the value of the Japanese yen relative to the U.S. dollar, as well as from transactions involving the Australian and New Zealand dollars. A reversal in the downward trend in the value of the U.S. dollar versus most major European currencies and the Japanese yen during May resulted in losses from transactions involving the German mark, French franc, Norwegian krone and\nJapanese yen. In June, small losses were recorded from transactions involving the Japanese yen, British pound and French franc as the value of most major world currencies moved in a trendless range versus the U.S. dollar and one another. These losses were partially offset by gains from trading in the German mark and Australian dollar.\nDuring July, Fund IV sustained losses as most foreign currencies, particularly the Australian and New Zealand dollars, as well as the German mark, continued to move in a trendless pattern relative to the U.S. dollar and one another. Trading gains were recorded during August as the Fund's previously established short positions in the Japanese yen profited from a sharp downward move in the value of the Japanese yen relative to the U.S. dollar. During September, the Fund recorded small net losses primarily as a result of a reversal in an upward move in the value of the U.S. dollar relative to most major European currencies, as well as the Japanese yen, on September 20 and 21. This sudden reversal resulted in losses from transactions involving the German mark, French franc and British pound. However, gains recorded from trading in the Japanese yen earlier in the month, offset a majority of Fund losses for the month.\nFund IV began the fourth quarter by recording net gains as the Fund's short yen positions profited from the continued decline of the Japanese yen relative to the U.S. dollar. Net losses were recorded during November due primarily to trendless movement in the value of world currencies, particularly the Australian dollar, German mark and French franc, relative to the U.S. dollar. Trading in the Japanese yen also resulted in losses as the previous downward trend in the value of the yen versus the U.S. dollar subsided during the month. During December, Fund IV recorded small net losses as the value of the British pound relative to the U.S. dollar moved sharply\nhigher late in the month. As a result, losses were recorded from the Fund's previously established short British pound positions. Trading gains from transactions involving the Japanese yen and German mark offset a majority of the losses experienced in the British pound.\nCornerstone Fund II, a diversified fund, recorded losses during January as a result of the aforementioned currency activity, as well as from trading in financial and agricultural futures. Fund II profited significantly during February and March as the value of most major world currencies relative to the U.S. dollar increased, resulting in profits for the Fund's long positions in major European currencies, as well as the Japanese yen. Additional gains were recorded from long positions in global bond futures positions as prices moved higher during this period as well as in crude oil futures trading.\nIn April, a continued upward trend in global financial futures prices resulted in gains for Fund II's previously established long stock index and bond futures positions. Additional gains were recorded for the Fund's long Japanese yen positions as the value of the yen continued to move higher versus the U.S. dollar. Small net losses were recorded during May as trading losses in traditional commodities, such as energy, agricultural and metals futures, as well as in currencies, more than offset gains recorded from long positions in global financial futures. During June, Fund II recorded small net losses as the previous upward trend in international interest rate futures prices pulled back during the month. These losses, coupled with smaller losses in the currency and agricultural futures markets, offset gains recorded in the energy and coffee futures markets.\nDuring July, Fund II posted net losses as a result of trading in both U.S. and international bond futures. Additional Fund losses were recorded in the currency markets as the value of most major world\ncurrencies moved in a narrow trading range relative to the U.S. dollar and one another. During August, losses were recorded in global bond futures, particularly in U.S. Treasury bond futures, as bond futures prices experienced a period of short-term volatile movement. These losses, coupled with losses recorded in soft commodities and silver futures, more than offset gains recorded from transactions involving the Japanese yen. Fund II also recorded losses in September due primarily to erratic price movement in global interest rate and stock index futures. Losses were also recorded in energy futures trading, as oil and gas prices reversed dramatically, and in metals futures trading, as both precious and base metals prices remained relatively trendless.\nSmall net losses were recorded during October as trendless price movement was commonplace in several of the markets traded by the Fund, including cotton, crude oil and overseas interest rate futures. However, trading profits were recorded from short Japanese yen positions, as well as from trading in the agricultural and metals markets. During November, profits were recorded as global bond futures prices increased during the month, resulting in gains in U.S., European and Japanese interest rate futures. Additional gains were recorded from short coffee futures positions as prices declined during the month. In December, Fund II was profitable primarily due to trading in the energy markets, as long positions in crude and heating oil profited from increasing oil prices, and in soft commodities, as gains were recorded as a result of trading in both sugar and coffee futures. Increasing soybean and corn prices during the month resulted in additional gains for the Fund's long soybean and corn futures positions.\nCornerstone Fund III, also a diversified fund, experienced losses during January due to trading in the currency, financial and agricultural markets. During February and March, significant gains were recorded as a\nresult of trading in the currency markets as the value of the U.S. dollar moved lower versus most world currencies. Strong gains were also recorded from long positions in global bond futures, as prices in these markets increased during this two month period.\nTrading in global financial futures was profitable during April and May as both U.S. and international interest rate futures prices continued to trend higher. Additional gains were recorded in stock index futures, specifically from trading Nikkei and S&P 500 Index futures. Small net gains were recorded during June as trading in base metals, energy and soft commodities futures more than offset trading losses recorded in international interest rate futures, currencies and livestock futures.\nDuring July, trading losses were recorded in financial futures as global interest rate futures prices retreated from their previous upward trend. Additional losses were recorded in Japanese stock index futures as a sharp reversal in Japanese stock prices resulted in losses for the Fund's previously established short Nikkei Index futures positions. In August, gains were recorded from short positions in the Japanese yen, as the value of the yen moved lower relative to the U.S. dollar, and from long positions in Nikkei Index and corn futures as prices in both of these markets moved higher. In September, net gains were recorded as long positions in Japanese, European and Australian interest rate futures profited from increasing global bond prices. Smaller gains in agricultural futures and soft commodities contributed to the Fund's gains for the month.\nNet losses were recorded during October due to losses in soft commodities trading as cotton and coffee prices moved in a trendless pattern, as well as from trading in currencies and global financial futures. During November, profits were recorded primarily from long positions in global interest rate\nand S&P 500 Index futures, as prices moved higher. Smaller gains were recorded in soft commodities and energy futures trading. Fund III ended 1995 with strong gains during December as a result of trading in energy futures as long gas and oil positions profited from a dramatic price move higher. Agricultural futures trading resulted in additional gains as long positions in corn, soybean meal and soybean futures also benefited from rising prices.\nOverall, each of the Cornerstone Funds was able to record significant profits during the calendar year of 1995. Cornerstone Funds II and III recorded profits primarily due to price trends in the global financial futures and currency markets. Cornerstone Fund IV profited as it was able to capitalize on currency trends in the first half of the year. Since their inception in 1985, Cornerstone Fund II has increased by 190.3% (a compound annualized return of 10.2%) and Cornerstone Fund III has increased by 157.3% (a compound annualized return of 9.0%). Cornerstone Fund IV, since its inception in 1987, has increased by 185.8% (a compound annualized return of 12.9%).\nShould you have any questions concerning this report, please feel free to contact Demeter Management Corporation at Two World Trade Center, 62nd Floor, New York, NY 10048 or your Dean Witter Account Executive.\nI hereby affirm, that to the best of my knowledge and belief, the information contained in this report is accurate and complete.\nSincerely,\n\/s\/ Mark J. Hawley Mark J. Hawley President Demeter Management Corporation General Partner\nDEAN WITTER CORNERSTONE FUNDS INDEPENDENT AUDITORS' REPORT\nThe Limited Partners and the General Partner of Dean Witter Cornerstone Fund II Dean Witter Cornerstone Fund III Dean Witter Cornerstone Fund IV:\nWe have audited the accompanying statements of financial condition of Dean Witter Cornerstone Fund II, Dean Witter Cornerstone Fund III and Dean Witter Cornerstone Fund IV (collectively, the \"Partnerships\") as of December 31, 1995 and 1994 and the related statements of operations, changes in partners' capital, and cash flows for each of the three years in the period ended December 31, 1995. These financial statements are the responsibility of the Partnerships' 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 Dean Witter Cornerstone Fund II, Dean Witter Cornerstone Fund III and Dean Witter Cornerstone Fund IV as of December 31, 1995 and 1994 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles.\n\/s\/ Deloitte & Touche LLP February 21, 1996 New York, New York\nDEAN WITTER CORNERSTONE FUND II STATEMENTS OF FINANCIAL CONDITION\nSTATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nThe accompanying notes are an integral part of these financial statements.\nDEAN WITTER CORNERSTONE FUND III STATEMENTS OF FINANCIAL CONDITION\nSTATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nThe accompanying notes are an integral part of these financial statements.\nDEAN WITTER CORNERSTONE FUND IV STATEMENTS OF FINANCIAL CONDITION\nSTATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nThe accompanying notes are an integral part of these financial statements.\nDEAN WITTER CORNERSTONE FUNDS\nSTATEMENT OF CHANGES IN PARTNERS' CAPITAL FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nDEAN WITTER CORNERSTONE FUNDS\nSTATEMENT OF CHANGES IN PARTNERS' CAPITAL FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nThe accompanying notes are an integral part of these financial statements.\nDEAN WITTER CORNERSTONE FUND II STATEMENTS OF CASH FLOWS\nThe accompanying notes are an integral part of these financial statements.\nDEAN WITTER CORNERSTONE FUND III STATEMENTS OF CASH FLOWS\nThe accompanying notes are an integral part of these financial statements.\nDEAN WITTER CORNERSTONE FUND IV STATEMENTS OF CASH FLOWS\nThe accompanying notes are an integral part of these financial statements.\nDEAN WITTER CORNERSTONE FUNDS NOTES TO FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nORGANIZATION--Dean Witter Cornerstone Fund II, Dean Witter Cornerstone Fund III and Dean Witter Cornerstone Fund IV (individually, a \"Partnership\", or collectively, the \"Partnerships\") are limited partnerships organized to engage in the speculative trading of commodity futures contracts and forward contracts on foreign currencies. The general partner for each Partnership is Demeter Management Corporation (the \"General Partner\"). The commodity broker is Dean Witter Reynolds Inc. (\"DWR\"). Both DWR and the General Partner are wholly-owned subsidiaries of Dean Witter, Discover & Co.\nThe General Partner is required to maintain a 1% minimum interest in the equity of each Partnership and income (losses) are shared by the General and Limited Partners based upon their proportional ownership interests.\nBASIS OF ACCOUNTING--The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts in the financial statements.\nREVENUE RECOGNITION--Commodity futures contracts and forward contracts on foreign currencies are open commitments until settlement date. They are valued at market and the resulting unrealized gains and losses are reflected in income. Monthly, DWR pays each Partnership interest income based upon 80% of its average daily Net Assets at a rate equal to the average yield on 13-Week U.S. Treasury Bills issued during such month. For purposes of such interest payments in Dean Witter Cornerstone Fund IV, Net Assets do not include monies due the Partnership on forward contracts and other commodity interests, but not actually received.\nNET INCOME (LOSS) PER UNIT--Net income (loss) per Unit is computed using the weighted average number of units outstanding during the period.\nEQUITY IN COMMODITY FUTURES TRADING ACCOUNTS-- The Partnerships' assets \"Equity in Commodity futures trading accounts\" consists of cash on deposit at DWR to be used as margin for trading and the net asset or liability related to unrealized gains or losses on open contracts. The asset or liability related to the unrealized gains or losses on forward contracts is presented as a net amount because each Partnership has a master netting agreement with DWR.\nDEAN WITTER CORNERSTONE FUNDS NOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nBROKERAGE COMMISSIONS AND RELATED TRANSACTION FEES AND COSTS--Brokerage commissions for each Partnership are accrued at 80% of DWR's published non- member rates on a half-turn basis.\nThrough March 31, 1995, brokerage commissions were capped at 1% per month of the adjusted Net Assets allocated to each trading program employed by a Trading Advisor. Effective April 1, 1995, the cap was reduced to 3\/4 of 1%.\nRelated transaction fees and costs are accrued on a half-turn basis.\nOPERATING EXPENSES--Each Partnership has entered into an exchange agreement pursuant to which certain common administrative expenses (i.e., legal, auditing, accounting, filing fees and other related expenses) are shared by each of the Partnerships based upon the number of Units of each Partnership outstanding during the month in which such expenses are incurred. In addition, the Partnerships incur monthly management fees and may incur incentive fees. The General Partner bears all other operating expenses.\nINCOME TAXES--No provision for income taxes has been made in the accompanying financial statements, as partners are individually responsible for reporting income or loss based upon their respective share of each Partnership's revenues and expenses for income tax purposes.\nDISTRIBUTIONS--Distributions, other than on redemptions of Units, are made on a pro-rata basis at the sole discretion of the General Partner. No distributions have been made to date.\nCONTINUING OFFERING--Through September 26, 1994, Units of each Partnership were offered at a price equal to 107.625% of the Net Asset Value per Unit as of the opening of business on the first day of the month, which price included a 5% selling commission and a 2.5% charge for expenses relating to the continuing offering of Units. These expenses were shared by the Partnerships. Any funds received by DWR as a result of the Continuing Offering Expense charges that were in excess of the Continuing Offering Expenses incurred, were contributed pro-rata to the Partnerships, as a contribution of capital to the Partnerships for which no Units were issued. On September 26, 1994, the Continuing Offering was discontinued.\nREDEMPTIONS--After an initial 180-day period, Limited Partners may redeem some or all of their Units at 100% of the Net Asset Value per Unit as of the last day of any month upon fifteen days advance notice by redemption form to the General Partner.\nDEAN WITTER CORNERSTONE FUNDS NOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nIf the proceeds of a redemption are reinvested in any of the Partnerships within 180 days, the General Partner will waive the selling commissions and continuous offering expense charges on the amount reinvested.\nEXCHANGES--On the last day of the first month, which occurs more than 180 days after a person first becomes a Limited Partner in any of the Partnerships, and the end of each month thereafter, Limited Partners may transfer their investment among the Partnerships (subject to certain restrictions outlined in the Limited Partnership Agreement) without paying additional charges.\nDISSOLUTION OF THE PARTNERSHIP--Each Partnership will terminate on September 30, 2025 regardless of its financial condition at such time, upon a decline in Net Assets to less than $250,000, a decline in the Net Asset Value per Unit to less than $250, or under certain other circumstances defined in the Limited Partnership Agreement.\n2. RELATED PARTY TRANSACTIONS\nEach Partnership pays brokerage commissions to DWR on trades executed on its behalf as described in Note 1. Each Partnership's cash is on deposit with DWR in commodity trading accounts to meet margin requirements as needed. DWR pays interest on these funds as described in Note 1.\n3. TRADING ADVISORS\nThe General Partner, on behalf of each Partnership, retains certain commodity trading advisors to make all trading decisions for the Partnerships. The trading advisors for each Partnership as of December 31, 1995 were as follows:\nDean Witter Cornerstone Fund II Abacus Asset Management Inc. John W. Henry & Co., Inc.\nDean Witter Cornerstone Fund III CCA Capital Management, Inc. Sunrise Capital Management\nDean Witter Cornerstone Fund IV John W. Henry & Co., Inc. Sunrise Capital Management\nEach trading advisor owns at least ten Units in its respective Partnership. Compensation to the trading\nDEAN WITTER CORNERSTONE FUNDS NOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nadvisors by the Partnerships consists of a management fee and an incentive fee as follows:\nMANAGEMENT FEE--The management fee is accrued at the rate of 1\/3 of 1% per month of the Net Assets under management by each trading advisor at each month end.\nINCENTIVE FEE--Each Partnership will pay an annual incentive fee equal to 15% of the \"New Appreciation\" in Net Assets as of the end of each annual incentive period ending December 31, except for Dean Witter Cornerstone Fund IV, which will pay incentive fees at the end of each annual incentive period ending May 31. Such incentive fee is accrued in each month in which \"New Appreciation\" occurs. In those months in which \"New Appreciation\" is negative, previous accruals, if any, during the incentive period will be reduced. In those instances in which a Limited Partner redeems an investment, the incentive fee (if earned through a redemption date) is to be paid on those redemptions to the trading advisor in the month of such redemption.\n4. FINANCIAL INSTRUMENTS\nThe Partnerships trade futures and forward contracts in interest rates, stock indices, commodities, currencies, petroleum and precious metals. Risk arises from changes in the value of these contracts and the potential inability of counterparties to perform under the terms of the contracts. There are numerous factors which may significantly influence the market value of these contracts, including interest rate volatility. At December 31, 1995 and 1994, open contracts were:\nDEAN WITTER CORNERSTONE FUNDS NOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nA portion of the amounts indicated as off-balance-sheet risk in forward foreign currency contracts is due to offsetting forward commitments to purchase and to sell the same currency on the same date in the future. These commitments are economically offsetting, but are not offset in the forward market until the settlement date.\nThe unrealized gains on open contracts are reported as a component of \"Equity in Commodity futures trading accounts\" on the Statements of Financial Condition and totaled at December 31, 1995 and 1994, respectively, $3,368,107 and $4,316,080 for Cornerstone II, $5,578,294 and $5,016,857 for Cornerstone III and $70,143 and $268,291 for Cornerstone IV.\nFor Cornerstone II, of the $3,368,107 net unrealized gain on open contracts at December 31, 1995, $3,448,812 related to exchange-traded futures contracts and ($80,705) related to off-exchange-traded forward currency contracts. Of the $4,316,080 net unrealized gain on open contracts at December 31, 1994, $4,296,011 related to exchange-traded futures contracts and $20,069 related to off-exchange-traded forward currency contracts.\nDEAN WITTER CORNERSTONE FUNDS NOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nFor Cornerstone III, net unrealized gain on open contracts at December 31, 1995 related entirely to exchange traded futures. Of the $5,016,857 net unrealized gain on open contracts at December 31, 1994, $5,788,691 related to exchange- traded futures contracts and ($771,834) related to off-exchange-traded forward currency contracts.\nFor Cornerstone IV, of the $70,143 net unrealized gain on open contracts at December 31, 1995, $534,487 related to exchange-traded futures contracts and $(464,344) related to off-exchange-traded forward currency contracts. The net unrealized gain on open contracts at December 31, 1994, related entirely to off-exchange-traded forward currency contracts.\nThe contract amounts in the above table represent the Partnership's extent of involvement in the particular class of financial instrument, but not the credit risk associated with counterparty nonperformance. The credit risk associated with these instruments is limited to the amounts reflected in the Partnerships' Statements of Financial Condition.\nExchange-traded contracts and off-exchange-traded forward currency contracts held by the Partnerships at December 1995 and 1994 mature as follows:\nThe Partnerships also have credit risk because the sole counterparty, with respect to most of the Partnerships' assets, is DWR. Exchange-traded futures contracts are marked to market on a daily basis, with variations in value settled on a daily basis. DWR, as the futures commission merchant of all of the Partnership's exchange-traded futures contracts, is required pursuant to regulations of the Commodity Futures Trading Commission to segregate from its own assets, and for the sole benefit of its commodity customers, all funds held by DWR with respect to exchange-traded futures contracts including an amount equal to the net\nDEAN WITTER CORNERSTONE FUNDS NOTES TO FINANCIAL STATEMENTS--(CONCLUDED)\nunrealized gain on all open futures contracts which funds totaled at December 31, 1995 and 1994 respectively, $31,506,001 and $31,866,995 for Cornerstone II, $47,872,659 and $48,673,471 for Cornerstone III, $105,462,448 and $111,508,180 for Cornerstone IV. With respect to the Partnership's off-exchange-traded forward currency contracts, there are no daily settlements of variations in value nor is there any requirement that an amount equal to the net unrealized gain on open forward contracts be segregated. With respect to those off- exchange-traded forward currency contracts, the Partnerships are at risk to the ability of DWR, the counterparty on all of such contracts, to perform.\nFor the year ended December 31, 1995 the average fair value of financial instruments held for trading purposes was as follows:\nDEAN WITTER REYNOLDS INC.\nTwo World Trade Center\n62nd Floor\nNew York, NY 10048 FIRST-CLASS MAIL ZIP + 4 PRESORT U.S. POSTAGE PAID BROOKLYN, NY PERMIT NO. 148","section_15":""}
{"filename":"899689_1995.txt","cik":"899689","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nThe Company is a fully-integrated real estate investment trust (\"REIT\") which owns, leases, develops, redevelops and manages retail and industrial properties primarily located in the Midatlantic and Northeast regions of the United States.\nThe Company's primary focus is on shopping centers. The Company's shopping centers are generally located on major regional highways in mature densely populated areas. The Company believes its shopping centers attract consumers from a regional, rather than a neighborhood, marketplace because of their location on regional highways and the high percentage of square feet dedicated to large stores. As of December 31, 1995, the Company owned 56 shopping centers in seven states containing 9.9 million square feet, including 1.2 million square feet built by tenants on land leased from the Company. The Company's shopping centers accounted for 92% and 91%, respectively, of the Company's rental revenue for the years ended December 31, 1995 and 1994. The occupancy rate of the Company's shopping center properties was 91% and 94% as of March 1, 1996 and 1995, respectively and has been over 90% in each of the past five years.\nFurther, the Company owns eight warehouse\/industrial properties in New Jersey containing 2.0 million square feet and one office building in New Jersey containing 100,000 square feet. In addition, the Company owns 29.3% of the common stock of Alexander's, Inc. (\"Alexander's\") which has nine properties in the greater New York metropolitan area.\nAs of December 31, 1995, approximately 80% of the square footage of the Company's shopping centers was leased to large stores (over 20,000 square feet) and over 93% was leased to tenants whose businesses are national or regional in scope. The Company's large tenants include destination retailers such as discount department stores, supermarkets, home improvements stores, discount apparel stores, membership warehouse clubs and \"category killers.\" Category killers are large stores which offer a complete selection of a category of items (e.g., toys, office supplies, etc.) at low prices, often in a warehouse format. The Company's large store tenants typically offer basic consumer necessities such as food, health and beauty aids, moderately priced clothing, building materials and home improvement supplies, and compete primarily on the basis of price. The Company believes that this tenant mix mitigates the effects on its properties of adverse changes in general economic conditions. Substantially all of the Company's large store leases are long-term with fixed base rents and provide for step-ups in rent typically occurring every five years.\nIn addition, the Company's leases generally provide for additional rents based on a percentage of tenants' sales. Of the Company's $80,429,000 of rental revenue in 1995, base rents accounted for approximately 98.8% and percentage rents accounted for approximately 1.2%. The Company's leases generally pass through to tenants the tenant's share of all common area charges (including roof and structure, unless it is the tenant's direct responsibility), real estate taxes and insurance costs and certain capital expenditures. As of December 31, 1995, the average annual base rent per square foot for the Company's shopping centers was $8.68.\nFrom 1991 through 1995, the Company's property rentals from shopping centers (including the effects of straight-lining of rents) was $54,700,000, $56,900,000, $61,900,000, $64,700,000 and $74,300,000 respectively. Straight-lining of rents averages the rent increases provided for in leases such that property rentals for financial statement purposes is constant throughout the term of the lease. This convention applies to leases entered into after November 14, 1985.\nITEM 1. BUSINESS - continued\nAs of December 31, 1995, no single shopping center property accounted for more than 6.3% of the Company's total leasable area for its shopping center properties or more than 5.2% of property rentals for its shopping center properties. Bradlees, Inc. (\"Bradlees\") accounted for 21%, 19% and 18% of total property rentals for each of the three years ended December 31, 1995, respectively. In June 1995, Bradlees filed for protection under Chapter 11 of the U.S. Bankruptcy Code (\"Chapter 11\"). The Company leases 21 locations to Bradlees of which 19 are fully guaranteed by Stop & Shop Companies, Inc. Further, Montgomery Ward & Co., Inc. remains liable on eight of such leases including the rent it was obligated to pay - approximately 70% of current rent. Home Depot represented 5% and Sam's Wholesale\/Wal*Mart, Shop Rite, Pathmark, T.J. Maxx\/Marshalls and Staples each accounted for approximately 3% of the total property rentals for the year ended December 31, 1995. Several of the Company's other tenants, whose rents aggregated less than 5% of the Company's total property rentals for the year ended December 31, 1995, have also filed for protection under Chapter 11.\nVornado, Inc., the immediate predecessor to the Company, was merged with the Company on May 6, 1993 in connection with the Company's conversion to a REIT.\nThe Company administers all operating functions, including leasing, management, construction, finance, legal, accounting and data processing, from its executive offices (other than the leasing of the Company's three Texas properties, which is done by an employee locally).\nThe Company's principal executive offices are located at Park 80 West, Plaza II, Saddle Brook, New Jersey 07663; telephone (201) 587-1000.\nRELATIONSHIP WITH ALEXANDER'S\nIn March 1995, the Company purchased all of the 1,353,468 shares of common stock of Alexander's then owned by Citibank, N.A. (\"Citibank\") representing 27.1% of the outstanding shares of common stock of Alexander's, for $40.50 per share in cash. As a result of the acquisition, the Company owns 29.3% of the common stock of Alexander's. In addition, the Company lent Alexander's $45,000,000 (see \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources\" at page 18).\nAlexander's has disclosed in its annual report on Form 10-K for the year ended December 31, 1995, that it has nine properties (where its department stores were formerly located) consisting of:\nOperating properties:\n(i) a recently redeveloped 359,000 square foot building, two-thirds of which is leased to Sears and Marshalls, on Queens Boulevard and 63rd Road in Rego Park, Queens, New York (\"Rego Park I\"), (ii) a 50% interest in the 427,000 square feet of mall stores at the Kings Plaza regional shopping center on Flatbush Avenue in Brooklyn, New York, (iii) a 303,000 square foot building leased to Caldor on Fordham Road in the Bronx, New York, (iv) a 177,000 square foot building subleased to Caldor at Roosevelt Avenue and Main Street in Flushing, New York and (v) a 173,000 square foot building leased to an affiliate of Conway located at Third Avenue and 152nd Street in the Bronx, New York, and\nNon-operating properties to be redeveloped:\n(i) the square block, including a 418,000 square foot building, bounded by Lexington Avenue and Third Avenue and 58th and 59th Streets in Manhattan, New York, in which Alexander's has the general partnership interest and a 92% limited partnership interest, (ii) 39.3 acres at the intersection of Routes 4 and 17 in Paramus, New Jersey, (iii) a 320,000 square foot anchor store which is one of the two anchor stores at the Kings Plaza regional shopping center and (iv) one and one-half blocks of vacant land adjacent to the Rego Park I location (\"Rego Park II\").\nITEM 1. BUSINESS - continued\nIn September 1995, Caldor filed for protection under Chapter 11. Caldor accounted for approximately 56% and 64% of Alexander's consolidated revenues for the years ended December 31, 1995 and 1994, respectively.\nThe Company manages, develops and leases the Alexander's properties under a management and development agreement (the \"Management Agreement\") and a leasing agreement (the \"Leasing Agreement\") pursuant to which the Company receives annual fees from Alexander's.\nAs of December 31, 1995, Interstate Properties owned 27.7% of the common shares of beneficial interest of the Company and 27.1% of Alexander's common stock. Interstate Properties is a general partnership in which Steven Roth, David Mandelbaum and Russell B. Wight, Jr. are partners. Mr. Roth is the Chairman of the Board and Chief Executive Officer of the Company, the Managing General Partner of Interstate Properties, and the Chief Executive Officer and a director of Alexander's. Messrs. Mandelbaum and Wight are trustees of the Company and are also directors of Alexander's. Effective March 2, 1995, for a three year period, the Company and Interstate Properties are restricted from owning in excess of two-thirds of Alexander's common stock or entering into certain other transactions with Alexander's, without the consent of the independent directors of Alexander's. Alexander's common stock is listed on the New York Stock Exchange under the symbol \"ALX\".\nCOMPETITION\nThe leasing of real estate is highly competitive. Demand for retail space has been impacted by the recent bankruptcy of a number of retail companies and a general trend toward consolidation in the retail industry which could adversely affect the ability of the Company to attract or retain tenants. The principal means of competition are price, location and the nature and condition of the facility to be leased. The Company directly competes with all lessors and developers of similar space in the areas in which its properties are located.\nENVIRONMENTAL REGULATIONS\nSee \"Note 10 - Contingencies\" to the Consolidated Financial Statements at page 37.\nEMPLOYEES\nThe Company employs 68 people.\nSEGMENT DATA\nThe company operates in one business segment - real estate. See \"Note 9 - Leases\" to the Consolidated Financial Statements at page 36 for information on significant tenants. Vornado engages in no foreign operations.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company leases 27,000 square feet in Saddle Brook, New Jersey for use as its executive offices.\nThe following table sets forth certain information as of December 31, 1995 relating to the properties owned by the Company.\n(1) Average annualized base rent per square foot does not include ground leases (which leases are included in percent leased) or rent for leases which had not commenced as of December 31, 1995.\n(2) The tenant at these locations has subleased or been assigned its space from Montgomery Ward & Co., Inc. which remains liable on such lease including the rent it was obligated to pay - approximately 70%.\n(3) These leases are guaranteed by the Stop & Shop Companies, Inc.\n(4) Ground and\/or building leasehold interest\n(5) The tenant has ceased operations at these locations but continues to pay rent.\n(6) Square footage excludes Albertson's which owns its land and building.\nINSURANCE\nThe Company carries comprehensive liability, fire, flood, extended coverage and rental loss insurance with respect to its properties with policy specifications and insured limits customarily carried for similar properties. Management of the Company believes that the Company's insurance coverage conforms to industry norms.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is from time to time involved in legal actions arising in the ordinary course of its business. In the opinion of management, after consultation with legal counsel, the outcome of such matters will not have a material effect on the Company's financial condition or results of operations.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matters were submitted to a vote of security holders during the fourth quarter of the year ended December 31, 1995.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe following is a list of the names, ages, principal occupations and positions with Vornado of the executive officers of Vornado and the positions held by such officers during the past five years. All executive officers of Vornado have terms of office which run until the next succeeding meeting of the Board of Trustees of Vornado following the Annual Meeting of Shareholders unless they are removed sooner by the Board.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\n- -------------------------------------------------------------------------------\nVornado's common shares are traded on the New York Stock Exchange.\nQuarterly price ranges of the common shares and dividends per share paid for the years ended December 31, 1995 and 1994 were as follows:\nThe approximate number of record holders of common shares of Vornado at December 31, 1995, was 2,000.\nPART II\nITEM 6.","section_6":"ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA\nITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA - (continued)\n(1) Funds from operations does not represent cash generated from operating activities in accordance with generally accepted accounting principles and is not necessarily indicative of cash available to fund cash needs. Funds from operations should not be considered as an alternative to net income as an indicator of the Company's operating performance or as an alternative to cash flows as a measure of liquidity.\n(2) Effective January 1, 1995, the Company changed its definition of funds from operations to exclude amortization of debt issuance costs and depreciation of personal property. Prior period amounts have been restated to conform to the current year's presentation. The Company's definition of funds from operations does not conform to the NAREIT definition because the Company deducts the effect of straight-lining of property rentals.\nAmounts included in revenues and expenses have been reclassified to conform with the current year's presentation.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\n- -------------------------------------------------------------------------------\nRESULTS OF OPERATIONS YEARS ENDED DECEMBER 31, 1995 AND DECEMBER 31, 1994\nThe Company's revenues, which consist of property rentals, tenant expense reimbursements and other income were $108,718,000 in 1995, compared to $93,998,000 in 1994, an increase of $14,720,000 or 15.7%.\nProperty rentals from shopping centers were $73,296,000 in 1995, compared to $63,778,000 in 1994, an increase of $9,518,000 or 14.9%. Of this increase, (i) $6,067,000 resulted from expansions of shopping centers and acquisitions of retail properties, (ii) $2,823,000 resulted from rental step-ups in existing tenant leases which are not subject to the straight-line method of revenue recognition and (iii) $628,000 resulted from property rentals received from new tenants exceeding property rentals lost from vacating tenants.\nProperty rentals from the remainder of the portfolio were $6,174,000 in 1995, compared to $6,090,000 in 1994, an increase of $84,000 or 1.4%. Percentage rent was $959,000 in 1995, compared to $887,000 in 1994.\nTenant expense reimbursements were $24,091,000 in 1995, compared to $21,784,000 in 1994, an increase of $2,307,000. This increase reflects a corresponding increase in operating expenses passed through to tenants.\nOther income was $4,198,000 in 1995, compared to $1,459,000 in 1994, an increase of $2,739,000. This increase resulted primarily from the fee income recognized in connection with the Management Agreement and Leasing Agreement with Alexander's (including $915,000 applicable to 1993 and 1994 recognized in the first quarter of 1995). No leasing fee income was recognized prior to 1995 because Alexander's had not repaid certain creditors, which was a condition precedent to the commencement of the payment of leasing fees owed by Alexander's to the Company. In addition to the Management Agreement fee income included in other income in 1995, $2,250,000 of such fees was earned in 1995 by Vornado Management Corp. (\"VMC\") and is included in the caption \"Income from investment in and advances to Vornado Management Corp.\" in the Consolidated Statements of Income.\nOperating expenses were $32,282,000 in 1995 as compared to $30,223,000 in 1994, an increase of $2,059,000. Of this increase (i) $1,484,000 resulted from real estate taxes from expansions and acquisitions, which were passed through to tenants, and (ii) $258,000 resulted from bad debt expenses primarily due to tenant bankruptcies.\nDepreciation and amortization expense increased in 1995, compared to 1994, primarily as a result of property expansions.\nGeneral and administrative expenses were $6,687,000 in 1995 as compared to $6,495,000 in 1994, an increase of $192,000. This increase is the net of increases from (i) payroll expenses of $1,017,000, (due to additions to staff and bonuses), and (ii) professional fees and other corporate office expenses of $305,000, offset by (iii) the reduction in expenses of $1,130,000 resulting from the assignment of the Company's Management Agreement with Alexander's to VMC in the third quarter of this year.\nIn March 1995, the Company purchased all of the 1,353,468 shares of common stock of Alexander's then owned by Citibank, representing 27.1% of the outstanding shares. As a result of the acquisition, the Company owns 29.3% of the common stock of Alexander's and has changed its accounting for its investment in Alexander's to the equity method. For the period from March 2, 1995 through December 31, 1995, Vornado's equity in Alexander's losses amounted to $1,972,000. In addition, during the same period the Company recognized interest income on its loan to Alexander's of $6,343,000 and fee income from its Management Agreement and Leasing Agreement with Alexander's of $2,973,000 (excluding $2,250,000 earned by VMC - see paragraph below). The Company believes that its share of Alexander's losses (which are non-cash) combined with its fee income and interest income will not have a negative effect on its results of operations, liquidity and financial condition.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)\n- -------------------------------------------------------------------------------\nOn July 6, 1995 the Company assigned its Management Agreement with Alexander's to VMC, a newly formed New Jersey corporation. In exchange, the Company received 100% of the non-voting preferred stock of VMC which entitles it to 95% of the distributions by VMC to its shareholders. In addition, the Company lent $5,000,000 to VMC for working capital purposes under a three year term loan bearing interest at the prime rate plus 2%. VMC is responsible for its pro-rata share of compensation (including bonuses) and fringe benefits of common employees and 30% of other common expenses. Income from investment in and advances to VMC consists of dividend income of $565,000 and interest income of $223,000.\nInvestment income (interest and dividend income and net gains\/(losses) on marketable securities) was $5,733,000 for 1995, compared to $8,132,000 in 1994, a decrease of $2,399,000 or 29.5%. This decrease was caused by (i) lower interest income resulting from the use of cash for the Alexander's investment and (ii) net gains on marketable securities being $349,000 less than in the prior year.\nInterest and debt expense was $16,426,000 in 1995 as compared to $14,209,000 in 1994, an increase of $2,217,000 or 15.6%. Of this increase, $1,046,000 resulted from borrowings under the revolving credit facility to temporarily fund the investment in Alexander's and $1,134,000 resulted from a decrease in interest capitalized during construction.\nThe Company operates in a manner intended to enable it to continue to qualify as a REIT under Sections 856-860 of the Internal Revenue Code of 1986 as amended (the \"Code\"). Under those sections, a REIT which distributes at least 95% of its REIT taxable income as a dividend to its shareholders each year and which meets certain other conditions will not be taxed on that portion of its taxable income which is distributed to its shareholders. The Company has distributed to its shareholders an amount greater than its taxable income. Therefore, no provision for Federal income taxes is required. In 1993, as a result of the Company's conversion to a REIT, the deferred tax balance of $6,369,000 at December 31, 1992 was reversed.\nRESULTS OF OPERATIONS YEARS ENDED DECEMBER 31, 1994 AND DECEMBER 31, 1993\nThe Company's revenues, which consist of property rentals, tenant expense reimbursements and other income were $93,998,000 in 1994, compared to $88,790,000 in 1993, an increase of $5,208,000 or 5.9%.\nProperty rentals from shopping centers were $63,778,000 in 1994, compared to $60,919,000 in 1993, an increase of $2,859,000 or 4.7%. This increase resulted from rental step-ups in leases which are not subject to the straight-line method of revenue recognition of $1,700,000 and $1,300,000 of rents from tenants at expansions of shopping centers. Property rentals from new tenants were approximately the same as property rentals lost from vacating tenants. Property rentals from the remainder of the portfolio were $6,090,000 in 1994 as compared to $5,340,000 in 1993, an increase of $750,000 or 14.0%. This increase resulted primarily from property rentals received from new tenants exceeding property rentals lost from vacating tenants. Percentage rent was $887,000 in 1994 as compared to $954,000 in 1993.\nTenant expense reimbursements were $21,784,000 in 1994, compared to $19,839,000 in 1993, an increase of $1,945,000. This increase reflects a corresponding increase in operating expenses passed through to tenants.\nOther income was greater in 1993 than in 1994 primarily as a result of reimbursements recognized under the Company's leasing agreement with Alexander's in 1993.\nOperating expenses were $30,223,000 in 1994 as compared to $27,994,000 in 1993, an increase of $2,229,000. This increase resulted primarily from an increase in real estate taxes, snow removal costs and other common area maintenance charges.\nDepreciation and amortization expense increased in 1994 primarily as a result of the completion of property expansions.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\n- -------------------------------------------------------------------------------\nGeneral and administrative expenses were $6,495,000 in 1994 as compared to $5,890,000 in 1993, an increase of $605,000. This increase resulted from higher professional fees and payroll.\nInvestment income was $8,132,000 in 1994 compared to $11,883,000 in 1993, a decrease of $3,751,000 or 31.6%. The change in investment income resulted primarily from a decrease in interest and dividend income of $4,131,000 as a result of lower average investments due to the use of approximately $100,000,000 to reduce debt in November 1993, partially offset by an increase in net gains on marketable securities.\nInterest and debt expense was $14,209,000 in 1994 as compared to $31,155,000 in 1993, a decrease of $16,946,000 or 54.3%. Of this decrease, (i) $14,586,000 resulted from the refinancing of a blanket mortgage loan (see Note 6), and (ii) $1,300,000 resulted from an increase in capitalized interest during construction.\nLIQUIDITY AND CAPITAL RESOURCES\nCASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nYear Ended December 31, 1995 Cash flows provided by operating activities of $62,882,000 was comprised of: (i) net income of $53,008,000 and (ii) adjustments for non-cash items of $11,305,000 less (iii) the net change in operating assets and liabilities of $1,431,000. The adjustments for non-cash items are primarily comprised of depreciation and amortization of $11,779,000, plus equity in loss of Alexander's of $2,389,000, offset by the effect of straight-lining of rental income of $2,569,000. Further, during this period in connection with the Alexander's transaction, \"Leasing fees and other receivables\" increased by $7,656,000 and \"Deferred leasing fee income\" correspondingly increased by $8,888,000. These amounts have been included in \"Changes in assets and liabilities: other\" in the Consolidated Statements of Cash Flows and are part of the net change in operating assets and liabilities shown in item (iii) above.\nNet cash used in investing activities of $103,891,000 was comprised of (i) the Company's investment in and advances to Alexander's of $100,482,000, (ii) capital expenditures of $16,644,000, (iii) a loan to VMC of $5,074,000 and (iv) purchases of securities available for sale of $4,027,000, offset by (v) the net proceeds from the sale of securities available for sale of $22,336,000.\nNet cash provided by financing activities of $36,577,000 was primarily comprised of (i) net proceeds from issuance of common shares of $79,831,000, and (ii) borrowings on U.S. Treasury obligations of $9,600,000, offset by (iii) dividends paid of $52,875,000.\nYear Ended December 31, 1994 Cash flows provided by operating activities of $46,948,000 was comprised of: (i) net income of $41,240,000, and (ii) adjustments for non-cash items of $8,015,000, less (iii) the net change in operating assets and liabilities of $2,307,000. The adjustments for non-cash items are primarily comprised of depreciation and amortization of $10,839,000, offset by the effect of straight-lining of rental income of $2,181,000.\nNet cash used in investing activities of $15,434,000 was comprised of capital expenditures of $25,417,000, offset by proceeds from the sale of securities available for sale of $9,983,000.\nNet cash used in financing activities of $32,074,000 was primarily comprised of dividends paid of $43,236,000, offset by borrowings on U.S. Treasury obligations of $11,428,000.\nYear Ended December 31, 1993 Cash flows provided by operating activities of $27,725,000 was primarily comprised of: (i) net income of $31,755,000, less (ii) adjustments for non-cash items of $599,000 and the net change in operating assets and liabilities of $2,831,000. The adjustments for non-cash items are primarily comprised of depreciation and amortization of $11,435,000, offset by (i) the effect of straight- lining of rental income of $2,200,000, (ii) the reversal of deferred income taxes of $6,369,000, and (iii) the loss on the early extinguishment of debt of $3,202,000.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)\n- -------------------------------------------------------------------------------\nNet cash provided by investing activities of $1,350,000 was comprised of net proceeds from the sale of securities available for sale of $28,336,000, offset by capital expenditures of $26,986,000.\nNet cash used in financing activities of $56,433,000 was primarily comprised of (i) debt repayments of $333,664,000, net of proceeds from borrowings of $227,000,000, less $5,247,000 of deferred debt expenses incurred therewith, (ii) dividends paid to shareholders of $84,482,000 (including a special dividend of $54,022,000 of accumulated earnings and profits, as determined for federal income tax purposes), and (iii) repayment of borrowings on U.S. Treasury obligations of $30,048,000, offset by (iv) net proceeds from issuance of common shares of $172,051,000.\nFUNDS FROM OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1995 AND 1994\nManagement considers funds from operations an appropriate supplemental measure of the Company's operating performance. Funds from operations were $62,409,000 in 1995, compared to $48,200,000 in 1994, an increase of $14,209,000 or 29.5%. The following table reconciles funds from operations and net income:\n* Effective January 1, 1995, the Company changed its definition of funds from operations to exclude amortization of debt issuance costs and depreciation of personal property. Prior period amounts have been restated to conform to the current year's presentation. The Company's definition of funds from operations does not conform to the NAREIT definition because the Company deducts the effect of the straight-lining of property rentals.\nFunds from operations does not represent cash generated from operating activities in accordance with generally accepted accounting principles and is not necessarily indicative of cash available to fund cash needs. Funds from operations should not be considered as an alternative to net income as an indicator of the Company's operating performance or as an alternative to cash flows as a measure of liquidity. Below are the cash flows provided by (used in) operating, investing and financing activities:\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)\n- -------------------------------------------------------------------------------\nOn June 23, 1995, Bradlees, which accounted for 21% of property rentals for the year ended December 31, 1995, filed for protection under Chapter 11. The Company leases 21 locations to Bradlees of which 19 are fully guaranteed by Stop & Shop Companies, Inc. Furthermore, Montgomery Ward & Co., Inc., remains liable on eight of such leases including the rent it was obligated to pay approximately 70% of current rent. Bradlees has not affirmed any of these leases.\nThe major items of capital expenditures for 1995 were $8,200,000 for expansions of four shopping centers and $4,600,000 for improvements at five shopping centers. The Company has budgeted approximately $3,000,000 for investment over the next year. In addition, the Company will continue its program of upgrading its shopping centers by refurbishing its parking lots (including resurfacing, new lighting, updated landscaping, islands and curbing) and re-roofing of buildings, the cost of which will be substantially reimbursed by tenants in accordance with existing lease terms.\nIn March 1995, the Company purchased all of the 1,353,468 shares of common stock of Alexander's then owned by Citibank, representing 27.1% of the outstanding shares of common stock of Alexander's, for $40.50 per share in cash or $56,615,000 (including $1,800,000 of costs incurred in the purchase). As a result of the acquisition, the Company owns 29.3% of the common stock of Alexander's.\nOn March 15, 1995, the Company lent Alexander's $45 million, the subordinated tranche of a $75 million secured financing, the balance of which was funded by a bank. The Company's loan has a three-year term and bears interest at 16.43% per annum for the first two years and at a fixed rate for the third year of 992 basis points over the one-year Treasury bill rate. In addition, the Company received a loan origination fee of $1,500,000 from Alexander's.\nAlexander's has disclosed in its annual report on Form 10-K for the year ended December 31, 1995, that its current operating properties (five of its nine properties) do not generate sufficient cash flow to pay all of its expenses, and that its four non-operating properties (Lexington Avenue, Paramus, the Kings Plaza Store and Rego Park II) are in various stages of redevelopment, and as rents commence from a portion of the redevelopment properties, it expects that cash flow will become positive.\nIn addition to the disclosures above, Alexander's estimates that the fair market values of its assets are substantially in excess of their historical cost and that there is additional borrowing capacity. Alexander's continues to evaluate its needs for capital, which may be raised through (a) property specific or corporate borrowing, (b) the sale of securities and (c) asset sales. Further, Alexander's may receive the proceeds from tax certiorari and\/or condemnation proceedings. Although there can be no assurance, Alexander's believes that these cash sources will be adequate to fund cash requirements until its operations generate adequate cash flow.\nOn February 27, 1995, the Company entered into a three-year unsecured revolving credit facility with a bank providing for borrowings of up to $75,000,000. Borrowings bear annual interest, at the Company's election, at LIBOR plus 1.50% or the higher of the federal funds rate plus 1% or prime rate plus .50%. At December 31, 1995 the Company had no borrowings outstanding under the facility.\nOn May 3, 1995, the Company completed the sale of 2,500,000 common shares in a public offering at $34.00 per share, which net of expenses yielded approximately $80,000,000 of which $60,000,000, was used to repay indebtedness incurred under a revolving credit facility in connection with the Alexander's investment. On December 26, 1995, a shelf registration statement relating to $500,000,000 of securities became effective.\nThe Company anticipates that cash from continuing operations, net liquid assets, borrowings under its revolving credit facility and\/or proceeds from the issuance of securities under the Company's shelf registration statement will be adequate to fund its business operations, capital expenditures, continuing debt obligations and the payment of dividends.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)\n- -------------------------------------------------------------------------------\nECONOMIC CONDITIONS\nAt December 31, 1995, approximately 80% of the square footage of the Company's shopping centers was leased to large stores (over 20,000 square feet). The Company's large store tenants typically offer basic consumer necessities such as food, health and beauty aids, moderately priced clothing, building materials and home improvement supplies, and compete primarily on the basis of price. The Company believes that this tenant mix mitigates the effects on its properties of adverse changes in general economic conditions. However, demand for retail space has been impacted by the recent bankruptcy of a number of retail companies (see page 18) and a general trend toward consolidation in the retail industry which could adversely affect the ability of the Company to attract or retain tenants.\nSubstantially all of the Company's leases contain step-ups in rent. Such rental increases are not designed to, and in many instances do not, approximate the cost of inflation, but do have the effect of mitigating the adverse impact of inflation. In addition, substantially all of the Company's leases contain provisions that require the tenant to reimburse the Company for the tenant's share of common area charges (including roof and structure, unless it is the tenant's direct responsibility) and real estate taxes thus passing through to the tenants the effects of inflation on such expenses.\nInflation did not have a material effect on the Company's results for the periods presented.\nRECENTLY ISSUED ACCOUNTING STANDARDS\nIn October 1995, the Financial Accounting Standards Board adopted Statement No. 123, \"Accounting for Stock-Based Compensation\". The statement is effective for fiscal years beginning after December 15, 1995. Pursuant to the new standard, companies are required to adopt the fair value method of accounting for employee stock-based transactions. The new standard requires expanded disclosures of stock-based compensation arrangements with employees and encourages, but does not require, application of the \"fair value\" recognition provisions in the new statement. Beginning with the first quarter of 1996, the Company will disclose in a note to the financial statements pro forma net income and earnings per share based on the new method of accounting.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH INDEPENDENT AUDITORS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable.\nINDEPENDENT AUDITORS' REPORT\nShareholders and Board of Trustees Vornado Realty Trust Saddle Brook, New Jersey\nWe have audited the accompanying consolidated balance sheets of Vornado Realty Trust and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of income, shareholders' equity (deficit) and cash flows for each of the three years in the period ended December 31, 1995. 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 Vornado Realty Trust and subsidiaries at December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nDELOITTE & TOUCHE LLP Parsippany, New Jersey March 7, 1996\nCONSOLIDATED BALANCE SHEETS\nCONSOLIDATED BALANCE SHEETS (CONTINUED)\nSee notes to consolidated financial statements.\nCONSOLIDATED STATEMENTS OF INCOME\nSee notes to consolidated financial statements.\nCONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY\n* Includes $3,435 in unrealized gains attributable to the Company's investment in the common stock of Alexander's, Inc. (see Note 3).\nSee notes to consolidated financial statements.\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nCONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)\nNON-CASH TRANSACTIONS:\nDuring the year ended December 31, 1995, the unrealized gain on securities available for sale included in shareholders' equity was adjusted to reflect (i) a reduction of $3,435 to the Company's investment in Alexander's as a result of the change from fair value to the equity method of accounting and (ii) a net decrease of $263 in the market value of other securities available to sale.\nDuring 1994, a credit to shareholders' equity of $2,336 was recorded to reflect an unrealized gain on securities available for sale.\nIn May 1993, 5,007,024 shares of common stock held in treasury were retired. The retirement of the shares was recorded by reducing the common stock account ($200), additional capital ($53,917) and retained earnings ($128,933).\n- ------------------------------------------------------------------------------- See notes to consolidated financial statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------\n1. ORGANIZATION AND BUSINESS\nOn May 6, 1993, Vornado, Inc. merged into Vornado Realty Trust, a Maryland real estate investment trust (\"REIT\"). Vornado Realty Trust was formed on March 29, 1993, as a wholly-owned subsidiary of Vornado, Inc., specifically for the purpose of the merger.\nThe Company is a fully-integrated REIT which owns, leases, develops, redevelops and manages retail and industrial properties primarily located in the Midatlantic and Northeast regions of the United States. In addition, the Company owns 29.3% of the common stock of Alexander's, Inc. which has nine properties in the greater New York metropolitan area.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBASIS OF PRESENTATION: The accompanying consolidated financial statements include the accounts of Vornado Realty Trust and its subsidiaries, all of which are wholly-owned. All significant intercompany balances and transactions have been eliminated.\nThe consolidated financial statements are prepared in conformity with generally accepted accounting principles. Management has made estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.\nThe financial statements for the applicable periods present the fleece apparel wholesaling business as a discontinued operation.\nREAL ESTATE: Real estate is carried at cost, net of accumulated depreciation and amortization. Betterments, major renewals and certain costs directly related to the acquisition, improvement and leasing of real estate are capitalized. Maintenance and repairs are charged to operations as incurred. Depreciation is provided on a straight-line basis over the assets estimated useful lives. Additions to real estate include interest expense capitalized during construction of $442,000 and $1,582,000 for the years ended December 31, 1995 and 1994.\nThe Company's policy is to assess any impairment in value by making a comparison of the current and projected operating cash flows of each of its properties into the foreseeable future on an undiscounted basis, to the carrying amount of such property. Such carrying amount would be adjusted, if necessary, to reflect an impairment in the value of the asset. This is in accordance with Financial Accounting Standards Board Statement No. 121 -\nAccounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of (SFAS No. 121).\nCASH AND CASH EQUIVALENTS: Cash and cash equivalents consist of highly liquid investments purchased with original maturities of three months or less.\nMARKETABLE SECURITIES: Marketable securities are carried at fair market value. The Company has classified debt and equity securities which it intends to hold for an indefinite period of time as securities available for sale and equity securities it intends to buy and sell on a short term basis as trading securities. Unrealized gains and losses are included in earnings for trading securities and as a component of shareholder's equity for securities available for sale. Realized gains or losses on the sale of securities are recorded based on average cost.\nREVENUE RECOGNITION: Base rents, additional rents based on tenants' sales volume and reimbursement of the tenants' share of certain operating expenses are generally recognized when due from tenants. The straight-line basis is used to recognize base rents under leases entered into after November 14, 1985 which provide for varying rents over the lease terms.\nINCOME TAXES: The Company operates in a manner intended to enable it to continue to qualify as a REIT under Sections 856-860 of the Internal Revenue Code of 1986 as amended. Under those sections, a REIT which distributes at least 95% of its REIT taxable income as a dividend to its shareholders each year and which meets certain other conditions will not be taxed on that portion of its taxable income which is distributed to its shareholders. The Company has distributed to\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) - -------------------------------------------------------------------------------\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED\nshareholders an amount greater than its taxable income. Therefore, no provision for Federal income taxes is required. As a result of the Company's conversion to a REIT in 1993, the deferred tax balance at December 31, 1992 was reversed in 1993. The basis in the Company's assets and liabilities for both financial reporting purposes and tax purposes is approximately the same.\nAMOUNTS PER SHARE: Amounts per share are computed based upon the weighted average number of shares outstanding during the year and the dilutive effect of stock options.\n3. INVESTMENT IN AND ADVANCES TO ALEXANDER'S\nIn March 1995, the Company purchased all of the 1,353,468 shares of common stock of Alexander's then owned by Citibank, N.A. (\"Citibank\") representing 27.1% of the outstanding shares of common stock of Alexander's for $40.50 per share in cash or $56,615,000 (including $1,800,000 of costs incurred in the purchase). At December 31, 1994, the Company owned 113,100 shares of Alexander's common stock. The investment was carried at market value of $5,980,000 at December 31, 1994 (cost was $2,545,000). As a result of the acquisition, the Company owns 29.3% of the common stock of Alexander's and has changed its accounting for its investment in Alexander's to the equity method. This required a reduction of its investment by the unrealized gain recorded in shareholders' equity at December 31, 1994, of $3,435,000. Prior years' financial statements were not restated as a result of the change in accounting for the Company's investment in Alexander's due to it not being material. In accordance with purchase accounting, Vornado's investment in Alexander's in excess of carrying amounts has been allocated two-thirds to land and one-third to building. The building allocation in excess of Alexander's carrying amount is being depreciated over a 35 year period.\nAlso, in March 1995, the Company lent Alexander's $45 million, the subordinated tranche of a $75 million secured financing, the balance of which was funded by a bank. The Company's loan has a three-year term and bears interest at 16.43% per annum for the first two years and at a fixed rate for the third year of 992 basis points over the one-year Treasury bill rate. In addition, the Company received a loan origination fee of $1,500,000 from Alexander's to be amortized over the term of the loan.\nInvestment in and advances to Alexander's consists of:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) - -------------------------------------------------------------------------------- 3. INVESTMENT IN AND ADVANCES TO ALEXANDER'S - CONTINUED Below is a summarized Balance Sheet as at December 31, 1995 and Statement of Operations of Alexander's for the period from March 2, 1995 to December 31, 1995:\nThe unaudited proforma information set forth below presents the condensed statement of income for Vornado for the years ended December 31, 1995 and 1994, as if on January 1, 1994, the investment in Alexander's and related agreements were consummated and 1,880,000 common shares of beneficial interest of Vornado were issued to partially fund the investment.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) - --------------------------------------------------------------------------------\n3. INVESTMENT IN AND ADVANCES TO ALEXANDER'S - CONTINUED\nIn March 1995, the Company and Alexander's entered into a three-year management and development agreement (the \"Management Agreement\"). The annual management fee payable to the Company by Alexander's is $3,000,000, plus 6% of development costs with a minimum guaranteed fee for the development portion of $1,650,000 in the first year and $750,000 in each of the second and third years. On July 6, 1995, the Company assigned this Management Agreement to Vornado Management Corp. Management fees subsequent to July 6, 1995 of $2,250,000 were received by Vornado Management Corp. (see Note 12).\nThe fee pursuant to the Management Agreement is in addition to the leasing fee the Company receives from Alexander's under the leasing agreement (the \"Leasing Agreement\") which has been in effect since 1992 and has been extended to be coterminous with the term of the Management Agreement. The Company recognized $1,448,000 of leasing fee income in 1995. The Leasing Agreement provides for the Company to generally receive a fee of (i) 3% of sales proceeds and (ii) 3% of lease rent for the first ten years of a lease term, 2% of lease rent for the eleventh through the twentieth years of a lease term and 1% of lease rent for the twenty-first through thirtieth year of a lease term. Subject to the payment of rents by Alexander's tenants, the Company is due $7,868,000 at December 31, 1995. Such amount is receivable annually in an amount not to exceed $2,500,000 until the present value of such installments (calculated at a discount rate of 9% per annum) equals the amount that would have been paid had it been paid on September 21, 1993, or at the time the transactions which gave rise to the commissions occurred, if later. Two leases which the Company had previously negotiated on behalf of Alexander's for its Paramus property terminated in the second quarter of 1995 because governmental approvals to begin construction on a timely basis could not be obtained as a result of a pending condemnation, resulting in $2,424,000 of previously recorded leasing fees receivable and a corresponding credit (deferred leasing fee income) being reversed.\nAs of December 31, 1995, Interstate Properties owned 27.7% of the common shares of the Company and 27.1% of Alexander's common stock. Steven Roth is the Chairman of the Board and Chief Executive Officer of the Company, the managing general partner of Interstate Properties and the Chief Executive Officer, and a director of Alexander's. Effective March 2, 1995, for a three-year period, the Company and Interstate agreed not to own in excess of two-thirds of Alexander's common stock or to enter into certain other transactions with Alexander's, other than the transactions described above, without the consent of Alexander's independent directors.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) - --------------------------------------------------------------------------------\n4. MARKETABLE SECURITIES\nThe aggregate cost and market value of securities held at December 31, 1995 and 1994 were as follows:\nGross unrealized gains and losses at December 31, 1995 and 1994 were as follows:\nOf the U.S. treasury obligations at December 31, 1995, $40,604,000 (market value $40,781,000) matured in the first quarter of 1996, $4,993,000 (market value $5,064,000) matures in the fourth quarter of 1996 and $10,468,000 (market value $10,776,000) matures in the fourth quarter of 1997.\nU.S. treasury obligations with a fair market value of $56,621,000 and $35,205,000 were held as collateral for amounts due for U.S. treasury obligations at December 31, 1995 and 1994. Amounts due for U.S. treasury obligations bear variable interest rates which averaged 6.08% and 4.36% for the years ended December 31, 1995 and 1994.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) - --------------------------------------------------------------------------------\n5. FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe estimated fair value of cash and cash equivalents, due from officer, accounts receivable, amounts due for U.S. Treasury obligations, accounts payable, and accrued expenses are reflected in the balance sheet. The fair value of marketable securities is based on quoted market prices. At December 31, 1995 and 1994, the fair value of marketable securities was $70,997,000 and $87,206,000 compared to carrying value of $72,251,000 and $88,297,000 at their respective dates. The fair value of the loan receivable from Alexander's and the notes and mortgages payable have been estimated by discounting cash flows at the current rate at which similar loans would be made to borrowers with similar credit ratings for the remaining term. At December 31, 1995, the fair value of the loan receivable was estimated at $46,100,000 compared to a carrying value of $45,000,000. At December 31, 1995 and 1994, the fair value of notes and mortgages payable was estimated to be $233,900,000 and $205,496,000, compared to carrying value of $233,353,000 and $234,160,000 at their respective dates. The fair value estimates presented herein are based on pertinent information available to management as of December 31, 1995 and 1994.\n6. NOTES AND MORTGAGES PAYABLE\nIn November 1993, a private placement of $227,000,000 aggregate principal amount of secured notes due December 1, 2000 was completed by Vornado Finance Corp., a wholly-owned, special-purpose subsidiary of the Company. The 7-year notes bear a fixed rate of interest of 6.36% per annum. The net proceeds from the offering, together with working capital of Vornado Realty Trust, were used to prepay $327,132,000 of debt, including $313,539,000 under a blanket mortgage loan which bore interest at a rate of 9.36% per annum and was scheduled to mature in January 1994. As a result of the early extinguishment of debt, a fourth quarter extraordinary charge of $3,202,000, which primarily represented prepayment penalties, was recorded in 1993.\nNotes and mortgages are summarized by range of interest rates as follows:\nThe net carrying value of property securing the notes and mortgages amounted to $172,306,000 at December 31, 1995. As at December 31, 1995, the maturities for the next five years are as follows:\nOn February 27, 1995, the Company entered into a three-year unsecured revolving credit facility with a bank providing for borrowings of up to $75,000,000. Borrowings bear annual interest, at the Company's election, at LIBOR plus 1.50% or the higher of the federal funds rate plus 1% or prime rate plus .50%. At December 31, 1995 the Company had no borrowings outstanding under the facility.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) - --------------------------------------------------------------------------------\n7. EMPLOYEES' SHARE OPTION PLAN\nVarious officers and key employees have been granted incentive share options and\/or nonqualified options to purchase common shares. Options granted are at prices equal to 100% of the market price of the Company's shares at date of grant, become exercisable up to 27 months after grant, and expire ten years after the date of grant.\nThe changes in number of shares under option for the three years ended December 31, 1995 were as follows:\n* Option prices and number of shares have been adjusted, as applicable, to reflect the impact of a $3.36 special dividend paid in June 1993, in accordance with the terms of the Plan.\n- -------------------------------------------------------------------------------- Shares available for future grant at December 31, 1995 were 1,252,816. - --------------------------------------------------------------------------------\nIn October 1995, the Financial Accounting Standards Board adopted Statement No. 123, \"Accounting for Stock-Based Compensation\". The statement is effective for fiscal years beginning after December 15, 1995. Pursuant to the new standard, companies are required to adopt the fair value method of accounting for employee stock-based transactions. The new standard requires expanded disclosures of stock-based compensation arrangements with employees and encourages, but does not require, application of the \"fair value\" recognition provisions in the new statement. Beginning with the first quarter of 1996, the Company will disclose in a note to the financial statements pro forma net income and earnings per share based on the new method of accounting.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) - --------------------------------------------------------------------------------\n8. RETIREMENT PLAN\nThe Company's qualified retirement plan covers all full-time employees. The Plan provides annual pension benefits that are equal to 1% of the employee's annual compensation for each year of participation.\nThe funding policy is in accordance with the minimum funding requirements of ERISA.\nPension expense includes the following components:\nThe following table sets forth the Plan's funded status and the amount recognized in the Company's balance sheet:\nPlan assets are invested in U.S. government obligations and securities backed by U.S. government guaranteed mortgages.\n- --------------------------------------------------------------------------------\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) - --------------------------------------------------------------------------------\n9. LEASES\nAs lessor:\nThe Company leases properties to tenants. The lease terms range from less than five years for smaller tenant spaces to as much as thirty years for major tenants. Most of the leases provide for the payment of fixed base rentals payable monthly in advance, and for the payment by the lessee of additional rents based on a percentage of the tenants' sales as well as reimbursements of real estate taxes, insurance and maintenance. As of December 31, 1995, future base rental revenue under noncancellable operating leases, excluding rents for leases with an original term of less than one year and rents resulting from the exercise of renewal options, is as follows:\nThese amounts do not include rentals based on tenants' sales. These percentage rents approximated $959,000, $887,000 and $954,000 for the years ended December 31, 1995, 1994 and 1993. Bradlees, Inc. accounted for 21%, 19% and 18% of total property rentals for each of the three years ended December 31, 1995, respectively. In June 1995, Bradlees filed for protection under Chapter 11 of the U.S. Bankruptcy Code. The Company leases 21 locations to Bradlees of which 19 are fully guaranteed by Stop & Shop Companies, Inc. Further, Montgomery Ward & Co., Inc. remains liable on eight of such leases including the rent it was obligated to pay - approximately 70% of current rent. Bradlees has not affirmed any of these leases.\nAs lessee:\nThe Company is a tenant under leases for certain properties. These leases will expire principally during the next twenty years. Future minimum lease payments under operating leases at December 31, 1995, are as follows:\nRent expense was $1,395,000, $1,313,000, and $1,366,000 for the years ended December 31, 1995, 1994 and 1993.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) - --------------------------------------------------------------------------------\n10. CONTINGENCIES\nIn order to comply with environmental laws and with relevant health-based standards, the Company has an active monitoring and maintenance program for asbestos-containing materials (\"ACMs\") on its properties. The Company's program to remove friable ACMs has been completed, except for one location. Pursuant to the lease for this location, it is the tenant's responsibility to remove such ACMs. The Company has received an estimate of $500,000 to remove such ACMs; if the Company has to make such expenditure, it will not have a material adverse effect on the Company's financial condition or results of operations.\nThe Company also has certain other existing and potential environmental liabilities with respect to compliance costs relating to underground storage tanks and cleanup costs relating to tanks at three Company sites at which preexisting contamination was found.\nThe Company believes that known and potential environmental liabilities will not have a material adverse effect on the Company's business, assets or results of operation. However, there can be no assurance that the identification of new areas of contamination, change in the extent or known scope of contamination, the discovery of additional sites, or changes in cleanup requirements would not result in significant costs to the Company.\nAt December 31, 1995, the Company had outstanding $900,000 of real estate related standby letters of credit which were drawn under a $5,000,000 unsecured line of credit with a bank bearing interest at prime.\nFrom time-to-time, the Company has disposed of substantial amounts of real estate to third parties for which, as to certain properties, it remains contingently liable for rent payments or mortgage indebtedness.\nThere are various legal actions against the Company in the ordinary course of business. In the opinion of management, after consultation with legal counsel, the outcome of such matters will not have a material effect on the Company's financial condition or results of operations.\n11. REPURCHASE AGREEMENTS\nThe Company enters into agreements for the purchase and resale of U.S. government obligations for periods of up to one week. The obligations purchased under these agreements are held in safekeeping in the name of the Company by various money center banks. The Company has the right to demand additional collateral or return of these invested funds at any time the collateral value is less than 102% of the invested funds plus any accrued earnings thereon.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) - --------------------------------------------------------------------------------\n12. VORNADO MANAGEMENT CORP.\nOn July 6, 1995, the Company assigned its Management Agreement with Alexander's (see Note 3) to Vornado Management Corp. (\"VMC\"), a newly formed New Jersey corporation. In exchange, the Company received 100% of the non-voting preferred stock of VMC which entitles it to 95% of the distributions by VMC to its shareholders. Steven Roth and Richard West, Trustees of the Company, own the common stock of VMC. In addition, the Company lent $5,000,000 to VMC for working capital purposes under a three year term loan bearing interest at the prime rate plus 2%. VMC is responsible for its pro-rata share of compensation and fringe benefits of common employees and 30% of other common expenses. This entity is not consolidated and the Company accounts for its investment in VMC on the equity method. Below is a summarized Statement of Operations of VMC for the period from July 6, 1995 to December 31, 1995:\n13. OTHER RELATED PARTY TRANSACTIONS\nAt December 31, 1995, the loans due from Mr. Roth ($13,122,500) Mr. Rowan ($253,000) and Mr. Macnow ($227,000) in connection with their stock option exercises aggregated $13,602,500 ($5,185,000 of which is shown as a reduction in shareholders' equity). The loans bear interest at a rate equal to the broker call rate (7.50% at December 31, 1995) but not less than the minimum applicable federal rate provided under the Internal Revenue Code. Interest on the loan to Mr. Roth is payable quarterly. Mr. Roth's loan is due on December 29, 1997. The loans to Messrs. Rowan and Macnow are due March 31, 1996.\nThe Company currently manages and leases the six shopping centers of Interstate Properties pursuant to a Management Agreement for which the Company receives a quarterly fee equal to 4% of base rent and percentage rent and certain other commissions. The Management Agreement has a term of one year and is automatically renewable unless terminated by either of the parties on sixty days' notice at the end of the term. Although the Management Agreement was not negotiated at arms length, the Company believes based upon comparable fees charged by other real estate companies, that its terms are fair to the Company. For the years ended December 31, 1995, 1994 and 1993, $1,150,000, $894,000 and $913,000 of management fees were earned by the Company pursuant to the Management Agreement.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) - --------------------------------------------------------------------------------\n14. SUMMARY OF QUARTERLY RESULTS (UNAUDITED)\nThe following summary represents the results of operations for each quarter in 1995 and 1994:\n* The total for the year ended December 31, 1994 differs from the sum of the quarters as a result of the weighting of the average number of shares outstanding and the dilutive effect of stock options.\n15. DIVIDEND DISTRIBUTIONS\nDividends are characterized for Federal income tax purposes as follows:\n* For shareholders who received all dividends distributed during 1993.\n16. SUBSEQUENT EVENT\nOn January 11, 1996, the Company provided $17 million of debtor-in-possession financing to Rickel Home Centers, Inc. (\"Rickel\"), which is operating under Chapter 11 of the Bankruptcy Code. The loan is secured by 29 of Rickel's leasehold properties and has a term of one year plus two annual extensions, but is due not later than the date on which Rickel's plan of reorganization is confirmed. The loan earns interest at 13% per annum for the first year and at a fixed rate of LIBOR plus 7.50% for the extension periods. In addition, the Company received a loan origination fee of 2% or $340,000 and will receive an additional fee of 2% of the outstanding principal amount on each extension.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nInformation relating to trustees of the Registrant will be contained in a definitive Proxy Statement involving the election of trustees which the Registrant will file with the Securities and Exchange Commission pursuant to Regulation 14A under the Securities Exchange Act of 1934 not later than 120 days after December 31, 1995, and such information is incorporated herein by reference. Information relating to Executive Officers of the Registrant appears at page 10 of this Annual Report on Form 10-K.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation relating to executive compensation will be contained in the Proxy Statement referred to above in Item 10, \"Directors and Executive Officers of the Registrant\", and such information 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 will be contained in the Proxy Statement referred to in Item 10, \"Directors and Executive Officers of the Registrant\", and such information is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation relating to certain relationships and related transactions will be contained in the Proxy Statement referred to in Item 10, \"Directors and Executive Officers of the Registrant\", and such information is incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) The following documents are filed as part of this report:\n1. The consolidated financial statements are set forth in Item 8 of this Annual Report on Form 10-K.\n2. Financial Statement Schedules.\nThe following financial statement schedules should be read in conjunction with the financial statements included in Item 8 of this Annual Report on Form 10-K.\nSchedules other than those listed above are omitted because they are not applicable or the information required is included in the consolidated financial statements or the notes thereto.\nThe consolidated financial statements of Alexander's, Inc. for the year ended December 31, 1995 are hereby incorporated by reference to Item 14(a)1 of the Annual Report on Form 10-K of Alexander's, Inc.\n3. Exhibits. See the Exhibit Index at page 48 of this Annual Report on Form 10-K. The following exhibits listed on the Exhibit Index are filed with 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.\nVORNADO REALTY TRUST\nBy: s\/JOSEPH MACNOW ------------------------------ Joseph Macnow, Vice President, Chief Financial Officer\nDate: March 25, 1996 ----------------------------\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:\nVORNADO REALTY TRUST\nAND SUBSIDIARIES\nSCHEDULE II\nVALUATION AND QUALIFYING ACCOUNTS\nVORNADO REALTY TRUST AND SUBSIDIARIES SCHEDULE III REAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1995 (amounts in thousands)\n----- CONTINUED -----\nVORNADO REALTY TRUST AND SUBSIDIARIES SCHEDULE III REAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1995 (amounts in thousands)\n--- CONTINUED ---\nVORNADO REALTY TRUST AND SUBSIDIARIES SCHEDULE III REAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1995 (amounts in thousands)\n* These encumbrances are cross collateralized under a blanket mortgage in the amount of $227,000,000 at December 31, 1995.\nNotes:\n1) Initial cost is cost as of January 30, 1982 (the date on which Vornado commenced real estate operations) unless acquired subsequent to that date - see Column H.\n2) Aggregate cost is approximately the same for federal income tax purposes.\n3) Date of original construction - many properties have had substantial renovation or additional construction - see Column D.\n4) Buildings on these properties were demolished in 1993. As a result, the cost of the buildings and improvements, net of accumulated depreciation, were transferred to land. In addition, the cost of the land in Kearny is net of a $1,615,000 insurance recovery.\nVORNADO REALTY TRUST AND SUBSIDIARIES SCHEDULE III REAL ESTATE AND ACCUMULATED DEPRECIATION (amounts in thousands)\nThe following is a reconciliation of real estate assets and accumulated depreciation:\nEXHIBIT INDEX\n- -------------------- * Incorporated by reference ** Management contract or compensatory plan\n- -------------------- * Incorporated by reference ** Management contract or compensatory plan\n- -------------------- * Incorporated by reference","section_15":""}
{"filename":"716314_1995.txt","cik":"716314","year":"1995","section_1":"Item 1. Business\n(a) General Development of Business\nRegistrant was organized in 1983 as a Delaware holding company and is the successor to Graham Manufacturing Co., Inc., now a wholly owned subsidiary of the Registrant. Graham Manufacturing Co., Inc. was organized in 1936 under the laws of the State of New York. The Registrant manages the activities of various subsidiaries that are located in the United States and the United Kingdom. It employs 11 people, which includes the Research and Development Group that serves each of the Registrant's subsidiaries.\nUNITED STATES OPERATIONS:\nDuring 1995 the Registrant's U.S. operations consisted of one independent subsidiary, namely, Graham Manufacturing Co., Inc. (GMC).\nGraham Manufacturing Co., Inc. -- Batavia, New York\nGraham Manufacturing Co., Inc. (GMC) in Batavia, New York is a well recognized supplier of steam jet ejector vacuum systems, surface condensers for steam turbines, liquid ring vacuum pumps and compressors, and various types of heat exchangers such as Heliflow, plate and frame, and special types of nuclear shell and tube heat exchangers. GMC possesses expertise in combining these various products into packaged systems for sale to its customers in a variety of industrial markets, including oil refining, chemical, petrochemical, power, pulp and paper, and shipbuilding.\n1995 sales for Graham Manufacturing Co., Inc. (GMC) were $45.4 million, about 5% more than forecasted, and 7% above the business plan for 1995. Throughout the year, new orders improved, which provided an opportunity to increase shipments in the second half of the year. A union attempt to organize GMC production workers had a negative impact on the first half. A majority of the Company's production workers ultimately voted against the union.\nNew orders for the year were $48.3 million, the highest in the Company's history, and reflected increased activity in the Company's export markets. For the first time in the Company's history, more than half of GMC's new business came from export sources. Countries in Asia accounted for over half of the export business the Company received, with the remaining half from the Middle East, Canada and South America. New orders from western Europe represented a 100% increase as compared to the previous year. This was partly due to the sale of Graham Manufacturing Limited in the U.K., which gave GMC an opportunity to compete more freely in the western European countries.\nGMC's backlog on December 31, 1995 was $21.1 million, which compares to $18.1 million at the same time in 1994. The increased backlog should result in an improvement in shipments for the first half of 1996, as compared to the same period in 1995. Major achievements for 1995 included:\n- exceeding the business plan for the year; - reducing debt to the lowest level in over five years; and - bringing new orders for export to more than half of all new orders, the highest level of export orders in GMC's history.\nSince October of 1995, the rate of new orders has dropped to an annualized rate of $42 million. However, there is reason to believe that new orders should improve as 1996 progresses.\nPetrochemical and fertilizers are two of the most promising markets served by GMC, in view of activity related to new ethylene, ammonia and urea plant projects currently in the planning stages. Although ethylene prices have softened, China's emerging role in the market could bring a renewed demand for the product, with as many as 25 new plants expected to be built in the next two years.\nNew ammonia plants are now in the planning stage, and there continues to be a demand for urea production capacity that will continue well into 1996. Refinery work is not expected to be as active as it was in 1995. While oil companies are boosting capital expenditures for 1996, the emphasis is on exploration and crude oil production, which is not an area of the oil industry that offers business potential to GMC. Ultimately, as oil production increases, there is likely to be an increase in demand for more refinery capacity in the future, bringing increased demand for process condensers and vacuum systems of the type manufactured by Graham. The Company's reputation for experience, quality and efficiency are excellent in this area.\nGraham sales to power plants in the U.S. are probably not going to improve during the year, but overseas the power industry should offer some opportunity for new business. GMC's export markets are expected to continue to be an important part of the Company's business in 1996.\nEmployment at GMC as of December 31, 1995 was 312, of which 9 were temporary or part time employees.\nUNITED KINGDOM OPERATIONS:\nDuring 1995, Graham Corporation owned one manufacturing subsidiary in the United Kingdom, Graham Precision Pumps Limited (GPPL) in Congleton, Cheshire. Ownership was through its U.K. holding company, Graham Vacuum & Heat Transfer Limited (GVHT), which has no employees.\nGraham Precision Pumps Limited - Congleton, Cheshire\nGPPL manufactures liquid ring vacuum pumps, rotary piston pumps, oil sealed rotary vane pumps, atmospheric air operated ejectors and complete vacuum pump systems that are factory assembled with self-supporting structure.\nGPPL's 1995 sales of $5,494,000 were lower than the previous year, as overall the markets were less buoyant and GPPL was unable to maintain the order intake rate achieved in 1994.\nAs in 1994, competitive pricing and delivery continued to be the key to achieving most of GPPL's orders, which in turn demanded a high level of flexibility in manufacturing. Overall, in spite of the lower total value, the sales achieved by GPPL represented a favorable mix and produced a contribution level which with lower overheads resulted in a small profit.\nIn 1996, the U.K. and European markets remain uncertain in spite of favorable forecasts in some countries. GPPL's 1996 business plan forecasts an improvement in specific market sectors to give limited growth over 1995 by means of further market development efforts.\nA restructured plan for the U.S.A. market is in the process of development, and is timed to provide an increase in sales in 1996.\nAs of December 31, 1995 employment stood at 74.\nCapital Expenditures\nThe Registrant's capital expenditures for 1995 amounted to $204,000. Of this amount, $159,000 was for GMC and $45,000 was in the U.K.\n(b) Financial Information About Industry Segments\n(1) Industry Segments and (2) Information as to Lines of Business\n(The information called for under this Item is set forth in statements contained in Notes 1 and 3 to Consolidated Financial Statements, on pages 24-26 and 27-28 of this Annual Report on Form 10- K).\n(c) Narrative Description of Business\n(1) Business Done and Intended to be Done\n(i) Principal Products and Markets\nThe Registrant designs and manufactures vacuum and heat transfer equipment, primarily custom built. The principal markets for this equipment are the chemical, petrochemical, petroleum refining, and electric power generating industries. The Registrant's equipment is sold by a combination of direct company sales engineers and independent sales representatives located in over 40 major cities in the United States and abroad.\n(ii) Status of Publicly Announced New Products or Segments\nThe Registrant has no plans for new products or for entry into new industry segments that would require the investment of a material amount of the Registrant's assets or that otherwise is material.\n(iii) Sources and Availability of Raw Materials\nRegistrant experienced no serious material shortages in 1995.\n(iv) Material Patents, Trademarks\nRegistrant holds no material patents, trademarks, licenses, franchises or concessions the loss of which would have a materially adverse effect upon the business of the Registrant.\n(v) Seasonal Variations\nNo material part of the Registrant's business is seasonal.\n(vi) Working Capital Practices (Not Applicable)\n(vii) Principal Customers\nRegistrant's principal customers include the large chemical, petroleum and power companies, which are end users of Registrant's equipment in their manufacturing and refining processes, as well as large engineering contractors who build installations for such companies and others.\nNo material part of Registrant's business is dependent upon a single customer or on a few customers, the loss of any one or more of whom would have a materially adverse effect on Registrant's business.\nNo customer of Registrant or group of related customers regularly accounts for as much as 10% of Registrant's consolidated annual revenue.\n(viii) Order Backlog\nBacklog of unfilled orders at December 31, 1995 was $21,837,000, compared to $18,997,000 in 1994 and $17,070,000 in 1993.\n(ix) Government Contracts (Not Applicable)\n(x) Competition\nRegistrant's business is highly competitive and a substantial number of companies having greater financial resources are engaged in manufacturing similar products. Registrant is a relatively small factor in the product areas in which it is engaged with the exception of steam jet ejectors. Registrant believes it is one of the leading manufacturers of steam jet ejectors.\n(xi) Research Activities\nDuring the fiscal years ended December 31, 1993, 1994, and 1995. Registrant spent approximately $304,000, $298,000 and $277,000 respectively, on research activities relating to the development of new products or the improvement of existing products.\n(xii) Environmental Matters Registrant does not anticipate that compliance with federal, state and local provisions, which have been enacted or adopted regulating the discharge of material in the environment or otherwise pertaining to the protection of the environment, will have a material effect upon the capital expenditures, earnings and competitive position of the Registrant and its subsidiaries.\n(xiii) Number of Persons Employed\nOn December 31, 1995, Registrant and its subsidiaries employed 397 persons.\n(d) Financial Information About Foreign and Domestic Operations and Export Sales\n(The information called for under this Item is set forth in Note 3 to Consolidated Financial Statements, on pages 27-28 of this Annual Report on Form 10-K.)\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nUnited States: Registrant's corporate headquarters is located at 20 Florence Avenue, Batavia, New York.\nRegistrant's subsidiary, Graham Manufacturing Co., Inc., operates a plant on approximately thirty-three acres in Batavia consisting of about 204,000 square feet in several connected buildings built over a period of time to meet increased space requirements, including 162,000 square feet in manufacturing facilities, 48,000 square feet for warehousing and a 6,000 square-foot building for product research and development. A 14,000 square foot extension to the Heavy Fabrication Building was completed in 1991.\nGraham Manufacturing Co., Inc.'s principal offices are in a 45,000 square-foot building located in Batavia adjacent to its manufacturing facilities.\nGraham Manufacturing Co., Inc. maintains U.S. sales offices in Clifton, New Jersey, Los Angeles and Houston.\nEngland: Registrant's subsidiary, Graham Precision Pumps Limited, has a 41,000 square-foot manufacturing facility located on 15 acres owned by that company in Congleton, Cheshire, England.\nAssets of the Registrant with a book value of $22,741,000 have been pledged to secure certain domestic long-term borrowings. Short and long-term borrowings of Registrant's United Kingdom subsidiary are secured by assets of the subsidiary, which have a book value of $589,000.\nItem 3.","section_3":"Item 3. Legal Proceedings\n(Not Applicable)\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\n(Not applicable)\nItem 4.1. Executive Officers of the Registrant The following information is given with respect to Registrant's executive officers, as defined by Rule 3b-7 of the Act.\nTotal 1 Prior Years 2 Name Age Office Office Served\nFrederick D. Berkeley 67 Chairman, Chairman and 45 President, President of and Chief Graham Manu- Executive facturing Co., Officer Inc.\nJ. Ronald Hansen 48 Vice President Chief Finan- 3 Finance & cial Officer Administration and Vice and Chief President- Financial Finance of Officer Al-Tech Specialty Steel Corp.\nAlvaro Cadena 52 President & Executive 26 Chief Vice Operating President, Officer, Graham Graham Manufacturing Manufacturing Co., Inc. Co., Inc.; Vice President of Registrant\nJoseph P. Gorman 52 Vice President- 26 Sales of Graham Manufacturing Co., Inc.\nStephen P. Northrup 44 Vice President- Vice Presi- 22 Engineering of dent-Opera- Graham Manu- tions facturing Co., Inc. _____________________________ 1 The term of office with Registrant for Mr. Berkeley began on August 1, 1983, the effective date of the reorganization of the Registrant and its predecessor, Graham Manufacturing Co., Inc.. The term of office of each executive officer extends to the first Meeting of Registrant's Board of Directors following the 1994 Annual Meeting of Shareholders or until his successor is chosen and shall have qualified. Mr. Hansen assumed his duties as Vice President-Finance & Chief Financial Officer in June 1993. Prior to his employment at Graham, Mr. Hansen was Chief Financial Officer and Vice President of Al Tech Specialty Steel Corp. Mr. Cadena was elected President of Graham Manufacturing Co., Inc. on March 11, 1991. Prior to his election to that office he served as Executive Vice President of Graham Manufacturing Co., Inc.\n2 Includes the number of years served with the Registrant, Registrant's predecessor company, Graham Manufacturing Co., Inc., and any of the Registrant's subsidiaries. PART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Stock and Related Security Holder Matters\n(a) The information called for under this Item is set forth under Item 8, \"Financial Statements and Supplementary Data\", in the Statement of Quarterly Financial Data appearing on page 41 of this Annual Report on Form 10-K.\n(b) On March 11, 1996, there were approximately 325 holders of the Registrant's common stock. This figure includes stockholders of record and individual participants in security position listings who have not objected to the disclosure of their names; it does not, however, include individual participants in security position listings who have objected to disclosure of their names. On March 11, 1996, the closing price of the Registrant's common stock on the American Stock Exchange was $15.25 per share.\n(c) The Registrant has not paid a dividend since January 4, 1993, when it paid a dividend of $.07 per share. Restrictions on dividends are described in Note 7 to the Consolidated Financial Statements, to be found on pages 30 to 31 of this Report.\nItem 6.","section_6":"Item 6. Selected Financial Data\nGRAHAM CORPORATION - TEN YEAR REVIEW\nGRAHAM CORPORATION - TEN YEAR REVIEW (CONCLUDED)\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nManagement's discussion and analysis reviews the company's financial operating results for each of the three years in the period ended December 31, 1995 and its financial condition at December 31, 1995. The focus of this review is on the underlying business reasons for significant changes and trends affecting sales, net earnings, and financial condition. This review should be read in conjunction with the consolidated financial statements, the related Notes to Consolidated Financial Statements, the Ten- Year Review and Form 10-K.\nExcept for the historical information contained herein, the matters discussed in this annual report are forward-looking statements which involve risks and uncertainties, including but not limited to economic, competitive, governmental and technological factors affecting the company's operations, markets, products, services and prices, and other factors discussed in the company's filings with Securities and Exchange Commission.\nResults of Operations\nConsolidated net income from continuing operations was $1,316,000 in 1995 as compared to $12,000 for 1994 and $672,000 in 1993. After Loss From Discontinued Operations and Loss From Disposal of Discontinued Operations, net income in 1995 was $1,134,000 or $1.08 per share as compared to a loss for 1994 of $8,415,000 or $8.01 per share and a net income of $408,000 or $0.39 for 1993.\nThe consolidated results from continuing operations consolidates the results of Graham Manufacturing Co., Inc. in Batavia, New York and Graham Precision Pumps Limited in Congleton, England. Operating profits discussed below include the results of intercompany transactions.\nOperating profits from Graham Manufacturing Co., Inc. for 1995 were about 127% greater than 1994 and about 10% greater than 1993. The 1994 operations included litigation expense of $1,502,000. Improved 1995 results as compared to 1993 were due to greater sales and reduced selling, general and administrative expenses.\nGraham Precision Pumps Limited's operating profit for the current year was about 59% less than 1994 and 157% greater than 1993. The company enjoyed an unusually strong operating performance in 1994.\nIn January 1995 the stock of Graham Manufacturing Limited was sold for the assumption of debt. The net write off of $8,475,000 was recognized in the Consolidated Statement of Operations under Loss From Discontinued Operations and Loss From Disposal of Discontinued Operations in 1994.\nIn December 1994 the real estate of L&A Engineering and Equipment Inc. was sold for $880,000. A $31,000 after tax gain on the sale was recognized as income under Loss From Disposal of Discontinued Operations in 1994. L&A Engineering and Equipment Inc. was reported as a discontinued operation in 1991. Net Sales\nConsolidated sales for 1995 of $49,480,000 represents a 4.5% increase over 1994 and a 9.5% increase over 1993.\nU.S. 1995 operations recorded increased sales of about 8% more than 1994. Virtually every major product category saw increased sales in 1995 with the exception of surface condensers. Sales by major market sector were proportionately increased over 1994 except for a small increase in the chemical sector and a decrease in the refinery sector. Sales in 1994 exceeded 1993 sales by about 3%. This increase resulted from improved surface condenser sales. Sales by market breakdown showed a decrease in activity in the power sector, but large increases in the chemical and refinery markets.\nU.K. sales in 1995 decreased almost 17% from 1994. Sales for 1994 were about 20% greater than 1993. As noted elsewhere, sales were down in 1995 due to the lack of major project work and offshore demand. Sales were up in 1994 over 1993 due to stronger offshore demand, particularly in the China Sea.\nGross Profit\nConsolidated gross profit margins for 1995, 1994 and 1993 were about 26%. Gross profit margins from the U.S. operation for 1995, 1994, and 1993 were about 25%, 24% and 26%, respectively. Graham Precision Pumps gross profit margins for 1995 decreased to about 28% from about 36% in 1994 as a result of fewer sales and less favorable product mix. Gross profit margins in 1993 were about 26%.\nSelling, General and Administrative Expenses\nSelling, general and administrative expenses continued the downward trend initiated in 1993. This three year trend is expected to reverse in 1996 as the company's strategic plan calls for a pro-active niche marketing effort and increased research and development programs in potentially expanding market areas.\nInterest Expense\nInterest expense for the current year increased about 17% over 1994 even though interest bearing debt decreased significantly from December 31, 1994. The company's borrowings to finance 1994 fourth quarter shipments resulted in greater interest expense the first part of 1995. Interest expense in 1994 was down slightly from 1993. This was due to management's efforts in reducing debt and working capital requirements.\nProvision for Income Taxes\nThe effective income tax rates for 1995, 1994 and 1993 related to continuing operations were 37%, 95% and 24%. The current year's consolidated effective tax rate differs from the statutory rate mainly due to a reduction in state deferred tax assets recognized under Statement of Financial Accounting Standard No. 109. The unusually large effective tax rate recognized in 1994 resulted from the disallowance of capital losses incurred with the disposal of Graham Manufacturing Limited. The 1993 tax provision was reduced as a result of the favorable reversal of a tax reserve established in a previous year. For an in depth analysis of the tax provision, see Note 9 in the accompanying Notes to Consolidated Financial Statements.\nWorking Capital\nWorking capital available to finance current operations at December 31, 1995 was $7,074,000. This compares to $6,845,000 at December 31, 1994. Current assets as of December 31, 1995 were about 3% greater than 1994. The accounts receivable balance was down almost 11% as a result of improved cash collections. Inventory on hand at December 31, 1995 increased about 46% or $2,074,000 over 1994. This increase is attributed to increased inventory in selected standard products stocked to shorten delivery times and the status of specific jobs in work-in-process as of December 31, 1995. Deferred tax assets decreased about 37% from 1994 as a result of the current deductibility of litigation charges incurred in 1994 but paid in 1995.\nCurrent liabilities increased about 2% over December 31, 1994 balances. The two significant increases came in accrued compensation (up almost 34% from 1994) and customer deposits (up about 258% from last year). Accrued compensation represents a timing difference between compensation earned and paid. Customer deposits represent cash collected from customers in advance of shipments and in excess of the carrying value of related inventory. The largest decrease in 1994 current liabilities was due to the payment of the accrued litigation reserve of $1,247,000 in 1995.\nLong Term Assets\nLong term assets consist of Deferred Income Taxes and Property, Plant and Equipment. Capital spending in 1995 and 1994 equalled about 22% and 40% of depreciation expense for the comparable respective years. Capital spending in 1996 is projected to equal or slightly exceed 1996 depreciation expense.\nNoncurrent Liabilities\nNoncurrent liabilities as set forth in the Consolidated Balance Sheets includes the long term portion of bank debt. Because the markets served by Graham are cyclical, the company has established a strategic goal to reduce the amount of interest bearing debt in relation to shareholders' equity.\nShareholders' Equity\nShareholders' Equity increased about 19% in 1995 over 1994. Most of this increase was due to earnings. Shareholders' Equity decreased about 52% in 1994 from 1993 due to the disposal of Graham Manufacturing Limited and an adverse jury verdict.\nLiquidity\nNet cash provided from operating activities in 1995 was $1,644,000 as compared to a deficit in 1994 of $906,000 and a surplus in 1993 of $2,085,000. The positive 1995 position was achieved due to a strong operating profit together with maintaining working capital levels approximating 1994. The 1994 cash operating deficit was largely due to the disposal of Graham Manufacturing Limited. The 1993 positive cash flow from operating activities was due to operating profit, inventory reduction programs, and income tax refunds.\nManagement believes that 1996 cash needs will be substantially provided from normal operations.\nAt December 31, 1995 the U.S. operation had an unused line of credit available to support its business of $8,727,000. The U.K. operation had an unused line of credit available of $181,000.\nNew Orders\nNew orders in 1995 were $52,319,000 compared to $49,527,000 in 1994 and $40,156,000 in 1993. In 1995, U.S. bookings were $48,358,000, up from $43,991,000 in 1994 and $35,571,000 in 1993. New orders from export from the U.S. operation equalled about 54% of the total new orders. This compares to about 46% of the orders received in 1994 and about 40% in 1993. Orders received in the U.K. operation in 1995 were $3,961,000. This compares to $5,536,000 in 1994 and $4,585,000 in 1993. Bookings in 1995 were down compared to 1994 due to the lack of major project work and weaker activity in the U.K. offshore pump product line.\nBacklog\nThe consolidated backlog as of December 31, 1995 was $21,837,000, up about 15% over 1994 and about 28% over 1993. The backlog as of December 31, 1994 was $18,997,000 and $17,070,000 on December 31, 1993. Graham Manufacturing Co., Inc.'s backlog equalled $21,136,000 for the current period as compared to $18,127,000 and $16,324,000 for 1994 and 1993, respectively. Graham Precision Pumps Limited's backlog was $701,000 as of December 31, 1995 and $870,000 in 1994 and $746,000 in 1993. Backlog figures exclude intercompany sales. Graham Manufacturing is a major customer of Graham Precision Pumps.\nThe backlog at December 31, 1995 will be shipped in 1996 and represents orders from traditional markets in Graham's established product lines.\nChange In Accounting Principles\nThe company adopted Statement of Financial Accounting Standard No. 107, Disclosure About Fair Value of Financial Instruments in 1995. See Notes to Consolidated Financial Statements No. 8 for additional information including Graham's use of derivatives.\nEffective January 1, 1994 the company adopted Statement of Financial Accounting Standard No. 112, Employer's Accounting for Postemployment Benefits.\nInflation\nIncreases in material costs have been offset by cost cutting measures and price increases absorbed in the marketplace. Graham will continue to monitor the impact of inflation in order to minimize its effects in future years through pricing and product mix strategies, productivity improvements, and cost reductions.\nForward Looking\nOn balance 1995 was an excellent year. In the first half of the year the company settled a major lawsuit and sold its subsidiary located in Gloucester, England. The expenses relating to these events were anticipated and substantially accounted for in 1994. In the second half of the year the company returned to profitability, posting one of its finest operating profits in several years.\nThe company enters 1996 with a consolidated backlog well in excess of recent past history. No one can predict with certainty, demand for Graham's products into the future, however, with guarded optimism the company does see opportunities in selected market niches in 1996. To what extent these potentially bright spots can offset other weakening market sectors and fierce global competition is difficult to comfortably predict.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\n(Financial Statements, Notes to Financial Statements, Quarterly Financial Data)\nCONSOLIDATED STATEMENTS OF OPERATIONS\nCONSOLIDATED BALANCE SHEETS\nCONSOLIDATED BALANCE SHEETS (CONCLUDED)\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nCONSOLIDATED STATEMENTS OF CASH FLOWS (CONCLUDED)\nConsolidated Statements of Changes in Shareholders' Equity\nNotes To Consolidated Financial Statements\nNote 1 - The Company and Its Accounting Policies:\nGraham Corporation and its subsidiaries are primarily engaged in the design and manufacture of vacuum and heat transfer equipment used in the chemical, petrochemical, petroleum refining, and electric power generating industries and sells to customers throughout the world. The company's significant accounting policies follow.\nPrinciples of consolidation and use of estimates in the preparation of financial statements - The consolidated financial statements include the accounts of the company and its majority-owned domestic and foreign subsidiaries. All significant intercompany balances, transactions and profits are eliminated in consolidation. 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, as well as the related revenues and expenses during the reporting period. Actual amounts could differ from those estimated.\nTranslation of foreign currencies- Assets and liabilities of foreign subsidiaries are translated into U.S. dollars at currency exchange rates in effect at year end and revenues and expenses are translated at average exchange rates in effect for the year. Gains and losses resulting from foreign currency transactions are included in results of operations. Gains and losses resulting from translation of foreign subsidiary balance sheets are reflected as a separate component of shareholders' equity.\nRevenue recognition- Revenues and all related costs on short-term contracts are accounted for on the completed contract method and included in income upon substantial completion or shipment to the customer.\nInventories- Inventories are stated at the lower of cost or market. Cost is determined on the first-in, first-out method. Progress payments for orders are netted against inventory to the extent the payment is less than the inventory balance relating to the applicable contract. Progress payments that are in excess of the corresponding inventory balance are presented as customer deposits in the Consolidated Balance Sheet.\nProperty and depreciation- Property, plant and equipment are stated at cost. Major additions and improvements are capitalized, while maintenance and repairs are charged to expense as incurred. Depreciation and amortization are provided based upon the estimated useful lives under the straight line method. Upon sale or retirement of assets, the cost and related accumulated depreciation are removed from the accounts and any resulting gain or loss is included in the results of operations.\nIncome taxes- The company recognizes 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. Deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using currently enacted tax rates.\nEmployee benefit plans and deferred compensation- The company has retirement plans covering substantially all employees. Charges to income are based upon actuarially determined costs. Pension liabilities are funded by periodic payments to the various pension plan trusts. The company has employment contracts with key employees which provide for current and deferred bonuses based upon the results of operations. The principal and interest earned on the deferred balances are payable upon retirement. Effective January 1, 1994, the company adopted Statement of Financial Accounting Standards No. 112 (SFAS 112), \"Employers' Accounting for Postemployment Benefits.\" SFAS 112 requires that projected future costs of providing postemployment benefits be recognized as an expense as employees render service rather than when the benefits are paid. The adjustment to adopt SFAS 112 of $9,000, net of the related tax benefit of $3,000, or $.01 per share, is presented in the Consolidated Statement of Operations as the cumulative effect of changes in accounting principles from continuing and discontinued operations. The incremental costs of adopting this statement are insignificant on an ongoing basis. The company provides certain health care benefits for eligible retirees and eligible survivors of retirees. The company recognizes the cost of postretirement health care benefits on the accrual basis as employees render service to earn the benefits.\nPer share data- Earnings per share is computed by dividing net income by the weighted average number of common shares and, when applicable, common equivalent shares outstanding during the period.\nCash flow statement- The company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. Actual interest paid was $631,000 in 1995, $500,000 in 1994, and $815,000 in 1993. In addition, actual income taxes paid were $246,000 in 1995, $39,000 in 1994, and $341,000 in 1993. In 1994, bonus amounts payable to all officers of Graham Corporation and its U.S. subsidiary were paid in Graham common stock valued at $12,000 and $73,000 in 1995 and 1994.\nRecently issued accounting standard - In October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation,\" which requires adoption no later than fiscal years beginning after December 15, 1995. The new standard defines a fair value method of accounting for stock options and similar equity instruments. Under the fair value method, compensation cost is measured at the grant date based on the fair value of the award and is recognized over the service period, which is usually the vesting period. Pursuant to the new standard, companies are encouraged, but not required, to adopt the fair value method of accounting for employee stock-based transactions. Companies are also permitted to continue to account for such transactions under Accounting Principles Board Opinion No. 25, \"Accounting for Stock Issued to Employees,\" but would be required to disclose in a note to the financial statements pro forma net income and, if presented, earnings per share as if the company had applied the new method of accounting. The accounting requirements of the new method are effective for all employee awards granted after the beginning of the fiscal year of adoption. The company has not yet determined if it will elect to change to the fair value method, nor has it determined the effect the new standard will have on net income and earnings per share should it elect to make such a change. Adoption of the new standard will have no effect on the company's cash flows.\nNote 2 - Discontinued Operations:\nIn September 1994, the company approved a formal plan to dispose of its subsidiary, Graham Manufacturing Limited (GML), located in Gloucester, England, and subsequently sold the operation on January 24, 1995. GML manufactured shell and tube heat exchangers. In addition, GML manufactured air cooled exchangers through a joint venture known as Graham Exchanger Services Limited of which GML owned seventy-five percent of the issued and outstanding shares. This joint venture was sold in November 1994. The disposal of GML has been presented in the Consolidated Statement of Operations as a discontinued operation and accordingly, the results of operations for the prior years have been restated to reflect GML's operations separately from continuing operations.\nNet sales for GML were $13,639,000 for the nine month operating period in 1994 and $16,086,000 in 1993.\nDuring 1995, the company incurred a loss of $182,000 for additional expenses related to the disposal of GML. There were no tax attributes associated with this loss. The 1994 loss from GML's discontinued operations is presented net of related tax benefits of $8,000. The 1994 loss from disposal, which includes operating losses of $1,909,000 during the phase-out period, is presented net of related tax benefits of $160,000. There were no tax attributes associated with the 1993 loss of GML. The remaining accrued liabilities for this disposal totalled $711,000 at December 31, 1995.\nIn December 1994, the company sold the property and plant of L&A Engineering & Equipment, Inc. (L&A), which was previously accounted for as a discontinued operation. A gain, net of related expenses, of $51,000 was recognized from the sale of the L&A property and plant. In addition, the remaining reserve for estimated net liabilities of L&A totalling $38,000 was reversed to income in 1994. The gain of $89,000, which is net of a $35,000 income tax provision, has been netted against the loss from disposal of discontinued operations in the 1994 Consolidated Statement of Operations.\nNote 3 - Operations by Geographic Area:\nThe company has operations in the United States and the United Kingdom.\nInter-geographic sales represent intercompany sales made based upon a competitive pricing structure. All intercompany profits in inventory are eliminated in the consolidated accounts and are included in the eliminations caption below. In computing operating profit, corporate and interest expense have been excluded. Included in corporate expense are research and development costs of $277,000, $298,000, and $304,000 in 1995, 1994 and 1993, respectively.\nThe breakdown of total United States export sales by geographic area was:\nNote 4 - Inventories:\nMajor classifications of inventories are as follows:\nNote 5 - Property, Plant and Equipment:\nMajor classifications of property, plant and equipment are as follows:\nNote 6 - Leases:\nThe company leases equipment and office space under various operating leases. Rent expense applicable to operating leases was $184,000, $180,000 and $249,000 for years 1995, 1994 and 1993, respectively.\nProperty, plant and equipment include the following amounts for leases which have been capitalized.\nAmortization of property, plant and equipment under capital lease amounted to $98,000, $72,000 and $114,000 for years 1995, 1994 and 1993, respectively, and is included in depreciation expense.\nAs of December 31, 1995, future minimum payments required under non-cancelable leases are:\nNote 7 - Debt:\nShort-Term Debt Due Banks\nThe company and its subsidiaries had short-term borrowings outstanding as follows:\nIn 1995, the United Kingdom subsidiary entered into a new revolving credit facility agreement which provides a line of credit of 250,000 pounds sterling ($387,000 at the December 31, 1995 exchange rate). Under the new facility, the interest rate is the bank's rate plus 1 1\/2%. The bank's base rate was 6 1\/2% and 3 3\/4% at December 31, 1995 and 1994, respectively. The United Kingdom operations had available unused lines of credit of $181,000 at December 31, 1995. The weighted average interest rate on short- term borrowings at December 31, 1995 and 1994 was 8% and 6.25%, respectively.\nLong-term Debt\nThe company and its subsidiaries had long-term borrowings outstanding as follows:\nThe United States revolving credit facility agreement provides a line of credit of up to $13,000,000, including letters of credit, through October 31, 1996. During 1995 and 1994, the company borrowed at a rate of prime plus 1\/2%. In June 1994, the company used proceeds of the revolving line of credit to refinance Industrial Development Revenue Bonds. The agreement allows the company at any time to convert balances outstanding not less than $2,000,000 and up to $9,000,000 into a two-year term loan. This conversion feature is available through October 1996, at which time the company may convert the principal outstanding on the revolving line of credit to a two-year term loan. The company had $2,282,000 and $4,171,000 outstanding on its revolving credit facility at December 31, 1995 and 1994, respectively. As the company has the intent and ability to maintain this balance on a long-term basis, the borrowings have been classified as long-term debt at December 31, 1995 and 1994. The bank's prime rate was 8.5% at December 31, 1995 and 1994. The United States subsidiary had available unused lines of credit of $8,727,000 at year end.\nThe Employee Stock Ownership Plan Loan Payable requires quarterly payments of $50,000 through 2000. (See Note 10 for a description of the Plan.)\nIn 1995, the United Kingdom subsidiary entered into a term loan at a fixed rate of 9%. This term loan is due in 2000 and is repayable in equal monthly installments commencing in 1996.\nLong-term debt requirements over the next five years, excluding capital leases, are: 1996 - $319,000, 1997 - $867,000, 1998 - $1,913,000, 1999 - $297,000 and 2000 - $148,000.\nThe company is required to pay commitment fees of 1\/2% on the unused portion of the domestic revolving credit facility. No other financing arrangements require compensating balances or commitment fees. Assets with a book value of $22,741,000 have been pledged to secure certain domestic long-term borrowings.\nThe United Kingdom short-term and long-term borrowings are secured by assets of the United Kingdom subsidiary which have a book value of $589,000.\nSeveral of the loan agreements contain provisions pertaining to the maintenance of minimum working capital balances, tangible net worth, capital expenditures and financial ratios as well as restrictions on the payment of cash dividends to the parent company and shareholders and incurrence of additional long-term debt. The most restrictive dividend provision limits the payment of dividends to shareholders to the greater of $400,000 or 25% of consolidated net income. In addition, the United States subsidiary cannot make any loans or advances exceeding $150,000 to any affiliates without prior consent of the bank. The United States subsidiary may pay dividends to the parent company as long as the subsidiary remains in compliance with all financial covenants after payment of the dividends. Under the agreement, restricted net assets of the subsidiary may not be reduced below $5,000,000 at December 31, 1995. Effective December 31, 1995, the United Kingdom subsidiary obtained a waiver through the end of 1996 from its bank of certain financial loan covenants.\nNote 8 - Financial Instruments and Derivative Financial Instruments:\nConcentrations of Credit Risk:\nFinancial instruments that potentially subject the company to concentrations of credit risk consist principally of temporary cash investments and trade receivables. The company places its temporary cash investments with high credit quality financial institutions and actively evaluates the credit worthiness of these financial institutions. Concentrations of credit risk with respect to trade receivables are limited due to the large number of customers comprising the company's customer base and their geographic dispersion. At December 31, 1995 and 1994, the company had no significant concentrations of credit risk.\nLetters of Credit:\nThe company has entered into standby letter of credit agreements with financial institutions relating to the guarantee of future performance on certain contracts. At December 31, 1995 and 1994, the company was contingently liable on outstanding standby letters of credit aggregating $2,127,000 and $2,256,000, respectively.\nForeign Exchange Risk Management:\nThe company, as a result of its global operating and financial activities, is exposed to market risks from changes in foreign exchange rates. In seeking to minimize the risks and\/or costs associated with such activities, the company utilizes foreign exchange forward contracts with fixed dates of maturity and exchange rates. The company does not hold or issue financial instruments for trading or other speculative purposes and only contracts with high quality financial institutions. If the counterparties to the exchange contracts do not fulfill their obligations to deliver the contracted foreign currencies, the company could be at risk for fluctuations, if any, required to settle the obligation.\nThe table below summarizes the notional amounts of the foreign exchange forward contracts held by the company. The \"buy\" amounts represent the U.S. dollar equivalent of commitments to purchase foreign currencies and the \"sell\" amounts represent the U.S. dollar equivalent of commitments to sell foreign currencies.\nThe company entered into these foreign exchange forward contracts to hedge a sales or purchase commitment denominated in the currency of the sales contract or purchase order. The term of the derivatives is less than one year.\nAt December 31, 1995 and 1994, the company had deferred unrealized gains and (losses) of $(7,000) and $7,000, respectively, which are recognized in income as part of the hedged transaction. These amounts represent the gain or loss that would have been recognized had these contracts been liquidated at market value in their respective years. The fair values of the foreign exchange forward contracts are estimated based on dealer quotes.\nFair Value of Financial Instruments:\nThe differences between the carrying amounts and estimated fair values of the company's short- and long-term debt are insignificant.\nThe methods and assumptions used to estimate the fair value of such debt are summarized as follows:\nShort-term debt due banks - The carrying value of short-term debt approximates fair value due to the short-term maturity of this instrument.\nLong-term debt - The carrying value of long-term debt excludes $114,000 and $150,000 of obligations under capital leases at December 31, 1995 and 1994, respectively. The carrying values of credit facilities with variable rates of interest approximates fair values. The fair value of fixed rate debt was estimated by discounting cash flows using rates currently available for debt of similar terms and remaining maturities.\nNote 9 - Income Taxes:\nAn analysis of the components of pre-tax income from continuing operations is presented below:\nThe provision (benefit) for income taxes on continuing operations consists of:\nThe reconciliation of the provision calculated using the United States Federal tax rate with the provision for income taxes presented in the financial statements, excluding discontinued operations, is as follows:\nThe deferred income tax asset (liability) recorded in the Consolidated Balance Sheets results from differences between financial statement and tax reporting of income and deductions. A summary of the composition of the deferred income tax asset (liability) follows:\nDeferred income taxes include the impact of state and foreign net operating loss carryforwards and investment tax credits which expire from 1996 to 2008. In accordance with the provisions of SFAS 109, a valuation allowance of $612,000 at December 31, 1995 is deemed adequate to reserve for these and other items which are not considered probable of realization.\nThe company does not provide for additional U.S. income taxes on undistributed earnings considered permanently invested in its United Kingdom subsidiary. At December 31, 1995, such undistributed earnings totaled $950,000. It is not practicable to determine the amount of income taxes that would be payable upon the remittance of assets that represent those earnings.\nNote 10 - Employee Benefit Plans:\nRetirement Plans\nThe company has defined benefit plans covering substantially all employees. The company's plan covering employees in the United States is non-contributory. Benefits are based on the employee's years of service and average earnings for the five highest consecutive calendar years of compensation for the ten year period preceding retirement. The plan for employees in the United Kingdom is contributory with the employer's share being actuarially determined. Benefits are based on the employee's years of service and average earnings for the three highest years for the ten year period preceding retirement. The company's funding policy for the United States plan is to contribute the amount required by the Employee Retirement Income Security Act of 1974. The pension obligations to employees covered by the company's former domestic plan, terminated in 1986, were settled through the purchase of annuity contracts for each participant which guaranteed these future benefit payments.\nThe components of pension cost are:\nThe service cost for 1995, 1994 and 1993 is net of employee contributions to the United Kingdom plan of $49,000, $22,000 and $51,000, respectively.\nThe actuarial assumptions are:\nThe funded status of the pension plans is presented below:\nThe current portion of the pension liability is included in the caption \"Accrued Compensation\" and the long-term portion is separately presented in the Consolidated Balance Sheets.\nAssets of the United States plan consist primarily of equity securities including 70,425 shares of the company's common stock at December 31, 1995 and 1994. Assets of the United Kingdom plan consist of an investment contract with an insurance company which is primarily invested in equity securities. The vested benefit obligation of the United Kingdom plan is the actuarial present value of the vested benefits to which the employee is currently entitled but based on the employee's expected date of separation or retirement. The unrecognized net asset at transition is being amortized over the remaining service lives of the participants which approximates 19 years for the domestic plan and 13 years for the United Kingdom plan.\nThe company has a defined contribution plan covering substantially all domestic employees. Company contributions to this plan are based on the profitability of the company and amounted to $320,000, $0 and $326,000 in 1995, 1994 and 1993, respectively. The company also maintains a supplemental defined contribution plan which covers selected employees in the United Kingdom. The expense associated with this plan was $4,000, $13,000 and $23,000 for the years ended December 31, 1995, 1994 and 1993, respectively.\nEmployee Stock Ownership Plan\nIn 1990, the company established a noncontributory Employee Stock Ownership Plan (ESOP) that covers substantially all employees in the United States. The company borrowed $2,000,000 under loan and pledge agreements. The proceeds of the loans were used to purchase 87,454 shares of the company's common stock. The purchased shares are pledged as security for the payment of principal and interest as provided in the loan and pledge agreements. It is anticipated that funds for servicing the debt payments will essentially be provided from contributions paid by the company to the ESOP, from earnings attributable to such contributions, and from cash dividends paid to the ESOP on shares of the company stock which it owns. During 1995, 1994, and 1993 the company recognized expense associated with the ESOP using the shares allocated method. This method recognizes interest expense as incurred on all outstanding debt of the ESOP and compensation expense related to principal reductions based on shares allocated for the period. Dividends received on unallocated shares that are used to service the ESOP debt reduce the amount of expense recognized each period. The compensation expense associated with the ESOP was $200,000 for each of the years ended December 31, 1995, 1994 and 1993. The ESOP received no dividends on unallocated shares in 1995, 1994 and 1993. Interest expense in the amount of $97,000, $96,000, and $96,000 was incurred in 1995, 1994 and 1993, respectively. Dividends paid on allocated shares accumulate for the benefit of the employees.\nOther Postretirement Benefits\nIn addition to providing pension benefits, the company has a United States plan which provides health care benefits for eligible retirees and eligible survivors of retirees. Effective January 1, 1994, early retirees who are eligible to receive benefits under the plan are required to share in twenty percent of the medical premium cost. In addition, the company's share of the premium costs has been capped.\nThe components of postretirement benefit cost are:\nThe assumptions used to develop the accrued postretirement benefit obligation were:\nThe medical care cost trend rate used in the actuarial computation ultimately reduces to 6% in 2002 and subsequent years. This was accomplished using 1\/2% decrements for the years 1996 through 2002.\nThe table of actuarially computed benefit obligations is presented below:\nThe effect of a one percentage point increase in each future year's assumed medical care cost trend rate, holding all other assumptions constant, would not have a material effect on the net postretirement benefit cost or the accrued postretirement benefit obligation.\nThe current portion of the postretirement benefit obligation is included in the caption \"Accrued Compensation\" and the long-term portion is separately presented in the Consolidated Balance Sheets.\nNote 11 - Stock Options:\nThe 1989 Stock Option and Appreciation Rights Plan provides for issuance of up to 125,800 shares of common stock in connection with grants of non-qualified stock options and tandem stock appreciation rights to officers, key employees and certain outside directors. The options may be granted at prices not less than the fair market value at the date of grant, and expire no later than ten years after the date of grant.\nThe 1981 Common Stock Incentive Plan for officers and other key employees provided for issuance of up to 80,000 shares of common stock in connection with grants of incentive stock options and tandem stock appreciation rights. Options can no longer be granted under this plan and at December 31, 1995, all outstanding options had been exercised.\nInformation on options and rights under the company's plans is as follows:\nThere were 79,940 options exercisable at December 31, 1995. The remaining options are exercisable at a rate of 20 percent per year from the date of grant. The outstanding options expire December 1999 to October 2005. The number of options available for future grants were 12,800 at December 31, 1995 and 24,200 at December 31, 1994.\nIn 1995, the Board of Directors adopted the 1995 Graham Corporation Incentive Plan to Increase Shareholder Value and approved the granting of non-qualified stock options to purchase 11,500 shares of the company's common stock at an exercise price of $12.00 to officers and other key employees. If approved by the shareholders, these options will be immediately exercisable and will expire no later than October 2005. This plan provides for the issuance of up to 128,000 shares of common stock in connection with grants of incentive stock options and non-qualified stock options to officers, key employees and outside directors. The options may be granted at prices not less than the fair market value at the date of grant and expire no later than ten years after the date of grant.\nNote 12 - Shareholder Rights Plan:\nOn February 23, 1990 the company adopted a Shareholder Rights Plan. Under the Plan, as of March 7, 1990, one share Purchase Right (\"Right\") is attached to each outstanding share of Common Stock. When and if the Rights become exercisable, each Right would entitle the holder of a share of Common Stock to purchase from the company an additional share of Common Stock for $70.00 per share, subject to adjustment. The Rights become exercisable upon certain events: (i) if a person or group of persons acquires 20% or more of the company's outstanding Common Stock; or (ii) if a person or group commences a tender offer for 30% or more of the company's outstanding Common Stock.\nThe company may redeem the Rights for $.01 per Right at any time prior to the close of business on the date when the Rights become exercisable.\nAfter the Rights become exercisable, if the company is acquired in a business combination transaction, or if at least half of the company's assets or earning power are sold, then each Right would entitle its holder to purchase stock of the acquirer (or Graham, if it were the surviving company) at a discount of 50%. The number of shares that each Right would entitle its holder to acquire at discount would be the number of shares having a market value equal to twice the exercise price of the Right.\nNote 13 - Litigation Settlement:\nA lawsuit was filed in November 1992 against the company's U.S. subsidiary, Graham Manufacturing Co., Inc. Following an adverse jury verdict, the company charged $1,502,000 to pre-tax income in 1994 for the judgment amount and related defense costs. Following trial in 1995, the company reached a settlement with the plaintiff and an additional $276,000 was expensed.\nQuarterly Financial Data:\nA capsule summary of the company's unaudited quarterly sales and earnings per share data for 1995 and 1994 is presented below:\nINDEPENDENT AUDITORS' REPORT\nBoard of Directors and Shareholders Graham Corporation Batavia, New York\nWe have audited the accompanying consolidated balance sheets of Graham Corporation and subsidiaries as of December 31, 1995 and 1994, 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, 1995. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Graham Corporation and subsidiaries at December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles.\nDeloitte & Touche LLP Rochester, New York February 22, 1996\nINDEPENDENT AUDITORS' REPORT\nBoard of Directors and Shareholders Graham Corporation Batavia, New York\nWe have audited the consolidated financial statements of Graham Corporation and subsidiaries as of December 31, 1995 and 1994 and for each of the three years in the period ended December 31, 1995, and have issued our report thereon dated February 22, 1996; such report is included elsewhere in this Annual Report on Form 10-K. Our audits also included the consolidated financial statement schedules of Graham Corporation and subsidiaries, listed in Item 14 (a) 2. These 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 financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nDeloitte & Touche LLP\nRochester, New York February 22, 1996\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\n(Not Applicable)\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers\n(The information called for under this Item pursuant to Item 401 of the Commission's Regulation S-K is set forth in statements under \"Election of Directors\" on pages 3 to 5 of the Registrant's Proxy Statement for its 1996 Annual Meeting of Stockholders, which statements are hereby incorporated herein by reference: except that the information regarding executive officers called for hereunder pursuant to Item 401(b) of Regulation S-K is furnished under a separate item captioned Executive Officers of the Registrant included in PART I of this annual report on Form 10-K pursuant to Instruction 3 to Item 401(b) of Regulation S-K and paragraph 3 of General Instruction G of Form 10-K. The information called for under this Item pursuant to Item 405 of the Commission's Regulation S-K is set forth in the statement on page 7 of Registrant's Proxy Statement for its 1996 Annual Meeting of Stockholders, which statement is hereby incorporated herein by reference.)\nItem 11.","section_11":"Item 11. Executive Compensation\n(The information called for under this Item is set forth in statements under \"Compensation of Executive Officers\" on pages 8 to 11 of Registrant's Proxy Statement for its 1996 Annual Meeting of Stockholders, which statements are hereby incorporated herein by reference.)\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\n(a) Security Ownership of Certain Beneficial Owners\n(The information called for under this Item is set forth in statements under \"Principal Stockholders\" on page 2 of Registrant's Proxy Statement for its 1996 Annual Meeting of Stockholders, which statements are hereby incorporated herein by reference.)\n(b) Security Ownership of Management\n(The information called for under this Item is set forth in statements under \"Principal Stockholders\" on page 2, \"Election of Directors\" on pages 3 to 5 and \"Executive Officers\" on page 7 of Registrant's Proxy Statement for its 1996 Annual Meeting of Stockholders, which statements are hereby incorporated herein by reference.) (c) Changes in Control (Not Applicable)\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\n(The information called for under this Item is set forth in statements under \"Principal Stockholders\" on page 2 and \"Election of Directors\" on pages 3 to 5 of Registrant's Proxy Statement for its 1996 Annual Meeting of Stockholders, which statements are 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) (1) The following are Financial Statements and related information filed as part of this Annual Report on Form 10-K:\nSequential Page Number\n(A) Consolidated Statements of Operations for the Years ended December 31, 1995, 1994, and 1993; 18\n(B) Consolidated Balance Sheets as of December 31, 1995 and 1994; 19-20\n(C) Consolidated Statements of Cash Flows for the Years Ended December 31, 1995, 1994 and 1993; 21-22\n(D) Consolidated Statements of Changes in Shareholders' Equity for the Years ended December 31, 1995, 1994 and 1993; 23\n(E) Notes to Consolidated Financial Statements; and 24-40\n(F) Report of Independent Auditors 42\n(a) (2) The following are Financial Statement Schedules and related information required to be filed as part of this Annual Report on Form 10-K by Items 8 and 14(d) of Form 10-K:\n(A) The items set forth in Items 14(a)(1)(A) through (E) above; and 18-40\n(B) Independent Auditors' Report on Financial Statement Schedules 43\nSequential Page Number Financial Statement schedules for the years ended December 31, 1995, 1994 and 1993 as follows:\n(i) Condensed Financial Information of Registrant (Schedule I) 47-50\n(ii) Valuation and Qualifying Accounts (Schedule II) 51-52\nOther financial statement schedules not included in this Annual Report on Form 10-K have been omitted because they are not applicable or because the required information is shown in the financial statements or notes thereto.\nGRAHAM CORPORATION AND SUBSIDIARIES* SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONDENSED STATEMENTS OF OPERATIONS\nGRAHAM CORPORATION AND SUBSIDIARIES* SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONDENSED BALANCE SHEETS\nCONDENSED BALANCE SHEETS (CONCLUDED)\nGRAHAM CORPORATION AND SUBSIDIARIES*\nSCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT\nCONDENSED STATEMENTS OF CASH FLOWS\nGRAHAM CORPORATION AND SUBSIDIARIES SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS (CONCLUDED)\n(a) (3) The following exhibits are required to be filed by Item 14(c) of Form 10-K:\nExhibit No.\n*3 (i) Articles of Incorporation of Graham Corporation\n3 (ii) By-laws of Graham Corporation\n*4 (a) Certificate of Incorporation of Graham Corporation (included as Exhibit 3.1)\n**4 (b) Shareholder Rights Plan of Graham Corporation\n***10 1989 Stock Option and Appreciation Rights Plan of Graham Corporation\n11 Statement regarding computation of per share earnings\n21 Subsidiaries of the registrant\n23 Consent of Experts and Counsel\n27 Financial Data Schedule\n(b) The Registrant filed no reports on Form 8-K during the last quarter of the fiscal year covered by this Annual Report on Form 10-K.\n___________________________\n* Incorporated herein by reference from the Annual Report of Registrant on Form 10-K for the year ended December 31, 1989.\n** Incorporated herein by reference from the Registrant's Current Report on Form 8-K dated February 26, 1991, as amended by Registrant's Amendment No. 1 on Form 8 dated June 8, 1991.\n*** Incorporated herein by reference from the Registrant's Proxy Statement for its 1991 Annual Meeting of Shareholders.\nCross Reference Sheet for Annual Report on Form 10-K for the year ended December 31, 1995, setting forth item numbers and captions of Form 10-K (and related Items of Regulation S-K referred to therein) under which information is incorporated by reference and the pages in the Registrant's Proxy Statement for the 1996 Annual Meeting of Stockholders where that information appears.\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.\nGRAHAM CORPORATION (Registrant)\nDATE: March 27, 1996 By s\\ J. Ronald Hansen\nJ. Ronald Hansen Vice President-Finance & Administration and Chief Financial Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nSignature\nChairman and Chief s\\ Frederick D. Berkeley Executive Officer; Frederick D. Berkeley Director March 27, 1996\nVice President-Finance & Administration and Chief s\\ J. Ronald Hansen Financial Officer J. Ronald Hansen March 27, 1996\ns\\ Philip S. Hill Philip S. Hill Director March 27, 1996\ns\\ Cornelius S. Van Rees Cornelius S. Van Rees Director March 27, 1996\ns\\ Jerald D. Bidlack Jerald D. Bidlack Director March 27, 1996\ns\\ Robert L. Tarnow Robert L. Tarnow Director March 27, 1996\ns\\ A. Cadena A. Cadena Director March 27, 1996\n_________________________________________________________________ _________________________________________________________________\nSECURITIES AND EXCHANGE COMMISSION\nWASHINGTON, D.C. 20549\n___________________________________\nEXHIBITS\nfiled with\nFORM 10-K\nANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)\nof\nTHE SECURITIES EXCHANGE ACT OF 1934\nFOR THE FISCAL YEAR ENDED DECEMBER 31, 1995\n___________________________________\nGRAHAM CORPORATION\n_________________________________________________________________ _________________________________________________________________\nGRAHAM CORPORATION\nFORM 10-K\nDECEMBER 31, 1995\nEXHIBIT DESCRIPTION SEQUENTIAL NUMBER OF DOCUMENT PAGE NUMBER\n3 (ii) By-laws of Graham Corporation\n11 Statement Regarding Computation of Per-Share Earnings\n21 Subsidiaries of the Registrant\n23 Consent of Deloitte & Touche\n27 Financial Data Schedule","section_15":""}
{"filename":"27367_1995.txt","cik":"27367","year":"1995","section_1":"Item 1. Business\nThe Daxor Corporation (the \"Company\") was formed in 1971, to develop cryopreservation technology for the freezing techniques of human semen. The Company's Idant Laboratory division (\"Idant\"), was the first human semen bank developed in the United States for general public use. In 1985, Idant developed the first autologous blood bank in the United States where individuals could store their own blood. In 1985, the Company also initiated the development of an instrument for the measurement of the total amount of blood in the human body, the Blood Volume Analyzer (BVA-100).\nThe Company has completed successful testing the BVA-100. The instrument utilizes an isotope (Albumin I-131) which is injected into a patient from whom blood samples are drawn at timed intervals. The instrument provides an accurate and rapid measurement of the total volume of blood in the human body. The technique currently employed takes 4-8 hours and is rarely performed in most hospitals. The BVA-100 will provide preliminary results within 20 minutes and complete results within 35 minutes. The instrument will also calculate the normal blood volume of a specific individual. It will, for example, provide a very accurate measurement of the amount of blood lost by a patient during surgery. Current methods of estimating blood loss are frequently inaccurate, and many have errors as large as 35%. At the present time, there is no similar instrument on the market. The instrument will require the use of a separate kit which will require FDA approval. The isotope in the kit has previously been specifically approved by the FDA for the measurement of blood volume. On March 20, 1996, the Company received approval for its U.S. patent application for the injection kit. The patent is for an injection syringe which will be used to provide a fixed quantitative amount of isotope for use with the BVA-100. To date over 300 patients have had their blood volumes measured utilizing these measurement techniques. The repeatability of the test is estimated to be + 2%. In 1991, the Company received a U.S. patent for the Blood Volume Analyzer itself and is the first U.S. patent issued for an instrument which successfully measures the total amount of blood in the human body. In November 1992, the Company received a European patent for its Blood Volume Analyzer covering 12 countries. On March 26, 1996, the Company received a Japanese patent for its BVA-100. This is the first patent ever issued in Japan to measure human blood volume.\nThe introduction and approval of the Company's Blood Volume Analyzer has been delayed by the lack of Albumin I-131. Squibb Pharmaceuticals, who was the only U.S. F.D.A.-approved manufacturer who was producing the isotope Albumin I-131, transferred its license to Iso-Tex Diagnostics. Iso-Tex has experienced multiple delays in the approval process of the isotope. In December 1995, a meeting was held in Washington, D.C. with representatives of the F.D.A., Iso-Tex and Daxor to facilitate the approval process. Iso-Tex was given specific guidelines for completion of the approval process and Daxor believes that the approval process will occur within 1996.\nIn 1985, the Company established the first facility in the United States for long-term autologous (self-storage) blood banking. The Company began exploring the possibility of long-term storage of blood utilizing freezing technology in 1974. However, market surveys indicated that the public underappreciated the risk free alternative of autologous blood banking because of a misperception that the traditional blood banking system was safe despite evidence that there were many risks from blood transfusions. The blood banking industry is a group of for-profit and not-for-profit corporations whose total revenue is estimated to exceed six billion dollars. These groups have a large financial stake in the continuity of the current system and have opposed the creation of autologous frozen blood banks.\nUtilizing cryobiology technology, frozen blood has been shown to be capable of being stored for up to 20 years. The present donor systems of blood transfusions presents risks to those individuals receiving blood. A risk which can be avoided by utilizing one's previously stored blood. There are approximately 12 - 15 million blood transfusions administered annually. One third of the blood utilized in New York City is imported from sources outside of NYS and overseas because of severe shortages. At the present time, an individual has a 1-in-50 chance of contracting hepatitis from transfused blood and a much smaller but still real risk of contracting AIDS. Autologous storage of blood protects an individual against these and other multiple problems associated with transfusions. The concept that the \"safest blood is one's own\" is specifically endorsed by the American Medical Association, a committee of the National Institute of Health, and transfusion committees of multiple hospitals.\nDaxor's Idant division was formed in 1971, and established the world's first human sperm bank for storage of human semen and donor semen for artificial insemination. Idant has provided frozen semen to physicians for use in artificial insemination. The semen was obtained from third-party donors who were anonymous to the recipients. The donors were recruited and screened by Idant with their physical characteristics matched to the extent practicable to the needs of the recipient. Idant also offered its \"sperm bank\" storage facilities for use by men undergoing vasectomies and patients undergoing chemotherapy and radiation treatment, who are in danger of becoming sterile. This division also has provided fertility testing services. The Company maintains the largest human sperm bank in the U.S.\nSince August 21, 1995, the Idant semen bank and blood bank have been operating on a partial storage basis only. On August 21, Daxor's New York State licenses were revoked without a hearing. Some of these licenses date back 25 years and the Company has responded with multiple lawsuits, which are more completely described in the Legal Proceedings section of this report. (Item 3) The Company has been able to ship previously stored client depositor semen specimens, but has not been able to process and\/or store new specimens.\nBLOOD BANKING\nIn December 1985, Daxor received the first FDA registration in the U.S. for long-term frozen autologous blood banking. The current donor system of blood banking exposes a transfusion recipient to the dangers of infections such as AIDS and hepatitis. There are over 50,000 cases of hepatitis from transfusions annually despite testing, of which a significant number develop into major illnesses. The current system of AIDS screening does not completely eliminate AIDS carriers as donor; it only reduces the risk of an AIDS carrier donating blood. Other viral diseases, such as the cytomegalo virus, are also transmitted via blood transfusion and are not detected by current screening methods. Blood matching of minor subtypes is never done and an individual has less than one chance in 100,000 of receiving a perfect match from an unrelated stranger. Approximately 5% of all transfusions result in transfusion reactions. Another major problem is the fact that diseases such as hepatitis and AIDS may be undetectable for six months or longer in healthy appearing, infected carriers. In March 1996, the NY Times reported a case of a blood donor infected with AIDS who donated 33 times before his condition was ever detected. Daxor introduced the quarantine the concept, donated blood and sperm specimens are frozen and stored for a minimum of six months and the donor is then retested for infectious diseases such as AIDS and hepatitis before his donation can be released for use. In 1987, Daxor signed the first U.S. corporate cantract with Warner Communications to develop a pool of frozen autologous blood and frozen quarantined donor blood. Frozen quarantined donor blood, is blood from donors which has been stored for a minimum of 6 months and the donors then retested for AIDS and hepatitis. Infected carriers of AIDS and hepatitis may be undetectable by standard antibody tests for periods of up to six months (and on rare occasions even longer). Quarantined frozen blood provides a much safer form of donated blood than refrigerated blood in which the donor is tested once and the blood must be used within 42 days or less. The utilization of frozen quarantined blood also permits transfusion of multiple units of blood from a single donor. This significantly diminishes the risk as compared to when the same quantity is obtained from multiple donors.\nCompounding the risks of infection and other complications,is the frequent withholding of blood from severly anemic patients by their physicians because of these known risks of transfusion. It is a common medical practice to replace the first three pints of lost blood with three pints of sterile water or the equivalent. This problem has not been brought to public attention, but is widely known among physicians who have treated patients who have lost blood. The number of patients who suffer major complications, including sudden death, from under transfusion is unknown but significant.\nThese complications and problems can be avoided by autologous storage (self-storage) of blood by individuals. The Company believes that a considerable educational process will be required to establish the desirability of autologous blood storage and to overcome opposition to any change in the current blood banking system from established tax-exempt (non-profit) and profit-making entities who have great financial stakes in insuring the continuity of the present donor system. The Company views its entry into this field as a major long-term commitment. The current blood banking system is a monopoly, or semi-monopoly, in most areas and is controlled by tax-exempt organiztions. One such non-taxpayer has \"excess revenues\" (i.e. profits) in excess of 50 million dollars in a recent year. These organizations, while maintaining a public posture of altruism, have been very aggressive in trying to maintain a monopoly on the supply of blood resources and the income derived from these blood banking activities. In N.Y.S., the prime supplier of blood in the lower NYS, Long Island and NYC region is the New York Blood Center. In the upper region of NYS, the Red Cross is the prime supplier of blood. Some individual hospitals have small in-house blood banks which provide a small portion of the hosptials transfusion needs. All hospitals within the region are\ndependent for their blood banking needs from the regional blood center structure in their geographic area.\nUnder the present system, it is a common practice to fractionate or separate whole blood into red blood cells, platelets, and plasma. Plasma contains the clotting elements of blood plus antibodies. Sometimes patients continue to bleed because they are transfused with red cells and salt water and no clotting factors. This can cause a patient to require even more transfusions than if they had been initially transfused with whole blood. Anyone who bleeds loses all of these components simultaneously. However, they regularly receive only partial replcement. As a result, when a patient receives complete replacement of one pint of blood, for example, he could receive red cells from one donor, platelets from another donor and plasma from yet another donor. A patient who requires complete replacemnt of 3 units of whole blood could be exposed to 9 different donors, each of whom is capable of transmitting an infection such as AIDS or hepatitis. The Red Cross and others have claimed that directed donation (i.e. a donation from a known source) is not safer than blood from an unknown source. Under the frozen quarantined blood banking system that Idant developed, directed donations will be far safer - in the example cited, the risk of infection drops from approximately 4% to less than 1\/2%. This is because instead of having 9 donors the recipient would receive 3 units of whole blood from one donor. In addition, the risk of sensitization which increases with each donor would also be reduced by the same amount when blood from a single donor is used. Also, the use of doubly tested quarantined donor blood significantly reduces infection risks as compared to single tested donor blood.\nAnother major problem addressed by Daxor's blood program is the severe shortage of blood. At the present time, 1\/3 of the blood and blood products used in the New York region are imported from Europe, and out of state sources. France, Germany and Japan have been rocked by blood banking scandals in which AIDS contaminated blood was transfused despite knowledge by officials that the blood was dangerous. In France, senior blood banking officials have been sentenced to jail terms. The shortage of blood compounded by the risk from blood trasfusion have made it a common practice to replenish individuals who have lost as much as 3 pints of blood with only salt water. In some cases, individuals who have lost as much as 4 pints of blood are replaced only by salt water. The human body, depending on its size, holds only 7 to 12 pints of blood. The practice of replacing blood with salt water, widely known to physicians, is almost unknown to the public at large. This practice of replacing blood with salt water leads to a significant number of unreported heart attacks, strokes, and sudden deaths every year. Some patients who receive salt water instead of blood develop a condition called pulmonary edema, where their lungs fill up with water. Patients who develop these complications rarely have their complications attributed to the severe under transfusion they have received. In the case of sudden death, the autopsy will reveal the heart attack or storke which will usually be listed as the cause of death instead of the real cause, which is inadequate replacement of blood. Blood volume depletion is very difficult to prove as a cause of death. In animals bled experimentally, death comes rapidly and with almost no warning as the brain is deprived of blood, with sudden loss of consiousness followed by sudden death. The practice of keeping patients, including elderly patients, severely blood-depleted, would end if a safe and adequate source of blood were available.\nThe Company plans to develop a nationwide network of autologous blood banks. This would possibly eliminate the shortage of blood, and the blood would be virtually AIDS-free and would be markedly less likely to transmit infection than the current system of donor blood transfusion. The special features of the Idant blood bank would include quarantined doubly tested frozen donor blood. The major Daxor advance is the provision of multiple units of donor blood from a single donor. These concepts could provide significant competition for the current blood banking system which has serious risks because diseases such as AIDS and hepatitis may be undetectable for periods as long as six months from infected yndividuals, and occasionally even longer. The Company's concept faces fierce opposition from tax-exempt blood banks which have often held a geographic monopoly postition. (see RICO\/Anti trust lawsuit)\nIn the late 1980's, the use of autologous blood was encouraged by increaing numbers of hospitals. These programs, however, are short-term programs in which liquid blood (unfrozen) is kept up to 42 days prior to use. In these programs individuals who face elective surgery are encouraged to store between 2 - 5 pints of blood in a 5-week period prior to surgery. Some patients are even bled 72 hours prior to surgery. This practice usually results in a patients being operated upon in an anemic (blood-thinned) or blood-depleted state because almost no one is able to replace blood at the rate at which it has been removed. It is gernerally acknowledged that the more blood-depleted an individual is, the greater the risk of a compliction. The decision to operate on individuals in a blood-depleted state is a compromise between increasing the risk of surgery in a blood-depleted stated and the risks from donor transfusions.\nIt is significant that the FDA guidelines for donors will not permit blood donations more frequently than once in 8 weeks, except in certain circumstances. These new practices of self donation violate these medical guidelines and may place the patients at greater risk than if non-autologous donors had been used.\nUnder Daxor's program these risks are eliminated by obtaining blood donations which are frozen over an extended period of time, instead of days and weeks just prior to surgery. Therefore, the patient does not become depleted. Patients undergoing surgery who had stored blood under the Company's program would not begin their surgery in a blood-depleted state as contrasted to patients who had their blood taken just prior to surgery.\nIn 1991, the Company's president, Dr. Joseph Feldschuh, authored a book entitiled \"Safe Blood\" which was published by the Free Press division of Macmillan Publishers. This book provides a detailed exposition of the problems and risks of the current blood banking system as well as an explanation of the mechanics of a family frozen blood banking program. The book details the use of quarantined donor blood and the advantages of obtaining multiple units of blood from a single donor. The book was specifically written to counter the false and misleading information which is provided to the public by the so-called 'non-profit' blood collecting agencies. This practice of splitting blood into multiple components further increases the risk of multiple exposure for a specific quantity of blood.\nThe current blood supply is and has been dangerous because there have been no competitive alternatives to the current monopoly structure. A blood transfusion is the most intimate contact one can have with another human being. It is more intimate than sexual contact, yet the public has almost no control or choice from whom transfusions are obtained. At the present time only a few states in the United States have so called \"Safe Blood\" acts. These legislative changes provide individuals such basic rights as the right to have access to ones own stored blood as well as the right to choose a donor.\nIn 1993 and 1995, a bill had been introduced in the New York State legislature to guarantee these rights. It was also lobbied against by New York State blood bank regulators. It was blocked by intensive lobbying efforts of the blood banking industry's representatives. This bill, called the Vellela-Weisenberg- Polonetsky Safe Blood Act, will be reintroduced. Presently, in New York, a hospital may take a patient's blood prior to surgery and give that blood to another patient without the first patients' permission even if that patient is left blood depleted. Blood banks may skim off the plasma without a patient's knowledge or permission and transfuse only the red cells. Blood banking monopolies are also protected in many states from liabilities by special blood shield laws which often protect them from lawsuits of negligence and their false claims about the safety of their blood supply. The proposed New York State Safe Blood Act, if enacted, will mandate informed consent disclosure of the risks of transfusion and the alternatives available to a transfusion candidate.\nDaxor family blood banking programs provide for donor exposure reduction by the following steps: 1) Storage of an indivieual's whole blood (i.e. both the red blood cells and the plasma). 2) Donor Reduction Program. Utilization of multiple units of frozen blood from a single donor where additional blood is necessary. For example, a person who has stored 2 units of whole blood comprising of 2 units of red ceells and 2 units of plasma could provide that blood to another individual who would be exposed to only a single donor for the quantity of blood which would currently be directed from four separate donors. 3) Utilization of Quarantined Blood. In 1985, Daxor's Idant Laboratory division was the first sperm bank in the United Staes to initiate the concept of quarantined sperm to reduce the risk of AIDS and hepatitis. The public is unaware that the current tests for the AIDS virus does not actually test for the virus, but is only a test for the antibodies to the virus which usually take months to appear. A blood or sperm donor recently infected with AIDS therefore will test negative on the standard test, but will be capable of transmitting AIDS to the recipient of the donation. A blood transfusion recipient receiving blood product from someone infected with the AIDS virus has almost a 100% guarantee of becoming infected. Some of these people, in turn, will infect other members of their family with the AIDS virus. Elizabeth Glazer is an example of a widely publicized case of a woman who received a single AIDS infected unit of blood and then, in turn, infected two of her children. There have been many cases where an individual infected from a transfusion infects other family members.\nTo prevent this problem, in 1985, Dxor's Idant laboratory division started the first quarantine in the United States (and possibly the world) for sperm donors whereby a sperm donor's semen was stored for a minimum of six months and the donor retested a second time. Most AIDS infected individuals will develop antibodies within 6 months so that a second negative test would indicate that the six month old semen was AIDS free. This concept was adopted by the American Association of Tissue Banks in 1986, and is now the law in states\n- - -4-\nwhich regulate sperm banking. In 1987, Idant adopted a similar concept for its blood bank, encouraging individuals to be retested so that their blood would meet the criteria for \"quarantined blood\". Daxor was the first blood bank in the United States to offer this service. It is the only blood bank in the United States providing this type of blood. At the present time, there is a 95% chance that an individual will require a transfusion within one's lifetime. The utilization of autologous blood storage combined with a quarantined donor blood program, could reduce the risk of donor exposure by over 90%.\nThere is an important parallel between sperm banking and blood banking. In the 1970's, Idant was alone in advocating frozen semen in the use in artificial insemination. It was not until the 1980's, when the safety and advantages of sperm banks (whereby donors could be properly tested before their semen was released) was appreciated by the general medical community. Today, frozen semen is the standard in the land and the use of untested fresh donor semen is illegal in many states.\nTo date, privately held blood banking companies focusing primarily on storage facilities have not been profitable. The many factors behind the slow acceptance of the concept have been: 1) Monopoly practices of tax-exempt blood suppliers. 2) The use of exclusive supply contracts of anti trust laws. 3) Relationships between regulators and blood bank monopolies enforcement activities of some regulatory agencies which provide extremely difficult entry barriers to innovators wishing to provide competing or alternative services. Some services such as frozen blood banking which Daxor provides. The passage of \"Safe Blood\" acts by various states is a major step towards protecting the rights of the public. We believe a federal law will provide uniform protection to patients throughout the United States.\nIt is a goal of the Company to develop a network of Family Frozen Blood Banks which will also have sperm banking capabilities throughout the United States. The Company believes that as the public becomes increasingly aware of the deceptions about the safety and inadequacy of current blood transfusion practices, that individuals will seek to provide this essential form of insurance for themselves.\nIn March 1995, Daxor assisted in the development of U.S. Cryobanks of Florida which provides both semen and blood banking. Daxor has a 29% interest in U.S. Cryobanks of Florida, which is under independent management.\nMeasurement of Human Blood Volume\nThe diagnostic data to be provided by the Company's blood volume measurement equipment would be usable by physicians in a variety of medical fields, including critical care, cardiology, peediatrics and surgery, to identify and quantify the amount of blood loss the patient has suffered, to determine the percentage of red blood cells or hemoglobin the patient has lost, and to help to determine the need for continuing treatment. An estimated 12 million blood transfusions per year are performed in U.S. hospitals. The Company believes that, if its blood volume measurement equipment were available in a hospital, it would be feasible for the hospital to routinely perform a blood volume test on every patient for whom a blood transfusion appeared to be indicated. Blood volume measurement would also provide a valuable diagnostic tool in treating certain types of heart and kidney disease. At the present time multiple medical conditions are associated with inadequate blood volume and occasionally excess blood volume.\nThe ability to accurtately measure the quantitiy or volume of blood in an individual would be expected to be particularly useful in surgical situations. The standard methods of estimating the amount of blood an individual has are called the hematocrit or hemoglobin. These tests actually measure the thickness of or quantity of red blood cells in an individual's blood rather than the blood volume itself. Blood is composed of cells, primarily red cells for carrying oxygen, white cells for fighting infections, and platelets, small cells used for clotting purposes. The remainder of the blood is called the plasma, which is primarily water in which are suspended the cells with various clotting factors and special blood proteins. When an individual bleeds, the body will attempt to maintain the same total blood volume by the transfer of water from other parts of the body into the circulatory system. This process causes a thinning of the blood called anemia. The thinning process may take hours or many days to occur, or may never occur completely. When the blood thinning process has not occurred completely, the hematocrit will overestimate the amount of blood the individual actually has.\n- - -5-\nThe more rapid the blood loss, the less likely the hematocrit will reflect the true picture of the patient's blood volume. For example, an individual who has just donated a pint of blood (usually over a 6-10 minute period) obviously has one pint less blood at the end of the donation than at the beginning. Yet a hematocrit measurement at the beginning and at the end of the donation may be almost unchanged, therefore giving no indication that the individual has just lost a pint of blood. Surgery is a situation in which individuals lose relatively large quantitites of blood in a short time. Despite infusion of saline (salt water) and other blood substitutes, the hematoctit is frequently very misleading at the end of surgery as to the quantity of blood lost. Patients may have lost 25 to 35 percent more blood than estimated from hematocrit measurement and the weighing of blood-soaked sponges. Patients losing more than 3 pints may have circulatory collapse when undergoing anesthesia. Even the loss of 1 - 2 pints in an individual with heart disease may have serious consequences.\nThe Blood Volume Analyzer, BVA-100, will permit patients to have their blood volume measured to within an estimted accuracy of +2% prior to surgery. It will also permit estimates of +5% during surgery within 20 minutes and +2% within 35 minutes.\nThe instrument will also calculate the normal blood volume for a specific individual. The normal blood volume for an individual is related to a complex interplay of height and weight. The instrument will provide these calculations. The instrument will calculate the deficit of excess of both the red cells and the plasma. The provision of this type of data in the opinion of the Company will provide critical information in a timely fashion not only in surgery but in other conditions such as heart failure and kidney failure.\nThe Company has developed a special injection kit which is used with the machine for each test. The injection system provides a quantitative highly precise injection. The system can be used in this situation where a precise injection is needed. The injection system received the first United States patent ever issued for such a kit on March 20, 1996. The Company, in 1991, recived a U.S. patent on the instrument itself, 12 European patents the following year and a Japanese patent on March 26, 1996. The Company is awaiting approval of the Iso- Tex Diagnostics, Inc. to manufacture Albumin I-131. The isotope itself has been previously approved by the F.D.A. for the measurement of human blood volume. Approval is needed for this specific manufacturing facility (Iso-Tex). The instrument could theoretically be used without the kit, but then the user would need several hours to obtain results. In addition, the costs of preparing a kit substitute would most likely be greter to any user than the purchase cost of the kit itself. The cost of a kit to hospitals is estimated to be about 1\/5 of the cost which a hospital would charge for the test.\nThe Company believes that the most significant market for its blood volume measurement equipment consists of the approximately 8,000 hospitals and large clinics in the United States and other hospitals outside the U.S. The Company believes that there is an international market of 10 -14,000 potential users of its BVA-100. In addition, many physicians conducting extensive practices in cardiology, radiology or internal medicine might purchase equipment and related test kits for diagnostic use.\nThe Company plans to demonstrate its blood volume equipment at trade shows across the United Staets and to market the equipment to the nation's hospitals on both an outright sale and lease basis. The Company will use its own capital to develop lease programs where hospitals will not purchase the equipment, but will commit to use a minimum number of kits per week. This marketing approch has been successfully used by other medical technology equipment manufacturers. The Company may possibly be in a position to market the BVA-100 overseas before final approval in the United States. In ddition, the Company may attempt to enter into distribution contracts with one or more large hospital supply companies. The Company will train hospital technicians to utilize its products and expects to supply test kits to users of its equipment on a continuing basis.\nThe Company will initially manufacture its instrument on a subcontract basis. It plans to establish service centers and currently plans to manufacture its own kits.\nPatent and Copyright Protection\nThe Company in 1991, after a five-year application period, received a United States patent on its Blood Volume Analyzer (BVA-100). This is the only patent ever issued for an instrument dedicated to the measurement of the total human blood volume for a specific individual. In 1992, the Company received a European patent covering 12 countries. On March 26, 1996, the Company received a Japanese patent for the BVA-100. The patent application was originally filed in 1989, and is the first patent ever issued in Japan to measure human blood\n- - -6-\nvolume. The Japanese patent provides protection until the year 2009. The instrument is designed to work with an injection kit to be manufactured by the Company. It is theoretically possible to use the blood volume analyzer without the kit by preparing the reagents used for the test. However, the cost and time for such preparations would be uneconomical and it is unlikely that a puchaser of the instrument would use it without purchasing the reagent kit. On March 20, 1996, the Company recived approval for its U.S. patent application for its injection kit, which is specifically designed to be used with the in instrument. This is the first US patent ever issued for a system which permits a fixed quantitative amount of isotope to be injected for diagnostic purposes. The injection system was specifically designed for use with the BVA-100. However, it can be used for other diagnostic test purposes where a precisse complete quantitative injection of a diagnostic reagent is required. Patent protection will extend for 17 years from the official date of issuance, which is expected to be within the next 60 - 90 days. The Company has explored a number of variations of the kit and recently successfully completed key tests on the final version of the kit.\nIdant Laboratory Division\nIdant pioneered both the technology and the commercial application of long-term preservation of human sperm for use in artificial insemenination. The division has provided frozen semen and services to physicians worldwide. As of February 1, 1996, Idant held approximately 55,000 human semen units in long-term storage at its central New York City facility. The Company maintains the largest human sperm bank in the U.S. A decrease in the number of adoptable children because of increased birth control and abortion has contributed to an increase in the number of patients and physicians seeking to utilize donor semen collected and stored by Idant in its sperm banking facilities.\nUse of Frozen Sperm for Artificial Insemination by Donors\nIdant, in 1985, was the first semen bank to institue an AIDS quarantine period for frozen semen. In 1989, New York State and a number of other states enacted laws requiring sperm banks to freeze and quarantine sperm for a minimum of six months with donors being tested at the beginning and at the end of the six-month period. By storing semen from a large cross-section of sperm donors, Idant can closely match the physical characteristics of the sperm donor (the Company maintains a complete physical description of each donor on file and matches multiple physical characteristics and additional special characteristics sought by the family) to those of the sterile father. The Company also provides, on request, special screening for rare hereditary recessive genetic traits. The increased likelihood of a child who resembles his reipient father cn make the child, who results from atrificial insemination, much more psychologically acceptable to the father. In February 1988, the Centers for Disease Control and the American Fertility Society both officially endorsed frozen semen as the only recommended form of semen for use in artificial insemination.\nBy eliminating the requirement of immediate donor availability, a physician utilizing frozen semen can more precisely match ovulation and insemination times. In addition, the use of frozen semen may enable a couple to utilize the same donor for future children, regardless of the availability of the donor at the time they desire a future child.\nThe Company is very selective in its choice of donors and estimates that only 5 - - - 10 percent of all donors are ultimately accepted as semen donors. Idant recruits these donors from the approximately 130 colleges and schools of advanced learning in the New York metropolitan area and does not accept donors from the public at large. Prospective donors are also screened on the basis of a three-generation family medical history and a battery of over 30 blood tests, including tests for AIDS and multiple forms of hepatitis. All semen specimens are checked for vibility of sperm, cultured to insure germ-free condition and screened for various forms of hereditary and metabolic disorders. Idant also screens semen for genetic diseases common to persons of the prospective donor's racial or ethnic background. The Company, upon request, also screens for rare genetic traits. Doctors who use fresh semen face potentially large lawsuits from patients who become infected. Fresh semen always involves the risk of infection.\nThe FDA is now instituting semen bank regulations and is expected to restrict the use of fresh donor semen, except for very special situations.\nStorage of Sperm for Personal Use\n- - -7-\nThe Company's sperm bank facilities contain stored sperm which should remain viable for many years. Semen stored for 23 years, at minus 321 degrees, has shown minimal change (the Company has had documented normal births from semen stored 16 years). The Company's facilities are used by men who, for a variety of reasons, anticipate imapairment of their ability to father children and by men who have been found to be marginally fertile. These men may now be able to have children by use of techniques that increase their fertility by treating their sperm to artificially inseminate their partners. The facilities are also used by men who plan to undergo steriliztion by vasectomy, but who believe that they might desire children in the future. Artificial insemination using stored sperm is much more effective and less expensive than present techniques of vasectomy reversal. In addition, patients with a variety of diseases, including many types of cancer, store semen prior to undergoing treatment by chemotherapy or radiation. By utilizing cryogenic preservation facilities, these patients, who are frequently in their teens or twenties, will be able to father their own children after treatment despite the high risk of sterility and birth defects associated with treatments. The Company receives referrals for these services from multiple sources, primarily physicians.\nDifferent technologies and methods have been used for freezing semen. Historically, sperm banking had a poor reputation for effective preservation of human semen. However, the Company's preservation techniques and methods overcame the difficulties associated with freezing human semen. Dr. Jack Shuber of Mount Sinai Hospital in Toronto reported almost identical pregnancy rates withfrozen semen as with fresh semen based on treatments of 193 patients verifying the effectiveness of Idant techniques. In addition, Dr. I. Ray King of Knoxville, Tennessee, completed an independent study which showed markedly higher pregnancy ratios in artificial inseminations using Idant semen as opposed to semen obtained from a competing semen bank. In Dr. King's study, Idant semen produced a 17.5% rate of pregnancy per insemination cycle and a 67.1% cumulative percentage of pregnancies over 11 cycles, as opposed to results of 10.3% and 42.3%, respectively, for its competitor. These results are significant when compared to studies using frozen semen from a variety of sources, which showed pregnancy rates from artificial insemination by thawed donor sperm to be much lower than results of artificial insemination by \"fresh\" donor sperm. Idant periodically spot-checks its bank storage to test viability of selected specimens of stored semen; results of these spot-checks have shown sperm samples held in excess of 23 years to have almost no loss in vability or change in condition.\nA major recent development has been the ability to achieve pregnancy by injecting a single sperm into a human egg. The fertilized egg is then placed within the uterus. This means that individuals with very low sperm counts may still be able to have their own children.\nThe Company is engaged in an area which requires a high degree of diligence. The Company utilizes a semen identification and quality control program which has 21 check points for identification and verifiction from the time the specimen is received from a patient storing his specimen and its eventual use by the patient's wife. A key part of the identification system is a numbering and labeling system in which the patient's specimen receives a unique (used only once) code number. The patient participates in the identification and labeling of his own specimen. This unique number is placed on the patient's aluminum storage canister and on the plastic straw containers which contain the patient's semen. The patient collects his semen in a special container with this code number. The patient's semen is mixed with a cryoprotective agent which prevents damage when the specimen is frozen. There is only a single physical transfer from the collection container to the storage straws. There are a total of 21 check points before the specimen is ready for long-term storage. Idant's system is designed so that the original storage straws can be used diretly for insemination. When specimens are shipped to the physician there are an additional five chick points with two (2) initial checks at the time of recipt of the specimen. Prior to use the physician should go through another triple check: (a) the shipping documents (b) the tags on the semen holder which contain the patient's code number, his name and social security number and most significantly, (c) the plastic straws themselves. In fact, patients can participate with their physician in this checking process. Utilized as designed, the Idant semen collection system is virtually fool-proof.\nProprietary Technology and Procedures\nThe Company uses a customized carousel canister system in its sperm bank storage system. This permits retrieval of specimens from lower levels without removal of upper specimens. Only a few other sperm banks in the U.S. are known to have such a system. Most other banks use a \"rack and cane\" pull-up system which requires removal of upper specimens from the tank to retrieve specimens at lower levels. In such a bank, a specimen may be exposed to a tmeperature change of\n- - -8-\nminus 321 degrees F (the temperature of the liquid nitrogen) to room temperature of 78 degrees more than 100 times during its storage lifetime. This will result in a gradual degradation of the specimen. In the Idant system the specimen remains under liquid nitrogen almost continuously while in storage.\nResearch into preservation of human sperm has shown that without tightly controlled conditions, a marked drop-off in viability of sperm (i.e. the number of live, active sperm in a sample which could be expected to fertilize an egg) occurs within one to two years of storage. In addition, frequent handling of specimens decreases the viability of sperm. Based on this research, Idant utilizes a non-patented proprietary technique of staged freezing combined with the use of Cryopreservation agents, prior to storage of the semen in liquid nitrogen at minus 321 degrees F. Levels of liquid nitrogen in its sperm bank storage tanks are continuously monitored. The liquid nitrogen tanks can maintain their temperature for over one week without additional liquid nitrogen. The Company has tecnicians on call during night hours as back-up for emergencies. The freezing sytems do not require electric power for maintenance of temperature levels. In addition, the Company has established and follows a ' complex procedure for collection, processing and retrieval designed to minimize the handling of specimens. The Company also uses liquid nitrogen in connection with its quality control and strict adherence to shipping, storage and handling procedures designed to minimize the exposure of its stored sperm to changes which would impair viability are major reasons for Idant's recognition in the industry as the major source for effective, viable frozen semen.\nMarketing\nIdant markets its services directly to physicians, primarily through attendance at medical trade shows and conferences at which its services are described. In addition, Idant offers education seminars in the use of frozen semen and advances in artificial insemination to medical and technical audiences and participates in numerous medical conferences. The Company's work in both semen preservation and blood banking has been featured multiple times on all national television networks as well as international networks and in the national magazine and major newspapers.\nConsultation, Labortory Management and Training Program\nDaxor provides consultation with regard to the requisite personnel, equipment and facilities for small specialized medical laboratories and offers, on a contract basis, to design, staff and manage such laboratories. Where Daxor provides management services for laboratories on an on-going basis, it employs and supervises laboratory personnel, establishes and maintains procedures and provides other continuing services.\nCompetition\nThe medical technology market is intensely competitive. There are, however, no competing instruments manufactured or marketed which perform semi-automatic blood volume analysis, such as the BVA-100. The Company believes that its receipt of a United States, European and Japanes patent for its Blood Volume Analyzer provides significant protection against any future portential competition in the blood volume ananlysis field. The receipt of the U.S. patent for the injection kit system provides significant additional protections as the Company believes that the kits will be a major source of revenue. The Company believes that its main hindrance to market acceptability will be the need to demonstrate that its blood volume measurement equipment is capable of producing accurate data on a cost effective basis. Test kit costs will be modest relative to cost of a trnsfusion and the critical information derived from the test.\nThere are at least 150 sperm banks in the United States operated by either commercial entities or by academic institutions. The Company believes that increased public awareness of the efficacy of frozen semen stored by it along with recent medical journal articles emphasizing the necessity of or careful screening of donors for artificial insemination will result in an increasing use of frozen semen for this purpose. The Company believes that Idant's reputation has been damaged by the false charges of the NYSDOH. The Company believes that the effects of its RICO\/Anti trust lawsuits will enable us to regain a significant portion of its former clients, when Idant's full licenses are reinstated.\n- - -9-\nBlood banking services are provided by a broad spectrum of organizations. Approximately one-half of the blood supply used for transfusions is supplied by the American Red Cross and its branches. The other portion is supplied by various other tax-exempt and for-profit organizations. Some hospitals operate their own donor services, but require the services of outside vendors such as the Red Cross for adequate supplies of blood products. The current practice in the blood banking field has been to split blood into various components such as red cells, platelets and plasma, which are then sold as separate units. Components of the plasma are usually sold to pharmaceutical companies which manufacture separate clotting and diagnostic factors. In many regions, blood banking is a monopoly or semi-monopoly structure. Blood banks almost unifomly do the minimum required testing on collected donor blood. Hospitals usually have one primary supplier and occasionally supplemental suppliers of donor blood. Many hospitals are very dependent on their primary geographic supplier of donor blood. The primary supplier is usually a monopoly, which may have exclusive contracts with the hospitals that they supply. Patients have almost no choice with respect to storage of their own blood prior to needing a transfusion for elective surgery. The blood banking industry has historically been opposed to the concept of frozen autologous storage of blood, even during a period when 1 in 10 transfused patients contracted hepatitis. The development of frozen autologous blood banking and quarantined frozen blood banking programs by tax paying corporations such as Daxor has been met by an extreme hostile response from the monopolistic controllers of donor blood. The advent of frozen autologous blood banking poses a fundamental threat to the staus quo of the current donor blood industry. These organizations, as far back as 1983, conducted internal reviews of the amount of income that they would lose for each percentage of the population that elected to store their own blood. Blood banking organizations have repeatedly made false claims concerning the availability of stored frozen blood. The New York Blood Center is the primary supplier of blood in lower NYS and the Red Cross is the primary supplier in the upper region of NYS. A number of hospitals maintains a small in house blood bank to supplement their blood supply which are inadequate for their internal needs. Therefore, they are very dependent on their blood suppliers.\nDaxor's program of quarantined donor blood and multiple units of donor blood from a single donor provides a basic fundamental threat to the existing blood banking system. Frozen blood banking incorporating quarantined blood and multi- unit single donor blood is demonstrably far safer than the existing blood banking system.\nDaxor believes that it has been extensively damaged by the collusive actions of the New York Blood Center and key members of the blood banking regulatory agency of New York State Department of Health (NYSDOH).\nDaxor believes that the availability of safer frozen blood to the public, utilizing either autologous blood or quarantined donor blood, would result in a basic chnge in the blood banking system. Sperm donors are usually paid. Sperm banking operates at a much higher level of donor testing safety and donated sperm is now usually quarantined at all AATB member sperm banks. The advent of quarantined frozen blood with paid donors could have a negative financial impact on tax exempt organizations which rely on free donors. Fifteen years ago, the majority of semen donations for artificial insemination derived from utilization of fresh semen with limiting testing of donors. Today, almost all donor semen is derived from frozen donor semen which has been quarantined for a minimum of six months and the donor retested. Despite the advantages of frozen blood programs, such as Daxor's, more than 99% of all donated blood used for transfusion is derived from refrigerated blood and transfused in under 42 days and where the donor has only been tested initially.\nThe Company is aware of two other lawsuits instutited by small private blood banks against the Red Cross. A successful conclusion of the Company's anti trust suit against the New York Blood Center will enable the Company to provide blood transfusion products that are clearly safer.\nRegulation\nThe Idant Sperm Bank was first licensed by New York City in 1971, and its Blood Bank in 1985. In 1989, Idant's blood bank was temporarily closed for four months after a number of false charges by an inspector of the New York City Department of Health. Following a hearing in the fall of 1989, Idant had its full Blood Bank license restored by the New York City Department of Health. The City inspector primarily responsible for the false charges against Idant took the Fifth Amendement against self-incrimination five times just prior to the hearings being stopped by mutual agreemtnet; he was later dismissed. The New York State Department of Health unexpectedly removed Idant's state permit in January 1990, just after New York City had restored its blood banking permit. The Company has retained attorneys to obtain full state licensing. The Company\n- - -10-\nbelieves that the difficulties with the New York State Department of Health (NYSDOH) are the result of a concerted effort by a combination of key regulators acting in conjunction with a major blood banking semi-monopoly system to destory Daxor's frozen blood banking program. In 1987, the signing of the Warner Communication contract for qurantine frozen blood and autologous blood provided for the development of frozen quarantined blood pools. This concept, if successful, would have a major financial impact on the New York Blood Center and any other blood banking semi-monopoly. The Company's president, Dr. Joseph Feldschuh, has been an outspoken critic of the blood banking establishment and has written a book entitled \"Safe Blood\" published by the Free Press division of the Macmillan Publishing Company which details deficiencies in the current blood banking system.\nIn NYS, blood banking and semen banking are under the control of Dr. Jeanne Linden. Blood banking regulations are developed by a quasi governmental body, the Council on Human Blood and Transfusion Services, which enacts blood banking regulations. Individuals such as Dr. Celso Bianco of the New York Blood Center, representatives of the Red Cross, and advisors to these organizations serve on this committee. One member of the Council on Human Blood and Transfusion Services told Dr. Feldschuh in 1988, that Idant would be put out of business. Since 1985, Idant has been inspected annually by the FDA and continously approved for operation, inspected by New York CIty since 1985, and approved annually, and has been inspected and accredited by the American Association of Blood Banks annually since 1986. Since January 1990, the state has blocked renewal of laboratory license and issued a providional semen bank license. Despite approval from the other aforementioned organizations, the NYSDOH has repeatedly denied Idant's licenses. The Company operated legally on the basis of its New York City licenses. In response to the repetitive denial of its state license, the Company istituted a number of legal actions. In 1994, the New York City and State licensing functions were merged and the state assumed sole control of all licensing. The background of the state's actions have been extensively described in a 2nd quarter 1995 special report that was issued to shareholders. (see Legal Proceedings section and 2nd quarter special report)\nOn August 21, 1995, Daxor was ordered to close all of its facilities, including its blood bank without a hearing. This action was a culmination of a campaign dating back to at least 1989, to terminate Daxor's blood banking services. Daxor iniated a $100 million RICO\/Anti trust suit against a number of key officials in both the city and state Departments of Health and Dr. Celso Bianco from the New York Blood Center. Daxor also instituted an immediate appeal. Daxor has tape recordings documenting perjury by inspectors of the NYSDOH and also has extensive evidence of falsified inspection reports.\nThe August 21, 1995, closure order by the State Health Department attempted to force the 3,000 blood and semen depositors to transfer their semen and blood specimens to another facility within 30 days of the closure order or have said specimens destroyed. A class afction suit was institute on behalf of the depositors which prevented this from taking place. On January 29, 1996, the Company had a hearing in the Appellate court concerning the issue of revocation of its licenses without a hearing. A decision is pending.\nDaxor has maintained that when the city and state licnsing functions were merged, that the Company was entitled to a state license or else a hearing on the basis for the denial . The Company believes that it has been the victim of collusive action by members of the regulatory agency which is partially controlled by monopolistic competitive blood banking organizations. These organizations would face a major change to their basic operations if Daxor's frozen blood programs become widely accepted.\nThe Idant Semen Bank has been the subject of a separate hearing concerning a 1993, inspection during which the department claimed that men storing semen to have their own children with surrogate mothers were a form of directed donors. The men in question had voluntarily undergone 40 tests, including tests for infectious diseases such as AIDS and hepatitis. Sperm donors require only 9 blood tests, including tests for infectious diseases such as hepatitis, by the NYSDOH. The 40 men in question had 10 different hepatitis blood tests, rather than the three recommended by the NYSDOH. Despite agreeing to classify future individuals who were actually having their own children s directed donors, the Company was charged with not testing donors and was deemed to be \"beyond rehabilitation\" by an administrative court judge who is an employee of the department. The department admitted that in Idant's 25-year history that in which it has handled approximately 600,000 specimens, they are unaware of anyone contracting infection from semen stored at Idant or that Idant had ever shipped out anonymous donor semen that was not tested. This case which was also by coincidence decided on August 21, 1995, is currently under separate appeal. With respect to the blood bank, in its 10-year history, Idant has never shipped\n- - -11-\nout a unit of infected donor blood. The Company has also formally reapplied for its semen bank license and believes that the vigorous legal actions that it has taken will result in a restoration of its licenses.\nThe Company was inspected by the FDA in May 1994, February 1995, and February 1996, and had no violations noted. The Company has applied for an FDA interstate license for the shipment of blood. The Idant blood bank is subject to inspection and regulation by the FDA. Idant has been inspected annually since 1985, by the FDA and received the first FDA registration for a frozen autologous blood bank in the United States. The FDA has two levels of inspection and approval. A blood bank operating primarily within a state is inspected, and if approved receives a \"registration certificate\". A blood bank which ships blood interstate and is a manufacturere of blood components must receive an interstate license. Interstate licensing inspections and requirements are particularly intensive with respect to documentation requirements. Members of the New York State Department of Health have claimed that Daxor cannot ship autologous blood outside NYS without an interstate license because it has only a FDA registration. The majority of NYS blood banks have only a FDA registration and not a license. The FDA has specifically informed Daxor that it can ship autologous blood interstate without a license and that it can ship special directed donor blood (such as quarantined donor blood) without an interstate license in the event of a docuemnted emergency.\nThe development, testing, production and marketing of medical devices are subject to regulation by the FDA under the Federal Food, Drug and Cosmetic Act, and may be subject to regulation by similar agencies in various states and foreign countries. The governing status and regulations generally require manufacturers to comply with regulatory requirements designed to assure the safety and effectiveness of medical devices. The key factor behind the delay in the Company's Blood Volume Analyzer has been the lack of availability of Albumin I-131. The Company's BVA-100 will require separate FDA approval by its medical device section. The Company's BVA-100 will be filed under a form 510(K), such approval processing usually require less than six months for approval from date of filing.\nEmployees\nOn March 20, 1996, the Company had 35 employees. None of the Company's employees are covered by a collective bargaining agreement. The Company believes that its employee relations are good.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nIn February 1992, the Company signed a thirteen year lease for a new facility at the Empire State Building. The initial space was for 6,000 square feet, with option provisions in the lease for up to 24,000 square feet. Future minimum rental payments under this non-cancelable lease are as follows: 1996 - $168,832, 1997 - $168,832 and 1998 - 168,832. The lease also contains CPI escalation clauses. The new facility was completed in July of 1992 and the Company moved in that same month. In March 1994, the Company obtained an additional 1,000 square feet of space.\nIn February 1996, the Company incorporated Daxor Health Services, Inc. a wholly owned subsidiary in Florida. Daxor acquired a 25% interest of Therapeutic Rehabilitation Services, a privately held Florida company engaged in rehabilatative services.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe Company, as a result of the Resimmo offer in July 1992, has had two class action lawsuits initiated against it. One group of investors who purchased stock allege, in essence, that Ressimo was non-existent, and that the offer was concocted by the Company's president, Dr. Joseph Feldschuh, and Ex-Vice President, Allen Gelb. Dr. Feldschuh had never sold any shares of Daxor in the 18 year period prior to the offer, including the period up to the time when the offer was withdrawn by Resimmo. The second action is by a group of investors who sold the stock short and also claim that Resimmo is non-existent, but names all officers and a single director. The Company believes there is no merit to these lawsuits.\nIn 1994, director Stephen Moss who was the only member of the board of directors who sold any stock during the period in question, had the charges against him dropped. All other members of the Board and executives named, neither bought nor sold stocks.\nThe Company is considering instituting legal action to countersue the claimants for frivolus claims. The Company feels that the above lawsuits are without merit.\n- - -12-\nThe Company is involved in several proceedings with the New York State Department of Health relating to its licenses to operate a laboratory and sperm and blood bank. These actions are as follows:\n1. Idant Laboratories, et al. v. State of New York Department of Health, et al. (Supreme Court, New York County; Index No. 105052\/94). Idant commenced suit challenging the State Health Department's denial of Idant's clinical laboratory and blood bank licensure operations for the periods including 1991 - 1993. By decision and order dated April 13, 1995, Justice Freeman denied Idant's petitions. A notice of appeal has been filed and motion to expand the time to file the appeal has been filed.\n2. Daxor Corp., et al. v. State of New York Department of Health, et al. (Supreme Court, New York County; Index No. 131181\/94). This matter was instituted by Daxor challenging the constitutionality of the State Health Department's semen bank regulations. By decision and order dated April 26, 1995, Justice Harold Tompkins denied the motion of the State Health Department to dismiss the complaint and declined Daxor's request to convert the State Health Department's motion to one for summary judgment. The proceeding remains ongoing.\n3. Daxor Corp., et al. v. State of New York Department of Health, et al. (Supreme Court, New York County; Index No. 10754\/95). This proceeding was instituted by Daxor to challenge the detemination of the State Department of Health to revoke all the determination of the State Department of Health to revoke all licenses issued to, and to deny all licensure applications for, Daxor's New York health care facilities. The Court (Tompkins, J.) heard argument on the petition on June 23, 1995, and by decision and order dated July 17, 1995, denied Daxor's application. An appeal from that decision was filed on November 6, 1995, with the Supreme Court, Appellate Division, First Department. The appeal was argued before the February Term of the court. The matter is pending a decision.\n4. Daxor Corp., et al. v. Linden, New York Blood Center et al. (United States District Court, Southern District, Case No 95 Civ. 7847 [KTD]). Daxor instituted an anti trust, Racketeering Influenced Corrupt Organizations Act and a $100 million action pursuant to 42 USC S 1983 for violations of its civil rights. This action alleges that the New York Blood Center with the other defendents engaged in predatory monopolistic actions to prevent the implementation of Daxor's frozen blood programs. The lawsuit also alleges that various members of the NYSDOH actively consipired with the New York Blood Center and other members of the blood banking community to drive Daxor's blood bank out of business. The defendants filed motions to dismiss the complaint. The matter is pending a decision by the court.\n5. Daxor, et al. v. Amy Clyde, et al. (Supreme Court, New York County; Index No. 122486\/95). Daxor instituted an action for defamation against Amy Clyde, the author of the article, and K-III Corp., the owner of the New York Magazine, which published the defamatory article. This proceeding remains ongoing.\n6. Daxor, et al. v. State of New York, (Court of Claims; Claim No 90213). Daxor instituted a claim for defamation against the State of New York resulting from the dissemination of false information regarding Daxor to the media. This claim remains ongoing.\n7. Daxor and Yaker, et al. v. DeBuono, (Supreme Court, New York County; Index No. 122486\/95). Justice Cohen. This is a class action instituted by tissue depositors of Daxor against the Department of Health from mandating the removal of the class' property from the Daxor\/Idant blood and semen bank premises. A hearing has been scheduled for May 3, 1996, before Justice Stuart Cohen.\n8. Idant v. DeBuono, (Supreme Court, Albany County; Index No. 471\/96). Justice Canefield. This is a petition instituted pursuant to CPLR Article 78, appealing the decision of the New York State Department of Health for revoking Idant's Semen Bank license. The basis of this action is that the Department of Health revoked the license in violation of Public Health Law section 4366. The matter was argued and submitted to Justice Canefield and a decision is pending.\n9. Idant v. The Department of Health of the City of New York, (Supreme Court, Appellate Division, First Department; Index No. 123218\/94). This action is an appeal of the City Department of Health's decision to prohibit Daxor from performing Semen Analysis. This matter was argued before the February Term of the Appellate Division. A decision is pending.\n10. Gregory Pollinger v. Joseph Feldschuh, Idant Laboratories and Daxor Corporation, (Supreme Court, New York County; Index No. 122560\/95). A Daxor semen bank depositor brought suit, alleging that his semen stored at Daxor is no\n- - -13-\nlonger viable. The plaintiff complaint does not allege a dollar amount in the ad adamnum clause. The standard Semen Depositor contract, that the Plaintiff signed, specifically states that Daxor cannot guarantee the viability of the semen and that there are no warranties, expressed or implied. Based upon the clear language of the contract, the Company believes that Plaintiff's action is without merit. Examination of the client's semen at an independent facility documented that the specimen was still viable. The Company believes this suit is without merit and may countersue for a fivoulous claim.\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 during the fourth quarter on 1995.\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters\nThe common stock is traded on the American Stack Exchange under the symbol DXR.\n_____________________________________________________________________________\nOn March 26, 1996, the Company had approximately 605 holders of record of the Common Stock. The Company believes there are approximately 25000 beneficial holders.\nThe Company has never paid any cash dividends on the Common Stock. Any future dividends will be dependent upon the Company's earnings, financial condition and other relevant factors.\n- - -14-\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe folllowing table sets forth certain selected financial data with respect to the Company and is qualified in its entirety by reference to the financial statements and notes thereto, from which these data were derived, included elsewhere in the report.\nSelected Operations: Statement Data:\n- - -------------------------------------------------------------------------------- Selected Balance Sheet Data:\n* Return on equity is calculated by dividing the Company's net income for the period by the shareholders' equity at the beginning of the period.\n- - -15-\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - - -------------------------------------------------------------------------------- GENERAL - - -------------------------------------------------------------------------------- Idant Laboratories contributed 85%, 82% and 82% of operating revenues in 1995, 1994, and 1993, respectively with the remainder coming from contract laboratory work. The Company has been injured by false claims by New York State Health Department Officials concerning its anonymous semen donor program. The August 21, 1995, closure order by the NYSDOH without a hearing on alleged violations unrelated to Idant's semen or blood bank has had a negative impact on the Company's revenues and earnings. The Company has continued to receive income from its storage clients of semen and blood deposits, but has been limited in its ability to ship donor semen. The Company also has received no revenue from satellite laboratory, which contributed approximately 15% to revenues prior to the closure order. The summary closure order is currently under appeal before the Appellate Court. If the Company is successful on its appeals, it is believed that the Company's laboratories will become fully functional. A number of other legal actions, including a RICO\/Anti trust suit have been initiated against the New York Blood Center and a number of key NYSDOH officials. If the Company prevails in its suit, the Company could receive recovery of legal fees and monetary compensation for lost business. The Company in 1995, acquired a 29% interest in U.S. Cryobanks in Altamonte Springs, Florida, a suburb of Orlando. In February 1996, the Company acquired a 25% interest in Therapeutic Rehabilitation Services and incorporated Daxor Health Services, Inc. in Florida. - - -------------------------------------------------------------------------------- YER ENDED DECEMBER 31, 1995 AS COMPARED TO DECEMBER 31, 1994 - - -------------------------------------------------------------------------------- Total revenues we $4,748,935 in 1995, up from the $4,587,135 reported in 1994. Dividend income earned on the Company's securities portfolio was $2,209,962, an increase from the $2,157,735 reported in 1994. Gains on the sale of investments were $607,163 in 1995 as compared to $435,198 in 1994. Net income before income taxes was $1,451,973 in 1995 vs. $2,613,481 in 1994. - - -------------------------------------------------------------------------------- YEAR ENDED DECEMBER 31, 1994 AS COMPARED TO DECEMBER 31, 1993 - - -------------------------------------------------------------------------------- Total revenues were $4,587,135, down from the $4,799,513 reported in 1993. Dividend income earned on the Company's securities portfolio was $2,157,735, a decrease from the $2,164,619 reported in 1993. Gains on the sale of investments of $435,198 in 1994, as compared to gains of $1,419,360 in 1993. Net income before income taxes was $1,973,654 vs. $2,310,654 in 1993.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company's management has pursued a policy of maintaining sufficient liquidity and capital resources in order to assure continued availability of necessary funds for the viability and projected growth of all ongoing projects.\nThe Company continues to maintain its diversified securities portfolio comprised primarily of high-yielding electric utility preferred and common stocks. The income derived from these investments has helped to offset increases in operating, selling and gerneral and administrative expenses and thus to maintain or fees at a competitive level. The portfolio also provides for the availability of funds as needed for new projects and the expansion of existing sources of revenue.\nAt December 31, 1995, the Company's short term debt was $1,536,609 vs. $3,864,605 in 1994. At year end 1995, shareholders' equity was $32,052,831. At year end 1995, shareholders' equity was $32,052,831. At year end 1994, the Company had shareholders' equity of $29,199,180. At year end 1993, shareholders' equity was $24,430,639. Shareholders' equity has thus increased $7,622,192 over the two year period from year end 1993.\n- - -16-\nThe Company has been blocked from proceeding towards approval of its Blood Volume Analyzer because of the lack of availability of an FDA approved supplier of Albumin I-131. In early 1994, the Company acquired the rights of reference to FDA-approved NDA's from two former manufacturers of Albumin I-131. The Company could become a manufacturer of the isotope and subcontract part of the process. The Company believes that Iso-Tex Diagnostics will soon receive FDA approval for this isotope and the Company would therefore develop its own kit production facility. The Company plans to offer to lease, as well as sell, its Blood Volume Analyzer (BVA-100) and could use its internal funds to provide some leases if an independent leasing agent were not available.\nThe Company plans to develop a comprehensive national network of autologous blood banks. A victory in the anti trust action would be important in the timing of such a decision. Should these plans proceed, the Company might require additional financing to sustain such operations until they become profitable, although present captial is sufficient for the initial pahses.\nYear end 1995, finds the Company in a satisfactory financial position with adequate funds available for its immediate anticipated needs. However, should the opportunity arise for the Company to proceed with is planned expansion as a nationwide network of blood banks, there would be a need for additional capital. Legal fees and obstructive actions of the NYSDOH have caused a decline in both revenues and profitability for the Company. A successful resolution of these suits would result in recovery of these costs.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe financial statements and the schedules listed on the index to Financial Statements and Schedules are filed with and as a part of this report.\nItem 9.","section_9":"Item 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURES Not applicable.\nPart III. In connection with the 1995 Annual Meeting of Shareholders of Registrant, Registrant intends to furnish sharehoders with proxy materials which set forth the information required by Items 10, 11, 12, and 13 of Part III. Copies of such material will be duly filed with the Securities and Exchange Commission pursuant to rule 14a-6 promulgated under the Securities Exchange Act of 1934, as ameded, not later than 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K.\nPart IV.\nItem 14.","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"Item 14. FINANCIAL STATEMENTS, FINANCIAL STATEMENT SCHEDULES, EXHIBITS, AND REPORTS ON FORM 8-K\n(a) Financial Statement, Financial Statement Schedules and Exhibits filed. 1. Financial statements and schedules shown by index on page 21.\n(b) Daxor filed no current reports on Form 8-K during the last quarter of the fiscal year ending December 31, 1995. - - -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, thereto duly authorized.\nDAXOR CORPORATION by:\/s\/Joseph Feldschuh --------------------------- Joseph Feldschuh, M.D. President and Cheif Executive Officer, Chairman of the Board\nDated: March 30, 1996 ----------------------------\nPursuant to the requirements of the Secutities Exchange Act of 1934, 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\/ Joseph Feldschuh President and Director March 30, 1996 - - -------------------- (Principal Executive Officer) Joseph Feldschuh, M.D.\n\/s\/ Octavia Atanasui Corporate Treasurer March 30, 1996 - - -------------------- Accounting Supervisor Octavia Atanasui (Principal Financial Officer)\n\/s\/ Stephen M. Moss Director March 30, 1996 - - -------------------- Stephen M. Moss, PhD\n- - -------------------- Director March 30, 1996 Veronica Schwendemann\n____________________ Director March 30, 1996 James Lombard\n\/s\/ Martin Wolpoff Director March 30, 1996 - - -------------------- Martin Wolpoff\nBoard of Directors: Name Title Dr. Joseph Feldschuh Chairman, President & CEO Stephen Moss Director James Lombard Director Martin Wolpoff Director Veronica Schwendemann Director\n- - -18-\nDAXOR CORPORATION\nItem 14(a) (1). Index to Financial Statements\nThe following statements and schedules of Daxor Corporation are submitted herewith:\nPage ---- Report of Independent Accountants............................\nFinancial Statements as at December 31, 1995 and 1994 and for the three years ended December 1993 Balance Sheets............................................. Statements of Income....................................... Statements of Shareholders' Equity......................... Statements of Cash Flows...................................\nNotes to Financial Statements................................\nSchedule I - Marketable Securities - Other Investments - Year ended December 31, 1995..........................................\nSchedule IX - Short-term Borrowings - Years ended December 31, 1995, 1994, and 1993.............................................\nSchedule X - Supplementary Income Statement Information - Years ended December 31, 1995, 1994, and 1993................\nAll other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions, are inapplicable or the required informarion is set forth in the financial statements filed herewith, including notes thereto, and therefore have been omitted.\nINDEPENDENT AUDITOR'S REPORT - - ----------------------------\nTo the Board of Directors and Shareholders of Daxor Corporation:\nWe have audited the accompanying balance sheets of Daxor Corporation as at December 31, 1995 and 1994, the related statements of income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1995. Our audits also included the financial statement schedules listed in the Index at Item 14 (a) (1).\nThese financial statements and financial statement schedules are the responsibility of the Corporation's management. Our responsiblity is to express an opinion on these financial statements and financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, such financial statements present fairly, in all material respects, the financial position of Daxor Corporation as at December 31, 1995, and 1994, and the results of their operations and its cash flows for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles. Also, in our opinion, such financial statements taken as a whole, present fairly in all material respects the information set forth herein.\nFrederick A. Kaden & Co.\nFranklin Square, New York March 30, 1996\n- - -F-1-\nFINANCIAL STATEMENTS DAXOR CORPORATION ================================================================================ - - -------------------------------------------------------------------------------- BALANCE SHEETS\nSee accompanying notes to financial statements. - - -F-2-\nDAXOR CORPORTATION - - -------------------------------------------------------------------------------- STATMENTS OF INCOME\nStatement of Common Stock Issued and Outstanding Shareholders' Equity\nSee accompanying notes to financial statements. - - -F-3-\nDAXOR CORPORATION - - ----------------- STATEMENTS OF CASH FLOW ================================================================================\nSee accompanying financial statements.\n- - -F-4-\nDAXOR CORPORATION NOTES TO FINANCIAL STATEMENTS\nThe accompanying financial statements as at December 31, 1995 and 1994 and for the three years ended December 31, 1995 have been prepared in conformity with principles of accounting applicable to a going concern. Daxor Corporation operates in the medical services and technology industry. - - -------------------------------------------------------------------------------- (1) Marketable Securities\nUpon adoption of FASB No. 115, management has determined that the Company's portfolio is best characterized as \"Available-For-Sale\". This has resulted in the balance sheet carrying value of the Company's marketable securities investments, as of December 31, 1995 and Decembe3r 31, 1994, being increased approximately 30.77% and 18.70% respectively over its historical cost. A corresponding increase in shareholders' equity has been effectuated. In accordance with the provisions of FASB No 115, the adjustment in shareholders' equity to reflect the Company's unrealized gains has been made net of the tax effect had these gains been realized.\nThe following tables summarize the Company's investments as of:\nAt December 31, 1995, the securities held by the Company had market value of $35,735,073 and a cost basis of $24,877,363 resulting in a net unrealized gain of $10,857,710 or 43.64% of cost.\nAt December 31, 1994, the securities held by the Company had a market value of $33,598,931 and a cost basis of $28,305,737 resulting in a net unrealized gain of $5,293,194 or 18.70% of cost. At December 31, 1994, marketable securities, primarily consisting of preferred and common stocks of utility companies, are valued at fair value. - - -------------------------------------------------------------------------------- - - -F-5-\nDAXOR CORPORATION NOTES TO STATEMENTS - CONTINUED (2) Loans Payable As at December 31, 1995, and December 31, 1994, the Company had loans outstanding aggregating $ 1,000,000 and $2,600,000 borrowed on a short term basis from a bank, which are secured by certain marketable securities of the Company. The loans bear interest at approximately 7.8%.\nShort-term margin debt due to brokers, secured by the Company's marketable securities, totalled $436,609 at December 31, 1995, and $1,264,605 at December 31, 1994. - - -------------------------------------------------------------------------------- (3) Accounts Receivable Accounts receibable are deemed to be fully collectible. - - -------------------------------------------------------------------------------- (4) Equipment and Improvements Depreciation of equipment and improvements is taken using the straight line method. For 1995, 1994, and 1993, the charge to income for depreciation under this method were $59,304, $54,380, and $46,790 respectively.\nThe cost of maintenance and repairs is charged to expense as incurred. The cost of betterments and additions are capitalized and depreciated over the life of the asset. The cost of assets desposed of or determined to be non-revenue producing, together with the related accumulated depreciation applicable therto, is eliminated from the accounts, and any gain or loss is recognized. - - -------------------------------------------------------------------------------- (5) Other Liabilities At December 31, 1995, and December 31, 1994, the Company also maintained a short position in certain marketable securities. These positions were sold for $83,779 at December 31, 1995, and $100,256 at Ddecember 31, 1994, and had respective market values of $71,589 and $106,267 resulting in an unrealized gain of $12,190 at December 31, 1995 and an unrealized loss of (13,186) at December 31, 1994. - - -------------------------------------------------------------------------------- (6) Commitments and Contingencies (A) Operating Leases Future minimum rentral payments under this non-cncelable operating lease are as follows: 1996 $168,832 1997 $168,832 1998 $168,832 1999 $168,832 2000 $168,832\nRent expense for all non-cancelable operating leases was $233,187, $205,036, and $176,352 for the yers ended December 31, 1995, 1994, and 1993, respectively.\n(B) Contingent Liabilities The Company has pending several claims incurred in the normal course of business whicfh, in the opinion of management, based on the advice of outside legal counsel, will not have a material effect on the financial statements.\nThe Company is also involved in several legal procedings with the State of New York Department of Health over licenses to opetate its facilities.\nEffective at the close of business on August 21, 1995, New York State Department of Health has ordered the Company to cease operations of its clinical laboratories, blood bank and tissue bank. They also ordered that the Company dispose of all client autologous blood and semen stored on the Company's premise within 30 days. - - -F-5-\nDAXOR CORPORATION NOTES TO FINANCIAL STATEMENTS - CONTINUED\nIn a hearing before the New York State Supreme CDourt the order to dispose of all client stored blood and semen has been enjoined pending a review of the Company's facilities by an independent outside expert. The Court will then rule on this matter.\nThe Company is vigorously pursuing all legal remedies to have its operations licensed by New York State. It is management's belief that these licenses are being arbitraily withheld and will eventually be obtained. However, at the present time, the Company's inability to operate other than ongoing storage is having a negative effect on current earnings and cash flow. - - -------------------------------------------------------------------------------- (8) Interest Expense and Income Interest expense was $205,413, $231,349, and $413,319 and interest income was $319,386, $220,233, and $232,966 in 1995, 1994, ans 1993, respectively. - - -------------------------------------------------------------------------------- (9) Income Taxes The following is a reconciliation of the federal statutory tax rate of 34% for 1995, 1994, and 1993, with the provision for income taxes:\n- - -------------------------------------------------------------------------------- (10) Shareholders' Equity During 1995, the Company purchased 324,921 shares of its own stock at a cost of $2,082,437. ________________________________________________________________________________ (11) Subsidiaries In August 1986, the Company purchased all of the outstanding shares of National Frozen Blood Repository Corporation. The results of opertions since acqusition have been in these statements. In 1995, National Frozen Blood Repository Corporation was dissolved and its operations combined with those of the parent resulting in a current charge against income of ($8,007). - - -------------------------------------------------------------------------------- (12) Related Parties In March of 1995, the Company entered into an agreement with US Cryobanks of Florida to provide its semen and blood banking technologies for a 35.2% interest in the company as well as other fees. At year end the Company's interests in US Cryobanks had been diluted to 39.1%. The following is a summary of these transactions which are included in the current years financial statements.\nGross Revenues $ 295,780 Related Costs and Expenses (approximately) 262,000 - - -F-5-\nDAXOR CORPORATION NOTES TO FINANCIAL STATEMENTS - CONTINUED SCHEDULE I MARKETABLE SECURITIES -- OTHER INVESTMENTS The following tables summarize the Company's investments as of:\n================================================================================ SCHEDULE IX SHORT-TERM BORROWINGS\nThe average borrowings were determined on the basis of the amounts outstanding at each month-end. The weighted interest rate during the year was computed by dividing actual interest expense in each year by average short-term borrowings in such year. - - -F-9-\nSCHEDULE X SUPPLEMENTARY INCOME STATEMENT INFORMATION\n- - -------------------- *less than 1% of total revenues for the year.","section_15":""}
{"filename":"706343_1995.txt","cik":"706343","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"Item 2. Properties 19 Item 3.","section_3":"Item 3. Legal Proceedings 20 Item 4.","section_4":"Item 4. Submission of Matters to a vote of security holders 20\n- -------------------------------------------------------------------------------- Part II Page - --------------------------------------------------------------------------------\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters 4, 20 Item 6.","section_6":"Item 6. Selected Financial Data 4, 19-20 Item 7.","section_7":"Item 7. Management Discussion and Analysis of Financial Condition and Results of Operations 8-19 Item 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data Delta National Bancorp and Subsidiaries - Consolidated Financial Statements 21-25 Notes to Consolidated Financial Statements 26-37 Independent Auditors' Report 38 Selected Statistical Information 4, 9-20 Item 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 39\n- -------------------------------------------------------------------------------- Part III Page - --------------------------------------------------------------------------------\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant 39-40 Item 11.","section_11":"Item 11. Executive Compensation 41 Item 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management 41-42 Item 13.","section_13":"Item 13. Certain Relationships and Related Transactions 42\n- -------------------------------------------------------------------------------- Part IV Page - --------------------------------------------------------------------------------\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 43 (a) (1) Financial Statements (See Item 8 for a listing of all financial statements (2) Financial Statement Schedules All schedules normally required by Form 10-K are omitted since they either are not applicable or the required information is shown in the financial statements and notes thereto. (3) Exhibits\n(b) No reports on Form 8-K have been filed during the fourth quarter of the last year.\nDESCRIPTION OF BUSINESS BUSINESS\nDelta National Bancorp (the \"Company\") is a single bank holding company, registered under the Bank Holding Company Act of 1956. The Company was incorporated under the laws of the State of California on December 21, 1981. The Company's principal office is located at 611 N. Main Street, Manteca, California. The Company owns all of the capital stock of its subsidiary, Delta National Bank (the \"Bank\").\nThe Company was organized at the direction of the Board of Directors for the purpose of becoming a bank holding company pursuant to a Plan of Reorganization and Agreement of a Merger which was consummated on June 27, 1983, following receipt of the required regulatory and shareholder approval. On that date, (1) Delta National Bank was merged into the New Delta National Bank, (an \"interim\" California Banking Corporation organized as a wholly-owned subsidiary of the Company for the purpose of facilitating the formation of the Company), (2) the name of the New Delta National Bank was changed to \"Delta National Bank\" , and (3) the shareholders of the Bank (with the exception of those shareholders who perfected their rights as deserting shareholders) became shareholders of the Company.\nThe Bank was organized in 1973 as a national banking association under the name First National Bank of Riverbank; its present name was adopted in 1975 when the Bank moved its headquarters location from Riverbank, California to Manteca, California. At the present time, the Bank operates four branches serving the communities of Manteca, Riverbank, Denair and Modesto, California. The service area of the Bank is located in the heart of California's Central Valley. The entire region consists of rich, flat farmland that benefits from a long growing season. The Bank has grown over the years, which is a direct result from the growth in the valley, both in employment and new construction, which has come from a prosperous agriculture industry.\nThrough its branches, the Bank provides a wide range of commercial banking services to individuals and small and medium-sized businesses. Services include those traditionally offered by commercial banks, such as checking and savings accounts, commercial, real estate, personal, home improvement, automobile and other installment and term loans, travelers' checks, safe deposit boxes, escrow services, collection services, computer payroll and accounting services, night depository facilities, and wire transfers. The Bank does not have a trust department; however, the Bank will make arrangements with its correspondent institution to provide trust services, investment and international banking services.\nCompetition: The banking business in California, especially in the market areas served by the Bank, is highly competitive. The Bank competes for loans and deposits with other commercial banks, savings and loan associations, finance companies, money market funds, and credit unions for deposit and loan business. Further, large commercial banks have greater lending limits than the Bank and perform certain other functions, including trust services, which the Bank does not offer directly. In competing for banking business, including deposits and other related activities, the Bank employs personal contact, localized advertising, interest rate competition and availability of specialized services in order to meet the needs of various types of customers.\nThe Bank's loan portfolio consists of both secured and unsecured loans with a significant portion either real estate secured or real estate related.\nThe latest available information indicates there were approximately 128 banking offices including the Bank's four offices operating throughout San Joaquin and Stanislaus county. The banking offices held approximately five billion in deposits of which approximately 85 million were held by the Bank. The Bank's deposit market share varies within the communities served by its offices ranging from 2% in Modesto, 15% in Manteca, 100% in Riverbank and 100% in Denair.\nSupervision, Regulation and Government Policies: The Bank as a National Banking Association, is subject to primary supervision, examination and regulation by the Comptroller of the Currency. It is also a member of the Federal Reserve System and as such, is subject to applicable provisions of the Federal Reserve Act and regulations issued thereunder. The deposits of the Bank are insured by the Federal Deposit Insurance Corporation to the maximum extent provided by law. The Bank is also subject to applicable provisions of California laws, insofar as they do not conflict with or are not preempted by Federal banking law.\nVarious requirements and restrictions under the laws of the United States and the State of California affect the operations of the Bank. Federal statutes and regulations relate to many aspects of the Bank's operations, including reserves against deposits, interest rates payable on loans, investments, mergers and acquisitions, borrowings, dividends, location of branch offices, and capital levels.\nIn addition, from time to time, legislation is proposed which has the effect of increasing the cost of doing business, limiting permissible activities or affecting the competitive balance between banks and other financial institutions. Changes in rates by the FDIC for deposit insurance will also effect the cost of business.\nRisk-adjusted capital guidelines were issued by bank regulatory authorities early in 1989. These guidelines assign risk weighting to assets and off-balance sheet items and place increased emphasis on common equity. The guidelines currently require a minimum Tier I (core) capital ratio of 4% and a total risk weighted capital ratio of 8% in order for an institution to be classified as adequately capitalized. Institutions which maintain a Tier I ratio of 6% and total capital ratio of 10% are defined as well capitalized. The Bank's Tier I and total risk-weighted ratios at December 31, 1995 were 16.88% and 18.14%, respectively.\nIn addition to the risk weighted ratios, the highest rated banks are required to maintain a minimum leverage ratio of 3%. All other banks are expected to maintain higher leverage ratios, to be determined on an individual basis. This ratio is defined as Tier I capital to average total assets for the most recent quarter. The Bank's leverage ratio at December 31, 1995 was 10.02%.\nIn September, 1995, FDICIA 305 was implemented and requires the banking agencies to revise their risk based capital standards to ensure that those standards take adequate account of interest rate risk. This rule amends the capital standards to specify that the banking agencies will include in their evaluations of capital adequacy an assessment of the exposure to declines in the economic value of the bank's capital due to changes in interest rates. A bank may be required to hold additional capital for interest rate risk if it has a significant exposure or a weak interest rate risk management process. To date, the final rule does not codify a measurement framework for assessing the level of a bank's interest rate risk exposure nor does it specify a level of exposure above which a bank will be required to hold more capital. The Bank is currently exempt from certain reporting of interest rate risk but is prudently managing its interest rate risk through risk management practices which include risk measurement, risk management and risk control.\nIn 1993, federal bank regulatory agencies issued a statement imposing certain limitations in the inclusion of net deferred tax assets calculated under Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"FAS 109\") in regulatory capital. Deferred tax assets that are dependent on future taxable income or the institution's tax planning strategies may only be counted as a component of Tier I capital to the extent they do not exceed the lesser of: (1) 10% of Tier 1 capital, or (2) the amount of such benefits which may be realized based on one year's projected earnings. The Company adopted FAS 109 on January 1, 1993 at which time this regulation became applicable in determination of its capital ratios. The effect of this new standard on income tax expense for the year ended December 31, 1993 was not material.\nThe Federal Deposit Insurance Corporation Act of 1991 (\"FDICIA\"), enacted on December 19, 1991 in connection with the recapitalization of the Banks Insurance Fund (\"BIF\"), required the FDIC to set semi-annual assessment rates at levels sufficient to increase the BIF's reserve ratio to a designated level within a prescribed period of time. In August, 1995, the FDIC announced that, effective June 1, 1995, it had significantly reduced the deposit insurance premiums paid by most banks. Under the new rate structure, the best-rated institutions insured by the BIF pay 4 cents per $100 of domestic deposits, down from the prior rate of 23 cents per $100. The weakest institutions continue to pay 31 cents per $100 of domestic deposits depending on their risk classification. This risk classification is based on an institution's capital group and supervisory subgroup assignments. The FDIC has assigned the Bank the lowest premium possible.\nIn November, 1995, the FDIC announced that, starting in January 1996, it will further reduce the deposit insurance premiums paid by most banks. Under the new rate structure for the BIF, assessment rates will be lowered by four cents per $100 of domestic deposits. Given the four cent reduction, the highest-rated institutions will pay the statutory annual minimum of $2,000 for FDIC insurance. Rates for all other institutions will be reduced by four cents per $100 as well, leaving a premium range of 3-27 cents per $100, instead of the current 4-31 cents per $100.\nEffective December 31, 1993, the Bank adopted SFAS No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\". These securities are classified into one of three categories: held-to-maturity, available-for-sale or trading. Held-to-maturity securities are measured at amortized cost and available-for-sale securities are measured at fair value. Unrealized holding gains and losses for available-for-sale securities are excluded from earnings and reported as a net amount in a separate component of stockholders' equity until realized. Risk-based and leverage capital ratios will not reflect the impact of unrealized gains or losses on securities available-for-sale as a result of the regulatory and industry concerns about the potential for volatility in regulatory capital ratios.\nIn May 1993, the Financial Accounting Standards Board (FASB) issued SFAS No. 114, \"Accounting by Creditors for Impairment of a Loan\". This statement, which is effective January 1, 1995, requires that impaired loans, as defined, 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. The Bank adopted and implemented SFAS No. 114 as of January 1, 1995.\nEmployees: The number of persons employed by the registrant is 61, as of December 31, 1995.\nEconomic Conditions and Governmental Monetary Policies: The Bank continues to be localized to two area counties with services provided to certain adjacent counties. Local economic conditions have steadily, but slowly improved during the year. Reductions in employment in the banking and finance industry, military and governmental agencies and in family owned small businesses have impacted the area significantly. Detrimental effects have been largely mitigated by the strong starter home construction market and consistent agricultural production. By capitalizing on the niche markets the Bank has identified, earnings have improved over the preceding year. Cost controls, liability pricing assessment and aggressive asset pricing have produced desirable margin management.\nWhile not directly affected by conditions in all areas of the state, the performance of California has a secondary, but significant influence in the local banking community. Anticipated state improvements in revenues appears to be altering the aggressiveness of area businesses and spurs the purchasing appetite of the consumer. The ability of California to positively adapt to the enormous defense cutbacks and large corporate workforce reductions bodes well in the nations financial markets and company boardrooms allowing the state to be considered as a desirable location for expansion.\nThe area of greatest concern and uncertainty is the unresolved federal budgeting process. The national economy has slowed considerably and confidence in the governmental process has diminished. Typically, the monetary policy of the Federal Reserve Board greatly influences business, but with no identifiable resolution to the budget because of deep political differences, interest rate adjustments will not likely have as great an impact. Management assesses all factors in determining strategies, planning and procedures for reacting to swift changes in governmental and monetary policy.\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nFINANCIAL REVIEW\nPERFORMANCE SUMMARY\nThe following discussion is intended to provide information to facilitate the understanding and assessment of significant changes in trends related to the financial condition of Delta National Bancorp (\"the Company\") and its results of operations. It should be read in conjunction with the audited financial statements and footnotes appearing elsewhere in this report.\nAt December 31, 1995, the Company's total assets were $94,924,333, net loans amounted to $46,519,819, stockholders' equity was $9,771,029 and the allowance for loan losses was $1,219,304. This compares to total assets of $89,189,024, net loans of $47,043,601, stockholders' equity of $8,747,535 and allowance for loan losses of $599,422 at December 31, 1994.\nNet income for 1995 amounted to $859,877 or $2.28 per share, as compared with $821,397 or $2.18 per share earned in 1994. A significant portion of the increase in net income from a year ago was due to increased interest and fees on loans and interest income earned on securities.\nEarnings as measured by return on assets remained constant at .93% for 1995 and .94% in the prior year. Return on equity approximated 8.73% in 1995 compared to 9.18% in 1994. The decrease in the return on equity is primarily due to a substantial increase in the reserve for loan loss made at the end of 1995.\nNon-accrual loans at year end amounted to $1,694,556, up from $10,267 at December 31, 1994. One large commercial loan makes up the major portion of the non-accrual loans. At December 31, 1995, other real estate owned (\"OREO\") totaled $560,600 compared with OREO of $939,381 at December 31, 1994. Restructured loans, loans outstanding whose original terms have been modified, totaled $1,146,080 at December 31, 1995, which consisted of one real estate loan. There were no restructured loans at December 31, 1994.\nAlthough there was an increase in the provision for loan losses, net charge-offs continued to decrease significantly in 1995 over the previous year. The provision for loan losses was $624,014, up from $191,750 for 1994. Net charge-offs amounted to $4,132 in 1995 versus $399,871 in 1994.\nNet interest income and net interest margin in 1995 were $4,846,567 and 5.66%, respectively, compared to $4,301,578 and 5.32%, respectively, for 1994. Net interest income increased approximately 13% in 1995.\nNon-interest income amounted to $674,677 in 1995, compared to $692,648 in 1994. Income related to the service charges on deposits decreased $29,674 while other income increased $11,703.\nOperating expenses amounted to $3,485,353 in 1995, compared to 3,442,079 in 1994. FDIC assessments decreased $78,096 in 1995 while employee benefits increased by approximately 38% due to a contribution that was made in 1995 to the employee profit sharing plan.\nEARNINGS PERFORMANCE\nDistribution of Average Assets, Liabilities, and Stockholders' Equity; Interest Rates and Interest Differential: The following table sets forth consolidated average daily balances of each principal category of assets, liabilities and stockholders' equity, interest on interest earning assets, and interest on interest bearing liabilities, and the average yields earned or rates paid thereon for the years ended December 31, 1995, 1994 and 1993. The table also shows the net interest earnings and the net yield on average earning assets. Averages were computed based upon daily balances.\nNet Interest Income: The Company's operating results depend primarily on net interest income. A primary factor affecting the level of net interest income is the Company's interest rate margin between the yield earned on interest-earning assets and the rate paid on interest-bearing liabilities as well as the difference between the relative amounts of average interest-earning assets and interest-bearing liabilities. Net interest income increased 13% to $4,846,567 for the year ended December 31, 1995 compared to $4,301,578 in 1994 and $4,279,657 in 1993.\nNet interest margin increased to 5.66% for 1995 from 5.32% for 1994, and 5.53% in 1993. The increase in income is a result of sound lending and investing practices, cost control methods and prudent management decisions.\nChanges in the Company's net interest income are a function of both changes in rates and changes in volumes of interest-earning assets and interest-bearing liabilities. The following table summarizes the changes in net interest income for the major categories of interest-earning assets and interest-bearing liabilities for 1995 and 1994. The total change is segmented into the change attributable to variations in volume (changes in volume multiplied by old rate) and the change attributable to variations in interest rates (changes in rates multiplied by old volume). Changes not solely attributable to volume or rate have been allocated to volume. Non-accrual loans are included in average loans used to compute this table.\n- -------------------------------------------------------------------------------- 1995 Over 1994 1994 over 1993 (In Thousands) Volume Rate Total Volume Rate Total - -------------------------------------------------------------------------------- Increase\/(Decrease) in: Loans, net of unearned income and deferred loan fees ..... $ 225 $ 450 $ 675 $(188) $ 118 $ (70) Interest-bearing deposits placed with banks ......... - - - - - - Taxable securities ........... 200 354 554 70 (136) (66) Tax-exempt securities (1) .... (45) 12 (33) 118 (51) 67 Federal funds sold ........... (29) 86 57 55 65 120 - -------------------------------------------------------------------------------- Total interest income ..... $ 351 $ 902 $1,253 $ 55 $ (4) $ 51 - -------------------------------------------------------------------------------- Total interest bearing deposits.................... $ 89 $ 619 $ 708 $ 47 $ (17) $ 30 - -------------------------------------------------------------------------------- Total interest expense .... $ 89 $ 619 $ 708 $ 47 $ (17) $ 30 - -------------------------------------------------------------------------------- Changes in net interest income...................... $ 262 $ 283 $ 545 $ 8 $ 13 $ 21 - -------------------------------------------------------------------------------- (1) Interest income is reflected on a fully tax equivalent basis.\nProvision for Loan Losses: The provision for loan losses totaled $624,014 for 1995, compared to $191,750 in 1994 and $642,000 in 1993. The increase in the provision in 1995 was primarily a response to the current state of the dairy industry which has somewhat deteriorated in recent months. One dairy loan in particular accounts for a significant portion of the increase to the allowance. The provision for loan losses reflects management's on-going evaluation of the risk inherent in the loan portfolio, which includes consideration of numerous factors, such as economic conditions, relative risks in the loan portfolio, loan loss experience and review and monitoring of individual loans for identification and resolution of potential problems.\nNon-Interest Income: Non-interest income amounted to $674,677 for 1995, down from $692,648 in 1994 and $906,587 in 1993. Service charges on deposits declined approximately 5.7% in 1995. Included in 1995 income is a pre-tax gain on the sale of one OREO property.\n- -------------------------------------------------------------------------------- (In Thousands) 1995 1994 1993 - -------------------------------------------------------------------------------- Service charges on deposit accounts ........... $486,673 $516,347 $656,056 Gain on sale of OREO .......................... 26,128 - - Gain on sale of fixed assets .................. - 2,912 19,880 Other income .................................. 161,876 173,389 230,651 -------- -------- -------- Total ..................................... $674,677 $692,648 $906,587 - --------------------------------------------------------------------------------\nNon-Interest Expense: Non-interest expense amounted to $3,485,353 in 1995, compared to $3,442,079 in 1994 and $3,238,790 in 1993. Employee benefits expense increased in 1995 over 1994 due to a contribution of $100,000 that was made to the employee profit sharing plan. No contribution was made to the plan in 1994 or 1993.\n- -------------------------------------------------------------------------------- (In Thousands) 1995 1994 1993 - -------------------------------------------------------------------------------- Salaries and wages ................ $1,589,306 $1,502,791 $1,490,436 Employee benefits ................. 307,076 222,797 242,256 Occupancy and equipment ........... 673,222 586,905 525,680 Data processing ................... 20,088 21,448 26,250 Stationary and supplies ........... 84,328 91,022 103,784 Professional fees ................. 155,132 137,757 136,655 FDIC assessments .................. 129,117 207,213 206,864 Other operating ................... 510,084 672,146 506,865 Loss on sale of available-for-sale security .......................... 17,000 - - - -------------------------------------------------------------------------------- Total ......................... $3,485,353 $3,442,079 $3,238,790 - --------------------------------------------------------------------------------\nINCOME TAXES\nFor the year ended December 31, 1995, the Company filed a consolidated Federal income tax return and State return. At December 31, 1995, the Company had a $450,000 net deferred tax asset. Income tax expense reflects rates on earnings before income taxes of 39.1% and 39.6% for the two years ended December 31, 1995 and 1994, respectively.\nASSET LIABILITY MANAGEMENT\nLiquidity: For the Company, as with most commercial banking institutions, liquidity is the ability to roll over substantial amounts of maturing liabilities and to acquire new liabilities at levels consistent with management's financial targets. During 1995, the Company continued to maintain a high level of liquidity. Highly liquid assets consisting of cash, deposits placed with banks, Federal funds sold and securities available for sale averaged approximately $26,622,000 or 28.9% of average total assets as compared with approximately $27,485,000 or 31.3% of average total assets for 1994. At year end, the Bank had a liquidity ratio of 22.48%.\nInterest Rate Sensitivity Management: The primary objectives of the asset liability management process are to provide a stable net interest margin, generate net interest income to meet the Company's earnings objectives and manage balance sheet risks. These risks include liquidity risk, capital adequacy and overall interest rate risk inherent in the Company's balance sheet. In order to manage its interest rate sensitivity, the Company has adopted policies which attempt to limit the change in pre-tax net interest income assuming various interest rate scenarios. This is accomplished by adjusting the repricing characteristics of the Company's assets and liabilities as interest rates change. The Company's Asset Liability Committee chooses strategies in conformance with its policies to achieve an appropriate trade off between interest rate sensitivity and the volatility of pre-tax net interest income and net interest margin.\nThe following table sets out the maturity and rate sensitivity of the Company's interest-earning assets and interest -bearing liabilities as of December 31, 1995. The cumulative interest sensitivity gap (\"gap\") as reflected in the table represents the difference between interest-earning assets and interest-bearing liabilities maturing or repricing, whichever is earlier, at a given point in time and is not necessarily indicative of the position on other dates.\nThe gap is considered positive when the amount of interest rate sensitive assets which reprice over a given time period exceeds the amount of interest rate sensitive liabilities which reprice over the same time period and is considered negative when the reverse is true. During a period of rising interest rates, a positive gap tends to result in increased net interest income while a negative gap would have an adverse affect on net interest income. As illustrated by the table, the Company maintained a positive gap at December 31, 1995. The Company, therefore, was asset sensitive and was positioned for increased net interest income given a rise in interest rates in 1995. The degree of positive gap is not so large that a significant detrimental impact would result from stable or declining interest rates.\nBALANCE SHEET ANALYSIS\nCash and Due from Banks: Average cash and due from banks for the year ended December 31, 1995 was $3,972,362, down 9.7% from the prior year average of $4,399,198 due to increased loan activity and lower cash balance requirements.\nSecurities: The fair value of available-for-sale securities totaled $12,926,352 at December 31, 1995, as compared to $21,231,071 at the end of 1994, with balances averaging approximately $ 17,650,000 and $17,422,000, respectively. The decrease in available-for-sale securities was primarily due to investments that matured during the year. New securities purchased in 1995 were placed in the held-to-maturity category due to the Banks intent to hold these funds until they mature. One available-for-sale security was sold in 1995 resulting in a loss of $17,000.\nThe Company's short-term investments, consisting of securities available-for-sale and federal funds sold averaged approximately $22,649,000 for 1995, compared to approximately $23,085,000 for 1994. These investments amounted to $20,526,352 at year-end 1995, compared to $24,031,071 for 1994. In 1995, the securities portfolio consisted primarily of U.S. government agency securities, municipals and corporate bonds. In 1995, federal funds sold averaged approximately $4,999,000 as compared to approximately $5,663,000 in 1994. The amortized cost of held-to-maturity securities totaled $20,351,537 in 1995, compared to $11,797,037 in 1994.\nThe following table shows the amortized cost (book value) of the Company's portfolio of available-for-sale and held-to-maturity securities for the periods ending 1995 and 1994:\n- -------------------------------------------------------------------------------- At December 31, (In Thousands) 1995 1994 - -------------------------------------------------------------------------------- Available-for-sale: U. S. Treasury ................... $ -- $ 1,996,348 U. S. government agencies ........ 12,188,734 16,187,511 States & political subdivisions .. 605,656 2,281,382 Corporate bonds and other ........ 55,350 1,419,755 - -------------------------------------------------------------------------------- Total ........................ $12,849,740 $21,884,996 - -------------------------------------------------------------------------------- Held-to-maturity: U. S. Treasury ................... $ -- $ -- U. S. government agencies ........ 18,252,276 7,695,521 States & political subdivisions .. 695,578 1,328,028 Corporate bonds and other ........ 1,403,683 2,773,488 - -------------------------------------------------------------------------------- Total ........................ $20,351,537 $11,797,037 - --------------------------------------------------------------------------------\nThe following tables show the amortized cost (book value) and maturities of securities at December 31, 1995 and the weighted average yields (1).\nLoan Composition: The loan portfolio totaled $46,519,819 at December 31, 1995 with a 1.1% decrease over $47,043,601 in 1994. There was a shift from real estate mortgage loans to commercial and real estate construction loans. Consumer loans declined by over $1,000,000 due to recessionary influences and competition. Commercial real estate mortgages declined due to refinancings because of lower interest rates. Significant gains were shown in real estate construction. The provision for loan losses increased primarily due to the condition of the dairy industry.\nThe composition of the Bank's loan portfolio as of December 31, is as follows:\n- -------------------------------------------------------------------------------- Percentage Percentage of Total of Total 1995 Loans 1994 Loans - -------------------------------------------------------------------------------- Commercial, financial and agricultural.............. $22,755,013 47.30% $20,991,617 43.70% Real Estate - construction . 9,175,475 19.10% 7,352,440 15.30% Real Estate - mortgage ..... 14,090,502 29.30% 16,610,145 34.50% Installment loans to individuals............... 2,073,749 4.30% 3,101,692 6.50% ----------- ------ ----------- ------ $48,094,739 100.00% $48,055,894 100.00% ====== ====== Unearned discount .......... (80,189) (167,027) Allowance for possible loan losses............... (1,219,304) (599,422) Deferred loan fees ......... (275,427) (245,844) ----------- ----------- Loans, net ............. $46,519,819 $47,043,601 =========== =========== - -------------------------------------------------------------------------------- (1) There were no lease financing or foreign loans\nLoan maturities as of December 31, 1995 are as follows:\nThe Bank's customers are primarily located in Stanislaus County and San Joaquin County. Approximately 48% of the Bank's loans are for real estate and construction and approximately 47% of the Bank's loans are for general commercial uses including professional, retail, agricultural and small business. Generally real estate loans are secured by real property and commercial and other loans are secured by funds on deposit, business or personal assets. Repayment is generally expected from the proceeds of the sales of property for real estate construction loans, and from cash flows of the borrower for other loans.\nNeither the Bank or the regulators have placed any limitations on the composition of the Bank's loan portfolio. There were no concentrations of loans exceeding 10% of total loans which were not otherwise disclosed as a category of loans in the above table. Unsecured loans are not a significant portion of the loan portfolio depicted in the above table. There were no other interest bearing assets at the end of the period.\nThe Bank has collateral management policies in place so that collateral lending of all types is on a basis which it believes is consistent with regulatory lending standards. Valuation analyses are utilized to take into consideration the potentially adverse economic conditions under which liquidation of collateral could occur. It is generally the Bank's policy to fully collateralize all loans with loan-to-value ratios determined on an individual loan basis taking into account the financial stability of each borrower and the value and type of the collateral.\nAllowance for Loan Losses: The provision for loan losses is based upon management's evaluation of the adequacy of the existing allowance for loans outstanding. These evaluations take into consideration such factors as changes in the nature and volume of the portfolio, overall portfolio quality, loan concentrations, specific loan problems and current economic conditions that may affect the borrower's ability to repay. The allowance for loan losses is increased by provisions charged to expense and reduced by loan charge-offs net of recoveries. Early recognition of problem credits is critical to avoid shortages in the allowance. The allowance for loan losses totaled $1,219,304 or 2.54% of total gross loans at December 31, 1995 compared to $599,422 or 1.25% at December 31, 1994 and $807,543 or 1.84% at December 31, 1993. The increase in the allowance in 1995 was primarily a response to the current state of the dairy industry which has somewhat deteriorated in recent months. One dairy loan in particular accounts for a significant portion of the increase to the allowance. The decrease in the allowance in 1994 over 1993 generally corresponds to the decrease in total charge offs over the previous years.\nThe provision for loan losses is a product of the Bank's allowance for loan loss methodology that reflects the potential losses in the loan portfolio. The Bank's conservative lending philosophy allows this provision to be quite manageable. Of particular importance is the three year trend of decreasing net charged off loans which reflects strong management of the loan portfolio. Loans totaling $112,366 were charged off during the period and $108,234 was collected in recoveries. Loans charged off totaled $563,719 in 1994 and $644,965 in 1993, while recoveries totaled $163,848 and $220,812 respectively. As a percent of average loans outstanding during the year, net loans charged off were .009% in 1995, .88% in 1994 and .91% in 1993.\nThe following table summarizes the loan loss experience of the Company for 1995, 1994 and 1993:\n- -------------------------------------------------------------------------------- 1995 1994 1993 - -------------------------------------------------------------------------------- Balance at January 1 ....... $ 599,422 $ 807,543 $ 589,696 Charge Offs: Commercial, financial and agricultural............ (357,634) (301,781) Real Estate-construction.. (238,211) Real Estate-mortgage...... (163,896) ( 25,072) Installment loans to individuals.......... (112,366) ( 42,189) ( 79,901) ----------- ----------- ----------- Total Charge Offs (112,366) (563,719) (644,965)\nRecoveries: Commercial, financial and agricultural............ 1,390 3,448 88,328 Real Estate-construction.. 80,425 80,436 6,868 Real Estate-mortgage...... 2,200 60,292 100,083 Installment loans to individuals.......... 24,219 19,672 25,533 ---------- ---------- ---------- Total Recoveries 108,234 163,848 220,812\nNet charge offs ............ ( 4,132) (399,871) (424,153)\nAdditions charged to operations ............... 624,014 191,750 642,000 ---------- ---------- ---------- Balance at December 31, .... $1,219,304 $ 599,422 $ 807,543 ========== ========== ========== Ratio of net charge-offs during period to average loans outstanding .......... .009% .879% .906% - --------------------------------------------------------------------------------\nThe following table sets forth the allocation for loan losses to each loan category and the percentage of each loan category to total loans for the past two years. The allocation of the allowance for loan losses should not be interpreted as an indication that charge-offs will occur in these amounts or that the allocation indicates future charge-off trends. Furthermore, the portion allocated to each loan category is not the total amount available for future losses that might occur within such categories.\n- -------------------------------------------------------------------------------- 1995 1994 - -------------------------------------------------------------------------------- Percentage Percentage of Loans of Loans in each in each Category to Category to Total Total Allowance Loans Allowance Loans - -------------------------------------------------------------------------------- Commercial, financial and agricultural .......... $ 599,783 47.30% $ 295,212 43.68% Real Estate-construction. 262,944 19.10% 96,601 15.30% Real Estate-mortgage .... 313,455 29.30% 147,491 34.56% Installment loans to individuals ........... 43,122 4.30% 60,118 6.46% Unallocated - - - -------------------------------------------------------------------------------- Total Reserves ..... $1,219,304 100.00% $ 599,422 100.00% - --------------------------------------------------------------------------------\nTotal loans classified for regulatory purposes as loss, doubtful, substandard, or special mention (including nonaccrual loans and troubled debt restructuring) at December 31, 1995 and 1994 were $9,189,084 and $2,111,775 respectively. Of the total classified none of the loans were classified as doubtful at the end of 1995, and $42,238 were classified doubtful at the end of 1994. Management is not aware of any other material credit which there is serious doubt regarding the ability to repay other than those reflected in classified loans and in the allowance for possible loan losses.\nImpaired Loans: In May 1993, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 114 entitled \"Accounting by Creditors for Impairment of a Loan\". This statement, which became effective January 1, 1995, requires that impaired loans, as defined, 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. The Bank adopted and implemented SFAS No. 114 as of January 1, 1995.\nImpaired loans totaled $2,840,637 at December 31, 1995, of which $1,146,080 is the result of a troubled debt restructuring. The average investment in impaired loans during 1995 was approximately $1,572,000. The total allowance for loans losses relating to these loans was $334,981. Total cash collected on impaired loans during 1995 approximated $78,800, of which $6,300 was credited to the principal balance outstanding, and $72,500 was recognized as interest income. Interest income that would have been recognized on impaired loans was approximately $210,000 for the year ended December 31, 1995.\nA 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. Amounts due according to the contractual terms include both principal and interest. The Company has determined that the definition of impaired loans will include any loans placed on nonaccrual status and any loans which have had a modification of terms under troubled debt restructuring. Loans in the amount of $300,000 or more will be evaluated individually. Large groups of smaller-balance homogenous loans, under $300,000, will be evaluated on a composite basis using historical data, such as average recovery period and average amount recovered, along with a composite rate of interest as a means of measuring for impairment. Loans that are not evaluated individually will be grouped together by similar risk characteristics. The following categories will be grouped together: Agricultural, Commercial, Real Estate Construction, Residential Real Estate, Consumer, and Commercial Real Estate loans.\nLoan impairment is measured by estimating the present value of expected future cash flows discounted at the loan's effective interest rate, its observable market price, or the fair value of collateral if the loan is collateral dependent. When it has been substantiated that a loss is evident and should be recognized, the impaired loan will be charged off. The recorded investment in these loans and the valuation allowance for loan losses related to loan impairment are as follows:\n- --------------------------------- ---------------------------------------- December 31, 1995 December 31, 1995 - --------------------------------- ---------------------------------------- Principal amount Valuation allowance at of impaired loans $ 2,840,637 beginning of period $ - Accrued interest 267 Net charges to operations Deferred loan costs 1,408 for impairment 334,981 ------------- Direct write-downs - 2,842,312 Recoveries - Less valuation ------------ allowance 334,981 Valuation allowance at ------------- end of period $ 334,981 Total carrying ============ value $ 2,507,331 ============= - --------------------------------- ----------------------------------------\nNon-Accrual Loans, Restructured Loans and Real Estate Owned: Information regarding non-accrual loans, past due loans and restructured loans is presented below.\n- -------------------------------------------------------------------------------- At December 31, 1995 1994 - -------------------------------------------------------------------------------- Non-accrual loans: Commercial loans ............. $ 1,200,342 $ - Real estate loans ............ 494,214 - Consumer loans ............... - 10,267 ------------ ------------- Total non-accrual loans .. $ 1,694,556 $ 10,267 - -------------------------------------------------------------------------------- Loans past due 90 days or more still accruing interest ........ - 1,003 - -------------------------------------------------------------------------------- Troubled debt restructuring ...... $ 1,146,080 $ - - --------------------------------------------------------------------------------\nNon-accrual loans at year-end amounted to $1,694,556, up from $10,267 at December 31, 1994. One large agricultural\/commercial loan makes up the major portion of the non-accrual loans. Gross interest income that would have been recorded for non-accrual loans if loans had been current in accordance with original terms and had been outstanding throughout the period or since origination for 1995 and 1996 was $115,869 and $1,187 respectively. There was no interest income included in net income for the period for non-accrual loans. There were no loans past due 90 days or more which were still accruing interest.\nManagement is constantly aware of the need for maintaining high credit standards. The Company is not involved in foreign lending and is not engaged in high yield, high risk loans. A loan is placed on nonaccrual status when either principal or interest is in default for 90 days more, or when external factors indicate that payment in full of principal and interest appears unlikely unless the loan is well secured and in the process of collection. When a loan is placed on nonaccrual status, all interest previously accrued but uncollected shall be reversed against the appropriate income account. In most cases, if the loan is rated substandard or better, payments shall be applied to interest first and then principal provided no loss is anticipated. If a loss is anticipated, all payments shall be applied to principal first and then interest. When one loan of a customer is placed on nonaccrual status related borrowings will be evaluated as to whether they should also be placed on nonaccrual status. Nonaccrual loans will be restored to an accruing status when principal and interest is no longer past due and unpaid, or the loan otherwise becomes well secured and in the process of collection.\nA troubled debt restructuring occurs when the Bank for economic or legal reasons related to the debtor's financial difficulties, grants a concession to the debtor that it would not ordinarily consider. Troubled debt restructuring can occur in a variety of forms, such as transferring assets in a full or partial settlement of the debt, issuing debt, or modifying terms including reducing the stated interest rate, extending maturity dates, reducing the face amount or maturity of the debt, or reducing accrued interest. Restructured loans totaled $1,146,080 at December 31, 1995. There were no restructured loans at the end of 1994. All restructured loans were current as to principal and interest.\nForeclosed real estate owned includes real estate acquired through foreclosure, or by obtaining a deed in lieu of foreclosure. Real estate properties acquired through foreclosure are initially recorded at fair value at the date of foreclosure establishing a new cost basis. After foreclosure, valuations are periodically performed and the real estate is carried at the lower of (1) cost or (2) fair market value minus estimated costs to sell. Total foreclosed real estate was $856,167 at December 31, 1995, this consisted of three properties, two of which represented bare land. The third property is a condominium complex consisting of eight units which were completed and placed in service as rental units by the Bank. The valuation allowance at the end of 1995 totaled $295,567.\n- ------------------------------------------------------------------------------- 1995 1994 - ------------------------------------------------------------------------------- Real estate owned: Foreclosed assets $ 856,167 $ 1,197,025 Less valuation allowance 295,567 257,644 ------------ ------------ OREO, net $ 560,600 $ 939,381 - -------------------------------------------------------------------------------\nFUNDING SOURCES\nDeposits: Total deposits amounted to $84,839,377 at December 31, 1995, compared to $80,220,761 at the end of 1994, and increase of 5.8%. Average deposits during the year increased 4.2%, averaging approximately $81,579,000 and $78,305,000, respectively, for 1995 and 1994.\nNon-interest bearing demand deposits averaged approximately $12,786,000 in 1995, compared to $12,072,000 in 1994. Interest bearing deposits averaged approximately $68,793,000 in 1995, an increase of 3.9%, or $2,560,000 from the average for 1994.\n- ------------------------------------------------------------------------------- 1995 1994\nAverage Average Average Average Balance Rate Balance Rate - ------------------------------------------------------------------------------- Interest bearing deposits Checking accounts $ 14,368,972 2.12% $ 16,753,519 2.13% Savings 21,271,869 3.91% 13,588,857 3.93% Time deposits (1) 33,152,076 5.59% 35,891,313 4.75% Non-interest bearing deposits 12,786,029 12,071,705 - ------------------------------------------------------------------------------- (1) Included at December 31, 1995 are $24,859,848 in time certificates of $100,000 or more, of which $6,722,445 matures in 3 months or less, $5,923,039 matures in 3 to 6 months, $10,553,604 matures in 6 to 12 months, and $1,660,760 matures in more than 12 months.\nOther Borrowings: There were no other borrowings as of December 31, 1995 or December 31, 1994.\nCapital: Retained earnings from operations has been the primary source of new capital for the Company. As of December 31, 1995, stockholders' equity was $9,771,029, compared to $8,747,535 at year-end 1994. Risk-adjusted capital guidelines, issued by bank regulatory agencies, assign risk weighting to assets and off-balance sheet items and place increased emphasis on common equity. The guidelines require adequately capitalized institutions to maintain a Tier I (core) capital ratio of 4% and a combined Tier I and Tier II capital ratio of 8%. Institutions whose Tier I and total capital ratios meet or exceed 6% and 10%, respectively, are deemed to be well capitalized. For the Company, Tier I capital consists of common stockholders' equity. In addition to the risk-weighted ratios, all banks are expected to maintain leverage ratios, to be determined on an individual basis, but not below a minimum of 3%. This ratio is defined as Tier I capital to average total assets for the most recent quarter. At December 31, 1995, the Company exceeded its capital requirements. Based on the guidelines, the Bank's Tier I and combined Tier I and Tier II risk-weighted ratios at December 31, 1995 were as follows:\n- ------------------------------------------------------------------------------- Minimum 1995 1994 1993 - ------------------------------------------------------------------------------- Risk Based Capital Ratio 8.00% 18.14% 15.47% 14.22% Tier I Ratio 4.00% 16.88% 14.49% 13.43% Leverage Ratio 3.00% 10.02% 9.92% 9.65% - -------------------------------------------------------------------------------\nSELECTED STATISTICAL INFORMATION\nFINANCIAL RATIOS\nThe following table shows key financial ratios for the Company for 1995, 1994 and 1993:\n- ------------------------------------------------------------------------------- 1995 1994 1993 - ------------------------------------------------------------------------------- Net income as a percentage of: Average stockholders' equity ................ 8.73% 9.18% 9.43% Average total assets ........................ .93% .94% .93% Average earning assets ...................... 1.01% 1.01% 1.02% Stockholders' equity at year-end as a percentage of: Total assets at year-end .................... 10.29% 9.81% 10.05% Net loans at year-end ....................... 21.00% 18.60% 20.19% Total deposits at year-end .................. 11.52% 10.90% 11.19% Average stockholders' equity as a percentage of: Average assets .............................. 10.69% 10.19% 9.86% Average loans ............................... 20.61% 19.67% 17.92% Average deposits ............................ 12.08% 11.42% 11.01% - -------------------------------------------------------------------------------\nPROPERTIES\nManteca Branch - In 1981 the Bank acquired the property located at 611 North Main Street , for $308,000. The Company's headquarters and administrative offices are also located there. The property consists of 2.4 acres and a building of approximately 13,000 square feet. On December 31, 1987, the property was transferred to the Company.\nRiverbank Branch - Prior to 1995, the Bank leased the facility located at 3300 Santa Fe in Riverbank, California. Under the terms of the lease which expired in 1995 the Bank pays $2,332 per month. The Bank did not renew the lease in 1995 and is currently renting on a month to month basis. Land was purchased by the Bank in 1995 for the purpose of building a new Riverbank facility. The facility is projected to be open by the end of 1996 or beginning of 1997.\nDenair Branch - The Bank currently leases the facility located at 4701 Main Street, Denair, California. Under the terms of the lease the Bank currently pays $3,100. The lease expires in the year 2008.\nModesto Branch - The Bank currently leases the facility located at 1901 McHenry Ave, Modesto, California. Under the terms of the lease the Bank currently pays $1,721. The lease expires in the year 2000 with one ten year option available.\nLEGAL PROCEEDINGS\nExcept for minor and usual collection litigation there are no pending claims against the company, or its subsidiary which in counsel's reasonable opinion will result in a substantial loss.\nSUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThere were no matters submitted during the fourth quarter of the fiscal year covered by this report to a vote of security holders through the solicitation of proxies or otherwise.\nMARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Company's common stock is listed with A. G. Edwards, Inc. The Company's stock is not listed with the National Association of Securities Dealers automated quotations system. There has been a limited trading market in the stock.\nThe following table states the high and low sales prices of the Company's stock for all quarters in 1995 and 1994:\n- ------------------------------------------------------------------------------ 1995 1994 - ------------------------------------------------------------------------------ High Low High Low\nFirst Quarter .......... $ 17.50 $ 16.50 $ 16.75 $ 16.00\nSecond Quarter .......... 17.00 16.75 17.00 16.50\nThird Quarter ........... 19.50 19.00 16.75 16.50\nFourth Quarter .......... 21.00 19.50 16.75 16.50 - ------------------------------------------------------------------------------\nThere can be no assurance that an established public market for the common stock will develop and the Company presently has no intention to seek the listing of the common stock on any Securities Exchange or quotation on the NASDAQ inter dealer quotation system, in the foreseeable future.\nAs of December, 1995, the Company had approximately 321 holders of record of Delta National Bancorp Stock. The shareholders of the Company will be entitled to receive dividends when and as declared.\nThe following table shows the dividends declared and paid by the Company for the years 1995, 1994 and 1993:\n- ------------------------------------------------------------------------------ 1995 1994 1993 - ------------------------------------------------------------------------------ Cash Dividends Paid ............... $ 263,747 $ 263,747 $ 263,747 Dividend payout ratio ............. 30.67% 32.11% 33.32% Book value at year end ............ $ 25.93 $ 23.22 $ 22.82 Market price\/book value at year end 80.99% 72.13% 70.42% - ------------------------------------------------------------------------------\nFINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nDELTA NATIONAL BANCORP AND SUBSIDIARY\nCONSOLIDATED BALANCE SHEETS\nDecember 31,\nASSETS\nThe accompanying notes are an integral part of these statements.\nDELTA NATIONAL BANCORP AND SUBSIDIARY\nCONSOLIDATED STATEMENTS OF EARNINGS\nYear ended December 31,\n1995 1994 1993 ---------- ---------- ---------- Interest income Interest and fees on loans ........... $5,564,417 $4,889,682 $4,960,279 Securities available-for-sale ........ 1,023,444 1,004,370 -- Securities held-to-maturity .......... 976,537 474,260 -- Investment securities ................ -- -- 1,477,263 Federal funds sold ................... 300,467 243,408 122,576 Interest-bearing deposits in banks ... 215 50 148 ---------- ---------- ----------\nTotal interest income ............. 7,865,080 6,611,770 6,560,266\nInterest expense on deposits (note I) ... 3,018,513 2,310,192 2,280,609 ---------- ---------- ----------\nNet interest income ............... 4,846,567 4,301,578 4,279,657\nProvision for loan losses ............... 624,014 191,750 642,000 ---------- ---------- ----------\nNet interest income after provision for loan losses ....... 4,222,553 4,109,828 3,637,657\nOther income Service charges on deposits .......... 486,673 516,347 656,056 Other ................................ 188,004 176,301 250,531 ---------- ---------- ----------\n674,677 692,648 906,587 ---------- ---------- ---------- Other expenses Salaries and wages ................... 1,589,306 1,502,791 1,490,436 Employee benefits .................... 307,076 222,797 242,256 Occupancy and equipment .............. 673,222 586,905 525,680 Data processing ...................... 20,088 21,448 26,250 Stationery and supplies .............. 84,328 91,022 103,784 Professional fees .................... 155,132 137,757 136,655 FDIC assessments ..................... 129,117 207,213 206,864 Other operating ...................... 527,084 672,146 506,865 ---------- ---------- ---------- 3,485,353 3,442,079 3,238,790 ---------- ---------- ----------\nEarnings before income taxes ...... 1,411,877 1,360,397 1,305,454\nIncome taxes (notes A9 and J) ........... 552,000 539,000 514,000 ---------- ---------- ----------\nNET EARNINGS ...................... $ 859,877 $ 821,397 $ 791,454 ========== ========== ==========\nNet earnings per share (note A10) ....... $ 2.28 $ 2.18 $ 2.10 ========== ========== ==========\nThe accompanying notes are an integral part of these statements.\nDELTA NATIONAL BANCORP AND SUBSIDIARY\nCONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY\nThree years ended December 31, 1995\nThe accompanying notes are an integral part of this statement.\nDELTA NATIONAL BANCORP AND SUBSIDIARY\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nYear ended December 31,\nDELTA NATIONAL BANCORP AND SUBSIDIARY\nCONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED\nYear ended December 31,\nNoncash investing and financing activities: The Bank foreclosed on loans with balances of $375,051 and $821,973 in 1994 and 1993, respectively. No loans were foreclosed on during 1995. The Bank recognized an increase of $730,537 in the fair value of its available-for-sale securities for the year ended December 31, 1995, a decline of $698,841 in the fair value of its available-for-sale securities for the year ended December 31, 1994, and an increase of $44,916 in the fair value of its available-for-sale securities for the year ended December 31, 1993.\nThe accompanying notes are an integral part of these statements.\nDELTA NATIONAL BANCORP AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDecember 31, 1995, 1994 and 1993\nNOTE A - SUMMARY OF ACCOUNTING POLICIES\nDelta National Bancorp (the Company) was incorporated under the laws of the State of California on December 21, 1981 for the purpose of serving as a bank holding company under the Bank Holding Company Act of 1956. The Company's wholly-owned subsidiary, Delta National Bank (the Bank), operates as a commercial bank in the cities of Manteca, Riverbank, Denair and Modesto, California. Through its branches the Bank provides traditional commercial banking services to individuals and small and medium-sized businesses located in the California Central Valley. The accounting and reporting policies of the Company and the Bank conform with generally accepted accounting principles and general practice within the banking industry.\nIn preparing financial statements in conformity with generally accepted accounting principles, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses during the reported period. Actual results could differ from those estimates.\nA summary of the significant accounting policies applied in the preparation of the accompanying financial statements follows.\n1. Consolidation\nThe consolidated financial statements of the Company include the accounts of the Company and the Bank. Significant intercompany transactions and amounts have been eliminated.\n2. Fair values of financial instruments\nThe financial statements include various estimated fair value information as of December 31, 1995, as required by Financial Accounting Standards Board Statement 107. Such information, which pertains to the Bank's financial instruments, is based on the requirements set forth in Statement 107 and does not purport to represent the aggregate net fair value of the Bank. Further, the fair value estimates are based on various assumptions, methodologies and subjective considerations, which vary widely among different financial institutions and which are subject to change.\nCash and cash equivalents: The carrying amounts reported in the balance sheet for cash and short-term instruments approximate those assets' fair values.\nSecurities: Fair values for securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments. Securities purchased under repurchase agreements are carried at the contract price.\nLoans receivable: For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. The fair values for other loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. The carrying amount of accrued interest approximates its fair value.\nNOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED\nOff-balance-sheet instruments: Fair values for the Bank's off-balance-sheet instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the credit standing of the counterparties.\nDeposit liabilities: The fair values estimated for demand deposits (interest and non-interest checking, passbook savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). The carrying amounts for variable-rate, fixed-term money market accounts and certificates of deposit approximate their fair values at the reporting date. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of the aggregate expected monthly maturities on time deposits. The carrying amount of accrued interest payable approximates its fair value.\nShort-term borrowings: The carrying amounts of borrowings under repurchase agreements and other short term borrowings approximate their fair values.\n3. Securities held-to-maturity\nBonds, notes and debentures for which the Bank has the positive intent and ability to hold to maturity are reported at cost, adjusted for amortization of premiums and accretion of discounts, which are recognized as adjustments to interest income over the period to maturity.\n4. Securities available-for-sale\nAvailable-for-sale securities consist of bonds, notes and debentures not classified as trading securities or held-to-maturity securities. Unrealized holding gains and losses, net of tax, are reported as a net amount in a separate component of stockholders' equity until realized. Gains and losses on the sale of available-for-sale securities are determined using the specific identification method. The amortization of premiums and accretion of discounts are recognized as adjustments to interest income over the period to maturity.\n5. Loans\nLoans are reported at the principal amount outstanding, net of unearned income, deferred loan fees, and the allowance for loan losses. Unearned discounts on installment loans are recognized as income over the terms of the loans. Interest on other loans is calculated by using the simple interest method on the daily balance of the principal amount outstanding.\nLoan fees net of certain direct costs of origination, which represent an adjustment to interest yield, are deferred and amortized over the contractual term of the loan.\nLoans on which the accrual of interest has been discontinued are designated as nonaccrual loans. Accrual of interest on loans is discontinued either when reasonable doubt exists as to the full and timely collection of interest or principal or when a loan becomes contractually past due by ninety days or more with respect to interest or principal. When a loan is placed on nonaccrual status, all interest previously accrued but not collected is reversed against current period interest income. Income on such loans is then recognized only to the extent that cash is received and where the future collection of principal is probable. Interest accruals are resumed on such loans only when they are brought fully current with respect to interest and principal and when, in the judgment of management, the loans are estimated to be fully collectible as to both principal and interest.\nNOTE A - SUMMARY OF ACCOUNTING POLICIES - CONTINUED\n6. Allowance for loan losses\nThe allowance for loan losses is established through a provision for loan losses charged to expenses. Loans are charged against the allowance for loan losses when management believes that the collectibility of the principal is unlikely. The allowance is an amount that management believes will be adequate to absorb losses inherent in existing loans and commitments to extend credit, based on evaluations of collectibility and prior loss experience of loans and commitments to extend credit. The evaluations take into consideration such factors as changes in the nature and volume of the portfolio, overall portfolio quality, loan concentrations, specific problem loans, commitments, and current economic conditions that may affect the borrowers' ability to pay.\nIn May 1993, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 114 entitled \"Accounting by Creditors for Impairment of a Loan\". This statement, which is effective January 1, 1995, requires that impaired loans, as defined, 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. The Bank adopted and implemented SFAS No. 114 as of January 1, 1995. The financial impact of this pronouncement was not significant.\n7. Property and equipment\nPremises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are provided for in amounts sufficient to relate the cost of depreciable assets to operations over their estimated service lives. Leasehold improvements are amortized over the lives of the improvements or the terms of the related leases, whichever is shorter. The straight-line method of depreciation is followed for financial reporting purposes, but accelerated methods are used for tax purposes. Deferred income taxes have been provided for the resulting depreciation differences.\n8. Foreclosed real estate\nReal estate properties acquired through foreclosure are initially recorded at fair value at the date of foreclosure, establishing a new cost basis. After foreclosure, valuations are periodically performed by management and the real estate is carried at the lower of (1) cost, or (2) fair market value minus estimated costs to sell. The net carrying value (included in other assets on the balance sheet) of foreclosed real estate was $560,600 and $939,381 at December 31, 1995 and 1994, respectively. Revenue and expenses from operations and additions to the valuation allowance (note F) are included in other expenses.\n9. Income taxes\nDeferred tax assets and liabilities are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes.\nNOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED\n10. Earnings per share\nEarnings per share amounts are computed on the basis of the weighted average number of shares outstanding during each year. The weighted average number of shares outstanding for 1995, 1994 and 1993 was 376,782.\n11. Cash and cash equivalents\nFor purposes of the statement of cash flows, the Bank considers due from banks and federal funds sold for one-day periods to be cash equivalents.\nNOTE B - CASH AND DEPOSITS\nThe Bank is required to maintain reserves by the Federal Reserve Bank. The average reserve requirements are based on a percentage of deposit liabilities. The Bank has met or exceeded the average reserve requirements for the periods presented in the financial statements. In addition, the Federal Reserve requires the Bank to maintain a certain minimum balance at all times, and such requirement was met by the Bank during the periods presented in the financial statements.\nNOTE C - SECURITIES\nEffective December 31, 1993, the Bank adopted SFAS No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\". These securities are classified into one of three categories: held-to-maturity, available-for-sale or trading. Held-to-maturity securities are measured at amortized cost and available-for-sale securities are measured at fair value. Unrealized holding gains and losses for available-for-sale securities are excluded from earnings and reported as a net amount in a separate component of stockholders' equity until realized.\nAmortized cost and estimated fair values of debt securities as of December 31, 1995 are as follows:\nNOTE C - SECURITIES\nAs of December 31, 1995, approximately 61% of the Bank's securities portfolio consisted of Small Business Administration Guaranteed Loan Pool Certificates. Credit risk related to such securities is greater than that of U.S. Treasuries.\nProceeds from sales of available-for-sale securities were approximately $483,000 in 1995. Gross losses of $17,000 were realized on these sales.\nThe amortized cost and estimated fair value of debt securities at December 31, 1995, 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.\nEstimated Amortized Fair Cost Value ----------- ----------- Available-for-sale securities: Due in one year or less .......................... $ 2,415,246 $ 2,392,518 Due after one year through five years ............ 498,340 490,262 Due after ten years .............................. 445,920 587,944 Not due at a single date ......................... 9,490,234 9,455,628 ----------- -----------\n$12,849,740 $12,926,352 =========== =========== Held-to-maturity securities: Due in one year or less .......................... $ 2,099,261 $ 2,089,362 Not due at a single date ......................... 18,252,276 18,394,560 ----------- -----------\n$20,351,537 $20,483,922 =========== ===========\nAmortized cost and estimated fair values of debt securities as of December 31, 1994 are as follows:\nInvestment securities carried at $10,802,942 and having a fair value of $10,943,601 at December 31, 1995 were pledged to secure public deposits as required or permitted by law. Pledged securities at December 31, 1994 had a carrying value of $10,161,557 and a fair value of $9,857,870.\nNOTE D - LOANS\nThe composition of the Bank's loan portfolio at December 31, is as follows:\n1995 1994 ------------ ------------ Commercial, financial and agricultural ..................... $ 22,755,013 $ 20,991,617 Real estate - construction ............. 9,175,475 7,352,440 Real estate - mortgage ................. 14,090,502 16,610,145 Installment ............................ 2,073,749 3,101,692 ------------ ------------\n48,094,739 48,055,894\nUnearned discount .................. (80,189) (167,027) Allowance for loan losses .......... (1,219,304) (599,422) Deferred loan fees ................. (275,427) (245,844) ------------ ------------\nLoans, net .................... $ 46,519,819 $ 47,043,601 ============ ============\nNon-performing assets are loans which are not accruing interest, and real estate acquired through foreclosure. At December 31, 1995 and 1994, non-performing assets amounted to $2,550,723 and $949,648, respectively.\nChanges in the allowance for loan losses for the years ended December 31, are summarized as follows:\n1995 1994 1993 ----------- ----------- -----------\nBalance at January 1, ............. $ 599,422 $ 807,543 $ 589,696 Provision charged to operations ... 624,014 191,750 642,000 Recoveries of loans previously charged off ..................... 108,234 163,848 220,812 Loans charged off ................. (112,366) (563,719) (644,965) ----------- ----------- -----------\nBalance at December 31, ........... $ 1,219,304 $ 599,422 $ 807,543 =========== =========== ===========\nImpaired loans aggregated approximately $2,841,000 at December 31, 1995, of which $1,146,000 is the result of a troubled debt restructuring. The average investment in impaired loans during 1995 was approximately $1,572,000. The total allowance for loan losses relating to these loans approximates $335,000. Total cash collected on impaired loans during 1995 approximated $78,800, of which $6,300 was credited to the principal balance outstanding, and $72,500 was recognized as interest income. Interest income that would have been recognized on impaired loans was approximately $210,000 for the year ended December 31, 1995.\nThe Bank's customers are primarily located in Stanislaus County and San Joaquin County. Approximately 48% of the Bank's loans are for real estate and construction and approximately 47% of the Bank's loans are for general commercial uses including professional, retail, agricultural and small business. Agricultural loans make up approximately 22% of the Bank's loan portfolio. Generally, real estate loans are secured by real property and commercial and other loans are secured by funds on deposit, business or personal assets. Repayment is generally expected from the proceeds of the sales of property for real estate construction loans, and from cash flows of the borrower for other loans.\nNOTE E - PROPERTY AND EQUIPMENT\nProperty and equipment, stated at cost, consists of the following at December 31: 1995 1994 ---------- ----------\nLand ................................. $ 636,117 $ 85,000 Building and improvements ............ 444,475 444,475 Furniture, fixtures and equipment .... 1,704,532 1,784,367 Leasehold improvements ............... 143,428 138,382 Automobiles .......................... 64,042 75,821 Construction in progress ............. 46,238 -- ---------- ---------- 3,038,832 2,528,045 Less accumulated depreciation and amortization ....................... 1,696,332 1,625,640 ---------- ----------\n$1,342,500 $ 902,405 ========== ==========\nDepreciation expense on property and equipment was $241,353, $231,468 and $185,082 in 1995, 1994 and 1993, respectively.\nDuring 1995, the Bank purchased land and prepared for the construction of a branch in the town of Riverbank, California.\nNOTE F - FORECLOSED REAL ESTATE\nChanges in the allowance for losses for foreclosed real estate for the years ended December 31, are as follows: 1995 1994 1993 --------- --------- --------- Balance at January 1, ............... $ 257,644 $ -- $ -- Provision charged to operations ..... 37,923 261,544 -- Charge-offs, net of recoveries ...... -- (3,900) -- --------- --------- --------- Balance at December 31, ............. $ 295,567 $ 257,644 $ -- ========= ========= =========\nNOTE G - TIME DEPOSITS\nAt December 31, 1995, the scheduled maturities of certificates of deposit are as follows:\n1996 $ 31,821,511 1997 2,581,421 1998 673,188 1999 441,450 2000 52,676 ---------------\n$ 35,570,246 ===============\nNOTE H - EMPLOYEE BENEFIT PLANS\nUnder the terms of the employee profit-sharing plan, a portion of the Bank's profits, determined annually by the Directors, will be set aside and maintained in a trust fund for the benefit of qualified employees. Contributions to the plan, included in employee benefits on the statements of earnings, were $100,000 in 1995. No contribution was made to the plan for 1994 or for 1993.\nDuring 1995, the Bank adopted a defined contribution 401(k) plan (the Plan). The Plan is available to all employees who are at least 18 years of age and who have worked a minimum of six months for the Bank. Eligible employees who elect to participate, may choose to contribute to the Plan, up to 10% of their compensation for the plan year. The Bank may also elect to make matching contributions to the Plan. The Bank did not make any matching contributions to the Plan in 1995.\nNOTE I - INTEREST EXPENSE ON DEPOSITS\nInterest expense on deposits was comprised of the following for the years ended December 31:\n1995 1994 1993 ---------- ---------- ----------\nDemand deposits and regular savings ..... $1,209,711 $ 755,796 $ 734,203 Time deposits greater than $100,000 ..... 522,539 559,932 1,019,095 Time deposits under $100,000 ............ 1,286,263 994,464 527,311 ---------- ---------- ----------\n$3,018,513 $2,310,192 $2,280,609 ========== ========== ==========\nNOTE J - INCOME TAXES\nEffective January 1, 1993, the Bank adopted SFAS No. 109, \"Accounting for Income Taxes\", which requires the use of the liability method in accounting for income taxes. The effect of this new standard on income tax expense for the year ended December 31, 1993 was not material.\nThe provision for income taxes for the years ended December 31, consists of the following: 1995 1994 1993 --------- --------- --------- Current: Federal ............. $ 632,000 $ 429,000 $ 420,000 State ............... 241,000 167,000 153,000 --------- --------- --------- 873,000 596,000 573,000 --------- --------- --------- Deferred: Federal ............. (240,000) (55,000) (52,000) State ............... (81,000) (2,000) (7,000) --------- --------- --------- (321,000) (57,000) (59,000) --------- --------- ---------\n$ 552,000 $ 539,000 $ 514,000 ========= ========= =========\nA reconciliation of income taxes computed at the federal statutory rate and the provision for income taxes for the years ended December 31, are as follows: 1995 1994 1993 --------- --------- ---------\nIncome taxes at statutory rates ......... $ 480,000 $ 463,000 $ 444,000 Reduction for tax exempt interest ....... (38,000) (53,000) (27,000) State income taxes, net of federal income tax benefit .................... 106,000 103,000 96,000 Other ................................... 4,000 26,000 1,000 --------- --------- ---------\n$ 552,000 $ 539,000 $ 514,000 ========= ========= =========\nThe tax effect of temporary differences giving rise to the Bank's deferred income tax asset at December 31, is as follows: 1995 1994 Deferred tax assets: Allowance for loan losses .......................... $ 318,000 $ 60,000 Foreclosed real estate ............................. 142,000 127,000 Unrealized loss on available-for-sale securities ... -- 272,000 State income taxes ................................. 80,000 54,000 --------- --------- 540,000 513,000 --------- --------- Deferred tax liabilities: Depreciation on property and equipment ............. (52,000) (75,000) Unrealized gain on available-for-sale securities ... (32,000) -- Accretion on investment securities ................. (6,000) (5,000) --------- --------- (90,000) (80,000) --------- --------- Deferred income tax asset (included in other assets on the balance sheet) ....................... $ 450,000 $ 433,000 ========= =========\nNOTE K - COMMITMENTS AND CONTINGENCIES\n1. Leases\nThe Company leases the Riverbank, Denair, and Modesto facilities under operating leases with initial terms expiring in 1996, 1998 and 2000, respectively.\nAt December 31, 1995 the future minimum rental payments under operating leases are as follows:\nYear ending December 31, ----------------------- 1996 $ 67,745 1997 57,857 1998 42,357 1999 20,657 2000 3,443 Thereafter -- -------- $192,059 ========\nRent expense under operating leases was $88,705, $86,973 and $80,973 for the years ended December 31, 1995, 1994 and 1993, respectively.\nNOTE L - FINANCIAL INSTRUMENTS\nThe Bank is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financial needs of its customers. These financial instruments include commitments to extend credit in the form of loans or through 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 balance sheet. The contract amounts of those instruments reflect the extent of involvement the Bank has in particular classes of financial instruments.\nThe Bank'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. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.\nContract Amount -------- Financial instruments whose contract amounts represent credit risk: Undisbursed loan commitments $ 6,266,356 Visa\/Mastercard lines 1,693,481 Standby letters of credit 68,000 -----------\n$ 8,027,837 ===========\nNOTE L - FINANCIAL INSTRUMENTS - CONTINUED\nCommitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer's credit worthiness 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. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties. All of the Bank's commitments are variable rate with no caps or floors.\nStandby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.\nThe following table provides summary information on the fair value of financial instruments at December 31, 1995:\nCarrying Estimated Amount Fair Value ----------- ----------- Financial assets: Cash and cash equivalents .......................... $11,930,351 $11,930,351 Interest-bearing deposits in banks ................. 51,043 51,043 Securities available-for-sale ...................... 12,926,352 12,926,352 Securities held-to-maturity ........................ 20,351,537 20,483,922 Loans receivable ................................... 48,094,739 47,877,723 Accrued interest receivable ........................ 814,267 814,267\nFinancial liabilities: Deposits ........................................... (84,839,377) (84,854,153) Accrued interest payable ........................... (199,188) (199,188)\nOff-balance-sheet liabilities: Commitments and letters of credit .................. -- (157,000)\nThe carrying amounts include $1,694,556 of non-accrual loans (loans that are not accruing interest) at December 31, 1995. Management has determined that primarily because of the uncertainty and the difficulty of predicting the timing of such cash flows excessive amounts of time and money would be incurred to estimate the fair values of nonperforming assets. The following aggregate information is provided about the contractual provisions of these assets:\nAggregate carrying amount $ 1,694,556 Effective rate 11.25% Average term to maturity 19 months\nNOTE M - RELATED-PARTY TRANSACTIONS\nThe Bank, in the ordinary course of business, makes loans and receives deposits from its directors and stockholders. As of December 31, 1995 and 1994 such loans amounted to $39,700 and $25,100, respectively. In management's opinion, these transactions were on substantially the same terms as comparable transactions with other customers of the Bank.\nNOTE N - CONDENSED FINANCIAL DATA\nThe following is the condensed financial data for Delta National Bancorp (parent company only):\nBALANCE SHEETS\nDecember 31,\nASSETS 1995 1994 ---------- ----------\nCash ................................................. $ 42,426 $ 35,652 Investment in subsidiary ............................. 9,399,721 8,855,561 Property and equipment, net .......................... 284,097 294,447 ---------- ----------\n$9,726,244 $9,185,660 ========== ==========\nLIABILITIES AND STOCKHOLDERS' EQUITY\nLiabilities: Accrued expenses and other liabilities ............. $ -- $ 55,546\nStockholders' equity ................................. 9,726,244 9,130,114 ---------- ----------\n$9,726,244 $9,185,660 ========== ==========\nSTATEMENTS OF EARNINGS\nYear ended December 31,\n1995 1994 1993 -------- -------- -------- Income Interest .............................. $ 943 $ 2,487 $ 3,594 Rent .................................. 83,698 74,800 66,800 Other ................................. 475 315 135 -------- -------- --------\n85,116 77,602 70,529 -------- -------- -------- Expenses General and administrative ............ 31,049 28,513 37,707 Depreciation .......................... 10,350 10,350 10,350 -------- -------- --------\n41,399 38,863 48,057 -------- -------- -------- Earnings before income taxes and equity in earnings of subsidiary ...................... 43,717 38,739 22,472\nIncome tax expense ...................... 18,000 16,000 13,400 -------- -------- --------\n25,717 22,739 9,072 Equity in earnings of Delta National Bank ................... 834,160 798,658 782,382 -------- -------- --------\nNET EARNINGS ............................ $859,877 $821,397 $791,454 ======== ======== ========\nNOTE N - CONDENSED FINANCIAL DATA - CONTINUED\nSTATEMENTS OF CASH FLOWS\nYear ended December 31,\nNOTE O - CAPITAL REQUIREMENTS\nBanks are required to maintain a minimum leverage-capital ratio of Tier I capital (as defined) to total assets based on bank ratings under its regulatory rating system. Currently, a rating of \"one\" is required to maintain a minimum leverage-capital ratio of 3 percent. Institutions with other ratings are required to maintain ratios of 4 percent to 5 percent. In addition, banks must maintain a ratio of total capital to risk-weighted assets of 8 percent (risk-based capital ratio) and a ratio of Tier I capital to risk-weighted assets of 4 percent (Tier I capital ratio). The Bank exceeded its capital requirements at December 31, 1995.\nNOTE P - SIGNIFICANT FOURTH-QUARTER ADJUSTMENTS\nIn December 1995, the Bank increased its allowance for loan losses through a provision for loan losses charged to operations by approximately $325,000 ($.86 per share).\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nBoard of Directors and Stockholders Delta National Bancorp\nWe have audited the accompanying consolidated balance sheets of Delta National Bancorp and Subsidiary as of December 31, 1995 and 1994, and the related consolidated statements of earnings, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1995. 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 Delta National Bancorp and Subsidiary as of December 31, 1995 and 1994, and the consolidated results of their operations and their consolidated cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\nAs described in note J, during the year ended December 31, 1993, the Company changed to the liability method of accounting for income taxes. As described in note C, the Company changed its method of accounting for securities as of December 31, 1993.\n\/s\/ Grant Thornton, LLP Stockton, California January 19, 1996\nCHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThere were no changes in or disagreements with accountants on accounting and financial disclosures during the fiscal years ending December 31, 1995 and 1994.\nDIRECTORS & EXECUTIVE COMPENSATION\nIdentification of directors: The names of each director of the Company and certain information about them, is set forth below:\n- -------------------------------------------------------------------------------- Director Director Age Principal Occupation Since - -------------------------------------------------------------------------------- Andrew J. Rossi .... 63 President and Chief Executive 1973 Officer - Delta National Bank (Executive Officer) President - A. Rossi, Inc.\nJack Dozier ........ 80 Attorney - Atherton & Dozier 1976\nJoseph A. Freitas .. 68 Secretary to the Board 1973 Public Relations-Delta National Bank - Retired 1991\nTheodore Poulos .... 67 Chairman of the Board-Delta National Bank 1973 Public Relations-Delta National Bank President-Manteca Drug, Inc. - Retired 1994\nToinette Rossi ..... 37 Vice President & Manager 1994 Delta National Bank (Executive Officer) - --------------------------------------------------------------------------------\nEach of the directors has been engaged in his\/her principal occupation set forth above during the past five years.\nIdentification of executive officers: The names of each executive officer of the Company not already listed in the table above and certain information about them, is set forth below:\n- -------------------------------------------------------------------------------- Executive Principal Occupations with Period Officer Age Delta National Bank Served - -------------------------------------------------------------------------------- Warren E. Wegge .... 47 Executive Vice President 1994 Senior Vice President\/Credit 1991 Administrator Vice President\/Corporate Banking Officer 1988\nChad B. Meyer (1) .. 42 Senior Vice President\/Credit 1994 Administrator Vice President\/Corporate Banking Officer 1991\nRonald P. Dalben ... 39 Vice President (Investment Officer 1987 & Appraiser) Various other positions 1980\nBarbara Jordan ..... 54 Vice President\/Operations 1992 Assistant Vice President\/Operations 1990 Various other positions 1983\nEileen Pastenieks .. 34 Vice President\/Accounting 1994 Assistant Vice President\/Note Dept. 1993 Operations Officer 1990 - -------------------------------------------------------------------------------- (1) Prior to his employment with Delta National Bank, Mr. Meyer was the Chief Financial Officer of a construction firm.\nFamily relationships: Except for Andrew Rossi and Toinette Rossi, who are related to each other, there are no other family relationships between any other director or executive officer of the Company.\nDirectorships: The following individuals hold other directorships as indicated below:\n- ------------------------------------------------------------------------------- DIRECTOR\/EXECUTIVE OFFICER OTHER DIRECTORSHIPS HELD - ------------------------------------------------------------------------------- Theodore Poulos ................... Doctors Hospital of Manteca Virotechnology, Inc.\nJoseph A. Freitas ................. Manteca Boys & Girls Club\nJack C. Dozier .................... Cal Cedar Products Duraflame, Inc. Rylock Ltd. Cal Mills - -------------------------------------------------------------------------------\nInvolvement in certain legal proceedings: None of the directors or executive officers named above have been involved in certain legal proceedings.\nEXECUTIVE COMPENSATION\nDirector Compensation Table: The following table sets forth information concerning compensation for Directors in 1995. (See \"Summary Compensation Table\" for additional information on Executive Officers)\n- ------------------------------------------------------------------------------- Annual Annual BCORP Bank Director Director Committee Name Fees Fees Retainer Fees (1) Other (2) - ------------------------------------------------------------------------------- Andrew J. Rossi ...... $4,800 $ - $ - $ - $ -\nJack Dozier .......... 4,800 7,200 28,800 - -\nJoseph A. Freitas .... 4,800 7,200 - - -\nTheodore Poulos ...... 4,800 7,200 - 15,600 27,450\nToinette Rossi ....... 4,800 - - - - - ------------------------------------------------------------------------------- (1) Finance Committee Annual Fee (2) Salary from Bank $24,000 for Public Relations and Past Due Meetings $1,650, $1,800 Club Membership Dues\nSummary Compensation Table: The following table shows, as to the Chief Executive Officer and each of the four other most highly compensated executive officers, information concerning compensation for services to the Company in all capacities. (Also see \"Director Compensation Table\")\n- ------------------------------------------------------------------------------- Club or Profit Organization Sharing Name and Principal Salary Bonus ($) Automobile Membership Plan Position Year ($) (1) Use Fees (2) - -------------------------------------------------------------------------------\nAndrew J. Rossi 1995 $112,000 $10,000 $ 1,500 $ 2,300 $13,944 President and Chief 1994 100,000 -- 4,081 Executive Officer 1993 88,860 10,000 3,897\nWarren E. Wegge 1995 $ 78,000 $13,500 $ -- $ -- $ 9,680 Executive Officer 1994 65,460 2,500 2,397 1993 60,660 7,595 2,200\nChad B. Meyer 1995 $ 62,400 $ 6,750 $ -- $ -- $ 6,086 Senior Vice 1994 60,000 1,000 775 President\/Credit 1993 53,400 4,716 603 Administrator\nToinette Rossi 1995 $ 60,000 $ 5,316 $ -- $ -- $ 9,577 Vice President & 1994 57,600 1,822 3,970 Manager 1993 54,780 1,480 3,913\nRonald P. Dalben 1995 $ 52,000 3,600 $ -- $ -- $ 7,133 Vice President 1994 50,000 2,000 2,537 1993 47,640 3,800 2,451 - ------------------------------------------------------------------------------- (1) 1995 Bonuses were actually paid in 1995 for services rendered in 1995 (2) Profit Sharing\nSECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS OF MANAGEMENT\nThe following table sets forth as of December 31, 1995 information relating to the beneficial owners of the Company's Common Stock by each person known by the Company to be the beneficial owner of more than five percent (5%) of the outstanding shares of Common Stock.\n- ------------------------------------------------------------------------------ Total Shares Percent of Name Address Owned Class - ------------------------------------------------------------------------------ Andrew J. Rossi 611 North Main St. 94,509 25.10% Manteca, CA 95336 - ------------------------------------------------------------------------------\nCommon Stock Ownership of Directors and Executive Officers: The following table reflects shares of Common Stock beneficially owned by each director of the Company, each of the executive officers named in the Summary Compensation Table appearing elsewhere herein, and by all directors and executive officers as a group, as of December 31, 1995.\n- ------------------------------------------------------------------------------- Direct Indirect Total Approximate Shares Shares Shares Percentage Name Position Owned Owned Owned Owned - ------------------------------------------------------------------------------- Jack C. Dozier ..... Director 5,190 -- 5,190 1.38%\nJoseph A. Freitas .. Director 11,185 -- 11,185 2.97%\nTheodore Poulos .... Chairman of the 12,100 1,142 13,242 3.52% . Board\/Director\nAndrew J. Rossi(1).. President & CEO\/ 75,539 18,970 94,509 25.10% Director\nToinette Rossi ..... V.P. & Manager\/ 2,708 -- 2,708 less than Director 1%\nWarren E. Wegge .... Executive Vice 100 -- 100 less than President 1%\nRonald P. Dalben ... Vice President 100 -- 100 less than 1% - ------------------------------------------------------------------------------- All directors and executive officers as a group: 127,034 33.74% - ------------------------------------------------------------------------------- (1) Indirect 5.04% of class Direct 20.06% of class\nCERTAIN RELATIONSHIPS & RELATED PARTIES\nIn 1995 the Bank renewed an extension of credit to Joseph A. Freitas, Director of the Company, in the amount of $17,353. As of December 31, 1995, the principal balance owing was $15,621. This loan bears interest at the a fixed rate of 8% and is scheduled to mature on April 19, 1996. The loan is collateralized by a Certificate of Deposit.\nIn 1994 the Bank funded an unsecured loan to Linda Abeldt, daughter of Joseph Freitas, Director of the Company, in the amount of $12,000. In 1995 the Bank funded an additional unsecured loan in the amount of $9,000. In addition, there was an unsecured line of credit issued in the amount of $50,000. The first two loans bear interest at a fixed rate of 7% and 10% while the line of credit bears interest at the Bank's reference rate plus 2%. As of December 31, 1995, the principal balance owing was $10,316. and $9,000. respectively on the two loans. There was no balance owed on the line of credit. The loans are scheduled to mature on January 25, 1999, March 22, 2000 and April 20, 1996 respectively.\nIn 1991 the Bank extended credit to Valerie Salas, daughter of Andrew Rossi, President, Chief Executive Officer and Director of the Company and sister of Toinette Rossi, Vice President\/Manager and Director of the Company, in the amount of $16,595. As of December 31, 1995, the principal balance owing was $7,979. This loan is unsecured and bears interest at a fixed rate of 13%. This loan matures on April 23, 1997.\nIn 1995 the Bank funded an unsecured line of credit to John Rossi, son of Andrew Rossi, President, Chief Executive Officer and Director of the Company and brother of Toinette Rossi, Vice President\/Manager and Director of the Company, in the amount of $303,250. On December 31, 1995, there was no principal balance owed. This loan bears interest at the Bank's reference rate plus 2.5% and is scheduled to mature on November 1, 1996.\nEXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8K\n(a) 1. Financial Statements: Delta National Bancorp and Subsidiary\nSee Item 8 for a listing of all financial statements.\n2. Financial Statement Schedules\nAdditional Supplementary Data not included in this section have been omitted because the information required has been included in the financial statements or notes thereto or are not applicable or not required.\n3. Exhibits\nRegistrant's Articles of Incorporation and Bylaws are furnished by way of incorporation by reference to Exhibit 3 to registrant's registration statement on Form S-14, as filed under the Securities Act of 1933 on September 10, 1982 and declared effective on October 8, 1982.\nPlan of Reorganization and Agreement of Merger is furnished by reference to registrant's Form S-14 as filed under the Securities Act of 1933 on September 10, 1982 and declared effective on October 8, 1982.\n(b) Reports on Form 8-K\nThe registrant did not file any reports on Form 8-K during the ended December 31, 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.\nDELTA NATIONAL BANCORP (Registrant)\nBy: \/s\/ Andrew Rossi President and Chief Executive Officer\/Director March 10, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the indicated capacities, on March 10, 1996.\n\/s\/ Andrew Rossi \/s\/ Theodore Poulos Andrew Rossi Theodore Poulos President and Chairman of the Board Chief Executive Officer and Director and Director (Principal Executive Officer)\n\/s\/ Joseph Freitas \/s\/ Eileen Pastenieks Joseph Freitas Eileen Pastenieks Secretary of the Board and Staff Vice President\/Accounting Director (Principal Accounting Officer)\n\/s\/ Warren Wegge \/s\/ Toinette Rossi Warren Wegge Toinette Rossi Executive Vice President Vice President and Manager and (Principal Financial Officer) Director","section_15":""}
{"filename":"828535_1995.txt","cik":"828535","year":"1995","section_1":"ITEM 1. BUSINESS\nCommercial National Financial Corporation (the \"Corporation\" or \"registrant\"), a bank holding company, was incorporated in Michigan on December 30, 1987. On May 31, 1988, the Corporation acquired all of the stock of Commercial National Bank, a national banking association chartered in 1962. On December 30, 1992, Commercial National Bank converted to a state-chartered bank under the name Commercial Bank (the \"Bank\").\nThe Bank's business is concentrated in a single industry segment - commercial banking. The Bank provides a full range of banking services to individuals, agricultural businesses, commercial businesses and light industries located in its service area. The Bank maintains a diversified loan portfolio, including loans to individuals for home mortgages, automobiles and personal expenditures, and loans to business enterprises for current operations and expansion. The Bank offers a variety of deposit vehicles, including checking, savings, money market and individual retirement accounts and certificates of deposit.\nThe principal markets for the Bank's financial services are the Michigan communities in which the Bank is located and the areas immediately surrounding these communities. The Bank serves these markets through nine offices located in and near these communities. Neither the Corporation nor the Bank has any material foreign assets or income.\nThe principal source of revenue for the Corporation and its subsidiary is interest and fees on loans. On a consolidated basis, interest and fees on loans accounted for 78.1% of the Corporation's total revenues in 1995, 75.5% in 1994, and 74.7% in 1993. Interest on investment securities accounted for 13.9% of the Corporation's total revenues in 1995, 16.1% in 1994, and 15.6% in 1993.\nAt December 31, 1995, the Bank had no significant concentrations of loans to any group of borrowers engaged in similar activities that would be impacted by economic or other conditions.\nThe business of banking is highly competitive. In addition to competition from other commercial banks, banks face competition from nonbank financial institutions. Savings associations compete with commercial banks for deposits and loans. Credit unions and finance companies compete for consumer loans. Commercial banks compete for deposits with other investments such as mutual funds and corporate and government debt securities. Financial service providers compete for customers principally through price (interest rates paid on deposits, interest rates charged on borrowings and fees charged for services) and service (convenience and quality of services rendered to customers).\nThe Bank competes directly with fifteen financial institutions in the market it serves. The Bank's competitors include other commercial banks, savings associations and local credit unions. When combining the deposits of those branches, the Bank ranks second in deposit size. The Bank does not believe that its ability to compete for loans and deposits is affected by the rank among its competitors.\nBanks and bank holding companies are extensively regulated. The Bank is chartered as a state bank under Michigan law and is supervised, examined and regulated by the Michigan Financial Institutions Bureau and the Federal Deposit Insurance Corporation (\"FDIC\"). The business activities of the registrant are limited to banking and to other activities determined by the Board of Governors of the Federal Reserve System to be closely related to banking. Deposits of the Bank are insured by the FDIC to the extent provided by law.\nCommercial banks are subject to a number of federal and state laws and regulations that have a material impact on their business. These include, among others, state usury laws, state laws relating to fiduciaries, the Truth in Lending Act, the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Expedited Funds Availability Act, the Community Reinvestment Act, electronic funds transfer laws, redlining laws, antitrust laws, environmental laws and privacy laws. The policies of the Federal Reserve System, and other authorities, may materially affect the growth and distribution of loans, investments and deposits and interest rates on deposits and loans.\nThe FDIC Improvement Act of 1991 (the \"FDIC Improvement Act\"), revised sections of the Federal Deposit Insurance Act affecting bank regulation, deposit insurance and provisions for the funding of the bank insurance fund. The FDIC\nImprovement Act also revised bank regulatory structures embodied in several other federal banking statutes, links the bank regulators' authority to intervene to the deterioration of a bank's capital level, places limits on real estate lending and increases audit requirements. Among the significant revisions that could have an impact on the Corporation is the authority granted the FDIC to impose special assessments on insured depository institutions to repay FDIC borrowings from the United States Treasury or other sources and to establish semiannual assessment rates on bank insurance fund member banks so as to maintain the bank insurance fund at the designated reserve ratio defined in the FDIC Improvement Act. The FDIC Improvement Act also required the FDIC to implement a system of risk-based premiums for deposit insurance pursuant to which the premiums paid by a depository institution are based on the perceived probability that the bank insurance fund will incur a loss in respect of such institution.\nUnder 1994 amendments to the Federal Bank Holding Company Act, the Corporation is authorized to acquire subsidiary banks in any state in which state laws permit such acquisitions. Out-of-state bank holding companies in any state are permitted to acquire banks located in Michigan if the laws of the state in which the out-of-state bank holding company is located authorize a bank holding company located in Michigan to acquire ownership of banks in that state on a reciprocal basis. Under amendments to the Michigan Banking Code which became effective on November 29, 1995, the Bank is authorized to merge with or acquire out-of-state banks or branches in any state in which state laws permit such acquisitions.\nAs of December 31, 1995, the Corporation and its subsidiary employed approximately 91 employees on a full-time equivalent basis.\nThe statistical information on the following pages further describes certain aspects of registrant's business.\nDistribution of Assets, Liabilities, and Shareholders' Equity\nThe following table sets forth the average amount of each principal category of assets, liabilities, and shareholders' equity for the periods indicated:\nInterest Rates and Interest Differential\nThe following tables present an analysis of net interest earnings for the periods indicated. All interest (including tax-exempt securities and tax-exempt loans) is presented on a fully taxable-equivalent basis.\n- --------------------------------\n(1) Loan fees are included in interest income and are used to calculate average rates earned. Non-accrual loans are included in the average loan balances.\n(2) Yields on tax exempt loans and investment securities are computed on a fully taxable-equivalent basis using a federal income tax rate of 34%.\nThe following table sets forth an analysis of interest differential, including the effect of volume and rate changes on interest income and expenses for the periods indicated. For purposes of these tables, change in interest due to volume and rate were determined as follows:\n- ---------------------------------\n(1) Loan fees are included in interest income and are used to calculate average rates earned. Non-accrual loans are included in the average loan balances.\n(2) Yields on tax exempt loans and investment securities are computed on a fully taxable-equivalent basis using a federal income tax rate of 34%.\nInvestment Portfolio\nThe book value of investment securities as of the dates indicated are summarized as follows:\nThe following table shows, by class of maturities as of December 31, 1995, the amounts and weighted average yields of held-to-maturity securities (1):\n- ----------------------------\n(1) The effective yields are weighted for the scheduled maturity of each security and weighted average yields are calculated on the basis of par value.\n(2) Weighted average interest rates have been computed on a fully taxable-equivalent basis. The rates shown on securities issued by states and political subdivisions have been restated, assuming a 34% tax rate.\n(3) As of December 31, 1995, the aggregate book value of investment securities issued by the State of Michigan and all its political subdivisions totaled $9,726 with an aggregate market value of $9,834.\nLoan Portfolio\nThe following table presents the amount of loans outstanding at the indicated dates by loan type, based on classifications used for regulatory reporting:\nThe following table shows the maturity of loans (excluding real estate mortgages and installment loans) outstanding at December 31, 1995. Also provided are the amounts due after one year classified according to their sensitivity to changes in interest rates.\nThe following table summarizes nonaccrual, past due, and restructured loans at the dates indicated:\nThe Corporation estimates the following additional information with respect to nonaccrual and restructured loans for the year ended December 31, 1995:\nLoan performance is reviewed regularly by loan review personnel, loan officers and senior management. Loans are placed on nonaccrual status when principal or interest is past due 90 days or more and the loan is not well-secured and in the process of collection, or when reasonable doubt exists concerning collectibility of interest or principal. Any interest previously accrued in the current period but not collected is reversed and charged against current earnings.\nAt December 31, 1995, the Corporation had $2,800 in domestic loans for which payments are presently current, but where the borrowers are currently experiencing financial difficulties. Those loans are subject to constant management attention and their classification is reviewed on a regular basis.\nAs of December 31, 1995, there were no concentrations of loans exceeding 10% of total loans.\nSummary of Loan Loss Experience\nThe following table summarizes loan balances at the end of each period and daily averages; changes in the allowance for possible loan losses arising from loans charged off and recoveries on loans previously charged off, by loan category; and additions to the allowance which have been charged to expense.\n- ----------------\n(1) The provision for loan losses charged to expense is based on loan loss experience and such other factors which, in management's judgment, deserve current recognition in maintaining an adequate allowance for loan losses. These other factors include, but are not limited to, a review of current economic conditions as they relate to loan collectibility and reviews of specific loans to evaluate their collectibility.\nThe allowance for loan losses has been allocated according to the amount deemed to be reasonably necessary to provide for the possibility of losses being incurred within the following categories at the dates indicated:\nDeposits\nThe daily average amounts of deposits and rates paid on such deposits for the periods indicated are:\nThe time remaining until maturity of time certificates of deposits of $100,000 or more at December 31, 1995, is as follows:\nReturn on Equity and Assets\nThe following table sets forth certain financial ratios at the end of each period:\nShort-Term Borrowings\nShort-term borrowed funds consist of securities sold under agreements to repurchase and treasury tax and loan demand notes. The following amounts and rates applied during the last two years:\nThe weighted average interest rates are derived by dividing the interest expense for the period by the daily average balance during the period.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Bank currently conducts business from nine banking offices including two branches located in supermarkets owned by a related party. The executive offices of the Corporation are located at 101 North Pine River Street, Ithaca, Michigan. The main office of the Bank is located at 301 North State Street, Alma, Michigan. The main office property of the Bank is leased for a term expiring on December 31, 2013. The branches of the Bank are located in Alma, Greenville, Midland, Middleton, Pompeii, and St. Louis, Michigan.\nThe Bank owns the property for five of the branch office locations. One branch office is leased pursuant to a lease that expires August 1, 1998, subject to 3 renewals of 10 years each. The Alma Supermarket Branch is leased pursuant to a five year lease beginning June 1, 1995 with two five year renewals. The Midland Supermarket Branch is leased pursuant to a five year lease beginning January 1, 1996 with two five year renewals. Aggregate rental expense represents less than 5% of the registrant's operating expenses. The Corporation considers all of its facilities to be well maintained and in generally good operating condition and suitable for the purposes for which they are intended.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThe Corporation and the Bank are parties, as plaintiff or defendant, to several legal proceedings, none of which is considered material, and all of which arose in the ordinary course of business.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNot applicable.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS.\nThe information under the captions \"Common Stock Information\" and \"Dividend Information\" of the registrant's annual report to shareholders for the year ended December 31, 1995, is here incorporated by reference to Exhibit 13.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe information under the caption \"Selected Financial Data\" of the registrant's annual report to shareholders for the year ended December 31, 1995, is here incorporated by reference to Exhibit 13.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nThe information under the heading \"Management's Review and Analysis\" of the registrant's annual report to shareholders for the year ended December 31, 1995, is here incorporated by reference to Exhibit 13.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe financial statements, notes and independent auditors' report of the registrant's annual report to shareholders for the year ended December 31, 1995, are here incorporated by reference to Exhibit 13.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nEffective December 13, 1995, the Corporation's Board of Directors approved the dismissal of its certifying accountants, BDO Seidman, LLP, to be effective upon completion of audit services for the year ending December 31, 1995, and retained as its new certifying accountants, Crowe, Chizek, and Co. LLP, for audit services beginning in 1996. BDO Seidman LLP's report on the Corporation's financial statements during the two most recent fiscal years preceding December 13, 1995 contained no adverse opinion or a disclaimer of opinion, and was not qualified or modified as to uncertainty, audit scope or accounting principles. During the last two fiscal years and the subsequent interim period to December 13, 1995, there were no disagreements between the Corporation and BDO Seidman, LLP, on any matters of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements, if not resolved to the satisfaction of BDO Seidman, LLP would have caused it to make a reference to the subject matter of the disagreements in connection with its reports.\nNone of the \"reportable events\" described in Item 304(a)(1)(v) of Regulation S-K occurred with respect to the Corporation within the last two fiscal years and the subsequent interim period to December 13, 1995.\nEffective December 13, 1995, the Corporation engaged Crowe, Chizek, and Co. LLP, as its principal accountants for audit services for the year ending December 31, 1996. During the last two fiscal years and the subsequent interim period to December 13, 1995, the Corporation did not consult Crowe, Chizek, and Co. LLP regarding any of the matters or events set forth in Item 304(a)(2)(i) and (ii) of Regulation S-K.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nThe information set forth under the caption \"Directors and Executive Officers\" and \"Other Matters\" in the registrant's definitive Proxy Statement for its April 23, 1996, annual meeting of shareholders is here incorporated by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe information set forth under the captions \"Compensation of Executive Officers\", \"Compensation of Directors\", and \"Employment, Termination of Employment, and Change in Control Agreement\", in the registrant's definitive Proxy Statement for its April 23, 1996, annual meeting of shareholders is here incorporated by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe information set forth under the caption \"Voting Securities\" in the registrant's definitive Proxy Statement for its April 23, 1996, annual meeting of shareholders is here incorporated by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe information set forth under the caption \"Certain Relationships\" in the registrant's definitive Proxy Statement for its April 23, 1996, annual meeting of shareholders is here incorporated by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(a)(1) Financial Statements.\nThe following financial statements, notes to financial statements, and independent auditors' report of the Corporation and its subsidiary are filed as part of this report:\nIndependent Auditors' Report Consolidated Balance Sheets - December 31, 1995 and 1994 Consolidated Statements of Income for each of the three years ended December 31, 1995 Consolidated Statements of Shareholders' Equity for each of the three years in the period ended December 31, 1995 Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 1995 Notes to Consolidated Financial Statements\nThe financial statements, notes to financial statements, and independent auditors' report for the years ended December 31, 1995 and 1994, listed above are incorporated by reference in Item 8 of this report from the corresponding portions of the registrant's annual report to shareholders for the year ended December 31, 1995. With the exception of the portions of the registrant's annual report to shareholders for the year ended December 31, 1995 specifically incorporated herein by reference, such report shall not be deemed filed as part of this annual report on Form 10-K.\n(2) All schedules have been omitted because they are inapplicable or otherwise not required.\n(3) The following exhibits are filed as part of this report:\nNumber Exhibit\n3(a) Restated Articles of Incorporation. Previously filed as an exhibit to the registrant's Form S-4 filed January 22, 1988. Here incorporated by reference.\n3(b) Bylaws. Previously filed as an exhibit to the registrant's Form S-4 filed January 22, 1988. Here incorporated by reference.\n10(a) Form of Indemnity Agreement. Previously filed as an exhibit to the registrant's Form S-4 filed January 22, 1988. Here incorporated by reference.\n10(b) 1989 Stock Option Plan. Previously filed as an exhibit to the registrant's Form 10-K for the year ended December 31, 1988. Here incorporated by reference.*\n10(c) 1991 Stock Option Plan. Previously filed as an exhibit to the registrant's Form 10-K for the year ended December 31, 1990. Here incorporated by reference.*\n10(d) Amendment to 1991 Stock Option Plan.*\n10(e) Lease for Main Office. Previously filed as an exhibit to registrant's Form 10-K for the year ended December 31, 1991. Here incorporated by reference.\n10(f) Branch Purchase and Assumption Agreement. Previously filed as an exhibit to registrant's Form 10-K for the year ended December 31, 1991. Here incorporated by reference.\n10(g) Executive Employment, Change of Control and Severance Agreements. Previously filed as an exhibit to registrant's Form 10-K for the year ended December 31, 1991. Here incorporated by reference.*\n10(h) Branch Lease for Alma Supermarket Branch.\n10(i) Branch Lease for Midland Supermarket Branch.\n13 Incorporated portions from 1995 Annual Report to Shareholders.\n16 Letter Concerning Change in Certifying Public Accountant. Previously filed as an exhibit to registrant's Form 8-K, filed December 28, 1995. Here incorporated by reference.\n21 Subsidiary of Registrant. Previously filed as an exhibit to the registrant's Form S-4 filed January 22, 1988. Here incorporated by reference.\n23 Consent of Independent Certified Public Accountants.\n24 Power of Attorney.\n27 Financial Data Schedule.\n* Management contract or compensatory plan or arrangement\nThe registrant will furnish a copy of any exhibit listed above to any shareholder of the registrant without charge upon written request to Marlyn Artecki, Commercial National Financial Corporation, 101 North Pine River Street, Ithaca, Michigan 48847.\n(b) Reports on Form 8-K.\nA Form 8-K was filed by the registrant on December 28, 1995, for Item 4, \"Changes in the Registrant's Certifying Accountant.\"\n(c) Exhibits.\nSee Item 14(a)(3)\n(d) Financial Statement Schedules.\nThere are no financial statement schedules required to be filed with 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.\nCOMMERCIAL NATIONAL FINANCIAL CORPORATION (registrant)\nMarch 20, 1996 By: \/s\/ Dean E. Milligan ------------------------------------- Dean E. Milligan 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.\nINDEX TO EXHIBITS","section_15":""}
{"filename":"2070_1995.txt","cik":"2070","year":"1995","section_1":"ITEM 1 - BUSINESS\nBUSINESS\nThe Registrant was duly organized and incorporated under the laws of the State of New York on April 26, 1946. Its sole line of business is the design and manufacture of power conversion equipment for electronic and electrical systems. Principal markets encompass the computer, office copier, information systems, military, aerospace and communications industries and a variety of industrial, commercial and residential fields for applications that require conversion of electrical energy from one useable state to another. Products are distributed to customers through the Registrant's sales force, independent sales representatives and wholesale distributors. The business of the Registrant is not seasonal in nature.\nCOMPETITION\nCompetitive conditions within the power conversion industry are intense. The Registrant competes with many other companies, some of which have far greater resources than the Registrant. The principal methods of competition within the industry are price, service and product performance. To meet this competition, the Registrant attempts to maintain high standards of engineering, manufacturing and customer service. Due to the number and variety of competitors, reliable data relative to the Registrant's competitive position within the power conversion industry would be difficult to develop and is not known nor believed to exist.\nCUSTOMERS\nTwo customers of the Company accounted for 13.4% and 10.6% of fiscal 1995 sales, respectively, one of which also accounted for 10.6% of June 30, 1995, accounts receivable. In comparison, there was one customer of the Company that accounted for 10.0% of fiscal 1994 sales and no customers were above the 10% threshold in 1993.\nBACKLOG\nThe backlog of orders believed to be firm totaled approximately $20,954,498 at June 30, 1995, compared with approximately $16,697,000 at June 30, 1994. The change in backlog as of June 30, 1995, compared with the backlog as of June 30, 1994, reflects increased order volume from a major OEM customer at the Electronics Division, combined with several significant development contracts received at the Aerospace Division. Backlog orders at June 30, 1995, are generally expected to be filled during the current fiscal year.\nRAW MATERIALS\nThe Registrant purchases materials in a semi-finished state from other manufacturers and distributors. Availability of materials is considered adequate to maintain current production levels.\nPATENTS\nThe Registrant holds several technical patents and trademarks and is a party to certain patent applications. The extent of the effect of such patents and trademarks is, however, in the opinion of management, not material at this time.\nLICENSES\nThe Registrant is a party to several license agreements. The only material license, providing for the sale and manufacture of a proprietary fiber nickel cadmium battery (FNC), is an agreement with Daug-Hoppecke Gesellschaft Fur Batteriesysteme mbH (\"DAHO\") of Brilon, Germany. The Company recorded an impairment loss write-off as of June 30, 1994, assigning zero value to the FNC license agreement. For further discussion, see attached referenced portions of the Registrant's Annual Report to Shareholders.\nEMPLOYEES\nAs of June 30, 1995, approximately 821 persons were employed by the Regis- trant.\nRESEARCH AND DEVELOPMENT\nApproximately 6% of the Registrant's employees are engaged in engineering design and product development. Most new products are designed to satisfy specific customer requirements, and the cost of such development is expensed as incurred. Since satisfaction of many customers' needs requires advancing applicable technology, applied research is an integral part of engineering- design and product-development activities. The cost of such activities during the fiscal years ended June 30, 1995, 1994 and 1993, was $4,791,000, $5,666,000 and $5,757,000, respectively.\nENVIRONMENTAL MATTERS\nThe Company was informed by the New York State Department of Environmental Conservation (DEC) on December 5, 1994, that the Municipal Waste Landfill, Cuba, NY, has been listed in the New York State Registry of Inactive Hazardous Waste Disposal Sites as a Class \"2\" site requiring remediation. Acme Electric Corporation has been determined by the DEC to be a potentially responsible party (PRP) by virtue of its disposal of wastes at the site. As a PRP, the Company may be subject to liability for the cost of site investigation and remediation. At this time, there is insufficient information available from which any reasonable estimate of such cost can be made. The Company did have insurance policies in effect during the period that waste was disposed of at the site, which the Company believes would provide coverage in the event the Company is liable.\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2 - PROPERTIES\nThe Registrant owns one plant located in Lumberton, North Carolina. The Registrant concluded the sale of its Cuba, New York, facility in September 1993\nand the sale of its Salt Lake City, Utah, facility in February 1994. The Registrant, under an operating lease agreement, leases back portions of the Cuba, New York, facility. The Registrant has completed the construction of a new 91,000-square-foot facility in Cuba, New York, and moved into it during fiscal 1995. The Registrant also maintains operating leases for its Corporate facility in East Aurora, New York, and its plant located in Tempe, Arizona. The Registrant also owns an idle facility in West Jordan, Utah, vacated in conjunction with the restructuring of its Utah activities into the Tempe, Arizona, location. The Registrant believes that these facilities provide adequate capacity for its current operations.\nSQUARE FOOTAGE SQUARE FOOTAGE LEASE EX- LOCATION OWNED LEASED PIRATION DATE\nCuba, NY (New Plant) - 91,000 April 2017 Cuba, NY (Old Plant) - 68,757 August 1996 East Aurora, NY - 10,000 April 1999 (Exec. Offices) Lumberton, NC 128,170 - N\/A Tempe, AZ - 40,260 March 2000 West Jordan, UT 23,242 - N\/A\nITEM 3","section_3":"ITEM 3 - LEGAL PROCEEDINGS\nThe Registrant is involved in ordinary routine litigation incidental to its business, but none is expected to have a material impact upon the financial condition of the Registrant.\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 II\nITEM 5","section_5":"ITEM 5 - MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS\nInformation relating to the market and market prices of the Registrant's common stock, the approximate number of Registrant's shareholders and its dividend history for the past two fiscal years appears on page 32 of the Registrant's Annual Report to Shareholders for the fiscal year ended June 30, 1995, submitted herewith as an exhibit and such information is incorporated by reference herein.\nInformation relating to long-term debt for the past two fiscal years appears on page 27 of the Registrant's Annual Report to Shareholders for the fiscal year ended June 30, 1995, submitted herewith as an exhibit and such information is incorporated by reference. The Registrant suspended its quarterly cash dividend effective the third quarter of fiscal 1991. The loss in fiscal 1991 resulted in a deficit of retained earnings. The Registrant, therefore, does not expect to reinstate dividends in the foreseeable future.\nITEM 6","section_6":"ITEM 6 - SELECTED FINANCIAL DATA\nA five-year summary of certain financial information relating to the financial condition and results of operations of the Registrant appears on page 21 of the Registrant's Annual Report to Shareholders for the fiscal year ended June 30, 1995, submitted herewith as an exhibit and such summary 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 appears on pages 18 and 20 of the Registrant's Annual Report to Shareholders for the fiscal year ended June 30, 1995, submitted herewith as an exhibit and such management's discussion and anaylsis is incorporated by reference herein.\nITEM 8","section_7A":"","section_8":"ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe following consolidated financial statements of the Registrant and its subsidiaries, appearing on pages 22 through 31 of the Registrant's Annual Report to Shareholders for the fiscal year ended June 30, 1995, submitted herewith as an exhibit, are incorporated by reference herein:\nConsolidated Statements of Operations - Years Ended June 30, 1995, 1994,\nConsolidated Balance Sheets - June 30, 1995 and 1994\nConsolidated Statements of Cash Flows - Years Ended June 30, 1995, 1994,\nConsolidated Statements of Shareholders' Equity - Years Ended June 30, 1995, 1994, 1993\nNotes to Consolidated Financial Statements\nITEM 9","section_9":"ITEM 9 - DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURES\nThere have been no disagreements with accountants on accounting and financial disclosure matters.\nPART III\nITEM 10","section_9A":"","section_9B":"","section_10":"ITEM 10 - DIRECTORS AND OFFICERS OF THE REGISTRANT\nIDENTIFICATION OF DIRECTORS\nInformation on directors of the Registrant is contained under the caption \"Election of Directors,\" presented in the Registrant's Definitive Proxy Statement filed pursuant to Regulation 14A and used in conjunction with the Registrant's 1995 Annual Meeting of Shareholders to be held on October 27, 1995, and is incorporated by reference herein.\nIDENTIFICATION OF EXECUTIVE OFFICERS\nSUMMARY OF BUSINESS EXPERIENCE NAME, AGE AND POSITION OVER THE LAST FIVE YEARS\nRobert J. McKenna, 47, Chairman, Prior to assuming the position currently President and Chief Executive Officer held in October 1994, served as President and Chief Executive Officer since October 1993. Prior thereto, served as President and Chief Operating officer since September 1992. Prior thereto, served as Group Vice President of the Diversified Products Group, Aeroquip Corporation since April 1990. Prior thereto, Vice President and General Manager of the Automotive Connectors Division of Aeroquip Corporation since July 1989.\nDaniel K. Corwin, 48, Prior to assuming the position currently Senior Vice President held in August 1994, served as Vice and Chief Financial Officer President of Administration and Chief Financial Officer since February 1992. Prior thereto, served as Vice President and General Manager, Electronics Division, since November 1990. Prior thereto, served as Vice President of Operations since July 1988.\nDavid G. Anderson, 43, Prior to assuming the position currently Corporate Secretary, Treasurer, held in February 1992, served as and General Counsel Corporate Secretary, Treasurer, Controller and General Counsel since April 1988.\nDonald J. Chesner, 51, Prior to assuming the position currently Vice President and General held in May 1993, served as General Manager, Acme Transformer Division Manager since February 1992. Prior thereto, served as National Sales Manager, Acme Transformer Division, since March 1987.\nJohn E. Gleason, 48, Prior to assuming the position currently Vice President and General held in May 1993, served as General Manager, Electronics Division Manager since February 1992. Prior thereto, served as Operations Manager, Cuba Electronics Division, since October 1991, and prior thereto, served as Operations Manager, Salt Lake City Electronics Division, since January 1987.\nMenahem Anderman, 42, Prior to assuming the position currently Vice President and General held in April 1994, served as Venture Manager, Advanced Energy Systems Director since May 1993. Prior thereto, served as Technical Director since May 1988.\nITEM 11","section_11":"ITEM 11 - MANAGEMENT REMUNERATION AND TRANSACTIONS\nInformation called for in response to this item is contained under the captions \"Compensation of Executive Officers,\" \"Employment Agreement,\" \"1981\nIncentive Stock Option Plan,\" \"1989 Stock Option Plan,\" and \"Pension Plan,\" presented in the Registrant's definitive proxy statement filed pursuant to Regulation 14A and used in conjunction with the Registrant's 1995 Annual Meeting of Shareholders to be held on October 27, 1995, and is incorporated by reference herein.\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 contained under the captions \"Voting Securities and Principal Holders Thereof\" and \"Nominees For Election As Directors\" in the Registrant's definitive proxy statement filed pursuant to Regulation 14A and used in conjunction with the Registrant's 1995 Annual Meeting of Shareholders to be held on October 27, 1995, and is incorporated by reference herein.\nITEM 13","section_13":"ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nCertain transactions have been referenced under Item 11. There are no other applicable relationships or related transactions.\nPART IV\nITEM 14","section_14":"ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) 1. FINANCIAL STATEMENTS\nSee the accompanying Index to Financial Statements and Financial Statement Schedules on page of this report.\n2. FINANCIAL STATEMENT SCHEDULES\nSee the accompanying Index to Financial Statements and Financial Statement Schedules on page of this report.\n3. EXHIBITS PAGE NUMBER OR INCORPORATION -------- BY REFERENCE ----------------------------\n3a Certificate of Incorporation, Exhibit (3a) to Report on as amended to date Form 10-K for fiscal year ended June 30, 1989.\n3b Bylaws, as amended to date Exhibit (3b) to Report on Form 10-K for fiscal year ended June 30, 1990.\n10 Employment Agreements See Exhibit 10 attached.\n11 Statement re. computation of Note (1e) to Consolidated per share earnings Financial Statements at page 26 of 1995 Annual Report to Shareholders.\n13 Acme Electric Corporation 1995 Annual Report to Shareholders See Exhibit 13 attached.\n21 Subsidiaries of Registrant See Exhibit 21 attached.\n22 1995 Proxy Statement Definitive Proxy Statement filed under Schedule 14A, September 18, 1995, File No. 001-08277.\n23 a,b, Additional Exhibits - Pages through on c,d Undertakings Report on Form 10-K for fiscal year ended June 30, 1995.\n99 Additional Exhibits - News Release, April 28 1995, announcing third quarter results. See Exhibit 99-1 attached. News Release, May 17, 1995, announcing Robert D. Batting being named to the board of directors. See Exhibit 99-2 attached. News Release, May 17, 1995, announcing Randall L. Clark being named to the board of directors. See Exhibit 99-3 attached. News Release, May 26, 1995, announcing response to recent stock activity. See Exhibit 99-4 attached. News Release, June 13, 1995, announcing response to recent stock activity. See Exhibit 99-5 attached. News Release, June 27, 1995, announcing response to recent stock activity. See Exhibit 99-6 attached. News Release, July 12, 1995, announcing an agreement with B.A.T. International. See Exhibit 99-7 attached. News Release, July 20, 1995, announcing response to news report about the Company. See Exhibit 99-8 attached. News Release, August 14, 1995, announcing fourth quarter and year-end results. See Exhibit 99-9 attached.\n(b) REPORTS ON FORM 8-K\nThere were no reports filed on Form 8-K during the fifty-two-week period ending June 30, 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.\nSIGNATURE AND TITLE DATE\n\/s\/ 09\/28\/95 Robert D. Batting, Director\n\/s\/ 09\/28\/95 Robert T. Brady, Director\n\/s\/ 09\/28\/95 Randall L. Clark, Director\n____________________________________ 09\/28\/95 W. Bennett Conner, Director\n\/s\/ 09\/28\/95 G. Wayne Hawk, Director\n\/s\/ 09\/28\/95 Terry M. Manon, Director\n\/s\/ 09\/28\/95 Robert J. McKenna, Director\n\/s\/ 09\/28\/95 James W. McLaughlin, Director\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the 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 ELECTRIC CORPORATION\nBy: \/s\/ Date: 09\/28\/95 Robert J. McKenna Chairman, President and Chief Executive Officer\nBy: \/s\/ Date: 09\/28\/95 Daniel K. Corwin Senior Vice President and Chief Financial Officer\nACME ELECTRIC CORPORATION\nThe financial statements together with the report thereon of Price Waterhouse LLP dated August 10, 1995, appearing on pages 22 through 31 of the accompanying 1995 Annual Report to Shareholders, are incorporated by reference in this Form 10-K Annual Report. With the exception of the aforementioned information and the information incorporated in Items 5, 6, 7, 8 and 14 of this Form 10-K, the 1995 Annual Report to Shareholders is not to be deemed filed as part of this report. The following financial statement schedules should be read in conjunction with the financial statements in such 1995 Annual Report to Shareholders. Financial statement schedules not included in this Form 10-K Annual Report have been omitted because they are not applicable or the required information is shown in the financial statements or notes thereto.\nFINANCIAL STATEMENT SCHEDULES\n1995 1994 AND 1993\nPAGE\nReport of independent accountants\nValuation and qualifying accounts and reserves (Schedule VIII)\nConsents of independent accountants , and\nREPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE\nTo the Board of Directors of Acme Electric Corporation\nOur audits of the consolidated financial statements referred to in our report dated August 10, 1995 appearing on page 31 of the 1995 Annual Report to Shareholders of Acme Electric 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 Schedule listed in the Index to Financial Statements and Financial Statement Schedules which appears on page 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\/\nPRICE WATERHOUSE LLP\nBuffalo, New York August 10, 1995\nCONSENT OF INDEPENDENT ACCOUNTANTS\nWe hereby consent to the incorporation by reference in the Registration Statement on Form S-8 (No. 2-45985) of Acme Electric Corporation of our report dated August 10, 1995 appearing on page 31 of the 1995 Annual Report to Shareholders which is incorporated in this Annual Report on Form 10-K. We also consent to the incorporation by reference of our report on the Financial Statement Schedule, which appears on page of this Form 10-K.\n\/s\/\nPRICE WATERHOUSE LLP\nBuffalo, New York September 28, 1995\nCONSENT OF INDEPENDENT ACCOUNTANTS\nWe hereby consent to the incorporation by reference in the Registration Statement on Form S-8 (No. 2-92825) of Acme Electric Corporation of our report dated August 10, 1995 appearing on page 31 of the 1995 Annual Report to Shareholders which is incorporated in this Annual Report on Form 10-K. We also consent to the incorporation by reference of our report on the Financial Statement Schedule, which appears on page of this Form 10-K.\n\/s\/\nPRICE WATERHOUSE LLP\nBuffalo, New York September 28, 1995\nCONSENT OF INDEPENDENT ACCOUNTANTS\nWe hereby consent to the incorporation by reference in the Registration Statement on Form S-8 (No. 2-89587) of Acme Electric Corporation of our report dated August 10, 1995 appearing on page 31 of the 1995 Annual Report to Shareholders which is incorporated in this Annual Report on Form 10-K. We also consent to the incorporation by reference of our report on the Financial Statement Schedule, which appears on page of this Form 10-K.\n\/s\/\nPRICE WATERHOUSE LLP\nBuffalo, New York September 28, 1995\nCONSENT OF INDEPENDENT ACCOUNTANTS\nWe hereby consent to the incorporation by reference in the Registration Statement on Form S-8 (No. 33-79488) of Acme Electric Corporation of our report dated August 10, 1995 appearing on page 31 of the 1995 Annual Report to Shareholders which is incorporated in this Annual Report on Form 10-K. We also consent to the incorporation by reference of our report on the Financial Statement Schedule, which appears on page of this Form 10-K.\n\/s\/\nPRICE WATERHOUSE LLP\nBuffalo, New York September 28, 1995","section_15":""}
{"filename":"315213_1995.txt","cik":"315213","year":"1995","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 1991, the Company formed OFFICETEAM-Registered Trademark- to provide skilled temporary administrative and office personnel. In 1994, the Company established RHI CONSULTING-Registered Trademark- to concentrate on providing temporary and contract information technology professionals in positions ranging from PC support technician to chief information officer. 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.\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 16 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 many 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 185 offices in 36 states and five foreign countries and placed approximately 101,000 employees on temporary assignment with clients in 1995.\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.\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 135 locations in the United States and Canada. OFFICETEAM operates in much the same fashion as the ACCOUNTEMPS and ROBERT HALF divisions.\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.\nRHI CONSULTING\nThe Company's RHI CONSULTING division, which commenced operations in 1994, specializes in providing information technology contract consultants in areas ranging from multiple platform systems integration to end-user support, including specialists in programming, networking, systems integration, database design and help desk support. RHI Consulting conducts its activities from 38 locations in the United States, Canada and Europe.\nTHE AFFILIATES\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.\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 Microsoft, 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-Registered Trademark- 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 185 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. The 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 2,100 full-time staff employees. The Company's offices placed approximately 101,000 employees on temporary assignments with clients during 1995. 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 185 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 March 7, 1996, there were approximately 1,487 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 1995 or 1994. 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, 1995\nTemporary services revenues increased 42% during 1995 and 46% during 1994, including the revenues generated from the Company's OfficeTeam and RHI Consulting divisions, which were started in 1991 and 1994, respectively. Permanent placement revenues increased 31% during the year ended December 31, 1995 and 47% during the year ended December 31, 1994. The revenue comparisons reflect continued improvement in the demand for the Company's services.\nGross margin dollars increased 41% during the year ended December 31, 1995 compared to 47% for the year ended December 31, 1994. Gross margin amounts equaled 39% of revenue in 1995, 1994 and 1993.\nSelling, general and administrative expenses were approximately $171 million during 1995 compared to $122 million in 1994 and $88 million in 1993. Selling, general and administrative expenses as a percentage of revenues were 27% in 1995 and 1994 and 29% in 1993. The percentage decline from 1993 was attributable to revenue growth coupled with the Company's continued cost containment.\nAmortization of intangible assets increased from 1993 to 1995 due to the acquisitions in each of those years of additional personnel services operations.\nInterest income\/expense for the years ended December 31, 1995 and 1994 decreased 130% and 61%, respectively, over the comparable prior periods due to an increase in interest income from an increase in cash and cash equivalents and a decrease in interest expense due to a reduction of outstanding indebtedness.\nThe provision for income taxes was 42% in 1995 and 1994 and 46% in 1993. The decrease in 1994 is the result of a smaller percentage of non-deductible intangible expenses.\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, capital expenditures, 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 the Company's outstanding convertible subordinated debentures were converted into common stock of the Company. See Note F in the Notes to 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)\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)\n1994 and 1993 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)\n1994 and 1993 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\nNATURE OF OPERATIONS. Robert Half International Inc. (the \"Company\") provides specialized staffing services through such divisions as Accountemps-Registered Trademark-, Robert Half-Registered Trademark-, OfficeTeam-Registered Trademark- and RHI Consulting-Registered Trademark-. The Company, through its Accountemps and Robert Half divisions, is the world's largest specialized provider of temporary and permanent personnel in the fields of accounting and finance. OfficeTeam specializes in skilled temporary administrative personnel and RHI Consulting provides contract information technology professionals. Revenues are predominantly from temporary services. The Company operates in the United States, Canada and Europe. The Company is a Delaware corporation.\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 balances have been eliminated. Certain reclassifications have been made to the 1994 and 1993 financial statements to conform to the 1995 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.\nCASH AND CASH EQUIVALENTS. The Company considers 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, 1995.\nINCOME TAXES. 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.\nFOREIGN CURRENCY TRANSLATION. The results of operations of the Company's foreign subsidiaries are translated at the monthly average exchange rates prevailing during the period. The financial position of the Company's foreign subsidiaries 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.\nUSE OF ESTIMATES. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.\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 61 separate transactions the Company acquired all of the outstanding stock of certain corporations operating Accountemps and\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE B -- ACQUISITIONS (CONTINUED) 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 $196 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 1995 and 1994 had no material pro forma impact on the results of operations.\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 $5,725,000 at December 31, 1995 and $4,214,000 at December 31, 1994. At December 31, 1995, $1,350,000 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, 1995 (in thousands):\nAt December 31, 1995, 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 7.3%, 8.2% and 11.1% for the years ended December 31, 1995, 1994 and 1993, respectively.\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, 1995 and 1994, the Company had no borrowings on the line of credit outstanding and had used $3,408,000 and $3,358,000 in debt support standby letters of credit, respectively. 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, 2001.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE E -- CURRENT LIABILITIES Other current liabilities included in accrued payroll costs consist of the following at December 31, 1995 and 1994 (in thousands):\nNOTE F -- 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. 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 G -- 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. 1994 and 1993 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.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE H -- INCOME TAXES\nThe provisions for income taxes for the years ended December 31, 1995, 1994 and 1993 consisted of the following (in thousands):\nThe 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):\nThe net 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, 1995 and 1994.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE H -- INCOME TAXES (CONTINUED) The components of the net deferred income tax liability at December 31, 1995 and 1994, were as follows (in thousands):\nNOTE I -- COMMITMENTS Rental expense, primarily for office premises, amounted to $11,027,000, $9,183,000 and $8,457,000 for the years ended December 31, 1995, 1994 and 1993, respectively. The approximate minimum rental commitments for 1996 and thereafter under non-cancelable leases in effect at December 31, 1995, 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 vest between four to seven 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, 1995, the total number of available shares to grant under the plans (consisting of either restricted stock or options) was 559,714.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE J -- STOCK PLANS (CONTINUED)\nThe following table reflects activity under all stock plans from January 1, 1993 through December 31, 1995, and the exercise prices:\nAs of December 31, 1995, an aggregate of 1,208,798 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.\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 (29,708,000, 28,484,000 and 25,260,000 shares for the years ending December 31, 1995, 1994 and 1993, respectively). An assumed conversion of the Convertible Debentures was not dilutive to income per share in 1993 (see Note E).\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE M -- QUARTERLY FINANCIAL DATA (UNAUDITED) The following tabulation shows certain quarterly financial data for 1995 and 1994 (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, 1995, 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 intangible assets of $992,000, $956,000 and $917,000 for the years ended December 31, 1995, 1994 and 1993, respectively. Domestic operating income reflects charges for amortization of intangibles of $4,307,000, $4,137,000 and $3,841,000 for the years ended December 31, 1995, 1994 and 1993, 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, 1995 and 1994, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1995. 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, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\nARTHUR ANDERSEN LLP\nSan Francisco, California January 26, 1996\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 1996.\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, 1995 and 1994.\nConsolidated statements of income for the years ended December 31, 1995, 1994 and 1993.\nConsolidated statements of stockholders' equity for the years ended December 31, 1995, 1994 and 1993.\nConsolidated statements of cash flows for the years ended December 31, 1995, 1994 and 1993.\nNotes to consolidated financial statements.\nReport of independent public accountants.\nSelected quarterly financial data for the years ended December 31, 1995 and 1994 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 did not file any reports on Form 8-K during the fiscal quarter ending December 31, 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.\nROBERT HALF INTERNATIONAL INC. (Registrant)\nDate: March 25, 1996 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.\nINDEX TO EXHIBITS","section_15":""}
{"filename":"354359_1995.txt","cik":"354359","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nThe Company is engaged in the offshore marine services business serving the oil and gas industry primarily in the Gulf of Mexico through its operation and management of a diversified fleet of 61 vessels, consisting of supply, tug\/supply, crew and specialty service vessels. The Company currently uses such vessels to provide a wide range of services, such as transporting supplies necessary to sustain drilling, workover and production activities; supporting offshore pipelaying and construction, and assisting geophysical evaluation. Fifty-six of these vessels are owned, four are chartered and one is managed by the Company. The Company operates the second largest fleet of supply vessels both in the Gulf of Mexico and in the world. The Company also has 49.9% equity interests in Ravensworth Investments Limited, an Isle of Man-based company (\"Ravensworth\"), and Seaboard Holdings Limited, an Aberdeen, Scotland-based company (\"Seaboard\"), which together have the largest safety standby fleet operating in the North Sea, a combined total of 29 vessels. Founded in 1981, the Company is headquartered in Galveston, Texas and also conducts its Gulf of Mexico operations from its office in Morgan City, Louisiana. North Sea operations of Ravensworth and Seaboard are conducted from offices in Douglas, Isle of Man, and Aberdeen, Scotland.\nThe Company's operating strategy is to provide its customers with high-quality, quick-response service and a well-equipped and maintained fleet of vessels. Offshore supply fleets compete on the basis of a variety of factors, including quality and type of equipment, price, service and reputation. Management believes that the Company's operating capabilities and reputation in the offshore marine services industry allow it to compete favorably with other fleets in the Gulf of Mexico.\nBefore entering into an agreement and plan of merger with Tidewater, Inc. on December 21, 1995, management had identified several strategies for future growth. If the merger contemplated in the Merger Agreement (as defined below) does not occur, the Company, which has made three significant Gulf fleet acquisitions and several smaller acquisitions since 1990, will continue to search for opportunities to enhance its position in the Gulf of Mexico through the strategic acquisition of vessels available in that market. The Company also will seek to increase the size of its fleet by purchasing or building new vessels if market conditions justify such purchases or construction. Additionally, the Company will continue to pursue potential opportunities for growth in the offshore marine services business in international markets, as evidenced by its July 1993 purchase of a substantial interest in Ravensworth and November 1994 purchase of a substantial interest in Seaboard.\nRECENT EVENTS\nTHE MERGER. On December 21, 1995, the Company signed a definitive Agreement and Plan of Merger (the \"Merger Agreement\") with Tidewater, Inc. (\"Tidewater\") providing for a business combination (the \"Merger\") between the Company and Tidewater in which a wholly owned subsidiary of Tidewater will be merged with and into the Company, the Company will become a wholly owned subsidiary of Tidewater and the holders of the Company's stock will be issued Tidewater common stock in a transaction intended to qualify as a pooling of interests for accounting purposes and as a tax-free reorganization within the meaning of Section 368(a) of the Internal Revenue Code of 1986, as amended (the \"Code\") for federal income tax purposes. Pursuant to the Merger Agreement, upon consummation of the Merger, each share of the Company's Common Stock that is issued and outstanding at the Effective Time (as defined below) will be converted, subject to the adjustment discussed in the following sentence, into the right to receive .667 of a share of common stock, $.10 par value per share, of Tidewater (the \"Tidewater Common Stock\"), together with certain associated rights under the Tidewater Restated Rights Agreement dated as of December 17, 1993, by and between Tidewater and the First National Bank of Boston, as rights agent (the \"Tidewater Stockholder Rights Plan\"). The Merger Agreement provides that if the Average Market Price (as defined below) of a share of Tidewater Common Stock is less than $24.50 or exceeds $32.50, then the conversion ratio will be adjusted, provided that the conversion ratio, as so adjusted, will not be less than .60 (if the Average Market Price is more than $32.50) or greater than .74 (if the Average Market Price - 1 -\nis less than $24.50) (as so adjusted, the \"Conversion Ratio\"). The Merger Agreement further provides that either the Company or Tidewater may terminate the Merger Agreement if the Conversion Ratio at the date of closing of the Merger would be less than .60 or greater than .74, by virtue of the Average Market Price being greater than $36.13 or less than $22.08. The term \"Average Market Price\" is defined as the average of the daily closing sale prices of a share of Tidewater Common Stock on the New York Stock Exchange as reported in THE WALL STREET JOURNAL for the ten consecutive trading days that end on the second trading day immediately prior to the date of the closing of the Merger. Each holder of the Company's Common Stock entitled upon conversion to a fractional share of Tidewater Common Stock will, in lieu thereof, receive a cash payment (without interest) equal to the product of the Average Market Price and such fraction.\nThe Company and Tidewater were required to make certain filings pursuant to the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (\"HSR\"), with respect to the proposed Merger and made such filings on January 2, 1996. The waiting period under HSR expired on February 1, 1996, without the imposition of any obstacles to the Merger. The Board of Directors of the Company has recommended that the Company's stockholders adopt the Merger Agreement and on or about February 8, 1996, the Company mailed to its stockholders of record on January 31, 1996 a notice of special meeting to be held on March 13, 1996, and related proxy materials with respect to the proposed adoption of the Merger Agreement. In addition to the approval of the Company's stockholders and HSR clearance, the consummation of the Merger Agreement is conditioned upon the satisfaction of certain conditions set forth in the Merger Agreement, including the receipt by each party of customary legal opinions, certificates, consents, resolutions and reports from the other and from third parties and confirmation of certain tax opinions and accountants' opinions or letters. Tidewater and the Company intend to consummate the Merger as soon as practicable following satisfaction or waiver of the conditions thereto. The Merger will become effective at the time (the \"Effective Time\") and on the date (the \"Effective Date\") the Certificate of Merger is filed with the Secretary of State of Delaware.\nCERTAIN OTHER TERMS OF THE MERGER. The Merger Agreement provides that Tidewater will indemnify and hold harmless each person who was an officer or director of the Company or any of its subsidiaries on December 21, 1995 or who previously served as such at any time after January 1, 1993, from and against all damages, liabilities, judgments and claims based upon or arising out of such person's service in such capacity to the same extent as he or she would have been indemnified under the Restated Certificate of Incorporation or Restated Bylaws of the Company as they were in effect on the date the Merger Agreement was executed. With certain exceptions, the aggregate amount of indemnification payments required to be made by Tidewater to such persons is limited to $50 million. Tidewater has also agreed to pay the insurance premiums required for any extension of the Company's director's and officer's insurance policy following the Effective Date for a period of six years or to provide comparable coverage under a Tidewater policy.\nThe Merger Agreement prohibits the Company and its subsidiaries and affiliated entities from, directly or indirectly, soliciting or encouraging the initiation or submission of any inquiries, proposals or other offers regarding any acquisition, merger, takeover bid, sale of all or substantially all of its assets, or sales of shares of capital stock of the Company or similar transactions involving the Company. The Merger Agreement provides that if the Company Board decides after considering advice of outside counsel and financial advisors that it would be consistent with its fiduciary responsibilities to approve or recommend another transaction in lieu of the Merger and therefore withdraws or modifies its recommendation that the Merger Agreement be adopted, the Company may not enter into any agreement for such other takeover proposal until the Merger Agreement is terminated and a termination fee of $6 million in cash (the \"Termination Fee\") is paid to Tidewater. The Company's obligation to pay the Termination Fee is not incurred if the Company or Tidewater otherwise terminates the Merger Agreement in accordance with its terms.\nThe Company and Tidewater may mutually agree to amend the Merger Agreement at any time before or after the Company stockholder approval, provided that no amendment is permissible following the Company stockholder approval if the amendment would by law require further stockholder approval, unless such further stockholder approval is obtained. Either party may waive compliance with any of the agreements or conditions contained in the Merger Agreement other than the satisfaction of all requirements prescribed by law for consummation of the Merger. - 2 -\nThe Merger Agreement may be terminated at any time before the Effective Time (i) by the mutual consent of the Board of Directors of the Company and the Tidewater Board or (ii) by the board of directors of either party if (a) the required approval by the Company's stockholders is not obtained at the Special Meeting, (b) there has been a material breach by the other party of any representation, warranty or covenant in the Merger Agreement which is not cured within 15 days after notice of such breach is given to the breaching party, (c) all conditions to closing have not been met by, or the Merger has not been consummated on or before, November 20, 1996 unless the party seeking to terminate the Merger Agreement is, at such time, in willful and material violation of its representations, warranties or covenants under the Merger Agreement, (d) any governmental entity shall have issued an order, decree, or ruling or taken any other action permanently enjoining, restraining or otherwise prohibiting the Merger and such order, decree, ruling or other action shall have become final and nonappealable, or (e) at the date of closing of the Merger, the Conversion Ratio would be less than .60 or greater than .74. Also, the Company may terminate the Merger if the Board of Directors of the Company withdraws its recommendation of the Merger to the holders of the Company's Common Stock in connection with its approval or recommendation to the holders of the Company's Common Stock of any alternate proposal and pays the Termination Fee to Tidewater.\nTHE INDUSTRY\nOffshore service vessels are generally used to support offshore oil and gas exploration, development and production and to provide other marine services. The largest class of offshore service vessels are supply vessels (also called workboats), which are capable of transporting drillpipe, drilling fluids and construction materials. Other service vessels include tug\/supply vessels, which have more powerful engines and are capable of towing and positioning offshore rigs; crewboats, which transport personnel; special service vessels, including geophysical boats which perform offshore seismic testing functions; and safety vessels, which are available for emergency response services related to oil and gas exploration, drilling and production. Although vessels servicing the offshore oil and gas industry are used to support existing production platforms, incremental vessel demand is largely dependent on new offshore drilling activity associated with new wells or the workover of older wells. Therefore, the demand for offshore service vessels generally correlates with oil and gas prices. The level of activity in the industry has been very cyclical.\nThe cyclical nature of the offshore marine services business and the decreased number of vessels have also contributed to a reduction in the number of vessel owning and operating companies. The Company estimates that there are currently 19 other supply vessel operating companies competing in the Gulf of Mexico, significantly lower than estimates made as recently as 1990. Thirteen companies have ten or fewer supply vessels.\nDuring the fourth quarter of 1992 and calendar 1993, supply vessel operations improved due to increased drilling activity in the Gulf of Mexico coupled with further downsizing of the industry's offshore vessel fleet. From December 1992 to December 1993, the number of contracted drilling rigs in the Gulf of Mexico increased from 109 to 137. In 1994, the number of contracted drilling rigs decreased to a low of approximately 120 before recovering to approximately 140 by year-end. In 1995, the number of contracted drilling rigs decreased before increasing in early 1996 to more than 150. Average industry utilization for offshore supply vessels, however, declined significantly from December 1993 levels of approximately 96% to a low in May 1994 of 80% due primarily to the increased number of vessels in the industry fleet. Company utilization and average supply vessel dayrates have peaked seasonally in late 1994 and 1995 after declining in the second quarter of 1994 and the first quarter of 1995. Recently utilization and dayrates have remained relatively strong compared to comparable periods in the previous year. On February 9, 1996, the utilization rate for the Company's vessels was 97% and the average supply vessel dayrate was approximately $3,650. The Company believes its current utilization and average dayrates are substantially comparable to those of the other major competitors in the offshore marine services business.\n- 3 - COMPANY VESSELS\nThe following table compares the number of vessels in the Company's fleet at the dates indicated:\nDECEMBER 31(1) -------------------------------- 1993 1994 1995 ---- ---- ----\nSupply\/Tug\/Supply .................... 49 59 58 Crewboats ............................ 2 2 2 Specialty service .................... 2 2 1 -- -- -- Total .......................... 53 63 61 == == == - ------------ 1. Includes vessels bareboat chartered or managed by the Company. Does not include Ravensworth or Seaboard vessels.\nFuture demand for the Company's vessels will be influenced by drilling activity in the Gulf of Mexico, by the degree of success of the Company's efforts to market its vessels outside the Gulf of Mexico and by the availability of competing vessels. Management believes that the number of vessels available in the Gulf will continue to decrease because current dayrates in the Gulf of Mexico do not justify the expense of building new vessels and current regulations prohibit foreign operators and foreign registered vessels from entering the offshore marine services business in the Gulf of Mexico. Furthermore, increased activities in overseas areas could result in reduction of Gulf fleet size as vessels are deployed to those areas. It is also possible that additional vessels could be redeployed to the Gulf of Mexico from other areas.\nThe Company's management believes that many of the vessels previously servicing the oil and gas industry could not be readily returned to service in the Gulf of Mexico because their condition would not meet U.S. Coast Guard and other industry standards or certain restrictions imposed by the Maritime Administration of the U.S. Department of Transportation (\"MARAD\") on their return to offshore service vessel use in United States coastal waters. In addition, the entry into the Gulf of Mexico market of certain foreign flag vessels currently operating in foreign waters is restricted as a result of the provisions of the Merchant Marine Act of 1920, which limits vessels carrying merchandise or passengers for hire in domestic waters to U.S. flag vessels, built in U.S. shipyards, which are owned and operated by U.S. citizens.\nTHE COMPANY'S FLEET\nThe Company's fleet has an average age of approximately 15 years. The Company's vessels support the entire range of the offshore exploration and development business, including transporting supplies necessary to sustain drilling, workover and production activities; supporting offshore pipelaying and construction activities; and assisting geophysical evaluation.\nThe following table provides information, as of January 31, 1996, regarding the 56 vessels owned, the four vessels bareboat chartered and the one vessel managed by the Company. LENGTH OVERALL YEAR NAME IN FEET CLASSIFICATION COMPLETED IHP - ---- ------- -------------- --------- ---\nOWNED(1): HOS War Admiral .............. 220 Supply 1991 4,000 HOS Man O'War ................ 220 Supply 1991 4,000 HOS Boss Hoss ................ 220 Supply 1991 4,000 HOS Sea Hero ................. 220 Supply 1991 4,000\nHOS Gallant Fox .............. 214 Supply 1978 3,600 HOS Sly Fox .................. 214 Supply 1978 3,600 HOS Majestic Prince .......... 192 Supply 1979 3,900 HOS Whirlaway ................ 192 Supply 1979 3,900 HOS Chief .................... 192 Supply 1982 2,500 HOS Belle .................... 192 Supply 1982 2,500 HOS Dark Star ................ 192 Supply 1985 4,600 HOS Native Dancer ............ 192 Supply 1975 2,240 HOS Sword Dancer ............. 192 Supply 1974 2,240 HOS Normandy ................. 191 Tug\/Supply 1982 4,600 HOS Bravo .................... 191 Tug\/Supply 1982 4,600 HOS Chaleur .................. 191 Tug\/Supply 1982 4,600 HOS Liberty .................. 191 Tug\/Supply 1982 4,600 HOS Fortune .................. 191 Tug\/Supply 1979 4,600 HOS Samson ................... 191 Tug\/Supply 1979 4,600 HOS Crusader ................. 188 Supply 1981 3,000 HOS High Quest ............... 188 Supply 1980 3,000 HOS Black Gold ............... 188 Supply 1981 3,000 HOS Lone Wolf ................ 188 Supply 1981 3,000 HOS Gate Dancer .............. 188 Supply 1981 3,000 HOS Risen Star ............... 185 Supply 1977 3,600 HOS Swaps .................... 185 Supply 1977 3,600 HOS Cavalcade ................ 185 Supply 1977 3,600 HOS Dover .................... 185 Supply 1978 3,600 HOS Barrow ................... 185 Supply 1978 3,600 HOS Success .................. 185 Supply 1976 3,600 HOS Conception ............... 185 Supply 1976 3,600 HOS Canonero ................. 180 Supply 1975 2,500 HOS Career Boy ............... 185 Supply 1973 2,250 HOS Nashua ................... 180 Supply 1978 2,500 HOS Iron Leige ............... 180 Supply 1979 2,500 HOS Gun Bow .................. 180 Supply 1979 2,500 HOS Gallant Man .............. 180 Supply 1979 2,500 HOS Seattle Slew ............. 180 Supply 1979 2,500 HOS High Gun ................. 180 Supply 1979 2,500 HOS Avatar ................... 180 Supply 1979 2,500 HOS Bold Ruler ............... 180 Supply 1975 1,800 HOS Alydar ................... 180 Supply 1979 2,100 HOS Alysheba ................. 180 Supply 1983 3,600 HOS Affirmed ................. 180 Supply 1975 2,100 HOS Bold Forbes .............. 180 Supply 1976 2,240 HOS Agile .................... 180 Supply 1979 3,000 HOS Gallant Knight ........... 175 Supply 1982 1,800 HOS Advocator ................ 170 Supply 1976 2,100 HOS Cape Charles ............. 166 Supply 1981 1,800 HOS Count Fleet .............. 166 Supply 1976 2,240 HOS Shut Out ................. 166 Supply 1977 2,240 HOS Count Turf ............... 166 Supply 1976 2,240 HOS Carry Back ............... 180 Supply 1981 1,800 HOS Secretariat .............. 150 Supply 1980 1,860\n- 5 -\nHOS Assault ..................... 110 Crew 1979 2,025 HOS Messenger ................... 110 Crew 1979 2,025\nBAREBOAT CHARTERED: HOS Bold Venture ................. 192 Supply 1981 2,500 HOS Centurion .................... 187 Supply 1982 2,500 HOS Citation ..................... 187 Supply 1982 2,500 HOS Determine .................... 185 Supply 1982 2,500\nMANAGED: Gyre ................... 170 Research 1979 2,250 - ------------ 1. At December 31, 1995, 22 vessels owned by the Company were pledged as security for approximately $3,300,000 of MARAD-guaranteed debt and approximately $12,100,000 of bank debt.\nCUSTOMERS AND CHARTER TERMS\nSubstantially all of the Company's charters in the Gulf of Mexico are short-term contracts (30 to 45 days) or spot contracts (less than 30 days) and all are cancelable upon short notice. The terms of charters are determined through negotiation and vary widely. Because of renewals, the stated duration of charters frequently has little relationship to the actual time a vessel is chartered to a particular customer. Charters are obtained through competitive bidding or, with established customers, through negotiation. The Company believes that the short terms of its charters can be advantageous as they will enable the Company to benefit from any increase in dayrates resulting from increased demand in the offshore marine services industry. Conversely, the short charter terms do not protect the Company against any decrease in utilization or dayrates resulting from a downturn in the industry. As discussed below, Ravensworth and Seaboard generally conduct their business pursuant to longer term contracts for vessel support service. The Company's customers consist principally of major and independent oil and gas exploration and development companies. During 1995, the Company's vessels were chartered to approximately 120 different customers. The number and identity of the Company's customers vary from year to year. In past years, several customers have accounted for 10% or more of the Company's consolidated revenues, although the identity of such customers varies from year to year. Typically, invoices for services were paid within 30 to 45 days of the invoice date. Because of the variety and number of customers each year, the Company's management believes that the loss of any one customer would not have a material adverse effect on the Company.\nCOMPETITION\nThe Company currently competes primarily in the Gulf of Mexico with many other owners and operators of offshore marine service vessels. In addition, since vessels can be easily moved from one geographic area to another, additional competition could come from U.S. flag vessels not currently active in the Gulf of Mexico. The Company's North Sea affiliates, Ravensworth and Seaboard, now compete and, if the Company commences work directly in overseas markets it will compete, with many different foreign and U.S. based operators. Competition from foreign operators in the U.S. Gulf of Mexico is restricted as a result of the provisions of the Merchant Marine Act of 1920, which limits vessels carrying merchandise or passengers for hire between two points in domestic waters to U.S. flag vessels, built in U.S. shipyards, which are owned and operated by U.S. citizens. The Company believes it currently operates the second largest fleet of supply vessels in the Gulf of Mexico. Certain of the Company's competitors own more vessels or have greater financial and other resources than the Company. A large number of companies that own a relatively small number of vessels also compete with the Company. Competition\n- 6 -\nin the offshore marine services industry involves such factors as availability of vessels of the type needed by the customer, experience and reputation of the operator and crews, quality of equipment and service, price and charter terms.\nCERTAIN GOVERNMENT REGULATIONS\nMany aspects of the offshore marine services industry are subject to direct governmental regulation. The Company is subject to the jurisdiction of the U.S. Coast Guard, the National Transportation Safety Board and the U.S. Customs Service, as well as private industry organizations such as the American Bureau of Shipping. The Coast Guard and the National Transportation Safety Board set safety standards and are authorized to investigate vessels at will. The operations of Ravensworth and Seaboard and Hornbeck Offshore Limited, an affiliate of the Company (the \"North Sea Manager\") are subject to direct governmental regulation, including by the Department of Transportation and the Health and Safety Executive of the United Kingdom. If the Company expands its operations to foreign waters, it will also be subject to regulation by other governments.\nIn addition to laws and regulations directly affecting the Company, the Company's business is also influenced by laws, regulations and policies which impact the drilling programs of its customers and of the oil and gas industry as a whole. The operations of the Company are subject to federal, state and, for onshore activities, local laws and regulations relating to protection of the environment. Although the Company believes that its operations are in general compliance with applicable environmental regulations, risks of substantial costs and liabilities are inherent in offshore marine service operations, and there can be no assurance that significant costs and liabilities will not be incurred. Moreover, it is possible that other developments, such as increasingly strict environmental laws, regulations and enforcement policies thereunder, and claims for damages to property, persons or the environment resulting from the Company's operations could result in substantial costs and liabilities to the Company. Without limiting the generality of the foregoing, the Company's operations are subject to the Outer Continental Shelf Lands Act, and regulations promulgated thereunder, which regulate the activities of offshore service vessels, require vessel owners and operators to demonstrate financial and operational responsibility and provide for certain limitations on the liability of vessel owners and operators. The Company's operations also are subject to the Federal Water Pollution Control Act of 1972, as amended, which imposes strict controls against the discharge of oil and other pollutants into surface waters within their jurisdiction. Any hazardous substances transported by the Company are subject to regulation under the Resource Conservation and Recovery Act and the Hazardous Materials Transportation Act. Numerous other environmental laws and regulations also apply to the operations of the Company, and such laws and regulations are subject to frequent changes. The Company's insurance policies provide coverage for accidental occurrences of seepage and pollution and\/or cleanup and containment of the foregoing. Although the Company's losses from such occurrences have not historically exceeded its insurance coverage, there is no assurance that this will continue to be the case. Management believes, however, that the Company's insurance coverage is adequate and comparable to that generally carried in the offshore marine services industry.\nThe Company has received and is responding to a subpoena for documents from the United States District Court for the Southern District of Texas, Houston Division. The scope of the subpoena suggests an interest in the Company's compliance with certain environmental statutes and regulations, violations of which could carry both civil and criminal liabilities. The subpoena seeks information concerning the Company's vessels since January 1, 1993 regarding vessel operations as they relate to the purchase, use and disposition of petroleum and related products.\nIt is the Company's policy to comply with all applicable laws, including laws designed to protect the environment. While management and the board of directors of the Company do not believe that any outcome of the investigation would have a material adverse effect on the financial position of the Company, they cannot predict the nature or ultimate outcome of the investigation or any proceeding that might be based thereon.\nUnder the Merchant Marine Act of 1920, the transportation of merchandise or passengers for hire in domestic waters is limited to vessels owned and operated by U.S. citizens that are built in U.S. shipyards and registered under the laws of the United States. For purposes of these requirements, no corporation is deemed a U.S. citizen unless, - 7 -\namong other things, no more than 25% of any class of its voting securities are owned by non-U.S. citizens, none of the corporation's chief executive officer, president or chairman of the board are non-U.S. citizens and no more than a minority of its board of directors necessary to constitute a quorum are non-U.S. citizens. If the Company should fail to meet any of the foregoing citizenship requirements, its vessels become ineligible to engage in trade in U.S. domestic waters. Furthermore, the foregoing citizenship requirements must be met in order for the Company to continue to qualify for MARAD-guaranteed financing that currently exists with respect to certain of its vessels. Certain provisions of the Company's Restated Certificate of Incorporation are intended to aid in compliance with the foregoing requirements regarding non-U.S. citizen ownership. Based on the composition of its management and board of directors and the most recent annual test of its stock ownership, the Company meets these citizenship requirements.\nUnder the provisions of the Restated Certificate of Incorporation (i) any transfer, or attempted or purported transfer, of any shares of capital stock which would result in the ownership or control by one or more persons who is not a U.S. citizen for purposes of United States coastwise domestic shipping (as defined in the Shipping Act of 1916, as amended), of an aggregate percentage of the shares of capital stock in excess of a fixed percentage (the \"Permitted Percentage\") which is equal to 5% less than the percentage that would prevent the Company from being a U.S. citizen (currently 25%) for purposes of engaging in United States coastwise domestic shipping, will, until such excess no longer exists, be void and ineffective as against the Company; and (ii) if at any time ownership of Common Stock (either of record or beneficial) by persons other than U.S. citizens exceeds the Permitted Percentage, the Company will withhold payment of any dividends on such shares deemed to be in excess of the Permitted Percentage and will suspend the voting rights of such shares.\nCertificates representing the Common Stock bear legends concerning the restrictions on ownership by persons other than U.S. citizens. In addition, the Company's board of directors is authorized to adopt bylaw provisions (i) requiring, as a condition precedent to the transfer of shares on the records of the Company, representations and other proof as to the identity of existing or prospective stockholders; and (ii) establishing and maintaining a dual stock certificate system under which different forms of certificates may be used to indicate whether or not the owner thereof is a U.S. citizen.\nSEASONALITY OF BUSINESS\nDemand for the Company's services is directly affected by the level of offshore drilling activity. Budgets of many companies which engage in offshore drilling and exploration activities are based upon a calendar year and, historically, demand for the Company's services has been stronger in the second, third and fourth calendar quarters when allocated budgets are expended by the Company's customers and weather conditions are more favorable for offshore activities. Many other factors such as the expiration dates of drilling leases and the supply of and demand for oil and gas can, however, affect this general trend in any particular year.\nNORTH SEA AFFILIATES -- THE RAVENSWORTH AND SEABOARD ACQUISITIONS\nBUSINESS\nRavensworth Investments Limited, an Isle of Man company (\"Ravensworth\") and Seaboard Holdings Limited, a Scottish company (\"Seaboard\"), through their subsidiaries, are engaged in the offshore marine services business primarily serving the oil and gas industry in the North Sea by providing safety standby vessels. Under the United Kingdom's Offshore Installations (Emergency Procedures) Regulations 1976 and Code for the Assessment of the Suitability of Standby Vessels, as revised in 1991 (collectively, the \"Safety Code\"), existing manned platforms and offshore drilling rigs are subject to offshore marine safety requirements and offshore operations and operators are required to engage and maintain the availability of safety standby vessels. The Safety Code requires that a vessel \"standby\" to provide a means of rescuing platform or rig personnel in the event of an emergency at such an offshore facility.\nThrough the combined fleet of 29 vessels, 23 owned and six chartered, Ravensworth and Seaboard provide such safety standby services, generally pursuant to long-term charters. Of the 29 vessels, 24 are currently under charters as of February 12, 1996. Thirteen of these charters expire in 1996, six expire in 1997, two expire in 1999, - 8 -\none expires in 2002 and two expire in 2003. Charters at Ravensworth and Seaboard are generally terminable upon varying notice periods, and certain charters provide for compensation for early termination or effectively prohibit termination due to charter rates being above then prevailing market rates. Due to the requirement to maintain a safety standby vessel in the operational area 24 hours per day, seven days per week, most charters provide for the safety standby service to be provided without specifying a particular vessel, thus allowing Ravensworth and Seaboard to move their vessels to an alternative project, to shipyards for repairs and maintenance, or to port to exchange crews and take on fuel and supplies, by replacing the primary vessel with a relief vessel. The requirement for constant coverage, however, requires, as a practical matter, that Ravensworth and Seaboard have vessels available for substitution when primary vessels are off-line and therefore prohibits commitment of all vessels to separate full time charters. From time to time, under short-term arrangements, Ravensworth and Seaboard may either charter in other vessels to meet their contractual commitments or charter out their own vessels to enable third parties to meet similar obligations. Recently, safety standby vessel utilization in the North Sea has been negatively affected by sharing arrangements, whereby operations with facilities in close proximity to one another coordinate in order to share safety standby vessel support. The increased drilling activity in the North Sea, however, has offset this sharing trend somewhat and has helped to offset its impact.\nDayrates for the Ravensworth and Seaboard vessels are not comparable to Gulf of Mexico supply vessel dayrates because (i) they are governed by long-term charters, and (ii) the rates are designed to cover significant additional costs borne by Ravensworth and Seaboard not applicable to supply vessel operations. These additional costs include larger, more expensive crews and fuel costs. Fuel costs are normally paid by the customer in supply vessel operations.\nAll of the Ravensworth vessels and all of the Seaboard vessels are operated by Seaboard and Hornbeck Offshore Limited, a 49.9% owned affiliate of the Company (the \"North Sea Manager\"). The crews and officers who work on the vessels are employed by foreign subsidiaries of Ravensworth and Seaboard.\nRavensworth has three full time and two part time employees who perform general and administrative functions of the Ravensworth operations and oversee the safety standby operations generally, including the contractual relations with clients. The North Sea Manager has 35 employees who manage the day-to-day operations.\nRavensworth's 23 vessels are registered as British ships, with ports of registry at Douglas, Isle of Man; Aberdeen, Scotland; Glasgow, Scotland; or London, England. Five of Seaboard's vessels are registered as British ships, and one Seaboard vessel is registered as a Bahamian ship, all with ports of registry at Inverness, Scotland. All of these vessels are subject to the laws of the applicable jurisdiction as to ownership, registration and manning of vessels. In addition, such vessels are subject to the requirements of a number of international conventions to which the jurisdictions where the vessels are registered are parties. Further, vessels operated as safety standby vessels in the U.K. sector of the North Sea are subject to the requirements of the Department of Transport and of the Health and Safety Executive of the United Kingdom pursuant to the Safety Code.\nRAVENSWORTH AND SEABOARD FLEETS\nThe following table provides information as of January 31, 1996, regarding the 29 vessels in which either Ravensworth or Seaboard has an interest, each of which is a safety standby vessel. LENGTH YEAR OVERALL COMPLETED\/ NAME IN FEET CONVERTED IHP ------- ---------- ---\nRAVENSWORTH OWNED: Hornbeck Snipe .................................... 185 1972\/92 3600 Scott Guardian .................................... 180 1993 2250 Trafalgar Guardian ................................ 180 1994 2250 Hornbeck Swan ..................................... 175 1971\/91 4200 Safe Transporter .................................. 175 1971\/90 4200\n- 9 -\nHornbeck Skua ..................................... 175 1971\/91 4200 Safe Carrier ...................................... 175 1967\/90 3000 Hornbeck Scout .................................... 175 1974\/90 2500 Sunset Baronet .................................... 175 1985\/92 2200 Sunset Earl ....................................... 175 1985\/91 2200 Safe Protector .................................... 175 1973\/91 2200 Sunset Searcher ................................... 174 1985\/91 4200 Sunset Seeker ..................................... 174 1985\/91 4200 Hornbeck Capella .................................. 168 1968\/91 2500 Hornbeck Swallow .................................. 165 1972\/90 2500 Hornbeck Swift .................................... 165 1973\/90 2500 Hornbeck Castor ................................... 154 1947\/90 1100\nRAVENSWORTH SALE\/CHARTERBACK\/REPURCHASE INTEREST:(1) Hornbeck Sapphire ................................. 182 1980\/90 2700 Hornbeck Supreme .................................. 182 1981\/90 2700 Hornbeck Sentry ................................... 182 1979\/90 2700 Hornbeck Support .................................. 182 1979\/90 2700 Hornbeck Sceptre .................................. 180 1981\/90 2700 Hornbeck Sovereign ................................ 180 1979\/90 2700\nSEABOARD OWNED: Hornbeck Implacable ............................... 245 1965\/84 2500 Hornbeck Illustrious .............................. 234 1972\/86 2160 Hornbeck Integrity ................................ 231 1969\/85 1750 Hornbeck Intrepid ................................. 231 1969\/85 1750 Hornbeck Invincible ............................... 231 1971\/86 2400 Hornbeck Coral .................................... 200 1977\/92 4200 - ------------ 1. These six vessels are operated under charters. Pursuant to agreements entered into at the time the vessels were sold and chartered back, Ravensworth may acquire the owners of the vessels or be required to repurchase such vessels from such owners.\nRAVENSWORTH ACQUISITION TERMS\nOn July 23, 1993, the Company acquired 49.9% (the \"Ravensworth Acquisition\") of the outstanding capital stock of Ravensworth, from Ravensworth Holdings Limited (\"RHL\"), the sole beneficial holder of the outstanding capital stock of Ravensworth, for a purchase price of $11 million in cash and approximately $2.7 million in the form of 158,978 restricted shares of common stock of the Company, $.10 par value per share (the \"Common Stock\") and options to acquire the remaining outstanding capital stock of Ravensworth (the \"Ravensworth Options\").\nPursuant to rights granted in connection with the Ravensworth Acquisition, the Company is entitled to nominate directors to be elected to the Board of Directors of Ravensworth commensurate with its ownership interest in Ravensworth, and RHL has agreed to vote its shares for the Company's designees to Ravensworth's Board. The Company has nominated and caused to be elected three directors to the six-member Board of Directors of Ravensworth. In addition, the consent of the Company is required before Ravensworth takes certain significant actions.\nSEABOARD ACQUISITION TERMS\nEffective November 30, 1994, the Company's newly formed 49.9% owned affiliate, Seaboard, acquired (the \"Seaboard Acquisition\"), for nominal consideration, all of the outstanding capital stock of Seaboard Offshore Group Limited (\"SOGL\") which, together with its subsidiaries, owns six (6) safety standby vessels operating in the North Sea. To facilitate the transaction, the Company made a (pound)1.5 million loan to SOGL and guaranteed approximately (pound)302,000 of SOGL debt. In connection with the Seaboard Acquisition and the formation of its 49.9% owned - 10 -\naffiliate, Hornbeck Offshore Limited, the Company acquired options to purchase, to the extent it has exercised the Ravensworth Options, the remaining equity interest in Seaboard.\nIn connection with the exercise of its options to acquire the remaining outstanding capital stock of Ravensworth, the Company will be entitled to receive for no additional consideration a corresponding amount of the remaining equity interests in North Sea Manager.\nPursuant to rights granted in connection with the Seaboard Acquisition and the formation of North Sea Manager, the Company is entitled to nominate directors to be elected to the boards of directors of Seaboard and North Sea Manager commensurate with its ownership interests in such companies, and RHL has agreed to vote its shares for the Company's designees to such companies' boards. The Company has nominated and caused to be elected the appropriate directors to the boards of directors of such companies. In addition, the consent of the Company is required before Seaboard or North Sea Manager take certain significant actions.\nEMPLOYEES\nAs of January 31, 1996, the Company had approximately 570 employees. The Company considers relations with its employees to be satisfactory. None of the Company's employees is represented by a collective bargaining unit.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe name, age and offices held by each of the executive officers of the Company at February 15, 1996 are as follows:\nNAME AGE OFFICE\/OFFICES ---- --- -------------- Larry D. Hornbeck ........................ 57 Chairman of the Board of Directors, President and Chief Executive Officer\nBernie W. Stewart ........................ 51 Senior Vice President and Chief Operating Officer\nRobert W. Hampton ........................ 44 Vice President, Treasurer and Chief Financial Officer\nRoger M. Sykes ........................... 51 Vice President - Marketing\nTerry Jett ............................... 51 Vice President of Sales, Manager - East\nHarvey C. Haskett ........................ 53 Vice President of Sales - West\nRichard R. Ellison ....................... 44 Vice President and Secretary\nJohn D. Opiela ........................... 37 Vice President and Controller\nOfficers each serve for a one-year term or until their successors are appointed and qualified.\nLarry D. Hornbeck is Chairman of the Board, President and Chief Executive Officer of the Company. He has held these positions and has been a director since he founded the Company in January of 1981. Prior to 1981, Mr. Hornbeck was Chairman of the Board, President and Chief Executive Officer of Seal Fleet, Inc., a publicly held offshore supply vessel company. Mr. Hornbeck has more than 27 years of senior management experience in the offshore marine services industry, including international operations. He also serves as a director of Coastal Towing, Inc. - 11 -\nBernie W. Stewart has been Senior Vice President and Chief Operating Officer of the Company since February 1995. From October 1993 until he joined the Company, he pursued various business opportunities. From 1989 to October 1993, Mr. Stewart was President of Western Oceanic Inc., a wholly owned subsidiary of The Western Company of North America.\nRobert W. Hampton has been Vice President, Treasurer and Chief Financial Officer of the Company since February 1990. He was Vice President of American Exploration Company, a publicly held independent oil and gas company, from 1986 to 1989. From 1982 to 1986, Mr. Hampton was a Senior Manager in the Houston office of Price Waterhouse. Mr. Hampton has more than six years of experience in the offshore marine services industry.\nRoger M. Sykes has been Vice President - Marketing of the Company since March 1993 and from January 1992 to March 1993 he was the Vice President - International of the Company. He was Director of International Marketing of Zapata Gulf Marine from 1985 to December 1991. Mr. Sykes has managed international marketing of offshore service vessels for more than 22 years.\nTerry Jett has been Vice President of Sales - East of the Company since March 1993, prior to that he was Vice President of Sales, Manager - East of the Company from January 1990 to March 1993. He was Vice President of Point Marine, Inc. from August 1976 until January 1990. Mr. Jett has more than 24 years of experience in the offshore marine services industry.\nHarvey C. Haskett has been Vice President of Sales - West of the Company since March 1993 and prior to that he was a Vice President of Operations of the Company from December 1981 to March 1993. He was a director of the Company from May 1982 to June 1989. Prior to joining the Company in 1981, Mr. Haskett was an officer of Seal Fleet, Inc., a publicly held offshore supply vessel company. Mr. Haskett has more than 24 years of experience in the offshore marine service industry.\nRichard R. Ellison has been Vice President and Secretary of the Company since August 1987. Mr. Ellison also served as Treasurer until February 1990. He was a director of the Company from August 1987 to June 1989. From December 1980 to August 1987, Mr. Ellison was Assistant Treasurer of Texas Foundries, Inc., which manufactures custom castings. Mr. Ellison has more than eight years of experience in the offshore marine services industry.\nJohn D. Opiela has been Vice President and Controller of the Company since March 1993 and prior to that he was Vice President and Controller of the Morgan City office from January 1990 to March 1993. He was the Controller of Point Marine, Inc. from November 1988 until January 1990. From 1983 through November 1988, Mr. Opiela worked for the accounting firm, L.D. Crocker and Company. Mr. Opiela has more than seven years of experience in the offshore marine services industry.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company owns approximately 2.6 acres in Galveston, Texas, on which its headquarters office and staging facility\/warehouse are located. Its offices and operating facilities near Morgan City and Houma, Louisiana, occupy leased space.\nThe vessels owned, bareboat-chartered or managed by certain subsidiaries of the Company and by Ravensworth and Seaboard are described in Item 1 of this Report.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThe Company is not a party to any legal proceedings the result of which could, in the opinion of management, have a material adverse effect upon the Company.\nThe Company has received and is responding to a subpoena for documents from the United States District Court for the Southern District of Texas, Houston Division. The scope of the subpoena suggests an interest in the Company's compliance with certain environmental statutes and regulations, violations of which could carry both civil and criminal liabilities. The subpoena seeks information concerning the Company's vessels since January 1,\n- 12 -\n1993 regarding vessel operations as they relate to the purchase, use and disposition of petroleum and related products.\nIt is the Company's policy to comply with all applicable laws, including laws designed to protect the environment. While management and the board of directors of the Company do not believe that any outcome of the investigation would have a material adverse effect on the financial position of the Company, they cannot predict the nature or ultimate outcome of the investigation or any proceeding that might be based thereon.\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 1995. The Company has distributed proxy materials to holders of record of the Common Stock on January 31, 1996 for the purpose of submitting the adoption of the Merger Agreement to a vote of security holders at a special meeting to be held on March 13, 1996. See discussion under Item 1: \"Recent Events\" above. PART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS.\nThe Company's Common Stock trades in the over-the-counter market and is quoted on the NASDAQ National Market System under the symbol \"HOSS\". At January 31, 1996, the Company had 214 holders of record of Common Stock. The Company estimates that there are approximately 4,500 beneficial holders of the Company's Common Stock based upon the number of individual participants in security position listings.\nThe following table sets forth the range of high and low closing sales prices of the Company's Common Stock as reported by NASDAQ for the quarters indicated. PRICE RANGE OF COMMON STOCK --------------- HIGH LOW ---- --- First quarter ................................ $ 18 5\/8 $ 13 1\/2 Second quarter ............................... 17 3\/8 12 7\/8 Third quarter ................................ 15 7\/8 11 1\/2 Fourth quarter ............................... 15 1\/2 12 1\/4\nFirst quarter ................................ $ 12 7\/8 $ 8 7\/8 Second quarter ............................... 16 5\/8 11 1\/4 Third quarter ................................ 16 3\/8 12 5\/8 Fourth quarter ............................... 20 1\/8 13 1\/2\nFirst quarter (through February 15, 1995) .... $ 21 3\/8 $ 19\nThe Company has never paid cash dividends on its Common Stock, and the Company's ability to pay cash dividends in the future is limited by its current debt arrangements. - 13 -\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe following selected financial data for the Company as of and for the years ended December 31, 1991 through December 31, 1995 were derived from the audited 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,\" the Consolidated Financial Statements of the Company and the related notes included elsewhere herein:\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nGENERAL\nTHE COMPANY\nThe Company's operating revenue is directly affected by average dayrates and fleet utilization which are closely aligned with the offshore oil and gas exploration and development industry. The level of exploration and development of offshore areas is affected by both short-term and long-term trends in oil and gas prices which, in turn, are related to the demand for petroleum products and the current availability of oil and gas resources. Although different geographic markets were affected at different times and to varying degrees, the level of activity in the oil and gas exploration and development industry and, therefore, the offshore marine services industry, was depressed in the U.S. Gulf of Mexico during the middle 1980's. In the period between 1988 and 1995, the U.S. Gulf of Mexico's market has experienced several periods of increased offshore activity as well as periods, both seasonal and otherwise, where demand for vessel services has decreased. Many industry experts anticipate that increased natural gas demand will increase activity in the U.S. Gulf. On the other hand, a reduced level of oil and gas prices could lead to less exploration and development of offshore areas, reduced activity for the offshore marine\n- 14 -\nservices industry, and an adverse effect of the Company's financial condition and results of operations. Internationally, in the North Sea, since the Company's 1993 acquisition of its Ravensworth affiliate, safety standby vessel demand has declined due to lower drilling activity caused by oil price declines and certain tax law changes affecting that area. Currently, there are industry expectations of increased drilling activity in the North Sea during 1995. Such drilling activity changes would increase demand and, potentially, dayrates for the safety standby vessel market. The Company, however, cannot predict future demand levels for its markets.\nAs the offshore marine services industry is cyclical, periods of increased demand for services result in higher utilization and dayrates and periods of lower demand result in lower utilization and dayrates. An upward or downward movement in dayrates has little direct impact on operating costs and expenses for a vessel. An increase or decrease in utilization of a vessel will incrementally increase or decrease certain operating costs and expenses but generally not in proportion to the associated revenue change. The Company's results of operations have not been significantly affected by inflation during the past five years. Since the time of the Company's investment in Ravensworth in mid-1993, it has become exposed to potential foreign exchange gains or losses. Through December 31, 1995, the Company has not recorded any significant foreign exchange gains or losses.\nIf the proposed Merger with Tidewater is not accomplished, the Company will seek to expand its fleet through acquisitions when industry cycles or other factors create attractive purchase opportunities. Through acquisitions, including those described below, the Company has grown to become the operator of the second largest fleet of supply vessels in the Gulf of Mexico and the world. The Company's most recent significant acquisitions are described below.\nTHE PETROL ACQUISITION\nOn November 19, 1992, the Company strengthened its fleet in the Gulf of Mexico by acquiring 20 offshore supply vessels and one utility vessel from Petrol Marine Corporation and certain related entities (collectively \"Petrol\") for $18,500,000. The aggregate consideration paid to Petrol consisted of $4,750,000 in cash, $5,250,000 in unsecured notes issued by the Company, and 1,365,462 restricted shares of Common Stock then valued at a market price of $8,500,000. As a condition to the transaction, $2,000,000 of the cash consideration was escrowed for purposes of refurbishing and recertifying seven of the acquired vessels that were not in service on the date of the acquisition. These seven vessels were subsequently repaired, refurbished, and returned to service. Because the escrowed funds were insufficient to pay for all of the costs for the required work on the seven vessels, the future debt service for the notes issued to Petrol in connection with the Petrol Acquisition was reduced by the excess of such costs over the escrowed funds, a total of approximately $1.8 million. In a transaction finalized effective March 18, 1994, the Company prepaid the balance of the unsecured notes.\nTHE RAVENSWORTH ACQUISITION\nOn July 23, 1993, the Company completed the acquisition of 49.9% of the outstanding capital stock of Ravensworth and certain options to acquire the balance of such capital stock. The Company purchased the 49.9% equity interest for a purchase price of $11,000,000 payable in cash in U.S. dollars and 158,978 shares of restricted Common Stock of the Company's capital stock valued at approximately $2.7 million. Based on Ravensworth's EBDIT performance in 1994, the option price for the 9.9% option exercised effective July 23, 1993 was adjusted downward by approximately $1,800,000, resulting in the surrender and cancellation of approximately 106,000 shares of the Company's common stock originally issued as partial consideration for such option exercise.\nTHE OIL & GAS ACQUISITION\nOn November 15, 1994, the Company once again added to its Gulf fleet by completing the acquisition of thirteen (13) large offshore supply vessels and related assets (collectively, the \"Oil & Gas Vessels\") from Oil & Gas Rental Services, Inc. for aggregate consideration of $46,000,000 in cash.\nOne-half of the purchase price was paid from the Company's cash reserves, while the other one-half was obtained under new loan facilities. In connection with the Company's acquisition of the Oil & Gas Vessels, on November 15, 1994, the Company entered into a loan agreement to provide a portion of the funds for the Oil & - 15 -\nGas Acquisition under a term loan as well as a revolving credit facility. The term loan ($12,100,000 at December 31, 1995) is secured by the thirteen acquired Oil & Gas Vessels. See \"-- Liquidity and Capital Resources.\"\nTHE SEABOARD ACQUISITION\nEffective November 30, 1994, the Company's newly formed 49.9% owned affiliate, Seaboard, acquired all of the outstanding capital stock of SOGL which, together with its subsidiaries, owns six safety-standby vessels operating in the North Sea. The acquisition of the SOGL equity securities was accomplished for nominal consideration. To facilitate the transaction, the Company made a (pound)1.5 million loan to SOGL and guaranteed approximately (pound)302,000 of SOGL debt. RHL, the 50.1% owner of the Company's 49.9% owned North Sea affiliate, Ravensworth, guaranteed to the Company the repayment of 50.1% of the loan to SOGL. The Company also acquired a 49.9% interest in North Sea Manager, which provides management services to the six Seaboard vessels and the 23 Ravensworth vessels.\nLIQUIDITY AND CAPITAL RESOURCES\nCash provided from operating activities totaled $23,457,000 for 1995 compared to $19,148,000 in the prior year. The Company had cash and equivalents of $13,945,000 at December 31, 1995. The improvement in operating cash flow resulted from increased operating income and lower tax and interest payments.\nIn connection with the Oil & Gas Acquisition, the Company entered into a loan agreement (the \"Loan Agreement\") with First Interstate Bank of Texas, N.A., as lender, and as agent for any future lenders who may participate in the loans under the Loan Agreement (collectively, the \"Lenders\") to provide a portion of the funds for the Oil & Gas Acquisition and a revolving credit facility. Under the Loan Agreement, the Company obtained a term loan in the amount of $20 million, payable over a five-year period in quarterly installments of $714,284 commencing March 31, 1995, with the balance due November 15, 1999. The term loan is secured by the 13 acquired Oil & Gas Vessels. The Loan Agreement also provides for a revolving credit facility of up to $10 million based on a Borrowing Base (as defined in the Loan Agreement) comprised of eligible accounts receivable of the Company and its subsidiaries. The loans bear interest at the agent's prime rate or, at the election of the Company, at LIBOR plus 1%.\nThe Company anticipates it will be able to generate sufficient cash flow from operations to meet its debt repayment and capital expenditure requirements and be in a position to invest a portion of its cash flow in other acquisitions in the offshore marine services industry. If the Merger is not completed, planned growth will be funded through future cash flow and\/or additional debt or equity financing. The Company believes that it possesses sufficient unencumbered assets (recognizing that only nineteen of the 56 U.S. flag vessels in which the Company has an ownership interest constitute collateral for outstanding debt) to support future debt financing.\nPursuant to an option agreement entered into in connection with the Ravensworth Acquisition, the Company may acquire the remaining 50.1% of Ravensworth equity that it does not presently own during the period January 1, 1995 through March 31, 1997. The option price will bear interest from the original acquisition date and the option prices are subject to upward or downward adjustment based on actual Ravensworth EBDIT performance. Performance of the North Sea Manager and of Seaboard is combined with that of Ravensworth for purposes of making such EBDIT calculations. Based on Ravensworth's EBDIT performance in 1994, the option price for the 9.9% option exercised effective July 23, 1993 was adjusted downward by approximately $1,800,000, resulting in the surrender and cancellation of approximately 106,000 shares of the Company's common stock originally issued as partial consideration for such option exercise. Assuming no performance adjustments and exercises of the options on March 31, 1996 and March 31, 1997, the total future purchase price, including interest, amounts to a payment of approximately $5.7 million in cash together with $11.4 million of Hornbeck common stock. If the Company does not exercise the option that may be exercised on or before March 31, 1996, both the option that may be exercised on or before March 31, 1996 and the option that may be exercised on or before March 31, 1997 will terminate. Pursuant to option agreements entered into in connection with the formation of the North Sea Manager and the Seaboard Acquisition, the Company may acquire the remaining 50.1% of the North Sea Manager and Seaboard that it does not presently own. In connection with the exercise of its options to acquire the remaining outstanding capital stock of Ravensworth, the Company will be entitled to receive for no additional consideration a corresponding\n- 16 -\namount of the remaining equity interests in North Sea Manager. If the Company has exercised its options to acquire the remainder of the capital stock of Ravensworth, the Company may exercise an option to acquire the remaining outstanding capital stock of Seaboard.\nThe Company's commitments for future capital expenditures were not material at December 31, 1995. The Company is subject to regulations which require supply vessels to be drydocked twice in a five-year period and, therefore, each year a portion of the Company's vessels undergo routine drydocking for maintenance and repairs.\nRESULTS OF OPERATIONS\nYEAR ENDED DECEMBER 31, 1995 VERSUS YEAR ENDED DECEMBER 31, 1994\nRevenues increased by $13,178,000 or 29% from $45,834,000 in the year ended December 31, 1994 to $59,012,000 in the year ended December 31, 1995. Relevant fleet statistics affecting the Company's revenues are as follows:\nYEAR ENDED DECEMBER 31, ----------------------- 1994 1995 ------- ------- Number of vessels in fleet at end of period 63 61 Average supply vessel dayrate $ 3,272 $ 3,194 Average fleet utilization 80% 83%\nRevenues increased due to the increased fleet utilization and the larger number of vessels in the fleet. This increase was partially offset by the impact of lower dayrates. Direct labor and other operating expenses increased from $23,484,000 in 1994 to $29,858,000 in 1995, an increase of $6,374,000 or 27%. This increase is due to the increased fleet utilization and the increased number of vessels in the fleet in 1995. Depreciation and amortization also increased because of the acquisition of vessels in November 1994. Average depreciation on a per vessel basis increased in 1995 because vessels acquired in late 1994 cost more than the average vessel in the existing fleet. General and administrative expenses increased $668,000 or 19% from $3,576,000 in 1994 to $4,244,000 in 1995 primarily because of the increase in shore-based staff to support the increased fleet size, the expense associated with a cancelled stock offering, and higher legal fees. Operating income increased 29% or $2,566,000 from $8,767,000 to $11,333,000 in 1994 and 1995, respectively.\nThe Company reported a gain on the sale of assets totalling $431,000 in 1995, which is primarily attributable to the sale of a vessel in June 1995 compared to a gain of $736,000 on three vessels sold in 1994, a decrease of $305,000. The Company also reported equity in earnings of affiliates of $53,000 representing its share of income of certain affiliates for the year ended December 31, 1995 as compared to $1,408,000 in the prior year. The Company's North Sea safety standby vessel affiliates recognized lower income primarily because of lower revenues due to decreased utilization and dayrates. Interest expense increased $884,000 or 102% because of the additional borrowings made in November 1994 in connection with the Oil & Gas Vessel Acquisition.\nIncome taxes represent a lower or higher percentage of pretax income than an expected \"statutory\" rate of approximately 35% due primarily to the fact that no income tax effect is recognized for the Company's equity in earnings of affiliates. Additionally, in 1995, certain property taxes paid on vessels generate state income tax credits which lower effective state tax rates.\nYEAR ENDED DECEMBER 31, 1994 VERSUS YEAR ENDED DECEMBER 31, 1993\nRevenues declined by $1,457,000 or 3% in 1994 compared to 1993. The primary cause for this reduction was the decline in overall fleet utilization in 1994 to 80% compared to 85% in the prior year. Relevant fleet statistics affecting the Company's revenues are as follows: - 17 - YEAR ENDED DECEMBER 31, ----------------------- 1993 1994 ------ ------ Number of vessels in fleet at end of period ....... 51 63(1) Average supply vessel dayrate ..................... $3,284 $3,272 Average fleet utilization ......................... 85% 80% - ------------ 1. Includes 13 vessels acquired on November 15, 1994.\nAlthough dayrates averaged approximately the same in 1993 and 1994, market conditions differed significantly, with increasing rates during 1993, which ended in December at approximately $4,000 per day for average supply vessel rates, and with rates declining in 1994 through the middle of the year to approximately $3,000 per day, flat in much of the third quarter and increasing in the fourth quarter of 1994 to slightly above $3,200 on average. Utilization declined in the first half of 1994, then increased in the second half of the year.\nDirect labor and other operating expenses increased by $2,896,000 or 14% in 1994 compared to 1993. Most of this increase was attributable to higher insurance premiums and insurance deductibles paid by the Company in 1994. Additionally, labor increased by 8.5% due to crewmembers' wage rate adjustments and payroll taxes related thereto. Generally, operating costs and expenses do not change in direct proportion to revenues.\nDepreciation and amortization increased 35% because of increased depreciation in 1994 on vessels purchased and because of a $1,630,000 increase in amortization of deferred drydocking costs compared to 1993 due to a larger fleet size that caused higher levels of deferred dry docking.\nGeneral and administrative expenses increased 22% because of an increased number of shore-based employees required to support the Company's increased fleet, both domestically and overseas, and because of higher insurance, travel, franchise tax and shareholder-related expenses associated with a larger company.\nEquity in earnings of affiliates increased due to the inclusion in 1994 of such earnings for all of 1994 compared to inclusion in 1993 from only the July 1993 acquisition date. Full-year earnings of affiliates were actually down in 1994 compared to 1993 due to lower dayrates in 1994. The gain on sale of assets relates to three vessels sold during the second quarter of 1994. Interest and other income increased primarily because of higher levels of investment and interest rates in 1994. Interest expense declined because of debt repayments in early 1994.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe Consolidated Financial Statements of the Company included in this Report are listed under Item 14.\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.\nThe following table sets forth for the directors and for each executive officer listed in the Summary Compensation Table the information regarding their names, ages, principal occupations for at least the last five years (directors only), other directorships in certain companies held by them and the length of continuous service as a director of the Company, as well as the number of shares of Common Stock beneficially owned by each of them and by the directors and officers as a group as of February 15, 1996.\n- 18 -\n- ------------ * Executive officer only - not a director ** Less than one percent\n1. The information presented reflects \"beneficial ownership\" as defined in Rule 13d-3 of the Securities Exchange Act of 1934, as amended (the \"Exchange Act\"), which includes the right to acquire beneficial ownership of a security within 60 days, whether upon the exercise of a stock option, conversion of a convertible security, or otherwise. In addition, securities must be listed as beneficially owned by a person who directly or indirectly holds or shares the power to vote or dispose of the securities, whether or not the person has any economic interest in the securities. Unless otherwise indicated, beneficial owners have sole voting and investment power with respect to the shares owned of record by them. All percentages set forth in this table have been rounded.\n2. Includes 219,800 shares held of record and 42,853 shares of Common Stock subject to stock options exercisable within 60 days.\n3. The number above includes (i) 91,054 shares of Common Stock owned by L. E. Simmons directly and (ii) 2,761 shares of Common Stock owned by Mr. Simmons indirectly.\n4. Bruce W. Hunt, the sole stockholder of Petrol Marine Corporation, the controlling stockholder of Portal Energy Corporation, a significant stockholder of Pentad Offshore Corporation and an executive officer and director of each of such corporations, may be deemed to be the beneficial owner of an aggregate of 1,365,462 shares of Common Stock held of record by these entities. Mr. Hunt owns directly 2,200 shares of Common Stock.\n5. Includes 1,519 shares of Common Stock held of record and 6,667 shares of Common Stock subject to stock options exercisable within 60 days.\n- 19 -\n6. Includes 26,609 shares of Common Stock held of record and 10,202 shares of Common Stock subject to stock options exercisable within 60 days.\n7. Includes 170,913 shares of Common Stock subject to stock options exercisable within 60 days.\nUnder Section 16(a) of the Securities Exchange Act of 1934, the Company's directors, its officers, and any person holding more than 10% of the Company's Common Stock are required to file reports of ownership and any changes in ownership with the Securities and Exchange Commission. Based solely on a review of copies of reporting forms furnished to the Company or written representations that no annual forms (Form 5) were required, the Company believes that, during 1995, each of its officers, directors and 10% stockholders were in compliance with all such filing requirements.\nEach of the directors named in the table above has been engaged in the principal occupation set forth beneath his name in such table for the past five years except as follows:\nBilly Pugh served for more than five years as Vice President of Owens Well Service, Inc. prior to his retirement in November 1992.\nWarren B. Idsal was from January 1991 through July 1991 Deputy Treasurer of the Texas State Treasury. He has been serving since August 1991 as Senior Vice President and Director of Corporate Finance at Principal Financial Securities, Inc. (formerly, The Principal\/Eppler, Guerin & Turner, Inc.).\nAnthony W. Henfrey has served as a principal since July 1995 of Postern Executive Group Limited, a firm specializing in the provision of corporate recovery services and headquartered in London, England. Since February 1991 he has served as Chairman, and since February 1995 as a director, of Oceonics Group PLC, an offshore services company headquartered in Great Yarmouth, England. From July 1994 to April 1995 he served as a director of Pavilion Services Group, a leading retailer of gasoline, convenience store merchandise and catering services on the UK freeway network.\nL.E. Simmons has for more than five years served as President of L.E. Simmons & Associates Incorporated (formerly SCF Investment Partners, Inc.), which is the general partner of SCF Partners, L.P.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nIn accordance with the rules promulgated by the Securities and Exchange Commission (\"SEC\"), the following compensation information is provided to enable stockholders to better understand the compensation of the Company's executive officers.\nDIRECTOR COMPENSATION\nMr. Hornbeck, the sole executive officer who also serves as a director of the Company, was paid $400 for each meeting of the Board of Directors that he attended through May 2, 1995 and $450 for each meeting attended thereafter in 1995. Other directors were paid an annual retainer of $10,000, paid semi-annually, plus $800 for each meeting of the Board of Directors and $800 for each committee meeting that they attended through May 2, 1995 and $900 for each meeting attended thereafter in 1995. At the request and direction of the Company, Messrs. Hornbeck, Henfrey and Hunt serve as directors of Ravensworth Investments Limited, an entity in which the Company owns a 49.9% equity interest. Pursuant to Ravensworth's compensation arrangements, Messrs. Hornbeck, Henfrey and Hunt each received in 1995 an annual retainer of (pound)5,000 for serving as a director of Ravensworth.\nThe Hornbeck Offshore Services, Inc. 1991 Restricted Stock Plan for Non-Employee Directors, as amended pursuant to a vote of the stockholders of the Company at the 1994 Annual Meeting (the \"1991 Plan\" or the \"Restricted Stock Plan\"), provides for awards of restricted shares of Common Stock, as part of their compensation, to persons who serve as directors of the Company and who are not employees of the Company (or its subsidiaries) or consultants to the Company (or its subsidiaries) under long-term agreements. At present, there are six non-\n- 20 -\nemployee directors. All non-employee directors participate in the Restricted Stock Plan. The awards are in addition to the directors' annual cash retainer and meeting attendance fees.\nAn award of 800 restricted shares of Common Stock was made to Messrs. Schuller, Pugh, Henfrey, Idsal, Hunt and Simmons in 1995. The awards to be made to the non-employee directors in conjunction with the 1996 Special Meeting will be the sixth successive award under the Restricted Stock Plan. If the proposed Merger is not consummated, annual awards consisting of restricted shares of Common Stock will continue to be made to each participant who is elected or appointed or continues as a director each year, effective as of the date of the annual meeting of stockholders.\nThe Restricted Stock Plan is administered by the Compensation Committee of the Board of Directors of the Company. As discussed below, the Compensation Committee is presently comprised of three independent non-employee directors, Messrs. Idsal, Henfrey and Pugh.\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION.\nThe persons who served on the Compensation Committee for 1995 were Messrs. Henfrey, Idsal and Pugh. None of such persons is or has been an officer or employee of the Company or any of its subsidiaries. No executive officer of the Company served in the last fiscal year as a director or member of the compensation committee of any other entity one of whose executive officers served as a director or on the Compensation Committee of the Company.\nCOMPENSATION TABLES\nThe SEC rules with respect to executive compensation require certain compensation information to be presented in tabular form. Such information is required for the Chief Executive Officer and the four most highly compensated executive officers of the Company whose total annual salary and bonus for 1995 exceeded $100,000. No executive officers of the Company received salary and bonuses in excess of the $100,000 disclosure limit except Mr. Hornbeck, Mr. Stewart and Mr. Hampton. - 21 -\n- ------------ * The Company has not determined bonuses, restricted stock awards or option awards for 1995.\n1. The Company has never paid cash dividends on its Common Stock. If the Merger is not consummated, the Company intends to retain any future earnings otherwise available for cash dividends on the Common Stock for use in its operations and for expansion and does not anticipate that any cash dividends will be paid in the foreseeable future. If the Company were to change its current policy of retaining earnings otherwise available for cash dividends, the Company's ability to pay cash dividends would be subject to continuing compliance with certain financial covenants in the loan agreement governing its bank term loan and revolving credit facility.\n2. Pursuant to agreements entered into as of December 28, 1995, the Company made advance cash payments to Messrs. Hornbeck, Stewart and Hampton in connection with the change in control agreements described below. If the proposed Merger is not consummated, each of such officers has agreed to remit to the Company an aggregate of (i) cash in an amount equal to 58.95% of the amount received by such executive officer in 1995, payable within five days of such event and (ii) an amount equal to any tax benefit received because of such reimbursement, payable subsequently.\n3. Represents a restricted stock award of 4,348 shares granted on April 1, 1995 ($11.50 per share market price) for fiscal year 1994. As of December 31, 1995, Mr. Hornbeck held an aggregate of 10,648 shares of restricted Common Stock issued to him as compensation awards with a market value of $108,967.\n4. Represents a restricted stock award of 3,900 shares granted on December 14, 1993 ($13.00 per share market price) for fiscal year 1993.\n5. Represents a restricted stock award of 1,519 shares granted on February 8, 1995 pursuant to a Hiring Agreement ($9.875 per share market price). Mr. Stewart was hired by the Company on February 8, 1995. As of December 31, 1995, Mr. Stewart held 1,519 shares of restricted Common Stock issued to him pursuant to a Hiring Agreement with an aggregate market value of $29,810.\n6. Represents an option granted on February 8, 1995 pursuant to a Hiring Agreement ($9.875 per share market price).\n7. Represents a restricted stock award of 1,461 shares granted on April 1, 1995 ($11.50 per share market price) for fiscal year 1994.\n8. Represents a restricted stock award of 1,200 shares granted on December 14, 1993 ($13.00 per share market price) for fiscal year 1993.\nIn addition to the above-mentioned compensation, executive officers are provided with certain other perquisites. Although the dollar amount of such benefits is not readily ascertainable, the Company believes that with\n- 22 -\nrespect to the named executive officers, any personal benefit derived from such perquisites does not exceed the lesser of $25,000 or 10% of such person's salary and bonus per year.\nCOMPENSATION PURSUANT TO PLANS\nThe Company currently has two employee incentive plans whereby the Company has granted or may grant stock options, stock appreciation rights, and make awards of shares of restricted stock. Each of these incentive plans, the 1989 Employee Incentive Plan (the \"1989 Plan\") and the 1993 Employee Incentive Plan (the \"1993 Plan\"), comply with the provisions of Rule 16b-3 of the Exchange Act. Pursuant to Rule 16b-3, the 1989 Plan and the 1993 Plan are administered by a committee consisting of two or more \"disinterested directors,\" as that term is defined in the Exchange Act. The Compensation Committee of the Board of Directors, presently comprised of Messrs. Idsal, Henfrey and Pugh, has been designated by the Board to administer the 1989 Plan and the 1993 Plan. The 1989 Plan has terminated pursuant to its terms, except for the continuing administration of outstanding options issued under that plan. The 1993 Plan authorized the issuance of 500,000 shares of the Company's Common Stock pursuant to incentive stock options, non-qualified stock options, restricted stock awards and stock appreciation rights granted pursuant to the 1993 Plan. Absent forfeiture of such options under the terms of the 1993 Plan, there are 390,739 shares available for additional grants to officers and employees.\n- 23 -\n- ------------ 1. Pursuant to the Hiring Agreement.\nAGGREGATE OPTION EXERCISES IN LAST FISCAL YEAR AND YEAR-END OPTION VALUES\nThe following table shows data regarding aggregate option exercises in the last fiscal year and fiscal year-end option values for the Chief Executive Officer and the other two executive officers named in the Summary Compensation Table. The Company has never granted any stock appreciation rights under its Employee Incentive Plans. - 24 -\n- ------------ 1. Computed based upon the difference between the fair market value on December 31, 1995 of the shares of Common Stock covered by the options and the exercise prices of each of the outstanding stock options held by such executive officers.\nCHANGE IN CONTROL AGREEMENTS\nThe Company has entered into change in control agreements (the \"Agreements\") with the following officers of the Company: Larry D. Hornbeck, Bernie W. Stewart, Robert W. Hampton and Robert M. Sykes. The Agreements set forth certain benefits that the Company will provide if their employment is terminated or, under certain conditions, they elect to terminate their employment after a \"change in control\" of the Company, as defined in the Agreements. The Agreements continue in effect for three years and thereafter until terminated by the Company upon specified notice; provided that they continue for two years after a change in control of the Company. The Agreements each provide that if the officer is terminated or if the officer so elects to terminate employment within two years after a change in control of the Company, the officer shall be entitled to a lump sum severance payment of (a) up to three times the officer's highest annual compensation within the five tax years preceding the change in control and (b) the difference between the market value and the exercise price of unexercised stock options. In addition, the officer is entitled to a two-year continuation of certain employee benefits and reimbursement of certain legal fees, expenses and any applicable excise taxes. On December 29, 1995, the Company made certain advance payments to three executive officers of a portion of the amounts to which such officers would have otherwise become entitled following consummation of the Merger under the terms of the Agreements.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe following table sets forth certain information regarding the beneficial ownership of the Common Stock of the Company by each person known by the Company to own more than five percent of the outstanding Common Stock, including any \"group\" as that term is used in Section 13(d)(3) of the Exchange Act, at January 31, 1996 (except as otherwise indicated):\n- 25 -\n- ------------ 1. The information presented reflects each stockholder's direct ownership of the 13,243,600 shares of Company Common Stock issued and outstanding as of January 31, 1996 (not including shares of Common Stock reserved for issuance upon exercise of options and\/or warrants).\n2. The information presented reflects \"beneficial ownership\" as defined in Rule 13d-3 of the Securities Exchange Act of 1934, as amended (the \"Exchange Act\"), which includes the right to acquire beneficial ownership of a security within 60 days, whether upon the exercise of a stock option, conversion of a convertible security, or otherwise. In addition, securities must be listed as beneficially owned by a person who directly or indirectly holds or shares the power to vote or dispose of the securities, whether or not the person has any economic interest in the securities. Unless otherwise indicated, beneficial owners have sole voting and investment power with respect to the shares owned of record by them. All percentages set forth in this table have been rounded.\n3. Portal Energy Corporation owns of record 660,428 shares of Common Stock. Pentad Offshore Corporation owns of record 657,053 shares of Common Stock. Petrol Marine Corporation owns of record 47,981 shares of Common Stock. These three corporations may be deemed affiliated through a common controlling stockholder. Bruce W. Hunt is the sole stockholder and an executive officer of Petrol Marine Corporation, a controlling stockholder and executive officer of Portal Energy Corporation and a significant stockholder and executive officer of Pentad Offshore Corporation. Mr. Hunt may be deemed to control or share in the control of the voting and\/or disposition of the securities of the Company owned by each of these three corporations. Each of these three corporations may be deemed to be the beneficial owner of 1,365,462 shares of Common Stock. The referenced numbers do not include 2,200 shares owned by Bruce W. Hunt directly.\n4. Includes 1,711,500 shares of Common Stock over which FMR Corp. may be deemed to have sole dispositive power and 13,000 shares of Common Stock over which FMR Corp. may be deemed to have sole voting power. Various persons have the right to receive or the power to direct the receipt of dividends from, or the proceeds from the sale of, the Common Stock. The interest of one person, Fidelity Equity-Income II Fund, an investment company registered under the Investment Company Act of 1940, in the Common Stock amounted to 876,200 shares or 6.66% of the total outstanding Common Stock at December 31, 1995. This information is based on a Schedule 13G filed with the Securities and Exchange Commission in February 1996.\n5. Based on a Schedule 13G filed with the Securities and Exchange Commission in February 1996. Includes 339,000 shares of Common Stock over which Wellington Management Company may be deemed to have shared voting power and 849,000 shares of Common Stock over which Wellington Management Company may be deemed to have shared dispositive power in its capacity as investment adviser to numerous investment counselling clients.\nSTOCK OWNERSHIP POLICY\nIn December 1993, the Company adopted a stock ownership policy requiring all employees at or above the Vice President level (\"Covered Employees\") to own shares of the Company's Common Stock equal to a specified\npercentage of their base salary as of January 1, 1994, or their hire date, if later. The ownership guidelines are calculated based on percentages of such base salary for each covered employee, ranging from 50% to 100% depending on the level of each Covered Employee's responsibility with the Company. The amount determined by applying such percentage to the base salary, divided by the closing price of the Company's Common Stock quoted on The NASDAQ Stock Market as of January 1, 1994, or the hire date, if later, establishes the number of shares that must be owned by each covered employee.\nCovered Employees must achieve the ownership guideline levels by January 1, 1998 (or four years from their hire date, if later). Shares of restricted stock, whether or not vested, will apply to achieving the prescribed ownership guideline level. After the ownership guideline level is achieved by a Covered Employee, such Covered Employee may sell shares of the Company's Common Stock owned by him as long as the ownership guideline level is maintained. During the four year period during which Covered Employees are acquiring shares of Company Common Stock in order to achieve their ownership guideline level, there are restrictions imposed on the ability of the Covered Employees to sell shares of Company Common Stock unless reasonable progress is being made to achieve the ownership guideline level. The Compensation Committee will annually review whether reasonable progress is being made by the Covered Employees. The Company believes that requiring executive officers of the Company to acquire a more substantial interest in the Company will more closely align the best interests of the executive officers with the stockholders of the Company by providing those persons who have substantial responsibility for the management and growth of the Company with additional proprietary interests in the success of the Company.\nPERFORMANCE GRAPH\nThe following performance graph compares the performance of the Company's Common Stock to the S & P 500 Index, the S & P Small Cap 600 Index, the SCI Offshore Transportation Services Index and the SCI Composite Index of 114 publicly traded oil service and equipment companies. Because the Company was added to the S & P Small Cap 600 Index in 1994, the Company intends to use the S & P Small Cap 600 Index and not the S & P 500 Index as its broad equity market index for comparisons in future filings. The graph assumes that the value of the investment in the Company's Common Stock was $100.00 at December 31, 1990. Although the Company has never paid any dividends, the indices assume reinvestment of dividends. The referenced SCI index is updated monthly and the numbers and identities of the companies included in the index may be changed by SCI from time to time to maintain comprehensive reporting on public oil services and equipment companies. SCI's Performance and Valuation Guide of Publicly Traded Oil Service Companies (the \"Stock Guide\") (and the referenced SCI index printed therein) is available to any stockholder of the Company who subscribes with SCI for the Stock Guide. Copies of the Stock Guide are also available for inspection at the Company's principal executive office.\n[LINEAR GRAPH PLOTTED FROM DATA IN TABLE BELOW]\n- 27 -\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nIn previous years, the Company granted certain registration rights with respect to shares of the Company's Common Stock held by Larry D. Hornbeck, L.E. Simmons and Petrol, which is controlled by Bruce W. Hunt. Messrs. Hornbeck, Simmons and Hunt are current members of the Board of Directors of the Company.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(a) The following financial statements, schedules and exhibits are filed as part of this Report:\n(1) and (2) Financial Statements and financial statement schedules.\nSee Index to Consolidated Financial Statements on page.\n(3) Exhibits\nSee Index to Exhibits on pages E-1 - E-3.\n(b) Reports on Form 8-K\n(1) Form 8-K dated December 4, 1995; and\n(2) Form 8-K dated December 28, 1995.\n- 28 -\nHORNBECK OFFSHORE SERVICES, INC.\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS\nReport of Independent Accountants ........................................\nConsolidated Balance Sheet at December 31, 1994 and 1995 .................\nConsolidated Statement of Income For the Years Ended December 31, 1993, 1994 and 1995 ........................................\nConsolidated Statement of Cash flows For the Years Ended December 31, 1993, 1994 and 1995 ........................................\nConsolidated Statement of Stockholders' Equity For the Years Ended December 31, 1993, 1994 and 1995 ........................................\nNotes to Consolidated Financial Statements ...............................\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Stockholders of Hornbeck Offshore Services, Inc.\nIn our opinion, the consolidated financial statements of Hornbeck Offshore Services, Inc. listed in the index appearing on page present fairly, in all material respects, the financial position of Hornbeck Offshore Services, Inc. and its subsidiaries at December 31, 1994 and 1995, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.\nAs discussed in Note 2 to the financial statements, the Company entered into an Agreement and Plan of Merger with Tidewater Inc. on December 21, 1995.\nPRICE WATERHOUSE LLP HOUSTON, TEXAS FEBRUARY 12, 1996\nHORNBECK OFFSHORE SERVICES, INC. CONSOLIDATED BALANCE SHEET\nThe accompanying notes are an integral part of this statement.\nHORNBECK OFFSHORE SERVICES, INC.\nCONSOLIDATED STATEMENT OF INCOME\nThe accompanying notes are an integral part of this statement.\nHORNBECK OFFSHORE SERVICES, INC.\nCONSOLIDATED STATEMENT OF CASH FLOWS (NOTE 12)\nThe accompanying notes are an integral part of this statement.\nHORNBECK OFFSHORE SERVICES, INC.\nCONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY\nYEARS ENDED DECEMBER 31, 1993, 1994 AND 1995\nThe accompanying notes are an integral part of this statement.\nHORNBECK OFFSHORE SERVICES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1 - BUSINESS AND SUMMARY OF ACCOUNTING POLICIES:\nORGANIZATION AND HISTORY\nHornbeck Offshore Services, Inc. was incorporated under the laws of the state of Delaware in January 1981. All references to the \"Company\" refer to Hornbeck Offshore Services, Inc. and its subsidiaries unless the context requires otherwise.\nAs discussed in Note 2, on December 21, 1995, the Company entered into an Agreement and Plan of Merger with Tidewater Inc. (Tidewater).\nNATURE OF OPERATIONS\nThe Company is engaged in the worldwide offshore marine services business, mainly serving the oil and gas industry through its operation and management of a diversified fleet of 61 vessels (the vessels) located primarily in the Gulf of Mexico. The fleet consists of supply, tug-supply, crew and specialty vessels; 56 of the vessels are owned, 4 are chartered and 1 is managed for an unrelated party. Additionally, the Company maintains a 49.9% equity interest in 3 entities which operate and own or lease a combined fleet of 29 safety standby vessels in the North Sea.\nThe Company's operating revenue is directly affected by average day rates and fleet utilization which are closely aligned with the offshore oil and gas exploration and development industry. The level of exploration and development of offshore areas is affected by both short-term and long-term trends in oil and gas prices which, in turn, are related to the demand for petroleum products and the current availability of oil and gas resources.\nCONSOLIDATED FINANCIAL STATEMENTS\nThe consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. The equity method of accounting is used when the Company has a 20%-50% interest in an affiliate. Under the equity method, original investments are recorded at cost and are adjusted by the Company's share of earnings or losses. All significant intercompany accounts and transactions have been eliminated. Any difference between the Company's share of book value of an equity affiliate and its investment amount is amortized over the remaining useful life of the underlying assets.\nUSE OF ESTIMATES\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nREVENUE AND EXPENSE RECOGNITION\nCharter revenue is earned and recognized on a daily rate basis. The Company's accounts receivable are generally unsecured and are due primarily from companies involved in exploration and production of oil and gas reserves. Operating and other costs are expensed as incurred.\nPROPERTY AND EQUIPMENT\nFor financial reporting purposes, the Company records depreciation expense using the straight-line method over the estimated useful lives of the related assets. For tax purposes, depreciation is computed using accelerated methods.\nThe net book value of the Company's vessels is reviewed periodically to determine that their recorded value does not exceed the estimated future benefit from utilization of those vessels in accordance with Statement of Financial Accounting Standards (SFAS) No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of\", issued in March 1995. The Company adopted SFAS No. 121 effective October 1, 1995 and such adoption had no impact.\nOTHER ASSETS\nOther assets consist primarily of drydocking expenditures. Drydocking expenditures are capitalized and amortized on a straight-line basis over the period to be benefitted (generally 24 to 36 months).\nDEFERRED INCOME TAXES\nDeferred income taxes are determined utilizing a liability approach. This method gives consideration to the future tax consequences associated with differences between financial accounting and tax bases of assets and liabilities. Such differences relate mainly to depreciable assets. This method gives immediate effect to changes in income tax laws upon enactment. The income statement effect is derived from changes in deferred income taxes on the balance sheet.\nEARNINGS PER SHARE\nEarnings per share is calculated using the weighted-average number of shares outstanding assuming exercise of dilutive stock options and conversion of preferred stock. The weighted-average number of primary shares, which includes common shares and equivalent common shares outstanding, during the years ended December 31, 1993, 1994 and 1995 was 11,901,000, 13,460,000 and 13,344,000, respectively. Fully diluted earnings per share amounts are not materially different from primary earnings per share amounts.\nCASH AND EQUIVALENTS\nFor purposes of the consolidated statement of cash flows, the Company considers all deposits readily convertible to known amounts of cash with original maturities of three months or less to be cash and equivalents. For the years ended December 31, 1994 and 1995, included in\"Interest and other income\" is interest income of $1,173,000 and $1,094,000 from such deposits.\nRECLASSIFICATIONS\nCertain 1993 and 1994 amounts were reclassified to conform to the 1995 presentation.\nNEW ACCOUNTING PRONOUNCEMENT\nIn October 1995, Statement of Financial Accounting Standards (SFAS) No. 123, \"Accounting for Stock-Based Compensation\" was issued. SFAS No. 123 provides companies with an alternative to the intrinsic value methodology of valuing stock based compensation pursuant to APB Opinion No. 25, \"Accounting for Stock Issued to Employees\". Under SFAS No. 123, companies have the option of valuing such stock based compensation using fair value. Companies electing to continue under the guidance of APB No. 25 are required to disclose the effects of SFAS No. 123 in proforma footnote disclosure. The Company is required to adopt SFAS No. 123 beginning January 1, 1996. Due to the pending merger with Tidewater, management has not selected a preferred accounting method.\nNOTE 2 - PROPOSED MERGER WITH TIDEWATER, INC.:\nOn December 21, 1995, Hornbeck Offshore Services, Inc. (Hornbeck) entered into an Agreement and Plan of Merger with Tidewater Inc. (Tidewater) to merge a wholly owned subsidiary of Tidewater into Hornbeck with Hornbeck becoming a wholly owned subsidiary of Tidewater. The merger will be structured as a tax free exchange of approximately 8,780,000 Tidewater shares for all Hornbeck shares (an exchange ratio of 0.667 Tidewater shares for each Hornbeck share, subject to adjustment) and will be accounted for as a pooling of interests.\nThe Board of Directors of both Hornbeck and Tidewater have approved the combination subject to the approval of stockholders of Hornbeck holding at least 66 2\/3% of the outstanding Hornbeck common stock and certain other conditions. The merger is expected to be presented for stockholders' approval on March 13, 1996 with consummation immediately thereafter, if approved. Upon consummation of the merger, Larry D. Hornbeck will join the Board of Directors of Tidewater and will become a consultant to Tidewater.\nOn December 29, 1995, Hornbeck made advance payments in the approximate aggregate amount of $2,500,000 to three executive officers, such payments being a portion of the amounts to which such officers would become entitled following consummation of the merger under the terms of change in control agreements between Hornbeck and such executive officers. The impact on operations of these amounts and certain other disbursements related to the merger have been deferred pending consummation of the transaction and are classified as merger costs in the consolidated balance sheet.\nNOTE 3 - ACQUISITIONS AND DISPOSITIONS OF BUSINESSES AND VESSELS:\nIn 1995, the Company sold one vessel for $1 million and realized a gain of $431,000. From January through September 1994, the Company sold four vessels for $3.1 million and realized a gain of $736,000. During the same period, three vessels were acquired for cash consideration of $5.2 million.\nOn November 30, 1994, the Company acquired an equity interest in Seaboard Holdings Limited (Note 5). On November 15, 1994, the Company completed the acquisition of 13 supply vessels from Oil and Gas Rental Services, Inc. (Oil & Gas) for cash consideration of $46 million. The Company borrowed $23 million in connection with this acquisition (Note 6).\nOn July 23, 1993, the Company acquired an equity interest in Ravensworth Investments Limited (Ravensworth), and the Company's share of earnings of this affiliate has been included in the Company's results of operations since that date (Note 4). On April 29, 1993, the Company sold two vessels previously being operated in the North Sea to an unrelated entity for approximately $1.3 million, which approximated the carrying value of the vessels. On June 17, 1993, the Company purchased a supply vessel for cash payment of $1,175,000.\nThe results of operations of the acquired vessels are included in the consolidated financial statements from the acquisition date of November 15, 1994 for the Oil & Gas acquisition. Substantially all of the purchase price was allocated to vessels acquired based on their fair market values and the transactions have been accounted for using the purchase method. The acquired vessels were employed prior to the acquisitions and continue to be employed by the Company after the closing of the acquisition in the offshore marine service business, primarily serving the oil and gas industry.\nAssuming the Oil & Gas transaction occurred at the beginning of each year presented and the Ravensworth transaction occurred at the beginning of 1993, condensed unaudited pro forma combined results of operations are as follows:\nYEAR ENDED DECEMBER 31, ------------------------------- 1993 1994 ------------ ------------- Revenues...................................... $ 62,109,000 $ 60,379,000 Income before extraordinary charge............ $ 13,464,000 $ 9,391,000 Earnings per share before extraordinary charge....................................... $ 1.12 $ .70\nNOTE 4 - PROPERTY AND EQUIPMENT:\nProperty and equipment consisted of the following at December 31:\nESTIMATED USEFUL LIVES 1994 1995 ------------ ----------- ------------ (in thousands)\nVessels......................... 25 $ 119,622 $ 119,125 Building........................ 25 771 971 Land............................ 182 274 Vehicles........................ 3 to 4 420 124 Furniture, fixtures and other... 3 to 10 332 429 ----------- ------------ 121,327 120,923 Less - accumulated depreciation. 19,764 27,805 ----------- ------------ Property and equipment, net..... $ 101,563 $ 93,118 =========== ============\nDepreciation expense related to property and equipment for 1993, 1994 and 1995 was $5,196,000, $6,267,000 and $9,343,000, respectively. A portion of property and equipment is pledged to secure long-term debt (Note 6).\nDrydocking expenditures included in other assets for the year ended December 31 are as follows (in thousands): 1993 1994 1995 --------- --------- --------- Balance -- beginning of year.. $ 1,519 $ 5,234 $ 4,409 Additions..................... 5,825 2,915 7,945 Amortization.................. (2,110) (3,740) (4,234) --------- --------- --------- Balance -- end of year $ 5,234 $ 4,409 $ 8,120 ========= ========= =========\nNOTE 5 - INVESTMENTS IN AFFILIATES:\nOn November 30, 1994, the Company acquired 49.9% of the equity interests of Seaboard Holdings Limited, a Scottish corporation (Seaboard). The transaction was accounted for using the purchase method of accounting. At the time of the transaction, Seaboard owned a fleet of six safety standby vessels operating in the North Sea. Consideration in the form of a guarantee of approximately $483,000 of certain Seaboard indebtedness was given. Further, the Company funded an unsecured loan totaling pound sterling 1.5 million ($2.35 million at November 30, 1994) to Seaboard for operational purposes and has recorded a note receivable from affiliate which bears interest at LIBOR plus 1 3\/4% and is payable in 32 equal monthly installments. During 1995, 50% of the remaining note balance was funded by Ravensworth Holdings Limited (RHL), the owner of a 50.1% interest in Seaboard and Ravensworth. The Company accounts for its investment in Seaboard using the equity method of accounting.\nIn connection with the Seaboard acquisition, the Company was granted an option by RHL to acquire the remaining outstanding equity interest in Seaboard. Exercise of the option is contingent upon the Company's exercise, in full, of the options to acquire the remaining capital stock of Ravensworth, as discussed below.\nOn July 23, 1993, the Company acquired 49.9% of the outstanding capital stock of Ravensworth from RHL, the owner of the outstanding capital stock of Ravensworth, for a purchase price of $11 million in cash and approximately $2.7 million in the form of 158,978 shares of restricted Common Stock (Ravensworth Acquisition). Ravensworth owned or chartered a fleet of 22 safety standby vessels operating in the North Sea at the time of the acquisition. The Company accounts for its investment in Ravensworth using the equity method of accounting. The difference between the Company's investment in Ravensworth and its proportionate share of Ravensworth's book equity totaled $7,985,000 at December 31, 1995 and this difference is being depreciated over the remaining useful life of the Ravensworth fleet. The Company used the purchase method of accounting for this transaction.\nIn connection with the Ravensworth Acquisition, the Company acquired options to purchase the remaining outstanding capital stock of Ravensworth, exercisable after January 1, 1995 in two equal annual installments, with the first option exercisable on or before March 31, 1996 (the 1995 Option) and the second option exercisable on or before March 31, 1997 (the 1996 Option). The Company may, at its election, accelerate the exercise of the 1996 Option to any date on or after January 1, 1995. The 1996 Option will expire unless the 1995 Option is exercised in full. The consideration payable upon exercise of the 1995 Option and the 1996 Option is to be paid one-third in cash and two-thirds in common stock of the Company valued at market price, as defined in the applicable agreements. The Company may elect to pay in U.S. dollars any payments that would otherwise be made to RHL in the Company's common stock.\nThe per share consideration to be paid for the remainder of Ravensworth (subject to the adjustment described below) will be equal to the per share price paid by the Company for the initial 49.9% investment, plus simple interest at 7% (compounded annually) from the closing of the initial acquisition to the date of payment. The consideration for Ravensworth will be adjusted by 50% of any difference in actual Ravensworth and Seaboard earnings before depreciation, interest and taxes (EBDIT) versus a target EBDIT for 1994 and 1995 and by 25% of such difference for 1996. The maximum adjustment to the consideration paid or payable for Ravensworth with respect to any year for which EBDIT is measured against a specified target is limited to $4 million. In the event the Company does not exercise either of the options to acquire additional interests in Ravensworth, the agreement calls for certain purchase\/sale arrangements between the parties with respect to Ravensworth.\nIn connection with the Company's initial purchase of 49.9% at Ravensworth, approximately 106,000 shares of the Company's common stock placed in escrow at the time of acquisition were returned to the Company based on Ravensworth's actual EBDIT for 1994 compared to targeted EBDIT as described under the agreement. Such shares, valued at approximately $1.8 million, were canceled and stockholders' equity and Ravensworth's investment accounts were reduced accordingly.\nSummarized historical, combined financial information for the affiliated investees, which includes Ravensworth as of and for the years ended December 31, 1994 and 1995 and Seaboard as of and for the one month ended December 31, 1994 and year ended 1995 is as follows (in thousands):\n1994 1995 ---------- ------------ (Unaudited) Current assets....................... $ 11,773 $ 11,979 Property and equipment, net.......... 73,389 66,619 Other noncurrent assets.............. 861 1,246 ---------- ------------ Total assets................... $ 86,023 $ 79,844 ========== ============ Current liabilities.................. $ 17,869 $ 14,275 Long-term debt....................... 50,328 47,349(1) Other noncurrent liabilities......... 1,574 953 Stockholders' equity................. 16,252 17,267 ---------- ------------ Total liabilities and equity... $ 86,023 $ 79,844 ========== ============ Revenues............................. $ 37,870 $ 49,937 Operating income..................... $ 5,823 $ 5,574 Foreign exchange loss (gain)......... (recognized in affiliates' accounts but not in the Company's accounts due to purchase accounting adjustments)........................ $ (684) $ (201) Net income........................... $ 3,765 $ 1,497 - ------------ (1) A total of approximately $30,000,000 of this debt is owed by certain subsidiaries of Ravensworth and Seaboard who collectively have negative shareholders' equity of approximately $400,000 which offsets the total combined Ravensworth and Seaboard shareholders' equity. Such debt is nonrecourse to both the Company and Ravensworth, except for a pound sterling 300,000 guarantee by Hornbeck Offshore Services, Inc.\nNOTE 6 - LONG-TERM DEBT: Long-term debt consisted of the following at December 31 (in thousands):\n1994 1995 ---------- ---------- Bank note payable; principal payable in quarterly installments of $714.4, plus accrued interest at LIBOR plus 1% (6.875% at December 31, 1995); secured by thirteen vessels; matures November 15, 1999............ $ 20,000 $ 12,143\nU.S. Government Guaranteed Ship Financing Bonds payable in semiannual installments of principal and interest as described below; secured by mortgages on nine vessels and guaranteed by the U.S. Maritime Administration (MARAD)........................ 4,490 3,270 ---------- ---------- 24,490 15,413 Less - current portion........................ 3,467 3,561 ---------- ---------- Long-term debt................................ $ 21,023 $ 11,852 ========== ==========\nMaturities of long-term debt outstanding at December 31, 1995 are as follows: 1996 - $3,561,000; 1997 - $3,433,000; 1998 - $3,367,000; 1999 - $4,081,000; and 2000 - $503,000.\nConcurrent with the November 15, 1994 Oil & Gas vessel acquisition, the Company entered into a $20 million term loan and a $10 million revolving credit facility with a bank. Any borrowings under the revolving credit facility will be due and payable on November 15, 1997. The availability of the revolving credit facility is based on specified trade receivables levels and will be reduced by outstanding letters of credit. At December 31, 1994 and 1995, there were no outstanding balances under the revolving credit facility.\nAt the Company's option, interest with respect to any amounts outstanding under the revolving credit facility and the bank term loan accrues at a rate equal to the lender's prime rate, or the LIBOR rate plus 1%, and is payable quarterly. The indebtedness is collateralized by 13 vessels owned by subsidiaries of the Company. The indebtedness also contains covenants which, among other things, provide limitations on the sale of such vessels and require the Company to maintain certain financial ratios and minimum net worth.\nThe U.S. Government Guaranteed Ship Financing Bonds represent several series of bonds which are guaranteed by MARAD. These bonds mature from 2000 to 2002 and bear interest at rates ranging from 8.75% to 10.75%. The related reserve fund balance was $1,024,000 at December 31, 1995. The Company expects to deposit approximately $220,000 in 1996.\nNOTE 7 - INCOME TAXES:\nThe components of the provision for income taxes for the years ended December 31 are as follows (in thousands):\nThe difference between the effective income tax rate and the amount which would be determined by applying the statutory U.S. income tax to income before taxes is as follows: DECEMBER 31, ------------------------------- 1993 1994 1995 ------ ------ ------ Provision for income taxes at U.S. statutory rates............ 34% 34% 34% Foreign earnings not includable in U.S. tax return.............. (2) (4) Tax restructuring benefit........ (4) (1) State taxes...................... 1 (2) ------ ------ ------ 29% 29% 32% ====== ====== =====\nThe deferred income tax liability is primarily comprised of differences in the tax and book basis of the Company's vessels and benefits from the carryforward tax attributes as described below.\nUndistributed earnings of the Company's foreign affiliates aggregated $3,986,000 on December 31, 1995, which, under existing law, will not be subject to U.S. tax until distributed as dividends. Since the earnings have been and are intended to be indefinitely reinvested in foreign operations, no provision has been made for any U.S. taxes that may be applicable thereto. The amount of unrecognized deferred U.S. taxes on these undistributed earnings is approximately $1,355,000. Furthermore, any taxes paid to foreign governments on those earnings may be used in whole or in part, as credits against the U.S. tax on any dividends distributed from such earnings.\nAs of December 31, 1995, the Company has net operating loss carryforwards of $347,000 which will expire from 2004 to 2005 if not used to offset future taxable income. The utilization of these net operating losses is subject to an annual limitation of $53,000. As of December 31, 1995, the Company has investment tax credit carryforwards of $1,006,000 which will expire in 1997, if not used to offset future income. As of December 31, 1995, the Company also has alternative minimum tax credit carryforwards of $4,600,000.\nNOTE 8 - COMMON STOCK, PREFERRED STOCK AND WARRANTS:\nOn July 21, 1993, the Company completed a public offering of 2,500,000 shares of common stock for aggregate proceeds of approximately $40,000,000, after expenses. Proceeds have been and will be utilized for the Ravensworth acquisition, to repay certain debt and for general corporate purposes. In connection with the July 23 closing of the Ravensworth acquisition, 158,978 shares of common stock were issued at an aggregate value of $2,722,500.\nIn September 1994, the Company purchased the remaining 71 shares of Series 1 Preferred Stock for $518,000 with the price determined in accordance with the liquidation preference thereof.\nIn June 1994, 928,752 common stock purchase warrants were exercised. Pursuant to the terms of the warrant agreement, the Company issued 480,588 shares of common stock in exchange for all of such warrants. In September 1994, the Company paid $368,896 to repurchase 71,428 warrants.\nAs discussed in Note 5, in 1995, approximately 106,000 shares were returned to the Company pursuant to the Ravensworth acquisition agreement. The shares were canceled by the Company.\nNOTE 9 - RELATED PARTY TRANSACTIONS:\nBareboat charter fees are paid to an affiliate of a director of the Company. Such fees totaled $600,000, $940,000 and $803,000 for the years ended December 31, 1993, 1994 and 1995, respectively. Until September 1993, a director of the Company was an affiliate of an investment banking firm providing investment banking services. The Company paid fees totaling $301,000 in 1993 for such services.\nNOTE 10 - EMPLOYEE INCENTIVE PLANS:\nPursuant to the Company's Employee Incentive Plans of 1982, 1989 and 1993, the Board of Directors (or compensation committee thereof) has been empowered to grant (over respective ten-year periods) stock options, stock appreciation rights and stock bonuses with respect to an aggregate of 950,000 shares of Common Stock. There were 466,770, 458,712 and 390,739 shares available for grant at December 31, 1993, 1994 and 1995, respectively.\nThe following is a summary of stock option activity for the years ended December 31:\nThe stock options are exercisable over a five-year or ten-year period which commences on the date of grant. The number of shares exercisable in each year during the period is determined by the Company's Board of Directors (or compensation committee) at the time of grant. At December 31, 1993, 1994 and 1995, options to purchase 246,739, 257,763 and 233,564 shares, respectively, were exercisable. If the merger with Tidewater as discussed in Note 2, is consummated, all options will be exercisable. Because the exercise price of the options equaled the market price of the Company's stock on the dates the options were granted, no compensation costs have been recognized by the Company.\nEffective January 1, 1993, a total of 13,975 shares were awarded to employees which vest over two years. Compensation expense of approximately $97,000 will be recorded for the stock awards over the vesting period. On December 14, 1993, a total of 13,070 shares were awarded to employees which vest over three years. Compensation expense of approximately $170,000 will be recorded for the stock awards over the vesting period.\nIn November 1994, a total of 2,698 shares which vest over a period of 1 1\/2 - 2 years were awarded to employees. Compensation expense of approximately $37,845 will be recorded for the stock awards over the vesting period.\nIn April 1995, a total of 17,310 shares which vest over a period of three years were awarded to employees. Compensation expense of approximately $199,065 will be recorded for stock awards over the vesting period.\nIn 1993, 1994 and 1995, shares totaling 3,500, 4,200 and 4,800, respectively, were awarded to the Company's Board of Directors pursuant to the Non-Employee Directors Restricted Stock Plan.\nNo stock appreciation rights have been awarded under the Employee Incentive Plans. The Company has no postretirement benefits that are required to be accrued under Statement of Financial Accounting Standards (SFAS) No. 106, \"Accounting for Postretirement Benefits Other Than Pensions\", nor does it have postemployment benefits that are required to be accrued under SFAS No. 112, \"Employer's Accounting for Postemployment Benefits\".\nNOTE 11 - SEGMENT INFORMATION:\nThe Company's operations which are conducted in one segment, the offshore service vessel industry. There were no charter fee revenues earned from customers in excess of 10% of total revenues for 1993 and 1994. In 1995, one customer accounted for approximately 10% of total revenues.\nNOTE 12 - COMMITMENTS AND CONTINGENCIES:\nHornbeck has received and is responding to a subpoena for documents from the U.S. District Court for the Southern District of Texas, Houston Division. The scope of the subpoena suggests an interest in Hornbeck's compliance with certain environmental statutes and regulations, violations of which could carry both civil and criminal liabilities. The subpoena seeks information concerning Hornbeck's vessels since January 1, 1993 regarding vessel operations as they relate to the purchase, use and disposition of petroleum and related products.\nIt is Hornbeck's policy to comply with all applicable laws, including laws designed to protect the environment. While management and the Hornbeck Board do not believe that any outcome of the investigation would have a material adverse effect on the financial position of Hornbeck, they cannot predict the nature or ultimate outcome of the investigation or any proceeding that might be based thereon.\nThe Company is not party to any legal proceedings the result of which could, in the opinion of management, have a material adverse effect upon the Company.\nNOTE 13 - CASH FLOW INFORMATION:\nThe following is a reconciliation of net income to net cash provided by operating activities (in thousands):\nThe following is a supplemental schedule of noncash investing and financing activities for the years ended December 31:\nNOTE 14 - QUARTERLY FINANCIAL DATA (UNAUDITED):\nSummarized quarterly financial data for 1993, 1994 and 1995 are as follows (in thousands, except per share data):\n- ------------ (1) Operating profit equals operating revenues minus direct labor and other operating expenses, depreciation and amortization and general and administrative expenses.\nSIGNATURES\nPURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.\nHORNBECK OFFSHORE SERVICES, INC. (Registrant)\nBy: \/s\/LARRY D. HORNBECK Larry D. Hornbeck Chairman of the Board, President and Chief Executive Officer\nDate: February 20, 1996\nPURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, 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-1\nINDEX TO EXHIBITS EXHIBIT NO. - ------- 2(a) Asset Purchase Agreement dated as of November 16, 1992, by and among Registrant, certain subsidiaries of Registrant, Pentad Offshore Corporation and Petrol Marine Corporation (Form 8-K, November 25, 1992, SEC File No. 0-10809, Exhibit 2(a)).\n2(b) Asset Purchase Agreement dated as of November 16, 1992, by and among Registrant, certain subsidiaries of Registrant, Pentad Offshore Corporation and Pentad Resources, Inc. (Form 8-K, November 25, 1992, SEC File No. 0-10809, Exhibit 2(b)).\n2(c) Asset Purchase Agreement dated as of November 16, 1992, by and among Registrant, certain subsidiaries of Registrant, Portal Energy Corporation and Portal Corporation (Form 8-K, November 25, 1992, SEC File No. 0-10809, Exhibit 2(c)).\n2(d) Stock Purchase Agreement, dated May 26, 1993, by and between the Registrant and Ravensworth Holdings Limited (Form 8-K, May 26, 1993, SEC File No. 0-10809, Exhibit 2(a)).\n2(e) Stock Option and Ancillary Rights Agreement, dated May 26, 1993, by and between Registrant and Ravensworth Holdings Limited (Form 8-K, May 26, 1993, SEC File No. 0-10809, Exhibit 2(b)).\n2(f) Agreement for Purchase and Sale of Vessels by and between Registrant and Oil & Gas Rental Services, Inc. (Form 8-K, October 6, 1994, SEC File No. 0-10809, Exhibit 2(a)).\n2(g) Share, Business and Asset Acquisition Agreement relating to purchase of Seaboard Offshore Group Limited dated as of November 30, 1994, by and among Seaboard Holdings Limited and the shareholders of Seaboard Offshore Group Limited and joined for limited purposes by certain other parties. (Form 10-k, December 31, 1994, SEC File No. 0-10809, Exhibit 2(g)).\n3(a) Restated Certificate of Incorporation of Hornbeck Offshore Service, Inc., as amended (Form 8-A\/A Amendment No. 2, June 21, 1995, SEC File No. 0-10809, Exhibit 3.2i).\n3(b) Bylaws of Hornbeck Offshore Services, Inc., as amended through June 20, 1995. (Form 8-A\/A Amendment No. 2, June 21, 1995, SEC File No. 0-10809, Exhibit 3.2ii)\n4(a) Agreement Concerning Registration Rights between Registrant and Larry D. Hornbeck, dated as of June 28, 1989. (Form S-1, March 22, 1990, Registration No. 33-33999, Exhibit 4(b)).\n4(b) Special Rights Agreement, dated January 30, 1990, by and between Registrant and HOS-2 Partners, L.P. (Form 8-K, January 30, 1990, SEC File No. 0-10809, Exhibit 4.7).\n4(c) Registration Rights Agreement, dated January 30, 1990, by and among Registrant, HOS-2 Partners, L.P. and Collecting Bank, N.A. (a bank in liquidation) (Form 8-K, January 30, 1990, SEC File No. 0-10809, Exhibit 4.8).\n4(d) Stockholders Agreement dated as of November 19, 1992, by and among Registrant, Petrol Marine Corporation, Pentad Offshore Corporation, Portal Energy Corporation, acknowledged and agreed to by Bruce W. Hunt and acknowledged and agreed to for certain limited purposes by HOS Partners, L.P. and HOS-2 Partners, L.P. (Form 8-K, November 25, 1992, SEC File No. 0-10809, Exhibit 28(b)).\nE-1\n4(e) Amendment No. 1 to Stockholders Agreement dated as of March 18, 1994 by and among Petrol Marine Corporation, Pentad Offshore Corporation, Portal Energy Corporation, acknowledged and agreed to by Bruce W. Hunt, and acknowledged and agreed to for certain limited purposes by HOS Partners, L.P. and HOS-2 Partners, L.P. (Form 10-K, December 31, 1994, SEC File No. 0-10809, Exhibit 4(e)).\n4(f) Registration Rights Agreement, dated July 23, 1993, by and between Hornbeck Offshore Services, Inc. and Ravensworth Holdings Limited (Form 10-K, December 31, 1993, SEC File No. 0-10809, Exhibit 4(g)).\n10(a) Hornbeck Offshore Services, Inc. 1982 Employee Incentive Plan (Form 10-K, December 31, 1982, SEC File No. 0-10809, Exhibit 10.16).\n10(b) Amendment No. 1 to the Hornbeck Offshore Services, Inc. 1982 Employee Incentive Plan (Form 10-K, December 31, 1993, SEC File No. 0-10809, Exhibit 10(b)).\n10(c) Bareboat Charters between HOS Marine Partners, Inc. and Hornbeck Offshore (1984) Corporation, dated as of June 28, 1989 (Form 10-Q, June 30, 1989, SEC File No. 0-10809, Exhibit 10.30).\n10(d) Letter agreements extending bareboat charters between HOS Marine Partners, Inc. and Hornbeck Offshore (1984) Corporation, dated February 21, 1992, May 28, 1993 and January 26, 1994 (Form 10-K, December 31, 1993, SEC File No. 0-10809, Exhibit 10(d)).\n10(e) Hornbeck Offshore Services, Inc. 1991 Restricted Stock Plan for Non-Employee Directors. (Form 10-K, December 31, 1991, SEC File No. 0-10809, Exhibit 10(n)).\n10(f) Hornbeck Offshore Services, Inc. 1993 Employee Incentive Plan (Form S-8, October 7, 1993, Registration No. 33-70048, Exhibit 4).\n10(g) Letter Loan Agreement among the Company and First Interstate Bank of Texas, N.A., as Agent and as Lender (Form 8-K, November 15, 1994, SEC File No. 0-10809, Exhibit 10).\n10(h) Rights Agreement dated as of June 20, 1995 between Hornbeck Offshore Services, Inc. and First Interstate Bank of Texas, N.A., as Rights Agent, which includes as Exhibit B the form of Right Certificate and as Exhibit C the form of Summary of Rights to Purchase Shares. (Form 8-A, June 21, 1995, SEC File No. 0-10809, Exhibit 4.1)\n10(i) Change in Control Agreement dated as of June 20, 1995, by and between Hornbeck Offshore Services, Inc. and Larry D. Hornbeck. (Form 8-K, June 21, 1995, SEC File No. 0-10809, Exhibit 10.1)\n10(j) Change in Control Agreement dated as of June 20, 1995, by and between Hornbeck Offshore Services, Inc. and Bernie W. Stewart. (Form 8-K, June 21, 1995, SEC File No. 0-10809, Exhibit 10.2)\n10(k) Change in Control Agreement dated as of June 20, 1995, by and between Hornbeck Offshore Services, Inc. and Robert W. Hampton. (Form 8-K, June 21, 1995, SEC File No. 0-10809, Exhibi 10.3)\n10(l) Change in Control Agreement dated as of June 20, 1995, by and between Hornbeck Offshore Services, Inc. and Roger M. Sykes. (Form 8-K, June 21, 1995, SEC File No. 0-10809, Exhibit 10.5)\n10(m) Agreement and Plan of Merger dated as of December 21, 1995 among Hornbeck Offshore Services, Inc., Tidewater, Inc. and Tidewater Expansion, Inc. (Form 8-K, December 28, 1995, SEC File No. 0-10809, Exhibit 2(a).) E-2\n*21(a) Subsidiaries of Hornbeck Offshore Services, Inc.\n*23(a) Consent of Price Waterhouse, LLP.\nRegistrant hereby agrees to furnish independently, upon request of the Commission, a copy of any omitted schedule, annexure or other attachment to the agreement referenced to in 10(m) above. - ------------ * filed herewith E-3","section_15":""}
{"filename":"857548_1995.txt","cik":"857548","year":"1995","section_1":"ITEM 1. BUSINESS\nTHE PARTNERSHIP. Jones Growth Partners II L.P. (the \"Partnership\") is a Colorado limited partnership that was formed to acquire, own and operate cable television systems in the United States. Jones Spacelink Cable Corporation, a Colorado corporation, is the general partner (the \"General Partner\") of the Partnership. The General Partner is a wholly-owned subsidiary of Jones Intercable, Inc. (\"Intercable\"). Intercable is a Colorado corporation engaged in the business of owning and operating cable television systems. The Partnership owns the cable television systems serving Yorba Linda and certain portions of Anaheim Hills, all in the State of California (the \"Yorba Linda System\"). See Item 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Partnership acquired the Yorba Linda System in April 1992. The following sets forth (i) the monthly basic plus service rates charged to subscribers and (ii) the number of basic subscribers and pay units for the Yorba Linda System. The monthly basic service rates set forth herein represent, with respect to systems with multiple headends, the basic service rate charged to the majority of the subscribers within the Yorba Linda System. 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, 1995, the Yorba Linda System operated cable plant passing approximately 23,000 homes, representing an approximate 72% penetration rate. Figures for numbers of subscribers, miles of cable plant and homes passed are compiled from the General Partner's records and may be subject to adjustments.\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's interests are publicly held, there is no established public market for the interests, and it is not expected that such a market will develop in the future. As of February 15, 1995, the number of equity security holders in the Partnership was 2,307.\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\n1995 Compared to 1994-\nRevenues of the Partnership for the year ended December 31, 1995 totaled $6,903,528 compared to $6,345,871 in 1994, an increase of $557,657, or approximately 9 percent. Increases in equipment rental revenue accounted for approximately 30 percent of the increase in revenues. The number of basic subscribers increased to 16,611 at December 31, 1995, compared to 15,961 at December 31, 1994, an increase of 650 basic subscribers, or approximately 4 percent. This increase in basic subscribers accounted for approximately 28 percent of the increase in revenues. Basic service rate adjustments accounted for approximately 21 percent of the increase in revenues. No other individual factor was significant to the increase in revenues.\nOperating expenses consist primarily of costs associated with the administration of the Yorba Linda System. The principal cost components are salaries paid to system personnel, programming expenses, professional fees, subscriber billing costs, rent for leased facilities, cable system maintenance expenses and consumer marketing expenses.\nOperating expenses increased $370,068, or approximately 10 percent, to $4,008,167 in 1995 from $3,638,099 in 1994. Operating expenses represented approximately 58 percent and 57 percent of revenues in 1995 and 1994, respectively. The increase in operating expenses was primarily due to increases in programming costs which were due, in part, to the increases in subscribers. No other individual factor significantly affected the increase in operating expense.\nManagement fees to the General Partner and allocated administrative costs from Jones Intercable, Inc. (\"Intercable\") increased $34,290, or approximately 4 percent, to $836,818 in 1995 from $802,528 in 1994. This increase was primarily the result of increases in revenues upon which such management fees are based.\nDepreciation and amortization expense increased $208,649, or approximately 6 percent, to $3,652,676 in 1995 from $3,444,027 in 1994. This increase in depreciation and amortization expense was attributable to additions to the Partnership's depreciable asset base.\nOperating loss increased $55,350, or approximately 4 percent, to $1,594,133 in 1995 from $1,538,783 in 1994. This increase was due to the increases in operating expenses, management fees to the General Partner and allocated administrative expenses from Intercable and depreciation and amortization exceeding the increase in revenues.\nThe cable television industry generally measures the financial performance of a cable television system in terms of cash flow or operating income before depreciation and amortization. The value of a cable television system is often determined using multiples of cash flow. This measure is not intended to be a substitute or improvement upon the items disclosed on the financial statements, rather it is included because it is an industry standard. Operating income before depreciation and amortization increased $153,299, or approximately 8 percent, to $2,058,543 in 1995 from $1,905,244 in 1994. The increase was due to the increases in revenues exceeding the increase in operating expenses and management fees to the General Partner and allocated administrative expenses from Intercable.\nInterest expense increased $239,372, or approximately 33 percent, to $959,284 in 1995 from $719,912 in 1994. The increase was primarily due to higher outstanding balances on interest bearing obligations during 1995.\nNet loss increased $289,498, or approximately 13 percent, to $2,553,640 in 1995 from $2,264,142 in 1994. The increase was a result of the factors discussed above.\n1994 Compared to 1993-\nRevenues of the Partnership for the year ended December 31, 1994 totaled $6,345,871, compared to $6,198,092 in 1993, an increase of $147,779, or approximately 2 percent. This increase is primarily the result of increases in advertising revenues, which were offset by decreases in equipment rental and additional outlet revenue. The increase in revenues would have been greater if not 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 individual factor was significant to the increase in revenues.\nOperating expenses increased $177,926, or approximately 5 percent, to $3,638,099 in 1994 from $3,460,174 in 1993. Operating expenses represented approximately 57 percent and 56 percent of revenues in 1994 and 1993, respectively. Of the total net increase in operating expenses, advertising related costs increased $158,613, representing approximately 89 percent of the total increase. No other individual factor significantly affected the increase in operating expense for the periods discussed.\nManagement fees to the General Partner and allocated administrative costs from Intercable increased $35,519, or approximately 5 percent, to $802,528 in 1994 from $767,009 in 1993. This increase was primarily the result of increases in allocated expenses from the General Partner. The General Partner has experienced increases in expenses during 1994, including personnel costs and reregulation costs, a portion of which are allocated to the Partnership.\nOperating loss increased $222,642, or approximately 17 percent, to $1,538,783 in 1994 from $1,316,141 in 1993. This increase was due to the increases in operating expenses, management fees to the General Partner and allocated administrative expenses from Intercable and depreciation and amortization exceeding the increase in revenues.\nOperating income before depreciation and amortization decreased $65,665, or approximately 3 percent, to $1,905,244 in 1994 from $1,970,909 in 1993. The decrease was due to the increases in operating expenses and management fees to the General Partner and allocated administrative expenses from Intercable exceeding the increase in revenues.\nInterest expense increased $128,337, or approximately 22 percent, to $719,912 in 1994 from $591,575 in 1993. The increase was primarily due to higher average interest rates and increased amounts due to the General Partner.\nNet loss increased $351,269, or approximately 18 percent, to $2,264,142 in 1994 from $1,912,873 in 1993. The increase was a result of the factors discussed above.\nFINANCIAL CONDITION\nFor the year ended December 31, 1995, the Partnership generated net cash from operating activities totaling $988,176 which is available to fund capital expenditures and non-operating costs. During 1995, the Partnership purchased approximately $2,500,000 of plant and equipment for the Yorba Linda System. Approximately 76 percent of these expenditures was for cable plant extensions, cable, hardware and labor for new subscriber installations and to replace equipment in the Yorba Linda System. The remainder of the capital expenditures was for enhancements to the Yorba\nLinda System. Capital expenditures for 1996 are expected to be approximately $2,300,000 and will be financed principally from cash flow from operations and borrowings under the Partnership's credit facility. For 1996, approximately 72 percent of the expected capital expenditures will be for cable, hardware and labor to extend the cable plant and to make additional subscriber installations in the Yorba Linda System, and the remainder of these expenditures will be for various other enhancements throughout the Yorba Linda System.\nAs of December 31, 1995, $12,650,000 was outstanding under the Partnership's $13,000,000 revolving credit facility, leaving $350,000 for borrowings during 1996. At December 31, 1996, the revolving credit facility's outstanding principal balance will convert to a term loan, payable in quarterly installments with a final maturity date of December 31, 2002. Generally, the interest on the outstanding principal balance is at the Partnership's option of the Prime rate plus 1\/4 percent to 1\/2 percent or the London Interbank Offered Rate plus 1-1\/4 percent to 1-1\/2 percent, depending upon the ratio of the Partnership debt to operating cash flow. The effective interest rates on amounts outstanding as of December 31, 1995 and 1994 were 7.45 percent and 7.51 percent, respectively.\nThe General Partner presently believes cash flow from operations and available borrowings under the credit facility and, if necessary and in its discretion, advances from the General Partner will be sufficient to fund capital expenditures and other liquidity needs of the Partnership in 1996.\nREGULATION AND LEGISLATION\nThe Partnership has filed a cost-of-service showing in response to rulemakings concerning the 1992 Cable Act for the Yorba Linda System and thus anticipates no further reductions in rates. The cost-of-service showing has not yet received final approval from regulatory 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 Telecommunications Act of 1996 (the \"1996 Act\"), which became law on February 8, 1996, substantially revised the Communications Act of 1934, as amended, including the 1984 Cable Act and the 1992 Cable Act, and has been described as one of the most significant changes in communications regulation since the original Communications Act of 1934. The 1996 Act is intended, in part, to promote substantial competition in the telephone local exchange and in the delivery of video and other services. As a result of the 1996 Act, local telephone companies (also known as local exchange carriers or \"LECs\") and other service providers are permitted to provide video programming, and cable television operators are permitted entry into the telephone local exchange market. The FCC is required to conduct rulemaking proceedings over the next several months to implement various provisions of the 1996 Act.\nAmong other provisions, the 1996 Act modified the 1992 Cable Act by deregulating the cable programming service tier of large cable operators including the Partnership effective March 31, 1999 and the cable programming service tier of \"small\" cable operators in systems providing service to 50,000 or fewer subscribers effective immediately. The 1996 Act also revised the procedures for filing cable programming service tier rate complaints and adds a new effective competition test.\nIt is premature to predict the specific effects of the 1996 Act on the cable industry in general or the Partnership in particular. The FCC will be undertaking numerous rulemaking proceedings to interpret and implement the 1996 Act. It is not possible at this time to predict the outcome of those proceedings or their effect on the Partnership. See Item 1.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements\nJONES GROWTH PARTNERS II L.P.\nFINANCIAL STATEMENTS\nAS OF DECEMBER 31, 1995 AND 1994\nAND FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nINDEX\nReport of Independent Public Accountants 14\nBalance Sheets 15\nStatements of Operations 17\nStatements of Partners' Capital (Deficit) 18\nStatements of Cash Flows 19\nNotes to Financial Statements 20\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Partners of Jones Growth Partners II L.P.:\nWe have audited the accompanying balance sheets of Jones Growth Partners II L.P. (a Colorado limited partnership) as of December 31, 1995 and 1994, and the related statements of operations, partners' capital (deficit) and cash flows for the three years in the period ended December 31, 1995. These financial statements are the responsibility of the General Partner's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Jones Growth Partners II L.P. as of December 31, 1995 and 1994, and the results of its operations and its cash flows for the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\n\/s\/ ARTHUR ANDERSEN LLP ARTHUR ANDERSEN LLP\nDenver, Colorado, March 8, 1996.\nJONES GROWTH PARTNERS II L.P. (A Limited Partnership)\nBALANCE SHEETS\nThe accompanying notes to financial statements are an integral part of these balance sheets.\nJONES GROWTH PARTNERS II L.P. (A Limited Partnership)\nBALANCE SHEETS\nThe accompanying notes to financial statements are an integral part of these balance sheets.\nJONES GROWTH PARTNERS II L.P. (A Limited Partnership)\nSTATEMENTS OF OPERATIONS\nThe accompanying notes to financial statements are an integral part of these statements.\nJONES GROWTH PARTNERS II L.P. (A Limited Partnership)\nSTATEMENTS OF PARTNERS' CAPITAL (DEFICIT)\nThe accompanying notes to financial statements are an integral part of these statements.\nJONES GROWTH PARTNERS II L.P. (A Limited Partnership)\nSTATEMENTS OF CASH FLOWS\nThe accompanying notes to financial statements are an integral part of these statements.\nJONES GROWTH PARTNERS II L.P. (A Limited Partnership)\nNOTES TO FINANCIAL STATEMENTS\n(1) ORGANIZATION AND PARTNERS' INTERESTS:\nFormation and Business\nJones Growth Partners II L.P. (the \"Partnership\"), a Colorado limited partnership, was formed on March 27, 1991, pursuant to a public offering of limited partnership interests sponsored by Jones Spacelink Cable Corporation (the \"General Partner\"). The Partnership was formed to acquire, construct, develop and operate cable television systems. The General Partner was a wholly owned subsidiary of Jones Spacelink, Ltd. (\"Spacelink\") until December 20, 1994. On that date, Jones Intercable, Inc. (\"Intercable\"), a Colorado corporation that was a subsidiary of Spacelink, acquired substantially all of the assets of Spacelink, including all of the shares of the General Partner. The General Partner is thus now a wholly owned subsidiary of Intercable. The General Partner and certain of its affiliates also owned and operated cable television systems for their own account and for the account of other managed limited partnerships.\nContributed Capital\nThe capitalization of the Partnership is set forth in the accompanying statements of partners' capital (deficit). No limited partner is obligated to make any additional contributions to Partnership capital. The General Partner purchased its general partner interest in the Partnership by contributing $1,000 to Partnership capital.\nCable Television System Acquisition\nOn April 17, 1992, the Partnership purchased the cable television systems serving the areas in and around the communities of Yorba Linda, certain portions of Anaheim Hills, and certain portions of unincorporated Orange County, all in the State of California (the \"Yorba Linda System\").\nAll profits and losses of the Partnership are allocated 99 percent to the limited partners and 1 percent to the General Partner, except for income or gain from the sale or disposition of cable television properties, which will be allocated to the partners based upon the formula set forth in the Partnership's 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.\nThe preparation of financial statements in conformity with generally accepted accounting principles requires the General Partner's 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.\nCash and Cash Equivalents\nCash and cash equivalents include cash on hand, amounts held in banks and highly liquid investments with a maturity at purchase of three months or less.\nProperty, Plant and Equipment\nDepreciation of property, plant and equipment is provided using the straight-line method over the following estimated service lives:\nCable distribution systems 5-15 years Equipment and tools 5 years Office furniture and equipment 5 years Buildings 10-20 years Vehicles 3 years\nReplacements, renewals and improvements are capitalized and maintenance and repairs are charged to expense as incurred.\nAllocation of Cost of Purchased Cable Television Systems\nBased on an independent appraisal, the Partnership allocated the total purchase price of the Yorba Linda System acquired as follows: first, to the fair value of net tangible assets acquired; second, to franchise costs in an amount equal to the estimated value of franchise agreements; third, to subscriber lists; fourth, to the noncompete agreement; and fifth, to costs in excess of interests in net assets purchased. The brokerage fee paid to an affiliate of the General Partner upon acquisition of the Yorba Linda System and other acquisition costs were capitalized and charged to investment in cable television properties in the accompanying balance sheets.\nIntangible Assets\nCosts assigned to intangible assets are being amortized using the straight-line method over the following estimated useful lives:\nFranchise costs 3-6 years Subscriber lists 3 years Noncompete agreement 1 year Costs in excess of interests in net assets purchased 36 years\nRevenue Recognition\nSubscriber prepayments are initially deferred and recognized as revenue when earned.\nReclassifications\nCertain prior year amounts have been reclassified to conform to the 1995 presentation.\n(3) TRANSACTIONS WITH THE GENERAL PARTNER AND CERTAIN OF ITS AFFILIATES:\nManagement Fees, Distribution Ratios and Reimbursements\nThe General Partner manages the Partnership and receives a fee for its services equal to five percent of the gross revenues of the Partnership, excluding revenues from the sale of cable television systems or franchises. Management fees paid to the General Partner by the Partnership for the years ended December 31, 1995, 1994 and 1993 were $345,176, $317,294 and $309,905, 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 generally allocated 99 percent to the limited partners and one percent to the General Partner. Any distributions other than from cash flow are generally made as follows: first, to the limited partners in an amount which, together with all prior distributions made from sources other than cash flow, will equal the amount initially contributed to partnership capital by the limited partners; second, to the limited partners an amount equal to eight percent per annum, cumulative and noncompounded, on an amount equal to their initial capital contributions (less any portion of such initial capital contributions returned by the distribution to limited partners from prior sale or refinancing proceeds) provided, however, that the eight percent return will be reduced by all prior distributions of cash flow from the partnership and prior distributions of proceeds of sales or refinancings that exceed an amount equal to the limited partner's initial capital contributions; third, any remaining distribution shall be allocated 80 percent to the limited partners and 20 percent to the General Partner until the limited partners have received 250 percent of their initial capital contribution, after which any remaining distribution shall be allocated 75 percent to the limited partners and 25 percent to the General Partner.\nThe Partnership reimburses the General Partner and certain of its affiliates for certain allocated general and administrative costs. These expenses include salaries and benefits paid to corporate personnel, office rent and related facilities expense. Such personnel provide engineering, marketing, administrative, accounting, legal, and investor\nrelations services to the Partnership. Allocations of personnel costs are based primarily on actual time spent by employees of the General Partner and certain of its affiliates with respect to each partnership managed. Remaining expenses are allocated based upon the pro rata relationship of the Partnership's revenues to the total revenues of all cable television systems owned or managed by the General Partner and certain of its affiliates. All cable television systems owned or managed by the General Partner and certain of its affiliates are allocated a proportionate share of these expenses. Included in the costs allocated from Intercable and certain of its affiliates are expenses allocated to the General Partner and certain of its affiliates from affiliated entities for information processing and administrative services. The General Partner believes that the methodology used in allocating general and administrative costs is reasonable. Reimbursements by the Partnership to the General Partner for allocated general and administrative costs for the years ended December 31, 1995, 1994 and 1993 were $491,642, $485,234 and $457,104, respectively.\nThe Partnership was charged interest during 1995 at an average rate of 10.51 percent on the amounts due to the General Partner, which approximated the General Partner's weighted average cost of borrowing. Interest charged to the Partnership by the General Partner totaled $10,802, $10,276 and $-0- during 1995, 1994 and 1993, respectively.\nPayments to\/from Affiliates for Programming Services\nThe Partnership receives programming from Product Information Network, Mind Extension University and Jones Computer Network, all of which are affiliates of Intercable.\nPayments to Mind Extension University for the years ended December 31, 1995, 1994 and 1993 totaled $10,072, $8,770 and $5,578, respectively. Payments to Jones Computer Network, which initiated service in 1994, totaled $20,037 in 1995 and $5,771 in 1994.\nThe 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 totaling $14,601 in 1995 and $2,389 in 1994.\n(4) PROPERTY, PLANT AND EQUIPMENT:\nProperty, plant and equipment as of December 31, 1995 and 1994, consisted of the following:\n(5) INCOME TAXES:\nIncome taxes have not been recorded in the accompanying financial statements because they accrue directly to the partners. The federal and state income tax returns of the Partnership are prepared and filed by the General Partner.\nThe Partnership's tax returns, the qualification of the Partnership as such for tax purposes, and the amount of distributable income or loss are subject to examination by federal and state taxing authorities. If such examinations result in changes with respect to the Partnership's qualification as such, or in changes with respect to the Partnership's recorded income or loss, the tax liability of the General Partner and limited partners would likely be changed accordingly.\nTaxable income or loss to the Partners is different from that reported in the statements of operations due to the difference in depreciation recognized under generally accepted accounting principles and the expense allowed for tax purposes under the Modified Accelerated Cost Recovery System (MACRS). There are no other significant differences between taxable income or loss and the net income or loss reported in the statements of operations.\n(6) DEBT:\nAs of December 31, 1995, $12,650,000 was outstanding under the Partnership's $13,000,000 revolving credit facility, leaving $350,000 for borrowings during 1996. At December 31, 1996, the revolving credit facility's outstanding principal balance will convert to a term loan, payable in quarterly installments with a final maturity date of December 31, 2002. Generally, the interest on the outstanding principal balance is at the Partnership's option of the Prime rate plus 1\/4 percent to 1\/2 percent or the London Interbank Offered Rate (\"LIBOR\") plus 1-1\/4 percent to 1- 1\/2 percent, depending upon the ratio of the Partnership debt to operating cash flow. The effective interest rates on amounts outstanding as of December 31, 1995 and 1994 were 7.45 percent and 7.51 percent, respectively.\nOn January 12, 1993, the Partnership entered into an interest rate cap agreement covering outstanding debt obligations of $7,000,000. The Partnership paid a fee of $67,900 for the rate cap agreement. The agreement protected the Partnership from LIBOR interest rates that exceeded 7 percent for three years from the date of the agreement. The agreement expired in January 1996.\nThe Partnership's debt consists of the following:\nMaturities of the revolving credit and term loan facility and capital lease obligations for the five years in the period ended December 31, 2000 and thereafter are as follows:\nAt December 31, 1995, the carrying amount of the Partnership's long-term debt did not differ significantly from the estimated fair value of the financial instruments. The fair value of the Partnership's long-term debt is estimated based on the discounted amount of future debt service payments using rates of borrowing for a liability of similar risk.\n(7) COMMITMENTS AND CONTINGENCIES:\nThe Partnership has filed a cost-of-service showing in response to rulemakings covering the 1992 Cable Act for the Yorba Linda System and thus anticipates no further reductions in rates. The cost-of-service showing has not yet received final approval from regulatory 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 paid under such lease arrangements totaled $67,319, $84,194 and $74,079 for the years ended December 31, 1995, 1994 and 1993, respectively. Future minimum lease payments, as of December 31, 1995, under noncancelable operating leases for the five years in the period ending December 31, 2000, and thereafter are as follows:\n1996 $ 74,223 1997 74,223 1998 51,575 1999 51,575 2000 51,575 Thereafter 39,806 -------- Total future minimum lease payments $342,977 ======== (8) SUPPLEMENTARY PROFIT AND LOSS INFORMATION:\nSupplementary profit and loss information is presented below:\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III.\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe Partnership itself has no officers or directors. Certain information concerning the directors and executive officers of the General Partner is set forth below.\nMr. Glenn R. Jones has served as Chief Executive Officer of the Managing General Partner since its inception in November 1988. Mr. Jones has served as Chairman of the Board of Directors and Chief Executive Officer of Intercable since its formation in 1970, and he was President from June 1984 until April 1988. 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 Intercable and of certain other affiliates of Intercable. 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 and the Executive Committee of the National Cable Television Association. He also is on the Executive Committee of Cable in the Classroom, an organization dedicated to education via cable. Additionally, in March 1991, Mr. Jones was appointed to the Board of Governors for the American Society for Training and Development, and in November 1992 to the Board of Education Council of the National Alliance of Business. Mr. Jones is also a founding member of the James Madison Council of the Library of Congress. 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; the Women in Cable Accolade in 1990 in recognition of support of this organization; the Most Outstanding Corporate Individual Achievement award from the International Distance Learning Conference; the Golden Plate Award from the American Academy of Achievement for his advances in distance education; the Man of the Year named by the Denver chapter of the Achievement Rewards for College Scientists; and in 1994 Mr. Jones was inducted into Broadcasting and Cable's Hall of Fame.\nMr. James B. O'Brien was appointed President of the General Partner in January 1995. Mr. O'Brien joined Intercable in January 1982. Prior to being elected President and a Director of Intercable 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 Intercable'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 Intercable. Mr. O'Brien is a board member of Cable Labs, Inc., the research\narm 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, the General Partner's Vice President\/Operations, joined Intercable 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 Intercable in September 1990.\nMs. Elizabeth M. Steele, the General Partner's Vice President and Secretary, joined Intercable in August 1987 as Vice President\/General Counsel and Secretary. From August 1980 until joining Intercable, Ms. Steele was an associate and then a partner at the Denver law firm of Davis, Graham & Stubbs, which serves as counsel to Intercable.\nMr. Kevin P. Coyle was appointed Vice President\/Finance of the General Partner in March 1995. Mr. 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 Intercable in August 1987, Vice President\/Treasurer in April 1988 and Group Vice President\/Finance and Chief Financial Officer in October 1990.\nMr. Larry Kaschinske was appointed Controller of the General Partner in March 1995. Mr. Kaschinske joined Intercable in 1984 as a staff accountant in Intercable's former Wisconsin Division; was promoted to Assistant Controller in 1990 and named Controller in August 1994.\nMr. Timothy J. Burke joined Intercable in August 1982 as corporate tax manager, was elected Vice President\/Taxation in November 1986 and Group Vice President\/Taxation\/Administration in October 1990.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe Partnership has no employees; however, various personnel are required to operate the Yorba Linda System. Such personnel are employed by the General Partner and, pursuant to the terms of the limited partnership agreement of the Partnership, the cost of such employment is charged by the General Partner to the Partnership as a direct reimbursement item. See Item 13.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGERS\nNo person or entity owns more than 5 percent of the limited partnership interests of the Partnership.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe General Partner and its affiliates engage in certain transactions with the Partnership as contemplated by the limited partnership agreement of the Partnership. The General Partner believes that the terms of such transactions are generally as favorable as could be obtained by the Partnership from unaffiliated parties. This determination has been made by the General Partner in good faith, but none of the terms were or will be negotiated at arm's-length and there can be no assurance that the terms of such transactions have been or will be as favorable as those that could have been obtained by the Partnership from unaffiliated parties.\nThe General Partner charges the Partnership a management fee, and the Partnership reimburses the General Partner for certain allocated overhead and administrative expenses in accordance with the terms of the limited partnership agreement of the Partnership. These expenses consist primarily of salaries and benefits paid to corporate personnel, rent, data processing services and other facilities costs. Such personnel provide engineering, marketing, administrative, accounting, legal and investor relations services to the Partnership. Allocations of personnel costs are based primarily on actual time spent by employees of the General Partner with respect to the\nPartnership managed. Remaining expenses are allocated based on the pro rata relationship of the Partnership's revenues to the total revenues of all systems owned or managed by Intercable and certain of its subsidiaries. Systems owned by Intercable and all other systems owned by partnerships for which Intercable and its affiliates are 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 Yorba Linda System receives 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 Yorba Linda System. In consideration, the revenues generated from the third parties are shared two-thirds and one-third between PIN and the Partnership. During the year ended December 31, 1995, the Partnership received revenues from PIN of $14,601.\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 Agreement of Limited Partnership. (1)\n10.1.1 Copy of a franchise and related documents thereto granting a community antenna television system franchise for the City of Anaheim, California. (3)\n10.1.2 Copy of a franchise and related documents thereto granting a community antenna television system franchise for the County of Orange, California. (3)\n10.1.3 Copy of a franchise and related documents thereto granting a community antenna television system franchise for the City of Yorba Linda, California. (3)\n10.2.1 Credit and Security Agreement dated as of April 15, 1992 among the Partnership and Credit Lyonnais New York Branch, as agent for various lenders. (3)\n10.2.2 Amendment No. 1 dated as of September 30, 1994 to the Credit and Security Agreement dated as of April 15, 1992 among Jones Growth Partners II L.P. and Credit Lyonnais New York Branch, as agent for various lenders. (4)\n10.3.1 Purchase and Sale Agreement dated August 24, 1990, by and among Empire Partners, a California general partnership, Empire Cable Television, Inc., a California corporation, Yorba Linda Television Co., Inc., a California corporation, and Crown Valley Cable Television, Inc., a California corporation, as sellers, and Jones Spacelink, Ltd., a Colorado corporation, as buyer. (2)\n10.3.2 Letter Agreement dated October 16, 1990, amending Purchase and Sale Agreement. (2)\n10.3.3 Second Amendment to Purchase and Sale Agreement dated May 31, 1991. (2)\n10.3.4 Third Amendment to Purchase and Sale Agreement dated June 14, 1991. (2)\n10.3.5 Fourth Amendment to Purchase and Sale Agreement dated August 9, 1991. (2)\n27 Financial Data Schedule.\n__________\n(1) Incorporated by reference from the Form 8-A Registration Statement of Jones Growth Partners II L.P. filed with the Securities and Exchange Commission on May 6, 1991 (Commission File No. 0-19259).\n(2) Incorporated by reference from the Form S-1 Registration Statement of Jones Growth Partners II L.P. filed with the Securities and Exchange Commission (Registration No. 33- 32169).\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, 1994.\n(b) Reports on Form 8-K\nNone.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nJONES GROWTH PARTNERS II L.P. a Colorado limited partnership By: Jones Spacelink Cable Corporation\nBy: \/s\/ GLENN R. JONES ---------------------------------- Glenn R. Jones Chairman of the Board and Chief Dated: March 25, 1996 Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nBy: \/s\/ GLENN R. JONES ----------------------------------- Glenn R. Jones Chairman of the Board and Chief Executive Officer Dated: March 25, 1996 (Principal Executive Officer)\nBy: \/s\/ KEVIN P. COYLE ----------------------------------- Kevin P. Coyle Vice President\/Finance Dated: March 25, 1996 (Principal Financial Officer)\nBy: \/s\/ LARRY KASCHINSKE ----------------------------------- Larry Kaschinske Controller Dated: March 25, 1996 (Principal Accounting Officer)\nBy: \/s\/ TIMOTHY J. BURKE ----------------------------------- Timothy J. Burke Dated: March 25, 1996 Director\nEXHIBIT INDEX\n__________\n(1) Incorporated by reference from the Form 8-A Registration Statement of Jones Growth Partners II L.P. filed with the Securities and Exchange Commission on May 6, 1991 (Commission File No. 0-19259).\n(2) Incorporated by reference from the Form S-1 Registration Statement of Jones Growth Partners II L.P. filed with the Securities and Exchange Commission (Registration No. 33- 32169).\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, 1994.","section_15":""}
{"filename":"354952_1995.txt","cik":"354952","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nSeagate Technology, Inc. (herein \"Seagate Technology\", \"Seagate\" or the \"Company\") designs, manufactures and markets a broad line of rigid magnetic disc drives for use in computer systems ranging from notebook computers and desktop personal computers to workstations and supercomputers as well as in multimedia applications such as digital video and video-on-demand. The Company's products include approximately 100 rigid disc drive models with form factors from 2.5 to 5.25 inches and capacities from 170 megabytes to 9 gigabytes. The Company sells its products to original equipment manufacturers (\"OEMs\") for inclusion in their computer systems or subsystems, and to distributors, resellers and dealers. The Company has pursued a strategy of vertical integration and accordingly designs and manufactures rigid disc drive components including recording heads, discs, substrates, motors and custom integrated circuits. It also assembles certain of the key subassemblies for use in its products including printed circuit board and head stack assemblies. The Company's products are currently manufactured primarily in the Far East with limited production in the United States.\nIn addition to pursuing its core rigid disc drive business, the Company is broadening its business strategy as a data technology company to more fully address the markets for storage, retrieval and management of data. In this regard, the Company has implemented a strategy to establish itself as a leading supplier of selected magnetic recording components, including thin-film heads, to other manufacturers. In line with this strategy the Company, in December 1994, acquired Applied Magnetics Corporation's tape head subsidiary, a manufacturer of magnetic recording tape heads for digital data storage. The Company has also invested in, and continues to investigate opportunities to invest in software activities (see Software Expansion, below). Finally, the Company's broadened strategy may include expanding its traditional rigid disc drive business to include other forms of data storage and retrieval, such as flash memory, where the Company has made a significant investment in SunDisk Corporation (\"SunDisk\"), a flash memory company. The Company anticipates that this broadened strategy may include additional acquisitions of, investments in and strategic alliances regarding complementary businesses, products and technologies. Neither the components business, the software business nor the investment in SunDisk was material to the Company's results of operations for fiscal 1995.\nSOFTWARE EXPANSION\nThe Company is seeking to leverage its name recognition, existing presence in international markets, distribution channels and OEM relationships by offering software products directed towards the client\/server environment.\nThe Company anticipates that users of computer systems will increasingly rely upon client\/server network computing environments and believes that as this reliance increases, users will demand software that more efficiently and securely manages and provides access to data across computer networked environments. As such, the Company is broadening its core competencies to include software products to meet these requirements.\nIn May 1994 Seagate acquired Crystal Computer Services, Inc., a Vancouver, Canada based developer and marketer of data access and reporting software for the Windows platform. These products are sold as Crystal Reports, Crystal Reports Pro and Crystal Reports Server.\nIn July 1994 the Company established an equity position in Dragon Systems, Inc., a Massachusetts based developer of advanced speech recognition technology and products for PC\/workstation platforms. The Dragon family of products consists of dictation command and control programs, and developer's tools, including Dragon Dictate, Dragon Talk->To, and Dragon VoiceTools.\nIn August 1994 the Company acquired Palindrome Corporation, an Illinois based developer and marketer of storage management software for Novell NetWare based networks and enterprise LANs. Palindrome provides data protection and management software including disaster recovery planning, backup archiving, migration, hierarchical storage management (HSM), library and robotics control, and centralized management.\nIn February 1995 Seagate acquired Network Computing, Inc., a California based developer and marketer of solutions for proactively managing NetWare file servers, workstations and SNMP devices. Its LANAlert product provides for automated monitoring and alerting of file servers and workstations.\nIn March 1995 the Company acquired NetLabs Inc., a California based developer and marketer of network management software solutions for UNIX-based networks. NetLabs markets an integrated suite of application software products that enable users to automate and simplify the monitoring of network status and performance, detect problems, issue alerts and initiate corrective action, track inventory, and manage changes in network operation.\nIn May 1995 the Company acquired Frye Computer Systems Inc., a Massachusetts based developer and marketer of network management software solutions for PC LANs. Fryes line of products, THE FRYE UTILITIES FOR NETWORKS, includes an integrated set of product modules providing solutions for complicated network management problems.\nIn June 1995 the Company acquired Creative Interaction Technologies, Inc. (CIT), a North Carolina based network management software company. CIT makes AshWin, a batch scheduler for heterogeneous client\/server computing.\nSeagate intends to continue its expansion into software and other complementary businesses and is actively pursuing discussions with companies that fit with its strategy. Key to the Company's software expansion success is acquiring companies that possess technology, development personnel and management providing long-term growth potential. However, implementation of this broadened strategy entails risks of entering markets in which the Company may have limited or no experience. In addition, such broadened strategy could result in the diversion of management's attention from the core rigid disc drive business which could adversely impact the core business. The broadened strategy has entailed and may continue to entail acquisitions of, or investments in, businesses, products and technologies. Acquisitions involve numerous risks, including difficulties in the assimilation of the operations and products of the acquired businesses and the potential loss of key employees or customers of the acquired businesses.\nRIGID DISC DRIVE TECHNOLOGY\nMagnetic disc drives are used in computer systems to record, store and retrieve digital information. Most computer applications require access to a greater volume of data than can economically be stored in the random access memory of the computer's central processing unit (commonly known as \"semiconductor\" memory). This information can be stored on a variety of storage devices, including rigid disc drives, flexible disc drives, magnetic tape drives, optical disc drives and semiconductor memory. Rigid disc drives provide access to large volumes of information faster than optical disc drives, flexible disc drives or magnetic tape drives and at substantially lower cost than high-speed semiconductor memory.\nAlthough products vary, all rigid disc drives incorporate the same basic technology. Inside a sealed housing, one or more rigid discs are attached to a spindle assembly that rotates the discs at a high constant speed around a hub. The discs, or media, are the components on which data is stored and from which it is retrieved. Each disc typically consists of a substrate of finely machined aluminum or glass with a magnetic layer of a \"thin-film\" metallic material.\nRead\/write heads, mounted on an arm assembly similar in concept to that of a record player, fly extremely close to each disc surface, and record data on and retrieve it from concentric tracks in the magnetic layers of the rotating discs.\nAreal density is a measure of storage capacity per square inch on the recording surface of a disc. It represents the number of bits of information on a linear inch of the recording track (called bits per inch or bpi) multiplied by the number of recording tracks on a radial inch of the disc. With the proliferation of multimedia applications, the demand for increased areal densities has and continues to increase at an accelerating rate since sound and moving pictures require many times the storage capacity of simple text. The Company is aggressively pursuing a range of technologies to increase areal densities across the entire range of its products including the use of advanced signal processing techniques such as PRML (Partial Response Maximum Likelihood) read\/write channels, advanced servo systems, higher precision mechanics and a more advanced head technology. Today, all Seagate drives use inductive thin-film heads, which are based on semiconductor processing technology. However, to attain greater areal densities, the Company currently has under development magneto-resistive (\"MR\") thin-film heads to be incorporated into its recently announced 8 GB Barracuda drive, the ST18771, as well as into future products. MR heads have discrete read and write structures which take advantage of special magnetic properties in certain metals to achieve significantly higher storage capacities. There can be no assurance that the Company's development efforts will be successful. See \"Product Development.\"\nUpon instructions from the drive's electronic circuitry, a head positioning mechanism (an \"actuator\") guides the heads to the selected track of a disc where the data will be recorded or retrieved. The disc drive communicates with the host computer through an internal controller. Disc drive manufacturers may use one or more of several industry standard interfaces, such as IPI (Intelligent Peripheral Interface), SCSI (Small Computer System Interface), ATA (AT Attachment), PCMCIA (Personal Computer Memory Card International Association) or proprietary interfaces, such as EISA (Extended Industry Standard Architecture).\nRigid disc drive performance is commonly measured by four key characteristics: average seek time (commonly expressed in milliseconds), which is the time needed to position the heads over a selected track on the disc surface; internal data transfer rate (commonly expressed in Megabits per second), which is the rate at which data is transferred to and from the disc; storage capacity (commonly expressed in Megabytes), which is the amount of data that can be stored on the disc; and spindle rotational speed (commonly expressed in revolutions per minute), which has an effect on average latency or access to data.\nMARKET OVERVIEW\nRigid disc drives are used in a broad range of computer systems as well as multimedia applications such as digital video and video-on-demand. The Company defines the major computer system markets to include mobile computers, personal computers, mid-range systems and high-end applications. Users of computer systems are increasingly demanding additional data storage capacity with higher performance in order to (i) use more sophisticated applications software, including database management, CAD\/CAM\/CAE, desktop publishing and enhanced graphics applications, and (ii) operate in multi-user, multitasking and multimedia environments.\nPERSONAL AND MOBILE COMPUTERS\nDesktop and portable personal computers are used in a number of environments, ranging from homes to businesses and multi-user networks. Software applications are primarily word processing, spreadsheet, desktop publishing, database management, multimedia and other related applications. The Company believes the minimum storage requirements in the past year for entry-level personal computers were generally 270 megabytes (\"MB\") to 540 MB of formatted capacity with average seek times of 15 milliseconds (\"msec\") or less. As the personal computer market has matured, users of\npersonal computers have become increasingly price sensitive. The Company's objective for the desktop and portable personal computer market is to design drives for high-volume, low-cost manufacture.\nSmaller footprint microcomputers, such as portable, laptop, notebook and sub-notebook computers require rigid disc drives in form factors of 2.5 inches or less that emphasize durability and low power consumption in addition to capacity and other performance characteristics found in their desktop functional equivalents. Personal digital assistants, hand-held and pen-based computers may use 1.8 or 2.5 inch hard disc drives or flash memory in the form of a PCMCIA card for additional memory. These applications also emphasize low power consumption as well as very high degrees of durability.\nMID-RANGE SYSTEMS\nMid-range systems include high performance microcomputers, technical workstations, servers and departmental minicomputers. Applications are characterized by compute- and data-intensive solutions, such as CAD\/CAM\/CAE, network management, larger database management systems, scientific applications and small to medium-sized business applications such as materials requirement planning, payroll, general ledger systems and related management reports. Mid-range systems typically require rigid disc drive storage capacities from 1 gigabyte (\"GB\") to 4 GB per drive and average seek times of less than 12 msec. Mid-range systems typically use 3.5 and 5.25 inch disc drives. Due to the leading edge characteristics required by end-users of mid-range systems, manufacturers of such systems emphasize performance as well as price as the key selling points.\nHIGH-END APPLICATIONS\nLarge systems include mainframes and supercomputers. Typical applications are medium and large business management systems, transaction processing, parallel processing applications and other applications requiring intensive data manipulation. Also inclusive in high-end applications are systems designed for video-on-demand and near-line storage.\nUsers of these systems generally require capacities of 1 GB to 9 GB per drive with average seek times of less than 12 msec. End-users of large systems are less concerned than users of smaller systems with the size, weight, power consumption and absolute cost of the drive. As with mid-range systems, disc drive products are typically designed into these systems by the OEM with emphasis on performance, reliability and capacity. In this arena, data storage subsystems are used containing large numbers of spindles. Data integrity is paramount, so high device reliability and maintainability are key features. Mainframe, supercomputer and digital video systems also benefit from very high device data rates (up to ten times that in small computer systems).\nPRODUCTS\nThe Company's products include approximately 100 rigid disc drive models with form factors from 2.5 to 5.25 inches and capacities from 170 megabytes to 9 gigabytes. The Company provides more than one product at some capacity points and differentiates products on a price\/performance and form factor basis. The Company believes that its broad range of rigid disc drives is particularly appealing to customers, such as large OEMs, which require a wide variety of drive capacities, performance levels and interfaces. Producing for several market segments also broadens the Company's customer base and reduces the Company's reliance on any one segment of the computer market. The Company continues to devote its resources to developing products with industry leading performance characteristics and to being among the first to introduce such products to market. The Company continuously seeks to enhance its market presence in emerging segments of the rigid disc drive market by drawing on its established capabilities in high-volume, low-cost production. The Company believes it offers the broadest range of disc storage products available.\nMOBILE COMPUTING\nAnnouncement of the Company's first 2.5 inch family of drives was made in November 1990 with the ST9096 family. The Company has continued to expand its 2.5 inch family with two different form\nfactors, the 19mm high form factor which is designed to address the highest capacity segment of the mobile computing market, and the 12.5mm high form factor which is designed to address the sub-notebook market. In November 1992 the Company introduced a patented shock sensing technology called SafeRite-TM-. SafeRite technology allows for a much higher specification of operating shock and helps to prevent the drive from writing data \"off track\". This technology is available in all of the Company's 2.5 inch drives.\nIn October 1993 the Company announced its ST9550 family, later renaming it the \"Marathon\" family. This 19mm height family was introduced in 455 MB and 341 MB versions. Recent additions to this family include the ST9655, the ST9420, and the ST9816, with formatted capacities of 520 MB, 420 MB and 816 MB respectively. The ST9655 and the ST9420 went into volume production during the first and fourth quarters of fiscal 1995, respectively. The ST9816 is expected to begin volume production in the first quarter of fiscal 1996. In January 1994 the 12.5mm high ST9300 family (Marathon \"SL\") was announced with 262, 210 and 131 MB versions. Volume production of the Marathon SL products began in the fourth quarter of fiscal 1994. Future plans for the 2.5 inch family of drives include continued higher capacities and lower cost designs.\nDESKTOP COMPUTING\nIn January 1995 the Company began volume shipments of the newest Medalist xe product, the Medalist 545xe (ST3660). This 545 MB drive ended the fiscal year as one of the Company's highest unit volume products. The Medalist xe family of 3.5 inch low-profile cost-effective disc drives features capacity points ranging from 214 MB to 545 MB of formatted capacity. The design was leveraged from the earlier ST3290 and ST3144 products that had been shipping in volume in 1993. The Medalist xe family, formerly the ST3491 family, began volume shipments in the third quarter of fiscal 1994.\nAlso in January 1995 the Company announced two new additions to the Decathlon family: the ST5850 and the ST51080. These drives have 850 MB and 1.08 GB of formatted capacity, respectively. Volume production of the ST5850 began in the third quarter of fiscal 1995. The ST51080 is expected to begin volume production in the first quarter of fiscal 1996. The Decathlon family of disc drives was first introduced in October 1993. The Decathlon family features a 3.5 inch, 19mm high profile which targets the emerging ultra-low profile PCs. This family also enables a mini-array package whereby up to six drives can be mounted in the space of one 5.25 inch full height drive. In addition to its unique form factor, the Company believes the Decathlon family offers the most energy efficient design in its class, providing advanced power savings for \"Green PCs\" and Energy Star systems. Volume production of the first product in this family, the ST5660 with 545 MB of formatted capacity, commenced in the first quarter of fiscal 1995.\nIn May 1995 the Company announced another expansion of the Medalist family to include a higher performance series of products with 1.6 GB and 2 GB formatted capacities. As of June 1995, the Medalist 2140 (2 GB) is the highest capacity ATA disc drive announced in the industry. These new products are directed to the growing capacity and cost-effective requirements of the PC market. They are scheduled for volume production in the second quarter of fiscal 1996. The Medalist family now features drives with capacity points ranging from 700 MB to 2 GB.\nMID-RANGE SYSTEMS\nIn October 1992 the Company expanded its low-profile 3.5 inch mid-range product line with the ST31200, a high performance drive with 1 GB of formatted capacity that began production during the first quarter of fiscal 1994. In October 1993 the Company expanded that product family to a 2 GB formatted capacity platform with the family name of Hawk. The Hawk 2 went into production the fourth quarter of fiscal 1994. In January 1994 the Hawk 4, 3.5 inch half-height 4 GB formatted capacity drive, was announced. Volume production began in the first quarter of fiscal 1995. In February 1995 the Company announced the Hawk 2XL in 1 GB and 2 GB versions. The Hawk 2XL features PRML read channels and embedded servos and is designed to provide a balance of price and\nperformance. Volume production of the Hawk 2XL is scheduled to begin in the first quarter of fiscal 1996. The Company plans to continue designing and manufacturing for the higher capacity, high performance and cost sensitive requirements of this market.\nHIGH-END COMPUTING\nHigh-end applications range from digital video, video-on-demand, high-end file servers, mainframes and minicomputers to supercomputers. Two new product families have been introduced by the Company to address this wide range of applications. The Barracuda family of 3.5 inch drives, first introduced in October 1992, had the highest rotational speed of any drives produced at that time. Since then three additional products have been added to the family. The Barracuda 4 and Barracuda 2-2HP were introduced in October 1993. The Barracuda 4 is a 4 GB formatted capacity, 7200 RPM drive in the half-height form factor. Volume production commenced in the first quarter of fiscal 1995. The Barracuda 2-2HP is a 2 GB formatted capacity high-performance drive in the half-height form factor featuring the 2 head parallel design which doubles the data transfer rate. Volume production of this product began in the first quarter of fiscal 1995. In January 1994 the Company announced the Barracuda 2, a 3.5 inch low-profile, one-inch high, 2 GB formatted capacity disc drive. Volume production of this product also began in the fourth quarter of fiscal 1994.\nIn May 1995 the Company announced the Barracuda 4 LP, a 4 GB formatted capacity, high-performance drive in the low-profile form factor. The Barracuda 4 LP is scheduled for volume production in the second quarter of fiscal 1996. Also announced in May 1995 was the Barracuda 8. This 8.7 GB drive is the third generation of ultrahigh performance disc drives in the 7200 RPM, 3.5 inch Barracuda family. The Barracuda 4 LP and the Barracuda 8 incorporate three new technologies into the Barracuda family. The new technologies are MR heads, a PRML data channel and a high-performance embedded servo. These technologies allow for greater areal densities and result in increased capacity per disc. The Barracuda 8 is scheduled for volume production in the second quarter of fiscal 1996.\nAddressing the high-end 5.25 inch market the Company has continued to leverage its Elite product line. The Elite 3, with 2.9 GB of formatted capacity began volume shipments in August 1992. To address the emerging digital video and near-line storage applications the Company introduced the Elite 9 in October 1993. The Elite 9 leverages the established design of the Elite family to an expanded 9 GB of formatted capacity. Volume production began in the fourth quarter of fiscal 1994.\nOTHER PRODUCTS\nIn January 1993 the Company established an equity position in SunDisk, a California-based designer, marketer and manufacturer of solid-state flash memory devices. These devices are designed for both integrated (embedded) applications and removable applications. The flash devices range from 1.8 MB to 175 MB and are best suited for highly rugged, power-sensitive environments.\nThe Company offers warranty and out-of-warranty repair service to users of its disc drives. The Company also designs and manufactures disc drive components, primarily thin-film heads, principally for use in its own products but also for sale to other disc drive manufacturers.\nMARKETING AND CUSTOMERS\nThe Company sells its products to OEMs and distributors. OEM customers incorporate Seagate disc drives into computer systems for resale. OEMs either manufacture and assemble computer system components into computer systems; purchase components to build their systems; or purchase complete computer systems and integrate the hard disc drives and other hardware and software. Distributors typically resell Seagate disc drives to small OEMs, dealers and other resellers. Certain resellers to which the Company directly sells its products also resell Seagate drives as part of enhanced packages (e.g., an add-on kit for a computer or as part of their own computers). Shipments to OEMs were 72%, 68% and 70% of net sales in fiscal 1995, 1994 and 1993, respectively. No customer accounted\nfor 10% or more of consolidated net sales in 1995 and 1994. During fiscal 1993 sales to Sun Microsystems, Inc. accounted for approximately 11% of the Company's consolidated net sales. No other customer accounted for 10% or more of consolidated net sales in 1993.\nOEMS -- OEM customers typically enter into purchase agreements with the Company. These agreements provide for pricing, volume discounts, order lead times, product support obligations and other terms and conditions, usually for periods of 12 to 24 months, although product support obligations generally extend substantially beyond this period. These master agreements typically do not commit the customer to buy any minimum quantity of products. Deliveries are scheduled only after receipt of purchase orders. In addition, with limited lead time, customers may cancel or defer most purchase orders without significant penalty. Anticipated orders from many of Seagate's customers have in the past failed to materialize or OEM delivery schedules have been deferred as a result of changes in their business needs. Such order fluctuations and deferrals have had a material adverse effect on the Company's operations in the past, and there can be no assurance that the Company will not experience such effects in the future.\nDISTRIBUTORS -- The Company's distributors, located throughout the world, generally enter into non-exclusive agreements for the redistribution of the Company's products. Distributors typically furnish the Company with a non-binding indication of their near-term requirements. Product deliveries are generally scheduled based on a weekly confirmation by the distributor of its requirements for that week. The agreements typically provide the distributors with price protection with respect to their inventory of Seagate drives at the time of a reduction by Seagate in its selling price for the drives, and also provide limited rights to return the product.\nSERVICE AND WARRANTY -- Seagate warrants its products against defects in design, materials and workmanship by the Company generally for three to five years depending upon the capacity category of the disc drive, with the higher capacity products being warranted for the longer periods. Warranty periods for disc drives have been increasing and may continue to increase. The Company's products are refurbished or repaired at facilities located in the United States, Singapore and Thailand.\nSALES OFFICES -- The Company maintains sales offices throughout the United States and in Australia, England, France, Hong Kong, Ireland, Italy, Japan, Singapore, South Korea, Taiwan, Thailand, Germany and Sweden. Foreign sales are subject to certain controls and restrictions, including, in the case of certain countries, approval by the office of Export Administration of the United States Department of Commerce.\nBACKLOG\nIn view of customers' rights to cancel or defer orders with little or no penalty, the Company believes backlog in the disc drive industry can be misleading.\nThe Company's backlog includes only those orders for which a delivery schedule has been specified by the customer. Substantially all orders shown as backlog at June 30, 1995 were scheduled for delivery within six months. Because many customers place large orders for delivery throughout the year, and because of the possibility of customer cancellation of orders or changes in delivery schedules, the Company's backlog as of any particular date is not indicative of the Company's potential sales for any succeeding fiscal period. The Company's order backlog at June 30, 1995 was approximately $1,103,000,000 compared with approximately $739,000,000 at July 1, 1994.\nMANUFACTURING\nThe Company's business objectives require it to establish manufacturing capacity in anticipation of market demand. The key elements of the Company's manufacturing strategy are: high-volume, low-cost assembly and test; vertical integration of selected components; and key vendor relationships. The highly competitive disc drive industry requires that the Company manufacture significant volumes of high-quality drives at low unit cost. To do this, the Company must achieve high manufacturing yields and obtain uninterrupted access to high-quality components in required volumes at competitive prices.\nThe Company is currently in the early stages of automating certain of its manufacturing processes. In the coming year it expects several such processes to become substantially automated. The Company believes its competitors' level of automation is significantly greater than its own.\nManufacturing of the Company's rigid disc drives is a complex process, requiring a \"clean room\" environment, the assembly of precision components within narrow tolerances and extensive testing to ensure reliability. The first step in the manufacturing of a rigid disc drive is the assembly of the actuator mechanism, heads, discs, and spindle motor in a housing to form the head-disc assembly (the \"HDA\"). The assembly of the HDA involves a combination of manual and semiautomated processes. After the HDA is assembled and servo writing has been completed, automated testing equipment subjects the HDA to several tests aimed at ensuring that it meets all of the Company's specifications for quality and performance. Upon completion of assembly and testing, circuit boards are added to the HDA and the completed unit is again tested prior to packaging and shipment. The Company uses statistical process control in an effort to continually improve its manufacturing processes. Final assembly and test operations of the Company's disc drives take place primarily at facilities located in Singapore, Thailand, Minnesota and Oklahoma. The Company has also announced plans to establish a disc drive manufacturing operation in the Republic of Ireland that will begin production in mid-October, 1995. Subassembly and component operations are performed at the Company's facilities in Singapore, Thailand, Minnesota, California, Malaysia, Scotland, Northern Ireland and Indonesia. In addition, independent entities manufacture or assemble components for the Company in the United States, Europe and various Far East countries including Hong Kong, Japan, Korea, China, the Philippines, Singapore, Taiwan and Thailand.\nThe cost, quality and availability of certain components including head, media, spindle motors, actuator motors, printed circuit boards and custom semiconductors are critical to the successful production of disc drives. The Company's design and vertical integration have allowed it to internally manufacture substantial percentages of its critical components. The Company's objectives of vertical integration are to maintain control over component technology, quality and availability, and to reduce costs. The Company believes that its strategy of vertical integration gives it an advantage over other disc drive manufacturers. However, this strategy entails a high level of fixed costs and requires a high volume of production to be successful. During periods of decreased production, these high fixed costs in the past have had and in the future could have a material adverse effect on the Company's results of operations.\nThin-film sliders are fabricated and assembled into head gimbal assemblies at the Company's facilities. Spindle motors are sourced principally from outside vendors in the Far East, although the Company is increasing its internal motor manufacturing capabilities. Actuator motors are sourced both from outside vendors and internally. The vast majority of the high-volume surface-mount printed circuit assemblies are assembled internally. The Company evaluates the need for second sources on a case-by-case basis and, where it is deemed desirable and feasible to do so, secures multiple sources for components. The Company has experienced production delays when unable to obtain sufficient quantities of certain components or assembly capacity. The Company maintains component inventory levels adequate for its short-term needs. However, an inability to obtain essential components, if prolonged, would adversely affect the Company's business.\nBecause of the significant fixed costs associated with the production of its products and components and the industry's history of declining prices, the Company must continue to produce and sell its disc drives in significant volume, continue to lower manufacturing costs and carefully monitor inventory levels. Toward these ends, the Company continually evaluates its components and manufacturing processes as well as the desirability of transferring volume production of disc drives and related components between facilities, including transfer overseas to countries where labor costs and other manufacturing costs are significantly lower than in the U.S., principally Singapore, Thailand, Malaysia and China. In addition, the Company is considering expanding its manufacturing operations into other third world countries. Frequently, transfer of production of a product to a different facility requires qualification of such new facility by certain of the Company's OEM customers. There can be\nno certainty that such changes and transfers will be implemented on a cost-effective basis without delays or disruption in the Company's production and without adversely affecting the Company's results of operations.\nAlthough offshore operations are subject to certain inherent risks, including delays in transportation, changes in governmental policies, tariffs, import\/export regulations, and fluctuations in currency exchange rates in addition to geographic limitations on management controls and reporting, the Company has not had any significant adverse experience in this regard and has significant experience in the offshore production of its products. Certain of the Far East countries in which the Company operates have experienced political unrest and the Company's operations have been adversely affected for short periods of time.\nPRODUCT DEVELOPMENT\nThe Company's strategy for new products emphasizes developing and introducing on a timely basis products that offer functionality and performance equal to or better than competitive product offerings. The rigid disc drive industry is characterized by ongoing, rapid technological change, relatively short product life cycles and rapidly changing user needs. The Company believes that its future success will depend upon its ability to develop, manufacture and market products which meet changing user needs, and which successfully anticipate or respond to changes in technology and standards on a cost-effective and timely basis. Accordingly, the Company is committed to the development of new component technologies, new products, and the continuing evaluation of alternative technologies. The Company is presently concentrating its product development efforts on new disc drives and improved disc drive components as described below.\nThe Company develops new disc drive products and the processes to produce them at four locations: Scotts Valley and Simi Valley, California; Oklahoma City, Oklahoma; and Bloomington, Minnesota. Generally speaking, Scotts Valley and Simi Valley are responsible for development of 3.5 inch, 2.5 inch and smaller form factor drives intended for desktop, laptop, notebook and sub-notebook personal computer systems; Oklahoma City is responsible for development of 3.5 inch disc drives with capacities and interfaces intended for use in minicomputers, supermicrocomputers, workstations and file servers; and Bloomington is responsible for 3.5 inch and 5.25 inch products principally intended for use in systems ranging from workstations and superminicomputers to mainframe and supercomputers as well as new markets such as digital video and video-on-demand.\nThe Company has focused its components research and development efforts in four main areas: motors, heads, media and ASICs (application specific integrated circuits). The major emphasis of this R&D is reduced size and power consumption, improved performance and reliability, and reduced cost. Disc drive customers require new products to have greater reliability with ever decreasing defective parts per million (\"DPPMs\") and ever increasing mean time between failures (\"MTBFs\").\nThe principal areas of research and development relating to motors are improved bearings, smaller form factors, lower power requirements, quieter operation, higher reliability, improved magnets and lower cost.\nThe Company's head research and development efforts are focused on increasing recording densities, reducing the size and mass of the slider, developing suspensions and assembly technology for reduced head size, reducing the cost and increasing the reliability. This research and development includes substantial effort to develop and manufacture magneto-resistive (\"MR\") heads and advanced air bearing sliders for high areal density and small form factor products. There can be no assurance that the Company's MR head development effort will be successful and a failure of the Company to successfully manufacture and market products incorporating MR head technology in a timely manner could have a material adverse effect on the Company's business and results of operations.\nMedia research and development efforts are focused on higher performance materials for increased areal density and better substrate and surface topographies for lower flying height applications, improved head\/disc separation margin and increased reliability.\nASIC development has been and will continue to be focused on optimizing the architecture for system performance, cost and reliability. In addition, the focus has been and will continue to be on reducing the number of parts, the amount of power consumption, and the size, and increasing areal densities by use of advanced signal processing techniques such as PRML (Partial Response Maximum Likelihood) read\/write channels. The Company designs nearly all of its ASICs for motor and actuator control and manufactures some of these circuits. It designs many of the other ASICs in the drive such as interface and read\/write, and procures these from third parties.\nIn addition to developing new products and components, the Company devotes significant resources to product engineering aimed at improving manufacturing processes, lowering manufacturing costs and increasing volume production of new and existing products. Process engineering groups are located with the disc drive development groups and the reliability engineering groups in locations listed above; however, most of the Company's volume production is done in locations remote from these groups and the development of the volume processes are completed at the volume manufacturing sites.\nNo assurance can be given that the Company will be able to successfully complete the design or introduction of new products in a timely manner, that the Company will be able to manufacture new products in volume with acceptable manufacturing yields, or successfully market these products, or that these products will perform to specifications on a long-term basis.\nDuring the fiscal years ended June 30, 1995, July 1, 1994 and July 2, 1993 the Company's product development expenses were $220,024,000, $171,907,000 and $154,005,000 respectively.\nPATENTS AND LICENSES\nThe Company has been issued over 460 U.S. patents and approximately 370 foreign patents relating to certain of its disc drive components and manufacturing processes. The Company also has approximately 254 U.S. and 250 foreign patent applications pending. Due to the rapid technological change that characterizes the rigid disc drive industry, the Company believes that the improvement of existing products, reliance upon trade secrets and unpatented proprietary know-how and development of new products are generally more important than patent protection in establishing and maintaining a competitive advantage. Nevertheless, the Company believes that patents are of value to its business and intends to continue its efforts to obtain patents, when available, in connection with its research and development program. There can be no assurance that any patents obtained will provide substantial protection or be of commercial benefit to the Company, or that their validity will not be challenged.\nBecause of rapid technological development in the disc drive industry, it is possible that certain of the Company's products could involve infringement of existing patents. The rigid disc drive industry has been characterized by significant litigation relating to patent and other intellectual property rights. From time to time, the Company receives claims that certain of its products infringe patents of third parties. Although the Company has been able to resolve some such claims or potential claims by obtaining licenses or rights under the patents in question without a material adverse affect on the Company, other such claims are pending which if resolved unfavorably to the Company could have a material adverse effect on the Company's business. For a description of current disputes see the \"Litigation\" note to the Company's consolidated financial statements. In addition, the costs of engaging in intellectual property litigation may be substantial regardless of outcome. The Company has patent cross licenses with Areal Technology, Hewlett-Packard Company, NEC Corporation, Toshiba Corporation, Hitachi, Ltd., Quantum Corporation, Western Digital Corporation, Ceridian Corporation (formerly Control Data Corporation), IBM, Maxtor Corporation, Read-Rite Corporation, Applied Magnetics Corporation and Headway Technologies, Inc., and is licensed under certain Unysis, Bull and Bull SA disc drive and controller patents by virtue of such companies' former ownership of Magnetic Peripherals Inc., now merged into the Company. Additionally, the Company has agreements in principle with other major disc drive companies.\nCOMPETITION\nThe rigid disc drive industry is intensely competitive, with manufacturers competing for a limited number of major customers. The principal competitive factors in the rigid disc drive market include product quality and reliability, form factor, storage capacity, price per unit, price per megabyte, product performance, production volume capability and responsiveness to customers. The relative importance of these factors varies with different customers and for different products. The Company believes that it is generally competitive as to these factors.\nThe Company has experienced and expects to continue to experience intense competition from a number of domestic and foreign companies, some of which have far greater resources than the Company. In addition to independent rigid disc drive manufacturers, the Company also faces competition from present and potential customers, including IBM, Hewlett-Packard, Toshiba, NEC and Fujitsu Limited who continually evaluate whether to manufacture their own drives or purchase them from outside sources. These manufacturers also sell drives to third parties which results in direct competition with the Company.\nProduct life cycles are relatively short in the disc drive industry. The Company expects its competitors to offer new and existing products at prices necessary to gain or retain market share and customers. To remain competitive, the Company believes it will be necessary to continue to reduce its prices and aggressively enhance its product offerings. In addition to the foregoing, the ability of the Company to compete successfully will also depend on its ability to provide timely product introductions and to continue to reduce production costs. The Company's establishment and ongoing expansion of production facilities in Singapore, Thailand, Malaysia and China are directed toward such cost reductions. The Company's four development centers and market-focused design strategies are structured for time-to-market product introductions.\nThe introduction of products using alternative technologies could be a significant source of competition. For example, optical recording and high-speed semiconductor memory could compete with the Company's products in the future. Although optical disc technologies are attractive for certain archival and imaging applications, they have lower performance and are more costly than magnetic disc drives and the Company does not believe that they will be competitive with magnetic disc drives in the near future in markets requiring on-line, random access, non-volatile mass storage. Semiconductor memory (SRAM and DRAM) is much faster than magnetic disc drives, but currently is volatile (i.e., subject to loss of data in the event of power failure) and much more costly. Flash EE prom, a nonvolatile semiconductor memory, is currently much more costly and, while it has higher read performance than disc drives, it has lower write performance. Flash EE prom could become competitive in the near future for applications requiring less storage capacity (i.e., less than 40 MB) than is required in the Company's more traditional computer related market place.\nENVIRONMENTAL MATTERS\nThe United States Environmental Protection Agency (EPA) and\/or similar state agencies have identified the Company as a potentially responsible party with respect to environmental conditions at several different sites to which hazardous wastes had been shipped or from which they were released. These sites were acquired by the Company from Ceridian Corporation (\"Ceridian\") (formerly Control Data Corporation) in fiscal 1990. Other parties have also been identified at certain of these sites as potentially responsible parties. Many of these parties either have shared or likely will share in the costs associated with the sites. Investigative and\/or remedial activities are ongoing at such sites.\nThe Company's portion of the estimated cost of investigation and remediation of known contamination at the sites to be incurred after June 30, 1995 was approximately $14,900,000. Through June 30, 1995 the Company had recovered approximately $2,500,000 from Ceridian through its indemnification and cost sharing agreements with Ceridian and, in addition, expects to recover approximately $9,800,000 from Ceridian over the next 30 years. After deducting the expected recoveries from Ceridian, the expected aggregate undiscounted liability was approximately $5,100,000 at\nJune 30, 1995 with payments expected to begin in 1999. The total liability for all sites recorded by the Company after considering the estimated effects of inflation, reimbursements by Ceridian and discounting was approximately $3,000,000 at June 30, 1995.\nThe Company believes that the indemnification and cost-sharing agreements entered into with Ceridian and the reserves that the Company has established with respect to its future environmental costs are such that, based on present information available to it, future environmental costs related to currently known contamination will not have a material adverse effect on its financial condition or results of operations.\nEMPLOYEES\nFrom July 1, 1994 to June 30, 1995, the number of persons employed worldwide by the Company increased from approximately 53,000 to approximately 65,000. Approximately 55,000 of the Company's employees were located in the Company's Far East operations as of June 30, 1995. In addition, the Company makes use of supplemental employees, principally in manufacturing, who are hired on an as-needed basis. Management believes that the future success of the Company will depend in part on its ability to attract and retain qualified employees at all levels, of which there can be no assurance. The Company believes that its employee relations are good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nSeagate's executive offices are located in Scotts Valley, California. Principal manufacturing facilities are located in Singapore, Thailand, Minnesota, Oklahoma, California, Malaysia, Scotland and Northern Ireland. A major portion of the Company's facilities are occupied under leases which expire at various times through 2005. The following is a summary of square footage owned or leased by the Company:\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe information required by this item is incorporated by reference to pages 30-31 and 33-36 of the Annual Report to Shareholders, filed as Exhibit 13.1 hereto.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNot applicable.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS\nThe information required by this Item is incorporated by reference to pages 1-2 of the Annual Report to Shareholders, filed as Exhibit 13.1 hereto.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe information required by this Item is incorporated by reference to pages 1-2 of the Annual Report to Shareholders, filed as Exhibit 13.1 hereto.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe information required by this Item is incorporated by reference to pages 3-11 of the Annual Report to Shareholders, filed as Exhibit 13.1 hereto.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe information required by this Item is incorporated by reference to pages 1-2 and 12-39 of the Annual Report to Shareholders, filed as Exhibit 13.1 hereto.\nITEM 9.","section_9":"ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe present directors and executive officers of the Company are as follows:\nAll directors hold office until the annual meeting of shareholders of the Company following their election, or until their successors are duly elected and qualified. Officers are elected annually by the Board of Directors and serve at the discretion of the Board.\nMr. Shugart was Chairman of the Board and Chief Executive Officer of the Company from its inception in 1979 until 1991. From 1979 until 1983 he also served as the Company's President. He now serves as Chairman of the Board, President and Chief Executive Officer. He was re-appointed Chairman of the Board in October 1992. Mr. Shugart is also currently a Director of Valence Technology, Inc.\nMr. Carballo was General Manager, Product Line Management for the Company's Oklahoma City operations at the time of the Company's acquisition of Imprimis in 1989. In 1990 he was promoted to Vice President, Product Line Management, Oklahoma City operations, in September 1991 he was promoted to Senior Vice President, Sales, Marketing and Product Line Management and in March 1995 he was promoted to Executive Vice President Worldwide Sales, Marketing, Product Line Management and Customer Service. Prior to joining the Company, Mr. Carballo had seventeen years with Control Data\/Imprimis.\nDr. Hegarty joined Control Data\/Imprimis in 1988 as Vice President, Thin-Film Heads. In October 1989 he was named Seagate's Vice President of Component Operations in Bloomington, Minnesota, and in August 1990 was promoted to Senior Vice President and Chief Technical Officer. In March 1995 he was promoted to Executive Vice President, Chief Operating Officer, Components Group. From October 1990 to October 1993 Dr. Hegarty was also a Director of the Company. Prior to joining Control Data\/Imprimis, Dr. Hegarty had twenty-one years with IBM in the U.K., Netherlands and the U.S.\nMr. Luczo joined the Company in October 1993 as Senior Vice President, Corporate Development. In March 1995 he was promoted to Executive Vice President, Corporate Development and Chief Operating Officer of the Software Group. Prior to joining the Company he was Senior Managing Director of the Global Technology Group of Bear, Stearns & Co. Inc., an investment banking firm, from September 1993 to October 1993. He served as Co-Head of the Global Technology Group of Bear, Stearns & Co. Inc. from February 1992 to October 1993. Prior to joining Bear, Stearns & Co. Inc., Mr. Luczo was with Salomon Brothers Inc., an investment banking firm, from 1984 to February 1992, most recently as Vice President and Head of West Coast Technology.\nMr. Verdoorn joined the Company in 1983. From 1987 to 1991 he was Vice President, Far East Manufacturing and in November 1991 he was promoted to Senior Vice President, Manufacturing Operations. In March 1995 he was promoted to Executive Vice President, Chief Operating Officer of the Storage Products Group.\nMr. Waite joined the Company in 1983 as Vice President of Finance and Chief Financial Officer, and was promoted to Senior Vice President, Finance in 1984. In March 1995 he was promoted to Executive Vice President, Chief Administrative Officer and Chief Financial Officer.\nMr. Greenspan joined the Company in September 1987 as Vice President, Process Development. In 1991 he was made Vice President, Manufacturing Operations for Singapore and California operations. He was promoted to Senior Vice President, Quality and Customer Service in November 1991. Prior to joining the Company, Mr. Greenspan had over twenty years experience in computer-related industries, including nineteen years with IBM.\nDr. Moghadam was Vice President, Engineering of Control Data\/Imprimis from December 1986 until October 1989 when he became Vice President, Engineering at Seagate concurrent with the Company's acquisition of Imprimis Technology. Dr. Moghadam was promoted to Senior Vice President and Chief Technical Officer, Data Storage Products in August 1993.\nMr. Sandie joined the Company in 1983 as Vice President, Materials. He was promoted to Senior Vice President, Corporate Materials in November 1991.\nMr. Filler was appointed Senior Vice President and Chief Financial Officer of Diamond Multimedia Systems, Inc. in January 1995. Diamond Multimedia Systems, Inc. designs, manufacturers and markets high-performance multimedia solutions. From February 1994 until June 1994 he served as Executive Vice President and Chief Financial Officer at ASK Group, Inc. From December 1989 to May 1993 he served as Chairman of the Board of Directors and Chief Executive Officer of Burke Industries, a manufacturer of rubber products for military and industrial usage. Mr. Filler was Chairman of the Board of Seagate from September 1991 until October 1992. From October 1990 until September 1991 Mr. Filler served as Vice Chairman of the Board of Directors of the Company.\nDr. Haughton is an engineering consultant. He was a Vice President of Engineering at DaVinci Graphics, a plotter manufacturer, from May 1990 until August 1991. Prior to that he was a consultant from May 1989 to May 1990. From August 1988 to May 1989 Dr. Haughton was Professor of Mechanical Engineering at Santa Clara University. Dr. Haughton is also a Director of Solectron Corporation.\nMr. Kleist has been President, Chief Executive Officer and a Director of Printronix, Inc., a manufacturer of computer printers, since 1974.\nMr. Perlman presently holds the position of Chairman of the Board of Directors and Chief Executive Officer of Ceridian Corporation (formerly Control Data Corporation), an information services and defense electronics company. He previously held several executive positions at Control Data Corporation including President and CEO of Imprimis. Prior to Control Data Corporation, he was in the private practice of law and at Medtronic, where he served as Executive Vice President for U.S. Pacemaker Operations. He also serves on a number of other corporate boards including Inter-Regional Financial Group, Inc., Computer Network Technology Corporation , Valspar Corporation, Bio-Vascular, Inc. and Kmart Corporation.\nGeneral Stafford, a former astronaut, has been Vice Chairman of Stafford, Burke and Hecker, Inc., a consulting firm based in Alexandria, Virginia since 1982. He also serves as a Director for the following companies: Allied-Signal Corporation, Pacific Scientific, Inc., Tremont, Inc., CMI, Inc., Fisher Scientific International, Inc., Wackenhut, Inc. and Wheelabrator Technologies, Inc.\nDr. Wilkening has served as Chancellor of the University of California, Irvine since July 1, 1993. From September 1988 to June 30, 1993 she was Provost and Vice President of Academic Affairs at the University of Washington. From 1991 to 1993 Dr. Wilkening also served as Chairwoman of the Space Policy Advisory Board of the National Space Council.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by this Item is incorporated by reference to the Company's Proxy Statement to be filed with the Commission within 120 days of the end of the Registrant's fiscal year pursuant to General Instruction G(3) to Form 10-K.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required by this Item is incorporated by reference to the Company's Proxy Statement to be filed with the Commission within 120 days of the end of the Registrant's fiscal year pursuant to General Instruction G(3) to Form 10-K.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by this Item is incorporated by reference to the Company's Proxy Statement to be filed with the Commission within 120 days of the end of the Registrant's fiscal year pursuant to General Instruction G(3) to Form 10-K.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) The following documents are filed as a part of this Report:\n1. FINANCIAL STATEMENTS. The following Consolidated Financial Statements of Seagate Technology, Inc. and subsidiaries and Report of Independent Auditors are incorporated by reference in Item 8:\nReport of Independent Auditors\nConsolidated Balance Sheets -- June 30, 1995 and July 1, 1994.\nConsolidated Statements of Income -- Years Ended June 30, 1995, July 1, 1994 and July 2, 1993.\nConsolidated Statements of Shareholders' Equity -- Years Ended June 30, 1995, July 1, 1994 and July 2, 1993.\nConsolidated Statements of Cash Flows -- Years Ended June 30, 1995, July 1, 1994 and July 2, 1993.\nNotes to Consolidated Financial Statements.\nSeparate financial statements of Seagate Technology, Inc. have not been presented because it is primarily an operating company and its subsidiaries included in the Consolidated Financial Statements are wholly-owned.\n2. FINANCIAL STATEMENT SCHEDULE. The following consolidated financial statement schedule of Seagate Technology, Inc. and subsidiaries is filed as part of this Report and should be read in conjunction with the Consolidated Financial Statements of Seagate Technology, Inc. and subsidiaries:\nSchedules not listed above have been omitted because they are not applicable or are not required or the information required to be set forth therein is included in the Consolidated Financial Statements or notes thereto.\n3. EXHIBITS: NOTES:\nSIGNATURES\nPURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.\nSEAGATE TECHNOLOGY, INC.\nBy: \/s\/ ALAN F. SHUGART\n----------------------------------- (ALAN F. SHUGART, CHAIRMAN OF THE BOARD, PRESIDENT AND CHIEF EXECUTIVE OFFICER)\nDated: August 4, 1995\nPOWER OF ATTORNEY\nKnow All Men By These Presents, that each person whose signature appears below constitutes and appoints Alan F. Shugart and Donald L. Waite, jointly and severally, his or her attorney-in-fact, each with the power of substitution, for him or her in any and all capacities, to sign any amendments to this Report on Form 10-K and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact, or his substitute or substitutes, may do or cause to be done by virtue hereof.\nPURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.\nSEAGATE TECHNOLOGY, INC. SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS\nSEAGATE TECHNOLOGY, INC. INDEX TO EXHIBITS","section_15":""}
{"filename":"718909_1995.txt","cik":"718909","year":"1995","section_1":"Item 1. BUSINESS\nGENERAL\nHPSC, Inc. (the \"Company\" or \"HPSC\") is a financial services company dedicated to providing financing for healthcare professionals. HPSC formerly provided financing exclusively to the dental profession, but in mid-1993 it began to expand into other healthcare markets and through its wholly-owned subsidiary, American Commercial Finance Corporation (\"AACFC\"), into asset based lending which focuses primarily on accounts receivable and inventory financing.\nThe Company's new business volume in 1995 increased substantially compared to 1994 - $68,554,000 versus $32,609,000. In 1993, Healthco International, Inc. (Healthco), the dental equipment supplier which previously supplied the Company with substantially all of its business, filed for bankruptcy. The bankruptcy of Healthco initially posed several significant challenges to the Company. Management has worked to replace its lost business while at the same time pursuing its plan to diversify into other markets. Within the dental industry the Company continues its efforts to expand its business by capitalizing on its reputation for providing a high level of customer service and innovative and competitive financing programs. Today the Company provides financing for over 500 different dental distributors and healthcare providers. While certain of these vendors provide a substantial amount of business for the Company, the Company is no longer dependent on any single source for its business. The Company is now also providing financing to the ophthalmic, podiatry, veterinary and chiropractic professions.\nThe Company finances dental, medical and other healthcare equipment as well as leasehold improvements, office furniture, supplies and certain other costs involved in opening, maintaining or acquiring a healthcare facility or practice. The Company finances transactions only after a customer's credit has been approved and a financing agreement has been executed.\nThe Company does not maintain any inventory. Typically, the manufacturer or distributor delivers the equipment directly to the customer, and the Company purchases the equipment from the supplier, at its customary selling price to the customer, upon installation and customer acceptance.\nSubstantially all of the Company's agreements with its customers are non-cancelable and provide for a full payout at a fixed financing rate with a fixed payment schedule. The majority of the agreements have a term of between three and seven years. All leases are classified as direct financing leases.\nThe Company's principal sources of funding include fixed rate borrowings of varying maturities and a revolving line of credit at variable rates (see Note B of Notes to Consolidated Financial Statements and \"Management's Discussion and Analysis of Financial Condition Liquidity and Capital Resources\" in the 1995 Annual Report). The Company's income depends, to a significant extent, upon its ability to maintain a satisfactory spread between its cost of borrowings and the rates that it charges its customers. In a rising interest rate environment, the Company's use of variable rate financing could adversely affect its ability to maintain these margins. Competitive pressures and other market conditions could hinder the Company's ability to raise the rates charged to its customers as quickly as its variable rate financing costs rise.\nIn July 1995 the Company completed payment for 1,225,182 shares of its Common Stock that it repurchased from certain secured creditors of Healthco (\"Secured Creditors\") pursuant to a Purchase and Sale Agreement among the Company and the Secured Creditors dated as of November 1, 1994. Healthco had pledged the shares of the Company's Common Stock to secure its obligations to the Secured Creditors. Upon final payment by the Company, the shares were released from the pledge and the Secured Creditors also released the Company from any claims that may arise out of the bankruptcy of Healthco. The Company has retired 1,125,182 of these shares and holds 100,000 of these shares in its treasury.\nItem 1. BUSINESS (continued)\nSEGMENT\nThe Company is principally engaged in providing financing to healthcare professionals.\nMARKETING AND SOURCES OF SUPPLY\nThe Company obtains its customers principally from equipment vendor referral programs and from advertising and direct mail brochures targeted to dentists and other professionals who use equipment in their practices. The vendor referral programs permit the Company to utilize vendors' sales personnel operating from retail distribution centers throughout the United States to generate business for the Company. The Company also sends representatives to major trade conventions.\nThe Company advertises its services through industry publications, its own marketing brochures which it distributes and also through direct mail advertising. Existing customers and referrals from existing customers of the Company are also important sources of business.\nLEASES AND NOTES RECEIVABLE\nAt December 31, 1995 the Company's lease, note receivable and asset based lending portfolio of $140,652,000 consisted of approximately 8,300 accounts and 6,300 customers with a weighted average remaining term of approximately 36 months. Lease and note terms ranged from 12-72 months, with the majority having a 36- or 60-month term. No single customer accounted for more than 1.0% of the Company's total receivables at December 31, 1995.\nFINANCING TERMS AND CONDITIONS\nThe Company generally finances equipment to customers through standard non-cancelable full payout leases or conditional sales agreements or notes. Following execution of an agreement, the equipment is delivered from either a distributor or a manufacturer directly to the customer. Following installation and customer acceptance of the equipment, the Company purchases the equipment from the supplier. The Company is the owner of the leased equipment and holds a security interest in equipment financed with conditional sales agreements or notes.\nThe Company makes no warranties to customers as to any matter, including the condition, performance or suitability of the equipment. In substantially all cases, customers are obligated to remit to the Company all amounts due regardless of the performance of the equipment, to maintain and service the equipment and to insure the equipment against casualty loss.\nThe Company establishes residual values when the equipment is purchased and leased. Substantially all the Company's direct financing leases include a lease purchase option. Historically, because substantially all lessees have exercised this option at the recorded value, the Company generally does not incur gains\/losses from the sale or releasing of equipment.\nItem 1. BUSINESS (continued)\nCREDIT REVIEW AND LOSS EXPERIENCE\nThe Company conducts a credit review of each prospective customer, using both commercial credit bureaus and its own internal credit procedures. The Company's collection department is responsible for monitoring slow paying accounts and collection activities when the Company determines such action to be appropriate. Slow paying accounts are subject to service charges.\nFor discussion of the provision for losses and allowance for losses, see \"Management's Discussion and Analysis of Financial Condition - Results of Operations, Fiscal 1995 Compared to 1994 and Fiscal 1994 Compared to 1993\" in the 1995 Annual Report.\nFUNDING\nAt December 31, 1995 the Company had financing from fixed rate securitizations, variable rate revolving lines of credit, and fixed rate bank loans and asset sales. See Note B of the \"Notes to Consolidated Financial Statements\" and \"Management's Discussion and Analysis of Financial Condition - Liquidity and Capital Resources\" in the 1995 Annual Report.\nPATENTS, TRADEMARKS, LICENSES, FRANCHISES AND CONCESSIONS\nThe Company does not have any material patents, trademarks, licenses, franchises or concessions.\nSEASONALITY\nThe Company's business is not seasonal; however, healthcare professionals generally tend to purchase more equipment in the fourth quarter, which may result in a higher volume of equipment purchases to be financed by the Company in that quarter.\nWORKING CAPITAL\nThe Company does not carry inventory or provide rights of return to its customers. Its working capital requirements relate directly to its volume of financing transactions (see \"Business - Credit Review and Loss Expedrience\" and \"Management's Discussion and Analysis of Financial Condition - Liquidity and Capital Resources\" in the 1995 Annual Report).\nItem 1. BUSINESS (continued)\nMATERIAL CUSTOMERS\nNo customer or group of related customers accounted for 1.0% or more of fiscal 1995 revenues. No individual supplier of leased equipment accounted for more than 8% of the current year's originations.\nRAW MATERIALS\nThe Company's business does not depend on raw materials.\nBACKLOG\nAt December 31, 1995, the Company had a backlog of approximately $35,000,000, consisting of customer applications which have been approved but have not yet resulted in a completed transaction, compared to $25,000,000 at the end of 1994. Not all approved applications will result in financing transactions for the Company.\nGOVERNMENT CONTRACTS OR SUB-CONTRACTS\nThe Company does not have a material amount of government contracts or subcontracts.\nCOMPETITION\nThe equipment financing business is highly competitive. Participants in the industry compete through vendor\/customer service, product innovation, and price. Pricing is affected by each participant's ability to control origination and funding costs, portfolio risk management and operating overhead costs. The Company's ability to compete effectively in this market depends upon: (i) its ability to procure financing on attractive terms; (ii) its knowledge of and experience in its markets; (iii) its flexibility and adaptability in dealing with the special needs of its clients; (iv) its relationships with equipment vendors; (v) its ability to continue to expand its business into areas other than the dental profession and (vi) its ability to manage its portfolio effectively.\nThe Company competes with finance divisions, affiliates and subsidiaries of equipment manufacturers, other leasing and finance companies, certain banks engaged in leasing and lease brokers. Many of these organizations are much larger than the Company, have greater financial or other resources than the Company and have access to funds at more favorable rates and terms than those available to the Company.\nRESEARCH AND DEVELOPMENT\nThe Company does not have research and development activities.\nENVIRONMENTAL PROTECTION\nThe Company's compliance with laws and regulations relating to the protection of the environment will not have a material effect on its capital expenditures, earnings or competitive position.\nEMPLOYEES\nAt December 31, 1995, the Company and its subsidiaries had 44 full-time employees, including 23 in general and administration and 21 in sales and marketing.\nItem 1. BUSINESS (continued)\nFOREIGN OPERATIONS\nThe Company, through its Canadian subsidiary, Credident, Inc., engaged in the financing of dental equipment in Canada. In 1994 the Company sold substantially all of Credident's assets to Newcourt Credit Group, Inc. Credident, Inc. was in substantially the same business as the Company, (see Note A of Notes to Consolidated Financial Statements). The Company has ceased to underwrite any new business in Canada. See \"Management's Discussion and Analysis of Financial Condition\" in the 1995 Annual Report.\nEXPORT SALES\nThe Company does not have any export sales.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nThe Company leases approximately 8,320 square feet of office space at 60 State Street, Boston, Massachusetts from the Trustees of 60 State Street Trust. Approximately 2,431 square feet at 433 South Main Street, West Hartford, Connecticut are leased by its wholly-owned subsidiary, American Commercial Finance Corporation. The Company also rents space as required for its sales locations on a short-term basis. (See Note C of the \"Notes to Consolidated Financial Statements\" in the 1995 Annual Report.) In March 1996, the Company executed an agreement to lease an additional 3,000 square feet adjacent to the current space at 60 State Street.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nThe Company was not subject to any material legal proceedings at December 31, 1995.\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, 1995.\nPART II\nItem 5.","section_5":"Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe common stock of HPSC is traded on the NASDAQ National Market System. The high and low sales prices for the common stock as reported by NASDAQ for each quarter in the last two fiscal years, as well as the approximate number of record holders and information with respect to dividend restrictions, are incorporated by reference from page 17 of the 1995 Annual Report.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA\nSelected financial data for the five years ended December 31, 1995 is incorporated by reference from page 16 of the 1995 Annual 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 Financial Condition of the Company is incorporated by reference from pages 17 through 19 of the 1995 Annual Report.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe information required by this item together with the Report of Independent Accountants is incorporated by reference from pages 4 through 14 and page 16 of the 1995 Annual Report. (See also the \"Financial Statement Schedule\" filed under Item 14 of this 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 following are the directors, nominees for director and executive officers of the Company:\nNOMINEES FOR CLASS I DIRECTOR\nLowell P. Weicker, Jr., age 64, was elected a director in December 1995. Mr. Weicker began his political career in 1962, when he was elected as a member of Connecticut's House of Representatives for Town of Greenwich. He served three terms. Mr. Weicker served concurrently as First Selectman of Greenwich from 1964 to 1968. He was elected to the U.S. Congress from Connecticut's 4th District in 1968. He was subsequently elected to the United States Senate in 1970, 1976 and 1982. Mr. Weicker served in the U. S. Senate until January 1989. In January 1991, Mr. Weicker was elected Governor of Connecticut, a position which he held until January 1995. Mr. Weicker has been associated with the firm of Dresing, Lierman, Weicker since 1995. Dresing, Lierman, Weicker provides a variety of health care related services.\nThomas M. McDougal, D.D.S., age 56, was elected a director of HPSC in 1991. He has been a practicing dentist for approximately 30 years. He is active in national, state and local dental organizations and has lectured extensively throughout the United States. He is a past President of the Dallas County Dental Society and is past Chairman of its Continuing Education Committee and its Banking, Nominating and Patient Relations Committee.\nMEMBERS OF THE BOARD OF DIRECTORS CONTINUING IN OFFICE\nCLASS II DIRECTORS (TERM EXPIRES AT THE 1997 ANNUAL MEETING)\nJoseph A. Biernat, age 68, became a director of HPSC in December 1993. Since his retirement in 1987, Mr. Biernat has served as a consultant for several investment management firms. From 1965 until 1987, he was employed with United Technologies Corporation, most recently as Senior Vice President -- Treasurer, and prior thereto as President, Treasurer and Chief Financial Officer of Philco-Ford Finance Corporation. He is also a director of The Hartford Insurance Company Mutual Funds and previously has been a director of several financial and civic organizations.\nRaymond R. Doherty, age 50, has been President of HPSC since December 1989 and Chief Operating Officer of HPSC since August 1993. He was Treasurer of HPSC from December 1988 until May 1994. He was elected a director of HPSC in June 1991. Mr. Doherty previously served as Chairman and Chief Executive Officer of HPSC from October 1992 until July 1993, Chief Operating Officer of HPSC from December 1989 to October 1992, and Chief Financial Officer of HPSC from December 1988 to October 1992. He was Assistant Treasurer of HPSC from June 1986 to December 1988. He was Vice President and Chief Operating Officer of Healthco International, Inc., a company engaged in sales of dental equipment and formerly affiliated with the Company, from October 1992 until August 1993. He was the Senior Vice President of Finance and Operational Controls of Healthco International, Inc. from January 1986 to October 1992.\nSamuel P. Cooley, age 64, became a director of HPSC in December 1993. From 1955 until his retirement at the end of 1993, Mr. Cooley was employed with Shawmut Bank Connecticut, N.A., and its predecessors and affiliates, including Hartford National Bank and Connecticut National Bank. His most recent position was Executive Vice President and Senior Credit Approval Officer. Mr. Cooley is also a director of Lydall, Inc. and the Connecticut Health and Education Facilities Authority and serves as a director or trustee of numerous nonprofit organizations in Connecticut.\nItem 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT (cont'd)\nCLASS III DIRECTORS (TERM EXPIRES AT THE 1998 ANNUAL MEETING)\nJohn W. Everets, age 49, has been Chairman of the Board and Chief Executive Officer of HPSC since July 1993 and has been a director of HPSC since 1983. He was Chairman of the Board and Chief Executive Officer of T.O. Richardson Co., Inc., a financial services company, from January 1990 until July 1993. Previously he was Executive Vice President of Advest, Inc., an investment banking firm, from 1977 to January 1990. Mr. Everets also served as Chairman of the Board of Billings and Co., Inc., a real estate investment banking firm, and Chairman of Advest Credit Corp., both subsidiaries of Advest Group, Inc. Mr. Everets formerly was Vice Chairman of the Connecticut Development Authority and Chairman of the Loan Committee of the Connecticut Development Authority. Mr. Everets is also a director of Dairy Mart Convenience Stores, Inc., Crown\/Northcorp, and the Eastern Company.\nDollie A. Cole, age 65, a director of HPSC since 1991, has been involved for many years in the leadership of several business, charitable and civic organizations. She serves as Chairman of the Dollie Cole Corporation, a venture capital and industrial consulting firm. For seven years Ms. Cole was an owner and board member of Checker Motors and Checker Taxi until selling her interest in 1988. Ms. Cole was also Senior Editor of Curtis Publishing until 1977, and was director of Public Relations for Magnetic Video and Twentieth Century Fox Video until 1985. She serves as a consultant to the Solar and Electric 500 Company based in Phoenix, Arizona, and to Separation Dynamics, an international company involved in the energy and manufacturing industries. In addition to these business activities, Ms. Cole serves on the boards of Project Hope -- the World Health Organization, the National Captioning Institute for the Hearing Impaired, the Smithsonian Institution and on the National Academy of Science -- President's Circle Board.\nJ. Kermit Birchfield, age 56, became a director of HPSC in December 1993. He currently serves as a consultant for various businesses. From 1990 until 1994, Mr. Birchfield served as Senior Vice President, Secretary, and General Counsel with M\/A-COM, Inc., a publicly-held manufacturer of semiconductors and communications equipment based in Wakefield, Massachusetts. Before joining M\/A-COM, he was Senior Vice President for Legal and Governmental Affairs and General Counsel for the Georgia Pacific Corporation. Mr. Birchfield is also a Managing Director of Century Partners, Incorporated, a privately-held investment and operating company, of Darien, Connecticut. He is also a director of Intermountain Industries Inc. and its wholly-owned subsidiary, Intermountain Gas Company, a public utility and Dairy Mart Convenience Stores, Inc.\nOTHER EXECUTIVE OFFICERS\nRene Lefebvre, age 49, has been Chief Financial Officer, Vice President of Finance and Treasurer of HPSC since May 1994. From June 1993 until May 1994, he was Chief Financial Officer of NETTS, Inc., a vocational training institution. He was an independent financial services consultant from February 1992 through May 1993. He served as interim Chief Financial Officer of the Business Funding Group from June through November of 1991. From September 1982 until March 1991, Mr. Lefebvre was Chief Financial Officer of Eaton Financial Corporation, a subsidiary of AT&T Capital Corporation.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION\nSUMMARY COMPENSATION TABLE\nItem 11. EXECUTIVE COMPENSATION (cont'd)\n(2) The amounts reported in this column represent the market price of the stock awarded under the Amended 1995 Stock Plan on the grant date without diminution in value attributable to the restrictions on such stock. The aggregate non-vested restricted stock holdings at the end of fiscal 1995 were as follows: for Mr. Everets - 185,000 shares (the value of these shares at fiscal year end equaled $878,750, which is 108.6% of the value at the grant date); for Mr. Doherty - 90,000 shares (the value at fiscal year end for these shares equaled $427,500, which is 108.6% of the value at the grant date); and for Mr. Lefebvre, 25,000 shares (the value at year end equaled $118,750, which is 108.6% of the value at the grant date). Dividends on stock awards will be paid at the same rate as dividends, if any, are paid to all shareholders.\n(3) Includes term life insurance premiums paid by the Company and Company contributions to the individual's 401(k) retirement plan account, respectively, in the following amounts for the fiscal year ended December 31, 1995: Mr. Everets, $3,240 and $4,049; Mr. Doherty, $3,240 and $3,696; and Mr. Lefebvre, $810 and $2,500. Also includes the value of shares of Common Stock in the Company's ESOP allocated to participants in the fiscal year ended December 31, 1995 (for services rendered during the previous fiscal year) in the following amounts: Mr. Everets, $11,670; Mr. Doherty, $11,670; and Mr. Lefebvre, $7,595. The value of the allocated ESOP shares was calculated by using the year-end closing price of $4.75 per share for fiscal 1995. The Company has not allocated shares of Common Stock to participants in its ESOP for services rendered during the fiscal year ended December 31, 1995 as of the date of this Proxy Statement.\n(4) Mr. Everets' employment with the Company commenced in July 1993. His compensation is governed by an employment agreement dated July 19, 1993. See \"Employment Agreements\" below.\n(5) Includes relocation and temporary living expenses of $81,806 paid in fiscal 1994 in connection with Mr. Everets' relocation to the Boston area.\n(6) Includes relocation and temporary living expenses of $9,794 paid in fiscal 1993 in connection with Mr. Everets' relocation to the Boston area.\n(7) Mr. Doherty's compensation is governed by an employment agreement dated August 2, 1993. See \"Employment Agreements\" below.\n(8) Includes $3,835 paid by the Company for an automobile for Mr. Doherty.\n(9) Mr. Lefebvre's employment with the Company commenced in May 1994. His compensation is governed by an employment agreement dated April 6, 1994. See \"Employment Agreements\" below.\nOPTION GRANTS IN LAST FISCAL YEAR\nThe Company made no option or SAR grants to its executive officers in its last fiscal year.\nAGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES\nThe following table provides information regarding the exercise of stock options by the Company's executive officers during fiscal 1995 and the value of unexercised \"in-the-money\" options at year-end. The columns showing the number of options exercised during fiscal 1995 and the value realized thereby have been omitted because none of the executive officers exercised any options during fiscal 1995.\nItem 11. EXECUTIVE COMPENSATION (cont'd)\nEMPLOYMENT AGREEMENTS\nJohn W. Everets and Raymond R. Doherty\nOn July 19, 1993, the Company entered into an employment agreement with each of John W. Everets and Raymond R. Doherty. The Company agreed to pay a base annual salary of $210,000 to Mr. Everets and $190,000 to Mr. Doherty as well as a bonus of up to 100% of base salary to each individual under an incentive plan developed by the Compensation Committee of the Board in consultation with management and approved by the full Board of Directors. The Company also granted options for 150,000 shares of Common Stock to Mr. Everets and 90,000 shares of Common Stock to Mr. Doherty, each at a price of $2.625 per share, which was the fair market value of a share of Common Stock on the date of grant. The Company also agreed to pay Mr. Everets' reasonable expenses incurred in his relocation to Boston, up to $50,000 on an after-tax basis.\nEach employment agreement has a three-year term and thereafter will automatically renew from year to year unless either party to such agreement gives notice of intention to terminate the agreement six months in advance of any anniversary. Either party to each employment agreement may terminate it at any time for any reason. In the event of decision not to renew by either party or a termination by the Company which is not \"for cause\" with respect to either Mr. Everets or Mr. Doherty (or, in the case of Mr. Everets, in the event of termination by Mr. Everets), the Company will pay the employee his base monthly pay plus his maximum monthly bonus for the next 12 months. Upon a termination by the Company which is not \"for cause,\" all of Mr. Everets' stock options will fully vest. Each employee agrees not to compete with the business of the Company while receiving termination payments and to maintain in confidence all of the Company's confidential information.\nIf, within three years after a \"change of control\" of the Company (as defined in each agreement), either the Company terminates Mr. Everets or Mr. Doherty other than \"for cause\" or the employee terminates his employment due to a \"change in employment\" (as defined in each agreement), the Company will pay the employee his base monthly pay plus the maximum monthly bonus for 24 months; the non-compete provisions will no longer apply; the employee's stock options will fully vest; and normal employee benefits will continue for 12 months. If, within three years after a \"change of control\", the employee terminates his employment for any reason other than a \"change in employment,\" the Company will pay the employee his base monthly pay plus the maximum monthly bonus and normal employee benefits for 12 months.\nItem 11. EXECUTIVE COMPENSATION (cont'd)\nEMPLOYMENT AGREEMENTS (CONT'D)\nRene Lefebvre\nDuring April 1994, the Company entered into an employment agreement with Rene Lefebvre for employment commencing in May 1994. The Company agreed to pay Mr. Lefebvre a base annual salary of $125,000 as well as a bonus of up to 50% of base salary at the discretion of the Chief Executive Officer and subject to approval of the Compensation Committee of the Board. The Company also granted to Mr. Lefebvre options for 30,000 shares of Common Stock at a price of $3.5625 per share, which was the fair market value of a share of Common Stock on the date of grant.\nThe employment agreement has a three-year term and thereafter will automatically renew from year to year unless either party to such agreement gives notice of intention to terminate the agreement 60 days in advance of any anniversary. Either party to Mr. Lefebvre's employment agreement may terminate it at any time for any reason. The Company is obligated to pay Mr. Lefebvre's salary for three months after termination, if it does not renew the agreement, and for six months after termination, if it otherwise terminates his employment without cause. Mr. Lefebvre has agreed not to compete with the business of the Company while receiving severance payments and to maintain in confidence all of the Company's confidential information.\nIn the event of a \"change of control\" of the Company (as defined in his agreement), Mr. Lefebvre's stock options will fully vest.\nCOMPENSATION OF DIRECTORS\nThe Company pays each non-employee director a fee of $5,000 per annum plus $2,500 per annum for each committee of the Board on which he or she serves and $500 for each meeting attended. In addition, the Company reimburses directors for their travel expenses incurred in attending meetings of the Board or its committees. Pursuant to the 1995 Stock Plan, each non-employee continuing director is granted 1,000 non-qualified stock options on the day of each Annual Meeting of Stockholders during the term of such Plan.\nMr. Weicker received a non-qualified option grant exercisable for 4,000 shares of Common Stock at $4.75 per share, the fair market value of Common Stock on the date of grant, at the time that he joined the Board of Directors.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nSHARE OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nItem 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT (cont'd)\nSHARE OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT (CONT'D)\n(2) Includes allocated shares under the HPSC, Inc. Employee Stock Ownership Plan (the \"ESOP\") of 4,714 for Mr. Everets, 6,711 for Mr. Doherty, 1,599 for Mr. Lefebvre and 13,024 for all executive officers and directors as a group.\n(3) Dimensional Fund Advisors, Inc. (\"Dimensional\") has filed an Amendment No. 5 to Schedule 13G with the SEC reporting that it is a registered investment adviser and is deemed to have beneficial ownership of 354,400 shares of Common Stock of the Company as of December 31, 1995, all of which shares are held in portfolios of DFA Investment Dimensions Group Inc., a registered open-end investment company, or in series of the DFA Investment Trust Company, a Delaware business trust, or the DFA Group Trust and DFA Participation Group Trust, investment vehicles for qualified employee benefit plans, all of which Dimensional serves as investment manager. Dimensional disclaims beneficial ownership of all such shares.\n(4) Fidelity Management and Research Corporation (\"FMRC\") filed a Form 13G with the SEC for the year ended December 31, 1995 reporting that it has investment discretion with respect to 352,500 shares of Common Stock of the Company. FMRC reports that it has no voting authority with respect to such shares.\n(5) Tweedy, Browne Company L.P. (\"TBC\"), TBK Partners, L.P. (\"TBK\") and Vanderbilt Partners, L.P. (\"Vanderbilt\") filed an Amendment No. 4 to their Form 13Ds on October 28, 1995 with the Securities and Exchange Commission. TBC is the beneficial owner of 408,285 shares of the Company's Common Stock. TBK owns directly 15,000 shares. Vanderbilt owns directly 10,000 shares. The aggregate number of shares of the Company's Common Stock of which TBC, TBK and Vanderbilt could be deemed to be beneficial owners is 433,285. TBC has investment discretion with respect to 408,285 shares and sole power to dispose or direct the disposition of all of such shares. TBC has shared power to vote or direct the vote of 350,285 shares. TBK has the sole power to vote or direct the voting of and to dispose or direct the disposition of the TBK shares. Vanderbilt has the sole power to vote or direct the voting of and dispose or direct the disposition of the Vanderbilt shares. The general partners of TBC and Vanderbilt are Christopher H. Browne, William H. Browne and John D. Spears. The general partners of TBK are Christopher H. Browne, William H. Browne, Thomas P. Knapp and John D. Spears. The general partners of TBC, by reason of their positions as such, may be deemed to have shared power to dispose of or to direct the disposition of 408,285 shares and shared power to vote or to direct the vote of 350,285 shares. Each of the general partners of TBK and Vanderbilt, by reason of his position as such, may be deemed to have shared power to vote or direct the vote of and to dispose or direct the disposition of the 15,000 shares held by TBK and the 10,000 shares held by Vanderbilt, respectively.\n(6) 59,652 of these shares have been allocated to the accounts of ESOP participants and 240,348 shares are unallocated. Messrs. Doherty and Everets disclaim beneficial ownership of all such shares, other than the shares allocated to their respective ESOP accounts listed in Note (2) above.\n(7) None of the 350,000 shares have been allocated to the accounts of participants in the HPSC, Inc. Supplemental Employee Stock Ownership Plan and Trust (the \"SESOP\"). Messrs. Doherty and Everets disclaim beneficial ownership of all such shares.\nItem 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT (cont'd)\nSHARE OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT (CONT'D)\n(8) Excludes the 300,000 shares held in the ESOP for the benefit of the employee participants (other than the shares allocated to the respective ESOP accounts of Messrs. Doherty and Everets listed in Note (2) above) and the 350,000 shares held in the SESOP for the benefit of the employee participants. Although Messrs. Doherty and Everets are the trustees of both the ESOP and SESOP and accordingly share voting power with respect to all unallocated shares and share dispositive power with respect to all shares in the ESOP and the SESOP, they disclaim beneficial ownership of all such shares, other than the shares allocated to their respective ESOP accounts listed in Note (2) above.\n(9) Includes 26,133 shares, 10,000 shares and 10,000 shares, respectively, for Messrs. Everets, Doherty and Lefebvre, purchased under the Stock Loan Program described in \"EXECUTIVE COMPENSATION -- Stock Loan Program.\" All such shares are pledged to the Company pursuant to such Program.\n(10) Includes 100 shares held by Mr. Everets' son, A. Hale W. Everets. Mr. Everets disclaims beneficial ownership of such shares.\n(11) Includes 185,000, 90,000 and 25,000 restricted shares granted to Messrs. Everets, Doherty and Lefebvre on May 12, 1995, as described under the Summary Compensation Table.\n(12) Includes 3,000 shares held by Mr. Birchfield's spouse. Mr. Birchfield disclaims beneficial ownership of such shares.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nSTOCK LOAN PROGRAM\nOn January 5, 1995 the Compensation Committee approved a Stock Loan Program whereby executive officers and other senior personnel of the Company earning more than $80,000 per year may borrow from the Company an amount equal to the cost of purchasing two shares of Common Stock, solely for the purpose of acquiring such stock, for each share of Common Stock purchased by the employee from sources other than Company funds. Such borrowings may not exceed $200,000 in any fiscal quarter of the Company, $200,000 per employee or $400,000 during the term of the loan program for all employees. All shares purchased with such loans are pledged to the Company as collateral for repayment of the loans. The loans are recourse, bear interest at a variable rate which is one-half of one percent above the Company's cost of funds, payable monthly in arrears, and are payable as to principal no later than five (5) years after the date of the loan. As of the date of this proxy statement, the Company has loans outstanding to executive officers in the following amounts secured by the number of shares listed: Mr. Everets, $98,000, secured by 26,133 shares; Mr. Doherty, $37,500, secured by 10,000 shares; and Mr. Lefebvre, $37,500, secured by 10,000 shares.\nREPURCHASE OF SHARES FORMERLY HELD BY HEALTHCO INTERNATIONAL, INC.\nIn July 1995 the Company completed payment for 1,225,182 shares of the Company's Common Stock which it repurchased from certain secured creditors of Healthco International, Inc. (\"Healthco\"), which was formerly the largest shareholder of the Company and which declared bankruptcy in June 1993, pursuant to a Purchase and Sale Agreement between the Company and the Healthco secured creditors, dated as of November 1, 1994. Healthco had pledged the shares of the Company's Common Stock to secure its obligations to the secured creditors. The shares were released from the pledge agreement upon the Company's completion of the payment. The secured creditors also released the Company from any claims that may arise out of the bankruptcy of Healthco, effective upon payment by the Company for the shares. The Company has retired 1,125,182 of these shares and holds 100,000 of these shares in its treasury.\nPART IV\nItem 14.","section_14":"Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K\nCopies of Exhibits may be obtained for a nominal charge by writing to:\nINVESTOR RELATIONS HPSC, INC. 60 STATE STREET BOSTON, MASSACHUSETTS 02019\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, HPSC, Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nHPSC, Inc.\nBy: \/s\/ John W. Everets ---------------------------- Dated: March 29, 1996 John W. Everets Chairman, Chief Executive Officer and Director\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Stockholders of HPSC, Inc.:\nOur report on the consolidated financial statements of HPSC, Inc. has been incorporated by reference in this Form 10-K from the 1995 Annual Report to Stockholders of HPSC, Inc. In connection with our audits of such financial statements, we have also audited the related financial statement schedule listed in item 14(a)2 of this Form 10-K.\nIn our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information required to be included therein.\nCOOPERS & LYBRAND, L.L.P.\nBoston, Massachusetts March 25,1996 SCHEDULE VIII","section_15":""}
{"filename":"50420_1995.txt","cik":"50420","year":"1995","section_1":"Item 1. Description of Business\nInfodata Systems Inc. (the \"Company\" or \"Infodata\") specializes in providing complex information solutions to large commercial organizations and Federal, state and local governmental agencies. \"Complex information solutions\" include integration services and software products. Infodata's integration services enable the storage, retrieval, control, and dissemination of documents, images, multimedia, and other unstructured information across departments, enterprises, and the global Internet. Infodata's existing commercial customer base and target market includes the Fortune 1000, banks and financial services firms, utilities and hospitals. The Company also derives significant revenues from various agencies of the United States government which accounted for 37% and 44% of total revenues for the years ended December 31, 1995 and 1994. All of these organizations share a common problem - managing complex, unstructured information across the enterprise.\nThe Company has been a pioneer in providing electronic document management solutions. Prior to 1994, substantially all of the Company's business was derived from the sale, support, and maintenance of its INQUIRE\/Text full text database management system - a leader in the IBM and IBM-compatible mainframe text retrieval marketplace.\nDuring 1994, Infodata successfully shifted its focus to providing a broader range of document management solutions deliverable through client\/server technology. The Company's shift into the client\/server arena accelerated with the acquisition of the business and certain assets of Merex, Inc., (\"Merex\") in October, 1995 (see Note 2 to the consolidated financial statements of the Company). Merex, a document systems solutions and integration firm, brought experienced management and staff, a diverse client base, and an established market reputation to Infodata.\nInfodata's legacy experience and recent successes in the client\/server arena, and Merex's project experience in client\/server document management technology, combine to produce an organization uniquely focused on solving complex information\/document management problems. Management believes that Infodata's desktop-to-mainframe know-how also positions the Company to exploit the mainframe's resurgence as a server in the client\/server environment, including Intranets and the Internet.\nServices offered by the Company include requirements definition, feasibility studies, process analysis, systems design, software development, implementation, documentation, and training. These services are delivered using a well-defined project management methodology. Most projects involve the integration of multiple commercial-off-the-shelf software products such as full text retrieval engines, document management systems, and Web browsers. Services are provided by highly skilled software engineers and project managers who are adept at dealing with the rapidly changing technologies necessary to construct the best possible solutions for customers.\nInfodata sells its own software products and those of third-party developers with which it maintains close relationships. In addition to INQUIRE\/Text, Infodata's own products include MxImage, an integrated client\/server imaging, cataloging, and storage management system. The Company, in conjunction with its own service offerings, is a value-added reseller of partner products under agreements with Verity, Inc., Fulcrum Technologies, PC DOCS Inc., Documentum, Inc., Adobe Systems, Inc., and Lotus Development Corporation.\nInfodata sells products and services through its own direct sales force to leads generated from its partners and its own marketing efforts. Marketing activities include selected trade shows, seminars, and direct mail. The Company quickly identifies potential customers and then salespersons and senior technical managers team to present the Company's qualifications and approach to solving the customer's complex information problem.\nFrequently, projects start as prototypes or pilots where concepts are proven to the customer's satisfaction. These initial projects are then followed by more substantial implementations. The Company performs under time and materials, fixed price, and cost-based contracts. Infodata has a high rate of repeat business which management believes is a result of the high degree of customer satisfaction with its services and solutions.\nThere are four components to the Company's business, all of which interact to provide differentiation from its competitors. The components consist of products and three markets for consulting services - commercial customers, the United States intelligence community, and other Federal, state and local government agencies.\nThe market sectors are distinct but related through a common objective of achieving solutions to complex information problems. For example, the intelligence community is frequently ahead of the commercial and other government agency arenas in terms of adopting new technologies. Therefore, the Company benefits from technology transfer from the intelligence community to other customers. On the other hand, certain commercial concepts may not have taken root in the intelligence community despite similar needs. The Company focuses on exploiting these similarities of interests to leverage projects from one sector to another.\nThe three consulting sectors - commercial, intelligence, and other government - provide real-world experience from which product concepts are generated. Management believes Infodata will derive increased volume from its product based business existing solutions are cross-marketed among the sectors.\nThe Company competes with larger service firms, such as the consulting divisions of the major accounting firms, prime contractors, and systems integrators, many of which have substantially greater financial resources than the Company. A primary competitive advantage for Infodata is its total business focus on document\/complex information systems as compared to the more diffuse approach of its competitors. The Company has chosen to deliver high quality results in a specialized, but rapidly growing, niche which cuts across all industries and segments of the economy as the need to manage and find complex information in the form of images, documents, and other objects is a universal one.\nThe Company is focusing attention on Internet-based solutions, particularly those internal to organizations, known as Intranets. Infodata has completed several projects incorporating a variety of state-of-the-art technologies which are presented to the users through the customer's Intranet. In addition, Infodata's mainframe legacy product, INQUIRE\/Text, is adaptable to operating as a large server for Intranet\/Internet information dissemination. This enables current INQUIRE\/Text customers to leverage their existing collections of information by making them available on their Intranets, and allows Infodata to offer solutions involving the latest in client\/server technologies coupled with the use of the mainframe in the role of server.\nThe Company continues to invest in software development involving INQUIRE\/Text in order to respond to its customers which provide a base of maintenance revenues. Research and development expense for the years ended December 31, 1995 and 1994 was $187,000 and $408,000, respectively. While software development projects have been limited in the last several years, the Company expects to devote more resources to software product development as marketable ideas arise from its consulting services. In some cases, early adopter customers fund new product concepts; in other cases the Company has the financial resources to invest when it is convinced it can effectively market the product suggested by its consulting projects.\nThe Company employed a total of 74 full time employees and no part time employees at December 31, 1995.\nInfodata's principal offices are located at 12150 Monument Drive, Fairfax, VA 22033. Its telephone number is 703-934-5205 and fax number is 703-934-7154. Infodata's Internet e-mail address is info@infodata.com and the Company maintains a World Wide Web home page at http:\/\/www.infodata.com.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Description of Property\nThe Company leases approximately 21,000 square feet of professional office space located at its Headquarters Office in Fairfax, Virginia (see Note 8 to the Consolidated Financial Statements contained elsewhere in this report).\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe Company 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\nNot Applicable.\nItem 4a. Executive Officers\nThe following information relates to Executive Officers of the Registrant as of March 20, 1996:\nName Age Position\nHarry Kaplowitz 52 President and Director\nRobert J. Loane 57 Senior Vice President\nRichard M. Tworek 39 Senior Vice President\nMr. Kaplowitz is a founder of the Company and was elected Vice President in 1973, Executive Vice President and Director in 1980. In 1989, he was promoted to President and Chief Operating Officer of the Company's INQUIRE Group. In 1990, he was named President of the Company. From January 1991 to January 1993, he served as Chairman of the Board of Directors of the Company.\nDr. Loane joined the Company in 1968, was elected Vice President in 1978 and Senior Vice President in 1980. He is the Company's Chief Scientist.\nMr. Tworek joined the Company in October, 1995 and was elected Senior Vice President. He was the founder and president of Merex, Inc. Since 1989, Merex designed and implemented large, complex client\/server document systems and offered its own products as part of the solution.\nPART II\nItem 5.","section_5":"Item 5. Market for Common Equity and Related Stockholder Matters\nInfodata's Common Stock has been quoted on the NASDAQ SmallCap Market under the symbol \"INFD\" since September 16, 1994. The Company's Common Stock was previously traded on the NASDAQ National Market. Market makers of the Company's Common Stock include Herzog, Heine, Geduld, Inc.; Mayer and Schweizter Inc.; M. Rimson & Co., Inc.; and Patterson Travis Inc.\nThe table below shows the range of closing bid prices for the Common Stock for the quarters indicated.\n1995 1994 High Low High Low\nFirst Quarter $6.00 $3.00 $3.56 $1.69 Second Quarter 4.25 3.375 3.75 2.72 Third Quarter 6.00 3.25 4.00 3.25 Fourth Quarter 4.75 3.50 7.00 3.25\nThe market quotations reflected above are inter-dealer prices, without retail mark-up, mark-down or commissions and may not represent actual transactions.\nThe Company has not paid cash dividends on its Common Stock and presently has no intention to do so. It believes that execution of its operating plan requires the Company to retain available funds to support future business activities. Payment of cash dividends on Common Stock in the future will be dependent upon the earnings and financial condition of the Company, and other factors which the Board of Directors may deem appropriate. See Note 7 to the 1995 Consolidated Financial Statements, contained elsewhere in this report, for information relating to cash dividends pertaining to Preferred Stock.\nAs of March 20, 1996, there were approximately 683 shareholders of record.\nItem 6.","section_6":"Item 6. Management's Discussion and Analysis\nResults of Operations\nSummary\nOver the last two years, the Company's focus has shifted from sales of its proprietary mainframe software product, INQUIRE\/Text, to providing document management solutions in the client\/server environment. INQUIRE\/Text will continue to play a role both from continuing maintenance revenues and as a mainframe server (including the Internet\/Intranet). It is expected, however, that stand-alone sales of INQUIRE\/Text will be minimal, and revenues derived from INQUIRE\/Text will, over time, decline as a percentage of aggregate revenues. Revenues derived from INQUIRE\/Text represented 77.1% of total revenues in 1995, compared with 85.4% in 1994. During the fourth quarter of 1995, INQUIRE\/Text revenues declined further to 57.4% of total fourth quarter revenues.\nDuring the fourth quarter of 1995, the drop in INQUIRE\/Text-related revenues was more than offset by government and commercial client\/server based consulting unrelated to INQUIRE\/Text, and by the acquisition of the assets of Merex, Inc. on October 11, 1995 (see Note 2 to the financial statements). The Merex acquisition had a positive impact on total revenues but a negative impact on operating income due to the costs of the integration of Merex and certain lower margin Merex government contracts. All of the costs of combining the two organizations were recognized by December 31, 1995.\nRevenues\nTotal revenues decreased $453,000 (6%) for the year ended December 31, 1995 compared to the prior year. The primary cause was a $971,000 decline in INQUIRE\/Text related revenue from the prior year, primarily reflecting reduced product license fees. The Company expects that INQUIRE\/Text related revenues will continue to decline over time as the product ages.\nDuring 1995, client\/server related consulting revenue increased 79% to $1,364,000 from $763,000 in the prior year. The acquisition of Merex in October 1995 resulted in approximately $550,000 in client\/server consulting revenue during the fourth quarter of 1995 which represents most of the increase. Total fourth quarter revenues increased from $1,837,000 in 1994 to $2,156,000 in 1995.\nGross Profit\nGross profit decreased to $2,883,000 (41% ) from $3,415,000 (45%) at December 31, 1995 and 1994, respectively. The decrease was due in part to the effect of a 6% decline in revenues and also certain lower margin government contracts acquired from Merex. The Company changed its methodology for overhead allocation in 1995 to more accurately reflect certain indirect costs of revenues which resulted in a reclassification of the 1994 statement of operations from a gross profit of 40% to a revised 45% but had no effect on operating income.\nResearch and Development Expense\nResearch and development expense was $187,000 and $408,000 for the years ended December 31, 1995 and 1994, respectively. The principal cause of the decrease was cost reduction due to outsourcing of mainframe related computer costs in the fourth quarter of 1994 which had a full year impact on 1995. The Company believes that substantially all of the impact of cost reduction has been realized and research and development expense is likely to increase in 1996 and beyond as new products are developed.\nSelling, General and Administrative Expenses\nSelling, general and administrative expenses were $2,657,000 and $2,482,000 for the years ended December 31, 1995 and 1994, respectively. The increase was due in part to the costs of building a sales force and associated marketings, an increase in consulting fees relating to execution of the Company's strategic plan to expand into client\/server based consulting, and the impact of integration costs arising from the Merex acquisition. As a percent of total revenue, these expenses increased to 38% from 33% in the prior year.\nInterest Income and Expense\nInterest income was $119,000 and $46,000 for the years ended December 31, 1995 and 1994, respectively. The increase was primarily due to a higher average balance of cash and cash equivalents in 1995 over 1994. The company invested only in short term, highly liquid money market instruments. Interest expense decreased to $24,000 in 1995 from $42,000 in the prior year. The expense is primarily related to certain capital equipment leases which expire through 1998.\nNet Income\nNet income was $131,000 and $518,000 for the years ended December 31, 1995 and 1994, respectively. The decrease in earnings was due to the factors discussed above. The Company expects the Merex acquisition to favorably impact net income in 1996.\nNew Accounting Pronouncements\nStatement of Financial Accounting Standard No. 123, \"Accounting for Stock-Based Compensation\" establishes financial accounting and reporting standards for stock-based employee compensation plans, including stock options and restricted stock. Effective for the Company's 1996 financial statements, this pronouncement encourages the use of a fair value based method of accounting for employee stock options which measures compensation cost at the grant date based on the value of the award and is recognized over the service period. The statement still allows the valuation method currently used by the Company, which results in no compensation expense. Management expects to continue to use this method of accounting for its stock options and will provide the additional disclosures required under the new standard.\nLiquidity and Capital Resources\nThe Company generated cash flow from operating activities of $208,000 in 1995 compared to $1,314,000 for the prior year. The decrease was due to the drop in net income discussed earlier and an increase in receivables. Receivables increased significantly at December 31, 1995 compared to the prior year due in part to a historically slower collection rate for the acquisition related receivables and in part from several fixed price contracts with significant balances which will be collected in early 1996.\nCash used in investing activities was $87,000 for the year ended December 31, 1995 compared to $122,000 for the prior year. The primary cause for the decrease was the absence of significant costs related to capitalized software but offset by purchases of property and equipment and payment of direct costs related to the Merex acquisition. The Company had no commitments for material capital expenditures as of December 31, 1995.\nCash used in financing activities was $370,000 for the year ended December 31, 1995 compared to $333,000 for the prior year. During 1995, the Company retired $155,000 of debt assumed in the Merex acquisition and paid $120,000 in dividends to preferred shareholders. Offsetting these cash outflows was a $110,000 decrease in principal payments on capital lease obligations due to maturities during 1995 and proceeds of $47,000 from exercise of common stock options . The Company expects payments on capital leases in 1996 to be substantially the same as 1995.\nWorking capital was $1,220,000 and $745,000 at December 31, 1995 and 1994, respectively. The current ratio increased to 1.52 from 1.27 over the same period. The Company's long term liabilities at December 31, 1995 consisted of $192,000 of deferred revenue relating to maintenance contracts which represents a non-cash liability and $134,000 related to deferred rent and capital equipment obligations which will require cash outlay.\nThe Company believes cash and cash equivalents on hand and cash flows from operating activities will be sufficient to fund operations for the next twelve months. However, the Company maintains a $500,000 line of credit with a bank from which no borrowings were made in 1995 and no balance is currently outstanding. In the longer term, the Company believes it has adequate financial flexibility to increase its borrowing capacity and access the public markets to accommodate its growth strategy.\nItem 7.","section_7":"Item 7. Financial Statements\nThe consolidated financial statements required hereunder are listed under Item 13(a) below.\nItem 8.","section_7A":"","section_8":"Item 8. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone. PART III\nItem 9.","section_9":"Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance With Section 16(a) of the Exchange Act\nPursuant to General Instruction E(3) of Form 10K-SB, the information called for by this Item regarding directors is hereby incorporated by reference from the Company's definitive proxy statement or amendment hereto to be filed pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this report. Information regarding the Company's executive officers is set forth under Item 4a of this Form 10K-SB.\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Executive Compensation\nPursuant to General Instruction E(3) of Form 10K-SB, the information call for by this Item is hereby incorporated by reference from the Company's definitive proxy statement or amendment hereto to be filed pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this report.\nItem 11.","section_11":"Item 11. Security Ownership of Beneficial Owners and Management\nPursuant to General Instruction E(3) of Form 10K-SB, the information call for by this Item is hereby incorporated by reference from the Company's definitive proxy statement or amendment hereto to be filed pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this report.\nItem 12.","section_12":"Item 12. Certain Relationships and Related Transactions\nPursuant to General Instruction E(3) of Form 10K-SB, the information call for by this Item is hereby incorporated by reference from the Company's definitive proxy statement or amendment hereto to be filed pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this report.\nItem 13.","section_13":"Item 13. Exhibits, List and Reports on Form 8-K\n(a) Financial Statements. The financial statements and exhibits required by Item 7 and this Item 13 of Form 10K-SB are listed below.\nReport of Independent Public Accountants\nConsolidated Statements of Operations - Each of the two years in the period ended December 31, 1995\nConsolidated Balance Sheets - December 31, 1995 and 1994\nConsolidated Statements of Shareholders' Equity - Each of the two years ended December 31, 1995\nConsolidated Statements of Cash Flows - Each of the two years in the period ended December 31, 1995\nNotes to Consolidated Financial Statements - December 31, 1995\n(b) Reports on Form 8-K.On October 27, 1995, the Company filed a Current Report on Form 8-K, dated October 11, 1995, as amended on December 26, 1996, to report under Item 2 thereof the Company's acquisition of the assets of Merex, Inc. And to include, under Items 7(a) and 7(b) thereof, the financial statements and pro forma financial information relating to such acquisition transaction.\nEXHIBIT INDEX\nExhibit Number Description - -------------- -----------\n3(a) Certificate of Incorporation (incorporated herein by reference to exhibit A to the Registrant's proxy statement dated April 10, 1995)\n(b) By-Laws (incorporated herein by reference to exhibit B to the Registrant's proxy statement dated April 10, 1995)\n10(a) Executive Separation Agreement between the Registrant and Harry Kaplowitz (incorporated herein by reference to exhibit 10(a) to the Registrant's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1993)\n(b) Executive Separation Agreement between the Registrant and Robert Loane (incorporated herein by reference to exhibit 10(b) to the Registrant's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1993)\n(c) Stay Incentive Bonus Agreement between the Registrant and David Karish (incorporated herein by reference to exhibit 10(c) to the Registrant's Quarterly Report on Form 10-QSB for the quarter ended March 31, 1994)\n(d) Incentive Stock Option Plan (incorporated herein by reference to exhibit 10(d) to the Registrant's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1993)\n(e) Incentive Stock Option Agreement between the Registrant and Robert J. Loane dated March 24, 1993 (incorporated herein by reference to exhibit 10(e) to the Registrant's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1994)\n(f) Incentive Stock Option Agreement between the Registrant and David A. Karish dated March 24, 1993 (incorporated herein by reference to exhibit 10(f) to the Registrant's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1994)\n(g) Incentive Stock Option Agreement between the Registrant and Harry Kaplowitz dated March 24, 1993 (incorporated herein by reference to exhibit 10(g) to the Registrant's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1994)\n(h) Incentive Stock Option Agreement between the Registrant and Richard T. Bueschel dated March 24, 1993 (incorporated herein by reference to exhibit 10(h) to the Registrant's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1994)\n(i) Incentive Stock Option Agreement between the Registrant and Robert M. Leopold dated March 24, 1993 (incorporated herein by reference to exhibit 10(i) to the Registrant's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1994)\n(j) Incentive Stock Option Agreement between the Registrant and Isaac M. Pollak dated March 24, 1993 (incorporated herein by reference to exhibit 10(j) to the Registrant's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1994)\nExhibit Number Description - -------------- -----------\n(k) Incentive Stock Option Agreement between the Registrant and Millard H. Pryor dated March 24, 1993 (incorporated herein by reference to exhibit 10(k) to the Registrant's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1994)\n(l) Incentive Stock Option Agreement between the Registrant and Laurence C. Glazer dated October 5, 1993 (incorporated herein by reference to exhibit 10(l) to the Registrant's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1994)\n(m) Incentive Stock Option Agreement between the Registrant and Richard T. Bueschel dated December 8, 1993 (incorporated herein by reference to exhibit 10(m) to the Registrant's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1994)\n(n) Incentive Stock Option Agreement between the Registrant and Robert M. Leopold dated March 17, 1994 (incorporated herein by reference to exhibit 10(n) to the Registrant's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1994)\n(o) Incentive Stock Option Agreement between the Registrant and David A. Karish dated July 28, 1994 (incorporated herein by reference to exhibit 10(o) to the Registrant's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1994)\n(p) Incentive Stock Option Agreement between the Registrant and Harry Kaplowitz dated July 28, 1994 (incorporated herein by reference to exhibit 10(p) to the Registrant's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1994)\n(q) Incentive Stock Option Agreement between the Registrant and Richard T. Bueschel dated July 28, 1994 (incorporated herein by reference to exhibit 10(q) to the Registrant's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1994)\n(r) Incentive Stock Option Agreement between the Registrant and Laurence C. Glazer dated July 28, 1994 (incorporated herein by reference to exhibit 10(r) to the Registrant's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1994)\n(s) Incentive Stock Option Agreement between the Registrant and Robert M. Leopold dated July 28, 1994 (incorporated herein by reference to exhibit 10(s) to the Registrant's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1994)\n(t) Incentive Stock Option Agreement between the Registrant and Isaac M. Pollak dated July 28, 1994 (incorporated herein by reference to exhibit 10(t) to the Registrant's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1994)\nExhibit Nummber Description - --------------- -----------\n(u) Incentive Stock Option Agreement between the Registrant and Millard H. Pryor dated July 28, 1994 (incorporated herein by reference to exhibit 10(u) to the Registrant's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1994)\n(v) Incentive Stock Option Agreement between the Registrant and Robert Loane dated December 13, 1994 (incorporated herein by reference to exhibit 10(v) to the Registrant's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1994)\n(w) Incentive Stock Option Agreement between the Registrant and David A. Karish dated December 13, 1994 (incorporated herein by reference to exhibit 10(w) to the Registrant's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1994)\n(x) Incentive Stock Option Agreement between the Registrant and Harry Kaplowitz dated December 13, 1994 (incorporated herein by reference to exhibit 10(x) to the Registrant's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1994)\n(y) Incentive Stock Option Agreement between the Registrant and David Van Daele dated December 27, 1994 (incorporated herein by reference to exhibit 10(y) to the Registrant's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1994)\n(z) Non-Qualified Stock Option Plan (incorporated herein by reference to exhibit 10(z) to the registrant's annual report on Form 10-KSB for the fiscal year ended December 31, 1994)\n(aa) Non-Qualified Stock Option Agreement between Registrant and Richard T. Bueschel dated November 1, 1994 (incorporated herein by reference to exhibit 10(aa) to the Registrant's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1994)\n(bb) Non-Qualified Stock Option Agreement between Registrant and Robert M. Leopold dated November 1, 1994 (incorporated herein by reference to exhibit 10(bb) to the Registrant's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1994)\n(cc) Stock Warrant Purchase Plan (incorporated herein by reference to exhibit 10(cc) to the Registrant's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1994)\n(dd) Office Building Lease, dated April 12, 1993, for One Monument Drive (incorporated herein by reference to exhibit 10(dd) to the registrant's annual report on Form 10-KSB for the fiscal year ended December 31, 1994)\nExhibit Nummber Description - --------------- -----------\n(ee) Lease for Data Processing Services Agreement, dated July 29, 1994, between the Registrant and Financial Technologies, Inc. relating to data processing services (incorporated herein by reference to exhibit 10(ee) to the Registrant's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1994)\n(ff) Commercial Note dated February 23, 1995 between the Registrant and Crestar Bank (incorporated herein by reference to exhibit 10(ff) to the Registrant's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1994)\n(gg) 1995 Stock Option Plan (incorporated herein by reference to exhibit D to the Registrant's proxy statement dated April 10, 1995)\n(hh) Non-Qualified Stock Option Agreement between Registrant and Millard H. Pryor dated May 23,1995\n(ii) Non-Qualified Stock Option Agreement between Registrant and Laurence C. Glazer dated May 23, 1995\n(jj) Non-Qualified Stock Option Agreement between Registrant and Isaac M. Pollak dated May 23, 1995\n(kk) Employment Agreement between Registrant and Richard M. Tworek dated October 11, 1995\n(ll) Employment Agreement between Registrant and Andrew M. Fregly dated October 11, 1995\n(mm) Asset Purchase Agreement and Plan of Reorganization, dated as of October 6, 1995, among Infodata Systems Inc., Merex, Inc., Richard M. Tworek, Mary Margaret Styer and Andrew M. Fregly (incorporated herein by reference to the Registrant's Form 8-K dated October 11, 1995)\n21 Subsidiaries of the Registrant (incorporated herein by reference to exhibit 22 to the Registrant's Annual Report on Form 10-KSB for 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.\nINFODATA SYSTEMS INC.\nBY:\/s\/Harry Kaplowitz ------------------- President\nPursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and on the dates indicated.\nSIGNATURE TITLE DATE\n\/s\/Richard T. Bueschel Chairman of the Board March 28 , 1996 - ------------------------ \/s\/Laurence C. Glazer Director March 28 , 1996 - ------------------------ \/s\/Harry Kaplowitz President and Director March 28 , 1996 - ------------------------ \/s\/Robert M. Leopold Director March 28 , 1996 - ------------------------ \/s\/Isaac M. Pollak Director March 28 , 1996 - ------------------------ \/s\/Millard Pryor Director March 28 , 1996 - ------------------------\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS PAGE\nReport of Independent Public Accountants\nConsolidated Statements of Operations - Each of the two years in the period ended December 31, 1995\nConsolidated Balance Sheets - December 31, 1995 and 1994 -F-4\nConsolidated Statements of Shareholders' Equity - Each of the two years ended December 31, 1995\nConsolidated Statements of Cash Flows - Each of the two years in the period ended December 31, 1995\nNotes to Consolidated Financial Statements - December 31, 1995 -F-15\nReport of Independent Public Accountants\nTo Infodata Systems Inc.:\nWe have audited the accompanying consolidated balance sheets of Infodata Systems Inc. (a Virginia corporation) and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations, shareholders' equity and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform 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 Infodata Systems Inc. and subsidiaries as of December 31, 1995 and 1994, and the results of their operations and their cash flows for the years then ended, in conformity with generally accepted accounting principles.\nWashington, D.C. Arthur Andersen LLP March 1, 1996\nINFODATA SYSTEMS INC. AND SUBSIDIARIES\nConsolidated Statements of Operations (Dollar Amounts in Thousands, Except Per Share Data)\nYear Ended December 31,\n1995 1994 ---- ----\nRevenues $7,049 $7,502\nCost of revenues.................................. 4,166 4,087 ------- ------- Gross profit...................................... 2,883 3,415 ------- ------- Operating expenses Research and development.. .................... 187 408 Selling, general and administrative: .......... 2,657 2,482 ------- ------- 2,844 2,890\nOperating income................................. 39 525 ------- ------- Interest income.................................. 119 46\nInterest expense................................. (24) (42) ------- ------- Income before income taxes. .................... 134 529\nProvision for income taxes....................... 3 11 ------- -------\nNet income....................................... $ 131 $518 ======== ======== Preferred dividends.............................. 120 120\nNet income available to common shareholders...... $ 11 $ 398 ======== ========\nPer share: Net income per common and equivalent share.... $ .02 $ .63 ======== ========\nINFODATA SYSTEMS INC. AND SUBSIDIARIES\nConsolidated Balance Sheets (Dollar Amounts in Thousands)\nAssets December 31,\n1995 1994 ------ ------ Current assets: Cash and cash equivalents....................... $1,476 $1,725 Short term investments..... .................... 33 80 Accounts receivable, net of allowance of $30 in 1995 and 1994.... 1,901 1,437 Prepaid royalties..... ......................... 18 141 Other current assets............................ 146 140 ------ ------ Total current assets.............. ............ 3,574 3,523 ------ ------\nProperty and equipment, at cost: Furniture and equipment......................... 2,046 1,901 Less accumulated depreciation and amortization.. (1,633) (1,380) ------- ------- 413 521\nGoodwill, net of amortization of $6 in 1995..... 264 --\nOther assets.................................... 68 --\nSoftware development costs, net of accumulated amortization of $2,010 and $1,634 in 1995 and 1994. 126 499 -------- -------\nTotal assets.................................... $4,445 $4,543 -------- -------\nINFODATA SYSTEMS INC. AND SUBSIDIARIES\nConsolidated Balance Sheets (Dollar Amounts in Thousands)\nLiabilities and shareholders' equity\nDecember 31, 1995 1994 ------- ------\nCurrent liabilities: Current portion of capital lease obligations... $ 106 $ 159 Current portion of note payable................ 2 37 Accounts payable ............................. 335 241 Accrued expenses 677 689 Deferred revenue ............................. 1,171 1,589 Preferred dividend payable..................... 30 30 Current portion of deferred rent............... 33 33 ------ ------\nTotal current liabilities.................... 2,354 2,778 ------ ------ Capital lease obligations....................... 82 151 Deferred revenue................................ 192 -- Note payable.................................... -- 69 Deferred rent................................... 52 84 ------ ------ Total liabilities............................. 2,680 3,082 ------ ------ Commitments and contingencies (Note 8)\nShareholders' equity:\nPreferred stock, $1.00 par value, 500,000 shares authorized; 131,500 and 133,500 issued and outstanding ($1,523 and $1,545 involuntary liquidation preference)in 1995 and 1994, respectively.................................. 132 134\nCommon stock, $.03 par value, 3,333,333 shares authorized; 732,668 and 602,374 shares issued and outstanding in 1995 and 1994...................................... 22 18\nAdditional paid-in capital..................... 8,078 7,787 Accumulated deficit........ ................... (6,467) (6,478) ------- ------- Total shareholders' equity..................... 1,765 1,461 ------- -------\nTotal liabilities and shareholders' equity..... $4,445 $4,543 ------- -------\nINFODATA SYSTEMS INC. AND SUBSIDIARIES\nConsolidated Statements of Shareholders' Equity (Dollar Amounts in Thousands)\nINFODATA SYSTEMS INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements As of December 31, 1995 and 1994\nNOTE 1. Summary of Significant Accounting Policies\nBasis of Presentation\nThe accompanying consolidated financial statements include the accounts of Infodata Systems Inc. and its wholly-owned subsidiaries, Infodata Systems International Inc. and Infodata Research and Development Corporation. These entities are collectively referred to herein as the \"Company\". All significant intercompany accounts and transactions have been eliminated in consolidation.\nCertain reclassifications have been made to 1994 balances to conform to the current year presentation.\nNature of Business\nThe Company provides complete Electronic Document Management System (\"EDMS\") solutions through the sale of products and software integration services. Sales to the United States government represent a significant portion of the Company's revenue.\nUse of Estimates\nThe Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities, the disclosure of contingent liabilities and the reporting of revenues and expenses to prepare these financial statements in conformity with Generally Accepted Accounting Principles. Actual results could differ from those estimates.\nRevenue Recognition\nSoftware Licenses -- The Company recognizes revenue from sales of software licenses upon delivery of the software product to the customer, or upon customer acceptance if a trial period exists.\nPost Contract Customer Support and Software Services -- Revenues from post contract support, including revenue bundled with the initial license fee, are recognized ratably over the period customer support services are provided. Software services revenue is recognized as performed.\nConsulting and Professional Service Contracts -- Revenues from consulting and professional service contracts are recognized on the percentage-of-completion method for fixed price agreements and on the basis of hours incurred at contract rates for time and material agreements. Revenues from cost reimbursement contracts are recognized as costs are incurred.\nRevenues from foreign customers totaled approximately $594,000 and $758,000 for the years ended December 31, 1995 and 1994, respectively.\nINFODATA SYSTEMS INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements As of December 31, 1995 and 1994\nCash Equivalents and Short Term Investments\nAll highly liquid investments with an original maturity of 90 days or less at time of purchase are considered to be cash equivalents. At December 31, 1995 and 1994, the Company had $1,269,000 and $752,000, respectively, of cash equivalents invested in commercial paper. At December 31, 1995 and 1994, the Company had certificates of deposit included in short term investments totaling $33,000 and $80,000, respectively, which were restricted pursuant to certain capital lease obligations.\nSupplemental Disclosures of Cash Flow Information\nCash payments for interest totaled $22,000 and $42,000 in 1995 and 1994, respectively. Cash payments for income taxes totaled $7,000 and $2,000 in 1995 and 1994, respectively.\nIn 1994, the Company incurred capital lease obligations totaling $60,000, for various computer and office equipment.\nIn connection with the transaction with the Open Text Corporation discussed in Note 6, prepaid royalties carried at $0 and $141,000 at December 31, 1995 and 1994, respectively, are included on the accompanying consolidated balance sheet. These prepaid royalties were financed in-part through the issuance of a non-interest bearing note payable with balances totaling $0 and $100,000 at December 31, 1995 and 1994, respectively.\nProperty and Equipment\nProperty and equipment is depreciated using the straight-line method over estimated useful lives ranging from three to six years. Leasehold improvements are amortized over the shorter of the useful life of the asset or the lease term.\nGoodwill\nGoodwill is amortized using the straight-line method over a life of 10 years. On a periodic basis, the expected future undiscounted cash flows are compared with the carrying value of goodwill to test for potential impairment. The amount of goodwill impairment, if any, would be measured based on the projected discounted cash flows using a discount rate reflecting the Company's average cost of funds. The Company believes that this policy is consistent with Statement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of,\" and that adoption of this statement will not have a material impact on the Company's financial position or results of future operations.\nResearch and Development\nResearch and development costs are expensed as incurred.\nINFODATA SYSTEMS INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements As of December 31, 1995 and 1994\nNet Income Per Common Share\nFor the year ended December 31, 1995, the weighted average number of common and common equivalent shares used in the calculation of net income per share was approximately 627,000. In 1994, the modified treasury stock method was used in calculating primary and fully-diluted net income per share due to the fact that the weighted average outstanding common stock options and common stock warrants exceeded 20% of the common shares outstanding. The weighted average number of common and common equivalent shares outstanding, which was utilized in the calculation of net income per share totaled approximately 658,000 for the year ended December 31, 1994. Net income for the years ended December 31, 1995 and 1994 have been decreased for preferred stock dividends of $120,000 to arrive at net income available to common shareholders. As required under the modified treasury stock method, $17,000 of net interest income, net of income taxes, has been added to net income for the year ended December 31, 1994, to arrive at net income available to common shareholders. With regard to the calculation of fully-diluted net income per share for the year ended December 31, 1994, the calculation of common stock equivalents under the modified treasury stock method coupled with the assumption of the conversion of the preferred stock and resultant elimination of preferred stock dividends is antidilutive when compared to primary net income per share.\nConversion of the preferred stock and resultant elimination of preferred stock dividends is antidilutive when compared to primary net income per share for the year ended December 31, 1995.\nSignificant Customers\nSales to United States government agencies totaled approximately $2,586,000 and $3,289,000 in 1995 and 1994, respectively. As of December 31, 1995 and 1994, accounts receivable due from United States government agencies amounted to approximately $678,000 and $753,000, respectively.\nNOTE 2. Business Acquisition\nOn October 11, 1995, the Company consummated its purchase of substantially all of the assets and the assumption of certain liabilities of Merex, Inc. (\"Merex\") in consideration for 105,000 shares of the Company's common stock (restricted as to sale) with a fair value estimated by the Company's Board of Directors at $2.25 per share. The total acquisition cost was approximately $319,000 including direct costs of acquisition. Approximately $60,000 was allocated to acquired identified intangibles, $270,000 to goodwill including purchase accounting adjustments of approximately $25,000 relating to termination of the Merex office lease. Merex was engaged in the business of marketing and delivering of electronic document management solutions to businesses and the government.\nThe unaudited proforma financial information presented below reflects the acquisition of Merex as if the acquisition had occurred on January 1, 1994. These results are not necessarily indicative of future operating results or of what would have occurred had the acquisitions been consummated at that time:\nINFODATA SYSTEMS INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements As of December 31, 1995 and 1994\n(Unaudited) December 31,\n1995 1994 ---- ----\nRev $8,888 $9,675 Net income 89 659 Less Preferred Dividends (120) (120) Net income (loss) available to common shareholders (31) 539 Earnings (loss) per share $(0.05) $ 0.73\nNOTE 3. Software Development Costs\nCapitalization of software development costs begins upon the establishment of technological feasibility. Capitalization ceases when the products are available for general release to customers. The establishment of technological feasibility and the continuing assessment of recoverability of capitalized software development costs requires considerable judgment by management with respect to certain external factors, including, but not limited to, anticipated future gross revenue, estimated economic life and changes in software and hardware technologies. Amortization expense is determined on an individual product basis and is computed as the greater of the amount calculated on a revenue basis or straight-line basis over the economic life of the product, generally three to five years. Amortization of software development costs is included in cost of revenues in the accompanying consolidated statements of operations.\nThe following summarizes costs capitalized and related charges for amortization during 1995 and 1994 in the accompanying consolidated financial statements:\nYears ended December 31,\n1995 1994 ---- ----\nCosts capitalized........ $3,000 $165,000\nAmortization............. (376,000) (448,000) ---------- ---------- Net cost amortized....... $(373,000) $(283,000) ---------- ----------\nPeriodically, the Company reviews the estimated lives of and amounts assigned to software development costs. In light of changing technology, the Company makes revisions to estimated lives and adjusts amounts assigned as appropriate. The Company will extend the remaining amortization period at December 31, 1995 through 1998 to reflect the continued longevity of the INQUIRE product as reflected by the substantial revenue stream associated with maintenance renewals. The impact of such revision in estimated remaining useful life will increase net income by approximately $22,000 in 1996.\nNOTE 4. Income Taxes\nAt December 31, 1995, the Company had approximately $5,201,000 in net operating loss carry-forwards for income tax reporting purposes. The operating loss carry forwards expire in varying amounts from 1998 through 2008. In addition, at December 31, 1995, the Company had $141,000 in research and development tax credit carry-forwards expiring in 1996 and 1997, and $66,000 in investment tax credit carry forwards expiring in 1996 through 2000.\nINFODATA SYSTEMS INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements As of December 31, 1995 and 1994\nThe actual income tax expense attributable to pretax income for the year ended December 31, 1995 and December 31, 1994, respectively, differed from the amount computed by applying the U.S. Federal statutory rate of 34 percent as a result of the following: 1995 1994 ---- ----\nTax at statutory rate..................... $ 46,000 $ 180,000 Benefit of operating loss carry-forwards.. (55,000) (190,000) Miscellaneous items....................... 9,000 10,000 Alternative Minimum Tax................... 3,000 11,000 --------- ----------- $3,000 $11,000 --------- -----------\nThe 1995 and 1994 provision for income taxes relates solely to the currently payable federal alternative minimum tax.\nThe significant components of net deferred tax (liabilities) assets are as follows as of December 31, 1995 and 1994.\n1995 1994 ---- ----\nDeferred tax liabilities: Net software development costs............... $(48,000) $(189,000) Other........................................ (10,000) -- --------- ---------- (58,000) (189,000)\nDeferred tax assets: Net operating loss carry-forward............. 1,974,000 2,129,000 Investment tax credit and research and development tax credits carry forward........ 207,000 207,000 Other........................................ 55,000 92,000 ---------- ----------- 2,236,000 2,428,000\nNet deferred tax asset before valuation allowance..................................... 2,178,000 2,239,000\nValuation allowance............................ (2,178,000) (2,239,000) ----------- ------------ Net deferred tax asset...................... $ -- $ --\n----------- ------------\nUnder the provisions of SFAS No. 109, the tax effect of the net operating loss and investment tax credit carry-forwards, together with net temporary differences, represents a net deferred tax asset against which management has fully reserved due to the uncertainty of future taxable income. The carry-forwards will be benefited for financial reporting purposes when utilized to offset future taxable income.\nINFODATA SYSTEMS INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements As of December 31, 1995 and 1994\nNOTE 5. Disclosures About Fair Value of Financial Instruments\nFinancial instruments are defined as cash, evidence of an ownership interest in an entity or a contract that imposes an obligation to deliver cash or other financial instruments to a second party. The carrying amounts of current assets and current liabilities approximate fair value due to the short maturity of these instruments.\nNOTE 6. Notes Payable\nDuring 1993, the Company entered into an agreement with Open Text Corporation (\"OTC\") whereby the Company acted as a reseller of OTC's text retrieval software. Under the terms of the agreement, the Company incurred a note payable for certain non-refundable royalties. Due to the Company's concern with OTC's product performance and timely delivery of new releases, and the attendant customer dissatisfaction, the Company terminated the reseller agreement during the second quarter of 1995 and negotiated cancellation of the remaining balance of the note during the third quarter of 1995.\nIn February, 1995, the Company entered into a working capital line of credit with a regional bank. This loan facility provides the Company with a $500,000 line of credit. Advances on the facility are based upon eligible billed accounts receivable less than 90 days in age. The facility expires in April, 1996, and is contingent upon the company meeting certain financial covenants, which have been met. There were no borrowings on the line of credit during 1995.\nNOTE 7. Shareholders' Equity\nPreferred Stock\nAs of December 31, 1995, 131,500 shares of convertible preferred stock were outstanding. These preferred shares have the following provisions:\nCumulative, preferential dividends are to be paid quarterly, if declared by the Board of Directors at an annual rate of 9% ($.90 per share)\nThe option to convert one share of preferred stock for 1.111 common shares\nFull voting rights, to the extent of common shares that would be held upon conversion\nPreference in the distribution of corporate assets up to $10.00 per share plus cumulative unpaid dividends\nAll or part (at least 25%) of the preferred stock is redeemable at the option of the Company at a price of $10.00 per share\nDividends on preferred stock are paid upon declaration by the Board of Directors. Cash dividends of $120,000 ($0.90 per preferred share) were declared during 1995 and $60,000 ($0.45 per share) in 1994. No cash dividends were paid for any quarterly period beginning with the fourth quarter of 1992 and ending with the second quarter of 1994; therefore, dividend arrearage on cumulative preferred stock as of December 31, 1995, totaled approximately $208,000 ($1.58 per preferred share).\nINFODATA SYSTEMS INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements As of December 31, 1995 and 1994\nOptions and Warrants\nIn April 1995, the Company's shareholders approved the adoption of the 1995 Stock Option Plan (the \"1995-Plan\") which consolidates and is the successor to the Company's Incentive Stock Option Plan approved by shareholders in 1991 and the Non-Qualified Stock Option Plan approved in 1992 (together, the \"Predecessor Plans\"). Options have been granted to employees as well as members of the Board of Directors. The 1995 Plan also provides for the automatic granting of a fixed number of options each year to members of the Compensation Committee of the Company's Board of Directors, and increases the total issuance upon the exercise of options from the 333,333 shares previously authorized to 433,333 shares.\nUnder the 1995 Plan, options may be granted at prices not less than 100% of the fair market value of the common stock at the date of the grant. Options vest over varying years of service. Vested options are exercisable until the earlier of ten years from the date of grant or three months after termination of employment for options granted under the Predecessor Plans, five years from the date of grant or one month after termination of employment for options issued under the 1995 Plan. At December 31, 1995, 185,500 options to purchase shares of common stock were exercisable.\nAs of December 31, 1995, warrants remained outstanding for the right to purchase 6,667 shares of common stock issued to certain members of the Board of Directors and to certain non-affiliated parties. These warrants, which are exercisable for seven years from date of grant, are exercisable upon grant. Warrants to purchase an additional 3,333 shares of common stock are authorized for future issuance.\nAs of December 31, 1995, the Company has reserved a total of approximately 589,000 shares of common stock for future issuance arising from the conversion of preferred stock, exercise of stock options, and exercise of stock warrants.\nA summary of option and warrant activity under the 1995 Plan and the Predecessor Plans is presented below:\nNumber of Equivalent Shares\nIncentive Stock Non-Qualified Option Stock Options Warrants\nOutstanding at December 31, 1993... 182,200 16,667 6,667 Granted........................... 90,231 34,000 -- Exercised......................... -- -- -- Expired or canceled............... (46,940) (13,333) -- -------- -------- ------- Outstanding at December 31, 1994... 225,491 37,334 6,667 Granted........................... 12,500 6,000 -- Exercised......................... (18,721) -- -- Expired or canceled............... (61,187) -- -- -------- -------- ------ Outstanding at December 31, 1995... 158,083 43,334 6,667 ------- ------ ------\nExercise price............ $2.53 to $13.11 $3.06 to $4.88 $5.07 to $6.38\nINFODATA SYSTEMS INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements As of December 31, 1995 and 1994\nSFAS No. 123, \"Accounting for Stock-Based Compensation\" establishes financial accounting and reporting standards for stock-based employee compensation plans, including stock options and restricted stock. Effective for the Company's 1996 financial statements, this pronouncement encourages the use of a fair value based method of accounting for employee stock options which measures compensation cost at the grant date based on the value of the award and is recognized over the service period. The statement still allows the intrinsic value method used by the Company. Management expects to maintain the same method of accounting for its stock options and will provide the necessary additional disclosures.\nNOTE 8. Commitments and Contingencies\nCapital Lease Obligations\nThe Company leases certain fixed assets under long-term capital lease agreements. These assets are included in the accompanying consolidated balance sheets as follows:\nDecember 31,\n1995 1994 ---- ----\nProperty and equipment............ $580,000 $633,000 Less accumulated depreciation and amortization................ (403,000) (345,000) --------- --------- $177,000 $288,000 --------- ---------\nDepreciation and amortization of these assets, computed using the straight-line method over the shorter of the useful lives of the assets or the term of the lease obligation.\nThe future maturities of capital lease obligations as of December 31, 1995, are as follows:\n1996.............................................. $117,000 1997.............................................. 52,000 1998.............................................. 28,000 1999.............................................. 6,000 -------- Total minimum payments........................ 203,000\nLess amount representing interest................ (15,000) --------- Present value of minimum lease payments........... 188,000 Less current portion.............................. (106,000) --------- Long-term portion................................. $82,000 ---------\nOperating Leases\nEffective August 1, 1993, the Company entered into a lease for its corporate headquarters facility in Fairfax, Virginia. This lease expires July 31, 1998. Under the terms of the lease, the landlord provided various incentives, which have been deferred and classified as deferred rent in the accompanying consolidated balance sheets. This amount will be amortized over the life of the lease.\nINFODATA SYSTEMS INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements As of December 31, 1995 and 1994\nDuring 1995 and 1994, the Company incurred an annual rent expense of $297,000 and $294,000 for office facilities. Commitments under the Fairfax, Virginia office facilities lease amount to approximately $300,000 annually.\nEffective September, 1994, the Company entered into a three year agreement with a third party to procure outside mainframe-related data processing services. The Company incurred $84,000 in expenses in 1994 relating to the termination of an operating lease for equipment entered into in May 1992, and migration expenses resulting from the outsourcing. The new agreement is non-cancelable over the first two years and becomes cancelable beginning in the third year with a penalty equal to $4,000 times the number of months remaining in the third year. The minimum annual commitment under this agreement amounts to $120,000.\nEmployee Benefit Plans\nIn 1988, the Company established an employee benefit plan (the \"Benefit Plan\") which qualifies under Section 401-(k) of the Internal Revenue Code. The Benefit Plan allows salaried employees to contribute a part of their compensation toward their retirement on a tax deferred basis. Company contributions equate to 10% of the employee's contribution to the Benefit Plan and totaled approximately $23,000 in 1995 and $15,000 in 1994. In addition to the aforementioned contributions, the Company, at the sole discretion of its Board of Directors, may make profit sharing contributions into the Benefit Plan; no contributions were made in 1995 or 1994.\nContingencies\nFrom time to time, the Company receives complaints from former employees concerning personnel issues. In the opinion of management, the ultimate outcome of any present matters will not have a material impact on the Company's financial position or future results of operations.\nCosts charged to cost type U.S. Government contracts are subject to annual audit by the Defense Contract Audit Agency or other duly authorized representatives of the Federal Government. No audits have been completed for any periods commencing after September 30, 1987, and in the opinion of management, adjustments resulting from the completion of such audits are not expected to have a material impact on the Companys financial position or future results of operations.\nRelated Party Transactions\nThe Company incurred management consulting fees of approximately $168,000 and $90,000 in 1995 and 1994, respectively, for services rendered by certain Directors of the Company. Amounts payable to such Directors was $15,000 and $-0- at December 31, 1995 and 1994, respectively.\nThe Company issued 4,000 shares of restricted common stock to a Director in consideration for services rendered during 1995.","section_14":"","section_15":""}
{"filename":"21438_1995.txt","cik":"21438","year":"1995","section_1":"Item 1. Business\n(a) Cognitronics Corporation (the Company) was incorporated in January 1962 under the laws of the State of New York. The Company designs, manufactures and markets voice processing systems.\n(b) The Company operates in one industry segment: voice processing products.\n(c) (i) A description of the fields of voice processing in which the Company operates and its products are as follows:\nPassive Announcers. These announcers are used by the telephone operating companies to inform callers about network conditions or procedures. The Company has been a major supplier to telephone companies of passive announcers, such as the Company's Speech Recorder\/Announcer (SRA), Automatic Number Announcer (ANA) and the McIAS(TM) 1500. The McIAS 950, introduced in 1995, is also capable of use as a passive announcer. These products are generally sold to telephone companies directly.\nIntelligent Announcers. The Company's McIAS 1100 and 2100 have been primarily used by the telephone companies to provide voice announcements in connection with custom calling features (CLASS), such as selective call forwarding and caller originator trace. Number change intercept is another important feature provided. These products are sold to telephone switch manufacturers and to telephone companies directly.\nIntroduced in 1994, a new generation of central office grade systems became available. Known as the McIAS 1607 and 1610, these systems provide a flexible voice platform which delivers enhanced features to the telephone network. Features include all those provided by the Company's earlier products as well as partitioning for multiple end users, music on hold, message on hold and Centrex ACD announcements. The Company sales effort is to not only sell this equipment into new installations, but also to transition existing customers from the McIAS 1100 and 2100 to these new products.\nA continuing evolution of these products can be expected in 1996. Introduced in the first quarter of 1995 were the McIAS 950 and 1685, and UNIX(R) based versions of the McIAS 1607 and 1610, named McIAS 1607\/IP and 1610\/IP. A new, larger capacity member of the product family, McIAS 1623\/IP, was introduced in October. The McIAS 950 and 1685 are fixed application systems designed to deliver important features to the market at low price points. The UNIX, RISC CPU-powered McIAS 16xx\/IP series will provide the ability to run multiple applications for multiple users simultaneously. Application examples will include number change with call completion, automated attendant, interactive voice response, fax, voice mail, audiotex, a graphical service creation environment and a number of application programming interfaces (APIs). All earlier installations of the McIAS 16xx series are fully upgradable to the UNIX version. Additionally, a new digital interface card is planned for introduction later in 1996. This new card will utilize the robust VMEbus architecture and will further enhance the Company's ability to deliver the scalable, advanced functionality required in the Advanced Intelligent Network (AIN). The Company believes that this technology will provide for a successful entry into the Intelligent Peripheral and wireless markets. Call Processing Systems. The Company's McIAS 950 is also an automated attendant and audiotex system with the flexibility to offer the caller various choices (dial and extension, talk to an operator, etc.) and provides menu- selected information. Another product, DART(R), offers automated attendant features in a single line, low cost system.\nEuropean Distributorship Operations. Dacon Electronics Plc., based in Hertfordshire, England, distributes call management and other voice processing products, including products manufactured by the Company, in Europe.\n(ii) Status of publicly announced new products or industry segments requiring material investment. Inapplicable.\n(iii) The Company has adequate sources for obtaining raw materials, components and supplies to meet production requirements and did not experience difficulty during 1995 in obtaining such materials and components; however, the components for the Company's older products, such as the McIAS 2100, are becoming more difficult to obtain. It is management's intention to transition existing and potential customers from the McIAS 2100 to more current products.\n(iv) The Company relies on technological expertise, responsiveness to users' needs and innovations and believes that these are of greater significance in its industry than patent protection. There can be no assurance that patents owned or controlled by others will not be encountered and asserted against the Company's voice processing products or that licenses or other rights under such patents would be available, if needed. The Company has registered trademarks and names which the Company considers important in promoting the business of the Company and its products.\n(v) Seasonality. Inapplicable.\n(vi) The discussion of liquidity and sources of capital as set forth in Management's Discussion and Analysis of Financial Condition and Results of Operations is included in Item 7 of this Annual Report on Form 10-K and is incorporated herein by reference.\n(vii) In 1995, revenues included sales to Northern Telecom, Inc. of $3.5 million and sales of $2.7 million to GTE Corp. The Company's U.K. operation had sales of $5.5 million to British Telecommunications Plc in 1995. Over the past several years, a major portion of the revenues of the domestic operations typically came from up to five or six large customers, but the identity of these customers has generally changed within each three or four year period. Accordingly, any dependence on one customer has tended to be of short duration. Substantially all of the revenues of the UK operation come from one customer, the loss of which could have a material adverse impact on the Company's results of operations.\n(viii) The dollar amount of orders believed by the Company to be firm as of December 31, 1995 and 1994, amounted to $1.4 million and $1.3 million, respectively. Substantially all of the orders as of December 31, 1995, can reasonably be expected to be filled during 1996.\n(ix) Business subject to renegotiation. Inapplicable.\n(x) The Company competes, and expects to compete, in fields noted for rapid technological advances and the frequent introduction of new products and services. The Company's products are similar to those manufactured, or capable of being manufactured, by a number of companies, some of which are well- established corporations with financial, personnel and technical resources substantially larger than those of the Company. The Company's ability to compete in the future depends on its ability to maintain the technological and performance advantages of its current products and to introduce new products and applications that achieve market acceptance. Future research and development expenditures will be based, in part, on future results of operations. There are no assurances that the Company will be able to successfully develop and market new products and applications.\n(xi) Expenditures for research and development activities of continuing operations, as determined in accordance with generally accepted accounting principles, amounted to $1.5 million in 1995 and 1994, and $2.3 million in 1993. In addition, the estimated dollar amount spent on the improvement of existing products or techniques and customer-sponsored research activities relating to the development of new products and techniques was $.1 million in 1995 and 1994, and $.2 million in 1993.\n(xii) Material effects of compliance with Federal, State or local provisions regulating the discharge of materials into the environment or otherwise relating to the protection of the environment. Inapplicable.\n(xiii) At December 31, 1995, the Company and its subsidiaries employed 80 people.\n(d) Sales to foreign customers primarily represent sales of Dacon Electronics Plc. (incorporated in the United Kingdom) of $7.5 million in 1995, $4.8 million in 1994 and $3.8 million in 1993. Additional information about foreign operations is included in Note M to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K and is incorporated herein by reference.\nFurther, there were export-type sales (primarily North America) of approximately $.1 million in 1995, $.2 million in 1994 and $.1 million in 1993. Export sales do not involve any greater business risks than do sales to domestic customers and in certain instances, the Company obtains an irrevocable letter of credit or payment prior to shipment of products to the customer. Selling prices and gross profit margins on export-type sales are comparable to sales to domestic customers.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe facilities of the Company and its subsidiaries are located as follows: Square Lease Expiration Location Description Feet Date - -------- ----------- ------ ---------------- Danbury, Connecticut: Office,engineering, 40,000 10\/31\/03 3 Corporate Drive production and service facility\nHemel Hempstead Office, distribution Hertfordshire, and service facility 4,000 Owned (1) United Kingdom 2,500 8\/18\/96 (1) Sovereign Park, Cleveland Way (1) Due to the growth of the Company's U.K. operations, the Company is currently negotiating the terms and conditions of a five-year lease for a new facility in Hemel Hempstead, Hertfordshire, U.K.\nExcept as noted in (1), the Company considers each of these facilities to be in good condition and adequate for the Company's business.\nItem 3.","section_3":"Item 3. Legal Proceedings\nIn 1993, purported class action lawsuits were filed against the Company and certain of its officers as follows:\n1. Michael Germano v. Cognitronics Corporation and Matthew J. Flanigan in the United States District Court, District of Connecticut, dated March 15, 1993;\n2. Barry L. Bragger and Eve Gerber vs. Matthew J. Flanigan and Cognitronics, Inc. in the United States District Court, District of Connecticut dated March 16, 1993; and\n3. John M. Mitnick, on behalf of himself and all other similarly situated v. Cognitronics Corp., Matthew J. Flanigan and G. Sullivan in the United States District Court for the Northern District of Georgia, Atlanta Division, dated March 15, 1993.\nThese actions were consolidated in the United States District Court in Connecticut and a consolidated amended complaint was filed on July 8, 1993. The consolidated lawsuit alleges securities law violations in connection with the purchase of the Company's common stock by members of the purported classes during the period from October 29, 1992 through March 12, 1993. The plaintiffs seek unspecified damages and related costs. On July 28, 1993, the Company and the other defendants filed a motion to dismiss the consolidated amended complaint. After briefing by the parties, the motion was submitted to the Court in October 1993 and since that time has been sub judice. On July 28, 1993, defendants moved to stay discovery pending resolution of defendants' motion to dismiss. On October 7, 1994, the Court denied that motion. Since that time the parties have engaged in limited discovery. The Company has denied any wrongdoing and believes it has presented viable grounds to support the motion to dismiss. Management has not made provision for liability which may result from this litigation, if any, in the financial statements of the Company.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nInapplicable.\nExecutive Officers of the Company\nThe executive officers of the Company, their positions with the Company and ages as of March 26, 1996 are as follows:\nName Position(s) and Office(s) Age ---- ------------------------- --- Brian J. Kelley President and Chief Executive Officer; Director 44 Kenneth G. Brix Vice President 49 Harold F. Mayer Secretary 66 Michael N. Keefe Vice President 40 Roy A. Strutt Vice President, Director 39 Garrett Sullivan Treasurer and Chief Financial Officer 50 Emmannuel A. Zizzo Vice President 55\nNo family relationships exist between the executive officers of the Company. Each of the executive officers was elected to serve until the next annual meeting of the Board of Directors or until his successor shall have been elected and qualified.\nMr. Kelley has been President and Chief Executive Officer of the Company since January 1994. Prior to that he was Executive Vice President of TIE\/Communications, Inc. from 1991 to 1994 with responsibility for business development, acquisitions and product management, President of CTG Inc., a subsidiary of TIE\/Canada, Inc., from 1990 to 1991 and President of TIE National Accounts, Inc., a subsidiary of TIE\/Communications, Inc., from 1986 to 1990.\nMr. Brix became a Vice President of the Company in March 1994 with responsibility for U.S. sales and marketing. Prior to that he was Director of Sales and Marketing of Syntellect Network Systems, Inc. from December 1993 to March 1994, Regional Vice President of Voicetek Corp. from 1990 to 1993 and President of Voicecom Associates, Inc. from 1987 to 1990.\nMr. Mayer has been Secretary of the Company since 1975. He was Treasurer from 1974 to 1989 and a Vice President of the Company from 1986 to 1996.\nMr. Keefe has been a Vice President of the Company since 1993 with responsibility for engineering, prior to which he was Manager of Software Planning and Development from 1992 until 1993 and senior engineer for more than five years. He has been employed by the Company since 1980.\nMr. Strutt became Vice President of the Company July 1994 with responsibility for European operations. Since 1994, he has been Managing Director of Dacon Electronics Plc, which was acquired by the Company in 1992, and Director of Sales and Operations from 1990 through 1994. Prior to that he was Managing Director of Automatic Answering Ltd. for four years.\nMr. Sullivan has been Treasurer and Chief Financial Officer of the Company since 1989. Prior to that he was Treasurer and Chief Financial Officer of Fundsnet, Inc., an electronic funds transfer company, from 1986 until 1989. He was employed by The Singer Co. from 1977 to 1986, where his most recent position was Vice President-Finance, Asia Division.\nMr. Zizzo became a Vice President of the Company in March 1995 with responsibility for operations, primarily manufacturing, purchasing and physical facilities, prior to which he had been Director of Operations since May 1994. He was an independent consultant from 1993 to April 1994. Prior to that he was a Vice President of TIE\/Communications, Inc., from 1991 to 1992, a Vice President of CTG Inc., a subsidiary of TIE\/Canada, Inc., from 1990 to 1991 and Director of Customer Support Services of TIE\/Communications, Inc. for more than five years. PART II\nItem 5.","section_5":"Item 5. Market for Company's Common Equity and Related Stockholder Matters\n(a) and (b) Cognitronics' stock is traded on the American Stock Exchange under the symbol CGN. On March 1, 1996 there were 1,060 shareholders of record. Information on quarterly stock prices is set forth in Item 8 of this Annual Report on this Form 10-K and is incorporated herein by reference.\n(c) The Company has never paid a cash dividend on its Common Stock and has used its cash for the development of its business. The Company has no present intention of paying a cash dividend, and payment of any future dividends will depend upon the Company's earnings, financial condition and other relevant factors.\nItem 6.","section_6":"Item 6. Selected Financial Data Year ended December 31, (in thousands except per share data) - -------------------------------------------------------------------------------- OPERATING RESULTS 1995 1994 1993 1992 1991 - -------------------------------------------------------------------------------- Revenues $17,485 $14,576 $16,417 $16,178 $14,618 Income (loss) from continuing operations 1,321 (297) (1,942) 1,915 796 Income (loss) from discontinued operations (386) (277) 45 Extraordinary credit 121 Cumulative effect of accounting changes (471) Net income (loss) 1,321 (297) (2,799) 1,638 962 Income (loss) per share: Continuing operations $.39 ($.09) ($.60) $.59 $.24 Discontinued operations (.12) (.08) .02 Extraordinary credit .04 Cumulative effect of accounting changes (.15) Net income (loss) .39 (.09) (.87) .51 .30 Weighted average number of common shares outstanding 3,424 3,144 3,206 3,240 3,223 - -------------------------------------------------------------------------------- FINANCIAL POSITION - -------------------------------------------------------------------------------- Working capital $ 7,374 $ 4,956 $ 2,726 $ 6,664 $ 6,551 Total assets 15,040 14,180 15,449 16,670 11,249 Common stock subject to repurchase 1,250 1,250 1,400 Stockholders' equity 9,044 7,042 7,193 10,698 8,372 Stockholders' equity per share $2.63 $2.25 $2.37 $3.42 $2.81 Cash dividends paid None None None None None - --------------------------------------------------------------------------------\nEffective the close of business December 31, 1991, the Company disposed of its scanning systems products and related maintenance business.\nOn November 13, 1992, The Company acquired all the outstanding stock of Dacon Electronics Plc.\nThe above Selected Financial Data should be read in conjunction with the Consolidated Financial Statements of the Company, including the notes thereto, and the unaudited quarterly financial data included in Item 8 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\nThe Company reported net income of $1.3 million for 1995 versus net losses of $.3 million in 1994 and $2.8 million in 1993, principally due to increased sales and reduced expenses.\nSales increased $2.9 million (20%) to $17.5 million in 1995 versus $14.6 million in 1994, primarily due to increased sales of $2.7 million in its UK distributorship operations. Sales of domestic operations increased $.2 million due to sales of McIAS upgrade kits ($2 million) and higher volumes of McIAS 16xxs and 2100s substantially offset by lower sales of McIAS 1100s and 1500s. Gross margins increased $2.4 million (35%) to $9.2 million in 1995 from $6.8 million 1994. Gross margins of the UK distributorship operations increased $1.8 million due to higher volume and improved product mix; the domestic operations gross margin increased $.9 million due to improved product mix. The sales of the UK distributorship operations, in all years, were principally to one customer. Loss of this customer would have an adverse impact upon the Company's operations.\nIn 1994, sales decreased $1.8 million (11%) to $14.6 million from $16.4 million in 1993, primarily due to lower sales of the domestic operations, $2.8 million, resulting from lower sales volume of McIAS 2100s and McIAS 1100s offset, in part, by higher volume of McIAS 1500s and McIAS 1600 series products. This decrease was offset by an increase of $1 million in sales of the Company's UK distributorship operations due to increased volume. Gross margin decreased $.9 million (12%) from the prior year principally due to lower sales volume and unfavorable sales product mix of the Company's domestic operations, $2.1 million, offset by a reduction of $.6 million for inventory provisions and by an increase of $.5 million in the gross margin of its UK distributorship operations due to higher sales volume, improved mix and lower costs.\nIn 1995, research and development expense was comparable to the prior year; however, the Company anticipates increased expenditures in 1996. Research and development decreased $.8 million, or 35%, in 1994 from 1993 primarily due to reduced utilization of outside consultants and lower headcount.\nSelling, general and administrative costs decreased $.1 million (2%) in 1995 due to a decrease of $.5 million in the domestic operations, attributable to lower personnel costs offset by a $.4 million increase in the UK distributorship operations primarily attributable to higher personnel costs. Selling, general and administrative expenses decreased $1 million (17%) in 1994 from 1993 due to the consolidation of US operations in late 1993, headcount reductions and lower advertising expenses; also, during 1994, the Company curtailed certain retirement and post-retirement benefit plans reducing the net periodic expense by approximately $.2 million from the prior year levels.\nOther expense, net, increased $.1 million in 1995 as compared to 1994 and decreased by $1 milion in 1994 as compared to 1993 (see Note H to the Consolidated Financial Statements).\nThe provision for income taxes is discussed in Note G to the Consolidated Financial Statements. Under Financial Accounting Standards Board (\"FASB\") Statement No. 109, the Company has recognized future tax benefits that management believes will be realized. In order to realize this benefit, the Company, exclusive of the results of Dacon Electronics Plc, will have to generate pretax income of $3.8 million. The current deferred tax benefit of $.5 million is primarily attributable to inventory provisions and the recognition of such loss, for tax purposes, is, in large measure, within the control of the Company. The non-current tax benefit, $.8 million, primarily relates to deferred compensation and benefit plans and, as such, would be recognized over a long period of time. The Company's U.S. pretax income (loss) from continuing operations was $1.0 million, $(.3) million and $(1.5) million in 1995, 1994 and 1993, respectively. In 1994, the benefit of cost reduction programs initiated in 1993 and 1994 were not fully realized and included in the 1993 loss were additional inventory provisions, severance expense and writedown of assets, aggregating approximately $1.5 million. The losses in 1994 and 1993 also reflect a decline in the demand for the Company's McIAS 2100 series of products. The Company anticipates additional revenue contributions from the introduction of new products at varying price feature points and upgrade programs for the large installed base of the McIAS systems. Based on this and the full impact of cost reduction programs already instituted, management anticipates that the Company will generate sufficient taxable income in the future to realize these benefits.\nThe effect of inflation has not had a major impact on the operating results of the Company over the past few years. However, technological advances and productivity improvements are continually being applied to reduce costs, thus reducing inflationary pressures on the operating results of the Company.\nIn 1993, the Company adopted FASB Statement No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (see Note J to the Consolidated Financial Statements), and FASB Statement No. 109, \"Accounting for Income Taxes\" (see Note G to the Consolidated Financial Statements). The adoption of these accounting standards resulted in a cumulative net, after-tax charge of $471,000.\nAlso in 1993, the Company disposed of its machined parts segment resulting in an after-tax loss of $386,000 (see Note N to the Consolidated Financial Statements).\nLiquidity and Sources of Capital\nNet cash flow from operations was $2.3 million in 1995 and $.9 million in 1994 and 1993.\nWorking capital increased to $7.4 million at December 31, 1995 from $5.0 million at December 31, 1994. Working capital was $2.7 million at December 31, 1993. The ratio of current assets to current liabilities increased to 3.3:1 at December 31, 1995 from 2.2:1 at December 31, 1994 and 1.6:1 at December 31, 1993. The increase in 1995 is primarily due to improved operating results.\nIn 1995, the Company used cash flows from operations to reduce debt and common stock subject to repurchase. In 1996, the Company will purchase approximately $.4 million of equipment and incur increased research and development expenditures. Management believes that the cash balance at December 31, 1995 and the cash flow from operations in 1996 will be sufficient to meet these needs. In 1993, a purported consolidated class action lawsuit was filed against the Company and certain of its officers (see Note L to the Consolidated Financial Statements). Due to the uncertainties involved in litigation, the ultimate outcome cannot be determined at this time. If adversely determined, the resolution of this matter could have a material negative affect on the Company's finanacial condition, results of operations and cash flows.\nCertain Factors that may Affect Future Results\nFrom time to time, information provided by the Company, statements made by its employees or information included in its filings with the Securities and Exchange Commission (including this Form 10-K) may contain statements which are not historical facts, so-called \"forward-looking statements\". These forward- looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. The Company's actual future results may differ significantly from those stated in any forward-looking statements. Forward-looking statements involve a number of risks and uncertainties including, but not limited to, product demand, pricing, market acceptance, litigation, risk of dependence on significant customers, third party suppliers and intellectual property rights, risks in product and technology development and other risks factors detailed in this Annual Report on Form 10-K and in the Company's other Securities and Exchange Commission filings.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nQUARTERLY FINANCIAL DATA (UNAUDITED) (in thousands except per share amounts)\n1995 First Second Third Fourth - -------------------------------------------------------------------------------- Sales $4,388 $5,010 $4,038 $4,049 Gross profit 2,270 2,693 2,163 2,033 Net income 252 410 344 315 Net income per share: $.08 $.12 $.10 $.09\nCommon Stock price range: High $3-1\/2 $4-3\/4 $6-3\/8 $7-1\/4 Low 2-1\/8 2-1\/2 3-1\/16 4-3\/8\n1994 First Second Third Fourth - -------------------------------------------------------------------------------- Sales $3,629 $3,914 $3,684 $3,349 Gross profit 1,607 1,875 1,794 1,494 Net income (loss) (104) 63 (24) (232) Net income (loss) per share: $(.03) $.02 $(.01) $(.07)\nCommon Stock price range: High $5-1\/4 $4 $3-1\/8 $2-1\/2 Low 4 1-7\/8 2-1\/8 1-3\/8\nIn the fourth quarter 1994, the Company granted extraordinary stock bonuses aggregating $163,000 ($.04 per share).\nThe above financial information should be read in conjunction with the Consolidated Financial Statements, including the notes thereto.\nReport of Independent Auditors\nShareholders and Board of Directors Cognitronics Corporation\nWe have audited the accompanying consolidated balance sheets of Cognitronics Corporation and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1995. 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 Cognitronics Corporation and subsidiaries at December 31, 1995 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, 1995, in conformity with generally accepted accounting principles.\nAs discussed in Notes G and J to the financial statements, in 1993 the Company changed its method of accounting for income taxes and postretirement benefits other than pensions.\nMarch 13, 1996 \/s\/ Ernst & Young LLP ----------------------- Ernst & Young LLP CONSOLIDATED BALANCE SHEETS COGNITRONICS CORPORATION AND SUBSIDIARIES - -------------------------------------------------------------------------------- (dollars in thousands) December 31, 1995 1994 ASSETS - -------------------------------------------------------------------------------- CURRENT ASSETS Cash and cash equivalents $ 3,668 $ 2,940 Accounts receivable, less allowances of $83 and $168 2,832 2,316 Inventories 2,983 2,682 Deferred income taxes 500 599 Other current assets 601 653 -------- ------- TOTAL CURRENT ASSETS 10,584 9,190 PROPERTY, PLANT AND EQUIPMENT, net 1,275 1,354 GOODWILL, less amortization of $1,064 and $731 2,313 2,646 DEFERRED INCOME TAXES 808 823 OTHER ASSETS 60 167 ------- ------- $15,040 $14,180 ================================================================================\nLIABILITIES AND STOCKHOLDERS' EQUITY - -------------------------------------------------------------------------------- CURRENT LIABILITIES Notes payable $ 78 $ 500 Accounts payable 705 1,064 Accrued compensation and benefits 769 596 Income taxes payable 786 44 Common stock subject to repurchase 1,250 Other accrued expenses 872 780 ------- ------ TOTAL CURRENT LIABILITIES 3,210 4,234 LONG-TERM DEBT 350 407 OTHER NON-CURRENT LIABILITIES 2,436 2,497\nCOMMITMENTS AND CONTINGENCIES (Notes J and L)\nSTOCKHOLDERS' EQUITY Common Stock, par value $.20 a share; authorized 10,000,000 shares; issued 3,437,936 and 3,164,621 shares 687 633 Additional paid-in capital 12,146 11,423 Accumulated deficit (3,453) (4,774) Currency translation adjustment (71) (48) Unearned compensation (265) Treasury shares, 33,071, at cost (192) ------- ------ TOTAL STOCKHOLDERS' EQUITY 9,044 7,042 ------- ------ $15,040 $14,180 ================================================================================ The accompanying notes to consolidated financial statements are an integral part of these statements. CONSOLIDATED STATEMENTS OF OPERATIONS COGNITRONICS CORPORATION AND SUBSIDIARIES - -------------------------------------------------------------------------------- (in thousands except per share data) Year ended December 31, 1995 1994 1993 - --------------------------------------------------------------------------------\nSALES $17,485 $14,576 $16,417\nCOSTS AND EXPENSES Cost of products sold 8,326 7,806 8,760 Research and development 1,472 1,523 2,348 Selling, general and administrative 4,990 5,083 6,119 Amortization of goodwill 333 332 355 Other expense, net 129 17 993 ------- ------- ------- 15,250 14,761 18,575 Income (loss) before income taxes, discontinued operations, and cumulative effect of accounting changes 2,235 (185) (2,158) PROVISION (BENEFIT) FOR INCOME TAXES 914 112 (216) ------- ------- ------- Income (loss) from continuing operations 1,321 (297) (1,942)\nLOSS FROM DISCONTINUED OPERATIONS (386)\nCUMULATIVE EFFECT OF ACCOUNTING CHANGES (471) ------- ------- ------- NET INCOME (LOSS) $ 1,321 $ (297) $(2,799) ================================================================================\nINCOME (LOSS) PER SHARE: From continuing operations $.39 $(.09) $(.60) From discontinued operations (.12) Cumulative effect of accounting changes, net (.15) ----- ----- ----- Net income (loss) $.39 $(.09) $(.87) ===============================================================================\nThe accompanying notes to consolidated financial statements are an integral part of these statements. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY COGNITRONICS CORPORATION AND SUBSIDIARIES Years ended December 31, 1993, 1994 and 1995\nCONSOLIDATED STATEMENTS OF CASH FLOWS COGNITRONICS CORPORATION AND SUBSIDIARIES - -------------------------------------------------------------------------------- (in thousands) Year ended December 31, 1995 1994 1993 - -------------------------------------------------------------------------------- OPERATING ACTIVITIES Net income (loss) $1,321 $ (297) $(2,799) Reconciliation to income (loss) from continuing operations: Loss from discontinued operations 386 Cumulative effect of accounting changes 471 ------ ------ ------- Income (loss) from continuing operations 1,321 (297) (1,942) Adjustments to reconcile income (loss) from continuing operations to net cash provided by operating activities: Income tax expense (benefit) 914 112 (216) Depreciation and amortization 351 377 377 Amortization of goodwill 333 332 355 (Gain) loss on deposition of assets 21 27 41 Shares issued as compensation 198 163 18 Net (increase) decrease in: Accounts receivable (546) (133) 769 Inventories (311) 315 116 Other assets 150 650 92 Net increase (decrease) in: Accounts payable (337) (364) 568 Accrued compensation and benefits 121 (817) 656 Other accrued expenses 195 49 449 ------ ----- ------- 2,410 414 1,283 Income taxes refunded (paid) (80) 522 (423) ------ ----- ------- NET CASH PROVIDED BY OPERATING ACTIVITIES OF CONTINUING OPERATIONS 2,330 936 860 - -------------------------------------------------------------------------------- NET CASH USED BY DISCONTINUED OPERATIONS (651) - -------------------------------------------------------------------------------- INVESTING ACTIVITIES Proceeds from disposition of assets 26 31 25 Additions to property, plant and equipment (286) (284) (575) Acquisition of Dacon, net of cash acquired (77) (557) ----- ---- ---- NET CASH USED BY INVESTING ACTIVITIES (260) (330) (1,107) - --------------------------------------------------------------------------------\ncontinued--- CONSOLIDATED STATEMENTS OF CASH FLOWS - Page 2 COGNITRONICS CORPORATION AND SUBSIDIARIES - -------------------------------------------------------------------------------- (in thousands) Year ended December 31, 1995 1994 1993 - -------------------------------------------------------------------------------- FINANCING ACTIVITIES Shares subject to repurchase (500) Principal payments on debt (1,715) (952 (216) Issuance of debt 725 952 599 Purchase of short-term investments (1,600) Proceeds from sale of short-term investments 1,600 Shares issued pursuant to employee stock plans 165 144 Shares purchased for treasury (837) Proceeds from sale of note receivable 1,893 ----- ----- ------- NET CASH (USED) PROVIDED BY FINANCING ACTIVITIES (1,325) 1,893 (310) - -------------------------------------------------------------------------------- EFFECT OF EXCHANGE RATE DIFFERENCES (17) 5 - -------------------------------------------------------------------------------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 728 2,504 (1,208) CASH AND CASH EQUIVALENTS - BEGINNING OF YEAR 2,940 436 1,644 ------ ------ ------ CASH AND CASH EQUIVALENTS - END OF YEAR $3,668 $2,940 $ 436 =============================================================================== The accompanying notes to consolidated financial statements are an integral part of these statements. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS COGNITRONICS CORPORATION AND SUBSIDIARIES\nNote A. Summary of Significant Accounting Policies\nOrganization. The Company designs, manufactures and markets voice processing products in the United States and, through a subsidiary, distributes call management and voice processing equipment in Europe.\nA major portion of the Company's domestic revenues come from a few customers whose identities change within each three to four year period. Substantially all of its European distributorship revenue comes from one customer, the loss of which would have a material adverse impact on the Company. The Company's receivables are primarily from major, well-established companies in the telecommunications industry, and at December 31, 1995, three such companies accounted for 66% of the accounts receivable. The Company's markets are subject to rapid technological change and frequent introduction of new products. The Company's products are similar to those manufactured, or capable of being manufactured, by a number of companies, some of which are well-established corporations with financial, personnel and technical resources substantially larger than those of the Company. The Company's ability to compete in the future depends on its ability to maintain the technological and performance advantages of its current products and to introduce new products and applications that achieve market acceptance.\nPrinciples of Consolidation. The financial statements include the accounts of the Company and its subsidiaries, all of which are wholly-owned. Intercompany accounts and transactions have been eliminated in consolidation.\nUse of Estimates. The preparation of the finanacial statements in conformity with generally accepted accounting principals requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.\nFair Value of Financial Instruments. The carrying amounts of the Company's financial instruments (trade receivables\/payables and other short-term and long- term debt) approximate fair value.\nCash and Cash Equivalents. The Company considers financial instruments with a maturity of three months or less from the date of purchase to be cash equivalents. At December 31, 1995, $3.2 million of the Company's cash and cash equivalent balances were with two financial institutions.\nInventories. Inventories are stated at the lower of cost (first-in, first-out method) or market.\nProperty, Plant and Equipment. Property, plant and equipment is carried at cost less allowances for depreciation, computed in accordance with the straight-line method based on estimated useful lives.\nForeign Exchange. Results of operations for the Company's foreign subsidiary were translated into U.S. dollars using average exchange rates during the period, while assets and liabilities are translated using current rates at the end of the period. Stock Based Compensation. The Company grants stock options for a fixed number of shares to employees with an exercise price equal to the fair value at the date of grant. The Company currently accounts for stock option grants in accordance with APB Opinion No. 25, \"Accounting for Stock Issued to Employees\", which method recognizes no compensation expense, and intends to continue to do so.\nEarnings (Loss) Per Share. Earnings per share are based on the weighted average number of common and dilutive common equivalent shares outstanding during the year as follows: 3,423,688 in 1995, 3,144,183 in 1994 and 3,206,489 in 1993. Fully diluted earnings per share did not differ significantly from primary earnings per share in any year.\nGoodwill. The Company has classified as goodwill the cost in excess of fair value of the net assets of companies acquired in purchase transactions. Goodwill is amortized using the straight-line method over its estimated useful life (10 years). Goodwill in excess of associated expected operating cash flows is considered to be impaired and is written down to fair value.\nNote B. Valuation and Qualifying Accounts\nThe allowance for doubtful accounts was increased by $84,000, $67,000 and $67,000 in 1995, 1994 and 1993, respectively, by charges to cost and expense. In 1995, the Company reclassified an allowance of $169,000, together with the related receivables to other assets. In 1993, the Company wrote off uncollectible accounts, net of recoveries, of $20,000 in 1993.\nNote C. Inventories (in thousands): 1995 1994 ------ ------ Finished and in process $2,012 $1,832 Materials and purchased parts 971 850 ------ ------ $2,983 $2,682 ====== ======\nNote D. Property, Plant and Equipment (in thousands): 1995 1994 ------ ------ Building $ 383 $ 390 Machinery and equipment 1,066 1,724 Furniture and fixtures 1,172 1,868 ------ ------ 2,621 3,982 Less allowances for depreciation 1,346 2,628 ------ ------ $1,275 $1,354 ====== ====== Note E. Other Non-current Liabilities (in thousands): 1995 1994 ------ ------ Accrued officers' supplemental pension plan expense $ 738 $ 741 Accrued deferred compensation 335 341 Accrued pension expense 776 804 Accrued postretirement benefit liability 798 764 ------ ------ 2,647 2,650 Less current portion 211 153 ------ ------ $2,436 $2,497 ====== ======\nNote F. Debt and Credit Arrangements 1995 1994 Notes payable (in thousands): ---- ---- Notes payable to financial services companies $412 Installment finance agreements, interest at 6.5% and 5.12% $78 88 ---- ---- $78 $500 ==== ====\nIn 1995, the Company entered into a $1,000,000 line of credit maturing in September, 1996. Borrowings under this arrangement are due on demand, are based on the amount of eligible accounts receivable, as defined, bear interest at the prime rate plus 1% and are secured by substantially all of the Company's assets. At December 31, 1995, no amounts were borrowed under this line of credit. Prior to September 1995, the Company had a line of credit with a financial service company. In addition, in connection with the shares subject to repurchase, the Company, in 1995, issued notes aggregating $750,000 (see Note I), which were repaid in 1995. The average outstanding balances of notes payable were $615,000 and $501,000 for 1995 and 1994, respectively, and the weighted average interest rates were 13.0% and 9.6%, respectively.\nDacon Electronics Plc has a bank line of credit of $153,000 expiring in 1996. No amounts were outstanding in 1995 and the average outstanding balance and average interest rate in 1994 were $36,000 and 10.6%, respectively.\nLong term debt (in thousands): 1995 1994 ---- ---- Mortgage note, interest at 12% per annum $269 $298 Installment finance agreements, interest at 10% to 12% per annum expiring through 1999 157 155 ---- ---- 426 453 Less current portion 76 46 ---- ---- $350 $407 ==== ====\nThe mortgage note is secured by Dacon Electronics Plc's land and building (net book value $367,000 at December 31, 1995), and is payable over fifteen years. Approximately $13,000 is due in each of the five years ending December 31, 2000. Payments on the installment finance agreements for each of the four years ending December 31, 1999 are $63,000, $51,000, $30,000 and $13,000, respectively.\nInterest of $141,000, $127,000 and $116,000 was paid in 1995, 1994 and 1993, respectively.\nNote G. Income Taxes\nThe Company adopted FASB Statement No. 109 \"Accounting for Income Taxes\" as of January 1, 1993. The cumulative effect of this accounting change, in 1993, resulted in recognizing previously unrecognized tax benefits of $267,000, or $.08 per share. Under FASB Statement No. 109, deferred tax assets and liabilities are adjusted to reflect changes in statutory rates, as income adjustments, in the period that changes are enacted.\nAs of December 31, 1995, consolidated accumulated deficit included approximately $600,000 of retained earnings applicable to Dacon Electronics Plc, a foreign subsidiary. If the undistributed earnings were remitted, any resulting federal tax would be substantially reduced by foreign tax credits.\nThe components of the provision (benefit) for income taxes for the years ended December 31, are as follows (in thousands): 1995 1994 1993 ----- ----- ----- Continuing operations Current: Federal $245 $(405) $ (22) Foreign 515 49 26 State 40 42 15 ----- ----- ----- Total current 800 (314) 19 ----- ----- ----- Deferred: Federal 97 308 (312) Foreign 48 (23) State 17 70 100 ----- ----- ----- Total deferred 114 426 (235) ----- ----- ----- $914 $ 112 $(216) ===== ===== ===== Discontinued operations Current: Federal $ 62 State 41 ----- Total current 103 Deferred: Federal (237) State (64) ----- Total deferred (301) ----- $(198) ===== Not reflected in the 1995 tax provision is $97,000 of income tax benefits related to the exercise of stock options; such amount was credited to additional paid-in capital.\nDomestic and foreign pretax income (loss) from continuing operations for the years ended December 31, are as follows (in thousands):\n1995 1994 1993 ------ ----- -------- Domestic operations $1,015 $(285) $(1,541) Foreign Operations 1,220 100 (617) ------ ----- ------- $2,235 $(185) $(2,158) ====== ===== =======\nDeferred income taxes reflect the net tax effects of temporary differences between carrying amounts of assets and liabilities for financial reporting purposes and amounts used for income tax purposes. Significant components of the Company's deferred tax liabilities and assets as of December 31, 1995 and 1994 are as follows (in thousands): 1995 1994 ------ ------ Deferred tax liabilities: Tax over book depreciation $ 61 $ 58 Other 30 37 ------ ------ Total deferred tax liabilities 91 95 ------ ------ Deferred tax assets: Inventory valuation 464 368 Accrued liabilities and employee benefits 402 405 Accrued deferred compensation 399 400 Other post-retirement benefits 298 285 Separate return federal operating loss carryforwards expiring in 2008 and 2009 445 445 General business tax credits 153 Other 47 41 ------ ------ Total deferred tax assets 2,055 2,097 Valuation allowance (656) (580) ------ ------ 1,399 1,517 ------ ------ Net deferred tax assets $1,308 $1,422 ====== ======\nValuation allowance at January 1 $(580) $(411) Charged to tax expense (76) (169) ----- ----- Valuation allowance at December 31 $(656) $(580) ===== ===== A reconciliation of the statutory federal income tax rate to the effective tax rate of income (loss) from continuing operations follows:\n1995 1994 1993 ----- ----- ------ Statutory federal income tax rate 34.0% (34.0)% (34.0)% State income taxes, net of federal tax benefit 1.7 40.0 3.5 Losses with no tax benefit 56.4 12.7 Utilization of foreign loss carryforwards (43.4) Lower foreign tax rate (0.5) (9.5) Goodwill amortization 5.1 61.0 5.6 Other .6 (10.0) 2.2 ----- ----- ----- 40.9% 60.5% (10.0)% ===== ===== =====\nNote H. Other Expense, Net (in thousands): 1995 1994 1993 ---- ---- ---- Interest expense $194 $151 $140 Interest income (70) (129) (108) Severance (75) 582 Curtailment of benefit plans 113 Write-down of assets 385 Foreign exchange gain 5 (43) (6) ---- ---- ---- $129 $ 17 $993 ==== ==== ====\nNote I. Common Stock Subject to Repurchase\nIn 1994, the sellers of Dacon Electronics Plc exercised their rights under the November 1992 purchase agreement, to put 106,383 shares of the Company's common stock to the Company for $11.75 per share. In February 1995, the Company and sellers renegotiated the terms of the put to provide for the immediate payment of an aggregate of $500,000 and the issuance of 10% promissory notes, aggregating $750,000, which were repaid in 1995. Under the terms of the promissory notes, certain of the sellers elected to retain or acquire all of the 106,383 shares at $1.98 per share, which was applied as a prepayment of the interest and principal of the promissory notes. In addition, the sellers were given warrants to purchase an aggregate of 50,000 shares of common stock at $2.375 per share; the warrants expire on December 14, 1998.\nNote J. Commitments\nLeases. Total rental expense amounted to $265,000 in 1995, $269,000 in 1994 and $326,000 in 1993. Future annual payments for long-term noncancellable leases are approximately $244,000 in 1996 and approximately $226,000 per year thereafter through the year 2003.\nPension Plan. The Company and its domestic subsidiaries have a defined benefit pension plan covering substantially all employees. The benefits are based on years of service and the employee's compensation. The Company's funding policy is to contribute amounts to the plan sufficient to meet the minimum funding requirements set forth in the Employee Retirement Income Security Act of 1974, plus such additional amounts as the Company may determine to be appropriate from time to time.\nIn 1994, the Company amended the plan so that no additional service cost benefits would be earned subsequent to June 30, 1994. With respect to this curtailment, the Company recognized an expense of $210,000 in 1994. Also due to this modification of the plan, the service cost-benefits earned was reduced from prior years in 1994 and was eliminated in 1995. In addition, the Projected Benefit Obligation was reduced to an amount equal to the Accumulated Benefit Obligation resulting in a reduction in the interest cost component of the net periodic pension cost.\nIn 1993, the Company recognized settlement and curtailment losses primarily related to discontinued operations.\nThe components of net cost of the plan for the years ended December 31, are as follows (in thousands): 1995 1994 1993 ---- ---- ---- Service cost-benefits earned during the period $ 63 $115 Interest cost on projected benefit obligation $111 128 178 Actual return on plan assets (199) 23 (129) Net amortization and deferral 120 (77) 79 ---- ---- ---- Net periodic pension cost 32 137 243 Effect of settlement 155 Effect of curtailment 210 126 ---- ---- ---- Total pension cost 32 347 524 Less cost charged to discontinued operations (295) ---- ---- ---- Costs charged to continuing operations $ 32 $347 $229 ==== ===== ===== The following table sets forth the plan's funded status and the accrued pension expense recognized in the Company's consolidated balance sheets at December 31 (in thousands): 1995 1994 ------ ------ Actuarial present value: Accumulated benefit obligation - Vested $1,453 $1,515 Non-vested 78 91 ------ ------ $1,531 $1,606 ====== ====== Projected benefit obligation for service rendered to date $1,531 $1,606 Plan assets at fair value 1,115 1,073 ------ ------ Plan assets less than projected benefit obligation (416) (533) Unrecognized net obligation, less accumulated amortization of $131 and $123 (50) (58) Unrecognized net gain (310) (213) ------ ------ Accrued pension expense (included in other non-current liabilities) $ (776) $ (804) ====== ====== The discount rate used in determining the projected benefit obligation was 7.25%, in 1995 and 1994. The expected long-term rate of return on plan assets used in determining the net periodic pension cost was 7% for all years presented.\nThe plan assets at December 31, 1995 and 1994 were principally invested in corporate debt and equity securities.\nEmployee Savings and Investment Plan. The Company has a defined contribution plan [a 401(k) plan] covering substantially all domestic employees. The Company's contribution is based upon the participants' contributions. The expense was $15,000, $17,000 and $32,000 in 1995, 1994 and 1993, respectively.\nOfficers' Supplemental Pension Plan. In 1991, the Company adopted an unfunded, noncontributory defined benefit pension plan covering the officers of the Company. Benefits under the plan are based on the final salary of qualified officers. In 1993, the plan was amended to increase the benefit under this plan, to cause the annual retirement benefit for the officers covered by this plan, when combined with other retirement plans of the Company, to be no less than $44,000 per year under certain circumstances. The impact of this amendment increased the accumulated and projected benefit obligations by $125,000 and was being accounted for as prior service cost. Accordingly, it had an insignificant effect on the 1993 net periodic pension cost. In 1994, the Company curtailed the supplemental pension plan by limiting the benefits to officers who retire by June 30, 1996, and recorded a curtailment expense of $312,000, primarily reflecting the write-off of substantially all of the unamortized prior service cost.\nThe components of net pension cost of the plan for the years ended December 31 are as follows (in thousands): 1995 1994 1993 ---- ---- ---- Service cost-benefits earned during the period $ 15 $ 28 Interest cost on projected benefit obligation $ 40 46 45 Amortization of prior service cost 13 28 42 Amortization of actuarial gains (9) (5) ---- ---- ---- Net periodic pension cost 44 84 115 Effect of curtailment 312 ---- ---- ---- Total pension cost $ 44 $396 $115 ==== ==== ====\nThe following table sets forth the plan's status and the accrued pension expense recognized in the Company's consolidated balance sheets at December 31 (in thousands):\n1995 1994 ----- ----- Actuarial present value of vested accumulated benefit obligation- $ 588 $ 578 ===== ====\nActuarial present value of projected benefit obligation $(588) $(578) for service rendered to date Unrecognized prior service cost 13 Unrecognized net gain (150) (176) ----- ----- Accrued pension expense (included in other non-current liabilities) $(738) $(741) ===== =====\nThe discount rate used in determining the projected benefit obligation in all years was 7.25%. All participants are retired and receiving benefits under the Plan and therefore future increases in compensation are not applicable.\nOther Postretirement Benefit Plans. In addition to the Company's pension plans, the Company has an unfunded contributory defined benefit plan providing certain health care benefits for retired domestic employees. Prior to 1994, substantially all of the Company's employees became eligible if they reached normal retirement age while working for the Company. The participants' contributions are adjusted periodically and are based on age and length of service at time of retirement. Effective January 1, 1993, the Company adopted FASB Statement No. 106, \"Employers Accounting for Postretirement Benefits Other Than Pensions\", on the immediate recognition basis and recorded a charge of $738,000 (net of $471,000 of deferred tax benefit), or $.23 per share. The effect of adopting this statement increased the net periodic postretirement cost by $100,000 in 1993. In 1994, the Company curtailed this benefit plan, limiting benefits to elegible employees who retire prior to March 31, 1996. This modificaton has the effect of reducing in 1994 and eliminating in future years the service cost component of the post retirement benefit costs. In connection with the sale of the Company's machined parts segment, a gain on curtailment of $154,000 was recognized in 1993. The assumed rate of increase in the per capita cost of covered benefits was 8.7% decreasing to 6% after 10 years. Increasing the health care cost trend rate by one percentage point each year would increase the accumulated postretirement benefit obligation by $70,000 at December 31, 1995 and the aggregate service and interest cost component of net periodic postretirement benefit cost for 1995 by $5,000. The weighted average discount rate used in determining the net periodic postretirement benefit cost and accumulated benefit obligation was 7.0%.\nThe following sets forth the plan's status and accrued post-retirement benefit liability recognized in the Company's Consolidated Balance Sheets (in thousands): 1995 1994 ---- ---- Actuarial present value of accumulated postretirement benefit obligation: Retirees $560 $470 Active plan participants 239 289 ---- ---- 799 759 Unrecognized net gain (loss) (1) 5 ---- ---- Accrued postretirement benefit liability (included $798 $764 in other non-current liabilities) ==== ====\nThe components of post-retirement benefit cost for the years ended December 31, are as follows (in thousands): 1995 1994 1993 ---- ---- ---- Service cost $ 26 $ 41 Interest cost $52 67 99 --- ---- ---- Net periodic cost 52 93 140 Curtailment gain (409) (154) --- ---- ---- Total plan cost (income) $52 $(316) $(14) === ===== ====\nDeferred Compensation. At December 31, 1995 and 1994, the liability relating to a deferred compensation arrangement between the Company and a director and former officer of the Company aggregated $335,000 and $341,000, respectively.\nNote K. Employee Stock Plans\nAt December 31, 1995, the Company has reserved 386,430 shares of its common stock for issuance to key employees under the 1990 Stock Option Plan. The plans provide for the grant, at fair market value on the date of grant, of nonqualified stock options and incentive stock options. Options generally become exercisable in three equal annual installments on a cumulative basis commencing six months from the date of grant and expire five years (maximum ten years) after the date granted.\nThe Company also has an Employee Stock Purchase Plan under which 108,948 shares are reserved. The purchase price is 85% of the fair market value of the stock on the date offered. Generally, rights to purchase shares under this plan expire up to 27 months after the date of grant. In 1995, the Company adopted the \"Restricted Stock Plan\", a time accelerated restricted stock plan (TARSP), under which 150,000 shares of its common stock were reserved. The Plan provides for the award of shares to key employees; generally, the awards vest in five equal annual installments commencing two years after the date of the award. Vesting may be accelerated based on the achievement of certain financial performance goals. In 1995, 139,000 shares were awarded under the plan, of which 41,700 became vested, and $198,000 of compensation expense was recognized.\nInformation pertaining to these plans is as follows:\nOption Purchase Plans Plan TARSP ------- ------- ------- Outstanding at January 1, 1993 248,976 17,330 0 Granted 76,000 19,717 Cancelled or expired (19,901) (4,619) Exercised (38,030) (14,634) ------- ------- ------- Outstanding at December 31, 1993 267,045 17,794 0 Granted 482,250 49,160 Cancelled or expired (348,032) (20,167) ------- ------- ------- Outstanding at December 31, 1994 401,263 46,787 0 Granted 37,500 139,000 Cancelled or expired (45,509) (7,385) Exercised (40,322) (19,246) Vested (41,700) ------- ------- ------- Outstanding at December 31, 1995 352,932 20,156 97,300 ======= ======= =======\nThe exercise price for options granted during 1993 ranged from $4.13 to $7.13, for options granted during 1994 ranged from $2.75 to $4.56 and for options granted during 1995 ranged from $2.375 to $6.75. The weighted average exercise price for the 352,932 options outstanding under the Option Plans is $2.76 with expiration dates ranging from 1999 to 2000. Options were exercised under the Option Plans at weighted average exercise prices of $2.66 and $2.80 in 1993 and 1995, respectively. Shares exercisable under the Option Plans at December 31, 1993, 1994 and 1995 were 113,151, 15,188 and 132,693, respectively.\nRights were granted under the Purchase Plan at exercise prices of $4.14 and $2.34 in 1993 and 1994, respectively. In 1993 and 1995, shares were exercised under the Purchase Plan at weighted average prices of $9.43 and $2.34, respectively. The exercise price for the 20,156 rights outstanding under the Purchase Plan is $2.34.\nNote L. Contingencies\nIn 1993, a purported consolidated class action lawsuit was filed against the Company and certain of its officers alleging securities law violations in connection with the purchase of the Company's common stock by members of the purported classes during the period from October 29, 1992 through March 12, 1993. The plaintiffs seek unspecified damages and related costs. The Company and the other defendants submitted a motion to dismiss the consolidated amended complaint. The Company has denied any wrongdoing and believes it has presented viable grounds to support the motion to dismiss. The motion is sub judice. Due to the uncertainties involved in litigation, the ultimate outcome cannot be determined at this time, and no provision for any liability that may result from this litigation, if any, has been made in the financial statements. If adversely determined, the resolution of this matter could have a material negative affect on the Company's financial condition, results of operation and cash flows.\nNote M. Operations by Industry Segment and Geographic Areas\nThe Company operates in one industry segment: voice processing products.\nThe Company operates in the United States and Europe (United Kingdom). Information about the Company's operations by geographic area for the years ended December 31, is as follows (in thousands): 1995 1994 1993 ------- ------- ------- Net sales United States: Unaffiliated customers $ 9,970 $ 9,785 $12,657 Inter-company transfers 636 411 439 ------- ------ ------- 10,606 10,196 13,096 Europe 7,515 4,791 3,760 Eliminations (636) (411) (439) ------- ------ ------- $17,485 $14,576 $16,417 ======= ======= ======= Operating profit (loss) United States $ 2,429 $ 1,009 $ 396 Europe 1,256 237 (522) Inter-company eliminations (8) 67 ------- ------- ------ 3,685 1,238 (59) General corporate expenses 1,321 1,444 2,073 Interest expense, net 124 22 32 Foreign exchange (gain) loss 5 (43) (6) ------- ------- ------- Income (loss) from continuing operations before income taxes $ 2,235 $ (185) $(2,158) ======= ====== ======= Identifiable assets United States $ 9,427 $ 9,353 $10,872 Europe 5,642 4,856 4,599 Inter-company eliminations (29) (29) (22) ------- ------- ------- $15,040 $14,180 $15,449 ======= ======= =======\nRevenues include sales of $3.5 million, $4.2 million and $3.9 million in 1995, 1994 and 1993, respectively, to one major customer; sales of $2.7 million in 1995 to another customer; sales of $1.0 million and $2.9 million in 1994 and 1993, respectively, to another customer; sales of $2.5 million in 1993 to another customer; and foreign sales of $5.5 million, $3.3 million and $2.9 million in 1995, 1994 and 1993, respectively, to another customer. Note N. Discontinued Operations\nIn June 1993, the Company sold its machined parts business for a secured note receivable of $1,907,000, bearing interest at 1.5% above the prime rate and payable in sixteen quarterly installments commencing September 1994. This note was paid in full in 1994.\nThe results of discontinued operations for the year ended December 31, 1993 are as follows (in thousands):\nRevenues $ 432 ===== Loss from operations, net of income tax benefit of $74 $(144) ===== Loss on disposal of discontinued operations, $(242) net of income tax benefit of $124 ===== Loss per share: From operations $(.04) ===== From disposal of discontinued operations $(.08) =====\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\n1. (a) The identification of the directors of the Company as of March 1, 1996 and persons nominated to become directors set forth under the capion Information Concerning Nominees in the Proxy Statement for the annual meeting of shareholders to be held on May 9, 1996 is incorporated herein by reference.\n(b) The identification of the executive officers of the Company and their positions with the Company and ages as of March 1, 1996, is set forth under the caption Executive Officers of the Company in Part I of this Annual Report on Form 10-K.\n2. The information regarding compliance with Section 16(a) of the Securities Exchange Act of 1934 set forth under the caption Certain Transactions in the Proxy Statement for the annual meeting of shareholders to be held on May 9, 1996 is incorporated herein by reference.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe information on executive compensation set forth under the caption Executive Compensation in the Proxy Statement for the annual meeting of shareholders to be held on May 9, 1996 is incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\n(a) and (b) Security ownership of certain beneficial owners and management set forth under the caption Security Ownership in the Proxy Statement for the annual meeting of shareholders to be held on May 9, 1996 is incorporated herein by reference.\n(c) Indebtedness of Management. None.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThe information on certain relationships and related transactions set forth under the caption Certain Transactions in the Proxy Statement for the annual meeting of shareholders to be held on May 9, 1996 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) and (d) The response to this portion of Item 14 is submitted as a separate section beginning on page 34 of this Annual Report on Form 10-K.\n(a)(3) and (c) The response to this portion of Item 14 is submitted as a separate section beginning on page 35 of this Annual Report on Form 10-K.\n(b) There were no reports filed on Form 8-K during the fourth quarter of 1995. SIGNATURES\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, on March 27, 1996.\nCOGNITRONICS CORPORATION Registrant\nby \/s\/ Garrett Sullivan -------------------- Garrett Sullivan 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 indicated on March 27, 1996.\nSignature Title\nChief Executive Officer:\n\/s\/Brian J. Kelley President and Chief ---------------------- Executive Officer Brian J. Kelley\nChief Financial and Accounting Officer:\n\/s\/Garrett Sullivan Treasurer ---------------------- Garrett Sullivan\nA Majority of the Board of Directors:\n\/s\/Edward S. Davis Director ---------------------- Edward S. Davis\n\/s\/Jack Meehan Director ---------------------- Jack Meehan\n\/s\/William A. Merritt Director ---------------------- William A. Merritt\n\/s\/Timothy P. Murphy Director ---------------------- Timothy P. Murphy Form 10-K -- Item 14 (a) (1) and (2) and (d)\n(a) (1) Financial Statements\nThe following financial statements of the Company are included in Item 8.\nFinancial Statements Covered by Report of Independent Auditors: Page\nReport of Independent Auditors . . . . . . . . . . . . . . . . . . . . . . . .13\nConsolidated Balance Sheets, December 31, 1995 and December 31, 1994 . . . . .14\nConsolidated Statements of Operations for each of the three years in the period ended December 31, 1995 . . . . . . . . . . . . . . . . . . . . 15\nConsolidated Statements of Stockholders' Equity for each of the three years in the period ended December 31, 1995 . . . . . . . . . . . . . 16\nConsolidated Statements of Cash Flows for each of the three years in the period ended December 31, 1995 . . . . . . . . . . . . . . . . . . . . 17\nNotes to Consolidated Financial Statements . . . . . . . . . . . . . . . . . 19\n(2) and (d) Financial Statement Schedules\nSchedules 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. Item 14(a)(3) and (c)\nINDEX TO EXHIBITS\nExhibit Page No.\n3.1 Certificate of Incorporation as filed on January 2, 1962 (Exhibit 3-1-A to Form S-1 Registration Statement No. 2-27439 and incorporated herein by reference).\n3.2 Amendment, dated June 28, 1965 (Exhibit 3-1-B to Form S-1 Registration Statement No. 2-27439 and incorporated herein by reference).\n3.3 Amendment, dated October 3, 1966 (Exhibit 3-1-C to Form S-1 Registration Statement No. 2-27439 and incorporated herein by reference).\n3.4 Amendment, dated October 30, 1967 (Exhibit 3-1-D to Form S-1 Registration Statement No. 2-27439 and incorporated herein by reference).\n3.5 Amendment, dated July 27, 1981 (Exhibit 3.5 to Annual Report on Form 10-K for the fiscal year ended December 31, 1983 and incorporated herein by reference).\n3.6 Amendment, dated September 27, 1984 (Exhibit 3.6 to Annual Report on Form 10-K for the fiscal year ended December 31, 1984 and incorporated herein by reference).\n3.7 Amendment dated June 13, 1988 (Exhibit 3.7 to Annual Report on Form 10-K for the fiscal year ended December 31, 1988 and incorporated herein by reference).\n3.8 Amendment dated November 3, 1994 (Exhibit 3.8 to Annual Report on Form 10-K for the year ended December 31, 1994 and incorporated herein by reference).\n3.9 By-laws of the Company (Exhibit 3.9 to Annual Report on Form 10-K for the year ended December 31, 1994 and incorporated herein by reference).\n4. Specimen Certificate for Common Stock (Exhibit 4-1 to Form S-1 Registration Statement No. 2-27439 and incorporated herein by reference).\n10.1 1990 Stock Option Plan, as amended (Exhibit 10.1 to Quarterly Report on Form 10-Q for the quarter ended September 30, 1994 and incorporated herein by reference).\n10.2 Lease, dated April 30, 1993, between Seymour R.Powers and The Danbury Industrial Corporation, landlord, and Cognitronics Corporation, tenant (Exhibit 10.3 to Annual Report on Form 10-K for the year ended December 31, 1993 and incorporated herein by reference).\nExhibit Page No.\n10.3 Form of Indemnity Agreement, dated October 27, 1986, between each Director (with equivalent form for each Officer) and Cognitronics Corporation (Exhibit 10.7 to Annual Report on Form 10-K for the year ended December 31, 1986 and incorporated herein by reference).\n10.4 Supplemental Pension Plan for Officers, as amended November 2, 1993 (Exhibit 10.6 to Annual Report on Form 10-K for the year ended December 31, 1993 and incorporated herein by reference).\n10.5 Dacon Put Agreement dated as of February 9, 1995 between Cognitronics Corporation and each of the former shareholders (other than Inkel) of Dacon Electronics Plc (Exhibit 10.6 to Annual Report on Form 10-K for the year ended December 31, 1994 and incorporated herein by reference).\n10.6 Form of Warrant Agreement dated February 9, 1995 between Cognitronics Corporation and each of the former shareholders (other than Inkel) of Dacon Electronics Plc, granting warrants to purchase up to an aggregate of 50,000 shares of the Company's Common Stock (Exhibit 10.9 to Annual Report on Form 10-K for the year ended December 31, 1994 and incorporated herein by reference).\n10.7 Cognitronics Corporation Restricted Stock Plan (Exhibit 10.1 to Quarterly Report on Form 10-Q for the quarter ended June 30, 1995 and incorporated herein by reference).\n10.8 Revolving Loan Agreement between Cognitronics Corporation and People's Bank dated September 8, 1995 (Exhibit 10.1 to Quarterly Report on Form 10-Q for the quarter ended September 30, 1995 and incorporated herein by reference).\n22. List of subsidiaries of the Company as of December 31, 1995 37 (attached as Exhibit 22 to this Annual Report on Form 10-K).\n23. Consent of Independent Auditors, dated March 27, 1996 38 (attached as Exhibit 23 to this Annual Report on Form 10-K).\n27. Financial Data Schedule (attached as Exhibit 27 to this Annual Report on Form 10-K).","section_15":""}
{"filename":"22301_1995.txt","cik":"22301","year":"1995","section_1":"ITEM 1 BUSINESS\nComcast Corporation and its subsidiaries (the \"Company\") is principally engaged in the development, management and operation of wired and wireless telecommunications and the provision of content. Wired telecommunications includes cable and telecommunications services in the United States (\"US\") and the United Kingdom (\"UK\"). Wireless telecommunications includes cellular services, personal communications services, provided through the Company's investment in Sprint Spectrum, and direct to home satellite television. Content is provided through QVC, Inc. and its subsidiaries (\"QVC\"), an electronic retailer, Comcast Content and Communication Corporation (\"C3\") and other programming investments (see \"General Developments of Business\"). The Company's consolidated domestic cable operations served more than 3.4 million subscribers and passed more than 5.5 million homes as of December 31, 1995. The Company owns a 50% interest in Garden State Cablevision L.P. (\"Garden State\"), a cable communications company serving approximately 200,000 subscribers and passing approximately 292,000 homes. In the UK, a subsidiary of the Company, Comcast UK Cable Partners Limited (\"Comcast UK Cable\"), holds ownership interests in four cable and telephony businesses that collectively have the potential to serve over 1.6 million homes. The Company provides cellular telephone communications services pursuant to licenses granted by the Federal Communications Commission (\"FCC\") in markets with a population of over 8.3 million, including the area in and around the City of Philadelphia, Pennsylvania, the State of Delaware and a significant portion of the State of New Jersey. Through QVC, the Company markets a wide variety of products and reaches over 52 million homes across the US and an additional 4 million in the UK.\nThe Company was organized in 1969 under the laws of the Commonwealth of Pennsylvania and has its principal executive offices at 1500 Market Street, Philadelphia, Pennsylvania, 19102-2148, (215) 665-1700.\nFINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS\nSee Note 11 to the Company's consolidated financial statements for information about the Company's operations by industry segment.\nGENERAL DEVELOPMENTS OF BUSINESS\nRegulatory Developments\nThe Telecommunications Act of 1996 (the \"1996 Telecom Act\"), the most comprehensive reform of the nation's telecommunications laws since the Communications Act of 1934 (the \"Communications Act\"), became effective in February 1996. The 1996 Telecom Act will result in changes in the marketplace for cable communications, telephone and other telecommunications services (see \"Description of the Company's Businesses - Wired Telecommunications - Cable Communications - Legislation and Regulation\").\nThe Company has settled the majority of outstanding proceedings challenging its rates charged for regulated cable services. In December 1995, the FCC adopted an order approving a negotiated settlement of rate complaints pending against the Company for cable programming service tiers (\"CPSTs\") which provided approximately $6.6 million in refunds, plus interest, being given in the form of bill credits, to approximately 1.3 million of the Company's cable subscribers. This FCC order resolved 160 of the Company's benchmark rate cases covering the period September 1993 through July 1994 and 104 of the Company's cost-of-service cases for CPSTs covering the period September 1993 through December 1995. As part of the negotiated settlement, the Company agreed to forego certain inflation and external cost adjustments for systems covered by its cost-of-service filings for CPSTs. The FCC's order has been appealed to a federal appellate court by a local franchising authority whose rate complaint against the Company was resolved by the negotiated settlement. The Company currently is seeking to justify rates for basic cable services and equipment in certain of its cable systems in the State of Connecticut on the basis of a cost-of-service showing. The State of Connecticut has ordered the Company to reduce such rates and to make refunds to subscribers. The Company has appealed the Connecticut decision to the FCC. The Company's management believes that the ultimate resolution of these pending regulatory matters will not have a material adverse impact on the Company's financial position or results of operations.\nSprint Spectrum\nEffective as of January 1996, the Company, Tele-Communications, Inc. (\"TCI\"), Cox Communications, Inc. (\"Cox,\" and together with the Company and TCI, the \"Cable Parents\") and Sprint Corporation (\"Sprint,\" and together with the Cable Parents, the \"Parents\"), and certain subsidiaries of the Parents (the \"Partner Subsidiaries\"), entered into a series of agreements relating to their previously announced joint venture (March 1995) to engage in the communications business. Under an Amended and Restated Agreement of Limited Partnership (the \"Partnership Agreement\") of MajorCo, L.P. (known as \"Sprint Spectrum\"), the business of Sprint Spectrum will be the provision of wireless telecommunications services and will not include the previously authorized business of providing local wireline communications services to residences and businesses. A partnership owned entirely by subsidiaries of the Company owns 15% of Sprint Spectrum. The Company accounts for its investment in Sprint Spectrum under the equity method.\nSprint Spectrum was the successful bidder for 29 personal communications services (\"PCS\") licenses in the auction conducted by the FCC from December 1994 through mid-March 1995. The purchase price for the licenses was approximately $2.11 billion, all of which has been paid to the FCC. Sprint Spectrum may also elect to bid in subsequent auctions for PCS licenses. In addition, Sprint Spectrum has invested, and may continue to invest, in other entities that hold PCS licenses, may acquire PCS licenses from other license holders and may affiliate with other license holders.\nThe Partner Subsidiaries have committed to contribute $4.2 billion in cash to Sprint Spectrum through 1997, of which the Company's share is $630.0 million. Of this funding requirement, the Company has made total cash capital contributions to Sprint Spectrum of $346.0 million through December 31, 1995. The Company anticipates that Sprint Spectrum's capital requirements over the next several years will be significant. Requirements in excess of committed capital are planned to be funded by Sprint Spectrum through external financing. Although it is anticipated that external financing will be available to Sprint Spectrum on acceptable terms and conditions, no assurances can be given as to such availability. The timing of the Company's remaining capital contributions to Sprint Spectrum is dependent upon a number of factors, including Sprint Spectrum's ability to obtain external financing as well as its working capital requirements.\nPursuant to separate Parent agreements, each Cable Parent and Sprint agreed to negotiate in good faith on a market- by-market basis for the provision of local wireline telephony services over the cable communications facilities of the applicable Cable Parent under the Sprint brand. Accordingly, local telephony offerings in each market will be the subject of individual agreements to be negotiated with Sprint, rather than being provided through Sprint Spectrum as originally contemplated. The offering of local wireline telephone services will require the removal of regulatory and legislative barriers to local telephone competition (see \"Description of the Company's Businesses - Wired Telecommunications - Cable Communications - Legislation and Regulation\"). Each Parent agreement also contains certain restrictions on the ability of each Parent to offer and promote, or package certain of its cable communications products or services with, certain products and services of other persons and requires the applicable Cable Parent to make its cable communications facilities available to Sprint for specified purposes to the extent that it has made such facilities available to certain others for such purposes.\nThe Partner Subsidiaries also terminated a contribution agreement pursuant to which they had agreed to contribute to Sprint Spectrum their respective interests in Teleport Communications Group Inc., TCG Partners and certain local joint ventures managed by such entities (collectively, \"TCG\"). TCG is one of the largest competitive access providers in the US in terms of route miles. The Parents reaffirmed their intention to continue to attempt to integrate the business of TCG with that of Sprint Spectrum.\nScripps Cable\nIn October 1995, the Company announced its agreement to purchase the cable television operations (\"Scripps Cable\") of The E.W. Scripps Company (\"E.W. Scripps\") in exchange for shares of the Company's Class A Special Common Stock, par value $1.00 per share (the \"Class A Special Common Stock\" -- see Item 5 - \"Market for the Registrant's Common Equity and Related Stockholder Matters\"), worth $1.575 billion (the \"Base Consideration\"), subject to certain closing adjustments (the \"Scripps Transaction\"). Scripps Cable passes approximately 1.2 million homes and serves approximately 800,000 subscribers, with over 60% of its subscribers located in Sacramento, California and\n- 2 -\nChattanooga and Knoxville, Tennessee. The purchase is expected to close in the second half of 1996, subject to shareholder and regulatory approval and certain other conditions.\nPursuant to the Agreement and Plan of Merger dated as of October 28, 1995 (the \"Merger Agreement\") by and among the Company, E.W. Scripps and Scripps Howard, Inc., a wholly owned subsidiary of E.W. Scripps, E.W. Scripps will distribute to its shareholders all assets other than Scripps Cable. Following such distribution, E.W. Scripps will be merged with and into the Company (the \"Merger\") and each share of E.W. Scripps common stock issued and outstanding immediately prior to the Merger will be converted into a portion of the shares of the Class A Special Common Stock to be paid as consideration in the Merger. Assuming (i) no adjustment has been made to the Base Consideration and (ii) the closing price of the Class A Special Common Stock is equal to the execution price ($20.075 per share), as such terms are defined in the Merger Agreement, the Company would issue to E.W. Scripps' shareholders an aggregate of approximately 78.5 million shares of Class A Special Common Stock in the Merger, subject to certain adjustments. Such shares would represent, in the aggregate, approximately 28.9% of the Class A Special Common Stock outstanding as of December 31, 1995, on a pro forma basis.\nShare Repurchase Program\nConcurrent with the announcement of the Scripps Transaction, the Company announced that its Board of Directors has authorized the repurchase of up to $500.0 million of its outstanding common equity securities. The Company expects such repurchases to be effected from time to time in the open market or in private transactions, subject to market conditions.\nQVC\nIn February 1995, the Company and TCI acquired all of the outstanding stock of QVC not previously owned by them (approximately 65% of such shares on a fully diluted basis) for $46, in cash, per share (the \"QVC Acquisition\"), representing a total cost of approximately $1.4 billion. The QVC Acquisition, including the exercise of certain warrants held by the Company, was financed with cash contributions from the Company and TCI of $296.3 million and $6.6 million, respectively, borrowings of $1.1 billion under a $1.2 billion QVC credit facility and existing cash and cash equivalents held by QVC. Following the acquisition, the Company and TCI own, through their respective subsidiaries, 57.45% and 42.55%, respectively, of QVC. The Company, through a management agreement, is responsible for the day to day operations of QVC. The Company has accounted for the QVC Acquisition under the purchase method of accounting and QVC was consolidated with the Company effective February 1, 1995.\nDESCRIPTION OF THE COMPANY'S BUSINESSES\nWIRED TELECOMMUNICATIONS\nWired telecommunications consists primarily of the Company's domestic cable communications operations. The Company's other wired telecommunications businesses include its UK cable and telecommunications operations, along with the Company's interests in alternate access providers, such as TCG (see \"General Developments of Business\" - \"Sprint Spectrum\").\nCable Communications\nGeneral\nA cable communications system receives signals by means of special antennae, microwave relay systems, earth stations and fiber optics. The system amplifies such signals, provides locally originated programs and ancillary services and distributes programs to subscribers through a fiber optic and coaxial cable system.\nCable communications systems generally offer subscribers the signals of all national television networks; local and distant independent, specialty and educational television stations; satellite-delivered non-broadcast channels; locally originated programs; educational programs; audio programming; video games; electronic retailing and public service announcements. In addition, each of the Company's systems offer, for an extra monthly charge, one or more premium services (\"Pay Cable\") such as Home Box Office(R), Cinemax(R), Showtime(R), The Movie Channel(TM),\n- 3 -\nEncore(R) and The (C)Disney Channel, which generally offer, without commercial interruption, feature motion pictures, live and taped sporting events, concerts and other special features. Substantially all of the Company's systems offer pay-per-view services, which permit a subscriber to order, for a separate fee, individual feature motion pictures and special event programs. The Company is field testing non-entertainment services such as cable modem, data transfer and other personal computer (\"PC\") based services (\"Non-entertainment Services\").\nCable communications systems are generally constructed and operated under non-exclusive franchises granted by state or local governmental authorities. Franchises typically contain many conditions, such as time limitations on commencement or completion of construction; conditions of service, including number of channels, types of programming and provision of free services to schools and other public institutions; and the maintenance of insurance and indemnity bonds. Cable franchises are subject to the Cable Communications Policy Act of 1984 (the \"1984 Cable Act\"), the Cable Television Consumer Protection and Competition Act of 1992 (the \"1992 Cable Act,\" and together with the 1984 Cable Act, the \"Cable Acts\") and the 1996 Telecom Act (see \"Legislation and Regulation\"), as well as FCC, state and local regulations.\nThe Company's franchises typically provide for periodic payments to the governmental authority of franchise fees of up to 5% of revenues derived from cable operations. Franchises are generally nontransferable without the consent of the governmental authority. Many of the Company's franchises were granted for an initial term of 15 years. Although franchises historically have been renewed and, under the Cable Acts, should continue to be renewed for companies that have provided adequate service and have complied generally with franchise terms, renewal may be more difficult as a result of the 1992 Cable Act and may include less favorable terms and conditions. Furthermore, the governmental authority may choose to award additional franchises to competing companies at any time (see \"Competition\" and \"Legislation and Regulation\"). In addition, under the 1996 Telecom Act certain providers of programming services may be exempt from local franchising requirements.\nCompany's Systems\nThe table below sets forth a summary of Homes Passed and Cable Subscriber information for the Company's domestic cable communications systems for the five years ended December 31, 1995:\nRevenue Sources\nThe Company's cable communications systems offer varying levels of service, depending primarily on their respective channel capacities. As of December 31, 1995, a majority of the Company's systems had the capacity to carry in excess of 50 channels.\n- 4 -\nMonthly service rates and related charges vary in accordance with the type of service selected by the subscriber. The Company may receive an additional monthly fee for Pay Cable service, the charge for which varies with the type and level of service selected by the subscriber. Additional charges are often imposed for installation services, commercial subscribers, program guides and other services. The Company also generates revenue from pay-per-view services, advertising sales and commissions from electronic retailing. Subscribers typically pay on a monthly basis and generally may discontinue services at any time (see \"Legislation and Regulation\").\nProgramming and Suppliers\nThe Company generally pays either a monthly fee per subscriber or a percentage of the Company's gross receipts for programming. Some of the programming suppliers provide volume discount pricing structures and\/or offer marketing support to the Company.\nNational manufacturers are the primary sources of supplies, equipment and materials utilized in the construction and upgrading of the Company's cable communications systems. Construction, rebuild and upgrade costs for these systems have increased during recent years and are expected to continue to increase as a result of the need to construct increasingly complex systems, overall demand for labor and other factors. The Company is unable to predict whether increases in such costs will have a material impact on its operations.\nUK Activities\nThe Company beneficially owns a 31.2% equity interest and controls 81.9% of the total voting power of Comcast UK Cable. Comcast UK Cable is consolidated with the Company. As of December 31, 1995, Comcast UK Cable has equity interests in four operating companies (the \"UK Operating Companies\"): Birmingham Cable Corporation Limited (\"Birmingham Cable\"), in which Comcast UK Cable owns a 27.5% interest, Cable London PLC (\"Cable London\"), in which Comcast UK Cable owns a 49.0% interest, Cambridge Holding Company Limited (\"Cambridge Cable\"), in which Comcast UK Cable owns a 50.0% interest and a 100% interest in the franchises for Darlington and Teesside, England (\"Teesside\"). The UK Operating Companies hold exclusive cable television licenses and non-exclusive telecommunications licenses and provide integrated cable television, residential telephony and business telecommunications services to subscribers in their respective franchise areas.\nIn December 1995, Comcast UK Cable and the parent company of Singapore Telecommunications Limited (\"SingTel\") executed a Share Exchange Agreement relating to the exchange (the \"SingTel Transaction\") by SingTel of its 50% interest in Cambridge Cable and certain loans made to Cambridge Cable for approximately 8.9 million of Comcast UK Cable's Class A Common Shares and (pound)3.7 million, subject to certain closing adjustments. If the SingTel Transaction is consummated, which is anticipated to occur in the first half of 1996, Comcast UK Cable would begin consolidating the financial position and results of operations of Cambridge Cable. Upon consummation of the SingTel Transaction, the Company will beneficially own a 25.7% equity interest in and control 77.6% of the total voting power of Comcast UK Cable. Consummation of the SingTel Transaction is subject to a number of conditions, including the receipt of necessary regulatory approvals.\n- 5 -\nUK Operating Companies' Systems\nThe table below sets forth Homes Passed, Cable Subscriber and Telephony Subscriber information for the UK Operating Companies' cable communications systems for the five years ended December 31, 1995.\nTeesside commenced construction of a cable telecommunications network to serve its franchises in the third quarter of 1994 and added its initial cable and telephony subscribers in June 1995. When build-out of the UK Operating Companies' systems is complete, these systems will have the potential to serve approximately 1.6 million homes and the businesses within their franchise areas. Based on its December 31, 1995 proportionate ownership interests in the UK Operating Companies, Comcast UK Cable's interests represent the potential to serve approximately 835,000 homes.\nCompetition\nCable communications systems face competition from alternative methods of receiving and distributing television signals and from other sources of news, information and entertainment such as off-air television broadcast programming, newspapers, movie theaters, live sporting events, interactive computer services and home video products, including videotape cassette recorders. The extent to which a cable communications system is competitive depends, in part, upon the cable system's ability to provide, at a reasonable price to consumers, a greater variety of programming and other communications services than are available off-air or through other alternative delivery sources (see \"Legislation and Regulation\") and upon superior technical performance and customer service.\nThe 1996 Telecom Act will make it easier for local exchange telephone companies (\"LECs\") and others to provide a wide variety of video services competitive with services provided by cable systems and to provide cable services directly to subscribers (see \"Legislation and Regulation\"). Various LECs currently are seeking to provide video services within their telephone service areas through a variety of distribution methods. Cable systems could be placed at a competitive disadvantage if the delivery of video services by LECs becomes widespread since LECs may not be required, under certain circumstances, to obtain local franchises to deliver such video services or to comply with the variety of obligations imposed upon cable systems under such franchises (see \"Legislation and Regulation\"). Issues of cross-subsidization by LECs of video and telephony services also pose strategic disadvantages for cable\n- 6 -\noperators seeking to compete with LECs who provide video services. The Company cannot predict at this time the likelihood of success of video service ventures by LECs or the impact on the Company of such competitive ventures.\nCable communications systems generally operate pursuant to franchises granted on a non-exclusive basis. The 1992 Cable Act gives local franchising authorities jurisdiction over basic cable service rates and equipment in the absence of \"effective competition,\" prohibits franchising authorities from unreasonably denying requests for additional franchises and permits franchising authorities to operate cable systems (see \"Legislation and Regulation\"). Well- financed businesses from outside the cable industry (such as the public utilities that own certain of the poles on which cable is attached) may become competitors for franchises or providers of competing services (see \"Legislation and Regulation - The 1996 Telecom Act\"). The costs of operating a cable system where a competing service exists will be substantially greater than if there were no competition present. Competition exists in several of the Company's systems. In addition, LECs in various states have announced plans to compete with various of the Company's cable communications systems.\nCable operators face additional competition from private satellite master antenna television (\"SMATV\") systems that serve condominiums, apartment and office complexes and private residential developments. The operators of these SMATV systems often enter into exclusive agreements with building owners or homeowners' associations. While the 1984 Cable Act gives a franchised cable operator the right to use existing compatible easements within its franchise area on nondiscriminatory terms and conditions, there have been conflicting judicial decisions interpreting the scope of the access right granted to serve such private property. Various states have enacted laws to provide franchised cable systems access to such private complexes. These laws have been challenged in the courts with varying results. Due to the widespread availability of reasonably priced earth stations, SMATV systems now can offer both improved reception of local television stations and many of the same satellite-delivered program services offered by franchised cable systems. The ability of the Company to compete for subscribers in residential and commercial developments served by SMATV operators is uncertain. The 1996 Telecom Act gives cable operators greater flexibility with respect to pricing of cable communications services provided to subscribers in residential and commercial developments. It also broadens the definition of SMATV systems not subject to regulation as a franchised cable communications service.\nThe availability of reasonably-priced home satellite dish earth stations (\"HSDs\") enables individual households to receive many of the satellite-delivered program services formerly available only to cable subscribers. Furthermore, the 1992 Cable Act contains provisions, which the FCC has implemented with regulations, to enhance the ability of cable competitors to purchase and make available to HSD owners certain satellite-delivered cable programming at competitive costs.\nIn recent years, the FCC and the Congress have adopted policies providing a more favorable operating environment for new and existing technologies that provide, or have the potential to provide, substantial competition to cable systems. These technologies include, among others, the direct broadcast satellite (\"DBS\") service whereby signals are transmitted by satellite to receiving facilities located on the premises of subscribers. Programming is currently available to the owners of HSDs through conventional, medium and high-powered satellites. Primestar Partners L.P. (\"Primestar\"), a consortium comprised of cable operators, including the Company and a satellite company, commenced operation in 1990 of a medium-power DBS satellite system using the Ku portion of the frequency spectrum and currently provides service consisting of approximately 95 channels of programming, including broadcast signals and pay-per-view services. DirecTV, which recently added AT&T Corp. as an investor, began offering nationwide high-power DBS service in 1994 accompanied by extensive marketing efforts. Several other major companies are preparing to develop and operate high-power DBS systems, including MCI Communications Corp. and News Corp. DBS systems are expected to use video compression technology to increase the channel capacity of their systems to provide movies, broadcast stations and other program services competitive with those of cable systems. The extent to which DBS systems are competitive with the service provided by cable systems depends, among other things, on the availability of reception equipment at reasonable prices and on the ability of DBS operators to provide competitive programming.\nCable communications systems also compete with wireless program distribution services such as multichannel, multipoint distribution service (\"MMDS\") which use low-power microwave frequencies to transmit video programming over-the-air to subscribers. There are MMDS operators who are authorized to provide or are providing broadcast and satellite programming to subscribers in areas served by the Company's cable systems. Recently, several Regional Bell Operating Companies (\"BOCs\") acquired significant interests in major MMDS companies operating\n- 7 -\nin certain of the Company's cable service areas. Additionally, the FCC has pending a rulemaking proceeding in which it proposed to allocate frequencies in the 28 GHz band for a new multichannel wireless video service similar to MMDS. The Company is unable to predict whether wireless video services will have a material impact on its operations.\nOther new technologies may become competitive with Non-entertainment Services that cable communications systems can offer. The FCC has authorized television broadcast stations to transmit textual and graphic information useful both to consumers and businesses. The FCC also permits commercial and non-commercial FM stations to use their subcarrier frequencies to provide non-broadcast services including data transmissions. The FCC established an over-the-air Interactive Video and Data Service that will permit two-way interaction with commercial and educational programming along with informational and data services. LECs and other common carriers also provide facilities for the transmission and distribution to homes and businesses of interactive computer-based services, including the Internet, as well as data and other non-video services. The FCC has conducted spectrum auctions for licenses to provide PCS. PCS will enable license holders, including cable operators, to provide voice and data services (see \"Wireless Telecommunications - Cellular Telephone Communications - Competition\").\nAdvances in communications technology as well as changes in the marketplace and the regulatory and legislative environment are constantly occurring. Thus, it is not possible to predict the effect that ongoing or future developments might have on the cable communications industry.\nLegislation and Regulation\nThe Cable Acts and the 1996 Telecom Act amended the Communications Act and established a national policy to guide the development and regulation of cable systems. Principal responsibility for implementing the policies of the Cable Acts is allocated between the FCC and state or local franchising authorities. In addition, legislative and regulatory proposals by the Congress and federal agencies, particularly the approximately eighty (80) rulemakings at the FCC resulting from the 1996 Telecom Act and the many state regulatory proceedings necessary to implement the 1996 Telecom Act, may materially affect the cable communications industry. The following is a summary of federal laws and regulations materially affecting the growth and operation of the cable communications industry and a description of certain state and local laws.\nThe 1996 Telecom Act\nThe 1996 Telecom Act, the most comprehensive reform of the nation's telecommunications laws since the Communications Act, became effective in February 1996. The 1996 Telecom Act will result in changes in the marketplace for cable communications, telephone and other telecommunications services. Although the long-term goal of this Act is to promote competition and decrease regulation of these industries, in the short-term the law delegates to the FCC (and in some cases the states) broad new rulemaking authority. The new law requires many of these rulemakings to be completed in a limited period of time. The following is a brief summary of the important features of the 1996 Telecom Act that will affect the cable communications, telephone and other telecommunications industries.\nCable Communications. The 1996 Telecom Act deregulates rates for CPSTs in March 1999 for large Multiple System Operators (\"MSOs\"), such as the Company, and immediately for certain small operators. Deregulation will occur sooner for systems in markets where comparable video services, other than DBS, are offered by the LECs, or their affiliates, or by a third parties utilizing the LECs' facilities or where \"effective competition\" is established under the 1992 Cable Act. The 1996 Telecom Act also modifies the uniform rate provisions of the 1992 Cable Act by prohibiting regulation of bulk discount rates offered to subscribers in commercial and residential developments and permits regulated equipment rates to be computed by aggregating costs of broad categories of equipment at the franchise, system, regional or company level. The 1996 Telecom Act eliminates the right of individual subscribers to file rate complaints with the FCC concerning certain CPSTs and requires the FCC to issue a final order within 90 days after receipt of CPST rate complaints filed by any franchising authority after the date of enactment of the 1996 Telecom Act. The 1996 Telecom Act also modifies the existing statutory provisions governing cable system technical standards, equipment compatibility, subscriber notice requirements and program access, permits certain operators to include losses incurred prior to September 1992 in setting regulated rates and repeals the three-year anti- trafficking prohibition adopted in the 1992 Cable Act.\n- 8 -\nThe 1996 Telecom Act eliminates the requirement that LECs obtain FCC approval under Section 214 of the Communications Act before providing video services in their telephone service areas and removes the telephone company\/cable television cross-ownership prohibition that had been codified by the 1984 Cable Act, thereby facilitating the ability of the LECs to offer video services in their telephone service areas. LECs may provide service as traditional cable operators with local franchises or they may opt to provide their programming over unfranchised \"open video systems,\" in which case they must set aside a portion of their channel capacity for use by unaffiliated program distributors and satisfy certain other requirements. Under certain circumstances, cable operators also may elect to offer services through open video systems. The 1996 Telecom Act also prohibits a LEC from acquiring a cable operator in its telephone service area except in limited circumstances.\nTelephone. The 1996 Telecom Act removes barriers to entry in the local telephone exchange market that is now monopolized by the seven BOCs and other LECs by preempting state and local laws that restrict competition and by requiring all LECs to provide nondiscriminatory access and interconnection to potential competitors, such as cable operators and long distance companies. At the same time, the new law eliminates the prospective effects of the AT&T, GTE and McCaw consent decrees and permits the BOCs to enter the market for long distance services (through a separate subsidiary) after they meet a series of requirements intended to open their telephone service areas to competition. The 1996 Telecom Act also permits interstate utility companies to enter the telecommunications market.\nWhile the 1996 Telecom Act imposes new requirements with regard to interconnection, it also directs the FCC to substantially relax much of its regulation of LECs to promote competition. The new law also eliminates or streamlines many of the requirements applicable to LECs, such as the requirement to obtain prior approval of construction or acquisition of new plant. In addition, the 1996 Telecom Act requires the FCC and states to review universal service programs and encourage access to advanced telecommunications services by schools, libraries and other public institutions.\nOther Telecommunications Services. In addition to these provisions governing regulation of specific segments of the market, the 1996 Telecom Act also contains provisions regulating the content of video programming and computer services. Specifically, the new law prohibits the use of computer services to transmit \"indecent\" material to minors. The 1996 Telecom Act also requires the FCC to prescribe guidelines for a ratings system for violent and indecent video programming and requires all new television sets to contain a so-called \"V-chip\" capable of blocking all programs with a given rating. The new law substantially relaxes current broadcast ownership rules by eliminating the 12 station limit for television station ownership, and, instead, limiting ownership to stations with a potential aggregate reach of 35 percent of television households in the US and eliminating the network\/cable cross-ownership prohibition.\nRate Regulation\nPrior to April 1993, virtually all of the Company's cable systems were free to adjust cable rates without first obtaining governmental approval. The 1992 Cable Act authorized rate regulation for cable communications services and equipment in communities that are not subject to \"effective competition,\" as defined in the 1992 Cable Act and as amended by the 1996 Telecom Act. Virtually all cable communications systems are now subject to rate regulation for basic cable service and equipment by local officials under the oversight of the FCC, which has prescribed detailed criteria for such rate regulation. The 1992 Cable Act also requires the FCC to resolve complaints about rates for CPSTs (other than programming offered on a per channel or per program basis, which programming is not subject to rate regulation) and to reduce any such rates found to be unreasonable. The 1996 Telecom Act provides for rate deregulation (see \"The 1996 Telecom Act\").\nIn April 1993, the FCC adopted regulations in accordance with the 1992 Cable Act governing rates that may be charged to subscribers for basic cable service and certain CPSTs (together, the \"Regulated Services\") and ordered an interim freeze on existing rates. The FCC's rate regulations became effective in September 1993 and the FCC's rate freeze was extended until the earlier of May 1994 or the date on which a cable system's basic cable service rate was regulated by a franchising authority.\nIn implementing the 1992 Cable Act, the FCC adopted a benchmark methodology as the principal method of regulating rates for Regulated Services. Cable operators were also permitted to justify rates using a cost-of-service methodology. As of September 1993, cable operators whose then current rates were above FCC benchmark levels\n- 9 -\nwere required, absent a successful cost-of-service showing, to reduce such rates to the benchmark level or by up to 10% of those rates in effect on September 30, 1992, whichever reduction was less, adjusted for equipment costs, inflation and programming modifications occurring subsequent to September 30, 1992. Effective May 1994, the FCC modified its benchmark methodology to require reductions of up to 17% of the rates for Regulated Services in effect on September 30, 1992, adjusted for inflation, programming modifications, equipment costs and increases in certain operating costs. In July 1994, the Company reduced rates for Regulated Services in the majority of its cable systems to comply with the FCC's modified benchmarks and regulations.\nThe FCC's initial \"Going Forward\" regulations limited rate increases for Regulated Services after the establishment of an initial regulated rate to an inflation-indexed amount plus increases for channel additions and certain external costs beyond the cable operator's control, such as franchise fees, taxes and increased programming costs. Under these regulations, cable operators are entitled to take a 7.5% mark-up on certain programming cost increases. In November 1994, the FCC modified these regulations and instituted an alternative three-year flat fee mark-up plan for charges relating to new channels added to the CPST. As of January 1995, cable operators were permitted to charge subscribers for channels added to the CPST after May 1994, at a monthly rate of up to 20 cents per added channel, up to a total of $1.20 plus an additional 30 cents for programming license fees per subscriber over the first two years of the three-year period; cable operators may charge an additional 20 cents plus the cost of the programming in the third year (1997) for one additional channel added in that year. Alternatively, operators may increase rates by the amount of any programming license fees in connection with such added channels, provided that the total monthly rate increase per subscriber for the added channels, including license fees, does not exceed $1.50 over the first two years, and $1.70, plus any increase in the license fees for the added channels, in the third year. Operators must make a one-time election to use either the 20 cents per channel adjustment or the 7.5% mark-up on programming cost increases for all channels added after December 31, 1994. The FCC is currently considering whether to modify or eliminate the regulation allowing operators to receive the 7.5% mark-up on increases in existing programming license fees. In September 1995, the FCC authorized a new, alternative method of implementing rate adjustments which will allow cable operators to increase rates for Regulated Services annually on the basis of projected increases in external costs (inflation, costs for programming, franchise-related obligations, and changes in the number of regulated channels) rather than on the basis of cost increases incurred in the preceding calendar quarter. Operators that elect not to recover all of their accrued external costs and inflation pass-throughs each year may recover them (with interest) in subsequent years.\nIn November 1994, the FCC adopted regulations permitting cable operators to create new product tiers (\"NPT\") that will not be subject to rate regulation if certain conditions are met. The FCC also revised its previously adopted policy and concluded that packages of a la carte services are subject to rate regulation by the FCC as CPSTs. Because of the uncertainty created by the FCC's prior a la carte package guidelines, the FCC will allow cable operators, including the Company, under certain circumstances, to treat previously offered a la carte packages as NPTs.\nFranchising authorities are empowered to regulate the rates charged for additional outlets and for the installation, lease and sale of equipment used by subscribers to receive the basic cable service tier, such as converter boxes and remote control units. The FCC's rules require franchising authorities to regulate these rates on the basis of actual cost plus a reasonable profit, as defined by the FCC. The 1996 Telecom Act requires the FCC to revise its regulations to permit operators to compute regulated equipment rates by aggregating costs of broad categories of equipment at the franchise, system, regional or company level. In November 1995, the FCC initiated a general rulemaking proposal that permits cable operators to price services uniformly across multiple franchise areas, as well as regional areas. If the FCC adopts the proposals, cable operators that provide service to clusters of systems would be permitted to charge uniform rates across large geographic areas. Because the proposal is designed to be revenue neutral, it would not affect the overall revenue that operators receive, but administrative and marketing costs could be reduced.\nCable operators required to reduce rates may also be required to refund overcharges with interest. Rate reductions will not be required where a cable operator can demonstrate that existing rates for Regulated Services are justified and reasonable using cost-of-service guidelines. In November 1993, the FCC ruled that operators choosing to justify rates through a cost-of-service submission must do so for all Regulated Services. In February 1994, the FCC adopted interim cost-of-service regulations establishing, among other things, the rebuttable presumptions of an industry-wide 11.25% after tax rate of return on an operator's allowable rate base and that acquisition costs above original historic book value of tangible assets should be excluded from the allowable rate base. In December 1995, the FCC adopted final cost-of-service rate regulations requiring, among other things, cable operators to exclude 34% of system acquisition\n- 10 -\ncosts related to intangible and tangible assets used to provide Regulated Services. The FCC also reaffirmed the industry-wide 11.25% after tax rate of return on an operator's allowable rate base, but initiated a further rulemaking in which it proposes to use an operator's actual debt cost and capital structure to determine an operator's cost of capital or rate of return.\nThe Company has settled the majority of outstanding proceedings challenging its rates charged for regulated cable services. In December 1995, the FCC adopted an order approving a negotiated settlement of rate complaints pending against the Company for CPSTs which provided approximately $6.6 million in refunds, plus interest, being given in the form of bill credits, to approximately 1.3 million of the Company's cable subscribers. This FCC order resolved 160 of the Company's benchmark rate cases covering the period September 1993 through July 1994 and 104 of the Company's cost-of-service cases for CPSTs covering the period September 1993 through December 1995. As part of the negotiated settlement, the Company agreed to forego certain inflation and external cost adjustments for systems covered by its cost-of-service filings for CPSTs. The FCC's order has been appealed to a federal appellate court by a local franchising authority whose rate complaint against the Company was resolved by the negotiated settlement. The Company currently is seeking to justify rates for basic cable services and equipment in certain of its cable systems in the State of Connecticut on the basis of a cost-of-service showing. The State of Connecticut has ordered the Company to reduce such rates and to make refunds to subscribers. The Company has appealed the Connecticut decision to the FCC. The Company's management believes that the ultimate resolution of these pending regulatory matters will not have a material adverse impact on the Company's financial position or results of operations.\nIn June 1995, the US Court of Appeals for the District of Columbia Circuit substantially upheld the cable rate regulations adopted by the FCC pursuant to the 1992 Cable Act. In February 1996, the US Supreme Court declined to review the circuit court decision.\n\"Anti-Buy Through\" Provisions. The 1992 Cable Act requires cable systems to permit subscribers to purchase video programming offered by the operator on a per channel or a per program basis without the necessity of subscribing to any tier of service, other than the basic cable service tier, unless the system's lack of addressable converter boxes or other technological limitations does not permit it to do so. The statutory exemption for cable systems that do not have the technological capability to offer programming in the manner required by the statute is available until a system obtains such capability, but not later than December 2002. The FCC may waive such time periods, if deemed necessary. Most of the Company's systems do not have the technological capability to offer programming in the manner required by the statute and thus currently are exempt from complying with the requirement.\nMust Carry\/Retransmission Consent. The 1992 Cable Act contains broadcast signal carriage requirements that allow local commercial television broadcast stations to elect once every three years to require a cable system to carry the station, subject to certain exceptions, or to negotiate for \"retransmission consent\" to carry the station. A cable system generally is required to devote up to one-third of its activated channel capacity for the carriage of local commercial television stations whether pursuant to the mandatory carriage or retransmission consent requirements of the 1992 Cable Act. Local non-commercial television stations are also given mandatory carriage rights; however, such stations are not given the option to negotiate retransmission consent for the carriage of their signals by cable systems. Additionally, cable systems are required to obtain retransmission consent for all \"distant\" commercial television stations (except for commercial satellite-delivered independent \"superstations\" such as WTBS), commercial radio stations and certain low power television stations carried by such systems after October 1993. In April 1993, a special three-judge federal district court issued a decision upholding the constitutional validity of the mandatory signal carriage requirements. In June 1994, the US Supreme Court vacated this decision and remanded it to the district court to determine, among other matters, whether the statutory carriage requirements are necessary to preserve the economic viability of the broadcast industry. In December 1995, the district court upheld the mandatory carriage requirements of the 1992 Cable Act. In February 1996, the Supreme Court agreed to review this decision of the district court. The Company cannot predict the ultimate outcome of this litigation. Pending action by the Supreme Court, the mandatory broadcast signal carriage requirements remain in effect.\nDesignated Channels. The 1984 Cable Act permits franchising authorities to require cable operators to set aside certain channels for public, educational and governmental access programming. The 1984 Cable Act also requires a cable system with 36 or more channels to designate a portion of its channel capacity for commercial leased access by third parties to provide programming that may compete with services offered by the cable operator. The FCC has adopted rules regulating: (i) the maximum reasonable rate a cable operator may charge for commercial use of the\n- 11 -\ndesignated channel capacity; (ii) the terms and conditions for commercial use of such channels; and (iii) the procedures for the expedited resolution of disputes concerning rates or commercial use of the designated channel capacity.\nFranchise Procedures. The 1984 Cable Act affirms the right of franchising authorities (state or local, depending on the practice in individual states) to award one or more franchises within their jurisdictions and prohibits non-grandfathered cable systems from operating without a franchise in such jurisdictions. The 1992 Cable Act encourages competition with existing cable systems by (i) allowing municipalities to operate their own cable systems without franchises; (ii) preventing franchising authorities from granting exclusive franchises or from unreasonably refusing to award additional franchises covering an existing cable system's service area; and (iii) prohibiting (with limited exceptions) the common ownership of cable systems and co-located MMDS or SMATV systems. In January, 1995, the FCC relaxed its restrictions on ownership of SMATV systems to permit a cable operator to acquire SMATV systems in the operator's existing franchise area so long as the programming services provided through the SMATV system are offered according to the terms and conditions of the cable operator's local franchise agreement.\nThe 1984 Cable Act also provides that in granting or renewing franchises, local authorities may establish requirements for cable-related facilities and equipment, but not for video programming or information services other than in broad categories. Among the more significant provisions of the 1984 Cable Act is a limitation on the payment of franchise fees to 5% of cable system revenues and the opportunity for the cable operator to obtain modification of franchise requirements by the franchise authority or judicial action if warranted by changed circumstances. The Company's franchises typically provide for payment of fees to franchising authorities of 5% of \"revenues\" (as defined by each franchise agreement), which fees may be passed on to subscribers.\nThe 1984 Cable Act contains renewal procedures designed to protect incumbent franchisees against arbitrary denials of renewal. The 1992 Cable Act makes several changes to the renewal process which could make it easier for a franchising authority to deny renewal. Moreover, even if the franchise is renewed, the franchising authority may seek to impose new and more onerous requirements such as significant upgrades in facilities and services or increased franchise fees as a condition of renewal. Similarly, if a franchising authority's consent is required for the purchase or sale of a cable system or franchise, such authority may attempt to impose more burdensome or onerous franchise requirements in connection with a request for such consent. Historically, franchises have been renewed for cable operators that have provided satisfactory services and have complied with the terms of their franchises. The Company believes that it has generally met the terms of its franchises and has provided quality levels of service and it anticipates that its future franchise renewal prospects generally will be favorable.\nVarious courts have considered whether franchising authorities have the legal right to limit franchise awards to a single cable operator and to impose certain substantive franchise requirements (e.g. access channels, universal service and other technical requirements). These decisions have been somewhat inconsistent and, until the US Supreme Court rules definitively on the scope of cable operators' First Amendment protections, the legality of the franchising process generally and of various specific franchise requirements is likely to be in a state of flux.\nOwnership Limitations. Pursuant to the 1992 Cable Act, the FCC adopted rules prescribing national subscriber limits and limits on the number of channels that can be occupied on a cable system by a video programmer in which the operator has an attributable interest. The effectiveness of these FCC horizontal ownership limits has been stayed because a federal district court found the statutory limitation to be unconstitutional. An appeal of that decision is pending. The 1996 Telecom Act eliminates the statutory prohibition on the common ownership, operation or control of a cable system and a television broadcast station in the same service area and directs the FCC to eliminate its regulatory restrictions on cross-ownership of cable systems and national broadcasting networks and to review its broadcast-cable ownership restrictions to determine if they are necessary in the public interest.\nLEC Ownership of Cable Systems. The 1984 Cable Act, FCC regulations, and the 1982 federal court consent decree that settled the antitrust suit against AT&T regulated the provision of video programming and other information services by LECs. The statutory provision and corresponding FCC regulations are of particular competitive importance because LECs already own much of the plant necessary for cable communications operations, such as poles, underground conduit and associated rights-of-way. The 1996 Telecom Act makes far-reaching changes in the regulation of LECs that provide cable services. The new law eliminates current legal barriers to competition in the local telephone and cable communications businesses, preempts legal barriers to competition that previously existed in state and local laws and regulations, and sets basic standards for relationships between telecommunications\n- 12 -\nproviders (see \"The 1996 Telecom Act\"). The FCC and, in some cases, states are required to conduct numerous rulemaking proceedings to implement the 1996 Telecom Act. The ultimate outcome of these rulemakings, and the ultimate impact of the 1996 Telecom Act or any final regulations adopted pursuant to the new law on the Company or its businesses cannot be determined at this time.\nPole Attachment. The Communications Act requires the FCC to regulate the rates, terms and conditions imposed by public utilities for cable systems' use of utility pole and conduit space unless state authorities can demonstrate that they adequately regulate pole attachment rates, as is the case in certain states in which the Company operates. In the absence of state regulation, the FCC administers pole attachment rates on a formula basis. In some cases, utility companies have increased pole attachment fees for cable systems that have installed fiber optic cables and that are using such cables for the distribution of non-video services. The FCC concluded that, in the absence of state regulation, it has jurisdiction to determine whether utility companies have justified their demand for additional rental fees and that the Communications Act does not permit disparate rates based on the type of service provided over the equipment attached to the utility's pole. The 1996 Telecom Act modifies the current pole attachment provisions of the Communications Act by immediately permitting certain providers of telecommunications services to rely upon the protections of the current law and by requiring that utilities provide cable systems and telecommunications carriers with nondiscriminatory access to any pole, conduit or right-of-way controlled by the utility. Additionally, within two years of enactment of the 1996 Telecom Act, the FCC is required to adopt new regulations to govern the charges for pole attachments used by companies providing telecommunications services, including cable operators. These new pole attachment regulations will become effective five years after enactment of the 1996 Telecom Act, and any increase in attachment rates resulting from the FCC's new regulations will be phased in equal annual increments over a period of five years beginning on the effective date of the new FCC regulations.\nOther Statutory Provisions. The 1992 Cable Act and the 1996 Telecom Act preclude video programmers affiliated with cable companies or common carriers providing video programming directly to subscribers from favoring the affiliated company over competitors and requires such programmers to sell their programming to other multichannel video distributors. This provision limits the ability of cable program suppliers affiliated with cable companies or common carriers providing video programming to offer exclusive programming arrangements to their affiliates. The Cable Acts also include provisions, among others, concerning horizontal and vertical ownership of cable systems, customer service, subscriber privacy, commercial leased access channels, marketing practices, equal employment opportunity, franchise renewal and transfer, award of franchises, obscene or indecent programming, regulation of technical standards and equipment compatibility. The FCC has adopted regulations implementing many of these statutory provisions and it has received numerous petitions requesting reconsideration of various aspects of its rulemaking proceedings.\nOther FCC Regulations. In addition to the FCC regulations noted above, there are other FCC regulations covering such areas as equal employment opportunity, syndicated program exclusivity, network program non-duplication, registration of cable systems, maintenance of various records and public inspection files, microwave frequency usage, lockbox availability, origination cablecasting and sponsorship identification, antenna structure notification, marking and lighting, carriage of local sports programming, application of rules governing political broadcasts, limitations on advertising contained in non-broadcast children's programming, consumer protection and customer service, leased commercial access, ownership of home wiring, indecent programming, programmer access to cable systems, programming agreements, technical standards, consumer electronics equipment compatibility and DBS implementation. The FCC has the authority to enforce its regulations through the imposition of substantial fines, the issuance of cease and desist orders and\/or the imposition of other administrative sanctions, such as the revocation of FCC licenses needed to operate certain transmission facilities often used in connection with cable operations.\nOther bills and administrative proposals pertaining to cable communications have previously been introduced in Congress or considered by other governmental bodies over the past several years on matters such as rate regulation, customer service standards, sports programming, franchising and copyright. It is probable that further attempts will be made by Congress and other governmental bodies relating to the regulation of communications services.\nCopyright. Cable communications systems are subject to federal copyright licensing covering carriage of television and radio broadcast signals. In exchange for filing certain reports and contributing a percentage of their revenues to a federal copyright royalty pool, cable operators can obtain blanket permission to retransmit copyrighted material on broadcast signals. The nature and amount of future payments for broadcast signal carriage cannot be predicted at this time. The possible simplification, modification or elimination of the compulsory copyright license is the\n- 13 -\nsubject of continuing legislative review. The elimination or substantial modification of the cable compulsory license could adversely affect the Company's ability to obtain suitable programming and could substantially increase the cost of programming that remained available for distribution to the Company's subscribers. The Company cannot predict the outcome of this legislative activity.\nIn October 1989, the special rate court of the US District Court for the Southern District of New York imposed interim rates on the cable industry's use of ASCAP-controlled music. Payment of these rates by cable programmers secures licenses that cover the use of the music licensed by ASCAP by both the cable programmers and their cable operator affiliates. A special rate court was recently created for the other major music performing rights society, BMI, to establish rates for the use of BMI-controlled music. BMI and cable industry representatives recently concluded negotiations for a standard licensing agreement covering the performance of BMI music contained in advertising and other information inserted by operators into cable programming and on certain local access and origination channels carried on cable systems. The Company's settlement with BMI did not have a significant impact on the Company's financial position or results of operations. ASCAP and cable industry representatives have met to discuss the development of a standard licensing agreement covering ASCAP-controlled music in local origination and access channels and pay-per-view programming.\nState and Local Regulation\nBecause a cable communications system uses local streets and rights-of-way, cable systems are subject to state and local regulation, typically imposed through the franchising process. Cable communications systems generally are operated pursuant to nonexclusive franchises, permits or licenses granted by a municipality or other state or local government entity. Franchises generally are granted for fixed terms and in many cases are terminable if the franchisee fails to comply with material provisions. The terms and conditions of franchises vary materially from jurisdiction to jurisdiction. Each franchise generally contains provisions governing cable service rates, franchise fees, franchise term, system construction and maintenance obligations, system channel capacity, design and technical performance, customer service standards, franchise renewal, sale or transfer of the franchise, territory of the franchisee, indemnification of the franchising authority, use and occupancy of public streets and types of cable services provided. A number of states subject cable communications systems to the jurisdiction of centralized state governmental agencies, some of which impose regulation of a character similar to that of a public utility. Attempts in other states to regulate cable communications systems are continuing and can be expected to increase. To date, those states in which the Company operates that have enacted such state level regulation are Connecticut, New Jersey and Delaware. State and local franchising jurisdiction is not unlimited, however, and must be exercised consistently with federal law. The 1992 Cable Act immunizes franchising authorities from monetary damage awards arising from regulation of cable systems or decisions made on franchise grants, renewals, transfers and amendments.\nThe foregoing does not purport to describe all present and proposed federal, state, and local regulations and legislation affecting the cable industry. Other existing federal regulations, copyright licensing, and, in many jurisdictions, state and local franchise requirements, are currently the subject of judicial proceedings, legislative hearings and administrative proposals which could change, in varying degrees, the manner in which cable communications systems operate. Neither the outcome of these proceedings nor their impact upon the cable communications industry or the Company can be predicted at this time.\nUK Regulation\nThe operation of a cable television\/telephony system in the UK is regulated under both the Broadcasting Act 1990 (the \"Broadcasting Act\") (which replaced the Cable and Broadcasting Act 1984 (the \"UK Cable Act\")) and the Telecommunications Act 1984 (the \"Telecommunications Act\"). The operator of a cable\/telephony franchise covering over 1,000 homes must hold two principal licenses: (i) a license (a \"cable television license\") issued in the past under the UK Cable Act or since 1990 under the Broadcasting Act, which allows the operator to provide cable television services in the franchise area, and (ii) a telecommunications license issued under the Telecommunications Act, which allows the operator to operate and use the physical network necessary to provide cable television and telecommunications services. The Independent Television Commission (\"ITC\") is responsible for the licensing and regulation of cable television. The Department of Trade and Industry (\"DTI\") is responsible for issuing, and the Office of Telecommunications (\"OFTEL\") is responsible for regulating the holders of, the telecommunications licenses. In addition, an operator is required to hold a license under the Wireless Telegraphy Acts of 1949-67 for the use of microwave distribution systems.\n- 14 -\nThe cable television licenses held by the relevant subsidiaries of the UK Operating Companies were issued under the UK Cable Act for 15-year periods and are scheduled to expire beginning in late 2004. The telecommunications licenses held by these subsidiaries of the UK Operating Companies are for 23-year periods and are scheduled to expire beginning in late 2012.\nWIRELESS TELECOMMUNICATIONS\nThe Company's wireless telecommunications operations primarily consist of the Company's cellular telephone communications operations. The Company's other wireless telecommunications businesses includes its DBS operations, including the Company's investment in Primestar (see \"Wired Telecommunications - Cable Communications - Competition\"), and its interest in Sprint Spectrum, which has acquired 29 PCS licenses and is in the process of developing operations to provide telecommunications services (see \"General Developments of Business - Sprint Spectrum\").\nCellular Telephone Communications\nGeneral\nThe Company is engaged in the development, management and operation of cellular telephone communications systems in various service areas pursuant to licenses granted by the FCC. Each service area is divided into segments referred to as \"cells\" equipped with a receiver, signaling equipment and a low-power transmitter. The use of low-power transmitters and the placement of cells close to one another permits re-use of frequencies, thus substantially increasing the volume of calls capable of being handled simultaneously over the number handled by conventional mobile telephone systems. Each cell has a coverage area generally ranging from one to more than 25 miles. A cellular telephone system includes a computerized central switching facility known as the mobile telephone switching office (\"MTSO\") which controls the automatic transfer of calls, coordinates calls to and from cellular telephones and connects calls to the LEC or to an interexchange carrier. The MTSO also records information on system usage and subscriber statistics.\nEach cell's facilities monitor the strength of the signal returned from the subscriber's cellular telephone. When the signal strength declines to a predetermined level and the transmission strength is greater at another cell in or interconnected with the system, the MTSO automatically and instantaneously passes the mobile user's call in progress to the other cell without disconnecting the call (\"hand off\"). Interconnection agreements between cellular telephone system operators and various LECs and interexchange carriers establish the manner in which the cellular telephone system integrates with other telecommunications systems.\nAs required by the FCC, all cellular telephones are designed for compatibility with cellular systems in all markets within the US so that a cellular telephone may be used wherever cellular service is available. Each cellular telephone system in the US uses one of two groups of channels, termed \"Block A\" and \"Block B,\" which the FCC has allotted for cellular service. Minor adjustments to cellular telephones may be required to enable the subscriber to change from a cellular system on one frequency block to a cellular system on the other frequency block.\nWhile most MTSOs process information digitally, most radio transmission of cellular telephone calls is done on an analog basis. Digital transmission of cellular telephone calls offers advantages, including improved voice quality under certain conditions, larger system capacity and the potential for lower incremental costs for additional subscribers. The FCC allows carriers to provide digital service and requires cellular carriers to provide analog service. The Company's conversion from analog to digital radio technology is expected to commence in 1997 and to take a number of years.\nThe Company provides services to its cellular telephone subscribers similar to those provided by conventional landline telephone systems, including custom calling features such as call forwarding, call waiting, conference calling, directory assistance and voice mail. The Company is responsible for the quality, pricing and packaging of cellular telephone service for each of the systems it owns and controls.\nReciprocal agreements among cellular telephone system operators allow their respective subscribers (\"roamers\") to place and receive calls in most service areas throughout the country. Roamers are charged rates which are generally at a premium to the regular service rate. In recent years, cellular carriers have experienced increased fraud associated\n- 15 -\nwith roamer service, including Electronic Serial Number (\"ESN\") cloning. The Company and other carriers have taken steps to combat roamer fraud, but it is uncertain to what extent roamer fraud will continue. In 1995, the Company implemented a number of features which it believes will decrease the incidents of fraudulent use of its systems. Among these are Personal Identification Numbers (\"PINs\"), which are required to be used by a majority of the Company's customers, and the Company's Security Zone feature which restricts customer usage outside the Company's consolidated footprint. The Company has established interoperability with the Washington-Baltimore cellular provider, and is currently working on interoperability with the New York cellular provider, to permit its customers' use of both PINs and Security Zone in neighboring systems frequented by the Company's customers.\nIn addition, the Company is evaluating the implementation of authentication and RF fingerprinting technologies which will associate ESN\/mobile number combinations with particular cellular telephone units. The use of digital technologies also purportedly will make it more difficult to commit cellular fraud.\nAllegations of harmful effects from the use of hand-held cellular phones have caused the cellular industry to fund additional research to review and update previous studies concerning the safety of the emissions of electromagnetic energy from cellular phones. In August 1993, the FCC adopted a notice of proposed rulemaking to consider the incorporation of the new standard for radiofrequency exposure adopted by the American National Standards Institute in association with the Institute of Electrical and Electronic Engineers, Inc. The FCC is considering the application of the new standard to low-power devices such as hand-held mobile transceivers. In addition, the FCC is considering how the new standard should apply to cellular transmitter sites. Pursuant to the 1996 Telecom Act, this proceeding must be completed within 180 days of the legislation's enactment.\nCompany's Systems\nThe table below sets forth summary information regarding the total population (\"Pops\") in the markets served by the Company's systems by Metropolitan Statistical Area (\"MSAs\") and Rural Service Area (\"RSAs\") and aggregate subscriber information as of December 31, 1995.\nAs of December 31, 1995, the Company's cellular telephone business had 665,000 subscribers in the markets listed above.\n- 16 -\nCompetition\nThe cellular telephone business is currently a regulated duopoly. The FCC generally grants two licenses to operate cellular telephone systems in each market. One of the two licenses was initially awarded to a company or group affiliated with the local landline telephone carriers in the market (the \"Wireline\" license), and the other license was initially awarded to a company, individual, or group not affiliated with any landline telephone carrier (the \"Non- Wireline\" license).\nThe Company's systems are all Non-Wireline systems and compete directly with the Wireline licensee in each market in attracting and retaining cellular telephone customers and dealers. Competition between the two licensees in each market is principally on the basis of services and enhancements offered, technical quality of the system, quality and responsiveness of customer service, price and coverage area. The Wireline licensee in the Company's principal markets is Cellco Partnership, a joint venture between Bell Atlantic Mobile Systems, Inc. and NYNEX Mobile Communications Co. The Company's principal Wireline competitor is significantly larger and may have access to more substantial financial resources than the Company.\nThe FCC requires cellular licensees to provide service to resellers of cellular service which purchase cellular service from licensees, usually in the form of blocks of numbers, then resell the service to the public. Thus, a reseller may be both a customer and a competitor of a licensed cellular operator. The FCC currently is seeking comment on whether resellers should be permitted to install separate switching facilities in cellular systems, although it has tentatively concluded not to require such interconnects. The FCC is also considering whether resellers should receive direct assignments of telephone numbers from LECs.\nCellular telephone systems, including the Company's systems, also face actual or potential competition from other current and developing technologies. Specialized Mobile Radio (\"SMR\") systems, such as those used by taxicabs, as well as other forms of mobile communications service, may provide competition in certain markets. SMR systems are permitted by FCC rules to be interconnected to the public switched telephone network and are significantly less expensive to build and operate than cellular telephone systems. SMR systems are, however, licensed to operate on substantially fewer channels per system than cellular telephone systems and generally lack cellular's ability to expand capacity through frequency reuse by using many low-power transmitters and to hand-off calls. Nextel Communications, Inc., in which the Company holds an equity interest, has begun to implement its proposal to use its available SMR spectrum in various metropolitan areas more efficiently to increase capacity and to provide a broad range of mobile radio communications services. This proposal, known as ESMR service, could provide additional competition to existing cellular carriers, including the Company. In 1994, the FCC decided to license SMR systems in the 800 MHz bands for wide-area use, thus increasing potential competition with cellular. The FCC recently decided to license SMR spectrum in contiguous blocks via the competitive bidding process. Although wide-area SMR spectrum has not yet been assigned, the licensing change may further the competitive potential of SMR services.\nOne-way paging or beeper services that feature voice message, data services and tones are also available in the Company's markets. These services may provide adequate capacity and sufficient mobile capabilities for some potential cellular subscribers, thus providing additional competition to the Company's systems.\nCertain new technologies and regulatory proposals potentially could affect the competitive position of the cellular industry. The most prominent is PCS, which includes a variety of digital, wireless communications systems currently primarily suited for use in densely populated areas. At the power levels that the FCC's rules now provide, each cell of a PCS system would have more limited coverage than a cell in a cellular telephone system. Current proposals for PCS include advanced cordless telephones, or CT-2, mobile data networks, and personal communications networks that might provide services similar to those provided by cellular at costs lower than those currently charged by cellular system operators. The FCC has allocated spectrum and adopted rules for both narrow and broadband PCS services. In 1994, the FCC completed a spectrum auction for nationwide narrowband PCS licenses, undertook the first regional narrowband PCS auction, and began the first auction of broadband PCS spectrum (see \"General Developments of Business - Sprint Spectrum\"). All of the 30 MHz Major Trading Area licenses for PCS were issued by June 1995 and PCS licensees are required to construct their networks to be capable of covering one third of their service area population within five years of the date of licensing. Broadband PCS service likely will become a direct competitor to cellular service. In December 1995, the FCC commenced the auction of additional PCS spectrum designated for license to small businesses, rural telephone companies and other entrepreneurs. The FCC intends to offer additional spectrum for Commercial Mobile Radio Service (\"CMRS\") licenses in the future.\n- 17 -\nApplicants have received and others are seeking FCC authorization to construct and operate global satellite networks to provide domestic and international mobile communications services from geostationary and low earth orbit satellites. In addition, the Omnibus Budget Reconciliation Act of 1993 (\"1993 Budget Act\") provided, among other things, for the release of 200 MHz of Federal government spectrum for commercial use over a fifteen year period. The FCC has already allotted 25 MHz of spectrum for fixed and mobile use. The 1993 Budget Act also authorized the FCC to conduct competitive bidding for certain radio spectrum licenses and required the FCC to adopt new rules that eliminate the regulatory distinctions between common and private carriers for those private carriers who interconnect with the public switched telephone network and make their services available to a substantial portion of the public for profit. These developments and further technological advances may make available other alternatives to cellular service thereby creating additional sources of competition.\nLegislation and Regulation\nFCC Regulation\nThe FCC regulates the licensing, construction, operation and acquisition of cellular telephone systems pursuant to the Communications Act. For licensing purposes, the FCC divided the US into separate markets: 306 MSAs and 428 RSAs. In each market, the allocated cellular frequencies are divided into two blocks: Block A, initially awarded for utilization by Non-Wireline entities such as the Company, and Block B, initially awarded for utilization by affiliates of local exchange Wireline telephone companies. There is no technical or operational difference between Wireline and Non-Wireline systems other than different frequencies.\nUnder the Communications Act, no party may transfer control of or assign a cellular license without first obtaining FCC consent. FCC rules (i) prohibit an entity controlling one system in a market from holding any interest in the competing cellular system in the market and (ii) prohibit an entity from holding non-controlling interests in more than one system in any market, if the common ownership interests present anticompetitive concerns under FCC policies. Cellular radio licenses generally expire on October 1 of the tenth year following grant of the license in the particular market and are renewable for periods of ten years upon application to the FCC. Licenses may be revoked for cause and license renewal applications denied if the FCC determines that a renewal would not serve the public interest. FCC rules provide that competing renewal applications for cellular licenses will be considered in comparative hearings, and establish the qualifications for competing applications and the standards to be applied in such hearings. Under current policies, the FCC will grant incumbent cellular licensees a \"renewal expectancy\" if the licensee has provided substantial service to the public, substantially complied with applicable FCC rules and policies and the Communications Act and is otherwise qualified to hold an FCC license. The FCC has granted renewal of the Company's licenses for the Philadelphia and Wilmington MSAs.\nThe FCC requires LECs in each market to offer reasonable terms and facilities for the interconnection of both cellular telephone systems in that market to the LECs' landline network. Cellular telephone companies affiliated with the LEC are required to disclose how their systems will interconnect with the landline network. The licensee not affiliated with the LEC has the right to interconnect with the landline network in a manner no less favorable than that of the licensee affiliated with the LEC. In addition, the licensee not affiliated with the LEC may, at its discretion, request reasonable interconnection arrangements that are different than those provided to the affiliated licensee in that market, and the LEC must negotiate such requests in good faith. The FCC reiterated its position on interconnection issues in a declaratory ruling which clarified that LECs are expected to provide, within a reasonable time, the agreed-upon form of interconnection.\nThe FCC regulates the ability of cellular operators to bundle the provision of service with hardware, the resale of cellular service by third parties and the coordination of frequency usage with other cellular licensees. The FCC also regulates the height and power of base station transmitting facilities and signal emissions in the cellular system. Cellular systems also are subject to Federal Aviation Administration and FCC regulations concerning the siting, construction, marking and lighting of cellular transmitter towers and antennae. In addition, the FCC also regulates the employment practices of cellular operators.\nThe Communications Act currently restricts foreign ownership or control over commercial mobile radio licenses, which include cellular radio service licenses. The FCC recently decided to consider the opportunities that other nations provide to US companies in their communications industries as a factor in deciding whether to permit higher levels of indirect foreign ownership in companies controlling common carrier and certain other radio licenses. The\n- 18 -\n1996 Telecom Act relaxes these restrictions by eliminating the statutory provisions restricting foreign officers and directors in licensees and their parent corporations.\nTo date, the FCC has undertaken significant efforts to reconsider the regulation of CMRS providers in the wake of competitive developments in the telecommunications marketplace. For instance, the FCC is considering whether all CMRS providers should provide interconnection to all other CMRS providers. Moreover, the FCC has proposed new rules to govern LEC-CMRS interconnection. Resolution of the issues raised in these proceedings may affect the costs of providing cellular service and the way in which the Company conducts its business.\nFinally, the 1996 Telecom Act relieves BOC-affiliated cellular providers of their equal access obligations. As such, BOC-affiliated carriers are afforded greater flexibility in contracting with interexchange carriers for the provision of long distance services. Prior to the legislative change, cellular systems affiliated with the BOCs were required to offer equal access to interexchange carriers and those affiliated with AT&T voluntarily provided equal access. Nevertheless, the FCC retains authority to require all CMRS operators to provide unblocked access through the use of other mechanisms if customers are being denied access to the telephone toll service providers of their choice, and if such denial is contrary to the public interest.\nState Regulation and Local Approvals\nExcept for the State of Illinois, the states in which the Company presently operates currently do not regulate cellular telephone service. In the 1993 Budget Act, Congress gave the FCC the authority to preempt states from regulating rates or entry into CMRS, including cellular. In the CMRS order, described above, the FCC preempted the states and established a procedure for states to petition the FCC for authority to regulate rates and entry into CMRS. The FCC, to date, has denied all state petitions to regulate the rates charged by CMRS providers.\nThe scope of the allowable level of state regulation of CMRS, however, remains unclear. The 1993 Budget Act does not identify the \"other terms and conditions\" of CMRS service that can be regulated by the states. Moreover, the FCC recently issued a Notice of Proposed Rulemaking requesting comment on the authority of states to regulate intrastate LEC-CMRS interconnection. The resolution of this issue will impact the extent to which cellular providers will be subject to state regulation of CMRS interconnection to the LECs. The siting of cells also remains subject to state and local jurisdiction.\nCONTENT\nContent consists primarily of the Company's 57.45% ownership interest in QVC, which is consolidated with and managed by the Company. In addition, the Company recently formed C3, whose worldwide activities will be focused on four distinct areas: development and production of programming for the Company and other media outlets; enhancement of existing and creation of new distribution channels; expansion of transactional services; and acquisitions of programming and media related companies. In the programming sector, C3 will assist the Company with its programming investments which include E! Entertainment, Viewer's Choice, Turner Broadcasting, The Golf Channel, Speedvision, Outdoor Life, Music Choice, Lightspan and the Sunshine Network.\nElectronic Retailing\nGeneral\nThe Company provides electronic retailing services through QVC, a nationwide general merchandise retailer. Through its merchandise-focused television programs (the \"QVC Service\"), QVC sells a wide variety of products directly to consumers. The products are described and demonstrated live by program hosts, and orders are placed directly with QVC by viewers who call a toll-free '800' telephone number. QVC television programming is produced at its facilities in Pennsylvania and is broadcast nationally via satellite to affiliated local cable system operators and other multichannel video programming providers (\"Program Carriers\") who have entered into carriage agreements (the \"Affiliation Agreements\") with QVC and who retransmit the QVC programming to their subscribers.\n- 19 -\nThe QVC Service\nProducts. QVC sells a variety of consumer products and accessories including jewelry, apparel and accessories, housewares, collectibles, electronics, toys and cosmetics. QVC obtains products from domestic and foreign manufacturers and wholesalers and is often able to make purchases on favorable terms based on the volume of the transactions. QVC intends to continue introducing new products and product lines. QVC is not dependent upon any one particular supplier for any significant portion of its inventory.\nProgramming. The QVC program schedule consists of one-hour and multi-hour program segments. Each program segment has a theme devoted to a particular category of product or lifestyle. From time to time, QVC broadcasts special program segments devoted to merchandise associated with a particular celebrity, event, geographical region or seasonal interest. QVC selects all products presented on its programs, stocks the merchandise, processes all orders and ships from its own distribution centers.\nProcess. Viewers place orders to purchase merchandise by calling a toll-free telephone number. QVC uses automatic call distributing equipment to distribute calls to its operators. The majority of all payments for purchases are made with a major credit card or QVC's private label credit card. The accounts receivable from QVC's private label credit card program are purchased (with recourse) and serviced by an unrelated third party. QVC's policy is to ship merchandise promptly, typically within two to three days after receipt of an order. QVC offers a return policy which permits customers to return within 30 days any merchandise purchased from QVC for a full refund of the purchase price and original shipping charges.\nPrimary Channel. QVC's main channel (the \"Primary Channel\"), as of December 31, 1995, is transmitted live 24 hours a day, 7 days a week, to approximately 49 million cable television homes and on a part-time basis to approximately 3 million additional cable television homes. In addition, the QVC Service can be received by approximately 4 million home satellite dish users.\nQ2. QVC's secondary channel (\"Q2\"), which broadcasts 24 hours a day, 7 days a week, reaches in excess of 9 million homes. In January 1996, the Company announced that the format of Q2 programming would be changed, effective in the first half of 1996, to become a faster-paced, news-like format, combining live hosts and edited tape of top products and stories from the Primary Channel.\nQVC UK. In October 1993, QVC launched an electronic retailing program service in the UK (\"QVC--The Shopping Channel\") through a joint venture agreement with British Sky Broadcasting Limited. This service currently reaches over 4 million homes in the UK.\niQVC. In December 1995, QVC launched its interactive shopping service (\"iQVC\") on The Microsoft Network (\"MSN\"), Microsoft Corporation's new on-line service. The iQVC service will offer MSN's on-line members a diverse array of merchandise, available on-line, 24 hours a day, 7 days a week.\nQVC Service Transmission\nThe QVC Service signal is transmitted via two exclusive, protected, non-preemptible transponders on communications satellites. Each communications satellite has a number of separate transponders. 'Protected' status means that, in the event of transponder failure, QVC's signal will be transferred to a spare transponder or, if none is available, to a preemptible transponder located on the same satellite or, in certain cases, to a transponder on another satellite owned by the same lessor if one is available at the time of the failure. 'Non-preemptible' status means that the transponder cannot be preempted in favor of a user of a 'protected' transponder that has failed. QVC has never had an interruption in programming due to transponder failure and believes that because it has the exclusive use of two protected, non-preemptible transponders, such interruption is unlikely to occur. There can be no assurance, however, that there will not be an interruption or termination of satellite transmission due to transponder failure. Such interruption or termination could have a material adverse effect on QVC.\nProgram Carriers\nQVC has entered into Affiliation Agreements with Program Carriers to carry the QVC Service. There are generally no additional charges to the subscribers for distribution of the QVC Service. In return for carrying the QVC Service,\n- 20 -\neach Program Carrier receives five percent (5%) of the net sales of merchandise sold to customers located in the Program Carrier's service area. The terms of most Affiliation Agreements are automatically renewable for one-year terms unless terminated by either party on at least 90 days notice prior to the end of the term. Affiliation Agreements covering most of the QVC's cable television homes can be terminated in the sixth year of their respective terms by the Program Carrier unless the Program Carrier earns a specified minimum level of sales commissions. QVC's sales are currently at levels that would meet such minimum requirements. The Affiliation Agreements provide for the Program Carrier to broadcast commercials regarding the QVC Service on other channels and to distribute QVC's advertising material to subscribers. As of December 31, 1995, approximately 30% of the total homes reached by QVC were attributable to QVC's Affiliation Agreements with the Company and TCI, and their respective subsidiaries.\nRenewal of these Affiliation Agreements on favorable terms is dependent upon QVC's ability to negotiate successfully with Program Carriers. The QVC Service competes for cable channels with competitive programming as well as alternative programming supplied by a variety of other well-established sources, including news, public affairs, entertainment and sports programmers. QVC's business is highly dependent on its affiliation with Program Carriers for the transmission of the QVC Service. The loss of a significant number of cable television homes because of termination or non-renewal of Affiliation Agreements would have a material adverse effect on QVC. To induce Program Carriers to enter into or extend Affiliation Agreements or to increase the number of cable television homes under existing Affiliation Agreements, QVC has developed other incentive programs, including various forms of marketing, launch and equipment purchase support. QVC will attempt to continue to recruit additional Program Carriers and seek to enlarge the audience for the QVC Service.\nLegislation and Regulation\nThe FCC does not directly regulate programming services like those offered by QVC. The FCC does, however, exercise regulatory authority over the satellites and uplink facilities which transmit programming services such as those provided by QVC. The FCC has granted permanent licenses subject to periodic reviews to QVC for its uplink facilities (and for backup equipment of certain of these facilities) at sufficient power levels for transmission of the QVC Service. Regarding the satellites from which QVC obtains transponder capacity, the FCC presently exercises licensing authority but does not regulate the rates, terms or conditions of service provided by these facilities. Pursuant to its residual statutory authority, the FCC could, however, alter the regulatory obligations applicable to satellite service providers.\nCompetition\nQVC operates in a highly competitive environment. As a general merchandise retailer, QVC competes for consumer expenditures and interest with the entire retail industry, including department, discount, warehouse and specialty stores, mail order and other direct sellers, shopping center and mall tenants and conventional free-standing stores, many of which are connected in chain or franchise systems. On television, it is also in competition with other satellite-transmitted programs for channel space and viewer loyalty. QVC believes that, at the present time, most Program Carriers are not willing to devote more than two channels to televised shopping and may allocate only one until digital compression is utilized on a large-scale basis several years in the future. Many systems have limited channel capacity and may be precluded from adding any new programs at the present time. The development and utilization of digital compression is expected to provide Program Carriers with greater channel capacity thereby increasing the opportunity for the QVC Service, in addition to other home shopping programs, to be broadcast on additional channels.\nSeasonality\nQVC's business is seasonal in nature, with its major selling season during the last quarter of the calendar year. Net revenue for the fourth quarter of the year ended December 31, 1995 accounted for approximately 32% of QVC's annual net sales from electronic retailing.\n- 21 -\nEMPLOYEES\nAs of December 31, 1995, the Company had 12,200 employees, excluding employees in managed operations. Of these employees, 5,700 were associated with cable communications, 4,700 were associated with electronic retailing and 1,100 were associated with cellular telephone communications. The Company believes that its relationships with its employees are good.\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2 PROPERTIES\nDomestic Cable Communications\nThe principal physical assets of a cable communications system consist of a central receiving apparatus, distribution cables, converters and local business offices. The Company owns or leases the receiving and distribution equipment of each system and owns or leases parcels of real property for the receiving sites and local business offices. The physical components of cable communications systems require maintenance and periodic upgrading and rebuilding to keep pace with technological advances. A significant number of the Company's systems will be upgraded or rebuilt over the next several years.\nCellular Communications\nThe principal physical assets of a cellular telephone communications system include cell sites and central switching equipment. The Company primarily leases its sites used for its transmission facilities and its administrative offices. The physical components of a cellular telephone communications system require maintenance and upgrading to keep pace with technological advances. It is anticipated that the Company's systems will be converted to digital technology over the next several years.\nElectronic Retailing\nThe principal physical assets of the Company's electronic retailing operations consist of television studios, telecommunications centers, local business offices and various product warehouses and distribution centers. The Company, through QVC, owns the majority of these assets. The physical components of electronic retailing operations require maintenance and require periodic upgrading and rebuilding to keep pace with technological advances. It is anticipated that QVC's warehousing and distribution facilities will be upgraded or rebuilt over the next several years.\nThe Company's management believes that substantially all of its physical assets are in good operating condition.\nITEM 3","section_3":"ITEM 3 LEGAL PROCEEDINGS\nThe Company is not party to litigation which, in the opinion of the Company's management, 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\nNo matters were submitted to a vote of security holders, through a solicitation of proxies or otherwise, during the fourth quarter of the year ended December 31, 1995.\nITEM 4A EXECUTIVE OFFICERS OF THE REGISTRANT\nThe current term of office of each of the officers expires at the first meeting of the Board of Directors of the Company following the next Annual Meeting of Shareholders, presently scheduled to be held in June 1996, or as soon thereafter as each of their successors is duly elected and qualified.\n- 22 -\nThe following table sets forth certain information concerning the principal executive officers of the Company, including their ages, positions and tenure as of February 1, 1996.\nRalph J. Roberts has served as a Director and Chairman of the Board of Directors of the Company for more than five years. Mr. Roberts has been the President and a Director of Sural Corporation, a privately-held investment company (\"Sural\"), the Company's largest shareholder, for more than five years. Mr. Roberts devotes a major portion of his time to the business and affairs of the Company. The shares of the Company owned by Sural constitute approximately 78% of the voting power of the two classes of the Company's voting common stock combined. Mr. Roberts has voting control of Sural. Mr. Roberts is also a Director of Comcast UK Cable Partners Limited, Cablevision Investment of Detroit, Inc. and Storer Communications, Inc.\nJulian A. Brodsky has served as Vice Chairman of the Board of Directors for more than five years. Mr. Brodsky presently serves as the Treasurer and a Director of Sural. Mr. Brodsky devotes a major portion of his time to the business and affairs of the Company. Mr. Brodsky is also a Director of Comcast UK Cable Partners Limited, Cablevision Investment of Detroit, Inc., Storer Communications, Inc., and RBB Fund, Inc.\nBrian L. Roberts has served as President of the Company and as a Director for more than five years. Mr. Roberts presently serves as Vice President and a Director of Sural. Mr. Roberts devotes a major portion of his time to the affairs of the Company. Mr. Roberts is also a Director of Turner Broadcasting System, Inc., Comcast UK Cable Partners Limited, Cablevision Investment of Detroit, Inc. and Storer Communications, Inc. In addition, Mr. Roberts presently serves as the Chairman of the National Cable Television Association. He is a son of Ralph J. Roberts.\nLawrence S. Smith was named Executive Vice President of the Company in December 1995. Prior to that time, Mr. Smith served as Senior Vice President of the Company for more than five years. Mr. Smith is the Principal Accounting Officer of the Company. Mr. Smith is a Director of Comcast UK Cable Partners Limited.\nJohn R. Alchin has served as Treasurer and Senior Vice President of the Company for more than five years. Mr. Alchin is a Director of Comcast UK Cable Partners Limited.\nStanley L. Wang has served as Senior Vice President, Secretary and General Counsel of the Company for more than five years. Mr. Wang is a Director of Cablevision Investment of Detroit, Inc. and Storer Communications, Inc.\n- 23 -\nPART II\nITEM 5","section_5":"ITEM 5 MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Class A Special Common Stock and Class A Common Stock of the Company are traded in the over-the-counter market and are included on Nasdaq under the symbols CMCSK and CMCSA, respectively. There is no established public trading market for the Class B Common Stock of the Company. The Class B Common Stock is convertible, on a share for share basis, into Class A Special or Class A Common Stock. The following table sets forth, for the indicated periods, the closing price range of the Class A Special and Class A Common Stock as furnished by Nasdaq. Such price ranges have been adjusted for the Company's three-for-two stock split effective February 2, 1994 and rounded to the nearest one-eighth.\nThe Company began paying quarterly cash dividends on its Class A Common Stock in 1977. Since 1978, the Company has paid equal dividends on shares of both the Class A Common Stock and the Class B Common Stock. Since December 1986, when the Class A Special Common Stock was issued, the Company has paid equal dividends on shares of the Class A Special, Class A and Class B Common Stock. The Company declared dividends of $.0933 for each of the years ended December 31, 1995 and 1994 on shares of Class A Special, Class A and Class B Common Stock (as adjusted for the Company's three-for-two stock split effective February 2, 1994).\nIt is the intention of the Board of Directors to continue to pay regular quarterly cash dividends on all classes of the Company's stock; however, the declaration and payment of future dividends and their amount depend upon the results of operations, financial condition and capital needs of the Company, contractual restrictions of the Company and its subsidiaries and other factors.\nThe holders of the Class A Special Common Stock are not entitled to vote in the election of directors or otherwise, except where class voting is required by applicable law or the Company's Articles of Incorporation, in which case, each holder of Class A Special Common Stock shall be entitled to one vote per share. Each holder of Class A Common Stock has one vote per share and each holder of Class B Common Stock has 15 votes per share. The Articles of Incorporation provide that the Class A Special Common Stock, the Class A Common Stock and the Class B Common Stock vote as separate classes on certain amendments to the Articles of Incorporation regarding conversion rights of the Class B Common Stock and as required by applicable law. Under applicable law, holders of Class A Special Common Stock have voting rights in the event of certain amendments to the Articles of Incorporation and certain mergers and other fundamental corporate changes. In all other instances, including the election of directors, the Class A Common Stock and the Class B Common Stock vote as one class. Neither the holders of Class A Common Stock nor the holders of Class B Common Stock have cumulative voting rights.\nAs of February 1, 1996, there were 2,332 record holders of the Company's Class A Special Common Stock and 1,792 record holders of the Company's Class A Common Stock. Sural Corporation is the sole record holder of the Company's Class B Common Stock.\n- 24 -\nITEM 6","section_6":"ITEM 6 SELECTED FINANCIAL DATA\n- 25 -\nITEM 7","section_7":"ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nOverview\nThe Company has experienced significant growth in recent years through both strategic acquisitions and growth in its existing businesses. The Company has historically met its cash needs for operations through its cash flows from operating activities. Cash requirements for acquisitions and capital expenditures have been provided through the Company's financing activities and sales of long-term investments as well as its existing cash and cash equivalents and short-term investments.\nGeneral Developments of Business\nSprint Spectrum\nEffective as of January 1996, the Company, Tele-Communications, Inc. (\"TCI\"), Cox Communications, Inc. (\"Cox,\" and together with the Company and TCI, the \"Cable Parents\") and Sprint Corporation (\"Sprint,\" and together with the Cable Parents, the \"Parents\"), and certain subsidiaries of the Parents (the \"Partner Subsidiaries\"), entered into a series of agreements relating to their previously announced joint venture (March 1995) to engage in the communications business. Under an Amended and Restated Agreement of Limited Partnership (the \"Partnership Agreement\") of MajorCo, L.P. (known as \"Sprint Spectrum\"), the business of Sprint Spectrum will be the provision of wireless telecommunications services and will not include the previously authorized business of providing local wireline communications services to residences and businesses. A partnership owned entirely by subsidiaries of the Company owns 15% of Sprint Spectrum. The Company accounts for its investment in Sprint Spectrum under the equity method.\nSprint Spectrum was the successful bidder for 29 personal communications services (\"PCS\") licenses in the auction conducted by the Federal Communications Commission (\"FCC\") from December 1994 through mid-March 1995. The purchase price for the licenses was approximately $2.11 billion, all of which has been paid to the FCC. Sprint Spectrum may also elect to bid in subsequent auctions for PCS licenses. In addition, Sprint Spectrum has invested, and may continue to invest, in other entities that hold PCS licenses, may acquire PCS licenses from other license holders and may affiliate with other license holders.\nPursuant to separate Parent agreements, each Cable Parent and Sprint agreed to negotiate in good faith on a market-by-market basis for the provision of local wireline telephony services over the cable communications facilities of the applicable Cable Parent under the Sprint brand. Accordingly, local telephony offerings in each market will be the subject of individual agreements to be negotiated with Sprint, rather than being provided through Sprint Spectrum as originally contemplated. The offering of local wireline telephone services will require the removal of regulatory and legislative barriers to local telephone competition (see \"Description of the Company's Businesses - Wired Telecommunications - Cable Communications - Legislation and Regulation\"). Each Parent agreement also contains certain restrictions on the ability of each Parent to offer and promote, or package certain of its cable communications products or services with, certain products and services of other persons and requires the applicable Cable Parent to make its cable communications facilities available to Sprint for specified purposes to the extent that it has made such facilities available to others for such purposes.\nThe Partner Subsidiaries also terminated a contribution agreement pursuant to which they had agreed to contribute to Sprint Spectrum their respective interests in Teleport Communications Group Inc., TCG Partners and certain local joint ventures managed by such entities (collectively, \"TCG\"). TCG is one of the largest competitive access providers in the United States (\"US\") in terms of route miles. The Parents reaffirmed their intention to continue to attempt to integrate the business of TCG with that of Sprint Spectrum.\nScripps Cable\nIn October 1995, the Company announced its agreement to purchase the cable television operations (\"Scripps Cable\") of The E.W. Scripps Company (\"E.W. Scripps\") in exchange for shares of the Company's Class A Special Common Stock, par value $1.00 per share (the \"Class A Special Common Stock\" -- see Item 5 - \"Market for the Registrant's Common Equity and Related Stockholder Matters\"), worth $1.575 billion (the \"Base Consideration\"), subject to certain closing adjustments (the \"Scripps Transaction\"). Scripps Cable passes approximately 1.2 million homes and serves approximately 800,000 subscribers, with over 60% of its subscribers located in Sacramento, California and\n- 26 -\nChattanooga and Knoxville, Tennessee. The purchase is expected to close in the second half of 1996, subject to shareholder and regulatory approval and certain other conditions.\nPursuant to the Agreement and Plan of Merger dated as of October 28, 1995 (the \"Merger Agreement\") by and among the Company, E.W. Scripps and Scripps Howard, Inc., a wholly owned subsidiary of E.W. Scripps, E.W. Scripps will distribute to its shareholders all assets other than Scripps Cable. Following such distribution, E.W. Scripps will be merged with and into the Company (the \"Merger\") and each share of E.W. Scripps common stock issued and outstanding immediately prior to the Merger will be converted into a portion of the shares of the Class A Special Common Stock to be paid as consideration in the Merger. Assuming (i) no adjustment has been made to the Base Consideration and (ii) the closing price of the Class A Special Common Stock is equal to the execution price ($20.075 per share), as such terms are defined in the Merger Agreement, the Company would issue to E.W. Scripps' shareholders an aggregate of approximately 78.5 million shares of Class A Special Common Stock in the Merger, subject to certain adjustments. Such shares would represent, in the aggregate, approximately 28.9% of the Class A Special Common Stock outstanding as of December 31, 1995, on a pro forma basis.\nShare Repurchase Program\nConcurrent with the announcement of the Scripps Transaction, the Company announced that its Board of Directors has authorized a market repurchase program (the \"Repurchase Program\") pursuant to which the Company may purchase, at such times and on such terms as it deems appropriate, up to $500.0 million of its outstanding common equity securities subject to certain restrictions and market conditions. Through December 31, 1995, the Company had repurchased shares of its common stock for aggregate consideration of $12.4 million. Through February 1, 1996, the Company had repurchased additional shares for aggregate consideration of $4.0 million.\nQVC\nIn February 1995, the Company and TCI acquired all of the outstanding stock of QVC, Inc. and its subsidiaries (\"QVC\") not previously owned by them (approximately 65% of such shares on a fully diluted basis) for $46, in cash, per share (the \"QVC Acquisition\"), representing a total cost of approximately $1.4 billion. The QVC Acquisition, including the exercise of certain warrants held by the Company, was financed with cash contributions from the Company and TCI of $296.3 million and $6.6 million, respectively, borrowings of $1.1 billion under a $1.2 billion QVC credit facility and existing cash and cash equivalents held by QVC. Following the acquisition, the Company and TCI own, through their respective subsidiaries, 57.45% and 42.55%, respectively, of QVC. The Company, through a management agreement, is responsible for the day to day operations of QVC. The Company has accounted for the QVC Acquisition under the purchase method of accounting and QVC was consolidated with the Company effective February 1, 1995.\nMaclean Hunter\nIn December 1994, the Company, through Comcast MHCP Holdings, L.L.C. (the \"LLC\"), acquired the US cable television and alternate access operations of Maclean Hunter Limited (\"Maclean Hunter\") from Rogers Communications Inc. and all of the outstanding shares of Barden Communications, Inc. (collectively, such acquisitions are referred to as the \"Maclean Hunter Acquisition\") for approximately $1.2 billion in cash. The Company and the California Public Employees' Retirement System (\"CalPERS\") invested $305.6 million and $250.0 million, respectively, in the LLC, which is owned 55% by a wholly owned subsidiary of the Company and 45% by CalPERS, and is managed by the Company. The balance of the Maclean Hunter Acquisition was financed through borrowings under a credit facility of a wholly owned subsidiary of the LLC. The Company has accounted for the Maclean Hunter Acquisition under the purchase method of accounting and has consolidated Maclean Hunter effective December 22, 1994.\n-------------------------\nLiquidity and Capital Resources\nCash, Cash Equivalents and Short-term Investments\nThe Company has traditionally maintained significant levels of cash, cash equivalents and short-term investments to meet its short-term liquidity requirements. Cash, cash equivalents and short-term investments as of December 31, 1995 and 1994 were $910.0 million and $465.5 million, respectively. As of December 31, 1995, approximately $410\n- 27 -\nmillion of the Company's cash, cash equivalents and short-term investments was restricted to use by subsidiaries of the Company under contractual or other arrangements, including approximately $341 million which is restricted to use by Comcast UK Cable Partners Limited (\"Comcast UK Cable\"), a subsidiary of the Company.\nThe Company's cash and cash equivalents and short-term investments are recorded at cost which approximates their fair value. At December 31, 1995, the Company's short-term investments of $371.0 million had a weighted average maturity of approximately 14 months. However, due to the high degree of liquidity and the intent of management to use these investments as needed to fund its commitments, the Company considers these as current assets.\nInvestments\nUnder the provisions of the Partnership Agreement, the Partner Subsidiaries have committed to contribute $4.2 billion in cash to Sprint Spectrum through 1997, of which the Company's share is $630.0 million. Of this funding requirement, the Company has made total cash capital contributions to Sprint Spectrum of $346.0 million through December 31, 1995. The Company anticipates that Sprint Spectrum's capital requirements over the next several years will be significant. Requirements in excess of committed capital are planned to be funded by Sprint Spectrum through external financing. Although it is anticipated that external financing will be available to Sprint Spectrum on acceptable terms and conditions, no assurances can be given as to such availability. The timing of the Company's remaining capital contributions to Sprint Spectrum is dependent upon a number of factors, including Sprint Spectrum's ability to obtain external financing as well as its working capital requirements.\nIn July 1995, the Company sold 11.3 million shares of Nextel common stock for $212.6 million (the \"Nextel Transaction\"). As a result of this transaction, the Company recognized a pre-tax gain of $36.2 million. In February 1996, in connection with certain preemptive rights of the Company under previously existing agreements with Nextel, the Company purchased approximately 8.16 million shares, classified as available for sale, of Nextel common stock at $12.25 per share, for a total cost of $99.9 million. The Company continues to hold options, which expire in 1997, to acquire an additional 25 million shares of Nextel common stock at $16 per share.\nIn January 1995, the Company exchanged its investments in Heritage Communications, Inc. with TCI for approximately 13.3 million publicly-traded Class A common shares of TCI with a fair market value of approximately $290.0 million. Shortly thereafter, the Company sold approximately 9.1 million unrestricted TCI shares for total proceeds of approximately $188.0 million (collectively, the \"Heritage Transaction\"). As a result of these transactions, the Company recognized a pre-tax gain of approximately $141.0 million in 1995.\nThe Company does not have any additional significant contractual commitments with respect to any of its investments. However, to the extent the Company does not fund its investees' capital calls, it exposes itself to dilution of its ownership interests.\nMinority Interest Rights\nLiberty Media Corporation (\"Liberty\"), a majority-owned subsidiary of TCI, may, at certain times following February 9, 2000, trigger the exercise of certain exit rights with respect to its investment in QVC. If the exit rights are triggered, the Company has first right to purchase Liberty's stock in QVC at Liberty's pro rata portion of the fair market value (on a going concern or liquidation basis, whichever is higher, as determined by an appraisal process) of QVC. The Company may pay Liberty for such stock, subject to certain rights of Liberty to consummate the purchase in the most tax-efficient method available, in cash, the Company's promissory note maturing not more than three years after issuance, the Company's equity securities or any combination thereof. If the Company elects not to purchase the stock of QVC held by Liberty, then Liberty will have a similar right to purchase the stock of QVC held by the Company. If Liberty elects not to purchase the stock of QVC held by the Company, then Liberty and the Company will use their best efforts to sell QVC.\nAs a result of the Maclean Hunter Acquisition, at any time after December 18, 2001, CalPERS may elect to liquidate its interest in the LLC at a price based upon the fair value of CalPERS' interest in the LLC, adjusted, under certain circumstances, for certain performance criteria relating to the fair value of the LLC or to the Company's common stock. Except in certain limited circumstances, the Company, at its option, may satisfy this liquidity arrangement by purchasing CalPERS' interest for cash, through the issuance of the Company's common stock (subject to certain limitations) or by selling the LLC.\n- 28 -\nCapital Expenditures\nIt is anticipated that during 1996, the domestic operations of the Company will incur approximately $600 million of capital expenditures, including $300 million for the upgrading and rebuilding of certain of the Company's cable communications systems, $100 million for the upgrading of QVC's warehousing and distribution facilities and $120 million for the upgrading of the Company's cellular communications systems. The amount of such capital expenditures for years subsequent to 1996 will depend on numerous factors, many of which are beyond the Company's control. These factors include whether competition in a particular market necessitates a system upgrade, whether a particular system has sufficient capacity to handle new product offerings including the offering of cable telephony and telecommunications services, whether and to what extent the Company will be able to recover its investment under FCC rate guidelines and whether the Company acquires additional systems in need of upgrading or rebuilding. The Company, however, anticipates capital expenditures for years subsequent to 1996 will continue to be significant. As of December 31, 1995, the Company does not have any significant contractual obligations for capital expenditures.\nFinancing\nThe Company has historically utilized a strategy of financing its acquisitions through senior debt at the acquired operating subsidiary level. Additional financing has also been obtained by the Company through the issuance of subordinated debt at the intermediate holding company and parent company levels and, to some extent, through public offerings of a subsidiary company's stock and debt instruments. As of December 31, 1995 and 1994, the Company's long-term debt, including current portion, was $7.029 billion and $4.993 billion, respectively, of which approximately 54% and 61%, respectively, was at variable rates. Maturities of long-term debt for the five years commencing in 1996 are $85.4 million, $154.8 million, $691.6 million, $444.3 million and $575.9 million. As of February 1, 1996, certain subsidiaries of the Company had unused lines of credit of $1.541 billion. Use of these unused lines of credit is restricted by the covenants of the related debt agreements and to subsidiary debt refinancing, subsidiary general corporate purposes and dividend declaration. The Company's long-term debt had estimated fair values of $7.074 billion and $4.828 billion as of December 31, 1995 and 1994, respectively. The Company's weighted average interest rate was approximately 8.32%, 7.75% and 8.45% during the years ended December 31, 1995, 1994 and 1993, respectively. The Company continually evaluates its debt structure with the intention of reducing its debt service requirements when desirable.\nIn May 1995, the Company issued $250.0 million principal amount of its 9-3\/8% senior subordinated debentures due 2005. In October 1995, the Company issued $250.0 million principal amount of its 9-1\/8% senior subordinated debentures due 2006. In November 1995, Comcast UK Cable received net proceeds of approximately $291.1 million from the sale of approximately $517.3 million principal amount at maturity of its 11.20% senior discount debentures due 2007 (the \"2007 Discount Debentures\"). Interest will accrete on the 2007 Discount Debentures at 11.20% per annum compounded semi-annually from November 15, 1995 to November 15, 2000, after which date interest will be paid in cash on each May 15 and November 15, through November 15, 2007. The net proceeds from the offering will be utilized by Comcast UK Cable for future advances and capital contributions to its equity investees and subsidiary primarily for the build-out of their telecommunications networks in the United Kingdom (\"UK\").\nIn conjunction with the Repurchase Program, in December 1995, the Company sold put options on 3.0 million shares of its Class A Special Common Stock. The put options give the holder the right to require the Company to repurchase such shares at specified prices on specific dates during the period from May through July 1996. Proceeds of $2.6 million from the sale of these put options were credited to additional capital. The amount the Company would be obligated to pay to repurchase such shares if all outstanding put options were exercised, totaling $52.1 million, has been reclassified to a temporary equity account in the Company's consolidated balance sheet as of December 31, 1995. Through February 1, 1996, the Company sold additional put options on 1.0 million shares of its Class A Special Common Stock, with expiration dates in July 1996. If the put options sold in January 1996 were exercised, the Company would be obligated to pay $17.5 million to repurchase such shares.\nRisk Management\nThe Company has entered into certain foreign exchange forward contracts, foreign exchange option contracts and interest rate swap and cap agreements as a normal part of its risk management efforts.\nForeign exchange forward contracts are used by Comcast UK Cable to hedge against the risk that monetary assets held or denominated in currencies other than its functional currency (the UK Pound Sterling or \"UK Pound\") are\n- 29 -\ndevalued as a result of changes in exchange rates. The notional amount of these contracts was $20.0 million and $100.0 million as of December 31, 1995 and 1994, respectively. Foreign exchange forward contracts provide an effective hedge against such monetary assets held since gains and losses realized on the contracts, which were not significant to the Company's results of operations, are offset against gains or losses realized on the underlying hedged assets. The remaining forward contract matures during 1996.\nDuring 1995, Comcast UK Cable entered into certain foreign exchange put option contracts which may be settled only on November 16, 2000. These put option contracts are used to limit Comcast UK Cable's exposure to the risk that the eventual cash outflows related to net monetary liabilities denominated in currencies other than the UK Pound (principally the 2007 Discount Debentures) are adversely affected by changes in exchange rates. As of December 31, 1995, Comcast UK Cable has (pound)250.0 million notional amount of foreign exchange put option contracts to purchase US dollars at an exchange rate of $1.35 per (pound)1.00 (the \"Ratio\"). Foreign exchange put option contracts provide a hedge, to the extent the exchange rate falls below the Ratio, against Comcast UK Cable's net monetary liabilities denominated in US dollars since gains and losses realized on the put option contracts are offset against foreign exchange gains or losses realized on the underlying net liabilities. Premiums paid for such put option contracts were not significant and have been recorded as assets in the Company's consolidated balance sheet. These premiums are being amortized over the terms of the related contracts.\nIn order to reduce hedging costs, Comcast UK Cable has sold (pound)250.0 million notional amount of foreign exchange call option contracts. These call option contracts may only be settled on their expiration dates. Of these call option contracts, (pound)200.0 million notional amount settle on November 16, 1996 at an exchange rate of $1.70 per (pound)1.00 and (pound)50.0 million notional amount settle on November 16, 2000 at an exchange rate of $1.62 per (pound)1.00. Changes in fair value between measurement dates relating to these call option contracts are not significant and have been recorded in the Company's consolidated statement of operations.\nThe Company has entered into interest rate swap and cap agreements to limit the Company's exposure to adverse fluctuations in interest rates. At December 31, 1995, $1.2 billion of the Company's variable rate debt was protected by these products. Such agreements mature on various dates through 2000 and the related differentials to be paid or received are recognized over the terms of the agreements. The estimated fair value of such instruments, based on discounted future cash flow models, was not significant to the Company as of December 31, 1995.\nThe credit risks associated with the Company's derivative financial instruments are controlled through the evaluation and continual monitoring of the creditworthiness of the counterparties. Although the Company may be exposed to losses in the event of nonperformance by the counterparties, the Company does not expect such losses, if any, to be significant.\n-------------------------\nThe Company expects to continue to recognize significant losses and to continue to pay dividends; therefore, it anticipates that it will continue to have a deficiency in stockholders' equity that will increase through the date of consummation of the Scripps Transaction. If the Scripps Transaction is consummated, the Company will no longer have a deficiency in stockholders' equity; however, the Company will continue to recognize losses for the foreseeable future, resulting in decreases in stockholders' equity. The telecommunications industry, including cable and cellular communications, and the electronic retailing industry are experiencing increasing competition and rapid technological changes. The Company's future results of operations will be affected by its ability to react to changes in the competitive environment and by its ability to implement new technologies. However, management believes that competition, technological changes and its significant losses and deficiency in stockholders' equity will not significantly affect its ability to obtain financing.\nThe Company believes that it will be able to meet its current and long-term liquidity and capital requirements, including its fixed charges, through its cash flows from operating activities, existing cash, cash equivalents, short-term investments and lines of credit and other external financing.\nStatement of Cash Flows\nCash and cash equivalents increased $203.7 million as of December 31, 1995 from December 31, 1994 and $174.9 million as of December 31, 1994 from December 31, 1993. Changes in cash and cash equivalents resulted from cash flows from operating, financing and investing activities which are explained below.\n- 30 -\nNet cash provided by operating activities amounted to $520.7 million, $369.0 million and $345.9 million for the years ended December 31, 1995, 1994 and 1993, respectively. The increase of $151.7 million in net cash provided by operating activities from 1994 to 1995 was principally due to effects of the QVC Acquisition and the Maclean Hunter Acquisition. The increase of $23.1 million in net cash provided by operating activities from 1993 to 1994 was principally due to a decrease in the Company's net cash interest expense, primarily from the effects of lower levels of debt outstanding and a lower average cost of debt, and changes in working capital as a result of the timing of receipts and disbursements.\nNet cash provided by financing activities, which includes the issuances of securities as well as borrowings, was $2.036 billion, $1.115 billion and $437.2 million for the years ended December 31, 1995, 1994 and 1993, respectively. During 1995, the Company borrowed $3.728 billion including $1.1 billion in connection with the QVC Acquisition, $1.085 billion in connection with the refinancing of certain indebtedness, $300.9 million associated with the funding of Sprint Spectrum, $300.0 million of the 2007 Discount Debentures, $250.0 million principal amount of the Company's 9-3\/8% senior subordinated debentures due 2005 and $250.0 million principal amount of the Company's 9-1\/8% senior subordinated debentures due 2006. In addition, during 1995, the Company retired and repaid $1.620 billion of its long-term debt, including $1.186 billion in connection with the refinancing of certain indebtedness, and $175.0 million of optional repayments on QVC's credit facility. Proceeds from borrowings of $1.201 billion in 1994 included $1.015 billion relating to the Maclean Hunter Acquisition. During 1994, the Company repurchased or redeemed and retired $509.0 million of its long-term debt including the Company's $150.0 million, 11-7\/8% senior subordinated debentures due 2004. Additionally, net cash provided by financing activities in 1994 excludes the conversion of $186.2 million of long-term debt into 16.8 million shares of Class A Special Common Stock of the Company. In 1994, the Company received an equity contribution to a subsidiary of $250.0 million in connection with the Maclean Hunter Acquisition and received proceeds from the issuance of common stock of Comcast UK Cable of $209.4 million. During 1993, proceeds from borrowings of $954.0 million included $200.0 million principal amount of 9-1\/2% senior subordinated debentures due 2008, $250.0 million principal amount of 3-3\/8% \/ 5-1\/2% step-up convertible subordinated debentures due 2005 and net proceeds of $300.0 million from the issuance of $541.9 million principal amount at maturity of its 1-1\/8% discount convertible subordinated debentures due 2007. During 1993, the Company retired $493.0 million of long-term debt. Additionally, net cash provided by financing activities in 1993 excludes the conversion of $185.4 million of long-term debt into 17.3 million shares of Class A Special Common Stock of the Company.\nNet cash used in investing activities was $2.353 billion, $1.309 billion and $836.1 million for the years ended December 31, 1995, 1994 and 1993, respectively. During 1995, net cash used in investing activities includes acquisitions of $1.386 billion, principally the acquisition of QVC, net of cash acquired, additional cash investments in affiliates of $480.2 million, including capital contributions to Sprint Spectrum of $327.5 million, additions to property and equipment of $623.0 million and net purchases of short-term investments of $240.8 million. Such amounts were offset by proceeds from sales of long-term investments of $410.5 million, principally in connection with the Heritage Transaction and the Nextel Transaction. Acquisitions in 1994 consisted principally of $1.2 billion paid, including certain transaction costs, in connection with the Maclean Hunter Acquisition. Net proceeds of $389.3 million from the sale of short-term investments during 1994 were used principally to redeem and retire long-term debt. In addition, during 1994, the Company made capital expenditures of $269.9 million and made additional cash investments in affiliates of $125.0 million. During 1993, the Company purchased $384.9 million of short-term investments, made $158.4 million of capital expenditures and made long-term investments of $272.5 million. Investments in 1993 included the purchase of an interest in and loans made to TCG of $77.8 million, the purchase of additional interests in Nextel totaling $118.2 million and the purchase of additional shares of QVC totaling $32.1 million.\nResults of Operations\nThe effects of the QVC Acquisition and the Maclean Hunter Acquisition have been to increase significantly the Company's revenues and expenses, resulting in substantial increases in its operating income before depreciation and amortization, net interest expense and depreciation and amortization expense (see \"Operating Results by Business Segment\" below). As a result of the increases in depreciation and amortization expense and interest expense associated with these acquisitions and their financing, it is expected that the Company will continue to recognize significant losses for the foreseeable future.\n- 31 -\nSummarized consolidated financial information for the Company for the three years ended December 31, 1995, 1994 and 1993 is as follows (dollars in millions, \"NM\" denotes percentage is not meaningful):\nOperating Results by Business Segment\nThe following represent the operating results of the Company's significant business segments, including: \"Domestic Cable Communications,\" the most significant of the Company's wired telecommunications operations; \"Electronic Retailing,\" the most significant of the Company's content businesses; and \"Cellular Communications,\" the most significant of the Company's wireless telecommunications operations. The remaining components of the Company's operations are not independently significant to the Company's consolidated financial position or results of operations (see Note 11 to the Company's consolidated financial statements).\n- 32 -\nDomestic Cable Communications\nThe following table sets forth operating results for the Company's domestic cable communications segment (dollars in millions).\nThe Maclean Hunter Acquisition accounted for $270.1 million of the $389.6 million increase in service income from 1994 to 1995. Of the remaining increase of $119.5 million, $46.0 million is attributable to subscriber growth, $54.6 million relates to changes in rates, which includes the change in the estimated effects of cable rate regulation, $14.0 million results from growth in cable advertising sales and $4.9 million relates to growth in other product offerings. The reduction in service income from 1993 to 1994 of $27.4 million is attributable to a reduction in rates, which includes the estimated effects on regulated rates as a result of cable rate regulation, of $76.8 million offset, in part, by the effects of subscriber growth of $32.6 million, growth in cable advertising sales of $9.2 million and growth in other product offerings of $7.6 million.\nThe Maclean Hunter Acquisition accounted for $143.7 million of the $188.6 million increase in operating, selling, general and administrative expenses from 1994 to 1995. Of the remaining increase of $44.9 million, $22.6 million is attributable to increases in the costs of cable programming as a result of subscriber growth, additional channel offerings and changes in rates, $7.2 million is attributable to increases in expenses associated with the growth in cable advertising sales and $15.1 million results from increases in the cost of labor and other volume related expenses. The $7.1 million increase from 1993 to 1994 is attributable to increases in the costs of labor, billing and cable programming as a result of subscriber growth, partially offset by a reduction of franchise fee expense. Franchise fees were reported by the Company as a component of operating expenses prior to the implementation of the Cable Television Consumer Protection and Competition Act of 1992 (\"1992 Cable Act\"). Effective September 1, 1993, the Company commenced charging subscribers directly for such fees as permitted under the 1992 Cable Act and recording amounts charged as an offset to operating expenses resulting in a decrease in franchise fee expense of $15.9 million from 1993 to 1994. It is anticipated that the Company's cost of cable programming will increase in the future as cable programming rates increase and additional sources of cable programming become available.\n- 33 -\nElectronic Retailing\nAs a result of the QVC Acquisition, the Company commenced consolidating the financial results of QVC, effective February 1, 1995. The following table presents comparative pro forma financial information for the years ended December 31, 1995 and 1994 and is presented herein for purposes of analysis and may not reflect what actual operating results would have been had the Company owned QVC since January 1, 1994 (dollars in millions).\nThe consolidation of QVC's UK operations, effective April 1, 1995, resulted in an increase in net sales from electronic retailing of $48.4 million from 1994 to 1995. The remaining increase of $196.3 million from 1994 to 1995 includes QVC's new businesses, which accounted for $34.4 million of the increase, and the effect of a 9.2% increase in the average number of QVC homes receiving QVC services.\nThe $136.9 million increase in cost of goods sold from electronic retailing is directly related to the growth in net sales. The 0.8 percentage point increase in gross margin is due to slight changes in product mix from year to year, resulting in the decrease in cost of goods sold as a percentage of net sales.\nThe consolidation of QVC's UK operations, effective April 1, 1995, resulted in an increase in operating, selling, general and administrative expenses of $25.8 million from 1994 to 1995. The remaining increase of $35.5 million from 1994 to 1995 is attributable to higher sales volume, increases in advertising costs and additional costs associated with new businesses.\nCellular Communications\nThe following table sets forth the operating results for the Company's cellular communications segment (dollars in millions).\nOf the respective $88.8 million and $84.1 million increases in service income from 1994 to 1995 and from 1993 to 1994, $99.6 million and $81.3 million, respectively, are attributable to the Company's subscriber growth, $10.1\n- 34 -\nmillion and $11.1 million, respectively, are attributable to growth in roamer revenue as a result of the overall growth in the cellular industry and $4.1 million and $1.2 million, respectively, are attributable to new products. Offsetting these increases are decreases of $25.0 million and $9.5 million, respectively, resulting from reductions in average minutes-of-use per cellular subscriber from both comparative periods. The Company expects that the decrease in average minutes-of-use per cellular subscriber to continue in the future, which is consistent with industry trends.\nOf the respective $67.3 million and $59.9 million increases in operating, selling, general and administrative expenses from 1994 to 1995 and from 1993 to 1994, $34.8 million and $55.4 million, respectively, are related to subscriber growth, including the costs to acquire and service subscribers. The remaining increases of $32.5 million and $4.5 million, respectively, are due to increases in other expenses, including subscriber retention costs, administrative costs and theft of service in 1995.\nConsolidated Analysis\nThe $352.5 million increase in depreciation and amortization expense from 1994 to 1995 is due to the acquisitions of QVC and Maclean Hunter, the effects of the rebuild of certain of the Company's cellular equipment, as described below, and capital expenditures during the periods, offset by the effects of asset disposals during the periods. The $5.0 million decrease from 1993 to 1994 is due to certain of the Company's assets becoming fully depreciated in 1993, partially offset by the effects of capital expenditures.\nIn 1995, the Company's cellular division purchased approximately $172.0 million of switching and cell site equipment which replaced the existing switching and cell site equipment. The Company substantially completed the rebuild in the third quarter of 1995. Accordingly, during 1995, the Company charged to its results of operations approximately $110.0 million which represented the difference between the net book value of the equipment replaced and the residual value realized upon its disposal. This charge has been reflected in the Company's consolidated statement of operations as a component of depreciation and amortization expense.\nThe $211.3 million increase in interest expense from 1994 to 1995 is primarily due to increased levels of debt associated with the acquisitions of QVC and Maclean Hunter. The $34.0 million decrease from 1993 to 1994 is due to the effects of lower levels of debt outstanding and a lower average cost of debt.\nThe Company anticipates that, for the foreseeable future, interest expense will be a significant cost to the Company and will have a significant adverse effect on the Company's ability to realize net earnings. The Company believes it will continue to be able to meet its obligations through its ability both to generate operating income before depreciation and amortization and to obtain external financing.\nThe $205.2 million increase in investment income from 1994 to 1995 is principally due to the $177.2 million in gains realized in the Heritage Transaction and Nextel Transaction. The remaining increase for this period is due to the effects of the QVC Acquisition and an increase in the Company's cash, cash equivalents and short-term investments, offset by $15.3 million of losses recorded relating to the net realizable value of certain of the Company's investments. The $4.6 million decrease from 1993 to 1994 is attributable to a decrease in the Company's cash, cash equivalents and short-term investments for this period.\nThe increases in equity in net losses of affiliates for both periods are due to increased losses incurred by the Company's international investees, losses incurred by Sprint Spectrum and certain programming investees and the effects of the QVC Acquisition.\nThe $51.3 million increase in income tax expense from 1994 to 1995 is primarily attributable to the consolidation of QVC for financial reporting purposes. The $24.4 million increase in income tax benefit from 1993 to 1994 is primarily attributable to the fact that the 1993 provision for income taxes includes an increase in income tax expense of approximately $21.0 million relating to the federal income tax rate change from 34% to 35%.\nThe $44.3 million increase in minority interest from 1994 to 1995 is attributable to minority interests in the net income or loss of QVC, Maclean Hunter and Comcast UK Cable. The $5.4 million increase from 1993 to 1994 is primarily attributable to minority interests in the net losses of Comcast UK Cable.\nThe Company incurred debt extinguishment costs totaling $9.4 million during the year ended December 31, 1995 in connection with the refinancing of certain indebtedness, resulting in the Company recording an extraordinary loss, net of tax, of $6.1 million or $.02 per share. During 1994, the Company paid premiums and\n- 35 -\nexpensed unamortized debt acquisition costs totaling $18.0 million, primarily in connection with the redemption of its $150.0 million, 11-7\/8% senior subordinated debentures due 2004, resulting in the Company recording an extraordinary loss, net of tax, of $11.7 million or $.05 per share. The Company paid similar premiums of $27.1 million during 1993 in connection with the redemption of certain of its debt resulting in the Company recording an extraordinary loss, net of tax, of $17.6 million or $.08 per share.\nOn January 1, 1993, the Company recorded a one time non-cash charge resulting from the adoption of Statement of Financial Accounting Standards (\"SFAS\") No. 109, \"Accounting for Income Taxes,\" SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" and SFAS No. 112, \"Employers' Accounting for Postemployment Benefits,\" totaling $742.7 million or $3.47 per share, net of tax.\nFor the years ended December 31, 1995, 1994 and 1993, the Company's earnings before cumulative effect of accounting changes, extraordinary items, income tax expense (benefit), equity in net losses of affiliates and fixed charges (interest expense) were $615.7 million, $269.8 million and $292.7 million, respectively. Excluding the pre-tax gains of $177.2 million recognized in 1995 in connection with the Heritage Transaction and the Nextel Transaction, such earnings were not adequate to cover the Company's fixed charges of $524.7 million, $313.5 million and $347.4 million for the years ended December 31, 1995, 1994 and 1993, respectively. These fixed charges include non-cash interest of $53.8 million, $53.5 million and $62.3 million for the years ended December 31, 1995, 1994 and 1993, respectively. For all periods presented, the inadequacy of these earnings to cover fixed charges is primarily due to the substantial non-cash charges for depreciation and amortization expense, including the 1995 charge associated with the rebuild of certain of the Company's cellular equipment.\nThe Company believes that its losses and inadequacy of earnings to cover fixed charges will not significantly affect the performance of its normal business activities because of its existing cash and cash equivalents and short-term investments, its ability to generate operating income before depreciation and amortization and its ability to obtain external financing.\nThe Company believes that its operations are not materially affected by inflation.\nRegulatory Developments\nThe Telecommunications Act of 1996 (the \"1996 Telecom Act\"), the most comprehensive reform of the nation's telecommunications laws since the Communications Act of 1934, became effective in February 1996. The 1996 Telecom Act will result in changes in the marketplace for cable communications, telephone and other telecommunications services, including the deregulation of rates on cable programming service tiers (\"CPSTs\") in March 1999 for large Multiple System Operators, such as the Company, and immediately for certain small operators (see \"Description of the Company's Businesses - Wired Telecommunications - Cable Communications - Legislation and Regulation\").\nThe Company has settled the majority of outstanding proceedings challenging its rates charged for regulated cable services. In December 1995, the FCC adopted an order approving a negotiated settlement of rate complaints pending against the Company for CPSTs which provided approximately $6.6 million in refunds, plus interest, being given in the form of bill credits, to approximately 1.3 million of the Company's cable subscribers. This FCC order resolved 160 of the Company's benchmark rate cases covering the period September 1993 through July 1994 and 104 of the Company's cost-of-service cases for CPSTs covering the period September 1993 through December 1995. As part of the negotiated settlement, the Company agreed to forego certain inflation and external cost adjustments for systems covered by its cost-of-service filings for CPSTs. The FCC's order has been appealed to a federal appellate court by a local franchising authority whose rate complaint against the Company was resolved by the negotiated settlement. The Company currently is seeking to justify rates for basic cable services and equipment in certain of its cable systems in the State of Connecticut on the basis of a cost-of-service showing. The State of Connecticut has ordered the Company to reduce such rates and to make refunds to subscribers. The Company has appealed the Connecticut decision to the FCC. The Company's management believes that the ultimate resolution of these pending regulatory matters will not have a material adverse impact on the Company's financial position or results of operations.\n- 36 -\nITEM 8","section_7A":"","section_8":"ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nINDEPENDENT AUDITORS' REPORT\nBoard of Directors and Stockholders Comcast Corporation Philadelphia, Pennsylvania\nWe have audited the accompanying consolidated balance sheet of Comcast Corporation and its subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations, stockholders' deficiency and of cash flows for each of the three years in the period ended December 31, 1995. Our audits also included the financial statement schedule listed in the Index at Item 14(b)(i). These financial statements and the financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and the financial statement schedule based on our audits. We did not audit the consolidated financial statements of QVC, Inc. (\"QVC\") as of and for the eleven month period ended December 31, 1995 and the consolidated financial statements of Comcast International Holdings, Inc. (\"International\") and the financial statements of Garden State Cablevision L.P. (\"Garden State\") as of and for each of the two years in the period ended December 31, 1994. QVC and International are consolidated with the Company. The Company's investment in Garden State is accounted for under the equity method. QVC's financial statements reflect total assets and revenues constituting 20% and 44%, respectively, of the Company's consolidated total assets and revenues as of and for the year ended December 31, 1995. The Company's combined equity in the net assets of International and Garden State of $111 million as of December 31, 1994 and the Company's combined equity in the net losses of International and Garden State for the years ended December 31, 1994 and 1993 of $39 million and $33 million, respectively, are included in the Company's consolidated financial statements. The financial statements of QVC, International and Garden State were audited by other auditors whose reports have been furnished to us, and our opinion, insofar as it relates to the amounts included in the Company's consolidated financial statements for QVC, International and Garden State for the periods specified above, is based solely upon the reports of the other auditors.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits and the reports of other auditors provide a reasonable basis for our opinion.\nIn our opinion, based on our audits and the reports of other auditors, such consolidated financial statements present fairly, in all material respects, the financial position of Comcast Corporation and its subsidiaries as of December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles. Also, in our opinion, the financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.\nAs discussed in the notes to consolidated financial statements, the Company changed its method of accounting for income taxes effective January 1, 1993 to conform with Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\"\n\/s\/ Deloitte & Touche LLP\nPhiladelphia, Pennsylvania February 29, 1996\n- 37 -\nCOMCAST CORPORATION AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEET (Dollars in thousands)\nSee notes to consolidated financial statements.\n- 38 -\nCOMCAST CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENT OF OPERATIONS (Amounts in thousands, except per share data)\nSee notes to consolidated financial statements.\n- 39 -\nCOMCAST CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENT OF CASH FLOWS (Dollars in thousands)\nSee notes to consolidated financial statements.\n- 40 -\nCOMCAST CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENT OF STOCKHOLDERS' DEFICIENCY (Dollars in thousands)\nSee notes to consolidated financial statements.\n- 41 -\nCOMCAST CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n1. BUSINESS\nComcast Corporation and its subsidiaries (the \"Company\") is principally engaged in the development, management and operation of wired and wireless telecommunications and the provision of content. Wired telecommunications includes cable and telecommunications services in the United States (\"US\") and the United Kingdom (\"UK\"). Wireless telecommunications includes cellular services, personal communications services, provided through the Company's investment in Sprint Spectrum, and direct to home satellite television. Content is provided through QVC, Inc. and its subsidiaries (\"QVC\"), an electronic retailer, Comcast Content and Communication Corporation (\"C3\") and other programming investments. The Company's consolidated domestic cable operations served more than 3.4 million subscribers and passed more than 5.5 million homes as of December 31, 1995. The Company owns a 50% interest in Garden State Cablevision L.P. (\"Garden State\"), a cable communications company serving approximately 200,000 subscribers and passing approximately 292,000 homes. In the UK, a subsidiary of the Company, Comcast UK Cable Partners Limited (\"Comcast UK Cable\"), holds ownership interests in four cable and telephony businesses that collectively have the potential to serve over 1.6 million homes. The Company provides cellular telephone communications services pursuant to licenses granted by the Federal Communications Commission (\"FCC\") in markets with a population of over 8.3 million, including the area in and around the City of Philadelphia, Pennsylvania, the State of Delaware and a significant portion of the State of New Jersey. Through QVC, the Company markets a wide variety of products and reaches over 52 million homes across the US and an additional 4 million in the UK.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBasis of Consolidation The consolidated financial statements include the accounts of the Company and all wholly owned, majority owned and controlled subsidiaries. All significant intercompany accounts and transactions among the consolidated entities have been eliminated. Included in the Company's consolidated balance sheet as of December 31, 1995 and 1994 are the net assets of foreign subsidiaries which total approximately $115.2 million and $146.4 million, respectively.\nManagement's Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nFair Values The estimated fair value amounts presented in these notes to consolidated financial statements have been determined by the Company using available market information and appropriate methodologies. However, considerable judgment is required in interpreting market data to develop the estimates of fair value. The estimates presented herein are not necessarily indicative of the amounts that the Company could realize in a current market exchange. The use of different market assumptions and\/or estimation methodologies may have a material effect on the estimated fair value amounts. Such fair value estimates are based on pertinent information available to management as of December 31, 1995 and 1994, and have not been comprehensively revalued for purposes of these consolidated financial statements since such dates. Current estimates of fair value may differ significantly from the amounts presented herein.\nCash Equivalents and Short-term Investments Cash equivalents consist principally of US Government obligations, commercial paper, repurchase agreements and certificates of deposit with maturities of three months or less when purchased. Short-term investments consist principally of US Government obligations, commercial paper, repurchase agreements and certificates of deposit with maturities greater than three months when purchased. The carrying amounts of the Company's cash equivalents and short-term investments, classified as available for sale securities, approximate their fair values, which are based on quoted market prices, as of December 31, 1995 and 1994.\n- 42 -\nCOMCAST CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (Continued)\nInventories - Electronic Retailing Inventories, consisting primarily of products held for sale, are stated at the lower of cost or market. Cost is determined by the first-in, first-out method.\nNet Sales and Returns - Electronic Retailing Net sales from electronic retailing are recognized at the time of shipment to customers. An allowance for returned merchandise is provided as a percentage of sales based on historical experience.\nInvestments, Principally in Affiliates Investments are accounted for based on the Company's ability to exercise significant influence over the operating and financial policies of the investee. Equity method investments are recorded at original cost and adjusted periodically to recognize the Company's proportionate share of the investees' net income or losses after the date of investment, and additional contributions made and dividends received. Unrestricted publicly traded investments, classified as available for sale, are recorded at their fair value as of December 31, 1995 and 1994, with unrealized gains or losses resulting from changes in fair value between measurement dates recorded as a component of stockholders' deficiency. Restricted publicly traded investments and investments in privately held companies are stated at cost, adjusted for any known diminution in value.\nInvestment Income Investment income includes interest income and gains, net of losses, on the sales of marketable securities. Gross realized gains and losses are recognized using the specific identification method (see Note 4). In 1995, investment income also includes losses incurred relating to the net realizable value of certain of the Company's investments.\nProperty and Equipment Property and equipment are stated at cost. Depreciation is provided by the straight-line method over estimated useful lives as follows:\nBuildings and improvements 15-40 years Operating facilities 5-20 years Other equipment 2-10 years\nImprovements and extraordinary repairs that extend asset lives are capitalized; other repairs and maintenance charges are expensed as incurred. The cost and related accumulated depreciation applicable to assets sold or retired are removed from the accounts and the gain or loss on disposition is recognized in net loss.\nDeferred Charges Franchise and license acquisition costs are amortized on a straight-line basis over their legal or estimated useful lives up to 40 years. The excess of cost over the fair value of net assets acquired is being amortized over their estimated useful lives of up to 40 years.\nValuation of Long-Lived Assets The Company periodically evaluates the recoverability of its long-lived assets, including property and equipment and deferred charges, using objective methodologies. Such methodologies include evaluations based on the cash flows generated by the underlying assets or other determinants of fair value.\nPostretirement and Postemployment Benefits The estimated costs of retiree benefits and benefits for former or inactive employees, after employment but before retirement, are accrued and recorded as a charge to operations during the years the employees provide services.\nForeign Currency Translation Assets and liabilities of the Company's foreign subsidiaries, where the functional currency is the local currency, are translated into US dollars at the December 31 exchange rate. The related translation adjustments are recorded as a separate component of stockholders' deficiency. Revenues\n- 43 -\nCOMCAST CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (Continued)\nand expenses are translated using average exchange rates prevailing during the year. Foreign currency transaction gains and losses are included in net loss.\nIncome Taxes The Company recognizes deferred tax assets and liabilities for temporary differences between the financial reporting basis and the tax basis of the Company's assets and liabilities and expected benefits of utilizing net operating loss carryforwards. The impact on deferred taxes of changes in tax rates and laws, if any, applied to the years during which temporary differences are expected to be settled, are reflected in the financial statements in the period of enactment.\nLoss per Share For the years ended December 31, 1995, 1994 and 1993, the Company's common stock equivalents have an antidilutive effect on the loss per share and therefore, have not been used in determining the total weighted average number of common shares outstanding. Fully diluted loss per share for 1995, 1994 and 1993 is antidilutive and, therefore, has not been presented.\nStock Split On December 21, 1993, the Company's Board of Directors (the \"Board\") authorized a three-for-two stock split in the form of a 50% stock dividend payable on February 2, 1994 to shareholders of record on January 12, 1994. The dividend was paid in Class A Special Common Stock to the holders of Class A Common, Class A Special Common and Class B Common Stock. Average number of shares outstanding and related prices, per share amounts, share conversion and stock option data have been retroactively restated to reflect the stock split.\nDerivative Financial Instruments The Company does not hold or issue any derivative financial instruments for trading purposes. The credit risks associated with the Company's derivative financial instruments are controlled through the evaluation and monitoring of the creditworthiness of the counterparties. Although the Company may be exposed to losses in the event of nonperformance by the counterparties, the Company does not expect such losses, if any, to be significant.\nNew Accounting Pronouncements In October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (\"SFAS\") No. 123, \"Accounting for Stock-Based Compensation,\" which will be adopted by the Company in 1996 as required by this statement. The Company has elected to continue to measure such compensation expense using the method prescribed by Accounting Principles Board Opinion No. 25, \"Accounting for Stock Issued to Employees,\" as permitted by SFAS No. 123. When adopted, SFAS No. 123 will not have any effect on the Company's financial position or results of operations but will require the Company to provide expanded disclosure regarding its stock-based employee compensation plans.\nEffective January 1, 1995, the Company adopted the provisions of SFAS No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.\" There was no cumulative effect of the adoption of SFAS No. 121.\n- 44 -\nCOMCAST CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (Continued)\nEffective January 1, 1994, the Company adopted the provisions of SFAS No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" (see Note 4).\nEffective January 1, 1993, the Company adopted the provisions of SFAS No. 109, \"Accounting for Income Taxes\", SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other than Pensions\" and SFAS No. 112, \"Employers' Accounting for Postemployment Benefits.\" The cumulative effect of the adoption of SFAS No. 109, SFAS No. 106 and SFAS No. 112 increased the Company's net loss for the year ended December 31, 1993 by $742.7 million, or $3.47 per share.\nReclassifications Certain reclassifications have been made to the prior years consolidated financial statements to conform to those classifications used in 1995.\n3. ACQUISITIONS AND OTHER SIGNIFICANT EVENTS\nSprint Spectrum Effective as of January 1996, the Company, Tele-Communications, Inc. (\"TCI\"), Cox Communications, Inc. (\"Cox,\" and together with the Company and TCI, the \"Cable Parents\") and Sprint Corporation (\"Sprint,\" and together with the Cable Parents, the \"Parents\"), and certain subsidiaries of the Parents (the \"Partner Subsidiaries\"), entered into a series of agreements relating to their previously announced joint venture (March 1995) to engage in the communications business. Under an Amended and Restated Agreement of Limited Partnership (the \"Partnership Agreement\") of MajorCo, L.P. (known as \"Sprint Spectrum\"), the business of Sprint Spectrum will be the provision of wireless telecommunications services and will not include the previously authorized business of providing local wireline communications services to residences and businesses. A partnership owned entirely by subsidiaries of the Company owns 15% of Sprint Spectrum. The Company accounts for its investment in Sprint Spectrum under the equity method (see Note 4).\nSprint Spectrum was the successful bidder for 29 personal communications services (\"PCS\") licenses in the auction conducted by the FCC from December 1994 through mid-March 1995. The purchase price for the licenses was approximately $2.11 billion, all of which has been paid to the FCC. Sprint Spectrum may also elect to bid in subsequent auctions for PCS licenses. In addition, Sprint Spectrum has invested, and may continue to invest, in other entities that hold PCS licenses, may acquire PCS licenses from other license holders and may affiliate with other license holders.\nThe Partner Subsidiaries have committed to contribute $4.2 billion in cash to Sprint Spectrum through 1997, of which the Company's share is $630.0 million. Of this funding requirement, the Company has made total cash capital contributions to Sprint Spectrum of $346.0 million through December 31, 1995. The Company anticipates that Sprint Spectrum's capital requirements over the next several years will be significant. Requirements in excess of committed capital are planned to be funded by Sprint Spectrum through external financing. Although it is anticipated that external financing will be available to Sprint Spectrum on acceptable terms and conditions, no assurances can be given as to such availability. The timing of the Company's remaining capital contributions to Sprint Spectrum is dependent upon a number of factors, including Sprint Spectrum's ability to obtain external financing as well as its working capital requirements.\nPursuant to separate Parent agreements, each Cable Parent and Sprint agreed to negotiate in good faith on a market-by-market basis for the provision of local wireline telephony services over the cable communications facilities of the applicable Cable Parent under the Sprint brand. Accordingly, local telephony offerings in each market will be the subject of individual agreements to be negotiated with Sprint, rather than being provided through Sprint Spectrum as originally contemplated. The offering of local wireline telephone services will require the removal of regulatory and legislative barriers to local telephone competition. Each Parent agreement also contains certain restrictions on the ability of each Parent to offer and promote, or package certain of its cable communications products or services with, certain products and services of other persons and requires the\n- 45 -\nCOMCAST CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (Continued)\napplicable Cable Parent to make its cable communications facilities available to Sprint for specified purposes to the extent that it has made such facilities available to others for such purposes.\nThe Partner Subsidiaries also terminated a contribution agreement pursuant to which they had agreed to contribute to Sprint Spectrum their respective interests in Teleport Communications Group Inc., TCG Partners (collectively, \"Teleport\") and certain local joint ventures managed by such entities (with Teleport, \"TCG\"). TCG is one of the largest competitive access providers in the US in terms of route miles. The Parents reaffirmed their intention to continue to attempt to integrate the business of TCG with that of Sprint Spectrum.\nScripps Cable In October 1995, the Company announced its agreement to purchase the cable television operations (\"Scripps Cable\") of The E.W. Scripps Company (\"E.W. Scripps\") in exchange for shares of the Company's Class A Special Common Stock, par value $1.00 per share (the \"Class A Special Common Stock\"), worth $1.575 billion (the \"Base Consideration\"), subject to certain closing adjustments (the \"Scripps Transaction\"). Scripps Cable passes approximately 1.2 million homes and serves approximately 800,000 subscribers, with over 60% of its subscribers located in Sacramento, California and Chattanooga and Knoxville, Tennessee. The purchase is expected to close in the second half of 1996, subject to shareholder and regulatory approval and certain other conditions.\nPursuant to the Agreement and Plan of Merger dated as of October 28, 1995 (the \"Merger Agreement\") by and among the Company, E.W. Scripps and Scripps Howard, Inc., a wholly owned subsidiary of E.W. Scripps, E.W. Scripps will distribute to its shareholders all assets other than Scripps Cable. Following such distribution, E.W. Scripps will be merged with and into the Company (the \"Merger\") and each share of E.W. Scripps common stock issued and outstanding immediately prior to the Merger will be converted into a portion of the shares of the Class A Special Common Stock to be paid as consideration in the Merger. Assuming (i) no adjustment has been made to the Base Consideration and (ii) the closing price of the Class A Special Common Stock is equal to the execution price ($20.075 per share), as such terms are defined in the Merger Agreement, the Company would issue to E.W. Scripps' shareholders an aggregate of approximately 78.5 million shares of Class A Special Common Stock in the Merger, subject to certain adjustments. Such shares would represent, in the aggregate, approximately 28.9% of the Class A Special Common Stock outstanding as of December 31, 1995, on a pro forma basis.\nShare Repurchase Program Concurrent with the announcement of the Scripps Transaction, the Company announced that its Board has authorized a market repurchase program (the \"Repurchase Program\") pursuant to which the Company may purchase, at such times and on such terms as it deems appropriate, up to $500.0 million of its outstanding common equity securities, subject to certain restrictions and market conditions (see Notes 6 and 9).\nQVC In February 1995, the Company and TCI acquired all of the outstanding stock of QVC not previously owned by them (approximately 65% of such shares on a fully diluted basis) for $46, in cash, per share (the \"QVC Acquisition\"), representing a total cost of approximately $1.4 billion. The QVC Acquisition, including the exercise of certain warrants held by the Company, was financed with cash contributions from the Company and TCI of $296.3 million and $6.6 million, respectively, borrowings of $1.1 billion under a $1.2 billion QVC credit facility and existing cash and cash equivalents held by QVC. Following the acquisition, the Company and TCI own, through their respective subsidiaries, 57.45% and 42.55%, respectively, of QVC. The Company, through a management agreement, is responsible for the day to day operations of QVC. The Company has accounted for the QVC Acquisition under the purchase method of accounting and QVC was consolidated with the Company effective February 1, 1995.\n- 46 -\nCOMCAST CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (Continued)\nMaclean Hunter In December 1994, the Company, through Comcast MHCP Holdings, L.L.C. (the \"LLC\"), acquired the US cable television and alternate access operations of Maclean Hunter Limited (\"Maclean Hunter\") from Rogers Communications Inc. and all of the outstanding shares of Barden Communications, Inc. (\"BCI,\" and collectively, such acquisitions are referred to as the \"Maclean Hunter Acquisition\") for approximately $1.2 billion in cash. The Company and the California Public Employees' Retirement System (\"CalPERS\") invested $305.6 million and $250.0 million, respectively, in the LLC, which is owned 55% by a wholly owned subsidiary of the Company and 45% by CalPERS, and is managed by the Company. The balance of the Maclean Hunter Acquisition was financed through borrowings under a credit facility of a wholly owned subsidiary of the LLC. The Company has accounted for the Maclean Hunter Acquisition under the purchase method of accounting and has consolidated Maclean Hunter effective December 22, 1994.\nCellular Rebuild In 1995, the Company's cellular division purchased approximately $172.0 million of switching and cell site equipment which replaced the existing switching and cell site equipment (the \"Cellular Rebuild\"). The Company substantially completed the Cellular Rebuild in the third quarter of 1995. Accordingly, during 1995, the Company charged to its results of operations approximately $110.0 million which represented the difference between the net book value of the equipment replaced and the residual value realized upon its disposal. This charge has been reflected in the Company's consolidated statement of operations as a component of depreciation and amortization expense.\nUnaudited Pro Forma Information The following unaudited pro forma information for the years ended December 31, 1995 and 1994 has been presented as if the QVC Acquisition and the Maclean Hunter Acquisition had occurred on January 1, 1994. This unaudited pro forma information is based on historical results of operations adjusted for acquisition costs and, in the opinion of management, is not necessarily indicative of what the results would have been had the Company operated the acquired entities since January 1, 1994 (dollars in millions, except per share data).\n4. INVESTMENTS\n- 47 -\nCOMCAST CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (Continued)\nInvestments - Equity Method Summarized financial information for equity method investments for 1995, 1994 and 1993 is as follows (dollars in thousands):\nThe original cost of investments accounted for under the equity method of accounting totaled approximately $964.7 million and $565.4 million as of December 31, 1995 and 1994, respectively. As of December 31, 1995 and 1994, equity method investments include the Company's interests in Sprint Spectrum (see Note 3), TCG (see Note 3), Garden State and interests in three of its four UK cable and telecommunications businesses.\nEffective January 1, 1994, the Company commenced accounting for QVC (see Note 3), TCG and certain other investments under the equity method of accounting due to changes in the nature of the relationships between the Company and the investees which allow the Company to exercise significant influence over their operating and financial policies. The Company's prior year financial statements were not restated due to the insignificance of the Company's proportionate ownership interests in the net income or loss of the investees for those periods.\n- 48 -\nCOMCAST CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (Continued)\nComcast UK Cable holds, among other things, the Company's equity method investments in UK affiliates: Birmingham Cable Corporation Limited, Cable London PLC and Cambridge Holding Company Limited. On September 27, 1994, Comcast UK Cable consummated an initial public offering (the \"IPO\") of 15.0 million of its Class A Common Shares for net proceeds of $209.4 million. As a result of the IPO and related transactions, the Company beneficially owns approximately 31.2% of the total outstanding Comcast UK Cable common shares. Because the Class A Common Shares are entitled to one vote per share and the Class B Common Shares are entitled to ten votes per share, the Company, through its ownership of the Class B Common Shares, controls approximately 81.9% of the total voting power of all outstanding Comcast UK Cable common shares and continues to consolidate Comcast UK Cable. As a result of the IPO and related transactions, the Company recorded an aggregate minority interest liability in Comcast UK Cable of $261.4 million in 1994. In addition, the Company recorded the increase in its proportionate share of Comcast UK Cable's net assets as an increase in additional capital of $59.3 million.\nThe Company holds a 20% interest in Teleport with an original cost of approximately $66.0 million as of December 31, 1995 and 1994. The Company also had loans to Teleport totaling $53.8 million and $39.5 million at December 31, 1995 and 1994, respectively.\nInvestments - Public Companies As of December 31, 1994, the Company held 11.3 million shares of common stock of Nextel Communications, Inc. (\"Nextel\"), classified as available for sale, representing a 10.7% interest in Nextel's then outstanding common stock. Nextel is a specialized mobile radio licensee developing an enhanced service capability. In July 1995, the Company sold these shares for $212.6 million (the \"Nextel Transaction\"). As a result of this transaction, the Company recognized a pre-tax gain of $36.2 million in 1995.\nThe Company had recorded its investment in Nextel common stock, with an historical cost of $175.9 million as of December 31, 1994, at its estimated fair value, resulting in an unrealized pre-tax loss of $14.0 million as of December 31, 1994. As of December 31, 1995, the Company held approximately 693,000 shares of Nextel common stock. The Company has recorded its investment, with an historical cost of $11.1 million, at its estimated fair value, resulting in an unrealized pre-tax loss of approximately $905,000 as of December 31, 1995.\nAs of December 31, 1995 and 1994, the Company owns options to acquire approximately 25.0 million and 25.2 million shares of Nextel common stock, respectively, principally at $16 per share, with an estimated fair value of $99.7 million and $149.2 million, respectively, which are recorded at their historical cost of $20.0 million and $23.5 million, respectively. Investments in options have been valued using the Black-Scholes Option Pricing method.\nIn February 1996, in connection with certain preemptive rights of the Company under previously existing agreements with Nextel, the Company purchased approximately 8.16 million shares, classified as available for sale, of Nextel common stock at $12.25 per share, for a total cost of $99.9 million. Had the Company owned such shares as of December 31, 1995, the fair value of these shares would have been $120.3 million.\nThe Company holds unrestricted equity investments in certain other publicly traded companies with an historical cost of $104.8 million and $10.7 million as of December 31, 1995 and 1994, respectively. As of December 31, 1995 and 1994, the Company has recorded these investments at their estimated fair values of $139.9 million and $30.6 million, resulting in unrealized pre-tax gains of $35.1 million and $19.9 million, respectively.\nInvestments - Privately Held Companies In January 1995, the Company exchanged its investments in Heritage Communications, Inc. (\"Heritage\") with TCI for approximately 13.3 million publicly-traded Class A common shares of TCI with a fair market value of approximately $290.0 million. Shortly thereafter, the Company sold approximately 9.1 million unrestricted TCI shares for total proceeds of approximately $188.0 million (collectively, the \"Heritage Transaction\"). As a result of these transactions, the Company recognized a pre-tax gain of approximately $141.0 million in 1995.\n- 49 -\nCOMCAST CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (Continued)\nIt is not practicable to estimate the fair value of the Company's other investments in privately held companies with a recorded cost, excluding Heritage, of $54.9 million and $50.3 million as of December 31, 1995 and 1994, respectively, due to a lack of quoted market prices and excessive costs involved in determining such fair value.\n5. LONG-TERM DEBT\nThe maturities of long-term debt outstanding as of December 31, 1995, as adjusted for the refinancing of a subsidiary's indebtedness in February 1996, for the four years after 1996 are as follows:\n(Dollars in thousands) 1997............................. $154,789 1998............................. 691,560 1999............................. 444,304 2000............................. 575,864\nZero Notes The Company issued the Senior participating redeemable zero coupon notes, due 2000 (the \"Zero Notes\"), in conjunction with its 1992 acquisition of AWACS, Inc. (\"AWACS\"), the non-wireline cellular telephone system serving the Philadelphia Metropolitan Statistical Area, from Metromedia Company. The Zero Notes outstanding have an aggregate face amount payable at maturity of $629.4 million, accreting at 11% per annum. If, at maturity, or an earlier redemption date, 35%, subject to reduction in certain circumstances, of the private market value, as determined by applicable procedures, of the Company's cellular subsidiaries is greater than the accreted value plus certain premiums, then such greater amount will constitute the redemption price. The holders of the Zero Notes have the right, upon request of the holders of the majority of the notes, to require the Company to redeem the Zero Notes at any time on or after March 5, 1998. The accreted value of the Zero Notes, without\n- 50 -\nCOMCAST CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (Continued)\ngiving effect to the alternative formula based on the private market value of the cellular business, of $402.4 million as of December 31, 1995 has been presented above as a 1998 maturity. As of December 31, 1995, approximately $188.4 million accreted value of the Zero Notes is payable, at the Company's option, either in cash or the Company's Class A Special Common Stock.\n2007 Discount Debentures In November 1995, Comcast UK Cable received net proceeds of approximately $291.1 million from the sale of approximately $517.3 million principal amount at maturity of its 11.20% senior discount debentures due 2007 (the \"2007 Discount Debentures\"). Interest will accrete on the 2007 Discount Debentures at 11.20% per annum compounded semi-annually from November 15, 1995 to November 15, 2000, after which date interest will be paid in cash on each May 15 and November 15, through November 15, 2007.\nConvertible Subordinated Debt The 3-3\/8% \/ 5-1\/2% step-up convertible subordinated debentures due 2005 are convertible into the Company's Class A Special Common Stock at a conversion price of $24.50 per share. Interest on the debentures accrues at a rate per annum of 3-3\/8% from the date of issuance to September 8, 1997, from and after such time the Company will have the right to redeem the debentures for cash. Interest will accrue at a rate per annum of 5- 1\/2% from September 9, 1997 to maturity, or earlier redemption.\nThe 1-1\/8% discount convertible subordinated debentures due 2007 are convertible into the Company's Class A Special Common Stock at a conversion rate equal to 19.3125 shares per $1,000 principal amount at maturity. The conversion price will not be adjusted for accrued interest or original issue discount. The debentures were issued at 55.363% of their principal amount of $541.9 million at maturity resulting in a 6% effective annual yield to maturity. At any time on or after October 15, 1997, the Company may redeem such debentures for cash.\nDuring 1994, $34.1 million of the zero coupon convertible subordinated notes due 1995 were converted into approximately 3.3 million shares of the Company's Class A Special Common Stock. In January 1995, the remaining $4.3 million of the notes were converted by the holders into approximately 395,000 shares of the Company's Class A Special Common Stock.\nIn February 1994, substantially all of the Company's 7% convertible subordinated debentures due 2001 were converted into approximately 13.5 million shares of the Company's Class A Special Common Stock.\nDebt Extinguishment The Company incurred debt extinguishment costs totaling $9.4 million during 1995 in connection with the refinancing of certain indebtedness, resulting in the Company recording an extraordinary loss, net of tax, of $6.1 million or $.02 per share. During 1994, the Company paid premiums and expensed unamortized debt acquisition costs totaling $18.0 million, primarily in connection with the redemption of its $150.0 million, 11-7\/8% Senior subordinated debentures due 2004, resulting in the Company recording an extraordinary loss, net of tax, of $11.7 million or $.05 per share. The Company paid similar premiums of $27.1 million during 1993 in connection with the redemption of certain of its debt resulting in the Company recording an extraordinary loss, net of tax, of $17.6 million or $.08 per share.\nInterest Rates Fixed interest rates on notes payable to banks and insurance companies range from 8.6% to 10.57%. Bank debt interest rates vary based upon one or more of the following rates at the option of the Company:\nPrime rate to prime plus 1%; London Interbank Offered Rate (LIBOR) plus 1\/2% to 2-1\/8%; and Certificate of deposit rate plus 7\/8% to 2-1\/8%.\nAs of December 31, 1995 and 1994, the Company's effective weighted average interest rate on its variable rate bank and insurance company debt outstanding was 7.87% and 7.63%, respectively.\n- 51 -\nCOMCAST CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (Continued)\nForeign Currency and Interest Rate Risk Management The Company has entered into interest rate swap and cap agreements to limit its exposure to adverse fluctuations in interest rates. As of December 31, 1995 and 1994, $1.2 billion and $415.0 million, respectively, of the Company's variable rate debt was protected by these products. Such agreements mature on various dates through 2000.\nThe Company has entered into certain foreign exchange option contracts as a normal part of its foreign currency risk management efforts. During 1995, Comcast UK Cable entered into certain foreign exchange put option contracts which may be settled only on November 16, 2000. These put option contracts are used to limit Comcast UK Cable's exposure to the risk that the eventual cash outflows related to net monetary liabilities denominated in currencies other than its functional currency (the UK Pound Sterling or \"UK Pound\") (principally the 2007 Discount Debentures) are adversely affected by changes in exchange rates. As of December 31, 1995, Comcast UK Cable has (pound)250.0 million notional amount of foreign exchange put option contracts to purchase US dollars at an exchange rate of $1.35 per (pound)1.00 (the \"Ratio\"). Foreign exchange put option contracts provide a hedge, to the extent the exchange rate falls below the Ratio, against Comcast UK Cable's net monetary liabilities denominated in US dollars since gains and losses realized on the put option contracts are offset against foreign exchange gains or losses realized on the underlying net liabilities. Premiums paid for such put option contracts were not significant and have been recorded as assets in the Company's consolidated balance sheet. These premiums are being amortized over the terms of the related contracts.\nIn order to reduce hedging costs, Comcast UK Cable has sold (pound)250.0 million notional amount of foreign exchange call option contracts. These call option contracts may only be settled on their expiration dates. Of these call option contracts, (pound)200.0 million notional amount settle on November 16, 1996 at an exchange rate of $1.70 per (pound)1.00 and (pound)50.0 million notional amount settle on November 16, 2000 at an exchange rate of $1.62 per (pound)1.00. Changes in fair value between measurement dates relating to these call option contracts are not significant and have been recorded in the Company's consolidated statement of operations.\nDebt Covenants Certain of the Company's subsidiaries' loan agreements contain restrictive covenants which limit the subsidiaries' ability to enter into arrangements for the acquisition of property and equipment, investments, mergers and the incurrence of additional debt. Certain of these agreements require that certain ratios and cash flow levels be maintained and contain certain restrictions on dividend payments and advances of funds to the Company. The Company and its subsidiaries were in compliance with such restrictive covenants for all periods presented. In addition, the stock of certain subsidiary companies is pledged as collateral for the notes payable to banks and insurance companies.\nAs of December 31, 1995, approximately $410 million of the Company's cash, cash equivalents and short-term investments was restricted to use by subsidiaries of the Company under contractual or other arrangements, including approximately $341 million which is restricted to use by Comcast UK Cable.\nLines and Letters of Credit As of February 1, 1996, certain subsidiaries of the Company had unused lines of credit of $1.541 billion. Use of these unused lines of credit is restricted by the covenants of the related debt agreements and to subsidiary debt refinancing, subsidiary general corporate purposes and dividend declaration.\nAs of December 31, 1995, the Company and certain of its subsidiaries had unused irrevocable standby letters of credit totaling $63.9 million to cover potential fundings associated with several projects.\n- 52 -\nCOMCAST CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (Continued)\n6. STOCKHOLDERS' DEFICIENCY\nPreferred Stock The Company is authorized to issue, in one or more series, up to a maximum of 20.0 million shares of preferred stock without par value. The shares can be issued with such designations, preferences, qualifications, privileges, limitations, restrictions, options, conversion rights and other special or related rights as the Board shall from time to time fix by resolution.\nCommon Stock Class A Special Common Stock is generally nonvoting and each share of Class A Common Stock is entitled to one vote. Each share of Class B Common Stock is entitled to fifteen votes and is convertible, share for share, into Class A or Class A Special Common Stock, subject to certain restrictions.\nAs of December 31, 1995, 20.7 million shares of Class A Special Common Stock were reserved for issuance upon conversion of the Company's convertible subordinated debentures.\nRepurchases and Retirements Through December 31, 1995, the Company had repurchased shares of its common stock for aggregate consideration of $12.4 million pursuant to the Repurchase Program (see Note 3). Through February 1, 1996, the Company had repurchased additional shares for aggregate consideration of $4.0 million. In addition, the Company sold put options on 3.0 million shares of its Class A Special Common Stock in December 1995. Through February 1, 1996, the Company sold additional put options on 1.0 million shares of its Class A Special Common Stock (see Note 9).\nIn December 1995, the Company issued 751,000 shares of its Class A Special Common Stock to the Company's Retirement-Investment Plan in exchange for an equivalent number of shares of its Class A Common Stock, held as an investment of the plan.\nStock Option Plans The Company maintains qualified and nonqualified stock option plans for employees, directors and other persons under which the option prices are not less than the fair market value of the shares at the date of grant. Under these plans, 16.3 million shares of Class A Special Common Stock, 229,000 shares of Class A Common Stock and 658,000 shares of Class B Common Stock were reserved as of December 31, 1995. Option terms are generally from five to ten and one-half years with options becoming exercisable at various dates.\n- 53 -\nCOMCAST CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (Continued)\nChanges in the number of shares subject to outstanding but unexercised options under the Company's option plans for the years ended December 31, 1995, 1994 and 1993 were as follows:\nAs of December 31, 1995, options to purchase 5.8 million shares of Class A Special Common Stock, 226,000 shares of Class A Common Stock and 557,000 shares of Class B Common Stock were exercisable.\nRestricted Stock Plan The Company has a restricted stock program whereby management employees may be granted restricted shares of the Company's Class A Special Common Stock. Shares are subject to certain vesting provisions. The shares awarded do not have voting or dividend rights until vesting occurs. Restrictions on the awards expire annually, over a period generally not to exceed five years from the date of the awards. The Company recognizes compensation expense over the vesting period. As of December 31, 1995, there were 1.1 million unvested shares granted under the program of which 509,000 vested in January 1996. Total compensation expense recognized in 1995, 1994 and 1993 under this program was $4.6 million, $4.4 million and $3.4 million, respectively.\nQVC Stock Option\/SAR Plans QVC maintains a qualified and nonqualified combination stock option\/Stock Appreciation Rights (\"SAR\") plan (the \"QVC Tandem Plan\") and a SAR plan (the \"QVC SAR Plan\") for employees, officers, directors and other persons designated by the Compensation Committee of QVC's Board of Directors. Under the QVC Tandem Plan, the option prices are not less than the fair market values at the date of grant. If the SAR feature of the Tandem Plan is elected, eligible participants receive 75% of the excess of the fair market value of a share of QVC stock over the exercise price of the option to which it is attached at the exercise date. Because the exercise of the option component is more likely, no compensation expense has been recorded. Under the QVC SAR Plan, eligible participants are entitled to receive 100% of the excess of the fair market value of the QVC stock at the exercise date over the fair value of such stock at the date of grant. Option and SAR terms may be up to 10 years from the date of grant, with options and SARs becoming exercisable at various dates.\nDuring the year ended December 31, 1995, 142,000 options were granted at a price of $460 per share. As the first vesting date was January 1, 1996, no options were exercisable as of December 31, 1995. Holders have stated an intention not to exercise the SAR feature of the QVC Tandem Plan.\n- 54 -\nCOMCAST CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (Continued)\nUnder the QVC SAR plan, 8,500 SARs are outstanding as of December 31, 1995 and compensation expense of $1.1 million was recorded in 1995 related to such plan.\n7. INCOME TAXES\nAs a result of the Maclean Hunter Acquisition, the Company's deferred income tax liability was increased in 1994 by approximately $488.0 million for temporary differences between the financial reporting basis and the income tax reporting basis of the assets of Maclean Hunter and BCI at the date of acquisition. Deferred charges were increased by the same amount as prescribed by SFAS No. 109.\nAs a result of the QVC Acquisition, the Company's deferred income tax liability was increased in 1995 by $45.7 million for temporary differences between the financial reporting basis and the income tax reporting basis of the assets of QVC at the date of acquisition. Deferred charges were increased by the same amount as prescribed by SFAS No. 109. At the date of acquisition, QVC had a net deferred income tax liability of $33.2 million, which was assumed by the Company.\nThe Company joins with its subsidiaries which it owns 80% or more in filing consolidated federal income tax returns. Both QVC and the direct subsidiary of the LLC file separate consolidated federal income tax returns.\nIncome tax expense (benefit) consists of the following components:\n- 55 -\nCOMCAST CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (Continued)\nThe effective income tax expense (benefit) of the Company differs from the statutory amount because of the effect of the following items:\nDeferred income tax expense (benefit) resulted from the following differences between financial and income tax reporting:\n- 56 -\nCOMCAST CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (Continued)\nSignificant components of the Company's net deferred tax liability are as follows:\nThe Company's valuation allowance against deferred tax assets includes approximately $120.0 million for which any subsequent tax benefits recognized will be allocated to reduce goodwill and other noncurrent intangible assets. For income tax reporting purposes, the subsidiaries of the LLC have net operating loss carryforwards of approximately $18.0 million, for which a deferred tax asset has been recorded, which expire primarily in 2010.\n8. STATEMENT OF CASH FLOWS - SUPPLEMENTAL INFORMATION\nThe Company made cash payments for interest of approximately $459.1 million, $261.6 million and $278.6 million during the years ended December 31, 1995, 1994 and 1993, respectively.\nThe Company made cash payments for income taxes of approximately $35.4 million during the year ended December 31, 1995. Cash payments for income taxes during the years ended December 31, 1994 and 1993 were not significant.\n9. COMMITMENTS AND CONTINGENCIES\nCommitments Liberty Media Corporation (\"Liberty\"), a majority owned subsidiary of TCI, may, at certain times following February 9, 2000, trigger the exercise of certain exit rights with respect to its investment in QVC. If the exit rights are triggered, the Company has first right to purchase Liberty's stock in QVC at Liberty's pro rata portion of the fair market value (on a going concern or liquidation basis, whichever is higher, as determined by an appraisal process) of QVC. The Company may pay Liberty for such stock, subject to certain rights of Liberty to consummate the purchase in the most tax-efficient method available, in cash, the Company's promissory note maturing not more than three years after issuance, the Company's equity securities or any combination thereof. If the Company elects not to purchase the stock of QVC held by Liberty, then Liberty will have a similar right to purchase the stock of QVC held by the Company. If Liberty elects not to purchase the stock of QVC held by the Company, then Liberty and the Company will use their best efforts to sell QVC.\n- 57 -\nCOMCAST CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (Continued)\nAs a result of the Maclean Hunter Acquisition, at any time after December 18, 2001, CalPERS may elect to liquidate its interest in the LLC at a price based upon the fair value of CalPERS' interest in the LLC, adjusted, under certain circumstances, for certain performance criteria relating to the fair value of the LLC or to the Company's common stock. Except in certain limited circumstances, the Company, at its option, may satisfy this liquidity arrangement by purchasing CalPERS' interest for cash, through the issuance of the Company's common stock (subject to certain limitations) or by selling the LLC.\nIn conjunction with the Repurchase Program, in December 1995, the Company sold put options on 3.0 million shares of its Class A Special Common Stock. The put options give the holder the right to require the Company to repurchase such shares at specified prices on specific dates during the period from May through July 1996. Proceeds of $2.6 million from the sale of these put options were credited to additional capital. The amount the Company would be obligated to pay to repurchase such shares if all outstanding put options were exercised, totaling $52.1 million, has been reclassified to a temporary equity account in the Company's consolidated balance sheet as of December 31, 1995. Through February 1, 1996, the Company sold additional put options on 1.0 million shares of its Class A Special Common Stock, with expiration dates in July 1996. If the put options sold in January 1996 were exercised, the Company would be obligated to pay $17.5 million to repurchase such shares.\nDuring 1994, Comcast UK Cable entered into foreign exchange forward contracts to protect Comcast UK Cable from the risk that monetary assets held or denominated in US dollars are devalued as a result of changes in exchange rates. The notional amount of these contracts was $20.0 million and $100.0 million as of December 31, 1995 and 1994, respectively. Foreign exchange forward contracts provide an effective hedge against such monetary assets held since gains and losses realized on the contracts, which were not significant to the Company's results of operations, are offset against gains or losses realized on the underlying hedged assets. The remaining forward contract matures during 1996.\nSee Note 5 for a description of certain foreign exchange option contracts entered into by Comcast UK Cable during 1995.\nMinimum annual rental commitments for office space and equipment under noncancellable operating leases as of December 31, 1995 are as follows:\n(Dollars in thousands)\n1996 $33,800 1997 29,230 1998 27,191 1999 25,336 2000 21,735 Thereafter 106,051\nRental expense of $44.6 million, $21.9 million and $19.3 million for 1995, 1994 and 1993, respectively, has been charged to operations.\nContingencies The Company is subject to claims which arise in the ordinary course of its business and other legal proceedings. In the opinion of management, the amount of ultimate liability with respect to these actions will not materially affect the financial position or results of operations of the Company.\nThe Company has settled the majority of outstanding proceedings challenging its rates charged for regulated cable services. In December 1995, the FCC adopted an order approving a negotiated settlement of rate complaints pending against the Company for cable programming service tiers (\"CPSTs\") which provided approximately $6.6 million in refunds, plus interest, being given in the form of bill credits, to approximately 1.3 million of the Company's cable subscribers. This FCC order resolved 160 of the Company's benchmark rate\n- 58 -\nCOMCAST CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (Continued)\ncases covering the period September 1993 through July 1994 and 104 of the Company's cost-of-service cases for CPSTs covering the period September 1993 through December 1995. As part of the negotiated settlement, the Company agreed to forego certain inflation and external cost adjustments for systems covered by its cost-of-service filings for CPSTs. The FCC's order has been appealed to a federal appellate court by a local franchising authority whose rate complaint against the Company was resolved by the negotiated settlement. The Company currently is seeking to justify rates for basic cable services and equipment in certain of its cable systems in the State of Connecticut on the basis of a cost-of-service showing. The State of Connecticut has ordered the Company to reduce such rates and to make refunds to subscribers. The Company has appealed the Connecticut decision to the FCC. The Company's management believes that the ultimate resolution of these pending regulatory matters will not have a material adverse impact on the Company's financial position or results of operations.\n10. DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe following summary table of the estimated fair value of the Company's financial instruments is made in accordance with the provisions of SFAS No. 107, \"Disclosures About Fair Value of Financial Instruments.\" See Note 2 for a description of methodologies used for such disclosures.\nThe Company's long-term debt had carrying amounts of $7.029 billion and $4.993 billion and estimated fair values of $7.074 billion and $4.828 billion as of December 31, 1995 and 1994, respectively. The estimated fair value of the Company's publicly traded debt is based on quoted market prices for that debt. Interest rates that are currently available to the Company for issuance of debt with similar terms and remaining maturities are used to estimate fair value for debt issues for which quoted market prices are not available.\nThe estimated liability to settle the Company's interest rate swap and cap agreements was $7.7 million and $39.0 million as of December 31, 1995 and 1994, respectively.\nThe differences between the carrying amounts and the estimated fair value of the Company's foreign exchange forward contracts and foreign exchange option contracts were not significant as of December 31, 1995 and 1994 (see Notes 5 and 9).\nThe difference between the proceeds received from the sale of put options on the Company's common stock (see Note 9) and the estimated fair value of such options was not significant as of December 31, 1995.\n- 59 -\nCOMCAST CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (Continued)\n11. FINANCIAL DATA BY BUSINESS SEGMENT\nThe following represents the Company's significant business segments, including: \"Domestic Cable Communications,\" the most significant of the Company's wired telecommunications operations; \"Electronic Retailing,\" the most significant of the Company's content businesses; and \"Cellular Communications,\" the most significant of the Company's wireless telecommunications operations. The remaining components of the Company's operations are not independently significant to the Company's consolidated financial position or results of operations and are included under the caption \"Corporate and Other\" (dollars in thousands).\n- 60 -\nCOMCAST CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1995, 1994 and 1993 (Concluded)\n12. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)\n- 61 -\nITEM 9","section_9":"ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable.\nPART III\nThe information called for by Item 10, Directors and Executive Officers of the Registrant (except for the information regarding executive officers called for by Item 401 of Regulation S-K which is included in Part I hereof as Item 4A in accordance with General Instruction G(3)), Item 11, Executive Compensation, Item 12, Security Ownership of Certain Beneficial Owners and Management, and Item 13, Certain Relationships and Related Transactions, is hereby incorporated by reference to the Registrant's definitive Proxy Statement for its Annual Meeting of Shareholders presently scheduled to be held in June 1996, which shall be filed with the Securities and Exchange Commission within 120 days of the end of the Registrant's latest fiscal year.\n- 62 -\nPART IV\nITEM 14 EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) The following consolidated financial statements of the Company are included in Part II, Item 8:\nIndependent Auditors' Report............................................37 Consolidated Balance Sheet--December 31, 1995 and 1994..................38 Consolidated Statement of Operations--Years Ended December 31, 1995, 1994 and 1993................................39 Consolidated Statement of Cash Flows--Years Ended December 31, 1995, 1994 and 1993................................40 Consolidated Statement of Stockholders' Deficiency--Years Ended December 31, 1995, 1994 and 1993..............41 Notes to Consolidated Financial Statements..............................42\n(b) (i) The following financial statement schedule required to be filed by Items 8 and 14(d) of Form 10-K is included in Part IV:\nSchedule II -- Valuation and Qualifying Accounts ...................73\nAll other schedules are omitted because they are not applicable, not required or the required information is included in the financial statements or notes thereto.\n(c) Exhibits required to be filed by Item 601 of Regulation S-K:\n2.1 Agreement and Plan of Merger by and among The E.W. Scripps Company, Scripps Howard, Inc., and Comcast Corporation dated as of October 28, 1995 (incorporated by reference to Exhibit 10.1 to Comcast Corporation's Current Report on Form 8-K filed on December 19, 1995).\n2.2 Voting Agreement by and among Comcast Corporation, The E.W. Scripps Company, Sural Corporation and The Edward W. Scripps Trust, dated as of October 28, 1995 (incorporated by reference to Exhibit 10.1 to Comcast Corporation's Current Report on Form 8-K filed on December 19, 1995).\n3.1(a) Amended and Restated Articles of Incorporation filed on July 24, 1990.\n3.1(b) Amendment to Articles of Incorporation filed on July 14, 1994.\n3.1(c) Amendment to Restated Articles of Incorporation filed on July 12, 1995.\n3.2 Amended and Restated By-Laws (incorporated by reference to Exhibit 3(ii) to the Company's Annual Report on Form 10-K for the year ended December 31, 1993).\n4.1 Specimen Class A Common Stock Certificate (incorporated by reference to Exhibit 2(a) to the Company's Registration Statement on Form S-7 filed with the Commission on September 17, 1980, File No. 2-69178).\n4.2 Specimen Class A Special Common Stock Certificate (incorporated by reference to Exhibit 4(2) to the Company's Annual Report on Form 10-K for the year ended December 31, 1986).\n4.3(a) Indenture (including form of Note), dated as of May 15, 1983, between Storer Communications, Inc. and The Chase Manhattan Bank, N.A., as Trustee, relating to 10% Subordinated Debentures due May 2003 of Storer Communications, Inc. (incorporated by reference to Exhibit 4.6 to the Registration Statement on Form S-1 (File No. 2-98938) of SCI Holdings, Inc.).\n4.3(b) First Supplemental Indenture, dated December 3, 1986 (incorporated by reference to Exhibit 4.5 to the Current Report on Form 8-K of Storer Communications, Inc. dated December 3, 1986).\n- 63 -\n4.4 Amended and Restated Indenture dated as of June 5, 1992 among Comcast Cellular Corporation, the Company and The Bank of New York, as Trustee, relating to $500,493,000 Series A Senior Participating Redeemable Zero Coupon Notes due 2000 and $500,493,000 Series B Senior Participating Redeemable Zero Coupon Notes due 2000 (incorporated by reference to Exhibit 4.3 to the Registration Statement on Form S-1 (File No. 33-46863) of Comcast Cellular Corporation).\n4.5 Indenture, dated as of October 17, 1991, between the Company and Morgan Guaranty Trust Company of New York, as Trustee (incorporated by reference to Exhibit 2 to the Company's Current Report on Form 8-K filed with the Commission on October 31, 1991).\n4.6 Form of Debenture relating to the Company's 10-1\/4% Senior Subordinated Debentures due 2001 (incorporated by reference to Exhibit 4(19) to the Company's Annual Report on Form 10-K for the year ended December 31, 1991).\n4.7 Form of Debenture relating to the Company's $300,000,000 10-5\/8% Senior Subordinated Debentures due 2012 (incorporated by reference to Exhibit 4(17) to the Company's Annual Report on Form 10-K for the year ended December 31, 1992).\n4.8 Form of Debenture relating to the Company's $200,000,000 9-1\/2% Senior Subordinated Debentures due 2008 (incorporated by reference to Exhibit 4(18) to the Company's Annual Report on Form 10-K for the year ended December 31, 1992).\n4.9 Indenture, dated as of February 20, 1991, between the Company and Bankers Trust Company, as Trustee (incorporated by reference to Exhibit 4.3 to the Company's Registration Statement on Form S-3, File No. 33-32830, filed with the Commission on January 11, 1990).\n4.10 Form of Debenture relating the Company's 3-3\/8% \/ 5-1\/2% Step-up Convertible Subordinated Debentures Due 2005 (incorporated by reference to Exhibit 4(14) to the Company's Annual Report on Form 10-K for the year ended December 31, 1993).\n4.11 Form of Debenture relating to the Company's 1-1\/8% Discount Convertible Subordinated Debentures Due 2007 (incorporated by reference to Exhibit 4 to the Company's Current Report on Form 8-K filed with the Commission on November 15, 1993).\n4.12 Form of Debenture relating to Comcast Corporation's $250.0 million 9-3\/8% Senior Subordinated Debentures due 2005 (incorporated by reference to Exhibit 4.1 to Comcast Corporation's Quarterly Report on Form 10-Q for the quarter ended June 30, 1995).\n4.13 Form of Debenture relating to Comcast Corporation's $250.0 million 9-1\/8% Senior Subordinated Debentures due 2006.\n4.14 Indenture dated as of November 15, 1995, between Comcast UK Cable Partners Limited and Bank of Montreal Trust Company, as Trustee, in respect of Comcast UK Cable Partners Limited's 11.20% Senior Discount Debentures due 2007 (incorporated by reference to Exhibit 4.1 to the Registration Statement on Form S-1 (File No. 33-96932) of Comcast UK Cable Partners Limited).\n4.14(a) Form of Debenture relating to Comcast Corporation's 11.20% Senior Discount Debentures due 2007 (incorporated by reference to Exhibit 4.2 to the Registration Statement on Form S-1 (File No. 33-96932) of Comcast UK Cable Partners Limited).\n- 64 -\n10.1\/*\/ Credit Agreement, dated as of September 14, 1995, between Comcast Cellular Communications, Inc., the banks listed therein, The Bank of New York, Barclays Bank PLC, The Chase Manhattan Bank, N.A., PNC Bank, National Association, and The Toronto-Dominion Bank, as Arranging Agents, and Toronto Dominion (Texas), Inc., as Administrative Agent.\n10.2\/*\/ Credit Agreement, dated as of September 19, 1995, between Comcast Holdings, Inc., the banks listed therein, The Chase Manhattan Bank, N.A., as Arranging Agent, Bank of Montreal, CIBC Inc., The Long-term Credit Bank of Japan, Limited, Royal Bank of Canada and Societe Generale, as Managing Agents, and The Chase Manhattan Bank, N.A., as Administrative Agent.\n10.3* 1982 Incentive Stock Option Plan, as amended (incorporated by reference to Exhibit 10(12) to the Company's Annual Report on Form 10-K for the year ended December 31, 1991).\n10.4(a)*1986 Amended and Restated Non-Qualified Stock Option Plan (incorporated by reference to Exhibit 10(11) to the Company's Annual Report on Form 10-K for the year ended December 31, 1991).\n10.4(b)*Amendment to 1986 Non-Qualified Stock Option Plan, dated September 16, 1994 (incorporated by reference to Exhibit 10.5(b) to Comcast Corporation's Annual Report on Form 10-K for the year ended December 31, 1994).\n10.5(a)*Comcast Corporation 1987 Stock Option Plan, as amended and restated (incorporated by reference to Exhibit 99 to the Company's Registration Statement on Form S-8 filed on December 16, 1994).\n10.5(b)*Amendment to 1987 Stock Option Plan, dated September 16, 1994 (incorporated by reference to Exhibit 10.6(b) to Comcast Corporation's Annual Report on Form 10-K for the year ended December 31, 1994).\n10.6 The Comcast Corporation Retirement-Investment Plan, as amended and restated effective January 1, 1993 (revised through September 30, 1995) (incorporated by reference to Exhibit 10.1 to Form S-8 of Comcast Corporation filed on October 5, 1995).\n10.7* Amended and Restated Deferred Compensation Plan, dated January 1, 1995 (incorporated by reference to Exhibit 10.8 to Comcast Corporation's Annual Report on Form 10-K for the year ended December 31, 1994).\n10.8* 1990 Restricted Stock Plan, as amended and restated effective December 13, 1995.\n10.9* 1992 Executive Split Dollar Insurance Plan (incorporated by reference to Exhibit 10(12) to the Company's Annual Report on Form 10-K for the year ended December 31, 1992).\n10.10* Form of Compensation and Deferred Compensation Agreement and Stock Appreciation Bonus Plan for Ralph J. Roberts (incorporated by reference to Exhibit 10(13) to the Company's Annual Report on Form 10-K for the year ended December 31, 1993).\n10.11 Defined Contribution Plans Master Trust Agreement, between Comcast Corporation and State Street Bank and Trust Company (incorporated by reference to Exhibit 10.2 to Form S-8 of Comcast Corporation filed on October 5, 1995).\n------------------\n* Constitutes a management contract or compensatory plan or arrangement.\n\/*\/ Pursuant to Item 601(b)(4)(iii)(A) of Regulation S-K, the Registrant agrees to furnish a copy of the referenced agreement to the Commission upon request.\n- 65 -\n10.12 Tax Sharing Agreement, dated as of December 2, 1992, among Storer Communications, Inc., TKR Cable I, Inc., TKR Cable II, Inc., TKR Cable III, Inc., Tele-Communications, Inc., the Company and each of the Departing Subsidiaries that are signatories thereto (incorporated by reference to Exhibit 4 to the Company's Current Report on Form 8-K filed with the Commission on December 17, 1992, as amended by Form 8 filed January 8, 1993).\n10.13(a)Credit Agreement, dated as of December 2, 1992, among Comcast Storer, Inc. and The Bank of New York, The Bank of Nova Scotia, Canadian Imperial Bank of Commerce, The Chase Manhattan Bank (National Association), Chemical Bank, LTCB Trust Company and The Toronto- Dominion Bank, as managing agents, and The Bank of New York, as administrative agent (incorporated by reference to Exhibit 5 to the Company's Current Report on Form 8-K filed with the Commission on December 17, 1992, as amended by Form 8 filed January 8, 1993).\n10.13(b)\/*\/ Amendment No. 1, dated as of November 30, 1994, to the Credit Agreement dated as of December 2, 1992, among Comcast Storer, Inc., the banks named therein and The Bank of New York, as administrative agent.\n10.13(c)\/*\/ Amendment No. 2, dated as of December 13, 1995, to the Credit Agreement dated as of December 2, 1992, as amended, among Comcast Storer, Inc., the banks named therein and The Bank of New York, as administrative agent.\n10.13(d)\/*\/ Amendment No. 3 and Waiver, dated as of February 29, 1996, to the Credit Agreement dated as of December 2, 1992, as amended, among Comcast Storer, Inc., the banks named therein and The Bank of New York, as administrative agent.\n10.14 Note Purchase Agreement, dated as of November 15, 1992, among Comcast Storer, Inc., Storer Communications, Inc., Comcast Storer Finance Sub, Inc. and each of the respective purchasers named therein (incorporated by reference to Exhibit 6 to the Company's Current Report on Form 8-K filed with the Commission on December 17, 1992, as amended by Form 8 filed January 8, 1993).\n10.15 Payment Agreement, dated December 2, 1992, among the Company, Comcast Storer, Inc., SCI Holdings, Inc., Storer Communications, Inc. and each of the Remaining Subsidiaries that are signatories thereto (incorporated by reference to Exhibit 7 to the Company's Current Report on Form 8-K filed with the Commission on December 17, 1992, as amended by Form 8 filed January 8, 1993).\n10.16 Intercreditor and Collateral Agency Agreement, dated as of December 2, 1992, among Comcast Storer, Inc., Comcast Cable Communications, Inc., Storer Communications, Inc., the banks party to the Credit Agreement dated as of December 2, 1992, the purchasers of the Senior Notes under the separate Note Purchase Agreements each dated as of November 15, 1992, the Senior Lenders (as defined therein) and The Bank of New York as collateral agent for the Senior Lenders (incorporated by reference to Exhibit 8 to the Company's Current Report on Form 8-K filed with the Commission on December 17, 1992, as amended by Form 8 filed January 8, 1993).\n10.17 Tax Sharing Agreement, dated December 2, 1992, between the Company and Comcast Storer, Inc. (incorporated by reference to Exhibit 9 to the Company's Current Report on Form 8-K filed with the Commission on December 17, 1992, as amended by Form 8 filed January 8, 1993).\n------------------\n\/*\/ Pursuant to Item 601(b)(4)(iii)(A) of Regulation S-K, the Registrant agrees to furnish a copy of the referenced agreement to the Commission upon request.\n- 66 -\n10.18 Pledge Agreement, dated as of December 2, 1992, between Comcast Cable Communications, Inc. and The Bank of New York (incorporated by reference to Exhibit 10 to the Company's Current Report on Form 8-K filed with the Commission on December 17, 1992, as amended by Form 8 filed January 8, 1993).\n10.19 Pledge Agreement, dated as of December 2, 1992, between Comcast Storer, Inc. and The Bank of New York (incorporated by reference to Exhibit 11 to the Company's Current Report on Form 8- K filed with the Commission on December 17, 1992, as amended by Form 8 filed January 8, 1993).\n10.20 Pledge Agreement, dated as of December 2, 1992, between Storer Communications, Inc. and The Bank of New York (incorporated by reference to Exhibit 12 to the Company's Current Report on Form 8-K filed with the Commission on December 17, 1992, as amended by Form 8 filed January 8, 1993).\n10.21 Note Pledge Agreement, dated as of December 2, 1992, between Comcast Storer, Inc. and The Bank of New York (incorporated by reference to Exhibit 13 to the Company's Current Report on Form 8-K filed with the Commission on December 17, 1992, as amended by Form 8 filed January 8, 1993).\n10.22 Guaranty Agreement, dated as of December 2, 1992, between Storer Communications, Inc. and The Bank of New York (incorporated by reference to Exhibit 14 to the Company's Current Report on Form 8-K filed with the Commission on December 17, 1992, as amended by Form 8 filed January 8, 1993).\n10.23 Guaranty Agreement, dated as of December 2, 1992, between Comcast Storer Finance Sub, Inc. and The Bank of New York (incorporated by reference to Exhibit 15 to the Company's Current Report on Form 8-K filed with the Commission on December 17, 1992, as amended by Form 8 filed January 8, 1993).\n10.24(a)Stock Purchase Agreement, dated September 14, 1992, among the Company, Comcast FCI, Inc. and Fleet Call, Inc. (incorporated by reference to Exhibit A to Amendment No. 1 to the Company's Schedule 13D dated September 22, 1992 filed with respect to Fleet Call, Inc.).\n10.24(b)Letter Agreement, dated October 28, 1992, amending Stock Purchase Agreement (incorporated by reference to Exhibit L to Amendment No. 2 to the Company's Schedule 13D dated February 23, 1993 filed with respect to Fleet Call, Inc.).\n10.24(c)Letter Agreement, dated November 24, 1992, amending Stock Purchase Agreement (incorporated by reference to Exhibit M to Amendment No. 2 to the Company's Schedule 13D dated February 23, 1993 filed with respect to Fleet Call, Inc.).\n10.24(d)Notice, dated February 15, 1993, from Fleet Call, Inc. to the Company pursuant to the Stock Purchase Agreement (incorporated by reference to Exhibit N to Amendment No. 2 to the Company's Schedule 13D dated February 23, 1993 filed with respect to Fleet Call, Inc.).\n10.24(e)Acknowledgement, dated February 15, 1993, among the Company, Comcast FCI, Inc. and Fleet Call, Inc. (incorporated by reference to Exhibit O to Amendment No. 2 to the Company's Schedule 13D dated February 23, 1993 filed with respect to Fleet Call, Inc.).\n10.24(f)Letter Agreement, dated February 15, 1993, amending the Stock Purchase Agreement (incorporated by reference to Exhibit P to Amendment No. 2 to the Company's Schedule 13D dated February 23, 1993 filed with respect to Fleet Call, Inc.).\n- 67 -\n10.24(g)Letter Agreement, dated July 22, 1993, among the Company, Comcast FCI, Inc. and Nextel Communications, Inc. (formerly Fleet Call, Inc.) (incorporated by reference to Exhibit A to Amendment No. 3 to Schedule 13D dated July 27, 1993 filed by the Company with respect to Nextel Communications, Inc.).\n10.24(h)Amendment, dated August 4, 1994, to Stock Purchase Agreement dated as of September 14, 1992 among Comcast Corporation, Comcast FCI, Inc. and Nextel Communications, Inc. (incorporated by reference to Exhibit C to Amendment No. 7 to the Schedule 13D of Comcast Corporation relating to common stock of Nextel Communications, Inc. filed on August 9, 1994).\n10.24(i)Amendment to Stock Purchase Agreement between Comcast Corporation, Comcast FCI, Inc. and Nextel Communications, Inc., dated as of April 3, 1995 (incorporated by reference to Exhibit 5.4 to Comcast Corporation's Current Report on Form 8-K filed on April 13, 1995).\n10.25 Option Agreement, dated September 14, 1992, between Fleet Call, Inc. and Comcast FCI, Inc. (incorporated by reference to Exhibit B to Amendment No. 1 to the Company's Schedule 13D dated September 22, 1992 filed with respect to Fleet Call, Inc.).\n10.26 Stockholders' Voting Agreement, dated September 14, 1992, among Comcast FCI, Inc. and the other parties named therein (incorporated by reference to Exhibit E to Amendment No. 1 to the Company's Schedule 13D dated September 22, 1992 filed with respect to Fleet Call, Inc.).\n10.27(a)Share Purchase Agreement, dated June 18, 1994, between Comcast Corporation and Rogers Communications Inc. (incorporated by reference to Exhibit 10(3) to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1994).\n10.27(b)First Amendment to Share Purchase Agreement, dated as of December 22, 1994, by and between Comcast Corporation and Rogers Communications Inc., to the Share Purchase Agreement dated June 18, 1994 (incorporated by reference to Exhibit 10.9 to the Company's Current Report on Form 8-K filed on January 6, 1995).\n10.28(a)Agreement and Plan of Merger, dated August 4, 1994, among Comcast Corporation, Liberty Media Corporation, Comcast QMerger, Inc. and QVC, Inc. (incorporated by reference to Exhibit 99.49 to Amendment No. 21 to the Schedule 13D of Comcast Corporation relating to common stock of QVC, Inc. filed on August 8, 1994).\n10.28(b)First Amendment to Agreement and Plan of Merger, dated as of February 3, 1995, (incorporated by reference to Exhibit (c)(35) to Amendment No. 17 to the Tender Offer Statement on Schedule 14D-1 filed with the Securities and Exchange Commission on February 6, 1995 by QVC Programming Holdings, Inc., Comcast Corporation and Tele-Communications, Inc. with respect to the tender offer for all outstanding shares of QVC, Inc.).\n10.29 Amended and Restated Stockholders Agreement, dated as of February 9, 1995, among Comcast Corporation, Comcast QVC, Inc., QVC Programming Holdings, Inc., Liberty Media Corporation, QVC Investment, Inc. and Liberty QVC, Inc. (incorporated by reference to Exhibit 10.5 to Comcast Corporation's Quarterly Report on Form 10-Q for the quarter ended March 31, 1995).\n10.30 Credit Agreement, dated as of February 15, 1995, among QVC, Inc. and the Banks listed therein (incorporated by reference to Exhibit (b)(6) to Amendment No. 21 to the Tender Offer Statement on Schedule 14D-1 filed with the Securities and Exchange Commission on February 17, 1995 by QVC Programming Holdings, Inc., Comcast Corporation and Tele-Communications, Inc. with respect to the tender offer for all outstanding shares of QVC, Inc.).\n- 68 -\n10.31 Credit Agreement, dated as of September 14, 1994, among Comcast Cable Tri-Holdings, Inc., The Bank of New York, The Chase Manhattan Bank (National Association), PNC Bank, National Association, as Managing Agents, and the Bank of New York, as Administrative Agent, and the banks named therein (incorporated by reference to Exhibit 10.3 to the Current Report on Form 8- K of the Company filed on November 2, 1994).\n10.32 Comcast MHCP Holdings, L.L.C. Amended and Restated Limited Liability Company Agreement, dated as of December 18, 1994, among Comcast Cable Communications, Inc., The California Public Employees' Retirement System and, for certain limited purposes, Comcast Corporation (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed on January 6, 1995).\n10.33 Credit Agreement, dated as of December 22, 1994, among Comcast MH Holdings, Inc., the banks listed therein, The Chase Manhattan Bank (National Association), NationsBank of Texas, N.A. and the Toronto-Dominion Bank, as Arranging Agents, The Bank of New York, The Bank of Nova Scotia, Canadian Imperial Bank of Commerce and Morgan Guaranty Trust Company of New York, as Managing Agents and NationsBank of Texas, N.A., as Administrative Agent (incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K filed on January 6, 1995).\n10.34 Pledge Agreement, dated as of December 22, 1994, between Comcast MH Holdings, Inc. and NationsBank of Texas, N.A., as the secured party (incorporated by reference to Exhibit 10.3 to the Company's Current Report on Form 8-K filed on January 6, 1995).\n10.35 Pledge Agreement, dated as of December 22, 1994, between Comcast Communications Properties, Inc. and NationsBank of Texas, N.A., as the Secured Party (incorporated by reference to Exhibit 10.4 to the Company's Current Report on Form 8-K filed on January 6, 1995).\n10.36 Affiliate Subordination Agreement (as the same may be amended, modified, supplemented, waived, extended or restated from time to time, this \"Agreement\"), dated as of December 22, 1994, among Comcast Corporation, Comcast MH Holdings, Inc., (the \"Borrower\"), any affiliate of the Borrower that shall have become a party thereto and NationsBank of Texas, N.A., as Administrative Agent under the Credit Agreement dated as of December 22, 1994, among the Borrower, the Banks listed therein, The Chase Manhattan Bank (National Association), NationsBank of Texas, N.A. and The Toronto-Dominion Bank, as Arranging Agents, The Bank of New York, The Bank of Nova Scotia, Canadian Imperial Bank of Commerce and Morgan Guaranty Trust Company of New York, as Managing Agents, and the Administrative Agent (incorporated by reference to Exhibit 10.5 to the Company's Current Report on Form 8-K filed on January 6, 1995).\n10.37 Registration Rights and Price Protection Agreement, dated as of December 22, 1994, by and between Comcast Corporation and The California Public Employees' Retirement System (incorporated by reference to Exhibit 10.8 to the Company's Current Report on Form 8-K filed on January 6, 1995).\n10.38 Amended and Restated Agreement of Limited Partnership of MajorCo, L.P., a Delaware Limited Partnership, dated as of January 31, 1996, among Sprint Spectrum, L.P., TCI Network Services, Comcast Telephony Services and Cox Telephony Partnership (incorporated by reference to Exhibit 1 to Comcast Corporation's Current Report on Form 8-K filed on February 12, 1996).\n10.39 Parents Agreement, dated as of January 31, 1996, between Comcast Corporation and Sprint Corporation (incorporated by reference to Exhibit 3 to Comcast Corporation's Current Report on Form 8-K filed on February 12, 1996).\n- 69 -\n10.40 Agreement of Limited Partnership of MinorCo, L.P., a Delaware Limited Partnership, dated as of March 28, 1995, among Sprint Spectrum, L.P., TCI Network Services, Comcast Telephony Services and Cox Telephony Partnership (incorporated by reference to Exhibit 5.3 to Comcast Corporation's Current Report on Form 8-K filed on April 13, 1995).\n21 List of Subsidiaries.\n23.1 Consent of Deloitte & Touche LLP\n23.2 Consents of Arthur Andersen LLP\n23.3 Consent of KPMG Peat Marwick LLP\n27 Financial Data Schedule.\n99.1 Report of Independent Public Accountants to QVC, Inc., as of December 31, 1995 and for the eleven-month period then ended.\n99.2 Report of Independent Public Accountants to Garden State Cablevision L.P., as of December 31, 1994 and 1993 and for the years then ended.\n99.3 Report of Independent Public Accountants to Comcast International Holdings, Inc., as of December 31, 1994 and 1993 and for the years then ended (incorporated by reference to Exhibit 99.3 to Comcast Corporation's Annual Report on Form 10-K for the year ended December 31, 1994).\n(c) Reports on Form 8-K\n(i) Comcast Corporation filed a Current Report on Form 8-K under Item 5 on November 7, 1995 relating its October 29, 1995 announcement of its agreement to purchase the cable television operations of The E.W. Scripps Company.\n(ii) Comcast Corporation filed a Current Report on Form 8-K under Item 5 on December 19, 1995 relating its agreement to purchase the cable television operations of The E.W. Scripps Company, which included Comcast Corporation's Unaudited Pro Forma Condensed Consolidated Financial Statements and the Combined Financial Statements of The E.W. Scripps Company Cable Television Division.\n- 70 -\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized in Philadelphia, Pennsylvania on March 1, 1996.\nComcast Corporation\nBy: \/s\/ Brian L. Roberts --------------------------------- Brian L. Roberts President and Director\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\n- 71 -\n- 72 -\nCOMCAST CORPORATION AND SUBSIDIARIES\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n(Dollars in thousands)\n- 73 -\nINDEX TO EXHIBITS Exhibit Number Exhibit\n3.1(a) Amended and Restated Articles of Incorporation filed on July 24, 1990.\n3.1(b) Amendment to Articles of Incorporation filed on July 14, 1994.\n3.1(c) Amendment to Restated Articles of Incorporation filed on July 12, 1995.\n4.13 Form of Debenture relating to Comcast Corporation's $250.0 million 9-1\/8% Senior Subordinated Debentures due 2006.\n10.1\/*\/ Credit Agreement, dated as of September 14, 1995, between Comcast Cellular Communications, Inc., the banks listed therein, The Bank of New York, Barclays Bank PLC, The Chase Manhattan Bank, N.A., PNC Bank, National Association, and The Toronto-Dominion Bank, as Arranging Agents, and Toronto Dominion (Texas), Inc., as Administrative Agent.\n10.2\/*\/ Credit Agreement, dated as of September 19, 1995, between Comcast Holdings, Inc., the banks listed therein, The Chase Manhattan Bank, N.A., as Arranging Agent, Bank of Montreal, CIBC Inc., The Long-term Credit Bank of Japan, Limited, Royal Bank of Canada and Societe Generale, as Managing Agents, and The Chase Manhattan Bank, N.A., as Administrative Agent.\n10.8* 1990 Restricted Stock Plan, as amended and restated effective December 13, 1995.\n10.13(b)\/*\/ Amendment No. 1, dated as of November 30, 1994, to the Credit Agreement dated as of December 2, 1992, among Comcast Storer, Inc., the banks named therein and The Bank of New York, as administrative agent.\n10.13(c)\/*\/ Amendment No. 2, dated as of December 13, 1995, to the Credit Agreement dated as of December 2, 1992, as amended, among Comcast Storer, Inc., the banks named therein and The Bank of New York, as administrative agent.\n10.13(d)\/*\/ Amendment No. 3 and Waiver, dated as of February 29, 1996, to the Credit Agreement dated as of December 2, 1992, as amended, among Comcast Storer, Inc., the banks named therein and The Bank of New York, as administrative agent.\n21 List of Subsidiaries.\n23.1 Consent of Deloitte & Touche LLP\n23.2 Consents of Arthur Andersen LLP\n23.3 Consent of KPMG Peat Marwick LLP\n27 Financial Data Schedule.\n99.1 Report of Independent Public Accountants to QVC, Inc., as of December 31, 1995 and for the eleven-month period then ended.\n99.2 Report of Independent Public Accountants to Garden State Cablevision L.P., as of December 31, 1994 and 1993 and for the years then ended.\n- --------------\n* Constitutes a management contract or compensatory plan or arrangement.\n\/*\/ Pursuant to Item 601(b)(4)(iii)(A) of Regulation S-K, the Registrant agrees to furnish a copy of the referenced agreement to the Commission upon request\n- 74 -","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"ITEM 14 EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) The following consolidated financial statements of the Company are included in Part II, Item 8:\nIndependent Auditors' Report............................................37 Consolidated Balance Sheet--December 31, 1995 and 1994..................38 Consolidated Statement of Operations--Years Ended December 31, 1995, 1994 and 1993................................39 Consolidated Statement of Cash Flows--Years Ended December 31, 1995, 1994 and 1993................................40 Consolidated Statement of Stockholders' Deficiency--Years Ended December 31, 1995, 1994 and 1993..............41 Notes to Consolidated Financial Statements..............................42\n(b) (i) The following financial statement schedule required to be filed by Items 8 and 14(d) of Form 10-K is included in Part IV:\nSchedule II -- Valuation and Qualifying Accounts ...................73\nAll other schedules are omitted because they are not applicable, not required or the required information is included in the financial statements or notes thereto.\n(c) Exhibits required to be filed by Item 601 of Regulation S-K:\n2.1 Agreement and Plan of Merger by and among The E.W. Scripps Company, Scripps Howard, Inc., and Comcast Corporation dated as of October 28, 1995 (incorporated by reference to Exhibit 10.1 to Comcast Corporation's Current Report on Form 8-K filed on December 19, 1995).\n2.2 Voting Agreement by and among Comcast Corporation, The E.W. Scripps Company, Sural Corporation and The Edward W. Scripps Trust, dated as of October 28, 1995 (incorporated by reference to Exhibit 10.1 to Comcast Corporation's Current Report on Form 8-K filed on December 19, 1995).\n3.1(a) Amended and Restated Articles of Incorporation filed on July 24, 1990.\n3.1(b) Amendment to Articles of Incorporation filed on July 14, 1994.\n3.1(c) Amendment to Restated Articles of Incorporation filed on July 12, 1995.\n3.2 Amended and Restated By-Laws (incorporated by reference to Exhibit 3(ii) to the Company's Annual Report on Form 10-K for the year ended December 31, 1993).\n4.1 Specimen Class A Common Stock Certificate (incorporated by reference to Exhibit 2(a) to the Company's Registration Statement on Form S-7 filed with the Commission on September 17, 1980, File No. 2-69178).\n4.2 Specimen Class A Special Common Stock Certificate (incorporated by reference to Exhibit 4(2) to the Company's Annual Report on Form 10-K for the year ended December 31, 1986).\n4.3(a) Indenture (including form of Note), dated as of May 15, 1983, between Storer Communications, Inc. and The Chase Manhattan Bank, N.A., as Trustee, relating to 10% Subordinated Debentures due May 2003 of Storer Communications, Inc. (incorporated by reference to Exhibit 4.6 to the Registration Statement on Form S-1 (File No. 2-98938) of SCI Holdings, Inc.).\n4.3(b) First Supplemental Indenture, dated December 3, 1986 (incorporated by reference to Exhibit 4.5 to the Current Report on Form 8-K of Storer Communications, Inc. dated December 3, 1986).\n- 63 -\n4.4 Amended and Restated Indenture dated as of June 5, 1992 among Comcast Cellular Corporation, the Company and The Bank of New York, as Trustee, relating to $500,493,000 Series A Senior Participating Redeemable Zero Coupon Notes due 2000 and $500,493,000 Series B Senior Participating Redeemable Zero Coupon Notes due 2000 (incorporated by reference to Exhibit 4.3 to the Registration Statement on Form S-1 (File No. 33-46863) of Comcast Cellular Corporation).\n4.5 Indenture, dated as of October 17, 1991, between the Company and Morgan Guaranty Trust Company of New York, as Trustee (incorporated by reference to Exhibit 2 to the Company's Current Report on Form 8-K filed with the Commission on October 31, 1991).\n4.6 Form of Debenture relating to the Company's 10-1\/4% Senior Subordinated Debentures due 2001 (incorporated by reference to Exhibit 4(19) to the Company's Annual Report on Form 10-K for the year ended December 31, 1991).\n4.7 Form of Debenture relating to the Company's $300,000,000 10-5\/8% Senior Subordinated Debentures due 2012 (incorporated by reference to Exhibit 4(17) to the Company's Annual Report on Form 10-K for the year ended December 31, 1992).\n4.8 Form of Debenture relating to the Company's $200,000,000 9-1\/2% Senior Subordinated Debentures due 2008 (incorporated by reference to Exhibit 4(18) to the Company's Annual Report on Form 10-K for the year ended December 31, 1992).\n4.9 Indenture, dated as of February 20, 1991, between the Company and Bankers Trust Company, as Trustee (incorporated by reference to Exhibit 4.3 to the Company's Registration Statement on Form S-3, File No. 33-32830, filed with the Commission on January 11, 1990).\n4.10 Form of Debenture relating the Company's 3-3\/8% \/ 5-1\/2% Step-up Convertible Subordinated Debentures Due 2005 (incorporated by reference to Exhibit 4(14) to the Company's Annual Report on Form 10-K for the year ended December 31, 1993).\n4.11 Form of Debenture relating to the Company's 1-1\/8% Discount Convertible Subordinated Debentures Due 2007 (incorporated by reference to Exhibit 4 to the Company's Current Report on Form 8-K filed with the Commission on November 15, 1993).\n4.12 Form of Debenture relating to Comcast Corporation's $250.0 million 9-3\/8% Senior Subordinated Debentures due 2005 (incorporated by reference to Exhibit 4.1 to Comcast Corporation's Quarterly Report on Form 10-Q for the quarter ended June 30, 1995).\n4.13 Form of Debenture relating to Comcast Corporation's $250.0 million 9-1\/8% Senior Subordinated Debentures due 2006.\n4.14 Indenture dated as of November 15, 1995, between Comcast UK Cable Partners Limited and Bank of Montreal Trust Company, as Trustee, in respect of Comcast UK Cable Partners Limited's 11.20% Senior Discount Debentures due 2007 (incorporated by reference to Exhibit 4.1 to the Registration Statement on Form S-1 (File No. 33-96932) of Comcast UK Cable Partners Limited).\n4.14(a) Form of Debenture relating to Comcast Corporation's 11.20% Senior Discount Debentures due 2007 (incorporated by reference to Exhibit 4.2 to the Registration Statement on Form S-1 (File No. 33-96932) of Comcast UK Cable Partners Limited).\n- 64 -\n10.1\/*\/ Credit Agreement, dated as of September 14, 1995, between Comcast Cellular Communications, Inc., the banks listed therein, The Bank of New York, Barclays Bank PLC, The Chase Manhattan Bank, N.A., PNC Bank, National Association, and The Toronto-Dominion Bank, as Arranging Agents, and Toronto Dominion (Texas), Inc., as Administrative Agent.\n10.2\/*\/ Credit Agreement, dated as of September 19, 1995, between Comcast Holdings, Inc., the banks listed therein, The Chase Manhattan Bank, N.A., as Arranging Agent, Bank of Montreal, CIBC Inc., The Long-term Credit Bank of Japan, Limited, Royal Bank of Canada and Societe Generale, as Managing Agents, and The Chase Manhattan Bank, N.A., as Administrative Agent.\n10.3* 1982 Incentive Stock Option Plan, as amended (incorporated by reference to Exhibit 10(12) to the Company's Annual Report on Form 10-K for the year ended December 31, 1991).\n10.4(a)*1986 Amended and Restated Non-Qualified Stock Option Plan (incorporated by reference to Exhibit 10(11) to the Company's Annual Report on Form 10-K for the year ended December 31, 1991).\n10.4(b)*Amendment to 1986 Non-Qualified Stock Option Plan, dated September 16, 1994 (incorporated by reference to Exhibit 10.5(b) to Comcast Corporation's Annual Report on Form 10-K for the year ended December 31, 1994).\n10.5(a)*Comcast Corporation 1987 Stock Option Plan, as amended and restated (incorporated by reference to Exhibit 99 to the Company's Registration Statement on Form S-8 filed on December 16, 1994).\n10.5(b)*Amendment to 1987 Stock Option Plan, dated September 16, 1994 (incorporated by reference to Exhibit 10.6(b) to Comcast Corporation's Annual Report on Form 10-K for the year ended December 31, 1994).\n10.6 The Comcast Corporation Retirement-Investment Plan, as amended and restated effective January 1, 1993 (revised through September 30, 1995) (incorporated by reference to Exhibit 10.1 to Form S-8 of Comcast Corporation filed on October 5, 1995).\n10.7* Amended and Restated Deferred Compensation Plan, dated January 1, 1995 (incorporated by reference to Exhibit 10.8 to Comcast Corporation's Annual Report on Form 10-K for the year ended December 31, 1994).\n10.8* 1990 Restricted Stock Plan, as amended and restated effective December 13, 1995.\n10.9* 1992 Executive Split Dollar Insurance Plan (incorporated by reference to Exhibit 10(12) to the Company's Annual Report on Form 10-K for the year ended December 31, 1992).\n10.10* Form of Compensation and Deferred Compensation Agreement and Stock Appreciation Bonus Plan for Ralph J. Roberts (incorporated by reference to Exhibit 10(13) to the Company's Annual Report on Form 10-K for the year ended December 31, 1993).\n10.11 Defined Contribution Plans Master Trust Agreement, between Comcast Corporation and State Street Bank and Trust Company (incorporated by reference to Exhibit 10.2 to Form S-8 of Comcast Corporation filed on October 5, 1995).\n------------------\n* Constitutes a management contract or compensatory plan or arrangement.\n\/*\/ Pursuant to Item 601(b)(4)(iii)(A) of Regulation S-K, the Registrant agrees to furnish a copy of the referenced agreement to the Commission upon request.\n- 65 -\n10.12 Tax Sharing Agreement, dated as of December 2, 1992, among Storer Communications, Inc., TKR Cable I, Inc., TKR Cable II, Inc., TKR Cable III, Inc., Tele-Communications, Inc., the Company and each of the Departing Subsidiaries that are signatories thereto (incorporated by reference to Exhibit 4 to the Company's Current Report on Form 8-K filed with the Commission on December 17, 1992, as amended by Form 8 filed January 8, 1993).\n10.13(a)Credit Agreement, dated as of December 2, 1992, among Comcast Storer, Inc. and The Bank of New York, The Bank of Nova Scotia, Canadian Imperial Bank of Commerce, The Chase Manhattan Bank (National Association), Chemical Bank, LTCB Trust Company and The Toronto- Dominion Bank, as managing agents, and The Bank of New York, as administrative agent (incorporated by reference to Exhibit 5 to the Company's Current Report on Form 8-K filed with the Commission on December 17, 1992, as amended by Form 8 filed January 8, 1993).\n10.13(b)\/*\/ Amendment No. 1, dated as of November 30, 1994, to the Credit Agreement dated as of December 2, 1992, among Comcast Storer, Inc., the banks named therein and The Bank of New York, as administrative agent.\n10.13(c)\/*\/ Amendment No. 2, dated as of December 13, 1995, to the Credit Agreement dated as of December 2, 1992, as amended, among Comcast Storer, Inc., the banks named therein and The Bank of New York, as administrative agent.\n10.13(d)\/*\/ Amendment No. 3 and Waiver, dated as of February 29, 1996, to the Credit Agreement dated as of December 2, 1992, as amended, among Comcast Storer, Inc., the banks named therein and The Bank of New York, as administrative agent.\n10.14 Note Purchase Agreement, dated as of November 15, 1992, among Comcast Storer, Inc., Storer Communications, Inc., Comcast Storer Finance Sub, Inc. and each of the respective purchasers named therein (incorporated by reference to Exhibit 6 to the Company's Current Report on Form 8-K filed with the Commission on December 17, 1992, as amended by Form 8 filed January 8, 1993).\n10.15 Payment Agreement, dated December 2, 1992, among the Company, Comcast Storer, Inc., SCI Holdings, Inc., Storer Communications, Inc. and each of the Remaining Subsidiaries that are signatories thereto (incorporated by reference to Exhibit 7 to the Company's Current Report on Form 8-K filed with the Commission on December 17, 1992, as amended by Form 8 filed January 8, 1993).\n10.16 Intercreditor and Collateral Agency Agreement, dated as of December 2, 1992, among Comcast Storer, Inc., Comcast Cable Communications, Inc., Storer Communications, Inc., the banks party to the Credit Agreement dated as of December 2, 1992, the purchasers of the Senior Notes under the separate Note Purchase Agreements each dated as of November 15, 1992, the Senior Lenders (as defined therein) and The Bank of New York as collateral agent for the Senior Lenders (incorporated by reference to Exhibit 8 to the Company's Current Report on Form 8-K filed with the Commission on December 17, 1992, as amended by Form 8 filed January 8, 1993).\n10.17 Tax Sharing Agreement, dated December 2, 1992, between the Company and Comcast Storer, Inc. (incorporated by reference to Exhibit 9 to the Company's Current Report on Form 8-K filed with the Commission on December 17, 1992, as amended by Form 8 filed January 8, 1993).\n------------------\n\/*\/ Pursuant to Item 601(b)(4)(iii)(A) of Regulation S-K, the Registrant agrees to furnish a copy of the referenced agreement to the Commission upon request.\n- 66 -\n10.18 Pledge Agreement, dated as of December 2, 1992, between Comcast Cable Communications, Inc. and The Bank of New York (incorporated by reference to Exhibit 10 to the Company's Current Report on Form 8-K filed with the Commission on December 17, 1992, as amended by Form 8 filed January 8, 1993).\n10.19 Pledge Agreement, dated as of December 2, 1992, between Comcast Storer, Inc. and The Bank of New York (incorporated by reference to Exhibit 11 to the Company's Current Report on Form 8- K filed with the Commission on December 17, 1992, as amended by Form 8 filed January 8, 1993).\n10.20 Pledge Agreement, dated as of December 2, 1992, between Storer Communications, Inc. and The Bank of New York (incorporated by reference to Exhibit 12 to the Company's Current Report on Form 8-K filed with the Commission on December 17, 1992, as amended by Form 8 filed January 8, 1993).\n10.21 Note Pledge Agreement, dated as of December 2, 1992, between Comcast Storer, Inc. and The Bank of New York (incorporated by reference to Exhibit 13 to the Company's Current Report on Form 8-K filed with the Commission on December 17, 1992, as amended by Form 8 filed January 8, 1993).\n10.22 Guaranty Agreement, dated as of December 2, 1992, between Storer Communications, Inc. and The Bank of New York (incorporated by reference to Exhibit 14 to the Company's Current Report on Form 8-K filed with the Commission on December 17, 1992, as amended by Form 8 filed January 8, 1993).\n10.23 Guaranty Agreement, dated as of December 2, 1992, between Comcast Storer Finance Sub, Inc. and The Bank of New York (incorporated by reference to Exhibit 15 to the Company's Current Report on Form 8-K filed with the Commission on December 17, 1992, as amended by Form 8 filed January 8, 1993).\n10.24(a)Stock Purchase Agreement, dated September 14, 1992, among the Company, Comcast FCI, Inc. and Fleet Call, Inc. (incorporated by reference to Exhibit A to Amendment No. 1 to the Company's Schedule 13D dated September 22, 1992 filed with respect to Fleet Call, Inc.).\n10.24(b)Letter Agreement, dated October 28, 1992, amending Stock Purchase Agreement (incorporated by reference to Exhibit L to Amendment No. 2 to the Company's Schedule 13D dated February 23, 1993 filed with respect to Fleet Call, Inc.).\n10.24(c)Letter Agreement, dated November 24, 1992, amending Stock Purchase Agreement (incorporated by reference to Exhibit M to Amendment No. 2 to the Company's Schedule 13D dated February 23, 1993 filed with respect to Fleet Call, Inc.).\n10.24(d)Notice, dated February 15, 1993, from Fleet Call, Inc. to the Company pursuant to the Stock Purchase Agreement (incorporated by reference to Exhibit N to Amendment No. 2 to the Company's Schedule 13D dated February 23, 1993 filed with respect to Fleet Call, Inc.).\n10.24(e)Acknowledgement, dated February 15, 1993, among the Company, Comcast FCI, Inc. and Fleet Call, Inc. (incorporated by reference to Exhibit O to Amendment No. 2 to the Company's Schedule 13D dated February 23, 1993 filed with respect to Fleet Call, Inc.).\n10.24(f)Letter Agreement, dated February 15, 1993, amending the Stock Purchase Agreement (incorporated by reference to Exhibit P to Amendment No. 2 to the Company's Schedule 13D dated February 23, 1993 filed with respect to Fleet Call, Inc.).\n- 67 -\n10.24(g)Letter Agreement, dated July 22, 1993, among the Company, Comcast FCI, Inc. and Nextel Communications, Inc. (formerly Fleet Call, Inc.) (incorporated by reference to Exhibit A to Amendment No. 3 to Schedule 13D dated July 27, 1993 filed by the Company with respect to Nextel Communications, Inc.).\n10.24(h)Amendment, dated August 4, 1994, to Stock Purchase Agreement dated as of September 14, 1992 among Comcast Corporation, Comcast FCI, Inc. and Nextel Communications, Inc. (incorporated by reference to Exhibit C to Amendment No. 7 to the Schedule 13D of Comcast Corporation relating to common stock of Nextel Communications, Inc. filed on August 9, 1994).\n10.24(i)Amendment to Stock Purchase Agreement between Comcast Corporation, Comcast FCI, Inc. and Nextel Communications, Inc., dated as of April 3, 1995 (incorporated by reference to Exhibit 5.4 to Comcast Corporation's Current Report on Form 8-K filed on April 13, 1995).\n10.25 Option Agreement, dated September 14, 1992, between Fleet Call, Inc. and Comcast FCI, Inc. (incorporated by reference to Exhibit B to Amendment No. 1 to the Company's Schedule 13D dated September 22, 1992 filed with respect to Fleet Call, Inc.).\n10.26 Stockholders' Voting Agreement, dated September 14, 1992, among Comcast FCI, Inc. and the other parties named therein (incorporated by reference to Exhibit E to Amendment No. 1 to the Company's Schedule 13D dated September 22, 1992 filed with respect to Fleet Call, Inc.).\n10.27(a)Share Purchase Agreement, dated June 18, 1994, between Comcast Corporation and Rogers Communications Inc. (incorporated by reference to Exhibit 10(3) to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1994).\n10.27(b)First Amendment to Share Purchase Agreement, dated as of December 22, 1994, by and between Comcast Corporation and Rogers Communications Inc., to the Share Purchase Agreement dated June 18, 1994 (incorporated by reference to Exhibit 10.9 to the Company's Current Report on Form 8-K filed on January 6, 1995).\n10.28(a)Agreement and Plan of Merger, dated August 4, 1994, among Comcast Corporation, Liberty Media Corporation, Comcast QMerger, Inc. and QVC, Inc. (incorporated by reference to Exhibit 99.49 to Amendment No. 21 to the Schedule 13D of Comcast Corporation relating to common stock of QVC, Inc. filed on August 8, 1994).\n10.28(b)First Amendment to Agreement and Plan of Merger, dated as of February 3, 1995, (incorporated by reference to Exhibit (c)(35) to Amendment No. 17 to the Tender Offer Statement on Schedule 14D-1 filed with the Securities and Exchange Commission on February 6, 1995 by QVC Programming Holdings, Inc., Comcast Corporation and Tele-Communications, Inc. with respect to the tender offer for all outstanding shares of QVC, Inc.).\n10.29 Amended and Restated Stockholders Agreement, dated as of February 9, 1995, among Comcast Corporation, Comcast QVC, Inc., QVC Programming Holdings, Inc., Liberty Media Corporation, QVC Investment, Inc. and Liberty QVC, Inc. (incorporated by reference to Exhibit 10.5 to Comcast Corporation's Quarterly Report on Form 10-Q for the quarter ended March 31, 1995).\n10.30 Credit Agreement, dated as of February 15, 1995, among QVC, Inc. and the Banks listed therein (incorporated by reference to Exhibit (b)(6) to Amendment No. 21 to the Tender Offer Statement on Schedule 14D-1 filed with the Securities and Exchange Commission on February 17, 1995 by QVC Programming Holdings, Inc., Comcast Corporation and Tele-Communications, Inc. with respect to the tender offer for all outstanding shares of QVC, Inc.).\n- 68 -\n10.31 Credit Agreement, dated as of September 14, 1994, among Comcast Cable Tri-Holdings, Inc., The Bank of New York, The Chase Manhattan Bank (National Association), PNC Bank, National Association, as Managing Agents, and the Bank of New York, as Administrative Agent, and the banks named therein (incorporated by reference to Exhibit 10.3 to the Current Report on Form 8- K of the Company filed on November 2, 1994).\n10.32 Comcast MHCP Holdings, L.L.C. Amended and Restated Limited Liability Company Agreement, dated as of December 18, 1994, among Comcast Cable Communications, Inc., The California Public Employees' Retirement System and, for certain limited purposes, Comcast Corporation (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed on January 6, 1995).\n10.33 Credit Agreement, dated as of December 22, 1994, among Comcast MH Holdings, Inc., the banks listed therein, The Chase Manhattan Bank (National Association), NationsBank of Texas, N.A. and the Toronto-Dominion Bank, as Arranging Agents, The Bank of New York, The Bank of Nova Scotia, Canadian Imperial Bank of Commerce and Morgan Guaranty Trust Company of New York, as Managing Agents and NationsBank of Texas, N.A., as Administrative Agent (incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K filed on January 6, 1995).\n10.34 Pledge Agreement, dated as of December 22, 1994, between Comcast MH Holdings, Inc. and NationsBank of Texas, N.A., as the secured party (incorporated by reference to Exhibit 10.3 to the Company's Current Report on Form 8-K filed on January 6, 1995).\n10.35 Pledge Agreement, dated as of December 22, 1994, between Comcast Communications Properties, Inc. and NationsBank of Texas, N.A., as the Secured Party (incorporated by reference to Exhibit 10.4 to the Company's Current Report on Form 8-K filed on January 6, 1995).\n10.36 Affiliate Subordination Agreement (as the same may be amended, modified, supplemented, waived, extended or restated from time to time, this \"Agreement\"), dated as of December 22, 1994, among Comcast Corporation, Comcast MH Holdings, Inc., (the \"Borrower\"), any affiliate of the Borrower that shall have become a party thereto and NationsBank of Texas, N.A., as Administrative Agent under the Credit Agreement dated as of December 22, 1994, among the Borrower, the Banks listed therein, The Chase Manhattan Bank (National Association), NationsBank of Texas, N.A. and The Toronto-Dominion Bank, as Arranging Agents, The Bank of New York, The Bank of Nova Scotia, Canadian Imperial Bank of Commerce and Morgan Guaranty Trust Company of New York, as Managing Agents, and the Administrative Agent (incorporated by reference to Exhibit 10.5 to the Company's Current Report on Form 8-K filed on January 6, 1995).\n10.37 Registration Rights and Price Protection Agreement, dated as of December 22, 1994, by and between Comcast Corporation and The California Public Employees' Retirement System (incorporated by reference to Exhibit 10.8 to the Company's Current Report on Form 8-K filed on January 6, 1995).\n10.38 Amended and Restated Agreement of Limited Partnership of MajorCo, L.P., a Delaware Limited Partnership, dated as of January 31, 1996, among Sprint Spectrum, L.P., TCI Network Services, Comcast Telephony Services and Cox Telephony Partnership (incorporated by reference to Exhibit 1 to Comcast Corporation's Current Report on Form 8-K filed on February 12, 1996).\n10.39 Parents Agreement, dated as of January 31, 1996, between Comcast Corporation and Sprint Corporation (incorporated by reference to Exhibit 3 to Comcast Corporation's Current Report on Form 8-K filed on February 12, 1996).\n- 69 -\n10.40 Agreement of Limited Partnership of MinorCo, L.P., a Delaware Limited Partnership, dated as of March 28, 1995, among Sprint Spectrum, L.P., TCI Network Services, Comcast Telephony Services and Cox Telephony Partnership (incorporated by reference to Exhibit 5.3 to Comcast Corporation's Current Report on Form 8-K filed on April 13, 1995).\n21 List of Subsidiaries.\n23.1 Consent of Deloitte & Touche LLP\n23.2 Consents of Arthur Andersen LLP\n23.3 Consent of KPMG Peat Marwick LLP\n27 Financial Data Schedule.\n99.1 Report of Independent Public Accountants to QVC, Inc., as of December 31, 1995 and for the eleven-month period then ended.\n99.2 Report of Independent Public Accountants to Garden State Cablevision L.P., as of December 31, 1994 and 1993 and for the years then ended.\n99.3 Report of Independent Public Accountants to Comcast International Holdings, Inc., as of December 31, 1994 and 1993 and for the years then ended (incorporated by reference to Exhibit 99.3 to Comcast Corporation's Annual Report on Form 10-K for the year ended December 31, 1994).\n(c) Reports on Form 8-K\n(i) Comcast Corporation filed a Current Report on Form 8-K under Item 5 on November 7, 1995 relating its October 29, 1995 announcement of its agreement to purchase the cable television operations of The E.W. Scripps Company.\n(ii) Comcast Corporation filed a Current Report on Form 8-K under Item 5 on December 19, 1995 relating its agreement to purchase the cable television operations of The E.W. Scripps Company, which included Comcast Corporation's Unaudited Pro Forma Condensed Consolidated Financial Statements and the Combined Financial Statements of The E.W. Scripps Company Cable Television Division.\n- 70 -\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized in Philadelphia, Pennsylvania on March 1, 1996.\nComcast Corporation\nBy: \/s\/ Brian L. Roberts --------------------------------- Brian L. Roberts President and Director\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\n- 71 -\n- 72 -\nCOMCAST CORPORATION AND SUBSIDIARIES\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n(Dollars in thousands)\n- 73 -\nINDEX TO EXHIBITS Exhibit Number Exhibit\n3.1(a) Amended and Restated Articles of Incorporation filed on July 24, 1990.\n3.1(b) Amendment to Articles of Incorporation filed on July 14, 1994.\n3.1(c) Amendment to Restated Articles of Incorporation filed on July 12, 1995.\n4.13 Form of Debenture relating to Comcast Corporation's $250.0 million 9-1\/8% Senior Subordinated Debentures due 2006.\n10.1\/*\/ Credit Agreement, dated as of September 14, 1995, between Comcast Cellular Communications, Inc., the banks listed therein, The Bank of New York, Barclays Bank PLC, The Chase Manhattan Bank, N.A., PNC Bank, National Association, and The Toronto-Dominion Bank, as Arranging Agents, and Toronto Dominion (Texas), Inc., as Administrative Agent.\n10.2\/*\/ Credit Agreement, dated as of September 19, 1995, between Comcast Holdings, Inc., the banks listed therein, The Chase Manhattan Bank, N.A., as Arranging Agent, Bank of Montreal, CIBC Inc., The Long-term Credit Bank of Japan, Limited, Royal Bank of Canada and Societe Generale, as Managing Agents, and The Chase Manhattan Bank, N.A., as Administrative Agent.\n10.8* 1990 Restricted Stock Plan, as amended and restated effective December 13, 1995.\n10.13(b)\/*\/ Amendment No. 1, dated as of November 30, 1994, to the Credit Agreement dated as of December 2, 1992, among Comcast Storer, Inc., the banks named therein and The Bank of New York, as administrative agent.\n10.13(c)\/*\/ Amendment No. 2, dated as of December 13, 1995, to the Credit Agreement dated as of December 2, 1992, as amended, among Comcast Storer, Inc., the banks named therein and The Bank of New York, as administrative agent.\n10.13(d)\/*\/ Amendment No. 3 and Waiver, dated as of February 29, 1996, to the Credit Agreement dated as of December 2, 1992, as amended, among Comcast Storer, Inc., the banks named therein and The Bank of New York, as administrative agent.\n21 List of Subsidiaries.\n23.1 Consent of Deloitte & Touche LLP\n23.2 Consents of Arthur Andersen LLP\n23.3 Consent of KPMG Peat Marwick LLP\n27 Financial Data Schedule.\n99.1 Report of Independent Public Accountants to QVC, Inc., as of December 31, 1995 and for the eleven-month period then ended.\n99.2 Report of Independent Public Accountants to Garden State Cablevision L.P., as of December 31, 1994 and 1993 and for the years then ended.\n- --------------\n* Constitutes a management contract or compensatory plan or arrangement.\n\/*\/ Pursuant to Item 601(b)(4)(iii)(A) of Regulation S-K, the Registrant agrees to furnish a copy of the referenced agreement to the Commission upon request\n- 74 -","section_15":""}
{"filename":"59527_1995.txt","cik":"59527","year":"1995","section_1":"ITEM 1. BUSINESS\nAs used in Item 1 of this report, the term \"Company\", except as otherwise indicated by the context, means The Lincoln Electric Company and its subsidiaries. The Lincoln Electric Company was incorporated under the laws of the State of Ohio in 1906. The Company is a full-line manufacturer of welding products and integral horsepower industrial electric motors. Welding products include arc welding machines, power sources, automated wire feeding systems, environmental fume systems, and arc welding consumable electrodes. The Company also sells industrial gases, regulators and torches used in oxy-fuel welding and cutting. Sales of arc welding and other welding products accounted for 93% of the Company's net sales in 1995.\nThe arc welding machines, power sources and automated wire feeding systems manufactured by the Company range in technology from basic units used for light manufacturing and maintenance to highly sophisticated machines for robotic applications, high production welding and fabrication. Three primary types of arc welding electrodes are produced: (1) coated manual or stick electrodes, (2) solid electrodes produced in coil form for continuous feeding in mechanized welding, and (3) cored electrodes produced in coil form for continuous feeding in mechanized welding. The integral horsepower electric motors manufactured by the Company range in size from 1\/3 to 1,250 horsepower.\nThe Company's products are sold in both domestic and international markets. In the domestic market, they are sold directly by the Company's own sales organization as well as by distributors. In the international markets, the Company's products are sold principally by foreign subsidiary companies. The Company also has an international sales organization comprised of international salesmen, direct sales distributors, agents and dealers that operate in more than eighty-six countries. The Company has manufacturing facilities located in the United States, Australia, Canada, Mexico, England, France, Ireland, Italy, the Netherlands, Norway and Spain. See Note G to the consolidated financial statements with respect to geographic area information.\nThe Company is not dependent on a single customer or a few customers. The loss of any one customer would not have a material adverse effect on its business. The Company's business is not seasonal.\nConditions in the arc welding industry are highly competitive. The Company believes that it is one of the largest manufacturers of consumables and machinery in a field of three or four major domestic competitors and numerous smaller competitors covering the industry. The Company continues to pursue strategies to heighten its competitiveness in international markets. Competition in the electric arc welding industry is on the basis of price, brand preference, product quality and performance, warranty, delivery, service and technical support. All of these factors have contributed to the Company's position as one of the leaders in the industry.\nVirtually all of the Company's products may be classified as standard commercial articles and are primarily manufactured for stock. The Company believes its product offerings are unique because of its highly trained technical sales force and the support of its welding research and development staff which allow it to uniquely assist the consumers of its products in solving their welding application problems. The Company utilizes this technical expertise to present its Guaranteed Cost Reduction Program to end users in which the Company guarantees that the user will save money in its manufacturing process when it utilizes the Company's products. This allows the Company to introduce its products to new users and to establish and maintain very close relationships with the consumers. This close relationship between the technical sales force and the direct consumers, together with its supportive relationship with its distributors, who are particularly interested in handling the broad breadth of the Company's products, is an important element of the Company's market success and a valuable asset of the Company.\nThe principal raw materials essential to the Company's business are various chemicals, steel, copper and aluminum, all of which are normally available for purchase in the open market.\nThe Company's operations are not materially dependent upon patents, trademarks, licenses, franchises or concessions.\nThe Company's facilities are subject to environmental control regulations. To date, compliance with these environmental regulations has not had a material effect on the Company's earnings nor has it required the Company to make significant capital expenditures.\nThe Company conducts a significant amount of its business and has a number of operating facilities in countries outside the United States. As a result, the Company is subject to business risks inherent in non-U.S. activities, including political uncertainty, import and export limitations, exchange controls and currency fluctuations. The Company believes risks related to its foreign operations are mitigated due to the political and economic stability of the countries in which its largest foreign operations are located.\nResearch activities relating to the development of new products and the improvement of existing products in 1995 were all Company-sponsored. These activities were primarily related to the development of new products utilizing the latest electronic technology. The number of professional employees engaged full-time in these research activities was 109. Refer to Note A to the consolidated financial statements with respect to total costs of research and development.\nThe number of persons employed by the Company worldwide at December 31, 1995 was approximately 6,000.\nThe table below sets forth consolidated net sales by product line for the most recent three years:\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's corporate headquarters and principal United States manufacturing facilities are located in the Cleveland, Ohio area. Total Cleveland area property consists of 223 acres, of which present manufacturing facilities comprise an area of approximately 2,587,000 square feet. While current utilization of existing facilities is high, the Company is adding capacity as necessary.\nIn addition to the principal facilities in Ohio, the Company operates two other manufacturing locations in the United States plus 12 manufacturing locations in 10 foreign countries, the locations of which are as follows:\nManufacturing facilities located in Germany, Venezuela, Japan and Brazil were closed in early 1994 under the Company's restructuring program.\nAll property relating to the Company's Cleveland, Ohio headquarters and manufacturing facilities is owned outright by the Company. In addition, the Company maintains operating leases for its distribution\ncenters and many sales offices throughout the world. See Note J to the consolidated financial statements with respect to leases. Most of the Company's foreign subsidiaries own manufacturing facilities in the foreign country where they are located. At December 31, 1995, $5.2 million of indebtedness was secured by property, plant and equipment.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is subject, from time to time, to a variety of civil and administrative proceedings arising out of its normal operations, including, without limitation, employment-related actions, product liability claims, and health, safety and environmental claims. Included in such proceedings are the cases summarily described below, in which claimants seek recovery for injuries allegedly resulting from exposure to fumes and gases in the welding environment.\nThe Company is a co-defendant in seventeen cases involving 26 plaintiffs alleging that exposure to manganese contained in arc welding electrode products caused the plaintiffs to develop a neurological condition known as manganism. The plaintiffs seek compensatory and, in most instances, punitive damages, usually for unspecified sums. Four similar cases have been tried, all resulting in defense verdicts.\nThe Company is also a defendant in one case, and one of several co-defendants in three other cases, alleging that exposure to welding fumes generally impaired the respiratory system of nineteen plaintiffs. The plaintiffs seek compensatory and punitive damages, in most cases for unspecified sums. During the preceding five years, forty-one similar cases have resulted in thirteen voluntary dismissals, seven defense verdicts or summary judgments and twenty-one settlements for immaterial amounts.\nClaims pending against the Company alleging asbestos induced illness total approximately 19,000; in each instance, the Company is one of a large number of defendants. Approximately 4,407 of these asbestos claims are pending in Orange County, Texas where a motion to certify a class action was recently denied. The asbestos claimants seek compensatory and punitive damages, in most cases for unspecified sums. Twenty-one cases have been tried to defense verdicts. Voluntary dismissals on such claims total approximately 15,000; summary judgments for the defense total 78.\nIncluded within the foregoing asbestos claims are approximately 930 claims pending in the Circuit Court of Kanawha County, West Virginia. On September 12, 1995, a jury returned a special interrogatory in that action finding that products manufactured and\/or sold by the Company and three other welding companies were defective in certain respects at the time of manufacture and\/or sale. Issues relating to whether or not claimants were exposed to Company products and, if so, whether Company products caused any injury, have not been addressed. Nor has there been any discovery relating to the plaintiffs and their potential compensatory damage claims. The court has dismissed punitive damage claims in that action.\nThe Company, together with hundreds of other co-defendants, is a defendant in state court in Morris County, Texas, in litigation on behalf of three thousand twenty five (3,025) claimants, all prior employees of a local pipe fabricator, alleging that occupational exposures caused a wide variety of illnesses. The plaintiffs seek compensatory and punitive damages of unspecified sums.\nThe Company bears the costs of defending those of its product liability cases arising and filed after 1990. In many cases where there are multiple defendants, cost sharing efficiencies are arranged. Subject to the Company's per claim retention under its insurance coverage, the Company has tendered the manganese, fume, asbestos and Morris County, Texas cases to its insurance carrier which has accepted such tender for all situations except those where liability would result solely from asbestos; no such situations have arisen to date. A dispute exists between the Company and its insurer as to the appropriate policies to which these claims should be applied, and the resolution of this dispute may provide additional coverage for such claims.\nEllis F. Smolik filed a proposed class action on April 27, 1995 in Common Pleas Court, Cuyahoga County, Ohio, alleging that the Company breached the terms of incentive stock award agreements with him and 49 others. According to the complaint, under those agreements these individuals were entitled to, but did not receive, an aggregate of approximately 530,000 shares of common stock of the Company based on what the complaint says was the Company's financial performance in the years 1989 through 1991. The complaint\nalso alleges that the Company breached fiduciary duties owed to these individuals. The complaint seeks compensatory damages of $31 million and punitive damages of eight times that amount. The Company believes that the allegations are without merit.\nThe Company believes that resolution of the pending cases referred to above, individually or in the aggregate, will not have a material effect upon 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 quarter ended December 31, 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS\nThe Company's Common Shares (LECO) and Class A Common Shares (LECOA) began trading on the NASDAQ market exchange in June 1995. The number of record holders of Common Shares and Class A Common Shares at December 31, 1995 was 2,669 and 2,566 respectively.\nThere is no public trading market for Class B Common Shares, which are only issued to the Company's Employee Stock Ownership Plan.\nQuarterly high and low stock prices and dividends declared for the last two years were:\n- --------------- * Source: NASDAQ; Ohio Dealers' Data Service prior to NASDAQ registration.\n** On June 12, 1995, holders of record of the Company's outstanding voting common shares as of June 5, 1995, received a dividend of one Class A Common Share for each outstanding share of the Company's voting common shares. Retroactive effect has been given to the stock dividend in the above per share data.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nSee Note C to the consolidated financial statements with respect to restructuring activities.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nGENERAL\nThe Company, now in its second century of operations, is one of the world's largest designers and manufacturers of arc welding products, manufacturing a full line of arc welding equipment, consumable welding products and other welding products which represented 93% of the Company's 1995 net sales. The Company also manufactures a broad line of integral horsepower industrial electric motors.\nFor the second consecutive year, in 1995, the Company reported its highest net sales and net income in its history. The sales increase was broadly based and was primarily attributable to increased volume and higher selling prices as a result of continued economic growth in served markets. The Company believes that the high quality of its products, advanced engineering expertise and strong distributor network, coupled with its large technically trained sales force, has enabled the Company to be a key participant in the global market place.\nThe Company is one of only a few worldwide broad line manufacturers of both arc welding equipment and consumable products. With highly competitive conditions in the welding industry, the Company will continue to emphasize its status as a single-source supplier, which it believes is most capable of meeting the broadest range of its customers' welding needs.\nIn 1995, the Company completed a recapitalization and stock distribution, resulting in changes to the existing classes of stock, authorization of a new class of non-voting shares and an increase in the total number of authorized common shares. The recapitalization modified the capital structure of the Company while maintaining, subject to certain limitations, the voting power of existing shareholders, thus allowing for increased flexibility in the Company's long-term strategy. See Note B to the consolidated financial statements.\nResearch and development expenditures by the Company increased 6.5% to $19.7 million in 1995 from $18.5 million in 1994. These activities were primarily related to the development of new products. The Company believes that over the past three years, expenditures for research and development activities have been adequate to maintain the Company's leadership position in its product lines and to introduce new\nproducts at an appropriate rate to sustain future growth. Expenditures on research and development are expected to increase again in 1996.\nRESULTS OF OPERATIONS\nThe following table shows the Company's results of operations for the years ended December 31, 1995, 1994 and 1993:\n1995 COMPARED TO 1994\nNet Sales. Net sales for 1995 were $1,032.4 million, an increase of $125.8 million or 13.9% from $906.6 million for 1994. Third-party sales from the Company's U.S. operations were $711.9 million in 1995 or 11.0% higher than 1994 sales of $641.6 million, attributable to volume and price increases in both the domestic and export markets. Non-U.S. third-party sales in 1995 were $320.5 million compared to $265.0 million in 1994, an increase of 20.9%. This increase was the result of improvement in the Company's international operations as well as improved economic conditions in the markets served, and the strengthening of certain foreign currencies against the U.S. dollar. Strengthening foreign currencies against the U.S. dollar increased non-U.S. sales by approximately $15.3 million or 5.8% during the year. European sales benefited from the previously reported restructuring of the Company's operations, increased customer focus and a general improvement in local economies which appeared to soften during the latter months in 1995. U.S. third-party export sales were $81.8 million in 1995, an increase of $17.4 million or 27.0% from $64.4 million in 1994. This increase in export sales largely reflects improved worldwide economic conditions and an increased sales focus by the Company in the non-U.S. market.\nGross Profit. Gross profit increased to $397.8 million in 1995 as compared with $350.4 million in 1994. Gross profit as a percentage of sales was flat in 1995 compared to 1994. Increased raw material and manufacturing overhead costs plus start-up costs associated with the opening of a new motor plant were offset by greater absorption of manufacturing expenses as a result of higher production volumes in both the U.S. and Europe, selected price increases and cost decreases by volume purchases.\nDistribution Cost\/Selling, General and Administrative (S, G & A) Expenses. Distribution cost\/selling, general and administrative expenses were $289.8 million in 1995 or 28.0% of sales, as compared to $261.7 million or 28.9% of sales in 1994. The decrease in S, G & A expenses as a percentage of sales is due to improved economies of scale achieved by higher worldwide sales volume. S, G & A for 1995 was affected by the devaluation of the Mexican peso, resulting in a charge to operations without tax benefit of approximately $2.3 million ($3.1 million in 1994). In addition, 1995 expenses included $4.0 million of severance costs recorded for retiring executives. Included in S, G & A expenses are the costs related to the Company's discretionary employee bonus program, net of hospitalization costs deducted therefrom ($66.4 million in 1995 and $59.6 million in 1994, or an increase of 11.4%).\nInterest Expense, Net. Interest expense, net, was $10.6 million in 1995 as compared with $14.3 million in 1994, a decrease which reflects the effect of lower debt levels as a result of the recapitalization and lower interest rates. The overall effective interest rate is higher than the prior year because a greater proportion of the remaining debt is comprised of higher-rate senior debt.\nIncome Taxes. Income taxes in 1995 were $38.1 million on income before income taxes of $99.6 million, an effective rate of 38.3%, as compared with income taxes of $32.2 million in 1994 on income before income taxes of $80.2 million or an effective tax rate of 40.1%. The decrease in the effective tax rate from the prior year is principally the result of lower non-U.S. losses without tax benefit and a lower effective tax rate on non-U.S. income.\nNet Income. Net income for 1995 was $61.5 million as compared to net income of $48.0 million in 1994, or an increase of 28.1%. 1994 net income benefited from a net reversal of $2.7 million of restructuring charges recorded previously.\n1994 COMPARED TO 1993\nNet Sales. Net sales for 1994 were $906.6 million, an increase of $60.6 million or 7.2% from $846.0 million for 1993. Net sales for 1993 include the sales of manufacturing operations (principally in Germany) that were closed in early 1994. Excluding the 1993 sales of the closed operations, sales for 1994 increased 17.0%. A portion of this increase was due to the absorption by the Company's other manufacturing operations of the sales formerly made by the closed operations. Third-party sales from the Company's U.S. operations were $641.6 million in 1994 or 18.1% higher than 1993 sales of $543.5 million, attributable to volume and price increases. Non-U.S. third-party sales in 1994 were $265.0 million compared to $302.5 million in 1993, a decrease of 12.4%. Excluding the 1993 sales of the closed operations, non-U.S. sales for 1994 increased 14.7% over non-U.S. sales for 1993 reflecting improved economic conditions in Europe and elsewhere in the world. U.S. third-party export sales were $64.4 million in 1994, an increase of $6.3 million or 10.8% from $58.1 million in 1993. This increase in export sales largely reflects improved worldwide economic conditions. In 1994, sales of certain new products were restricted by capacity limitations inherent in tooling up production which have now been resolved.\nGross Profit. Gross profit increased to $350.4 million in 1994 as compared with $313.2 million in 1993. Gross profit as a percentage of sales improved to 38.7% in 1994 from 37.0% in 1993. This improvement in gross profit is largely attributable to a greater percentage of total sales coming from the higher-margin U.S. operations in 1994. In addition, 1993 gross profit was unfavorably affected by lower gross profit levels for the manufacturing operations closed in early 1994.\nDistribution Cost\/Selling, General and Administrative (S, G & A) Expenses. Distribution cost\/selling, general and administrative expenses were $261.7 million in 1994 or 28.9% of sales, as compared to $277.0\nmillion or 32.7% of sales in 1993. The decrease in these expenses as a percentage of sales evidences the effects of the closing of the German subsidiary, the Company's restructuring program and management's initiatives to control operating costs throughout the Company. The higher expense level in 1993 was principally due to the inclusion of the operating results of the Company's closed German subsidiary. Included in S, G & A expenses are the costs related to the Company's discretionary employee bonus program, net of hospitalization costs deducted therefrom ($59.6 million in 1994 and $53.5 million in 1993 or an increase of 11.4%).\nInterest Expense, Net. Interest expense, net, was $14.3 million in 1994 as compared with $16.0 million in 1993, a decrease which reflects the effect of lower debt levels offset partially by higher interest rates.\nIncome Taxes. Income taxes in 1994 were $32.2 million on income before income taxes of $80.2 million, an effective rate of 40.1%, as compared to a tax benefit of $6.4 million on a loss before income taxes of $47.0 million in 1993. The 1993 tax benefit principally reflects the tax benefits attributable to the plant closure and liquidation of the German subsidiary. Results from 1993 also benefited from the cumulative effect of a change in accounting for income taxes, which decreased the net loss by $2.5 million or $0.12 per share.\nNet Income. As a result of the restructuring programs in 1992 and 1993 and the improvement in economic conditions in Europe, the United States and Canada, net income for 1994 was $48.0 million as compared to a net loss of $38.1 million in 1993. Results in 1993 were adversely affected by a $40.9 million after-tax restructuring charge. 1994 results benefited from a net reversal of $2.7 million of restructuring charges recorded previously.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company's financial position significantly improved during 1995 as a result of positive operating cash flow as well as the recapitalization. The Company anticipates that it will be able to satisfy its ongoing cash requirements for the foreseeable future primarily with cash generated by operations and borrowings under its existing credit facilities.\nCash provided from operations was $65.5 million in 1995 versus $68.7 million in 1994, a decrease of $3.2 million or 4.7%. This decrease in cash flow resulted from increased working capital offset by the Company's increase in net income. Accounts receivable balances increased due to higher sales and a slight increase in collection periods. Although the increase in inventory balance reflects higher sales volume, management plans to reduce overall inventory levels by the utilization of more \"just-in-time\" inventory methods and changes in production planning methodology.\nCapital expenditures for property, plant and equipment amounted to $48.4 million in 1995 as compared to $37.4 million in 1994, or an increase of $11.0 million. These expenditures for property, plant and equipment represent the Company's continued commitment to support and develop advanced technologies, support new products, expand current capacity and reduce future manufacturing costs. In particular, the Company has modernized and expanded its motor division by establishing a separate facility in Cleveland, Ohio, which is dedicated to motor manufacturing and increased testing and design capacity to be able to reduce costs and increase output. Investments to meet scheduled higher industry efficiency standards will continue. The Company expects to add capacity and modernize facilities selectively in the domestic market, and it also expects measured investment to encourage overseas growth.\nThe Company completed its recapitalization in 1995 which included the authorization of Class A Common Shares, a new class of non-voting common shares. The recapitalization included a distribution payable on June 12, 1995, to holders of record of the Company's outstanding voting common shares as of June 5, 1995, of a dividend of one Class A Common Share for each outstanding share of the Company's voting common shares. Prior to the adoption of the recapitalization, the Company had two authorized and outstanding classes of voting common shares. As a result, the Company's authorized capital consists of two voting classes, the Common Shares, without par value (formerly the \"Common Stock\"), and the Class B Common Shares, without par value (formerly the \"Class A Common Stock\"), and one non-voting class, the Class A Common Shares (the new \"Class A Common Shares\"). In addition, the recapitalization included an\nincrease in the total number of authorized common shares of all classes from 17 million to 62 million shares consisting of 30 million Common Shares, 30 million Class A Common Shares and 2 million Class B Common Shares.\nIn 1995, the Company successfully completed a public offering by selling 2,863,507 Class A Common Shares and realized $81.2 million in proceeds, net of the underwriters' discount. The proceeds from the offering were used to reduce debt, which has improved the Company's leverage and enhanced its financial position.\nIn December 1995, the Company entered into a new $200 million unsecured, multi-currency Credit Agreement (\"Credit Agreement\"). The Credit Agreement provides more favorable pricing levels, and the financial covenants which require interest coverage and funded debt to capital ratios are less restrictive, a result of the Company's improved liquidity and financial position. See Note D to the consolidated financial statements for additional information regarding the terms and financial covenants of the Company's borrowing arrangements. The Company's available borrowings under the Credit Agreement as of December 31, 1995 amounted to $190 million. At December 31, 1995, $10 million was outstanding under the Credit Agreement.\nTotal debt at December 31, 1995 was $123.4 million compared to $212.9 million at December 31, 1994, reflecting the reduction in debt from funds generated by the public offering and cash flow from operating activities. At December 31, 1995, total debt was 27.2% of total capitalization compared with 52.3% at year-end 1994.\nA total of $9.1 million in dividends was paid in 1995. In addition, the Board of Directors has declared a cash dividend of $0.12 per share, payable on April 15, 1996, to shareholders of record on March 29, 1996.\nCHANGES IN ACCOUNTING STANDARDS\nIn March 1995, Statement of Financial Accounting Standards (SFAS) No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of,\" was issued. SFAS No. 121 requires long-lived assets, primarily property, plant and equipment, identified intangible assets, and excess of cost over net assets of businesses acquired, to be reviewed for impairment losses whenever events or changes in circumstances indicate the carrying amount may not be recovered through future net cash flows generated by the assets. The Company will adopt SFAS No. 121 in 1996 and believes the effect of adoption will not be material.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe response to this item is submitted in a separate section of this report following the signature page.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNone.\nPART III\nA definitive proxy statement will be filed pursuant to Regulation 14A of the Securities Exchange Act prior to April 30, 1996. Therefore, information required under this part, unless set forth below, is incorporated herein by reference from such definitive proxy statement.\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 are included in a separate section of this report following the signature page:\nStatements of Consolidated Financial Condition -- December 31, 1995 and\nStatements of Consolidated Operations -- Years ended December 31, 1995, 1994 and 1993\nStatements of Consolidated Shareholders' Equity -- Years ended December 31, 1995, 1994 and 1993\nStatements of Consolidated Cash Flows -- Years ended December 31, 1995, 1994 and 1993\nNotes to Consolidated Financial Statements -- December 31, 1995\nReport of Independent Auditors\n(A) (2) FINANCIAL STATEMENT SCHEDULES\nThe following consolidated financial statement schedule of the Company is included in a separate section of this report following the signature page:\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.\n(A) (3) EXHIBITS\nUpon request, The Lincoln Electric Company will furnish to security holders copies of any exhibit to the Form 10-K report upon payment of a reasonable fee. Any requests should be made in writing to: Mr. H. Jay Elliott, Senior Vice President, Chief Financial Officer and Treasurer, The Lincoln Electric Company, 22801 St. Clair Avenue, Cleveland, Ohio 44117, Phone: (216) 481-8100.\n(B) NO REPORTS ON FORM 8-K WERE FILED DURING THE LAST QUARTER OF THE PERIOD COVERED BY THIS REPORT.\nSIGNATURES\nPURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.\nTHE LINCOLN ELECTRIC COMPANY (Registrant)\nBy: \/s\/ H. JAY ELLIOTT -------------------- H. Jay Elliott Senior Vice President, Chief Financial Officer and Treasurer (principal financial and accounting officer)\nPURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES INDICATED ON MARCH 15, 1996.\nANNUAL REPORT ON FORM 10-K\nITEM 8, ITEM 14(A)(1) AND (2) AND ITEM 14(D)\nFINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nFINANCIAL STATEMENT SCHEDULE\nYEAR ENDED DECEMBER 31, 1995\nTHE LINCOLN ELECTRIC COMPANY AND SUBSIDIARIES\nREPORT OF INDEPENDENT AUDITORS\nShareholders and Board of Directors The Lincoln Electric Company\nWe have audited the consolidated financial statements of The Lincoln Electric Company and subsidiaries listed in the accompanying Index to financial statements at Item 14 (a1). Our audits also included the financial statement schedule listed in the Index at Item 14 (a2). 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 The Lincoln Electric Company and subsidiaries at December 31, 1995 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, 1995 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, effective January 1, 1993, the Company changed its method of accounting for income taxes.\nERNST & YOUNG LLP\nCleveland, Ohio February 27, 1996\nSTATEMENTS OF CONSOLIDATED FINANCIAL CONDITION\nTHE LINCOLN ELECTRIC COMPANY AND SUBSIDIARIES\nSTATEMENTS OF CONSOLIDATED FINANCIAL CONDITION\nTHE LINCOLN ELECTRIC COMPANY AND SUBSIDIARIES\nShare amounts reflect the recapitalization (see Note B).\nSee notes to consolidated financial statements.\nSTATEMENTS OF CONSOLIDATED OPERATIONS\nTHE LINCOLN ELECTRIC COMPANY AND SUBSIDIARIES\nPer share amounts reflect the June 12, 1995 stock dividend (see Note B).\nSee notes to consolidated financial statements.\nSTATEMENTS OF CONSOLIDATED SHAREHOLDERS' EQUITY THE LINCOLN ELECTRIC COMPANY AND SUBSIDIARIES YEAR ENDED DECEMBER 31, 1995, 1994 AND 1993\nSee notes to consolidated financial statements.\nSTATEMENTS OF CONSOLIDATED CASH FLOWS THE LINCOLN ELECTRIC COMPANY AND SUBSIDIARIES\nSee notes to consolidated financial statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nTHE LINCOLN ELECTRIC COMPANY AND SUBSIDIARIES\n(IN THOUSANDS OF DOLLARS EXCEPT PER SHARE DATA)\nDECEMBER 31, 1995 NOTE A -- ACCOUNTING POLICIES\nPrinciples of Consolidation: The consolidated financial statements include the accounts of The Lincoln Electric Company and its subsidiaries (the \"Company\") after elimination of all significant intercompany accounts, transactions and profits.\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 valued at the lower of cost or market. For domestic inventories, cost is determined principally by the last-in, first-out (LIFO) method, and for foreign inventories cost is determined by the first-in, first-out (FIFO) method. At December 31, 1995 and 1994, approximately 63% and 62%, respectively, of total inventories were valued using the LIFO method. The excess of current cost over LIFO cost amounted to $55,300 at December 31, 1995 and $51,739 at December 31, 1994.\nProperty, Plant and Equipment: Property, plant and equipment, including facilities and equipment under capital leases (not material), are stated at cost and include improvements which significantly extend the useful lives of existing plant and equipment. Depreciation and amortization are computed by both accelerated and straight-line methods over useful lives ranging from 3 to 20 years for machinery, tools and equipment, and up to 50 years for buildings. Net gains or losses related to asset dispositions are recognized in earnings in the period in which dispositions occur.\nResearch and Development: Research and development costs, which are expensed as incurred, were $19,736 in 1995, $18,473 in 1994 and $19,210 in 1993.\nGoodwill: The excess of the purchase price over the fair value of net assets acquired (goodwill) is amortized on a straight-line basis over periods not exceeding 40 years. Amounts are stated net of accumulated amortization of $6,750 and $5,784 in 1995 and 1994, respectively.\nThe carrying value of goodwill is reviewed if facts and circumstances indicate a potential impairment of carrying value utilizing relevant cash flow and profitability information.\nTranslation of Foreign Currencies: Asset and liability accounts are translated into U.S. dollars using exchange rates in effect at the balance sheet date; revenue and expense accounts are translated at average monthly exchange rates. Translation adjustments are reflected as a component of shareholders' equity.\nTransaction gains and losses are included in the statements of consolidated operations in distribution cost\/selling, general and administrative expenses. The Company recorded transaction losses of $1,930 in 1995, $3,746 in 1994 and $228 in 1993. The higher level of transaction losses in 1995 and 1994 is attributable to the effect of the devaluation of the Mexican peso on a U.S. dollar denominated debt obligation which was less in 1995 than it was in 1994. This U.S. dollar denominated debt was settled in 1995.\nFinancial Instruments: The Company utilizes forward exchange contracts to hedge exposure to exchange rate fluctuations on certain intercompany loans, purchase and sales transactions and other intercompany commitments. Any contracts that are entered into are written on a short-term basis, are not held for trading purposes, and are not held for purposes of speculation. Gains and losses on all forward exchange contracts described herein are not material and are recognized in the statements of consolidated operations in the periods the exchange rates change. At December 31, 1995, the Company had $35 million of outstanding forward exchange contracts. These forward exchange contracts are principally denominated in the French Franc ($7,134), British Pound ($6,127), Dutch Guilder ($18,231) and Norwegian Krone ($2,885).\nTHE LINCOLN ELECTRIC COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nThe Company is exposed to credit-related losses in the event of nonperformance by counterparties to financial instruments. No counterparties are expected to fail to meet their obligations given their high credit ratings, so the Company usually does not obtain collateral for these instruments.\nEstimates: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions in certain circumstances that affect the amounts reported in the accompanying consolidated financial statements and notes. Actual results could differ from these estimates.\nAccounting Change: Effective January 1, 1993, the Company adopted FASB Statement No. 109, \"Accounting for Income Taxes.\" Under 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. As permitted by Statement No. 109, the Company elected not to restate the financial statements of any prior year. The cumulative effect of the change decreased the net loss for 1993 by $2,468 or $.12 per share.\nIn March 1995, Statement of Financial Accounting Standards (SFAS) No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of\", was issued. SFAS No. 121 requires long-lived assets, primarily property, plant and equipment, identified intangible assets, and excess of cost over net assets of businesses acquired, to be reviewed for impairment losses whenever events or changes in circumstances indicate the carrying amount may not be recovered through future net cash flows generated by the assets. The Company will adopt SFAS No. 121 in 1996 and believes the effect of adoption will not be material.\nNet Income (Loss) per Share: Net income (loss) per share is based on the average number of all shares outstanding during the year (23,350,254 in 1995; 21,939,982 in 1994 and 21,703,982 in 1993).\nSupplemental Earnings per Share: In 1995, the Company sold Class A Common Shares in an underwritten public offering (see Note B). The proceeds of the offering were used to reduce the Company's outstanding indebtedness. Had the proceeds been received and applied to reduce indebtedness as of January 1, 1995, net income per share for 1995 would have been $2.54, compared to $2.06 for 1994, if the proceeds were received and applied to reduce indebtedness as of January 1, 1994.\nOther: Included in distribution cost\/selling, general & administrative expenses are the costs related to the Company's discretionary employee bonus, net of hospitalization costs deducted therefrom ($66,357 in 1995; $59,559 in 1994; and $53,450 in 1993.) Certain reclassifications have been made to prior year financial statements to conform to current year classifications.\nNOTE B -- RECAPITALIZATION AND OTHER EQUITY TRANSACTIONS\nThe Company completed a recapitalization in 1995 that included the authorization of Class A Common Shares, which is a new class of non-voting common shares. The recapitalization included a distribution payable on June 12, 1995, to holders of record of the Company's outstanding voting common shares as of June 5, 1995, of a dividend of one Class A Common Share for each outstanding share of the Company's voting common shares. Retroactive effect has been given to the stock dividend in the computation of all per share data in these financial statements.\nPrior to the adoption of the recapitalization, the Company had two authorized and outstanding classes of voting common shares. As a result of the recapitalization, the Company's authorized capital consists of two voting classes, the Common Shares, without par value (formerly the \"Common Stock\"), and the Class B Common Shares, without par value (formerly the \"Class A Common Stock\"), and one non-voting class, the Class A Common Shares (the new \"Class A Common Shares\").\nTHE LINCOLN ELECTRIC COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nThe recapitalization included an increase in the total number of authorized common shares of all classes from 17 million to 62 million shares consisting of 30 million Common Shares, 30 million Class A Common Shares and 2 million Class B Common Shares.\nOn June 29, 1995, the Company sold in an underwritten public offering 2,796,914 Class A Common Shares for $28.35 per share, net of the underwriting discount. The closing date for the transaction was July 6, 1995 at which time the Company received the net proceeds of $79.3 million which were used to reduce debt of the Company. On August 2, 1995, the Company sold an additional 66,593 Class A Common Shares for $28.35 per share under an over allotment provision of the Underwriting Agreement and received additional net proceeds of $1.9 million which were also used to reduce debt of the Company.\nThe Lincoln Electric Company Employees' Stock Purchase Plan (\"Plan\") which provided that employees could purchase shares of the Company's Common Stock, when offered, at its book value, was terminated by the Board of Directors effective March 30, 1995. Under the Plan, the Company had the option to repurchase the shares, but in 1992 the Company suspended the repurchase of all shares under the Plan. Upon termination of the Plan, all shares issued under the Plan (1,639,686) became unrestricted shares. In May 1995, the shareholders approved the 1995 Lincoln Stock Purchase Plan (\"Purchase Plan\"), which provides employees the ability to purchase open market shares on a commission free basis up to a limit of ten thousand dollars annually. There were no purchases during 1995 under this Purchase Plan.\nThe Lincoln Electric Company 1988 Incentive Equity Plan (\"Incentive Equity Plan\") provides for the award or sale of Common Shares and Class A Common Shares to officers and other key employees of the Company and its subsidiaries. Following grants of deferred stock in 1989, the terms of which were satisfied in 1991, the Company distributed a total of 32,524 Common Shares (including 524 Shares issued for dividends accrued during the deferral period) of which 10,660 Common Shares were distributed in 1992, 11,510 Common Shares in 1993, and 10,354 Common Shares in 1994 (and a corresponding number of Class A Common Shares were distributed at the time of the 1995 stock dividend). These shares, along with 15,000 Common Shares issued to a former officer of the Company and corresponding Class A Common Shares received in the 1995 stock dividend, are restricted as to resale rights with the Company having a right of first refusal at a purchase price based on the book value of the shares. Additionally in 1994, 15,000 shares of restricted stock (after the stock dividend, 30,000 shares) were issued to two officers of the Company, with scheduled vesting that will be satisfied over time and completed in January 1997. In 1995, 5,000 shares of restricted stock were issued to another officer with vesting over a six year period. At December 31, 1995, there were no other outstanding awards under the Plan, and 1,899,952 shares (949,976 Common Shares and 949,976 Class A Common Shares) are reserved for future issuance under the Incentive Equity Plan.\nThe Lincoln Electric Company Employee Stock Ownership Plan (the \"ESOP\") is a non-contributory profit-sharing plan established to provide deferred compensation benefits for all eligible employees. The cost of the plan is borne by the Company through contributions to an employee stock ownership trust as determined annually by the Board of Directors. In May 1989, shareholders authorized 2,000,000 shares of Class B Common Shares (formerly the \"Class A Common Stock\"), without par value. The Company's Common Shares and Class B Common Shares are identical in all respects, except that holders of Class B Common Shares are subject to certain transfer restrictions and the Class B Common Shares are only issued to the ESOP. In 1995 and 1994, no shares were issued to the ESOP. In 1993, the Company issued 49,220 shares to the ESOP with an estimated fair value of $916 which was recorded as compensation expense. The difference between the total stated capital amount of $.20 per share and the estimated fair value was recorded as additional paid-in-capital. At December 31, 1995 and 1994, 1,500,160 authorized but unissued shares are available for future issuance to the ESOP. In 1995, the Company repurchased 12,723 Class B Common Shares for $114.\nIn May 1995, the shareholders approved The Lincoln Non-Employee Directors' Restricted Stock Plan (\"Non-Employee Directors' Plan\"). The Non-Employee Directors' Plan provides for distributions of ten\nTHE LINCOLN ELECTRIC COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nthousand dollars worth of Common Shares to each non-employee Director as part of an annual retainer. During 1995, 4,163 shares were issued to 13 non-employee Directors under this Plan.\nNOTE C -- RESTRUCTURING CHARGES\nIn 1993 the Company substantially completed its plan to downsize and streamline its foreign operations (principally in Europe) and close manufacturing facilities in Germany, Japan and South America. Management's decisions resulted in a restructuring charge in 1993 of $70,100 ($40,900 after tax or $1.88 per share) which was comprised of (1) asset write-downs in the amount of $45,900 including goodwill of $8,900; (2) severance and other redundancy costs of $27,500; and (3) a net credit of $3,300 comprised of a claim settlement and other restructuring liabilities including estimated losses through the final facility closing dates in 1994.\nIn 1994 all of the planned facility closings were completed and one of the facilities was disposed of. In total, approximately 1,400 employees were terminated as a result of the 1993 program and prior year program. In 1994 the restructuring accruals were adjusted to reflect management's current cost estimates to complete the program which resulted in a credit to income of $2,735.\nIn 1995, an additional facility was sold. The restructuring accrual at December 31, 1995 (included in other current liabilities) is $5,555. The remaining expenditures, which include costs related to the sale of the remaining facilities closed and holding costs to be incurred through the estimated date of disposal, are anticipated to be incurred in 1996.\nNOTE D -- SHORT-TERM AND LONG-TERM DEBT\nIn December 1995, the Company entered into a new $200 million unsecured, multi-currency Credit Agreement. The terms of the new Credit Agreement which expires December 20, 2000, provide for annual extensions. The new Credit Agreement provides more favorable pricing levels and less restrictive covenants. The interest rate on outstanding borrowings is determined based upon defined leverage rates for the pricing options selected. The interest rate can range from LIBOR plus .20% to LIBOR plus .30% depending upon the defined leverage rate. The agreement also provides for a facility fee ranging from .10% to .15% per annum based upon the daily aggregate amount of the commitment. Simultaneously, with the signing of the Credit Agreement, the $75,000 8.73% Senior Note due in 2003 was amended to conform with the financial covenants of the new Credit Agreement, which requires interest coverage and funded debt to capital ratios.\nTHE LINCOLN ELECTRIC COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nThe principal payment due in 1996 ($9,375,000) on the 8.73% Senior Note is classified as long-term debt as the Company intends to refinance the amount on a long-term basis under the Multi-currency Credit Agreement.\nMaturities of long-term debt for the five years succeeding December 31, 1995 are $1,268 in 1996, $10,510 in 1997, $10,117 in 1998, $9,752 in 1999, $29,002 in 2000 and $34,201 thereafter.\nAt December 31, 1995, loans amounting to $5,177 were collateralized by property and equipment.\nTotal interest paid was $12,606 in 1995, $17,400 in 1994 and $19,000 in 1993. Weighted average interest rates on notes payable to bank at December 31, 1995 and 1994 were 6.4% and 6.8%, respectively.\nNOTE E -- INCOME TAXES\nThe components of income (loss) before income taxes and cumulative effect of accounting change are as follows:\nComponents of income tax expense (benefit) for the years ended December 31, are as follows:\nTHE LINCOLN ELECTRIC COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nThe differences between total income tax expense (benefit) and the amount computed by applying the statutory Federal income tax rate to income (loss) before income taxes and cumulative effect of accounting change are as follows:\nTotal income tax payments, net of refunds, were $22,428 in 1995, $6,115 in 1994 and $19,400 in 1993.\nAt December 31, 1995, the Company's foreign subsidiaries had net operating loss carryforwards of approximately $61,000 which expire in various years from 1996 through 2002, except for $20,000 for which there is no expiration date.\nSignificant components of the Company's deferred tax assets and liabilities at December 31, 1995 and 1994, are as follows:\nThe Company does not provide deferred income taxes on unremitted earnings of foreign subsidiaries as such funds are deemed permanently reinvested to finance foreign expansion and meet operational needs on an\nTHE LINCOLN ELECTRIC COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nongoing basis. Upon distribution of those earnings in the form of dividends or otherwise, the Company would be subject to both U.S. income taxes subject to an adjustment for foreign tax credits and withholding taxes payable to the various foreign countries. Determination of the amount of unrecognized deferred U.S. income tax liability is not practicable because of the complexities associated with its calculation; however, unrecognized non-U.S. tax credits and non-U.S. withholding taxes paid upon distribution would be available to reduce some portion of the U.S. liability.\nNOTE F -- RETIREMENT ANNUITY AND GUARANTEED CONTINUOUS EMPLOYMENT PLANS\nThe Company and its subsidiaries maintain a number of defined benefit and defined contribution plans to provide retirement benefits for their employees in the United States as well as their employees in foreign countries. These plans are maintained and contributions are made in accordance with the Employee Retirement Income Security Act of 1974, local statutory law or as determined by the Board of Directors. The plans generally provide benefits based upon years of service and compensation. Pension costs accrued are funded except for the cost associated with a supplemental employee retirement plan for certain key employees.\nA summary of the components of total pension expense is as follows:\nTHE LINCOLN ELECTRIC COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nThe funded status of the U.S. and Non-U.S. plans at December 31, 1995 and 1994 is as follows:\nThe increase in the actuarial present value of accumulated benefit obligations (\"ABO\") for the domestic plans is largely due to the change in the discount rate from 8.25% to 7.5% as well as the normal one year's additional accrual of benefit under all plans. The increase in the ABO for the foreign plans is largely due to the normal one year's accrual of additional benefits.\nAssumptions used in accounting for the defined benefit plans as of December 31, 1995 and 1994 for both the U.S. and Non-U.S. plans were as follows:\nPlan assets for the U.S. plans consist principally of deposit administration contracts and an investment contract with an insurance company. Other assets held by the U.S. plans not under insurance contracts are invested in equity and fixed income securities. Plan assets for the non-U.S. plans are invested in non-U.S. insurance contracts and non-U.S. equity and fixed income securities.\nThe Company does not have and does not provide for any postretirement or postemployment benefits other than pensions.\nThe Cleveland, Ohio area operations have a Guaranteed Continuous Employment Plan covering substantially all employees, which, in general, states that the Company will provide work for at least 75% of every standard work week (presently 40 hours). This plan does not guarantee employment when the Company's ability to continue normal operations is seriously restricted by events beyond the control of the\nTHE LINCOLN ELECTRIC COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nCompany. The Company has reserved the right to terminate this plan effective at the end of a calendar year by giving notice of such termination not less than six months prior to the end of such year.\nNOTE G -- INDUSTRY AND GEOGRAPHIC SEGMENT INFORMATION\nThe Company's primary business is the design, manufacture and sale, in the domestic and international markets of arc and other welding products and related gases used in the welding process. The Company also designs, manufactures and sells integral horsepower industrial electric motors. Financial information by geographic areas follows:\nIntercompany sales between geographic regions are accounted for at prices comparable to normal, customer sales and are eliminated in consolidation.\nExport sales (excluding intercompany sales) from the United States were $81,770 in 1995, $64,400 in 1994 and $58,100 in 1993.\nNOTE H -- ACQUISITIONS\nIn June 1993, the Company purchased the outstanding minority interest in its subsidiary in Spain for approximately $8,500. The transaction was accounted for as a purchase and the increased interest in the results of operations was included in the consolidated statements of operations from the transaction date.\nNOTE I -- FAIR VALUES OF FINANCIAL INSTRUMENTS\nThe Company has various financial instruments, including cash, cash equivalents and short and long-term debt. The Company has determined the estimated fair value of these financial instruments by using available\nTHE LINCOLN ELECTRIC COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nmarket information and appropriate valuation methodologies which require judgment. Accordingly, the use of different market assumptions or estimation methodologies could have a material effect on the estimated fair value amounts. The total notional value of forward currency exchange contracts at December 31, 1995 is $35 million.\nThe carrying amounts and estimated fair value of the Company's significant other financial instruments at December 31, 1995 are as follows:\nNOTE J -- OPERATING LEASES\nThe Company leases sales offices, warehouses and distribution centers, office equipment and data processing equipment. Such leases, some of which are noncancellable, and in many cases, include renewals, expire at various dates. The Company pays most maintenance, insurance and tax expenses relating to leased assets. Rental expense was $8,852 in 1995, $9,226 in 1994 and $9,864 in 1993.\nAt December 31, 1995, total minimum lease payments for noncancellable operating leases are as follows:\nNOTE K -- CONTINGENCIES\nThe Company and its subsidiaries are involved in various litigation in the ordinary conduct of its business. Based on information known to the Company, Management believes the outcome of all pending litigation will not have a material effect upon the financial position of the Company.\nTHE LINCOLN ELECTRIC COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE L -- QUARTERLY FINANCIAL DATA (UNAUDITED)\n- ---------------\n(a) Net income per share is computed independently for each of the quarters presented. Therefore, the sum of the quarterly earnings per share in 1995 does not equal the total computed for the year due to stock transactions which occurred during 1995.\n(b) Per share amounts reflect the June 12, 1995 stock dividend (see Note B).\n(c) Includes $2,500 of net adjustments to various expense accruals and $3,140 for the devaluation of the Mexican peso, offset partially by net favorable inventory adjustments of $1,900 and adjustments to restructuring accruals of $3,235. Also includes a favorable $2,000 adjustment to income taxes to reflect the annual effective income tax rate.\nSCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS\nTHE LINCOLN ELECTRIC COMPANY AND SUBSIDIARIES\n(IN THOUSANDS OF DOLLARS)\n- --------------------------------------------------------------------------------\n- ---------------\n(1) Currency translation adjustment.\n(2) Uncollectible accounts written-off, net of recoveries.\n(3) Includes $2,480 relating to accounts written off during 1994 in connection with the Company's restructuring activities.\nINDEX TO EXHIBITS","section_15":""}
{"filename":"99102_1995.txt","cik":"99102","year":"1995","section_1":"Item 1. Business.\nIntroduction\nTrans-Industries, Inc. (and its subsidiaries) (the \"Company\") was incorporated in Delaware in 1967 to acquire the business of Transign, Inc., a company founded in 1952 to manufacture mechanical bus signs. Initially, the Company produced mechanical signage for the mass transit market, but its current efforts have been concentrated on electronic systems for the display of information, bus lighting products and source extraction systems for the environmental market. These products are sold to virtually all aspects of the transportation industry and to a broad range of commercial and industrial markets. The Company has two major customers, Gillig Corp. and Addco Mfg. each of which accounted for nearly 10 percent of consolidated annual sales. Although these are highly valued customers, the Company does not consider itself dependent upon them for continued, ongoing operations. Sales volume is significantly affected by state and municipal government spending for mass transit, highway systems, and airports. As of February 28, 1996, the Company's backlog was $8,641,900, compared with $5,762,600 and approximately $4,812,900 for the same dates in 1995 and 1994, respectively. Of the current backlog, it is anticipated that 90 percent will be completed within one year.\nOperations\nA. Industry Segment.\nThe Company is a leader in the supply of lighting and information display systems for mass transit operations. Also, new and growing markets are being developed for electronic information display systems, liquid crystal displays, and the Company's dust control product line. Dust control is an air impurity extraction system that is designed to remove air pollution at its source. Based on the nature of the Company's products, production process, types of customers, and marketing methods, management believes the Company operates in predominately one broad industry segment which is the transportation industry. The Company continues to decrease its dependence upon the mass transit portion of this market.\nB. Foreign and Domestic Operations and Export Sales.\nThrough subsidiaries, the Company operates manufacturing, assembly, sales, and service facilities in the United Kingdom. These operations sell products purchased from the affiliated domestic companies, as well as products manufactured in the United Kingdom, to European and Australian customers. Additional foreign sales are made on an export basis from domestic offices as well as through certain agents abroad. Summarized financial information about foreign operations and exports are in Notes D and I to the Consolidated Financial Statements.\nC. Research and Quality Control.\nThe Company's principal research activities are conducted at its product development center in Rochester Hills, Michigan, where line maintenance and new product programs are carried out according to perceived market opportunities. Quality control, rather than being centralized, is a function performed at each manufacturing plant.\nApproximately $438,000, $438,000, and $354,000 were spent on research and development during the years ended December 31, 1995, 1994, and 1993, respectively.\nD. Competition.\nIn each of the market niches where the Company competes, there are one or more competitors. Sizes of these concerns range from small to large integrated enterprises, both domestically and internationally, with no single company dominating the various markets. The Company owns and has licensed United States and foreign patents relating to the manufacture of most of its products, but these are not deemed sufficient to substantially minimize competition from other parties. It is felt that success in the marketplace is due to the ability to compete on the basis of price, service, and product performance.\nE. Raw Materials.\nThe principal raw materials used by the Company include steel, plastics, electronic components, and synthetic materials, all of which are presently available in adequate supply on the open market.\nF. Employee Relations.\nThe Company employs approximately 232 people, supplemented by temporary workers, with a minority of these employees covered by a union contract that expires August 7, 1998. The Company considers its overall labor relations with employees to be good.\nThe Company maintains profit sharing and 401-K plans for all of its full-time employees who are not part of a bargaining unit.\nG. Environmental Considerations.\nThe Company believes it is in compliance with all state and federal regulations for environmental control and safety, and the related expenditures are generally not significant.\nH. Directors and Officers of the Registrant.\nSee Part III, Item 10 for certain information regarding officers and directors.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nDomestic operations are conducted at six principal facilities. Four are owned, of which two are located in Waterford, Michigan, one is located in Rochester Hills, Michigan and one is located in Bad Axe, Michigan. Two locations are leased. One of the leased facilities is located in Rochester Hills, Michigan under a lease agreement expiring in February 1999. The other leased facility is in Wilmington, North Carolina and is leased through January 1999. International operations are conducted at a leased facility located in Leeds, and an owned facility in Telford, England. The lease agreement for the facility in Leeds expires in December 2009.\nThe plants, all of which are well maintained and in good operating condition, contain an aggregate of approximately 219,000 square feet of floor space. Generally, the plants have been operating on a five day a week basis with occasional overtime.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nThe Company is the plaintiff in a patent infringement lawsuit. During November of 1993, an advisory jury recommended a decision in favor of the Company. In April of 1994, the judge concurred with the advisory jury and ordered that the defendant be enjoined from any further manufacture, use, or sale of the accused patented device. It was also ordered that the defendant pay approximately $3 million in damages. During 1994, the defendant appealed the case. A final outcome is expected to be reached in 1996. Because this decision can be further appealed by the Defendant, the ultimate award to the Company will be recorded in the financial statements when realized. Additionally, any award received by the Company will be net of certain contingent legal fees related to the lawsuit.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote for Security Holders.\nNo matters were submitted during the fourth quarter of the fiscal year covered by this report to a vote of security holders through solicitations 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 is traded on the Over-the-Counter Market and is included in the National Association of Securities Dealers Automated Quotation System under the symbol TRNI. The following table sets forth the range of trade prices as reported by the National Securities Dealers Association, Inc. for the preceding two years:\nThese quotations reflect actual transactions without retail markup, markdown, or commission.\nAs of December 31, 1995, there were 331 registered holders of the Common Stock of the Registrant.\nItem 6.","section_6":"Item 6. Selected Financial Data.\n(a) Tangible net worth equals total assets less intangible assets, less total liabilities. Subordinated debt consists of two convertible subordinated debentures. (See Note E of notes to consolidated financial statements.)\n(b) Based on weighted average number of common shares and equivalents outstanding.\n(c) Based on shares outstanding at year end.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nOPERATIONS\n1995 Compared With 1994\nSales for 1995 were $24.9 million compared to $23.2 million for the previous year. This sales increase of $1.7 million or 7.3 percent from 1994 sales levels was attributable to achieving higher sales levels of the Company's multi-functional lighting systems for use in mass transit vehicles. Increased bus production, as well as increased market share accounted for the improved sales levels in 1995. Foreign operations also showed slightly improved sales volumes over 1994. Inflationary impact on sales for 1994 and 1995 was minimal.\nFor the first quarter of 1996, the Company expects sales to be up from the levels achieved for the same period last year. The increase in sales is due primarily to a strong market for the Company's bus lighting products and to a lesser extent, increased demand for the Company's variable message displays.\nThe Company's pretax income for 1995 amounted to $1,100,733 compared to a pretax loss of $451,413 for the 1994 fiscal year. The income generated in 1995 was due to increased sales volume as well as a much improved product mix compared to the previous year.\nCost of sales for 1995 was $17,109,368 compared to $16,615,601 for the year before. As a percentage of sales, cost of sales decreased to 68.6 percent in 1995, from 71.6 percent in 1994. The decrease of 3.0 percent is attributable primarily to the discontinuation of the molded composite product line which shipped its final production in September of 1994.\nSelling, general, and administrative expenses showed a net decrease of $191,984 for 1995 compared to 1994. This decrease approximates the one time benefit the Company recognized in 1995, as a result of discontinuing a foreign venture.\nInterest expense increased in 1995 to $909,458 from $809,060 in 1994. This increase of $100,398 was due to higher interest rates in 1995 and slightly higher borrowings.\n1994 Compared With 1993\nSales for 1994 were $23.2 million compared to $25.6 million for the previous year. This sales decrease of $2.4 million, or 9.4 percent from 1993 sales levels, was attributable to the Company's subsidiaries located in England. Their sales were depressed due to product problems associated with a\ncomponent supplier as well as delivery postponements by certain customers. Domestic sales were able to keep pace with the previous year's volumes despite the discontinuation of the structural composite product line and the corresponding fall off in sales of $674,000. Inflationary impact on sales for 1993 and 1994 was minimal.\nFor the first quarter of 1995, the Company's sales were down from the levels achieved for the same period in the prior year. The reduction in sales was due primarily to a softness in the capital expenditure market which reduced sales of the Company's dust extraction equipment below the prior year's results. Sales were further impacted by one of the major bus builders who shipped minimal product during the quarter because of financial difficulties, as well as certain customers being placed on credit hold. Increased sales of the Company's information displays and bus lighting beginning in the second quarter provided improved operating results.\nDuring the first quarter of 1994, the Company decided to discontinue production of its molded composite product line, which allowed the Company to focus its financial and human resources on other profitable core endeavors. Orders were taken through the end of February 1994 to satisfy customer needs, and a build-out schedule was put in place. This program was in effect until September when the last quantity of parts was shipped. All the associated inventory, tooling, and equipment were either sold in 1994 or sufficient reserves for the sale were set up.\nThe Company's pre-tax loss for 1994 amounted to $451,413 compared to a pre-tax loss of $653,466 for the 1993 fiscal year. The 1994 loss was primarily due to lower sales attributable entirely to the foreign operations. Domestic sales were consistent with the prior year's, and operations showed a marginal loss.\nCost of sales for 1994 was $16,615,601 compared to $19,691,806 for the year before. As a percentage of sales, cost of sales decreased to 71.6 percent in 1994, from 77.0 percent in 1993. This decrease of 5.4 percent was primarily attributable to the discontinuation of the molded composite product line which had a high cost-of-sales percentage.\nSelling, general, and administrative expenses showed a net increase of $267,989 for 1994 compared to 1993. This increase approximates the one time benefit the Company recognized in 1993, as a result of revising the apportionment factor for its Michigan Single Business Tax returns for the years 1988 through 1993. The one time benefit amounted to $215,000.\nInterest expense increased in 1994 to $809,060 from $717,979 in 1993. This increase of $91,081 was due to higher interest rates in 1994.\nLIQUIDITY AND CAPITAL RESOURCES\nAs of year end 1995, the Company had $5.3 million of working capital compared with $4.8 million at year end 1994 and $5.2 million at year end 1993. This increase in working capital of $500,000 resulted primarily from the Company's net income for 1995. In October of 1995 the Company retired $700,000 of convertible debentures with funds acquired through short term borrowings. If the Company's award of approximately $3 million in its patent litigation is upheld on appeal, liquidity will be enhanced.\nAt December 31, 1995, there were no material commitments for capital expenditures. It is expected that capital expenditures for 1996 will increase moderately from 1995 levels. It is management's belief that cash flow from operations and short term borrowings will be sufficient for working capital requirements, debt service obligations, and capital expenditures for the ensuing year.\nDIVIDENDS\nThe Company has not paid cash dividends on its common stock for its three most recent fiscal years, and does not anticipate that it will do so in the foreseeable future. The Company's term loan agreement restricts the payment of cash dividends on its common stock. See Note E to the Consolidated Financial Statements.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements.\nThe following pages contain the Consolidated Balance Sheets as of December 31, 1995 and 1994 and the related Consolidated Statement of Operations, Stockholders' Equity and Cash Flows for each of the years in the three year period ended December 31, 1995, including the reports of the Company's independent certified public accountants.\nCONSOLIDATED FINANCIAL STATEMENTS AND REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nTRANS-INDUSTRIES, INC. AND SUBSIDIARIES\nDECEMBER 31, 1995, 1994 AND 1993\nCONTENTS\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nBoard of Directors Trans-Industries, Inc.\nWe have audited the accompanying consolidated balance sheets of Trans-Industries, Inc. (a Delaware corporation) and Subsidiaries as of December 31, 1995 and 1994 and the related consolidated statements of operations, 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 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 Trans-Industries, Inc. and Subsidiaries as of December 31, 1995 and 1994, and the consolidated results of their operations and their consolidated cash flows for the years then ended, in conformity with generally accepted accounting principles.\nGrant Thornton LLP\nDetroit, Michigan February 9, 1996\nIndependent Auditors' Report\nThe Stockholders and Board of Directors Trans-Industries, Inc.:\nWe have audited the consolidated statements of operations, stockholders' equity, and cash flows of Trans-Industries, Inc. and subsidiaries for the year ended December 31, 1993. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these 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 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 consolidated financial statements referred to above, present fairly, in all material respects, the results of operations and cash flows of Trans-Industries, Inc. and subsidiaries for the year ended December 31, 1993 in conformity with generally accepted accounting principles.\nAs discussed in notes B and G 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, in 1993.\nKPMG Peat Marwick LLP\nDetroit, Michigan April 8, 1994\nTRANS-INDUSTRIES, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\nDECEMBER 31, 1995 AND 1994\nTHE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.\nTRANS-INDUSTRIES, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\nDECEMBER 31, 1995 AND 1994\nTHE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.\nTRANS-INDUSTRIES, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF OPERATIONS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nTHE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.\nTRANS-INDUSTRIES, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF OPERATIONS - CONTINUED\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nTHE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.\nTRANS-INDUSTRIES, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nTHE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.\nTRANS-INDUSTRIES, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSUPPLEMENTAL DISCLOSURES OF NONCASH FINANCING ACTIVITIES During 1995, the deferred compensation plan sponsored by the Company (the Plan) acquired $300,000 of the Company's convertible subordinated debentures held by Figgie International, Inc. The Plan exercised its conversion privileges and the Company issued 150,000 shares of its common stock and retired the debt. THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.\nTRANS-INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1995, 1994 AND 1993\nNOTE A - NATURE OF OPERATIONS\nThe Company is a multinational manufacturer of lighting and information display systems. The principal markets for its products are the United States, the United Kingdom and Canada. Sales volume is significantly affected by state and municipal government spending for mass transit, highway systems and airports.\nNOTE B - SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the accounts of the parent company and its wholly owned subsidiaries (the Company). All significant intercompany balances and transactions have been eliminated in consolidation.\nINVENTORIES\nInventories are stated at the lower of cost (first-in, first-out) or market (net realizable value).\nPROPERTY AND EQUIPMENT\nProperty and equipment are stated at cost. Depreciation is provided using straight line and accelerated methods over the estimated useful lives of the assets which range from 10-40 years for buildings and 3-10 years for machinery and equipment.\nINTANGIBLE ASSETS\nThe excess of the cost of the investment in a wholly owned subsidiary (Transign, Inc.) over the equity in underlying net assets at the date of acquisition is being amortized over 30 years.\nFOREIGN CURRENCY TRANSLATION\nAssets and liabilities of foreign subsidiaries are translated principally at year-end exchange rates. Income and expense accounts are converted using the average exchange rate prevailing throughout the period. The gains and losses resulting from the translation of these accounts are reported as a separate component of stockholders' equity.\nRESEARCH AND DEVELOPMENT\nResearch and development costs are expensed as incurred. Research and development costs approximated $438,000, $438,000 and $354,000 for the years ended December 31, 1995, 1994 and 1993, respectively.\nINCOME TAXES\nEffective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes, and reported the cumulative effect of that change in the method of accounting for income taxes in the 1993 consolidated statement of operations.\nTRANS-INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nDECEMBER 31, 1995, 1994 AND 1993\nNOTE B - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)\nUnder the asset and liability method mandated by 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 the effects of 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 enactment date.\nEARNINGS (LOSS) PER SHARE\nEarnings (loss) per share are based on the weighted average number of shares of common stock outstanding during each year. When issued, the convertible subordinated debentures were determined not to be common stock equivalents. In computing fully diluted earnings (loss) per share for 1994 and 1993, the conversion of the subordinated debentures was not assumed, as the effect would have been anti-dilutive. Fully diluted earnings per share for 1995 are computed based on the weighted average number of shares of common stock and common stock equivalents outstanding during the period as if the subordinated debentures were converted into common stock at the beginning of the period after giving effect to the retroactive elimination of interest expense, net of income tax effects, applicable to the subordinated debentures.\nUSE OF ESTIMATES\nIn preparing financial statements in conformity with generally accepted accounting principles, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses during the reporting period. Actual results could differ from those estimates.\nFAIR VALUE OF FINANCIAL INSTRUMENTS\nThe carrying amounts of financial instruments approximate their fair values.\nNEW PRONOUNCEMENT\nIn March 1995, the Financial Accounting Standards Board issued \"Statement of Financial Accounting Standards No. 121 - Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of.\" This statement establishes accounting standards for the impairment of long-lived assets, certain identifiable intangibles and goodwill related to those assets to be held and used, and for long-lived assets and certain identifiable intangibles to be disposed of. The statement is effective for the year ended December 31, 1996. Management does not believe the adoption of this standard will have a material effect on the consolidated financial statements.\nTRANS-INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nDECEMBER 31, 1995, 1994 AND 1993\nNOTE C - INVENTORIES\nThe major components of inventories at December 31 are:\nNOTE D - TRANSACTIONS WITH AFFILIATE\nIn late 1992, an Australian affiliate of the Company commenced operations that consisted primarily of the manufacture and installation of variable message signs for highway, airport, transit and commercial use.\nAdvances receivable and net investment in this fifty percent-owned affiliate which was accounted for under the equity method, amounted to $147,000 at December 31, 1993.\nSummarized financial information for this affiliate for the year ended December 31, 1993 follow:\nDuring 1994, the Company acquired the remaining fifty percent of this company for nominal consideration, and included its operations in the consolidated financial statements.\nIn 1995, the Company sold this affiliate and recognized a gain net of income taxes, of approximately $50,000.\nNOTE E - LINE OF CREDIT AND LONG-TERM DEBT\nThe Company has a secured line of credit facility with a bank, which allows it to borrow based on qualifying accounts receivable and inventory up to $5,500,000. At December 31, 1995, the outstanding balance was $2,981,788. Interest is payable monthly at 1.25 percent over the bank's prime lending rate. (Effective rate of 9.75% at December 31, 1995.)\nTRANS-INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nDECEMBER 31, 1995, 1994 AND 1993\nNOTE E - LINE OF CREDIT AND LONG-TERM DEBT (CONTINUED)\nLong-term debt at December 31 consisted of the following:\nTRANS-INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nDECEMBER 31, 1995, 1994 AND 1993\nNOTE E - LINE OF CREDIT AND LONG-TERM DEBT (CONTINUED)\nThe $1,000,000 convertible subordinated debentures were held by Figgie International, Inc. for which the Company's chief executive officer was a member of the Board of Directors. In October 1995, these debentures were retired by the Company's repayment of $700,000 and the purchase by the deferred compensation plan sponsored by the Company of $300,000 in principal amount. Concurrently, the Plan exercised its option to convert the debentures into 150,000 shares of the Company's common stock. The $257,142 convertible subordinated debentures are held by the Gerald J. Murphy charitable trust, Kirksville College of Osteopathic Medicine, trustee. Dr. Murphy is a member of the board of directors of Trans-Industries, Inc. These subordinated debentures are convertible into common shares at any time at a conversion price of $2 per share (or as adjusted, as defined in the debenture agreement).\nThe aggregate maturities of long-term debt by year are as follows:\nThe term loan and line of credit agreements, as amended, require the Company to maintain certain financial ratios. The agreements also restrict the payment of dividends, repurchase of common stock, and acquisition of fixed assets.\nNOTE F - LEASES\nThe Company leases facilities and equipment under operating leases with unexpired terms ranging from one to five years. Rent expense for all operating leases approximated $331,000, $325,000, and $321,000 for 1995, 1994 and 1993, respectively. Future minimum rentals required under noncancelable lease agreements are not material.\nNOTE G - INCOME TAXES\nAs discussed in Note A, the Company adopted Statement 109 as of January 1, 1993. The cumulative effect of this change in accounting for income taxes of $100,000 was determined as of January 1, 1993, and is reported separately in the consolidated statement of operations for the year ended December 31, 1993.\nTRANS-INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nDECEMBER 31, 1995, 1994 AND 1993\nNOTE G - INCOME TAXES (CONTINUED)\nThe components of earnings (loss) before income taxes were as follows:\nIncome taxes have been charged (credited) to operations as follows:\nA reconciliation of actual income tax (benefit) expense to the expected amounts computed by applying the effective U.S. federal income tax rate of 34 percent to earnings or losses before income taxes is as follows:\nTRANS-INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nDECEMBER 31, 1995, 1994 AND 1993\nNOTE G - INCOME TAXES (CONTINUED)\nThe tax effects of temporary differences that give rise to significant deferred tax assets and liabilities at December 31, 1995 and 1994 are as follows:\nThe Company has a foreign tax net operating loss carryforward of approximately $1,600,000 at December 31, 1995. A valuation allowance of $535,000 has been recognized to reduce the deferred tax assets principally due to the uncertainty of realizing the benefit of the tax loss carryforward. The valuation allowance decreased by $66,000 in 1995 and increased by $126,000 in 1994.\nNOTE H - EMPLOYEE BENEFIT PLANS\nThe Company has a Voluntary Employee Benefit Trust (Plan) designed to provide for the payment or reimbursement of all or a portion of certain medical and dental expenses to eligible participants. Eligible participants include active full-time employees of the Company and their dependents. Eligible terminated and retired employees may continue to participate in the Plan, on a contributory basis, for up to 18 months subsequent to the date of termination or retirement. The provision for Company contributions to the Plan approximated $402,000, $462,000 and $507,000 for the years ended December 31, 1995, 1994 and 1993, respectively.\nTRANS-INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nDECEMBER 31, 1995, 1994 AND 1993\nNOTE H - EMPLOYEE BENEFIT PLANS (CONTINUED)\nThe Company has a deferred compensation plan for all employees who are not part of a bargaining unit. Company contributions are voluntary and are established as a percentage of each participant's base salary. Company contributions to the Plan were $225,000, $23,000 and $29,000 for 1995, 1994 and 1993, respectively.\nNOTE I - CONCENTRATION OF CREDIT RISK AND GEOGRAPHIC SEGMENT INFORMATION\nThe Company has two major customers which account for 10 percent or more of consolidated net sales. Sales to these major customers amounted to $4,100,000, $5,300,000 and $3,300,000 for the years ended December 31, 1995, 1994 and 1993, respectively. Additionally, sales to foreign customers (primarily in the United Kingdom and Canada) amounted to 23 percent of consolidated net sales in 1995 and 30 percent in 1994. Total accounts receivable from foreign customers approximated $1,800,000 and $1,500,000 at December 31, 1995 and 1994, respectively.\nFinancial information summarized by geographic area is as follows:\nTRANS-INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nDECEMBER 31, 1995, 1994 AND 1993\nNOTE I - CONCENTRATION OF CREDIT RISK AND GEOGRAPHIC SEGMENT INFORMATION (CONTINUED)\nNOTE J - CONTINGENCIES\nThe Company is a plaintiff in a patent infringement lawsuit. During November 1993, an advisory jury recommended a decision in favor of the Company. On April 8, 1994, the judge concurred with the advisory jury's recommendation and awarded the Company approximately $3,000,000 in damages. During 1994, the defendant appealed the case based on the lower court's interpretation of the law. A final outcome is expected to be reached in 1996. Because this decision can be further appealed by the defendant, the ultimate award to the Company will be recorded in the financial statements when realized. Additionally, any award received by the Company will be net of certain contingent legal fees related to the lawsuit.\nItem 9.","section_9":"Item 9. Disagreements on Accounting and Financial Disclosure.\n(a) On April 14, 1994 the Board of Directors of the Company, upon recommendation of the Audit Committee, dismissed, for cost considerations, KPMG Peat Marwick LLP as its principal accountants for the 1994 fiscal year. KPMG Peat Marwick's reports on the Company's consolidated financial statements as of and for each of the years ended December 31, 1993 and 1992 were unqualified. During these years, there were no disagreements with KPMG Peat Marwick LLP on any matter of accounting principles or practices, financial statement disclosures, or auditing scope or procedure or any reportable events.\nGrant Thornton LLP, Southfield, Michigan, was selected and approved by the Board of Directors, and ratified by the Company's shareholders, as the Company's independent public accountants.\n(b) There have been no disagreements with the auditors on matters of accounting and financial disclosure.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant.\nThe Company's directors and executive committee's fees for 1995 were as follows: Dale S. Coenen, $25,000.00; Duncan Miller, $25,000.00; Gerald J. Murphy, $25,000.00; and Matthew M. Wirgau, $25,000.00.\nMr. Miller is a director of W. R. Berkley Corp.\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 Part III (Items 11, 12, and 13, and additional information regarding Item 10), is incorporated by reference from the Registrant's definitive proxy statement in connection with its Annual Meeting of Shareholders to be held on May 22, 1996, which Proxy Statement will be filed 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, 2. Consolidated Financial Statements for Trans-Industries, Inc. and Subsidiaries for years ended December 31, 1995, 1994, and 1993 are filed under Part II, Item 8.\n3. Exhibits: Exhibit 3 (a) Restated Certificate of Incorporation incorporated herein by reference to Form 8 filed May 17, 1982. Exhibit 13 (b) Form 10-Q for quarter ended September 30, 1995, filed with the Securities and Exchange Commission on November 14, 1995 incorporated herein by reference. Exhibit 22 List of Subsidiaries (see page 35).\n(b) No reports on Form 8-K for the three months ended December 31, 1995 were required to be 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 Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nTRANS-INDUSTRIES, INC.\nDate: ___________________ _________________________________________ Dale S. Coenen 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, which include the President, the Chief Financial Officer, the Assistant Treasurer, and a majority of the Board of Directors on behalf of the Registrant and in the capacities and on the dates indicated:\n____________________________ President ____________________ (Dale S. Coenen)\n___________________________ Vice-President ____________________ (Kai Kosanke) and Chief Financial Officer\n___________________________ Assistant Treasurer ____________________ (Paul Clemo)\n___________________________ Director ____________________ (Matthew M. Wirgau)\n___________________________ Director ____________________ (Duncan Miller)\nExhibit Index\nExhibit Number Description - ------- ---------- 21 List of Subsidiaries\n27 Financial Data Schedule","section_15":""}
{"filename":"28345_1995.txt","cik":"28345","year":"1995","section_1":"Item 1. Business\nDeSoto, Inc. (\"DeSoto\" or the \"Company\") was incorporated in 1927 under the laws of Delaware. The Company's principal executive offices are located at 900 East Washington Street, Joliet, Illinois, 60433.\nOn July 21, 1995, the Company announced the transfer and assignment of various operations and assets involved in its liquid detergent and fabric softener dryer sheet businesses to two separate buyers. The Company assigned the rights to certain customers with respect to these businesses. The Company also sold other assets which included certain accounts receivable, inventory and machinery and equipment. Both transactions also provide for the Company to receive royalties and other earn-out opportunities over a three-year period in one case and over a four-year period in the other case. The proceeds of these transactions were utilized to reduce the Company's senior secured debt owed to CIT. For additional information, see Note O of the Notes to Consolidated Financial Statements.\nProducts The Company operates primarily in only one industry segment, the manufacturing and packaging of household cleaning products, including powdered and liquid laundry detergents. The Company also performs contract manufacturing and packaging of household cleaning products.\nCustomers The Company divides its sales between private label sales (including control brands) and contract manufacturing. The Company had four customers that each accounted for greater than 10% of the Company's revenues in 1995: Sears, Roebuck and Co. (\"Sears\"), Kmart, Procter and Gamble and Benckiser. As a result of the disposition of the liquid laundry detergent and fabric softener sheet businesses, Kmart and Benckiser are no longer customers of the Company. The loss of either Sears or Procter and Gamble as a customer would have a material adverse effect on the Company. In 1994, Sears, Kmart and Procter and Gamble each accounted for greater than 10% of the Company's revenues. In 1993, Sears, Lever Brothers Company (\"Lever\") and Kmart each accounted for greater than 10% of the Company's revenues.\nThe Company has been a supplier of Sears branded home laundry products for over 30 years. During the three years ended December 31, 1995, Sears accounted for the following percentages of net revenues:\n1995 1994 1993 20% 16% 14%\nDuring 1995 and 1994 sales to Procter and Gamble accounted for the following percentages of net revenues:\n1995 1994 13% 10%\nSales to Procter and Gamble did not account for more than 10% of net revenues in 1993.\nThe Company produces its contract manufacturing business on a make and ship basis; therefore, minimal inventories are carried. The Company carries a minimal buffer inventory for its private label accounts. Primarily, the Company extends industry standard terms to its customers.\n- 2 -\nDistribution The Company's private label and control label products are sold in retail stores, including mass merchants and service centers. The Company primarily uses its own sales force to sell its products. Products produced under contract manufacturing agreements are generally distributed under arrangements made by the purchaser.\nRaw Materials The primary raw materials used in the Company's products include soda ash, surfactants, brighteners, packaging materials. In 1995, in general, raw materials were available in adequate quantities to meet the needs of the business. It is believed that raw materials will, in general, be available to meet the Company's anticipated requirements in 1996 and beyond. During 1995, energy resources were adequate to meet the needs of the business and it is believed they will be adequate during 1996.\nCompetition The Company competes nationally in all major markets in the household detergent category. The Company faces significant competition. The Company believes that there are 15 major domestic producers of household detergent with substantial sales, five of which account for approximately 73% of industry sales. The top five companies are the major national brand detergent producers. The private label market represents approximately 3% of the detergent market. The remaining major domestic producers compete within this 3%. Several of these second tier companies also participate in the contract packaging segment of the business. The Company believes that it is the twelfth largest domestic manufacturer of household detergents. The Company competes on the basis of price, service and product quality. The Company believes there is a heavy emphasis on price in the marketplace. Management believes that the Company has expertise in a broad array of detergent products and offers experience in contract packaging with major companies.\nAs part of its quality control program, the Company subjects raw materials and packaging components to quality tests upon purchase. Company products are made to predetermined specifications with quality tests conducted during production.\nResearch and Development The Company spent approximately $218,000, $345,000, and $665,000, during 1995, 1994 and 1993, respectively, on Company-sponsored research relating to the development of new products or the improvement of existing products.\nPatents, Licenses, Franchises and Concessions The Company, in management's opinion, holds no material patents, licenses, franchises or concessions. The Company has no licenses with foreign manufacturers.\nExport sales did not constitute a material portion of the Company's business in 1995.\n- 3 -\nEnvironmental Compliance The Company believes that it is currently in compliance in all material respects with all presently applicable federal, state and local provisions regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment. Capital expenditures of the Company attributable to compliance with such provisions were immaterial in 1995 and the Company anticipates such expenditures to be immaterial in 1996. For additional information regarding special accruals relating to environmental compliance with respect to discontinued operations, see \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources\" under Item 7 hereof.\nBacklog The Company believes that the dollar amount of backlog orders for its business is immaterial.\nSeasonality The Company does not believe the household cleaning product business is seasonal; however, promotional activities of certain customers can result in increased sales during specific time frames.\nEmployees The Company had approximately 127 employees as of the close of business on December 31, 1995.\n- 4 - EXECUTIVE OFFICERS\nThe following table sets forth the names of the executive officers at February 15, 1996, the positions and offices with the Company held by them, the date they first became officers, and their ages at February 15, 1996:\nFirst Became Name Office an Officer Age\nWilliam Spier Director, Chairman of the Board, 1991 61 and Chief Executive Officer\nAnders U. Schroeder Director and Vice Chairman 1991 45\nAnne E. Eisele Director, President, and Chief Financial Officer 1991 40\nFred J. Flaxmayer Corporate Controller and Chief Accounting Officer 1995 39\nIrving Kagan Secretary and Legal Counsel 1992* 59\nEach executive officer was appointed to serve in the office or offices indicated until the first meeting of the Board of Directors following the annual meeting of stockholders in 1996 and until his or her successor is elected and qualified.\nNo family relationships exist among the above named individuals and any directors of the Company.\nMessrs. Spier and Schroeder have held their positions as officers of the Company since June 5, 1991. Mr. Spier has been President and Chairman of Sutton Holding Corp. from 1989 to present and a private investor from 1982 to present. Mr. Schroeder has been Chief Executive Officer of Asgard Ltd. since 1990; Chairman and Chief Executive Officer of Odin International N.V. (a wholly owned subsidiary of Asgard Ltd.) since 1989; Executive Vice President of Sutton Holding Corp. since 1989; Vice Chairman of The Holding Company of 1867, Inc. since 1986. Ms. Eisele and Mr. Flaxmayer have held the positions set forth above or served the Company in various executive or administrative positions for at least the past five years.\n* Mr. Kagan was the Company's Senior Vice President and General Counsel from November 1992 to February 1994 and now serves as legal consultant and special counsel to the Company. In September 1995, Mr. Kagan was appointed as Secretary of the Company. Mr. Kagan was a director of GAF Corporation from 1989 to 1993.\n- 5 -\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nAs of December 1995, the Company's general offices are located in Joliet, Illinois. In 1992, the Company sold three of its operating facilities (buildings and land) to its Pension Plan (the \"Plan\") and entered into 10-year leases by which the Company leased the facilities from the Plan. This transaction included the plants in Joliet, Illinois, Columbus, Georgia, and Union City, California. The Company ceased operations at the Columbus, Georgia plant in March 1994 and the facility has been subleased to an unrelated third party through September 30, 1997. In December 1994, the Company sold its plant (building and land) in South Holland, Illinois, to the Plan and leased it back. The Company ceased operations at the South Holland, Illinois facility in October 1995. For further information regarding these transactions, refer to Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and Note C of the Notes to the Consolidated Financial Statements.\nAt December 31, 1995, the Company's manufacturing and warehousing operations were located at the following facilities. Approximate Floor Area Location in sq. ft. Nature of Operation\nUnion City, California 130,000(a) Production and distribution of spray dried powder detergents\nJoliet, Illinois 160,000(b) Production and distribution of agglomerated powder detergents and liquid detergents --------- Total 290,000\nApproximately 61% of the 290,000 sq. ft. of the floor area listed in the table above is currently being used for warehousing and administrative purposes. The properties are well maintained and in good operating condition. In general, the Company's present manufacturing facilities are adequate for current production as well as for a material increase in production.\n__________ (a)Includes approximately 57,000 sq. ft. which were sold to the Plan in 1992 and are now leased by the Company and 73,000 sq. ft. which are leased from an unrelated party. (b) This facility was sold to the Plan in 1992 and is leased by the Company.\n- 6 -\nItem 3.","section_3":"Item 3. Legal Proceedings\n(i) Lundman Development Corporation v. DeSoto, Inc.\nAs previously reported, the Company was served with a Summons and Complaint filed in the United States District Court for the Eastern District of Wisconsin. The Complaint alleges, inter alia, that DeSoto violated the Comprehensive Environmental Response, Compensation and Liability Act (\"CERCLA\") with respect to property the Company once owned in Fredonia, Wisconsin. The Company has denied the allegations in the Complaint and the matter is in the pre-trial discovery stage.\n(ii) West County Landfill v. Raychem International et al\nAs previously reported, the Company was served with an Amended Complaint filed in the United States District Court for the Northern District of California. The Amended Complaint alleges, inter alia, that DeSoto violated CERCLA with respect to the West County Landfill in California. The Company has denied the allegations in the Amended Complaint and the matter is in the pre-trial discovery stage.\n(iii) Ninth Avenue Remedial Group et al v. Allis-Chambers Corporation et al\nAs previously reported, the Company was named in a complaint filed in the United States District Court for the Northern District of Indiana. The complaint alleges that DeSoto and numerous other parties are jointly and severally responsible under CERCLA for the cleanup and future cleanup of the site. Also, as previously reported, the U. S. EPA issued an administrative order against the Company under Section 106(a) of CERCLA demanding that the Company, inter alia, undertake the remediation at the Ninth Avenue Site. DeSoto has responded that it intends to comply with all terms of the order.\n(iv) As previously reported, an insurance carrier to a third party has asserted a claim against the Company for property damage allegedly incurred when a fertilizer product manufactured by the third party, containing a chemical sold to that party by one of the Company's discontinued operations, allegedly caused or promoted a fungus infection resulting in failure of certain tomato crops in the United Kingdom. The damages alleged are approximately $1.4 million. The Company's defense has been undertaken by one of its insurance carriers, with a reservation of rights.\n(v) In re DeSoto, Inc. Shareholder Litigation\nAs previously reported, there are several shareholder actions still pending in the Delaware courts relating to various proposals of Sutton Holding Corp. to acquire the Company in the period 1989 to 1991. These actions, all of which were consolidated, have not been actively pursued and it appears the case was removed from the court's calendar; however, the plaintiffs recently served a discovery request upon the Company. The Company believes that these actions are not material.\n(vi) United States of America v. Akzo et. al.\nAs previously reported, the Company was named in a complaint filed in the United States District Court for the Eastern District of Michigan. The complaint, filed on behalf of the U.S. EPA, alleges, inter alia, that the Company and four other parties are responsible under Section 107 CERCLA for costs the EPA incurred at the Metamora Landfill site in Lapeer, Michigan. The complaint also seeks a declaration under Section 113 of CERCLA that the Company is liable for the EPA's future costs that may be incurred at this site.\n- 7 - The State of Michigan had also served a complaint upon the Company in the United States District Court for the Eastern District of Michigan paralleling the Federal action. The State has since dismissed the action as to the Company.\nThe Company's defense in these actions has been assumed by the firm and its principal shareholder from which the Company purchased certain assets of the business which is alleged by the EPA to be partially responsible for the alleged contamination at this site. The former owners have also agreed to indemnify the Company with respect to the claims asserted in the complaints.\n(vii) As previously reported, the Company was named as a defendant in an action brought by Liberty Mutual Insurance Company in the Circuit Court of Cook County, Illinois, seeking declaratory relief with respect to insurance coverage previously purchased by the Company from Liberty, that Liberty had no insurance obligation to the Company with respect to environmental sites and litigations where the Company has been named as a defendant or been identified as a potentially responsible party. The Company moved to dismiss on the grounds that the Company had previously filed a more comprehensive action in the federal district court in New Jersey. In December 1995, the state court ruled in favor of the Company and dismissed the action. Liberty has recently filed a notice of appeal seeking to overturn the court's ruling.\nIn August 1995, the Company commenced an action in the federal district court in New Jersey, seeking contract and declaratory relief with respect to insurance coverage that the Company purchased from Liberty. Liberty moved to dismiss the complaint on the grounds that the District of New Jersey is not a proper forum for the dispute. The motion is pending and discovery has not yet commenced.\nAs previously reported, the Company, in 1993, had commenced an action in the federal district court in New Jersey, which had sought contract and declaratory relief with respect to certain insurance coverage purchased from Liberty. That action was settled in July 1995 pursuant to a confidential settlement agreement.\n(viii) As previously reported, the Company received a unilateral Administrative Order issued by the U. S. EPA under Section 106 of CERCLA, alleging that the Company is a potentially responsible party in connection with the Marina Cliffs Site in the South Milwaukee, Wisconsin. The Company presently believes that it has no liability and that any potential environmental damage at the site is the result of activity by parties other than the Company.\n(ix) As previously reported, Fort Dearborn Lithograph Co. has filed suit against the Company in the Circuit Court of Cook County, Illinois, seeking to collect allegedly unpaid invoices for goods and services, of approximately $500,000. The disposition of this action has been stayed by agreement of the parties, pending resolution of an overall trade creditor arrangement.\n(x) Liquid Container, L. P. has filed suit against the Company in the Circuit Court of Cook County, Illinois, claiming breach of contract and damages relating to a transaction involving, in part, the Company's former blow molding operations. The Company has asserted a number of defenses and counterclaims. The action is in the early stages of pre- trial discovery.\n(xi) Rooney v. DeSoto, Inc., et. al. This action was filed in 1991 in the District Court of Tarrant County, Texas, by various emergency health care providers against the Company, among others, claiming damages for alleged personal injuries purportedly related to an industrial accident involving a Company employee at its former facility in Fort Worth, Texas. The case has been finally set for trial in May 1996.\n- 8 - (xii) Environmental Matters\nThe Company has been identified by government authorities as one of the parties potentially responsible for the cleanup costs at a number of waste disposal sites, several of which are on the U.S. EPA's Superfund priority list. In addition, damages are being claimed against the Company in private actions for alleged personal injury or property damage in the case of certain other waste disposal sites.\nFor further information regarding environmental liabilities, refer to Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and Note I of the Notes to Consolidated Financial Statements.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nThe annual meeting of stockholders was held on December 20, 1995. Matters submitted to and approved by the stockholders included the election of directors and the ratification of the appointment of Arthur Andersen LLP as auditors.\nEach nominee for election as a director was approved. 4,314,440 shares of voting stock were voted for Anders U. Schroeder and 45,791 shares of such stock were withheld; 4,314,413 shares of voting stock were voted for David M. Tobey and 45,818 shares of such stock withheld.\n4,346,754 shares of voting stock were voted for the ratification of the appointment of Arthur Andersen LLP as independent auditors, 6,371 of such shares were voted against the appointment and 7,106 shares of such stock abstained.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Stock and Related Security Holder Matters\nThe common stock of the Company and the associated preferred share purchase rights are traded on the New York Stock Exchange. (The preferred share purchase rights do not trade separately from the common stock and are represented by certificates for the common stock.)\nInformation with respect to the high and low sales prices of the Company's common stock and dividends is as follows: 1995 1994 Price Range Dividend Price Range Dividend in Dollars Declared in Dollars Declared High Low Per Share High Low Per Share\n1st Quarter $5 3\/8 $ 3 $ - $8 5\/8 $6 3\/4 $ - 2nd Quarter 6 1\/4 4 3\/4 - 7 3\/8 5 1\/2 - 3rd Quarter 5 3\/8 4 1\/4 - 6 7\/8 4 - 4th Quarter 5 3\/8 2 3\/4 - 5 3\/8 3 - ------ ------ $ - $ -\nAt a meeting of the Company's Board of Directors on March 11, 1992, a resolution was approved eliminating the regular quarterly dividend on common stock until further action by the Board. Terms of the senior preferred stock prohibit the declaration of dividends on common stock while dividends are in arrears on the senior preferred.\nAt March 5, 1996, there were 1,738 stockholders of record of the Company's common stock.\n- 9 - Item 6.","section_6":"Item 6. Selected Financial Data\n(1) Operating results subsequent to November 12, 1992 include revenues and results from operations of J. L. Prescott Company which was acquired on that date. In July 1995, the Company sold the liquid laundry detergent and fabric softener sheet businesses it had acquired from J. L. Prescott Company.\n(2) The loss from operations before income taxes and accounting change included net non-operating income of $6,361,000, $1,303,000 and $2,420,000 in 1995, 1994 and 1993, respectively; provision for restructuring of operations of $3,100,000, $2,900,000 and $1,229,000 in 1995, 1993 and 1992, respectively; and $3,059,000 and $3,025,000 of other non recurring charges in 1995 and 1993, respectively.\n(3) Net loss included the cumulative effect of an accounting change of $162,000 of expense ($0.04 per share) in 1992.\n(4) In November 1992, the Company purchased J. L. Prescott Company. In July 1995, the Company sold its liquid laundry detergent and fabric softener sheet businesses.\n(5) In December 1994, the Company entered into a three-year revolving credit facility with CIT. The characteristics of the arrangement were such that the entire debt was classified as current. The long-term debt outstanding at the commencement of the CIT credit facility was paid off as part of the transaction. As of September 30, 1995, the Company completely repaid the outstanding borrowings under the credit facility with CIT and the facility was terminated; and the Company had no outstanding borrowing as of that date.\n- 10 -\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nLIQUIDITY AND CAPITAL RESOURCES\nAs discussed in Note B to the Consolidated Financial Statements, the Company has continued to experience losses from operations and negative operating and financing cash flows. As part of the Company's continuing effort to manage its accounts payable and cash flow requirements, the Company has been negotiating a Trade Composition Agreement and a related Security Agreement with its trade creditors as represented by a committee of six major creditors of the Company. The proposed agreements include a standstill agreement related to accounts payable existing as of September 22, 1995. Also, as part of the proposed Trade Composition Agreement, the Company initiated the termination of its overfunded pension plan to be effective contingent upon the receipt of appropriate governmental approvals. For further information regarding the plan termination, refer to Note C to the Consolidated Financial Statements. Under the standstill agreement, if certain conditions are met, the creditors who sign the agreement agree not to initiate litigation or other efforts to collect amounts owed to them. The Company has agreed to pay each Qualified Trade Creditor (as defined) the balance owed to that creditor within 10 days of receipt of the reverted excess pension plan assets. If payment is not made by July 1, 1996, interest would accrue from that date at 8% per annum on the outstanding balance. The proposed Security Agreement would grant a security interest and lien on all of the Company's assets to secure the obligations of the Company to the Qualified Trade Creditors. The proposed Trade Composition Agreement further stipulates that the Company may suspend efforts to terminate its pension plan if the Company enters into a binding agreement for a merger, asset sale or similar transaction, involving substantially all of the Company's assets, which provides that all Qualified Trade Creditors will be paid in full. The Company and most of its creditors have been operating within the understanding outlined above. The final Trade Composition Agreement and related documents were circulated for signatures on March 11, 1996 and execution of the documents has not yet been completed. The Company is continuing to pursue, with the assistance of its investment bankers, a possible business combination; however, there can be no assurance as to the outcome of such efforts. For further information regarding a possible business combination, refer to Note P to the Consolidated Financial Statements.\nAs a result of its liquidity situation, the Company is currently operating on a C.O.D. or limited credit basis with respect to purchases of supplies and raw materials. The Company has been able to operate within these constraints and expects to be able to continue to do so for the immediate future.\nThe Company continues to manufacture powdered laundry detergents at its facilities in Joliet, Illinois and Union City, California. The Company also continues to manufacture certain liquid detergents at its Joliet facility. During July 1995, the Company completed the transfer and assignment to two separate buyers of various operations and assets involved in its liquid detergent and fabric softener sheet businesses. The assets involved included certain customer rights, accounts receivable, inventory and machinery and equipment. Both transactions provide for the Company to receive royalties and other earn-out opportunities over a three-year period in one case and over a four-year period in the other case.\nInitial proceeds from these transactions were used to reduce the Company's senior secured debt under its revolving credit agreement with CIT. In September 1995, the Company completely repaid the outstanding borrowing under its revolving credit agreement with CIT and the agreement was terminated. The Company currently has no outstanding secured debt or revolving credit arrangements.\n- 11 -\nCash flow from operations in 1995 was a positive $1.0 million. The positive cash flow from operations included the cash proceeds of $6.1 million from insurance settlements regarding the cost of cleanup at certain hazardous waste sites. Cash flow from operations also reflects the impact of no longer carrying receivables or inventory related to the liquid laundry detergent and fabric softener sheets businesses. The disposition of these businesses and the resulting shut-down of the Company's operating facilities in South Holland, Illinois and Thornton, Illinois, are expected to reduce the cash required to fund continuing operations on a going forward basis.\nAccounts receivable at December 31, 1995, when compared to December 31, 1994, also reflects a reduction in trade accounts receivable due to the impact of reduced sales. Inventory levels have declined during the same time period due in part to lower requirements stemming from lower sales as well as the continued impact of a product rationalization\/inventory control program.\nThe decline in property, plant and equipment reflects the disposition discussed above, the sale of equipment no longer used in operations as well as the write-down to net realizable value of machinery and equipment at the Company's South Holland facility. This equipment was sold as part of an auction that took place in February 1996. In addition, the excess of depreciation over capital expenditures in 1995 contributed to the reduction in net property, plant and equipment.\nThe decline in other non-current assets during the year was largely due to the write-off of approximately $3.3 million of goodwill related to the liquid detergent and fabric softener sheet businesses in the third quarter. This write-off was partially offset by the minimum long-term royalty of $1.5 million recorded as part of the sale of the liquid detergent and fabric softener sheet businesses in July.\nReserves and liabilities related to restructuring programs increased during 1995 primarily due to provision for expenses related to the disposition of the liquid laundry detergent business and the related shutdown of the South Holland facility. Significant components of this accrual include future rental payments to the Company's pension plan and future real estate taxes on the property.\nThe Company expects to fund operations in 1996 with proceeds from insurance settlements and other settlements, proceeds from the sale of machinery and equipment formerly utilized in the liquid business in South Holland, Illinois and via spot factoring of accounts receivable. As reported previously, the Company is evaluating various methods of maximizing the economic benefit of its overfunded pension plan. However, there can be no assurance as to the outcome of such efforts.\nThe Company has been identified by government authorities as one of the parties potentially responsible for the cleanup costs at a number of waste disposal sites and for certain alleged contamination. In addition, damages are being claimed against the Company in private actions for alleged personal injury or property damages in the case of some of the waste disposal sites. Special accruals have been made for the estimated costs of the Company's expected resulting liability. These estimates are subject to numerous variables, the effects of which are difficult to measure, including the stage of the investigations, the nature of potential remedies, the joint and several liability with other potentially responsible parties and other issues. Accordingly, the accruals represent the Company's best estimates of its potential exposure at this time. It is the opinion of management, after evaluating the variables discussed above as well as the anticipated time frame for remediation, that the resolution of the waste-site liability will not have a material adverse effect on the Company's financial position. Of the $2.0 million accrued as a current liability for waste site cleanup, $755,000 is fully funded by a trust fund which was included in restricted investments as part of current assets on the Company's balance sheets. The fund was established in 1990 as part of the sale of discontinued operations and may be accessed by the Company and, in certain circumstances, a certain purchaser of the discontinued operations. Another $29,000 of the current waste site liability is covered by funds from an escrow which the Company received in 1993 and placed in a restricted cash account to secure a certain cleanup obligation. In 1995, the Company paid out approximately $2.3 million on waste site related liabilities, excluding legal and administrative costs; of this amount $1.1 million was disbursed from the trust discussed above and $29,000 was disbursed from the restricted cash account discussed above. Based upon currently available information, the Company is unable to determine the timing of future payments for that portion of the liability which has been classified as long-term. For additional information regarding the waste site cleanup liability, refer to Note I of the Notes to Consolidated Financial Statements.\n- 12 - The Financial Accounting Standards Board has issued Statement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of\". The Company has not yet determined what impact adoption of the new standard will have on the Company's results of operations or financial position; however, management does not believe the impact will be material. The Company ceased operations at its South Holland facility in 1995. Machinery and equipment that was located at the facility was written down to net realizable value as of December 31, 1995. This value was based upon the proceeds received at an auction of the equipment held in February 1996 when the equipment was completely liquidated.\nRESULTS OF OPERATIONS\n1995 Versus 1994\nResults of operations for 1995 reflect the disposition of the Company's liquid detergent and fabric softener dryer sheet businesses as of July 14, 1995. These businesses accounted for approximately $27.2 million of net revenues in 1995 versus $51.7 million of net revenues during 1994. The Company continues to manufacture powdered laundry detergents.\nOverall net revenues in 1995 decreased approximately 40% versus the prior year. Net revenues from the continuing business (excluding liquid detergent and fabric softener sheet revenues) decreased approximately 29% in 1995 versus 1994. This decline can be attributed largely to a decrease in sales to two customers: Sears and Lever Brothers.\nSales to Sears in 1995 were approximately $3.5 million lower than last year; a decrease of approximately 25%. This decline was partially attributable to promotional activity in 1994 as well as competitive pressures that have had a negative impact on sales in general.\nSales to Lever Brothers in 1994 included approximately $2.0 million of sales of autodish gel and concentrated fabric softener and $1.3 million of sales of fabric softener sheets. As previously reported, Lever transferred this business out of DeSoto during the second and third quarters of 1994. The Company no longer manufactures either product.\nSales to Kmart in 1995 were approximately $8.2 million lower than the comparable period in 1994. Sales were made to Kmart as part of the liquid laundry detergent operations which were sold in July. Approximately $3.4 million of the decline in sales to Kmart occurred before this business was disposed of.\nThe decline in gross profit resulted from pricing pressures, product and customer mix, reduced volume, increased packaging costs and unrecovered fixed costs at certain of the Company's operating plants. In addition, the Company continued to manufacture products for the buyer of its liquid detergent business from July to October in 1995. These products were sold to the buyer at prices that approximated cost.\nSelling, general and administrative costs declined approximately 15% in 1995 versus 1994. This decline reflects the elimination of administrative personnel subsequent to the business dispositions in 1995 as well as continued efforts at cost containment. Selling, general and administrative expenses in 1994 also included the operation of the Columbus, Georgia facility, which closed in March 1994 and the Stone Mountain, Georgia facility, which closed in July 1994.\nNonrecurring expense included a net loss on the sale of the liquid detergent and fabric softener sheet businesses (including the write-off of related goodwill) and a $3.1 million provision for costs associated with the resulting closure of operating facilities due to these dispositions.\n- 13 -\nInterest expense in 1995 was lower than the prior year because the Company had no outstanding borrowing subsequent to September 1995 when the Company completely repaid the outstanding borrowing under its credit facility with CIT. Nonoperating income in 1995 included approximately $6.1 million from insurance settlements and approximately $244,000 of royalty income related to technology sold by the Company in 1990.\nIn general, the effects of inflation have not been material to the Company.\n1994 Versus 1993\nNet revenues decreased approximately 14% from 1993. The decrease was primarily the result of lower sales to Lever and the loss of a customer to which the Company made $5.0 million in sales during 1993. Other losses and gains of business for the most part offset each other. The 1993 revenues also included approximately $3.1 million in sales related to Jean Sorelle, the assets and business of which were sold on December 30, 1993. Sales to Lever declined approximately $7.0 million versus 1993. During 1994, Lever transferred its autodish gel business to one of Lever's own production facilities and transferred its fabric sheet business to another company.\nThe decline in gross profit was attributable to customer and product mix. Competitive pricing pressures in the marketplace continued to depress pricing. While new business was obtained, in most cases it was at a lower gross profit than the lost business it replaced. There was also continued pressure to participate in advertising and promotional support of various customers. This too negatively impacted gross profit.\nSelling, general, and administrative costs were reduced significantly from 1993. Approximately $1.2 million of the reduction related to the fact that the 1993 results included an entire year of expenses related to Jean Sorelle. This business was sold on December 30, 1993. The shutdown of the two Georgia facilities also resulted in a reduction of approximately $500,000. The disposition of the former headquarters facility in 1993 resulted in the elimination of approximately $750,000 in carrying costs in 1994. There was a significant reduction in 1994 with respect to legal fees and outside professional fees resulting from the settlement of various outstanding legal matters. The reduction also reflected the Company's continued focus on cost control and containment across all functions of the Company.\nNonoperating income in 1994 included the settlement of arbitration related to a portion of the business sold in 1990. Other components of nonoperating income included a settlement related to fees paid for professional services and royalty income related to technology sold by the Company in 1990.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe financial statements listed in the \"Index to Financial Statements and Financial Statement Schedule\" are filed as a part of this report on page S-1 hereof.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone.\n- 14 - PART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nBOARD OF DIRECTORS\nSet forth below is certain information, as of February 15, 1996, about each director of the Company. Unless otherwise provided, each director has served in the capacity indicated (or in comparable administrative or executive positions with the same corporation) for the past five years.\nTerms Expiring at the 1996 Annual Meeting (Class II)\nANNE E. EISELE Director since 1994 President of the Company since September 1995; Chief Financial Officer of the Company since Age: 40 November 1992; served the Company in various executive or administrative positions since March 1984.\n_______________\nPAUL E. PRICE Director since 1988 Retired Senior Vice President of The Quaker Oats Company (manufacturer of grocery products and pet foods) Age: 61\nDirector: Xytronyx, Inc.; and Eljer Industries, Inc.\n_______________\nTerms Expiring at the 1997 Annual Meeting (Class III)\nDANIEL T. CARROLL Director since 1991 Chairman of the Board and President of the Carroll Group, Inc. (a management consulting firm). Age: 69\nDirector: Aon Corporation; Comshare, Inc.; Diebold, Inc.; Wolverine World Wide, Inc.; A. M. Castle & Co.; American Woodmark Corporation; Oshkosh Truck Corp.; and Woodhead Industries, Inc.\n_______________\nWILLIAM P. LYONS Director since 1991 Chairman of JVL Corp., (a manufacturer of generic and over- the-counter pharmaceutical products) since 1992; President Age: 54 and Chief Executive Office of William P. Lyons and Co., Inc. (an investment firm) since 1975; Chairman and Chief Executive Officer of Duro Test Corp. (a manufacturer of specialty lighting products) from 1988 to 1991.\nDirector: Holmes Protection Group, Inc.; Lydall, Inc.; and Video Lottery Technologies, Inc.\n_______________\nWILLIAM SPIER Director since 1990 Chairman of the Company from 1991 to present; Chief Executive Officer of the Company from 1991 to January 1994 and from Age: 61 September 1995 to present; President and Chairman of Sutton Holding Corp. (a corporation formed for the purpose of acquiring the Company) from 1989 to present, and a private investor from 1982 to present.\nDirector: Geotek Communications, Inc.; Holmes Protection Group, Inc.; and Video Lottery Technologies, Inc.\n_______________ Terms Expiring at the 1998 Annual Meeting (Class I)\nANDERS U. SCHROEDER Director since 1990 Vice Chairman of the Company from 1991 to present; Chief Executive Officer of Asgard Ltd. (real estate investments and Age: 45 corporate investments) since 1990; Executive Vice President of Sutton Holding Corp. (a corporation formed for the purpose of acquiring the Company) since 1989; partner in law firm of O Bondo Svane from 1982 to 1992.\n_______________\nDAVID M. TOBEY Director since 1990 Managing Director of Parkway M&A Capital Corporation (a company engaged in investments) since 1988. Age: 57\nDirector: Competitive Technologies, Inc.\n_______________\nSection 16(a) of the Securities Exchange Act of 1934 (the \"Exchange Act\") requires the Company's directors and executive officers, and persons who own more than ten percent of a registered class of the Company's equity securities, to file by specific dates with the Securities and Exchange Commission (the \"SEC\") initial reports of ownership and reports of changes in ownership of Common Stock and other equity securities of the Company on Forms 3, 4 and 5. Officers, directors and greater than ten-percent stockholders are required by SEC regulation to furnish the Company with copies of all Section 16(a) forms they file. The Company is required to report in this proxy statement any failure to file by the relevant due date any of these reports based solely on the Company's review of copies of such reports furnished to it and written representations received by the Company that the filing of a Form 5 was not required. Based upon this review, the Company is not aware of any person, who at any time during 1995, was a director, officer or a beneficial owner of more than ten percent of any class of equity securities of the Company registered pursuant to the Exchange Act that failed to file on a timely basis reports required by Section 16(a) of the Exchange Act during 1995.\n- 16 - Item 11.","section_11":"Item 11. Executive Compensation\nCOMPENSATION OF EXECUTIVE OFFICERS\nThe following table sets forth certain information for the years ended December 31, 1993, 1994, and 1995 concerning the compensation of the Chief Executive Officer and the one other most highly compensated executive officer of the Company who was serving as an executive officer as of December 31, 1995. The table also sets forth the compensation paid to two other executive officers who left the Company during 1995 and who otherwise would have been included in the table. In accordance with the rules and regulations of SEC, the compensation of only three executive officers in addition to the Chief Executive Officer is reported because no other executive officer serving as such as of December 31, 1995 earned from the Company $100,000 or more in salary for the year ended December 31, 1995.\nSummary Compensation Table\n________________________\n(a) Includes participants' before tax deposits to the DeSoto Stock Ownership Plus Plan. (b) Mr. Spier served as Chief Executive Officer until December 13, 1993; effective September 1, 1995, Mr. Spier was again appointed Chief Executive Officer. (c) Mr. Phillips first became an employee of the Company as of December 13, 1993. Mr. Phillips' employment contract provided for the grant on January 3, 1994 of an award of 30,000 shares of restricted stock pursuant to the 1992 Stock Plan of which 15,000 vested on grant and the remaining 15,000 shares vested on December 13, 1994. The value of Mr. Phillips' 30,000 shares as presented in the table is based upon the stock price on the dates the shares vested. The value of Mr. Phillips' 30,000 shares of stock at December 31, 1995 was $105,000. The amount under \"All Other Compensation\" represents paid vacation of $12,740 and contributions by the Company to Mr. Phillips' account in the DeSoto Stock Ownership Plus Plan of $2,772 in 1995 and contributions by the Company to Mr. Phillips' account in the DeSoto Stock Ownership Plus Plan in 1994. Mr. Phillips resigned as President and Chief Executive Officer, effective August 31, 1995. See \"Employment Contracts\". (d) During 1993, Ms. Eisele was Vice President - Finance, Chief Financial Officer and Secretary; Ms. Eisele was named Senior Vice President in October 1993. As of September 1, 1995, Ms. Eisele was appointed President and continued as Chief Financial Officer. The amount under All Other Compensation represents contributions by the Company to Ms. Eisele's account in the DeSoto Stock Ownership Plus Plan. Ms. Eisele has been granted 10,000 shares of common stock under the 1992 Stock Plan to be awarded in 2,500 share installments on each May 2 from 1995 through 1998. The value of Ms. Eisele's 2,500 shares as presented in the table is based upon the stock price on the date the shares vested. The value of Ms. Eisele's 2,500 shares of stock at December 31, 1995 was $8,750. On November 8, 1995, Ms. Eisele was granted an option to purchase an additional 10,000 shares of Common Stock.\n- 17 - (e) Mr. Bowen first became an employee of the Company as of May 2, 1994. The amount under \"All Other Compensation\" represents paid vacation of $8,654 and severance pay of $75,000 in 1995 and contributions by the Company to Mr. Bowen's account in the DeSoto Stock Ownership Plus Plan in 1994. Mr. Bowen had been granted 10,000 shares of common stock under the 1992 Stock Plan to be awarded in 5,000 share installments on each May 2 from 1995 through 1996. Mr. Bowen resigned as an employee of the Company, effective May 31, 1995, and the second 5,000 share installment has been forfeited. Additionally, the options grant for 20,000 shares has also been forfeited. The value of Mr. Bowen's 5,000 shares as presented in the table is based upon the stock price on the date the shares vested. The value of Mr. Bowen's 5,000 shares of stock at December 31, 1995 was $17,500.\nShown below is information with respect to stock options granted during the year ended December 31, 1995 under the Company's 1992 Stock Plan, which provides, among other things, for the grant of options to purchase shares of Common Stock.\nOption Grants, Exercises and Year-End Values - 1995 Option Grants\n_______________________\n(a) Stock appreciation rights may not be granted under the Company's 1992 Stock Plan. (b) Under the rules and regulations of the SEC, the potential realizable value of a grant is the product of (i) the difference between (x) the product of the per share market price at the time of grant and the sum of 1 plus the adjusted stock price appreciation rate (the assumed rate of appreciation compounded annually over the term of the option) and (y) the per share exercise price of the option and (ii) the number of securities underlying the grant at year-end. Assumed annual rates of stock price appreciation of 5% and 10% are specified by the SEC and are not intended to forecast possible future appreciation, if any, of the price of the shares of Common Stock of the Company. (For example, if the price of shares of Common Stock remained at the exercise price of the options, (i.e. a 0% appreciation rate), the potential realized value of the grant would be $0.) The actual performance of such shares may be significantly different from the rates specified by the SEC. (c) The grant was made as of November 8, 1995 with an exercise price equal to the market price at that time. The options were immediately exercisable.\nThe following table provides certain information with respect to the number and value of unexercised options outstanding as of December 31, 1995.\nAggregated 1995 Option Exercises and December 31, 1995 Option Values\n(a) Calculated by determining the difference between the fair market value of the Common Stock underlying the options on December 31, 1995 (3 1\/2, the closing price on the New York Stock Exchange - Composite Transactions) and the exercise price of the options on that date.\n- 18 - DEFINED BENEFIT PLAN\nThe following table presents the estimated annual benefits payable upon retirement at age 65, after selected periods of continuous service, under the DeSoto Employees' Retirement Plan (the \"Pension Plan\") and the Salaried Employees' Pension Preservation Plan (the \"Preservation Plan\"):\nEstimated Annual Pension Benefits at Age 65\nYears of Service in DeSoto Employee's Retirement Plan Average Annual Cash Compensation During Five Consecutive 10 Years 20 Years 30 Years 35 Years Years of Highest Pay Service Service Service Service\n$100,000 $ 16,700 $ 33,300 $ 50,000 $ 58,500 125,000 20,850 41,650 62,500 73,000 150,000 25,000 50,000 75,000 87,500 175,000 29,150 58,350 87,500 102,000 200,000 33,300 66,700 100,000 116,500 225,000 37,500 75,000 112,500 131,250 250,000 41,650 83,350 125,000 145,850 275,000 45,850 91,650 137,500 160,400 300,000 50,000 100,000 150,000 175,000 325,000 54,150 108,350 162,500 189,600\nThe compensation covered by the Pension Plan and the Preservation Plan is substantially the same as that reported under the \"Salary\" and \"Bonus\" columns of the Summary Compensation Table, limited, however, to $150,000 for 1995 (or such other amount provided by Section 401(a)(17) of the Internal Revenue Code of 1986, as amended (the \"Code\")). As of December 31, 1995, the estimated credited years of service of Messrs. Spier and Phillips and Ms. Eisele are approximately 5,2 and 12, respectively. Mr. Bowen was not vested in the Plan as of the date of his resignation from the Company. Benefits are computed on the basis of a straight life annuity and are subject to offset for Social Security benefits (although the calculation of the offset under the Salaried Pension Plan differs from the offset under the Preservation Plan). To the extent an employee's benefit as computed under the Salaried Pension Plan exceeds the limitations provided under the Code or an employee's service exceeds 35 years, the benefit will be provided under the Preservation Plan.\nIn a settlement of litigation which became effective in 1992 related, among other things, to the Company's pension plans, employees of the Company who were participants in the pension plans on or after March 1, 1989 and prior to June 10, 1991, in essence, will receive a 3% increase in their accrued pension benefits as of June 10, 1991 under the plans, and such participants who have completed ten years of service with DeSoto but whose employment terminates or terminated prior to their attaining age 55 will be entitled to receive unreduced deferred vested benefits under the plans beginning at age 63 instead of age 65, but if they commence receiving such benefits prior to age 63, they will continue to receive reduced benefits on the same terms and conditions as previously. (Messrs. Spier, Phillips and Bowen are not eligible for these increased benefits; Ms. Eisele is eligible.)\nCOMPENSATION OF DIRECTORS\nDirectors who are not employees of the Company are paid an annual retainer fee of $6,000 and, in addition, receive $800 for each Board or committee meeting attended and for each day such director is deposed for litigation concerning the Company. In addition, in accordance with the terms of the DeSoto, Inc. 1992 Stock Plan, which was approved by stockholders at the 1992 Annual Meeting of Stockholders on May 27, 1992, each non-employee director of the Company receives an initial grant of options to purchase 3,000 shares of Common Stock upon the date the individual becomes a non-employee director (directors serving on May 27, 1992 received the grant 30 days subsequent to stockholder approval) and, thereafter, annual grants of options to purchase 500 shares of Common Stock. Options granted to non-employee directors have an exercise price equal to one hundred percent of the fair market value (as defined in the Plan) of the Common Stock on the date the options are granted, have a term of ten years, and are exercisable at any time after the date of grant.\n- 19 -\nEMPLOYMENT CONTRACTS\nIn connection with the employment of John R. Phillips by the Company and as an incentive for Mr. Phillips to join the Company, the Company entered into an employment contract, dated as of December 13, 1993, with Mr. Phillips employing him as President and Chief Executive Officer and appointing him as a member of the Board of Directors effective as of January 3, 1994. The contract provided for an annual base salary of $250,000, the provision of benefits including life insurance and medical benefit plans and the use of a company car and, after 1994, participation in bonus plans generally on the same terms as other senior officers of the Company, the provision of $12,000 per year as a housing allowance, and reimbursement of business expenses and a club membership. In addition, the contract provided for the grant on January 3, 1994 of an award of 30,000 shares of restricted Common Stock pursuant to the 1992 Stock Plan, of which 15,000 vested on grant and the remaining 15,000 shares vested on December 13, 1994; and the grant, pursuant to the 1992 Stock Plan, on March 31, 1994, of a non-statutory option to purchase 70,000 shares of Common Stock with an exercise price equal to the \"Fair Market Value\" on that date (as defined in the 1992 Stock Plan as the last sale price of shares on that date), of which 14,000 shares would vest on each December 13 from 1994 through 1998. The contract had an initial term of two years and, unless notice not to extend was given by the Company or Mr. Phillips, as of June 13, 1994, would be automatically extended so that the unexpired term as of any day would always be eighteen months. Under the contract, Mr. Phillips agreed to certain confidentiality and other similar provisions and to restrictions on his ability to compete with the Company.\nFollowing a reported restructuring of the Company in July 1995, Mr. Phillips resigned, effective as of August 31, 1995, as President and Chief Executive Officer and as a member of the Company's Board of Directors; and entered into an agreement with the Company, dated as of September 1, 1995, providing for the termination of his employment contract, effective as of August 31, 1995, and for his employment by the Company, for a six-month period from September 1, 1995 through February 29, 1996, to assist the Company during the transition following his resignation. Under the new agreement with Mr. Phillips, Mr. Phillips will continue to receive, over the aforesaid six-month period, an aggregate compensation of $62,500, payable in equal installments in accordance with the Company's customary payroll practices, corresponding to the salary he received under his original employment contract. For the thirty months next following the expiration of said six-month period, Mr. Phillips will receive the aggregate sum of $312,500, in equal installments, also in accordance with the Company's customary payroll practices, corresponding to the balance of the amount otherwise due to Mr. Phillips, under his original employment contract, upon the termination of that contract, Mr. Phillips' having agreed to the extension of the payout of his severance entitlement ($325,000), under his original employment contract, from eighteen to thirty-six months. Additionally, Mr. Phillips' options to purchase 70,000 shares of Common Stock were immediately vested, under the terms of his original employment contract, upon the termination of that contract; and Mr. Phillips has a period of nine months, from September 1, 1995 through May 31, 1996, within which to exercise such options in whole or in part. Under Mr. Phillips' new agreement, he will continue to receive the same medical and other insurance benefits he had received under his original employment contract, under the same conditions, until the earlier of August 31, 1996 or his obtaining alternative coverage elsewhere; the continued use of a company car through May 1996; and continued club membership through 1996. Mr. Phillips also agreed to continue to abide by the confidentiality and other similar provisions, and to restrictions on his ability to compete with the Company, as contained in his original employment contract.\nIn September 1993, the Company entered into an agreement with Anne E. Eisele, then Senior Vice President and Chief Financial Officer, which provided for certain payments to be made to her in the event of a change in control of the Company, the amount of which depends on whether she remains in the Company's employ. This arrangement was amended as of March 12, 1996, to provide for the payment of two years' severance based upon her then current compensation in the event of a change in control of the Company.\n- 20 -\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nSTOCK OWNERSHIP OF MANAGEMENT AND OTHERS\nThe following table sets forth certain information as of February 15, 1996 (except as otherwise indicated) regarding the beneficial ownership of shares of voting stock of the Company held by (i) directors, (ii) each person or entity known to the Company who beneficially owns more than 5% of the outstanding Common Stock or Senior Preferred Stock, (iii) each executive officer named in the Summary Compensation Table appearing in \"Compensation of Executive Officers\", and (iv) all directors (including nominees) and executive officers as a group. Except as otherwise indicated, each person or entity has sole voting and investment power of the shares listed. For purposes of this table, shares which are not outstanding but which are subject to options or warrants are deemed to be outstanding for purposes of computing the percentage of outstanding shares of the class owned by the holder of the option or warrants but are not deemed to be outstanding for the purpose of computing the percentage of the class owned by other persons.\n(1) The information under this caption is based on representations made to the Company by individual directors or nominees and\/or filings made with the Securities and Exchange Commission.\n(2) Sutton Holding Corp., a New York corporation, is part of a group filing a joint Schedule 13D with respect to ownership of shares of Common Stock that includes Anders U. Schroeder, an affiliate of William Spier, and parties having a business relationship with David Tobey. Sutton is owned by, Asgard Ltd. (an affiliate of Anders U. Schroeder), Parkway M&A Capital Corporation (\"Parkway\"), M&A Investment Pte Ltd. (\"M&A\") (entities having a business relationship with David Tobey), and an individual having no other relationship with the Company. Messrs. Spier, Schroeder and Tobey are directors and officers of Sutton. Sutton's address is 101 East 52nd Street, 11th Floor, New York, New York 10022.\n- 21 - (3) Sutton is the record owner of 100 shares of Common Stock. The stock ownership reported in the table for Sutton also includes the stock ownership of the other parties to the Schedule 13D referred to in Note 2 as follows: Coatings Group, Inc. (\"Coatings Group\") beneficially owns 779,840 shares of Common Stock, of which 246,507 shares are currently outstanding and 533,333 shares are issuable upon warrants beneficially owned by Coatings Group; Anders U. Schroeder and an affiliated entity beneficially own 618,970 shares of Common Stock, of which 218,970 shares are currently outstanding and 400,000 are issuable upon warrants beneficially owned by the affiliate of Mr. Schroeder (options granted to Mr. Schroeder pursuant to the 1992 Stock Plan have not been included in the foregoing or in the ownership for Sutton reported in the table); Parkway beneficially owns 350,811 shares of Common Stock, of which 84,144 are currently outstanding and 266,667 are issuable upon exercise of warrants beneficially owned by Parkway; and M&A beneficially owns 47,368 shares of Common Stock, all of which are currently outstanding. Consequently, Sutton and these related parties currently beneficially own an aggregate of 597,089 currently outstanding shares of Common Stock and 1,200,000 shares of Common Stock issuable upon exercise warrants having an exercise price of $7.00 per share, representing the 1,797,089 shares of Common Stock reported in the table. (Options granted pursuant to the 1992 Plan to affiliates of any of these parties have not been included in these numbers.)\n(4) Parties related to Sutton own all of the shares of Senior Preferred Stock reported in the table. Coatings Group owns 259,259 of such shares, an affiliate of Anders U. Schroeder owns 194,444 of such shares, and Parkway owns 129,630 of such shares.\n(5) Represents shares of Common Stock and Senior Preferred Stock currently owned by parties referred to in Note 2 and 1,200,000 shares of Common Stock issuable upon exercise of warrants owned by such parties as described in Note 3.\n(6) Mr. Spier's stock ownership includes 246,507 currently outstanding shares of Common Stock and 533,333 shares of Common Stock issuable upon exercise of warrants owned by Coatings Group, a corporation of which Mr. Spier is President and Chairman of the Board, and options to purchase 30,000 shares of Common Stock which are currently exercisable and were granted pursuant to the 1992 Stock Plan. (The Coatings Group stock ownership also has been included in the stock ownership reported for Sutton. See Note 3.) The listed shares do not include the 100 shares owned by Sutton or 100 shares held by Mr. Spier's father-in-law, as to which Mr. Spier may be deemed the beneficial owner.\n(7) All such shares are owned by Coatings Group. See Note 3.\n(8) As reported by Mario J. Gabelli and various entities which he directly or indirectly controls and for which he acts as chief investment officer (the \"Gabelli Group\") its members include the following: Gabelli Funds, Inc. (\"GFI\"), GAMCO Investors, Inc. (\"GAMCO\"), Gabelli Securities, Inc. (\"GSI\"), Gabelli & Company, Inc. (\"Gabelli & Company\"), Gabelli Performance Partnership (\"GPP\"), GLI, Inc. (\"GLI\"), The Gabelli Associates Fund (\"Gabelli Associates\"), Gabelli Associates Limited (\"GAL\"), The Gabelli & Company, Inc. Profit Sharing Plan; Gabelli International Limited (\"GIL\"), Gabelli International II Limited (\"GIL II\"), Mario J. Gabelli (\"Mr. Gabelli\"), Lynch, Safety Railway and Western New Mexico. The address of Mario J. Gabelli and the Gabelli Group is c\/o J. Hamilton Crawford, Jr., Gabelli Funds, Inc., One Corporate Center, Rye, New York 10580-1434. Based on information in Amendment No. 22 to Schedule 13D, dated July 14, 1995, the Gabelli Group owns its shares of Common Stock as follows: Mario J. Gabelli, 7,500 shares; GAMCO, 602,800 shares; GSI, 1,000 shares; and GIL II, 6,500 shares. Each of the above persons or entities has sole voting and dispositive power over its shares, except that GAMCO does not have authority to vote 62,900 reported shares.\n(9) Does not include options not yet issued in 1996 under the 1992 Stock Plan, but which under the terms of such Plan will be automatically granted shortly to non-employee directors. Pursuant to the Plan, on June 6, 1996, each of the non-employee directors will receive a grant of options to purchase 500 shares of Common Stock.\n(10) Mr. Schroeder's stock ownership includes stock owned by Asgard Ltd. (\"Asgard\"). Asgard, a corporation affiliated with Mr. Schroeder, owns 218,970 currently outstanding shares of Common Stock, 194,444 shares of Senior Preferred Stock and beneficially owns 400,000 shares of Common Stock issuable upon exercise of warrants. (Asgard's stock ownership has been included in the stock ownership reported for Sutton. See Note 3.) Also includes options to purchase 20,000 shares of Common Stock, which are currently exercisable and were granted pursuant to the 1992 Stock Plan.\n- 22 -\n(11) All such shares are owned by Asgard Ltd., a corporation affiliated with Mr. Schroeder.\n(12) Based on information in Schedule 13G, dated as of January 26, 1996. The address of Pioneering Management Corporation is 60 State Street, Boston, Massachusetts 02109.\n(13) Based on information in Amendment No. 3 to Schedule 13D filed jointly by LL Capital Partners, L.P. and its general partner Lance Lessman, dated as of December 1, 1995. The address of LL Capital Partners, L.P. is 375 Park Avenue, New York, New York 10152.\n(14) Based on information in Schedule 13G, dated as of February 7, 1996, filed by Dimensional Fund Advisors Inc. (\"Dimensional\"), a registered investment advisor, Dimensional is deemed to have beneficial ownership of 242,300 shares of common stock, all of which shares are held in portfolios of DFA Investment Dimensions Group Inc., a registered open-end investment company, or in series of the DFA Investment Trust Company, a Delaware business trust, or the DFA Group Trust and DFA Participation Group Trust, investment vehicles for qualified employee benefit plans, all of which Dimensional Fund Advisors Inc. serves as investment manager. Dimensional disclaims beneficial ownership of all such shares.\n(15) Includes options to purchase 70,000 shares of Common Stock which are currently exercisable and were granted pursuant to the 1992 Stock Plan.\n(16) Includes shares of Common Stock held in Ms. Eisele's account in the DeSoto Stock Ownership Plus Plan and options to purchase 30,000 shares of Common Stock which are currently exercisable and were granted pursuant to the 1992 Stock Plan. Does not include 2,500 shares of common stock to be awarded on May 2, 1996 under the 1992 Stock Plan.\n(17) Includes 25,000 shares of Common Stock owned by the William P. Lyons and Co., Inc. Pension Trust, the only participant and beneficiary of which is Mr. Lyons. Also includes options to purchase 4,500 shares of Common Stock, which are currently exercisable and were granted pursuant to the 1992 Stock Plan.\n(18) Includes options to purchase 4,500 shares of Common Stock, which are currently exercisable and were granted pursuant to the 1992 Stock Plan. Does not include the stock ownership of Parkway and M&A. See Note 3.\n(19) Does not include the 129,630 shares owned by Parkway.\n(20) Does not include stock ownership of Parkway and M&A. See Note 3.\n(21) Includes shares of Common Stock held in Mr. Bowen's account in the DeSoto Stock Ownership Plus Plan.\n(22) Includes options to purchase 4,500 shares of Common Stock which are currently exercisable and were granted pursuant to the 1992 Stock Plan.\n(23) Includes 1,943 shares of Common Stock beneficially held in the DeSoto Stock Ownership Plus Plan for the account of executive officers. Also includes stock ownership of Sutton Holding Corp. to the extent not otherwise included in the beneficial ownership of directors and officers, stock options held by directors and officers if exercisable within 60 days and shares issuable upon exercise of warrants. (Without inclusion of such Sutton Holding Corp. stock ownership, directors and officers, as a group, would own (i) 1,676,253 shares of Common Stock, representing approximately 28.8% of the outstanding shares of Common Stock, (ii) 453,703 shares of Senior Preferred Stock, representing approximately 28.8% of all such shares, and (iii) approximately 33.3% of all voting stock.)\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nInapplicable.\n- 23 -\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(a) The following documents are filed as a part of this report:\n1. The financial statement schedule listed in the \"Index to Financial Statements and Financial Statement Schedule\" filed as a part of this report on page S-1 hereof.\n2. The exhibits listed in the \"Index to Exhibits\" filed as a part of this report on pages E- 1 through E-3 hereof.\n(b) Reports on Form 8-K\nA current report on Form 8-K dated as of January 16, 1996 was filed to report under Item 5 that the Company had notified the Pension Benefit Guaranty Corporation of its intention to terminate its Employee Retirement Plan, effective as of April 15, 1996, contingent upon the receipt of appropriate governmental approvals.\nA current report on Form 8-K dated as of March 13, 1996 was filed to report under Item 5 that the Company was discussing a proposed merger with Keystone Consolidated Industries, Inc.\n- 24 -\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.\nDeSoto, Inc. (Registrant)\nBy Anne E. Eisele* Anne E. Eisele President March 29, 1996\nPursuant to the requirements of the Securities Exchange Act 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\nWilliam Spier* Director, Chief Executive Officer and Chairman of the Board ) ) Anders U. Schroeder* Director and Vice Chairman ) ) ) Anne E. Eisele* Director, President and ) Chief Financial Officer ) March 29, 1996 ) Fred J. Flaxmayer* Corporate Controller and ) Chief Accounting Officer ) ) Daniel T. Carroll* Director ) ) William P. Lyons* Director ) ) Paul E. Price* Director ) ) David M. Tobey* Director )\n*By Anne E. Eisele___________________________ Anne E. Eisele, Attorney-in-Fact\n- 25 -\nDeSOTO, INC. AND SUBSIDIARIES\nINDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE Year Ended December 31, 1995\nPage\nReport by management S-2\nReport of Independent Public Accountants S-3\nConsolidated statements of operations S-4\nConsolidated statements of stockholders' equity S-5\nConsolidated balance sheets S-6\nConsolidated statements of cash flows S-7\nNotes to consolidated financial statements S-8 to S-23\nQuarterly revenues and earnings data (1995 versus 1994) S-24\nThe following financial statement schedule is furnished herewith pursuant to the requirements of Form 10-K:\nSchedule II - Valuation and Qualifying Accounts S-25\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 in notes thereto.\nS-1 Report By Management\nThe management of the Company has prepared the accompanying financial statements. The financial statements for the year ended December 31, 1995 have been audited by Arthur Andersen LLP. Arthur Andersen LLP's report indicates that the 1995 financial statements present fairly, in all material respects, the financial position, results of operations and cash flows of the Company in accordance with generally accepted accounting principles, but raises matters that create doubt about the Company's ability to continue as a going concern, and states that the financial statements do not include adjustments that might result from the outcomes of the uncertainties.\nThe financial statements were prepared from the Company's accounting records, books and accounts which, in reasonable detail, accurately and fairly reflect all material transactions. To assure the accuracy of the Company's accounting records, books and accounts, the Company maintains a system of internal controls. These internal controls are designed to provide reasonable assurance that transactions are executed and recorded in the Company's books and records, and the Company's assets are maintained and accounted for, in accordance with management's authorizations. The Company's accounting records, policies and internal controls are reviewed by the Company's internal audit staff.\nThe Audit Committee of the Board of Directors of the Company, which is comprised of three outside directors, recommends for appointment by the Board and approval by the stockholders the firm of independent public accountants who are engaged on a yearly basis to audit the financial statements of the Company. The Audit Committee meets with the independent auditors to review the scope of the audit, the results of the audit and the recommendations made by said accountants with respect to the Company's accounting methods and system of internal controls.\nAnne E. Eisele President and Chief Financial Officer\nWilliam Spier Chairman of the Board and Chief Executive Officer\nS-2\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Stockholders and Board of Directors of DeSoto, Inc.\nWe have audited the accompanying consolidated balance sheets of DeSoto, Inc. (a Delaware corporation) and Subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1995. 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 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 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 DeSoto, Inc. and Subsidiaries as of December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\nThe accompanying financial statements for 1995 have been prepared assuming that the Company will continue as a going concern. As discussed in Note B to the financial statements, the Company has suffered recurring losses from operations and negative operating and financing cash flows, and has contingent liabilities related to environmental matters, income taxes and the 1992 acquisition of J.L. Prescott Company, that collectively raise substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in Note B. The financial statements do not include any adjustments that might result from the outcome of these uncertainties.\nOur audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule listed in the Index to Financial Statements and Financial Statement Schedule is the responsibility of the Company's management and is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\nARTHUR ANDERSEN LLP\nChicago, Illinois, March 25, 1996\nS-3\nCONSOLIDATED STATEMENTS OF OPERATIONS DeSoto, Inc. and Subsidiaries\nYear Ended December 31, 1995 1994 1993 (in thousands except per share amounts)\nNET REVENUES............................ $52,339 $87,182 $101,175\nCOSTS AND EXPENSES: Cost of sales........................ 54,069 84,800 96,309 Selling, administrative and general.. 10,164 11,889 18,794 Retirement security program.......... (6,846) (6,495) (4,753) Nonrecurring expense................. 6,159 - 5,925 -------- -------- -------- TOTAL OPERATING COSTS AND EXPENSES...... 63,546 90,194 116,275 -------- -------- -------- LOSS FROM OPERATIONS.................... (11,207) (3,012) (15,100)\nOTHER CHARGES AND CREDITS: Interest expense..................... 546 575 642 Nonoperating expense................. - - 1,601 Nonoperating income.................. (6,360) (1,303) (4,021) -------- -------- -------- Loss before Income Taxes................ (5,393) (2,284) (13,322) Benefit for Income Taxes................ (758) (649) (5,232) -------- -------- -------- NET LOSS................................ (4,635) (1,635) (8,090)\nDividends on Preferred Stock............ (507) (319) (302) -------- -------- -------- Net Loss Available for Common Shares.... $(5,142) $(1,954) (8,392) ======== ======== ======== NET LOSS PER COMMON SHARE............... $ (1.10) $ (0.42) $ (1.83) ======== ======== ======== Average Common Shares Outstanding....... 4,677 4,657 4,598 ======== ======== ========\nSEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nS-4\nS-5\nS-6\nS-7 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nA. SUMMARY OF ACCOUNTING POLICIES\nPrinciples of Consolidation. The consolidated financial statements include the accounts of the company and its subsidiaries. All significant intercompany accounts and transactions have been eliminated.\nShort-Term Investments. For purposes of the statements of cash flows, the Company considers all investments purchased with a maturity of three months or less to be cash equivalents.\nInventories. Inventories are valued at the lower of cost or market. Cost is computed on the last-in, first-out (LIFO) method for all inventories. The cost of products includes raw materials, direct labor and operating overhead. If the first-in, first-out (FIFO) method of inventory accounting had been used for all of the Company's inventories, inventories would have been $1,493,000 and $1,889,000 higher than reported at December 31, 1995 and 1994, respectively.\nProperty and Depreciation. Property is recorded at cost. Repairs and maintenance are charged to expense. Depreciation of property, plant and equipment is provided by charges to earnings based on the estimated useful lives of the assets, computed primarily on accelerated methods. Useful lives were 10-40 years for buildings and improvements and are 10 years for machinery and equipment.\nGoodwill and Amortization. Goodwill represented the excess of cost over the fair value of net assets acquired, and was being amortized by the straight-line method over 40 years until the related businesses were sold in 1995. This goodwill was written off in 1995 as a result of the disposition of the liquid detergent and fabric softener sheet businesses in 1995.\nReclassifications. Certain reclassifications have been made to the 1994 and 1993 financial statements and footnotes to conform with current year presentation.\nRevenue. Revenue is recognized at the time goods are shipped.\nResearch and Development. Research and development costs are charged to expense. These charges were $218,000 in 1995, $345,000 in 1994, and $665,000 in 1993.\nIncome Taxes. Income taxes are provided based on the liability method of accounting pursuant to Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes.\" Deferred income taxes are recorded to reflect the tax consequences on future years of differences between the tax basis of assets and liabilities and their financial reporting amounts at each year-end.\nUse of Estimates. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent 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.\nS-8\nB. LIQUIDITY AND CAPITAL RESOURCES\nThe Company's financial statements for the year ended December 31, 1995 have been prepared on a going concern basis which contemplates the realization of assets and the settlement of liabilities and commitments in the normal course of business. The Company has incurred operating losses of $11.2 million, $3.0 million, and $15.1 million in 1995, 1994 and 1993, respectively; and cash flows from operations have been $1.0 million, $(1.9) million and $(4.0) million in 1995, 1994 and 1993, respectively. Cash flows from operations in 1995, however, included the cash proceeds from insurance settlements of $6.1 million, and $10.0 million from the reduction of working capital.\nIn addition to operating and financing cash flow losses, the Company continues to be party to environmental exposures as discussed in Note I, has received a notice of tax deficiencies from the IRS as discussed in Note F., and has a contingent liability related to the 1992 Prescott acquisition as discussed in Note L. Although management has used the best information available to record the estimated liabilities for these matters, actual outcomes could differ from recorded amounts. Additionally, the timing of cash required to satisfy these obligations could significantly impact the Company's cash flows in 1996.\nAs part of the Company's continuing effort to manage its accounts payable and cash flow requirements, the Company has been negotiating a Trade Composition Agreement and a related Security Agreement with its trade creditors as represented by a committee of six major creditors of the Company. The proposed agreements include a standstill agreement related to accounts payable existing as of September 22, 1995. Also, as part of the proposed Trade Composition Agreement, the Company initiated the termination of its overfunded pension plan to be effective contingent upon the receipt of appropriate governmental approvals. For further information regarding the plan termination, refer to Note C to the Consolidated Financial Statements. Under the standstill agreement, if certain conditions are met, the creditors who sign the agreement agree not to initiate litigation or other efforts to collect amounts owed to them. The Company has agreed to pay each Qualified Trade Creditor (as defined) the balance owed to that creditor within 10 days of receipt of the reverted excess pension plan assets. If payment is not made by July 1, 1996, interest would accrue from that date at 8% per annum on the outstanding balance. The proposed Security Agreement would grant a security interest and lien on all of the Company's assets to secure the obligations of the Company to the Qualified Trade Creditors. The proposed Trade Composition Agreement further stipulates that the Company may suspend efforts to terminate its pension plan if the Company enters into a binding agreement for a merger, asset sale or similar transaction, involving substantially all of the Company's assets, which provides that all Qualified Trade Creditors will be paid in full. The Company and its creditors have been operating within the understanding outlined above. The actual Standstill Agreement document was circulated for signatures on March 11, 1996 and final execution of the documents has not yet been completed. The Company is continuing to pursue, with the assistance of its investment bankers, a possible business combination; however, there can be no assurance as to the outcome of such efforts. For further information regarding a possible business combination, refer to Note P to the Consolidated Financial Statements.\nS-9 C. PENSION AND EMPLOYEE INVESTMENT PLANS\nThe Company's retirement security program includes a noncontributory defined benefit pension plan and an employee investment plan covering substantially all employees except certain hourly-rated employees; the Company also contributes to union sponsored plans. The Company's pension plan benefits are principally based on the employee's compensation and years of service. The Company's funding policy is to contribute annually at a rate that is intended to remain at a level percentage of compensation for the covered employees. The Company was not required to make contributions to the Company sponsored pension plan in 1995, 1994 and 1993 due to the plan's overfunded status.\nIn January 1996, the Company announced that it had notified the Pension Benefit Guaranty Corporation of its intention to terminate the pension plan to be effective contingent upon the receipt of appropriate governmental approvals. The Company further intends to use 25% of the excess assets in the pension plan to fund a replacement plan and purchase an annuity contract to cover accrued plan benefits. The remaining excess plan assets will be subject to a 20% federal excise tax and federal and state income taxes. If more than 75% of the excess assets were reverted to the Company from the plan, such reversion would be subject to a 50% federal excise tax and federal and state income taxes. The Company intends to utilize the reversionary funds to satisfy, among other things, various creditor obligations and stabilize ongoing operations. As an alternative to termination of the pension plan, the Company is also continuing to pursue a possible business combination, in its ongoing efforts to preserve and maximize shareholder values; however, there can be no assurance as to the outcome of such efforts. For further information regarding the possible business combination, refer to Note P to the Consolidated Financial Statements.\nThe Company makes contributions to the employee investment plan in cash or Company stock in an amount equal to 30% of employee deposits up to 5% of such employee's gross pay.\nThe costs of the pension and employee investment plans are summarized as follows:\nThe change in the net amortization and deferral from 1993 to 1994 and from 1994 to 1995 was primarily due to the difference between the actual return on Plan assets, which was favorable in 1995 and unfavorable in 1994, versus the expected return on Plan assets. Under Statement of Financial Accounting Standards No. 87, the difference between the actual and expected return on assets is deferred and amortized over subsequent periods.\nS-10 The pension plan's assets at December 31, 1995 are invested in United States Treasury Notes, corporate bonds and notes, investment partnerships, United States Treasury Securities, time deposits, commercial paper, interest rate futures, forward exchange contracts, foreign currency, certain real estate operated by the Company, various mutual funds invested in bonds, equity and real estate, mortgages and other short-term investments. The pension plan's funded status and amounts recognized in the Company's balance sheets at December 31 are presented below:\n1995 1994 (in thousands of dollars)\nActuarial present value of vested benefit obligation... $ 65,719 $ 57,540 ======== ======== Accumulated benefit obligation......................... $ 65,877 $ 57,702 ======== ======== Plan assets at fair value.............................. $162,017 $135,764 Actuarial present value of projected benefit obligation......................... 66,832 59,471 -------- -------- Plan assets in excess of projected benefit obligation.. 95,185 76,293 Unrecognized net gain.................................. (40,595) (27,707) Prior service costs.................................... 2,064 2,259 Unrecognized net asset................................. (9,741) (11,526) -------- -------- Prepaid pension cost recognized on the balance sheet... $ 46,913 $ 39,319 ======== ========\nThe weighted average discount rate used in determining the actuarial present value of the projected benefit obligation was 7.5% in 1995 and 8.9% in 1994. The rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligation was 5.0% in 1995 and 1994. The expected long-term rate of return on assets used in determining pension income was 8.0% in 1995 and 7.0% in 1994.\nIn October 1992, the Company completed the sale of its real properties in Joliet, Illinois, Columbus, Georgia, and Union City, California, to a real property trust created by DeSoto's pension plan. This trust paid approximately $6.5 million in cash for the properties and entered into a ten- year lease of the properties to the Company. The Company's initial annualized rental obligation was $707,000. The amount paid to the Company by the trust and the Company's annual rental obligation were based upon an independent appraisal and approved by the Company's Board of Directors.\nEffective January 1, 1994, the DeSoto Salaried Plan, Hourly Plan and J. L. Prescott Plan were merged into the DeSoto Employee Retirement Plan. This action resulted in a combination of the assets of each of these plan into one trust fund. The method of calculating benefits under each of these plans remained unchanged.\nIn March 1994, the Company ceased operations at the Columbus, Georgia facility. Effective October 1, 1994, the Company entered into an agreement to sublease the facility for a term of three years. The subtenant makes monthly rental payments directly to the pension trust; the Company continues to make monthly rental payments to the pension trust for the amount by which the Company's initial rental obligation exceeds the subtenant's rental obligation.\nIn December 1994, the Company sold its real property located in South Holland, Illinois, to the real property trust of the Company's pension plan. The trust paid $4,117,000 in cash for the properties and has entered into a ten-year lease of the properties to the Company. The Company's annualized rental obligation (net of receipts from subtenants) is approximately $898,000 including the South Holland facility. The amount paid to the Company by the trust and the Company's annual rental obligation were based upon an independent appraisal and approved by the Company's Board of Directors.\nS-11\nD. POST RETIREMENT AND OTHER POST EMPLOYMENT BENEFITS\nThe Company provides certain health care and life insurance benefits for retired employees on a contributory basis. Substantially all of the Company's employees, except certain hourly-rated employees, may become eligible for such benefits if they reach qualifying retirement age while working for the Company. Such benefits and similar benefits for active employees are administered by two outside companies whose administrative fees are based upon number of participants and claims processed. The health care program is self funded by the Company with purchased stop loss coverage for claims over certain levels. Life insurance benefits are funded by policies for which the Company pays premiums. In certain cases the participants also contribute to the premium payment. The following table presents the costs of accruing the postretirement insurance benefits in 1995, 1994, and 1993:\nThe following table presents the components of the Company's post- retirement benefit obligation and the amount recognized in the Company's balance sheets at December 31, 1995 1994 (in thousands of dollars) Accumulated post-retirement benefit obligation: Current retirees $2,831 $2,819 Active plan participants 373 393 ------ ------ Total 3,204 3,212 Unrecognized net loss 1,621 1,687 Accrued post-retirement liability ------ ------ recognized on the balance sheet $1,583 $1,525 ====== ======\nThe assumed health care cost trend rate used to measure the expected cost of benefits covered by the plan was 7% and 8% as of December 31, 1995 and 1994, respectively. The weighted average discount rate used to measure the accumulated post-retirement insurance obligation was 7.5% for 1995 and 9.0% for 1994. A one percentage point increase in the assumed health care cost trend rate for each future year would have resulted in additional obligation of $288,000 at December 31, 1995 and would have increased the aggregate service and interest cost by $29,000 in 1995.\nThe Company adopted Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits\" effective January 1, 1994. The impact of adoption was not material to the Company's financial position or results of operations.\nS-12 E. REVOLVING CREDIT AGREEMENT AND OTHER DEBT\nOn November 12, 1992, in conjunction with the acquisition of J. L. Prescott Company (\"Prescott\"), the Company entered into an amended credit agreement with Harris Trust and Savings Bank and two additional banks. The agreement had originally provided for a two-year revolving credit facility of up to $20,000,000. Effective October 1, 1993, the credit facility was reduced to $15,000,000 per conditions set in the November 12, 1992 amendment. The termination date of this amended agreement was originally October 31, 1994. In March 1994, the facility was further amended setting a termination date of January 1, 1995. Effective with the March 1994 amendment, the Company paid $2,700,000 of the outstanding debt upon the receipt of its income tax refund for fiscal year 1993. Up to the March 1994 amendment, the revolver carried an interest rate equal to either the prime rate of Harris Trust and Savings Bank plus 1 1\/4% or the IBOR rate plus 3 1\/2% (as amended in the third quarter of 1993). Effective in March 1994, the interest rate became the prime rate of Harris Trust and Savings plus 2%.\nOn December 7, 1994, the Company entered into a revolving credit facility with CIT. The agreement provided for up to $14,000,000 under a revolving credit facility. The funds available for borrowing were based on a formula which included specified percents of accounts receivable and inventory. The interest rate on the facility was prime plus 1 1\/4%. Commitment fees under the revolving credit facility were calculated at 1\/4 of one percent per annum of the average unused and available portion of the facility. The facility was collateralized by substantially all of the Company's assets. A portion of the line of credit was available in the form of letters of credit. As of September 30, 1995, the revolving credit agreement was terminated and the Company had no outstanding borrowing as of that date.\nCash payments for interest were $546,000 in 1995, $575,000 in 1994 and $535,000 in 1993.\nS-13\nF. INCOME TAXES 1995 1994 1993 (in thousands of dollars) The benefit for income taxes is comprised of: Federal Income Taxes: Currently Refundable........... $ - $ - $(4,808) Deferred....................... (608) (493) 249 ------ ------ -------- Federal Income Taxes........... (608) (493) (4,559) State and Local Income Taxes... (150) (156) (673) ------ ------ -------- Total Income Tax Benefit....... $(758) $(649) $(5,232) ====== ====== ========\nNet cash refunds of income taxes were $0 in 1995, $8,742,000 in 1994 and $1,446,000 in 1993.\nA reconciliation of the statutory federal income tax rate to the effective tax rate is presented below:\n1995 1994 1993\nStatutory Federal Income Tax Rate............... (35.0)% (35.0)% (34.0)% Effect of: Write off of Goodwill......................... 22.0 - - Effect of Tax Rate Changes on Deferred Taxes.. (0.9) 7.6 - State Income Taxes, Net....................... (0.9) (3.6) (3.4) E.P.A. Fine................................... - 0.3 0.3 Other......................................... 0.7 2.3 (2.2) ------ ------ ------ Effective Rate................................ (14.1)% (28.4)% (39.3)% ====== ====== ======\nS-14\nThe components of the net deferred income tax asset and liability were as follows:\nDecember 31, 1995 1994 (in thousands of dollars) Current Deferred Tax Asset: Restructuring and Cost Containment....... $ 1,899 $ 917 Inventory................................ 531 1,989 Retirement Security Program.............. 272 315 Insurance................................ 210 441 Valuation Reserves....................... 144 844 Vacation Pay............................. 137 225 Other.................................... (1,144) (1,436) -------- -------- Total Current Deferred Tax Asset........... $ 2,049 $ 3,295 ======== ======== Long Term Deferred Tax Liability: Prepaid Pension.......................... $18,390 $15,570 Other Reserves........................... 3,919 3,092 Restricted Investments................... 1,773 2,129 Depreciation............................. 1,287 2,413 Net Operating Loss Carryforward.......... (7,681) (3,889) Waste Site Cleanup....................... (2,859) (3,669) Deferred Gain - Sale of Assets........... (1,091) (1,255) Post Retirement Insurance................ (658) (624) State and Local Income Taxes............. (459) (480) Valuation Reserves....................... (377) (404) Other.................................... (783) 509 -------- -------- Total Long-Term Deferred Tax Liability..... $11,461 $13,392 ======== ========\nAt December 31, 1995, the company had net operating loss carryforwards of approximately $22.0 million. These carryforwards expire between 2007 and 2010.\nThe Company has received a Report of Tax Examination Changes from the Internal Revenue Service that proposes adjustments resulting in additional taxes due of $6.5 million and penalties of $1.4 million, as well as an unspecified amount of interest for the years 1990 through 1993. The Company has filed a formal appeal of the proposed adjustments. The Company believes that the resolution of this matter will not have a material adverse effect on the Company's financial position or results of operations, although the timing of cash required to settle any amounts ultimately due could have a significant impact on the Company's cash flows.\nS-15 G. LEASE COMMITMENTS\nThe Company leases certain facilities and equipment under lease agreements which are classified as operating leases. These leases are for remaining periods ranging from one to ten years and in some instances include renewal provisions at the option of the Company. Rental expense was $1,592,000 in 1995, $1,652,000 in 1994 and $2,107,000 in 1993.\nRENTAL COMMITMENTS (in thousands of dollars) Total\n1996....................................................... $1,267 1997....................................................... 1,263 1998....................................................... 1,101 1999....................................................... 1,098 2000....................................................... 1,098 2001-2004.................................................. 2,978 ------ $8,805 ======\nH. SEGMENT REPORTING\nThe Company operates in one industry segment, the manufacture of detergent. The Company also performs contract manufacturing and packaging of detergents. The Company's products are sold in retail stores, including mass merchants and service centers, throughout the United States. The Company's revenues are derived from several customers. There are five customers which each have accounted for more than 10% of the Company's revenues as indicated below. The Company no longer does business with Kmart or Benckiser as a result of the transactions disclosed in Note O to the Consolidated Financial Statements.\n% of Consolidated Net Revenues 1995 1994 1993\nSears, Roebuck & Co. 20% 16% 14% Kmart 10% 15% 10% Procter & Gamble 13% 10% * Benckiser 12% * * Lever Brothers * * 11%\n*Less than 10% of consolidated net sales.\nFrom time to time, the Company enters into manufacturing and packaging agreements with its contract packaging customers. These contracts include product specifications, production procedures and other general terms. The contracts do not obligate the customer to make any purchases.\nS-16\nI. ENVIRONMENTAL MATTERS\nThe Company has been identified by government authorities as one of the parties potentially responsible for the cleanup costs of waste disposal sites, many of which are on the U.S. EPA's Superfund priority list, and for certain alleged contamination. In addition, damages are being claimed against the Company in private actions for alleged personal injury or property damage in the case of certain other waste disposal sites. The waste disposal sites relate to the Company's discontinued operations. The Company's potential responsibility in connection with these sites generally depends upon, among other things, whether it, directly or through third parties, engaged in the business of waste disposal or storage, shipped waste to the sites and, in those cases in which the Company did so ship waste, the relative amount and\/or composition of waste material attributable to the Company as compared to the waste material attributable to other solvent parties. Typically, the Company is one of numerous parties involved in actions or proceedings relating to these waste disposal sites and its obligations in connection with its share of cleanup and other costs extend over a number of years rather than being payable at one time.\nThe Company believes that it has made adequate provisions for the costs it may incur with respect to the sites. The Company provides a reserve for the lower end of an estimated range of total loss from $7.3 to $21.6 million (after considering information provided by independent legal counsel). These estimates are subject to numerous variables, the effects of which are difficult to measure, including the stage of the investigations, the nature of potential remedies, the joint and several liability with other potentially responsible parties and other issues. Accordingly, the reserves represent the Company's best estimates of its potential exposure at this time. The reserve balance was $7.3 million as of December 31, 1995 and $9.3 million as of December 31, 1994. In 1995, the Company paid out approximately $2.3 million on waste site related liabilities, excluding legal and administrative costs; of this amount $1.1 million was disbursed from the trust discussed below and $29,000 was disbursed from the restricted cash account discussed below.\nActual costs to be incurred in future periods may vary from the estimates. The Company's potential liability may be materially impacted in the future as a result of final determinations of the extent of environmental damage, the share of the cost of cleanup technology which is ultimately chosen, the extent of the cleanup required, the solvency of other potentially responsible parties, changes in law and unanticipated awards of damages for personal injury or property damages. In addition, the Company has not reduced its estimates of liability to reflect the possible proceeds of insurance coverage which may be applicable to these costs. The Company from time to time engages in discussions with insurance carriers regarding Company claims in this regard and the Company may pursue litigation if no satisfactory resolution of the claims is reached. The Company reached settlements with two insurance carriers in 1995 regarding the cost of cleanup at certain waste disposal sites. As a result of these settlements, the Company received proceeds in 1995 totaling approximately $6.1 million.\nIn connection with the Company's acquisition of Prescott in November 1992, the Company assumed the cleanup obligations of Prescott under New Jersey's Environmental Cleanup and Responsibility Act (\"ECRA\"). Pursuant to an agreement with certain former owners of Prescott, the Company in 1993 received funds to offset the cost of the cleanup previously held in escrow for the benefit of Prescott. (The Company has placed these funds in a restricted cash account to secure its cleanup obligations.) The Company currently expects that these funds will fully cover the costs of cleanup required by New Jersey. The remaining liability related to this site is included in the ranges above. The remaining funds are shown on the balance sheet under the caption, restricted cash.\nS-17\nUnder the terms of the 1990 consumer paint asset purchase agreement with Sherwin-Williams, $6.0 million of the sale's proceeds were used to establish a trust fund to fund potential clean-up liabilities. The trust agreement expires on October 26, 2000, or when the trust is depleted, whichever occurs first. A portion of the trust has been set aside with respect to a specific site; the agreement governing that portion of the trust expires on October 26, 2008. The Company has access to the trust fund, subject to the other party's approval, for any expenses or liabilities incurred by the Company regarding environmental claims relating to the sites identified in the trust agreement. Sherwin-Williams has access to the trust fund, subject to the other party's approval, for any expenses or liabilities incurred as a result of DeSoto's failure to meet its obligations relating to the sites identified in the agreement. The Company was reimbursed $1,095,000 in 1995 and $145,000 in 1994 from the trust to cover waste site payments. The balance in the trust fund, primarily invested in United States Treasury securities and classified as a restricted investment on the balance sheet, as of December 31, 1995 was $4,524,000. Of the estimated range of total loss noted above, $2.3 to $5.0 million relate to sites which are covered by the escrow account. The accrued waste site cleanup liability that was covered by the trust at December 31, 1995 was $2,346,000 of which $755,000 was classified as current.\nUnder the terms of the 1990 industrial coatings business purchase agreement, the Company had delivered to the Valspar Corporation an irrevocable standby letter of credit in the amount of $2.0 million. The letter of credit was delivered to secure the Company's obligation to indemnify Valspar for certain environmental matters. The Company reached a settlement with Valspar in 1994 under which the letter of credit was terminated.\nIn December 1993, the Company transferred approximately $9.0 million of liabilities for certain of its clean-up costs and related expenses at certain waste disposal sites to DeSoto Environmental Management, Inc. (DEMI), a subsidiary of the Company. The Company remains liable for the potential environmental clean-up costs if DEMI is unable to satisfy the obligations. The purpose of DEMI is to provide focused, strategic management of the environmental liabilities and the related clean-up costs. The Company and certain members of the Company's management and consultants are stockholders in DEMI. Refer to Note K of the Notes to Consolidated Financial Statements for further information.\nIt is the opinion of management, after evaluating the variables discussed above as well as the anticipated time frame for remediation, that the resolution of the waste site liability will not have a material adverse effect on the Company's financial position, cash flows or results of operations.\nJ. CONTINGENCIES & LITIGATION\nAs previously reported, there are several shareholder actions still pending in the Delaware courts relating to various proposals of Sutton Holding Corp. to acquire the Company in the period 1989 to 1991. These actions, all of which consolidated, have not been actively pursued and it appears the case was removed from the courts calendar; however, the plaintiffs recently served a discovery request upon the Company. The Company believes that these actions are not material.\nSee Note L to the Consolidated Financial Statements for information regarding the Contingent Value Rights (\"CVR's\") which were issued by the Company to the sellers in connection with the Company's acquisition of J.L. Prescott Company in November 1992.\nThe Company is also a party to other litigation arising out of the ordinary conduct of its business or results of current and discontinued operations.\nThe Company believes that the disposition of all such actions, individually and in the aggregate, will not have a material adverse effect on the Company's financial position, cash flows, or results of operations.\nS-18 K. RELATED PARTY TRANSACTIONS\nIn December 1993, the Company completed a number of transactions involving certain of its subsidiaries and officers and directors. J. L. Prescott Company, a wholly-owned subsidiary of the Company, paid off a portion of intercompany obligations to the Company by means of the issuance of a ten-year, $9 million principal amount, promissory note. The Company used this note to purchase 100 shares of a non-voting class of common stock of another of its subsidiaries, DeSoto Environmental Management, Inc. (\"DEMI\"). (This class of common stock is entitled to 15% of the dividends or other distributions made to all classes of common stock.) As part of the sale of stock to the Company, DEMI assumed up to a maximum of $9 million of certain of the Company's possible clean-up costs and related expenses at waste disposal sites. The Company remains liable for these possible environmental clean-up costs if DEMI is unable to satisfy these obligations. The Company subsequently sold at a price of $1 per share the shares of non- voting common stock of DEMI to Anders Schroeder (Vice Chairman) (33 shares), William Spier (Chairman and Chief Executive Officer) (33 shares), Anne Eisele (President and Chief Financial Officer) (20 shares), and Irving Kagan (Special Counsel) (14 shares). Messrs. Schroeder and Spier subsequently sold 8 shares and 9 shares, respectively, of their common stock to John Phillips upon his becoming President and Chief Executive Officer in 1994. Mr. Phillips sold his shares back to Messrs. Spier and Schroeder upon his resignation in 1995. Each of these persons agreed that upon complete satisfaction of the Company's existing environmental clean-up liabilities or when that person ceases to be an officer, director or consultant of the Company, the DEMI shares held by that person would be repurchased by the Company at the greater of $1 per share or the per share book value of DEMI. As a general matter, the value of this DEMI stock will be dependent upon the ability of DEMI, which has no other significant business or assets, to satisfy the Company's existing environmental liabilities for less than $9 million, which was the approximate minimum amount included in the 1994 estimated range of environmental liability. Consequently, the holders of this DEMI stock have a direct incentive to minimize the costs of satisfying environmental liabilities. In any event, the Company will retain 85% of the savings below the 1994 estimated minimum costs and savings which do not reduce the liabilities below such estimated minimum will accrue entirely to the Company. This transaction was approved by a unanimous vote of all disinterested directors.\nIn November 1992, the Company announced the completion of the sale of certain real properties to a trust created by the Company's Pension Plans. In 1993, certain of these assets were repurchased from the Pension Plans by the Company and then sold to an unrelated third party. In 1994, the Company's facility in South Holland, Illinois, was sold to the real property trust of the Company's Pension Plans. Refer to Note C of the Notes to Consolidated Financial Statements for further information.\nIn July 1992, the Company entered into an agreement with parties related to Sutton Holding Corp. (\"Sutton\"), which as of December 31, 1995 and in conjunction with parties related to Sutton, owns 14% of the Company's outstanding common stock and approximately 23% of all of the Company's outstanding voting stock, providing for a cash purchase of newly issued DeSoto securities. The investment resulted in Sutton's acquiring 583,333 shares of a new series of DeSoto senior preferred stock and warrants to acquire 1.2 million shares of common stock. Refer to Note L of the Notes to Consolidated Financial Statements, for further information regarding this transaction.\nL. REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY\nAs of December 31, 1995, there were 5,619,274 shares of common stock issued of which 940,067 shares were held as treasury stock. The Company's common stock has a $1 par value per share, and there are 20,000,000 shares authorized.\nIn July 1992, the Company entered into an agreement with parties related to Sutton Holding Corp. (\"Sutton\"), providing for a $3.5 million cash purchase of newly issued DeSoto securities. The investment resulted in Sutton's acquisition of 583,333 shares of a new series of DeSoto senior preferred stock and warrants to acquire 1.2 million shares of common stock per approval of the Company's stockholders at the 1993 Annual Meeting.\nS-19 The DeSoto senior preferred pays 8% quarterly cumulative dividends (which increase to 10% if dividends earned remain unpaid for more than one year), has one vote per share (voting with common stock as a single class), has a liquidation preference of $6.00 per share, must be redeemed by the Company at liquidation preference after eight years and may be redeemed at the Company's option after five years. The carrying amount of the preferred shares on the balance sheet represents the proceeds received upon issuance (net of related expenses) plus accretion to the redemption value of the shares in five years. The carrying value has also been increased by cumulative dividends not currently declared. The warrants have a term of six years and are exercisable at $7.00 per share of common stock.\nDividends have not been paid on the preferred stock since the date of issuance. In addition, dividends may not be declared on the common stock while dividends on the preferred stock are in arrears. At December 31, 1995 unpaid dividends on the preferred totaled approximately $1,197,000.\nThe purchase price of $3.5 million for the new securities was allocated by the Company, upon the advice of an independent financial advisor, as $2.5 million for the preferred stock and $1.0 million for the warrants. The valuation took into account the terms of the purchase agreement and applied customary financial analyses used in such transactions to those terms.\nThe agreement with Sutton resulted from negotiations between Sutton and a Special Committee of the Company's Board of Directors comprised of persons unaffiliated with Sutton. The Special Committee was represented by independent legal counsel and received an opinion from an independent financial advisor, selected by the Committee, that the arrangements with Sutton are fair, from a financial point of view, to the stockholders of the Company (other than those related to Sutton).\nSutton includes entities affiliated with William Spier, Chairman and Chief Executive Officer of the Company, and Anders Schroeder, Vice Chairman of the Company, and entities represented by David Tobey, a director of the Company.\nIn 1992, the Company also amended the terms of its stockholder rights plan to permit the parties related to Sutton to increase their ownership of common shares and other voting securities to approximately 38.2% of the Company's outstanding voting power (whether by exercise of warrants or acquisitions of common shares in the market or otherwise). In addition, the plan was amended to permit any stockholder to acquire up to 25% of the Company's outstanding voting power (as compared to the previous 20% limit).\nAs a result of the $3.5 million purchase of senior preferred stock, parties related to Sutton now hold securities representing approximately 23% of the Company's currently outstanding voting securities. If securities issuable upon exercise of warrants are included, parties related to Sutton would own approximately 38% of the outstanding voting power of the Company.\nIn connection with the 1992 Prescott acquisition, the Company also issued 522,775 shares of DeSoto common stock, which were held in treasury, and agreed to make a per share payment at the end of three years equal to the difference, if any, between $12 and the highest 60-day average trading price, if lower than $12 per share, of DeSoto common stock during the second and third years following the acquisition, with a maximum obligation of $6 per share (the \"Contingent Value Rights\" or \"CVR's'). The payment shall be subject to reduction as provided by the Agreement which governs the payment (the \"Agreement\"). Per the Agreement, the payment, if any, shall be made in cash to the extent not prohibited (as defined in the Agreement). Any payment not made in cash is to be made by issuance of DeSoto securities and\/or DeSoto common stock in that order. As of the measurement date of the Agreement (November 12, 1995), the amount calculated as payable under the terms of the Agreement, before the deduction of amounts the Company believes are appropriate and permitted under the terms of the Agreement, is $1,934,000; after applying such deductions the Company believes it is not required to make any payment, although the CVR holders contend otherwise, and accordingly, no obligation has been recorded related to the Agreement. The Company intends to vigorously defend its position in this matter, which may include additional claims by the Company.\nS-20\nM. STOCK OPTIONS AND STOCK GRANTS\nShares of stock and stock options have been granted to certain employees, consultants, and nonemployee directors under the stock plan adopted in 1992. The options granted to employees and consultants are qualified stock options (ISO) and the options granted to non employee directors are nonqualified options. The ISO options vest equally over the three years subsequent to the first anniversary of the grant date and are exercisable for a period of 10 years from the grant date. The nonqualified options are exercisable immediately upon grant and are exercisable for a period of 10 years from the grant date. All options have been granted at the prices equal to the fair market value of the stock on the dates the options were granted. At December 31, 1995, 50,500 of the 400,000 shares of stock available for options or grants under the Company's stock option plan remained available for grants. Options which are terminated, lapsed or expired shall again become available for issuance under the stock option plan.\nStock options have been granted and exercised as set forth below:\nOutstanding Option Price Exercisable Options Per Share-Range Options\nDecember 31,1993 181,500 5.875 - 10.125 83,833 Options granted 122,000 5.50 - 7.00 27,000 Options that became exercisable - 7.00 - 9.00 60,333 Options exercised (10,000) 7.00 (10,000) Options lapsed and canceled (29,000) 5.875 - 9.00 (19,000) ------- ------- December 31, 1994 264,500 5.50 - 10.125 142,166 Options granted 27,000 4.375 - 4.750 27,000 Options that became exercisable - 6.625 - 9.00 122,334 Options lapsed and cancelled (35,000) 6.625 - 9.00 (35,000) ------- ------- December 31, 1995 256,500 4.375 - 10.125 256,500 ======= =======\nDuring 1994, 30,000 shares of common stock were granted to an officer of the Company at no cost. All granted shares vested in 1994. The average market price of the common stock at the close of business on the vesting dates in 1994 was $5.81. An additional 20,000 shares of common stock were granted to officers of the Company in 1994. Of those shares, 7,500 shares vested in 1995 and 5,000 shares were canceled in 1995; the remaining shares vest over the period from 1996 to 1998. The average market price of the common stock at the close of business on the vesting date in 1995 was $5.13.\nS-21 N. OTHER INCOME AND EXPENSE\nThe following are components of the respective captions in the statements of operations:\n1995 1994 1993 (in thousands of dollars) Nonrecurring expense: Provision for restructuring due to disposition of liquid laundry and fabric softener sheet businesses $ 3,100 $ - $ - Loss on disposition of liquid laundry detergent and fabric softener sheet businesses 3,059 - - Provision for shutdown of Columbus, Georgia Plant - - 2,000 Loss on disposition of Jean Sorelle - - 1,331 Write-down of machinery and equipment held for resale - - 1,194 Provision for manufacturing and product rationalization - - 900 Settlement of lawsuit (including plaintiff's legal fees) - - 369 Other - - 131 ------- ------- ------- Total $ 6,159 $ - $ 5,925 ======= ======= ======= Nonoperating expense: Provision for waste site cleanup $ - $ - $ 1,467 Other - - 134 ------- ------- ------- Total $ - $ - $ 1,601 ======= ======= ======= Nonoperating income: Insurance settlements $(6,067) $ - $ (232) Royalties (244) (222) (53) Arbitration settlement - discontinued operations - (837) - Reimbursement of legal fees - (244) - Sale of land and building - - (3,235) Pension settlement - discontinued operations - - (454) Other (49) - (47) ------- ------- ------- Total $(6,360) $(1,303) $(4,021) ======= ======= =======\nO. DISPOSITIONS\nOn July 21, 1995, the Company announced the transfer and assignment of various operations and assets involved in its liquid detergent and fabric softener dryer sheet businesses to two separate buyers. The Company assigned the rights to certain customers with respect to these businesses. The Company also sold other assets which included certain accounts receivable, inventory and machinery and equipment. The proceeds of these transactions were utilized to reduce the Company's senior debt owed to CIT. Both transactions also provide for the Company to receive royalties and other earn-out opportunities over a three-year period in one case and over a four-year period in the other case.\nS-22 The Company recorded a net loss on the sale of the liquid detergent and fabric softener sheet businesses (including the write-off of related goodwill). The Company also recorded a charge of $3.1 million in the third quarter relative to costs associated with the closure of operating facilities relative to these transactions. Significant components of the charge included severance, rent, real estate taxes and amounts to reduce assets to their net realizable value. The non-recurring expense of $6,159,000 reflects the net impact of these transactions.\nThe following information is provided on a pro forma basis to illustrate the effect of certain adjustments to the historical consolidated financial statements that would have resulted from the above dispositions if such transactions had occurred on January 1, 1994. The results are not necessarily indicative of actual results had the foregoing transactions occurred as described above, nor do they purport to represent results of future operations of the Company.\nTwelve Months Ended December 31, 1995 1994 (in thousands except per share amounts - unaudited)\nNet revenues $25,082 $35,424 ======= ======= Net earnings $ 2,682 $ 1,037 ======= ======= Net earnings per common share $ 0.47 $ 0.21 ======= =======\nThe following table summarizes the non-cash aspects of the sale of the liquid detergent and fabric softener sheet businesses:\nNet selling prices of businesses sold $6,782 Minimum royalty to be paid over a four-year period 1,477 ------ Cash received as part of the transactions $5,305 ======\nP. SUBSEQUENT EVENT\nOn March 13, 1996, the Company announced that it was discussing a proposed merger with Keystone Consolidated Industries, Inc. which, as presently contemplated, would involve an exchange of all of the Company's shares of outstanding stock for 3.5 million shares of Keystone common stock, in a tax-free transaction.\nMerger discussions are ongoing, and are subject to mutual due diligence by the parties, the negotiation and signing of a definitive agreement, the approval of DeSoto's and Keystone's boards of directors and shareholders and Keystone's primary lender, as well as the requisite governmental review. Additionally, the prospective transaction would require a satisfactory resolution of the payout plan with the Company's trade creditors.\nThe merger with Keystone would provide an alternative to the prospective termination of the Company's overfunded pension plan. The termination will not occur if the proposed merger is completed. Additionally, Keystone has an underfunded pension plan with certain funding waivers relating to prior years and has preliminarily discussed the possible merger with the Pension Benefit Guaranty Corporation.\nThere can be no assurance as to the outcome of the merger discussions; or, in this connection, the resolution of DeSoto's trade creditor plan.\nKeystone, headquartered in Dallas, Texas, is engaged in the manufacture and distribution of fencing and wire products, carbon steel rods, industrial wire, nails and construction products.\nS-23 QUARTERLY REVENUES AND EARNINGS DATA (1995 Versus 1994)\n______________________________________________________________ First Second Third Fourth Quarter Quarter Quarter Quarter Total (in thousands of dollars except per share amounts)\nNet Revenues $18,927 $16,314 $11,132 $ 5,966 $52,339 ======= ======= ======= ======= ======= Gross Profit $ (516) $ (58) $(1,093) $ (63) $(1,730) ======= ======= ======= ======= ======= Net Earnings (Loss) $(1,022) $ 2,897 $(6,146) $ (364) $(4,635) ======= ======= ======= ======= ======= Net Earnings (Loss) Per Common Share $ (0.24) $ 0.60 $ (1.33) $ (0.13) $(1.10) ======= ======= ======= ======= =======\n______________________________________________________________ First Second Third Fourth Quarter Quarter Quarter Quarter Total (in thousands of dollars except per share amounts)\nNet Revenues $23,640 $22,286 $21,394 $19,862 $87,182 ======= ======= ======= ======= ======= Gross Profit $ 977 $ 639 $ 543 $ 223 $ 2,382 ======= ======= ======= ======= ======= Net Earnings (Loss) $ 51 $ (744) $ (782) $ (160) $(1,635) ======= ======= ======= ======= ======= Net Earnings (Loss) Per Common Share $ (0.01) $ (0.18) $ (0.19) $ (0.05) $ (0.42) ======= ======= ======= ======= =======\nNOTES: In the third quarter of 1995, the Company completed the transfer and assignment of various operations and assets involved in its liquid detergent and fabric softener dryer sheet businesses to two separate buyers.\nThe results for the second quarter of 1995 include $6.1 million of non-operating income.\nThe results for the fourth quarter of 1994 include $2.9 million of income from the Company's retirement plans. The results for the first quarter of 1994 include $1.1 million of non-operating income.\nThe quarterly information presented above is unaudited.\nS-24 Schedule II\nDeSOTO, INC. AND SUBSIDIARIES\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS FOR THE THREE YEARS ENDED DECEMBER 31, 1995 (in thousands of dollars)\n(A) Accounts written off and cash receipts on reserved accounts. (B) Accounts written off during the respective year. (C) Represents payment of expenses accrued and reclassifications to other reserves. (D) Reclassification of existing reserves and liabilities that now relate to restructured operations. (E) Represents payments of expenses accrued.\nS-25\nDeSOTO, INC.\nINDEX TO EXHIBITS\n3(a) - Certificate of Incorporation (Incorporated by reference to Exhibit 3(a) to the Company's Form SE dated March 22, 1989*)\n3(b) - By-Laws, as amended (Incorporated by reference to Exhibit 3 to the Company's Form SE dated March 25, 1992*).\n4(a)(i) - Rights Agreement dated as of February 20, 1989 between the Company and Harris Trust and Savings Bank (Incorporated by reference to Exhibit 4 to the Company's Form SE dated February 22, 1989*).\n4(a)(ii) - Series A Junior Participating Preferred Stock (Incorporated by reference to Exhibit A to Exhibit 4 to the Company's Form SE dated February 22, 1989*).\n4(a)(iii) - Amendment to Rights Agreement (Incorporated by reference to Exhibit 4 to the Company's Form SE dated November 27, 1989*).\n4(a)(iv) - Amendment to Rights Agreement (Incorporated by reference to Exhibit 4(a) to the Company's Form SE dated March 26, 1991*).\n4(a)(v) - Amendment to Rights Agreement (Incorporated by reference to Exhibit A to the Company's Form 8 dated October 1, 1992*).\n4(b) - The registrant hereby agrees to furnish the Commission, upon request, with the instruments defining the rights of holders of each issue of long-term debt of the registrant.\n4(c)(i) - Preferred Stock and Warrant Purchase Agreement dated as of July 21, 1992 by and among the Company and Management Partners I, L. P., Odin Asgard Overseas N.V. and Parkway M&A Capital Corporation (Incorporated by reference to exhibit 4(b)(i) to the Company's Form SE dated March 22, 1993*).\n4(c)(ii) - Certificate of Designations of Series B Senior Preferred Stock of the Company (Incorporated by reference to exhibit 4(b)(ii) to the Company's Form SE dated March 22, 1993.*)\n4(c)(iii) - Certificate of Designations of Series C Junior Participating Preferred Stock of the Company (Incorporated by reference to exhibit 4(b)(iii) to the Company's Form SE dated March 22, 1993.*)\n________________ *SEC File No. 1-1915\nE-1 10(a)(i) - Employment Agreement, dated as of December 13, 1993, by and between DeSoto, Inc. and a certain former officer of the Company (Incorporated by reference to exhibit 10(d) to the Company's Form SE dated March 25, 1994.*)\n10(a)(ii) - Agreement between the Company and a former officer and former director of the Company (Incorporated by reference to Exhibit 10 to the Company's Form SE dated March 25, 1996*).\n10(b) - Agreement, dated April 5, 1990, with Sutton Holding Corp. (\"Sutton\") and affiliates of Sutton (Incorporated by reference to Exhibit 1 to the Company's Form SE dated April 5, 1990*).\n10(c)(i) - DeSoto Salaried Employees' Pension Preservation Plan (Incorporated by reference to Exhibit 10(i) to the Company's annual report on Form 10-K for the fiscal year ended December 31, 1985*).\n10(c)(ii) - Form of DeSoto Employees Retirement Plan (Incorporated by reference to Exhibit 10(a) to the Company's Form SE dated March 25, 1994*).\n10(d) - Loan and Security Agreement dated as of December 7, 1994 by and between the Company and the CIT Group\/Credit Finance, Inc. (Incorporated by reference to Exhibit 10(a) to the Company's Form SE dated March 24, 1995.*)\n10(e)(i) - Plan and Agreement of Merger, dated as of August 21, 1992, by and among DeSoto, Inc., DeSoto Subsidiary One Corp. and J. L. Prescott Company (Incorporated by reference to Exhibit 2(a) to the Company's Form SE dated August 28, 1992*)\n10(e)(ii) - Stock Redemption Agreement, dated as of August 21, 1992, by and among Narragansett\/Prescott, Inc. DeSoto, Inc., and Matthew Carroll (Incorporated by reference to Exhibit 2(b) to the Company's Form SE dated August 28, 1992*)\n10(e)(iii) - Letter Agreement, dated as of August 21, 1992, by and among Narragansett\/Prescott, Inc. and DeSoto, Inc., (Incorporated by reference to Exhibit 2(c) to the Company's Form SE dated August 28, 1992*)\n10(e)(iv) - Stockholders Agreement, dated as of August 21, 1992, by and between Narragansett\/Prescott, Inc. and DeSoto, Inc., (Incorporated by reference to Exhibit 2(c) to the Company's Form SE dated August 28, 1992*)\n10(f)(i) - Real Estate Sale Contract dated as of December 1, 1994 between DeSoto, Inc., a Delaware corporation (\"DeSoto\"), as Seller, and John M. Gillen, not personally but as Trustee of the DeSoto, Inc. Pension Plans Real Property Trust under Trust Agreement dated October 1, 1992 (the \"Trustee\"), as Purchaser. (Incorporated by reference to Exhibit 10(b) to the Company's Form SE dated March 24, 1995.*)\n________________ *SEC File No. 1-1915\nE-2 10(f)(ii) - Industrial Building Lease dated December 7, 1994 between Trustee as Landlord and DeSoto as Tenant relating to the property at 16750 South Vincennes Road, South Holland, Illinois. (Incorporated by reference to Exhibit 10(c) to the Company's Form SE dated March 24, 1995.*)\n10(g) - Letter Agreement dated August 6, 1993 between DeSoto, Inc. and John Gillen, Trustee of The DeSoto, Inc. Pension Plans Real Property Trust, dated August 6, 1993 (Incorporated by reference to Exhibit 10(c)(ii) to the Company's Form SE dated March 25, 1994.*)\n10(h)(i) - Purchase Agreement, dated as of July 18, 1995, by and among Jennico, Inc. and DeSoto, Inc. (Omitted and filed separately with the Commission requesting Confidential Treatment).\n10(h)(ii) - Asset Purchase Agreement, dated as of July 14, 1995, by and among Meridian Industries, Inc. (d\/b\/a Kleen Test Products) and DeSoto, Inc. (Omitted and filed separately with the Commission requesting Confidential Treatment).\n11 - Computation of Fully Diluted Earnings Per Share.\n21 - The subsidiaries of the Company are as follows:\nSubsidiary State of Incorporation\nJ. L. Prescott Company New Jersey DeSoto Subsidiary Two Corporation New Jersey DeSoto Environmental Management, Inc. Delaware\n23 - Consent of Arthur Andersen LLP\n24 - Power of Attorney by directors and officers of the Company (Incorporated by reference to Exhibit 24 to the Company's Form SE dated March 25, 1996*).\n27 - Financial Data Schedule\n________________ *SEC File No. 1-1915\nE-3 Exhibit 11 DeSOTO, INC. AND SUBSIDIARIES\nCOMPUTATION OF FULLY DILUTED EARNINGS PER SHARE (in thousands except per share amounts)\nYear Ended December 31, 1995 1994 1993\nNet Loss Available for Common Shares $(5,142) $(1,954) $(8,392) ======= ======= ======= Net Loss Per Common Share $ (1.10) $ (0.42) $ (1.83) ======= ======= ======= Average Common Shares Outstanding (A) 4,677 4,657 4,598 ======= ======= =======\nNet Fully Diluted Loss Per Common Share (B) $ (1.10) $ (0.42) $ (1.72) ======= ======= ======= Average Common Shares Outstanding 4,677 4,657 4,598 Additional Shares Outstanding After Application of the Treasury Stock Method 1 - 283 ------- ------- ------- Total (B) 4,678 4,657 4,881 ======= ======= ======= (A) Outstanding common stock options and common stock warrants have been omitted because the effect is anti-dilutive.\n(B) Reflecting the dilutive effect of outstanding common stock options and common stock warrants under the treasury stock method.\nExhibit 23\nCONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS\nAs independent public accountants, we hereby consent to the incorporation of our report dated March 25, 1996, included in this Form 10-K, into the Company's previously filed Form S-8 Registration Statement File Nos. 2-98318 and 2-68923.\nARTHUR ANDERSEN LLP\nChicago, Illinois, March 25, 1996","section_15":""}
{"filename":"805574_1995.txt","cik":"805574","year":"1995","section_1":"ITEM 1. BUSINESS\nOVERVIEW\nRadius Inc. (the \"Company\" or the \"Registrant\" or \"Radius\") designs, develops, manufactures, markets and supports color publishing and digital video computer products for creative professionals. The Company's current product line includes: accelerated color graphics products that facilitate the creation and manipulation of graphical images; video systems and software that can acquire and manipulate video and audio information; high resolution color reference displays that allow users to view two full pages of text, graphics, images and video; and Macintosh operating system (\"MacOS\") compatible computer systems.\nThe primary target markets for the Company's products are color publishing and multimedia. These markets encompass creative professionals involved in such areas as color prepress, graphic arts, video editing, video and multimedia production and playback, and corporate training.\nTo date substantially all of the Company's products have been designed for and sold to users of Macintosh computer products (the \"Macintosh\") manufactured by Apple Computer, Inc. (\"Apple\") as Apple products have been the preferred platform in the Company's target markets.\nAs shown in the accompanying consolidated financial statements, the Company has incurred substantial operating losses and has a deficiency in assets and working capital. Management has implemented, or has developed plans to implement, a number of actions to address this situation including: refocusing its efforts on providing solutions for high end digital video and graphics customers; discontinuing sales of mass market and other low value added products; divesting its color server and monochrome display businesses and exploring opportunities for the divestiture of its MacOS compatible systems products and other product lines; significantly reducing expenses and headcount; subleasing all or a portion of its current facility given its reduced occupancy requirements; and investigating various strategic partnering opportunities.\nThe Company acquired SuperMac Technologies, Inc. (\"SuperMac\") effective August 31, 1994 (the \"Merger\"). The Company's executive offices are located at 215 Moffett Park Drive, Sunnyvale, CA 94089, and its telephone number is (408) 541- 6100.\nPRODUCTS AND APPLICATIONS\nA summary of some of the Company's principal products and their typical applications is set forth below:\nACCELERATED COLOR GRAPHICS PRODUCTS The Radius graphics product families offer a wide range of user choices to enhance the graphics performance of Apple Macintosh computers based on both the NuBus and PCI bus architectures. The choices range from an entry level accelerated 8-bit color graphics card (256 colors with up to 1 million pixels of color display information) to a variety of accelerated 24-bit color graphics cards (up to 16.7 million colors). All of the Company's graphics card products offer a range of high speed QuickDraw acceleration features and support numerous Radius, Apple and other third-party displays ranging from 13-inches to 21-inches in size. The Company's graphics card products also allow the user to switch resolutions \"on-the-fly\" without having to reboot the computer.\nThe ThunderColor (PCI) and Thunder IV (NuBus) class graphics cards offer enhanced resolutions, as well as a number of other acceleration capabilities for Adobe Photoshop, a popular application for working with computer images. These graphics cards also feature hardware pan and zoom capability, enabling users to quickly change the size and the amount of the information on their color display. The Company believes these capabilities allow users working with large amounts of detailed information to be more productive because they can quickly accomplish a variety of tasks using these hardware-based acceleration features.\nThe ThunderColor (PCI), Thunder 30 (PCI), and Thunder IV (NuBus) graphics cards include multiple 66 MHz AT&T digital signal processors (\"DSPs\") that accelerate Adobe Photoshop. Having parallel processing DSPs rather than the base Macintosh's CPU perform the millions of computations required to manipulate Photoshop images means that customers can produce finished results more quickly and are more productive in their creative and production process. These cards include chip technology that enables users to use Photoshop's CMYK color mode faster than the native Macintosh. This is attractive to imaging professionals who use Photoshop to work with and edit images comprised of 'ink' data which is ready for printing. The Company believes this special \"CMYK acceleration\" technology makes working with ink images on a computer display more interactive.\nDIGITAL VIDEO SYSTEMS AND SOFTWARE Radius offers a number of products for the non-linear digital video editing and production market. Non-linear digital editing enables video editors to manipulate pictures and sound in a faster, easier and more cost effective manner than traditional analog tape-based systems. Editors can randomly access and digitally \"cut and paste\" images, videos and sound clips avoiding the tedious process of winding and rewinding of linear tape and the subsequent physical cutting and splicing of film segments.\nVideoVision Studio, Radius' leading desktop video product, was the first fully QuickTime compatible video editing and production system that supported full- screen (640 x 480 pixels), full-motion video at 60-fields per-second.\nVideoVision Studio offers JPEG video compression\/decompression capabilities, 16- bit stereo audio, and allows users to output their finished product directly and easily to videotape. VideoVision Studio is compatible with QuickTime based software applications for editing, effects, titling, graphics, animation and audio.\nRadius Telecast offers broadcast quality digital video for short form projects. Radius Telecast features include: high-quality, Betacam SP component, S- video and composite digitizing and play back; QuickTime-compliant video system software; 16-bit analog audio; and a 19\" rack-mountable design. Radius Telecast is designed to provide full QuickTime support, a high degree of studio integration and professional video and audio support.\nRadius also offers a variety of QuickTime compliant digital video software applications that facilitate the creation and editing of digital video content. Radius Edit is a non-linear professional digital video editing solution that features an intuitive user interface, FX templates, built-in titling, multiple key frames, batch digitizing and picture-in-picture capabilities. VideoFusion offers a variety of high-quality special effects for digital video editing including dynamic morphing, warping, pan-zoom-rotating, titling, chroma keying and compositing. QuickFLIX! is an inexpensive entry level application for creating QuickTime movies for business and education presentations.\nDISPLAYS The Company currently offers a variety of large color reference displays designed for desktop color publishers and graphic artists. The PressView SR series (PressView 21SR and PressView 17SR) is designed to offer the color accuracy, resolution and clarity needed for high quality color prepress, media authoring, photography, medical imaging and scientific image processing. These color reference displays offer consistent and accurate color preproofing at resolutions of up to 1600 by 1200 pixels and support advanced Diamondtron technology. The PrecisionView 21 also offers resolutions of up to 1600 by 1200 pixels but at a lower price point. When used with Radius' ProSense Display Calibrator, the PressView SR series and the PrecisionView 21 support Kodak PrecisionColor, Agfa FotoFlow, Apple ColorSync 2.0 and EFI Color management systems to ensure color accuracy.\nIn the past, the Company has also offered a variety of monochrome displays. As part of its strategy to refocus its business, the Company entered into a definitive agreement on December 21, 1995 to sell its monochrome display business to Display Technologies Electrohome Inc. For a more complete discussion see \"Management's Discussion and Analysis of Financial Condition -- Business Divestitures.\"\nCOLOR MANAGEMENT PRODUCTS Color peripherals tend to vary over time from their original specifications, thus causing significant color variances. Display calibrators control the way peripherals produce color, making the color more consistent and predictable. The Company's Prosense Display Calibrator works with sensing technology and Macintosh software to measure the actual color performance of a display and then adjust information in the Macintosh graphics card so that the colors will be \"in balance.\" This product also communicates with a number of third party color management systems to provide color information about the display so that color can be managed from one peripheral to another.\nMACOS COMPATIBLE SYSTEMS The Company currently offers two MacOS-compatible systems for the color publishing and multimedia markets: The Radius 81\/110 and the Radius System 100. The Radius 81\/110 is based on Apple's 110 MHz PowerPC 601 processor and is designed for the NuBus bus architecture. The Radius 81\/110 provides the user with a base system that can then be customized to meet the users specific color publishing or multimedia needs. The Radius System 100 is preconfigured with Radius' Thunder IV GXY1600 graphics card, a 2 gigabyte hard drive and preloaded application software.\nRadius faced a number of challenges in entering the MacOS-compatible systems market including shortages of MacOS compatible systems components, Apple's transition from NuBus to PCI based systems that resulted in severe price erosion for NuBus based systems, manufacturing start-up issues, and the availability of sufficient capital to finance the business. For these and other reasons, the Company is now negotiating to sell its MacOS compatible systems business.\nCOLOR SERVER PRODUCTS The Company's Splash color server products enable customers to turn their Xerox MajestiK Color Copiers into printers and scanners that operate over a network. A Splash card is configured in a Macintosh computer and works in concert with Adobe CPSI (Configurable Postscript Interpreter) software to turn complex images of text, graphics and photographic information into high-resolution (400 dpi), high quality color prints. Splash cards process computer information and then quickly send it to a MajestiK Color Copier so that the copier engine technology can operate as a color printer connected to a network (Macintosh or PC). Both the Splash MX Plus and the Splash TX products also enable customers to use the Majestik scanning technology to capture high-resolution color images and download their images to their computer.\nOn December 23, 1995, the Company entered into a definitive agreement to sell its color server business to Splash Technology, Inc., a company in which Radius will retain a 19.9% equity interest, for approximately $21.9 million. That sale is anticipated to be completed in January 1996. For a more complete discussion see \"Management's Discussion and Analysis of Financial Condition -- Business Divestitures.\"\nTECHNOLOGY AND PRODUCT DEVELOPMENT\nThe Company's research and development efforts are focused on creating new products and technologies for customers who create, review, approve and utilize high resolution color images and moving video. Current research and development efforts include: (i) performance improvements and cost reductions of current products; (ii) development of 3D graphics subsystems; (iii) development of application software to facilitate the creation and manipulation of video and high resolution still images; (iv) development of integrated software that improves ease of use and functionality of the Company's graphics cards, digital video cards, and color reference displays; and (v) development of next generation technology to enable new methods of displaying and creating information with greater flexibility, speed, and quality.\nThe principles and features underlying the design of the Company's products are: identification and reduction of performance bottlenecks in graphics and video systems; providing consistency of color fidelity across products and applications; utilization of ASIC technology; and innovation within standard operating system environments.\nIDENTIFICATION AND REDUCTION OF BOTTLENECKS IN GRAPHICS AND VIDEO SYSTEMS The Company analyzes the performance of applications and hardware products within the environment of the host CPU and operating system with the goal of determining which parts of the overall solution are most resource and time intensive so that products can be developed which outperform the existing solutions. The Company has developed considerable knowledge of system software such as Apple's QuickDraw and QuickTime and critical application software such as Adobe Photoshop. The Company believes that its ability to eliminate bottlenecks in a manner that is compatible with existing Apple and third party products is a significant advantage in the marketplace.\nPROVIDING CONSISTENCY OF COLOR FIDELITY ACROSS PRODUCTS AND APPLICATIONS The Company strives to provide users with the most accurate and repeatable color available. The Company's high-end color reference displays provide tools to calibrate the display with both objective standards and visual perception, and to adjust the color range of the display to fit user needs.\nUTILIZATION OF ASIC TECHNOLOGY On a selective basis, the Company uses its in-house integrated computer aided engineering capabilities to develop proprietary ASIC chips for use in its own products. The use of ASIC chips allows the Company to increase performance while reducing chip count and board size which thereby reduces cost. ASICs are used heavily throughout the Company's graphics card line. In some cases, however, commercially available devices offer better overall price\/performance than proprietary ASICs (given the development cost involved), and the Company's strategy is to make the tradeoff on a product-by-product basis to provide the most cost-effective solution.\nINNOVATION WITHIN STANDARD OPERATING SYSTEM ENVIRONMENTS In order to maintain compatibility with the broad existing base of installed hardware and software, the Company seeks to innovate in conjunction with existing standards. For example, the Company's graphics cards are compatible with third party graphics software (such as Adobe Photoshop and Quark Pagemaker) as well as NuBus\nand PCI-based computers. Similarly, the Company's digital video cards are tightly integrated into Apple's standard QuickTime environment.\nThe Company believes that the competitive nature of the computer industry, along with the rapid pace of technological evolution, requires that it continue to introduce innovative products on a timely basis to compete effectively. During fiscal 1995, 1994 and 1993, the Company's expenditures for research and development totaled $19,310,000, $33,956,000, and $33,503,000, respectively. To date, all of the Company's research and development expenditures have been charged to operations as incurred.\nThere can be no assurance that the Company's development efforts will result in commercially successful products, or that the Company's products will not be rendered obsolete by changing technology or new products introduced by others. Additionally, should the Company fail to introduce new products on a timely basis, the Company's operating results could be adversely affected. For a more complete discussion see \"Management's Discussion and Analysis of Financial Condition -- Certain Factors That May Affect the Company's Future Results of Operations -- Technological Change; Continuing Need to Develop New Products.\"\nMARKETING, SALES AND DISTRIBUTION\nThe Company employs a two-tiered distribution model whereby it sells its products primarily through a limited number of distributors and master resellers that in turn distribute the Company's products to variety of resellers including superstores, independent dealers, educational resellers, systems integrators, value added resellers and mail order resellers. The Company's distributors and master resellers purchase products at discounts from suggested retail prices based on purchase volumes.\nIn the United States, the Company sells its products primarily through the following major distributors and master resellers: Ingram Micro, Inc.; Intelligent Electronics; and MicroAge. The Company's business and financial results are highly dependent on the success of these distributors and master resellers. To assist these domestic distributors and master resellers and to provide marketing, training and technical support, the Company maintains field sales facilities in a number of locations throughout the United States. For a more complete discussion see \"Management's Discussion and Analysis of Financial Condition -- Certain Factors That May Affect the Company's Future Results of Operations -- Distribution.\"\nSince fiscal 1993, the Company has utilized the Reseller Alliance Marketing Program (\"RAMP\") for its domestic sales channel. Under RAMP, distributors and master resellers that meet certain volume sales commitments and reporting capabilities are extended deeper discounts than other distributors and master resellers on the Company's higher margin products such as graphics cards and digital video products. RAMP also includes a market development funding program that gives distributors and master resellers incentives to lower returns, increase sales, improve reporting and achieve a product mix favoring higher margin products.\nInternationally, sales are made through worldwide distributors, which market, sell and service the Company's products, and through the Company's wholly owned subsidiary located in Tokyo, Japan. In addition to its facilities in Japan, the Company maintains international sales offices in Surrey, England; Hamburg, Germany; and Paris, France.\nFor the fiscal years ended September 30, 1995, 1994 and 1993, the Company's export sales accounted for approximately 40.4%, 34.5%, and 32.0%, respectively, of the Company's net sales. See Note 7 of Notes to Consolidated Financial Statements.\nThe Company's export sales are subject to certain risks common to international operations, such as currency fluctuations and governmental regulations. For a more complete discussion see \"Management's Discussion and Analysis of Financial Condition --Certain Factors That May Affect the Company's Future Results of Operations --International Sales.\"\nFor the fiscal years ended September 30, 1995, 1994 and 1993, Ingram Micro, Inc. accounted for approximately 34.0%, 13.5% and 11.5% of the Company's net sales, respectively.\nMany of the Company's distributors and master resellers have the right to return products purchased from the Company. While the Company provides for estimated product returns, if in the future the Company were to experience returns from customers significantly in excess of this estimate, such returns could have a material adverse effect on the Company's results of operations.\nThe Company's marketing programs support worldwide sales and distribution of its products. The Company's principal marketing activities include frequent participation in industry trade shows and seminars, advertising in major trade publications worldwide, public relations activities with the trade and business press, publication of technical articles, distribution of sales literature and product specifications and communications with its installed base of end users. The Company's marketing programs are designed to generate sales leads for its distributors and master resellers as well as to enhance the Company's brand name recognition.\nMANUFACTURING\nAs a result of the Company's outsourcing of manufacturing, substantially all of the Company's assembly, quality control testing, packaging and other manufacturing operations are performed by the Company's suppliers, contract manufacturers, and other subcontractors. The Company has developed a quality assurance program with these third parties.\nThe Company attempts to utilize standard parts and components available from multiple vendors. However, certain components used in the Company's products are available only from sole or limited suppliers, such as certain ASICs from LSI Logic and certain VideoVision parts from Toshiba. The Company's products also incorporate components, such as video random access memory, that are available from multiple sources but have been subject to substantial fluctuations in availability and price. Although the Company has been able to obtain an adequate supply of such components in the past, there can be no assurance that it will be able to obtain an adequate supply in the future. For a more complete discussion see \"Management's Discussion and Analysis of Financial Condition -- Certain Factors That May Affect the Company's Future Results of Operations -- Dependence on Suppliers.\"\nCOMPETITION\nThe color publishing and multimedia markets are, and are expected to remain, highly competitive. The Company's principal competitors in the color publishing market include Apple, ATI Technology and Diamond Multimedia Systems. The Company's principal competitors in the multimedia market include Truevision (formerly RasterOps Corporation), Data Translation, Inc., Matrox, Inc., Avid Technology, Inc., VideoLogic, Inc. and Fast Electronics Gmbh. The market for the Company's products is evolving, and it is difficult to predict all future sources of competition.\nAlthough Apple is principally a supplier of general purpose computing platforms upon which third parties are encouraged to build more complete solutions, the Company also faces competition from Apple. Apple markets a number of products, including computer systems and color displays, that compete directly or indirectly with the Company. Apple also could introduce additional products, add functionality to their computer systems that is similar to that provided by certain of the Company's products, or alter its systems' architecture in a manner that could adversely affect the Company's ability to compete. For example, Apple's PowerPC based products which have on-board graphic functionality and faster processing speed, could be considered competitors of specific product lines of the Company's. For a more complete discussion see \"Management's Discussion and Analysis of Financial Condition -- Certain Factors That May Affect the Company's Future Results of Operations -- Dependence on and Competition With Apple.\"\nThe Company believes that the principal competitive factors for its product line are product performance, breadth of distribution, brand name recognition, price and customer support. There can be no assurance that the Company will be able to compete successfully with respect to these factors In addition, many of the Company's current and prospective competitors have significantly greater technical, manufacturing and marketing resources that the Company. For a more complete discussion see \"Management's Discussion and Analysis of Financial Condition -- Certain Factors That May Affect the Company's Future Results of Operations -- Competition.\"\nPATENTS AND LICENSES\nThe Company has been granted patents in the United States and in foreign countries and also has pending United States and foreign patent applications. The Company also has registered some of its trademarks in the United States and in foreign countries and has several trademark applications pending in the United States and other countries. In addition, the Company attempts to protect its software and other intellectual property under copyright and trade secret laws, through agreements with employees and consultants, and by other security measures.\nAlthough the Company believes that the ownership of patents, copyrights, trade secrets and trademarks is an important factor in its business, the Company relies primarily on the innovative skills, technological expertise and marketing abilities of its employees. The Company continues to implement protective measures and intends to defend its intellectual property rights, but there can be no assurance that these measures will be successful. For a more complete discussion see \"Management's Discussion and Analysis of Financial Condition -- Certain Factors That May Affect the Company's Future Results of Operations -- Dependence on Proprietary Rights.\"\nEMPLOYEES\nAs of December 15, 1995, the Company had approximately 237 full time employees. The Company anticipates reducing its work force to under 200 employees as a result of the sale of its color server group.\nThe Company's success will depend, in large measure, on its ability to attract and retain highly qualified technical, marketing, engineering and management personnel, who are in great demand. For a more complete discussion see \"Management's Discussion and Analysis of Financial Condition -- Certain Factors That May Affect the Company's Future Results of Operations -- Dependence on Key Personnel.\"\nThe Company's employees are not represented by any collective bargaining agreements, and the Company has never experienced a work stoppage. The Company believes that its employee relations are good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's primary facilities are located in Sunnyvale, California and consist of an 153,000 square foot building. These facilities, which house all of the Company's engineering, marketing, operations, finance and administration, and sales management operations, are substantially larger than the Company currently requires given recent reductions in its workforce. The Company is now attempting to sublease all or a portion of this facility. The lease on the primary facility will expire in March 1998.\nThe Company has subleased to other companies approximately 281,000 square feet of facilities which the Company is currently not using.\nThe Company maintains field sales facilities in a number of locations throughout the United States as well as in Surrey, England; Paris, France; Hamburg, Germany; and Tokyo, Japan. For additional information concerning the Company's lease commitments, see Note 3 of Notes to Consolidated Financial Statements.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\n(a) On November 16, 1995, Electronics for Imaging, Inc. (\"EFI\") filed a suit in the United States District Court in the Northern District of California alleging that the Company infringes a patent allegedly owned by EFI. Although the complaint does not specify which of the Company's products allegedly infringe the patent, subsequent pleading indicates that EFI alleges that the Company's Color Server products allegedly infringe. The Company's Color Server products are material to its business.\nThe Company has filed an answer denying all material allegations, and has filed counterclaims against EFI alleging causes of action for interference with prospective economic benefit, antitrust violations, and unfair business practices. EFI has filed a motion to dismiss or sever the Company's counterclaims. The Company believes it has meritorious defenses to EFI's claims and is defending them vigorously. In addition, the Company believes it may have indemnification rights with respect to EFI's claims. In the opinion of management, based on the facts known at this time, the eventual outcome of this case is unlikely to have a material adverse effect on the results of operations or financial position of the Company.\n(b) In September 1992, the Company and certain of its officers and directors were named as defendants in a securities class action litigation brought in the United States District Court for the Northern District of California that sought unspecified damages, prejudgment and post judgment interest, attorneys' fees, expert witness fees and costs, and equitable relief. In July 1994, SuperMac and certain of its officers and directors, several venture capital firms and several of the underwriters of SuperMac's May 1992 initial public offering and its February 1993 secondary offering were named as defendants in a class action litigation brought in the same court that sought unspecified damages, prejudgment and post judgment interest, attorneys' fees, experts' fees and costs, and equitable relief (including the imposition of a constructive trust on the proceeds of defendants' trading activities).\nIn June 1995, the Court approved the settlement of both litigations and entered a Final Judgment and Order of Dismissal. Under the settlement of the litigation brought in 1992 against the Company, the Company's insurance carrier paid $3.7 million in cash and the Company will issue a total of 128,695 shares of its Common Stock to a class action settlement fund. In the settlement of the litigation brought in 1994 against SuperMac, the Company paid $250,000 in cash and will issue into a class action settlement fund a total of 707,609 shares of its Common Stock. The number of shares to be issued by the Company will increase by up to 100,000 if the price of the Company's Common Stock is below $12 per share during the 60-day period following the initial issuance of shares. See Note 3 of Notes to Consolidated Financial Statements.\n(c) In January 1995, a patent infringement lawsuit was filed in the United States District Court for the Northern District of California by Mark C. Koz. Mr. Koz is the alleged holder of a patent involving video pixel data transfer and claims that Radius infringes that patent. The complaint sought injunctive relief and damages in an unspecified amount. The complaint did not specify which products of the Company allegedly infringed the patent; subsequent pleadings indicated that the plaintiff contended that Radius' VideoVision line of products infringed the patent. The Company licensed the technology for the products in question from Apple and has certain limited contractual\nindemnification rights from Apple. On November 14, 1995 the parties entered into a Patent License and Settlement Agreement which granted to the Company a license under the patent for a small one time fee.\n(d) The Company was named as one of approximately 42 defendants in Shapiro et al. v. ADI Systems, Inc. et al., Superior Court of California, Santa Clara County, case no. CV751685, filed August 14, 1995. Radius was named as one of approximately 32 defendants in Maizes & Maizes et al. v. Apple Computer et al., Superior Court of New Jersey, Essex County, case no. L-13780-95, filed December 15, 1995. Plaintiffs in each case purport to represent alleged classes of similarly situated persons and\/or the general public, and allege that the defendants falsely advertise that the viewing areas of their computer monitors are larger than in fact they are.\nThe Company was served with the Shapiro complaint on August 22, 1995, and has not yet been served with the Maizes complaint. Defendants' petition to the California State Judicial Council to coordinate the Shapiro case with similar cases brought in other California jurisdictions was granted in part and it is anticipated that the coordinated proceedings will be held in Superior Court of California, San Francisco County. Discovery proceedings have not yet begun in either case. In the opinion of management, based on the facts known at this time, the eventual outcome of these cases is unlikely to have a material adverse effect on the results of operations or financial position of the Company.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nA Special Meeting of Shareholders (the \"Special Meeting\") was held on August 23, 1995. The sole matter voted upon at this Special Meeting was a proposal to increase the number of shares reserved for issuance under the Company's 1990 Employee Stock Purchase Plan from 300,000 to 650,000. The proposal was approved with 13,089,331 affirmative votes, 306,300 negative votes, and 136,127 votes abstaining.\nITEM 4A. EXECUTIVE OFFICERS OF REGISTRANT\nThe executive officers of the Company are as follows:\nMR. BERGER was appointed President, Chief Executive Officer and a director of the Company in March 1993 and Chairman of the Board of Directors in March 1994. From April 1992 until he joined the Company, Mr. Berger was Senior Vice President, Worldwide Sales, Operations and Support for Claris Corporation (\"Claris\"), a subsidiary of Apple that develops and markets application software. From February 1991 to April 1992, he was President of Sun Microsystems Federal, Inc., a subsidiary of Sun Microsystems, Inc. (\"Sun\"), a manufacturer of computer work stations. From July 1989 to February 1991, he served as Vice President of Business Development for Sun, and from March 1989 to July 1989, he was Sun's Vice President of Product Marketing. From April 1982 to March 1989, Mr. Berger held numerous management positions involving, sales, marketing, business development and finance for Apple.\nMR. BLOOM was appointed Vice President of North America Sales when he joined the Company in July 1994. From December 1992 until he joined the Company, Mr. Bloom was Vice President of North American Sales for EO Inc., a manufacturer of pen- based computers. Mr. Bloom also spent eight years at Apple where he held a number of sales management positions including Director of Channel Sales and Development for Apple USA from July 1989 to April 1992 and Western Regional Manager for the Business Market Development Division from April 1992 to December 1992.\nMR. BOAKE was appointed Vice President and General Manager, Pacific, Asia and Latin America when he joined the Company in September 1993. From January 1993 until he joined the Company, Mr. Boake was President and Representative Director of Claris Japan Inc., a wholly owned Japanese subsidiary of Claris. He was managing director of Claris Pacific from October 1988 to January 1993.\nMR. BURNS was appointed Vice President and General Manager, Video and Graphics when he joined the Company in June 1995. From April 1994 until he joined the Company, Mr. Burns was Vice President, West Coast Operations for Chyron Corp., a manufacturer of digital electronics graphics equipment. He was Director of International Marketing for VeriFone Inc., a manufacturer of transaction automation systems, from May 1993 to April 1994.\nMR. DUNNIGAN joined Radius in August 1995 as Chief Financial Officer. Since 1986, Mr. Dunnigan has provided financial consultancy services and served as chief financial officer to a number of publicly-held companies in variety of industries including computers and high technology.\nMS. GODWIN was appointed Vice President, Operations in August 1995 and prior to assuming that position served as the Company's Director of Operations Engineering beginning when she joined the Company in July 1993 . Prior to joining the Company, Ms. Godwin spent seven years with Apple as a supply base manager, and seven years with Xerox Corporation (\"Xerox\"), a diversified manufacturer of document copying and processing equipment, as a technical specialist.\nMR. HARRIS was appointed Vice President and General Manager, European Operations in March 1994. He joined the Company in June 1990 as Director of UK Operations and was appointed Managing Director of Radius UK Limited, a subsidiary of Radius, in May 1991. From 1978 until joining the Company, Mr. Harris worked for Rank Xerox, a subsidiary of Xerox, in a variety of sales management positions concluding manager of the Indirect Operations Group where he was responsible for channel management and a wide variety of business units.\nMR. MACGILLIVRAY was appointed Vice President and General Manager, Publishing in April 1995. He joined the Company in January 1994 as Director, OEM Programs. Prior to joining the Company, Mr. MacGillivray served as Vice President, General Manager at ICE Graphics from 1983 to 1994.\nMR. MILLAR was appointed Vice President, Engineering and Chief Technology Officer in October 1995 and prior to assuming that position served as the Company's Vice President, Research from October 1993 to October 1995, and as Vice President, Engineering from July 1991 to October 1993. From January 1989 to July 1991, he held various managerial positions in the Company including General Manager of the Advanced Development Group, General Manager of the Macintosh Business Unit and Director of Software Development. Prior to joining the Company, Mr. Millar was Vice President of Engineering and a founder of Infa Corporation, a pen-based computing company, from June 1987 to December 1988.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS\nThe Company's Common Stock is traded in the over-the-counter market on the Nasdaq National Market under the symbol \"RDUS.\" The following table sets forth, for the periods indicated, the high and low bid prices of the Common Stock as reported on the Nasdaq National Market, giving effect to the one-for-two reverse stock split of its Common Stock, which first affected trading on August 31, 1994. These prices reflect inter-dealer bid prices and do not include retail markups, mark downs or commissions.\n1995 Fiscal Year - ---------------- Quarter 1 ended December 31, 1994 10 1\/4 to 7 5\/8 Quarter 2 ended March 31, 1995 14 1\/2 to 9 Quarter 3 ended June 30, 1995 13 3\/4 to 9 1\/8 Quarter 4 ended September 30, 1995 12 1\/2 to 6 15\/16\n1994 Fiscal Year - ---------------- Quarter 1 ended December 31, 1993 17 1\/2 to 7 1\/4 Quarter 2 ended March 31, 1994 17 3\/4 to 13 3\/4 Quarter 3 ended June 30, 1994 15 1\/2 to 8 3\/4 Quarter 4 ended September 30, 1994 10 1\/4 to 8\nAs of December 15, 1995, there were 598 holders of record of the Company's Common Stock, which does not include those who held in street or nominee name.\nThe Company has never declared or paid any cash dividends on its capital stock. In addition, the Company's revolving line of credit agreements require the prior written consent of the lenders before the Company can pay any cash dividend on its capital stock. The Company anticipates that it will retain earnings for use in the operation and expansion of its business and does not anticipate paying any cash dividends in the foreseeable future.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following selected consolidated financial data should be read in conjunction with the consolidated financial statements and the notes thereto included elsewhere herein. The consolidated statements of operations data set forth below with respect to the years ended September 30, 1995, 1994 and 1993 and the consolidated balance sheet data at September 30, 1995 and 1994 are derived from, and are qualified by reference to, the audited consolidated financial statements included elsewhere herein and should be read in conjunction with those financial statements and the notes thereto. The consolidated statements of operations data for the year ended September 30, 1992 and 1991 and the consolidated balance sheet data as of September 30, 1993, 1992 and 1991 are derived from audited consolidated financial statements not included herein.\n(1) The Company's fiscal year ends on the Saturday closest to September 30 and includes 53 weeks in fiscal 1993 and 52 weeks in all other fiscal years presented. During fiscal 1995, the Company changed its fiscal year end from the Sunday closest to September 30 to the Saturday closest to September 30 for operational efficiency purposes. For clarity of presentation, all fiscal periods in this Form 10-K are reported as ending on a calendar month end.\n(2) These periods have been restated to reflect the Merger of Radius and SuperMac which has been accounted for as a pooling of interests. See Note 10 of Notes to the Consolidated Financial Statements. The consolidated financial statements for all periods prior to fiscal 1994 have not been restated to adjust SuperMac's fiscal year end to that of Radius. Such periods include Radius' results of operations and balance sheet data on a September 30 fiscal year basis and SuperMac's on a December 31 calendar year basis.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION\nRESULTS OF OPERATIONS--ANNUAL PERIODS The following table sets forth for the years indicated certain operational data as a percentage of net sales (may not add due to rounding).\n(1) These periods have been restated to reflect the Merger of Radius and SuperMac which has been accounted for as a pooling of interests. See Note 10 of Notes to the Consolidated Financial Statements. The consolidated financial statements for all periods prior to fiscal 1994 have not been restated to adjust SuperMac's fiscal year end to that of Radius. Such periods include Radius' results of operations and balance sheet data on a September 30 fiscal year basis and SuperMac's on a December 31 calendar year basis. The operating results for both the twelve months ended September 30, 1994 and September 30, 1993 include the restructuring and other charges of $16.6 million recorded by SuperMac in December 1993.\nFISCAL 1995 COMPARED TO FISCAL 1994\nNET SALES. The Company's net sales decreased 5.1% to $308.1 million in fiscal 1995 from $324.8 million in fiscal 1994. Fiscal 1995 net sales were reduced by approximately $11.4 million due to reserves taken by the Company in anticipation of future price reductions on a number its graphics cards, MacOS compatible systems and other products that are designed for Apple's NuBus-based computers which have been largely replaced by Apple's recently introduced PCI Bus-based computers.\nDuring the fiscal year, net sales of graphics cards declined substantially due primarily to reduced demand resulting from Apple's incorporation of built-in graphics capabilities in its PowerPC based Macintosh systems. Net sales from displays, accelerator cards and printers also declined during the fiscal year. These declines were largely offset by sales of MacOS compatible systems which were first introduced in the 1995 fiscal year and by a substantial increase in net sales from the Company's color server products.\nWhile net sales from the Company's digital video products increased slightly during the fiscal year, the Company anticipates lower revenue from this product line until the introduction of new products now under development.\nThe Company anticipates significantly lower overall net sales in fiscal 1996 as a result of the Company's decision to focus its efforts on providing solutions for high end digital video and graphics customers, discontinue selling mass market displays and other low value added products, and divest of certain businesses such as color servers and MacOS compatible systems.\nOn December 23, 1995, the Company entered into a definitive agreement to sell its color server business to Splash Technology, Inc., a company in which Radius will retain a 19.9% equity interest, for approximately $21.9 million. That sale is anticipated to be completed in January 1996. In addition the Company is now negotiating to sell its MacOS compatible systems business and does not anticipate significant net sales from this business during the 1996 fiscal year.\nExport sales represented approximately 40.4%, 34.5%, and 32.0% of net sales for fiscal 1995, 1994 and 1993, respectively. See Note 7 of Notes to Consolidated Financial Statements. Export sales are subject to the normal risks associated with doing business in foreign countries such as currency fluctuations, longer payment cycles, greater difficulties in accounts receivable collection, export controls and other government regulations and, in some countries, a lesser degree of intellectual property protection as compared to that provided under the laws of the United States.\nGROSS PROFIT. The Company's gross profit margin including restructuring and other charges declined to 1.7% in fiscal 1995, compared to 14.7%, in fiscal 1994. The Company's gross profit margin excluding the restructuring and other charges declined to 16.9% in fiscal 1995, compared to 27.3% in fiscal 1994. Excluding restructuring and other charges, the Company's gross profit margin declined primarily due to lower sales of higher margin graphics cards, costs incurred to process higher than expected product returns resulting from the consolidation of the Radius and SuperMac product lines and slower than expected sell through of its Radius Telecast digital video product, significant price erosion on NuBus based MacOS compatible systems combined with high production costs for these systems, the sale of end of life products, and increased pricing pressures. The Company anticipates continued competitive pricing actions resulting in declining prices in its industry.\nRESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses decreased to $19.3 million (6.3% of net sales) in fiscal 1995 from $34.0 million (10.5% of net sales) in fiscal 1994. The Company's research and development expenses in fiscal 1994 included restructuring and other charges of $4.3 million. No restructuring and other charges were included in research and development expenses in fiscal 1995.\nThe decrease in research and development expenses during the fiscal year was primarily due to the reduction of expenses as a result of the Company's restructuring following the Merger. The merger-related restructuring resulted in reduced costs primarily related to headcount, depreciation, and facilities.\nWhile there can be no assurance that the Company's product development efforts will result in commercially successful products, the Company believes that development of new products and enhancement of existing products\nare essential to its continued success, and management intends to continue to devote substantial resources to research and new product development.\nSELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and administrative expenses including restructuring and other charges decreased to $90.1 million (29.2% of net sales) in fiscal 1995 from $94.7 million (29.2% of net sales) in fiscal 1994. Selling, general and administrative expenses excluding restructuring and other charges decreased to $79.2 million (25.7% of net sales) in fiscal 1995 from $84.0 million (25.9% of net sales) in fiscal 1994.\nThe decrease in selling, general and administrative expenses during the fiscal year was primarily due to the reduction of expenses as a result of the Company's restructuring following the Merger. The merger-related restructuring resulted in reduced costs primarily related to headcount, depreciation and facilities.\nPROVISION FOR INCOME TAXES. The Company's annual combined federal and state effective income tax rates were approximately (7.4%) (expense) in fiscal 1995 and 6% (benefit) in fiscal 1994. In fiscal 1995, the rate differs from the combined statutory rate in effect during the period primarily as a result of the impact of not benefiting the 1995 operating losses and the reversal of existing deferred tax assets. The fiscal 1994 rate differs from the combined statutory rate in effect during the period primarily as a result of non-deductible merger related costs, the one time write-off of purchased research and development which is not tax deductible and the impact of not benefiting a significant portion of the 1994 operating loss.\nFASB Statement 109 provides for the recognition of deferred tax assets if realization of such assets is more likely than not. The Company's valuation allowance reduced the deferred tax asset to the amount realizable. The Company has provided a full valuation allowance against its net deferred tax assets due to uncertainties surrounding their realization. Due to the net losses reported in the prior three years and as a result of the material changes in operations reported in its 1995 fiscal fourth quarter, predictability of earnings in future periods is uncertain. The Company will evaluate the realizability of the deferred tax asset on a quarterly basis.\nFISCAL 1994 COMPARED TO FISCAL 1993\nNET SALES. The Company's net sales decreased 3.7% to $324.8 million in fiscal 1994 from $337.4 million in fiscal 1993. The Company believes that this decline in net sales was in part attributable to the customers postponing purchasing decisions during the fourth quarter while waiting to see which of the Company's product lines would be supported and which would be discontinued following the Merger. Sales were flat for the nine months ended June 30, 1994 prior to the Merger. Net sales of video products and displays increased but this increase was offset by pricing pressure on graphics cards. Demand was lower than anticipated for graphics cards due to the introduction of the Power Macintosh by Apple and the resulting customer uncertainty surrounding the need for graphics acceleration given the built-in video capabilities of this new product.\nGROSS PROFIT. The Company's gross profit margin including the restructuring and other charges declined to 14.7% in fiscal 1994, compared to 24.6%, in fiscal 1993. The Company's gross profit margin excluding the restructuring charges declined to 27.3% in fiscal 1994, compared to 31.8% in fiscal 1993. See Note 8 of Notes to Consolidated Financial Statements regarding the restructuring and other charges for SuperMac in December 1993 and Merger related restructuring and other charges in September 1994. Excluding the restructuring charges, the decline in gross margins was due to increased pricing pressures and a change in the product mix favoring lower margin displays over higher margin graphics accelerator cards.\nRESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses increased slightly to $34.0 million (10.5% of net sales) in fiscal 1994 from $33.5 million (9.9% of net sales) in fiscal 1993. The relatively flat absolute dollar expenditures in research and development activities were due to recording significant restructuring and other charges related to development project cancellations, equipment disposal, and severance in fiscal 1994 offset by the decrease in expenditures in fiscal 1994 as a result of the cancellation of Radius' efforts to develop a variety of technologies originally intended for a minicomputer-class server product. Additionally, the research and development expenses appeared flat due to the SuperMac 1993 restructuring of $2.0 million for development project cancellations included in both the fiscal 1993 and fiscal 1994 results of operations.\nSELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and administrative expenses increased to $94.7 million (29.2% of net sales) in fiscal 1994 from $84.1 million (24.9% of net sales) in fiscal 1993. The increase in\nabsolute dollars was primarily due to increased personnel expense, market development expenses, restructuring and other charges in fiscal 1994 and the Company's investment in its information system. The 1993 restructuring and other charges included the elimination of excess facilities, capital equipment write-offs, severance payments and the termination of certain contractual agreements. Restructuring and other charges for fiscal 1994 included the elimination of duplicative facilities, property and equipment and other assets, severance payments, as well as transaction fees and costs incidental to the Merger.\nPROVISION FOR INCOME TAXES. The Company's annual combined federal and state effective income tax rates were approximately 6% in fiscal 1994 and 40% in fiscal 1993 before the cumulative effect of the change in method of accounting for income taxes. The fiscal 1994 rate differs from the combined statutory rate in effect during the period primarily as a result of non-deductible merger related costs, the one time write-off of purchased research and development which is not tax deductible and the impact of not benefiting a significant portion of the 1994 operating loss. The 1993 rate differs from the combined statutory rate in effect during the period primarily as a result of the utilization of the research and development tax credit.\nRESTRUCTURING, MERGER AND OTHER CHARGES\nDuring fiscal 1993, 1994 and 1995, four restructuring and other charges were recorded. Radius recorded a $15.5 million restructuring charge during the third quarter of fiscal 1993 in connection with the implementation of a program designed to reduce costs and improve operating efficiencies. SuperMac recorded a $16.6 million restructuring charge during December 1993 in connection with a program to realign its inventory and facility and personnel resources. Subsequently, the two companies merged and incurred a restructuring charge of $43.4 million. In September 1995, Radius recorded $57.9 million restructuring charge in connection with the Company's efforts to refocus and streamline its business. A discussion of each of these events follows.\nRADIUS JUNE 1993 RESTRUCTURING AND OTHER CHARGES In June 1993, Radius announced a restructuring program designed to reduce costs and improve operating efficiencies. The program included, among other things, the write-down of inventory following Radius' decision to phase out its older generation of products, lease termination expenses, capital equipment write- offs, severance payments, and costs associated with the discontinuation of Radius' minicomputer-class server product. The restructuring program costs of $15.5 million were recorded during the third quarter of fiscal 1993. These charges (in thousands) are included in: cost of sales ($10,993); research and development ($411); and selling, general and administrative expenses ($4,096). The Company completed this restructuring event by the end of calendar 1994. There were no material changes in the restructuring plan or in the estimates of the restructuring costs from the recognition of the charge in June 1993 with the completion of the restructuring program in December 1994.\nSUPERMAC DECEMBER 1993 RESTRUCTURING AND OTHER CHARGES In December 1993, SuperMac recorded charges of $16.6 million in connection with a program to adjust inventory levels, eliminate excess facilities, terminate certain projects and contract arrangements and reduce the number of employees. The charges (in thousands) are included in: cost of sales ($13,352); research and development ($2,000); and selling, general and administrative expenses ($1,238). There have been no material changes in the restructuring plan or in the estimates of the restructuring costs. The Company has $236,000 remaining in its restructuring reserve related to facility costs, the balance of which is expected to be eliminated in fiscal 1996. As noted in the Consolidated Financial Statements, the consolidated results for the Company in both the twelve months ended September 30, 1994 and the fiscal period ended 1993 include SuperMac's $16.6 million charge.\nRADIUS FISCAL 1994 MERGER RELATED RESTRUCTURING AND OTHER CHARGES In the fourth quarter of fiscal 1994, the Company recorded charges of $43.4 million in connection with the Merger of Radius and SuperMac. These charges include the discontinuance of duplicative product lines and related assets; elimination of duplicative facilities, property and equipment and other assets; and personnel severance costs as well as transaction fees and costs incidental to the merger. The charges (in thousands) are included in: net sales ($3,095); cost of sales ($25,270); research and development ($4,331); and selling, general and administrative expenses ($10,711). The elements of the total charge as of September 30, 1995 are as follows (in thousands):\nThe adjustment of inventory levels reflects the discontinuance of duplicative product lines. The provision for excess facility costs represents the write-off of leaseholds and sublease costs of Radius' previous headquarters, the consolidation into one main headquarters and the consolidation of sales offices. The revision of the operations business model reflects the reorganization of the combined Company's manufacturing operations to mirror Radius' manufacturing reorganization in 1993. This reorganization was designed to outsource a number of functions that previously were performed internally, reduce product costs through increased efficiencies and lower overhead, and focus the Company on a limited number of products. Employee severance costs are related to employees or temporary employees who were released due to the revised business model. Approximately 250 employees were terminated in connection with the Merger. The provision for merger related costs is for the costs associated with the Merger transaction, such as legal, investment banking and accounting fees. The Company has spent $15.9 million of cash for restructuring through September 30, 1995. The Company expects to have substantially completed the restructuring by September 1996. During fiscal 1995, approximately $2.1 million of merger related restructuring reserves were reversed and recorded as an expense reduction due to changes in estimated requirements.\nRADIUS FISCAL 1995 RESTRUCTURING AND OTHER CHARGES In September 1995, Radius recorded charges of $57.9 million in connection with the Company's efforts to refocus its business on the color publishing and multimedia markets. The charges primarily included a writedown of inventory and other assets. Additionally, it included expenses related to the cancellation of open purchase orders, excess facilities and severance. The charges (in thousands) are included in cost of sales ($47,004), and selling, general and administrative expense ($10,861). The elements of the total charge as of September 30, 1995 are as follows (in thousands):\nThe adjustment of inventory levels reflects the discontinuance of several product lines. The provision for excess facility costs represent the write-off of leasehold improvements and the costs associated with anticipated reductions in facilities. The cancellation fees and asset write-offs reflect the Company's decision to refocus its efforts on providing solutions for the color publishing and multimedia markets. Employee severance costs are related to employees or temporary employees who have been or will be released due to the revised business model. As of December 15, 1995, approximately 157 positions had been eliminated in connection with the new business model. The Company had not spent any cash for this restructuring as of September 30, 1995. As of September 30, 1995, the Company had cash and cash equivalents of $4.8 million. See \"Management's Business Recovery Plans\" at Note 1 due to the Consolidated Financial Statements. The Company expects to have substantially completed the restructuring by September 1996.\nBUSINESS DIVESTITURES\nCOLOR SERVER GROUP On December 23, 1995, the Company signed a definitive agreement pursuant to which the Company will sell its Color Server Group (\"CSG\") to Splash Merger Company, Inc. (the \"Buyer\"), a wholly owned subsidiary of Splash Technology Holdings, Inc. (the \"Parent\"), a corporation formed by various investment entities associated with Summit Partners. The Company will receive approximately $21,945,175 in cash (subject to certain post-closing adjustments) and 4,282 shares of the Parent's 6% Series B Redeemable and Convertible Preferred Stock (the \" Series B Preferred Stock\"). The shares of Series B Preferred Stock will be convertible by the Company at any time into 19.9% of the Parent's common stock outstanding as of the closing of the transaction. The shares of Series B Preferred Stock also will be redeemable by the Parent at any time, and will be subject to mandatory redemption beginning on the sixth anniversary of issuance, in each case at a redemption price of $1,000 per share plus accrued dividends. The transaction is expected to close in January 1996. Under the Inventory and Working Capital Agreement, as recently amended, with IBM Credit Corp., the Company is required to pay all of the net proceeds of the Color Server Group transaction to IBM Credit Corp. in order to reduce the Company's outstanding indebtedness under that agreement.\nPORTRAIT DISPLAY LABS On December 19, 1995, the Company signed a series of agreements with Portrait Display Labs, Inc. (\"PDL\"). The agreements assigned the Company's pivoting technology to PDL and canceled PDL's on-going royalty obligation to the Company under an existing license agreement in exchange for a one-time cash payment. PDL also granted the Company a limited license back to the pivoting technology. Under these agreements, PDL also settled its outstanding receivable to the Company by paying the Company $500,000 in cash and issuing to the Company 214,286 shares of PDL's Common Stock. See Note 1 to the Consolidated Financial Statements.\nDISPLAY TECHNOLOGIES ELECTROHOME INC. On December 21, 1995, the Company signed a Business Purchase Agreement and an Asset Purchase and License Agreement with Display Technologies Electrohome Inc. (\"DTE\"). Pursuant to the agreements and subject to certain closing conditions, DTE will purchase Radius' monochrome display monitor business and certain assets related thereto, for approximately $200,000 in cash and cancellation of $2.5 million of the Company's indebtedness to DTE. In addition, DTE and Radius will cancel outstanding contracts relating to DTE's manufacture and sale of monochrome display monitors to Radius.\nRESULTS OF OPERATIONS--QUARTERLY PERIODS\nThe following table sets forth certain unaudited quarterly financial information for the Company's last eight fiscal quarters (in thousands, except per share data). The information includes all adjustments (consisting only of normal recurring adjustments) that management considers necessary for a fair presentation thereof. The operating results for any quarter are not necessarily indicative of results for any future period. The Company's fiscal year ends on the Sunday closest to September 30.\n(1) These periods have been restated to reflect the Merger of Radius and SuperMac which has been accounted for as a pooling of interests. See Note 10 of Notes to the Consolidated Financial Statements. The consolidated financial statements for all periods prior to fiscal 1994 have not been restated to adjust SuperMac's fiscal year end to that of Radius. Such periods include Radius' results of operations and balance sheet data on a September 30 fiscal year basis and SuperMac's on a December 31 calendar year basis. Therefore, results for the quarter ended September 30, 1993 shown above include a $16.6 million charge recorded by SuperMac in December 1993. Additionally, the results for the quarter ended December 31, 1993 reflect this same $16.6 million charge recorded by SuperMac in December 1993.\nThe Company's operating results are subject to quarterly fluctuations as a result of a number of factors, including: the sales rate and mix of Apple computers; the introduction of new products by Apple, the Company or its competitors; the timing of sales and marketing expenses by the Company; the timing of business cycles in the United States and worldwide; the availability and cost of key components; the Company's ability to develop innovative products; the Company's product and customer mix; and the level of competition.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company's cash and cash equivalents decreased approximately $11.2 million during fiscal 1995 to approximately $4.8 million at September 30, 1995, as compared with the fiscal 1994 ending balance of cash and cash equivalents of $16.0 million. Approximately $1.6 million of the $4.8 million of cash and cash equivalents available at September 30, 1995 was restricted under various letters of credit. Capital expenditures were $1.9 million in fiscal 1995 and $3.5 million in fiscal 1994.\nThe decrease in the Company's cash and cash equivalents during fiscal 1995 was primarily attributable to expenditures made in connection with the development and introduction of the Company's MacOS compatible systems.\nThe Company completed a private placement during the third quarter of the 1995 fiscal year, the proceeds of which allowed the Company to build inventory of MacOS-compatible systems components and reduce other vendor payables. In the private placement, the Company sold 2,509,319 shares of its Common Stock resulting in net proceeds of approximately $21.4 million.\nAt September 30, 1995, the Company's principal sources of liquidity included approximately $30.0 million in inventory and working capital financing under an agreement with IBM Credit Corporation (the \"ICC Agreement\") together with an additional $20.0 million provided by IBM Credit Corp. under the ICC Agreement to finance the manufacturing of the Company's MacOS compatible products, all of which was fully utilized.\nIn addition, the Company has a $5.0 million credit arrangement with Silicon Valley Bank (\"SVB\") which was partially utilized as of that date. Additionally, the Company's Japanese subsidiary has a revolving line of credit with a bank in Japan under which $3.1 million has been utilized as of September 30, 1995.\nAs of September 30, 1995, the Company was not in compliance with all of its contractual obligations and financial covenants under the ICC Agreement; however, IBM Credit Corp. has waived such defaults pursuant to an amendment to the ICC Agreement executed in December 1995 (the \"ICC Amendment\"). The ICC Amendment, among other things, also provides that until March 31, 1996 IBM Credit Corp. will extend advances to the Company in an amount up to 90% of the Company's collections and fund the Company's payroll in the event that collections are insufficient to permit the advances needed for this purpose. Such advances and payroll funding, however, may be suspended by IBM Credit Corp. (i) immediately following a default of the ICC Amendment, and (ii) following thirty (30) days notice in the event of any default of the ICC Agreement.\nAs of September 30, 1995, the Company was not in compliance with all of its contractual obligations and financial covenants under its credit arrangement with SVB. As of December 15, 1995 approximately $1,200,000 was outstanding under this credit arrangement, all of which the Company anticipates paying SVB during the first calendar quarter of 1996.\nRecently, the Company's limited cash resources have restricted the Company's ability to purchase inventory which in turn has limited its ability to manufacture and sell products and has resulted in additional costs for expedited deliveries. The Company also is delinquent in its accounts payables as payments to vendors are not being made in accordance with vendor terms. The adverse effect on the Company's results of operations due to its limited cash resources can be expected to continue until such time as the Company is able to return to profitability, or generate additional cash from other sources. There can be no assurance that the Company will be able to do so.\nAdditional funds will be needed to finance the Company's development plans and for other purposes, and the Company is now investigating possible financing opportunities. There can be no assurance that additional financing will be available when needed or, if available, that the terms of such financing will not adversely affect the Company's results of operations.\nCERTAIN FACTORS THAT MAY AFFECT THE COMPANY'S FUTURE RESULTS OF OPERATIONS\nA number of uncertainties exist that could affect the Company's future operating results, including, without limitation, the following:\nCONTINUING OPERATING LOSSES The Company experienced net operating losses in the fiscal years ended September 30, 1993, 1994 and 1995. The Company's ability to achieve and sustain profitable operations will depend upon a number of factors, including the Company's ability to control costs; to develop innovative and cost-competitive new products and to bring those products to market in a timely manner; the rate and mix of Apple computers and related products sold; competitive factors such as new product introductions, product enhancements and aggressive marketing and pricing practices; general economic conditions; and other factors. The Company has faced and expects to continue to face increased competition in graphic cards as a result of Apple's transition of its product line to the PCI Bus. In addition, the Company anticipates significantly lower revenue and gross profit from its digital video products primarily due to lower than anticipated sell trough rates for Radius Telecast. For these and other reasons, there can be no assurance that the Company will be able to achieve profitability in the near term.\nFLUCTUATIONS IN OPERATING RESULTS The Company has experienced substantial fluctuations in operating results. The Company's customers generally order on an as-needed basis, and the Company has historically operated with relatively small backlogs. Quarterly sales and operating results depend heavily on the volume and timing of bookings received during the quarter, which are difficult to forecast. A substantial portion of the Company's revenues are derived from sales made late in each quarter, which increases the difficulty in forecasting sales accurately. Recently, shortages of available cash have delayed the Company's receipt of products from suppliers and increased shipping and other costs. The Company recognizes sales upon shipment of product, and allowances are recorded for estimated noncollectable amounts, returns, credits and similar costs, including product warranties and price protection. Due to the inherent uncertainty of such estimates, there can be no assurance that the Company's forecasts regarding bookings, collections, rates of return, credits and related matters will be accurate. A significant portion of the operating expenses of the Company are relatively fixed in nature, and planned expenditures are based primarily on sales forecasts which, as indicated above, are uncertain. Any inability on the part of the Company to adjust spending quickly enough to compensate for any failure to meet sales forecasts or to receive anticipated collections, or any unexpected increase in product returns or other costs, could also have an adverse impact on the Company's operating results.\nDEPENDENCE ON AND COMPETITION WITH APPLE Historically, substantially all of the Company's products have been designed for and sold to users of Apple personal computers, and it is expected that sales of products for such computers will continue to represent substantially all of the net sales of the Company for the foreseeable future. The Company's operating results would be adversely affected if Apple should lose market share, if Macintosh sales were to decline or if other developments were to adversely affect Apple's business. As software applications for the color publishing and multimedia markets become more available on platforms other than Macintosh, it is likely that these other platforms will continue to gain acceptance in these markets. For example, recently introduced versions of the Windows operating environment support high performance graphics and video applications similar to those offered on the Macintosh. There is a risk that this trend will reduce the support given to Macintosh products by third party developers and could substantially reduce demand for Macintosh products and peripherals over the long term.\nA number of the Company's products compete with products marketed by Apple. As a competitor of the Company, Apple could in the future take steps to hinder the Company's development of compatible products and slow sales of the Company's products. The Company's business is based in part on supplying products that meet the needs of high-end customers that are not fully met by Apple's products. As Apple improves its products or bundles additional hardware or software into its computers, it reduces the market for Radius products that provide those capabilities. For example, the Company believes that the on-board performance capabilities included in Macintosh Power PC products have reduced and continue to reduce overall sales for the Company's graphics cards. In the past, the Company has developed new products as Apple's progress has rendered existing Company products obsolete, but there can be no assurance that the Company will continue to develop successful new products on a timely basis in the future. In order to develop products for the Macintosh on a timely basis, the Company depends upon access to advance information concerning new Macintosh products. A decision by Apple to cease sharing advance product information with the Company would adversely affect the Company's business.\nNew products anticipated from and introduced by Apple could cause customers to defer or alter buying decisions due to uncertainty in the marketplace, as well as presenting additional direct competition for the Company. For example, the Company believes that Apple's transition during 1994 to Power PC products caused delays and uncertainties in the market place and had the effect of reducing demand for the Company's products. In addition, sales of the Company's products have been adversely affected by Apple's revamping of its entire product line from NuBus-based to PCI Bus-based computers. In the past, transitions in Apple's products have been accompanied by shortages in those products and in key components for them, leading to a slowdown in sales of those products and in the development and sale by the Company of compatible products. In addition, it is possible that the introduction of new Apple products with improved performance capabilities may create uncertainties in the market concerning the need for the performance enhancements provided by the Company's products and could reduce demand for such products.\nCOMPETITION The markets for the Company's products are highly competitive, and the Company expects competition to intensify. Many of the Company's current and prospective competitors have significantly greater financial, technical, manufacturing and marketing resources than the Company. The Company believes that its ability to compete will depend on a number of factors, including the success and timing of new product developments by the Company and its competitors, product performance, price and quality, breadth of distribution and customer support. There can be no assurance that the Company will be able to compete successfully with respect to these factors. In addition, the introduction of lower priced competitive products could result in price reductions that would adversely affect the Company's results of operations.\nDEPENDENCE ON SUPPLIERS The Company outsources the manufacturing and assembly of its products to third party suppliers. Although the Company uses a number of manufacturer\/assemblers, each of its products is manufactured and assembled by a single supplier. The failure of a supplier to ship the quantities of a product ordered by the Company could cause a material disruption in the Company's sales of that product. In the past, the Company has at times experienced substantial delays in its ability to fill customer orders for displays and other products, due to the inability of certain suppliers to meet their volume and schedule requirements and, recently, due to the Company's shortages in available cash. Due to recent shortages in cash resources and because the Company seeks to manage its use of working capital by, among other things, limiting the backlog of inventory it purchases, the Company is particularly vulnerable to delays in shipments from suppliers. Such delays can cause fluctuations in the Company's short term results and contribute to order cancellations.\nThe Company is also dependent on sole or limited source suppliers for certain key components used in its products, including certain digital to analog converters, digital video chips, and other products. Certain other semiconductor components and molded plastic parts are also purchased from sole or limited source suppliers. The Company purchases these sole or limited source components primarily pursuant to purchase orders placed from time to time in the ordinary course of business and has no guaranteed supply arrangements with sole or limited source suppliers. The Company expects that these suppliers will continue to meet its requirements for the components, but there can be no assurance that they will do so. The introduction of new products presents additional difficulties in obtaining timely shipments from suppliers. Additional time may be needed to identify and qualify suppliers of the new products. Also, the Company has experienced delays in achieving volume production of new products due to the time required for suppliers to build their manufacturing capacity. An extended interruption in the supply of any of the components for the Company's products, regardless of the cause, could have an adverse impact on the Company's results of operations. The Company's products also incorporate components, such as VRAMs, DRAMs and ASICs that are available from multiple sources but have been subject to substantial fluctuations in availability and price. Since a substantial portion of the total material cost of the Company's products is represented by these components, significant fluctuations in their price and availability could affect its results of operations.\nTECHNOLOGICAL CHANGE; CONTINUING NEED TO DEVELOP NEW PRODUCTS The personal computer industry in general, and the color publishing and video applications within the industry, are characterized by rapidly changing technology, often resulting in short product life cycles and rapid price declines. The Company believes that its success will be highly dependent on its ability to develop innovative and cost-competitive new products and to bring them to the marketplace in a timely manner. Should the Company fail to introduce new products on a timely basis, the Company's operating results could be adversely affected. Technological innovation is particularly important for the Company, since its business is based on its ability to provide functionality and features not included in Apple's products. As Apple introduces new products with increased functionality and features, the Company's business will be adversely affected unless it develops new products that provide advantages over Apple's latest offerings. Continued reduction in the available cash resources of the Company could result in the interruption or cancellation of research and product development efforts.\nThe Company anticipates that the video editing industry will follow the pattern of the professional publishing industry in which desktop publishing products, including those produced by Radius, replaced more expensive, proprietary products, and the Company also anticipates that this evolution will lead to a significant increase in the purchase and use of video editing products. There is a risk that this evolution will not occur in the video editing industry as expected by the Company, or that it will occur at a slower pace than anticipated.\nThe introduction of new products is inherently subject to risks of delay. Should the Company fail to introduce new products on a timely basis, the operating results of the Company could be adversely affected. The introduction of new products and the phasing out of older products will require the Company to carefully manage its inventory to avoid inventory obsolescence and may require increases in inventory reserves. The long lead times -- as much as three to five months -- associated with the procurement of certain components (principally displays and ASICs) exposes the Company to greater risk in forecasting the demand for new products. There can be no assurance that the Company's forecasts regarding new product demand and its estimates of appropriate inventory levels will be accurate. Moreover, no assurance can be given that the Company will be able to cause all of its new products to be manufactured at acceptable manufacturing yields or that the Company will obtain market acceptance for these products.\nDISTRIBUTION The Company's primary means of distribution is through a limited number of third-party distributors and master resellers. As a result, the Company's business and financial results are highly dependent on the amount of the Company's products that is ordered by these distributors and resellers. Such orders are in turn dependent upon the continued viability and financial condition of these distributors and resellers as well as on their ability to resell such products and maintain appropriate inventory levels. Due in part to the historical volatility of the personal computer industry, certain of the Company's resellers have from time to time experienced declining profit margins, cash flow shortages and other financial difficulties. The future growth and success of the Company will continue to depend in large part upon its reseller channels. If its resellers were to experience financial difficulties, the Company's results of operations could be adversely affected.\nINTERNATIONAL SALES The Company's international sales are primarily made through distributors and the Company's subsidiary in Japan. The Company expects that international sales will represent a significant portion of its net sales and that it will be subject to the normal risks of international sales such as currency fluctuations, longer payment cycles, export controls and other governmental regulations and, in some countries, a lesser degree of intellectual property protection as compared to that provided under the laws of the United States. In addition, fluctuations in exchange rates could affect demand for the Company's products. If for any reason exchange or price controls or other restrictions on foreign currencies are imposed, the Company's business and operating results could be materially adversely affected.\nDEPENDENCE ON KEY PERSONNEL The Company's success depends to a significant degree upon the continued contributions of its key management, marketing, product development and operational personnel and the Company's ability to retain and continue to attract highly skilled personnel. Competition for employees in the computer industry is intense, and there can be no assurance that the Company will be able to attract and retain qualified employees. The Company has recently made a number of management changes, including the appointment of a new Chief Financial Officer. If the Company continues to experience financial difficulties, it may become increasingly difficult for it to hire new employees and retain current employees. The Company does not carry any key person life insurance with respect to any of its personnel.\nDEPENDENCE ON PROPRIETARY RIGHTS The Company relies on a combination of patent, copyright, trademark and trade secret protection, nondisclosure agreements and licensing arrangements to establish and protect its proprietary rights. The Company has a number of patents and patent applications and intends to file additional patent applications as it considers appropriate. There can be no assurance that patents will issue from any of these pending applications or, if patents do issue, that any claims allowed will be sufficiently broad to protect the Company's technology. In addition, there can be no assurance that any patents that may be issued to the Company will not be challenged, invalidated or circumvented, or that any rights granted thereunder would provide proprietary protection to the Company. The Company has a number of trademarks and trademark applications. There can be no assurance that litigation with respect to trademarks will not result from the Company's use of registered or common law marks, or that, if litigation against the Company were successful, any resulting loss of the right to use a trademark would not reduce sales of the Company's products in addition to the possibility of a significant damages award. Although, the Company intends to defend its proprietary rights, policing unauthorized use of proprietary technology or products is difficult, and there can be no assurance that the Company's efforts will be successful. The laws of certain foreign countries may not protect the proprietary rights of the Company to the same extent as do the laws of the United States.\nThe Company has received, and may receive in the future, communications asserting that its products infringe the proprietary rights of third parties, and the Company is engaged and has been engaged in litigation alleging that the Company's products infringe others' patent rights. As a result of such claims or litigation, it may become necessary or desirable in the future for the Company to obtain licenses relating to one or more of its products or relating to current or future technologies, and there can be no assurance that it would be able to do so on commercially reasonable terms.\nVOLATILITY OF STOCK PRICE; DILUTION The price of the Company's Common Stock has fluctuated widely in the past. Management believes that such fluctuations may have been caused by announcements of new products, quarterly fluctuations in the results of operations and other factors, including changes in conditions of the personal computer industry in general. Stock markets have experienced extreme price volatility in recent years. This volatility has had a substantial effect on the market prices of securities issued by the Company and other high technology companies, often for reasons unrelated to the operating performance of the specific companies. Due to the factors referred to herein, the dynamic nature of the Company's industry, general economic conditions and other factors, the Company's future operating results and stock prices may be subject to significant volatility in the future. In addition, any change in other operating results could have an immediate and significant effect on the prices of the Company's Common Stock. Such stock price volatility for the Common Stock has in the past provoked securities litigation, and future volatility could provoke litigation in the future that could divert substantial management resources and have an adverse effect on the Company's results of operations.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe index to the Company's Financial Statements, Financial Schedules, and the Report of the Independent Auditors appears in Part IV of this Form 10-K.\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 specifically stated as being incorporated by reference from the Company's definitive Proxy Statement for its 1995 Annual Meeting of Shareholders (the \"Proxy Statement\") in Part III of this Annual Report on Form 10-K, the Company's Proxy Statement is not to be deemed as filed as part of this report. The Proxy Statement will be filed with the Securities and Exchange Commission within 120 days of the Company's fiscal year end.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT\nThe information concerning the Company's directors required by Item 10 is incorporated by reference herein to section entitled \"Proposal No. 1 - Election of Directors\" of the Proxy Statement The information concerning the Company's executive officers required by Item 10 is incorporated by reference to Item 4A in Part 1 hereof entitled \"Executive Officers of Registrant.\"\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by Item 11 is incorporated herein by reference to the sections entitled \"Executive Compensation\" and \"Proposal No. 1 - Election of Directors--Compensation of Directors\" of the Proxy Statement.\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 section entitled \"Security Ownership of Certain Beneficial Owners and Management\" of the Proxy Statement.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by Item 13 is incorporated herein by reference to the section entitled \"Certain Transactions\" of the Proxy Statement.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a)(1) FINANCIAL STATEMENTS. The Company's financial statements filed herewith are as follows:\nPage ---- Report of Ernst & Young LLP, Independent Auditors 35\nConsolidated Balance Sheets at September 30, 1995 and 1994 36\nConsolidated Statements of Operations for the Years Ended September 30, 1995, 1994 and 1993 37\nConsolidated Statements of Shareholders' Equity for the Years Ended September 30, 1995, 1994, and 1993 38\nConsolidated Statements of Cash Flows for the Years Ended September 30, 1995, 1994, and 1993 39\nNotes to Consolidated Financial Statements 40\n(a)(2) FINANCIAL STATEMENT SCHEDULES. The Company's financial statement schedule filed herewith is as follows: Page ----\nSchedule II: Valuation and Qualifying Accounts 54\nAll other financial statement schedules are omitted because the information called for is not present in amounts sufficient to require submission of the schedules or because the information required is shown either in the financial statements or the notes thereto.\n(a) (3) EXHIBITS.\nExhibit Number Title ------ -----\n2.01 Agreement and Plan of Reorganization dated May 20, 1994 between Radius Inc. and SuperMac Technology, Inc. (9)\n2.02 Modification Agreement dated July 21, 1994 to Agreement and Plan of Reorganization between Radius Inc. and SuperMac Technology, Inc. (9)\n2.03 Agreement of Merger dated August 31, 1994 between Radius Acquisition Corp. and SuperMac Technology, Inc.\n2.04 Certificate of Ownership and Merger of SuperMac Technologies, Inc. into Radius Inc. dated September 7, 1994 and Certificate of Ownership of SuperMac Technologies, Inc. by Radius Inc. dated September 8,\n2.05 Agreement and Plan of Reorganization dated July 19, 1994 between Radius Inc. and VideoFusion, Inc. (12)\n2.06 First Amendment to Agreement and Plan of Reorganization between Radius Inc. and Video Fusion, Inc. dated August 25, 1994\n2.07 Second Amendment to Agreement and Plan of Reorganization between Radius Inc. and VideoFusion, Inc. dated September 6, 1994.\n2.08 Third Amendment to Agreement and Plan of Reorganization between Radius Inc. and VideoFusion, Inc. dated May 10,\n3.01 A Registrant's Sixth Amended and Restated Articles of Incorporation. (2)\n* B Certificate of Amendment of Registrant's Sixth Amended and Restated Articles of Incorporation.\n3.02 Registrant's Bylaws. (4)\n4.01 Form of Specimen Certificate for Registrant's Common Stock. (1)\n4.04 * Non-Plan Stock Option Grant to Charles W. Berger. (8)\n10.01 * A Registrant's 401(k) Savings and Investment Plan. (6)\n* B Amendment to the Registrant's 401(k) Savings and Investment Plan.\n* C Registrant's 401(k) Savings and Investment Plan Loan Policy\n10.02 * Registrant's 1995 Stock Option Plan.\n10.03 * Form of Stock Option Agreement and Exercise Request as currently in effect under 1995 Stock Option Plan.\n10.04 * Registrant's 1990 Employee Stock Purchase Plan and related documents. (3)\n10.05 * Registrant's 1994 Directors' Stock Option Plan.\nExhibit Number Title ------ -----\n10.07 Form of Indemnity Agreement with Directors. (1)\n10.08 A Credit Agreement by and among Radius Inc., the certain financial institutions, and Silicon Valley Bank, dated March 20, 1995. (14)\nB Credit Agreement by and among Radius Inc., the certain financial institutions, and International Business Machines Credit Corporation, dated February 17, 1995. (14)\nC Acknowledgment, Waiver and Amendment to Radius Inc. Inventory and Working Capital Financing Agreement by and between Radius Inc. and International Business Machines Credit Corporation dated December 14, 1995.\n10.09 A Lease Agreement by and between Registrant and the Equitable Life Assurance Society of the United States dated June 22, 1988, as amended by the Commencement of Term Agreement dated February 13, 1989 and Amendment No. One dated July 20, 1989, and related documents (1710 Fortune Drive, San Jose, California offices). (1)\nB Second Amendment to Lease dated January 27, 1993 amending Lease Agreement by and between Registrant and Fortune Drive Partners (successor in interest to the Equitable Life Assurance Society of the United States) dated June 22, 1988 (1710 Fortune Drive, San Jose, California offices). (7)\n10.10 Lease Agreement by and between Registrant and Board of Administration, as Trustee for the Police and Fire Department Fund, and Board of Administration, as Trustee for the Federated City Employees Retirement Fund dated December 11, 1990, and related documents (Milpitas, California warehouse space). (2)\n10.11 Lease Agreement by and between Registrant and South Bay\/Copley Associates III Joint Venture dated May 11, 1992; Sublease by and between Core Industries, Inc. and Registrant dated May 12, 1992; and related documents (2040 Fortune Drive, San Jose, California offices). (5)\n10.12 A Lease Agreement between SuperMac Technologies, Inc. and Connecticut General Life Insurance Company dated as of November 13, 1993 (215 Moffett Park Drive, Sunnyvale, California offices). (10)\nB First Amendment to Lease Agreement between SuperMac Technologies, Inc. and Connecticut General Life Insurance Company dated as of May 4, 1993 (215 Moffett Park Drive, Sunnyvale, California offices).\n10.13 Lease Agreement between SuperMac Technologies, Inc. and RREEF USA Fund-II, Inc. dated as of June 16, 1993 (Borregas Avenue, Sunnyvale, California warehouse space).\n10.14 * Employment Agreement by and between Registrant and Charles W. Berger dated February 26, 1993 as amended on September 17, 1993. (11)\n10.17 Full Recourse Promissory Note with Charles W. Berger. (11)\nExhibit Number Title ------ -----\n10.18 Full Recourse Promissory Notes with J. Daniel Shaver.\n10.19 Full Recourse Promissory Note from Michael A. McConnell.\n10.20 * SuperMac Technology, Inc.'s 1988 Stock Option Plan (\"Option Plan\"). (13)\n10.21 * SuperMac Technology, Inc.'s Form of Incentive Stock Option Agreement under the Option Plan. (13)\n10.22 * SuperMac Technology, Inc.'s Form of Supplemental Stock Option Agreement under the Option Plan. (13)\n10.23 * SuperMac Technology, Inc.'s Form of Early Exercise Stock Purchase Agreement under the Option Plan. (13)\n10.24 Distribution Agreement between Radius Inc. and Ingram Micro, Inc. dated June 5, 1991 as amended on April 1, 1992, May 31, 1995 and July 14, 1995. (Confidential treatment has been requested with respect to certain portions of this exhibit). (15)\n11.01 Computation of per share earnings\n21.01 List of Registrant's subsidiaries\n23.01 Consent of Ernst & Young, LLP, Independent Auditors\n27 Financial Data Schedules\n* Management contracts or compensatory plans required to be filed as an exhibit to Form 10-K.\n(1) Incorporated by reference to exhibits to the Company's Registration Statement on Form S-1 (File No. 33-35769), which became effective on August 16, 1990.\n(2) Incorporated by reference to exhibits to the Company's Report on Form 10-K filed on December 24, 1990.\n(3) Incorporated by reference to exhibits to the Company's Report on Form 10-K filed on December 30, 1991.\n(4) Incorporated by reference to exhibits to the Company's Registration Statement on Form S-8 filed on April 29, 1992 (File No. 33-47525).\n(5) Incorporated by reference to exhibits to the Company's Report on Form 10-Q filed on August 12, 1992.\n(6) Incorporated by reference to exhibits to the Company's Report on Form 10-K filed on December 28, 1992.\n(7) Incorporated by reference to exhibits to the Company's Report on Form 10-Q filed on August 18, 1993.\n(8) Incorporated by reference to exhibits to the Company's Registration Statement on Form S-8 filed on November 15, 1993 (File No. 33-71636).\n(9) Incorporated by reference to exhibits to the Company's Amendment No. 2 (File No. 33-79732) to Form S-4 filed on July 25, 1994.\n(10) Incorporated by reference to exhibits to SuperMac's Form S-1 (File No. 33-58158) filed on February 11, 1993.\n(11) Incorporated be reference to exhibits to the Company's Report on Form 10-K filed on January 3, 1994.\n(12) Incorporated by reference to exhibits to the Company's Report on Form 10-Q filed on August 17, 1994.\n(13) Incorporated by reference to exhibits to SuperMac Technology, Inc.'s Registration Statement on Form S-1, as amended (File No. 33-46800), which became effective on May 15, 1992.\n(14) Incorporated by reference to exhibits to the Company's Report on Form 10-Q filed on May 10, 1995.\n(15) Incorporated by reference to exhibits to the Company's Report on Form 10-Q filed on August 15, 1995.\n(b) REPORTS ON FORM 8-K. No report on Form 8-K was filed during the last quarter of the period covered by this report.\n(c) EXHIBITS - See (a) (3) above.\n(d) FINANCIAL STATEMENT SCHEDULES - See (a) (2) above.\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.\nRADIUS INC.\nBy: \/s\/ Charles W. Berger ------------------------------ Charles W. Berger President, Chief Executive Officer and Director\nPOWER OF ATTORNEY\nEach person whose signature appears below constitutes and appoints Charles W. Berger and David G. Pine, jointly and severally, his true and attorneys-in-fact, each with the power of substitution, for him in any and all capacities, to sign amendments to this Report on Form 10-K, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that 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:\nNAME TITLE DATES\nPRINCIPAL EXECUTIVE OFFICER:\n\/s\/ Charles W. Berger President, Chief Executive 12\/28\/95 - ------------------------------------ Officer and Chairman of Charles W. Berger the Board of Directors\nPRINCIPAL FINANCIAL OFFICER:\n\/s\/ Dennis J. Dunnigan Chief Financial Officer 12\/28\/95 - ------------------------------------ Dennis J. Dunnigan\nCHIEF ACCOUNTING OFFICER:\n\/s\/ Cherrie L. Jurado Controller 12\/28\/95 - ------------------------------------ Cherrie L. Jurado\nDIRECTORS:\n\/s\/ Michael D. Boich Director 12\/28\/95 - ------------------------------------ Michael D. Boich\n\/s\/ Michael A. McConnell Director 12\/28\/95 - ------------------------------------ Michael A. McConnell\n\/s\/ Regis McKenna Director 12\/28\/95 - ------------------------------------ Regis McKenna\n\/s\/ David B. Pratt Director 12\/28\/95 - ------------------------------------ David B. Pratt\nREPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS\nTHE BOARD OF DIRECTORS AND SHAREHOLDERS RADIUS INC.\nWe have audited the accompanying consolidated balance sheets of Radius Inc. as of September 30, 1995 and 1994, and the related consolidated statements of operations, shareholders' equity (net capital deficiency) and cash flows for each of the three years in the period ended September 30, 1995. 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 respect, the consolidated financial position of Radius Inc. at September 30, 1995 and 1994, and the consolidated results of its operations and its cash flows for each of the three years in the period ended September 30, 1995, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nThe accompanying consolidated financial statements have been prepared assuming that Radius Inc. will continue as a going concern. As more fully described in Note 1, the Company has incurred recurring operating losses, and has a deficiency in assets and working capital. In addition the Company has not complied with certain covenants of loan agreements with its lenders. These conditions raise substantial doubt about the Company's ability to continue as a going concern. (Management's plans in regard to these matters are also described in Note 1.) The financial statements do not include any adjustment to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.\nAs discussed in Note 1 to the Consolidated Financial Statements, in 1993 the Company changed its method of accounting for income taxes.\nPalo Alto, California December 8, 1995 except for Note 11, as to which the date is December 27, 1995\nCONSOLIDATED BALANCE SHEETS\nSee accompanying notes.\nCONSOLIDATED STATEMENTS OF OPERATIONS\nFor years ended September 30 (in thousands, except per share data)\nSee accompanying notes.\n(1) This period has been restated to reflect the 1994 Merger of Radius and SuperMac which was accounted for as a pooling of interests. See Note 10 of Notes to the Consolidated Financial Statements. The consolidated financial statements for fiscal 1993 have not been restated to adjust SuperMac's fiscal year end to that of Radius. This period includes Radius' results of operations and balance sheet data on a September 30 fiscal year basis and SuperMac's on a December 31 calendar year basis. The operating results for both the twelve months ended September 30, 1994 and September 30, 1993 include the restructuring and other charges of $16.6 million recorded by SuperMac in December 1993.\nCONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY\nFor the years ended September 30, 1995, 1994 and 1993 (in thousands, except share data)\nSee accompanying notes.\n(1) These periods have been restated to reflect the 1994 Merger of Radius and SuperMac which was accounted for as a pooling of interests. See Note 10 of Notes to the Consolidated Financial Statements. The consolidated financial statements for all periods prior to fiscal 1994 have not been restated to adjust SuperMac's fiscal year end to that of Radius. Such periods include Radius' results of operations and balance sheet data on a September 30 fiscal year basis and SuperMac's on a December 31 calendar year basis.\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nINCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS For years ended September 30 (in thousands)\nSee accompanying notes.\n(1) This period has been restated to reflect the 1994 Merger of Radius and SuperMac which was accounted for as a pooling of interests. See Note 10 of Notes to the Consolidated Financial Statements. The consolidated financial statements for fiscal 1993 have not been restated to adjust SuperMac's fiscal year end to that of Radius. This period includes Radius' results of operations and balance sheet data on a September 30 fiscal year basis and SuperMac's on a December 31 calendar year basis.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE ONE. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nORGANIZATION AND BASIS OF PRESENTATION\nThe consolidated financial statements include the accounts of Radius Inc. (\"Radius\") and its wholly owned subsidiaries after elimination of significant intercompany transactions and balances.\nRadius and SuperMac Technologies, Inc. (\"SuperMac\") merged into the combined company (the \"Company\") effective August 31, 1994 (the \"Merger\"), which was accounted for as a pooling of interests. The consolidated financial statements for fiscal 1993 have not been restated to adjust SuperMac's fiscal year end to that of Radius. This period includes Radius' results of operations and balance sheet data on a September 30 fiscal year basis and SuperMac's on a December 31 calendar year basis.\nFINANCIAL STATEMENTS ESTIMATES\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Such estimates include the level of allowance for potentially uncollectible receivables and sales returns; inventory reserves for obsolete, slow-moving, or non-salable inventory; and estimated cost for installation, warranty and other customer support obligations. Actual results could differ from these estimates.\nMANAGEMENT'S BUSINESS RECOVERY PLANS\nAs shown in the accompanying consolidated financial statements, the Company has incurred recurring operating losses, and has a deficiency in assets and working capital. In addition, as of September 30, 1995, the Company was not in compliance with all of its contractual obligations and financial covenants under its credit agreements. The Company also is delinquent in its accounts payables as payments to vendors are not being made in accordance with vendor terms.\nThe Company's relatively limited cash resources have restricted the Company's ability to purchase inventory which in turn has limited its ability to manufacture and sell products and has resulted in additional costs for expedited deliveries. The adverse effect on the Company's results of operations due to its limited cash resources can be expected to continue until such time as the Company is able to return to profitability, or generate additional cash from other sources.\nThese conditions raise concerns about the Company's ability to continue operations as an ongoing concern. Management has implemented, or has developed plans to implement, a number of actions to address these conditions including: refocusing its efforts on providing solutions for high end digital video and graphics customers; discontinuing sales of mass market and other low value added products; divesting its color server and monochrome display businesses and exploring opportunities for the divestiture of its MacOS compatible systems products and other product lines; significantly reducing expenses and headcount; subleasing all or a portion of its current facility given its reduced occupancy requirements; and investigating various strategic partnering opportunities.\nAdditional funds will be needed to finance the Company's development plans and for other purposes, and the Company is now investigating possible financing opportunities. There can be no assurance that additional financing will be available when needed or, if available, that the terms of such financing will not adversely affect the Company's results of operations.\nFISCAL YEAR\nThe Company's fiscal year ends on the Saturday closest to September 30 and includes 53 weeks in fiscal 1993 and 52 weeks in all other fiscal years presented. During fiscal 1995, the Company changed its fiscal year end from the Sunday closest to September 30 to the Saturday closest to September 30 for operational efficiency\npurposes. For clarity of presentation, all fiscal periods in this Form 10-K are reported as ending on a calendar month end.\nFOREIGN CURRENCY TRANSLATION\nThe Company translates the assets and liabilities of its foreign subsidiaries into dollars at the rates of exchange in effect at the end of the period and translates revenues and expenses using rates in effect during the period. Gains and losses from these translations are accumulated as a separate component of shareholders' equity. Foreign currency transaction gains or losses, which are included in the results of operations, are not material.\nINVENTORIES\nInventories are stated at the lower of cost or market. The Company reviews the levels of its inventory in light of current and forecasted demand to identify and provide reserve for obsolete, slow-moving, or non-salable inventory. Cost is determined using standard costs that approximate cost on a first-in, first-out basis. Inventories consist of the following (in thousands):\nPROPERTY AND EQUIPMENT\nProperty and equipment is stated at cost and consists of the following (in thousands):\nDepreciation has been provided for using the straight-line method over estimated useful lives of three to five years. Equipment under capital leases and leasehold improvements are being amortized on the straight-line method over six years or the remaining lease term, whichever is shorter.\nLONG-LIVED ASSETS\nIn 1995, the Financial Accounting Standards Board released the Statement of Financial Accounting Standards No. 121 (SFAS 121), \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of.\" SFAS 121 requires recognition of impairment of long-lived assets in the event the net book value of such assets exceeds the future undiscounted cash flows attributable to such assets. SFAS 121 is effective for fiscal years beginning after December 15, 1995. Adoption of SFAS 121 is not expected to have a material impact on the Company's financial position or results of operations.\nREVENUE RECOGNITION\nRevenue is recognized when products are shipped. Sales to certain resellers are subject to agreements allowing certain rights of return and price protection on unsold merchandise held by these resellers. The Company provides for estimated returns at the time of shipment and for price protection following price declines.\nWARRANTY EXPENSE\nThe Company provides at the time of sale for the estimated cost to repair or replace products under warranty. The warranty period commences on the end user date of purcahse and is normally one year for displays and digital video products and for the life of the product for graphics cards.\nINCOME TAXES\nEffective October 1, 1992, the Company adopted FASB Statement 109, \"Accounting for Income Taxes.\" Under Statement 109, the liability method is used in accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. Prior to the adoption of Statement 109, income tax expense was determined using the liability method prescribed by Statement 96, which is superseded by Statement 109. Among other changes, Statement 109 changes the recognition and measurement criteria for deferred tax assets included in Statement 96.\nAs permitted by Statement 109, the Company has elected not to restate the financial statements of any prior years. The cumulative effect of the change in method of accounting for income taxes decreased the net loss by $600,000 or $0.05 per share in fiscal 1993 on a combined basis.\nLOSS PER SHARE\nNet loss per share is computed using the weighted average number of common shares outstanding.\nCASH AND CASH EQUIVALENTS The Company considers all highly liquid investments with a maturity from date of purchase of three months or less to be cash equivalents; investments with maturities between three and twelve months are considered to be short-term investments. Cash equivalents are carried at cost which approximates market. There were no short-term investments as of September 30, 1995 or 1994. Approximately $1.6 million of the $4.8 million of cash and cash equivalents available at September 30, 1995 was restricted under various letters of credit.\nOFF BALANCE-SHEET RISK AND CONCENTRATION OF CREDIT RISK\nThe Company sells its products to direct computer resellers in the United States and to distributors in various foreign countries. The Company performs on-going credit evaluations of its customers and generally does not require collateral. The Company maintains reserves for potential credit losses.\nThe Company also hedges substantially all of its trade accounts receivable denominated in foreign currency through the use of foreign currency forward exchange contracts based on firm commitments. Gains and losses associated with currency rate changes on forward contracts are recognized in the consolidated statements of operations and were not material. At September 30, 1995, the Company had forward contracts to sell three different foreign currencies which totaled the equivalent of approximately $11.1 million and mature between October 1995 and November 1995. At September 30, 1995, the fair value of the Company's forward contracts approximated cost.\nRELATED PARTIES\nIn fiscal 1994, the Company acquired shares of preferred stock of Portrait Display Labs (\"PDL\") and a warrant to purchase additional shares of PDL preferred stock in exchange for the cancellation of certain rights held by the Company to purchase all of the outstanding equity securities or assets of the predecessor entity to PDL. The warrant permitted the purchase of approximately an additional 10% interest in PDL. The Company also was granted one seat on PDL's Board of Directors. In addition, the Company licensed PDL certain pivot display technology in exchange for the payment of royalties. Product revenues were approximately $5.0 million in fiscal 1994. In fiscal 1995, the Company exercised the warrant for an additional 10% interest in PDL in exchange for cancellation of approximately $945,000 in accounts receivable. There were no product revenues for the fiscal 1995 to this related party. The receivable from PDL at September 30, 1995 was approximately $980,000.\nSubsequent to September 30, 1995, the Company signed a series of additional agreements with Portrait Display Labs, see Note 11 to the Consolidated Financial Statements.\nThere were no material transactions from this or any other related party during fiscal 1993.\nNOTE TWO. BORROWINGS\nLINE OF CREDIT ARRANGEMENT\nIn February 1995, the Company and IBM Credit Corp. (\"ICC\") entered into a $30.0 million Inventory and Working Capital Financing Agreement (the \"ICC Agreement\"). The ICC Agreement permits advances for inventory and working capital up to the lesser of $30.0 million or 85% of eligible receivables (\"Inventory and Working Capital Advances\"). In September 1995, ICC advanced an additional $20.0 million under the ICC Agreement to finance the manufacturing of the Company's MacOS compatible products (the \"MacOS Advances\"). Advances bear interest at rates ranging from prime rate plus 2.25% to prime rate plus 4% and are secured by all the assets of the Company. The ICC Agreement expires in March 1996.\nAs of September 30, 1995, $50.8 million was outstanding under the ICC Agreement consisting of $30.8 million in Inventory and Working Capital Advances and approximately $20.0 million in MacOS Advances. The outstanding Inventory and Working Capital Advances included $18.7 million in working capital advances supported by eligible receivables, $6.1 million in working capital advances in excess of the borrowing base, and $6.1 million in inventory advances. The $24.7 million in working capital advances are included in Short-term borrowings in the Consolidated Financial Statements. The $6.1 million in inventory advances, together with the approximately $20.0 million in MacOS Advances, are included in Accounts payable in the Consolidated Financial Statements.\nAs of September 30, 1995, the Company was not in compliance with all of its contractual obligations and financial covenants under the ICC Agreement (specifically, revenues to working capital ratio, net profit to revenue, and total liabilities to total net worth); however, IBM Credit has waived such defaults pursuant to an amendment to the ICC Agreement. See Note 11 to the Consolidated Financial Statements.\nIn addition, the Company entered into a Business Loan Agreement on March 20, 1995 with Silicon Valley Bank. The agreement, which expires on March 19, 1996, allows the Company to issue letters of credit as a sub-facility under a $5.0 million foreign accounts receivable revolving line of credit subject to an interest rate of up to the prime rate plus 1.25%. The related debt outstanding as of September 30, 1995 was $1.7 million and outstanding letters of credit were $0.8 million. The Company was not in compliance with all the terms of this credit arrangement.\nOne of the Company's subsidiaries has a revolving line of credit with a bank in Japan. Borrowings were approximately $3.1 million at September 30, 1995. This note bears interest at the lesser of the Euro-yen rate or the bank's prime lending rate (1.5 percent at September 30, 1995, the prime rate). The line of credit is renewed every six months with the next renewal in December 1995.\nNOTE THREE. COMMITMENTS AND CONTINGENCIES\nLEASES\nThe Company leases facilities under operating leases and certain computer equipment and office furniture under capital leases. Depreciation expense for assets under capital leases is included in depreciation and amortization expense. The cost and net book value of these capitalized lease assets included in property and equipment are (in thousands):\nFuture minimum lease payments at September 30, 1995, under capital leases and noncancelable operating leases are as follows (in thousands):\nRent expense charged to operations amounted to approximately $3.5 million, $3.0 million and $3.8 million for the years ended September 30, 1995, 1994 and 1993, respectively. The rent expense amounts for fiscal 1995, 1994 and 1993 exclude a provision for remaining lease obligations on excess facilities. See Note 8 of Notes to the Consolidated Financial Statements.\nSublease income for fiscal 1995 and 1994 was approximately $0.6 million and $0.1 million. There was no sublease income for fiscal 1993.\nCONTINGENCIES\nDISPLAY SCREEN SIZE The Company was named as one of approximately 42 defendants in Shapiro et al. v. ADI Systems, Inc. et al., Superior Court of California, Santa Clara County, case no. CV751685, filed August 14, 1995. Radius was named as one of approximately 32 defendants in Maizes & Maizes et al. v. Apple Computer et al., Superior Court of New Jersey, Essex County, case no. L-13780-95, filed December 15, 1995. Plaintiffs in each case purport to represent alleged classes of similarly situated persons and\/or the general public, and allege that the defendants falsely advertise that the viewing areas of their computer monitors are larger than in fact they are.\nThe Company was served with the Shapiro complaint on August 22, 1995, and has not yet been served with the Maizes complaint. Defendants' petition to the California State Judicial Council to coordinate the Shapiro case with similar cases brought in other California jurisdictions was granted in part and it is anticipated that the coordinated proceedings will be held in Superior Court of California, San Francisco County. Discovery proceedings have not yet begun in either case. In the opinion of management, based on the facts known at this\ntime, the eventual outcome of these cases is unlikely to have a material adverse effect on the results of operations or financial position of the Company.\nELECTRONICS FOR IMAGING On November 16, 1995, Electronics for Imaging, Inc. (\"EFI\") filed a suit in the United States District Court in the Northern District of California alleging that the Company infringes a patent allegedly owned by EFI. Although the complaint does not specify which Radius products allegedly infringe the patent, EFI is a prime competitor of Radius in the Color Server market. Radius' Color Server products are material to its business.\nThe Company has filed an answer denying all material allegations, and has filed counterclaims against EFI alleging causes of action for interference with prospective economic benefit, antitrust violations, and unfair business practices. The Company believes it has meritorious defenses to EFI's claims and is defending them vigorously. In addition, the Company believes it may have indemnification rights with respect to EFI's claims. In the opinion of management, based on the facts known at this time, the eventual outcome of this case is unlikely to have a material adverse effect on the results of operations or financial position of the Company.\nSECURITIES LITIGATION. In September 1992, the Company and certain of its officers and directors were named as defendants in a securities class action litigation brought in the United States District Court for the Northern District of California that sought unspecified damages, prejudgment and postjudgment interest, attorneys' fees, expert witness fees and costs, and equitable relief. In July 1994, SuperMac and certain of its officers and directors, several venture capital firms and several of the underwriters of SuperMac's May 1992 initial public offering and its February 1993 secondary offering were named as defendants in a class action litigation brought in the same court that sought unspecified damages, prejudgment and postjudgment interest, attorneys' fees, experts' fees and costs, and equitable relief (including the imposition of a constructive trust on the proceeds of defendants' trading activities).\nIn June 1995, the Court approved the settlement of both litigations and entered a Final Judgment and Order of Dismissal. Under the settlement of the litigation brought in 1992 against the Company, our insurance carrier paid $3.7 million in cash and the Company will issue 128,695 shares of its Common Stock to a class action settlement fund. In the settlement of the litigation brought in 1994 against SuperMac, the Company paid $250,000 in cash and will issue into a class action settlement fund 707,609 shares of its Common Stock. The number of shares to be issued by the Company will increase by up to 100,000 if the price of the Common Stock is below $12 per share during the 60-day period following the initial issuance of shares. In connection with these settlements, the Company recorded a charge of $12.4 million in the Consolidated Financial Statements reflecting settlement costs not covered by insurance as well as related legal fees.\nThe Company has periodically received communications from third parties asserting infringement of patent rights on certain of the Company's products and features. Management does not believe any claims made will have a material adverse effect on the results of operations or financial position of the Company.\nNOTE FOUR. SHAREHOLDERS' EQUITY\nCOMMON STOCK\nIn June 1995, the Company sold approximately 2.5 million shares of its Common Stock in a series of private placements to a small number of investors unaffiliated with the Company. Proceeds from the offering, net of commission and other related expenses were $21.4 million. The net proceeds were used for working capital.\nSTOCK OPTIONS\nThe Company's 1986 Stock Option Plan, as amended, authorizes the issuance of up to 2,975,000 shares of common stock upon the exercise of incentive stock options or nonqualified stock options that may be granted to officers, employees (including directors who are also employees), consultants and independent contractors. Under the plan, options are exercisable for a term of up to ten years after issuance. Options may be granted at prices ranging from 50% to 100% of the fair market value of the stock on the date of grant, as determined by the Board of Directors. Vesting of shares is also determined by the Board of Directors at the date of grant. The 1986 Stock Option Plan will expire in October 1996.\nOn August 31, 1994, pursuant to the Merger, Radius assumed 975,239 outstanding options originally issued under the SuperMac 1988 Stock Option Plan. These options will be administered in accordance with the SuperMac 1988 Stock Option Plan until all options are exercised or expired. Under the plan, options are exercisable for a term of up to ten years after issuance.\nThe following table summarizes the consolidated activity of the 1986 and 1988 Stock Option Plans and the 1992 Non-Employee Directors' Stock Option Plan:\nThe stock option activity as shown in the table for fiscal 1993 has not been restated to adjust SuperMac's fiscal year end to that of Radius. Fiscal 1993 includes Radius' activity on a September 30 fiscal year basis and SuperMac's activity on a December 31 calendar year basis. The fiscal 1994 period includes the Radius activity for fiscal year ended September 30, 1994 and SuperMac activity for the nine months ended September 30, 1994.\nThe Company has also reserved 100,000 shares of common stock for issuance to non-employee directors pursuant to options granted under the 1994 Directors' Stock Option Plan (the \"1994 Plan\"). Such options may only be nonqualified stock options, must be exercised within ten years from the date of grant, and must be granted in accordance with a non-discretionary formula. Under this formula, each new director receives an option to purchase 10,000 shares when that director is first appointed to the Board and an option to purchase 2,500 shares on each anniversary of such director's appointment. As of September 30, 1995, 27,500 shares had been granted under this plan at exercise prices ranging from $7.44 to $12.00 per share. Options to purchase 1,250 shares were canceled following the resignation of a director. None of the options granted under the 1994 Plan are exercisable.\nPrior to the approval of the 1994 Plan, the 1990 Directors' Stock Option Plan (the \"Prior Plan\") was in effect. As of September 30, 1995, the Prior Plan had 33,750 options outstanding at prices ranging from $8.00 to $17.25. Such options are nonqualified stock options, must be exercised within five years from the date of grant, and were granted in accordance with a non-discretionary formula. Options unissued under the Prior Plan become available for grant under the 1994 Plan. As of September 30, 1995, options to purchase 37,500 shares became available upon the resignation of three directors. In addition, 28,750 options to purchase shares, which were never granted under the Prior Plan were transferred to the 1994 Plan.\nIn March 1993, the Company granted a nonqualified stock option to one officer to purchase a total of 250,000 shares of common stock outside the Company's 1986 Stock Option Plan at an exercise price of $7.75 per share. This option is exercisable for a term of ten years and vests over a fifty month period commencing on the date of grant. During fiscal 1994, 150 of these shares were exercised by the officer, and as of September 30, 1995 an additional 149,850 shares were exercisable.\nIn June 1995, the Company repriced approximately 232,000 of then outstanding options to an exercise price of $12.00 per share, the fair market value of the Company's stock on the date of the repricing.\nEMPLOYEE STOCK PURCHASE PLAN\nThe Company has an employee stock purchase plan under which substantially all employees may purchase common stock through payroll deductions at a price equal to 85% of its fair market value as of certain specified dates. Stock purchases under this plan are limited to 10% of an employee's compensation, and in no event may exceed $21,250 per year. Under this plan a total of 650,000 shares of common stock have been reserved for issuance to employees. At September 30, 1995, 255,859 shares remain available for issuance under the plan.\nEMPLOYEE STOCK PLANS\nThe Company account for its stock option plans and the Employee Stock Purchase Plan in accordance with provisions of the accounting Principles Board's Opinion No. 25 (APB 25), \"Accounting for Stock Issued to Employees.\" In 1995, the Financial Accounting Standards Board released the Statement of Financial Accounting Standard No. 123 (SFAS 123), \"Accounting for Stock Based Compensation.\" SFAS 123 provides an alternative to APB 25 and is effective for fiscal years beginning after December 15, 1995. The Company expects to continue to account for its employee stock plans in accordance with the provision of APB 25. Accordingly, SFAS 123 is not expected to have any material impact on the Company's financial position or results of operations.\nNOTE FIVE. FEDERAL AND STATE INCOME TAXES\nThe provision (benefit) for income taxes consists of the following:\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:\nFASB Statement 109 provides for the recognition of deferred tax assets if realization of such assets is more likely than not. The Company's valuation allowance reduced the deferred tax asset to the amount realizable. The Company has provided a full valuation allowance against its net deferred tax assets due to uncertainties surrounding their realization. Due to the net losses reported in the prior three years and as a result of the material changes in operations reported in its 1995 fiscal fourth quarter, predictability of earnings in future periods is uncertain. The Company will evaluate the realizability of the deferred tax asset on a quarterly basis.\nThe provision for income taxes differs from the amount computed by applying the statutory federal income tax rate to income before taxes. The sources and tax effects of the differences are as follows:\nAs of September 30, 1995, the Company had net operating loss carryforwards for federal and state income tax purposes of approximately $71,000,000 and $27,900,000, respectively. The state loss carryforwards will expire beginning in 1998, if not utilized, and the federal loss carryforwards will expire beginning in 2010, if not utilized. In addition, the Company had tax credit carryforwards of approximately $6,280,000 which will expire beginning in 2005, if not utilized.\nUtilization of net operating loss and tax credit carryforwards may be subject to substantial annual limitation due to the ownership change limitations provided by the Internal Revenue Code of 1986 and similar state provisions. The annual limitation may result in the expiration of net operating losses before utilization.\nNOTE SIX. STATEMENTS OF CASH FLOWS\nNOTE SEVEN. EXPORT SALES AND MAJOR CUSTOMERS\nThe Company currently operates in one principal industry segment: the design, manufacturing and marketing of color publishing and digital video computer products. The Company's export sales were approximately $124,469,000, $112,050,000 and $108,115,000 in the fiscal years ended September 30, 1995, 1994 and 1993, respectively, and included export sales to Europe of approximately $57,257,000, $60,621,000, and $59,473,000, respectively. The Pacific, Asia, and Latin America region sales were approximately $67,212,000, $51,428,000 and $48,642,000 for fiscal years ended September 30, 1995, 1994 and 1993, respectively.\nOne customer accounted for approximately 34.0%, 13.5% and 11.5% of the Company's net sales during the years ended September 30, 1995, 1994 and 1993, respectively.\nNOTE EIGHT. RESTRUCTURING AND OTHER CHARGES\nRADIUS JUNE 1993 RESTRUCTURING AND OTHER CHARGES In June 1993, Radius announced a restructuring program designed to reduce costs and improve operating efficiencies. The program included, among other things, the write-down of inventory following Radius' decision to phase out its older generation of products, lease termination expenses, capital equipment write-offs, severance payments, and costs associated with the discontinuation of Radius' minicomputer-class server product. The restructuring program costs of $15.5 million were recorded during the third quarter of fiscal 1993. These charges (in thousands) are included in: cost of sales ($10,993); research and development ($411); and selling, general and administrative expenses ($4,096). The Company completed this restructuring event by the end of calendar 1994. There were no material changes in the restructuring plan or in the estimates of the restructuring costs from the recognition of the charge in June 1993 with the completion of the restructuring program in December 1994.\nSUPERMAC DECEMBER 1993 RESTRUCTURING AND OTHER CHARGES In December 1993, SuperMac recorded charges of $16.6 million in connection with a program to adjust inventory levels, eliminate excess facilities, terminate certain projects and contract arrangements and reduce the number of employees. The charges (in thousands) are included in: cost of sales ($13,352); research and development ($2,000); and selling, general and administrative expenses ($1,238). There have been no material changes in the restructuring plan or in the estimates of the restructuring costs. The Company has $236,000 remaining in its restructuring reserve related to facility costs, the balance of which is expected to be eliminated in fiscal 1996. As noted in the Consolidated Financial Statements, the consolidated results for the Company in both the twelve months ended September 30, 1994 and the fiscal period ended 1993 include SuperMac's $16.6 million charge.\nRADIUS FISCAL 1994 MERGER RELATED RESTRUCTURING AND OTHER CHARGES In the fourth quarter of fiscal 1994, the Company recorded charges of $43.4 million in connection with the Merger of Radius and SuperMac. These charges include the discontinuance of duplicative product lines and related assets; elimination of duplicative facilities, property and equipment and other assets; and personnel severance costs as well as transaction fees and costs incidental to the merger. The charges (in thousands) are included in: net sales ($3,095); cost of sales ($25,270); research and development ($4,331); and selling, general and administrative expenses ($10,711). The elements of the total charge as of September 30, 1995 are as follows (in thousands):\nThe adjustment of inventory levels reflects the discontinuance of duplicative product lines. The provision for excess facility costs represents the write-off of leaseholds and sublease costs of Radius' previous headquarters, the consolidation into one main headquarter and the consolidation of sales offices. The revision of the operations business model reflects the reorganization of the combined Company's manufacturing operations to mirror Radius' manufacturing reorganization in 1993. This reorganization was designed to outsource a number of functions that previously were performed internally, reduce product costs through increased efficiencies and lower overhead, and focus the Company on a limited number of products. Employee severance costs are related to employees or temporary employees who were released due to the revised business model. Approximately 250 employees were terminated in connection with the Merger. The provision for merger related costs is for the costs associated with the Merger transaction, such as legal, investment banking and accounting fees. The Company has spent $15.9 million of cash for restructuring through September 30, 1995. The Company expects to have substantially completed the restructuring by September 1996. During fiscal 1995, approximately $2.1 million of merger related retructuring reserves were reversed and recorded as an expense reduction due to changes in estimated requirements.\nRADIUS FISCAL 1995 RESTRUCTURING AND OTHER CHARGES In September 1995, Radius recorded charges of $57.9 million in connection with the Company's efforts to refocus its business on the color publishing and multimedia markets. The charges primarily included a writedown of inventory and other assets. Additionally, it included expenses related to the cancellation of open purchase orders, excess facilities and severance. The charges (in thousands) are included in cost of sales ($47,004), and selling, general and administrative expense ($10,861). The elements of the total charge as of September 30, 1995 are as follows (in thousands):\nThe adjustment of inventory levels reflects the discontinuance of several product lines. The provision for excess facility costs represent the write-off of leasehold improvements and the costs associated with anticipated reductions in facilities. The cancellation fees and asset write-offs reflect the Company's decision to refocus its efforts on providing solutions for the color publishing and multimedia markets. Employee severance costs are related to employees or temporary employees who have been or will be released due to the revised business model. As of December 15, 1995, approximately 157 positions had been eliminated in connection with the new business model. The Company had not spent any cash for this restructuring as of September 30, 1995. As of September 30, 1995, the Company had cash and cash equivalents of $4.8 million. See \"Management's Business Recovery Plans\" at Note 1 due to the Consolidated Financial Statements. The Company expects to have substantially completed the restructuring by September 1996.\nNOTE NINE. VIDEOFUSION ACQUISITION\nThe Company acquired VideoFusion, Inc. (\"VideoFusion\") on September 9, 1994. VideoFusion is a developer of advanced digital video special effects software for Apple Macintosh and compatible computers. The Company acquired VideoFusion in exchange for approximately 890,000 shares of the Company's Common Stock, 205,900 shares of which were issued at the closing of the acquisition. The balance of the shares were to be issued in installments over a period of time contingent on the achievement of certain performance milestones and other factors. In addition, the Company was required to pay up to $1.0 million in cash based upon net revenues derived from future sales of products incorporating VideoFusion's technology. The purchase price for VideoFusion, including closing costs and the issuance of shares of Common Stock valued at $500,000 in connection with the achievement of the first milestone was approximately $2.4 million. This amount was allocated to the assets and liabilities of VideoFusion and resulted in identifiable intangibles of approximately $440,000 and an in- process research and development expense of approximately $2.2 million. The intangible asset was to be amortized over\ntwo years. The Company recognized the charge of approximately $2.7 million for in-process research and development and other costs associated with the acquisition of VideoFusion during the fourth quarter of fiscal 1994.\nIn May 1995, the Company entered into an agreement with the former holders of VideoFusion stock to settle the contingent stock and earnout payments that were originally contemplated. Pursuant to this agreement, the Company issued approximately 212,000 shares, and paid approximately $200,000, to the former holders of VideoFusion stock. These transactions resulted in additional compensation expense of approximately $3.0 million which was recorded in fiscal 1995.\nNOTE TEN. MERGER WITH SUPERMAC TECHNOLOGIES, INC.\nOn August 31, 1994, Radius merged with SuperMac in exchange for 6,632,561 shares of Radius' common stock. SuperMac was a designer, manufacturer, and marketer of products that enhanced the power and graphics performance of personal computers. The Merger was accounted for as a pooling of interests, and, accordingly, the Company's Consolidated Financial Statements and Notes to Consolidated Financial Statements have been restated to include the results of SuperMac for all periods presented.\nSeparate results of operations for the periods prior to the Merger are as follows (in thousands):\nThe merger related expenses reflect the recording of the merger related restructuring and other charges.\nPrior to the Merger, SuperMac's fiscal year end was December 31. SuperMac's separate results for fiscal 1994 have been restated to conform with the twelve months ended September 30. The Consolidated Financial Statements for all periods prior to fiscal 1994 have not been restated to adjust SuperMac's fiscal year end to that of Radius. Such periods include Radius' results of operations and balance sheet data on a September 30 fiscal year basis and SuperMac's on a December 31 calendar year basis. Therefore, the results for both the fiscal year ended September 30, 1994 and the results for the fiscal year ended 1993 include the results for SuperMac's three months ended December 31, 1993. Unaudited revenues, cost and expenses, and net loss of SuperMac for the three months ended December 31, 1993 were, $48,478,000, $64,715,000 and $9,914,000, respectively.\nThe Company incurred substantial costs in connection with the Merger and consolidation of operations. Included in the accompanying consolidated statement of operations for the year ended September 30, 1994 are merger related expenses totaling $43,407,000 consisting primarily of charges for the discontinuance of duplicative product lines and related assets, elimination of duplicative facilities, property and equipment and other assets, and personnel severance costs as well as transaction fees and costs incident to the Merger. See Note 8 of Notes to the Consolidated Financial Statements.\nNOTE ELEVEN. SUBSEQUENT EVENTS\nPORTRAIT DISPLAY LABS On December 19, 1995, the Company signed a series of agreements with Portrait Display Labs, Inc. (\"PDL\"). The agreements assigned the Company's pivoting technology to PDL and canceled PDL's on-going royalty obligation to the Company under an existing license agreement in exchange for a one- time cash payment. PDL also granted the Company a limited license back to the pivoting technology. Under these agreements, PDL settled its outstanding receivable to the Company by paying the Company $500,000 in cash and issuing to the Company 214,286 shares of PDL's Common Stock. See Note 1 to the Consolidated Financial Statements.\nDISPLAY TECHNOLOGIES ELECTROHOME INC. On December 21, 1995, the Company signed a Business Purchase Agreement and an Asset Purchase and License Agreement with Display Technologies Electrohome Inc. (\"DTE\"). Pursuant to the agreements and subject to certain closing conditions, DTE will purchase Radius' monochrome display monitor business and certain assets related thereto, for approximately $200,000 in cash and cancellation of $2.5 million of the Company's indebtedness to DTE. In addition, DTE and Radius will cancel outstanding contracts relating to DTE's manufacture and sale of monochrome display monitors to Radius.\nCOLOR SERVER GROUP On December 23, 1995, the Company signed a definitive agreement pursuant to which the Company will sell its Color Server business to Splash Merger Company, Inc. (the \"Buyer\"), a wholly owned subsidiary of Splash Technology Holdings, Inc. (the \"Parent\"), a corporation formed by various investment entities associated with Summit Partners. The Company will receive approximately $21,945,175 in cash (subject to certain post-closing adjustments) and 4,282 shares of the Parent's 6% Series B Redeemable and Convertible Preferred Stock (the \" Series B Preferred Stock\"). The shares of Series B Preferred Stock will be convertible by the Company at any time into 19.9% of the Parent's common stock outstanding as of the closing of the transaction. The shares of Series B Preferred Stock also will be redeemable by the Parent at any time, and will be subject to mandatory redemption beginning on the sixth anniversary of issuance, in each case at a redemption price of $1,000 per share plus accrued dividends. The transaction is expected to close in January 1996. Under the Inventory and Working Capital Agreement, as recently amended, with IBM Credit Corp., the Company is required to pay all of the net proceeds of the Color Server business transaction to IBM Credit Corp. in order to reduce the Company's outstanding indebtedness under that agreement.\nIBM CREDIT CORP. On December 14, 1995, the Company and IBM Credit Corp. (\"ICC\") amended the Inventory and Working Capital Financing Agreement (the \"ICC Agreement\") entered into by the Company and ICC on February 17, 1995 and subsequently revised in September 1995 to fund the manufacturing of the Company's MacOS compatible systems products. See Note 2 to the Consolidated Financial Statements. Under the amendment, ICC waived the Company's failure to comply with all of its contractual obligations and financial covenants under the ICC Agreement. The ICC Amendment, among other things, also provides that until March 31, 1996 ICC will extend advances to the Company in an amount up to 90% of the Company's collections and fund the Company's payroll in the event that collections are insufficient to permit the advances needed for this purpose. Such advances and payroll funding, however, may be suspended by ICC (i) immediately following a material default of the ICC Amendment, and (ii) following thirty (30) days notice in the event of any default of the ICC Agreement. The ICC Amendment also requires the Company to pay all of the net proceeds of the Color Server Group transaction to ICC to reduce the Company's outstanding indebtedness under the ICC Agreement.\n1995 STOCK OPTION PLAN On December 20, 1995, the Company's Board of Directors adopted the 1995 Stock Option Plan to replace the 1986 Stock Option Plan that expires in 1996, and reserved 850,000 shares (plus all unissued and unexercised shares available under the existing 1986 Stock Option Plan) for issuance thereunder. The 1995 Stock Option Plan is subject to shareholder approval. See Note 4 to the Consolidated Financial Statements.\nSCHEDULE II --- VALUATION AND QUALIFYING ACCOUNTS (IN THOUSANDS)\n(1) Uncollectable accounts written off.\n(2) The Consolidated Financial Statements for fiscal 1993 have not been restated for the change in fiscal year.This period includes Radius' results of operations and balance sheet data on a September 30 fiscal year basisand SuperMac's on a December 31 calendar year basis.\nEXHIBIT INDEX\nExhibit Number Title - ------- -----\n2.06 First Amendment to Agreement and Plan of Reorganization between Radius Inc. and Video Fusion, Inc. dated August 25, 1994\n2.07 Second Amendment to Agreement and Plan of Reorganization between Radius Inc. and VideoFusion, Inc. dated September 6, 1994.\n2.08 Third Amendment to Agreement and Plan of Reorganization between Radius Inc. and VideoFusion, Inc. dated May 10, 1995\n10.01 * C Registrant's 401(k) Savings and Investment Plan Loan Policy\n10.02 * Registrant's 1995 Stock Option Plan.\n10.03 * Form of Stock Option Agreement and Exercise Request as currently in effect under 1995 Stock Option Plan.\n10.08 C Acknowledgement, Waiver and Amendment to Radius Inc. Inventory and Working Capital Financing Agreement by and between Radius Inc. and International Business Machines Credit Corporation dated December 14, 1995.\n11.01 Computation of per share earnings\n21.01 List of Registrant's subsidiaries\n23.01 Consent of Ernst & Young, LLP, Independent Auditors\n27 Financial Data Schedule","section_15":""}
{"filename":"37661_1995.txt","cik":"37661","year":"1995","section_1":"ITEM 1. BUSINESS\nFlorida Steel Corporation (\"the Company\") operates a group of five union-free minimills, located in the southeastern United States, that produce steel products, including concrete reinforcing bar (\"rebar\"), merchant bars, and rods. Rebar is used primarily for strengthening concrete in highway and building construction and other construction applications. Merchant bars and light structural shapes (\"merchant bars\"), which include rounds, squares, flats, angles and channels are used in a wide variety of applications including floor and roof joists, transmission towers, and farm equipment. Rods are used in a variety of applications, including the manufacture of welded wire fabric and nails. The Company's rebar either is sold directly to distributors and third-party fabricating companies in stock lengths and sizes or is transferred to one of the Company's 13 fabricating plants where it is cut and bent to meet engineering, architectural or other end-product specifications. Merchant bars and rods generally are sold directly to customers in stock lengths and sizes. For the year ended March 31, 1995, approximately 23% of the Company's sales were derived from fabricated rebar, 27% were from stock rebar, 31% were from merchant rebar, 7% were from rods, and 12% were from other products.\nThe Company currently operates minimills located in Tampa and Jacksonville, Florida; Charlotte, North Carolina; and Jackson and Knoxville, Tennessee. Minimills are steel mills that use electric arc furnaces to melt scrap steel and cast the resulting molten steel into long strands called billets in a continuous casting process. Billets are then reheated and rolled into rebar, merchant bars, and rods. The Company also sells billets to other steel mills.\nThe Company estimates that it currently has annual steel melting capacity of 1.8 million tons and finished product rolling capacity of 1.8 million tons.\nThe predecessor of the Company was formed in 1937 as a rebar fabricator. In 1956, it merged with five steel fabricators in Florida to form the Company, which began construction of its first minimill in Tampa. The Company subsequently built minimills in Charlotte, North Carolina; Indiantown and Jacksonville, Florida; and Jackson, Tennessee and acquired a minimill in Knoxville, Tennessee, (the Indiantown minimill was closed for economic reasons in 1982). In 1988, the Company was acquired by FLS Holdings Inc. (\"Holdings\" or \"FLS\") in a leveraged buyout (\"The 1988 Acquisition\").\nACQUISITION\nFLS, the Company's parent, on June 26, 1992, signed an agreement of merger providing for its acquisition by Kyoei Steel Ltd. (\"Kyoei\") (the \"Acquisition\").\nOn December 21, 1992, closing of the Acquisition by Kyoei occurred. For financial reporting purposes, the Company accounted for the transaction effective December 31, 1992. In connection with the closing, FLS received an equity infusion of $150 million. Of the $150 million, $29 million was used or reserved to retire all of the outstanding Redeemable Preferred Stock, and $9 million was paid to the holders of common stock of FLS. In addition, the Company received net proceeds of approximately $93 million from the issuance of new 11 1\/2% First Mortgage Notes (the \"First Mortgage Notes\"), $50 million from an Intercompany Note from FLS, and $16 million under a Revolving Credit Agreement. The Revolving Credit agreement provided the Company aggregate borrowings up to the lesser of $100 million or a borrowing base amount generally based on 85% of eligible accounts receivable and 62.5% of eligible inventory. The proceeds provided by the new debt agreements, together with the remaining proceeds from the additional equity infusion were used to retire all of the previously outstanding indebtedness under the senior term loan and revolving credit agreement, plus accrued and unpaid interest. Additionally, $92 million of the subordinated\ndebentures were retired, representing the debentures which were purchased pursuant to the tender offer. Interest was paid on the tendered debentures through the date of closing. Interest on the untendered debentures was paid through the regularly scheduled interest payment date of November 15, 1992. Payment of such interest eliminated the Company's covenant noncompliance with respect to the subordinated debentures.\nThe statement of financial position as of December 31, 1992 reflected a new basis of accounting in which the total cost of the purchase was allocated to the assets and liabilities using estimates of fair values (known as the purchase method of accounting pushed down to the subsidiary's financial statements or \"push-down\" accounting). The excess purchase price over net assets acquired was recorded as goodwill. The deficit at September 30, 1992, and the loss for three-months ended December 31, 1992, were eliminated under purchase accounting. The net adjustment to assets and liabilities, as a result of applying push-down accounting, was to increase assets and liabilities by approximately $14 million.\nThe Company has changed its fiscal year-end from September 30th to March 31st to coincide with Kyoei's fiscal year-end. Financial data as of or for any period prior to December 31, 1992, pertains to the \"Predecessor\" Company.\nCUSTOMERS\nPrincipal customers of the Company include steel distributors, steel service centers, reinforcing steel fabricators, other metal fabricators and manufacturers, railroads, building material dealers, and contractors. Its fabricated products are sold to contractors performing work for residential and nonresidential building, road, bridge, public works, utility and other miscellaneous construction. The Company's business is not dependent upon any particular single customer or group of customers. During fiscal year 1995, the largest single customer accounted for 2.9% of total sales and the five largest customers accounted for 10.8% of total sales.\nSales under patents, trademarks, licenses, franchises, and concessions amount to less than 1% of sales for the 1995 fiscal year.\nSales order backlog is meaningful only as it pertains to fabrication contract sales inasmuch as stock sales are primarily on a spot order basis. The amount of sales order backlog pertaining to fabrication contracts was approximately $86 million at March 31, 1995, as compared to $83 million at March 31, 1994. All of the backlog at March 31, 1995 is expected to be filled during fiscal 1996.\nNone of the business for the 1995 fiscal year is subject to renegotiation or termination of subcontract at the election of the government.\nThe Company's payment terms to customers are generally determined based on market conditions given the cyclical nature of its sales. However, the Company generally does not offer extended payment terms to customers.\nPRODUCTION AND FACILITIES\nSteel Production. Minimills are steel mills that use electric arc furnaces to melt scrap steel and cast the resulting molten steel into long strands called billets in a continuous casting process. The billets are typically transferred to a rolling mill where they are reheated, passed through roughing mills for size reduction and then rolled into rebar, merchant bars, or rods. These products emerge from the rolling mill and are allowed to cool uniformly on a cooling bed.\nSteel can be produced at significantly lower costs by minimills than by integrated steel operations. Integrated steel mills, which typically process iron ore and other raw materials in blast furnaces to produce steel, generally use costlier raw materials, consume more energy, consist of older facilities that are more labor intensive and employ a larger and more highly paid labor force. In general, minimills serve localized markets and produce a limited line of commodity steel products.\nThe domestic minimill steel industry currently has excess production capacity. This excess capacity has resulted in competitive product pricing and cyclical pressures on industry profit margins. The high fixed costs of operating a minimill encourage mill operators to maintain high levels of output even during periods of reduced demand which exacerbates the pressures on profit margins. In this environment, efficient production and cost controls are important to domestic minimill steel producers.\nThe Company's Jackson, Tennessee; Jacksonville, Florida and Charlotte, North Carolina minimills operated their melting facilities seven days per week, the Knoxville mill five days per week, and have an annual aggregate melting capacity of approximately 1.8 million tons. The Jackson, Charlotte and Jacksonville mills operated their rolling facilities seven days per week. The Knoxville, Tennessee and Tampa, Florida minimills operated their rolling facilities five days per week. On June 15, 1994, the Tampa Melting facility was closed and production transferred to the other four mills.\nThe following table sets forth the estimated annual production capacity and actual production of the Company's five minimills in thousands of tons at March 31, 1995.\n(a) Purchase Date\nJACKSON MINIMILL\nThe Jackson minimill produces mostly merchant bars and some rebar. This minimill is the Company's largest single producer of merchant bars. The merchant bars are marketed primarily in the southeastern United States, as well as into southern Illinois, Indiana, and Ohio.\nThe Jackson minimill, constructed in 1981, is the newest of the Company's steel making facilities. Jackson's melting equipment includes an electric arc furnace, a continuous caster, and material handling equipment. The rolling mill consists of a reheat furnace, 16 in-line mill stands, a cooling bed, an in-line straightener, a cut-to-length product shear, an automatic stacker, and associated shipping and material handling facilities.\nThe facility has 298 employees.\nJACKSONVILLE MINIMILL\nThe Jacksonville minimill produces rebar and rods. The rebar is marketed primarily in Florida, the nearby Gulf Coast states and Puerto Rico, with coiled and 3\/8 inch diameter rebar, being shipped throughout the Company's marketing area. The rod products are sold throughout the southeastern United States.\nJacksonville's melting equipment consists of an electric arc furnace, continuous caster, and material handling equipment. The rolling mill includes a reheat furnace, a #1-stand in-line mill, a 10-stand rod block, two cooling beds, a cut-to-length product shear, and associated shipping and material handling facilities.\nThe facility has 271 employees.\nCHARLOTTE MINIMILL\nThe Charlotte minimill produces rebar and merchant bars. Rebar produced in Charlotte is marketed in the states from South Carolina to Pennsylvania. Merchant bar produced in Charlotte is marketed along the eastern seaboard states from Florida to Pennsylvania.\nCharlotte melting equipment includes an electric arc furnace, a continuous scrap feeding and preheating system and a ladle refining station, all of which were installed in 1989. The melting facilities also include a continuous caster and material handling equipment. Charlotte's rolling mill, which was upgraded in 1988, includes a reheat furnace, 15 in-line mill stands, a cooling bed, a cut-to-length shear, and an automated material bundling unit.\nThe facility has 275 employees.\nKNOXVILLE MINIMILL\nThe Knoxville minimill, which the Company acquired in 1987, produces almost exclusively rebar and some merchant bars. The rebar is marketed throughout the Ohio Valley, including all areas of Ohio and Kentucky and parts of Illinois, Indiana, Virginia, West Virginia, Tennessee and rebar is sold in portions of North and South Carolina, Georgia and Alabama.\nKnoxville melting equipment includes two electric arc furnaces, a continuous caster, and material handling equipment. The rolling mill, which was installed in 1986, consists of a reheat furnace, 16 in-line mill stands, a cooling bed, a cut-to-length shear line and associated shipping and material handling facilities.\nThe facility has 223 employees.\nTAMPA MINIMILL\nThe Tampa minimill has 117 employees who produce rebar that is sold primarily in Florida. In March 1994, the Company decided to close the Tampa Melt Shop and only roll excess billets from the other plants to serve the Florida market. The Tampa Melt Shop was the highest cost melt shop within the Company, and the lack of a market for export billets and export rebar was also a contributing factor to the announced closing.\nThe rolling mill includes a reheat furnace, a roughing mill, four cross-country rolling stands, four in-line finishing stands, a cooling bed, a cut-to-length product shear and storage and shipping facilities.\nFABRICATION: The Company's 13 fabricating plants are located throughout the southeastern United States and have an annual capacity of 334 thousand tons. The following table shows the plant locations and approximate annual tonnage on a two-shift per day, five days per week operating basis.\nDuring 1994, the Company announced the closing of the Fort Myers, Florida and Woodbridge, Virginia fab shops. The Fort Myers facility was sold in March 1995.\nOTHER OPERATIONS\nThe Company's railroad spike operation, located in Lancaster, South Carolina, forges steel squares into railroad spikes that are sold on an annual contract basis to various railroad companies. A new plant in Arkansas, will be completed in fiscal 1996 and will enable the Company to efficiently serve the Western U.S. market. The Company's facility in New Orleans, Louisiana, produces wire from steel rod. The wire is then either manufactured into welded wire fabric for concrete pavement or converted into collated nails for use in high-speed nail machines.\nCAPITAL EXPENDITURES\nOver the years, the Company has expanded capacity by means of modernizing and upgrading facilities together with selective acquisitions. Capital expenditures were $25.8 million for the year ended March 31, 1995, $18.2 million for the year ended March 31, 1994, $1.8 million for the period ended March 31, 1993, and $1.7 million in fiscal 1992. The major projects in fiscal 1995 included a new bag house in Knoxville, a cooling bed in Jacksonville, mill stands in the Jackson rolling mill, the new Arkansas spike plant, a new warehouse in Charlotte, and the start of a new rolling mill in Charlotte that will be complete by the end of fiscal 1996.\nRAW MATERIALS\nScrap steel, which is the Company's primary raw material and comprises approximately 49% of finished steel products cost, is presently supplied by one company, David Joseph, Inc. (\"David Joseph\"). David Joseph is a scrap broker and scrap yard operator headquartered in Cincinnati, Ohio, with locations throughout the United States, buys substantially all of the scrap required by the Company, for which it receives a fixed brokerage fee per ton. In addition, David Joseph operates shredders for the Company at the Jacksonville, Florida and Jackson, Tennessee minimill sites for a fixed gross profit amount per ton. Although the Company obtains its scrap steel from David Joseph, Management believes that the Company readily could obtain adequate supplies of scrap, if necessary, from suppliers other than David Joseph at competitive prices. In fiscal 1995, the Company consolidated the scrap purchasing activities under the newly established position of Vice President of Material Procurement. This position will focus on optimizing the purchasing, scheduling, and delivery of scrap and other related items.\nThe Company's manufacturing processes consume large amounts of energy in the form of electricity and natural gas. The Company purchases its electricity from regulated utilities under interruptible service contracts. Under such contracts, the utility provides service at discount rates in return for the right to interrupt service during peak demand periods. These interruptions are generally limited to several hours and have occurred on no more than five to ten days per year. Since deregulation of the natural gas industry, natural gas requirements generally have been provided through negotiated contract purchases of well-head gas with supplemental transportation through local pipeline distribution networks.\nThe other important raw or stock materials required for the Company's business, such as refractories, ferro alloys, carbon electrodes, etc., are supplied by various domestic and foreign firms. The Company has historically obtained adequate quantities of scrap steel and other raw materials to permit efficient mill operations.\nPRODUCTS AND MARKETS\nThe following tables set forth the tonnage shipped and average selling price per ton of the Company's five major product groups.\n(a) Includes products that are further fabricated by the Company.\n(a) Includes products that are further fabricated by the Company.\nREBAR PRODUCTS. The Company produces rebar products at all five of its minimills. The Company's rebar either is sold directly to distributors and third-party fabricating companies in stock lengths and sizes or is transferred to one of the Company's 13 fabricating plants where it is cut and bent to meet engineering, architectural or other end product specifications. Rebar is used primarily for strengthening concrete in highway and building construction and other construction applications. Rebar is consumed in a wide variety of private sector applications and public works projects. Private sector applications include construction of commercial and industrial buildings, apartments and hotels, utility construction, agricultural uses and various maintenance and repair applications. Public works projects include construction of highways, streets and bridges, public buildings, water treatment facilities and other projects.\nMERCHANT BARS. The Company produces merchant bars at its minimills in Jackson, Tennessee and Charlotte, North Carolina, and to a lesser degree in Knoxville, Tennessee. Merchant bars consist of rounds, squares, flats, angles and channels. Merchant bars are generally sold to fabricators, steel service centers, and manufacturers who fabricate the steel to meet engineering or end product specifications. Merchant bars are used to manufacture a wide variety of products, including gratings, transmission towers, steel floor and roof joists, safety walkways, ornamental furniture, stair railings, and farm equipment.\nMerchant bar products typically require more specialized processing and handling than rebar, including straightening, stacking, and specialized bundling. Because of the greater variety of shapes and sizes, merchant bars typically are produced in shorter production runs, necessitating more frequent changeovers in rolling mill equipment. Merchant products generally command higher prices and produce higher profit margins than rebar.\nRODS. The Company produces steel rod at its Jacksonville, Florida minimill. Most of this rod is sold directly to third-party customers, while the remainder, depending on market conditions, is shipped to the Company's New Orleans, Louisiana facility, where the rod is drawn down to wire for use in the manufacture of welded wire fabric and nails.\nMARKETING AND CUSTOMERS. The Company conducts its marketing operation through its own sales personnel who specialize in either mill products or fabricated rebar. Sales personnel for mill products including stock rebar and merchant bars are located in major metal markets in the Company's market area. Metallurgical service representatives located at the Company's minimills provide technical and sales support to the mill products sales force and fabricated rebar sales force, where needed. Fabricated rebar sales personnel are located at the Company's 13 fabricating facilities where engineering service representatives provide technical and sale support.\nThe Company's customer base is fairly stable from year to year, and currently no one customer accounts for more than 2.9% of sales. The Company's business is slightly seasonal with orders in the second and third calendar quarters tending to be strongest and those in the rest of the year tending to be the weakest. Stock rebar and merchant bar are generally sold from inventory. Fabricated rebar is generally produced in response to specific customer orders, rather than selling from inventory.\nDespite the commodity characteristics of the stock rebar and merchant bar markets, the Company believes that it is able to distinguish itself from its competitors to some extent due to its product quality, its consistent delivery record, its capacity to service large orders and its ability to fill most orders quickly from inventory. Moreover, while construction and infrastructure projects are generally nonrecurring in nature, the steel fabricators, distributors and service centers which supply many of these projects directly tend to be long-time customers of the Company.\nENVIRONMENTAL MATTERS\nThe Company is subject to federal and state requirements governing the remediation of environmental contamination associated with past releases of hazardous substances (collectively, \"Environmental Cleanup Laws\") and to extensive federal, state, and local laws and regulations governing discharges to the air and water as well as the handling and disposal of solid and hazardous wastes (collectively, \"Environmental Regulatory Laws\"). Governmental authorities have the power to enforce compliance with these requirements, and violators may be subject to civil or criminal penalties, injunctions or both. Third parties also may have the right to sue to enforce compliance. The Company anticipates that it will incur significant costs under Environmental Cleanup Laws and Environmental Regulatory Laws, as discussed below.\nEnvironmental Cleanup Laws. The Company is subject to federal and state hazardous substance cleanup laws that impose liability for the costs of cleaning up contamination resulting from past spills, disposal, or other releases of hazardous substances. In particular, the Company may be subject to liability under the federal Comprehensive Environmental Response, Compensation, and Liability Act (\"CERCLA\" or \"Superfund\") and similar state laws that impose liability--without a showing of fault, negligence, or regulatory violation--on the generation of hazardous substances that have caused, or may cause, environmental contamination. The current owner and operator of contaminated property also are liable for cleanup of the property even if they have not contributed to the contamination of such property. The Company expects to incur assessment, remediation, and related costs at Company-owned minimills and at certain off-site locations.\nThe on-site cleanups of which the Company is presently aware relate primarily to emission control (\"EC\") dust and, in two instances, to polychlorinated biphenyls (\"PCBs\"). EC dust, which is a hazardous waste under federal and most state regulations, is generated in large quantities by electric arc furnaces, and currently is collected by air emission control devices associated with the furnaces. EC dust generated by the Company currently is shipped to zinc reclamation facilities under applicable Environmental Regulatory Laws. Prior to the early 1970s, air emission control devices generally were not required and prior to approximately 1980, EC dust generally was not regulated as, or known to be, a hazardous waste and often was disposed of on minimill property. The Company is also aware that during the early 1970s contamination involving PCBs occurred at two of the Company's facilities.\nThe Company's inactive minimill in Indiantown, Florida, was placed on the National Priorities List (\"NPL\") as a Superfund site in 1982. The NPL is the formal list of sites maintained by the U.S. Environmental Protection Agency (\"EPA\") which are likely to require long-term cleanups. The Indiantown site has undergone extensive investigation and study under the Superfund program. The EPA has issued two Records of Decision selecting remedial measures for soil and groundwater respectively and specifying the remedial goals for the site. The Company has negotiated two consent orders with the EPA regarding the preparation and implementation of remedial design plans to comply with the Records of Decision.\nThe Company's Charlotte, North Carolina minimill is included on the North Carolina Inactive Hazardous Waste Sites Priority List because of an on-site landfill for EC dust that was used from approximately 1968 to 1980. In 1988, North Carolina recommended that the landfill be included on the NPL, but to date the EPA has not taken such action. The Company is now independently conducting the necessary remediation.\nThe Company is currently negotiating a consent order with the Florida Department of Environmental Protection relating to an investigation and major cleanup, involving both soil and ground water, at the Tampa minimill. The Company also is investigating its Jacksonville minimill for potential soil or groundwater contamination and with respect to past use of EC dust as fill material and believes that some remediation will be required. There can be no assurance that the Company will not be required to conduct additional investigations and cleanups at these or other Company facilities in the future.\nOff-site contamination problems involving the Company primarily relate to the disposal of EC dust historically generated by the Company and shredder fluff generated by David Joseph. Shredder fluff is the largely nonmetallic waste that remains after scrap steel has been reclaimed from discarded cars and appliances. Under an agreement with David Joseph, the Company is responsible, with certain limited exceptions, for paying any remediation costs incurred by David Joseph at sites operated for the Company and any claims against David Joseph for environmental matters associated with the shredder fluff generated by the David Joseph operations for the benefit of the Company. The Company or David Joseph (with respect to alleged Company matters) has been identified as a potentially responsible party (\"PRP\") for the cleanup of contamination at eight off-site NPL sites to which it has been alleged that the Company or David Joseph sent hazardous substances in the past. Under CERCLA, in certain circumstances, the\nEPA may order one or more PRPs to clean up environmental contamination. In other cases, the EPA may clean up a site and then seek reimbursement of expenditures of federal funds plus punitive damages from PRPs. Often, however, some PRPs cooperate with the EPA and each other to conduct voluntarily needed investigation and cleanup.\nCourts have interpreted CERCLA generally to impose joint and several liability for cleanup (and certain other) costs on all PRPs. This means that each PRP conceivably could be held liable for the entire amount of necessary cleanup costs.\nThe Company also may incur cleanup liabilities at certain off-site locations that have not been added to the NPL. For example, the Company recently completed remediation of contaminated soils at two formerly owned facilities. Generally, state environmental protection agencies provide oversight of such cleanups under the state cleanup laws.\nOverall, the Company has been notified that it is potentially liable for remediation costs at 21 off-site locations, eight of which are the previously mentioned NPL sites. The Company has fulfilled its obligations for the investigation and\/or cleanup at ten of these sites, and is participating in the assessment and clean-up at the other sites.\nDuring April 1994, the radiation detection alarms at the Company's Jackson minimill were set off by two loads of outgoing EC dust. The dust was held on-site and, upon confirming the validity of the alarm, the Company immediately shut down the melt shop. The subsequent investigation, which was conducted by a specialty contractor licensed by the State of Tennessee to perform assessment and remediation activities involving radioactive contamination, revealed that a radioactive source containing Cesium 137, a man-made, radioactive material, had in fact been received, undetected with a load of scrap and melted along with the scrap. The assessment identified EC dust contaminated with low levels of Cesium within the baghouse and connected ductwork and equipment, all of which had to be decontaminated and verified clean prior to melt shop startup. Low level Cesium contamination has also been identified in the soil and in drums of splash condenser dross residue (SCDR) located at the mill, at an off-site warehouse and at the contractors off-site SCDR processing facility. Decontamination of the SCDR at the off-site warehouse is almost complete. The last remaining task is the disposal. After a review of the data available regarding the extent of the contamination and the options and associated costs for cleanup and disposal, the Company has estimated its potential costs to be approximately $10.0 million of which $5.4 million has been spent to-date.\nBased on past use of certain technologies and remediation methods by third parties, evaluation of those technologies and methods by the Company's consultants and quotations and third-party estimates of costs of remediation-related services provided to the Company or of which the Company and its consultants are aware, the Company and its consultants continue to believe that the Company's cost estimates are reasonable. The Company has estimated its potential costs for further remediation under Environmental Cleanup Laws at on-site and off-site locations through 2009 to be approximately $19 million and has included this amount in the Company's recorded liabilities as of March 31, 1995.\nEnvironmental Regulatory Laws. The Company anticipates that it will incur potentially significant costs to comply with Environmental Regulatory Laws, including correcting existing noncompliance with such laws and achieving compliance with anticipated future standards for air emissions.\nThe Company will spend approximately $9.3 million on environmental compliance during fiscal 1996 (not including remediation costs or capital expenditures). This includes costs for baghouse waste disposal, maintenance, permits, monitoring, investigation, consulting fees, and legal fees. Similar annual compliance costs are expected to be incurred for the foreseeable future and will continue to be reflected in the Company's cost of sales.\nThe Company's projected capital budget for its fiscal year ending March 31, 1996 of approximately $30 million includes capital expenditures for air pollution control equipment at the Knoxville and Jackson, Tennessee minimills. In addition, the Company expects to spend approximately $2 million annually for the foreseeable future for environmentally related maintenance capital expenditures.\nBased on a preliminary EPA determination, the Company no longer expects to incur significant costs to comply with the recent amendments to the federal Clean Air Act under which the EPA was expected to promulgate strict standards that would govern the emission of hazardous air pollutants from electric arc furnaces such as those used by the Company. The EPA regulations are not scheduled to be promulgated until 1997, with compliance expected to be required by 2000, and it is not known when a final determination as to electric arc furnaces will be made by the EPA.\nLITIGATION\nSee \"Environmental Matters\" for a discussion of the Company's cleanup liabilities and its consent agreements with state and federal regulators regarding the investigation and\/or cleanup of certain Superfund and non-Superfund sites.\nCOMPETITION\nThe Company experiences substantial competition in the sale of each of its products from a large number of domestic companies in its geographic markets.\nRebar and merchant bars are commodity steel products, making price the primary competitive factor. Due to the high cost of freight relative to the value of the Company's steel products, competition from non-regional producers is limited; and rebar deliveries are generally concentrated within a 350 mile radius of a minimill while merchant bar deliveries are generally concentrated within a 500 mile radius of a minimill. Except in unusual circumstances, the customer's delivery expense is limited to freight charges from the nearest competitive minimill and any incremental freight charges must be absorbed by the supplier.\nThe level and degree of foreign competition faced by the Company within the Florida rebar market have varied from time to time depending upon factors including foreign government subsidies and currency exchange rates. Very little rebar has been imported into Florida in the last five years and, consequently, rebar imports have had little effect on the market.\nThe Company's competitive environment varies by product. The following is a discussion of the Company's competitive environment with respect to its five major product categories: stock rebar, fabricated rebar, merchant bars, rods and billets.\nSTOCK REBAR. The boundary of the current market area for the Company's rebar products is roughly defined by a line running through New Orleans, Louisiana; Little Rock, Arkansas; Kansas City, Kansas; St. Louis, Missouri; Indianapolis, Indiana; Columbus, Ohio; and Baltimore, Maryland. The Company has found shipping outside of this market area to be only marginally profitable because of freight cost considerations.\nMERCHANT BAR. The Company's primary marketing area for merchant bars encompasses the southeastern and midwestern United States. The Company did not enter the merchant bar market in a significant way until 1982 and does not have the same market strength as it does in the rebar market. The Company's presence in the southeastern and midwestern markets has grown steadily, and its merchant bar sales now represent approximately 31% of the Company's total sales.\nThe market for merchant bars is very competitive, with price being the primary competitive factor. In the last two years, the Company has upgraded its rolling mill facilities at Charlotte, to increase the Company's ability to shift production from rebar to merchant bar depending upon market conditions and demand.\nRODS. The Company produces rods at its Jacksonville minimill. The Company's primary marketing area for rods includes Florida, South Carolina, Georgia, Alabama and Louisiana. The Company does not intend to geographically expand its marketing beyond these states due to the relatively low margins and prohibitive freight cost inherent to rod products. While the market for rods can be heavily influenced by foreign imports, rod sales by foreign competitors did not have a material effect on the Company's rod sales in the last three years.\nFABRICATED REBAR. With 13 fabricating plants located throughout the southeastern United States, all within good support distance from one of the Company's five minimills, the Company is a major factor in all markets it serves. The Company believes its intracompany minimill support gives it a significant competitive advantage on major construction projects. In the sale of fabricated rebar, the Company competes with other steel fabricators in its marketing area some of whom purchase their stock rebar from the Company.\nBILLETS. The Company produces billets (semi-finished steel) for conversion to rebar, merchant bar and rods. When the market for finished product is down, the Company sells the excess billet production.\nEMPLOYEES\nThe Company has approximately 2,000 employees, none of whom is covered by a collective bargaining agreement. The Company believes that its relations with its employees are good and a participatory style of labor-management relations is important to the efficiency of the Company's operations.\nOn January 1, 1995 an incentive plan based on production tons, was put into effect at the five mills. Each mill has a melting and rolling target which provide a 1.5% increase in pay for each 1% increase in production. Effective April 1, 1995, the fab group, mill sales and the corporate administrative group pay policy included monthly incentives similar to the mills. The executive group (approximately 40 key executives) are covered by an incentive plan that is based on return on capital.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's buildings are of various ages and forms of construction and are all properly maintained and adequately equipped for the purposes for which they are used. The Company's five minimills are owned in fee simple and serve as the collateral for the First Mortgage Notes together with the other collateral.\nThe following tables present information with respect to the buildings and facilities:\n(a) The First Mortgage Notes are secured by a first priority lien on substantially all the real property, machinery, equipment, and fixtures of each of the Company's five minimills. (b) Includes a fabricating plant, which is not a part of the collateral package.\n(c) These properties do not constitute collateral for either the First Mortgage Notes or the Revolving Credit Agreement.\n(d) These properties do not constitute collateral for either the First Mortgage Notes or the Revolving Credit Agreement.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS Not Applicable\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not Applicable.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS\nMARKET PRICE AND CASH DIVIDENDS\nEffective with the 1988 Acquisition, through May 31, 1994, all of the outstanding common stock of the Company was owned by Holdings. On June 1, 1994, Phillip E. Casey (as part of an employment agreement) received 7 1\/2% of the outstanding shares and purchased an additional 2 1\/2% of the shares in November 1994. No established public trading market exists for the Company's common stock. No dividends were declared or paid on the Company's common stock during any of the reporting periods.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe summary financial information presented below should be read in conjunction with the Financial Statements of Florida Steel Corporation and the notes thereto ($ in thousands except per share data):\nThe following table shows the percentage of the Company's revenues derived from each product category in the relevant time period:\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nMANAGEMENT DISCUSSION AND ANALYSIS\nThe Company changed its year-end from September 30th to March 31st effective March 1993. References to fiscal years 1991 and 1992 are the fiscal years of the Company ended September 30th. To assist in the analysis of fiscal year ended March 31, 1994 and the period October 1, 1992 to March 31, 1993, the quarter ended December 31, 1992 of the Predecessor has been combined with the March 31, 1993 quarter. Results for the comparable six month period, October 1, 1991 to March 31, 1992 and the twelve month period ended March 31, 1993, are provided.\nRESULTS OF OPERATIONS ($ in thousands)\nFISCAL 1995 VERSUS FISCAL 1994\nLiquidity and Capital Resources\nAs of March 31, 1995, the Company's total outstanding borrowings were $259.3 million of which $16.2 million is due within fiscal 1996. Outstanding borrowings under the Revolving Credit Agreement totaled $65.2 million. Effective June 1995 the Company negotiated a New Revolving Credit Agreement to replace the Revolving Credit Agreement and provide additional liquidity. See Note F - Notes to Financial Statements for additional details concerning the new agreement.\nNet cash provided by operating activities improved substantially in fiscal 1995 as a result of improved net income. Working capital requirements increased because of the higher volume and the payments of environmental clean up previously expensed. Capital expenditures increased to $25.8 million as compared with $18.2 million in fiscal 1994. The Note to Parent totaled $18.2 million with $.9 million outstanding at March 31, 1995.\nThe First Mortgage notes, the Revolving Credit Agreement and the New Revolving Credit agreement contain certain restrictions to incur additional indebtedness and other covenants deemed appropriate. The Company, however, believes that the available borrowings and the cash flow generated from operations will be sufficient to fund the current operations and the current capital expenditure program. The Company is currently in compliance with all of the covenants of its loan agreements.\nSeasonality\nThe Company's business is slightly seasonal with orders in the second and third calendar quarters tending to be stronger than the rest of the year.\nImpact of Inflation\nThe Company's primary costs include ferrous scrap, energy and labor which can be affected by inflationary conditions. The Company has been able to pass on cost increases through price adjustments, however the ability to pass on these increases depends on the level of construction activity. Another factor that may limit the Company's ability to increase prices is the over-capacity in the industry.\nFISCAL 1995 VERSUS FISCAL 1994\nSales\nNet sales for fiscal 1995 were 17% higher than fiscal 1994 as a result of both higher volume and improved selling prices. Shipments for all finished products were up 12.6% while billet shipments, primarily export shipments at low margins, were lower. All selling prices were higher this year over last year with mill finished products 10.3% higher and fabricated rebar 13.5% higher.\nCost of Sales\nCost of sales excluding depreciation was 85.3% of net sales as compared with 91.2% for the previous year. The substantial improvement was the result of the increased sales volume and prices and a $11 per ton decrease in mill conversion costs. While scrap costs increased $12 per ton the spread between mill finished products average selling prices and scrap increased $20 per ton in fiscal 1995 versus fiscal 1994.\nSelling and Administrative Expenses\nSelling and administrative expenses for fiscal 1995 were higher than fiscal 1994 primarily because of employment costs related to the hiring of the new Chairman of the Board and Chief Executive Officer and higher wages and benefits.\nDepreciation\nDepreciation expense was lower in fiscal 1995 versus fiscal 1994 because of the shut down of the Tampa melt shop in June 1994.\nInterest\nInterest expense was higher in fiscal 1995 versus fiscal 1994 as a result of higher rates and higher average borrowings. The Company capitalized $654 thousand of interest in the current year versus zero a year ago.\nAmortization of Deferred Financing Costs\nAmortization of deferred financing costs were higher in fiscal 1995 versus a year ago primarily because of financing costs associated with the Revolving Credit Agreement.\nIncome Taxes\nThe effective federal and state income tax rate for fiscal 1995 was 38.8% compared with 36.5% for the previous year, excluding the effect of goodwill amortization which is not deductible for income tax purposes. The increased rate reflects the higher federal rate and to a lesser extent higher state rates, based on net income levels.\nFISCAL 1994 VERSUS TWELVE MONTHS ENDED MARCH 31, 1993\nSales\nNet sales for the fiscal year ended March 31, 1994, were 14.0% higher than the twelve month period ended March 31, 1993. Total tons shipped were up 6.0% while selling prices for rolled products were up 5.8%. Higher billet sales accounted for the balance of the increase.\nThe higher volume reflects an improving market during the year with the increased billet sales the result of higher production. Selling prices, with the exception of the Fab Group, were higher, primarily driven by higher scrap costs.\nCost of Sales\nCost of sales, excluding depreciation, was 91.2% of sales for fiscal 1994 as compared with 89.9% for the twelve month period ended March 31, 1993. The primary reasons for this increase in cost of sales, excluding depreciation, were higher scrap costs and higher mill conversion costs. Scrap costs increased $26 per ton during the year.\nOverall, the various product groups selling price increases covered the scrap increases except the Fab Group, which was not able to recover any of the scrap increases because of the competitive market and the longer term contracts associated with this part of the business. Conversion costs were higher primarily as a result of higher maintenance costs.\nSelling and Administrative Expenses\nSelling and administrative expenses for fiscal 1994 were lower than the comparable period a year ago primarily due to higher outside professional service fees incurred in connection with the Company's restructuring efforts in the prior twelve month period ended March 31, 1993.\nAmortization of Goodwill\nAmortization of goodwill was higher in the current year versus the comparable prior year period as a result of using a twenty-five year period as compared with a forty year period used prior to January 1, 1993.\nOther Operating Expenses\nOther operating expenses for fiscal 1994 included the write-down of fixed assets of $9.1 million and $1.2 million for employee benefits, as a result of the Tampa Melt Shop closing, a $.6 million charge for the effect of the Fort Myers, Florida and Woodbridge, Virginia Fab Shop closings and a $4.3 million charge for anticipated increases in the environmental clean up of sites previously identified. As a result of the Tampa Melt Shop closing working capital should be reduced and operating results should improve. In fiscal 1995 billets from the other Florida Steel mills will be shipped to Tampa for finishing. Expansion of the current Company's melt shops are planned to meet the anticipated domestic market demands.\nInterest\nInterest expense was substantially lower in fiscal 1994 as compared with the same period a year ago primarily because of the lower debt as a result of the Acquisition and lower interest rates.\nAmortization of Deferred Financing Costs\nAmortization of deferred financing costs were higher in fiscal 1994 versus a year ago primarily because of financing costs associated with the new capital structure.\nExtraordinary Item\nThe Company redeemed $20 million of the 14.5% subordinated debentures at a premium of 6% or $1.2 million. The expense net of income tax was $748,000. The $4.2 million charge in the twelve month period ended March 31, 1993, was related to the repayment of existing debt as of December 1992. See Note C for additional information.\nIncome Taxes\nThe effective federal and state income tax rate for the fiscal year ended March 31, 1994, was 37.7% as compared with 34.4% for the comparable period a year ago, excluding the effect of goodwill amortization which is not deductible for income tax purposes.\nSIX MONTHS ENDED MARCH 31, 1993 VERSUS SIX MONTHS ENDED MARCH 31, 1992\nSales\nNet sales for the six month period ended March 31, 1993 were $231.1 million or 6.8% higher than the six month period ended March 31, 1992. Total tons shipped were 754,305 versus 655,816 for the prior year period or a 15% increase while selling prices, with the exception of merchant bar, were down.\nStock rebar shipments were up 32%, merchant bar was up 14%, rod was up 7%, fabricated rebar was down 11% and billet shipments were up 46%.\nStock rebar selling prices were down 7%, rod was down 4%, fabricated rebar was down 4%, billets were down 2% and merchant bar selling prices were up 2%,\nThe higher shipments of billets and stock rebar were primarily the result of higher exports. The lower selling prices reflect the competitive pricing in the industry.\nCost of Sales\nCost of sales excluding depreciation was 90.4% of net sales for the six month period ended March 31, 1993 as compared with 84.3% for the six month period ended March 31, 1992. The primary reason for the increase in cost of sales excluding depreciation was the effect of the lower selling prices and product mix. Scrap costs were 4.6% higher for the current period as compared with a year ago. As a result of the higher volume and production efficiencies, the cost to convert scrap to finished products remained approximately the same even though wages were increased as of the merger date after being frozen for approximately 19 months.\nSelling and Administrative Expenses\nSelling and administrative expenses increased in 1993 versus the comparable period, primarily due to higher outside professional services fees incurred in connection with the Company's restructuring efforts. Non-recurring costs related to the restructuring totaled $1.4 million for the six month period ended March 31, 1993.\nDepreciation\nDepreciation was lower in the 1993 period versus the 1992 comparable period primarily because of the reduction in the recorded values of fixed assets of the Acquisition.\nAmortization\nAmortization of goodwill and deferred financing costs for the 1993 period was higher than the comparable period a year ago. The amortization of goodwill costs for the quarter ended March 31, 1993, was based on a 25 year period as compared with 40 years in the prior period.\nInterest Expense\nInterest expense for the six months ended March 31, 1993, was lower than the 1992 comparable period because of substantially lower debt as a result of the Acquisition, and to a lesser extent lower interest rates.\nIncome Taxes\nThe effective federal and state income tax rate for the six months period ended March 31, 1993 was 38.1% compared with 37.7% for the six months period ended March 31, 1992, excluding the effect of goodwill amortization, which is not deductible for income tax purposes.\nFISCAL 1992 VERSUS FISCAL 1991\nSales\nNet sales for the fiscal year ended September 30, 1992 were $465.2 million compared to $463.2 million for the fiscal year ended September 30, 1991. Finished tons shipped during fiscal 1992 were less than 1% higher than the prior year. Average selling prices for fiscal 1992 were 4.5% lower than in the prior year. The effect of lower average selling prices, however, was offset by an increase in billet shipments from approximately 71,000 tons in 1991 to 202,000 tons in 1992. Billet production in fiscal 1992 was higher than in fiscal 1991 because of improved production efficiency and the effect on fiscal 1991 production of the start-up of the new Tampa melting facility. Billet shipments rose in fiscal 1992 because the Company's higher production of billets was not matched by increased demand for finished products.\nStock rebar shipments were down 3.8% as compared to the prior year, fabricated rebar shipments decreased 1.9% while merchant bar and rod shipments increased 4.2% and 7.3%, respectively. Stock rebar selling prices decreased 4.2% from a year ago, fabricated rebar prices decreased 8.2%, merchant bar prices decreased 1.0% and rod prices decreased 1.3%.\nCost of Sales\nCost of sales, including depreciation, was 90.4% of net sales for the year ended September 30, 1992 as compared to 89.4% for the fiscal year ended September 30, 1991. Mill production costs for fiscal 1992 decreased 8.7% versus fiscal 1991. Approximately one-third of the reduction in mill production costs was the result of lower scrap costs. The remainder of the reduction was primarily the result of an 11% increase in melting production, and the effects of the continuing improvements in production efficiency resulting from new technology and improved equipment.\nThe favorable mill production costs were, however, offset by the lower average selling prices and $7.9 million of expenses associated with increasing the reserve for environmental remediation costs. This increase in the reserve plus expenditures resulted in environmental remediation costs of $9.6 million in 1992 versus costs of $0.8 million in 1991. Of the $8.8 million increase in environmental remediation expense (i) $2.7 million related to the identification of new sites in fiscal 1992 and related testing costs; (ii) $1.9 million related to an April 1992 regulatory change regarding tolerable limits for lead in soil, which increased the volume of soil which had to be remediated by the Company; and (iii) $1.4 million related to regulatory communications received in 1992 concerning one of the Company's identified sites, which made the Company's previously planned remediation methodology unfeasible. The remaining increase, resulting from the Company's regular review of the costs associated with environmental remediation at previously identified sites, was attributable to changes in the estimates of contaminated material quantities, prices to be obtained from the sale of remediation by-products and costs of expected technology for remediation. Results for the year ended September 30, 1991 were adversely affected by approximately $8 million for the start-up costs related to the newly installed electric arc furnace at the Tampa, Florida minimill.\nFrom April 1991 through the closing of the Acquisition, the Company had frozen compensation for all employees and had reduced compensation for management and had curtailed or scaled back some employee benefit programs. Management estimates that if the wage and salary freeze had not been instituted, expenses would have been higher by approximately $1.2 million and $3.2 million for the years ended September 30, 1991 and 1992, respectively.\nSelling and Administrative Expenses\nSelling and administrative expenses increased in the year ended September 30, 1992 versus fiscal 1991, primarily due to higher outside professional services fees incurred in connection with the Company's restructuring efforts. Nonrecurring costs related to the restructuring totaled $3.9 million for the year ended September 30, 1992.\nDepreciation\nDepreciation was higher for the year ended September 30, 1992, when compared to fiscal 1991 primarily because of the depreciation attributable to additional capital expenditures.\nAmortization\nAmortization of goodwill and deferred financing costs for the year ended September 30, 1992 was generally consistent with that for fiscal 1991.\nInterest Expense\nInterest expense for the year ended September 30, 1992, was lower than in fiscal 1991, primarily because of lower interest rates payable on a portion of the Company's borrowings.\nIncome Taxes\nThe effective federal and state tax rate for the year ended September 30, 1992 was 31.7% as compared to 37.7% for fiscal 1991, excluding the effect of goodwill amortization, which is not deductible for income tax purposes. The lower effective tax rate for fiscal 1992 was the result of additional nondeductible costs related to the proposed merger and settlement of an investigation as discussed below.\nOther Operating Expense\nThe Company recorded a liability of $9.0 million as of September 30, 1992 representing the settlement of an investigation by the U.S. Attorney's Office regarding the Company's compliance with Florida Department of Transportation epoxy coated rebar specifications. See Note L of the Notes to Financial Statements.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nRefer to index in Item 14 for financial statements and supplementary data filed as a part of this report.\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\nGeneral: The Bylaws of the Company provide that the business shall be managed by a Board of Directors.\nThe name, age, present principal occupation or employment and five-year employment history of each of the directors and executive officers of the Company are set forth below. All officers serve at the pleasure of the Board. Directors serve no specific term of office. Each director and executive officer listed below is a citizen of the United States, except as noted below. Refer to Item 13 for information on other directorships held by each director.\nCommittees of the Board of Directors\nFlorida Steel's Board of Directors has an executive committee consisting of Mr. Casey, Mr. Fujimura, and Mr. Creed. The Company also has an Executive Compensation Committee and an Audit Committee. Committees of the Board of Directors may be appointed by the Board of Directors in accordance with the Bylaws of Florida Steel.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe tables and descriptive information set forth below are intended to comply with the amendments adopted by the SEC to the executive compensation requirements applicable to, among other filings, this report. This information is being furnished with respect to those persons who, were the Company's Chief Executive Officer and its four most highly compensated executive officers, other than the Chief Executive Officer, whose salary and bonus (see adjusted for the short 1993 fiscal year) exceeded $100,000 for the most recent fiscal year (together, the \"named executive officers\"). Tables have been omitted where no compensation was awarded to, earned by or paid to any of the named executives required to be reported in any fiscal year covered by that table.\nSUMMARY COMPENSATION TABLE (1)\n(1) This table sets forth certain information concerning compensation for services rendered to the Company in all capacities by the named executive officers for the fiscal years ending March 31, 1995, March 31, 1994, and September 30, 1992. Columns have been omitted where no compensation was awarded to, earned by, or paid to any of the named executives required to be reported in any fiscal year covered by that column. Salaries for 1993 for comparability are double the amounts for the six month period ended March 31, 1993.\n(2) Effective June 1, 1994, the Company entered into an employment agreement with Mr. Phillip Casey to serve as the Company's Chairman of the Board of Directors and Chief Executive Officer. The Agreement includes a one time signing bonus of $500,000, base annual salary of $300,000, equity interest of 7.5% of the outstanding common stock of the Company ($4.5 million to vest ratably over the next five years), a tax bonus in the amount of $1,946,000 paid to Mr. Casey with respect to his receipt of the 7.5% equity interest, and other benefits commensurate with his position. In addition, Mr. Casey was granted and exercised an option to purchase an additional 2.5% of the outstanding common stock of the Company for $1.5 million. The agreement provides for certain termination benefits and places restrictions on the disposition of the Company's stock. On April 17, 1995, the Company made a Tax Loan agreement with Mr. Phillip Casey for $731,511 at market interest rates to be paid over the next 5 years. Mr. Casey also received a bonus based on the fiscal 1995 short term plan.\n(3) Effective April 1, 1995, the Company entered into an employment offer with Mr. Tom J. Landa to serve as the Vice-President and Chief Financial Officer of the Company. The agreement includes a one time signing bonus of $100,000, base annual salary of $160,000 and a grant of 12,000 shares of restricted common stock and a grant of 12,000 common stock options.\nPension Benefit\nThe Pension Table sets forth the estimated annual benefits, payable as a single life annuity, at various remuneration levels and for representative years of service at normal retirement date under the Company's tax-qualified noncontributory defined benefit pension plan. The years of credited service for the named executives are 22 years for Thomas G. Creed, 37 years for J. Donald Haney and 29 years for James C. Hogue. The final average compensation for the named executives, for purposes of this plan for 1995 is, for, Thomas G. Creed - $219,224, J. Donald Haney - $198,896 and James C. Hogue - $175,704. The table does not reflect the maximum benefit limitations under Internal Revenue Code Section 415.\nSupplemental Retirement Plan. The Company maintains a nonqualified, unfunded supplemental retirement plan, which provides certain officers defined pension benefits in addition to those provided under the Company's other plans. The supplemental plan provides an annual retirement benefit equal to the greater of (i) 50% of final average compensation (as defined above), and (ii) 2.4% of final average compensation multiplied by years of service (up to 25), plus 1% of final average compensation multiplied by years of service in excess of 25 (up to 10), less (in either case) amounts to which the participant is entitled under other retirement plans of the Company and prior employers and under Social Security. In 1988, as a result of the Change in Control of the Company, the accrued benefits under this Plan became immediately due and payable in a lump sum, although all of the active officers in the Company elected to waive receipt of their accrued benefits in exchange for common stock of Holdings. Additional benefits over and above those resulting from the acceleration continue to be earned. Upon retirement at January 26, 1995, R. R. Boswell received a one-time payment of $332,223 for supplemental retirement benefit. As of March 31, 1995 the Company has accrued approximately $470,000 in supplemental retirement benefits for the remaining active employees covered by the Plan.\nIn connection with the Acquisition, the officers covered by this Plan have all waived their rights to an immediate lump sum payment, provided, that if such officers are terminated without Cause (as defined in the severance agreements entered into with such officers), resign for Good Reason (as defined in the severance agreements) or die, retire or become disabled, then such officers will be entitled to receive the amounts they would have received had such officers not waived the above described rights.\nSeverance Agreements\nThe Company and the senior executives have entered into an agreement providing that, if the Company terminates any executive other than for cause, or reassigns such executive to a new position, the Company shall continue to pay the executive his current base pay through August 30, 1996.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nSee Item 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\n90% of the outstanding stock of Florida Steel is owned by FLS Holdings, with 10% owned by Phillip E. Casey. All of the outstanding stock of FLS Holdings is owned by Kyoei Steel Ltd.\nManagement believes all of the transactions discussed above were on terms comparable to those that could have been obtained from unaffiliated third parties.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nFLORIDA STEEL CORPORATION\nBy: \/s\/ Phillip Casey June 15,1995 ------------------------------------------- Phillip Casey, Chairman of the Board Date 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.\nPART IV\nITEM 14, (a),(1),(2),(B)1 FINANCIAL STATEMENTS, SUPPLEMENTARY DATA AND REPORTS ON FORM 8-K\n(A) (1) The following financial statements of Florida Steel Corporation as of the dates and for the periods indicated are included herein:\n(2) The following financial statement schedules of Florida Steel Corporation are filed as part of this report:\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.\n(B) Reports on Form 8-K.\nNone for the quarter ended March 31, 1995.\nARTHUR ANDERSEN LLP\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nTo the Board of Directors and Shareholders of Florida Steel Corporation:\nWe have audited the accompanying statement of financial position of Florida Steel Corporation (a Florida corporation) as of March 31, 1995, and the related statements of operations, shareholders' equity 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 Florida Steel Corporation as of March 31, 1995, and the results of its operations and its cash flows for the year then ended in conformity with generally accepted accounting principles.\nOur audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule listed in the index of financial statements is presented for purposes of complying with the Securities and Exchange Commissions 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\nTampa, Florida, April 28, 1995 (except with respect to the matter discussed in Note F, as to which the date is June 9, 1995, and the matter discussed in the third section of Note M, as to which the date is May 22, 1995)\nINDEPENDENT AUDITORS' REPORT\nBoard of Directors and Shareholder Florida Steel Corporation Tampa, Florida\nWe have audited the accompanying statement of financial position of Florida Steel Corporation (the \"Company\") as of March 31, 1994 (Successor Company statement of financial position), and the related statements of operations, shareholders' equity (deficit), and cash flows for the year ended March 31, 1994 and the three months ended March 31, 1993 (Successor Company operations) and for the three months ended December 31, 1992 (Predecessor Company operations). Our audits also included the financial statement schedules listed in the Index at Item 14(a) for the year ended March 31, 1994 and for each of the three-month periods ended March 31, 1993 and December 31, 1992. 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 Successor Company's financial statements referred to above present fairly, in all material respects, the financial position of Florida Steel Corporation at March 31, 1994, and the results of its operations and its cash flows for the year ended March 31, 1994 and for the three months ended March 31, 1993, in conformity with generally accepted accounting principles. Further, in our opinion the Predecessor Company statements of operations, shareholders' equity (deficit) and cash flows for the three months ended December 31, 1992 present fairly, in all material respects, the\nresults of its operations and its cash flows in conformity with generally accepted accounting principles. Also, in our opinion, such financial statement schedules, for the year ended March 31, 1994 and for each of the three-month periods ended March 31, 1993 and December 31, 1992, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein for the year ended March 31, 1994 and for each of the three-month periods ended March 31, 1993 and December 31, 1992.\nAs discussed in Note B to the financial statements, the Company changed its method of accounting for income taxes effective December 31, 1992 to conform with Statement of Financial Accounting Standards No. 109 and its method of accounting for post-retirement benefits effective December 31, 1992 to conform with Statement of Financial Accounting Standards No. 106.\n\/s\/ Deloitte & Touche LLP June 6, 1994 (May 22, 1995 as to the portion of Note M captioned \"Stock Dividend\")\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nBoard of Directors and Shareholders Florida Steel Corporation\nWe have audited the accompanying statements of operations, shareholders' equity (deficit), and cash flows of Florida Steel Corporation and subsidiaries for the year ended September 30, 1992. Our audit also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.\nWe conducted our 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 of Florida Steel Corporation and subsidiaries for the year ended September 30, 1992, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.\nAs discussed in Note J to the financial statements, the Company is responsible for the remediation of hazardous waste at some of its facilities and at other locations. The ultimate amount of the liability for remediation cannot be determined at this time.\nAs discussed in Note C to the financial statements, during fiscal 1992 the Company changed its method of accounting for the liability for environmental remediation costs.\nErnst & Young LLP\nTampa, Florida November 4, 1992, except for the third paragraph of Note A, as to which the date is December 21, 1992\nFLORIDA STEEL CORPORATION STATEMENTS OF FINANCIAL POSITION ($ in thousands)\nSee notes to financial statements.\nFLORIDA STEEL CORPORATION STATEMENTS OF FINANCIAL POSITION -- Continued ($ in thousands except share data)\nSee notes to financial statements.\nFLORIDA STEEL CORPORATION STATEMENTS OF OPERATIONS ($ in thousands except earnings per share)\nSee notes to financial statements.\nFLORIDA STEEL CORPORATION STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT) ($ in thousands except share data)\nSee notes to financial statements.\nFLORIDA STEEL CORPORATION STATEMENTS OF CASH FLOWS ($ in thousands)\nSee notes to financial statements.\nFLORIDA STEEL CORPORATION STATEMENTS OF CASH FLOWS - - Continued ($ in thousands)\nSee notes to financial statements.\nFLORIDA STEEL CORPORATION NOTES TO FINANCIAL STATEMENTS MARCH 31, 1995\nNOTE A--ACQUISITION, MERGER AND BASIS OF PRESENTATION\nThese financial statements include the accounts of Florida Steel Corporation (the \"Company\"). During the year ended March 31, 1994, all wholly owned subsidiaries were liquidated into the Company. The financial statements for the previous periods include the accounts of the Company and its wholly owned subsidiaries. Financial statements of the Company as of and for any period prior to the Acquisition described below are designated as \"Predecessor\".\nFLS Holdings Inc. (\"FLS\" or \"Holdings\"), the Company's parent, on June 26, 1992 signed an agreement of merger providing for its acquisition (the \"Acquisition\") by Kyoei Steel Ltd. (\"Kyoei\"), which closed December 21, 1992. For financial reporting purposes, the Company accounted for the transaction effective December 31, 1992. In connection with the closing, FLS received an equity infusion of $150 million from Kyoei.\nThe statement of financial position at December 31, 1992 reflected a new basis of accounting in which the total cost of the purchase was allocated to the assets and liabilities using estimates of fair values (known as the purchase method of accounting pushed down to the Company's financial statements or \"pushdown\" accounting). The excess purchase price over net assets acquired is reflected as goodwill. The deficit at September 30, 1992 and the loss for three-months ended December 31, 1992, were eliminated under purchase accounting. The following Condensed Statement of Financial Position at December 31, 1992, reflects the purchase accounting adjustments and the new basis of the assets and liabilities.\nFLORIDA STEEL CORPORATION NOTES TO FINANCIAL STATEMENTS MARCH 31, 1995\nNOTE A--ACQUISITION, MERGER AND BASIS OF PRESENTATION -- Continued ($ in thousands)\nThe following unaudited Predecessor proforma condensed consolidated results of operations were prepared assuming the acquisition of the Company occurred at the beginning of each of the periods presented. The proforma information includes adjustments for the amortization of asset value changes based on fair value adjustments, amortization of the excess of cost over fair value of assets acquired, interest expense related to acquisition indebtedness and the elimination of nonrecurring expenses related to the transactions:\nFLORIDA STEEL CORPORATION NOTES TO FINANCIAL STATEMENTS MARCH 31, 1995\nNOTE A--ACQUISITION, MERGER AND BASIS OF PRESENTATION -- Continued\nCHANGE IN YEAR END\nEffective March 18, 1993, the Company adopted a March 31 fiscal year end. The accompanying financial statements include audited financial statements for the transition periods ended December 31, 1992 and March 31, 1993.\nThe following unaudited Predecessor information is presented for comparative purposes only: ($ in thousands)\nNOTE B--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nCredit Risk: The Company extends credit, primarily on a basis of 30-day terms, to various customers in the steel distribution, fabrication and construction industries, primarily located in the southeastern United States. The Company performs periodic credit evaluations of its customers and generally does not require collateral. Credit losses, in the past, have not been significant.\nBusiness Segment: The Company is engaged in steel production and the manufacture, fabrication and marketing of steel products, primarily for use in construction and industrial markets. In the year ended March 31, 1995, export sales were less than 1% of total sales, in fiscal year 1994 approximately 6%. For the six months ended March 31, 1993, approximately 12% of total sales represented export sales and for the year ended September 30, 1992, export sales were approximately 3% of total sales.\nFLORIDA STEEL CORPORATION NOTES TO FINANCIAL STATEMENTS MARCH 31, 1995\nNOTE B--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued\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 (first-in, first-out method) or market.\nReal Estate Held for Sale: Real estate held for sale is carried at the lower of cost or estimated fair value.\nProperty, Plant and Equipment: Major renewals and betterments are capitalized and depreciated over their estimated useful lives. Maintenance and repairs are charged against operations as incurred. Upon retirement or other disposition of property, plant and equipment, the cost and related allowances for depreciation are removed from the accounts and any resulting gain or loss is reflected in operations.\nPlant start-up and other preoperating costs of new facilities are charged against operations as incurred. Interest costs for property, plant and equipment construction expenditures of $654 thousand were capitalized for the year ended March 31, 1995. For financial reporting purposes, the Company provides for depreciation of property, plant and equipment using the straight-line method over the estimated useful lives of 20 to 30 years for buildings and improvements and 4 to 15 years for all other property, plant and equipment.\nGoodwill: Goodwill consists of the excess of purchase price over the fair value of acquired assets and liabilities. Goodwill is stated at cost less accumulated amortization of $9,207,375 and $5,077,155 at March 31, 1995 and 1994, respectively. Goodwill was being amortized over a 40-year period for the reporting periods through December 31, 1992. Effective January 1, 1993, the balance of goodwill was adjusted to reflect the Acquisition and the amortization period was reduced to 25 years. The cost to finalize the Preferred Stock Redemption of $1,695,210 has been accounted for as an increase in goodwill as of March 31, 1994.\nDeferred Financing Costs: The deferred financing costs as of March 31, 1995 and 1994, are net of accumulated amortization of $6,067,332 and $3,204,600, respectively, and relate principally to the debt issued in December 1992. These amounts will be amortized over the term of the respective debt instruments, which range from 3 to 8 years.\nEarnings per Common Share Earnings per common share are computed using the weighted average number of outstanding common shares. On May 22, 1995, the Company's Board of Directors authorized a 49,999 for 1 stock dividend. Earnings per common share and weighted average shares outstanding have been retroactively adjusted for the stock dividend for all periods subsequent to December 31, 1992.\nIncome Taxes: The provision for income taxes is based on financial statement income and, therefore, includes deferred income taxes on items reported in different periods for income tax purposes. The Company adopted Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes\" (\"SFAS 109\") effective October 1, 1992. The Company had previously followed SFAS 96. The effect of adopting SFAS 109 was immaterial for all periods presented.\nFLORIDA STEEL CORPORATION NOTES TO FINANCIAL STATEMENTS MARCH 31, 1995\nNOTE B--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued\nPost-Retirement Benefits: In December 1990, the Financial Accounting Standards Board issued SFAS No. 106 \"Employers' Accounting for Post Retirement Benefits Other Than Pensions\" which requires that the projected future cost of providing post-retirement benefits, such as health care and life insurance, be recognized as an expense as employees render service instead of when the benefits are paid. Companies can elect to record the cumulative effect of the accounting change as a charge against income in the year the rules are adopted, or alternatively, on a prospective basis as a part of the future annual benefit cost. The Company has applied the new rules at the time of the Acquisition using the cumulative effect method. Under this method, the Company recorded a liability of $7.3 million at the date of acquisition.\nDelivery Expenses: The Company's policy is to include all delivery expenses in cost of goods sold.\nSelf Insurance: As part of its risk management strategies, the Company is self-insured, up to certain amounts, for risks such as workers' compensation, employee health benefits, and long-term disability. Risk retention is determined based on savings from insurance premium reductions, and, in the opinion of management, does not result in unusual loss exposure relative to other companies in the industry.\nReclassifications: Certain amounts in the fiscal 1994 financial statements have been reclassified to conform to the fiscal 1995 financial statement presentation.\nNOTE C--ACCOUNTING CHANGE AND EXTRAORDINARY ITEM\nDuring fiscal 1992, the Company changed its method of accounting for the liability for environmental remediation costs. Events which occurred during fiscal 1992 resulted in the Company concluding that it can no longer estimate the effects of changes in environmental laws and regulations regarding the timing of the cash flows required to remediate environmental contamination. In addition, estimates of the cost of remediation are impacted by rapid changes in available technologies. Under the newly adopted method, the Company has recorded the gross amount of the liability whereas in the past, the Company had recorded the net present value of the amount. The cumulative effect of this change, after reduction for an income tax benefit of $2,570,000, was to increase the net loss by $4,270,000 and is shown separately in the consolidated statement of operations for the year ended September 30, 1992.\nIn March 1994, the Company redeemed $20,000,000 of 14.5% subordinated debentures. The 6% premium, equal to $1,200,000 was charged to expense net of a $452,000 income tax benefit, and was classified as an extraordinary item for financial reporting purposes.\nIn December 1992, the Company repaid $239,619,000 of existing debt. The net carrying amount of this debt was $233,017,000 resulting in a loss of $4,185,000, net of an income tax benefit of $2,417,000 which has been classified as an extraordinary item for financial reporting purposes.\nNOTE D--INVENTORIES\nInventories consist of the following: ($ in thousands)\nNOTE E--BORROWINGS\nLong-term borrowings consist of the following: ($ in thousands)\nThe Debentures bear interest at 14.5% and mature in fiscal 2001, but will be redeemable if certain tests are met, at the option of the Company, in whole or in part from time to time, on and after September 30, 1994 at redemption prices (expressed as percentages of the outstanding principal amount) if redeemed during the twelve-month period commencing on November 15 of the year set forth below, plus, in each case accrued interest thereon to the date of redemption:\nThe Company maintains a revolving credit agreement with BT Commercial Corporation (\"BTCC\"), as agent, which consists of a three year revolving credit facility for making revolving credit loans and issuing letters of credit in the aggregate principal amount of up to $100 million (the \"Revolving Credit Agreement\"). Loans and letters of credit under the Revolving Credit Agreement are limited, in the aggregate, to the lesser of the $100 million commitment amount and a \"borrowing base\" amount. Letters of credit are subject to an aggregate sublimit of $30 million. The borrowing base will not exceed the sum of 85% of eligible accounts receivable plus 60.0% of eligible inventory.\nThe Revolving Credit Agreement provides that the foregoing advance rates and the criteria for eligibility of accounts receivable and inventory may be adjusted by BTCC from time to time. Loans based on eligible inventory are subject to an inventory sublimit.\nFLORIDA STEEL CORPORATION NOTES TO FINANCIAL STATEMENTS MARCH 31, 1995\nNOTE E--BORROWINGS -- Continued\nThe Revolving Credit Agreement contains (a) covenants standard for BTCC's secured financing generally and other covenants deemed appropriate by BTCC, including, without limitation, financial ratios, limitations on indebtedness, limitations on liens and limitations on loans, investments, dispositions of assets and dividends and distributions and (b) events of default deemed appropriate by BTCC. The Company is in compliance with these covenants at March 31, 1995.\nThe Revolving Credit Agreement is collateralized by first priority security interests in all accounts receivable and inventory of the Company.\nA portion of the loans under the Revolving Credit Agreement bear interest at a per annum rate equal to the Bankers Trust Company Prime Rate plus 1.75%, and a portion of the loans bear interest at a percent per annum rate equal to the Bankers Trust Company's 30-, 60-, or 90-day Eurodollar Rate (the \"Eurodollar Rate\") plus 3.25%. The average interest rate at March 31, 1995 was 9.6%. In addition, the Revolving Credit Agreement provides for a .5% per annum unused line fee on the unused portion of the Revolving Credit Agreement.\nThe First Mortgage Notes were issued under an indenture (the \"Indenture\") as of December 15, 1992 by and among the Company and Shawmut Bank Connecticut, N.A., as Trustee (the \"Trustee\"). The First Mortgage Notes are collateralized senior obligations of the Company limited in aggregate principal amount to $100 million and will mature on December 15, 2000. Interest on the First Mortgage Notes will accrue at the rate of 11.5% per annum and are payable semiannually on each June 15 and December 15, commencing on June 15, 1993, to the holder of record on the immediately preceding June 1 and December 1. Interest on the First Mortgage Notes will accrue from the most recent date to which interest has been paid or, if no interest has been paid, from the original date of issuance. The Company shall pay interest on overdue principal and (to the extent permitted by law) on overdue installments of interest at a rate equal to 13.5% per annum.\nThe First Mortgage Notes will be redeemable, at the option of the Company, in whole or in part from time to time, on or after December 15, 1996 at redemption prices (expressed as percentages of the outstanding principal amount) if redeemed during the twelve-month period commencing on December 15 of the year set forth below, plus, in each case, accrued interest thereon to the date of redemption:\nThe First Mortgage Notes rank pari passu with respect to the payment in full of the principal and interest on all existing and future senior indebtedness of the Company and rank senior to all subordinated indebtedness of the Company, including the Debentures and the Subordinated Intercompany Note described below. The Company will not issue any indebtedness that is subordinated to any other indebtedness of the Company unless each subordinated indebtedness is subordinated to the same extent to the First Mortgage Notes.\nFLORIDA STEEL CORPORATION NOTES TO FINANCIAL STATEMENTS MARCH 31, 1995\nNOTE E--BORROWINGS -- Continued\nThe Company has assigned and pledged as collateral (the \"Collateral\") to the Trustee for the benefit of the Trustee and the Holders of the First Mortgage Notes a security interest in certain of its real and personal property summarized below, whether now owned or hereafter acquired, together with the proceeds therefrom and permanent additions and accessions thereto, but such security interest will not extend to the inventory or accounts receivable of the Company, which will be pledged to secure the obligations under the Revolving Credit Agreement. The Collateral for the First Mortgage Notes will represent substantially all the real and personal property (other than inventory and accounts receivable) of the Company's five minimills. The security interest in the Collateral will be a first priority interest (to the extent attainable by filing or possession), subject to certain permitted encumbrances, which encumbrances, in the judgment of the Company, will not adversely affect the value of the collateral.\nThe First Mortgage Notes contain covenants that include, without limitation, maintenance of sufficient consolidated net worth and limitations on additional indebtedness, transactions with affiliates, dispositions of assets, liens, dividends and distributions. The Company is in compliance with these covenants at March 31, 1995.\nThe Company has issued to Holdings a $50 million note (the \"Subordinated Intercompany Note\") which matures December 21, 2001, and is not transferable, by way of sale, pledge, hypothecation or otherwise and is subordinated to the First Mortgage Notes, the Revolving Credit Agreement and the IRBs. The Subordinated Intercompany Note bear interest at variable rates. The weighted average interest rate at March 31, 1995 was 8.3%.\nThe Company also has outstanding borrowings obtained through industrial revenue bonds (\"IRBs\") issued to construct facilities in Jackson, Tennessee; Charlotte, North Carolina; Jacksonville, Florida; and Plant City, Florida. The interest rates on these bonds range from 50% to 75% of the prime rate. The IRBs mature in fiscal 2004. The IRBs are backed by irrevocable letters of credit issued pursuant to the Revolving Credit Agreement. As of March 31, 1995, the Company had approximately $17.8 million of outstanding letters of credit, primarily for IRBs, insurance-related matters and surety bonds.\nThe Note to Parent is an unsecured non-interest bearing note with no stated maturity. Accordingly, amounts due are classified as current as of March 31, 1995 in the accompanying statements of financial position.\nThe Company has borrowed $5.3 million as of March 31, 1995 from Mitsubishi International Corporation, (the \"Mitsubishi Trade Loan Agreement\"). The loan bears interest at 7.75% and matures on December 29, 1995. The Company has also borrowed $3.9 million as of March 31, 1995 from Marubeni America Corporation (The \"Marubeni Trade Loan Agreement\"). The loan bears interest at 8.50% and matures on April 15, 1996. The proceeds from both loans are to be used for the purchase of steel mill equipment which shall collateralize the loans.\nAs of March 28, 1994, the Company entered into a subordinated note agreement (the \"Bank of Tokyo Loan\") with the Bank of Tokyo, LTD., New York Agency. The Company pays interest on the $10 million note semiannually commencing September 28, 1994. Interest will be computed at the six-month Eurodollar Rate plus 1.5%. (7.9% effective March 31, 1995). This note, which matures March 28, 1996, is subordinated to the Company's senior debt and the Company may not make payments if the senior debt is in default until certain conditions are met.\nFLORIDA STEEL CORPORATION NOTES TO FINANCIAL STATEMENTS MARCH 31, 1995\nNOTE E--BORROWINGS -- Continued\nThe maturities of long-term borrowings for the years subsequent to March 31, 1995 are as follows: ($ in thousands)\nNOTE F -- NEW REVOLVING CREDIT AGREEMENT\nEffective June 9, 1995, the Company entered into a two-year revolving bank agreement (the \"New Revolving Credit Agreement\"), which replaces the Revolving Credit Agreement and provides up to $140 million borrowings subject to a \"borrowing base\" amount. The borrowing base amount will not exceed the sum of 85% of eligible accounts receivable plus 65% of eligible inventory. Letters of credit are subject to an aggregate sublimit of $50 million.\nThe New Revolving Credit Agreement contains certain covenants including financial ratios and limitations on indebtedness, liens, investments and disposition of assets and dividends.\nRevolving Loans under the New Revolving Credit Agreement bear interest at a per annum rate equal to one of several rate options (LIBOR, Fed Funds, or Cost of Funds) at the discretion of the Company plus an applicable margin determined by tests of performance from time to time. Prime interest rate loans, not previously mentioned , have no additional margin. In addition to Revolving Loans, the Company has the option of incurring Swingline Loans, subject to an aggregate sub-limit of $10 million, for short-term cash needs at rates near prime. The initial borrowing under the New Revolving Credit Agreement, used to pay off the Revolving Credit Agreement, was LIBOR plus 1.5%.\nThe New Revolving Credit Agreement is collateralized by first priority security interests in substantially all accounts receivable and inventory of the Company.\nFLORIDA STEEL CORPORATION NOTES TO FINANCIAL STATEMENTS MARCH 31, 1995\nNOTE G -- INCOME TAXES\nThe provision (benefit) for income taxes are comprised of the following amounts: ($ in thousands)\nFor the year ended March 31, 1994, and for the three months ended December 31, 1992, the benefit for income taxes includes a $452,000 and $2,417,000 current benefit, respectively, for an extraordinary item related to the early extinguishment of debt. The benefit from continuing operations of $10,833,000 and $6,001,418, respectively, is exclusive of this amount.\nA reconciliation of the difference between the effective income tax rate for each period and the statutory federal income tax rate follows: ($ in thousands)\nFLORIDA STEEL CORPORATION NOTES TO FINANCIAL STATEMENTS MARCH 31, 1995\nNOTE G --INCOME TAXES -- CONTINUED\nThe sources of temporary differences on which deferred income taxes have been provided and the related income tax effect follows: ($ in thousands)\nFLORIDA STEEL CORPORATION NOTES TO FINANCIAL STATEMENTS MARCH 31, 1995\nNOTE G -- INCOME TAXES -- Continued\nThe components of the deferred tax assets and liabilities consisted of the following at March 31: ($ in thousands)\nThe Company has net operating loss carryforwards of approximately $7.3 million and $29.9 million for federal and state income taxes, respectively, expiring through 2009. As a result of a change in tax fiscal year, recognition of federal net operating loss carryforwards are limited to approximately $1.5 million each year. The Company also has alternative minimum tax credit carryforwards of approximately $3.1 million which have no expiration.\nThe Company changed its Federal and state tax year end from September 30, to March 31, effective March 31, 1994, to conform with its financial reporting year end.\nFLORIDA STEEL CORPORATION NOTES TO FINANCIAL STATEMENTS MARCH 31, 1995\nNOTE H --BENEFIT PLANS\nThe Company maintains a defined benefit pension plan covering substantially all employees. The benefits are based on years of service and compensation during the period of employment. Annual contributions are made in conformity with minimum funding requirements and maximum deductible limitations.\nThe plan's funded status and the amounts recognized in the accompanying statements of financial position are as follows: ($ in thousands)\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 8.0% and 4.5%, respectively for both the years ended March 31, 1995 and March 31, 1994, and 8.4% and 4.5% for both the three months ended March 31, 1993, and for the three months ended December 31, 1992, and 8.75% and 5.0%, respectively, for the year ended September 30, 1992. The expected rate of return on plan assets was 9.5% for the years ended March 31, 1995 and March 31, 1994 and 9% for all other periods.\nFLORIDA STEEL CORPORATION NOTES TO FINANCIAL STATEMENTS MARCH 31, 1995\nNOTE H --BENEFIT PLANS -- Continued\nPension cost included in the accompanying statements of operations are comprised of the following: ($ in thousands)\nThe Company also has a voluntary savings plan available to substantially all of its employees. Under this plan, the Company contributes amounts based upon a percentage of the savings paid into the plan by employees. Effective January, 1993, the Company matched 50% of the employees' contribution up to 4% of employees' salaries. Costs under this plan were $1.2 million, $1.2 million, $.2 million, $0, and $.1 million for the years ended March 31, 1995 and March 31, 1994, the three month periods ended March 31, 1993 and December 31, 1992 and for the year ended September 30, 1992.\nThe Company has an unfunded Supplemental Benefits Plan, which is a nonqualified plan that provides certain officers defined pension benefits in excess of limits imposed by federal tax laws. The charges to earnings under the Supplemental Benefits Plan for the years ended March 31, 1995 and March 31, 1994, the three month periods ended March 31, 1993 and December 31, 1992 were $159 thousand, $765 thousand, $23 thousand and $347 thousand, respectively. The charge to earnings under this plan for fiscal year ended September 30, 1992, was $59 thousand. Approximately $470 thousand was included in salaries, wages and employee benefits as of March 31, 1995.\nFLORIDA STEEL CORPORATION NOTES TO FINANCIAL STATEMENTS MARCH 31, 1995\nNOTE H --BENEFIT PLANS -- Continued\nPost Retirement Benefits: The Company currently provides specified health care benefits to retired employees. Employees who retire after a certain age with specified years of service become eligible for benefits under this unfunded plan. The Company has the right to modify or terminate these benefits. The Company adopted SFAS No. 106, \"Employers' Accounting for Post Retirement Benefits Other Than Pensions as of December 31, 1992. SFAS 106 requires the cost of these benefits be recognized in the Company's financial statements over an employee's service period with the Company. The following table summarizes the accumulated post retirement benefit obligations included in the Company's statements of financial position:\nThe following table summarizes the net post retirement benefit costs: ($ in thousands)\nThe weighted average discount rate used in determining the accumulated benefit obligation was 8.25%. The gross medical trend rate was assumed to be 11.0% in 1994 and dropping .346% per year to 6.5% in 2007 and beyond for pre-65 retirees that retired before January 1, 1994 and 10% decreasing by .5% per year to 5.5% in 2003 and beyond for post 65-retirees that retired before January 1, 1994. For retirees on or after January 1, 1994, the trend rate is the same until the Company's expected costs are double the 1992 costs. At that point, future increases in the medical trend will be paid by the retirees. The health care cost trend rate assumption has a significant effect on the amount of the obligation reported.\nFLORIDA STEEL CORPORATION NOTES TO FINANCIAL STATEMENTS MARCH 31, 1995\nNOTE H --BENEFIT PLANS -- Continued\nThe incremental effect of a 1% increase in the medical trend rate would result in an increase of approximately $230,000 and $17,000 to the accumulated post retirement benefit obligation and net post retirement benefit cost, respectively, as of and for the year ended March 31, 1995.\nNOTE I--INCENTIVE COMPENSATION PLAN\nDuring 1989, the Board of Directors of Holdings approved a short-term incentive plan to reward key employees who are significant to the Company's long-term success. The awards are based on the Company's actual operating results, as compared to targeted results. The plan provides for annual distributions to participants based on that relationship. The plan is amended annually by the Board of Directors to reflect changes in expected operating results, and to adjust target results accordingly. The award for fiscal 1995 was $1.9 million which is included in salaries, wages and employee benefits at March 31, 1995. No amounts were awarded under the plan for the year ended March 31, 1994, the six month period ended March 31, 1993 or for the year ended 1992.\nNOTE J--ENVIRONMENTAL MATTERS\nBecause the Company is involved in the manufacture of steel, it produces and uses certain substances that may pose environmental hazards. The principal hazardous waste generated by current and past operations is emission control dust (\"EC dust\"), a residual from the production of steel in electric arc furnaces. The emission control dust generated by current operations is shipped to zinc reclamation facilities under applicable environmental laws. In the past, some of the Company's facilities and those of some reclaimers to whom shipments were made became contaminated by emission control dust. In addition, during the early 1970s, contamination involving polychlorinated biphenyls (PCBs), occurred at several of the Company's facilities. Environmental legislation and regulation at both the federal and state level is subject to change, which may change the cost of compliance. Various possible methods of remediation are presently being studied for approval; however, it is expected that the investigation and remediation process will take a number of years. Although the ultimate costs associated with the remediation are not presently known, the Company has estimated the cost to be approximately $21.7 million. Approximately $19.1 million of these costs is recorded in accrued liabilities as of March 31, 1995. The remaining amounts consist of site restoration and environmental exit costs to ready idle facilities for sale, and have been considered in determining whether the carrying amounts of the properties exceed their net realizable values. The Company paid approximately $14 million in remediation costs in fiscal 1995. Of the amount accrued at March 31, 1995, the Company expects to pay approximately $10.9 million in fiscal 1996, the timing of future payments are uncertain due to the various remediation alternatives being considered. The Company had recorded a reserve of approximately $27 million as of March 31, 1994 and approximately $21 million at March 31, 1993. The Company's estimate of the remediation costs is based on its review of each site and the nature of such problems. The Company then determines for each site the expected remediation methods, and the estimated cost for each step of remediation. In all such determinations, the Company employs outside consultants, and providers of such remedial services where necessary, to assist in making such determinations.\nFLORIDA STEEL CORPORATION NOTES TO FINANCIAL STATEMENTS MARCH 31, 1995\nNOTE J--ENVIRONMENTAL MATTERS -- Continued\nDuring the years ended March 31, 1995, March 31, 1994, and three months ended March 31, 1993 and December 31, 1992 and the fiscal year 1992, the Company expensed approximately $6 million, $10 million, $.6 million, $.5 million, and $9.6 million, respectively, for environmental remediation costs. Such amounts are included in the accompanying statements of operations as a component of costs of sales, excluding depreciation.\nBased on past use of certain technologies and remediation methods by third parties, evaluation of those technologies and methods by the Company's consultants and quotations and third-party estimates of costs of remediation-related services provided to the Company or of which the Company and its consultants are aware, the Company and its consultants believe that the Company's cost estimates are reasonable. In light of the uncertainties inherent in determining the costs associated with the clean-up of such contamination, including the time periods over which such costs must be paid, the extent of contribution by parties which are joint and severally liable, and the nature and timing of payments to be made under cost sharing arrangements; there can be no assurance the ultimate costs of remediation may not be greater or less than the estimated remediation costs.\nNOTE K -- COMMITMENTS\nOperating Leases The Company leases certain equipment and real property under noncancelable operating leases. Aggregate future minimum payments under these leases are as follows:\n($ in thousands)\nTotal rent expense was approximately $5.0 million, $4.8 million, $1.0 million, $.9 million, and $3.9 million for the years ended March 31, 1995 and March 31, 1994, the three months ended March 31, 1993, the three months ended December 31, 1992 and the year-ended September 30, 1992, respectively.\nOn April 1, 1995, the Company entered into two noncancelable operating lease agreements with an initial lease term of five years to lease land and land improvements to a third party. Aggregate future minimum gross rentals under these leases is $100,000 per year. Cost of the land and land improvements was $1.6 million.\nFLORIDA STEEL CORPORATION NOTES TO FINANCIAL STATEMENTS MARCH 31, 1995\nNOTE K -- COMMITMENTS - Continued\nService Commitments The Company entered into two noncancelable agreements to purchase transportation services. The rates charged are based on a fixed dollar amount and number of miles. These rates are subject to change each year based on inflation. The term for each agreement is 5 years, beginning April 1, 1995, renewable for successive one-year periods.\nEmployment Agreement On June 1, 1994, the Company entered into a five-year employment agreement (the \"Employment Agreement\") with a senior member of management. The Employment Agreement provides for, among other benefits, a one-time bonus of $2,446,000, base annual salary of $300,000, and equity interest of 7.5% of the outstanding common stock of the Company to vest ratably over the next five years. Deferred compensation of $4,500,000 was recorded related to the common stock granted, and is being amortized on a straight-line basis over the term of the Employment Agreement. The Employment Agreement also provides for certain additional benefits in the event of termination.\nInterest Rate Swap The Company maintains an interest rate swap (the \"Swap\") agreement as a hedge against fluctuations in interest rates on certain debt. The Swap has a notional amount of $20 million and a three-year term expiring February 24, 1997. Under the terms of the Swap the Company has agreed to pay fixed interest at 9% and receive variable interest at the LIBOR Rate (6.38% at March 31, 1995) + 3.0%, computed based on the notional amount. The Company is amortizing the premium paid to acquire the Swap over its term as an adjustment to interest expense.\nLitigation The Company is defending various claims and legal actions which are common to its operations. While it is not feasible to predict or determine the ultimate outcome of these matters, none of them, in the opinion of management, will have a material effect on the Company's financial position or results of operations.\nNOTE L--OTHER OPERATING EXPENSES\nIn March 1994, the Company announced the closing of the Tampa Mill melt shop resulting in a $10.3 million charge of which $9.1 million was to reduce fixed assets to realizable value and the balance was primarily benefit costs for affected employees. The Company also announced the closing of the Ft. Myers, Florida and Woodbridge, Virginia fabricating shops at a cost of $600,000.\nOn November 4, 1992, the Company entered into a Settlement Agreement with the United States and Florida Departments of Transportation (the \"Departments\"). The Company paid the Departments $9 million five days after the closing of the Acquisition by Kyoei Steel (Note A). The Company recorded the $9 million as of September 30, 1992 in other operating expenses.\nFLORIDA STEEL CORPORATION NOTES TO FINANCIAL STATEMENTS MARCH 31, 1995\nNOTE M--SUBSEQUENT EVENTS\nEmployment Agreement On April 1, 1995, the Company entered into an employment agreement with a senior member of management that provides for, among other things, a signing bonus and the receipt of restricted common stock and options to purchase common stock.\nShareholder Loan On April 15, 1995, the Company loaned approximately $731,000 to a shareholder. The loan bears interest at 7.15% and calls for quarterly interest payments until September 1997. Quarterly interest and principal payments are due starting September 1, 1997 to June 1, 2000.\nStock Dividend On May 22, 1995, the Company's Board of Directors and shareholders authorized an increase in the number of shares of common stock from 1,000 to 30,000,000 and the Board of Directors declared a stock dividend of 49,999 shares for 1, pending approval of an amendment to the Company's Articles of Incorporation by the State of Florida. These changes have been retroactively reflected to March 31, 1995, in the accompanying financial statements.\nFLORIDA STEEL CORPORATION\nSCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS\n(1) Represents accounts considered to be uncollectible and charged off, less recoveries on accounts previously charged off.\nSee notes to financial statements.\nINDEX TO EXHIBITS -----------------\nEXHIBIT NO. DESCRIPTION - ------- ----------- 27 Financial Data Schedule (for SEC use only)","section_14":"","section_15":""}
{"filename":"93675_1995.txt","cik":"93675","year":"1995","section_1":"Item 1. Business\nStarrett Corporation was organized in New York in 1922. Through its subsidiary Levitt Corporation (\"Levitt\"), the Company engages in the construction and sale of single-family homes and garden apartments in the United States and Puerto Rico. See \"Levitt Corporation.\" Over the years Starrett and its subsidiaries have constructed a wide range of office, industrial, public and institutional buildings, among the most notable being the Empire State Building, the Rockefeller Research Laboratories at Memorial Sloan Kettering Cancer Center, Whitney Museum, Citicorp Center and Chemical Bank World Headquarters, and many well-known residential communities and developments, including Starrett at Spring Creek, Manhattan Park at Roosevelt Island, Trump Tower and the Trump International Hotel in New York City. The Company today is actively engaged in all fields of construction, development, management and technical services.\nUnless the context otherwise requires, references to the \"Company,\" the \"Registrant\" or \"Starrett\" include Starrett Corporation and\/or one or more of its subsidiaries.\nLevitt Corporation\nLevitt's operations include sales of single family homes and condominium garden apartments, development and sale of rental apartment complexes and mortgage banking.\nHousing\nLevitt's residential housing operations are concentrated in Florida and Puerto Rico. In Puerto Rico, Levitt is the largest home builder and has been building on the island since 1960. It's Florida operations were started in 1978 and are currently conducted on Florida's southeast and southwest coasts.\nDuring 1994, several new sites were acquired and opened in Florida. These projects are under full development, and have received favorable responses from home-buyers. During 1995, Levitt and a joint venture partner acquired a parcel of land located adjacent to an existing project, which opened for sale in December, 1995. The excellent sales results at the existing site are expected to benefit the new development. Additionally, new properties are under contract for future developments and should provide steady growth for the next several years.\nLevitt has concentrated its significant Puerto Rico homebuilding activities in the greater San Juan area. In recent years, Puerto Rico operations have provided a major portion of revenue and profits for Levitt. Levitt has a large scale planned unit development called Encantada and several other subdivisions under development in the San Juan metropolitan area which will provide a steady inventory of houses for the next several years.\nEncantada is planned for approximately 2,600 homes of which more than 1,800 homes have been contracted for sale with over 1,600 deliveries as of February 28, 1996. Both single family homes and garden apartments are offered for sale at various prices in the community. The Company believes that Encantada's success can be attributed to the excellent quality of the community, the housing and the family lifestyle it provides. With approximately 800 more homes to be sold, Encantada, together with the region's other projects, is expected to continue as an important source of revenues and profits for the Company. During 1995, the Company has contracted under option to acquire additional sites for future development.\nLevitt's business is affected by several factors such as housing affordability, increased land costs, legislative growth restrictions, sewer and water moratoriums, possible changes in the Internal Revenue Code, including changes in Section 936 of the Internal Revenue Code relating to the taxability of corporations doing business in Puerto Rico, and infrastructure requirements.\nLevitt's backlog of homes contracted for sale at December 31, 1995 was $86,104,000 compared to $80,523,000 at December 31, 1994. Included in Levitt's sales backlog at December 31, 1995 and 1994 is $41,040,000 and $39,490,000, respectively, which constitutes the full backlog from joint ventures in which Levitt has 50% interests. Backlog consists of units which are under sales contract but where title has not yet passed, and comprises completed and uncompleted houses as well as houses where construction has not yet begun.\nThe following table sets forth information concerning homes contracted for sale (net of cancellations during each period), housing units delivered (construction completed and title passed), and backlog:\nJoint Venture Projects (Reported at 100% of Joint Venture Backlog)\nAfter the initial contract has been received, contracts for the sale of houses may be canceled at or prior to closing for various reasons, including failure of the buyer to make the remainder of the required contract deposit, or qualify for mortgage financing, or a default by the buyer. Levitt retains the buyer's deposit only if cancellation results from default by the buyer, except in Puerto Rico where under local law Levitt can retain only a portion of the deposit. When computing homes contracted for sale and backlog, Levitt makes no deduction for future cancellations, but nets cancellations as they occur against sales contracts. Levitt generally estimates that of the sales contracts entered into by buyers, approximately 70% have historically resulted in delivered homes. Contracts for sale are not recorded as revenues until the houses have been completed and title delivered.\nLevitt generally builds subdivisions on undeveloped suburban land having access to water and sewer services, although it does occasionally purchase fully developed land. Development plans must be approved by local authorities, which may take two years or more after the signing of a purchase contract. See \"Regulation of the Company's Activities,\" page 8.\nLevitt provides home purchasers with warranties against construction defects for a period of up to two years from the date of purchase. In Puerto Rico there is a statutory warranty for certain construction defects which appear generally within ten years after completion.\nRental Apartment Development\nDuring 1991 through 1994, Levitt, in joint venture with an established apartment developer, constructed, leased and sold two rental apartment complexes totaling 424 units. During 1995, a third rental apartment community comprising 200 units was sold. The three rental apartment complexes were sold at a substantial profit. A new fourth site is under contract and is being evaluated for future development.\nLevitt's current policy is to develop, lease and sell the apartment projects and not hold them for investment. The apartment development program is an integral part of Levitt's business and is anticipated to provide it with a continuous source of income. It is the Company's plan to develop at least one apartment project every eighteen months.\nMortgage Banking\nLevitt Mortgage Corp. (\"Mortgage\") is a full service mortgage lender that processes and originates loans in Puerto Rico and processes mortgage loans domestically. Fees are earned on mortgage placements and processing. Mortgage is a designated approved direct endorser of FHA loans in Puerto Rico but does not service loans.\nIn Puerto Rico, Mortgage also acts as a mortgage banker for third parties and processes and issues the mortgages it underwrites. These mortgages are sold to investors in accordance with firm purchase commitments with the investors. Mortgages are solicited through four offices in the San Juan area. Mortgage is the sixth largest mortgage banker in Puerto Rico based on mortgage commitments.\nStarrett's Development Activities\nIn its development activities, the Company's services, in addition to those of a construction manager or general contractor, may include initial planning and development, acquisition of the property, arranging for financing and ownership of the project typically through general or limited partnerships, and providing management, consulting and related services. The Company anticipates marketing its development projects to investors or other purchasers, based principally on cash flow, capital appreciation and other non-tax considerations, and may in some instances retain ownership of such projects. In connection with its sale of projects, the Company may provide guarantees of completion and cash flow for varying periods.\nThe Company is proceeding with certain development projects. While the Company has generally been successful in developing such projects, these projects are in various stages of development, and there can be no assurance that any particular project will be completed.\nPursuant to a Memorandum of Understanding between the Company and the City of New York, the Company has been designated as the developer of a mixed use project known as Gateway Estates in Brooklyn, New York, currently anticipated to consist of a shopping center, housing and related components. The project is in the plan development stage and requires various government agency approvals. Milstein Properties, in which Paul Milstein, and members of his family are the principal owners, is the Company's 35% joint venture partner in the project.\nOwnership of Partnership Interests\nThe Company reviews from time to time projects in which it acts as a general partner or in which it has an equity interest (which for the most part have a low income tenancy subsidized in whole or in part by government-assistance programs) to determine the possibility of refinancing, resyndicating, selling, converting to condominiums, or co-oping such projects to obtain fees and other economic benefits.\nOn December 14, 1995, a limited partnership in which the Company is a general partner owning a HUD financed housing project on the upper West Side of Manhattan refinanced the project. At the closing, the Company received approximately $3,000,000 most of which represents fees, with the remainder attributable to repayment of sums owed, return of capital, and partnership distributive share of refinancing proceeds.\nStarrett's Construction Activities\nThrough its HRH Construction Corporation subsidiary (\"HRH\"), the Company primarily acts as construction manager in the construction of hospital and medical research facilities, institutional, office and residential projects, most of which are located in the New York City Metropolitan area. HRH builds projects either as a construction manager on a cost plus fee basis or a general contractor in which case it assumes the construction risk. The construction management and general contracting fees and other income earned by HRH during 1995, 1994 and 1993 were $8,917,000, $4,278,000 and $4,000,000, respectively. See \"Segment Information,\" page 9.\nHRH has focused its activities on institutional construction and construction funded by City, State and Federal governments and is seeking to diversify into new areas of construction.\nIn the case of projects where HRH acts as general contractor rather than construction manager (which has included projects in which the Company acts as a developer\nor has an ownership interest), the Company is required from time to time, as is customary in projects of this kind, to furnish payment and performance bonds assuring payment to subcontractors. The Company believes its bonding capacity is adequate for both present and projected requirements. The aggregate amount of bonds or other security the Company can obtain at any one time is dependent upon its overall financial strength.\nHRH's estimated backlog of fees including fees for projects where development work has begun but contracts have not yet been executed, was $16,304,000 at December 31, 1995 as compared to $8,950,000 and $8,151,000 at the end of 1994 and 1993, respectively. HRH is actively seeking to increase its backlog of business, particularly in the hospital and medical research facilities, as well as, the governmental and institutional sectors.\nIn August 1995 HRH expanded its business into interior work for office buildings, retail stores, hotels, etc., by creating HRH Construction Interiors, Inc. (\"HRHI\").\nThis type of work is performed under various forms of contract, such as construction management, lump sum, and guaranteed maximum price. HRHI is currently performing construction and renovation work for clients such as Nordstrom Stores, Smith Barney and Gucci.\nManagement Services\nGrenadier Realty Corp. (\"Grenadier\") is one of the largest and most diverse full service real estate management firms in the New York metropolitan area. Its management portfolio includes 60 developments containing more than 28,000 housing units. The types of properties include government-assisted housing, low income tax credit developments, high-rise luxury rentals, cooperatives and condominiums. The portfolio also includes in excess of one million square feet of commercial space and 10,000 garage spaces. In 1995, Grenadier was named Property Management Company of the Year in the Assisted Housing Category by the National Association of Home Builders' Multi-Family Council. It is the 20th largest property management firm in the United States based on units under management, and one of the largest managers of affordable housing in the New York City Metropolitan area.\nGrenadier and its subsidiaries provide a variety of real estate management services, ranging from full service-management to back office services in specific areas such as budgeting and accounting, rent collection, recertification and energy management. Prominent developments in Grenadier's full-service management portfolio include Starrett at Spring Creek in Brooklyn, New York, the nation's largest government-assisted housing development and Manhattan Park, a luxury high-rise development with a 20% affordable housing segment on New York City's Roosevelt Island. Developments that utilize Grenadier's back-office services include the 4,000-unit Parkchester North Condominium Development in the Bronx, New York.\nIn the latter half of 1994, Grenadier entered the field of public housing management when it was named to oversee the Chester Housing Authority (CHA), a distressed housing authority in Chester, Pennsylvania.\nGrenadier has overseen a complete reorganization of CHA's operations and staff, initiated or restarted long-stalled plans for the modernization and physical rehabilitation of CHA developments, and established programs aimed at encouraging financial independence and social, cultural and intellectual growth among the public housing residents. Based on its success in Chester, Grenadier is now actively pursuing opportunities to provide management or consulting services to a number of other distressed public housing authorities around the United States.\nGrenadier's subsidiary Security Plus Service Inc. (SPS) provides security services for 55 residential properties and public institutions throughout the New York metropolitan area. Its client portfolio has increased steadily over the last few years. SPS believes that it has established an excellent reputation in the industry by setting stringent standards for recruitment, training and on-the-job supervision. These standards far exceed requirements for security guard companies mandated by the New York Security Guard Act of 1992.\nRegulation of the Company's Activities\nThe development business and home building industry in which the Company is engaged have, in the last several years, become subject to increased environmental, building, land use, zoning and sales regulations administered by various federal, state and local authorities, which affect construction activities as well as sales activities and other dealings with customers. Additionally, sewer moratoriums have been imposed from time to time in Puerto Rico which have caused delays in the delivery of homes to customers. The Company must obtain for its development and housing activities the approval of numerous governmental authorities which often have wide discretion in such matters. Changes in local circumstances or applicable law may necessitate applications for additional approvals or the modification of existing approvals. Compliance with these regulations has extended the time required to market projects by prolonging the time between the initiation of projects and the commencement and completion of construction. The Company is currently in various stages of securing governmental approvals for its development and homebuilding projects. Delay or inability to obtain all required approvals for a project could have a materially adverse effect on the marketability or profitability of a project.\nSegment Information\nThe Company's operations consist of (i) the development, management and ownership of real estate properties; (ii) the single-family home and garden apartment business conducted through its Levitt subsidiary; and (iii) the supplying of construction services through its HRH subsidiary. The Company groups its business into these three segments. The following table sets forth the Company's revenues and operating profit attributable to the respective segments of its operations for each of the years 1993 through 1995, and the identifiable assets attributable to the respective segments as at the end of each of those years:\nOperating profit comprises revenues less operating expenses. In computing operating profit, general corporate expenses and income taxes have not been deducted.\nThere were no individual customers from which the Company derived 10% or more of its revenues in 1993, 1994 or 1995.\nCompetition\nThe construction, development and home building industries in all of the areas in which the Company operates are highly competitive, and the Company competes with major concerns as well as with smaller contractors or builders.\nRaw Materials and Equipment\nSubstantially all the materials used by the Company in projects now under construction, including fixtures, appliances and systems, are readily available from many sources. The Company has from time to time experienced some shortages, delays and increased costs in connection with material shortages and increases in material prices but the Company does not believe the effect to have been significant.\nEmployees--Labor Relations\nThe Company directly employed, at December 31, 1995, a total of approximately 1,486 persons. Where the Company has union members working, it believes that it has satisfactory relations with them.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company leases 25,000 square feet of space located at 909 Third Avenue in New York City for the construction management and interiors business and its development and corporate offices. The lease for such space, which it occupied in 1973, expires in 1997. The Company also maintains field offices at each of its construction sites.\nLevitt leases approximately 8,800 square feet of office space which it uses for its executive office and main office for its Florida homebuilding operation in Boca Raton, Florida, and also leases 10,000 square feet of office space in San Juan, Puerto Rico.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe Company is involved in litigation and claims incident to the normal conduct of its business. Management believes that such litigation and claims will not have a materially adverse effect on the Company's business operations.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNot Applicable\nExecutive Officers of the Company\nThe following table sets forth the names and ages of all executive officers of the Company, the positions and offices with the Company held by each such person, and the period during which each such person has served as an executive officer.\nThe term of office of each executive officer continues until the first meeting of the Board of Directors of the Company following the next annual meeting of shareholders, and until the election and qualification of such officer's successor. There is no family relationship between the executive officers listed above, or between such executive officers and directors. All of the executive officers except Paul Milstein and Frank Ross, Sr. have been principally engaged in his present employment for more than five years. Mr. Milstein became Chairman on January 1, 1994, and for more than five years has been active as a real estate developer and investor. Mr. Ross has been employed by HRH since 1976 and has been President of Construction operations for HRH Construction Corporation since 1990.\nPART II\nItem 5.","section_5":"Item 5. Market for the Company's Common Equity and Related Stockholder Matters\nOn March 18, 1996, there were 710 record holders of the Company's common stock and approximately 1460 additional persons whose shares of Common Stock were held in street name. Such common stock is listed on the American Stock Exchange, which is the principal market on which such stock is traded. High and low sales prices on the American Stock Exchange for the Company's common stock during the last two years have been as follows:\nThe Company established a program of regular annual cash dividends of $.25 per share of common stock, payable $.0625 per quarter.\nItem 6.","section_6":"Item 6. Selected Financial Data\nStarrett Corporation and Subsidiaries\n(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\n1995 Compared to 1994\nDuring the year ended December 31, 1995 the Company had income from operations of $12,377,000 compared to $10,306,000 for the year ended December 31, 1994 and net income of $7,365,000 ($1.18 per share) as compared to $6,159,000 ($.98 per share). Earnings per share were based on average shares outstanding of 6,261,000 in 1995 and 1994, respectively.\nThe Company's revenues decreased $3,003,000 compared with the similar period in 1994. This decrease was primarily attributable to Levitt Corporation. Revenues from house sales in the Company's Puerto Rico region decreased significantly as production was disrupted by heavy rain storms and several hurricane warnings. Despite this decrease in revenues, Levitt's operating income increased to $10,823,000 from $10,085,000 in 1994. This increase was the result of significantly higher average net sales prices on homes delivered in the Company's domestic region, the increase in equity earnings from joint ventures, and the expansion of the mortgage banking business in Puerto Rico.\nLevitt's backlog of homes contracted for sale at December 31, 1995 was $86,104,000 compared to $80,523,000 at December 31, 1994, which includes $41,040,000 and $39,490,000, respectively, which constitutes the full backlog from joint ventures in which Levitt has a 50% interest.\nLevitt's gross profit from house sales remained steady in 1995, with increases in domestic gross profit margins offset by a modest decrease in Puerto Rico's margins .\nMortgage operation costs increased due to the continued expansion of the mortgage operation business both domestically and in Puerto Rico.\nInterest incurred, real estate taxes, and sales costs incurred in connection with certain properties are capitalized in order to achieve better matching of costs with revenues. Interest incurred on loans was $3,778,000 in 1995 and $3,435,000 in 1994, of which $3,327,000 in 1995 and $2,775,000 in 1994 was capitalized. Amortization of capitalized interest of $3,726,000 in 1995 and $4,941,000 in 1994 was charged to construction costs.\nHRH Construction continued to operate at a profit while significantly increasing its backlog of fees. HRH's estimated backlog of fees for development work and uncompleted construction in connection with construction projects, including fees for projects where development work has begun but contracts have not yet been executed increased to $16,304,000 at December 31, 1995 as compared to $8,950,000 at December 31, 1994. The increase in backlog of fees is primarily attributable to HRH's expansion of business into interiors work for office buildings, retail stores, hotels, etc., through its subsidiary HRHI. HRH is actively seeking to increase its backlog of business, particularly in the hospital and medical research facilities, as well as, governmental and institutional sectors.\nGrenadier continued its steady profitability in 1995 and has expanded its management services to private owners and institutional property owners as well as the public housing sectors.\nGeneral and administrative expenses increased $2,883,000 in 1995 principally due to the expansion of operations in all segments of the Company's business. The significant increases were attributable to personnel and general office overhead.\nSecurity service labor and other costs increased $1,323,000 in 1995 as a result of an increase in the Company's security protection operation.\nOn December 14, 1995, a limited partnership in which the Company is a general partner owning a HUD financed housing project on the Upper West Side of Manhattan refinanced the project. At the closing, the Company received approximately $3,000,000 most of which represents fees, with the remainder attributable to repayment of sums owed, return of capital, and partnership distributive share of refinancing proceeds. The fees earned on this transaction are included in the Company's 1995 earnings.\nDuring 1995 the Company wrote down certain investments in partnerships which were previously recorded at cost. The Company contracted for sale, and recorded the loss on sale, of a self-storage mini-warehouse. Inclusive of these losses, the Company recorded approximately $2,200,000 of non-recurring losses during 1995. The Company does not anticipate any additional writedowns of this nature in 1996.\n1994 Compared to 1993\nDuring the year ended December 31, 1994 the Company had income from operations of $10,306,000 compared to $4,588,000 for the year ended December 31, 1993 and net income of $6,159,000 ($.98 per share) as compared to $2,140,000 ($.34 per share). Earnings per share were based on average shares outstanding of 6,261,000 and 6,356,000 in 1994 and 1993, respectively.\nThe Company's revenues increased by $19,153,000 in 1994 compared with the similar period in 1993. This increase was primarily attributable to Levitt Corporation. Levitt's net income increased to $10,085,000 from $4,257,000 in 1993, including income in 1994 from the sale of its interest in a rental apartment project. Levitt's backlog of homes contracted for sale at December 31, 1994 was $80,523,000 compared to $32,320,000 at December 31, 1993. The December 31, 1994 backlog includes $39,490,000 relating to joint ventures in which Levitt has a 50% interest. Levitt's revenues were greater because of an increase in the number of houses delivered, coupled with a higher average selling price. The increase in the average selling prices are attributable to various factors, including product mix, lot premiums, and sale of optional items.\nLevitt's gross profit from house sales increased in 1994 as compared to 1993. This increase in gross profit is due to the Florida region's significantly improving domestic gross profit margins, as well as, the Puerto Rico region having an increase in gross profit margin.\nSecurity service labor and other costs increased by $1,471,000 as a result of an increase in the security service operations and the discontinuance of Levitt's life care management operations requiring 1995 costs to be accrued in 1994.\nMortgage and closing costs increased due to local taxing authorities in Puerto Rico assessing significant increased taxes related to construction activity. Mortgage operation costs increased due to an expansion of business in Levitt's Puerto Rico operation and the recent addition of branch offices.\nLevitt's interest, real estate taxes and sales costs incurred with certain properties are capitalized in order to achieve better matching of costs with revenues. The Company's interest incurred on loans was $3,435,000 in 1994 and $3,893,000 in 1993, of which $2,775,000 in 1994 and $2,959,000 in 1993 was capitalized by Levitt in its operations. Levitt amortized capitalized interest of $4,941,000 in 1994 and $5,802,000 in 1993 to construction and related costs.\nHRH's estimated backlog of fees for development work and uncompleted construction in connection with construction projects, including fees for projects where development work has begun but contracts have not yet been executed, was $8,950,000 at December 31, 1994 as compared to $8,151,000 at the end of 1993. HRH is actively seeking to increase its backlog of business, particularly in the hospital and medical research facilities, as well as, governmental and institutional sectors.\nGrenadier continued its steady profitability in 1994 and has expanded its management services to private owners and institutional property owners as well as banks and thrift institutions.\nFinancial Condition and Capital Resources\nThe Company meets its short-term financing needs with cash generated from operations and funds available under several unsecured credit agreements. On January 31, 1996, Levitt satisfied a $14,400,000 unsecured credit facility through a $4,400,000 payment from working capital and a $10,000,000 payment from an unsecured term loan. The new loan requires semi-annual principal payments of $1,000,000 and $1,500,000 in July and January, respectively, through January 2000.\nHomebuilding Operations\nThe Company generally meets its land acquisition, development and construction needs through mortgage loans and unsecured revolving credit facilities. During March 1996, the Company renewed and extended its $15,000,000 revolving unsecured credit agreement used to finance its Puerto Rico homebuilding operation for an additional year.\nMortgage Operations\nDuring 1995 the Company entered into a credit agreement with a Puerto Rico bank to provide an unsecured revolving line of credit of $3,000,000 to finance the working capital needs of the expanding Puerto Rico mortgage banking operation.\nDevelopment\/Construction Management\nDuring 1995 the Company entered into a credit agreement with a New York bank to provide a $3,000,000 unsecured line of credit to finance development, construction and other operating activities.\n1995 Cash Flows\nCash used in operating activities comprised (1) an increase in receivables of $6,672,000, (2) an increase in inventories of $6,457,000, (3) an increase in other assets of $6,451,000, (4) net adjustments for non-cash items of $866,000, and (5) a net change in other operating assets and liabilities of $1,231,000, offset by net income of $7,365,000.\nThe increase in receivables reflects the continued growth in construction activity. Inventories increased due to the timing of titling homes in Puerto Rico and domestically. The increase in other assets is directly attributable to the expansion of development projects and pre-acquisitioned land costs.\nNet cash provided by investing activities of $4,376,000 comprised net proceeds from joint ventures of $4,206,000 and other net investing activities of $170,000.\nNet cash used in financing activities of $312,000 comprised net proceeds from notes and mortgages payable of $1,253,000 offset by dividends paid to stockholders of $1,565,000.\n1994 Cash Flows\nCash provided by operating activities comprised (1) net income of $6,159,000, (2) an increase in receivables of $3,194,000, (3) a decrease in inventories of $8,536,000, (4) net adjustments for non-cash items of $1,761,000 and (5) a net change in other operating assets and liabilities of $4,389,000.\nThe increase in receivables resulted from the growth in construction activity. Inventories decreased due to the timing of titling homes both in Puerto Rico and domestically.\nNet cash used in investing activities of $3,796,000 comprised net investments in joint ventures of $2,949,000 and other net investing activities of $847,000.\nNet cash used in financing activities of $7,328,000 comprised net principal payments on notes and mortgages payable of $6,937,000 plus dividends paid to stockholders of $391,000.\nSeasonality\nThe timing of introducing Levitt's new projects to the market, weather conditions in certain of Levitt's regions, and traditional periods of greater customer activity have tended to create seasonal trends in Levitt's residential home building activities. Historically, the number of homes delivered has been greater in the second half of the calendar year.\nExcept as discussed above, management is not aware of any trends or events, commitments or uncertainties that will impact liquidity in a material way.\nNet Operating Loss Carryforwards\nAt December 31, 1995 the Company had net tax operating loss carryforwards which can be utilized against future taxable income of approximately $8,937,000 expiring in 2005 through 2009. Under current tax laws, if the aggregate voting stock owned by the Company's 5% shareholders increases over the lowest percentage owned by such shareholders during a three-year period by an amount exceeding 50% of Starrett's total voting stock, then Starrett's utilization of the net tax operating loss carryforwards could be limited to an amount per year equal to the market value of all Starrett equity securities multiplied by an adjusted federal long-term interest rate. In general, all non-5% shareholders are treated as a single 5% shareholder for the purpose of such calculations. Such an ownership change might be caused by sales of shares by the Company's shareholders, repurchases of shares by the Company, certain reorganizations, or certain other transactions.\nInflation\nThe Company believes that inflation has not had a material adverse effect upon its construction, development and management business. Levitt has from time to time been adversely affected by high interest costs and increases in material and labor costs which it has not been able to pass through entirely to home purchasers.\nItem 8.","section_7A":"","section_8":"Item 8. Consolidated Financial Statements and Supplementary Data\nSee \"Table of Contents to Consolidated Financial Statements and Financial Statement Schedules,\" page 21.\nItem 9.","section_9":"Item 9. Disagreements on Accounting and Financial Disclosure\nNone\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 1996 Meeting of Shareholders.\nPART IV\nItem 13.","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"Item 13. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(a) See the accompanying Table of Contents to Consolidated Financial Statements and Schedules and the accompanying Exhibit Index.\n(b) Reports on Form 8-K: The Registrant did not file any report on Form 8-K during the quarter ended December 31, 1995.\nTO CONSOLIDATED FINANCIAL STATEMENTS\nAND FINANCIAL STATEMENT SCHEDULES\nFinancial Statement Schedules, other than that listed above, are omitted because of the absence of the conditions under which they are required, or because the information required therein is set forth in the financial statements or the notes thereto.\n[DELOITTE & TOUCHE LETTERHEAD]\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Shareholders of Starrett Corporation\nWe have audited the consolidated financial statements and the related financial statement schedule of Starrett Corporation and consolidated subsidiaries, listed in the foregoing table of contents. These consolidated financial statements and the financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company and its consolidated subsidiaries at December 31, 1995 and 1994 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995 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.\nMarch 18, 1996\nSTARRETT CORPORATION AND SUBSIDIARIES STATEMENTS OF CONSOLIDATED FINANCIAL POSITION December 31, 1995 and 1994 (In Thousands)\nSee Notes to Consolidated Financial Statements\nSTARRETT CORPORATION AND SUBSIDIARIES STATEMENTS OF CONSOLIDATED OPERATIONS For the Years Ended December 31, 1995, 1994 and 1993 (In Thousands Except Per Share Data)\nSee Notes to Consolidated Financial Statements\nSTARRETT CORPORATION AND SUBSIDIARIES STATEMENTS OF CONSOLIDATED STOCKHOLDERS' EQUITY For the Years Ended December 31, 1995, 1994 and 1993 (In Thousands Except Share Data)\nSee Notes to Consolidated Financial Statements\nSTARRETT CORPORATION AND SUBSIDIARIES STATEMENTS OF CONSOLIDATED CASH FLOWS For the Years Ended December 31, 1995, 1994 and 1993 (In Thousands)\nSee Notes to Consolidated Financial Statements\nSTARRETT CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nThe Company:\nThe Company's operations consist of (i) the development, management and ownership of real estate properties principally in the New York City Metropolitan area; (ii) the single-family home and garden apartment business conducted through its Levitt subsidiary in Florida and Puerto Rico; and (iii) the supplying of construction services through its HRH subsidiary principally in the New York City Metropolitan area.\nPrinciples of Consolidation:\nThe consolidated financial statements include the accounts of Starrett Corporation and subsidiaries (the \"Company\"). Intercompany accounts and transactions have been eliminated in the consolidated financial statements.\nRecognition of Income:\nThe Company follows the percentage-of-completion method of recording revenues and related costs from construction contracts using the cost-to-cost method and provides currently for estimated losses on uncompleted contracts. Profits relating to sales of limited partnership interests and development fees are recognized on the percentage-of-completion method and full accrual method as appropriate.\nRevenues from house sales and all related costs and expenses are recognized upon passage of title to the buyer and receipt of an adequate down payment.\nMortgage operations include loan origination and other fees received for the processing and closing of mortgage loans. Revenues from mortgage operations are primarily for houses constructed and sold by the Company and are recorded when the transfer of the corresponding mortgages to third parties has been consummated.\nRevenues from cost-plus fee contracts are recognized on the basis of costs incurred during the period plus the fee earned.\nUse of Estimates:\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of\nrevenues and expenses during the reporting period. Actual results could differ from those estimates.\nFair Value of Financial Instruments:\nStatement of Financial Accounting Standards (\"SFAS\") No. 107, \"Disclosure about Fair Value of Financial Instruments,\" requires disclosure of the fair value of financial instruments, both assets and liabilities, recognized and not recognized in the consolidated statement of financial position of the Company, for which it is practicable to estimate fair value. The estimated fair values of financial instruments which are presented herein 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 estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of amounts the Company could realize in a current market exchange.\nThe following methods and assumptions were used to estimate fair value:\n- The carrying amounts of cash and cash equivalents, receivables, accounts payable and accrued liabilities approximate fair value due to their short term nature.\n- The carrying amounts of notes and mortgages payable approximate fair value as the terms of the credit facilities generally require periodic market adjustment of interest rates.\nInventory of Real Estate:\nInventory of real estate is stated at the lower of cost or estimated net realizable value. Cost includes direct acquisition, development and construction costs, interest and other indirect construction costs. Estimated net realizable value is defined as an estimate of sales proceeds less all estimated costs of carrying, completing and disposing of the property. Interest is capitalized at the effective interest rates paid on borrowings for interest costs incurred on real estate inventory components during the preconstruction and planning stage and the periods that projects are under development. Capitalization of interest is discontinued if development ceases at a project.\nLand and land development, are accumulated by specific area and allocated proportionately to homes within the respective area. Construction costs are charged to individual homesites based on specific identification.\nLand Held for Investment:\nLand parcels for which the Company has no formal plans to develop or sell are classified as land held for investment. Land purchased for investment is carried at cost. Land parcels previously included in inventory of real estate and reclassified to land held for investment are carried at the lower of acquisition cost or fair value at\nthe time of transfer. The carrying value of land held for investment is evaluated for other than temporary declines in value. For the years 1995, 1994 and 1993, no adjustments for other than temporary declines were recorded.\nProperty and Equipment:\nProperty and equipment are carried at cost less accumulated depreciation and are depreciated using the straight-line method over the estimated useful lives of the assets which range from three to five years. Expenditures for maintenance and repairs are charged to expense as incurred. Costs of major renewals and betterments which extend useful lives are capitalized.\nCapitalized Costs:\nInterest incurred, real estate taxes, and sales costs incurred in connection with certain properties are capitalized in order to achieve better matching of costs with revenues. Interest incurred on loans was $3,778,000 in 1995, $3,435,000 in 1994 and $3,893,000 in 1993, of which $3,327,000 in 1995, $2,775,000 in 1994 and $2,959,000 in 1993 was capitalized. Amortization of capitalized interest of $3,789,000 in 1995, $4,941,000 in 1994 and $5,802,000 in 1993 was charged to construction costs.\nCosts related to predevelopment activities associated with the Company's various development projects, such as architect and engineering fees, legal costs, etc., are capitalized to the extent that management believes such costs are recoverable from the estimated earnings of the project.\nCertain costs incurred that are used directly throughout the selling period to aid in the sale of units, such as model furnishings and decorations, sales office furnishings and facilities, exhibits, displays and signage, are capitalized as deferred selling costs and amortized over the number of units to be delivered. Costs incurred during the initial and due diligence phases of a project, such as land deposits and studies, are capitalized as preacquisition costs. The unrecovered preacquisition costs are written off in the period the Company ceases development of the project.\nInvestments in Partnerships and Joint Ventures:\nInvestments in partnerships and joint ventures in which the Company does not have a controlling interest are accounted for at cost and investments in partnerships in which the Company does have a controlling interest are accounted for on the equity method. Under the equity method, the Company's initial investment is recorded at cost and is subsequently adjusted to recognize its share of the earnings or losses. Distributions received reduce the carrying amount of the investment.\nCash and Cash Equivalents:\nThe Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.\nIncome Taxes:\nAs required by Statement of Financial Accounting Standard No. 109, \"Accounting for Income Taxes\", deferred taxes are provided for the temporary differences between the tax bases of the assets and liabilities and the amounts reported in the financial statements.\nRecently Issued Accounting Pronouncement:\nIn March 1995, The Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of\", (SFAS 121), which is effective January 1, 1996. This standard specifies when assets should be reviewed for impairment, how to determine if an asset is impaired, how to measure an impairment loss, and what disclosures are necessary in the financial statements. SFAS No. 121 will apply to the Company for the year ended December 31, 1996. The Company does not believe that this statement would have had a material effect on its financial position or the results of its operations had it been applied in 1995.\nReclassifications:\nCertain prior year amounts have been reclassified in the financial statements and segment information to conform with the 1995 presentation.\n2. RECEIVABLES\nReceivables are summarized as follows:\nIt is expected that the receivables at December 31, 1995 as set forth above will be realized as follows: $24,957,000 in 1996, $2,978,000 in 1997, $37,000 in 1998, $41,000 in 1999, $46,000 in 2000 and $4,531,000 thereafter. At December 31, 1995, approximately $1,600,000 ($1,700,000 at December 31, 1994) of these mortgage notes receivable have been pooled into GNMA certificates, which have been guaranteed by the United States Government. The Company has pledged these mortgage notes as collateral to borrow funds from institutions at interest rates lower than those earned on the mortgage notes receivable and as collateral for GNMA matched payment serial notes (Note 8). The remaining mortgage notes receivable have been originated by the Company under firm commitments for sale to various third parties. The Company receives certain fees for the origination and processing of these mortgages.\nThe mortgage notes receivable, which result primarily from sales of homes in Puerto Rico, are payable in monthly installments and earned interest at stated interest rates which ranged from 6.75% to 9.88% in 1995 and 1994.\n3. INVENTORY OF REAL ESTATE\nInventory of real estate is summarized as follows:\n4. INVESTMENTS IN JOINT VENTURES\nThe Company owns investments in joint ventures that are engaged in homebuilding and development of residential rental apartments. Condensed financial information is as follows:\nCombined Balance Sheets\nDuring 1995 and 1994, in accordance with the partnership agreements, the Company made capital contributions to the joint ventures in excess of its proportionate ownership interests. The Partnership agreements provide for the Company to receive preferential income and cash distributions until the Company's invested capital is proportionate to its ownership interests.\nCombined Statements of Operations\nThe Company's equity in earnings of joint ventures is included in Revenues in the Statements of Consolidated Operations.\nDuring 1994, the Company's homebuilding joint ventures acquired land, commenced land development and home construction activity. Through December 31, 1994, no homes were delivered and, accordingly, no revenues from house sales were recognized.\nIn addition, the Company had an ownership interest in a joint venture that owns a self-storage warehouse in New York. The joint venture had $8,943,000 and $9,138,000 in assets with $8,183,000 and $8,627,000 in liabilities at December 31, 1995 and 1994, respectively. The Company sold the warehouse on March 15, 1996. The loss on sale of the warehouse is included in the Statement of Operations for the year ended December 31, 1995.\n5. PROPERTY AND EQUIPMENT\nProperty and equipment are summarized as follows:\n6. OTHER ASSETS\nOther assets are summarized as follows:\nOn December 14, 1995, a limited partnership in which the Company is a general partner owning a HUD financed housing project on the upper West Side of Manhattan refinanced the project. At the closing, the Company received approximately $3,000,000 most of which represents fees, with the remainder attributable to repayment of sums owed, return of capital, and partnership distributive share of refinancing proceeds.\n7. INCOME TAXES\nThe Company and its domestic subsidiaries file a consolidated federal income tax return. The provision for income taxes consists of the following:\nAt December 31, 1995 the Company had a net tax operating loss carryforward, which can be utilized against future taxable income, of approximately $8,937,000 expiring in 2005 through 2009. There is no net operating loss carryforward for financial statement reporting purposes.\nCash payments for income taxes during the years ended December 31, 1995, 1994 and 1993 were $2,630,000, $5,195,000 and $2,251,000, respectively.\nThe effective tax rate was different from the statutory Federal tax rate for the following reasons:\nDeferred income taxes result from temporary differences in the recognition of revenue and expense for tax and financial reporting purposes. The tax effect of each type of temporary difference that gave rise to the Company's net deferred tax liability is as follows:\nTotal deferred tax assets and liabilities were $10,288,000 and $16,665,000, respectively, at December 31, 1995 and $11,942,000 and $16,507,000, respectively, at December 31, 1994. No valuation allowance was required for deferred tax assets.\n8. DEBT\nNotes, mortgages payable and long-term obligations are summarized as follows:\n(A) On December 31, 1990, the Company redeemed all of its $5.81 cumulative convertible preferred stock and issued to the preferred shareholders six equal subordinated promissory notes in the aggregate principal amount of $8,800,000, maturing 1992 through 1997. The notes bear simple interest at the rate of 15% per annum. In January 1996 the fifth promissory note in the amount of $1,466,667 was paid.\n(B) In January 1996, a subsidiary of the Company repaid this note from proceeds of a $10,000,000 unsecured term note and from working capital. The unsecured term note requires semi-annual principal payments of $1,000,000 and $1,500,000 in July and January, respectively, through January 2000. The term note credit agreement requires the Company to maintain certain financial covenants during the term of the loan.\n(C) In March 1996 the Company renewed its unsecured revolving credit agreement through March 31, 1997 to finance its Puerto Rico homebuilding operations. The credit agreement provides for available loans up to $15,000,000. The credit agreement requires the Company's Puerto Rico subsidiary to maintain certain financial covenants during the term of the agreement. As of December 31, 1995 and 1994, $10,000,000 and $13,000,000 respectively, were outstanding under this facility.\nIn June 1994, the previous credit agreement was amended to provide for an additional short-term $7,000,000 secured facility. This facility was secured by certain developed and undeveloped lots. The Company has drawn and repaid $5,000,000 under this facility through December 31, 1995. As of December 31, 1994, $1,550,000 was outstanding under this facility. The facility expires in March 1996.\n(D) On December 31, 1995, the Company had loans totaling $1,600,000 (secured by a pledge of GNMA certificates in the same amount) through the issuance of long-term debentures by a subsidiary of a non-profit community development corporation in Puerto Rico. Both the short-term loans and debentures, which are secured by mortgage notes receivable pooled into GNMA certificates, bear interest at rates lower than the interest rates on such mortgage receivables.\n(E) During 1995, the Company entered into a loan agreement to provide financing for the acquisition and site improvement of property and financing for construction of residential units. The loan agreement provides for advances on a revolving loan basis up to a maximum outstanding balance of $11,250,000 and is secured by a mortgage on the property including all improvements. Principal payments are required as homes are delivered. The loan matures in September 1998.\n(F) During 1994, the Company entered into a loan agreement to provide financing for the acquisition and site improvement of property and financing for\nconstruction of residential units. The loan agreement provides for advances on a revolving loan basis up to a maximum outstanding balance of $6,300,000 and is secured by a mortgage on the property including all improvements. Principal payments are required as homes are delivered. The loan matures in April 1998.\n(G) During 1995, the Company entered into a credit agreement to provide an unsecured revolving line of credit of $3,000,000 to finance its Puerto Rico mortgage operations. The credit agreement requires the Company's Puerto Rico subsidiary to maintain certain financial ratios and provides other restrictions. The loan matures in October 1997.\nNotes and mortgages payable were collateralized by real estate and mortgage notes receivable with net carrying values aggregating $33,851,000 and $23,240,000 at December 31, 1995 and 1994, respectively.\nCertain of the debt instruments associated with joint ventures require guarantees of the related indebtedness by the Company. At December 31, 1995 and 1994, the Company's guarantees on outstanding joint venture indebtedness were $2,405,000 and $300,000, respectively.\nDebt obligations are scheduled to mature as follows: $7,387,000 in 1996, $16,942,000 in 1997, $2,057,000 in 1998, $12,546,000 in 1999, $1,550,000 in 2000 and $1,364,000 thereafter. Certain mortgage notes contain provisions for reducing the principal as individual homes are sold by the Company.\nInterest paid for the years ended December 31, 1995, 1994 and 1993 was $3,722,000, $3,402,000 and $4,321,000, respectively. The weighted average interest rate on the Company's debt was 9.22% and 7.93% for the years ended December 31, 1995 and 1994, respectively.\nAs of December 31, 1995, the Company had outstanding letters of credit totalling approximately $140,000 on which there are service charges ranging from 0.5% to 1% on the outstanding balances. The Company in the normal course of business obtains payment and performance bonds and financial security bonds in connection with its construction and development activities.\n9. PENSION PLAN\nThe Company and certain of its subsidiaries have a noncontributory defined benefit pension plan (the \"Plan\") covering employees not represented by a union. The benefits are based on years of service and the employees' compensation over the last five years.\nEffective July 31, 1992, the Board of Directors amended the Plan to freeze accrued benefits for all participants. The Company will continue to fund the Plan as required, including any interest at the assumed average rate of return on Plan assets.\nAs of December 31, 1995, the Plan held equity securities, fixed income securities, life insurance policies and short-term investments. Assumed average future rate of return on Plan assets was 8.75% for the years ended December 31, 1995 and 1994, respectively, and the projected benefit obligation was based on 7.25% and 8.75% assumed discount rates at December 31, 1995 and 1994, respectively.\nThe net periodic pension benefit was $2,000 for the year ended December 31, 1993. The components of net periodic pension cost for the years ended December 31, 1995 and 1994 are as follows:\nThe following table sets forth the Plan's funded status as of December 31, 1995 and 1994:\nIn accordance with Statement of Financial Accounting Standards No. 87, \"Employers' Accounting for Pensions,\" an additional minimum pension liability, representing the excess of accumulated benefits over plan assets and accrued pension costs, was recognized at December 31, 1995 and 1994. A corresponding amount, net of income tax benefit of $548,000 and $525,000 was recorded as a separate reduction to stockholders' equity in 1995 and 1994, respectively.\nThe significant increase in accrued pension cost is directly attributable to the use of a lower discount rate in calculating the projected benefit obligation due to the dramatic drop in interest rates during 1995.\nThe Plan made significant lump sum distributions during 1994 resulting in a settlement of the Plan as defined by Statement of Financial Accounting Standards No. 88, \"Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination of Benefits\". As a result, the Company recorded an additional expense of $451,000 for the year ended December 31, 1994.\nThe Company does not provide postretirement or postemployment benefits other than pensions to employees. Therefore, SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" and SFAS No. 112, \"Employers' Accounting for Postemployment Benefits\" have no impact on the Company's financial statements.\n10. SEGMENT INFORMATION\nThe Company's operations consist of (i) the development, management and ownership of real estate properties; (ii) the single-family home and garden apartment business conducted through its Levitt subsidiary; and (iii) the supplying of construction services through its HRH subsidiary. The Company groups its business into these three segments. The following table sets forth the Company's revenues and operating profit attributable to the respective segments of its operations for each of the years 1993 through 1995, and the identifiable assets attributable to the respective segments as at the end of each of those years:\n(1) Operating profit is comprised of revenues less operating expenses. In computing operating profit, general corporate expenses and income taxes have not been deducted.\n(2) There were no customers from which the Company derived more than 10% of its revenues in 1995, 1994 or 1993.\n11. COMMITMENTS AND CONTINGENCIES\nRoosevelt Island Associates (\"RIA\"), a partnership in which a Company subsidiary is one of several partners, has provided guaranteed payments to the investor partner. The Company's share of such guarantees is approximately $100,000 each year until 2005, which will be paid by the Company if project cash flow is insufficient to cover these amounts. In connection with this project, the Company also provided cash flow guarantees from which it will be released if the project achieves a certain cash flow level over a specified period of time. The Company believes it has adequately provided for any future obligations under this guarantee.\nThe Company's Levitt subsidiary provides for estimated warranty costs when homes are sold and continuously monitors its warranty exposure and service program.\nRent expense for the years ended December 31, 1995, 1994 and 1993 was $1,336,000, $1,133,000 and $1,004,000, respectively. At December 31, 1995 the Company and its subsidiaries are committed under long-term leases expiring at various dates through 2000. The minimum rentals are $1,280,000 in 1996, $637,000\nin 1997, $557,000 in 1998, $401,000 in 1999, and $210,000 in 2000, or an aggregate of $3,085,000.\nThe Company is involved in litigation and claims incident to the normal conduct of its business. Management believes that such litigation and claims will not have a materially adverse effect on the Company's consolidated financial position or results of operations.\n12. QUARTERLY FINANCIAL DATA (Unaudited)\nThe quarterly financial data are set forth below (dollars in thousands, except per share amounts):\nCertain quarterly amounts have been reclassified to conform with the annual presentation.\nSchedule III\nSTARRETT CORPORATION (Parent Company Only) CONDENSED STATEMENTS OF FINANCIAL POSITION December 31, 1995 and 1994 (In Thousands)\nSTARRETT CORPORATION (Parent Company Only) CONDENSED STATEMENTS OF OPERATIONS For the Years Ended December 31, 1995, 1994 and 1993 (In Thousands)\nSchedule III\nSTARRETT CORPORATION (Parent Company Only) CONDENSED STATEMENTS OF CASH FLOWS (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.\nSTARRETT CORPORATION\nDate: March 18, 1996 By \/s\/ Paul Milstein ------------------------------------- Paul Milstein Chairman of the Board\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nDate: March 18, 1996 By \/s\/ Paul Milstein ------------------------------------- Paul Milstein, Principal Director\nDate: March 18, 1996 By \/s\/ Lewis A. Weinfeld ------------------------------------- Lewis A. Weinfeld, Principal Financial and Accounting Officer\nDate: March 18, 1996 By \/s\/ Henry Benach ------------------------------------- Henry Benach, Director\nDate: March 18, 1996 By \/s\/ John Zuccotti ------------------------------------- John Zuccotti, Director\nDate: March 18, 1996 By \/s\/ Robert Berne ------------------------------------- Robert Berne, Director\nDate: March 18, 1996 By \/s\/ Irving Fischer ------------------------------------- Irving Fischer, Director\nDate: March 18, 1996 By \/s\/ Robert C. Rosenberg ------------------------------------- Robert C. Rosenberg, Director\nDate: March 18, 1996 By \/s\/ Elliott M. Wiener ------------------------------------- Elliott M. Wiener, Director\nSTARRETT CORPORATION\nEXHIBITS\nDECEMBER 31, 1995\nCOMMISSION FILE NUMBER 1-6736 STARRETT HOUSING CORPORATION EXHIBIT INDEX\nNote: The Exhibits which have not previously been filed are marked with an asterisk (*).","section_14":"","section_15":""}
{"filename":"790362_1995.txt","cik":"790362","year":"1995","section_1":"Item 1 - Business: National Bancshares Corporation (the \"Company\"), incorporated in 1985, is a one bank holding company for First National Bank, Orrville, Ohio (the \"Bank\"). The formation was approved by shareholders on April 24, 1986 and consummated on June 2, 1986. The Bank offers a full line of services usually found in any commercial bank operation, including checking accounts, savings accounts, certificates of deposit, personal loans, loans to business and industry, installment loans, safety deposit boxes and credit cards. The Bank does not have trust powers and, therefore, does not offer trust services. The Bank operates nine full service offices and one limited service office in a market area comprising most of Wayne County, portions of western Stark County, northeastern Holmes County and southern Medina County. There are approximately 17 other banking and thrift organizations in the immediate market area. No major elimination of services presently offered is anticipated in the immediate future.\nThe Bank is a member of the Federal Reserve System and its deposits are insured by the Federal Deposit Insurance Corporation. It is subject to supervision, examination and regulation by the Comptroller of the Currency. The Company is also subject to supervision, examination and regulation by the Federal Reserve System. Management is not currently aware of any regulatory recommendations which if were to be implemented would have a material effect on the registrant.\nItem 2","section_1A":"","section_1B":"","section_2":"Item 2 - Properties: The headquarters of the Company and the Bank are located in Orrville, Ohio. The Bank has a total of ten banking office buildings which are located in Orrville, Dalton, Kidron, Smithville, Mt. Eaton, Apple Creek, Lodi and Seville, Ohio. All buildings are owned by the Bank with the exception of the Seville Office which is a leased facility.\nItem 3","section_3":"Item 3 - Legal Proceedings There were no legal proceedings other than ordinary routine litigation incidental to business during 1995.\nItem 10","section_4":"","section_5":"","section_6":"","section_7":"","section_7A":"","section_8":"","section_9":"","section_9A":"","section_9B":"","section_10":"Item 10 - Executive Officers The Executive Officers of the Company are as follows:\nName Age Position Charles J. Dolezal 43 President President of First National Bank\nMichael D. Hofstetter 43 Sr. Vice President & Secretary-Treasurer Sr. Vice President & Controller of First National Bank\nThere is no family relationship between any of the above executive officers. Mr. Dolezal has been an executive officer of the Company since its formation in 1986 and the Bank during the past 5 years. Mr. Hofstetter was appointed Sr. Vice President and Secretary-Treasurer of the Company on January 1, 1990 and has been an executive officer of the Bank during the past 5 years.\nPAGE 4 VOLUME AND RATE VARIANCE ANALYSIS\nThe following table represents a summary analysis of changes in interest income, interest expense and the resulting net interest income on a tax equivalent basis for the periods presented each, as compared with the preceding period. Volume is based on daily average balances.\n* Tax equivalence based on highest statutory tax rates of 34%.\nPAGE 5 RATE SENSITIVITY ANALYSIS\nThe following table summarizes the repricing opportunities of interest bearing assets and liabilities\n(1) Checking includes NOW and MMDA (2) Savings includes passbook and statement savings which do not have a preset repricing date and have been included in the 1-5 years due to the relative interest rate insensitivity.\nThe potential impact on the net interest margin from modestly rising interest would be relatively insignificant due to the short duration of mismatch within the first 12 months. If interest rates were to immediately increase by 200 basis points, this could cause an increase interest expense greater than interest income. The potential impact would equate to lowering the current net interest income by approximately 2.7% over the first 12 months.\nPAGE 6 INVESTMENT PORTFOLIO\nThe carrying amounts and distribution of the Company's investment securities held are summarized in the Annual Report to Shareholders (Appendix A, Page 15, Note 3). The carrying amount, maturities and approximate weighted average yields (on a tax equivalent basis) at December 31, 1995 are as follows:\nINVESTMENT PORTFOLIO\n$2.8 million of investment securities have a remaining maturity more than 10 years. There was no single issuer of securities where the total book value of such securities exceeded 10% of shareholders' equity except for US government obligations.\nPAGE 7 LOAN PORTFOLIO\nThe detail of the loan portfolio balances are included in the Annual Report to Shareholders (Appendix A, Page 16, Note 4).\nMATURITIES AND SENSITIVITIES OF LOANS TO CHANGES IN INTEREST RATES The following are approximate maturities and sensitivity to changes in interest rates of certain loans exclusive of real estate mortgages and consumer loans as of December 31, 1995.\nNONACCRUAL AND PAST DUE LOANS Generally, recognition of interest income is discontinued where reasonable doubt exists as to the collectability of the interest. Income from nonaccrual loans is recorded when received. The difference between interest income recognized on such loans and income that would have been recognized at original contractual rates is immaterial. The bank generally places loans on a non-accrual status when a default of principal or interest has existed for 90 days or more. The bank generally does not renegotiate loans due to deterioration in the financial position of the borrower. The amounts of renegotiated loans are not considered material.\n(Dollars in Thousands) 12\/31\/95 12\/31\/94\n90 Days Past Due and Accruing $138 $59 Nonaccruing Loans $68 $111\nPOTENTIAL LOAN PROBLEMS Management reviews the loan portfolio for potential loan problems on a monthly basis. The following loans were classified by management and include in the above nonaccrual and past due loan totals. The amount shown below is the outstanding loan balance which has not been reduced by collateral values.\n(Dollars in Thousands) 12\/31\/95 12\/31\/94 Loss $0 $0 Doubtful 80 104 Substandard 623 750 OAEM 1,036 957 Watch 9 7 -------------------- Total $1,748 $1,818 ====================\nLOAN CONCENTRATIONS Due to the nature of our market area, it is management's opinion that there are no significant loan concentrations of 10% of total loans to borrowers engaged in similar activities other than noted in the loan categories disclosed in the Annual Report to Shareholders (Appendix A, Page 16, Note 4).\nPAGE 8 SUMMARY OF LOAN LOSS EXPERIENCE The determination of the balance of the allowance for loan losses historically has been based on an overall analysis of the loan portfolio and reflects an amount, which, in management's judgment, is adequate to provide for potential loan losses. This analysis considers, among other things, the Company's loan loss experience, present and potential risks of the loan portfolio and general economic conditions. In addition, management considers the examinations of the loan portfolio by federal regulatory agencies and internal reviews and evaluations. The Company's allocation of the allowance for loan losses by category represents only an estimate for each category of loans based upon a detailed review of the loan portfolio by management.\nTransactions in the allowance for loan losses are maintained by three major loan categories and the summary of such transactions for periods indicated follows:\nCHANGES IN ALLOWANCE FOR LOAN LOSSES (Dollars in Thousands) 1995 1994\nBalance at the beginning of period $891 $606 Loans charged off: Commercial & industrial 3 20 Real estate 0 15 Consumer 38 14 ---------------------- Total loans charged off 41 49 ----------------------\nRecoveries of loans charged off: Commercial & industrial 0 30 Real estate 3 18 Consumer 13 106 ---------------------- Total recoveries 16 154 ---------------------- Net loans charged off 25 -105 ---------------------- Provision charged to operating expense 180 180 ---------------------- Balance at end of period $1,046 $891 ======================\nNet charge-offs to average loans 0.03 -0.18 ======================\nDISTRIBUTION OF ALLOWANCE FOR\nLOAN LOSSES BY CATEGORY (Dollars in thousands) December 31, 1995 December 31, 1994\n% of % of Amount Total Loans Amount Total Loans\nCommercial & industrial $113 17% $97 16% Real estate construction 0 2% 0 1% Real estate mortgages 10 61% 5 69% Consumer loans 20 20% 10 14% Unallocated 903 N\/A 779 N\/A ---------------------------------------- TOTAL $1,046 100% $891 100% ========================================\nPAGE 9 DEPOSITS\nThe classification of average deposits and the average rate paid on such deposits for periods ending December 31, 1995, 1994 and 1993 is included in Analysis of Net Interest Earnings included in the Annual Report to Shareholders (Appendix A, Page 22).\nThe summary of maturities of time deposits of $100,000 or more is included in the Annual Report to Shareholders (Appendix A, Page 17, Note 7).\nPAGE 10 SIGNATURES\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.\nNATIONAL BANCSHARES CORPORATION\nDATE: 3-19-96 \/s\/ Charles J. Dolezal ----------------- ------------------------------------------- Charles J. Dolezal, President\nDATE: 3-19-96 \/s\/ Michael D. Hofstetter ----------------- ------------------------------------------- Michael D. Hofstetter, Secretary-Treasurer (Principal Financial 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.\nDATE: 3-19-96 \/s\/ Charles J. Dolezal ----------------- ------------------------------------------- Charles J. Dolezal, Chairman\nDATE: 3-19-96 \/s\/ James F. Woolley ----------------- ------------------------------------------- James F. Woolley, Director\nDATE: 3-19-96 \/s\/ James L. Gerber ----------------- ------------------------------------------- James L. Gerber, Director\nDATE: 3-19-96 \/s\/ John E. Sprunger ----------------- ------------------------------------------- John E. Sprunger, Director\nDATE: 3-19-96 \/s\/ Sara E. Balzarini ----------------- ------------------------------------------- Sara E. Balzarini, Director\nDATE: 3-19-96 \/s\/ John W. Kropf ----------------- ------------------------------------------- John W. Kropf, Director\nPAGE 11\nNo other exhibits are required to be filed herewith pursuant to Item 601 of Regulation S-K.\nPAGE 12","section_11":"","section_12":"","section_13":"","section_14":"","section_15":""}
{"filename":"62737_1995.txt","cik":"62737","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nAt April 1, 1995, Marsh Supermarkets, Inc. (the \"Company\" or \"Marsh\") operated 88 supermarkets and 181 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 owns and operates a specialized convenience store distribution business which services its Village Pantry stores as well as over 1,350 unaffiliated convenience stores in an eight-state area. Marsh also owns and operates a catering, vending and food services division.\nSUPERMARKETS\nAt April 1, 1995, the Company operated 88 supermarkets, 75 in central Indiana and 13 in western Ohio. The 36 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 72% of the Company's fiscal 1995 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, 15 are open until midnight, with the remainder having various other schedules. All stores are open seven days a week.\nThe Company believes 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 (88 stores), bakeries (88), prime cut service meat (58), fresh service seafood (58), floral shops (61), imported cheese shops (49), salad bars (49), video rental (78), and shoe repair (18). Nineteen 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, 55 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 its large supermarket store format with new generation superstores in excess of 80,000 square feet. The Company currently operates four such stores and plans to build an additional one in Lafayette, Indiana 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. As of April 1, 1995, the Company operated seven of its supermarkets under this concept. Subsequent to April 1, 1995, three conventional Marsh supermarkets were converted to this format. The stores operate under the trade name LoBill Foods. There is an ongoing development program within the Company's market area to construct new LoBill stores and to\nremodel selected Marsh supermarkets to the LoBill format. The Company believes the LoBill format offers an 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 stores.\nThe Company's supermarkets range in size from 15,000 to 81,530 square feet. The average size is approximately 35,900 square feet. The Company has an ongoing development program of constructing larger Marsh supermarkets 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\nAt April 1, 1995, the Company operated 188 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 1995 consolidated sales and other revenues. Carry-out cold beer, a high-volume item typically found in convenience stores in other states, may be sold only by package liquor stores and taverns in Indiana; accordingly, it is not sold in the Company's convenience stores. In Indiana, all but six of the Company's convenience stores are open 24 hours a day; the remaining stores close at 11:00 P.M. or midnight. All stores are open seven days a week.\nThese stores offer fresh pastry products and sandwiches prepared in the stores. The Company has added higher margin food and beverage products, such as store-prepared pizza (39 stores), broasted chicken (43 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 3,700-4,500 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\")\nCSDC, a wholly-owned subsidiary of the Company, serves the Company's Village Pantry stores and over 1,350 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 210,000 square foot warehouse and distribution facility in Richmond, Indiana, which the Company estimates is operating at 70% of capacity. CSDC utilizes its own trucks and drivers for its transportation needs. The CSDC sales and marketing staff of approximately 27 employees services existing customers and actively solicits new customers. CSDC accounted for approximately 15% of the Company's fiscal 1995 consolidated sales and other revenues.\nSUPPLY AND DISTRIBUTION\nThe 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 currently operate 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 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 seven year contract dated September 18, 1987, which is automatically renewed 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\nAll 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 electronic messaging, 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 19 food and drug combination stores, and time keeping for payroll processing. Future applications, currently under development, include computer-assisted reordering.\nAll convenience stores are equipped with micro-computers 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 83 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\nThe retail food industry is highly competitive. Marsh believes competitive factors include quality 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 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 three large food and general merchandise combination stores in the Company's Ohio market area, four stores in the Indianapolis market, and has five 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\nMarsh'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\nThe Company has approximately 11,600 employees. Approximately 6,900 employees are employed on a part-time basis. All employees are non-union, except 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\nAs a retailer of alcoholic beverages and gasoline, the Company is subject to federal and state 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 (USTs) at 25 Village Pantry locations prior to December, 1998. Earlier removal or abandonment would be required in the event any of these USTs fail any leak detection test, which the Company performs at least annually. All USTs at these 25 locations passed the most recent leak detection tests in December 1994, which results were consistent with data from the Company's established petroleum product inventory control program.\nThe Company is aware of the existence of petroleum contamination at nine Village Pantry locations and has commenced remediation at each of these sites. The cost of remediation varies 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 USTs and to remediate the known contamination at these nine locations has been estimated at approximately $960,000. The Company has charged this amount to earnings.\nThe Company currently estimates the maximum aggregate cost remaining to be incurred in connection with compliance with existing environmental laws and regulations applicable to owners and operators of USTs will not exceed approximately $1.5 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 Indiana Underground Storage Tank Excess Liability Fund, which reimburses owners and operators of USTs 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\nThe following table summarizes the per unit and aggregate size of the retail facilities operated by Marsh, together with an indication of the age of the total square footage operated.\nOwned and leased retail facilities are summarized as follows:\nAll leases, except for two supermarkets and sixteen Village Pantry stores, 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 27 closed stores, of which 23 were subleased at April 1, 1995.\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 banquet hall 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 as a distribution center for non-food products, 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. A second 24,000 square foot warehouse in Indianapolis is leased for use as a product reclamation center.\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 210,000 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 the Company at the expiration of the leases.\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\nNo matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended April 1, 1995.\nEXECUTIVE OFFICERS OF REGISTRANT\nInformation required by Item 10 with respect to the Registrant's executive officers is set forth below. Each officer has been elected for a term to expire in August 1995 or upon election of his successor by the Board of Directors.\nMr. Don E. Marsh has held his current position as President and Chief Executive Officer of the Company for more than the past five years. On May 2, 1991 he was elected Chairman of the Board of Directors, on which he has served as a member since 1959. He has been employed by the Company in various supervisory and executive capacities since 1961. - --------------------------------------------------------------------------------\nMr. C. Alan Marsh has held his current position since February 23, 1992. For more than five years prior thereto, he served as President and Chief Operating Officer, Marsh Village Pantries, Inc. He has been employed by the Company in various supervisory and executive capacities since 1965. - --------------------------------------------------------------------------------\nMr. P. Lawrence Butt has held his current position for more than the past five years. He has been employed by the Company in various executive capacities since 1977. - --------------------------------------------------------------------------------\nMr. Douglas W. Dougherty has been employed by the Company as Chief Financial Officer since March 1994. His prior experience includes senior financial executive positions with Hartmarx, Inc. from November 1990 to March 1994, and Lieberman Enterprises from August 1988 to November 1990. - --------------------------------------------------------------------------------\nMr. William L. Marsh has held his current position for more than the past five years. On May 2, 1991, he was elected a director of the Company. He has been employed by the Company in various supervisory and executive capacities since 1974. - --------------------------------------------------------------------------------\nMr. Ronald R. Walicki has held his current position since August 2, 1994. Prior thereto, he served as Executive Vice President, Supermarket Division since February 7, 1994, and President and Chief Operating Officer of Marsh Village Pantries, Inc. since February 1992. For more than five years prior to February 1992, he served as Vice President - General Manager, Supermarket Division. He has been employed by the Company in various supervisory and management positions since 1965. - --------------------------------------------------------------------------------\nMr. David M. Redden has held his current position since February 7, 1994. Prior thereto, he served as Vice President -- General Manager, Supermarket Division since February 1992, and as Vice President -- Warehousing and Transportation from April 1988 to February 1992. He has been employed by the Company in various supervisory and management positions since 1969. - --------------------------------------------------------------------------------\nMr. Michael D. Castleberry has held his current position, as Assistant Treasurer, since August 2, 1994. Prior thereto, he served as Director of Corporate Accounting since March 1991. Prior to March 1991 he served as Assistant Controller for Fleming Inc., at its Fort Worth, Texas division from September 1990, and as Vice President -- Finance for Falley's Food-4-Less from February 1988 to September 1990.\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 19 and 35 of the annual report to shareholders for the year ended April 1, 1995 is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nSelected Financial Data on page 18 of the annual report to shareholders for the year ended April 1, 1995 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 20 through 22 of the annual report to shareholders for the year ended April 1, 1995 is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe consolidated financial statements on pages 24 to 33 of the annual report to shareholders for the year ended April 1, 1995 are incorporated herein by reference.\nQuarterly Financial Data on page 19 of the annual report to shareholders for the year ended April 1, 1995 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\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 1, 1995, 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 1, 1995, are incorporated by reference in Item 8.\nConsolidated Balance Sheets as of April 1, 1995 and April 2, 1994.\nConsolidated Statements of Income for each of the three years in the period ended April 1, 1995.\nConsolidated Statements of Changes in Shareholders' Equity for each of the three years in the period ended April 1, 1995.\nConsolidated Statements of Cash Flows for each of the three years in the period ended April 1, 1995.\n(2) The following consolidated financial statement schedules of Marsh Supermarkets, Inc. and subsidiaries are included in Item 14(d):\nNote: All 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) The following exhibits are included in Item 14(c):\n(b) Reports on Form 8-K:\nThere were no reports on Form 8-K filed by the Registrant with respect to the fourth quarter of its fiscal year ended April 1, 1995.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nMARSH SUPERMARKETS, INC.\nBy: \/s\/ DON E. MARSH ------------------------------------ Don E. Marsh Chairman of the Board, President and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nEXHIBIT INDEX","section_15":""}
{"filename":"87050_1995.txt","cik":"87050","year":"1995","section_1":"ITEM 1. BUSINESS\nSBE, Inc. develops, markets, sells and supports remote access internetworking products and high speed intelligent computer communications controllers that enable users to exchange data between computer systems. The Company's products are distributed worldwide through a direct sales force, distributors, independent manufacturers' representatives, and value-added resellers.\nFounded in 1961 as Linear Systems, Inc., the Company evolved from a high-quality supplier of radio communications equipment to a provider of comprehensive network communications solutions for original equipment manufacturers and end users. In September 1995, the Company began shipping a suite of new products known as netXpand to meet the growing need for remote access data communications products.\nThe Company markets, sells and supports a broad range of high-speed intelligent communications controller products sold primarily to original equipment manufacturers. These products support applications in a broad spectrum of industrial and commercial markets. Markets and application areas include data networking, process control, medical imaging, CAE\/automated test equipment, military defense systems and telecommunications networks.\nThe initial products for the Company's new suite of netXpand remote access products are netXpand SoHo and Central; both of these products allow a remote PC or network to access an existing network as a fully functional network node, thereby enabling users to access network resources from their remote locations as if they were directly connected to the enterprise network. These products include server hardware and software, client software and network management software. SBE's remote access products allow for single user dial-in to local area networks (LANs) over analog or digital phone lines, individual dial-out from LANs to other locations and routed or bridged LAN to LAN dial-up or direct connections. These products support all major desktop computing platforms, including IBM-compatible PCs and UNIX workstations.\nINDUSTRY BACKGROUND:\nSignificant changes in computer-based information systems have occurred over the last decade. Historically, information stored in computer databases could only be accessed by terminals or personal computers emulating terminals directly connected to a central or host computer. Remote users wishing to access information over the public switched telephone network used a modem to dial from their terminal or computer into another modem which was usually connected directly to the central or host computer.\nBeginning in the late 1980s the following factors changed the nature of, and increased the demand for, remote network access.\nGROWTH OF THE INTERNET AND ON-LINE SERVICES. The number of users of the Internet and on-line services such as America Online, CompuServe and Prodigy has grown rapidly in recent years. It is estimated that the number of users linked to the Internet has grown from less than 2 million in 1992 to approximately 30 million today. This growth is due to increased use of electronic mail and the proliferation of databases and other information platforms such as the World Wide Web.\nDEVELOPMENT OF DISTRIBUTED, CLIENT \/SERVER COMPUTING. With the development of LANs it became possible for information to be stored on a number of computers which were connected to each other and located within a building or campus. Simultaneously, the advent of new communications products such as hubs, bridges, and routers allowed multiple LANs to be integrated into distributed, enterprise- wide computer networks. To take advantage of these distributed computer networks, products utilizing client\/server architecture, including relational databases, e-mail and file and printer sharing were introduced to collect, retrieve and distribute information. Distributed computing and client\/server- based software are now being used on a corporate enterprise-wide and departmental basis to run critical processes and to provide the primary means for corporate communications.\nGROWTH IN MOBILE, REMOTE AND HOME OFFICES. Corporations, government agencies, universities and other organizations are increasingly looking to control costs while providing their employees with access to essential information and resources to perform their jobs efficiently and effectively from any location. The proliferation of notebooks and home computers is allowing a newly created remote workforce to work from home or on the road. To remain productive, these users must be able to access their cooperative distributed networks from remote locations.\nTECHNOLOGICAL ADVANCES. Advances in modem technology such as the V.34 communications standard and switched digital service technology, such as ISDN and Frame Relay are helping to increase the speed of network communication, which is a key user requirement for remote network access.\nThe above factors have created an enormous growth in the number of remote users seeking to access information on the corporate network or to connect to the Internet and on-line services through network access providers. As a result, the need for hardware and software products to support, expand and enhance remote network access has created a number of rapidly growing markets.\nEarly remote connectivity solutions have typically followed three principal computing oriented approaches: host-oriented terminal emulation; PC remote control software, and application-specific solutions.\nTerminal emulation products allow remote workstations to simulate a local \"dumb\" terminal session with a mainframe. These products are better suited to a character-based centralized system and not the graphical client server systems that are predominant today.\nRemote control software products allow a dial-in user to take control of a PC on the network and remotely view the networked PC's screen. Like terminal emulation, remote control software works best with character-based computing. In addition, remote control solutions present both network security and management problems as the controlled PC typically has complete access to all the resources of the network and the network manager is typically unable to identify an unauthorized remote user.\nApplication-specific solutions overcome the limitations of terminal emulation by enabling users to access a single network application as a specialized remote client. Examples of this type of solution would include electronic mail programs that offer remote versions. However these application-specific products provide an incomplete remote access solution for users who require access to other resources or applications on the enterprise network.\nToday's solutions use a communications-oriented approach where the network is extended to users through the combination of hardware and software that lets users expand their network using analog, digital or leased circuits. These solutions have typically used expensive router products to connect branch offices to networks using leased lines. But more recently introduced products allow users to establish lower-cost dial-up connections that provide multiprotocol, multiplatform routing and routing-related communications technologies and hardware that address performance and security requirements of remote network access. However, these products are typically designed to principally provide routing or remote access functions.\nPRODUCTS\nThe Company manufactures data communications products designed to allow the connection of LANs to external Wide Area Networks (WANs). The Company began shipping a suite of new products known as netXpand to meet the growing demand for remote access data communications products in September 1995.\nREMOTE ACCESS PRODUCTS. The initial products for the Company's family of netXpand remote access products are netXpand SoHo and Central. SoHo (Small office, Home office) is a remote access product which can serve either as an access server or a branch office router. Central is a larger version of SoHo with more WAN interfaces. The products have been designed to provide cost- effective internetworking capabilities to the broadest range of end-users, the users of UNIX and Novell networking products. Both products allow users to access remote networks resources as full network clients or as nodes. Applications appear the same to users as they do when directly connected to the enterprise network, except that the speed of computing through the remote access connection may be reduced as a result of the speed limitations of telephone connections.\nThe Company's remote access products support up to 10 wide area network interfaces at speeds up to T1\/E1(1.5mbs). The products feature full routing for Novell IPX and TCP\/IP (Transmission Control Protocol, Internet Protocol); other protocols are transparently bridged with filtering. The products use Windows- based configuration tools, are SNMP manageable, and support PAP, CHAP and direct callback security. The\nremote access products list from $899 to $2,499 with various software configurations available.\nINTELLIGENT CONTROLLER PRODUCTS. Intelligent controller products are used to provide connectivity between a system, such as a mini-computer or bridge\/router, and a local or wide area network. Communication controller products enable computers to exchange data in much the same way as the telephone system allows people to converse with one another. As computers become more pervasive in all areas of society, computer users are demanding greater productivity, efficiency, and lower costs in their computer systems, which has led to the sharing of databases, software applications, and computer peripheral equipment. Communications controllers have become a central component to connecting networks and computers to deliver information more efficiently.\nThe Company's communications products target all four major protocol communications technologies for each of the bus architectures: Fiber Distributed Data Interface (FDDI), Token Ring, Ethernet and high speed serial communications. The latter is a growing wide-area networking technology that enables computers to talk to one another using telephone lines. FDDI, Token Ring and Ethernet are local area networking technologies that offer a wide range of speed and reliability options.\nThe Company's strategy for its intelligent controller products is to expand its offerings to more segments of the market by adding software interfaces, improved performance and new technologies that will provide lower-cost solutions for high speed, high volume communications.\nSINGLE-BOARD COMPUTER PRODUCTS. The Company supplies high performance single- board computers (SBC) for Multibus* and VMEbus architectures. An SBC manages and processes the data that passes between the boards within a computer system. The Company's SBC products provide a high-speed interface for linking to peripherals and intelligent I\/O controllers that accommodate plug-on modules for many industrial applications.\nCUSTOM PRODUCTS. The Company has developed several products specifically for single customer applications. These products typically have proprietary functions that meet specific application needs of the customer. Recently the Company has not sought new custom relationships unless the products have significant sales potential.\nINTEGRATED CIRCUITS. The Company has designed a number of proprietary integrated circuits that are used on many SBE products. The Company has a small group of customers that purchase some of these proprietary chips for their applications. This line of business is not being actively pursued by the Company.\nSOFTWARE PRODUCTS. The Company supplies software products that operate various communications protocols for certain communications controller products including X.25 for serial communications, SMT (Station Management) for FDDI, and TCP\/IP for Ethernet applications. Real-time operating systems for Motorola's 68000 family are also\n- - --------------------------- *Multibus is a Trademark of Intel Corporation\nsupported. The Company's software products are principally bundled with the hardware platform based upon the customer's application requirement.\nThe following table shows sales by major product type as a percentage of total sales for fiscal 1995, 1994, and 1993.\nYear Ended October 31, (percent of annual sales) 1995 1994 1993 ---------------------------- Communication Controllers 72% 62% 59% Single Board Computer 9 9 14 netXpand Remote Access 3 -- -- Integrated Circuits 3 10 2 Custom 1 11 15 Other 12 8 10 ----------------------------\n100% 100% 100% ---------------------------- ----------------------------\nDISTRIBUTION, SALES AND MARKETING\nThe Company markets its netXpand remote access products through multiple indirect distribution channels worldwide, including distributors, manufacturers' representatives, value-added resellers, and certain OEM partners. The Company had relationships with over 40 distributors and value-added resellers as of October 31, 1995. Approximately half of the Company's distributors and resellers operate outside the United States.\nThe Company actively supports its indirect channel marketing partners with its own sales and marketing organization. SBE's sales staff solicits prospective customers, provides technical advice with respect to SBE products and works closely with marketing partners to train and educate their staffs on how to sell, install and support the netXpand product line.\nThe Company has focused its sales and marketing efforts principally in the United States and Asia, including Japan. International sales for the netXpand product line represented 92 percent of total netXpand sales in fiscal 1995. The Company expects that, in the future, domestic sales will represent a greater percentage of total netXpand sales. All of the Company's international sales are negotiated in U.S. dollars.\nThe Company provides most of its distributors and resellers with product return rights for stock balancing or product evaluation. Stock balancing permits distributors to return products for credit, within specified limits and subject to purchasing additional products. The Company believes that it has adequate reserves to cover product returns although there can be no assurance that the Company will not experience significant returns in the future.\nThe Company primarily markets its computer controller products to OEMs and systems integrators. The Company sells its products both domestically and internationally using a direct sales force as well as through independent manufactures' representatives. The\nCompany also sells certain products directly to end-users. During 1993 the Company established a channel partnership arrangement with Hewlett Packard (HP). This arrangement provides the Company's direct sales force access to HP customers that require VME and EISA communications controllers. The Company believes that it has successfully positioned itself as a leading supplier of VME high speed serial and EISA communications controllers to HP workstations. The Company believes that a direct sales force is well suited to differentiate the Company's communications controller products from those of its competitors.\nThe Company conducts its sales and marketing activities from its principal offices in San Ramon, California. The Company's direct sales force is based in five locations in the United States and one location in Germany. The Company's sales offices are located in Greensboro, North Carolina; Damon, Texas; Malden, Massachusetts; Mountain View, California; Lake Oswego, Oregon; and Munich, Germany.\nThe Company's computer controller sales are concentrated among a small number of customers and consequently, the timing of significant orders from major customers cause the Company's operating results to fluctuate.\nRESEARCH AND DEVELOPMENT\nThe Company's product development efforts are focused principally on its strategic businesses, remote internetworking and intelligent communications controllers. The Company's experience in high-speed data communication creates opportunities to leverage its engineering investments and develop more integrated products for simpler, more innovative communications solutions for customers. The development of new remote internetworking products, high performance communications controllers, and communications-related software is critical to attracting new and retaining existing customers\nDuring the past year, the Company has developed communication products based on PCIbus, VMEbus and EISA architecture. The Company has also redesigned and upgraded certain communications products to improve the products' performance and lower the products' manufacturing costs. The Company also acquired or licensed certain hardware products that have been integrated principally through the addition of software into the Company's product line.\nDuring fiscal 1995 the Company focused the majority of its development efforts on the netXpand remote access product line, and it expects to continue this focus in 1996. These products leverage existing product designs and incorporate routing software.\nThe Company has purchased extensive design and testing tools (CAD\/CAE) that will simulate new product designs prior to building prototype boards. These tools have decreased the time required to develop new designs, thereby allowing the Company to take advantage of new market demands and meet its customers' product development schedules. The Company expects to continue to invest in product design tools to enhance its product development activities.\nInformation relating to accounting for research and development costs is included in Note 1 of the Notes to the Consolidated Financial Statements on Page 32 of this document. Also see the section labeled \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" appearing on Pages 13 through 17 of this document.\nSOURCES AND AVAILABILITY OF RAW MATERIALS\nThe Company does not use raw materials in any of its products or production activity. Products are constructed from components which are generally available as needed from a variety of suppliers. The Company believes that it currently possesses adequate supply channels. An interruption in its existing supplier relationships or delays by some suppliers could result in production delays and may have a material adverse effect on the Company's operations.\nCertain parts used in the Company's products are purchased from a single supplier. New state-of-the-art high technology parts are normally available only from a single supplier when first introduced into the market. These components generally become available from alternative suppliers over time. Although the Company has rarely experienced any significant problems in obtaining sole-source components, the Company has sought to establish a close relationship with sole-source suppliers and if necessary build up an inventory of such components.\nCOMPETITION\nThe market for remote access products is highly competitive. The Company competes directly with traditional vendors of terminal servers, modems, remote control software, terminal emulation software and application-specific remote access solutions, such as Shiva, Ascend Communications, Xylogics, Inc., Livingston Enterprises, Inc., Telebit Corporation, and Microcom, Inc.. The Company also competes with suppliers of routers, hubs, and other data communications products, such as Cisco and 3Com. In addition the Company may encounter increased competition from operating system and network operating system vendors, such as Microsoft and Novell, to the extent that such vendors include full remote access or routing capabilities in their products. The Company believes that it can compete successfully in the remote access market by (1) focusing on the low end of the remote LAN access and internetworking markets; (2) providing low-cost, fully functional remote access product solutions; (3) expanding significantly into the Asia-Pacific region; (4) providing easy-to-use software and hardware; and (v) providing accessible and local support.\nBy focusing on the above factors the company believes that it can compete within the remote access market.\nCompetition within the intelligent communications controller market is fragmented principally by application segment. The Company's VMEbus communications controllers compete primarily with products from Motorola, Interphase Corp., CMC, a Rockwell Company, Themis Computers, Network Peripherals, Performance Technologies, and various other companies on a product- by-product basis. To compete\nin this market the Company emphasizes the functionality, support, quality and price of its product in relation to its competitors as well as the Company's ability to customize the product or software to exactly meet the customer needs. Competition within the EISAbus communications controller market is also fragmented among various companies providing different applications. The Company's EISAbus-based products are targeted to potential customers using Hewlett Packard (HP) 9000 and HP Apollo workstations. Currently, the Company's EISAbus products face nominal competition in this market.\nAdditionally, the Company competes with the internal engineering resources of its customers. As its customers become successful with their products they examine methods to reduce costs and integrate functions. To compete with the internal engineering resources of its customers, the Company works jointly with their engineering staff to understand its customers system requirements and anticipate product needs.\nINTELLECTUAL PROPERTY\nThe Company believes that its future success will depend principally on its continuing product innovation, sales, marketing, technical expertise, product support and customer relations. The Company also believes that it needs to protect the proprietary technology contained in its products. The Company does not currently hold any patents and relies on a combination of copyright, trademark, trade secret laws and contractual provisions to establish and protect proprietary rights in its products. The Company typically enters into confidentiality agreements with its employees, strategic partners, indirect channel marketing partners and suppliers and limits access to the distribution of its proprietary information.\nBACKLOG\nOn January 2, 1996, the Company had a backlog of orders of approximately $2,429,000 for shipment within the next twelve months. At December 31, 1994, the Company had a backlog of orders of approximately $3,026,000. Since recorded sales orders are subject to changes in customer delivery schedules, cancellation, or price changes, the Company's backlog as of any particular date may not be representative of actual sales for any succeeding fiscal period and is not considered firm.\nEMPLOYEES\nOn January 2, 1996, the Company had 162 employees. None of the Company's employees is represented by a labor union and the Company has experienced no work stoppages. The Company's management believes its employee relations are good.\nThe Company's management believes that the Company's future success will depend, in part, on its ability to attract and retain qualified technical, marketing, and management personnel. Such experienced personnel are in great demand, and the Company must compete for their services with other firms, many of which have greater financial resources than the Company.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nIn April 1993 the Company relocated its engineering, manufacturing, and administrative headquarters to 63,000 square feet of leased space in a building located in San Ramon, California. The lease was amended in June 1995 to extend its term from seven years to thirteen years. The lease contains an option to increase the leased space by 10,000 square feet. The Company expects that the facility will satisfy its anticipated needs through the foreseeable future.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company 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\nNone\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY & RELATED SHAREHOLDER MATTERS.\nSBE, Inc. common stock is quoted on the Nasdaq National Market under the symbol SBEI. The above table sets forth the high and low closing sales prices for 1995 and 1994 for the quarters indicated. The Company has not paid cash dividends on its common stock and is prohibited from doing so by its credit line agreement. As of December 29, 1995, SBE, Inc. had approximately 808 shareholders of record.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nFor the last decade, the Company has specialized in the development of computer board data communications products and industrial computer equipment. In the early 1990s, the Company determined that a large opportunity existed in the emerging remote LAN market for affordable remote access router products. To seize that opportunity, the Company has invested significant resources in developing netXpand, its new line of standalone remote LAN access server\/router products. In addition, the Company began and is continuing to restructure its existing sales and marketing channels and adding new sales channels to access customers for its netXpand products. The Company also has added certain key management personnel to better serve this emerging market. Primarily as a result of this investment and of decreased sales of computer board communications products attributable to the decline in business with Cisco Systems, the Company incurred substantial operating losses in fiscal 1995. Prior to fiscal 1995, the Company reported profitable quarterly operations for over ten years.\nThe Company began shipping its netXpand products in September 1995. Sales of these products constituted over 11 percent of net sales for the fourth quarter of fiscal 1995, and the Company expects them to constitute an increasing percentage of net sales in future periods. netXpand is targeted at the high- growth, price-sensitive sectors of the internetworking market. The Company expects these segments to grow at a compounded annual rate of over 50 percent in the United States and at a greater rate in international markets. However, there can be no assurance that the market will grow at this rate, if at all, or that the Company will be successful in achieving widespread market acceptance of its netXpand products.\nThe Company intends to continue to support its existing computer board controller business by developing new products for strategic customer accounts and by focusing on emerging technologies that can be leveraged into the sales channels the Company is developing for its netXpand remote LAN access products. The Company introduced a line of PCI-bus based products in late 1995 that it expects to help to expand its computer board controller business. The computer board portion of the Company's business is characterized by a concentration of sales to a small number of customers, and consequently the timing of significant orders from major customers and their product cycles may cause fluctuations in the Company's operating results.\nRESULTS OF OPERATIONS\nThe following table sets forth, as a percentage of net sales, certain consolidated statements of operations data for the fiscal years ended October 31, 1995, 1994 and 1993. These operating results are not necessarily indicative of Company's operating results for any future period.\nNET SALES\nNet sales for fiscal 1995 were $19.4 million, a 13 percent decrease from fiscal 1994. Net sales for fiscal 1994 were $22.3 million, a 16 percent decrease from fiscal 1993. These decreases were primarily attributable to lower sales of the Company's board-level products to certain large customers. Sales to Cisco represented 21 percent and 36 percent of net sales in fiscal 1994 and fiscal 1993, respectively. There were no sales to Cisco in fiscal 1995. Sales to America Online and Tandem Computers represented 16 percent and 14 percent of net sales, respectively, in fiscal 1995, and sales to G.E. Capital Spacenet Services represented 11 percent and 16 percent of net sales in fiscal 1994 and 1993, respectively. The Company expects to experience fluctuation in computer board product sales as large customers needs change. Partially offsetting the lower sales to these large customers, sales of VMEbus-based communications products and interface chips increased by $5.1 million, or 60 percent, from fiscal 1994 to fiscal 1995, and by $3.1 million, or 34 percent, from fiscal 1993 to fiscal 1994. In addition, approximately $575,000 of net sales in fiscal 1995 were attributable to sales of the new netXpand products.\nInternational sales constituted 11 percent, 4 percent and 9 percent of net sales in fiscal 1995, fiscal 1994 and fiscal 1993, respectively. The increase in international sales is primarily attributable to increased sales of VME computer board products to a large customer in Germany and sales of netXpand products in Japan and Korea. Sales of VMEbus-based communications products through the Company's Channel Partner relationship with Hewlett Packard constituted 27, 13 and 4 percent of net sales in fiscal 1995, fiscal 1994 and fiscal 1993, respectively. No customer within this channel, other than America Online, represented more than 5% of total sales. The Company expects that future sales through the HP channel will continue, however sales to this channel will be subject to significant variability from quarter to quarter.\nGROSS PROFIT\nGross profit as a percentage of sales was 51 percent, 56 percent and 55 percent in fiscal 1995, fiscal 1994 and fiscal 1993, respectively. The decrease from fiscal 1994 to fiscal 1995 was primarily attributable to higher manufacturing overhead costs incurred in connection with expanding manufacturing capacity for the new netXpand products. These costs included the cost of leasing additional high speed placement and testing equipment. The Company believes this equipment will significantly increase manufacturing capacity and reduce production cycle time, leading to lower cost of sales as a percentage of net sales, as production volumes increase for the netXpand product line. However, there can be no assurance that the Company will be successful in increasing volume sufficiently to offset the increased overhead costs. The increase in gross profit from fiscal 1993 to fiscal 1994 was primarily attributable to a change in the Company's mix of products.\nPRODUCT RESEARCH AND DEVELOPMENT\nProduct research and development expenses net of capitalized software costs were $6.9 million in fiscal 1995, $4.8 million in fiscal 1994, and $4.7 million in fiscal 1993, representing 36, 21, and 18 percent of sales respectively. The Company capitalized software development costs of $1.5 million, $230,000 and $108,000 in fiscal 1995, fiscal 1994 and fiscal 1993 respectively, in accordance with Statement of Financial Accounting Standards No. 86. The amounts capitalized represented 22, 5 and 2 percent, respectively, in fiscal 1995, fiscal 1994 and fiscal 1993 of gross product research and development expenditures. The increase in software costs capitalized in fiscal 1995 was due to software development related to the new netXpand product line. Those costs will be amortized over a three year period. The increases in net research and development expenses as a percent of sales were primarily attributable to additional staff, consulting costs and contract professional expenses relating to development of the netXpand product line. Contractual reimbursements under joint development contracts are accounted for as a reduction of product research and development expenses. The Company received $221,000, $439,000 and $80,000 of such reimbursements in fiscal 1995, fiscal 1994 and fiscal 1993, respectively. The Company does not expect any significant reimbursements in the future. The Company expects that product research and development expenses will continue to increase in absolute dollars as it continues to expand and improve its remote LAN access product line and enhance its traditional board-level product lines.\nSALES AND MARKETING\nSales and marketing expenses for fiscal 1995 were $5.0 million, an 87 percent increase from fiscal 1994. Sales and marketing expenses for fiscal 1994 were $2.7 million, a 7 percent decrease from fiscal 1993 in absolute dollars, but representing a greater percentage of net sales in fiscal 1994 as a result of decreased sales in fiscal 1994. These increases were primarily attributable to expansion of the Company's worldwide sales operations to support the netXpand product line. The expansion included hiring additional sales and marketing and technical support personnel and implementing new advertising programs. The Company expects sales and marketing expenses to increase in absolute dollars as sales of the netXpand products increase.\nGENERAL AND ADMINISTRATIVE\nGeneral and administrative expenses for fiscal 1995 were $3.9 million, a 7 percent increase from fiscal 1994. General and administrative expenses for fiscal 1994 were $3.7 million, a 3 percent decrease from fiscal 1993 in absolute dollars, but representing a greater percentage of net sales in fiscal 1994 as a result of decreased sales in fiscal 1994. The increase from fiscal 1994 to fiscal 1995 was primarily attributable to recruiting costs and consulting expenses related to the transition of the Company into the emerging remote access markets. The decrease in absolute dollars from fiscal 1993 to fiscal 1994 was primarily attributable to non-recurring charges incurred in fiscal 1993 related to the Company's relocation to its San Ramon, California facility, as well as decreased incentive payments to employees in fiscal 1994 due to reduced profitability.\nINTEREST AND OTHER INCOME (EXPENSE), NET\nInterest income, net, decreased in fiscal 1995 from fiscal 1994 and 1993 due to lower investment balances. Additionally, non recurring charges were taken in fiscal 1995 to write off an equity investment in a strategic software partner and to report realized losses on the liquidation of investments.\nINCOME TAXES\nThe Company's effective tax rate was (27), 26 and 34 percent in fiscal 1995, fiscal 1994 and fiscal 1993, respectively. The Company's operating losses in fiscal 1995 enabled it to realize a $1.7 million tax benefit, all of which the Company expects to realize as a carryback against prior taxes paid. The Company has recorded a valuation allowance in fiscal 1995 and 1994 for certain deferred tax assets due to the uncertainty of realization. This valuation allowance increased from approximately $179,000 in fiscal 1994 to $948,000 in fiscal 1995. In the event of future taxable income, the Company's effective income tax rate in future periods could be lower as such tax assets could be realized. The decrease in the effective tax rate from fiscal 1993 to fiscal 1994 was primarily attributable to the utilization of research and development tax credits, which resulted in the amendment of prior years' tax returns to adjust research and development tax credits claimed. As a result, the Company's fiscal 1994 fourth quarter results reflected a $153,000 tax benefit. The Company's adoption of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes,\" in fiscal 1994 did not have a material impact on the Company's financial statements.\nNET (LOSS) INCOME\nAs a result of the factors discussed above, the Company recorded a net loss of $4.6 million in fiscal 1995, and net income of $1.3 million and $2.5 million in fiscal 1994 and fiscal 1993, respectively.\nLIQUIDITY AND CAPITAL RESOURCES\nAt October 31, 1995, the Company had cash and cash equivalents of $900,000, as compared to $2.6 million at October 31, 1994. During fiscal 1995, $4.4 million of cash was used in operating activities, primarily to fund operating losses. Working capital at October 31, 1995 was $7.6 million, as compared to $7.4 million at October 31, 1994.\nIn fiscal 1995 the Company purchased $1.8 million of fixed assets, consisting primarily of computer and manufacturing equipment. In addition, the Company entered into operating leases for approximately $900,000 of manufacturing equipment for its new netXpand product line. The Company expects capital expenditures during fiscal 1996 to decrease from fiscal 1995 levels because the Company's current facilities have been expanded to meet production levels anticipated through fiscal 1996. Additionally, the Company capitalized $1.5 million of software costs related to the netXpand product line. These costs will be amortized over three years.\nIn fiscal 1995 the Company liquidated all of its long term investments and as a result recorded a realized loss of $294,000. Additionally, the Company recorded a writeoff of an equity investment in a software technology partner of $330,000 due to management's evaluation that the carrying value of this investment will not be recoverable.\nThe Company received $287,000 of proceeds from employee stock option and stock purchase plans, an increase of 76 percent from 1994 amounts.\nOn May 23, 1995, the Company signed a loan agreement for a $4.0 million revolving line of credit for working capital purposes that expires on April 30, 1996. The agreement was modified on January 17, 1996. Borrowings under the credit line agreement bear interest at the bank's prime rate plus one percent and are collateralized by accounts receivable and other assets. Borrowings are limited to 70 percent of adjusted accounts receivable balances, and the Company is subject to certain financial covenants, including the maintenance of minimum tangible net worth of $7.0 million and minimum debt ratio of 0.7:1.0. On October 31, 1995, the Company had no balance outstanding under its revolving line of credit.\nBased on the current operating plan, the Company anticipates that existing cash balances, credit facilities, income tax refunds and lease lines will be sufficient to meet short-term operating requirements. In late 1995, in connection with the review of its 1996 operating plan, the Company decided it must obtain additional working capital in 1996 to support its expansion of the netXpand product lines. Additional working capital would be used to support accounts receivable and inventory growth, research and development activities, geographic sales expansion and licensing of technology. The Company expects to seek additional capital in 1996 through the sale of equity securities. If the Company is unsuccessful in the sale of equity securities, it will initially scale back its efforts to gain additional market penetration for its netXpand product and reduce its development of new netXpand and communications controller products. The Company also may need to seek alternative sources of financing, including debt. There can be no assurance that the Company will be successful in obtaining additional working capital or in expanding its netXpand business.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe financial statements and supplementary data required under Item 8 are provided under Item 14.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nIDENTIFICATION OF DIRECTORS\nInformation concerning the Company's directors is incorporated by reference to the information in the section captioned \"Nominees\" appearing in the Company's definitive Proxy Statement for the Annual Meeting of Shareholders to be held on April 16, 1996.\nIDENTIFICATION OF EXECUTIVE OFFICERS\nThe executive officers of the Company and their respective ages and positions with the Company are set forth in the following table. Executive officers serve at the discretion of the Board of Directors. There are no family relationships between a director or executive officer and any other director or executive officer of the Company.\nName Age Position - - -------------------------------------------------------------------------------- William R. Gage 53 Chairman of the Board\nWilliam B. Heye, Jr. 57 President and Chief Executive Officer\nTimothy J. Repp 36 Vice President, Finance, and Chief Financial Officer\nBelton E. Allen 48 Vice President, Sales\nAnthony Spielman 47 Vice President, Network Systems Marketing\nGene Buechele 49 Vice President, Engineering and Secretary\nNorman E. O'Shea 47 Vice President, Manufacturing\nMr. Gage has been Chairman of the Board since January of 1990. From 1986 until March 1989 he was President of the Company, from March 1989 until January 1990 he served as Senior Vice President of the Company and from January 1990 until November 1991 he was Chief Executive Officer of the Company. From 1982 to 1986, Mr. Gage also served at various times as Chief Operating Officer, Senior Vice President, Vice president of Programming and Treasurer of the Company.\nMr. Heye has been President and Chief Executive Officer of the Company since November, 1991. From 1989 to November 1991, he served as Executive Vice President of Ampex Corporation, a manufacturer of high-performance scanning recording systems, and President of Ampex Video Systems Corporation, a wholly- owned subsidiary of Ampex Corporation and a manufacturer of professional video recorders and editing systems for the television industry. From 1986 to 1989, Mr. Heye served as Executive Vice President of Airborn, Inc., a manufacturer of connectors for the aerospace and military markets.\nMr. Repp has served as Vice President of Finance and Chief Financial Officer since January of 1992. He joined the Company in January 1991 as Controller. From 1987 until 1990 he was assistant controller at Grubb and Ellis, a national real estate firm, and prior to 1987 he was an audit manager at Coopers and Lybrand, an international accounting firm.\nMr. Allen has been Vice President, Sales since March 1990. He joined the Company in December of 1987 as Vice President, Software Products after the acquisition of Alcyon by the Company. From February of 1980 until the acquisition he was Vice President, Software Products for Alcyon.\nMr. Spielman has served as Vice President, Network Systems Marketing since May 1994. Prior to joining the Company Mr. Spielman was Director of Product Marketing at Asante Technologies, Inc., a networking equipment company, responsible for various product lines. He was at Asante Technologies, Inc. from 1993 to 1994. From 1992 to 1993 Mr. Spielman was Director of Product Marketing for the Internetworking division of Network Systems Corp., a networking equipment company. From 1990 to 1992, Mr. Spielman was Manager of Business Strategy at 3Com Corporation, an internetworking equipment company, and from 1989 to 1990 Mr. Spielman was a Product Manager at Ungermann-Bass, a wholly owned subsidiary of Tandem Computers, Inc. and a computer equipment company, responsible for developing the strategic plan for Ungermann-Bass's Access\/One Token Ring product line.\nMr. Buechele has been Vice President of Engineering since December 1993. From October 1992 until joining the Company, Mr. Buechele was Managing Partner of the Prosper Group, located in San Francisco, California. The Prosper Group is a consulting organization focused on strategic and management projects combining networking with multimedia. From July 1988 to September 1992, Mr. Buechele was Vice President Engineering for the Network Systems Division of 3Com Corporation, San Jose, California, a manufacturer and developer of networking systems.\nMr. O'Shea joined the Company in February 1995. From March 1993 until joining the Company, Mr. O'Shea was Director of Operations for Berkeley Process Control, a motion control systems company located in Point Richmond, California. From January 1987 to February 1993 Mr. O'Shea served in various operational and engineering management positions at NeXT Computer Inc., a manufacturer of computer workstations and software.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information called for by Item 11 is incorporated by reference to the section entitled \"Executive Compensation\" appearing in the 1996 Proxy Statement.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information called for by Item 12 is incorporated by reference to the section entitled \"Security Ownership of Certain Beneficial Owners and Management\" appearing in the 1996 Proxy Statement.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nNone.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\nThe following documents are filed as part of this Report:\n(a) Financial Statements (see Item 8). ---------------------------------\nPage ---- Report of Independent Accountants 27\nConsolidated Balance Sheets at October 31, 1995 and 1994 28\nConsolidated Statements of Operations for fiscal years 1995, 1994, and 1993 29\nConsolidated Statements of Shareholders' Equity for fiscal years 1995, 1994, and 1993 30\nConsolidated Statements of Cash Flows for fiscal years 1995, 1994, and 1993 31\nNotes to Consolidated Financial Statements 32\n(b) Financial Statement Schedule ----------------------------\nSchedule II - Valuations and Qualifying Accounts 42\nAll other schedules are omitted as the required information is not applicable or has been included in the consolidated financial statements or the notes thereto.\n(c) Exhibits\nExhibit Sequential Number Description Page No. ------- ----------- --------\n(a) 10.1 1984 Incentive Stock Option Plan, as amended.\n(a) 10.2 1987 Supplemental Stock Option Plan.\n(b) 10.3 1991 Non-Employee Directors' Stock Option Plan\n(c) 10.4 Lease for 4550 Norris Canyon Road, San Ramon, California dated November 2, 1992 between the Company and PacTel Properties\n10.5 Amendment dated June 6, 1996 to lease for 4550 Norris Canyon Road, San Ramon, California, between the Company and CalProp L.P. (assignee of PacTel Properties) 43\n10.6 Letter of agreement to provide credit facilities between the Company and Comerica Bank - California, dated May 23, 1995 44\n10.7 Modification of letter of agreement between the Company and Comerica Bank - California, dated January 17, 1996 59\n11.1 Statement re computation of per share earnings 62\n24.1 Consent of Coopers & Lybrand, Independent Public Accountants 63\n27.1 Financial Data Schedule 64\n(d) REPORTS ON FORM 8-K\nNo report on Form 8-K was filed by the Company during the quarter ended October 31, 1995.\nExplanations for letter footnotes are on the following page.\nExplanations for letter footnotes: - - --------------------------------------------------------------------------------\n(a) Filed as an exhibit to Annual Report on Form 10-K for the year ended October 31, 1986, and incorporated herein by reference.\n(b) Filed as an exhibit to Annual Report on Form 10-K for the year ended October 31, 1991, and incorporated herein by reference.\n(c) Filed as an exhibit to Annual Report on Form 10-K for the year ended October 31, 1993, and incorporated herein by reference.\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.\nSBE, Inc. (Registrant)\nDated: January 26, 1996 By: \/s\/ Timothy J. Repp -------------------------- Timothy J. Repp Chief Financial Officer and Vice President of Finance\nPursuant to the requirements for 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, as of January 26, 1996.\nSignature Title --------- -----\n\/s\/ William B. Heye, Jr. - - ------------------------ William B. Heye Jr. Chief Executive Officer, President, and Director (Principal Executive Officer)\n\/s\/ Timothy J. Repp - - ------------------- Timothy J. Repp Chief Financial Officer, Vice President of Finance (Principal Financial and Accounting Officer)\nSignature - - --------- Title\n\/s\/ William R. Gage - - ------------------- Chairman of the Board William R. Gage\n\/s\/ Edward H. Laird - - ------------------- Director Edward H. Laird\n\/s\/ Harold T. Hahn - - ------------------ Director Harold T. Hahn\n\/s\/ Ramon L. Conlisk - - -------------------- Director Raimon L. Conlisk\n\/s\/ George E. Grega - - ------------------- Director George E. Grega\nReport of Independent Accountants\nTo the Board of Directors and Shareholders SBE, Inc. San Ramon, California\nWe have audited the consolidated financial statements of SBE, Inc. and subsidiary as of October 31, 1995 and 1994, and for each of the three years in the period ended October 31, 1995. We have also audited the financial statement schedule listed in Item 14(b) 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 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 SBE, Inc. and subsidiary as of October 31, 1995 and 1994, and the consolidated results of their operations and their cash flows for each of the three years in the period ended October 31, 1995, 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.\n\/s\/ Coopers & Lybrand L.L.P.\nOakland, California December 14, 1995\nSBE, INC. CONSOLIDATED BALANCE SHEETS\nThe accompanying notes are an integral part of the consolidated financial statements.\nSBE, INC. CONSOLIDATED STATEMENTS OF OPERATIONS\nThe accompanying notes are an integral part of the consolidated financial statements.\nSBE, INC. CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY\nThe accompanying notes are an integral part of the consolidated financial statements.\nSBE, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS\nThe accompanying notes are an integral part of the consolidated financial statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBUSINESS SEGMENT:\nSBE, Inc. and subsidiary (the Company) designs and manufactures high-performance network systems and products for world-wide distribution. During 1995 the Company invested significant resources in developing netXpand, its new line of standalone remote LAN access server\/router products. As a result of this investment and decreased sales attributable to the shift in product focus, the Company incurred substantial operating losses in fiscal 1995. The Company's business falls exclusively within one industry segment.\nPRINCIPLES OF CONSOLIDATION:\nThe consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary.\nCASH EQUIVALENTS:\nThe Company considers all highly liquid investments readily convertible into cash with an original maturity of three months or less upon acquisition by the Company to be cash equivalents. Substantially all of its cash and cash equivalents are held in two large financial institutions.\nINVESTMENTS:\nEffective November 1, 1993, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 115 \"Accounting for Certain Investments in Debt and Equity Securities.\" This statement requires that securities be classified as \"held to maturity,\" \"available for sale,\" or \"trading,\" and the securities in each classification be accounted for at either amortized cost or fair market value, depending upon their classification. The Company classifies its investments as \"available for sale,\" and therefore records the investment at fair market value with any unrealized losses or gains reflected as a separate component of shareholders' equity. The Company had no investments as of October 31, 1995. During fiscal 1995, the Company sold all of its investments for proceeds of $5,936,416 and realized losses of $293,797. For purposes of determining realized losses, the cost of investments is based upon the specific identification method.\nINVENTORIES:\nInventories are stated at the lower of cost, using the first-in, first-out method, or market value.\nPROPERTY, PLANT AND EQUIPMENT:\nProperty, plant and equipment are carried at cost. The Company provides for depreciation by charges to expense, which are sufficient to write off the costs of the assets over their estimated useful lives of three to eight years, on a straight-line basis. Leasehold improvements are amortized over the lesser of their useful lives or the remaining term of the related leases. When assets are sold or otherwise disposed of, the cost and accumulated depreciation are removed from the asset and allowance for depreciation accounts, and any gain or loss on such sale or disposal is credited or charged to income. Maintenance, repairs, and minor renewals are charged to expense as incurred. Expenditures which substantially increase an asset's useful life are capitalized.\nCAPITALIZED SOFTWARE COSTS:\nCapitalized software costs consist of costs to purchase software and to internally develop software. Capitalization of software costs begins upon the establishment of technological feasibility. All capitalized software costs are amortized over related sales on a per-unit basis with a minimum amortization based on a straight-line method over a three-year useful life. The Company evaluates the estimated net realizable value of each software product and records provisions to the asset value of each product for which the net book value is in excess of the net realizable value.\nREVENUE RECOGNITION AND WARRANTY COSTS:\nThe Company records product sales at the time of product shipment. Warranty costs are not significant; however, the Company provides a reserve for estimated warranty costs at the time of sale and periodically adjusts such amounts to reflect actual expenses. The Company's sales transactions are negotiated principally in U.S. dollars.\nPRODUCT RESEARCH AND DEVELOPMENT EXPENDITURES:\nProduct research and development (R&D) expenditures, except certain software development costs, are charged to expense as incurred. Contractual reimbursements for R&D expenditures under joint R&D contracts with customers are accounted for as a reduction of related expenses as incurred. For the years ended October 31, 1995, 1994, and 1993, direct costs incurred under R&D contracts were $112,868, $382,397, and $102,183, respectively, and reimbursements earned were $221,120, $439,000, and $80,000, respectively.\nINCOME TAXES:\nEffective November 1, 1993, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes.\" Previously, the Company used SFAS No. 96 in accounting for income taxes. SFAS No. 109 requires recognition of deferred tax liabilities and assets for the expected future tax consequences of items that have been included in the consolidated financial statements or tax returns. Under SFAS No. 109 the Company provides a deferred tax expense or benefit equal to the change in\nthe deferred tax asset or liability during the year. Deferred income taxes represent future net tax effects resulting from temporary 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. Valuation allowances are recorded against net deferred tax assets, where in the opinion of management realization is uncertain. SFAS No. 109 was applied on a prospective basis, and the amounts presented for prior years have not been restated. The adoption of SFAS No. 109 did not have a material impact on net income, and did not require the recording of a cumulative effect of change in accounting principle.\nNET INCOME (NET LOSS) PER COMMON SHARE:\nNet income per common share for the years ended October 31, 1994 and 1993 was computed by dividing net income by the weighted average number of shares of common stock and common stock equivalents outstanding. Common stock equivalents relate to stock options. Common stock equivalents are excluded from the net loss per common share (LPS) calculation for the year ended October 31, 1995, as they have the effect of decreasing LPS. The difference between primary and fully diluted net income per share was not significant in any year.\nACCOUNTING FOR STOCK-BASED COMPENSATION:\nIn October 1995, Statement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation\" (SFAS 123), was issued and is effective for the Company's 1997 fiscal year. The Company intends to continue to account for employee stock options in accordance with APB Opinion No. 25 and, accordingly, will comply with the pro forma disclosure required by SFAS 123.\nRECLASSIFICATIONS:\nCertain reclassifications have been made to the 1994 and 1993 financial statements to conform to the 1995 presentation with no effect on net income as previously reported.\n2. INVENTORIES\nInventories at October 31, 1995 and 1994 are comprised of the following :\n3. PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment at October 31, 1995 and 1994 are comprised of the following:\nDepreciation and amortization expense totaled $1,251,513, $979,430 and $929,455 for the years ending October 31, 1995, 1994 and 1993, respectively.\n4. LINE OF CREDIT\nThe Company had a line of credit for $1,000,000 which expired on February 28, 1995. On May 23, 1995, the Company entered into a $4,000,000 revolving working capital line of credit agreement which expires on April 30, 1996. The agreement was modified on January 17, 1996. Borrowings under the new line of credit, as modified, bear interest at the bank's prime rate plus one percent and are collateralized by accounts receivable and other assets. Borrowings are limited to 70 percent of adjusted accounts receivable balances, and the Company is required to maintain minimum tangible net worth of $7.0 million, a minimum debt ratio of 0.7:1.0, a quick ratio of cash, investments, and receivables to current liabilities of not less than 1.0:1.0, and minimum profitability levels. The line of credit agreement also prohibits the payment of cash dividends without the consent of the bank. As of October 31, 1995 and 1994, there were no borrowings under either credit line.\n5. OTHER CURRENT LIABILITIES\nOther current liabilities at October 31, 1995 and 1994 are comprised of the following:\n6. INCOME TAXES\nThe components of the provision for income taxes for the years ended October 31, 1995, 1994, and 1993 are as follows:\nThe effective income tax rate differs from the statutory federal income tax rate for the following reasons:\nSignificant components of the Company's deferred tax balances as of October 31, 1995 and 1994 are as follows:\nA valuation allowance was established to offset certain deferred tax assets due to management's uncertainty of realizing the benefit of these items. The net increase in the valuation allowance was $769,374 and $178,626 for the years ended October 31, 1995 and 1994, respectively. The Company has research and experimentation tax credit carryforwards of $536,000 and $158,000 for federal and state tax purposes respectively. These carryforwards expire in the periods ending 2007 through 2010. The Company has a net operating loss carryforward for state income tax purposes of approximately $3,000,000 which expires in 1999.\n7. CAPITALIZED SOFTWARE COSTS\nSoftware costs at October 31, 1995 and 1994 comprise the following:\nThe Company capitalized $120,000 and $75,000 of purchased software costs in 1995 and 1994, respectively. Additionally, $1,366,967 and $155,000 of internally developed software costs were capitalized in 1995 and 1994, respectively. Amortization of capitalized software costs totaled $60,548, $135,743 and $91,878 for the years ended October 31, 1995, 1994 and 1993, respectively.\n8. COMMITMENTS\nThe Company leases all its buildings under noncancelable operating leases which expire at various dates through the year 2006. Future minimum lease payments under all operating leases with initial or remaining noncancelable lease terms in excess of one year at October 31, 1995 are as follows:\nUnder the terms of the San Ramon, California building lease, rent includes the lessor's operating costs. The building lease also includes two five-year renewal options at market rates as defined by the lease. Rent expense under all operating leases for the years ended October 31, 1995, 1994 and 1993 was $794,700, $786,513 and $840,676, respectively.\n9. STOCK OPTION AND STOCK PURCHASE PLANS\nThe Company has two employee stock option plans: a 1987 nonqualified plan and a 1984 incentive plan. Shares of common stock reserved under the plans are pooled and aggregated to 930,000 shares (830,000 shares as of October 31, 1994). Stock options granted under employee plans are exercisable over a maximum term of ten years from the date of grant, vest in various installments over this period and have exercise prices reflecting market value at the date of grant.\nAdditionally, in 1991, shareholders approved a \"Non-Employee Director Stock Option Plan\" (the Plan). Common stock reserved for issuance under the Plan, as amended in fiscal 1994, allows for the issuance of 140,000 shares of stock to nonemployee directors. Options granted under the plan vest over a four-year period and expire five years after the date of grant and have exercise prices reflecting market value at the date of grant.\nAt October 31, 1995 and 1994, 94,928 and 233,333 shares, respectively, were available for stock option grants under the employee plans, and 74,000 and 94,000 shares, respectively, were available for grant under the Non-Employee Director Plan.\nA summary of the activity under the stock option plans is set forth below:\nThe Company has an Employee Stock Purchase Plan (the Purchase Plan) under which 100,000 shares of common stock have been reserved for issuance. The Purchase Plan allows participating employees to purchase, through payroll deductions, shares of the Company's common stock at 85 percent of the stock's fair market value at specified dates. At October 31, 1995, 156 employees were eligible to participate in the Purchase Plan and 51,851 common shares were available for issuance. In fiscal year 1995, 1994 and 1993, 17,869, 11,502 and 12,745 shares were issued under the Purchase Plan, respectively.\n10. EMPLOYEE SAVINGS AND INVESTMENT PLAN\nThe Company contributes a percentage of income before income taxes into an employee savings and investment plan. The percentage is determined annually by the board of directors. The Company makes matching payments of 50 percent of each employee's contribution up to three percent of employees' earnings. Additional contributions to the savings and investment plan are payable annually, vest over five years and cover substantially all employees who have been with the Company at least one year.\nFor the years ended October 31, 1995, 1994 and 1993, total expense under the above program and plan was $202,228, $169,116 and $442,796, respectively.\n11. CONCENTRATION OF CREDIT RISK AND SIGNIFICANT CUSTOMERS\nThe Company's trade accounts receivable are concentrated among a small number of customers, principally located in the United States. Ongoing credit evaluations of customers' financial condition are performed and, generally, no collateral is required. The Company maintains an allowance for doubtful accounts for potential credit losses, and actual bad debt losses have not been material and have not exceeded management's expectations. Trade accounts receivable are recorded net of allowance for doubtful accounts of $130,000 and $100,000, at October 31, 1995 and 1994, respectively.\nSales to individual customers in excess of 10 percent of net sales of the Company included sales to America Online and Tandem Computers of $3,062,000 and $2,785,000, respectively, in fiscal 1995. Sales to Cisco Systems and G.E. Capital Spacenet Services, respectively, accounted for $4,635,000 and $2,526,000 of revenues in fiscal 1994 and $9,586,000 and $4,083,000 in fiscal 1993. International sales accounted for 11% of total revenues during fiscal 1995.\n12. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)\nThe Company has amended its financial statements for the three months ended April 30, 1995 to reflect a $650,000 writedown of capitalized software costs. This adjustment resulted from the capitalization of products that either did not achieve technological feasibility or were subsequently discontinued. The effect of this adjustment was to increase the second quarter net loss by $474,000, or $.23 per share. The Company's fiscal 1994 fourth quarter reflects a $153,000 tax benefit as a result of the Company's amendment of its prior years' tax filings to adjust its research and development tax credits claimed.\n13. SUBSEQUENT EVENT\nIn November 1995, the Company's Board of Directors approved an amendment to the Company's Articles of Incorporation to increase the Company's authorized shares of common and preferred stock to 10,000,000 and 2,000,000 shares, respectively.\nSBE, INC. SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED OCTOBER 31, 1995, 1994, AND 1993\n(a) Deductions represent activity charged to related asset or liability account.","section_15":""}
{"filename":"68330_1995.txt","cik":"68330","year":"1995","section_1":"Item 1. Business\nGeneral\nMGI Properties (the \"Trust\" or \"MGI\") is an unincorporated business trust organized under the laws of the Commonwealth of Massachusetts. MGI commenced operations in 1971 as a real estate investment trust. Since that time, the Trust has elected to be treated as a real estate investment trust (a \"REIT\") under Sections 856-860 of the Internal Revenue Code of 1986, as amended (the \"Internal Revenue Code\"), and expects to continue to operate in a manner which will entitle the Trust to be so treated. For each taxable year in which the Trust qualifies as a REIT under the Internal Revenue Code, taxable income distributed to the holders of its shares will not be taxable to the Trust (other than certain items of tax preference which are subject to minimum tax in the hands of the Trust). See \"Investment and Operating Policies\" and \"Portfolio\" below and the description of dividend policy included under Item 5 of this Annual Report on Form 10-K for the year ended November 30, 1995 (the \"Report\").\nReferences herein to the Trust include its wholly-owned subsidiaries.\nNarrative Description of Business\nThe Trust, which is a self-administered and self-managed equity REIT, owns and manages a diversified portfolio of income-producing real estate assets. The Trust's portfolio consists of investments in multi-use industrial facilities (such as warehouses and research and development buildings), office buildings, apartment complexes and shopping centers. The primary investment objective of the Trust is to make diversified equity and equity-oriented investments in existing properties believed to be capable of producing stable and rising income streams and having long-term capital appreciation potential. The Trust also believes that its active managing and leasing practices can enhance rental income, funds from operations and long-term capital appreciation. These investments have typically taken the form in recent years of a direct equity ownership interest.\nThe Trust employs thirteen persons.\nInvestment and Operating Policies\nThe investment policy of the Trust in its broadest aspect is to seek income of the types permitted to a REIT under Section 856 of the Internal Revenue Code, consistent with its Declaration of Trust. Under its Declaration of Trust, the Trust is permitted to invest in a broad range of real estate and mortgage investments, including among other things equity interests, full or participating interests in securities, whether or not secured by mortgages, interests in rents and any other interests related to real property. The Trust's policies are subject to ongoing review by the Board of Trustees and may be modified from time to time to take into consideration changes in business or economic conditions or otherwise as circumstances warrant.\nThe Trust's investment focus with respect to type of property has, during the last several years, been directed to equity and equity-oriented investments in existing income-producing properties, principally multi-use industrial facilities, office buildings, apartment complexes and shopping centers. MGI continues to believe it is beneficial to diversify its assets by location and type of real estate, although it periodically changes its emphasis from one sector to another in accordance with its perception of market opportunities. Over the past several years,\nMGI has increased its emphasis on acquisitions in the northeastern region of the United States, primarily in Massachusetts and particularly industrial and office properties.\nAlthough the principal investment emphasis is on the direct ownership of income-producing equity real estate, MGI was historically an equity-oriented or \"hybrid\" (equity and mortgage) trust. MGI's focus turned from mortgage loans with equity participations toward equity investments in which the Trust becomes the sole owner of the property and realizes all of the property's future benefits and risks. Management believes that this evolution has given the Trust greater control over the direction of its portfolio and the opportunity to increase its capital gains potential.\nIn making new investments, MGI's investment focus has been primarily directed to acquiring quality income-producing properties. Over the last several years, MGI's investment philosophy has been to seek what management believes to be value-creating opportunities by acquiring quality properties that have not met their full potential at a cost believed to be below or near replacement value. Management believes that its investments can be managed to create a total return which includes current income and appreciation. The Trust seeks to implement its investment objectives through selective acquisitions of quality properties, leasing and property management in accordance with its defined long term goals, investment in property improvements and periodic sales of selected properties. The Trust has recently operated with an individual investment parameter of below $20,000,000, but has exceeded and may occasionally exceed this parameter. The decision to sell specific properties or investments involves a number of factors, including the economic climate (giving effect also to the impact of tax laws and other regulatory factors), future potential and reinvestment alternatives. As indicated above, the investment focus may change, based upon the ongoing review of the Trust's policies by the Board of Trustees.\nAs is common with any real estate owner or lender investing in equity real estate, partnerships, mortgage loans and other investments, the Trust from time to time may restructure its financial arrangements with partners, tenants or borrowers who encounter financial or other difficulties. Accordingly, the Trust, as circumstances warrant, has modified and will modify a lease, partnership, loan or other agreement if, after investigation, it is established that such modification would be economically feasible and in the best interests of the Trust. Protection of the Trust's investments may require foreclosure or other action leading to acquisition of title to properties underlying its mortgage loans or investments.\nThe Trust's business is limited to investments in real estate, direct or indirect, including investments in and possible future acquisitions of real estate companies. To the extent that the Trust has assets not otherwise invested in real estate, the Trust may invest such assets in other securities, including United States government obligations and commercial paper, so long as, in the opinion of the Trustees, such securities may be held without jeopardizing the Trust's qualification as a REIT under the Internal Revenue Code.\nFunds necessary to conduct operations are provided from rental and interest income, mortgaging of equity investments, lines of credit, corporate borrowings, sale of marketable securities and loan repayments and amortization. Such operations include the Trust's continuous incurrence of costs, reimbursed and unreimbursed, for improvements and renovations of its existing properties in order to maintain and enhance their value. From time to time, as conditions warrant, the Trust may operate on a leveraged basis by incurring indebtedness in order to increase its capital available for investment when, in the Trustees' judgment, the Trust will benefit thereby. There is no assurance at any given time that borrowed funds will be available or that the terms and conditions of such borrowings will be acceptable. The Trust may employ short-term or long-term borrowings to fund some of its investments. Reference is made to Note 4 of the Notes to Consolidated Financial Statements included in Item 14 below.\nPortfolio\nThe Trust's real estate portfolio as of November 30, 1995 consisted of interests in fifty-four properties, fifty-one of which are wholly-owned, two are owned by partnerships in which the Trust has an equity interest, one is a property sold by the Trust in a prior year transaction which did not meet the conditions for a completed sale and is still carried as a real estate investment for financial accounting purposes. For tax purposes, the property sold is treated as a mortgage loan receivable.\nThe Trust's real estate investments can be classified by type of property and market region. As of November 30, 1995, the Trust's real estate investments were diversified by type of property as follows:\nNumber of Percent of Type of Property Properties Cost Total - ---------------- ---------- ---- ----- Industrial 28 $ 91,571,000 31% Office 12 78,382,000 27 Retail 6 64,048,000 22 Apartment 8 59,468,000 20 -- ------------ --- Total 54 $293,469,000 100% == ============ ===\nAs of November 30, 1995, the Trust's real estate investments were diversified by geographic region as follows:\nNumber of Percent of Region Properties Cost Total - ------ ---------- ---- ----- Northeast 25 $128,450,000 44% Midwest 15 90,766,000 31 Southeast 9 51,493,000 17 Mid-Atlantic 4 22,535,000 8 Other 1 225,000 * -- ------------ --- Total 54 $293,469,000 100% == ============ ===\n- -------------- * Less than 1%\nTerms under leases to tenants at the Trust's properties range from tenancies-at-will up to twenty years. The Trust leases commercial space to approximately 287 commercial tenants, including 153 office tenants, 71 retail tenants and 63 industrial tenants.\nAdditional information concerning the Trust's mortgage and real estate investments is set forth under Item 2","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nThe following table sets forth certain information concerning the Trust's properties.\nNote: See Note 2 of the Notes to Consolidated Financial Statements included under Item 14 of this Report.\nReference is made to Notes 1, 2 and 3 in the Notes to the Consolidated Financial Statement and Schedules III and IV of the Financial Statement Schedules for descriptions of the Trust's investments and properties.\nExecutive Office.\nThe Trust's headquarters, at 30 Rowes Wharf, Boston, Massachusetts, includes approximately 5,400 square feet and is occupied under a lease expiring during 1996.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe Trust is not a party to any material legal proceedings as to which it does not have adequate insurance coverage.\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.\n(a) Market Information and Dividends.\nThe principal market on which the Trust's common shares are traded is the New York Stock Exchange, under the symbol MGI. The table below sets forth, for the fiscal quarters indicated, the high and low sales prices on the New York Stock Exchange of the Trust's common shares and dividends paid per common share.\nFiscal Sales Price 1995 High Low Dividends ---- ---- --- --------- First Quarter 14 7\/8 13 3\/8 $.22 Second Quarter 15 1\/2 14 1\/8 $.22 Third Quarter 15 1\/8 14 $.23 Fourth Quarter 16 1\/8 14 7\/8 $.23\nFiscal Sales Price 1994 High Low Dividends ---- ---- --- --------- First Quarter 15 5\/8 13 1\/8 $.21 Second Quarter 16 5\/8 14 3\/8 $.21 Third Quarter 16 14 3\/8 $.22 Fourth Quarter 16 13 5\/8 $.22\nFuture dividends will be determined by the Trust's Board of Trustees and will be dependent upon the earnings, financial position and cash requirements of the Trust and other relevant factors existing at the time. The Trust must distribute at least 95% of the Trust's taxable income in order to enable it to qualify as a real estate investment trust for tax purposes. So long as the Trust continues to qualify as a REIT, shareholders will, therefore, receive in the form of dividends at least 95% of the taxable income of the Trust.\n(b) Approximate Number of Holders of Common Shares.\nApproximate Number of Holders (as of Title of Class January 30, 1996) - -------------- ----------------- Common Shares, $1.00 2,800 par value\nItem 6.","section_6":"Item 6. Selected Financial Data (a)\nNote: Reference is made to the Index to Consolidated Financial Statements filed as part of this report under Item 14. Item 6, Selected Financial Data, should be read in conjunction with the Consolidated Financial Statements and the related notes appearing elsewhere herein.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nLIQUIDITY\nShareholders' equity at November 30, 1995 was $180.5 million, compared to $176.1 million at November 30, 1994. The increase primarily reflects net income in excess of distributions. At November 30, 1995 financial liquidity was provided by $7.0 million in cash and investment securities and by unused lines of credit of $33.0 million. The $5.8 million decrease in cash and investment securities, from $12.9 million at November 30, 1994, reflects the Trust's investing activity during 1995. The principal sources and uses of funds in fiscal 1995 are summarized below:\nSource of Funds - --------------- Trust operations $19,300,000 Sales of real estate, net 16,900,000 New borrowing, net of fees, prepayments and amortization 12,600,000 $48,800,000 Uses of Funds - ------------- Real estate acquisitions $38,300,000 Dividends 10,300,000 Additions to real estate 4,400,000 Deferred tenant charges 1,600,000 $54,600,000\nDuring 1995, the Trust acquired eight Massachusetts properties -- three office and five industrial buildings. In addition, upon the completion of construction, the Trust acquired title to a department store which was subject to the Trust's $10.2 million first mortgage construction loan and which had been previously reflected as an investment in real estate for financial reporting purposes. In December 1995, the Trust acquired three additional industrial buildings. A summary of real estate acquisitions is as follows:\nDate Square Fiscal 1995 Acquisitions Acquired Feet Cost - ------------------------ -------- ---- ---- Industrial Tewksbury, Massachusetts 3\/95 189,200 $10,700,000 Northborough, Massachusetts 5\/95 102,300 2,300,000 Marlborough, Massachusetts 6\/95 59,400 2,400,000 Littleton, Massachusetts 9\/95 66,500 2,400,000 Chelmsford, Massachusetts 10\/95 108,500 4,600,000 Office Boston, Massachusetts 12\/94 37,700 1,900,000 Andover, Massachusetts 10\/95 97,700 7,700,000 Boston, Massachusetts 11\/95 27,100 1,300,000 Retail Peabody, Massachusetts 8\/95 106,900 5,000,000 (Additions) ------- --------- 795,300 $38,300,000 ======= =========== Fiscal 1996 Acquisitions through January 1996 - ---------------------------------------------\nIndustrial Marlborough, Massachusetts 12\/95 75,000 $ 2,800,000 Franklin, Massachusetts 12\/95 83,500 3,800,000 Franklin, Massachusetts 12\/95 65,300 3,200,000 ------ --------- 223,800 $ 9,800,000 ======= ===========\nMortgage and other loans payable totaled $84.5 million at November 30, 1995 (79% at fixed rates and 21% at floating rates), a net increase of $13.5 million compared to $71.0 million at November 30, 1994. During 1995, the Trust executed four mortgages totaling $29.0 million with an average effective interest rate of 7.8%. In addition, the Trust repaid $24.0 million of debt in conjunction with mortgage refinancings. The retired debt had an average effective rate of 9.1%. Scheduled payments of loan principal amortization and other payments totaled $1.5 million. In 1995, MGI increased its secured lines of credit by approximately $9.0 million, which increased the total lines of credit to $45.0 million. At November 30, 1995, the Trust had $12.0 million outstanding on its lines. Subsequent to year end, the Trust borrowed an additional $9.5 million from its lines which was used to acquire the three industrial properties. Scheduled loan principal payments due within twelve months of November 30, 1995 total $7.8 million. MGI believes it will continue to be able to extend or refinance maturing mortgage loans upon satisfactory terms.\nOther cash requirements in 1996 are distributions to shareholders, capital and tenant improvements and other leasing expenditures required to maintain MGI's current occupancy levels and other investment undertakings. During 1995, expenditures for capital and tenant improvements totaled $1.8 million and $2.5 million, respectively. Included in the amount for capital improvements are $0.4 million of costs associated with building renovations. During 1996, budgeted renovation costs are anticipated to aggregate $2.4 million, of which approximately $1.5 million is related to Boston office properties, the balance being associated with the partial remodeling of a Michigan apartment complex. Additionally, for 1996 the Trust has estimated recurring capital expenditures will total $1.1 million, including $0.6 million which pertains to interior and exterior improvements for its apartment complexes and $0.5 million for its commercial properties. The Trust has also budgeted $2.3 million for tenant improvements related to recently executed leases. The Trust is contractually committed to approximately $2.9 million of the 1996 capital and tenant improvement projects.\nPrincipal sources of funds in the future are expected to be from property operations, mortgaging or refinancing of existing mortgages on properties and MGI's portfolio of investment securities. Other potential sources of funds include the proceeds of public or private offerings of additional equity or debt securities or the sale of real estate investments. The cost of new borrowings or issuances of equity securities will be measured against the anticipated returns of investments to be acquired with such funds. In lieu of proceeds from real estate sales or the sale of equity securities, it is presently anticipated that the purchase of additional properties in 1996 will be primarily financed by debt and, to a lesser extent, by cash flow from operations and short-term investments. MGI believes the combination of available cash and investment securities, the value of MGI's unencumbered properties and other resources are sufficient to meet its short- and long-term liquidity requirements.\nRESULTS OF OPERATIONS 1995 Compared to 1994\nNet income for 1995 of $14.3 million, or $1.25 per share, included a net gain of $3.2 million, or $.27 per share, which resulted from the sale of real estate investments. Net income for 1994 was $14.5 million, or $1.26 per share, which included a net gain of $4.5 million, or $.39 per share, resulting from similar sales. Income before net gains increased by $1.2 million to $11.2 million for 1995, compared to $10.0 million in 1994.\nFunds from operations in 1995 totaled $19.0 million, or $1.65 per share, compared to $17.7 million, or $1.54 per share, in 1994. MGI defines funds from operations as net income (computed in accordance with generally accepted accounting principles), excluding gains (or\nlosses) from debt restructuring, sales of property and similar non-cash items, depreciation and amortization charges and equity method partnership losses. MGI believes funds from operations is an appropriate supplemental measure of operating performance. The change in funds from operations is attributable to the same factors that affected income before net gains, with the exception of depreciation and amortization expense.\nWhen comparing 1995 to 1994, the increase in income before net gains resulted principally from an increase in property operating income, which is defined as rental and other income less property operating expenses and real estate taxes. The change in property operating income reflects improvement in properties owned throughout both 1994 and 1995, as well as the effects resulting from the sales and acquisitions of properties.\nProperty Operating Income 1995 Compared To 1994 Net Change - ----------------------------------------------- ---------- Properties held during 1994 and 1995 $ 800,000 1995 and 1994 acquisitions 3,200,000 1995 and 1994 sales (2,700,000) ---------- $ 1,300,000 ==========\nThe change in operating income from the property segments generally derives from the Trust's pattern of acquisitions and sales.\nProperty Operating Income Change By Segment Net Change - ------------------------------------------- ----------\nIndustrial $1,100,000 Office 600,000 Apartment (300,000) Retail (100,000) -------- $1,300,000 ==========\nThe income growth in the industrial segment is primarily due to the twelve acquisitions completed during the prior two years. These properties added 1.4 million square feet to this segment which now totals 2.7 million square feet. The properties were near or at 100% occupancy throughout 1995, and the Trust executed 405,400 and 224,600 square feet of leases related to 1995 and 1996 expirations, respectively. Scheduled lease expirations for 1996 are 346,800 square feet.\nThe increase in the office segment reflects $0.3 million from the 1995 acquisitions and a $0.3 million improvement from the properties owned throughout both 1995 and 1994. The three 1995 acquisitions totaled 162,500 square feet and bring the office portfolio to 932,600 square feet. As two of the acquisitions occurred in the latter part of the fourth quarter, their earnings impact will not be appreciable until 1996. The increase in operating income from comparable properties is due to an improvement in occupancy and to a lesser extent rental rates. Average occupancy during 1995 was 90%, compared to 88% in 1994. The Trust executed 141,900 and 22,800 square feet of leases related to 1995 and 1996 expirations, respectively. Scheduled lease expirations for 1996 are 84,100 square feet.\nThe change in the apartment segment reflects improvement from comparable properties offset by the effect of property sales in 1994 and 1995. The comparable properties experienced a 4.5% increase in revenue, principally from an increase in rental rates, while operating expenses were relatively unchanged from 1994. This resulted in an increase in operating income of $0.4 million which was offset by the loss of income of $0.9 million from properties sold, when 1995 is compared to 1994. The Trust's interest in a Metairie, Louisiana apartment complex, which\nwas sold in September 1995 for $12.0 million, had generated $1.1 million of operating income for the ten months it was owned during 1995. The Trust's partnership interests contributed an additional $0.2 million of income compared to 1994.\nOperating income in the retail segment decreased slightly from 1994 due to charges associated with tenant terminations. During the latter part of the third quarter, the Trust acquired a Peabody, Massachusetts department store. The building is being leased by Bradlees, Inc., which filed for bankruptcy under Chapter 11 of the Federal Bankruptcy Code in June 1995. In October 1995, Bradlees affirmed its lease with the Trust and subsequently began paying rent. The commencement and affirmation of the lease should help expand revenue for this segment. The Trust executed 115,100 square feet of leases during 1995. Scheduled lease expirations for 1996 are 94,500 square feet.\nAlso contributing to the change in income before net gains and funds from operations when 1995 is compared to 1994 is an increase in interest income which is due generally to higher interest rates on short-term investments during 1995. Depreciation expense increased due to the increase in the number of properties owned.\n1994 Compared to 1993\nNet income for 1994 of $14.5 million, or $1.26 per share, exceeded net income of $8.0 million, or $.75 per share, in 1993. Included in net income in 1994 was a net gain of $4.5 million, or $.39 per share, which resulted from the sale of real estate investments for an aggregate sales price of $25.2 million. Income before net gains increased 25% to $10.0 million for 1994, compared to $8.0 million in 1993. Funds from operations in 1994 totaled $17.7 million, or $1.54 per share, compared to $15.0 million, or $1.42 per share, in 1993.\nA primary component of the change in income before net gains is property operating income. Property operating income increased by $4.2 million (20%) to $25.6 million in 1994 from $21.4 million in 1993. This increase is largely due to the 1993 and 1994 acquisitions which contributed $4.2 million and $1.1 million to the increase, respectively. These properties consist of seventeen industrial and two office buildings totaling over 1.9 million square feet. Properties sold during 1994 reduced property operating income by less than $0.3 million. Property operating income for the balance of the portfolio, which the Trust owned as of the beginning of fiscal 1993, increased by $0.2 million to $16.1 million excluding $1.0 million of income received during 1993 in connection with the amendment and assignment of a lease at Yorkshire Plaza located in Aurora, Illinois.\nWith respect to the group of properties owned throughout all of 1993 and 1994, apartment property operating income improved by 6% largely due to increases in rental rates, with average occupancy at 94% for both 1993 and 1994. Industrial property operating income improved 20% due to an increase in occupancy. Overall, average occupancy for all industrial properties owned improved by 2% to 98% during 1994. The increases in property operating income from comparable apartment and industrial buildings were offset, however, by a $0.5 million decline from comparable office buildings. Average occupancy in office buildings declined from 94% in 1993 to 88% in 1994, primarily due to increased average vacancy at the suburban Chicago, Illinois and Somerset, New Jersey buildings during 1994. Retail property operating income was largely unchanged, excluding the $1.0 million lease amendment income received in 1993, and average occupancy increased modestly from 92% in 1993 to 93% in 1994.\nThe $7.3 million increase in rental and other income in 1994 compared to 1993 was principally the result of $1.5 million from the properties acquired in 1994, $6.8 million due to the partial-year ownership of properties acquired in 1993, offset by a decrease of $0.5 million due to\nthe sale of properties in 1994 and a decrease of $0.5 million from the balance of the portfolio. Included in 1993 rental and other income, however, was $1.0 million of income received in connection with the lease amendment previously mentioned. Exclusive of this income, revenue in the group of properties which the Trust owned throughout all of 1993 and 1994 increased by $0.5 million. Rental income from the comparable portfolio of apartments and industrial buildings increased while revenue in the office segment declined due to factors similar to those affecting property operating income.\nThe $2.0 million increase in property operating expenses and the $1.2 million increase in real estate taxes in 1994 as compared to 1993, reflect primarily (i) $0.2 million and $0.3 million, respectively, attributable to the properties acquired in 1994, (ii) $1.7 million and $0.9 million, respectively, due to the buildings acquired in 1993 and (iii) $0.2 million and $0.1 million, respectively, from the balance of the portfolio, which are offset by the decreases of $0.1 million and $0.1 million, respectively, due to buildings sold in 1994. The $0.7 million increase in depreciation and amortization expense for 1994 when compared to 1993 was mostly due to partial-year ownership of the properties acquired in 1994 and 1993.\nThree additional factors also contributed to the change in income before net gains and funds from operations when 1994 is compared to 1993. Interest income in 1994 reflects a decrease in the average outstanding balance of short-term investments. General and administrative expenses increased in 1994 primarily reflecting an increase in personnel and shareholder-related items. Interest expense increased reflecting a higher average level of debt outstanding.\nDuring the past three fiscal years, the impact of inflation on MGI's operations and investment activity has not been significant.\nReal estate investments and operations are subject to a number of factors, including changes in general economic climate, local conditions (such as an oversupply of space, a decline in effective rents or a reduction in the demand for real estate), competition from other available space, the ability of the owner to provide adequate maintenance, to fund capital and tenant improvements required to maintain market position and control of operating costs. In certain markets in which the Trust owns real estate, overbuilding and local or national economic conditions have combined to produce lower effective rents and\/or longer absorption periods for vacant space. As the Trust re-leases space, certain effective rents may be less than those earned previously. Management believes its diversification by region and property type reduces the risks associated with these factors and enhances opportunities for cash flow growth and capital gains potential, although there can be no assurance thereof.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe financial statements and supplementary data are included under Item 14 of this Report.\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, 11, 12 and 13 of this Part III has been omitted from this Report since the Registrant intends to file with the Securities and Exchange Commission a definitive proxy statement which involves the election of Trustees not later than 120 days after the close of the Registrant's last 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. CONSOLIDATED FINANCIAL STATEMENTS\nINDEX\nIndependent Auditors' Report Financial Statements: Consolidated Balance Sheets, November 30, 1995 and 1994 Consolidated Statements of Earnings, Years ended November 30, 1995, 1994 and 1993 Consolidated Statements of Cash Flows, Years ended November 30, 1995, 1994 and 1993 Consolidated Statements of Changes in Shareholders' Equity, Years ended November 30, 1995, 1994 and 1993 Notes to Consolidated Financial Statements\n2. CONSOLIDATED FINANCIAL STATEMENT SCHEDULES\nFinancial Statement Schedules (as of or for the year ended November 30, 1995): Schedule III, Real Estate and Accumulated Depreciation Schedule IV, Mortgage and Other Loans on Real Estate\nExhibit XI - Computation of Net Income Per Share Assuming Full Dilution\nExhibit XXVII - Financial Data Schedule for year ended November 30, 1995 (EDGAR filing only)\nOther schedules are omitted for the reasons that they are not required, are not applicable, or the required information is set forth in the financial statements or notes thereto.\n3. EXHIBITS\nSequentially Numbered Page 3(a) Second Amended and Restated Declaration of Trust, incorporated by reference to Exhibit 3 of the Trust's Annual Report on Form 10-K for the fiscal year ended November 30, 1981 (the \"1981 10-K\").\n(b) Certificate of First Amendment of Second Amended and Restated Declaration of Trust, incorporated by reference to Exhibit 3 of the 1981 10-K.\n(c) Certificate of Second Amendment of Second Amended and Restated Declaration of Trust, incorporated by reference to the Trust's Report on Form 8-K, filed on January 13, 1983.\n(d) Certificate of Third Amendment of Second Amended and Restated Declaration of Trust, incorporated by reference to Exhibit 3(d) to Amendment No. 1 to the Trust's Registration Statement on Form S-2 filed on June 7, 1985.\n(e) Certificate of Fourth Amendment of Second Amended and Restated Declaration of Trust, dated October 17, 1986, incorporated by reference to the Trust's Annual Report on Form 10-K for the year ended November 30, 1986.\n(f) Certificate of Fifth Amendment of Second Amended and Restated Declaration of Trust, dated March 25, 1987, incorporated by reference to Exhibit 3(f) of the Trust's Annual Report on Form 10-K for the fiscal year ended November 30, 1987.\n(g) Certificate of Sixth Amendment of Second Amended and Restated Declaration of Trust, dated February 10, 1988, incorporated by reference to Exhibit 4(g) of the Trust's Registration Statement on Form S-8 filed on May 3, 1988.\n(h) Certificate of Seventh Amendment of Second Amended and Restated Declaration of Trust, dated June 30, 1988, incorporated by reference to Exhibit 4.8 of the Trust's Registration Statement on Form S-4 filed on November 10, 1988 (Reg. No. 33-25495).\n(i) Certificate of Eighth Amendment of Second Amended and Restated Declaration of Trust, dated March 27, 1989, incorporated by reference to Exhibit 3(i) of the Trust's Annual Report on Form 10-K for the fiscal year ended November 30, 1989 (the \"1989 10-K\").\n(j) By-Laws, incorporated by reference to the Trust's Report on Form 8-K, filed on January 12, 1983.\n(k) Certificate of Amendment of By-Laws, dated March 21, 1989, incorporated by reference to the Trust's Report on Form 8-K dated March 21, 1989.\n(l) Rights Agreement, dated as of June 21, 1989 between the Trust and The First National Bank of Boston as Rights Agent, incorporated by reference to Exhibit 1 to the\nTrust's Registration Statement on Form 8-A, filed on June 27, 1989.\n(m) Certificate of Vote of the Trustees Designating a Series of Preferred Shares, dated June 21, 1989, incorporated by reference to Exhibit 3(m) of the 1989 10-K.\n(n) Certificate of Eleventh Amendment of Second Amended and Restated Declaration of Trust which increased the authorized number of Common Shares from 15,000,000 to 17,500,000 incorporated by reference to Exhibit B to the Trust's Quarterly Report Form 10-Q for the ended May 31, 1995.\n(o) Certificate of Twelfth Amendment of Second Amended and Restated Declaration of Trust which increased the authorized number of Preferred Shares from 2,000,000 to 6,000,000 incorporated by reference to Exhibit B to the Trust's Quarterly Report Form 10-Q for the quarter ended May 31, 1995.\n10(a) Mortgage Growth Investors Incentive Stock Option Plan for Key Employees, incorporated by reference to the Trust's Definitive Proxy Statement dated March 15, 1982.\n(b) Mortgage Growth Investors Stock 1982 Option Plan For Trustees, incorporated by reference to the Trust's Definitive Proxy Statement dated March 15, 1982.\n(c) MGI Properties 1988 Stock Option and Stock Appreciation Rights Plans for Key Employees and Trustees, incorporated by reference to the Trust's Definitive Proxy Statement, dated February 19, 1988.\n(d) Amendment to MGI Properties' 1982 Incentive Stock Option Plan for Key Employees, dated as of December 19, 1989, incorporated by reference to Exhibit 10(d) of the 1989 10-K.\n(e) Amendment to MGI Properties' 1982 Stock Option Plan for Trustees, dated as of December 19, 1989, incorporated by reference to Exhibit 10(e) of the 1989 10-K.\n(f) Amendment to MGI Properties' 1988 Stock Option and Stock Appreciation Rights Plan for Key Employees, dated as of December 19, 1989, incorporated by reference to Exhibit 10(f) of the 1989 10-K.\n(g) Amendment to MGI Properties' 1988 Stock Option Plan for Trustees, dated as of December 19, 1989, incorporated by reference to Exhibit 10(g) of the 1989 10-K.\n(h) Amended and Restated Severance Compensation Plan, dated as of December 19, 1989, incorporated by reference to Exhibit 10(i) of the 1989 10-K.\n(i) Amended and Restated MGI Properties Long Term Share Bonus Plan, dated December 18, 1991, incorporated by reference to Exhibit 10(i) of the 1991 10-K.\n(j) MGI Properties 1994 Stock Option and Stock Appreciation Rights Plan for Key Employees and Trustees incorporated by reference to the Trust's Definitive Proxy Statement, dated February 18, 1994.\n(k) The Dividend Reinvestment and Share Purchase Plan of MGI Properties incorporated by reference to the Trust's Report on Form S-3, filed on July 1, 1994.\n11 Computation of Net Income Per Share, Assuming Full Dilution, included under Item 14 of this Report.\n24 Auditors' consent.\n(b) REPORTS ON FORM 8-K:\nNo reports on Form 8-K were filed during the fourth quarter of the fiscal year ended November 30, 1995. -------------------------\nMGI Properties (the \"Trust\") is a Massachusetts business trust and all persons dealing with the Trust must look solely to the property of the Trust for the enforcement of any claims against the Trust. Neither the Trustees, officers, agents nor shareholders of the Trust assume any personal liability in connection with its business or assume any personal liability for obligations entered into in its behalf.\nPOWER OF ATTORNEY\nMGI Properties and each of the undersigned do hereby appoint W. Pearce Coues and Phillip C. Vitali and each of them severally, its or his true and lawful attorneys to execute on behalf of MGI Properties and the undersigned any and all amendments to this Report and to file the same with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission. Each of such attorneys shall have the power to act hereunder with or without the other.\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.\nDated: January 31, 1996 MGI PROPERTIES (Registrant)\nBy: \/s\/ W. Pearce Coues W. Pearce Coues, Chairman of the Board of Trustees\nPursuant to the requirements of the Securities Exchange Act 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\/ W. Pearce Coues Chairman of the Board of January 31, 1996 W. Pearce Coues Trustees and Chief Executive Officer\n\/s\/ Phillip C. Vitali Principal Financial Officer January 31, 1996 Phillip C. Vitali\n\/s\/ David P. Morency Principal Accounting Officer January 31, 1996 David P. Morency\n\/s\/ George S. Bissell Trustee January 31, 1996 George S. Bissell\n\/s\/ Herbert D. Conant Trustee January 31, 1996 Herbert D. Conant\n\/s\/ Francis P. Gunning Trustee January 31, 1996 Francis P. Gunning\n\/s\/ Colin C. Hampton Trustee January 31, 1996 Colin C. Hampton\n\/s\/ George M. Lovejoy, Jr. Trustee January 31, 1996 George M. Lovejoy, Jr.\n\/s\/ Rodger P. Nordblom Trustee January 31, 1996 Rodger P. Nordblom\nUNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549\nFORM 10-K\nITEM 8 -- CONSOLIDATED FINANCIAL STATEMENTS November 30, 1995\nMGI PROPERTIES\nMGI PROPERTIES\nIndex to Consolidated Financial Statements and Schedules\nPage\nIndependent Auditors' Report 1\nFinancial Statements: Consolidated Balance Sheets, November 30, 1995 and 1994 2 Consolidated Statements of Earnings, Years ended November 30, 1995, 1994 and 1993 3 Consolidated Statements of Cash Flows, Years ended November 30, 1995, 1994 and 1993 4 Consolidated Statements of Changes in Shareholders' Equity, Years ended November 30, 1995, 1994 and 1993 5 Notes to Consolidated Financial Statements 6-11\nFinancial Statement Schedules (as of or for the year ended November 30, 1995): Schedule III - Real Estate and Accumulated Depreciation Schedule IV - Mortgage and Other Loans on Real Estate\nExhibit XI - Computation of Net Income Per Share, Assuming Full Dilution\nOther schedules are omitted as they are not required, are not applicable, or the required information is set forth in the consolidated financial statements or notes thereto.\nIndependent Auditors' Report\nThe Board of Trustees and Shareholders MGI Properties:\nWe have audited the accompanying consolidated balance sheets of MGI Properties and subsidiaries as of November 30, 1995 and 1994, and the related consolidated statements of earnings, changes in shareholders' equity, and cash flows for each of the years in the three-year period ended November 30, 1995. These consolidated financial statements are the responsibility of the Trust'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 MGI Properties and subsidiaries as of November 30, 1995 and 1994, and the results of their operations and their cash flows for each of the years in the three-year period ended November 30, 1995 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\nBoston, Massachusetts December 29, 1995\nMGI PROPERTIES\nConsolidated Balance Sheets\nNovember 30, 1995 and 1994\nSee accompanying notes to consolidated financial statements.\nMGI PROPERTIES\nConsolidated Statements of Earnings\nSee accompanying notes to consolidated financial statements.\nMGI PROPERTIES\nConsolidated Statements of Cash Flows\nSee accompanying notes to consolidated financial statements.\nMGI PROPERTIES\nConsolidated Statements of Changes in Shareholders' Equity\nSee accompanying notes to consolidated financial statements.\nMGI PROPERTIES\nNotes to Consolidated Financial Statements\n(1) Summary of Significant Accounting Policies\n(a) Consolidation The consolidated financial statements of the Trust include the accounts of its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.\n(b) Income Taxes The Trust intends to continue to qualify to be taxed as a real estate investment trust under Sections 856-860 of the Internal Revenue Code of 1986 and the related regulations. In order to qualify as a real estate investment trust for tax purposes, the Trust, among other things, must distribute to shareholders at least 95% of its taxable income. It has been the Trust's policy to distribute 100% of its taxable income to shareholders; accordingly, no provision has been made for Federal income taxes.\n(c) Income and Expense Recognition Income and expenses are recorded using the accrual method of accounting for financial reporting and tax purposes. Income or loss from real estate partnerships is accounted for according to generally accepted accounting principles using either the cost method or the equity method.\n(d) Depreciation and Amortization Real estate investments, excluding land costs, are depreciated using the straight-line method over estimated useful lives of 20 to 40 years. Tenant improvements are amortized over the shorter of their estimated useful lives or lease terms ranging from 1 to 20 years. Equipment is depreciated over a range from 5 to 20 years. Maintenance and repairs are charged to expense as incurred; major improvements are capitalized.\n(e) Statements of Cash Flows For purposes of the statements of cash flows, all short-term investments with a maturity, at date of purchase, of three months or less are considered to be cash equivalents.\nDuring 1994, the Trust sold seven industrial properties for $14.9 million in a single transaction. The properties were secured by a $10.2 million loan payable which was assigned to the purchaser at closing. Only the cash portion of the sale is reflected in the accompanying consolidated statement of cash flows.\nCash interest payments of $6.5 million, $5.8 million and $5.3 million were made for the years ended November 30, 1995, 1994 and 1993, respectively. During 1995, the Trust capitalized interest of $.4 million.\n(f) Fair Value of Financial Instruments The Trust estimated the fair values of its financial instruments at November 30, 1995 using dis-counted cash flow analysis and quoted market prices. Such financial instruments include short-term investments, U.S. Government securities, mortgage and other loans payable and mortgage notes receivable which were received in connection with transactions not qualifying as sales for financial accounting purposes and accordingly not reflected in the Trust's consolidated balance sheet. The excess of the aggregate fair value of the Trust's financial instruments over their aggregate carrying amounts is not material.\n(Continued)\nMGI PROPERTIES\nNotes to Consolidated Financial Statements\n(g) Net Income Per Share Net income per share is computed based on the weighted average number of common shares outstanding.\n(h) Reclassifications Certain prior year amounts have been reclassified to conform with the current year presentation.\n(2) Investments\n(a) Real Estate A summary of real estate investments follows:\nAccumulated Buildings depreciation Type of and and Net carrying amount Investment Land improvements amortization 1995 1994 - ---------- ---- ------------ ------------ ---- ----\nIndustrial $ 19,432,000 $ 72,139,000 $ 4,335,000 $ 87,236,000 $ 69,321,000 Office 15,254,000 63,128,000 11,362,000 67,020,000 55,332,000 Retail 23,647,000 40,401,000 6,842,000 57,206,000 47,760,000 Apartment 8,691,000 50,536,000 13,836,000 45,391,000 57,377,000 Construction in Progress - 5,470,000 Partnership 241,000 241,000 ------------ ------------ ------------ ------------ ------------ $ 67,024,000 $ 226,204,000 $ 36,375,000 $ 257,094,000 $235,501,000 ============ ============= ============ ============= ============\nA discussion of certain real estate investments follows:\nEffective August 1995, the Trust acquired title to the completed department store which was subject to the Trust's $10.2 million first mortgage construction loan. The building is being leased in its entirety by Bradlees, Inc. which filed for bankruptcy under Chapter 11 of the Federal Bankruptcy Code in June 1995. In October 1995, Bradlees affirmed its lease with the Trust and subsequently began paying rent.\nIn 1982, the Trust sold its investment in a Michigan apartment complex and received a $15.5 million purchase money mortgage in a transaction that did not meet the conditions for a completed sale for financial accounting purposes. The loan was scheduled to mature in 1995, and the Trust agreed to extend the maturity until January 1997 on essentially the same terms including an interest rate of 7% and a provision for the Trust to receive at least 50% but not more than 60% of the shared appreciation value in excess of the outstanding note balance. In addition, the Trust's 35% ownership interest, direct and indirect, in the partnership owning this complex will increase to 46%. The Trust will retain a purchase option which will allow it to obtain a maximum equity interest of 100%. At November 30, 1995, the Trust carried this asset as a real estate investment at a net carrying value of $7.1 million, which excludes the gain from the sale.\n(Continued)\nMGI PROPERTIES\nNotes to Consolidated Financial Statements\nWith respect to a San Bruno, California partnership interest, the Trust is entitled to receive 50% of property cash flow and residuals through a 2% limited partnership interest (carrying value of $225,000) and has an option to increase its equity interest. In connection with a December 1991 refinancing by the partnership, the Trust has deferred the recognition of a gain of $3.7 million. Prior to the completion of the December 1991 transaction, a 1976 sale had not met the conditions for a completed sale and the Trust carried this property as real estate investment for financial reporting purposes. In addition, the Trust has a loan receivable from the partnership with a $3.1 million tax basis. Such loan is not recorded in the accompanying financial statements.\n(b) Net Gains In 1995, the Trust recognized gains of $3.2 million principally from the sale of one industrial building and the repayment of its loan on a Metairie, Louisiana apartment complex that had been carried as real estate owned for financial reporting purposes.\nIn 1994, the Trust sold nine properties and one real estate partnership interest with an aggregate net carrying value of $20.7 million for an aggregate net sales price of $25.2 million, resulting in gains totalling $4.5 million.\n(3) Leases\nAll leases relating to real estate investments are operating leases; accordingly, rental income is reported when earned.\nFuture minimum lease payments on noncancelable operating leases at commercial properties at November 30, 1995 are: $30.3 million in 1996, $25.9 million in 1997, $20.9 million in 1998, $16.6 million in 1999, $11.7 million in 2000, and $64.5 million thereafter.\nThe above amounts do not include contingent rental income which is received under certain leases based upon tenant sales, ad valorem taxes, property operating expenses and\/or costs to maintain common areas. Contingent rental income was $5.6 million in 1995, $5.4 million in 1994 and $3.4 million in 1993.\nOperating leases on apartments generally have a term of one year or less.\n(Continued)\nMGI PROPERTIES\nNotes to Consolidated Financial Statements\n(4) Mortgage and Other Loans Payable\nMortgage and other loans payable at November 30 follow:\nThe mortgage loans payable are nonrecourse and are collateralized by certain real estate investments having a net carrying value of $107 million and the Trust's guarantee of $4.5 million. Loans require monthly principal amortization and\/or a balloon payment at maturity.\nThe housing revenue bond is tax exempt and is secured by real estate having a net carrying value of $4.8 million. The bond is also secured by a letter of credit which is collateralized by $2.6 million of short-term investments and U.S. Government securities. The Trust has also guaranteed $3.0 million of the debt. The base interest rate floats weekly and was 3.75% at November 30, 1995 (an effective interest rate of 5.7% due to the payment of fees).\nThe Trust has lines of credit of $30.0 million and $15.0 million maturing August 1998 and June 1996, respectively. Both credit agreements contain restrictive covenants which, among other things, require the Trust to maintain certain financial ratios and restrict the incurrence of certain indebtedness and the making of certain investments. Borrowings under the lines are secured by mortgage and security interests in real estate having a net carrying value of $53.1 million and are subject to a variable interest rate. A fee in the amount of .25% per annum is charged on the unused amounts.\nPrincipal payments on mortgage and other loans payable due in the next five years and thereafter are as follows: $7.8 million in 1996, $1.9 million in 1997, $8.0 million in 1998, $2.2 million in 1999, $13.9 million in 2000, and $50.7 million thereafter.\n(Continued)\nMGI PROPERTIES\nNotes to Consolidated Financial Statements\n(5) Shareholders' Equity\n(a) Stock Option Plans Under the Trust's 1994 and 1988 stock option plans for key employees and Trustees (the \"Plans\"), incentive stock options with or without stock appreciation rights or nonqualified options and related stock appreciation rights may be granted to employees, and nonqualified options may be granted to Trustees. Under the Plans, options may be granted at an exercise price not less than fair market value of the Trust's common shares on the date of grant. Changes in options outstanding during the years ended November 30 were as follows:\n1995 1994 1993 ---- ---- ----\nBalance at beginning of year 549,632 464,532 467,000\nGranted 132,000 101,000 24,000 Exercised (7,221) (15,900) (14,468) Expired (5,000) -- (12,000) ------- ------- ------- Balance at end of year 669,411 549,632 464,532 ======= ======= ======= Shares reserved for granting future options 458,325 590,325 121,325 ======= ======= =======\nThe weighted average exercise price per option at November 30, 1995, 1994 and 1993 was $13.02, $12.62 and $12.16, respectively. The shares reserved expire by April 2004 and all outstanding options expire by April 2005. Of the options granted in fiscal 1995, 56,000 became exercisable in December 1995. Subsequent to November 30, 1995, 132,500 options were granted, of which half are currently exercisable and half are exercisable in December 1996. All other options outstanding are currently exercisable.\n(b) Shareholder Rights Plan On June 21, 1989, the Board of Trustees adopted a shareholder rights plan. Under this plan, one right was attached to each outstanding common share on July 5, 1989, and one right will be attached to each share issued thereafter. Each right entitles the holder to purchase, under certain conditions, one one-hundredth of a share of Series A participating preferred stock for $60. The rights may also, under certain conditions, entitle the holders to receive common shares of the Trust, common shares of an entity acquiring the Trust, or other consideration, each having a value equal to twice the exercise price of each right ($120). One hundred fifty thousand preferred shares have been designated as Series A participating preferred shares and are reserved for issuance under the shareholder rights plan. The rights are redeemable by the Trust at a price of $.01 per right. If not exercised or redeemed, all rights expire in July 1999.\n(c) Dividend Reinvestment and Share Purchase Plan Under the Trust's Dividend Reinvestment and Share Purchase Plan shareholders of record who own 100 shares or more have the option of electing to receive, in full or in part, dividends in the form of MGI shares in lieu of cash. The price of shares purchased with reinvested dividends is at a 3% discount in the case of newly issued shares. If MGI purchases shares in the open market for the plan, the price for such shares is 100% of the average purchase price paid. Participants in the plan may make additional cash purchases of shares at the same price as shares purchased through the reinvestment of dividends. During the years ended November 30, 1995 and 1994 the Trust issued 18,828 shares and 4,121 shares of common stock through its Dividend Reinvestment and Share Purchase Plan, respectively. (Continued)\nMGI PROPERTIES\nNotes to Consolidated Financial Statements\n(d) Common Stock Offering In May 1993 the Trust sold 2,000,000 shares of common stock in a public offering for a price of $13.785 per share. The Trust received net proceeds of $25.6 million after the underwriting discount and offering costs.\n(6) Cash Distributions and Federal Income Taxes\nThe difference between taxable income and net income reported in the consolidated financial statements is due principally to reporting certain gains for tax purposes under the installment method, use of net operating loss carryforwards available and differences in depreciation and in the basis of real estate sold as reported for tax and financial statement purposes.\nThe Trust made cash distributions of ordinary income and capital gains of $.90 per share ($10.3 million) in 1995, and cash distributions of ordinary income and capital gains of $.86 per share ($9.8 million) in 1994 and cash distributions of ordinary income of $.81 per share ($8.5 million) in 1993.\nOn December 19, 1995, the Trust declared a dividend of $.24 per share payable on January 12, 1996 to shareholders of record on January 5, 1996.\n(7) Commitments\nAs of November 30, 1995, the Trust had commitments to purchase three industrial buildings located in Massachusetts totaling 224,000 square feet for an aggregate purchase price of $9.8 million. The three acquisitions were completed in December 1995. In addition, the Trust is contractually committed to approximately $2.9 million of capital and tenant improvements which are expected to be completed during 1996.\n(8) Quarterly Financial Information (Unaudited)\nQuarterly results of operations for the years ended November 30, 1995 and 1994 follow:\nSchedule III\nMGI PROPERTIES\nReal Estate and Accumulated Depreciation\nNovember 30, 1995\nSchedule III (Continued) MGI PROPERTIES\nReal Estate and Accumulated Depreciation\nNovember 30, 1995\n(A) These properties collateralize the Trust's $45 million credit facilities.\nSchedule III (Continued) MGI PROPERTIES\nReal Estate and Accumulated Depreciation\nYears ended November 30, 1995, 1994 and 1993\nA summary of real estate investments and accumulated depreciation and amortization for the three years ended November 30 follows:\nThe aggregate cost for Federal income tax purposes of the above investments at November 30, 1995 is approximately $283 million.\nRefer to Note 1 regarding the Trust's accounting policies on real estate investments and depreciation and amortization.\nSchedule IV\nMGI PROPERTIES\nMortgage and Other Loans on Real Estate\nYears ended November 30, 1995, 1994 and 1993\nA summary of mortgage and other loan activity for the years ended November 30 follows:\n1995 1994 1993 ---- ---- ----\nBalance at beginning of year $ -- $ -- $ 5,880,000 (a)\nAdd: Additions and advances -- -- 79,000 ----------- ----------- ---------- -- -- 5,959,000 Less: Other principal reductions -- -- (5,959,000)(a) ----------- ----------- ----------\nBalance at end of year $ -- $ -- $ -- =========== =========== =============\nNotes: (a) The face value of this wrap-around mortgage loan was $6,613,000 and was carried net of four first mortgage loans. At November 30, 1992, the Trust had reached agreement with the borrower to purchase the four industrial properties securing this loan. The acquisition was completed on December 31, 1992.\nExhibit XI\nMGI PROPERTIES\nComputation of Net Income Per Share Assuming Full Dilution\nYear ended November 30,\nConsent of Independent Auditors\nThe Board of Trustees MGI Properties:\nWe consent to incorporation by reference in the registration statements (Nos. 33-21584, 2-97270, 33-65844, 33-53433 and 33-63901) on Form S-8 of MGI Properties and subsidiaries of our report dated December 29, 1995, relating to the consolidated balance sheets of MGI Properties and subsidiaries as of November 30, 1995 and 1994, and the related consolidated statements of earnings, changes in shareholders' equity, and cash flows and related schedules for each of the years in the three-year period ended November 30, 1995, which report appears in the November 30, 1995 annual report on Form 10-K of MGI Properties and subsidiaries.\nKPMG Peat Marwick LLP\nBoston, Massachusetts January 31, 1996","section_15":""}
{"filename":"101271_1995.txt","cik":"101271","year":"1995","section_1":"ITEM 1. BUSINESS\nUnited Industrial Corporation (\"United\" or the \"Company\") was incorporated under the laws of the State of Delaware on September 14, 1959 under the name Topp Industries Corporation. On December 31, 1959, the name of the corporation was changed to United Industrial Corporation.\nThe operations of United consist of three principal industry segments: defense, energy systems and plastic products, conducted through four wholly-owned subsidiaries.\nDefense ------- AAI Corporation\nAAI Corporation (\"AAI\") is engaged in research, development and manufacture in the following major areas: (1) training and simulation systems; (2) automatic test equipment for electronic systems and components; (3) ordnance systems; (4) mechanical support systems for industrial, military, and marine applications; (5) unmanned air vehicle systems; (6) automated weather monitoring systems; and (7) transportation systems. Since its inception, AAI's business has been primarily in support of the U.S. Department of Defense (\"DOD\"). Since 1990, the Company has emphasized diversification into other markets to reduce its dependence on the DOD. The United States defense budget has been significantly reduced in recent years and this trend is expected to continue. In 1995 approximately 64% of the sales volume of AAI consisted of research, development and production of military items under defense contracts compared to 74% in 1994. Certain of the contracts currently being worked on by AAI involve testing systems for U.S. Navy aircraft, training equipment for the U.S. Air Force and U.S. Navy, and weapons handling systems for the U.S. Army.\nThe balance of AAI's business consists of work performed in the non- Department of Defense markets. These areas include hydraulic test equipment, transportation equipment and weather systems. AAI was awarded a contract for 1,096 weather systems to be installed in certain government airports throughout the country. This contract was recently restructured and extended through 1997. New orders were received in 1995 for 53 additional systems. In 1995, 144 weather systems were installed bringing total systems installed since inception of the contract to 677.\nBecause of the variety of its activities, it is not possible to state precisely the competitive position of AAI with respect to each of its product lines. In the area of training and simulation systems, AAI is one of approximately ten leading organizations developing equipment for the U.S. Government. AAI's ability to obtain orders for training and simulation systems is dependent principally on the ability, expertise and training of its\nNYFS11...:\\95\\78495\\0001\\1196\\FRM3196L.18B\nemployees and the level of funding by the DOD and foreign military users. A number of large and small companies produce automatic test equipment that compete with AAI for market share. In the area of weapons and munitions, AAI ranks among approximately ten leading companies engaged in development work. However, AAI's production activity in this field is less significant. AAI began development in the Unmanned Air Vehicle business in 1986. The Company produced the highly successful Pioneer Unmanned Air Vehicle employed by the United States during Operation Desert Storm, and presently is pursuing contracts with foreign countries. AAI is one of several large and small competitors in this field.\nOn January 16, 1992, AAI acquired, through a newly-formed subsidiary AAI\/ACL Technologies, Inc. (\"AAI\/ACL\"), substantially all of the assets and business of ACL Technologies, Inc., a manufacturer of hydraulic test equipment for the commercial airline and defense markets. Business results of AAI\/ACL have been less than anticipated because of the continued unfavorable economic situation of the commercial airline industry in the U.S. and worldwide. However, activity in this market is beginning to recover.\nOn March 29, 1993, the Company's Board of Directors approved a plan of reorganization and restructuring whereby, in light of existing circumstances such as the declining Department of Defense budget and the continuing financial problems of the airline industry and in order to position itself for both short and long-term growth, it took a one- time restructuring charge. The charge covered the anticipated cost of organizational and product-line changes, the consolidation of facilities, and work force reductions of approximately 300 in AAI and its four subsidiaries. The non-recurring charge of $22.5 million ($14,370,000 or $1.17 per share, net of tax benefit) was taken during 1993. As at December 31, 1993, the restructuring program was substantially completed. During 1994, $750,000 was expended. A major portion of the charge resulted from the discontinuance of operations of AAI\/MICROFLITE. AAI\/MICROFLITE, acquired in 1991, was formerly the commercial division of Singer-Link Corporation, a manufacturer of flight simulators and training devices for commercial aircraft. All of the remaining assets of AAI\/MICROFLITE were sold in 1994.\nAAI's administrative offices and the major part of its manufacturing and engineering facilities are located in Hunt Valley, Maryland.\nSymtron Systems, Inc.\nOn January 18, 1994, the Company acquired all of the outstanding shares of Symtron Systems, Inc. (\"Symtron\"), a producer of firefighter training simulators for the government, military and commercial markets. The purchase price consisted of initial cash payments of $2,000,000, assumption of certain liabilities of approximately $5,900,000 and a contingent payment, not to exceed $1,000,000, based on the profits on contracts existing at the acquisition date. In 1995, the Company made the contingent payment of $1,000,000 which was classified as selling and administrative expense in the 1995 financial statements.\nAdditionally, contingent amounts are payable if certain pretax profits, as defined in the purchase agreement, are earned for each of the years in the four year period ending December 31, 1998. Funds generated from operations and an existing line of credit were utilized to finance the purchase of Symtron. The acquisition was accounted for as a purchase, accordingly, the operations of Symtron are included in the Company's 1994 financial statements. In 1995 approximately $11,500,000 of the sales volume of Symtron consisted of production for the Navy and commercial customers. The main office and plant of Symtron are located in Fair Lawn, New Jersey.\nEnergy Systems --------------\nDetroit Stoker Company\nDetroit Stoker Company (\"Detroit Stoker\") is engaged in the design, manufacture and sale of industrial stokers, gas\/oil burners, municipal solid waste combustion systems for waste to energy plants, rotary seal feeders for the metering of granular materials, replacement parts and aftermarket services. Its products are used for the generation of process steam and electric power in a wide range of industrial and municipal applications. Principal customers include public utilities, industrial manufacturing plants, universities, pulp and paper mills, sugar mills and independent power producers (non-utility generators). Its waste to energy technology is used extensively in both public and private plants which generate steam and power from municipal waste. Its solid fuel combustion technologies are particularly well suited to the burning of biomass fuels. The primary raw materials used by Detroit Stoker are iron and steel which are available from many sources. The main office and plant of Detroit Stoker are located in Monroe, Michigan.\nThe products of Detroit Stoker compete with those of several other manufacturers. Detroit Stoker is presently marketing a liquid and gaseous fuel burning product line with low emissions for the power industry, primarily for boiler applications. Potential customers for these products consist of original boiler manufacturers as well as all major industrial and institutional energy consumers. Competition is based on several factors including price, features and performance.\nIn 1995, Detroit Stoker withdrew from the bulk material handling systems business in a strategic move to allow better use of resources in more profitable areas.\nMidwest Metallurgical Laboratory, Inc. (\"Midwest\"), a subsidiary of Detroit Stoker, is a foundry engaged in the manufacture of grey and ductile iron, stainless steel and special alloy iron castings. Approximately 85% of the sales of Midwest are to Detroit Stoker. Midwest's plant and offices are located in Marshall, Michigan.\nPlastic Products ----------------\nNeo Products Co.\nNeo Products Co. (\"Neo\") engineers and fabricates thermoplastic products to the specifications submitted by its customers. Neo also manufactures items for point of purchase display advertising and consumer products related primarily to infants, food service equipment for a major airline and fuel tank reservoirs for the auto industry.\nSales to customers of items for point of purchase display advertising represented approximately 30% of sales in 1995. These sales principally consisted of display racks and trays. Sales of consumer end use items represented 63% of sales in 1995. These sales primarily included carrier cradles, chairs and waste baskets. Sales to the auto industry represented approximately 7% of sales in 1995. The largest customer of Neo accounted for approximately 54% of sales in 1995 compared to 39% and 32% in 1994 and 1993, respectively. Neo's main office and plant are located in Chicago, Illinois.\nNeo is engaged in the highly competitive field of thermoplastic fabrication. Neo's operations are in potential and actual competition with fabrication facilities of some of its own customers as well as other thermoplastic fabricators. Neo has improved its competitive position by increasing the size of its larger injection molding presses to accommodate larger size molded parts. Although it is not possible to estimate the position of Neo among competitors in this field, it is believed to hold less than 1% market share. The primary raw material used by Neo is plastic resin, which is available from many sources.\nFor additional information concerning United's subsidiaries reference is made to information set forth in the sections entitled \"AAI Corporation\", \"Symtron Systems, Inc.\", \"Detroit Stoker Company\" and \"Neo Products Company\" commencing on page 5 of United's 1995 Annual Report to Shareholders (the \"Annual Report\"), which sections are incorporated herein by reference.\nGeneral -------\nEmployees\nAs of March 1, 1996 United and its subsidiaries had approximately 2,000 employees. Approximately 200 of these employees are represented by several unions under contracts expiring between July 1997 and March 1999. United considers its employee relationships to be satisfactory.\nPatents\nUnited and its subsidiaries own more than 100 United States patents relating to various products, including stokers, marine equipment, ordnance and electronic equipment, and\nfirefighter trainers. In addition, United has numerous pending applications for patents. There is no assurance as to how many patents will be issued pursuant to these pending applications. The applications relate to a wide variety of fields, including automation control systems, ordnance devices, and electronic developments. No patent is considered to be of material importance to United.\nResearch and Development\nDuring 1995, 1994 and 1993, the subsidiaries of United (exclusive of AAI) expended approximately $194,000, $98,031, and $126,300, respectively, on the development of new products and the improvement of existing products. All of the programs and the funds to support such programs are sponsored by the subsidiary involved. In addition to the above amount, AAI is substantially engaged in research and development for the U.S. Government.\nBacklog\nThe backlog of orders by industry segment at December 31, 1995 and 1994 was as follows:\nThe defense contract backlog decrease more than offsets the increase in commercial backlog of the defense segment. The increase in backlog for energy systems was due to the increased level of new contracts being awarded. Except for approximately $66,000,000 of research and development backlog, substantially all of the backlog orders at December 31, 1995 are expected to be filled in 1996.\nGovernment Contracts\nNo single customer other than the U.S. Government, principally the Department of Defense, accounted for 10% or more of net sales during the year. Sales to the Government normally carry a lesser margin of profit than commercial sales and may be subject to price redetermination under certain circumstances. Contracts for such sales can be terminated for the convenience of the Government.\nFinancial Information Relating to Industry Segments\nFor financial information with respect to industry segments of United, reference is made to the information set forth in Note 13 of the Notes to Financial Statements included in Item 8 of this Report, which Note is incorporated herein by reference.\nForeign Operations and Export Sales\nUnited and its subsidiaries have no significant foreign operations. During 1993 export sales by United and its subsidiaries amounted to approximately $31,258,000. Export sales in 1995 and 1994 amounted to less than 10% of net sales for these years.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nUnited maintains executive and administrative offices at leased premises at 18 East 48th Street, New York, N.Y., which lease expires in December 1997. The following is a tabulation of the principal properties owned or leased by United's subsidiaries as at March 1, 1996.\nApproximate Area in Square Owned Location Principal Use Feet or Leased -------- ------------- ---- ---------\n1510 East First Street Machine shop, steel 194,910 Owned in Monroe, MI fabrication, floor space fee engineering and sales on 14.4 facilities of Detroit acres of Stoker land (East Building)\n1426 East First Street Assembly, shipping 101,000 Owned in Monroe, MI and administrative floor space fee facilities of Detroit on 2.2 Stoker acres of land (West Building)\n15290 Fifteen Mile Road Foundry, 59,386 Owned in Marshall, MI Midwest Metallurgical floor space fee on 28.4 acres of land\nIndustry Lane Manufacturing, 770,918 Owned in Cockeysville, MD engineering floor space fee and administrative on 92 acres facilities of AAI of land\nGilroy Road Additional 66,400 Leased to Hunt Valley, MD manufacturing and (Building April 22, engineering 200) 1999 facilities of AAI\n1701 Pollitt Drive Administrative, 30,000 Leased to Fair Lawn, NJ engineering and June 30, manufacturing 2001 facilities of Symtron\n1505 East Warner Avenue Manufacturing, 145,000 Leased to Santa Ana, CA engineering and January administrative 31, 1997 facilities of ACL Technologies\n2801 Professional Parkway Manufacturing, 71,142 Leased to Ocoee, FL engineering and July 31, administrative 1996 facilities of AAI\n1035 Semoran Boulevard Sales office 900 Leased to Winter Park, FL for Symtron April 30,\n5400 S. Kilbourn Avenue Manufacturing and 45,000 Owned in Chicago, IL administrative fee facilities of Neo\nFor information with respect to obligations for lease rentals, see Note 9 of the Notes to Financial Statements in the Annual Report, which Note is incorporated herein by reference. United considers its properties to be suitable and adequate for its present needs. The properties are being fully utilized.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company, along with numerous other parties, has been named in five tort actions relating to environmental matters based on allegations partially related to a predecessor's operations. These tort actions seek recovery for personal injury and property damage among other damages. One tort claim is a certified property and medical class action.\nThe Company owned and operated a small facility at a site in the State of Arizona that manufactured semi-conductors between 1959 and 1960. All such operations of the Company were sold by 1961. Although this facility may have used trichloroethylene (\"TCE\") in small quantities, there is no evidence that this facility released or disposed of TCE at this site.\nOn May 18, 1993, the State of Arizona filed suit against the Company seeking the recovery of investigative costs, injunctive relief to require the Company to perform a Remedial Investigation and Feasibility Study (\"RI\/FS\"), and ultimately to require the remediation of alleged soil and groundwater contamination at and near a certain industrial site. Since then the State has brought in co-defendants whose operations at the site were substantially larger than those of the Company.\nOn June 20, 1995 the Company and the State of Arizona executed an agreement in principle to settle the litigation. In exchange for a full release from liability by the State and the Arizona Department of Environmental Quality, the Company, without admitting liability, has agreed to the following:\n* Undertake and pay for the costs of an RI\/FS Work Plan, estimated at $1,300,000.\n* Pay $125,000 towards past costs incurred by the State of Arizona and the Department of Environmental Quality.\n* Pay $125,000 towards costs of future remediation and clean-up of the site. In addition, at the time the State selects a remedy, the Company agrees to an additional contribution in the amount of a percentage of the total estimated clean-up cost not to exceed an additional $1,120,000.\n* The Company reserves all rights to seek contribution from other responsible parties.\nThe Company and the State have signed a Consent Decree and Work Plan incorporating these terms and conditions. The Consent Decree has been lodged with the United States District Court for the District of Arizona for a 30-day public comment period, at the conclusion of which the parties will seek court approval of the settlement. Resolution of this matter will not have a materially adverse effect on the consolidated financial position of the Company. The Company has provided approximately $1,900,000 based on estimates of the total cost for the RI\/FS, estimates of amounts specified for past costs and estimates of future remediation and clean-up costs.\nOn February 11, 1992 a complaint was filed against the Company and ten other named and ten unnamed entities in the Maricopa County Superior Court of Arizona by seven individuals seeking to represent a class. A class in excess of 10,000 was originally alleged. The plaintiffs have amended their complaint to separate the larger property damage and medical monitoring classes into smaller subclasses based on geographic location and alleged exposure to solvents. In the process of amendment, the overall sizes of the respective classes have been significantly reduced. This suit alleges that the members of the class have been exposed to contaminated groundwater in the Phoenix\/ Scottsdale, Arizona area and suffer increased risk of disease and other physical effects. They also assert property damages under various theories; seek to have certain scientific studies performed concerning health risks, preventative measures and long-term effects; and seek incidental and consequential damages, punitive damages and an injunction against actions causing further exposures. The property and medical classes recently were certified. The Company has joined with the other defendants and appealed the class certification issue to the Arizona Supreme Court. The Company intends to vigorously contest these actions and believes that the resolution of these actions will not be material to the Company.\nFour additional lawsuits were filed on April 7, 1993, December 20, 1993, June 10, 1994 and July 18, 1995 in the Maricopa County Superior Court of Arizona. These matters allege personal injury and wrongful death by multiple plaintiffs arising from the alleged contamination in the Phoenix\/Scottsdale, Arizona area. The Company intends to aggressively defend against these claims; however, at this time, no estimate can be made as to the amount or range of potential loss, if any, to the Company with respect to these matters. In comparison to the other defendants, the operations of the Company were very limited in time and size.\nIn January 1993, Detroit Stoker was named a third-party defendant in four lawsuits pending in the United States District Court for the Northern District of Ohio. The third-party plaintiffs are ship owners who have been sued by Great Lakes maritime workers who allege personal injuries and disease as a result of exposure to asbestos while working aboard the ships. The ship owners claim that Detroit Stoker and other suppliers to the ship owners furnished products, supplies or components of the ships that contained asbestos. These cases are now consolidated in the multi-district litigation proceeding currently pending in the United States District Court in Philadelphia. Detroit Stoker intends to aggressively defend these claims, however, at this time, no estimate can be made as to the amount or range of potential loss, if any, to Detroit Stoker with respect to this action.\nDetroit Stoker was notified in March 1992 by the Michigan Department of Natural Resources (MDNR) that it is a potentially responsible party in connection with the clean-up of a former industrial landfill located in Port of Monroe, Michigan. MDNR is treating the Port of Monroe landfill site as a contaminated facility within the meaning of the Michigan Environmental Response Act (MERA), MCLA Section 299.601 et seq. Under MERA, if a -- --- release or a potential release of a discarded hazardous substance is or may be injurious to the environment or to the public health, safety, or welfare, MDNR is empowered to undertake or\ncompel investigation and response activities in order to alleviate any contamination threat. Detroit Stoker intends to aggressively defend these claims, however, at this time, no estimate can be made as to the amount or range of potential loss, if any, to Detroit Stoker with respect to this action.\nIn May 1995, AAI Systems Management, Inc. (the \"subsidiary\"), an indirect subsidiary of the Company, submitted to the U.S. Government (the \"customer\") a Request for Equitable Adjustment (\"REA\") totaling approximately $11,800,000 in connection with a certain contract with the subsidiary. The REA seeks monetary damages based on costs incurred by the subsidiary arising out of or in connection with customer directed suspension of work and resulting schedule delays, additional work directives, and other actions by the customer in connection with the contract for which contractors are allowed recovery under the Federal Acquisition Regulations. On July 14, 1995, the subsidiary received the final decision of the customer rejecting the REA in its entirety. To fully protect the Company's interest, on October 10, 1995, a Notice of Appeal of the final decision was filed with the Armed Services Board of Contract Appeals seeking monetary damages plus interest. While the Company believes that the formal claims asserted against the customer are meritorious and the Company will vigorously pursue recovery of the monies claimed, the customer has asserted substantive defenses to these claims. Because the proceedings are currently in the discovery phase, it is not possible at this time to determine the ultimate amount of recovery of these costs.\nThe Company is involved in various other lawsuits and claims, including certain other environmental matters, arising out of the normal course of its business. In the opinion of management, the ultimate amount of liability, if any, under pending litigation, including claims described above, will not have a materially adverse effect on the Company.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nAnnual elections are held in May to elect officers for the ensuing year. Interim elections are held as required. Except as otherwise indicated, each executive officer has held his current position for the past five years.\nAge at December 31, ------------ Name Position, Office 1995 ---- ---------------- ----\nRichard R. Erkeneff* -- President of the Company (since 60 October 1995) and AAI (since November 1993); Senior Vice President of the Aerospace Group at McDonnell Douglas Corporation, an aerospace firm (October 1992 to November 1993); and President (March 1992 to October 1992) and Executive Vice President (1988 to 1992) of McDonnell Douglas Electronics Systems Company.\nRobert Worthing -- Vice President and General 50 Counsel of the Company (since July 18, 1995); General Counsel of AAI (since April, 1992); and Vice President and Senior Counsel of TRW's Space and Defense Sector (October 1979- January 1992).\nSusan Fein Zawel* -- Vice President, Corporate 41 Communications and Associate General Counsel (since June 1995), Secretary (since May 1994) and Counsel (1992 to 1995) of the Company; and part- time practice of law in public service sector (1990-1991)\nJames H. Perry -- Chief Financial Officer (since 34 October 25, 1995) and Treasurer (since December 1994) of the Company; and Senior Manager (October 1992-November 1994) and Manager (1988-September 1992) at Ernst & Young LLP.\nJames M. Ballantine, Jr.-- Acting President of Detroit 62 Stoker (since April 1995); President of Saddle River Partners, a consulting and investment company (since August 1992); and President of Hydrotherm, Inc., a multiplant manufacturer of boilers and air conditioning equipment (1979 to August 1992).\nJohn J. Henning -- President of Symtron (since 1988). 54\nMichael A. Schillaci -- President of Neo (since 1987). 48\n____________________ * Member of the Company's Board of Directors\nPART II -------\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS\nReference is made to the information set forth in Note 15 of the Notes to Financial Statements included in Item 8 of this Report concerning dividends, stock prices, stock listing and record holders, which information is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nReference is made to the information set forth in the sections entitled \"Five-Year Financial Data\" on page 38 of the Annual Report, which section is incorporated herein by reference.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nReference is made to the information set forth in the section entitled \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" commencing on page 17 of the Annual Report, which section 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 included on pages 20 through 37 of the Annual Report are incorporated herein 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\nReference is made to the information to be set forth in the section entitled \"Election of Directors\" in the definitive proxy statement involving the election of directors in connection with the Annual Meeting of Stockholders of United to be held on May 14, 1996 (the \"Proxy Statement\"), which section (other than the Compensation Committee Report and Performance Graph) 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, 1995, pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended.\nThe information required with respect to executive officers is set forth in Part I of this report under the heading \"Executive Officers of the Registrant,\" pursuant to instruction 3 to paragraph (b) of Item 401 of Regulation S-K.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nReference is made to the information to be set forth in the section entitled \"Election of Directors\" in the Proxy Statement, which section (other than the Compensation Committee Report and Performance Graph) is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nReference is made to the information to be set forth in the section entitled \"Voting Rights\" and \"Security Ownership of Management\" in the Proxy Statement, which sections are incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nReference is made to the information to be set forth in the section entitled \"Election of Directors\" in the Proxy Statement, which section (other than the Compensation Committee Report and Performance Graph) 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 this portion of Item 14 is submitted as a separate section of this report entitled \"List of Financial Statements and Financial Statement Schedules\".\n(3) Exhibits:\n(3)(a)- Restated Certificate of Incorporation of United (1).\n(3)(b)- Amended and Restated By-Laws of United.\n(10)(a)- United Industrial Corporation 1994 Stock Option Plan (1).\n(10)(b)- Purchase Agreement, dated January 18, 1994, between United and Symtron Systems, Inc. (1).\n(10)(c)- Note Purchase Agreement (the \"Note Agreement\") dated as of July 15, 1992 among AAI Corporation (\"AAI\") and Principal Mutual Life Insurance Company, The Travelers Insurance Company and The Travelers Indemnity Company of Rhode Island (the \"Purchasers\") (2).\n(10)(d)- Guaranty Agreement (the \"Note Guaranty\") dated as of July 15, 1992 by United in favor of the Purchasers (2).\n(10)(e)- Amendment No. 1 dated July 15, 1993 to the Note Agreement (3).\n(10)(f)- Amendment No. 1 dated July 15, 1993 to the Note Guaranty (3).\n(10)(g)- Amendment No. 2 to Note Agreement dated as of December 20, 1993 among AAI and the Purchasers (4).\n(10)(h)- Amendment No. 3 to Note Agreement dated as of October 13, 1994 among AAI and the Purchasers (5).\n(10)(i)- Amendment No. 2 to the Note Guaranty dated as of October 13, 1994 (5).\n(10)(j)- Credit Agreement dated as of October 13, 1994 among AAI, the Lenders parties thereto and First Fidelity Bank, National Association, as Agent (the \"Agent\") and Issuing Bank (5).\n(10)(k)- Pledge and Security Agreement dated as of October 13, 1994 by AAI in favor of the Agent (5).\n(10)(l)- Pledge and Security Agreement dated as of October 13, 1994 by the Company in favor of the Agent (5).\n(10)(m)- Security Agreement dated as of October 13, 1994 between AAI and the Agent (5).\n(10)(n)- Security Agreement dated as of October 13, 1994 between each subsidiary of AAI, certain subsidiaries of the Company and the Agent (5).\n(10)(o)- Guaranty dated as of October 13, 1994 by the Company and certain of its subsidiaries and by each subsidiary of AAI in favor of the Agent (5).\n(10)(p)- Employment Agreement dated March 26, 1996, between United and Richard R. Erkeneff.\n(10)(q)- Employment Agreement, dated January 8, 1996, between United and Susan Fein Zawel.\n(10)(r)- Employment Agreement, dated February 9, 1996, between United and James H. Perry.\n(10)(s)- Severance Agreement, dated October 10, 1995, between United and P. David Bocksch.\n(11)- Computation of Earnings Per Share.\n(13)- United's 1995 Annual Report to Shareholders\n(21)- Subsidiaries of United.\n(23)- Consent of Independent Auditors.\n(27)- Financial Data Schedule.\n--------------------\n(1) Incorporated by reference to United's Annual Report on Form 10-K for the year ended December 31, 1993. (2) Incorporated by reference to United's Quarterly Report on Form 10-Q for the quarter ended September 30, 1992. (3) Incorporated by reference to United's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993. (4) Incorporated by reference to United's Annual Report on Form 10-K for the year ended December 31, 1994. (5) Incorporated by reference to United's Quarterly Report on Form 10-Q for the quarter ended September 30, 1994.\n(b) - Reports on Form 8-K - United did not file any reports on Form 8-K during the quarter ended December 31, 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.\nUNITED INDUSTRIAL CORPORATION (Registrant)\nBy: \/s\/ Richard R. Erkeneff ------------------------------------- Richard R. Erkeneff, President\nDate: March 26, 1996 --------------------------------- Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated.\nName Date ---- ----\n\/s\/Harold S. Gelb March 26, 1996 --------------------------------------- Harold S. Gelb, Chairman of the Board and Director\n\/s\/Howard M. Bloch March 26, 1996 --------------------------------------- Howard M. Bloch, Vice-Chairman of the Board and Director\n\/s\/Richard R. Erkeneff March 26, 1996 --------------------------------------- Richard R. Erkeneff, President and Chief Executive Officer and Director\n\/s\/Myron Simons March 26, 1996 ---------------------------------------- Myron Simons, Director\n\/s\/Susan Fein Zawel March 26, 1996 ---------------------------------------- Susan Fein Zawel, Vice President and Director\n\/s\/Edward C. Aldridge, Jr. March 26, 1996 ---------------------------------------- Edward C. Aldridge, Jr., Director\n\/s\/James H. Perry March 26, 1996 ---------------------------------------- James H. Perry, Treasurer (Principal Financial and Accounting Officer)\nAnnual Report on Form 10-K\nItem 14(a) (1) and (2), (c) and (d)\nList of Financial Statements and Financial Statement Schedules\nCertain Exhibits\nFinancial Statement Schedules\nYear ended December 31, 1995\nUnited Industrial Corporation New York, New York\nForm 10-K Item 14(a) (1) and (2)\nUNITED INDUSTRIAL CORPORATION AND SUBSIDIARIES\nList of Financial Statements and Financial Statement Schedules\nThe following consolidated financial statements of United Industrial Corporation and subsidiaries, included in the annual report of the registrant to its shareholders for the year ended December 31, 1995, are incorporated by reference in Item 8:\nConsolidated Balance Sheets -- December 31, 1995 and 1994 Consolidated Statements of Operations -- Years Ended December 31, 1995, 1994 and 1993 Consolidated Statements of Cash Flows Years Ended December 31, 1995, 1994 and 1993 Notes to Financial Statements\nThe following consolidated financial statement schedules of United Industrial Corporation and subsidiaries are included in Item 14(d):\nSchedule I Condensed Financial Information of Registrant 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, therefore, have been omitted.\nReport of Independent Auditors\nBOARD OF DIRECTORS AND SHAREHOLDERS UNITED INDUSTRIAL CORPORATION\nWe have audited the accompanying consolidated balance sheets of United Industrial Corporation and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations and cash flows for each of the three years in the period ended December 31, 1995. 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 United Industrial Corporation and subsidiaries at December 31, 1995 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, 1995 in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nAs discussed in Notes 12 and 14 to the consolidated financial statements, effective January 1, 1993 the Company changed its method of accounting for postretirement benefits other than pensions and income taxes.\nERNST & YOUNG LLP New York, New York February 21, 1996\nSchedule I - Condensed Financial Information of Registrant United Industrial Corporation Condensed Balance Sheets\n(Dollars in thousands) December 31\n1995 1994 ------ ------\nASSETS Current Assets: Cash and cash equivalents $4,453 $5,635 Prepaid expenses and other current assets 205 208 Deferred income taxes 6,487 3,169 ------ ----- Total current assets 11,145 9,012\nEquipment 342 325 Less allowances for depreciation (235) (240) -------- -------- 107 85 Other assets (principally investments in and amounts due from wholly-owned subsidiaries) 163,552 165,370 -------- -------- $174,804 $174,467 ======== ========\nLIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities, including notes payable of $3,000 $7,220 $ 6,899 Income taxes - 3,333 ----- ------ Total current liabilities 7,220 10,232 Deferred income taxes $9,820 9,228\nOther liabilities (principally amounts due to wholly-owned subsidiaries) 71,604 66,586\nShareholders' equity: Common Stock 14,374 14,374 Other shareholders' equity 71,786 74,047 -------- -------- 86,160 88,421 -------- -------- $174,804 $174,467 ======== ========\nSee notes to condensed financial statements of registrant.\nSchedule I - Condensed Financial Information of Registrant\nUnited Industrial Corporation\nCondensed Statements of Operations\nYear ended December 31\n(DOLLARS IN THOUSANDS) 1995 1994 1993 ------- ------ ------ Management fees from wholly-owned subsidiaries $ 2,310 $2,064 $ 2,571 Other revenue (expense) - net (15) 150 41 ------- ------ ------- 2,295 2,214 2,612\nOther (income) and expenses: Administrative Expenses 5,558 3,247 4,590 Interest income (2,277) (1,292) (364) Interest expense 7,174 4,708 2,110 ------- ------ ------- 10,455 6,663 6,336 ======= ====== =======\nLoss before income taxes and equity in net income of subsidiaries (8,160) (4,449) (3,724) Income tax benefit 2,526 1,639 933 ------- ----- ------ Loss before equity in net income of subsidiaries (5,634) (2,810) (2,791) Equity in net income (loss) of subsidiaries 6,522 8,022 (8,232) ------- ------ -------\nNet income (loss) $ 888 $5,212 $(11,023) ======= ====== ======= Dividends paid by subsidiaries to Parent $ 1,000 $ - $ 1,500 ======= ====== =======\nSee notes to condensed financial statements of registrant.\nSCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT UNITED INDUSTRIAL CORPORATION\nCONDENSED STATEMENTS OF CASH FLOWS\n(DOLLARS IN THOUSANDS) Year ended December 31\n1995 1994 1993 ------ ------ ------\nOperating activities: Net income (loss) $ 888 $5,212 $(11,023) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization 17 9 33 Deferred income taxes (126) (441) (680) Undistributed (earnings) loss of subsidiaries (5,522) (8,022) 9,732 Changes in operating assets and liabilities: Income taxes (3,333) 6,951 (3,618) Prepaid expenses and other current assets 3 732 (939) Current liabilities 321 (616) (2,912) Accounts with wholly-owned subsidiaries 9,785 3,037 21,874 -------- ----- ------ Net cash provided by operating activities: 2,033 6,862 12,467 -------- ----- ------ Investing activities: Purchase of property and equipment (39) (69) - Decrease (increase) in intercompany receivables due to transfer of deferred taxes from wholly- owned subsidiaries 2,600 (3,523) 24,109 (Decrease) increase in deferred taxes resulting from transfer from wholly owned subsidiaries (2,600) 3,523 (24,109) Other, net (27) (53) -\n------ -------- ------- Net cash used in investing activities $ (66) $ (122) $ - ------ ------- -------\n(Condensed Statements of Cash Flows - continued on next page)\nSchedule I - Condensed Financial Information of Registrant\nUnited Industrial Corporation\nCondensed Statements of Cash Flows (continued)\n(DOLLARS IN THOUSANDS) YEAR ENDED DECEMBER 31\n1995 1994 1993 ------ ------ ------\nFinancing activities: Proceeds from borrowings $9,000 $12,000 $ 9,000 Payments on borrowings (9,000) (12,000) (16,000) Dividends paid (3,165) (2,571) (4,290) Purchase of treasury shares - (475) - Proceeds from exercise of stock options 16 - - ------ ------- -------\nNet cash used in financing activities (3,149) (3,046) (11,290) ------ ------- ------- (Decrease) increase in cash and cash equivalents (1,182) 3,694 1,177 Cash and cash equivalents at beginning of year 5,635 1,941 764 ------ ------- ------- Cash and cash equivalents at end of year $4,453 $ 5,635 $ 1,941 ====== ======= =======\nSee notes to condensed financial statements of registrant.\nA. ACCOUNTING POLICIES\nBASIS OF PRESENTATION\nIn the parent-company-only financial statements, the Company's investment in subsidiaries is stated at cost plus equity in undistributed earnings of subsidiaries since the date of acquisition. The Company's share of the net income of its unconsolidated subsidiaries is reflected using the equity method. Parent-company-only financial statements should be read in conjunction with the Company's consolidated financial statements.\nB. EQUITY IN NET INCOME (LOSS) OF SUBSIDIARIES\nIn 1993, included in the equity in net loss of subsidiaries is a restructuring charge of $22,500,000 ($14,370,000, net of tax benefit) regarding the Company's defense industry subsidiary. A major portion of the charge resulted from the termination of the operations of AAI\/MICROFLITE, a manufacturer of flight simulators and training devices, due to a lack of new orders. Also, in 1993 the Company changed its method of accounting for postretirement benefits other than pensions and income taxes. The implementation of these accounting changes resulted in a cumulative effect charge against income of $12,890,000, net of tax benefit and a cumulative effect of $13,884,000 which reduced the 1993 net loss, respectively. Consequently, the net cumulative effect of these accounting changes resulted in a $994,000 reduction of the net loss in 1993.\nSchedule II -- Valuation and Qualifying Accounts\nUnited Industrial Corporation and Subsidiaries\nDecember 31, 1995\nEXHIBIT INDEX ------------- Exhibit No. Page ----------- ----\n(3)(a)- Restated Certificate of Incorporation of United (1).\n(3)(b)- Amended and Restated By-Laws of United.\n(10)(a)- United Industrial Corporation 1994 Stock Option Plan (1).\n(10)(b)- Purchase Agreement, dated January 18, 1994, between United and Symtron Systems, Inc. (1).\n(10)(c)- Note Purchase Agreement (the \"Note Agreement\") dated as of July 15, 1992 among AAI Corporation (\"AAI\") and Principal Mutual Life Insurance Company, The Travelers Insurance Company and The Travelers Indemnity Company of Rhode Island (the \"Purchasers\") (2).\n(10)(d)- Guaranty Agreement (the \"Note Guaranty\") dated as of July 15, 1992 by United in favor of the Purchasers (2).\n(10)(e)- Amendment No. 1 dated July 15, 1993 to the Note Agreement (3).\n(10)(f)- Amendment No. 1 dated July 15, 1993 to the Note Guaranty (3).\n(10)(g)- Amendment No. 2 to Note Agreement dated as of December 20, 1993 among AAI and the Purchasers (4).\n(10)(h)- Amendment No. 3 to Note Agreement dated as of October 13, 1994 among AAI and the Purchasers (5).\n(10)(i)- Amendment No. 2 to the Note Guaranty dated as of October 13, 1994 (5).\n(10)(j)- Credit Agreement dated as of October 13, 1994 among AAI, the Lenders parties thereto and First Fidelity Bank, National Association, as Agent (the \"Agent\") and Issuing Bank (5).\n(10)(k)- Pledge and Security Agreement dated as of October 13, 1994 by AAI in favor of the Agent (5).\n(10)(l)- Pledge and Security Agreement dated as of October 13, 1994 by the Company in favor of the Agent (5).\n(10)(m)- Security Agreement dated as of October 13, 1994 between AAI and the Agent (5).\n(10)(n)- Security Agreement dated as of October 13, 1994 between each subsidiary of AAI, certain subsidiaries of the Company and the Agent (5).\n(10)(o)- Guaranty dated as of October 13, 1994 by the Company and certain of its subsidiaries and by each subsidiary of AAI in favor of the Agent (5).\n(10)(p)- Employment Agreement dated March 26, 1996, between United and Richard R. Erkeneff.\n(10)(q)- Employment Agreement, dated January 8, 1996, between United and Susan Fein Zawel.\n(10)(r)- Employment Agreement, dated February 9, 1996, between United and James H. Perry.\n(10)(s)- Severance Agreement, dated October 10, 1995, between United and P. David Bocksch.\n(11)- Computation of Earnings Per Share.\n(13)- United's 1995 Annual Report to Shareholders\n(21)- Subsidiaries of United.\n(23)- Consent of Independent Auditors.\n(27)- Financial Data Schedule.\n-------------------- (1) Incorporated by reference to United's Annual Report on Form 10-K for the year ended December 31, 1993. (2) Incorporated by reference to United's Quarterly Report on Form 10-Q for the quarter ended September 30, 1992. (3) Incorporated by reference to United's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993. (4) Incorporated by reference to United's Annual Report on Form 10-K for the year ended December 31, 1994. (5) Incorporated by reference to United's Quarterly Report on Form 10-Q for the quarter ended September 30, 1994.","section_15":""}
{"filename":"909832_1995.txt","cik":"909832","year":"1995","section_1":"ITEM 1 -- BUSINESS\nPrice\/Costco, Inc. (\"PriceCostco\" or the \"Company\") began operations in 1976 in San Diego, California as The Price Company (\"Price\"), pioneering the membership warehouse concept. Costco Wholesale Corporation (\"Costco\") began operations in 1983 in Seattle, Washington with a similar membership warehouse concept. PriceCostco was formed in October 1993 as a result of a merger of Price and Costco -- a combination that resulted in a company with over $15 billion in sales, more than 200 warehouse clubs in operation and in excess of 40,000 employees throughout the United States and Canada (See \"Note 2 -- Merger of Price and Costco\").\nIn the second quarter of fiscal 1995, the Company completed the spin-off of Price Enterprises, Inc. (\"Price Enterprises\"). Price Enterprises consisted of PriceCostco's discontinued non-club commercial real estate operations and certain other assets. (See \"Note 3 -- Spin-off of Price Enterprises, Inc. and Discontinued Operations\").\nGENERAL\nPriceCostco operates 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 125,000 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. Losses associated with dishonored checks have also been minimal, 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 lower 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 traditional discount grocery retailers and supermarkets, 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 a centralized, automated check-out facility. Items are not individually price marked. Rather, each item is barcoded so it can be scanned into PriceCostco's electronic cash registers. This allows price changes without remarking merchandise. Substantially all manufacturers provide special, larger package sizes and merchandise pre-marked with the item numbers and bar codes.\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. Items which members may request but which cannot be purchased at prices low enough to pass along meaningful cost savings are usually 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 4,500 active stockkeeping units (\"SKU's\") per warehouse as opposed to discount retailers and supermarkets 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 products 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 net sales accounted for by each major category of items sold by PriceCostco during fiscal 1995, 1994 and 1993:\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. PriceCostco also purchases different national brand name or selected private label merchandise of the same product, as long as cost, 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 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 $30 for the primary membership card with additional membership cards available for an annual fee of $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 spouse card.\nAs of September 3, 1995, PriceCostco had approximately 3.3 million Business memberships and approximately 6.7 million Gold Star memberships. Members can utilize their memberships at any Price Club or Costco Wholesale location.\nLABOR\nAs of September 3, 1995, PriceCostco had approximately 52,000 employees, about 50% of which were part time. Substantially all of Price's 11,000 hourly employees in California, Connecticut,\nMaryland, Massachusetts, New Jersey, New York and one Price Club warehouse in Virginia are represented by the International Brotherhood of Teamsters. All remaining hourly Price employees and all employees of Costco 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 850 warehouse clubs exist across the U.S. and Canada, including the 240 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 significant 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 institutional food business, companies such as Smart & Final, which operates in Arizona and California, are 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. (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 retailers 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.\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2 -- PROPERTIES\nWAREHOUSE PROPERTIES\nAt September 3, 1995, 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 region:\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, 1995:\n- ------------------------ (a) As of September 3, 1995, the Company operated (through a 50%-owned joint venture) thirteen warehouses in Mexico (one opened in fiscal 1992, two opened in fiscal 1993, five opened in fiscal 1994, and five opened in fiscal 1995). These warehouses are not included in the number of warehouses open in any period because the joint venture is accounted for on the equity basis and therefore its operations are not consolidated in the Company's financial statements.\nThe Company's headquarters are located in Issaquah, Washington. 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 Complaint alleged violation of certain state and federal laws during the time period prior to Price's earnings release for the second quarter of fiscal year 1992. 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 filed an Appeal in the Ninth Circuit Court of Appeals. In an opinion dated November 20, 1995, the Ninth Circuit reversed and remanded the lawsuit. The Company believes that this lawsuit is without merit and is vigorously defending the lawsuit. 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.\nOn December 19, 1994, a Complaint was filed against PriceCostco in an action entitled SNYDER V. PRICE\/COSTCO, INC. ET. AL., Case No. C94-1874Z, United States District Court, Western District of Washington. On January 4, 1995, a Complaint was filed against PriceCostco in an action entitled BALSAM V. PRICE\/COSTCO, INC. ET. AL., Case No. C95-0009Z, United States District Court, Western District of Washington. The Snyder and Balsam Cases were subsequently consolidated and on March 15, 1995, plaintiffs' counsel filed a First Amended And Consolidated Class Action And Derivative Complaint. On November 9, 1995, plaintiffs' counsel filed a Second Amended And Consolidated Class Action And Derivative Complaint. The Second Amended Complaint alleges violation of certain state and federal laws arising from the spin-off and Exchange Transaction and the merger between Price and Costco. The Company believes that this lawsuit is without merit and is vigorously defending against this lawsuit. 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 February 1, 1996 at The Pan Pacific Hotel in Anaheim, California. 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.\nJames D. Sinegal has been President, Chief Executive Officer and a director of the Company since October 1993 upon consummation of the merger of Costco Wholesale Corporation (\"Costco\") and The Price Company (the \"Merger\"). From its inception until 1993, he was President and Chief Operating Officer of Costco and served as Chief Executive Officer from August 1988 until October 1993. Mr. Sinegal is a co-founder of Costco and has been a director of Costco since its inception. Mr. Sinegal is a director of Price Enterprises, Inc. (\"Price Enterprises\") but his term as a director of Price Enterprises will expire as of that company's next election of directors on January 16, 1996. Mr. Sinegal does not intend to stand for reelection to Price Enterprise's Board of Directors.\nJeffrey H. Brotman is a native of the Pacific Northwest and is a 1967 graduate of the University of Washington Law School. Mr. Brotman was elected Chairman of the Board of the Company on December 21, 1994. Mr. Brotman was the Vice Chairman of the Board of the Company from October 1993 (upon consummation of the Merger) until December 21, 1994. He is a co-founder of Costco and founder of a number of other specialty retail chains. Mr. Brotman is a director of Seafirst Bank, Starbucks Corp., The Sweet Factory and Garden Botanika.\nRichard D. DiCerchio has been Executive Vice President -- Merchandising, Distribution, Construction and Marketing and a director of the Company since October 1993 (upon consummation of 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 and has been a Director of PriceCostco since January 1995. He was Senior Vice President, Chief Financial Officer and Treasurer of Costco since January 1985, having joined Costco as Vice President - -- Finance in March 1984. From 1978 to February 1984, Mr. Galanti was an Associate with Donaldson, Lufkin & Jenrette Securities Corporation.\nFranz E. Lazarus was named Executive Vice President -- International Operations in September, 1995, prior to which he had served as Executive Vice President, Chief Operating Officer -- Northern Division of PriceCostco since August 1994 and 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 Executive Vice President -- Manufacturing and Ancillary Businesses 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.\nWalter C. (\"Craig\") Jelinek has been Executive Vice President, Chief Operating Officer -- Northern Division since September 1995. He had been Senior Vice President, Operations -- Northwest Region since September 1992. From May 1986 to September 1994 he was Vice President, Regional Operations Manager -- Los Angeles Region and has held various management positions since joining Costco in April 1984.\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 has held various management positions since joining Costco in June 1985.\nJoseph P. Portera has been Executive Vice President, Chief Operating Officer - -- Eastern Division of PriceCostco 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 has held various management positions since joining Costco in April 1984.\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 and has held various management positions since joining Price in October 1981.\nPART II\nITEM 5","section_5":"ITEM 5 -- MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nTrading in PriceCostco Common Stock commenced on October 22, 1993, and is quoted on The Nasdaq Stock Market's National Market under the symbol \"PCCW.\" Prior 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.\"\nIn the Merger between Price and Costco, which occurred on October 21, 1993, each share of Price Common Stock, par value $.10 per share, was exchanged for 2.13 shares of PriceCostco Common Stock and each share of Costco Common Stock, par value $.0033 per share, was exchanged for one share of PriceCostco Common Stock.\nThe following table sets forth the high and low sales prices of PriceCostco Common Stock for the period October 22, 1993 through October 31, 1995, and Price Common Stock and Costco Common Stock for the periods indicated. All Price Common Stock data below has been adjusted to reflect the 2.13 exchange ratio in the Merger. The quotations are as reported in published financial sources.\nOn October 31, 1995, the last reported sales price per share of PriceCostco Common Stock was $17.00. On October 31, 1995, the Company had 9,025 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 September 3, 1995 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 1995 (53 WEEKS) AND FISCAL 1994 (52 WEEKS): (DOLLARS IN THOUSANDS, EXCEPT EARNINGS PER SHARE)\nNet operating results for fiscal 1995 reflect net income of $133,878 or $.68 per share (fully diluted), as compared to a fiscal 1994 net loss of $112,368 or $.51 per share (fully diluted). The fiscal 1995 results include a non-cash charge of $83,363 or $.37 per share, reflecting the final calculation for the loss on the disposal of the discontinued real estate operations following the completion of the Spin-off of Price Enterprises. The fiscal 1994 loss of $112,368 includes the provision for merger and restructuring costs of $120,000 pre-tax ($80,000 or $.36 per share after tax), a provision included in loss from discontinued operations 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, and a non-cash 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 1995 was $217,241 or $1.05 per share, compared to income from continuing operations for fiscal 1994 of $110,898 or $.51 per share. Excluding the $120,000 pre-tax ($80,000 after tax) merger and restructuring charge, income from continuing operations for fiscal 1994 would have been $190,898 or $.87 per share.\nNet sales increased 10.8% to $17,905,926 in fiscal 1995 from $16,160,911 in fiscal 1994. This increase was due to: (i) first year sales at the 24 new warehouses opened during fiscal 1995, which increase was partially offset by 5 warehouses closed during fiscal 1995 that were in operation during fiscal 1994; (ii) increased sales at 29 warehouses that were opened in fiscal 1994 and that were in operation for the entire 1995 fiscal year; (iii) higher sales at existing locations opened prior to fiscal 1994; and (iv) one additional week of sales related to having a 53-week fiscal year. Changes in prices did not materially impact sales levels.\nComparable sales, that is sales in warehouses open for at least a year, increased at a 2% annual rate in fiscal 1995, compared to a negative 3% annual rate during fiscal 1994. The improvement in comparable sales levels in fiscal 1995, as compared to fiscal 1994, reflects new marketing and merchandising efforts, including the rollout of fresh foods and various ancillary businesses to certain existing locations.\nMembership fees and other revenue increased 6.8% from $319,732, or 1.98% of net sales, in fiscal 1994 to $341,360, or 1.91% of net sales in fiscal 1995. This increase is primarily due to membership sign-ups at the 24 new warehouses opened in fiscal 1995 and one additional week of membership fees related to having a 53-week fiscal year.\nGross margin (defined as net sales minus merchandise costs) increased 12.2% from $1,498,020, or 9.27% of net sales in fiscal 1994 to $1,680,078, or 9.38% of net sales in fiscal 1995. Gross margin as a percentage of net sales increased due to greater purchasing power realized since the Merger and the expanded use of the Company's depot facilities. The gross margin figures reflect accounting for most U.S merchandise inventories on the last-in, first-out (LIFO) method. For fiscal 1995 there was a $9,500 LIFO provision, or $.03 per share (fully diluted), decreasing income after tax due to the use of the LIFO method compared to the first-in, first-out (FIFO) method. This compares to a $2,600 LIFO benefit or $.01 per share (fully diluted) in fiscal 1994.\nSelling, general and administrative expenses as a percent of net sales improved from 8.82% during fiscal 1994 to 8.69% during fiscal 1995, reflecting lower expense ratios resulting from improved comparable sales increases, as well as the implementation of front-end scanning and automated receiving at certain existing warehouses, partially offset by higher expenses associated with international expansion and certain ancillary operations.\nPreopening expenses totaled $25,018 or 0.14% of net sales during fiscal 1995 and $24,564 or 0.15% of net sales during fiscal 1994. During fiscal 1995, the Company opened 24 new warehouses\ncompared to opening 29 new warehouses during fiscal 1994. Fiscal 1995 preopening expenses also included an increased level of costs associated with remodels and expanding fresh foods and ancillary operations at existing warehouses.\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 estimated closing costs for certain warehouses, which were or will be replaced by new warehouses, the closing of a regional office and additional costs related to warehouse clubs closed in prior years. Warehouse closing costs were also $7,500 (pre-tax) or $.02 per share in fiscal 1994.\nInterest expense totaled $67,911 in fiscal 1995, 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. Interest expense in fiscal 1995 also includes interest on the Senior Notes (as hereafter defined) issued in June, 1995. The increase in interest expense is primarily related to higher borrowings and interest rates under the Company's bank lines and commercial paper programs and the issuance of the Senior Notes.\nInterest income and other totaled $2,783 in fiscal 1995, and $13,888 in fiscal 1994. This decrease was primarily due to the Company reflecting its share of losses in certain unconsolidated joint ventures, the elimination of interest income on certain notes receivable that were transferred to Price Enterprises as of fiscal 1994 year-end, and an approximate $2,500 pre-tax charge representing the Company's share of foreign currency exchange losses incurred by Price Club Mexico due to Mexico's currency devaluation during fiscal 1995.\nThe $120,000 pre-tax provision for merger and restructuring costs reflected in fiscal 1994 includes direct transaction costs, expenses related to consolidating and restructuring certain functions, the closing of certain facilities and disposal of related properties, severance and employee payouts, write-offs of certain redundant capitalized costs and certain other costs. These costs were provided for in the first quarter of fiscal 1994. For additional information see \"Note 2 -- Merger of Price and Costco\" to the consolidated financial statements.\nIn fiscal 1995 and 1994, the effective income tax rate on income from continuing operations before provision for income taxes was 41.0% (excluding the merger and restructuring charges in fiscal 1994).\nDISCONTINUED OPERATIONS\nIncome from discontinued real estate operations is not included in operating results for periods subsequent to the announcement date (fourth quarter of fiscal 1994) and through the date of disposal (second quarter of fiscal 1995). The fiscal 1994 loss on discontinued real estate operations (net of operating expenses and taxes) included 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 $.22 per share) related to a change in calculating estimated losses for assets which were considered to be economically impaired. This change in accounting estimates resulted 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 were significantly different than the strategies of the Company.\nDiscontinued operations in fiscal 1995 includes a non-cash charge of $83,363 or $.37 per share, reflecting the final calculation for the loss on disposal of the discontinued real estate operations. Fiscal 1994 includes a $182,500 or $.83 per share charge for the estimated loss on the disposal of the discontinued real estate operations. These charges relate 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. The Exchange Transaction was completed on December 20, 1994, and the estimated loss on disposal was adjusted to actual. For a more detailed discussion of the Exchange Transaction, see \"Note 3 -- Spin-off of Price Enterprises, Inc. and Discontinued 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 reflected 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). The fiscal 1994 net loss included the provision for merger and restructuring costs of $120,000 pre-tax ($80,000 or $.36 per share after tax), a non-cash 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, and a non-cash 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 eight warehouses closed during fiscal 1994 that were in operation during fiscal 1993; and (ii) increased sales at 37 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 affect 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 a continued strong membership base at existing warehouses, membership sign-ups at the 29 new warehouses and an annualized effect of membership fee increases in certain markets implemented in fiscal 1993.\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 29 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 $28,172 or 0.19% of net sales during fiscal 1993, and $24,564 or 0.15% of net sales during fiscal 1994. 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 included $5,750 (pre-tax) related to settlement of a\nlease 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 replaced by new warehouses. This compared 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\nIncome from discontinued real estate operations (net of operating expenses and taxes) was $20,404 or $.08 per share in fiscal 1993, compared to a loss from discontinued real estate operations of $40,766 or $.19 per share in fiscal 1994. Discontinued real estate operations include the results of income producing properties, gains on sale of property, and interest income. In fiscal 1994 the results included a provision of $90,200 pre-tax of which $80,500 pre-tax ($47,500 after tax or $.22 per share) related to a change in calculating estimated losses for assets which are considered to be economically impaired.\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, related 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 \"Note 3 -- Spin-off of Price Enterprises, Inc. and Discontinued Operations.\"\nRECENT SALES RESULTS\nPriceCostco's net sales for the eight-week period ended October 29, 1995 were approximately $2,756,000 an increase of 9.2% from approximately $2,524,000 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 3 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, as well as additional capital for international expansion through investments in foreign subsidiaries and joint ventures.\nIn fiscal 1995, cash provided from operations was approximately $278,000. In June 1995, the Company issued $300,000 of 7 1\/8% Senior Notes due June 15, 2005 (the \"Senior Notes\"). The net proceeds from the sale of the Senior Notes were used to repay existing indebtedness incurred under the Company's $500,000 commercial paper program. The Senior Notes indenture contains limitations on the Company's and certain subsidiaries ability to create liens securing indebtedness and to enter certain sale-leaseback transactions. Cash flow from operations, borrowings under the Company's commercial paper program and the proceeds from the Senior Notes provided the primary sources of funds for additions to property and equipment for warehouse clubs and related operations of $531,000 and other investing activities related primarily to investments in unconsolidated joint ventures of $11,500.\nExpansion plans for the United States and Canada during fiscal 1996 are to open 20-25 new warehouse clubs. The Company also expects to continue expansion of its international operations. To date the Company has opened four warehouses in the United Kingdom through a 60%-owned subsidiary, and plans to open three to four additional United Kingdom units during fiscal 1996. Other markets are being assessed, particularly in the Pacific Rim, and include the planned opening of a warehouse club location in Taiwan during the summer of 1996.\nPriceCostco and its Mexico-based joint venture partner, Controladora Comercial Mexicana, each own a 50% interest in Price Club Mexico following the Company's acquisition of Price Enterprises' interest in Price Club Mexico in April, 1995. See \"Note 4 -- Acquisition of Price Enterprises' Interest in Price Club Mexico\" in Notes to Consolidated Financial Statements. As of September 3, 1995, Price Club Mexico operated 13 Price Club warehouses in Mexico.\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 $450,000 to $500,000 during fiscal 1996 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 and cash equivalents (which totaled $45,688 at September 3, 1995), short-term borrowings under revolving credit facilities and\/or commercial paper facilities, and other financing sources as required.\nThe Company has a domestic multiple-option loan facility with a group of 13 banks, which provides for borrowings of up to $500,000 or standby support for a $500,000 commercial paper program. Of this amount, $250,000 expires on January 30, 1996, 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 September 3, 1995, no amounts were outstanding under the loan facility and $51,965 was outstanding under the commercial paper program. The Company expects to renew for an additional one-year term the $250,000 portion of the loan facility expiring on January 30, 1996 at substantially the same terms.\nIn addition, the Company's wholly-owned Canadian subsidiary has a $103,000 commercial paper program supported by a bank credit facility with three Canadian banks, of which $63,000 will expire in April 1996 and $40,000 will expire in April 1999. The interest rate on bank borrowings is based on the prime rate or the \"Bankers' Acceptance\" rate. At September 3, 1995, no amounts were outstanding under the bank credit facility and $23,760 was outstanding under the Canadian commercial paper program.\nThe Company also has separate letter of credit facilities (for commercial and standby letters of credit), totaling approximately $196,000. The outstanding commitments under these facilities at September 3, 1995 totaled approximately $127,000, including approximately $51,000 in standby letters of credit 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 September 3, 1995, working capital totaled $9,000 compared to a working capital (deficit) of ($113,000) at August 28, 1994. This increase in net working capital is primarily related to reductions in notes payable of $74,000 as long-term debt proceeds were used to refinance certain short-term borrowings.\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 commerical paper program were used to finance: 1) additions to property and equipment for warehouse clubs and related operations of $475,000; 2) net inventory\ninvestment (merchandise inventories less accounts payable) of $66,000; and 3) other investing activities related primarily to net discontinued operations and investments in unconsolidated joint ventures, which together totaled approximately $73,500.\nITEM 8","section_7A":"","section_8":"ITEM 8 -- FINANCIAL STATEMENTS\nFinancial 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 February 1, 1996, 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 February 1, 1996, 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 February 1, 1996, 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 February 1, 1996, to be filed with the Commission pursuant to Regulation 14A. PART 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 Statement Schedules -- None.\n(b) No reports on Form 8-K were filed during the last quarter of the period covered by this Annual Report.\n3. Exhibits:\nThe required exhibits are included at the end of the Form 10-K Annual Report and are described in the Exhibit Index immediately preceding the first exhibit.\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 22, 1995\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 September 3, 1995 and August 28, 1994, and the related statements of operations, stockholders' equity and cash flows for the 53-week period ended September 3, 1995, and the 52-week periods ended August 28, 1994 and August 29, 1993. 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. We did not audit the financial statements of The Price Company and subsidiaries (Price), which statements reflect total revenues of 51% of the consolidated totals for the 52-week period ended August 29, 1993. Those 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 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 September 3, 1995 and August 28, 1994, and the results of its operations and its cash flows for the 53-week period ended September 3, 1995, and the 52-week periods ended August 28, 1994, and August 29, 1993 in conformity with generally accepted accounting principles.\nArthur Andersen LLP\nSeattle, Washington October 25, 1995\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 financial statements.\nPRICE\/COSTCO, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE 53 WEEKS ENDED SEPTEMBER 3, 1995 AND THE 52 WEEKS ENDED AUGUST 28, 1994, AND AUGUST 29, 1993 (IN THOUSANDS)\nThe accompanying notes are an integral part of these financial statements.\nPRICE\/COSTCO, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS IN THOUSANDS)\nThe accompanying notes are an integral part of these financial 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. Price and Costco primarily operate cash and carry membership warehouses.\nAs described more fully in \"Note 3 -- Spin-off of Price Enterprises, Inc. and Discontinued Operations,\" the Company treated the spin-off of its non-club real estate operations as discontinued operations in the fourth quarter of fiscal 1994.\nThe Company's investment in the Price Club Mexico joint venture and in other unconsolidated joint ventures that are less than majority owned are accounted for under the equity method.\nFISCAL YEARS\nThe Company reports on a 52\/53 week fiscal year basis which ends on the Sunday nearest August 31st. Fiscal year 1995 was 53 weeks and fiscal year 1994 and 1993 were each 52 weeks.\nCASH AND CASH EQUIVALENTS\nThe Company considers all investments in highly liquid debt instruments maturing within 90 days after purchase 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 $16,150 at September 3, 1995, $6,650 at August 28, 1994, and $9,250 at August 29, 1993.\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\nReceivables consist primarily of vendor rebates and promotional allowances and other miscellaneous amounts due to the Company, and are net of allowance for doubtful accounts of $4,628 at September 3, 1995 and $3,045 at August 28, 1994.\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 $3,275 in fiscal 1995, $5,209 in fiscal 1994 and $5,423 in fiscal 1993. The amount of capitalized interest relating to the discontinued real estate operations for fiscal 1994 and 1993 was $1,961 and $4,060, respectively.\nGOODWILL\nGoodwill, included in other assets, totaled $51,063 at September 3, 1995 and $38,761 at August 28, 1994 and resulted from certain previous business combinations and the purchase of Price Enterprises' interest in Price Club Mexico in March 1995. Goodwill is being amortized over 5 to 40 years using the straight-line method. Accumulated amortization was $7,016 at September 3, 1995 and $5,986 at August 28, 1994.\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 1995 and 1993, 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 1995, 1994 and 1993 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, major remodels\/expansion, 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. It 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.\nSUPPLEMENTAL DISCLOSURE OF NON-CASH ACTIVITIES\nFISCAL 1995 NON-CASH ACTIVITIES\n- During December 1994, the Company exchanged 23,224,028 shares of Price Enterprises common stock valued at $282,462 for an equal number of shares of Price Costco common stock.\n- In February 1995, the Company exchanged 3,775,972 shares of Price Enterprises common stock valued at $45,925 for an interest-bearing note receivable from Price Enterprises due in December 1996.\n- As of August 28, 1994, the net assets of Price Enterprises consisted primarily of the discontinued operations net assets of $377,085 and certain other assets. In connection with the spin-off of Price Enterprises, all of these assets were eliminated from the consolidated balance sheet during fiscal 1995. For additional information see \"Note 3 -- Spin-off of Price Enterprises, Inc. and Discontinued Operations.\"\n- In April 1995, the Company purchased Price Enterprises' 25.5% interest in Price Club Mexico for $30,500 by a partial offset to the $45,925 note receivable due from Price Enterprises.\n- During fiscal 1995, the company increased its investment in certain unconsolidated joint ventures by $23,100 through reductions of accounts receivable due from those joint ventures.\nFISCAL 1994 NON-CASH ACTIVITIES\n- During fiscal 1994, the Company transferred approximately $127,055 of property and equipment and other assets to its discontinued non-club real estate operations.\nFISCAL 1993 NON-CASH ACTIVITIES\n- During fiscal 1993, the Company transferred approximately $72,093 of property and equipment and other assets to its discontinued non-club real estate operations.\nPRICE\/COSTCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)\nNOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) DERIVATIVES\nThe Company has limited involvement with derivative financial instruments and only uses them to manage well-defined interest rate and foreign exchange risks. Forward foreign exchange contracts are used to hedge the impact of fluctuations of foreign exchange on inventory purchases. The amount of interest rate and foreign exchange contracts outstanding at year-end or in place during fiscal 1995 was immaterial to the Company's results of operations or its financial position.\nRECENT ACCOUNTING PRONOUNCEMENTS\nIn March 1995, the Financial Accounting Standards Board issued Statement No. 121 (\"SFAS No. 121\") on accounting for the impairment of long-lived assets, certain identifiable intangibles, and goodwill related to assets to be held and used. SFAS No. 121 also establishes accounting standards for long-lived assets and certain identifiable intangibles to be disposed of. The Company is required to adopt SFAS No. 121 no later than fiscal 1996. The Company has not yet determined when SFAS No. 121 will be adopted or what the impact of adoption will be on the carrying value of its long-lived and related intangible assets.\nIn November 1995, the Financial Accounting Standards Board issued Statement No. 123, \"Accounting for Stock-Based Compensation\" (\"SFAS No. 123\"), which established financial accounting and reporting standards for stock-based employee compensation plans. SFAS No. 123 specifies a fair value based method of accounting for stock-based compensation plans and encourages (but does not require) entities to adopt that method in place of the provisions of APB Opinion 25, \"Accounting for Stock Issued to Employees\". The Company has not yet determined which method of accounting will be used or what impact the adoption of the accounting requirements of SFAS No. 123 might have on the Company's results of operations.\nRECLASSIFICATIONS\nCertain reclassifications have been reflected in the financial statements in order to conform prior years to the current year presentation.\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 PriceCostco (the \"Merger\"). PriceCostco was formed to effect the Merger which 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 Merger 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 are as follows:\nNOTE 3 -- SPIN-OFF OF PRICE ENTERPRISES, INC. AND DISCONTINUED OPERATIONS On 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 was 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.\" Pursuant to the Transfer and Exchange Agreement, PriceCostco offered 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\").\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) of $182,500 as a result of entering into the Transfer and Exchange Agreement. The loss also included 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.\nThe Exchange Transaction was completed on December 20, 1994, with 23,224,028 shares of PriceCostco Common Stock tendered and exchanged for an equal number of shares of Price Enterprises Common Stock. On February 9, 1995 Price Enterprises purchased from PriceCostco 3,775,972\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) shares of Price Enterprises Common Stock, constituting all of the remaining shares of Price Enterprises Common Stock held by PriceCostco. Price Enterprises issued to PriceCostco a secured promissory note in the amount of $45,925 due in December 1996 as payment for such shares, based on an average closing sales price $12.1625 of Price Enterprises Common Stock. The price per share of Price Enterprises Common Stock represented 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.\nBased on the aggregate number of shares of Price Enterprises Common Stock (27 million shares) exchanged for PriceCostco Common Stock and sold to Price Enterprises for a secured promissory note and an average closing sales price of $12.1625 per share for Price Enterprises Common Stock, the loss on disposal of the discontinued real estate operations increased by $83,363 (27 million shares multiplied by $3.0875 per share representing the difference between the estimated and actual price per share). This non-cash charge was reflected as an additional loss on disposal of discontinued operations in the second quarter ended May 7, 1995.\nThe following real estate related assets were 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 Price Club warehouses (\"Warehouse Properties\") which were adjacent to existing non-club real estate properties, which are now 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 transferred to Price Enterprises 51% of the outstanding capital stock of Price Quest, Inc. (\"Price Quest\") and Price Global Trading, Inc. (\"Price Global\"). Price Quest operates the Quest interactive electronic shopping business and provides other services to members. Price Global has the rights to develop membership warehouse club businesses in certain geographical areas specified in the Transfer and Exchange Agreement.\nPriceCostco also transferred to Price Enterprises a 25.5% interest in the Price Club Mexico joint venture. This interest was subsequently acquired from Price Enterprises in fiscal 1995. Price Club Mexico is a joint venture with Controladora Comercial Mexicana, S.A. de CV. operating Price Clubs in Mexico. See \"Note 4 -- Acquisition of Price Enterprises' Interest in Price Club Mexico.\"\nPriceCostco and Price Enterprises entered into an unsecured revolving credit agreement under which PriceCostco agreed to advance Price Enterprises up to a maximum principal amount of $85,000. All amounts have been paid under this agreement and PriceCostco no longer has any obligations to provide financing for Price Enterprises.\nDISCONTINUED OPERATIONS\nHistorically, the Company treated non-club real estate investments as a separate reportable business segment. The primary assets generating operating income for the segment were non-club real estate properties, consisting of property owned directly and property owned by real estate joint\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) venture partnerships in which the Company had a controlling interest. Real estate joint ventures related to real estate partnerships that were less than majority owned. In fiscal 1994, the Atlas Note was purchased and the related interest income was included in the non-club real estate segment.\nAdditionally, the Warehouse Properties and City Notes transferred to Price Enterprises as of August 28, 1994 were included in the net assets of the discontinued operations as of August 28, 1994, in the accompanying consolidated balance sheet. 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 Price Quest, Price Global and the 25.5% interest in the Price Club Mexico joint venture 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 sheet at August 28, 1994 consisted of the following:\nINCOME (LOSS) FROM DISCONTINUED OPERATIONS\nComponents of net income (loss) from discontinued operations for fiscal 1994 and 1993, prior to the effective date of the Exchange Transaction, 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\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) 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 believed 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 Enterprises 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. 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.\nDuring fiscal 1993, the Company entered into two transactions with The Price 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.\nRELATED PARTY TRANSACTIONS\nJoseph Kornwasser, a former 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\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) K & F. On August 12, 1993, Mr. Kornwasser became Chief Executive Officer and director of The Price REIT. On that date, The Price REIT also obtained the right to acquire certain of the partnership interest of K & F described above. On August 28, 1994, the Company purchased both K & F's interest in the two partnerships and its rights under the Development Agreement for a total of $2,500.\nNOTE 4 -- ACQUISITION OF PRICE ENTERPRISES' INTEREST IN PRICE CLUB MEXICO In April 1995, the Company purchased Price Enterprises' 25.5% interest in Price Club Mexico for $30,500. The purchase price was paid by a partial offset of the $45,925 secured promissory note owed to PriceCostco by Price Enterprises (see \"Note 1 -- Summary of Significant Accounting Policies\"). As a result of the purchase, the Company owns a 50% interest in the Price Club Mexico joint venture. Controladora Comercial Mexicana owns the other 50% interest in the Price Club Mexico joint venture. In January 1995, PriceCostco assumed management responsibility over operations, merchandising and site acquisitions for Price Club Mexico.\nNOTE 5 -- DEBT\nSHORT-TERM BORROWINGS\nThe company has a domestic multiple option loan facility with a group of 13 banks which provides for borrowings of up to $500,000 or standby support for a $500,000 commercial paper program. Of this amount, $250,000 expires on January 30, 1996, 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 September 3, 1995, no amounts were outstanding under the loan facility and $51,965 was outstanding under the Company's commercial paper program. The Company expects to renew for an additional one-year term the $250,000 portion of the loan facility expiring on January 30, 1996, at substantially the same terms. The weighted average borrowings, highest borrowings and interest rate under all short-term borrowing arrangements were as follows for fiscal 1995, 1994 and 1993:\nPRICE\/COSTCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)\nNOTE 5 -- DEBT (CONTINUED) In addition, the Company's wholly-owned Canadian subsidiary has a $103,000 commercial paper program supported by a bank credit facility with three Canadian banks of which $63,000 will expire in April 1996 and $40,000 will expire in April 1999. The interest rate on bank borrowings is based on the prime rate or the \"Bankers' Acceptance\" rate. At September 3, 1995, no amounts were outstanding under the bank credit facility and $23,760 was outstanding under the Canadian commercial paper program.\nThe Company has separate letter of credit facilities (for commercial and standby letters of credit) totaling approximately $196,000. The outstanding commitments under these facilities at September 3, 1995 totaled approximately $127,000, including approximately $51,000 in standby letters for workers' compensation requirements.\nLONG-TERM DEBT\nLong-term debt at September 3, 1995 and August 28, 1994 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.\nThe 5 3\/4% convertible subordinated debentures due May 2002 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.\nThe 6 3\/4% convertible subordinated debentures are convertible into shares of PriceCostco common stock at any time on or before March 2001, unless previously redeemed, at a conversion price of $22.54 per share, subject to adjustment in certain events. Interest on the debentures 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. During fiscal 1994 in connection with the Merger, approximately $2,421 of these debentures were purchased at their face value.\nThe 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 debentures provide for payments to an annual sinking fund in the amount of 5% of the original principal amount ($10,000), commencing February 1998, calculated to retire 70% of the principal\nPRICE\/COSTCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)\nNOTE 5 -- DEBT (CONTINUED) amount prior to maturity. During fiscal 1990, the Company repurchased debentures with a face value of $20,597 and will apply this purchase to the initial sinking fund payments. Interest is payable semiannually on February 28 and August 31.\nThe 7 1\/8% Senior Notes were issued on June 7, 1995. Interest on the notes is payable semiannually on June 15 and December 15. The indentures contain limitations on the Company's and certain subsidiaries' ability to create liens securing indebtedness and to enter into certain sale leaseback transactions.\nAt September 3, 1995, 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 $276,000, $291,000, and $173,000 respectively. Early retirement of these debentures would result in the Company paying a call premium. The fair value of the 7 1\/8% Senior Notes, based on market quotes on September 3, 1995, were approximately $302,000. The Senior Notes are not redeemable prior to maturity.\nMaturities of long-term debt during the next five fiscal years and thereafter are as follows:\nNOTE 6 -- LEASES The Company leases land and\/or warehouse buildings at 49 warehouses open at September 3, 1995 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 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 1995, 1994 and 1993 was $53,600, $44,900, and $38,700, respectively. Future minimum payments during the next five fiscal years and thereafter under noncancelable leases with terms in excess of one year, at September 3, 1995, were as follows:\nPRICE\/COSTCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)\nNOTE 7 -- 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 upon vesting. 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:\nThe 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.\nStock option and grant transactions relating to the New Stock Option Plan are summarized below:\nA foreign subsidiary of the Company has a separate stock option plan whereby employees of the subsidiary receive stock option grants of subsidiary stock. At September 3, 1995, stock option grants were approximately 1% of the subsidiary's outstanding shares.\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\nPRICE\/COSTCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)\nNOTE 7 -- STOCK OPTIONS AND WARRANTS (CONTINUED) period from the date of issuance and were exercisable up to eight years and one month from the grant date. A total of 532,500 warrants have been exercised. The remaining 532,500 warrants were cancelled during fiscal 1995.\nNOTE 8 -- RETIREMENT PLANS On January 1, 1995, the Company amended and restated The Price Company Retirement Plan, The Price Company 401(k) Plan and the Costco Wholesale 401(k) Plan into the PriceCostco 401(k) Retirement Plan. This new plan is available to all U.S. employees who have one year or more of service except California union employees. The plan allows pre-tax deferral against which the Company matches 50% of eligible employee contributions up to a maximum Company contribution per employee per year. In addition, the Company will provide each participant a contribution based on salary and years of service. The Company has a defined contribution plan for Canadian Price, Canadian Costco and United Kingdom Costco employees and contributes a percentage of each employee's salary.\nCalifornia union employees participate in a defined contribution plan sponsored by its union. The Company makes contributions based upon its union agreement. In June 1995, the Company also established a 401(k) plan for the California union employees. The Company matches 25% of eligible employee contributions up to a maximum Company contribution per employee per year.\nAmounts expensed under these plans were $37,298, $27,859, and $26,609 for fiscal 1995, 1994 and 1993, respectively. The Company has defined contribution 401(k) and retirement plans only and thus has no liability for postretirement benefit obligations under the Financial Accounting Standards Board Statement No. 106 \"Employer's Accounting for Postretirement Benefits Other than Pensions.\"\nNOTE 9 -- INCOME TAXES The provisions for income taxes from continuing operations for fiscal 1995, 1994, and 1993 are as follows:\nPRICE\/COSTCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)\nNOTE 9 -- INCOME TAXES (CONTINUED) A reconciliation between the statutory tax rate and the effective rate from continuing operations for fiscal 1995, 1994 and 1993 is as follows:\nThe components of the deferred tax assets and liabilities related to continuing operations are as follows:\nThe net deferred tax (assets) liabilities at September 3, 1995 and August 28, 1994 include current deferred income tax assets of $56,909 and $54,717, respectively, and non-current deferred income tax liabilities of $64,293 and $65,679, respectively.\nNOTE 10 -- 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.\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 Complaint alleged violation of certain state and federal laws during the time period prior to Price's earnings release for the second quarter of fiscal year 1992. 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 filed an Appeal in the Ninth Circuit Court of Appeals. In an opinion dated November 20, 1995, the Ninth Circuit reversed and remanded the lawsuit. The Company believes that this lawsuit is without merit\nPRICE\/COSTCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)\nNOTE 10 -- COMMITMENTS AND CONTINGENCIES (CONTINUED) and is vigorously defending the lawsuit. 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.\nOn December 19, 1994, a Complaint was filed against PriceCostco in an action entitled SNYDER V. PRICE\/COSTCO, INC. ET. AL., Case No. C94-1874Z, United States District Court, Western District of Washington. On January 4, 1995, a Complaint was filed against PriceCostco in an action entitled BALSAM V. PRICE\/COSTCO, INC. ET. AL., Case No. C95-0009Z, United States District Court, Western District of Washington. The Snyder and Balsam Cases were subsequently consolidated and on March 15, 1995, plaintiffs' counsel filed a First Amended And Consolidated Class Action And Derivative Complaint. On November 9, 1995, plaintiff's counsel filed a Second Amended And Consolidated Class Action And Derivative Complaint. The Second Amended Complaint alleges violation of certain state and federal laws arising from the spin-off and Exchange Transaction and the merger between Price and Costco. The Company believes that this suit is without merit and is vigorously defending the lawsuit. 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 11 -- GEOGRAPHIC INFORMATION The following table indicates the relative amounts of total revenue, operating income and identifiable assets for the Company during fiscal 1995, 1994 and 1993:\nPRICE\/COSTCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)\nNOTE 12 -- QUARTERLY FINANCIAL DATA (UNAUDITED) The tables that follow on the next two pages reflect the unaudited quarterly results of operations for fiscal 1995 and 1994.\nShares used in the earnings per share calaculation fluctuate by quarter depending primarily upon whether convertible subordinated debentures are dilutive during the respective period.\nPRICECOSTCO, INC. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED) (DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)\nPRICECOSTCO, INC. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)\nEXHIBIT INDEX\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 the end of this exhibit index for a listing of cross reference documents.\n- ------------------------\n(1) Registration Statement of The Price Company on Form SE filed February 12, 1987 is hereby incorporated by reference\n(2) Registration Statement of The Price Company on Form S-3 (File No. 33-38966) filed February 27, 1991 is hereby incorporated by reference\n(3) Incorporated herein by reference to the identical exhibit filed as part of The Price Company's Form 10-K for the fiscal year ending August 31, 1991\n(4) Incorporated by reference to the Registration Statement of Price\/Costco, Inc. Form S-4 (File No. 33-50359) dated September 22, 1993\n(5) Incorporated by reference to Costco's Registration Statement on Form S-3 (File No. 33-47750) filed May 22, 1992\n(6) Incorporated by reference to Schedule 13E-4 of The Price Company and Price\/Costco, Inc. filed November 4, 1993\n(7) Incorporated by reference to the exhibits filed as part of Amendment No. 1 to the Registration Statement on Form 8-A of The Price Company\n(8) Incorporated by reference to the exhibits filed as part of Amendment No. 2 to the Registration Statement on Form 8-A of Costco\n(9) Incorporated by reference to the exhibits filed as part of the Annual Report on Form 10-K\/A of Price\/Costco, Inc. for the fiscal year ended August 29, 1993\n(10) Incorporated by reference to the exhibits filed as part of the Registration Statement on Form S-4 of Price Enterprises, Inc. (File No. 33-55481) filed on September 15, 1994\n(11) Incorporated by reference to the exhibits filed as part of Amendment No. 1 to the Registration Statement on Form S-4 of Price Enterprises, Inc. (File No. 33-55481) filed on November 3, 1994\n(12) Incorporated by reference to the exhibits filed as part of the Quarterly Report on Form 10-Q of Price\/Costco, Inc. for the 12 weeks ended February 13, 1994\n(13) Incorporated by reference to the exhibits filed as part of the Registration Statement on Form S-3 of Price\/Costco, Inc. (File No. 33-59403) filed on May 17, 1995.\n(14) Incorporated by reference to the exhibits filed as part of the Annual Report on Form 10K of Price\/ Costco, Inc. for the fiscal year ended August 28, 1994.","section_15":""}
{"filename":"200776_1995.txt","cik":"200776","year":"1995","section_1":"ITEM 1. BUSINESS\nFirst Commonwealth Corporation (the \"Registrant\") was incorporated in 1967, under the laws of the State of Virginia to serve as an insurance holding company. At December 31, 1995, the parent, significant majority-owned subsidiaries and affiliates of the Registrant were as depicted on the following organizational chart:\nORGANIZATIONAL CHART AS OF DECEMBER 31, 1995\nUnited Trust, Inc. (\"UTI\") is the ultimate controlling company. UTI owns 53% of United Trust Group (\"UTG\") and 30% of United Income, Inc. (\"UII\"). UII owns 47% of UTG. UTG owns 72% of First Commonwealth Corporation (\"FCC\"). FCC owns 100% of Universal Guaranty Life Insurance Company (\"UG\"). UG owns 100% of United Security Assurance Company (\"USA\"). USA owns 84% of Appalachian Life Insurance Company (\"APPL\") and APPL owns 100% of Abraham Lincoln Insurance Company (\"ABE\").\n(a) GENERAL\nThe Registrant and its subsidiaries (the \"Company\") operate principally in the individual life insurance business. The primary business of the Company has been the servicing of existing insurance business in force, the solicitation of new insurance business, and the acquisition of other companies in similar lines of business.\nIn September 1989, APPL acquired Farmers and Ranchers Life Insurance Company (\"F&R\"). This company was purchased primarily as a marketing opportunity. It had very few policies in force and limited assets. However, it is loosely affiliated with the Oklahoma Farmers Union which has over 300,000 members. The Company planned for F&R to market to these members.\nOn December 11, 1989, FCC acquired UG and Alliance Life Insurance Company (\"ALLI\"). At the time of this acquisition the Company effectively doubled in size to $230 million in assets. These companies also had marketing forces that had successfully written new business for the last few years prior to the acquisition.\n(b) CHANGE IN CONTROL\nOn June 16, 1992, certain shareholders of CIC sold their CIC Shares to UTG in exchange for cash and promissory notes of UTG (the \"UTG Notes\") in the aggregate amount of $15,478,570.15. At the closing of the CIC Stock Purchase Agreement on June 16, 1992, UTG became the owner of 6,771 shares (approximately 77%) of CIC common stock and options to purchase 1,300 shares of CIC common stock. UTG exercised the options and became the holder of 8,071 shares (80%) of the outstanding stock of CIC. CIC then issued 315 shares of CIC common stock to UGIC and 2,730 shares of CIC common stock to FCC to extinguish debt, which reduced the percentage of CIC common stock held by UTG to 62%.\nIn a separate transaction, on June 16, 1992, UTG also purchased 729 shares (7%) of the issued and outstanding shares of common stock of CIC from James E. Melville for a purchase price of $1,946.28 per share. The total purchase price for the shares was $1,418,840 evidenced by UTG's twenty year 8 1\/2% promissory note in that amount. At the closing of this sale, UTG became the owner of approximately 67% of the outstanding shares of common stock of CIC.\nCIC owned approximately 58% of the outstanding common stock of ITI, which, in turn, owned 100% of the outstanding common stock of ITAC. ITAC owned approximately 65% of the outstanding common stock of UGIC, which in turn owned approximately 93% of the outstanding common stock of FCC prior to the closing. At the closing, control of CIC changed from John K. Cantrell and Mildred G. Cantrell to UTG. Because of its stock ownership of CIC, UTG may be deemed, under the beneficial ownership rules of the Securities and Exchange Commission, to be the beneficial owner of the stock owned by CIC, ITI, ITAC, and UGIC. Therefore, at the date of the closing of the CIC Stock Purchase Agreement, the control of FCC also changed to UTG.\nAlso on June 16, 1992, pursuant to the terms of an FCC-UTG Stock Purchase Agreement, UTG contributed $6,000,000 of FCC Senior Debt for retirement and all of the outstanding capital stock of United Trust Assurance Company (\"UTAC\") and USA to FCC in exchange for the FCC Notes, $3,300,000 in cash and 11,134,000 shares of FCC common stock (the \"FCC Shares\"). Upon the issuance of the FCC Shares, in addition to the outstanding shares of FCC common stock which may be deemed to be beneficially owned by UTG, UTG will also have a direct ownership interest in the FCC Shares which represented approximately 45.74% of the issued and outstanding common stock of FCC.\n(c) RESTRUCTURING OF AFFILIATES\nThe Company has taken several steps to streamline and simplify the corporate structure following the acquisitions.\nOn December 28, 1992, UG was the surviving company to a merger with Roosevelt National Life Insurance Company (\"RNLIC\"), United Trust Assurance Company (\"UTAC\") and Cimarron Life Insurance Company (\"CIM\"). On June 30, 1993, Alliance Life Insurance Company (\"ALLI\"), a subsidiary of UG, was merged into UG.\nOn March 30, 1994, Farmers and Ranchers Life Insurance Company (\"F&R\") was sold to an unrelated third party. F&R was a small life insurance company which did not significantly contribute to the operations of the group. F&R primarily represented a marketing opportunity. The Company determined it would not be able to allocate the time and resources necessary to properly develop the opportunity, due to continued focus and emphasis on certain other agency forces of the Company.\nThe transactions described below, which transpired during 1994, were necessary to position Universal Guaranty Investment Company (\"UGIC\"), Investors Trust, Inc. (\"ITI\") and Commonwealth Industries Corporation (\"CIC\") for liquidation and dissolution.\nPursuant to an Agreement of Merger dated July 7, 1994 between Investors Trust Assurance Company, an Illinois life insurance company (\"ITAC\"), and ALIC, on July 31, 1994, ITAC merged with and into ALIC and ALIC was the surviving company. On the effective date of the merger, ALIC succeeded to all the rights and property of ITAC and assumed all of the liabilities and obligations and became subject to all of the debts of ITAC in the same manner as if ALIC had itself incurred them. The merger was approved by the Illinois Director of Insurance.\nPrior to the merger of ITAC with and into ALIC, ITAC was a wholly owned subsidiary of ITI. ITAC owned 1,549,549 (approximately 66%) of the issued and outstanding common stock of UGIC. Prior to July 31, 1994, ITI was the indirect beneficial owner of the shares of UGIC common stock directly owned by ITAC. On July 31, immediately prior to the effectiveness of the merger of ITAC with and into ALIC, ITI purchased 758,946 shares of the UGIC common stock owned by ITAC. The total purchase price was $2,276,793. On July 31, 1994, ITAC also transferred to ITI at no cost 790,603 shares of the common stock of the Company. On such date, ITI became the direct beneficial owner of all 1,549,549 shares of the common stock of UGIC. In order to purchase the 758,946 shares of UGIC common stock, ITI received a loan from UTI and UII in the aggregate principal amount of $2,164,293. ITI transferred 721,431 shares of the common stock of UGIC that it purchased from ITAC to UTI and UII in payment of the loan. These shares were then contributed by UTI and UII to their subsidiary, UTG.\nThe balance sheet of Commonwealth Industries Corporation for the period ended July 31, 1994, included liabilities in the aggregate amount of $402,861 comprised of a future liability under a consulting agreement, escheat funds and an account payable. On July 31, 1994, these liabilities were assumed by UTG in exchange for 1,558,318 shares of the common stock of ITI.\nThe balance sheet of UGIC for the period ended July 31, 1994, included liabilities in the aggregate amount of $461,102. On July 31, 1994, these liabilities were assumed by UTG in exchange for 106,392 shares of the common stock of FCC and 315 shares of the common stock of CIC. The FCC shares transferred reduced UGIC's percentage ownership of FCC from 50.396% to 49.959%.\nPrior to these transactions, UGIC, ITI and CIC each had liabilities in excess of assets excluding the stock holdings of their respective subsidiary. The 1994 transactions enabled the companies to extinguish their liabilities.\nOn August 15, 1995, the shareholders of CIC, ITI, and UGIC voted to voluntarily liquidate each of the companies and distribute the assets to the shareholders (consisting solely of common stock of their respective subsidiary). As a result of the liquidations, the shareholders of each company became shareholders of FCC, following the liquidations, UTG holds 72% of the common stock of FCC.\nPRODUCTS\nThe Company's portfolio consists of three universal life insurance products. The primary universal life insurance product is referred to as the \"Century 2000\". This product was introduced to the marketing force in 1993 and has become the cornerstone of current marketing. This product has a minimum face amount of $25,000. The product currently credits 6% interest with a guaranteed rate of 4.5% in the first 20 years and 3% in years 21 and greater. The policy values are subject to a $4.50 monthly policy fee, an administrative load and a premium load of 6.5% in all years. The administrative load and surrender charge are based on the issue age, sex and rating class of the policy. A surrender charge is effective for the first 14 policy years. In general, the surrender charge is very high in the first couple of years and then declines to zero at the end of 14 years. Policy loans are available at 7% interest in advance. The policy's accumulated fund will be credited the guaranteed interest rate in relation to the amount of the policy loan.\nThe second product, referred to as the \"Eagle USL 400\" has a minimum face amount of $50,000 with a 3% load on all premiums and a policy fee of $4.75 per month. This product is sold at issue ages of 0-18. The Eagle USL 400 currently credits 6% interest and 4% guaranteed interest rate. Partial withdrawals are allowed after the first policy duration. Partial withdrawals are allowed once a year subject to a $25 fee. Partial withdrawals are subject to a minimum of $500 cash surrender value remaining. Policy loans are charged 8% interest in arrears with the loaned value receiving the 4% guaranteed rate. Surrender charges are based on a percentage of target premium starting at 150% for years 1-5 and decreasing 10% each year thereafter until year 15 when it becomes zero.\nThe third universal life product was designed in 1990 and introduced for sale in the fourth quarter of that year. This product, referred to as the \"UL90A\", has a minimum face amount of $25,000. The administrative load is based on the issue age, sex and rating class of the policy. Policy fees vary from $1 per month in the first year to $4 per month in the second and third years and $3 per month each year thereafter. The UL90A currently credits 6% interest and 4.5% guaranteed interest rate. Partial withdrawals are allowed after the first duration. Partial withdrawals are allowed once a year subject a $25 fee. A partial withdrawal is subject to a minimum of $500 cash surrender value remaining. Policy loans are available at 7% interest in advance. The policy's accumulated fund will be credited the guaranteed interest rate in relation to the amount of the policy loan. Surrender charges are based on a percentage of target premium starting at 120% for years 1-5 then grading downward to zero in year 15. This policy contains a guaranteed interest credit bonus for the long term policyholder. From years 10 through 20, additional interest bonuses are earned with a total in the twentieth year of 1.375%. The bonus is calculated from the policy issue date and is contractually guaranteed.\nThe Company markets other products, none of which is significant to the operations of the Company. In late 1994, the Company discontinued marketing interest sensitive whole life insurance and traditional participating whole life insurance policies. The Company has a variety of policies in force different from those which are currently being marketed. Approximately 34% of the insurance in force is participating business. The Company's average persistency rate for all policies in force for 1995 and 1994 has been approximately 87.5% and 86.3%, respectively. The Company does not anticipate any material fluctuations in these\nrates in the future that may result from competition.\nThe Company's experience for earned interest, persistency and mortality vary from the assumptions applied to pricing and determining premiums. Accordingly, differences between the Company's experience and those assumptions applied may impact the profitability of the Company. The minimum interest spread between earned and credited rates is 1% on the \"Century 2000\" universal life insurance product, the Company's primary product. The Company monitors investment yields, and when necessary takes action to reduce credited interest rates on its insurance products to preserve targeted interest spreads. Credited rates are reviewed and established by the Board of Directors.\nThe premium rates are competitive with other insurers doing business in the states in which the Company is marketing its products.\nMARKETING\nThe Company markets its products through separate and distinct agency forces. The Company has approximately 100 independent agents who actively write new business. No individual sales agent accounted for over 10% of the Company's premium volume in 1995. The Company's sales agents do not have the power to bind the Company.\nThe change in marketing strategy from traditional life insurance products to universal life insurance products had a significant impact on new business production. As a result of the change in marketing strategy the agency force went through a restructure and retraining process. Marketing is based on a referral network of community leaders and shareholders of UII and UTI. Recruiting of new agents is also based on the same referral network.\nNew sales are marketed by UG and USA through their agency forces using contemporary sales approaches with personal computer illustrations. Current marketing efforts are primarily focused on the Midwest region.\nRecruiting agents is based on obtaining people with little or no experience in the life insurance business. These recruits go through an extensive internal training program.\nUSA is licensed in Illinois, Indiana and Ohio. During 1995, Ohio accounted for 99% of USA's direct premiums collected.\nALIC is licensed in Alabama, Arizona, Illinois, Indiana, Louisiana and Missouri. During 1995, Illinois and Indiana accounted for 47% and 33%, respectively of ALIC's direct premiums collected.\nAPPL is licensed in Alabama, Arizona, Colorado, Georgia, Illinois, Indiana, Kansas, Kentucky, Louisiana, Missouri, Montana, Nebraska, Ohio, Oklahoma, Tennessee, Utah, Virginia, West Virginia and Wyoming. During 1995, West Virginia accounted for 95% of APPL's direct premiums collected.\nUG is licensed in Alabama, Arizona, Arkansas, Colorado, Delaware, Florida, Georgia, Idaho, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Massachusetts, Michigan, Minnesota, Mississippi, Missouri, Montana, Nebraska, Nevada, New Mexico, North Carolina, North Dakota, Ohio, Oklahoma, Oregon, Pennsylvania, Rhode Island, South Carolina, South Dakota, Tennessee, Texas, Utah, Virginia, Washington, West Virginia and Wisconsin. During 1995, Illinois and Ohio accounted for 32% and 16%, respectively, of UG's direct premiums collected. No other states account for more than 6% of UG's direct premiums collected.\nUNDERWRITING\nPolicies are issued by the Company based upon underwriting practices established for each market in which the Company operates. Most policies are individually underwritten. Applications for insurance are reviewed to determine additional information required to make an underwriting decision, which depends on the amount of insurance applied for and the applicant's age and medical history. Additional information may include medical examinations, statements from doctors who have treated the applicant in the past and, where indicated, special medical tests. After reviewing the information collected, the Company either issues the policy as applied for or rejects the application.\nRESERVES AND REINSURANCE\nThe Company establishes reserves for future policy benefits, unearned premiums, reported claims and claims incurred but not reported. Such reserves are based on regulatory accounting requirements and generally accepted accounting principles.\nThe Company reinsures its insurance products with other insurance companies under agreements of reinsurance. Reinsurance agreements are intended to limit the Company's maximum loss and provide other financial benefits. The ceding of reinsurance does not discharge the Company's primary liability to the insured, however it is the practice of insurers to reduce their financial statement liabilities to the extent that they have been reinsured with other insurance companies.\nIn selecting a reinsurance company, the Company examines many factors including:\n1) Whether the reinsurer is licensed in the states in which reinsurance coverage is being sought;\n2) the solvency and stability of the company. One source utilized is the rating given the reinsurer by the A.M. Best Company, an insurance industry rating company. Another source is the statutory annual statement of the reinsurer;\n3) the history and reputation of the Company;\n4) competitive pricing of reinsurance coverage. The Company generally seeks quotes from several reinsurers when considering a new treaty.\nOn existing reinsurance treaties, the Company monitors reinsurers through sources such as, the ratings provided by the A.M. Best Company, reinsurer financial statements and industry publications and literature.\nIn December 1991, UG entered into a 50% coinsurance arrangement with Republic Vanguard Life Insurance Company to enable the Company to maintain increased production levels while containing first year statutory costs. The ceding of new business under this treaty was terminated December 31, 1993. Republic Vanguard holds an \"A\" (Excellent) rating from A. M. Best, an industry rating company. The coinsurance arrangement, which was effective January 1, 1991, allowed UG to cede to Republic Vanguard a 50% quota share of all new universal life policies issued after the effective date through date of termination. UG receives a commission allowance of 11% of excess premium and renewal premium. Monies pertaining to the coinsurance arrangement are settled monthly. The agreement contains a provision whereby risks in excess of UG's retention ($125,000 maximum) are transferred to the reinsurer. Risks are transferred under an automatic ceding arrangement up to $1,000,000 and a facultative arrangement for amounts in excess of $1,000,000.\nIn December 1993, UG entered into reinsurance agreements with Business Men's Assurance Company, (\"BMA\") and Life Reassurance Corporation, (\"LIFE RE\"). BMA and LIFE RE each hold an \"A+\" (Superior) rating from A.M. Best, an industry rating company. The reinsurance arrangement was effective December 1, 1993, and covered all new business of the Company. The agreements are a yearly renewable term (\"YRT\") treaty where the Company cedes amounts above its retention limit of $100,000 with a minimum cession of $25,000.\nDuring 1993, USA entered into a coinsurance agreement with LIFE RE. The coinsurance arrangement allows USA to cede to LIFE RE a 50% quota share of the traditional participating policies issued by USA after the effective date of July 1, 1992. USA entered into the arrangement to enable the Company to maintain increased production levels while containing first year statutory costs. USA receives commission allowances of 150% of first year premium, 27% of second year premium, 32% of third year premium and 37% of fourth year and beyond. Monies pertaining to the coinsurance arrangement are settled monthly.\nThe Company does not have any short-duration reinsurance contracts. The effect of the Company's long duration reinsurance contracts on premiums earned in 1995, 1994 and 1993 was as follows:\nShown in thousands 1995 1994 1993 Premiums Premiums Premiums Earned Earned Earned\nAssumed 0 0 0 Ceded (5,203) (5,627) (8,630) Net premiums $ 29,998 $ 32,284 $ 30,727\nAs a result of amounts ceded to under reinsurance treaties, total life insurance in force was reduced by approximately $1.088 billion and $1.217 billion at December 31, 1995 and 1994, respectively. Ceded reinsurance premiums as a percentage of gross premium revenues were 15%, 15% and 22% in 1995, 1994 and 1993, respectively.\nINVESTMENTS\nEffective December 1992, the Investment Committee of the Board of Directors retained Alpha Advisors, Inc., of Chicago, Illinois, a registered investment advisor, to assist the Company in managing its investment portfolio. The Company may modify its present investment strategy at any time, provided its strategy continues to be in compliance with the limitations of state insurance department regulations.\nInvestment income represents a significant portion of the Company's total income. Investments are subject to applicable state insurance laws and regulations which limit the concentration of investments in any one category or class and further limit the investment in any one issuer. Generally, these limitations are imposed as a percentage of statutory assets or percentage of statutory capital and surplus of each company.\nThe following table reflects net investment income by type of investment.\nDecember 31, 1995 1994 1993 Fixed maturities and fixed maturities held for sale $ 13,292,552 $ 12,174,226 $ 10,759,045 Equity securities 52,445 3,999 228,762 Mortgage loans 1,257,189 1,408,558 1,708,842 Real estate 975,080 990,857 968,620 Policy loans 1,041,900 978,555 954,609 Short term investments 498,496 412,135 1,068,313 Collateral loans 0 0 5,121 Other 143,527 135,051 175,873 Total consolidated investment income 17,261,189 16,103,381 15,869,185 Investment expense (1,761,438) (1,914,920) (1,781,476) Consolidated net investment income $ 15,499,751 $ 14,188,461 $ 14,087,709\nAt December 31, 1995, the Company had a total of $7,703,000 of investments which did not produce income during 1995. The investments were comprised of $6,894,000 in real estate including its home office property and $809,000 in equity securities.\nThe following table summarizes the Company's fixed maturities distribution at December 31, 1995 and 1994 by ratings category as issued by Standard and Poor's, a leading ratings analyst.\nFixed Maturities\nRating % of Portfolio 1995 1994 Investment grade AAA 27% 23% AA 14% 9% A 48% 58% BBB 11% 10% Below investment grade 0% 0% 100% 100%\nThe following table summarizes the Company's fixed maturity holdings and fixed maturities held for sale by major classifications.\nCarrying Value 1995 1994 U.S. government and government agencies $ 29,209,267 $ 22,736,183 States, municipalities and political subdivisions 7,597,203 8,021,951 Collateralized mortgage obligations 15,428,596 19,114,044 Public utilities 59,219,088 57,587,697 Corporate 82,330,372 79,804,491 $ 193,784,526 $187,264,366\nThe following table shows the composition and average maturity of the Company's investment portfolio at December 31, 1995.\nCarrying Average Average Investments Value Maturity Yield\nFixed maturities and fixed maturities held for sale. . . . . $193,784,526 5 years 6.98% Equity securities. . . . . . . . . 1,946,481 not applicable 3.67% Mortgage loans . . . . . . . . . . 13,891,762 11 years 8.46% Investment real estate . . . . . . 17,015,988 not applicable 5.63% Policy loans . . . . . . . . . . . 16,941,359 not applicable 6.26% Short term investments . . . . . . 425,000 190 days 5.01% Total Investments . . . . . . . . $244,005,116 7.10%\nAt December 31, 1995, fixed maturities and fixed maturities held for sale have a market value of $202,179,000. Fixed maturities are carried at amortized cost. It is management's intent to hold these securities until maturity. Fixed maturities held for sale are carried at market.\nThe Company holds approximately $425,000 in short term investments. Other investments include fixed maturities and mortgage loans of $10,753,000 and $523,000 respectively, maturing in one year and $89,405,000 and $2,420,000, respectively, maturing in two to five years, which in the opinion of management is sufficient to meet the Company's cash requirements.\nThe Company holds approximately $13,892,000 in mortgage loans which represents 4% of the total assets. All mortgage loans are first position loans. Before a new loan is issued, the applicant is subject to certain criteria set forth by Company management to ensure quality control. These criteria include, but are not limited to, personal financial information such as outstanding debt, sources of income, and personal equity. A credit report is also obtained. Loans issued are limited to no more than 80% of the appraised value of the property, and the loan must have first position against the collateral.\nThe Company has $618,000 of mortgage loans, net of a $10,000 reserve allowance, which are in default or in the process of foreclosure. These loans represent approximately 4% of the total portfolio. The Company has three loans that total approximately $102,000 which are under a repayment plan. Letters are sent to each mortgagee when the loan becomes 30 days or more delinquent. Loans 90 days or more delinquent are placed on a non-performing status and classified as delinquent loans. Reserves for loan losses are established based on management's analysis of the loan balances compared to the expected realizable value should foreclosure take place. Loans are placed on a non-accrual status based on a quarterly analysis of the likelihood of repayment. All delinquent and troubled loans held by the Company were loans held in portfolios by acquired companies at the time of acquisition. Management believes the internal controls surrounding, the mortgage loan selection process have provided a quality portfolio with minimal risk of foreclosure and\/or negative financial impact.\nThe Company has in place a monitoring system to provide management with information regarding potential troubled loans. Management is provided with a monthly listing of loans that are 30 days or more past due along with a brief description of what steps are being taken to resolve the delinquency. Quarterly, coinciding with external financial reporting, the Company determines how each delinquent loan should be classified. All loans 90 days or more\npast due are classified as delinquent. Each delinquent loan is reviewed to determine the classification and status the loan should be given. Interest accruals are analyzed based on the likelihood of repayment. In no event will interest continue to accrue when accrued interest along with the outstanding principal exceeds the net realizable value of the property. The Company does not utilize a specified number of days delinquent to cause an automatic non-accrual status.\nThe mortgage loan reserve is established and adjusted based on management's quarterly analysis of the portfolio and any deterioration in value of the underlying property which would reduce the net realizable value of the property below its current carrying value.\nIn addition, the Company also monitors that the insurance on the property is being maintained. The Company requires proof of insurance on each loan and further requires to be shown as a lienholder on the policy so that any change in coverage status is reported to the Company. Proof of payment of real estate taxes is another monitoring technique utilized by the Company. Management believes a change in insurance status or non-payment of real estate taxes are indicators that a loan is potentially troubled. Correspondence with the mortgagee is performed to determine the reasons for either of these events occurring.\nThe following table shows a distribution of mortgage loans by type.\nMortgage Loans Amount % of Total FHA\/VA $ 785,973 6% Commercial $ 3,329,884 24% Residential $ 9,775,905 70%\nThe following table shows the geographic distribution of the mortgage loan portfolio and real estate held. Mortgage Real Loans Estate Colorado 2% 0% Illinois 20% 54% Kansas 12% 0% Louisiana 13% 10% Mississippi 0% 21% Missouri 2% 1% North Carolina 5% 6% Oklahoma 6% 1% Virginia 4% 3% West Virginia 32% 3% Other 4% 1% Total 100% 100%\nThe following table summarizes delinquent mortgage loan holdings.\nDelinquent 31 Days or More 1995 1994 1993\nNon-accrual status $ 0 $ 0 $ 0 Other 628,000 911,000 1,011,000 Reserve on delinquent loans (10,000) (26,000) (300,000) Total Delinquent $ 618,000 $ 885,000 $ 711,000\nInterest income foregone (Delinquent loans) $ 16,000 $ 4,000 $ 33,700\nIn Process of Restructuring $ 0 $ 0 $ 0\nRestructuring on other than market terms 0 0 0\nOther potential problem loans 0 0 0\nTotal Problem Loans $ 0 $ 0 $ 0\nInterest income foregone (Restructured loans) $ 0 $ 0 $ 0\nSee Item 2, Properties, for description of real estate holdings.\nCOMPETITION\nThe insurance business is highly competitive and there are a number of other companies, both stock and mutual, doing business in areas where the Company operates. Many of these competing insurers are larger, have more diversified lines of insurance coverage, have substantially greater financial resources and have a greater number of agents. Other significant competitive factors include policy holder benefits, service to policyholders, and premium rates.\nThe products offered (see Products) are similar to those offered by other major companies. The product features are regulated by the states and are subject to extensive competition among major insurance organizations. The Company believes a strong service commitment to policy holders, efficiency and flexibility of operations, timely service to the agency force and the expertise of its key executives help minimize the competitive pressures of the insurance industry.\nGOVERNMENT REGULATION\nIn common with all domestic insurance companies, the Company is subject to regulation and supervision in the jurisdictions in which it does business under statutes which typically delegate regulatory, supervisory and administrative powers to state insurance commissions. USA, UG, APPL and ALIC are domiciled in the states of Ohio, Ohio, West Virginia and Illinois, respectively. The method of regulation varies, but generally, regulation relates to the\nlicensing of insurers and their agents, nature of and limitations on investments, approval of policy forms, reserve requirements, standards of solvency, deposits of securities for the benefit of policyholders, periodic examination of insurers, and trade practices.\nMost states also have insurance holding company statutes which require registration and periodic reporting by insurance companies controlled by other corporations licensed to transact business within their respective jurisdictions. The insurance subsidiaries are subject to such legislation and are registered as controlled insurers in those jurisdictions in which such registration is required. Statutes vary from state to state but typically require periodic disclosure concerning the corporation that controls the registered insurers and all subsidiaries of such corporation. In addition, prior notice to, or approval by, the state insurance commission of material intercorporate transfers of assets, reinsurance agreements, management agreements (see Note 9 to Notes to Financial Statements), and payment of dividends (see Note 2 to Notes to Financial Statements) in excess of specified amounts by the insurance subsidiary within the holding company system are required.\nThe National Association of Insurance Commissioners (NAIC) is an association whose membership consists of the insurance commissioners or their designees of the various states. The NAIC has no direct regulatory authority over insurance companies. The primary purpose of the NAIC is to provide a more consistent method of regulation and reporting from state to state. This is accomplished through the issuance of model regulations, which can be adopted by the individual state as presented, modified to meet the state's own needs or requirements, or dismissed entirely.\nEach year the NAIC prepares financial ratio results (commonly referred to as IRIS ratios) for each company. These ratios compare various financial information pertaining to the statutory balance sheet and income statement. The results are then compared to pre-established normal ranges determined by the NAIC. Results outside the range typically require explanation to the domiciliary insurance department.\nAt year end 1995, UG had two ratios outside the norm. The first ratio compared investment in affiliates to total capital and surplus. At December 31, 1995, UG had an investment in affiliate (USA) slightly greater than capital and surplus. It is believed that this ratio will be outside the normal range in future periods, but is not considered by management to be an issue as both companies are under common control.\nThe second ratio related to the decrease in premium. The ratio fell outside the norm due to the significant reduction in first year business compared to the prior year. Management does not believe that this ratio will be outside the normal range in future periods.\nThe NAIC has adopted Risk Based Capital (\"RBC\") rules, which became effective December 31, 1993, to evaluate the adequacy of statutory capital and surplus in relation to a company's investment and insurance risks. The RBC formula reflects the level of risk of invested assets and the types of insurance products. The formula classifies company risks into four categories:\n1) Asset risk - the risk of loss of principal due to default through creditor bankruptcy or decline in market value for assets reported at market.\n2) Pricing inadequacy - the risk of adverse mortality, morbidity, and expense experience in relation to pricing assumptions.\n3) Asset and liability mismatch - the risk of having to reinvest funds when market yields fall below levels guaranteed to contract holders, and the risk of having to sell assets when market yields are above the levels at which the assets were purchased.\n4) General risk - the risk of fraud, mismanagement, and other business risks.\nThe RBC formula will be used by the states as an early warning tool to identify weakly capitalized companies for the purpose of initiating regulatory action. Generally, the RBC requirements provide for four different levels of regulatory attention depending upon the ratio of a company's total adjusted capital (defined as the total of its statutory capital, surplus and asset valuation reserve) to its RBC. The \"Company Action Level\" is triggered if a company's total adjusted capital is less than 100% but greater than or equal to 75% of its Company Action Level RBC. At The Company Action Level, the company must submit a comprehensive plan to the regulatory authority which discusses proposed corrective actions to improve its capital position. The \"Regulatory Action Level\" is triggered if a company's total adjusted capital is less than 75% but greater than or equal to 50% of its Company Action Level RBC. At the Regulatory Action Level, the regulatory authority will perform a special examination if the company's total adjusted capital is less than 50% but greater than or equal to 35% of its Company Action Level RBC, and the regulatory authority may take any action it deems necessary, including placing the company under regulatory control. The \"Mandatory Control Level\" is triggered if a company's total adjusted capital is less than 35% of its Company Action Level RBC, and the regulatory authority mandates that the company be placed under its control. At December 31, 1995, each of the Company's insurance subsidiaries has a Ratio in excess of 250% of the authorized control level; accordingly the subsidiaries meet the RBC requirements.\nThe NAIC has proposed a new Model Investment Law that may affect the statutory carrying values of certain investments; however, the final outcome of that proposal is not certain, nor is it possible to predict what impact the proposal will have or whether the proposal will be adopted in the foreseeable future.\nThe current statutory accounting treatment of DAC taxes results in an understatement of companies' surplus. These taxes result from a law that approximates acquisition expenses and then spreads the corresponding deductions over a period of years. The result is a DAC tax which is collected immediately and subsequently returned through deductions in later years.\nEMPLOYEES\nThere are approximately 110 persons who are employed by the Company and its affiliates.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe following table shows the distribution of real estate by type.\nReal Estate Amount % of Total Home Office $ 2,759,115 16% Commercial $ 2,680,318 16% Residential development $ 6,244,142 37% Foreclosed real estate $ 5,332,413 31%\nReal estate holdings, net of accumulated depreciation of $3,254,000 and $3,007,000 at December 31, 1995 and 1994, respectively, represent approximately 5% of the total assets. The Company owns an office complex in Springfield, Illinois, which houses the primary insurance operations. The office buildings contain 57,000 square feet of office and warehouse space. During 1991, the Company completed construction on a new 20,000 square foot office building adjacent to its existing buildings to house part of the Company's operations.\n16, 1994. All of the suits allege that the plaintiff was libeled by statements made in a letter sent by UG. The letter was sent to persons who had been issued life insurance policies by UG as the result of policy applications submitted by the five agents. Mr. Melville is a defendant in some of the suits because he signed the letter as president of UG.\nIn addition to the defamation count, Mr. Freeman alleges that UG breached a contract by failing to pay his commissions for policies issued. Mr. Freeman claims unpaid commissions of $104,000. In the libel claim, Mr. Freeman claims compensatory damages of over $5,000,000, punitive damages of over $3,000,000, costs, and litigation expenses. The other plaintiffs request the award of unspecified compensatory damages and punitive (or special) damages as well as costs and attorney's fees. UG has filed Answers to all of these suits asserting various defenses and, where appropriate, counterclaims. UG believes that it has no liability to any of the plaintiffs and intends to defend each of the suits vigorously. The Freeman suit is scheduled for trial April 8, 1996.\nJeffrey Ploskonka, Keith Bohn and Paul Phinney v. Universal Guaranty Life Insurance Company (Circuit Court of the Seventh Judicial Circuit Sangamon County, Illinois Case No.: 95-L-0213)\nOn March 9, 1995 a lawsuit was filed against Universal Guaranty Life Insurance Company on behalf of three insureds and a potential class of other insureds. The Plaintiffs allege that UG violated the insurance contract in attempting to cancel life insurance contracts. Additionally, the Plaintiffs assert violations of Illinois law alleging vexations and unreasonable insurance practices, breach of duty of good faith and fair dealing, and that Illinois consumer fraud laws have been violated. The Plaintiffs seek unspecified compensatory damages, injunctive relief, attorneys' fees, statutory damages in an amount up to $25,000, punitive damages of $1,000,000, and other equitable relief. UG filed an Answer to this lawsuit in May 1995, asserting various defenses and reserving the right to assert counterclaims. UG has also filed motions to dismiss certain allegations and claims made in the lawsuit. UG believes it has no liability to any of the plaintiffs, or other potential class members, and intends to defend the lawsuit vigorously. In June 1995, the court conditionally certified a class of non-settling insureds.\nThe Company and its subsidiaries are named as defendants in a number of legal actions arising primarily from claims made under insurance policies. Those actions have been considered in establishing the Company's liabilities. Management and its legal counsel are of the opinion that the settlement of those actions will not have a material adverse effect on the Company's financial position or results of operations.\nITEM 4.","section_3":"","section_4":"ITEM 4. SUBMISSION OF MATTERS OF A VOTE OF SECURITY HOLDERS\nNone\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR COMPANY'S COMMON STOCK AND RELATED SECURITY HOLDERS MATTERS\nFCC STOCK INFORMATION\nThe Company's common stock is traded in the over-the-counter market. The following table shows the high and low bid quotations for each quarterly period during the past two years as reported by Dean Witter Reynolds, Inc., a market maker in such stock. Such quotations represent inter-dealer quotations and do not include retail markup or markdown or commission nor do they represent actual sales. Trading in this stock is very limited.\nPERIOD LOW HIGH First quarter 1\/16 1\/8 Second quarter 1\/8 1\/8 Third quarter 1\/8 1\/8 Fourth quarter 1\/16 1\/8\nPERIOD LOW HIGH First quarter 1\/16 3\/16 Second quarter 1\/16 3\/16 Third quarter 1\/16 1\/8 Fourth quarter 1\/16 1\/8\nThe Company did not pay any dividends during 1995 or 1994. Limitations on shareholders dividends are described in Note 2 of the Notes to Financial Statements.\nNumber of Common Shareholders as of March 6, 1996\n16,632\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nFINANCIAL HIGHLIGHTS (000's omitted, except per share data)\n1995 1994 1993 1992 1991\nPremium income net of reinsurance $ 29,998 $ 32,284 $ 30,727 $ 21,614 $ 18,628\nNet investment income $ 15,500 $ 14,188 $ 14,088 $14,580 $ 14,313\nNet income (loss) $ (1,452) $ (1,775) $ (3,343) $(4,020) $ (448)\nEarnings (loss) per share on:\nNet income (loss) $ (0.06) $ (0.07) $ (0.14) $ (0.21) $ (0.03)\nTotal assets $334,220 $331,410 $326,390 $319,628 $232,978\nTotal long term debt $ 20,623 $ 21,529 $ 23,535 $ 26,240 $ 23,046\nDividends paid per share NONE NONE NONE NONE NONE\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company and its consolidated subsidiaries have three principal needs for cash - the insurance company's contractual obligations to policyholders, the payment of operating expenses and servicing of its long-term debt. Cash and cash equivalents as a percentage of total assets were 4% and 3% as of December 31, 1995, and 1994, respectively. Fixed maturities as a percentage of total invested assets were 78% and 77% as of December 31, 1995 and 1994, respectively. Fixed maturities increased 4% in 1995 compared to 1994. Investing cash and cash equivalents in fixed maturities allowed the Company to increase investment yield on these monies by extending time to maturity while maintaining cash balances at an adequate level to meet the Company's short term obligations.\nThe Company holds approximately $425,000 in short term investments with other investments maturing at varying times including bonds and mortgage loans of $10,753,000 and $523,000, respectively, maturing in one year and $89,405,000 and $2,420,000, respectively, maturing in two to five years, which in the opinion of management is sufficient to meet the Company's cash requirements.\nConsolidated operating activities of the Company produced negative cash flows of ($5,957,000), ($4,593,000) and ($6,517,000) in 1995, 1994 and 1993, respectively. The net cash provided by operating activities plus interest credited to account balances and net policyholder contract deposits after the payment of policyholder withdrawals, equalled $9,701,000 in 1995, $9,555,000 in 1994, and $10,810,000 in 1993. Management believes this measurement of cash flows more accurately indicates the performance of the Company's insurance operations, since reporting regulations require cash inflows and outflows from universal life insurance products to be shown as financing activities.\nCash used in investing activities was ($8,030,000), ($26,847,000) and ($23,913,000), for 1995, 1994 and 1993, respectively. The most significant aspect of investing activities is the fixed maturity transactions. Fixed maturities account for 76%, 78% and 88% of the total cost of investments acquired in 1995, 1994 and 1993, respectively. The Company has not directed its investable funds to so-called \"junk bonds\" or derivative investments. The cash used by investing activities in the last three years was provided by investing excess cash and cash equivalents and financing activities.\nNet cash provided by financing activities was $14,752,000, $12,142,000 and $14,621,000 for 1995, 1994 and 1993, respectively. Policyholder contract deposits increased 8% in 1995 compared to 1994, and decreased 4% in 1994 when compared to 1993. The increase between 1995 and 1994 is due to the change in marketing focus of the Company. All of the Company's agency forces is marketing universal life insurance products. The change between 1994 and 1993 is a normal fluctuation in marketing of the Company's universal life products. Policyholder contract withdrawals has increased 7% in 1995 compared to 1994, and increased 10% in 1994 compared to 1993. The increase in 1995 and 1994 is not attributable to any one significant event. Factors that may be causing the increase are the fluctuation of interest rates, competition and other economic factors. The Company's current marketing strategy and portfolio is directly structured to conserve the existing customer base and at the same time increase the customer base through new policy production.\nInterest credited to account balances increased 12% in 1995 compared to 1994, and decreased 14% when comparing 1994 to 1993. The increase in 1995 is due to the increase in policyholder contract deposits. The decrease in 1994 is due to a reduction in credited interest rates on the Company's insurance products in January 1994. It takes approximately one year to fully realize a change in credited rates, as such a change becomes effective on each policy's next anniversary. Insurance products that the Company is issuing are crediting 6% interest. The Company does not have any immediate plans to change product interest rates.\nThe payment of cash dividends to shareholders is not legally restricted. At December 31, 1995, substantially all of the consolidated shareholders equity represents net assets of its subsidiaries. FCC'S primary needs for cash are for payments related to its servicing of its long-term debt. FCC is able to meet these cash needs through monies received from its life insurance subsidiaries from management and cost sharing arrangements and through dividends. Insurance company dividend payments are regulated by the state insurance department where the company is domiciled. UG's dividend limitations are described below.\nOhio domiciled insurance companies require five days prior notification to the insurance commissioner for the payment of an ordinary dividend. Ordinary dividends are defined as the greater of: a) prior year statutory earnings or b) 10% of statutory capital and surplus. For the year ended December 31, 1995, UG had a statutory gain from operations of $3,197,000. At December 31, 1995, UG's statutory capital and surplus amounted to $7,274,000. Extraordinary dividends (amounts in excess of ordinary dividend limitations) require prior approval of the insurance commissioner and are not restricted to a specific calculation.\nThe Company's Senior Debt bears interest equal to 1% over the variable per annum rate most recently announced by the First Bank of Missouri as its \"Base Rate\". As of March 1, 1996, the \"Base Rate\" was 8.25%. The principal balance of the Company's Senior Debt is payable in installments on June 1st of each year. On December 2, 1994, the Company prepaid $2,000,000 of the $2,900,000 scheduled principal payment due June 1, 1995. On March 1, 1995, the Company prepaid the remaining $900,000 of the June 1, 1995 scheduled principal payment. On January 31, 1996, the Company prepaid $1,500,000 of the $3,900,000 scheduled principal payment due June 1, 1996.\nManagement believes the overall sources of liquidity available will be sufficient to satisfy its financial obligations.\nRESULTS OF OPERATIONS\n1995 COMPARED TO 1994\n(a) REVENUES\nTotal revenue decreased 2% when comparing 1995 to 1994.\nPremium income, net of reinsurance premium, decreased 7% when comparing 1995 to 1994. The decrease is primarily attributable to the decrease in new business production and the change in products marketed. In 1995, the Company has streamlined the product portfolio, as well as restructured the marketing force. The decrease in first year premium production is directly related to the Company's change in distribution systems. The Company has changed its focus from primarily a broker agency distribution system to a captive agent system. Business written by the broker agency force in recent years did not meet Company expectations. With the change in focus of distribution systems, most of the broker agents were terminated.\nThe change in marketing strategy from traditional life insurance products to universal life insurance products had a significant impact on new business production. As a result of the change in marketing strategy the agency force went through a restructure and retraining process. Cash collected from the universal life and interest sensitive products contribute only the risk charge to premium income, however traditional insurance products contribute monies received to premium income. One factor that has had a positive impact on premium income is the improvement of persistency. Persistency is a measure of insurance in force retained in relation to the previous year. Overall, persistency improved to 87.5% in 1995 compared to 86.3% in 1994.\nOther considerations net of reinsurance increased 13% compared to one year ago. Other considerations consists of administrative charges on universal life and interest sensitive life insurance products. The insurance in force relating to these types of products continues to increase as marketing efforts are focused on universal life insurance products.\nNet investment income increased 9% when comparing 1995 to 1994. The change reflected an increase in the amount of invested assets, which was partially offset by a lower effective yield on investments made during 1995. The overall investment yields for 1995, 1994 and 1993, are 7.10%, 7.19% and 7.40%, respectively. The Company has been able to increase its investment portfolio through financing cash flows, generated by cash received through sales of universal life insurance products. Although the Company sold no fixed maturities during the last few years, it did experience a significant turnover in the portfolio. Many companies with bond issues outstanding took advantage of the lower interest rates and retired older debt which carried higher rates. This was accomplished through early calls and accelerated pay-downs of fixed maturity investments.\nThe Company's investments are generally managed to match related insurance and policy holder liabilities. The Company in conjunction with the decrease in average yield of the Company's fixed maturity portfolio has decreased the average crediting rate for the Company's insurance and investment products. The comparison of investment return with insurance or investment product crediting rates establishes an interest spread. The minimum interest spread between earned and credited rates is 1% on the \"Century 2000\" universal life insurance product, the Company's primary product. The Company monitors investment yields, and when necessary takes action to adjust credited interest rates on its insurance products to preserve targeted spreads. Over 60% of the insurance and investment product reserves are crediting 5% or less in interest and 39% of the insurance and investment product reserves are crediting 5.25% to 6% in interest. It is expected that the monitoring of the interest spreads by management will provide the necessary margin to adequately provide for associated costs on insurance policies that the Company has in force and will write in the future.\nRealized investment losses were $349,000 and $146,000 in 1995 and 1994, respectively. Fixed maturities and equity securities realized net investment losses of $169,000 and real estate realized net investment losses 180,000 in 1995. The net realized investment losses for fixed maturities in 1995 is not attributable to any one specific transaction. The Company experienced moderate turnover in its fixed maturities portfolio during 1995. This was the result of many companies taking advantage of lower interest rates and refinancing higher coupon rate bonds with new securities at current lower rates. This was accomplished through early calls and accelerated pay downs that generated the net investment losses of fixed maturities. The realized investment losses for real estate is primarily attributable to one property. The property was re-evaluated during the year in relation to property values in the surrounding area of the property owned by the Company. In 1994, the Company realized net investment losses from equity securities and real estate of $119,000 and $513,000, respectively and realized an investment gain of $467,000 due to the sale of an insignificant subsidiary. The realized investment losses from real estate in 1994, was due to permanent impairment of the value of property located in Louisiana. The permanent impairment was due\nto recent appraisals and marketing analysis. The Company had other gains and losses during the period that compromised the remaining amount reported but were routine or immaterial in nature to disclose on an individual basis.\n(b) EXPENSES\nTotal expenses decreased 3% when comparing 1995 to 1994.\nLife benefits net of reinsurance benefits and claims decreased 16% compared to 1994. The decrease is related to the decrease in first year premium production. Another factor that has caused life benefits to decrease is that during 1994, the Company lowered its crediting rates on interest sensitive products in response to financial market conditions. This action will facilitate the appropriate spreads between investment returns and credited interest rates. It takes approximately one year to fully realize a change in credited rates since a change becomes effective on each policy's next anniversary. Please refer to discussion of net investment income for analysis of interest spreads.\nThe Company experienced an increase of 6% in mortality during 1995 compared to 1994. The increase in mortality is due primarily to settlement expenses discussed in the following paragraph:\nDuring the third quarter of 1994, UG became aware that certain new insurance business was being solicited by certain agents and issued to individuals considered to be not insurable by Company standards. These policies had a face amount of $22,700,000 and represent 1\/2 of 1% of the insurance in force. Management's analysis indicates that the expected death claims on the business in force to be adequately covered by the mortality assumptions inherent in the calculation of statutory reserves. Nevertheless, management has determined it is in the best interest of the Company to repurchase as many of the policies as possible. As of December 31, 1995, there remained approximately $5,738,000 of the original face amount which have not been settled. The Company will continue its efforts to repurchase as many of the policies as possible and regularly apprise the Ohio Department of Insurance regarding the status of this situation. Through December 31, 1995, the Company spent a total of $2,886,000 for the repurchase of these policies and for the legal defense of related litigation. In relation to the repurchase of insurance policies the Company incurred life benefits of $720,000 and $1,250,000 in 1995 and 1994, respectively. The Company incurred legal costs of $687,000 and $229,000 in 1995 and 1994, respectively.\nDividends to policyholders increased approximately 26% when comparing 1995 to 1994. USA continued to market participating policies through most of 1994. Management expects dividends to policyholders will continue to increase in the future. A significant portion of the insurance in force is participating insurance. A significant portion of the participating business is relatively newer business, and the dividend scale for participating policies increases in the early durations. The dividend scale is subject to approval of the Board of Directors and may be changed at their discretion. The Company has discontinued its marketing of participating policies.\nCommissions and amortization of deferred policy acquisition costs increased 10% in 1995 compared to 1994. The increase is directly attributed to the amortization of a larger asset. The increase is also caused by the reduction in first year premium production. To a lesser extent the increase in amortization of deferred policy acquisition costs is directly related to the change in products that is currently marketed. The Company revised its portfolio of products as previously discussed in premium income. These new products pay lower first year commissions than the products sold in prior periods. The asset increased due to first year premium production by the agency force. The Company did benefit from improved persistency.\nOperating expenses increased 19% in 1995 compared to 1994. The increase was caused by several factors. The primary factor for the increase in operating expenses is due to the decrease in production. The decrease in production was discussed in the analysis of premium income. As such, the Company was positioned to handle significantly more first year production than was produced. First year operating expenses that were deferred and capitalized as a deferred policy acquisition costs asset was $532,000 in 1995 compared to $1,757,000 in 1994. The difference between the policy acquisition costs deferred in 1995 compared to 1994, effected the increase in operating expenses. The increase in operating expenses was offset, to a lesser extent, from a 12% reduction in staff in 1995 compared to 1994. The reduction in staff was achieved by attrition.\nAnother factor that caused the increase in operating expenses is directly related to increased legal costs. During the third quarter of 1994, UG became aware that certain new insurance business was being solicited by certain agents and issued to individuals considered to be not insurable by Company standards. These policies had a face amount of $22,700,000 and represent 1\/2 of 1% of the insurance in force of the Company. As of December 31, 1995, there remained approximately $5,738,000 of the original face amount which have not been settled. The Company will continue its efforts to repurchase as many of the policies as possible and regularly apprise the Ohio Department of Insurance regarding the status of this situation. The Company incurred legal costs of $687,000 and $229,000 in 1995 and 1994, respectively, for the legal defense of related litigation.\nInterest expense decreased slightly in 1995 compared to 1994. The decrease was due to the decrease in the outstanding principal balance. The interest rate increased to 10% on March 1, 1995 compared to 7% on March 1, 1994. The Company was able to minimize the effect of the higher interest rate in 1995 by early payments of principal. The Company paid $600,000 in principal payments in 1995. The interest rate on the senior debt has decreased to 9.25% as of March 1, 1996.\n(c) NET LOSS\nThe Company had a net loss of $1,452,000 in 1995 compared to a net loss of $1,775,000 in 1994. The moderate improvement in 1995 is primarily attributable to the increase in net investment income and the decrease in life benefits.\n1994 COMPARED TO 1993\n(a) REVENUES\nTotal revenue increased 4% when comparing 1994 to 1993. The termination of the Company's coinsurance agreement with Republic Vanguard contributed significantly to the increase in revenues.\nPremium income, net of reinsurance premium, increased 5% when comparing 1994 to 1993. The termination of the coinsurance agreement with Republic Vanguard contributed significantly to the increase in premium, net of reinsurance premium. UG terminated the coinsurance agreement with Republic Vanguard on December 31, 1993. In UG, first year reinsurance premium was 21% of direct first year premium in 1993 compared to 3% in 1994. Coinsurance agreements provide a sharing or 50\/50 relationship between the direct company and the reinsurer of the premiums, benefits and the profitability of the underlying product. Management believes that terminating the agreement was the best alternative for long term benefit of the Company.\nIn 1994, the Company has been very active in streamlining the product portfolio, as well as restructuring the marketing force. The Company is currently marketing three universal life products. In late 1994, the Company discontinued marketing the traditional or interest sensitive products. The current universal life products feature lower first year costs compared to the discontinued products. The marketing force is made up of three distinct groups. Business produced by the broker agency force did not meet the Company standards. Therefore, most of the agents associated with that group were terminated. The other two agency forces continued to grow in 1994. First year direct premium decreased 3% in 1994 compared to 1993. The small decrease is perceived as a positive result when considering the changes to the portfolio and marketing force.\nNet investment income increased slightly when comparing 1994 to 1993. The Company's average yield on its investments declined slightly in 1994 compared to 1993. The Company has been able to increase its investment portfolio through financing cash flows and reducing its cash and short term positions. Although the Company sold no fixed maturities during 1994 or 1993, it did experience a significant turnover in the portfolio. Many companies with bond issues outstanding took advantage of the lower interest rates in the market during 1993 and early 1994 and retired older debt which carried higher rates. This was accomplished through early calls and accelerated pay-downs of fixed maturity investments. In late 1994 and early 1995, there has been a slight upward movement in general interest rates.\nThe Company's investments are generally managed to match related insurance and policyholder liabilities. The overall investment yields for 1994, 1993 and 1992, are 7.19%, 7.40% and 7.69%, respectively. The Company in conjunction with the decrease in average yield of the Company's fixed maturity portfolio has decreased the average crediting rate for the Company's insurance and investment products. The comparison of investment return with insurance or investment product crediting rates establishes an interest spread. Minimum interest spreads between earned and credited rates are 1% to 1.5%. The Company continually assesses investment yields, and when necessary takes action to reduce credited interest rates on its insurance products to preserve targeted spreads. Credited rates are established by the Board of Directors. Over 60% of the insurance and investment product reserves are crediting 5% or less in interest and 39% of the insurance and investment product reserves are crediting 5.25% to 6% in interest. It is expected that the monitoring of the interest spreads by management will provide the necessary margin to adequately provide for associated costs on insurance policies that the Company has in force and will write in the future.\nRealized investment losses were $146,000 and $194,000 in 1994 and 1993, respectively. The Company realized losses of $513,000 and $423,000 due to permanent impairment of the value of the property located in Louisiana, in 1994 and 1993, respectively. The Company is actively pursuing a buyer for the property. The permanent impairment was due to recent appraisals and marketing analysis. The Company realized a gain of $467,000 due to the sale of an insignificant subsidiary in 1994. The Company realized a loss of $119,000 due to the sale of common stock, which was acquired through the reorganization of a fixed maturity security of Savin Corporation. The Company had other gains and losses during the period that compromised the remaining amount reported but were routine or immaterial in nature to disclose on an individual basis.\n(b) EXPENSES\nTotal expenses increased 3% when comparing 1994 to 1993. Life and annuity benefits, net of reinsurance, contributed significantly to the increase in expenses. Commissions and amortization of deferred policy acquisition costs and operating expenses decreased during 1994 compared to 1993.\nLife benefits and reinsurance benefits and claims increased 17% compared to 1993. Reinsurance benefits and claims changed significantly due to the termination of the coinsurance treaty with Republic Vanguard. Coinsurance agreements provide a sharing or 50\/50 relationship between the direct company and the reinsurer of the premiums, benefits and the profitability of the underlying product. Management believes that terminating the agreement was the best alternative for the long term benefit of the Company.\nMortality remained at the same level in 1994 compared to 1993. Changes in mortality can have a significant impact to life benefits.\nDuring the third quarter of 1994, UG became aware that certain new insurance business was being solicited by certain agents and issued to individuals considered to be not insurable by Company standards. These policies had a face amount of $22,700,000 and represent less than 1\/2 of 1% of the insurance in force of the Company. Management's analysis of the business in force indicates that the expected death claims on the business in force to be adequately covered by the mortality assumptions inherent in the calculation of statutory reserves. Nevertheless, management has determined it is in the best interest of the Company to attempt to acquire as many of the policies as possible.\nDuring 1994, the Company authorized $1,250,000 for the acquisition of these policies. At December 31, 1994, the Company had $227,961 remaining for the purchase of these policies. The $1,250,000 has been charged to life benefits, claims and settlement expenses.\nDuring 1993, and early 1994, the Company lowered its crediting rates on interest sensitive products in response to financial market conditions. This action will facilitate the appropriate spreads between investment returns and credited interest rates. The result is a reduction to the life benefits line item as the increase in policy values through credited interest is lower. The overall investment yields for 1994, 1993 and 1992, are 7.19%, 7.40% and 7.69%, respectively. The Company in conjunction with the decrease in average yield of the Company's fixed maturity portfolio has decreased the average crediting rate for the Company's insurance and investment products. The comparison of investment return with insurance or investment product crediting rates establishes an interest spread. Minimum interest spreads between earned and credited rates are 1% to 1.5%. The Company continually assesses investment yields, and when necessary takes action to reduce credited interest rates on its insurance products to preserve targeted spreads. Credited rates are established by the Board of Directors. Over 60% of the insurance and investment product reserves are crediting 5% or less in interest and 39% of the insurance and investment product reserves are crediting 5.25% to 6% in interest. It is expected that the monitoring of the interest spreads by management will provide the necessary margin to adequately provide for associated costs on insurance policies that the Company has in force and will write in the future. Management anticipates that the lowering of credited interest rates will benefit future periods.\nDividends to policyholders increased approximately 14% when comparing 1994 to 1993. USA continued to market participating policies through most of 1994. Management expects dividends to policyholders will continue to increase in the future. A portion of the Company's insurance in force is participating insurance. A significant portion of the participating business is relatively newer business. The dividend scale for participating policies increases significantly in the early years. The dividend scale is subject to approval of the Board of Directors and may be changed at their discretion. The Company no longer markets any participating policies.\nCommissions and amortization of deferred policy acquisition costs and amortization of agency force decreased 22% in 1994 compared to 1993. Two factors contributed to the decrease. The Company's persistency improved and commissions paid to agents was reduced. Persistency is the measurement of policies that the Company was able to retain in a given period of time. The Company's average persistency rate for all policies in force for 1994 and 1993 has been approximately 86% and 85%, respectively. The overall improvement appears small but has a significant impact on the amortization of deferred policy acquisition costs. There was significant improvement in persistency on certain blocks of insurance that are sensitive to fluctuations in persistency and directly affect the amortization of deferred policy acquisition costs. The Company revised its portfolio of products as previously discussed in premium income. These new products pay lower commissions than the previous products sold in prior periods.\nOperating expenses decreased 15% in 1994 compared to 1993. The decrease is not attributable to one particular event but to the overall savings produced from the recent streamlining efforts. A reduction of operating expenses is being realized from operating fewer insurance subsidiaries. In 1992, the Company was operating eleven insurance companies, but through mergers and the sale of one insignificant subsidiary, the Company is now operating four insurance companies. The Company also completed conversion of an insurance subsidiary's computer system to its Life 70 system. The Company had a 11% reduction in staff in 1994 compared to 1993. This was achieved mostly by attrition. The Company feels that this reduction was necessary and could be achieved through continued improvement in efficiency and automation. The Company expects that further savings will be realized in the future.\nInterest expense increased 3% in 1994 compared to 1993. The increase was due to an increase in the interest rate on the Company's senior debt, which is tied to the prime rate of the lead bank. The Company was able to minimize the effect of the increase in interest rate by early payments of principal. The Company paid $2,000,000 in principal payments in 1994. The Company believes that interest rates will not change dramatically in 1995, and therefore will not significantly impact interest expense.\n(c) NET LOSS\nThe Company had a loss of $1,775,000 in 1994 compared to a loss of $3,343,000 in 1993. The establishment of a reserve of $1,250,000 liability through life benefits, claims and settlement expenses to cover cash payments to acquire the policies of certain individuals considered to be not insurable contributed significantly to the 1994 loss. The improvement in 1994 was the result of an increase in the credit provided by deferred income taxes. Deferred income taxes are affected by changes in timing differences between the financial statements and reportable for federal income tax purposes. Also, an improvement in operating expenses and commissions and amortization of deferred policy acquisition costs contributed to reducing the loss in 1994. Management anticipates that the lowering of credited interest rates on the Company's insurance and investment products will benefit future periods.\nFINANCIAL CONDITION\n(a) ASSETS\nThe Company's financial position at December 31, 1995, reflected an increase in assets and an increase in liabilities compared to the preceding year end. As of December 31, 1995 and 1994, cash and invested assets represented approximately 77% and 75% of consolidated assets, respectively. Cash and cash equivalents increased 7% when comparing 1995 to 1994. As of December 31, 1995 and 1994, fixed maturities represented 74% of total invested assets and cash.\nBy insurance statute, the majority of the Company's investment portfolio is required to be invested in investment grade securities to provide ample protection for policyholders. The liabilities are predominantly long term in nature and therefore, the Company invests in long term fixed maturity investments which are reported in the financial statements at their amortized cost. The Company has the ability and intent to hold these investments to maturity; consequently, the Company does not expect to realize any significant loss from these investments. The Company does not own any derivative investments or \"junk bonds\". As of December 31, 1995, the carrying value of fixed maturity securities in default as to principal or interest was immaterial in the context of consolidated assets or shareholders' equity. The Company has identified securities it may sell and classified them as \"investments held for sale\". Investments held for sale are carried at market.\nThe Company's fixed maturity securities include mortgage-backed bonds of $21,415,000 and $22,444,000 at December 31, 1995 and 1994, respectively. The mortgage-backed bonds are subject to risks associated with variable prepayments of the underlying mortgage loans. Prepayments cause those securities to have different actual maturities than that expected at the time of purchase. Prepayment of mortgage backed securities with an amortized cost greater than par will incur a reduction in yield or loss. Those securities that have an amortized cost less than par will generate an increase in yield or gain. The degree to which a security is susceptible to either gains or losses is influenced by the difference between its amortized cost and par, the relative interest rate sensitivity of the underlying mortgages backing the assets and the repayment priority of the securities in the overall securitization structure.\nThe Company limits its credit risk by purchasing securities backed by stable collateral and by concentrating on securities with enhanced priority in their trust structure. Such securities with reduced risk typically have a lower yield (but higher liquidity) than higher-risk mortgage-backed bonds (i.e., mortgage-backed bonds structured to share in residual cash flows or which cover only interest payments). At December 31, 1995, the Company does not have a significant amount of higher-risk mortgage-backed bonds. There are negligible default risks in the Company's mortgage-backed bond portfolio as a whole. The vast majority of the assets are either guaranteed by U.S. government-sponsored entities or are supported in the securitization structure by junior securities enabling the assets to achieve high investment grade status.\nThe Company experienced moderate turnover in its fixed maturities portfolio during 1995. As previously discussed, this was the result of many companies taking advantage of lower interest rates and refinancing higher coupon rate bonds with new securities at current lower rates. This was accomplished through early calls and accelerated pay downs. During the year, the Company reinvested its funds and invested new monies from operations and from cash and short term investments primarily in investment grade corporate bonds.\nMortgage loans decreased 12% in 1995 as compared to 1994. The Company is not actively seeking new mortgage loans, and the decrease is due to early pay-offs from mortgagee's seeking refinancing at lower interest rates. All mortgage loans held by the Company are first position loans. The Company has $618,000 in mortgage loans, net of a $10,000 reserve allowance, which are in default or in the process of foreclosure, this represents approximately 4% of the total portfolio.\nInvestment real estate and real estate acquired in satisfaction of debt decreased slightly in 1995 compared to 1994. The decrease is primarily the net result of improvements made and sales of homes and lots from the residential development. Total real estate is separated into four categories: Home Office 16%, Commercial 16%, Residential Development 37% and Foreclosed Properties 31%.\nPolicy loans increased 4% in 1995 compared to 1994. There is no single event that caused policy loans to increase. Industry experience for policy loans indicates that very few policy loans are repaid by the policy holder other than through termination of the policy. Policy loans are systematically reviewed to verify that no individual policy loan exceeds the underlying cash value of the policy. Policy loans will generally increase due to new loans and interest compounding on existing policy loans.\nValue of agency force and cost in excess of net assets purchased decreased 6% in 1995 compared to 1994. The decrease is directly attributable to normal amortization during the period. The Company did not recognize any impairments during the period.\nDeferred policy acquisition costs increased 8% in 1995 compared to 1994. The Company had $2,370,000 in policy acquisition costs deferred, $338,000 in interest accretion and $1,905,000 in amortization. The Company anticipates similar activity in the future due to continued marketing efforts by the Company's agency force. The Company did not recognize any impairments during the period.\n(b) LIABILITIES\nTotal liabilities increased approximately 3% in 1995 compared to 1994. Future policy benefits increased 4% in 1995 and represented 83% of total liabilities at December 31, 1995. Management expects future policy benefits to increase in the future due to the aging of the volume of insurance in force and continued production by the Company's sales force.\nPolicy claims and benefits payable decreased 3% in 1995 compared to 1994. There is no single event that caused this item to decrease. Policy claims vary from year to year and therefore, fluctuations in this liability are to be expected and are not considered unusual by management.\nOther policyholder funds decreased 4% in 1995 compared to 1994. The decrease can be attributed to a decrease in premium deposit funds. Premium deposit funds are funds deposited by the policyholder with the insurance company to accumulate interest and pay future policy premiums. The change in marketing from traditional insurance products to universal life insurance products is the primary reason for the decrease. Universal life insurance products do not have premium deposit funds. All premiums received from the policyholder are credited to the life insurance policy and are reflected in future policy benefits.\nDividend and endowment accumulations increased 15% in 1995 compared to 1994. The increase is attributed to the significant amount of participating business the Company has in force. There are generally four options a policyholder can select to pay policy dividends. Over 47% of all dividends paid were put on deposit to accumulate with interest. Accordingly, management expects this liability to increase in the future.\nIncome taxes payable and deferred income taxes payable decreased 15% in 1995 compared to 1994. The change in deferred and current income taxes payable is attributable to temporary differences between Generally Accepted Accounting Principles (\"GAAP\") and tax basis. Federal income taxes are fully disclosed in Note 3 of the Notes to the Financial Statements.\nNotes payable decreased $906,000 in 1995 compared to 1994. On January 31, 1996, the Company, prepaid $1,500,000 of the $3,900,000 principal payment due on June 1, 1996. The Company's long term debt is discussed in more detail in Note 9 of the Notes to the Financial Statements.\n(c) SHAREHOLDERS' EQUITY\nTotal shareholders' equity decreased 11% in 1995 compared to 1994. The decrease in shareholders' equity is primarily due to the net loss of $1,452,000 in 1995. The Company experienced $293,000 in unrealized appreciation of equity securities and investments held for sale in 1995.\nREGULATORY ENVIRONMENT\nThe Company is highly regulated by state insurance authorities in the states its affiliates are domiciled. Such regulations, among other things, limit the amount of dividends, tax sharing payments, other payments that can be made by affiliates without prior regulatory approval and impose restrictions on the amount and type of investments the Company may own. The Company also is regulated in various states as an insurance holding company system. Because the Company is an insurance holding company, an investment in the Company which could result in a change in control must be passed on by certain state departments of insurance.\nThere is currently increased scrutiny placed upon the insurance regulatory framework. As a result, certain state legislatures have considered or enacted laws that alter, and in many cases increase, state authority to regulate insurance companies and insurance holding company systems. In light of recent legislative developments, the National Association of Insurance Commissioners (\"NAIC\") and state insurance regulators have begun examining existing laws and regulations, specifically focusing on insurance company investments, solvency issues, risk-adjusted capital guidelines, interpretations of existing laws, the development of new laws, the implementation of nonstatutory guidelines, and the circumstances under which dividends may be paid. The Company cannot predict with certainty the effect that any NAIC recommendations, proposed or future legislation, may have on the financial condition or operations.\nThe Company receives funds from its insurance subsidiaries in the form of management and cost sharing arrangements (See Note 9) and through dividends. Annual dividends in excess of maximum amounts prescribed by state statutes (\"extraordinary dividends\") may not be paid without the approval of the insurance commissioner in which an insurance subsidiary is domiciled. The National Association of Insurance Commissioners (\"NAIC\") has proposed, and certain states have adopted, legislation that lowers the threshold amount for determining what constitutes an extraordinary dividend. Such legislative changes could make it more difficult for insurance subsidiaries to pay dividends to their parents.\nThe NAIC has adopted Risk-Based Capital (\"RBC\") requirements for life\/health insurance companies to evaluate the adequacy of statutory capital and surplus in relation to investment and insurance risks such as asset quality, mortality and morbidity, asset and liability matching and other business factors. The RBC formula 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 low fixed minimum capital and surplus requirements on a state-by- state basis. Regulatory compliance is determined by a ratio of the insurance company's regulatory total adjusted capital, as defined by the NAIC, to its authorized control level RBC, as defined by the NAIC. Insurance company's below specific trigger points or ratios are classified within certain levels, each of which requires specific corrective action.\nThe levels and ratios are as follows:\nRatio of Total Adjusted Capital to Authorized Control Level RBC Regulatory Event (Less Than or Equal to)\nCompany action level 2* Regulatory action level 1.5 Authorized control level 1 Mandatory control level 0.7\n* Or, 2.5 with negative trend.\nAt December 31, 1995, each of the Company's insurance subsidiaries has a Ratio that is in excess of 250% of the authorized control level; accordingly the Company's subsidiaries meet the RBC requirements.\nThe NAIC has proposed a new Model Investment Law that may affect the statutory carrying values of certain investments; however, the final outcome of that proposal is not certain, nor is it possible to predict what impact the proposal will have on the Company or whether the proposal will be adopted in the foreseeable future.\nFUTURE OUTLOOK\nFactors expected to influence life insurance industry growth include: 1) competitive pressure among the large number of existing firms; 2) competition from financial service companies, as they seek to expand into insurance marketing; 3) customers' changing needs for new types of insurance products; 4) customers' lack of confidence in the entire industry as a result of the recent highly visible failures; and 5) uncertainty concerning the future regulation of the industry. Growth in demand for insurance products will depend upon demographic variables such as income growth, wealth accumulation, population and work force changes.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nNEW ACCOUNTING STANDARDS\nThe Financial Accounting Standards Board (FASB) has issued Statement of Financial Accounting Standards No. 114 entitled \"Accounting by Creditors for Impairment of a Loan\" and Statement of Financial Accounting Standards No. 118, an amendment of Statement No. 114. The Statement amends FASB Statement No. 5 \"Accounting for Contingencies\" and FASB Statement No. 15 \"Accounting by Debtors and Creditors for Troubled Debt Restructuring\". This Statement, which became effective for financial statements for fiscal years beginning after December 15, 1994, applies to all troubled debt restructuring involving a modification of terms.\nA loan is 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. As used in this Statement and in Statement 5, as amended, all amounts due according to the contractual terms means that both the contractual interest payments and the contractual principal payments of a loan will be collected as scheduled in the loan agreement. This Statement does not specify how a creditor should determine that it is probable that it will be unable to collect all amounts due according to the contractual terms\nof a loan. A creditor should apply its normal loan review procedures in making that judgment. An insignificant delay or insignificant shortfall in amount of payments does not require application of this Statement. A loan is not impaired during a period of delay in payment if the creditor expects to collect all amounts due including interest accrued at the contractual interest rate for the period of delay. Thus, a demand loan or other loan with no stated maturity is not impaired if the creditor expects to collect all amounts due including interest accrued at the contractual interest rate during the period the loan is outstanding.\nThis statement was adopted for the 1995 Financial Statements. The adoption did not have any impact on the Company's financial statement.\nThe Financial Accounting Standards Board (FASB) has issued Statement of Financial Accounting Standards No. 121 entitled \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of\". This Statement, becomes effective for financial statements for fiscal years beginning after December 31, 1995, with early adoption encouraged.\nAn entity shall review long-lived assets and certain identifiable intangibles for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If certain events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable, the entity shall estimate the future cash flows expected to result from the use of the asset and its eventual disposition. Future cash flows are the future cash inflows expected to be generated by an asset less the future cash outflows expected to be necessary to obtain those inflows. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of the asset, the entity shall recognize an impairment loss in accordance with this Statement. Otherwise, an impairment loss shall not be recognized; however, a review of depreciation policies may be appropriate.\nThis statement was adopted for the 1995 financial statements. The adoption did not have any impact on the Company's financial statements.\nListed below are the financial statements included in this Part of the Annual Report on SEC Form 10-K:\nPage No. FIRST COMMONWEALTH CORPORATION AND CONSOLIDATED SUBSIDIARIES Independent Auditors' Report for the Years ended December 31, 1995, 1994, 1993 . . . . . . . . . . . . 33\nConsolidated Balance Sheets . . . . . . . . . . . . . . . . . . . 34\nConsolidated Statements of Operations . . . . . . . . . . . . . . 35\nConsolidated Statements of Shareholders' Equity . . . . . . . . . 36\nConsolidated Statements of Cash Flows . . . . . . . . . . . . . . 37\nNotes to Financial Statements . . . . . . . . . . . . . . . . . . 38-59\nITEM 9.","section_9":"ITEM 9. DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone\nIndependent Auditors' Report\nBoard of Directors and Shareholders First Commonwealth Corporation\nWe have audited the accompanying consolidated balance sheets of First Commonwealth Corporation (a Virginia corporation) and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1995. 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 First Commonwealth Corporation and subsidiaries as of December 31, 1995 and 1994, and the consolidated results of their operations and their consolidated cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\nWe have also audited Schedule I as of December 31, 1995, and Schedules II, IV and V as of December 31, 1995 and 1994, of First Commonwealth Corporation and subsidiaries and Schedules II, IV and V for each of the three years in the period then ended. In our opinion, these schedules present fairly, in all material respects, the information required to be set forth therein.\nKERBER, ECK & BRAECKEL LLP\nSpringfield, Illinois March 26, 1996\nSee accompanying notes.\nSee accompanying notes\nSee accompanying notes.\nSee accompanying notes.\nFIRST COMMONWEALTH CORPORATION NOTES TO FINANCIAL STATEMENTS\n1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nA. ORGANIZATION - At December 31, 1995, the parent, significant majority-owned subsidiaries and affiliates of First Commonwealth Corporation were as depicted on the following organizational chart.\nORGANIZATIONAL CHART AS OF DECEMBER 31, 1995\nUnited Trust, Inc. (\"UTI\") is the ultimate controlling company. UTI owns 53% of United Trust Group (\"UTG\") and 30% of United Income, Inc. (\"UII\"). UII owns 47% of UTG. UTG owns 72% of First Commonwealth Corporation (\"FCC\"). FCC owns 100% of Universal Guaranty Life Insurance Company (\"UG\"). UG owns 100% of United Security Assurance Company (\"USA\"). USA owns 84% of Appalachian Life Insurance Company (\"APPL\") and APPL owns 100% of Abraham Lincoln Insurance Company (\"ABE\").\nA summary of the Company's significant accounting policies consistently applied in the preparation of the accompanying financial statements follows.\nB. NATURE OF OPERATIONS - First Commonwealth Corporation is an insurance holding company that, through its insurance subsidiaries sells individual life insurance products. The Company's principal market is the midwestern United States. The primary focus of the Company has been the servicing of existing insurance business in force, the solicitation of new life insurance products and the acquisition of other companies in similar lines of business.\nC. PRINCIPLES OF CONSOLIDATION - The consolidated financial statements include the accounts of the Company and its majority-owned subsidiaries. Other investments in affiliates are carried at cost. All significant intercompany accounts and transactions have been eliminated.\nD. BASIS OF PRESENTATION - The financial statements of First Commonwealth Corporation's life insurance subsidiaries have been prepared in accordance with generally accepted accounting principles which differ from statutory accounting practices permitted by insurance regulatory authorities.\nE. USE OF ESTIMATES - In preparing financial statements in conformity with generally accepted accounting principles, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities, the 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.\nF. INVESTMENTS - Investments are shown on the following bases:\nFixed maturities -- at cost, adjusted for amortization of premium or discount and other-than-temporary market value declines. The amortized cost of such investments differs from their market values; however, the Company has the ability and intent to hold these investments to maturity, at which time the full face value is expected to be realized.\nInvestments held for sale -- at current market value, unrealized appreciation or depreciation is charged directly to shareholders' equity.\nMortgage loans on real estate -- at unpaid balances, adjusted for amortization of premium or discount, less allowance for possible losses.\nReal estate -- at cost, less allowances for depreciation and any impairment which would result in a carrying value below net realizable value. Foreclosed real estate is adjusted for any impairment at the foreclosure date.\nPolicy loans -- at unpaid balances including accumulated interest but not in excess of the cash surrender value.\nShort term investments -- at cost, which approximates market value.\nRealized gains and losses on sales of investments are recognized in net income on the specific identification basis.\nG. RECOGNITION OF REVENUES AND RELATED EXPENSES - Premiums for traditional life insurance products, which include those products with fixed and guaranteed premiums and benefits, consist principally of whole life insurance policies, limited-payment life insurance policies, and certain annuities with life contingencies are recognized as revenues when due. Accident and health insurance premiums are recognized as revenue pro rata over the terms of the policies. Benefits and related expenses associated with the premiums earned are charged to expense proportionately over the lives of the policies through a provision for future policy benefit liabilities and through deferral and amortization of deferred policy acquisition costs. For universal life and investment products, generally there is no requirement for payment of premium other than to maintain account values at a level sufficient to pay mortality and expense charges. Consequently, premiums for universal life policies and investment products are not reported as revenue, but as deposits. Policy fee revenue for universal life policies and investment products consists of charges for the cost of insurance, policy administration, and surrenders assessed during the period. Expenses include interest credited to policy account balances and benefit claims incurred in excess of policy account balances.\nH. DEFERRED POLICY ACQUISITION COSTS - Commissions and other costs of acquiring life insurance products have been deferred. Traditional life insurance and accident and health insurance acquisition costs are being amortized over the premium-paying period of the related policies using assumptions consistent with those used in computing policy benefit reserves.\nFor universal life insurance and interest sensitive life insurance products, acquisition costs are being amortized generally in proportion to the present value of expected gross profits from surrender charges and investment, mortality, and expense margins. This amortization is adjusted retrospectively when estimates of current or future gross profits to be realized from a group of products are revised.\nDeferred policy acquisition costs established at the time a company is acquired are amortized with interest in relation to expected future profits, including direct charge-offs for any excess of the unamortized asset over the projected future profits.\nThe following table summarizes deferred policy acquisition costs and related data for the years shown.\n1995 1994 1993\nDeferred, beginning of year $41,886,000 $41,357,000 $41,540,000\nAcquisition costs deferred: Commissions, net of reinsurance of $0, $1,837,000 and $2,871,000 1,838,000 3,182,000 4,399,000 Marketing, salaries and other expenses 532,000 1,757,000 1,832,000 Total 2,370,000 4,939,000 6,231,000\nInterest accretion 2,626,000 2,603,000 2,674,000 Amortization charged to income (6,361,000) (6,121,000) (9,088,000) Net amortization (3,735,000) (3,518,000) (6,414,000)\nDeferred acquisition costs disposed of at date of sale of subsidiary 0 (892,000) 0 Change for the year (1,365,000) 529,000 (183,000)\nDeferred, end of year $40,521,000 $41,886,000 $41,357,000\nThe following table reflects the components of the income statement for the line item Commissions and amortization of deferred policy acquisition costs.\n1995 1994 1993\nNet amortization of deferred policy acquisition costs $ 3,735,000 $ 3,518,000 $ 6,414,000 Commissions 3,340,000 2,909,000 1,721,000 Total $ 7,075,000 $ 6,427,000 $ 8,135,000\nEstimated net amortization expense of deferred policy acquisition costs for the next five years is as follows:\nInterest Net Accretion Amortization Amortization\n1996 2,600,000 5,600,000 3,000,000 1997 2,400,000 5,200,000 2,800,000 1998 2,300,000 4,700,000 2,400,000 1999 2,200,000 4,400,000 2,200,000 2000 2,000,000 4,100,000 2,100,000\nI. COST IN EXCESS OF NET ASSETS PURCHASED - Cost in excess of net assets purchased are amortized over periods not exceeding forty years using the straight-line method. Management reviews the valuation and amortization of goodwill on an annual basis. As part of this review, the Company estimates the value of and the estimated undiscounted future cash flows expected to be generated by the related subsidiaries to determine that no impairment has occurred.\nJ. FUTURE POLICY BENEFITS AND EXPENSES - The liabilities for traditional life insurance and accident and health insurance policy benefits are computed using a net level method. These liabilities include assumptions as to investment yields, mortality, withdrawals, and other assumptions based on the life insurance subsidiaries' experience adjusted to reflect anticipated trends and to include provisions for possible unfavorable deviations. Reserve interest assumptions are graded and range from 6% to 2%. Such liabilities, for certain plans, are graded to equal statutory values or cash values prior to maturity. Benefit reserves for traditional life insurance policies include certain deferred profits on limited-payment policies that are being recognized in income over the policy term. Policy benefit claims are charged to expense in the period that the claims are incurred. Current mortality rate assumptions are based on 1975-80 select and ultimate tables. Withdrawal rate assumptions are based upon Linton B or Linton C.\nBenefit reserves for universal life insurance and interest sensitive life insurance products are computed under a retrospective deposit method and represent policy account balances before applicable surrender charges. Policy benefits and claims that are charged to expense include benefit claims in excess of related policy account balances. Interest crediting rates for universal life and interest sensitive products range from 5.0% to 6.0% in 1995, 5.0% to 6.0% in 1994 and 5.0% to 7.5% in 1993.\nK. POLICY AND CONTRACT CLAIMS - Policy and contract claims include provisions for reported claims in process of settlement, valued in accordance with the terms of the policies and contracts, as well as provisions for claims incurred and unreported based on prior experience of the Company.\nL. PARTICIPATING INSURANCE - Participating business represents 34% and 31% of the ordinary life insurance in force at December 31, 1995 and 1994, respectively. Premium income from participating business represents 55%, 53%, and 51% of total premiums for the years ended December 31, 1995, 1994 and 1993, respectively. The amount of dividends to be paid is determined annually by the Board of Directors. Earnings allocable to participating policyholders are based on legal requirements which vary by state.\nM. INCOME TAXES - Income taxes are reported under Statement of Financial Accounting Standards Number 109. Deferred income taxes are recorded to reflect the tax consequences on future periods of differences between the tax bases of assets and liabilities and their financial reporting amounts at the end of each such period.\nN. BUSINESS SEGMENTS - The companies operate principally in the individual life insurance business.\nO. EARNINGS PER SHARE - Earnings per share are based on the weighted average number of common shares outstanding during the respective period.\nP. CASH EQUIVALENTS - The Company considers certificates of deposit and other short term instruments with an original purchased maturity of three months or less cash equivalents.\nQ. RECLASSIFICATIONS - Certain prior year amounts have been reclassified to conform with the 1995 presentation.\nR. REINSURANCE - In the normal course of business, the Company seeks to limit its exposure to loss on any single insured and to recover a portion of benefits paid by ceding reinsurance to other insurance enterprises or reinsurers under excess coverage and coinsurance contracts. The Company retains a maximum of $125,000 of coverage per individual life.\nAmounts paid or deemed to have been paid for reinsurance contracts are recorded as reinsurance receivables. Reinsurance premiums, commissions, expense reimbursements, and reserves on reinsured business are accounted for on a basis consistent with those used in accounting for the original policies issued and the terms of the reinsurance contracts. Expense reimbursements received in connection with reinsurance ceded have been accounted for as a reduction of the related policy acquisition costs or, to the extent such reimbursements exceed the related acquisition costs, as revenue.\nReinsurance contracts do not relieve the Company from its obligations to policyholders. Failure of reinsurers to honor their obligations could result in losses to the Company; consequently, allowances are established for amounts deemed uncollectible. The Company evaluates the financial condition of its reinsurers and monitors concentrations of credit risk arising from similar geographic regions, activities, or economic characteristics of the reinsurers to minimize its exposure to significant losses from reinsurer insolvencies.\n2. SHAREHOLDER DIVIDEND RESTRICTION\nAt December 31, 1995, substantially all of consolidated shareholders' equity represents net assets of FCC's subsidiaries. The payment of cash dividends to shareholders by FCC is not legally restricted. UG's dividend limitations are described below.\nOhio domiciled insurance companies require five days prior notification to the insurance commissioner for the payment of an ordinary dividend. Ordinary dividends are defined as the greater of: a) prior year statutory earnings or b) 10% of statutory capital and surplus. For the year ended December 31, 1995, UG had a statutory gain from operations of $3,197,000. At December 31, 1995, UG's statutory capital and surplus amounted to $7,274,000. Extraordinary dividends (amounts in excess of ordinary dividend limitations) require prior approval of the insurance commissioner and are not restricted to a specific calculation.\n3. FEDERAL INCOME TAXES\nUntil 1984, the insurance companies were taxed under the provisions of the Life Insurance Company Income Tax Act of 1959 as amended by the Tax Equity and Fiscal Responsibility Act of 1982. These laws were superseded by the Deficit Reduction Act of 1984. All of these laws are based primarily upon statutory results with certain special deductions and other items available only to life insurance companies. If certain of the life companies pay shareholder dividends in excess of \"shareholders' surplus\" they will be required to pay taxes on income not taxed under the pre-1984 acts.\nThe following table summarizes the companies with this situation and the maximum amount of income which has not been taxed in each.\nShareholders Untaxed Company Surplus Balance\nABE $ 5,327,000 $ 1,150,000 APPL 4,128,000 1,525,000 UG 22,195,000 4,364,000 USA 1,101,000 0\nThe payment of taxes on this income is not anticipated; and, accordingly, no deferred taxes have been established.\nThe life insurance company subsidiaries file a consolidated federal income tax return. The holding companies of the group file separate returns.\nLife insurance company taxation is based primarily upon statutory results with certain special deductions and other items available only to life insurance companies. Income tax expense consists of the following components:\n1995 1994 1993\nCurrent tax expense (credit) $ (1,000) $ 35,000 $ (108,000) Deferred tax expense(credit) (1,435,000) (2,031,000) (643,000) $(1,436,000) $(1,996,000) $ (751,000)\nThe Companies have net operating loss carryforwards for federal income tax purposes expiring as follows:\nFCC UG 2001 0 117,000 2003 0 57,000 2006 0 4,388,000 2007 46,000 783,000 2008 0 940,000 2010 0 2,540,000 TOTAL $ 46,000 $ 8,825,000\nThe Company has established a deferred tax asset of $3,105,000 for its operating loss carryforwards and has established an allowance of $3,105,000.\nThe provision or (credit) for income taxes shown in the statements of operations does not bear the normal relationship to pre-tax income as a result of certain permanent differences.\nThe sources and effects of such differences are summarized in the following table:\n1995 1994 1993\nTax computed at standard corporate rate $ (992,000) $(1,298,000) $(1,408,000) Changes in taxes due to: Companies incurring losses without tax benefit 0 0 427,000 Goodwill 154,000 158,000 230,000 Benefit of prior losses (599,000) (696,000) Other 1,000 (160,000) 0 Income tax expense (credit) $ (1,436,000) $(1,996,000) $ (751,000)\nThe following table summarizes the major components which comprise the deferred tax liability as reflected in the balance sheets:\n1995 1994\nInvestments $ (332,722) $ (254,075) Value of agency force 2,270,007 2,378,642 Deferred policy acquisition costs 14,182,255 14,660,060 Agents balances (71,625) (77,310) Furniture and equipment (34,104) (53,454) Due premiums (1,285,212) (1,378,163) Discount of notes 1,003,038 987,932 Future policy benefits (3,656,260) (2,920,295) Other liabilities (1,346,525) (1,456,827) Federal tax DAC (2,862,999) (2,586,157)\nDeferred tax liability $ 7,865,853 $ 9,300,353\n4. ANALYSIS OF INVESTMENTS, INVESTMENT INCOME AND INVESTMENT GAIN\nA. NET INVESTMENT INCOME - The following table reflects net investment income by type of investment:\n1995 1994 1993 Fixed maturities and fixed maturities held for sale $13,292,552 $12,174,226 $10,759,045 Equity securities 52,445 3,999 228,762 Mortgage loans 1,257,189 1,408,558 1,708,842 Real estate 975,080 990,857 968,620 Policy loans 1,041,900 978,555 954,609 Short term investments 498,496 412,135 1,068,313 Collateral loans 0 0 5,121 Other 143,527 135,051 175,873 Total investment income 17,261,189 16,103,381 15,869,185 Investment expense (1,761,438) (1,914,920) (1,781,476) Net investment income $15,499,751 $14,188,461 $14,087,709\nAt December 31, 1995, the companies had a total of $7,703,000 of investments, comprised of $6,894,000 in real estate including its home office property and $809,000 in equity securities, which did not produce income during 1995.\nThe following table summarizes the Company's fixed maturity holdings and investments held for sale by major classifications.\nCarrying Value 1995 1994 Investments held for sale: Fixed maturities $ 3,226,175 $ 3,337,672 Equity securities 1,946,481 911,012\nFixed maturities: U.S. Government and government agencies 27,205,449 20,874,683 State, municipalities and political subdivisions 6,774,185 7,092,424 Collateralized mortgage obligations 15,395,913 18,567,399 Public utilities 59,101,260 57,587,697 Corporate 82,081,544 78,916,639 $195,731,007 $187,287,526\nBy insurance statute, the majority of the Company's investment portfolio is required to be invested in investment grade securities to provide ample protection for policyholders. The Company does not invest in so- called \"junk bonds\" or derivative investments.\nBelow investment grade debt securities generally provide higher yields and involve greater risks than investment grade debt securities because their issuers typically are more highly leveraged and more vulnerable to adverse economic conditions than investment grade issuers. In addition, the trading market for these securities is usually more limited than for investment grade debt securities. Debt securities classified as below- investment grade are those that receive a Standard & Poor's rating of BB or below.\nThe following table summarizes by category securities held that are below investment grade at amortized cost:\nBelow Investment Grade Investments 1995 1994 1993\nState, Municipalities and Political Subdivisions $ 0 $ 32,370 $ 1,750 Public Utilities 119,379 168,869 138,159 Corporate 833,142 848,033 330,335 Total $ 952,521 $ 1,049,272 $ 470,244\nB. INVESTMENT SECURITIES\nThe amortized cost and estimated market values of investments in securities including investments held for sale are as follows:\nCost or Gross Gross Estimated Amortized Unrealized Unrealized Market 1995 Cost Gains Losses Value\nInvestments Held for Sale: U.S. Government and govt. agencies and authorities $ 2,001,860 $ 2,579 $ 621 $ 2,003,818 States, municipalities and political subdivisions 812,454 14,313 3,749 823,018 Collateralized mortgage obligations 32,177 506 0 32,683 Public utilities 119,379 572 2,123 117,828 All other corporate bonds 258,169 337 9,678 248,828 3,224,039 18,307 16,171 3,226,175\nEquity securities 2,086,159 80,721 220,399 1,946,481 Total $ 5,310,198 $ 99,028 $ 236,570 $5,172,656\nHeld to Maturity Securities: U.S. Government and govt. agencies and authorities $27,205,449 $ 1,075,742 $ 27,634 $ 28,253,557 States,municipalities and political subdivisions 6,774,185 312,253 6,804 7,079,634 Collateralized mortgage obligations 15,395,913 295,344 67,472 15,623,785 Public utilities 59,101,260 2,307,613 126,760 61,282,113 All other corporate bonds 82,081,544 2,974,554 288,930 84,767,168 Total $190,558,351 $ 6,965,506 $ 517,600 $197,006,257\nCost or Gross Gross Estimated Amortized Unrealized Unrealized Market 1994 Cost Gains Losses Value\nInvestments Held for Sale: U.S. Government and govt. agencies and authorities $ 1,993,503 $ 0 $ 132,003 $ 1,861,500 States, municipalities and political subdivisions 914,902 23,496 8,871 929,527 Collateralized mortgage obligations 541,868 4,777 0 546,645 Public utilities 0 0 0 0 All other corporate bonds 0 0 0 0 3,450,273 28,273 140,874 3,337,672\nEquity securities 1,235,840 1,800 326,628 911,012 Total $ 4,686,113 $ 30,073 $ 467,502 $ 4,248,684\nHeld to Maturity Securities: U.S. Government and govt. agencies and authorities $ 20,328,039 $ 155,347 $ 374,992 $ 20,108,393 States, municipalities and political subdivisions 7,092,424 75,052 302,152 6,865,324 Collateralized mortgage obligations 19,114,044 55,736 991,431 18,178,349 Public utilities 57,587,697 27,200 4,793,518 52,821,379 All other corporate bonds 78,916,638 165,497 5,120,550 73,961,585\nTotal $183,038,842 $ 478,832 $ 11,582,643 $171,935,030\nThe amortized cost of debt securities at December 31, 1995, 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.\nFixed Maturities Held to Maturity Amortized December 31, 1995 Cost\nDue in one year or less $ 10,752,755 Due after one year through five years 89,247,186 Due after five years through ten years 80,406,194 Due after ten years 10,152,216 $190,558,351\nFixed Maturities Held for Sale Amortized December 31, 1995 Cost\nDue in one year or less $ 0 Due after one year through five years 2,249,473 Due after five years through ten years 682,573 Due after ten years 291,993 $ 3,224,039\nProceeds from sales, calls, and maturities of investments in debt securities during 1995 were $16,885,000. Gross gains of $107,000 and gross losses of $228,000 were realized on those sales, calls and maturities.\nProceeds from sales, calls, and maturities of investments in debt securities during 1994 were $23,852,000. Gross gains of $168,000 and gross losses of $272,000 were realized on those sales, calls and maturities.\nProceeds from sales, calls, and maturities of investments in debt securities during 1993 were $45,733,000. Gross gains of $539,000 and gross losses of $437,000 were realized on those sales, calls and maturities.\nC. INVESTMENTS ON DEPOSIT - At December 31, 1995, investments carried at approximately $46,957,000 were on deposit with various state insurance departments.\n5. DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS\nThe financial statements include various estimated fair value information at December 31, 1995 and 1994, as required by Statement of Financial Accounting Standards 107, Disclosure about Fair Value of Financial Instruments (\"SFAS 107\"). Such information, which pertains to the Company's financial instruments, is based on the requirements set forth in that Statement and does not purport to represent the aggregate net fair value of the Company.\nThe following methods and assumptions were used to estimate the fair value of each class of financial instrument required to be valued by SFAS 107 for which it is practicable to estimate that value:\n(a) Cash and Cash equivalents\nThe carrying amount in the financial statements approximates fair value because of the relatively short period of time between the origination of the instruments and their expected realization.\n(b) Fixed maturities and investments held for sale\nQuoted market prices, if available, are used to determine the fair value. If quoted market prices are not available, management estimates the fair value based on the quoted market price of a financial instrument with similar characteristics.\n(c) Mortgage loans on real estate\nAn estimate of fair value is based on management's review of the portfolio in relation to market prices of similar loans with similar credit ratings, interest rates, and maturity dates. Management conservatively estimates fair value of the portfolio is equal to the carrying value.\n(d) Investment real estate and real estate acquired in satisfaction of debt\nAn estimate of fair value is based on management's review of the individual real estate holdings. Management utilizes sales of surrounding properties, current market conditions and geographic considerations. Management conservatively estimates the fair value of the portfolio is equal to the carrying value.\n(e) Policy loans\nIt is not practicable to estimate the fair value of policy loans as they have no stated maturity and their rates are set at a fixed spread to related policy liability rates. Policy loans are carried at the aggregate unpaid principal balances in the consolidated balance sheets, and earn interest at rates ranging from 4% to 8%. Individual policy liabilities in all cases equal or exceed outstanding policy loan balances.\n(f) Short term investments\nFor short term instruments, the carrying amount is a reasonable estimate of fair value. All short term instruments represent certificates of deposit with various banks and all are protected under FDIC.\n(g) Notes and accounts receivable and uncollected premiums\nThe Company holds a $840,000 note receivable for which the determination of fair value 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. Accounts receivable and uncollected premiums are primarily insurance contract related receivables which are determined based upon the underlying insurance liabilities and added reinsurance amounts, and thus are excluded for the purpose of fair value disclosure by paragraph 8(c) of SFAS 107.\n(h) Notes payable\nFor borrowings under the senior loan agreement, which is subject to floating rates of interest, carrying value is a reasonable estimate of fair value. For subordinated borrowings fair value was determined based on the borrowing rates currently available to the Company for loans with similar terms and average maturities.\nThe estimated fair values of the Company's financial instruments required to be valued by SFAS 107 are as follows as of December 31:\n1995 1994 Estimated Estimated Carrying Fair Carrying Fair Assets Amount Value Amount Value\nFixed maturities $190,558,351 $197,006,257 $183,038,842 $171,935,030 Fixed maturities held for sale 3,226,175 3,226,175 3,337,672 3,337,672 Equity securities 1,946,481 1,946,481 911,012 911,012 Mortgage loans on real estate 13,891,762 13,891,762 15,822,056 15,822,056 Policy loans 16,941,359 16,941,359 16,338,632 16,338,632 Short term investments 425,000 425,000 350,000 350,000 Investment real estate 11,683,575 11,683,575 11,712,847 11,712,847 Real estate acquired in satisfaction of debt 5,332,413 5,332,413 5,620,101 5,620,101 Notes receivable 840,066 775,399 840,066 768,094\nLiabilities\nNotes payable 20,623,328 19,987,666 21,529,189 20,842,111\n6. STATUTORY EQUITY AND GAIN FROM OPERATIONS\nThe Company's insurance subsidiaries are domiciled in Ohio, Illinois and West Virginia and prepare their statutory-based financial statements in accordance with accounting practices prescribed or permitted by the respective insurance department. These principles differ significantly from generally accepted accounting principles. \"Prescribed\" statutory accounting practices include state laws, regulations, and general administrative rules, as well as a variety of publications of the National Association of Insurance Commissioners (\"NAIC\"). \"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 NAIC currently is in the process of codifying statutory accounting practices, the result of which is expected to constitute the only source of \"prescribed\" statutory accounting practices. Accordingly, that project, which is expected to be completed in 1996, will likely change prescribed statutory accounting practices, and may result in changes to the accounting practices that insurance enterprises use to prepare their statutory financial statements. UG's total statutory shareholders' equity was $7,274,000 and $7,683,000 at December 31, 1995 and 1994, respectively. The combined statutory gain from operations (exclusive of intercompany dividends) was $3,633,000, $3,074,000 and $1,581,000 for 1995, 1994 and 1993, respectively.\n7. REINSURANCE\nIn December 1991, UG entered into a 50% coinsurance arrangement with Republic Vanguard Life Insurance Company to enable the Company to maintain increased production levels while containing first year statutory costs. The ceding of new business under this treaty was terminated December 31, 1993. Republic Vanguard holds an \"A\" (Excellent) rating from A. M. Best, an industry rating company. The coinsurance arrangement, which was effective January 1, 1991, allowed UG to cede to Republic Vanguard a 50% quota share of all new universal life policies issued after the effective date through date of termination. UG receives a commission allowance of 11% of excess premium and renewal premium. Monies pertaining to the coinsurance arrangement are settled monthly. The agreement contains a provision whereby risks in excess of UG's retention ($125,000 maximum) are transferred to the reinsurer. Risks are transferred under an automatic ceding arrangement up to $1,000,000 and a facultative arrangement for amounts in excess of $1,000,000.\nIn December 1993, UG entered into reinsurance agreements with Business Men's Assurance Company, (\"BMA\") and Life Reassurance Corporation, (\"LIFE RE\"). BMA and LIFE RE each hold an \"A+\" (Superior) rating from A.M. Best, an industry rating company. The reinsurance arrangement was effective December 1, 1993, and covered all new business of the Company. The agreements are a yearly renewable term (\"YRT\") treaty where the Company cedes amounts above its retention limit of $100,000 with a minimum cession of $25,000.\nDuring 1993, USA entered into a coinsurance agreement with LIFE RE. The coinsurance arrangement allows USA to cede to LIFE RE a 50% quota share of the traditional participating policies issued by USA after the effective date of July 1, 1992. USA entered into the arrangement to enable the Company to maintain increased production levels while containing first year statutory costs. USA receives commission allowances of 150% of first year premium, 27% of second year premium, 32% of third year premium and 37% of fourth year and beyond. Monies pertaining to the coinsurance arrangement are settled monthly.\nThe Company does not have any short-duration reinsurance contracts. The effect of the Company's long duration reinsurance contracts on premiums earned in 1994, 1993 and 1992 was as follows:\nShown in thousands 1995 1994 1993 Premiums Premiums Premiums Earned Earned Earned\nDirect $ 35,201 $ 37,911 $ 39,357 Assumed 0 0 0 Ceded (5,203) (5,627) (8,630) Net premiums $ 29,998 $ 32,284 $ 30,727\nReinsurance receivables for future policy benefits were $13,540,000 and $12,819,000 at December 31, 1995 and 1994, respectively, for estimated recoveries under reinsurance treaties.\n8. COMMITMENTS AND CONTINGENCIES\nDuring the third quarter of 1994, UG became aware that certain new insurance business was being solicited by certain agents and issued to individuals considered to be not insurable by Company standards. These policies had a face amount of $22,700,000 and represent 1\/2 of 1% of the insurance in force. Management's analysis indicates that the expected death claims on the business in force to be adequately covered by the mortality assumptions inherent in the calculation of statutory reserves. Nevertheless, management has determined it is in the best interest of the Company to repurchase as many of the policies as possible. As of December 31, 1995, there remained approximately $5,738,000 of the original face amount which have not been settled. The Company will continue its efforts to repurchase as many of the policies as possible and regularly apprise the Ohio Department of Insurance regarding the status of this situation. Through December 31, 1995, the Company spent a total of $2,886,000 for the repurchase of these policies and for the defense of related litigation.\nThe Company is currently involved in the following litigation: Freeman v. Universal Guaranty Life Insurance Company (U.S.D.C.,N.D.Ga, 1994, 1-94-CV- 2593-RCF); Armstrong v. Universal Guaranty Life Insurance Company and James Melville (Circuit Court of Davidson County, Tenn., 1994, 94C3222); Armstrong v. Universal Guaranty Life Insurance Company and James Melville (Circuit Court of Davidson County, Tenn., 1994, 94C3720); Ridings v. Universal Guaranty Life Insurance Company and James Melville (Circuit Court of Davidson County, Tenn., 1994, 94C3221).\nFour general agents of UG filed independent suits against UG in the latter part of September or early October 1994. Kathy Armstrong (3-94-1085), another general agent, filed her suit on November 16, 1994. All of the suits allege that the plaintiff was libeled by statements made in a letter sent by UG. The letter was sent to persons who had been issued life insurance policies by UG as the result of policy applications submitted by the five agents. Mr. Melville is a defendant in some of the suits because he signed the letter as president of UG.\nIn addition to the defamation count, Mr. Freeman alleges that UG also breached a contract by failing to pay his commissions for policies issued. Mr. Freeman claims unpaid commissions of $104,000. In the libel claim, Mr. Freeman claims compensatory damages of over $5,000,000, punitive damages of over $3,000,000, costs, and litigation expenses. The other plaintiffs request the award of unspecified compensatory damages and punitive (or special) damages as well as costs and attorney's fees. UG has filed Answers to all of these suits asserting various defenses and, where appropriate, counterclaims. UG believes that it has no liability to any of the plaintiffs and intends to defend each of the suits vigorously. The Freeman suit is scheduled for trial April 8, 1996.\nJeffrey Ploskonka, Keith Bohn and Paul Phinney v. Universal Guaranty Life Insurance Company (Circuit Court of the Seventh Judicial Circuit Sangamon County, Illinois Case No.: 95-L-0213)\nOn March 9, 1995 a lawsuit was filed against Universal Guaranty Life Insurance on behalf of three insureds and a potential class of other insureds. The Plaintiffs allege that UG violated the insurance contract in attempting to cancel life insurance contracts. Additionally, the Plaintiffs assert violations of Illinois law alleging vexations and unreasonable insurance practices, breach of duty of good faith and fair dealing, and that Illinois consumer fraud laws have been violated. The Plaintiffs seek unspecified compensatory damages, injunctive relief, attorneys' fees, statutory damages in an amount up to $25,000.00, punitive damages of $1,000,000.00, and other equitable relief. UG filed an Answer to this lawsuit in May 1995, asserting various defenses and reserving the right to\nassert counterclaims. UG has also filed motions to dismiss certain allegations and claims made in the lawsuit. UG believes it has no liability to any of the plaintiffs, or other potential class members, and intends to defend the lawsuit vigorously. In June 1995, the court conditionally certified a class of non-settling insureds.\nThe Company and its subsidiaries are named as defendants in a number of legal actions arising primarily from claims made under insurance policies. Those actions have been considered in establishing the Company's liabilities. Management and its legal counsel are of the opinion that the settlement of those actions will not have a material adverse effect on the Company's financial position or results of operations.\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 guarantee 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, the Company has accrued for those assessments.\n9. RELATED PARTY TRANSACTIONS\nThe employees of the Company have extensive experience and expertise in acquiring, managing and operating corporations and other business entities engaged in the general life insurance business as well as other financial and investment companies. None of the Company's subsidiaries has employees of their own. On January 1, 1993, FCC entered into an agreement with UG pursuant to which FCC provides management services necessary for UG to carry on its business. In addition to the UG agreement, FCC and its affiliates have either directly or indirectly entered into management and\/or cost-sharing arrangements whereby FCC provides management services. FCC received net management fees of $10,464,000, $10,912,000 and $10,658,000 under these arrangements in 1995, 1994 and 1993, respectively. UG paid $10,164,000, $10,587,000 and $10,368,000 to FCC in 1995, 1994 and 1993, respectively.\nIn addition to the above agreements, USA has a service agreement with UII to provide services for claim processing, underwriting, processing and servicing of policies, accounting services, agency services, data processing and all other expenses necessary to carry on the business of a life insurance company. Fees are based on percentages of premium revenue applied to both first year and renewal premiums. USA paid $2,015,000, $1,357,000 and $1,202,000 under this agreement in 1995, 1994 and 1993, respectively.\nThe agreements of the insurance companies have been approved by their respective domiciliary insurance departments and it is Management's opinion that where applicable, costs have been allocated fairly and such allocations are based upon generally accepted accounting principles. The costs paid by FCC for these services include costs related to the production of new business which are deferred as policy acquisition costs and charged off to the income statement through \"Amortization of deferred policy acquisition costs\". Also included are costs associated with the maintenance of existing policies which are charged as current period costs and included in \"general expenses\".\nThe transactions described below, which transpired during 1994, were necessary to position Universal Guaranty Investment Company (\"UGIC\"), Investors Trust, Inc. (\"ITI\") and Commonwealth Industries Corporation (\"CIC\") for liquidation and dissolution.\nPursuant to an Agreement of Merger dated July 7, 1994 between Investors Trust Assurance Company, an Illinois life insurance company (\"ITAC\"), and ALIC, on July 31, 1994, ITAC merged with and into ALIC and ALIC was the surviving company. On the effective date of the merger, ALIC succeeded to all the rights and property of ITAC and assumed all of the liabilities and obligations and became subject to all of the debts of ITAC in the same manner as if ALIC had itself incurred them. The merger was approved by the Illinois Director of Insurance.\nPrior to the merger of ITAC with and into ALIC, ITAC was a wholly owned subsidiary of ITI. ITAC owned 1,549,549 (approximately 66%) of the issued and outstanding common stock of UGIC. Prior to July 31, 1994, ITI was the indirect beneficial owner of the shares of UGIC common stock directly owned by ITAC. On July 31, immediately prior to the effectiveness of the merger of ITAC with and into ALIC, ITI purchased 758,946 shares of the UGIC common stock owned by ITAC. The total purchase price was $2,276,793. On July 31, 1994, ITAC also transferred to ITI at no cost 790,603 shares of the common stock of the Company. On such date, ITI became the direct beneficial owner of all 1,549,549 shares of the common stock of UGIC. In order to purchase the 758,946 shares of UGIC common stock, ITI received a loan from UTI and UII in the aggregate principal amount of $2,164,293. ITI transferred 721,431 shares of the common stock of UGIC that it purchased from ITAC to UTI and UII in payment of the loan. These shares were then contributed by UTI and UII to their subsidiary, UTG.\nThe balance sheet of Commonwealth Industries Corporation for the period ended July 31, 1994, included liabilities in the aggregate amount of $402,861 comprised of a future liability under a consulting agreement, escheat funds and an account payable. On July 31, 1994, these liabilities were assumed by UTG in exchange for 1,558,318 shares of the common stock of ITI.\nThe balance sheet of UGIC for the period ended July 31, 1994, included liabilities in the aggregate amount of $461,102. On July 31, 1994, these liabilities were assumed by UTG in exchange for 106,392 shares of the common stock of FCC and 315 shares of the common stock of CIC. The FCC shares transferred reduced UGIC's percentage ownership of FCC from 50.396% to 49.959%.\nPrior to these transactions, UGIC, ITI and CIC each had liabilities in excess of assets excluding the stock holdings of their respective subsidiary. The 1994 transactions enabled the companies to extinguish their liabilities.\nOn August 15, 1995, the shareholders of CIC, ITI, and UGIC voted to voluntarily liquidate each of the companies and distribute the assets to the shareholders (consisting solely of common stock of their respective subsidiary). As a result of the liquidations, the shareholders of each company became shareholders of FCC, following the liquidations, UTG holds 72% of the common stock of FCC.\n10. NOTES PAYABLE\nAt December 31, 1995, the Company has $20,623,000 in long term debt outstanding. The debt is comprised of the following components:\n1995 1994 Senior debt $ 11,400,000 $ 12,300,000 Subordinated 10 yr. notes 5,370,000 5,670,000 Subordinated 20 yr. notes 3,830,000 3,530,000 Encumbrance on real estate 23,000 29,000 $ 20,623,000 $ 21,529,000\nThe senior debt is comprised of participations of the First Bank of Missouri, (First Bank of Missouri was the successor bank to a merger with First Bank of Gladstone, Citizen's Bank and Trust Company, and Bank of St. Joseph, all Missouri Banks), Massachusetts General Life Insurance Company and Philadelphia Life Insurance Company (the \"Senior Lenders\"). The loan is subject to a certain Credit Agreement between the parties stipulating the terms of the loan. The FCC Senior Debt bears interest at a variable per annum rate equal to 1% over the variable per annum rate of interest most recently announced by the First Bank of Missouri as its \"Base Rate\". As of March 1, 1996, the \"Base Rate\" was 8.25%. The principal balance of the FCC Senior Debt is payable in installments on June 1st of each year commencing June 1, 1994 and ending June 1, 1998. On January 31, 1996, FCC prepaid $1,500,000 of the $3,900,000 scheduled principal payment due June 1, 1996. At December 31, 1995, the principal amount of the FCC Senior Debt to outside parties was $10,400,000.\nThe Credit Agreement includes an earnings covenant which provides that FCC will not permit the sum of (i) the combined pre-tax earnings of the subsidiaries of FCC, excluding the results of any surplus relief reinsurance and any intercompany dividends, determined in accordance with statutory accounting practices, and (ii) the pre-tax earnings of FCC plus interest expense and non-cash charges, determined in accordance with generally accepted accounting practices, to be less than the amounts specified in the Credit Agreement. The Credit Agreement requires that the earnings as specified above, be not less than $7,450,000 for 1995. The Company has not satisfied the earnings requirement for the past several years. The lenders have granted waivers or modifications to the earnings requirement in each of the past years in which the Company did not meet the requirement. Management expects similar treatment of the 1995 requirement.\nThe subordinated debt was incurred June 16, 1992 as a part of an acquisition. The 10 year notes bear interest at the rate of 7 1\/2% per annum, payable semi- annually beginning December 16, 1992. These notes provide for principal payments equal to 1\/20th of the principal balance due with each interest installment beginning June 16, 1997, with a final payment due June 16, 2002. During 1995, the Company refinanced $300,695 of the 10 year notes to 20 year notes bearing interest at the rate of 8.75%. The repayment terms of these notes are similar to the original 20 year notes. The 20 year notes bear interest at the rate of 8 1\/2% per annum, payable semi-annually beginning December 16, 1992, with a lump sum principal payment due June 16, 2012. Scheduled principal reductions on the Company's debt for the next five years is as follows:\nYear Amount\n1996 3,900,000 1997 4,437,000 1998 3,137,000 1999 537,000 2000 537,000\n11. OTHER CASH FLOW DISCLOSURE\nOn a cash basis, the Company paid $1,887,170, $1,883,198, and $1,836,881 in interest expense for the years 1995, 1994 and 1993, respectively. The Company paid $25,821, $190, and $425,071 in federal income tax for the years 1995, 1994 and 1993 respectively.\nThe Company held an investment in an intermediate parent, Commonwealth Industries Corporation (\"CIC\"), with a carrying value of $3,462,500. Upon liquidation of CIC in August of 1995, FCC received 372,506 shares of its own stock from the distribution of assets of CIC. These shares are classified as treasury stock with a basis equal to the carrying value of the original CIC shares.\n12. DEFERRED COMPENSATION PLAN\nUTI and FCC have instituted a deferred compensation plan effective May 1, 1993 pursuant to which an officer or agent of FCC, UTI or affiliates of UTI, may defer a portion of their income over the next two and one-half years in return for a deferred compensation payment payable at the end of seven years in the amount equal to the total income deferred plus interest at a rate of approximately 8.5% per annum and a stock option to purchase shares of common stock of UTI. An officer or agent will receive an immediately exercisable option to purchase 23,000 shares of UTI common stock at $1.75 per share for each $25,000 ($10,000 per year for two and one-half years) of total income deferred. The option expires on December 31, 2000. At December 31, 1995 and 1994, the Company held a liability of $1,167,000 and $851,000, respectively, relating to this plan.\n13. CONCENTRATION OF CREDIT RISK\nThe Company maintains cash balances in financial institutions which at times may exceed federally insured limits. The Company has not experienced any losses in such accounts and believes it is not exposed to any significant credit risk on cash and cash equivalents.\n14. NEW ACCOUNTING STANDARDS\nThe Financial Accounting Standards Board (FASB) has issued Statement of Financial Accounting Standards No. 114 entitled \"Accounting by Creditors for Impairment of a Loan\" and Statement of Financial Accounting Standards No. 118, an amendment of Statement No. 114. The Statement amends FASB Statement No. 5 \"Accounting for Contingencies\" and FASB Statement No. 15 \"Accounting by Debtors and Creditors for Troubled Debt Restructuring\". This Statement, which becomes effective for financial statements for fiscal years beginning after December 15, 1994, applied to all troubled debt restructuring involving a modification of terms.\nA loan is 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. As used in this Statement and in Statement 5, as amended, all amounts due according to the contractual terms means that both the contractual interest payments and the contractual principal payments of a loan will be collected as scheduled in the loan agreement. This Statement does not specify how a creditor should determine that it is probable that it will be unable to collect all amounts due according to the contractual terms of a loan. A creditor should apply its normal loan review procedures in making that judgment. An insignificant delay or insignificant shortfall in amount of payments does not require application of this Statement. A loan is not impaired during a period of delay in\npayment if the creditor expects to collect all amounts due including interest accrued at the contractual interest rate for the period of delay. Thus, a demand loan or other loan with no stated maturity is not impaired if the creditor expects to collect all amounts due including interest accrued at the contractual interest rate during the period the loan is outstanding.\nThis statement was adopted for the 1995 financial statements. The adoption did not have any impact on the Company's financial statements.\nThe Financial Accounting Standards Board (FASB) has issued Statement of Financial Accounting Standards No. 121 entitled \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of\". This Statement, becomes effective for financial statements for fiscal years beginning after December 31, 1995, with early adoption encouraged.\nAn entity shall review long-lived assets and certain identifiable intangibles for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If certain events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable, the entity shall estimate the future cash flows expected to result from the use of the asset and its eventual disposition. Future cash flows are the future cash inflows expected to be generated by an asset less the future cash outflows expected to be necessary to obtain those inflows. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of the asset, the entity shall recognize an impairment loss in accordance with this Statement. Otherwise, an impairment loss shall not be recognized; however, a review of depreciation policies may be appropriate.\nThis statement was adopted for the 1995 financial statements. The adoption did not have any impact on the Company's financial statements.\n15. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)\n1st 2nd 3rd 4th Premium income and other considerations, net $ 9,445,222 $ 8,765,804 $ 7,868,803 $ 7,018,707 Net investment income $ 3,868,022 $ 3,871,973 $ 3,746,400 $ 4,013,356 Total revenues $ 13,393,826 $ 12,589,288 $ 11,555,186 $10,826,874 Policy benefits including dividends $ 8,227,705 $ 8,940,389 $ 7,014,070 $ 7,041,851 Amortization of def. policy acquisitions $ 2,243,591 $ 2,601,769 $ 1,845,751 $ 694,340 Operating expenses $ 3,001,897 $ 2,296,482 $ 2,025,224 $ 3,349,393 Operating income (loss) $ (570,700) $ (1,722,716) $ 193,517 $ (734,749) Net income (loss) $ 124,352 $ (1,544,567) $ 1,186,214 $(1,217,637) Net income (loss) per share $ 0.01 $ (0.06) $ 0.05 $ (0.06)\n1st 2nd 3rd 4th\nPremium income and other considerations, net $ 8,964,962 $ 9,934,140 $ 7,910,808 $ 8,214,359 Net investment income $ 3,300,446 $ 3,417,511 $ 3,622,195 $ 3,848,309 Total revenues $ 12,681,470 $ 13,207,458 $ 11,297,282 $12,075,161 Policy benefits including dividends $ 7,383,334 $ 9,440,534 $ 8,994,923 $ 9,613,116 Amortization of def. policy acquisitions $ 1,759,083 $ 1,791,036 $ 1,797,961 $ 1,271,180 Operating expenses $ 2,214,390 $ 1,406,224 $ 2,345,992 $ 3,009,379 Operating income $ 876,062 $ 88,949 $ (2,346,822) $(2,325,535) Net income (loss) $ 768,075 $ 427,438 $ (2,090,687) $ (879,670) Net income (loss) per share $ 0.03 $ 0.02 $ (0.09) $ (0.03)\n1st 2nd 3rd 4th\nPremium income and other considerations, net $ 9,721,559 $ 8,651,168 $ 7,312,005 $ 7,411,913 Net investment income $ 3,949,496 $ 3,339,979 $ 3,353,208 $ 3,445,026 Total revenues $ 13,556,195 $ 12,159,438 $ 11,136,672 $ 10,332,416 Policy benefits including dividends $ 8,445,955 $ 9,282,815 $ 7,485,959 $ 5,052,857 Amortization of def. policy acquisitions $ 2,631,755 $ 1,564,443 $ 2,088,932 $ 1,850,218 Operating expenses $ 2,737,801 $ 2,702,851 $ 2,254,271 $ 2,905,800 Operating income $ (752,387) $ (1,880,563) $ (1,147,901) $ (243,179) Net income (loss) $ (650,633) $ (1,708,410) $ (588,683) $ (394,958) Net income (loss) per share $ (0.03) $ (0.07) $ (0.02) $ (0.02)\nPART III\nWith respect to Items 10 through 13, the Company will file with the Securities and Exchange Commission, within 120 days of the close of its fiscal year, a definitive proxy statement pursuant to Regulation 14-A.\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nInformation regarding directors of the Company will be set forth in the Company's proxy statement relating to the annual meeting of shareholders to be held June 3, 1996, and is incorporated herein by reference. Information regarding executive officers of the Company is set forth under the caption \"Executive Officers\".\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation regarding executive compensation will be set forth in the Company's proxy statement relating to the annual meeting of shareholders to be held June 3, 1996, 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 will be set forth in the Company's proxy statement relating to the annual meeting of shareholders to be held June 3, 1996, and is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation regarding certain relationships and related transactions will be set forth in the Company's proxy statement relating to the annual meeting of shareholders to be held June 3, 1996, and is incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) The following documents are filed as a part of the report:\n(1) Financial Statements: See Item 8, Index to Financial Statements\n(2) Financial Statement Schedules\nSchedule I - Summary of Investments - other than invested in related parties.\nSchedule II - Condensed financial information of registrant\nSchedule IV - Reinsurance\nSchedule V - Valuation and Qualifying Accounts\nNOTE: Schedules other than those listed above are omitted for the reasons they are not required or the information is disclosed in the financial statements or footnotes.\n(b) Reports on Form 8-K filed during fourth quarter.\nNone\n(c) Exhibits:\nIndex to Exhibits (See Pages 62 - 65).\nINDEX TO EXHIBITS\nExhibit Number\n3(a) (1) Articles of Incorporation for the Company dated August 25, 1967.\n3(b) (1) Amended Articles of Incorporation for the Company dated January 27, 1988.\n3(c) (1) Charter Agreement for the Company dated May 22, 1991.\n3(d) (1) Amended Articles of Incorporation for the Company dated March 12, 1993.\n3(e) (1) Code of By-Laws for the Company dated September 30, 1992.\n10(a) (1) Compromise and Settlement Agreement dates as of February 27, 1991, among First Commonwealth Corporation, Universal Guaranty Life Insurance Company, Alliance Life Insurance Company, Roosevelt National Life Insurance Company of America, Abraham Lincoln Insurance Company, Appalachian Life Insurance Company, Liberty American Assurance Company, and Farmers and Ranchers Life Insurance Company, and Southshore Holding Corp., Public Investors, Inc., Fidelity Fire and Casualty Insurance Company, Insurance Premium Assistance Company, Agency Premium Assistance Company, Coastal Loans Acquisition Company, Bob F. Shamburger, Gary E. Jackson, Leonard H. Aucoin, Dennis J. Lafont, William Joel Herron and Jerry Palmer\n10(b) (1) Credit Agreement dated as of December 11, 1989 among First Commonwealth Corporation, Commonwealth Industries Corporation, Investors Trust, Inc., Universal Guaranty Investment Company, John K. Cantrell, Mildred G. Cantrell and First Bank of Gladstone\n10(c) (1) Guaranty Agreement among Commonwealth Industries Corporation, Investors Trust, Inc. and Universal Guaranty Investment Company dated as of December 11, 1989\n10(d) (1) Security Agreement-Pledge dated as of December 11, 1989 between First Commonwealth Corporation and First Bank of Gladstone\n10(e) (1) Security Agreement-Pledge dated as of December 11, 1989 between Commonwealth Industries Corporation and First Bank of Gladstone\n10(f) (1) Security Agreement-Pledge dated as of December 11, 1989 between Universal Guaranty Investment Company and First Bank of Gladstone\n10(g) (1) Security Agreement-Pledge dated as of December 11, 1989 between Investors Trust, Inc. and First Bank of Gladstone\nINDEX TO EXHIBITS\nExhibit Number\n10(h) (1) Amendment to the Credit Agreement dated as of May 31, 1991 among First Commonwealth Corporation, Commonwealth Industries Corporation, Investors Trust, Inc., Universal Guaranty Investment Company, John K. Cantrell,, Mildred G. Cantrell, and the Banks\n10(i) (1) Confirmation of Guaranty Agreement dated as of May 31, 1991 by Commonwealth Industries Corporation, Investors Trust, Inc. and Universal Guaranty Investment Company\n10(j) (1) Confirmation of Security Agreement-Pledge dated as of May 31, 1991 by Universal Guaranty Investment Company\n10(k) (1) Confirmation of Security Agreement-Pledge dated as of May 31, 1991 by First Commonwealth Corporation\n10(l) (1) Confirmation of Security Agreement-Pledge dated as of May 31, 1991 by Commonwealth Industries Corporation\n10(m) (1) Confirmation of Security Agreement-Pledge dated as of May 31, 1991 by Investors Trust, Inc.\n10(n) (1) Second Amendment to Credit Agreement dated as of June 12, 1992 among First Commonwealth Corporation, Commonwealth Industries Corporation, Investors Trust, Inc., Universal Guaranty Investment Company, John K. Cantrell, Mildred G. Cantrell, United Trust Group, Inc. and the Banks\n10(o) (1) Confirmation of Guaranty Agreement dated as of June 16, 1992 by Commonwealth Industries Corporation, Investors Trust, Inc. and Universal Guaranty Investment Company\n10(p) (1) Confirmation of Security Agreement-Pledge dated as of June 16, 1992 by Commonwealth Industries Corporation\n10(q) (1) Amendment and Confirmation of Security Agreement-Pledge dated as of June 16, 1992 by First Commonwealth Corporation\n10(r) (1) Amendment and Confirmation of Security Agreement-Pledge dated as of June 16, 1992 by Investors Trust, Inc.\n10(s) (1) Amendment and Confirmation of Security Agreement-Pledge dated as of June 16, 1992 by Universal Guaranty Investment Company\n10(t) (1) Pledge Agreement dated as of June 16, 1992 by United Trust Group, Inc.\n10(u) (1) Note Purchase Agreement dated as of June 16, 1992 by United Trust Group, Inc.\nINDEX TO EXHIBITS\nExhibit Number\n10(v) (1) $1,909,882.00 Term Note of First Commonwealth Corporation to Massachusetts General Life Insurance Company dated as of June 16,\n10(w) (1) $6,909,867.00 Term Note of First Commonwealth Corporation to Philadelphia Life Insurance Company dated as of June 16, 1992\n10(x) (1) $5,453,509.30 Term Note of First Commonwealth Corporation to First Bank of Gladstone dated as of June 16, 1992\n10(y) (1) $879,588.60 Term Note of First Commonwealth Corporation to Citizens Bank & Trust Co. dated as of June 16, 1992\n10(z) (1) $1,847,153.10 Term Note of First Commonwealth Corporation to Bank of St. Joseph dated as of June 16, 1992\n10(aa)(1) Subcontract Agreement dated September 1, 1990 between United Trust, Inc. and United Income, Inc.\n10(bb)(1) Service Agreement dated November 8, 1989 between United Security Assurance Company and United Income, Inc.\n10(cc)(1) Management and Consultant Agreement dated as of January 1, 1993 between First Commonwealth Corporation and Universal Guaranty Life Insurance Company\n10(dd)(1) Management Agreement dated December 20, 1981 among Commonwealth Industries Corporation, Executive National Life Insurance Company (now known as Investors Trust Assurance Company) and Abraham Lincoln Insurance Company\n10(ee)(1) Reinsurance Agreement dated January 1, 1991 between Universal Guaranty Life Insurance Company and Republic-Vanguard Life Insurance Company\n10(ff)(1) Reinsurance Agreement dated July 1, 1992 between United Security Assurance Company and Life Reassurance Corporation of America\n10(gg)(1) United Trust, Inc. Stock Option Plan\n10(hh)(1) Board Resolution adopting United Trust, Inc.'s Officer Incentive Fund\n10(ii)(1) Employment Agreement dated as of April 15, 1993 between Larry E. Ryherd and First Commonwealth Corporation and United Trust, Inc.\n10(jj)(1) Employment Agreement dated as of April 15, 1993 between Thomas F. Morrow and First Commonwealth Corporation and United Trust, Inc.\nINDEX TO EXHIBITS\nExhibit Number\n10(kk)(1) Employment Agreement dated as of April 15, 1993 between James E. Melville and First Commonwealth Corporation and United Trust, Inc.\n10(ll)(1) Employment Agreement dated as of June 16, 1992 between George E. Francis and First Commonwealth Corporation\n10(mm)(1) Amendment Number One to Employment Agreement dated as of April 15, 1993 between George E. Francis and First Commonwealth Corporation\n10(nn)(1) Consulting Arrangement entered into June 15, 1987 between Robert E. Cook and United Trust, Inc.\n10(oo)(1) Agreement dated June 16, 1992 between John K. Cantrell and First Commonwealth Corporation\n10(pp)(1) Termination Agreement dated as of January 29, 1993 between Scott J. Engebritson and United Trust, Inc., United Fidelity, Inc., United Income, Inc., First Commonwealth Corporation and United Security Assurance Company\n10(qq)(1) Stock Purchase Agreement dated February 20, 1992 between United Trust Group, Inc. and Sellers\n10(rr)(1) Amendment No. One dated April 20, 1992 to the Stock Purchase Agreement between the Sellers and United Trust Group, Inc.\n10(ss)(1) Security Agreement dated June 16, 1992 between United Trust Group, Inc. and the Sellers\n10(tt)(1) Stock Purchase Agreement dated June 16, 1992 between United Trust Group, Inc. and First Commonwealth Corporation\nFootnote (1) Incorporated by reference from the Company's Annual Report on Form 10-K, File No. 0-5392, as of December 31, 1993.\nFIRST COMMONWEALTH CORPORATION CONDENSED FINANCIAL INFORMATION OF REGISTRANT Schedule II NOTES TO CONDENSED FINANCIAL INFORMATION\n(a) The condensed financial information should be read in conjunction with the consolidated financial statements and notes of First Commonwealth Corporation and Consolidated Subsidiaries.\n* All assumed business represents the Company's participation in the Servicemen's Group Life Insurance Program (SGLI).\n* All assumed business represents the Company's participation in the Servicemen's Group Life Insurance Program (SGLI).\n* All assumed business represents the Company's participation in the Servicemen's Group Life Insurance Program (SGLI).\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the 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 COMMONWEALTH CORPORATION Registrant\n\/s\/ John S. Albin Date: March 26, 1996 John S. Albin, Director\n\/s\/ John K. Cantrell Date: March 26, 1996 John K. Cantrell, Chairman of the Board and Director\n\/s\/ William F. Cellini Date: March 26, 1996 William F. Cellini, Director\n\/s\/ John W. Collins Date: March 26, 1996 John W. Collins, Director\n\/s\/ George E. Francis Date: March 26, 1996 George E. Francis, Senior Vice President and Director\n\/s\/ Donald G. Geary Date: March 26, 1996 Donald G. Geary, Director\n\/s\/ James E. Melville Date: March 26, 1996 James E. Melville, Senior Executive Vice President, Chief Financial Officer and Director\n\/s\/ Joseph H. Metzger Date: March 26, 1996 Joseph H. Metzger, Senior Vice President and Director\n\/s\/ Luther C. Miller Date: March 26, 1996 Luther C. Miller, Director\n\/s\/ Thomas F. Morrow Date: March 26, 1996 Thomas F. Morrow, Vice Chairman, Chief Operating Officer and Director\n\/s\/ Robert V. O'Keefe Date: March 26, 1996 Robert V. O'Keefe, Director\n\/s\/ Larry E. Ryherd Date: March 26, 1996 Larry E. Ryherd, President, Chief Executive Officer and Director\n\/s\/ Robert W. Teater Date: March 26, 1996 Robert W. Teater, Director\n\/s\/ Howard A. Young Date: March 26, 1996 Howard A. Young Director","section_15":""}
{"filename":"855654_1995.txt","cik":"855654","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nImmunoGen leases approximately 52,700 square feet of laboratory and office space at two locations in Cambridge, Massachusetts, of which approximately 30,800 square feet has been subleased by the Company as of September 1, 1995. The Company also leases 27,500 square feet of space in Norwood, Massachusetts, which is currently the Company's pilot manufacturing facility, and 47,000 square feet of space in Canton, Massachusetts, which have been idle since the Company implemented its restructuring plan in December 1994. The Company believes that the manufacturing portion of each of the Norwood and Canton facilities, although not yet inspected by the FDA, complies with all applicable FDA Good Manufacturing Practice Regulations.\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.\nDIRECTORS AND EXECUTIVE OFFICERS\nSee Item 10 below.\nPART II\nAs of June 30, 1995, there were approximately 729 holders of record of the Company's Common Stock and, according to the Company's estimates, approximately 9,500 beneficial owners of the Company's Common Stock.\nThe Company has not paid any cash dividends on its Common Stock since its inception and does not intend to pay any cash dividends in the foreseeable future.\nITEM 7.","section_5":"","section_6":"","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nOVERVIEW\nSince its inception, ImmunoGen has been primarily engaged in research and development of immunoconjugate products which it believes have significant commercial potential as human therapeutics. The major sources of the Company's working capital have been the proceeds of equity financings, license fees and income earned on the investment of those funds.\nIn an action to reduce costs, the Company in December 1994 implemented a restructuring plan, suspending its operations at its Canton and Norwood, Massachusetts production facilities, reducing or eliminating certain areas of research and focusing its clinical efforts on its first product. This plan resulted in the termination of approximately 100 employees and affected all functional areas within the Company. Restructuring charges approximating $643,000 were charged to expense in December 1994 representing severance costs for terminated employees. As of June 30, 1995 all costs related to the plan had been paid.\nIn a further cost reduction effort, the Company entered into an agreement effective September 1, 1995 to sublease approximately 82% of one of its Cambridge, Massachusetts facilities. The initial term of this agreement expires in February 1997 (with two one-year renewal options).\nThe Company has been unprofitable since inception and incurred net operating losses of $18.6 million in fiscal 1993, $23.7 million in fiscal 1994 and $19.9 million in fiscal 1995. The Company expects to incur net losses over the next several years.\nRESULTS OF OPERATIONS\nRevenues in fiscal 1993, 1994 and 1995 were derived principally from interest income on the proceeds of the Company's equity offerings. Smaller amounts of development revenues were received under the Small Business Innovative Research Program of the U.S. National Science Foundation and under the Orphan Product Development Program of the U.S. Department of Health and Human Services. In addition, a gain on sale of assets which resulted from a sale\/leaseback agreement executed in March 1994 has been deferred and is being recorded as other income over the life of the lease.\nInterest income decreased 44% from approximately $1.5 million in fiscal 1993 to approximately $0.8 million in fiscal 1994 and then decreased 45% to approximately $0.5 million in fiscal 1995. These decreases are attributable to the lower cash balances available for investment between these periods.\nThe Company's total expenses increased 21% from approximately $20.3 million in fiscal 1993 to approximately $24.6 million in fiscal 1994 and then decreased 17% to approximately $20.4 million in fiscal 1995. Research and development costs constituted the primary component of the Company's total expenses (84%, 81% and 83% in fiscal 1993, 1994 and 1995, respectively) increasing from approximately $17.1 million in fiscal 1993 to approximately $19.9 million in fiscal 1994 and then decreasing to approximately $16.8 million in fiscal 1995. The 17% increase between fiscal 1993 and fiscal 1994 resulted largely from continued expansion of the Company's medical affairs department to support ongoing clinical trials, full-year operations of the Company's 72%-owned subsidiary, Apoptosis Technology, Inc. (\"ATI\"), commencement of operations at the Company's Canton, Massachusetts facility and certain facilities costs of the Company's new Cambridge, Massachusetts facility allocated to research\nand development. The 16% decrease between fiscal 1994 and fiscal 1995 is the result of the Company's restructuring plan implemented in December 1994, offset somewhat by increased costs associated with ATI and increased non-cash depreciation charges associated with the capital expenditures made in prior periods. A planned substantial reduction in raw materials purchases in fiscal 1995 also contributed to the decrease in expenses.\nGeneral and administrative expenses increased 43% from approximately $3.1 million in fiscal 1993 to approximately $4.5 million in fiscal 1994 and then decreased 33% to approximately $3.0 million in fiscal 1995. Increases from fiscal 1993 to fiscal 1994 were due largely to the facilities costs associated with the new Cambridge facility allocated to administration, increases in the Company's management information services and business development efforts, increased director and officer liability insurance costs and severance costs to one of the Company's former senior executives. Decreases from fiscal 1994 to fiscal 1995 represented savings associated with the restructuring plan and reductions in management and administrative staff in the second and third quarters of calendar 1994, offset somewhat by the restructuring charges incurred.\nInterest expense increased 167% from approximately $65,000 in fiscal 1993 to approximately $174,000 in fiscal 1994 and increased 193% to approximately $510,000 in fiscal 1995 as the Company utilized capital lease arrangements to finance certain equipment and leasehold improvements at its Canton production facility.\nLIQUIDITY AND CAPITAL RESOURCES\nSince July 1, 1992 the Company has financed its operating deficit of $62.2 million from various sources, including net proceeds of $13.0 million raised in its fiscal 1994 public offering and from the exercise of stock options. Since July 1, 1992 the Company has received approximately $0.2 million from development and licensing revenues and $2.8 million of interest income. At June 30, 1995 approximately $3.0 million of cash and cash equivalents remained available.\nIn February 1994 the Company sold in a public offering 2,012,500 shares of its common stock. Net proceeds to the Company amounted to $13,242,250. In March 1994 the Company executed a sale\/leaseback agreement to finance approximately $4.0 million of equipment at the Canton facility. At June 30, 1994 all monies available under this agreement had been received. The transaction included warrants to purchase common stock which expire in April 1999.\nIn August 1995 the Company issued $3.6 million of subordinated convertible debentures, due July 31, 1996, in a private placement to a small number of foreign investors. Net proceeds to the Company amounted to approximately $3.3 million. Subject to certain restrictions, the debentures are convertible to common stock, at the holders' discretion, at any time between October 1995 and July 1996.\nIn the period since July 1, 1992 approximately $16.3 million was expended on property and equipment, including the equipment sold and leased back, principally for construction of the Company's manufacturing facilities in Norwood, Massachusetts. No significant amounts are expected to be expended on property and equipment in fiscal 1996.\nPursuant to its agreements with ATI, the Company committed to provide ATI with $3.0 million in research and development services and $2.0 million of cash equity contributions. At June 30, 1995 these obligations had been fulfilled by the Company. ImmunoGen has also agreed to obtain or furnish an additional $3.0 million in equity for ATI on such terms and conditions as may be mutually agreed to by\nATI and the providers of such additional equity. The Company anticipates that approximately $650,000 of funding may be required by ATI during calendar year 1996 in order for ATI to satisfy certain contractual obligations.\nThe Company anticipates that its existing capital resources will enable it to maintain its current and planned operations through January 1996. Because of its continuing losses from operations and working capital deficit, the Company will be required to obtain additional capital to satisfy its ongoing capital needs and to continue its operations. Although managment continues to pursue additional funding arrangements, no assurance can be given that such financing will in fact be available to the Company. If the Company is unable to obtain financing on acceptable terms in order to maintain operations through the next fiscal year, it could be forced to curtail or discontinue its operations.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTO THE BOARD OF DIRECTORS AND SHAREHOLDERS OF IMMUNOGEN, INC.:\nWe have audited the accompanying consolidated balance sheets of ImmunoGen, Inc. as of June 30, 1994 and 1995, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended June 30, 1995. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. These standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of ImmunoGen, Inc. as of June 30, 1994 and 1995 and the consolidated results of its operations and its cash flows for each of the three years in the period ended June 30, 1995, in conformity with generally accepted accounting principles.\nThe accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note A, the Company has suffered recurring losses from operations, has a net working capital deficit and requires significant additional financing. These factors raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are also described in Note A. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.\n\/s\/Coopers & Lybrand L.L.P. ---------------------------\nCOOPERS & LYBRAND L.L.P.\nBoston, Massachusetts September 1, 1995\nThe accompanying notes are an integral part of the financial statements.\nThe accompanying notes are an integral part of the financial statements.\nThe accompanying notes are an integral part of the financial statements.\nThe accompanying notes are an integral part of the financial statements.\nIMMUNOGEN, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nA. NATURE OF BUSINESS AND PLAN OF OPERATION:\nImmunoGen, Inc. (the \"Company\") was incorporated in Massachusetts on March 27, 1981. The Company was formed to develop, produce and market commercial cancer and other pharmaceuticals based on molecular immunology. The Company continues research and development of its various products, and expects no revenues to be derived from product sales in the near future.\nIn an action to reduce costs, the Company in December 1994 implemented a restructuring plan, suspending its operations at its Canton and Norwood, Massachusetts production facilities (with a net book value of approximately $8.8 million), reducing or eliminating certain areas of research and focusing its clinical efforts on certain products. This plan resulted in the termination of approximately 100 employees and affected all functional areas within the Company. Restructuring charges approximating $643,000 were charged to expense in December 1994 representing severance costs for terminated employees. As of June 30, 1995 all severance costs have been paid.\nIn a further reduction effort, the Company entered into an agreement effective September 1, 1995 to sublease approximately 82% of one of its Cambridge, Massachusetts facilities. This initial lease term expires in February 1997, with two one-year renewal options.\nIn August 1995 the Company issued $3.6 million of 7% subordinated convertible debentures, due July 31, 1996, in a private placement to a small number of overseas investors. Subject to certain restrictions, the debentures are convertible to common stock, at the holders' discretion at any time between October 1995 and July 1996.\nBecause of its continuing losses from operations and working capital deficit, the Company will be required to obtain additional capital in the short term to satisfy its ongoing capital needs and to continue its operations. Although management continues to pursue additional funding arrangements and\/or strategic partnering, no assurance can be given that such financing will in fact be available to the Company. If the Company is unable to obtain financing on acceptable terms in order to maintain operations through the next fiscal year, it could be forced to curtail or discontinue its operations. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.\nB. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, ImmunoGen Securities Corp. (established in December 1989), and its 72%-owned subsidiary, Apoptosis Technology, Inc. (\"ATI\") (established in January 1993) (see Note D). All intercompany activity has been eliminated.\nRESEARCH AND DEVELOPMENT COSTS\nResearch and development costs are expensed as incurred.\nIMMUNOGEN, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\nCASH, CASH EQUIVALENTS AND MARKETABLE SECURITIES\nThe Company considers all investments purchased with maturity dates of three months or less from date of acquisition to be cash equivalents.\nCash and cash equivalents include, at cost plus accrued interest which approximates market value, $1,572,389 and $3,047,236 of money market funds, demand notes and repurchase agreements at June 30, 1994 and 1995, respectively.\nAs of June 30, 1994, marketable securities, consisting primarily of U.S. Government debt securities of approximately $19.6 million, were carried at amortized cost which approximates market value.\nIn fiscal 1995 the Company implemented Financial Accounting Standard (SFAS) No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" The impact was immaterial to its financial position and results of operations.\nCONCENTRATION OF CREDIT RISK\nThe Company minimizes the risk associated with concentration of credit by utilizing the services of more than one custodian for its cash and assuring that financial instruments purchased by its cash managers include only high-grade, low-risk investments. At June 30, 1994 and 1995, those investments included various U.S. Government securities, money market investments with major financial institutions and cash on deposit with major banks.\nMaintenance and repairs are charged to expense as incurred. Upon retirement or sale, the cost of disposed assets and the related accumulated depreciation are removed from the accounts and any resulting gain or loss is credited or charged to operations. Gains recorded under sale\/leaseback arrangements are deferred and amortized to operations over the life of the lease.\nINCOME TAXES\nThe Company uses the liability method whereby the deferred tax liabilities and assets are recognized based on temporary differences between the financial statement and tax basis of assets and liabilities using current statutory tax rates. A valuation allowance against net deferred tax assets is recorded if,\nIMMUNOGEN, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\nbased on the weighted available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized.\nC. LOSS PER COMMON SHARE:\nNet loss per common share is based on the weighted average number of common shares outstanding during the periods. Common share equivalents have not been included because their effect would be anti-dilutive. Fully diluted earnings per share are the same as primary earnings per share.\nD. AGREEMENTS:\nThe Company has a long-standing research and license agreement with the Dana-Farber Cancer Institute, Inc. (\"Dana-Farber\"), a Massachusetts not-for-profit corporation. As part of the agreement, the Company has agreed to fund certain research and development projects conducted by Dana-Farber in relation to the development and eventual commercialization of certain biologicals to be used in the treatment of certain forms of cancer. In fiscal years 1993, 1994 and 1995 the Company incurred research and development expenses of approximately $825,000, $567,000 and $225,000 respectively, in connection with this agreement. To the extent that an invention is developed at Dana-Farber with principal support and funding by the Company, the Company shall have the exclusive right to use the invention. As part of this arrangement, the Company is required to pay to Dana-Farber, when product sales commence, certain royalties based on a formula stipulated in the agreement. The Company owed Dana-Farber approximately $1,207,000 and $1,169,000 at June 30, 1994 and 1995, respectively, for work performed under this agreement.\nThe agreement also contains provisions, which expired in June 1994, whereby Dana-Farber is required to pay to the Company a percentage of royalties received by Dana-Farber in consideration for the Company's consulting in connection with the identification of a commercial entity through which Dana-Farber can develop and market certain antibodies of its own. The Company earned royalties under these provisions of approximately $13,000 in each of fiscal years 1993 and 1994.\nIn January 1993, the Company purchased 7,000 shares of Class A Preferred Stock of ATI. ATI is a joint venture between ImmunoGen and Dana-Farber established to develop therapeutics based on apoptosis technology developed at Dana-Farber. ATI is the licensee of Dana-Farber's apoptosis technology. Under an agreement entered into between ATI and ImmunoGen, subject to certain provisions of the agreement between ATI and Dana-Farber, ImmunoGen has the exclusive right to license products developed by ATI, including those based on Dana-Farber's apoptosis technology.\nThe Preferred Stock is voting stock and carries a liquidation preference over the common stock. The Company's investment represents 72% of the currently authorized equity of ATI and, accordingly, is consolidated. In addition, the Company has a right of first refusal to purchase any ATI shares which may be offered for sale by the other current stockholders of ATI. If ATI has not concluded a public offering of its stock for at least $5.0 million prior to January 11, 1998, the other stockholders (currently representing 2,765 shares of common stock) of ATI can require ImmunoGen to purchase, or ImmunoGen can require such stockholders to sell, their shares in ATI at a predetermined price. At ImmunoGen's option, the shares of common stock of ATI can be paid for in cash or by delivery of shares of ImmunoGen common stock.\nIMMUNOGEN, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\nA portion of the Company's research and development expenses was incurred in connection with an agreement between ATI and Dana-Farber, under which ATI has agreed to fund certain research projects conducted at Dana-Farber. In fiscal 1993, 1994 and 1995 these expenses amounted to approximately $273,000, $530,000 and $670,000, respectively.\nImmunoGen was committed to provide ATI with $3.0 million in research and development services and $2.0 million in cash equity contributions over a three-year period. At June 30, 1995 these obligations had been fulfilled by the Company. ImmunoGen has also agreed to obtain or furnish an additional $3.0 million in equity for ATI on such terms and conditions as may be mutually agreed to by ATI and the providers of such additional equity.\nDevelopment revenues of approximately $159,000 and $75,000 in fiscal 1993 and 1994, respectively, represent payments received under the Small Business Innovative Research Program of the U.S. National Science Foundation and under the Orphan Product Development Program of the U.S. Department of Health and Human Services.\nDepreciation and amortization expense was $1,349,580, $2,043,537 and $3,284,583 for the years ended June 30, 1993, 1994 and 1995, respectively.\nMaintenance and repair expense was approximately $135,000, $229,000 and $173,000 for fiscal years 1993, 1994 and 1995, respectively.\nIMMUNOGEN, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\nF. INCOME TAXES:\nNo income tax provision or benefit has been provided for U.S. federal income tax purposes as the Company has incurred losses since inception. As of June 30, 1995 net deferred tax assets totaled approximately $40.0 million consisting of federal net operating loss carryforwards of approximately $102.0 million and approximately $4.0 million of research and experimentation credit carryforwards. These net operating loss and credit carryforwards will expire at various dates between 1996 and 2010 and may be subject to limitation when used due to certain changes in ownership of the Company's capital stock. Due to the uncertainty surrounding the realization of these favorable tax attributes in future tax returns, the net deferred tax assets of approximately $38.0 million and $40.0 million at June 30, 1994 and June 30, 1995, respectively, have been fully offset by a valuation allowance. Income tax expense consists primarily of state income taxes levied on the interest income of the Company's wholly-owned subsidiary, ImmunoGen Securities Corp., at a rate of 1.32%.\nG. CAPITAL STOCK:\nCOMMON STOCK\nOn February 2, 1994 the Company sold 1,750,000 shares of common stock in a public offering. Proceeds to the company before deducting expenses amounted to $12,250,000. On February 8, 1994 as part of the same public offering, the Underwriters exercised their over-allotment option to purchase an additional 262,500 shares of common stock. Additional proceeds to the Company totaled $1,837,500 before deducting offering expenses.\nSTOCK OPTIONS\nUnder the Company's Restated Stock Option Plan (the \"Stock Option Plan\") originally adopted by the Board of Directors on February 13, 1986, and subsequently amended and restated, employees, consultants, and directors may be granted options to purchase up to 2,400,000 shares of common stock of the Company. Prior to June 7, 1994, 1,700,000 shares of Common Stock were reserved for the grant of options under the Plan. On June 7, 1994, the Board of Directors authorized, and the shareholders subsequently approved, an amendment to the Plan to increase the number of shares reserved for the grant of options to 2,400,000 shares of Common Stock.\nIMMUNOGEN, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\nIn addition to options granted under the Stock Option Plan, the Board previously has approved the granting of other, non-qualified options. In July 1987 and February 1988, the Company granted non-qualified options for the purchase of 115,500 and 15,000 shares of common stock at exercise prices of $0.67 and $0.90 per share, respectively. During 1994 and 1995, options for 2,000 and 13,000 shares were exercised at a price of $0.67 per share. As of June 30, 1995, options for 19,687 of these shares had been canceled, 32,813 had been exercised and 78,000 were outstanding and exercisable.\nThere are a total of 697,632 stock options exercisable under the Company's stock option plans as of June 30, 1995.\nOptions vest at various rates over periods up to four years and may be exercised within ten years from the date of grant.\nCOMMON STOCK RESERVED\nShares of authorized common stock have been reserved for the exercise of all options and warrants outstanding.\nWARRANTS\nIn connection with a capital lease financing in March 1994 the Company issued warrants to purchase 26,738 shares of Common Stock at an exercise price of $7.48 expiring in April 1999. The value of these warrants, approximating $77,000, is being recognized as interest expense over the life of the lease.\nIMMUNOGEN, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\nH. COMMITMENTS:\nOPERATING LEASES\nAt June 30, 1995 the Company is leasing facilities in Cambridge, Norwood and Canton, Massachusetts. The facilities are rented under four separate lease arrangements whereby the respective lease terms expire in June 1997 (with a three-year extension option), September 1997, June 2002 (with an option to purchase at any time throughout the lease term) and April 2003. The Company is required to pay all operating expenses for the leased premises subject to escalation charges for certain expense increases over a base amount. Rent expense for leased facilities and equipment was approximately $936,000, $1,186,000 and $913,000 during fiscal years 1993, 1994 and 1995, respectively.\nCAPITAL LEASES\nIn fiscal year 1988, the Company, as part of one of its lease agreements, arranged financing for $989,975 of improvements to one of its leased facilities through the lessor. The lessor obtained a five-year promissory note with a bank specifically to finance the improvements to the facility. The promissory note was amortized over a ten-year period. At the end of the first five years, the lessor refinanced the unamortized principal due the bank. Interest expense on the new note is incurred at the rate of 7.50% per annum.\nIn fiscal 1993 the Company executed a sale\/leaseback agreement to finance up to $4.0 million of equipment costs at its Canton, Massachusetts manufacturing facility. In October 1993 the Company utilized $0.9 million of the agreement, subsequently terminated this agreement and the outstanding balance was repaid in April 1994.\nIn March 1994 the Company executed a sale\/leaseback agreement to finance approximately $4.0 million of equipment at the Canton, Massachusetts manufacturing facility. As of June 30, 1994 all funds available under this agreement had been received. This transaction resulted in a gain on the sale of the assets which has been deferred and included in other non-current liabilities. This deferred gain is being amortized as other income over the life of the lease and amounted to approximately $56,000 in fiscal year 1995. The transaction also included warrants which expire in April 1999 (see Note G). The agreement commenced April 1, 1994 and expires in September 1998.\nIMMUNOGEN, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED\nI. RELATED PARTY TRANSACTION:\nIn April 1991 the Company made a $70,000 loan to one of its executive officers. The note carried an interest rate of 8.75% and was payable in equal, biweekly installments over a period of three years. In December 1993, the loan was paid in full.\nJ. EMPLOYEE BENEFIT PLANS:\nEffective September 1, 1990, the Company implemented a deferred compensation plan under Section 401(k) of the Internal Revenue Code (the \"Plan\"). Under the Plan, eligible employees are permitted to contribute, subject to certain limitations, up to 15% of their gross salary. The Company makes a matching contribution which currently totals 20% of the employee's contribution, up to a maximum amount equal to 1% of the employee's gross salary. In fiscal 1994 and 1995, the Company's contributions to the Plan amounted to $62,000 and $51,000, respectively.\nK. SEVERANCE AGREEMENTS:\nTwo of the Company's senior executives terminated their employment in fiscal 1994. At June 30, 1995 all severance costs had been paid to these individuals.\nITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone\nPART III\nITEM 10. DIRECTORS AND EXECUTIVE OFFICERS\nDIRECTORS\nThe section entitled \"Election of Directors\" in the Company's definitive proxy statement for its 1995 Annual Meeting of Shareholders, which the Company intends to file with the Securities and Exchange Commission on or about October 1, 1995, is hereby incorporated by reference.\nThe background of these executive officers is as follows:\nMitchel Sayare, Chief Executive Officer and a Director since 1986, joined the Company in 1986. He served as President from 1986 to July 1992. From 1982 to 1985, Mr. Sayare was an executive at Xenogen, Inc., a biotechnology company specializing in monoclonal antibody-based diagnostic systems for cancer. As Vice President for Development at Xenogen, Mr. Sayare was responsible for the development of several diagnostic kits which were licensed to major pharmaceutical companies. From 1977 to 1982, Mr. Sayare was Assistant Professor of Biophysics and Biochemistry at the University of Connecticut. He holds a Ph.D. in Biochemistry from Temple University School of Medicine.\nFrank J. Pocher, Vice President, Chief Financial Officer and Treasurer joined the Company in November 1988. Prior to joining ImmunoGen, Mr. Pocher was the Executive Vice President and Chief Financial Officer of Seragen, Inc., a biotechnology company developing recombinant products for cancer and transplantation rejection. From 1980 to 1984, Mr. Pocher served as Chief Financial Officer and then President and Chief Executive Officer of Aviation Simulation Technology, Inc. Prior to that time, he held a variety of senior financial positions at General Electric Company and Honeywell, Inc. He holds an MBA from Rutgers University.\nWalter A. Blattler, Ph.D., Senior Vice President, Research and Development, joined the Company in October 1987. From 1981 to 1987, Dr. Blattler was chief scientist for the ImmunoGen-supported research program at Dana-Farber\nCancer Institute, where he managed the work of fourteen other scientists. Dr. Blattler received his Ph.D. from the Swiss Federal Institute of Technology in Zurich in 1978.\nCarol A. Gloff, Ph.D., Vice President, Chief Regulatory Officer, joined the Company in November 1993. Prior to joining ImmunoGen, Dr. Gloff held various positions at Alkermes, Inc., a neuropharmaceutical company developing CNS therapeutics and diagnostics, including Director of Product Development and most recently Vice President of Regulatory Affairs. From 1984 to 1990, Dr. Gloff held a variety of positions at Triton Biosciences, Inc., a biotechnology firm specializing in recombinant DNA and monoclonal antibody-derived technologies applied to cancer diagnosis and therapy, most recently as Manager of Toxicology\/Pharmacology. Prior to that time, Dr. Gloff held positions at Pennwalt Pharmaceuticals and the University of Rochester Medical Center. Dr. Gloff holds a Ph.D. in Pharmaceutical Chemistry from the University of California San Francisco.\nThe section entitled \"Compliance with Section 16(a) of the Securities Exchange Act of 1934\" in the Company's definitive proxy statement for its 1995 Annual Meeting of Shareholders is hereby incorporated by reference.\nITEM 11. EXECUTIVE COMPENSATION\nThe reports entitled \"Summary Compensation Table,\" \"Option Grants in Last Fiscal Year,\" \"Employment Contracts, Termination of Employment and Change in Control Agreements\" and \"Aggregated Option Exercises in Last Fiscal Year and Fiscal Year-End Values\" in the Company's definitive proxy statement for its 1995 Annual Meeting of Shareholders are hereby incorporated by reference.\nITEM 12. SECURITIES OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe section entitled \"Principal Shareholders\" in the Company's definitive proxy statement for its 1995 Annual Meeting of Shareholders is hereby incorporated by reference.\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe section entitled \"Certain Transactions\" in the Company's definitive proxy statement for its 1995 Annual Meeting of Shareholders is hereby incorporated by reference.\nPART IV\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) Financial Statements\n(1) and (2) See \"Index to Consolidated Financial Statements and Supplemental Schedules\" at 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":"30573_1995.txt","cik":"30573","year":"1995","section_1":"ITEM 1. BUSINESS.\nGeneral - -------------------------------------------------------------------------------\nPart I of this Annual Report, Form 10-K (Report) should be read in conjunction with Duquesne's audited consolidated financial statements, which are set forth on pages 38 through 62 in Part IV of this Report. Explanations of certain financial and operating terms used in this Report are set forth in a glossary on page 37 of this Report.\nDuquesne Light Company (Duquesne) is a wholly owned subsidiary of DQE, an energy services holding company formed in 1989. Duquesne is engaged in the production, transmission, distribution and sale of electric energy. Duquesne was formed under the laws of Pennsylvania by the consolidation and merger in 1912 of three constituent companies. Duquesne has one wholly owned subsidiary, Monongahela Light and Power, also a Pennsylvania corporation, which currently holds energy related lease investments.\nService Territory\nDuquesne provides electric service to customers in Allegheny County, including the City of Pittsburgh, and Beaver County. This represents a service territory of approximately 800 square miles in southwestern Pennsylvania. The population of the area served by Duquesne, based on 1990 census data, is approximately 1,510,000, of whom 370,000 reside in the City of Pittsburgh. In addition to serving approximately 580,000 customers within this service area, Duquesne also sells electricity to other utilities beyond its service territory.\nRegulation\nDuquesne's operations are subject to regulation by the Pennsylvania Public Utility Commission (PUC), as well as to regulation by the Federal Energy Regulatory Commission (FERC) under the Federal Power Act with respect to rates for interstate sales, transmission of electric power, accounting and other matters.\nDuquesne's operations are also subject to regulation by the Nuclear Regulatory Commission (NRC) under the Atomic Energy Act of 1954, as amended, with respect to the operation of its jointly owned\/leased nuclear power plants, Beaver Valley Unit 1 (BV Unit 1), Beaver Valley Unit 2 (BV Unit 2) and Perry Unit 1. Duquesne is also subject to the accounting and reporting requirements of the United States Securities and Exchange Commission.\nDuquesne's consolidated financial statements report regulatory assets and liabilities in accordance with Statement of Financial Accounting Standards No. 71, Accounting for the Effects of Certain Types of Regulation (SFAS No. 71) and reflect the effects of the ratemaking process. In accordance with SFAS No. 71, Duquesne's consolidated financial statements reflect regulatory assets and liabilities based on current cost-based ratemaking regulations. The regulatory assets represent probable future revenue to Duquesne because provisions for these costs are currently included, or are expected to be included, in charges to electric utility customers through the ratemaking process.\nDuquesne's operations currently satisfy the SFAS No. 71 criteria. However, a company's utility operations or a portion of such operations could cease to meet these criteria for various reasons, including a change in the PUC or the FERC regulations. Should Duquesne's operations cease to meet the SFAS No. 71 criteria, Duquesne would be required to write off any regulatory assets or liabilities for those operations that no longer meet these requirements. Management will continue to evaluate significant changes in the regulatory and competitive environment in order to assess Duquesne's overall consistency with the criteria of SFAS No. 71.\nResults of Operations - -------------------------------------------------------------------------------\nSeasonality\nSales of electricity to customers by Duquesne tend to increase during the warmer summer and colder winter seasons because of greater customer use of electricity for cooling and heating.\nIn the near term, weather conditions and the overall level of business activity in Duquesne's service territory are expected to continue to be the primary factors affecting sales of electricity to customers. In the long-term, Duquesne's electric sales may also be affected by increased competition in the electric utility industry. (See \"Competition\" discussion on page 15.)\nSales of Electricity to Customers\nOperating revenues are derived from Duquesne's sales of electricity to customers and are based on rates authorized by the PUC. These rates are cost- based and are designed to recover Duquesne's energy and other operating expenses and investment in electric utility assets and to provide a return on such investment. Sales to Duquesne's 20 largest customers accounted for 14.2 percent and 14.6 percent of customer revenues in 1995 and 1994, respectively. Sales to USX Corporation, Duquesne's largest customer, accounted for 3.7 percent and 3.8 percent of total 1995 and 1994 customer revenues, respectively. Total kilowatt- hour (KWH) sales to customers in 1995 increased 2.5 percent when compared to KWH sales to customers in 1994. In response to extreme 1995 summer and winter temperatures, residential and commercial KWH sales increased 4.9 percent and 3.0 percent, respectively. Industrial sales volume in 1995 declined when compared to the prior year because of temporary production facility outages experienced by some of Duquesne's large industrial customers. The severe weather conditions in 1995 also resulted in higher residential KWH sales volume when compared to 1993.\nComponents of Change in Operating Revenues from the Prior Year - -------------------------------------------------------------------------------\nCustomer revenues fluctuate as a result of changes in sales volume and changes in fuel and other energy costs.\nNet customer revenues in 1995 when compared to 1994 increased by $7.8 million, or 0.7 percent. The change is the net result of higher sales, partially offset by lower energy costs per megawatt hour (MWH), the benefits of which are passed through to the customers in the form of lower rates. The significantly hotter summer temperatures in 1995 resulted in increased sales of electricity to residential customers in particular. Revenues attributable to electric sales to residential customers in 1995 exceeded 1994 residential revenues by $13.2 million, or 3.3 percent. Net customer revenues also increased $6.0 million, or 0.6 percent, in 1994 when compared to 1993. The 1994 variation represented higher sales to commercial and industrial customers, driven in part by an expanded customer base.\nNet customer revenues for 1994 and 1993 include phase-in deferrals that represented the deferral and subsequent recovery of revenues resulting from a $232 million rate increase granted in early 1988. The PUC required Duquesne to phase this increase in during a six-year period, which ended in April 1994. During this phase-in period, the rate increase was recognized in operating revenues. (See \"1987 Rate Case\" discussion in Note F to the consolidated financial statements on page 48.)\nSales to Other Utilities\nShort-term sales to other utilities are regulated by the FERC and are made at market rates. Short-term power sales to other utilities in 1995, 1994 and 1993 were 2,974,797 KWH, 3,212,110 KWH and 2,820,920\nKWH, respectively. Fluctuations in electricity sales to other utilities are related to Duquesne's customer energy requirements, the energy market and transmission conditions and the availability of Duquesne's generating stations. Revenues from sales to other utilities were $56.0 million, $58.3 million and $50.7 million in 1995, 1994 and 1993, respectively. Sales to other utilities were less prevalent in 1995 than in 1994 because severe weather conditions resulted in greater sales to Duquesne's customers. (See \"Sales of Electricity to Customers\" discussion on page 2.) Increased customer sales reduce power available to sell to other utilities. Future levels of short-term sales to other utilities will be affected by the resolution of Duquesne's proposed sale of its ownership interest in the Ft. Martin Power Station and by the outcome of Duquesne's FERC filings requesting firm transmission access. (See \"Sale of Ft. Martin\" and \"Transmission Access\" discussions on pages 9 and 16, respectively.)\nGenerally, Duquesne is permitted to recover (to the extent that such amounts are not included in base rates) fuel and other energy costs from its customers through an Energy Cost Rate Adjustment Clause (ECR), subject to the PUC review. This revenue adjustment also includes a credit to Duquesne's customers for profits from short-term sales to other utilities. The credit to Duquesne's customers for profits from short-term sales to other utilities was $15.5 million in 1995, $16.6 million in 1994 and $12.1 million in 1993. Included in a petition currently before the PUC, Duquesne proposes a five-year annual $5 million credit to the ECR to compensate Duquesne's customers for the lost profits from any reduced short-term power sales caused by the sale of its ownership interest in the Ft. Martin Power Station. (See \"Energy Cost Rate Adjustment Clause (ECR)\" and \"Sale of Ft. Martin\" discussions on pages 6 and 9, respectively.)\nOther Operating Revenues\nDuquesne's non-KWH revenues comprise other operating revenues in Duquesne's statement of consolidated income. Other operating revenues are primarily comprised of revenues from joint owners of BV Unit 1 and BV Unit 2 for their shares of the administrative and general costs of operating these units. Other operating revenues, therefore, fluctuate depending on the timing of scheduled refueling and maintenance outages at Beaver Valley Power Station (BVPS) when significant costs are incurred. Both BV Unit 1 and BV Unit 2 underwent refueling outages in 1995 and in 1993. There were no refueling outages in 1994; accordingly, other operating revenues increased $5.7 million in 1995, when compared to the prior year. Conversely, other operating revenues decreased $5.7 million in 1994 when compared to 1993.\nOperating Expenses\nTotal operating expenses increased $6.5 million in 1995 when compared to 1994. Total operating expenses increased from 1993 to 1994 by $8.9 million. Fuel and purchased power expense fluctuations generally result from changes in the cost of fuel, the mix between coal and nuclear generation, the total KWHs sold and generating station availability. Because of the ECR, changes in fuel and purchased power cost normally do not impact earnings.\nComponents of Change in Fuel and Purchased Power Expense from the Prior Year - -------------------------------------------------------------------------------\nThe average unit cost of fuel is based on fuel costs divided by generation. The average unit cost of fuel decreased in 1995 when compared to 1994 and 1993 largely because of lower nuclear fuel costs.\nGeneration mix impacts fuel expense as Duquesne's nuclear fuel cost per KWH is less than its fossil fuel cost per KWH. During 1993, compared to 1994 and 1995, Duquesne had more nuclear station outages, resulting in less nuclear generation and more fossil fuel and purchased power expense.\nGeneration volume during 1995 decreased 2.7 percent when compared to 1994 due to more generating station outages. Overall nuclear generation increased in 1995 due to strong performances at the nuclear units. (See \"Beaver Valley Power Station (BVPS)\" and \"Perry Unit 1\" discussions on page 9.) Major outages at coal stations, including an extended forced outage at the Ft. Martin Power Station, resulted in reduced coal generation which more than offset the increased nuclear generation. During 1994, generation increased 3.4 percent from 1993 due to fewer generating station outages.\nPurchased power volume increased in 1995 when compared to 1994 primarily due to generating station outages during periods of extreme weather conditions. Purchased power volume increased in 1994 when compared to 1993 primarily due to the performance of Perry Unit 1.\nOther operating expense continued to decrease in 1995. The $7.8 million decrease from 1994 to 1995 and the $18.9 million decrease from 1993 to 1994, are largely attributable to cost reduction measures instituted by Duquesne.\nMaintenance expense fluctuations primarily result from the timing of scheduled generating station outages, the timing of scheduled transmission and distribution line maintenance and the effect of storms on overhead lines and transformers. Incremental maintenance expense incurred for scheduled refueling outages at Duquesne's nuclear units is deferred for amortization over the period between refueling outages (generally 18 months). Influenced by extreme weather conditions and the timing of outages at both fossil and nuclear stations, maintenance costs incurred by Duquesne in 1995 exceeded the prior year by $2.0 million. During 1994 and 1993, amortization of deferred nuclear refueling outage expense increased, reflecting the higher costs of refueling outages. Offsetting this increase in 1994 was a decrease in transmission and distribution line maintenance expense.\nDuquesne changed, as of January 1, 1993, its method of accounting for maintenance costs during scheduled major fossil generating station outages. Under the new accounting policy, Duquesne accrues, over the periods between outages, anticipated expenses for scheduled major fossil generating station outages. The cumulative effect (approximately $5.4 million, net of income taxes of approximately $3.9 million) of the change on prior years was included in net income in 1993. The effect of the change in 1993 was to reduce income, before the cumulative effect of changes in accounting principles, by approximately $2.4 million and to reduce net income, after the cumulative effect of changes in accounting principles, by approximately $7.8 million.\nDepreciation and amortization expense increased $25.9 million in 1995, primarily due to the change in Duquesne's composite depreciation rate from 3.0 percent to 3.5 percent effective January 1, 1995. Depreciation and amortization expense increased $12.3 million in 1994 when compared to the prior year due to increases in depreciable property and nuclear decommissioning expense.\nAs part of Duquesne's plan to optimize generation capacity, a petition pending before the PUC proposes an annual increase in depreciation and amortization expense related to Duquesne's nuclear power investment of $25 million for three years. Consistent with the 1995 increase in the composite depreciation rate, Duquesne is not seeking a rate increase to recover these additional costs. (See \"Sale of Ft. Martin\" discussion on page 9.)\nTaxes other than income taxes were lower in 1993 compared to 1995 and 1994, primarily as a result of a favorable resolution of certain property tax assessments. In 1993, Duquesne recorded, on the basis of these revised assessments, the expected refunds for overpayments in prior years.\nIncome taxes were lower in 1993, when compared to 1995 and 1994, because of a favorable settlement with the Internal Revenue Service (related to Duquesne's 1988 federal income tax return and DQE's 1989 consolidated federal income tax return). The remaining fluctuations result from changes in taxable income. During 1994 the statutory Pennsylvania income tax rate was reduced from 12.25 percent to 9.99 percent.\nThis resulted in a net decrease of $80.5 million in deferred tax liabilities and a corresponding reduction in the regulatory receivable.\nOther Income and Deductions\nOther income and deductions decreased $4.9 million in 1995 when compared to 1994 primarily due to increases in income taxes related to other income. The $5.4 million decrease in other income and deductions from 1993 to 1994 reflects the favorable corporate federal income tax settlements recorded in 1993 offset that year by a $15.2 million long-term power sale write-off.\nCapital Expenditures\nDuquesne spent approximately $78.7 million in 1995, $94.3 million in 1994 and $100.6 million in 1993 for construction. These amounts were expended to improve and\/or expand electric production, transmission and distribution systems. Duquesne's capital expenditures for construction focus on extending service to new customers, providing for the replacement of utility property and modifying facilities consistent with the most current environmental and safety regulations. Duquesne estimates that it will spend, excluding the allowance for funds used during construction (AFC) and nuclear fuel, approximately $90 million, $90 million and $100 million for construction during 1996, 1997 and 1998, respectively. Approximately $5 million of capital expenditures for reliability enhancements to the simple cycle units located at Brunot Island (BI) contemplated in Duquesne's petition before the PUC are excluded from these estimates. (See \"Sale of Ft. Martin\" discussion on page 9.) Duquesne expects that funds generated from operations will continue to be sufficient to finance a large part of its capital needs.\nInvesting\nDuquesne's long-term investments consist of Duquesne's holdings of DQE common stock, investments in affordable housing, leasehold and other investments, and Duquesne's nuclear decommissioning trusts. Investing activities increased in 1995, after staying relatively constant in 1994 when compared to 1993. Duquesne invested $5.4 million and $5.3 million in affordable housing funds during 1995 and 1994, respectively. In addition, Duquesne invested $57.5 million in other leases and investments during 1995.\nLiquidity and Capital Resources - -------------------------------------------------------------------------------\nFinancing\nDuquesne expects to meet its current obligations and debt maturities through the year 2000 with funds generated from operations and through new financings. At December 31, 1995, Duquesne was in compliance with all of its debt covenants.\nDuquesne's 1947 first mortgage bond indenture was retired in the third quarter of 1995 following the maturity of the last bond series issued under the indenture. All of Duquesne's First Collateral Trust Bonds have been issued under a new mortgage indenture that was established in April 1992 (the 1992 Indenture). All First Collateral Trust Bonds became first mortgage bonds when the 1947 mortgage indenture was retired. The 1992 Indenture includes more flexible provisions and eliminates conventions such as mandatory sinking funds and formula-derived maintenance and replacement clauses.\nOn September 1, 1995, Duquesne redeemed all of its outstanding shares of $7.20 Preferred Stock for $29.9 million. On August 29, 1995, Duquesne repurchased $7 million of its 8-3\/8% First Collateral Trust Bonds maturing in 2024.\nIn May 1996, $50.0 million of First Collateral Trust Bonds will mature. Duquesne expects to retire these bonds with internally generated funds or to refinance the bonds.\nShort-Term Borrowings\nAt December 31, 1995, Duquesne had an extendible revolving credit agreements with a group of banks totaling $150 million. This facility expires in October 1996. Interest rates on this credit agreement vary. Commitment fees are based on the unborrowed amount of the commitments. The credit facility contains a two-year repayment period for any amount outstanding at the expiration of the revolving credit period. At December 31, 1995 and 1994, there were no short-term borrowings outstanding.\nInterest Charges\nDuquesne achieved a $3.8 million and a $9.1 million reduction in interest charges in 1995 and 1994, respectively, primarily due to the retirement of long- term debt. Duquesne's interest on long-term debt and dividends on preferred and preference stock declined to $100.7 million in 1995 from $107.1 million in 1994 and $117.7 million in 1993. Interest expense in 1996 will be influenced by fluctuations in short-term rates and any new financing.\nSale of Accounts Receivable\nDuquesne and an unaffiliated corporation have an agreement that entitles Duquesne to sell, and the corporation to purchase, on an ongoing basis, up to $50 million of accounts receivable. At December 31, 1995, Duquesne had sold $7 million of receivables to the unaffiliated corporation. Duquesne had no receivables sold at December 31, 1994. The accounts receivable sales agreement, which expires in June 1996, is one of many sources of funds available to Duquesne. Duquesne may attempt to extend the agreement, or to replace the facility with a similar one or to eliminate it upon expiration.\nNuclear Fuel Leasing\nDuquesne finances its acquisitions of nuclear fuel through a leasing arrangement under which it may finance up to $75 million of nuclear fuel. As of December 31, 1995, the amount of nuclear fuel financed by Duquesne under this arrangement totaled approximately $40.8 million. Duquesne plans to continue leasing nuclear fuel to fulfill its requirements at least through September 1998, the remaining term of the leasing arrangement.\nRate Matters - --------------------------------------------------------------------------------\nElectric rates charged by Duquesne to its customers are regulated by the PUC. Electric rates charged to the Borough of Pitcairn and rates charged for sales to other electric utilities are regulated by the FERC. These rates are designed to recover Duquesne's operating expenses, investment in utility assets, and to provide a return on those investments. Sales to other utilities are made at market rates. At this time, Duquesne has no pending base rate case and has no immediate plans to file a base rate case. In Duquesne's petition currently before the PUC for the sale of its ownership interest in the Ft. Martin Power Station, Duquesne proposes to freeze its base rates for a five-year period. (See \"Sale of Ft. Martin\" discussion on page 9.)\nEnergy Cost Rate Adjustment Clause (ECR)\nThrough the ECR, Duquesne recovers (to the extent that such amounts are not included in base rates) nuclear fuel, fossil fuel and purchased power expenses and, also through the ECR, passes to its customers the profits from short-term power sales to other utilities (collectively, ECR energy costs). Nuclear fuel expense is recorded on the basis of the quantity of electric energy generated and includes such costs as the fee imposed by the United States Department of Energy (DOE) for future disposal and ultimate storage and disposition of\nspent nuclear fuel. Fossil fuel expense includes the costs of coal, natural gas and fuel oil used in the generation of electricity.\nOn Duquesne's statement of consolidated income, these ECR revenues are included as a component of operating revenues. For ECR purposes, Duquesne defers fuel and other energy expenses for recovery, or refunding, in subsequent years. The deferrals reflect the difference between the amount that Duquesne is currently collecting from customers and its actual ECR energy costs. The PUC annually reviews Duquesne's ECR energy costs for the fiscal year April through March, compares them to previously projected ECR energy costs and adjusts the ECR for over- or under-recoveries and for two PUC-established coal cost standards. (See \"Deferred Coal Costs\" and \"Warwick Mine Costs\" discussions in Note F to the consolidated financial statements on pages 49 and 50, respectively.)\nOver- or under-recoveries from customers are recorded on the consolidated balance sheet as payable to, or receivable from, customers. At December 31, 1995, $5.8 million was payable to customers and shown as other current liabilities. At December 31, 1994, $5.9 million was receivable from customers and shown as other current assets.\nDeferred Rate Synchronization Costs\nIn 1987, the PUC approved Duquesne's petition to defer initial operating and other costs of Perry Unit 1 and BV Unit 2. Duquesne deferred the costs incurred from November 17, 1987, when the units went into commercial operation, until March 25, 1988, when a rate order was issued. In its order, the PUC postponed ruling on whether these costs would be recoverable from Duquesne's customers. At December 31, 1995, these costs totaled $51.1 million, net of deferred fuel savings related to the two units. Duquesne is not earning a return on the deferred costs. Duquesne believes that these costs are recoverable. In 1990 and 1995, the PUC permitted other Pennsylvania electric utilities rate recovery of such costs.\nProperty, Plant and Equipment (PP&E) - --------------------------------------------------------------------------------\nInvestment in PP&E and Accumulated Depreciation\nDuquesne's total investment in property, plant and equipment and the related accumulated depreciation balances for the following major classes of property at December 31, 1995 and 1994, are as follows:\nPP&E and Related Accumulated Depreciation at December 31 - --------------------------------------------------------------------------------\nJoint Interests in Generating Units\nDuquesne has various contracts with The Potomac Edison Company, Monongahela Power Company, Ohio Edison Company, Pennsylvania Power Company, The Cleveland Electric Illuminating Company (CEI) and The Toledo Edison Company that include provisions for coordinated maintenance responsibilities, limited and qualified mutual back-up in the event of outages and certain capacity and energy transactions.\nUnder the agreements governing the operation of these jointly owned generating units, the day-to-day operating authority is assigned to a specific company. CEI has such authority for Perry Unit 1 and Eastlake Unit 5; Ohio Edison Company has authority for Sammis Unit 7; Pennsylvania Power Company has authority for Bruce Mansfield Units 1, 2 and 3; and Monongahela Power Company operates Ft. Martin Unit 1.\nIn September 1995, Duquesne served a demand for arbitration on CEI seeking, among other things, a partition of Eastlake Unit 5 through a sale of Duquesne's interest therein and a termination of its operating agreement with CEI for that unit. The demand alleges, among other things, the improper allocation by CEI of fuel and related costs between itself and Duquesne; the mismanagement by CEI of the closing of the Saginaw Mine, which historically supplied coal to the unit; and the concealment by CEI of information. In October 1995, CEI filed its own arbitration demand and asserted counterclaims seeking Duquesne's alleged share of costs relating to the unit. A panel of arbitrators has been appointed.\nDuquesne has a joint interest in the following nuclear power stations with the following companies:\n*Denotes Operator (a) Subsidiary of Ohio Edison Company (b) Subsidiary of Centerior Energy Corporation (c) In 1987, Duquesne sold and subsequently leased back its 13.74 percent interest in BV Unit 2; the sale was exclusive of transmission and common facilities. The total sales price of $537.9 million was the appraised value of Duquesne's interest in the property. Duquesne leased back its interest in the unit for a term of 29.5 years. The lease provides for semiannual payments and is accounted for as an operating lease. Duquesne is responsible under the terms of the lease for all costs of its interest in the unit. (See \"Property, Plant and Equipment,\" Note B to the consolidated financial statements on page 46.)\nDuquesne has a joint interest in the following fossil plants with the following companies:\n*Denotes Operator (a) Subsidiary of Ohio Edison Company (b) Subsidiary of Centerior Energy Corporation (c) Subsidiary of, and currently known as, Allegheny Power System\nBeaver Valley Power Station\nBVPS continues to demonstrate excellence in operating performance. During 1995, BV Unit 1 and BV Unit 2 both underwent scheduled refueling outages, which were completed in the shortest duration in both the units' history. Further exemplifying BVPS' accomplishments, both refueling outages were completed under budgeted cost. In spite of these scheduled refueling outages, the combined capacity factor for the units averaged 80 percent during 1995. Capacity factor is a key production measure and indicates how well the plant operated based on its design capacity. It is the ratio of the power actually generated by a facility to the facility's rated capacity during a given period of time. Also, BV Unit 2 achieved an unplanned capability loss factor of 0.7 percent, which is significantly better than the industry standard of 4.0 percent. This factor measures how much power production was lost due to unplanned outages.\nIn addition to optimizing generation and cost efficiency, BVPS management continues to emphasize safety in operations. During 1995, BVPS employees achieved the milestone of more than three million hours worked without incurring a single lost time accident.\nPerry Unit 1\nDuquesne has a 13.74 percent ownership interest in Perry Unit 1, a nuclear generating unit located in Ohio and operated by CEI. Perry Unit 1 experienced improved performance during 1995, a year without a refueling outage, and achieved a capacity factor of 87.5 percent. CEI has submitted to the NRC an action plan, called the Perry Course of Action (PCA). CEI management continues to represent to Duquesne that the PCA is on schedule and will be an effective program to ensure that Perry Unit 1 is in conformance with applicable industry standards. The PCA is scheduled to be completed by the end of Perry Unit 1's fifth refueling outage, presently scheduled for the spring of 1996. Duquesne cannot predict the effectiveness of the PCA. Duquesne will continue to monitor closely this situation.\nSale of Ft. Martin\nOn November 29, 1995, Duquesne and AYP Capital, Inc., an unregulated subsidiary of the Allegheny Power System (APS), entered into an agreement for the sale of Duquesne's 50 percent ownership interest in Unit 1 of the Ft. Martin Power Station, for the sum of $169 million. The agreement is subject to all necessary regulatory approvals. On December 20, 1995, Duquesne filed a Petition for Declaratory Order with the PUC requesting approval for the sale in conjunction with a six-point plan to be financed in part by the proceeds of the Ft. Martin transaction.\nUnder the plan, Duquesne offers to freeze its base rates for a period of five years. If approved, the rate freeze is expected to produce a 14 percent reduction in the real price of electricity based on an average annual inflation rate of 2.7 percent. In addition, Duquesne proposes to record a one-time reduction of approximately $130 million in the value of Duquesne's nuclear plant investment. Duquesne also proposes to use the proceeds from the sale to finance reliability enhancements to the simple cycle units located at BI, to retire debt and to reduce equity. The BI simple cycle units will provide 135 megawatts (MW) of summer peaking capacity and 168 MW of winter peaking capacity and permit Duquesne to achieve greater operational flexibility in meeting peak system demands. The plan also proposes an annual increase of $25 million for three years in depreciation and amortization expense related to Duquesne's nuclear investment, as well as additional annual contributions to its nuclear plant decommissioning funds of $5 million for five years, without any increase in existing electric rates. Lastly, Duquesne proposes a five-year annual $5 million credit to the ECR to compensate Duquesne's customers for the lost profits from any reduced short-term power sales foregone by the sale of its ownership interest in the Ft. Martin Power Station. (See \"Energy Cost Rate Adjustment Clause (ECR)\" discussion on page 6.)\nThe PUC is currently reviewing Duquesne's petition.\nProperty Held for Future Use\nIn 1986, the PUC approved Duquesne's request to remove Phillips Power Station (Phillips) and a portion of BI from service and from rate base. Duquesne expects to recover its net investment in these plants through future electricity sales. Duquesne believes its investment in these plants will be necessary in order to meet future business needs outlined in Duquesne's plans for optimizing generation resources. (See \"Generation Resource Optimization\" discussion on page 17.) If business opportunities do not develop as expected, Duquesne will consider the sale of these assets. In the event that market demand, transmission access or rate recovery do not support the utilization or sale of the plants, Duquesne may have to write off part or all of their costs. A portion of the BI combustion turbine capacity currently held for future use may be returned to service pending the outcome of the sale of Duquesne's ownership interest in Ft. Martin. (See \"Sale of Ft. Martin\" discussion on page 9.) At December 31, 1995, Duquesne's net investment in Phillips and BI held for future use was $77.4 million and $44.9 million, respectively.\nEmployees - --------------------------------------------------------------------------------\nAt December 31, 1995, Duquesne had 3,515 employees, including 1,178 employees at Duquesne-operated BVPS. The International Brotherhood of Electrical Workers (IBEW) union represents 2,086 of Duquesne's employees. The current collective bargaining agreement with the IBEW expires on September 30, 1998.\nElectric Utility Operations - --------------------------------------------------------------------------------\nApproximately 69 percent of the electric energy generated by Duquesne's system during 1995 was produced by its coal-fired generating capacity and approximately 31 percent was produced by its nuclear generating capacity. Duquesne normally experiences its peak loads in the summer. The 1995 customer system peak of 2,666 MW, the highest system peak in Duquesne's history, occurred on August 16, 1995.\nDuquesne's fossil plants operated at 76 percent availability in 1995 and 85 percent availability in 1994. Duquesne's nuclear plants operated at 83 percent availability in 1995 and 75 percent in 1994. The timing and duration of scheduled maintenance and refueling outages, as well as the duration of forced outages, affect the availability of power stations.\nDuquesne determines the need for and timing of generation resource additions based on maintaining an adequate level of resources in reserve above the projected weather normalized annual peak demand. In addition, capacity resources throughout the region can supplement Duquesne's in-service generation resources, if required, through Duquesne's substantial transmission import capability, currently in excess of 4,000 MW. The North American Electric Reliability Council, of which Duquesne is a member, uses \"capacity margin\" to report generating capability when compared to customer demand. Capacity margin is one of the criteria used by Duquesne in assessing the need for future resources. Duquesne's capacity margin in 1995 was 11.7 percent. The capacity portfolio reflected in Duquesne's capacity margin includes in-service generating capacity, plus 21 MW capacity provided by non-utility generation contracts, plus a portion of the capacity from property held for future use available to meet customer needs during peaking or emergency conditions. The customer peak demand reflected in Duquesne's capacity margin is based on the actual peak demand experienced during the extraordinarily hot 1995 summer weather conditions, less 97 MW of interruptible load resources available from Duquesne's interruptible customers, but not actually interrupted during the peak period.\nThe successful resolution of Duquesne's proposed sale of its ownership interest in Ft. Martin will reduce in-service capacity by 276 MW. Duquesne expects to replace Ft. Martin capacity by(1) utilizing the 168 MW oil-fired combustion turbines at the BI combined cycle facility, which is property held for future use, and (2) acquiring seasonal peaking capacity from power marketplace resources, as required. These additional resources ensure that adequate capacity will be available to enable Duquesne to continue to maintain the expected level of power generation reliability.\nFossil Fuel - --------------------------------------------------------------------------------\nDuquesne believes that sufficient coal for its coal-fired generating units will be available from various sources to satisfy its requirements for the foreseeable future. During 1995, approximately 2.6 million tons of coal were consumed at Duquesne's two wholly owned coal-fired stations, Cheswick Power Station (Cheswick) and Elrama Power Station (Elrama).\nDuquesne owns Warwick Mine, an underground mine located on the Monongahela River approximately 83 river miles from Pittsburgh. Warwick Mine has been excluded from rate base since 1981. Duquesne temporarily idled the mine in June 1988 due to excess coal inventories. In 1990, Duquesne restarted the mine and entered into an agreement under which an unaffiliated company will operate the mine until March 2000 and sell the coal produced. Production began in late 1990. The mine produced 1.1 million tons of coal in 1995. The Warwick Mine coal reserves include both high and low sulfur coal; the sulfur content averages in the mid-range at 1.7 percent to 1.9 percent. More than 60 percent of the coal mined at Warwick Mine currently is used by Duquesne. Duquesne receives a royalty on any sales of Warwick coal in the open market. These royalties are credited to Duquesne's ECR. The Warwick Mine currently supplies less than one-fifth of the coal used in the production of electricity at the plants owned or jointly owned by Duquesne. Duquesne estimates that, at December 31, 1995, its economically recoverable coal reserves at Warwick Mine were 9.0 million tons. Costs at Warwick Mine and Duquesne's investment in the mine are expected to be recovered through the cost of coal in the ECR. Recovery is subject to the system-wide coal cost standard. Duquesne also has an opportunity to earn a return on its investment in the mine through the cost of coal during the period of the system- wide coal cost standard. At December 31, 1995, Duquesne's net investment in the mine was $14.9 million. The current estimated liability, including final site reclamation, mine water treatment and certain labor liabilities, for mine closing is $34.1 million, and Duquesne has recorded a liability on the consolidated balance sheet of approximately $15.9 million toward these costs. (See \"Warwick Mine Costs\" discussion in Note F to the consolidated financial statements on page 50.)\nDuring 1995, 56 percent of Duquesne's coal supplies were provided by contracts including Warwick Mine, with the remainder satisfied through purchases on the spot market. Duquesne had four long-term contracts in effect at December 31, 1995, which, in combination with spot market purchases, are expected to furnish an adequate future coal supply. Duquesne does not anticipate any difficulty in replacing or renewing these contracts as they expire from 1996 through 2002. At December 31, 1995, Duquesne's wholly owned and jointly owned generating units had on hand an average coal supply of 45 days.\nThe PUC has established two market price coal cost standards. One applies only to coal delivered at the Bruce Mansfield Power Station (Bruce Mansfield). The other, the system-wide coal cost standard, applies to coal delivered to the remainder of Duquesne's system. Both standards are updated monthly to reflect prevailing market prices of similar coal. The PUC has directed Duquesne to defer recovery of the delivered cost of coal to the extent that such cost exceeds generally prevailing market prices for similar coal, as determined by the PUC. The PUC allows deferred amounts to be recovered from customers when the delivered costs of coal fall below such PUC-determined prevailing market prices.\nThe system-wide coal cost standard extends through March 2000. The unrecovered cost of Bruce Mansfield coal was $8.4 million and the unrecovered cost of the remainder of the system-wide coal was $4.4 million at December 31, 1995. Duquesne estimates that all deferred coal costs will be recovered. Duquesne's average cost per ton of coal consumed, including the cost of delivery, during the past three years at generating units which it operates or in which it has an ownership interest was $38.86, $39.12 and $40.08 in 1995, 1994 and 1993, respectively. The cost of coal, which falls within the market price limitations, is recovered from Duquesne's customers through the ECR. (See \"Rate Matters\" discussion on page 6, and also see \"Deferred Coal Costs\" discussion in Note F to the consolidated financial statements on page 49.)\nNuclear Fuel - --------------------------------------------------------------------------------\nThe cycle of production and utilization of nuclear fuel consists of (1) mining and milling of uranium ore and processing the ore into uranium concentrates, (2) converting uranium concentrates to uranium hex-\nafluoride, (3) enriching the uranium hexafluoride, (4) fabricating fuel assemblies, (5) utilizing the nuclear fuel in the generating station reactor and (6) storing and disposing of spent fuel.\nAdequate supplies of uranium and conversion services are under contract for Duquesne's requirements for its jointly owned\/leased nuclear units through 1996. Enrichment services are supplied under a 1984 United States Enrichment Corporation Utility Services Contract entered into for a period of 30 years by Duquesne for joint interests in Perry Unit 1, BV Unit 1 and BV Unit 2. Under the terms and conditions of this contract, Duquesne is committed to 100 percent of its enrichment needs through 1998 and 70 percent in 1999; Duquesne has terminated, at zero cost, all of its enrichment services requirements for fiscal years 2000 through 2005 and continues to review the need for further services on an annual basis. Fuel fabrication contracts are in place to supply reload requirements for the next two cycles for BV Unit 1, the next two cycles for BV Unit 2 and the next sixteen cycles for Perry Unit 1. Duquesne will be required to make arrangements for uranium supply and related services as existing commitments expire.\nEach utility company is responsible for financing its proportionate share of the costs of nuclear fuel for each nuclear unit in which it has an ownership or leasehold interest. (See \"Nuclear Fuel Leasing\" discussion on page 6.) Duquesne's nuclear fuel costs, which are amortized to reflect fuel consumed, are charged to fuel expense and are recovered through rates. Duquesne estimates that, over the next three years, the amortization of nuclear fuel consumed will exceed the expenditures for new fuel by approximately $1.7 million. The actual nuclear fuel costs to be financed and amortized during the period 1996 through 1998 will be influenced by such factors as changes in interest rates; lengths of the respective fuel cycles; reload cycle design; and changes in nuclear material costs and services, the prices and availability of which are not known at this time. Such costs may also be influenced by other events not presently foreseen.\nDuquesne's nuclear fuel costs related to BV Unit 1, BV Unit 2 and Perry Unit 1 under the fuel lease arrangement are charged to fuel expense based on the quantity of energy generated. Nuclear fuel costs for these units averaged .750, .903 and .918 cents per KWH, inclusive of charges associated with spent fuel, in 1995, 1994 and 1993, respectively. Duquesne is recovering from its customers the costs associated with the ultimate disposal of spent fuel.\nNuclear Decommissioning - --------------------------------------------------------------------------------\nThe PUC ruled that recovery of the decommissioning costs for BV Unit 1 could begin in 1977, and that recovery for BV Unit 2 and Perry Unit 1 could begin in 1988. Duquesne expects to decommission BV Unit 1, BV Unit 2 and Perry Unit 1 no earlier than the expiration of each plant's operating license, 2016, 2027 and 2026, respectively. BV Unit 1 is expected to be placed in safe storage until the expiration of the BV Unit 2 operating license, at which time the units may be decommissioned together.\nBased on site-specific studies finalized in 1992 for BV Unit 2, and in 1994 for BV Unit 1 and Perry Unit 1, Duquesne's share of the total estimated decommissioning costs, including removal and decontamination costs, currently being used to determine Duquesne's cost of service, are $122 million for BV Unit 1, $35 million for BV Unit 2 and $67 million for Perry Unit 1.\nIn conjunction with an August 18, 1994, PUC Accounting Order, Duquesne has increased the annual contribution to its decommissioning trusts by approximately $2 million to bring the total annual funding to approximately $4 million per year. In collaboration with Duquesne and several other Pennsylvania utilities, the PUC Office of Special Assistants is evaluating various decommissioning issues, including funding methods. Duquesne expects that any action relating to any forthcoming PUC report will result in further increases in annual contributions to its decommissioning trusts. Consistent with these anticipated future PUC actions, Duquesne's petition before the PUC for the sale of its ownership interest in the Ft. Martin Power Station provides for additional annual contributions to its nuclear decommissioning funds of $5 million for five years without any increase in existing electric rates. (See \"Sale of Ft. Martin\" discussion on page 9.)\nDuquesne records decommissioning costs under the category of depreciation and amortization expense and accrues a liability, equal to that amount, for nuclear decommissioning expense. Such nuclear decommis-\nsioning funds are deposited in external, segregated trust accounts. The funds are invested in a portfolio of municipal bonds, certificates of deposit and United States government securities having a weighted average duration of four to seven years. Trust fund earnings increase the fund balance and the recorded liability. The market value of the aggregate trust fund balances at December 31, 1995, totaled approximately $28.5 million. On Duquesne's consolidated balance sheet, the decommissioning trusts have been reflected in other long-term investments, and the related liability has been recorded as other non-current liabilities.\nNuclear Insurance - --------------------------------------------------------------------------------\nAll of the companies with an interest in BV Unit 1, BV Unit 2 and Perry Unit 1 maintain nuclear property insurance, which provides coverage for property damage, decommissioning and decontamination liabilities. Duquesne's share of this program provides for $1.2 billion of insurance coverage for its net investment of $407.8 million in the BVPS and $565.5 million in Perry Unit 1, plus its interest in BV Unit 2 with lease commitments of $405.2 million, at December 31, 1995. The lease commitments of $405.2 million represent the net present value of future lease payments discounted at 10.94 percent, the return currently authorized Duquesne by the PUC. Duquesne would be responsible for its share of any damages in excess of insurance coverage. In addition, if the property damage reserves of Nuclear Electric Insurance Limited (NEIL), an industry mutual insurance company, are inadequate to cover claims arising from an incident at any United States nuclear site covered by that insurer, Duquesne could be assessed retrospective premiums totaling a maximum of $10.9 million.\nThe Price-Anderson Amendments to the Atomic Energy Act of 1954 limit public liability from a single incident at a nuclear plant to $8.9 billion. Duquesne has purchased $200 million of insurance, the maximum amount available, which provides the first level of financial protection.\nAdditional protection of $8.3 billion would be provided by an assessment of up to $75.5 million per incident on each nuclear unit in the United States. Duquesne's maximum total assessment, $56.6 million, which is based on its ownership or leasehold interests in three nuclear generating units, would be limited to a maximum of $7.5 million per incident per year. A further surcharge of 5 percent could be levied if the total amount of public claims exceeded the funds provided under the assessment program. Additionally, a state premium tax may be charged on the assessment and surcharge. Finally, the United States Congress could impose other revenue-raising measures on the nuclear industry if funds prove insufficient to pay claims.\nDuquesne carries extra expense insurance which would pay the incremental cost of any replacement power purchased (in addition to costs that would have been incurred had the units been operating) and other incidental expense after the occurrence of certain types of accidents at its nuclear units in a limited amount for a limited period of time. The coverage provides for 100 percent of the estimated extra expense per week during the 52-week period starting 21 weeks after an accident and 80 percent of such estimate per week for the following 104 weeks, with no coverage thereafter. The amount and duration of actual extra expense could substantially exceed insurance coverage. NEIL also provides this insurance. If NEIL's reserves are inadequate to cover claims at any United States nuclear site covered by that insurer, Duquesne could be assessed retrospective premiums totaling a maximum of $3.5 million.\nSpent Nuclear Fuel Disposal - --------------------------------------------------------------------------------\nThe Nuclear Waste Policy Act of 1982 established a policy for handling and disposing of spent nuclear fuel and a policy requiring the established final repository to accept spent fuel. Electric utility companies have entered into contracts with the DOE for the permanent disposal of spent nuclear fuel and high-level radioactive waste in compliance with this legislation. The DOE has indicated that its repository under these contracts will not be available for acceptance of spent fuel before 2010 at the earliest. Existing on-site spent fuel storage capacities at BV Unit 1, BV Unit 2 and Perry Unit 1 are expected to be sufficient until 2016, 2010 and 2011, respectively.\nUranium Enrichment Decontamination and Decommissioning Fund - --------------------------------------------------------------------------------\nNuclear reactor licensees in the United States are assessed annually for the decontamination and decommissioning of DOE uranium enrichment facilities. Assessments are based on the amount of uranium a utility had processed for enrichment prior to enactment of the National Energy Policy Act of 1992 (NEPA) and are to be paid by such utilities over a 15-year period. At December 31, 1995, Duquesne's liability for contributions is approximately $9.9 million (subject to an inflation adjustment). Contributions, when made, are recovered from electric utility customers through the ECR.\nEnvironmental Matters - --------------------------------------------------------------------------------\nThe Comprehensive Environmental Response, Compensation and Liability Act of 1980 and the Superfund Amendments and Reauthorization Act of 1986 (Superfund) established a variety of informational and environmental action programs. The United States Environmental Protection Agency (EPA) has informed Duquesne of its involvement or potential involvement in three hazardous waste sites. Duquesne has reached agreements to make minimal financial payments related to two of the three sites in order to resolve any associated liability. If Duquesne is ultimately determined to be a responsible party with respect to the remaining site, it could be liable for all or a portion of the cleanup costs. However, other solvent, potentially responsible parties that may bear all or part of any liability are also involved. In addition, Duquesne believes that available defenses, along with other factors (including overall limited involvement and low estimated remediation costs) will limit any potential liability that Duquesne may have for cleanup costs. Duquesne believes that it is adequately reserved for all known liabilities and costs and, accordingly, that this matter will not have a materially adverse effect on its financial position or results of operations.\nIn 1990, Congress approved amendments to the Clean Air Act, which established the Emission Allowance Trading System. Allowances are issued by the EPA to fossil-fired stations with generating capability of more than 25 MW that were in existence as of the passage of the 1990 amendments. Allowances are part of an innovative market-based approach to sulfur dioxide (SO\\\\2\\\\) reduction. Emission allowances can also be obtained through purchases on the open market or directly from other sources. Excess allowances may be banked for future use or sold on the open market to other parties to offset their emissions.\nAlthough Duquesne has satisfied all of the Phase I requirements of the Clean Air Act, Phase II requires significant additional reductions of SO\\\\2\\\\ and oxides of nitrogen (NO\\\\X\\\\) by the year 2000. Duquesne currently has 662 MW of nuclear capacity, 1,187 MW of coal capacity equipped with SO\\\\2\\\\ emission reducing equipment (including 300 MW of property held for future use at Phillips) as well as 757 MW of capacity that meets the 1995 standards of the Clean Air Act Amendments through the use of low sulfur coal. Through the year 2000, Duquesne is considering a combination of compliance methods that include fuel switching; increased use of, and improvements in, SO\\\\2\\\\ emission reducing equipment; low NO\\\\X\\\\ burner technology; and the purchase of emission allowances. Flue gas conditioning and post combustion NO\\\\X\\\\ reduction technologies may also be employed if economically justified. In addition, Duquesne is examining and developing innovative emissions technologies designed to reduce costs. Duquesne continues to work with the operators of its jointly owned stations to implement cost-effective compliance strategies to meet these requirements. NO\\\\X\\\\ reductions under Title IV of the Clean Air Act were required at Cheswick, and the work to achieve the reductions was completed in 1993. The ozone attainment provisions of Title I of the Clean Air Act Amendments also required NO\\\\X\\\\ reductions by mid-1995 at Cheswick, Elrama and Bruce Mansfield. Duquesne achieved such reductions using innovative combustion system modifications and low NO\\\\X\\\\ burner technology. Duquesne currently estimates that additional capital costs to comply with Clean Air Act requirements through the year 2000 will be approximately $20 million. This estimate is subject to the finalization of federal and state regulations and the PUC approval of the sale of Duquesne's interest in the Ft. Martin Power Station. (See \"Sale of Ft. Martin\" discussion on page 9.)\nDuquesne has developed, patented and installed low NO\\\\X\\\\ burner technology for the Elrama boilers. These cost-effective NO\\\\X\\\\ reduction systems installed on the Elrama roof fired boilers was specified as the benchmark for the industry for this class of boilers in the EPA's pending Group II rulemaking. Duquesne is also currently evaluating additional low cost, developmental NO\\\\X\\\\ reduction technologies at Cheswick and\nElrama. An Artificial Neural Network control system enhancement, co-sponsored by the Electric Power Research Institute and Duquesne, will be demonstrated at Cheswick. The Gas Research Institute and Duquesne are sponsoring a targeted natural gas reburn demonstration at Elrama. Both demonstrations will be completed in 1996.\nAs required by Title V of the Clean Air Act Amendments, Duquesne has filed comprehensive air operating permit applications for Cheswick, Elrama, BI and Phillips during the last half of 1995. Duquesne also filed its Title IV Phase II Clean Air Act compliance plan with the PUC on December 27, 1995.\nDuquesne is closely monitoring other potential future air quality programs and air emission control requirements, including additional NO\\\\X\\\\ control requirements that were recommended for fossil fuel plants by the Ozone Transport Commission and the potential for more stringent ambient air quality and emission standards for SO\\\\2\\\\ particulates, and other by-products of coal combustion. As these potential programs are in various stages of discussion and consideration, it is impossible to make reasonable estimates of the potential costs and impacts, if any.\nIn 1992, the Pennsylvania Department of Environmental Protection (DEP) issued Residual Waste Management Regulations governing the generation and management of non-hazardous residual waste, such as coal ash. Duquesne is assessing the sites which it utilizes and has developed compliance strategies under review by the DEP. Capital compliance costs of $3.0 million were incurred by Duquesne in 1995 to comply with these DEP regulations; on the basis of information currently available, an additional $2.5 million will be incurred in 1996. The expected additional capital cost of compliance through the year 2000 is estimated, based on current information, to be approximately $25 million. This estimate is subject to the results of ground water assessments and DEP final approval of compliance plans.\nDuquesne is involved in various other environmental matters. Duquesne believes that such matters, in total, will not have a materially adverse effect on its financial position or results of operations.\nOutlook - --------------------------------------------------------------------------------\nCompetition\nThe electric utility industry is undergoing fundamental change in response to the open transmission access and increased availability of energy alternatives fostered by NEPA which has served to increase competition in the industry. Previously captive customers are seeking freedom to choose alternative suppliers of energy. These competitive pressures require utilities to offer competitive pricing and terms to retain customers and to develop new markets for the optimal utilization of their generation capacity.\nAt the national level, NEPA was designed to encourage competition among electric utility companies, improve energy resource planning and to encourage the development of alternative sources of energy. NEPA authorizes the FERC to require electric utilities to provide wholesale suppliers of electric energy with nondiscriminatory access to the utility's wholesale transmission system. In response to this mandate, the FERC has issued a Notice of Proposed Rulemaking (NOPR) on Open Access Nondiscriminatory Transmission Services and a supplemental NOPR on the Recovery of Stranded Costs. The NOPR on open access transmission would define the terms under which independent power producers, neighboring utilities and others could gain access to a utility's transmission grid to deliver power to customers. The supplemental NOPR on stranded costs would address the issue of recovery of a utility's unrecovered costs that were incurred to provide service to customers that subsequently leave a utility's system in favor of another supplier. A final order is expected in mid-1996 on both NOPRs. Also, in January 1996, the FERC announced its plans to reconsider its public utility merger guidelines. The FERC actions are expected to have a significant impact on competition in the electric utility industry.\nIn Pennsylvania, the PUC currently is conducting an investigation concerning regulatory reform and has indicated an intention to issue a report to the governor and the Pennsylvania General Assembly by June 1996. The PUC staff issued an interim report in August 1995 that recommended that retail wheeling not be\nimplemented at that time because of concerns that retail wheeling would benefit large industrials at the expense of smaller customers and utility shareholders, who would absorb the costs of stranded investments, and that service reliability could be impaired. The report concludes that performance-based ratemaking, wholesale competition and utility cost cutting could provide the benefits of retail wheeling without the attendant disruptions.\nDuquesne is aware of the foregoing federal and state regulatory and business uncertainties, and is attempting to position itself to operate in a more competitive environment. Its current rate structure allows some flexibility in setting rates to retain its customer base and attract new business. Furthermore, as discussed below, open access transmission offers Duquesne the opportunity to sell power on a market basis to customers outside of its service territory.\nDuquesne has proposals before both the FERC and the PUC that address specific issues relating to its competitive position. Because of Duquesne's current electric generating configuration, some of its baseload capacity is used less than optimally. Two options Duquesne is currently considering to align its generating capabilities more closely with customer demand are discussed in \"Transmission Access\" below and \"Generation Resource Optimization\" on page 17. First, through open transmission access, Duquesne is seeking to increase its level of fixed demand through the negotiation of long-term power sale contracts to customers outside its service territory. Second, Duquesne proposes to change its generation profile through the sale of its interest in the Ft. Martin Power Station.\nAs part of its petition currently before the PUC with respect to the sale of its interest in Ft. Martin, Duquesne has proposed, among other concessions, a five-year freeze on base rates and a five-year annual $5 million credit to the ECR (which would otherwise remain unaffected by the freeze) to compensate Duquesne's electric utility customers for short-term power sales foregone by the sale of its interest in the plant. (See \"Sale of Ft. Martin\" discussion on page 9.) Although Duquesne believes a rate freeze will enable it to maintain and expand its existing customer base, if the rate freeze is implemented, Duquesne could face the risk of reduced rates of return if unforeseen costs arise and if revenues from sales prove inadequate to fund those costs.\nFinally, as noted above, open access transmission requirements implicitly create the potential for stranded costs. To address these issues, Duquesne has implemented, and will continue to evaluate, the accelerated depreciation of its generating assets as one method to guard against the competitive risks of stranded investments. (See \"Operating Expenses\" discussion on page 4.) At present, the FERC and the PUC appear supportive of stranded cost recovery; however, implementation details for recovery of stranded costs are extremely vague and far from decided. The petition for the sale of Duquesne's ownership interest in the Ft. Martin Power Station currently before the PUC proposes to further increase depreciation and amortization expense related to Duquesne's nuclear power investment by $75 million over a three-year period. This petition also proposes to record a one-time write-down in the value of Duquesne's nuclear plant investment of approximately $130 million and to increase by $5 million the annual contribution to Duquesne's nuclear plant decommissioning funds, for a total of $25 million in contributions over the next five years. (See \"Sale of Ft. Martin\" discussion on page 9.) These current and proposed accelerated investment cost recovery measures will be absorbed by Duquesne without an increase in base rates.\nDuquesne believes that these and similar initiatives will strengthen its position to succeed in a more competitive environment by eliminating the need to charge its electric utility customers in the future for these currently recognized expenses. At this time, however, there is no assurance as to the extent to which Company initiatives can or will ultimately eliminate regulatory and other uncertainties associated with increased competition.\nTransmission Access\nIn March 1994, Duquesne submitted, pursuant to the Federal Power Act, two separate \"good faith\" requests for transmission service with APS and the Pennsylvania-New Jersey-Maryland Interconnection Association (PJM Companies), respectively. Each request is based on 20-year firm service with flexible delivery points for 300 MW of transfer capability over the APS and PJM Companies transmission networks, which\ntogether extend from western Pennsylvania to the East Coast. Because of a lack of progress on pricing and other issues, on August 5 and September 16, 1994, Duquesne filed with the FERC applications for transmission service from the PJM Companies and APS, respectively. The applications are authorized under Section 211 of the Federal Power Act, which requires electric utilities to provide firm wholesale transmission service. In May 1995, the FERC issued proposed orders instructing APS and the PJM Companies to provide transmission service to Duquesne and directing the parties to negotiate specific rates, terms and conditions. Duquesne was unable to agree to terms for transmission service with either APS or the PJM Companies. Briefs were filed with the FERC outlining the areas of disagreement among the companies. The matter is now pending before the FERC. Duquesne cannot predict the final outcome of these proceedings.\nGeneration Resource Optimization\nDuquesne's plans for optimizing generation resources are designed to reduce underutilized generating capacity, promote competition in the wholesale marketplace, maintain stable prices and meet customer-specified levels of service reliability. Duquesne is committed to explore firm energy sales to wholesale customers, system power sales, system power sales with specific unit back-up, unit power sales, generating asset sales and any other approach to efficiently managing capacity and energy.\nThe proposed sale of Duquesne's ownership interest in the Ft. Martin Power Station demonstrates Duquesne's ongoing efforts to optimize the utilization of generation resources. (See \"Sale of Ft. Martin\" discussion on page 9.) The sale is expected to reduce power production costs by employing a cost-effective source of peaking capacity through enhanced reliability of the simple cycle units at BI. Implementation of the proposed plan will better align Duquesne's generating capabilities with its native load requirements.\nCustomer Service Guarantees\nDuquesne's commitment to provide reliable, quality service to its customers is characterized by its customer service guarantees. On March 6, 1995, Duquesne became the first Pennsylvania regulated utility, and the third in the United States, to offer its residential customers guarantees of its commitment to courteous, reliable and efficient service. Duquesne offers a $25 credit to a customer's account if Duquesne fails to provide accurate billings; to meet punctual service appointments; to extend prompt, courteous and professional service; or to connect new services within one day of the date requested by the customer.\nCustomer Advanced Reliability System\nIn January 1996, Duquesne announced its Customer Advanced Reliability System, a new communications service that will provide its customers with superior levels of service reliability, security and convenience. Duquesne has signed a long-term, full service contract with Itron, Inc. (Itron), a leading supplier of energy information and communication solutions to the electric utility industry. Over the next two years, Itron will install, operate and maintain a communications network that will provide Duquesne with an electronic link to its 580,000 customers.\nThe Customer Advanced Reliability System is designed to respond to customer needs on the basis of immediate information about the status of power delivery at individual homes and businesses. This electronic communications service is another major element in Duquesne's multi-step plan to make Duquesne's operations more competitive and efficient.\nOther - --------------------------------------------------------------------------------\nFinancial Accounting Pronouncement\nThe Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of (SFAS No. 121),\nin March 1995. This statement is effective for years beginning after December 15, 1995. Duquesne anticipates adopting this standard on January 1, 1996, and does not expect that it will have a material impact on its financial position or results of operations, based on the current regulatory structure in which it operates. As competitive factors influence pricing in the utility industry, this opinion may change in the future. The general requirements of SFAS No. 121 apply to non-current assets and require impairment to be considered whenever evidence suggests that it is no longer probable that future cash flows in an amount at least equal to the asset will result.\nRetirement Plan Measurement Assumptions\nDuquesne decreased the discount rate used to determine the projected benefit obligation on Duquesne's retirement plans at December 31, 1995, to 7.0 percent. The assumed change in future compensation levels was also decreased to reflect current market and economic conditions. The effects of these changes on Duquesne's retirement plan obligations are reflected in the amounts shown in \"Employee Benefits,\" Note M to the consolidated financial statements on page 56. The resulting change in related expenses for subsequent years is not expected to be material.\n------------------------------\nExcept for historical information contained herein, the matters discussed in this Annual Report on Form 10-K, are forward-looking statements that involve risks and uncertainties including, but not limited to, economic, competitive, governmental and technological factors affecting Duquesne's operations, markets, products, services and prices, and other factors discussed in Duquesne's filings with the Securities and Exchange Commission.\nExecutive Officers of the Registrant - --------------------------------------------------------------------------------\nSet forth below are the names, ages as of March 1, 1996, positions and brief accounts of the business experience during the past five years of the executive officers of Duquesne.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nDuquesne's properties consist of electric generating stations, transmission and distribution facilities, and supplemental properties and appurtenances, comprising as a whole an integrated electric utility system, located substantially in Allegheny and Beaver counties in southwestern Pennsylvania.\nDuquesne owns all or a portion of the following generating units except Beaver Valley Unit 2, which is leased.\n(1) Amounts represent Duquesne's share of the unit which is owned by Duquesne in common with one or more other electric utilities (or, in the case of Beaver Valley Unit 2, leased by Duquesne).\nDuquesne owns 25 transmission substations (including interests in common in the step-up transformers at Fort Martin Unit 1; Sammis Unit 7; Eastlake Unit 5; Bruce Mansfield Unit 1; Beaver Valley Unit 1; Beaver Valley Unit 2; Perry Unit 1; Bruce Mansfield Unit 2; and Bruce Mansfield Unit 3) and 562 distribution substations. Duquesne has 714 circuit-miles of transmission lines, comprising 345,000, 138,000 and 69,000 volt lines. Street lighting and distribution circuits of 23,000 volts and less include approximately 50,000 miles of lines and cable.\nDuquesne owns the Warwick Mine, including 4,849 acres owned in fee of unmined coal lands and mining rights, located on the Monongahela River in Greene County, Pennsylvania, approximately 83 river miles from Pittsburgh. (See Item 1. BUSINESS. \"Fossil Fuel\" discussion on page 11.)\nDuquesne's 1947 mortgage bond indenture was retired in the third quarter of 1995 following the maturity of the last bond series issued under the indenture. All First Collateral Trust Bonds have been issued under a new mortgage indenture that was established in April 1992 (the 1992 Indenture). The 1992 Indenture includes more flexible provisions and eliminates conventions such as mandatory sinking funds and formula-derived maintenance and replacement clauses.\nAdditional information relating to Item 2. PROPERTIES, is set forth in Note B, \"Property, Plant and Equipment,\" of the consolidated financial statements for year ended December 31, 1995, on page 46. The information is incorporated here by reference.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nRate-Related Legal Proceedings, Property, Plant and Equipment-Related Legal Proceedings and Environmental Legal Proceedings - --------------------------------------------------------------------------- Eastlake Unit 5\nIn October 1995, CEI commenced an action (Action) in the Common Pleas Court of Lake County, Ohio, seeking to enjoin Duquesne from seeking a partition of the Unit, through arbitration or otherwise, on the basis of a waiver of partition contained in the deed to the Unit. It is Duquesne's position that the deed covenant is unenforceable by CEI due to CEI's bad faith conduct toward Duquesne. Duquesne removed the Action to the United States District Court for the Northern District of Ohio, where it is now pending, and then, brought a motion requesting that all claims in dispute between the parties (including its arbitration claims) be heard by the Court or, alternatively, that the Court stay the Action and compel arbitration of all claims and filed an answer and counterclaims. This motion and nine other motions are pending before the Court. Until order of the federal court is issued on this issue, both the arbitration and the federal litigation are proceeding.\nProceedings involving Duquesne's rates are reported in Item 1. BUSINESS \"Rate Matters.\" Proceedings involving Property, Plant and Equipment are reported in Item 1. BUSINESS \"Property, Plant and Equipment.\" Proceedings involving environmental matters are reported in Item 1. BUSINESS \"Environmental Matters.\"\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 SHARE-HOLDER MATTERS.\nDuquesne's common stock is not publicly traded. Effective July 7, 1989, Duquesne became a wholly owned subsidiary of DQE, the holding company formed as part of a shareholder-approved restructuring. As a result of the restructuring, Duquesne's shareholders received DQE common stock in exchange for their shares of Duquesne common stock, which were cancelled. DQE owns all of Duquesne's outstanding common stock, which consists of 10 shares. As such, this item is not applicable to Duquesne because all its common equity is held solely by DQE. During 1995 and 1994, Duquesne declared quarterly dividends on its common stock totaling $144 million each year.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nSelected financial data for Duquesne for each year of the six-year period ended December 31, 1995, are set forth on page 63. The financial data is incorporated here by reference.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDI- TION AND RESULTS OF OPERATIONS.\nManagement's discussion and analysis of financial condition and results of operations are set forth in Item 1. BUSINESS. The discussion and analysis are incorporated here by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe Consolidated Balance Sheet of Duquesne Light Company and its Subsidiary as of December 31, 1995 and 1994, and the related Statements of Consolidated Income, Retained Earnings and Cash Flows for each of the three years in the period ended December 31, 1995, together with the Independent Auditors' Report dated January 30, 1996, are set forth in pages 38 to 62 of this Report. The consolidated financial statements and report are incorporated here by reference. Quarterly financial information is included on page 62 in Note O to Duquesne's consolidated financial statements and is incorporated here 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.\nAll directors of DQE are also directors of Duquesne. Information relating to DQE's and Duquesne's board of directors is set forth on page 20 of the 1995 DQE Annual Report to Shareholders filed here as part of this Report in Exhibit 99.2. The information is incorporated here by reference. Information relating to 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.\nThe information relating to executive compensation is set forth in Exhibit 99.1, filed as part of this Report. The information is incorporated here by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nDQE is the beneficial owner and holder of all shares of outstanding Common Stock, $1 par value, of Duquesne Light, consisting of 10 shares as of February 21, 1996. Information relating to the ownership of equity securities of DQE and Duquesne Light by directors and executive officers of Duquesne Light is set forth in Exhibit 99.1, filed as part of this Report. The information is incorporated here 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) The following information is set forth here on pages 38 through 62:\nReport of Independent Certified Public Accountants.\nStatement of Consolidated Income for the Three Years Ended December 31, 1995.\nConsolidated Balance Sheet, December 31, 1995 and 1994.\nStatement of Consolidated Cash Flows for the Three Years Ended December 31, 1995.\nStatement of Consolidated Retained Earnings for the Three Years Ended December 31, 1995.\nNotes to Consolidated Financial Statements.\n(a)(2) The following financial statement schedule and the related Report of Independent Certified Public Accountants (See page 38.) are filed here as a part of this Report:\nSchedule for the Three Years Ended December 31, 1995:\nII- Valuation and Qualifying Accounts.\nThe remaining schedules 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 or notes to the financial statements.\n(a)(3) Exhibits are set forth in the Exhibit List on pages 24 through 34 and incorporated here by reference. Documents other than those designated as being filed here are incorporated here by reference. Previously filed documents incorporated by reference to a DQE Annual Report on Form 10-K, a Quarterly Report on Form 10-Q or a Current Report on Form 8-K are at Securities and Exchange Commission File No. 1-10290. Documents incorporated by reference to a Duquesne Light Company Annual Report on Form 10-K, Quarterly Report on Form 10-Q or a Current Report on Form 8-K are at Securities and Exchange Commission File No. 1-956. The Exhibits include the management contracts and compensatory plans or arrangements required to be filed as exhibits to this Form 10-K by Item 601(d)(10)(iii), of Regulation S-K.\n(b) Reports on Form 8-K filed during the twelve months ended December 31, 1995:\n(1) May 22, 1995 - The following event was reported:\nItem 5. Federal Energy Regulatory Commission responded favorably to Section 211 applications filed by Duquesne Light Company for transmission service from the Pennsylvania-New Jersey-Maryland Power Pool and Allegheny Power System by issuing proposed orders requiring the provision of firm transmission service at comparable prices.\nNo financial statements were filed with this report.\n(2) December 4, 1995 - The following event was reported:\nItem 5. On November 29, 1995, Duquesne Light Company announced it will seek approval from the Pennsylvania Public Utility Commission for a five-year freeze on base rates, the sale of Duquesne's interest in the Fort Martin Power Station, the accelerated depreciation of Duquesne's investment in its nuclear power plants and the return to service of three units at the Brunot Island Power Station. In addition, Duquesne reiterated its proposal for the inclusion of all Pennsylvania electric utilities in a region wide independent transmission organization, and reaffirmed its commitment to the highest levels of guaranteed customer service.\nNo financial statements were filed with this report.\nEXHIBITS INDEX\nx An additional document, substantially identical in all material respects to this Exhibit, has been entered into relating to one additional limited partnership Owner Participant. Although the additional document may differ in some respects (such as name of the Owner Participant, dollar amounts and percentages), there are no material details in which the document differs from this Exhibit.\ny Additional documents, substantially identical in all material respects to this Exhibit, have been entered into relating to four additional corporate Owner Participants. Although the additional documents may differ in some respects (such as names of the Owner Participants, dollar amounts and percentages), there are no material details in which the documents differ from this Exhibit.\nz Additional documents, substantially identical in all material respects to this Exhibit, have been entered into relating to six additional Owner Participants. Although the additional documents may differ in some respects (such as names of the Owner Participants, dollar amounts and percentages), there are no material details in which the documents differ from this Exhibit.\n* This document is required to be filed as an exhibit to this form under Item 14(c).\nCopies of the exhibits listed above will be furnished, upon request, to holders or beneficial owners of any class of Duquesne's stock as of February 21, 1996, subject to payment in advance of the cost of reproducing the exhibits requested.\nSCHEDULE II\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS For the Years Ended December 31, 1995, 1994 and 1993 (Thousands of Dollars)\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nDUQUESNE LIGHT COMPANY (Registrant)\nDate: March 26, 1996 By: \/s\/ Wesley W. von Schack ------------------------- (Signature) Wesley W. von Schack 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.\nGlossary of Terms\nFollowing are explanations of certain financial and operating terms used in this Report and unique in the utility business.\nAllowance for Funds Used During Construction (AFC) - -------------------------------------------------------------------------------- AFC is an amount recorded on the books of a utility during the period of construction of utility assets. The amount represents the estimated cost of both debt and equity used to finance the construction.\nBaseload - -------------------------------------------------------------------------------- The amount of electric power delivered or needed at the lowest point of demand during the day.\nConstruction Work In Progress (CWIP) - -------------------------------------------------------------------------------- This amount represents assets in the process of construction but not yet placed in service. The amount is shown on the consolidated balance sheet as a component of property, plant and equipment.\nDeferred Energy Costs - -------------------------------------------------------------------------------- In conjunction with the Energy Cost Rate Adjustment Clause, Duquesne records deferred energy costs to offset differences between actual energy costs and the level of energy costs currently recovered from electric utility customers.\nDemand - -------------------------------------------------------------------------------- The amount of electricity delivered to consumers at any instant or averaged over a period of time.\nEnergy Cost Rate Adjustment Clause (ECR) - -------------------------------------------------------------------------------- Duquesne recovers through the ECR, to the extent that such amounts are not included in base rates, the cost of nuclear fuel, fossil fuel and purchased power costs and passes to its customers the profits from short-term power sales to other utilities.\nFederal Energy Regulatory Commission (FERC) - -------------------------------------------------------------------------------- The FERC is an independent five-member commission within the United States Department of Energy. Among its many responsibilities, the FERC sets rates and charges for the wholesale transportation and sale of natural gas and electricity, and licenses hydroelectric power projects.\nInterruptible Customer - -------------------------------------------------------------------------------- Interruptible customers receive a discount in exchange for allowing temporary interruptions in their service during Duquesne's peak load periods or during emergency conditions.\nKilowatt (KW) - -------------------------------------------------------------------------------- A kilowatt is a unit of power or capacity. A kilowatt hour (KWH) is a unit of energy or kilowatts times the length of time the kilowatts are used. For example, a 100-watt bulb has a demand of .1 KW and, if burned continuously, will consume 1 KWH in ten hours. One thousand KWs is a megawatt (MW). One thousand KWHs is a megawatt hour (MWH).\nNuclear Decommissioning Costs - -------------------------------------------------------------------------------- Decommissioning costs are expenses to be incurred in connection with the entombment, decontamination, dismantlement, removal and disposal of the structures, systems and components of a nuclear power plant that has permanently ceased the production of electric energy.\nPeak Demand - -------------------------------------------------------------------------------- Peak demand is the amount of electricity required during periods of highest usage. Peak periods fluctuate by season and generally occur in the morning hours in winter and in late afternoon during the summer.\nPennsylvania Public Utility Commission (PUC) - -------------------------------------------------------------------------------- The Pennsylvania governmental body that regulates all utilities (electric, gas, telephone, water, etc.), which is made up of five members nominated by the governor and confirmed by the senate.\nRegulatory Asset - -------------------------------------------------------------------------------- Costs that Duquesne would otherwise have charged to expense which are capitalized or deferred because these costs are currently being recovered or because it is probable that the PUC and the FERC will allow recovery of these costs through the ratemaking process.\nRetail or Wholesale Access - -------------------------------------------------------------------------------- The ability of customers to contract for electrical energy from competing generating suppliers.\nStranded Cost - -------------------------------------------------------------------------------- Stranded costs include any prudent utility investment, commitments or expenses not yet recovered, made during a period when there was an obligation or authorization to provide service at a regulated price, that are no longer necessary or economical due to a change in statute or regulatory policy which allows others to compete for the utility's customers. For example, Duquesne recently refinanced its long-term debt. Refinancing costs will be recovered and amortized for accounting purposes over the term of the debt, unless regulatory changes prevent future recovery, and result in \"stranded costs.\"\nWheeling - -------------------------------------------------------------------------------- An electric operation wherein transmission facilities of one system are used to transmit power of another system.\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nTo the Directors and Stockholder of Duquesne Light Company:\nWe have audited the accompanying consolidated balance sheet of Duquesne Light Company and its subsidiary (Duquesne) as of December 31, 1995 and 1994, and the related consolidated statements of income, retained earnings, and cash flows for each of the three years in the period ended December 31, 1995. Our audits also included the financial statement schedule listed in Item 14. These financial statements and financial statement schedule are the responsibility of Duquesne'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 Duquesne as of December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995 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 A to the consolidated financial statements, effective January 1, 1993, Duquesne changed its method of accounting for income taxes to conform with Statement of Financial Accounting Standards No. 109, and Duquesne changed its method of accounting for maintenance costs during scheduled major fossil station outages.\n\/s\/ Deloitte & Touche LLP\nDELOITTE & TOUCHE LLP Pittsburgh, Pennsylvania January 30, 1996\nSee notes to consolidated financial statements.\nSee notes to consolidated financial statements.\nSee notes to consolidated financial statements.\nSee notes to consolidated financial statements.\nA. Summary of Significant Accounting Policies\nNotes to Consolidated Financial Statements\nConsolidation - --------------------------------------------------------------------------------\nDuquesne Light Company (Duquesne) is a wholly owned subsidiary of DQE, an energy services holding company formed in 1989. Duquesne is engaged in the production, transmission, distribution and sale of electric energy. Duquesne was formed under the laws of Pennsylvania by the consolidation and merger in 1912 of three constituent companies. Duquesne has one wholly owned subsidiary, Monongahela Light and Power, also a Pennsylvania corporation, which makes long-term lease investments.\nAll material intercompany balances and transactions have been eliminated in the preparation of the consolidated financial statements of Duquesne.\nBasis of Accounting - --------------------------------------------------------------------------------\nDuquesne is subject to the accounting and reporting requirements of the Securities and Exchange Commission (SEC). In addition, Duquesne's operations are subject to the regulation of the Pennsylvania Public Utility Commission (PUC) and the Federal Energy Regulatory Commission (FERC). As a result, the consolidated financial statements contain regulatory assets and liabilities in accordance with Statement of Financial Accounting Standards No. 71, Accounting for the Effects of Certain Types of Regulation (SFAS No. 71) and reflect the effects of the ratemaking process. Such effects concern mainly the time at which various items enter into the determination of net income in accordance with the principle of matching costs and revenues. (See \"Rate Matters,\" Note F, on page 48.)\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. The reported amounts of revenues and expenses during the reporting period may also be affected by the estimates and assumptions management is required to make. Actual results could differ from those estimates.\nRevenues - --------------------------------------------------------------------------------\nMeters are read monthly and customers are billed on the same basis. Revenues are recorded in the accounting periods for which they are billed, with the exception of energy cost recovery revenues. Deferred revenues are associated with Duquesne's 1987 rate case. (See \"Energy Cost Rate Adjustment Clause (ECR)\" discussion on page 44 and \"1987 Rate Case\" discussion, Note F, on page 48).\nDuquesne's Electric Service Territory - --------------------------------------------------------------------------------\nDuquesne provides electric service to customers in Allegheny County, including the City of Pittsburgh, and Beaver County. This represents a service territory of approximately 800 square miles in southwestern Pennsylvania. The population of the area served by Duquesne, based on 1990 census data, is approximately 1,510,000, of whom 370,000 reside in the City of Pittsburgh. In addition to serving approximately 580,000 customers within this service area, Duquesne also sells electricity to other utilities beyond its service territory.\nNet Customer Revenues for the Year ended December 31 - --------------------------------------------------------------------------------\nEnergy Cost Rate Adjustment Clause (ECR) - --------------------------------------------------------------------------------\nThrough the ECR, Duquesne recovers (to the extent that such amounts are not included in base rates) nuclear fuel, fossil fuel and purchased power expenses and, also through the ECR, passes to its customers the profits from short-term power sales to other utilities (collectively, ECR energy costs). Nuclear fuel expense is recorded on the basis of the quantity of electric energy generated and includes such costs as the fee imposed by the United States Department of Energy (DOE) for future disposal and ultimate storage and disposition of spent nuclear fuel. Fossil fuel expense includes the costs of coal, natural gas and fuel oil used in the generation of electricity.\nOn Duquesne's statement of consolidated income, these energy cost recovery revenues are included as a component of operating revenues. For ECR purposes, Duquesne defers fuel and other energy expenses for recovery, or refunding, in subsequent years. The deferrals reflect the difference between the amount that Duquesne is currently collecting from customers and its actual ECR energy costs. The PUC annually reviews Duquesne's ECR energy costs for the fiscal year April through March, compares them to previously projected ECR energy costs and adjusts the ECR for over- or under-recoveries and for two PUC-established coal cost standards. (See \"Deferred Coal Costs\" and \"Warwick Mine Costs\" discussions, Note F, on pages 49 and 50, respectively.)\nOver- or under-recoveries from customers are recorded in the consolidated balance sheet as payable to, or receivable from, customers. At December 31, 1995, $5.8 million was payable to customers and shown as other current liabilities. At December 31, 1994, $5.9 million was receivable from customers and shown as other current assets.\nMaintenance - --------------------------------------------------------------------------------\nIncremental maintenance expense incurred for refueling outages at Duquesne's nuclear units is deferred for amortization over the period between refueling outages (generally 18 months). Duquesne changed, as of January 1, 1993, its method of accounting for maintenance costs during scheduled major fossil generating station outages. Prior to that time, maintenance costs incurred for scheduled major outages at fossil generating stations were charged to expense as these costs were incurred. Under the new accounting policy, Duquesne accrues, over the periods between outages, anticipated expenses for scheduled major fossil generating station outages. Maintenance costs incurred for non-major scheduled outages and for forced outages are charged to expense as such costs are incurred. This method was adopted to match more accurately the maintenance costs and the revenue produced during the periods between scheduled major fossil generating station outages.\nThe cumulative effect (approximately $5.4 million, net of income taxes of approximately $3.9 million) of the change on prior years was included in net income in 1993. The effect of the change in 1993 was to reduce income, before the cumulative effect of changes in accounting principles, by approximately $2.4 million, and to reduce net income, after the cumulative effect of changes in accounting principles, by approximately $7.8 million.\nDepreciation and Amortization - --------------------------------------------------------------------------------\nDepreciation of property, plant and equipment, including plant-related intangibles, is recorded on a straight-line basis over the estimated remaining useful lives of properties. Amortization of other intangibles is recorded on a straight-line basis over a five-year period. Depreciation and amortization of other properties are calculated on various bases.\nDuquesne records decommissioning costs under the category of depreciation and amortization expense and accrues a liability, equal to that amount, for nuclear decommissioning expense. Such nuclear decommissioning funds are deposited in external, segregated trust accounts. The funds are invested in a portfolio of municipal bonds, certificates of deposit and United States government securities. Trust fund earnings increase the fund balance and the recorded liability. The market value of the aggregate trust fund balances at December 31, 1995, totaled approximately $28.5 million. On Duquesne's consolidated balance sheet, the decommissioning trusts have been reflected in other investments, and the related liability has been recorded as other non-current liabilities. (See \"Nuclear Decommissioning\" discussion, Note N, on page 59.)\nDepreciation and amortization expense increased $25.9 million primarily due to the change in Duquesne's composite depreciation rate from 3.0 percent to 3.5 percent effective January 1, 1995.\nIncome Taxes - --------------------------------------------------------------------------------\nOn January 1, 1993, Duquesne adopted Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (SFAS No. 109). Implementation of SFAS No. 109 involved a change in accounting principle. The cumulative $8 million effect on prior years was reported in 1993 as an increase in net income.\nSFAS No. 109 requires that the liability method be used in computing deferred taxes on all differences between book and tax bases of assets. These book\/tax differences occur when events and transactions recognized for financial reporting purposes are not recognized in the same period for tax purposes. SFAS No. 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 1994, the statutory Pennsylvania income tax rate was reduced from 12.25 percent to 9.99 percent. This resulted in a net decrease of $80.5 million in deferred tax liabilities and a corresponding reduction in the regulatory receivable.\nDuquesne recognizes a regulatory asset for the deferred tax liabilities that are expected to be recovered from customers through rates. (See \"Rate Matters,\" Note F, and \"Income Taxes,\" Note K, on pages 48 and 54, respectively.)\nWith respect to the financial statement presentation of SFAS No. 109, Duquesne reflects the amortization of the regulatory tax receivable resulting from reversals of deferred taxes as depreciation and amortization expense. Reversals of accumulated deferred income taxes are included in income tax expense.\nWhen applied to reduce Duquesne's income tax liability, investment tax credits related to electric utility property generally were deferred. Such credits are subsequently reflected, over the lives of the related assets, as reductions to tax expense.\nProperty, Plant and Equipment - --------------------------------------------------------------------------------\nThe asset values of Duquesne's properties are stated at original construction cost, which includes related payroll taxes, pensions and other fringe benefits, as well as administrative and general costs. Also included in original construction cost is an allowance for funds used during construction (AFC), which represents the estimated cost of debt and equity funds used to finance construction. The amount of AFC that is capitalized will vary according to changes in the cost of capital and in the level of construction work in progress (CWIP). On a current basis, Duquesne does not realize cash from the AFC. Duquesne does realize cash, during the service life of the plant, through increased revenues reflecting a higher rate base (upon which a return is earned) and increased depreciation. The AFC rates applied to CWIP were 8.7 percent in 1995, 9.0 percent in 1994 and 9.6 percent in 1993.\nAdditions to, and replacements of, property units are charged to plant accounts. Maintenance, repairs and replacement of minor items of property are recorded as expenses when they are incurred. The costs of properties that are retired (plus removal costs and less any salvage value) are charged to accumulated depreciation and amortization.\nSubstantially all of Duquesne's properties are subject to a first mortgage lien.\nOther Current Assets and Long-Term Investments - --------------------------------------------------------------------------------\nDuquesne's other current assets and long-term investments include certain investments in marketable securities. In accordance with Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities (SFAS No. 115), these investments are classified as available- for-sale and are stated at market value.\nFinancial Accounting Pronouncement - --------------------------------------------------------------------------------\nThe Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of (SFAS No. 121) in March 1995. This statement is effective for years beginning after December 15, 1995. Duquesne anticipates adopting this standard on January 1, 1996, and does not expect that it will have a material impact on its financial position or results of operations, based on the current regulatory structure in which it operates. As competitive factors influence pricing in the utility industry, this opinion may change in the future. The general requirements of SFAS No. 121 apply to non- current assets and require impairment to be considered whenever evidence suggests that it is no longer probable that future cash flows in an amount at least equal to the asset will result.\nTemporary Cash Investments - --------------------------------------------------------------------------------\nTemporary cash investments are short-term, highly liquid investments with original maturities of three or fewer months. They are stated at market, which approximates cost. Duquesne considers temporary cash investments to be cash equivalents.\nB. Property, Plant and Equipment\nReclassifications - --------------------------------------------------------------------------------\nThe 1994 and 1993 consolidated financial statements have been reclassified to conform with accounting presentations adopted during 1995.\nIn addition to its wholly owned generating units, Duquesne, together with other electric utilities, has an ownership or leasehold interest in certain jointly owned units. Duquesne is required to pay its share of the construction and operating costs of the units. Duquesne's share of the operating expenses of the units is included in the statement of consolidated income.\nGenerating Units at December 31, 1995 - --------------------------------------------------------------------------------\n(a) The unit is equipped with flue gas desulfurization equipment. (b) See \"Sale of Ft. Martin\" discussion below. (c) The Nuclear Regulatory Commission (NRC) has granted a license to operate through January 2016. (d) On October 2, 1987, Duquesne sold its 13.74 percent interest in Beaver Valley Unit 2 (BV Unit 2) and leased it back; the sale was exclusive of transmission and common facilities. Amounts shown represent facilities not sold and subsequent leasehold improvements. (e) The NRC has granted a license to operate through May 2027. (f) The NRC has granted a license to operate through March 2026. (g) Combustion turbine capacity held for future use representing 135 megawatts summer and 168 megawatts winter may be returned to service pending outcome of the sale of Ft. Martin. (See \"Sale of Ft. Martin\" discussion below.)\nSale of Ft. Martin - --------------------------------------------------------------------------------\nIn December 1995, Duquesne filed a Petition for Declaratory Order with the PUC requesting approval for the sale of its ownership interest in the Ft. Martin Power Station and for a six-point plan to be financed in part by the proceeds of the Ft. Martin transaction. Under the plan, Duquesne offers to freeze its base rates for a period of five years. In addition, Duquesne proposes to record a one-time reduction of approximately $130 million in the value of Duquesne's nuclear plant investment. Duquesne also proposes to use the proceeds from the sale to finance reliability enhancements to the simple cycle units located at Brunot Island (BI), to retire debt and to reduce equity. The plan also proposes an annual increase of $25 million for three years in depreciation and amortization expense to Duquesne's nuclear investment, as well as additional annual contributions to its nuclear plant decommissioning funds of $5 million for five years, without any increase in existing electric rates. Lastly, Duquesne proposes a five-year annual $5 million credit to the ECR to compensate Duquesne's customers for the lost profits from any reduced short-term power sales foregone by the sale of its ownership interest in the Ft. Martin Power Station. (See \"Energy Cost Rate Adjustment Clause (ECR)\" discussion, Note A, on page 44.) The PUC is currently reviewing Duquesne's petition.\nAt December 31, 1995 and 1994, the fair market value of Duquesne's investment in DQE common stock was $66.8 million and $43.1 million, respectively. At December 31, 1995 and 1994, the cost of Duquesne's investment in DQE common stock was $43.9 million and $45.9 million, respectively.\nC. Long-Term Investments\nDuquesne makes equity investments in affordable housing. At December 31, 1995, Duquesne had investments in seven affordable housing funds.\nDeferred income primarily relates to Duquesne's leasehold investments. Deferred amounts will be recognized as income over the lives of the underlying leasehold investments over periods generally not exceeding five years.\nDuquesne's other investments are primarily in assets of nuclear decommissioning trusts and marketable securities. In accordance with SFAS No. 115, these investments are classified as available-for-sale and are stated at market value. The amount of unrealized holding gains related to marketable securities at December 31, 1995, is $22.8 million ($13.4 million net of tax). There were no material unrealized gains or losses on investments at December 31, 1994.\nD. Receivables\nDuquesne and an unaffiliated corporation have an agreement that entitles Duquesne to sell, and the corporation to purchase, on an ongoing basis, up to $50 million of accounts receivable. At December 31, 1995, Duquesne had sold $7 million of receivables to the unaffiliated corporation. Duquesne had no receivables sold at December 31, 1994. The accounts receivable sales agreement, which expires in June 1996, is one of many sources of funds available to Duquesne. Duquesne may attempt to extend the agreement, or to replace the facility with a similar one or to eliminate it upon expiration.\nE. Changes in Working Capital Other than Cash\nChanges in Working Capital Other than Cash - --------------------------------------------------------------------------------\nF. Rate Matters\n1987 Rate Case - --------------------------------------------------------------------------------\nIn March 1988, the PUC adopted a rate order that increased Duquesne's revenues by $232 million annually. This rate increase was phased-in from April 1988 through April 1994. Deficiencies in current revenues which resulted from the phase-in plan were included in the consolidated statement of income as phase-in deferrals. Phase-in deferrals were recorded on the consolidated balance sheet as a regulatory asset. As customers were billed for deficiencies related to prior periods, this regulatory asset was reduced.\nAt this time, Duquesne has no pending base rate case and has no immediate plans to file a base rate case. In Duquesne's petition currently before the PUC for the sale of its ownership interest in the Ft. Martin Power Station, Duquesne proposes to freeze its base rates for a five-year period. (See \"Sale of Ft. Martin\" discussion, Note B, on page 47.)\nRegulatory Assets - --------------------------------------------------------------------------------\nAs a result of the application of SFAS No. 71, Duquesne records regulatory assets on its consolidated balance sheet. The regulatory assets represent probable future revenue to Duquesne because provisions for these costs are currently included, or are expected to be included, in charges to customers through the ratemaking process.\nDuquesne's operations currently satisfy the SFAS No. 71 criteria. However, a company's electric utility operations or a portion of such operations could cease to meet these criteria for various reasons, including a change in the PUC or the FERC regulations. Should Duquesne's operations cease to meet the SFAS No. 71 criteria, Duquesne would be required to write off any regulatory assets or liabilities for those operations that no longer meet these requirements. Management will continue to evaluate significant changes in the regulatory and competitive environment in order to assess Duquesne's overall consistency with the criteria of SFAS No. 71.\nRegulatory Assets at December 31 - --------------------------------------------------------------------------------\n(a) The premiums paid to reacquire debt prior to scheduled maturity dates are deferred for amortization over the life of the debt issued to finance the reacquisitions. (b) The premium paid to refinance the BV Unit 2 lease was deferred for amortization over the life of the lease. (c) Includes amounts for recovery of accrued compensated absences and accrued claims for workers' compensation.\nDeferred Rate Synchronization Costs - --------------------------------------------------------------------------------\nIn 1987, the PUC approved Duquesne's petition to defer initial operating and other costs of Perry Unit 1 and BV Unit 2. Duquesne deferred the costs incurred from November 17, 1987, when the units went into commercial operation, until March 25, 1988, when a rate order was issued. In its order, the PUC postponed ruling on whether these costs would be recoverable from Duquesne's customers. Duquesne is not earning a return on the deferred costs. Duquesne believes that these deferred costs are recoverable. In 1990 and 1995, the PUC permitted other Pennsylvania electric utilities rate recovery of such costs.\nExtraordinary Property Loss - --------------------------------------------------------------------------------\nDuquesne abandoned its interest in the partially constructed Perry Unit 2 in 1986 and subsequently disposed of its interest in 1992. In the 1987 rate case, the PUC approved recovery, over a 10-year period, of Duquesne's original $155 million investment in Perry Unit 2. Duquesne is not earning a return on the as- yet-unrecovered portion of its investment in the unit.\nDeferred Coal Costs - --------------------------------------------------------------------------------\nThe PUC has established two market price coal cost standards. One applies only to coal delivered at the Bruce Mansfield Power Station (Bruce Mansfield). The other, the system-wide coal cost standard, applies to coal delivered to the remainder of Duquesne's system. Both standards are updated monthly to reflect prevailing market prices for similar coal. The\nPUC has directed Duquesne to defer recovery of the delivered cost of coal to the extent that such cost exceeds generally prevailing market prices for similar coal, as determined by the PUC. The PUC allows deferred amounts to be recovered from customers when the delivered costs of coal fall below such PUC-determined prevailing market prices.\nIn 1990, the PUC approved a joint petition for settlement that clarified certain aspects of the system-wide coal cost standard and gave Duquesne options to extend the standard through March 2000. In December 1991, Duquesne exercised the first of two options that extended the standard through March 1996. In December 1995, Duquesne exercised the second option to extend the standard through March 2000. The unrecovered cost of coal used at Bruce Mansfield amounted to $8.4 million and $7.3 million and the unrecovered cost of coal used throughout the system amounted to $4.4 million and $3.4 million at December 31, 1995 and 1994, respectively. Duquesne believes that all deferred coal costs will be recovered.\nWarwick Mine Costs - --------------------------------------------------------------------------------\nThe 1990 joint petition for settlement (See preceding discussion on \"Deferred Coal Costs.\") also recognized costs at Duquesne's Warwick Mine, which had been on standby since 1988, and allowed for recovery of such costs, including the costs of ultimately closing the mine. In 1990, Duquesne entered into an agreement under which an unaffiliated company will operate the mine until March 2000 and sell the coal produced. Production began in late 1990. The mine reached a full production rate in early 1991. The Warwick Mine coal reserves include both high and low sulfur coal; Duquesne's contract is for medium to high sulfur (1.3 percent to 2.5 percent) coal. More than 60 percent of the coal mined at Warwick Mine currently is used by Duquesne. Duquesne receives a royalty on sales of Warwick coal in the open market. These royalties are credited to Duquesne's ECR. In the past year, the Warwick Mine supplied slightly less than one-fifth of the coal used in the production of electricity at Duquesne's wholly owned and jointly owned plants.\nCosts at the Warwick Mine and Duquesne's investment in the mine are expected to be recovered through the cost of coal in the ECR. Recovery is subject to the system-wide coal cost standard. Duquesne also has an opportunity to earn a return on its investment in the mine through the cost of coal during the period of the system-wide coal cost standard including extensions. At December 31, 1995, Duquesne's net investment in the mine was $14.9 million. The current estimated liability, including final site reclamation, mine water treatment and certain labor liabilities, for mine closing is $34.1 million and Duquesne has recorded a liability on the consolidated balance sheet of approximately $15.9 million toward these costs.\nProperty Held for Future Use - --------------------------------------------------------------------------------\nIn 1986, the PUC approved Duquesne's request to remove Phillips Power Station (Phillips) and a portion of BI from service and from rate base. Duquesne expects to recover its net investment in these plants through future electricity sales. Duquesne believes its investment in these plants will be necessary in order to meet future business needs outlined in Duquesne's plans for optimizing generation resources. If business opportunities do not develop as expected, Duquesne will consider the sale of these assets. In the event that market demand, transmission access or rate recovery do not support the utilization or sale of the plants, Duquesne may have to write off part or all of their costs. A portion of the BI combustion turbine capacity currently held for future use may be returned to service pending the outcome of the sale of Duquesne's ownership interest in Ft. Martin. (See \"Sale of Ft. Martin\" discussion, Note B, on page 47.) At December 31, 1995, Duquesne's net investment in Phillips and BI held for future use was $77.4 million and $44.9 million, respectively.\nG. Common Stock and Capital Surplus\nCommon Stock and Capital Surplus - --------------------------------------------------------------------------------\nIn July 1989, Duquesne became a wholly owned subsidiary of DQE, the holding company formed as part of a shareholder-approved restructuring. As a result of the restructuring, DQE common stock replaced all outstanding shares of Duquesne common stock, except for ten shares which DQE holds.\nDQE or its predecessor, Duquesne, has continuously paid dividends on common stock since 1953. Dividends may be paid on DQE common stock to the extent permitted by law and as declared by its board of directors. However, in Duquesne's Restated Articles of incorporation, provisions relating to preferred and preference stock may restrict the payment of Duquesne's common dividends. No dividends or distributions may be made on Duquesne's common stock if Duquesne has not paid dividends or sinking fund obligations on its preferred or preference stock. Further, the aggregate amount of Duquesne's common stock dividend payments or distributions may not exceed certain percentages of net income if the ratio of common stockholder's equity to total capitalization is less than specified percentages. As all of Duquesne's common stock is owned by DQE, to the extent that Duquesne cannot pay common dividends, DQE may not be able to pay dividends to its common shareholders. No part of the retained earnings of Duquesne was restricted at December 31, 1995.\nH. Preferred and Preference Stock\nHolders of Duquesne's preferred stock are entitled to cumulative quarterly dividends. If four quarterly dividends on any series of preferred stock are in arrears, holders of the preferred stock are entitled to elect a majority of Duquesne's board of directors until all dividends have been paid. At December 31, 1995, Duquesne had made all preferred stock dividend payments.\nHolders of Duquesne's preference stock are entitled to receive cumulative quarterly dividends if dividends on all series of preferred stock are paid. If six quarterly dividends on any series of preference stock are in arrears, holders of the preference stock are entitled to elect two of Duquesne's directors until all dividends have been paid. At December 31, 1995, Duquesne had made all dividend payments. Preferred and preference dividends were $5.3 million, $6.0 million and $9.2 million in 1995, 1994 and 1993, respectively.\nIn December 1991, Duquesne established an Employee Stock Ownership Plan (ESOP) to provide matching contributions for a 401(k) Retirement Savings Plan for Management Employees. (See \"Employee Benefits,\" Note M, on page 56.) Duquesne issued and sold 845,070 shares of preference stock, plan series A to the trustee of the ESOP. As consideration for the stock, Duquesne received a note valued at $30 million from the trustee. The preference stock has an annual dividend rate of $2.80 per share, and each share of the preference stock is exchangeable for one and one half shares of DQE common stock. At December 31, 1995, $22.3 million of preference stock issued in connection with the establishment of the ESOP had been offset, for financial statement purposes, by the recognition of a deferred ESOP benefit. Dividends on the preference stock and cash contributions from Duquesne are used to repay the ESOP note. Duquesne made cash contributions of approximately $2.1 million for 1995, $2.3 million for 1994 and $2.1 million for 1993. These cash contributions were the difference between the ESOP debt service and the amount of dividends on ESOP shares (approximately $2.3 million in 1995, $2.4 million in 1994 and $2.3 million in 1993). As shares of preference stock are allocated to the accounts of participants in\nthe ESOP, Duquesne recognizes compensation expense, and the amount of the deferred compensation benefit is amortized. Duquesne recognized compensation expense related to the 401(k) plans of $2.3 million in 1995, $1.8 million in 1994 and $1.7 million in 1993.\nOutstanding preferred and preference stock is generally callable, on notice of not less than thirty days, at stated prices plus accrued dividends. On September 1, 1995, Duquesne called for redemption of all of its outstanding shares of $7.20 preferred stock. On January 14, 1994, Duquesne called for redemption of all of its outstanding shares of $2.10 and $7.50 preference stock. None of the remaining Duquesne preferred or preference stock issues has mandatory purchase requirements.\nPreferred and Preference Stock at December 31 - --------------------------------------------------------------------------------\n(a) Preferred stock: 4,000,000 authorized shares; $50 par value; cumulative (b) $50 per share involuntary liquidation value (c) Non-redeemable (d) $100 per share involuntary liquidation value (e) 500 authorized shares; 10 issued $300,000 par value; involuntary liquidation value $300,000 per share; redeemable beginning August 2000 (f) Preference stock: 8,000,000 authorized shares; $1 par value; cumulative (g) $25 per share involuntary liquidation value (h) Redeemable (i) $35.50 per share involuntary liquidation value\nI. Long-Term Debt\nDuquesne's 1947 first mortgage bond indenture was retired in the third quarter of 1995 following the maturity of the last bond series issued under the indenture. All of Duquesne's First Collateral Trust Bonds have been issued under a new mortgage indenture that was established in April 1992 (the 1992 Indenture). All First Collateral Trust Bonds became first mortgage bonds when the 1947 mortgage indenture was retired. The 1992 Indenture includes more flexible provisions and eliminates conventions such as mandatory sinking funds and formula-derived maintenance and replacement clauses.\nThe pollution control notes arise from the sale of bonds by public authorities for the purposes of financing construction of pollution control facilities at Duquesne's plants or refunding previously issued bonds. Duquesne is obligated to pay the principal and interest on these bonds. For certain of the pollution control notes, there is an annual commitment fee\nfor an irrevocable letter of credit. Under certain circumstances, the letter of credit is available for the payment of interest on, or redemption of, all or a portion of the notes. In late 1994, pollution control notes totaling $114.1 million with an average interest rate of 10.34 percent were refinanced at lower adjustable interest rates.\nLong-Term Debt at December 31 - --------------------------------------------------------------------------------\n(a) Excludes $50.0 million in 1995 related to a current maturity on May 15, 1996. (b) Excludes $9.6 million in 1994 related to sinking fund requirements on the underlying first mortgage bonds and $49.0 million related to the maturity on June 1, 1995, of the last first mortgage bonds issued under the 1947 indenture. (c) Excludes $0.9 million in 1994 related to sinking fund requirements on the underlying first mortgage bonds. (d) The pollution control notes have adjustable interest rates. The interest rates at year-end averaged 3.9 percent in 1995 and 4.3 percent in 1994.\nAt December 31, 1995, sinking fund requirements (related solely to the sinking fund debentures) and maturities of long-term debt outstanding for the next five years were: $50.4 million in 1996; $50.7 million in 1997, $75.7 million in 1998, $75.8 million in 1999 and $100.8 million in 2000.\nTotal interest costs incurred were $103.3 million in 1995, $107.7 million in 1994 and $117.0 million in 1993. Interest costs attributable to long-term debt and other interest were $98.0 million, $102.1 million and $110.9 million in 1995, 1994 and 1993, respectively. Interest costs incurred also include $5.3 million, $5.6 million and $6.1 million attributable to capital leases in 1995, 1994 and 1993, respectively. Of these amounts, $1.8 million in 1995, $2.0 million in 1994 and $2.0 million in 1993 were capitalized as AFC. Debt discount or premium and related issuance expenses are amortized over the lives of the applicable issues.\nDuring 1994, Duquesne's BV Unit 2 lease arrangement was amended to reflect an increase in federal income tax rates. At the same time, the associated letter of credit securing the lessor's equity interest in the unit was increased from $188 million to $194 million and the term of the letter of credit was extended to 1999. If certain specified events occur, the letter of credit could be drawn down by the owners, the leases could terminate and collateralized lease bonds ($409 million at December 31, 1995) would become direct obligations of Duquesne.\nAt December 31, 1995 and 1994, Duquesne was in compliance with all of its debt covenants. At December 31, 1995, the fair value of Duquesne's long-term debt, including current maturities and sinking fund requirements, estimated on the basis of quoted market prices for the same or similar issues or current rates offered to Duquesne for debt of the same remaining maturities, was $1,401.4 million. The principal amount included in Duquesne's consolidated balance sheet is $1,376.7 million.\nJ. Short-Term Borrowing and Revolving Credit Arrangements\nAt December 31, 1995, Duquesne had an extendible revolving credit agreement with a group of banks totaling $150 million. This facility expires in October 1996. Interest rates on this credit agreement vary. Commitment fees are based on the unborrowed amount of the commitments. The credit facility contains a two- year repayment period for any amount outstanding at the expiration of the revolving credit period. At December 31, 1995 and 1994, there were no short-term borrowings outstanding.\nK. Income Taxes\nDuquesne's federal income tax returns have been audited by the Internal Revenue Service (IRS) for the tax years through 1989. The tax years 1990 through 1995 remain subject to IRS review. Duquesne does not believe that final settlement of the federal income tax returns for these years will have a materially adverse effect on its financial position or results of operations. The effects of the 1993 adoption of SFAS No. 109 are discussed in \"Income Taxes,\" Note A, on page 45. Implementation of the standard involved a change in accounting principle. The cumulative effect of $8 million on prior years was reported in 1993 as an increase in net income. The SFAS No. 109 impact on 1993 income before cumulative effect of changes in accounting principles is immaterial.\nDeferred Tax Liabilities - --------------------------------------------------------------------------------\nIncome Taxes - --------------------------------------------------------------------------------\nTotal income taxes differ from the amount computed by applying the statutory federal income tax rate to income before income taxes and before the cumulative effect of changes in accounting principles.\nIncome Tax Expense Reconciliation - --------------------------------------------------------------------------------\nL. Leases\nDuquesne leases nuclear fuel, a portion of a nuclear generating plant, certain office buildings, computer equipment and other property and equipment.\n(a) Includes $2,910 in 1995 and $3,201 in 1994 of capital leases with associated obligations retired.\nIn 1987, Duquesne sold and leased back its 13.74 percent interest in BV Unit 2; the sale was exclusive of transmission and common facilities. The total sales price of $537.9 million was the appraised value of Duquesne's interest in the property. Duquesne leased back its interest in the unit for a term of 29.5 years. The lease provides for semiannual payments and is accounted for as an operating lease. Duquesne is responsible under the terms of the lease for all costs of its interest in the unit. In December 1992, Duquesne participated in the refinancing of collateralized lease bonds to take advantage of lower interest rates and reduce the annual lease payments. The bonds were originally issued in 1987 for the purpose of partially financing the lease of BV Unit 2. In accordance with the BV Unit 2 lease agreement, Duquesne paid the premiums of approximately $36.4 million as a supplemental rent payment to the lessors. This amount was deferred and is being amortized over the remaining lease term. At December 31, 1995, the deferred balance was approximately $31.6 million.\nLeased nuclear fuel is amortized as the fuel is burned. The amortization of all other leased property is based on rental payments made. Payments for capital and operating leases are charged to operating expenses on the statement of consolidated income.\nFuture minimum lease payments for capital leases are related principally to the estimated use of nuclear fuel financed through leasing arrangements and building leases. Minimum payments for operating leases are related principally to BV Unit 2 and certain of the corporate offices. Future payments due to Duquesne, as of December 31, 1995, under subleases of certain corporate office space are approximately $4.4 million in 1996, $4.5 million in 1997 and $23.1 million thereafter.\n(a) Includes current obligations of $21.1 million at December 31, 1995.\nM. Employee Benefits\nRetirement Plans - --------------------------------------------------------------------------------\nDuquesne maintains retirement plans to provide pensions for all full-time employees. Upon retirement, an employee receives a monthly pension based on his or her length of service and compensation. The cost of funding the pension plan is determined by the unit credit actuarial cost method. Duquesne's policy is to record this cost as an expense and to fund the pension plans by an amount that is at least equal to the minimum funding requirements of the Employee Retirement Income Security Act of 1974 (ERISA) but not to exceed the maximum tax deductible amount for the year. Pension costs charged to expense or construction were $6.1 million for 1995, $8.9 million for 1994 and $9.8 million for 1993.\nFunded Status of the Retirement Plans and Amounts Recognized on the Consolidated Balance Sheet at December 31\nPension assets consist primarily of common stocks, United States obligations and corporate debt securities.\nComponents of Net Pension Cost\nRetirement Savings Plan and Other Benefit Options - --------------------------------------------------------------------------------\nDuquesne sponsors separate 401(k) retirement plans for its management and bargaining unit employees.\nThe 401(k) Retirement Savings Plan for Management Employees provides that Duquesne will match employee contributions to a 401(k) account up to a maximum of six percent of an employee's eligible salary. Duquesne's match consists of a $.25 base match per eligible contribution dollar and an additional $.25 incentive match per eligible contribution dollar, if Board-approved targets are achieved. The 1995 incentive target for management was accomplished. Duquesne is funding its matching contributions to the 401(k) Retirement Savings Plan for Management Employees with payments to an ESOP established in December 1991. (See \"Preferred and Preference Stock,\" Note H, on page 51.)\nThe 401(k) Retirement Savings Plan for IBEW Represented Employees provides that beginning in 1995, Duquesne will match employee contributions to a 401(k) account up to a maximum of four percent of an employee's eligible salary. Duquesne's match consists of a $.25 base match per eli-\ngible contribution dollar and an additional $.25 incentive match per eligible contribution dollar, if certain non-occupational illness and injury targets are met. In 1995, these incentive targets were not met by Duquesne's union- represented employees.\nDQE's shareholders have approved a long-term incentive plan through which Duquesne may grant management employees options to purchase, during the years 1987 through 2003, up to a total of 6.9 million shares of DQE's common stock at prices equal to the fair market value of such stock on the dates the options were granted. At December 31, 1995, approximately 2.6 million of these shares were available for future grants.\nOn April 19, 1995, DQE's board of directors declared a three-for-two stock split for shareholders of record on May 1, 1995. One additional share of common stock was issued for every two shares outstanding as of the record date.\nThe following information is restated to reflect the 1995 stock split. As of December 31, 1995, 1994 and 1993, respectively, active grants totaled 2,159,000; 2,118,000; and 1,763,000 shares. Exercise prices of these options ranged from $8.2084 to $27.625 at December 31, 1995, and from $8.2084 to $23.0833 at December 31, 1994 and December 31, 1993. Expiration dates of these grants ranged from 1997 to 2005 at December 31, 1995; from 1997 to 2004 at December 31, 1994; and from 1997 to 2003 at December 31, 1993. As of December 31, 1995, 1994 and 1993, respectively, stock appreciation rights (SARs) had been granted in connection with 1,202,000; 1,190,000 and 1,193,000 of the options outstanding. During 1995, 367,000 SARs were exercised; 133,000 options were exercised at prices ranging from $8.2084 to $21.6667 and 28,000 options were cancelled. During 1994, 1,254,000 SARs were exercised; 339,000 options were exercised at prices ranging from $8.2084 to $18.9167; and 80,000 options were cancelled. During 1993, 1,122,000 SARs were exercised; 227,000 options were exercised at prices ranging from $8.2084 to $18.9167; and 78,000 options were cancelled. Of the active grants at December 31, 1995, 1994 and 1993, respectively, 929,000; 918,000; and 867,000 were not exercisable.\nOther Postretirement Benefits - --------------------------------------------------------------------------------\nIn addition to pension benefits, Duquesne provides certain health care benefits and life insurance for some retired employees. Substantially all of Duquesne's full-time employees may, upon attaining the age of 55 and meeting certain service requirements, become eligible for the same benefits available to retired employees. Participating retirees make contributions, which are adjusted annually, to the health care plan. The life insurance plan is non-contributory. Company-provided health care benefits terminate when covered individuals become eligible for Medicare benefits or reach age 65, whichever comes first. Duquesne funds actual expenditures for obligations under the plans on a \"pay-as-you-go\" basis. Duquesne has the right to modify or terminate the plans.\nAs of January 1, 1993, Duquesne adopted Statement of Financial Accounting Standards No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions, which requires the actuarially determined costs of the aforementioned postretirement benefits to be accrued over the period from the date of hire until the date the employee becomes fully eligible for benefits. Duquesne has adopted this standard prospectively and has elected to amortize the transition liability over 20 years.\nComponents of Postretirement Cost\nFunded Status of Postretirement Plan and Amounts Recognized on the Consolidated Balance Sheet at December 31\nThe accumulated postretirement benefit obligation comprises the present value of the estimated future benefits payable to current retirees and a pro rata portion of estimated benefits payable to active employees after retirement.\nN. Commitments and Contingencies\nConstruction - --------------------------------------------------------------------------------\nDuquesne estimates that it will spend, excluding AFC and nuclear fuel, approximately $90 million, $90 million and $100 million on construction during 1996, 1997 and 1998, respectively. Approximately $5 million of capital expenditures for the reliability enhancements to the simple cycle units located at BI contemplated in Duquesne's petition before the PUC are excluded from these estimates. (See \"Sale of Ft. Martin\" discussion, Note B, on page 47.)\nNuclear-Related Matters - --------------------------------------------------------------------------------\nDuquesne operates two nuclear units and has an ownership interest in a third. The operation of a nuclear facility involves special risks, potential liabilities and specific regulatory and safety requirements. Specific information about risk management and potential liabilities is discussed below.\nNuclear Decommissioning. The PUC ruled that recovery of the decommissioning costs for Beaver Valley Unit 1 (BV Unit 1) could begin in 1977, and that recovery for BV Unit 2 and Perry Unit 1 could begin in 1988. Duquesne expects to decommission BV Unit 1, BV Unit 2 and Perry Unit 1 no earlier than the expiration of each plant's operating license, 2016, 2027 and 2026, respectively. BV Unit 1 will be placed in safe storage until the expiration of the BV Unit 2 operating license, at which time the units may be decommissioned together.\nBased on site-specific studies finalized in 1992 for BV Unit 2, and in 1994 for BV Unit 1 and Perry Unit 1, Duquesne's share of the total estimated decommissioning costs, including removal and decontamination costs, currently being used to determine Duquesne's cost of service, are $122 million for BV Unit 1, $35 million for BV Unit 2, and $67 million for Perry Unit 1.\nIn conjunction with an August 18, 1994, PUC Accounting Order, Duquesne has increased the annual contribution to its decommissioning trusts by approximately $2 million to bring the total annual funding to approximately $4 million per year. In collaboration with Duquesne and several other Pennsylvania utilities, the PUC Office of Special Assistants is evaluating various decommissioning issues, including funding methods. Duquesne expects that any action relating to any forthcoming PUC report will result in further increases in annual contributions to its decommissioning trusts. Consistent with these anticipated future PUC actions, Duquesne's petition before the PUC for the sale of its ownership interest in the Ft. Martin Power Station provides for additional annual contributions to its nuclear decommissioning funds of $5 million for five years without any increase in existing electric utility rates. (See \"Sale of Ft. Martin\" discussion, Note B, on page 47.)\nDuquesne records decommissioning costs under the category of depreciation and amortization expense and accrues a liability, equal to that amount for nuclear decommissioning expense. Such nuclear decommissioning funds are deposited in external, segregated trust accounts. The funds are invested in a portfolio of municipal bonds, certificates of deposit and United States government securities having a weighted average duration of four to seven years. Trust fund earnings increase the fund balance and the recorded liability. The market value of the aggregate trust fund balances at December 31, 1995, totaled approximately $28.5 million. On Duquesne's consolidated balance sheet, the decommissioning trusts have been reflected in other long-term investments, and the related liability has been recorded as other non-current liabilities.\nNuclear Insurance. All of the companies with an interest in BV Unit 1, BV Unit 2 and Perry Unit 1 maintain nuclear property insurance, which provides coverage for property damage, decommissioning and decontamination liabilities. Duquesne's share of this program provides for $1.2 billion of insurance coverage for its net investment of $407.8 million in the Beaver Valley Power Station (BVPS) and $565.5 million in Perry Unit 1, plus its interest in BV Unit 2 with lease commitments of $405.2 million, at December 31, 1995. The lease commitments of $405.2 million represent the net present value of future lease payments discounted at 10.94 percent, the return currently authorized Duquesne by the PUC. Duquesne would be responsible for its share of any damages in excess of insurance coverage. In addition, if the property damage reserves of Nuclear Electric Insurance Limited (NEIL), an industry mutual insurance company, are inadequate to cover claims arising from an incident at any United States nuclear site covered by that insurer, Duquesne could be assessed retrospective premiums totaling a maximum of $10.9 million.\nThe Price-Anderson Amendments to the Atomic Energy Act of 1954 limit public liability from a single incident at a nuclear plant to $8.9 billion. Duquesne has purchased $200 million of insurance, the maximum amount available, which provides the first level of financial protection.\nAdditional protection of $8.3 billion would be provided by an assessment of up to $75.5 million per incident on each nuclear unit in the United States. Duquesne's maximum total assessment, $56.6 million, which is based on its ownership or leasehold interests in three nuclear generating units, would be limited to a maximum of $7.5 million per incident per year. A further surcharge of 5 percent could be levied if the total amount of public claims exceeded the funds provided under the assessment program. Additionally, a state premium tax may be charged on the assessment and surcharge. Finally, the United States Congress could impose other revenue-raising measures on the nuclear industry if funds prove insufficient to pay claims.\nDuquesne carries extra expense insurance which would pay the incremental cost of any replacement power purchased (in addition to costs that would have been incurred had the units been operating) and other incidental expense after the occurrence of certain types of accidents at its nuclear units in a limited amount for a limited period of time. The coverage provides for 100 percent of the estimated extra expense per week during the 52-week period starting 21 weeks after an accident and 80 percent of such estimate per week for the following 104 weeks with no coverage thereafter. The amount and duration of actual extra expense could substantially exceed insurance coverage. NEIL also provides this insurance. If NEIL's reserves are inadequate to cover claims at any United States nuclear site covered by that insurer, Duquesne could be assessed retrospective premiums totaling a maximum of $3.5 million.\nBeaver Valley Power Station Steam Generators. BVPS' units are equipped with steam generators designed and built by Westinghouse Electric Corporation (Westinghouse). Similar to other Westinghouse nuclear plants, stress corrosion cracking (SCC) has occurred in the steam generator tubes of BV Unit 1. BV Unit 2, which was placed in service eleven years after BV Unit 1, has not yet exhibited the degree of steam generator tube SCC experienced at BV Unit 1. It is, however, too early in the life of BV Unit 2 to determine the extent to which steam generator tube SCC may become a problem.\nDuquesne has undertaken certain measures, such as increased inspections and tube plugging, to minimize the operational impact and to reduce susceptibility to steam generator tube SCC. Although Duquesne has taken these steps to allay the effects of steam generator tube SCC, the inherent potential for future SCC in steam generator tubes of the Westinghouse design still exists. Material acceleration in SCC could lead to loss of plant efficiency, significant repairs or possible replacement of BV Unit 1's steam generators. Total replacement cost of BV Unit 1 steam generators is currently estimated at approximately $125 million. Duquesne would be responsible for $59 million of this total, which includes the cost of equipment removal and replacement, but excludes replacement power costs. The earliest that BV Unit 1's steam generators could be replaced is 1999.\nDuquesne continues to explore all viable means of mitigating steam generator tube SCC, including new repair technologies. Both units will undergo 100 percent tube inspection during scheduled refueling outages in 1996. Duquesne will continue to monitor and evaluate the condition of the BVPS steam generators.\nSpent Nuclear Fuel Disposal. The Nuclear Waste Policy Act of 1982 established a policy for handling and disposing of spent nuclear fuel and a policy requiring the established final repository to accept spent fuel. Electric utility companies have entered into contracts with the DOE for the permanent disposal of spent nuclear fuel and high-level radioactive waste in compliance with this legislation. The DOE has indicated that its repository under these contracts will not be available for acceptance of spent fuel before 2010 at the earliest. Existing on-site spent fuel storage capacities at BV Unit 1, BV Unit 2 and Perry Unit 1 are expected to be sufficient until 2016, 2010 and 2011, respectively.\nUranium Enrichment Decontamination and Decommissioning Fund. Nuclear reactor licensees in the United States are assessed annually for the decontamination and decommissioning of DOE uranium enrichment facilities. Assessments are based on the amount of uranium a utility had processed for enrichment prior to enactment of the National Energy Policy Act of 1992 (NEPA) and are to be paid by such utilities over a 15-year period. At December 31, 1995, Duquesne's liability for contributions is approximately $9.9 million (subject to an inflation adjustment). Contributions, when made, are recovered from customers through the ECR.\nGuarantees - --------------------------------------------------------------------------------\nDuquesne and the owners of Bruce Mansfield have guaranteed certain debt and lease obligations related to a coal supply contract for the Bruce Mansfield plant. At December 31, 1995, Duquesne's share of these guarantees was $25.4 million. The prices paid for the coal by the companies under this contract are expected to be sufficient to meet debt and lease obligations to be satisfied in the year 2000. (See \"Deferred Coal Costs\" discussion, Note F, on page 49.) The minimum future payments to be made by Duquesne solely in relation to these obligations are $6.2 million in 1996, $5.9 million in 1997, $5.6 million in 1998, $5.3 million in 1999 and $4.2 million in 2000. Duquesne's total payments for coal purchased under the contract were $28.9 million in 1995, $23.3 million in 1994 and $26.5 million in 1993.\nResidual Waste Management Regulations - --------------------------------------------------------------------------------\nIn 1992, the Pennsylvania Department of Environmental Protection (DEP) issued Residual Waste Management Regulations governing the generation and management of non-hazardous residual waste, such as coal ash. Duquesne is assessing the sites which it utilizes and has developed compliance strategies under review by the DEP. Capital compliance costs of $3.0 million were incurred by Duquesne in 1995 to comply with these DEP regulations; on the basis of information currently available, an additional $2.5 million will be incurred in 1996. The expected additional capital cost of compliance through the year 2000 is estimated, based on current information, to be approximately $25 million. This estimate is subject to the results of ground water assessments and DEP final approval of compliance plans.\nOther - --------------------------------------------------------------------------------\nDuquesne is involved in various other legal proceedings and environmental matters. Duquesne believes that such proceedings and matters, in total, will not have a materially adverse effect on its financial position or results of operations.\nO. Quarterly Financial Information (Unaudited)\nSummary of Selected Quarterly Financial Data (Thousands of Dollars)\n(a) Restated to conform with presentations adopted during 1995.\n------------------\nExcept for historical information contained herein, the matters discussed in this Annual Report on Form 10-K are forward-looking statements that involve risks and uncertainties including, but not limited to, economic, competitive, governmental and technological factors affecting Duquesne's operations, markets, products, services and prices, and other factors discussed in Duquesne's filings with the Securities and Exchange Commission.\nSELECTED FINANCIAL DATA - -------------------------------------------------------------------------------","section_15":""}
{"filename":"71829_1995.txt","cik":"71829","year":"1995","section_1":"ITEM 1. Business\nThe Company\nNewpark Resources, Inc. (\"Newpark\" or the \"Company\") provides\nintegrated environmental services to the oil and gas exploration and\nproduction industry in the Gulf Coast area, principally in Louisiana\nand Texas. Those services are concentrated in three key product\nlines: (i) mat rental servicesDthe use of patented prefabricated\nwooden mats as temporary worksites in oilfield and other construction\napplications; (ii) processing and disposal of nonhazardous oilfield\nwaste (\"NOW'); and (iii) processing and disposal of NOW which is\ncontaminated with naturally occurring radioactive material (\"NORM\").\nIn its waste disposal operations, the Company utilizes proprietary\ntechnology.\nThe Company's mat rental services have been provided primarily to\nthe oil and gas exploration and production industry. The mats provide\ntemporary worksites in unstable soil conditions typically found along\nthe Gulf Coast. In addition to the installation and rental of mats,\nthe Company also provides for the management and treatment of\nnonhazardous oilfield waste on the well site, the remediation of waste\npits, and general oilfield services. In 1994, the Company began\nmarketing these temporary worksites to other industries. Increasing\nenvironmental regulation affecting the construction of pipelines,\nelectrical distribution systems and highways in and through wetlands\nenvironments has provided a substantial and rapidly growing new\nmarket for these services and have broadened the geographic market\nserved by the Company to include the coastal areas of the Southeastern\nstates, particularly Florida and Georgia, in addition to its\ntraditional Gulf Coast market. The Company believes that heightened\nenvironmental concern in other markets and other countries, such as\nthat developing in Venezuela, will continue to provide opportunities\nfor the mat rental business.\nIn its NOW processing and disposal business, Newpark processes\nthe majority of the NOW received at its facilities for injection into\ngeologically secure formations deep underground and creates from the\nremainder a reuse product which is used as intermediate daily cover\nmaterial or cell liner material at municipal waste landfills. Since\nthe fourth quarter of 1994, the Company has provided processing and\ndisposal of NOW waste that is contaminated with NORM, processing the\nwaste for injection disposal in wells owned by the Company. In\naddition, the Company provides laboratory and consulting services for\nits customers in connection with its NOW and NORM services.\nThe Company offers these services individually and as an\nintegrated package. The recent trend toward more strict environmental\nregulation of both drilling and production operations conducted by the\nCompany's customers has resulted in greater synergy between the\nCompany's mat rental and oilfield general construction services and\nits other environmental services. The Company provides a\ncomprehensive integrated combination of in-situ waste management and\nconstruction services for both the drilling of new sites and the\nremediation of existing sites. This integration provides it a\ncompetitive advantage in an era of downsizing by its major customers,\nwhich has made those customers more reliant upon outside suppliers for\nmany services. By providing a broad array of integrated services,\nNewpark reduces the number of contractors necessary to provide these\nservices, decreasing the customer's administrative workload.\nNewpark's offsite waste processing operations utilize a\ncombination of proprietary preparation technology to blend the waste\ninto an injectible slurry and specific underground geology into which\ninjection is effected, and patent applications have been filed to\nprotect this proprietary methodology. The Company's mat rental\nbusiness uses a patented interlocking wooden mat system, patent\nprotection of which extends to the year 2003. Newpark believes that\nthe proprietary aspects of these businesses cannot be easily\nduplicated, thereby providing a competitive advantage.\nIn anticipation of increased demand for hardwood lumber used in\nconstruction of its rental mats, the Company purchased a sawmill in\nBatson, Texas, in October 1992. Newpark has since doubled the\ncapacity of the facility, and expects to fully utilize such capacity\nin serving its mat rental business.\nThe following table sets forth for the years ended December 31,\n1995, 1994, and 1993, respectively, the amount of revenues for each\nclass of similar products and services.\nYear ended December 31, _______________________ 1995 1994 1993 ____ ____ ____ (Dollars in thousands)\nRevenues: Offsite waste processing $31,126 $20,738 $11,354 Mat rental 30,775 23,048 21,042 General oilfield services 14,511 13,452 11,358 Wood products sales 12,609 13,105 7,947 Onsite environmental management 7,361 7,689 4,629 Other 1,600 1,600 - ______ ______ ______ Total revenues $97,982 $79,632 $56,330 ====== ====== ======\nNewpark was organized in 1932 as a Nevada corporation and in\nApril 1991 changed its state of incorporation to Delaware. The\nCompany's principal executive offices are located at 3850 North\nCauseway Boulevard, Suite 1770, Metairie, Louisiana 70002, and its\ntelephone number is (504) 838-8222.\nDevelopment of the Business\nSince 1990, the Company has concentrated on expanding and further\nintegrating its environmental service capabilities. Through\nacquisitions in 1990 and 1991, Newpark extended its environmental\nservices into the Texas Gulf Coast region. In May 1991, the Company\nexpanded its processing capacity by constructing a new NOW processing\nplant in Port Arthur, Texas, replacing a smaller facility. The\nCompany has further increased plant capacity through subsequent\nequipment additions and improvements in process technology and\nprocedures. Beginning in 1992, the Company accelerated the\ndevelopment of its deep well injection program and, in November 1993,\nopened its first facility for underground disposal of NOW, at Big\nHill, Texas.\nSignificant developments in 1995 included:\n. The Company's license to process NORM waste was amended to\nincrease the maximum level of radioactive contamination\npermitted and to increase the capacity of the facility.\n. The trend toward a more strict regulation of NOW and NORM waste\ncontinued. NORM regulations were adopted in several states,\nmost importantly New Mexico and Texas. The NORM regulations\nwere revised in Louisiana and are under revision in the\nstate of Mississippi. Draft regulations have been prepared,\nbut are not yet proposed in Oklahoma.\n. The volume of NOW processed by the Company grew by 25% to 2.9\nmillion barrels despite lower drilling activity as measured\nby the rig count.\n. A second NOW facility, located near Fannett, Texas, was opened\nin the third quarter of 1995, and additional wells were\ndrilled at the Big Hill facility, providing a further\nincrease in waste disposal capacity.\n. The market for the Company's mat rental services in non-\noilfield markets expanded into Florida and Georgia.\n. The Company initiated a joint venture to provide its\nproprietary mat rental services to the exploration and\nproduction market in Venezuela.\n. The effect on the Company's services of a decline in the number\nof active drilling rigs was substantially offset by deeper\ndrilling by the Company's customers.\nNOW and NORM are defined as follows:\nNOW - Nonhazardous Oilfield Waste or NOW is waste generated in\nthe exploration or production of oil and gas. These wastes typically\ncontain levels of oil and grease, salts or chlorides, and heavy metals\nin excess of concentration limits defined by state regulators. NOW\nalso includes soils which have become contaminated by these materials.\nIn the environment, oil and grease and chlorides disrupt the food\nchain and have been determined by regulatory authorities to be harmful\nto plant and animal life. Heavy metals are toxic and can become\nconcentrated in living tissues.\nNORM - Naturally Occurring Radioactive Material or NORM is\npresent throughout the earth's crust at very low levels. Among the\nradioactive elements, only Radium 226 and Radium 228 are slightly\nsoluble in water. Because of their solubility, which can carry them\ninto living plant and animal tissues, these elements present a hazard.\nRadium 226 and Radium 228 can be leached out of hydrocarbon bearing\nstrata deep underground by salt water which is produced with the\nhydrocarbons. Radium generally precipitates out of the production\nstream as it is drawn to the surface and encounters a pressure or\ntemperature change in the well tubing or production equipment, forming\na rust-like scale. This scale contains radioactive elements which,\nover many years, can become concentrated on tank bottoms or at water\ndischarge points at production facilities. Thus, NORM waste is NOW\nthat has become contaminated with these radioactive elements above\nconcentration levels defined by state regulatory authorities.\nAmendment to NORM waste license - During 1994, Newpark became a\nlicensed NORM contractor in Louisiana and Texas. The Company built a\nNORM waste treatment plant adjacent to its NOW treatment plant in Port\nArthur, Texas, at which the Company uses a proprietary process to\nslurry the material and reduce the NORM concentration below the level\nat which it is regulated as NORM in preparation for underground\ninjection. Newpark applied for U.S. patents on certain aspects of its\ntreatment and disposal processes. The facility began operations in\nOctober 1994, and is one of only four commercial offsite facilities in\nthe United States that is licensed to process and dispose of NORM\nwaste. The license was modified during 1995 to increase the maximum\npermitted concentration of Radium 226 present in the waste received at\nthe facility from 400 picocuries per gram to 6,000, and the total\nconcentration of radioactive isotopes from 2,000 picocuries per gram\nto 30,000.\nDevelopments related to NOW - The Company processed and\ndisposed of 2,905,000 barrels of NOW in 1995, of which 2,364,000\nbarrels were generated from current drilling and production operations\nand 541,000 barrels were generated from the remediation of old pits\nand production facilities, compared with 2,329,000 barrels in 1994, of\nwhich 1,974,000 were from current drilling and production operations\nand 355,000 were from remediation activities. The increase resulted\nprincipally from the further tightening of state and federal\nregulations limiting the discharge of waste into inland waterways and\noffshore and, to a lesser extent, from changes in the type and mix of\ndrilling activity.\nDuring 1995, Newpark further expanded its NOW injection facility,\nlocated at Big Hill, Texas, drilling two additional injection wells\nand constructing a grinding mill at the site to more efficiently\nhandle the large quantities of waste resulting from the growing\nremediation market. The mill is used to reduce and make uniform the\nsize of the particles in the waste stream to maintain desired flow\ncharacteristics in the Company's injection wells. In September 1995,\nthe Company opened its second injection site, at Fannett, Texas,\ndrilling two wells at that facility, and in the fourth quarter,\ncompleted a bulk barge unloading facility adjacent to the original\nPort Arthur processing plant. Together with additions to personnel\nand equipment at its receiving facilities, this increased its NOW\nprocessing capacity to approximately 500,000 barrels per month.\nServices to wetlands construction projects - Many of the\nenvironmental concerns that have affected drilling in the\nenvironmentally sensitive marshes of the Gulf Coast are now beginning\nto affect other construction activities in the Gulf Coast and other\ngeographic areas. Federal and state regulatory agencies have begun to\nrequire increased precautions to prevent construction-related damage\nto the environment in wetlands areas throughout the United States.\nNewpark believes that its prefabricated mat technology is well-suited\nfor use in construction projects in wetlands areas. During 1995, the\nCompany performed projects in connection with pipeline, electrical\nutility and highway construction projects in Georgia, Florida, Texas\nand Louisiana. The Company anticipates that similar opportunities\nwill allow it to continue to diversify its geographic base, following\nthe wetlands activity to construction related markets in other states.\nVenezuela joint venture - During the first quarter of 1995, the\nCompany invested in a joint venture providing mat rental services in\nVenezuela in support of oil and gas exploration and production\nactivities. A total of 7,000 mats were shipped to the market during\nthe year and, by year end, substantially all were under contract to a\ncustomer. The government of Venezuela has made increasing its output\nof oil over the next several years a national priority, and has begun\nattracting outside investment partners from among the international\noil companies, many of which are Newpark's customers in the domestic\nmarket. Subsequent to December 31, 1995, the joint venture arranged\nshipment of an additional 5,000 mats to Venezuela, and expects that\nactivity there will continue to increase as further exploration\nconcessions are granted. Newpark holds a 38.8% interest in the\nventure.\nDrilling activity - The level of drilling activity in Newpark's\nkey market declined 4% to an average of 195 rigs running in 1995\ncompared to 202 during 1994. This mirrored the decline in the U.S.\nrig count, which averaged 723 in 1995 compared to 774 in 1994. The\n1995 activity level was the second lowest since 1940, after an average\nof 717 recorded in 1992. In much of the coastal marsh and inland\nwaters, termed the \"transition zone,\" the high cost associated with\naccess to the site and lack of seismic data has been an obstacle to\ndevelopment, and as a result, the area has been less actively drilled\ncompared to the offshore and land areas. High quality seismic data\nhas become available only through recent improvements in technology.\nThe increased use of advanced seismic data and the computer-enhanced\ninterpretation of that data has enabled Newpark's customers to select\nexploratory drilling sites with greater likelihood of success. This\nenables them to undertake more expensive projects, such as drilling in\nthe transition zone along the Gulf Coast region.\nSuch projects rely heavily on services such as the Company's\nintegrated environmental services. Deeper wells require the\nconstruction of larger locations to accommodate the drilling equipment\nand the equipment for handling drilling fluids and associated wastes;\nsuch locations generally are in service for significantly longer\nperiods and generate additional mat rental revenues. Deeper wells\nalso require more chemically complex drilling fluids programs, which\nare more difficult and costly to dispose of than the simpler systems\nused in shallower wells. The Company believes that, in 1995, deeper\ndrilling contributed significantly to the increased demand for the\nCompany's services.\nRegulatory Background\nThe oilfield market for environmental services has increased as\nregulations have increased. Louisiana, Texas, and other states have\nenacted comprehensive laws and regulations governing the proper\nhandling of NOW and NORM. This has also heightened the awareness of\nboth the generators of waste and landowners of the need for proper\ntreatment and disposal of such waste in both the drilling of new wells\nand the remediation of production facilities.\nFor many years, prior to current regulation, industry practice\nwas to allow NOW to remain in the environment. Onshore, surface pits\nwere used for the disposal of NOW; offshore, NOW was discharged\ndirectly into the water. As a result of increasing public concern\nover the environment, NOW has in recent years become subject to public\nscrutiny and governmental regulation. Operators of exploration and\nproduction facilities, including major and independent oil companies,\nhave found themselves subject to a multiplicity of laws and\nregulations issued by numerous jurisdictions and agencies. These laws\nand regulations have imposed strict requirements for ongoing drilling\nand production activities in certain geographic areas, as well as for\nthe remediation of sites contaminated by past disposal practices and,\nin many respects, have prohibited the prior disposal practices. In\naddition, operators have become increasingly concerned about possible\nlong-term liability for remediation, and landowners have become more\naggressive about land restoration. For these reasons, operators are\nincreasingly retaining service companies, such as Newpark, to devise\nand implement comprehensive waste management techniques to handle\nwaste on an ongoing basis and to remediate past contamination of oil\nand gas properties.\nLate in 1992, the Louisiana Department of Environmental Quality\n(\"DEQ\") began to promulgate and enforce new, stricter limits on the\nlevel of radium concentration above which NOW became categorized as\nNORM. NORM regulations require more stringent worker protection,\nhandling and storage procedures than those required of NOW under\nLouisiana Statewide Executive Order 29-B. Uncertainty in measuring\nNORM concentration was created by apparent inconsistencies in the\nresults produced by alternative testing methodologies allowed in then\ncurrent regulations. Early in 1994, DEQ published draft NORM\nregulations which, with minor modification, became effective January\n20, 1995, as LAC 33:XV.1401-1420, Chapter 14. In Texas, the Railroad\nCommission adopted final rules (\"Rule 94\") effective February 1, 1995.\nAdoption of these regulations has resolved the regulatory uncertainty\nassociated with NORM.\nThe primary laws that have helped to create the market for\nNewpark's environmental services in the Gulf Coast region, and which\napply to Newpark in the conduct of its business, are the Resource\nConservation and Recovery Act of 1976, as amended in 1984 (\"RCRA\"),\nthe Comprehensive Environmental Response, Compensation, and Liability\nAct, as amended in 1986 (\"CERCLA\"), the laws and regulations\npromulgated by the states of Louisiana, Texas and Alabama, the Federal\nWater Pollution Control Act, as amended (the \"Clean Water Act\"), and\nthe Federal Oil Pollution Act of 1990 (\"OPA\"). These laws are\ndiscussed under \"Environmental Regulation\".\nDescription of Business\nThe principal services and products provided by the Company are\nclassified as follows:\nOffsite Waste Processing\nNOW Waste Processing. Under state regulation, if NOW cannot be\ntreated for discharge or disposed of on the oil or gas lease location\nwhere it is generated, it must be transported to a licensed NOW\ndisposal or treatment facility. There are three primary alternatives\nfor offsite disposal of NOW available to generators in the Gulf Coast:\n(i) land-farming, provided by the Company's competitors; (ii)\nprocessing and conversion of the NOW into a reuse product; and (iii)\nunderground injection (See \"Injection Wells\"). The Company processes\nNOW waste at a facility located at Port Arthur, Texas, which was\nopened in 1991. Newpark also operates six other receiving and\ntransfer facilities located along the Gulf Coast from Venice,\nLouisiana, to Corpus Christi, Texas. Waste products are collected at\nthe transfer facilities from three distinct markets: offshore\nexploration and production; land and inland waters exploration and\nproduction; and remediation of existing or inactive well sites and\nproduction facilities. These facilities are supported by a fleet of\n42 double-skinned barges certified by the U. S. Coast Guard to\ntransport NOW. Waste received is transported by barge through the\nGulf Intracoastal Waterway to the Company's processing facility at\nPort Arthur, Texas, or trucked to facilities at Fannett or Big Hill,\nTexas.\nThe Company has historically converted the waste stream to a\ncommercial reuse product meeting the specifications under applicable\nfederal and state regulations for reuse as a covering material or cell\nliner material at sanitary landfills. Under these regulations,\nlandfills must cover the solid waste deposited daily with earth or\nother inert material. The Company's reuse product is deposited at\neither the City of Port Arthur Municipal Landfill or the City of\nBeaumont Municipal Landfill for use as such cover material pursuant to\ncontracts with the respective cities. This reuse is conducted under\nauthorization from the Texas Natural Resources Conservation Commission\nand is permitted by the Texas Railroad Commission, under a permit that\nwas renewed in January 1994, for a three year period. The Company has\nalso developed alternative uses for the product as roadbase material\nor construction fill material.\nCurrently, only a portion of the waste received by the Company\nis processed into a reuse product. Since November 1994, the Company\nhas disposed of a majority of the waste received at its processing\nfacility by injection of the waste into disposal wells at its Big Hill\nfacility and, since the third quarter of 1995, its Fannett Facility.\nNORM Processing and Disposal. Newpark's entry into the onsite\nremediation (1993) and disposal (1994) of NORM waste is discussed\nunder \"Business - Development of the Business.\" Many alternatives are\navailable to the generator for the treatment and disposal of NORM.\nThese include both chemical and mechanical methods designed to achieve\nvolume reduction, in-situ burial of encapsulated NORM within old well\nbores, and soil washing and other techniques of dissolving and\nsuspending the radium in solution for onsite injection of NORM\nliquids. When the application of these techniques are insufficient to\nbring the site into compliance with applicable regulations, the NORM\nmust be transported to a licensed storage or disposal facility.\nNewpark's NORM processing facility was licensed in September 1994\nand began operations October 21, 1994. The facility receives NORM\nwaste from production operations and remediation sites, generally by\nbarge, truck, in drums or other containers. The material, which is\nsimilar to NOW in virtually all respects other than its elevated level\nof Radium 226 or Radium 228, is processed to achieve a uniform\nparticle size and, through the introduction of viscosifiers and\ncarrying agents, is suspended in a liquid stream suitable for disposal\nin Class II injection wells operated by the Company. Such processing\nalso reduces the concentration of radioactive material to a level at\nwhich the material is no longer regulated as NORM, but reverts to NOW\ncharacteristics. The processed waste meets the criteria for injection\ndisposal under Texas Railroad Commission Rule 9 and Rule 94 and is\ntransported by truck to the Company's injection well facility. During\n1995, the facility license was modified to increase the level of total\nradioactive contamination permitted in the waste received at the\nfacility from 2,000 picocuries per gram to 30,000, and the level of\nRadium 226, upon which most regulation is primarily focused, from 400\nto 6,000 picocuries per gram.\nDuring 1995, the Company received 70,000 barrels of NORM\ncontaminated waste. Much of the growth in the market can be\nattributed to increased litigation on the part of landowners concerned\nover the past practices of the oil and gas industry which have\nresulted in numerous instances of radioactive contamination of the\nsurface. In some cases, settlement of the litigation has mandated the\nremediation of such sites.\nInjection Wells. In February 1993, upon receipt of a permit\nfrom the Texas Railroad Commission, the Company began development of a\n50 acre injection well facility in the Big Hill Field in Jefferson\nCounty, Texas. Newpark's injection technology is distinguished from\nconventional methods in that it utilizes very low pressure, typically\nunder 100 pounds per square inch, to move the waste into the injection\nzone. Conventional wells typically use pressures as high as 2,000\npounds per square inch. In the event of a formation failure or\nblockage of the face of the injection zone, such pressure can force\nwaste material beyond the intended zone, posing a hazard to the\nenvironment. The low pressure used by Newpark is inadequate to drive\nthe injected waste from its intended injection zone.\nThree wells were initially installed at this facility and two\nadditional wells were successfully completed during 1995. Disposal\noperations began at this site in November 1993. During 1995, the\nCompany licensed and constructed a new injection well facility at a\n400 acre site near Fannett, Texas, which was placed in service in\nSeptember 1995. Because of differences between the geology and\nphysical size of the two sites, the Fannett site is expected to\nprovide greater capacity than the Big Hill site.\nThe injection wells at Big Hill and Fannett receive NOW waste\nfrom the Company's processing facilities at Port Arthur, as well as\nfrom customers in the surrounding area. Newpark anticipates that it\nwill open additional injection facilities for both NOW and NORM waste\nin Louisiana and Texas over the next two to three years. The Company\nhas identified a number of sites in the Gulf Coast region as suitable\nfor development of such disposal facilities, has received permits for\none additional site in Texas, and plans to file for additional permit\nauthority in Louisiana.\nThe Company believes that its proprietary injection technology\nhas application to other markets and waste streams, and has begun\npreliminary work and analysis to enter the nonhazardous industrial\nwaste market in the future.\nThe Company also operates an analytical laboratory in Lafayette,\nLouisiana, which supports all phases of its environmental services and\nprovides independent laboratory services to the oil and gas industry.\nThese services include analytical laboratory and sampling services,\npermit application and maintenance services and environmental site\nassessment and audit services.\nMat Rental\nIn 1988, the Company acquired the right to use, in Louisiana and\nTexas, a patented prefabricated interlocking mat system for the\nconstruction of drilling and work sites, which has displaced use of\nindividual hardwood boards. This system is quicker to install and\nremove, substantially reducing labor costs. It is also stronger,\neasier to repair and maintain, and generates less waste material\nduring construction and removal than conventional board roads. In\n1994, the Company acquired the exclusive right to use this system in\nthe Continental U.S. for the life of the patent, which expires in\n2003. Newpark provides this service to two markets:\nOilfield market: Newpark provides this patented interlocking mat\nsystem to the oil and gas industry to ensure all-weather access to\nexploration and production sites in the unstable soil conditions\ncommon along the onshore Gulf of Mexico. These sites are generally\nrented to the customer for an initial period of 60 days; after that\ntime, additional rentals are earned on a monthly basis until the mats\nare released by the customer.\nWetlands market: Beginning in 1994, the Company recognized the\ndevelopment of another market for its patented mat system in providing\naccess roads and temporary work sites to the pipeline, electrical\nutility and highway construction industries. Demand for these\nservices was spurred by Federal Energy Regulatory Commission orders\nrequiring compliance with environmental protection rules under the\nClean Water Act in the pipeline construction business. In 1994, the\nCompany received approximately $2.4 million in revenue from this\nsource. During 1995, approximately $7.0 million in revenues were\nreceived in this market.\nRerentals. Drilling and work sites are typically rented by the\ncustomer for an initial period of 60 days. Often, the customer\nextends the rental term for additional 30 day periods, resulting in\nadditional revenues to the Company. These rerental revenues provide\nhigh margins because only minimal incremental depreciation and\nmaintenance costs accrue to each rerental period. Factors which may\nincrease rerental revenue include: (i) the trend toward increased\nactivity in the \"transition zone\" along the Gulf of Mexico, an area in\nwhich the Company's mat system provides the primary means of access;\n(ii) a trend toward deeper drilling, taking a longer time to reach the\ndesired target; and, (iii) the increased frequency of commercial\nsuccess, requiring logging, testing, and completion (hook-up),\nextending the period during which access to the site is required. In\nthe opinion of industry analysts, application of advanced\ntechnologies, particularly the use of three- dimensional seismic data,\nhas contributed to these trends.\nOnsite Environmental Management\nPromulgation and enforcement of increasingly stringent\nenvironmental regulations affecting drilling and production sites has\nincreased the scope of services required by the oil companies. Often\nit is more efficient for the site operator to contract with a single\ncompany that can provide all-weather site access and provide the\nrequired onsite and offsite environmental services on a fully\nintegrated basis. The Company provides a comprehensive range of\nenvironmental services necessary for its customers' oil and gas\nexploration and production activities. These services include:\nSite Assessment: Site assessment work begins prior to\ninstallation of mats on a drilling site, and generally begins with a\nstudy of the proposed well site, which includes site photography,\nbackground soil sampling, laboratory analysis and investigation of\nflood hazards and other native conditions. The assessment determines\nwhether the site has previously been contaminated and provides a\nbaseline for later restoration to pre-drilling condition.\nPit Design, Construction and Drilling Waste Management. Under\nits Environmentally Managed Pit (\"EMP\") Program, the Company\nconstructs waste pits at drilling sites and monitors the waste stream\nproduced in drilling operations and the contents and condition of the\npits with the objective of minimizing the amount of waste generated on\nthe site. Where possible, the Company disposes of waste onsite by\nland-farming, through chemical and mechanical treatment of liquid\nwaste and by annular injection into a suitably permitted underground\nformation. Waste water treated onsite may be reused in the drilling\nprocess or, where permitted, discharged into adjacent surface waters.\nRegulatory Compliance. Throughout the drilling process, the\nCompany assists the operator in interfacing with the landowner and\nregulatory authorities. The Company also assists the operator in\nobtaining necessary permits and in complying with record maintenance\nand reporting requirements.\nSite Remediation.\nNOW (Drilling). At the completion of the drilling process,\nunder applicable regulations, waste water on the site may be\nchemically or mechanically treated and discharged into surface waters.\nOther waste that may not remain on the surface of the site may be\nland-farmed on the site or injected under permit into geologic\nformations to minimize the need for offsite disposal. Any waste that\ncannot, under regulations, remain onsite is manifested (in Louisiana)\nand transported to an authorized facility for processing and disposal\nat the direction of the generator or customer (See \"Description of\nBusiness- NOW Waste Processing\").\nNOW (Production). The Company also provides services to\nremediate production pits and inactive waste pits including those from\npast oil and gas drilling and production operations. The Company\nprovides the following remediation services: (i) analysis of the\ncontaminants present in the pit and a determination of whether\nremediation is required by applicable state regulation; (ii) treatment\nof waste onsite, and where permitted, reintroduction of that material\ninto the environment, (iii) removal, containerization and\ntransportation to the Company's processing facility of NOW waste not\ntreated onsite.\nNORM. In January 1994, Newpark became a licensed NORM\ncontractor, allowing the Company to perform site remediation work at\nNORM contaminated facilities in Louisiana and Texas. Because of the\nneed for increased worker-protective equipment, extensive\ndecontamination procedures and other regulatory compliance issues at\nNORM sites, the cost of providing such services are materially greater\nthan at NOW facilities, and generates proportionately higher revenues\nthan similar work at a NOW facility.\nSite Closure. The location is restored to its pre-drilling\ncondition and reseeded with native grasses. Closure also involves\ndelivery of test results indicating that closure has been completed in\ncompliance with applicable regulations. This information is important\nto the customer because the operator is subject to future regulatory\nreview and audits. In addition, the information may be required on a\ncurrent basis if the operator is subject to a pending regulatory\ncompliance order.\nWood Product Sales\nBy the end of 1991, the Company had become aware of increasing\nenvironmental regulation affecting wetlands areas. These regulations\nhave affected the oil and gas drilling industry as well as pipeline,\nelectrical distribution and highway projects. In anticipation of\nincreased demand for hardwood lumber used in providing access to such\nwetlands sites, the Company purchased a sawmill in Batson, Texas, in\nOctober 1992. The mill's products include lumber, timber, and wood\nchips, as well as bark and sawdust. Pulp and paper companies in the\narea supply a large proportion of the hardwood logs processed at the\nsawmill and, in turn, are the primary customers for wood chips created\nin the milling process. During 1993, Newpark invested approximately\n$1.0 million in expansion of the sawmill to increase its capacity for\nproducing wood chips. During 1995, the Company invested an additional\n$750,000 to: (i) install a log watering system to maintain the level\nof moisture in the wood chips produced, as desired by its customers,\nand; (ii) for expanded and improved sawing capacity, which improved\nboth production and efficiency.\nGeneral Oilfield Services\nThe Company performs general oilfield services throughout the\nGulf Coast area between Corpus Christi, Texas and Pensacola, Florida.\nGeneral oilfield services performed by the Company include preparation\nof work sites for installations of mats, connecting wells and placing\nthem in production, laying flow lines and infield pipelines, building\npermanent roads, grading, lease maintenance (the maintenance and\nrepair of producing well sites), cleanup and general roustabout\nservices. General oilfield services are typically performed under\nshort-term time and material contracts, which are obtained by direct\nnegotiation or bid.\nThe Company manufactures and sells a line of American Petroleum\nInstitute certified wellheads and valves (flow and pressure control\nequipment, principally installed above ground) to oil and gas\nexploration and production companies. Most of the Company's wellhead\nsales include installation and service for which the Company earns\nadditional revenues. The Company also repairs and refurbishes\ncustomer-owned wellheads. Newpark has entered into an agreement to\nsell this operating unit to an unrelated third party, and expects to\nconsummate that transaction before mid-1996.\nInternational Expansion\nDuring the first quarter of 1995, the Company initiated\nparticipation in a venture which provides mat rental services to the\noil and gas industry in Venezuela. Revenue from foreign operations\nhas been immaterial in each of the past three years.\nSources and Availability of Raw Materials and Equipment\nNewpark believes that its sources of supply for any materials or\nequipment used in its businesses are adequate for its needs and that\nit is not dependent upon any one supplier. No serious shortages or\ndelays have been encountered in obtaining any raw materials.\nPatents and Licenses\nNewpark seeks patents and licenses on new developments whenever\nfeasible, and has recently applied for U.S. patents on its new NOW and\nNORM waste processing and injection disposal system. Newpark has the\nexclusive license for the life of the patent (which expires in 2003)\nto use, sell and lease the prefabricated mats that it uses in\nconnection with its site preparation business in the 48 contiguous\nstates of the United States. The licensor has the right to sell mats\nin states where Newpark is not engaged in business, but only after\ngiving Newpark the opportunity to take advantage of the opportunity\nitself. The license is subject to a royalty which Newpark can satisfy\nby purchasing specified quantities of mats annually from the licensor.\nThe utilization of proprietary technology and systems is an\nimportant aspect of the Company's business strategy. For example, the\nCompany relies on a variety of unpatented proprietary technologies and\nknow-how in the processing of NOW. Although the Company believes that\nthis technology and know-how provide it with significant competitive\nadvantages in the environmental services business, competitive\nproducts and services have been successfully developed and marketed by\nothers. The Company believes that its reputation in its industry, the\nrange of services offered, ongoing technical development and know-how,\nresponsiveness to customers and understanding of regulatory\nrequirements are of equal or greater competitive significance than its\nexisting proprietary rights.\nWorking Capital Practice\nNewpark does not have any special working capital practices which\ndiffer significantly from those generally practiced in the oil and gas\nor environmental services industries. For additional information on\nNewpark's current borrowings see \"Management's Discussion and Analysis\nof Results of Operations and Financial Condition-Liquidity and Capital\nResources,\" and \"Note E. Credit Arrangements and Long-Term Debt,\" in\nthe \"Notes to Consolidated Financial Statements.\"\nDependence Upon Limited Number of Customers\nThe Company's customers are principally major and independent oil\nand gas exploration and production companies operating in the Gulf\nCoast area, with the vast majority of the Company's customers\nconcentrated in Louisiana and Texas.\nDuring the year ended December 31, 1995, approximately 30% of the\nCompany's revenues were derived from 14 major oil companies, and one\nother customer accounted for approximately 16% of consolidated\nrevenues. Given current market conditions and the nature of the\nproducts involved, management does not believe that the loss of this\ncustomer would have a material adverse effect upon the Company.\nThe Company performs services either pursuant to standard\ncontracts or under longer term negotiated agreements. As most of the\nCompany's agreements with its customers are cancelable upon limited\nnotice, the Company's backlog is not significant. For the year ended\nDecember 31, 1995, approximately half of the revenues of the\nenvironmental services segment were obtained on a bid basis, and half\nof its revenues were derived on a negotiated or contractual basis.\nNewpark does not derive a significant portion of its revenues\nfrom government contracts of any kind.\nCompetition\nThe Company operates in highly competitive industry segments.\nThe Company believes that the principal competitive factors in its\nbusinesses are reputation, technical proficiency, reliability, quality\nand breadth of services offered, managerial experience and price. The\nCompany believes that it effectively competes on the basis of these\nfactors, and that its competitive position benefits from its\nproprietary position with respect to the patented mat system used in\nits site preparation business, its proprietary treatment and disposal\nmethods for both NOW and NORM waste streams and its ability to provide\nits customers with an integrated well site management program\nincluding environmental and general oilfield services.\nIt is often more efficient for the site operator to contract with\na single company that can prepare the well site and provide the\nrequired onsite and offsite environmental services. The Company\nbelieves that its ability to provide a number of services as part of a\ncomprehensive program enables the Company to price its services\ncompetitively.\nThe Company believes that there are certain barriers to entry in\nthe environmental and oilfield services industry in the Gulf Coast\nregion. These barriers include formalized procedures for customer\nacceptance, licenses, and permits, and the need for specially equipped\nfacilities and trained personnel. Facilities disposing of NOW are\nsubject to permitting and regulatory requirements which pose a barrier\nto entry into the market. The market, however, is very large. Only a\nsmall portion of the total waste generated is taken to a commercial\ndisposal facility and many other methods exist for dealing with the\nwaste stream. In the market served by the Company there are over one\nhundred permitted commercial facilities, including landfarms,\nlandfills, and injection facilities authorized to dispose of NOW.\nFor additional information concerning the markets that Newpark\nserves and the effects of competition, see \"Description of Business\"\nand \"Management's Discussion and Analysis of Results of Operations and\nFinancial Condition.\"\nEnvironmental Disclosures\nNewpark has sought to comply with all applicable regulatory\nrequirements concerning environmental quality. The Company has made,\nand expects to continue to make, the necessary capital expenditures\nfor environmental protection at its facilities, but does not expect\nthat these will become material in the foreseeable future. No\nmaterial capital expenditures for environmental protection were made\nduring 1995.\nNewpark derives a significant portion of its revenue from\nproviding environmental services to its customers. These services\nhave become necessary in order for these customers to comply with\nregulations governing the discharge of materials into the environment.\nSubstantially all of Newpark's capital expenditures made during 1994\nand 1995, and those planned for 1996, are directly or indirectly the\nresult of such regulation.\nEmployees\nAt February 16, 1996, Newpark employed approximately 565 full and\npart-time personnel, none of which are represented by unions. Newpark\nconsiders its relations with its employees to be satisfactory.\nEnvironmental Regulation\nThe Company's business is affected both directly and indirectly\nby governmental regulations relating to the oil and gas industry in\ngeneral, as well as environmental, health and safety regulations that\nhave specific application to the Company's business. The Company,\nthrough the routine course of providing its services, handles and\nprofiles hazardous regulated material for its customers. Newpark also\nhandles, processes and disposes of nonhazardous regulated materials.\nThis section discusses various federal and state pollution control and\nhealth and safety programs that are administered and enforced by\nregulatory agencies, including, without limitation, the U. S.\nEnvironmental Protection Agency (\"EPA\"), the U.S. Coast Guard, the\nDepartment of the Interior's Office of Surface Mining, the U.S. Army\nCorps of Engineers, the Texas Natural Resource Conservation\nCommission, the Texas Department of Health, the Texas Railroad\nCommission, the Louisiana Department of Environmental Quality and the\nLouisiana Department of Natural Resources. These programs are\napplicable or potentially applicable to the Company's current\noperations. Although the Company intends to make capital expenditures\nto expand its environmental services capabilities, the Company\nbelieves that it is not presently required to make material capital\nexpenditures to remain in compliance with federal, state and local\nprovisions relating to the protection of the environment.\nRCRA. The Resource Conservation and Recovery Act of 1976, as\namended in 1984, (\"RCRA\"), is the principal federal statute governing\nhazardous waste generation, treatment, storage and disposal. RCRA and\nEPA-approved state hazardous waste management programs govern the\nhandling of \"hazardous wastes\". Under RCRA, liability and stringent\noperating requirements are imposed on a person who is either a\n\"generator\" or \"transporter\" of hazardous waste or an \"owner\" or\n\"operator\" of a hazardous waste treatment, storage or disposal\nfacility. The EPA and the states have issued regulations pursuant to\nRCRA for hazardous waste generators, transporters and owners and\noperators of hazardous waste treatment, storage or disposal\nfacilities. These regulations impose detailed operating, inspection,\ntraining and emergency preparedness and response standards and\nrequirements for closure, continuing financial responsibility,\nmanifesting of waste, record-keeping and reporting, as well as\ntreatment standards for any hazardous waste intended for land\ndisposal.\nThe Company's primary operations involve NOW, which is exempt\nfrom classification as a RCRA-regulated hazardous waste. However,\nextensive state regulatory programs govern the management of such\nwaste. In addition, in performing other services for its customers,\nthe Company is subject to both federal (RCRA) and state solid or\nhazardous waste management regulations as contractor to the generator\nof such waste.\nProposals have been made to rescind the exemption of NOW from\nregulation as hazardous waste under RCRA. Repeal or modification of\nthis exemption by administrative, legislative or judicial process\ncould require the Company to change significantly its method of doing\nbusiness. There is no assurance that the Company would have the\ncapital resources available to do so, or that it would be able to\nadapt its operations.\nSubtitle I of RCRA regulates underground storage tanks in which\nliquid petroleum or hazardous substances are stored. States have\nsimilar regulations, many of which are more stringent in some respects\nthan federal programs. The implementing regulations require that each\nowner or operator of an underground tank notify a designated state\nagency of the existence of such underground tank, specifying the age,\nsize, type, location and use of each such tank. The regulations also\nimpose design, construction and installation requirements for new\ntanks, tank testing and inspection requirements, leak detection,\nprevention, reporting and cleanup requirements, as well as tank\nclosure and removal requirements.\nThe Company has a number of underground storage tanks that are\nsubject to the requirements of RCRA and applicable state programs.\nViolators of any of the federal or state regulations may be subject to\nenforcement orders or significant penalties by the EPA or the\napplicable state agency. The Company is not aware of any instances in\nwhich it has incurred liability under RCRA. Cleanup costs or costs\nassociated with changes in environmental laws or regulations could be\nsubstantial and could have a material adverse effect on the Company.\nCERCLA. The Comprehensive Environmental Response, Compensation\nand Liability Act, as amended in 1986, (\"CERCLA\"), provides for\nimmediate response and removal actions coordinated by the EPA for\nreleases of hazardous substances into the environment and authorizes\nthe government, or private parties, to respond to the release or\nthreatened release of hazardous substances. The government may also\norder persons responsible for the release to perform any necessary\ncleanup. Liability extends to the present owners and operators of\nwaste disposal facilities from which a release occurs, persons who\nowned or operated such facilities at the time the hazardous substances\nwere released, persons who arranged for disposal or treatment of\nhazardous substances and waste transporters who selected such\nfacilities for treatment or disposal of hazardous substances. CERCLA\nhas been interpreted to create strict, joint and several liability for\nthe costs of removal and remediation, other necessary response costs\nand damages for injury to natural resources.\nAmong other things, CERCLA requires the EPA to establish a\nNational Priorities List (\"NPL\") of sites at which hazardous\nsubstances have been or are threatened to be released and that require\ninvestigation or cleanup. The NPL is constantly expanding. In\naddition, the states in which the Company conducts operations have\nenacted similar laws and keep similar lists of sites which may be in\nneed of remediation.\nAlthough Newpark primarily handles oilfield waste classified as\nNOW under relevant laws, this waste typically contains constituents\ndesignated by the EPA as hazardous substances under RCRA, despite the\ncurrent exemption of NOW from hazardous substance classification.\nWhere the Company's operations result in the release of hazardous\nsubstances, including releases at sites owned by other entities where\nthe Company performs its services, the Company could incur CERCLA\nliability. Previously owned businesses also may have disposed or\narranged for disposal of hazardous substances that could result in the\nimposition of CERCLA liability on the Company in the future. In\nparticular, divisions and subsidiaries previously owned by the Company\nwere involved in extensive mining operations at facilities in Utah and\nNevada. In addition, divisions and subsidiaries previously owned by\nthe Company were involved in waste generation and management\nactivities in numerous states. These activities involved substances\nthat may be classified as RCRA hazardous substances. Any of those\nsites or activities potentially could be the subject of future CERCLA\ndamage claims.\nWith the exception of the sites discussed in \"Legal Proceedings -\nEnvironmental Proceedings\" below, the Company is not aware of any\ninstances in which it has incurred liability under CERCLA.\nNonetheless, the identification of additional sites at which clean-up\naction is required could subject the Company to liabilities which\ncould have a material adverse effect on the Company.\nThe Clean Water Act. The Clean Water Act regulates the discharge\nof pollutants, including NOW, into waters. The Clean Water Act\nestablishes a system of standards, permits and enforcement procedures\nfor the discharge of pollutants from industrial and municipal waste\nwater sources. The law sets treatment standards for industries and\nwaste water treatment plants and provides federal grants to assist\nmunicipalities in complying with the new standards. In addition to\nrequiring permits for industrial and municipal discharges directly\ninto waters of the United States, the Clean Water Act also requires\npretreatment of industrial waste water before discharge into municipal\nsystems. The Clean Water Act gives the EPA the authority to set\npretreatment limits for direct and indirect industrial discharges.\nIn addition, the Clean Water Act prohibits certain discharges of\noil or hazardous substances and authorizes the federal government to\nremove or arrange for removal of such oil or hazardous substances. The\nClean Water Act also requires the adoption of the National Contingency\nPlan to cover removal of such materials. Under the Clean Water Act,\nthe owner or operator of a vessel or facility may be liable for\npenalties and costs incurred by the federal government in responding\nto a discharge of oil or hazardous substances.\nThe Company treats and discharges waste waters at certain of its\nfacilities. These activities are subject to the requirements of the\nClean Water Act and federal and state enforcement of these\nregulations.\nThe EPA Region 6 Outer Continental Shelf (\"OCS\") permit covering\noil and gas operations in federal waters in the Gulf (seaward of the\nLouisiana and Texas territorial seas) was reissued in November, 1992\nand modified in December, 1993. This permit includes stricter limits\nfor oil and grease concentrations in produced waters to be discharged.\nThese limits are based on the Best Available Treatment (\"BAT\")\nrequirements contained in the Oil and Gas Offshore Subcategory\nnational guidelines which were published March 3, 1993. Additional\nrequirements include toxicity testing and bioaccumulation monitoring\nstudies of proposed discharges.\nEPA Region 6, which includes the Company's market, continues to\nissue new and amended National Pollution Discharge Elimination System\n(\"NPDES\") general permits further limiting or restricting\nsubstantially all discharges of produced water from the Oil and Gas\nExtraction Point Source Category into Waters of the United States.\nThese permits include:\n1) Onshore subcategory permits for Texas, Louisiana, Oklahoma and\nNew Mexico issued in February, 1991 (56 Fed. Reg. 7698). This permit\ncompletely prohibits the discharge of drilling fluids, drill cuttings,\nproduced water or sand, and various other oilfield wastes generated by\nonshore operations into waters of the U.S. This provision has the\neffect of requiring that most oilfield wastes follow established state\ndisposal programs.\n2) Permits for produced water and produced sand discharges into\ncoastal waters of Louisiana and Texas issued on January 9, 1995 (60\nFed. Reg. 2387). Coastal means \"any water landward of the territorial\nseas... or any wetlands adjacent to such waters\". All such discharges\nmust cease by January 1, 1997.\n3) The Outer Continental Shelf (OCS) permit for the western Gulf of\nMexico, covering oil and gas operations in federal waters (seaward of\nthe Louisiana and Texas territorial seas) was reissued in November\n1992 and modified in December 1993. It is expected to be combined\nwith an OCS general permit covering new sources at its next revision.\n4) Permits for the territorial seas of Louisiana and Texas were\nscheduled to be proposed in the spring of 1995. The most recent\ninformation from the EPA indicates the permits should be proposed in\nthe spring of 1996. The territorial seas part of the Offshore\nSubcategory begins at the line of ordinary low water along the part of\nthe coast which is in direct contact with the open sea, and extends\nout three nautical miles. These permits will cover both existing\nsources and new sources. All discharges in state waters must comply\nwith any more stringent requirements contained in Louisiana Water\nQuality Regulations, LAC 33.IX.7.708.\nThe combined effect of all these regulations will closely\napproach a \"zero discharge standard\" affecting all waters except those\nof the OCS. The Company and many industry participants believe that\nthese permits may ultimately lead to a total prohibition of overboard\ndischarge in the Gulf of Mexico.\nThe Clean Air Act. The Clean Air Act provides for federal, state\nand local regulation of emissions of air pollutants into the\natmosphere. Any modification or construction of a facility with\nregulated air emissions must be a permitted or authorized activity.\nThe Clean Air Act provides for administrative and judicial enforcement\nagainst owners and operators of regulated facilities, including\nsubstantial penalties. In 1990, the Clean Air Act was reauthorized\nand amended, substantially increasing the scope and stringency of the\nClean Air Act's regulations. The Clean Air Act has very little impact\non the Company's operations.\nOil Pollution Act of 1990. The Oil Pollution Act of 1990\ncontains liability provisions for cleanup costs, natural resource\ndamages and property damages as well as substantial penalty\nprovisions. The OPA also requires double hulls on all new oil tankers\nand barges operating in waters subject to the jurisdiction of the\nUnited States. All marine vessels operated by the Company already\nmeet this requirement.\nState Regulation. In 1986, the Louisiana Department of Natural\nResources promulgated Order 29-B. Order 29-B contains extensive rules\ngoverning pit closure and the generation, treatment, storage,\ntransportation and disposal of NOW. Under Order 29-B, onsite disposal\nof NOW is limited and is subject to stringent guidelines. If these\nguidelines cannot be met, NOW must be transported and disposed of\noffsite in accordance with the provisions of Order 29-B. Moreover,\nunder Order 29-B, most, if not all, active waste pits must be closed\nor modified to meet regulatory standards; those pits that continue to\nbe allowed may be used only for a limited time. A material number of\nthese pits may contain sufficient concentrations of NORM to become\nsubject to regulation by the DEQ. Rule 8 of the Texas Railroad\nCommission also contains detailed requirements for the management and\ndisposal of NOW and Rule 94 governs the management and disposal of\nNORM. In addition, the Texas Legislature recently enacted a law that\nhas established an Oilfield Cleanup Fund to be administered by the\nTexas Railroad Commission to plug abandoned wells if the Commission\ndeems it necessary to prevent pollution, and to control or clean up\ncertain oil and gas wastes that cause or are likely to cause pollution\nof surface or subsurface water.\nThe Railroad Commission of Texas Rule 91 (16 TAC 3.91) became\neffective November 1, 1993. This rule regulates the cleanup of spills\nof crude oil and gas exploration and production activities including\ntransportation by pipeline. In general, contaminated soils must be\nremediated to oil and grease content of less than 1%.\nMany states maintain licensing and permitting procedures for the\nconstruction and operation of facilities that emit pollutants into the\nair. In Texas, the Texas Natural Resource Conservation Commission\n(the \"TNRCC\") requires companies that emit pollutants into the air to\napply for an air permit or to satisfy the conditions for an exemption.\nThe Company has obtained certain air permits and believes that it is\nexempt from obtaining other air permits at its facilities including\nits Port Arthur, Texas, NOW processing facility. The Company met with\nthe TNRCC and filed for an exemption in the fall of 1991. A\nsubsequent renewal letter was filed in 1995. Based upon its feedback\nfrom the TNRCC, the Company expects that it will continue to remain\nexempt. However, should it not remain exempt, the Company believes\nthat any remedial actions that the TNRCC may require with regard to\nnon-exempt air emissions would not have a material adverse effect on\nthe financial position or operation of the Company.\nOther Environmental Laws. Newpark may be subject to other\nfederal and state environmental protection laws, including without\nlimitation, the Toxic Substances Control Act, the Surface Mining\nControl and Reclamation Act (\"SMCRA\") and the Super Fund Amendments\nand Reauthorization Act, including the Emergency Planning and\nCommunity Right-To-Know-Act. In particular, SMCRA established a\nnationwide program to regulate surface mining and reclamation, and the\nsurface effects of underground mining. It sets strict reclamation\nstandards and a mandatory enforcement system. While the Company does\nnot currently conduct mining activities, SMCRA reclamation\nresponsibility and corresponding state regulatory programs could apply\nto any of the facilities in which the Company participated in mining\nactivities in the past.In addition, the Company is subject to the\nOccupation Safety and Health Act that imposes requirements for\nemployee safety and health and applicable state provisions adopting\nworker health and safety requirements. Moreover, it is possible that\nother developments, such as increasingly stricter environmental,\nsafety and health laws, and regulations and enforcement policies\nthereunder, could result in substantial additional regulation of the\nCompany and could subject to further scrutiny the Company's handling,\nmanufacture, use or disposal of substances or pollutants. The Company\ncannot predict the extent to which its operations may be affected by\nfuture enforcement policies as applied to existing laws or by the\nenactment of new statutes and regulations.\nRisk Management\nThe Company's business exposes it to substantial risks. For\nexample, the Company's environmental services routinely involve the\nhandling, storage and disposal of nonhazardous regulated materials and\nwaste, and in some cases, handling of hazardous regulated materials\nand waste for its customers which are generators of such waste. The\nCompany could be held liable for improper cleanup and disposal, which\nliability could be based upon statute, negligence, strict liability,\ncontract or otherwise. As is common in the oil and gas industry, the\nCompany often is required to indemnify its customers or other third-\nparties against certain risks related to the services performed by the\nCompany, including damages stemming from environmental contamination.\nThe Company has implemented various procedures designed to ensure\ncompliance with applicable regulations and reduce the risk of damage\nor loss. These include specified handling procedures and guidelines\nfor regulated waste, ongoing training and monitoring of employees and\nmaintenance of its insurance coverage.\nThe Company carries a broad range of insurance coverages that\nmanagement considers adequate for the protection of its assets and\noperations. This coverage includes general liability, comprehensive\nproperty damage, workers' compensation and other coverage customary in\nits industries; however, this insurance is subject to coverage limits.\nThe Company could be materially adversely affected by a claim that is\nnot covered or only partially covered by insurance. There is no\nassurance that insurance will continue to be available to the Company,\nthat the possible types of liabilities that may be incurred by the\nCompany will be covered by its insurance, that the Company's insurance\ncarriers will meet their obligations or that the dollar amount of such\nliabilities will not exceed the Company's policy limits.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. Properties\nLease of Principal Facilities\nWith few exceptions, the Company leases its principal facilities and certain equipment.\nNewpark's corporate offices in Metairie, Louisiana, are occupied at an annual rental of approximately $127,000 under a lease expiring in December 1997.\nIts NOW processing facility in Port Arthur, Texas, is occupied at a current annual rental of $168,000 under a lease of which the Company entered, during 1995, the first of three 4-year renewal options. The facility, which is located on 2.9 acres near the Intracoastal Waterway, was constructed by the landowner to the Company's specifications beginning late in 1990 and began operations in mid 1991.\nThe Company's NORM processing facility is also located in Port Arthur, Texas on 3.0 acres of leased land adjacent to the NOW facility. Annual property rentals are currently $37,000. The lease expires in July of 1997 and has two 5-year renewal options available. The Company constructed the processing facility during 1994.\nThe Company owns two injection disposal sites in Jefferson County, Texas, one on 50 acres of land and the other on 400 acres. Seven wells are currently operational at these sites.\nThe Company maintains a fleet of forty-two barges of which twenty-one are owned by the Company, fifteen are on daily rental agreements, six are under 10-year lease terms, and four are under 7- year terms. The barges are used to transport waste to processing stations and are certified for this purpose by the U. S. Coast Guard. Annual rentals under the barge leases totaled approximately $1,500,000 during 1995.\nAdditional facilities are held under short-term leases with annual rentals aggregating approximately $800,000 during 1995. The Company believes that its facilities are suitable for their respective uses and adequate for current needs.\nThe Company owns property leased to others and used as a marine repair facility occupying approximately 23 acres on an island in the Houston Ship Channel. In December 1993, the property was leased to a third party that also obtained the option to purchase the facility as part of the lease agreement. Early in 1994, the Company entered into a new financing of the property.\nThe Company also owns 80 acres occupied as a sawmill facility near Batson, Texas. The Company believes this facility is adequate for current production needs.\nITEM 3.","section_3":"ITEM 3. Legal Proceedings\nNewpark and its subsidiaries are involved in litigation and other claims or assessments on matters arising in the normal course of business. In the opinion of management, any recovery or liability in these matters should not have a material effect on Newpark's consolidated financial statements.\nEnvironmental Proceedings\nIn the ordinary course of conducting its business, the Company becomes involved in judicial and administrative proceedings involving governmental authorities at the federal, state and local levels, as well as private party actions. Pending proceedings that may involve liability for violation of environmental matters are described below. The Company believes that none of these matters involves material exposure. There is no assurance, however, that such exposure does not exist or will not arise in other matters relating to the Company's past or present operations.\nThe Company was identified by the EPA as a minor or \"de minimus\" contributor of waste to a disposal site requiring cleanup under CERCLA, as amended in 1986. That facility, the French Limited site, located in Southeast Texas, is currently undergoing a voluntary cleanup by those parties identified as waste contributors. Five related private party suits have been filed against the Company and the other potentially responsible parties at the French Limited site. The Company has settled its potential liability in four of those suits. Management does not anticipate that the outcome of the remaining suit will have a material adverse impact upon the Company, and anticipates either a nominal settlement or dismissal from the action.\nThe Company has been identified by the EPA as a potentially responsible party in two other CERCLA actions, based on its contribution of oilfield waste to three disposal sites. In the first case, the Company was the largest volume contributor of waste to the Disposal Services, Inc. Clay Point site, located in southern Mississippi. The Company has resolved its liability by its voluntary participation in a consent decree with the EPA, and payment of $158,900 in 1992 as its pro rata share of the removal costs. Two other facilities operated by the same company, the Lee Street and Woolmarket sites, are not subject to any enforcement action by a federal regulatory agency, and the EPA has specifically declined pursuing an action for remediation of these two facilities. However, the Mississippi Department of Environmental Quality is overseeing a continued, voluntary cleanup at the three sites.\nIn the second CERCLA action, the Company has taken the position that it has been incorrectly identified by the EPA as a potentially responsible Ode minimus' party for the cleanup of an abandoned oilfield site in Louisiana referred to as the PAB site. The Company settled its potential liability on a \"de minimus\" buy-out.\nThe Company has been identified as one of 600 contributors of material to the MAR Services facility, a state voluntary cleanup site. Because the Company delivered only processed solid meeting the requirements of Louisiana Statewide Executive Order 29-B to the site, it does not believe it has material financial liability for the site cleanup cost. The Louisiana Department of Environmental Quality is overseeing voluntary cleanup at the site.\nRecourse against its insurers under general liability insurance policies for reimbursement of cost and expense in the foregoing CERCLA actions is uncertain as a result of conflicting court decisions in similar cases. In addition, certain insurance policies under which coverage may be afforded contain self-insurance levels that may exceed the Company's ultimate liability.\nThe Company believes that any liability incurred in the foregoing matters will not have a material adverse effect on the Company's consolidated financial statements. However, a material adverse outcome in any of the foregoing matters could have an adverse effect on the Company.\nITEM 4.","section_4":"ITEM 4. Submission of Matters to a Vote of Shareholders\nNone\nPART II\nITEM 5.","section_5":"ITEM 5. Market for the Registrant's Common Equity and Related Stockholder Matters\nNewpark's common stock traded on The Nasdaq Stock Market under the symbol \"NPRS\" through December 5, 1995, and commenced trading on the New York Stock Exchange on December 6, 1995 under the symbol \"NR\".\nThe following table sets forth the range of the high and low sales prices for the periods indicated.\nPeriod High Low\n1st Quarter $14.50 $ 8.25 2nd Quarter $16.75 $13.50 3rd Quarter $19.75 $15.75 4th Quarter $25.00 $18.25\n1st Quarter $26.00 $14.75 2nd Quarter $24.25 $20.25 3rd Quarter $23.25 $17.00 4th Quarter $22.86 $15.50\nAt December 31, 1995, the Company had 4,230 stockholders of record. Newpark paid a 5% stock dividend on the Common Stock on December 30, 1995 to shareholders of record on November 30, 1995.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nselected consolidated financial information\nThe following tables set forth selected consolidated financial information with respect to Newpark for the five years ended December 31, 1995. The selected consolidated financial information for the five years ended December 31, 1995 is derived from the audited consolidated financial statements of Newpark. Information with respect to this item can also be found in \"Management's Discussion and Analysis of Results of Operations and Financial Condition\" and \"Notes to Consolidated Financial Statements.\"\nFor information regarding dispositions, see \"Note B. Discontinued Operations,\" in the \"Notes to Consolidated Financial Statements.\"\nITEM 7.","section_7":"ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nThe following discussion of the Company's financial condition, results of operations, liquidity and capital resources should be read in conjunction with the \"Consolidated Financial Statements\" and the \"Notes to Consolidated Financial Statements\" included elsewhere in this report.\nOverview\nSince 1990, Newpark has concentrated on expanding and further integrating its environmental service capabilities. The Company has made several acquisitions to extend its integrated environmental services into the Texas Gulf Coast region. During 1991, the Company completed a NOW processing plant and in 1993 opened its first injection well facility for underground disposal of NOW. During 1994, Newpark obtained a permit to process NORM waste for disposal and thus became a participant in the NORM disposal business.\nIn 1994, the Company began to offer temporary worksite installation and mat rental services utilizing its proprietary prefabricated mat system outside of the oil and gas industry in connection with pipeline construction, electrical power distribution and highway construction projects, in environmentally sensitive \"wetlands\" and other areas where unstable soil conditions exist.\nThe Baker-Hughes Rotary Rig Count has historically been viewed as the most significant single indicator of oil and gas drilling activity in the domestic market. In 1993, the United States rig count averaged 754 rigs in operation, and increased to 774 in 1994. In 1995, the rig count averaged 723, the second lowest on record since the advent of the indicator in the early 1940's.\nNewpark's key market area includes the (i) South Louisiana Land, (ii) Texas Railroad Commission Districts 2 and 3, (iii) Louisiana and Texas Inland Waters and (iv) the Offshore Gulf of Mexico rig count measurement areas. The rig count trend in the Company's primary market has tracked these national trends as set forth in the table below:\nManagement believes that the improved natural gas drilling activity, as evidenced by the rig count in its key market, was an important factor which allowed a trend of increasing prices in its site preparation and mat rerental business to continue through 1994. The upward trend in pricing abated with the decline in the rig count within the Company's key market during 1995.\nDespite this decline in rig activity, the volume of waste received by Newpark increased at a compound rate of 44% from 1993 to 1995, primarily due to: (i) the recovery of the remediation market following implementation of NORM regulations; and, (ii) new, more stringent regulations governing the discharge of drilling and production waste in the coastal and inland waters and in the offshore Gulf of Mexico. Since 1993, the total volume of waste in Newpark's key market has grown at a compound rate of 24% for the same reasons.\nThe Company's financial statements do not include any provision for possible contingent liabilities, such as liability for violation of environmental laws or other risks noted under \"Business - Risk Management.\" To the best of the Company's knowledge, it has conducted its business in compliance with applicable laws and, except as noted under \"Legal Proceedings,\" is not involved in any material litigation with respect to violations of such laws.\nResults of Operations\nThe following table represents revenue by product line, for each of the three years ended December 31, 1995, 1994 and 1993. The product line data has been reclassified from prior years' presentation in order to more effectively distinguish the offsite waste processing and mat rental services, in which the Company maintains certain proprietary advantages, from its other service offerings.\nYear Ended December 31, 1995 Compared to Year Ended December 31, 1994\nRevenues\nTotal revenues increased to $98.0 million in 1995 from $79.6 million in 1994, an increase of $18.4 million or 23.0%. The components of the increase by product line are as follows: (i) offsite waste processing revenues increased $10.4 million, as NOW revenue increased $5.5 million, due almost exclusively to additional volume, and NORM processing revenue increased to $6.0 million on approximately 70,000 barrels in 1995 from $1.2 million and 15,000 barrels in 1994; (ii) mat rental revenue increased $7.7 million, or 34% due to two factors: (a) increased volume installed at similar pricing compared to the prior year, and, (b) an increase in revenues from extended rerentals of $3.6 million resulting from the longer use of sites, consistent with the trend toward deeper drilling. The size of the average location installed in 1995 grew 17% from the prior year, primarily the result of the trend toward deeper drilling in more remote locations, requiring larger sites to accommodate increased equipment and supplies on the site; (iii) general oilfield service revenue increased $1.1 million or 7.9%. The increase resulted primarily from the increased level of site preparation work incident to the rental of mats in the oilfield segment of that business; (iv) onsite environmental management service revenue declined approximately $300,000 or 4% with the reduced level of current drilling-related projects more than offsetting increased activity in the remediation of old sites; and (v) revenue from wood product sales decreased approximately $500,000 due in part to production inefficiency during the start-up of a new processing line and the inclusion of a large non-recurring order in prior year revenue.\nOperating Income from Continuing Operations\nOperating income from continuing operations increased by $9.1 million or 76.4% to total $21.0 million in the 1995 period compared to $11.9 million in the prior year, representing an improvement in operating margin to 21.4% in 1995 compared to 14.9% in 1994.\nPrimary components of the increase included: (i) approximately $2.9 million related to the effect of volume increases in both NOW and NORM processing; (ii) $3.6 million from increased mat rerentals, and, (iii) $1.3 million resulting from the increase in the volume of mats rented, to approximately 220 million board feet compared to 157 million in 1994, at similar margins, and, (iv) an approximate $200,000 increase in operating profit on better gross margin mix from wood product sales.\nThe decline of $573,000 in general and administrative expenses reflects, primarily, the impact of approximately $600,000 of prior year charges for legal costs incurred in an appeal of an expropriation matter. Additionally, the provision for uncollectible accounts was $511,000 less in the 1995 period as compared to the 1994 period.\nInterest Expense\nInterest expense increased to $3.7 million in 1995 from $2.7 million in 1994. The increase is a result of an increase in borrowings, proceeds of which were used to fund continued additions to productive capacity, including the Company's waste processing facilities, its prefabricated board road mats, and additions to inventory, primarily at the sawmill facility.\nNon-recurring Expense\nResults for the current period include $436,000 of non-recurring cost associated with a proposed merger which was not completed.\nProvision for Income Taxes\nDuring 1995, the Company recorded an income tax provision of $4.8 million equal to 28% of pre-tax income. While the Company's net operating loss carryforwards remain to be used for income tax return purposes, for financial reporting purposes, substantially all of the remaining net operating loss and tax credit carryforwards applicable to federal taxes were recognized in the first half of the year, which reduced the effective tax rate for that portion of the year. During 1994, the Company recorded a tax benefit of $85,000 as a result of the availability of net operating loss carryforwards.\nNet Income\nNet income increased by $2.8 million or 30% to $12.2 million in 1995 compared to $9.4 million in 1994.\nYear Ended December 31, 1994 Compared to Year Ended December 31, 1993\nRevenues\nTotal revenues increased from $56.3 million in 1993 to $79.6 million in 1994, an increase of $23.3 million or 41.4%. Components of the increase by product line included: (i) a $9.4 million increase in offsite waste processing, composed of (a) an increase of $8.2 million the result of a 72.5% increase in the number of barrels of NOW waste received, which grew to 2.3 million in 1994 from 1.3 million in 1993; and (b) $1.2 million from NORM processing which began in the fourth quarter of 1994; (ii) an increase of $5.2 million of wood product sales revenue due to an increase in the total tonnage of products sold at similar pricing; (iii) a $3.0 million increase in onsite environmental management revenue reflecting the recovery of this market during 1994 once definitive NORM regulations were effected in both Louisiana and Texas. A total of 355,000 barrels of remediation waste was handled in 1994 compared to only 22,000 in 1993; (iv) a $2.0 million increase in mat rental revenue, the net effect of a 29% increase in average pricing to approximately $93 per thousand board feet installed and a 4% decline in total volume to 157 million board\nfeet in 1994 compared to 164 million board feet in 1993; and, (v) an increase of approximately $2.1 million in general oilfield service revenue, which primarily reflects the increased site construction services related to the increased volume of mats installed on customer's sites. Other revenue included $1.6 million in 1994 from the lease of the facility formerly operated as a marine repair yard in Houston, Texas.\nOperating Income from Continuing Operations\nOperating income from continuing operations increased $7.5 million from $4.4 million or 7.8% of revenue in 1993 to $11.9 million or 14.9% of revenue in the current period. Factors contributing to the increase included: (i) a $3.1 million increase in operating income from offsite waste processing, of which approximately $600,000 relates to receipt of 14,711 barrels of NORM waste, solely during the fourth quarter of 1994, with the remainder attributable to increased volume and substantially unchanged profit contribution per barrel of NOW processed; (ii) $2.7 million from increased mat rental revenue, (iii) a $2.5 million increase resulting from the increase in the volume of mats rented; and, (iv) a profit of approximately $800,000 (before related interest expense) from the lease of the Company's former marine repair facility; net of (v) a $258,000 decrease in operating income from wood products sales due to higher inventory costs relative to 1993; (vi) a $1.1 million increase in general and administrative expenses and (vii) a $300,000 increase in the provision for uncollectible accounts and notes receivable.\nGeneral and administrative expenses as a proportion of revenue rose to 4.1% in 1994 from 3.8% in 1993, while rising in total by $1.1 million to $3.2 million in 1994 from $2.1 million in 1993. The principal items associated with the increase included a charge for legal costs of approximately $600,000 incurred due to the appeal of an expropriation matter and a $130,000 provision for additional franchise taxes, as a result of a recently completed audit.\nInterest Expense\nInterest expense increased $1.4 million to $2.7 million in 1994 compared to $1.3 million in 1993, as the Company added approximately $17.5 million in net borrowings to finance new and existing facilities and equipment during 1994.\nIncome from Continuing Operations\nIncome from continuing operations increased 96.2% or $4.6 million to $9.4 million in the 1994 period from $4.8 million in the 1993 period.\nProvision for Income Taxes\nDuring 1994, the Company recorded a net deferred tax benefit of $200,000 as a result of recognizing the future benefit of the income tax carryforwards available to offset the estimated future earnings (See \"Note F. Income Taxes\", in the \"Notes to Consolidated Financial\nStatements\"). The net deferred tax benefit was partially offset by current tax expense of $115,000.\nNet Income\nNet income increased to $9.4 million in 1994 from $2.4 million in 1993, an increase of $7.0 million or 288% equal to 29.9% of incremental revenues.\nLiquidity and Capital Resources\nThe Company's working capital position increased by $18.5 million during the year ended December 31, 1995. Key working capital data is provided below:\nYear Ended December 31, ______________________ 1995 1994 ____ ____ Working Capital (000's) $32,108 $13,585 Current Ratio 2.3 1.8\nDuring 1995, the Company's working capital needs were met primarily from operating cash flow.\nThroughout 1995, the company invested heavily to provide future capacity within key product lines. These improvements included addition of two additional injection wells and a grinding mill at the Big Hill plant, construction of a new injection facility which includes two injection wells at the Fannett site, construction of a bulk waste unloading facility adjacent to the existing Port Arthur plants, and additions to its inventory of rental mats in the domestic market and in the expansion into Venezuela. As a result of these asset additions, long term debt increased to $46.7 million at year end, representing 36.3% of total long-term capital. A total of $43.4 million of the debt was funded within a $50 million commitment which was completed during the second quarter of the year.\nOn June 29, 1995, the Company entered into a new credit agreement with a group of three banks, providing a total of up to $50 million of term financing. This facility included the refinancing of $25 million of existing debt amortized over a five year term. At the Company's option, these borrowings bear interest at either a specified prime rate or LIBOR rate, plus a spread which is determined quarterly based upon the ratio of the Company's funded debt to cash flow.\nIn addition, up to $25 million is available under a revolving line of credit which matures December 31, 1998. Availability under this facility is tied to the level of the Company's accounts receivable and certain inventory. Advances under the line bear interest, at the Company's option, at either a specified prime rate or the LIBOR rate, plus a spread calculated quarterly based upon the ratio of the Company's funded debt to cash flow; interest is payable monthly. At December 31, 1995, $6.3 million of letters of credit were issued and outstanding within the facility and $18.4 million had been\nborrowed. The credit agreement requires that the Company maintain certain specified financial ratios and comply with other usual and customary requirements. The Company was in compliance with the agreement at December 31, 1995.\nSubsequent to December 31, 1995, the banks providing the credit facility approved an increase of $10 million in the term note portion of the facility, which will be used initially to reduce borrowings on the revolving line of credit of the credit facility.\nPotential sources of additional funds, if required by the Company, would include additional borrowings and the sale of equity securities. The Company presently has no commitments beyond its bank lines of credit by which it could obtain additional funds for current operations; however, it regularly evaluates potential borrowing arrangements which may be utilized to fund future expansion plans.\nInflation has not materially impacted the Company's revenues or income.\nDeferred Tax Asset\nThe 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 and credit carryforwards to the extent that realization of such benefits is more likely than not. The Company has provided a valuation allowance ($236,000 at December 31, 1995) for deferred tax assets which cannot be realized through future reversals of existing taxable temporary differences. Management believes that remaining deferred tax assets ($10,450,000 at December 31, 1995) are realizable through reversals of existing taxable temporary differences. Management will continue to assess the adequacy of the valuation allowance on a quarterly basis.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Shareholders Newpark Resources, Inc.\nWe have audited the accompanying consolidated balance sheets of Newpark Resources, Inc. and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1995. Our audits also included the financial statement schedule for the years ended December 31, 1995, 1994 and 1993 listed in the Index at Item 14. 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 Newpark Resources, Inc. and subsidiaries at December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles. Also, in our opinion, such financial statement schedule for the years ended December 31, 1995, 1994 and 1993, 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\nNew Orleans, Louisiana March 1, 1996\nNEWPARK RESOURCES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nA. Summary of Significant Accounting Policies\nOrganization and Principles of consolidation. Newpark Resources, Inc. (\"Newpark\" or the \"Company\") provides comprehensive environmental management and oilfield construction services to the oil and gas industry in the Gulf Coast region, principally Louisiana and Texas. The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All material intercompany transactions are eliminated in consolidation.\nUse of Estimates. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the 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.\nCash equivalents. All highly liquid investments with a remaining maturity of three months or less at the date of acquisition are classified as cash equivalents.\nFair Value Disclosures. Statement of Financial Accounting Standards (\"SFAS\") No. 107, \"Disclosures about Fair Value of Financial Instruments\", requires the disclosure of the fair value of all significant financial instruments. The estimated fair value amounts have been developed based on available market information and appropriate valuation methodologies. However, considerable judgment is required in developing the estimates of fair value. Therefore, such estimates are not necessarily indicative of the amounts that could be realized in a current market exchange. After such analysis, management believes the carrying values of the Company's significant financial instruments (consisting of cash and cash equivalents, receivables, payables and long-term debt) approximate fair values at December 31, 1995.\nInventories. Inventories are stated at the lower of cost (principally average and first-in, first-out) or market. The cost of lumber and related supplies for board roads is amortized on the straight-line method over their estimated useful life of approximately one year.\nDepreciation and amortization. Depreciation of property, plant and equipment, including interlocking board road mats, is provided for financial reporting purposes on the straight-line method over the estimated useful lives of the individual assets which range from three to thirty years. For income tax purposes, accelerated methods of depreciation are used.\nDuring the year ended December 31, 1993, the Company made a change in the estimated service lives of its board road mats from five years to seven years. The new lives were adopted to recognize the longer service life provided by the mats. The effect of the change for the\nyear ended December 31, 1993 was to increase income from continuing operations $1,175,000 ($0.12 per share).\nThe cost in excess of net assets of purchased businesses (\"excess cost\") is being amortized on a straight-line basis over forty years, except for $2,211,000 relating to acquisitions prior to 1971 that is not being amortized. Management of the Company periodically reviews the carrying value of the excess cost in relation to the current and expected operating results of the businesses which benefit therefrom in order to assess whether there has been a permanent impairment of the excess cost of the net purchased assets. Accumulated amortization on excess cost was $437,000 and $374,000 at December 31, 1995 and 1994, respectively.\nRevenue recognition. Revenues from certain contracts, which are typically of short duration, are reported as income on a percentage- of-completion method. Contract revenues are recognized in the proportion that costs incurred bear to the estimated total costs of the contract. When an ultimate loss is anticipated on a contract, the entire estimated loss is recorded. Included in accounts receivable are unbilled revenues in the amounts of $8,600,000 and $2,674,000 at December 31, 1995 and 1994, respectively, all of which are due within a one year period.\nIncome Taxes. Income taxes are provided using the liability method in accordance with SFAS No. 109, \"Accounting for Income Taxes.\" Under this method, deferred income taxes are recorded based upon differences between the financial reporting and income tax basis of assets and liabilities and are measured using the enacted income tax rates and laws that will be in effect when the differences are expected to reverse.\nNon-recurring Expense. Results for the current period include $436,000 of non-recurring cost associated with a proposed merger which was not completed.\nInterest Capitalization. For the years ended December 31, 1995, 1994 and 1993 the Company incurred interest cost of $4,198,000, $2,805,000, and $1,359,000 of which $458,000, $145,000, and $85,000 was capitalized, respectively, on qualifying construction projects.\nIncome per share. Income per share amounts are based on the weighted average number of shares outstanding during the respective year and exclude the negligible dilutive effect of shares issuable in connection with all stock plans. All per share and weighted average share amounts have been restated to give retroactive effect to a 5% stock dividend declared and paid during 1995.\nNew Accounting Standards. During 1995, SFAS No. 121 \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of\" was issued. SFAS No. 121 establishes accounting standards for recording the impairment of long-lived assets, certain identifiable intangibles, goodwill, and assets to be disposed of. The Company is required to adopt SFAS No. 121 effective for fiscal 1996.\nDuring 1995, SFAS No. 123 \"Accounting for Stock-Based Compensation\" was also issued. SFAS No. 123, which the Company is required to adopt effective for fiscal 1996, provides guidance relating to the recognition, measurement and disclosure of stock-based compensation.\nManagement believes that the implementation of SFAS No.'s 121 and 123 will not have a material impact on the Company's consolidated financial statements.\nReclassifications. Certain reclassifications of prior year amounts have been made to conform to the current year presentation.\nB. Discontinued Operations\nOn December 30, 1993, the operations of the Company's marine service subsidiary were sold to an unrelated third party for their estimated net book value of $1,135,000 of which $661,000 was received in cash during 1994 and a short term note was issued for the remainder. The Company leased the facility and certain equipment to the new operator through June 30, 1996, with an option to purchase these assets at specified times during the lease term. The new operator has notified the Company of their intent to exercise the purchase option before the expiration of the lease term. The Company also agreed to make available certain short-term financing of up to $1.6 million through June 30, 1996, with annual interest at 7%; secured by, among other items, certain assets of the third party and the personal guarantee of one of its principals. Advances related to this financing arrangement amounted to $1.6 million at December 31, 1995 and $1.4 million at December 31, 1994. Revenue of the marine repair business was $16,251,000 for the year ended December 31, 1993.\nC. Inventories\nThe Company's inventories at December 31, 1995 and 1994 are summarized as follows: ______________________________________________________________________ (In thousands) 1995 1994 ______________________________________________________________________ Raw materials and supplies (including logs and board road lumber) $11,641 $ 6,752 Finished goods 355 347 _______ _______ $11,996 $ 7,099 ======================================================================\nD. Property, Plant and Equipment\nThe Company's investment in property, plant and equipment at December 31, 1995 and 1994 is summarized as follows:\n______________________________________________________________________ (In thousands) 1995 1994 ______________________________________________________________________ Land $ 5,072 $ 4,273 Buildings and improvements 30,172 19,554 Machinery and equipment 90,448 77,353 Other 2,537 2,208 ______ ______ 128,229 103,388 Less accumulated depreciation (42,768) (35,758) _______ _______ $85,461 $67,630 ======================================================================\nAs further discussed in Note B., the former marine repair facility is currently held for lease and included in the above table. The cost of this facility totaled $19.9 million at December 31, 1995 and 1994, with related accumulated depreciation at $6.3 million and $5.6 million, respectively. The principal components of the cost of this facility include land of $3.1 million, buildings and improvements of $9.8 million, and machinery and equipment of $6.4 million. Rentals received during 1995 and 1994 amounted to $1.6 million annually.\nE. Credit Arrangements and Long-Term Debt\nCredit arrangements and long-term debt consisted of the following at December 31, 1995 and 1994: ______________________________________________________________________ (In thousands) 1995 1994 ______________________________________________________________________\nBank - line of credit $18,378 $ 8,767 Bank - term note 25,000 - Assets subject to lease, financed through 2001 with an interest rate of 10.1% 8,075 8,558 Interim construction credit agreement 482 - Acquisition financing due in 1996 with an interest rate of 8% 327 743 Bank - inventory line of credit - 1,796 Term financing of board road mats - 8,730 Term financing of barges - 2,814 Other, principally installment notes secured by machinery and equipment, payable through 2000 with interest at 3.3% to 13.5% 2,373 7,516 ______ ______ 54,635 38,924\nLess: current maturities of long-term debt (7,911) (8,236) current maturities of lines of credit - (1,796) ______ ______ Long-term portion $46,724 $28,892 ======================================================================\nThe Company maintains a $50.0 million bank credit facility with $25.0 million in the form of a revolving line of credit commitment and the remaining $25.0 million in a term note. The line of credit is secured by a pledge of accounts receivable and certain inventory. It bears interest at either a specified prime rate (8.5% at December 31, 1995) or the LIBOR rate (5.63% at December 31, 1995) plus a spread which is determined quarterly based upon the ratio of the Company's funded debt to cash flow. The average interest rate for the year ended December 31, 1995 was 8.56%. The line of credit requires monthly interest payments and matures on December 31, 1998. At December 31, 1995, $6.3 million of letters of credit were issued and outstanding and $18.4 million had been borrowed. The term note was used to refinance existing debt and requires monthly interest installments and seventeen equal quarterly principal payments commencing March 31, 1996. The term note bears interest at the Company's option of either a specified prime rate or LIBOR rate, plus a spread which is determined quarterly based upon the ratio of the Company's funded debt to cash flow. The average interest rate for the year ended December 31, 1995 was 8.40%. The credit facility requires that the Company maintain certain specified financial ratios and comply with other usual and customary requirements. The Company was in compliance with the agreement at December 31, 1995.\nSubsequent to December 31, 1995, the banks providing the credit facility approved an increase of $10 million in the term note portion of the facility, which will be used initially to reduce borrowings on the revolving line of credit of the credit facility.\nOn December 1, 1995, the Company entered into an interim construction credit agreement in an aggregate amount not to exceed $1,840,000 for the construction of an office building for two of its subsidiaries. The outstanding balance of this credit agreement was $482,000 at December 31, 1995. The agreement provides for an interest rate of 8.75% during construction. At the completion of construction, the interim construction credit agreement will be converted to a term loan. The term loan will require monthly principal and interest payments to fully amortize the amount over 10 years. The term note will bear a fixed interest rate of 2.25% per annum in excess of the treasury rate in effect on the date the term loan is signed.\nMaturities of Long-Term Debt are $7,911,000 in 1996, $7,438,000 in 1997, $26,067,000 in 1998, $7,638,000 in 1999, $4,941,000 in 2000 and $640,000 thereafter.\nF. Income Taxes\nThe provision for income taxes charged to continuing operations (income taxes related to discontinued operations for 1993 were not segregated as the amounts were immaterial) is almost exclusively U. S. Federal tax as follows:\nYear Ended December 31, ______________________________________________________________________ (In thousands) 1995 1994 1993 ______________________________________________________________________ Current tax expense $ 1,534 $ 115 $ 30 Deferred tax expense (benefit) 3,217 (200) (1,700) ______ _____ ______ Total provision (benefit) $ 4,751 $ (85) $(1,670) ======================================================================\nThe deferred tax expense (benefit) includes a decrease in the valuation allowance for deferred tax assets of $1,700,000, $3,129,000, and $2,407,000 for 1995, 1994 and 1993, respectively.\nThe effective income tax rate is reconciled to the statutory federal income tax rate as follows: Year Ended December 31, ______________________________________________________________________ 1995 1994 1993 ______________________________________________________________________ Income tax expense at statutory rate 34.0% 34.0% 34.0% Non-deductible portion of business expenses 1.4 (2.5) 1.6 Tax benefit of NOL utilization (10.0) (33.6) (90.1) Other 2.6 1.2 0.9 ______________________ Total income tax expense (benefit) 28.0% (0.9%) (53.6%) ======================================================================\nFor federal income tax return purposes, the Company has net operating loss carryforwards (\"NOLs\") of $22,835,000 (net of amounts disallowed pursuant to IRC Section 382) that, if not used, will expire in 1998 through 2009. The Company also has $1,592,000 of alternative minimum tax credit carryforwards available to offset future regular income taxes subject to certain limitations. Substantially all of these carryforwards have been recognized for financial reporting purposes.\nTemporary differences and carryforwards which give rise to a significant portion of deferred tax assets and liabilities at December 31, 1995 and 1994 are as follows:\n______________________________________________________________________ (In thousands) 1995 1994 ______________________________________________________________________ Deferred tax assets: Net operating losses $ 8,696 $ 9,893 Alternative minimum tax credits 1,592 295 All other 398 444 _______ _______\nTotal deferred tax assets 10,686 10,632 Valuation allowance (236) (967) _______ _______\nNet deferred tax assets $ 10,450 $ 9,665 _______ _______ Deferred tax liabilities: Depreciation $ 8,767 $ 6,244 Amortization 1,823 1,074 All other 1,177 447 _______ ________\nTotal deferred tax liabilities 11,767 7,765 _______ ________\nTotal net deferred tax (liabilities) assets $ (1,317) $ 1,900 ======================================================================\nUnder SFAS No. 109 a valuation allowance must be established to offset a deferred tax asset if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax asset will not be realized. At December 31, 1994, the Company evaluated the available evidence and believed that it was more likely than not that a portion of the deferred tax asset would not be realized. A valuation allowance was recorded in the financial statements to offset NOLs which the Company believed would not be utilized. At December 31, 1994, the Company recorded a net deferred tax asset of $1,900,000, of which $2,271,000 was recorded in non- current assets and $371,000 was recorded in current accrued liabilities, the realization of which was dependent on the Company's ability to generate taxable income in future periods. The Company believed that its estimate of future earnings based on contracts in place, the overall improved gas market, and its prior earnings trend supported the recorded net deferred tax asset.\nAt December 31, 1995, the deferred tax liabilities of the consolidated group exceeded the deferred tax assets, therefore a deferred tax benefit was recorded for the full amount of the remaining federal NOLs. The valuation allowance recorded at December 31, 1995 relates to certain state NOLs which have not to date been recognized for financial reporting purposes. At December 31, 1995, the Company has recorded a net deferred tax liability of $1,317,000, of which $2,701,000 has been recorded in other current assets and $4,018,000 has been recorded as long-term deferred taxes payable.\nG. Preferred Stock\nThe Company has been authorized to issue up to 1,000,000 shares of Preferred Stock, $.01 par value, none of which are issued or outstanding at December 31, 1995.\nH. Common Stock and Stock Options\nChanges in outstanding Common Stock for the three years ended December 31, 1995, 1994, and 1993 were as follows: ______________________________________________________________________ (In Thousands of Shares) 1995 1994 1993 ______________________________________________________________________ Outstanding, beginning of year 9,986 9,858 9,130 Shares issued in exchange for extinguishment of debt - - 700 Dividend shares issued 505 - - Shares issued upon exercise of Options 143 128 28 _____ _____ _____ Outstanding, end of year 10,634 9,986 9,858 ======================================================================\nThe Amended and Restated Newpark Resources, Inc. 1988 Incentive Stock Option Plan (the \"1988 Plan\") was adopted by the Board of Directors on June 22, 1988 and thereafter was approved by the shareholders. The 1988 Plan was amended and restated by the Board of Directors and shareholders in 1992 to increase the number of shares of Common Stock issuable thereunder from 100,000 to 450,000; was further amended by the Board of Directors and shareholders in 1994 to increase the number of shares of Common Stock issuable thereunder from 450,000 to 650,000, and was further amended by the Board of Directors and shareholders in 1995 to increase the number of shares of Common Stock issuable thereunder from 650,000 to one million shares. An option may not be granted for an exercise price less than the fair market value on the date of grant and may have a term of up to ten years.\nStock option transactions for the 1988 Plan for the three years ended December 31, 1995, 1994 and 1993 are summarized below:\n______________________________________________________________________ Years Ended December 31, 1995 1994 1993 ______________________________________________________________________ Outstanding, beginning of year 374,981 303,149 215,191 Options granted 387,000 191,000 117,500 Dividend options granted 32,610 - - Options exercised (87,667) (119,168) (27,542) Options canceled (22,166) - (2,000) _______ _______ _______ Outstanding, end of year 684,758 374,981 303,149 ======= ======= ======= Option price per share: Outstanding, end-of-year $3.80-$18.88 $3.00-$18.75 $3.00-$9.25 ======================================================================\nAt December 31, 1995 and 1994, the total number of outstanding exercisable options were 145,979 and 54,144, respectively.\nThe 1992 Directors' Stock Option Plan (the \"1992 Directors' Plan\") was adopted on October 21, 1992 by the Compensation Committee and, thereafter, was approved by the shareholders in 1993.\nThe purpose of the 1992 Directors' Plan was to provide two directors (\"Optionees\") additional compensation for their services to Newpark and to promote an increased incentive and personal interest in the welfare of Newpark by such directors. The Optionees were each granted a stock option to purchase 50,000 shares of Common Stock at an exercise price of $8.75 per share, the fair market value of the Common Stock on the date of grant for a term of ten years. No additional options may be granted under the Directors\" Plan. At December 31, 1995, 50,000 options had been exercised under this plan.\nThe 1993 Non-Employee Directors' Stock Option Plan (the \"1993 Non- Employee Directors' Plan\") was adopted on September 1, 1993 by the Board of Directors and, thereafter, was approved by the shareholders in 1994.\nThe 1993 Non-Employee Directors' Plan is intended to allow each non-employee director of Newpark to purchase 15,000 shares of Common Stock. Non-employee directors are not eligible to participate in any other stock option or similar plan currently maintained by Newpark. The purpose of the 1993 Non-Employee Directors' Plan is to promote an increased incentive and personal interest in the welfare of Newpark by those individuals who are primarily responsible for shaping the long- range plans of Newpark, to assist Newpark in attracting and retaining on the Board persons of exceptional competence and to provide additional incentives to serve as a director of Newpark.\nUpon the adoption of the 1993 Non-Employee Directors' Plan, the five non-employee directors were each granted a stock option to purchase 15,000 shares of Common Stock at an exercise price of $9.00 per share, the fair market value of the Common Stock on the date of grant. In addition, each new Non-Employee Director, on the date of\nhis or her election to the Board of Directors automatically will be granted a stock option to purchase 15,000 shares of Common Stock at an exercise price equal to the fair market value of the Common Stock on the date of grant. The determination of fair market value of the Common Stock is based on market quotations. On November 2, 1995, the Board of Directors adopted, subject to shareholder approval, amendments to the Non-Employee Directors' Plan to increase the maximum number of shares issuable thereunder from 150,000 to 200,000 and to provide for the automatic grant at five year intervals of additional stock options to purchase 10,000 shares of Common Stock to each non- employee director who continues to serve on the Board. At December 31, 1995, 15,000 options had been exercised.\nOn November 2, 1995, the Board of Directors adopted, subject to shareholder approval, the Newpark Resources, Inc. 1995 Incentive Stock Option Plan (the \"1995 Plan\"), pursuant to which the Compensation Committee may grant incentive stock options and nonstatutory stock options to designated employees of Newpark. Initially, a maximum of 500,000 shares of Common Stock may be issued under the 1995 Plan, with such maximum number increasing on the last business day of each fiscal year of Newpark, commencing with the last business day of the fiscal year ending December 31, 1996, by a number equal to 1.25% of the number of shares of Common Stock issued and outstanding on the close of business on such date, with a maximum number of shares of Common Stock that may be issued upon exercise of options granted under the 1995 Plan being limited to 1,250,000.\nI. Supplemental Cash Flow Information\nDuring 1994, the Company's noncash transactions included the consummation of the sale of the operations of the Company's marine repair business for $661,000 in cash and a $400,000 note receivable.\nDuring 1993, the Company's noncash transactions included the issuance of 700,000 shares of the Company's common stock for extinguishment of certain notes payable issued in connection with the assets purchased from Quality Mill, Inc. and accrued liabilities incurred with the purchase of other fixed assets. Additionally, the Company sold property with a book value of $250,000 in exchange for $100,000 in cash and a $400,000 note receivable.\nIncluded in accounts payable and accrued liabilities at December 31, 1995, 1994 and 1993, were equipment purchases of $4,141,000, $774,000, and $933,000 respectively. Also included are notes payable for equipment purchases in the amount of $257,000 and $635,000 for 1995 and 1993, respectively.\nInterest of $4,235,000, $2,713,000, and $1,912,000 was paid in 1995, 1994 and 1993, respectively. Income taxes of $51,000, $90,200, and $82,000 were paid in 1995, 1994 and 1993, respectively.\nJ. Commitments and Contingencies\nNewpark and its subsidiaries are involved in litigation and other claims or assessments on matters arising in the normal course of business. In the opinion of management, any recovery or liability in these matters will not have a material adverse effect on Newpark's consolidated financial statements.\nDuring 1992, the State of Texas assessed additional sales taxes for the years 1988-1991. The Company has filed a petition for redetermination with the Comptroller of Public Accounts. The Company believes that the ultimate resolution of this matter will not have a material adverse effect on the consolidated financial statements.\nIn the normal course of business, in conjunction with its insurance programs, the Company has established letters of credit in favor of certain insurance companies in the amount of $2,825,000 at December 31, 1995 and December 31, 1994. At December 31, 1995, the Company had outstanding guaranty obligations totaling $469,000 in connection with facility closure bonds issued by an insurance company.\nSince May 1988, the Company has held the exclusive right to use a patented prefabricated mat system with respect to the oil and gas exploration and production industry within the State of Louisiana. On June 20, 1994, the Company entered into a new license agreement by which it obtained the exclusive right to use the same patented prefabricated mat system, without industry restriction, throughout the continental United States. The license agreement requires, among other things, that the company purchase a minimum of 20,000 mats annually through 2003. The Company has met this annual mat purchase requirement since the inception of the agreement. Any purchases in excess of that level may be applied to future annual requirements. The Company's annual commitment to maintain the agreement in force is currently estimated to be $4,600,000.\nAt December 31, 1995, the Company had outstanding a letter of credit in the amount of $3,816,000 issued to a state regulatory agency to assure funding for future site closure obligations at its NORM processing facility.\nThe Company leases various manufacturing facilities, warehouses, office space, machinery and equipment and transportation equipment under operating leases with remaining terms ranging from one to ten years with various renewal options. Substantially all leases require payment of taxes, insurance and maintenance costs in addition to rental payments. Total rental expenses of continuing operations for all operating leases were $5,210,000, $4,049,000, and $4,226,000, 1995, 1994 and 1993, respectively.\nFuture minimum payments under noncancelable operating leases, with initial or remaining terms in excess of one year are: $1,683,000 in 1996, $1,192,000 in 1997, $924,000 in 1998, $859,000 in 1999, $781,000 in 2000, and $562,000 thereafter.\nCapital lease commitments are not significant.\nK. Business and Credit Concentration\nDuring 1995, one customer accounted for approximately 16%, $15,890,000, of total revenue. In 1993 and 1994, the Company did not derive ten percent or more of its revenues from sales to any single customer.\nExport sales are not significant.\nL. Concentrations of Credit Risk\nFinancial instruments which potentially subject the Company to significant concentrations of credit risk consist principally of cash investments and trade accounts and notes receivable.\nThe Company maintains cash and cash equivalents with various financial institutions. These financial institutions are located throughout the Company's trade area and company policy is designed to limit exposure to any one institution. The Company performs periodic evaluations of the relative credit standing of these financial institutions which are considered in the Company's investment strategy.\nConcentrations of credit risk with respect to trade accounts and notes receivable are limited due to the large number of entities comprising the Company's customer base, and for notes receivable, the required collateral. The Company maintains an allowance for losses based upon the expected collectibility of accounts and notes receivable.\nM. Supplemental Selected Quarterly Financial Data (Unaudited)\nQuarter Ended ______________________________________________________________________ Mar 31 Jun 30 Sep 30 Dec 31 (In thousands, except per share amounts) _____________________________________________________________ Fiscal Year 1995 Revenues $22,209 $22,454 $24,793 $28,526 Operating income 3,711 4,789 5,529 6,951 Net income 2,490 3,206 2,700 3,840 Net income per share 0.24 0.30 0.26 0.36\nFiscal Year 1994 Revenues $17,146 $19,396 $21,169 $21,921 Operating income 2,288 2,843 3,165 3,595 Net income 1,740 2,273 2,436 2,945 Net income per share 0.17 0.22 0.23 0.28\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 information required by this Item is incorporated by reference to the registrantOs Proxy Statement to be filed pursuant to Regulation 14A under the Securities Act of 1934 in connection with the CompanyOs 1996 Annual Meeting of Shareholders.\nITEM 11.","section_11":"ITEM 11. Executive Compensation\nThe information required by this Item is incorporated by reference to the registrantOs Proxy Statement to be filed pursuant to Regulation 14A under the Securities Act of 1934 in connection with the CompanyOs 1996 Annual Meeting of Shareholders.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThe information required by this Item is incorporated by reference to the registrantOs Proxy Statement to be filed pursuant to Regulation 14A under the Securities Act of 1934 in connection with the Company's 1996 Annual Meeting of Shareholders.\nITEM 13.","section_13":"ITEM 13. Certain Relationships and Related Transactions\nThe information required by this Item is incorporated by reference to the registrantOs Proxy Statement to be filed pursuant to Regulation 14A under the Securities Act of 1934 in connection with the Company's 1996 Annual Meeting of Shareholders.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(a) 1. Financial Statements\nReports of Independent Auditors\nConsolidated Balance Sheets as of December 31, 1995 and 1994\nConsolidated Statements of Income for the years ended December 31, 1995, 1994 and 1993\nConsolidated Statements of Shareholders' Equity for the years ended December 31, 1995, 1994 and 1993\nConsolidated Statements of Cash Flows for the years ended December 31, 1995, 1994 and 1993\nNotes to Consolidated Financial Statements\n2. Financial Statement Schedules\nThe following financial statement schedule is included:\nSchedule II - Valuation and Qualifying Accounts\nAll other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted.\n3. Exhibits\n3.1 Certificate of Incorporation\n3.1.1 Certificate of Amendment to Certificate of Incorporation**\n3.2 Bylaws\n10.1 Employment Agreement, dated as of October 23, 1990, between the registrant and James D. Cole. *\n10.2 Lease Agreement, dated as of May 17, 1990, by and between Harold F. Bean Jr. and Newpark Environmental Services, Inc. (\"NESI\").\n10.3 Building Lease Agreement, dated April 10, 1992, between the registrant and The Traveler' Insurance Company.\n10.4 Building Lease Agreement, dated May 14, 1992, between State Farm Life Insurance Company, and SOLOCO, Inc.\n10.5 Operating Agreement, dated June 30, 1993, between Goldrus Environmental Services, Inc. and NESI.\n10.6 1992 Directors' Stock Option Plan. *\n10.7 1993 Non-Employee Directors' Stock Option Plan. *\n10.7.1 Amendment to the 1993 Non-Employee Directors' Stock Option Plan.**\n10.8 Amended and Restated 1988 Incentive Stock Option Plan. *\n10.8.1 1995 Incentive Stock Option Plan**\n10.9 Loan Agreements, dated December 30, 1993, between the registrant and SFA Industries, Inc.\n10.10 Continuing Guaranty, dated December 30, 1993, between the registrant and Sam Eakin.\n10.11 Pledge Agreement, dated December 30, 1993, between the registrant and SFA Industries, Inc.\n10.12 Security Agreement, dated December 30, 1993, between the registrant and SFA Industries, Inc.\n10.13 Lease and Security Agreement, dated December 30, 1993, between the registrant and SFA Industries, Inc.\n10.14 Guaranty of Lease, dated December 30, 1993, between the registrant and SFA Industries, Inc.\n10.15 Equipment Lease Agreement, dated March 11, 1994, among Republic Financial Corporation (\"RFC\"), the registrant and Newpark Shipholding, Inc.\n10.16 Guaranty, dated March 11, 1994, by the registrant in favor of RFC.\n10.17 First Note, dated March 11, 1994, by the registrant in favor of RFC.\n10.18 Special Guaranty, dated March 11, 1994, by the registrant in favor of Lockwood National Bank of Houston.\n10.19 Exclusive License Agreement, dated June 20, 1994, between SOLOCO, Inc. and Quality Mat Company.\n10.20 Lease Agreement, dated as of July 29, 1994, by and between Harold F. Bean Jr. and NESI.\n10.21 Credit Agreement by and among Newpark Resources, Inc., SOLOCO, Inc., Newpark Environmental Services, Inc., SOLOCO Texas, L. P., Batson Mill, L.P., Newpark Environmental Water Services, Inc., Newpark Shipholding Texas, L.P., Mallard and Mallard of La., Inc., SOLOCO, L. L. C., Newpark Texas, L. L. C., Newpark Holdings, Inc., Hibernia National Bank, Bank One Texas, N. A., and Premier Bank, National Association.\n10.21.1Second Amendment and Supplement to the Credit Agreement, dated March 5, 1996 to Credit Agreement by and among Newpark Resources, Inc., SOLOCO, L. L. C., Newpark Environmental Services, L. L. C., Newpark Shipholding Texas, L.P., SOLOCO Texas, L. P., Batson Mill, L. P., Newpark Environmental Water Services, Inc., Mallard and Mallard of La., Inc., Newpark Texas, L. L. C., Newpark Holdings, Inc., Hibernia National Bank, Bank One Texas, N. A., and Premier Bank, National Association. **\n10.22 Credit Agreement, dated December 1, 1995, between SOLOCO, Inc., and Hibernia National Bank**\n21.1 Subsidiaries of the Registrant **\n23.1 Consent of Deloitte & Touche **\n24.1 Powers of Attorney **\n________________________________\n* Management Compensation Plan or Agreement.\n** Filed herewith.\nPreviously filed in the exhibits to the registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 1991, and incorporated by reference herein.\nPreviously filed in the exhibits to the registrant's Registration Statement on Form S-1 (File No. 33-40716) filed on June 21, 1991, and incorporated by reference herein.\nPreviously filed in the exhibits to the registrant's Registration Statement on Form S-8 (File No. 33-67284) filed on August 12, 1993, and incorporated by reference herein.\nPreviously filed in the exhibits to the registrant's Registration Statement on Form S-8 (File No. 33-83680) filed on August 12, 1993, and incorporated by reference herein.\nPreviously filed in the exhibits to the registrant's Current Report on Form 8-K, dated January 14, 1994, and incorporated by reference herein.\nPreviously filed in the exhibits to the registrant's Current Report on Form 8-K, dated March 25, 1994, and incorporated by reference herein.\nPreviously filed in the exhibits to the registrant's Annual Report on Form 10-K for the year ended December 31, 1994, and incorporated by reference herein.\nPreviously filed in the exhibits to the registrant's Current Report on Form 8-K, dated July 18, 1995, and incorporated by reference herein.\nPreviously filed as Exhibit B to the registrant's Definitive Proxy Materials relating to its Annual Meeting of Shareholders held on June 28, 1995 and incorporated by reference herein.\n(b) Reports on Form 8-K\nThe registrant did not file a report on Form 8-K during the fourth quarter of 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.\nDated: March 8, 1996\nNEWPARK RESOURCES, INC.\nBy: \/s\/ James D. Cole James D. Cole, President\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the date indicated.\nNewpark Resources, Inc. SCHEDULE II Valuation and Qualifying Accounts Years Ended December 31, 1995, 1994 and 1993 (In thousands of dollars)","section_15":""}
{"filename":"786344_1995.txt","cik":"786344","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL DESCRIPTION\nGAINSCO, INC. is a holding company, the only operations of which are to provide administrative and financial services for its wholly-owned subsidiaries. The term \"Company\" as used in this document includes GAINSCO, INC. and its subsidiaries, unless the context otherwise requires. The Company was incorporated in Texas on October 11, 1978. It completed its initial public offering on November 14, 1986.\nThe Company is a property and casualty insurance company concentrating its efforts on certain specialty excess and surplus markets within the commercial auto, auto garage and general liability insurance lines. The Company's insurance operations are conducted through three insurance companies, General Agents Insurance Company of America, Inc., an Oklahoma corporation, MGA Insurance Company, Inc., a Texas corporation, and GAINSCO County Mutual Insurance Company, a Texas chartered company. The Company is approved to write insurance in 49 states and the District of Columbia on a non-admitted basis and in 43 states on an admitted basis. The Company markets its lines of insurance through 180 non-affiliated general agents' offices. Approximately 76% of the Company's gross premiums written during 1995 resulted from risks located in Arkansas, California, Florida, Georgia, Kentucky, Louisiana, Pennsylvania, Tennessee, Texas and West Virginia.\nExcess and surplus lines of insurance are generally written on classes of risks which admitted insurers will not write; many of which are too small in premium size for larger companies to handle efficiently. For a description of the product lines presently written by the Company, see \"Business-Product Lines.\" Because of the lack of availability of coverage from admitted insurers, premium levels for excess and surplus policies are generally higher than for standard coverages provided by admitted insurers. State insurance authorities permit excess and surplus lines companies greater rate and policy form flexibility than admitted companies. The Company, therefore, sets its policy premiums by applying its own judgment after consideration of the risks involved. Part of its analysis includes the review of historical premium rate and loss cost information as compiled and reported by independent rating bureaus. The Company's current premiums typically range from 160% to 275% of the loss costs published by the rating organizations. These loss cost multipliers approximate a range of 100% to 170% of manual rates.\nThe strategy of the Company is to identify various types of risks where it can price its coverages favorably and maximize the potential for underwriting profit. This strategy has resulted in changes in product mix and product design from time to time.\nThe Company is currently writing 20 classes of general liability on a claims-made basis. The remaining classes of general liability are written on an occurrence basis. At December 31, 1995, approximately 4% of the Company's general liability policies in force were on a claims-made basis. The claims-made form of policy provides that coverage applies only to claims which occur and claims that are made during the term of the policy. Once the policy period is over in claims-made policies, the approximate extent of the insurer's liability is known. The occurrence form of policy provides coverage for losses from claims which occurred during the policy period, regardless of when the claims are asserted. Under the claims-made basis the insurer has greater certainty in predicting the extent of its liability for claims. The Company has had no legal challenges on the enforceability of its claims-made policies where denial of coverage was made by the Company under the limited reporting period provision. The Company does have a 60 day grace period provision for reporting claims after the policy expiration date on its claims-made form of policy. The Company feels this provision remedies it against issues of enforceability in recent court decisions. In the reserving process, claims-made coverages are reserved separately from occurrence coverages. By examining the separate payout patterns, the average outstanding claims, and the distribution of claims by age of claim, IBNR reserves are set to reflect the coverage differences.\nThe Company, through a wholly-owned subsidiary, has developed and is marketing a computer software package related to general agency operations. Through another wholly-owned subsidiary, the Company is engaged in the premium finance business. Through MGA Insurance Company, Inc., a wholly-owned subsidiary, the Company earns fee revenues by acting as a servicing carrier for the Commercial Automobile Insurance Procedures of Arkansas, California, Louisiana, and Mississippi and the Commercial Assignment Procedure of Pennsylvania. Through GAINSCO County Mutual Insurance Company, the Company entered into fronting agreements with two non-affiliated insurance companies. The business written under these agreements is ceded 100% to reinsurers rated \"A- (Excellent)\" or better by A. M. Best and 100% of the liabilities are fully collateralized with pledged investment grade securities or letters of credit.\nPRODUCT LINES\nThe Company's principal products serve certain specialty markets within the commercial auto, auto garage and general liability insurance lines. The following table sets forth, for each product line, gross premiums written (before ceding any amounts to reinsurers), percentage of gross premiums written for the periods indicated and the number of policies in force at the end of each period.\nCommercial Auto The commercial auto coverage underwritten by the Company includes risks associated with local haulers of specialized freight (e.g. sand and gravel), tradespersons' vehicles and trucking companies (other than long haulers). Policies are written only for vehicles primarily operated within the state of garaging and one state beyond or 1,000 miles, whichever is the greater distance. Liability and physical damage coverages for these risks are currently limited to $1,000,000 per accident and $100,000 per unit, respectively.\nAuto Garage The Company's auto garage program includes garage liability, garage keepers' legal liability and dealers' open lot coverages. The maximum limit on these coverages is $1,000,000. The Company targets its coverage to used car dealers, recreational vehicle dealers, automobile repair shops and wrecker\/towing risks.\nGeneral Liability The Company underwrites general liability insurance with liability limits up to $1,000,000 for small businesses such as car washes, janitorial services, small contractors, apartment buildings, rental dwellings and retail stores. The Company does not underwrite professional liability, manufacturers' products liability, liquor liability, heavy contracting liability, oil well drilling liability, marine liability or municipality risks.\nOther Lines The Company also issues a variety of other property and casualty insurance coverages including monoline property insurance. The Company's restricted commercial property policy covers fire, extended coverage, vandalism and malicious mischief for commercial establishments. This policy covers property damage up to $200,000.\nREINSURANCE\nThe Company purchases reinsurance in order to reduce its liability on individual risks and to protect against catastrophe claims. A reinsurance transaction takes place when an insurance company transfers, or \"cedes\", to another insurer a portion or all of its exposure. The reinsurer assumes the exposure in return for a portion or all of the premium. The ceding of insurance does not legally discharge the insurer from its primary liability for the full amount of the policies, and the ceding company is required to pay the claim if the reinsurer fails to meet its obligations under the reinsurance agreement.\nDuring 1993 and 1994, the Company reinsured its business under a 5% quota-share reinsurance treaty which was not renewed in 1995. Under the quota-share reinsurance treaties, the Company and its reinsurers share the premium and claims proportionately and the reinsurers pay the Company a ceding commission for their share of acquisition and operating expenses. In 1995 the Company commuted its 1993 and 1994 quota-share treaties thereby reassuming all risks and relieving the reinsurers of any further liability under those treaties.\nIn 1991 the Company wrote casualty policy limits of $1,000,000. For policies having effective dates of January 1 through September 30, 1991, the Company has excess reinsurance for 80% of casualty claims in excess of $200,000 but not exceeding $500,000 and 95% of casualty claims in excess of $500,000 up to the $1,000,000 policy limits. For policies with an effective date of October 1, 1991 through December 31, 1994, the Company has excess reinsurance for 100% of casualty claims exceeding $300,000 up to the $1,000,000 policy limits. For policies with an effective date of January 1, 1995 or\nafter, the Company has excess reinsurance for 100% of casualty claims exceeding $500,000 up to the $1,000,000 policy limits which results in a maximum net claim retention per risk of $500,000. The Company's maximum net claim retention per risk is $285,000 for policies with an effective date of January 1, 1991 through September 30, 1991 and $300,000 for policies with an effective date of October 1, 1991 through December 31, 1994.\nExcess casualty reinsurance carried by the Company includes \"extra-contractual obligations\" coverage. This coverage protects the Company against claims arising out of certain legal liability theories not directly based on the terms and conditions of the Company's policies of insurance. Extra-contractual obligation claims are covered 90% under the excess casualty reinsurance treaty up to its respective limits. The Company carries catastrophe property reinsurance to protect it against catastrophe occurrences for 95% of the property claims which exceed $500,000 but do not exceed $8,000,000. From time to time the Company makes use of facultative reinsurance to cede unusual risks on a negotiated basis.\nThe Company has signed contracts in force for its reinsurance treaties for all years through 1995. The Company has written confirmations from reinsurers for 1996 from its reinsurance intermediaries regarding the basic terms and provisions under which they will cede the Company's risks, but, as of the date hereof, formal reinsurance treaty contracts with these reinsurers have not been executed. It is customary in the industry for insurance companies and reinsurers to operate under such commitments pending the execution of formal reinsurance treaties. No assurance can be given that such reinsurance treaties will be executed or, if executed, that the terms and provisions thereof will not be modified.\nThe Company is operating under excess casualty reinsurance treaties with two reinsurance companies, each of which reinsures a given percentage of ceded risks. The Company's excess reinsurance is provided in varying amounts by reinsurers rated \"A (Excellent)\" or better by A.M. Best Company (Best's). See \"Business--Rating.\" The following table identifies each such reinsurer and sets forth the percentage of the coverage assumed by each of them:\nMARKETING AND DISTRIBUTION\nThe Company markets its insurance products through 180 non-affiliated general agents' offices, commonly referred to as wholesale agents. These general agents each represent several insurance companies, some of which may compete with the Company. The general agents solicit business from\nindependent local agents or brokers, commonly referred to as retail agents, who are in direct contact with insurance buyers.\nThe Company has elected to utilize general agents to market its insurance products in order to avoid the fixed costs of a branch office system. These general agents have experience in the specialty lines of coverages in which the Company concentrates and, in many instances, a long business history with members of the Company's management. The Company requires that its general agents have a specified level of errors and omissions insurance coverage, which indirectly protects the Company against certain negligence on the part of general agents. The Company performs annual financial reviews and does limited quarterly reviews on each of its agent entities. The Company has errors and omissions insurance coverage to protect against negligence on the part of its employees.\nThe Company has developed underwriting manuals to be used by its general agents. The general agents are authorized to commit the Company to provide insurance if the risks and terms involved in the particular coverage are within the underwriting guidelines set forth in the Company's underwriting manuals. The Company has devoted extensive resources to the development of detailed underwriting manuals so that its general agents can consistently price and select risks, and the Company believes its manuals have been a significant factor in consistently producing superior underwriting results. All manuals stipulate minimum rates to be charged for the various classes of coverage offered.\nThe general agents are compensated on a commission basis which varies by line of business. In addition, the general agency contracts between the Company and its general agents contain significant profit contingency inducements designed to reward those general agents with superior claim ratios who write certain minimum levels of premium with the Company. The general agents also retain a portion of the payment made by the insured as policy fee in connection with the issuance of most of the Company's non- admitted policies.\nCertain coverages, such as auto liability, may only be written in some states by companies with the authority to write insurance on an admitted basis in such states. The Company currently is approved to write insurance on an admitted basis in 41 states and plans to seek authority to write insurance on an admitted basis in virtually all of the remaining states, but no assurance can be given of when or if this goal will be reached.\nUNPAID CLAIMS AND CLAIM ADJUSTMENT EXPENSES\nThe Company maintains reserves for the payment of claims and claim adjustment expenses for both reported and unreported claims. Claim reserves are estimates, at a given point in time, of amounts that the Company expects to pay on incurred claims based on facts and circumstances then known. The amount of claim reserves for reported claims is primarily based upon a case-by-case evaluation of the type of claim involved, the circumstances surrounding the claim, and the policy provisions relating to the type of claim. The amount of claim reserves for unreported claims and case reserve development is determined on the basis of historical information and anticipated future conditions by lines of insurance and actuarial review. Reserves for claim adjustment expenses are intended to cover the ultimate costs of settling claims, including investigation and defense of lawsuits resulting from such claims. Inflation is implicitly reflected in the reserving process through analysis of cost trends and review of historical\nreserve results.\nUltimate liability may be greater or lower than current reserves. Reserves are continually monitored by the Company using new information on reported claims and a variety of statistical techniques. The Company does not discount to present value that portion of its claim reserves expected to be paid in future periods.\nThe following table sets forth the changes in unpaid claims and claim adjustment expenses, net of reinsurance cessions, as shown in the Company's consolidated financial statements for the periods indicated:\n(1) The Company commuted its 1993 and 1994 quota-share reinsurance treaties in 1995, respectively, and thereby reassumed all risks and the related unpaid claims and claim adjustment expenses of $2,223,000 (see note 4 to the consolidated financial statements). This was accounted for using the paid claim method, whereby unpaid claims and claim adjustment expenses were increased $2,223,000 and paid claims and claim adjustment expenses were decreased $2,223,000, thus preventing distortion of claims and claim adjustment expenses incurred.\nThe following table sets forth, as of December 31, 1995, 1994, and 1993, differences between the amount of net unpaid claims and claim adjustment expenses reported in the Company's statements, prepared in accordance with statutory accounting principles (\"SAP\"), and filed with the various state insurance departments, and those reported in the consolidated financial statements prepared in accordance with generally accepted accounting principles (\"GAAP\"):\nThe following table represents the development of GAAP balance sheet reserves for the period 1985 through 1995. The top line of the table shows the reserves for unpaid claims and claim adjustment expenses for all current and prior years as recorded at the balance sheet date for each of the indicated years. The reserves represent the estimated amount of claims and claim adjustment expenses for claims arising in the current and all prior years that are unpaid at the balance sheet date, including claims that have been incurred but not yet reported to the Company.\nThe upper portion of the following table shows the net cumulative amount paid with respect to the previously recorded liability as of the end of each succeeding year. The lower portion of the table shows the reestimated amount of the previously recorded net reserves based on experience as of the end of each succeeding year, including net cumulative payments made since the end of the respective year. For example, the 1990 liability for net claims and claim adjustment expenses reestimated five years later (as of December 31, 1995) was $29,022,000 of which $26,970,000 has been paid, leaving a net reserve of $2,052,000 for claims and claim adjustment expenses in 1990 and prior years remaining unpaid as of December 31, 1995.\n\"Net cumulative redundancy (deficiency)\" represents the change in the estimate from the original balance sheet date to the date of the current estimate. For example, the 1990 net reserve for unpaid claims and claim adjustment expenses indicates a $116,000 net deficiency from December 31, 1990 to December 31, 1995 (five years later). Conditions and trends that have affected development of 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.\nThe Company has an indicated deficiency of approximately 1% of initial reserves for the 1994 year. Net reserves at December 31, 1995 were approximately $70,361,000, which the Company believes are adequate.\nOPERATING RATIOS\nCLAIMS, EXPENSE AND COMBINED RATIOS: Claims and expense ratios are traditionally used to interpret the underwriting experience of property and casualty insurance companies.\nStatutory Accounting Principles (SAP) Basis - Claims and claim adjustment expenses are stated as a percentage of premiums earned because claims may occur over the life of a particular insurance policy. Underwriting expenses on a SAP basis are stated as a percentage of net premiums written rather than premiums earned because most underwriting expenses are incurred when policies are written and are not spread over the policy period. Underwriting profit margin is achieved when the combined ratio is less than 100%. The Company's claims, expense and combined ratios and the property and casualty industry's claims, expense and combined ratios, both on a SAP basis, are shown in the following table:\n- ----------\n(1) The property and casualty industry as a whole, not companies with comparable lines of coverage, was used in the calculation of these ratios by A.M. Best Company. 1995 is estimated.\nThe Company has continued to produce favorable claims ratios when compared to the industry. This has resulted from the Company maintaining its high underwriting standards and closely monitoring its pricing structure and adjusting it when needed. Since 1988 the Company has targeted, through its pricing decisions, a claims ratio range of 50-55% and a combined ratio range of 85-90%. The Company has been very successful in attaining these goals and when results have fallen outside of the range, it has been on the favorable side. The unfavorable variance to the industry with regard to the expense ratios is because of the specific lines that the Company writes and the profit contingency inducements. The Company's commission expense ratio is higher than the average of the overall industry on a net premiums written basis. Its higher expense ratios are more than offset by significantly lower claims ratios (favorable by an estimated 31.3 percentage points in 1995 and 33.2 percentage points in 1994, when compared to the industry) which results in the highly favorable combined ratio variances of an estimated 23.2 and 24.8 percentage points in 1995 and 1994, respectively. It should be noted that the Company ratios relate only to insurance operations. The holding company provides administrative and financial services for its wholly-owned subsidiaries. The allocation of the holding company's expenses solely to its insurance companies would have an impact on their results of operations and would also affect the ratios presented.\nGenerally Accepted Accounting Principles (GAAP) Basis - Claims and claim adjustment expenses are stated as a percentage of premiums earned as they are on a SAP basis. However, earned premiums include net policy fees earned whereas on a SAP basis policy fees earned are recorded on a gross basis. The GAAP expense ratio is based on premiums earned and includes the change in policy acquisition costs and underwriting expenses. Other differences include the treatment of the allowance for doubtful accounts. The following table presents the Company's claims, expense and combined ratios on a GAAP basis:\nPREMIUM TO SURPLUS RATIO: The following table shows, for the periods indicated, the Company's statutory ratios of statutory net premiums written to statutory policyholders' surplus. While there is no statutory requirement which establishes a permissible net premiums written to surplus ratio, guidelines established by the National Association of Insurance Commissioners (NAIC) provide that this ratio should be no greater than 3 to 1.\nINVESTMENTS\nThe Company's investment portfolio is under the direction of the Board of Directors acting through the Investment Committee. The Investment Committee establishes the Company's investment policy, which is to maximize after-tax yield while maintaining safety of capital together with adequate liquidity for insurance operations. The investment portfolio consists primarily of fixed maturity tax-exempt municipal bonds and United States Government securities. The Company does not invest in high yield (\"junk\") securities. As of December 31, 1995 and 1994, the Company had no high-yield fixed maturity securities nor non-performing fixed maturity securities. Furthermore, the Company has never bought nor sold either high-yield fixed maturity securities or derivatives. The Company does not actively trade its bonds, however, it does classify certain bond securities as available for sale. The Company holds no equity securities in issuers of high-yield debt securities.\nThe following table sets forth, for the periods indicated, the Company's investment results, before income tax effects:\n- ----------\n(1) Average investments is the average of beginning and ending investments at amortized cost, computed on an annual basis.\n(2) Includes taxable and tax-exempt securities.\nThe following table sets forth the composition of the investment portfolio of the Company.\nThe maturity distribution of the Company's investments in fixed maturities at December 31, 1995 and 1994, is as follows:\nRATING\nA.M. Best Company (\"Best's\"), publisher of Best's insurance reports, property-casualty, has currently assigned an \"A+ (Superior)\" pooled rating to the Company. Best's ratings are based on an analysis of the financial condition and operation of an insurance company as they relate to the industry in general. Best's generally reviews its ratings on a quarterly basis.\nGOVERNMENT REGULATION\nThe Company's insurance companies are subject to varied governmental regulation in the states in which they conduct business. Such regulation is vested in state agencies having broad administrative power dealing with all aspects of the Company's business and is concerned primarily with the protection of policyholders rather than shareholders. It is the Company's position that Proposition 103, which was enacted by the State of California and imposes a roll-back of property and casualty insurance rates, does not apply to the premium writings of the Company since the Company only writes in the surplus lines market in California.\nThe Company is also subject to statutes governing insurance holding company systems in the states of Oklahoma and Texas. These statutes require the Company to file periodic information with the state regulatory authorities, including information concerning its capital structure, ownership, financial condition and general business operation. These statutes also limit certain transactions between the Company and its insurance companies, including the amount of dividends which may be declared and paid by the insurance companies (see note 6 to the consolidated financial statements). Additionally, the Texas statutes restrict the ability of any one person to acquire 10% or more of the Company's voting securities without prior regulatory approval while the Oklahoma statute restricts the ability of any one person to acquire 15% or more of the Company's voting securities without prior regulatory approval.\nCOMPETITION\nThe property and casualty insurance industry is highly competitive, with over 2,500 insurance companies transacting business in the United States. The Company underwrites specialty lines of\ninsurance on risks not generally insured by many of the large standard property and casualty insurers. However, few barriers exist to prevent property and casualty insurance companies from entering into the Company's segments of the industry. In such event, the Company would be at a competitive disadvantage because many of these companies have substantially greater financial and other resources and could offer a broader variety of specialty risk coverages. The Company's competitive advantages are 1) specialized expertise in its product lines which enables it to price with a great deal of accuracy and 2) superior service in underwriting and claims handling which provides its agents with a competitive advantage and a stable market.\nEMPLOYEES\nAs of December 31, 1995, the Company employed 184 persons, of which 11 were officers, 138 were staff and administrative personnel, and 35 were part-time employees.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nInformation concerning the executive officers of the Company as of February 29, 1996 is set forth below:\nMr. Joseph D. Macchia is the founder of the Company and has served as Chairman of the Board, President and Chief Executive Officer since its formation in 1978. Mr. Macchia has been engaged in the property and casualty insurance business since 1961.\nMr. Jack L. Johnson has served as Senior Vice President of the Company since 1984. From 1979 to 1984, Mr. Johnson served as a Vice President of the Company. Mr. Johnson has been engaged in the property and casualty insurance business since 1962.\nMr. Daniel J. Coots has served as Vice President, Treasurer and Chief Financial Officer of the Company since 1987. In 1991 Mr. Coots was promoted to Senior Vice President. Mr. Coots has been engaged in the property and casualty insurance business since 1983.\nMr. Norman Alberigo has served as Vice President of the Company since 1988. From 1986 to 1988, Mr. Alberigo served as Assistant Vice President of the Company. Mr. Alberigo has been engaged in the property and casualty insurance business since 1970.\nMr. Mark D. Brissman has served as Vice President of the Company since October of 1994. From 1989 to 1994, Mr. Brissman was with State Farm Insurance Company in the position of Senior Associate Actuary. Mr. Brissman has been engaged in the property and casualty insurance business since 1978.\nMr. J. Landis Graham has served as Vice President of the Company since September of 1993. From 1988 to 1993, Mr. Graham was with Maryland Casualty Company in the position of Claim Manager. Mr. Graham has been engaged in the property and casualty insurance business since 1976.\nMs. Carolyn E. Ray has served as Vice President of the Company since 1986. From 1984 to 1985, Ms. Ray served as Assistant Vice President of the Company. Ms. Ray has been engaged in the property and casualty insurance business since 1976.\nMr. Sam Rosen has served as the Secretary of the Company since 1983. Mr. Rosen is a partner with the law firm of Shannon, Gracey, Ratliff & Miller, L.L.P. He has been a partner in that firm or its predecessors since 1966.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTY\nThe Company owns its Corporate offices which provide approximately 25,000 square feet of office space, and additionally provides parking. Future expansion will be possible by converting the parking area into office space.\nThe Company owns a 3.28 acre tract of land in Fort Worth, Texas and all improvements located thereon, including a 10,000 square foot office building, which previously served as its corporate offices. The Company currently has this property under lease.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIn the normal course of its operations, the Company has been named as defendant in various legal actions seeking payments for claims denied by the Company and other monetary damages. In the opinion of the Company's management the ultimate liability, if any, resulting from the disposition of these claims will not have a material adverse effect on the Company's consolidated financial position. The Company's management believes that unpaid claims and claim adjustment expenses are adequate to cover liabilities from claims which arise in the normal course of its insurance 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 SHAREHOLDER MATTERS.\nThe Company's Common Stock is listed on the American Stock Exchange (Symbol: GNA). The following table sets forth for the fiscal periods indicated the high and low closing sales prices per share of the Common Stock as reported by the American Stock Exchange, as adjusted for stock dividends. The prices reported reflect actual sales transactions on the American Stock Exchange.\nIn 1991 the Company adopted a policy to declare quarterly cash dividends of $.01 per share until further action by the Board of Directors. In November of 1995, the Board of Directors increased the quarterly cash dividend to $.0125 per share. Cash dividends of $.01 per share were granted to shareholders of record on March 31, June 30, September 30 and December 31, 1993 and 1994 and March 31, June 30 and September 30, 1995. Cash dividends of $.0125 per share were granted to shareholders of record on December 31, 1995. On February 20, 1996, the Company declared a $.0125 per share cash dividend payable to shareholders of record on March 29, 1996. The Company depends on cash flow from cash dividends paid by its subsidiaries.\nStock dividends of 5% were granted to shareholders of record on March 31 and September 30, 1993, 1994 and 1995. In November, 1995, the Board of Directors discontinued the semi-annual stock dividends.\nAs of February 29, 1996, there were 633 shareholders of record of the Company's Common Stock.\nITEM 6.","section_6":"ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA\nThe selected consolidated financial data presented below for, and as of the end of each of the years ended December 31, have been derived from the consolidated financial statements of the Company which have been audited by KPMG Peat Marwick LLP, independent certified public accountants. The consolidated balance sheets as of December 31, 1995 and 1994, and the consolidated statements of operations, shareholders' equity and cash flows for each of the years in the three-year period ended December 31, 1995, and the report thereon are included elsewhere in this document. The information presented below should be read in conjunction with \"Management's Discussion and Analysis of Financial Condition and Results of Operations,\" consolidated financial statements and the notes thereto, and the other financial information included herein.\n- ----------\n(1) Excludes premiums of $5,626,000 in 1995, $5,056,000 in 1994, $5,418,000 in 1993, $6,942,000 in 1992 and $4,452,000 in 1991 from the commercial automobile plans of Arkansas, California, Louisiana, Mississippi, and Pennsylvania under which a subsidiary of the Company is a servicing carrier.\n(2) Includes after tax net realized gains of $70,000, $87,000, $3,000, $114,000 and $45,000 for 1995, 1994, 1993, 1992 and 1991, respectively.\n(3) All years retroactively adjusted for stock dividends and stock splits effected as stock dividends as follows: two 5% in 1995, two 5% in 1994, two 5% in 1993, one 5% and one 50% in 1992 and one 50% in 1991.\n(4) Certain reclassifications have been made to years prior to 1993 to comply with Statement of Financial Accounting Standards No. 113 \"Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts\" which the Company implemented in the first quarter of 1993.\n(5) Based on number of shares outstanding at the end of each year, retroactively adjusted for stock dividends and stock splits effected as stock dividends.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nBUSINESS OPERATIONS\nNet income in 1995 increased 16% to $17,627,855, or $.81 per share compared to 1994 net income of $15,168,800, or $.70 per share and 1993 net income of $13,240,254, or $.61 per share. The Company recorded a 22% return on beginning equity and a GAAP combined ratio of 82.9% in 1995.\nThe discussion below primarily relates to the Company's insurance operations, although the selected consolidated financial data appearing elsewhere is on a consolidated basis. The revenue item \"Insurance services\" includes net revenues from the computer software operation, the plan servicing operation and the premium finance operation. The expense item \"Underwriting and operating expenses\" includes the operating expenses of these operations.\nRESULTS OF OPERATIONS\nGross premiums written in 1995 of $108,071,871 were 10% above the $98,163,684 recorded in 1994. In 1994, gross premiums written increased 15% over the 1993 level. The following table compares the product line mix between the years for gross premiums written:\nCOMMERCIAL AUTO increased 8% in 1995 from 1994 after recording a 13% increase in 1994 from 1993. Significant growth continued for this product in Kentucky and Pennsylvania in 1995, as it had in 1994, with New Jersey contributing in 1995. The AUTO GARAGE product line produced a 26% increase in 1995 after a 25% increase in 1994. Florida and Pennsylvania continued to provide significant growth in 1995, as was the case in 1994. Entry into the Connecticut market and significant growth in Kentucky in 1995 also contributed. The GENERAL LIABILITY line continues to record increases with 3% in 1995 after an increase of 14% in 1994. For 1995, gross written percentages by significant state\/product line are as follows: Texas commercial auto (23%), Pennsylvania commercial auto (7%), Texas general liability (7%), and Kentucky commercial auto (5%) with no other individual state\/product line comprising 5% or more. The persistency rate increased for all major product lines, overall the rate went from 44% in 1994 to 47% in 1995. Premiums earned increased 15% in 1995 to $97,254,816 and increased 11% in 1994 to $84,394,874 as a direct result of the continued increase in writings.\nNet investment income increased 19% in 1995 over 1994 and increased 12% in 1994 over 1993.\nThese increases are the result of growth in the portfolio due to continued positive cash flows from operations. The return on average investments for 1995 is 4.8% versus 4.6% in 1994 and 4.8% in 1993. The increase from 1994 to 1995 is attributable to the reinvestment of maturing securities at higher yields. The decrease from 1993 to 1994 is related to the Company maintaining larger than usual balances in short-term funds (which have lower yields than bonds), during the third quarter of 1994 in anticipation of an increase in interest rates. Inflation can cause interest rates to increase, which would cause the Company's interest income to increase. Because of the Company's profitability in the underwriting operations, the Company achieves the highest after tax net income by investing predominantly in tax-exempt securities. At December 31, 1995, 89% of the Company's investments were in investment grade tax-exempt bonds with an average maturity of approximately 3.5 years. Since the majority of the Company's investments are tax-exempt, the yields appear lower than those of the industry; however, the industry as a whole has a significantly larger percentage of investments in taxable securities with substantially longer maturities. On a taxable equivalent basis the return on average investments was 6.6% in 1995, 6.4% in 1994 and 6.6% in 1993. The Company has the ability to hold its fixed maturity securities until their maturity date. The Company does not actively trade its bonds, however, it does classify certain bond securities as available for sale. At December 31, 1995, approximately 5% of the Company's investments were in U.S. Treasury securities and 5% were in short-term money market funds. The Company has not and does not intend to invest in derivatives or high-yield (\"junk\") securities, nor equity securities in issuers of \"junk\" debt securities. The Company does not have any non-performing fixed maturity securities.\nInsurance services revenue increased $126,152 from 1994 to 1995 following a decrease of $331,175 in 1994 from 1993. The table below presents the components.\nRevenues in the computer software operation were 15% below 1994 following an increase in revenues of 9% in 1994 over 1993. New management was brought in during the third quarter of 1995 to improve this operation.\nRevenues from the premium finance operation are up 83% in 1995 over the 1994 level which was 3% below the 1993 level. Intensified marketing efforts implemented in 1995 account for the increase in 1995. The decrease in 1994 was the result of the run- off of a book of business produced in 1993. Amounts financed in 1995 were 84% above 1994 which had increased 48% over 1993. Premium finance notes receivable were approximately $2,015,000 at December 31, 1995 versus $977,000 at December 31, 1994 and the average return was 19% for 1995 versus 18% in 1994 and 13% in 1993.\nPlan servicing revenues from commercial automobile plans increased 2% in 1995 over 1994 following a 21% decrease in 1994. The Louisiana plan continued to depopulate in 1995, but its decrease was more\nthan offset by the addition of the California plan in the second quarter of 1995. The decrease in 1994 was largely due to a decrease in premium writings in the Louisiana plan. In 1994, the Pennsylvania and Mississippi plans recorded significant increases in premium writings but fell short of the decrease in the Louisiana plan. The Company continues to pursue management contracts with other states to administer their commercial automobile plans.\nClaims and claim adjustment expenses (C & CAE) increased $7,276,443 in 1995 over 1994 and $1,949,774 in 1994 over 1993. The increase in both years was largely due to the Company's increased levels of writings. The C & CAE ratio was 49.8% in 1995, 48.8% in 1994 and 51.7% in 1993. While the Company writes a material amount of business in areas where catastrophes have recently occurred, the gross and net claims incurred from these events were immaterial because the Company primarily writes liability coverages. Five separate hailstorms, which occurred during the second quarter of 1995, accounted for approximately .9 points of the 1995 C & CAE ratio. With regard to environmental and product liability claims, the Company has an immaterial amount of exposure. The Company does not provide environmental impairment coverage and excludes pollution and asbestos related coverages in its policies. Less than .1% of the Company's premium writings are for product liability coverages and this is limited to non-manufacturing risks only. Inflation impacts the Company by causing higher claim settlements than may have originally been estimated. Inflation is implicitly reflected in the reserving process through analysis of cost trends and review of historical reserve results.\nCommissions increased in 1995 over 1994 as a result of the increase in written premiums between these years and as a result of commission income from the 1994 5% quota share treaty (which was not renewed in 1995) only reducing commission expense approximately $200,000 in 1995, whereas it decreased commission expense in 1994 by approximately $2,364,000. The increase in commissions from 1993 to 1994 is directly related to the increase in gross premiums written. The ratio of commissions to gross premiums written increased to 20% in 1995 from the 19% level in 1994 and 1993 as a result of the decrease in commission income in 1995 discussed previously. The ratio of commissions to premiums earned was 23% for 1995 as compared to 22% for the 1994 and 1993 years. The increase in 1995 was related to the decrease in commission income in 1995.\nThe change in deferred policy acquisition costs and deferred ceding commission income (DAC) resulted in a net increase to income of $2,284,138, $1,321,946 and $305,495 for 1995, 1994 and 1993, respectively. The change in the amount of the increase in DAC between the comparable periods is directly related to the rate at which unearned premiums are growing as a result of the growth rate of premium writings. Since DAC (asset) is a function of unearned premiums (liability), an increase in the growth rate of unearned premiums would correspondingly result in an increase in the growth rate of DAC and vice versa. The ratio of DAC to net unearned premiums was 25.5%, 25.4% and 25.3% at December 31, 1995, 1994 and 1993, respectively.\nUnderwriting and operating expenses increased for each of the years, but remain in a 16-17% range (as a percent of premiums earned and insurance services revenues) as they have been for the previous two years.\nThe effective tax rate of the Company was 26% in 1995, 26% in 1994 and 21% in 1993. The 21% rate in 1993 is primarily due to a tax benefit generated from the exercise of stock options by insiders during the first quarter of 1993. This was a permanent tax difference which was deducted for tax but not for book purposes. For the Company, the fresh start adjustment (tax benefit) was immaterial for all years presented. A reconciliation between income taxes computed at the Federal statutory rates and the\nprovision for income taxes is included in Note 5 of Notes to Consolidated Financial Statements.\nThe cumulative effect of change in accounting principle is the result of the Company implementing Financial Accounting Standards Board Statement 109 \"Accounting for Income Taxes\" on a cumulative basis during the first quarter of 1993. The major portion of the $216,278 deferred tax benefit is attributable to the increase in the tax discount of unpaid claim and claim adjustment expenses.\nThe Company has, for the 11th consecutive year, achieved a return on beginning equity of at least 22% and for the tenth consecutive year recorded a GAAP combined ratio at 86% or below. For 1996 the Company is targeting premiums written to be within a $110-120 million range with a GAAP combined ratio of 82-85% and a return on beginning equity of 20-22%. While the Company is optimistic these forward-looking goals can be attained no assurances can be given they will occur.\nLIQUIDITY AND CAPITAL RESOURCES\nThe primary sources of the Company's liquidity are funds generated from insurance premiums, net investment income and maturing investments. The short-term investments and cash are intended to provide adequate funds to pay claims without selling fixed maturity investments. At December 31, 1995, the Company held short-term investments and cash of $7,750,020 which the Company believes is adequate liquidity for the payment of claims and other short-term commitments.\nWith regard to long term liquidity, the average duration of the investment portfolio is approximately 2.8 years. The fair value of the fixed maturity portfolio at December 31, 1995 was $2,772,216 above amortized cost. With regard to the availability of funds to the holding company, see Note 6 of Notes to Consolidated Financial Statements for restrictions on the payment of dividends by the insurance companies.\nThe Company's fronting arrangements require that it maintain escrow accounts to assure payment of the unearned premiums and unpaid claims and claim adjustment expenses relating to risks insured through such fronting arrangements and assumed by the Company. At December 31, 1995 and 1994, the balance in such escrow accounts totalled approximately $1,100,000. In addition, various insurance departments of states in which the Company operates require the deposit of funds to protect policyholders within those states. At December 31, 1995 and 1994, the balance on deposit for the benefit of such policyholders totalled approximately $11,860,000 and $11,010,000, respectively.\nThe increase in investments is primarily attributable to continued positive cash flows from operating activities which are the result of continued and substantial underwriting profits. Premiums receivable increased as a result of the large increase in premium writings late in the fourth quarter of 1995 over the amounts written in the comparable 1994 period. Also contributing to this increase was the large increase in premium finance notes receivable mentioned previously. Deferred policy acquisition costs (DAC) increased primarily as a result of the increase in premium writings. DAC is 25.5% and 25.4% of unearned premiums at December 31, 1995 and 1994, respectively.\nUnpaid claims and claim adjustment expenses have increased as a result of an increase in incurred but not reported reserves under the excess casualty treaty and because of the increase in writings. Unearned premiums increased because of the increase in writings. Reinsurance balances payable decreased largely due to the commutation in 1995 of the 5% quota share treaty that was in effect for the 1993 and 1994 years. Under the terms of the treaty, the Company held the funds due to the reinsurers and recorded them as reinsurance balances payable. When the Company commuted this treaty the liability was released. Drafts payable decreased because drafts were issued late in the fourth quarter of\n1994 to pay several large claims, there were no exceptionally large claim settlements made late in 1995. The note payable decreased as a result of principal repayment during the second quarter (see Note 3 of Notes to Consolidated Financial Statements). The Company's liquidity position remains strong as a result of cash flows from underwriting and investment activities.\nThe increase in common stock is largely the result of the 5% stock dividends paid on April 14 and October 16, 1995. This also accounts for the increase in additional paid-in capital and the decrease in retained earnings.\nFinancial Accounting Standards Board Statement 115, \"Accounting for Certain Investments in Debt and Equity Securities\" was adopted by the Company in the first quarter of 1994. This Statement specifies the accounting and reporting for investments in equity securities that have readily determinable fair values and for all investments in debt securities. Under this statement, the Company classifies certain debt securities as \"available for sale\" and records them at fair value. As a result of the \"Implementation Guide\" for Statement 115, in December, 1995, the Company transferred certain fixed maturity securities from the held to maturity classification to the available for sale classification. The amortized cost of these transfers was $18,519,856 with unrealized gains of $93,803, net of tax.\nThe unrealized gains or losses on fixed maturities available for sale are presented, net of tax, as a separate component of shareholders' equity (see Note 2 of Notes to Consolidated Financial Statements). The net unrealized gain on the fixed maturities classified as held to maturity was $1,120,527 at December 31, 1995.\nIn October 1994, the FASB issued Statement 119, \"Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments.\" The Statement was effective for years ending after December 15, 1994 and did not have any impact on the financial statements.\nIn March 1995, the FASB issued Statement 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.\" The Statement was effective for years ending after December 15, 1995, and did not have any impact on the financial statements.\nIn October 1995, the FASB issued Statement 123, \"Accounting for Stock-Based Compensation.\" The Statement is effective for years beginning after December 15, 1994, if awards are granted in the fiscal year. The Company did not grant any awards during 1995.\nThe Company is not aware of any current recommendations by the regulatory authorities, which if implemented, would have a material effect on the Company's liquidity, capital resources or results of operations. The Company's statutory capital significantly exceeds the benchmark capital level under the Risk Based Capital formula.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe following consolidated Financial Statements are on pages 33 through 56:\nPage ---- Report of Management 33 Independent Auditors' Report 34\nConsolidated Balance Sheets as of December 31, 1995 and 1994 35-36\nConsolidated Statements of Operations for the Years Ended December 31, 1995, 1994, and 1993 37\nConsolidated Statements of Shareholders' Equity for the Years Ended December 31, 1995, 1994, and 1993 38-39\nConsolidated Statements of Cash Flows for the Years Ended December 31, 1995, 1994, and 1993 40-41\nNotes to Consolidated Financial Statements December 31, 1995, 1994, and 1993 42-56\nThe following Consolidated Financial Statements Schedules are on pages 57 through 68:\nSchedule Page -------- ----\nIndependent Auditors' Report on Supplementary Information 57\nI Summary of Investments 58\nII Condensed Financial Information of the Registrant 59-65\nIII Supplementary Insurance Information 66\nIV Reinsurance 67\nVI Supplemental Information 68\nITEM 9.","section_9":"ITEM 9. DISAGREEMENTS 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 by this item with regard to Executive Officers is included in Part 1 of this report under the heading \"Executive Officers of the Registrant\".\nThe other information required by this item is hereby incorporated by reference from the Registrant's definitive 1996 Proxy Statement.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by this item is hereby incorporated by reference from the Registrant's definitive 1996 Proxy Statement.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required by this item is hereby incorporated by reference from the Registrant's definitive 1996 Proxy Statement.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by this item is hereby incorporated by reference from the Registrant's definitive 1996 Proxy Statement.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) Documents filed as part of the report:\n1. The following financial statements filed under Part II, Item 8:\nIndependent Auditors' Report\nConsolidated Balance Sheets as of December 31, 1995 and 1994\nConsolidated Statements of Operations for the Years Ended December 31, 1995, 1994 and 1993\nConsolidated Statements of Shareholders' Equity for the Years Ended December 31, 1995, 1994 and 1993\nConsolidated Statements of Cash Flows for the Years Ended December 31, 1995, 1994 and 1993\nNotes to Consolidated Financial Statements, December 31, 1995, 1994 and 1993\n2. The following Consolidated Financial Statement Schedules are filed Under Part II, Item 8:\nSchedule Description -------- -----------\nI Summary of Investments\nII Condensed Financial Information of the Registrant\nIII Supplementary Insurance Information\nIV Reinsurance\nVI Supplemental Information\n3. The following Exhibits:\nExhibit No.\n3.1 Restated Articles of Incorporation of Registrant (Exhibit 3.1)(1)\n3.2 Articles of Amendment to the Articles of Incorporation dated June 9, 1988 (Exhibit 3.2)(2)\n3.3 Restated Bylaws of Registrant (Exhibit 3.2)(1)\n3.4 Amendment to the Bylaws dated June 10, 1988 (Exhibit 3.4)(2)\n3.5 Sections 2.06 and 2.07 of the Bylaws as Amended on May 25, 1993 (Exhibit 3.5)(7)\n3.6 Articles of Amendment to Articles of Incorporation effective August 13, 1993 (Exhibit 3.6)(7)\n4.2 Rights Agreement, dated as of March 3, 1988, between the Registrant and Team Bank\/Fort Worth, N.A. (incorporated by reference to Exhibit 1 to the Registrant's Current Report on Form 8-K filed with the Securities and Exchange Commission on March 15, 1988) (Exhibit 4.2)(3)\n4.3 Amendment No. 1 dated as of March 5, 1990 to Rights Agreement dated as of March 3, 1988 between GAINSCO, INC. and Team Bank as Rights Agent (Exhibit 4.2)(5)\n4.4 Amendment No. 2 dated as of May 25, 1993 to Rights Agreement between GAINSCO, INC. and Society National Bank (successor to Team Bank (formerly Texas American Bank\/Fort Worth, N.A.)), as Rights Agent (Exhibit 4.4)(7)\n4.5 Stock certificate as amended to give notice of Amendment No. 2 to Rights Agreement (Exhibit 4.5)(7)\n10.2 (Restated) Incentive Compensation Plan of the Registrant (Exhibit 10.2)(2)\n10.14 Profit Sharing Plan and Trust of GAINSCO, INC. effective January 1, 1985, as amended, and Adoption Agreement (Exhibit 10.14)(4)\n10.16 1990 Stock Option Plan of the Registrant (Exhibit 10.16)(4)\n10.17 Loan Agreement and Amendment No. 1 to Loan Agreement between GAINSCO Service Corp., GAINSCO, INC. and BankOne Texas, N.A. (Exhibit 10.17)(6)\n10.18 Promissory Note made by GAINSCO Service Corp. payable to BankOne, Texas, N.A. (Exhibit 10.18)(6)\n10.19 Guaranty Agreement executed by GAINSCO, INC., in favor of BankOne Texas, N.A. (Exhibit 10.19)(6)\n10.20 Negative Pledge Agreement executed by GAINSCO, INC. (Exhibit 10.20)(6)\n10.21 Negative Pledge Agreement executed by GAINSCO Service Corp. (Exhibit 10.21)(6)\n10.23 Surplus Debenture issued by GAINSCO County Mutual Insurance Company. (Exhibit 10.23)(6)\n10.24 Management Contract between GAINSCO County Mutual Insurance Company and GAINSCO Service Corp. (Exhibit 10.24)(6)\n10.25 Certificate of Authority and accompanying Commissioner's Order granting Certificate of Authority, allowing for charter amendments and extension of charter (Exhibit 10.25)(6)\n10.26 Contract between GAINSCO, INC. and International Business Machines Corporation covering the Company's acquisition and installation of the WINS software package and of the AS\/400 hardware and systems software required to support it for use by the Company (Exhibit 10.26)(7)\n10.27 Amendment to Surplus Debenture issued by GAINSCO County Mutual Insurance Company (Exhibit 10.27)(7)\n10.28 Agreement dated August 26, 1994 appointing Continental Stock Transfer & Trust Company transfer agent and registrar (Exhibit 10.28)(8).\n10.29 Amendment No. 3 to Rights Agreement and appointment of Continental Stock Transfer & Trust Company as Successor Rights Agent, made September 30, 1994 (Exhibit 10.29)(8).\n10.30 Second Amendment to Loan Agreement among GAINSCO Service Corp., GAINSCO, INC. and BankOne Texas, N.A. made on July 26, 1990 (Exhibit 10.30)(8)\n10.31 1995 Stock Option Plan of the Registrant (9)\n10.32 Clarification to the GAINSCO, INC. Executive Incentive Compensation Plan (9)\n11 (Not required to be filed as an Exhibit. See footnote (1)(j) on page 47 of this 10-K Report for information called for by number 11 of the Exhibit Table to Item 601 of S-K)\n22.2 Subsidiaries of Registrant (9)\n24.2 Consent of KPMG Peat Marwick LLP to incorporation by reference (9)\n25.1 Powers of Attorney (9)\n27 Financial Data Schedule (9)\n28.8 Schedule P from the 1995 Annual Statement of General Agents Insurance Company of America, Inc. (10)\n28.9 Schedule P from the 1995 Annual Statement of MGA Insurance Company, Inc. (10)\n28.10 Schedule P from the 1995 Annual Statement of GAINSCO County Mutual Insurance Company (10)\n(1) Incorporated by reference to the Exhibit shown in parenthesis filed in Registration Statement No. 33-7846 on Form S-1, and amendments thereto, filed by the Company with the Securities and Exchange Commission and effective November 6, 1986.\n(2) Incorporated by reference to the Exhibit shown in parenthesis filed in Registration 33-25226 on Form S-1, and amendments thereto, filed by the Company with the Securities and Exchange Commission and effective November 14, 1988.\n(3) Incorporated by reference to the Exhibit shown in parenthesis filed in the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1988.\n(4) Incorporated by reference to the Exhibit shown in parenthesis filed in the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1990.\n(5) Incorporated by reference to the Exhibit shown in parenthesis filed in the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1991.\n(6) Incorporated by reference to the Exhibit shown in parenthesis filed in the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1992.\n(7) Incorporated by reference to the Exhibit shown in parenthesis filed in the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1993.\n(8) Incorporated by reference to the Exhibit shown in parenthesis filed in the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1994.\n(9) Filed herewith, See Exhibit Index.\n(10) Filed under Form SE.\n(b) Reports on Form 8-K\nDuring the last quarter of the fiscal year ended December 31, 1995, no reports on Form 8-K have been filed by the Company.\n(c) Exhibits required by Item 601 of Regulation SK\nThe exhibits listed in Item 14(a) 3 of this Report, and not incorporated by reference to a separate file are filed herewith.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nGAINSCO, INC. (Registrant)\n\/s\/ Joseph D. Macchia - --------------------------------- By: Joseph D. Macchia, President\nDate: 3\/28\/96\nPursuant to the requirements of the Securities Exchange Act of 1934, 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\/ Joseph D. Macchia ------------------------------------- Joseph D. Macchia, Attorney in-fact Under Power of Attorney\nSubsequent to the filing of the Annual Report on this Form, an Annual Report to Security Holders covering the Registrant's last fiscal year and a Proxy Statement and Form of Proxy will be sent to more than ten of the Registrant's security holders with respect to the Annual Meeting.\nREPORT OF MANAGEMENT\nThe accompanying consolidated financial statements were prepared by the Company, which is responsible for their integrity and objectivity. The statements have been prepared in conformity with generally accepted accounting principles and include some amounts that are based upon the Company's best estimates and judgement. Financial information presented elsewhere in this report is consistent with the accompanying consolidated financial statements.\nThe accounting systems and controls of the Company are designed to provide reasonable assurance that transactions are executed in accordance with management's criteria, that the financial records are reliable for preparing financial statements and maintaining accountability for assets, and that assets are safeguarded against claims from unauthorized use or disposition.\nThe Company's consolidated financial statements have been audited by KPMG Peat Marwick LLP, independent auditors. The auditors have full access to each member of management in conducting their audits.\nThe Audit Committee of the Board of Directors, comprised solely of directors from outside of the Company, meets regularly with management and the independent auditors to review the work and procedures of each. The auditors have free access to the Audit Committee, without management being present, to discuss the results of their work as well as the adequacy of the Company's accounting controls and the quality of the Company's financial reporting. The Board of Directors, upon recommendation of the Audit Committee, appoints the independent auditors, subject to shareholder approval.\n\/s\/ Joseph D. Macchia ------------------------------------ Joseph D. Macchia Chairman of the Board, President and Chief Executive Officer\n\/s\/ Daniel J. Coots ------------------------------------ Daniel J. Coots Senior Vice President and Chief Financial Officer\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Shareholders GAINSCO, INC.:\nWe have audited the consolidated balance sheets of GAINSCO, INC. and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the years in the three-year period ended December 31, 1995. 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 GAINSCO, INC. and subsidiaries at December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1995, in conformity with generally accepted accounting principles.\nWe have also previously audited, in accordance with generally accepted auditing standards, the consolidated balance sheets of GAINSCO, INC. and subsidiaries as of December 31, 1993, 1992, and 1991, and the related consolidated statements of operations, shareholders' equity and cash flows for the years ended December 31, 1992, and 1991, and we expressed unqualified opinions on those consolidated financial statements.\nIn our opinion, the information set forth in the selected consolidated financial data for each of the years in the five-year period ended December 31, 1995, appearing on pages 17 and 18, is fairly presented, in all material respects, in relation to the consolidated financial statements from which it has been derived.\nKPMG Peat Marwick LLP\nDallas, Texas February 26, 1996\nGAINSCO, INC. AND SUBSIDIARIES\nConsolidated Balance Sheets\nDecember 31, 1995 and 1994\nSee accompanying notes to consolidated financial statements.\nGAINSCO, INC. AND SUBSIDIARIES Consolidated Balance Sheets\nDecember 31, 1995 and 1994\nSee accompanying notes to consolidated financial statements.\nGAINSCO, INC. AND SUBSIDIARIES\nConsolidated Statements of Operations\nYears ended December 31, 1995, 1994 and 1993\nSee accompanying notes to consolidated financial statements.\nGAINSCO, INC. AND SUBSIDIARIES\nConsolidated Statements of Shareholders' Equity\nYears ended December 31, 1995, 1994, and 1993\n(continued) GAINSCO, INC. AND SUBSIDIARIES\nConsolidated Statements of Shareholders' Equity\nYears ended December 31, 1995, 1994, and 1993\nSee accompanying notes to consolidated financial statements.\nGAINSCO, INC. AND SUBSIDIARIES\nConsolidated Statements of Cash Flows\nYears ended December 31, 1995, 1994 and 1993\n(continued)\nGAINSCO, INC. AND SUBSIDIARIES\nConsolidated Statements of Cash Flows\nYears ended December 31, 1995, 1994 and 1993\nSee accompanying notes to consolidated financial statements.\nGAINSCO, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\nDecember 31, 1995, 1994 and 1993\n(1) SUMMARY OF ACCOUNTING POLICIES\n(a) Basis of Consolidation\nThe accompanying consolidated financial statements include the accounts of GAINSCO, INC. (the Company) and its wholly-owned subsidiaries, General Agents Insurance Company of America, Inc. (General Agents), General Agents Premium Finance Company (GAPFCO), Agents Processing Systems, Inc., Risk Retention Administrators, Inc. and GAINSCO Service Corp. (GSC). General Agents has one wholly-owned subsidiary, MGA Insurance Company, Inc. (MGAI) which, in turn, owns 100% of MGA Agency, Inc. GSC has one wholly-owned subsidiary, MGA Premium Finance Company. GSC also owns the management contract and charter of GAINSCO County Mutual Insurance Company (GCM) and its accounts have been included in the accompanying consolidated financial statements. All significant intercompany accounts have been eliminated in consolidation.\nThe accompanying consolidated financial statements are prepared in conformity 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.\n(b) Nature of Operations\nThe Company is predominantly a property and casualty insurance company concentrating its efforts on certain specialty excess and surplus markets within the commercial auto, auto garage and general liability insurance lines. The Company is approved to write insurance in 49 states and the District of Columbia on a non-admitted basis and in 41 states on an admitted basis. The Company markets its lines of insurance through 180 non-affiliated general agents' offices. Approximately 76% of the Company's gross premiums written during 1995 resulted from risks located in Arkansas, California, Florida, Georgia, Kentucky, Louisiana, Pennsylvania, Tennessee, Texas and West Virginia.\nGAINSCO, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\nDecember 31, 1995, 1994 and 1993\n(c) Investments\nBonds held to maturity are stated at amortized cost, bonds available for sale are stated at fair value. Short-term investments are stated at cost. The \"specific identification\" method is used to determine costs of investments sold. Since investments not available for sale are generally held until maturity or recovery of fair value, provisions for possible losses are recorded only when the values have experienced impairment considered \"other than temporary\". Proceeds from the sale of debt securities totalled $10,741,080, $6,378,737 and $4,869,622 in 1995, 1994 and 1993, respectively. The realized gains were $108,024, $134,641 and $3,841 in 1995, 1994 and 1993, respectively. There were no realized losses in any of the years presented.\n(d) Financial Instruments\nFor premiums receivable, which include premium finance notes receivable, and all other accounts (except investments) defined as financial instruments in Financial Accounting Standards Board (FASB) Statement 107, \"Disclosures About Fair Values of Financial Instruments,\" the carrying amount approximates fair value due to the short-term nature of these instruments. These balances are disclosed on the face of the balance sheet.\nFair values for investments, disclosed in note 2, were obtained from independent brokers and published valuation guides.\n(e) Deferred Policy Acquisition Costs and Deferred Ceding Commission Income\nPolicy acquisition costs, principally commissions, marketing and underwriting expenses, are deferred and charged to operations over periods in which the related premiums are earned. Ceding commission income, which is realized on a written basis, is deferred and recognized over periods in which the premiums are earned. Deferred ceding commission income is netted against deferred policy acquisition costs. The marketing expenses are predominately salaries, salary related expenses and travel expenses of the Company's marketing representatives who actively solicit business from the independent general agents.\nGAINSCO, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\nDecember 31, 1995, 1994 and 1993\nThe change in the resulting deferred asset or liability is charged (credited) to operations. Information relating to these net deferred amounts, as of and for the years ended December 31, 1995, 1994 and 1993 is summarized as follows:\n(f) Property and Equipment\nProperty and equipment are stated at cost. Depreciation is calculated using the straight-line method over the estimated useful lives of the respective assets (30 years for buildings and primarily 5 years for furniture, equipment and software).\nThe following schedule summarizes the components of property and equipment:\nThere are no material capital leases.\nGAINSCO, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\nDecember 31, 1995, 1994 and 1993\n(g) Software Costs\nThe Company capitalizes certain costs of developing computer software intended for resale. Costs relating to programs for internal use are recorded in property and equipment and are amortized using the straight-line method over five years or the estimated useful life, whichever is shorter. The deferred cost is also reduced by incidental sales of programs developed for internal use.\n(h) Premium Revenues\nPremiums are recognized as earned on a pro rata basis over the period the Company is at risk under the related policy. Unearned premiums represent the portion of premiums written which are applicable to the unexpired terms of policies in force.\n(i) Claims and Claim Adjustment Expenses\nClaims and claim adjustment expenses, less related reinsurance, are provided for as claims are incurred. The provision for unpaid claims and claim adjustment expenses includes: (1) the accumulation of individual case estimates for claims and claim adjustment expenses reported prior to the close of the accounting period; (2) estimates for unreported claims based on past experience modified for current trends; and (3) estimates of expenses for investigating and adjusting claims based on past experience.\nLiabilities for unpaid claims and claim adjustment expenses are based on estimates of ultimate cost of settlement. Changes in claim estimates resulting from the continuous review process and differences between estimates and ultimate payments are reflected in expense for the year in which the revision of these estimates first became known.\nGAINSCO, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\nDecember 31, 1995, 1994 and 1993\nThe following table sets forth the changes in unpaid claims and claim adjustment expenses, net of reinsurance cessions, as shown in the Company's consolidated financial statements for the periods indicated:\n(1) The Company commuted its 1993 and 1994 quota-share reinsurance treaties in 1995 and thereby reassumed all risks and the related unpaid claims and claim adjustment expenses of $2,223,000 (see note 4 to the consolidated financial statements). This was accounted for using the paid claim method, whereby unpaid claims and claim adjustment expenses were increased $2,223,000 and paid claims and claim adjustment expenses were decreased $2,223,000, thus preventing distortion of claims and claim adjustment expenses incurred.\nGAINSCO, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\nDecember 31, 1995, 1994 and 1993\n(j) Income Taxes\nThe Company and its subsidiaries file a consolidated Federal income tax return. Deferred income tax items are accounted for under the deferred method which provides for timing differences between the reporting of earnings for financial statement purposes and for tax purposes, primarily deferred policy acquisition costs, the discount on unpaid claims and claim adjustment expenses and the nondeductible portion of the change in unearned premiums. The Company paid income taxes of $5,413,486, $5,500,787 and $3,860,000 during 1995, 1994 and 1993, respectively.\n(k) Earnings Per Share\nThe weighted average number of shares outstanding for the years ending December 31, 1995, 1994 and 1993 were 21,512,741, 21,437,031 and 21,379,098, respectively. Primary earnings per share were $.81, $.70 and $.61 based on the weighted average number of shares outstanding and common stock equivalents (which consist of stock options), when dilutive, of 309,549, 278,490, and 438,963 for the years ending December 31, 1995, 1994, and 1993, respectively. The calculations were made after giving retroactive effect to the stock dividends and stock splits granted to shareholders (note 6).\n(l) Accounting Pronouncements\nIn October 1994, the FASB issued Statement 119, \"Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments.\" The Statement was effective for years ending after December 15, 1994 and did not have any impact on the financial statements.\nIn March 1995, the FASB issued Statement 121, \"Accounting for the Impairment of Long-Lived Assets and for Long- Lived Assets to Be Disposed Of.\" The Statement was effective for years ending after December 15, 1995, and did not have any impact on the financial statements.\n(2) INVESTMENTS\nThe following schedule summarizes the components of net investment income:\nGAINSCO, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\nDecember 31, 1995, 1994 and 1993\nThe following schedule summarizes the amortized cost and estimated fair values of investments in debt securities:\nThe amortized cost and estimated fair value of debt securities at December 31, 1995 and 1994, by maturity, are shown below.\nGAINSCO, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\nDecember 31, 1995, 1994 and 1993\nInvestments of $1,100,000 were maintained in escrow at December 31, 1995 and 1994 on behalf of certain insurance companies under the terms of their reinsurance agreements with General Agents. In addition, investments of $11,860,000 and $11,010,000, at December 31, 1995 and 1994, respectively, were on deposit with various regulatory bodies as required by law.\nThe Financial Accounting Standards Board has issued Statement 115 \"Accounting for Certain Investments in Debt and Equity Securities\" (Statement 115). Under this statement, the Company carries certain debt securities classified as \"available for sale\" at fair value. The unrealized gain or loss, net of tax, is presented as a separate component of shareholders' equity.\nDuring 1995, as a result of the Statement 115 \"Implementation Guide,\" the Company transferred certain fixed maturities from the held to maturity portfolio to the available for sale portfolio. The amortized cost of securities transferred was $18,519,856 and the unrealized gain on the date of transfer was $93,803, net of taxes. There were no transfers during 1994.\n(3) NOTE PAYABLE TO BANK\nThe Company made principal payments of $1,750,000 and $1,000,000 in June, 1995 and May, 1994, respectively. The note payable balance of $1,750,000 is due in one installment on June 1, 1996. Interest is paid monthly at a rate that approximates the prime lending rate. The Company recorded interest expense (which approximates interest paid) of $221,934, $273,552 and $275,250 in 1995, 1994 and 1993, respectively. The note payable is stated at book value which approximates fair value.\n(4) REINSURANCE\nIn 1995, 1994 and 1993, General Agents and MGAI (the Insurers) wrote casualty policy limits of $1,000,000. For policies with an effective date of January 1, 1992 through December 31, 1994, the Insurers have excess reinsurance for 100% of casualty claims exceeding $300,000 up to the $1,000,000 policy limits. For policies with an effective date of January 1, 1995 or after, the Insurers have excess reinsurance for 100% of casualty claims exceeding $500,000 up to the $1,000,000 policy limits.\nIn 1995, the Insurers terminated the quota-share reinsurance treaties that were in effect for 1994 and 1993. Under the terms of the termination agreement, the reinsurer returned assets to the Insurers equal to the remaining unpaid claims and claim adjustment expenses of $2,223,000. The Insurers reassumed all risks and the reinsurer was relieved of any further liability with respect to risks previously covered by the contract.\nDuring 1995, GCM entered into fronting arrangements with two non-affiliated insurance companies. GCM retains no liability as the business written under these agreements is 100% ceded. Although these cessions are made to authorized reinsurers rated \"A- (Excellent)\" or better by A. M. Best Company, the agreements require that collateral accounts be maintained to assure\nGAINSCO, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\nDecember 31, 1995, 1994 and 1993\npayment of the unearned premiums and unpaid claims and claim adjustment expenses relating to the risks insured under these fronting arrangements. At December 31, 1995, the balance in such accounts totalled approximately $3,527,000.\nThe amounts deducted in the consolidated financial statements for reinsurance ceded as of and for the years ended December 31, 1995, 1994, and 1993 respectively, are set forth in the following table. Premiums and claims ceded to the commercial automobile plans of Arkansas, California, Louisiana, Mississippi and Pennsylvania are designated as \"plan servicing\".\nGAINSCO, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\nDecember 31, 1995, 1994 and 1993\nThe amounts included in the Consolidated Balance Sheets for reinsurance ceded under fronting arrangements and reinsurance ceded to the commercial automobile plans of Arkansas, California, Louisiana, Mississippi, and Pennsylvania were as follows:\nThe Insurers remain directly liable to their policyholders for all policy obligations and the reinsuring companies are obligated to the Insurers to the extent of the reinsured portion of the risks.\nThe Insurers, for years prior to 1993, utilized reinsurance arrangements with various non-affiliated admitted insurance companies, whereby the Insurers underwrote the coverage and assumed the policies 100% from the companies. During 1993, 1994 and 1995, the business generated from these arrangements was in a run-off position. These arrangements require that the Insurers maintain escrow accounts to assure payment of the unearned premiums and unpaid claims and claim adjustment expenses relating to risks insured through such arrangements and assumed by the Insurers. For each of the years ended December 31, 1995, 1994, and 1993, the balance in such escrow accounts totalled $1,100,000. For 1995, 1994 and 1993, the premiums earned by assumption were $(2,496), $0, and $11,233,000, respectively and the assumed unpaid claims and claim adjustment expenses were $4,427,000, $6,804,000 and $20,850,000, respectively.\nThe Company has not and does not intend to utilize retrospectively rated reinsurance contracts with indefinite renewal terms. This form of reinsurance is commonly known as a \"funded cover\". Under a funded cover reinsurance arrangement, an insurance company essentially deposits money with a reinsurer to help cover future losses and records the \"deposit\" as an expense instead of as an asset; or, the insurance company can borrow from a reinsurer recording the \"loan\" as income instead of as a liability with the future \"loan\" payments recorded as expense when the payments are made.\nGAINSCO, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\nDecember 31, 1995, 1994 and 1993\n(5) FEDERAL INCOME TAXES\nIn the accompanying consolidated statements of operations, the provisions for Federal income tax as a percent of related pretax income differ from the Federal statutory income tax rate. A reconciliation of income tax expense using the Federal statutory rates to actual income tax expense follows:\nThe fresh start adjustment represents the tax effect of the discount on the portion of the 1986 unpaid claims and claim adjustment expenses that changed in 1995, 1994 and 1993, respectively.\nThe Financial Accounting Standards Board issued Statement 109 \"Accounting for Income Taxes\" which changed the Company's method of accounting for income taxes. Under Accounting Principles Board (APB) Opinion 11, the primary objective was to match the tax expense with pre-tax operating income on the statement of operations. Under Statement 109, the primary objective is to establish deferred tax assets and liabilities for the temporary differences between the financial reporting basis and the tax basis of the Company's assets and liabilities at enacted tax rates expected to be in effect when such amounts are realized or settled. As a consequence, the portion of the tax expense which is a result of the change in the deferred tax asset or liability may not always be consistent with the income reported on the statement of operations. The Company implemented Statement 109 in 1993, the cumulative effect of which resulted in a $216,278 tax benefit ($.01 per share) which has been reported in the consolidated Statement of Operations as a \"cumulative effect of a change in accounting principle\". In the Company's opinion, there will be adequate earnings in future years to recover its deferred tax asset and as such, the Company has not established a valuation allowance.\nGAINSCO, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\nDecember 31, 1995, 1994 and 1993\nThe following table represents the tax effect of temporary differences giving rise to the net deferred tax asset established under Statement 109.\n(6) SHAREHOLDERS' EQUITY\nIn May, 1993, the shareholders approved an amendment to the Company's Articles of Incorporation to increase the number of shares of authorized $.10 par value common stock from 50,000,000 shares to 250,000,000 shares. Of the authorized shares, 21,637,481 and 19,611,368 were issued as of December 31, 1995 and 1994, respectively and 21,525,221 and 19,509,544 were outstanding as of December 31, 1995 and 1994, respectively. The Company also has 10,000,000 shares of preferred stock with $100 par value authorized of which no shares have been issued. The Board of Directors can designate the relative rights and preferences of the authorized preferred stock to be issued.\nIn 1991, the Company adopted a policy to pay a quarterly cash dividend of $.01 per share on its common stock every quarter until further action by the Board of Directors. In November of 1995, the Board of Directors increased the cash dividend to $.0125 per share and announced the discontinuance of the semi-annual stock dividends. The Board of Directors granted 5% stock dividends to shareholders of record on March 31, 1995, September 30, 1995, March 31, 1994, September 30, 1994, March 31, 1993 and September 30, 1993. The market value of the stock dividends was charged to retained earnings, common stock was credited for the par value, the excess of market value over par value was credited to additional paid-in capital and cash was paid in lieu of fractional shares for the stock dividends and the shares were cancelled. The earnings per share computation and the number of stock options and their exercise price have been\nGAINSCO, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\nDecember 31, 1995, 1994 and 1993\nretroactively adjusted for the effect of the stock dividends.\nThe amount of consolidated statutory shareholder's equity or policyholders' surplus of General Agents and MGAI was $47,880,301, $40,100,250, and $33,777,209 at December 31, 1995, 1994 and 1993, respectively, and the amount of consolidated statutory net income was $15,167,151, $13,909,896, and $12,107,933 for the years ended 1995, 1994, and 1993, respectively. The amount of policyholders' surplus of GCM was $2,260,001, $2,250,001 and $2,128,748 at December 31, 1995, 1994 and 1993, respectively, and the amount of statutory net income was $369,356, $644,257 and $50,782 for the years ended December 31, 1995, 1994 and 1993, respectively. The Company's statutory capital significantly exceeds the benchmark capital level under the Risk Based Capital formula.\nStatutes in Texas and Oklahoma restrict the payment of dividends by the insurance company subsidiaries to the available surplus funds derived from their realized net profits. The maximum amount of cash dividends that each subsidiary may declare without regulatory approval in any 12-month period is the lesser of net income for the 12-month period ended the previous December 31 or ten percent (10%) of policyholders' surplus as of the previous December 31. At December 31, 1995, General Agents, the Oklahoma subsidiary, had net income of $10,425,054 and policyholders' surplus of $47,880,301 and MGAI, the Texas subsidiary, had net income of $4,742,096 and policyholders' surplus of $15,545,587.\nIn 1988, the Board of Directors declared, pursuant to a Rights Plan, a dividend distribution of one common share purchase right on each outstanding share of $.10 par value common stock. The dividend distribution was made on March 18, 1988, payable to shareholders of record on that date. In 1993, the Board of Directors amended the Rights Plan and extended the expiration date of these rights from March 18, 1998 to May 25, 2003. Each right, as amended during 1993, has an exercise price of $70. The rights are not exercisable until the Distribution Date (as defined in the Rights Plan). The Rights Plan provides, among other things, that if any person or group (other than the Company, one of its subsidiaries or an employee benefit plan of the Company or a subsidiary) acquires 20% or more of the Company's common stock (except pursuant to an offer for all outstanding common stock which the Continuing Directors (as defined in the Rights Plan) have determined to be in the best interests of the Company and its shareholders), if a 20% holder engages in certain self-dealing transactions or if a holder of 15% or more of the Company's common stock is declared an Adverse Person (as defined in the Rights Plan) by the Board of Directors, each holder of a right (other than the 20% holder or the Adverse Person, whose rights would become null and void) would have the right to receive, upon exercise of the right, common stock having a market value of two times the exercise price of the right. The Company is able to redeem rights under certain conditions set forth in the Rights Plan. If, following a public announcement that a person has acquired 20% or more of the common stock, the Company is acquired in a merger (other than a merger which follows an offer approved by the Continuing Directors as described above) or other business combination transaction or if 50% of the assets or earning power of the Company is sold, each right (except rights which have previously become null and void as described above), will entitle its holder to purchase, at the right's then-current\nGAINSCO, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\nDecember 31, 1995, 1994 and 1993\nexercise price, shares of the acquiring Company's common stock having a market value of two times the exercise price of the right.\n(7) BENEFIT PLANS\nOn May 16, 1995, the Board of Directors adopted the GAINSCO, INC. 1995 Stock Option Plan (the \"Plan\") subject to approval by the shareholders no later than May 15, 1996. Under the Plan, 1,020,000 shares were reserved for issuance upon the exercise of these nonqualified stock options.\nUnder the 1990 Stock Option Plan of the Company, no options were granted in 1995, 6,784 options were granted in 1994, and 20,508 options were granted in 1993. These options were granted at fair market value on the date of grant. During 1995, options for 16,316 shares of common stock were exercised at a price of $38,489 and the shares were issued. Options outstanding (after adjusting for stock dividends) at December 31, 1995, 1994 and 1993 were 401,277, 427,863 and 612,810, respectively. The options outstanding at December 31, 1995 are exercisable at an average price of $2.60.\nIn October 1995, the FASB issued Statement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation\" (SFAS 123). SFAS 123 defines a fair value based method of accounting for an employee stock option or similar equity instrument. Under SFAS 123, the Company will elect to measure compensation costs using the intrinsic value based method of accounting prescribed by Accounting Principles Board Opinion No. 25. SFAS is effective for financial statements for fiscal years beginning after December 15, 1995.\nThe Company has a profit sharing and trust plan for the benefit of its eligible employees. Contributions are made in such amounts as the Company elects. The annual contributions amounted to $605,935, $536,124, and $494,727 for 1995, 1994 and 1993, respectively.\nThe Company has an incentive compensation plan in which certain key officers of the Company participate and earn bonuses. The fund from which bonuses are paid is comprised of net income for the current year that is in excess of ten percent (10%) of beginning shareholders' equity for the current year, with the fund not to exceed ten percent (10%) of net income for the current year.\n(8) CONTINGENCIES\nIn the normal course of its operations, the Company has been named as defendant in various legal actions seeking payments for claims denied by the Company and other monetary damages. The Company's management believes that unpaid claims and claim adjustment expenses are adequate to cover possible liability from lawsuits which arise in the normal course of its insurance business. In the opinion of the Company's management the ultimate liability, if any, resulting from the disposition of all claims will not have a material adverse effect on the Company's\nGAINSCO, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\nDecember 31, 1995, 1994 and 1993\nconsolidated financial position. The Company does not have any financial instruments where there is off-balance-sheet-risk of accounting loss due to credit or market risk. There is credit risk in the premiums receivable and reinsurance balances receivable of the Company. At December 31, 1995 and 1994 the Company did not have a premiums receivable balance nor a reinsurance balance receivable from any one entity that was material with regard to shareholders' equity.\n(9) QUARTERLY FINANCIAL DATA (UNAUDITED)\nThe following table contains selected unaudited consolidated financial data for each quarter (in thousands, except per share data):\n(a) Adjusted for stock dividends and stock splits effected as stock dividends. (b) As reported by the American Stock Exchange.\nINDEPENDENT AUDITORS' REPORT ON SUPPLEMENTARY INFORMATION\nThe Board of Directors and Shareholders GAINSCO, INC:\nUnder date of February 26, 1996, we reported on the consolidated balance sheets of GAINSCO, INC. and subsidiaries as of December 31, 1995 and 1994 and the related consolidated statements of operations, shareholders' equity and cash flows for each of the years in the three-year period ended December 31, 1995. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related financial statement schedules as listed in the accompanying index. These financial statement schedules are the responsibility of the company's management. Our responsibility is to express an opinion on these financial statement schedules based on our audits.\nIn our opinion, 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\nDallas, Texas February 26, 1996\nSchedule I\nGAINSCO, INC. AND SUBSIDIARIES\nSummary of Investments - Other Than Investments in Related Parties\n(Amounts in thousands)\nSee accompanying independent auditors' report on supplementary information.\nSchedule II\nCONDENSED FINANCIAL INFORMATION OF THE REGISTRANT\nGAINSCO, INC. (PARENT COMPANY)\nBalance Sheets December 31, 1995 and 1994\nSee accompanying notes to condensed financial statements.\nSee accompanying independent auditors' report on supplementary information.\nSchedule II\nCONDENSED FINANCIAL INFORMATION OF THE REGISTRANT\nGAINSCO, INC. (PARENT COMPANY)\nStatements of Operations Years ended December 31, 1995, 1994 and 1993\nSee accompanying notes to condensed financial statements.\nSee accompanying independent auditors' report on supplementary information.\nSchedule II\nCONDENSED FINANCIAL INFORMATION OF THE REGISTRANT\nGAINSCO, INC. (PARENT COMPANY)\nStatements of Shareholders' Equity Years ended December 31, 1995, 1994 and 1993\n(continued)\nSchedule II CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT\nGAINSCO, INC. (PARENT COMPANY)\nStatements of Shareholders' Equity Years ended December 31, 1995, 1994 and 1993\nSee accompanying notes to condensed financial statements.\nSee accompanying independent auditors' report on supplementary information.\nSchedule II\nCONDENSED FINANCIAL INFORMATION OF THE REGISTRANT\nGAINSCO, INC. (PARENT COMPANY)\nStatements of Cash Flows Years ended December 31, 1995, 1994 and 1993\n(continued)\nSchedule II\nCONDENSED FINANCIAL INFORMATION OF THE REGISTRANT\nGAINSCO, INC. (PARENT COMPANY)\nStatements of Cash Flows Years ended December 31, 1995, 1994 and 1993\nSee accompanying notes to condensed financial statements.\nSee accompanying independent auditors' report on supplementary information.\nSchedule II\nCONDENSED FINANCIAL INFORMATION OF THE REGISTRANT\nGAINSCO, INC. (PARENT COMPANY)\nNotes to Condensed Financial Statements December 31, 1995, 1994 and 1993\n(1) GENERAL\nThe accompanying condensed financial statements should be read in conjunction with the notes to the consolidated financial statements for the years ended December 31, 1995, 1994 and 1993 included elsewhere in this Annual Report.\n(2) RELATED PARTIES\nDuring 1994, the Company made a cash capital contribution to Risk Retention Administrators, Inc. in the amount of $900 and a capital contribution to General Agents Premium Finance Company in the amount of $100,000.\nSee accompanying independent auditors' report on supplementary information.\nSchedule III\nGAINSCO, INC. AND SUBSIDIARIES\nSupplementary Insurance Information\nYears ended December, 1995, 1994 and 1993 (Amounts in thousands)\n(1) Net of the amortization of deferred ceding commission income.\nSee accompanying independent auditors' report on supplementary information.\nSchedule IV\nGAINSCO, INC. AND SUBSIDIARIES\nReinsurance\nYears ended December 31, 1995, 1994 and 1993 (Amounts in thousands, except percentages)\nSee accompanying independent auditors' report on supplementary information.\nSchedule VI\nGAINSCO, INC. AND SUBSIDIARIES\nSupplemental Information\nYears ended December 31, 1995, 1994 and 1993 (Amounts in thousands)\n(1) Net of the amortization of deferred ceding commission income.\nSee accompanying independent auditors' report on supplementary information.\nEXHIBIT INDEX -------------","section_15":""}
{"filename":"760461_1995.txt","cik":"760461","year":"1995","section_1":"Item 1. BUSINESS\n(a) Pentech International, Inc. (the \"Company\") was formed in April 1984 to design and market writing and drawing instruments and other stationery products. In November 1989, the Company formed a wholly-owned subsidiary, Sawdust Pencil Co., to manufacture certain of the Company's writing instruments. In October 1993, the Company formed a wholly-owned subsidiary, Pentech Cosmetics, Inc., to manufacture and distribute a line of cosmetic products. The Company and its wholly-owned subsidiaries are collectively referred to herein as the Company.\n(b) The Company primarily operates in one business segment: the manufacture and marketing of pens, markers, pencils and other writing instruments and related products and miscellaneous cosmetic products, primarily to major mass market retailers located in the United States, under the \"Pentech\" name and a related product name and logo. For financial information relating to this business segment, please refer to the financial statements contained elsewhere herein.\n(c) The Company's product line consists of pens, markers, pencils, other writing instruments, children's activity kits, related products and miscellaneous cosmetic products. These products compete on the basis of special features, packaging design, quality and price, or a combination of these characteristics. The Company believes its reputation and ability to develop marketing programs for its products, through the industry experience and marketing expertise of its management, are principal factors in its business.\n(d) The Company also has obtained license agreements with owners of established trademarks to develop marketing programs with the Company's products utilizing these trademarks. The Company views the use of these established trademarks as providing further product recognition as well as offering a new strategic direction for the Company.\n(i) The Company presently markets several types of pens, markers, pencils, other writing instruments, children's activity kits, related products and miscellaneous cosmetic products, directly and through approximately 100 independent, nonexclusive, sales representatives throughout the United States. Generally, sales initiated by the sales representative are made directly to retail chains, wholesalers and distributors in various areas.\nThe percentages of revenues contributed by the following classes of products over the Company's last three fiscal years are as follows:\nOther Writing Miscellaneous Instruments and Cosmetic Pens Markers Pencils Related Products Products\nFY 1993 27.7% 28.0% 30.2% 14.1% - FY 1994 17.9% 26.9% 35.3% 17.9% 2% FY 1995 18.6% 23.0% 34.1% 20.3% 4%\n(ii) The Company engages in ongoing market research to identify writing instruments and related products that elicit strong demand in the American marketplace. The Company, once it identifies a product, generally either selects an overseas manufacturer which it believes to be most suitable to manufacture the product and works with such manufacturer to develop the product to the Company's specifications or elects to manufacture the product itself.\nThe Company's domestic pencil and marker manufacturing facility, Sawdust Pencil Company (\"Sawdust\") is presently being utilized by the Company to manufacture a significant portion of the Company's writing instruments. Sawdust's capacity (on a two shift basis) is approximately $34,500,000 (wholesale value) of pencils, markers and other writing instruments. During its fiscal year ended September 30, 1995 (\"Fiscal 1995\"), the Company manufactured approximately $20,000,000 wholesale value of products at Sawdust, which represents 58% of its current capacity and approximately 36% of the Company's current requirements. During periods when Sawdust is not being utilized at full capacity, it scales down its workforce.\nDuring Fiscal 1995, the Company manufactured at Sawdust approximately 36% of the wholesale value of the products it sold, down from approximately 41% for Fiscal 1994.\nDuring its fiscal year ended September 30, 1994 (\"Fiscal 1994\"), the Company established a second pencil manufacturing facility which also has the capability to manufacture cosmetic pencils.\nThe Company emphasizes its unique packaging style that graphically reinforces the Company's image as a marketer of well- designed, high quality, reasonably priced pens and markers. Management believes that the Company's packaging designs are important to its efforts at penetrating the American marketplace for writing instruments.\nOnce a product's design is finalized, the Company develops packaging for the product. Designs for these packages are then shipped to the manufacturer which generally prints the packaging and packages the product prior to its shipment to the Company. With respect to products manufactured domestically at Sawdust, the Company does its own packaging as well as arranges to print some of its packaging with independent entities.\n(iii) The Company utilizes foreign manufacturers to supply a large percentage of pens, markers, other writing instruments and related products and miscellaneous cosmetic products that it sells throughout the United States. It continues to acquire a majority of its products from contract manufacturers located in Korea, Italy, India, Taiwan and other foreign countries. Such products are manufactured to the Company's order with the \"Pentech\" logo and label. The Company generally acquires its imported products pursuant to purchase orders, which typically provide for delivery within 60 days to 90 days after the order. Most of these purchases are paid by posting a letter of credit payable from zero to 120 days after shipment.\nTo date, the Company has experienced limited supply shortages with respect to these imported products. The Company has occasionally incurred additional costs by shipping goods into its warehouse via airfreight, as opposed to by ship when the manufacturers did not timely deliver products or the Company required faster delivery than was normally available. The Company is unable to predict whether it will experience any other similar or worse product shortages in the future. The Company has successfully developed alternative sources of supply for virtually all of its important items to ensure timely deliveries in the event of a disruption in deliveries due to a dispute with any one overseas manufacturer or any other reason. The Company has achieved this through building Sawdust and developing multiple sources in Korea, Italy, India, Taiwan and other countries. As a result, the loss of any one overseas manufacturer would unlikely create any long-term disruptions in the Company's ability to ship its goods to its customers on a timely basis. Management believes that it is not now dependent, nor is it likely to become dependent, upon any one manufacturer for its product lines. It believes that products of quality comparable to its present products could, if necessary, be acquired from a variety of manufacturers located primarily in Korea, Italy, Taiwan, India and Japan, or other locations at comparable rates.\nThe Company obtains raw materials for Sawdust from domestic and foreign suppliers of these materials. It has not faced any material supply shortages, and it generally has multiple sources for most of its product requirements. Due to a recent determination by the United States International Trade Commission (the \"ITC\") that certain manufacturers of Chinese pencils were dumping them in the United States, the Company has been required to develop additional sources for its supply of certain of its pencils, which, to date, it has been successful in doing. In some instances, this has resulted in increasing the Company's costs for wood for its pencils.\n(iv) The primary focus of the Company's marketing efforts is to market its products under the individual product's name and the Company's name. In the event opportunities present themselves which the Company determines are advantageous for it to import certain products in bulk on a private label basis (i.e., store brand), the Company may capitalize on such opportunity. In such event, the Company may request an advance deposit from the customer before effecting such transaction, depending on the credit- worthiness of the customer. This, historically, has been a small segment of the Company's business.\nThe Company's marketing efforts include the development of special promotions in connection with purchases of merchandise by certain major chain stores. These promotions often feature advertising allowances, free goods and free displays or permit the sale of several of the Company's products at one favorable price. The funding for these special promotions is substantially derived from the revenues to be received from the sales themselves, and generally the Company is not required to allocate any portion of its working capital to such efforts. The Company also has designed point of purchase product displays which it offers to its customers.\nIn addition to the Company's licenses with the Walt Disney Company, the Company has entered into licensing agreements for its writing instruments with the NBA (National Basketball Association) and NHL (National Hockey League) to use each league's team logos on the Company's products, as well as the Coca-Cola Company, using this trademark name on the Company's products. The Company has also entered into a licensing agreement with the Fisher-Price Co. to manufacture arts and crafts kits containing the Company's products, which license has been modified to reflect a slower than expected start-up due to technical issues.\nExcept when the Company uses trademarks owned by others, the Company follows a policy of registering with the U.S. Patent and Trademark Office trademarks covering the names of items in its product line and proposed names for new items. The Company has been awarded trademarks in the past. There is no assurance that any pending trademarks will be registered. Petitions have been filed with the U.S. Patent and Trademark Office to cancel the Federal trademark registration of the Company's \"Pentech\" trademark. See Item 3. \"Legal Proceedings.\"\n(v) The business of the Company has certain seasonal aspects. Sales tend to increase during the months of May through August, because retailers buy in anticipation of fall school opening, and to decrease during the months of September through December. The Company has been developing marketing programs to reduce this seasonality.\n(vi) The Company has changed during Fiscal 1995 from utilizing an unaffiliated warehouse to store and ship its products on a contract basis, to leasing and maintaining a warehouse in North Brunswick, New Jersey.\nGenerally, the Company does not require any of its customers to post any letters of credit or to advance any deposits on orders, except in certain instances, depending upon the creditworthiness of the customer, for special orders. The Company analyzes each special order customer independently to determine whether any deposits should be paid. The Company considers credit rating, location, and amount of order, among other factors, to determine whether a deposit is required. Normal credit terms are \"net 30 days.\" The Company, in certain instances, follows the industry practice of \"School Dating,\" which is the shipment of products from May through August, for which payment is not due until September or October. The Company reviews its credit practices regularly and currently attempts to insure 80% of its receivables through credit insurance. In the past, except for the Phar-Mor bankruptcy in Fiscal 1992, the Company has experienced a limited amount of bad debts from its customers, usually as a result of a bankruptcy. In such a case the Company's policy has been to liquidate its claims as promptly as reasonable under the circumstances. This has been further ameliorated since the Company obtained credit insurance. The Company believes it has sufficient resources to manage its credit functions.\n(vii) The Company's primary customers include major mass market retailers in the United States. In Fiscal 1995, one customer accounted for 9% of the Company's revenues. While the loss of this customer could have a material adverse impact upon the Company in the short-term, the Company believes such impact would be minimized in the long-term since the Company could either reduce its expenses related to this customer or sell all or a portion of these products to other customers.\nCertain of the Company's customers include:\n- Eckerd Drug - Walgreen Drug - Walmart - CVS Stores - Target - K-Mart\nThe above list of customers does not include independent distributors nor products the Company sells to the stationery, military and college store markets.\nThe Company advertises in trade journals on a limited basis and maintains display booths for use at trade shows. It owns several booths that attractively display its line of products for such trade shows. The Company has no current plans for any other major advertising campaign, but it is investigating additional advertising avenues.\nThe Company warrants its merchandise against manufacturing defects. In the event of any such returns the Company evaluates the problem and attempts to rectify the problem for the customer, if possible. The Company believes it maintains adequate product liability insurance.\n(viii) As of December 1995 and December 1994, the Company's backlog of firm written orders was approximately $3,100,000 and $2,600,000, respectively. This backlog is comprised of the normal delay between receipt and processing of orders and orders for delayed delivery. All orders were delivered or are expected to be filled within the applicable fiscal year.\n(x) The industry in which the Company is engaged is highly competitive. The Company competes with a large number of companies, including such well known companies as Bic Pen Company, Papermate, Pilot Pen, Newell, some of which may have far greater financial resources and sales. The Company generally competes on the basis of the special features of its products, quality, packaging design (which includes the individual product's name and the Company's name and logo) and price.\n(xiii) As of November 30, 1995, the Company had approximately 185 employees, including Messrs. Norman Melnick, David Melnick, John Linster and John F. Kuypers. The Company's sales are made primarily by independent sales organizations which are compensated exclusively on a commission basis with commissions ranging from two and one half to seven percent. The Company does not anticipate a substantial increase in the number of its employees in the near future. The Company considers its relations with its employees to be good. In December 1992, the production and maintenance employees of the Company's wholly-owned subsidiary, Sawdust Pencil Co. (\"Sawdust\"), voted to join Local 478 of the International Brotherhood of Teamsters (the \"Union\"). In Fiscal 1993, Sawdust entered into a labor agreement with Union representatives for the benefit of these employees which expires August 31, 1996.\n(e) The Company exports approximately 2 percent of its sales, primarily to customers in Canada, Europe, Brazil and Mexico.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nThe Company's present offices are located at 195 Carter Drive, Edison, New Jersey 08817, where it occupies general office, sales and warehouse space of approximately 40,500 square feet pursuant to a five year lease expiring March 1, 1998. Management believes that the space under lease will be adequate for the Company's operations for the term of the lease. See sub-item (vi) under Item 1. \"Business\" for information concerning the Company's other warehousing practices.\nThe Company exercised its first option and extended its lease for five years (the \"Lease\") with an unaffiliated company for approximately 50,000 square feet which commenced on June 1, 1995 for Sawdust's premises located at 44 National Road, Edison, New Jersey 08817. The Lease, which is triple net, requires annual rental payments of $170,856 for the first year until May 31, 1996, with yearly moderate increment additions in each subsequent year of the Lease's term. The Lease contains an option to renew on terms providing for moderate increases in rent for up to an additional five years.\nThe Company entered into a five year lease for a warehouse at 1101 Corporate Road, North Brunswick, New Jersey (the \"Warehouse Lease\") with an unaffiliated Company for approximately 130,000 square feet which commenced on September 1, 1995. The Warehouse Lease provides for annual based rent of approximately $410,000 with an increase to approximately $436,000 per year after the first year.\nThe Company entered into a four year lease for a sales office in Madison, Wisconsin (the \"Madison Lease\"). The Madison Lease, which is with an unaffiliated party, is for approximately 1,140 square feet and commenced December 1, 1992. The Madison Lease calls for a second year annual rental of $15,120, which increases by five percent each subsequent lease year until termination.\nThe Company sublet premises located at 2 Ethel Road, Edison, New Jersey, which it originally leased from a company controlled by Messrs. Norman and David Melnick (the \"Sublease\"). The Company's sublease is triple net and provides for base rent of $3,930 per month. The Sublease, which commenced on December 1, 1993, is to an unaffiliated company and is currently continuing on a month-to- month basis. The Company receives a monthly rental of $2,750 from this sublet. The Company had used these premises as its corporate offices for four years prior to its move to 195 Carter Drive, Edison, New Jersey, during Fiscal 1993.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\n(a) In November 1986, a petition for cancellation of the Company's trademark \"Pentech\" was filed by Pentel Kabushiki Kaisha d\/b\/a Pentel Co., Ltd. (\"Pentel\") with the U.S. Patent and Trademark Office (the \"PTO\") seeking to cause the Company's \"Pentech\" Federal trademark to be canceled. The Company received notice of the filing of the Petition on February 24, 1987. The Petition alleges that the Pentech trademark was not used in the United States prior to January 12, 1984, long after Pentel's trademarks were issued, and that the \"Pentech\" trademark so closely resembles the \"Pentel\" trademark as to cause confusion and to be misleading. In November 1995, after the PTO refused to grant any further extension, the Company moved to dismiss this Petition on the basis of Pentel's failure to proceed after nine years. Although unexpected, the Company recognizes the risk of an adverse decision with respect to this Petition. In such event, it is likely that Pentel would seek to cause the Company not to use the trademark \"Pentech.\" The loss of the use of the trademark could result in a short-term negative impact on the Company as it would be required to alter its packaging and possibly change its corporate name. Since all of the Company's products are marketed under individual product trade names, the Company does not believe that it would materially adversely impact its sales or financial position.\n(b) In October 1987, the Company commenced an action against Leon Hayduchok, All-Mark Corporation and Paradise Creations, Inc., in the United States District Court for the Southern District of New York (\"USSDNY\") seeking a declaratory judgment that U.S. Patent No. 4,681,471 entitled \"Kit Comprising Multicolored Fluid Dispenser Markers Together With Eradicating Fluid Dispenser\" is not infringed, and is invalid and unenforceable. The defendants asserted counterclaims against the Company for patent infringement and misappropriation. The action was bifurcated into two parts: (i) liability and (ii) damages. A trial on liability was held and on November 12, 1990 the Court issued an order determining that the patent was valid, that the Company had infringed the patent but that no misappropriation was found. A trial on damages must still be held. The Company established a reserve (the \"Reserve Amount\") in anticipation of payment of damages. Although the Company expects the Reserve Amount to be sufficient based on its analysis, there is no assurance that such amount will be adequate and that the USSDNY will not find the Company liable for damages in excess of the Reserve Amount.\nOther than as set forth above, there are no legal proceedings to which the Company is a party or known to be contemplated that are deemed material by the Company at the present time, and the Company knows of no material legal proceedings pending or threatened, or judgments entered, against any director or officer of the Company in his capacity as such.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF SHAREHOLDERS\nNot applicable.\nPART II\nItem 5.","section_5":"Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\n(a) The shares of Common Stock are traded on the National Association of Securities Dealers Automatic Quotation System (\"NASDAQ\") National Market System under the symbol PNTK. The following table shows the closing high and low \"bid\" prices of these shares as reported by NASDAQ during the Company's last two fiscal years presented on a calendar year basis. Such quotations represent prices between dealers without retail markups, markdowns or commissions and may not represent actual transactions.\nHigh Low\n1st Quarter 6 1\/4 4 11\/16 2nd Quarter 6 3\/4 5 1\/2 3rd Quarter 6 3\/4 5 1\/4 4th Quarter 6 1\/4 4 3\/4\n1st Quarter 5 1\/4 3 1\/2 2nd Quarter 4 1\/4 3 3\/8 3rd Quarter 4 1\/4 2 3\/4 4th Quarter 3 1\/2 1 7\/8\nOn December 18, 1995, the closing \"bid\" and \"ask\" prices for the Common Stock were $2 3\/8 and $2 7\/16 respectively, as reported by NASDAQ.\n(b) On December 18, 1995, the number of shareholders of record of the Common Stock was 509.\n(c) The Company has not declared a cash dividend in the past and is not permitted to do so without the consent of European American Bank, N.J. (the \"Bank\"), one of the banks with whom the Company maintains a short-term line of credit. See Item 7. \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA\nThe following summary of financial information should be read in conjunction with the Financial Statements and notes thereto included elsewhere in this Form 10-K.\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nFiscal 1995 Compared to Fiscal 1994\nNet sales for Fiscal 1995 were $54,891,592 as compared to $62,136,134 for Fiscal 1994, reflecting a decrease of $7,244,542 or approximately 11.7%. The decrease in sales in Fiscal 1995 was principally related to the overall softness in the retail industry, evidenced by Chapter 11 filings by several retailers and corrective inventory measures taken by other major mass merchandisers. Despite this softness, the Company's relationships with many of its customers remains strong and the Company did see positive sales growth with many customers due primarily to the successful introduction of its Pro Sports Licensed Products.\nIn Fiscal 1995, the Company incurred a loss from operations of $474,368 as compared to income from operations of $8,361,628 for Fiscal 1994, reflecting a decrease of $8,835,996. The Company's gross profit of 28.8% in Fiscal 1995 was down from 35.1% in Fiscal 1994. The decline in gross profit can be attributed to the Company's decision to eliminate about 500 items from its product line and the related increase in the reserve for slow-moving inventory by approximately $1.3 million. In addition, the Company continued to invest in its emerging cosmetic business and incurred a loss of about $500,000. The gross profit was also impacted by higher manufacturing unit costs at its domestic facility due to the lower sales volume. Finally, gross profit was affected by higher than usual return levels. In some instances, retailers consider stationery merchandise to be highly promotional and seasonal and sometimes request to return the unsold goods.\nThe Company's selling, general and administrative (\"SG&A\") expenses increased during Fiscal 1995 to $15,871,636 from $13,459,402 in Fiscal 1994, reflecting an increase of $2,412,234. SG&A as a percentage of sales increased to 28.9% from 21.7%. The increase was primarily related to the continued higher royalty costs associated with many of its new products. In addition, the Company had higher freight costs, higher distribution costs associated with the Company relocating its distribution center, and higher advertising allowances associated with more aggressive pricing campaigns by many of its customers. Finally, the Company continued to invest in its creative, sales and product development team with the goal of marketing longer lived products and gaining deeper penetration of its existing client base.\nDuring Fiscal 1995, the Company increased its short-term borrowings to an average level of $15,618,000 from $12,250,000 in the prior year. The increase was primarily due to increased borrowings to finance the Company's stock buy back program of approximately 1,000,000 shares for approximately $4,000,000. In addition, the Company's effective interest rate increased from 6.0% to 8.1% due to the overall rise in short-term interest rates. As a result, interest expense increased during Fiscal 1995 from $740,953 to $1,259,145.\nFinally, primarily as a result of the peso devaluation in Mexico in the Company's first fiscal quarter, the Company sustained a write-down of $407,000 on its receivable position with its Mexican affiliate for Fiscal 1995. This affiliation was ended in Fiscal 1995.\nBased on the above factors, the Company incurred a loss of $1,058,946 in Fiscal 1995 as compared to net income of $4,700,598 in Fiscal 1994, reflecting a decrease of $5,759,544.\nWith respect to the Company's new line of cosmetic products, the Company achieved several goals it established for Fiscal 1995. The Company developed its new \"Fun\" Cosmetics line of product, established a regional network of sales representatives and launched a new advertising campaign. Sales of its line of miscellaneous cosmetic products increased to $2.3 million (or approximately 4% of net sales) up from $1.3 million (approximately 2% of net sales) in Fiscal 1994. This product line did incur a loss of approximately $500,000 due to start-up costs.\nDuring Fiscal 1996, the Company's goal regarding its line of miscellaneous cosmetic products is to continue to increase the sales of the cosmetic company by the introduction of its product line to new customers and to improve the overall profitability of this product line.\nFiscal 1994 Compared to Fiscal 1993\nNet sales for Fiscal 1994 were $62,136,134 as compared to $51,320,794 for Fiscal 1993, reflecting an increase of $10,815,340 or approximately 21.1%. The increase in sales in Fiscal 1994 was principally related to the seasonal sales promotions in the first half of the fiscal year and growth in the Company's bulk pencil program and Color Club line.\nIncome from continuing operations was $8,361,628 for Fiscal 1994 as compared to $6,979,450 for Fiscal 1993, reflecting an increase of $1,382,178. The Company's gross profit of 35.1% in Fiscal 1994 remained relatively constant from 35.0% in Fiscal 1993. Lower manufacturing costs at Sawdust were offset by higher costs associated with the Company's new cosmetic operations and higher freight-in cost associated with its chalk products. Gross profit on imported products remained constant during the two periods.\nThe Company's SG&A expenses increased during Fiscal 1994 to $13,459,402 from $10,992,105 in Fiscal 1993, reflecting an increase of $2,467,297. SG&A as percentage of sales increased to 21.7% from 21.4% primarily because of higher office and rent expenses since the Company was in its expanded office location for a full twelve months this year as compared to three months during Fiscal 1993. In addition, the Company had higher royalty payments due to an increase in sales of licensed products, higher freight costs due to shipping certain products and higher legal fees.\nDuring Fiscal 1994, the Company increased its short-term borrowings to an average level of $12,250,000 from $9,686,000 in the prior year, primarily to finance its increase in receivables and inventory. In addition, the Company's effective interest rate increased from 5.3% to 6.0%. As a result, interest expense increased during Fiscal 1994 from $517,960 to $740,853.\nBased on the above factors, net income for Fiscal 1994 was $4,700,598 as compared to $3,985,887 in Fiscal 1993, reflecting an increase of $714,711 or 17.9%.\n(b) Liquidity and Capital Resources\nCash and cash equivalents decreased to zero at September 30, 1995 from $697,545 at September 30, 1994. The Company uses its cash to reduce its outstanding borrowings in order to reduce interest costs. Accounts receivable decreased to $12,450,960 at September 30, 1995 from $13,129,842 at September 30, 1994, primarily due to decreased sales in the fourth quarter, and the write-off of certain Mexican receivables. The Company believes that its allowance for doubtful accounts and its accrual for returns and advertising allowances are adequate given the Company's detailed review of its accounts receivable aging, its review of subsequent cash receipts, its use of credit limits and its on-going credit evaluation and account monitoring. In addition, the Company has credit insurance on most of its major accounts receivable. Inventory increased to $22,844,482 at September 30, 1995 from $21,326,694. The Company's finished goods inventory increased primarily due to the increase of its Cosmetic Product line and the Company's continued expansion of licensed products in its stationary business. This increase was somewhat offset by the Company's decision to eliminate about 500 items from its product line and increase its reserve for slow-moving inventory by $1.3 million. The decrease to $4,805,175 for equipment at September 30, 1995 from $5,000,870 at September 30, 1994 primarily reflects a slowing of the Company's equipment purchases. Notes payable at September 30, 1995 were $15,169,103 as compared to $9,162,724 at September 30, 1994. This is due primarily to the Company's decision to buy-back approximately 1,000,000 shares of its own stock for approximately $4,000,000.\nNet cash used in operating activities for the year ended September 30, 1995 was $1,906,872 as compared to cash provided by operating activities for Fiscal 1994 of $4,187,060. This change was primarily due to a loss this year of $1,058,946 as compared to a net income of $4,700,598 in Fiscal 1994. In addition, there was an increase in income tax receivables and an increase in inventory. This was partially offset by an increase in accounts payable and a decrease in accounts receivable.\nCash used in investing activities during Fiscal 1995 of $721,762 was less than the prior year due to the decrease in fixed asset additions. This primarily represented the slowdown in fixed asset additions for Sawdust and the cosmetic product line.\nThe cash provided by financing activities during Fiscal 1995 was $1,931,089 as compared to cash used in financing activities of $3,442,947 in Fiscal 1994. The increase in cash used in financing activities was primarily due to the Company increasing its short- term borrowings to finance the stock buy-back program and the cash used in operating and investing activities. As a result of these activities, cash and cash equivalents decreased $697,545 during Fiscal 1995 as compared to a decrease of $145,804 during Fiscal 1994.\nThe Company's working capital decreased to $16,928,685 at September 30, 1995 from $21,451,147 at September 30, 1994. This decrease was primarily due to the stock buy-back program and the net loss sustained for the year.\nThe Company maintains short-term lines of credit facilities with European American Bank (\"EAB\") and Chemical Bank New Jersey N.A. (the \"Banks\"). During Fiscal 1995, the Company increased its lines of credit to a maximum amount of $34,000,000. These lines of credit are available at the Banks' discretion and are subject to limitations based upon eligible inventory and accounts receivable as defined by the Banks. The obligations are collateralized by a security interest in substantially all of the assets of the Company. In connection with these lines of credit, the Company has agreed, among other things, to the maintenance of certain minimum amounts of tangible net worth and working capital, a maximum ratio of total liabilities to tangible net worth, restriction on dividend payment and maintenance of Key Man Life Insurance. During Fiscal 1995, the Company violated certain of its covenants with EAB, primarily because of the stock buy-back program, which violations have been waived by EAB so as to remain in compliance. The Company and EAB amended the covenants through March 31, 1996 (the termination of the credit agreement) and the Company presently expects to be in compliance with the covenants in its Fiscal year ending September 30, 1996. The Company's lines of credit are renewable annually. The Company believes its lines of credit will be renewed for its current fiscal year with substantially similar terms.\nAs a result of the seasonal nature of the Company's business, the Company's use of these lines of credit increases significantly in the months of May, June and July as the Company finances its inventory and receivables, and declines in September and October upon collection of the invoices from its back to school sales.\nThe Company expects that its lines of credit with the Banks, together with anticipated income from operations, will be sufficient to provide liquidity on both a short-term and long-term basis to finance current and future operations. The Company believes these resources are sufficient to support its needs for letters of credit usually required on its overseas purchases, to finance its operations at the Factory and to support its other operating expenses. However, the Company is considering a new-long- term facility with the Banks to better structure its debt. There is no assurance, however, that the Company will be able to successfully negotiate such a facility.\nThe Company has periodically repurchased its securities in the public market. The Company announced a program to repurchase 500,000 shares of its stock on August 16, 1994. On December 8, 1994, the Company announced a second program to repurchase an additional 500,000 shares. During Fiscal 1995, the Company completed both of those stock repurchase programs. For the Fiscal year ended September 30, 1995, the Company repurchased 999,400 shares for $4,067,790.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS\nThis information is contained on pages through hereof.\nItem 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nThe information required by this section will be incorporated by reference to the Proxy Statement of the Company to be filed with the Securities and Exchange Commission on or before January 29, 1996.\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 Page\nIndependent Auditors' Report............................\nConsolidated Balance Sheets as of September 30, 1995 and 1994....................................................... -3\nConsolidated Statements of Operations for the years ended September 30, 1995, 1994 and 1993 .............\nConsolidated Statements of Shareholders' Equity for the years ended September 30, 1995, 1994 and 1993..........\nConsolidated Statements of Cash Flows for the years ended September 30, 1995, 1994, and 1993............. -8\nNotes to Consolidated Financial Statements................. -21\n(a) (2) Financial Statement Schedules\nSchedule II - Valuation and Qualifying Accounts and Reserves..................................................\nAll other schedules are omitted because they are not applicable, not required, or because the required information is included in the financial statements or notes thereto.\n(a) (3) Exhibits\n3.1 The Company's Certificate of Incorporation, as amended, incorporated by reference to Exhibit 3.1 to Registration Statement No. 2-95102-NY of the Company (\"Form S-18\").\n3.2 The Company's By-laws incorporated by reference to Exhibit 3.2 of Form S-18.\n10.1 Incentive Stock Option Plan incorporated by reference to Exhibit 10.8 of Form S-18.\n10.2 1989 Stock Option Plan incorporated by reference to the Registration Statement No. 33-27009 filed on Form S-8.\n10.3 1993 Stock Option Plan incorporated by reference to the 1992 Form 10-K. 10.4 Letter dated December 22, 1995 between the Company and European-American Bank, NJ.\n10.5 Loan Commitment dated January 31, 1995 between the Company and Chemical Bank New Jersey N.A.\n10.6 Employment Agreement dated November 3, 1995, between the Company and John W. Linster.\n10.7 Lease Agreement for the Premises located at 1101 Corporate Road, North Brunswick, New Jersey, between the Company and Sudler Companies, dated August 28, 1995.\n21. Subsidiaries of the Company.\n23.1 Consent of Ernst & Young LLP dated December 27, 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.\nPENTECH INTERNATIONAL, INC.\nDecember 21, 1995 By: s\/John W. Linster John W. Linster, President and 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 in the capacities and on the dates indicated.\ns\/Norman Melnick Chairman of the Board December 20, 1995 Norman Melnick of Directors\ns\/John W. Linster President and Chief Executive December 21, 1995 John W. Linster Officer (principal executive officer)\ns\/David Melnick Chief Operating Officer and December 21, 1995 David Melnick Director (principal operating officer)\ns\/ John F. Kuypers Executive Vice President- John F. Kuypers Sales and Director December 21, 1995\ns\/Richard S. Kalin Secretary and Director December 26, 1995 Richard S. Kalin\nDirector December , 1995 Jerry Della Femina\nDirector December , 1995 Roy L. Boe\ns\/William Visone Treasurer (principal December 21, 1995 William Visone accounting officer)\nptk\\10K.95\nREPORT OF INDEPENDENT AUDITORS\nBoard of Directors Pentech International, Inc.\nWe have audited the accompanying consolidated balance sheets of Pentech International, Inc. and subsidiaries as of September 30, 1995 and 1994 and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended September 30, 1995. 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 Pentech International, Inc. and subsidiaries as of September 30, 1995 and 1994, and the consolidated results of their operations and their cash flows for each of the three years in the period ended September 30, 1995, 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.\ns\/ERNST & YOUNG LLP ERNST & YOUNG LLP\nMetroPark, New Jersey December 11, 1995\nPENTECH INTERNATIONAL, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements September 30, 1995\n1. Summary of Significant Accounting Policies\nOrganization\nPentech International, Inc. (the \"Company\") was formed in April 1984. A wholly-owned subsidiary, Sawdust Pencil Company (\"Sawdust\"), was formed in November 1989. The Company and its subsidiary are engaged in the production, design, and marketing of writing and drawing instruments. In October 1993, the Company formed a wholly-owned subsidiary, Pentech Cosmetics, Inc., to manufacture and distribute cosmetic pencils.\nPrinciples of Consolidation\nThe consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany balances and transactions have been eliminated.\nCash Equivalents\nThe Company considers all time deposits with a maturity of three months or less to be cash equivalents.\nInventory and Cost of Sales\nInventory is stated at the lower of cost (first-in, first-out) or market. Cost of sales for imported products includes the invoice cost, duty, freight in, display and packaging costs. Cost of domestically manufactured products includes raw materials, labor, overhead and packaging costs.\nEquipment and Depreciation\nEquipment is stated at cost. Depreciation is provided by the straight-line method over the estimated useful lives of the assets, which range between five to ten years. Major improve- ments to existing equipment are capitalized. Expenditures for maintenance and repairs which do not extend the life of the assets are charged to expense as incurred.\nTrademarks\nCosts related to trademarks are being amortized over a five year period on a straight-line basis.\nReclassification\nCertain 1994 amounts have been reclassified to conform to the 1995 presentation.\n1. Summary of Significant Accounting Policies (cont'd)\n(Loss) Earnings Per Common and Common Equivalent Share\nPrimary and fully diluted (loss) earnings per share are computed on the basis of the weighted average number of shares outstanding plus the common stock equivalents which would arise from the exercise of stock options and warrants.\nThe average number of shares used was:\nPrimary Fully Diluted\nYear ended September 30, 1995 10,660,988 10,660,988* Year ended September 30, 1994 11,855,700 11,855,700* Year ended September 30, 1993 11,876,244 11,876,244*\n* In 1995, 1994 and 1993 fully diluted was anti-dilutive.\n2. Inventory\n1995 1994\nRaw materials $ 8,644,695 $ 7,711,951 Work-in-process 1,746,149 1,203,002 Finished goods 13,839,638 12,511,741 Allowance for slow- moving items (1,386,000) (100,000) $22,844,482 $21,326,694\n3. Notes and Bankers' Acceptances Payable\nSeptember 30, September 30, Interest 1995 Interest 1994\nNotes payable 7.875% $ 9,000,000 Notes payable 8.75% $ 6,169,103 7.75% $ 9,162,724 Total $15,169,103 $ 9,162,724\nBankers' None $ 1,841,985 None $ 1,860,196 acceptances payable\n3. Notes and Bankers' Acceptances Payable (cont'd)\nNotes and bankers' acceptances payable are advanced under a $34,000,000 line of credit which is available at the banks' discretion. The $34,000,000 is subject to limitations based upon eligible inventory and accounts receivable as defined by the banks. The obligations are collateralized by a security interest in substantially all of the assets of the Company. In connection with this line of credit, the Company has agreed, among other things, to the maintenance of certain minimum amounts of tangible net worth and working capital, a maximum ratio of total liabilities to tangible net worth, restrictions on dividend payments and maintenance of keyman life insurance.\nDuring Fiscal 1995, the Company violated certain of its covenants with EAB Bank, which violations have been waived so as to remain in compliance. The Company and EAB Bank amended the covenants through March 31, 1996 (the termination of the credit agreement) and the Company presently expects to be in compliance with the covenants in its Fiscal year ending September 30, 1996.\nThe weighted average interest rate during the periods on the outstanding short-term borrowings was 8.1% and 6.0% for fiscal years ended September 30, 1995 and 1994, respectively.\n4. Shareholders' Equity\nStock Options\nDuring Fiscal 1993, the Company granted options covering in the aggregate 60,000 shares of common stock at an exercise price of $6.75 per share (representing fair market value at date of grant). During Fiscal 1994 and 1995, there were no options granted. During this period, 33,000 options were exercised resulting in the issuance of 33,000 shares of common stock and proceeds of $53,400. At September 30, 1995, 175,000 options remain outstanding at prices ranging from $5.50 to $7.375 per share of which 100,000 are exercisable.\n4. Shareholders' Equity (cont'd)\nStock Option Plans\nOn October 1, 1984, the Company adopted an incentive stock option plan (\"1984 Plan\"). The 1984 Plan provided for options to be granted to issue up to 600,000 shares of common stock. The exercise price of options granted may not be less than the fair market value of the shares on the date of grant (110% of such fair market value for a holder of more than 10% of the Company's voting securities (a \"10% Holder\"), nor may options be exercised more than ten years from the date of grant (five years for a 10% holder). The 1984 Plan terminated on October 1, 1994. All shares that were eligible for exercise expired.\nOn January 5, 1989, the Company adopted a stock option plan (\"1989 Plan\"). The 1989 Plan provides for options and limited stock appreciation rights (\"Limited SARs\") to be granted in tandem to issue up to 600,000 shares of common stock. Limited SARs may only be granted in conjunction with related options. The determination of the exercise price and terms of the options granted under the 1989 Plan are the same as those of the 1984 Plan. No SARs have been granted. The 1989 Plan will terminate on January 5, 1999.\nOn April 14, 1993, the Company adopted a Stock Option Plan (\"1993 Plan\"). The 1993 Plan provides for the issuance of incentive and nonstatutory stock options to employees, consultants, advisors and\/or directors for a total up to 700,000 shares of common stock. The exercise price of options granted may not be less than the fair market value of the shares on the date of grant (110% of such fair market value for a holder of more than 10% of the Company's common stock), nor may options be exercised more than five years from date of grant. The 1993 Plan will terminate on January 4, 2003.\n4. Shareholders' Equity (cont'd)\nThe table below presents option information for the 1984 Plan:\n4. Shareholders' Equity (cont'd)\n4. Shareholders' Equity (cont'd)\n5. Income Taxes\n1995 1994 1993\n(Benefit)\/Expense (Liability (Liability (Deferred Method) Method) Method) Federal: Current $ (73,837) $2,395,908 $1,920,643 Deferred (503,308) 45,400 159,292 State: Current -- 482,941 366,708 Deferred (62,207) 12,410 37,000 (639,352) $2,936,659 $2,483,643\nDuring the fiscal years ended September 30, 1995, 1994 and 1993, non- qualified options were exercised resulting in an aggregate income tax reduction of $0, $0 and $34,000 respectively, which were credited to \"capital in excess of par.\"\nReconciliations of the statutory federal income tax rate of 34% to the effective tax rates are as follows:\n1995 1994 1993\nStatutory tax rate (34.00%) 34.00% 34.00% State income taxes, net of federal tax benefit (3.63) 4.45 4.39 Effective tax rate (37.63%) 38.45% 38.39%\nEffective October 1, 1993, the Company adopted FASB Statement No. 109, Accounting for Income Taxes. Under Statement 109, the liability method is used in accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on the difference between financial reporting and tax bases\n5. Income Taxes (cont'd)\nof assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. Prior to the adoption of Statement 109, income tax expense was determined using the deferred method. Deferred tax expense was based on items of income and expense that were reported in different years in the financial statements and tax returns and were measured at the tax rate in effect in the year the differences originated.\nAs permitted by Statement 109, the Company has elected not to restate the financial statements for prior years. The effect of the change on pre-tax income from continuing operations for the year ended September 30, 1994 was not material.\nSignificant components of the Company's deferred tax liability as of September 30, 1995 and 1994 are as follows:\nSeptember 30, 1995 1994\nDeferred tax liability: Depreciation $765,132 $698,102\nDeferred tax assets: Bad debts 26,719 Reserve for lawsuit 140,600 99,000 Inventory reserve 520,453 37,000 Reserve for returns and allowances 259,886 124,000 Unicap 34,200 16,000 Loss on foreign affiliate 76,000 Other 8,687 6,000\n990,545 358,000\nDeferred income tax asset $225,413 ($340,102) (liability) net\n6. Commitments and Contingencies\nLetters of Credit\nThe Company was contingently liable for outstanding letters of credit of $2,750,655 at September 30, 1995.\nLeases\nRent expense for the years ended September 30, 1995, 1994 and 1993 amounted to $487,959, $435,742 and $377,958, respectively.\nIn May 1990, the Company entered into a 60 month lease for manufacturing space. The lease provides for all real estate taxes and operating expenses to be paid by the Company and it contains options to renew for two sixty month periods. In March 1993, the Company exercised its first option and extended the lease for an additional 60 months.\nIn March 1993, the Company entered into a 60 month lease for office, warehouse and manufacturing space. The lease provides for all real estate taxes and operating expenses to be paid by the Company and it contains an option to renew for an additional 60 month period.\nIn August, 1995, the Company entered into a 60 month lease for its new 130,000 square foot distribution center. The lease provides for all real estate taxes and operating expenses to be paid by the Company and it contains two options to renew for two five year periods.\n6. Commitments and Contingencies (cont'd)\nFuture minimum rental payments under operating leases are as follows:\n1996 $ 738,329 1997 739,151 1998 658,302 1999 614,416 2000 556,624 Thereafter 36,000 $3,342,822\nTrademark Litigation\nOn November 24, 1986, a petition for cancellation of the Company's trademark \"Pentech\" was filed by another company which alleges that the Company's use of \"Pentech\" as it relates to the Company's products, might cause confusion, mistake or deception. In November 1995, the Company filed a motion to dismiss this petition for failure to proceed by the petitioner. The Company recognizes the risk of an adverse decision with respect to this petition; the loss of the use of the trademark could result in a short-term negative impact on the Company as it would be required to alter its packaging and possibly to change its corporate name. Although the ultimate outcome of the petition cannot be predicted nor the amount of loss, if any, estimated, the Company does not believe that an adverse decision is likely due to the relatively inactive status of this petition and in the unlikely event of an adverse decision the Company does not believe that such decision would materially adversely impact its sales or financial position, since all of the Company's products are marketed under individual product trade names. The Company intends to vigorously defend itself against this petition.\nIn October 1987, the Company commenced an action against certain individuals and entities seeking a declaratory judgment that a patent entitled \"Kit Comprising Multicolored Fluid Dispenser Markers Together With Eradicating Fluid Dispenser\" is not infringed, and is invalid and unenforceable. The defendants asserted counterclaims against the Company for patent infringement. In November 1990, an opinion and order findings of\n6. Commitments and Contingencies (cont'd)\nfact and conclusions of law were released finding that Pentech infringed said patent. The Court of Appeals affirmed this decision in September 1992.\nA trial as to damages, if any, must still be held. The Company intends to vigorously defend itself at such trial, and has provided for a loss contingency in the event it does not prevail.\n7. Major Customer and Concentration of Credit Risk\nFor the years ended September 30, 1995, 1994 and 1993, the Company had one customer who accounted for 9%, 23% and 23%, respectively, of net sales. Concentration of credit risk with respect to trade receivables is generally limited due to the Company's use of credit limits, credit insurance and ongoing credit evaluations and account monitoring procedures.\n8. 401(k) Plan\nThe Company adopted a defined contribution 401(k) plan effective April 1, 1993, covering substantially all employees not covered under a collective bargaining agreement. The plan provides employees an opportunity to make pre-tax payroll contributions to the plan. The Company has the option to make a contribution at its discretion. During 1995, 1994 and 1993, the Company did not make contributions.\n9. Accrued Expenses September 30, 1995 1994 Accrued returns and advertising $2,062,948 $2,268,851 rebates Other accrued expenses 950,777 663,132 3,013,725 $2,931,983\n10. Unaudited Summarized Quarterly Information\nUnaudited summarized quarterly financial information for the years ended September 30, 1995 and 1994 are as follows:\n(000's except for per share information)\nThree Months Ended December March June September 31, 1994 31, 1995 30, 1995 30, 1995(a)\nNet sales $ 9,644 $12,249 $20,013 $12,986 Gross profit 3,436 4,295 6,805 1,268 Net income\/(loss) 283 375 910 (2,626) Earnings per common share .03 .04 .09 (.25)\nThree Months Ended December March June September 31, 1993 31, 1994 30, 1994 30,1994\nNet sales $12,074 $11,153 $22,928 $15,981 Gross profit 4,145 4,332 8,215 5,129 Net income 833 714 2,280 874 Earnings per common share .07 .06 .19 .08\n(a) Fourth quarter results reflect various advertising and volume rebate activity which is not earned by customers until the end of the fiscal year. In addition, in the fourth quarter, the Company reviewed its product line and decided to increase its reserve for slow-moving inventory by $1.3 million, its Cosmetic Division incurred a loss and certain unfavorable domestic manufacturing variances were incurred.\n11. Loss on Mexican Affiliate\nIn 1992, the Company began an affiliation with a Mexican distributor to sell its products in Mexico. As a result of the Pesos devaluation and the eventual termination of the relationship in Fiscal 1995, the Company incurred a loss of $407,000.\nEXHIBIT INDEX\nExhibit 10.4 - Letter dated December 22, 1995 from European-American Bank, NJ.\nExhibit 10.5 - Loan Commitment dated January 31, 1995 between the Company and Chemical Bank, New Jersey N.A.\nExhibit 10.6 - Employment Agreement dated November 3, 1995 between the Company and John W. Linster.\nExhibit 10.7 - Lease Agreement for the premises located at 1101 Corporate Road, North Brunswick, New Jersey between the Company and The Sudler Companies dated August 28, 1995.\nExhibit 21 - Subsidiaries of the Company.\nExhibit 23.1 - Consent of Ernst & Young, LLP.\nEXHIBIT 10.4\nEAB\nDecember 22, 1995\nMr. David Melnick President Pentech International, Inc. 195 Carter Drive Edison, NJ 08817\nRe: $18,000,00 line of credit\nDear David:\nEuropean American Bank (\"EAB\") is pleased to advise you it holds available for Pentech International, Inc. a line of credit (the \"Line\") in the amount of $18,000,000, subject to the following terms and conditions:\n1. Borrower:\nThe Borrower shall be Pentech International, Inc., a corporation organized and in good standing under the laws of the State of Delaware.\n2. Description of the Line:\nThe Line shall be available for documentary sight and time letters of credit (each, an \"L\/C\" and collectively, the \"L\/Cs\"). Each L\/C issued under the Line shall be evidenced by EAB's standard Letter of Credit Application. The maximum tenor of each L\/C shall be 180 days. There shall be payable in respect of each L\/C, a fee equal to $50.00 upon the opening and 1\/4% upon the negotiation thereof (minimum $50.00) together with EAB's standard fees and charges therewith including, but not limited to, EAB's amendment fee of $30.00.\nThere shall be available under the Line a sublimit (the \"Direct Debt Sublimit\") in the aggregate amount of $16,000,000. The Direct Debt Sublimit shall be available for own note borrowings and bankers acceptances.\nOwn note loans provided under the Line shall be evidenced by EAB's standard Master Note for Eurodollar\/Prime Rate Borrowings (the \"Note\") which Note shall bear interest at a rate (the \"Interest Rate\") equal to either (a) EAB's Prime Rate (the rate of interest stated by EAB to be its Prime Rate in effect from time to time and adjusted when said Prime Rate changes) or (b) LIBOR + 1.50% per annum as may be quoted for 30, 60, 90, 180 or 360 day interest periods. Interest on any borrowings shall be computed on the basis of actual days elapsed in a 360 day year.\nInterest on the unpaid principal balance of the Note from time to time outstanding shall be payable monthly in arrears commencing on the first day of the month following the date of the first advance under the Note. Any advance under the Line made by EAB in its discretion shall be in an amount not less than $10,000 for Prime Rate loans and not less than $50,000 for LIBOR loans. The Borrower may prepay, in full or in part, at any time, any Prime Rate loans outstanding under the Line in increments of not less than $10,000 without premium or penalty. LIBOR loans shall be held to maturity. Availability under the Line shall be subject to the discretion of EAB and nothing contained herein shall obligate EAB to fund a request for an advance.\nB\/As shall be evidenced by EAB's standard Acceptance Credit Agreement which shall provide for the payment of a commission, upon the acceptance of each draft which shall constitute a B\/A equal to 1.5% per annum for B\/As created under time L\/C's, with a minimum commission for each B\/A of $75.00. Each B\/A shall have a maximum tenor of 180 days.\nNotwithstanding any indications herein to the contrary, the maximum availability for loans and B\/As in the aggregate shall not exceed an amount determined with application to the following borrowing base formula:\nThe sum of (i) 85% of the Borrower's Eligible Accounts Receivable\" and (ii) 50% of the Borrower's \"Eligible Inventory\" subject to a cap of $11 million on borrowings against inventory with a seasonal cap of $13 million during the calendar months of April and May. \"Eligible Accounts Receivable\" shall mean all accounts of the Borrower less (i) uncollectible accounts; (ii) accounts remaining unpaid after a date which is more than 90 days after the due; and (iii) receivables deemed ineligible by EAB in its sole reasonable discretion.\n\"Eligible Inventory\" shall be defined as goods on hand and\/or goods in transit for which payment has been made by or on behalf of the Borrower or its wholly-owned subsidiaries, Sawdust Pencil Co., Inc. or Pentech Cosmetics, Inc. less any inventory deemed ineligible by EAB in its sole discretion.\nThere shall be available under the Direct Debt Sublimit a sublimit for standby letters of credit (each an \"SBLC\" and, collectively, the \"SBLCs\") in an amount not exceeding $105,000. The maximum tenor of each SBLC shall be one (1) year. Each SBLC issued under the Line shall be evidenced by EAB's standard Standby Letter of Credit Application. There shall be payable in respect of each SBLC, a fee equal to one percent (1%) per annum.\nThe Borrower acknowledges and agrees that the Line is uncommitted and requests for advances of extensions of credit thereunder shall be approved in the discretion of EAB, which may refuse to make an extension of credit under the Line at any time without prior notice to the Borrower, and that the performance or compliance by the Borrower of the agreements contained in this letter, or in any other document or agreement evidencing or securing such advances or extensions of credit, shall not obligate EAB to make an advance or provide an extension of credit thereunder.\nSubject to the terms and conditions of the Note, the Line shall be available until March 31, 1996.\n3. Guarantors:\nRepayment of all loans, extensions of credit, and financial accommodations provided under the Line together with interest and cost thereon shall be guaranteed, jointly and severally, by Sawdust Pencil Company, Inc. and Pentech Cosmetics, Inc. (collectively, the \"Guarantors\") pursuant to EAB's standard Guarantee of All Liability (the \"Guarantee\") and General Security Agreement under which the Guarantors shall secure their obligations under the Guarantee with a lien in favor of EAB on all their accounts and inventory.\n4. Purpose of the Line:\nThe purpose of the line shall be to finance the importation of merchandise from foreign suppliers and the post- financing required through the asset conversion cycle. In addition, the Line shall support the working capital needs of the Borrower.\n5. Security for the Line:\nThe Line shall be secured by a first priority security interest in all assets and personal property of the Borrower pursuant to a EAB's standard General Security Agreement and duly filed UCC-1 Financing Statements which shall be shared pro rata with Chemical Bank New Jersey NA through an intercreditor agreement in form and substance satisfactory to EAB.\n6. Condition Precedent:\nAvailability under the Line shall be subject to, among other things, the execution of all documents and agreements required by EAB to evidence and secure the Line including, without limitation, an Assignment of Life Insurance Policy as Collateral by which the life insurance policies covering the lives of Norman Melnick and David Melnick in the respective amounts of $1,000,000 shall be assigned to EAB.\n7. Financial Reporting:\nThe Borrower shall provide to EAB:\n(i) As soon as available, but in any event within 90 days after the last day of its September 30, 1995 fiscal year, a balance sheet of the Borrower, as of such last day of the fiscal year, and statements of income and retained earnings and cash flows for such fiscal year prepared in accordance with generally accepted accounting principles consistently applied, in reasonable detail, such statements to be audited by a firm of independent certified public accountants satisfactory to EAB.\n(ii) As soon as available, but in any event within 60 days after the end of the first three calendar quarters for each fiscal year, a balance sheet of the Borrower and statements of income and retained earnings and cash flow of the Borrower for each quarter, and the portion of the fiscal year through such date all in reasonable detail, such statements to be prepared on an unaudited basis consistent with the report 10Q filed by the Borrower with the Securities and Exchange Commission (\"SEC\").\nEach of the financial statements specified in Sections (i) and (ii) above shall be accompanied by a certificate signed by the president or chief financial officer of the Borrower to the effect that such statements fairly present the financial condition of the Borrower as of the balance sheet date and results of the operations of the Borrower for the periods then ended in accordance with generally accepted accounting principles consistently applied.\n(iii) Copies of the filings with the SEC, including forms 10K and 10Q, to be submitted within a reasonable time after filing with the SEC.\n(iv) As soon as available, but in any event within 15 days after the end of each calendar month, a schedule of accounts receivable aged to show the number of days each such account has been outstanding from its due date, and a Borrowing Base Certificate, all in form satisfactory to EAB.\n(v) As soon as available, but in any event within 20 days after the end of each calendar month, a statement in such form and in such detail as EAB may reasonably require, setting forth a description of the Borrower's and Guarantors' inventory and their valuation as of the end of such month accompanied by a certificate signed by the Borrower's president or chief financial officer to the effect that such statement is true and correct and, for all statements after the first such statement has been prepared, in accordance with the Borrower's prior methods and procedures.\n(vi) Such other financial or additional information as EAB may from time to time request.\n8. Special Requirements:\na. The Borrower agrees to maintain at all times:\n(i) a minimum working capital (the excess of current assets over current liabilities) of not less than $16,250,000. Minimum working capital shall not include receivables due from stockholders, officers or affiliates but will include amounts due pursuant to the Note.\n(ii) a \"tangible net worth\" (the sum of capital surplus, earned surplus, capital stock and such other items as are allowable under generally accepted accounting principles minus deferred charges, intangibles, receivables due from stockholders, officers or affiliates and treasury stock) in an amount not less than $20,500,000.\n(iii) a maximum leverage ratio (the ratio of total liabilities to tangible net worth) of not greater than 1.5 to 1.\n(iv) Maximum advised credit lines available for Loans, B\/As, L\/Cs and SBLCs from any bank or financial institution, including EAB, and\/or other lending institution in an amount not greater than $36,000,000.\n(v) Maximum direct debt (the sum of Loans and B\/As) from any bank, including EAB, and\/or other lending institution whatsoever of not greater than $30,000,000.\nb. The Borrower agrees:\n(i) To maintain hazard insurance on its inventory with a financially sound and reputable insurance company in such amounts as are necessary to cover not less than the replacement cost of such inventory, and covering such risks as are usually carried by companies engaged in the same or similar business which insurance policy shall be endorsed to name EAB lender loss payee.\n(ii) To maintain life insurance policies in an amount not less than $1,000,000 covering the lives of David Melnick and Norman Melnick issues by an insurance company satisfactory to EAB which policies shall remained assigned to EAB pursuant to a form Assignment of Life Insurance Policy as Collateral satisfactory to EAB.\n(iii) To maintain, to the satisfaction of EAB, a demand deposit account with EAB.\n9. No Prior Agreements:\nThis letter replaces and supersedes that certain letter agreement dated November 30, 1995 between the Borrower and EAB.\n10. Acceptance:\nIf the foregoing is acceptable, please so indicate by signing and returning this letter before December 31, 1995, the date this letter will otherwise expire, unless extended in writing by EAB.\nVery truly yours, EUROPEAN AMERICAN BANK,\nBy: \/s\/Thomas Keith Thomas Keith Vice President\/Group Credit Mgr.\nBy: \/s\/Peter J. McGovern Peter J. McGovern Vice President\nACCEPTED AND AGREED:\nPENTECH INTERNATIONAL, INC.\n\/s\/William Visone\nEXHIBIT 10.5\nCHEMICAL\nChemical Bank New Jersey NA Michael J. Miler East 36 Midland Avenue Vice President Paramus, New Jersey 07652 201\/599-6838\nJanuary 31, 1995\nMr. David Melnick, President Pentech International, Inc. 195 Carter Drive Edison, New Jersey 08817\nDear David:\nWe are pleased to advise you that based upon your annual financial statement for the fiscal year 9\/30\/94 Chemical Bank New Jersey, National Association (the \"Bank\") has approved your request for a line of credit in the aggregate amount of $16,000,000. Our officers may, in their discretion, make short-term loans to Pentech International, Inc. in the amount of $14,000,000 on such terms as are mutually agreed upon between us, from time to time.\nBorrowings under this line of credit are intended to be used to meet the normal short term working capital needs of Pentech International, Inc.\nAs this line is not a commitment, credit availability is, in addition, subject to your execution and delivery of such documentation as the Bank deems appropriate and the receipt and continuing satisfaction with current financial information, which information will be furnished to the Bank as it may from time to time reasonably request. This line of credit expires on January 31, 1996.\nThe approved line of credit is to be secured by a blanket lien on all asset of Pentech International, Inc., Sawdust Pencil, Co., and Pentech Cosmetics, Inc., and furthermore, will be guaranteed by Sawdust Pencil, Co. and Pentech Cosmetics, Inc.\nThe Bank will require reviewed quarterly statements and an audited fiscal year end 9\/30\/95 and a $2500 administrative fee for processing this line of credit.\nWe are pleased to be of service and trust you will call upon us to assist in any of your banking requirements.\nVery truly yours,\nMichael J. Miller\nEXHIBIT 10.6\nEMPLOYMENT AGREEMENT\nEMPLOYMENT AGREEMENT dated as of November 3, 1995 by and between PENTECH INTERNATIONAL, INC., a Delaware corporation, (referred to as the \"Company\") and JOHN W. LINSTER of 62 Teresa Road, Hopkinton, MA 01748 (the \"Executive\").\nW I T N E S S E T H :\nWHEREAS, the Company is in the business of marketing pens, pencils and markers throughout the United States and the world;\nWHEREAS, the Executive is an experienced executive in the business of selling goods in the stationery departments of mass market retailers and others; and\nWHEREAS the Company and the Executive desire to establish an employment relationship with each other.\nNOW, THEREFORE, in consideration of the premises and the mutual covenants hereinafter set forth, the parties hereto agree as follows:\n1. Employment. The Company agrees that the Company shall employ the Executive, and the Executive accepts employment with the Company, on the terms and conditions set forth herein.\n2. Term. The term of employment (the \"Employment Term\") under this Agreement shall commence as of the date hereof and continue, subject to the terms and conditions of this Agreement, for a period of eight years from such date.\n3. Position. The Company shall employ the Executive for the Employment Term as its President and Chief Executive Officer, to be located at the Company's headquarters facility, presently in Edison, New Jersey, to perform when and where necessary such duties relating to the overall operation of the Company as may from time to time be assigned to the Executive by the Board of Directors. These duties shall include duties related to the \"First Six Month's Agenda\" attached hereto as Exhibit A. The Executive agrees to accept such employment and to devote his best efforts in and to the faithful performance of his duties hereunder to the exclusion of all other employment, subject to the general direction and control of the Board of Directors of the Company.\n4. Elected to Board. The Company shall use its best efforts to cause the Executive to be elected to the Board of Directors of the Company at the next Annual Meeting of Shareholders of the Company.\n5. Compensation. (a) In consideration of the services to be rendered by the Executive for his duties pursuant to Section 3 of this Agreement, including, without limitation, any services rendered by the Executive as a director, officer or employee of the Company or of any of its subsidiaries, divisions or affiliated companies, and in full payment for the due and faithful performance of said services, the Company shall pay the Executive and the Executive agrees to accept a salary at the rate of $250,000 per year for the Employment Term (the \"Base Compensation\"). The Base Compensation shall commence as of November 27, 1995. The Base Compensation will be evaluated on at least an annual basis during the Employment Term by the Board of Directors and may be increased in the sole discretion of the Board of Directors.\n(b) Payments to the Executive of his Base Compensation hereunder shall be made periodically on the dates established by the Company for payment of other executive employees, but not less frequently than once a month. All payments under this agreement shall be subject to all deductions and withholdings required by law.\n(c) The Executive shall be entitled to reimbursement for reasonable expenses incurred by him in connection with his employment hereunder, upon the presentation of proper vouchers therefor in accordance with the usual procedures of the Company.\n(d) The Executive shall be entitled to participate in and receive benefits (including vacation benefits) under and in accordance with the provisions of any of the Company's employee benefit plans or programs now or hereafter in effect, to the same extent that employees of The Company in positions similar to that of the Executive have the right to participate in such plans and programs. Such plans and programs presently include medical and life insurance plans.\n(e) The Executive shall be entitled to term life insurance on his life during the Employment Term in the amount of $500,000, the beneficiary of which shall be determined by the Executive.\n(f) The Executive shall be entitled during the Employment Term to a Company-supplied automobile, including insurance and maintenance, comparable to a Lexus 400 in quality.\n(g) The Executive shall be entitled to an option to purchase an aggregate of 200,000 shares of Common Stock of the Company, exercisable as to 25,000 shares per year commencing one year from the date hereof, except in the event of termination of this Agreement before one year from the date hereof in which case the Executive shall be entitled to exercise the option as to 25,000 shares of Common Stock (the \"Option\"). The exercise price of the Option shall be at $3.125 per share, that being the fair market value of a share of Common Stock as of the date hereof.\n6. Termination. The employment of the Executive may be terminated by the Company upon the ocurrence of any of the following events:\n(a) The Company may terminate such employment at any time without good cause upon written notice to the Executive;\n(b) Such employment shall terminate automatically on the death of the Executive;\n(c) The Company may terminate this employment immediately upon written notice to the Executive for good cause. For purposes of this Agreement \"good cause\" shall include the following circumstances:\n(i) If there is a repeated and demonstrable failure on the part of the Executive to perform material duties of Executive's management position in a competent manner and where the Executive fails to substantially remedy the failure within a reasonable period of time after receiving written notice of such failure from the Company;\n(ii) If the Executive is convicted of a criminal offense involving fraud or dishonesty;\n(iii) If the Executive or any member of his family makes any personal profit at the expense of the Company without prior written consent of the Company.\n(iv) If the Executive fails to fully observe the fiduciary duties appropriate to his position; and\n(v) If the Executive disobeys reasonable instructions given in the course of employment by the Board of Directors of the Company that are not inconsistent with the Executive's management position and not remedied by the Executive within a reasonable period of time after receiving written notice of such disobedience.\n(d) The Executive may terminate his employment hereunder upon three months prior written notice to the Company.\n7. Payments on Termination; Change of Control.\n(a) Upon termination of the Executive's employment for any reason, the Company shall pay to the Executive, or if the termination is as a result of the death of the Executive, to his personal representative, any accrued but previously unpaid Basic Compensation prorated to the effective date of such termination. In the event the Company terminates the Executive's employment without good cause on or before December 31, 1996, the Company shall make severance payments equal to and in the same manner as the Executive's Basic Compensation in effect at the time of such termination for a period of 12 months from the effective date of such termination, and the Executive shall be entitled to receive the services of an outplacement firm at a total cost to the Company which shall not exceed 15% of the Executive's Base Compensation in effect at the time of such termination. In the event the Company terminates the Executive's employment without good cause after December 31, 1996, the Company shall make severance payments equal to and in the same manner as the Executive's Base Compensation in effect at the time of such termination for a period of three months from the effective date of such termination; if such termination occurs during 1997, four months from such date; if such termination occurs during 1998 or 1999, five months from such date; if such termination occurs during 2000 or 2001 and six months from such date if such termination occurs during 2002 or 2003.\n(b) In the event of a Change of Control, the Executive shall, during the three month period following such Change of Control, have the right to terminate his employment by giving 30 days prior written notice of such termination to the Company. In the event of such termination, the Executive shall be entitled to receive the severance payments described in subparagraph (a) above for 12 months from such termination. In addition, the Company agrees that the Executive shall have the right to exercise the Option as if the Executive's interest in the Option had vested for two additional years and otherwise in accordance with the terms of the Option. \"Change of Control\" shall mean the acquisition by any corporation, person or entity or any associated group acting in concert not affiliated with the current owners of the Company to (A) gain a majority of the outstanding voting shares, whether by purchase, merger, consolidation, reorganization or other similar transaction, or (B) all or substantially all of the assets of the Company.\n8. Covenant Not to Compete.\n(a) The Executive agrees that during the Employment Term, he will not, directly or indirectly, have any ownership interest of five percent or more in a corporation, firm, trust, association or other entity which is in competition with the Company. (b) The Executive shall not, during the Employment Term and at any time within one year after the termination of his employment with the Company, in any manner, engage or become interested in (as owner, stockholder, partner, director, officer, employee, consultant or otherwise) any business which is competitive with the business conducted by the Company or any of its affiliates at the time of the termination of his employment hereunder. The Executive's ownership of less than five percent of the stock of a publicly-owned company which competes with the Company shall not be considered a violation of the provisions of this Section 8(b).\n(c) Without limiting the rights of the Company hereunder, the parties agree that in the event the Executive violates (in other than a willful violation) any of the provisions of this Section 8, the Company may give the Executive 30 days notice of such violation and opportunity to cure it; in the event the violation is not cured within such 30-day period, such violation will be grounds for termination of this Agreement and the Executive's employment hereunder for cause.\n9. Inventions. (a) For purposes of this Agreement, \"Invention\" shall mean any and all machines, apparatuses, compositions of matter, methods, know-how, processes, designs, configurations, uses, ideas, concepts, or writings of any kind, discovered, conceived, developed, made, or produced, or any improvements to them, and shall not be limited to the definition of an invention contained in the United States Patent Laws.\n(b) The Executive understands and agrees that all Inventions, or trademarks or copyrights relating thereto, which reasonably relate to the business of the Company and which are conceived or made by him during his employment by the Company either alone or with others, are the sole and exclusive property of the Company. The Executive understands and agrees that all Inventions, trademarks, or copyrights described above in this Section 9(a) are the sole and exclusive property of the Company whether or not they are conceived or made during regular working hours.\n(c) The Executive agrees that he will disclose promptly and in writing to the Company all Inventions within the scope of this Agreement, whether he considers them to be patentable or not, which he, either alone or with others, conceives or makes (whether or not during regular working hours). The Executive hereby assigns and agrees to assign all his right, title, and interest in and to those Inventions which relate to the business of the Company and agrees not to disclose any of these to others without the written consent of the Company, except as required by the conditions of his employment.\n(d) The Executive agrees that he will at any time during his employment hereunder, or after this Employment Agreement terminates, on the request of the Company, (i) execute specific assignments in favor of the Company, or its nominee, of any of the Inventions covered by this Agreement, (ii) execute all papers and perform all lawful acts the Company considers necessary or advisable for the preparation, application procurement, maintenance, enforcement, and defense of patent applications and patents of the United States and foreign countries for these Inventions, for the perfection or enforcement of any trademarks or copyrights relating to such Inventions, and for the transfer of any interest the Executive may have, and (iii) execute any and all papers and lawful documents required or necessary to vest sole right, title, and interest in the Company or its nominee of the above Inventions, patent applications, patents, or any trademarks or copyrights relating thereto. The Executive will, at the Company's expense, execute all documents (including those referred to above) and do all other acts necessary to assist in the preservation of all the Company's interests arising under this Agreement.\n10. Secrecy.\n(a) For purposes of this Agreement, \"proprietary information\" shall mean any information relating to the business of the Company that has not previously been publicly released by duly authorized representatives of the Company and shall include (but shall not be limited to) Company information encompassed in all drawings, designs, plans, proposals, marketing and sales plans, financial information, costs, pricing information, customer information, and all methods, concepts, or ideas in or reasonably related to the business of the Company.\n(b) The Executive agrees to regard and preserve as confidential all proprietary information pertaining to the Company's business that has been or may be obtained by the Executive prior to or during his employment by the Company (whether before, during or after the Employment Term hereof), whether he has such information in his memory or in writing or other physical form. The Executive will not use for his benefit or purposes, nor disclose to others, either during the Employment Term or thereafter, except as required by the conditions of his employment hereunder, any proprietary information connected with the business or developments of the Company. This provision shall not apply after the proprietary information has been voluntarily disclosed to the public by the Company or upon its express authorization or has been independently developed and disclosed by others.\n(c) The Executive agrees not to remove from the premises of the Company, except as an employee of the Company in pursuit of the business of the Company or any of its subsidiaries, or except as specifically permitted in writing by the Company, any document or object containing or reflecting any proprietary information of the Company. The Executive recognizes that all such documents and objects, whether developed by him or by someone else, are the exclusive property of the Company. Upon termination of his employment hereunder, the Executive shall forthwith deliver up to the Company all proprietary information, including, without limitation, all lists of customers, correspondence, accounts, records and any other documents or property made or held by him or under his control in relation to the business or affairs of the Company or its affiliates, and no copy of any such proprietary information shall be retained by him.\n11. Injunctive Relief. The Executive acknowledges that in the event of a breach or threatened breach by the Executive of any of the provisions of Sections 8, 9 or 10, monetary damages will not adequately compensate the Company and the Company shall be entitled to an injunction restraining the Executive from the commission of such breach.\n12. Relocation Allowance. In connection with the Executive's agreement to relocate to New Jersey, it is the Company's intention, other than as to the underlying value of the Executive's home in Massachusetts, that the Executive not incur any loss or receive any profit solely as a result of such move. In order to simplify this process the Company has agreed to the following:\n(a) The Company will pay for a suitable apartment for the Executive for up to six months from the time he moves to New Jersey until the Executive moves into a permanent residence in New Jersey.\n(b) The Company will pay or reimburse the Executive for the sales commission to the real estate broker who assists the Executive to sell his house in Massachusetts.\n(c) In respect of all other costs related to this move, the Company will pay the Executive $26,000.\nThe amounts set forth above shall be final unless there is a substantial difference other than related to points or size of the Executive's mortgage, for which there will be no adjustment.\n13. Notices. Any notice required or permitted to be given hereunder shall be in writing and shall be delivered by prepaid registered or certified mail, return receipt requested. Such duly mailed notice shall be deemed given when dispatched. The address for mailed notices shall be:\n(a) For the Executive - the address set forth above\n(b) For the Company - Pentech International, Inc. 195 Carter Drive Edison, NJ 08817\nwith a copy to:\nRichard S. Kalin, Esq. KALIN & BANNER 757 Third Avenue - 7th Floor New York, NY 10017\nAny party may notify the other parties in writing of a change of address by serving notice in the manner provided in this Section.\n14. No Conflicting Agreements. Except as set forth herein, the Executive represents and warrants that neither the execution and delivery of this Agreement nor the performance of his duties hereunder violates or will violate the provisions of any agreement to which he is a party or by which he is bound. The parties acknowledge that the Executive is subject to a restriction in his employment agreement with his former employer, Avery Dennison Corporation (\"Avery\"). The Executive has advised the Company that Avery has orally waived the provisions of such restriction to the extent of the Executive's responsibilities pursuant to this Agreement. Notwithstanding the foregoing, this Agreement is immediately cancellable by the Company in the event the Executive does not deliver to the Company a written confirmation of such waiver by Avery to the reasonable satisfaction of the Company.\n15. New York Law. This Agreement shall be construed according to the laws of the State of New York, and constitutes the entire understanding between the parties, superseding and replacing all prior understandings and agreements between the Company and the Executive and the parties shall cause such other agreements, if any, to be terminated. In any event, following the effectiveness of this Agreement, the Executive shall be entitled to no compensation from the Company, except as required by this Agreement. This Agreement cannot be changed or terminated except by an instrument in writing signed by each of the parties hereto.\n16. Amendments. If any provision of this Agreement or the application thereof shall for any reason be invalid or unenforceable, such provision shall be limited only to the extent necessary in the circumstances to make such provision valid and enforceable and its partial or total invalidity or unenforceability shall in any event not affect the remaining provisions of this Agreement which shall continue in full force and effect.\nIN WITNESS WHEREOF, the undersigned have duly executed and delivered this Agreement as of the date first above written.\nPENTECH INTERNATIONAL, INC.\nBy: \/s\/ David W. Melnick David W. Melnick, Chief Operating Officer\n\/s\/ John W. Linster John W. Linster\nEXHIBIT 10.7\nAGREEMENT OF LEASE\nFOR AND IN CONSIDERATION of the mutual covenants herein contained, the parties hereto do hereby agree as follows:\n1. Incorporated Terms. The following terms are incorporated by reference into this Agreement:\n(a) DATE OF LEASE:\nAugust 28, 1995\n(b) NAME AND ADDRESS OF LANDLORD:\nPENSUD COMPANY LIMITED PARTNERSHIP a New Jersey limited partnership c\/o The Sudler Companies 75 Eisenhower Parkway Roseland, New Jersey 07068-1696\n(c) NAME AND ADDRESS OF TENANT:\nPENTECH INTERNATIONAL, INC. a Delaware corporation 195 Carter Drive Edison, New Jersey 08817\n(d) DESCRIPTION OF PROPERTY:\nThe premises known as 1101 Corporate Road, North Brunswick, New Jersey on which is located a building containing approximately 130,275 square feet commonly known as Block 17, Lot 95.02 on the Tax Map of North Brunswick, New Jersey and shown on the Plot Plan Rider.\n(e) TERM OF LEASE:\nCommencing on September 1, 1995 and expiring October 31, 2000.\n(f) PERMITTED USE:\nGeneral warehousing and light assembly and ancillary offices incidental thereto.\n(g) SECURITY DEPOSIT:\n$75,000.00.\n(h) BROKER:\nContinental Realty Advisors, Inc. and Stanford Realty Corp.; commission to be paid by Landlord.\n(i) RIDERS TO LEASE:\nRent Rider Extension Options Rider Plot Plan Rider Landlord's Work Rider\n2. Description of Property. Landlord hereby leases to Tenant and Tenant hereby hires from Landlord, the land (the \"Land\"), building (the \"Building\") and other improvements described in Section 1(d) (collectively the \"Property\").\n3. Term. The term of the Lease (the \"Term\") shall commence on the date set forth in Section 1(e) (the \"Commencement Date\") and terminate on the date set forth in Section 1(e) (the \"Expiration Date\"), except as hereinafter provided.\nTenant shall be subject to all of the provisions of this Lease from the Commencement Date, except that Tenant shall not be obligated to pay Base Rent until October 16, 1995 (the \"Rent Start Date\").\nThe first Lease Year shall be the period commencing on the Commencement Date and ending twelve calendar months from the last day of the month in which the Rent Start Date occurs. Each succeeding twelve calendar month period thereafter shall be a Lease Year.\n4. Base Rent. Tenant shall pay to Landlord at the address set forth in Section 1(b), or to such other person or at such other place as Landlord may from time to time designate, without previous demand therefor and without counterclaim, deduction or set-off, the rent (\"Base Rent\") set forth on the Rent Rider annexed hereto, such Base Rent to be payable in monthly installments as set forth on the Rent Rider in advance on the first day of each month during the term of the Lease. The first monthly installment of Base Rent is being paid by Tenant on execution of this Lease.\n5. Net Lease. It is the intention of Landlord and Tenant that this is a net lease and that the Base Rent shall be absolutely net to Landlord and that Tenant shall be solely responsible for and pay all costs for the use, operation, maintenance, care and repair of the Property. All obligations with respect to the Property payable by Tenant other than the Base Rent are additional rent under this Lease. The term \"rent\" means the Base Rent and additional rent.\n6. Real Property Taxes. (a) Tenant shall pay all real property impositions during the Term, such payment to be made in accordance with Section 2 of the Rent Rider. As used herein, the term \"real property impositions\" means (i) any tax, assessment or other governmental charge of any kind which at any time during the Term may be assessed, levied, imposed upon or become due and payable with respect to the Property; (ii) any tax on the Landlord's right to receive, or the receipt of rent or income from the Property, or against Landlord's business of leasing the Property; (iii) any tax or charge for fire protection, refuse collection, streets, sidewalks or road maintenance or other services provided to the Property by any governmental agency; (iv) any tax replacing or supplementing in whole or in part any tax previously included within the definition of real property impositions under this Lease; and (v) the cost of prosecuting any appeal of the real property impositions with respect to the Property, including attorneys' fees, appraisers' fees, and any administration charge of the managing agent of the Property, if such appeal is prosecuted at the request of Tenant. During the first and last years of the Term, the real property impositions payable by Tenant shall be prorated for the fraction of the tax fiscal year included in the Term.\n(b) If an assessment for public improvements is levied against the Property, Landlord shall be deemed to have elected to pay such assessment in the maximum number of installments then permitted by law (whether or not Landlord actually so elects), and Tenant shall pay the installments payable during or attributable to the Term, together with any interest due as a result of the installment payments. Any installment for a period during which the Commencement Date or Expiration Date occurs shall be prorated for the fraction of the period included in the Term.\n(c) Real property impositions do not include Landlord's federal or state income, franchise, inheritance or estate taxes.\n7. Insurance. (a) Throughout the Term, Landlord shall procure and maintain, at Tenant's expense (to be paid in accordance with Section 2 of the Rent Rider), the following policies of insurance: (i) insurance covering all risk of physical loss or damage to the Building in the full amount of its replacement value (including agreed amount endorsement), but in no event less than the amount required by any mortgagee of the Property (\"Landlord's Mortgagee\") (such policy shall provide protection against all perils included within the classification of fire, extended coverage, vandalism, malicious mischief, special extended perils, including demolition and increased cost of construction, water damage, sprinkler leakage, and any other perils which Landlord or Landlord's Mortgagee deems necessary); (ii) rental income insurance in an amount equal to one year's Base Rent, estimated real property impositions and insurance premiums; (iii) insurance against loss or damage by boiler or machinery or internal explosion or breakdown of boilers, equipment or electrical appurtenances, in an amount required by Landlord or any Landlord's Mortgagee; (iv) insurance against breakage of all plate glass on the Property; (v) flood hazard insurance in the amount of the full replacement cost of the Building, or if such amount of insurance is not obtainable, in the maximum amount which is obtainable; and (vi) such other insurance as Landlord or any Landlord's Mortgagee may reasonably require. All proceeds payable under any such policy shall be paid to Landlord or Landlord's Mortgagee, as their respective interests may appear. Tenant shall be responsible for payment of any deductible amount under any of the policies maintained in accordance with this Section 7 in the event of casualty.\n(b) Throughout the Term, Tenant shall procure and maintain, at its expense, a policy of comprehensive public liability insurance, including contractual liability coverage insuring Landlord, Sudler Construction Co., Inc., Landlord's managing agent, Landlord's mortgagee and Tenant against liability arising out of the ownership, use, occupancy or maintenance of the Property or in any manner related to the Property or any act or omission of Tenant. The initial amount of such insurance shall be at least $5,000,000 in combined single limit with respect to injury or death in any one accident, and at least $1,000,000 for damage to property. Such amount shall be subject to periodic increase as reasonably required by Landlord. However, the amount of such insurance shall not limit Tenant's liability hereunder. Tenant's insurance shall be written on an occurrence basis and shall be primary with respect to the Property.\n(c) Each insurance policy shall name as insureds Landlord, Sudler Construction Co., Inc. and any Landlord's Mortgagee, as their respective interests may appear. Each policy shall contain standard mortgagee endorsement clauses. All insurance policies shall be maintained with insurance companies authorized to transact insurance business in the state in which the Property is located and holding a \"General Policyholder's Rating\" of A or better, as set forth in the most current issue of \"Best's Insurance Guide\". The original all risk insurance policy (or copy thereof certified by the insurer) and certificates evidencing other insurance Tenant is required to maintain hereunder shall be deposited with Landlord at least ten (10) days prior to the Commencement Date. Evidence of renewals of all policies shall be deposited with Landlord not less than thirty (30) days prior to the end of the term of each such policy. Original and renewal policies or certificates shall be accompanied by proof of payment of the premiums therefor. Such insurance shall not be subject to cancellation except after at least thirty (30) days prior written notice to Landlord and Landlord's Mortgagee, and any loss shall be payable notwithstanding any act or negligence of Tenant or Landlord.\n(d) Tenant shall obtain for each insurance policy procured by it regarding the Property or any property located thereon, an appropriate clause therein or endorsement thereto pursuant to which each such insurance company waives its subrogation rights against Landlord, Landlord's managing agent and Sudler Construction Co., Inc. If waiver of subrogation shall not be obtainable except at additional charge, Tenant shall pay the insurer's additional charge therefor.\n8. Utilities. Tenant shall pay, directly to the appropriate supplier, the cost of all light, power, natural gas, fuel, oil, sewer service, sprinkler stand-by service, water, telephone, refuse disposal and other utilities and services supplied to the Property. Landlord shall not be liable to Tenant, and Tenant's obligations under the Lease shall not be abated, in the event of any interruption or inadequacy of any utility or service supplied to the Property.\n9. Use of Property. (a) The Property may only be used for the use set forth in Section 1(f).\n(b) Notwithstanding the foregoing, Tenant shall not use or permit the Property to be used for (i) any unlawful purpose; (ii) in violation of any certificate of occupancy covering the Property; (iii) any use which may constitute a public or private nuisance or make voidable any insurance in force relating to the Property; or (iv) any purpose which creates or produces noxious odors, smoke, fumes, emissions, noise or vibrations.\n(c) Tenant shall not cause or permit any overloading of the floors of the Building. Tenant shall not install any equipment or other items upon or through the roof, or cause openings to be made in the roof, without Landlord's prior written consent.\n(d) No storage of any goods, equipment or materials shall be permitted outside the Building on the Property except for one (1) garbage dumpster and the occasioned storage of two (2) truck trailers.\n10. Existing Conditions. Except for any work required to be performed by Landlord as provided in the Landlord's Work Rider, Tenant accepts the Property in its \"as is\" condition as of the date hereof. Tenant acknowledges that Landlord has not made any representation as to the condition of the Property or the suitability of the Property for Tenant's intended use. Landlord shall have the right to perform items of Landlord's Work after the Commencement Date. Tenant agrees to cooperate with Landlord by removing furniture, fixtures, equipment and product from the areas in which Landlord is performing work.\n11. Maintenance and Repairs. (a) Tenant shall keep and maintain the Property (including all structural, non-structural, exterior, interior and landscaped areas, and systems and equipment) in good order, condition and repair during the Term. Tenant shall promptly replace any portion of the Property or any systems or equipment thereof which cannot be fully repaired. All repairs and replacements shall be performed in a good and workmanlike manner. All of Tenant's obligations to maintain and repair the Property shall be accomplished at Tenant's sole expense.\n(b) Tenant shall keep and maintain all portions of the Property and the parking areas, sidewalks and landscaped areas, in an attractive and clean condition free of dirt and rubbish, and clear the parking areas and sidewalks of accumulations of snow and ice.\n(c) During the Term, Tenant shall procure and maintain the following service contracts: (i) contract for the inspection, service, maintenance and repair of all heating, ventilating and air conditioning equipment installed in the Building (the inspection pursuant to such contract shall be made at least quarterly); and (ii) contract for maintenance of the landscaped areas of the Property. The identity of each contractor and each contract shall be subject to Landlord's reasonable approval. Copies of reports of inspections made hereunder shall be promptly supplied to Landlord.\n(d) During the Term, Landlord shall procure and maintain, at Tenant's expense (to be paid in accordance with Section 2 of the Rent Rider), a contract for inspection and maintenance of the roof of the Building (the inspections pursuant to such contract shall be made at least semi-annually). The costs of any repairs and\/or replacements of the roof shall be amortized on a straight line basis over ten (10) years and Tenant shall, upon demand, pay Landlord that portion of such costs applicable to the Term and any extension(s) thereof.\n12. Alterations and Improvements. (a) Tenant shall not make any alterations, additions or improvements to the Property (the \"Alterations\") without Landlord's prior written consent, except for non-structural Alterations which do not exceed $15,000 in cost and which are not visible from the outside of the Building. In no event shall Alterations reduce the size or cubic content of the Building or reduce the value of the Property. Tenant shall submit to Landlord detailed plans and specifications for Alterations requiring Landlord's consent and reimburse Landlord for all reasonable expenses incurred by Landlord in connection with its review thereof. Tenant shall also provide to Landlord for its reasonable approval the identity of the contractor Tenant proposes to employ to construct the Alterations. All Alterations shall be accomplished in accordance with the following conditions:\n(1) Tenant shall procure all governmental permits and authorizations for the Alterations, and obtain and provide to Landlord an official certificate of occupancy and\/or compliance upon completion of the Alterations, if appropriate.\n(2) Tenant shall arrange for extension of the general liability insurance provided for in Section 7(b) to apply to the construction of the Alterations. Further, Tenant shall procure and maintain Builders Risk Casualty Insurance in the amount of the full replacement cost of the Alterations and statutory Workers Compensation Insurance covering all persons employed in connection with the work. All such insurance shall conform to the requirements of Section 7(c).\n(3) Tenant shall construct the Alterations in a good and workmanlike manner utilizing materials of first class quality for the particular use and in compliance with all laws and governmental regulations.\n(b) Upon completion of the Alterations, Tenant shall provide Landlord with \"as built\" reproducible transparency plans of the Alterations.\n(c) Alterations shall be the property of Landlord and shall remain on the Property upon termination of the Lease, or, if Landlord so requires, a portion of or all Alterations shall be removed by Tenant on or prior to the termination of the Lease and Tenant shall restore the Property to its condition prior to such Alterations.\n(d) Under no circumstances shall Tenant's furniture and equipment be deemed an Alteration pursuant to this Section 12.\n(e) Notwithstanding anything to the contrary contained herein, Tenant shall at all times have the right to remove its trade fixtures and personal property from the Property; provided, however, that Tenant shall, at its own cost and expense, repair any damage caused by such removal and shall restore the Property to the condition that it was in prior to the installation of Tenant's said trade fixtures and personal property.\n13. Covenant Against Liens. Tenant shall not have any right to subject to Landlord's interest in the Property to any mechanic's lien or any other lien whatsoever. If any mechanic's lien or other lien, charge or order for payment of money shall be filed as a result of the act or omission of Tenant, Tenant shall cause such lien, charge or order to be discharged or appropriately bonded within ten (10) days after notice from Landlord thereof, and Tenant shall indemnify and save Landlord harmless from all liabilities and costs resulting therefrom.\n14. Signs. Tenant shall not place any signs on the Property without Landlord's prior written approval of its design, location and manner of installation. In no event shall any sign be installed on the roof or above the parapet height of the Building. Tenant shall remove its signs upon termination of this Lease and restore the Property to its condition prior to installation of the signs.\n15. Compliance with Law. Tenant shall take all necessary action to conform to and comply with all laws, orders and regulations of any governmental authority or Landlord's or Tenant's insurers, or any Landlord's Mortgagee, now or hereafter applicable to the Property or Tenant's use or occupancy. Tenant shall obtain all permits, including a certificate of occupancy, necessary for Tenant's occupancy or use of the Property.\n16. Environmental Law Compliance. (a) Tenant shall, at Tenant's sole cost and expense, comply with the Industrial Site Recovery Act, N.J.S.A. 13:1K-6 et seq. and the regulations promulgated thereunder (\"ISRA\"). Tenant shall, at Tenant's sole cost and expense, make all submissions to, provide all information to, and comply with all requirements of, the New Jersey Department of Environmental Protection (\"NJDEP\"). If any spill or discharge of hazardous substances or wastes occurs during the Term, and the Bureau or other division of NJDEP determines that a cleanup plan be prepared and a cleanup be undertaken, then Tenant shall, at Tenant's sole cost and expense, prepare and submit the required plans and financial assurances, and carry out the approved plans. Such cleanup shall be to the strictest standard required by NJDEP regardless of use. Tenant's obligations under this Section shall arise if there is any closing, terminating or transferring of operations by any person or entity of an industrial establishment at the Property pursuant to ISRA, including without limitation a sale, transfer or conveyance of the Property by Landlord or an assignment or subletting by Tenant. At no expense to Landlord, Tenant shall promptly provide all information requested by Landlord for preparation of non-applicability affidavits and shall promptly sign such affidavits when requested by Landlord.\n(b) Tenant shall indemnify, defend and hold harmless Landlord from all fines, suits, procedures, claims and actions of any kind arising out of or in any way connected with any spills or discharges of hazardous substances or wastes at the Property which occur during the Term and from all fines, suits, procedures, claims and actions of any kind arising out of Tenant's failure to provide all information, make all submissions and take all actions required by the Bureau or any other division of NJDEP or any other governmental agency with respect to the Property.\n(c) Tenant's obligations under this Section shall survive the expiration of this Lease.\n(d) Anything herein to the contrary notwithstanding, Landlord shall be responsible for the cleanup of any hazardous materials or wastes on the Property which were present on the Property prior to the Commencement Date and the presence of which was not caused by Tenant or Tenant's agents, employees, invitees, contractors and\/or licensees. Landlord shall indemnify, defend and hold harmless Tenant from all fines, suits, procedures, claims and actions of any kind resulting from the existence of any hazardous materials and\/or wastes on the Property which were present on the Property prior to the Commencement Date and the presence of which was not caused by Tenant or Tenant's agents, employees, invitees, contractors and\/or licensees.\n17. Landlord's Access. Landlord and its representatives may enter the Property at all reasonable times (or at any time in the event of emergency) for the purpose of inspecting the Property, or making any necessary repairs, or to show the Property to prospective purchasers, investors, encumbrances, tenants or other parties, or for any other purpose Landlord deems necessary. During the final six (6) months of the Term, Landlord may place customary \"For Sale\" or \"For Lease\" signs on the Property.\n18. Assignment and Subletting. (a) Except as otherwise provided in this paragraph, Tenant shall not assign or encumber Tenant's interest in this Lease, or sublet any portion of the Property, or grant concessions or licenses with respect to the Property, without Landlord' s prior written consent, which consent shall not be unreasonably withheld or delayed. The cumulative change of more than twenty-five (25%) percent of the ownership interest of Tenant shall be deemed to be an assignment of this Lease requiring Landlord's consent. However, Tenant may assign this Lease or sublet the Property, without Landlord's consent, to any corporation which controls, is controlled by or is under common control with Tenant, or to any corporation resulting from the merger of or consolidation with Tenant, provided such assignee shall assume all of Tenant's obligations under this Lease, and such assignee or sublessee shall then have a net worth at least equal to that of Tenant on the date hereof.\n(b) If Tenant desires to assign this Lease or sublet all or any portion of the Property, Tenant shall submit to Landlord a written request for Landlord's approval thereof, setting forth the name, principal business address, and nature of business of the proposed assignee or sublessee; the financial, banking and other credit information relating to the proposed assignee or sublease; and the details of the proposed assignment or subletting, including a copy of the proposed assignment or sublease instrument and plans for any Alterations required for the proposed assignee or sublessee. Tenant shall also furnish any other information reasonably requested by Landlord. Landlord shall have the option (i) to withhold its consent; (ii) to grant consent; or (iii) in the event of a proposed assignment of this Lease or sublease of a substantial portion of the Property, to terminate this Lease as of the effective date of such proposed assignment or sublease. Landlord may enter into a direct lease with the proposed assignee or sublessee, if Landlord so elects. Landlord's acceptance of rent from a proposed assignee or sublessee shall not be construed to constitute its consent to an attempted assignment or subletting.\n(c) In the event of a permitted assignment or subletting, Tenant shall remit to Landlord as additional rent each month during the remainder of the Term fifty (50%) percent of any rent or other sums received by Tenant from its assignee or sublessee in excess of the Base Rent and other charges paid by Tenant allocable to the Property or portion thereof sublet, as the case may be.\n(d) No assignment or subletting hereunder, whether or not with Landlord's consent, shall release Tenant from any obligations under this Lease, and Tenant shall continue to be primarily liable hereunder. If Tenant's assignee or sublessee defaults under this Lease, Landlord may proceed directly against Tenant without pursuing its remedies against the assignee or sublessee. Consent to one assignment or subletting shall not be deemed a consent to any subsequent assignment or subletting. Landlord may consent to subsequent assignments or modifications of this Lease or sublettings without notice to Tenant and Tenant shall not be relieved of liability under this Lease.\n(e) Tenant shall pay to Landlord upon demand all costs, including reasonable legal fees, which Landlord shall incur in reviewing any proposed assignment or subletting.\n(f) Notwithstanding anything herein to the contrary, provided that Tenant shall not be in default of any of its obligations under this Lease, Tenant may sublet up to an aggregate of twenty (20%) percent of the Premises, without Landlord's consent, but nevertheless subject to all of the other terms and provisions of this Article 18. Tenant shall give Landlord prompt notice of any such subletting.\n19. Casualty. If the Building is damaged by fire or other casualty, and (i) the insurance proceeds received by Landlord on account of such damage are sufficient to pay for the necessary repairs, (ii) Landlord's Mortgagee permits Landlord to utilize the insurance proceeds to repair such damage, and (iii) the Building can be fully repaired within one hundred eighty days (180) days after such casualty occurred, this Lease shall remain in effect and Landlord shall repair the damage as soon as reasonably possible. If any of the foregoing conditions requiring Landlord to repair the Building is not met, Landlord may elect either to (i) terminate this Lease; or (ii) repair the damage as soon as reasonably possible, in which event this Lease shall remain in full force and effect (but Tenant shall then have the right to terminate this Lease if the Building cannot be fully repaired within one hundred eighty (180) days after such casualty occurred). Landlord shall notify Tenant of its election within thirty (30) days after Landlord receives notice of the occurrence of the casualty. Tenant's notification, if any, shall be required within ten (10) days thereafter. In the event this Lease shall remain in full force and effect following a casualty, there shall be no abatement of the Base Rent or additional rent payable hereunder, but the proceeds of the rental income insurance described in Section 7 shall be applied against Tenant's rental obligations as received by Landlord. Tenant waives the protection of any law which grants a tenant the right to terminate a lease in the event of the destruction of a leased property, and agrees that the provisions of this paragraph shall govern in the event of any destruction of the Building. Landlord shall not be required to repair improvements or alterations to the Property made by Tenant. Landlord shall have the option to terminate this Lease if more than twenty five (25%) percent of the ground floor area of the Building is damaged or destroyed by fire or other casualty or by the elements during the last two (2) years of the Term.\n20. Condemnation. If more than thirty-five (35%) percent of the Land and\/or Building shall be taken under the power of eminent domain or sold under the threat thereof (\"Condemnation\") and Tenant's use of the Property is materially adversely affected in the reasonable opinion of Tenant exercised in good faith, this Lease shall terminate on the date on which title to the Property or portion thereof shall vest in the condemning authority. If this Lease shall remain in effect as to the portion of the Property not taken, Landlord shall restore the improvements not taken as nearly as reasonably practicable to their condition prior to the Condemnation, and the Base Rent shall be reduced proportionately in accordance with the reduction in the square foot area of the Building following the Condemnation. Landlord shall be entitled to receive the entire award in any Condemnation proceeding relating to the Property, except that Tenant may assert a separate claim to an award for its moving expenses and for fixtures and personal property installed by Tenant at its expense. It is understood that Tenant shall have no claim against Landlord for the value of the unexpired Term of this Lease or any options granted under this Lease. Landlord shall not be required to restore improvements or alterations to the Property made by Tenant.\n21. Surrender of Property. Upon termination of the Lease, Tenant shall surrender the Property to Landlord broom clean, and in good order and condition, except for ordinary wear and tear, and damage by casualty which Tenant was not obligated to remedy under Section 19. Tenant shall remove its machinery and equipment and repair any damage to the Property caused by such removal. Tenant shall not remove any power wiring or power panels, lighting or lighting fixtures, wall coverings, blinds or other window coverings, carpets or other floor coverings, heaters or air conditioners or fencing or gates, except if installed by Tenant and required by Landlord to be removed from the Property. All personal property of Tenant remaining on the Property after Tenant's removal shall be deemed abandoned and at Landlord's election may either be retained by Landlord or may be removed from the Property at Tenant's expense.\n22. Holdover. In the event Tenant remains in possession of the Property after the expiration of the term of this Lease (the \"Holdover Period.), in addition to any damages to which Landlord may be entitled or other remedies Landlord may have by law, Tenant shall pay to Landlord a rental for the Holdover Period at the rate of twice the sum of (i) the annual rent payable during the last lease year of the term, plus (ii) all items of additional rent and other charges with respect to the Property payable by Tenant during the last lease year of the Term. Nothing herein contained shall be deemed to give Tenant any right to remain in possession of the Property after the expiration of the Term of this Lease. The sum due to Landlord hereunder shall be payable by Tenant upon demand.\n23. Events of Default; Remedies. (a) Tenant shall be in default upon the occurrence of one or more of the following events (an \"Event of Default\"): (i) Tenant fails to pay rent or any other sum of money required to be paid by Tenant hereunder within five (5) days of the date when due; (ii) Tenant fails to perform any of Tenant's non-monetary obligations under this Lease within thirty (30) days after written notice thereof from Landlord (provided that if more than thirty (30) days are required to complete such performance, Tenant shall not be in default if Tenant promptly commences such performance and thereafter diligently pursues its completion); (iii) Tenant abandons the Property for thirty (30) days or more; or (iv) Tenant makes an assignment for the benefit of creditors, or if a petition for adjudication of bankruptcy or for reorganization is filed by or against Tenant and is not dismissed within thirty (30) days, or if a receiver or trustee is appointed for a substantial part of Tenant's property and such appointment is not vacated within thirty (30) days.\n(b) On the occurrence of an Event of Default, without limiting any other right or remedy Landlord may have, without notice or demand, Landlord may:\n(i) Terminate this Lease and Tenant's right to possession of the Property by any lawful means, in which event Tenant shall immediately surrender possession of the Property to Landlord. At its option, Landlord may occupy the Property or cause the Property to be redecorated, altered, divided, consolidated with other adjoining property, or otherwise prepared for reletting, and may relet the Property or any part thereof for a term or terms to expire prior to, at the same time or subsequent to the original Expiration Date, and receive the rent therefor, applying the sums received first to the payment of such expenses as Landlord may have incurred in connection with the recovery of possession, preparing for reletting and the reletting itself, including brokerage and attorneys' fees, and then to the payment of damages in amounts equal to the rent hereunder and to the cost and expense of performance of the other covenants of Tenant under this Lease. Tenant agrees to pay to Landlord damages equal to the rent and other sums payable by Tenant under this Lease, reduced by the net proceeds of the reletting, if any, as ascertained from time to time. In reletting the Property, Landlord may grant rent concessions, and Tenant shall not be entitled to any credit therefor. Tenant shall not be entitled to any surplus resulting from any reletting. Tenant expressly agrees that Landlord shall not be obligated to re-rent the Property or take any other action to mitigate its damages in the event Tenant is in default under this Lease.\n(ii) Permit Tenant to remain in possession of the Property, in which event this Lease shall continue in effect. Landlord shall be entitled to enforce all of Landlord's rights and remedies under this Lease, including the right to receive the rent as it becomes due under this Lease.\n(iii) Pursue any other remedy now or hereafter available under the laws of the jurisdiction in which the Property is located.\n(c) The remedies available to Landlord herein specified are not intended to be exclusive and prevent Landlord from exercising any other remedy or means of redress to which Landlord may be lawfully entitled. In addition to other remedies provided in this Lease, Landlord shall be entitled to restraint by injunction of any violation or threatened violation by Tenant of any of the provisions of this Lease. Landlord's exercise of any right or remedy shall not prevent Landlord from exercising any other right or remedy.\n(d) To the extent permitted by law, Tenant, for itself and any person claiming through or under Tenant, waives any equity or right of redemption provided by any law.\n(e) Tenant agrees to pay as additional rent all attorneys fees and other expenses incurred by Landlord in the enforcement of any of the agreements or obligations of Tenant under this Lease.\n24. Service Fee: Interest. (a) Tenant's failure to pay rent promptly or make other payments required under this Lease may cause Landlord to incur unanticipated costs, which are impractical to ascertain. Therefore, if Landlord does not receive any payment of Base Rent, additional rent or other sums due from Tenant to Landlord within five (5) days after it becomes due, without the need for any notice thereof by Landlord (except Landlord agrees to give written notice thereof not more than once in any twelve (12) month period during the Term and the said five (5) day period shall commence as of the date of such notice) Tenant shall pay Landlord as additional rent a service fee equal to eight (8%) percent of the overdue amount. This service fee shall be in addition to reasonable legal fees and costs incurred by Landlord in enforcing this Lease.\n(b) Any amount owed by Tenant to Landlord which is not paid within thirty (30) days after it becomes due shall bear interest at the rate of eighteen (18%) percent per annum (\"Default Interest\") from the expiration of such thirty (30) day period. The payment of Default Interest on such amounts shall not extend the due date of any amount owed. If the interest rate specified in this Lease shall exceed the rate permitted by law, the Default Interest shall be deemed to be the maximum legal interest rate permitted by law.\n25. Indemnification by Tenant. Tenant shall indemnify and hold harmless Landlord, Sudler Construction Co., Inc. and Landlord's managing agent from and against all liability, claims or costs, including reasonable legal fees, arising from (i) Tenant's use of the Property; (ii) any breach of this Lease by Tenant; (iii) any other act or omission of Tenant; or (iv) any injury to person or damage to property occurring on or about the Property. Tenant shall defend Landlord, Sudler Construction Co., Inc. and Landlord's managing agent against any such claim of a third party, with counsel reasonably acceptable to Landlord or, at Landlord's election, Tenant shall reimburse Landlord for reasonable legal fees incurred by Landlord's employment of its own counsel.\n26. Landlord's Right to Cure Tenant's Default. If Tenant fails to make any payment or perform any act on its part to be made or performed, then Landlord, without waiving or releasing Tenant from such obligation, may, after any applicable cure period granted to Tenant herein, make such payment or perform such act on Tenant's part, and the costs incurred by Landlord in connection with such payment or performance, together with Default Interest thereon, shall be paid on demand by Tenant to Landlord as additional rent.\n27. Waiver of Liability. Landlord shall not be liable for any injury or damage to the business, equipment, merchandise or other property of Tenant or any of Tenant's employees or invitees or any other person on or about the Property, resulting from any cause, including, but not limited to: (i) fire, steam, electricity, water, gas or rain; (ii) leakage, obstruction or other defects of pipes, sprinklers, wires, plumbing, air conditioning, boilers or lighting fixtures; or (iii) condition of the Property.\n28. Force Majeure. If Landlord is unable to perform any of its obligations due to events beyond Landlord's reasonable control, the time provided to Landlord for performing such obligations shall be extended by a period of time equal to the duration of such events, and Tenant shall not be entitled to any claim against Landlord by reason thereof. Events beyond Landlord's reasonable control include, but are not limited to, acts of God, war, civil commotion, labor disputes, strikes, casualty, weather conditions, labor or material shortages, or government regulation or restriction.\n29. Notice of Landlord's Default. Tenant shall give written notice of any failure by Landlord to perform any of its obligations under this Lease to Landlord and any ground lessor or Landlord's Mortgagee whose name and address have been furnished to Tenant. Landlord shall not be in default under this Lease unless Landlord (or such ground lessor or Landlord's Mortgagee) fails to cure such non-performance within thirty (30) days after receipt of Tenant's notice. If more than thirty (30) days are required to cure such non-performance, Landlord shall not be in default if such cure is commenced within such thirty (30) day period and thereafter diligently pursued to completion.\n30. Landlord's Liability Limited. There shall be no personal liability of the Landlord or any partner, stockholder, officer, director or other principal of Landlord in connection with this Lease. Tenant agrees to look solely to the interest of Landlord in the Property for the collection of any judgment or other judicial process requiring the payment of money by Landlord in the event of any default or breach by Landlord with respect to this Lease or in any way relating to the Property. No other assets of Landlord or any principal of Landlord shall be subject to levy, execution or other procedures for the satisfaction of Tenant's remedies.\n31. Estoppel Statement: Financial Statement. (a) Upon Landlord's request, Tenant shall execute, acknowledge and deliver to Landlord a written statement certifying: (i) the Commencement Date; (ii) the Expiration Date; (iii) that this Lease is in full force and effect and unmodified (or if modified, stating the n modifications); (iv) the last date of payment of the Base Rent and other charges and the time period covered by each payment; (v) that Landlord is not in default under this Lease (or, if Landlord is claimed to be in default, stating the nature of the default); and (vi) such other matters as may be reasonably required by Landlord or any Landlord's Mortgagee. Tenant shall deliver such statement to Landlord within ten (10) days after Landlord's request. Any such statement may be given to and relied upon by any prospective purchaser or encumbrancer of the Property.\n(b) Within ten (10) days after Landlord's request, Tenant shall deliver to Landlord such financial statements as are reasonably required to verify the net worth of Tenant. Any such statement may be given by Landlord to any Landlord's Mortgagee or prospective encumbrancer of the Property, but otherwise shall be kept confidential by Landlord. Tenant represents to Landlord that each such financial statement is a true and accurate statement as of the date of such statement.\n32. Quiet Enjoyment. (a) Landlord covenants that as long as Tenant pays the Base Rent and additional rent and performs its other obligations under this Lease, Tenant shall peaceably and quietly have, hold and enjoy the Property for the term provided by this Lease, subject to the provisions of this Lease.\n(b) Landlord reserves to itself such access and utility easements over, under and across the Property as may be required by Landlord from time to time in connection with the ownership, use or operation of any other property of Landlord or any affiliated party of Landlord. No such easement shall materially interfere with Tenant's use of the Property.\n33. Subordination: Attornment. (a) This Lease is subject and subordinate to any ground lease or mortgage which may now or hereafter encumber the Property, and any renewals, modifications, consolidations, replacements or extensions thereof.\n(b) If Landlord's interest in the Property is acquired by any ground lessor, Landlord's Mortgagee, or purchaser at a foreclosure sale, Tenant shall attorn to the transferee of or successor to Landlord's interest in the Property and recognize such transferee or successor as landlord under this Lease. Such transferee or successor shall not be liable for any act or omission of any prior landlord, or be subject to any offsets or defenses which Tenant might have against any prior landlord, or be bound by any Base Rent which Tenant might have paid for more than the current month to any prior landlord, or be liable for any security deposit under this Lease unless actually transferred to such transferee or successor.\n(c) Tenant agrees that this Lease shall be modified in accordance with the reasonable request of any institutional Landlord's Mortgagee, provided no such modification adversely affects the business terms of this Lease.\n(d) The foregoing provisions shall be self-operative and no further instrument or act on the part of Tenant shall be necessary to effect the same. Tenant shall nevertheless sign and deliver any document necessary or appropriate to evidence the subordination, attornment or agreement above provided.\n34. Brokerage. Each party represents to the other that it did not deal with any real estate broker in connection with this Lease, other than the real estate broker whose identity is set forth in Section 1(h). The commission of such broker shall be paid by the party as set forth in Section 1(h). Each party shall indemnify and hold the other harmless from any claim for a commission or other fee made by any broker with whom the indemnifying party has dealt, other than the broker identified in Section 1(h).\n35. Security Deposit. (a) Upon execution of this Lease, Tenant shall deposit with Landlord the sum set forth in Section 1(g) as security for the performance by Tenant of its obligations under this Lease (the \"Security Deposit\"). Landlord shall have the right to use the Security Deposit to cure any default of Tenant hereunder, including, but not limited to, payment of Base Rent, additional rent, service fees or other debts of Tenant due Landlord, or repair or restoration of the Property. If Landlord uses any part of the Security Deposit, Tenant shall restore the Security Deposit to its full amount within ten (10) days after Landlord's demand therefor. Provided Tenant has fully complied with all of the terms of this Lease, Landlord shall return the Security Deposit to Tenant without interest on the date thirty (30) days after the surrender of the Property by Tenant. Landlord may deliver the Security Deposit to the purchaser or other transferee of Landlord's interest in the Property in the event the Property is sold or otherwise transferred, and Landlord shall be discharged from any further liability with respect to the Security Deposit.\n(b) In lieu of a cash security deposit, Tenant shall have the option to deliver to Landlord an irrevocable unconditional letter of credit (the \"L.O.C.\") drawn on a bank which is a member of the New York Clearing House Association with assets in excess of $100,000,000.00. The L.O.C. shall be in the sum of $75,000.00 and shall be payable in the event Tenant defaults in any of its obligations under this Lease. If Tenant elects to deliver the L.O.C. in lieu of a cash security deposit, Tenant shall be in default under this Lease if Tenant fails to maintain the L.O.C. at any time during the Term hereof.\n36. Notices. All notices in connection with this Lease or the Property shall be in writing and shall be personally delivered, or sent by certified mail, return receipt requested, postage prepaid, or sent by commercial overnight courier (e.g., Federal Express, Airborne). Notices to Landlord shall be delivered to the address specified in Section 1(b). Notices to Tenant shall be delivered to the address specified in Section 1(c) with a copy of each such notice delivered to Richard S. Kalin, Esq., Kalin & Banner, 757 Third Avenue, New York, New York 10017. All notices shall be effective upon delivery or attempted delivery in accordance with this provision. Either party may change its notice address upon written notice to the other party given in accordance with this provision.\n37. Railroad License. Tenant is hereby granted a non-exclusive license to use the lead track (\"Lead Track\") now installed in Landlord's industrial park for the purpose of shipping and receiving freight by rail via the facilities of common carriers holding franchises to serve the area in which the Property is located. The Tenant shall, subject to the terms and conditions hereof, have the license to use the Lead Track in common with Landlord, Landlord's designees and others, only as and for a railroad right-of-way. Tenant shall not use the Lead Track for loading and\/or unloading purposes.\nTenant shall, at its sole cost and expense, maintain the side track serving the Property, including any maintenance contract therefor maintained. Provided that Tenant exercises its right to use the Lead Track, Tenant covenants and agrees to pay to Landlord as additional rent the cost of maintaining, repairing, replacing and restoring the Lead Track and the appurtenances thereto installed within Landlord's industrial park. Landlord shall make an allocation of the cost of maintaining, repairing, replacing and restoring the Lead Track and the appurtenances thereto by and among the parties utilizing the Lead Track.\nAnything contained herein to the contrary notwithstanding, Landlord specifically reserves the right at its sole cost and in its sole discretion from time to time and at any time to relocate the presently existing Lead Track. In the event that the Lead Track is so relocated by Landlord, the license granted hereby shall then be deemed to have been relocated so as to affect only the Lead Track as so relocated.\nThis License is made upon the express condition that Tenant agrees to and shall at all times keep, save and hold Landlord free and harmless from and indemnify it against all liability, penalties, losses, damages, costs, expenses, causes of action, claims and\/or judgments (whether by reason of damage to property or bodily injury to persons or otherwise) arising out of or in connection with the use of the Lead Track and\/or side track by Tenant, its agents, successors or assigns.\n38. Miscellaneous. (a) The failure of either party to insist on strict performance of any provision of this Lease, or to exercise any right contained herein, shall not be construed as a waiver of such provision or right in any other instance. All amendments to this Lease shall be in writing and signed by both parties.\n(b) The captions in this Lease are intended to assist the parties in reading this Lease and are not a part of the provisions of this Lease. Whenever required by the context of this Lease, the singular shall include the pleural and the plural shall include the singular. The masculine, feminine and neuter genders shall each include the other.\n(c) Landlord and Tenant hereby waive trial by jury in any legal proceeding brought by either of them against the other with respect to any matters arising out of or in any way connected with this Lease or the Property.\n(d) The laws of the state in which the Proper y is located shall govern this Lease.\n(e) If Tenant is a corporation or partnership, each person signing this Lease on behalf of Tenant represents that he has full authority to do so and that this Lease binds the corporation or partnership, as the case may be.\n(f) Landlord shall not be liable for consequential damages arising from any negligence, tortious act, breach of any term, covenant or obligation under this Lease, or any other act or omission affecting this Lease.\n(g) This Lease is binding upon any party who legally acquires any rights or interest in this Lease from Landlord or Tenant; provided, however, Landlord shall have no obligation to Tenant's successor unless the interest of Tenant's successor in this Lease is acquired in accordance with Section 18.\n(h) The submission of this Lease to Tenant shall not be deemed to be an offer and shall not bind either party until duly executed by Landlord and Tenant.\n(i) This Lease may be executed in counterparts, and, when all counterpart documents are executed, the counterparts shall constitute a single binding instrument.\n(j) A determination by a court of competent jurisdiction that any provision of this Lease or any part thereof is illegal or unenforceable shall not invalidate the remainder of this Lease or such provision, which shall continue to be in effect.\n(k) Tenant shall not record this Lease.\nThe riders enumerated in Section 1(i) are attached hereto and made a part of this lease as fully as if set forth herein at length. The terms used in the rider have the same meanings as set forth in the Lease. The provisions of a rider shall prevail over any provisions of the lease which are inconsistent or conflict with the provisions of the rider.\nIN WITNESS HEREOF, the parties hereby have duly executed this Lease as of the date set forth in Section 1(a).\nLANDLORD:\nWITNESS: PENSUD COMPANY LIMITED PARTNERSHIP\nBy: Stanford Realty Group, L.P. its general partner Dolores A. Bocian David S. Steiner\nIts: General Partner\nTENANT:\nATTEST: PENTECH INTERNATIONAL, INC.\nBy:Richard S. Kalin By:David Melnick\nIts:Secretary Its:President\nRENT RIDER\nDate of Lease: August 28, 1995\nLandlord: Pensud Company Limited Partnership\nTenant: Pentech International, Inc.\nProperty: 1101 Corporate Road North Brunswick, New Jersey\n1. The Base Rent payable by Tenant to Landlord during the Term shall be at the annual Base Rent rate and be payable in monthly installments as follows:\nMonthly Annual Period PSF Installment Amount\nSeptember 1, 1995 through October 15, 1995 0 0 0 October 16, 1995 through October 31, 1996 $3.15 $34,197.19 $410,366.25 November 1, 1996 through October 31, 2000 $3.35 $36,368.44 $436,421.25\n2. Escrow Payments. Tenant shall pay to Landlord real property impositions, insurance premiums, and other expenses of the Property in monthly installments on an estimated basis as determined by Landlord sufficient to pay such real property impositions, insurance premiums, and other expenses of the Property before the same become due. Landlord may adjust such estimate at any time and from time to time based upon Landlord's anticipation of costs. After the end of each calendar year during the Term, Landlord shall deliver to Tenant a statement setting forth the actual real property impositions, insurance premiums, and other expenses incurred by Landlord and paid from the deposits made by Tenant for such calendar year. If Tenant has paid less than the actual amount due, Tenant shall pay the difference to Landlord within ten (10) days after Landlord's request therefor. Any amount paid by Tenant which exceeds the amount due shall be credited against the next succeeding estimated payments due hereunder, unless the Lease has terminated, in which event the excess amount shall be refunded to Tenant.\nInitials:\nDSS Landlord\nDM Tenant\nEXTENSION OPTIONS RIDER\nDate of Lease: August 28, 1995\nLandlord: Pensud Company Limited Partnership\nTenant: Pentech International, Inc.\nProperty: 1101 Corporate Road North Brunswick, New Jersey\n1. Grant of Options. Subject to the provisions of Section 3 of this Rider, Landlord hereby grants to Tenant two options (each such option is referred to as the \"Option\") to extend the Term following the expiration of the original term hereof (the \"Initial Term \") for additional teens of five (5) years each (each such additional term is hereinafter referred to as the \"Extension Term\").\n2. Exercise of Options. Each Option shall be exercised only by written notice (the \"Extension Notice\") delivered to Landlord in accordance with Section 36 of the Lease at least six (6) months before the expiration of the Initial Term or the expiration of the current Extension Term, as the case may be. Time shall be of the essence with respect to delivery of the Extension Notice and if Tenant fails to deliver any Extension Notice within the specified time period, the Option related thereto and any succeeding Option shall lapse, and Tenant shall have no further right to extend the Term.\n3. Conditions Precedent to Options. Each Option shall be exercisable by Tenant and the Lease shall continue for the Extension Term on all of the following conditions: (a) At the time Landlord receives the Extension Notice and at the commencement of the Extension Term related thereto, Tenant shall not be in default under any of the provisions of the Lease.\n(b) At the time Landlord receives the Extension Notice and at the commencement of the Extension Term related thereto, the Tenant named in Section 1(c) of the Lease shall not have assigned the Lease or sublet any portion of the Property, except as permitted in Section 18(a) of the Lease.\n(c) With respect to any Option for an Extension Term following the first Extension Term, Tenant shall have theretofore timely exercised all prior Options.\n4. Extension Term Provisions. Each Extension Term shall be on all of the same terms and conditions set forth in the Lease and applicable to the Initial Term, except the annual Base Rent for each Extension Term shall be as follows:\nMonthly Annual Period PSF Installment Amount November 1, 2000 through October 31, 2005 $4.00 $43,425.00 $521,100.00 November 1, 2005 through October 31, 2010 $4.75 $51,567.19 $618,806.25\nInitials:\nDSS Landlord\nDM Tenant\nPLOT PLAN RIDER\nDate of Lease: August, 28, 1995\nLandlord: Pensud Company Limited Partnership\nTenant: Pentech International, Inc.\nProperty: 1101 Corporate Road North Brunswick, New Jersey\nThe diagram shows an aerial view of the warehouse space being rented.\nInitials:\nDSS Landlord\nDM Tenant\nLandlord's Work Rider\nDate of Lease: August, 28, 1995\nLandlord: Pensud Company Limited Partnership\nTenant: Pentech International, Inc.\nProperty: 1101 Corporate Road North Brunswick, New Jersey\nLandlord shall, at its sole cost and expense, perform the following work (Landlord's Work) to the Property:\na. Place plumbing, electrical, fire sprinkler and heating, ventilating and air conditioning systems in good working order.\nb. Place overhead doors, and dock levellers in good working order.\nInitials:\nDSS Landlord\nDM Tenant\nEXHIBIT 21\nSubsidiaries of Pentech International, Inc.\nJurisdiction of Name Incorporation\nSawdust Pencil Co. Delaware\nPentech Cosmetics, Inc. Delaware\nEXHIBIT 23.1\nConsent of Independent Auditors\nWe consent to the incorporation by reference in (i) the Registration Statement (Form S-8 No. 33-27009) dated February 28, 1989 pertaining to the 1984 and 1989 Stock Option Plans of Pentech International, Inc. and (ii) the Registration Statement (Form S-8 No. 33-67802) dated August 23, 1993 pertaining to the 1993 Stock Option Plan of Pentech International, Inc. of our report dated December 11, 1995, with respect to the consolidated financial statements and schedule of Pentech International, Inc. included in this Annual Report (Form 10-K) for the year ended September 30, 1995.\nERNST & YOUNG LLP\nBy: \/s\/ Ernst & Young LLP\nMetroPark, New Jersey December 27, 1995\nptk\\10K.95","section_15":""}
{"filename":"730030_1995.txt","cik":"730030","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nComm Bancorp, Inc. (\"Company\"), a Pennsylvania business corporation, is a bank holding company registered with and supervised by the Board of Governors of the Federal Reserve System (\"Federal Reserve Board\"). The Company was organized on May 20, 1983, and commenced operations on February 1, 1984, upon consummation of the acquisition of all of the outstanding stock of Community National Bank, Forest City, Pennsylvania (which has subsequently converted to a Pennsylvania state-chartered commercial bank and renamed Community Bank and Trust Company) (\"Community Bank\"). On January 20, 1993, the First National Bank of Nicholson (\"FNB Nicholson\"), Nicholson, Pennsylvania (which was acquired on December 30, 1988), was merged with and into Community Bank and FNB Nicholson ceased to exist as a separate legal entity. The branch facilities and related equipment formerly used by FNB Nicholson are being used by Community Bank. The Company's business has consisted primarily of managing and supervising Community Bank and its principal source of income has been dividends paid by Community Bank. At December 31, 1995, the Company had total consolidated assets, deposits and stockholders' equity of approximately $350.9 million, $317.1 million and $27.9 million, respectively.\nCommunity Bank is a Pennsylvania state-chartered commercial bank and a member of the Federal Reserve System. Community Bank's deposits are insured by the Federal Deposit Insurance Corporation (\"FDIC\") under the Bank Insurance Fund (\"BIF\"). As of December 31, 1995, Community Bank had ten branch locations, including its main office in Forest City, Susquehanna County, Pennsylvania. Community Bank's branch offices are located in the Pennsylvania counties of Lackawanna, Susquehanna, Wayne and Wyoming.\nSUPERVISION AND REGULATION - COMPANY\nThe Company is subject to the jurisdiction of the Securities and Exchange Commission (\"SEC\") and of state securities' law administrators for matters relating to the offering and sale of its securities. The Company is currently subject to the SEC's rules and regulations relating to periodic reporting, insider trading reports and proxy solicitation materials in accordance with the Securities Exchange Act of 1934 (\"Exchange Act\").\nThe Company is also subject to the provisions of the Bank Holding Company Act of 1956 (\"Bank Holding Company Act\") as amended, and to supervision by the Federal Reserve Board. The Bank Holding Company Act will require the Company to secure the prior approval of the Federal Reserve Board before it owns or controls, directly or indirectly, more than 5.0 percent of the voting shares or substantially all of the assets of any institution, including another bank. The Bank Holding Company Act prohibits acquisition by the Company or more than 5.0 percent of the voting shares of, or interest in, or substantially all of the assets of, any bank, unless such an acquisition has been specifically approved by the Federal Reserve Board.\nA bank holding company is prohibited from engaging in, or acquiring direct or indirect control of, more than 5.0 percent of the voting shares of any company engaged in non-banking activities unless the Federal Reserve Board, by order or regulation, has found such activities to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. In making this determination, the Federal Reserve Board considers whether the performance of these activities by a bank holding company would offer benefits to the public that outweigh possible adverse effects.\nThe Bank Holding Company Act also prohibits acquisitions of control of a bank holding company, such as the Company, without prior notice to the Federal Reserve Board. Control is defined for this purpose as the power, directly or indirectly, to influence the management or policies of a bank holding company or to vote 25.0 percent or 10.0 percent, if no other person or persons acting in concert, holds a greater percentage of the common stock or more of the Company's common stock. The Company is required to file an annual report with the Federal Reserve Board and any additional information that the Federal Reserve Board may require pursuant to the Bank Holding Company Act. The Federal Reserve Board may also make examinations of the Company and its subsidiary. Further, under Section 106 of the 1970 amendments to the Bank Holding Company Act and the Federal Reserve Board's regulations, a bank holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit or provision of credit or provision of any property or services. The so-called \"Anti-tie-in\" provisions state generally that a bank may not extend credit, lease, sell property or furnish any service to a customer on the condition that the customer provide additional credit or service to the bank, to its bank holding company or to any other subsidiary of its bank holding company or on the condition that the customer not obtain other credit or service from a competitor of the bank, its bank holding company or any subsidiary of its bank holding company. Subsidiary banks of a bank holding company are subject to certain restrictions imposed by the Federal Reserve Act on any extensions of credit to the bank holding company or any of its subsidiaries, on investments in the stock or other securities of the bank holding company and on taking of such stock or securities as collateral for loans to any borrower.\nPERMITTED NON-BANKING ACTIVITIES\nThe Federal Reserve Board permits bank holding companies to engage in non-banking activities so closely related to banking, or managing or controlling banks as to be a proper incident thereto. While the types of permissible activities are subject to change by the Federal Reserve Board, the principal non-banking activities that presently may be conducted by a bank holding company are:\n1. Making, acquiring or servicing loans and other extensions of credit for its own account or for the account of others, such as would be made by the following types of companies: consumer finance, credit card, mortgage, commercial finance and factoring.\n2. Operating as an industrial bank, Morris Plan bank or industrial loan company in the manner authorized by state law so long as the institution does not accept demand deposits or make commercial loans.\n3. Operating as a trust company in the manner authorized by federal or state law so long as the institution does not make certain types of loans or investments or accept deposits, except as may be permitted by the Federal Reserve Board.\n4. Subject to certain limitations, acting as an investment or financial advisor to investment companies and other persons.\n5. Leasing personal and real property or acting as agent, broker or advisor in leasing property, provided that it is reasonably anticipated that the transaction will compensate the lessor for not less than the lessor's full investment in the property and provided further that the lessor may rely on estimated residual values of up to 100.0 percent of the acquisition cost of the leased property.\n6. Making equity and debt investments in corporations or projects designed primarily to promote community welfare, such as the economic rehabilitation and development of low-income areas by providing housing, services or jobs for residents.\n7. Providing to others financially oriented data processing or bookkeeping services.\n8. Subject to certain limitations, acting as an insurance principal, agent or broker in relation to insurance for itself and its subsidiaries or for insurance directly related to extensions of credit by the bank holding company system.\n9. Owning, controlling or operating a savings association, if the savings association engages only in deposit taking activities, lending and other activities permissible for bank holding companies.\n10. Providing courier services of a limited character.\n11. Subject to certain limitations, providing management consulting advice to nonaffiliated banks and non-bank depository institutions.\n12. Selling money orders having a face value of $1.0 thousand or less, travelers' checks and United States savings bonds.\n13. Performing appraisals of real estate and personal property, including securities.\n14. Subject to certain limitations, acting as intermediary for the financing of commercial or industrial income-producing real estate by arranging for the transfer of the title, control and risk of such a real estate project to one or more investors.\n15. Subject to certain limitations, providing full-service brokerage and financial advisory activities, and selling, solely as an agent or broker for customers, shares of investment companies advised by an affiliate of the bank holding company or providing investment advice to customers about the purchase and sale of shares of investment companies advised by an affiliate of the bank holding company.\n16. Underwriting and dealing in obligations of the United States, general obligations of states and their political subdivisions and other obligations such as bankers' acceptances and certificates of deposit.\n17. Subject to certain limitations, providing by any means, general information and statistical forecasting with respect to foreign exchange markets; advisory services designed to assist customers in monitoring, evaluating and managing their foreign exchange exposures; and certain transactional services with respect to foreign exchange.\n18. Subject to certain limitations, acting as a futures commission merchant in the execution and clearance on major commodity exchanges of futures contracts and options on futures contracts for bullion, foreign exchange, government securities, certificates of deposit and other money market instruments.\n19. Subject to certain limitations, providing commodity trading and futures commission merchant advice, including counsel, publications, written analysis and reports.\n20. Providing consumer financial counseling that involves educational courses and distribution of instructional materials to individuals on consumer-oriented financial management matters, including debt consolidation, mortgage applications, bankruptcy, budget management, real estate tax shelters, tax planning, retirement and estate planning, insurance and general investment management, so long as this activity does not include the sale of specific products or investments.\n21. Providing tax planning and preparation advice such as strategies designed to minimize tax liabilities and includes, for individuals, analysis of the tax implications of retirement plans, estate planning and family trusts. For a corporation, tax planning includes the analysis of the tax implications of mergers and acquisitions, portfolio mix, specific investments, previous tax payments and year-end tax planning. Tax preparation involves the preparation of tax forms and advice concerning liability, based on records and receipts supplied by the client.\n22. Providing check guaranty services to subscribing merchants.\n23. Subject to certain limitations, operating a collection agency.\n24. Operating a credit bureau that maintains files on the past credit history of consumers and providing such information to a lender that is considering a borrower's application for credit, provided that the credit bureau does not grant preferential treatment to an affiliated bank in the bank holding company system.\nPENNSYLVANIA BANKING LAW\nUnder the Pennsylvania Banking Code of 1965 (\"Code\"), as amended, the Company is permitted to control an unlimited number of banks. However, the Company would be required, under the Bank Holding Company Act, to obtain the prior approval of the Federal Reserve Board before it could acquire all or substantially all of the assets of any bank, or acquire ownership or control of any voting shares of any bank other than Community Bank, if, after such acquisition, it would own or control more than 5.0 percent of the voting shares of such bank.\nINTERSTATE BANKING AND BRANCHING\nOn September 29, 1994, the President signed into law the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (\"Interstate Banking Act\"). The following discussion describes those provisions of the Interstate Banking Act that would pertain to the Company. It is not an exhaustive description of all provisions of the Interstate Banking Act.\nIn general, the Federal Reserve Board may approve an application by the Company to acquire control of, or acquire all or substantially all of the assets of, a bank located outside of the Commonwealth of Pennsylvania without regard to whether such acquisition is prohibited under the law of any state. The Federal Reserve Board may approve such application if it finds, among other things, that the Company is adequately capitalized and adequately managed. Moreover, the Federal Reserve Board may not approve such acquisition if the target bank has not been in existence for the minimum period of time, if any, required by such target bank's \"host\" state. The Federal Reserve Board may, however, approve the acquisition of the target bank that has been in existence for at least five years without regard to any longer minimum period of time required under the law of the \"host\" state of the target bank. The above provisions took effect on September 30, 1995.\nFurthermore, the Interstate Banking Act provides that, beginning June 1, 1997, appropriate federal supervisory agencies may approve a merger of Community Bank with another bank located in a different state or the establishment by Community Bank of a new branch office either by acquisition or de novo, unless the Commonwealth of Pennsylvania enacts a law prior to June 1, 1997, allowing an interstate merger or expressly prohibiting merger with an out-of-state bank. The Commonwealth of Pennsylvania has enacted a law to \"opt-in\" early to these interstate mergers.\nMoreover, the Interstate Banking Act provides that Community Bank may establish and operate a de novo branch in any state that \"opts-in\" to de novo branching. A \"denovo branch\" is a branch office that is originally established as a branch and does not become a branch as a result of an acquisition or merger. The Commonwealth of Pennsylvania has enacted a law to \"opt-in\" early to de novo interstate branching.\nOn December 13, 1995, the Banking Commissioners of the states of Delaware, Maryland, Pennsylvania and Virginia executed a Cooperative Agreement that governs the manner in which state-chartered banks with branches in multiple states will be supervised. This Cooperative Agreement was necessitated by the Interstate Banking Act and was drafted to create a level playing field for state-chartered banks with respect to supervision and regulation of branch offices in a multiple state setting. Specifically, this agreement outlines general principles for determining whether home or host state law applies, including the following: (1) host state law applies to operational issues relating to a branch located in a host state, including antitrust, community reinvestment, consumer protection, usury and fair lending laws; (2) the state law of the home state will apply to corporate structure issues, such as charter, by-laws, incorporation, liquidation, stockholders and directors, capital and investments; and (3) bank powers issues will be resolved with reference to both home and host state laws. As of the filing date of this report, the Company and Community Bank have no plans to engage in interstate banking or branching.\nLEGISLATION AND REGULATORY CHANGES\nFrom time to time, legislation is enacted that has the effect of increasing the cost of doing business, limiting or expanding permissible activities or affecting the competitive balance between banks and other financial institutions. Proposals to change the laws and regulations governing the operations and taxation of banks, bank holding companies and other financial institutions are frequently made in Congress and before various bank regulatory agencies. No prediction can be made as to the likelihood of any major changes or the impact such changes might have on the Company and Community Bank. Certain changes of potential significance to the Company that have been enacted or promulgated, as the case may be, by Congress or various regulatory agencies, respectively, are discussed below.\nFINANCIAL INSTITUTIONS REFORM, RECOVERY AND ENFORCEMENT ACT OF 1989 (\"FIRREA\")\nOn August 9, 1989, major reform and financing legislation, i.e., FIRREA, was enacted into law in order to restructure the regulation of the thrift industry, to address the financial condition of the Federal Savings and Loan Insurance Corporation and to enhance the supervisory and enforcement powers of the federal bank and thrift regulatory agencies. The Federal Reserve Board, as the primary federal regulator of Community Bank, is responsible for supervision of Community Bank. The Federal Reserve Board and FDIC have far greater flexibility to impose supervisory agreements on an institution that fails to comply with its regulatory requirements, particularly with respect to the capital requirements. Possible enforcement actions include the imposition of a capital plan, termination of deposit insurance and removal or temporary suspension of an officer, director or other institution-affiliated party.\nUnder FIRREA, civil penalties are classified into three levels, with amounts increasing with the severity of the violation. The first tier provides for civil penalties of up to $5.0 thousand per day for any violation of law or regulation. A civil penalty of up to $25.0 thousand per day may be assessed if more than a minimal loss or a pattern of misconduct is involved. Finally, a civil penalty of up to $1.0 million per day may be assessed for knowingly or recklessly causing a substantial loss to an institution or taking action that results in a substantial pecuniary gain or other benefit. Criminal penalties are increased to $1.0 million per violation, up to $5.0 million for continuing violations or for the actual amount of gain or loss. These monetary penalties may be combined with prison sentences for up to five years.\nFEDERAL DEPOSIT INSURANCE CORPORATION IMPROVEMENT ACT OF 1991 (\"FDICIA\")\nGENERAL\nThe FDICIA was enacted in December 1991 and reformed a variety of bank regulatory laws. Some of these reforms have a direct impact on Community Bank. Certain of these provisions are discussed below.\nEXAMINATIONS AND AUDITS\nAnnual full-scope, on-site examinations are required for all FDIC-insured institutions with assets of $500.0 million or more. For bank holding companies with $500.0 million or more in assets, the independent accountants of such companies shall attest to the accuracy of management's report. Such accountants shall also monitor management's compliance with governing laws and regulations. Such companies are also required to select an independent audit committee, composed of outside directors who are independent of management, to review with management and the independent accountants the reports that must be submitted to the appropriate bank regulatory agencies. If the independent accountants resign or are dismissed, written notification must be given to the FDIC and to the appropriate federal and state bank regulatory agencies.\nPROMPT CORRECTIVE ACTION\nIn order to reduce losses to the deposit insurance funds, the FDICIA established a format to more closely monitor FDIC-insured institutions and to enable prompt corrective action by the appropriate federal supervisory agency if an institution begins to experience any difficulty. The FDICIA established five capital categories. They are: (1) well-capitalized; (2) adequately capitalized; (3) undercapitalized; (4) significantly undercapitalized; and (5) critically undercapitalized. The overall goal of these new capital measures is to impose more scrutiny and operational restrictions on depository institutions as they descend the capital categories from well- capitalized to critically undercapitalized.\nThe FDIC, the Office of the Comptroller of the Currency, the Federal Reserve Board and the Office of Thrift Supervision have jointly issued regulations relating to these capital categories and prompt corrective action. These capital measures for prompt corrective action are defined as follows:\nA well-capitalized institution would be one that has a 10.0 percent or greater total risk-based capital ratio, a 6.0 percent or greater Tier I risk-based capital ratio, a 5.0 percent or greater Tier I Leverage capital ratio and is not subject to any written order or final directive by the FDIC to meet and maintain a specific capital level.\nAn adequately capitalized institution would be one that meets the required minimum capital levels, but does not meet the definition of a well-capitalized institution. The existing capital rules generally require banks to maintain a Tier I Leverage capital ratio of at least 4.0 percent and an 8.0 percent or greater total risk-based capital ratio. Since the risk-based standards also require at least half of the total risk-based capital requirement to be in the form of Tier I capital, this also will mean that an institution would need to maintain at least a 4.0 percent Tier I risk-based capital ratio. Thus, an institution would need to meet each of the required minimum capital levels in order to be deemed adequately capitalized.\nAn undercapitalized institution would fail to meet one or more of the required minimum capital levels for an adequately capitalized institution. An undercapitalized institution must file a capital restoration plan and is automatically subject to restrictions on dividends, management fees and asset growth. In addition, the institution is prohibited from making acquisitions, opening new branches or engaging in new lines of business without the prior approval of its primary federal regulator. A number of other discretionary restrictions also may be imposed on a case-by-case basis, and more stringent restrictions that otherwise would apply to significantly undercapitalized institutions may be imposed on an undercapitalized institution that fails to file or implement an acceptable capital restoration plan.\nA significantly undercapitalized institution would have a total risk-based capital ratio of less than 6.0 percent, a Tier I risk-based capital ratio of less than 3.0 percent or a Tier I Leverage capital ratio of less than 3.0 percent, as the case may be. Institutions in this category would be subject to all the restrictions that apply to undercapitalized institutions. Certain other mandatory prohibitions also would apply, such as restrictions against the ] payment of bonuses or raises to senior executive officers without the prior approval of the institution's primary federal regulator. A number of other restrictions may also be imposed.\nA critically undercapitalized institution would be one with a tangible equity (Tier I capital) ratio of 2.0 percent or less. In addition to the same restrictions and prohibitions that apply to undercapitalized and significantly undercapitalized institutions, the FDIC's rule implementing this provision of the FDICIA also addresses certain other provisions for which the FDIC has been accorded responsibility as the insurer of depository institutions.\nAt a minimum, any institution that becomes critically undercapitalized is prohibited from taking the following actions without the prior written approval of its primary federal regulator: engaging in any material transactions other than in the usual course of business; extending credit for highly leveraged transactions; amending its charter or bylaws; making any material changes in accounting methods; engaging in certain transactions with affiliates; paying excessive compensation or bonuses; and paying interest on liabilities exceeding the prevailing rates in the institution's market area. In addition, a critically undercapitalized institution is prohibited from paying interest or principal on its subordinated debt and is subject to being placed in conservatorship or receivership if its tangible equity capital level is not increased within certain mandated time frames.\nAt any time, an institution's primary federal regulator may reclassify it into a lower capital category. All institutions are prohibited from declaring any dividends, making any other capital distribution or paying a management fee if it would result in downward movement into any of the three undercapitalized categories. The FDICIA provides an exception to this requirement for stock redemptions that do not lower an institution's capital and would improve its financial condition, if the appropriate federal regulator has consulted with the FDIC and approved the redemption.\nThe regulation requires institutions to notify the FDIC following any material event that would cause such institution to be placed in a lower category. Additionally, the FDIC monitors capital levels through call reports and examination reports.\nDEPOSIT INSURANCE\nOn January 1, 1994, the FDIC implemented the permanent Risk Related Premium System (\"RRPS\") with respect to the assessments and payments of deposit insurance premiums. Under the RRPS, the FDIC, on a semi-annual basis, will assign each institution to one of three capital groups (well-capitalized, adequately capitalized or undercapitalized, in each case as these terms are defined for purposes of prompt corrective action rules described above) and further assign such institution to one of three subgroups within a capital group corresponding to the FDIC's judgment of its strength based on supervisory evaluations, including examination reports, statistical analysis and other information relevant to gauging the risk posed by the institution. Only institutions with a total capital to risk-adjusted assets ratio of 10.0 percent or greater, a Tier I capital to risk-adjusted assets ratio of 6.0 percent or greater and a Tier I Leverage ratio of 5.0 percent or greater are assigned to the well- capitalized group.\nEffective January 1, 1996, the FDIC Board of Directors has further reduced BIF premiums. Highly-rated institutions will pay only the statutory minimum of $2.0 thousand annually for FDIC insurance. The remaining institutions will pay on a scale ranging from 3 to 27 cents per every one hundred dollars of insured deposits, which is down from the scale in the latter half of 1995 of 4 to 31 cents. If such lower FDIC insurance premium rates were in effect for all of 1995, then Community Bank would have paid approximately $415 thousand less in such premiums based upon current deposit levels.\nREAL ESTATE LENDING STANDARDS\nPursuant to the FDICIA, the Federal Reserve Board and other federal banking agencies adopted real estate lending guidelines that would set loan-to-value (\"LTV\") ratios for different types of real estate loans. An LTV ratio is generally defined as the total loan amount divided by the appraised value of the property at the time the loan is originated or the purchase price, whichever is lower. If the institution does not hold a first lien position, the total loan amount would be combined with the amount of all senior liens when calculating the ratio. In addition to establishing the LTV ratios, the guidelines require all real estate loans to be based upon proper loan documentation and a recent appraisal of the property.\nBANK ENTERPRISE ACT OF 1991\nWithin the overall FDICIA is a separate subtitle called the Bank Enterprise Act of 1991 (\"ACT\"). The purpose of the Act is to encourage banking institutions to establish \"basic transaction services for consumers\" or so-called \"lifeline depository accounts.\" The FDIC assessment rate is reduced for all lifeline depository accounts. The Act establishes ten factors that are the minimum requirements to qualify as a lifeline depository account. Some of these factors relate to minimum opening and balance amounts, minimum number of monthly withdrawals, the absence of discriminatory practices against low-income individuals and minimum service charges and fees. Moreover, the Housing and Community Development Act of 1972 requires that the FDIC's risk-based assessment system include provisions regarding lifeline depository accounts. Assessment rates applicable to lifeline depository accounts are to be established by FDIC rule.\nTRUTH IN SAVINGS ACT\nFDICIA also contains the Truth in Savings Act (\"TSA\"). The Federal Reserve Board has adopted Regulation DD under the TSA. The purpose of the TSA is to require the clear and uniform disclosure of the rates of interest that are payable on deposit accounts by depository institutions and the fees that are assessable against deposit accounts, so that consumers can make a meaningful comparison between the competing claims of banks with regard to deposit accounts and products. In addition to disclosures to be provided when a customer establishes a deposit account, the TSA requires the depository institution to include, in a clear and conspicuous manner, the following information with each periodic statement: (1) the annual percentage yield earned; (2) the amount of interest earned; (3) the amount of any fees and charges imposed; and (4) the number of days in the reporting period. The TSA allows for civil lawsuits to be initiated by customers if the depository institution violates any provision or regulation under the TSA.\nREGULATORY CAPITAL REQUIREMENTS\nThe Company was required to implement, on January 1, 1994, Statement of Financial Accounting Standards (\"SFAS\") No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" For financial capital reporting purposes, SFAS No. 115 changed the composition of stockholders' equity in financial statements prepared in accordance with generally accepted accounting principles by including, as a separate component of equity, the amount of net unrealized holding gains or losses on debt and equity securities that are deemed to be available for sale.\nEffective December 31, 1994, the Federal Reserve Board has issued a final rule with respect to the implementation of SFAS No. 115 for regulatory capital reporting purposes. Under this final rule, net unrealized holding losses on available for sale equity securities, but not debt securities, with readily determinable fair values will be included when calculating consolidated Tier I capital. All other unrealized holding gains and losses on available for sale securities will be excluded from consolidated Tier I capital.\nThe Company's ability to maintain the required levels of capital is substantially dependent upon the success of its capital and business plans, the impact of future economic events on loan customers, the ability to manage its interest rate risk and investment portfolio and control its growth and other operating expenses.\nEFFECT OF GOVERNMENT MONETARY POLICIES\nThe earnings of the Company are, and will be, affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies. The monetary policies of the Federal Reserve Board have had, and will likely continue to have, an important impact on the operating results of commercial banks through its power to implement national monetary policy in order to curb inflation or combat a recession, among other things. The Federal Reserve Board has a major affect upon the levels of bank loans, investments and deposits through its open market operations in United States government securities and through its regulations of, among other things, the discount rate on borrowings of member banks and the reserve requirements against member bank deposits. It is not possible to predict the nature and impact of future changes in monetary and fiscal policies.\nHISTORY AND BUSINESS - COMMUNITY BANK\nCommunity Bank's legal headquarters is located at 521 Main Street, Forest City, Pennsylvania 18421. As of December 31, 1995, Community Bank had total assets of $347.1 million, total stockholders' equity of $24.8 million and total deposits and other liabilities of $322.3 million.\nCommunity Bank is a community bank that seeks to provide personal attention and professional financial assistance to its customers. Community Bank is a locally managed and oriented financial institution established to serve the needs of individuals and small- and medium-sized businesses. Community Bank's business philosophy includes offering direct access to its President and other officers and providing friendly, informed and courteous service, local and timely decision making, flexible and reasonable operating procedures and consistently-applied credit policies.\nCommunity Bank is a full-service commercial bank offering a range of commercial and retail banking services to its customers. These include personal and business checking and savings accounts, certificates of deposit and mortgage, home equity and commercial loans. In addition, Community Bank provides safe deposit boxes, travelers' checks, wire transfers of funds and certain personal, corporate and pension trust services. Community Bank is a member of the MAC system and provides customers with access to this automated teller machine network. Community Bank also makes credit cards available to its customers. In addition, Community Bank has a trust department that provides traditional fiduciary services to its customers.\nCommunity Bank solicits small- and medium-sized businesses located primarily within its market area that typically borrow less than $100 thousand. In the event that certain loan requests exceed Community Bank's lending limit to any one customer, Community Bank seeks to arrange such loans on a participation basis with other financial institutions.\nMARKET AREA\nCommunity Bank's primary market area comprises the counties of Lackawanna, Susquehanna, Wayne and Wyoming that are located in the Northeast corner of the Commonwealth of Pennsylvania. The largest municipality in this market area is the city of Scranton with a population of approximately 82 thousand inhabitants based upon 1990 census data. None of Community Bank's branches are within the city of Scranton. All of the branches are located well outside of Scranton in rural or small-town settings. See Item 2","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company owns no property other than through Community Bank as follows:\nType of Approximate Property Location Ownership Square Footage Use ________ ________ _________ ______________ ___\n1 521 Main Street Owned 7,100 Banking services. Forest City, PA\n2 528 Main Street Leased 4,250 Administrative Forest City, PA offices.\n3 347 Main Street Owned 5,500 Banking services. Simpson, PA\n4 37 Dundaff Street Leased 4,300 Banking services. Carbondale, PA\n5 Route 370 Leased 900 Banking services. Lakewood, PA\n6 57 Main Street Owned 6,000 Banking services. Nicholson, PA\n7 Route 6 Owned 3,500 Banking services. Tunkhannock, PA\n8 Route 106 Owned 1,300 Banking services. Clifford, PA\n9 61 Church Street Owned 3,500 Banking services. Montrose, PA\n10 Route 29 Leased 2,175 Banking services. Eaton Township, PA\n11 Route 307 Leased 1,250 Banking services. Lake Winola, PA\nThe administrative offices, located at 528 Main Street, Forest City, have a property lease that expires in 1997 and contains an option that allows for an additional term of five years. The Carbondale property lease expires in 1998 and contains an option that allows Community Bank to purchase the property at fair market value or renew the lease for two additional terms of five years each. The Lakewood property lease expires in 1998 and contains an option to renew the lease for three additional terms of five years each. The Route 29 Eaton Township property lease and Lake Winola property lease expire in 2009. For information with respect to obligations for lease rentals, refer to Note 5 of the Notes to Consolidated Financial Statements in the Company's Annual Report to Stockholders filed at Exhibit 13 hereto and incorporated in its entirety by reference.\nIt is management's opinion that the facilities currently utilized are suitable and adequate for current and immediate future purposes.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nGENERAL\nThe nature of the Company's and Community Bank's business generates a certain amount of litigation involving matters arising in the ordinary course of business. However, in the opinion of management of the Company and Community Bank, there are no proceedings pending to which the Company and Community Bank are a party or to which their property is subject, which, if determined adversely, would be material in relation to the Company's and Community Bank's undivided profits or financial position, nor are there any proceedings pending other than ordinary routine litigation incident to the business of the Company and Community Bank. In addition, no material proceedings are pending or are known to be threatened or contemplated against the Company and Community Bank by government authorities or others.\nENVIRONMENTAL ISSUES\nThere are several federal and state statutes that govern the obligations of financial institutions with respect to environmental issues. Besides being responsible for its own conduct under such statutes, a bank also may be held liable under certain circumstances for actions of borrowers or other third parties on properties that collateralize loans held by the bank. Such potential liability may far exceed the original amount of the loan made by the bank. Currently, Community Bank is not a party to any pending legal proceedings under any environmental statute nor is Community Bank aware of any circumstances that may give rise to liability of Community Bank under any such statute.\nMEMORANDUM OF UNDERSTANDING\nOn May 24, 1995, the Boards of Directors of the Company and Community Bank entered into a MOU with the Federal Reserve Bank of Philadelphia (\"FRB\") in recognition of their common goals to restore and maintain the financial soundness of the Company and Community Bank and to improve the overall financial condition of Community Bank. Under the terms of the MOU, the Company and Community Bank were required to: (I) obtain the prior written approval of the FRB to declare or pay any dividends; (II) obtain the prior written approval of the FRB before the Company incurs any debt other than normal operating expenses; (III) obtain the prior written approval of the FRB before the Company redeems its own stock; (IV) submit to the FRB a written plan to maintain capital ratios well in excess of minimum regulatory guidelines; (V) submit to the FRB a written plan to ensure appropriate authority over and oversight of Community Bank's investment practices; (VI) prohibit Community Bank from additional purchases of high-risk securities and structured notes as well as securities not in compliance with the Federal Reserve Board's Supervisory Policy Statement on Securities Activities; (VII) retain an independent consultant to review Community Bank's securities activities and investments in the context of its overall interest rate risk and liquidity position and provide a written report to the FRB thereon; (VIII) submit to the FRB revised investment policies and procedures to correct deficiencies cited in the FRB's examinations with respect to prior investment practices involving the investment portfolio; (IX) submit to the FRB a written liquidity plan to provide for an adequate level of assets to fund operations and meet customer needs; (X) submit quarterly progress reports to the FRB to assure compliance with the MOU; and (XI) submit the written plans, policies and procedures to the FRB for review and approval. As a result of the Company's substantial compliance with the terms, conditions and provisions of the MOU and its overall improved financial condition, the FRB terminated the MOU effective February 16, 1996.\nPART II\nITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nShares of the Company's common stock are traded in the over-the-counter market and \"bid\" and \"asked\" quotations regularly appear on the Over-the-Counter Electronic Bulletin Board system under the symbol \"CCBP.\" As of March 1, 1996, two firms were listed on the Over-the-Counter Electronic Bulletin Board system as market makers for the Company's common stock. The following table sets forth: (1) the quarterly average bid and asked prices for a share of the Company's common stock during the periods indicated as reported by Rutherford Brown and Catherwood, Inc. of Clarks Summit, Pennsylvania, one of the market makers of the Company's common stock and (2) dividends on a share of the common stock with respect to each dividend payment since January 1, 1994. The following quotations represent prices between buyers and sellers and do not include retail markup, markdown or commission. They may not necessarily represent actual transactions.\nAs of February 6, 1996, the Company had 702 stockholders of record.\nSince its formation in 1984 as the parent holding company of Community Bank, the Company has paid cash dividends. It is the present intention of the Company's Board of Directors to continue the dividend payment policy, although the payment of future dividends must necessarily depend upon earnings, financial condition, appropriate restrictions under applicable law and other factors relevant at the time the Board of Directors considers any declaration of dividends. Cash available for the payment of dividends must initially come from dividends paid by Community Bank to the Company. Therefore, the restrictions on Community Bank's dividend payments are directly applicable to the Company.\nDuring 1995 under the MOU, the Company and Community Bank could not declare or pay any dividends without the prior written approval of the FRB. The dividends declared and paid during 1995 did receive such prior written approval.\nDIVIDEND RESTRICTIONS ON COMMUNITY BANK\nFederal Reserve Board Regulation H restricts state member banks from paying a dividend if the total of all dividends declared by the bank in any calendar year exceeds the total of its net profits for that year combined with its retained net profits of the preceding two calendar years, less any required transfers to surplus, unless the bank has received the prior approval from the Federal Reserve Board. Accordingly, Community Bank, without prior approval of bank regulators, may declare dividends to the Company in 1996 totaling $1,612 thousand plus net profits earned by Community Bank for the period from January 1, 1996, through the date of declaration, less dividends previously paid in 1996.\nIn addition, the Code provides that cash dividends may be declared and paid by Community Bank only out of accumulated net earnings. Prior to the declaration of any dividend, if the surplus of Community Bank is less than the amount of its capital, Community Bank shall, until surplus is equal to such amount, transfer to surplus an amount that is at least 10.0 percent of the net earnings of Community Bank for the period since the end of the fiscal year or for any shorter period since the declaration of a dividend. If the surplus of Community Bank is less than 50.0 percent of the amount of the capital, no dividend may be declared or paid without prior approval of the Department until such surplus is equal to 50.0 percent of Community Bank's capital.\nDIVIDEND RESTRICTIONS ON THE COMPANY\nUnder the Pennsylvania Business Corporation Law of 1988 (\"BCL\"), as amended, the Company may not pay a dividend if, after giving effect thereto, either (a) the Company would be unable to pay its debts as they become due in the usual course of business or (b) the Company's total assets would be less than its total liabilities. The determination of total assets and liabilities may be based upon: (I) financial statements prepared on the basis of generally accepted accounting principles; (II) financial statements that are prepared on the basis of other accounting practices and principles that are reasonable under the circumstances; or (III) a fair valuation or other method that is reasonable under the circumstances.\nITEM 6. SELECTED FINANCIAL DATA\nThe information called for by this item is filed at Exhibit 13 hereto and is incorporated in its entirety by reference under this Item 6.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe information called for by this item is filed at Exhibit 13 hereto and is incorporated in its entirety by reference under this Item 7.\nITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe Company's consolidated financial statements and notes thereto are filed at Exhibit 13 hereto and are incorporated in their entirety by reference under this Item 8.\nThe Company does not meet both of the tests under Item 302(a)(5) of Regulation S-K, and therefore, is not required to provide supplementary financial data.\nPART III\nITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY\nEach director of the Company is elected for a one-year term and until his successor is duly elected and qualified. Current directors were elected at the 1995 Annual Meeting of Stockholders, which was held on September 15, 1995. The following table contains certain information with respect to the directors and executive officers of the Company:\nDIRECTOR OF PRINCIPAL OCCUPATION FOR PAST COMPANY\/ AGE AS OF FIVE YEARS AND POSITION HELD COMMUNITY MARCH 1, WITH THE COMPANY BANK SINCE NAME 1996 AND COMMUNITY BANK ____ _________ ____________________________ __________\nDavid L. Baker 50 President and Chief Executive 1988\/1993 Officer (\"CEO\") of the Company and Community Bank (as of April 26, 1995); Senior Vice President of Community Bank (as of January 20, 1993); President of FNB Nicholson (1987-1992) prior to its merger with Community Bank\nDonald R. Edwards, Sr.(1) 52 Owner, Mountain View Inn 1988\/1993\nWilliam F. Farber, Sr. 59 President, Farber's Restaurants; 1983\/1970 Chairman of the Boards of Directors of the Company and Community Bank\nJudd B. Fitze 44 Partner, Farr, Davis & Fitze 1995\/1992 (attorney-at-law)\nMichael T. Goskowski(2) 73 President, Kartri Sales Mfg. 1984\/1984 (manufacturing); Secretary of the Company and Community Bank\nJohn P. Kameen 54 Publisher, Forest City News 1983\/1979\nWilliam B. Lopatofsky 64 Owner, Northeast Distributors 1983\/1982 and Equipment\nJ. Robert McDonnell 60 Owner, McDonnell's Restaurant; 1983\/1979 Vice President of the Company\nJoseph P. Moore, Jr. 69 President, Moore Motors Inc. 1988\/1992 (automobile dealership); President Elk Mountain Ski Resort, Inc.\nEric Stephens(1) 44 Auto Dealer, H.L. Stephens and Son 1988\/1993 (automobile dealership) [FN] (1) Eric Stephens is married to the niece of Donald R. Edwards, Sr.\n(2) In accordance with Article 10 of the Amended Articles of Incorporation of the Company, Mr. Goskowski served as a director of the Corporation until December 31, 1995, the completion of the year in which he attained 72 years of age. Mr. Goskowski continues to serve as a director of Community Bank.\nPRINCIPAL OFFICERS OF THE COMPANY\nThe following table sets forth selected information about the principal officers of the Company, each of whom is elected by the Board of Directors and each of whom holds office at the discretion of the Board of Directors:\nCOMPANY HELD EMPLOYEE NUMBER OF SHARES AGE AS OF NAME AND POSITION SINCE SINCE BENEFICIALLY OWNED MARCH 1, 1996 - - ----------------- ----- ---------- ------------------ ------------- William F. Farber, Sr. 1983 (1) 62,440 59 Chairman of the Board\nDavid L. Baker 1995 1992(2) 3,768(3) 50 President and CEO\nScott A. Seasock 1987 1992(4) 915(5) 38 Senior Vice President and Chief Financial Officer\nThomas E. Sheridan 1989 1985 588(6) 39 Senior Vice President and Chief Operating Officer\nJ. Robert McDonnell 1983 (1) 10,848(6) 60 Vice President\nMichael T. Goskowski 1984 (1) 7,032(7) 73 Secretary [FN]\n(1) Messrs. Farber, McDonnell and Goskowski are not employees of Community Bank. (2) Prior to the merger of FNB Nicholson with Community Bank, Mr. Baker was employed by FNB Nicholson from 1987 to 1992 as the President. (3) Includes 1,680 shares held individually; 1,600 shares held jointly with his spouse; 244 shares held under his IRA; and 244 shares held under his spouse's IRA. (4) Prior to the merger of FNB Nicholson with Community Bank, Mr. Seasock was employed by FNB Nicholson from 1987 to 1992 as Senior Vice President and Chief Financial Officer. (5) Includes 220 shares held under his IRA; 275 shares held jointly with his spouse; 20 shares held jointly with his spouse and son; and 400 shares held jointly with his spouse and sons. (6) Held jointly with his spouse. (7) Includes 3,180 shares held jointly with his spouse; 412 shares held in trust for his granddaughter; and 3,440 shares held jointly with his spouse and daughter.\nPRINCIPAL OFFICERS OF COMMUNITY BANK\nThe following table sets forth selected information about the principal officers of Community Bank, each of whom is elected by the Board of Directors of Community Bank and each of whom holds office at the discretion of Community Bank's Board of Directors:\nCommunity Bank Held Employee Number of Shares Age as of Name and Position Since Since Beneficially Owned March 1, 1996 - - ----------------- ----- --------- ------------------ ------------- David L. Baker 1995 1993(1) 3,768 50 President and CEO\nScott A. Seasock 1992 1992(2) 915 38 Senior Vice President and Chief Financial Officer\nThomas E. Sheridan 1989 1985 588 39 Senior Vice President and Chief Operating Officer\nThomas M. Chesnick 1989 1952 9,300(3) 61 Vice President, Cashier and Assistant Secretary [FN]\n(1) See footnote (2) above under the caption entitled \"Principal Officers of the Company\" as to the employment history of Mr. Baker. (2) See footnote (4) above under the caption entitled \"Principal Officers of the Company\" as to the employment history of Mr. Seasock. (3) Includes 5,960 shares held jointly with his spouse; and 3,340 shares held jointly with various relatives.\nSection 16(a) of the Exchange Act, as amended, requires the Company's officers and directors, and persons who own more than 10.0 percent of the registered class of the Company's equity securities, to file reports of ownership and changes in ownership with the SEC. Officers, directors and persons who own more than 10.0 percent of the Company's stock are required by the SEC regulation to furnish the Company with copies of all Section 16(a) forms they file. Based solely on its review of the copies of such forms received by it, or written representations from certain reporting persons that no Form 5 was required for any of those persons, the Company believes that during the period January 1, 1995, through December 31, 1995, its officers and directors were in compliance with all filing requirements applicable to them.\nITEM 11. EXECUTIVE COMPENSATION\nShown below is information concerning the annual compensation for services in all capacities to the Company and Community Bank for the fiscal years ended December 31, 1995, 1994 and 1993, to the present and former President and CEO of the Company and Community Bank. No other officers' total annual salary and bonus exceeded $100,000 during the fiscal years reported:\nSUMMARY COMPENSATION TABLE\nPENSION PLAN\nThe Company has a profit sharing plan (\"Plan\"), which covers all employees who have completed 1,000 hours of service, attained 21 years of age and have been employed by the Company for at least one year. The entry date of an employee into the Plan is January 1 of the year following the satisfaction of the eligibility requirements. Normal retirement age is sixty-five (65). The normal retirement benefit is the accumulated account balance of annual contributions, investment income and forfeitures. The annual contribution is determined by the Board of Directors each year. Contributions are allocated to each participant based on a pro-rata share of compensation covered under the Plan. Investment income is allocated to each participant based on a pro-rata share of the account balances accumulated at the beginning of the year. Forfeitures are allocated to each participant based on a pro-rata share of compensation covered under the Plan. If a participant separates from service prior to retirement, the participant will be entitled to a portion of the profit sharing account based on years of service according to the following schedule:\nYears of Service Vested Interest ---------------- --------------- Less than 1 0% 1 10 2 20 3 30 4 40 5 60 6 80 7 or more 100%\nA participant is always 100.0 percent vested in pension plan transferred balances.\nDuring 1995, $113,728 was allocated among the participants' accounts of the Plan. The amount contributed by Community Bank in 1995 to the Plan for Mr. Franceski, the then President and CEO of the Company was $3,000. Mr. Franceski had sixteen (16) years of credited service under the Plan. The amount contributed by Community Bank in 1995 to the Plan for Mr. Baker, the President and CEO of the Company was $4,296. Mr. Baker had nine (9) years of credited service under the Plan.\nCOMPENSATION OF DIRECTORS\nDuring 1995, Messrs. Franceski and Baker, officers of the Company and Community Bank, sat on the Company's and Community Bank's Board of Directors and various committees of the Company and Community Bank. Messrs. Baker and Franceski received no fees for their services on such committees. Messr. Franceski received $620 in fees for his services as a director on the Company's Board and no fees for his services on Community Bank's Board. Messr. Baker received no fees for his services on the Company's or Community Bank's Board.\nExcept for Mr. Farber, members of Community Bank's Board of Directors received a fee of $800 per month. Mr. Farber, as the Chairman of Community Bank, received a fee of $1,300 per month. Aggregate directors' fees paid by Community Bank in 1995 were $140,400. All members of the Company's Board of Directors, including Mr. Farber, the Chairman of the Company, received a fee of $400 per quarter. Aggregate directors' fees paid by the Company in 1995 were $24,520.\nBOARD COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION\nThe Board of Directors of the Company is responsible for the governance of the Company and its subsidiary, Community Bank. In fulfilling its fiduciary duties, the Board of Directors acts in the best interests of the Company's stockholders, customers and the communities served by the Company and Community Bank. To accomplish the strategic goals and objectives of the Company, the Board of Directors engages competent persons who undertake to accomplish these objectives with integrity and in a cost-effective manner. The compensation of these individuals is part of the Board of Directors' fulfillment of its duties to accomplish the Company's strategic mission. Community Bank provides compensation to the employees of the Company and Community Bank.\nThe fundamental philosophy of the Company's and Community Bank's compensation program is to offer competitive compensation opportunities for all employees based on the individual's contribution and personal performance. The compensation program is administered by the Executive Compensation Committee (\"Committee\") comprised of four outside directors, and a member of Community Bank's Board of Directors listed in the section \"Executive Officers,\" thereto. The objectives of the Committee are to establish a fair compensation policy to govern executive officers' base salaries and incentive plans to attract and motivate competent, dedicated and ambitious managers whose efforts will enhance the products and services of the Company, the results of which will be improved profitability, increased dividends to our stockholders and subsequent appreciation in the market value of our stock.\nThe compensation of the Company's and Community Bank's top executives is reviewed and approved annually by the Board of Directors. The top executives whose compensation is determined by the Committee include the CEO and all other Vice Presidents. As guidance for review in determining base salaries, the Committee uses information composed of a Pennsylvania bank peer group. This bank peer group is different than the peer group utilized for the performance chart. Pennsylvania peer group banks have been utilized because of common industry issues and competition for the same executive talent group.\nCEO COMPENSATION\nThe Board of Directors has determined that the CEO's 1995 compensation of $90,666 (which represents Mr. Baker's annual salary and bonus) was appropriate in light of the Company's 1995 performance accomplishments. There is no direct correlation, however, between the President and CEO's compensation and the Company's performance, nor is there any weight given by the Committee to any specific individual criteria. Such 1995 compensation was based on the Committee's subjective determination after review of all information that it deemed relevant.\nEXECUTIVE OFFICERS\nCompensation for Community Bank's executive officers is determined by the Committee based on its subjective analysis of the individual's contribution to the Company's strategic goals and objectives. In determining whether strategic goals have been achieved, the Board of Directors considers, among numerous other factors, the following: the Company's performance as measured by earnings, revenues, return on assets, return on equity, market share, total assets and nonperforming loans. Although the performance and increases in compensation are measured in light of these factors, there is no direct correlation between any specific criterion and the employees compensation, nor is there any specific weight provided to any such criteria in the Committee's analysis. The determination by the Committee is subjective after review of all information, including the above, it deems relevant.\nTotal compensation opportunities available to the employees of Community Bank are influenced by general labor market conditions, the specific responsibilities of the individual and the individual's contributions to the Company's success. Individuals are reviewed annually on a calendar year basis. Community Bank strives to offer compensation that is competitive with that offered by employers of comparable size in the banking industry. Through these compensation policies, the Company strives to meet its strategic goals and objectives to its constituents and provide compensation that is fair and meaningful to its employees.\nSubmitted by the Executive Compensation Committee ------------------------------------------------- William F. Farber, Sr. Michael T. Goskowski John P. Kameen Joseph P. Moore, Jr. Judd B. Fitze\nStock Performance Graph and Table - - --------------------------------- The following graph and table compare the cumulative stockholder return on the Company's Common Stock during the period January 1, 1990, through and including December 31, 1995, with (I) a Peer Group Index(1) and (II) the Standard & Poor's 500 Index. The comparison assumes $100 was invested on January 1, 1990, in the Company's Common Stock and in each of the below indices and assumes further the reinvestment of dividends into the applicable securities.\nITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nPrincipal Owners\nThe following table sets forth, as of February 7, 1996, the name and address of each person who owns of record or who is known by the Board of Directors to be the beneficial owner of more than 5.0 percent of the outstanding Common Stock, the number of shares beneficially owned by such person and the percentage of the outstanding Common Stock so owned.\nPercent of Outstanding Shares Beneficially Common Stock Name and Address Owned(1) Beneficially Owned - - ---------------- ------------------- ---------------------- Joseph P. Moore, Jr. 72,420(2) 9.88% 400 Williamson Road Gladwyne, PA 19035\nWilliam F. Farber, Sr. 62,440 8.51% Crystal Lake Road R.R. 1, Box 1281 Carbondale, PA 18407\nGerald B. Franceski 51,350(3) 7.00% Lewis Lake, P.O. Box 88 Union Dale, PA 18470\nRobert T. Seamans 43,120(4) 5.88% P.O. Box 462 Factoryville, PA 18419 [FN]\n(1) The securities \"beneficially owned\" by an individual are determined in accordance with the definitions of \"beneficial ownership\" set forth in the General Rules and Regulations of the SEC and may include securities owned by or for the individual's spouse and minor children and any other relative who has the same home, as well as securities to which the individual has or shares voting or investment power or has the right to acquire beneficial ownership within sixty (60) days after February 7, 1996. Beneficial ownership may be disclaimed as to certain of the securities. (2) Includes 10,080 shares held individually; 2,100 shares held in the Moore Motors, Inc. Profit Sharing Plan, an automobile dealership of which he is President; and 60,240 shares held beneficially by Moore & Company, which are held in trust for his various relatives. (3) Includes 34,350 shares held jointly with his spouse; and 17,000 shares held jointly in various combinations with his spouse, sons, brother, sister and aunt. (4) Includes 42,675 shares held individually; and 445 shares held individually by his spouse.\nBeneficial Ownership by Executive Officers and Directors\nThe following table sets forth as of February 7, 1996, the amount and percentage of the Common Stock beneficially owned by each director and all officers and directors of the Company as a group.\nNAME OF INDIVIDUAL AMOUNT AND NATURE OF PERCENT OR IDENTITY OF GROUP BENEFICIAL OWNERSHIP(1)(2)(3) OF CLASS(4) - - -------------------- ----------------------------- ----------- David L. Baker 3,768(5) ---- Donald R. Edwards, Sr. 17,272(6) 2.36% William F. Farber, Sr. 62,440 8.51% Judd B. Fitze 3,400(7) ---- Michael T. Goskowski 7,032(8) ---- John P. Kameen 6,760(9) ---- William B. Lopatofsky 8,470(9) 1.15% J. Robert McDonnell 10,848(9) 1.48% Joseph P. Moore, Jr. 72,420(10) 9.88% Scott A. Seasock 915(11) ---- Thomas E. Sheridan 588(9) ---- Eric Stephens 2,320(12) ----\nAll Executive Officers and Directors of the Company as a Group (9 Directors, 6 Officers, 12 Persons in Total) 196,233 26.76% [FN]\n(1) Does not include any Common Stock held in fiduciary accounts under the control of the Trust Department of Community Bank. (2) See footnote (1) under the above caption entitled \"Principal Owners\" for the definition of \"beneficial ownership.\" (3) Information furnished by the directors and the Company. (4) Less than 1.0 percent unless otherwise indicated. (5) See footnote (3) under the above caption entitled \"Principal Officers of the Company.\" (6) Includes 14,940 shares held individually; 1,860 shares held individually by his spouse; 300 shares held jointly with his daughter; 100 shares held jointly by his spouse and daughter; 36 shares held under his IRA; and 36 shares held under his spouse's IRA. (7) Includes 400 shares held under his IRA; and 3,000 shares held jointly with his spouse. (8) See footnote (7) under the above caption entitled \"Principal Officers of the Company.\" (9) Held jointly with his spouse. (10) See footnote (2) under the above caption entitled \"Principal Owners.\" (11) See footnote (5) under the above caption entitled \"Principal Officers of the Company.\" (12) Includes 1,780 shares held individually; 300 shares held individually by his spouse; and 240 shares held individually by his children.\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nExcept as described in the paragraphs below, there have been no material transactions between the Company and Community Bank, nor any material transactions proposed, with any director or executive officer of the Company and Community Bank, or any associate of the foregoing persons. The Company and Community Bank have had financial transactions in the ordinary course of business with directors and officers of the Company and Community Bank. The Company and Community Bank intend to continue to have banking and financial transactions in the ordinary course of business with directors and officers of the Company and Community Bank and their associates on substantially the same terms, including interest rates and collateral, as those prevailing from time to time for comparable transactions with other persons. Total loans outstanding from Community Bank as of December 31, 1995, to the Company's and Community Bank's executive officers and directors as a group and members of their immediate families and companies in which they had an ownership interest of 10.0 percent or more was $3,157,222 or approximately 11.3 percent of the total equity capital of the Company. Loans to such persons were made in the ordinary course of business and 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 the normal risk of collectibility or present other unfavorable features.\nCommunity Bank leases its Carbondale branch office from William F. Farber, Sr., the Chairman of the Boards of Directors of the Company and Community Bank. The lease, which commenced in October 1988, expires in 1998 and contains an option that allows Community Bank to purchase the property at fair market value or renew the lease for two additional terms of five years each. In 1995, lease payments to Mr. Farber were $6,020 per month or $72,240 annually.\nCommunity Bank has extended credit to Joseph P. Moore, Jr., a director of the Company and Community Bank, who is President of Elk Mountain Ski Resort, Inc. (\"Elk Mountain\"). As of December 31, 1995, the Bank had outstanding balances with Elk Mountain of $540.0 thousand, secured by a first lien mortgage on all real property and equipment, and of $750.0 thousand, secured by a second lien mortgage on all real property and equipment. The interest rate on these mortgages was, and is, Community Bank's prime rate of interest.\nPART IV\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) 1. The Company's consolidated financial statements and notes thereto as well as the applicable reports of the independent certified public accountants are filed at Exhibit 13 hereto and are incorporated in their entirety by reference under this Item 14(a)1.\n2. All schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto.\n3. The exhibits required by Item 601 of Regulation S-K are included under Item 14(c) hereto.\n(b) Reports on Form 8-K\nThe Company filed no current reports on Form 8-K during the quarter ended December 31, 1995.\n(c) Exhibits required by Item 601 of Regulation S-K:\nExhibit Number Referred to Item 601 of Regulation S-K Description of Exhibit - - -------------------------- ---------------------- 2 None. 3 Bylaws of the Company, amended as of December 31, 1995. 4 None. 9 None. 10 None. 11 None. 12 None. 13 Portions of the Annual Report to Stockholders for Fiscal Year Ended December 31, 1995. 16 None. 18 None. 21 List of Subsidiaries of the Company. 22 None. 23 None. 24 None. 27 None. 28 None.\nComm Bancorp, Inc. 521 Main Street Forest City, Pennsylvania 18421 Telephone: (717) 785-3181\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto, duly authorized.\nCOMM BANCORP, INC. (Registrant)\nBY:\/s\/ David L. Baker March 10, 1996 --------------------------------- David L. Baker, President and Chief Executive Officer (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.\nSignature and Capacity Date\n\/s\/ David L. Baker March 10, 1996 - - ---------------------------------- --- David L. Baker, President and Chief Executive Officer\/Director\n\/s\/ Donald R. Edwards, Sr. March 10, 1996 - - ---------------------------------- --- Donald R. Edwards, Sr., Director\n\/s\/ William F. Farber, Sr. March 10, 1996 - - ---------------------------------- --- William F. Farber, Sr., Chairman of the Board\/Director\n\/s\/ Judd B. Fitze March 10, 1996 - - ---------------------------------- --- Judd B. Fitze, Director\n\/s\/ Michael T. Goskowski March 10, 1996 - - ---------------------------------- --- Michael T. Goskowski, Secretary\/Director\n\/s\/ John P. Kameen March 10, 1996 - - ---------------------------------- --- John P. Kameen, Director\n\/s\/ William B. Lopatofsky March 10, 1996 - - ---------------------------------- --- William B. Lopatofsky, Director\n\/s\/ J. Robert McDonnell March 10, 1996 - - ---------------------------------- --- J. Robert McDonnell, Vice President\/Director\n\/s\/ Joseph P. Moore, Jr. March 10, 1996 - - ---------------------------------- --- Joseph P. Moore, Jr., Director\n\/s\/ Scott A. Seasock March 10, 1996 - - ---------------------------------- --- Scott A. Seasock, Chief Financial Officer (Principal Financial Officer)\n\/s\/ Eric Stephens March 10, 1996 - - ---------------------------------- --- Eric Stephens, Director\nEXHIBIT INDEX\nItem Number Description Page - - ----------- ----------- ---- 3 Bylaws of the Company, amended as of December 31, 1995 38\n13 Portions of the Annual Report to Stockholders for the Fiscal Year Ended December 31, 1995 52\n21 List of Subsidiaries of the Company 161","section_4":"","section_5":"ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nShares of the Company's common stock are traded in the over-the-counter market and \"bid\" and \"asked\" quotations regularly appear on the Over-the-Counter Electronic Bulletin Board system under the symbol \"CCBP.\" As of March 1, 1996, two firms were listed on the Over-the-Counter Electronic Bulletin Board system as market makers for the Company's common stock. The following table sets forth: (1) the quarterly average bid and asked prices for a share of the Company's common stock during the periods indicated as reported by Rutherford Brown and Catherwood, Inc. of Clarks Summit, Pennsylvania, one of the market makers of the Company's common stock and (2) dividends on a share of the common stock with respect to each dividend payment since January 1, 1994. The following quotations represent prices between buyers and sellers and do not include retail markup, markdown or commission. They may not necessarily represent actual transactions.\nAs of February 6, 1996, the Company had 702 stockholders of record.\nSince its formation in 1984 as the parent holding company of Community Bank, the Company has paid cash dividends. It is the present intention of the Company's Board of Directors to continue the dividend payment policy, although the payment of future dividends must necessarily depend upon earnings, financial condition, appropriate restrictions under applicable law and other factors relevant at the time the Board of Directors considers any declaration of dividends. Cash available for the payment of dividends must initially come from dividends paid by Community Bank to the Company. Therefore, the restrictions on Community Bank's dividend payments are directly applicable to the Company.\nDuring 1995 under the MOU, the Company and Community Bank could not declare or pay any dividends without the prior written approval of the FRB. The dividends declared and paid during 1995 did receive such prior written approval.\nDIVIDEND RESTRICTIONS ON COMMUNITY BANK\nFederal Reserve Board Regulation H restricts state member banks from paying a dividend if the total of all dividends declared by the bank in any calendar year exceeds the total of its net profits for that year combined with its retained net profits of the preceding two calendar years, less any required transfers to surplus, unless the bank has received the prior approval from the Federal Reserve Board. Accordingly, Community Bank, without prior approval of bank regulators, may declare dividends to the Company in 1996 totaling $1,612 thousand plus net profits earned by Community Bank for the period from January 1, 1996, through the date of declaration, less dividends previously paid in 1996.\nIn addition, the Code provides that cash dividends may be declared and paid by Community Bank only out of accumulated net earnings. Prior to the declaration of any dividend, if the surplus of Community Bank is less than the amount of its capital, Community Bank shall, until surplus is equal to such amount, transfer to surplus an amount that is at least 10.0 percent of the net earnings of Community Bank for the period since the end of the fiscal year or for any shorter period since the declaration of a dividend. If the surplus of Community Bank is less than 50.0 percent of the amount of the capital, no dividend may be declared or paid without prior approval of the Department until such surplus is equal to 50.0 percent of Community Bank's capital.\nDIVIDEND RESTRICTIONS ON THE COMPANY\nUnder the Pennsylvania Business Corporation Law of 1988 (\"BCL\"), as amended, the Company may not pay a dividend if, after giving effect thereto, either (a) the Company would be unable to pay its debts as they become due in the usual course of business or (b) the Company's total assets would be less than its total liabilities. The determination of total assets and liabilities may be based upon: (I) financial statements prepared on the basis of generally accepted accounting principles; (II) financial statements that are prepared on the basis of other accounting practices and principles that are reasonable under the circumstances; or (III) a fair valuation or other method that is reasonable under the circumstances.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe information called for by this item is filed at Exhibit 13 hereto and is incorporated in its entirety by reference under this Item 6.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe information called for by this item is filed at Exhibit 13 hereto and is incorporated in its entirety by reference under this Item 7.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe Company's consolidated financial statements and notes thereto are filed at Exhibit 13 hereto and are incorporated in their entirety by reference under this Item 8.\nThe Company does not meet both of the tests under Item 302(a)(5) of Regulation S-K, and therefore, is not required to provide supplementary financial data.\nPART III\nITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY\nEach director of the Company is elected for a one-year term and until his successor is duly elected and qualified. Current directors were elected at the 1995 Annual Meeting of Stockholders, which was held on September 15, 1995. The following table contains certain information with respect to the directors and executive officers of the Company:\nDIRECTOR OF PRINCIPAL OCCUPATION FOR PAST COMPANY\/ AGE AS OF FIVE YEARS AND POSITION HELD COMMUNITY MARCH 1, WITH THE COMPANY BANK SINCE NAME 1996 AND COMMUNITY BANK ____ _________ ____________________________ __________\nDavid L. Baker 50 President and Chief Executive 1988\/1993 Officer (\"CEO\") of the Company and Community Bank (as of April 26, 1995); Senior Vice President of Community Bank (as of January 20, 1993); President of FNB Nicholson (1987-1992) prior to its merger with Community Bank\nDonald R. Edwards, Sr.(1) 52 Owner, Mountain View Inn 1988\/1993\nWilliam F. Farber, Sr. 59 President, Farber's Restaurants; 1983\/1970 Chairman of the Boards of Directors of the Company and Community Bank\nJudd B. Fitze 44 Partner, Farr, Davis & Fitze 1995\/1992 (attorney-at-law)\nMichael T. Goskowski(2) 73 President, Kartri Sales Mfg. 1984\/1984 (manufacturing); Secretary of the Company and Community Bank\nJohn P. Kameen 54 Publisher, Forest City News 1983\/1979\nWilliam B. Lopatofsky 64 Owner, Northeast Distributors 1983\/1982 and Equipment\nJ. Robert McDonnell 60 Owner, McDonnell's Restaurant; 1983\/1979 Vice President of the Company\nJoseph P. Moore, Jr. 69 President, Moore Motors Inc. 1988\/1992 (automobile dealership); President Elk Mountain Ski Resort, Inc.\nEric Stephens(1) 44 Auto Dealer, H.L. Stephens and Son 1988\/1993 (automobile dealership) [FN] (1) Eric Stephens is married to the niece of Donald R. Edwards, Sr.\n(2) In accordance with Article 10 of the Amended Articles of Incorporation of the Company, Mr. Goskowski served as a director of the Corporation until December 31, 1995, the completion of the year in which he attained 72 years of age. Mr. Goskowski continues to serve as a director of Community Bank.\nPRINCIPAL OFFICERS OF THE COMPANY\nThe following table sets forth selected information about the principal officers of the Company, each of whom is elected by the Board of Directors and each of whom holds office at the discretion of the Board of Directors:\nCOMPANY HELD EMPLOYEE NUMBER OF SHARES AGE AS OF NAME AND POSITION SINCE SINCE BENEFICIALLY OWNED MARCH 1, 1996 - - ----------------- ----- ---------- ------------------ ------------- William F. Farber, Sr. 1983 (1) 62,440 59 Chairman of the Board\nDavid L. Baker 1995 1992(2) 3,768(3) 50 President and CEO\nScott A. Seasock 1987 1992(4) 915(5) 38 Senior Vice President and Chief Financial Officer\nThomas E. Sheridan 1989 1985 588(6) 39 Senior Vice President and Chief Operating Officer\nJ. Robert McDonnell 1983 (1) 10,848(6) 60 Vice President\nMichael T. Goskowski 1984 (1) 7,032(7) 73 Secretary [FN]\n(1) Messrs. Farber, McDonnell and Goskowski are not employees of Community Bank. (2) Prior to the merger of FNB Nicholson with Community Bank, Mr. Baker was employed by FNB Nicholson from 1987 to 1992 as the President. (3) Includes 1,680 shares held individually; 1,600 shares held jointly with his spouse; 244 shares held under his IRA; and 244 shares held under his spouse's IRA. (4) Prior to the merger of FNB Nicholson with Community Bank, Mr. Seasock was employed by FNB Nicholson from 1987 to 1992 as Senior Vice President and Chief Financial Officer. (5) Includes 220 shares held under his IRA; 275 shares held jointly with his spouse; 20 shares held jointly with his spouse and son; and 400 shares held jointly with his spouse and sons. (6) Held jointly with his spouse. (7) Includes 3,180 shares held jointly with his spouse; 412 shares held in trust for his granddaughter; and 3,440 shares held jointly with his spouse and daughter.\nPRINCIPAL OFFICERS OF COMMUNITY BANK\nThe following table sets forth selected information about the principal officers of Community Bank, each of whom is elected by the Board of Directors of Community Bank and each of whom holds office at the discretion of Community Bank's Board of Directors:\nCommunity Bank Held Employee Number of Shares Age as of Name and Position Since Since Beneficially Owned March 1, 1996 - - ----------------- ----- --------- ------------------ ------------- David L. Baker 1995 1993(1) 3,768 50 President and CEO\nScott A. Seasock 1992 1992(2) 915 38 Senior Vice President and Chief Financial Officer\nThomas E. Sheridan 1989 1985 588 39 Senior Vice President and Chief Operating Officer\nThomas M. Chesnick 1989 1952 9,300(3) 61 Vice President, Cashier and Assistant Secretary [FN]\n(1) See footnote (2) above under the caption entitled \"Principal Officers of the Company\" as to the employment history of Mr. Baker. (2) See footnote (4) above under the caption entitled \"Principal Officers of the Company\" as to the employment history of Mr. Seasock. (3) Includes 5,960 shares held jointly with his spouse; and 3,340 shares held jointly with various relatives.\nSection 16(a) of the Exchange Act, as amended, requires the Company's officers and directors, and persons who own more than 10.0 percent of the registered class of the Company's equity securities, to file reports of ownership and changes in ownership with the SEC. Officers, directors and persons who own more than 10.0 percent of the Company's stock are required by the SEC regulation to furnish the Company with copies of all Section 16(a) forms they file. Based solely on its review of the copies of such forms received by it, or written representations from certain reporting persons that no Form 5 was required for any of those persons, the Company believes that during the period January 1, 1995, through December 31, 1995, its officers and directors were in compliance with all filing requirements applicable to them.\nITEM 11. EXECUTIVE COMPENSATION\nShown below is information concerning the annual compensation for services in all capacities to the Company and Community Bank for the fiscal years ended December 31, 1995, 1994 and 1993, to the present and former President and CEO of the Company and Community Bank. No other officers' total annual salary and bonus exceeded $100,000 during the fiscal years reported:\nSUMMARY COMPENSATION TABLE\nPENSION PLAN\nThe Company has a profit sharing plan (\"Plan\"), which covers all employees who have completed 1,000 hours of service, attained 21 years of age and have been employed by the Company for at least one year. The entry date of an employee into the Plan is January 1 of the year following the satisfaction of the eligibility requirements. Normal retirement age is sixty-five (65). The normal retirement benefit is the accumulated account balance of annual contributions, investment income and forfeitures. The annual contribution is determined by the Board of Directors each year. Contributions are allocated to each participant based on a pro-rata share of compensation covered under the Plan. Investment income is allocated to each participant based on a pro-rata share of the account balances accumulated at the beginning of the year. Forfeitures are allocated to each participant based on a pro-rata share of compensation covered under the Plan. If a participant separates from service prior to retirement, the participant will be entitled to a portion of the profit sharing account based on years of service according to the following schedule:\nYears of Service Vested Interest ---------------- --------------- Less than 1 0% 1 10 2 20 3 30 4 40 5 60 6 80 7 or more 100%\nA participant is always 100.0 percent vested in pension plan transferred balances.\nDuring 1995, $113,728 was allocated among the participants' accounts of the Plan. The amount contributed by Community Bank in 1995 to the Plan for Mr. Franceski, the then President and CEO of the Company was $3,000. Mr. Franceski had sixteen (16) years of credited service under the Plan. The amount contributed by Community Bank in 1995 to the Plan for Mr. Baker, the President and CEO of the Company was $4,296. Mr. Baker had nine (9) years of credited service under the Plan.\nCOMPENSATION OF DIRECTORS\nDuring 1995, Messrs. Franceski and Baker, officers of the Company and Community Bank, sat on the Company's and Community Bank's Board of Directors and various committees of the Company and Community Bank. Messrs. Baker and Franceski received no fees for their services on such committees. Messr. Franceski received $620 in fees for his services as a director on the Company's Board and no fees for his services on Community Bank's Board. Messr. Baker received no fees for his services on the Company's or Community Bank's Board.\nExcept for Mr. Farber, members of Community Bank's Board of Directors received a fee of $800 per month. Mr. Farber, as the Chairman of Community Bank, received a fee of $1,300 per month. Aggregate directors' fees paid by Community Bank in 1995 were $140,400. All members of the Company's Board of Directors, including Mr. Farber, the Chairman of the Company, received a fee of $400 per quarter. Aggregate directors' fees paid by the Company in 1995 were $24,520.\nBOARD COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION\nThe Board of Directors of the Company is responsible for the governance of the Company and its subsidiary, Community Bank. In fulfilling its fiduciary duties, the Board of Directors acts in the best interests of the Company's stockholders, customers and the communities served by the Company and Community Bank. To accomplish the strategic goals and objectives of the Company, the Board of Directors engages competent persons who undertake to accomplish these objectives with integrity and in a cost-effective manner. The compensation of these individuals is part of the Board of Directors' fulfillment of its duties to accomplish the Company's strategic mission. Community Bank provides compensation to the employees of the Company and Community Bank.\nThe fundamental philosophy of the Company's and Community Bank's compensation program is to offer competitive compensation opportunities for all employees based on the individual's contribution and personal performance. The compensation program is administered by the Executive Compensation Committee (\"Committee\") comprised of four outside directors, and a member of Community Bank's Board of Directors listed in the section \"Executive Officers,\" thereto. The objectives of the Committee are to establish a fair compensation policy to govern executive officers' base salaries and incentive plans to attract and motivate competent, dedicated and ambitious managers whose efforts will enhance the products and services of the Company, the results of which will be improved profitability, increased dividends to our stockholders and subsequent appreciation in the market value of our stock.\nThe compensation of the Company's and Community Bank's top executives is reviewed and approved annually by the Board of Directors. The top executives whose compensation is determined by the Committee include the CEO and all other Vice Presidents. As guidance for review in determining base salaries, the Committee uses information composed of a Pennsylvania bank peer group. This bank peer group is different than the peer group utilized for the performance chart. Pennsylvania peer group banks have been utilized because of common industry issues and competition for the same executive talent group.\nCEO COMPENSATION\nThe Board of Directors has determined that the CEO's 1995 compensation of $90,666 (which represents Mr. Baker's annual salary and bonus) was appropriate in light of the Company's 1995 performance accomplishments. There is no direct correlation, however, between the President and CEO's compensation and the Company's performance, nor is there any weight given by the Committee to any specific individual criteria. Such 1995 compensation was based on the Committee's subjective determination after review of all information that it deemed relevant.\nEXECUTIVE OFFICERS\nCompensation for Community Bank's executive officers is determined by the Committee based on its subjective analysis of the individual's contribution to the Company's strategic goals and objectives. In determining whether strategic goals have been achieved, the Board of Directors considers, among numerous other factors, the following: the Company's performance as measured by earnings, revenues, return on assets, return on equity, market share, total assets and nonperforming loans. Although the performance and increases in compensation are measured in light of these factors, there is no direct correlation between any specific criterion and the employees compensation, nor is there any specific weight provided to any such criteria in the Committee's analysis. The determination by the Committee is subjective after review of all information, including the above, it deems relevant.\nTotal compensation opportunities available to the employees of Community Bank are influenced by general labor market conditions, the specific responsibilities of the individual and the individual's contributions to the Company's success. Individuals are reviewed annually on a calendar year basis. Community Bank strives to offer compensation that is competitive with that offered by employers of comparable size in the banking industry. Through these compensation policies, the Company strives to meet its strategic goals and objectives to its constituents and provide compensation that is fair and meaningful to its employees.\nSubmitted by the Executive Compensation Committee ------------------------------------------------- William F. Farber, Sr. Michael T. Goskowski John P. Kameen Joseph P. Moore, Jr. Judd B. Fitze\nStock Performance Graph and Table - - --------------------------------- The following graph and table compare the cumulative stockholder return on the Company's Common Stock during the period January 1, 1990, through and including December 31, 1995, with (I) a Peer Group Index(1) and (II) the Standard & Poor's 500 Index. The comparison assumes $100 was invested on January 1, 1990, in the Company's Common Stock and in each of the below indices and assumes further the reinvestment of dividends into the applicable securities.\nITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nPrincipal Owners\nThe following table sets forth, as of February 7, 1996, the name and address of each person who owns of record or who is known by the Board of Directors to be the beneficial owner of more than 5.0 percent of the outstanding Common Stock, the number of shares beneficially owned by such person and the percentage of the outstanding Common Stock so owned.\nPercent of Outstanding Shares Beneficially Common Stock Name and Address Owned(1) Beneficially Owned - - ---------------- ------------------- ---------------------- Joseph P. Moore, Jr. 72,420(2) 9.88% 400 Williamson Road Gladwyne, PA 19035\nWilliam F. Farber, Sr. 62,440 8.51% Crystal Lake Road R.R. 1, Box 1281 Carbondale, PA 18407\nGerald B. Franceski 51,350(3) 7.00% Lewis Lake, P.O. Box 88 Union Dale, PA 18470\nRobert T. Seamans 43,120(4) 5.88% P.O. Box 462 Factoryville, PA 18419 [FN]\n(1) The securities \"beneficially owned\" by an individual are determined in accordance with the definitions of \"beneficial ownership\" set forth in the General Rules and Regulations of the SEC and may include securities owned by or for the individual's spouse and minor children and any other relative who has the same home, as well as securities to which the individual has or shares voting or investment power or has the right to acquire beneficial ownership within sixty (60) days after February 7, 1996. Beneficial ownership may be disclaimed as to certain of the securities. (2) Includes 10,080 shares held individually; 2,100 shares held in the Moore Motors, Inc. Profit Sharing Plan, an automobile dealership of which he is President; and 60,240 shares held beneficially by Moore & Company, which are held in trust for his various relatives. (3) Includes 34,350 shares held jointly with his spouse; and 17,000 shares held jointly in various combinations with his spouse, sons, brother, sister and aunt. (4) Includes 42,675 shares held individually; and 445 shares held individually by his spouse.\nBeneficial Ownership by Executive Officers and Directors\nThe following table sets forth as of February 7, 1996, the amount and percentage of the Common Stock beneficially owned by each director and all officers and directors of the Company as a group.\nNAME OF INDIVIDUAL AMOUNT AND NATURE OF PERCENT OR IDENTITY OF GROUP BENEFICIAL OWNERSHIP(1)(2)(3) OF CLASS(4) - - -------------------- ----------------------------- ----------- David L. Baker 3,768(5) ---- Donald R. Edwards, Sr. 17,272(6) 2.36% William F. Farber, Sr. 62,440 8.51% Judd B. Fitze 3,400(7) ---- Michael T. Goskowski 7,032(8) ---- John P. Kameen 6,760(9) ---- William B. Lopatofsky 8,470(9) 1.15% J. Robert McDonnell 10,848(9) 1.48% Joseph P. Moore, Jr. 72,420(10) 9.88% Scott A. Seasock 915(11) ---- Thomas E. Sheridan 588(9) ---- Eric Stephens 2,320(12) ----\nAll Executive Officers and Directors of the Company as a Group (9 Directors, 6 Officers, 12 Persons in Total) 196,233 26.76% [FN]\n(1) Does not include any Common Stock held in fiduciary accounts under the control of the Trust Department of Community Bank. (2) See footnote (1) under the above caption entitled \"Principal Owners\" for the definition of \"beneficial ownership.\" (3) Information furnished by the directors and the Company. (4) Less than 1.0 percent unless otherwise indicated. (5) See footnote (3) under the above caption entitled \"Principal Officers of the Company.\" (6) Includes 14,940 shares held individually; 1,860 shares held individually by his spouse; 300 shares held jointly with his daughter; 100 shares held jointly by his spouse and daughter; 36 shares held under his IRA; and 36 shares held under his spouse's IRA. (7) Includes 400 shares held under his IRA; and 3,000 shares held jointly with his spouse. (8) See footnote (7) under the above caption entitled \"Principal Officers of the Company.\" (9) Held jointly with his spouse. (10) See footnote (2) under the above caption entitled \"Principal Owners.\" (11) See footnote (5) under the above caption entitled \"Principal Officers of the Company.\" (12) Includes 1,780 shares held individually; 300 shares held individually by his spouse; and 240 shares held individually by his children.\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nExcept as described in the paragraphs below, there have been no material transactions between the Company and Community Bank, nor any material transactions proposed, with any director or executive officer of the Company and Community Bank, or any associate of the foregoing persons. The Company and Community Bank have had financial transactions in the ordinary course of business with directors and officers of the Company and Community Bank. The Company and Community Bank intend to continue to have banking and financial transactions in the ordinary course of business with directors and officers of the Company and Community Bank and their associates on substantially the same terms, including interest rates and collateral, as those prevailing from time to time for comparable transactions with other persons. Total loans outstanding from Community Bank as of December 31, 1995, to the Company's and Community Bank's executive officers and directors as a group and members of their immediate families and companies in which they had an ownership interest of 10.0 percent or more was $3,157,222 or approximately 11.3 percent of the total equity capital of the Company. Loans to such persons were made in the ordinary course of business and 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 the normal risk of collectibility or present other unfavorable features.\nCommunity Bank leases its Carbondale branch office from William F. Farber, Sr., the Chairman of the Boards of Directors of the Company and Community Bank. The lease, which commenced in October 1988, expires in 1998 and contains an option that allows Community Bank to purchase the property at fair market value or renew the lease for two additional terms of five years each. In 1995, lease payments to Mr. Farber were $6,020 per month or $72,240 annually.\nCommunity Bank has extended credit to Joseph P. Moore, Jr., a director of the Company and Community Bank, who is President of Elk Mountain Ski Resort, Inc. (\"Elk Mountain\"). As of December 31, 1995, the Bank had outstanding balances with Elk Mountain of $540.0 thousand, secured by a first lien mortgage on all real property and equipment, and of $750.0 thousand, secured by a second lien mortgage on all real property and equipment. The interest rate on these mortgages was, and is, Community Bank's prime rate of interest.\nPART IV\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) 1. The Company's consolidated financial statements and notes thereto as well as the applicable reports of the independent certified public accountants are filed at Exhibit 13 hereto and are incorporated in their entirety by reference under this Item 14(a)1.\n2. All schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto.\n3. The exhibits required by Item 601 of Regulation S-K are included under Item 14(c) hereto.\n(b) Reports on Form 8-K\nThe Company filed no current reports on Form 8-K during the quarter ended December 31, 1995.\n(c) Exhibits required by Item 601 of Regulation S-K:\nExhibit Number Referred to Item 601 of Regulation S-K Description of Exhibit - - -------------------------- ---------------------- 2 None. 3 Bylaws of the Company, amended as of December 31, 1995. 4 None. 9 None. 10 None. 11 None. 12 None. 13 Portions of the Annual Report to Stockholders for Fiscal Year Ended December 31, 1995. 16 None. 18 None. 21 List of Subsidiaries of the Company. 22 None. 23 None. 24 None. 27 None. 28 None.\nComm Bancorp, Inc. 521 Main Street Forest City, Pennsylvania 18421 Telephone: (717) 785-3181\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto, duly authorized.\nCOMM BANCORP, INC. (Registrant)\nBY:\/s\/ David L. Baker March 10, 1996 --------------------------------- David L. Baker, President and Chief Executive Officer (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.\nSignature and Capacity Date\n\/s\/ David L. Baker March 10, 1996 - - ---------------------------------- --- David L. Baker, President and Chief Executive Officer\/Director\n\/s\/ Donald R. Edwards, Sr. March 10, 1996 - - ---------------------------------- --- Donald R. Edwards, Sr., Director\n\/s\/ William F. Farber, Sr. March 10, 1996 - - ---------------------------------- --- William F. Farber, Sr., Chairman of the Board\/Director\n\/s\/ Judd B. Fitze March 10, 1996 - - ---------------------------------- --- Judd B. Fitze, Director\n\/s\/ Michael T. Goskowski March 10, 1996 - - ---------------------------------- --- Michael T. Goskowski, Secretary\/Director\n\/s\/ John P. Kameen March 10, 1996 - - ---------------------------------- --- John P. Kameen, Director\n\/s\/ William B. Lopatofsky March 10, 1996 - - ---------------------------------- --- William B. Lopatofsky, Director\n\/s\/ J. Robert McDonnell March 10, 1996 - - ---------------------------------- --- J. Robert McDonnell, Vice President\/Director\n\/s\/ Joseph P. Moore, Jr. March 10, 1996 - - ---------------------------------- --- Joseph P. Moore, Jr., Director\n\/s\/ Scott A. Seasock March 10, 1996 - - ---------------------------------- --- Scott A. Seasock, Chief Financial Officer (Principal Financial Officer)\n\/s\/ Eric Stephens March 10, 1996 - - ---------------------------------- --- Eric Stephens, Director\nEXHIBIT INDEX\nItem Number Description Page - - ----------- ----------- ---- 3 Bylaws of the Company, amended as of December 31, 1995 38\n13 Portions of the Annual Report to Stockholders for the Fiscal Year Ended December 31, 1995 52\n21 List of Subsidiaries of the Company 161","section_9":"","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY\nEach director of the Company is elected for a one-year term and until his successor is duly elected and qualified. Current directors were elected at the 1995 Annual Meeting of Stockholders, which was held on September 15, 1995. The following table contains certain information with respect to the directors and executive officers of the Company:\nDIRECTOR OF PRINCIPAL OCCUPATION FOR PAST COMPANY\/ AGE AS OF FIVE YEARS AND POSITION HELD COMMUNITY MARCH 1, WITH THE COMPANY BANK SINCE NAME 1996 AND COMMUNITY BANK ____ _________ ____________________________ __________\nDavid L. Baker 50 President and Chief Executive 1988\/1993 Officer (\"CEO\") of the Company and Community Bank (as of April 26, 1995); Senior Vice President of Community Bank (as of January 20, 1993); President of FNB Nicholson (1987-1992) prior to its merger with Community Bank\nDonald R. Edwards, Sr.(1) 52 Owner, Mountain View Inn 1988\/1993\nWilliam F. Farber, Sr. 59 President, Farber's Restaurants; 1983\/1970 Chairman of the Boards of Directors of the Company and Community Bank\nJudd B. Fitze 44 Partner, Farr, Davis & Fitze 1995\/1992 (attorney-at-law)\nMichael T. Goskowski(2) 73 President, Kartri Sales Mfg. 1984\/1984 (manufacturing); Secretary of the Company and Community Bank\nJohn P. Kameen 54 Publisher, Forest City News 1983\/1979\nWilliam B. Lopatofsky 64 Owner, Northeast Distributors 1983\/1982 and Equipment\nJ. Robert McDonnell 60 Owner, McDonnell's Restaurant; 1983\/1979 Vice President of the Company\nJoseph P. Moore, Jr. 69 President, Moore Motors Inc. 1988\/1992 (automobile dealership); President Elk Mountain Ski Resort, Inc.\nEric Stephens(1) 44 Auto Dealer, H.L. Stephens and Son 1988\/1993 (automobile dealership) [FN] (1) Eric Stephens is married to the niece of Donald R. Edwards, Sr.\n(2) In accordance with Article 10 of the Amended Articles of Incorporation of the Company, Mr. Goskowski served as a director of the Corporation until December 31, 1995, the completion of the year in which he attained 72 years of age. Mr. Goskowski continues to serve as a director of Community Bank.\nPRINCIPAL OFFICERS OF THE COMPANY\nThe following table sets forth selected information about the principal officers of the Company, each of whom is elected by the Board of Directors and each of whom holds office at the discretion of the Board of Directors:\nCOMPANY HELD EMPLOYEE NUMBER OF SHARES AGE AS OF NAME AND POSITION SINCE SINCE BENEFICIALLY OWNED MARCH 1, 1996 - - ----------------- ----- ---------- ------------------ ------------- William F. Farber, Sr. 1983 (1) 62,440 59 Chairman of the Board\nDavid L. Baker 1995 1992(2) 3,768(3) 50 President and CEO\nScott A. Seasock 1987 1992(4) 915(5) 38 Senior Vice President and Chief Financial Officer\nThomas E. Sheridan 1989 1985 588(6) 39 Senior Vice President and Chief Operating Officer\nJ. Robert McDonnell 1983 (1) 10,848(6) 60 Vice President\nMichael T. Goskowski 1984 (1) 7,032(7) 73 Secretary [FN]\n(1) Messrs. Farber, McDonnell and Goskowski are not employees of Community Bank. (2) Prior to the merger of FNB Nicholson with Community Bank, Mr. Baker was employed by FNB Nicholson from 1987 to 1992 as the President. (3) Includes 1,680 shares held individually; 1,600 shares held jointly with his spouse; 244 shares held under his IRA; and 244 shares held under his spouse's IRA. (4) Prior to the merger of FNB Nicholson with Community Bank, Mr. Seasock was employed by FNB Nicholson from 1987 to 1992 as Senior Vice President and Chief Financial Officer. (5) Includes 220 shares held under his IRA; 275 shares held jointly with his spouse; 20 shares held jointly with his spouse and son; and 400 shares held jointly with his spouse and sons. (6) Held jointly with his spouse. (7) Includes 3,180 shares held jointly with his spouse; 412 shares held in trust for his granddaughter; and 3,440 shares held jointly with his spouse and daughter.\nPRINCIPAL OFFICERS OF COMMUNITY BANK\nThe following table sets forth selected information about the principal officers of Community Bank, each of whom is elected by the Board of Directors of Community Bank and each of whom holds office at the discretion of Community Bank's Board of Directors:\nCommunity Bank Held Employee Number of Shares Age as of Name and Position Since Since Beneficially Owned March 1, 1996 - - ----------------- ----- --------- ------------------ ------------- David L. Baker 1995 1993(1) 3,768 50 President and CEO\nScott A. Seasock 1992 1992(2) 915 38 Senior Vice President and Chief Financial Officer\nThomas E. Sheridan 1989 1985 588 39 Senior Vice President and Chief Operating Officer\nThomas M. Chesnick 1989 1952 9,300(3) 61 Vice President, Cashier and Assistant Secretary [FN]\n(1) See footnote (2) above under the caption entitled \"Principal Officers of the Company\" as to the employment history of Mr. Baker. (2) See footnote (4) above under the caption entitled \"Principal Officers of the Company\" as to the employment history of Mr. Seasock. (3) Includes 5,960 shares held jointly with his spouse; and 3,340 shares held jointly with various relatives.\nSection 16(a) of the Exchange Act, as amended, requires the Company's officers and directors, and persons who own more than 10.0 percent of the registered class of the Company's equity securities, to file reports of ownership and changes in ownership with the SEC. Officers, directors and persons who own more than 10.0 percent of the Company's stock are required by the SEC regulation to furnish the Company with copies of all Section 16(a) forms they file. Based solely on its review of the copies of such forms received by it, or written representations from certain reporting persons that no Form 5 was required for any of those persons, the Company believes that during the period January 1, 1995, through December 31, 1995, its officers and directors were in compliance with all filing requirements applicable to them.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nShown below is information concerning the annual compensation for services in all capacities to the Company and Community Bank for the fiscal years ended December 31, 1995, 1994 and 1993, to the present and former President and CEO of the Company and Community Bank. No other officers' total annual salary and bonus exceeded $100,000 during the fiscal years reported:\nSUMMARY COMPENSATION TABLE\nPENSION PLAN\nThe Company has a profit sharing plan (\"Plan\"), which covers all employees who have completed 1,000 hours of service, attained 21 years of age and have been employed by the Company for at least one year. The entry date of an employee into the Plan is January 1 of the year following the satisfaction of the eligibility requirements. Normal retirement age is sixty-five (65). The normal retirement benefit is the accumulated account balance of annual contributions, investment income and forfeitures. The annual contribution is determined by the Board of Directors each year. Contributions are allocated to each participant based on a pro-rata share of compensation covered under the Plan. Investment income is allocated to each participant based on a pro-rata share of the account balances accumulated at the beginning of the year. Forfeitures are allocated to each participant based on a pro-rata share of compensation covered under the Plan. If a participant separates from service prior to retirement, the participant will be entitled to a portion of the profit sharing account based on years of service according to the following schedule:\nYears of Service Vested Interest ---------------- --------------- Less than 1 0% 1 10 2 20 3 30 4 40 5 60 6 80 7 or more 100%\nA participant is always 100.0 percent vested in pension plan transferred balances.\nDuring 1995, $113,728 was allocated among the participants' accounts of the Plan. The amount contributed by Community Bank in 1995 to the Plan for Mr. Franceski, the then President and CEO of the Company was $3,000. Mr. Franceski had sixteen (16) years of credited service under the Plan. The amount contributed by Community Bank in 1995 to the Plan for Mr. Baker, the President and CEO of the Company was $4,296. Mr. Baker had nine (9) years of credited service under the Plan.\nCOMPENSATION OF DIRECTORS\nDuring 1995, Messrs. Franceski and Baker, officers of the Company and Community Bank, sat on the Company's and Community Bank's Board of Directors and various committees of the Company and Community Bank. Messrs. Baker and Franceski received no fees for their services on such committees. Messr. Franceski received $620 in fees for his services as a director on the Company's Board and no fees for his services on Community Bank's Board. Messr. Baker received no fees for his services on the Company's or Community Bank's Board.\nExcept for Mr. Farber, members of Community Bank's Board of Directors received a fee of $800 per month. Mr. Farber, as the Chairman of Community Bank, received a fee of $1,300 per month. Aggregate directors' fees paid by Community Bank in 1995 were $140,400. All members of the Company's Board of Directors, including Mr. Farber, the Chairman of the Company, received a fee of $400 per quarter. Aggregate directors' fees paid by the Company in 1995 were $24,520.\nBOARD COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION\nThe Board of Directors of the Company is responsible for the governance of the Company and its subsidiary, Community Bank. In fulfilling its fiduciary duties, the Board of Directors acts in the best interests of the Company's stockholders, customers and the communities served by the Company and Community Bank. To accomplish the strategic goals and objectives of the Company, the Board of Directors engages competent persons who undertake to accomplish these objectives with integrity and in a cost-effective manner. The compensation of these individuals is part of the Board of Directors' fulfillment of its duties to accomplish the Company's strategic mission. Community Bank provides compensation to the employees of the Company and Community Bank.\nThe fundamental philosophy of the Company's and Community Bank's compensation program is to offer competitive compensation opportunities for all employees based on the individual's contribution and personal performance. The compensation program is administered by the Executive Compensation Committee (\"Committee\") comprised of four outside directors, and a member of Community Bank's Board of Directors listed in the section \"Executive Officers,\" thereto. The objectives of the Committee are to establish a fair compensation policy to govern executive officers' base salaries and incentive plans to attract and motivate competent, dedicated and ambitious managers whose efforts will enhance the products and services of the Company, the results of which will be improved profitability, increased dividends to our stockholders and subsequent appreciation in the market value of our stock.\nThe compensation of the Company's and Community Bank's top executives is reviewed and approved annually by the Board of Directors. The top executives whose compensation is determined by the Committee include the CEO and all other Vice Presidents. As guidance for review in determining base salaries, the Committee uses information composed of a Pennsylvania bank peer group. This bank peer group is different than the peer group utilized for the performance chart. Pennsylvania peer group banks have been utilized because of common industry issues and competition for the same executive talent group.\nCEO COMPENSATION\nThe Board of Directors has determined that the CEO's 1995 compensation of $90,666 (which represents Mr. Baker's annual salary and bonus) was appropriate in light of the Company's 1995 performance accomplishments. There is no direct correlation, however, between the President and CEO's compensation and the Company's performance, nor is there any weight given by the Committee to any specific individual criteria. Such 1995 compensation was based on the Committee's subjective determination after review of all information that it deemed relevant.\nEXECUTIVE OFFICERS\nCompensation for Community Bank's executive officers is determined by the Committee based on its subjective analysis of the individual's contribution to the Company's strategic goals and objectives. In determining whether strategic goals have been achieved, the Board of Directors considers, among numerous other factors, the following: the Company's performance as measured by earnings, revenues, return on assets, return on equity, market share, total assets and nonperforming loans. Although the performance and increases in compensation are measured in light of these factors, there is no direct correlation between any specific criterion and the employees compensation, nor is there any specific weight provided to any such criteria in the Committee's analysis. The determination by the Committee is subjective after review of all information, including the above, it deems relevant.\nTotal compensation opportunities available to the employees of Community Bank are influenced by general labor market conditions, the specific responsibilities of the individual and the individual's contributions to the Company's success. Individuals are reviewed annually on a calendar year basis. Community Bank strives to offer compensation that is competitive with that offered by employers of comparable size in the banking industry. Through these compensation policies, the Company strives to meet its strategic goals and objectives to its constituents and provide compensation that is fair and meaningful to its employees.\nSubmitted by the Executive Compensation Committee ------------------------------------------------- William F. Farber, Sr. Michael T. Goskowski John P. Kameen Joseph P. Moore, Jr. Judd B. Fitze\nStock Performance Graph and Table - - --------------------------------- The following graph and table compare the cumulative stockholder return on the Company's Common Stock during the period January 1, 1990, through and including December 31, 1995, with (I) a Peer Group Index(1) and (II) the Standard & Poor's 500 Index. The comparison assumes $100 was invested on January 1, 1990, in the Company's Common Stock and in each of the below indices and assumes further the reinvestment of dividends into the applicable securities.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nPrincipal Owners\nThe following table sets forth, as of February 7, 1996, the name and address of each person who owns of record or who is known by the Board of Directors to be the beneficial owner of more than 5.0 percent of the outstanding Common Stock, the number of shares beneficially owned by such person and the percentage of the outstanding Common Stock so owned.\nPercent of Outstanding Shares Beneficially Common Stock Name and Address Owned(1) Beneficially Owned - - ---------------- ------------------- ---------------------- Joseph P. Moore, Jr. 72,420(2) 9.88% 400 Williamson Road Gladwyne, PA 19035\nWilliam F. Farber, Sr. 62,440 8.51% Crystal Lake Road R.R. 1, Box 1281 Carbondale, PA 18407\nGerald B. Franceski 51,350(3) 7.00% Lewis Lake, P.O. Box 88 Union Dale, PA 18470\nRobert T. Seamans 43,120(4) 5.88% P.O. Box 462 Factoryville, PA 18419 [FN]\n(1) The securities \"beneficially owned\" by an individual are determined in accordance with the definitions of \"beneficial ownership\" set forth in the General Rules and Regulations of the SEC and may include securities owned by or for the individual's spouse and minor children and any other relative who has the same home, as well as securities to which the individual has or shares voting or investment power or has the right to acquire beneficial ownership within sixty (60) days after February 7, 1996. Beneficial ownership may be disclaimed as to certain of the securities. (2) Includes 10,080 shares held individually; 2,100 shares held in the Moore Motors, Inc. Profit Sharing Plan, an automobile dealership of which he is President; and 60,240 shares held beneficially by Moore & Company, which are held in trust for his various relatives. (3) Includes 34,350 shares held jointly with his spouse; and 17,000 shares held jointly in various combinations with his spouse, sons, brother, sister and aunt. (4) Includes 42,675 shares held individually; and 445 shares held individually by his spouse.\nBeneficial Ownership by Executive Officers and Directors\nThe following table sets forth as of February 7, 1996, the amount and percentage of the Common Stock beneficially owned by each director and all officers and directors of the Company as a group.\nNAME OF INDIVIDUAL AMOUNT AND NATURE OF PERCENT OR IDENTITY OF GROUP BENEFICIAL OWNERSHIP(1)(2)(3) OF CLASS(4) - - -------------------- ----------------------------- ----------- David L. Baker 3,768(5) ---- Donald R. Edwards, Sr. 17,272(6) 2.36% William F. Farber, Sr. 62,440 8.51% Judd B. Fitze 3,400(7) ---- Michael T. Goskowski 7,032(8) ---- John P. Kameen 6,760(9) ---- William B. Lopatofsky 8,470(9) 1.15% J. Robert McDonnell 10,848(9) 1.48% Joseph P. Moore, Jr. 72,420(10) 9.88% Scott A. Seasock 915(11) ---- Thomas E. Sheridan 588(9) ---- Eric Stephens 2,320(12) ----\nAll Executive Officers and Directors of the Company as a Group (9 Directors, 6 Officers, 12 Persons in Total) 196,233 26.76% [FN]\n(1) Does not include any Common Stock held in fiduciary accounts under the control of the Trust Department of Community Bank. (2) See footnote (1) under the above caption entitled \"Principal Owners\" for the definition of \"beneficial ownership.\" (3) Information furnished by the directors and the Company. (4) Less than 1.0 percent unless otherwise indicated. (5) See footnote (3) under the above caption entitled \"Principal Officers of the Company.\" (6) Includes 14,940 shares held individually; 1,860 shares held individually by his spouse; 300 shares held jointly with his daughter; 100 shares held jointly by his spouse and daughter; 36 shares held under his IRA; and 36 shares held under his spouse's IRA. (7) Includes 400 shares held under his IRA; and 3,000 shares held jointly with his spouse. (8) See footnote (7) under the above caption entitled \"Principal Officers of the Company.\" (9) Held jointly with his spouse. (10) See footnote (2) under the above caption entitled \"Principal Owners.\" (11) See footnote (5) under the above caption entitled \"Principal Officers of the Company.\" (12) Includes 1,780 shares held individually; 300 shares held individually by his spouse; and 240 shares held individually by his children.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nExcept as described in the paragraphs below, there have been no material transactions between the Company and Community Bank, nor any material transactions proposed, with any director or executive officer of the Company and Community Bank, or any associate of the foregoing persons. The Company and Community Bank have had financial transactions in the ordinary course of business with directors and officers of the Company and Community Bank. The Company and Community Bank intend to continue to have banking and financial transactions in the ordinary course of business with directors and officers of the Company and Community Bank and their associates on substantially the same terms, including interest rates and collateral, as those prevailing from time to time for comparable transactions with other persons. Total loans outstanding from Community Bank as of December 31, 1995, to the Company's and Community Bank's executive officers and directors as a group and members of their immediate families and companies in which they had an ownership interest of 10.0 percent or more was $3,157,222 or approximately 11.3 percent of the total equity capital of the Company. Loans to such persons were made in the ordinary course of business and 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 the normal risk of collectibility or present other unfavorable features.\nCommunity Bank leases its Carbondale branch office from William F. Farber, Sr., the Chairman of the Boards of Directors of the Company and Community Bank. The lease, which commenced in October 1988, expires in 1998 and contains an option that allows Community Bank to purchase the property at fair market value or renew the lease for two additional terms of five years each. In 1995, lease payments to Mr. Farber were $6,020 per month or $72,240 annually.\nCommunity Bank has extended credit to Joseph P. Moore, Jr., a director of the Company and Community Bank, who is President of Elk Mountain Ski Resort, Inc. (\"Elk Mountain\"). As of December 31, 1995, the Bank had outstanding balances with Elk Mountain of $540.0 thousand, secured by a first lien mortgage on all real property and equipment, and of $750.0 thousand, secured by a second lien mortgage on all real property and equipment. The interest rate on these mortgages was, and is, Community Bank's prime rate of interest.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) 1. The Company's consolidated financial statements and notes thereto as well as the applicable reports of the independent certified public accountants are filed at Exhibit 13 hereto and are incorporated in their entirety by reference under this Item 14(a)1.\n2. All schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto.\n3. The exhibits required by Item 601 of Regulation S-K are included under Item 14(c) hereto.\n(b) Reports on Form 8-K\nThe Company filed no current reports on Form 8-K during the quarter ended December 31, 1995.\n(c) Exhibits required by Item 601 of Regulation S-K:\nExhibit Number Referred to Item 601 of Regulation S-K Description of Exhibit - - -------------------------- ---------------------- 2 None. 3 Bylaws of the Company, amended as of December 31, 1995. 4 None. 9 None. 10 None. 11 None. 12 None. 13 Portions of the Annual Report to Stockholders for Fiscal Year Ended December 31, 1995. 16 None. 18 None. 21 List of Subsidiaries of the Company. 22 None. 23 None. 24 None. 27 None. 28 None.\nComm Bancorp, Inc. 521 Main Street Forest City, Pennsylvania 18421 Telephone: (717) 785-3181\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto, duly authorized.\nCOMM BANCORP, INC. (Registrant)\nBY:\/s\/ David L. Baker March 10, 1996 --------------------------------- David L. Baker, President and Chief Executive Officer (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.\nSignature and Capacity Date\n\/s\/ David L. Baker March 10, 1996 - - ---------------------------------- --- David L. Baker, President and Chief Executive Officer\/Director\n\/s\/ Donald R. Edwards, Sr. March 10, 1996 - - ---------------------------------- --- Donald R. Edwards, Sr., Director\n\/s\/ William F. Farber, Sr. March 10, 1996 - - ---------------------------------- --- William F. Farber, Sr., Chairman of the Board\/Director\n\/s\/ Judd B. Fitze March 10, 1996 - - ---------------------------------- --- Judd B. Fitze, Director\n\/s\/ Michael T. Goskowski March 10, 1996 - - ---------------------------------- --- Michael T. Goskowski, Secretary\/Director\n\/s\/ John P. Kameen March 10, 1996 - - ---------------------------------- --- John P. Kameen, Director\n\/s\/ William B. Lopatofsky March 10, 1996 - - ---------------------------------- --- William B. Lopatofsky, Director\n\/s\/ J. Robert McDonnell March 10, 1996 - - ---------------------------------- --- J. Robert McDonnell, Vice President\/Director\n\/s\/ Joseph P. Moore, Jr. March 10, 1996 - - ---------------------------------- --- Joseph P. Moore, Jr., Director\n\/s\/ Scott A. Seasock March 10, 1996 - - ---------------------------------- --- Scott A. Seasock, Chief Financial Officer (Principal Financial Officer)\n\/s\/ Eric Stephens March 10, 1996 - - ---------------------------------- --- Eric Stephens, Director\nEXHIBIT INDEX\nItem Number Description Page - - ----------- ----------- ---- 3 Bylaws of the Company, amended as of December 31, 1995 38\n13 Portions of the Annual Report to Stockholders for the Fiscal Year Ended December 31, 1995 52\n21 List of Subsidiaries of the Company 161","section_15":""}
{"filename":"63528_1995.txt","cik":"63528","year":"1995","section_1":"ITEM 1. BUSINESS\nTHE COMPANY\nMaynard Oil Company is a Delaware corporation which was organized in 1971 to continue the oil and gas operations conducted on an individual basis by its founders, including Mr. James G. Maynard, its Chairman of the Board and Chief Executive Officer. The Company's principal executive office is located at 8080 N. Central Expressway, Suite 660, Dallas, Texas 75206, and its telephone number is (214) 891-8880. Unless the context requires otherwise, as used herein the term \"Company\" refers to Maynard Oil Company and its subsidiaries.\nThe Company's principal line of business is the production and sale of, and exploration and development of, crude oil and natural gas. The Company's oil and gas operations are conducted exclusively in the United States, primarily in the states of Texas and Oklahoma.\nRECENT ACQUISITION ACTIVITIES\nSince January 1, 1995, the Company has purchased two sizable groups of producing oil and gas properties.\nIn March, 1995, the Company purchased 200 producing wells located in the Permian Basin of West Texas from a major oil company for total cash consideration $10,500,000. The Company utilized $1,000,000 from its own cash resources and financed the balance, $9,500,000, through an amended term loan arrangement with Bank One, Texas. Total proved reserves were estimated to be .99 million barrels of oil and 6.5 billion cubic feet of gas (BCF).\nDuring September, 1995 one prospect acquired in March was sold generating proceeds of $2,985,935 and a gain of $817,794.\nOn December 21, 1995, the Company purchased an interest in 250 producing wells in the Garza Field of West Texas for cash consideration of $18,750,000. The Company provided $5,750,000 from its own cash resources and entered into a new term loan arrangement with Bank One, Texas for the balance. Total proved reserves were estimated to be 2.46 million barrels of oil and .3 BCF of gas.\nThe new bank loan agreement, entered into on December 20, 1995 in connection with the Garza acquisition, provides for the repayment of the outstanding $26,062,500 over a five year period with a maturity date of January 1, 2001. (See Note 4 of the Notes to the Consolidated Financial Statements). The Company has certain significant properties remaining unmortgaged, and consequently, has further borrowing capacity available for future projects.\nOIL AND GAS OPERATIONS\nThe Company is an independent oil and gas company, engaged primarily in the production and exploration phases of the oil and gas business. Company operations include acquiring, exploring, developing, and operating crude oil and natural gas properties.\nThe Company seeks to accomplish its overall goal of increasing hydrocarbon reserves and cash flow by selectively acquiring and exploiting producing oil and gas properties. When possible, the Company acquires producing properties on which it can act as operator, and thus, supervise production and development activities.\nAs mentioned in the 1994 annual report, the Company has invested approximately $30.1 million in seven acquisitions over the preceding five years, which has added estimated proved reserves of 4.6 million barrels of oil and 2.1 billion cubic feet (BCF) of natural gas. During 1995, the Company was successful in consummating two other producing property acquisitions, investing $29.25 million and adding estimated proved reserves of 3.45 million barrels of oil and 6.8 BCF of natural gas.\nThe availability of a ready market for the sale of oil and gas from the Company's wells depends on numerous factors beyond the control of the Company, including the amount of domestic production, the importation of oil, the proximity of the Company's property to natural gas pipelines and the capacity of such pipelines, the market for other competitive fuels, fluctuations in seasonal demand, and governmental regulations relative to hydrocarbon production and pricing. The production of oil and gas is also subject to the laws of supply and demand, and therefore, is subject to purchaser cutbacks and price reductions during periods of oversupply. At December 31, 1995 almost 74% of the Company's estimated proved reserves, as well as 68% of the Company's 1995 production, were attributable to crude oil and condensate on a net equivalent barrel basis (net equivalent barrel \"NEB\" uses a conversion ratio of six thousand cubic feet of gas (MCF) to one net equivalent barrel of oil) and consequently, the Company is primarily impacted by oil markets.\nThe market price for natural gas has fluctuated significantly from month to month and year to year for the past several years. The Company cannot predict gas price movements with any certainty.\nDuring the year ended December 31, 1995, three customers, Total Petroleum, Koch Industries, and Ashland Inc., accounted for approximately 21%, 18%, and 14%, respectively, of total consolidated oil and gas revenues. The Company does not believe it would be adversely affected by the loss of any of its oil or gas purchasers.\nExcept for curtailed exploration and production activity occasionally experienced in severe weather and normal curtailments of gas sales in summer months, the Company does not consider its business to be seasonal and does not carry significant amounts of inventory.\nDuring 1995, a total of twenty-four wells were drilled, five exploratory wells, twelve development wells, and seven water injection wells to service waterflood operations. Below is a brief description of the work completed during the year and the results thereof.\nFullerton Field, Andrews County, Texas - this area represented the most significant development activity for the second succeeding year. Five successful development oil wells were drilled in a secondary recovery project which is owned 100% by the Company. Current production exceeds 400 barrels of oil per day.\nOf the remaining seven development wells, two were horizontal wells drilled in the Medrano Field in Caddo County, Oklahoma and one was a horizontal development well offsetting a 1995 exploratory discovery in Stephens County, Texas. A gas well was added in the Destino Field in Duval County, Texas and two infill wells were drilled in the Claytonville Unit located in Fisher County, Texas. The seventh development well was testing commercial quantities of gas at year end in the Knox Field of Grady County, Oklahoma, where the Company owns a 10% working interest.\nThe Company's 1995 exploratory drilling was accomplished on plays generated from three dimensional seismic projects. Three of the five exploratory tests resulted in successful oil wells. The Hankins #1 and the Fisher #1 were drilled in the Hardeman Basin area, where the Company has been active for the last two years. The Hankins #1, located in Jackson County, Oklahoma, resulted in a flowing oil well producing 160 barrels of oil per day (BOPD). The Fisher #1, located in Hardeman County, Texas, is currently pumping 62 BOPD. Maynard owns a 25% and 18.75% working interest, respectively, in these two wells. The third successful exploratory well, the County Line #1, was drilled in Stephens County, Texas and is flowing 150 BOPD and 1.2 million cubic feet of gas per day. The Company owns a 12.5% working interest in this well.\nGENERAL\nThe oil and gas business involves intense competition in all of its phases and, because of its size, the Company is not a significant competitive factor in the industry. In its efforts to acquire property rights, the Company competes with many companies having access to substantially greater financial resources and larger technical staffs.\nThe Company's oil and gas exploration effort often involves exploratory drilling on unproven acreage involving high risks. There is no assurance that any oil or gas production will be obtained, or that such production, if obtained, will be profitable. The cost of drilling, completing and operating wells is often uncertain. Drilling may be curtailed or delayed as a result of many factors, including title problems, weather conditions, delivery delays, and shortages of pipe and equipment.\nThe Company's operations are subject to potential hazards, inherent in the exploration for and production of hydrocarbons, including blowouts and fires. These and other events can cause a suspension of drilling operations, severe damage to equipment or surrounding property, personal injury, and perhaps even a loss of life. The Company may be subject to liability for pollution and other damages and is subject to statutes and regulations relating to environmental and other matters. While the Company maintains insurance against certain of these risks, there are certain risks against which it cannot insure, or which it may elect not to insure due to premium costs, or for other reasons. Substantial uninsured liabilities to third parties may be incurred.\nThe oil and gas operations of the Company are subject to local, state and Federal environmental regulations. To date, compliance with these regulations by the Company has had no material effect on the Company's capital expenditures. The Company is unable to assess or predict at this time the impact that compliance with such environmental regulations may have on its future capital expenditures, earnings and competitive position. The Company presently estimates that it will not make any material capital expenditures for environmental control facilities for its fiscal year ending December 31, 1996.\nMany facets of the Company's operations are subject to governmental regulations. All of the Company's oil and gas properties are located in states in which oil and gas production is regulated by state production and conservation laws and regulations. These laws and regulations in many instances also require permits for the drilling of wells, the spacing of wells, prevention of waste, conservation of oil and natural gas and various other requirements.\nThe Company's activities are subject to taxation at all levels of government, including taxes on income, severance of minerals, and payroll. Laws governing taxation, protection of the environment, crude oil and natural gas operations and production, and other crucial areas are all subject to modification at any time.\nAt March 18, 1996, the Company employed approximately 37 persons, including one geologist and five petroleum engineers.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's executive offices are presently located at 8080 N. Central Expressway, Suite 660, Dallas, Texas occupying approximately 11,300 square feet of space under a lease agreement which expires in April, 2000.\nThe Company's principal property holdings consist of leasehold interests in oil and gas properties located in the United States, primarily in Oklahoma and Texas. The leaseholds are continued in force so long as production from lands under lease is maintained. The Company believes that it has satisfactory title to its oil and gas properties. Such properties are subject to customary royalty interests, liens incident to operating agreements, liens for current taxes, and other burdens and minor encumbrances, easements, and restrictions. The Company believes that such burdens do not materially detract from the value of the properties or materially interfere with their use in the operation of the Company's business. The Company has pledged certain of its oil and gas properties to secure its term loan.\nESTIMATED PROVED RESERVES, FUTURE NET REVENUES AND PRESENT VALUE\nReflected below are the estimated quantities of proved developed and undeveloped reserves of crude oil and natural gas owned by the Company as of December 31, 1995, 1994, and 1993. Such reserve information has been prepared by the Company's staff of petroleum engineers and audited by the independent petroleum consulting firm of Netherland, Sewell, and Associates, Inc. No reserve reports with respect to the Company's proved net oil or gas reserves were filed with any Federal authority or agency during the fiscal year ended December 31, 1995.\nThe following table summarizes the future net revenues, using current prices and costs as of the dates indicated, as well as the present value, discounted at 10%, of such future net revenues from estimated production of proved reserves of crude oil and natural gas as of December 31, 1995, 1994, and 1993. Oil and gas prices used in the tabulation of the amounts below are based on the price received for each lease at December 31, of the appropriate year. The weighted average prices at December 31, 1995, 1994, and 1993 respectively, used in the estimates were $18.13, $16.06, and $11.36 per barrel of oil and $1.65, $1.62, and $2.22 per mcf of natural gas. Lease and well operating costs are based upon actual operating expense records.\nPRODUCTION, SALES PRICES AND COSTS\nThe following table sets forth the Company's net oil and gas production, average sales prices and production costs for the three years ended December 31, 1995.\nDecember 31 --------------------------------- 1995 1994 1993 ---- ---- ---- Production: Oil (MB) 957.9 558.3 557.7 Gas (MMCF) 2,720.4 2,390.3 2,717.2\nAverage Sales Prices: Oil (per BBL) $16.98 $15.47 $16.15 Gas (per MCF) $ 1.57 $ 1.94 $ 2.16\nAverage Production Costs: Per net equivalent barrel of oil (1)(2) $ 5.98 $ 5.20 $ 5.37\n(1) Six MCF of gas equals one net equivalent barrel (\"NEB\"). (2) Production costs include severance and advalorem taxes, if applicable, and lease operating expenses including workover costs.\nPRODUCTIVE WELLS AND ACREAGE\nAs of December 31, 1995, the Company owned an interest in approximately 1,273 gross (330.3 net) wells, of which 1,208 gross (310.3 net) are oil wells and 65 gross (20.0 net) are gas wells, located on approximately 42,093 gross (24,411 net) producing acres.\nUNDEVELOPED ACREAGE\nThe following table sets forth the Company's gross and net undeveloped acreage as of December 31, 1995.\nUndeveloped Acreage ------------------ Gross Net ----- ----- Colorado . . . . . . . . . . . . . . . 80 10 Louisiana . . . . . . . . . . . . . . . 80 40 North Dakota . . . . . . . . . . . . . 62 4 Oklahoma . . . . . . . . . . . . . . . 2,558 619 Texas . . . . . . . . . . . . . . . . . 9,408 3,307 Wyoming . . . . . . . . . . . . . . . . 2,256 794 ------ -----\nTotal 14,444 4,774 ====== =====\nDRILLING ACTIVITY\nThe following table sets forth the results of the Company's drilling activity during the three years ended December 31, 1995.\nAt March 18, 1996 the Company had two gross (2.00 net) development wells in the process of being drilled.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is a defendant in minor lawsuits that have arisen in the ordinary course of business. The Company does not expect any of these to have a material adverse effect on the Company's consolidated financial position.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNone.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nInformation with respect to the Company's executive officers as of March 18, 1996, is set forth in the table below.\nName Position Age Since ----- -------- --- -----\nJames G. Maynard Chairman of the Board, 69 1971 Chief Executive Officer and Treasurer\nGlenn R. Moore President and Chief 58 1982 Operating Officer\nL. Brent Carruth Vice President of 62 1984 Operations\nKenneth W. Hatcher Vice President of 52 1983 Finance\nLinda K. Burgess Corporate Secretary 47 1984 and Controller\nMr. Maynard has been a director since 1971 and engaged in oil and gas exploration as an independent operator and private investor for the past 40 years.\nMr. Moore has over 30 years experience in domestic and foreign oil and gas exploration and production. Prior to joining the Company in November, 1982, Mr. Moore served as President of Shannon Oil and Gas, Inc. and Hanover Petroleum Corporation.\nMr. Carruth has over 30 years of petroleum engineering experience. Prior to joining the Company in January, 1984, he served for one year as Vice President of Operations of Cordova Resources. Preceding that, Mr. Carruth was a petroleum consultant for three years and served as Manager of Engineering of Texas Pacific Oil Company for eight years.\nMr. Hatcher has over 25 years of finance and accounting experience in the oil and gas industry and is a Certified Public Accountant. Prior to joining the Company in February, 1983, Mr. Hatcher served as Controller and Vice President of Finance of Shannon Oil and Gas, Inc. for three years and as Controller and Vice President of Hanover Petroleum Corporation for four years.\nMs. Burgess has in excess of 20 years of oil and gas accounting experience. Prior to joining the Company in May, 1984, Ms. Burgess served as Controller for Trans-Western Exploration Inc. for four years and as Controller for Energy Resources Oil and Gas for three years.\nEach officer's term of office expires on the date of the next annual meeting of the Board of Directors, or until his earlier resignation or removal. There are no family relationships among the executive officers listed, and there are no arrangements or understandings pursuant to which any of them were elected or appointed as officers.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS.\nThe Company's Common Stock is traded in the over-the-counter market, NASDAQ trading symbol \"MOIL\". The high and low sales prices for each quarterly period during the two years ended December 31, 1995, were as follows:\nAs of March 18, 1996, the Company had approximately 1,050 shareholders of record.\nThe Company has not paid any dividends on its Common Stock in the past, nor does it plan to pay dividends in the foreseeable future. The Company's ability to pay dividends is currently restricted under its Loan Agreement with Bank One, Texas.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe following table summarizes certain selected financial data to highlight significant trends in the Company's financial condition and operating results for the periods indicated. The selected financial information presented should be read in conjunction with the consolidated financial statements and related notes appearing elsewhere in this Report and the Management's Discussion and Analysis set forth under Item 7","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nLIQUIDITY ---------\nNet cash provided by operating activities before changes in assets and liabilities increased 50% in 1995 to $9,870,251. Higher crude oil sales was the principal reason for this sharp rise in operating cash flow. In the fourth quarter of 1994 and in the second quarter of 1995, the Company was successful in consummating two significant property acquisitions, which were largely responsible for the substantial increases in oil production. 1995 operating cash flow was also favorably impacted by higher crude oil prices, lower exploration costs (which include dry holes and abandonments and lease rentals and seismic) and general and administrative costs, which was partially offset by higher lease operating and interest expense.\nIn March and December, 1995 the Company completed the acquisition of working interests in 200 and 250 producing properties, respectively, in the Permian Basin of West Texas. These two acquisitions were financed with $6.75 million of the Company's cash resources and $22.5 million in additional bank financing. Thus, total bank debt at the end of 1995 was $26.1 million. A restated loan agreement was put into place on December 20, 1995 in connection with the second property acquisition. This new loan has a term of five years with principal and interest to be paid quarterly and with a maturity date of January 1, 2001. The loan agreement allows the Company to choose between three interest rate options ranging from Bank One prime rate to its certificate of deposit rate to a LIBOR rate. The loan is secured by certain producing properties, but the Company also has significant groups of properties remaining unmortgaged should the opportunity arise to make additional property acquisitions.\nCAPITAL RESOURCES -----------------\nNet working capital at December 31, 1995 was a negative $370,000 compared to $4,079,000 at December 31, 1994. Negative working capital is attributable to the second property acquisition, which closed on December 20, 1995, and the current portion of long-term debt outstanding at that time. The Company's cash position grew over $300,000 during 1995 while significant amounts were spent on property acquisitions, development drilling, and debt repayment. The year end cash position was $6.1 million, and the Company believes it will generate sufficient cash in 1996 to support its debt service, fund its capital expenditure program, and pursue other acquisition candidates.\nThe Company's recent drilling and acquisition activities have increased its reserve base and its productive capacity and ultimately its potential cash flow. Each outstanding share of common stock is supported by 2.46 net equivalent barrels (\"NEB\") of oil compared with 1.8 and 1.3 NEB respectively, for the prior two years. Management of the Company intends to continue to acquire and develop oil and gas properties in its areas of activity as allowed by market conditions and financial ability.\nRESULTS OF OPERATIONS YEAR ENDED DECEMBER 31, 1995 COMPARED TO DECEMBER 31, 1994 ----------------------------------------------------------\nNet income for 1995 more than tripled 1994 levels, rising from $943,216 to $3,023,107, representing sixty two cents per share for 1995 versus nineteen cents per share in 1994.\nThis earnings increase was fueled by higher oil and gas revenues, which rose 55% to $20,710,243. Higher revenues were the result of a 72% increase in oil production and a 14% increase in natural gas production. These sharp increases reflect the late 1994 acquisition of waterflood properties in Carter and Stephens Counties, Oklahoma, and the March 1995 acquisition of Permian Basin properties in West Texas, as well as results from 1995 drilling activities.\nIn 1995, oil prices averaged $16.98 per barrel compared to $15.47 during 1994, a $1.51 per barrel increase. Natural gas prices experienced a 19% decline in 1995, from an average price of $1.94 per thousand cubic feet of gas sold (MCF) in 1994 to $1.57 per MCF in 1995. Natural gas prices reflect the country's mild weather conditions and excess domestic supply.\nLease operating expenses rose $3,472,960 in 1995. On a net equivalent barrel (NEB) basis, lifting costs rose seventy-eight cents per barrel in 1995 to $5.98 per barrel, reflecting higher costs associated with waterflood properties which were acquired in fourth quarter 1994 and first quarter 1995.\nExploration costs were 48% lower in 1995, totaling $609,279, versus $1,169,680 primarily due to reduced activity in the three dimensional seismic program, which the Company had utilized to establish exploratory drilling projects for the last two years.\nDepletion and amortization expense grew almost 46% in 1995 to $6,879,672. This significant increase was principally attributable to the addition of properties in late 1994 and first quarter 1995, which added approximately $20 million to the Company's depletable costs.\nThe Company accounts for overhead charges billed to working interest owners, including the Company, as a reduction to general and administrative expenses. The Company's proportionate share of the amounts billed are included in lease operating expenses. Since the number of operated properties increased due to the recent acquisitions, the amounts billed out in 1995 resulted in a 45% reduction in general and administrative expenses from $1,676,228 to $925,822.\nOther income (deductions) has been impacted by the Company's property acquisitions. Interest expense grew $844,702 in 1995 due to bank borrowings to finance the properties acquired. Additionally, a gain of $991,875 was generated for the year, the largest portion being realized when a newly acquired property was sold.\nIncome tax expense rose to $1,330,500 in 1995 from $252,482 in 1994, due primarily to improved earnings and additional state taxes arising from an audit assessment.\nYEAR ENDED DECEMBER 31, 1994 COMPARED TO DECEMBER 31, 1993 CAPITAL RESOURCES AND LIQUIDITY ----------------------------------------------------------\nAt December 31, 1994 the Company had cash and short-term investments of $5,836,389, working capital of $4,078,580, property and equipment of $39,041,167 and total assets of $48,071,094. Cash and short-term investments decreased $6.6 million, working capital decreased $5.4 million and property and equipment increased $10.4 million between 1993 and 1994 as the Company invested its monies in oil and gas properties.\nOver the last five years, management's strategy has been to purchase producing oil and gas properties, whose reserves can be enhanced with additional development work and to selectively participate in exploration activities. The funding for these activities has been provided by operating cash flows and bank financing. Net cash provided by operating activities for 1994 and 1993 was $5,696,279 and $6,737,745, while property and equipment expenditures over this same period were $15,373,776 and $6,065,590.\nIn December, 1994 the Company amended its term loan agreement in connection with a $9.5 million property acquisition, borrowing an additional $5 million. At year end 1994, the major properties not subject to mortgage under the amended term loan agreement and accordingly, available for future financing, were the Levelland, Fullerton, and the newly acquired Sholem-Alechem waterfloods.\nRESULTS OF OPERATIONS YEAR ENDED DECEMBER 31, 1994 COMPARED TO DECEMBER 31, 1993 ----------------------------------------------------------\nIncome before cumulative effect of an accounting change rose $76,334, or 1 cent per share, during 1994 in spite of a decline in revenues. Oil and gas revenues for the 1994 year were $1,664,236 lower than a year ago due to a reduction in gas volumes sold and a drop in product pricing. Gas volumes declined 12%, oil prices 4%, and gas pricing 10%. Offsetting these revenue losses were cost reductions in every category except dry holes and abandonments, which increased $417,194, as the three dimensional seismic (3-D) program completed its shooting phase and entered the drilling phase ($332,320 was spent in 1994 on rentals and seismic compared with $1,309,158 in 1993). A total of ten exploratory wells were drilled based upon 3-D, resulting in three producers and seven dry holes compared with four dry holes a year ago.\nThe other cost category which declined significantly in 1994 was depreciation and amortization which dropped $1,130,776 due to reduced gas volumes and positive reserve revisions on certain properties. Thus, operating profit increased almost 10 fold over last year - $815,420 in 1994 versus $86,338 in 1993.\nThe other income (deductions) category was unfavorably impacted in the amount of $985,790. In 1993, the Company realized a $1.0 million dollar gain from the sale of gas processing rights which was non-recurring in 1994.\nCurrent period income tax expense was $333,042 lower than a year ago, primarily due to lower taxable income.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe information required by Item 8 is included on pages 19 through 36 of this Report.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNONE\nPART III\nThe information required by Part III (Items 10 through 13) is set forth in the Company's Proxy Statement for the annual meeting of stockholders to be held on May 21, 1996, and is incorporated herein by reference. Information with respect to the Company's executive officers as of March 18, 1996, is set forth commencing on pages 9 and 10 hereof under the caption \"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 8K\nFINANCIAL STATEMENTS AND SCHEDULES\nSee Index to Consolidated Financial Statements and Schedules on page 18 of this Report.\nREPORTS ON FORM 8-K\nOn January 4, 1996, the Company filed a Form 8-K with the Securities and Exchange Commission, as amended by Amendment No. 1 on Form 8-KA dated February 28, 1996 to report the acquisition of producing oil and gas properties. Pro forma financial information was included in the report, as amended.\nEXHIBITS\n3.1(a) Certificate of Incorporation, as amended, filed as Exhibit 3.1 to the Company's Annual Report on Form 10-K for its fiscal year ended December 31, 1980 (the \"1980 Form 10-K\"), and incorporated herein by reference.\n(b) Certificate of Amendment of Certificate of Incorporation dated May 19, 1981, filed as Exhibit 3.1(b) to the Company's Annual Report on Form 10-K for its fiscal year ended December 31, 1981 (the \"1981 form 10-K\"), and incorporated herein by reference.\n(c) Certificate of Amendment of Certificate of Incorporation dated May 22, 1987, filed as Exhibit 3.1 to the Company's Quarterly Report on Form 10-Q for the period ended June 30, 1987, and incorporated herein by reference.\n(d) Certificate of Amendment of Certificate of Incorporation dated June 3, 1993, filed as Exhibit 3.1 to the Company's Quarterly Report on Form 10-Q for the period ended June 30, 1993, and incorporated herein by reference.\n3.2(a) By-Laws, as amended, filed as Exhibit 3.2(b) to the 1981 Form 10-K and incorporated herein by reference.\n(b) Amendment to the By-Laws, filed as Exhibit 3.2(b) to the 1981 Form 10-K and incorporated herein by reference.\n(c) Amendment to the By-Laws, filed as Exhibit 3.2(c) to the Company's Annual Report on Form 10-K for its fiscal year ended December 31, 1984, and incorporated herein by reference.\n(d) Amendment to the By-Laws, filed as Exhibit 3.2 to the Company's Quarterly Report on Form 10-Q for the period ended June 30, 1987, and incorporated herein by reference.\n(e) Amendment to the By-Laws, filed as Exhibit 3.2 to the Company's Annual Report on Form 10-K for its fiscal year ended December 31, 1993 and incorporated herein by reference.\n4.1 Credit agreement ($10,000,000 Term Facility) dated October 1, 1990 between Maynard Oil Company and First City, Texas - Dallas, filed as Exhibit 4.2 to the Company's Annual Report on Form 10-K for its fiscal year ended December 31, 1990, and incorporated herein by reference.\n4.2 First Amendment to Loan Agreement dated November 19, 1991 between Maynard Oil Company and First City, Texas - Dallas, filed as Exhibit 4.2 to the Company's Annual Report on Form 10-K for its fiscal year ended December 31, 1992, and incorporated herein by reference.\n4.3 Second Amendment to Loan Agreement, dated February 1, 1993 between Maynard Oil Company and Bank One, Texas, N.A. filed as Exhibit 4.1 to the Company's Quarterly Report on Form 10-Q for the period ended June 30, 1993, and incorporated herein by reference.\n4.4 Third Amendment to Loan Agreement, dated December 22, 1994 between Maynard Oil Company and Bank One, Texas, N.A., filed as Exhibit 4.4 to the Company's Annual Report on Form 10-K for its fiscal year ended December 31, 1994, and incorporated herein by reference.\n4.5 Fourth Amendment to Loan Agreement, dated March 29, 1995 between Maynard Oil Company and Bank One, Texas, N.A., filed as Exhibit 4.1 to the Company's Quarterly Report on Form 10-Q for the period ended March 31, 1995, and incorporated herein by reference.\n*4.6 Restated Loan Agreement, dated December 20, 1995 between Maynard Oil Company and Bank One, Texas, N.A., filed herewith.\n*10.1 1989 Stock Participation Plan, filed herewith.\n*11.1 Computation of per share earnings, filed herewith.\n*21.1 List of subsidiaries of the Company as of December 31, 1995, filed herewith.\n*27 Financial Data Schedules, filed herewith.\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.\nMAYNARD OIL COMPANY\nBy \\s\\ James G. Maynard --------------------------- James G. Maynard Chairman of the Board\nDate: March 29, 1996\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 in multiple counterparts with the same force and effect as if each person executing a separate counterpart has joined in execution of the same counterpart.\n\/s\/ James G. Maynard Chairman of the Board, March 29, 1996 ------------------------ Chief Executive James G. Maynard Officer & Treasurer\n\/s\/ Glenn R. Moore President and Chief March 29, 1996 ----------------------- Operating Officer Glenn R. Moore\n\/s\/ Kenneth W. Hatcher Vice President of Finance March 29, 1996 ----------------------- (Principal Financial Kenneth W. Hatcher and Accounting Officer)\n\/s\/ Robert B. McDermott Director March 29, 1996 ----------------------- Robert B. McDermott\n\/s\/ Ralph E. Graham Director March 29, 1996 ---------------------- Ralph E. Graham\nMAYNARD OIL COMPANY AND SUBSIDIARIES\nIndex to Consolidated Financial Statements and Schedules\nPage ---- Financial Statements:\nReport of Independent Accountants 19\nConsolidated Balance Sheets - December 31, 1995 and 1994 20\nConsolidated Statements of Income - Three years ended December 31, 1995 21\nConsolidated Statements of Shareholders' Equity - Three years ended December 31, 1995 22\nConsolidated Statements of Cash Flows - Three years ended December 31, 1995 23\nNotes to Consolidated Financial Statements 24\nFinancial Statement Schedules for the Three years ended December 31, 1995\nII - Valuation and Qualifying Accounts 36\nAll other schedules are omitted as the required information is inapplicable or the information is presented in the Consolidated Financial Statements or Notes thereto.\nREPORT OF INDEPENDENT ACCOUNTANTS ---------------------------------\nTo the Board of Directors and Shareholders of Maynard Oil Company\nIn our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Maynard Oil Company and its subsidiaries at December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995, 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, in 1993 the Company changed its method of accounting for income taxes.\nPrice Waterhouse LLP March 25, 1996 Dallas, Texas\nMAYNARD OIL COMPANY AND SUBSIDIARIES Notes to Consolidated Financial Statements\n(1) Summary of Significant Accounting Policies ------------------------------------------\nBusiness Activity -----------------\nThe Company is engaged in the production and sale of and the acquisition, exploration and development of crude oil and natural gas in the Continental United States.\nPrinciples of Consolidation ---------------------------\nThe consolidated financial statements include the accounts of Maynard Oil Company (Company) and its subsidiaries, all of which are wholly-owned. All significant intercompany balances and transactions have been eliminated in consolidation.\nProperty and Equipment ----------------------\nThe Company follows the \"successful efforts\" method of accounting for its costs of acquisition, exploration and development of oil and gas properties. Intangible drilling and development costs related to development wells and successful exploratory wells are capitalized, whereas the costs of exploratory wells which do not find proved reserves are expensed. Costs of acquiring unproved leases are evaluated for impairment until such time as the leases are proved or abandoned. All geological and geophysical costs not reimbursed are expensed as incurred.\nDepreciation and amortization of producing properties is computed using the unit-of-production method based upon estimated proved recoverable reserves. Depreciation of other property and equipment is calculated by the straight-line method based upon estimated useful lives ranging from two to ten years.\nMaintenance and repairs are charged to expense as incurred. Renewals and betterments are capitalized. When assets are sold, retired or otherwise disposed of, the applicable costs and accumulated depreciation and amortization are removed from the accounts, and the resulting gain or loss is recognized.\nOverhead Reimbursement Fees ---------------------------\nOverhead charges billed to working interest owners including the Company of $1,892,370, $805,982, and $681,389 for the three years ended December 31, 1995, respectively, have been classified as a reduction of general and administrative expenses in the accompanying Consolidated Statements of Income. The Company's working interest portion of the amounts billed are included in lease operating expenses.\nDeferred Income Taxes ---------------------\nEffective January 1, 1993 the Company adopted Statement of Financial Accounting Standards No. 109 (SFAS 109), \"Accounting for Income Taxes\", which changed the Company's method of accounting for income taxes from the deferred method to an asset and liability approach. SFAS 109 requires the recognition of deferred tax liabilities and assets (net of any required valuation allowance) for the expected future tax consequences, if any, of temporary differences between the financial statement balance and the tax basis of assets and liabilities. The cumulative effect of the change in accounting for income taxes was an increase in net income of $1,386,844. No valuation allowance was provided in determining the cumulative effect adjustment. This adjustment was primarily attributable to a reduction in the deferred tax liability, which was originally recorded when the tax rate was 46%.\nIncome per Common Share -----------------------\nIncome per common share is computed using the weighted average number of common shares outstanding during each year. The difference between primary and fully diluted earnings per share, which assumes the exercise of stock options in 1994 and 1993, was not significant. During 1995, all outstanding stock options were exercised, and consequently, primary and fully diluted earnings per share are the same for the current year.\nFinancial Instruments ---------------------\nThe carrying amounts of cash and cash equivalents, accounts receivable and accounts payable approximate fair value because of the short maturity of these instruments. The carrying amount of long-term debt, including the current portion, approximates fair value because the interest rate on this instrument changes with market interest rates.\nFinancial instruments, which potentially subject the Company to concentrations of credit risk, consist principally of cash and cash equivalents and accounts receivable. The Company places its cash and cash equivalents with high credit quality institutions. With respect to accounts receivable, these financial instruments primarily pertain to oil and gas sales and joint interest billings. These accounts receivable are due from small to mid-size companies engaged principally in oil and gas activities. The Company performs ongoing credit evaluations of its customers' financial condition and, generally, requires no collateral from its customers. Payment terms are on a short- term basis and in accordance with industry standards.\nThe Use of Estimates in Preparing Financial Statements ------------------------------------------------------\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses, disclosure of gain and loss contingencies at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Since estimates are made based on all information available at the time, it is reasonably possible that, in the near term, a change in an estimate may occur or that actual amounts may differ from estimated amounts.\nFuture Reporting Requirements -----------------------------\nThe Company has elected to postpone adoption of SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of until fiscal 1996. The effect of SFAS 121, which requires that long-lived assets be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable, will not have a material impact on the Company's financial statements.\n(2) Acquisitions and Dispositions (Reserve information is unaudited) ----------------------------------------------------------------\nDuring 1995, the Company consummated two separate producing property acquisitions for a gross purchase price of $29,250,000. On March 29, 1995, the Company closed its acquisition of working interests in 200 producing wells in the Permian Basin of West Texas. Estimated proved reserves associated with this transaction approximated .99 million barrels of oil and 6.5 billion cubic feet of gas (BCF). Total consideration paid was $10,500,000.\nOn December 20, 1995, the Company closed the acquisition of working interests in 250 producing wells located in Garza County, Texas. Total consideration paid was $18,750,000, $13,000,000 of which was borrowed under a new term loan arrangement with Bank One, Texas. Proved reserves are estimated to be 2.46 million barrels of oil and .3 BCF of gas.\nIn December, 1994, the Company purchased working interests in one gas well and seven waterflood units in the Sholem Alechem area of Carter and Stephens Counties, Oklahoma for a gross purchase price of $9.5 million. Proved reserves associated with this purchase were 1.6 million barrels of oil and .8 BCF of gas.\nThe above acquisitions were accounted for as purchases, and their results of operations are included in the Consolidated Statements of Income from the closing dates, while their results of operations from the effective date through the closing date were recorded as purchase price adjustments.\nThe following table presents unaudited pro forma operating results as if the acquisitions had occurred on January 1, 1994.\nYears ended December 31, ----------------------- 1995 1994 ---- ---- Amounts in thousands, except per share amounts Sales $26,062 $26,857 Income before cumulative effect of accounting change 3,568 1,921 Income per common share: Income before accounting change .73 .39\nIn September 1995, one prospect, which had been acquired in March, was sold after the Company received an unsolicited purchase offer. The economics were attractive, and the Company sold this prospect for $2,985,935 in cash proceeds realizing a gain of $817,794.\n(3) Cash Flow Data --------------\nCash in excess of daily requirements is invested in marketable securities, consisting of repurchase agreements, certificates of deposit, and commercial paper, with maturities of three months or less. At December 31, 1995 and 1994, such investments totaled $6,300,000 and $6,150,000, respectively, and are considered to be cash equivalents, which are carried at the lower of cost or market.\nSupplemental cash flow information for the three years ended December 31, 1995 is summarized as follows:\n1995 1994 1993 ---- ---- ---- Cash paid (received): Interest expense $ 853,247 $ 175,319 $ 200,539 ======== ======== ========\nIncome taxes paid $ 121,674 $ 28,016 $ 643,662 ======== ======== ========\nIncome taxes refunded $ -- $(369,528) $ -- ======== ======== ========\n(4) Long-term Debt --------------\nLong-term debt at December 31, 1995 and 1994 is summarized as follows:\n1995 1994 ---- ---- Term note due in 20 equal quarterly installments of $1,250,000 commencing April 1, 1996 plus one payment of $1,062,500 made January 1, 1996. Interest paid quarterly at varying rates. Secured by certain oil and gas properties with a net book value of $36,843,000. $26,062,500 -- Amended term note due in 16 equal quarterly installments commencing January 1,1995. Interest paid quarterly at varying rates. Secured by certain oil and gas properties. -- $7,000,000 Less current installments 4,812,500 1,750,000 ----------- ----------\nLong-term debt $21,250,000 $5,250,000 =========== ==========\nEffective December 21, 1995, the Company executed a new loan agreement with Bank One, Texas, increasing its outstanding loan from $13,062,500 to $26,062,500 in connection with the acquisition of producing properties discussed in Note 2. This new term loan agreement replaced a March, 1995 bank loan amendment, which had increased the outstanding loan amount from $7,000,000 to $16,062,500. The Company made scheduled loan repayments of $437,500 in January, 1995 and April, 1995 and $781,250 in July and October of 1995. Additionally, the Company prepaid $1,000,000 on September 1, 1995 after the sale of certain properties previously acquired.\nThe term note permits the Company to choose between three interest rate options and to specify what portion of the loan is covered by a specific interest rate option and the applicable funding period to which the interest rate option is to apply. The interest rate options are as follows:\n(1) Bank's prime lending rate (2) Bank's certificate of deposit rate (3) London interbank eurodollar rate (Eurodollar)\nAt December 31, 1995, interest on the bank term loan was at a rate of approximately 7.21%.\nThe term note agreement contains restrictions related to working capital, net worth, and cash flow. Additionally, the debt agreement places certain limitations on the incurrence of additional debt and prohibits the payment of dividends.\n(5) Employee Incentive Plans ------------------------\nIn August 1989, an employee incentive plan was adopted, whereby stock participation units might be granted to officers and key employees. Such stock participation units will entitle a participant to a cash payment following termination of employment in an amount equal to the excess, if any, of the fair market value of one share of the Company's common stock over a share price specified on the date of grant, multiplied by the number of vested units. The units vest over a five year period with 25% vesting after two years and the remainder in three equal annual installments. For the year ended December 31, 1989, 73,000 units were awarded to certain employees at a price of $4.50 per share of which 49,500 units remain outstanding at December 31, 1995, all of which are 100% vested. During August 1993, 52,000 additional units were awarded at $5.625 per share of which 13,000 units are vested. Earnings are charged over the life of the units for increases in stock prices (if any) over $4.50 per share and $5.625 per share. During the periods ended December 31, 1995 and 1993, operations were charged $76,183 and $1,484 respectively, in regard to the stock participation units granted in 1989. During 1995, operations were also charged $15,676 in regard to the units awarded in 1993. There were no such charges in 1994.\nIn March 1982, an employee incentive plan was adopted whereby stock options and stock appreciation rights might be granted to officers and key employees. A total of 281,517 shares were initially reserved for issuance. This plan terminated in March 1992 and no further grants may be made under this plan. The options became exercisable cumulatively in five equal installments, beginning on the first anniversary of the date of grant. The option price for shares granted pursuant to the plan was not less than the fair market value of the shares at the date of grant.\nA summary of stock option activity for the 1982 plan for the past three years is as follows:\nNumber of Option Price Shares per Share ------- -------------\nOutstanding at December 31, 1992 45,600 $4.50 to $6.50 Granted -0- -- Exercised -0- -- Cancelled (5,000) $4.75\nOutstanding at December 31, 1993 40,600 $4.50 to $6.50 Granted -0- -- Exercised (11,500) $4.69 Cancelled (5,100) $4.50 to $6.50\nOutstanding at December 31, 1994 24,000 $4.50 Exercised (24,000) $4.50\nOutstanding at December 31, 1995 -0-\nDuring September 1995, options for 24,000 shares were exercised. Common stock was credited for $2,400 and additional paid-in capital was credited for $105,600. The Company simultaneously repurchased and cancelled 23,500 of the shares exercised for $6.50 per share. Common stock was debited for $2,350 and retained earnings charged $150,400 in regard to the repurchased shares.\n(6) Income Taxes ------------ Income tax expense (benefit) consists of the following:\nYears ended December 31, -------------------------------------- 1995 1994 1993 ---- ---- ---- Federal Current $ 620,500 $(615,028) $ 461,840 Deferred 480,000 867,510 26,000 State 230,000 -- 97,684 ---------- --------- ---------\n$1,330,500 $ 252,482 $ 585,524 ========== ========= =========\nIncome tax expense for the three years ended December 31, 1995 differs from the amount computed by applying the applicable U.S. corporate income tax rate of 34% to income before income taxes. The reasons for this difference are as follows:\nYear ended December 31, --------------------------------- 1995 1994 1993 ---- ---- ----\nIncome tax expense at U.S. statutory rate $1,480,226 $ 406,537 $ 493,818 State income taxes 230,000 -- 97,684 Allowable depletion in excess of cost depletion (281,526) -- (188,700) Items not related to current year earnings (89,198) (294,528) 146,000 Net operating loss not utilized -- 88,000 -- Other items (9,002) 52,473 36,722 ---------- --------- --------- Income tax expense $1,330,500 $ 252,482 $ 585,524 ========== ========= =========\nThe components of the net deferred tax liability were as follows:\nDecember 31, ------------------------------ 1995 1994 ---- ----\nDepreciable assets $ 61,510 $ 29,210 Depletable assets 14,400 (6,100) Intangible drilling and development costs 2,542,600 2,115,400 Tax credit carryforwards (406,000) (406,000) ---------- ---------- Net deferred tax liability $2,212,510 $1,732,510\nIn November 1995 the Oklahoma State Tax Commission completed an examination of the 1990 through 1993 state income tax returns for Maynard Oil Company. Taxes on the adjustments amounted to $149,690. The Company had followed a three factor apportionment formula (sales, property, and payroll) as allowed and utilized by the majority of taxpayers in calculating their Oklahoma tax liability. However, the Oklahoma Tax Commission requires a separate accounting theory to calculate the state tax liability. Management believes it has made adequate provision for all income taxes and interest arising as a result of this examination.\nAs of December 31, 1995, the Company has alternative minimum tax credit carryforwards of approximately $406,000 available for Federal income tax purposes. No valuation allowance has been provided for this deferred asset.\n(7) Employee Benefit Plans ----------------------\nEffective January 1, 1985 the Company adopted a noncontributory defined contribution retirement plan for all full-time employees age 21 or older who have completed one year of service. The plan provides for a minimum annual contribution by the Company equal to 3% of an employee's base salary plus overtime compensation. At its discretion the Company may also make supplemental contributions to the plan. Under this plan, amounts equal to retirement plan expense are funded annually, which amounted to $40,777, $28,298, and $23,012, respectively, for the years ended December 31, 1995, 1994, and 1993. The contributions for the same three year period have been reduced by $1,818, $10,407, and $20,104, respectively, for forfeitures attributable to employees terminated in prior years.\nEffective February 1, 1991, the Company adopted a profit sharing plan pursuant to Section 401 of the Internal Revenue Code, whereby participants may contribute a percentage of compensation. The Plan provides for a matching contribution by the Company equal to one-half of the employee's percentage contribution up to the first 10% of compensation for 1995, 1994, and 1993. During this same three year period, the Company's matching portion amounted to $59,579, $52,710, and 57,191, respectively.\n(8) Major Customers ---------------\nDuring the years ended December 31, 1995, and 1993, oil and gas sales to three customers, amounting to approximately $4,377,000, $3,746,000, and $2,946,000, and $4,356,000, $1,857,000, and $1,749,000, respectively, each accounted for more than 10% of total consolidated revenues. During the year ended December 31, 1994, oil and gas sales to two customers, amounting to approximately $5,166,000 and $1,500,000, each accounted for more than 10% of total consolidated revenues.\n(9) Contingencies and Commitments -----------------------------\nThe Company is a defendant in certain non-environmental litigation arising from operations in the normal course of business. While it is not feasible to determine the outcome of these actions, it is the Company's opinion that the ultimate outcome of the litigation will have no material adverse effect in the financial position or results of operations of the Company.\nThe Company leases office space and certain equipment under various operating leases which expire over the next five years. All leases require the payment of taxes and insurance, and the office lease requires the Company to pay its pro rata share of increases in maintenance expense above that prevailing in base years. Management expects that in the normal course of business, leases will be renewed or replaced by other leases. The Company extended its office space lease, which was scheduled to terminate April 30, 1996, for an additional four years, such that the expiration date is now April 30, 2000. Rent expense for the three years ended December 31, 1995 was $298,371, $266,967, and $256,984, respectively.\nMinimum payments for operating leases having initial or noncancellable terms in excess of one year are as follows:\n1996 $ 245,186 1997 219,214 1998 207,063 1999 197,798 2000 58,531 ---------\nTotal minimum payments $ 927,792 =========\n(10) Quarterly Financial Data (Unaudited) ------------------------------------\nSummarized quarterly financial data for the years ended December 31, 1995 and 1994 is as follows:\nDuring the fourth quarter of 1995, the Company recorded an impairment of $491,051 to unproved leasehold costs relating to the Company's three-dimensional seismic program. The effect of this impairment is included in Dry holes and abandonments on the Consolidated Statements of Income.\n(11) Supplemental Oil and Gas Disclosures (Unaudited) ------------------------------------------------\nCapitalized Costs -----------------\nA summary of the Company's aggregate capitalized property and equipment costs relating to oil and gas exploration and development activities follows:\nDecember 31, 1995 1994 ------------ ----------- Undeveloped leaseholds and royalties $ 124,924 $ 771,614 Producing properties 111,348,464 81,091,640 ------------ ----------- 111,473,388 81,863,254 Accumulated depreciation and amortization 48,807,308 43,002,143 ------------ -----------\nNet capitalized costs $ 62,666,080 $38,861,111 ============ ===========\nCosts Incurred --------------\nA summary of costs incurred in oil and gas acquisition, exploration and development activities follows:\nYears ended December 31, ------------------------ 1995 1994 1993 ---- ---- ---- Acquisition of properties Undeveloped $ 59,010 $ 293,472 $ 644,666 Proved 29,234,607 9,679,619 3,544,615 Exploration costs 413,632 1,473,571 1,609,065 Development costs 3,949,882 4,972,784 1,736,360 ----------- ----------- -----------\n$33,657,131 $16,419,446 $7,534,706 =========== =========== ==========\nResults of Operations ---------------------\nThe results of operations from oil and gas producing activities are as follows:\nYears ended December 31, ------------------------------------ 1995 1994 1993 ---- ---- ----\nSales $20,710,243 $13,358,560 $15,022,796 Production costs (a) (8,443,466) (4,970,506) (5,430,105) Exploration expenses (661,319) (2,093,756) (2,777,119) Depreciation and amortization (6,801,115) (4,671,569) (5,790,825) ---------- ---------- ---------- 4,804,343 1,622,729 1,024,747 Income tax expense (1,535,000) (408,000) (382,000) ---------- ---------- ----------\nResults of operations from oil and gas producing activities $3,269,343 $1,214,729 $ 642,747 ========== ========== =========\n(a) Includes lifting costs, severance taxes and ad valorem taxes.\nOil and Gas Reserve Quantities ------------------------------\nThe following unaudited tables represent the Company's estimates of its proved oil and gas reserves. 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 were evaluated by the Company's staff of petroleum engineers and audited by independent petroleum engineers. It is their opinions that the reserve quantity and present value information in the following tables complies with the applicable rules and regulations of the SEC. All of the Company's reserves are located within the United States.\nProved Developed and Oil Gas Undeveloped Reserves (Barrels) (MCF) -------------------- --------- ----------\nTotal as of December 31, 1992 3,507,995 16,933,100 Revisions of previous estimates (253,871) 1,354,522 Purchases of reserves 1,094,331 348,432 Extensions and discoveries 238,240 8,504 Production (557,704) (2,717,162) Sales of reserves in place (14,966) (68,756) --------- ----------\nTotal as of December 31, 1993 4,014,025 15,858,640 Revisions of previous estimates 310,471 290,761 Purchases of reserves 1,618,491 806,119 Extensions and discoveries 778,924 395,184 Production (558,295) (2,390,298) Sales of reserves in place (10,554) (8,946) --------- ----------\nTotal as of December 31, 1994 6,153,062 14,951,460 Revisions of previous estimates (113,124) (291,417) Purchases of reserves 3,399,040 7,951,973 Extensions and discoveries 455,693 969,038 Production (957,873) (2,720,441) Sales of reserves in place (64,283) (1,996,593) --------- ----------\nTotal as of December 31, 1995 8,872,515 18,864,020 ========= ==========\nProved Developed Reserves ------------------------- December 31, 1993 2,907,466 15,004,678 December 31, 1994 5,485,909 14,355,633 December 31, 1995 8,712,835 18,214,860\nStandardized Measure --------------------\nThe standardized measure of discounted future cash flows from proved oil and gas reserves determined in accordance with rules prescribed by the Financial Accounting Standards Board is summarized as follows:\nYears ended December 31, ----------------------------- 1995 1994 1993 (000's) (000's) (000's) ------- ------- -------\nFuture cash inflows $192,794 $123,865 $80,832 Future production costs (92,873) (61,969) (35,984) Future development costs (1,146) (2,166) (4,864) ------- ------- ------- 98,775 59,730 39,984 Future income tax expenses (14,464) (8,590) (4,413) ------- ------- ------- Future net cash flows 84,311 51,140 35,571 10% annual discount for estimated timing of cash flows (27,710) (16,929) (12,635) ------- ------- ------- Standardized measure of discounted future net cash flows $56,601 $34,211 $22,936 ======= ======= =======\nThe following are the principal sources of changes in the standardized measure of discounted future net cash flows.\nSchedule II\nMAYNARD OIL COMPANY AND SUBSIDIARIES Valuation and Qualifying Accounts Three Years Ended December 31, 1995\nCharged to Beginning Cost and Ending Description Balance Expenses Deductions Balance ----------- ------- -------- ---------- -------\nAllowance for Doubtful Accounts - (a) -------------------------------------\nDecember 31, 1993 $ 43,000 -- -- $43,000 ======== ======= ======= =======\nDecember 31, 1994 $ 43,000 -- -- $43,000 ======== ======= ======= =======\nDecember 31, 1995 $ 43,000 -- -- $43,000 ======== ======= ======= =======\n(a) Valuation account deducted in the balance sheet from trade accounts receivable.","section_15":""}
{"filename":"711210_1995.txt","cik":"711210","year":"1995","section_1":"ITEM 1. BUSINESS\n(a) General Development of Business. Orion Financial, Ltd. (the \"Company,\" formerly known as Orion Broadcast Group, Inc.), is a Colorado corporation formed on October 7, 1981. In May 1987, the Company, through Orion Financial Services Corporation, completed the acquisition and reorganization of FNRS Acquisition Corporation, formerly known as FN Acquisition, an indirect subsidiary of the Company, including the purchase of FN Realty Services (\"FN Realty\"), and the formation of FNRS Financial Corporation, both wholly-owned subsidiaries of FNRS Acquisition Corporation.\nThe principal activities of these corporations included providing loan servicing and collection, accounting, data processing and portfolio administration services to the real estate and finance industries.\nOn July 13, 1992, FNRS Financial Corporation, FN Realty Services, Inc., FNRS Acquisition Corporation, Orion Services Company, Orion Financial Services Corporation and Orion Broadcast of Rockford, Inc., all of which were direct or indirect subsidiaries of Orion Financial, Ltd., filed voluntary petitions in the United States Bankruptcy Court for the District of Colorado to reorganize under Chapter 11 of the Federal Bankruptcy laws.\nEffective June 25, 1993, the Company sold to Thomas A. Breen, who is currently a director of the Company and who was previously the President of the Company, all of the outstanding common stock of Orion Broadcast of Rockford, Inc. and all of the outstanding common stock of Orion Services Company, for $10.00. As a result, the Company no longer has any operations. The Company is seeking to enter into a business combination that would provide the Company with operations. Although at this time the Company is investigating business combinations, the Company has not agreed upon any specific business combination.\n(b) Financial Information About Industry Segments. The Company has no industry segments.\n(c) Narrative Description of Business. The Company has no operations to describe.\n(i) Products and Services. The Company has no operations.\n(ii) Status of Product. There has been no public announcement of, nor has the Company otherwise made public information about, any new product or industry segment of the Company requiring the investment by the Company of a material amount of its total assets, or which is otherwise material to the Company's operations.\n(iii) Raw Materials. The availability of raw materials is not applicable to the Company because the Company has no operations.\n(iv) Patents, Trademarks and Licenses. Not applicable.\n(v) Seasonality. The Company has no operations that could be seasonal in nature.\n(vi) Working Capital Items. The Company has no operations and, therefore, has no need to carry any significant amount of inventory or accounts receivable or other items which would require a large amount of working capital.\n(vii) Customer Dependence. The Company has no customers.\n(viii) Backlog of Orders. The Company has no operations that would give rise to a backlog of orders.\n(ix) Government Contracts. The Company has no government contracts.\n- 2 -\n(x) Competition. The Company has no operations.\n(xi) Research and Development. The Company has not engaged in any material research and development activities during its last three years.\n(xii) Environmental Regulation. Compliance with federal, state and local provisions regulating the discharge of materials into the environment does not have any material effect on the capital expenditures, earnings and competitive positions of the Company.\n(xiii) Employees. The Company currently has one part-time employee, Dean H. Boedeker, the Company's President, who receives compensation of $1,000 per month.\n(d) Financial Information About Foreign and Domestic Operations and Export Sales. The Company has no operations.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company has no properties.\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 matter was submitted to a vote of the Company's security holders during the Company's fiscal quarter ended June 30, 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\n(a) Market Information. The Company's common stock is traded in the over-the-counter market. The following table shows the range of high and low bid quotations for the common stock, for the periods indicated, as reported by the National Quotation Bureau, Inc. These quotations represent inter-dealer prices without adjustment for retail markup, markdown, or commission and may not necessarily represent actual transactions.\n(b) Holders. As of March 8, 1996, the Company had approximately 1,029 holders of record of its no ------- par value common stock.\n- 3 -\n(c) Dividends. The Company has not declared cash dividends on its common stock since its inception and the Company does not anticipate paying any dividends in the foreseeable future.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following is selected consolidated financial information concerning the Company. This information should be read in conjunction with the consolidated financial statements appearing 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 has working capital of approximately $246,000 which should be sufficient for the Company to fund its obligations for the next 18 to 24 months provided the Company does not enter into a business combination that provides the Company with business operations. The Company's minimal cash position limits the Company in its future direction because it does not have the ability to raise additional funds through borrowings or equity offerings given its lack of business operations. The long term survivability of the Company depends on whether or not the Company is able to enter into a business combination that would provide the Company with successful business operations.\nThe Company was relieved of its major debt guaranty due to the sale of its subsidiaries in June 1993. At the time of the sale, the Company had guaranteed approximately $485,000 of a subsidiary's bank debt.\nThe Company has no material commitments for capital expenditures.\n- 4 -\nResults of Operations\nThe Company had no significant operations during fiscal 1995, 1994 and 1993 other than occasional supervision of the bankruptcy proceedings of its subsidiaries. In January 1995, the Company received $208,000 from the settlement proceeds of a lawsuit in which FNRS Acquisition Corporation, a former subsidiary of the Company, was the plaintiff. The settlement proceeds were the only source of cash for the Company during fiscal 1995 and resulted in the Company realizing net income of $90,488 for fiscal 1995. The Company reported a loss of approximately $57,000 in fiscal 1994 and a loss of approximately $129,000 in fiscal 1993. The loss in fiscal 1994 was less than in fiscal 1993 because approximately $70,000 of the loss in fiscal 1993 was a one time loss that related to depreciation and writedown of obsolete computer equipment utilized by the bankrupt subsidiaries. Revenue in each fiscal year consisted of interest income on the remaining cash on hand.\nOn July 13, 1992, the subsidiaries of the Company filed for protection under Chapter 11 of the federal bankruptcy laws. The filings were precipitated by a breach of contract by the Resolution Trust Corporation with FNRS Financial Corp. These subsidiaries were sold to an officer of the Company for a nominal amount in June 1993.\nInflation\nThe effects of inflation of the Company's operations is not material and is not anticipated to have any material effect in the future.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nSee Item 14(a) for a list of the Financial Statements included in this report following the signature page.\nThe supplementary financial information required by Item 302 of Regulation S-K does not apply to the Company.\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 of the type required to be reported under this item between the Company and its independent accountants during the fiscal years ended June 30, 1995, and 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\nThe present term of office of each director will expire at the next annual meeting of shareholders. The name, position with the Company, age of each director and the period during which each director has served are as follows:\nThere was no arrangement or understanding between any director or any other person pursuant to which any director was selected as such.\n(b) Identification of Executive Officers.\nEach executive officer will hold office until his successor duly is elected and qualified, until his resignation or until he shall be removed in the manner provided by the Company's Bylaws. The Company's executive officers, their ages, positions with the Company and periods during which they served are as follows:\nThere was no arrangement or understanding between any executive officer and any other person pursuant to which any person was selected as an executive officer.\n(c) Identification of Certain Significant Employees.\nNot applicable.\n(d) Family Relationships.\nNot applicable.\n(e) Business Experience.\nBackground. The following is a brief account of the business experience during the past five years of each director and executive officer of the Company:\nName of Director or Officer Principal Occupation During the Last Five Years - ---------------- ------------------------------------------------\nThomas A. Breen Senior Vice President of WestStar Loan Servicing, Inc., which services loans, since January 1, 1995; President of Orion Broadcast of Rockford, Inc., a holding company which through its subsidiaries provides loan servicing, since June 1991; President of the Company from June 1991 to September 1993; Chief Financial Officer of the Company from January 1984 to September 1993; Secretary of the Company from May 1985 through June 1991; and director of the Company since July 1987.\n- 6 -\nDean H. Boedeker Director of the Company since 1981; Chairman of the Board of Directors of the Company since July 1991; President and Chief Executive Officer of the Company since September 1993; Senior Vice President or Vice President of R A F Financial Corporation, an investment banking firm, since March 1992; Secretary and Treasurer and a director of Diones, Broom, Battreall & Boedeker, Inc., an investment banking firm, from June 1985 to March 1992.\nDonald W. Diones Director of the Company since 1981; Senior Vice President of Bigelow & Company, an investment banking firm, since May 1995; Senior Vice President of Dougherty Dawkins Strand & Bigelow, Incorporated, an investment banking firm, from October 1992 to May 1995; Senior Vice President of R A F Financial Corporation, an invest-ment banking firm, from March 1992 to October 1992; President and a director of Diones, Broom, Battreall & Boedeker, Inc., an investment banking firm, from June 1982 to March 1992.\nWilliam J. White Director of the Company since 1995; Chairman of Bigelow & Company, an investment banking firm, since May 1995 President and owner of First Denver Financial Corporation, a private investment firm, since April 1992; President of the Affiliated Capital Markets division of Affiliated National Bank Denver (now BankOne), a national bank, from June 1990 to April 1992.\nDirectorships.\nNo director of the Company is a director of an entity that has its securities registered pursuant to Section 12 of the Securities Exchange Act of 1934.\n(f) Involvement in Certain Legal Proceedings.\nNo event required to be reported hereunder has occurred during the past five years.\n(g) Promoters and Control Persons.\nNo event required to be reported hereunder has occurred during the past five years.\n(h) Compliance With Section 16(a) of the Securities Exchange Act of 1934.\nTo the Company's knowledge, during the Company's fiscal year ended June 30, 1995, the only director, officer or more than 10% shareholder of the Company failed to timely file a Form 3, Form 4 or Form 5 was William J. White who was late in filing a Form 3.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe following table provides certain information pertaining to the compensation paid by the Company and its subsidiaries for services rendered to Dean H. Boedeker, the President of the Company during the Company's fiscal year ended June 30, 1995. No executive officer of the Company was paid over $100,000 in compensation from the Company and its subsidiaries during the Company's fiscal year ended June 30, 1995.\n- 7 -\n(1) Mr. Boedeker is entitled to $1,000 per month for serving as the President and Chief Executive Officer of the Company.\nOPTION GRANTS IN LAST FISCAL YEAR\nNo options were granted by the Company to Dean H. Boedeker during the Company's fiscal year ended June 30, 1995.\nFISCAL YEAR END OPTION VALUES\nThe following table sets forth information with respect to the unexercised options held by Dean H. Boedeker as of June 30, 1995.\n(1) Value of unexercised in-the-money options is the market price of the underlying shares of common stock at June 30, 1995, less the exercise price of the options.\nMr. Boedeker did not exercise any options during the Company's fiscal year ended June 30, 1995.\nCompensation of Directors--Standard Arrangement.\nDirectors of the Company who are not employees or officers receive $500.00 plus expense reimbursement for each Board of Directors meeting which they attend. The Chairman of the Board and President receives $1,000 per month, as a stipend for the services he performs.\nCompensation of Directors--Other Arrangements.\nNone.\n- 8 -\nEmployment Contracts and Termination of Employment and Change-In-Control Arrangements.\nThere is no employment contract between the Company and Dean H. Boedeker or any compensatory plan or arrangement between the Company and Dean H. Boedeker.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\n(a)(b) Security Ownership of Certain Beneficial Owners and Management.\nThe following table sets forth as of March 11, 1996, the number of shares of the Company's outstanding common stock beneficially owned by each of the Company's current directors and officers, sets forth the number of shares of the Company's common stock beneficially owned by all of the Company's current directors and officers as a group and sets forth the number of shares of the Company's common stock owned by each person who owned of record, or was known to own beneficially, more than 5% of the Company's outstanding shares of common stock:\n(1) Each person has the sole voting and investment power over the shares indicated. (2) Includes 400,000 shares underlying a stock option. Dean H. Boedeker's address is 1700 Lincoln Street, 32nd Floor, Denver, Colorado 80203. (3) Includes 400,000 shares underlying a stock option. Thomas A. Breen's address is 116 North Maryland, Lower Level, Glendale, California 91206. (4) Includes 400,000 shares underlying a stock option. Donald W. Diones' address is 1401 Seventeenth Street, Suite 1300, Denver, Colorado 80202. (5) Includes shares underlying the stock options held by Messrs. Boedeker, Breen and Diones. (6) Includes 400,000 shares underlying a stock option. Thomas J. Bonomo's address is 388 Market Street, No. 900, San Francisco, California 94111.\n(c) Changes in Control.\nThere are presently no arrangements of any kind which may at a subsequent date result in a change in control of the Company.\n- 9 -\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\n(a)(b) Transactions With Management and Others and Certain Business Relationships.\nEffective June 25, 1993, the Company sold all the outstanding shares of common stock of Orion Broadcast of Rockford, Inc. and Orion Services Company to Thomas A. Breen, the former President and a current director of the Company. Orion Broadcast of Rockford, Inc. directly or indirectly held a controlling interest in Orion Financial Services Corporation, FNRS Acquisition Corporation, FNRS Financial Corporation and FN Realty Services, Inc. Because of the bankruptcy of FNRS Financial Corporation and FN Realty Services, Inc., the Board of Directors of the Company determined that there was no possible benefit to the Company in retaining any direct ownership of Orion Broadcast of Rockford, Inc. or its subsidiaries. The total amount paid by Thomas A. Breen for the shares was $10.00. In addition, the Company was released from the Company's guarantee of approximately $500,000 of debt owed by FNRS Financial Corporation. In addition, Thomas A. Breen agreed for a two year period to provide services to the Company in the connection with the preparation of financial records and statements and in connection with the Company's filing requirements under the federal securities laws.\nAt the same time, the Company entered into an agreement with Orion Broadcast of Rockford, Inc. pursuant to which the Company agreed to advance funds to enable Orion Broadcast of Rockford, Inc. to file lawsuits against certain persons who owed funds to Orion Broadcast of Rockford, Inc. In consideration for the advance of the funds, the Company agreed with Orion Broadcast of Rockford, Inc. that the Company would receive all amounts paid or advanced to collect on the debts and 50% of any amount over and above such amounts. The Company received a total of $1,000.\nIn addition, the Company entered into an agreement with FNRS Acquisition Corporation pursuant to which the Company agreed to advance funds or directly pay all costs and expenses of pursuing the litigation of FNRS Acquisition Corporation, against First Nationwide Financial Corporation and others. The Company's total obligation was $50,000, which the Company would be entitled to receive out of the proceeds of the litigation. The balance of the proceeds would be divided so that the Company would receive 80% of the first $100,000, 70% of the next $100,000, 60% of the next $100,000 and 50% of any balance. As a result of settlement of the lawsuits, the Company has received approximately $208,500.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a)(1) Financial Statements.\nIndependent Auditor's Report Balance Sheets--As of June 30, 1995 and 1994 Statements of Operations--Years ended June 30, 1995, 1994, and 1993 Statement of Changes in Stockholders' Equity--For the Period from July 1, 1992 through June 30, 1995 Statements of Cash Flows--Years ended June 30, 1995, 1994, and 1993 Notes to Financial Statements\n(a)(2) Financial Statement Schedules.\nNone.\n(b) Current Reports on Form 8-K:\nNo Current Reports on Form 8-K were filed during the fiscal quarter ended June 30, 1995.\n- 10 -\n(c) Exhibits.\nExhibit 3(A) Articles of Incorporation of Orion Financial, Ltd., as amended (incorporated by reference to Exhibit 3(A) to Orion Financial, Ltd.'s Annual Report on Form 10-K for the fiscal years ended June 30, 1993 and 1992.\nExhibit 3(B) Bylaws of Orion Financial, Ltd., as amended (incorporated by reference to Exhibit 3(B) to Orion Financial, Ltd.'s Annual Report on Form 10-K for the fiscal years ended June 30, 1993 and 1992.\nExhibit 10(A) Orion Financial, Ltd. 1991 Non-Qualified Stock Option Plan (incorporated by reference to Exhibit 10(A) to Orion Financial, Ltd.'s Annual Report on Form 10-K for the fiscal years ended June 30, 1993 and 1992.\nExhibit 10(B) Form of Option Agreement dated April 27, 1993 (incorporated by reference to Exhibit 10(B) to Orion Financial, Ltd.'s Annual Report on Form 10-K for the fiscal years ended June 30, 1993 and 1992.\nExhibit 10(C) Form of Amendment to Option Agreement dated September 27, 1993 (incorporated by reference to Exhibit 10(C) to Orion Financial, Ltd.'s Annual Report on Form 10-K for the fiscal years ended June 30, 1993 and 1992.\nExhibit 10(D) Agreement dated as of April 7, 1993, between the Company and Thomas A. Breen (incorporated by reference to Exhibit 10(D) to Orion Financial, Ltd.'s Annual Report on Form 10-K for the fiscal years ended June 30, 1993 and 1992.\nExhibit 10(E) Agreement dated as of April 7, 1993, between the Company and Orion Broadcast of Rockford, Inc. (incorporated by reference to Exhibit 10(E) to Orion Financial, Ltd.'s Annual Report on Form 10-K for the fiscal years ended June 30, 1993 and 1992.\nExhibit 10(F) Agreement dated as of April 7, 1993, between the Company and FNRS Acquisition Corporation (incorporated by reference to Exhibit 10(F) to Orion Financial, Ltd.'s Annual Report on Form 10-K for the fiscal years ended June 30, 1993 and 1992.\n- 11 -\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nORION FINANCIAL, LTD. a Colorado corporation\nBy \/s\/ Dean H. Boedeker ----------------------- Dean H. Boedeker President, Principal Executive Officer Chief Financial Officer, and Principal Accou ting Officer\nDated April 9, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, 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 Name and Title Signature - ---- ---------------- ----------\nApril 9, 1996 Thomas A. Breen \/s\/ Thomas A. Breen Director ----------------------\nApril 9, 1996 Dean H. Boedeker \/s\/ Dean H. Boedeker Director ----------------------\nApril 9, 1996 Donald W. Diones \/s\/ Donald W. Diones Director -----------------------\nApril 9, 1996 William J. White \/s\/ William J. White Director -----------------------\n- 12 -\nOrion Financial, Ltd.\nReport on Audit of Financial Statements For the Years Ended June 30, 1995, 1994, and 1993\nORION FINANCIAL, LTD.\nPage ----\nIndependent Auditor's Report................................................F-2\nBalance Sheets - June 30, 1995 and 1994.....................................F-3\nStatements of Operations - For the Years Ended June 30, 1995, 1994, and 1993........................................................F-4\nStatement of Changes in Stockholders' Equity - For the Period from July 1, 1992 through June 30, 1995...............................F-5\nStatements of Cash Flows - For the Years Ended June 30, 1995, 1994, and 1993.........................................................F-6\nNotes to Financial Statements................................................F-7\nINDEPENDENT AUDITOR'S REPORT\nBoard of Directors Orion Financial, Ltd. Denver, Colorado\nWe have audited the accompanying balance sheets of Orion Financial, Ltd. as of June 30, 1995 and 1994, and the related statements of operations, stockholders' equity and cash flows for each of the three years in the period ended June 30, 1995. 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 Orion Financial, Ltd., as of June 30, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended June 30, 1995, in conformity with generally accepted accounting principles.\nHEIN + ASSOCIATES LLP\nDenver, Colorado February 8, 1996\nSee accompanying notes to these financial statements.\nSee accompanying notes to these financial statements.\nSee accompanying notes to these financial statements.\nSee accompanying notes to these financial statements.\nORION FINANCIAL, LTD.\nNOTES TO FINANCIAL STATEMENTS\n1. ORGANIZATION AND OPERATIONS:\nOperations - Orion Financial, Ltd. (the Company) was incorporated in Colorado in 1981. Through June 25, 1993, the Company had the following wholly-owned subsidiaries: Orion Services Company (formerly Vehicle Resource Corporation or VRC), Orion Broadcast of Rockford, Inc. (Orion Rockford), and United Leasing Company (inactive). In 1987, Orion Rockford formed Orion Financial Services Corporation (Orion Financial), a 94% owned subsidiary, to enter into the acquisition of FNRS Acquisition Corporation (FNRS Acquisition). FNRS Acquisition acquired FN Realty Services, Inc. (FN Realty) and formed FNRS Financial Corporation (FNRS) in fiscal 1988. The operations of VRC were discontinued in fiscal 1990, while the operations of FN Realty were discontinued during fiscal 1991.\nOn July 13, 1992, all of the Company's active subsidiaries declared bankruptcy under Chapter 11 of the bankruptcy code. Effective June 25, 1993, the Company sold its entire interest in VRC and Orion Rockford to the former president of the Company (see Note 3). At present, the Company has no operations.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:\nCash Equivalents - Cash equivalents are generally comprised of highly liquid instruments with original maturities of three months or less, such as money funds and certificates of deposit. These investments are stated at cost which approximates market value.\nFurniture, Fixtures, and Equipment - Such amounts are stated at cost with depreciation computed principally using the straight-line method over the estimated useful lives of the assets, ranging from three to six years.\nNet Income (Loss) Per Share - Net income (loss) per share has been computed based on the weighted average number of shares outstanding during the period. Stock options have been excluded from the computation because their effect would be anti-dilutive.\nIncome Taxes - The Company accounts for income taxes on the liability method, which 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 difference between the financial statements and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse.\nMarketable Securities - Marketable securities consist of U.S. Treasury bills, which have been classified as trading securities. Trading securities are carried at market value (which approximates cost) at June 30, 1995.\nORION FINANCIAL, LTD.\nNOTES TO FINANCIAL STATEMENTS\n3. SALE OF SUBSIDIARIES:\nOn July 13, 1992, all of the Company's active subsidiaries declared bankruptcy under Chapter 11 of the bankruptcy code, due to, among other things, cash flow difficulties experienced after the loss of a major customer. The subsidiaries attempted to reorganize, but effective June 25, 1993, due to continuing losses, the Company sold its entire interest in the subsidiaries to the former president of the Company for a nominal amount and a release of the Company's guarantee on certain debt of FNRS. The transaction resulted in no gain or loss.\n4. RESTRICTED CASH:\nRestricted cash is comprised of collateral on a bond posted by the Company for FNRS. The bond was required by a state in which FNRS previously conducted business. FNRS has voluntarily withdrawn from doing business in this state and surrendered its license. The underlying bond was released in August 1994.\n5. RELATED PARTY TRANSACTIONS:\nOn April 7, 1993, the Company entered into an agreement with FNRS Acquisition to advance it funds for a lawsuit it had brought against another party. The agreement limited such advances to a maximum of $50,000, of which $25,000 had been advanced at June 30, 1993. The Company was to be reimbursed for any advances made out of the proceeds of any settlement or judgment received, with proceeds in excess of advances allocated between the Company and FNRS Acquisition. The litigation was settled in January 1995, and the Company received approximately $208,000 from the settlement proceeds, resulting in a gain of approximately $129,000.\nThe Company paid approximately $8,000 in legal expenses on behalf of some of its former subsidiaries during fiscal 1993. The legal expenses related to the bankruptcies of the former subsidiaries.\nThe Company received $39,832 in repayments in July 1992 on amounts owed to it from VRC and Orion Rockford.\n6. COMMITMENTS AND CONTINGENCIES:\nThe Company was named as a co-defendant in a lawsuit brought against FNRS by a former vendor, which alleged breach of contract. Damages were not specified. The claim was dismissed pending settlement of FNRS's bankruptcy, but if the claim is not disposed of in the bankruptcy settlement, it could be refiled. The Company believes it has valid defenses against this claim.\nORION FINANCIAL, LTD.\nNOTES TO FINANCIAL STATEMENTS\n7. STOCKHOLDERS' EQUITY:\nThe Company adopted an incentive stock option plan in 1984 reserving 312,500 shares of common stock for certain employees, officers, and directors. The exercise price was required to be at least the fair market value of the stock on the date of the grant, and the term of each option granted was not to be for more than ten years from the date of the grant. The plan expired in February 1994.\nIf options were granted to individuals owning more than ten percent (10%) of the outstanding common stock, the exercise price had to be at least one hundred ten percent (110%) of the fair market value of the stock on the date of the grant and the term for each option granted would not be for more than five years from the date of the grant.\nOn July 13, 1987, the Board of Directors of the Company granted a stock option under the 1984 stock option plan for 187,500 shares of the Company's common stock to a director and officer of the Company. The option was exercisable at $.72 per share with 62,500 options expiring in July 1992, 1993, and 1994. No options were exercised and they have all expired. In June 1991, the Board granted a stock option under the 1984 plan to an officer of the Company for 30,000 shares exercisable at $.47 per share through 2001. None of these options have been exercised.\nOn November 8, 1991, the Company adopted a 1991 Non-Qualified Stock Option Plan for the directors, officers and employees of the Company. Two million shares are reserved under this plan. The terms of each option granted will not be for more than ten years from date of grant, and no options can be granted under the plan after November 8, 2001. No options have been granted under this plan.\nIn April 1993, the Board of Directors of the Company granted stock options covering 2,000,000 shares of the Company's common stock, 400,000 shares each to four directors of the Company at that time (including the president of the Company), and 400,000 shares to an individual from the Company's legal counsel. The options are exercisable at $.03 per share through April 1998. None have been exercised to date.\nThe Company has authorized, but unissued, preferred stock which may be issued in series with such preferences as determined by the Company's Board of Directors.\nORION FINANCIAL, LTD.\nNOTES TO FINANCIAL STATEMENTS\n8. INCOME TAXES:\nThere was no provision for income taxes for the year ended June 30, 1995 due to the use of net operating loss carryforwards.\nThe amounts which give rise to the net deferred tax asset (liability) as of June 30, 1995, are as follows:\nNet operating loss carryforward..... $ 450,000\nValuation allowance ................ (450,000) -------- Net deferred tax asset (liability).. $ -- =========\nAt June 30, 1995, the Company had net operating losses (NOL) carryforwards for income tax purposes of approximately $1,200,000 that will expire between 1997 and 2010. Upon the sale of the Company's subsidiaries in June 1993, a substantial portion of the NOL carryforwards were lost for use by the Company, as they had been incurred at the subsidiary level.\n9. SUMMARIZED FINANCIAL INFORMATION OF SUBSIDIARIES:\nFollowing are the results of operations of FNRS Acquisition:\nStatement of Operations\nEXHIBIT INDEX\nExhibit Description Page No. - ------- ----------- --------\n3(A) Articles of Incorporation of Orion Financial, N\/A Ltd., as amended (incorporated by reference to Exhibit 3(A) to Orion Financial, Ltd.'s Annual Report on Form 10-K for the fiscal years ended June 30, 1993 and 1992.\n3(B) Bylaws of Orion Financial, Ltd., as amended N\/A (incorporated by reference to Exhibit 3(B) to Orion Financial, Ltd.'s Annual Report on Form 10-K for the fiscal years ended June 30, 1993 and 1992.\n10(A) Orion Financial, Ltd. 1991 Non-Qualified Stock N\/A Option Plan (incorporated by reference to Exhibit 10(A) to Orion Financial, Ltd.'s Annual Report on Form 10-K for the fiscal years ended June 30, 1993 and 1992.\n10(B) Form of Option Agreement dated April 27, 1993 N\/A (incorporated by reference to Exhibit 10(B) to Orion Financial, Ltd.'s Annual Report on Form 10-K for the fiscal years ended June 30, 1993 and 1992.\n10(C) Form of Amendment to Option Agreement dated N\/A September 27, 1993 (incorporated by reference to Exhibit 10(C) to Orion Financial, Ltd.'s Annual Report on Form 10-K for the fiscal years ended June 30, 1993 and 1992.\n10(D) Agreement dated as of April 7, 1993, between the N\/A Company and Thomas A. Breen (incorporated by reference to Exhibit 10(D) to Orion Financial, Ltd.'s Annual Report on Form 10-K for the fiscal years ended June 30, 1993 and 1992.\n10(E) Agreement dated as of April 7, 1993, between the N\/A Company and Orion Broadcast of Rockford, Inc. (incorporated by reference to Exhibit 10(E) to Orion Financial, Ltd.'s Annual Report on Form 10-K for the fiscal years ended June 30, 1993 and 1992.\n10(F) Agreement dated as of April 7, 1993, between the N\/A Company and FNRS Acquisition Corporation (incorporated by reference to Exhibit 10(F) to Orion Financial, Ltd.'s Annual Report on Form 10-K for the fiscal years ended June 30, 1993 and 1992.","section_15":""}
{"filename":"45729_1995.txt","cik":"45729","year":"1995","section_1":"ITEM 1 - BUSINESS\nBusiness Overview\nHarris Bankcorp, Inc. (\"Bankcorp\") is a Delaware multibank holding company headquartered in Chicago. Bankcorp is a wholly-owned subsidiary of Bankmont Financial Corp. (\"Bankmont\"), a wholly-owned U.S. subsidiary of Bank of Montreal (\"BMO\"). On October 1, 1994, Bankmont also became the parent company for Harris Bankmont, Inc. (formerly Suburban Bancorp, Inc.), a Chicago area multibank holding company with assets of $1.5 billion at December 31, 1994. The transaction added 13 banks and 30 locations in Illinois in addition to those owned by Bankcorp.\nBankcorp provides banking, trust and other services domestically and internationally through 14 bank and 17 active nonbank subsidiaries. The bank subsidiaries include Harris Trust and Savings Bank; Harris Bank Barrington, N.A.; Harris Bank Frankfort; Harris Bank Glencoe-Northbrook, N.A.; Harris Bank Hinsdale, N.A.; Harris Bank Libertyville; Harris Bank Naperville; Harris Bank Roselle; Harris Bank Argo; Harris Bank Wilmette, N.A.; Harris Bank Winnetka, N.A.; Harris Bank St. Charles; Harris Bank Batavia, N.A.; and Harris Trust Bank of Arizona. All bank subsidiaries, with the exception of Harris Trust Bank of Arizona, are located in Illinois. Nonbank subsidiaries consist of trust companies and other specialized financial services companies. The trust companies include Harris Trust Company of California, Harris Trust Company of Florida, Harris Trust Company of New York and Bank of Montreal Trust Company. They provide specialized nondeposit services, notably stock transfer and indenture trust. Other principal nonbank subsidiaries, Harris Investors Direct, Inc., a discount brokerage company, and Harris Investment Management, Inc., a registered investment adviser, are headquartered in Chicago. Throughout this Form 10-K (\"Report\"), the term \"Corporation\" refers to Harris Bankcorp, Inc. and subsidiaries.\nBankcorp's lead bank subsidiary is Harris Trust and Savings Bank (\"HTSB\"), an Illinois state-chartered bank with its principal office, three domestic branch offices, an international banking facility and two automatic banking centers located in Chicago. Additionally, HTSB has representative offices in Los Angeles, New York and Tokyo; foreign branch offices in Nassau and London; and an Edge Act subsidiary, Harris Bank International Corporation (\"HBIC\"), in New York.\nHTSB provides a variety of banking and financial services to commercial and industrial companies, financial institutions, governmental units, not-for-profit organizations and individuals throughout the U.S. and abroad. Services rendered and products sold to customers include numerous types of demand, savings and time deposit accounts; negotiable certificates of deposit; various types of loans including term, real estate and those under lines of credit and revolving credit facilities; sales and purchases of foreign currencies; interest rate management products including swaps, forward rate agreements and interest rate guarantees; cash management services including lockbox and controlled disbursement processing; underwriting of municipal bonds; and financial consulting. Additionally, HTSB trades foreign currencies and a variety of debt securities for its own account and utilizes interest rate swaps, financial futures and options both to manage its risk exposure and as trading vehicles. Effective April 3, 1995, HTSB and BMO agreed to combine their U.S. foreign exchange activities (\"FX\"). Under this arrangement, FX net profit will be shared by HTSB and BMO in accordance with a specific formula set forth in the agreement.\nHTSB's overseas activities are conducted through its representative offices, branches, an international banking facility, Bank of Montreal Trust Company (Channel Islands), Ltd., and HBIC. Services include various types of loans and deposits, letters of credit, personal trust services, export and import financing and foreign exchange products.\nHTSB's Trust Department furnishes a variety of trust services to individuals, businesses, municipalities and charitable organizations. HTSB acts as trustee of personal, corporate, pension and other employee benefit trusts; serves as executor and administrator of estates; provides global custody and master trust services; and acts as stock and bond registrar and transfer agent, dividend reinvestment agent and paying agent. On January 11, 1996, HTSB announced the sale of its securities custody and related trustee services business for large institutions to Citibank.\nEffect of Government Policies\nThe operations of the Corporation are affected by general economic conditions and the policies of various governmental regulatory authorities. In particular, the Federal Reserve System regulates money and credit conditions and interest rates in order to influence general economic conditions, primarily through open market operations in U.S. Government securities, varying the discount rate on bank borrowings, setting reserve requirements against financial institution deposits and prescribing minimum capital requirements for member banks. These policies have a significant influence on overall growth and distribution of bank loans, investments and deposits, and affect interest rates charged on loans and earned on investments or paid for time, savings and other deposits. Federal Reserve Board monetary policies have had a significant effect on the operating results of commercial banks in the past and this is expected to continue. The effect of such policies upon the future business and earnings of the Corporation cannot accurately be predicted.\nRegulation and Supervision\nBankcorp is a legal entity separate and distinct from its subsidiaries. There are various legal limitations on the ability of its banking subsidiaries to finance or otherwise supply funds to Bankcorp or various of its other affiliates. Note 13 to Financial Statements on page 53 of this Report provides details with respect to regulatory restrictions on dividends.\nIn addition, the banking subsidiaries are subject to certain restrictions on any extensions of credit to Bankcorp and (with certain exceptions) other affiliates, on investments in stock or other securities thereof and on the taking of such securities as collateral for loans. As a bank holding company, Bankcorp is subject to the Bank Holding Company Act of 1956, as amended, which generally limits the activities of the holding company and its subsidiaries to those so closely related to banking or managing or controlling banks as to be a proper incident thereto.\nBankcorp and its banking subsidiaries are subject to regulation by various State and Federal authorities. Applicable laws and regulations relate to reserves, deposit insurance, investments, loans, mergers and consolidations, issuance of securities, payment of dividends, capital adequacy and other aspects of their operations. Bankcorp and its nonbank subsidiaries are affiliates of the banking subsidiaries within the meaning of the Federal Reserve Act and the Illinois Banking Act. Certain nonbank subsidiaries including the trust companies; Harris Investment Management, Inc.; Harris Investors Direct, Inc. and others are subject to a variety of Federal and state regulations.\nThe enactment of the Federal Deposit Insurance Corporation Improvement Act of 1991, and the regulations adopted to implement its various provisions, have had a significant effect on commercial banks. Five capital categories ranging from \"well capitalized\" to \"critically undercapitalized\" were defined. Adequate capital is essential if a bank or thrift is to avoid the statute's prompt corrective action provisions. Federal regulators adopted safety and soundness standards covering operations and management, asset quality, earnings and stock valuation, and compensation. Federal regulations require establishment of annual independent audits, management's assessment of internal controls over financial reporting and compliance with designated laws and regulations, independent auditor reports and independent audit committees. A risk-based assessment system was designed for the calculation of deposit insurance premiums. Truth-in-savings regulations, loan-to-value ratios for real estate lending and standards to limit interbank exposures were adopted. The Corporation's subsidiaries are in compliance with the statute and its regulations.\nCompetition\nActive competition exists in all principal geographic and product line areas in which the Corporation is presently engaged. Competitors include other commercial banks, investment banks, savings and loan associations, finance companies, credit unions, insurance companies, mutual funds, mortgage banks, investment managers and advisors, leasing companies, other domestic and foreign financial institutions and various nonfinancial intermediaries.\nEmployees\nThe Corporation and HTSB had full-time equivalent employees of 5,749 and 4,256, respectively, at December 31, 1995.\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2 - PROPERTIES\nThe Corporation's headquarters and HTSB's main banking premises are located at 111 West Monroe Street, Chicago, Illinois. This bank and office building complex is comprised of three connected buildings containing a total of approximately 1,590,000 gross square feet. Approximately 56 percent of the rentable space is committed to use by HTSB. Virtually all of the remaining space in the entire building complex has been rented to tenants. HTSB holds title to this property.\nHTSB also owns its operations center. This 15-story building contains approximately 415,000 gross square feet and is totally dedicated to bank use. It is located at 311 West Monroe Street, Chicago.\nCertain banking subsidiaries, other than HTSB, individually own premises used to conduct banking business. Nonbank subsidiaries, certain divisions of HTSB and certain other subsidiaries conduct activities from leased premises.\nIn 1990 and 1991, HTSB purchased air rights and a 72,000 square foot parcel of vacant land in Chicago's downtown business district. Construction plans for a new operations and office building complex on this site were deferred. For more information, see Note 5 to Financial Statements on page 43 of this Report.\nITEM 3","section_3":"ITEM 3 - LEGAL PROCEEDINGS\nFor information on the Corporation's legal proceedings, see Note 14 to Financial Statements on page 53 of this Report.\nITEM 4","section_4":"ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matters were submitted to a vote of the Stockholder during the fourth quarter of 1995.\n- ------------------------------------------------------------------------------- Part II\nITEM 5","section_5":"ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nBankmont presently owns all 6,667,490 shares of the voting stock of Bankcorp, which are not listed or traded on any securities exchange. In 1995, Bankcorp declared and paid approximately $262.7 million in cash dividends to Bankmont, including a $205 million special dividend in connection with the capital restructuring described below. Dividends amounting to approximately $34.7 million and $56.6 million were declared and paid to Bankmont in 1994 and 1993, respectively. The 1993 dividend included a $7.2 million dividend-in-kind related to the transfer of Harris Futures Corporation to Bankmont.\nEffective December 27, 1995, Bankcorp increased its capital base by $40 million. At the same time, Bankcorp adjusted its capital structure to mirror the capital mix of BMO and more closely resemble its peer group comprising other major U.S. and Chicago bank holding companies. Bankcorp issued $180 million of Series A non-voting, callable, perpetual preferred stock and an additional $65 million of long-term subordinated debt, both purchased by Bankmont. The 180 shares of preferred stock have no par value and a stated value of $1.0 million per share. The dividend rate per annum is 7.25 percent of the stated value per share. No dividends were accrued or paid on the preferred stock in 1995. Concurrently, common equity was reduced by $205 million through the declaration of a special dividend. These actions resulted in a total capital base, including long-term subordinated debt, of approximately $1.5 billion at December 31, 1995, and a reduced overall cost of capital for the Corporation.\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\nSummary\n1995 Compared to 1994\nThe Corporation's 1995 net income was $147.6 million, up 52 percent from $97.3 million in 1994. For 1995, the return on average common equity was 13.6 percent and the return on average assets was 0.95 percent, compared to returns of 9.70 percent and 0.68 percent, respectively, a year ago. Year to year earnings comparisons were significantly affected by a one-time $33.4 million after-tax charge in 1994 resulting from management's decision to absorb the impact of higher interest rates on mortgage-backed securities held in certain customer accounts of HTSB's Securities Lending unit. Excluding the effect of the securities lending charge, returns on average common equity and average assets were, respectively, 13.0 percent and 0.92 percent in 1994, compared to 13.6 percent and 0.95 percent in 1995; and 1995 earnings increased by 13 percent compared to 1994. The earnings gain is attributable to strong growth and business momentum broadly across the Corporation--and in particular loan growth in corporate banking, community banking and the credit card business; sustained cost control, overhead reduction and operations consolidation; gains from securities transactions; and reduced FDIC premiums.\nNet interest income on a fully taxable equivalent (\"FTE\") basis was $500.3 million in 1995, up $19.9 million or 4 percent from $480.4 million in 1994. Average earning assets rose 10 percent to $13.33 billion from $12.17 billion in 1994, attributable to an increase of 15 percent or $1.11 billion in average loans. Net interest margin declined to 3.75 percent in 1995 from 3.95 percent the previous year, reflecting rate compression in certain asset categories, a lower mix of noninterest-bearing deposits, and the relationship which existed in the markets between short and longer term rates.\nNoninterest income increased $23.8 million or 8 percent in 1995, to $338.3 million. In 1995, net gains from the sale of debt securities amounted to $23.4 million, compared to $5.3 million in the prior year. Most of these 1995 gains were recognized in the second quarter when conditions in the U.S. bond market led to significant price rallies. This enabled the Corporation to sell certain U.S. government agency securities and reinvest the proceeds to reposition its portfolio, taking advantage of profit opportunities not typically available. Money market and bond trading profits increased by $5.5 million in 1995, while charge card fees increased $4.4 million, and trust and investment management revenue rose $1.9 million. Other sources of non-interest income, which include fees for letters of credit, corporate finance income and gains on asset sales, increased $3.7 million year to year. Service charges declined by $4.3 million due to the higher interest rate environment and to customer refunds with respect to FDIC insurance. Foreign exchange revenue decreased by $5.5 million. This revenue is now reported net of expenses under a new profit sharing arrangement with BMO effective April 3, 1995.\nNoninterest expenses in 1995 declined to $560.1 million from $604.1 million a year ago, reflecting the one-time $51.3 million (pretax) charge in the securities lending unit in 1994 and lower FDIC insurance premiums in 1995. Excluding the effect of these two events, noninterest expenses increased by 3 percent.\nIncome taxes increased by $45.6 million in 1995, reflecting substantially higher pretax income and a smaller tax-exempt municipal bond portfolio.\nThe 1995 provision for credit losses was $43.0 million, down from $45.0 million in 1994. Net loan charge-offs for the current year were $38.5 million, down from $52.0 million a year ago, resulting primarily from lower write-offs in the commercial loan, installment loan and real estate mortgage loan portfolios.\nNonperforming assets at December 31, 1995 totaled $55 million or 0.6 percent of total loans, down from $94.8 million or 1.15 percent of loans a year ago. At December 31, 1995, the allowance for possible credit losses was $129 million or 1.4 percent of total loans outstanding, compared with $125 million or 1.5 percent of loans at the end of 1994. As a result, the ratio of the allowance for possible credit losses to nonperforming assets increased from 132 percent at December 31, 1994 to 235 percent at December 31, 1995. During the first quarter of 1995, the Corporation adopted Statement of Financial Accounting Standards (\"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. SFAS No. 114 addresses accounting by creditors for impairment of certain loans. It requires that impaired loans within the scope of the statement (primarily commercial credits) be measured based on the present value of expected future cash flows (discounted at the loan's effective interest rate) or, alternatively, at the loan's observable market price or the fair value of supporting collateral. The Corporation determines loan impairment when assessing the adequacy of the allowance for possible credit losses. SFAS No. 118 permits existing income recognition practices to continue. The adoption of these Statements did not have a material impact on the Corporation's net income or financial position.\nAt December 31, 1995, the Corporation's consolidated equity capital increased $124.6 million from the prior year-end to $1.15 billion. The increase resulted from the issuance of $180 million of preferred stock, earnings for the prior twelve months and $59.8 million of after-tax unrealized holding gains related to the Corporation's debt and equity securities classified as available for sale. Also, the Corporation paid $262.7 million of dividends. To support continued business growth and expansion, Bankcorp increased its capital base by $40 million, effective December 27, 1995. At the same time, Bankcorp adjusted its capital structure to mirror the capital mix of BMO and more closely resemble the Corporation's peer group comprising other major U.S. and Chicago bank holding companies. Bankcorp issued $180 million of preferred stock and an\nadditional $65 million of long-term subordinated debt, purchased by Bankmont. Concurrently, common equity was reduced by $205 million through the declaration of a special dividend. These actions resulted in a total capital base, including long-term subordinated debt, of approximately $1.5 billion at December 31, 1995, and a reduced overall cost of capital for the Corporation. On a proforma basis, had these changes to the Corporation's capital mix occurred on January 1, 1995, they would have increased the Corporation's 1995 return on average common equity by approximately 1.4 percent, from 13.6 percent to 15.0 percent.\nThe Corporation's regulatory capital leverage ratio was 6.77 percent for fourth quarter 1995 compared to 7.03 percent one year earlier. Regulators require most banking institutions to maintain capital leverage ratios of not less than 4.0 percent. At December 31, 1995, the Corporation's Tier 1 and Total Risk-based capital ratios were 8.14 percent and 11.79 percent, respectively, compared to respective ratios of 8.86 percent and 12.49 percent at December 31, 1994. The 1995 year-end ratios substantially exceeded minimum required regulatory ratios of 4.0 percent and 8.0 percent, respectively.\n1994 Compared to 1993\nThe Corporation's 1994 net income was $97.3 million, down 17 percent from $117.6 million in 1993. The earnings decline was primarily caused by the one-time $33.4 million after-tax charge resulting from management's decision in the second quarter of 1994 to absorb the impact of higher interest rates on mortgage-backed securities held in certain customer accounts of HTSB's Securities Lending unit. Excluding the effect of this charge and the favorable benefit in 1993 of a mandatory accounting change for income taxes, 1994 earnings would have increased by approximately 13 percent. Returns on average assets and equity in 1994 were 0.68 percent and 9.70 percent, respectively, compared to 1993 returns of 0.90 percent and 12.31 percent.\nFTE net interest income was $480.4 million, up 5 percent from $459.0 million in 1993. Average earning assets, led by loan growth, rose 7 percent from $11.35 billion in 1993 to $12.17 billion in 1994. However, the positive effects of higher earning asset levels were somewhat offset by a narrower net interest margin, which declined to 3.95 percent in 1994 from 4.04 percent in 1993.\nAverage loans increased $628 million, or 9 percent, led by increases in domestic commercial loans, installment loans and charge card outstandings. Average portfolio securities, which include securities held to maturity and securities available for sale, increased $239 million, or 8 percent to $3.23 billion, primarily reflecting increased holdings of U.S. Treasury securities. Money market assets, consisting of interest-bearing deposits at banks, Federal funds sold and reverse repurchase agreements, were up $23 million compared to 1993. Average levels of trading account assets employed decreased by $70 million year to year.\nIncremental funding for the growth in average earning assets came mainly from a $444 million increase in interest-bearing deposits and a $323 million increase in short-term borrowings. Foreign office time deposits grew by $292 million and other interest-bearing time deposits were up $169 million. Average noninterest-bearing supporting funds, primarily demand deposits and stockholder's equity, increased $51 million compared to 1993.\nThe Corporation's consolidated net interest margin declined by 9 basis points to 3.95 percent. Factors causing this decline were rate compression within certain asset categories, the relative decline in noninterest-bearing funds, and sales and maturities of portfolio securities where proceeds were reinvested at slightly lower yields. Positive factors relative to 1993 included favorable retail spreads, an enrichment in the mixture of earning assets because of overall loan growth and a restructuring of the Corporation's long-term notes issued to Bankmont, converting them to a floating rate structure and extending their maturities by two years.\nTotal noninterest income in 1994 was $314.4 million, down $22.6 million or 7 percent from 1993. The most significant factor causing this decline resulted from sales of portfolio securities. The Corporation realized a $5.3 million net gain on the sale of certain portfolio securities during 1994, compared to a net gain of $13.0 million in 1993. Bond and financial instrument trading activities reported a $.4 million loss in 1994 compared to a $5.3 million profit in 1993. Foreign exchange income also declined from $24.3 million in 1993 to $19.8 million at year-end 1994. Service fees and charges declined $4.2 million or 5 percent from $77.8 million in 1993 to $73.6 million in 1994.\nNoninterest expenses totaled $604.1 million in 1994, up $52.0 million or 9 percent from 1993. Expenses in 1994 contained the one-time $51.3 million (pretax) charge in the Securities Lending unit. Expenses in 1993 benefited from the reversal of $7.2 million of reserves previously recorded for anticipated costs of customer guarantees that were no longer necessary. Excluding both special items, expenses would have decreased by 1 percent.\nIncome tax expense decreased by $13.6 million in 1994, resulting from lower pretax income. In addition, the Corporation adopted SFAS No. 109--Accounting for Income Taxes in the first quarter of 1993. The cumulative effect of this change, approximately $1.8 million, increased 1993 net income.\nThe 1994 provision for credit losses of $45.0 million was down from $62.8 million recorded in 1993. Net loan charge-offs were also down from $61.3 million in 1993 to $52.0 million in 1994. At December 31, 1994, the allowance for possible credit losses was $125 million, or 1.5 percent of total loans outstanding, compared to the December 31, 1993 allowance of $132 million, or 1.7 percent of loans. Total nonperforming assets declined to $95 million at December 31, 1994, from $113 million at December 31, 1993.\nAt December 31, 1994, the Corporation's consolidated equity capital increased $3.5 million to $1.02 billion. The increase resulted from earnings for the prior twelve months less $59.1 million of after-tax unrealized holding losses related to the Corporation's debt and equity securities classified as available for sale, and reduced further by $34.7 million of dividends paid. The Corporation's regulatory capital leverage ratio was 7.03 percent for fourth quarter 1994 compared to 7.33 percent one year earlier. Regulators require most banking institutions to maintain capital leverage ratios of not less than 4.0 percent. At December 31, 1994, the Corporation's Tier 1 and total risk-based capital ratios were 8.86 percent and 12.49 percent, respectively, compared to respective ratios of 9.00 percent and 13.00 percent at December 31, 1993. The 1994 year-end ratios substantially exceed minimum required regulatory ratios of 4.0 percent and 8.0 percent, respectively.\n1. Fully taxable equivalent adjustment\nTax-exempt interest income (for Federal purposes) has been restated to a comparable taxable level. The statutory tax rate used for this purpose was 35 percent in 1995, 1994, and 1993.\n2. Interest income\nThe impact of restructured and nonaccrual loans is reflected in all average balance, net interest income and related yield calculations. Average balances include restructured and nonaccrual loans. Interest income and yields on these assets reflect income recorded on a cash basis.\n3. Volume and rate variances\nThe change in interest income\/expense attributable to volume is calculated by multiplying the annual change in volume by the prior year's rate. The rate variance is calculated by multiplying the annual change in rate by the prior year's volume. Any variance attributable jointly to volume and rate changes is prorated on a weighted basis between volume and rate.\n4. Average rate on portfolio securities\nYields on the portion of average portfolio securities classified as available for sale are based on amortized cost.\nNet Interest Income\nNet interest income, the difference between interest and fees recognized on earning assets and total interest expense, is the major component of operating income for the Corporation. Since income on certain earning assets may be exempt from Federal and\/or State income taxes, the Management's Discussion and Analysis section of this Report is prepared on an FTE basis, which, in effect, restates tax-advantaged income to a comparable level. In 1995, the Corporation's FTE net interest income was $500.3 million, up 4 percent from $480.4 million in 1994.\nThe year-to-year change in net interest income is typically explained by analyzing its two principal components, average earning assets and net interest margin. Average earning assets represent the average volume of assets employed by the Corporation during the year which generate interest income. Net interest margin is the difference between the overall FTE yield on earning assets and the average cost of supporting liabilities, including noninterest-bearing funds. For 1995, the Corporation's average earning assets grew 10 percent, while net interest margin decreased 20 basis points from 3.95 percent in 1994 to 3.75 percent in 1995.\nAverage earning assets in 1995 totaled $13.33 billion, up $1.16 billion, or 10 percent, from $12.17 billion in 1994. This growth is primarily the result of an increase in average loans of $1.11 billion, or 15 percent, to $8.79 billion, led by increases in average commercial, charge card, real estate and installment loan outstandings of $608 million (12 percent), $232 million (31 percent), $174 million (14 percent), and $85 million (20 percent), respectively. The growth in average loans is attributable to both a growing demand for credit in the U.S. economy and an aggressive marketing effort by the Corporation. Average portfolio securities increased $349 million, or 11 percent, to $3.58 billion primarily as a result of increased holdings of Federal agency securities of $542 million. Loans and portfolio securities, as a percent of earning assets, were 65.9 percent and 26.9 percent, respectively, compared to 63.1 percent and 26.6 percent, respectively, in 1994. Average federal funds sold and securities purchased under agreement to resell decreased approximately 38 percent, or $206 million, year to year.\nChanges in the mix of total supporting funds are a function of loan demand, consumer preferences for maintaining funds in so-called core deposits and wholesale market spreads. The Corporation manages its wholesale funding activity at the margin primarily by using the least expensive products given requirements for matched funding, maturity, ability and expected cost to refund, reserve requirements and deposit insurance costs. Secured borrowings, such as repurchase agreements, may also depend on availability of collateral. Nearly all major categories of supporting liabilities increased year to year. The issuance of new senior notes totaling $512 million accounted for the largest increase in supporting liabilities. Short-term borrowings rose $356 million or 13 percent from 1994 levels. Federal funds purchased and securities sold under agreement to repurchase grew $329 million, representing 93 percent of the growth in short- term borrowings. Domestic interest-bearing deposits increased $56 million, or 1 percent, from one year ago. Average foreign office time deposits totaled $2.4 billion, up 16 percent or $328 million, compared to $2.1 billion in 1994. Noninterest-bearing funds supporting earning assets decreased $90 million, and declined from 20 percent to 18 percent year to year as a percentage of average supporting liabilities.\nThe Corporation's consolidated net interest margin declined to 3.75 percent from 3.95 percent in the prior year. This decrease reflects rate compression within certain asset categories, the maturity of certain higher-yielding municipal bond holdings, the narrowed relationship which existed in the market between short and longer term rates (i.e. flattened yield curve), the relative decline in noninterest-bearing funds and sales and maturities of portfolio securities where proceeds were reinvested at slightly lower yields. This was somewhat offset by an improved mix of earning assets resulting from the aforementioned loan growth.\nNoninterest income for the year was $338.3 million in 1995, up $23.8 million or 8 percent from 1994, primarily due to an $18.1 million increase in net gains from the sale of debt securities. During the second quarter of 1995, conditions in the U.S. bond market led to significant price rallies, enabling the Corporation to sell certain U.S. government agency securities and reinvest the proceeds to reposition its portfolio and take advantage of profit opportunities not typically available.\nTrading account gains, primarily from municipal bond trading, totaled $5.1 million up $5.5 million from the prior year when these activities reported losses of $.4 million. Financial results from trading activities will typically exhibit greater fluctuations over time than other business activities. Charge card fees were $41.8 million in 1995, up $4.4 million or 12 percent from the previous year as a result of charge card loan volume increases. Trust and investment management fees were $150.0 million up $1.9 million or 1 percent from the prior year. On January 11, 1996 the Corporation announced the sale of its securities custody and related trustee services business for large institutions to Citibank. After restructuring charges, it is estimated that the net gain on the sale will approximate $4.0 million in 1996. The sale of the custody business for large institutions is not expected to have a material impact on 1996 earnings.\nForeign exchange revenues were $14.2 million, down $5.5 million or 28 percent from 1994. Effective April 3, 1995, the Corporation and BMO agreed to combine their U.S. foreign exchange activities (\"FX\"). Under this arrangement, FX net profit will be shared by the Corporation and BMO in accordance with a specific formula set forth in the agreement. This agreement expires in April 2002 but may be extended at that time. Either party may terminate the arrangement at its option. Beginning with second quarter 1995, FX revenues were reported net of expenses. This agreement did not have a material impact on the Corporation's 1995 net income or financial position as of December 31, 1995. Service fees and charges were $69.3 million, down $4.3 million or 6 percent from last year due to the higher interest rate environment and customer refunds with respect to FDIC insurance.\nNoninterest expenses totaled $560.1 million, down $44.0 million or 7 percent from 1994. In 1994, the Corporation recorded a one-time $51.3 million pretax charge to absorb the impact of higher interest rates on mortgage-backed securities held in certain customer accounts of HTSB's Securities Lending unit. Excluding the effect of this item, 1995 noninterest expenses would have increased $7.3 million or 1 percent from 1994 and 1994 noninterest expenses would have approximated 1993 levels.\nThe aforementioned charge in the second quarter of 1994 resulted from investments of cash collateral managed by HTSB as agent for certain of its institutional trust customers in its Securities Lending unit. The investments consisted of floating rate mortgage-backed securities with caps on interest ranging from 8.5 percent to 10 percent. HTSB's Securities Lending unit had invested in these types of securities on behalf of customers since 1991, with the total positions growing to $2.3 billion (representing about one-third of total customer positions) by the second quarter of 1994. HTSB management believed that the securities satisfied customer guidelines at the time of their acquisition. All securities were AAA rated and the interest returns were tied to movements in LIBOR. As of March 31, 1994 and December 31, 1993, HTSB had no reason to believe that there were either imbedded customer losses on these securities or that they violated customer guidelines for appropriate investments. Subsequent to March 31, 1994, rising short-term rates substantially extended the average duration of the securities. At that point, customers had an exposure to long-term securities in portfolios that should be kept relatively short. Given customer expectations and a con-\ncern that further rate increases could have a disproportionate negative impact on market values, HTSB made a decision to eliminate all the mortgage-backed securities from these customer accounts and absorb the full loss on behalf of customers. Of the approximately $2.3 billion outstanding, one-third was sold into the market place while the remaining two-thirds were sold to the Corporation's ultimate parent, BMO. Sales prices were determined based on available market quotations, which resulted in a loss approximating $51.3 million ($33.4 million after-tax). At June 30, 1994, all mortgage-backed securities that had been included in this portfolio were disposed of, and neither HTSB nor its customers were at risk for subsequent declines in the market value of those securities.\nDeposit insurance was $8.1 million, down $7.6 million or 48 percent from 1994, reflecting lower FDIC insurance premiums in 1995, primarily in the latter half of the year. These premiums, assessed at individual bank subsidiaries, were reduced for U.S. banks with favorable risk characteristics.\nEmployment expenses were $318.3 million, up $5.7 million or 2 percent from the previous year, reflecting normal salary increases, greater incentive payments attributable to substantially stronger earnings performance partially offset by reduced pension and retiree medical expenses. Communication and delivery expenses were $20.3 million, an increase of $2.5 million or 14 percent over 1994 due primarily to postage and printing for promotions and increased use of communications technology. Net occupancy costs were $46.1 million, up $1.0 million or 2 percent from 1994 reflecting increased rental expenses partially offset by lower real estate taxes and building maintenance.\n1993 noninterest expenses included the reversal of $7.2 million of reserves previously recorded for anticipated costs of customer guarantees that were no longer necessary.\nIncome Taxes\nThe Corporation recorded income tax expense of $70.2 million in 1995, compared to $24.5 million in 1994, primarily due to higher (approximately $89.7 million FTE) pretax earnings and a reduction in the current year's tax-exempt income. The Corporation's effective tax rate increased to 32.2% in 1995 from 20.1% in 1994.\nAt December 31, 1995, the Corporation's Federal and Illinois net deferred tax assets were $62.4 million and $12.1 million, respectively. The Corporation has fully recognized both its Federal and Illinois deferred tax assets. Current taxable income and taxable income generated in the statutory carryback period is sufficient to support the entire Federal and Illinois deferred tax assets.\nThe deferred taxes reported on the Corporation's Statement of Condition at December 31, 1995 also include a $17.8 million liability for the tax effect of unrealized gains or losses associated with marking to market certain securities designated as available for sale in accordance with SFAS No. 115.\nImpact of New Accounting Standards\nIn March 1995, the FASB issued SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. This Statement applies to long-lived assets, certain identifiable intangibles and goodwill related to those assets to be held and used and to long-lived assets and certain identifiable intangibles to be disposed of. The Statement requires that long- lived assets to be held and used be reviewed for impairment when events indicate that the carrying value of an asset may not be recoverable and that impairment be measured based on the fair value of the asset. The Statement requires that long-lived assets to be disposed of be reported at the lower of carrying value or fair value less cost to sell, except for assets covered by APB 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. This Statement is effective for fiscal years beginning after December 15, 1995. The Corporation intends to adopt the Statement in 1996 and does not expect it to have a material effect on the Corporation's financial position or results of operations.\nIn May 1995, the FASB issued SFAS No. 122, Accounting for Mortgage Servicing Rights. This Statement amends SFAS No. 65, Accounting for Certain Mortgage Banking Activities. The Statement applies to transactions in which a mortgage banking enterprise acquires mortgage servicing rights through the purchase or origination of mortgage loans and then sells or securitizes those loans with servicing rights retained by the seller. The Statement requires that the rights to service mortgage loans for others be recognized as separate assets by allocating the total cost of the mortgage loans to the mortgage servicing rights and the loans (without the mortgage servicing rights) based on their relative fair values. The Statement also requires that the capitalized mortgage servicing rights be periodically evaluated for impairment based on the fair value of those rights. The Statement applies prospectively in fiscal years beginning after December 15, 1995. The Corporation intends to adopt the Statement in 1996 and does not expect it to have a material effect on the Corporation's financial position or results of operations.\nIn October 1995, the FASB issued SFAS No. 123, Accounting for Stock-Based Compensation. This Statement applies to transactions in which an employer issues shares of its stock or other equity instruments to employees or incurs liabilities to employees based on the price of its stock or other equity instruments. The Statement also applies to transactions in which an entity issues shares of its stock or other equity instruments to nonemployees in exchange for goods or services. The Statement establishes a fair value based method of accounting for stock-based compensation plans and proposes the use of that method rather than an intrinsic value based method as prescribed by APB Opinion No. 25, Accounting for Stock Issued to Employees. The Statement is effective for fiscal years beginning after December 15, 1995. At 1995 year-end, the Corporation had no stock options outstanding. During the first quarter of 1996, options were issued to certain executives of the Corporation's subsidiaries enabling them to acquire Bank of Montreal shares under specific circumstances. The Corporation is currently evaluating the alternatives available under SFAS No. 123 but does not believe that the impact of adopting the Statement will be material.\nOn November 15, 1995, the FASB issued a Special Report, A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities. As described in detail in Question 61 of that report, an enterprise was allowed to conduct a one-time reassessment of the classifications of securities held. Any reclassifications from the held-to-maturity category made in conjunction with that reassessment will not call into question an enterprise's intent to hold other debt securities to maturity in the future and must be accounted for as transfers in accordance with paragraph 15 of Statement 115 and disclosed in accordance with Paragraph 22. The FASB intended that any resulting one-time reclassifications would occur on a single date between November 15, 1995 and December 31, 1995. The Corporation reclassified all held- to-maturity securities to available-for-sale on December 29, 1995. The transaction did not have a material effect on the Corporation's financial position. For additional information, see Note 2 to Financial Statements on page 41 of this Report.\nReturn on Assets and Common Stockholder's Equity\nReturn on assets, measured by net income as a percentage of average total assets, was .95 percent in 1995 compared with .68 percent in 1994. The current year's return on assets was higher than the average return on assets of .84 percent for the five-year period ended December 31, 1995. Average common stockholder's equity to average total assets provides a measure of leverage for the Corporation. Return on common stockholder's equity is computed by dividing return on assets by this leverage ratio. The ratio of average common stockholder's equity to average total assets was 6.99 percent in 1995 compared to 7.06 percent in 1994. For 1995, the return on common stockholder's equity was 13.61 percent, up from the 9.70 percent achieved in 1994 and greater than the 12.21 percent five-year average return for the period ended December 31, 1995. Returns on both average assets and common stockholder's equity in 1994 were adversely affected by the one-time $33.4 million after-tax charge related to HTSB's Securities Lending unit. Excluding this charge, in 1994 return on assets would have been approximately .92 percent and return on common equity would have been approximately 13.02 percent.\n(1) Total average assets and average common equity used in these calculations include average gross and net unrealized gains or losses on available for sale securities, respectively.\n(2) Dividends as a percent of net income. 1995 ratio includes the impact of a $205 million special dividend as part of a capital restructuring. Excluding the payment of the special dividend, the dividend payout ratio would have been 39.11 percent.\n(3) Earnings retained is defined as net income minus dividends. 1995 includes the impact of a $205 million special dividend as part of a capital restructuring. Excluding the payment of the special dividend, earnings retained as a percentage of common stockholder's equity would have been 8.29 percent.\nCapital Position\nThe Corporation's equity capital of $1.15 billion at December 31, 1995, has increased significantly from five years earlier when equity capital amounted to $805 million. Growth has come primarily from the of earnings and the recent issuance of preferred stock. During 1995, Bankcorp declared and paid $262.7 million of cash dividends, including a $205 million special dividend as part of a capital restructuring. For additional information see the Summary of 1995 Compared to 1994 section of this Report. During 1994 and 1993, dividends declared and paid amounted to $34.7 million and $56.6 million, respectively. Included in 1993 dividends were cash dividends of $49.4 million and a $7.2 million dividend-in-kind related to the transfer of Harris Futures Corporation to Bankmont. During 1995, the Corporation's equity capital was increased by $59.8 million of after-tax unrealized holding gains related to the Corporation's debt and equity securities classified as available for sale. During 1994, equity capital was reduced by $59.1 million of after-tax unrealized holding losses. Average consolidated equity capital for 1995 was $1.1 billion, compared with the 1994 average of $1.0 billion and the 1993 average of $956 million.\nBankcorp's double leverage ratio, which is the Bankcorp parent company-only net equity investment in bank and nonbank subsidiaries and other equity investments as a percentage of its equity capital, was 103 percent at December 31, 1995, up from 101 percent at December 31, 1994. This ratio generally measures the extent to which holding company equity investments are supported, in part, by parent-issued debt instruments. A double leverage ratio greater than 100 percent indicates that parent company equity investments are supported, in part, by parent-issued debt. In the case of Bankcorp, outstanding long-term debt is sufficient to fund equity investments not otherwise covered by equity capital.\nRisk-Based Capital\nU.S. banking regulators have issued risk-based capital guidelines, based on the international \"Basle Committee\" agreement, which are applicable to all U.S. banks and bank holding companies. These guidelines serve to: 1) establish a uniform capital framework which is more sensitive to risk factors, including off-balance-sheet exposures; 2) promote the strengthening of capital positions; and 3)diminish a source of competitive inequality arising from differences in supervisory requirements among countries. Bankcorp, as a U.S. bank holding company, and HTSB, as a state-member bank, must each adhere to the guidelines of the Federal Reserve Board (the \"Board\"), which are not significantly different than those published by other U.S. banking regulators. Effective December 31, 1992, the guidelines specify minimum ratios for Tier 1 capital to risk-weighted assets of 4 percent and total regulatory capital to risk-weighted assets of 8 percent.\nRisk-based capital guidelines define total capital to consist of Tier 1 (core) and Tier 2 (supplementary) capital. In general, Tier 1 capital is comprised of stockholder's equity, including certain types of preferred stock, less goodwill and cer-\ntain other intangibles. Core capital must comprise at least 50 percent of total capital. Tier 2 capital basically includes subordinated debt (less a discount factor during the five years prior to maturity), other types of preferred stock and the allowance for possible credit losses. At year-end 1995, the portion of the allowance for possible credit losses includable in Tier 2 capital is limited to 1.25 percent of risk-weighted assets. The Corporation's Tier 1 and total risk-based capital ratios were 8.14 percent and 11.79 percent, respectively, at December 31, 1995.\nThe Board also requires an additional measure of capital adequacy, the Tier 1 leverage ratio, which is evaluated in conjunction with risk-based capital ratios. The Tier 1 leverage ratio is computed by dividing period-end Tier 1 capital by adjusted quarterly average assets. The Board established a minimum ratio of 3 percent applicable only to the strongest banking organizations having, among other things, excellent asset quality, high liquidity, good earnings and no undue interest rate risk exposure. Other institutions, including those experiencing or anticipating significant growth, are expected to maintain a ratio which exceeds the 3 percent minimum by at least 100 to 200 basis points. The Corporation's Tier 1 leverage ratio was 6.77 percent for fourth quarter 1995 and 7.03 percent for fourth quarter 1994.\nThe Federal Deposit Insurance Corporation Improvement Act of 1991 contains several provisions that established five capital categories for all FDIC-insured institutions ranging from \"well capitalized\" to \"critically undercapitalized.\" Based on those regulations effective at December 31, 1995, all of the Corporation's subsidiary banks were designated as \"well capitalized\" at year-end 1995, the highest capital category.\nIn February 1993, the Board revised the capital adequacy guidelines by further restricting the inclusion of intangible assets in Tier 1 capital. Purchased mortgage servicing rights and the premium on purchased credit card relationships are, in general, included with (i.e., not deducted from) Tier 1 capital provided that, in the aggregate, they do not exceed a limit of 50 percent of Tier 1 capital. In addition, intangibles from purchased credit card relationships may not exceed a sublimit of 25 percent of Tier 1 capital. All other intangibles (including core deposit premiums), along with amounts in excess of the above limits, are deducted from Tier 1 capital for purposes of risk-based and leverage capital ratio calculations. Identifiable intangibles acquired before February 19, 1992 continue to be included with Tier 1 capital. The previous requirement to deduct all goodwill from Tier 1 capital is unchanged. At December 31, 1995, the Corporation's intangible assets totaled $38.4 million, including approximately $1.0 million of intangibles excluded under the new rules and an additional $16.5 million of goodwill excluded under 1992 guidelines. The Corporation's tangible Tier 1 leverage ratio (which excludes all intangibles) was 6.65 percent for the fourth quarter of 1995.\nIn September 1993, U.S. banking regulators proposed adding an additional element to risk-based capital rules which would essentially require financial institutions with levels of interest-rate risk above a specified threshold amount to maintain higher capital levels. Based on the proposed rules, management does not expect any of the Corporation's banking subsidiaries to be subject to these higher capital requirements.\nEffective January 17, 1995, the Board issued amendments to its risk-based capital guidelines for state member banks regarding concentration of credit risk and risks of nontraditional activities. The guidelines now explicitly identify these items, as well as an institution's ability to manage them, as important factors in assessing the institution's overall capital adequacy. The Corporation does not expect this amendment to have a significant effect on its capital adequacy.\nThe Board further amended risk-based capital guidelines relating to deferred tax assets. Effective April 1, 1995, deferred tax assets included in Tier 1 capital are limited to the amount of taxable income that an institution expects to realize within one year of its quarter-end report date or 10 percent of Tier 1 capital, whichever is less. Deferred tax assets that can be realized from taxes paid in prior carryback years are generally not limited. This amendment did not have a material impact on its risk-based capital ratios.\nAs of December 31, 1993, the Corporation adopted SFAS No. 115-Accounting for Certain Investments in Debt and Equity Securities. This pronouncement requires an adjustment to stockholder's equity for the tax effected unrealized gain or loss associated with marking to market securities designated as available for sale. Effective December 31, 1994, the Board amended its risk- based capital guidelines to exclude net unrealized holding gains (losses) from Tier 1 capital with the exception of unrealized depreciation of marketable equity securities, which will continue to be deducted from Tier 1 capital. Net unrealized holding gains(losses) excluded for risk-based capital purposes amounted to $27.1 million and $(32.7) million at December 31, 1995 and 1994, respectively.\nThe following table summarizes the Corporation's risk-based capital ratios and Tier 1 leverage ratio for the past three years.\nLiquidity And Sources of Funds\nSummary\nEffective liquidity management allows a banking institution to accommodate the changing net funds flow requirements of customers who may deposit or withdraw funds, or modify their credit requirements. One of the principal obligations of the banking system, and individual banks, is to provide for the legitimate credit demands of customers. The liquidity of the banking system as a whole may be viewed as the ability of the system to satisfy aggregate credit demand; however, individual banks experience changes in liquidity resulting from interbank transfers of deposits which do not affect the liquidity of the banking system. Therefore, liquidity management within individual banks must deal with the potential for greater volatility of net deposit flows which have little or no impact on the banking system itself.\nThe Corporation manages its liquidity position through continuous monitoring of profitability trends, asset quality, interest rate sensitivity, maturity schedules of earning assets and supporting liabilities, the composition of managed and other (primarily demand) liabilities, and prospective customer credit demand based upon knowledge of major customers and overall economic conditions. Appropriate responses to changes in these conditions preserve customer confidence in the ability of the Corporation to continually serve their credit and deposit withdrawal requirements.\nSome level of liquidity is provided by maintaining assets which mature within a short time-frame or could be sold quickly without significant loss. The Corporation's liquid assets include cash and demand balances due from banks, money market assets, portfolio securities available for sale and trading account assets. Liquid assets represented approximately 36 percent of the Corporation's total assets and amounted to $5.65 billion at December 31, 1995 compared to liquid assets of $5.18 billion or approximately 34 percent of total assets one year earlier. However, the most important source of liquidity is the ability to raise funds, as required, in a variety of markets using multiple instruments. This fund-raising activity involves the identification of broadly distributed sources of funds, typically referred to as managed liabilities, which are varied by type, maturity and geographical location of customers. The Corporation monitors and controls the sources of these funds to avoid unwarranted market activity or customer concentrations.\nThe principal sources of external funds available to the Corporation are retail and wholesale liabilities. Retail liabilities are comprised of demand deposits, money market accounts, NOW accounts, passbook savings and nonnegotiable certificates of deposit, typically of small denomination. Wholesale funding sources include Eurodollar deposits in foreign offices, Federal funds borrowed, securities sold under agreement to repurchase, negotiable large denomination certificates of deposit and commercial paper. HTSB offers to institutional investors from time to time, unsecured short-term and medium-term bank notes in an aggregate principal amount of up to $1.5 billion outstanding at any time. The term of each note could range from fourteen days to fifteen years. The notes are subordinated to deposits and rank pari passu with all other senior unsecured indebtedness of HTSB. As of December 31, 1995, $478 million of short-term notes were outstanding with maturities and interest rates ranging from 29 to 180 days and 5.50 to 5.79 percent, respectively. There were no outstandings under this program at December 31, 1994.\nThe Corporation's average volume of core deposits, consisting of demand deposits, interest checking deposits, savings deposits and certificates, and money market accounts remained consistent with 1994. Core deposits represented 51.9 percent of average supporting liabilities in 1995 down from 56.6 percent in 1994. Average money market liabilities increased 13 percent to $3.01 billion from $2.65 billion for 1994, primarily as a result of increases in Federal funds borrowed and securities sold under repurchase agreements slightly offset by a decrease in commercial paper. Average money market assets decreased $326.3 million or 26.7 percent from 1994 mainly as a result of the increase in loans and portfolio securities. These assets represented 7 percent of average earning assets in 1995 compared to 10 percent one year ago.\nThe Corporation, in connection with the issuance of commercial paper and for other corporate purposes, has a $150 million revolving credit agreement with five nonaffiliated banks and BMO that terminates on December 18, 1999. There were no borrowings under this credit facility in 1995 or 1994.\nThe maintenance of an appropriate balance of maturity and interest rate sensitivity risks between assets and liabilities is an integral component of overall liquidity management. Mismatches of actual asset and liability maturities, or interest rate sensitivity of assets and liabilities, will increase the potential for profit or loss relative to changes in the general level of interest rates. Asset and liability mismatches result in the normal course of servicing customer credit and deposit requirements. The Corporation uses interest rate swaps and financial futures, as appropriate, to reduce the level of financial risk inherent in asset and liability mismatches. Gross cash flows from the Corporation's derivative positions as an end-user were not material to gross cash flows from financing and investing activities. The Corporation's Asset\/Liability Management Committee monitors and adjusts its strategies in response to changing liquidity demands.\nInterest Sensitivity\nInterest rate sensitivity information, in the form of interest sensitivity gap schedules and simulations reflecting exposure of earnings to future changes in interest rates, is used in conjunction with other data by the Corporation's banking subsidiaries to monitor and manage their individual interest rate exposures. The Corporation uses various derivative products, including interest rate swaps, forward rate agreements, futures, options, and forward commitments to manage interest rate sensitivities corresponding to various balance sheet items, thereby modifying its exposure to changing interest rates.\nThe schedule above presents the Corporation's consolidated interest sensitivity gap at December 31, 1995. This point-in-time analysis depicts repricing dates for earning assets, supporting funds and related off-balance- sheet activities. Generally, dates for repricing are included on a contractual basis. A negative gap in a given time span indicates an excess of interest- bearing liabilities over interest earning assets which reprice in that period. After including interest rate swaps, derivative products and forward commitments, at December 31, 1995, the Corporation had a cumulative negative one-year interest rate gap of $301 million. This measure, called the \"contractual gap\" position, is calculated without regard to the existence of nonrepricing items, the behavior of which must be considered in the evaluation of the Corporation's overall interest rate sensitivity.\nIn addition to gap measurements, the Corporation uses simulation modeling to measure valuation risk, risk to earnings, assets, liabilities and equity, as a result of various interest rate scenarios and balance sheet structures. Shifts in the yield curve and changes in the shape of the yield curve are among the variables considered. Limits are established for valuation risk at the individual bank and consolidated levels and actual exposure is monitored to ensure that these limits are not exceeded. At December 31, 1995, simulations indicate that for an immediate 100 basis point upward movement in interest rates, net interest income would increase by approximately $8 million over the next year compared to what it would otherwise have been, and the change in the value of all gap positions, contractual and non-contractual, would be $55 million lower. Conversely, a decline in rates would have approximately the same absolute impact but in the opposite direction.\nManagement believes that the Corporation is well positioned with its mix of assets and liabilities to respond to interest rate movements in either direction.\nCash Flows\nCash flow analysis is an essential element for evaluating a company's ability to satisfy its obligations to short- and long-term creditors, bondholders and investors. The Corporation's Consolidated Statement of Cash Flows can be found on page 37 of this Report. This financial statement is based on period-end balances and does not reflect average investment or financing levels.\nAs a bank holding company, the Corporation regularly receives and disperses large volumes of cash and cash equivalents. Since these gross numbers provide little additional information to financial statement users, the FASB permits bank holding companies to net certain cash receipts and payments in their cash flow statements. The Corporation has adopted this net presentation for loans and deposits.\nThe Corporation's Consolidated Statement of Cash Flows divides its activities into three main categories: operating, investing and financing. Operating activities consist of those activities not categorized as investing or financing and generally include cash revenues and expenses associated with providing services to customers. Investing cash flows are defined as those arising from the acquisition or disposal of loans, portfolio securities, money market assets, subsidiaries, and fixed assets. Financing cash flows include both infusions from and dividend payments to stockholders, along with borrowings and principal repayments to bondholders or other creditors.\nCash flows from operations are a significant source of operating capital. Since applicable accounting statements require that cash transactions involving assets held for sale and for trading purposes be included with operating cash flows, normal year-end fluctuations in these holdings may not appropriately portray the company's generated cash flows from operations. Excluding net changes in loans held for sale and trading account assets, cash generated from operations amounted to approximately $266 million in 1995 and $133 million in 1994. The change in cash flows from operations, from year to year, was mainly due to increases in net income before provision for credit losses and gains on sales of portfolio securities. Year-end trading account assets increased $63 million year to year, while loans held for sale (primarily residential mortgages) increased $21 million.\nIn 1995, the Corporation's investing activities utilized a total of $252 million in net cash. Loans, the primary use of new funds, increased $1.31 billion. Interest-bearing deposits at banks decreased $300 million, Federal funds sold and securities purchased under agreement to resell decreased $225 million, and portfolio securities decreased $421 million in 1995.\nIn 1995, the Corporation's financing activities included accepting customer deposits, purchasing Federal funds and issuing long-term notes, short-term senior notes and preferred stock. Financing activities provided $192 million of net cash to the Corporation in 1995. Deposits increased $309 million. In addition, net new short-term senior notes and preferred stock of $478 million and $180 million, respectively, were issued. Gross cash received and paid resulting from the Corporation's derivative positions as an end-user were not material relative to gross cash flows from financing or investing transactions.\nSince 1992, the Corporation has had three significant noncash transactions. On December 29, 1995, all held to maturity securities were reclassified to available for sale. See Portfolio Securities section below for further information. On December 31, 1993, the Corporation adopted SFAS No. 115-- Accounting for Certain Investments in Debt and Equity Securities. In compliance with this Statement, portfolio securities designated as available for sale are marked to market on the Corporation's Consolidated Statement of Condition. On July 1, 1993, the Corporation paid a $7.2 million dividend-in-kind to Bankmont related to the transfer of Harris Futures Corporation. Non-cash portions of these transactions were excluded from the Corporation's Consolidated Statement of Cash Flows.\nSelected Loan Maturity Spread\nVariable rate loans, excluding consumer loans, accounted for 55 percent of total loans in 1995 compared to 57 percent in 1994. Excluding consumer loans, term loans (those with a remaining contractual maturity in excess of one year) totaled $1.035 billion. Of these loans, $893 million or 86 percent are due within five years. Overall, the average FTE yield on total loans increased to 8.89 percent in 1995 from 7.75 percent in 1994. The Corporation's average prime rate in 1995 was 8.83 percent compared to 7.07 percent in 1994.\nPortfolio Securities\nOn December 31, 1993, the Corporation adopted SFAS No. 115--Accounting for Certain Investments in Debt and Equity Securities, which requires debt and marketable equity securities to be classified into three categories. Trading account securities continue to include those securities purchased for sale in the near term. The remaining securities have been segregated into \"Held to Maturity\" and \"Available for Sale\" categories. Held to maturity securities include those debt securities where a company has both the ability and positive intent to hold to maturity. All other securities are classified as available for sale, even if the company has no current intent to dispose of them. Held to maturity securities are carried at amortized historical cost while available for sale securities are carried at fair value, with net unrealized gains and losses (after-tax) reported as a separate component of equity.\nThroughout this Report the term \"portfolio securities\" encompasses both the held to maturity and available for sale categories. At December 31, 1995, available for sale securities included $44.9 million of fair value above amortized cost, and stockholder's equity included $27.1 million of unrealized (after tax effect) holding gains.\nPortfolio securities averaged $3.57 billion in 1995. On an FTE basis, interest income from portfolio securities increased $31.6 million to $241 million. The overall FTE yield on the Corporation's portfolio securities averaged 6.72 percent during 1995. Yields on the portion of average portfolio securities classified as available for sale are based on amortized cost.\nThe Corporation periodically repositions its investment portfolio in response to changes in laws, in order to meet regulatory capital requirements or, as part of asset\/liability management, to enhance future net interest income levels while maintaining an appropriate risk\/reward relationship. During 1995, the Corporation purchased $7.09 billion of available for sale securities and $445 million of held to maturity securities, sold $2.03 billion of available for sale securities and had $5.22 billion available for sale securities and $714 million held to maturity securities mature. The aforementioned sales of portfolio securities generated a pretax net gain of $23.4 million during 1995 compared to a net gain of $5.3 million during 1994 and $13.0 million in 1993. $16.8 million of net gain was realized in the second quarter of 1995 when conditions in the U.S. bond market led to significant price rallies. These events enabled the Corporation to sell certain U.S. government agency securities and reinvest the proceeds to reposition its portfolio and take advantage of profit opportunities not typically available. On an after-tax basis, the Corporation recorded a net gain from securities sales of $14.3 million in 1995 compared to $3.2 million in 1994 and $7.9 million in 1993. In some cases, security gains are taken in order to realize otherwise unrealized profits in anticipation of near-term increases in interest rates.\nOn November 15, 1995, the FASB issued a Special Report, A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities. In accordance with that report, the Corporation conducted a one-time reassessment of the classifications of all securities held. As a result, the Corporation reclassified all held to maturity securities to available for sale on December 29, 1995. The amortized cost of the transferred securities was $839 million and the related unrealized gross holding gain was $20 million.\nThe estimated market value of held to maturity securities was $1,102 million at December 31, 1994, compared to a carrying value of $1,108 million. See Note 2 to Financial Statements, page 41 of this Report for details on specific types of securities.\nUnrealized holding gains for available for sale securities, as of December 31, 1995, amounted to $44.9 million compared to unrealized holding losses of $54.2 million as of December 31, 1994. The change in net unrealized gains and losses of $99.1 million was due to gains in market value as a result of declines in interest rates during the year, a change in the mix of the portfolio and the aforementioned reclassification of all held to maturity securities.\nAt year-end 1995, the weighted average maturity of the Corporation's portfolio securities was 3 years and 3 months, an increase of 1 year from the average maturity at the end of 1994. The maturity distribution of the investment portfolio at December 31, 1995, together with the approximate taxable equivalent yield of the portfolio, is presented in the following table. The weighted average yields shown are computed by dividing an annualized interest income amount, including the accretion of discounts and the amortization of premiums, by the amortized cost of the securities outstanding at December 31, 1995. Yields on tax-exempt securities have been calculated on an FTE basis.\nOther than securities of the U.S. Government and its agencies and corporations, at December 31, 1995, there were no portfolio securities of any one issuer aggregating more than 10 percent of stockholder's equity of the Corporation. In the opinion of management, there were no material investments in securities which would have constituted an unusual risk or uncertainty for the Corporation at December 31, 1995.\nDeposits\nTotal deposits in 1995 averaged $10.04 billion, up $321 million or 3 percent from 1994. Average total deposits in foreign offices experienced the largest growth, up $325 million or 15 percent over 1994 levels. The growth was attributed primarily to foreign office time deposits which increased by $328 million to $2.40 billion, up 16 percent from 1994. The Corporation's core deposits, consisting of demand deposits, interest checking deposits, money market accounts, passbook and statement savings accounts and savings certificates grew $36 million or 1 percent to $6.92 billion. Savings certificates increased by $259 million while money market accounts decreased by $132 million and demand deposits decreased $51 million, accounting for the net increase in core deposits. Other time deposits decreased $40 million or 6% from 1994 levels. Daily averages and year to year comparisons are summarized below.\nInterest expense on deposits increased by $109 million or 43 percent in 1995 primarily due to higher effective interest rates. Interest expense on domestic deposits rose 34 percent from 1994, while interest on foreign office deposits increased by 60 percent compared to the prior year. Effective interest rates on both domestic and foreign office interest-bearing deposits are summarized below.\nCertificates of deposit in denominations of $100,000 or more issued by domestic offices totaled $1.12 billion at December 31, 1995. These deposits totaled $653 million and $753 million at December 31, 1994 and 1993, respectively. During the past three years, virtually all time deposits in foreign offices were in denominations of $100,000 or more.\nThe remaining maturity of domestic office certificates of deposit of $100,000 or more is as follows:\nMoney Market Assets and Liabilities\nThe Corporation conducts most of its money market activities through HTSB. Average money market assets, consisting primarily of interest-bearing deposits at banks, Federal funds sold and securities purchased under agreement to resell, decreased 27 percent to $897 million in 1995 from $1.22 billion in 1994. The average yield on money market assets increased from 4.27 percent in 1994 to 6.46 percent in 1995. Interest income earned on these assets increased 11 percent to $57.9 million in 1995. At December 31, 1995, interest-bearing deposits at banks, Federal funds sold and reverse repurchase agreements totaled $458 million, $100 million and $79 million, respectively, compared to $757 million, $394 million and $10 million at year-end 1994. The decrease in money market assets was primarily the result of accommodating customers' borrowing requirements at the end of 1995, thereby increasing loan volume.\nMoney market liabilities, consisting of Federal funds purchased, securities sold under agreement to repurchase, commercial paper and other short-term borrowings, represent a managed source of funds for the Corporation. During 1995, money market liabilities averaged $3.01 billion, an increase of 13 percent from 1994, when money market liabilities averaged $2.65 billion. The average rate paid on these borrowings increased from 4.09 percent in 1994 to 5.61 percent in 1995, reflecting generally higher short-term interest rates experienced by the market during 1995. At December 31, 1995, repurchase agreements totaled $1.18 billion compared to $1.53 billion at year-end 1994. Federal funds purchased and securities sold under agreement to repurchase consist of overnight Federal funds borrowed and securities sold to banks, brokers and corporations under agreement to repurchase. The repurchase agreements are generally outstanding for periods ranging from one day to six months. The following amounts and rates applied during 1995, 1994 and 1993:\nShort-term borrowings consist primarily of term borrowings in excess of three days, term Federal funds purchased and short sales of securities. The following amounts and rates applied during 1995, 1994 and 1993:\nCommercial paper has been sold directly by Bankcorp to a number of investors, including individuals, partnerships, corporations, banks and other financial institutions in various amounts with initial terms not exceeding 270 days. The following amounts and rates applied during 1995, 1994 and 1993:\nLoans\nSummary\nIn 1995, significant year-to-year loan growth occurred among the following loan categories: manufacturing and processing, public and private service industries, other financial institutions, mortgages secured by commercial and residential property, charge card and other installment.\nDistribution of Loans by Type of Borrower\nAverage loans increased by 15 percent during 1995 compared to 1994. Daily average loans over the last five years were as follows:\nLending is diversified into several categories at the Corporation. Concentrations to individual and related customers are monitored and risks within specific industries are tracked in order to reduce overall expense. When lending to specialized industries such as Agribusiness or Futures and Securities, the risks are mitigated by following specifically developed policies and procedures in the underwriting process as well as obtaining security for most of these transactions. Secured and unsecured loans totaled $5.87 billion and $3.65 billion, respectively, of total loans at 1995 year-end.\nRisk Management\nSummary\nIn a commercial banking environment, corporate personnel must identify, quantify, monitor, evaluate and manage the risks inherent in its businesses, product lines and other activities. Through its risk management framework which continued to be enhanced during 1995, the Corporation: 1) maintains a clear philosophy, approach and accountabilities towards risk taking activities in well documented policies, directives and procedures; 2) fosters an environment where risks incurred are commensurate with an individual's qualifications, skills and expertise; 3) implements risk measures and limits to contain, diversify, or otherwise mitigate certain risks the Corporation faces; and 4) continuously enhances information flows and reporting to monitor exposures and ensure timely responses to any change in risk profiles. The risk management framework helps to ensure the Corporation employs its capital efficiently and achieves returns commensurate with the risk undertaken.\nThe Corporation's risk management process includes continuous monitoring and review of the following classes of risk: 1) Credit risk, which is risk of loss of principal, interest or revenues due to the obligor's inability or failure to repay a financial obligation. This includes loan loss risk, replacement risk, and settlement risk. 2) Position risk, which is risk of loss associated with taking a position in an asset and is inclusive of interest rate risk, foreign exchange risk and liquidity risk. 3) Operating risk, which is risk that systems and control environments do not accurately or safely process transactions or assets. Legal and regulatory risks are included in this category. 4) Fiduciary risk, which arises when the Corporation, or its employees acting purportedly on its behalf, take actions which violate the trust and confidence properly placed in the Corporation by the client.\nThe Corporation applies a comprehensive risk assessment framework to monitor these risks by line of business, customer and product line. The roles and relationships of the Corporation's Management Committees and the Board Oversight Committees are well defined and ensure comprehensive risk management and oversight. The Risk Management and Fiduciary Risk Management Committees are manned by senior managers from various business units of the Corporation who bring specialized expertise to bear on risk management issues. Through this risk management structure, the Corporation evaluates risks, establishes formal policies, sets risk\/return parameters and reviews performance versus objectives. Management believes that effective policies, procedures, monitoring and review systems are in place to determine that risk is thoroughly and effectively analyzed, risk is well diversified, any exceptions are dealt with in a timely manner and compensation for risk is appropriately established and meets return objectives.\nAlthough the majority of the Corporation's customers are located in the Midwestern region of the United States, this risk is mitigated by a number of factors (see Note 9 to Financial Statements on page 49 of this Report for a detailed discussion). Further, the Corporation maintains a watch on the economic health of the region, primarily to address risk in its consumer lending business. With the national unemployment rate for the 1995 fourth quarter at 5.6 percent and projected to increase to 5.9 percent in 1996, the unemployment rate in the various states of the Midwestern region is also expected to be equal to, or lower than, the national rate due to a resurgence of traditional manufacturing. Real estate sales of existing housing in Illinois are expected to remain strong relative to many other areas of the country because of the strength of the job market and loan rates on adjustable mortgages.\nThe level of credit risk inherent in the Corporation's earning assets is evidenced, in part, by nonperforming assets consisting of loans placed on nonaccrual status when collection of interest is doubtful, restructured loans on which interest is being accrued but which have terms that have been renegotiated to provide for a reduction of interest or principal, and real estate or other assets which have been acquired in full or partial settlement of defaulted loans. These assets, as a group, are not earning at rates comparable to other earning assets. Assets received in satisfaction of debt are recorded by the Corporation at lower of cost or fair value less estimated sales costs. Losses of principal on nonperforming assets are charged off when, in management's opinion, the amounts are uncollectible. Interest on nonaccrual loans is recognized as income only at the time cash is received, although such interest may be applied to reduce a loan's carrying value if the collectibility of principal is in doubt. Information is reported monthly to the Board of Directors regarding nonperforming loans and other nonperforming assets owned, primarily real estate. During the first quarter of 1995, the Corporation adopted SFAS No. 114- Accounting by Creditors for Impairment of a Loan and SFAS No. 118-Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures. For additional information see Notes 1 and 4 to Financial Statements on pages 39 and 42 of this Report.\nManagement places an individual commercial or real estate credit on nonaccrual status when the collection of interest is doubtful or when principal or interest is 90 days past due unless the past due amounts are in process of collection and the loan is adequately collateralized. Consumer loans and charge card receivables are charged off when 180 and 150 days past due, respectively. Accrued interest on charge card loans is reversed against interest income when principal is charged-off. Consumer loans and charge card loans are not normally placed on nonaccrual status. The purpose of this policy is to avoid excessive administrative costs for relatively insignificant balances.\nThe Corporation extends credit to both commercial and retail customers. Lending activities are centered in those industries in which it has demonstrated expertise and specialized knowledge. All recognized risks are mitigated, to the fullest extent possible, through loan structure and the perfection of a security interest in collateral. The Corporation prescribes, within policy guidelines, specific advance rates to be used in lending against readily marketable collateral. These rates take into consideration the collateral type and the term. Other collateral advances are set to reflect the marketability and liquidation value of the collateral and normal advance rates are set by corporate policy with deviations necessitating specific documentation and approval.\nIn addition to risks on earning assets, the Corporation has various commitments and contingent liabilities outstanding that are not reflected on its Statement of Condition. Examples of these \"off-balance-sheet\" items include foreign exchange and interest rate contracts, assets held in trust, loan commitments and letters of credit. Virtually all off-balance-sheet items must conform to the same risk review process as loans and are subject to the Corporation's preset limits on customer and product risk. Various hedging strategies are employed to reduce certain types of exposure. Management reviews the magnitude and quality of outstanding commitments and contingent liabilities.\nNonaccrual, Restructured and Past Due Loans\nManagement closely monitors nonperforming assets, including assets received in satisfaction of debt. Nonperforming assets were .58 percent of total loans at December 31, 1995, compared with 1.15 percent at year-end 1994. All nonperforming loans are domestic.\nInterest shortfall is the difference between the gross amount of interest that would have been recorded if all year-end nonperforming loans had been accruing at their original terms and the cash-basis interest income actually recognized. Interest shortfall was $2.9 million in 1995 compared to $3.9 million a year ago.\nLoan Concentrations\nManagement monitors industry loan concentrations in an effort to maintain a well-diversified loan portfolio. Excluding total residential mortgages and charge card outstandings, at December 31, 1995 the Corporation's loan portfolio did not include any single industry concentration in excess of 10 percent of total consolidated loans.\nThe largest category of the Corporation's loans was domestic commercial, which totaled $4.53 billion, or 48 percent of total outstandings at year-end 1995. Most of these credits were extended to manufacturing and service-related companies. Outstandings to machinery industries represented 22 percent of all manufacturing loans and 3 percent of total consolidated loans. The largest concentration within service-related industries was consumer wholesalers, which accounted for 38 percent of all service-related credits and 8 percent of total loans.\nForeign loans totaled $203 million at year-end 1995, accounting for 2 percent of the Corporation's total outstandings. Further details on the Corporation's foreign loans can be found in the Foreign Outstandings section on page 26 of this Report.\nReal estate loans, including residential mortgages, totaled $2.19 billion at December 31, 1995, or 23 percent of total outstandings. Mortgages collateralized by residential property totaled $1.51 billion, or 16 percent of loans. Commercial real estate mortgages and construction loans totaled $681 million at the end of 1995, representing 7 percent of loans. Further details on the Corporation's commercial real estate outstandings can be found on page 27 of this Report.\nForeign Outstandings\nForeign outstandings consist of loans, acceptances, interest-bearing deposits with other financial institutions and other interest-bearing investments and monetary assets. At December 31, 1995, substantially all foreign outstandings represented U.S.dollar claims. Foreign outstandings of certain countries are net of: a) written guarantees by domestic or other non-local third parties or b) the value of tangible, liquid collateral deemed realizable by the Corporation. A significant portion of the Corporation's foreign outstandings are placed with major financial institutions and governments and their agencies. The Corporation continually monitors its risk related to foreign outstandings and imposes internal limits on its foreign exposure.\nInformation provided in the table on foreign outstandings is presented in accordance with guidelines of the Securities and Exchange Commission and is not intended to be indicative of prudent lending levels.\nAt December 31, 1995, the Corporation had no aggregate public and private sector outstandings to any single country experiencing liquidity problems which exceeded one percent of the Corporation's consolidated assets.\nCommercial Real Estate\nThe commercial real estate market in certain areas of the country has historically experienced depressed conditions from time to time. Many banks with loans to borrowers in this industry have reported large increases in nonperforming assets and corresponding increases in their allowances for credit losses resulting from commercial real estate transactions. This phenomenon tends to be cyclical and varies by location.\nAs of December 31, 1995, the Corporation, primarily through its banking subsidiaries, had outstanding commercial real estate loans of approximately $681 million which included both construction loans and commercial credits collateralized by commercial real estate. The vast majority of these loans are collateralized by real estate located in the Chicago metropolitan area. Of the outstanding commercial real estate loans, approximately $6.4 million were classified as nonperforming assets representing less than 1% of total consolidated loans. There were no material charge-offs related to commercial real estate loans during 1995 or 1994. Other real estate owned and other assets received in satisfaction of debt were $2.5 million at December 31, 1995, compared to $8.1 million at December 31, 1994, and comprised approximately 4% of total nonperforming assets. Management does not currently anticipate the need to increase its allowance for possible credit losses to reflect potential charge- offs in its commercial real estate loan portfolio.\nHighly Leveraged Transactions\nThe Corporation, primarily through HTSB, selectively engages in highly leveraged transactions (\"HLTs\") by originating and participating in financings for highly leveraged customers. Such financings are generally senior and collateralized. The Corporation controls the HLT portfolio through its normal credit extension process with the goal of not materially changing the risk profile of the Corporation.\nThe Corporation internally defines and manages its HLT portfolio using a total debt to assets ratio exceeding 75 percent as an initial indicator of high leverage, though other facts and circumstances of a transaction, such as typical leverage ratios in the customer's industry, may affect that judgment. All loans and letters of credit extended to a highly leveraged customer represent HLT exposure, regardless of their purpose. The following discussion of HLTs uses the Corporation's internal definition.\nAll corporate credit policies are strictly applied to HLT credits. The credit analysis performed on an HLT credit must indicate strong primary debt repayment sources as well as contingency plans providing secondary sources of repayment. The primary source of expected repayment for HLTs is typically cash flow from operations. Most HLT loans are also fully collateralized either by a direct pledge of operating assets or by the stock of operating subsidiaries. Cash flows based on contingent events such as asset sales or substantial operating improvements are not treated as primary repayment sources. If, during the course of the credit review, sensitivity analysis reveals that the borrower's ability to generate future cash flows would be significantly impaired by higher interest rates, the borrower may be required to hedge a meaningful portion of its debt. Pricing guidelines require HLT relationships to earn a premium over existing minimum risk relationship return-on-asset standards.\nThe Corporation manages its HLT portfolio to obtain proper portfolio quality and diversification and, to this end, all HLT credits are subject to periodic review by senior management. Aggregate commitments (including outstandings) are currently capped at $600 million. Overall, target credit outstandings are not to exceed 10 percent of total Corporation loans. Commitments, including outstandings, represented less than 3 percent of the Corporation's outstanding loans at December 31, 1995.\nProvision and Allowance for Possible Credit Losses\nThe provision for credit losses is based upon management's estimate of potential credit losses and its evaluation of the adequacy of the allowance for possible credit losses. Factors which influence management's judgment in estimating credit losses and the adequacy of the allowance include the impact of anticipated general economic conditions, the nature and volume of the current loan portfolio, historical loss experience, the balance of the allowance in relation to total loans outstanding and the evaluation of risks associated with nonperforming loans.\nIn 1994, the Corporation adopted the guidelines set forth under the December 1993 \"Interagency Policy Statement on the Allowance for Loan and Lease Losses\" issued by the Office of the Comptroller of the Currency, the Office of Thrift Supervision, the Federal Deposit Insurance Corporation and the Federal Reserve Board. This statement outlines a methodology management should follow in order to properly measure the adequacy of the allowance for possible credit losses. It includes specific quantitative measures as well as certain subjective factors that may cause estimated credit losses to differ from historical loss experience. The quantitative measures basically require a bank to place its loans into \"separate pools\" with like characteristics and then measure the historical loss experience of these loan pools. In the case of \"non-classified loans,\" it is sufficient to estimate credit losses for the upcoming 12 months. But in the case of \"classified loans,\" the losses must be projected for the remaining effective lives of the loans. The subjective factors that should also be considered and that could potentially modify some of the conclusions reached by only looking at the quantitative measures are: significant changes in the institution's lending policies and procedures; changes in national and local business and economic conditions; changes in the nature and volume of the loan portfolio; changes in the experience, ability, and depth of lending management and staff; changes in the trend of the volume and severity of past due and classified loans; changes in the quality of the institution's loan review system; the existence and effect of any concentrations, and changes in the level of such concentrations; and the effect of external factors such as competition or any special legal or regulatory changes.\nThe Corporation's aggregate allowance for possible credit losses is derived from the combination of allowances at its individual subsidiaries, primarily banks. Each subsidiary has a responsibility to maintain an adequate allowance based on an evaluation of its own loan portfolio and considering the guidelines set forth in the aforementioned interagency credit statement. Although allocations of the Corporation's allowance are made for reporting purposes, each subsidiary's individual allowance for possible credit losses is available for use against its total loan portfolio.\nOn a regular basis, management identifies portions of specific commercial and real estate credits as \"doubtful.\" These credits include loans where less than full repayment is reasonably possible, the loan is classified as nonaccrual and the borrower is experiencing serious financial problems. Approximately 12 percent, 11 percent, 23 percent, 24 percent and 27 percent of the consolidated allowance for possible credit losses was represented by doubtful portions of loans at December 31, 1995, 1994, 1993, 1992, and 1991, respectively. At December 31, 1995, the Corporation had allocated $14.9 million to loans internally categorized as doubtful, compared to $13.6 million at year-end 1994.\nAt December 31, 1995, the Corporation designated all of the allocated portion of the allowance to cover total domestic credit exposure, compared to $102.4 million and $3.8 million for domestic and foreign, respectively, at December 31, 1994 due to declining foreign credit exposure.\nDuring 1995, the provision for credit losses decreased to $43.0 million, compared to $45.0 million in 1994. At year-end 1995, the allowance for possible credit losses was $129.3 million, or 1.36 percent of total loans outstanding, compared to $124.7 million or 1.52 percent of total loans one year ago. The provision for credit losses is established and reviewed based on the following criteria: current economic trends, current status of loan portfolio, federal regulatory requirements, expected net charge-offs and peer group analysis. With regard to establishing the provision and as a monitoring tool, the ratio of the allowance for possible credit losses to total loans and the ratio of the allowance for possible credit losses to nonperforming loans are evaluated on a regular basis. At year-end 1995, the ratios of the allowance for possible credit losses to total loans and to nonperforming loans were 1.36% and 246%, respectively. Both ratios are acceptable when compared to peers and are adequate when considered in conjunction with the previously-mentioned criteria. Accordingly, the 1995 provision for credit losses was established, in part, to achieve these ratios.\nNet charge-offs in 1995 were $38.5 million, or .44 percent of average loans outstanding as compared to $52.0 million, or .68 percent of average loans outstanding in 1994. Net charge-offs of domestic commercial loans amounted to $9.9 million in 1995, or .17 percent of average domestic commercial loans outstanding, down from $24.7 million, or .48 percent of average domestic commercial loans outstanding in 1994. The charge card portfolio experienced net charge-offs of $27.4 million and $21.3 million in 1995 and 1994, respectively, or 2.82 percent and 2.88 percent, respectively, of average outstandings. Installment loans, including real estate mortgages, had net charge-offs of $1.3 million in 1995, or 0.8 percent of average outstandings, down from $5.9 million, or .40 percent of average outstandings in 1994. Over the five-year period ending December 31, 1995, combined net charge-offs were .81 percent of average total loans outstanding.\nThe Board of Governors of the Federal Reserve System has established rules requiring banking institutions to establish special reserves against the risks presented in certain international assets, as determined by the Federal Reserve Board. At December 31, 1995 and 1994, the Corporation was not required to maintain any special reserve under the aforementioned regulation.\nThe following table sets forth the Corporation's allocation of the allowance for possible credit losses. This allocation is based on management's subjective estimates. The amount allocated to a particular category should not be interpreted as the only amount available for future charge-offs that may occur within that category; it may not be indicative of future charge-off trends and it may change from year to year based on management's assessment of the risk characteristics of the loan portfolio.\n*Prior to 1992, the Corporation charged off past-due charge card interest to the allowance for possible credit losses. In 1995, 1994, 1993, and 1992, $1.9 million, $2.0 million, $2.6 million and $3.0 million, respectively, of such interest was recorded as a reduction of interest income.\nInternational Banking\nSummary\nInternational banking services of the Corporation include extension of foreign credits, foreign exchange trading activities and dealings in Eurocurrencies. These services are conducted through the Chicago headquarters; the London and Nassau branch offices; representative offices in Los Angeles and Tokyo; Bank of Montreal Trust Company (Channel Islands), Ltd.; and Harris Bank International Corporation, a wholly-owned Edge Act subsidiary of HTSB located in New York City.\nInternational banking services contributed $15.3 million, or 10 percent, of the Corporation's 1995 consolidated net income, compared to $18.0 million or 18 percent in 1994. International operating income decreased $4.1 million, or 8 percent, to $49.3 million in 1995 and represented 4 percent of the Corporation's total operating income. In 1994 and 1993, international operating income represented 5 percent of the Corporation's total operating income. Assets and liabilities associated with foreign domiciled customers are summarized as follows:\nGeographic Distribution\nAs of year-end 1995, substantially all international loans, interest-bearing deposits at banks and deposits in foreign offices represented U.S. dollar claims. The geographical distribution of international loans and interest- bearing deposits at banks is presented in the following table:\nVision 2002\nThe Corporation and its parent company, Bank of Montreal, have developed a joint, long-term strategic plan with the goal of becoming, over a period of 10 years, a North American financial services organization with comprehensive capabilities in both Canada and the United States. This plan, called Vision 2002, envisions Harris as one of four main operating entities within the Bank of Montreal organization, with the responsibility for serving individuals and small to mid-sized businesses in the Midwest while providing trust, cash management, investment management and special industries services nationally.\nVision 2002 will lead to a substantially larger Bank of Montreal presence in the United States, principally focused in the Harris organization and its subsidiaries. The Corporation's services to individuals, small businesses and mid-market corporations will be expanded throughout Chicago, Illinois and neighboring states. Additionally, trust, cash management, investment management and special industries services will continue to grow nationwide.\nOver a period of 10 years, Bank of Montreal plans to invest up to $700 million in the Corporation with the purpose of expanding, through acquisition and de novo branching, its distribution network within the City of Chicago, Cook County and surrounding counties. As part of this expansion, in October 1994, Bank of Montreal and Suburban Bancorp, Inc. completed their merger. The merger was effected using Bank of Montreal stock valued at approximately $237 million. Suburban Bancorp, now known as Harris Bankmont, Inc., became a wholly-owned subsidiary of Bankmont Financial Corp. The transaction added 13 banks with 30 locations in Cook and surrounding counties, thereby doubling the number of community banks in the Chicago area and making Harris (the Corporation and Harris Bankmont, Inc.) the area's third largest community bank network with 86 locations opened or announced at year end 1995. The Corporation and its sister company, Harris Bankmont, Inc., plan to open approximately 10 new branches in 1996. The two-to-three year process of building a cost-effective operations and staff support infrastructure, started in 1994, continued in 1995, with over $20 million in infrastructure costs reduced and redeployed into marketing, sales, and service. The goal is to obtain North American scale advantages and reduce fixed costs. Building broad-based centers of competence within corporate services and operations will eliminate duplication, create scale efficiencies and improve quality and responsiveness. Additionally, the use of advanced technology to auto-\nmate processing activities at the point of customer contact will lower costs and increase quality. To this end, the consolidation of processing functions for Harris' and Bank of Montreal's U.S.-based foreign currency operations at a single location in Montreal was completed in 1995 as was the consolidation of credit card remittance processing in suburban Chicago. The new community bank operations center, which provides centralized customer support functions, opened at 1994 year-end. Customer support functions include stop payments, overdrafts, application balancing, customer account set-up and maintenance and proofing and encoding. The center consolidated all bookkeeping and proofing functions during 1995. Bank of Montreal and Harris loan administration functions will be consolidated in 1996. Management believes that new and existing customers will have even better access to the wide range of services that the Corporation has built over its 114 years, as well as to the additional services it will provide in the years ahead.\nFourth Quarter 1995 Compared with Fourth Quarter 1994\nNet income for the fourth quarter of 1995 was $38.8 million, up 9 percent from fourth quarter 1994 earnings of $35.6 million. The earnings growth is attributable primarily to an improvement in net interest income, securities gains, increased other income and lower FDIC insurance premiums. The Corporation recorded returns on average assets and average common equity of 0.94 percent and 13.7 percent, respectively, in fourth quarter 1995, compared to returns of 0.96 percent and 14.0 percent in last year's fourth quarter.\nFTE net interest income was $127.7 million during the 1995 fourth quarter, an increase of 1 percent from $126.8 million for the same quarter one year ago. Net interest margin fell from 4.03% to 3.62%, reflecting rate compression in certain asset categories, a lower mix of noninterest-bearing deposits, and the relationship which existed in the markets between short and longer term rates. Average earning assets rose 12% from $12.5 billion to $14.0 billion and average loans increased by $1.5 billion or 19% with commercial loans, real estate loans and charge card outstandings being the strongest contributors to this growth. Average portfolio securities increased $226 million in fourth quarter 1995 compared to 1994, offset by a $227 million decrease in money market assets and interest bearing deposits at banks.\nFunding for the quarter's asset growth came from interest-bearing liabilities, which rose $1.6 billion from last year's fourth quarter. Average interest-bearing deposits increased $334 million, or 5 percent to $7.31 billion, reflecting increased savings and certificates of deposits as well as time deposits in foreign offices. Short-term borrowings were up $503 million or 18 percent and senior notes increased $739 million from the prior year as described in the \"Liquidity and Sources of Funds\" section of this Report. Noninterest- bearing supporting funds were virtually unchanged, representing 16 percent of supporting liabilities in fourth quarter 1995, down from 19 percent in the 1994 fourth quarter.\nThe fourth quarter provision for credit losses of $11.6 million was up from $10.5 million provided in the fourth quarter of 1994. Net loan charge-offs during the current quarter were $11.7 million, compared to $12.9 million in the same period last year.\nIn the fourth quarter of 1995, noninterest revenue increased $9.3 million or 12% to $86.3 million. Net gains from the sale of debt securities amounted to $2.8 million compared to a $0.4 million loss in the fourth quarter of 1994. Money market and bond trading profits rose $1.4 million, while other sources of noninterest income increased $4.9 million.\nNoninterest expenses for the fourth quarter of 1995 of $141.7 million were 2% higher than the comparable quarter a year ago, primarily reflecting normal salary increases and higher variable compensation attributable to substantially stronger earnings performance. FDIC insurance premiums declined by $3.1 million while other expense categories approximated last year's levels.\nIncome tax expense increased $6.0 million or 48 percent, quarter to quarter, attributable to higher pretax income and a smaller tax-exempt municipal bond portfolio.\nRows may not add to annual amounts because of rounding.\nFINANCIAL STATEMENTS\nConsolidated Statement of Income Harris Bankcorp, Inc. and Subsidiaries\nThe accompanying notes to financial statements are an integral part of this statement.\nThe accompanying notes to financial statements are an integral part of this statement.\nNotes to Financial Statements\n1. Summary Of Significant Accounting Policies\nPrinciples of consolidation and nature of operations\nHarris Bankcorp, Inc. (\"Bankcorp\"), a Delaware corporation, is a wholly-owned subsidiary of Bankmont Financial Corp. (\"Bankmont\"), a Delaware corporation and a wholly-owned subsidiary of Bank of Montreal (\"BMO\"). Throughout these Notes to Financial Statements, the term \"Corporation\" refers to Bankcorp and subsidiaries.\nThe consolidated financial statements include the accounts of Bankcorp and its wholly-owned subsidiaries including Harris Trust and Savings Bank (\"HTSB\"). Significant intercompany accounts and transactions have been eliminated. Certain reclassifications were made to conform prior years' financial statements to the current year's presentation. See Note 17 for additional information on business combinations and Note 18 for additional information on related party transactions.\nThe Corporation provides banking, trust and other services domestically and internationally through 14 bank and 17 active nonbank subsidiaries. HTSB and the Corporation's other banking and non-bank subsidiaries provide a variety of banking and financial services to commercial and industrial companies, financial institutions, governmental units, not-for-profit organizations and individuals throughout the U.S., primarily the Midwest, and abroad. Services rendered and products sold to customers include demand and time deposit accounts and certificates; various types of loans; sales and purchases of foreign currencies; interest rate management products; cash management services; underwriting of municipal bonds; and financial consulting.\nBasis of accounting\nThe accompanying financial statements are prepared in accordance with generally accepted accounting principles and conform to practices within the banking industry.\nForeign currency and foreign exchange contracts\nAssets and liabilities denominated in foreign currencies have been translated into United States dollars at respective year-end rates of exchange. Monthly translation gains or losses are computed at rates prevailing at month-end. There were no material translation gains or losses during any of the years presented. Foreign exchange trading positions including spot, forward, futures and options contracts are revalued monthly using prevailing market rates. Exchange adjustments are included with foreign exchange income in the Consolidated Statement of Income.\nInterest rate futures, forward rate agreements, options and guarantees\nInterest rate futures contracts can be used in the management of the Corporation's risk strategy or as part of its dealer and trading activities. Open positions on such contracts not designated as hedges of existing positions or anticipated transactions are marked to market daily and the resulting gains and losses are recognized in noninterest income. Deferred gains and losses on futures contracts used to hedge existing assets and liabilities are included in the basis of the item being hedged. For hedges of anticipated transactions, the Corporation recognizes deferred gains or losses on futures transactions as adjustments to the cash position eventually taken. Interest rate forward rate agreements, options and guarantees, including caps, floors and collars, are marked to market with the resulting gains and losses recorded in trading account profits.\nInterest rate swaps\nThe Corporation engages in interest rate swaps in order to manage its interest rate risk exposure, generate fee income and as a trading vehicle. Gains and losses on swaps designated as hedges are deferred and recognized over the lives of the related hedged positions. Contractual payments under interest rate swaps designated as hedges are recognized in the Statement of Income. Swaps not designated as hedges are marked to market with realized and unrealized gains and losses included with trading account profits.\nSecurities\nIn May 1993, the Financial Accounting Standards Board (\"FASB\") issued Statement of Financial Accounting Standards (\"SFAS\") No. 115-Accounting for Certain Investments in Debt and Equity Securities, which the Corporation elected to adopt as of December 31, 1993. As required by the Statement, securities are classified as either trading account assets, held to maturity or available for sale. Trading account assets include securities acquired as part of trading activities and are typically purchased with the expectation of near-term profit. These assets consist primarily of municipal bonds and U.S. government securities. Securities are classified as held to maturity when the Corporation has both the positive intent and ability to hold them to maturity. All other securities are classified as available for sale, even if the Corporation has no current plans to divest. Trading account assets are reported at fair value with unrealized gains and losses included in trading account results, which also includes realized gains and losses from closing such positions. Held-to-maturity securities are stated at cost, adjusted for amortization of premium and accretion of discount. Available-for-sale securities are reported at fair value with unrealized gains and losses included, on an after-tax basis, in a separate component of stockholder's equity. For comparative purposes (primarily for periods prior to the adoption of SFAS No. 115), the Corporation considers \"portfolio securities\" to include both held to maturity and available for sale securities.\nApplication of SFAS No. 115 to prior periods is not permitted and, accordingly, prior-period financial statements have not been restated to reflect the change in accounting principle. There is no cumulative effect on the Corporation's Consolidated Statement of Income as of December 31, 1993, from adopting SFAS No. 115. However, the December 31, 1993 balance of stockholder's equity was increased by $26.4 million (net of $17.4 million in deferred taxes) to reflect the net unrealized holding gains on securities classified as available for sale which were previously carried at amortized cost or lower of cost or market. On December 29, 1995, the Corporation transferred all held-to- maturity securities to available for sale. See Note 2 on page 41 for further information.\nInterest income on securities, including amortization of discount or premium, is included in earnings. Realized gains and losses, as a result of portfolio securities sales, are included in securities gains and losses, with the cost of securities sold determined on the specific identification basis.\nLoans, loan fees and commitment fees\nLoans not held for sale are recorded at the principal amount outstanding, net of unearned income, deferred fees and origination costs. Origination fees collected on commercial loans, loan commitments, mortgage loans and standby letters of credit, which are not held for sale, are generally deferred and amortized over the life of the related facility. Other loan-related fees that are not the equivalent of yield adjustments are recognized as income when received or earned. At December 31, 1995 and 1994, the Corporation's Consolidated Statement of Condition included approximately $13.8 million and $11.0 million, respectively, of deferred loan-related fees net of deferred origination costs.\nIn conjunction with its mortgage and commercial banking activities, the Corporation will originate loans with the intention of selling them in the secondary market. These loans are carried at the lower of original cost or current market value, on a portfolio basis. Deferred origination fees and costs associated with these loans are not amortized, and are included as part of the basis of the loan at time of sale. Realized gains and unrealized losses are included with other noninterest income.\nCommercial and real estate loans are placed on nonaccrual status when the collection of interest is doubtful or when principal or interest is 90 days past due, unless the credit is adequately collateralized and the past due amount is in process of collection. When a loan is placed on nonaccrual status, all interest accrued but not yet collected which is deemed uncollectible is charged against interest income in the current year. Interest on nonaccrual loans is recognized as income only when cash is received and the Corporation expects to collect the entire principal balance of the loan. Interest income on restructured loans is accrued according to the most recently agreed upon contractual terms.\nCommercial and real estate loans are charged off when, in management's opinion, the loan is deemed uncollectible. Charge card and consumer installment loans are charged off when 150 and 180 days past due, respectively. Accrued interest on these loans is charged to interest income. Such loans are not normally placed on nonaccrual status.\nLoan commitments and letters of credit are executory contracts and are not reflected on the Corporation's Consolidated Statement of Condition. Fees collected are generally deferred and recognized over the life of the facility.\nDuring the first quarter of 1995, the Corporation adopted SFAS No. 114- Accounting by Creditors for Impairment of a Loan and SFAS No. 118-Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures. SFAS No. 114 addresses accounting by creditors for impairment of certain loans. It requires that impaired loans within the scope of the statement (primarily commercial credits) be measured based on the present value of expected future cash flows (discounted at the loan's effective interest rate) or, alternatively, at the loan's observable market price or the fair value of supporting collateral. Impaired loans are defined as those where it is probable that amounts due according to contractual terms, including principal and interest, will not be collected. Both nonaccrual and certain restructured loans meet this definition. Large groups of smaller-balance, homogeneous loans, primarily charge card, residential real estate and consumer installment loans, are excluded from the scope of these Statements. The Corporation determines loan impairment when assessing the adequacy of the allowance for possible credit losses. SFAS No. 118 permits existing income recognition practices to continue. The adoption of these Statements did not have a material impact on the Corporation's net income or financial position.\nAllowance for possible credit losses\nThe allowance for possible credit losses is maintained at a level considered adequate to provide for potential credit losses. The allowance is increased by provisions charged to operating expense and reduced by net charge-offs. Known losses of principal on impaired loans are charged off. The provision for credit losses is based on past loss experience, management's evaluation of the loan portfolio under current economic conditions and management's estimate of anticipated, but as yet not specifically identified, credit losses. Such estimates are reviewed periodically and adjustments, if necessary, are recorded during the periods in which they become known.\nPremises and equipment\nPremises and equipment are stated at cost less accumulated depreciation and amortization. Interest costs associated with long-term construction projects are capitalized and then amortized over the life of the related asset after the project is completed. For financial reporting purposes, the provision for depreciation and amortization is computed on the straight-line basis over the estimated useful lives of the assets.\nOther assets\nThe Corporation records specifically identifiable and unidentifiable (goodwill) intangibles in connection with the acquisition of assets from unrelated parties or the acquisition of new subsidiaries. Original lives range from 3 to 15 years. Goodwill is amortized on the straight-line basis. Identifiable intangibles are amortized on either an accelerated or straight-line basis depending on the character of the acquired asset.\nProperty or other assets received in satisfaction of debt are included in \"Other Assets\" on the Corporation's Consolidated Statement of Condition and are recorded at the lower of remaining cost or fair value. Fair values for other real estate owned generally are reduced by estimated costs to sell. Losses arising from subsequent write-downs to fair value are charged directly to expense.\nRetirement and other postemployment benefits\nThe Corporation has noncontributory defined benefit pension plans covering virtually all its employees. For its primary plan, the policy of the Corporation is to, at a minimum, fund annually an amount necessary to satisfy the requirements under the Employee Retirement Income Security Act (\"ERISA\"), without regard to prior years' contributions in excess of the minimum.\nSFAS No. 106-Employers' Accounting for Postretirement Benefits Other Than Pensions, requires that certain retiree benefit plans, including health care plans for retirees and their dependents, be treated as a form of deferred compensation that should be recognized on an accrual basis over the employment period. The Corporation adopted SFAS No. 106 in the first quarter of 1993, and elected to defer its accumulated postretirement benefit obligation of approximately $42 million and amortize it on a straight-line basis over 20 years.\nThe Corporation adopted SFAS No. 112, Employers' Accounting for Postemployment Benefits, in the first quarter of 1994. As required by the Statement, postemployment benefits provided to former or inactive employees after employment but before retirement are accrued in accordance with SFAS No. 43, Accounting for Compensated Absences, if they meet the conditions for accrual of compensated absences. Otherwise, postemployment benefits are accrued or disclosed in accordance with SFAS No. 5, Accounting for Contingencies. The effect of initially adopting SFAS No. 112 was not material.\nCash flows\nOn December 29, 1995, the Corporation transferred all held to maturity securities to available for sale. See Note 2 on page 41 for further information. On December 31, 1993, the Corporation adopted SFAS No. 115-Accounting for Certain Investments in Debt and Equity Securities. In compliance with this Statement, portfolio securities designated as available for sale were marked to market on the Corporation's Consolidated Statement of Condition. On July 1, 1993, the Corporation paid a $7.2 million dividend-in-kind to Bankmont related to the transfer of Harris Futures Corporation. Non-cash portions of these transactions were excluded from the Corporation's Consolidated Statement of Cash Flows.\nIncome taxes\nBankmont, Bankcorp and their wholly-owned subsidiaries file a consolidated Federal income tax return. Accordingly, no Federal income tax is applicable to dividends received by Bankmont from Bankcorp, or to dividends received by Bankcorp from its subsidiaries. Income tax return liabilities for the Corporation are not materially different than they would have been if computed on a separate return basis.\nManagement's estimates\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The accounts within the consolidated financial statements of the Corporation requiring significant management judgment include: provision and allowance for possible credit losses, income taxes, pension cost, post employment benefits, fair values and temporary - - vs - other than temporary impairment.\n2. Portfolio Securities\nThe amortized cost and estimated market value of \"held to maturity\" and \"available for sale\" securities were as follows:\nAt December 31, 1995 and 1994, portfolio and trading account securities having a par value of $1.7 billion and $2.7 billion, respectively, were pledged as collateral for certain liabilities, securities sold under agreement to repurchase, public and trust deposits, trading account activities and for other purposes where permitted or required by law. Securities carried at approximately $1.1 billion and $1.4 billion were sold under agreement to repurchase at December 31, 1995 and 1994, respectively.\nOn November 15, 1995, the FASB issued a Special Report, A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities. In accordance with that report, the Corporation conducted a one-time reassessment of the classifications of securities held. As a result, the Corporation reclassified all held-to-maturity securities to available-for- sale on December 29, 1995. The amortized cost of the transferred securities was $839 million and the related unrealized holding gain was $20 million.\nThe amortized cost and estimated market value of available-for-sale securities at December 31, 1995, by contractual maturity, are shown below. Expected maturities can differ from contractual maturities since borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.\nIn 1995 and 1994, proceeds from the sale of securities available for sale amounted to $2,025 million and $146 million. Proceeds from sales of portfolio securities during 1993 were $211 million. Gross gains of $26,284,000 and gross losses of $2,905,000 were realized on these sales in 1995, while gains of $6,032,000 and losses of $778,000 were realized in 1994, and gains of $13,204,000 and losses of $166,000 were realized in 1993. Net unrealized holding gain or loss on trading securities included in earnings during 1995 changed by $833,000 from an unrealized loss of $72,000 at December 31, 1994 to an unrealized gain of $761,000 at December 31, 1995.\n3. Loans\nThe following table summarizes loan balances by category:\nThe Corporation had approximately $103 million and $82 million of loans classified as held for sale at December 31, 1995 and 1994, respectively. Approximately 80 percent and 58 percent of these respective amounts were real estate mortgages\nNonaccrual loans, restructured loans and other nonperforming assets are summarized below:\nAt December 31, 1995 and 1994, the Corporation had no aggregate public and private sector outstandings to any single country experiencing liquidity problems which exceeded one percent of the Corporation's consolidated assets. Additional information on foreign outstandings is provided in the Foreign Outstandings section on page 26 of this Report.\n4. Allowance For Possible Credit Losses The changes in the allowance for possible credit losses were as follows:\n5. Premises And Equipment\nPremises and equipment are stated at cost less accumulated depreciation and amortization. A summary of these accounts is stated below:\nThe provision for depreciation and amortization was $39,142,000 in 1995, $39,524,000 in 1994, and $41,018,000 in 1993.\nIn 1990 and 1991, HTSB purchased a 72,000 square foot parcel of vacant land in Chicago's downtown business district. Construction plans for a new operations and office building complex on this site were deferred, pending strategic clarification as to the appropriate size and functional characteristics of this facility.\nDuring the second quarter of 1992, management determined that a writedown was necessary because of the uncertainty of proceeding with this project in the near future. Therefore, all capitalized expenditures associated with this project, totaling $8.8 million were written off. In addition, the land was written down by $3.0 million, leaving the Corporation's December 31, 1995 and 1994 Consolidated Statement of Condition reflecting a value of $8.5 million for this property.\n6. Short, Medium and Long-Term Notes and Unused Lines Of Credit\nThe following table summarizes the Corporation's long-term notes:\nOn December 27, 1995 in connection with a capital restructuring, Bankcorp issued a $65 million par value 6-1\/2% subordinated note to Bankmont that matures on December 27, 2007. All of the Bankcorp notes are unsecured obligations, ranking on a parity with all unsecured and subordinated indebtedness of the Corporation and are not subject to redemption prior to maturity at the election of the debtholders. The interest rate on the floating rate notes reprices semiannually and floats at 50 basis points above 180 day LIBOR. At year-end 1995, 180 day LIBOR stood at 5.51 percent.\nIn connection with the issuance of commercial paper and for other corporate purposes, Bankcorp has a revolving credit agreement with a group of five nonaffiliated banks and BMO. On December 18, 1995, this revolving credit agreement was amended to increase the credit limit from $130 million to $150 million and to extend the maturity date to December 18, 1999. There were no borrowings under this credit agreement during 1995 or 1994.\nHTSB offers to institutional investors from time to time, unsecured short- term and medium-term bank notes in an aggregate principal amount of up to $1.5 billion outstanding at any time. The term of each note could range from fourteen days to fifteen years. The notes are subordinated to deposits and rank pari passu with all other unsecured senior indebtedness of HTSB. As of December 31, 1995, $478 million of short-term notes were outstanding with maturities and interest rates ranging from 29 to 180 days and 5.50 to 5.79 percent, respectively. There were no outstandings under this program at December 31, 1994.\n7. Fair Value of Financial Instruments\nGenerally accepted accounting principles require the disclosure of estimated fair values for both on- and off-balance-sheet financial instruments. The Corporation's fair values are based on quoted market prices when available. For financial instruments not actively traded, such as certain loans, deposits, off- balance-sheet transactions and long term borrowings, fair values have been estimated using various valuation methods and assumptions. Although management used its best judgement in estimating these values, there are inherent limitations in any estimation methodology. In addition, accounting pronouncements require that fair values be estimated on an item-by-item basis, thereby ignoring the impact a large sale would have on a thin market and intangible values imbedded in established lines of business. Therefore, the fair value estimates presented herein are not necessarily indicative of the amounts the Corporation could realize in an actual transaction. The fair value estimation methodologies employed by the Corporation were as follows:\nThe carrying amounts for cash and demand balances due from banks along with short-term money market assets and liabilities reported on the Corporation's Consolidated Statement of Condition were considered to be the best estimates of fair value for these financial instruments. Fair values of trading account assets and portfolio securities were based on quoted market prices.\nA variety of methods were used to estimate the fair value of loans. Changes in estimated fair value of loans reflect changes in credit risk and general interest rates which have occurred since the loans were originated. Fair values of floating rate loans, including commercial, broker dealer, financial institution, construction, charge card, consumer and home equity, were assumed to be the same as book value as the loans' interest rates automatically reprice to market. Fair values of residential mortgages were based on current prices for securities backed by similar loans. For long-term fixed rate loans, including consumer installment and commercial mortgage loans, fair values were estimated based on the present value of future cash flows with current market rates as discount rates. A fair-value discount related to nonperforming loans included in the above categories, along with a discount for future credit risk throughout the portfolio, was based on an analysis of expected and unidentified future losses. Accordingly, the fair value estimate for total loans was reduced by these discounts, which in total approximated the allowance for possible credit losses on the Corporation's Consolidated Statement of Condition. Additionally, management considered appraisal values of collateral when nonperforming loans were secured by real estate.\nThe fair values of demand deposits, savings accounts, interest checking deposits, and money market accounts were the amounts payable on demand at the reporting date, or the carrying amounts. The fair value of time deposits was estimated using a discounted cash flow calculation with current market rates offered by the Corporation as discount rates.\nThe fair value of long-term notes was determined using a discounted cash flow calculation with current rates available to the Corporation for similar debt as discount rates.\nThe estimated fair values of the Corporation's financial instruments at December 31, 1995 and 1994 are presented in the following table. See Note 8 for additional information regarding fair values of off-balance-sheet financial instruments.\n8. Financial Instruments With Off-Balance-Sheet Risk\nThe Corporation utilizes various financial instruments with off-balance-sheet risk in the normal course of business to a) meet its customers' financing and risk management needs, b) reduce its own risk exposure, and c) produce fee income and trading profits. The Corporation's major categories of financial instruments with off-balance-sheet risk include credit facilities, interest rate and foreign exchange contracts, and various securities-related activities. Fair values of off-balance-sheet instruments were based on fees currently charged to enter into similar agreements, market prices of comparable instruments, pricing models using year-end rates and counterparty credit ratings.\nCredit facilities\nCredit facilities with off-balance-sheet risk include commitments to extend credit, standby letters of credit and commercial letters of credit.\nCommitments to extend credit are contractual agreements to lend to a customer as long as contract terms have been met. They generally require payment of a fee and have fixed expiration dates. The Corporation's commitments serve both business and individual customer needs, and include commercial loan commitments, credit card lines, home equity lines, commercial real estate loan commitments and mortgage loan commitments. The Corporation's maximum risk of accounting loss is represented by the total contractual amount of commitments which was $8.20 billion and $7.43 billion at December 31, 1995 and 1994, respectively. Since only a portion of commitments will ultimately be drawn down, the Corporation does not expect to provide funds for the total contractual amount. Risks associated with certain commitments are reduced by participations to third parties, which at December 31, 1995, totaled $244 million and at December 31, 1994, totaled $217 million.\nStandby letters of credit are unconditional commitments which guarantee the obligation of a customer to a third party should that customer default. They are issued to support financial and performance-related obligations including brokers' margin maintenance, industrial revenue bond repayment, debt repayment, construction contract performance and trade agreement performance. The Corporation's maximum risk of accounting loss for these items is represented by the total commitments outstanding of $1.59 billion at December 31, 1995 and $1.23 billion at December 31, 1994. Risks associated with standby letters of credit are reduced by participations to third parties which totaled $270 million at December 31, 1995 and $168 million at December 31, 1994.\nCommercial letters of credit are commitments to make payments on behalf of customers when letter of credit terms have been met. Maximum risk of accounting loss is represented by total commercial letters of credit outstanding of $131 million at December 31, 1995 and $148 million at December 31, 1994.\nCredit risks associated with all of these facilities are mitigated by reviewing customers' creditworthiness on a case-by-case basis, obtaining collateral, limiting loans to individual borrowers, setting restrictions on long-duration maturities and establishing stringent covenant terms outlining performance expectations which, if not met, may cause the Corporation to terminate the contract. Credit risks are further mitigated by monitoring and maintaining portfolios that are well diversified.\nCollateral is required to support certain of these credit facilities when they are drawn down and may include equity and debt securities, commodities, inventories, receivables, certificates of deposit, savings instruments, fixed assets, real estate, life insurance policies and seats on national or regional exchanges. Requirements are based upon the risk inherent in the credit and are more stringent for firms and individuals with greater default risks. The Corporation monitors collateral values and appropriately perfects its security interest. Periodic evaluations of collateral adequacy are performed by Corporation personnel.\nThe fair value of credit facilities (i.e. deferred income) is approximately equal to their carrying value of $13.8 million at December 31, 1995 and $11.0 million at December 31, 1994.\nInterest rate contracts\nInterest rate contracts include futures, forward rate agreements, option contracts, guarantees (caps, floors and collars) and swaps. The Corporation enters into these contracts for dealer, trading and risk management purposes.\nDealer and trading activity\nAs dealer, the Corporation serves customers seeking to manage interest rate risk by entering into contracts as a counterparty to their (customer) transactions. In its trading activities, the Corporation uses interest rate contracts to profit from expected future market movements.\nThese contracts may create exposure to both credit and market risk. Replacement risk, the primary component of credit risk, is the risk of loss should a counterparty default following unfavorable market movements and is measured as the Corporation's cost of replacing contracts at current market rates. The Corporation manages credit risk by establishing credit limits for customers and products through an independent corporate-wide credit review process and continually monitoring exposure against those limits to ensure they are not exceeded. Credit risk is, in many cases, further mitigated by the existence of netting agreements which provide for netting of contractual receivables and payables in the event of default or bankruptcy.\nMarket risk is the risk of loss as a result of changes in interest rates. The Corporation manages market risk by establishing limits which are based on dollars at risk given a parallel shift in the yield curve. Limits are established by product, maturity and volatility. Limits are approved by management and monitored independently of the traders on a regular basis. Market risk is further diminished by entering into offsetting positions. Senior management oversees all dealer risk-related activities.\nFutures and forward contracts are agreements in which the Corporation is obligated to make or take delivery, at a specified future date, of a specified instrument, at a specified price or yield. Futures contracts are exchange traded and, because of exchange requirements that gains and losses be settled daily, create negligible exposure to credit risk.\nForward rate agreements are arrangements between two parties to exchange amounts, at a specified future date, based on the difference between an agreed upon interest rate and reference rate applied to a notional principal amount. These agreements enable purchasers and sellers to fix interest costs and returns.\nOptions are contracts that provide the buyer the right (but not the obligation) to purchase or sell a financial instrument, at a specified price, either within a specified period of time or on a certain date. Interest rate guarantees (caps, floors and collars) are agreements between two parties that, in general, establish for the purchaser a maximum level of interest expense or a minimum level of interest revenue based on a notional principal amount for a specified term. Options and guarantees written create exposure to market risk. As a writer of interest rate options and guarantees, the Corporation receives a premium at the\noutset of the agreement and bears the risk of an unfavorable change in the price of the financial instrument underlying the option or guarantee. Options and guarantees purchased create exposure to credit risk and, to the extent of the premium paid, market risk.\nInterest rate swaps are contracts involving the exchange of interest payments based on a notional amount for a specified period. Most of the Corporation's activity in swaps is as intermediary in the exchange of interest payments between customers, although the Corporation also uses swaps to manage its own interest rate exposure (see discussion of risk management activity below).\nThe following table summarizes the Corporation's dealer\/trading interest rate contracts and their related contractual or notional amounts and maximum replacement costs. Contractual or notional amount gives an indication of the volume of activity in the contract. Maximum replacement cost reflects the potential loss resulting from customer defaults and is computed as the cost of replacing, at current market rates, all outstanding contracts with unrealized gains.\nThe following table summarizes average and end of period fair values of dealer\/trading interest rate contracts for the years ended December 31, 1995 and 1994:\nNet gains (losses) from dealer\/trading activity in interest rate contracts and nonderivative trading account assets for the years ended December 31, 1995, 1994 and 1993 are summarized below:\nThe following table summarizes the maturities and weighted average interest rates paid and received on dealer\/trading interest rate swaps as of December 31, 1995:\nRisk management activity\nIn addition to its dealer activities, the Corporation uses interest rate contracts, primarily swaps, to reduce the level of financial risk inherent in mismatches between the interest rate sensitivities of certain assets and liabilities. During 1995 and 1994, interest rate swaps were primarily used to alter the character of funds supporting the municipal bond portfolio and the senior note program. The Corporation had $281 million notional amount of swap contracts, used for risk management purposes, outstanding at December 31, 1995 with a fair value of $(11.8) million and a replacement cost of zero. At December 31, 1994, the Corporation had $497 million notional amount of swap contracts outstanding with a fair value of $(16.4) million and a replacement cost of $263 thousand. Gross unrealized gains and losses, representing the difference between fair value and carrying value (i.e. accrued interest payable or receivable) on these contracts, totaled zero and $6.3 million, respectively, at December 31, 1995 and $134 thousand and $7.8 million, respectively, at December 31, 1994. Risk management activity, including the related cash positions, had no material effect on the Corporation's net income for the year ended December 31, 1995 or 1994. There were no deferred gains or losses on terminated contracts at December 31, 1995 or 1994.\nThe following table summarizes swap activity for risk management purposes during 1995 and 1994:\nThe following table summarizes the maturities and weighted average interest rates paid and received on interest rate swaps used for risk management as of December 31, 1995:\nForeign exchange contracts Dealer activity\nThe Corporation is also a dealer in foreign exchange, having a significant presence in the marketplace. Foreign exchange contracts may create exposure to market and credit risk, including replacement risk and settlement risk. Credit risk is managed by establishing limits for customers through an independent corporate-wide credit approval process and continually monitoring exposure against those limits. In addition, both settlement and replacement risk are reduced through netting by novation, agreements with counterparties to offset certain related obligations. Market risk is managed through establishing exposure limits by currency and monitoring actual exposure against those limits, entering into offsetting positions, and closely monitoring price behavior. Effective April 3, 1995, the Corporation and BMO agreed to combine their U.S. foreign exchange activities (\"FX\"). Under this arrangement, FX net profit will be shared by the Corporation and BMO in accordance with a specific formula set forth in the agreement. This agreement expires in April 2002 but may be extended at that time. Either party may terminate the arrangement at its option. Beginning with second quarter 1995, FX revenues were reported net of expenses. This agreement did not have a material impact on the Corporation's 1995 net income or financial position at December 31, 1995.\nAt December 31, 1995, approximately two-thirds of the Corporation's gross notional positions in foreign currency contracts are represented by five currencies: English pounds, German deutsche marks, Canadian dollars, Japanese yen and French francs.\nForeign exchange contracts include spot, future, forward and option contracts that enable customers to manage their foreign exchange risk. Spot, future and forward contracts are agreements to exchange currencies at a future date, at a specified rate of exchange. Foreign exchange option contracts give the buyer the right and the seller an obligation (if the buyer asserts his right) to exchange currencies during a specified period (or on a certain date in the case of \"European\" options) at a specified exchange rate.\nThe following table summarizes the Corporation's dealer\/trading foreign exchange contracts and their related contractual or notional amount and maximum replacement cost:\nThe following table summarizes average and end of period fair values of dealer\/trading foreign exchange contracts for the years ended December 31, 1995 and 1994:\nNet gains (losses) from dealer\/trading foreign exchange contracts, for the years ended December 31, 1995, 1994 and 1993 are summarized below. 1995 net foreign exchange gains include $8.8 million of net profit under the aforementioned agreement with BMO.\nSecurities activities\nThe Corporation's securities activities that have off-balance-sheet risk include municipal bond underwriting, short selling and indemnified lending of securities held in trust.\nThrough its municipal bond underwriting activities, the Corporation commits to buy and offer for resale newly issued bonds. The Corporation is exposed to market risk because it may be unable to resell its inventory of bonds profitably as a result of unfavorable market conditions. In syndicate arrangements, the Corporation is obligated to fulfill syndicate members' commitments should they default. The syndicates of which the Corporation was a member had underwriting commitments totaling $15.5 million at December 31, 1995 and $14.6 million at December 31, 1994.\nSecurity short selling, defined as selling of securities not yet owned, exposes the Corporation to off-balance-sheet market risk because the Corporation may be required to buy securities at higher prevailing market prices to cover its short positions. The Corporation had no short position at December 31, 1995 and a short position of $10 million at December 31, 1994.\nSecurities lending, a service the Corporation provides to master trust and institutional custody customers, exposes the Corporation to off-balance-sheet credit risk when it indemnifies its customers against the risks of borrower default. Risks are minimized by lending to approved brokers and dealers, up to a lending limit established for each broker, and by obtaining collateral in excess of the value of the loan. Collateral is typically cash, U.S. Government securities or letters of credit from approved banks. The value of the collateral is monitored daily and additional collateral is obtained when deemed necessary. Highly liquid collateral, such as cash and U.S. Government securities, typically represents over 95 percent of the collateral held by the Corporation. The Corporation's maximum risk of accounting loss is represented by the amount of securities lent under indemnification, which totaled $1.04 billion at December 31, 1995 and $2.09 billion at December 31, 1994.\n9. Concentrations Of Credit Risk In Financial Instruments\nThe Corporation had four concentrations of credit risk arising from financial instruments at December 31, 1995 and 1994. These concentrations were the Midwest geographic area, individuals, brokers and dealers, and commercial banks. Each concentration exceeded 10 percent of the Corporation's total credit exposure, which is the total potential accounting loss should all customers fail to perform according to contract terms and all collateral prove to be worthless.\nMidwestern geographic area\nA majority of the Corporation's customers are located in the Midwestern region of the United States, defined here to include Illinois, Indiana, Iowa, Michigan, Minnesota, Missouri and Wisconsin. The Corporation provides credit to these customers through a broad array of banking and trade financing products including commercial loans, commercial loan commitments, commercial real estate loans, consumer installment loans, charge card loans and lines, mortgage loans, home equity loans and lines, standby and commercial letters of credit and banker's acceptances. The financial viability of customers in the Midwest is, in part, dependent on the region's economy. Corporate customers headquartered in the region and serving a national or international market are not included in this concentration because their business is broad-based and not dependent on the region's economy. The Corporation's maximum risk of accounting loss, should all customers making up the Midwestern concentration fail to perform according to contract terms and all collateral prove to be worthless, was approximately $12.8 billion or 49 percent of the Corporation's total credit exposure at December 31, 1995 and $12.1 billion or 47 percent of the Corporation's total credit exposure at December 31, 1994.\nThe Corporation manages this exposure by continually reviewing local market conditions and customers, adjusting individual and industry exposure limits within the region and by obtaining or closely monitoring collateral values. See Note 8 for information on collateral supporting credit facilities.\nIndividuals\nThe Corporation extends credit to individuals through credit card lines, style lines of credit, installment and single payment loans. Credit card and style lines are unsecured revolving lines of credit, accessed through VISA and MasterCard, special drafts, and\/or automated teller machines. The Corporation's credit card lines represent most of its total credit exposure to individuals. Although credit card loans are not collateralized, measures have been implemented to reduce credit loss. These measures include strict credit approval criteria, card use monitoring, automated authorization procedures and aggressive collection procedures. Further, credit card customers are broad-based geographically, although currently about 50 percent are located in the Midwest.\nInstallment and single payment loans are generally collateralized by personal property and have a fixed maturity. The Corporation ensures that it has sufficient collateral by monitoring its value and perfecting its legal rights to the property upon default.\nThe Corporation's maximum risk of accounting loss, should all individual customers fail to perform according to contract terms and all available collateral prove to be worthless, was approximately $5.7 billion or 22 percent of the Corporation's total credit exposure at December 31, 1995 and $5.2 billion or 20 percent of the Corporation's total credit exposure at December 31, 1994.\nBrokers and dealers\nThe Corporation has credit exposure to various brokers and dealers in securities and commodities through securities lending, commercial lending and standby letter of credit guarantees. Securities lending represents most of the total credit exposure to this group and consists of loans of securities held by trust customers where the Corporation has provided indemnification against borrower default. Securities are typically used by brokers and dealers to cover their short positions. These loans are generally collateralized by cash, U.S. Government securities and letters of credit with values in excess of loan amounts. Cash collateral is typically held at the Corporation while other collateral is usually held at the depositories through which securities lending transactions are conducted.\nCommercial loans are used by brokers and dealers to fund the purchase of securities, while standby letters are used to maintain margins. Collateral is typically equity and debt securities, commodities, futures and option contracts held by the Corporation or other appropriate custodians or depositories. Security interest is obtained to ensure access to collateral.\nThe Corporation's maximum risk of accounting loss, should brokers and dealers fail to fulfill their contractual obligations and all collateral prove to be worthless, was approximately $1.8 billion or 7 percent of the Corporation's total credit exposure at December 31, 1995 and $3.1 billion or 12 percent of the Corporation's total credit exposure at December 31, 1994.\nCommercial banks\nThe Corporation has credit exposure to the domestic and international banking industry through its participation in check clearing, international banking transactions, foreign exchange transactions, Eurodollar investing and through correspondent banking services including Federal fund loans and standby letter of credit guarantees. Generally, collateral is not held to support credit exposure to banks, although risks are mitigated since durations are short, investments are highly liquid, and counterparties are geographically diverse. The Corporation's maximum risk of accounting loss, should all commercial banks fail to fulfill their contractual obligations, was approximately $2.0 billion or 8 percent of the Corporation's total credit exposure at December 31, 1995 and $2.8 billion or 11 percent of the Corporation's total credit exposure at December 31, 1994.\n10. Retirement And Other Postemployment Plans\nThe Corporation has noncontributory defined benefit pension plans covering virtually all its employees as of December 31, 1995. Most of the employees participating in retirement plans were included in one primary plan (\"primary plan\") during the three-year period ended December 31, 1995. The benefit formula for this plan is based upon length of service and an employee's highest qualifying compensation during five consecutive years of active employment. The plan is a multiple-employer plan covering the Corporation's employees as well as persons employed by certain affiliated entities. In 1995, the Corporation prospectively expanded the definition of qualifying compensation and reduced the rate used to compute retirement benefits. The estimated net cost savings generated by these changes is $2.28 million in 1995.\nThe policy for this plan is to have the participating entities, at a minimum, fund annually an amount necessary to satisfy the requirements under ERISA, without regard to prior years' contributions in excess of the minimum. For 1994, the minimum and maximum deductible contribution were both zero as a result of the full funding limitation. For 1995 and 1993, cumulative contributions were greater than the amount recorded as pension expense for financial reporting purposes.\nIn 1995, the Corporation changed mortality rates from the 1984 Unisex Pensioner Mortality Table to the 1983 Group Annuity Mortality Table in accordance with the Retirement Protection Act of 1994. In addition, the assumption regarding future annual increases were modified as follows: the wage base was decreased from 6% to 5% and the Consumer Price Index was reduced by 1% at each age. These changes had no material effect on 1995 pension expense. In 1994, the Corporation elected to change the measurement date for plan assets and liabilities from December 31 to September 30. The change had no material effect on 1994 or prior years' pension expense.\n*Plan assets consist primarily of participating units in collective trust funds administered by HTSB, along with U.S. Government bonds. **Plan assets and obligations measured as of September 30, 1994. ***Plan assets and obligations measured as of September 30, 1995.\nNet pension expense included the following components for the primary plan:\nCertain employees participating in the primary plan are also covered by a supplemental unfunded retirement plan. The purpose of this plan is to extend full retirement benefits to individuals without regard to statutory limitations for qualified funded plans. The following table sets forth the status of this supplemental plan:\nDuring 1995, 1994 and 1993, the Corporation's lump-sum benefit payments to retirees resulted in settlement losses of approximately $.8 million, $3.1 million and $3.4 million, respectively, reflected above as a portion of net periodic pension expense.\nThe total consolidated pension expense of the Corporation, including the supplemental plan, for 1995, 1994 and 1993 was $9,770,000, $15,222,000, and $13,830,000, respectively.\nIn addition to pension benefits, the Corporation provides medical care benefits for retirees (and their dependents) who have attained age 55 and have at least 10 years of service. In 1994, the Corporation expanded the plan to provide medical care benefits for disabled employees and widows of former employees (and their dependents). The Corporation provides these medical care benefits through a self-insured plan. Under the terms of the plan, the Corporation contributes to the cost of coverage based on employees' length of service. Cost sharing with plan participants is accomplished through deductibles, coinsurance and out-of-pocket limits. Funding for the plan largely comes from the general assets of the Corporation, although recently contributions to a trust fund have been made under Internal Revenue Code Section 401(h).\nIn 1994 the Corporation elected to change the measurement date for plan assets and liabilities from December 31 to September 30; the change had no material effect on 1994 benefit expense. The following table sets forth the postretirement medical care benefit plan's status at December 31, 1995, 1994 and 1993 for the Corporation:\n*Plan assets consist primarily of participating units in collective trust funds administered by HTSB. **Plan assets and obligations measured as of September 30, 1994. ***Plan assets and obligations measured as of September 30, 1995. ****For 1993 postretirement medical expense, no assets were assumed to exist. The initial funding occurred in 1993.\nNet postretirement benefit expense included the following components:\nFor 1995, the weighted average annual rate of increase in the per capita cost of covered benefits was assumed to be 9 percent and was assumed to decrease gradually to 6 percent in 2001 and remain level thereafter. For 1994 and 1993, the weighted average annual rate of increase in the per capita cost of covered benefits was assumed to be 12 percent and was assumed to decrease gradually to 7 percent in 2001 and remain level thereafter. This health care cost trend rate assumption had a significant effect on the amounts reported. Increasing the assumed health care cost trend rates by one percentage point each\nyear would have increased the accumulated postretirement benefit obligation as of September 30, 1995, September 30, 1994 and December 31, 1993 by $6.3 million, $7.3 million and $6.7 million, respectively, and the aggregate service and interest cost components of net postretirement benefit expense for 1995 by approximately $.7 million.\n11. Lease Expense And Obligations\nRental expense for all operating leases was $18,144,000 in 1995, $16,002,000 in 1994, and $16,623,000 in 1993. These amounts include real estate taxes, maintenance, and other rental-related operating costs of $3,992,000, $4,151,000, and $4,712,000 for 1995, 1994, and 1993 respectively, paid under net lease arrangements. Lease commitments are primarily for office space. Minimum rental commitments as of December 31, 1995 for all noncancelable operating leases are as follows:\nOccupancy expenses for 1995, 1994 and 1993 have been reduced by $13,200,000, $13,816,000 and $13,300,000, respectively, for rental income from leased premises.\n12. Income Taxes\nThe 1995, 1994 and 1993 applicable income tax expense (benefit) was as follows:\nDeferred tax assets (liabilities) are comprised of the following at December 31, 1995, and at December 31, 1994:\nAt December 31, 1995, the net deferred tax asset of $74.5 million included $62.4 million for Federal tax and $12.1 million for Illinois tax. The Corporation has fully recognized both its Federal and Illinois deferred tax assets. Current taxable income and taxable income generated in the statutory carryback period is sufficient to support the entire deferred tax asset. The deferred taxes reported on the Corporation's Consolidated Statement of Condition at December 31, 1995 also include a $17.8 million deferred tax liability for the tax effect of the net unrealized gains associated with marking to market certain securities designated as available for sale.\nTotal income tax expense of $70,175,000 for 1995, $24,528,000 for 1994, and $39,879,000 for 1993 reflects effective tax rates of 32.2 percent, 20.1 percent and 25.6 percent, respectively. The reasons for the differences between actual tax expense and the amount determined by applying the U.S. Federal income tax rate of 35 percent to income before income taxes were as follows:\nThe tax expense from net gains on security sales amounted to $9,094,000, $4,440,000, and $5,166,000 in 1995, 1994, and 1993, respectively.\n13. Investments In Subsidiaries And Statutory Restrictions\nBankcorp's investment in the combined net assets of its wholly-owned subsidiaries was $1,175,037,000 and $1,026,515,000 at December 31, 1995 and 1994, respectively.\nProvisions of both Illinois and Federal banking laws place restrictions upon the amount of dividends that can be paid to Bankcorp by its bank subsidiaries. Illinois state law requires that no dividends may be paid in an amount greater than the net profits then on hand, reduced by certain loan losses (as defined). In addition to these restrictions, Federal Reserve member banking subsidiaries require prior approval of Federal banking authorities if dividends declared by a subsidiary bank, in any calendar year, will exceed its net profits (as defined in the applicable statute) for that year, combined with its retained net profits, as so defined, for the preceding two years. Based on these and certain other prescribed regulatory limitations, Bankcorp subsidiaries could have declared, without regulatory approval, $235,622,000 of dividends at December 31, 1995. Actual dividends paid, however, would be subject to prudent capital maintenance. Cash dividends paid to Bankcorp by its subsidiaries amounted to $63,265,000 and $49,731,000 in 1995 and 1994, respectively.\nThe Federal Reserve Act also places restrictions on certain transactions between Bankcorp and its affiliates, including loans from subsidiary banks. Such restrictions include collateralization requirements and quantitative limitations. Essentially, a member bank's aggregate involvement in these restricted transactions may not exceed 20 percent of its capital and surplus, as defined by the Federal Reserve Board. In addition, restricted transactions involving an individual affiliate are limited to 10 percent of its capital and surplus.\nThe bank subsidiaries of Bankcorp are required by the Federal Reserve Act to maintain reserves against certain of their deposits. Reserves are held either in the form of vault cash or balances maintained with the Federal Reserve Bank. Required reserves are essentially a function of daily average deposit balances and statutory reserve ratios prescribed by type of deposit. During 1995 and 1994, daily average reserve balances of $198 million and $206 million, respectively, were required for those subsidiaries of Bankcorp that must maintain such balances. At year-end 1995 and 1994, balances on deposit at the Federal Reserve Bank totaled $441 million and $219 million, respectively.\n14. Contingent Liabilities\nCertain subsidiaries of Bankcorp are defendants in various legal proceedings arising in the normal course of business. In the opinion of management, based on the advice of legal counsel, the ultimate resolution of these matters will not have a material adverse effect on the Corporation's financial position.\n15. Foreign Activities (By Domicile Of Customer)\nIncome and expenses identifiable with foreign and domestic operations are summarized in the table below:\nDetermination of rates for foreign funds generated or used are based on the actual external costs of specific interest-bearing sources or uses of funds for the periods. Internal allocations for certain unidentifiable income and expenses were distributed to foreign operations based on the percentage of identifiable foreign income to total income. As of December 31, 1995, 1994 and 1993, identifiable foreign assets accounted for 5, 7 and 6 percent, respectively, of total consolidated assets.\n16. Parent Company Only Condensed Financial Information\nPresented below is the statement of income, balance sheet and statement of cash flows for Harris Bankcorp, Inc. (parent company only):\n*Eliminated in consolidation.\n*Eliminated in consolidation\nStatement of Cash Flows\n17. Business Combinations\/Intangibles\nAt December 31, 1995 and 1994, intangible assets, including goodwill resulting from business combinations, amounted to $38,407,000 and $47,757,000, respectively. Intangible assets are included in \"Other Assets\" on the Consolidated Statement of Condition. Amortization of these intangibles amounted to $9,350,000 in 1995, $10,266,000 in 1994, and $11,785,000 in 1993. The impact of purchase accounting adjustments, other than amortization of intangibles, was not material to the Corporation's reported results.\n18. Related Party Transactions\nBankcorp is a wholly-owned subsidiary of Bankmont, a Delaware corporation. Bankmont is a wholly-owned subsidiary of BMO. Unamortized goodwill of $16.5 million at December 31, 1995 associated with the acquisition of Bankcorp in 1984 is reflected on the accounting records of Bankmont and has not been \"pushed down\" to the Corporation.\nDuring 1995, 1994 and 1993, the Corporation engaged in various transactions with BMO and its subsidiaries. These transactions included the payment and receipt of service fees and occupancy expenses, and purchasing and selling Federal funds, repurchase and reverse repurchase agreements, long-term borrowings and interest rate and foreign exchange contracts. The purpose of these transactions was to facilitate a more efficient use of combined resources and to better serve customers. Management fees were determined in accordance with applicable banking regulations. During 1995, 1994 and 1993, the Corporation received from BMO approximately $15.7 million, $12.8 million and $8.0 million respectively, primarily for trust services, data processing and other operations support provided by the Corporation.\nEffective April 3, 1995, the Corporation and BMO agreed to combine their U.S. foreign exchange activities. Under this arrangement, FX net profit will be shared by the Corporation and BMO in accordance with a specific formula set forth in the agreement. This agreement expires in April 2002 but may be extended at that time. Either party may terminate the arrangement at its option. Beginning with second quarter 1995, FX revenues were reported net of expenses. 1995 foreign exchange revenues included $8.8 million of net profit under this agreement. This agreement did not have a material impact on the Corporation's 1995 net income or financial position at December 31, 1995.\nIn October 1991, the Corporation announced that certain U.S. corporate banking units of HTSB and BMO were to be merged into a single organizational unit in order to better accommodate the requirements of certain customers in the large corporate market. The transition was expected to take place over several months. During the 1991 fourth quarter, a total of 38 employees had transferred from HTSB to BMO's payroll, although all related customer business remained with the Corporation at that time. During 1992, 75 customers representing approximately $214 million in outstanding credits and $2.3 billion in unused commitments were transferred to BMO. In 1993, an additional 31 customers representing approximately $22 million in outstanding credits and $533 million in commitments were also transferred. BMO was compensated for expenses incurred on behalf of HTSB's customers through December 31, 1993. No material transfers occurred in 1995 or 1994.\n19. Subsequent Event\nOn January 11, 1996, the Corporation announced the sale of its securities custody and related trustee services business for large institutions to Citibank. After restructuring charges, it is estimated that the net gain on the sale will approximate $4.0 million. The sale of the custody business for large institutions is not expected to have a material impact on 1996 earnings.\nExplanation of Joint Independent Auditors' Reports - ------------------------------------------------------------------------------- The Board of Directors of Harris Bankcorp, Inc. engaged the firms of KPMG Peat Marwick LLP and Coopers & Lybrand L.L.P. to serve as joint auditors for the three years ended December 31, 1995, 1994 and 1993.\nBankmont Financial Corp., a wholly-owned subsidiary of Bank of Montreal, owns all outstanding shares of Harris Bankcorp, Inc. Canadian bank shareholders had been required by the Canadian Bank Act to appoint each year two firms of independent public accountants to be auditors of their bank and all significant subsidiaries. In prior years, the change in the Corporation's independent public accountants reflected identical changes made by Bank of Montreal. The Canadian Bank Act was revised during 1992; accordingly, the Corporation no longer expects a planned rotation of independent auditors.\nIndependent Auditors' Report - -------------------------------------------------------------------------------\nTo the Stockholder and Board of Directors of Harris Bankcorp, Inc.:\nWe have audited the accompanying consolidated statements of condition of Harris Bankcorp, Inc. and Subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of income, changes in stockholder's equity and cash flows for each of the years in the three year period ended December 31, 1995. These consolidated financial statements are the responsibility of Harris Bankcorp, Inc.'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 Harris Bankcorp, Inc. and Subsidiaries as of December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the years in the three year period ended December 31, 1995 in conformity with generally accepted accounting principles.\nKPMG Peat Marwick LLP Coopers & Lybrand L.L.P. Chicago, Illinois January 26, 1996\nITEM 9","section_7A":"","section_8":"","section_9":"ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThere were no disagreements between the Corporation and its independent auditors related to accounting matters and\/or financial disclosures. There were no changes in independent auditors since December 31, 1993.\n- ------------------------------------------------------------------------------- PART III\nITEM 10","section_9A":"","section_9B":"","section_10":"ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nBankcorp's Board of Directors consists of seventeen members. Directors are elected annually. Each present director, except Mrs. Congalton and Ms. Decyk (both of whom are attorneys), has been employed in an executive capacity by his or her employer for more than five years. Set forth below is certain biographical information concerning each director, including principal occupation, age, the year first elected a director of Bankcorp and HTSB and other directorships.\nMatthew W. Barrett, age 51, Chairman and Chief Executive Officer of Bank of Montreal. Elected in 1988.\nF. Anthony Comper, age 50, President and Chief Operating Officer and a Director of Bank of Montreal. Elected in 1990.\nSusan T. Congalton, age 49, Managing Director, Lupine Partners (private investments). Elected in 1988.\nRoxanne J. Decyk, age 43, Vice President, Planning, Amoco Corp. (petroleum products) and a Director of Material Sciences Corporation and Snap-On Incorporated. Elected in 1990.\nWilbur H. Gantz, age 58, President and Chief Executive Officer of PathoGenesis Corporation (diagnostic health care) and a Director of W.W. Grainger, Gillette Corporation and Bank of Montreal. Elected in 1984.\nJames J. Glasser, age 61, Chairman of GATX Corporation (capital equipment and services for extracting, processing and distributing dry and liquid bulk commodities) and a Director of The B. F. Goodrich Company, Stone Container Corporation and Bank of Montreal. Elected in 1980.\nDaryl F. Grisham, age 69, President and Chief Executive Officer of Parker House Sausage Company (meat processor). Elected in 1983.\nDr. Leo M. Henikoff, age 56, President and Chief Executive Officer of Rush- Presbyterian-St. Luke's Medical Center (health care and related services). Elected in 1986.\nDr. Stanley O. Ikenberry, age 61, Regent Professor and President Emeritus of the University of Illinois and a Director of Franklin Life Insurance Company and Pfizer, Inc. Elected in 1985.\nRichard M. Jaffee, age 60, Chairman and Chief Executive Officer, Oil-Dri Corporation of America (a developer, manufacturer and marketer of sorbent products). Elected in 1995.\nEdward W. Lyman, Jr., age 53, Vice Chair of the Board of Bankcorp and Harris Trust and Savings Bank. Elected in 1995.\nAlan G. McNally, age 50, Chairman of the Board and Chief Executive Officer of Bankcorp and Harris Trust and Savings Bank. Elected in 1993.\nMaribeth S. Rahe, age 47, Vice Chair of the Board of Bankcorp and Harris Trust and Savings Bank. Elected in 1995.\nCharles H. Shaw, age 63, Chairman, The Charles H. Shaw Company (real estate development). Elected in 1990.\nRichard E. Terry, age 58, Chairman and Chief Executive Officer, Peoples Energy Corporation (public utility) and a Director of Amsted Industries. Elected in 1992.\nJames O. Webb, age 64, President, James O. Webb & Associates, Inc. (consultant in new ventures and business development). Elected in 1995.\nWilliam J. Weisz, age 69, Chairman of the Board, Motorola, Inc. (manufacturer of electronic equipment). Elected in 1988.\nIn addition to Messrs. McNally and Lyman and Ms. Rahe, the Corporation had nine executive officers at December 31, 1995--Richard J. Brown, age 51, Jeffrey D. Butterfield, age 49, Charles H. Davis, age 53, Pierre O. Greffe, age 43, Kenneth R. Keck, age 57, Louis F. Lanwermeyer, age 47, Charles R. Tonge, age 46, Edward J. Williams, age 53 and Nancy B. Wolcott, age 41. Each officer has held executive positions with the Corporation or an affiliate for many years.\nITEM 11","section_11":"ITEM 11 - OMITTED PURSUANT TO GENERAL INSTRUCTION (J)(2)(c) OF FORM 10-K.\nITEM 12","section_12":"ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nBank of Montreal, through its subsidiary, Bankmont Financial Corp., a U.S. bank holding company chartered in Delaware, owns all 6,667,490 issued and outstanding shares of Bankcorp's common stock.\nITEM 13","section_13":"ITEM 13 - OMITTED PURSUANT TO GENERAL INSTRUCTION (J)(2)(c) OF FORM 10-K.\nPart IV\nITEM 14","section_14":"ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) Documents filed with Report:\n(l) Financial Statements (See page 1 for a listing of all financial statements included in Item 8)\n(2) Financial Statement Schedules\nAll Schedules normally required by Form 10-K are omitted since they are either not applicable or the required information is shown in the financial statements or the notes thereto.\n(3) Exhibits:\n3. Articles of Incorporation and By-laws\na) Restated Certificate of Incorporation (filed as an Exhibit to Bankcorp's 1987 Form 10-K and incorporated herein by reference)\nb) By-laws of Bankcorp\n4. Indenture dated as of June 1, 1989 relating to Bankcorp's 9 3\/8% Subordinated Notes Due 2001 (filed as an Exhibit to Bankcorp's May 24, 1989 Registration Statement on Form S-3 and incorporated herein by reference). In addition, Bankcorp has issued three Floating Rate Subordinated Notes and one Fixed Rate Subordinated Note to its parent company, Bankmont. The principal amount of these notes totals $200 million for the floating rate notes and $65 million for the fixed rate note, respectively. The floating rate notes mature in 2004, 2005 and 2006, respectively. The fixed rate note matures in 2007. Bankcorp hereby agrees to file a copy of the agreement relating to any such notes with the Commission upon request.\n10. Material Contracts and Compensatory Plans\na) 1995 Managerial Incentive Plan\nb) Harris Growth Incentive Plan (filed as an Exhibit to Bankcorp's 1991 Form 10-K and incorporated herein by reference)\nc) Employees' Savings and Profit Sharing Plan\nd) 1995 Stock Appreciation Rights Plan\ne) Harris Retirement Benefit Replacement Plan (filed as an Exhibit to Bank of Montreal's August 3, 1994 Registration Statement on Form, File No. 33-82358, and incorporated herein by reference)\n23. Consents of Experts and Counsel (consents of Independent Auditors)\n24. Power of Attorney\n(b) No reports on Form 8-K were filed during the last quarter of 1995. - ------------------------------------------------------------------------------- *Copies of Exhibits (a)(3) 3, 4, 10, 23 and 24, not contained herein, may be obtained at a cost of 25 cents per page upon written request to the Secretary of Harris Bankcorp, Inc.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Harris Bankcorp, Inc. has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized on the 25th day of March 1996.\nAlan G. McNally Chairman of the Board and Chief Executive Officer\nPierre O. Greffe Chief Financial Officer\nPaul R. Skubic Chief Accounting Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed by Alan G. McNally, Chairman of the Board and Chief Executive Officer of the Corporation, as attorney-in-fact for the following Directors on behalf of Harris Bankcorp, Inc. on the 25th day of March 1996.\nF. Anthony Comper Daryl F. Grisham Maribeth S. Rahe Susan T. Congalton Leo M. Henikoff Charles H. Shaw Roxanne J. Decyk Stanley O. Ikenberry Richard E. Terry Wilbur H. Gantz Richard M. Jaffee James O. Webb James J. Glasser Edward W. Lyman, Jr. William J. Weisz\nAlan G. McNally Attorney-In-Fact\nSupplemental Information\nNo annual report or proxy statement will be sent to security holders in 1996.","section_15":""}
{"filename":"700664_1995.txt","cik":"700664","year":"1995","section_1":"Item 1. BUSINESS\nGeneral Development of Business\n\tSuper 8 Economy Lodging IV, Ltd. (the \"Partnership\") is a limited partnership which was organized under the Uniform Limited Partnership Act of the State of California on February 5, 1982. \t \tThe Managing General Partner of the Partnership is Grotewohl Management Services, Inc., a California corporation organized and wholly-owned by Philip B. Grotewohl. The Associate General Partner is Robert J. Dana. The Associate General Partner does not have general responsibility in connection with the management of the business and affairs of the Partnership. The Managing General Partner and the Associate General Partner are sometimes referred to collectively as the \"General Partners.\"\n\tThrough two public offerings of units of limited partnership interest in the Partnership (\"Units\"), the Partnership sold 10,000 Units at a price of $1,000 each.\n\tThe net proceeds of the offerings were expended for the acquisition and development of properties located in Pleasanton, California and Santa Ana, California. Motel operations commenced on October 4, 1983 at the Pleasanton property and on February 19, 1985 at the Santa Ana property. The Partnership's Pleasanton motel is operated pursuant to franchises acquired from Super 8 Motels, Inc. under the name \"Super 8 Motel.\" On April 30, 1992 the Partnership sold the Santa Ana motel.\n\tThere is hereby incorporated by reference herein the information regarding the Partnership's motel property contained in Part I, Item 2","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\n\tOn October 4, 1982, the Partnership acquired from Hopyard Associates, a general partnership, a parcel of 2.037 acres of unimproved real property located in Pleasanton, California.\n\tThe property is located immediately adjacent to Interstate Highway 580, on the southeast quadrant of the Hopyard Road overpass approximately one mile east of Interstate Highway 680 and approximately 40 miles east of San Francisco.\n\tConstruction of the 102 room motel commenced on October 18, 1982 and was completed on October 4, 1983, at which point motel operations commenced.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS \tInapplicable.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\n\t Inapplicable. \t\n\t\t\t\t - 5 -\n\t\t\t\t PART II\nItem 5.","section_5":"Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nMarket Information\n\tThe Units are not freely transferable and no public market for the Units has developed or is expected to develop.\nHolders\n\tAs of December 15, 1995 a total of 2,110 investors (\"Limited Partners\") held Units in the Partnership.\nDistributions\n\tCash Available for Distribution is defined as the cash funds provided from operations without deduction for depreciation, but after deducting cash funds used to pay or provide for payment of debt service, capital improvements and replacements and the operating expenses of the property, also less adequate cash reserves for obligations of the Partnership for which there is no provision.\n\tCash Available for Distribution shall be distributed quarterly in the following manner:\n\t\t(1) 90% to the Limited Partners \t\t(2) 9% to the General Partners as a fee for managing the \t\t\tPartnership \t\t(3) 1% to the General Partners on account of their \t\t\tPartnership interest.\n\tNotwithstanding the foregoing, the General Partners shall receive no distributions of Cash Available for Distribution until the Limited Partners have received a cumulative 10% per annum return on their \"Adjusted Capital Contributions\" (i.e., their original capital contributions, adjusted for previous returns of capital or sale or refinancing proceeds). Inasmuch as the Limited Partners have not received a cumulative 10% per annum return, the General Partners have not received any share of the Cash Available for Distribution since inception of the Partnership.\n\tThe proceeds from the sale or refinancing of properties not reinvested are to be distributed first to the Limited Partners until they have received cumulative payments from all distribution sources equal to 100% of their original capital contribution and a cumulative 10% per annum return on their Adjusted Capital Contributions. When the foregoing requirement has been satisfied, any remaining funds from the sale or refinancing of properties will be distributed 15% to the General Partners and 85% to the Limited Partners.\n\t\t\t\t - 6 -\nThe following distributions (all from Cash Available for Distribution) were made during the two most recent fiscal years:\n\t\t\n\t\t\t Amount Amount \t\t\t Distributed Distributed Date Per Unit to General Partners\n11\/15\/93 $10.00 - 0 - 02\/15\/94 $12.50 - 0 - 05\/15\/94 $12.50 - 0 - 08\/15\/94 $13.65 - 0 - 11\/15\/94 $13.65 - 0 - 02\/15\/95 $13.65 - 0 - 05\/15\/95 $13.65 - 0 - 08\/15\/95 $13.65 - 0 -\n\t\n\t\t\t\t - 7 -\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA\nFollowing are selected financial data of the Partnership for the fiscal years ended September 30, 1995, 1994, 1993, 1992 and 1991. Due to the sale of the Santa Ana motel on April 30, 1992, data for the 1992 fiscal year is not comparable to any other fiscal year, and data for the 1995, 1994 and 1993 fiscal years is not comparable to data for the 1991 fiscal year.\n\t\t\t\t Years Ended September 30: \t\t ----------------------------------------------------------\n\t\t 1995 1994 1993 1992 1991 \t\t ---- ---- ---- ---- ----\nTotal income $1,510,802 $1,415,308 $1,395,176 $1,871,469 $2,257,931 Motel room income $1,448,486 $1,354,227 $1,337,670 $1,757,132 $2,110,358 Interest income $22,379 $19,181 $18,138 $34,085 $56,618 Other income: Loss on sale of Santa Ana Motel - - - $(2,297,181) - Gain on sale of Pleasanton land parcel - - $5,825 - - Net income (loss) $513,436 $419,009 $386,643 $(2,314,004) $(299,447)\nPer Partnership Unit: Cash distributions: Proceeds from sale of Santa Ana Motel - - - $57.11 - Other $54.60 $48.65 $40.00 $42.89 - Net income (loss) $51.34 $41.90 $38.66 $(231.40) $(29.95)\n\t\t\t\t Years Ended September 30: \t\t ----------------------------------------------------------\n\t\t 1995 1994 1993 1992 1991 \t\t ---- ---- ---- ---- ----\nTotal assets $2,769,469 $2,786,858 $2,864,030 $2,832,368 $7,997,998 Long-term debt - - - - $1,546,493\n\t\t\t\t - 8 -\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL \t CONDITION AND RESULTS OF OPERATIONS\nLiquidity - ---------\n\tThe Partnership's current assets of $829,176 exceed its current liabilities of $111,441 by $717,735. This amount exceeds the General Partners' cash reserve target of $455,000. In the opinion of the General Partners, the Partnership's Pleasanton motel provides adequate liquidity to satisfy the Partnership's financial obligations.\n\tThe Partnership's primary source of liquidity is its gross revenues from operations. As noted below, the Partnership has a positive cash flow from motel operations. In addition, the Partnership's equity in its Pleasanton motel, which is presently unencumbered, would provide a potential source of liquidity through financing in the event the Partnership's liquidity were impaired. There can be no assurance, however, that the Partnership could borrow against such equity on favorable terms should additional liquidity be required.\nCapital Resources - ------------------ \t \tThe Partnership owns and operates one motel property, a 102-room lodging facility located in Pleasanton, California.\n\tThe Partnership currently has no material commitments for capital expenditures. Its motel property is in full operation, and no further property acquisitions or extraordinary capital improvements are contemplated. Except as described below, the General Partners are aware of no material trends or changes with respect to the mix or relative cost of the Partnership's capital resources. Working capital is expected to be generated by revenues from operations.\n\tDuring the fiscal year covered by this report, the Partnership spent $98,364 ($60,317 of which was capitalized) on the refurbishment of its motel and its furnishings. The capitalized items included $19,888 for a new roof, $13,564 for new televisions, $7,561 for a new washer, $2,559 for a new dryer and $4,099 for replacement chairs. The Managing General Partner anticipates the expenditure of an undetermined amount during the next fiscal year on further refurbishment of the Partnership's motel, such amount to be paid from operating cash flow or, if operating cash flow is inadequate, from reserves.\nNew Accounting Standards - -------------------------\n\tSFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of, requires the Partnership to disclose information about potential impairment to the value of long-lived assets. The Partnership is not required to adopt and does not currently plan to adopt\n\t\t\t\t - 9 -\nSFAS No. 121 until its fiscal year ending September 30, 1997. The Partnership does not expect to make any disclosures about impairment of long-lived assets under SFAS No. 121.\nResults of Operation - --------------------\nPartnership's Combined Financial Results - -----------------------------------------\n\tThe following is a comparison of combined results for the twelve-month periods ending September 30, 1993, 1994 and 1995. Comparative revenue and expense data is included in the financial statements found in Item 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nSee Financial Statements and Notes to Financial Statements at pages through.\n\t\t\t\t - 12 -\n\t\t\t ANNUAL REPORT ON FORM 10-K\n\t\t\t\t ITEM 8\n\t\t\t FINANCIAL STATEMENTS\n\t\t\tSUPER 8 ECONOMY LODGING IV, LTD.\n\t\t\t SACRAMENTO, CALIFORNIA\n\t\t\t SEPTEMBER 30, 1995\n\t\t\t\t\nItem 8: Financial Statements \t\t \t\t\tSUPER 8 ECONOMY LODGING IV, LTD. \t\t\t \t\t\t INDEX OF FINANCIAL STATEMENTS \t\t\n\t\t\t\t\t\t\t Pages \t\t\t\t\t\t\t -----\nFinancial Statements: Report of Independent Certified Public Accountants\nBalance Sheets, September 30, 1995 and 1994\nStatements of Operations for the years ended September 30, 1995, 1994 and 1993\nStatements of Partners' Equity for the years ended September 30, 1995, 1994 and 1993\nStatements of Cash Flows for the years ended to September 30, 1995, 1994 and 1993\nNotes to Financial Statements to \t\t\t\t\t\t\t\n\t\t\t\t Note: 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 financial statements or notes thereto.\n\t\t\t\t\n\t REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nTo the Partners Super 8 Economy Lodging IV, Ltd.\nWe have audited the accompanying balance sheets of Super 8 Economy Lodging IV, Ltd., a California limited partnership, as of September 30, 1995 and 1994 and the related statements of operations, partners' equity and cash flows for each of the three years in the period ended September 30, 1995. 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 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 Super 8 Economy Lodging IV, Ltd. as of September 30, 1995 and 1994 and the results of its operations and its cash flows for each of the three years in the period ended September 30, 1995, in conformity with generally accepted accounting principles.\nVOCKER KRISTOFFERSON AND CO.\nNovember 17, 1995 San Mateo, California\n\t\t\t\t\n\t\t\tSUPER 8 ECONOMY LODGING IV, LTD. \t\t (A California Limited Partnership) \t\t\t\t BALANCE SHEETS \t\t\t September 30, 1995 and 1994\n\t\t\t \t\t\t\t ASSETS \t\t\t\t \t\t\t\t\t\t\t1995 1994 \t\t\t\t\t\t\t---- ---- Current Assets: Cash and temporary investments (Notes 1 and 3) $ 794,899 $ 763,487 Accounts receivable 22,343 25,087 Prepaid expenses 11,934 11,459 \t\t\t\t\t\t ---------- ---------- Total Current Assets 829,176 800,033 \t\t\t\t\t\t ---------- ----------\nProperty and Equipment (Notes 2 and 5): Land 799,311 799,311 Buildings 2,226,531 2,226,531 Furniture and equipment 548,367 504,918 \t\t\t\t\t\t ---------- ---------- \t\t\t\t\t\t 3,574,209 3,530,760 Accumulated depreciation (1,672,013) (1,577,026) \t\t\t\t\t\t ---------- ---------- Property and Equipment, Net 1,902,196 1,953,734 \t\t\t\t\t\t ---------- ----------\nOther Assets (Note 2): Deposit of federal income taxes 38,097 33,091 \t\t\t\t\t\t ---------- ----------\n\t Total Assets $2,769,469 $2,786,858 \t\t\t\t\t\t ========== ==========\n\t\t LIABILITIES AND PARTNERS' EQUITY\nCurrent Liabilities: Accounts payable and accrued liabilities $ 109,975 $ 88,167 Due to related parties (Note 4) 1,466 8,099 \t\t\t\t\t\t ---------- ---------- Total Liabilities 111,441 96,266\nPartners' Equity: General Partners (17,358) (22,492) Limited Partners 2,675,386 2,713,084 \t\t\t\t\t\t ---------- ---------- Total Partners' Equity 2,658,028 2,690,592 \t\t\t\t\t\t ---------- ----------\n\t Total Liabilities and Partners' Equity $2,769,469 $2,786,858 \t\t\t\t\t\t ========== ==========\nThe accompanying notes are an integral part of these financial statements.\n\t\t\t\t\n\t\t\tSUPER 8 ECONOMY LODGING IV, LTD. \t\t (A California Limited Partnership) \t\t\t STATEMENTS OF OPERATIONS\n\t\t\t\t\t Years Ended September 30: \t\t\t\t --------------------------------------- \t\t\t\t\t 1995 1994 1993 \t\t\t\t\t ---- ---- ---- Income: Motel room $1,448,486 $1,354,227 $1,337,670 Telephone and vending 36,519 37,699 34,984 Interest 22,379 19,181 18,138 Other 3,418 4,201 4,384 \t\t\t\t ---------- ---------- ---------- Total Income 1,510,802 1,415,308 1,395,176 \t\t\t\t ---------- ---------- ----------\nExpenses: Motel operations (Notes 4 and 5) 777,015 787,553 800,431 General and administrative (Note 4) 36,760 33,331 38,444 Depreciation and amortization (Note 2) 109,175 105,784 106,826 Property management fees (Note 4) 74,416 69,631 68,657 \t\t\t\t ---------- ---------- ---------- Total Expenses 997,366 996,299 1,014,358 \t\t\t\t ---------- ---------- ----------\nOther Income (Expenses): Gain on sale of Pleasanton Land parcel (Note 6) - - 5,825 \t\t\t\t ---------- ---------- ----------\nNet Income $ 513,436 $ 419,009 $ 386,643 \t\t\t\t ========== ========== ==========\nNet Income Allocable to General Partners $ 5,134 $ 4,190 $ 3,866 \t\t\t\t =========== ========== ==========\nNet Income Allocable to Limited Partners $ 508,302 $ 414,819 $ 382,777 \t\t\t\t =========== ========== ==========\nNet Income Per Partnership Unit (Note 1) $ 51.34 $ 41.90 $ 38.66 \t\t\t\t =========== ========== ==========\nDistributions to Limited Partners Per Partnership Unit (Note 1) $ 54.60 $ 48.65 $ 40.00 \t\t\t\t =========== ========== ==========\nThe accompanying notes are an integral part of these financial statements.\n\t\t\t\t\n\t\t\tSUPER 8 ECONOMY LODGING IV, LTD. \t\t (A California Limited Partnership) \t\t\t STATEMENTS OF PARTNERS' EQUITY\n\t\t\t\t\t Years Ended September 30: \t\t\t\t --------------------------------------- \t\t\t\t\t 1995 1994 1993 \t\t\t\t\t ---- ---- ---- General Partners: Balance at beginning of year $ (22,492) $ (26,682) $ (30,548) Net income 5,134 4,190 3,866 \t\t\t\t ---------- ---------- ---------- Balance at End of Year (17,358) (22,492) (26,682) \t\t\t\t ---------- ---------- ----------\nLimited Partners: Balance at beginning of year 2,713,084 2,784,765 2,801,988 Net income 508,302 414,819 382,777 Distributions to Limited Partners (546,000) (486,500) (400,000) \t\t\t\t ---------- ---------- ---------- Balance at End of Year 2,675,386 2,713,084 2,784,765 \t\t\t\t ---------- ---------- ----------\nTotal Partners' Equity $2,658,028 $2,690,592 $2,758,083 \t\t\t\t ========== ========== ==========\nThe accompanying notes are an integral part of these financial statements.\n\t\t\t\t\n\t\t\tSUPER 8 ECONOMY LODGING IV, LTD. \t\t (A California Limited Partnership) \t\t\t STATEMENTS OF CASH FLOWS\n\t\t\t\t\t Years Ended September 30: \t\t\t\t --------------------------------------- \t\t\t\t\t 1995 1994 1993 \t\t\t\t\t ---- ---- ----\nCash Flows From Operating Activities: Received from motel operations $1,492,593 $1,407,648 $1,374,125 Expended for motel operations and general and administrative expenses (877,067) (934,917) (857,609) Interest received 20,953 18,719 18,107 \t\t\t\t ---------- ---------- ---------- Net Cash Provided by Operating Activities 636,479 491,450 534,623 \t\t\t\t ---------- ---------- ----------\nCash Flows From Investing Activities: Purchases of property and equipment (60,317) (3,311) (30,583) Proceeds from sale of equipment 1,250 - - Proceeds from sale of parcel of land - - 9,700 \t\t\t\t ---------- ---------- ---------- Net Cash Used by Investing Activities (59,067) (3,311) (20,883) \t\t\t\t ---------- ---------- ----------\nCash Flows From Financing Activities: Distributions paid to limited partners (546,000) (486,500) (400,000) \t\t\t\t ---------- ---------- ---------- Net Cash Used by Financing Activities (546,000) (486,500) (400,000) \t\t\t\t ---------- ---------- ----------\nNet Increase in Cash and Temporary Investments 31,412 1,639 113,740\nCash and Temporary Investments: Beginning of year 763,487 761,848 648,108 \t\t\t\t ---------- ---------- ----------\nEnd of Year $ 794,899 $ 763,487 $ 761,848 \t\t\t\t ========== ========== ==========\nThe accompanying notes are an integral part of these financial statements.\n\t\t\t\t\n\t\t\tSUPER 8 ECONOMY LODGING IV, LTD. \t\t (A California Limited Partnership) \t\t STATEMENTS OF CASH FLOWS (Continued) \t\t\t\t \t\t\t\t\t Years Ended September 30: \t\t\t\t --------------------------------------- \t\t\t\t\t 1995 1994 1993 \t\t\t\t\t ---- ---- ---- \t\t\t\t Reconciliation of Net Income to Net Cash Provided by Operating Activities: Net income $513,436 $419,009 $386,643 \t\t\t\t\t -------- -------- -------- Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 109,175 105,784 106,826 (Gain) loss on disposition of property and equipment 1,430 - (5,826) (Increase) decrease in accounts receivable 2,745 11,059 (2,943) (Increase) decrease in prepaid expenses (475) (1,630) 795 (Increase) decrease in other assets (5,006) (33,091) 4,109 Increase (decrease) in accounts payable and accrued liabilities 15,174 (9,952) 45,151 Increase (decrease) in due to related parties - 271 (132) \t\t\t\t\t -------- -------- -------- \tTotal Adjustments 123,043 72,441 147,980 \t\t\t\t\t -------- -------- --------\n\tNet Cash Provided by \t Operating Activities $636,479 $491,450 $534,623 \t\t\t\t\t ======== ======== ========\nThe accompanying notes are an integral part of these financial statements.\n\t\t\t\t\n\t\t\tSUPER 8 ECONOMY LODGING IV, LTD. \t\t (A California Limited Partnership) \t\t\t NOTES TO FINANCIAL STATEMENTS\nNOTE 1 - THE PARTNERSHIP\nSuper 8 Economy Lodging IV, Ltd., is a limited partnership organized under California law on February 5, 1982, to acquire and operate motel properties in Pleasanton and Santa Ana, California. The Pleasanton motel was opened in October, 1983, and the Santa Ana motel was opened in February, 1985. The Partnership grants credit to customers, substantially all of which are local businesses in Pleasanton. The Santa Ana property was sold in April, 1992.\nThe net income or net loss of the Partnership is allocated 1% to the General Partners and 99% to the Limited Partners. Net income (loss) and distributions per partnership unit are based upon 10,000 units outstanding. All partnership units are owned by the Limited Partners.\nThe Partnership agreement requires that the Partnership maintain reserves for normal repairs, replacements, working capital and contingencies in an amount of at least 5% of adjusted capital contributions. As of September 30, 1995, the Partnership had a combined balance in cash and temporary investments of $794,899, which was $339,899 in excess of the $455,000 required amount.\nNOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nItems of Partnership income are passed through to the individual partners for income tax purposes, along with any income tax credits. Therefore, no federal or California income taxes are provided for in the financial statements of the Partnership, except for a deposit of federal income taxes which is required of partnerships with fiscal year ends other than a calendar year. The amount of the deposit is based upon the taxable income of the partnership in the prior year.\nProperty and equipment are recorded at cost. Depreciation and amortization are computed using the following estimated useful lives and methods:\n\t Description Methods Useful Lives ----------------------- ---------------------- ------------\nBuildings 150% declining balance \t\t\t\t and straight-line 10-25 years\nFurniture and equipment 200% and 150% declining \t\t\t\tbalance and straight-line 3-7 years\nCosts incurred in connection with maintenance and repair are charged to expense. Major renewals and betterments that materially prolong the life of assets are capitalized.\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect certain reported amounts and disclosures. Accordingly, actual results could differ from those estimates.\n\t\t\t\t\n\t\t\tSUPER 8 ECONOMY LODGING IV, LTD. \t\t (A California Limited Partnership) \t\t\t NOTES TO FINANCIAL STATEMENTS\nNOTE 3 - CASH AND TEMPORARY INVESTMENTS\nCash and temporary investments as of September 30, 1995 and 1994 consist of the following: \t\t\t\t\t\t\t 1995 1994 \t\t\t\t\t\t\t ---- ---- Cash in bank, non-interest bearing $ 26,949 $ 31,742 Money market accounts 567,950 531,745 Certificates of deposit and commercial paper 200,000 200,000 \t\t\t\t\t\t --------- --------- Total Cash and Temporary Investments $ 794,899 $ 763,487 \t\t\t\t\t\t ========= ========= Temporary investments are recorded at cost, which approximates market value. The Partnership considers temporary investments and all highly liquid marketable securities with original maturities of six months or less to be cash equivalents for purposes of the statement of cash flows.\nNOTE 4 - RELATED PARTY TRANSACTIONS Franchise Fees Super 8 Motels, Inc., now a wholly-owned subsidiary of Hospitality Franchise Systems, Inc., is franchisor of all Super 8 Motels. The Partnership pays to the franchisor monthly fees equal to 4% of the gross room revenues of the motel and contributes an additional 1% of the gross room revenues to an advertising fund administered by the franchisor. In return, the franchisor provides the right to use the name \"Super 8,\" a national institutional advertising program, an advance room reservation system, and inspection services. These costs ($72,424 in 1995, $67,631 in 1994 and $66,694 in 1993) are included in motel operations expense in the accompanying statements of operations. The Partnership operates its motel property as a franchisee of Super 8 Motels, Inc. through a sub-franchise agreement with Brown & Grotewohl, a partnership of the Estate of Dennis A. Brown and Grotewohl Management Services, Inc., the general partner of Super 8 Economy Lodging IV, Ltd. Under the sub-franchise agreement, Brown & Grotewohl earned 40% of the above franchise fees, which amounted to $28,970, $27,052 and $26,678 in 1995, 1994 and 1993, respectively.\nProperty Management Fees Brown & Grotewohl, an affiliate of one of the General Partners, manages the motel property of the Partnership. The fee for this service is 5% of the gross revenues from Partnership operations as defined in the Partnership agreement, and amounted to $74,416, $69,631 and $68,657 in 1995, 1994 and 1993, respectively.\nSubordinated Partnership Management Fees During the Partnership's operational stage, the General Partners are to receive 9% of cash available for distribution for Partnership management services, along with an additional 1% of cash available for distribution on account of their interest in the income and losses, subordinated, however, to receipt by the Limited Partners of a 10% per annum cumulative return on their adjusted capital investments. At September 30, 1995 the Limited Partners had not received the 10% cumulative return, and accordingly, no Partnership management fees are payable. Management does not anticipate payment of these fees in the immediate future; therefore, they are not reflected in these financial statements. \t\t\t\t\n\t\t\tSUPER 8 ECONOMY LODGING IV, LTD. \t\t (A California Limited Partnership) \t\t\t NOTES TO FINANCIAL STATEMENTS\nNOTE 4 - RELATED PARTY TRANSACTIONS (Continued)\nSubordinated Incentive Distributions Under the terms of the Partnership agreement, the General Partners are to receive 15% of distributions of net proceeds from the sale or refinancing of Partnership property remaining after distribution to the Limited Partners of any portion thereof required to cause distributions to the Limited Partners from all sources to be equal to their capital contributions plus a cumulative 10% per annum pre-tax return on their adjusted capital contributions.\nExpenses Shared by the Partnership and its Affiliates There are certain expenses which are allocated between the Partnership and affiliated Super 8 partnerships. These expenses, which are allocated based on usage, are telephone, data processing, rent of the administrative office, administrative salaries and duplication expenses. The expenses allocated to the Partnership were approximately $110,000 in 1995, $104,000 in 1994 and $115,000 in 1993 and are included in motel and restaurant operations and general and administrative expenses in the accompanying statements of operations. Included in administrative salaries are allocated amounts paid to three employees who are related to Philip B. Grotewohl, the sole shareholder of Grotewohl Management Services, Inc., a general partner of the Partnership.\nNOTE 5 - MOTEL OPERATING EXPENSES\nThe following table summarizes the major components of motel operating expenses for the years ended September 30, 1995, 1994 and 1993:\n\t\t\t\t\t 1995 1994 1993 \t\t\t\t\t ---- ---- ----\nSalaries and related costs $282,994 $298,050 $333,675 Utilities 70,349 70,875 69,795 Allocated costs, mainly indirect salaries 89,327 85,609 93,675 Other operating expenses 334,34 333,019 303,286 \t\t\t\t\t -------- -------- -------- Total Motel Operating Expenses $777,015 $787,553 $800,431 \t\t\t\t\t ======== ======== ========\nNOTE 6 - SALE OF LAND PARCEL\nOn March 29, 1993 the Partnership conveyed approximately 428 square feet of the Pleasanton land adjacent to the freeway to the State of California. The proceeds of the sale consisted of $9,700. The sale resulted in a net gain of $5,825.\n\t\t\t\t\nItem 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\n\tInapplicable.\n\t\t\t\t PART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\n\tThe original Managing General Partners of the Partnership were Dennis A. Brown and Grotewohl Management Services, Inc., whose sole shareholder is Philip B. Grotewohl. The original Associate General Partners were BWC Incorporated and Robert J. Dana.\nUpon Mr. Brown's death on February 25, 1988, Mr. Grotewohl, as president of Grotewohl Management Services, Inc. and Mr. Dana elected to continue the Partnership. BWC Incorporated was dissolved in 1989.\n\tMr. Grotewohl is currently age 77. Mr. Dana is age 67.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION\n\tThe following discussion contains certain information regarding aggregate direct or indirect compensation paid or accrued by the Partnership during the fiscal year ended September 30, 1995 to the General Partners and the Estate of Dennis A. Brown, and\/or their affiliates. Although Mr. Brown ceased to be a general partner of the Partnership upon his death, his estate shares in certain compensation otherwise payable to the General Partners and their affiliates.\nProperty Management Fees - ------------------------\n\tThe Manager, a California general partnership which is owned equally by the Estate of Dennis A. Brown and the Managing General Partner, is managing the Partnership's motel. The fee for this service is 5% of the gross proceeds from the operation of the motel. This compensation is in addition to the cost of compensating the Partnership's employees and the cost of goods and services acquired for the Partnership from independent contractors.\n\tDuring the fiscal year covered by this report the Partnership accrued such fees in the amount of $74,416, all of which were paid.\nFranchise Fees and Advertising Fees - ------------------------------------\n\tThe Partnership operates its motel as a franchisee of Super 8 Motels, Inc., through a sub-franchise obtained from Super 8 Management Corporation, a corporation of which the Estate of Dennis A. Brown and Philip B. Grotewohl are the sole shareholders. In March 1988 the shareholders of Super 8 Management Corporation transferred their interests in the\n\t\t\t\t - 13 -\nsub-franchise agreement to the Manager. The Partnershipo as franchisee, pays to the franchisor monthly franchise fees equal to 4% of its gross room revenue and contributes 1% pf its gross room revenue to an advertising fund administered by the franchisor to finance institutional advertising. The Manager is entitled to one-half of the 4% franchise fee.\n\tThe total of franchise fees accrued during the fiscal year covered by this report was $57,939, of which $28,970 accrued to the Manager. All of the above sums have been paid.\nGeneral Partners' Interest in Cash Available for Distribution - --------------------------------------------------------------\nAt quarterly intervals, the total amount of the Partnership's Cash Available for Distribution is determined at the discretion of the General Partners. (See Item 5 above.) Distributions therefrom are made as follows: (1) 90% of such distributions are paid to the Limited Partners; (2) 9% thereof is paid to the General Partners as Partnership management fees; and (3) 1% thereof is paid to the General Partners in accordance with their interest in the income and losses of the Partnership.\n\tNotwithstanding the foregoing, however, distributions of Cash Available for Distribution to the General Partners which would otherwise be paid to the General Partners are deferred and paid only after payment to the Limited Partners of distributions of Cash Available for Distribution in an amount equal to 10% per annum cumulative on their Adjusted Capital Contributions. During the fiscal year covered by this report, $546,000 in distributions of Cash Available for Distribution were paid to the Limited Partners. A total of $366,104 representing the General Partners' Interest in Cash Available for Distribution has been deferred and remains unpaid since commencement of the Partnership. The Limited Partners must receive $8,681,355 (calculated through September 30, 1995) and $910,000 each year thereafter in additional distributions before any of the accrued amounts will be paid to the General Partners. Accordingly, the General Partners consider the payment of these deferred amounts to be unlikely.\nGeneral Partner's Interest in Sale or Refinancing Proceeds - -----------------------------------------------------------\n\tThe proceeds from the sale or refinancing of properties not reinvested are to be distributed first to the Limited Partners until they have received cumulative payments from all distribution sources equal to 100% of their original capital contribution and a cumulative 10% per annum return on their Adjusted Capital Contributions. When the foregoing requirement has been satisfied, any remaining funds from the sale or refinancing of properties will be distributed 15% to the General Partners and 85% to the Limited Partners.\n\tNo such distributions were paid or accrued for the account of the General Partners during the fiscal year covered by this report. \t\t\t\t - 14 -\nAllocation of General Partners' Interest - -----------------------------------------\nCompensation to the General Partners and their affiliates in the form of franchise fees and property management fees is allocated 1\/3 each to the Estate of Dennis A. Brown, the Managing General Partner and the Associate General Partner.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nSecurity Ownership of Certain Beneficial Owners - ------------------------------------------------\nNo person is known by the Partnership to be the beneficial owner of more than 5% of the Units.\nSecurity Ownership of Management - --------------------------------\n\tThe General Partners do not beneficially own any Units.\nChanges in Control - -------------------\n\tWith the consent of all other General Partners and Limited Partners holding more than 50% of the Units, a General Partner may designate a successor or additional general partner, in each case with such participation in such General Partner's interest as such General Partner and successor or additional general partner may agree upon, provided that the interests of the Limited Partners are not affected thereby.\nA General Partner may withdraw from the Partnership at any time upon 60 days' prior written notice to the Limited Partners and any other General Partners, or may transfer his interest to an entity controlled by him; provided, however, that in either such event, if it is determined that the Partnership business is to be continued rather than dissolved and liquidated upon the happening thereof, the withdrawal or transfer will be effective only after receipt by the Partnership of an opinion of counsel to the effect that such withdrawal or transfer will not cause the Partnership to be classified as an association taxable as a corporation rather than as a partnership for federal income tax purposes.\nThe Limited Partners shall take no part in the management of the Partnership's business; however, a majority in interest of the Limited Partners, without the concurrence of the General Partners, shall have the right to amend the Partnership Agreement, dissolve the Partnership, remove a General Partner or any successor general partner, elect a new general partner or general partners upon the removal, retirement, death, insanity, insolvency or bankruptcy of a General Partner, and approve or disapprove the sale, exchange or pledge in a single transaction of all or substantially all of the properties acquired by the Partnership. \t\t\t\t - 15 -\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nAdministrative Expenses Shared by the Partnership and its Affiliates - --------------------------------------------------------------------\n\tThere are certain administrative expenses allocated between the Partnership and affiliated Super 8 partnerships. These expenses, which are allocated based on usage, are telephone, data processing, rent of administrative offices and administrative salaries. The administrative expenses allocated to the Partnership were approximately $110,000 in the fiscal year ended September 30, 1995 and are included in general and administrative expenses and motel and restaurant operations expenses in the Partnership's financial statements. Included in administrative salaries are allocated amounts paid to three employee who are related to Philip B Grotewohl, the sole shareholder of a General Partner.\n\t\t\t\t - 16 -\n\t\t\t\t PART IV\nItem 14.","section_14":"Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) Documents filed as part of this report: 1. Financial Statements Included in Part II of this Report \t Report of Independent Certified Public Accountants \t Balance Sheets, September 30, 1995 and 1994 \t Statement of Operations for the Years Ended September 30, \t\t1995, 1994 and 1993 \t Statements of Partners' Equity for the Years Ended September 30, \t\t1995, 1994 and 1993 \t Statements of Cash Flows for the Years Ended September 30, \t\t1995, 1994 and 1993 \t Notes to Financial Statements\n2. Financial Statement Schedules Included in Part IV of the Report \t None\n3. Exhibits \t 3. and 4. The Partnership Agreement is incorporated herein \t\t as an exhibit from the annual report on Form 10-K for the \t\t fiscal year ended September 30, 1994\n(b) Reports on Form 8-K: \t Inapplicable\n\t\t\t\t - 17 -\n\t\n\t\t\t\tSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the 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(Registrant) SUPER 8 MOTELS II, LTD. \t\t\t ----------------------- (Signature and Title) \/s\/ Philip B. Grotewohl \t\t\t ---------------------------- \t\t\t Philip B. Grotewohl, President of Grotewohl \t\t\t Management Services, Inc. Managing General Partner\nDate December 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.\nBy (Signature and Title) \/s\/ Philip B. Grotewohl \t\t\t\t--------------------------- \t\t\t Philip B. Grotewohl, Chief executive officer, \t\t\t chief financial officer, chief accounting \t\t\t officer and sole director of Grotewohl \t\t\t Management Services, Inc., Managing General \t\t\t Partner\nDate December 28, 1995 \t \t\n\t\t\t\t - 18 -","section_15":""}
{"filename":"97886_1995.txt","cik":"97886","year":"1995","section_1":"ITEM 1. BUSINESS\na. General Development of Business.\nThe Company began operations in 1928 and has grown through both internal expansion and new business acquisitions. Efforts since 1984 have focused on expansion of the Lighting Segment and the Compressors and Vacuum Pumps Segment as the two core businesses. The significant recent additions to these two core segments have been ASF, Pneumotive, Brey, and WISA, all compressor and vacuum pump companies, acquired from 1987 through 1990; and the Lumec and Day-Brite Lighting additions in 1987 and 1989, respectively. These acquisitions have been strategically important as they allow the Company to offer a more complete product line and make the Company a more prominent participant in both the lighting and compressor and vacuum pump markets.\nThe Lighting Segment operates in a multi-faceted industry, serving the consumer, commercial, industrial, and outdoor markets. The industry is dominated by five companies in the U.S. and Canada, one of which is Thomas Industries. Although the industry is subject to the cyclicality of residential and commercial construction activity, replacement and renovation activity moderates these cycles somewhat.\nOperations of the Compressors and Vacuum Pumps Segment help the Company moderate the impact of the Lighting Segment's vulnerability to construction and economic cycles. Thomas believes it is the major supplier to the original equipment manufacturer (OEM) medical market and a significant participant in its other OEM compressor and vacuum pump markets.\nb. Financial Information about Industry Segments.\nThe information required by this item is set forth in Exhibit 13 under the heading \"Notes to Consolidated Financial Statements,\" which information is hereby incorporated herein by reference.\nc. Narrative Description of Business.\nThe Company's principal businesses are lighting, including consumer, commercial, industrial, and outdoor lighting fixtures; and compressors and vacuum pumps. The Company designs, manufactures, markets, and sells these products; and maintains corporate offices in Louisville, Kentucky. The Company operates numerous divisions and subsidiaries, with facilities throughout the U.S. and operations in Canada and Germany. The Company also maintains sales offices in Brazil, England, Italy, and Japan and has joint ventures in Japan and in the U.S. and Canada with a Belgian company.\nLighting Segment\nThe Company's consumer lighting products--its original base--are designed for a broad range of consumers. The Company stresses product development to meet changing needs and demands. The Company typically targets the more upscale, single-family homeowner but also has a line for the do-it-yourself homeowner. The Company also is strongly involved in the replacement lighting market, which is a growing component of the overall lighting industry. Under the Thomas and Do-It-Yourself brand names, the Company's consumer lighting line includes high-style chandeliers and bathroom fixtures, plus quality lighting products for foyers, dining rooms, living rooms, entertainment areas, kitchens, bedrooms, and outdoors.\nThe Thomas and Do-It-Yourself lines are distributed throughout the United States through a network of electrical distributors, lighting showrooms, and home centers, which, in turn, sell to electrical contractors, builders, and consumers.\nConsumer lighting fixtures are manufactured and sold in the U.S. and Canada under the Thomas and Do-It-Yourself trade names; and those trade names are recognized as important to this Segment's business.\nThe Company believes it has established a reputation as an innovator and pioneer in track and recessed lighting technology and is one of the nation's leading manufacturers of fluorescent and high-intensity discharge (\"HID\") commercial and industrial products. The Company's commercial and industrial product line can be applied to virtually any application, using a variety of lamp sources, and is designed for efficiency as well as energy savings. The Company's outdoor lighting products are known for their high performance in efficiency, glare control, and uniformity of illumination. Products are manufactured and sold in the U.S. and Canada under the Day-Brite, Gardco, Capri, Electro\/Connect, McPhilben, Omega, Emco, Lumec, and Thomas Lighting trade names.\nThe Lighting Segment accounted for 68 percent of the Company's sales in 1995, compared to 67 percent in 1994 and 66 percent in 1993.\nCompressors and Vacuum Pumps Segment\nThis Segment includes air compressors and vacuum pumps manufactured under the Thomas name in the U.S. and ASF\/Thomas in Europe for use in the finished products of other domestic or foreign manufacturers. Its products also are manufactured for private-label sale in the construction compressor industry. Thomas specializes in compressor applications below the 1.5 horsepower range. Such compressors and vacuum pumps are found in medical equipment, vending machines, photocopiers, computer tape drives, automotive and transportation equipment, liquid dispensing applications, gasoline vapor recovery, refrigerant recovery and waste disposal equipment. Thomas is the major compressor and vacuum pump participant in the medical OEM industry worldwide. The Company offers a wide selection of standard air compressors and vacuum pumps and will modify or design its products to meet exacting OEM applications.\nIn addition, the Company manufactures and sells compressors and related accessories for commercial and consumer use. Sales, both domestic and international, traditionally are made through hardware stores, home centers, and building supply dealers.\nThe U.S. operations manufacture rotary vane, piston, and diaphragm compressors and vacuum pumps, as well as air motors and vacuum ejectors. These products are distributed worldwide to original equipment manufacturers as well as through fluid power and large compressor distributors. Primary markets served include medical, environmental, instrumentation, mobile, construction, and consumer.\nThe European operations manufacture a complementary line of miniature rotary vane, piston, linear, and diaphragm compressors and vacuum pumps, with expertise in applications of less than 1\/8 horsepower. These products are currently distributed worldwide to original equipment manufacturers. Primary applications for products manufactured in Europe include medical, air and gas sampling, photography, and dish washing equipment, as well as laboratory instruments and leak detection devices.\nThe Thomas, ASF\/Thomas, and Sprayit trade names are recognized in the market and are important to the Segment.\nThe Compressors and Vacuum Pumps Segment accounted for 32 percent of the Company's sales in 1995, compared to 32 percent in 1994 and 29 percent in 1993.\n---------------------\nNo single customer of the Company accounted for more than 10 percent of consolidated net sales or more than 10 percent of any segment's net sales in 1995, and no material part of the business is dependent upon a single customer the loss of which could have a materially adverse effect on the business of the Company.\nThe backlog of unshipped orders was $90 million at December 31, 1995--47 percent Lighting and 53 percent Compressors and Vacuum Pumps--and $90 million at December 31, 1994--48 percent Lighting and 52 percent Compressors and Vacuum Pumps. The Company believes substantially all of such orders are firm, although some orders are subject to cancellation. Substantially all of these orders are filled in the succeeding year.\nCompetition in the lighting industry is strong in all markets served by the Company. The industry has been consolidating significantly over the last few years. It is estimated that five companies control the majority of the market in the U.S. and Canada. Thomas Industries is one of these top five. The Company stresses high quality, and energy efficient lighting products, while providing value and strong customer support to compete in its markets.\nThe Compressors and Vacuum Pumps Segment competes worldwide in the fractional horsepower compressor and vacuum pump markets. Management believes it is the major supplier to the OEM medical market and a significant participant in its other OEM markets.\nThe Company believes that it has adequate sources of materials and supplies for each of its businesses.\nThere is no significant seasonal impact on the business of any industry segment of the Company. Many of the lighting businesses continue to be dependent on the construction markets, which are subject to the overall health of the economy.\nWorking capital is provided principally from operating profits. The Company maintains adequate lines of credit and financial resources to meet the anticipated cash requirements in the year ahead.\nThe Company has various patents and trademarks but does not consider its business to be materially dependent upon any individual patent or trademark.\nDuring 1995, the Company spent $13.4 million on research activities relating to the development of new products and the improvement of existing products. Substantially all of this amount was Company-sponsored activity. During 1994, the Company spent $12.7 million on these activities and during 1993, $12.4 million.\nContinued compliance with present and reasonably expected federal, state, and local environmental regulations is not expected to have any material effect upon capital expenditures, earnings, or the competitive position of the Company and its subsidiaries.\nThe Company employs approximately 3,100 people.\nd. Financial Information about Foreign and Domestic Operations and Export Sales.\nSee Notes to Consolidated Financial Statements, as set forth in Exhibit 13, which information is incorporated herein by reference to the Company's 1995 Annual Report to Shareholders, for financial information about foreign and domestic operations. Export sales for the years 1995, 1994, and 1993, were $40,900,000, $36,600,000, and $34,500,000, respectively.\ne. Executive Officers of the Registrant.\nAll other officers listed have been executive officers for the past five years.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Corporate offices of the Company are located in Louisville, Kentucky. Due to the large number of individual locations and the diverse nature of the operating facilities, it is neither practical nor significant to describe all of the properties owned and leased by the Company. All of the buildings are of steel, masonry, and concrete construction, are in generally good condition, provide adequate and suitable space for the operations at each location, and are of sufficient capacity for present and foreseeable future needs.\nThe following listing summarizes the Company's properties.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIn the normal course of business, the Company and its subsidiaries are parties to legal proceedings. Management believes that these proceedings will be resolved with no materially adverse impact on the financial condition and results of operations of the Company.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone\nPART II.\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS\nThe information required by this item is set forth in Exhibit 13 under the heading \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and under the heading \"Notes to Consolidated Financial Statements,\" which information is contained in the Company's 1995 Annual Report to Shareholders and hereby incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe information required by this item is set forth in Exhibit 13 under the heading \"Five-Year Summary of Operations and Statistics,\" which information is contained in the Company's 1995 Annual Report to Shareholders and hereby incorporated herein by reference.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe information required by this item is set forth in Exhibit 13 under the heading \"Management's Discussion and Analysis of Financial Condition and Results of Operations,\" which information is contained in the Company's 1995 Annual Report to Shareholders and hereby incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe information required by this item is set forth in Exhibit 13 under the headings \"Consolidated Financial Statements,\" \"Notes to Consolidated Financial Statements,\" and \"Report of Management and Independent Auditors,\" which information is contained in the Company's 1995 Annual Report to Shareholders and hereby incorporated herein by reference.\nThe supplementary data regarding quarterly results of operations is set forth in Exhibit 13 under the heading \"Notes to Consolidated Financial Statements,\" which information is contained in the Company's 1995 Annual Report to Shareholders and hereby incorporated herein by reference.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable.\nPART III.\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\na. Directors of the Company\nThe information required by this item is set forth in registrant's Proxy Statement for the Annual Meeting of Shareholders to be held on April 18, 1996, under the headings \"Election of Directors\" and \"Compliance with Section 16(a),\" which information is hereby incorporated herein by reference.\nb. Executive Officers of the Company\nReference is made to \"Executive Officers of the Registrant\" in Part I, Item 1e.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by this item is set forth in registrant's Proxy Statement for the Annual Meeting of Shareholders to be held on April 18, 1996, under the headings \"Executive Compensation,\" \"Compensation Committee Interlocks and Insider Participation,\" and \"Board of Directors,\" which information is hereby incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required by this item is set forth in registrant's Proxy Statement for the Annual Meeting of Shareholders to be held on April 18, 1996, under the heading \"Securities Beneficially Owned by Principal Shareholders and Management,\" which information is hereby incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by this item is set forth in registrant's Proxy Statement for the Annual Meeting of Shareholders to be held on April 18, 1996, under the caption \"Board of Directors,\" 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\na. (1) Financial Statements\nThe following consolidated financial statements of Thomas Industries Inc. and subsidiaries, included in the Company's 1995 Annual Report to Shareholders are included in Part II, Item 8:\nConsolidated Balance Sheets--December 31, 1995 and 1994 Consolidated Statements of Income--Years ended December 31, 1995, 1994, and 1993 Consolidated Statements of Shareholders' Equity--Years ended December 31, 1995, 1994, and 1993 Consolidated Statements of Cash Flows--Years ended December 31, 1995, 1994, and 1993 Notes to Consolidated Financial Statements--December 31, 1995 Five-Year Summary of Operations and Statistics Independent auditors report from KPMG Peat Marwick LLP\n(2) Financial Statement Schedule\nSchedule II -- Valuation and Qualifying Accounts\n(3) Listing of Exhibits\nExhibit No. Exhibit\n3(a) Restated Certificate of Incorporation, as amended, filed as Exhibit 3(a) to registrant's report on Form 10-Q dated August 11, 1988, hereby incorporated by reference.\n3(b) Bylaws, as amended December 14, 1995.\n4(a) Note Agreement dated January 19, 1990, by and among the Company and its Day-Brite Lighting, Inc., subsidiary, Allstate Life Insurance Company, and other investors filed as Exhibit No. 4 to registrant's report on Form 10-K dated March 22, 1990, hereby incorporated by reference.\nCopies of debt instruments for which the related debt is less than 10% of consolidated total assets will be furnished to the Commission upon request.\n4(b) Rights Agreement filed as Exhibit 1 to registrant's report on Form 8-A on December 23, 1987, hereby incorporated by reference.\n4(c) Amendment to Rights Agreement filed as Exhibit 1 to the registrant's report on Form 8-K on October 18, 1990, hereby incorporated by reference.\n10(a) Employment Agreements with Timothy C. Brown, Gilbert R. Grady, Jr., C. Barr Schuler, and Phillip J. Stuecker filed as Exhibits 3(a), 3(f), 3(i), and 3(j), respectively, to registrant's report on Form 10-Q dated November 11, 1988, hereby incorporated by reference.\n10(b) Employment Agreement with Clifford C. Moulton filed as Exhibit 10(b) to registrant's report on Form 10-K dated March 25, 1993, hereby incorporated by reference.\n10(c) Employment Agreement with Richard J. Crossland filed as Exhibit 10(c) to registrant's report on Form 10-K dated March 22, 1994, hereby incorporated by reference.\n10(d) Trust Agreement, filed as Exhibit 10(1) to registrant's report on Form 10-Q dated November 11, 1988, hereby incorporated by reference.\n10(e) Form of Indemnity Agreement and Amendment thereto entered into by the Company and each of its Executive Officers filed as Exhibits 10 (g) and (h) to registrant's report on Form 10-K dated March 23, 1988, hereby incorporated by reference.\n10(f) Severance pay policy of the Company, effective October 1, 1988, covering all Executive Officers, filed as Exhibit 10(d) to registrant's report on Form 10-K dated March 23, 1989, hereby incorporated by reference.\n10(g) 1987 Incentive Stock Plan as Amended, filed as Annex A to the registrant's Proxy Statement on March 17, 1989, hereby incorporated by reference.\n10(h) Non-Employee Director Stock Option Plan, filed as Exhibit A to the registrant's Proxy Statement on March 10, 1994, hereby incorporated by reference.\n10(i) 1995 Incentive Stock Plan, filed as Exhibit A to the registrant's Proxy Statement on March 14, 1995, hereby incorporated by reference.\n13 Certain portions of the Company's 1995 Annual Report to Shareholders as specified in Part II hereof to be incorporated by reference in this Annual Report on Form 10-K.\n21 Subsidiaries of the Registrant.\n23 Consent of KPMG Peat Marwick LLP.\n27 Financial Data Schedule.\nb. Reports on Form 8-K\nThere were no reports on Form 8-K for the three months ended December 31, 1995.\nc. Exhibits\nThe exhibits filed as part of this Annual Report on Form 10-K are as specified in Item 14(a)(3) herein.\nS I G N A T U R E S\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, there unto duly authorized.\nTHOMAS INDUSTRIES INC.\nDate: March 21, 1996 By \/s\/ Timothy C. Brown Timothy C. Brown, Chairman of the Board\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nSignature Title Date\n\/s\/ Timothy C. Brown Chairman of the Board; 3\/21\/96 Timothy C. Brown President; Chief Executive Officer; Chairman of the Executive Committee; Director (Principal Executive Officer)\n\/s\/ Phillip J. Stuecker Vice President of Finance; 3\/21\/96 Phillip J. Stuecker Chief Financial Officer; Secretary (Principal Financial Officer)\n\/s\/ Ronald D. Wiseman Controller; Assistant 3\/21\/96 Ronald D. Wiseman Secretary (Principal Accounting Officer)\n\/s\/ Peter P. Donis Director 3\/21\/96 Peter P. Donis\n\/s\/ Wallace H. Dunbar Director 3\/21\/96 Wallace H. Dunbar\n\/s\/ Roger P. Eklund Director 3\/21\/96 Roger P. Eklund\n\/s\/ H. Joseph Ferguson Director 3\/21\/96 H. Joseph Ferguson\n\/s\/ Gene P. Gardner Director 3\/21\/96 Gene P. Gardner\n\/s\/ Lawrence E. Gloyd Director 3\/21\/96 Lawrence E. Gloyd\n\/s\/ William M. Jordan Director 3\/21\/96 William M. Jordan\n\/s\/ Ralph D. Ketchum Director 3\/21\/96 Ralph D. Ketchum\n\/s\/ Franklin J. Lunding, Jr. Director 3\/21\/96 Franklin J. Lunding, Jr.\nIndependent Auditors' Report\nThe Board of Directors and Shareholders Thomas Industries Inc.\nWe have audited the consolidated financial statements of Thomas Industries Inc. and subsidiaries as listed in the accompanying index. In connection with our audits of the financial statements, we also have audited the financial statement schedule as listed in the accompanying index. These 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 Thomas Industries Inc. and subsidiaries as of December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1995, 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\nLouisville, Kentucky February 7, 1996\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS Thomas Industries Inc. and Subsidiaries December 31, 1995\nEXHIBIT INDEX\nExhibit No. Exhibit Page\n3(b). Bylaws, as amended December 14, 1995\n13. Certain portions of the Company's 1995 Annual Report to Shareholders as specified in Part II hereof to be incorporated by reference in this Annual Report on Form 10-K 21. Subsidiaries of the Registrant\n23. Consent of KPMG Peat Marwick\n27. Financial Data Schedule","section_15":""}
{"filename":"790027_1995.txt","cik":"790027","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nWhitehall Income Fund-86 Limited (the \"Registrant\" or the \"Partnership\") is a limited partnership formed in 1985 under the Limited Partnership Act of the State of California to acquire, improve, operate and hold for investment income producing real property. The Partnership purpose is to purchase Properties and to own and operate the Properties for a period of five to ten years. Currently, the Partnership employs approximately 8 individuals.\nThe Registrant has acquired two self storage facilities, a shopping center, two office buildings and a building leased to fast food restaurant operations for a total cost of $5,675,566 as further described in Item 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Registrant owns six income producing real properties as described below.\nMCRAE SQUARE SHOPPING CENTER\nOn December 30, 1986, the Partnership purchased, from an unaffiliated third party, the commercial income project known as McRae Square Shopping Center (the \"Shopping Center\") located in the southeastern area of Georgia in McRae for a total of $793,840. The building has a cost basis of $734,611 and the land was allocated a cost of $59,229 based upon an independent appraisal dated March 1986. The Shopping Center is located directly across the street from the local Winn Dixie Shopping Center on U.S. Highway 341-Oak Street, one of the primary traffic arteries in the area. The Shopping Center is approximately two acres in size and encompasses approximately 12,630 square feet of leasable area with room for\nexpansion. The Shopping Center was completed in December of 1985 and commenced operation on December 31, 1985.\nThe Shopping Center's current tenants include Rite Aid Drug, the drugstore chain subsidiary of Rite Aid Corporation. Another major tenant is Family Dollar Stores, Inc., a discount variety store. Family Dollar Store's initial lease term expired during December 31, 1994, with six (6) five-year options; Rite Aid Drug's initial lease term expired May 25, 1995, with four (4) five-year options. Each tenant has exercised its first option for a period of five (5) years. Family Dollar's annual base rent is $26,000; Rite Aid's $48,067.50.\nThe Partnership, under the terms of the Shopping Center leases and options, is entitled to receive as additional rental, subject to certain offsets, percentage rental participation of two percent (2%) to two and one-half percent (2.5%) of annual gross sales, above certain sales levels.\nThe Shopping Center is directly across the highway from the Winn Dixie Shopping Center which contains two department stores similar to the Family Dollar and Rite Aid Drug. There are retail shopping areas in Helens, .5 miles to the west and in McRae .3 miles east, which contain two drug stores. These retail establishments compete with the establishments which are lessees of the McRae Square Shopping Center.\nRental income for the Shopping Center was $78,396, $87,568 and $67,126 for 1995, 1994, and 1993, respectively. Operating expenses for the same years were $43,177 $ 42,992 and $48,387 respectively. The rental income increase for 1994 reflected collection of $14,376 from Rite Aid for reimbursement of their share of real estate taxes and general insurance for previous years.\nAs of December 31, 1995 the Shopping Center is 100% occupied.\nThe Partnership paid to, in prior years, an affiliate of the General Partner an acquisition fee of $44,000 for its efforts in the negotiation, execution and purchase of the Shopping Center.\nThe property was unencumbered as of December 31, 1995.\nTANQUE VERDE SELF STORAGE\nOn March 31, 1987, the Partnership acquired the Tanque Verde\/Kolb Self Storage facility (the \"Property\") in Tucson, Arizona. The original purchase price of the Property was $1,945,000 plus legal, title, and recording fees of $17,140. Of the original purchase price, $194,031 was allocated to land and $1,768,109 to the building, based upon an independent appraisal. The Property is located on a parcel of land comprising approximately 60,209 square feet, which consists of approximately 43,200 square feet of self-storage facilities, approximately 950 square feet of\noffice\/residence space, and approximately 16,059 square feet of non-rentable space. The Property was completed in December 1984, and commenced operations during that month. There are 875 self-storage units within the Property. One hundred twenty-eight (14.6%) are 4'x5'x9' units, 110 (12.6%) are 3'x4' units and 90 (10.3%) are 5'x12' units. The remainder of the units vary in size from 4'x4' to 11'x18'.\nMonthly rents vary from $15.00 to $166.00 per unit. The Property is over 90% occupied.\nThere are four self-storage facilities in the eastern Tucson, Arizona area which are in direct competition with the Property. They currently have occupancy ranges of approximately 90% to 95%, with rents substantially similar to the those charged by the Partnership.\nThe Property has a $1,000,000 note payable which is collateralized by the Property's real and personal property. The note calls for interest adjusted semi-annually to 3.5% above the coupon rate with a maximum rate of 16.65% and minimum of 9.66%. Monthly principal and interest payments of $8,528 are due until the interest rate is adjusted then the monthly installment will be adjusted accordingly. The entire unpaid balance is due September 1999. The outstanding balance on this note at December 31, 1995 was $951,603.\nRental income from the Property was $374,824, $354,097 and $333,723 for 1995, 1994, and 1993, respectively. Operating expenses for the same years were $324,237, $373,034 and $373,176, respectively. Rental income increased based on rental rate increases in July of 1995; while, expenses increased due to an increase in real estate tax assessment and replacement of the cooling units at the facility.\nThe Partnership paid, in prior years, an affiliate of the General Partner an acquisition fee of $144,900 for its efforts in negotiations and purchase of the facility.\nATHENS SELF STORAGE\nOn May 23, 1988, the Partnership purchased a self-storage facility (\"Athens Self Storage\") in Athens, Georgia for a purchase price of $1,132,974. Of the original purchase price, $862,974 was allocated to the building and $270,000 was allocated to the land. The Athens Self Storage is comprised of a 3.4 acre parcel of land and mini storage warehouse, which is a 31,630 square foot storage facility. The property was subject to a first mortgage for $643,872 and the mortgage was paid in full in 1989.\nDuring 1990, the Partnership signed a $575,000 note payable to obtain funds to assist in expanding the Athens facility. In connection with this note, the Partnership acquired additional land for approximately $73,000. The note requires monthly principal and\ninterest installments of $6,717 through November 1995, at which time the interest will adjust to prime plus 1.5% and monthly principal and interest payments will be based on a ten year amortization period. The remaining balance of the note becomes due November 2000. The note contains restrictions which, among other things, require maintenance of certain financial ratios and the subordination of distributions to the terms and conditions of the note.\nOccupancy rates were over 90% and rental income from Athens Self Storage was $ 175,319, $231,611 and $213,529 for 1995, 1994 and 1993, respectively. Operating expenses for the same years were $169,036, $250,694 and $292,005 respectively.\nThe Athens Self Storage was exchanged for a larger storage facility in Tucson, Arizona on November 3, 1995 at a difference of $535,000. The exchange property, known as Capitol Self Storage, was acquired with a debt of $1,250,000 payable in monthly installments of principle and interest of $10,490 at nine percent (9%)annually, amortized over a twenty-five (25) year period with a ten (10) year balloon payment.\nCAPITOL SELF STORAGE\nOn November 3, 1995, the Partnership exchanged Athens Self Storage for Capitol Self Storage, a 43,890 square foot storage facility on 1.5 acres in Tucson, Arizona. The purchase price was $1,925,000 and consists of 471 storage units and 43 parking spaces. The storage buildings are built of block with metal roofs, with perimeter fencing and electronic gates with touch pads. The driveway areas are of both asphalt and concrete. The managers are a husband and wife who reside at the apartment on site.\nThe facility, built in 1984 has maintained an occupancy of 85% to 95% over the past three years, as have the four area facilities which are in direct competition with Capitol. Partnership rate ranges are similar to those of the competing facilities. Located on a main east-west thoroughfare with a traffic count of 30,000 per day, the facility attracts customers from a heavy concentration of apartments in the area, winter visitors and a military base.\nThe property was held as collateral for a mortgage of $1,250,000 outstanding as of December 31, 1995.\nPAN AMERICAN OFFICE BUILDING\nOn December 29, 1988, the Partnership purchased a 16,315 square foot office building on a 1.39 acre tract of land (the \"Pan Am Plaza\") in Edinburgh, Texas for a purchase price of $600,067. The Pan Am Plaza is fully occupied by the Department of Human Resources of the State of Texas on a five year noncancellable lease with annual increases. The lease was renewed in August of 1993 for a\nfive-year period and also contains options for future renewal.\nRental revenue for the Pan Am Plaza was $82,446, $81,906 and $87,452 for 1995, 1994 and 1993, respectively. Operating expenses for the same years were $65,793, $54,097 and $147,230 respectively. The increase in operating expenses in 1993 was due primarily to the allocation of accrued property taxes and insurance to the lessor and repairs and improvements made for lease renewal.\nThe property was held as collateral for a mortgage of $335,819 outstanding as of December 31, 1995, which the partnership assumed in 1995. The Partnership holds as collateral against said mortgage a collateral interest in a mortgage note in the amount of $346,000 against a Krogers in Atlanta, Georgia.\nTHE RAX\/HONEY BAKED HAM IN LOUISIANA\nOn December 29, 1988, the Partnership purchased land and a 3,500 square foot building in Gretna, Louisiana for a purchase price of $600,000. The building's cost basis is $455,077 (including improvements totaling $5,077 made subsequent to acquisition) and the land cost is $150,000. During 1991, The Original Honey Baked Ham Co. of Georgia signed a three year lease providing for monthly payments of $3,000. On July 30, 1993 The Original Honey Baked Ham Co. of Georgia signed a First Amendment to the Lease adding an additional option period of two years commencing on January 1, 1994 and ending on December 31, 1995 for $36,000 per year. The amendment also provides the lessee with three options to extend the lease for additional five year terms, which the tenant did not exercise in for 1996. However, the tenant did extend the lease for a one-year period at the same rate commencing January 1, 1996 and ending December 31, 1996. The former tenant, Rax Restaurants, defaulted on its lease agreement in 1990.\nRental revenue for this property was $36,150 $38,112 and $36,000 for 1995, 1994 and 1993, respectively. Operating expenses for the same years were $30,897, $21,111 and $22,168, respectively.\nThe property was not held as collateral for any mortgages outstanding as of December 31, 1995.\nWENDY'S RESTAURANT IN BUFORD, GA\nOn December 17, 1987, the Partnership acquired a building in Buford, Georgia for $513,749. The building was not completed until 1988. The building is occupied by a Wendy's Restaurant franchise with a twenty year lease term expiring in 2008. The lease also provides four options to extend the lease for 5 year periods each.\nOn September 10, 1993 the Partnership sold the land and building related to Wendy's in Buford, Georgia for $552,843 resulting in a gain on sale of $84,715.\nORACLE OFFICE PLAZA IN TUCSON, ARIZONA\nOn November 29, 1993 the Partnership acquired a 50% undivided preferential interest in an office building (\"Oracle\") in Tucson, Arizona for $300,000.\nThe Partnership's investment is accounted for on the equity method. The Partnership is entitled to an annual return of 10% of its original investment. If the available net cash flow from the property is insufficient to pay the preferred return, 5600 N. Oracle Group, LLC (\"5600\"), the holder of the remaining undivided 50% interest, must contribute additional capital to pay the remainder. In the event the net cash flow exceeds the preferred return, the excess will be distributed first to \"5600\" until they have received distributions equal to the Partnership's preferred return and thereafter in accordance with the ownership percentages.\nOperation deficits, if any, will be funded by \"5600\" during the ownership of the property. A preferred return of $44,715, which is collected in a monthly payment of $2,500, was received in 1995.\nThe property incorporates three separate buildings, consisting of 6,800, 12,000 and 6,000 square feet, comprising approximately 2 acres located in the northwest region of Tucson, Arizona.\nThe Property was held as collateral for an underlying mortgage of $884,436, outstanding as of December 31, 1995.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nNone\nITEM 4.","section_4":"ITEM 4. SUBMISSION OR MATTERS TO A VOTE OF SECURITY HOLDERS\nThe Registrant did not solicit proxies and the Directors\/Officers, as previously reported to the Commission, was re-elected in its entirety.\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS\nThere has not been a public market and it is not anticipated that a public market for Limited Partnership Interests will develop.\nAs of December 31, 1995 the number of holders of record of Limited Partnership Interests of the Registrant was 741.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following table sets forth selected operations data with respect to the Partnership for each of the five years in the period ended December 31, 1995:\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nA real estate limited partnership passes through four phases during its life cycle. These phases are:\n1. Sale of limited partnership interests (equity-raising). 2. Acquisition of income producing property and property management. 3. Management of acquired property.\n4. Sale of appreciated property.\nThe partnership is currently in the property management phase of its life cycle.\nRESULTS OF OPERATIONS\nThe Partnership commenced its operations January 1, 1987 with the acquisition of McRae Shopping Center in McRae, Georgia. Since that time, the Partnership has acquired five additional income producing properties. As of December 31, 1995, the Partnership has distributed $1,944,922 to the Limited Partners and $28,369 to the General Partner.\nRental revenues less rental operating expenses decreased $61,508 from fiscal 1994 to fiscal 1995. This was primarily due to rental decreases at the Athens property, as a result of competition with a newly built U-Haul facility; property tax adjustments at Honey Baked Ham; and, selling and acquisition expenses.\nOne rental property was sold and one rental property was purchased during 1995 resulting in an increase of $823,496 in rental property assets and an increase of $768,879 in notes payable. The remaining increase of $335,819 in notes payable is a result of assuming a mortgage on the Pan American Office Building for which a $297,138 note receivable exists.\nIt is anticipated the sale of Athens Self storage and the purchase of the Capitol Self Storage in a tax-free exchange will result in increased revenues for 1996.\nRental revenues less rental operating expenses increased $159,924 from fiscal 1993 to fiscal 1994. This was primarily due to rental increases at several of the properties and lower rental operating expenses at Pan Am Plaza.\nInflation has historically been a contributing factor to the increase in capital appreciation of income producing real estate and may continue to be a contributing factor in the future. The Partnership's intention is to own and operate the Properties for a period of five to ten years. At this time it is not possible to anticipate what the real estate market and capital appreciation will be in the future. Currently, the properties are generating sufficient cash flow to cover their own cash operating expenses.\nLIQUIDITY AND CAPITAL RESOURCES\nThe cash position of the Partnership and distributions to Limited Partners should remain constant during 1996 due to the proceeds of the offering remaining invested in the income producing real properties and most of the cash flow from the properties being distributed every quarter to the Limited Partners. In 1993 a decline in cash flow was experienced due to improvement requirements for lease renewal at Pan American Plaza and continuing legal bills on the Athens dispute. In 1995 a decline in cash flow was experienced due to an increase in interest payments, property tax assessments, amortization and professional services as a result of exchanging Athens Self Storage for Capitol Self Storage, in addition to assuming the mortgage on Pan American Plaza. Payroll, general and administrative expenses also increase in 1995. It is anticipated that distributions to the Limited Partners in 1996 will be greater in comparison to those of 1995, since the exchange expenses will not be recurring; however, the time and amount of distributions is at the sole subjective discretion of the General Partner.\nThe liquidity of the Partnership relies almost entirely on the financial market fluctuation and availability of funds with regard to lending and investing in commercial property. Funds appear to be coming more available and therefore may provide liquidity in 1996 or 1997 which the Partnership has not experienced in previous years.\nThe Partnership feels that they have adequate cash reserves to meet working capital requirements as they arise.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe Reports of Independent Auditors and the financial statements as set forth on pages to are hereby incorporated herein.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES\nThe Partnership changed accountants to HEIN + Associates LLP from BDO Seidman, with no disagreement, on January 10, 1996. The form 8-K was filed with the Securities and Exchange Commission on January 11, 1996.\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 W & C Income Company Ltd., its General Partner, has a Board of Directors.\n(b,c,d,&e)The General Partner of the Registrant is W&C Income Company, Ltd., a California Limited Partnership.\nW & C INCOME COMPANY, LTD: a California Limited Partnership, does not have an operations history; however, the resources from Whitehall Capital Investment Group, Inc. have been utilized by the Partnership.\nJACK C. WEST: Mr. West, age 46, a Managing Member, has been a private investor since 1988. From 1986 to 1988, Mr. West was President and Director of Whitehall Capital Corporation. Before that time Mr. West was Senior Vice President\/National Marketing Director as well as director of the Whitehall Capital Corporation's Irvine, California offices, in charge of the company's marketing programs. Prior to joining Whitehall Capital Corporation in 1982, he was active from 1977 until 1982 as a Senior Account Manager-portfolio management with First National Corporation, an asset portfolio management corporation.\nWHITEHALL CAPITAL INVESTMENT GROUP: The corporation has an interest in over $500 million of income producing real estate projects. Whitehall Capital Investment Group's investment portfolio includes an interest in over 100 major credit tenant commercial projects located primarily throughout the Sun Belt States.\n(f)No Managing Members of the General Partner were involved with legal proceedings.\n(g)There were no transactions with promoters or control persons.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\n(a,b,c, & d)The Registrant has not paid and does not propose to pay any compensation or retirement benefits to members of the General Partner.\n(e)There were no termination of employment or change of control arrangements with members of the General Partner.\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)W & C Income Company, Ltd. and its members own as a group or individually, 1% of the Limited Partnership Interests of the Registrant.\n(c)There were no changes in control or arrangements for changes in control.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation respecting certain relationships and related transactions is incorporated herein by reference to and is set forth in Note 5 of Notes to the Financial Statements on page of this Form 10-K.\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES AND REPORTS ON FORM 8-K\n(a) Financial Statements: (1) The index to the Financial Statements is included on of this report. (2) Financial Statement Schedules - through.\n(b) Reports on Form 8-K: The Registrant did not file any Form 8-K reports during the fiscal year ended December 31, 1995.\n(c) Exhibits required by Item 601 of Regulation S-K: The Registrant does not have any exhibits attached to Form 10-K.\n(d) Financial Statement Schedules required by Regulation S-X: All required information is included in the financial statements or notes thereto.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant had duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nWhitehall Income Fund - 86, A California Limited Partnership (Registrant)\nBy W & C Income Company, Ltd. General Partner of the Registrant\nDate: 3\/7\/96 By: \/s\/ Jack C. West ----------------- _______________________ Jack C. West Managing Member\nWHITEHALL INCOME FUND - 86 (A CALIFORNIA LIMITED PARTNERSHIP)\nFINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nINDEPENDENT AUDITOR'S REPORT\nThe Partners Whitehall Income Fund - 86 (A California limited partnership) Tucson, Arizona\nWe have audited the accompanying balance sheet of Whitehall Income Fund - 86 (a California limited partnership) as of December 31, 1995 and the related statements of operations, changes in partners' capital (deficit) and cash flows 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 Whitehall Income Fund - 86 (a California limited partnership) at December 31, 1995, and the results of its operations and its cash flows for the year then ended in conformity with generally accepted accounting principles.\nOur audit referred to above included an audit of the financial statement schedules listed under Item 14(a)(2). In our opinion, these financial statement schedules present fairly, in all material respects, in relation to the financial statements taken as a whole, the information required to be stated therein.\nHEIN + ASSOCIATES LLP Orange, California March 7, 1996 REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nTo the Partners Whitehall Income Fund - 86 (A California limited partnership) Tucson, Arizona\nWe have audited the accompanying balance sheet of Whitehall Income Fund - 86 (a California limited partnership) as of December 31, 1994 and the related statements of operations, changes in partners' capital (deficit) and cash flows for each of the two 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 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 Whitehall Income Fund - 86 (a California limited partnership) at December 31, 1994, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 1994 in conformity with generally accepted accounting principles.\nBDO Siedman, LLP\nMarch 3, 1995\nWhitehall Income Fund - 86 (A California limited partnership)\nWHITEHALL INCOME FUND - 86 (A CALIFORNIA LIMITED PARTNERSHIP)\nBALANCE SHEETS\nSee accompanying notes to these financial statements.\nWHITEHALL INCOME FUND - 86 (A CALIFORNIA LIMITED PARTNERSHIP)\nSTATEMENTS OF OPERATIONS\nSee accompanying notes to these financial statements.\nWHITEHALL INCOME FUND - 86 (A CALIFORNIA LIMITED PARTNERSHIP)\nSTATEMENT OF CHANGES IN PARTNERS' CAPITAL (DEFICIT) YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSee accompanying notes to these financial statements.\nWHITEHALL INCOME FUND - 86 (A CALIFORNIA LIMITED PARTNERSHIP)\nSTATEMENTS OF CASH FLOWS\nSee accompanying notes to these financial statements.\nWHITEHALL INCOME FUND - 86 (A CALIFORNIA LIMITED PARTNERSHIP)\nNOTES TO FINANCIAL STATEMENTS\n1. SUMMARY OF ACCOUNTING POLICES:\nNature of Business - Whitehall Income Fund - 86 (the \"Partnership\") was organized in the State of California on December 15, 1985 for the purpose of investing in, holding, developing and managing income producing properties.\nAllocations and Distributions - Generally, net losses are allocated 1% to W&C Income Company, Ltd. (the \"General Partner\") and 99% to the Limited Partners. Net income is allocated in the same proportion as net losses until all such losses have been recaptured, and then in proportion to distributions of cash from operations until the partners' capital accounts equal their original invested capital. Finally, the remaining net income is allocated 15% to the General Partner and 85% to the Limited Partners.\nDistributions of cash from operations, as defined, are divided 1% to the General Partner and 99% to the Limited Partners until the Limited Partners have received their priority return. The Limited Partners are entitled to a cumulative noncompounded return on adjusted invested capital, as defined in the Partnership Agreement, of 7% in 1986, 8% in 1987, and 9% in 1988, and 10% per annum thereafter. Thereafter, distributions are divided 5% to the General Partner and 95% to the Limited Partners. As of December 31, 1994 the Limited Partners had not received their full cumulative priority return.\nFees - The General Partner provides property management and leasing services to the Partnership and is compensated at 5% of the gross receipts from the properties (see Note 7). The General Partner is also entitled to a partnership management fee of 5% of all distributions of cash from operations after the Limited Partners have received their priority return. During the years ended December 31, 1995, 1994 and 1993, the partnership management fees were waived by the General Partner.\nThe Partnership reimburses the General Partner for a portion of payroll, relating to an in-house legal counsel and a managing agent, and certain general and administrative expenses (see Note 7).\nImpact of Recently Issued Accounting Standards - In March 1995, the Financial Accounting Standards Board issued a new statement titled \"Accounting for Impairment of Long-Lived Assets.\" This new standard is effective for years beginning after December 15, 1995 and would change the Company's method of determining impairment of long-lived assets. Although the Company has not performed a detailed analysis of the impact of this new standard on the Company's financial statements, the Company does not believe that adoption of the new standard will have a material effect on the financial statements.\nRental Properties - Rental properties and improvements are recorded at cost. The Partnership capitalizes and depreciates all buildings used for investment income over thirty-one to thirty-nine years, the estimated useful life of the property, using an accelerated method for financial reporting purposes. Depreciation of improvements is calculated using the same accelerated method over the estimated useful lives (ranging from 5 to 10 years) of the respective assets. The cost of normal maintenance and repairs is charged to operating expenses as incurred. Material expenditures which increase the life of an asset are capitalized and depreciated over the estimated remaining useful life of the asset. The cost of properties sold, or otherwise disposed of, and the related accumulated depreciation or amortization are removed from the accounts, and\nWHITEHALL INCOME FUND - 86 (A CALIFORNIA LIMITED PARTNERSHIP)\nNOTES TO FINANCIAL STATEMENTS\nany gains or losses are reflected in current operations.\nInvestment in Office Building - The Partnership owns a fifty percent undivided preferential interest in an office building in Tucson, Arizona. The Partnership's investment is accounted for on the equity method. Accordingly, the Partnership's share of earnings or losses are included in the accompanying financial statements.\nNet Loss Per Limited Partner Unit - Net loss per limited partner unit has been computed for each fiscal year on the basis of the weighted average number of limited partner units outstanding.\nAmortization - Organization costs of the Partnership are capitalized and amortized over five years using the straight line method. Loan closing costs are amortized over the lives of the loans using the straight line method.\nIncome Taxes and Other - The activity of the Partnership is included in the respective tax returns of the partners and no income taxes are provided or imposed at the Partnership level. This report does not give effect to any assets that the partners may have outside their interests in the Partnership, nor to any obligations, including income taxes, of the partners.\nUse of Estimates - The preparation of the Partnership's consolidated financial statements in conformity with generally accepted accounting principles requires the Partnership's management to make estimates and assumptions that affect the amounts reported in these financial statements and accompanying notes. Actual results could differ from those estimates.\nStatement of Cash Flows - For purposes of the statement of cash flows, the Partnership considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents. Cash equivalents consist of certificates of deposit.\nReclassifications - Certain reclassifications were made to the 1994 and 1993 financial statements in order to conform to the 1995 presentation. Such reclassifications had no effect on the net loss previously reported.\nWHITEHALL INCOME FUND - 86 (A CALIFORNIA LIMITED PARTNERSHIP)\nNOTES TO FINANCIAL STATEMENTS\n2. RENTAL PROPERTIES:\nThe Partnership currently owns five rental properties. During 1995, the Partnership exchanged Athens Self Storage for Capitol Self Storage in a tax-free transaction. Capitol Self Storage and its related note payable (Note 5) were recorded at the net carrying value of Athens Self Storage at the time of transfer. No gain or loss was recognized. One rental property was sold in 1993.\nBelow is a summary of the properties' cost and related depreciation as of December 31, 1995, 1994 and 1993, and revenue and related expenses, consisting of rental, depreciation and interest, for the years ended December 31, 1995, 1994, and 1993:\nWHITEHALL INCOME FUND - 86 (A CALIFORNIA LIMITED PARTNERSHIP)\nNOTES TO FINANCIAL STATEMENTS\nDuring 1995, one tenant accounted for approximately 11% of rental revenue. During 1994 and 1993, one tenant accounted for approximately 10% of rental revenue.\nWHITEHALL INCOME FUND - 86 (A CALIFORNIA LIMITED PARTNERSHIP)\nNOTES TO FINANCIAL STATEMENTS\n3. INVESTMENT IN OFFICE BUILDING:\nOn November 29, 1993 the Partnership acquired a 50% undivided preferential interest in an office building (\"Oracle\") in Tucson, Arizona for $300,000.\nThe Partnership is entitled to an annual preferred return of 10% of its original investment. If the available net cash flow from the property is insufficient to pay the preferred return, 5600 N. Oracle Group, L. L. C. (\"5600\"), the holder of the remaining undivided 50% interest, must contribute additional capital to fund any remaining unpaid preferred return. In the event the Property's net cash flow exceeds the preferred return, the excess will be distributed first to 5600 until they have received distributions equal to the Partnership's preferred return and thereafter in accordance with ownership percentages.\n5600 acquired the building with a non-interest bearing note due to the seller, totaling $1,000,000 and cash of $300,000. The present value of the note was approximately $752,000 at an interest rate of 9.59%. The basis of the building, including land, and the note were originally recorded at $1,052,000 and $752,000, respectively. The note is collateralized by the building.\n5600 is responsible for funding any debt service payments or operating deficits if the cash flow from the operations of the office building is not sufficient. The Partnership may elect to pay debt service payments or operating deficits if 5600 fails to provide the funding. As compensation for any payments, the Partnership can either attempt to recover any payments from 5600 or apply the amount of payments as additional preferential contributions which will bear interest at 20% per annum.\nThe Partnership received $44,715 and $30,000 in preferred and excess distributions during 1995 and 1994, respectively. The Partnership did not pay any debt service payments or operating deficits for 1995 and 1994 because these amounts were disbursed from the building's cash flow.\nThe investment in Oracle as of December 31, 1995, accounted for under the equity method, is summarized as follows:\nWHITEHALL INCOME FUND - 86 (A CALIFORNIA LIMITED PARTNERSHIP)\nNOTES TO FINANCIAL STATEMENTS\nThe condensed statement of operations of Oracle for 1995, 1994 and 1993 are presented below:\nA condensed balance sheet of the Oracle has not been provided due to the inmateriality of the Company's 50% undivided interest in the office building.\n4. NOTE RECEIVABLE:\nPrior to 1995, one of the properties of the Partnership was held as collateral for a note payable of the original owner. During 1995, the Partnership assumed this note payable in exchange for a note receivable from the original note holder with a December 31, 1995 balance of $297,138. Interest payments of 5.871% are due monthly with the entire principal amount to be received July 1997.\n5. NOTES PAYABLE:\nNotes payable consisted of:\nWHITEHALL INCOME FUND - 86 (A CALIFORNIA LIMITED PARTNERSHIP)\nNOTES TO FINANCIAL STATEMENTS\nFuture maturities of notes payable are as follows:\nWHITEHALL INCOME FUND - 86 (A CALIFORNIA LIMITED PARTNERSHIP)\nNOTES TO FINANCIAL STATEMENTS\n6. LEASES:\nFuture minimum lease payments to be received on non-cancelable leases for each of the next five years and thereafter are as follows:\n7. RELATED PARTY TRANSACTIONS:\nAt December 31, 1995 and 1994, the General Partner was owed $17,767 and $17,347, respectively, for distributions of cash from operations, as defined in the partnership agreement.\nDuring 1995, one of the general partners sold its interest in the Partnership. At both December 31, 1995 and 1994, the Partnership owed $13,318 for various general and administrative expenses paid by this former General Partner. In 1995, 1994 and 1993 the Partnership was charged property management and leasing fees of $42,230, $40,069 and $40,539 by an affiliate of the former General Partner. In 1995, 1994 and 1993, the Partnership incurred payroll expenses relating to certain of the former General Partner's employees and other administrative expenses totaling $275,125, $216,612, and $215,130, respectively. Additionally during 1995, costs related to the exchange of Capitol Self Storage for Athens Self Storage of $46,152 were paid to the former General Partner and capitalized by the Partnership as organization costs. In years prior to 1992, the former General Partner did not allocate or charge all of these expenses to the Partnership. Payroll expenses for the year ended December 31, 1993 includes the salaries of certain employees incurred by the former General Partner during 1991, 1990 and 1989 and reimbursed during 1993, to the former General Partner. The former General Partner believes that all of the expenses allocable, under the Partnership Agreement, had not been charged to the Partnership for 1991, 1990 and 1989 and has exercised its right to charge these expenses to the Partnership in 1993. Certain amounts of the administrative expenses paid by the former General Partner are allocated to the Partnership based upon the former General Partner's estimates.\nWHITEHALL INCOME FUND - 86 (A CALIFORNIA LIMITED PARTNERSHIP)\nNOTES TO FINANCIAL STATEMENTS\n8. FINANCIAL INSTRUMENTS\nConcentrations of Credit Risk\nCredit risk represents the accounting loss that would be recognized at the reporting date if counterparties failed completely to perform as contracted. Concentrations of credit risk (whether on or off balance sheet) that arise from financial instruments exist for groups of customers or counterparties when they have similar economic characteristics that would cause their ability to meet contractual obligations to be similarly effected by changes in economic or other conditions. In accordance with FASB Statement No. 105, Disclosure of Information about Financial Instruments with Off-Balance-Sheet Risk and Financial Instruments with Concentrations of Credit Risk, the credit risk amounts shown do not take into account the value of any collateral or security.\nFinancial instruments that subject the Partnership to credit risk consist principally of accounts receivable, cash on deposit and lease receivables.\nAt December 31, 1995, accounts receivable totaled $12,252 and the Partnership has not provided an allowance for doubtful accounts. Bad debts were immaterial for 1995, 1994, and 1993. The Partnership performs periodic credit evaluations on its customers' financial condition and believes that the allowance for doubtful accounts is adequate.\nThe Partnership periodically maintains cash balances in excess of FDIC insurance limits.\nNotes and lease receivables are described in Notes 2 and 6.\nThe Partnership's properties are located in the states of Texas, Arizona, Georgia and Louisiana. A downturn in the economies in any of these states could have an adverse impact on the Partnership.\nFair Value of Financial Instruments\nThe estimated fair values on the Partnership financial instruments were determined by management using available market information and appropriate valuation methodologies. The estimates are not necessarily indicative of the amount the Partnership could realize in a current market exchange.\nAt December 31, 1995, cash, accounts receivable and accounts payable have fair values that approximate book values based on their short term or demand maturity.\nThe fair value of notes receivable and notes payable are based on estimated discounted cash flows. The fair value of these instruments approximates book value at December 31, 1995.\nWhitehall INCOME FUND - 86 (A CALIFORNIA LIMITED PARTNERSHIP)\nSCHEDULE III REAL ESTATE AND ACCUMULATED DEPRECIATION December 31, 1995\n(continued)\nWHITEHALL INCOME FUND - 86 (A CALIFORNIA LIMITED PARTNERSHIP)\nSCHEDULE III REAL ESTATE AND ACCUMULATED DEPRECIATION December 31, 1995 (continued)\nThe following shows the changes in the total amounts at which real estate was carried during the periods:\nWHITEHALL INCOME FUND - 86 (A CALIFORNIA LIMITED PARTNERSHIP)\nSCHEDULE IV MORTGAGE LOANS ON REAL ESTATE December 31, 1995\nThe following shows the changes in the carrying amounts of mortgage loans during the periods:","section_15":""}
{"filename":"789943_1995.txt","cik":"789943","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nIndustries has no significant properties other than common stock of affiliates, temporary cash investments and cash surrender value of corporate life insurance policies.\nUtilities' principal electric generating stations at December 31, 1995, are as follows:\nName and Location Major Fuel Net Kilowatts Accredited of Station Type Generating Capability\nDuane Arnold Energy Center, Palo, Iowa Nuclear 364,000 (1)\nOttumwa Generating Station, Ottumwa, Iowa Coal 343,440 (2) Prairie Creek Station, Cedar Rapids, Iowa Coal 212,500 Sutherland Station, Marshalltown, Iowa Coal 143,000 Sixth Street Station, Cedar Rapids, Iowa Coal 71,000 Burlington Generating Station, Burlington, Iowa Coal 211,800 George Neal Unit 3, Sioux City, Iowa Coal 144,200 (3) Total Coal 1,125,940\nPeaking Turbines, Marshalltown, Iowa Oil 162,500 Centerville Combustion Turbines, Centerville, Iowa Oil 48,000 Diesel Stations, all in Iowa Oil 12,200 Total Oil 222,700\nGrinnell Station, Grinnell, Iowa Gas 47,200 Agency Street Combustion Turbines, West Burlington, Iowa Gas 63,750 Burlington Combustion Turbines, Burlington, Iowa Gas 47,400 Total Gas 158,350\nTotal generating capability 1,870,990\n(1) Represents Utilities' 70% ownership interest in this 520,000 Kw generating station. The plant is operated by Utilities.\n(2) Represents Utilities' 48% ownership interest in this 715,500 Kw generating station. The plant is operated by Utilities.\n(3) Represents Utilities' 28% ownership interest in this 515,000 Kw generating station which is operated by an unaffiliated utility.\nAt December 31, 1995, the transmission lines of Utilities, operating from 34,000 to 345,000 volts, approximated 4,409 circuit miles (all located in Iowa). Utilities owned 108 transmission substations (all located in Iowa) with a total installed capacity of 8,597.1 MVa and 468 distribution substations (all located in Iowa) with a total installed capacity of 2,593.1 MVa.\nSubsidiaries other than Utilities also own property which primarily represents investments in transportation, energy-related and real estate properties.\nThe Company's principal properties are suitable for their intended use. Utilities' principal properties are held subject to liens of indentures relating to its Bonds.\nItem 3.","section_3":"Item 3. Legal Proceedings\nIndustries, Diversified, IES Energy, MicroFuel Corporation (the Corporation) now known as Ely, Inc. in which IES Energy has a 69.40% equity ownership, and other parties have been sued in Linn County District Court in Cedar Rapids, Iowa, by Allen C. Wiley. Mr. Wiley claims money damages on various tort and contract theories arising out of the 1992 sale of the assets of the Corporation, of which Mr. Wiley was a director and shareholder. All of the defendants in Mr. Wiley's suit answered the complaint and denied liability. Industries and Diversified were dismissed from the suit in a motion for summary judgment. In addition a motion for summary judgement has reduced Mr. Wiley's claims against the remaining parties to breach of fiduciary duty. All of the defendants believe that the claims are without merit and are vigorously contesting them. The trial has been continued to April 8, 1996, but will likely be continued again given the decision in the appeal related to a separate suit discussed below.\nThe Corporation commenced a separate suit to determine the fair value of Mr. Wiley's shares under Iowa Code section 490. A decision was issued on August 31, 1994, by the Linn County District Court ruling that the value of Mr. Wiley's shares was $377,600 based on a 40 cent per share valuation. The Corporation contended that the value of Mr. Wiley's shares was 2.5 cents per share. The Decision was appealed to the Iowa Supreme Court by the Corporation on a number of issues, including the Corporation's position that the trial court erred as a matter of law in discounting the testimony of the Corporation's expert witness. The Iowa Supreme Court assigned the case to the Iowa Court of Appeals. On February 2, 1996, the Iowa Court of Appeals reversed the District Court ruling after determining the District Court erred in discounting the expert testimony. Mr. Wiley has a limited time period to make application to the Supreme Court for further review of the Court of Appeals ruling, otherwise the case is remanded back to the District Court for consideration of the expert testimony, but with no additional evidence being taken. Neither Mr. Wiley or his counsel have indicated whether they will ask for further review.\nReference is made to Notes 3 and 12 of the Notes to Consolidated Financial Statements for a discussion of Utilities' rate proceedings and the Company's environmental matters, respectively. Also see Item 1. \"Business - Environmental Matters\" and Item 7. \"Management's Discussion and Analysis of the Results of Operations and Financial Condition.\"\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNone.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters\n(a) Price Range of Common Stock and Dividends Declared\nIES Industries Common Stock is listed on the New York Stock Exchange (NYSE) under the symbol \"IES.\" The table below sets forth, for the calendar quarters indicated, the reported high and low sales prices of IES Industries Common Stock as reported on the NYSE Composite Tape based on published financial sources, and the dividends declared per share on IES Industries Common Stock.\nIES Industries Common Stock\nHigh Sale Low Sale Dividend (i) First Quarter $ 27 5\/8 $ 24 5\/8 $ .525 Second Quarter 26 3\/8 20 3\/8 .525 Third Quarter 26 3\/4 21 3\/8 .525 Fourth Quarter 28 1\/2 25 7\/8 .525\nFirst Quarter 31 3\/8 27 .525 Second Quarter 29 25 1\/2 .525 Third Quarter 28 3\/8 24 7\/8 .525 Fourth Quarter 26 5\/8 24 3\/4 .525\n(i) The Company has paid regular quarterly dividends on its common stock since April 1, 1950. Although the Company's practice has been to pay dividends quarterly, the timing of payment and amount of future dividends are necessarily dependent upon earnings, financial requirements and other factors.\n(b) Approximate Number of Equity Security Holders\nApproximate Number of Record Title of Class Holders (as of December 31, 1995)\nCommon Stock, no par value 29,731\n(c) Restriction on Payment of Dividends\nUnder provisions of the Merger Agreement, Industries' annual dividend payment cannot exceed $2.10 per share, the current annual payment level, pending the Proposed Merger.\nItem 6.","section_6":"Item 6. Selected Consolidated Financial Data\nThe following selected consolidated financial data, in the opinion of the Company, includes adjustments, which are normal and recurring in nature, necessary for the fair presentation of the results of operations and financial position. See Item 7.","section_7":"Item 7.\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF THE RESULTS OF OPERATIONS AND FINANCIAL CONDITION\nThe Consolidated Financial Statements include the accounts of IES Industries Inc. (Industries) and its consolidated subsidiaries (collectively the Company). Industries' wholly-owned subsidiaries are IES Utilities Inc. (Utilities) and IES Diversified Inc. (Diversified).\nPROPOSED MERGER OF THE COMPANY\nThe Company, WPL Holdings, Inc. (WPLH) and Interstate Power Company (IPC) have entered into an Agreement and Plan of Merger (Merger Agreement), dated November 10, 1995 (the Proposed Merger). The new holding company will be named Interstate Energy Corporation (Interstate Energy) and Industries will cease to exist. The Proposed Merger, which will be accounted for as a pooling of interests, has been approved by the respective Boards of Directors. It is still subject to approval by the shareholders of each company as well as several federal and state regulatory agencies. The companies expect to receive the shareholder approvals in the second quarter of 1996 and the regulatory approvals by the second quarter of 1997.\nThe business of Interstate Energy will consist of utility operations and various non-utility enterprises, and it is expected that its utility subsidiaries will serve more than 870,000 electric customers and 360,000 natural gas customers in Iowa, Illinois, Minnesota and Wisconsin.\nThe operating revenues, net income from continuing operations and total assets of the companies were as follows: PRO FORMA IES COMBINED INDUSTRIES WPLH IPC (Unaudited) (in thousands)\n1995 operating revenues $ 851,010 $ 807,255 $ 318,542 $ 1,976,807\n1995 net income from continuing operations 64,176 71,618 25,198 160,992\nAssets at December 31, 1995 $ 1,985,591 $ 1,872,414 $ 634,316 $ 4,492,321\nUnder the terms of the Merger Agreement, the outstanding shares of WPLH's common stock will remain unchanged and outstanding as shares of Interstate Energy. Each outstanding share of the Company's common stock will be converted to .98 shares of Interstate Energy's common stock. Each share of IPC's common stock will be converted to 1.11 shares of Interstate Energy's common stock. It is anticipated that Interstate Energy will retain WPLH's common share dividend payment level as of the effective time of the merger. On January 24, 1996, the Board of Directors of WPLH declared a quarterly dividend of 49.25 cents per share. This represents an equivalent annual rate of $1.97 per share. Under provisions of the Merger Agreement, Industries' annual dividend payment cannot exceed $2.10 per share, the current annual payment level, pending the Proposed Merger.\nInterstate Energy will be the parent company of Utilities, Wisconsin Power and Light Company and IPC and will be registered under the Public Utility Holding Company Act of 1935, as amended (1935 Act). The Merger Agreement provides that these operating utility companies will continue to operate as separate entities for a minimum of three years beyond the effective date of the merger. In addition, the non-utility operations of the Company and WPLH will be combined shortly after the effective date of the merger under one entity to manage the diversified operations of Interstate Energy.\nThe SEC historically has interpreted the 1935 Act to preclude registered holding companies, with limited exceptions, from owning both electric and gas utility systems. Although the SEC has recently recommended that registered holding companies be allowed to hold both gas and electric utility operations if the affected states agree, it remains possible that the SEC may require as a condition to its approval of the Proposed Merger that the Company, WPLH and IPC divest their gas utility properties, and possibly certain non-utility ventures of the Company and WPLH, within a reasonable time after the effective date of the Proposed Merger.\nLegislation to repeal the 1935 Act was introduced in Congress in 1995 and is pending. No assurance can be given as to when or if such legislation will be considered or enacted. The Staff of the SEC has also recommended that the SEC \"permit combination systems by registered holding companies if the affected states concur,\" and the SEC has proposed rules that would relax current restrictions on investment by registered holding companies in certain \"energy related,\" non-utility businesses. No prediction can be made as to the outcome of these legislative and regulatory proposals.\nSee Note 2 of the Notes to Consolidated Financial Statements for a further discussion of the Proposed Merger.\nRESULTS OF OPERATIONS\nThe following discussion analyzes significant changes in the components of net income and financial condition from the prior periods for the Company:\nThe Company's net income decreased ($2.6) million and ($1.1) million during 1995 and 1994, respectively. Earnings per average common share declined to $2.20 in 1995 from $2.34 in 1994. The 1995 results reflect the impact of the Iowa Utilities Board (IUB) price reduction order in Utilities' recent electric rate case. The effect of the lower electric prices, including the required refund, reduced the 1995 net income by approximately $9.7 million ($0.33 per share). (See Note 3(b) of the Notes to Consolidated Financial Statements for a further discussion of the electric rate case). Warmer than normal weather conditions during the summer months, which added $0.18 to earnings, and an aggressive cost containment program partially offset the negative effects of the IUB order. The 1994 results were affected by milder than normal weather, particularly during the summer months. The 1993 results reflect the recording of certain property write-downs at Diversified and a $2.5 million contribution to the IES Industries Charitable Foundation.\nThe Company's operating income increased or (decreased) $3.8 million and ($3.3) million during 1995 and 1994, respectively. Reasons for the changes in the results of operations are explained in the following discussion.\nElectric Revenues Electric revenues and Kwh sales for Utilities increased or (decreased) as compared with the prior year as follows:\n1995 1994 ($ in millions)\nTotal electric revenues $ 23.1 $ (13.2) Change in off-system sales revenues (0.3) (11.3) Electric revenues (excluding off-system sales) $ 23.4 $ (1.9)\nElectric sales (excluding off-system sales): Residential and Rural 7.9% (1.4%) General Service 6.1 0.4 Large General Service 5.9 8.9 Total 5.3 4.3\nWarmer than normal weather during the summer of 1995 significantly increased sales. Utilities set new usage records several times, culminated by a new energy peak demand record of 1,824 megawatts on July 12, 1995. The 1994 Kwh sales were adversely affected by milder than normal weather, particularly during the summer months. The largest effect of weather each year was on sales to residential and rural customers. Under historically normal weather conditions, total sales (excluding off-system sales) during 1995 and 1994 would have increased 3.6% and 4.8%, respectively. Sales during 1995 also benefited from the effects of Utilities' annual true-up adjustment to unbilled sales. The growth in general service and large general service sales continues to reflect the underlying strength of the economy as industrial expansions in Utilities' service territory continued during 1995.\nUtilities' electric tariffs include energy adjustment clauses (EAC) that are designed to currently recover the costs of fuel and the energy portion of purchased power billings to customers. See Note 1(k) of the Notes to Consolidated Financial Statements for discussion of the EAC.\nThe increase in the 1995 electric revenues was primarily due to the increased sales (excluding off-system sales), higher fuel costs collected through the EAC, the unbilled revenue adjustment and the recovery of expenditures for energy efficiency programs pursuant to an IUB order. The effect of the warmer than normal weather increased 1995 electric revenues by approximately $9 million. These items were partially offset by a reduction in revenues of approximately $17 million during 1995 as the result of the IUB price reduction order. Approximately $3.5 million, $0.07 per share, of the price reduction decrease related to revenues collected in the fourth quarter of 1994. See Notes 3(b) and 3(c) of the Notes to Consolidated Financial Statements for a further discussion of the electric rate case and the energy efficiency cost recovery case, respectively.\nThe decrease in the 1994 electric revenues was attributable to lower fuel costs collected through the EAC, lower off-system sales to other utilities and the effect of the mix of sales between lower margin industrial customers and higher margin residential and rural customers. Increased total 1994 sales (excluding off-system sales) partially offset the effects of the above items.\nGas Revenues Gas revenues increased or (decreased) as compared with the prior year as follows:\n1995 1994 (in millions)\nGas revenues: Utilities $ (1.7) $ (15.3) Industrial Energy Applications, Inc. (IEA) 26.5 (1.1) $ 24.8 $ (16.4)\nUtilities' gas sales and transported volumes in therms increased or (decreased) as compared with the prior period as follows:\n1995 1994\nResidential 3.4% (7.1%) Commercial 2.5 (8.2) Industrial (22.7) (13.2)\nSales to consumers (0.5) (8.3)\nTransported volumes 22.1 22.2\nTotal 4.8 (2.7)\nUnder historically normal weather conditions, Utilities' gas sales and transported volumes would have increased 3.5% and 0.7% in 1995 and 1994, respectively.\nUtilities' gas tariffs include purchased gas adjustment clauses (PGA) that are designed to currently recover the cost of gas sold. See Note 1(k) of the Notes to Consolidated Financial Statements for discussion of the PGA.\nOn August 4, 1995, Utilities applied to the IUB for an annual increase in gas rates of $8.8 million, or 6.2%. An interim increase of $7.1 million became effective October 11, 1995, subject to refund. Utilities, the Office of Consumer Advocate and all three industrial intervenor groups have entered into a settlement agreement, subject to IUB approval, which allows Utilities a $6.3 million annual increase. Utilities expects that the IUB will rule on the settlement agreement no later than the second quarter of 1996.\nUtilities' gas revenues decreased in 1995 primarily because of lower gas costs recovered through the PGA, and was substantially offset by the effects of the interim rate increase, recovery of expenditures for the energy efficiency programs and increased revenues from transported gas volumes. The 1994 revenue decrease was primarily due to lower gas costs recovered through the PGA and, to a lesser extent, the effect of the lower sales.\nIEA's gas revenues increased in 1995 primarily due to an increase of 121% in gas volumes, partially offset by lower unit gas costs. The significant increase in gas volumes was due to heightened marketing efforts as well as expanding into additional regional markets. IEA, which is based in Cedar Rapids, IA, opened branch offices in Phoenix, Denver, St. Louis and Atlanta in 1995. The decrease in IEA's 1994 gas revenues was due to lower gas costs, partially offset by a 16% increase in gas volumes.\nOther Revenues Other revenues increased $17.2 million and $14.1 million during 1995 and 1994, respectively, primarily because of increased revenues at Whiting Petroleum Company (Whiting). Whiting's operations have expanded significantly the last several years as a result of continued acquisitions of oil and gas properties. These increases were partially offset as the result of the sale of several of Diversified's subsidiaries during 1994 and 1995. The operations of the subsidiaries that were sold were not significant to the results of operations or financial position of the Company. An increase in Utilities' steam revenues also contributed to the 1995 increase.\nOperating Expenses Fuel for production increased $10.3 million during 1995 due to higher fuel cost recoveries through the EAC, which are included in fuel for production, and a higher average fuel cost. Total 1995 Kwh generation at Utilities' generating stations was flat compared to 1994. The Duane Arnold Energy Center (DAEC), Utilities' nuclear generating facility, generated less Kwh in 1995 because it was down from late February 1995 to late April 1995 for a scheduled refueling outage. There was no refueling outage in 1994. Increased generation at Utilities' fossil-fueled generating stations, due to the increased sales and the DAEC outage, virtually offset the decreased DAEC generation. Fuel for production decreased ($1.8) million in 1994 largely because of lower average fuel prices and the effect of lower fuel cost recoveries through the EAC. Generation at Utilities' generating stations increased during 1994 primarily because of increased sales and the increased availability of DAEC as there was a scheduled refueling outage in 1993 also.\nPurchased power decreased ($1.9) million and ($24.7) million in 1995 and 1994, respectively. The 1995 decrease was primarily due to lower capacity costs of ($6.6) million, partially offset by higher energy purchases of $4.7 million due to the increased sales to customers and flat generation, as discussed above. The 1994 decrease was caused by lower off-system sales to other utilities, increased generation at Utilities' generating stations and the expiration, in April 1993, of a purchase power agreement with the City of Muscatine.\nGas purchased for resale increased $20.9 million in 1995 due to the increased gas sales at IEA and the timing of the recovery of gas costs through the PGA at Utilities, partially offset by lower natural gas prices. Gas purchased for resale decreased ($15.0) million in 1994 because of lower gas costs and lower gas sales at Utilities.\nOther operating expenses increased $24.5 million and $14.2 million in 1995 and 1994, respectively. Increased labor and benefits costs and increased operating activities at Whiting contributed to both increases. The 1995 increase was also due to costs associated with a project to review and redesign Utilities' major business processes, the amortization of previously deferred energy efficiency expenditures at Utilities (which are currently being recovered through rates), increased operating activities at IEA and costs relating to the Proposed Merger. These increases were partially offset by decreased nuclear operating costs, lower insurance costs at Utilities and decreased costs resulting from the sale of the Diversified subsidiaries. In addition, following the receipt of the IUB price reduction order, Utilities took action and successfully reduced 1995 operating and maintenance costs by about $8 million from budgeted levels. The 1994 increase was also attributable to higher nuclear operating costs, former manufactured gas plant (FMGP) clean-up costs and increased information technology costs at Utilities.\nMaintenance expenses increased or (decreased) ($6.7) million and $3.9 million during 1995 and 1994, respectively. The 1995 decrease was due to less required maintenance activities at the DAEC and at Utilities' fossil-fueled generating stations and the cost containment actions discussed above. The 1994 increase was primarily because of increased labor costs and maintenance at the DAEC, partially offset by lower maintenance at Utilities' fossil-fueled generating stations.\nDepreciation and amortization increased during both years because of increases in utility plant in service and the acquisition of oil and gas operating properties. The 1995 increase was partially offset by lower depreciation rates implemented at Utilities as a result of the IUB electric price reduction order. Depreciation and amortization expenses for all periods include a provision for decommissioning the DAEC, which is collected through rates. The annual recovery level was increased to $6.0 million in 1995 from $5.5 million, as a result of Utilities' recent electric rate case.\nDuring the first quarter of 1996, the Financial Accounting Standards Board (FASB) issued an Exposure Draft on Accounting for Liabilities Related to Closure and Removal of Long-Lived Assets which deals with, among other issues, the accounting for decommissioning costs. If current electric utility industry accounting practices for such decommissioning are changed: (1) annual provisions for decommissioning could increase relative to 1995 and, (2) the estimated cost for decommissioning could be recorded as a liability, rather than as accumulated depreciation, with recognition of an increase in the recorded amount of the related DAEC plant. If such changes are required, Utilities believes that there would not be an adverse effect on its financial position or results of operations based on current rate making practices. (See Note 1(g) of the Notes to Consolidated Financial Statements for a discussion of the recovery of decommissioning costs allowed in Utilities' most recent rate case).\nTaxes other than income taxes increased $2.7 million and $1.9 million during 1995 and 1994, respectively, largely because of increased property taxes at Utilities caused by increases in assessed property values.\nInterest Expense and Other Interest expense increased $4.7 million during 1995 primarily because of an increase in the average amount of short-term debt outstanding and interest related to Utilities' electric rate refund. Lower average interest rates, attributable to refinancing $100 million of long-term debt at lower rates and the mix of long-term and short-term debt, partially offset the increase.\nMiscellaneous, net reflected a decrease in income of ($0.3) million during 1995 and an increase in income of $6.4 million during 1994. The 1995 decrease was primarily due to an increase in fees related to the sale of utility accounts receivable as the average amount of receivables sold during the year increased. Gains on the sale of several investments by Diversified's subsidiaries partially offset these fees. The 1994 increase was primarily due to the effect of transactions recorded in 1993 for certain property write-downs at Diversified, a contribution to the IES Charitable Foundation and a loss on the defeasance of Industries' debentures.\nFederal and state income taxes increased $0.9 million and $4.5 million in 1995 and 1994, respectively. The increases for both years are due to the effect of property related temporary differences for which deferred taxes had not been provided, pursuant to rate making principles, that are now becoming payable. Adjustments to tax reserves also contributed to the increased taxes in 1995.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company's capital requirements are primarily attributable to Utilities' construction programs, its debt maturities and the level of Diversified's business opportunities. The Company's pretax ratio of times interest earned was 3.12, 3.38 and 3.38 in 1995-1993, respectively. In 1995, cash flows from operating activities were $196 million versus $216 million in 1994. The decrease was primarily due to expenditures related to the effect of the 1995 DAEC refueling outage and other changes in working capital.\nThe Company anticipates that future capital requirements will be met by cash generated from operations and external financing. The level of cash generated from operations is partially dependent upon economic conditions, legislative activities, environmental matters and timely rate relief for Utilities. See Notes 3 and 12 of the Notes to Consolidated Financial Statements.\nAccess to the long-term and short-term capital and credit markets is necessary for obtaining funds externally. The Company's debt ratings are as follows:\nMoody's Standard & Poor's\nUtilities - Long-term debt A2 A - Short-term debt P1 A1\nDiversified - Short-term debt P2 A2\nThe Company's liquidity and capital resources will be affected by environmental and legislative issues, including the ultimate disposition of remediation issues surrounding the Company's environmental liabilities and the Clean Air Act as amended, as discussed in Note 12 of the Notes to Consolidated Financial Statements, and the National Energy Policy Act of 1992 as discussed in the Other Matters section. Consistent with rate making principles of the IUB, management believes that the costs incurred for the above matters will not have a material adverse effect on the financial position or results of operations of the Company. It is not certain if, and how, the Proposed Merger may affect the Company's debt ratings.\nThe IUB has current rules which require Utilities to spend 2% of electric and 1.5% of gas gross retail operating revenues annually for energy efficiency programs. Energy efficiency costs in excess of the amount in the most recent electric and gas rate cases are being recorded as regulatory assets by Utilities. At December 31, 1995, Utilities had approximately $50 million of such costs recorded as regulatory assets. On June 1, 1995, Utilities began recovery of those costs incurred through 1993. See Note 3(c) of the Notes to Consolidated Financial Statements for a discussion of the timing of the filings for the recovery of these costs under IUB rules.\nUnder provisions of the Merger Agreement, there are restrictions on the amount of common stock and long-term debt the Company can issue pending the merger. The Company does not expect the restrictions to have a material effect on its ability to meet its future capital requirements.\nCONSTRUCTION AND ACQUISITION PROGRAM\nThe Company's construction and acquisition program anticipates expenditures of approximately $245 million for 1996, of which approximately $164 million represents expenditures at Utilities and approximately $81 million represents expenditures at Diversified. Of the $164 million of Utilities' expenditures, 55% represents expenditures for electric, gas and steam transmission and distribution facilities, 19% represents fossil-fueled generation expenditures, 13% represents information technology expenditures and 5% represents nuclear generation expenditures. The remaining 8% represents miscellaneous electric and general expenditures. In addition to the $164 million, Utilities anticipates expenditures of $13 million in connection with mandated energy efficiency programs. Diversified's anticipated expenditures include approximately $75 million for domestic and international energy-related construction and acquisition expenditures.\nThe Company's levels of construction and acquisition expenditures are projected to be $283 million in 1997, $255 million in 1998, $247 million in 1999 and $215 million in 2000. It is estimated that approximately 80% of Utilities' construction and acquisition expenditures will be provided by cash from operating activities (after payment of dividends) for the five-year period 1996-2000. Financing plans for Diversified's construction and acquisition program will vary, depending primarily on the level of energy- related acquisitions.\nCapital expenditure and investment and financing plans are subject to continual review and change. The capital expenditure and investment programs may be revised significantly as a result of many considerations including changes in economic conditions, variations in actual sales and load growth compared to forecasts, requirements of environmental, nuclear and other regulatory authorities, acquisition opportunities, the availability of alternate energy and purchased power sources, the ability to obtain adequate and timely rate relief, escalations in construction costs and conservation and energy efficiency programs.\nUnder provisions of the Merger Agreement, there are restrictions on the amount of construction and acquisition expenditures the Company can make pending the merger. The Company does not expect the restrictions to have a material effect on its ability to implement its anticipated construction and acquisition program.\nLONG-TERM FINANCING\nOther than Utilities' periodic sinking fund requirements, which Utilities intends to meet by pledging additional property, the following long-term debt will mature prior to December 31, 2000:\n(in millions) Utilities $ 140.3 Diversified's variable rate credit facility 124.2 Other subsidiaries' debt 11.4 $ 275.9\nThe Company intends to refinance the majority of the debt maturities with long-term securities.\nIn December 1995, Utilities issued $50 million of Subordinated Deferrable Interest Debentures, 7-7\/8%, due 2025. The proceeds from the issuance of the debentures were used to retire short-term borrowings which were incurred in October 1995 to repay at maturity, $50 million of Series X, 9.42% First Mortgage Bonds.\nIn March 1995, Utilities repaid at maturity $50 million of Series W, 9.75% First Mortgage Bonds and, in a separate transaction, issued $50 million of Collateral Trust Bonds, 7.65%, due 2000.\nUtilities has entered into an Indenture of Mortgage and Deed of Trust dated September 1, 1993 (New Mortgage). The New Mortgage provides for, among other things, the issuance of Collateral Trust Bonds upon the basis of First Mortgage Bonds being issued by Utilities. The lien of the New Mortgage is subordinate to the lien of Utilities' first mortgages until such time as all bonds issued under the first mortgages have been retired and such mortgages satisfied. Accordingly, to the extent that Utilities issues Collateral Trust Bonds on the basis of First Mortgage Bonds, it must comply with the requirements for the issuance of First Mortgage Bonds under Utilities' first mortgages. Under the terms of the New Mortgage, Utilities has covenanted not to issue any additional First Mortgage Bonds under its first mortgages except to provide the basis for issuance of Collateral Trust Bonds.\nThe indentures pursuant to which Utilities issues First Mortgage Bonds constitute direct first mortgage liens upon substantially all tangible public utility property and contain covenants which restrict the amount of additional bonds which may be issued. At December 31, 1995, such restrictions would have allowed Utilities to issue at least $258 million of additional First Mortgage Bonds.\nIn order to provide an instrument for the issuance of unsecured subordinated debt securities, Utilities entered into an Indenture dated December 1, 1995 (Subordinated Indenture). The Subordinated Indenture provides for, among other things, the issuance of unsecured subordinated debt securities. Any debt securities issued under the Subordinated Indenture are subordinate to all senior indebtedness of Utilities, including First Mortgage Bonds and Collateral Trust Bonds.\nUtilities has received authority from the Federal Energy Regulation Commission (FERC) and the SEC to issue up to $250 million of long-term debt, and has $150 million of remaining authority under the current FERC docket and $200 million of remaining authority under the current SEC shelf registration. Utilities expects to replace one series of First Mortgage Bonds that mature in 1996 with other long- term securities.\nDiversified has a variable rate credit facility that extends through November 9, 1998, with a one-year extension available to Diversified. The facility also serves as a stand-by agreement for Diversified's commercial paper program. The agreement provides for a combined maximum of $150 million of borrowings under the agreement and commercial paper to be outstanding at any one time. Interest rates and maturities are set at the time of borrowing for direct borrowings under the agreement and for issuances of commercial paper. The interest rate options are based upon quoted market rates and the maturities are less than one year. At December 31, 1995, there were no borrowings outstanding under this facility. Diversified had $124.2 million of commercial paper outstanding at December 31, 1995, with interest rates ranging from 5.85% to 6.50% and maturity dates in the first quarter of 1996. Diversified intends to continue borrowing under the renewal options of the facility and no conditions exist at December 31, 1995, that would prevent such borrowings. Accordingly, this debt is classified as long-term in the Consolidated Balance Sheets. The facility contains covenants that could restrict the amount of borrowings available under the facility.\nRefer to Note 6(b) of the Notes to Consolidated Financial Statements for a discussion of a guarantee associated with debt issued by McLeod, Inc.\nThe Articles of Incorporation of Utilities authorize and limit the aggregate amount of additional shares of Cumulative Preference Stock and Cumulative Preferred Stock that may be issued. At December 31, 1995, Utilities could have issued an additional 700,000 shares of Cumulative Preference Stock and 100,000 additional shares of Cumulative Preferred Stock. In addition, Industries had 5,000,000 shares of Cumulative Preferred Stock, no par value, authorized for issuance, none of which were outstanding at December 31, 1995.\nThe Company's capitalization ratios at year-end were as follows:\n1995 1994\nLong-term debt 49% 48% Preferred stock 2 2 Common equity 49 50 100% 100%\nThe 1995 and 1994 ratios include $15 million and $100 million, respectively, of long-term debt due in less than one year because it was the Company's intention to refinance the debt with long-term securities.\nUnder provisions of the Merger Agreement, there are restrictions on the amount of common stock and long-term debt the Company can issue pending the merger. The Company does not expect the restrictions to have a material effect on its ability to meet its future capital requirements.\nSHORT-TERM FINANCING\nFor interim financing, Utilities is authorized by the FERC to issue, through 1996, up to $200 million of short- term notes. In addition to providing for ongoing working capital needs, this availability of short-term financing provides Utilities flexibility in the issuance of long-term securities. At December 31, 1995, Utilities had outstanding short-term borrowings of $109.9 million, including $8.9 million of notes payable to associated companies.\nUtilities has an agreement, which expires in 1999, with a financial institution to sell, with limited recourse, an undivided fractional interest of up to $65 million in its pool of utility accounts receivable. At December 31, 1995, Utilities had sold $58 million under the agreement.\nAt December 31, 1995, the Company had bank lines of credit aggregating $131.1 million (Industries - $1.5 million, Utilities - $121.1 million, Diversified - $7.5 million and Whiting - $1.0 million). Utilities was using $101 million to support commercial paper (weighted average interest rate of 5.81%) and $11.1 million to support certain pollution control obligations. Commitment fees are paid to maintain these lines and there are no conditions which restrict the unused lines of credit. In addition to the above, Utilities has an uncommitted credit facility with a financial institution whereby it can borrow up to $40 million. Rates are set at the time of borrowing and no fees are paid to maintain this facility. At December 31, 1995, there were no borrowings under this facility.\nENVIRONMENTAL MATTERS\nUtilities has been named as a Potentially Responsible Party (PRP) by various federal and state environmental agencies for 28 FMGP sites, but believes it is not responsible for two of these sites. There are also six other sites for which it may be designated as a PRP in the future. Utilities is working pursuant to the requirements of the various agencies to investigate, mitigate, prevent and remediate, where necessary, damage to property, including damage to natural resources, at and around the sites in order to protect public health and the environment. Utilities believes it has completed the remediation of five sites although it is in the process of obtaining final approval from the applicable environmental agencies on this issue for each site. Utilities is in various stages of the investigation and\/or remediation processes for 19 sites and expects to begin the investigation process in 1996 for the other two sites. Utilities estimates the range of costs to be incurred for investigation and\/or remediation of the sites to be approximately $22 million to $55 million.\nUtilities has recorded environmental liabilities related to the FMGP sites of approximately $35 million (including $4.6 million as current liabilities) at December 31, 1995. These amounts are based upon Utilities' best current estimate of the amount to be incurred for investigation and remediation costs for those sites where the investigation process has been or is substantially completed, and the minimum of the estimated cost range for those sites where the investigation is in its earlier stages or has not started. It is possible that future cost estimates will be greater than the current estimates as the investigation process proceeds and as additional facts become known. Utilities may be required to monitor these sites for a number of years upon completion of remediation, as is the case with several of the sites for which remediation has been completed.\nUtilities has begun pursuing claims under its prior coverage for investigation, mitigation, prevention, remediation and monitoring costs from its insurance carriers and is investigating the potential for third party cost sharing for FMGP investigation and clean-up costs. The amount of shared costs, if any, can not be reasonably determined and, accordingly, no potential sharing has been recorded at December 31, 1995. Regulatory assets of approximately $35 million, which reflect the future recovery that is being provided through Utilities' rates, have been recorded in the Consolidated Balance Sheets. Considering the current rate treatment allowed by the IUB, management believes that the clean-up costs incurred by Utilities for these FMGP sites will not have a material adverse effect on its financial position or results of operations.\nThe Clean Air Act Amendments Act of 1990 (Act) requires emission reductions of sulfur dioxide and nitrogen oxides (NOx) to achieve reductions of atmospheric chemicals believed to cause acid rain. The provisions of the Act are being implemented in two phases with Phase I affecting two of Utilities' units beginning in 1995 and Phase II affecting all units beginning in the year 2000. Utilities has completed the modifications necessary to meet the Phase I requirements and has installed continuous emission monitors on all affected units as required by the Act. Utilities expects to meet the requirements of Phase II by switching to lower sulfur fuels, capital expenditures primarily related to fuel burning equipment and boiler modifications and the possible purchase of sulfur dioxide allowances. Utilities estimates capital expenditures at approximately $20 million, including $4 million in 1996, in order to meet the acid rain requirements of the Act.\nThe acid rain program under the Act also creates sulfur dioxide allowances. An allowance is defined as an authorization for an owner to emit one ton of sulfur dioxide into the atmosphere. Currently, Utilities receives a sufficient number of allowances annually to offset its emissions of sulfur dioxide from its Phase I units. It is anticipated that in the year 2000, when the Phase II units participate in the allowance program, Utilities may have an insufficient number of allowances annually to offset its estimated emissions and may have to purchase additional allowances, or make modifications to the plants or limit operations to reduce emissions. Utilities is reviewing its options to ensure that it will have sufficient allowances to offset its emissions in the year 2000 and thereafter. Utilities believes that the potential cost of ensuring sufficient allowances will not have a material adverse effect on its financial position or results of operations.\nThe Act also requires the United States Environmental Protection Agency (EPA) to study and regulate, if necessary, additional issues that potentially affect the electric utility industry, including emissions relating to nitrogen oxides (NOx), ozone transport and mercury. Currently, the impacts of these potential regulations are too speculative to quantify.\nIn 1995, the EPA published the Sulfur Dioxide Network Design Review for Cedar Rapids, Iowa, which, based on the EPA's assumptions and worst-case modeling methods, suggests that the Cedar Rapids area could be classified as \"nonattainment\" for the National Ambient Air Quality Standard (NAAQS) established for sulfur dioxide. The worst- case modeling study suggests that two of Utilities' generating facilities contribute to the modeled exceedences and recommends that additional monitors be located near Utilities' sources to assess actual ambient air quality. In the event that Utilities' facilities contribute excessive emissions, Utilities would be required to reduce emissions, which would primarily entail capital expenditures for modifications to the facilities. Utilities is currently reviewing EPA's assumptions and modeling results and is proposing a strategy to voluntarily reduce the excessive emissions through modification of its facilities at a potential capital cost of up to $10 million over the next four years.\nThe National Energy Policy Act of 1992 requires owners of nuclear power plants to pay a special assessment into a \"Uranium Enrichment Decontamination and Decommissioning Fund.\" The assessment is based upon prior nuclear fuel purchases and, for the DAEC, averages $1.4 million annually through 2007, of which Utilities' 70% share is $1.0 million. Utilities is recovering the costs associated with this assessment through its electric fuel adjustment clauses over the period the costs are assessed. Utilities' 70% share of the future assessment, $10.9 million payable through 2007, has been recorded as a liability in the Consolidated Balance Sheets, including $0.8 million included in \"Current liabilities - Environmental liabilities,\" with a related regulatory asset for the unrecovered amount.\nThe Nuclear Waste Policy Act of 1982 assigned responsibility to the U.S. Department of Energy (DOE) to establish a facility for the ultimate disposition of high level waste and spent nuclear fuel and authorized the DOE to enter into contracts with parties for the disposal of such material beginning in January 1998. Utilities entered into such a contract and has made the agreed payments to DOE. The DOE, however, has experienced significant delays in its efforts and material acceptance is now expected to occur no earlier than 2010 with the possibility of further delay being likely. Utilities has been storing spent nuclear fuel on-site since plant operations began in 1974 and has current on-site capability to store spent fuel until 2002. Utilities is aggressively reviewing options for additional spent nuclear fuel storage capability, including expanding on-site storage and supporting legislation currently before the U.S. Congress, to resolve the lack of progress by the DOE.\nThe Low-Level Radioactive Waste Policy Amendments Act of 1985 mandated that each state must take responsibility for the storage of low-level radioactive waste produced within its borders. The State of Iowa has joined the Midwest Interstate Low-Level Radioactive Waste Compact Commission (Compact), which is planning a storage facility to be located in Ohio to store waste generated by the Compact's six member states. At December 31, 1995, Utilities has prepaid costs of approximately $1.1 million to the Compact for the building of such a facility. A Compact disposal facility is anticipated to be in operation in approximately ten years after approval of new enabling legislation by the member states. Such legislation is expected to be considered by the member states in 1996. On- site storage capability currently exists for low-level radioactive waste expected to be generated until the Compact facility is able to accept waste materials. In addition, the Barnwell, South Carolina disposal facility has reopened for an indefinite time period and Utilities is in the process of shipping to Barnwell the majority of the low-level radioactive waste it has accumulated on-site, and intends to ship the waste it produces in the future as long as the Barnwell site remains open, thereby minimizing the amount of waste stored on-site.\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 has been the subject of increased public, governmental, industry and media attention. A considerable amount of scientific research has been conducted on this topic without definitive results. Research is continuing in order to resolve scientific uncertainties.\nWhiting is responsible for certain dismantlement and abandonment costs related to various off-shore oil and gas properties, the most significant of which is located off the coast of California. Whiting accrues these costs as reserves are extracted and such costs are included in \"Depreciation and amortization\" in the Consolidated Statements of Income. A corresponding environmental liability, $1.7 million at December 31, 1995, has been recognized in the Consolidated Balance Sheets for the cumulative amount expensed.\nOTHER MATTERS\nCompetition As legislative, regulatory, economic and technological changes occur, electric utilities are faced with increasing pressure to become more competitive. Such competitive pressures could result in loss of customers and an incurrence of stranded costs (i.e. the cost of assets which could be rendered otherwise unrecoverable as the result of competitive pricing). To the extent stranded costs cannot be recovered from customers, they would be borne by security holders.\nThe National Energy Policy Act of 1992 addresses several matters designed to promote competition in the electric wholesale power generation market, including mandated open access to the electric transmission system. In March 1995, the FERC issued a Notice of Proposed Rulemaking pursuant to which FERC proposes to promote competition in the electric utility industry by requiring that each transmission owning utility must 1) implement non- discriminatory tariffs allowing open access to that utility's transmission facilities by wholesale buyers and sellers of electricity and 2) charge itself the same price for transmission and ancillary services as it charges third parties under the tariffs. Utilities filed conforming pro- forma open access transmission tariffs with the FERC on July 24, 1995. The tariffs were accepted by the FERC and became effective October 1, 1995. The geographic position of Utilities' transmission system could provide revenue opportunities in the open access environment. FERC's proposal would allow for recovery of certain wholesale stranded costs in connection with wholesale transmission. IEA received approval in the same FERC proceeding to market electric power at market based rates. The Company cannot predict the final regulations that may be adopted.\nThe IUB initiated a Notice of Inquiry (Docket No. NOI- 95-1) in early 1995 on the subject of \"Emerging Competition in the Electric Utility Industry.\" A one-day roundtable discussion was held to address all forms of competition in the electric utility industry and to assist the IUB in gathering information and perspectives on electric competition from all persons or entities with an interest or stake in the issues. Additional discussions were held in December 1995. The IUB is expected to release a status report on the inquiry in the first quarter of 1996.\nUtilities is subject to the provisions of Statement of Financial Accounting Standards No. 71, \"Accounting for the Effects of Certain Types of Regulation\" (SFAS 71). If a portion of Utilities' operations become no longer subject to the provisions of SFAS 71, a write-down of related regulatory assets would be required, unless some form of transition cost recovery is established by the appropriate regulatory body. Utilities believes that it still meets the requirements of SFAS 71. Refer to Note 1(c) of the Notes to Consolidated Financial Statements for a further discussion.\nThe Company cannot predict the long-term consequences of these competitive issues on its results of operations or financial condition. The Company's strategy for dealing with these emerging issues includes seeking growth opportunities, continuing to offer quality customer service, ongoing cost reductions and productivity enhancements. In 1995, the Company initiated a program called Process Redesign to examine all of the major business processes of Utilities. The goals of Process Redesign include improving customer service and commitment and significantly reducing Utilities' cost structure. In 1995, Process Redesign identified many of the changes that Utilities should pursue and Utilities has begun implementing many of those actions. Implementation will be substantially completed in 1996.\nAccounting Pronouncements SFAS 121, issued in March 1995 by the Financial Accounting Standards Board (FASB) and effective for 1996, establishes accounting standards for the impairment of long-lived assets. SFAS 121 also requires that regulatory assets that are no longer probable of recovery through future revenues be charged to earnings. SFAS 121 is not expected to have an impact on the financial position or results of operations of the Company upon adoption.\nFinancial Derivatives The 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, 1995, the Company had no financial derivatives outstanding.\nInflation Under the rate making principles prescribed by the regulatory commissions to which Utilities is subject, only the historical cost of plant is recoverable in revenues as depreciation. As a result, Utilities has experienced economic losses equivalent to the current year's impact of inflation on utility plant. In addition, the regulatory process imposes a substantial time lag between the time when operating and capital costs are incurred and when they are recovered. Utilities does not expect the effects of inflation at current levels to have a significant effect on its financial position or results of operations.\nSelected Consolidated Quarterly Financial Data (unaudited)\nThe following unaudited consolidated quarterly data, in the opinion of the Company, includes adjustments, which are normal and recurring in nature, necessary for the fair presentation of the results of operations and financial position. Utilities' results of operations are a significant portion of the consolidated results. The quarterly amounts were affected by Utilities' rate activities and seasonal weather conditions. The first quarter net income in 1995 was significantly lower than 1994 as Utilities recorded a $8.0 million pre-tax reserve for electric rate refund in the first quarter of 1995. Approximately $3.5 million of the reserve related to revenues collected in the fourth quarter of 1994. Milder weather in 1995 also contributed to the decrease. Utilities' rate activities are discussed in Note 3 of the Notes to Consolidated Financial Statements. Refer to Management's Discussion and Analysis for a discussion of the impacts of weather.\nQuarter Ended March June September December 31 30 30 31 (in thousands, except per share amounts) Operating revenues $ 206,392 $ 189,447 $ 238,467 $ 216,704 Operating income 22,115 33,456 63,710 32,431 Net income 6,740 12,508 31,120 13,808 Earnings per average common share 0.23 0.43 1.06 0.48\nOperating revenues $ 211,621 $ 171,117 $ 207,345 $ 195,781 Operating income 35,694 28,436 56,700 27,103 Net income 15,144 10,858 28,009 12,807 Earnings per average common share 0.53 0.38 0.98 0.45\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nInformation required by Item 8. begins on page 70.\nREPORT OF MANAGEMENT\nThe Company's management has prepared and is responsible for the presentation, integrity and objectivity of the consolidated financial statements and related information included in this report. The consolidated financial statements have been prepared in conformity with generally accepted accounting principles applied on a consistent basis and, in some cases, include estimates that are based upon management's judgment and the best available information, giving due consideration to materiality. Financial information contained elsewhere in this report is consistent with that in the consolidated financial statements.\nThe Company 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 system of internal accounting controls is supported by written policies and procedures, by a staff of internal auditors and by the selection and training of qualified personnel. The internal audit staff conducts comprehensive audits of the Company's system of internal accounting controls. Management strives to maintain an adequate system of internal controls, recognizing that the cost of such a system should not exceed the benefits derived. In accordance with generally accepted auditing standards, the independent public accountants (Arthur Andersen LLP) obtained a sufficient understanding of the Company's internal controls to plan their audit and determine the nature, timing and extent of other tests to be performed. Management is not aware of any material internal control weaknesses.\nThe Board of Directors, through its Audit Committee comprised entirely of outside directors, meets periodically with management, the internal auditor and Arthur Andersen LLP to discuss financial reporting matters, internal control and auditing. To ensure their independence, both the internal auditor and Arthur Andersen LLP have full and free access to the Audit Committee.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Board of Directors of IES Industries Inc.:\nWe have audited the accompanying consolidated balance sheets and statements of capitalization of IES Industries Inc. (an Iowa corporation) and subsidiary companies as of December 31, 1995 and 1994, and the related consolidated statements of income, retained earnings and cash flows for each of the three years in the period ended December 31, 1995. These financial statements and the financial statement schedule referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of IES Industries Inc. and subsidiary companies as of December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995, 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 schedule listed in Item 14(a)2 is presented for purposes of complying with the Securities and Exchange Commission's rules and are 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.\nAs discussed in Note 8 to the consolidated financial statements, effective January 1, 1993, IES Industries Inc. and subsidiary companies changed their method of accounting for postretirement benefits other than pensions.\n\/s\/ ARTHUR ANDERSEN LLP ARTHUR ANDERSEN LLP\nChicago, Illinois February 2, 1996\nCONSOLIDATED STATEMENTS OF INCOME Year Ended December 31 1995 1994 1993 (in thousands, except per share amounts) Operating revenues: Electric $ 560,471 $ 537,327 $ 550,521 Gas 190,339 165,569 181,923 Other 100,200 82,968 68,822 851,010 785,864 801,266\nOperating expenses: Fuel for production 96,256 85,952 87,702 Purchased power 66,874 68,794 93,449 Gas purchased for resale 141,716 120,795 135,830 Other operating expenses 201,390 176,863 162,642 Maintenance 46,093 52,841 48,913 Depreciation and amortization 97,958 86,378 77,012 Taxes other than income taxes 49,011 46,308 44,449 699,298 637,931 649,997\nOperating income 151,712 147,933 151,269\nInterest expense and other: Interest expense 50,727 46,010 44,440 Allowance for funds used during construction -3,424 -3,910 -1,972 Preferred dividend requirements of IES Utilities Inc. 914 914 914 Miscellaneous, net -3,170 -3,472 2,908 45,047 39,542 46,290\nIncome before income taxes 106,665 108,391 104,979\nFederal and state income taxes 42,489 41,573 37,041\nNet income $ 64,176 $ 66,818 $ 67,938\nAverage number of common shares outstanding 29,202 28,560 27,764\nEarnings per average common share $ 2.20 $ 2.34 $ 2.45\nThe accompanying Notes to Consolidated Financial Statements are an integral part of these statements.\nCONSOLIDATED STATEMENTS OF RETAINED EARNINGS Year Ended December 31 1995 1994 1993 (in thousands)\nBalance at beginning of year $ 218,293 $ 211,750 $ 202,919 Add: Net income 64,176 66,818 67,938\nDeduct: Cash dividends declared on common stock, at a per share rate of $2.10 for all years 61,392 60,065 59,107 Other 0 210 0 Balance at end of year $ 221,077 $ 218,293 $ 211,750\nThe accompanying Notes to Consolidated Financial Statements are an integral part of these statements.\nCONSOLIDATED BALANCE SHEETS December 31 ASSETS 1995 1994 (in thousands) Property, plant and equipment: Utility - Plant in service - Electric $ 1,900,157 $ 1,798,059 Gas 165,825 158,115 Other 106,396 86,005 2,172,378 2,042,179 Less - Accumulated depreciation 950,324 880,888 1,222,054 1,161,291 Leased nuclear fuel, net of amortization 36,935 49,731 Construction work in progress 52,772 73,339 1,311,761 1,284,361 Other, net of accumulated depreciation and amortization of $53,026,000 and $35,767,000, respectively 193,215 154,657 1,504,976 1,439,018\nCurrent assets: Cash and temporary cash investments 6,942 4,993 Accounts receivable - Customer, less reserve 37,214 26,098 Other 10,493 10,388 Income tax refunds receivable 982 6,434 Production fuel, at average cost 12,155 13,988 Materials and supplies, at average cost 28,354 30,216 Adjustment clause balances 0 1,433 Regulatory assets 22,791 20,145 Oil and gas properties held for resale 9,843 0 Prepayments and other 23,099 24,692 151,873 138,387\nInvestments: Nuclear decommissioning trust funds 47,028 33,779 Investment in foreign entities 24,770 473 Cash surrender value of life insurance policies 9,838 8,867 Investment in McLeod, Inc. 9,200 7,500 Other 3,897 4,274 94,733 54,893\nOther assets: Regulatory assets 207,202 192,955 Deferred charges and other 26,807 23,840 234,009 216,795 $ 1,985,591 $ 1,849,093\nDecember 31 CAPITALIZATION AND LIABILITIES 1995 1994 (in thousands) Capitalization (See Consolidated Statements of Capitalization): Common stock $ 391,269 $ 373,490 Retained earnings 221,077 218,293 Total common equity 612,346 591,783 Cumulative preferred stock of IES Utilities Inc. 18,320 18,320 Long-term debt (excluding current portion) 601,708 473,206 1,232,374 1,083,309\nCurrent liabilities: Short-term borrowings 101,000 37,000 Capital lease obligations 15,717 14,385 Maturities and sinking funds 15,447 100,422 Accounts payable 80,089 78,582 Dividends payable 16,244 15,839 Accrued interest 8,051 9,494 Accrued taxes 53,983 50,001 Accumulated refueling outage provision 7,690 15,196 Adjustment clause balances 3,148 0 Environmental liabilities 5,634 5,428 Other 21,800 21,680 328,803 348,027\nLong-term liabilities: Pension and other benefit obligations 44,619 38,643 Capital lease obligations 21,218 35,346 Environmental liabilities 43,087 38,288 Other 21,097 20,314 130,021 132,591\nDeferred credits: Accumulated deferred income taxes 257,278 245,365 Accumulated deferred investment tax credits 37,115 39,801 294,393 285,166\nCommitments and contingencies (Note 12)\n$ 1,985,591 $ 1,849,093\nThe accompanying Notes to Consolidated Financial Statements are an integral part of these statements.\nCONSOLIDATED STATEMENTS OF CAPITALIZATION December 31 1995 1994 (in thousands) Common equity: Common stock - no par value - authorized 48,000,000 shares; outstanding 29,508,415 and 28,777,046 shares, respectively $ 391,269 $ 373,490 Retained earnings 221,077 218,293 612,346 591,783\nCumulative preferred stock of IES Utilities Inc. 18,320 18,320\nLong-term debt: IES Utilities Inc. - Collateral Trust Bonds - 7.65% series, due 2000 50,000 0 6% series, due 2008 50,000 50,000 7% series, due 2023 50,000 50,000 5.5% series, due 2023 19,400 19,400 169,400 119,400\nFirst Mortgage Bonds - Series J, 6-1\/4%, due 1996 15,000 15,000 Series L, 7-7\/8%, due 2000 15,000 15,000 Series M, 7-5\/8%, due 2002 30,000 30,000 Series W, 9-3\/4%, retired in 1995 0 50,000 Series X, 9.42%, retired in 1995 0 50,000 Series Y, 8-5\/8%, due 2001 60,000 60,000 Series Z, 7.60%, due 1999 50,000 50,000 6-1\/8% series, due 1997 8,000 8,000 9-1\/8% series, due 2001 21,000 21,000 7-3\/8% series, due 2003 10,000 10,000 7-1\/4% series, due 2007 30,000 30,000 239,000 339,000\nPollution control obligations - 5.75%, due serially 1996 to 2003 3,556 3,696 5.95%, due 2007, secured by First Mortgage Bonds 10,000 10,000 Variable rate (5.10% - 5.95% at December 31, 1995) due 2000 to 2010 11,100 11,100 24,656 24,796\nSubordinated Deferrable Interest Debentures, 7-7\/8%, due 2025 50,000 0\nTotal IES Utilities Inc. 483,056 483,196\nIES Diversified Inc. - Variable rate credit facility 124,245 80,500 Other subsidiaries' debt maturing through 2013 12,307 12,584 619,608 576,280 Unamortized debt premium and (discount), net -2,453 -2,652 617,155 573,628 Less - Amount due within one year 15,447 100,422 601,708 473,206 $ 1,232,374 $ 1,083,309\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: (a) Basis of Consolidation -\nThe Consolidated Financial Statements include the accounts of IES Industries Inc. (Industries) and its consolidated subsidiaries (collectively the Company). Industries is an investor-owned holding company whose primary operating company, IES Utilities Inc. (Utilities), is engaged principally in the generation, transmission, distribution and sale of electric energy and the purchase, distribution, transportation and sale of natural gas. The Company's principal markets are located in the state of Iowa. The Company also has various non-utility subsidiaries which are primarily engaged in the energy-related, transportation and real estate development businesses.\nAll subsidiaries for which Industries owns directly or indirectly more than 50% of the voting stock are included as consolidated subsidiaries. Industries' wholly-owned subsidiaries are Utilities and IES Diversified Inc. (Diversified). All significant intercompany balances and transactions, other than energy-related transactions affecting Utilities, have been eliminated from the Consolidated Financial Statements. Such energy-related transactions are made at prices that approximate market value and the associated costs are recoverable from Utilities' customers through the rate making process.\nInvestments for which the Company has at least a 20% interest are generally accounted for under the equity method of accounting. These investments are stated at acquisition cost, increased or decreased for the Company's equity in undistributed net income or loss, which is included in \"Miscellaneous, net\" in the Consolidated Statements of Income. Investments that do not meet the criteria for the consolidating or equity methods of accounting are accounted for under the cost method.\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect: 1) the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, and 2) the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nCertain prior period amounts have been reclassified on a basis consistent with the 1995 presentation.\n(b) Regulation -\nBecause of its ownership of Utilities, Industries is a holding company under the Public Utility Holding Company Act of 1935, but claims an exemption from all provisions thereof except Section 9(a)(2), which applies to the purchase of stock of other utility companies. Utilities is subject to regulation by the Iowa Utilities Board (IUB) and the Federal Energy Regulatory Commission (FERC).\nRefer to Note 2 for a discussion of the proposed merger of the Company.\n(c) Regulatory Assets -\nUtilities is subject to the provisions of Statement of Financial Accounting Standards No. 71, \"Accounting for the Effects of Certain Types of Regulation\" (SFAS 71). The regulatory assets represent probable future revenue to Utilities associated with certain incurred costs as these costs are recovered through the rate making process. At December 31, regulatory assets as reflected in the Consolidated Balance Sheets were comprised of the following items:\n1995 1994 (in millions)\nDeferred income taxes (Note 1(d)) $ 91.1 $ 90.1 Energy efficiency program costs (Note 3(c)) - . Currently being recovered through rates 18.3 20.3 . Recovery has not yet been requested 31.4 14.4 Environmental liabilities (Note 12(f)) 46.9 43.8 Employee pension and benefit costs (Note 8) 27.5 25.0 Unamortized loss on reacquired debt 5.7 6.1 FERC Order No. 636 transition costs (Note 12(h)) 5.0 8.0 Other 4.1 5.4 230.0 213.1 Classified as \"Current assets - regulatory assets\" 22.8 20.1 Classified as \"Other assets - regulatory assets\" $ 207.2 $ 193.0\nRefer to the individual footnotes referenced above for a further discussion of certain items reflected in regulatory assets.\nIf a portion of Utilities' operations become no longer subject to the provisions of SFAS 71, a write-off of related regulatory assets would be required, unless some form of transition cost recovery is established by the appropriate regulatory body.\nSFAS 121, issued in March 1995 by the Financial Accounting Standards Board (FASB) and effective for 1996, establishes accounting standards for the impairment of long- lived assets. SFAS 121 also requires that regulatory assets that are no longer probable of recovery through future revenues be charged to earnings. SFAS 121 is not expected to have an impact on the financial position or results of operations of the Company upon adoption.\n(d) Income Taxes -\nThe Company follows the liability method of accounting for deferred income taxes, which requires the establishment of deferred tax liabilities and assets, as appropriate, for all temporary differences between the tax basis of assets and liabilities and the amounts reported in the financial statements. Deferred taxes are recorded using currently enacted tax rates.\nExcept as noted below, income tax expense includes provisions for deferred taxes to reflect the tax effects of temporary differences between the time when certain costs are recorded in the accounts and when they are deducted for tax return purposes. As temporary differences reverse, the related accumulated deferred income taxes are reversed to income. Investment tax credits for Utilities have been deferred and are subsequently credited to income over the average lives of the related property.\nConsistent with rate making practices for Utilities, deferred tax expense is not recorded for certain temporary differences (primarily related to utility property, plant and equipment). As the deferred taxes become payable, over periods exceeding 30 years for some generating plant differences, they are recovered through rates. Accordingly, Utilities has recorded deferred tax liabilities and regulatory assets, as identified in Note 1(c).\n(e) Temporary Cash Investments -\nTemporary cash investments are stated at cost, which approximates market value, and are considered cash equivalents for the Consolidated Statements of Cash Flows. These investments consist of short-term liquid investments that have maturities of less than 90 days from the date of acquisition.\n(f) Depreciation of Utility Property, Plant and Equipment -\nThe depreciation life of Utilities' nuclear generating station, the Duane Arnold Energy Center (DAEC), was increased from 36 years to 40 years based on an extension of the Nuclear Regulatory Commission (NRC) license life to 2014, using the remaining life method, as part of Utilities' most recent rate case as discussed in note 3(b). The average rates of depreciation for electric and gas properties of Utilities, consistent with current rate making practices, were as follows:\n1995 1994 1993\nElectric 3.4% 3.6% 3.5% Gas 3.5% 3.8% 3.5%\nThe electric and gas depreciation rates declined in 1995 from 1994 because of revised depreciation rates approved in Utilities' most recent electric and gas rate proceedings.\n(g) Decommissioning of the DAEC -\nPursuant to the recent electric rate case order, the IUB allowed Utilities to increase the recovery of anticipated costs to decommission the DAEC from $5.5 million to $6.0 million annually. Decommissioning expense is included in \"Depreciation and amortization\" in the Consolidated Statements of Income and the cumulative amount is included in \"Accumulated depreciation\" in the Consolidated Balance Sheets to the extent recovered through rates. The current recovery figures are based on the following assumptions: 1) cost to decommission the DAEC of $252.8 million in 1993 dollars, based on the NRC minimum formula (which exceeds the amount in the current site-specific study completed in 1994); 2) inflation of 4.91% annually through 1997; 3) the prompt dismantling and removal method of decommissioning, which is assumed to begin in the year 2014; 4) monthly funding of all future collections into external trust funds and funded on a tax-qualified basis to the extent possible; and 5) an average after-tax return of 6.82% for all external investments. All of these assumptions are subject to change in future regulatory proceedings. At December 31, 1995, Utilities had $47.0 million invested in external decommissioning trust funds as indicated in the Consolidated Balance Sheets, and also had an internal decommissioning reserve of $21.7 million recorded as accumulated depreciation. Earnings on the external trust funds, which were $1.0 million in 1995, are recorded as interest income and a corresponding interest expense payable to the funds is recorded. The earnings accumulate in the external trust fund balances and in accumulated depreciation on utility plant.\nSee \"Management's Discussion and Analysis of the Results of Operations and Financial Condition\" for a discussion of the Exposure Draft on Accounting for Liabilities Related to Closure and Removal of Long-Lived Assets, issued by the FASB in the first quarter of 1996, which deals with, among other issues, the accounting for decommissioning costs.\n(h) Property, Plant and Equipment -\nUtility plant (excluding acquisition adjustments of $30.6 million, net of accumulated amortization, recorded at cost) is recorded at original cost. The allowance for funds used during construction (AFC), which represents the cost during the construction period of funds used for construction purposes, is capitalized by Utilities as a component of the cost of utility plant. The amount of AFC applicable to debt funds and to other (equity) funds, a non- cash item, is computed in accordance with the prescribed FERC formula. The aggregate gross rates used by Utilities for 1995-1993 were 6.5%, 9.3% and 5.7%, respectively. These capitalized costs are recovered by Utilities in rates as the cost of the utility plant is depreciated.\nOther property, plant and equipment is recorded at cost. Upon retirement or sale of other property and equipment, the cost and related accumulated depreciation are removed from the accounts and any gain or loss is included in \"Miscellaneous, net\" in the Consolidated Statements of Income.\nNormal repairs, maintenance and minor items of utility plant and other property, plant and equipment are expensed. Ordinary retirements of utility plant, including removal costs less salvage value, are charged to accumulated depreciation upon removal from utility plant accounts, and no gain or loss is recognized.\n(i) Oil and Gas Properties -\nWhiting Petroleum Corporation (Whiting), a wholly-owned subsidiary under Diversified, uses the full cost method of accounting for its oil and gas properties. Accordingly, all costs of acquisition, exploration and development of properties are capitalized. Amortization of proved oil and gas properties is calculated using the units of production method. At December 31, 1995, capitalized costs less related accumulated amortization did not exceed the sum of (1) the present value of future net revenue from estimated production of proved oil and gas reserves (calculated using current prices); plus (2) the cost of properties not being amortized, if any; plus (3) the lower of cost or estimated fair value of unproved properties included in the costs being amortized, if any; less (4) income tax effects related to differences in the book and tax basis of oil and gas properties. The Company has $9.8 million on its Consolidated Balance Sheet at December 31, 1995, relating to specific oil and gas properties purchased by Whiting in the fourth quarter of 1995 that it intends to sell during 1996.\n(j) Operating Revenues -\nThe Company accrues revenues for services rendered but unbilled at month-end in order to more properly match revenues with expenses.\n(k) Adjustment Clauses -\nUtilities' tariffs provide for subsequent adjustments to its electric and natural gas rates for changes in the cost of fuel and purchased energy and in the cost of natural gas purchased for resale. Changes in the under\/over collection of these costs are reflected in \"Fuel for production\" and \"Gas purchased for resale\" in the Consolidated Statements of Income. The cumulative effects are reflected in the Consolidated Balance Sheets as a current asset or current liability, pending automatic reflection in future billings to customers.\n(l) Accumulated Refueling Outage Provision -\nThe IUB allows Utilities to collect, as part of its base revenues, funds to offset other operating and maintenance expenditures incurred during refueling outages at the DAEC. As these revenues are collected, an equivalent amount is charged to other operating and maintenance expenses with a corresponding credit to a reserve. During a refueling outage, the reserve is reversed to offset the refueling outage expenditures.\n(2) PROPOSED MERGER OF THE COMPANY:\nThe Company, WPL Holdings, Inc. (WPLH) and Interstate Power Company (IPC) have entered into an Agreement and Plan of Merger (Merger Agreement), dated November 10, 1995, providing for: a) IPC becoming a wholly-owned subsidiary of WPLH, and b) the merger of the Company with and into WPLH, which merger will result in the combination of the Company and WPLH as a single holding company (collectively, the Proposed Merger). The new holding company will be named Interstate Energy Corporation (Interstate Energy) and Industries will cease to exist. The Proposed Merger, which will be accounted for as a pooling of interests, has been approved by the respective Boards of Directors. It is still subject to approval by the shareholders of each company as well as several federal and state regulatory agencies. The companies expect to receive the shareholder approvals in the second quarter of 1996 and the regulatory approvals by the second quarter of 1997.\nThe operating revenues, net income from continuing operations and total assets of the companies were as follows:\nPRO FORMA IES COMBINED INDUSTRIES WPLH IPC (Unaudited) (in thousands)\n1995 operating revenues $ 851,010 $ 807,255 $ 318,542 $ 1,976,807\n1995 net income from continuing operations 64,176 71,618 25,198 160,992\nAssets at December 31, 1995 1,985,591 1,872,414 634,316 4,492,321\nUnder the terms of the Merger Agreement, the outstanding shares of WPLH's common stock will remain unchanged and outstanding as shares of Interstate Energy. Each outstanding share of the Company's common stock will be converted to .98 shares of Interstate Energy's common stock. Each share of IPC's common stock will be converted to 1.11 shares of Interstate Energy's common stock. It is anticipated that Interstate Energy will retain WPLH's common share dividend payment level as of the effective time of the merger. On January 24, 1996, the Board of Directors of WPLH declared a quarterly dividend of 49.25 cents per share. This represents an equivalent annual rate of $1.97 per share.\nWPLH is a holding company headquartered in Madison, Wisconsin, and is the parent company of Wisconsin Power and Light Company (WP&L) and Heartland Development Corporation (HDC). WP&L supplies electric and gas service to approximately 377,000 and 146,000 customers, respectively, in south and central Wisconsin. HDC and its principal subsidiaries are engaged in businesses in three major areas: environmental engineering and consulting, affordable housing and energy services. IPC, an operating public utility headquartered in Dubuque, Iowa, supplies electric and gas service to approximately 163,000 and 49,000 customers, respectively, in northeast Iowa, northwest Illinois and southern Minnesota.\nInterstate Energy will be the parent company of Utilities, WP&L and IPC and will be registered under the Public Utility Holding Company Act of 1935, as amended (1935 Act). The Merger Agreement provides that these operating utility companies will continue to operate as separate entities for a minimum of three years beyond the effective date of the merger. In addition, the non-utility operations of the Company and WPLH will be combined shortly after the effective date of the merger under one entity to manage the diversified operations of Interstate Energy. The corporate headquarters of Interstate Energy will be in Madison.\nThe SEC historically has interpreted the 1935 Act to preclude registered holding companies, with limited exceptions, from owning both electric and gas utility systems. Although the SEC has recently recommended that registered holding companies be allowed to hold both gas and electric utility operations if the affected states agree, it remains possible that the SEC may require as a condition to its approval of the Proposed Merger that the Company, WPLH and IPC divest their gas utility properties, and possibly certain non-utility ventures of the Company and WPLH, within a reasonable time after the effective date of the Proposed Merger.\n(3) RATE MATTERS: (a) 1995 Gas Rate Case -\nOn August 4, 1995, Utilities applied to the IUB for an annual increase in gas rates of $8.8 million, or 6.2%. An interim increase of $8.6 million was requested and the IUB, subsequently, approved an interim increase of $7.1 million annually, effective October 11, 1995, subject to refund. Utilities, the Office of Consumer Advocate and all three industrial intervenor groups have entered into a settlement agreement, subject to IUB approval, which allows Utilities a $6.3 million annual increase. Utilities expects that the IUB will rule on the settlement agreement no later than the second quarter of 1996.\n(b) 1994 Electric Rate Case -\nIn 1994, Utilities applied to the IUB for an increase in retail electric rates of approximately $26 million annually, or 5.2%. The IUB issued its final order on June 30, 1995, which resulted in an annual retail rate reduction of approximately $14.4 million. The Board ruled against Utilities on issues of increased recovery levels of nuclear depreciation expense and nuclear decommissioning expense, and recovery of the full purchase price of Union Electric Company's (UE) Iowa service territory.\nOn August 16, 1995, Utilities received approval from the IUB to implement final prices. Northern and Southeastern zone price changes became effective on that date. A price design change was implemented in the Southern zone effective January 1, 1996. As a result of the IUB order, Utilities refunded approximately $12.8 million, including interest, in the fourth quarter of 1995.\n(c) Energy Efficiency Cost Recovery -\nThe IUB has current rules that mandate Utilities to spend 2% of electric and 1.5% of gas gross retail operating revenues for energy efficiency programs. Under provisions of the IUB rules, Utilities applied in 1994 to the IUB for recovery of costs incurred through 1993 for such programs. In April 1995, the IUB issued its Final Decision and Order concerning Utilities' energy efficiency expenditures, which allows Utilities to recover its direct expenditures, carrying costs, and a return on its expenditures, as well as a reward of approximately $4 million for a total allowed recovery of approximately $32 million. Recovery of energy efficiency costs will be over a four-year period and began on June 1, 1995. In 1996, under provisions of the IUB rules, the Company will file for recovery of the costs incurred after December 31, 1993 ($31.4 million as of December 31, 1995).\n(4) LEASES:\nUtilities has a capital lease covering its 70% undivided interest in nuclear fuel purchased for the DAEC. Future purchases of fuel may also be added to the fuel lease. This lease provides for annual one-year extensions and Utilities intends to exercise such extensions through the DAEC's operating life. Interest costs under the lease are based on commercial paper costs incurred by the lessor. Utilities is responsible for the payment of taxes, maintenance, operating cost, risk of loss and insurance relating to the leased fuel.\nThe lessor has a $65 million credit agreement with a bank supporting the nuclear fuel lease. The agreement continues on a year-to-year basis, unless either party provides at least a three-year notice of termination; no such notice of termination has been provided by either party.\nAnnual nuclear fuel lease expenses include the cost of fuel, based on the quantity of heat produced for the generation of electric energy, plus the lessor's interest costs related to fuel in the reactor and administrative expenses. These expenses (included in \"Fuel for production\" in the Consolidated Statements of Income) for 1995-1993 were $18.0 million, $17.8 million and $12.4 million, respectively.\nThe Company's operating lease rental expenses for 1995-1993 were $10.4 million, $11.1 million and $9.1 million, respectively.\nThe Company's future minimum lease payments by year are as follows:\nCapital Operating Year Lease Leases (in thousands)\n1996 $ 15,515 $ 8,083 1997 13,787 7,241 1998 6,389 6,932 1999 3,865 5,220 2000 824 2,403 2001 149 178 40,529 $ 30,057 Less: Amount representing interest 3,594 Present value of net minimum capital lease payments $ 36,935\n(5) UTILITY ACCOUNTS RECEIVABLE:\nCustomer accounts receivable, including unbilled revenues, arise primarily from the sale of electricity and natural gas. At December 31, 1995, Utilities was serving a diversified base of residential, commercial and industrial customers consisting of approximately 333,000 electric and 174,000 gas customers.\nUtilities has entered into an agreement, which expires in 1999, with a financial institution to sell, with limited recourse, an undivided fractional interest of up to $65 million in its pool of utility accounts receivable. At December 31, 1995, $58 million was sold under the agreement.\n(6) INVESTMENTS: (a) Foreign Entities -\nAt December 31, 1995, the Company had $24.8 million of investments in foreign entities on its Consolidated Balance Sheet that included 1) investments in two New Zealand electric distribution entities, 2) a loan to a New Zealand company, and 3) an investment in an international venture capital fund. The Company accounts for these investments under the cost method.\n(b) McLeod, Inc. -\nAt December 31, 1995, Diversified had a $9.2 million investment in Class B Common Stock of McLeod, Inc. (McLeod), which is accounted for under the cost method. McLeod provides local and long-distance telecommunication services to business customers and other services related to fiber optics. In 1994, Diversified entered into an agreement whereby it will guarantee $6 million under a credit facility between McLeod and its bankers. Diversified is paid an annual commitment fee and receives options to purchase additional shares of Class B Common Stock for as long as the guarantee remains outstanding. At December 31, 1995, McLeod had $3.6 million of borrowings outstanding under its facility.\n(7) INCOME TAXES:\nThe components of federal and state income taxes for the years ended December 31, were as follows:\n1995 1994 1993 (in millions)\nCurrent tax expense $ 34.7 $ 37.5 $ 27.8 Deferred tax expense 10.5 6.7 14.1 Amortization and adjustment of investment tax credits (2.7) (2.6) (4.9) $ 42.5 $ 41.6 $ 37.0\nThe overall effective income tax rates shown below for the years ended December 31, were computed by dividing total income tax expense by income before income taxes.\n1995 1994 1993\nStatutory federal income tax rate 35.0% 35.0% 35.0% Add (deduct): State income taxes, net of federal benefits 5.5 5.9 5.5 Effect of rate making on property related differences 2.6 1.6 (0.2) Amortization of investment tax credits (2.5) (2.5) (2.6) Adjustment of prior period taxes (0.4) (1.6) (2.3) Other items, net (0.4) - (0.1) Overall effective income tax rate 39.8% 38.4% 35.3%\nThe accumulated deferred income taxes as set forth below in the Consolidated Balance Sheets at December 31, arise from the following temporary differences:\n1995 1994 (in millions)\nProperty related $ 296 $ 288 Investment tax credit related (26) (28) Decommissioning related (14) (13) Other 1 (2) $ 257 $ 245\n(8) BENEFIT PLANS: (a) Pension Plans -\nThe Company has two non-contributory pension plans that, collectively, cover substantially all of its employees. Plan benefits are generally based on years of service and compensation during the employees' latter years of employment. Payments made from the pension funds to retired employees and beneficiaries during 1995 totaled $9.2 million.\nThe Company's policy is to fund the pension cost at an amount that is at least equal to the minimum funding requirements mandated by the Employee Retirement Income Security Act (ERISA) and that does not exceed the maximum tax deductible amount for the year. The Company has an investment policy governing asset allocation guidelines for its pension plans. The target ranges are as follows: 1) 37%- 43% in large and mid-sized domestic company equity securities, 2) 7%-13% in foreign equity securities, 3) 7%- 13% in small domestic company equity securities, 4) 0-5% in real estate, and 5) the remainder in fixed income securities. As of December 31, 1995, the plan's investment mix was consistent with the policy guidelines.\nPursuant to the provisions of SFAS 71, certain adjustments to Utilities' pension provision are necessary to reflect the accounting for pension costs allowed in its most recent rate cases.\nThe components of the pension provision for the years ended December 31, were as follows:\n1995 1994 1993 (in thousands)\nService cost $ 5,215 $ 5,863 $ 4,342 Interest cost on projected benefit obligation 11,811 11,431 11,314 Assumed return on plans' assets (12,567) (12,593) (12,363) Amortization of unrecognized gain (754) (180) (767) Amortization of prior service cost 1,355 1,354 1,213 Amortization of unrecognized plans' assets as of January 1, 1987 (333) (333) (389) Pension cost 4,727 5,542 3,350 Adjustment to funding level (4,727) (5,431) (2,940) Total pension costs paid to the Trustee $ - $ 111 $ 410\nActual return on plans' assets $ 36,614 $ (97) $ 12,880\nThe reduction in the service cost for 1995 was primarily due to an increase in the discount rate at December 31, 1994.\nA reconciliation of the funded status of the plans to the amounts recognized in the Consolidated Balance Sheets at December 31, is presented below: 1995 1994 (in thousands)\nFair market value of plans' assets $ 195,329 $ 167,535 Actuarial present value of benefits rendered to date - Accumulated benefits based on compensation to date, including vested benefits of $119,996,000 and $98,384,000, respectively 131,274 108,585 Additional benefits based on estimated future salary levels 41,581 40,146 Projected benefit obligation 172,855 148,731 Plans' assets in excess of projected benefit obligation 22,474 18,804 Remaining unrecognized net asset existing at January 1, 1987, being amortized over 20 years (3,511) (3,844) Unrecognized prior service cost 16,905 18,260 Unrecognized net gain (41,795) (34,420) Accrued pension cost recognized in the Consolidated Balance Sheets $ (5,927) $ (1,200)\nAssumed rate of return, all plans 8.00% 8.00% Weighted average discount rate of projected benefit obligation, all plans 7.50% 8.25% Range of assumed rates of increase in future compensation levels for the plans 4.75% 4.00-5.75%\nThe increase in the projected benefit obligation was primarily due to changes in the mortality rate assumptions and a reduction in the discount rate at December 31, 1995.\n(b) Other Postemployment Benefit Plans -\nThe Company provides certain benefits to retirees (primarily health care benefits). Effective January 1, 1993, the Company adopted SFAS 106, which requires the accrual of the expected cost of postretirement benefits other than pensions during the employees' years of service. The IUB adopted rules stating that postretirement benefits other than pensions will be included in Utilities' rates pursuant to the provisions of SFAS 106. The rules permit Utilities to amortize the transition obligation as of January 1, 1993, over 20 years and require that all amounts collected are to be funded into an external trust to pay benefits as they become due. The gas and electric portions of these costs are being recovered through rates beginning in 1993 and 1995, respectively, including amounts that were deferred by the Company between when SFAS 106 was adopted and when recovery through rates began. The amounts deferred are being amortized as they are collected through rates over a three-year period. Utilities' unamortized balance of these deferred costs was $3.4 million at December 31, 1995.\nThe transition obligation for the non-regulated operations was expensed in 1993 and is reflected in other operating expenses.\nPursuant to the provisions of SFAS 71, certain adjustments to Utilities' other postretirement benefit provisions are necessary to reflect the accounting for other postretirement benefit costs allowed in its most recent rate cases.\nThe components of postretirement benefit costs for the years ended December 31, were as follows:\n1995 1994 1993 (in thousands)\nService cost $ 1,387 $ 1,838 $ 1,744 Interest cost on accumulated postretirement benefit obligation 3,175 3,275 3,363 Assumed return on plans' assets (56) (60) - Amortization of transition obligation existing at January 1, 1993, for regulated operations 2,024 2,024 2,024 Amortization of unrecognized gain (230) (6) - Amortization of prior service cost 19 19 - Write-off of transition obligation existing at January 1, 1993, for non-regulated operations - - 1,434 Postretirement benefit costs 6,319 7,090 8,565 Amortized\/(deferred) postretirement benefit costs 2,220 (2,732) (2,858) Adjustment to funding level 1,162 - - Net postretirement benefit costs $ 9,701 $ 4,358 $ 5,707\nActual return on plans' assets $ 273 $ 47 $ -\nThe reduction in the service cost for 1995 was primarily due to an increase in the discount rate at December 31, 1994.\nA reconciliation of the funded status of the plans to the amounts recognized in the Consolidated Balance Sheets at December 31, is presented below:\n1995 1994 (in thousands)\nFair market value of plans' assets $ 6,515 $ 1,127 Accumulated postretirement benefit obligation - Active employees not yet eligible 22,254 18,896 Active employees eligible 6,282 5,306 Retirees 22,575 18,602 Total accumulated postretirement benefit obligation 51,111 42,804 Accumulated postretirement benefit obligation in excess of plans' assets (44,596) (41,677) Unrecognized transition obligation 34,415 36,439 Unrecognized net (gain)\/loss 349 (5,703) Unrecognized prior service cost 151 170 Accrued postretirement benefit cost in the Consolidated Balance Sheets $ (9,681) $ (10,771)\nAssumed rate of return 8.00% 8.00% Weighted average discount rate of accumulated postretirement benefit obligation 7.50% 8.25% Medical trend on paid charges: Initial trend rate 10.00% 11.00% Ultimate trend rate 6.50% 6.50%\nThe increase in the accumulated postretirement benefit obligation was primarily due to a reduction in the discount rate at December 31, 1995, as well as changes made for mortality, turnover and age assumptions. The assumed medical trend rates are critical assumptions in determining the service and interest cost and accumulated postretirement benefit obligation related to postretirement benefit costs. A 1% change in the medical trend rates, holding all other assumptions constant, would have changed the 1995 service and interest cost by $0.9 million (21%) and the accumulated postretirement benefit obligation at December 31, 1995, by $8.7 million (17%).\n(9) COMMON, PREFERRED AND PREFERENCE STOCK: (a) Common Stock -\nThe following table presents information relating to the changes in common stock.\nCommon Stock Number of Shares Amount Outstanding (in thousands)\nBalance, December 31, 1992 25,556,963 $ 279,810 Public offering 2,300,000 66,555 Stock plan issuances* 447,225 13,936 Balance, December 31, 1993 28,304,188 360,301 Shares issued in connection with acquisition of oil and gas companies 139,102 4,027 Purchases of treasury stock (213,300) (6,233) Stock plan issuances* 547,056 15,395 Balance, December 31, 1994 28,777,046 373,490 Shares issued in connection with acquisition of oil and gas companies 75,638 1,925 Stock plan issuances* 655,731 15,854 Balance, December 31, 1995 29,508,415 $ 391,269\nShares reserved for issuance pursuant to the Company's stock plans at December 31, 1995* 2,201,666\n* Dividend Reinvestment and Stock Purchase Plan, Employee Stock Purchase Plan, Employee Savings Plan, Long-Term Incentive Plan, IES Bonus Stock Ownership Plan and Whiting Stock Option Plans\nIn March 1995, Industries issued 75,638 shares of its common stock for the purchase of oil and gas companies, which are now wholly-owned subsidiaries of Whiting.\nDuring 1994, Industries reacquired 213,300 shares of its common stock on the open market, at an average price of $29.22 per share, which were subsequently issued to the Dividend Reinvestment Plan and certain of its benefit plans. At December 31, 1995, no shares remained held as treasury stock.\n(b) Preferred and Preference Stock:\nUtilities has 466,406 shares of Cumulative Preferred Stock, $50 par value, authorized for issuance at December 31, 1995, of which the 6.10%, 4.80% and 4.30% Series had 100,000, 146,406 and 120,000 shares, respectively, outstanding at both December 31, 1995 and 1994. These shares are redeemable at the option of Utilities upon 30 days notice at $51.00, $50.25 and $51.00 per share, respectively, plus accrued dividends.\nThere are 5,000,000 shares of Industries Cumulative Preferred Stock (no par value) and 700,000 shares of Utilities Cumulative Preference Stock ($100 par value) authorized for issuance, of which none were outstanding at December 31, 1995.\n(10) DEBT: (a) Long-Term Debt -\nIn December 1995, Utilities issued $50 million of Subordinated Deferrable Interest Debentures, 7-7\/8%, due 2025. The proceeds from the issuance of the debentures were used to retire short-term borrowings which were incurred in October 1995 to repay at maturity, $50 million of Series X, 9.42% First Mortgage Bonds.\nIn March 1995, Utilities repaid at maturity $50 million of Series W, 9.75% First Mortgage Bonds and, in a separate transaction, issued $50 million of Collateral Trust Bonds, 7.65%, due 2000.\nUtilities' Indentures and Deeds of Trust securing its First Mortgage Bonds constitute direct first mortgage liens upon substantially all tangible public utility property. Utilities' Indenture and Deed of Trust securing its Collateral Trust Bonds constitutes a second lien on substantially all tangible public utility property while First Mortgage Bonds remain outstanding.\nDiversified has a variable rate credit facility that extends through November 9, 1998, with a one-year extension available to Diversified. The facility also serves as a stand-by agreement for Diversified's commercial paper program. The agreement provides for a combined maximum of $150 million of borrowings under the agreement and commercial paper to be outstanding at any one time. Interest rates and maturities are set at the time of borrowing for direct borrowings under the agreement and for issuances of commercial paper. The interest rate options are based upon quoted market rates and the maturities are less than one year. At December 31, 1995, there were no borrowings outstanding under this facility. Diversified had $124.2 million of commercial paper outstanding at December 31, 1995, with interest rates ranging from 5.85% to 6.50% and maturity dates in the first quarter of 1996. Diversified intends to continue borrowing under the renewal options of the facility and no conditions exist at December 31, 1995, that would prevent such borrowings. Accordingly, this debt is classified as long-term in the Consolidated Balance Sheets.\nRefer to Note 6 (b) for a discussion of a guarantee associated with debt issued by McLeod.\nTotal sinking fund requirements, which Utilities intends to meet by pledging additional property under the terms of Utilities' Indentures and Deeds of Trust, and debt maturities for 1996-2000 are as follows:\nDebt Maturities (in thousands)\nDebt Issue 1996 1997 1998 1999 2000 Utilities - Sinking fund requirements $ 630 $ 550 $ 550 $ 550 $ 550 Pollution control 140 140 140 140 1,696 Series J 15,000 - - - - 6-1\/8% Series - 8,000 - - - Series Z - - - 50,000 - Series L - - - - 15,000 7.65% Series - - - - 50,000\nDiversified - Variable rate credit facility - - - 124,245 - Other subsidiaries' debt 307 333 360 10,366 35 Total $ 16,077 $ 9,023 $ 1,050 $ 185,301 $ 67,281\nThe Company intends to refinance the majority of the debt maturities with long-term securities.\n(b) Short-Term Debt -\nAt December 31, 1995, the Company had bank lines of credit aggregating $131.1 million (Industries - $1.5 million, Utilities - $121.1 million, Diversified - $7.5 million and Whiting - $1.0 million). Utilities was using $101 million to support commercial paper (weighted average interest rate of 5.81%) and $11.1 million to support certain pollution control obligations. Commitment fees are paid to maintain these lines and there are no conditions which restrict the unused lines of credit. In addition to the above, Utilities has an uncommitted credit facility with a financial institution whereby it can borrow up to $40 million. Rates are set at the time of borrowing and no fees are paid to maintain this facility. At December 31, 1995, there were no borrowings outstanding under this facility.\n(11) ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS:\nThe estimated fair values of financial instruments at December 31, 1995, and December 31, 1994, and the basis upon which they were estimated are as follows:\n(a) Current Assets and Current Liabilities -\nThe carrying amount approximates fair value because of the short maturity of such financial instruments.\n(b) Nuclear Decommissioning Trust Funds -\nThe carrying amount represents the fair value of these trust funds, as reported by the trustee. The balance of the \"Nuclear decommissioning trust funds\" as shown in the Consolidated Balance Sheets included $5.3 million of unrealized gains at December 31, 1995, and $0.8 million of unrealized losses at December 31, 1994, on the investments held in the trust funds. The accumulated reserve for decommissioning costs was adjusted by a corresponding amount.\n(c) Cumulative Preferred Stock of Utilities -\nThe estimated fair value of this stock of $11.3 million and $10.2 million at December 31, 1995, and December 31, 1994, respectively, is based upon the market yield of similar securities and quoted market prices.\n(d) Long-Term Debt -\nAt December 31, 1995, and December 31, 1994, the carrying amount of long-term debt was $620 million and $576 million, respectively, compared to estimated fair values of $644 million and $551 million, respectively. The estimated fair value of long-term debt is based upon the market yield of similar securities and quoted market prices.\nSince Utilities is subject to regulation, any gains or losses related to the difference between the carrying amount and the fair value of financial instruments may not be realized by the Company's shareholders.\n(12) COMMITMENTS AND CONTINGENCIES: (a) Construction Program -\nThe Company's construction and acquisition program anticipates expenditures of approximately $245 million for 1996, which includes $164 million at Utilities and $81 million at Diversified. In addition to the $164 million, Utilities anticipates expenditures of approximately $13 million for mandated energy efficiency programs, which expenditures will be deferred pursuant to IUB rules as discussed in Note 3(c). Substantial commitments have been made in connection with these expenditures.\n(b) Purchase Power Contracts -\nUtilities is purchasing power from UE under a firm capacity contract with 1996 and 1997 requirements of 80 Mw and 60 Mw of delivered capacity, respectively. Utilities will also purchase an additional annual maximum interruptible capacity of up to 54 Mw of 25 Hz power, which extends through 1998. The costs of capacity purchases for these contracts are reflected in \"Purchased power\" in the Consolidated Statements of Income.\nUtilities has also entered into an agreement with Basin Electric Power Cooperative to purchase capacity of 50 Mw, 75 Mw, 100 Mw and 100 Mw during the annual six-month summer season for the years 1996 through 1999, respectively.\nTotal capacity charges expected to be incurred under all existing contracts will approximate $14.1 million, $11.1 million, $3.3 million, $3.4 million and $0.4 million for the years 1996-2000, respectively.\n(c) Coal Contract Commitments -\nUtilities has entered into coal supply contracts which expire between 1996 and 2001 for its fossil-fueled generating stations. At December 31, 1995, the contracts cover approximately $158 million of coal over the life of the contracts, which includes $55 million expected to be incurred in 1996. Utilities expects to supplement these coal contracts with spot market purchases to fulfill its future fossil fuel needs.\n(d) Information Technology Services -\nThe Company entered into an agreement, expiring in 2004, with Electronic Data Systems Corporation (EDS) for information technology services. The contract is subject to declining termination fees. The Company's anticipated operating and capital expenditures under the agreement for 1996 are estimated to total approximately $13 million. Future costs under the agreement are variable and are dependent upon the Company's level of usage of technological services from EDS.\n(e) Nuclear Insurance Programs -\nPublic liability for nuclear accidents is governed by the Price Anderson Act of 1988 which sets a statutory limit of $8.9 billion for liability to the public for a single nuclear power plant incident and requires nuclear power plant operators to provide financial protection for this amount. As required, Utilities provides this financial protection for a nuclear incident at the DAEC through a combination of liability insurance ($200 million) and industry-wide retrospective payment plans ($8.7 billion). Under the industry-wide plan, each operating licensed nuclear reactor in the United States is subject to an assessment in the event of a nuclear incident at any nuclear plant in the United States. Based on its ownership of the DAEC, Utilities could be assessed a maximum of $79.3 million per nuclear incident, with a maximum of $10 million per incident per year (of which Utilities' 70% ownership portion would be approximately $55 million and $7 million, respectively) if losses relating to the incident exceeded $200 million. These limits are subject to adjustments for changes in the number of participants and inflation in future years.\nUtilities is a member of Nuclear Mutual Limited (NML) and Nuclear Electric Insurance Limited (NEIL). These companies provide $1.9 billion of insurance coverage on certain property losses at DAEC for property damage, decontamination and premature decommissioning. The proceeds from such insurance, however, must first be used for reactor stabilization and site decontamination before they can be used for plant repair and premature decommissioning. NEIL also provides separate coverage for the cost of replacement power during certain outages. Owners of nuclear generating stations insured through NML and NEIL are subject to retroactive premium adjustments if losses exceed accumulated reserve funds. NML and NEIL's accumulated reserve funds are currently sufficient to more than cover its exposure in the event of a single incident under the primary and excess property damage or replacement power coverages. However, Utilities could be assessed annually a maximum of $3.1 million under NML, $9.8 million for NEIL property and $0.7 million for NEIL replacement power if losses exceed the accumulated reserves funds. Utilities is not aware of any losses that it believes are likely to result in an assessment.\nIn the unlikely event of a catastrophic loss at DAEC, the amount of insurance available may not be adequate to cover property damage, decontamination and premature decommissioning. Uninsured losses, to the extent not recovered through rates, would be borne by Utilities and could have a material adverse effect on Utilities' financial position and results of operations.\n(f) Environmental Liabilities -\nThe Company has recorded environmental liabilities of approximately $48.7 million in its Consolidated Balance Sheets at December 31, 1995. The significant items are discussed below.\nFormer Manufactured Gas Plant (FMGP) Sites\nUtilities has been named as a Potentially Responsible Party (PRP) by various federal and state environmental agencies for 28 FMGP sites, but believes it is not responsible for two of these sites. There are also six other sites for which it may be designated as a PRP in the future. Utilities is working pursuant to the requirements of the various agencies to investigate, mitigate, prevent and remediate, where necessary, damage to property, including damage to natural resources, at and around the sites in order to protect public health and the environment. Utilities believes it has completed the remediation of five sites although it is in the process of obtaining final approval from the applicable environmental agencies on this issue for each site. Utilities is in various stages of the investigation and\/or remediation processes for 19 sites and expects to begin the investigation process in 1996 for the two other sites. Utilities estimates the range of costs to be incurred for investigation and\/or remediation of the sites to be approximately $22 million to $55 million.\nUtilities has recorded environmental liabilities related to the FMGP sites of approximately $35 million (including $4.6 million as current liabilities) at December 31, 1995. These amounts are based upon Utilities' best current estimate of the amount to be incurred for investigation and remediation costs for those sites where the investigation process has been or is substantially completed, and the minimum of the estimated cost range for those sites where the investigation is in its earlier stages or has not started. It is possible that future cost estimates will be greater than the current estimates as the investigation process proceeds and as additional facts become known. Utilities may be required to monitor these sites for a number of years upon completion of remediation, as is the case with several of the sites for which remediation has been completed.\nUtilities has begun pursuing claims under its prior coverage for investigation, mitigation, prevention, remediation, and monitoring costs from its insurance carriers and is investigating the potential for third party cost sharing for FMGP investigation and clean-up costs. The amount of shared costs, if any, cannot be reasonably determined and, accordingly, no potential sharing has been recorded at December 31, 1995. Regulatory assets of approximately $35 million, which reflect the future recovery that is being provided through Utilities' rates, have been recorded in the Consolidated Balance Sheets. Considering the current rate treatment allowed by the IUB, management believes that the clean-up costs incurred by Utilities for these FMGP sites will not have a material adverse effect on its financial position or results of operations.\nNational Energy Policy Act of 1992\nThe National Energy Policy Act of 1992 requires owners of nuclear power plants to pay a special assessment into a \"Uranium Enrichment Decontamination and Decommissioning Fund.\" The assessment is based upon prior nuclear fuel purchases and, for the DAEC, averages $1.4 million annually through 2007, of which Utilities' 70% share is $1.0 million. Utilities is recovering the costs associated with this assessment through its electric fuel adjustment clauses over the period the costs are assessed. Utilities' 70% share of the future assessment, $10.9 million payable through 2007, has been recorded as a liability in the Consolidated Balance Sheets, including $0.8 million included in \"Current liabilities - Environmental liabilities,\" with a related regulatory asset for the unrecovered amount.\nOil and Gas Properties Dismantlement and Abandonment Costs\nWhiting is responsible for certain dismantlement and abandonment costs related to various off-shore oil and gas properties, the most significant of which is located off the coast of California. Whiting accrues these costs as reserves are extracted and such costs are included in \"Depreciation and amortization\" in the Consolidated Statements of Income. A corresponding environmental liability, $1.7 million at December 31, 1995, has been recognized in the Consolidated Balance Sheets for the cumulative amount expensed.\n(g) Air Quality Issues -\nThe Clean Air Act Amendments Act of 1990 (Act) requires emission reductions of sulfur dioxide and nitrogen oxides (NOx) to achieve reductions of atmospheric chemicals believed to cause acid rain. The provisions of the Act are being implemented in two phases with Phase I affecting two of Utilities' units beginning in 1995 and Phase II affecting all units beginning in the year 2000. Utilities has completed the modifications necessary to meet the Phase I requirements and has installed continuous emission monitors on all affected units as required by the Act. Utilities expects to meet the requirements of Phase II by switching to lower sulfur fuels, capital expenditures primarily related to fuel burning equipment and boiler modifications and the possible purchase of sulfur dioxide allowances. Utilities estimates capital expenditures at approximately $20 million, including $4 million in 1996, in order to meet the acid rain requirements of the Act.\nThe acid rain program under the Act also creates sulfur dioxide allowances. An allowance is defined as an authorization for an owner to emit one ton of sulfur dioxide into the atmosphere. Currently, Utilities receives a sufficient number of allowances annually to offset its emissions of sulfur dioxide from its Phase I units. It is anticipated that in the year 2000, when the Phase II units participate in the allowance program, Utilities may have an insufficient number of allowances annually to offset its estimated emissions and may have to purchase additional allowances, or make modifications to the plants or limit operations to reduce emissions. Utilities is reviewing its options to ensure that it will have sufficient allowances to offset its emissions in the year 2000 and thereafter. Utilities believes that the potential cost of ensuring sufficient allowances will not have a material adverse effect on its financial position or results of operations.\nThe Act also requires the United States Environmental Protection Agency (EPA) to study and regulate, if necessary, additional issues that potentially affect the electric utility industry, including emissions relating to nitrogen oxides (NOx), ozone transport and mercury. Currently, the impacts of these potential regulations are too speculative to quantify.\nIn 1995, the EPA published the Sulfur Dioxide Network Design Review for Cedar Rapids, Iowa, which, based on the EPA's assumptions and worst-case modeling methods, suggests that the Cedar Rapids area could be classified as \"nonattainment\" for the National Ambient Air Quality Standard (NAAQS) established for sulfur dioxide. The worst- case modeling study suggests that two of Utilities' generating facilities contribute to the modeled exceedences and recommends that additional monitors be located near Utilities' sources to assess actual ambient air quality. In the event that Utilities' facilities contribute excessive emissions, Utilities would be required to reduce emissions, which would primarily entail capital expenditures for modifications to the facilities. Utilities is currently reviewing EPA's assumptions and modeling results and is proposing a strategy to voluntarily reduce the excessive emissions through modification of its facilities at a potential capital cost of up to $10 million over the next four years.\n(h) FERC Order No. 636 -\nPursuant to FERC Order No. 636 (Order 636), which transitions the natural gas supply business to a less regulated environment, Utilities has enhanced access to competitively priced gas supply and more flexible transportation services. However, under Order 636, Utilities is required to pay certain transition costs incurred and billed by its pipeline suppliers.\nUtilities began paying the transition costs in 1993 and at December 31, 1995, has recorded a liability of $5.0 million for those transition costs that have been incurred, but not yet billed, by the pipelines to date, including $1.9 million expected to be billed through 1996. Utilities is currently recovering the transition costs from its customers through its Purchased Gas Adjustment Clauses as such costs are billed by the pipelines. Transition costs, in addition to the recorded liability, that may ultimately be charged to Utilities could approximate $7.0 million. The ultimate level of costs to be billed to Utilities depends on the pipelines' future filings with the FERC and other future events, including the market price of natural gas. However, Utilities believes any transition costs that the FERC would allow the pipelines to collect from Utilities would be recovered from its customers, based upon regulatory treatment of these costs currently and similar past costs by the IUB. Accordingly, regulatory assets, in amounts corresponding to the recorded liabilities, have been recorded to reflect the anticipated recovery.\n(13) JOINTLY-OWNED ELECTRIC UTILITY PLANT:\nUnder joint ownership agreements with other Iowa utilities, Utilities has undivided ownership interests in jointly-owned electric generating stations and related transmission facilities. Each of the respective owners is responsible for the financing of its portion of the construction costs. Kilowatt-hour generation and operating expenses are divided on the same basis as ownership with each owner reflecting its respective costs in its Statements of Income. Information relative to Utilities' ownership interest in these facilities at December 31, 1995 is as follows:\nOttumwa Neal DAEC Unit 1 Unit 3 ($ in millions)\nUtility plant in service $ 498.0 $ 189.3 $ 56.2 Accumulated depreciation $ 201.2 $ 86.0 $ 27.1 Construction work in progress $ 2.7 $ 1.7 $ 0.7 Plant capacity - Mw 520 716 515 Percent ownership 70% 48% 28% In-service date 1974 1981 1975\n(14) SEGMENTS OF BUSINESS:\nThe principal business segments of Industries are the generation, transmission, distribution and sale of electric energy by Utilities and the purchase, distribution, transportation and sale of natural gas by Utilities and Industrial Energy Applications, Inc., a wholly-owned subsidiary under Diversified. Certain financial information relating to Industries' significant segments of business is presented below:\nYear Ended December 31 1995 1994 1993 (in thousands) Operating results: Revenues - Electric $ 560,471 $ 537,327 $ 550,521 Gas 190,339 165,569 181,923\nOperating income - Electric 130,390 125,487 128,994 Gas 11,056 8,762 13,673\nOther information: Depreciation and amortization - Electric 72,487 68,640 63,832 Gas 6,176 6,214 5,186\nConstruction and acquisition expenditures - Electric * 108,356 112,773 96,736 Gas 9,368 10,066 15,428\nAssets - Identifiable assets - Electric 1,395,666 1,347,024 1,288,505 Gas 199,050 192,397 168,800 1,594,716 1,539,421 1,457,305 Other corporate assets 390,875 309,672 242,514 Total consolidated assets $ 1,985,591 $ 1,849,093 $ 1,699,819\n* Excludes intercompany acquisitions which are eliminated for consolidated financial statement purposes.\nItem 9.","section_9":"Item 9. Changes and Disagreements with Accountants on Accounting and Financial Disclosure\nNone.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors, Executive Officers, Promoters and Control Persons of the Registrant\nInformation regarding the identification of directors of Industries and compliance with Section 16(a) reporting requirements of the Securities and Exchange Commission is included in Industries' definitive proxy statement prepared for the 1996 annual meeting of stockholders, which will be filed within 120 days of December 31, 1995, (Proxy Statement under the captions \"Election of IES Directors\" and \"Certain SEC Filings\") and is incorporated herein by reference. The executive officers of the registrant are as follows:\nExecutive Officers of the Registrant (Effective February 6, 1996)\nLee Liu, 62, Chairman of the Board, President & Chief Executive Officer. First elected officer in 1975.\nBlake O. Fisher, Jr., 51, Executive Vice President & Chief Financial Officer and Director. First elected officer in 1991. (i)\nStephen W. Southwick, 49, Vice President, General Counsel & Secretary. First elected officer in 1982.\nDean E. Ekstrom, 48, Vice President, Administration. First elected officer in 1991.\nPeter W. Dietrich, 56, Vice President, Corporate Development. First elected officer in 1988.\nRichard A. Gabbianelli, 39, Controller & Chief Accounting Officer. First elected officer in 1994.\nDennis B. Vass, 46, Treasurer. First elected officer in 1995. (ii)\nOfficers are elected annually by the Board of Directors and each of the officers named above, except Dennis B. Vass, has been employed by Industries or one of its significant subsidiaries as an officer or in other responsible positions at such companies for at least five years. There are no family relationships among these officers. There are no arrangements or understandings with respect to election of any person as an officer.\n(i) Blake O. Fisher, Jr. resigned as Executive Vice President & Chief Financial Officer and Director of IES Industries Inc. effective February 21,1996.\n(ii) Dennis B. Vass was elected as Treasurer & Principal Financial Officer effective February 21, 1996. Prior to the appointment of Mr. Vass as Treasurer of the Company in February 1995, he was employed by Consumers Power Company as Financial Projects Director and by the Company in April 1991, as Manager of Finance.\nLarry D. Root, Executive Vice President, retired effective December 31, 1995.\nItem 11.","section_11":"Item 11. Executive Compensation\nInformation regarding executive compensation and transactions is included in the Proxy Statement under the captions \"Compensation of Directors\", \"Summary Compensation Table\" and \"IES Plans\" and is incorporated herein by reference, except for the \"Report of the Compensation Committee on Executive Compensation\" and the \"Performance Graph\", which are not 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 included in the Proxy Statement under the captions \"Security Ownership of Beneficial Owners\" and \"Security Ownership of Management\" and is incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nInformation regarding certain relationships and related transactions is included in the Proxy Statement under the captions \"Other Transactions\" and \"Compensation of 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\nPage No.\n(a) 1. Financial Statements -\nIncluded in Part II of this report -\nReport of Management. 67 - 68\nReport of Independent Public Accountants. 69\nConsolidated Statements of Income for the years ended December 31, 1995, 1994 and 1993. 70\nConsolidated Statements of Retained Earnings for the years ended December 31, 1995, 1994 and 1993. 71\nConsolidated Balance Sheets at December 31, 1995 and 1994. 72 - 73\nConsolidated Statements of Capitalization at December 31, 1995 and 1994. 74\nConsolidated Statements of Cash Flows for the years ended December 31, 1995, 1994 and 1993. 75\nNotes to Consolidated Financial Statements. 76 - 110\n(a) 2. Financial Statement Schedules -\nIncluded in Part IV of this report -\nSchedule II - Valuation and Qualifying Accounts and Reserves for the years ended December 31, 1995, 1994 and 1993. 116\nOther schedules are omitted as not required under Rules of Regulation S-X.\n(a) 3. Exhibits -\nSee Exhibit Index beginning on page 119.\n(b) Reports on Form 8-K -\nItems Reported Financial Statements Date of Report\n5,7 None February 9, 1996 (1) 5,7 None November 10, 1995 (2)\n(1) The Form 8-K report was filed on February 20, 1996 with the earliest event reported occurring on February 9, 1996.\n(2) The Form 8-K report was filed on November 17, 1995 with the earliest event reported occurring on November 10, 1995.\nIES INDUSTRIES INC.\nSCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS AND RESERVES\nFOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nColumn A Column B Column E\nBalance Balance Description January 1 December 31 (in thousands) IES Utilities Inc.:\n1995: Accumulated provision for uncollectible accounts $ 650 $ 676\nAccumulated provision for rate refunds $ - $ 106\n1994: Accumulated provision for uncollectible accounts $ 409 $ 650\nAccumulated provision for rate refunds $ 8,670 $ -\n1993: Accumulated provision for uncollectible accounts $ 567 $ 409\nAccumulated provision for rate refunds $ 9,020 $ 8,670\nNon-utility Subsidiaries:\n1995: Accumulated provision for uncollectible accounts and other $ 372 $ 685\n1994: Accumulated provision for uncollectible accounts and other $ 506 $ 372\n1993: Accumulated provision for uncollectible accounts and other $ 247 $ 506\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the 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 1996.\nIES INDUSTRIES INC. (Registrant)\nBy \/s\/ Lee Liu Lee Liu Chairman of the Board, 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 indicated on March 7, 1996:\n\/s\/ Lee Liu Chairman of the Board, President & Lee Liu Chief Executive Officer (Principal Executive Officer)\n\/s\/ Dennis B. Vass Treasurer & Principal Financial Officer Dennis B. Vass (Principal Financial Officer)\n\/s\/ Richard A. Gabbianelli Controller & Chief Accounting Officer Richard A. Gabbianelli (Principal Accounting Officer)\n\/s\/ C.R.S. Anderson Director C.R.S. Anderson\n\/s\/ J. Wayne Bevis Director J. Wayne Bevis\nDirector Dr. George Daly\n\/s\/ G. Sharp Lannom, IV Director G. Sharp Lannom, IV\n\/s\/ Jack R. Newman Director Jack R. Newman\n\/s\/ Robert D. Ray Director Robert D. Ray\n\/s\/ David Q. Reed Director David Q. Reed\n\/s\/ Henry Royer Director Henry Royer\n\/s\/ Robert W. Schlutz Director Robert W. Schlutz\n\/s\/ Anthony R. Weiler Director Anthony R. Weiler\nEXHIBIT INDEX\nThe Exhibits designated by an asterisk are filed herewith and all other Exhibits as stated to be filed are incorporated herein by reference.\nExhibit\n3(a) Articles of Incorporation of Registrant, Amended and Restated as of May 4, 1993 (Filed as Exhibit 3(a) to Company's Form 10-K for the year 1993).\n3(b) Bylaws of Registrant, as amended November 2, 1994 (Filed as Exhibit 3 to Company's Registration Statement, File No. 33-56981).\n4(a) Indenture of Mortgage and Deed of Trust, dated as of September 1, 1993, between Utilities (formerly Iowa Electric Light and Power Company (IE)) and The First National Bank of Chicago, as Trustee (Mortgage) (Filed as Exhibit 4(c) to IE's Form 10-Q for the quarter ended September 30, 1993).\n4(b) Supplemental Indentures to the Mortgage:\nNumber Dated as of IE File Reference Exhibit\nFirst October 1, 1993 Form 10-Q, 11\/12\/93 4(d) Second November 1, 1993 Form 10-Q, 11\/12\/93 4(e) Third March 1, 1995 Form 10-Q, 5\/12\/95 4(b)\n4(c) Indenture of Mortgage and Deed of Trust, dated as of August 1, 1940, between Utilities (formerly IE) and The First National Bank of Chicago, Trustee (1940 Indenture) (Filed as Exhibit 2(a) to IE's Registration Statement, File No. 2-25347).\n4(d) Supplemental Indentures to the 1940 Indenture:\nNumber Dated as of IE File Reference Exhibit\nFirst March 1, 1941 2-25347 2(a) Second July 15, 1942 2-25347 2(a) Third August 2, 1943 2-25347 2(a) Fourth August 10, 1944 2-25347 2(a) Fifth November 10, 1944 2-25347 2(a) Sixth August 8, 1945 2-25347 2(a) Seventh July 1, 1946 2-25347 2(a) Eighth July 1, 1947 2-25347 2(a) Ninth December 15, 1948 2-25347 2(a) Tenth November 1, 1949 2-25347 2(a) Eleventh November 10, 1950 2-25347 2(a) Twelfth October 1, 1951 2-25347 2(a) Thirteenth March 1, 1952 2-25347 2(a) Fourteenth November 5, 1952 2-25347 2(a) Fifteenth February 1, 1953 2-25347 2(a) Sixteenth May 1, 1953 2-25347 2(a) Seventeenth November 3, 1953 2-25347 2(a) Eighteenth November 8, 1954 2-25347 2(a) Nineteenth January 1, 1955 2-25347 2(a) Twentieth November 1, 1955 2-25347 2(a) Twenty-first November 9, 1956 2-25347 2(a) Twenty-second November 6, 1957 2-25347 2(a) Twenty-third November 4, 1958 2-25347 2(a) Twenty-fourth November 3, 1959 2-25347 2(a) Twenty-fifth November 1, 1960 2-25347 2(a) Twenty-sixth January 1, 1961 2-25347 2(a) Twenty-seventh November 7, 1961 2-25347 2(a) Twenty-eighth November 6, 1962 2-25347 2(a) Twenty-ninth November 5, 1963 2-25347 2(a) Thirtieth November 4, 1964 2-25347 2(a) Thirty-first November 2, 1965 2-25347 2(a) Thirty-second September 1, 1966 Form 10-K, 1966 4.10 Thirty-third November 30, 1966 Form 10-K, 1966 4.10 Thirty-fourth November 7, 1967 Form 10-K, 1967 4.10 Thirty-fifth November 5, 1968 Form 10-K, 1968 4.10 Thirty-sixth November 1, 1969 Form 10-K, 1969 4.10 Thirty-seventh December 1, 1970 Form 8-K, 12\/70 1 Thirty-eighth November 2, 1971 2-43131 2(g) Thirty-ninth May 1, 1972 Form 8-K, 5\/72 1 Fortieth November 7, 1972 2-56078 2(i) Forty-first November 7, 1973 2-56078 2(j) Forty-second September 10, 1974 2-56078 2(k) Forty-third November 5, 1975 2-56078 2(l) Forty-fourth July 1, 1976 Form 8-K, 7\/76 1 Forty-fifth November 1, 1976 Form 8-K, 12\/76 1 Forty-sixth December 1, 1977 2-60040 2(o) Forty-seventh November 1, 1978 Form 10-Q, 6\/30\/79 1 Forty-eighth December 1, 1979 Form S-16, 2-65996 2(q) Forty-ninth November 1, 1981 Form 10-Q, 3\/31\/82 2 Fiftieth December 1, 1980 Form 10-K, 1981 4(s) Fifty-first December 1, 1982 Form 10-K, 1982 4(t) Fifty-second December 1, 1983 Form 10-K, 1983 4(u) Fifty-third December 1, 1984 Form 10-K, 1984 4(v) Fifty-fourth March 1, 1985 Form 10-K, 1984 4(w) Fifty-fifth March 1, 1988 Form 10-Q, 5\/12\/88 4(b) Fifty-sixth October 1, 1988 Form 10-Q, 11\/10\/88 4(c) Fifty-seventh May 1, 1991 Form 10-Q, 8\/13\/91 4(d) Fifty-eighth March 1, 1992 Form 10-K, 1991 4(c) Fifty-ninth October 1, 1993 Form 10-Q, 11\/12\/93 4(a) Sixtieth November 1, 1993 Form 10-Q, 11\/12\/93 4(b) Sixty-first March 1, 1995 Form 10-Q, 5\/12\/95 4(a)\n4(e) Indenture or Deed of Trust dated as of February 1, 1923, between Utilities (successor to Iowa Southern Utilities Company (IS) as result of merger of IS and IE) and The Northern Trust Company (The First National Bank of Chicago, successor) and Harold H. Rockwell (Richard D. Manella, successor), as Trustees (1923 Indenture) (Filed as Exhibit B-1 to File No. 2-1719).\n4(f) Supplemental Indentures to the 1923 Indenture:\nDated as of File Reference Exhibit\nMay 1, 1940 2-4921 B-1-k May 2, 1940 2-4921 B-1-l October 1, 1945 2-8053 7(m) October 2, 1945 2-8053 7(n) January 1, 1948 2-8053 7(o) September 1, 1950 33-3995 4(e) February 1, 1953 2-10543 4(b) October 2, 1953 2-10543 4(q) August 1, 1957 2-13496 2(b) September 1, 1962 2-20667 2(b) June 1, 1967 2-26478 2(b) February 1, 1973 2-46530 2(b) February 1, 1975 2-53860 2(aa) July 1, 1975 2-54285 2(bb) September 2, 1975 2-57510 2(bb) March 10, 1976 2-57510 2(cc) February 1, 1977 2-60276 2(ee) January 1, 1978 0-849 2 March 1, 1979 0-849 2 March 1, 1980 0-849 2 May 31, 1986 33-3995 4(g) July 1, 1991 0-849 4(h) September 1, 1992 0-849 4(m) December 1, 1994 0-4117-1 4(f)\n4(g) Second Amended and Restated Credit Agreement dated as of November 9, 1994 among IES Diversified Inc. as Borrower, certain banks and Citibank, N.A., as Agent. (Filed as Exhibit 4(i) to the Company's Form 10-K for the year 1994).\n4(h) Indenture (For Unsecured Subordinated Debt Securities), dated as of December 1, 1995, between Utilities and The First National Bank of Chicago, as Trustee (Subordinated Indenture) (Filed as Exhibit 4(i) to Utilities' Amendment No. 1 to Registration Statement, File No. 33-62259).\n4(i) Officer's Certificate establishing the terms of new Series of Subordinated Debentures (Filed as Exhibit 4 to Utilities' Current Report on Form 8-K, dated December 8, 1995).\n10(a) Operating and Transmission Agreement between Central Iowa Power Cooperative and IE (Filed as Exhibit 10(q) to IE's Form 10-K for the year 1990).\n10(b) Duane Arnold Energy Center Ownership Participation Agreement dated June 1, 1970 between Central Iowa Power Cooperative, Corn Belt Power Cooperative and IE. (Filed as Exhibit 5(kk) to IE's Registration Statement, File No. 2-38674).\n10(c) Duane Arnold Energy Center Operating Agreement dated June 1, 1970 between Central Iowa Power Cooperative, Corn Belt Power Cooperative and IE. (Filed as Exhibit 5(ll) to IE's Registration Statement, File No. 2-38674).\n10(d) Duane Arnold Energy Center Agreement for Transmission, Transformation, Switching, and Related Facilities dated June 1, 1970 between Central Iowa Power Cooperative, Corn Belt Power Cooperative and IE. (Filed as Exhibit 5(mm) to IE's Registration Statement, File No. 2-38674).\n10(e) Basic Generating Agreement dated April 16, 1975 between Iowa Public Service Company, Iowa Power and Light Company, Iowa-Illinois Gas and Electric Company and IS for the joint ownership of Ottumwa Generating Station-Unit 1 (OGS-1). (Filed as Exhibit 1 to IE's Form 10-K for the year 1977).\n10(f) Addendum Agreement to the Basic Generating Agreement for OGS-1 dated December 7, 1977 between Iowa Public Service Company, Iowa-Illinois Gas and Electric Company, Iowa Power and Light Company, IS and IE for the purchase of 15% ownership in OGS-1. (Filed as Exhibit 3 to IE's Form 10-K for the year 1977).\n10(g) Second Amended and Restated Credit Agreement dated as of September 17, 1987 between Arnold Fuel, Inc. and the First National Bank of Chicago and the Amended and Restated Consent and Agreement dated as of September 17, 1987 by IE. (Filed as Exhibit 10(j) to IE's Form 10-K for the year 1987).\nManagement Contracts and\/or Compensatory Plans (Exhibits 10(h) through 10(q))\n10(h) Supplemental Retirement Plan. (Filed as Exhibit 10(l) to the Company's Form 10-K for the year 1987).\n10(i) Management Incentive Compensation Plan. (Filed as Exhibit 10(m) to the Company's Form 10-K for the year 1987).\n10(j) Key Employee Deferred Compensation Plan. (Filed as Exhibit 10(n) to the Company's Form 10-K for the year 1987).\n10(k) Long-Term Incentive Plan. (Filed as Exhibit A to the Company's Proxy Statement dated March 20, 1995).\n10(l) Executive Guaranty Plan. (Filed as Exhibit 10(p) to the Company's Form 10-K for the year 1987).\n10(m) Executive Change of Control Severance Agreement. (Filed as Exhibit 10(s) to the Company's Form 10-K for the year 1989).\n10(n) Amendments to Key Employee Deferred Compensation Agreement for Directors. (Filed as Exhibit 10(u) to the Company's Form 10-Q for the quarter ended March 31, 1990).\n10(o) Amendments to Key Employee Deferred Compensation Agreement for Key Employees. (Filed as Exhibit 10(v) to the Company's Form 10-Q for the quarter ended March 31, 1990).\n10(p) Amendments to Management Incentive Compensation Plan. (Filed as Exhibit 10(y) to the Company's Form 10-Q for the quarter ended March 31, 1990).\n10(q) Director Retirement Plan. (Filed as Exhibit 10(t) to the Company's Form 10-K for the year 1993).\n10(r) Agreement and Plan of Merger, dated as of February 27, 1991, by and between IE Industries Inc. and Iowa Southern Inc. (Filed as Exhibit 2 to the Company's Form 8-K dated February 27, 1991).\n10(s) IES Industries Inc. Shareholders' Rights Plan. (Filed as Exhibit I-2 to the Company's Registration Statement on Form 8-A filed November 13, 1991).\n10(t) Restated Agreement and Plan of Merger among IES Industries Inc., WPC Acquisition Corp. and Whiting Petroleum Corporation dated November 15, 1991. (Filed as Annex A to the Company's Form S-4 Registration Statement No. 33-44495).\n10(u) Agreement for Purchase and Sale of Certain Assets and Real Estate and Assignment of Easements, Leases and Licenses between Union Electric Company (Seller) and IE (Buyer). (Filed as exhibit 10(t) to IE's Form 10-K for the year 1991).\n10(v) Lease and Security Agreement, dated October 1, 1993, between IES Diversified Inc., as lessee, and Sumitomo Bank Leasing and Finance, Inc., as lessor. (Filed as Exhibit 10(z) to the Company's Form 10-K for the year 1993).\n10(w) Receivables Purchase and Sale Agreement dated as of June 30, 1989, as Amended and Restated as of April 15, 1994, among IES Utilities Inc. (as Seller) and CIESCO L.P. (as the Investor) and Citicorp North America, Inc. (as Agent). (Filed as Exhibit 10(a) to Utilities' Form 10-Q for the quarter ended March 31, 1994 (File No. 0-4117-1)).\n10(x) Agreement and Plan of Merger among IES Industries Inc., WOC Acquisition Company, Okie Crude Company, Elba Gas Company, Kimble Gas Gathering Company, Thomas M. Atkinson and Joan B. Atkinson, dated as of March 25, 1994. (Filed as Exhibit 10(b) to Company's Form 10-Q for the quarter ended March 31, 1994).\n10(y) IES Diversified Inc. Guaranty with McLeod, Inc., dated May 16, 1994 (Filed as Exhibit 10(c) to Company's Form 10-Q for the quarter ended June 30, 1994).\n10(z) Agreement Regarding Guaranty Between McLeod, Inc. and IES Diversified Inc., dated May 16, 1994 (Filed as Exhibit 10(d) to Company's Form 10-Q for the quarter ended June 30, 1994).\n10(aa) Guaranty (IES Utilities Trust No. 1994-A) from IES Utilities Inc., dated as of June 29, 1994. (Filed as Exhibit 10(b) to Utilities' Form 10-Q for the quarter ended June 30, 1994 (File No. 0-4117-1)).\n10(ab) Agreement and Plan of Merger between IE and IS dated as of June 4, 1993 (Agreement and Plan of Merger) (Filed as Exhibit 2 to the Company's Current Report on Form 8-K, dated June 4, 1993).\n10(ac) Amendment 1 dated June 16, 1993, to the Agreement and Plan of Merger (Filed as Exhibit 2(b) to the IE Registration Statement on Form S-3, dated September 14, 1993 (File No. 33- 68796)).\n10(ad) Amendment 2 dated September 8, 1993, to the Agreement and Plan of Merger (Filed as Exhibit 2(c) to the IE Registration Statement on Form S-3, dated September 14, 1993 (File No. 33- 68796)).\n10(ae) Amendment 3 dated September 27, 1993, to the Agreement and Plan of Merger (Filed as Exhibit 2(d) to the Company's Current Report on Form 8-K, dated December 9, 1993).\n10(af) Agreement and Plan of Merger among IES Industries Inc., WOK Acquisition Company, Okie Energy Company, Keener Energy Company, Thomas M. Atkinson and Joan B. Atkinson, dated as of March 15, 1995 (Filed as Exhibit 10(a) to the Company's Form 10-Q for the quarter ended March 31, 1995).\n10(ag) Agreement and Plan of Merger, dated as of November 10, 1995, by and among WPL Holdings, Inc., IES Industries Inc., Interstate Power Company and AMW Acquisition, Inc. (Filed as Exhibit 2.1 to the Company's Form 8-K, dated November 10, 1995).\n10(ah) Copy of Coal Supply Agreement, dated July 27, 1977, between IS and Sunoco Energy Development Co. (former parent of Cordero Mining Co.), and letter memorandum thereto, dated October 29, 1984, relating to the purchase of coal supplies for the fuel requirements at the Ottumwa Generating Station. (Filed as Exhibit 10-A-4 to File No. 33-3995).\n* 21 Subsidiaries of the Registrant.\n* 23 Consent of Independent Public Accountants.\n* 27 Financial Data Schedule.\nNote: Pursuant to (b)(4)(iii)(A) of Item 601 of Regulation S-K, the Company has not filed as an exhibit to this Form 10-K certain instruments with respect to long-term debt that has not been registered if the total amount of securities authorized thereunder does not exceed 10% of total assets of the Company but hereby agrees to furnish to the Commission on request any such instruments.","section_15":""}
{"filename":"84801_1995.txt","cik":"84801","year":"1995","section_1":"ITEM 1. BUSINESS -----------------\nGENERAL\nRohr Inc., (the \"Company\"), incorporated in Delaware in 1969, is the successor to a business originally established in 1940 under the name of Rohr Aircraft Corporation. The Company, a leading aerospace supplier, provides nacelle and pylon systems integration, design, development, manufacturing, and support services to the aerospace industry worldwide. The Company focuses its efforts on the market for commercial aircraft which seat 100 or more passengers. Its principal products include nacelles, which are the aerodynamic structures or pods that surround an aircraft's engines; thrust reversers, which are part of the nacelle system and assist in the deceleration of jet aircraft after landing; pylons (sometimes referred to as struts) which are the structures that attach the jet engines or the propulsion system to the aircraft; noise suppression systems; engine components; and structures for high-temperature environments. In addition, the Company conducts product research and development in advanced composites and metals, high-temperature materials, acoustics, and manufacturing processes for existing and future applications.\nThe Company sells products and services to the three major commercial airframe manufacturers (Boeing, Airbus, and McDonnell Douglas) and to the five major jet engine manufacturers (General Electric, Rolls-Royce, Pratt & Whitney, CFM International, and International Aero Engines). In addition, the Company has the right on certain programs to provide customer and product support directly to airline operators and service centers around the world, including on-site field services and the sale of spare parts. The Company's commercial and government (military and space) products represented 88% and 12%, respectively, of its sales in the fiscal year ended July 31, 1995.\nThe Company has over 50 years of experience in the aerospace industry. Originally, the Company operated as a subcontractor to the airframe manufacturers, building parts to the customer's design. Later, it began to build to its own designs based on customer specifications. Eventually, the Company also began operating as a subcontractor to the engine manufacturers who then provided the engine with nacelle to the airframe manufacturers. Over the last decade, the Company significantly expanded its role in many newer programs by becoming a systems integrator for nacelle systems with responsibility for the integration and management of the design, tooling, manufacture, and delivery of complete nacelle systems, directing the efforts of international consortia in some cases. As a result of this range of experience, the Company can provide many different levels of service to its customers depending upon their needs. The Company can build to the customer's design, assist in that design, or assume total responsibility for design, manufacture, integration and product support. In addition, over the last several years, the Company has expanded its services to the airlines through the direct sale of spare parts, the provision of technical support and training, and the operation of repair and overhaul facilities.\nPRODUCTS\nGeneral. The Company designs and manufactures nacelle systems, nacelle ------- components, pylons or struts, non-rotating components for jet engines, and other components for commercial and military aircraft. A nacelle system generally includes the nose cowl or inlet, fan cowl, nozzle systems and thrust reverser. The nacelle houses electrical, mechanical, fluid, and pneumatic systems together with various panels, firewalls, and supporting structures; the aircraft engine (which is provided by the customer); and purchased or customer-furnished engine equipment such as electrical generators, starters, fuel pumps and oil coolers. The Company also performs engine build-ups (\"EBU\") by assembling nacelle systems and the related electrical, mechanical, fluid and pneumatic systems onto core aircraft engines.\nCommercial. The Company manufactures and\/or is responsible for the design ---------- of nacelle systems, including thrust reversers, for the McDonnell Douglas MD-80 and MD-90, the Pratt & Whitney PW4000 series engine option for the McDonnell Douglas MD-11 and the Airbus A310 and A300-600. The Company manufactures the thrust reverser, nozzle, pylons and fan cowl for Rolls-Royce engine options for the Boeing 757; the nacelle without thrust reverser for the CF6-80C2, which is the General Electric engine option for the Airbus A310 and A300-600 and McDonnell Douglas MD-11; nacelle components, including the nose cowl, fan cowl, and extension ring, for the Boeing 737; and the aft fan case nozzle and plug for the General Electric GE 90 engine option for the Boeing 777. Major components produced by the Company for the General Electric CF6-80C2 nacelle are also used on the Boeing 747 and 767.\nPrograms for which the Company has become a systems integrator, with responsibility for the integration and management of the design, tooling, manufacture, and delivery of the complete nacelle or pylon system, include the CFM International CFM56-5 and the International Aero Engines (an international consortium) V2500 nacelle program, both of which engines are being competitively marketed for the Airbus A319, A320 and A321; the pylon program for the McDonnell Douglas MD-11 aircraft; the nacelle with thrust reverser for the CFM International-powered Airbus A340; and the nacelle with thrust reverser for the McDonnell Douglas MD-90 aircraft. The Company's enhanced role on these programs broadens the Company's business base in the commercial aerospace industry, but terms and conditions of these contracts require a substantial investment in working capital and subject the Company to increased market risk relative to the ultimate success of such programs. The Company, in turn, has subcontracted the design and production of most components for the CFM56-5, nacelle components on the V2500, and major components of the MD-11 and A340 contracts to foreign and domestic companies. This enables the Company to improve its competitive position and to pass on some of the risks associated with such programs to subcontractors. However, the Company's performance and ultimate profitability on these programs is dependent on the performance of its subcontractors, including the timeliness and quality of their work, as well as the ability of the Company to monitor and manage its subcontractors. See \"Subcontractors\".\nGovernment (Military and Space). For military aircraft, the Company ------------------------------- manufactures nacelles for the Lockheed C-130 propjet transport aircraft on which final deliveries are scheduled for fiscal year 1996 and nacelle components for re-engining of existing Boeing KC-135 military aerial refueling tankers. For the U.S. space program, the Company is scheduled\nto complete deliveries in fiscal year 1996 of solid fuel rocket motor nozzles and insulated casings which are used on the Titan Space Launch Vehicle. The Company is providing technical support in designing the engine bay doors for the U.S. Air Force tactical fighter aircraft. The Company's government business has declined in recent years and the Company expects the percentage of its revenues attributable to government sales to decline further in future years. The extent of future sales under military programs is dependent, among other things, upon continued government funding.\nSpare Parts. The Company sells spare parts for both military and ----------- commercial aircraft, including those for aircraft in use but no longer in production. Such sales from continuing operations were approximately $142.5 million in fiscal 1995, $148.9 million in fiscal 1994, and $166.9 million in fiscal 1993.\nHistorically, the Company has sold spare parts for commercial programs to airframe or engine manufacturers which then resold them to the end user. However, in recent years, under certain programs, the Company has acquired the right from its customers to sell spare parts directly to airlines (although on certain programs royalty payments to its customers are required). The contracts that grant these rights to the Company generally require that the Company provide technical and product support directly to the airlines. Thus, on certain programs, the Company has the right to provide customer and product support directly to approximately 150 airline operators and service centers worldwide. The Company's direct sales of spare parts to the airlines are expected to increase in the future as nacelle programs on which the Company sells spare parts directly to the airlines mature and as the aircraft using those nacelles age. Generally, the Company earns a higher margin on the direct sale of spare parts to airlines than it does on the sale of spare parts to prime contractors (for resale to the airlines). Prices for direct spare part sales are higher than prices for spare parts sold to prime contractors, in part, because of additional costs related to the technical and customer support activities provided to the airlines.\nBusiness Jets. In fiscal 1994, the Company sold and commenced the transfer ------------- to the buyer of its business jet line of business which is accounted for as a discontinued operation. The purchase agreement required the Company to manufacture and deliver certain components and transfer program engineering and tooling, tasks which were substantially completed in fiscal 1995. See \"Notes to the Consolidated Financial Statements, Note 11,\" contained in the Company's 1995 Annual Report to Shareholders.\nOther Activities. The Company also manufactures other components for ---------------- military and commercial jet aircraft, including the nozzle and plug used on the Rolls-Royce-powered versions of the Boeing 747 and 767 and the Airbus A330, the fan exit duct for the Rolls-Royce engine used on the Boeing 757, the pylon or strut assemblies for the Boeing 757 and the acoustical ducts and\/or acoustic panels for the Pratt & Whitney engine used on the McDonnell Douglas MD-80 and the Boeing 757.\nIn June 1995, the Company finalized an agreement with Boeing to design, tool and manufacture the inlet and fan cowls for the Boeing 737-700 aircraft. Delivery of hardware is scheduled to start in fiscal 1997.\nThe Company has been performing nacelle modification and integration services for Pratt & Whitney, installing Boeing 757 nacelles under a Pratt & Whitney license, on the PW2000 series engine for use on the former Soviet Union's IL-96M\/T transport aircraft. Pratt & Whitney has entered into a contract with Boeing for additional nacelles and is negotiating final arrangements with the Company for additional modification and integration services.\nCONTRACTS\nMost of the Company's major commercial contracts establish a firm unit price, subject to cost escalation, over a number of years or, in certain cases, over the life of the related program. Life-of-program agreements generally entitle the Company to work as a subcontractor in the program during the entire period the customer produces its aircraft or engine. While the customer retains the right to terminate these long-term and life-of-program arrangements, there are generally significant costs for doing so. The Company has experienced pressures from customers to reduce prices. In response, the Company has incorporated or is in the process of incorporating design changes on certain programs, allowing for a more cost effective manufacture of certain products, and is exerting pressure on its own suppliers to reduce prices.\nThe Company's long-term contracts generally contain escalation clauses for revising prices based on published indices which reflect increases in material and labor costs. Furthermore, in almost all cases, when a customer orders production schedule revisions (outside of a range provided in the contract) or design changes, the contract price is subject to adjustment. These long-term contracts provide the Company with an opportunity to obtain increased profits if the Company can improve production efficiencies over time, and the potential for significant losses if it cannot produce the product for the agreed upon price.\nThe Company's other commercial contracts generally provide a fixed price for a specified number of units which, in many cases, are to be delivered over a specified period of time. Under these contracts, prices are re-negotiated for each new order. As a result, the Company has the opportunity to negotiate price increases for subsequent units ordered if production costs are higher than expected. The Company's customers, however, may seek price reductions from the Company in connection with any new orders they place.\nOn its longer-term contracts, the Company bases initial production prices on estimates of the average cost for a block of the units which it and its customer believe will be ordered. Generally, production costs on initial units are substantially higher during the early years of a new contract or program, when the efficiencies resulting from learning are not yet fully realized, and decline as the program matures. Learning typically occurs on a program as tasks and production techniques become more efficient through repetition of the same manufacturing operation and as management implements actions to simplify product design and improve tooling and manufacturing techniques. If the customer orders fewer than the expected number of units within a specified time period, certain of the Company's contracts have repricing clauses which increase the prices for units that have already been delivered. However, other contracts do not include such repricing provisions and force the Company to bear certain market risks. The Company analyzed the potential market for the products under such contracts and agreed to prices based on its estimate of the average estimated costs for the units it expected to deliver under the program.\nMany of the Company's contracts have provided for the recovery of a specified amount of nonrecurring, pre-production costs, consisting primarily of design and tooling costs. In some cases, a significant portion of such pre- production costs have been advanced by the customer. However, in negotiating some contracts, the Company has agreed to defer recovery of pre-production costs and instead to recover a certain amount of such costs with the sale of each production unit over an agreed number of production units plus spares equivalents. In addition, on some of these contracts, based on its analysis of the potential market for the products covered by such contracts, the Company agreed to amortize pre-production costs over a number of units which was larger than the anticipated initial fabrication orders without the protection of a repricing clause or guaranteed quantities of orders. On other commercial contracts, the Company receives advance payments with orders, or other progress or advance payments, which assist the Company in meeting its working capital requirements for inventories. To reduce such funding requirements and market risks, the Company has subcontracted substantial portions of several of its programs. See \"Subcontractors\".\nIn accordance with practices in the aircraft industry, most of the Company's commercial orders and contracts are subject to termination at the convenience of the customer and on many programs the tooling and design prepared by the Company are either owned by the customer or may be purchased by it at a nominal cost. The contracts generally provide, upon termination of firm orders, for reimbursement of costs incurred by the Company, plus a reasonable profit on the work performed. The costs of terminating an entire contract or program can be significantly greater for the customer than the costs of terminating specific firm orders. All of the Company's government contracts are subject to termination at the convenience of the government. In such a situation, the Company is entitled to recover the costs it incurred prior to termination, plus a reasonable profit on the work performed.\nUnder all contracts, the Company may encounter, and on several programs from time to time has encountered, preproduction and\/or production cost overruns caused by increased material, labor or overhead costs, design or production difficulties, increased quality requirements, redefined acceptance criteria on government programs, and various other factors such as technical and manufacturing complexity. The Company seeks recovery of such cost overruns from the customer if they are caused by the action or inaction of the customer; otherwise, such cost overruns will be, and in many cases have been, borne by the Company.\nIncident to the manufacture and sale by the Company of its products, the Company is subject to possible liability by reason of (i) warranties against defects in design, material and workmanship; (ii) potential product liability responsibility arising out of the use of its products; and (iii) strict liability arising from the disposal of certain wastes covered by environmental protection laws. The Company also has varying contractual obligations to maintain the ability to produce and service spare parts as long as there are specified numbers of aircraft still in operation. Provisions of the Company's contracts provide remedies ranging from actual damages to specified daily penalties for late deliveries of products.\nSUBCONTRACTORS\nThe competitive market has required the Company to make substantial financial investments in programs on which it participates. Both to reduce the burden and risk of such financial investments, and also in some cases to participate in foreign programs, the Company has further subcontracted the design, development and production of substantial portions of several of its major contracts to other foreign and domestic corporations. In return, those companies provided a portion of the investment and assumed a portion of the risk associated with various of the Company's programs. The Company's performance and ultimate profitability on these programs is dependent on the performance of its subcontractors, including the timeliness and quality of their work, as well as the ability of the Company to monitor and manage its subcontractors.\nPROGRAM FUNDING\nThe highly competitive nature of the aerospace market has required the Company to commit substantial financial resources, largely for working capital, to participate with its customers on certain long-term programs. Those working capital requirements consist primarily of nonrecurring pre-production costs such as design and tooling, recurring costs for inventories and accounts receivables.\nIn some cases, a significant portion of the pre-production costs have been advanced by the customer. However, in negotiating some contracts, the Company has agreed to defer recovery of pre-production costs and instead to recover a certain amount of such costs with the sale of each production unit over an agreed number of production units plus spares equivalents. On some commercial contracts, the Company receives advance payments with orders, or other progress or advance payments, which assist the Company in meeting its working capital requirements for inventories. On government contracts, the Company receives progress payments for both pre-production and inventory costs. To reduce both its pre-production funding requirements and the build-up of program inventories, the Company has entered into agreements with subcontractors to provide a portion of the program funding needs and has subcontracted to these entities substantial portions of many of its programs. See \"Subcontractors.\" Advances and progress payments have varied in the past and are subject to change in the future based on changes in both commercial and government procurement practices and governmental regulations. Any future change could affect the Company's need for program funding.\nAccounts receivable balances vary in accordance with various payment terms and other factors including the periodic receipt of large payments from customers for reimbursement of non-recurring costs or for amounts which had been deferred pending aircraft certification.\nThe Company's primary sources of program funding have been funds generated from operations and borrowings. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources\" in the Company's 1995 Annual Report to Shareholders. With respect to new programs which are developed, the Company anticipates that it may team with partners, or obtain financial commitments from one or more qualified subcontractors, prior to entering bids for work.\nPRINCIPAL CUSTOMERS\nFor a discussion of the Company's sales to its principal customers, see \"Notes to the Consolidated Financial Statements\" in the Company's 1995 Annual Report to Shareholders, Note 3--\"Accounts Receivable--Sales.\"\nBACKLOG\nThe Company's backlog is significant to its business because the production of most Company products involves a long lead time from order to shipment date. Firm backlog represents the sales price of all undelivered units covered by customer orders. Firm backlog includes units ordered by a customer although the Company and the customer have not yet agreed upon a sales price. In such cases, the Company records in backlog an amount it believes (based upon all available information) is a reasonable price estimate. The Company also reports anticipated backlog, which represents the sales price of units which the Company expects (based upon all available information) that its customers will order under existing contracts and the Company will deliver within the next seven years.\nThe Company's firm backlog at July 31, 1995, was approximately $1.0 billion, compared to $1.2 billion at July 31, 1994. Of such backlog, approximately $0.5 billion is scheduled for delivery on or before July 31, 1996, with the balance to be delivered in subsequent periods. A portion of the Company's expected sales for fiscal 1996 is not included in firm backlog. Anticipated backlog approximated $2.8 billion at July 31, 1995, and $2.5 billion at July 31, 1994.\nAll of the Company's firm and anticipated backlog is subject to termination or rescheduling at the customer's convenience. The Company's contracts generally provide for reimbursement of costs incurred, plus a reasonable profit on such costs, with respect to any firm orders that are terminated. Historically, it has been rare for a customer to cancel units in firm backlog because of its obligations to the Company with respect to such units and its obligations to suppliers of components other than nacelles and pylons, who frequently are producing concurrently components for use with the units ordered from the Company.\nCOMPETITION\nThe Company's principal competition is Boeing (which in addition to being a Company customer also manufactures nacelle systems and pylons for its own aircraft), other significant aerospace corporations who have development and production experience with respect to portions of the nacelle system, and the companies to whom the Company has subcontracted various components and who could (and have) bid on contracts in competition with the Company. Military aerospace contractors are also potential competitors, as excess capacity created by reductions in defense spending could cause some of these contractors to look to expand in commercial markets.\nBecause of recent reductions in demand in the aircraft manufacturing industry, excess production capacity exists in the market for a number of the Company's principal products, which may result in increasingly intense price competition for orders. While the Company believes it competes effectively, there can be no assurance that the Company can maintain its share of the market for these products.\nThe Company believes that its capabilities and technology, which range from research and development through component design and testing, flight certification assistance, component production and integration and airframe production line assistance, contribute significantly to its market position. The Company also believes that its contractual rights to participate on programs for long periods of time or, in some cases, over the life of programs also contribute to the maintenance of its market position.\nEven with respect to its shorter term contracts, the Company is likely to continue working as a subcontractor for the prime contractors well beyond the end of the existing shorter term contracts. The Company has long standing relationships with all of its significant customers. The Company's continued participation on existing programs provides cost advantages to the prime contractors because it avoids the cost of disassembling, moving, reassembling and recalibrating the customized tooling used to manufacture aerospace products which would be necessary if a program were transferred to a new subcontractor at the end of a short-term contract. In addition, the delays inherent in such a transfer are likely to disrupt the prime contractor's own production schedule as the flow of deliveries from the subcontractor is interrupted during the transfer. It is also generally more expensive for a new subcontractor to begin producing products in the middle of an existing program than it is for the Company to continue producing the required products. A new subcontractor's employees must learn program specific tasks with which the Company's employees will already be familiar. As a result of all of these factors, it is unusual for a prime contractor to shift a major aerospace subcontract from one manufacturer to another at the end of a short-term contract.\nCompetitive factors include price, quality of product, design and development capability, ability to consistently achieve scheduled delivery dates, manufacturing capabilities and capacity, technical expertise of employees, the desire or lack thereof of airframe and engine manufacturers to produce certain components in-house, and the willingness, and increasingly the ability, of the Company and other nacelle manufacturers to accept financial and other risks in connection with new programs.\nRAW MATERIALS AND SUPPLIERS\nThe principal raw materials used by the Company are sheet, plate, rod, bar, tubing, and extrusions made of aluminum, steel, Inconel and titanium; electrical wire; rubber; adhesives; and advanced composite products. The principal purchased components are aircraft engine equipment, custom machined parts, sheet metal details, and castings and forgings. All of these items are procured from commercial sources. Supplies of raw materials and purchased parts historically have been adequate to meet the requirements of the Company. However, from time to time, shortages have been encountered, particularly during high industry production and demand. While the Company endeavors to assure the availability of multiple sources of supply, there are many instances in which, either because of a customer requirement or the complexity of the item, the Company may rely on a single source. The failure of any of these single source suppliers or subcontractors to meet the Company's needs could seriously delay production on a program. The Company monitors the delivery performance, product quality and financial health of its critical suppliers, including all of its single source suppliers. Over the last ten years, which includes the period from 1987 through 1991 when the Company's sales grew rapidly, there have been occasions of periodic, short-\nterm delays from suppliers, but none of these delays has had a material adverse effect on the Company or its ability to deliver products to its customers.\nEMPLOYEES\nAt July 31, 1995, the Company had approximately 4,000 full-time employees, of whom approximately 1250 were represented by the International Association of Machinists and Aerospace Workers under agreements which expire on February 15, 1996, and approximately 125 were represented by the International Union, United Automobile, Aerospace and Agricultural Implement Workers of America under an agreement which expires on October 29, 2000. The Company considers its relationship with its employees generally to be satisfactory.\nENVIRONMENTAL MATTERS\nAs an international aerospace manufacturing corporation, the Company is subject to foreign, federal, state and local laws and regulations that limit the discharge of pollutants into the air, soil and water and establish standards for the treatment, storage and disposal of hazardous wastes. If the Company were to violate or otherwise to have liability pursuant to any of these laws or regulations, it could be subject to judicial or administrative enforcement proceedings requiring the Company to investigate the nature and extent of any pollution it caused, to remediate such pollution, to install control devices in its manufacturing facilities to reduce the amount of pollutants entering the environment and to otherwise respond to orders and requests of the courts and the various regulatory agencies. These proceedings could result in the Company expending additional funds to satisfy judicial or regulatory decisions. The Company does not believe that its environmental risks are materially different from those of comparable manufacturing companies. Nevertheless, the Company cannot provide assurances that environmental laws will not adversely affect the Company's operations and financial condition in the future. Environmental risks are generally excluded from coverage under the Company's current insurance policies. See \"Management's Discussion And Analysis of Financial Condition and Results of Operations--Environmental Matters\" and \"Notes to the Consolidated Financial Statements, Note 8, Commitments and Contingencies,\" in the Company's 1995 Annual Report to Shareholders. See, also, Item 3, \"Legal Proceedings,\" in this report.\nThe Company is involved in several proceedings and investigations related to waste disposal sites and other environmental matters. See Item 3, \"Legal Proceedings,\" for a discussion of these matters, and additional suits and matters that are pending or have been threatened against the Company.\nBased upon presently available information, the Company believes that aggregate costs in relation to all environmental matters of the Company will not have a material adverse effect on the Company's financial condition, liquidity, results of operations or capital expenditures.\nRESEARCH AND DEVELOPMENT\nThe Company's research and development activities are designed to improve its existing products and manufacturing processes, to enhance the competitiveness of its new products, and to broaden the Company's aerospace product base.\nMost of its product development is funded through regular production contracts. The Company developed the world's first all composite nacelle and its large cascade thrust reverser under such contracts. The Company also performs self-funded research and development through which it developed proprietary products which control noise and prevent ice formation on nacelles.\nThe Company seeks research and development contracts from the U.S. government and from commercial customers in targeted areas of interest such as composite materials and advanced low-cost processing and joining of new materials. From time to time, the Company also enters into joint research and development programs with its customers.\nPATENTS AND PROPRIETARY INFORMATION\nThe Company has obtained patents and developed proprietary information which it believes provide it with a competitive advantage. For example, the Company holds patents on the DynaRohr family of honeycomb sound attenuation structures, the state-of-the-art RohrSwirl system which prevents ice formation on the leading edges of nacelles, and bonding processes for titanium and other metals. In addition, the Company has developed proprietary information covering such matters as nacelle design, sound attenuation, bonding of metallic and advanced composite structures, material specifications and manufacturing processes. The Company protects this information through inventions and confidentiality agreements with its employees and other third parties. Although the Company believes that its patents and proprietary information allow it to produce superior products, it also believes that the loss of any such patent or disclosure of any item of proprietary information would not have a material adverse effect on the Company.\nMANUFACTURING\nThe Company's products are manufactured and assembled at its facilities in the United States and Europe by an experienced workforce. The Company considers its facilities and equipment generally to be in good operating condition and adequate for the purpose for which they are being used. In addition, it has a substantial number of raw material suppliers and numerous subcontractors to produce components, and in some cases, major assemblies.\nThe Company's European final assembly sites, which are located adjacent to the Company's major European customer, Airbus, allow the Company to respond quickly to customer needs. The Company believes that these European sites provide it with advantages in obtaining certain contracts with Airbus because they allow the Company to perform a portion of the required work in Europe.\nMISCELLANEOUS\nNo material portion of the Company's business is considered to be seasonal.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES -------------------\nAll owned and leased properties of the Company are generally well maintained, in good operating condition, and are generally adequate and sufficient for the Company's business. The Company's properties are substantially utilized; however, due to the downturn in the aerospace industry, the Company has excess manufacturing capacity. All significant leases (except for leases associated with industrial revenue bond financings) are renewable at the Company's option on substantially similar terms, except for increases of rent which must be negotiated in some cases.\nThe following table sets forth the location, principal use, approximate size and acreage of the Company's major production facilities. Those which are owned by the Company and its subsidiaries are owned free of material encumbrances, except as noted below:\n__________________ (1) The letters indicated for each location describe the principal activities conducted at that location: A-Office B-Manufacturing C-Warehouse D-Research and Testing (2) Subject to a capital lease. (3) The completion of construction of this facility has been deferred. (4) This facility has been vacated and listed for sale.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS --------------------------\nA. Accounts receivable and inventories include estimated recoveries on constructive change claims that the Company has asserted with respect to costs it incurred as a result of government imposed redefined acceptance criteria on several government subcontracts. In connection with the Grumman subcontract, the Company filed Appeal No. 47139 (filed February 7, 1994) before the Armed Service Board of Contract Appeals (\"ASBCA\"). In connection with the Boeing E3\/E6 subcontract, the Company filed Appeal No. 47430, (filed April 11, 1994) before the ASBCA. In the above appeals, the Company's customers are sponsors of the claims, the U.S. Navy is the defendant, and the Company is claiming monetary damages. Management believes that the amounts reflected in the financial statements are a reasonable estimates of the amounts for which these matters will be resolved. The resolution of these matters may take several years. See \"Notes to the Consolidated Financial Statements, Note 3\", contained in the Company's 1995 Annual Report to Shareholders.\nB. In June 1987, the U.S. District Court of Los Angeles, in U.S. et al. vs. Stringfellow (United States District Court for the Central District of California, Civil Action No. 83-2501 (JMI)), granted partial summary judgment against the Company and 14 other defendants on the issue of liability under the Comprehensive Environmental Response, Compensation and Liability Act (\"CERCLA\"). This suit, along with related lawsuits, alleges that the defendants are jointly and severally liable for all damage in connection with the Stringfellow hazardous waste disposal site in Riverside County, California. In June 1989, a federal jury and a special master appointed by the federal court found the State of California also liable for the cleanup costs. On November 30, 1993, the special master released his \"Findings of Fact, Conclusion of Law and Reporting Recommendations of the Special Master Regarding the State Share Fact Finding Hearing\". In it, he allocated liability between the State of California and other parties. As this hearing did not involve the valuation of future tasks and responsibilities, the order did not specify dollar amounts of liability. The order, phrased in percentages of liability, recommended allocating liability on the CERCLA claims as follows: 65% to the State of California and 10% to the Stringfellow entities, leaving 25% to the generator\/counterclaimants (including the Company) and other users of the site (or a maximum of up to 28% depending on the allocation of any Stringfellow entity orphan share). On the state law claims, the special master recommended a 95% share for the State of California, and 5% for the Stringfellow entities, leaving 0% for the generator\/counter claimants. The special master's recommendation is subject to a final decision and appeal. The Company and other generators of wastes disposed at the Stringfellow site, which include numerous companies with assets and equity significantly greater than the Company, are jointly and severally liable for the share of cleanup costs for which the generators, as a group, ultimately are found to be responsible. Notwithstanding, CERCLA liability is sometimes allocated among hazardous waste generators who used a waste disposal site based on the volume of hazardous waste they disposed of at the site. The Company is the second largest generator of wastes disposed at the site by volume, although it and certain other generators have argued the final allocation among generators of their shares of cleanup costs should not be determined solely by volume. The largest generator of wastes disposed at the Stringfellow site, by volume, has indicated it is significantly dependent on insurance to fund its share of any cleanup costs, and that it is in litigation with certain of its insurers. The Company intends to continue to defend vigorously these matters and believes, based on currently available information, that the ultimate\nresolutions of these matters will not have a material adverse effect on the financial position or results of operations of the Company.\nThe Company filed claims against its comprehensive general liability insurers for reimbursement of its cleanup costs at the Stringfellow site. These claims are the subject of separate litigation, United Pacific Insurance Co., et al. vs. Rohr Industries, Inc., et al., No. C634195 in the Los Angeles Superior Court. The Company has reached settlements with its primary comprehensive general liability insurance carriers and has retained the right to file future claims against its excess carriers.\nC. In December 1989, the Maryland Department of the Environment (\"MDE\") served the Company with a Letter and Consent Order No. CO-90-093. The Consent Order calls for investigation and remediation of chemicals detected in soil and ground water at the Company's bonding facility in Hagerstown, Maryland. The Company and MDE subsequently negotiated a mutually acceptable Consent Order under which the Company has developed a work plan to determine the nature and extent of the pollution at the bonding plant. The Company had acquired the bonding plant from Fairchild Industries, Inc. (\"Fairchild\"), in September 1987 and Fairchild had agreed to retain responsibility for and to indemnify the Company against any claims and fees in connection with any hazardous materials or pollutants released into the environment at or near the bonding plant or any other property before the closing date of the sale. On March 11, 1993, the Company and Fairchild executed a settlement agreement pursuant to which Fairchild substantially reimbursed the Company for past costs relating to environmental investigations at the bonding plant. The parties also agreed on a procedure to perform the work required under the MDE Consent Order. Based on currently available information, the Company believes that the resolution of this matter will not have a material adverse effect on the financial position or results of operation of the Company.\nD. On March 23, 1992, a Deputy Attorney General for the State of California advised the Company that it may be subject to suit pursuant to Proposition 65 on the basis of data contained in a health risk assessment (\"HRA\") of the Company's Chula Vista facility conducted pursuant to the Air Toxics Hot Spots Act, also known as California Assembly Bill AB-2588. Proposition 65 requires manufacturers who expose any person to a chemical resulting in an increased risk of cancer to issue a clear and reasonable warning to such person and imposes substantial penalties for non-compliance. AB-2588 requires manufacturers to inventory their air emissions and to submit an HRA to assess and quantify health risks associated with those emissions. On April 9, 1993, representatives of the Company met with the Deputy Attorney General to discuss this matter and agreed to supply certain requested data to the government. The Company is presently working on the procedures required to produce this data. Based on currently available information, the Company believes that the resolution of this matter will not have a material adverse effect on the financial position or results of operation of the Company.\nE. On July 22, 1994, the Department of Toxic Substances Control of the State of California Environmental Protection Agency (\"DTSC\") filed an action against the Company and other individuals and companies in the U. S. District Court for the Eastern District of California, Case No. CV-F-94-5683-GEB DLB, seeking, among other things, recovery of response costs approximating $1.3 million plus interest and attorney fees. The demand for payment, which is joint and several, is for expenses allegedly incurred by DTSC personnel in the oversight of the cleanup of the Rio Bravo deep injection well disposal site in Shafter,\nCalifornia. The cleanup is currently being conducted by a group of cooperating potentially responsible parties (\"PRPs\"), including the Company (\"the Cooperating PRPs\"). In February 1993, the Cooperating PRP group wrote to DTSC and advised them, among other things, of the Cooperating PRPs' continuing efforts at the site and suggested that DTSC seek recovery of the oversight funds from the non-cooperating PRPs. Since the demand of the DTSC was joint and several, and would arguably cover all generators including the non-cooperating PRPs, none of the $1.3 million demanded by the DTSC has been allocated to the Cooperating PRPs. Some PRPs estimate the potential cost of cleanup to be approximately $7 million. The Company and other PRPs could face joint and several liability for the entire amount of cleanup costs, regardless of Cooperating PRP or non-cooperating PRP status. The Company intends to vigorously argue that such oversight costs should be recovered from the non-cooperating PRPs. Based on currently available information, the Company believes that the resolution of this matter will not have a material adverse effect on the financial position or results of operation of the Company.\nF. The Department of Toxic Substances Control of the State of California Environmental Protection Agency (\"DTSC\") has informed the Company and approximately 100 other individuals and companies that DTSC considered the recipients to be potentially responsible parties liable for cleanup at the Chatham Brothers Barrel Yard Site located in Escondido, California (the \"Chatham Site\"). DTSC further advised the Company that unless a settlement could be reached with the Company, it intended to name the Company as a defendant in a cost recovery action it proposed to file in June 1993. The Company has no knowledge of the filing of any such suit. After a thorough review of the Company's records and information possessed by DTSC, and interviews of present and former Company employees, the Company remains convinced that it has no relationship whatsoever with the Chatham Site and, therefore, is not liable for the cleanup of that site. In addition, the Company has discussed this matter with a group of PRPs for the Chatham Site and has indicated its lack of involvement with the site. If the Company fails to persuade DTSC that it is not a PRP with regard to the Chatham Site, the Company could face joint and several liability for the amounts involved. The potential cost of cleanup for the Chatham Site is estimated by some PRPs to be approximately $30 million. If suit is filed against the Company, the Company intends to defend vigorously this matter. Based on currently available information, the Company believes that the resolution of this matter will not have a material adverse effect on the financial position or results of operation of the Company.\nG. During fiscal 1993, Region IX of the United States Environmental Protection Agency (\"EPA\") named the Company as a first-tier generator of hazardous wastes that were transported to the Casmalia Resources Hazardous Waste Management Facility (the \"Casmalia Site\") in Casmalia, California. First-tier generators are the top 82 generators by volume of waste disposed of at the Casmalia Site. The size of this group was chosen by the EPA. The EPA has given the first-tier generators a list of work-related elements needing to be addressed in a good faith offer to investigate and remediate the site. The first-tier generators believe a collaborative approach early in the site cleanup and closure process offers all parties an opportunity to help determine a technical course of action at this site before the EPA has made final decisions on the matter. The Company has joined approximately 49 other companies in the Casmalia Resources Site Steering Committee which recently made a good faith offer to the EPA. The Company could be found jointly and\nseverally liable for the total amount of cleanup cost. The Company does not yet know the ability of all other PRPs at this site, which include companies of substantial assets and equity, to fund their allocable share. Some PRPs have made preliminary estimates of cleanup costs at this site of approximately $60 to $70 million and the Company's share (based on estimated, respective volumes of discharge into such site by all generators, all of which cannot now be known with certainty) could approximate $1.8 million. Based on currently available information, the Company believes that the resolution of this matter will not have a material adverse effect on the financial position or results of operation of the Company.\nH. By letter dated November 30, 1993, the Environmental Protection Agency of the State of Ohio advised the Company that it is investigating potential sources of contamination in the vicinity of property which was previously owned by a wholly-owned subsidiary of the Company in the Village of Millersburg, Ohio. This property was sold by the Company in December 1977 under a purchase and sale agreement that transferred any such liability for contamination to the purchaser The Company intends to cooperate fully with the Ohio Environmental Protection Agency. Based on currently available information, the Company believes that the resolution of this matter will not have a material adverse effect on the financial position or results of operation of the Company.\nI. By letter dated July 14, 1994, the Company was notified by the State of Washington's Department of Ecology that the Department believes that the Company to be a \"potentially liable person\" (\"PLP\") under the Model Toxics Control Act of the Revised Code of Washington. The Company is alleged to have arranged for the disposal or treatment of a hazardous substance or arranged with a transporter for disposal or treatment of a hazardous substance at a facility in Washington known as the Yakima Railroad Area. The Department has made a written determination that the Company is a PLP. Based on currently available information, the Company believes that the resolution of this matter will not have a material adverse effect on the financial position or results of operation of the Company.\nJ. From time to time, various environmental regulatory agencies request that the Company conduct certain investigations on the nature and extent of pollution, if any, at its various facilities. For example, such a request may follow the spill of a reportable quantity of certain chemicals. At other times, the request follows the removal, replacement or closure of an underground storage tank pursuant to applicable regulations. At present, the Company's Chula Vista facility is conducting certain investigations pursuant to discussions with the San Diego County Department of Health Services, Hazardous Materials Management Division and the San Diego Regional Water Quality Control Board. The Company intends to cooperate fully with the various regulatory agencies.\nK. In addition to the litigation discussed above, from time to time the Company is a defendant in lawsuits involving (i) claims based on the Company's alleged negligence or strict liability as a manufacturer in the design or manufacture of various products; (ii) claims based upon environmental protection laws; and (iii) claims based on the alleged wrongful termination of its employees due to, among other things, discrimination based on race, age, sex, national origin, handicap status, sexual preference, etc. The Company believes that in those types of cases now pending, or in claims known by the Company to be asserted against it whether or not reduced to a legal proceeding, it either has no material liability or any such liability is adequately covered by its reserves or its liability insurance, subject to certain deductible\namounts. The Company is aware that various of its insurers may assert, and in some such cases have asserted, that their insurance coverage does not provide protection against punitive damages in any specific lawsuit. While there can be no assurances that the Company will not ultimately be found liable for material punitive damages, the Company does not now believe that it has an exposure to any material liability for punitive damages.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ------------------------------------------------------------\nThere is no information required to be submitted by the Company under this Item.\nADDITIONAL ITEM. EXECUTIVE OFFICERS OF THE COMPANY ---------------------------------------------------\nAs of September 11, 1995, the executive officers of the Company, in addition to R. H. Rau, President and Chief Executive Officer, referred to at Item 10, Part III, were as follows:\nLAURENCE A. CHAPMAN, Senior Vice President and Chief Financial Officer, age 46, joined the Company in May 1994. Prior to that and since 1981, he worked for Westinghouse Electric Company (\"Westinghouse\"). He had been the Vice President and Treasurer of Westinghouse since January 1992. He was previously the Chief Financial Officer of Westinghouse Financial Services, Inc., a wholly-owned subsidiary of Westinghouse. Prior to that, Mr. Chapman held positions in Corporate Finance and Corporate Planning with Westinghouse.\nJOHN R. JOHNSON, Senior Vice President, Programs, Technical Resources, and Quality Assurance, age 58, has served in his present position since January 1994. Prior to that and since September 1979, he has served in other senior management positions, including Senior Vice President, Programs and Support from March 1993 to January 1994; Vice President, Government Business from February 1990 to February 1993; Vice President, Planning from May 1989 to February 1990; and Vice President, Manufacturing, Chula Vista, from April 1986 to May 1989. He joined the Company in September 1979.\nRICHARD W. MADSEN, Vice President, General Counsel and Secretary, age 56, has served in his present position since December 5, 1987. Prior to that and since August 1979, he served as Secretary and head of the legal function, and has been an employee of the Company since 1974.\nALVIN L. MAJORS, Vice President and Controller (Chief Accounting Officer), age 55, has served in his present position since May 1989. Prior to that and since December 1987 he served as the Company's Controller. Prior to that and since 1971, he has served in other senior management positions. He has been an employee of the Company since 1971.\nDAVID R. WATSON, Senior Vice President - Customer Support and Business Development, age 44, has served in his present position since March 1994, assuming the title of Senior Vice President in June 1994. Prior to that and since May 1991, he served as Vice President, Commercial Programs. In May 1989, he assumed the position of Vice President and General Manager of the Company's Riverside facility. He has been an employee since February 1988 when he joined the Company as Vice President, Quality Assurance.\nGRAYDON A. WETZLER, Senior Vice President, Operations, age 53, has served in his present position since January 1994. Prior to that and since July 1993, he served as Vice President, Technical and Quality Assurance. From November 1990 to July 1993, he served as Vice President Quality\/Product Assurance. From April 1987 to November 1990, he served as Vice President - Management Information Systems. He has served in other senior management positions. He has been an employee of the Company since 1979.\nThe terms of office of Messrs. Chapman and Madsen expire on December 2, 1995. The initial term of Mr. Rau's Employment Agreement terminates on July 31, 1996. The other executive officers named above serve at the pleasure of the Chief Executive Officer.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS ------------------------------------------------------------------------------\nAlthough a cash dividend has not been paid since 1975, a 2-for 1 stock dividend was paid in December 1985. Currently, under the terms of certain covenants in several of the Company's principal financing agreements, the Company may not pay cash dividends until after April 25, 1997. Thereafter, the Company's ability to pay cash dividends is restricted substantially.\nOther information required by this Item is set forth in the section headed \"Rohr Profile\" in the Registrant's Annual Report to Shareholders for the fiscal year ended July 31, 1995, and such information is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA --------------------------------\nThe information required by this Item is set forth in the section headed \"Selected Financial Data\" in the Company's Annual Report to Shareholders for the fiscal year ended July 31, 1995, and 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 set forth in the section headed \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" in the Company's Annual Report to Shareholders for the fiscal year ended July 31, 1995, and such information is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA -----------------------------------------------------\nThe information required by this Item is set forth in the section headed \"Consolidated Balance Sheets,\" \"Consolidated Statements of Operations,\" \"Consolidated Statements of Shareholders' Equity,\" \"Consolidated Statements of Cash Flows,\" and \"Notes to the Consolidated Financial Statements\" in the Company's Annual Report to Shareholders for the fiscal year ended July 31, 1995, and 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 is no information required to be submitted by the Company under this Item.\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 officers and directors, and persons who own more than 10 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 greater than 10-percent shareholders are required by SEC regulation to furnish the Company with copies of all Section 16(a) forms they file. Based solely on its review of the copies of such forms received by it, or written representations from certain reporting persons that no such forms were required for those persons, the Company believes that, during fiscal year 1995, all filing requirements applicable to its officers, directors, and greater than 10-percent beneficial owners were complied with.\nThe other information required under this Item is set forth in the section headed \"Election of Directors\" in the Company's Proxy Statement for the 1995 Annual Meeting of Shareholders for fiscal year ended July 31, 1995, and such information is incorporated herein by reference. See also \"Additional Item\" at Part I of this report.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION --------------------------------\nThe information required by this Item is set forth in the section headed \"Executive Compensation and Other Information\" and in the section headed \"Directors' Beneficial Ownership and Compensation\" in the Company's Proxy Statement for the 1995 Annual Meeting of Shareholders for fiscal year ended July 31, 1995, 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 is set forth in the table headed \"Beneficial Ownership of Shares\" in the Company's Proxy Statement for the 1995 Annual Meeting of Shareholders for fiscal year ended July 31, 1995, and such information is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS --------------------------------------------------------\nThere is no information required to be submitted by the Company under this Item.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON ----------------------------------------------------------------- FORM 8-K --------\nThe following consolidated financial statements of the Company and consolidated subsidiaries, included in the Company's 1995 Annual Report to Shareholders, are incorporated by reference in Item 8:\n(a) 1. Financial Statements --------------------\nConsolidated Balance Sheets at July 31, 1995, and 1994\nConsolidated Statements of Operations for Years Ended July 31, 1995, 1994, and 1993\nConsolidated Statements of Shareholders' Equity for Years Ended July 31, 1995, 1994, and 1993\nConsolidated Statements of Cash Flows for Years Ended July 31, 1995, 1994, and 1993\nNotes to the Consolidated Financial Statements\n(a) 2. Financial Statement Schedule -----------------------------\nThe following consolidated financial statement schedule of the Company and subsidiaries is included in Part IV of this report.\nSchedule II - Valuation and Qualifying Accounts\nAll other schedules are omitted because they are not applicable, not required under the instructions or the information is included in the financial statements or notes thereto.\n(a) 3. Index to exhibits -----------------\n3.1 Restated Certificate of Incorporation of Rohr Industries, Inc., dated December 7, 1985, incorporated herein by reference to Exhibit 3.1 filed with Form 10-K for fiscal year ended July 31, 1986.\n3.2 Certificate of Designations of Series C Junior Participating Cumulative Preferred Stock $1.00 Par Value of Rohr Industries, Inc., dated August 15, 1986, incorporated herein by reference to Exhibit 3.2 filed with Form 10-K for fiscal year ended July 31, 1986.\n3.3 Certificate of Amendment to Restated Certificate of Incorporation, dated December 9, 1986, incorporated herein by reference to Exhibit 3.3 filed with Form 10-K for fiscal year ended July 31, 1987.\n3.4 Certificate of Amendment to Restated Certificate of Incorporation, dated December 10, 1991, incorporated herein by reference to Exhibit II filed with Form 8-K dated as of December 7, 1991.\n3.5 Bylaws, as amended December 3, 1994, incorporated herein by reference to Exhibit 3.8 filed with Form 10-Q for period ended January 29, 1995.\n4.1 Indenture, dated as of March 1, 1987, between Rohr Industries, Inc., and Bankers Trust Company, trustee, relating to 9 1\/4% subordinated debentures, incorporated herein by reference to Exhibit 4.1 filed with Form 10-Q for period ended May 2, 1993.\n4.2 Indenture, dated as of October 15, 1987, between Rohr Industries, Inc., and Bankers Trust Company, trustee, relating to 7% convertible subordinated debentures, incorporated herein by reference to Exhibit 4.2 filed with Form 10-Q for period ended May 2, 1993.\n4.3 Indenture, dated as of May 15, 1994, between Rohr, Inc., and IBJ Schroder Bank and Trust Company, trustee, relating to 11 5\/8% senior notes, incorporated herein by reference to Exhibit 4.5 filed with Form 10-Q for period ended May 1, 1994.\n4.4 Indenture, dated as of May 15, 1994, between Rohr, Inc., and The Bank of New York, trustee, relating to 7 3\/4% convertible subordinated notes, incorporated herein by reference to Exhibit 4.6 filed with Form 10-Q for period ended May 1, 1994.\n4.5 Rohr, Inc. Amended and Restated Note Agreement dated as of May 10, 1994, for 9.35% senior notes due January 29, 2000, incorporated herein by reference to Exhibit 4.5, filed with Form 10-K for fiscal year ended July 31, 1994.\n*4.5.1 First Amendment to Restated Note Agreement, dated as of June 30, 1995, relating to 9.35% senior notes due January 29, 2000.\n4.6 Rohr, Inc. Amended and Restated Note Agreement dated as of May 10, 1994, for 9.33% senior notes due December 15, 2002, incorporated herein by reference to Exhibit 4.6, filed with Form 10-K for fiscal year ended July 31, 1994.\n*4.6.1 First Amendment to Restated Note Agreement, dated as of June 30, 1995, relating to 9.33% senior notes due December 15, 2002.\n4.7 Amended and Restated Rights Agreement, dated as of April 6, 1990, incorporated herein by reference to Item 7 of Form 8-K dated as of April 6, 1990.\n10.1 Rohr Industries, Inc., Directors Retirement Plan, as amended through the Seventh Amendment, incorporated herein by reference to Exhibits 10.1 through 10.7, as set forth in Form 10-K for fiscal year ended July 31, 1994.\n10.2 Rohr Industries, Inc., Supplemental Retirement Plan (Restated 1983), as amended through the Twenty-Seventh Amendment, incorporated herein by reference to Exhibits 10.2.1 through 10.2.27, as set forth in Form 10-K for fiscal year ended July 31, 1994.\n*10.2.28 Twenty-eighth Amendment to Rohr Industries, Inc., Supplemental Retirement Plan (Restated 1983), dated April 7, 1995.\n*10.2.29 Twenty-ninth Amendment to Rohr Industries, Inc., Supplemental Retirement Plan (Restated 1983), dated April 7, 1995.\n*10.2.30 Thirtieth Amendment to Rohr Industries, Inc., Supplemental Retirement Plan (Restated 1983), dated July 24, 1995.\n10.3 Rohr, Inc. 1991 Stock Compensation for Non-Employee Directors, incorporated by reference to Exhibit 10.5 filed with Form 10-K for fiscal year ended July 31, 1992.\n10.4 Rohr Industries, Inc., Management Incentive Plan (Restated 1982), as amended through the Fifteenth Amendment, incorporated herein by reference to Exhibits 10.4.1 through 10.4.15, as set forth in Form 10-K for fiscal year ended July 31, 1994.\n10.5 Rohr Industries, Inc., 1988 Non-Employee Director Stock Option Plan, incorporated herein by reference to Exhibit 10.17 filed with Form 10-K for fiscal year ended July 31, 1989.\n10.6 Performance Unit Plan as amended through January 7, 1993, incorporated herein by reference to Exhibit 10.13, filed with Form 10-Q for period ended May 2, 1993.\n10.7 Employment Agreement with Robert H. Rau, incorporated herein by reference to Exhibit 10.12, filed with Form 10-Q for period ended May 2, 1993.\n10.8 Employment Agreement with L. A. Chapman, incorporated herein by reference to Exhibit 10.12, filed with Form 10-K for fiscal year ended July 31, 1994.\n10.13 Credit Agreement, dated as April 26, 1989, among Rohr Industries, Inc., as Borrower, and Citibank, N. A., Bankers Trust Company, The First National Bank of Chicago and Wells Fargo Bank, N. A., and Citibank, N.A., as Agent, as amended through the Seventh Amendment, incorporated herein by reference to Exhibits 10.13 through 10.13.7, as set forth in Form 10-K for the fiscal year ended July 31, 1994.\n*10.13.8 Eighth Amendment to Credit Agreement, dated as of November 29, 1994.\n*10.13.9 Ninth Amendment to Credit Agreement, dated as of June 30, 1995.\n10.14 Lease Agreements, dated as of September 14, 1992, by and between Rohr, Inc., as lessor, and State Street Bank and Trust Company of California, National Association and W. Jeffrey Kramer, Trustees, as lessee, incorporated herein by reference to Exhibit 10.22 filed with Form 10-K for fiscal year ended July 31, 1992.\n10.15 Sublease Agreements, dated as of September 14, 1992, by and between State Street Bank and Trust Company of California, National Association and W. Jeffrey Kramer, Trustees, as sublessor, and Rohr, Inc., as sublessee, as amended, supplemented and modified through July 31, 1994, incorporated herein by reference to Exhibits 10.15 through 10.15.5, as set forth in Form 10-K for the fiscal year ended July 31, 1994.\n*10.15.6 Third Amendment Agreement, dated as of November 29, 1994, to Sublease Agreement, dated as of September 14, 1992.\n*10.15.7 Fourth Amendment Agreement, dated as of June 30, 1994, to Sublease Agreement, dated as of September 14, 1992.\n10.16 Pooling and Servicing Agreement, dated as of December 23, 1992, among Rohr, Inc., RI Receivables, Inc., and Bankers Trust Company, as Trustee, as amended through the Second Amendment, incorporated herein by reference to Exhibits 10.16, through 10.16.2, as set forth in Form 10-K for the fiscal year ended July 31, 1994.\n10.17 Receivables Purchase Agreement, dated as of December 23, 1992, among Rohr, Inc., and RI Receivables, Inc., incorporated herein by reference to Exhibit 10.11, filed with Form 10-Q for period ended May 2, 1993.\n*11.1 Calculation of Primary Earnings per Share.\n*11.2 Calculation of Fully Diluted Earnings per Share.\n*13 Annual Report to Shareholders for fiscal year ended July 31, 1995. (The Annual Report, except for the portions thereof which are expressly incorporated by reference in the Form 10-K, is being furnished for the information of the Commission and is not to be deemed \"filed\" as part of the Form 10-K.)\n*23. Consent of Deloitte & Touche.\n*27. Financial Data Schedule. (Filed with EDGAR filing only.)\n(b) Reports on Form 8-K for Fourth Quarter of Fiscal 1995 -----------------------------------------------------\nThere were no reports on Form 8-K filed by the Company for the fourth quarter of fiscal 1995.\n(c) Exhibits required by Item 601 of Regulation S-K -----------------------------------------------\nSee Subparagraph (a) above.\n(d) Financial Statements required by Regulation S-X -----------------------------------------------\nSee Subparagraph (a) and (b) above.\n__________________ * Exhibits filed with this report.\nINDEPENDENT AUDITORS' REPORT\nTo the Board of Directors and Shareholders of Rohr, Inc.:\nWe have audited the consolidated financial statements of Rohr, Inc., as of July 31, 1995 and 1994, and for each of the three years in the period ended July 31, 1995, and have issued our report thereon dated September 11, 1995; such consolidated financial statements and report are included in your 1995 Annual Report to Shareholders and are incorporated herein by reference. Our audits also included the financial statement schedule of Rohr, Inc., listed in Item 14(a)(2). This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion 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\nSan Diego, California September 11, 1995\nROHR, INC., AND SUBSIDIARIES SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED JULY 31, 1995, 1994, AND 1993 (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.\nROHR, INC. (Registrant)\nBy: \/s\/ R. H. Rau ------------------------------------- R. H. Rau President and Chief Executive Officer\nBy: \/s\/ L. A. Chapman ------------------------------------- L. A. Chapman Senior Vice President and Chief Financial Officer\nBy: \/s\/ A. L. Majors ------------------------------------- A. L. Majors Vice President and Controller (Chief Accounting Officer)\nDate: September 11, 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.","section_15":""}
{"filename":"320121_1995.txt","cik":"320121","year":"1995","section_1":"Item 1. Business\nHistory and Introduction\nFounded in 1968, Telos Corporation (\"Telos\" or the \"Company\") provides information and network technology products and services primarily to the government and industry. The Company's offerings encompass the full life cycle of computer services, including analysis, system specification, evaluation, hardware and software integration, deployment, installation, training, hardware maintenance and software sustainment.\nA substantial portion of the Company's revenues are generated by long-standing customers. In 1995, over 55% of the Company's total revenue was generated from customers who have done business continuously with the Company for at least five years. For example, since 1976, the Company has provided life-cycle software engineering services for the U.S. Army's tactical fire support systems. The first contract award from this customer was for $1.7 million of software services. Since 1976, the Company has generated $197 million of revenue from this customer, and in May 1994 a new five-year contract for an additional $90 million was awarded. In addition, the Company has historically received orders from this customer for follow-on work, which may significantly increase the contract amount. The most recently completed fire support contract was for an initial award of $70.5 million; however, $99.4 million was recognized in revenue as a result of follow-on work.\nCertain other long-term customers of the Company include the California Institute of Technology's Jet Propulsion Laboratory, for which the Company has designed, developed and supported ground based telemetry and mission operations systems since 1975; subsidiaries of Hughes Aircraft Company, for which the Company has provided technical consultation, design, development, and test support for tactical military systems since 1969; the U.S. Coast Guard, for which the Company has provided integrated hardware solutions and technical support services since 1981; and the U.S. Navy and Marines, for which the Company has provided ruggedized computer systems since 1988.\nThe Company has further enhanced its ability to deliver solutions to its customers' information requirements by providing tools and applications focused in emerging information and network technology markets. These tools and applications include, data mining, data warehousing, middleware connectivity, public-private network security, data access and workflow, high speed information exchange and communication systems; and electronic commerce. The Company also offers proprietary software applications that support Internet-based electronic commerce, criminal justice, military tactical, and simulation training environments.\nCustomers include organizations in numerous agencies of federal, state, and local governments, as well as financial, industrial, and services industries. The Company provides its services primarily in the United States and in a limited number of international markets.\nOperating Groups\nThe Company provides its services through three operating groups. Although the groups operate on a substantially decentralized basis, they work together to offer customers a broad range of information and network technology services. The Company believes that this cooperative approach enables each of the operating groups to offer its services in specific market segments using their specialized expertise and market knowledge, while drawing on the market access, technical breadth and management capability of the entire Telos organization. The market segments in which the Company operates and the operating groups performing services within these areas are as follows:\no Systems and Services provides computer and large scale network integration services to customers through software and hardware engineering; computer hardware integration and component manufacture; and installation, training and service support.\no Field Engineering provides computer hardware maintenance to federal, state and local government clients, as well as commercial entities.\no Consulting Services provides computer consulting services and contract labor to support its customers' existing information technology capabilities. Specific tasks include concept formulation, system specification, system engineering design\/development, and project management.\nSystems and Services\nThe Company's Systems and Services Group provides turnkey system solutions and maintains and extends the life of existing systems through technology insertion, system redesign, and software reengineering. The units also perform value engineering and system integration activities, including design and manufacturing engineering, network integration, data warehousing and middleware connectivity, COTS integration, system installation, and support services. This group (i) holds the largest network integration contract ever awarded by the federal government, a three year contract representing backlog of over $900 million (see backlog discussions), (ii) is the largest provider of life cycle software engineering services to the U.S. Army and (iii) is the largest provider of ground based technical services to the California Institute of Technology Jet Propulsion Laboratory, a federally funded Research and Development Center managed by the National Aeronautics and Space Administration (\"NASA\"). Additionally, the group is developing and installing the information system technology infrastructure in support of the Immigration and Naturalization Service (\"INS\").\nTelos' Systems and Services group is a leading implementer and innovator of enabling technology. In 1981, the group implemented one of the first client-server architectures for the U.S. Coast Guard and, as a system integrator, developed the Navy's flagship desktop tactical computer system, the DTC-II. Today, one of the main focuses of the group is developing and bringing to market software applications to support the emerging Internet marketplace. Subsequent to December 31, 1995 the Company formed enterWorks.com, a wholly-owned subsidiary focused on the Internet and related software products including Pangaea, the Company's Commerceware product line, to pursue and expand such opportunities.\nFor fiscal year 1995, this group generated $142.9 million in revenues, or 70.5% of the Company's total revenues. Of this amount, contracts with the U.S. Army Communications-Electronics Command for its fire support and communication life cycle software engineering contracts and its contract with the Immigration and Naturalization Service accounted for 26% and 20%, respectively, of the Company's total revenue in 1995.\nField Engineering\nHardware maintenance services are provided by the field engineering group, known as Telos Field Engineering (\"TFE\"). TFE was formed in 1977 and provides a \"one stop\" maintenance service approach that includes hardware maintenance and repair, quality assurance, configuration management, and property management. In response to the increasing prevalence of customers owning more than one type or brand of computer, TFE specializes in third party maintenance of computer hardware and peripheral equipment manufactured by others. The majority of TFE's revenues are generated from work performed on Sun Microsystems, DEC, IBM, Data General, Hewlett-Packard, Wang, and Telos (previously known as C3) equipment.\nFor fiscal year 1995, TFE generated revenues of $32.8 million or 16.2% of the Company's total revenue.\nConsulting Services\nConsulting services are provided by Telos Consulting Services (\"TCS\"). TCS, formed in 1969, delivers consulting expertise, primarily on a contract labor basis, in support of the client's own information technology capabilities. TCS's areas of expertise include business process reengineering, team application development, software and hardware engineering and analysis, networking, computer security, team facilitation, and team communication. Operating from eleven field offices throughout the United States, TCS supports a business base of several hundred clients, many with multiple contracts. TCS's staff of professionals work as part of client organizations' teams, helping customers meet their organizational goals.\nFor fiscal year 1995, TCS generated revenues of $27.1 million or 13.3% of the Company's total revenue.\nRevenues by Major Market and Significant Customers\nRevenue by major market for the Company is:\nPercentage of total revenues for fiscal year 1995 1994 1993\nFederal Government 80.6% 84.5% 89.0% Commercial 15.2 11.4 7.8 State and local governments 4.2 4.1 3.2 ---- ---- ------ Total 100.0% 100.0% 100.0% ===== ===== =====\nTotal Company revenue at December 31, 1995 includes 43.1% of revenue from contracts with the Department of Defense, 6.1% of revenue from subcontracts with U.S. government prime contractors, 6.0% of revenue from the contracts with National Aeronautics and Space Administration (\"NASA\"), and 20.0% of revenue from contracts with the U.S. Department of Justice.\nOverview of 1995\nThe Company viewed 1995 as a year to solidify its market position in existing markets, achieve profitability, and create value through planned and focused diversification in emerging markets. The Company was successful in achieving these goals.\nFrom a market positioning stand-point, the Company was successful in its efforts to maintain and increase its contract base. During 1995, the Company won a significant rebid with an award from the U.S. Army Communication-Electronics Command of $118 million for systems and software engineering. Additionally, the Company won the largest network integration contract ever awarded by the federal government, a three year contract representing backlog of over $900 million.\nThe Company achieved profitability and positioned itself for future stability and growth through investment in bid and proposal, marketing and sales activities. During 1995, the Company achieved 310% growth in total backlog, establishing a solid base for future years. (See Backlog). While there can be no assurance of future contract awards, the Company continued to invest in its marketing, proposal and sales activities in 1995 in order to develop and capture new business opportunities.\nIn the area of focused diversification, the Company is establishing itself in two emerging markets: internet commerce and international business. With regard to the emerging internet market, the Company has enhanced and expanded its Commerceware product line, Pangaea. The Company's second generation firewall, NetSeer, and its middleware connectivity\/data mining product, Virtual db, were successfully released and are in use by commercial customers, including McDonnell Douglas, Northrop Grumman, and the Internet Cafe. In addition, the Company established an international joint venture to pursue third party maintenance contracts in the Middle East.\nDuring 1995, the Company continued the streamlining and consolidation of its infrastructure with consolidation of marketing efforts as well as consolidation of various general and administrative functions. The Company continuously evaluates its organizational structure in response to customer and market demands as well as to ensure it is providing cost effective solutions. In order to gain further operational efficiencies, in 1996 the Company will consolidate and reorganize certain divisions.\nCompetition\nThe segments of the information services industry in which the Company operates are highly fragmented with no single company or small group of companies in a dominant position. Some of the Company's competitors also operate in international markets, along with other entities that operate exclusively or primarily outside the United States. Some of the larger competitors offer services in a number of markets which overlap many of the same areas in which the Company offers services, while certain companies are focused on only one or a few of these markets. The firms that compete with the Company are consulting firms, computer services firms, applications software companies and the consulting groups of accounting firms, as well as the computer service arms of computer manufacturing companies and defense and aerospace firms. Thousands of firms fall into these categories. Among the major competitors are AT&T, Computer Data Systems, Computer Sciences Corporation, Electronic Data Systems Corporation, Unisys, Scientific Applications International Corporation, GTE Corporation and General Electric Corporation. In addition, the internal staffs of client organizations, non-profit federal contract research centers and universities are competitors of the Company. Some of the Company's competitors have greater financial and other resources than the Company and may have greater capabilities to perform services similar to those provided by the Company.\nThe Company believes that the principal competitive factors in the segments of the information and network technology market in which it competes include project management capability, technical expertise, and reputation for providing quality service and price. The Company believes its technical competence in computer engineering, systems software, engineering, system and network integration, and hardware maintenance will enable it to compete favorably in the information and network technology market.\nEmployees\nThe Company employs approximately 1,658 persons as of December 31, 1995. The services the Company provides require proficiency in many fields, such as computer science, mathematics, physics, engineering, operations research, economics, and business administration.\nOf the total Company personnel, approximately 955 provide Systems and Services, 295 provide Maintenance Services, and 280 provide Consulting Services. An additional 128 employees provide corporate and business services functions.\nBacklog\nMany of the Company's contracts with the U.S. Government are funded by the procuring government agency from year to year, primarily based upon the government's fiscal requirements. This results in two different categories of backlog: funded and unfunded. Total backlog consists of the aggregate contract revenues remaining to be earned by the Company based on total contract value over the life of its contracts, whether or not funded. Funded backlog consists of the aggregate contract revenues remaining to be earned by the Company at a given time, but only to the extent, in the case of government contracts, funded by a procuring government agency and allotted to the contracts. Unfunded backlog is the difference between total backlog and funded backlog. Included in unfunded backlog are revenues that may be earned only if customers exercise delivery orders and\/or renewal options to continue existing contracts.\nA number of contracts undertaken by the Company extend beyond one year, and accordingly, portions of contracts are carried forward from one year to the next as part of the backlog. Because many factors affect the scheduling and continuation of projects, no assurance can be given as to whether or when revenue will be realized on projects included in the Company's backlog.\nAt December 31, 1995 and 1994, the Company had total backlog from existing contracts of $1.3 billion and $328.4 million, respectively. This is the maximum value of additional future orders for systems, products, consulting services, maintenance and other support services presently allowable under those contracts, including renewal options available on the contracts if exercised by the client, over periods extending up to five years. Approximately $65.6 million and $93.4 million of the total was funded backlog at December 31, 1995 and 1994, respectively.\nOther\nThe Company has been incorporated under the laws of Maryland since 1971.\nIn 1995, the Company's shareholders and directors approved an amendment to the Company's Charter changing the Company's name to Telos Corporation. References to the \"Company\" or to \"Telos\" herein represent Telos Corporation (Maryland) (formerly C3, Inc.,) and except where expressly noted, its consolidated subsidiaries. References to \"Telos Corporation (California)\" are to the Company's wholly-owned subsidiary.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company leases 150,256 square feet of space in Herndon, Virginia for its corporate headquarters, integration facility, and primary service depot. This lease expires in March 1997, with a five year extension available at the Company's option. The Company, given its recent contract wins, has assessed its current office and integration space requirements. In March 1996, the Company signed a long-term lease for a building in Loudoun County, Virginia that will serve as its Corporate headquarters as well as provide significant additional manufacturing and integration space.\nThe Company leases additional space for regional field engineering, contract work sites, training, and sales offices in 53 separate facilities located in 22 states, the District of Columbia, and Europe under various leases, each of which expires on different dates through February, 2000. The Company also owns two buildings and a warehouse in Amery, Wisconsin. One of these two owned buildings is currently being leased to another company.\nItem 3.","section_3":"Item 3. Legal Proceedings\nA description of certain legal matters follows:\nRosecliff, Inc., et al v. C3, Inc., et al. (94 CIV. 9104) - - ---------------------------------------------------------\nThis case was filed in December, 1994 in the United States District Court for the Southern District of New York. Rosecliff, Inc. (\"Rosecliff\") is a merchant banking group with whom the Company had been negotiating an equity\/subordinated debt private placement transaction. Upon termination of this transaction, Rosecliff filed a suit seeking payment of its expenses, the specific enforcement of the acquisition agreement (or in the alternative lost profits) and $1 million for the violation of the \"no-shop\" provision in the Agreement. On motion to dismiss, the Court dismissed the claim seeking specific enforcement or lost profits (whether the plaintiffs will seek to replead that claim is unclear). A magistrate has recommended that the Company be held liable for the payment of Rosecliff's expenses in the amount of $1.1 million. Discovery is ongoing as to the remainder of the suit. While no ultimate assurances can be made as to those claims that the Court has not dismissed, the Company believes it has substantial defenses to the claim for violation of the no-shop provision and has made adequate provision for the payment of Rosecliff expenses.\nThe Company is a party to various other lawsuits arising in the ordinary course of business. In the opinion of management, while the results of litigation cannot be predicted with certainty, the final outcome of such matters will not have a materially adverse effect on the Company's consolidated financial position or results of operations.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nDuring the fourth quarter of fiscal year 1995, no matters were 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\nNo public market exists for the Company's Class A or B Common Stock. As of March 1, 1996, there were 72 holders of the Company's Class A Common Stock and 3 holders of the Company's Class B Common Stock.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe following should be read in connection with the accompanying information presented in Item 7","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nGeneral\nOver the past two years, the Company has invested significant resources into marketing, bid and proposal efforts, and into development of certain software and hardware products. The purpose of the marketing investment was to (1) retain significant contracts that were being rebid and (2) to capture new business. The Company has won all of its significant rebids including a $118 million software services contract with the U.S. Army Communications-Electronics Command. In addition, in 1995, the Company was awarded the Army's Small Multiuser Computer II Contract, which has a potential value of $907 million, the Realtime Automated Personnel Identification System (\"RAPIDS\") contract valued at nearly $18 million and a contract with the United States House of Representatives with a minimum value of $3.4 million.\nAs a result of the above contract awards, total backlog from existing contracts increased to $1.3 billion as of December 31, 1995, as compared to $328.4 million at December 31, 1994. As of December 31, 1995, the funded backlog of the Company totaled $65.6 million as compared to $93.4 million at December 31, 1994.\nThe Company has also invested in certain new software products primarily focused around the Internet. These investments have led to the development of a number of software products including NetSeer, an Internet firewall product, and Pangaea, the Company's Commerceware product line. The Company has also invested in certain new computer hardware products in support of new contract and business initiatives. While there can be no assurance as to the ultimate success of these investments, management believes that these investments will provide the Company with opportunity to expand its presence in the rapidly growing Internet market and to obtain additional revenues through new contract vehicles.\nRevenue by Contract Type\nApproximately 84.8% of the Company's total revenues in 1995 were attributable to contracts with federal, state, and local governments, including 80.6% attributable to the federal government. The Company's revenues are generated from various contract vehicles. In general, the Company believes its contract portfolio is characterized as having low to moderate financial risk as the Company has minimal long-term fixed price development contracts. The Company's firm fixed price contracts represent either contracts for the purchase of computer equipment at established contract prices or contracts for maintenance of computer hardware. A significant portion of the Company's revenue is from time and material and cost reimbursable contracts, which generally allow the pass-through of allowable costs plus a profit margin. For the year ended December 31, 1995, revenue by contract type was as follows: time and material, 36.7%; firm fixed price, 36.1%; cost reimbursable, 18.7%; fixed monthly rate, 8.1%; and other, 0.4%. While the Company has not experienced any significant recent terminations or renegotiations, government contracts may be terminated or renegotiated at any time at the convenience of the government.\nStatement of Income Data\nThe following table sets forth certain consolidated financial data and related percentages for the periods indicated:\nFinancial Data By Market Segment\nThe Company operates in three market segments: systems and services (the \"Systems and Services Group\"), which consists of systems integration and software services; computer hardware maintenance (the \"Field Engineering Group\"); and consulting services (the \"Consulting Group\"). Field engineering and consulting services are considered by the Company to be additional segments of the complete life cycle services offered by the Company. The Company is currently evaluating its organizational structure and its defined market segments and in order to gain further operational efficiencies, in 1996 the Company will consolidate and reorganize certain divisions.\nSales, gross profit and gross margin by market segment for the periods designated below are as follows:\nResults of Operations\nYears ended December 31, 1995 and 1994\nSales increased $27.7 million, or 15.8%, from $175.1 million to $202.8 million for the year ended December 31, 1995 as compared to the same 1994 period. This increase was primarily attributable to the Systems and Services Group, which reported an increase in sales of $26.9 million for the year, and to the Consulting Group which reported increased sales of $2.6 million. These increases were offset by a decline in sales in the Field Engineering Group of $1.8 million for the year.\nWithin the Systems and Services Group, systems integration sales accounted for the majority of the increase, as sales improved $30.7 million to $70 million in 1995 from $39.3 million in 1994 due to increased order volume during the second half of 1995. Increased orders in systems integration were due to the INS contract, as well as increased sales in other business lines of the division. Software services sales experienced a decline of $3.8 million for the year ended December 31, 1995 as compared to the same period in 1994. These decreases in sales were due to declines in contract activity on existing contracts as well as certain contracts not being renewed during 1995.\nThe increase in Consulting Services sales of $2.6 million is attributable to expansion of the breadth of services within this group in such areas as system integration services and software products, as well as an increase in billable hours in its traditional business areas. The revenue decline in the Field Engineering Group is primarily due to lower warranty revenue resulting from the low 1994 system integration sales, lack of follow-on maintenance contracts after the end of the warranty period for certain of the TSI equipment previously sold and delayed starts on certain of the Group's recent contract awards. In addition, the Field Engineering Group is experiencing a shift in its business as its customers migrate from mainframe computing to distributed processing through personal computers and networks. Generally, maintenance services for distributed processing equipment generate a lower revenue stream as billing rates for maintaining personal computers are lower.\nBased on the Company's significant growth in backlog, 1996 should present significant opportunities for revenue growth. However, sales have been adversely impacted during the first quarter of 1996 by the Federal government shutdown and budget impasse that occurred in late 1995 and early 1996. As the Company begins its 1996 fiscal year, the Company has experienced reduced order flow on its large equipment contracts with certain agencies of the Federal government. Accordingly, the Company anticipates lower sales and profitability for the first half of 1996 than might otherwise have been expected given its performance in the second half of 1995. It is management's belief that sales and related profitability should recover during the second half of 1996, although there can be no assurance as to such performance.\nCost of sales increased by $20.3 million, or 13.8%, to $167.6 million in 1995, from $147.2 million in 1994. This increase is the result of the increase in sales for the period.\nGross profit increased by $7.4 million for the year to $35.3 million, from $27.9 million in the comparable 1994 period. The increase in the period is primarily attributable to the higher sales volume previously discussed within the Systems and Services Group and the Consulting Services Group. These increases were offset by declines in gross profit for the Field Engineering Group, attributable primarily to start-up costs associated with recent contract awards as well as lower profit margins associated with maintaining distributed processing equipment. Also negatively impacting profit margins of the Group is the investment currently being made in certain international offices to support the Company's international efforts. The Group has recently undertaken a number of cost-cutting measures such as staff reduction and branch consolidation to increase its profitability. The Company's gross margin was 17.4% for the year ended December 31, 1995 as compared to 15.9% for the comparable period of 1994.\nSelling, general, and administrative expense (\"SG&A\") decreased for the year by approximately $2.6 million, to $26.3 million in 1995 from $28.9 million in 1994 for the comparable period. These decreases were primarily due to reduced expenses associated with research and development initiatives, lower contract rebid efforts in 1995 as compared to 1994, and reduced expenses in certain administrative cost areas. Also, in 1995, based on a review of its operations and requirements, the Company had certain one-time adjustments to previously recorded reserves which reduced SG&A by $1.7 million in such areas as employee benefits and certain closure reserves. For 1996, the Company believes that SG&A will increase over 1995 levels due to additional investment in sales, marketing and products, and taking into account the effect of the one time adjustments described above. SG&A as a percentage of sales decreased to 13.0% for the year ended December 31, 1995 from 16.5% in the comparable 1994 period.\nGoodwill amortization expense was $2.4 million for the year ended December 31, 1995 compared to $3.2 million for the period ended December, 1994. The reduction in goodwill amortization is attributable to the completion of the amortization of the goodwill created by the 1989 leveraged buyout of the Company. The Company continues to amortize the goodwill balance which resulted from the acquisition of Telos Corporation (California).\nOperating income (loss) increased by $10.8 million to $6.6 million in the year from ($4.2) million in the comparable 1994 period as a result of the aforementioned increases in sales and gross profit.\nOther non-operating income was approximately $27,000 for the year ended December 31, 1995 compared to approximately $5.5 million of other non-operating expense in the comparable 1994 period. The $5.5 million expense in 1994 was attributable to costs incurred from attempts to recapitalize the Company's balance sheet and refinance the Company's existing debt. It was also due to the write-off of the remaining asset value of a software license purchased from Sapien's International in 1993. (See the transaction costs section in Note 5 as well as the discussion of Sapiens International in Note 8 to the consolidated financial statements.)\nInterest expense increased approximately $1.4 million to $5.5 million for the year ended December 31, 1995 from $4.1 million in the comparable 1994 period. The variance is a result of the increase in the average outstanding balance of the senior credit facility and related interest rate, as well as an increase in the outstanding balance of the subordinated debt and related interest rate. The Company believes its interest expense in 1996 will at least approximate the 1995 level and may be higher depending on its working capital financing requirements.\nThe Company had an income tax provision of $75,000 for the year ended December 31, 1995 primarily due to state income taxes. For the comparable period of 1994, the Company had a tax benefit of $1.3 million.\nYears Ended December 31, 1994 and 1993\nThe Company viewed 1994 with several objectives. These objectives included completing a refinancing\/recapitalization in order to provide enhanced liquidity and funding for future growth. Second, to increase bid and proposal spending to retain existing contracts up for rebid and to increase the Company's contract base through new awards. Third, to continue to consolidate and streamline its administrative functions as well as enhance its internal information systems. The Company was successful in expanding its contract base as demonstrated by its backlog growth. The Company also continued to consolidate administrative functions including finance and accounting and certain marketing efforts. The Company was not successful in completing several refinancing and recapitalization alternatives, and incurred significant costs in doing so. However, funding of the Company's financial requirements was completed by a combination of an increased senior credit facility and additional advances by certain of the Company's existing shareholders.\nSales declined $36.1 million, or 17.1%, from $211.2 million to $175.1 million for the year ended December 31, 1994 as compared to 1993. The decrease for the year is primarily attributable to the Systems and Services Group, which reported decreases in sales of $29.4 million for the year and to the Field Engineering Group, which reported decreased sales of $7.2 million for 1994 as compared to 1993.\nWithin the Systems and Services Group, systems integration sales accounted for the majority of the decrease, as sales declined $25.3 million for the year, due to reduced order volume which began in the fourth quarter of 1993 and continued throughout 1994. The reduced volume was a result of completion of a large contract with the U.S. Navy in 1993 and lack of a significant new contract. Services sales declined $4.1 million for the year ended December 31, 1994 due to reduced contract volume. The reduced volume in services is due to the completion of certain contracts either as a result of the contract requirements ending or the follow-on contract becoming small business set aside contracts.\nThe decline in sales within the Field Engineering Group of $7.2 million for 1994 is attributable to the shutdown of a board repair facility, reductions in contract activity for the segment and a reduction in warranty services related to systems integration customers.\nCost of sales decreased by $26.4 million, or 15.2%, to $147.2 million for the year ended December 31, 1994, from $173.6 million in 1993. The decline is the result of the decrease in sales for the year.\nFor 1994, gross profit decreased by $9.7 million to $27.9 million from $37.6 million in 1993. The decline is primarily attributable to the lower sales volume previously discussed within the Systems and Services Group and the Field Engineering Group. The gross overall margin for 1994 was 15.9% as compared to 17.8% for the comparable period of 1993.\nSelling, general, and administrative expense (\"SG&A\") increased by approximately $3.4 million, to $28.9 million in 1994 from $25.5 million in 1993. The increase is primarily due to an increase in marketing and bid and proposal costs, funding of new product development and\ntechnology research, and increased internal information system spending to enhance the Company's capability. Also, SG&A for 1994 includes the costs associated with Mr. Beninati's decision to resign as Chairman of the Board. Mr. Beninati will continue to serve as a director of the Company. SG&A as a percentage of sales increased to 16.5% in 1994 from 12.1% in the comparable 1993 period.\nGoodwill amortization expense was $3.2 million in each of 1994 and 1993, as the Company continues to amortize its goodwill balance which resulted primarily from the acquisition of Telos Corporation (California) in 1992.\nOperating income decreased by $13.1 million to a loss of $4.2 million for the year from $8.9 million in 1993, as a result of the aforementioned declines in sales and gross profit as well as SG&A expenditures.\nFor 1994, non-operating expenses were $5.5 million as compared to an expense of $3.4 million for 1993. During 1994 the Company attempted to restructure its debt and capital structure. During the fourth quarter of 1994, the Company concluded that the pending transactions were not going to be completed and therefore expensed the associated costs that the Company had incurred. Such expenses total $4.1 million, of which $1.9 million has been paid at December 31, 1994. The Company recorded these financing expenses as non-operating for financial statement presentation purposes. Also, during the fourth quarter of 1994, the Company reassessed its business plans and strategy for the mainframe software license tools purchased. As a result of concluding that the initial strategy was not going to produce the business results first planned, the Company wrote-off the remaining asset value of the license investment. As the investment in licenses did not contribute to the operations, the Company recorded the $1.4 million charge as a non-operating expense.\nIn 1993, the Company incurred $3.2 million in costs in connection with the settlement of a shareholder suit. These costs represented legal fees paid on behalf of the Company and other parties to the suit, and estimated future consulting fees and expenses incurred in connection with the suit.\nInterest expense for 1994 increased $1.1 million to $4.1 million from $3.0 million in 1993. The increase is a result of the increase in the outstanding balance of the senior credit facility and the related interest rate due to increases in the prime lending rate. Also, during 1994, the Company recorded interest expense of $410,000 associated with the funding by its majority shareholder, Mr. John R.C. Porter (\"Porter\") (see \"Liquidity and Capital Resources\" below).\nThe income tax benefit of $1.3 million for the year ended December 31, 1994, due to the carryback of the operating loss, compares to a provision of $1.9 million in the comparable 1993 period.\nThe $196,000 of extraordinary loss in 1994 results from the early retirement of $1.8 million of senior subordinated notes and represents unamortized debt discount that was expensed when the notes were retired.\nLiquidity And Capital Resources\nIn 1995, the Company experienced improved liquidity particularly during the third and fourth quarters. This improvement in liquidity resulted from the completion of the transaction with certain of the Company's common shareholders whereby the shareholders provided $13.5 million of cash to the Company for the retirement of senior subordinated notes, held by Union de Banques Suisses (Luxembourg) S.A. (\"UBS\"), and for the reduction of the outstanding balance of the senior credit facility. The Company issued Senior Subordinated Notes - Series B and C, in the total amount of $14.4 million in October 1995 to the shareholders providing the cash infusion.\nAlso improving the Company's liquidity were significantly improved operating results in the third and fourth quarter of 1995. The combined third and fourth quarter net income totaled $913,000 as compared to net income of $102,000 for the first two quarters of 1995. The improved results were due to significantly higher revenue in the last two quarters of 1995 due primarily to the increased volume in the Company's system integration division.\nFor the year ended December 31, 1995, the Company used approximately $6.4 million of cash in operating activities. This use of cash in operations was primarily a result of the increases in the accounts receivable and inventory balances after adjustment for non-cash items. The growth in accounts receivable and inventory was primarily due to increased third and fourth quarter revenue activity thereby increasing products and services purchased from the Company's vendors. Also contributing to the growth in accounts receivable at December 31, 1995 was the Federal government shut-down which resulted in the closing of one of the Company's significant customers and its paying office. The Company also used cash in purchase of property and equipment as well as in investments in internally developed software and hardware products for sale to third parties. The use of cash resulting from the operating and investing activities was funded by the issuance of the senior subordinated notes as mentioned above.\nAt December 31, 1995, the Company had an outstanding balance of $32.3 million on its $45 million senior credit facility. The facility is collateralized by certain assets of the Company (primarily inventory and accounts receivable) and the amount of borrowings fluctuates based on the underlying asset borrowing base as well as the Company's working capital requirements. At December 31, 1995, the Company, under its borrowing base formula, had $7,200,000 of unused availability. The facility expires on July 1, 1996.\nAt December 31, 1995, the Company was not in compliance with two of the four financial covenants contained in the Facility. Subsequent to December 31, 1995, the Company's bank waived the non-compliance with the covenants and entered into an agreement with the Company to refinance its $45 million Facility and extend the maturity date to July 1, 1997. Other terms and conditions of the Facility are similar to the Company's previous Facility.\nWith the contract awards in 1995, the Company is evaluating its financing requirements to support these contracts. The Company anticipates that its current Facility will be adequate for the first half of 1996. The Company currently believes that an expanded senior credit facility may be required in the future and is currently reviewing with its senior lender a prospective multi-bank syndication arrangement.\nThe Company is actively reviewing its business opportunities surrounding its Internet products. Subsequent to December 31, 1995 the Company formed enterWorks.com, a wholly-owned subsidiary focused on the Internet and related software products, including Pangaea, to pursue and expand such opportunities. While the Company is currently funding the on-going product development and business growth in this area, it is reviewing the potential for external capital to fully exploit this emerging market and to build the enterWorks.com business.\nDuring the first quarter of 1996, the Company's liquidity was impacted by the various Federal Government shutdowns and the related impasse on the 1996 Federal Government budget. While the services side of the Company's business was generally unaffected, certain of its large equipment contracts within its system integration division were adversely impacted both through reduced order volume and collections on outstanding accounts receivable. The effect of this was an overall reduction in the Company's liquidity. The Company has counteracted this negative effect with an aggressive cash management program. One of these aggressive actions has been to establish extended payment terms to the Company's vendors as well as to reduce discretionary spending in certain areas. While the Company has recently begun to see improved order flow and cash collections, the Company believes that the impact from the Government shut-down and budget impasse will be felt through the middle of the second quarter of 1996 in its results from operations and financial condition.\nThe Company has a net deferred tax asset of $3.1 million at December 31, 1995. Management believes that the asset is fully realizable given the Company's existing backlog and projected future taxable income and the expected reversal of temporary differences existing at December 31, 1995.\nCapital Expenditures\nThe Company believes that its business is not capital intensive, however, the Company expects that property, plant and equipment expenditures in 1996 will experience moderate growth compared to 1995 and 1994 levels. The Company, given its recent contract wins, is actively reviewing its office and integration space requirements. In March 1996, the Company signed a long term lease for a building that will serve as its Corporate headquarters and provide significant additional manufacturing and integration space. The lease, which has a twenty year term, will result in significant cost savings to the Company as it provides for reduced monthly lease payments compared to the costs incurred under the Company's current leasing arrangement.\nInflation\nThe rate of inflation has been moderate over the past five years and, accordingly, has not had a significant impact on the Company. The Company has generally been able to pass through increased costs to customers through higher prices to the extent permitted by competitive pressures. The Company's cost reduction efforts have offset the effects of inflation, if any, on the Company's performance.\nForward-looking Statements\nThis annual report on Form 10-K contains forward-looking statements. For this purpose, any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words \"believes,\" \"anticipates,\" \"plans,\" \"expects\" and similar expressions are intended to identify forward-looking statements. There are a number of important factors that could cause the Company's actual results to differ materially from those indicated by such forwarding-looking statements. These factors include, without limitation, those set forth below under the caption \"Certain Factors That May Affect Future Results.\"\nCertain Factors That May Affect Future Results\nThe following important factors, among others, could cause actual results to differ materially from those indicated by forward-looking statements made in this Annual Report on Form 10-K and presented elsewhere by management from time to time.\nA number of uncertainties exist that could affect the Company's future operating results, including, without limitation, general economic conditions, the timing and approval of the Federal government's fiscal year budget, business growth through obtaining new business and, once obtained, the Company's ability to successfully perform at a profit, the Company's ability to convert contract backlog to revenue, the Company's ability to secure adequate capital and financing to support continued business growth and the risk of the Federal government terminating contracts with the Company. While the Company has not experienced contract terminations with the Federal government, the Federal government can terminate its contracts at its convenience, should this occur, the Company's operates results would be adversely impacted.\nAs a high percentage of the Company's revenue is derived from business with the Federal government, the Company's operating results could be adversely impacted should the Federal government not approve and implement its annual budget in a timely fashion.\nThe Company's success and future growth opportunities are highly dependent upon its ability to timely identify new market opportunities, and aggressively pursue and capture marketshare.\nThe Company has been successful in increasing its contract backlog in 1995. However, the Company's furture success is highly dependent upon it converting the backlog into revenue.\nWhile the Company believes it has adequate financing to support a revenue base consistent with 1995 results, the Company's growth depends upon its ability to obtain additional capital and financing sources. The Company is actively identifying and planning for the additional financing. However, no assurance can be made on whether such financing can be obtained, or if available, that it will be available on acceptable terms.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nINDEX TO SCHEDULES\nAll schedules are omitted because they are not applicable or the required information is included in the consolidated financial statements or notes thereto.\nReport of Independent Accountants\nTo the Board of Directors and Stockholders of Telos Corporation\nWe have audited the accompanying consolidated balance sheets of Telos Corporation and Subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of income, stockholders' investment (deficit), and cash flows for each of the three years in the period ended December 31, 1995. 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 Telos Corporation and Subsidiaries as of December 31, 1995 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, 1995, in conformity with generally accepted accounting principles.\nCOOPERS & LYBRAND L.L.P.\nWashington, DC March 29, 1996\nThe accompanying notes are an integral part of these consolidated financial statements.\nTELOS CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (amounts in thousands)\nASSETS\nAs of December 31 ------------------------------- 1995 1994 ---- ----\nCurrent assets Cash and cash equivalents $ 735 $ 441 Accounts receivable, net 44,112 40,345 Inventories, net 15,877 8,696 Deferred income taxes 1,217 584 Prepaid income taxes 320 2,845 Other current assets 384 489 ---- -------\nTotal current assets 62,645 53,400 ------ ------\nProperty and equipment Land and building 408 408 Furniture and equipment 18,180 17,178 Leasehold improvements 2,683 2,666 ------ ------\n21,271 20,252 Accumulated depreciation (18,600) (16,769) ------ ------\nTotal property and equipment 2,671 3,483 ----- ------\nGoodwill 22,814 26,822 Deferred income taxes 1,868 448 Other assets 4,494 2,719 ------ -------\n$94,492 $86,872 ====== ======\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.\nTELOS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNote 1. Summary of Significant Accounting Policies\nBusiness and Organization\nTelos Corporation (\"Telos\" or the \"Company\") (formerly C3, Inc.) provides information and network technology products and services primarily to various agencies of the Federal Government . The Company also provides these services to state and local governments and the private sector. Services provided by the Company encompass the full life cycle of computer services including system specification and evaluation, hardware and software integration deployment, installation, training, hardware maintenance and software sustainment. The Company has further enhanced its ability to deliver solutions to its customers by providing tools and applications focused on emerging information and network technology markets such as data mining, data warehousing, middleware connectivity and data access and workflow.\nThe Company, founded in 1968, is incorporated under the laws of the State of Maryland.\nAcquisitions\nIn 1992, the Company acquired all of the outstanding capital stock of Telos Corporation, (California) from Contel Federal Systems, Inc. (\"Contel\"), a wholly owned subsidiary of GTE Corporation for $32 million in a transaction accounted for as a purchase.\nPrinciples Of Consolidation\nThe accompanying consolidated financial statements include the accounts of Telos Corporation and its wholly owned subsidiaries, Telos Corporation (California), Telos Field Engineering, Inc. and Telos International Corporation (collectively the \"Company\"). All significant inter-company transactions have been eliminated in consolidation. The Company also has an investment in a joint venture located in Kuwait that is accounted for under the equity method of accounting.\nRevenue Recognition\nThe majority of the Company's sales are made directly or indirectly to the Federal Government. A substantial portion of the Company's revenues are derived from time and materials and cost reimbursement contracts, under which revenue is recognized as services are performed and costs are incurred. The Company generally recognizes equipment revenue as products are shipped, although certain revenue recognition practices are dependent upon contract terms. Revenue for maintenance contracts is recognized as such services are performed. Revenue from the licensing of software is recognized, in accordance with AICPA SOP 91-1 \"Software Revenue Recognition\" whereby revenue is recognized when a non cancelable revenue agreement is in force, the product has been shipped and no significant obligations remain. Revenue generated from warranty service contracts is recognized ratably over the warranty service period. The Company records loss provisions for its contracts, if required, at the time such losses are identified.\nCash and Cash Equivalents\nThe Company considers all highly liquid investments with an original maturity of three months or less at the date of purchase to be cash equivalents. The Company's cash management program utilizes zero balance accounts. Accordingly, all book overdraft balances have been reclassified to accounts payable.\nInventories\nInventories are stated at the lower of cost or market, cost being determined primarily on the first-in, first-out method. Substantially all inventories consist of purchased hardware and component computer parts used in connection with system integration services performed by the Company. Inventories also include spare parts of $1,508,000 and $2,008,000 at December 31, 1995 and 1994, respectively, which are utilized to support maintenance contracts. Spare parts inventory is amortized on a straight line basis over five years. An allowance for obsolete, slow-moving or non-salable inventory is provided for all other inventory. This allowance is based on the Company's overall obsolescence experience and its assessment of future inventory requirements.\nAt December 31, 1995, 1994, and 1993, the Company's allowance for inventory obsolescence was $1,385,000, $1,078,000 and $2,189,000 respectively. The components of the allowance for inventory obsolescence are set forth below (in thousands):\nProperty and Equipment\nProperty and equipment is recorded at cost. Depreciation and amortization are provided for using the straight-line method over the estimated useful lives of the assets as follows:\nBuildings 19 Years Machinery and equipment 3 - 7 Years Office furniture and fixtures 5 - 7 Years Leasehold Life of Lease\nUpon sale or retirement of property and equipment, the costs and related accumulated depreciation are eliminated from the accounts, and any gain or loss on such disposition is reflected in the statement of income. Expenditures for repairs and maintenance are charged to operations as incurred.\nDepreciation and amortization expense related to property and equipment was $1,862,000, $2,463,000, and $2,978,000 for the years ended December 31, 1995, 1994 and 1993, respectively.\nGoodwill\nGoodwill of approximately $31.19 million resulted from the acquisition of Telos Corporation (California) and has been assigned a useful life of twenty years. The twenty year life considered a number of factors including the Company's maintenance of long-term customer relationships with significant customers for periods of up to twenty-seven years and its strong\npositions in the marketplace. Also, Telos Corporation (California) did not perform significant software development for general resale or license to customers thereby avoiding the risks associated with rapidly changing technological environments .\nThe Company assesses the potential impairment and recoverability of goodwill on an annual basis and more frequently if factors dictate. Management forecasts are used to evaluate the recovery of goodwill through determining whether amortization of goodwill can be recovered through undiscounted operating cash flow (excluding goodwill amortization, interest expense, and non-recurring charges). If an impairment of goodwill appears to have occurred, impairment is measured based on projected discounted operating cost flow (excluding goodwill amortization, interest expense, and non-recurring charges) using a discount rate reflecting the Company's cost of funds. In addition, the Company may assess the net carrying amount of goodwill using internal and\/or independent valuations of the Company.\nAccumulated amortization of goodwill for Telos Corporation (California) at December 31, 1995 and 1994 was $6,054,000 and $4,628,000, respectively. The goodwill amortization related to the purchase of Telos Corporation (Maryland) (formerly C3, Inc.) was $944,000 for 1995 and has now been fully amortized as of December 31, 1995.\nIncome Taxes\nThe Company has adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (SFAS 109). Under this method, deferred tax assets and liabilities are recognized for the estimated future tax consequences of temporary differences and income tax credits. Deferred tax assets and liabilities are measured by applying enacted statutory tax rates, that are applicable to the future years in which deferred tax assets or liabilities are expected to be settled or realized, to the differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities. Any change in tax rates on deferred tax assets and liabilities is recognized in net income in the period in which the tax rate change is enacted.\n401(k) Retirement Savings And Profit Sharing Plan\nThe Company sponsors a defined contribution employee savings plan (the \"Plan\") under which substantially all full-time employees are eligible to participate. The Company matches one-half of voluntary participant contributions to the Plan up to a maximum Company contribution of 3% of a participant's salary. Additionally, the Company, on a discretionary basis, has contributed 1% of all eligible employee wages to the Plan regardless of whether the employee elected to participate in the Plan. Total Company contributions to the Plan for 1995 and 1994 were $2,397,000, $2,517,000, respectively. In 1993, the Company had two different savings plans for which it contributed $2,925,000.\nSoftware Development Costs\nThe Company expenses all research and development costs incurred in connection with software development projects until such software achieves technical feasibility. All costs thereafter are capitalized. The Company is amortizing such capitalized costs over the estimated product life of three years. The Company periodically evaluates the realizability of these capitalized costs through evaluation of anticipated gross revenue as compared to current gross revenues.\nUnamortized software costs at December 31, 1995 and 1994 were $1.2 million and $649,000, respectively. Amortization expense associated with these capitalized software costs was $80,000 in 1995 and zero during 1994.\nDuring 1995 and 1994, the Company incurred $1.4 million, and $1.9 million in research and development costs, respectively. Prior to 1994, these types of costs were not significant.\nUse of Estimates\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nNewly Issued Accounting Pronouncements\nStatement of Financial Accounting Standards (\"SFAS\" or \"Standard\") No. 121 \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of\" establishes standards for recognizing and measuring impairment of long-lived assets to be held and used as well as assets held for disposal. The effective date for SFAS 121 is for fiscal years beginning after December 15, 1995, with earlier application encouraged. The Company's current accounting policies incorporate the requirements of the new Standard; therefore, the Company has effectively implemented the Standard as of December 31, 1995.\nSFAS No. 123 \"Accounting for Stock-Based Compensation\" establishes a fair-value based method of accounting for stock compensation plans with employees and others. Entities are encouraged but not required to adopt SFAS 123; the entity may continue to account for stock-based compensation under APB Opinion 25, so long as the entity adopts the disclosure requirements of SFAS 123. Recognition and measurement in accordance with SFAS 123 can only be applied to awards granted after the beginning of the fiscal year in which the SFAS is adopted. The disclosure requirements of the Standard are effective for fiscal years beginning after December 15, 1995. The Company did not award stock based compensation to employees or others during 1995, and is still reviewing which method of recognition and disclosure it will adopt under the standard.\nReclassifications\nCertain reclassifications have been made to the prior years' financial statements to conform to the classifications used in the current period.\nNote 2. Changes in Company Ownership\nIn September 1993, the Company entered into a Settlement Agreement with Mr. John R.C. Porter (\"Porter\"), the Company's majority shareholder, and related entities; Mr. Fred Knoll, formerly Chairman of the Board of Directors; Cottonwood Holdings, Inc. (\"Cottonwood\"); C3 Investors, L.P. (\"C3 Investors\"); Mr. Joseph P. Beninati, a Company director and formerly the Chairman of the Board of Directors; Mr. John B. Wood, a Company director and its Chief Executive Officer; and the Company's wholly-owned subsidiary, Telos Corporation (California). The Settlement Agreement of October 8, 1993 provided for the settlement of a dispute instituted by Mr. Knoll against the other three Company directors, Messrs. Porter, Beninati and Wood, and the Company, regarding the ownership, control and management of the Company.\nPursuant to the terms of the Settlement Agreement, Cottonwood and C3 Investors sold to Porter for a purchase price of $12,000,000 all of the Company securities which they previously held, excepting only $1,825,000 in debt evidenced by a Series A senior subordinated note issued by the Company which Cottonwood retained (retired in July 1994).\nIn connection with the Settlement Agreement, Mr. Knoll resigned as a Company director and officer and from all other posts held with the Company and entered into an agreement prohibiting Mr. Knoll from acquiring any interest in the Company's publicly-held 12% Cumulative Exchangeable Redeemable Preferred Stock. Additionally, under the terms of the Settlement Agreement, Mr. Knoll has been retained as a consultant to the Company for a period of four years at an annual rate of $300,000. The parties also agreed to a schedule regarding the payment by the Company of $450,000 in deferred fees owed to Mr. Knoll and these fees were paid in 1995.\nUnder the terms of the Settlement Agreement the Company incurred $3,174,000 of other non-operating expenses which include legal fees. All legal costs incurred in connection with the suit were paid by the Company on behalf of all the parties to the Settlement Agreement, pursuant to indemnification by the Company's bylaws. Through the year ended December 31, 1995, the Company has paid $2,652,000 related to the costs incurred under the Settlement Agreement.\nNote 3. Revenue and Accounts Receivable\nRevenue resulting from contracts and subcontracts with Federal, state, and local governments accounted for 84.8% 88.6%, and 92.2% of total revenue in the years ended December 31, 1995, 1994 and 1993, respectively. As the Company's primary customer is the Federal Government, the Company has a concentration of credit risk associated with its accounts receivable. However, the Company does not believe the likelihood of loss arising from such concentration is significant.\nThe components of accounts receivable are as follows (in thousands):\nAs of December 31, ------------------ 1995 1994 ---- ----\nBilled accounts receivable $30,286 $32,483 ------ ------\nAmounts billable upon acceptance by customer 6,900 4,805 Amounts currently billable 7,650 4,326 Costs incurred in excess of contractual authorization, billable upon contractual amendment increasing funding -- 18 --- ---\nTotal unbilled accounts receivable 14,550 9,149 ------ -----\nAllowance for doubtful accounts (724) (1,287) ----- -----\n$44,112 $40,345 ====== ======\nThe provision for doubtful accounts was $103,000, $(319,000), and $1,243,000 for the years ended December 31, 1995, 1994 and 1993, respectively. Reductions to the allowance were primarily due to account receivable write-offs and other adjustments.\nNote 4. Income Taxes\nThe provision (benefit) for income taxes include the following (in thousands):\nThe provisions for income taxes vary from the amount of income taxes determined by applying the federal income tax statutory rate to the income or loss before income taxes. The reconciliation of these differences is as follows:\nThe tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 1995 and 1994 are as follows (in thousands):\nThe net change in the valuation allowance was a decrease of $4,195,000 for 1995 and an increase of $2,314,000 for 1994. Included in the change in the valuation allowance were decreases of approximately $1,391,000 and $720,000 for 1995 and 1994, respectively, related to the reversal of temporary differences acquired from Telos Corporation. The reversals of the temporary differences related to the Telos Corporation acquisition reduce goodwill. The total tax benefits of future deductible temporary differences acquired in connection with the Telos Corporation acquisition were $6,097,000 at January 14, 1992. As of December 31, 1995, $1,549,000 of tax benefits remain and will reverse in future years.\nFor the year ended December 31, 1995, for Federal income tax purposes, the Company generated a net operating loss of $3,872,000 which increases the net operating loss available for carryforward to $9,819,000 to offset future regular taxable income. Additionally, $8,181,000 is available to offset future alternative minimum taxable income. The net operating loss carryforward will begin expiring in the year 2011. Additionally, the Company has $994,000 of alternative minimum tax credits available to be carried forward indefinitely to reduce future regular tax liabilities.\nDuring 1995 the Company settled an Internal Revenue Service audit for the years 1987 through 1991. The audit resulted in the disallowance of certain costs that the Company had previously claimed, thereby reducing the Company's net operating loss carryforward by $1.3 million. Accordingly, the Company reduced its deferred tax asset and the related valuation allowance.\nAt December 31, 1995, the Company has a $3.1 million deferred tax asset. The realization of this asset is largely dependent upon future income, which cannot be predicted with certainty. However, given the Company's return to profitability and its backlog growth, the Company believes that it is more likely than not that the Company will realize the net deferred tax asset recorded.\nNote 5. Debt Obligations\nThe Company's debt obligations consist of a $45 million Senior Revolving Credit Facility, and three levels of Senior Subordinated Notes, Series A, B and C. Each of these obligations is described below.\nSenior Revolving Credit Facility\nAt December 31, 1995, the Company has a $45 million Senior Revolving Credit Facility (the \"Facility\") with its bank which expires on July 1, 1996 and has an outstanding balance of $32.3 million. Borrowings under the facility are collateralized by certain assets of the Company (primarily accounts receivable and inventory), and the amount of borrowings fluctuate based on the underlying asset borrowing base as well as on the Company's working capital requirements. The Facility bears interest at 1.5% over the bank's base rate or 10.00% at December 31, 1995. The weighted average interest rate on the outstanding borrowings under the facility was 9.32% for the year ended December 31, 1995 compared with 8.60% for the year ended December 31, 1994. At December 31, 1995, the Company had $7,200,000 of availability under the Facility.\nDuring 1994 and 1995, Porter and certain of the Company's shareholders deposited a total of $7.0 million with the Company's bank to provide the Company with additional borrowing capacity under the Facility. In October, 1995, these deposits were transferred to the Company in exchange for the issuance to the shareholders of Senior Subordinated Notes, Series B and C. (Refer to Senior Subordinated Notes and Note 7 for further discussion).\nAt December 31, 1995, the Company is not compliant with two of the four financial covenants contained in the Facility. Subsequent to December 31, 1995, the Company's bank waived the covenant violations and agreed to refinance the Facility. Under the agreement, the Facility will remain at $45 million with terms and conditions similar to the Company's previous Facility with an expiration date of July 1, 1997.\nSenior Subordinated Notes\nAt December 31, 1995 the Company had a $675,000 Senior Subordinated Note, Series A with a balance of $631,000 outstanding with Porter. The Note had an interest rate per annum of 11.875% from January 1 through January 14, 1995, then increased to 14% per annum from January 15, 1995 through January 14, 1997, and increases to 17% thereafter. Interest is payable in semi-annual installments on June 30 and December 31 of each year. The note is collateralized by certain assets of the Company. The note was issued in 1992 and matures on January 14, 2002.\nOn June 8, 1995, the Company entered into an agreement with Union de Banques Suisses (Luxembourg) S.A. (\"UBS\") whereby the Company paid UBS $5.8 million in outstanding principal, $500,000 of accrued interest and $200,000 of legal and other fees in exchange for the retirement of the Series B-1 and B-2 Senior Subordinated Notes.\nThe funds to pay UBS were provided by certain of the Company's common shareholders. The shareholders were issued $6.5 million Subordinated Bridge Notes in exchange for these funds. On October 13, 1995, the Company issued to these shareholders $14.4 million of Senior\nSubordinated Notes (\"Notes\") which included shareholder fees related to the debt issuance, in exchange for the $6.5 million Subordinated Bridge Notes, as well as the transfer to the Company of these shareholders' deposits held with the Company's bank. The Notes are classified as either Series B or Series C. Series B Notes, which total $6.5 million and replace the Senior Subordinated Notes Series B held by UBS, are collateralized by fixed assets of the Company. Series C Notes which total $7.9 million are unsecured.\nBoth the Series B and Series C Notes have a maturity date of October 1, 2000 and have interest rates ranging from 14% to 17%. Interest is paid quarterly on January 1, April 1, July 1, and October 1 of each year. The Notes can be prepaid at the Company's option. Additionally, these notes have a cumulative payment premium of 13.5% per annum payable only upon certain circumstances. These circumstances include an initial public offering of the Company's common stock or a significant refinancing, to the extent that net proceeds from either of the above events are received and are sufficient to pay the premium. Due to the contingent nature of the premium payment, the associated premium expenses will only be recorded after occurrence of a triggering event. However, the interest portion of the notes is treated as a period expense.\nTransaction Costs\nIn 1994, the Company attempted to recapitalize its balance sheet and refinance its existing debt. These transactions were not completed and accordingly, the Company recorded $4,205,000 of non-operating expenses for the cost of the failed transactions in December 1994. Included in the above amount are certain provisions for settlement with parties involved in the failed financing transaction. The Company has paid $2.9 million of the costs as of December 31, 1995.\nNote 6. Redeemable Preferred Stocks\nSenior Redeemable Preferred Stock\nThe components of the senior redeemable preferred stock are Series A-1 and Series A-2 redeemable preferred stock each with $.01 par value and 1,250 and 1,750 shares authorized, issued and outstanding, respectively. Through June 30, 1995, the Series A-1 and Series A-2 carried a cumulative per annum dividend rate of 9% of their liquidation value of $1,000 per share. From July 1, 1995 through June 30, 1997, the Series A-1 and A-2 each carry a cumulative dividend rate equal to 11.125%, and increases again to 14.125% per annum thereafter. The liquidation preference of the preferred stock is the face amount of the Series A-1 and A-2 Stock ($1,000 per share), plus all accrued and unpaid dividends. The Company is required to redeem all of the outstanding shares of the stock on December 31, 2001, subject to the legal availability of funds. The Series A-1 and A-2 Preferred Stock is senior to all other present and future equity of the Company. The Series A-1 is senior to the Series A-2. At December 31, 1995 and 1994 undeclared, unpaid dividends relating to Series A-1 and A-2 Preferred Stock totaled $1,494,000 and $1,192,000, respectively, and have been accrued and are included in the Series A-1 and A-2 redeemable preferred stock balance. Mandatory redemptions are required from excess cash flows, as defined in the stock agreements. Through December 31, 1995, there has been no available cash flow permitting mandatory redemption.\nClass B Redeemable Preferred Stock\nThe Class B Redeemable Preferred Stock has a $.01 par value, with 7,500 shares authorized, issued and outstanding. Through June 30, 1995, the Class B Redeemable Preferred Stock carried a cumulative per annum dividend rate of 9% of its liquidation value of $1,000 per share. From July 1, 1995 through June 30, 1997, the Class B Redeemable Preferred Stock has a cumulative dividend rate per annum equal to 11.125% and increases to 14.125% per annum\nthereafter. The Class B Redeemable Preferred Stock may be redeemed at its liquidation value together with all accrued and unpaid dividends at any time at the option of the Company. The liquidation preference of the Class B Redeemable Preferred stock is the face amount, $1,000 per share, plus all accrued and unpaid dividends. The Company is required to redeem all of the outstanding shares of the stock on December 31, 2001, subject to the legal availability of funds. At December 31, 1995 and 1994 undeclared, unpaid dividends relating to the Class B Redeemable Preferred Stock totaled $2,752,000 and $1,997,000, respectively, and have been accrued and are included in the Class B Redeemable Preferred Stock balance.\nRedemption of the stock may occur after payment in full of the principal and interest amount due on the senior subordinated notes, and the redemption of the Series A-1 and A-2 Preferred Stock. Mandatory redemptions are required from excess cash flows, as defined in the stock agreements. Through December 31, 1995, there has been no available cash flow permitting mandatory redemption.\n12% Cumulative Exchangeable Redeemable Preferred Stock\nThe Company initially issued 2,858,723 shares of 12% Cumulative Exchangeable Redeemable Preferred Stock (the \"Public Preferred Stock\"), par value $.01 per share, pursuant to the acquisition of the Company during fiscal year 1990. The Public Preferred Stock was recorded at fair value on the date of original issue, November 21, 1989, and the Company is making periodic accretions under the interest method of the excess of the redemption value over the recorded value. Accretion for the years ended December 31, 1995 and 1994 was $1,148,000 and $1,040,000, respectively.\nThe Public Preferred Stock has a 20 year maturity, however, the Company must redeem, out of funds legally available, 20% of the Public Preferred Stock on the 16th, 17th, 18th and 19th anniversaries of November 21, 1989, the date of the stock's issuance, leaving 20% to be redeemed at maturity. On any dividend payment date, after November 21, 1991, the Company may exchange the Public Preferred Stock, in whole or in part, for 12% Junior Subordinated Debentures that are redeemable upon terms substantially similar to the Public Preferred Stock and subordinated to all indebtedness for borrowed money and like obligations of the Company.\nThe Public Preferred Stock accrues a semi-annual dividend at an annual rate of 12% ($1.20) per share, based on the liquidation preference of $10 per share, and is fully cumulative. Through November 21, 1995, the Company had the option to pay dividends in additional shares of Preferred Stock in lieu of cash. Dividends in additional shares of the Preferred Stock are paid at the rate of 0.06 of a share of the Preferred Stock for each $.60 of such dividends not paid in cash. Dividends are payable by the Company, provided the Company has legally available funds under Maryland law, when and if declared by the Board of Directors, commencing June 1, 1990, and on each six month anniversary thereof. For the years 1992 through 1994 and for the dividend payable June 1, 1995, the Company has accrued undeclared dividends in additional shares of preferred stock. These accrued dividends are valued at $3,950,000. Had the Company accrued such dividends on a cash basis, the total amount accrued would have been $15,101,000. For the dividend payable December 1, 1995, the Company accrued $2,157,000 of dividends using a cash basis. All future dividend accruals will be on a cash basis.\nThe Company has not declared or paid dividends since 1991, due to restrictions and ambiguities relating to the payment of dividends contained within its charter, its working capital facility agreement, and under Maryland law.\nNote 7. Stockholders' Investment and Stock Options\nCommon Stock\nAt December 31, 1995 and 1994, common stock consists of 50,000,000 shares authorized and 23,076,753 shares issued and outstanding of Class A common stock; and 5,000,000 shares authorized and 4,037,628 shares issued and outstanding of Class B common stock. The common stock has no par value and an aggregate capital value for all shares of $77,500.\nThe relative rights, preferences, and limitations of the Class A common stock and the Class B common stock are in all respects identical. The holders of the common stock have one vote for each share of common stock held. Subject to the prior rights of the Public Preferred Stock or any series of the Series A preferred stock, holders of Class A and the Class B common stock are entitled to receive such dividends as may be declared.\nStock Warrants\nThe Company issued the Class B Preferred Stock shareholder common stock warrants to purchase up to 3,150,468 of Class A common stock of the Company in 1992. The stock warrant was valued at $1,109,000 and such amount was shown as an increase in Capital in Excess of Par. The warrant was initially exercisable to purchase up to 1,181,425 shares at any time. The warrant increased by 656,348 shares on June 30, 1993, and July 1, 1994 and by 656,347 shares on July 1, 1995. Through December 31, 1995, 1,837,773 shares of Class A Common Stock has been purchased under the warrant. The price per share at which shares have been purchased and are purchasable upon the exercise of the warrant is $.0025.\nIn 1994, Porter deposited $3 million with the Company's bank to provide the Company with increased borrowing capability under its senior credit facility (see Note 5). In exchange, Porter was issued 500,000 shares of Class A common stock for which the Company recorded additional interest expense of $410,000. The Company also granted Porter a warrant to acquire 7,228,916 shares of the Company's Class A common stock at a purchase price of $.83 per share which approximated the estimated market value of the Company's common stock at the issuance date. The warrant is fully exercisable and has a term of ten years from the date of issue.\nStock Options\nThe Company's Long-Term Incentive Compensation Plan (the \"Stock Option Plan\") provides for the issuance of both incentive and non statutory stock options. Under the terms of the Stock Option Plan, 2,168,215 shares of the Company's Class A common stock are available for issuance under options granted by the Plan Administrator, who is appointed by the Board of Directors, to key employees, including officers and directors. The option price of $1.42 per share, determined by the Board of Directors, is not less than the fair market value at the date of the grant and the options are generally exercisable over a four year period. Additional information as to options is as follows (amounts in thousands, except per share data):\nOptions ----------------------------------------- Option price Outstanding per share ----------- ----------\nBalance, December 31, 1992 702 $1.42\nGranted 10 1.42 Exercised (3) 1.42 Canceled (26) 1.42 --- ---- Balance, December 31, 1993 683 1.42\nGranted -- -- Exercised -- -- Canceled (57) 1.42 ----- ---- Balance, December 31, 1994 626 1.42\nGranted -- -- Exercised -- -- Canceled (28) 1.42 ----- ---- Balance, December 31, 1995 598 $1.42\nIn 1993, an agreement was reached to provide Mr. Beninati and Mr. Wood with an option to individually purchase up to 700,459 shares of the Company's Class A Common Stock from the Company at $.50 per share. Under the terms of the agreement 350,230 shares vested immediately and the remainder vested ratably over the next twelve months. The Company recorded compensation expense related to these options based upon the difference between the exercise price and the estimated fair value of $.82 per share at the measurement date of the stock options.\nIn March 1996, the Board of Directors approved, subject to ratification by the voting common stockholders, two stock option plans for certain key executives and for a larger employee group. Under the plans, a total of 6,644,974 shares of common stock may be awarded at an exercise price not lower than fair market value with vesting based upon the passage of time and\/or certain significant events.\nNote 8. Agreement with Sapiens International\nIn 1993, the Company entered into a series of agreements (the \"Sapiens Agreements\") with Sapiens, the developers of certain commercial user interface software. The Sapiens Agreements gave the Company exclusive rights to distribute and integrate certain Sapiens software to the Federal Government, in selected areas of the United States and parts of the Pacific Rim. During 1994, the Company and Sapiens restructured the existing agreements releasing the Company from its existing obligations under the agreements in certain U.S. locations and parts of Asia and relinquishing certain exclusive rights in those territories. The Company retained certain rights to market certain software to the Federal Government and others in exchange for remaining payments of $800,000 in license fees, payable in eight monthly installments of $100,000 beginning December 1994, which have been fully paid. The Company also agreed to terminate a proposed joint venture with Sapiens, and accordingly repaid Sapiens the amount of $400,000 previously paid to the Company in contemplation of the proposed joint venture. In 1994, the Company also recorded a provision of approximately $1.4 million to fully write-off the remaining asset value of the license based on a reevaluation of its business plans.\nNote 9. Commitments and Contingencies\nLeases\nThe Company leases office space and equipment under non-cancelable operating leases with variable expiration dates, some of which contain renewal options.\nAt December 31, 1995, minimum rent payments under non-cancelable operating leases are as follows (in thousands):\n1996 $5,486 1997 3,349 1998 2,005 1999 1,495 2000 254 ----\nTotal minimum lease payments 12,589 Less total minimum sublease rentals (936) ------ Net minimum lease commitments $11,653 ======\nRent expense charged to operations for 1995, 1994, and 1993 totaled $4,349,000, $5,178,000 and $6,188,000, respectively.\nIn March 1996, the Company signed a twenty year lease with annual lease payments of $1,447,000 for a building that will serve as its Corporate headquarters and provide significant additional manufacturing and integration space. This lease will result in a reduction of the Company's lease costs.\nLegal - - -----\nA description of certain legal matters follows:\nRosecliff, Inc., et al v. C3, Inc., et al. (94 CIV. 9104) - - ---------------------------------------------------------\nThis case was filed in December, 1994 in the United States District Court for the Southern District of New York. Rosecliff, Inc. (\"Rosecliff\") is a merchant banking group with whom the Company had been negotiating an equity\/subordinated debt private placement transaction. Upon termination of this transaction, Rosecliff filed a suit seeking payment of its expenses, the specific enforcement of the acquisition agreement (or in the alternative lost profits) and $1 million for the violation of the \"no-shop\" provision in the Agreement. On motion to dismiss, the Court dismissed the claim seeking specific enforcement or lost profits (whether the plaintiffs will seek to replead that claim is unclear). A magistrate has recommended that the Company be held liable for the payment of Rosecliff's expenses in the amount of $1.1 million. Discovery is ongoing as to the remainder of the suit. While no ultimate assurances can be made as to those claims that the Court has not dismissed, the Company believes it has substantial defenses to the claim for violation of the no-shop provision and has made adequate provision for the payment of Rosecliff expenses.\nThe Company is a party to various other lawsuits arising in the ordinary course of business. In the opinion of management, while the results of litigation cannot be predicted with certainty, the final outcome of such matters will not have a materially adverse effect on the Company's consolidated financial position or results of operations.\nNote 10. Related Parties\nMr. Joseph P. Beninati and Mr. John B. Wood became employees of the Company in 1992 and currently serve as a Director, and President, Chief Executive Officer and Director, respectively. Mr. Beninati served as Chairman of the Board for the majority of 1994 before resigning January 5, 1995 and the Company will pay him $165,000 annually subject to a three year employment agreement beginning in 1995. Prior to 1992 they provided consulting services to the Company through their firm, Beninati & Wood, Inc. for which unpaid advisory fees at December 31, 1995 totaled $525,000. During 1993, $132,000 in legal costs were paid by the Company on behalf of Mr. Beninati and Mr. Wood in connection with the Settlement Agreement, pursuant to indemnification provisions of the Company's bylaws.\nMr. Fred Knoll, former Chairman of the Board of Directors of the Company, and various related entities, were paid $759,000 in 1993 for reimbursement of expenses. Amounts reimbursed in fiscal year 1993 include $612,000 of legal fees and other costs incurred in connection with the Settlement Agreement, pursuant to indemnification provisions of the Company's bylaws.\nMr. Porter has a consulting agreement with the Company whereby he will be compensated $200,000 a year for specified services. Mr. Porter has not requested payment under this agreement in 1995 or 1994.\nMr. Byers, a director of the Company, has a consulting agreement with the Company to help the Company expand its business operations into the international marketplace. Under this agreement Mr. Byers receives $8,000 a month for his services, and receives an additional $500 per day for overseas travel undertaken on behalf of the Company. In 1995, Mr. Byers was compensated $121,500.\nNote 11. Business Segments\nThe Company operates in three market segments: systems and services (\"The Systems and Services Group\"); maintenance services (the \"Field Engineering Group\") and consulting services (the \"Consulting Group\").\nThe Systems and Services Group consists of systems integration and software services. This group provides turnkey system solutions, supports clients through software, hardware and systems engineering services, hardware integration, facilities management, training and post-implementation technical services.\nThe Field Engineering Group provides third party computer hardware maintenance services.\nThe Consulting Group provides computer consulting (primarily on a contract labor basis) to support its customers' existing information technology capabilities.\nField Engineering and Consulting are viewed by the Company to be additional segments of the complete life cycle services offered by the Company.\nIn order to gain further operational efficiencies, in 1996 the Company will consolidate and reorganize certain divisions.\nSelected financial information for the Company's three business segments is presented below (in thousands). For a description of the accounting policies related to this information see Note 1.\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\nDr. Fred Charles Ikl'e, Chairman of the Board - - --------------------------------------------- Dr. Ikl'e (age 71) was elected to the Company's Board of Directors on January 31, 1994 and was elected Chairman of the Board at the January 6, 1995 Board of Directors meeting. He is Chairman of Conservation Management Corporation and Director of the Zurich-American Insurance Companies. Dr. Ikl'e is also a Director of the National Endowment for Democracy and a Distinguished Scholar at the Center for Strategic & International Studies. From 1981 to 1988, Dr. Ikl'e served as Under Secretary of Defense for Policy.\nJohn B. Wood, Director, President and Chief Executive Officer - - -------------------------------------------------------------\nMr. Wood (age 32) was elected President and Chief Executive Officer on February 16, 1994. Mr. Wood was appointed Chief Operating Officer on October 8, 1993 after serving as Executive Vice President from May of 1992. He was elected to the Board of Directors on May 13, 1992. Mr. Wood joined the Company on February 13, 1992. Prior to joining the Company, Mr. Wood was a founder of Beninati & Wood, Inc., an investment banking firm which had provided services to the Company. Prior to that time, in 1990, he was a member of the Private Placement Department at UBS Securities, Inc.\nJoseph P. Beninati, Director - - ----------------------------\nMr. Beninati (age 32), a director, is presently a founding general partner of Antares, a private equity firm devoted to information technology and healthcare investments. Mr. Beninati was the Company's Chairman of the Board from 1994 until 1995. Mr. Beninati was appointed Chief Marketing Officer in October of 1993, and prior to that served as Executive Vice President of Finance. He joined the Company in February of 1992 and was elected to the Board of Directors in May of 1992. Mr. Beninati resigned in 1995 to organize Antares while operating Beninati & Wood, Inc., an investment banking firm which he co-founded in 1990. In the 1980's Mr. Beninati was an officer of the Long-Term credit Bank of Japan and in the Corporate Finance Department of Dean Witter Reynolds, Inc.\nDr. Stephen D. Bryen, Director - - ------------------------------\nDr. Stephen Bryen (53) was elected to the Company's Board of Directors on January 31, 1994. He is currently President of Delta Tech, a high technology consulting and government relations firm. Delta Tech specializes in U.S. and foreign high technology issues. Delta Tech's mission is to promote new technology, represent high technology companies and identify business opportunities for Delta Tech clients. Concurrently, Dr. Bryen is President of Secured Communications Technology, Inc. a developer of computer security software. Dr. Bryen serves as a Security Board Member of the Space Systems\/Loral Corporation of Palo Alto, California which develops and manufactures civilian and military satellites for telecommunications, television, weather forecasting, mapping, scientific measurement and other tasks. Dr. Bryen is a board member of Greenray\/CMAC Industries, based in Mechanicsburg, Pennsylvania. Greenray\/CMAC makes high technology quartz crystals used in various defense and civilian electronics applications. From 1981 to 1988 Dr. Bryen served as Deputy Under Secretary of Defense for Trade Security Policy and as the Director of the Defense Technology Security Administration, which he founded.\nNorman P. Byers, Director - - -------------------------\nMr. Byers (age 49) was elected to the Board of Directors on January 31, 1994. He has been president of International Strategies Limited, a Washington, DC international business consulting firm since November, 1993. Before that appointment, he had served as the vice president of the Beaconsfield Corporation, another local international business consulting firm. From 1968 until his retirement in 1989, Mr. Byers served in a variety of operational and staff positions in the United States Air Force.\nWilliam L. Prieur Brownley, Vice President and General Counsel and Secretary - - ----------------------------------------------------------------------------\nMr. Brownley (age 39) joined the Company in April, 1991 and is responsible for the management of the Company's legal affairs. For the five years prior to joining the Company, he served as Assistant General Counsel and then as General Counsel at Infotechnology Inc., an investment company whose holdings included various companies in the communications industry. Mr. Brownley also served as a Director at Comtex Scientific Corporation and the Learning Channel, Inc. from 1990 to 1991.\nGerald D. Calhoun, Vice President, Human Resources, and Secretary, Telos - - -------------------------------------------------------------------------------- Corporation - - -----------\nMr. Calhoun (age 46) joined the Company as Vice President, Human Resources, in August, 1989. Prior to joining the Company he served as Director, Risk and Financial Management of BDM International, a government contractor which provides consulting services, Vice President, Human Resources of Halifax Corp. a government contractor providing technical services and third party computer maintenance, and as Director for the U.S. Department of Labor, Employment Standards Administration.\nF. Bruce Eckhoff, President, Telos Consulting Services - - ------------------------------------------------------\nMr. Eckhoff (age 51) became President of Telos Consulting Services in 1992. Mr. Eckhoff served as Chairman and Chief Executive Officer of Telos's Corporation subsidiary, Telecommunications Sciences Corporation, from 1989 until its divestiture in 1992. Mr. Eckhoff joined Telos Corporation in 1980 as a Regional Manager. Prior to joining Telos Corporation, Mr. Eckhoff was an independent consultant in the programming and analysis field.\nMark W. Hester, President, Telos Field Engineering and Vice President, Telos - - -------------------------------------------------------------------------------- Corporation - - -----------\nMr. Hester (age 43) joined Telos in 1979 and was appointed as President of Field Engineering in 1987. He is responsible for all new business activities and operations activities at 85 computer Field Service locations nationally as well as 6 overseas locations. Previously he has held progressive positions within Telos as a Field and Regional Manager of Operations and Vice President of Marketing. Mr. Hester received extensive training from IBM Corporation after a successful military commitment of nearly eight years.\nRobert J. Marino, President, Telos Systems Integration and Executive Vice - - -------------------------------------------------------------------------------- President - - ---------\nMr. Marino (age 59) joined the Company in 1988 as Senior Vice President of Sales and Marketing. In 1990, his responsibilities were expanded to include Program Management in addition to sales and marketing. On January 1, 1994, Mr. Marino was promoted to President of Telos Systems Integration, a position he currently holds. Prior to joining the Company in February, 1988, Mr. Marino held the position of Sr. Vice President of Sales and Marketing with Centel Federal Systems and M\/A-COM Information Systems, both of which are U.S. Government contractors.\nRobert A. Spearing, President, Telos Information Systems - - --------------------------------------------------------\nMr. Spearing (age 56) was appointed President of Telos Information Systems in 1993 and is responsible for all sales and operations activities of that division. Previously, Mr. Spearing held the position of Vice President of Eastern Operations within the Telos Systems Group. Prior to joining Telos Corporation in 1992, Mr. Spearing was with the National Aeronautics and Space Administration for 28 years. His last assignment at NASA was Director of Mission Operations and Data Systems at the Goddard Space Flight Center.\nLorenzo Tellez, Chief Financial Officer, Treasurer, and Vice President - - ----------------------------------------------------------------------\nMr. Tellez (age 38) was appointed Chief Financial Officer of the Company in 1993 and Treasurer in 1994. He joined Telos Corporation (California) in 1989 where he was responsible for all financial and regulatory functions. Mr. Tellez is a Certified Public Accountant. Prior to joining Telos Corporation, Mr. Tellez served as a Senior Manager with Arthur Andersen & Company, a public accounting firm.\nLee R. Whitley, President, Telos Federal Systems - - ------------------------------------------------\nMr. Whitley (age 58) was appointed President of Telos Federal Systems in October 1993, and has been with Telos Corporation in various diversified key management positions since 1981. Previously, Mr. Whitley was Vice President of Central Operations in Telos Systems Group. Before joining Telos Corporation, Mr. Whitley served for twenty years in the U.S. Army Field Artillery, retiring as a Lieutenant Colonel. Mr. Whitley resigned from the Company in January 1996.\nEach of the directors and executive officers of the Company is a United States citizen.\nItem. 11. Executive Compensation\nInformation is set forth in the Summary Compensation Table included on the following page with respect to all forms of compensation for service rendered in all capacities to the Company during the fiscal years ended December 31, 1995, 1994, and 1993, of the Chief Executive Officer and four other most highly paid executive officers during 1995.\nStock Option Grants\nThe Company did not grant any stock options in 1995, and therefore the Summary Table of Options\/SAR Grants in the Last Fiscal Year has been omitted.\nManagement Stock Options\nThe following table shows, as to the individuals named in the Summary Compensation table the number of shares acquired during such period through the exercise of options, and the number of shares subject to and value of all unexercised options held as of December 31, 1995.\nCompensation of Directors\nDuring the fiscal year ended December 31, 1995, employee directors were paid a fee of $2,000 for each Board meeting attended. Outside directors Mr. Byers and Dr. Bryen were paid an annual fee of $25,000, and further compensated at a rate of $750 for each meeting in excess of four meetings a year. Chairman of the Board, Dr. Ikle', is paid $25,000 quarterly for his service on the Board. In addition, Mr. Byers receives $5,000 per annum for his service as Proxy Chairman. The compensation paid to the outside directors is paid pursuant to a proxy agreement between the Company, the Defense Investigative Service and certain of the Company shareholders. Other directors have been awarded stock options in prior years as additional\ncompensation for their services as directors. Additional options may be awarded to outside directors in the future. During the fiscal year ended December 31, 1995, no directors of the Company were awarded options.\nEmployment Contracts\nThe Company is a party to agreements with certain of its executive officers. Mr. William Brownley, General Counsel, Mr. Gerald Calhoun, Vice President Human Resources, Mr. Mark Hester, President of Telos Field Engineering, Mr. Robert Marino, President of Telos Systems Integration, Mr. Lorenzo Tellez, Chief Financial Officer, and Mr. John Wood, Chief Executive Officer, have agreements with the Company which provide for a payment of two year's base salary then in effect if involuntarily terminated. Accordingly, Mr. Brownley, Calhoun, Hester, Marino, Tellez and Wood would receive, given their present salary levels, $130,000, $130,000, $163,500, $165,000, $170,000 and $225,000, respectively. In addition, these executive officer's agreements provide for bonus payments should certain operating results be attained.\nThe Company is also a party to a three year employment agreement with Mr. Beninati, Director, and former Chairman of the Board. Under the agreement, Mr. Beninati will receive $165,000 in each of the next two years.\nItem 12.","section_11":"","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nMr. Joseph P. Beninati and Mr. John B. Wood became employees of the Company in 1992 and currently serve as a Director, and President, Chief Executive Officer and Director, respectively. Mr. Beninati served as Chairman of the Board for the majority of 1994 before resigning January 5, 1995 and the Company will pay him $165,000 annually subject to a three year employment agreement beginning in 1995. Prior to 1992 they provided consulting services to the Company through their firm, Beninati & Wood, Inc. for which unpaid advisory fees at December 31, 1995 totaled $525,000. During 1993, $132,000 in legal costs were paid by the Company on behalf of Mr. Beninati and Mr. Wood in connection with the Settlement Agreement, pursuant to indemnification provisions of the Company's bylaws.\nMr. Fred Knoll, former Chairman of the Board of Directors of the Company, and various related entities, were paid $759,000 in 1993 for reimbursement of expenses. Amounts reimbursed in fiscal year 1993 include $612,000 of legal fees and other costs incurred in connection with the Settlement Agreement, pursuant to indemnification provisions of the Company's bylaws.\nMr. Porter has a consulting agreement with the Company whereby he will be compensated $200,000 a year for specified services. Mr. Porter has not requested payment under this agreement in 1995 or 1994.\nMr. Byers, a director of the Company, has a consulting agreement with the Company to help the Company expand its business operations into the international marketplace. Under this agreement Mr. Byers is compensated $8,000 per month for his services, as well as $500 per day for overseas travel undertaken on behalf of the Company. In 1995, Mr. Byers was compensated $121,500.\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\nAll schedules are omitted because they are not applicable or the required information is included in the consolidated financial statements or notes thereto.\n(a) 3. Exhibits:\nExhibits marked with (1*) are incorporated by reference to the Company's Registration Statement No. 2-84171 filed June 2, 1983. The exhibits marked with (2*) are incorporated by reference to the Company's Amendment No. 1 to Schedule 14D-9 filed on December 2, 1988. Exhibits marked with (3*) are incorporated by reference to the Company's Form 10-K report for the fiscal year ended March 31, 1987. Exhibits marked with (4*) are incorporated by reference to the Company's Form 10-K report for the fiscal year ended March 31, 1989. Exhibits marked with (5*) are incorporated by reference to the Company's Form 10-K report for the fiscal year ended March 31, 1990. Exhibits marked with (6*) are management contracts or compensatory plans or arrangements required to be filed by Item 14(c) of Form 10K. The registrant will furnish to stockholders a copy of other exhibits upon payment of $.20 per page to cover the expense of furnishing such copies. Requests should be directed to the attention of Investor Relations at Telos Corporation, 460 Herndon Parkway, Herndon, Virginia 22070-5201.\n2.6 Stock Purchase Agreement dated as of January 14, 1992, by and among C3, Inc., Telos Corporation and Contel Federal Systems, Inc. (Incorporated by reference to C3, Inc. Form 8-K filed January 29, 1992)\n3.1 (1*) Articles of Amendment and Restatement of C3, Inc.\n3.2 (1*) Articles of Amendment of C3, Inc. dated August 31, 1981.\n3.3 (3*) Articles supplementary of C3, Inc. dated May 31, 1984.\n3.4 (4*) Articles of Amendment of C3, Inc. dated August 18, 1988.\n3.5 Articles of Amendment and Restatement Supplementary to the Articles of Incorporation dated August 3, 1990. (Incorporated by reference to C3, Inc. 10-Q for the quarter ended June 30, 1990)\n3.6 Restated Bylaws of C3, Inc. (Incorporated by reference to C3, Inc. 10-Q for the quarter ended December 31, 1990)\n3.7 Articles of Amendment of C3, Inc. dated April 13, 1995\n4.1 Form of Indenture between the Registrant and Bankers Trust Company, as Trustee, relating to the 12% Junior Subordinated Debentures Due 2009. (Incorporated herein by reference to C3's Registration Statement on Form S-4 filed October 20, 1989)\n4.3 Form of the terms of the 12% Cumulative Exchangeable Redeemable Preferred Stock of the Registrant. (Incorporated herein by reference to C3's\nRegistration Statement on Form S-4 filed October 20, 1989)\n4.4 Shareholders Agreement dated as of August 3, 1990 by and among C3, Inc.; Union de Banques Suisses (Luxembourg), S.A.; C3 Investors, L.P.; Anthony Craig, together with the investors; the Class A holders; MIM Limited; Knoll and Associates, Inc.; Murray Enterprises PLC; Electra Development Holdings; and Hartley Limited. (Incorporated by reference to C3, Inc. 10-Q for the quarter ended June 30, 1990)\n4.5 Articles of Amendment and Restatement of the Company, filed with the Secretary of State of the State of Maryland on January 14, 1992. (Incorporated by reference to C3, Inc. Form 8-K filed January 29, 1992)\n10.10 (3*) Lease Agreement for the Herndon Facility.\n10.11 (4*) Amended Lease Agreement - Herndon Facility.\n10.20 Revolving and Reducing Senior Facility Credit Agreement dated as of January 14, 1992, among C3, Inc., Telos Corporation and NationsBank, N.A. (Incorporated by reference to C3, Inc. Form 8-K filed January 29, 1992)\n10.31 September 27, 1993 Settlement Agreement among John R.C. Porter, Toxford Corporation, Cantrade Nominees Ltd., Cantrade Trust Company (Cayman) Ltd., Cantrade Trustee, AG, Fred Knoll, Cottonwood Holdings, C3 Investors L.P., C3, Inc., Telos Corporation, Joseph P. Beninati, John B. Wood and Beninati & Wood, Inc. (Incorporated by reference to C3, Inc. Form 8-K filed October 18, 1993)\n10.32 September 27, 1993 Stock Purchase and Sale Agreement between Mr. John R.C. Porter and C3 Investors, L.P. (Incorporated by reference to C3, Inc. Form 8-K filed October 18, 1993)\n10.33 September 27, 1993 Stock Purchase and Sale Agreement between Mr. John R.C. Porter and Cottonwood Holdings, Inc. (Incorporated by reference to C3, Inc. Form 8-K filed October 18, 1993)\n10.34 September 27, 1993 Note Interest Purchase and Sale Agreement among Mr. John R.C. Porter, Cottonwood and C3, Inc. (Incorporated by reference to C3, Inc. Form 8-K filed October 18, 1993)\n10.35 October 8, 1993 Promissory Note in the amount of $8,438,000 issued by Mr. John R.C. Porter in favor of C3 Investors, L.P. (Incorporated by reference to C3, Inc. Form 8-K filed October 18, 1993)\n10.36 October 8, 1993 Promissory Note in the amount of $1,562,000 issued by Mr. John R.C. Porter in favor of Cottonwood Holdings, Inc. (Incorporated by reference to C3, Inc. Form 8-K filed October 18, 1993)\n10.37 September 27, 1993 Collateral Agency, Security and Pledge Agreement among Mr. John R.C. Porter, Mr. Fred Knoll, Cottonwood Holdings, C3 Investors, L.P., C3, Inc., Telos Corporation, Toxford Corporation, Cantrade Nominees Limited, Mr. Robert M. Ercole and Mr. Frank S. Jones, Jr. (Incorporated by reference to C3, Inc. Form 8-K filed October 18, 1993)\n10.38 September 27, 1993 Standstill Agreement among Mr. John R.C. Porter, Mr. Fred Knoll, Mr. Alfredo Frohlich and C3, Inc. (Incorporated by reference to C3, Inc. Form 8-K filed October 18, 1993)\n10.39 September 27, 1993 Mutual Release among Mr. John R.C. Porter, Mr. Fred Knoll, Cottonwood Holdings, C3 Investors, L.P., C3, Inc., Telos Corporation, Mr. Joseph P. Beninati, Mr. John B. Wood, and Beninati & Wood, Inc. (Incorporated by reference to C3, Inc. Form 8-K filed October 18, 1993)\n10.40 September 27, 1993 Consulting Agreement among Mr. Fred Knoll, C3, Inc. and Telos Corporation. (Incorporated by reference to C3, Inc. Form 8-K filed October 18, 1993)\n10.41 September 27, 1993 Letter Agreement among C3, Inc., Knoll Capital Management, Inc. and Telos Corporation regarding deferred Telos Corporation fees. (Incorporated by reference to C3, Inc. Form 8-K filed October 18, 1993)\n10.43 Amendment to Revolving and Reducing Senior Credit Facility dated as of December 31, 1993 among C3, Inc., Telos Corporation and NationsBank, N.A.\n10.44 Amendment to Revolving and Reducing Senior Credit Facility dated as of April 11, 1994 among C3, Inc., Telos Corporation and NationsBank, N.A.\n10.45 Amendment to Revolving and Reducing Senior Credit Facility dated as of June 8, 1994 among C3, Inc., Telos Corporation and NationsBank, N.A.\n10.46 Amendment to Revolving and Reducing Senior Credit Facility dated as of October 7, 1994 among C3, Inc., Telos Corporation and NationsBank, N.A.\n10.47 October 7, 1994 Letter Agreement among C3, Inc., Toxford Corporation, and NationsBank, N.A. regarding cash collateral held on behalf of the Company.\n10.48 October 25, 1994 General Release and Settlement memorandum among Sapiens International Corporation N.V., Sapiens International Corporation B.V., Sapiens U.S.A., Inc., C3, Inc. and Telos Corporation.\n10.49 Amendment to Revolving and Reducing Senior Credit Facility dated as of January 5, 1995 among C3, Inc., Telos Corporation and NationsBank, N.A.\n10.50 Amendment to Revolving and Reducing Senior Credit Facility dated as of January 12, 1995 among C3, Inc., Telos Corporation and NationsBank, N.A.\n10.51 Waiver and Amendment to Revolving and Reducing Senior Credit Facility dated as of April 17, 1995 among C3, Inc., Telos Corporation and NationsBank, N.A.\n10.52 Subordinated Bridge Note\/Promissory Note as of June 8, 1995 between Telos Corporation (Maryland) and Drayton English and International Investment Trust\n10.53 Subordinated Bridge Note\/Promissory Note as of June 8, 1995 between Telos Corporation (Maryland) and J. O. Hambro Investment Management, Ltd.\n10.54 Subordinated Bridge Note\/Promissory Note as of June 8, 1995 between Telos Corporation (Maryland) and North Atlantic Smaller Companies Investment Trust, PLC\n10.55 Subordinated Bridge Note\/Promissory Note as of June 8, 1995 between Telos Corporation (Maryland) and Mr. John R.C. Porter\n10.56 Subordinated Bridge Note\/Promissory Note as of June 8, 1995 between Telos Corporation (Maryland) and Sir Leslie Porter\n10.57 Subordinated Bridge Note\/Promissory Note as of June 8, 1995 between Telos Corporation (Maryland) and Second Consolidated Trust, PLC\n10.58 Series B Senior Subordinated Secured Note due October 1, 2000 as of October 13, 1995 between Telos Corporation (Maryland) and Drayton English and International Investment Trust\n10.59 Series B Senior Subordinated Secured Note due October 1, 2000 as of October 13, 1995 between Telos Corporation (Maryland) and J. O. Hambro Investment Management, Ltd.\n10.60 Series B Senior Subordinated Secured Note due October 1, 2000 as of October 13, 1995 between Telos Corporation (Maryland) and North Atlantic Smaller Companies Investment Trust, PLC\n10.61 Series B Senior Subordinated Secured Note due October 1, 2000 as of October 13, 1995 between Telos Corporation (Maryland) and Mr. John R.C. Porter\n10.62 Series B Senior Subordinated Secured Note due October 1, 2000 as of October 13, 1995 between Telos Corporation (Maryland) and Sir Leslie Porter\n10.63 Series B Senior Subordinated Secured Note due October 1, 2000 as of October 13, 1995 between Telos Corporation (Maryland) and Second Consolidated Trust, PLC\n10.64 Series B Senior Subordinated Secured Note due October 1, 2000 as of October 13, 1995 between Telos Corporation (Maryland) and Toxford Corp.\n10.65 Series C Senior Subordinated Unsecured Note due October 1, 2000 as of October 13, 1995 between Telos Corporation (Maryland) and Drayton English and International Investment Trust\n10.66 Series C Senior Subordinated Unsecured Note due October 1, 2000 as of October 13, 1995 between Telos Corporation (Maryland) and J.O. Hambro Investment Mangement, Ltd.\n10.67 Series C Senior Subordinated Unsecured Note due October 1, 2000 as of October 13, 1995 between Telos Corporation (Maryland) and North Atlantic Smaller Companies Investment Trust, PLC\n10.68 Series C Senior Subordinated Unsecured Note due October 1, 2000 as of October 13, 1995 between Telos Corporation (Maryland) and Mr. John R.C. Porter\n10.69 Series C Senior Subordinated Unsecured Note due October 1, 2000 as of October 13, 1995 between Telos Corporation (Maryland) and Sir Leslie Porter\n10.70 Series C Senior Subordinated Unsecured Note due October 1, 2000 as of October 13, 1995 between Telos Corporation (Maryland) and Second Consolidated Trust, PLC\n10.71 Series C Senior Subordinated Unsecured Note due October 1, 2000 as of October 13, 1995 between Telos Corporation (Maryland) and Toxford Corp.\n10.72 Amendment to Revolving and Reducing Senior Credit Facility dated as of August 4, 1995 Telos Corporation (Maryland), Telos Corporation (California) and NationsBank N.A.\n10.73 Amendment to Revolving and Reducing Senior Credit Facility dated as of October 13, 1995 Telos Corporation (Maryland), Telos Corporation (California) and NationsBank N.A.\n21 Schedule of Subsidiaries.\n27 Financial Data Schedule\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, Telos Corporation has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nTELOS CORPORATION\nBy: \/s\/John B. Wood ------------------------------ President and Chief Executive Officer\nDate: March 29, 1996 -----------------------------\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of Telos Corporation and in the capacities and on the date indicated.\nTelos Corporation Exhibit Index\nExhibit Number Exhibit Name ------ ------------\n3.7 Articles of Amendment of C3, Inc. dated April 13, 1995\n10.72 Amendment to Revolving and ReducingSeniorCredit Facility dated as of August 4, 1995 Telos Corporation (Maryland), Telos Corporation (California) and NationsBank N.A.\n10.73 Amendment to Revolving and ReducingSeniorCredit Facility dated as of October 13, 1995 Telos Corporation (Maryland), Telos Corporation (California) and NationsBank N.A.\n21 Schedule of Subsidiaries\n27 Financial Data Schedule","section_15":""}
{"filename":"818350_1995.txt","cik":"818350","year":"1995","section_1":"ITEM 1. BUSINESS\nRoadmaster Industries, Inc. (the \"Company\" or \"Roadmaster\" or \"RMI\"), through its operating subsidiaries, is one of the largest manufacturers of bicycles and a leading manufacturer of fitness equipment and toy products in the United States. The Company's major product lines consist of bicycles for the adult, teen and juvenile markets, fitness equipment, including stationary aerobic equipment, multi-station weight systems and benches, toy products such as tricycles, wagons, toy horses, bulk plastic toys, sleds and swing sets and hosiery and team sports equipment. The Company markets its products, primarily through mass merchandisers, under well established trade names with widespread consumer recognition and long operating histories, including Roadmaster(R) (1935), Vitamaster(R) (1950), Flexible Flyer(R) (1889), American Playworld(R) (1983), MacGregor(R) (1870), DP(R) (1953), Hutch(R) (1906), Reach(R) (1960) and Forster(R) (1988). In 1995, the Company had sales greater than $10 million each to 11 leading mass merchandisers, including Toys \"R\" Us, Inc. (\"Toys \"R\" Us\"); Wal-Mart Stores, Inc. (\"Wal-Mart\") and Target Stores, Inc. (\"Target\"). The Company has received several Vendor of the Year awards in the last couple of years from mass merchandisers, including Toys \"R\" Us, Wal-Mart, Target, Sears Canada, Shopko and Pamida.\nThe Company has developed successful relationships with mass merchandisers by providing a low cost product that management believes is differentiated from the competition based on superior features, and by supplying just-in-time inventory with proven reliability. Low costs are achieved through modern and efficient manufacturing facilities, low selling, general and administrative costs, and an experienced workforce. Savings from manufacturing are reinvested into higher quality componentry for Company products, thus providing a higher value product at a competitive cost. The Company emphasizes quality through strict design criteria to ensure high standards for all its products and believes that its return rates generally are among the lowest in the industry. In addition, the Company has developed flexible and efficient manufacturing operations that enable it to shift production runs to match demand.\nThe Company has achieved significant sales growth during the last several years. Since 1990, total sales have increased approximately 377%, from $153.1 million in 1990 to $730.9 million in 1995. The increase is due to a combination of increased sales in the Company's existing product lines, particularly in its core bicycle business, and the sales contributed by recent acquisitions, most notably the sporting goods subsidiaries acquired from The Actava Group Inc. (\"Actava\") in December 1994. Total sales for the year ended December 31, 1995 increased approximately 60% from the year ended December 31, 1994.\nThe Company, formed on June 1, 1987, acquired Roadmaster Corporation (\"RMC\"), a manufacturer of bicycles, fitness equipment and junior products, on August 10, 1987. On August 31, 1988, the Company acquired Ajay Enterprises Corporation, a manufacturer of fitness equipment and sports accessories which it subsequently merged with RMC. In June 1989, RMC sold its sports product line to Ajay Sports, Inc. (\"Ajay Sports\") and its wholly-owned subsidiary Ajay Leisure, Inc., the sale of which was not recorded for financial statement purposes until May 1992. In September 1993, the Company acquired certain assets of the Flexible Flyer Company (\"Flexible Flyer\"), a manufacturer of a variety of toy products. In September 1993, the Company, in a separate transaction, also acquired all of the capital stock of Flexible Flyer Europe, Ltd. (now \"Roadmaster Limited\"), a United Kingdom company and distributor of Flexible Flyer products which now distributes the Company's products in Europe. In October 1993, RMC entered into a distribution agreement with MacGregor Sports Products, Inc., a wholly-owned subsidiary of MacGregor Sports and Fitness, Inc., a publicly-held company engaged in the business of marketing and distributing a broad range of sports, recreational and fitness products under the MacGregor trademark. Pursuant to such distribution agreement, RMC became the exclusive worldwide distributor of MacGregor(TM) brand baseball, softball, basketball, football, soccer, hockey, volleyball, racquet sports and other products, for a term of five years, with a five-year renewal option. In early 1994, the Company consolidated several of its operating subsidiaries, including Flexible Flyer, Inc. with its RMC subsidiary.\nIn February 1994, the Company acquired substantially all the assets of American Playworld, Inc., a leading manufacturer of trampolines distributed mainly to mass merchants. American Playworld's operations are now conducted by RMC. On December 6, 1994, the Company acquired Diversified Products Corporation (\"DP\"), Nelson\/Weather-Rite, Inc. (\"Nelson\/Weather-Rite\"), Willow Hosiery Company, Inc. (\"Willow\") and Hutch Sports USA, Inc. (\"Hutch\") (collectively referred to as the \"Sports Subsidiaries\") from Actava. On March 23, 1995, Hutch acquired the sporting goods division of Forster Manufacturing Company (\"Forster\"). The Forster product categories acquired include various backyard and lawn games, including croquet, bocce ball, and volleyball. On April 28, 1995, Nelson\/Weather-Rite finalized the acquisition of certain assets and the business of MZH, Inc. (\"MZH\"), a manufacturer and marketer of sleeping bags. The Company's financial statements include the operations of its camping subsidiary, Nelson\/Weather-Rite from December 6, 1994 through December 31, 1995. Substantially all of Nelson\/Weather-Rite's assets were sold on March 8, 1996 to Brunswick Corporation (\"Brunswick\") for $120 million in cash and the assumption of certain liabilities. The net proceeds of such sale were applied to reduce outstanding indebtedness. As a result of such divestiture, the manufacturing and distribution of camping products is no longer a material portion of the Company's business.\nThe Company's principal executive offices are located at 250 Spring Street NW, Suite 3 South, Atlanta, Georgia 30303 and its telephone number is (404) 586-9000. The Company is incorporated under Delaware law.\nPRODUCTS\nBicycle Products. In recent years, sales of bicycles have increased primarily as a result of favorable social and demographic factors. Bicycling continues to rank as one of the most popular leisure time activities in the United States. Social factors behind this trend include increased consciousness of health, fitness and appearance. Demographic trends in the United States also favor strong bicycle sales. In particular, the post-war \"baby boom\" generation is a prime bicycle user group. According to the Bicycle Manufacturers' Association (\"BMA\"), an industry trade group comprised of the Company, Huffy Corporation (\"Huffy\") and Murray-Ohio Manufacturing Company (\"Murray\"), total bicycle industry sales have increased 6% from 1991 to 1995. During such period, the Company's sales growth for bicycles has been 192%.\nRoadmaster's line of bicycles includes virtually all types and sizes of bicycles for the juvenile, teen and adult markets and consists of numerous models which differ by frame style, size, gearing, braking systems, components, graphics and color. Models include both motocross-style bicycles and \"high-rise\" types, aimed primarily at juveniles, and a broad selection of all-terrain bicycles (\"ATBs\"). Roadmaster currently focuses its efforts on ATBs, which the BMA estimates accounted for approximately 54% of the bicycles sold in the United States in 1995. The most recent introductions to its bicycle product line are \"dual-suspension\" and oversized frame bicycles in the 26 inch ATB category and the expansion of the Motocyke(TM) line of 12, 16 and 20 inch bicycles (\"sidewalk bicycles\"). Management believes Roadmaster's line of sidewalk bicycles are among the most significant sellers in such bicycle products category.\nFitness Products. Sales of fitness equipment (including free weights and benches, multi-station weight systems, skiers, stair steppers, stationary exercise bikes and treadmills) in the United States have grown significantly as a consequence of increased consciousness of health, fitness and appearance and often benefit from the same demographic and social factors that positively affect bicycle sales. According to the National Sporting Goods Association (\"NSGA\"), a trade association, wholesale sales of exercise equipment in the United States market grew by an estimated 6% in 1995 to a total estimated market size of $1.935 billion. Sales of the Company's fitness products increased 57% in 1995 compared to 1994 due to increased sales of infomercial and Body By Jake(R) products and sales attributable to the acquisition of DP.\nToday, Roadmaster is a leading domestic manufacturer of a variety of fitness equipment such as stationary exercise bicycles, treadmills, weight benches, stack weight and other resistance systems,\nspecialty fitness items, ski machines and stair steppers. The Company's exercise and fitness equipment is sold primarily under the Vitamaster(R) and DP(R) names.\nIn 1995, Roadmaster broadened its fitness distribution channels by placing increased emphasis on television infomercials and television home shopping programs including the Home Shopping Network. Management believes the rollout of new products in this format increases consumer awareness of the Company's products and provides benefits of additional distribution along with \"as seen on TV\" advertising campaigns for the mass merchandisers. The Body By Jake(R), AB and Back Plus(TM) product and infomercial were selected as the Best Infomercial Product of the Year (1995) and the Best Infomercial of the Year, respectively, by the National Infomercial Marketing Association (\"NIMA\").\nToys. The Company's toy products are composed of many different kinds of products, including metal and plastic tricycles, preschool \"foot-to-floor\" ride-ons, wagons, 10 inch \"junior\" sidewalk bikes, snow sleds, plastic snow toys, swingsets, trampolines, toy horses and bulk plastic toys. The Company also manufactures and sells a variety of table and decorative lamps focusing on the children's market, such as decorative lamps employing licensed rights to various themes and characters of Disney Enterprises, Inc. (\"Disney\"). See \"LICENSING\" below for additional discussion.\nToy product categories in which the Company competes, which comprise only a portion of the total toy products market, accounted for approximately $315 million in wholesale sales in 1995 according to management's estimates. In addition, the Company estimates there were $127 million in wholesale sales of residential metal swing sets and gym sets and over $525 million in bulk plastic toys in 1995. Demographic trends in the United States continue to support strong sales of toy products as the number of children who are prime users of toy products remain at relatively high levels on a historical basis.\nThe Company is a leading domestic manufacturer and distributor of tricycles, wagons, 10 inch sidewalk bikes, swing sets, toy horses, trampolines, traditional wood and steel sleds and other toy products. The overall growth in the toy line has been the result of increases in its market share for traditional products including metal tricycles, metal swingsets, wagons and ride-ons, as well as the introduction of new products.\nIn 1995, the Company introduced a number of new and innovative toy products including: the Prodigy Swing System(TM); Bounce-A-Round See-Saw(TM); Sand Dune Rally(TM) sandbox; Having a Ball(TM) ball cage; 8' Junior All Pro Trampoline; Wave, Wiggle and Roll(TM) tricycles; Ready-Set-Grow(TM) ride-on; Shark Snow Board(TM) and Sno-Kat(TM) sled. New product introductions represented 9.1% of total toy sales in 1995 and accounted for 53.5% of the $15.6 million increase in total sales for toys from 1994 to 1995. Products introduced both capitalize on the Company's strong brand names, including Roadmaster(R), Flexible Flyer(R), American Playworld(R) and PlaySafe(TM) and provided further line extensions to the wide range of toy categories in which the Company competes.\nCamping. Subsequent to its acquisition of the Sports Subsidiaries, the Company, through its Nelson\/Weather-Rite subsidiary, was a leading supplier of outdoor and camping equipment to mass merchandisers and specialty stores.\nIn 1995, Nelson\/Weather-Rite expanded its product line by acquiring MZH, a manufacturer and marketer of sleeping bags. See Item 7. \"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION\" for a further description of the MZH acquisition.\nNelson\/Weather-Rite continued to perform well during 1995 growing revenues 50.8% and more than doubling operating profits. Excluding the acquisition of MZH, Nelson\/Weather-Rite's operating profit increase was approximately 50.9% on a 7.1% increase in revenues. Nelson\/Weather-Rite contributed $96.4 million in sales for 1995 and $3.2 million in net income for the year then ended.\nIn order to reduce the Company's substantial indebtedness, the Company decided to divest its camping operations based on anticipated realizable values for such operations. Subsequent to year end, on January 22, 1996, the Company entered into an agreement to sell Nelson\/Weather-Rite to Brunswick for cash consideration of $120 million and the assumption of certain liabilities. Such transaction was consummated on March 8, 1996. See Item 7. \"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION\" for a further discussion of the sale.\nOther Products. The Company also markets and distributes a line of team sports and hosiery products through its Hutch and Willow subsidiaries, respectively.\nHutch is a national marketer and distributor of products for team sports and is an official licensee for The National Football League (\"NFL\"), The National Basketball Association (\"NBA\"), The National Hockey League (\"NHL\"), Major League Baseball (\"MLB\") and various colleges. Its major product lines include basketballs, footballs, baseballs, baseball gloves and football outfits. Hutch markets its products under both the Hutch(R) and MacGregor(R) brands. The MacGregor(R) products are marketed under Roadmaster's Distribution Agreement with MacGregor Sports Products, Inc. signed in October 1993. Hutch employs similar distribution channels to Roadmaster.\nIn March 1995, Hutch acquired the sporting goods division of Forster Manufacturing Company. The product categories acquired include various backyard and lawn games, including croquet, bocce ball, and volleyball. The Forster products contributed $6.8 million in sales in 1995.\nWillow has a nationally distributed line of hosiery and is a licensee for the NFL, Keds(R) and Pro Keds(R), as well as various colleges and universities. Willow's products are manufactured to specification by hosiery manufacturers located in the southeastern United States. Like Hutch, Willow employs distribution channels similar to the Company's other operating subsidiaries. During the second quarter of 1995, the operations of Willow were consolidated with those of Hutch at one location in Erlanger, Kentucky.\nLICENSING\nIn tandem with its product and design innovation efforts, the Company and its subsidiaries are licensees of numerous heavily promoted trademarked themes which are used to support sales of toys, children's lighting products, fitness products, team sports products, and certain hosiery lines. Characters from popular television programs and feature films, and professional team and college logos, frequently are added to increase consumer appeal. Usually, a royalty is paid to the licensor based on a negotiated fixed percentage of sales.\nThe Company or its subsidiaries have various license agreements with Disney(TM) to utilize various character names and depictions such as Mickey and Minnie , Pocohontas(TM), and Gargoyles(TM) on Company products such as tricycles, sidewalk bikes, action riders, wagons and children's lamps. Such licenses, which expire at various dates through June 1997, provide for royalties based on a negotiated percentage of sales and provide for guaranteed minimum royalties with royalty payments payable quarterly. Although such licenses are generally non-exclusive, the Disney trademarks typically have not been licensed to competitors of the Company. The Company has always been able to obtain renewals of its license rights with Disney. The Company also has licenses to utilize the Barbie(R) and Precious Moments(R) characters for use with its children's lamps. These licenses expire at separate times through December 1996. While no assurances can be given, the Company expects to maintain, and is seeking to expand, its license rights to certain other popular children's themes and characters.\nThe Company utilizes certain endorsement and license agreements for use with its fitness marketing programs. These agreements include both print and television promotions as well as personal appearances of certain \"sports celebrities\" to promote the Company's products. Current agreements\ninclude agreements with Body By Jake Licensing Corporation, Pro Group, Inc. and Thighmaster Corporation. These agreements expire at various times through December 1998.\nHutch is an official licensee for the NFL, NBA, NHL, MLB and various colleges. Hutch also has agreements with Glenn Robinson and Chris Mullin of the NBA to use their names in endorsing their products. Willow is a licensee for the NFL, Keds(R), Pro Keds(R) and various colleges. Current licenses for Hutch and Willow expire at various times through October 1997.\nMANUFACTURING\nThe Company's manufacturing operations primarily employ a focused factory approach utilizing individual \"manufacturing cells\". Like a factory within a factory, each manufacturing cell supports an entire product line from welding to packaging. This approach allows a flexible response to both increases in demand and changing seasonal product mix and has allowed the Company to acquire a reputation as a proven, reliable supplier of just-in-time inventory. The ability to rapidly respond to changing demands and to produce products just-in-time minimizes the Company's risk of over production and inventory obsolescence. Roadmaster manufactures children's bicycles, sidewalk bikes, toy products, stationary exercise bikes and free weights at its manufacturing facilities in Olney, Illinois; adult bicycles at its facilities in Delavan, Wisconsin and Effingham, Illinois. Lighting products are manufactured at the Company's facilities in Kansas City and North Kansas City, Missouri. Trampolines and related products are manufactured at the Company's facility in Ogden, Utah. The Company's facility located in Opelika, Alabama, manufactures DP and Vitamaster fitness products, as well as mountain bikes.\nThe Company's facility located in West Point, Mississippi, manufactures traditional Flexible Flyer products as well as a number of new toy products. Flexible Flyer's plastic molding capacity has allowed the Company to expand its toy products lines into a variety of molded plastic toys. During 1995, the Company added additional plastic molding capacity thereby decreasing its dependency on outside parties for certain plastic parts.\nThe Company previously manufactured treadmills, swing sets and certain fitness equipment at a facility in Tyler, Texas. During the year, the Company realigned certain fitness operations by moving production of weight systems, weight benches, stair steppers, ski machines and specialty fitness products from the Tyler facility to Opelika. In December 1995, the Company announced plans to close its Tyler facility and consolidate its remaining Tyler operations into the Opelika facility. The Company also is relocating its stationary exercise bikes production from the Olney facility to Opelika with a corresponding transfer of Opelika's mountain bike production to Olney. These actions are designed to reduce certain fixed costs as well as streamline and focus operational activities along product categories. This restructuring of operations is expected to be finished by mid-year 1996. See Item 7. \"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION\" for a further discussion of the restructuring.\nBasic materials used by Roadmaster are purchased primarily from domestic sources. Certain component parts (such as bicycle tires and derailleurs) are currently obtainable on an economically feasible basis only from foreign suppliers and, therefore, are subject to changes in price as a result of changes in foreign currencies against the U.S. dollar. Final production of the Company's bicycle products occurs at facilities located in the United States. Alternative domestic and\/or foreign sources are available for raw materials and components, and the Company anticipates no significant difficulty in obtaining raw materials or components.\nCAPITAL IMPROVEMENTS AND EXPANSION\nThe Company's capital expansion plans contemplate the investment of up to approximately $25 million for plant and capital improvements of its businesses over the next two years. The Company\nbelieves that less than half of that amount is necessary to maintain production facilities. The majority of these planned expenditures include projects to integrate and streamline the Opelika facility; tooling for new products, machinery and equipment for cost reductions; and equipment upgrades. The Company analyzes each of its investment projects to seek to ensure that the investment yields acceptable returns and is in accordance with the Company's current and future growth plans. See \"PROPERTIES,\" and \"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS LIQUIDITY AND CAPITAL RESOURCES.\"\nDISTRIBUTION AND MARKETING\nThere are two principal channels of bicycle distribution in the United States: mass merchandisers and specialty bicycle shops. Management estimates that specialty shops account for approximately 20% of bicycles sold in the United States and mass merchandisers, which primarily sell popular-priced models, account for approximately 80% of the bicycles sold. In general, specialty bicycle shops and mass merchandisers are not in direct competition. Roadmaster's bicycles are sold primarily to mass merchandisers. Fitness products are marketed primarily to mass merchants and through direct marketing channels, including television infomercials. Toys are marketed to mass market retailers, discount department stores and large chain toy stores. Team sports and hosiery products employ similar distribution channels as bicycles and toys, including distribution to mass merchandisers and discount department stores.\nRoadmaster maintains showrooms in New York, New York; Delavan, Wisconsin; Olney, Illinois; Opelika, Alabama; and Atlanta, Georgia, and sponsors promotional events such as the annual Little 500 bike race at Indiana University in Bloomington, Indiana. The Company participates in trade shows, advertises in trade publications and supplies large numbers of catalogs to retail trade groups and consumers.\nRoadmaster advertises its products with \"point of purchase\" materials and has both print and TV media advertising campaigns to emphasize its products including the Motocyke line of childrens bikes and PlaySafe line of swing sets. The Company also advertises certain fitness products through the \"infomercial\" format. See \"PRODUCTS, FITNESS\" for a discussion of the Company's infomercial programs.\nDue to the relatively short period of time between placement of orders for products and shipments, the Company normally does not consider its open orders to be significant to its business. Because of rapid delivery requirements of its customers, the Company does maintain certain quantities of finished goods inventories to respond to short notice demand and to provide high service levels to its customers. However, since some of Roadmaster's customers also share point of sale information through Electronic Data Interchange (\"EDI\") with the Company, management believes the Company is able to adequately project its customers' requirements, limit its inventory levels and reduce its exposure to inventory obsolescence. The Company either ships products directly from its plants or, in the case of imported products, arranges for direct container shipments to certain U.S. ports designated by customers for pickup.\nThe Company presently distributes and markets a broad range of recreation and fitness products in Canada. The majority of the products distributed in Canada are manufactured by Roadmaster, with the remainder sourced from other suppliers. In addition, the Company currently distributes a variety of products in Europe and Asia. Products distributed in Europe and Asia are manufactured by the Company or by third parties in the United Kingdom. International sales in 1995 accounted for 4.3% of the consolidated net sales of the Company versus 4.0% of net sales for the prior fiscal year. The Company intends to continue increasing its international sales by expanding its distribution channels in Canada, Europe and Asia.\nCUSTOMERS\nIn 1995, the Company had sales greater than $10 million each to 11 leading mass merchandisers. Wal-Mart, Toys \"R\" Us, K-Mart and Sears collectively accounted for 42.9% and 49.7%, of the Company's total sales in 1995 and 1994, respectively. One of these customers, Wal-Mart, accounted for 26.2% and 28.2% of total sales in 1995 and 1994, respectively. Other than Wal-Mart, no other customer accounted for more than 10% of the Company's sales in 1995 and 1994. The loss of, or a material reduction in, business from any of these customers could adversely affect the Company's business.\nCOMPETITION\nAll of the Company's businesses are extremely competitive. Roadmaster competes primarily on the basis of just-in-time delivery, production innovation, consistent quality control and price. Roadmaster competes in the bicycle market with domestic manufacturers Huffy and Murray. Roadmaster also competes with various distributors of imported bikes produced primarily in China, Taiwan and Korea. The market share of imported bikes sold in the United States was approximately 59% of total units sold in 1987 compared to approximately 45% of total units in 1995.\nThe BMA on behalf of its members, Roadmaster, Huffy and Murray, filed a petition on April 5, 1995, with the United States International Trade Commission (\"ITC\") regarding the import of bicycles from China that are allegedly sold in the United States at less than fair value. The Company has completed various questionnaires from the ITC and is waiting for a determination on the case. No assurances can be given regarding the ultimate timing and extent of a positive or negative determination from the ITC regarding this case. See Item 3. \"LEGAL PROCEEDINGS\".\nRoadmaster competes in the fitness equipment market with domestic companies such as ICON Health and Fitness, Inc. and importers of foreign sourced products.\nIn the toy products category, the Company competes with a number of competitors, including the Rubbermaid Corporation and Mattel, Inc. Some of the Company's competitors may have substantially greater financial resources than the Company.\nImports of low cost bicycles, toy products and fitness equipment have subjected domestic producers to price competition, especially over the past five years, and have created price sensitivity. Imports constitute a significant source of competition for Roadmaster because the vast majority of the imports continue to be distributed to major national and regional mass merchandisers including Roadmaster's major existing customers.\nPATENTS AND TRADEMARKS\nThe Roadmaster(R) trademark, registered in the United States and other countries, is important to the Company's business and has been in continuous use since 1935 in the United States. Roadmaster's toys and bicycle products are sold primarily under the Roadmaster(R) and Flexible Flyer(R) brand names. Flexible Flyer(R), one of the Company's most recognizable brand names, dates back to 1889. Most of Roadmaster's fitness products are sold under the Vitamaster(R) and DP(R) brand names, which have been in use since the early 1950s and 1960s, respectively. Tradenames used to market the Company's team sports products include Hutch(R), MacGregor(R), Reach(R) and Forster(R).\nThe Company owns numerous patents and trademarks. The Company believes that the loss of any of its patents and trademarks (other than the Roadmaster(R), DP(R), Vitamaster(R), and Flexible Flyer(R) trademarks) would not have a material adverse effect on its business. Both international patent and trademark protection will be expanded as the Company's international sales activities are expanded.\nEMPLOYEES\nThe Company and its subsidiaries have approximately 5,700 employees of which approximately 2,000 are represented by various trade unions. Substantially all of the Company's corporate services are provided by its subsidiaries, primarily by Roadmaster. Management believes the Company's relations with its employees are good and does not anticipate material labor problems; however, in the event of a strike or work stoppage at one or more of its facilities, the strike or work stoppage, depending on its duration and magnitude, could result in a disruption of the Company's operations and have a material adverse effect on its financial condition or results of operations.\nTERMINATION OF SHAREHOLDER'S AGREEMENT\nThe Company, Mr. Fong and Mr. Shake were parties to a shareholders' agreement (such agreement hereinafter the \"Shareholders' Agreement\") with Metromedia International Group, Inc. (\"Metromedia\"), as successor by merger to Actava, entered into on December 6, 1994 in connection with the acquisition by the Company from Actava all of the issued and outstanding capital stock of the Sports Subsidiaries. The Shareholders' Agreement obligated each party thereto to use their best efforts to cause the nomination and election of persons designated by the Company and Actava, respectively, to the Company's Board of Directors. Pursuant to the Shareholders' Agreement, Messrs. Fong, Shake, Conti, Rand and Bradley initially were designated by the Company and Messrs. Phillips, Long, Marshall and Sanders were designated by Actava. Such Shareholders' Agreement terminated on or about March 31, 1996.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's major manufacturing and distribution sites are described below. In addition, the Company owns or leases other facilities consisting primarily of warehouse space. The Company's largest facility was acquired with DP in 1994 and is located on a 121 acre site in Opelika, Alabama. It consists of approximately 1,000,000 square feet of modern manufacturing and warehouse space. Treadmills, fitness systems, fitness cycles and bicycles are manufactured at this facility.\nThe Company's first factory was built in 1962 on a 122 acre site in Olney, Illinois. After many additions and modernizations, it is currently a 720,000 square foot facility that houses administration, manufacturing, warehouse and showroom space. This facility is served by rail and is readily accessible from several interstate highways. The Company manufactures children's bicycles, sidewalk bikes, tricycles, children's ride-ons, wagons, toy products and stationary exercise bikes at this facility.\nThe Company's weight filling operation is located in a 40,000 square foot leased facility in Olney, Illinois.\nIn 1989, Roadmaster purchased a 16,000 square foot facility in Olney, located adjacent to its primary manufacturing facility. This facility houses the Company's 6,000 square foot Design and Development Center. A 17,000 square foot warehouse was added to this facility in 1989.\nThe Company leases 72,000 square feet of space in Effingham, Illinois as a satellite manufacturing facility which the Company utilizes to manufacture bicycles. The plant became operational in September 1993.\nRoadmaster owns a manufacturing facility located on a 12 acre site in Delavan, Wisconsin. This facility, which primarily manufactures adult bicycles, consists of over 140,500 square feet of manufacturing space.\nRoadmaster leases a 280,000 square foot manufacturing and warehouse facility in Tyler, Texas. Treadmills and swing sets were manufactured at this facility through February 1996. The Company also leases a 101,500 square foot facility in Tyler used for warehousing and distributing treadmills and swingsets. The annual rent obligations for the leased facilities are $275,000 for the manufacturing facility and $228,000 for the distribution facility. The leases for these facilities terminate in October 1998 and January 2005 for the manufacturing and distribution facilities, respectively. The Company is actively seeking to sublease these facilities. See Item 7. \"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION\" for a discussion regarding the closing of the Tyler facilities.\nThe Company leases a 315,000 square foot facility located in West Point, Mississippi. Molded plastic toys, metal and molded plastic swing sets and traditional wood and steel sleds are manufactured at this facility.\nThe Company leases two facilities located in Ogden, Utah totaling 74,000 square feet. Trampolines and related products are manufactured at these facilities.\nHutch leases a 70,000 square foot facility in Erlanger, Kentucky. This location includes both warehouse and office space. Footballs, baseballs, basketballs, licensed gift sets and backboards are stored in this warehouse. A smaller warehouse, 19,000 square feet, is also leased in Erlanger. This smaller warehouse is used to store clothing, licensed gift sets and various baseball items. During the second quarter of 1995, the operations of Willow were consolidated with those of Hutch with Willow relocating its headquarters to Hutch's offices in Erlanger.\nThe Company's executive offices are located in approximately 25,000 square feet of leased office and showroom space in Atlanta, Georgia.\nThe leased properties of the Company and its subsidiaries are held under leases expiring over a period from 1996 to 2005. The Company believes that property comparable to its leased properties can be obtained at a comparable cost.\nENVIRONMENTAL MATTERS\nThe Company is subject to regulation under federal, state, local and provincial laws and regulations governing pollution and protection of human health and the environment, including air emissions, water discharges, management and cleanup of solid and hazardous substances and wastes. The Company believes that its facilities and operations are in material compliance with all existing applicable laws and regulations. The Company cannot at this time estimate the impact of any future laws or regulations on its future operations or future capital expenditure requirements. The Company is not aware of any pending federal or state legislation that would have a material impact on the Company's financial position, results of operations or capital expenditure requirements.\nThe Company has been identified as a potentially responsible party (\"PRP\") for hazardous wastes in connection with the Four County Landfill Superfund proceeding in Rochester, Indiana, pursuant to the Comprehensive Environmental Response, Compensation, and Liability Act of 1980, as amended (\"CERCLA\" or \"Superfund\"). CERCLA requires cleanup of sites from which there has been a release or threatened release of hazardous substances and authorizes the United States Environmental Protection Agency (the \"EPA\") to take any necessary response action at Superfund sites, including ordering PRPs liable for the release to take or pay for these actions. The Company disposed of hazardous substances at the Four County Landfill, composed of paint sludge, plating sludge and plating pre-treatment sludge. Although the Company has been invited to settle this matter as a de minimis party, it has not yet done so. The Indiana Department of Environmental Management, which has responsibility for the site, estimates the Company's liability to be less than 1% of the total cleanup costs (approximately 0.28%). In management's opinion, based on the proceedings and investigations to date and the amount of wastes sent by the\nCompany to the Four County Landfill, the costs associated with the cleanup at this site will not have a material effect on the Company's financial condition or results of operations.\nThe Company is currently conducting remedial activities at its Olney, Illinois manufacturing facility, where approximately 3,000 barrels of paint waste and solvents were buried between 1974 and 1978. This site also includes three small inactive disposal pits for paints, sludges, solvents, and oils, and four inactive surface settling basins for plating wastewater (such paint waste, sludges, solvents and oils collectively referred to herein as the \"contaminants\"). The pits and basins were utilized by one or more prior owners of the facility, and the burial of the barrels was carried out by a prior owner of the facility, AMF Corporation. In 1980, the then current owner of the facility installed six monitoring wells strategically located near each area to monitor any migration of contaminants. Based on the most recent results from the monitoring wells and additional sampling and testing by an environmental engineering firm, Environmental Science & Engineering, Inc. (\"ESE\"), some minor migration of contaminants has been detected from the buried barrels toward the southern portion of the site. Since the soil at the site is a glacial till composed of dense clay, the Company believes, based on further investigation during the drilling of additional monitoring wells by ESE, that the probability of significant movements of contaminants from the buried barrels is small. ESE is currently pursuing a testing and remedial plan for the site, which will be subject to approval by the Illinois Environmental Protection Agency (\"IEPA\"). The cleanup has been accepted as part of the State of Illinois' Voluntary Cleanup Program, which allows the Company to clean up the site, subject to IEPA supervision and review, without any enforcement action by the IEPA or the EPA. While no assurances can be given, the Company believes that by participating in the Voluntary Cleanup Program, it may be able to reduce its total cleanup costs. The remedial program could include placement of additional monitoring wells or other monitoring instruments, \"capping\" the site, installation of slurry or containment walls or interception trenches, hydraulic containment using sump pumps to recover contaminants and other liquids and discharge them through a new and existing wastewater treatment facility or removal of the barrels and surrounding soils. No assurances can be given that the costs associated with the remedial program will not be material or that unanticipated environmental matters resulting in additional material cost for the Company will not arise. However, in management's opinion the costs associated with the remedial program will be expended over a number of years and will not have a material adverse effect on its financial condition or results of operations.\nPrior to the purchase of DP by Roadmaster, the Alabama Department of Environmental Management (\"ADEM\") issued an administrative order on May 14, 1991, obligating DP to undertake various investigative activities with respect to an inactive chrome plating tank at its Opelika facility. This area is located on the property acquired by Roadmaster. The required investigation called for, among other things: (a) preparation of a \"Groundwater Quality Assessment Work Plan,\" (b) closure of the chrome tank area, and (c) submission of a complete post-closure permit application for the chrome tank area. Closure of the chrome tank area was completed in April 1992 and the Company has subsequently worked with Alabama authorities to comply with the terms of the order. In addition, a final Groundwater Quality Assessment Report was submitted to ADEM in May 1994. The Company submitted its application for a post-closure permit for the chrome tank area on July 31, 1995. In addition, the Company has submitted a Risk-Based Closure Report seeking a Clean Closure Equivalency Determination with respect to the chrome tank area, which would, if granted, avoid further corrective action near the chrome tank area and additional long-term groundwater monitoring. It is anticipated that the Company may be required to conduct additional investigative and corrective action at the Opelika facility. In the Resource Conservation and Recovery Act (\"RCRA\") facility assessment, the EPA identified 45 solid-waste management units and one area for further study at that portion of the Opelika facility acquired by Roadmaster. A contiguous land parcel, \"the Materials Storage Area\", which was retained by a subsidiary of Actava, the former owner of the Sports Subsidiaries, was identified as an additional solid-waste management unit. It is anticipated that the EPA will require confirmatory sampling and testing for some or all of the 45 identified solid-waste management units. Depending on the results of this additional investigation, the Company and\/or other persons will be required to develop and implement a corrective action plan for those solid-waste management units that pose potential threats to human health and the environment, if any. In connection with any investigation and corrective action which is required at the Materials Storage Area, federal and\nstate environmental authorities have acknowledged that Actava has retained ownership of this area, and are requiring Actava, rather than Roadmaster, to undertake and finance any necessary investigation and corrective action with respect thereto. The ADEM and EPA permitting processes are expected to require several years of investigation, design, construction and negotiation. Unless the Clean Closure Equivalency Determination is granted, subsequent post-closure care of the chrome tank area may last as long as 30 years. The extent of the remediation of soil and groundwater contamination that may have to be undertaken at the Opelika facility will be determined by the results of additional on-site investigation. Any environmental remediation costs associated with the Opelika facility will not have any effect on the Company's income statements unless remediation costs exceed the reserve which is established or the Company incurs liability for the Materials Storage Area which is not covered by an environmental indemnity agreement between Roadmaster and Actava pursuant to which Actava has agreed to indemnify Roadmaster for costs and liabilities resulting from the presence on or migration of regulated materials from the Materials Storage Area. Notwithstanding the foregoing, no assurances can be given that costs ultimately associated with the actual remediation program will not be material or that unanticipated environmental matters resulting in material costs for the Company will not arise in the future.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is a defendant, along with two other major U.S. manufacturers of bicycles, Huffy and Murray, in a case brought in the U.S. District Court for the District of Massachusetts in November 1995 (case number 95-12532), by two major importers of bicycles manufactured in the People's Republic of China, Dynacraft Industries, Inc. and China Bicycle Company (Holdings) Ltd. (the \"Chinese Importers\"). The Chinese Importers are seeking to prevent these three U.S. manufacturers of bicycles from marketing their bicycles as \"Made in the USA\". The Chinese Importers have brought this action under the Lanham Act and the Massachusetts unfair trade practices statute, alleging that the three U.S. manufacturers are deceiving retailers and the consumers by advertising the bicycles as \"Made in the USA\" while making bicycles which include foreign components and therefore are not 100% made in the U.S. The Chinese Importers claim that they have lost over $100 million in sales as a result, and assert that amount as alleged damages. The U.S. manufacturers, including the Company, have answered and demanded a jury trial, asserting that 100% content is not only not legally required, but also impossible because some components are only available from foreign sources, and therefore these bicycles are made in the U.S. to the fullest economically practical extent, as well as other defenses. The Company, together with the two other U.S. manufacturers of bicycles, intends to vigorously defend this action.\nOn March 6, 1990, the Company entered into an agreement to acquire all of the issued and outstanding common stock of Columbia Manufacturing Company (\"Columbia\"), but on or before July 19, 1990, the Company rescinded the agreement to acquire Columbia based upon, among other things, material misrepresentations and omissions of material facts regarding its environmental and financial condition. In association with a declaratory judgment action filed by the Company in 1990, the Columbia shareholders filed counterclaims against the Company and others. After the U.S. District Court for the District of Massachusetts entered partial summary judgment in favor of the Company, all matters in dispute were settled, with final documents being circulated for signature. The Company incurred no liability or expense under the settlement.\nThe adversary proceeding by the Unsecured Creditors Committee of MacGregor Sporting Goods, Inc. previously pending in the United States Bankruptcy Court for the District of New Jersey against the Company was settled in 1995 without material impact on the results of operations of the Company, with the Company obtaining a full release.\nThe Company, through its operating subsidiaries, is involved in various legal proceedings which are normal to its business, including product liability, patent infringement, contested OSHA matters and workers' compensation claims. In management's opinion, the ultimate resolution of those proceedings or any of the litigation discussed above is not likely to have a material adverse effect on its financial condition or its 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 stockholders of the Company during the fourth quarter of the year ended on December 31, 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. PRICE RANGE FOR COMMON STOCK\nThe Company's Common Stock has traded on the New York Stock Exchange under the symbol \"RDM\" since December 12, 1994. From May 26, 1993 to December 12, 1994, the Common Stock traded on the American Stock Exchange under the symbol \"RDM\". The following table indicates the high and low closing sale prices of the Common Stock on the New York Stock Exchange and the American Stock Exchange.\nOn March 21, 1996 there were 1,582 registered holders of the Company's Common Stock.\nDIVIDEND POLICY\nHolders of Common Stock are entitled to such dividends as may be declared by the Board of Directors and paid out of funds legally available for payment of dividends. The Company has never paid any dividends on its Common Stock. The Company intends to retain earnings to finance the development and expansion of its business and does not anticipate paying cash dividends in the foreseeable future. Future determination as to the payment of dividends is subject to the discretion of the Board of Directors and will depend upon a number of factors, including future earnings, capital requirements, financial condition and the existence or absence of any contractual limitations on the payment of dividends. For more information as to the current contractual limitations on the payment of dividends, see Item 7. \"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS LIQUIDITY AND CAPITAL RESOURCES\" and Note 3 of Notes to Consolidated Financial Statements.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following table sets forth selected consolidated financial data for each of the years in the five-year period ended December 31, 1995. The income statement data for the fiscal years ended December 31, 1995, 1994 and 1993 and the balance sheet data as of December 31, 1995 and 1994 have been derived from the Company's consolidated financial statements included elsewhere in this report. This data should be read in conjunction with Item 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION\nOVERVIEW AND RECENT DEVELOPMENTS\nBicycle and fitness products together accounted for 60% of the Company's net sales in 1995. The Company has experienced sales growth in these categories of 66% from 1993 to 1995. Total sales for the year ended December 31, 1995 increased approximately 60% to $730.9 million from 1994, primarily due to revenue attributable to recent acquisitions and increased sales in the Company's existing product lines.\nThe Company's business tends to have varying degrees of seasonally. Accordingly, quarterly results may not be indicative of yearly results. The historical seasonally of the recently acquired Sports Subsidiaries and Flexible Flyer businesses has been countercyclical to that of the rest of the Company. While no assurances can be given, these recently completed acquisitions may result in a moderation in the seasonally of the Company's consolidated business. See \"LIQUIDITY AND CAPITAL RESOURCES\".\nSale of Nelson\/Weather-Rite\nThe Company decided to divest its camping operations based on the anticipated realizable values for such operations. Subsequent to year end, on January 22, 1996, the Company entered into an agreement to sell the assets of Nelson\/Weather-Rite, which includes MZH, to Brunswick for cash consideration of $120 million. The sale includes the purchase of all the assets, and the assumption of accounts payable and accrued liabilities which totaled $8.5 million at December 31, 1995. Such transaction was consummated on March 8, 1996. The final purchase price is subject to ordinary post closing adjustments based on closing working capital levels. The Company used the net proceeds to reduce its outstanding revolving credit facility by approximately $110 million. Pending final purchase price adjustments, the Company expects a pretax gain of more than $25 million to be recognized in the first quarter of 1996. In 1995, Nelson\/Weather-Rite contributed $96.4 million in sales and $3.2 million in net income for the year then ended.\nACQUISITIONS\nMZH\nIn April 1995, Nelson\/Weather-Rite finalized the acquisition of certain assets and the business of MZH, a manufacturer and marketer of sleeping bags with revenues of approximately $28 million in 1994. The purchase price included $21.5 million in cash, 400,000 shares of the Company's Common Stock valued at $1.5 million, and the assumption of certain liabilities. MZH's results of operations were included in the Company's consolidated operations beginning March 1, 1995, contributing approximately $27.9 million or 3.8% of net sales for the year ended.\nForster\nIn March 1995, Hutch acquired the sporting goods division of Forster Manufacturing Company for $7.4 million in cash. The product categories acquired include various backyard and lawn games, including croquet, bocce ball and volleyball. Sales of the Forster products were included in the Company's consolidated operations beginning March 23, 1995, contributing $6.8 million or 0.9% of net sales for the year ended.\nRESULTS OF OPERATIONS\nThe following table reflects the percentage relationship between net sales and specified line items from the Consolidated Statements of Operations and the percentage change in the dollar amount of each of such line items for the periods indicated:\nFiscal year 1995 compared to fiscal year 1994. The 1995 year was a difficult one for the Company as a variety of internal and external factors adversely affected both revenue growth and profitability. These factors included market pricing pressures in bicycle and fitness products, high material costs related to cardboard, plastics and steel, elevated interest expense and higher product warranty costs associated with DP products. Nevertheless, overall sales increased $275.2 million (60%) in 1995 compared to 1994. The increase was primarily attributable to a full year of sales contributed by the Sports Subsidiaries as well as an increase in sales of the Company's core fitness and toy products.\nSales of fitness products increased 57% in 1995 compared to 1994 due to increased sales of infomercial and Body By Jake(R) products and sales attributable to the acquisition of DP. Sales of bicycles were flat for the year, however, the Company continued to increase its market share in bicycles. Sales of toy products increased 20% compared to 1994 due to the introduction of several new products, including snow toys, and increasing sales of trampolines and swingsets.\nGross profit increased $19.8 million in 1995 compared to 1994 due to higher sales volume. Gross profit as a percentage of net sales was 11.8% verses 14.7% in 1994. This decrease was attributable to large increases in raw material prices in steel, cardboard, and plastics in the fourth quarter of 1994, which remained in effect through much of 1995. Additionally, competitive pricing pressures in the bicycle and fitness markets contributed to the decline in gross profit. The Company moved to offset these factors in the second half of the year by successfully introducing new products with higher profit margins, by implementing price increases designed to mitigate increases in raw material costs and by undertaking cost reduction projects. However, the total potential impact of these improvements was dampened by softness in retail orders in the fourth quarter.\nSelling, General and Administrative (\"SG&A\") expenses were $92.8 million or 12.7% of net sales compared to $38.0 million or 8.3% of net sales in 1994. The increase in expenses from 1994 was due to volume related expenses such as commissions and a full year impact of the Sports Subsidiaries acquisitions which occurred in December 1994. SG&A expenses for the Sports Subsidiaries historically have been at higher levels than the Company's historical levels due to a higher composition of product warranty and administration expenses. Additionally, the Company experienced higher than normal warranty expenses due to product warranty claims caused by faulty treadmill motors. Product warranty expenses increased to\n3.8% of sales in 1995 versus 2.1% in 1994. Although no assurances can be given, the Company anticipates warranty expenses, as a percentage of sales, will be lower in 1996 due to sourcing treadmill motors from new suppliers and the implementation of stringent quality assurance measures. In 1995, the Company began and successfully implemented cost reductions relating to administrative expenses, including the consolidation of certain operations and a reduction in personnel. With respect to its fitness operations, the Company has announced plans to streamline such operations by consolidating all fitness products manufacturing at its Opelika facility. With respect to Willow and Hutch, the Company reduced certain administrative costs by eliminating certain positions and consolidating operations beginning in the second quarter of 1995. While no assurances can be given, management believes the combination of the above actions will assist in reducing its product warranty costs and administrative costs and will ultimately bring such costs in line with the Company's historical percentages. The full impact of these actions on SG&A expenses is not expected to be realized until 1997.\nThe Company wrote off $23.5 million of goodwill related to the DP fitness business since the Company determined it would not be able to recover the associated goodwill based on an undiscounted cash flow analysis. On the balance sheet, the $23.5 million writeoff of goodwill is offset against goodwill generated on the acquisition of MZH and Forster, as well as final purchase accounting adjustments related to the acquisition of the Sports Subsidiaries. See Note 2 of Notes to the Consolidated Financial Statements for additional discussion.\nThe Company recorded a one time Restructuring Charge of $7.5 million in connection with closing its Tyler, Texas facility and the change in the method of the Company's overseas distribution operations. Although no assurances can be given, the Company does not anticipate the change in its overseas distribution methodology will adversely affect overseas sales. See Note 16 of Notes to the Consolidated Financial Statements for additional discussion.\nOther expense in 1995 was $7.8 million, representing mainly amortization of other long-term assets and the write off of certain acquisition related costs for transactions the Company is now no longer pursuing. Additionally, the Company recognized a writedown of investments that were received in exchange for receivables from a bankrupt customer.\nInterest expense for 1995 was $35.4 million verses $21.3 million in 1994. This increase in interest expense was attributable to higher interest rates in 1995 and increased borrowings necessary to support higher inventories and receivables resulting from the 60% increase in sales.\nFiscal year 1994 compared to fiscal year 1993. Net sales increased $143.5 million (46.0%) in 1994 compared to 1993, resulting from increased sales of bicycles, fitness products, toys and sales attributable to recent acquisitions. Sales of bicycles increased 22.1% in 1994 compared to 1993 due to increasing sales of ATBs and Motocykes(TM). Sales of fitness products increased 51.1% in 1994 compared to 1993 primarily due to increased sales of treadmills and sales to a lesser degree attributable to DP during the three weeks of the Company's ownership in 1994. The overall increase in fitness products was partially offset by a decline in stairstepper sales. Sales of toy products increased 112.5% in 1994 compared to 1993, primarily due to a full year's sales of swingsets, hobby horses and snow goods from Flexible Flyer in 1994, and the first period of sales of trampolines from American Playworld.\nGross profit increased $18.7 million (38.8%) in 1994 compared to 1993, primarily due to higher sales volume. Gross profit, expressed as a percent of net sales, was 14.7% for 1994 versus 15.4% in 1993. The decrease in gross profit percentage was attributable to price increases in steel, cardboard and plastic raw materials. This decrease was partially offset by overhead efficiencies as fixed costs were absorbed by higher production in support of the greater sales volume.\nSelling, general and administrative expenses in 1994 were $38.0 million or 8.3% of net sales compared to $27.1 million or 8.7% of net sales during 1993. The $10.9 million higher expense in 1994 was primarily due to volume-related expenses such as commissions and product warranty costs. Other selling expenses, primarily advertising, marketing and administrative expenses also increased in connection with the promotion of new products and higher sales volume. The decrease in such costs expressed as a percent of net sales reflects the relatively fixed nature of certain administrative costs.\nInterest expense for 1994 was $21.3 million or 4.7% of net sales compared with $9.5 million or 3.0% in 1993. Higher interest expense is the result of additional bank borrowings and debt offerings to fund acquisitions, higher inventory levels due to increased sales and the resulting higher accounts receivable balances, and increased interest rates throughout 1994.\nThe Company recorded a 1994 tax expense of $2.9 million, representing an effective tax rate of 36.7%, compared to a $4.0 million expense and 34.5% effective tax rate in 1993. See Note 7 of Notes to the Consolidated Financial Statements for additional discussion.\nLIQUIDITY AND CAPITAL RESOURCES\nHistorically, the Company's working capital has been obtained primarily from internally generated funds and revolving lines of credit from banks. On a consolidated basis, during 1995, the Company's operations used cash of approximately $37 million. The seasonal nature of the Company's sales imposes fluctuating demands on its cash flow, due to the temporary buildup of inventories in anticipation of, and receivables subsequent to, the peak seasonal period, which historically has occurred around November of each year.\nThe Company entered into a revolving credit facility in January 1994 providing $100 million, $50 million of which was subject to restrictions on borrowings pursuant to the Company's $100 million 11.75% Senior Subordinated Notes due 2002 (the \"Notes\"). This facility had a four-year term and provided for interest at the prime rate, as defined, plus 1.25%. Such rate was later reduced to prime plus 0.75%.\nEffective November 15, 1994, and prior to completing the acquisition of the Sports Subsidiaries, the Company obtained consents from a majority of the holders of its Notes to increase the amount of indebtedness it could incur without meeting an interest coverage test from $50 million to $150 million. The Notes indenture does not limit the amount of indebtedness the Company can incur under circumstances where the Company's earnings before interest, taxes, depreciation and amortization is equal to at least two times its cash interest expense.\nIn December 1994, the Company restructured its revolving credit line (the \"Revolver\") to include the Sports Subsidiaries as borrowers. The Revolver provides for borrowings of up to $200 million at the prime rate plus 0.75%, as defined, and includes a LIBOR rate option which equals LIBOR plus 2.75%. Borrowings are supported by eligible inventory, certain raw materials and finished goods and accounts receivable.\nIn September 1995, the Company amended and restated the Revolver. The Amended and Restated Revolver provides a term loan facility and a revolving credit facility of up to $300 million, subject to restrictions on borrowings pursuant to certain covenants in the indenture, as amended, for the Company's Notes. The revolving credit facility provides for borrowings of up to $275 million based on eligible trade receivables and inventory. At December 31, 1995, the Amended and Restated Revolver's interest rate was 9.25%. The term of the Amended and Restated Revolver is through September 29, 1998, and is automatically renewed for successive one year terms unless terminated by either the lender or the Company.\nThe Amended and Restated Revolver requires the maintenance of various financial covenants including minimum net worth, fixed maturity coverages and minimum working levels. In the first quarter of 1996, the Company was not in compliance with several of its loan covenants calculated as of December 31, 1995. These events of non-compliance were waived as of December 31, 1995 by the lenders under the Amended and Restated Revolver pursuant to the further amendment and restatement of the Revolver in the first quarter of 1996. At no time was the Company in default with respect to the payment of indebtedness under the Amended and Restated Revolver. The Company expects to remain in compliance with the amended covenants in 1996.\nThe Company has two long-term debt issues, the $51,745,000 Convertible Subordinated Debentures due 2003 (the \"Debentures\") and the Notes. The Debentures are convertible at the option of the Company on September 15, 1996 and thereafter at a price of $4.00 per share of common stock. Before the Company's Debentures can be called for redemption, the Company's Common Stock must meet or exceed a minimum closing price of $5.0625 per share for the thirty day period prior to such notice of redemption.\nSubject to the foregoing limitation, the Notes are redeemable at the option of the Company beginning September 15, 1996, at a price of 105.875%. The redemption price declines to par on or after December 15, 2000.\nThe Notes and Debentures are obligations of the Company and are, to a large extent, dependent on the Company's operating subsidiaries for the payment of interest. Such interest payments are permitted under the Revolver with certain restrictions. The Company does not anticipated any restrictions on its ability to make such interest payments pursuant to the Revolver.\nAt December 31, 1995 and December 31, 1994, the Company, on a consolidated basis, had stockholders' equity of $55.5 million and $103.1 million, respectively.\nIn connection with the March 8, 1996 sale of Nelson\/Weather-Rite for cash consideration of $120 million, the Company utilized substantially all of the proceeds to reduce its revolving line of credit. Management believes this transaction significantly improves the Company's working capital position.\nThe Company's capital expenditures plan contemplates the investment of up to approximately $25 million for plant improvements, expansion of production capability and other capital improvements of its businesses over the next two years. Such capital expenditures program could be curtailed or deferred depending on the availability of financing and the Company believes that less than half of that amount is necessary to maintain production facilities. The majority of the Company's capital expenditures are planned for tooling of new products and cost reductions. Management believes that the Company's sources of financing and anticipated cash flow are adequate to provide the funds necessary to support operations and to meet its obligations over the next several years.\nINFLATION AND FOREIGN CURRENCY FLUCTUATIONS\nIncreases in the materials price of plastics, cardboard and steel had a significant negative impact on the results of operations. The manner in which sales programs are set causes a delay in price adjustments which limits the Company's ability to pass some or all of these increased costs on to the Company's customers as such costs are incurred. Furthermore, depending on the competitive environment, the Company may or may not be able to timely pass along material price increases to its customers.\nAlthough the Company's foreign operations were negatively impacted by the reduction in the value of the Canadian dollar versus the U.S. dollar, such transaction exposure did not have a material adverse effect on the Company's results of operations for the year ended 1995.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nAll financial statements required to be filed herein are attached hereto following Item 14.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information required by Item 10 is incorporated by reference from the information in Registrant's proxy statement (filed or to be filed pursuant to Regulation 14A) for its Annual Meeting of Stockholders scheduled for June 12, 1996.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by Item 11 is incorporated by reference from the information in Registrant's proxy statement (filed or to be filed pursuant to Regulation 14A) for its Annual Meeting of Stockholders scheduled for June 12, 1996.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required by Item 12 is incorporated by reference from the information in Registrant's proxy statement (filed or to be filed pursuant to Regulation 14A) for its Annual Meeting of Stockholders scheduled for June 12, 1996.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by Item 13 is incorporated by reference from the information in Registrant's proxy statement (filed or to be filed pursuant to Regulation 14A) for its Annual Meeting of Stockholders scheduled for June 12, 1996.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n__________\n(1) Previously filed with the SEC and incorporated by reference from the Registrant's Registration Statement, File Number 33-18366, filed November 9, 1987, or as subsequently amended December 9, 1987 and December 9, 1994.\n(2) Previously filed with the SEC and incorporated by reference from the Registrant's From 8-K filed April 16, 1992.\n(3) Previously filed with the SEC and incorporated by reference from the Registrant's Registration Statement, File Number 33-64230, filed on June 10, 1993 or as subsequently amended on July 9, 1993, July 29, 1993 and December 9, 1994.\n(4) Previously filed with the SEC and incorporated by reference from the Registrant's Form 8-K filed on September 29, 1993.\n(5) Previously filed with the SEC and incorporated by reference from the Registrant's Number 33-71586 filed November 12, 1993 or as subsequently amended on November 26, 1993, December 14, 1993 or December 16, 1993.\n(6) Previously filed with the SEC and incorporated by reference from the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1993, filed on March 31, 1994.\n(7) Previously filed with the SEC and incorporated by reference from the Registrant's Definitive Proxy Statement for a Special Meeting of Stockholders held on October 31, 1994, filed on September 28, 1994.\n(8) Previously filed with the SEC and incorporated by reference from the Registrant's Definitive Proxy Statement for its Annual Meeting of Stockholders held on June 14, 1995, filed on May 13, 1995.\n(b) The consolidated financial statements and schedules filed as a part of this Annual Report on Form 10-K are as follows:\n1.) Consolidated Financial Statements of Roadmaster Industries, Inc.\n2.) Financial Statement Schedules\n(c) Reports on Form 8-K:\nNo reports on Form 8-K were filed in the 4th quarter of 1995.\nOn January 19, 1996, the Company filed a current report on Form 8-K announcing the acquisition of its Nelson\/Weather-Rite, Inc. subsidiary by Brunswick Corporation\n(d) Executive Compensation Plans and Arrangements.\n(I) Form of Warrant dated July 6, 1992 for employees (10.40) (ii) Form of Warrant dated September 9, 1992 (10.41) (iii) Form of Warrant dated November 2, 1992 for directors (10.42) (iv) Form of Warrant dated November 2, 1992 for employees (10.43) (v) Form of Warrant dated July 6, 1992 for directors (10.39) (vi) Form of Stock Purchase Agreement and Shareholder Agreement dated November 11, 1991 (10.38) (vii) Employment Agreement for Henry Fong dated December 6, 1994 (10.3) (viii) Employment Agreement for Edward E. Shake dated December 6, 1994 (10.4) (ix) Key Employee Stock Incentive Plan dated October 25, 1995 (10.65) (x) Directors Restricted Stock Plan dated October 25, 1995 (10.66)\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nROADMASTER INDUSTRIES, INC. --------------------------- Registrant\nBy: \/s\/ HENRY FONG Date: March 27, 1996 ------------------------ Henry Fong Chairman of the Board and Chief Executive Officer (Principal Executive Officer)\nBy: \/s\/ CHARLES E. SANDERS Date: March 27, 1996 ------------------------ Charles E. Sanders Secretary, Principal Financial Officer (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.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Stockholders and Board of Directors of Roadmaster Industries, Inc.:\nWe have audited the accompanying consolidated balance sheets of ROADMASTER INDUSTRIES, INC. (a Delaware corporation) AND SUBSIDIARIES as of December 31, 1995 and 1994, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1995. 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 financial statements referred to above present fairly, in all material respects, the financial position of Roadmaster Industries, Inc. and Subsidiaries as of December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\nOur audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule listed in the index of financial statements is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the 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 March 29, 1996 - ----------- ----\nROADMASTER INDUSTRIES, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\n(in thousands except share data)\nSee Notes to Consolidated Financial Statements\nROADMASTER INDUSTRIES, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS - CONTINUED\n(in thousands except share data)\nSee Notes to Consolidated Financial Statements\nROADMASTER INDUSTRIES, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF OPERATIONS\n(in thousands except per share data)\nSee Notes to Consolidated Financial Statements\nROADMASTER INDUSTRIES, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\n(in thousands)\nSee Notes to Consolidated Financial Statements\nROADMASTER INDUSTRIES, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED\n(in thousands)\nSee Notes to Consolidated Financial Statements\nROADMASTER INDUSTRIES, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (in thousands)\nSee Notes to Consolidated Financial Statements.\nROADMASTER INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (INCLUDING NOTES APPLICABLE TO THE UNAUDITED PERIODS)\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nOrganization\nRoadmaster Industries, Inc. (the \"Company\"), formed on June 1, 1987, acquired Roadmaster Corporation (\"Roadmaster\" or \"RMC\") on August 10, 1987. Roadmaster is a manufacturer of bicycles, toys and fitness equipment. In September 1993, the Company acquired certain assets of the Flexible Flyer Company (\"Flexible Flyer\"), and the stock of Flexible Flyer Europe Limited (\"Roadmaster Limited\"), manufacturers of toy products. In February 1994, the Company acquired substantially all the assets of American Playworld, Inc. (\"American Playworld\"), a leading manufacturer of trampolines. In December 1994, the Company acquired Diversified Products Corporation (\"DP\"), Nelson\/Weather-Rite, Inc. (\"Nelson\/Weather-Rite\"), Willow Hosiery Company, Inc. (\"Willow\") and Hutch Sports USA, Inc. (\"Hutch\") (collectively referred to as the \"Sports Subsidiaries\") from The Actava Group Inc. (\"Actava\"). The Sports Subsidiaries manufacture, market and distribute a variety of products including camping equipment, fitness equipment, team sports products and hosiery. In March 1995, the Company acquired the sporting goods division of Forster Manufacturing Company. In April 1995, the Company finalized the acquisition of the business of MZH, Inc. (\"MZH\"), a manufacturer and marketer of sleeping bags.\nNature of Operations\nThe Company is a United States manufacturer and distributor whose principal lines of business are bikes, toys, fitness, team sports and hosiery products. The principal markets for the Company's products are mass merchandisers located primarily in the United States and Canada.\nPrinciples of Consolidation\nThe Consolidated Financial Statements include the accounts of the Company and its subsidiaries. All significant intercompany accounts and transactions have been eliminated. Certain prior year amounts have been reclassified to conform to the current year's presentation.\nForeign Currency Translation\nThe financial statements of the Company's foreign subsidiaries are translated into U.S. dollars using current exchange rates in effect at the balance sheet date for assets and liabilities and weighted average exchange rates for revenues and expenses. The resulting translation adjustments are accumulated as a separate component of stockholders' equity and are included within retained earnings on the consolidated balance sheet.\nInvestments\nThe Company invests in various equity securities. In May, 1993, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" which requires certain debt securities to be reported at amortized cost, certain debt and equity securities to be reported at market with current recognition of unrealized gains and losses, and certain debt and equity securities to be reported at market with unrealized gains and losses as a separate component of stockholders' equity. The Company adopted the provisions of the new standard for investments held as of or acquired after January 1, 1994. In accordance with the Statement, prior period financial statements have not been restated to reflect the change in accounting principle. The cumulative effect of adopting Statement 115 as of January 1, 1994 was not material.\nManagement determines the appropriate classification of investments as held-to-maturity or available-for-sale at the time of purchase and reevaluates such designation as of each balance sheet date. The Company has classified all investments as available-for-sale. Available-for-sale securities are carried at fair value, with the unrealized gains and losses reported in stockholders' equity. Realized gains and losses and declines in value judged to be other-than-temporary on available-for-sale securities are included in investment income. The cost of securities sold is based on the specific identification method.\nInventories\nInventories are valued at the lower of cost or market and include the combined costs of purchased materials, labor and manufacturing overhead. Cost is determined on approximately 81% and 65% of the inventory at December 31, 1995 and 1994, respectively, using the last-in, first-out (LIFO) method, and the first-in, first-out (FIFO) method on the remaining inventory.\nDepreciation and Amortization\nDepreciation and amortization of plant and equipment are computed using the straight-line method over the estimated useful lives of the related assets: 15-20 years for buildings and 5-15 years for machinery and equipment. Goodwill and other intangible assets, representing costs in excess of net assets acquired, are amortized over 40 years using the straight-line method.\nThe Company continually evaluates whether later events and circumstances have occurred that indicate the remaining estimated useful life of goodwill and other intangible assets may warrant revision or that the remaining balance of goodwill and other intangible assets may not be recoverable. The Company's policy is to recognize any impairment through the reduction of current earnings in the period in which such determination is made (See Note 2 \"Impairment of Long-Lived Assets\").\nGoodwill and other intangible assets are presented in the consolidated balance sheets net of accumulated amortization of $3,011,000 at December 31, 1995 and $543,000 at December 31, 1994. Other assets and deferred charges are presented in the consolidated balance sheets net of accumulated amortization of $6,586,000 at December 31, 1995 and $1,451,000 at December 31, 1994.\nIncome Taxes\nDeferred income taxes are provided for differences between the financial statement and income tax basis of assets and liabilities using enacted tax law. Deferred income tax expense is based on the change in the net deferred income tax asset or liability from period to period. The Company does not provide income taxes on the undistributed earnings of its foreign subsidiaries that are deemed to be permanently reinvested.\nResearch and Development\nExpenditures for research and development are charged to operations in the year incurred. Such costs aggregated $3,721,000 in 1995, $1,862,000 in 1994 and $1,081,000 in 1993.\nProduct Warranty Costs\nEstimated product warranty costs are provided at the time the Company sells the product, based on experience.\nCash and Cash Equivalents\nThe Company considers cash equivalents to be temporary investments that are readily convertible to cash and have original maturities of three months or less.\nMajor Customers\nOne of the Company's customers accounted for 26.2%, 28.2% and 28.0% of net sales during 1995, 1994 and 1993 respectively. No other customer accounted for more than 10% of sales in 1995.\nThe Company sells to mass merchandisers, including national retailers, regional retailers, and smaller customers. At December 31, 1995 and 1994, the Company had approximately 83% and 85%, respectively, of trade accounts receivable due from national retailers. The Company's credit granting process includes comprehensive analyses of each potential customer's financial condition. In some situations, cash deposits and\/or other collateral are required before the Company authorizes a sale. The Company grants credit up to specific amounts after sufficient favorable experience is achieved or if its analysis of the customer's financial condition and operating cash flows provide sufficient comfort.\nUse of Estimates in the Preparation of Financial Statements\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nFair Value of Financial Instruments\nThe following assumptions are used to estimate the fair value of each class of financial instruments:\nCash and Short-term Investments: The carrying amount approximates fair value because of the short maturity of those instruments.\nLong-term Investments: The fair values of the Company's investments are estimated based on quoted market prices for those investments at December 31, 1995.\nLong-term Debt: The fair value of the Company's long-term debt is estimated based on the quoted market prices for the same or similar issues or on the current rates offered to the Company for debt of the same remaining maturities.\n(2) IMPAIRMENT OF LONG-LIVED ASSETS\nIn the fourth quarter of 1995, the Company adopted Statement of Financial Standards (\"SFAS\") No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of\". The application of the statement requires the Company to evaluate facts and circumstances that indicate the costs of certain property, plant and equipment and intangible assets may be impaired. The evaluation is based upon the estimated future net cash flows (undiscounted and without interest charges) associated with the property, plant and equipment and intangible assets compared to the carrying value of the asset to determine whether a write-down to fair value is required.\nAs a result of this adoption, the Company has included in its consolidated statement of operations an impairment loss of $23,500,000. This amount relates to the goodwill associated with the 1994 acquisition of the Sport Subsidiaries acquired from Actava related to the DP fitness business. Based upon the Company's undiscounted cash flow projections of this business, the Company determined it would not be able to recover the associated goodwill. The amount of the impairment loss is based upon the Company's determination of fair value based on discounted cash flow methodology over a fifteen year period.\n(3) REVOLVING LINES OF CREDIT\nAt December 31, 1995, the Company had a $275 million revolving credit facility (the \"Amended and Restated Revolver\"). At December 31, 1994, the Company had a $200 million revolving credit facility.\nAmounts outstanding under the revolving lines of credit facilities at the dates indicated were:\nThe amounts classified as long-term at December 31, 1995 and 1994, represent the minimum borrowings that were expected to be outstanding during the next twelve months.\nThe Company entered into a revolving credit facility in January 1994 providing $100 million, $50 million of which was subject to restrictions on borrowings pursuant to the Company's $100 million 11.75% Senior Subordinated Notes due 2002 (the \"Notes\"). This facility had a four year term and provided for interest at the prime rate, as defined, plus 1.25%. Such rate was later reduced to prime plus 0.75%.\nIn December 1994, the Company restructured its revolving credit line to include the Sports Subsidiaries, as borrowers. The Revolver provided for borrowings of up to $200 million based on eligible trade receivables and inventory. The Revolver's interest was calculated at the prime rate plus 0.75% (9.25% at December 31, 1994) and included a LIBOR rate option which equals LIBOR plus 2.75%. The unused line fee is 0.25% on the available unused portion of the line. The term of the Revolver was through January 31, 1997.\nIn September 1995, the Company amended and restated the Revolver. The Amended and Restated Revolver provides for a term loan facility and a revolving credit facility of up to $300 million, subject to restrictions on borrowings pursuant to certain covenants in the indenture, as amended, for the Company's Notes. The revolving credit facility provides for borrowings of up to $275 million based on eligible trade receivables and inventory. At December 31, 1995, the Amended and Restated Revolver's interest rate was 9.25%. The term of the Amended and Restated Revolver is through September 29, 1998, and is automatically renewed for successive one year terms unless terminated by either the lenders or the Company.\nThe Amended and Restated Revolver requires the maintenance of various financial covenants including minimum net worth, fixed maturity coverages and minimum working levels. In the first quarter of 1996, the Company was not in compliance with several of its loan covenants calculated as of December 31, 1995. These events of non-compliance were waived as of December 31, 1995 by the lenders under the Amended and Restated Revolver pursuant to the further amendment and restatement of the Revolver in the first quarter of 1996. At no time was the Company in default with respect to the payment of indebtedness under the Amended and Restated Revolver. The Company expects to remain in compliance with amended covenants in 1996. Unutilized credit available under this facility was approximately $45.9 million at December 31, 1995. At December 31, 1995, the Company had outstanding commercial letters of credit totaling approximately $7.0 million.\n(4) INVENTORIES\nInventories consisted of the following:\nIf the FIFO inventory valuation method had been used for all inventories, they would have been $2,072,000 higher than reported at December 31, 1995. The estimated current cost of inventories is approximately the same as the LIFO or FIFO inventory values at December 31, 1994.\n(5) PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment consisted of the following:\nAdditions and improvements to property, plant and equipment are capitalized while maintenance and repairs are charged to expense as incurred. Upon disposal or retirement of property, plant and equipment, the cost and accumulated depreciation are eliminated from the accounts and the gain or loss on the transaction is included in earnings.\nApproximately $31 million of property, plant and equipment was acquired in the acquisition of the Sports Subsidiaries (See Note 14 \"Acquisitions\").\nIncluded in machinery and equipment at December 31, 1995 and 1994 is approximately $4,639,000 and $3,165,000, respectively, of equipment under capital leases.\nDepreciation of plant and equipment was $9,660,000 in 1995, $4,662,000 in 1994 and $2,864,000 in 1993.\n(6) LONG-TERM DEBT\nLong-Term Debt is summarized as follows at:\nAggregate maturities are as follows: 1996, $1,519,000; 1997, $1,237,000; 1998, $1,081,000; 1999, $480,000; 2000, $398,000; and thereafter, $144,192,000.\nIn August 1993, the Company issued $51,745,000 of its 8% Convertible Subordinated Debentures (\"the Debentures\") due 2003. The Debentures are convertible into the Company's $0.01 par value common stock at $4.00 per share. The Company can call the Debentures on or after September 15, 1996 subject to the attainment of certain minimum stock price levels. The Debentures were issued to repay certain term loans under the Roadmaster Loan Agreement, provide funds for the acquisition of Flexible Flyer, and for general corporate purposes.\nIn December 1993, the Company issued $100 million of its 11.75% Senior Subordinated Notes (the \"Notes\") due 2002. The Notes were issued to diminish the Company's reliance on traditional asset-based revolving lines of credit and establish a more permanent capital structure in connection with the Company's long-term growth objectives. The funds were used to partially repay amounts due under the Roadmaster Loan Agreement, meet seasonal working capital requirements and provide for the Company's three year, $35 million capital expenditures budget. Much of the additional expenditures were targeted for cost reduction projects and tooling of new products. The Company repurchased $7.3 million of its Notes in January 1994 and $5.0 million in November 1994. In August 1995, in a private transaction, the Company sold $2.4 million of its Notes held in treasury. The entire $100 million is issued and outstanding, and the $9.9 million repurchased are held in treasury.\nDeferred offering costs of $12.5 million at December 31, 1995, are amortized on the effective interest rate method over the life of the related obligations.\nAt December 31, 1993, the Company placed $60 million in an irrevocable trust for the purpose of reducing the previous bank credit facility. Accordingly, the Company treated this transaction as an in-substance defeasance and accounted for the proceeds in the trust account as a reduction in the loan balance. In January 1994, the previous bank credit facility was retired and replaced with the Revolver.\nUnder terms of the UDAG agreement between Roadmaster, the City of Olney, Illinois, and the United States Department of Housing and Urban Development (\"HUD\"), Roadmaster agreed to invest matching funds to renovate, expand, and upgrade its plant and equipment. Roadmaster failed to comply with the schedule of investing funds and, in 1986, HUD terminated the UDAG grant but indicated it would not accelerate the then outstanding loan balance. The City of Olney, Illinois, which administers the UDAG loan, waived the matching requirement under the UDAG agreement and indicated it would not accelerate the loan so long as Roadmaster repaid the loan according to the scheduled maturities. Roadmaster is current in making its scheduled payments under the loan.\n(7) INCOME TAXES\nIncome tax (benefit) expense for the years ended December 31, 1995, 1994 and 1993 consists of:\nThe Company's effective tax rate varies from the statutory Federal income tax rate as a result of the following items for the years ended December 31, 1995, 1994 and 1993:\nAt December 31, 1995, the Company had a foreign tax credit carryforward of $1,002,000 which expires in 1997.\nThe components of the net deferred tax asset\/(liability) as of December 31, 1995 and 1994 are as follows:\nRelated to the acquisition of the Sports Subsidiaries, as of December 6, 1994, a preliminary allocation had been provided for a valuation allowance related to the acquired net deferred tax assets. During 1995, the Company completed its purchase accounting to record the final acquired net deferred tax assets and made adjustment to the initial valuation allowance. Subsequent tax benefits related to the valuation allowance\nestablished will be allocated directly to goodwill. As of December 31, 1995, the remaining valuation allowance is $3,579,000. The valuation allowance was established due to the poor earnings history of the acquired Sports Subsidiaries, excluding Nelson\/Weather-Rite.\nIn management's opinion, based on the Company's earnings history, expectations of future taxable income, and other relevant considerations, it is more likely than not that future taxable income will be sufficient to fully utilize the deferred tax assets, net of the valuation allowance, which existed at December 31, 1995.\n(8) LEASES\nThe Company leases certain equipment and machinery under noncancellable operating leases. Rent expense was $9,942,000 in 1995, $3,783,000 in 1994 and $2,065,000 in 1993.\nThe Company leases certain equipment under capital leases. Future aggregate minimum lease payments under capital and operating leases that have initial or remaining noncancellable lease terms in excess of one year as of December 31, 1995, are as follows:\n(9) COMMITMENTS AND CONTINGENCIES\nRoadmaster Leisure, Inc., a wholly-owned indirect subsidiary of the Company, files a separate Canadian income tax return. Revenue Canada has proposed a reassessment of amounts due under income tax returns previously filed. The Company intends to vigorously oppose any reassessment and believes that, in the event of an unfavorable outcome, amounts payable (net of potential recoveries) will not have a material adverse impact on the Company's annual consolidated results of operations or financial condition.\nThe Company and its subsidiaries are involved in certain other legal actions and claims arising in the ordinary course of business. In addition, from time to time the Company becomes aware of certain environmental remediation related matters which may result in the incurrence of non-reimbursable costs. Management believes that the resolution of such contingencies will not have a materially adverse impact on the Company's annual consolidated results of operations or financial position.\nIn connection with the acquisition of the assets of American Playworld, the Company granted a price guarantee for the 606,061 shares issued. The seller is guaranteed a price of $4.125 per share by the Company. In the event the seller sells the shares at a price below $4.125, the Company may be required to pay the seller the difference between the price received and $4.125 per share. Any such payment would result in an increase to goodwill.\nIn connection with the acquisition of MZH, the Company granted a price guarantee for the 400,000 shares issued. The seller is guaranteed a price of $3.75 per share by the Company. In the event the seller sells the shares at a price below $3.75, the Company may be required to pay the seller the difference between the price received and $3.75 per share. Any such payment would result in an increase to goodwill.\n(10) BENEFIT PLANS\nThe Company maintains three Employee Stock Ownership Plans (the \"Plans\" or \"ESOP\") and each incorporates salary deferral and employer matching contribution features (\"401(k)\"). The Company makes basic contributions to the Plan in amounts necessary to pay any maturing obligations under any outstanding ESOP loans. The ESOP has no maturity obligations at December 31, 1995. Additionally, the Company periodically makes discretionary contributions of shares of its common stock or cash for the benefit of eligible employees.\nThe Company sponsors a 401(k) savings plan under which eligible U.S. employees may choose to save up to 15% of their salary income on a pre-tax basis, subject to certain IRS limits. The Company matches 4% of employee contributions with Company common stock up to a minimum of 1% of net income. The shares for this purpose are provided principally by the Company's ESOP, supplemented as needed by newly issued shares. The Company makes annual contributions to the ESOP. The ESOP shares were initially pledged as collateral for the Company's debt. As the debt is repaid over a 10 year period, shares are released from collateral and allocated to employees who made 401(k) contributions that year. The Company accounts for its ESOP in accordance with Statement of Position 93-6. Accordingly, the shares pledged as collateral are reported as unearned ESOP shares in the statement of financial position. As shares are released from collateral, the Company reports compensation expense equal to the current market price of the shares, and the shares become outstanding for earnings per share computations.\nCompensation expense for the 401(k) match and the ESOP was $696,000 in 1995. The ESOP shares as of December 31, 1995 and 1994 were as follows:\nThe Company has received favorable tax qualification determination letters from the Internal Revenue Service (\"IRS\") on all three of its Plans.\nThe Company also maintains three qualified defined benefit plans on a curtailed basis. Net periodic pension income for the years ended December 31, 1995 and 1994 consisted of the following:\nThe following table sets forth the funded status at December 31, 1995 and 1994 of the pension plans and amounts recognized in the Company's consolidated financial statements as of December 31, 1995 and 1994:\nThe weighted average discount rate used in determining the actuarial present value of the projected benefit obligation was 6.5% both in 1995 and 1994. The expected long-term rate of return on assets was 8.5% in both 1995 and 1994. No rate of increase in future compensation levels is considered since the plans are frozen.\nPlan assets are invested in a collective guaranteed investment contract fund, a collective equity investment fund and temporary investments.\nRoadmaster acquired the Actava Group Inc. Sports Group Profit Sharing Plan (\"Actava Plan\") and the Diversified Products Corporation Profit Sharing\/401(k) Plan (\"DP Plan\") with the 1994 acquisition of the Sports Subsidiaries. The Actava Plan is a defined contribution plan for the employees of Nelson\/Weather-Rite and Willow whose assets are invested in money market funds, bond funds and U.S. Treasury Bills. The DP Plan is a defined contribution plan with 401(k) features for the employees of DP whose plan assets are primarily invested in a guaranteed interest contract. Both plans were inactive during 1995.\n(11) RELATED-PARTY TRANSACTIONS\nOn October 7, 1993, Roadmaster entered into a distribution agreement with MacGregor Sports Products, Inc. (\"MSP\"), a wholly-owned subsidiary of MacGregor Sports and Fitness, Inc. (\"MacGregor\"), a publicly-held company engaged in the business of marketing and distributing a broad range of sports, recreational and fitness products under the MacGregor trademark. Roadmaster became the exclusive worldwide distributor of MacGregor brand baseball, softball, basketball, football, soccer, hockey, volleyball, racquet sports, and other products, for a term of five years, with a five-year renewal option. Pursuant to the distribution agreement, Roadmaster is obligated to pay MSP a 3% royalty based on a percentage of Roadmaster's net revenues from products bearing the MacGregor trademarks and brand names, with certain minimum royalties. In addition, Roadmaster acquired certain accounts receivable, inventory, general intangibles and equipment, for a purchase price of $1.6 million. The Company's Chief Executive Officer (\"CEO\") and Chief Operating Officer are serving or have served as directors of MacGregor. The Company is a significant shareholder of MacGregor.\nEquitex is a major stockholder of the Company and the CEO of Equitex is also the CEO and a director of the Company. Equitex earned management fees of $144,000 for each of the years from 1993 through 1995.\n(12) COMMON STOCK\nIn connection with the acquisition of Flexible Flyer in September 1993, the Company issued 617,165 shares of redeemable common stock valued at $2.0 million. These shares contained a contractual\nright to put the shares back to the Company at $3.24 per share. This right expired on October 15, 1994. Accordingly, since this right has expired, these shares were included as a component of stockholders' equity at December 31, 1994 in the accompanying balance sheet.\nDuring 1994, the Company issued warrants to purchase up to a total of 888,145 shares of the Company's common stock at prices ranging from $3.63 to $4.06 per share. In addition, warrants to purchase 409,175 shares were issued with an exercise price of the fair market value of the Company's common stock at the date of exercise.\nDuring 1995, the Company issued warrants to purchase up to a total of 1,575,250 shares of the Company's common stock at prices ranging from $2.56 to $4.00 per share. In addition, warrants to purchase 442,700 shares were issued with an exercise price of the fair market value of the Company's common stock at the date of exercise.\nStock option and warrant transactions are summarized below for the three year period ended December 31, 1995:\nAs of December 31, 1995, the Company had a total of 7,378,378 shares of common stock reserved for issuance upon exercise of warrants ($1.33-$6.60 exercise price per share).\n(13) EARNINGS PER COMMON SHARE\nIn 1995, primary and fully diluted earnings per common share were based on the weighted average number of common shares outstanding during the year.\nIn 1993 and 1994, primary earnings per common share were based on the weighted average number of common shares outstanding during the year and common stock equivalent shares assumed to be exercised with the proceeds used to repurchase common shares at the average market price for the year.\nIn 1993 and 1994, fully diluted earnings per common share further assumed that the proceeds of common equivalent shares were used to repurchase common shares as of the beginning of the year, at the higher of the market price at the close of the period or the average market price for the year, to reflect maximum potential dilution. In 1993, the computation of fully diluted earnings per share also includes interest savings assuming conversion of the Debentures and the 12,936,000 shares issuable under that assumption as the effect of their inclusion is dilutive for 1993.\n(14) ACQUISITIONS\nACQUISITION OF MZH\nIn April 1995, the Company finalized the acquisition of certain assets and the business of MZH, a manufacturer and marketer of sleeping bags. MZH had revenues of approximately $28 million in 1994. The purchase price included $21.5 million in cash, 400,000 shares of the Company's common stock valued at $1.5 million and the assumption of certain liabilities.\nACQUISITION OF FORSTER\nIn March 1995, Hutch acquired the sporting goods division of Forster Manufacturing Company for $7.4 million in cash. The product categories acquired include various backyard and lawn games, including croquet, bocce ball and volleyball.\nThe pro forma effect of the 1995 acquisitions on the 1995 financial statements is not material.\nACQUISITION OF THE SPORTS SUBSIDIARIES\nOn December 6, 1994, the Company exchanged with Actava all of the issued and outstanding capital shares of DP, Hutch, Nelson\/Weather-Rite, and Willow, wholly-owned subsidiaries of Actava, for an aggregate 19,169,000 shares of the Company's common stock, par value $0.01 per share valued at $76.7 million.\nThe acquisition has been accounted for as a purchase, and the net assets and results of operations are included in the Company's Consolidated Financial Statements beginning December 7, 1994. The purchase price has been allocated to the assets and liabilities of the Sports Subsidiaries based on their estimated fair values. The purchase price and expenses associated with the acquisition exceeded the fair value of net assets by $71.0 million. These amounts have been included in goodwill and other intangible assets.\nACQUISITION OF AMERICAN PLAYWORLD\nIn February 1994, the Company acquired the assets and business of American Playworld. American Playworld is a manufacturer of trampolines distributing mainly to mass merchants and had revenues of approximately $17 million in 1993. The purchase price included $7.0 million in cash, 606,061 shares of the Company's common stock valued at $2.5 million, and the assumption of certain trade payables.\nACQUISITION OF FLEXIBLE FLYER COMPANY\nOn September 14, 1993, the Company purchased from Par Industries, Inc. (\"Par\") certain assets and the business of, and assumed certain recorded liabilities incurred in the ordinary course of business by, Flexible Flyer Company, a division of Par. The price paid by the Company for the Flexible Flyer assets and business was approximately $23.0 million. The purchase financing included the issuance of 617,165 shares of redeemable common stock valued at $2.0 million and the assumption of $4.2 million of accounts payable. In addition, the principal stockholders of Par agreed to a five-year non-compete arrangement for which the Company will pay an additional $1.5 million over the five-year period following the closing date of the Flexible Flyer acquisition.\nThe acquisition was accounted for as a purchase, and the net assets and results of operations are included in the Company's Consolidated Financial Statements beginning September 14, 1993. The purchase price was allocated to the assets and liabilities of Flexible Flyer based on their estimated fair values. The purchase price and expenses associated with the acquisition exceeded the fair value of Flexible Flyer's net assets by approximately $6.6 million. These amounts have been included in goodwill and other intangible assets.\nThe following unaudited pro forma information combines the consolidated results of operations of the Company, Flexible Flyer, American Playworld and the Sports Subsidiaries as if the acquisitions had occurred on January 1 of the respective years, after giving effect to amortization of goodwill and noncompetition agreements and increased interest expense at approximately 8% on average borrowings to finance the acquisition. The pro forma results of operations exclude salary expense for the terminated salary employees not rehired by the Company, as provided for in the Flexible Flyer Acquisition Agreement, and direct costs associated with assets not purchased or liabilities not assumed as provided by the Flexible Flyer Acquisition Agreement. The pro forma information is not necessarily indicative of the results of operations which would have actually been obtained during such periods.\n(15) NEW ACCOUNTING PRONOUNCEMENTS\nIn 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (\"SFAS\") No. 123, \"Accounting for Stock-Based Compensation\", which is required to be adopted for fiscal years beginning December 15, 1995. The Company anticipates including the appropriate disclosure requirements in its 1996 financial statements. The Company anticipates that there will be no financial statement impact.\n(16) RESTRUCTURING CHARGE\nIn December 1995, the Company recorded a restructuring charge of $7.5 million, primarily related to the closure of its Tyler, Texas manufacturing facility and the downsizing of its European distribution operations. The operations of the Tyler facility will be integrated with the Company's Opelika, Alabama manufacturing operations enabling the Company to reduce fixed costs and increase utilization and efficiency of existing manufacturing facilities. The components of the restructuring charge include $1.4 million for employee severance, $3.9 million to cover lease obligations for facilities which will no longer be needed and $2.2 million for the maintenance, security and other facility related carrying costs. Total cash expenditures of $7.5 million are included in this charge. All employees were notified of this restructuring by December 31, 1995. The Company plans to substantially complete all related restructuring activities by December 31, 1996.\n(17) SUBSEQUENT EVENT\nOn March 8, 1996, the Company completed the sale of the assets of its Nelson\/Weather-Rite camping division, including MZH, to Brunswick Corporation for cash consideration of $120 million. The sale includes the\npurchase of all the assets and the assumption of accounts payable and accrued liabilities, which totaled $87.7 million at December 31, 1995. Such transaction was consummated on March 8, 1996. The final purchase price is subject to ordinary post closing adjustments based on closing working capital levels. The Company used the net proceeds to reduce its outstanding revolving credit facility by approximately $120 million. Pending final purchase price adjustments, the Company expects a pretax gain of more than $25 million to be recognized in the first quarter of 1996.\n(18) QUARTERLY FINANCIAL DATA (UNAUDITED)\n(1) This loss includes costs associated with the impairment loss and restructuring costs.\nSCHEDULE II\nROADMASTER INDUSTRIES, INC. AND SUBSIDIARIES\nVALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (in thousands)\nNotes: (1) Represents amounts charged off as uncollectible. (2) Represents amounts assumed through the acquisition of Flexible Flyer Company. (3) Represents amounts assumed through the acquisition of the Sports Subsidiaries.","section_15":""}
{"filename":"842815_1995.txt","cik":"842815","year":"1995","section_1":"ITEM 1. BUSINESS\nPool Energy Services Co. (the \"Company\") is the largest well-servicing and workover company in the world based on the number of rigs it operates. It operates onshore and offshore, both domestically and internationally, providing services for multi-national, foreign national and independent oil and natural gas producers. The Company performs the routine maintenance and major overhauls necessary for oil and natural gas wells to function efficiently. The Company typically provides a well-servicing or workover rig, the crew to operate the rig and such other specialized equipment as may be needed. The Company also provides services for the drilling and completion of new oil and natural gas wells. The Company conducts a significant part of its foreign operations through unconsolidated affiliates.\nThe Company was formed in 1988 to acquire Pool Company, the oilfield services business of ENSERCH Corporation (\"ENSERCH\"), and that acquisition was completed on April 24, 1990. Pool Company was established in 1948. As used in this document, except where the context otherwise requires, the term \"Company\" refers to Pool Energy Services Co., its subsidiary corporations and its unconsolidated affiliates.\nBUSINESS STRATEGY\nUnder the Company's strategic plan that was developed during 1994, key growth strategies include: seeking expansion opportunities in existing core market areas, particularly acquisitions which result in consolidation savings; entering new foreign markets with significant ongoing industry activity;and offering services complementary to the Company's core businesses through existing field locations. Notable examples of actions taken in the implementation of these strategies are as follows:\nIn September 1994, the Company acquired the 60.7% interest not already owned by the Company in Pool Arctic Alaska, a partnership, for $12.1 million in cash. The Company's Alaska operation now includes the three highly specialized Arctic land drilling rigs and related equipment formerly owned by the partnership. It provides rig and contract labor services, both onshore and offshore, in Alaska.\nOn June 13, 1995, the Company acquired all of the outstanding capital stock of Golden Pacific Corp. (\"GPC\"). Prior to the acquisition, GPC had annual revenues of approximately $50 million and operated a fleet of approximately 155 land well-servicing rigs in California. See Note 3 of Notes to Consolidated Financial Statements for a discussion of this acquisition.\nIn the second half of 1995, the Company commenced operations under a term contract offshore Australia with a newly constructed platform workover rig. In addition, Antah Drilling Sdn. Bhd., the Company's 49%-owned Malaysia affiliate, is currently substantially modifying its platform drilling rig for operation under a term contract offshore Australia which is expected to commence in mid-1996.\nTYPES OF SERVICES PROVIDED\nWELL-SERVICING\/MAINTENANCE SERVICES\nThe Company provides maintenance services on the mechanical apparatus used to pump or lift oil and natural gas from producing wells. The Company provides the rigs, equipment and crews for these tasks, which are performed on both oil and natural gas wells but which are more commonly required on oil wells. Well-servicing rigs have the same basic components as drilling rigs (i.e., a derrick, a hoisting mechanism and an engine). Many of these rigs also have pumps and tanks that can be used for circulating fluids into and out of the well. Maintenance jobs typically take less than 48 hours to complete.\nWORKOVER SERVICES\nIn addition to needing periodic maintenance, producing oil and natural gas wells occasionally require major repairs or modifications, called \"workovers.\" Workover operations are similar to maintenance operations but differ mainly in the extent of the repairs or services required. Workovers may be done, for example, to remedy equipment failures, to deepen a well in order to tap a new producing reservoir, to plug back the bottom of a well to reduce the amount of water being produced with the oil and natural gas, to clean out and recomplete a well if production has declined, to repair leaks or to convert a producing well to an injection well for secondary or enhanced recovery projects. These extensive workover operations are normally carried out with a well-servicing type rig with additional specialized accessory equipment, which may include rotary drilling equipment, mud pumps, mud tanks and blowout preventers, depending upon the particular type of workover operation. Most of the Company's well-servicing rigs are designed and equipped to handle the more complex workover operations. A workover may last anywhere from a few days to several weeks.\nCOMPLETION SERVICES\nThe kinds of activities necessary to carry out a workover operation are essentially the same as those that are required to \"complete\" a well when it is first drilled. The completion process may involve selectively perforating the well casing at the depth of discrete producing zones, stimulating and testing these zones and installing down-hole equipment. Oil companies often find that it is more efficient to move a larger and more expensive drilling rig off location after an oil or natural gas well has been drilled and to move in a specialized well-servicing rig to perform completion operations. The Company's rigs are often used for this purpose. The completion process may require from a few days to several weeks.\nCONTRACT DRILLING SERVICES\nThe Company provides contract drilling services to oil and natural gas operators in all markets it serves except onshore markets in the lower 48 states. The Company's workover rigs can be used for drilling, although the Company typically uses its specialized drilling rigs for such operations. The Company also provides specialized accessory equipment, including pumps, rotary drilling equipment, trucks, camps and cranes. Several of the Company's land drilling rigs are equipped for self-sustained operations in remote locations in Alaska and overseas.\nPRODUCTION AND OTHER SPECIALIZED SERVICES\nThe Company provides other specialized services that are required, or can be used effectively, in conjunction with the previously described basic services. The main additional services are production\nservices, consisting of the provision of onsite temporary fluid-storage facilities, the provision, removal and disposal of specialized fluids used during certain completion and workover operations, and the removal and disposal of salt water that is often produced in conjunction with the production of oil and natural gas. The Company also provides plugging services for wells from which the oil or natural gas has been depleted and further production has become uneconomical.\nBUSINESS BY GEOGRAPHIC AREA\nFinancial data by geographic area for the three years ended December 31, 1995 are presented in Note 10 of Notes to Consolidated Financial Statements.\nBUSINESS BY SERVICE LINE\nThe Company operates in only one business segment - the oilfield services industry. Within that segment, the Company conducts business in the following distinct markets or business lines: domestic onshore well-servicing and production services, Gulf of Mexico offshore workover\/drilling, international workover\/drilling and related services and Alaska onshore and offshore workover\/drilling.\nDOMESTIC ONSHORE ACTIVITIES\nThe Company's domestic onshore operation, which provides well-servicing, workover and production services, has locations in many of the major oil and natural gas producing fields in the continental United States. This operation currently provides services in ten states and is divided into two separate geographic divisions: (i) the Central division (principally Texas and Oklahoma) and (ii) the California division. The Company's domestic onshore operation has 655 well-servicing rigs, of which 298 are located in Texas, 256 in California, 54 in Oklahoma and 47 in North Dakota, New Mexico, Arkansas, Montana and Louisiana. In 1995 rig hours were comprised of well-servicing\/maintenance (56%), workover (29%), completion (10%) and plugging operations (5%). The Company's domestic onshore operation also provides production services consisting chiefly of fluid hauling and frac tank rental. The production services assets, located primarily in Texas, consist of 273 fluid hauling trucks, 682 frac tanks and nine saltwater disposal well facilities.\nGULF OF MEXICO OFFSHORE ACTIVITIES\nOffshore in the Gulf of Mexico, the Company provides workover, well-servicing, completion and drilling services with its fleet of thirteen platform rigs and five jackup rigs. The Company also provides crews to oil and natural gas well operators under labor contracts. During the year ended December 31, 1995 approximately 86% of the Company's Gulf of Mexico offshore rig hours were related to workover, well-servicing and completion operations with the balance related to contract drilling. Offshore operations are normally conducted 24 hours a day, seven days a week under a term contract that is either for a specific period of time or until a program of work is completed.\nINTERNATIONAL ACTIVITIES\nInternationally, the Company provides workover, well-servicing and drilling services, both onshore and offshore, with specialized rigs designed and fabricated to meet various types of operating conditions. During 1995, the Company operated in ten foreign countries. The Company has 39 rigs in foreign locations of which 22 are located in the Middle East, 12 in South America, three in Asia, one in Africa and one in Australia. The Company conducts a significant part of its foreign operations through joint venture companies in which it has approximately a 50% participation. The principal joint venture operations are conducted in Saudi Arabia (Pool Arabia, Ltd.), Malaysia (Antah Drilling Sdn. Bhd.) and Trinidad (Pool Santana, Limited). Beginning in mid-1996 Antah Drilling Sdn. Bhd. will also operate in Australia. The Company uses the equity method to account for these unconsolidated affiliates in the Company's financial statements. See Note 9 of Notes to Consolidated Financial Statements.\nALASKA ACTIVITIES\nIn Alaska, the Company provides drilling, workover and well-servicing with its fleet of three highly specialized Arctic land drilling rigs, two offshore platform rigs and one multi-purpose rig. The Company also provides crews to oil and natural gas well operators in Alaska under labor contracts. The Company's services are principally provided onshore on the North Slope and offshore in the Cook Inlet. On September 28, 1994, the Company acquired the 60.7% partnership interest not already owned by the Company in Pool Arctic Alaska for $12.1 million in cash. For further information related to this acquisition, see Note 3 of Notes to Consolidated Financial Statements.\nFINANCIAL DATA BY SERVICE LINES\nThe following table presents information by service lines:\n_____________ (1) A significant part of the operations of the Company is conducted through its unconsolidated affiliates, which are accounted for using the equity method. See Note 3 of Notes to Consolidated Financial Statements for information related to the Pool Arctic Alaska acquisition in 1994. (2) See Note 1 of Notes to Consolidated Financial Statements for information related to the revision of estimated remaining depreciable lives of certain rigs and equipment in October 1994. (3) See Note 6 of Notes to Consolidated Financial Statements for information related to the provision for leasehold impairment in 1994.\nEMPLOYEES\nAt December 31, 1995, the Company had 4,982 employees, of whom 468 were employed by unconsolidated affiliates. None of the employees at any of the Company's locations (except Australia) are represented by a collective bargaining unit. Management believes that the Company's relationship with its employees is excellent.\nOTHER MATTERS\nINTERNATIONAL RISKS\nThe Company's foreign operations are subject to such uncertainties as the risk of expropriation or forced renegotiation of agreements, adverse tax policies, instability of foreign economies, foreign exchange restrictions and the possibility of armed conflict in certain areas. The Company has had no significant losses from any of the foregoing risks during the last five years in any country in which the Company presently operates. However, in Colombia weak demand for the Company's midsize drilling rigs, coupled with the escalation of drug-related violence during recent years resulted in the Company's disposing in 1993 of its Colombia assets, which as a result of a previously established reserve had no significant carrying value. Also in 1993, as a result of civil unrest in Djibouti, the Company wrote off against a previously established reserve the carrying value of its equipment in that country. In 1995, proceeds of an insurance settlement were received which partially offset the 1993 writeoff in Djibouti.\nThe Company is subject to taxation in many jurisdictions, and the final determination of its tax liabilities involves the interpretation of the statutes and requirements of various domestic and foreign taxing authorities. Foreign income tax returns of foreign subsidiaries, unconsolidated affiliates and related entities are routinely examined by foreign tax authorities. The Company maintains reserves for potential tax audit assessments and, in the opinion of management, any additional provision ultimately determined to be required as a result of such examinations or assessments will not be material to the Company's financial position or operations.\nENVIRONMENTAL REGULATION AND CLAIMS\nThe Company's well-servicing, workover and production services operations routinely involve the handling of significant amounts of waste materials, some of which are classified as hazardous substances. The Company's operations and facilities are subject to numerous state and federal environmental laws, rules and regulations, including, without limitation, laws concerning the containment and disposal of hazardous materials, oilfield waste and other waste materials, the use of underground storage tanks and the use of underground injection wells. The Company employs personnel responsible for monitoring environmental compliance and arranging for remedial actions that may be required from time to time and also uses outside experts to advise on and assist with the Company's environmental compliance efforts. Costs incurred by the Company to investigate and remediate contaminated sites are expensed unless the remediation extends the useful lives of the assets employed at the site. Remediation costs that extend the useful lives of the assets are capitalized and amortized over the remaining useful lives of such assets. Liabilities are recorded when the need for environmental assessments and\/or remedial efforts become known or probable and the cost can be reasonably estimated.\nLaws protecting the environment have generally become more stringent than in the past and are expected to continue to do so. Environmental laws and regulations typically impose \"strict liability,\" which means that in some situations the Company could be exposed to liability for cleanup costs and other damages as a result of conduct of the Company that was lawful at the time it occurred or conduct of, or conditions caused by, others. Cleanup costs and other damages arising as a result of environmental laws, and costs associated with changes in environmental laws and regulations could be substantial and could have a material adverse effect on the Company's financial condition. From time to time, claims have been made and litigation has been\nbrought against the Company under such laws. However, the costs incurred in connection with such claims and other costs of environmental compliance have not had any material adverse effect on the Company's operations, financial condition or competitive position in the past, and management is not currently aware of any situation or condition that it believes is likely to have any such material adverse effect in the future.\nUnder the Comprehensive Environmental Response, Compensation and Liability Act, also known as \"Superfund,\" and related state laws and regulations, liability can be imposed without regard to fault or the legality of the original conduct on certain classes of persons that contributed to the release of a \"hazardous substance\" into the environment. The Company has been notified of its possible involvement with respect to the cleanup of two Superfund sites which were formerly operated by parties unrelated to the Company as oilfield waste disposal facilities, and has been named as a potentially responsible party with respect to the cleanup of one other Superfund site which was formerly operated by various parties unrelated to the Company as an oil refining and reclamation facility. Although at this time information about these matters has not been fully developed and it is not feasible to predict their outcome with certainty, management is of the opinion that their ultimate resolution should not have a material adverse effect on the Company's financial condition.\nFederal and state environmental regulations and changes thereto may also negatively impact oil and natural gas exploration and production companies, which in turn could have a material adverse effect on the Company. For example, legislation has been proposed from time to time in Congress which would reclassify oil and natural gas production wastes as \"hazardous wastes.\" If enacted, such legislation could dramatically increase operating costs for domestic oil and natural gas companies and this could reduce the market for the Company's services by making many wells and\/or oilfields uneconomical to operate. To date, such legislation has not made significant progress toward enactment.\nPATENTS, TRADEMARKS, LICENSES, FRANCHISES AND CONCESSIONS\nThe Company owns several U.S. patents on designs for various types of oilfield equipment and on methods for conducting certain oilfield activities. The Company uses some of these designs and methods in the conduct of its business. The patents expire at various times to the year 2014. The Company also has several trademarks and service marks that it uses in various aspects of its business. While management believes its patent and trademark rights are valuable, the expiration or loss thereof would not have a material adverse effect on the Company's financial condition or results of operations.\nCOMPETITIVE CONDITIONS\nAlthough the number of available rigs has materially decreased over the past ten years, the well-servicing, workover and drilling industry remains very competitive. The number of rigs continues to exceed demand, resulting in severe price competition. Many of the total available contracts are currently awarded on a bid basis, which further increases competition based on price. In all of the Company's market areas, competitive factors also include: the availability and condition of equipment to meet both special and general customer needs; the availability of trained personnel possessing the specialized skills required; and the overall quality of service, measured by performance and safety records. As an enhancement to its competitive position, the Company has been able to establish numerous strategic alliances with major customers in its domestic onshore, international and Alaska markets, including several alliances in California which were obtained upon the acquisition of GPC. One customer, Shell Oil Company, accounted for approximately 11% of the Company's consolidated revenues during 1995.\nCertain competitors are present in more than one of the Company's markets, although no one competitor operates in all of these areas. With 655 rigs, the Company has the most well-servicing rigs of any company in the domestic onshore market. In this market, the second largest competitor has approximately 400 rigs, two competitors have 100 to 200 rigs each, and several hundred competitors have smaller regional or local\nrig operations. In each of its domestic onshore locations, the Company competes with several firms of varying size. In the Gulf of Mexico, the Company is among five principal competitors providing workover\/maintenance services. Internationally, the Company competes directly with various competitors at each location where it operates. In Alaska, the Company has six major competitors.\nEXECUTIVE OFFICERS\nListed below are the names, ages and positions of the Company's executive officers. Officers are elected annually following the Annual Meeting of Shareholders and serve one-year terms or until their successors are elected and qualified to serve.\nMr. Jongebloed has been President and Chief Executive Officer of the Company since 1990 and President and Chief Operating Officer since 1989. He served Pool Company from 1978 to 1989 as Executive Vice President, Western Hemisphere, President of Pool-Intairdril and Group Vice President-International Operations.\nMr. Myers has been Group Vice President-U.S. Operations of the Company since 1988. From 1985 to 1987 he was self employed, and from 1976 to 1985 he was the President and Chief Executive Officer of Anderson-Myers Drilling Company in Denver, Colorado.\nMr. Hale has served in various management and executive positions with the Company for more than the last 15 years. From 1985 to 1989 he served as Vice President, Mid-East and Africa Region, International Operations. He became Group Vice President-International Operations in 1989.\nMr. Spillard served from 1979 to 1981 as Controller of Pool Arabia, Ltd. From 1981 to 1986, he held various executive positions with the Company. He was Senior Vice President, Corporate Services, from 1986 to 1987 and has been Senior Vice President, Finance of the Company since 1987.\nMr. Arms has been Vice President and General Counsel of the Company since 1985 and has been Corporate Secretary since 1990. He has served the Company as an attorney in various other positions since 1978.\nMr. Dupre has been Vice President, Human Resources of the Company since 1994. From 1986 to 1994, he served as the Company's Controller. He has been an employee of the Company since 1978.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe following table sets forth the type, number and location of the domestic onshore equipment operated by the Company as of December 31, 1995:\nThe following table sets forth the type, number and location of the Alaska, Gulf of Mexico and International rigs owned by the Company and its joint ventures as of December 31, 1995:\n___________ (a) A multi-purpose workover or drilling rig that can be configured for either onshore or offshore use.\nThe Company's corporate offices are located in Houston, Texas, where the Company subleases office space from ENSERCH at market rates under an agreement that expires in November 1997. The Company also leases from an unrelated party a 65- acre former rig and equipment manufacturing and storage facility in San Angelo, Texas, which includes approximately 245,000 square feet of buildings and other structural facilities. The annual lease payments are approximately $2.2 million per year through March 1998 and $4.4 million per year thereafter until expiration of the lease in 2003. Effective October 1, 1994, the Company vacated this facility and subleased it in its entirety to a third party, under an operating sublease which expires in September 1997. The sublease provides for minimum sublease payments of $0.5 million per year for three years. Based on a conclusion that none of the facility is likely to be used in its future operations, the Company, in the fourth\nquarter of 1994, made a provision of $23.6 million to recognize all future lease expense, net of anticipated sublease income. The Company owns 32 and leases 50 domestic office and yard locations of which seven locations are not currently used. Internationally, the Company leases office and yard facilities at nine locations and owns facilities at five locations. In Alaska, the Company leases an office and yard facility in Anchorage and a yard facility on the North Slope.\nAs partial consideration for the acquisition of GPC, the Company issued subordinated notes which are collateralized by the well-servicing rigs and related equipment and certain real property obtained in the GPC acquisition. The Company's 13 platform rigs located in the Gulf of Mexico and the property owned by the Company's Alaska subsidiary are pledged as collateral to secure payment of the Company's syndicated bank revolving line of credit and $10 million term loan (of which $7.4 million was outstanding at December 31, 1995). Eight domestic well-servicing rigs and related equipment purchased in 1994 are pledged as security for long-term debt related to the purchase thereof. The Company's offshore platform workover rig located in Australia was pledged in January 1996 as security for a four-year loan related to the construction of such rig.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company from time to time is involved in ordinary and routine litigation incidental to its business, which often involves claims for significant monetary amounts, some, but not all, of which would be covered by insurance. In the opinion of management, none of the existing litigation will have any material adverse effect on the Company.\nSee also \"Item 1. Business - Other Matters - Environmental Regulation and Claims.\"\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 PRICES AND COMMON STOCK DATA\nThe Company's common stock is traded on the NASDAQ National Market System under the symbol \"PESC.\" At February 15, 1996, the approximate number of holders of record of the Company's common stock was 3,584. The following tables set forth the high and low sale prices per share of the Company's common stock for the periods indicated, as reported by NASDAQ.\nDIVIDEND POLICY\nThe Company has not paid dividends on its common stock. The Board of Directors currently intends to retain any earnings for use in the Company's business and does not intend to pay dividends in the foreseeable future. In addition, certain of the Company's credit facilities prohibit the payment of dividends.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following table sets forth certain historical consolidated financial data 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 Notes thereto included elsewhere herein. The data has been derived from the Company's audited consolidated financial statements.\n_________________ (1) Includes the results of GPC since the June 13, 1995 acquisition, which was accounted for under the purchase method. See Note 3 of Notes to Consolidated Financial Statements. (2) Includes the results from Pool Arctic Alaska since the September 28, 1994 acquisition, which was accounted for under the purchase method. See Note 3 of Notes to Consolidated Financial Statements. (3) The Company conducts a significant part of its operations through unconsolidated affiliates. See Note 9 of Notes to Consolidated Financial Statements. (4) See Note 3 of Notes to Consolidated Financial Statements for a discussion of the GPC acquisition related costs of $0.6 million pretax ($0.4 million, or $.03 per share after-tax). (5) See Note 6 of Notes to Consolidated Financial Statements for a discussion of the $23.6 million pretax ($15.3 million, or $1.13 per share, after-tax) provision for leasehold impairment. (6) In 1992, the Company recorded a $4.6 million pretax ($3.0 million, or $.23 per share, after-tax) writedown of certain of the Company's domestic offshore rigs and equipment. (7) The Company changed its method of accounting for income taxes in 1992. (8) At the beginning of the fourth quarter of 1994, the Company revised its estimate of the remaining depreciable lives of certain rigs and equipment to better reflect the remaining economic lives of the assets. The effect of this change in accounting estimate was to increase the 1995 net income by approximately $2.1 million or $.15 per share and to decrease the 1994 net loss by approximately $0.5 million or $.04 per share. At the beginning of the third quarter of 1991, the Company changed the estimated salvage values and remaining depreciable lives of certain equipment of the Company and its unconsolidated affiliates to better reflect the remaining economic lives of the assets and to treat them consistently with similar assets held by the Company. This change had the effect of decreasing the net loss for the year ended December 31, 1992 by $2.8 million or $.21 per share and increasing net income for the year ended December 31, 1991 by $1.2 million or $.09 per share. (9) Excluding acquisition of businesses.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\nGOLDEN PACIFIC CORP. ACQUISITION. On June 13, 1995, the Company acquired all of the outstanding capital stock of GPC. Prior to the acquisition, GPC had annual revenues of approximately $50 million and operated a fleet of approximately 155 land well-servicing rigs in California. See Note 3 of Notes to Consolidated Financial Statements for a discussion of this acquisition.\n1995 COMPARED TO 1994. The Company, on a consolidated basis, had net income of $3.1 million in 1995, compared with a net loss of $12.7 million in 1994. The 1995 net income included a $0.6 million ($0.4 million after-tax) charge for costs related to the GPC acquisition. The 1994 results included a $23.6 million ($15.3 million after-tax) provision for leasehold impairment. (See \"San Angelo Lease Commitment.\") The average price per barrel of West Texas Intermediate crude oil was higher by approximately 7% in 1995 than in 1994. Although average natural gas prices dropped approximately 15% from 1994 to 1995, natural gas prices in December 1995 rose above $2.00 per mcf, the highest they had been since the first quarter of 1994. Results from the Company's domestic operations improved primarily because of increased activity onshore in the lower 48 states, offsetting the effect of reduced operating results in Alaska. The Company's domestic onshore operation reported rig hours 28% higher for 1995 than in 1994, primarily due to the inclusion of rigs from the GPC acquisition since June 14, 1995. The Company's offshore operation in the Gulf of Mexico experienced rig utilization of 65% in 1995, compared to 53% in 1994; average rig rates, however, were lower, particularly for the jackup rigs. Earnings from the Company's Alaska operations decreased from 1994 due to one of its three Arctic land drilling rigs being on standby status during 1995, whereas it operated for the first four months of 1994 before going on standby status for the remainder of the year, and due to the completion in late 1994 of a long-term offshore drilling rig contract. Results from the Company's international operations decreased primarily due to lower earnings from the Company's unconsolidated affiliate located in Saudi Arabia, reduced land drilling activity in Ecuador and the absence of two rig contracts in Kuwait which were completed in mid-1994.\nRevenues. Revenues were $277.3 million in 1995, compared to $229.2 million in 1994. This increase was attributable to the inclusion of revenues for the entire year of 1995 from rigs and equipment previously owned by the Pool Arctic Alaska partnership compared to three months of revenues in 1994 (see \"Pool Arctic Alaska Acquisition\"), revenues from rigs and equipment acquired in the GPC acquisition (see \"Golden Pacific Corp. Acquisition\"), a higher level of activity by the Company's domestic onshore well-servicing rig fleet, increased rig activity in Tunisia, Oman and Pakistan, revenues attributable to a new offshore platform workover rig in Australia and increased domestic production services activity in 1995, offset partly by the absence of two rig contracts in Kuwait which were completed in mid-1994 and reduced land drilling activity in Ecuador. Domestic onshore well-servicing and related services revenues increased $33.5 million or 29% in 1995 from 1994, chiefly as a result of the GPC acquisition. In addition, domestic production services revenues increased $1.2 million or 3% in 1995 from 1994. Domestic onshore rig utilization was 52% in 1995, compared to 48% in 1994. Gulf of Mexico offshore workover and drilling revenues in 1995 increased $1.4 million or 4% compared to 1994, due to higher rig utilization which was somewhat offset by lower rig rates. Revenues from international operations increased $1.6 million or 6% in 1995 from 1994, due to increased rig activity in Tunisia, Oman, Pakistan and Australia, offset partly by the absence of two rig contracts in Kuwait which were completed in mid-1994 and reduced land drilling activity in Ecuador. Revenues for international operations do not include revenues from the Company's foreign joint ventures, which are unconsolidated affiliates.\nIn September 1994, the Company acquired the 60.7% partnership interest not already owned by the Company in Pool Arctic Alaska (see \"Pool Arctic Alaska Acquisition\"), and, accordingly, revenues generated from Pool Arctic Alaska rigs and equipment have been included in the Company's consolidated financial\nstatements since the date of such acquisition. Revenues for Alaska operations included in the Company's consolidated financial statements were $20.4 million in 1995. Revenues generated by the Company's wholly-owned operations in Alaska in 1994 were $9.9 million, which included $5.7 million from an offshore rig operating in the Cook Inlet and $4.2 million generated after the acquisition date by the acquired Pool Arctic Alaska rigs and equipment. Prior to the date of such acquisition, the Company's revenues did not include revenues of Pool Arctic Alaska, which was an unconsolidated affiliate, but did include revenues from the Company's wholly-owned operations in Alaska.\nEarnings Attributable to Unconsolidated Affiliates. Earnings attributable to unconsolidated affiliates were $3.0 million in 1995, compared to $5.0 million in 1994. Earnings attributable to Pool Arabia, Ltd., the Company's Saudi Arabia affiliate, decreased $1.3 million from 1994 to $2.3 million in 1995 primarily as a result of the completion in early 1995 of three land workover rig contracts in Kuwait and the completion in March 1995 of a land drilling contract in Saudi Arabia. Earnings attributable to Pool Arctic Alaska in 1994 were $0.5 million through the date of acquisition (see \"Pool Arctic Alaska Acquisition\"). Earnings from Pool Arctic Alaska ceased to be included in earnings attributable to unconsolidated affiliates immediately following the Company's purchase of its partner's interest in September 1994.\nCosts and Expenses. The Company's costs and expenses were $274.6 million in 1995, compared to $232.7 million in 1994 (excluding the provision for leasehold impairment). Such increase was attributable to (i) the inclusion, for the period June 14 through December 31, 1995, of costs and expenses related to the rigs and equipment obtained in the GPC acquisition, (ii) the inclusion in 1995 of a full year's costs and expenses related to the rigs and equipment previously owned by the Pool Arctic Alaska partnership, (iii) $0.6 million of expenses related to the GPC acquisition, primarily for yard closings, and (iv) costs associated with higher levels of activity in the Company's domestic onshore well- servicing line as well as in Tunisia, Oman, Pakistan and Australia. Partially offsetting these higher costs and expenses were lower repair and maintenance expenses for the Company's Gulf of Mexico offshore fleet, lower costs and expenses in Ecuador due to a reduced level of land drilling activity and a reduction in the accrued liability for workers' compensation and property damage claims. For a discussion of the $23.6 million provision for leasehold impairment included in the Company's 1994 costs and expenses, see \"San Angelo Lease Commitment.\" At the beginning of the fourth quarter of 1994, the Company revised its estimate of the remaining depreciable lives of certain rigs and equipment to better reflect the remaining economic lives of such assets. Such change increased net income for 1995 as compared to 1994 by approximately $1.6 million or $.11 per share.\nOther Income - Net. Other income - net in 1994 included a $0.5 million gain resulting from a settlement related to the sale in 1991 of Libya assets that had been written off in the mid-1980's when the Company terminated operations in that country.\nInterest Expense. Interest expense was $1.6 million higher in 1995 than in 1994 due primarily to the $10 million term loan to refinance the acquisition of the 60.7% partnership interest in Pool Arctic Alaska, the GPC acquisition debt and higher average borrowings under the Company's syndicated bank revolving line of credit.\nIncome Taxes. The Company recorded income tax expense of $2.0 million on income before income taxes of $5.1 million in 1995, compared to an income tax benefit of $8.4 million on a loss before income taxes of $21.1 million in 1994. The Company had income tax expense in 1995, compared to an income tax benefit in 1994 primarily as a result of the Company's recording in 1994 a provision for leasehold impairment which generated a deferred income tax benefit of $8.2 million. The 1995 tax expense was due to stronger domestic operating results in 1995 plus the effect of certain amendments to prior period U.S. federal tax returns, partly offset by the reversal of no longer needed deferred foreign taxes for 1990 income tax indemnities and the elimination of the Company's valuation allowance related to its U.S. federal net operating loss (\"NOL\") carryforwards. The 1994 tax benefit also included a net reversal of $0.6 million of previously accrued foreign income taxes. At December 31, 1995, the Company had recognized $6.7 million of deferred income tax assets, net of valuation allowance, in excess of deferred income tax liabilities. The net deferred\nincome tax assets resulted primarily from the 1994 provision for leasehold impairment and the Company's U.S. federal income tax NOL carryforwards, which are expected to be realized within the 15-year carryforward periods. The U.S. NOL carryforwards at December 31, 1995 were $12.0 million from 1991, $18.3 million from 1992, $8.0 million from 1994 and an estimated $5.9 million from 1995; they are available for utilization through the year(s) 2006, 2007, 2009 and 2010, respectively. The NOL carryforwards are expected to be realized through future increases in taxable income as a result in part of lower tax depreciation charges due to most existing property becoming fully depreciated for U.S. tax purposes within the next one to two years and the expected increase in taxable income resulting from the GPC acquisition. If necessary, the Company also will consider repatriating future foreign earnings in order to fully realize the NOL carryforwards before their expiration. See Note 4 of Notes to Consolidated Financial Statements.\n1994 COMPARED TO 1993. The Company, on a consolidated basis, had a net loss of $12.7 million in 1994 compared with net income of $6.2 million in 1993. The 1994 results included a $23.6 million ($15.3 million after-tax) provision for leasehold impairment. (See \"San Angelo Lease Commitment.\") The 1994 results also reflected weaker market conditions than those prevailing in the prior year. Natural gas prices and the average price per barrel of West Texas Intermediate crude oil were both notably lower in 1994 than in 1993. The drop in the Company's domestic activity levels resulted primarily from the diminished interest of its customers in investing in U.S. exploration and production because of the weaker oil and natural gas prices during 1994. The Company's 1994 domestic onshore well-servicing rig hours were 9% lower than in 1993; however, rig rates increased slightly. Gulf of Mexico offshore rig utilization was 53% in 1994, compared to 77% in 1993. Despite the decrease in rig utilization, average rig rates were approximately 8% higher in 1994 than in 1993. Earnings from the Company's international operations decreased primarily due to the mid-1994 completion of two rig contracts in Kuwait and lower earnings from the Company's unconsolidated affiliates located in Saudi Arabia and Malaysia, offset partly by the contribution from increased rig activity in Ecuador. Earnings from the Company's Alaska operations in 1993 included a $1.1 million net after-tax gain on the sale of an offshore rig, Rig 428, resulting from the exercise of a purchase option by a customer.\nRevenues. Revenues were $229.2 million in 1994, compared to $240.5 million in 1993. The decrease in revenues from 1993 to 1994 was attributable to lower activity by the Company's domestic onshore well-servicing and Gulf of Mexico offshore rig fleets, lower rig mobilization revenues in Alaska, contracts being completed during 1993 in the Adriatic Sea and the Ivory Coast, and the mid-1994 completion of two rig contracts in Kuwait, offset partly by higher rig activity in Ecuador, higher domestic production services activity in 1994 and the inclusion since late September 1994 of revenues from rigs previously owned by Pool Arctic Alaska (see \"Pool Arctic Alaska Acquisition\"). Domestic onshore well-servicing revenues decreased $8.9 million or 7% in 1994 from 1993; this decrease was offset partly by domestic production services revenues which increased $4.2 million or 11% in 1994 from 1993. Domestic onshore rig utilization was 48% in 1994, compared to 51% in 1993. Gulf of Mexico offshore workover and drilling revenues in 1994 decreased $2.7 million or 7% compared to 1993, due to lower rig utilization caused by weaker natural gas prices during 1994. Revenues from international operations decreased $4.1 million or 14% in 1994 from 1993, due primarily to contracts being completed during 1993 in the Adriatic Sea and the Ivory Coast and the mid-1994 completion of two rig contracts in Kuwait, offset partly by higher rig activity in Ecuador. Revenues for international operations do not include revenues from the Company's foreign unconsolidated affiliates.\nBeginning in mid-1992, Alaska operations began operating an offshore rig in the Cook Inlet which earned revenues of $9.9 million in 1993 and $5.7 million in 1994, before coming off contract in late 1994. The utilization of this offshore rig, reassigned from California, marked the first time the Company had recognized revenues from its Alaska operations, as previous contracts had been performed by rigs owned or leased by Pool Arctic Alaska, an unconsolidated affiliate prior to September 1994. In September 1994, the Company acquired the 60.7% partnership interest not already owned by the Company in Pool Arctic Alaska, (see \"Pool Arctic Alaska Acquisition\") and accordingly revenues of $4.2 million generated from Pool Arctic Alaska rigs and equipment were included in the Company's consolidated financial statements from the date of such acquisition. Prior to the date of such acquisition, the Company's revenues did not include revenues from Pool\nArctic Alaska, which was an unconsolidated affiliate, but did include revenues from the Company's wholly-owned operations in Alaska.\nEarnings Attributable to Unconsolidated Affiliates. Earnings attributable to unconsolidated affiliates were $5.0 million in 1994, compared to $6.9 million in 1993. Earnings from Pool Arabia, Ltd., the Company's Saudi Arabia affiliate, decreased $1.2 million from 1993 to $3.7 million in 1994 primarily as a result of lower management fees paid to the Company in 1994 and the release of an offshore rig in early 1994. Earnings from Pool Arctic Alaska in 1994 were $0.5 million through the date of acquisition (see \"Pool Arctic Alaska Acquisition\") as compared to breakeven for the year ended December 31, 1993; these 1994 earnings were favorably affected by higher rig activity on the North Slope and improved results from labor and maintenance contracts in the Cook Inlet compared to the prior year. Earnings from the Company's Malaysia affiliate in 1994 decreased $1.3 million from 1993 due to the completion of a contract for an offshore rig during the first quarter of 1994.\nCosts and Expenses. The Company's costs and expenses were $232.7 million in 1994 (excluding the provision for leasehold impairment), compared to $241.5 million in 1993. The decrease in costs and expenses from 1993 to 1994 was attributable to (i) lower levels of activity for the Company's domestic onshore well-servicing, Gulf of Mexico offshore and international rig fleets, (ii) lower rig mobilization expenses in Alaska, (iii) lower depreciation expense chiefly due to assets becoming fully depreciated and to a revision in the estimate of remaining depreciable lives of certain rigs and equipment and (iv) a $1.0 million pretax charge recorded in 1993 against the carrying value of certain patent rights related to horizontal drilling technology. These cost reductions were offset partly by 1994 maintenance and lease expenses related to three Gulf of Mexico jackup workover rigs which were leased in December 1993. For a discussion of the $23.6 million provision for leasehold impairment included in the Company's costs and expenses in 1994, see \"San Angelo Lease Commitment.\" At the beginning of the fourth quarter of 1994, the Company revised its estimate of the remaining depreciable lives of certain rigs and equipment to better reflect the remaining economic lives of such assets. Such change decreased the net loss for the year ended December 31, 1994 by approximately $0.5 million or $.04 per share.\nOther Income-Net. Other income-net in 1994 included a $0.5 million gain resulting from a settlement related to the sale in 1991 of Libya assets that had been written off in the mid-1980's when the Company terminated operations in that country. Other income-net in 1993 included a $1.2 million pretax gain related to the sale of Rig 428.\nIncome Taxes. The Company recorded an income tax benefit of $8.4 million on a loss before income taxes of $21.1 million in 1994, compared to income tax expense of $1.4 million on income before income taxes of $7.6 million in 1993. The Company had an income tax benefit in 1994, compared to income tax expense in 1993 primarily as a result of the Company recording a provision for leasehold impairment in 1994 which generated a deferred income tax benefit of $8.2 million. The 1994 tax benefit also included a net reversal of $0.6 million of previously accrued foreign income taxes. The Company's U.S. federal income tax provision for 1993 reflected the effect, which was not significant, of the Revenue Reconciliation Act of 1993.\nFINANCIAL CONDITION AND LIQUIDITY\nThe Company had cash and cash equivalents of $5.5 million at December 31, 1995 compared to $2.6 million at December 31, 1994. Working capital was $27.0 million and $33.0 million at December 31, 1995 and 1994, respectively.\nCash Flows. For the year ended December 31, 1995, net cash flows provided by operating activities were $20.6 million, compared with $5.3 million and $15.3 million in 1994 and 1993, respectively. The Company used a net $21.2 million for investing activities in 1995, primarily for capital expenditures of $23.4 million, including $6.9 million for the construction of a new offshore platform workover rig which began earning revenues in Australia in the third quarter of 1995, and $3.4 million, net of cash acquired, used in connection with the GPC acquisition and the related direct acquisition costs, partly offset by $2.4 million of proceeds from dispositions of equipment and $2.9 million of dividends from unconsolidated affiliates. The Company used a net $9.5 million for investing activities in 1994. This included the purchase of 60.7% of Pool Arctic Alaska for $11.3 million, net of cash acquired, and $11.4 million of other capital expenditures, offset partly by $7.0 million of proceeds from the sale and leaseback of three offshore jackup rigs, $3.4 million of proceeds from sales of other equipment and the receipt of $2.9 million of dividends from unconsolidated affiliates. The Company used a net $10.5 million for investing activities in 1993, including $14.2 million of capital expenditures, $1.4 million placed in escrow as collateral in connection with a sale and leaseback arrangement, $2.6 million of proceeds, net of related construction expenditures, from the sale of Alaska Rig 428, $1.7 million of proceeds from sales of other equipment and $0.7 million of dividends received from unconsolidated affiliates.\nGolden Pacific Corp. Acquisition. On June 13, 1995, the Company acquired all of the outstanding capital stock of GPC for approximately $18.8 million, consisting of $11.5 million of subordinated long-term notes due in 2005, 493,543 shares of the Company's common stock valued at $4.2 million and $3.1 million in cash. See Notes 3 and 5 of Notes to Consolidated Financial Statements for further discussion.\nAlso in connection with the GPC acquisition the Company assumed a liability for certain deferred compensation obligations of GPC. To evidence such obligations, the Company issued notes aggregating $1.5 million in principal amount to three employees of GPC. See Note 5 of Notes to Consolidated Financial Statements for further discussion.\nAs part of the acquisition of GPC, the Company assumed GPC's debt of $2.0 million, all of which was retired in June 1995.\nPool Arctic Alaska Acquisition. On September 28, 1994, the Company acquired the 60.7% partnership interest in Pool Arctic Alaska it did not previously own for $12.1 million in cash. The Company's Alaska operation now includes the three highly specialized Arctic land drilling rigs and related equipment formerly owned by the Pool Arctic Alaska partnership, and provides rig and contract labor services, both onshore and offshore, in Alaska. This acquisition was accounted for under the purchase method, and was initially funded from the Company's cash resources and approximately $6.7 million borrowed under its Line of Credit. In April 1995, the Company obtained a three-year loan (the \"Alaska Loan\") to refinance $10 million of the purchase price. During 1995, the Company made scheduled principal payments of $2.6 million on the Alaska Loan. See Note 5 of Notes to Consolidated Financial Statements for further discussion.\nCredit Facilities and Long-Term Debt. The Company has available a syndicated bank revolving line of credit (the \"Line of Credit\") to finance temporary working capital requirements and to support the issuance of letters of credit. During 1995 expiration of the Line of Credit was extended from April 1996 to April 1997, and the maximum availability thereunder was increased. The maximum availability is the lesser of (i) $35 million (previously $30 million), or (ii) a calculated amount based upon a percentage of domestic receivables meeting certain criteria. At February 16, 1996, the maximum availability was $32.4 million, of which none had been drawn in cash and $13.4 million was being utilized to support the issuance of letters of credit. The interest rate is a floating rate which is, at the Company's option, (i) the lender's prime rate plus 0.25%, or (ii) the London Interbank Offered Rate (LIBOR) plus 2.625%, with the Company's choice of a one-, two-, three-, or six-month interest period. There is an approximate 1\/2 of 1% commitment fee on the unutilized portion. The terms of the Line of Credit include restrictive covenants which, among other things, limit capital expenditures, prohibit certain liens, prohibit payment of dividends, limit additional debt and set certain minimum financial requirements. Advances under the Line of Credit are secured by certain\naccounts receivable, certain deposit accounts, all of the stock of the Company's domestic subsidiaries, 66% of the stock of the Company's consolidated foreign subsidiaries, the property of the Company's Alaska subsidiary and the Company's 13 platform rigs located in the Gulf of Mexico. See Note 5 of Notes to Consolidated Financial Statements for a discussion of the credit agreement and the restrictions it imposes.\nIn January 1996 the Company received $6.5 million under a four-year term loan agreement in order to refinance the construction costs incurred during 1995 to build a new offshore platform workover rig for a contract in Australia. The rig construction costs were initially funded from the Company's cash resources and borrowings under its Line of Credit. See Note 5 of Notes to Consolidated Financial Statements for further discussion of this term loan.\nIn August 1994 the Company issued a four-year $0.5 million note in connection with a purchase of eight well- servicing rigs and related equipment. The note bears interest at 7% and is secured by the eight rigs and equipment that were purchased.\nModifications to Alaska Rig 428 were funded in 1993 primarily through approximately $10 million of project financing which was repaid during 1993 from the proceeds from the sale of such rig. In May 1992 the Company had entered into a $4.4 million term loan and a $0.5 million revolving line of credit to finance the upgrade of another rig under contract in Alaska, and both of these loans were repaid in 1993.\nThere were no long-term financing activities in 1993 except by unconsolidated affiliates. Two of the Company's unconsolidated affiliates have entered into loan agreements which impose restrictions on the ability of such affiliates to distribute dividends to the Company.\nCapital Expenditures. During 1996, the Company anticipates capital expenditures for improvements and upgrades to its existing rig fleet of approximately $16 million, most of which are not subject to fixed commitments. It is anticipated that these expenditures will be financed chiefly through internally generated funds, although the Company may avail itself of borrowings as needed. Acquisitions of additional assets and businesses are expected to continue to be an important part of the Company's strategy for growth. The Company would, under certain circumstances, need to obtain additional debt and\/or equity financing to fund such acquisitions.\nOTHER MATTERS\nAccounting Standards. The Company adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other than Pensions\" (\"SFAS 106\") on January 1, 1993. SFAS 106 requires the Company to accrue the estimated cost of certain retiree benefits during the years the employee provides services. The Company previously expensed the cost of these benefits as they were paid. In accordance with SFAS 106, the Company has elected to recognize the approximately $2.9 million accumulated benefit obligation at the date of adoption over a period of twenty years. See Note 7 of Notes to Consolidated Financial Statements.\nThe Company also adopted Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits,\" which requires the accrual of benefits provided after employment but before retirement to former or inactive employees, their beneficiaries and covered dependents. The adoption of the statement in 1993 had no significant effect on the Company's financial condition or results of operations.\nThe Financial Accounting Standards Board has issued Statement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.\" This statement requires that long-lived assets and certain identifiable intangibles held and used by the Company be reviewed for impairment whenever events or changes in circumstances indicate that the carrying\namount of an asset may not be recoverable. The adoption of this statement in the first quarter of 1996 will not have a material effect on the Company's financial position or results of operations.\nIn October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation\" (\"SFAS 123\"), which sets forth alternative accounting and disclosure requirements for stock-based compensation arrangements. SFAS 123 does not rescind the existing accounting for employee stock-based compensation under APB Opinion No. 25. Companies may continue to follow the current accounting to measure and recognize employee stock-based compensation; however, SFAS 123 requires disclosure of pro forma net income and earnings per share that would have been reported under the \"fair value\" based recognition provisions of SFAS 123. The Company has elected to continue to follow the provisions of APB Opinion No. 25, \"Accounting for Stock Issued to Employees\" for employee compensation and will disclose the pro forma information required under SFAS 123.\nContingent Support Agreement. ENSERCH provides the Company with certain guarantees relating to (i) debt of the Company's Saudi Arabia affiliate and (ii) the San Angelo lease (see \"San Angelo Lease Commitment\"). See also Note 8 to Notes to Consolidated Financial Statements. As required by such agreement, the Company in early 1993 replaced guarantees with respect to certain letters of credit that related principally to the Company's current and previous insurance programs. The Company in 1993 also satisfied certain other conditions set forth in the Contingent Support Agreement, enabling it to repurchase its preferred stock from ENSERCH for $1,000. Also under the agreement, ENSERCH had prepaid $4.0 million to the Company in 1990 for future domestic onshore well-servicing and production services to be provided by the Company to ENSERCH. The prepayment was applied annually against the first $1.0 million of such services provided and as of September 30, 1994 the entire $4.0 million of such prepayment had been applied.\nInsurance Obligations. The Company is obligated to pay the uninsured portion of the costs of personal injury and property damage incidents. For incidents that occurred prior to 1990, the Company incurred significant obligations under ENSERCH's insurance programs. The unpaid balance is estimated to be $2.7 million at December 31, 1995, and has been provided for in the Consolidated Financial Statements. The Company expects this obligation will continue to decline as the pre-1990 claims are settled and paid. Effective January 1, 1990, the Company entered into a new insurance program, under which the Company's exposure for covered employee injury and third-party liability claims has been limited to deductibles which are significantly lower than those under the ENSERCH program.\nSan Angelo Lease Commitment. The Company has an operating lease, effective through March 2003, for a 65-acre facility at San Angelo, Texas which it previously used for rig and equipment manufacturing and storage. Annual lease payments are $2.2 million through March 1998 and $4.4 million thereafter for the remaining five years of the lease. Effective October 1, 1994, the Company vacated this facility and subleased it in its entirety for $0.5 million per year under an operating sublease which expires in September 1997. Prior to subleasing and vacating this facility in 1994, the Company beneficially utilized approximately 12% of the facility and charged to operations a proportionate share of the cost of the lease. In September 1988, the Company, anticipating that it would not be able to fully utilize the facility for a period of years, accrued a $15.9 million liability for the expected underutilization. Since September 1988, the cost associated with the unutilized portion of the facility has been charged against this accrued liability, which as of the fourth quarter of 1994, had substantially been used. For the remainder of the lease term, the Company does not anticipate utilizing any of this facility in its future operations nor does it expect to be able to sublease this facility to third parties for an amount equivalent to the annual lease payments; therefore, in the fourth quarter of 1994 the Company recorded a provision for leasehold impairment of $23.6 million. This provision recognizes all future lease expense, net of anticipated sublease income. Such provision for leasehold impairment decreased 1994 net income by $15.3 million, or $1.13 per share.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nINDEPENDENT AUDITORS' REPORT\nPool Energy Services Co.:\nWe have audited the accompanying consolidated balance sheets of Pool Energy Services Co. and its subsidiaries ( the \"Company\") as of December 31, 1995 and 1994, and the related statements of consolidated operations and cash flows for each of the three years in the period ended December 31, 1995. Our audits also included the financial statement schedule listed in the Index at Item 14. 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 Pool Energy Services Co. and its subsidiaries at December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.\nDELOITTE & TOUCHE LLP\nHouston, Texas February 22, 1996\nPOOL ENERGY SERVICES CO. STATEMENTS OF CONSOLIDATED OPERATIONS (IN THOUSANDS EXCEPT NUMBER OF SHARES AND PER SHARE AMOUNTS)\nSee Notes to Consolidated Financial Statements.\nPOOL ENERGY SERVICES CO. STATEMENTS OF CONSOLIDATED CASH FLOWS (IN THOUSANDS)\nSee Notes to Consolidated Financial Statements.\nPOOL ENERGY SERVICES CO. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS EXCEPT NUMBER OF SHARES)\nSee Notes to Consolidated Financial Statements.\nPOOL ENERGY SERVICES CO.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nAll dollar amounts in the tabulations in the notes to the financial statements are stated in thousands unless otherwise indicated. All dollar amounts included in the text are in whole dollars, unless otherwise indicated. Certain reclassifications have been made in the 1993 and 1994 financial statements to conform with the 1995 presentation.\nThe Company - Pool Energy Services Co. (the \"Company\") was formed in November 1988 to acquire all of the oilfield services business of ENSERCH Corporation (\"ENSERCH\"), and that acquisition was consummated on April 24, 1990. As used herein, except where the context otherwise requires, the term \"Company\" refers to Pool Energy Services Co., its subsidiary corporations and its unconsolidated affiliates. The Company operates in only one business segment - the oilfield services industry. Within the oilfield services industry, the Company provides services and products to oil and natural gas well operators for the workover, maintenance and plugging of existing oil and natural gas wells and for the drilling and completion of new oil and natural gas wells. The Company operates in the United States, South America, the Middle East, Asia, Africa and Australia.\nBasis of Financial Statements - The consolidated financial statements include the financial statements of the Company and its wholly owned subsidiaries, and all significant intercompany accounts and transactions have been eliminated in consolidation. The Company uses the equity method to account for affiliates in which it does not have voting control. 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.\nRevenue Recognition - The Company generally recognizes revenue when services are rendered or products are shipped.\nForeign Currency Gains and Losses - The U.S. dollar is the functional currency for most of the Company's foreign operations, and for those operations, foreign currency gains and losses are included in the statement of consolidated operations as incurred. The functional currency of Pool Santana, Limited, the Company's unconsolidated affiliate in Trinidad, is the Trinidad and Tobago dollar, and the Company's share of Pool Santana's cumulative translation gains and losses is carried as an adjustment in the shareholders' equity section of the consolidated balance sheets.\nProperty, Plant and Equipment - Depreciation of plant and equipment is provided on a straight-line basis over the estimated useful lives of the assets. The components of a rig that generally require replacement during the rig's life have useful lives that range from three to 12 years. The basic rigs, excluding such components, have estimated useful lives from date of original manufacture ranging from 22 to 35 years. Other property and equipment have useful lives that range from three to seven years. Estimated salvage values are assigned to the rigs based on an individual assessment of each rig and generally approximate 15% of cost. The estimated remaining depreciable lives of certain rigs and equipment were revised in October 1994 to better reflect their remaining economic lives. The effect of this change in accounting estimate was to increase 1995 net income by approximately $2.1 million or $.15 per share and to decrease the 1994 net loss by approximately $0.5 million or $.04 per share.\nPOOL ENERGY SERVICES CO.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nThe Financial Accounting Standards Board has issued Statement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.\" This statement requires that long-lived assets and certain identifiable intangibles held and used by the Company be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The adoption of this statement in the first quarter of 1996 will not have a material effect on the Company's financial position or results of operations.\nThe Company capitalizes interest applicable to the construction of significant additions to property and equipment. Interest capitalized for the year ended December 31, 1995 was $0.1 million. No interest was capitalized in 1994 or 1993.\nGoodwill - Goodwill represents the excess of the aggregate price paid by the Company in the 1995 acquisition of Golden Pacific Corp. (\"GPC\"), accounted for as a purchase, over the fair market value of the net assets acquired. Goodwill is being amortized on a straight-line basis over a period of 30 years. Management continually evaluates whether events or circumstances have occurred that indicate the remaining useful life of goodwill may warrant revision or the remaining balance of goodwill may not be recoverable. Goodwill amortization expense totaled $0.2 million for the year ended December 31, 1995.\nEnvironmental Remediation and Compliance - Costs incurred to investigate and remediate contaminated sites are expensed unless the remediation extends the useful lives of the assets employed at the site. Remediation costs that extend the useful lives of the assets are capitalized and amortized over the remaining economic lives of such assets. Liabilities are recorded when the need for environmental assessments and\/or remedial efforts becomes known or probable and the cost can be reasonably estimated.\nIncome Taxes - The Company accounts for income taxes based upon Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS 109\") which requires recognition of deferred income tax liabilities and assets 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 liabilities and assets are determined based on the temporary differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities and available tax credit carryforwards.\nInventories - Inventories of spare parts, materials and supplies held for consumption are stated principally at average cost.\nConcentration of Credit Risk - Financial instruments, which potentially subject the Company to concentrations of credit risk, consist primarily of temporary cash investments and trade receivables. The Company restricts investment of temporary cash investments to financial institutions with high credit standing and by policy limits the amount of credit exposure to any one financial institution. The Company's customer base consists primarily of multi-national, foreign national and independent oil and natural gas producers. During 1995, one customer accounted for approximately 11% of the Company's consolidated revenues. During 1994 and 1993, no customer accounted for more than 10% of consolidated revenues. The Company performs ongoing credit evaluations of its customers and generally does not require collateral on its trade receivables. Such credit risk is considered by management to be limited due to the large number of customers comprising the Company's customer base. The Company maintains reserves for potential credit losses, and such losses have been within management's expectations.\nPOOL ENERGY SERVICES CO.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nFair Values of Financial Instruments - Except for investments in its unconsolidated affiliates, which are accounted for under the equity method, the Company's financial instruments consist primarily of short-term, variable rate items for which management believes fair value approximates carrying value.\nForeign Exchange Risk Management - The Company operates internationally, giving rise to exposure to market risks from changes in foreign exchange rates. The Company uses forward exchange contracts as economic hedges of exposed net investments in foreign entities in which that exposure exceeds $0.2 million and in currencies for which such contracts are available. At December 31, 1995 and 1994, only the Company's exposed net investment in its Malaysia affiliate was hedged. The Company's foreign exchange contracts do not subject the Company to the risk of exchange rate movements because gains and losses on these contracts offset gains and losses on the exposed investments being hedged. Realized and unrealized gains and losses on these contracts are recognized currently in the statement of consolidated operations. The forward exchange contracts generally have maturities which do not exceed 30 days. The Company had forward exchange contracts to purchase $3.3 million and $4.8 million in Malaysian ringgits at December 31, 1995 and 1994, respectively. The Company does not hold or issue financial instruments for trading purposes.\nStock Incentive Plans - The Company accounts for stock option grants using the intrinsic value method of accounting prescribed by APB Opinion No. 25, \"Accounting for Stock Issued to Employees.\" Under the Company's stock incentive plans, the price of the stock on the grant date is the same as the amount an employee must pay to exercise the option to acquire the stock; accordingly, the options have no intrinsic value at grant date, and in accordance with the provisions of APB Opinion No. 25 no compensation cost is recognized.\nIn October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation\" (\"SFAS 123\"), which sets forth alternative accounting and disclosure requirements for stock-based compensation arrangements. SFAS 123 does not rescind the existing accounting for employee stock-based compensation under APB Opinion No. 25. Companies may continue to follow the current accounting to measure and recognize employee stock-based compensation; however, SFAS 123 requires disclosure of pro forma net income and earnings per share that would have been reported under the \"fair value\" based recognition provisions of SFAS 123. The Company has elected to continue to follow the provisions of APB Opinion No. 25 for employee compensation and will disclose the pro forma information required under SFAS 123.\nCash Flows - For cash flow purposes, the Company considers all unrestricted highly liquid investments with less than a three-month maturity when purchased as cash equivalents.\nEarnings Per Share of Common Stock - Earnings per share is based on the average number of common shares and common equivalent shares outstanding during the year.\nPOOL ENERGY SERVICES CO.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\n2. SHAREHOLDERS' EQUITY\nThe following is a summary of transactions affecting shareholders' equity for the last three fiscal years:\nPreferred Stock\nAt the time of the Company's 1990 purchase of ENSERCH's oilfield services business, ENSERCH acquired 1,000 shares of the Company's preferred stock, with a total stated value of $1,000. The preferred stock was repurchased by the Company in October 1993 and is currently held in treasury.\nShareholder Rights Plan\nThe Company maintains a Shareholder Rights Plan (the \"Rights Plan\") that is designed to deter coercive or unfair takeover tactics, to prevent a person or group from gaining control of the Company without offering fair value to all shareholders and to deter other abusive takeover tactics which are not in the best interests of shareholders. The Company's Board of Directors adopted the Rights Plan on June 7, 1994 and declared a dividend of one right (\"Right\") for each outstanding share of the Company's common stock to shareholders of record on June 23, 1994. The Rights only become exercisable, and transferable apart from the Company's common stock, ten business days following a public announcement that a person or group (\"Acquirer\") has acquired beneficial ownership of, or has commenced a tender or exchange offer for, 15% or more of the Company's common stock (each a \"Triggering Event\").\nEach Right initially entitles the holder to purchase one-third of one share of the Company's common stock at a price of $9.00, subject to adjustment. Upon the occurrence of a Triggering Event, each Right, in the absence of timely redemption of the Rights by the Company, will entitle the holder thereof (other than the Acquirer), instead, to receive upon exercise of the Right a number of the Company's common shares (or,\nPOOL ENERGY SERVICES CO.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nin certain circumstances, cash, property or other securities of the Company) having a current market price equal to twice the exercise price for a full share. Following the occurrence of a Triggering Event, if the Company is acquired in a merger or other business combination, or 50% or more of the Company's assets or earning power are sold or transferred, each Right, in the absence of timely redemption of the Rights by the Company, will entitle the holder thereof (other than the Acquirer) to receive a number of shares of common stock of the acquiring company having a current market price equal to twice the exercise price for a full share.\nThe Rights may be redeemed by the Company in whole, but not in part, at a redemption price of $.01 per Right at any time prior to the Rights becoming exercisable. The Rights will expire on June 7, 2004. Until the Rights become exercisable, they have no dilutive effect on earnings per share. As of December 31, 1995, a total of 4,413,337 shares of the Company's common stock were reserved for issuance upon exercise of Rights.\nThe description and terms of the Rights are set forth in a Rights Agreement between the Company and the First National Bank of Boston, as Rights Agent.\nStock Incentive Plans\nIn December 1993 the Company adopted the 1993 Employee Stock Incentive Plan for officers and key employees, which plan reserved for issuance up to 600,000 shares of the Company's common stock. The shares may be issued upon the exercise of non-qualified stock options granted under the plan or may be granted as restricted stock awards or bonus stock awards. Stock options are exercisable over a ten-year term and, unless specified otherwise at the time of the grant, vest at the rate of 25 percent per year of continuous employment following the grant of the options. Shares of common stock awarded as restricted stock are subject to restrictions on transfer and subject to risk of forfeiture until earned by continued employment or the achievement of specific goals. During the restriction period, holders of restricted stock have the rights of stockholders, including the right to vote and receive cash dividends, except for the right to transfer ownership.\nIn April 1990 the Company adopted the 1990 Employee Stock Option Plan for key employees, which plan reserved for issuance up to 1,000,000 shares of the Company's common stock, of which 62,830 had been purchased as of December 31, 1995 through the exercise of options. Options are exercisable over a ten-year term and, unless specified otherwise at the time of the grant, vest at the rate of 25 percent per year of continuous employment following the grant of the options. Since the adoption of the 1993 Employee Stock Incentive Plan no additional options may be granted under the 1990 Employee Stock Option Plan.\nEffective October 1991, the Company adopted the 1991 Directors' Stock Option Plan for members of its Board of Directors who are not full-time employees of the Company. The plan provides for the granting of options to purchase a maximum of 150,000 shares of the Company's common stock, of which 7,000 had been purchased as of December 31, 1995 through the exercise of options. The plan provides for each eligible director to receive automatically an initial option for 5,000 shares and to receive automatically an additional option for 2,000 shares on the date of each Annual Meeting of Shareholders after the initial grant at which such director is reelected. Options expire ten years after the date of the grant. Each option becomes exercisable as to 50% of the shares covered thereby at the end of one year from the date of grant and as to the remaining 50% at the end of two years from the date of grant.\nPOOL ENERGY SERVICES CO.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nThe exercise price of options under all plans is the fair market value per share on the date the option is granted. The following table summarizes the stock option activity related to the Company's plans:\n3. BUSINESS ACQUISITIONS\nGolden Pacific Corp. Acquisition\nOn June 13, 1995, the Company acquired all of the outstanding capital stock of GPC, a privately-owned California well-servicing company with a fleet of approximately 155 rigs and related equipment, for $18.8 million, consisting of long-term notes in the amount of $11.5 million, 493,543 shares of the Company's common stock valued at $4.2 million and $3.1 million in cash. The cash paid in the transaction was provided by the Company's existing syndicated bank revolving line of credit.\nThe acquisition was accounted for under the purchase method, and accordingly the results of the acquired company have been included in the accompanying consolidated financial statements since the date of acquisition. The purchase price was allocated on the basis of the estimated fair market value of the assets acquired and the liabilities assumed as of the date of acquisition. This allocation resulted in goodwill of approximately $11.4 million, which is being amortized on a straight-line basis over 30 years. In connection with the purchase of GPC, the Company recorded acquisition related costs totaling $0.6 million, primarily for yard closings. The fair values of the assets acquired and liabilities assumed were as follows:\nPOOL ENERGY SERVICES CO.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nThe following unaudited pro forma summary of financial information presents the Company's consolidated results of operations as if the acquisition had occurred at the beginning of the periods indicated, after including the impact of certain adjustments, such as: additional depreciation expense, amortization of goodwill, increased interest expense on the acquisition debt, decreased insurance expense, elimination of certain transactions with affiliates of GPC and related income tax effects.\nThe above pro forma financial information is presented for informational purposes only and is not necessarily indicative of the operating results that would have occurred if the acquisition had taken place at the beginning of the periods presented, nor is it necessarily indicative of future operating results.\nPool Arctic Alaska Acquisition\nOn September 28, 1994, the Company acquired the 60.7% interest not already owned by the Company in Pool Arctic Alaska, a partnership, for $12.1 million in cash. The Company's Alaska operation now includes the three highly specialized Arctic land drilling rigs and related equipment formerly owned by the partnership. It provides rig and contract labor services, both onshore and offshore, in Alaska. The acquisition was funded from the Company's existing syndicated bank revolving line of credit and cash resources. During 1995, the Company obtained a three-year term loan to refinance $10 million of the purchase price (see Note 5).\nThe acquisition has been accounted for under the purchase method and, accordingly, the results of Pool Arctic Alaska have been included in the accompanying consolidated financial statements since the date of acquisition. Prior to the date of acquisition, Pool Arctic Alaska was accounted for under the equity method based upon the Company's 39.3% partnership interest. The 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 fair values of the assets acquired and liabilities assumed were as follows:\nThe Company also reclassified its investment in Pool Arctic Alaska of $10.9 million to its related assets and liabilities at the time of the acquisition.\nPOOL ENERGY SERVICES CO.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\n4. INCOME TAXES\nProvision (credit) for income taxes is summarized below:\nThe 1995 deferred income tax provision resulted primarily from the effect of certain amendments to prior period U.S. federal tax returns, partly offset by the reversal of no longer needed deferred foreign taxes for 1990 income tax indemnities and the elimination of the Company's valuation allowance related to the U.S. federal net operating loss (\"NOL\") carryforwards. The 1994 deferred income tax benefit resulted primarily as a result of the Company's recording a provision for leasehold impairment which generated an income tax benefit of $8.2 million. The 1994 tax benefit also included a net reversal of $0.6 million of previously accrued foreign income taxes. The 1993 deferred income tax provision resulted primarily from an increase in deferred tax liabilities arising from the use of different depreciation methods for book and tax purposes. It reflects the effect, which was not significant, of the Revenue Reconciliation Act of 1993.\nTemporary differences and carryforwards which gave rise to deferred tax assets and liabilities as of December 31, 1995 and 1994 were as follows:\nPOOL ENERGY SERVICES CO.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nThe total valuation allowance decreased a net $2.2 million in 1995 and $0.6 million in 1994.\nIn 1995, the Company eliminated the valuation allowance related to its U.S. federal NOL carryforwards. Management believes that it is now more likely than not that the Company will generate taxable income sufficient to realize the tax benefit of the NOL carryforwards prior to their expiration due to among other factors, anticipated lower tax depreciation charges within the next one to two years as a result of most existing property becoming fully depreciated for U.S. tax purposes, the expected increase in taxable income resulting from the GPC acquisition and consideration of available tax planning strategies. If necessary, the Company also will consider repatriating future foreign earnings in order to fully realize the NOL carryforwards before their expiration.\nAt December 31, 1995, the Company had $44.2 million of NOL available for carryforward to reduce U.S. federal income taxes payable in future years. The U.S. NOL carryforwards were $12.0 million from 1991, $18.3 million from 1992, $8.0 million from 1994 and an estimated $5.9 million from 1995; they are available for utilization through the year(s) 2006, 2007, 2009 and 2010, respectively. State and foreign NOL carryforwards have been fully reserved for in the Company's consolidated balance sheet.\nA reconciliation between income taxes computed at the U.S. federal statutory rate and the Company's income taxes for financial reporting purposes is shown below:\nForeign income before income taxes is defined as income generated from operations in a foreign country, regardless of whether it is currently reportable for U.S. tax purposes. Components of income (loss) before income taxes are as follows:\nThe earnings of the Company's foreign subsidiaries and affiliates are indefinitely invested outside the United States, and the Company estimates that no U.S. income taxes would be payable upon distribution of those unremitted earnings.\nPOOL ENERGY SERVICES CO.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nThe Company is subject to taxation in many jurisdictions, and the final determination of its tax liabilities involves the interpretation of the statutes and requirements of various domestic and foreign taxing authorities. At December 31, 1995, foreign income tax returns for prior years of certain foreign subsidiaries, unconsolidated affiliates and related entities were under examination and\/or tax deficiencies had been assessed. In the opinion of management, any additional provisions for taxes which may ultimately be determined to be required as a result of such examinations or assessments will not be material to the Company's financial position or operations.\n5. LONG-TERM DEBT AND LINES OF CREDIT\nLines of Credit\nThe Company has a syndicated bank revolving line of credit (the \"Line of Credit\") to finance temporary working capital requirements and to support the issuance of letters of credit. During 1995 the expiration date of the Line of Credit was extended from April 1996 to April 1997, and the maximum availability thereunder was increased. The maximum availability under the Line of Credit is the lesser of (i) $35 million (previously $30 million), or (ii) a calculated amount based upon a percentage of domestic receivables which meet certain criteria. At December 31, 1995, the Company had $30.0 million available under the Line of Credit of which none had been drawn in cash and $13.7 million was being utilized to support the issuance of letters of credit, including $5.9 million in letters of credit issued in connection with the GPC acquisition as security for the acquisition debt and for obligations to GPC's insurers. The Line of Credit provides for certain restrictions on the Company, including a prohibition against additional debt (excluding $7 million of overdraft facilities), a prohibition on payment of dividends, a prohibition on certain liens, a limitation on capital expenditures, and minimum net worth and working capital covenants. Advances under the Line of Credit are secured by certain accounts receivable, certain deposit accounts, all of the stock of the Company's domestic subsidiaries, 66% of the stock of the Company's consolidated foreign subsidiaries, the property owned by the Company's Alaska subsidiary (net book value of $26.8 million at December 31, 1995) and the Company's 13 platform rigs located in the Gulf of Mexico (net book value of $6.1 million at December 31, 1995). The interest rate for the Line of Credit is a floating rate which is, at the Company's option, (i) the lenders' prime rate plus 0.25%, or (ii) the London Interbank Offered Rate (LIBOR) plus 2.625%, with the Company's choice of a one-, two-, three-, or six-month interest period. The applicable interest rate was 8.75% and 9.625% at December 31, 1995 and 1994, respectively. There is an approximate 1\/2 of 1% commitment fee on the unutilized portion of the Line of Credit.\nAt December 31, 1995, the Company's unconsolidated affiliates had $5.2 million of unused short-term lines of credit and overdraft facilities.\nLong-Term Debt\nLong-term debt consisted of the following at December 31:\nPOOL ENERGY SERVICES CO.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nIn June 1995, as partial consideration for the acquisition of GPC, the Company issued 10% subordinated notes aggregating $11.5 million which are due in 2005. These notes are subordinate to the Company's Line of Credit and $10 million term loan and are collateralized by (i) the well-servicing rigs and related equipment of the acquired business which had an aggregate net book value of $9.3 million at December 31, 1995, (ii) a second priority security interest in certain real property of the acquired business which had a carrying value of $1.4 million at December 31, 1995 and (iii) a $5 million letter of credit. The agreement pertaining to the subordinated notes contains various restrictive covenants, including covenants pertaining to the creation of certain encumbrances, the transaction of certain mergers or sales of assets, the creation of certain additional debt and other matters.\nIn April 1995, the Company obtained a three-year term loan (the \"Alaska Loan\") to refinance $10 million of the purchase price for the 60.7% partnership interest in Pool Arctic Alaska which was acquired in September 1994. This acquisition was originally funded from the Company's cash resources and approximately $6.7 million borrowed under the Line of Credit. The Alaska Loan agreement contains restrictive covenants similar to those pertaining to the Line of Credit and, in addition, includes a fixed charge coverage ratio covenant. At the Company's option, interest accrues at a floating rate based upon (i) the lenders' prime rate plus 0.5%, or (ii) LIBOR plus 2.75%, with the Company's choice of a one-, two-, three-, or six-month interest period. The applicable interest rate on amounts outstanding at December 31, 1995 was 8.5%. The Alaska Loan is cross-collateralized to the Line of Credit.\nIn August 1994 the Company issued a four-year $0.5 million note in connection with a purchase of eight rigs and related equipment. The note bears interest at 7% and is secured by the eight rigs and equipment purchased, which had an aggregate net book value of $0.6 million at December 31, 1995.\nThe annual maturities of long-term debt outstanding as of December 31, 1995 (including current portion) are as follows:\nBased on rates currently available to the Company for debt with similar terms and remaining maturities, the Company believes that the recorded value of long-term debt approximates fair market value at December 31, 1995.\nIn January 1996 the Company received $6.5 million under a term loan agreement in order to refinance the construction costs incurred during 1995 to build a new offshore platform workover rig under contract in Australia. The rig construction costs were initially funded from the Company's cash resources and borrowings under its Line of Credit. The loan will be repaid monthly, beginning in January 1996, from the rig contract proceeds over approximately four years. At the Company's option, interest accrues at a floating rate based upon (i) the lenders' prime rate plus 0.5% or (ii) LIBOR plus 2.75%, with the Company's choice of a one-, two-, three- or six-month interest period. The loan is collateralized by the offshore platform\nPOOL ENERGY SERVICES CO.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nworkover rig (net book value of $6.8 million at December 31, 1995) and all payments under, and proceeds of, the rig contract.\nNotes Payable to Related Parties\nIn connection with the GPC acquisition in June 1995 the Company issued notes to three employees related to certain deferred compensation obligations of GPC. These 10% two-year promissory notes aggregating $1.5 million in principal amount are secured by a first priority security interest in certain real property of the acquired business, which had a carrying value of $1.4 million at December 31, 1995.\n6. COMMITMENTS AND CONTINGENT LIABILITIES\nLegal Proceedings - The Company is routinely involved in litigation incidental to its business, which often involves claims for significant monetary amounts, some, but not all, of which would be covered by insurance. In the opinion of management, none of the existing litigation will have any material adverse effect on the Company.\nPersonal Injury and Property Damage Liability Claims - Some of the operations of the Company are hazardous, and the Company has experienced personal injury and property damage incidents. For claims prior to 1990, the Company maintains a reserve for the self-insured portion of its personal injury and property damage coverage. Periodically, the Company evaluates the adequacy of this reserve as compared with estimated settlements for filed and anticipated claims. Estimated settlements for claims are based on the Company's historical experience, type of claim, knowledge of the specific circumstances of the claim and judgment of the possible effect that future economic and legal factors might have on the ultimate settlement of the claim. The Company believes that for claims prior to 1990, the accrued liability for personal injury and property damage claims aggregating $2.7 million at December 31, 1995 is adequate.\nBeginning in 1990, the Company obtained workers' compensation and third-party liability insurance under which its exposure to the risks covered by those policies is significantly lower than under the pre-1990 coverage. The Company provided $4.0 million, $3.1 million and $2.9 million in 1995, 1994 and 1993, respectively, as estimates of the aggregate uninsured portion of claims for those years. The accrued liability for the uninsured portion of workers' compensation and third-party claims incurred after 1989 was $7.4 million at December 31, 1995, of which $0.9 million was held in a deposit account accessible by the insurance underwriters. In addition, at December 31, 1995 the Company had a $0.9 million receivable related to claims payments made by the Company that are reimbursable by insurance.\nIn connection with the GPC acquisition the Company assumed a liability for the uninsured portion of workers' compensation and third-party claims incurred prior to the June 13, 1995 acquisition date. At December 31, 1995, the accrued liability for such claims was $1.0 million.\nLease Commitments - At December 31, 1995, the Company had a number of noncancelable long-term operating leases, principally for yards and office space, rigs, computer equipment, and a manufacturing and storage facility, with various expiration dates. Future minimum net rentals under such leases aggregate $6.3 million for 1996; $5.8 million for 1997; $5.6 million for 1998; $5.9 million for 1999; $5.8 million for 2000; and $10.9 million thereafter. Rental expense incurred under operating leases aggregated $13.3 million in 1995, $11.2 million in 1994 and $9.4 million in 1993.\nPOOL ENERGY SERVICES CO.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nThe Company has an operating lease, effective through March 2003, for a 65-acre facility at San Angelo, Texas which it previously used for rig and equipment manufacturing and storage. The annual lease payments, which are included in future minimum net rentals above, are $2.2 million through March 1998 and $4.4 million thereafter for the remaining five years of the lease. Effective October 1, 1994, the Company vacated this facility and subleased it in its entirety under an operating sublease which expires in September 1997. The sublease provides for minimum sublease payments of $0.5 million per year for three years. Prior to subleasing and vacating this facility in 1994, the Company beneficially utilized approximately 12% of the facility and charged to operations a proportionate share of the cost of the lease. In September 1988, the Company, anticipating that it would not be able to fully utilize the facility for a period of years, accrued a $15.9 million liability for the expected underutilization. Since September 1988, the cost associated with the unutilized portion of the facility has been charged against this accrued liability, which as of the fourth quarter of 1994, had substantially been used. For the remainder of the lease term, the Company does not anticipate utilizing any of this facility in its future operations nor does it expect to be able to sublease this facility to third parties for an amount equivalent to the annual lease payments; therefore, in the fourth quarter of 1994 the Company recorded a provision for leasehold impairment of $23.6 million (see Note 10). The provision recognizes all future lease expense, net of anticipated sublease income. The impact of the provision for leasehold impairment was to decrease 1994 net income by $15.3 million, or $1.13 per share.\nIn December 1993 the Company entered into sale\/leaseback agreements with a leasing company with respect to three offshore jackup rigs located in the Gulf of Mexico. The three jackup rigs had been purchased from a third party for $7.0 million and were sold to the leasing company for $7.0 million in cash, which was received in early 1994. The leases, classified as operating leases, have an aggregate annual lease rate of approximately $1 million per year for seven years and are included in the future minimum net rentals above. The sale and leaseback agreements required the Company to place cash in a restricted investment account which serves as collateral for the leases and will reduce as lease payments are made. As of December 31, 1995, the Company had $1.1 million of restricted cash of which $1.0 million was classified as noncurrent. Employment contracts - In connection with the GPC acquisition, the Company entered into three-year employment contracts in June 1995 with three key employees previously employed by GPC. The Company's minimum aggregate salary and bonus obligation remaining at December 31, 1995 under such contracts was approximately $1.2 million.\n7. PENSION, POSTRETIREMENT AND POSTEMPLOYMENT BENEFITS\nPension Plans\nThe Pool Company Retirement Income Plan, a defined benefit plan, covers substantially all of the Company's domestic employees. The Company's policy is to fund the minimum amount required by the Employee Retirement Income Security Act of 1974. The benefits are based on years of service and the average of the highest five consecutive years of compensation during the final ten years of employment.\nEffective January 1, 1993, the Company established a Supplementary Executive Retirement Plan to provide certain management employees with defined benefits in excess of those provided by the Retirement Income Plan. The Company's policy is to fund annually, within 60 days following the end of the plan year, the amount necessary to make plan assets sufficient to pay each participant or beneficiary the benefits payable as of the close of that plan year. The benefits are based on years of service and the average of the five highest years of compensation during the final ten years of employment.\nPOOL ENERGY SERVICES CO.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nThe following is a summary of the components of net pension cost:\nThe following table sets forth the funded status of the plans and amounts recognized in the Company's consolidated balance sheets at December 31:\nPostretirement Benefits Other Than Pensions\nThe Company provides certain health care and life insurance benefits to all of its retirees who meet eligibility requirements based on age and years of service. The benefits are paid from the general funds of the Company and, in the case of the health care benefits, are partially funded by contributions from the retirees.\nPOOL ENERGY SERVICES CO.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nEffective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (\"SFAS 106\"). SFAS 106 requires the Company to accrue the estimated cost of its retiree health care and life insurance benefits during the years the employees provide services entitling them to the benefits. The Company previously expensed the cost of these benefits as they were paid. In accordance with the provisions of SFAS 106, the Company has elected to recognize the liability of approximately $2.9 million at the implementation date over a period of twenty years.\nThe following table sets forth certain information with respect to the Company's postretirement benefits obligation at December 31:\n_____________ (a) Includes effect of June 13, 1995 GPC acquisition. See Note 3.\nNet postretirement benefit cost consisted of the following components:\nThe assumed health care cost trend rate used to measure the expected cost of the benefits was 6.5% for 1995 and thereafter. If the assumed health care cost trend rate were increased by one percent, the accumulated postretirement benefit obligation as of December 31, 1995 would have increased by 14%, and the aggregate of service and interest cost components for 1995 would have increased 17%. The assumed discount rate used in determining the accumulated postretirement benefit obligation was 7.25% in 1995, 8.5% in 1994 and 8% in 1993.\nPostemployment Benefits\nThe Company adopted Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits,\" which requires the accrual of benefits provided after employment but before\nPOOL ENERGY SERVICES CO.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nretirement to former or inactive employees, their beneficiaries, and covered dependents. The adoption of this statement in 1993 had no significant effect on the Company's financial condition or results of operations.\n8. TRANSACTIONS WITH ENSERCH\nENSERCH leases office space to the Company and previously provided claims handling services, both at negotiated rates. Total direct costs charged by ENSERCH were $0.8 million in 1995, $0.9 million in 1994 and $0.9 million in 1993.\nIn connection with the Company becoming an independent public company, ENSERCH and the Company entered into a contingent support agreement (the \"Contingent Support Agreement\") by which ENSERCH is providing the Company with limited financial support, including (a) continuing contingent obligations under a letter of credit in support of the refinancing of debt of the Company's Saudi Arabia affiliate, until July 1996, and (b) continuing a guarantee of the Company's lease obligations with respect to the facility in San Angelo, Texas, through March 2003. At December 31, 1995, the amounts outstanding under (a) and (b) were $0.6 million and $26.6 million, respectively. As required by the Contingent Support Agreement, the Company in early 1993 replaced certain guarantees provided by ENSERCH with respect to (c) the Company's obligations with respect to letters of credit, bank guarantees and bid and performance bonds and (d) standby letters of credit in favor of the Company's insurers. The Company pays ENSERCH an annual fee under the Contingent Support Agreement for (a) and paid fees for (c) and (d) through April 1993; such fees are based upon the amount of ENSERCH's guarantees. These fees approximated $2,000 in 1995, $3,000 in 1994 and $7,000 in 1993. The Company is also obligated to reimburse ENSERCH for any amounts paid out under the guarantees. The Company has pledged the stock of Pool International, Inc., the holder of the Company's interest in Pool Arabia, Ltd., as collateral under the Contingent Support Agreement.\nUnder the Contingent Support Agreement, ENSERCH advanced $4.0 million in cash to the Company in 1990 in payment of future domestic onshore well-servicing and production services to be applied annually against the first $1.0 million of such services. During the years 1991 through 1994, the Company performed $1.0 million of such services in each year and has now fulfilled its obligation.\nCertain oilfield services are performed for various affiliates and entities managed by affiliates of ENSERCH at prices comparable to those received from nonaffiliated customers. Revenues from the performance of those services, including the $1.0 million of prepaid services in both 1994 and 1993, amounted to $1.8 million in 1995, $2.9 million in 1994 and $3.4 million in 1993.\n9. UNCONSOLIDATED AFFILIATES\nA significant part of the operations of the Company is conducted through the following unconsolidated affiliates, in which the Company held the indicated ownership interest at December 31, 1995: Pool Arabia, Ltd. - 51%; Intairdril Oman L.L.C. - 49%; Pool Santana, Limited - 49%; and Antah Drilling Sdn. Bhd. - 49%. The Company charges its unconsolidated affiliates for the provision of management services and, in some cases, financing and equipment rental.\nPOOL ENERGY SERVICES CO.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nThe following table sets forth certain summarized financial information of the Company's unconsolidated affiliates as shown by the financial statements of the affiliates. In September 1994 the Company acquired the 60.7% interest not already owned by the Company in Pool Arctic Alaska. Prior to the date of acquisition, Pool Arctic Alaska was accounted for under the equity method based upon the Company's 39.3% partnership interest (see Note 3). Pool Arctic Alaska's 1994 net income included a $1.0 million gain on debt restructuring. Included in Pool Arctic Alaska's net income for 1993 was a $0.4 million gain on debt restructuring and a $1.4 million loss on disposal of equipment.\n__________ (a) Gross profit is computed as revenues less operating expenses (which exclude depreciation and general and administrative expenses). (b) On September 28, 1994, the Company acquired the 60.7% interest not already owned by the Company in Pool Arctic Alaska, a partnership. The results of Pool Arctic Alaska have been included in the accompanying consolidated financial statements since the date of such acquisition. See Note 3.\nPOOL ENERGY SERVICES CO.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nThe Company's investment in its unconsolidated affiliates differs from its ownership percentage of the affiliates' equity based on the financial statements of the affiliates chiefly because of the allocation of the purchase price for the 1990 purchase of ENSERCH's oilfield services business, unrecognized gains on asset sales and other transactions as set forth below.\nAt December 31, 1995, the Company's investment in unconsolidated affiliates included $13.2 million of net undistributed earnings of the affiliates. Antah Drilling Sdn. Bhd. and Pool Arabia, Ltd. are parties to agreements which contain covenants restricting the ability to distribute, by dividend or otherwise, their respective earnings to the Company. The Company received dividends from unconsolidated affiliates of $2.9 million in 1995, $2.9 million in 1994 and $0.7 million in 1993.\nPOOL ENERGY SERVICES CO.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nPrincipal payments required on long-term debt of unconsolidated affiliates are $12.8 million in 1996 and $1.2 million in 1997.\nAt December 31, 1995, the Company had agreed to guarantee certain borrowings of its unconsolidated affiliates up to an aggregate of $0.6 million, of which all was outstanding.\nIn management's opinion, the Company has no significant exposure from currency restrictions on its foreign subsidiaries and affiliates. See Note 1.\n10. SUPPLEMENTAL FINANCIAL INFORMATION\n_________________ (a) A provision for leasehold impairment of $23.6 million was recorded in 1994 to offset all future lease expense, net of anticipated sublease income, related to the facility in San Angelo, Texas. See Note 6.\nPOOL ENERGY SERVICES CO.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nIn December 1993, the Company entered into agreements with a leasing company to sell for $7.0 million and lease back three offshore jackup rigs which the Company had recently purchased from a third party; the sales proceeds were received in January 1994 (see Note 6). See Note 3 for non-cash investment activity related to the Company's business acquisitions.\nPOOL ENERGY SERVICES CO.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nBUSINESS BY GEOGRAPHIC AREA:\nThe following table sets forth certain financial data of the Company by geographic area:\n_____________________ (a) Operating income (loss) is revenues less related costs and expenses; it excludes earnings attributable to unconsolidated affiliates. (b) A provision for leasehold impairment of $23.6 million was recorded in 1994 to offset all future lease expense, net of anticipated sublease income, related to the facility in San Angelo, Texas. See Note 6.\nPOOL ENERGY SERVICES CO.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\n11. QUARTERLY FINANCIAL DATA (UNAUDITED)\nThe following is a summary of unaudited quarterly financial data for 1995 and 1994.\n_________ (a) Gross profit is computed as consolidated revenues plus earnings attributable to unconsolidated affiliates, less operating expenses (which excludes selling, general and administrative expenses and depreciation and amortization). (b) Includes GPC acquisition related costs of $0.6 million pretax ($0.4 million, or $.03 per share after-tax). See Note 3. (c) Includes the $23.6 million pretax ($15.3 million, or $1.13 per share after-tax) provision for leasehold impairment during the fourth quarter of 1994. See Note 6.\nINDEPENDENT AUDITORS' REPORT Pool Arabia, Ltd.:\nWe have audited the accompanying balance sheets of Pool Arabia, Ltd. (the \"Company\") as of December 31, 1995 and 1994, and the related statements of operations and cash flows for each of the three years in the period ended December 31, 1995. 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 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 financial statements present fairly, in all material respects, the financial position of the Company at December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles. Also, in our opinion, the financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.\nDELOITTE & TOUCHE LLP Houston, Texas January 31, 1996\nPOOL ARABIA, LTD.\nSTATEMENTS OF OPERATIONS\n(In thousands)\nSee Notes to Financial Statements.\nPOOL ARABIA, LTD.\nSTATEMENTS OF CASH FLOWS\n(In thousands)\nSee Notes to Financial Statements.\nPOOL ARABIA, LTD.\nBALANCE SHEETS\n(In thousands except number of shares and per share amount)\nSee Notes to Financial Statements.\nPOOL ARABIA, LTD. NOTES TO FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nAll dollar amounts in the tabulations in the notes to the financial statements are in thousands unless otherwise indicated. All dollar amounts included in the text are in whole dollars, unless otherwise indicated. Certain amounts in the 1994 and 1993 financial statements have been reclassified to conform with the 1995 presentation.\nThe Company - Pool Arabia, Ltd. (the \"Company\") is a limited liability company formed under the Regulations for Companies in the Kingdom of Saudi Arabia for the purpose of performing oil and gas production services. The Company's Commercial Registration No. 2051002523 was issued in Dammam on September 15, 1976 and the Company commenced operations on May 1, 1977. The Company is owned 51% by Pool International, Inc. (\"Pool\"), a U.S. corporation and wholly owned subsidiary of Pool Energy Services Co., and 49% by Arabian Petroleum Services (\"Petroserv\"), a Saudi Arabian company.\nThe primary business of the Company is operating workover and drilling rigs (onshore and offshore) under contracts with Saudi Arabian Oil Company (\"Saudi Aramco\") and with the Joint Operations of Kuwait Oil Company and Saudi Arabian Texaco, Inc. (\"Joint Operations\"). During 1995, approximately 98% of revenues were earned from Saudi Aramco (1994 - 86%; 1993 - 83%) and approximately 2% were earned from the Joint Operations (1994 - 14%; 1993 - 17%).\nForeign Currency Translation - The Company's functional currency is the United States dollar. Transactions denominated in foreign currencies are translated into United States dollars at exchange rates prevailing at the dates of such transactions. Assets and liabilities denominated in foreign currencies are translated into United States dollars at exchange rates prevailing on the balance sheet date. Translation gains (losses) resulting from changes in exchange rates are credited (charged) to income in the current period. The net amount of such gains (losses) during each of the three years in the period ended December 31, 1995 was not significant.\nProperty and Equipment - Property and equipment are stated at cost, less a 1985 provision to reduce the carrying value of certain rig equipment to reflect an impairment in value resulting from the depressed conditions in the oilfield service industry. Maintenance and repairs are charged to expense as incurred. Depreciation of rigs and related equipment is computed principally using a service life method equivalent to straight-line depreciation on a ten-year service life if the rigs were continuously utilized. The actual useful lives of such assets extend beyond the nominal service life period because of anticipated periods of nonutilization and because of maintenance and rebuilding expenditures during periods of such nonutilization. The carrying values and service lives of such assets are periodically assessed to assure that, at the minimum, the cost of assets is depreciated over a period of time that is not greater than their remaining useful lives. Depreciation of buildings and certain other equipment (primarily vehicles) is computed using the straight-line method over the estimated useful lives of the related assets. See also Note 4.\nThe Financial Accounting Standards Board has issued Statement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.\" This statement requires that long- lived assets and certain identifiable intangibles held and used by the Company be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of\nPOOL ARABIA, LTD.\nNOTES TO FINANCIAL STATEMENTS - (CONTINUED)\nan asset may not be recoverable. The adoption of this statement in the first quarter of 1996 will not have a material effect on the Company's financial position or results of operations.\nRevenue Recognition - The Company generally recognizes revenue when services are rendered. Mobilization fees received from customers net of mobilization costs are deferred. Deferred mobilization fees - net are amortized over the terms of the related contracts.\nDeferred Saudi Arabian Income Taxes - The Company provides for deferred Saudi Arabian income taxes on temporary differences which arise principally from differences in depreciation methods used for financial reporting and tax purposes. The Company accounts for income taxes based upon Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" which requires recognition of deferred income tax liabilities and assets 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 liabilities and assets are determined based on the temporary differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities and available tax credit carryforwards. See also Note 7.\nCash Flows - During each of the three years in the period ended December 31, 1995, the Company paid interest charges and income taxes and zakat as follows:\nCash Equivalents - Time deposits with less than a three-month maturity when purchased are considered cash equivalents and are included in cash and cash equivalents.\nFair Values of Financial Instruments - The Company estimates the fair values of its financial instruments, which consist of variable rate debt and short-term items, to approximate the related carrying values.\nPOOL ARABIA, LTD.\nNOTES TO FINANCIAL STATEMENTS - (CONTINUED)\n2. SHAREHOLDERS' EQUITY\nThe following is a summary of transactions affecting shareholders' equity for the last three fiscal years.\n3. ACCOUNTS RECEIVABLE\nAccounts receivable - trade at December 31, 1995 include current retentions of $1.9 million (1994 - $2.8 million), which represent withholdings from periodic contract billings.\n4. PROPERTY AND EQUIPMENT\nProperty and equipment - net at December 31 was comprised of:\nAs explained in Note 1, rigs and related equipment are depreciated using a service life method which results in suspension of depreciation on temporarily idle rigs and related equipment during periods of nonutilization. During 1993, the Company commenced recording depreciation on temporarily idle rigs and equipment at the rate of approximately one-quarter of the normal in-service depreciation rate in order to\nPOOL ARABIA, LTD.\nNOTES TO FINANCIAL STATEMENTS - (CONTINUED)\nrecognize an estimated reduction in the remaining useful lives of such assets. At December 31, 1995, property and equipment includes temporarily idle rigs and equipment with a cost of $64.8 million (1994 - $50.3 million) and net book value of $29.2 million (1994 - $27.5 million).\n5. SHORT-TERM CREDIT FACILITIES\nAt December 31, 1995 and 1994 the Company had available a short-term credit facility of Saudi riyals 19 million (equivalent to $5.1 million) from a local bank. Borrowings under the facility bear interest principally at the Saudi Interbank Offer Rate plus 3\/8%. No amount was drawn on this facility at December 31, 1995. The commitment fee payable on the facility is not significant.\nThe credit facility agreement with the bank places restrictions on any dividend distributions and any repayment of advances from the shareholders. In 1995, 1994 and 1993, the Company obtained waivers of these restrictions in order to repay advances from shareholders and to pay dividends.\n6. LONG-TERM DEBT AND NOTE PAYABLE\nLong-term debt is collateralized by a standby letter of credit from Pool and a guarantee by Petroserv in proportions equivalent to their respective shareholdings. Certain contract revenues are also assigned as collateral for the loan. Semi-annually, the Company can elect the denomination of the loan as either United States dollars or Saudi riyals. At December 31, 1995 the Company had elected Saudi riyals. The outstanding balance of the loan at December 31, 1995 is repayable in 1996. The loan agreement requires interest charges ranging from 3\/16% to 7\/8% over the London or Riyadh Interbank Offer Rates (effective rates from 6.1875% to 6.875% at December 31, 1995).\nThe loan agreement places restrictions on any dividend distributions and any repayment of advances from shareholders. In 1995, 1994 and 1993, the Company obtained waivers of these restrictions in order to repay advances from shareholders and to pay dividends.\nDuring 1993, the Company borrowed Saudi riyals 150 million ($40 million) from a bank in Bahrain under a demand note. The note bears interest at a variable rate, which was 7.8125% per annum at December 31, 1995. The Company does not expect the bank to require repayment within the next year, nor does the Company intend to repay any of the outstanding principal in 1996. In addition, the Company's shareholders have agreed that if the bank called the note, any repayment would be effected through an increase in shareholders' contributions.\n7. SAUDI ARABIAN INCOME TAXES AND ZAKAT\nThe Company provides for Saudi Arabian income taxes on the portion of income attributable to Pool and for zakat which is attributable to Petroserv. For purposes of determining the distributable share of retained earnings, these amounts are charged against the retained earnings of the individual shareholders.\nDuring 1994, the Company received assessments from the DZIT totaling approximately $1.9 million for income tax and zakat related to 1992 and the Company also received additional inquiries from the DZIT related to the years 1978 through 1990 for which it had previously obtained final tax clearance certificates. The Company has appealed the assessments which relate primarily to the timing of the Company's recognition of\nPOOL ARABIA, LTD.\nNOTES TO FINANCIAL STATEMENTS - (CONTINUED)\ntax depreciation and the 1992 tax loss on the sale of an offshore rig. Management believes that any additional provisions for taxes that may be required as a result of such assessments will not be material to the Company's financial position or operations. In late 1995 DZIT issued requests for documentation related to 1993. The Company continues responding to DZIT with no further notices regarding any tax year.\n8. SHAREHOLDERS' AGREEMENT\nPursuant to a shareholders' agreement between Pool and Petroserv, Petroserv has the option to acquire additional ownership from Pool, and ultimately ownership of the Company could change to 65% by Petroserv and 35% by Pool. The purchase price for Petroserv to acquire additional ownership is to be determined as provided in the agreement.\nThe Board of Directors of the Company consists of nine persons: five named by Pool and four by Petroserv. Decisions affecting, among other things, capital contributions by the shareholders, capital expenditures, issuance of indebtedness, and payment of a liquidation dividend must be unanimously approved by the Board of Directors. Certain specific actions shall be undertaken by the Company only with the unanimous consent of its shareholders.\n9. LEGAL RESERVE\nIn accordance with the Regulations for Companies in the Kingdom of Saudi Arabia, the Company maintains a legal reserve equal to one-half of its share capital. Such reserve currently is not available for distribution to the shareholders.\n10. RELATED PARTY TRANSACTIONS\nSignificant related party transactions were as follows:\na) $4.0 million of property, equipment and inventory was acquired in 1995 from affiliates (1994 - $4.2 million; 1993 - 3.5 million).\nb) $0.6 million of costs and expenses was charged in 1995 by affiliates (1994 - $1.7 million; 1993 - $2.1 million).\n11. CONTINGENCIES\nAt December 31, 1995, the Company had outstanding bank guarantees of $2.0 million issued in connection with its contracts (1994 - $1.5 million). See also Note 7 related to income tax contingencies.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEMS 10-13.\nPursuant to Instruction G(3) to Form 10-K, the information required in Items 10-13 is incorporated by reference from the Company's definitive proxy statement, which will be filed with the Commission pursuant to Regulation 14A within 120 days of December 31, 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\nIncluded in Part II of this report:\n(a)-2 FINANCIAL STATEMENT SCHEDULES - (CONTINUED)\nThe supplemental schedules other than those listed above are omitted because of the absence of the conditions under which they are required or because the required information is included in the Financial Statements or Notes thereto.\n(a)-3 EXHIBITS\n(a)-3 EXHIBITS - (CONTINUED)\n(a)-3 EXHIBITS - (CONTINUED)\n(a)-3 EXHIBITS - (CONTINUED)\n___________________\n(*) Management contract or compensatory plan or arrangement\n(**) Filed herewith\nThe schedules to Exhibits 10.26, 10.27 and 10.28 have been omitted. The Company hereby agrees to furnish supplementally to the Commission upon request copies of any such omitted schedules.\n(b) REPORTS ON FORM 8-K - There were no reports on Form 8-K filed during the quarter ended December 31, 1995.\nSCHEDULE II\nPOOL ENERGY SERVICES CO. CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS AS OF DECEMBER 31 (IN THOUSANDS)\n_________________ (a) Includes amounts reclassified between allowance for doubtful accounts and allowance for doubtful noncurrent receivables. (b) Includes a reduction of $490 of allowance related to a revised estimate of the accounts receivable allowance. (c) Includes a reduction of $707 of allowance related to a revised estimate of the accounts receivable allowance. (d) Includes $1,077 related to inventory written off and $589 related to inventory sold. (e) Includes $1,505 related to inventory written off and $1,286 related to inventory sold. (f) Includes a reduction of $2,362 of allowance related to accounts receivable written off. (g) Includes a reduction of $775 of allowance related to accounts receivable written off. (h) Includes a reduction of $1,131 of allowance related to accounts receivable written off.\nSCHEDULE II POOL ARABIA, LTD.\nVALUATION ACCOUNTS\nAs of December 31\n(In thousands)\n(1) Represents inventory written off by utilizing the allowance.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nBy: \/S\/ J. T. JONGEBLOED ------------------------------- J. T. Jongebloed Chairman, President and Chief Executive Officer\nDated: March 12, 1996\nPursuant to the requirements of the Securities Exchange Act 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.\nPOOL ENERGY SERVICES CO. INDEX TO EXHIBITS","section_15":""}
{"filename":"319416_1995.txt","cik":"319416","year":"1995","section_1":"ITEM 1. BUSINESS (Continued)\nBusiness Plan and Investment Policy (Continued)\nThe type of new real estate investments made by the Trust will depend upon the availability of suitable real estate investment opportunities. In general, the Trust intends to be an aggressive and opportunistic investor. In 1996, the Trust's investment strategy will be to balance its portfolio of apartments with new leveraged investments in commercial properties (office buildings, industrial facilities or shopping centers) in the Southeast and Southwest, where a majority of the Trust's properties are located and where the Trust's management believes there remains a potential for sustained appreciation. The Trust will also increase its emphasis on property sales to take advantage of strengthening real estate markets, selling stabilized properties that have reached their potential. Further, to obtain additional funds and lock in current interest rates, mortgage financing will be sought on all of the Trust's presently unencumbered apartments held for investment, consisting of three properties as of December 31, 1995 and to refinance properties which are currently encumbered by mortgage debt that matures in the next two years or where there is an interest rate advantage to the Trust.\nManagement of the Trust\nAlthough the Trust's Board of Trustees is directly responsible for managing the affairs of the Trust and for setting the policies which guide it, the day-to-day operations of the Trust are performed by Basic Capital Management, Inc. (\"BCM\" or the \"Advisor\"), a contractual advisor under the supervision of the Trust's Board of Trustees. The duties of the Advisor include, among other things, locating, investigating, evaluating and recommending real estate and mortgage note investment and sales opportunities as well as financing and refinancing sources for the Trust. The Advisor also serves as a consultant in connection with the Trust's business plan and investment policy decisions made by the Trust's Board of Trustees.\nBCM is a company owned by a trust for the benefit of the children of Gene E. Phillips. Mr. Phillips served as a Trustee of the Trust until December 31, 1992. Mr. Phillips also served as a director of BCM until December 22, 1989 and as Chief Executive Officer of BCM until September 1, 1992. Mr. Phillips serves as a representative of his children's trust which owns BCM and, in such capacity, has substantial contact with the management of BCM and input with respect to its performance of advisory services to the Trust. BCM is more fully described in ITEM 10. \"TRUSTEES, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT - The Advisor\".\nBCM has been providing advisory services to the Trust since March 28, 1989. Renewal of BCM's advisory agreement with the Trust was approved at the annual meeting of the Trust's shareholders held on March 7, 1995. BCM also serves as advisor to Income Opportunity Realty Investors, Inc., formerly Income Opportunity Realty Trust (collectively \"IORI\") and Transcontinental Realty Investors, Inc. (\"TCI\"). The Trustees of the Trust are also directors of IORI and TCI and the officers of the Trust\nITEM 1. BUSINESS (Continued)\nManagement of the Trust (Continued)\nare also officers of IORI and TCI. Mr. Phillips is a general partner of Syntek Asset Management, L.P. (\"SAMLP\"), the general partner of National Realty, L.P. (\"NRLP\") and National Operating, L.P. (\"NOLP\"), the operating partnership of NRLP. BCM performs certain administrative functions for NRLP and NOLP on a cost-reimbursement basis. BCM also serves as advisor to American Realty Trust, Inc. (\"ART\"). Mr. Phillips served as a director and Chairman of the Board of ART until November 16, 1992. Randall M. Paulson, President of the Trust, also serves as the President of BCM, IORI, TCI and as the President and a director of Syntek Asset Management, Inc. (\"SAMI\"), which is the managing general partner of SAMLP. The officers of the Trust are also officers of ART. As of March 15, 1996 ART and BCM owned approximately 38% and 11%, respectively, of the Trust's outstanding shares of beneficial interest and BCM and the Trust owned approximately 42% and 7%, respectively, of ART's outstanding shares of common stock.\nSince February 1, 1990, affiliates of BCM have provided property management services to the Trust. Currently, Carmel Realty Services, Ltd. (\"Carmel, Ltd.\") provides such property management services. Carmel, Ltd. subcontracts with other entities for the provision of the property-level management services to the Trust. The general partner of Carmel, Ltd. is BCM. The limited partners of Carmel, Ltd. are (I) Syntek West, Inc. (\"SWI\"), of which Mr. Phillips is the sole shareholder, (ii) Mr. Phillips and (iii) a trust for the benefit of the children of Mr. Phillips. Carmel, Ltd. subcontracts the property-level management and leasing of twelve of the Trust's commercial properties and the industrial warehouse facilities owned by a real estate partnership in which the Trust is a partner to Carmel Realty, Inc. (\"Carmel Realty\"), which is a company owned by SWI. Carmel Realty is entitled to receive property and construction management fees and leasing commissions in accordance with the terms of its property-level management agreement with Carmel, Ltd.\nCarmel Realty is also entitled to receive real estate brokerage commissions in accordance with the terms of a nonexclusive brokerage agreement as discussed in ITEM 10. \"TRUSTEES, EXECUTIVE OFFICERS AND ADVISOR TO THE REGISTRANT - The Advisor.\"\nThe Trust has no employees. Employees of the Advisor render services to the Trust.\nCompetition\nThe real estate business is highly competitive and the Trust competes with numerous entities engaged in real estate activities (including certain entities described in ITEM 13. \"CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - Related Party Transactions\"), some of which may have greater financial resources than those of the Trust. The Trust's management believes that success against such competition is dependent upon the geographic location of the property, the performance of property managers in areas such as marketing, collection and the ability\nITEM 1. BUSINESS (Continued)\nCompetition (Continued)\nto control operating expenses, the amount of new construction in the area and the maintenance and appearance of the property. Additional competitive factors with respect to commercial properties are the ease of access to the property, the adequacy of related facilities, such as parking, and sensitivity to market conditions in setting rent levels. With respect to apartments, competition is also based upon the design and mix of the units and the ability to provide a community atmosphere for the tenants. The Trust's management believes that general economic circumstances and trends and new or renovated properties in the vicinity of each of the Trust's properties are also competitive factors.\nTo the extent that the Trust seeks to sell any of its properties, the sales prices for such properties may be affected by competition from other real estate entities and financial institutions also attempting to sell their properties located in areas in which the Trust's properties are located.\nAs described above and in ITEM 13. \"CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - Related Party Transactions\", certain of the officers and Trustees of the Trust also serve as officers and directors of certain other entities, each of which is also advised by BCM, and each of which has business objectives similar to the Trust's. The Trust's Trustees, officers and Advisor owe fiduciary duties to such other entities as well as to the Trust under applicable law. In determining to which entity a particular investment opportunity will be allocated, the officers, trustees or directors and the Advisor consider the respective investment objectives of each such entity and the appropriateness of a particular investment in light of each such entity's existing real estate and mortgage notes receivable portfolios. To the extent that any particular investment opportunity is appropriate to more than one of such entities, such investment opportunity will be allocated to the entity which has had funds available for investment for the longest period of time or, if appropriate, the investment may be shared among all or some of such entities.\nIn addition, also as described in ITEM 13. \"CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - Certain Business Relationships\", the Trust also competes with other entities which are affiliates of the Advisor and which may have investment objectives similar to the Trust's and that may compete with the Trust in purchasing, selling, leasing and financing real estate and real estate related investments. In resolving any potential conflicts of interest which may arise, the Advisor has informed the Trust that it intends to continue to exercise its best judgment as to what is fair and reasonable under the circumstances in accordance with applicable law.\nCertain Factors Associated with Real Estate and Related Investments\nThe Trust is subject to all the risks incident to ownership and financing of real estate and interests therein, many of which relate to the general illiquidity of real estate investments. These risks\nITEM 1. BUSINESS (Continued)\nCertain Factors Associated with Real Estate and Related Investments (Continued)\ninclude, but are not limited to, changes in general or local economic conditions, changes in interest rates and the availability of permanent mortgage financing which may render the acquisition, sale or refinancing of a property difficult or unattractive and which may make debt service burdensome, changes in real estate and zoning laws, increases in real estate taxes, federal or local economic or rent controls, floods, earthquakes, hurricanes and other acts of God and other factors beyond the control of the Trust's management or Advisor. Also, the illiquidity of real estate investments may impair the ability of the Trust to respond promptly to changing circumstances. The Trust's management believes that such risks are partially mitigated by the diversification by geographic region and property type of the Trust's real estate and mortgage notes receivable portfolios. However, to the extent property acquisitions are concentrated in any particular region, the advantages of diversification may be mitigated.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Trust's principal offices are located at 10670 North Central Expressway, Suite 300, Dallas, Texas 75231. In the opinion of the Trust's management, the Trust's offices are suitable and adequate for its present operations.\nDetails of the Trust's real estate and mortgage notes receivable portfolios at December 31, 1995, are set forth in Schedules III and IV, respectively, to the Consolidated Financial Statements included at ITEM 8. \"FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\". The discussions set forth below under the headings \"Real Estate\" and \"Mortgage Loans\" provide certain summary information concerning the Trust's real estate and mortgage notes receivable portfolios.\nThe Trust's real estate portfolio consists of properties held for investment, investments in partnerships and properties held for sale, which were primarily acquired through foreclosure of the collateral securing mortgage notes receivable. The Trust holds a fee simple title to all of the properties in its real estate portfolio. The discussion set forth below under the heading \"Real Estate\" provides certain summary information concerning the Trust's real estate and further summary information with respect to the Trust's properties held for investment, properties held for sale and investments in partnerships.\nThe Trust's real estate is geographically diversified. At December 31, 1995, the Trust held investments in apartments and commercial properties in each of the geographic regions of the continental United States. However, the Trust's apartments and commercial properties are concentrated in the Southeast and Southwest regions, as shown more specifically in the table under \"Real Estate\" below. At December 31, 1995, the Trust held mortgage notes receivable secured by real estate located in the Southeast, Southwest and Midwest regions of the\nITEM 2. PROPERTIES (Continued)\ncontinental United States with a concentration in the Southeast and Southwest regions, as shown more specifically in the table under \"Mortgage Loans\" below.\nAt December 31, 1995, none of the Trust's properties, partnership investments or mortgage notes receivable exceeded 10% of the Trust's total assets. At December 31, 1995, 80% of the Trust's assets consisted of properties held for investment, 4% consisted of properties held for sale, 6% consisted of investments in partnerships and 2% consisted of mortgage notes and interest receivable. The remaining 8% of the Trust's assets were cash, cash equivalents, marketable equity securities and other assets. The percentage of the Trust's assets invested in any one category is subject to change and no assurance can be given that the composition of the Trust's assets in the future will approximate the percentages listed above.\nTo continue to qualify for federal taxation as a REIT under the Internal Revenue Code of 1986, as amended, the Trust is required, among other things, to hold at least 75% of the value of its total assets in real estate assets, government securities, cash and cash equivalents at the close of each quarter of each taxable year.\n[THIS SPACE INTENTIONALLY LEFT BLANK.]\nITEM 2. PROPERTIES (Continued)\nGeographic Regions\nThe Trust has divided the continental United States into the following geographic regions.\nNortheast region comprised of the states of Connecticut, Delaware, Maryland, Massachusetts, New Hampshire, New Jersey, New York, Pennsylvania, Rhode Island and Vermont, and the District of Columbia. The Trust has 1 apartment in this region.\nSoutheast region comprised of the states of Alabama, Florida, Georgia, Mississippi, North Carolina, South Carolina, Tennessee and Virginia. The Trust has 6 apartments and 4 commercial properties in this region.\nSouthwest region comprised of the states of Arizona, Arkansas, Louisiana, New Mexico, Oklahoma and Texas. The Trust has 17 apartments and 5 commercial properties in this region.\nMidwest region comprised of the states of Illinois, Indiana, Iowa, Kansas, Kentucky, Michigan, Minnesota, Missouri, Nebraska, North Dakota, Ohio, South Dakota, West Virginia and Wisconsin. The Trust has 3 apartments and 2 commercial properties in this region.\nMountain region comprised of the states of Colorado, Idaho, Montana, Nevada, Utah and Wyoming. The Trust has 3 apartments and 1 commercial property in this region.\nPacific region comprised of the states of California, Oregon and Washington. The Trust has 2 apartments in this region.\nExcluded from the above are three parcels of unimproved land, as described below.\nReal Estate\nAt December 31, 1995, 90% of the Trust's assets were invested in real estate. The Trust invests in real estate located throughout the continental United States, either on a leveraged or nonleveraged basis. The Trust's real estate portfolio consists of properties held for investment, investments in partnerships, properties held for sale, which were primarily acquired through foreclosure of the collateral securing mortgage notes receivable, and investments in the equity securities of real estate entities.\nTypes of Real Estate Investments. The Trust's real estate consists of commercial properties (office buildings, industrial facilities and shopping centers) and apartments or similar properties having established income-producing capabilities. In selecting new real estate investments, the location, age and type of property, gross rentals,\nITEM 2. PROPERTIES (Continued)\nReal Estate (Continued)\nlease terms, financial and business standing of tenants, operating expenses, fixed charges, land values and physical condition are among the factors considered. The Trust may acquire properties subject to or assume existing debt and may mortgage, pledge or otherwise obtain financing for its properties. The Trust's Board of Trustees may alter the types of and criteria for selecting new real estate investments and for obtaining financing without a vote of shareholders to the extent such policies are not governed by the Trust's Declaration of Trust.\nAs of December 31, 1995, the Trust did not have any properties on which significant capital improvements were in process.\nIn the opinion of the Trust's management, the properties owned by the Trust are adequately covered by insurance.\nThe following table sets forth the percentages, by property type and geographic region, of the Trust's real estate (other than unimproved land as described below) at December 31, 1995.\nThe foregoing table is based solely on the number of apartment units and amount of commercial square footage owned by the Trust and does not reflect the value of the Trust's investment in each region. The Trust also owns three parcels of unimproved land, 5 acres located in the Southeast region and 128 acres and 6 acres in the Southwest region. See Schedule III to the Consolidated Financial Statements included at ITEM 8. \"FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\" for a more detailed description of the Trust's real estate portfolio.\nA summary of the activity in the Trust's owned real estate portfolio during 1995 is as follows:\nITEM 2. PROPERTIES (Continued)\nReal Estate (Continued)\nProperties Held for Investment. Set forth below are the Trust's properties held for investment and the monthly rental rate for apartments and the average annual rental rate for commercial properties and occupancy thereof at December 31, 1995, 1994 and 1993:\nITEM 2. PROPERTIES (Continued)\nReal Estate (Continued)\n_______________________ * Property was purchased in 1994 or 1995.\nOccupancy presented above and throughout this ITEM 2. is without reference to whether leases in effect are at, below or above market rates.\nIn February 1995, the Trust purchased the Sullyfield Commerce Center, a 243,813 square foot industrial facility in Chantilly, Virginia, for $11.0 million. The Trust paid $2.2 million in cash and the seller provided mortgage financing of $8.8 million. The mortgage bears interest at a rate of 6% per annum through December 1996 and 9% per annum thereafter, requires monthly payments of interest only through January 1999 and principal and interest payments of $73,000 thereafter and matures in January 2001. The Trust paid a real estate brokerage commission of $285,000 to Carmel Realty and an acquisition fee of $110,000 to BCM based on the $11.0 million purchase price of the property.\nAlso in February 1995, after determining that further investment in Genesee Towers, an office building in Flint, Michigan, could not be justified without a substantial modification of the mortgage debt, the Trust ceased making debt service payments on the $8.8 million nonrecourse mortgage secured by the property. Accordingly, as of December 31, 1994, the carrying value of the property was written down by $1.2 million, which is included in the 1994 provision for losses, to the amount of the nonrecourse mortgage. In February 1996, the Trust and the lender entered into a forbearance agreement that provides, among other things, that for a period of 90 days, the Trust make monthly payments of the greater of regular scheduled principal and interest or cash flow from the property. The deed to the property has been\nITEM 2. PROPERTIES (Continued)\nReal Estate (Continued)\nplaced in escrow during the term of the forbearance agreement. The Trust anticipates that the property will be returned to the lender at the expiration of the agreement. The Trust does not anticipate incurring a loss as the carrying value of the property has been written down to the amount of the nonrecourse mortgage debt, which approximates the fair value of the property at December 31, 1995.\nIn March 1995, the Trust purchased the Kelly Warehouses, six industrial warehouse facilities with a total of 330,334 square feet in Dallas, Texas, for $5.4 million. The Trust paid $696,000 in cash, obtained new mortgage financing of $4.6 million and the seller provided additional financing of $403,000. The $4.6 million mortgage bears interest at a variable rate, 8.91% per annum at December 31, 1995, requires monthly payments of interest only and matures in July 1999. The $403,000 of seller financing bears interest at rates ranging from 6% to 8% per annum, requires monthly payments of principal and interest totaling $3,000 and matures in July 1999. The Trust paid a real estate brokerage commission of $178,000 to Carmel Realty and an acquisition fee of $54,000 to BCM based on the $5.4 million purchase price.\nIn May 1995, the Trust purchased the Willo-Wick Gardens Apartments, a 152 unit apartment complex in Pensacola, Florida, for $3.6 million. The Trust paid $687,000 in cash, assumed the existing first mortgage of $2.8 million and the seller provided additional financing of $79,000. The $2.8 million first mortgage bears interest at 9.915% per annum, requires monthly payments of principal and interest of $26,000 and matures in April 2001. The $79,000 seller financing bears interest at 9.9% per annum and requires monthly payments of interest only through maturity in May 1997 at which time the entire outstanding principal balance and all accrued and unpaid interest is due. The Trust paid a real estate brokerage commission of $127,000 to Carmel Realty and an acquisition fee of $36,000 to BCM based on the $3.6 million purchase price of the property.\nIn July 1995, the Trust purchased the McCallum Glen Apartments, a 275 unit apartment complex in Dallas, Texas, for $6.0 million. The Trust paid $1.8 million in cash and obtained new mortgage financing of $4.2 million. The new first mortgage bears interest at a variable rate, 8.6% per annum at December 31, 1995, requires monthly payments of principal and interest and matures on August 1, 2002. The Trust paid a real estate brokerage commission of $190,000 to Carmel Realty and an acquisition fee of $60,000 to BCM based on the $6.0 million purchase price.\nIn November 1995, the Trust purchased the Willow Wick Apartments, a 104 unit apartment complex in North Augusta, South Carolina, for $1.5 million. The Trust paid $595,000 in cash and assumed the existing first mortgage of $930,000. The mortgage bears interest at 7% per annum, requires monthly payments of principal and interest of $8,000 and matures in January 2013. The Trust paid a real estate brokerage commission of $61,000 to Carmel Realty and an acquisition fee of $15,000 to BCM based on the $1.5 million purchase price of the property.\nITEM 2. PROPERTIES (Continued)\nReal Estate (Continued)\nIn December 1995, the Trust purchased the Heritage on the River Apartments, a 301 unit apartment complex in Jacksonville, Florida, for $7.9 million. The Trust paid $1.4 million in cash and assumed the existing first mortgage of $6.3 million and the seller provided additional financing of $193,000. The mortgages bear interest at a variable rate, 9.18% per annum at December 31, 1995, require monthly payments of interest only and mature in December 1998. The Trust paid a real estate brokerage commission of $228,000 to Carmel Realty and an acquisition fee of $79,000 to BCM based on the $7.9 million purchase price of the property.\nAlso in December 1995, the Trust purchased the Brookfield Corporate Center, a 63,504 square foot industrial facility in Chantilly, Virginia, for $3.5 million. The Trust paid $650,000 in cash and the seller provided mortgage financing of $2.8 million. The mortgage bears interest at 7.6% per annum, requires monthly payments of principal and interest of $21,000 and matures in December 1998. The Trust paid a real estate brokerage commission of $124,000 to Carmel Realty and an acquisition fee of $35,000 to BCM based on the $3.5 million purchase price of the property.\nIn May and December 1995, the Trust refinanced the mortgage debt secured by the Sunset Lake Apartments in Waukegan, Illinois in the amount of $8.0 million. The Trust received net cash of $5.3 million after the payoff of $1.9 million in existing mortgage debt. The remainder of the refinancing proceeds were used to fund repair escrows and to pay various closing costs associated with the refinancings. The new mortgage bears interest at 7.625% per annum, requires monthly payments of principal and interest of $60,000 and matures in January 2006. The Trust paid BCM a total of $134,000 in mortgage brokerage and equity refinancing fees based upon the initial refinancing of $5.4 million and the second refinancing of $8.0 million.\nIn August 1995, the Trust obtained mortgage financing secured by the previously unencumbered Quail Oaks Apartments in Balch Springs, Texas in the amount of $750,000. The mortgage bears interest at a variable rate, 9.75% at December 31, 1995, requires monthly payments of principal and interest, currently $7,000 and matures in August 2000. The Trust received net cash of $734,000 after the payment of various closing costs associated with the financing. The Trust paid BCM a mortgage brokerage and equity refinancing fee of $7,500 based upon the $750,000 financing.\n[THIS SPACE INTENTIONALLY LEFT BLANK.]\nITEM 2. PROPERTIES (Continued)\nReal Estate (Continued)\nPartnership Properties. Set forth below are the properties owned by the partnerships in which the Trust is an equity investee and the average annual rental rate and occupancy thereof at December 31, 1995, 1994 and 1993:\nThe Trust, in partnership with National Income Realty Trust (\"NIRT\"), owns Sacramento Nine (\"SAC 9\") which in turn owns two office buildings. The Trust has a 30% general partner interest in the partnership. The Trust accounts for its investment in the partnership using the equity method. Until August 1994, Bennett B. Sims and Ted P. Stokely, Trustees of the Trust, also served as Trustees of NIRT. Until March 31, 1994, BCM served as advisor to NIRT. See ITEM 13. \"CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\"\nIn August 1995, SAC 9 obtained mortgage financing secured by a previously unencumbered office building in Rancho Cordova, California in the amount of $3.5 million. SAC 9 received net cash of $3.4 million after the payment of various closing costs associated with the financing, of which the Trust's equity share was $1.0 million. The new mortgage bears interest at a variable rate, currently 8.59% per annum, requires monthly payments of principal and interest, currently $31,000, and matures in September 2000.\nThe Trust and NIRT are also the partners in Income Special Associates (\"ISA\"), a joint venture partnership in which the Trust has a 60% partnership interest. ISA in turn owns a 100% interest in Indcon, L.P. (\"Indcon\"), formerly known as Adams Properties Associates. At December 31, 1995, Indcon owned 31 industrial warehouse facilities. The Indcon partnership agreement requires consent of both the Trust and NIRT for any material changes in the operations of the partnership's properties, including sales, refinancings and changes in property manager. Therefore, the Trust is a noncontrolling partner and accounts for its investment in Indcon using the equity method. See ITEM 13. \"CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\"\nIn February and March 1996, Indcon completed the sale of 25 of its industrial warehouses for a total of $36.2 million in cash. Indcon received net cash of $11.1 million, of which the Trust's equity share was $6.7 million, after the payoff of existing mortgage debt with a principal balance of $23.5 million at December 31, 1995. Indcon will recognize a gain of approximately $617,000 on the sale, of which the Trust's equity share will be approximately $370,000. Indcon paid a real estate sales commission of $585,000 to Carmel Realty based upon the $36.2 million sales price of the properties.\nITEM 2. PROPERTIES (Continued)\nReal Estate (Continued)\nProperties Held for Sale. Set forth below are the Trust's foreclosed properties held for sale and a property under contract for sale, and the monthly rental rate for apartments and the average annual rental rate for commercial properties and occupancy thereof at December 31, 1995, 1994 and 1993:\n__________________\n* Property obtained through foreclosure in 1995.\nAt December 31, 1995, Rivertree Apartments was under contract for sale. In February 1996, the Trust completed the sale of the apartment complex for $1.8 million. In conjunction with the sale the Trust provided $750,000 of purchase money financing in the form of a wraparound mortgage note. The Trust received net cash of $959,000 after the payment of various closing costs associated with the sale. The Trust paid a real estate sales commission of $70,000 to Carmel Realty based on the $1.8 million sales price of the property. The Trust will recognize a gain of approximately $378,000 on the sale. See \"Mortgage Loans\" below.\nIn March 1995, the Trust recorded the insubstance foreclosure of the Driftwood Apartments, a 138 unit apartment complex in Detroit, Michigan. Driftwood Apartments had an estimated fair value (minus estimated costs of sale) at the date of foreclosure, which exceeded the carrying value of the Trust's note receivable. Foreclosure of the property was completed on May 2, 1995. The foreclosure resulted in no loss to the Trust.\nThe three parcels of unimproved land owned by the Trust were each obtained through foreclosure. Two were obtained through foreclosure of a mortgage note secured primarily by office buildings. The third and largest, the Round Mountain parcel, was intended to be developed in 1983 when the Trust funded the mortgage loan secured by the land.\nITEM 2. PROPERTIES (Continued)\nReal Estate (Continued)\nThe Trust intends to hold these parcels of unimproved land until the market conditions in the areas in which the properties are located improve, at which time the Trust intends to offer the properties for sale. The Declaration of Trust provides that the Trust may not invest in unimproved real estate or make mortgage loans secured by unimproved real estate unless the property is being or is expected to be developed within a reasonable period of time or unless the unimproved real estate serves as additional security on a permitted type of mortgage loan.\nIn 1996, the Trust intends to increase its emphasis on the sale of foreclosed properties.\nMortgage Loans\nIn addition to real estate, a substantial portion of the Trust's assets are invested in mortgage notes receivable, principally those secured by income-producing real estate. The Trust expects that the percentage of its assets invested in mortgage loans will decrease, as it has determined that it will no longer actively seek to fund or acquire mortgage loans. It may, however, originate mortgage loans in conjunction with providing purchase money financing of a property sale. The Trust does intend, however, to service and hold for investment the mortgage notes currently in its portfolio. The Trust's mortgage notes receivable consist of first mortgage loans and junior mortgage loans.\nTypes of Mortgage Activity. In the past, the Trust has originated its own mortgage loans as well as acquired existing mortgage notes either directly from builders, developers or property owners, or through mortgage banking firms, commercial banks or other qualified brokers. The Trust is generally not considering new mortgage lending, except in connection with purchase money financing offered to facilitate the sale of Trust properties. BCM, in its capacity as a mortgage servicer, services the Trust's mortgage notes. The Trust's investment policy is described in ITEM 1. \"BUSINESS - Business Plan and Investment Policy\".\nTypes of Properties Subject to Mortgages. The properties securing the Trust's mortgage notes receivable portfolio at December 31, 1995, consisted of office buildings, apartments and single-family residences. To the extent that the Declaration of Trust does not control such matters, the Trust's Board of Trustees may alter the types of properties subject to mortgage loans in which the Trust invests without a vote of the Trust's shareholders. In addition to restricting the types of collateral and priority of mortgage loans in which the Trust may invest, the Declaration of Trust imposes certain restrictions on transactions with related parties, as discussed in ITEM 13. \"CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\".\nAt December 31, 1995, the Trust's mortgage notes receivable portfolio included eight mortgage loans with an aggregate outstanding balance of $7.6 million secured by income-producing real estate located throughout the United States and seven mortgage loans with an aggregate outstanding\nITEM 2. PROPERTIES (Continued)\nMortgage Loans (Continued)\nbalance of $654,000 secured by single-family residences also located throughout the United States. At December 31, 1995, a total of 2% of the Trust's assets were invested first in mortgage notes.\nThe following table sets forth the percentages (based on the outstanding mortgage note balance), by both property type and geographic region, of the properties that serve as collateral for the Trust's outstanding mortgage notes receivable portfolio at December 31, 1995. The table does not include the $654,000 in mortgage notes secured by single- family residences discussed in the preceding paragraph or the $1.6 million first mortgage secured by a ranch located in Southwest region. See Schedule IV to the Consolidated Financial Statements included at ITEM 8. \"FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\" for further details of the Trust's mortgage notes receivable portfolio.\nA summary of the activity in the Trust's mortgage notes receivable portfolio during 1995 is as follows:\nFirst Mortgage Loans. The Trust has invested in first mortgage notes, with either short, medium or long-term maturities. First mortgage loans generally provide for level periodic payments of principal and interest sufficient to substantially repay the loan prior to maturity, but may involve interest-only payments or moderate amortization of principal and a \"balloon\" principal payment at maturity. With respect to first mortgage loans, it was the Trust's general policy to require that the borrower provide a mortgagee's title policy or an acceptable legal title opinion as to the validity and the priority of the mortgage lien over all other obligations, except liens arising from unpaid property taxes and other exceptions normally allowed by first mortgage lenders in the relevant area. The Trust may grant to other lenders participations in first mortgage loans originated by the Trust.\nThe following discussion briefly describes the events that affected previously funded first mortgage loans, during 1995.\nAt December 31, 1994, the $1.5 million first mortgage note receivable secured by the Alderwood Apartments in Detroit, Michigan was in default. In May 1995, the Trust accepted $1.0 million in cash in full satisfac-\nITEM 2. PROPERTIES (Continued)\nMortgage Loans (Continued)\ntion of the debt. A provision for loss of $541,000 was recognized in 1995 to provide for the loss on the discounted payoff of the mortgage note receivable.\nAlso at December 31, 1994, the first mortgage note secured by the Driftwood Apartments, with a principal balance at that date of $891,000 was in default. In March 1995, the Trust recorded the insubstance foreclosure of the collateral property securing the mortgage note receivable. See \"Real Estate,\" above.\nAt December 31, 1995, two of the Trust's first mortgage notes receivable with principal balances totaling $2.1 million were in default. One of the notes, with a principal balance of $1.4 million matured in November 1995. The borrower is currently negotiating with the Trust for an extension of the note in return for a principal paydown and payment of all accrued interest, which totaled $198,000 at December 31, 1995. The Trust does not anticipate incurring a loss on this note as the estimated value of the property securing the note is in excess of the carrying value of the note. The other note, with a principal balance of $700,000, matured in July 1993. The Trust continues to receive partial interest payments monthly on the note. The Trust is evaluating its options with respect to foreclosure of the collateral property and does not anticipate incurring a loss on this note in excess of previously established reserves.\nWraparound Mortgage Loans. The Trust has invested in wraparound mortgage loans, sometimes called all-inclusive loans, made on real estate subject to prior mortgage indebtedness. A wraparound mortgage loan is a mortgage loan having an original principal amount equal to the outstanding balance under the prior existing mortgage loan(s) plus the amount actually advanced under the wraparound mortgage loan.\nWraparound mortgage loans may provide for full, partial or no amortization of principal. The Trust's policy was to make wraparound mortgage loans in amounts and on properties as to which it would otherwise make first mortgage loans. At December 31, 1995, the Trust's mortgage notes receivable portfolio contained no wraparound mortgage loans.\nIn February 1996, the Trust sold the Rivertree Apartments and provided $750,000 in purchase money financing in the form of a wraparound mortgage note. The wraparound mortgage note bears interest at 9% per annum, requires monthly payments of interest only and matures in November 1996. See \"Real Estate,\" above.\nJunior Mortgage Loans. The Trust has invested in junior mortgage loans. Such loans are secured by mortgages that are subordinate to one or more prior liens either on the fee or a leasehold interest in real estate. Recourse on such loans ordinarily includes the real estate on which the loan is made, other collateral and personal guarantees by the borrower. The Trust's Declaration of Trust restricts investment in junior mortgage\nITEM 2. PROPERTIES (Continued)\nMortgage Loans (Continued)\nloans, excluding wraparound mortgage loans, to not more than 10% of the Trust's assets. At December 31, 1995, none of the Trust's assets were invested in junior mortgage loans.\nThe Trust did not originate or acquire any junior mortgage loans during 1995. The following discussion briefly describes the events that affected previously funded junior mortgage loans during 1995 and a junior mortgage loan originated by the Trust in 1996.\nIn September 1991, the Trust funded a $2.0 million junior mortgage loan, secured by the Aspen Village Townhomes, located in Hartland, Wisconsin. On March 27, 1992, the Trust funded an additional $150,000 junior mortgage loan, also secured by the Aspen Village Townhomes. The notes had an extended maturity date of April 27, 1992 and September 23, 1992, respectively. The underlying first lienholder has notified the Trust that it has commenced foreclosure proceedings. In December 1995, the Trust wrote off the mortgage notes as uncollectible. No loss was incurred beyond the reserves previously provided.\nIn February 1996, the Trust funded a $1.5 million second lien mortgage secured by the Signature Athletic Club Building in Dallas, Texas. The note bears interest at 12% per annum and requires monthly interest only payments to the extent of available cash flow. Any accrued but unpaid interest is added to the principal balance of the note annually. In addition, the note requires quarterly principal payments equal to the excess property cash flow for the quarter. The note matures in October 1998 with an option to extend the note to December 2000. The Trust has also guaranteed the underlying $3.0 million first mortgage secured by the property. The Trust has an option to purchase a 50% interest in the partnership which owns the Signature Athletic Club Building for $100 at any time. The option expires in December 2005.\nEquity Investments in Real Estate Entities\nIn September 1990, the Trust's Board of Trustees authorized the purchase of up to $2.0 million of the common stock of ART through negotiated or open market transactions. The officers of the Trust also serve as officers of ART and BCM. BCM, the Trust's advisor, also serves as advisor to ART. At March 15, 1996, ART owned approximately [38]% of the Trust's outstanding shares of beneficial interest. At December 31, 1995, the Trust owned 409,044 shares of ART's common stock, approximately 7% of ART's outstanding shares of common stock, which the Trust had purchased in open market transactions in 1990 and 1991, at a total cost to the Trust of $1.6 million. The ART common stock owned by the Trust is considered to be available for sale and accordingly, is carried at fair value defined as the period end closing market value. At December 31, 1995, the market value of the ART common stock was $3.0 million. See ITEM 8. \"FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\"\nIn December 1990, the Trust's Board of Trustees authorized the purchase of up to $1.0 million of the shares of beneficial interest of National Income Realty Trust (\"NIRT\"), a REIT that until March 31, 1994, was also\nITEM 2. PROPERTIES (Continued)\nEquity Investments in Real Estate Entities (Continued)\nadvised by BCM, and up to $1.0 million of the shares of common stock of TCI through negotiated or open market transactions. The Trustees of the Trust serve as directors of TCI and the officers of the Trust also serve as officers of TCI. BCM, the Trust's advisor, also serves as advisor to TCI. At December 31, 1995, the Trust owned 84,580 shares of beneficial interest of NIRT acquired at a total cost to the Trust of $415,000 and 79,500 shares of common stock of TCI acquired at a total cost to the Trust of $235,000 all of which shares the Trust had purchased in open market transactions in 1990 and 1991. The Trust's investment in these entities is also considered as available for sale and is also carried at fair value. At December 31, 1995, the market value of the Trust's investment in NIRT and TCI shares was $941,000 and $795,000, respectively.\nUnder the original terms of its Declaration of Trust, the Trust was prohibited from investing in equity securities for a period in excess of 18 months. However, pursuant to an amendment to the Trust's Declaration of Trust approved by the Trust's shareholders in May 1992, the Trust may hold these shares of ART, NIRT and TCI until July 30, 1996. At the Annual Meeting of Shareholders to be held in April 1996, shareholder's of the Trust will be ask to repeal that section of the Trust's Declaration of Trust which limits the holding period for equity securities.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nOlive Litigation\nIn February 1990, the Trust, together with IORI, NIRT and TCI, three real estate entities with, at the time, the same officers, directors or trustees and advisor as the Trust, entered into a settlement of a class and derivative action entitled Olive et al. v. National Income Realty Trust et al., in the United State District Court for the Northern District of California, relating to the operation and management of each of such entities. On April 23, 1990, the court granted final approval of the terms of the settlement.\nOn May 4, 1994, the parties entered into a Modification of Stipulation of Settlement dated April 27, 1994 (the \"Modification\") which settled subsequent claims of breaches of the settlement which were asserted by the plaintiffs and modified certain provisions of the April 1990 settlement. The Modification was preliminarily approved by the court on July 1, 1994. Final court approval of the Modification was entered on December 12, 1994. The effective date of the Modification was January 11, 1995.\nThe Modification, among other things, provided for the addition of three new unaffiliated members to the Trust's Board of Trustees and set forth new requirements for the approval of any transactions with affiliates until April 28, 1999. In addition, BCM, the Trust's advisor, Gene E. Phillips and William S. Friedman, who served as President and Trustee of the Trust until February 24, 1994, President of BCM until May 1, 1993\nITEM 3. LEGAL PROCEEDINGS\nOlive Litigation\nand director of BCM until December 22, 1989, agreed to pay a total of $1.2 million to the Trust, IORI, NIRT and TCI, of which the Trust's share is $750,000. As of March 1, 1996, the Trust had received payments totaling $594,000. The remaining $156,000 is being paid in monthly installments through August 1, 1996.\nUnder the Modification, the Trust, IORI, NIRT, TCI and their shareholders released the defendants from any claims relating to the plaintiffs' allegations. The Trust, IORI, NIRT and TCI also agreed to waive any demand requirement for the plaintiffs to pursue claims on behalf of each of them against certain persons or entities. The Modification also requires that any shares of the Trust held by Messrs. Phillips, Friedman or their affiliates shall be (i) voted in favor of the reelection of all current members of the Trust's Board of Trustees that stand for reelection during the two calendar years following the effective date of the Modification and (ii) voted in favor of all new members of the Trust's Board of Trustees appointed pursuant to the terms of the Modification that stand for reelection during the three calendar years following the effective date of the Modification.\nPursuant to the terms of the Modification, certain related party transactions which the Trust may enter into prior to April 28, 1999, require the unanimous approval of the Trust's Board of Trustees. In addition, such related party transactions are to be discouraged and may only be entered into in exceptional circumstances and after a determination by the Trust's Board of Trustees that the transaction is in the best interests of the Trust and that no other opportunity exists that is as good as the opportunity presented by such transaction.\nFor purposes of the Modification requirements, the term \"related party transaction\" means and includes (I) any transaction between or among the Trust or IORI, NIRT or TCI or any of their affiliates or subsidiaries; (ii) any transaction between or among the Trust, its affiliates or subsidiaries and the Advisor, Mr. Phillips, Mr. Friedman or any of their affiliates; and (iii) any transaction between or among the Trust or any of its affiliates or subsidiaries and a third party with whom the Advisor, Mr. Phillips, Mr. Friedman or any of their affiliates has an ongoing or contemplated business or financial transaction or relationship of any kind, whether direct or indirect, or has had such a transaction or relationship in the preceding one year.\nThe Modification requirements for related party transactions do not apply to direct contractual agreements for services between the Trust and the Advisor or one of its affiliates, (including the Advisory Agreement, the Brokerage Agreement and the property management contracts). These agreements require the prior approval by two-thirds of the Trustees of the Trust, and if required, approval by a majority of the shareholders. The Modification requirements for related party transactions also do not apply to joint ventures between or among the Trust and IORI, NIRT or TCI or any of their affiliates or subsidiaries and a third party having no prior or intended future business or\nITEM 3. LEGAL PROCEEDINGS\nOlive Litigation\nfinancial relationship with Mr. Phillips, Mr. Friedman, the Advisor, or any affiliate of such parties. Such joint ventures may be entered into on the affirmative vote of a majority of the Trustees of the Trust.\nThe Modification also terminated a number of the provisions of the settlement, including the requirement that the Trust, IORI, NIRT and TCI maintain a Related Party Transaction Committee and a Litigation Committee of their respective Boards. The court retains jurisdiction to enforce the Modification.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNot applicable.\n________________________\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S SHARES OF BENEFICIAL INTEREST AND RELATED SHAREHOLDER MATTERS\nThe Trust's shares of beneficial interest are traded on The Nasdaq Stock Market (\"Nasdaq\") using the symbol \"CMETs\". The following table sets forth the high and low prices as reported by the Nasdaq.\n_______________________\n* Restated for the three for two forward share split effected February 15, 1996.\nAs of March 15, 1996, the closing price of the Trust's shares of beneficial interest on the Nasdaq was $9.63 per share.\nAs of March 15, 1996, the Trust's shares of beneficial interest were held by 6,884 holders of record.\nITEM 5. MARKET FOR THE REGISTRANT'S SHARES OF BENEFICIAL INTEREST AND RELATED SHAREHOLDER MATTERS (Continued)\nThe Trust paid distributions in 1995 and 1994 as follows:\n________________\n* Restated for the three for two forward share split effected February 15, 1996.\nThe Trust reported to the Internal Revenue Service that 100% of the distributions paid in 1995 and 1994 represented a return of capital.\nOn December 5, 1989, the Trust's Board of Trustees approved a program for the Trust to repurchase its shares of beneficial interest. The Trust's Board of Trustees has authorized the Trust to repurchase a total of 1,465,000 of its shares of beneficial interest pursuant to such program. Through December 31, 1995, the Trust had repurchased 1,177,725 of its shares at a total cost to the Trust of $5.0 million. The Trust purchased none of its shares of beneficial interest during 1995. In 1996, through March 15, 1996, the Trust has repurchased 128,994 additional shares at a total cost to the Trust of $1.3 million.\nOn March 24, 1989, the Trust distributed one share purchase right for each outstanding share of beneficial interest of the Trust. On December 10, 1991, the Trust's Board of Trustees voted to redeem the rights, having determined that the rights were no longer necessary to protect the Trust from coercive tender offers. In connection with such redemption, Messrs. Phillips and Friedman and their affiliates, who owned approximately 28% of the Trust's outstanding shares of beneficial interest at the time, agreed not to acquire more than 40% of the Trust's outstanding shares of beneficial interest without the prior action of the Trust's Board of Trustees to the effect that they do not object to such increased ownership.\nIn August 1994, Mr. Phillips and his affiliates, primarily ART and BCM, owned approximately 39.9% of the Trust's outstanding shares of beneficial interest. This shareholder group desired to purchase additional shares of the Trust and requested that the Trust's Board of Trustees consider the elimination of the limitation on the percentage of shares which may be acquired by the shareholder group. The Board of Trustees reviewed the limitation and determined that, due to the fact that Mr. Friedman is no longer affiliated with the shareholder group, and had disposed of any shares of the Trust which he or his affiliates\nITEM 5. MARKET FOR THE REGISTRANT'S SHARES OF BENEFICIAL INTEREST AND RELATED SHAREHOLDER MATTERS (Continued)\nmay have owned, the limitation should no longer apply to Mr. Friedman or his affiliates. The Board of Trustees also determined that there was no reason to object to the purchase of additional shares of the Trust by the shareholder group and on August 23, 1994, the Trust's Board of Trustees adopted a resolution to the effect that they do not object to the acquisition of up to 49% of the Trust's outstanding shares of beneficial interest by Mr. Phillips and his affiliates. In determining total ownership, shares of beneficial interest of the Trust, if any, owned by Mr. Friedman and his affiliates are no longer to be included. Pursuant to this action, Mr. Phillips and his affiliates may not acquire more than 49% of the Trust's outstanding shares of beneficial interest without the prior action of the Trust's Board of Trustees to the effect that they do not object to such increased ownership. At March 15, 1996, Mr. Phillips and his affiliates, primarily ART and BCM, owned approximately [51]% of the Trust's outstanding shares of beneficial interest. The increase in ownership above 49% is the result of the Trust repurchasing its shares in 1996.\nOn March 21, 1996, the Trust's Board of Trustees reconsidered the share ownership limitation and determined that there was no reason to object to the purchase by Mr. Phillips and his affiliates of additional shares in excess of 49% of the Trust's outstanding shares. Accordingly, there is no longer any limitation on the percentage of shares of the Trust which may be acquired by Mr. Phillips and his affiliates.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nITEM 6. SELECTED FINANCIAL DATA (Continued)\nThe Trust purchased seven properties in 1995 for a total of $38.9 million, eight properties in 1994 for a total of $32.7 million and five properties in 1993 for a total of $16.9 million. See ITEM 8. \"FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\"\nShares and per share data have been restated for the three for two forward share split effected February 15, 1996.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nIntroduction\nContinental Mortgage and Equity Trust (the \"Trust\") was formed to invest in real estate through acquisitions, leases and partnerships and in mortgage loans on real estate, including wraparound, first and junior mortgage loans. The Trust was organized on August 27, 1980 and commenced operations on December 3, 1980.\nLiquidity and Capital Resources\nCash and cash equivalents totaled $6.4 million at December 31, 1995 compared with $7.5 million at December 31, 1994. The principal reasons for this decrease in cash are discussed in the paragraphs below.\nThe Trust's principal sources of cash have been and will continue to be from property operations, proceeds from property sales, principal payments on mortgage notes receivable and borrowings. The Trust expects that net cash provided by operating activities and from anticipated external sources, such as property sales, financings and refinancings, will be sufficient to meet the Trust's various cash needs in 1996, including, but not limited to, the payment of distributions, debt service obligations coming due and property maintenance and improvements, as more fully discussed in the paragraphs below.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nLiquidity and Capital Resources (Continued)\nThe Trust's cash flow from property operations (rents collected less payments for property operating expenses) has continually increased over the past three years from $8.4 million in 1993 to $10.7 million in 1994 to $15.1 million in 1995. Of this $6.7 million net increase from 1993 to 1995, $6.1 million is the result of the Trust having acquired additional income producing properties, both through purchase and foreclosure, and the remainder of $600,000 is due to increased occupancy and rental rates, primarily at its apartments, and the Trust's control of operating expenses. The Trust's management believes that this trend will continue, particularly in the Trust's apartments, if the economy remains stable or improves.\nInterest collected on mortgage notes receivable decreased over the past three years from $2.4 million in 1993 to $2.2 million in 1994 to $688,000 in 1995. These decreases are primarily attributable to the foreclosure of the collateral property securing mortgage notes receivable and the payoff of mortgage notes receivable in 1994 and 1995.\nInterest will continue to decrease as a source of cash to the Trust as the Trust has determined that generally, it will not seek to originate new mortgage loans, other than those resulting from Trust provided purchase money financing in connection with a property sale.\nInterest paid on the Trust's notes payable increased from $6.6 million in 1994 to $8.9 million in 1995. This increase is primarily attributable to interest paid on mortgages secured by properties acquired in 1994 and 1995, and interest paid on borrowings in 1995 and 1994 secured by mortgages on previously unencumbered properties. The Trust believes that interest paid on notes payable will continue to increase in 1996 if the Trust continues to acquire additional properties and\/or obtain financing on unencumbered properties.\nThe Trust was involved in significant investing activities during 1995. The Trust purchased four apartment complexes and three commercial properties during 1995, for which the Trust paid a total of $40.8 million. The Trust paid $9.8 million in cash, with the remaining $31.0 million financed through new or assumed mortgage debt. The Trust also made improvements to its properties totaling $1.2 million. In addition, the Trust collected $1.1 million on its mortgage notes receivable, primarily from the payoff of one note of $1.0 million, with the remainder being collected from scheduled paydowns on the Trust's other mortgage notes receivable.\nDuring 1995, the Trust received net financing proceeds of $734,000 from mortgage financing secured by a previously unencumbered apartment complex. In addition, the Trust refinanced the mortgage secured by another apartment complex. The Trust received a total of $11.8 million in net cash proceeds after the payoff of $6.3 million in existing mortgage debt and the payment of various closing costs associated with the financings. Also during 1995, the Trust made scheduled principal payments on mortgages totaling $1.3 million.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nLiquidity and Capital Resources (Continued)\nIn January 1993, the Trust's Board of Trustees approved the resumption of quarterly distributions. In 1995 and 1994, the Trust paid distributions to shareholders of $.40 per share or a total of $1.8 million in each year.\nDuring the first quarter of 1996, the Trust has continued to be an active investor. The Trust has purchased one office building, for $7.7 million, the Trust paying $1.1 million in cash with the remainder of the purchase price financed through mortgage debt. In connection with the financing the Trust also established various escrow accounts in the amount of $1.5 million. In February 1996, the Trust funded a $1.5 million junior mortgage secured by a building occupied by an athletic club. The Trust derived the cash portions of these investments from its cash on hand at December 31, 1995. See NOTE 17. \"SUBSEQUENT EVENTS.\"\nPursuant to a repurchase program originally announced by the Trust on December 5, 1989, the Trust's Board of Trustees have authorized the Trust to repurchase a total of 1,465,000 of its shares of beneficial interest. Through December 31, 1995, the Trust had repurchased 1,177,725 of its shares at a total cost to the Trust of $5.0 million. During 1995, the Trust did not repurchase any of its shares. In 1996, through March 15, 1996, the Trust has repurchased 128,994 additional shares at a total cost to the Trust of $1.3 million and at such date, 158,281 shares remain to be repurchased.\nOn a quarterly basis, the Trust's management reviews the carrying value of the Trust's mortgage notes receivable, properties held for investment and properties held for sale. Generally accepted accounting principles require that the carrying value of an investment cannot exceed the lower of its cost or its estimated net realizable value. In those instances in which estimates of net realizable value of the Trust's properties or notes are less than the carrying value thereof at the time of evaluation, a provision for loss is recorded by a charge against earnings. Estimated net realizable value of mortgage notes receivable is based on the Trust's management's review and evaluation of the collateral properties securing such notes. The property review generally includes selective property inspections, a review of the property's current rents compared to market rents, a review of the property's expenses, a review of maintenance requirements, discussions with the manager of the property and a review of properties in the surrounding area.\nResults of Operations\n1995 compared to 1994. For the year 1995, the Trust had a net loss of $1.4 million, as compared to a net loss of $833,000 for the year 1994. The primary factors contributing to the increase in the Trust's net loss are discussed in the following paragraphs.\nNet rental income (rents less expenses applicable to rents) increased from $10.2 million in 1994 to $14.9 million in 1995. Of this increase,\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nResults of Operations (Continued)\n$1.8 million is due to the acquisition of four apartment complexes and three commercial properties in 1995, $1.7 million is due to the acquisition of seven apartment complexes and one commercial property in 1994, which did not contribute to net rental income for the full year in 1994, and $804,000 of the increase is attributable to two apartment complexes obtained through foreclosure in 1994. An additional increase of $640,000 is attributable to generally higher rents and occupancy at the Trust's apartment complexes. These increases are offset in part by a $244,000 decrease in net rental income at one of the Trust's commercial properties and one of the Trust's apartment complexes due to a decrease in occupancy and higher operating expenses incurred in an effort to increase occupancy. Net rental income is expected to continue to increase in 1996, primarily from a full year of operations from the four apartment complexes and three commercial properties acquired in 1995 and from the anticipated purchase of additional real estate in 1996.\nInterest income decreased from $2.7 million in 1994 to $723,000 in 1995. Of this decrease, $1.7 million is attributable to a $14.0 million wraparound mortgage note receivable which was paid in full in December 1994 and $99,000 is attributable to the discounted payoff of a $1.5 million first mortgage note receivable in May 1995. An additional $486,000 is due to the foreclosure of two properties during 1994 and one property during 1995 which secured three of the Trust's other mortgage notes receivable. These decreases are partially offset by an increase of $299,000 attributable to a $1.4 million first mortgage note receivable which was received in December 1994 in connection with the payoff of the $14.0 million mortgage note receivable discussed above. Interest income is expected to continue at the current level in 1996, as the Trust is generally not considering new mortgage lending except in connection with purchase money financing of sales of the Trust's properties.\nThe Trust's equity in partnerships improved from a loss of $479,000 in 1994 to income of $230,000 in 1995. This improvement is primarily due to higher rents and occupancy at the 31 industrial warehouse facilities owned by Indcon, L.P. (\"Indcon\"), a joint venture partnership. This improvement is partially offset by an increase in losses in Sacramento Nine (\"SAC 9\"), a joint venture partnership due to increased interest expense, as a result of new mortgage financing secured by a previously unencumbered office building. In February and March 1996, Indcon completed the sale of 25 of its 31 industrial warehouse facilities. See NOTE 6. \"INVESTMENT IN EQUITY METHOD PARTNERSHIPS.\"\nInterest expense increased from $7.7 million in 1994 to $10.0 million in 1995. Of this increase, $2.4 million is due to interest expense recognized on mortgages secured by properties acquired in 1994 and 1995. An additional $766,000 is due to interest expense on six borrowings in 1994 and 1995, secured by mortgages on previously unencumbered apartment complexes and refinancing of existing mortgages. These increases are\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nResults of Operations (Continued)\npartially offset by a decrease of $855,000 due to the payoff of the underlying lien related to the payoff of a $14.0 million wraparound mortgage note receivable in December 1994.\nDepreciation expense increased from $3.2 million in 1994 to $4.3 million in 1995. This increase is due to the acquisition of four apartment complexes and three commercial properties in 1995 and seven apartment complexes and one commercial property in 1994.\nA provision for losses of $541,000 was recorded in 1995 to provide for the loss on the discounted payoff of the mortgage note receivable secured by Alderwood Apartments. A provision for losses of $1.2 million was recorded in 1994 to write down the Genessee Towers, an office building, to the amount of the nonrecourse mortgage debt. In addition, a provision for losses of $200,000 was recorded in 1994 to provide for the loss on the sale of Oak Forest Apartments, one of the Trust's foreclosed properties held for sale. See NOTE 4. \"REAL ESTATE AND DEPRECIATION.\"\nAdvisory fee to affiliate was comparable at $1.3 million in 1995 and 1994.\nGeneral and administrative expenses were comparable at $1.2 million in 1995 and 1994. A decrease in legal fees was offset by expenses incurred in connection with the Trust's annual meeting.\nFor the year 1994, the Trust recognized a gain on the sale of real estate of $577,000 related to the sale of an industrial warehouse facility by Indcon. In addition, the Trust recognized a gain of $1.1 million on the settlement of a profit participation related to the December 1994 payoff of one of the Trust's wraparound mortgage note receivable. See NOTE 2. \"NOTES AND INTEREST RECEIVABLE.\"\n1994 compared to 1993. For the year 1994, the Trust had a net loss of $833,000, as compared to net income of $615,000 for the year 1993. The primary factors contributing to the decrease in the Trust's net income are discussed in the following paragraphs.\nNet rental income (rents income less expenses applicable to rents) increased from $8.2 million in 1993 to $10.2 million in 1994. Of this increase, $1.5 million is due to the acquisition of seven apartment complexes and one commercial property in 1994. An additional $284,000 of the increase is attributable to two apartment complexes obtained through foreclosure in 1994 and $1.1 million is due to the acquisition of three apartment complexes and one commercial property in 1993. An\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nResults of Operations (Continued)\nadditional increase of approximately $400,000 is attributable to generally higher rents and occupancy at the Trust's properties. These increases are offset in part by a $1.3 million decrease in net rental income at four of the Trust's commercial properties and three of the Trust's apartment complexes due to a decrease in occupancy and higher operating expenses incurred in an effort to increase occupancy.\nInterest income decreased from $3.3 million in 1993 to $2.7 million in 1994. Of this decrease, $356,000 is attributable to a loan on which the borrower filed for bankruptcy protection in November 1993 and began making cash flow only payments in April 1994. The Trust completed foreclosure of the property securing this loan in October 1994. Of the decrease, an additional $191,000 is attributable to three loans which were paid off subsequent to August 1993 and $38,000 is attributable to loans which were classified as nonperforming in 1994. Interest income is expected to decline further in 1995 due to a $14.0 million wraparound mortgage note receivable being paid in full in December 1994 and due to the foreclosure during 1994 of two properties securing two of the Trust's other mortgage notes receivable.\nThe Trust's equity in losses of partnerships decreased from $578,000 in 1993 to $479,000 in 1994. This decrease in equity losses is primarily due to higher rents and occupancy at the industrial warehouse facilities owned by Indcon, a joint venture partnership.\nInterest expense increased from $5.5 million in 1993 to $7.7 million in 1994. Of this increase, $1.5 million is due to interest expense recorded on mortgages secured by properties acquired in 1993 and 1994. An additional $597,000 is due to interest expense on a borrowing in September 1993 and four borrowings in 1994, all secured by mortgages on previously unencumbered apartment complexes.\nDepreciation expense increased from $2.4 million in 1993 to $3.2 million in 1994. This increase is due to the acquisition of seven apartment complexes and one commercial property in 1994 and four apartment complexes and one commercial property in 1993.\nA provision for losses of $1.2 million was recorded in 1994 to write down the Genessee Towers, an office building, to the amount of the nonrecourse mortgage debt. In addition, a provision for losses of $200,000 was recorded in 1994 to provide for the loss on the sale of Oak Forest Apartments, one of the Trust's foreclosed properties held for sale. (See NOTE 4. \"REAL ESTATE AND DEPRECIATION.\") A provision for loss of $221,000 was recorded in 1993 to provide for the loss on the sale of English Hills Apartments, also a foreclosed property held for sale.\nAdvisory fee to affiliate increased from $1.2 million in 1993 to $1.3 million in 1994. This increase is due to an increase in the Trust's gross assets, the basis for the advisory fee, as a result of the Trust's acquisition of eight properties in 1994 and five properties in 1993.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nResults of Operations (Continued)\nGeneral and administrative expenses decreased from $1.3 million in 1993 to $1.2 million in 1994. A decrease in legal fees and expenses incurred in connection with the Trust's annual meeting were offset in part by an increase in cost reimbursements to the Trust's advisor.\nFor the year 1994, the Trust recognized a gain on the sale of real estate of $577,000 related to the sale of an industrial warehouse facility by Indcon, a joint venture partnership. In addition, the Trust recognized a gain of $1.1 million on the settlement of a profit participation related to the 1994 payoff of one of the Trust's notes receivable. For the year 1993, the Trust recognized gains on sale of real estate of $365,000 related to the sale of three properties by SAC 9, a joint venture partnership.\nEnvironmental Matters\nUnder various federal, state and local environmental laws, ordinances and regulations, the Trust may be potentially liable for removal or remediation costs, as well as certain other potential costs relating to hazardous or toxic substances (including governmental fines and injuries to persons and property) where property-level managers have arranged for the removal, disposal or treatment of hazardous or toxic substances. In addition, certain environmental laws impose liability for release of asbestos-containing materials into the air, and third parties may seek recovery from the Trust for personal injury associated with such materials.\nThe Trust's management is not aware of any environmental liability relating to the above matters that would have a material adverse effect on the Trust's business, assets or results of operations.\nInflation\nThe effects of inflation on the Trust's operations are not quantifiable. Revenues from property operations fluctuate proportionately with increases and decreases in housing costs. Fluctuations in the rate of inflation also affect the sales values of properties and, correspondingly, the ultimate gains to be realized by the Trust from property sales. Inflation also has an effect on the Trust's earnings from short-term investments.\nTax Matters\nFor the years ended December 31, 1995, 1994 and 1993, the Trust elected and in the opinion of the Trust's management, qualified to be treated as a REIT as defined under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the \"Code\"). To continue to qualify for federal taxation as a REIT under the Code, the Trust is required to hold at least 75% of the value of its total assets in real estate assets, government securities, cash and cash equivalents at the close of each quarter of each\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nTax Matters (Continued)\ntaxable year. The Code also requires a REIT to distribute at least 95% of its REIT taxable income plus 95% of its net income from foreclosure property, as defined in Section 857 of the Code, on an annual basis to shareholders.\nRecent Accounting Pronouncements\nIn March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (\"SFAS\") No. 121 - \"Accounting for the Impairment of Long-lived Assets and for Long-lived Assets to Be Disposed Of\". The statement requires that long-lived assets be considered impaired \"...if the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of the asset.\" If impairment exists, an impairment loss shall be recognized, by a charge against earnings, equal to \"...the amount by which the carrying amount of the asset exceeds the fair value of the asset.\" If impairment of a long-lived asset is recognized, the carrying amount of the asset shall be reduced by the amount of the impairment, shall be accounted for as the asset's \"new cost\" and such new cost shall be depreciated over the asset's remaining useful life.\nSFAS No. 121 further requires that long-lived assets held for sale \"...be reported at the lower of carrying amount or fair value less cost to sell.\" If a reduction in a held for sale asset's carrying amount to fair value less cost to sell is required, a provision for loss shall be recognized by a charge against earnings. Subsequent revisions, either upward or downward, to a held for sale asset's fair value less cost to sell shall be recorded as an adjustment to the asset's carrying amount, but not in excess of the asset's carrying amount when originally classified or held for sale. A corresponding charge or credit to earnings is to be recognized. Long-lived assets held for sale are not to be depreciated. SFAS No. 121 is effective for fiscal years beginning after December 15, 1995.\nThe Trust's management estimates that if the Trust had adopted SFAS No. 121 effective January 1, 1995, the Trust's depreciation for 1995 would have been reduced by $229,000, its net loss would have been reduced by a like amount and a provision for loss for either impairment of its properties held for investment or for a decline in estimated fair value less cost to sell of its properties held for sale would not have been required. The Trust adopted SFAS No. 121 effective January 1, 1996.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS\nAll other schedules are omitted because they are not required, are not applicable or the information required is included in the Financial Statements or the notes thereto.\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nBoard of Trustees of Continental Mortgage and Equity Trust\nWe have audited the accompanying consolidated balance sheets of Continental Mortgage and Equity Trust and Subsidiaries as of December 31, 1995 and 1994 and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1995. We have also audited the schedules listed in the accompanying index. These financial statements and schedules are the responsibility of the Trust's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and schedules are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements and schedules. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements and schedules. We believe our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Continental Mortgage and Equity Trust and Subsidiaries as of December 31, 1995 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, 1995, in conformity with generally accepted accounting principles.\nAlso, in our opinion, the schedules referred to above present fairly, in all material respects, the information set forth therein.\nBDO Seidman, LLP\nDallas, Texas March 21, 1996\nCONTINENTAL MORTGAGE AND EQUITY TRUST CONSOLIDATED BALANCE SHEETS\nThe accompanying notes are an integral part of these Consolidated Financial Statements.\nCONTINENTAL MORTGAGE AND EQUITY TRUST CONSOLIDATED STATEMENTS OF OPERATIONS\nThe accompanying notes are an integral part of these Consolidated Financial Statements.\nCONTINENTAL MORTGAGE AND EQUITY TRUST CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY\nThe accompanying notes are an integral part of these Consolidated Financial Statements.\nCONTINENTAL MORTGAGE AND EQUITY TRUST CONSOLIDATED STATEMENTS OF CASH FLOWS\nThe accompanying notes are an integral part of these Consolidated Financial Statements.\nCONTINENTAL MORTGAGE AND EQUITY TRUST CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)\nThe accompanying notes are an integral part of these Consolidated Financial Statements.\nCONTINENTAL MORTGAGE AND EQUITY TRUST CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)\nThe accompanying notes are an integral part of these Consolidated Financial Statements.\nCONTINENTAL MORTGAGE AND EQUITY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nThe accompanying Consolidated Financial Statements of Continental Mortgage and Equity Trust and consolidated entities (the \"Trust\") have been prepared in conformity with generally accepted accounting principles, the most significant of which are described in NOTE 1. \"SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\". These, along with the remainder of the Notes to the Consolidated Financial Statements, are an integral part of the Consolidated Financial Statements. The data presented in the Notes to Consolidated Financial Statements are as of December 31 of each year and for the year then ended, unless otherwise indicated. Dollar amounts in tables are in thousands, except per share amounts.\nShares and per share data have been restated for the three for two forward share split effected February 15, 1996.\nNOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nOrganization and Trust business. Continental Mortgage and Equity Trust (\"CMET\") is a California business trust organized on August 27, 1980. The Trust may invest in real estate through direct ownership, leases and partnerships and it may also invest in mortgage loans on real estate, including first, wraparound and junior mortgage loans.\nBasis of consolidation. The Consolidated Financial Statements include the accounts of CMET and partnerships and subsidiaries which it controls. All intercompany transactions and balances have been eliminated.\nAccounting estimates. In the preparation of the Trust's Consolidated Financial Statements in conformity with generally accepted accounting principles it was necessary for the Trust's 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 Consolidated Financial Statements and the reported amounts of revenues and expenses for the year then ended. Actual results could differ from these estimates.\nInterest recognition on notes receivable. It is the Trust's policy to cease recognizing interest income on notes receivable that have been delinquent for 60 days or more. In addition, accrued but unpaid interest income is only recognized to the extent that the net realizable value of the underlying collateral exceeds the carrying value of the receivable.\nAllowance for estimated losses. Valuation allowances are provided for estimated losses on notes receivable and properties held for sale to the extent that the investment in the notes or properties exceeds the Trust's estimate of net realizable value of the property or collateral securing each such note, or fair value of the collateral if foreclosure is probable. In estimating net realizable value, consideration is given to the current estimated collateral or property value adjusted for costs\nCONTINENTAL MORTGAGE AND EQUITY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)\nto complete or improve, hold and dispose. The provision for losses is based on estimates, and actual losses may vary from current estimates. Such estimates are reviewed periodically and any additional provision determined to be necessary is charged against earnings in the period in which it becomes reasonably estimable.\nForeclosed real estate held for sale. Foreclosed real estate is initially recorded at new cost, defined as the lower of original cost or fair value minus estimated costs of sale. After foreclosure, the excess of new cost, if any, over fair value minus estimated costs of sale is recognized in a valuation allowance. Subsequent changes in fair value either increase or decrease such valuation allowance. See \"Allowance for estimated losses\" above. Properties held for sale are depreciated in accordance with the Trust's established depreciation policies. See \"Real estate and depreciation\" below.\nAnnually, all foreclosed properties held for sale are reviewed by the Trust's management and a determination is made if the held for sale classification remains appropriate. The following are among the factors considered in determining that a change in classification to held for investment is appropriate: (i) Trust management has no intent to dispose of the property within the next twelve months; (ii) the property is a \"qualifying asset\" as defined in the Internal Revenue Code of 1986, as amended; (iii) property improvements have been funded; and (iv) the Trust's financial resources are such that the property can be held long-term. The subsequent classification of property previously held for sale to held for investment does not result in a restatement of previously reported revenues, expenses or net income (loss).\nReal estate and depreciation. Real estate is carried at the lower of cost or estimated net realizable value, except for foreclosed properties held for sale, which are recorded initially at the lower of original cost or fair value minus estimated costs of sale. Depreciation is provided for by the straight-line method over the estimated useful lives of the assets, which range from 5 to 40 years.\nPresent value premiums\/discounts. The Trust provides for present value premiums and discounts on notes receivable or payable that have interest rates that differ substantially from prevailing market rates and amortizes such premiums and discounts by the interest method over the lives of the related notes. The factors considered in determining a market rate for notes receivable include the borrower's credit standing, nature of the collateral and payment terms of the note.\nRevenue recognition on the sale of real estate. Sales of real estate are recognized when and to the extent permitted by Statement of Financial Accounting Standards No. 66, \"Accounting for Sales of Real Estate\" (\"SFAS No. 66\"). Until the requirements of SFAS No. 66 for full\nCONTINENTAL MORTGAGE AND EQUITY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)\nprofit recognition have been met, transactions are accounted for using either the deposit, the installment, the cost recovery or the financing method, whichever is appropriate.\nInvestment in noncontrolled partnerships. The Trust uses the equity method to account for investments in partnerships which it does not control. Under the equity method, the Trust's initial investment, recorded at cost, is increased by the Trust's proportionate share of the partnership's operating income and additional advances and decreased by the Trust's share of the partnership's operating losses and distributions received.\nMarketable equity securities. Marketable equity securities are considered to be available-for-sale and are carried at fair value, defined as period end closing market value. Net unrealized holding gains and losses are reported as a separate component of shareholders' equity until realized.\nFair value of financial instruments. The Trust used the following assumptions in estimating the fair value of its notes receivable, marketable equity securities and notes payable. For performing notes receivable, the fair value was estimated by discounting future cash flows using current interest rates for similar loans. For nonperforming notes receivable, the estimated fair value of the Trust's interest in the collateral property was used. For marketable equity securities, fair value was based on the year end closing market price of each security. The estimated fair values presented do not purport to present amounts to be ultimately realized by the Trust. The amounts ultimately realized may vary significantly from the estimated fair values presented. For notes payable, the fair value was estimated using current rates for mortgages with similar terms and maturities.\nCash equivalents. For purposes of the Consolidated Statements of Cash Flows, the Trust considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.\nEarnings per share. Income (loss) per share of beneficial interest is computed based upon the weighted average number of shares of beneficial interest outstanding during each year, adjusted for the three for two forward share split effected February 15, 1996.\n[THIS SPACE INTENTIONALLY LEFT BLANK.]\nCONTINENTAL MORTGAGE AND EQUITY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 2. NOTES AND INTEREST RECEIVABLE\nNotes and interest receivable consisted of the following:\nThe Trust does not recognize interest income on nonperforming notes receivable. For the years 1995, 1994 and 1993, unrecognized interest income on nonperforming notes totaled $554,000, $1.3 million and $681,000, respectively.\nNotes receivable at December 31, 1995 mature from 1996 through 2018, with interest rates ranging from 6.5% to 12.5% and a weighted average rate of 8.3%. Discounts are based on an imputed interest rate of 12% and premiums are based on an imputed interest rate of 10%. Notes receivable are nonrecourse and are collateralized by real estate.\nAt December 31, 1994, the $1.5 million first mortgage note receivable secured by the Alderwood Apartments in Detroit, Michigan was in default. In May 1995, the Trust accepted $1.0 million in cash in full satisfaction of the debt. A provision for loss of $541,000 was recognized to provide for the loss on the discounted payoff of the mortgage note receivable.\nAlso at December 31, 1994, another first mortgage note with a principal balance at that date of $891,000 was in default. In March 1995, the Trust recorded the insubstance foreclosure of the collateral property securing the mortgage note receivable. Foreclosure of the property was completed on May 2, 1995. The foreclosure resulted in no loss to the Trust, as the property's estimated fair value at foreclosure, exceeded the carrying value of the note receivable.\nAt December 31, 1995, two of the Trust's mortgage notes receivable with principal balances totaling $2.1 million were in default. One of the notes, with a principal balance of $1.4 million matured in November 1995. The borrower is currently negotiating with the Trust for an extension of the note in return for a principal paydown and payment of all accrued interest. The Trust does not anticipate incurring a loss on this note as the estimated value of the property securing the note is in excess of the carrying value of the note. The other note, with a\nCONTINENTAL MORTGAGE AND EQUITY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 2. NOTES AND INTEREST RECEIVABLE (Continued)\nprincipal balance of $700,000, matured in July 1993. The Trust continues to receive partial interest payments monthly on the note. The Trust is evaluating its options with respect to foreclosure of the collateral property and does not anticipate incurring a loss on this note in excess of previously established reserves.\nIn May 1994, the Trust sold the Forest Ridge Shopping Center, a foreclosed property held for sale, financing the sale through acceptance of a $365,000 purchase money mortgage. See NOTE 4. \"REAL ESTATE AND DEPRECIATION.\"\nIn December 1994, the Trust received payment in full of the wraparound mortgage note secured by the Fountainview Retirement Center. The Trust received $5.0 million in cash, equal to the Trust's equity in the wraparound mortgage note. In addition, the note agreement required that the debtor make an additional profit participation payment. In settlement of the profit participation, the borrower assigned a $1.8 million first mortgage, secured by Cypress Creek Executive Court, an office building in Ft. Lauderdale, Florida, to the Trust for which the Trust paid $283,000 in cash. The Trust discounted the note to yield 12.0% per annum. The Trust recognized a $1.1 million gain on the settlement of the profit participation, which is included in \"Gain on sale of real estate\" on the Trust's Statement of Operations.\nIn September 1994, the Trust recorded the insubstance foreclosure of the Circletree Apartments and the Woodbridge Apartments, the collateral properties securing two of the Trust's mortgage notes receivable. See NOTE 4. \"REAL ESTATE AND DEPRECIATION.\"\nNOTE 3. ALLOWANCE FOR ESTIMATED LOSSES\nActivity in the allowance for estimated losses was as follows:\nIn addition to the above, the provision for losses in the accompanying Consolidated Statements of Operations consists of a $1.2 million write down of the carrying value of the Genesee Towers office building to the amount of the nonrecourse mortgage and a $200,000 loss on the sale of a foreclosed property held for sale in 1994, and a $221,000 loss on the sale of a foreclosed property held for sale in 1993. See NOTE 4. \"REAL ESTATE AND DEPRECIATION\" and NOTE 7. \"NOTES AND INTEREST PAYABLE.\"\nCONTINENTAL MORTGAGE AND EQUITY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 4. REAL ESTATE AND DEPRECIATION\nIn 1995, the Trust purchased four apartment complexes and three industrial warehouse facilities.\nIn February 1995, the Trust purchased the Sullyfield Commerce Center, a 243,813 square foot industrial facility in Chantilly, Virginia, for $11.0 million. The Trust paid $2.2 million in cash and the seller provided mortgage financing for the remainder of the purchase price.\nIn March 1995, the Trust purchased the Kelly Warehouses, six industrial warehouse facilities with a total of 330,334 square feet in Dallas, Texas, for $5.4 million. The Trust paid $696,000 in cash and obtained new mortgage financing for the remainder of the purchase price.\nIn May 1995, the Trust purchased the Willo-Wick Gardens Apartments, a 152 unit apartment complex in Pensacola, Florida, for $3.6 million. The Trust paid $687,000 in cash and assumed the existing first mortgage.\nIn July 1995, the Trust purchased the McCallum Glen Apartments, a 275 unit apartment complex in Dallas, Texas, for $6.0 million. The Trust paid $1.8 million in cash and obtained new mortgage financing for the remainder of the purchase price.\nIn November 1995, the Trust purchased the Willow Wick Apartments, a 104 unit apartment complex in North Augusta, South Carolina, for $1.5 million. The Trust paid $595,000 in cash and assumed the existing first mortgage.\nIn December 1995, the Trust purchased the Heritage on the River Apartments, a 301 unit apartment complex in Jacksonville, Florida, for $7.9 million. The Trust paid $1.4 million in cash and assumed the existing first mortgage.\nAlso in December 1995, the Trust purchased the Brookfield Corporate Center, a 63,504 square foot industrial facility in Chantilly, Virginia for $3.5 million. The Trust paid $650,000 in cash and the seller provided mortgage financing for the remainder of the purchase price.\nIn December 1995, the Trust's management made its annual review of the Trust's real estate portfolio and reclassified the Forest Ridge Apartments, Quail Oaks Apartments, Sunset Lake Apartments and Woodbridge Apartments from properties held for sale to properties held for investment. At December 31, 1995, Rivertree Apartments in Hurst, Texas, was under contract for sale and was reclassified from properties held for investment to properties held for sale.\nIn 1994, the Trust purchased the following seven apartment complexes: the Fountain Lake Apartments, a 166 unit apartment complex in Texas City, Texas; the McCallum Crossing Apartments, a 322 unit apartment complex in Dallas, Texas; the Willowcreek Apartments, a 112 unit apartment complex in El Paso, Texas; the Park Avenue Apartments, a 108\nCONTINENTAL MORTGAGE AND EQUITY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 4. REAL ESTATE AND DEPRECIATION (Continued)\nunit apartment complex in Clute, Texas; the Parkwood Knoll Apartments, a 178 unit apartment complex in San Bernardino, California; the Pierce Towers Apartments, a 57 unit apartment complex in Denver, Colorado; and the In The Pines Apartments, a 242 unit apartment complex in Gainesville, Florida; and one commercial property, the McLeod Commerce Center, a 111,115 square foot industrial facility in Orlando, Florida, for a total of $32.6 million. The Trust paid $7.7 million in cash and either obtained new mortgage financing or assumed existing mortgage debt for the remainder of the purchase prices.\nIn September 1994, the Trust recorded the insubstance foreclosure of two apartment complexes, the Sunset Lake Apartments, a 414 unit apartment complex in Waukegan, Illinois, and the Woodbridge Apartments, a 194 unit apartment complex in Westminster, Colorado. Both properties had estimated fair values, less estimated costs of sale, which either approximated or exceeded the carrying value of the Trust's mortgage notes receivable. The foreclosures resulted in no loss to the Trust.\nIn 1994, the Trust sold two shopping centers: Kimberly Square Shopping Center in Fort Lauderdale, Florida and the Forest Ridge Shopping Center in Denton, Texas; one apartment complex, the Oak Forest Apartments in Tampa, Florida; a 546 acre tract of undeveloped land in Morgan, Utah; and two single family residences, one in Arizona and the other in South Dakota, all of which were foreclosed properties held for sale. The Trust received $2.2 million in cash and provided purchase money financing of $365,000 in connection with the sales. The Trust incurred a loss of $200,000 in excess of previously established reserves on the sale of the apartment complex. No loss in excess of previously established reserves was recognized on any of the other sales.\nNOTE 5. INVESTMENT IN MARKETABLE EQUITY SECURITIES\nThe Trust's investments in marketable equity securities consist of the following:\nThe Trust's marketable equity securities are considered available-for-sale and are carried at fair value (period end market value). The Trustees of the Trust are also directors of TCI and the executive officers of the Trust are also executive officers of ART and TCI. The Trust's advisor serves as advisor to ART and TCI and prior to March 31, 1994 to NIRT.\nSection 5.3(g) of the Trust's Declaration of Trust limits to 18 months the period of time that the Trust can hold an investment in an equity security. The Trust's shareholders approved an amendment to the Trust's\nCONTINENTAL MORTGAGE AND EQUITY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 5. INVESTMENT IN MARKETABLE EQUITY SECURITIES (Continued)\nDeclaration of Trust allowing the Trust to hold these shares of ART, NIRT and TCI until July 30, 1996. At the Annual Meeting of Shareholders to be held in April 1996, the Trust's shareholders will be asked to repeal Section 5.3(g) of the Trust's Declaration of Trust which limits the holding period of equity investments by the Trust.\nThe Trust has margin arrangements with brokerage firms which provide for borrowings of up to 50% of the market value of equity securities. The borrowings under such margin arrangement are secured by equity securities of ART, NIRT and TCI and bear interest at 8.2% per annum. Margin borrowings were $411,000 at December 31, 1995 and 1994 and are included in other liabilities in the accompanying Consolidated Balance Sheets.\nNOTE 6. INVESTMENT IN EQUITY METHOD PARTNERSHIPS\nThe Trust's investments in equity method partnerships consist of the following:\nThe Trust, in partnership with NIRT, owns SAC 9, which in turn owns two office buildings in the vicinity of Sacramento, California. The Trust has a 30% interest in the partnership's earnings, losses and distributions.\nIn August 1995, SAC 9 obtained mortgage financing secured by a previously unencumbered office building in the amount of $3.5 million. SAC 9 received net cash of $3.4 million after the payment of various closing costs associated with the financing, of which the Trust's equity share was $1.0 million.\nIn 1993, SAC 9 sold three of its office buildings for a total of $4.5 million. SAC 9 received net cash of $2.5 million, of which the Trust's equity share was $748,000 and recognized gains totaling $1.2 million on the sales, of which the Trust's equity share was $365,000.\nThe Trust and NIRT are also partners in Income Special Associates (\"ISA\"), a joint venture partnership in which the Trust has a 60% interest in the partnership's earnings, losses and distributions. ISA in turn owns a 100% interest in Indcon, which owns 31 industrial warehouse facilities. The Indcon partnership agreement requires the consent of both the Trust and NIRT for any material changes in the operations of the partnership's properties, including sales, refinancings and changes in property management. The Trust, as a noncontrolling partner, accounts for its investment in Indcon using the equity method.\nCONTINENTAL MORTGAGE AND EQUITY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 6. INVESTMENT IN EQUITY METHOD PARTNERSHIPS (Continued)\nIn February and March 1996, Indcon completed the sale of 25 of its industrial warehouses for $36.2 million in cash. Indcon received net cash of $11.1 million, of which the Trust's equity share was $6.7 million, after the payoff of existing mortgage debt with a principal balance of $23.5 million. Indcon will recognize a gain of approximately $617,000 on the sale, of which the Trust's equity share will be approximately $370,000.\nSet forth below are summarized financial data for the partnerships the Trust accounts for using the equity method:\nNOTE 7. NOTES AND INTEREST PAYABLE\nNotes and interest payable consist of the following:\n[THIS SPACE INTENTIONALLY LEFT BLANK.]\nCONTINENTAL MORTGAGE AND EQUITY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 7. NOTES AND INTEREST PAYABLE (Continued)\nNotes payable at December 31, 1995 bear interest at rates ranging from 3.0% to 10.5% and mature between 1996 and 2024. These notes payable are nonrecourse and are collateralized by deeds of trust on real estate with a carrying value of $206.3 million.\nIn February 1995, after determining that further investment in Genesee Towers, an office building in Flint, Michigan, could not be justified without a substantial modification of the mortgage debt, the Trust ceased making debt service payments on the $8.8 million nonrecourse mortgage secured by the property. Accordingly, as of December 31, 1994, the Trust wrote down the carrying value of the property by $1.2 million, which is included in the 1994 provision for losses, to the amount of the nonrecourse mortgage. In February 1996, the Trust and the lender entered into a forbearance agreement that provides, among other things, that for a period of 90 days, the Trust make monthly payments of the greater of regular scheduled principal and interest or cash flow from the property. The deed to the property has been placed in escrow during the term of the forbearance agreement. The Trust anticipates that the property will be returned to the lender at the expiration of the agreement. The Trust does not anticipate incurring a loss as the carrying value of the property has been written down to the amount of the nonrecourse mortgage debt, which approximates fair value of the property at December 31, 1995.\nIn May and December 1995, the Trust refinanced the mortgage debt secured by the Sunset Lake Apartments in Waukegan, Illinois in the amount of $8.0 million. The Trust received net cash of $5.3 million after the payoff of $1.9 million in existing mortgage debt. The remainder of the refinancing proceeds were used to fund repair escrows and to pay various closing costs associated with the refinancings. The new mortgage bears interest at 7.625% per annum, requires monthly payments of principal and interest of $60,000 and matures in January 2006.\nAlso in 1995, the Trust obtained mortgage financing secured by the previously unencumbered Quail Oaks Apartments in Balch Springs, Texas in the amount of $750,000. The mortgage bears interest at a variable rate, 9.75% at December 31, 1995, requires monthly payments of principal and interest, currently $7,000 and matures in August 2000. The Trust received net cash of $734,000 after the payment of various closing costs associated with the financing.\nCONTINENTAL MORTGAGE AND EQUITY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 7. NOTES AND INTEREST PAYABLE (Continued)\nIn 1995, the Trust purchased four apartment complexes and three industrial warehouse facilities for a total of $38.9 million. In connection with the acquisitions, the Trust either assumed existing mortgage debt or obtained new mortgage financing totaling $31.0 million. The new mortgages bear interest at rates ranging from 6.0% to 9.915% per annum, require monthly payments of principal and interest, currently totaling $243,000, and mature from May 1997 to January 2013.\nIn 1994, the Trust obtained mortgage financing secured by the previously unencumbered Park Lane Apartments in Dallas, Texas, Southgate Apartments in Roundrock, Texas, 4242 Cedar Springs Apartments in Dallas, Texas and Willow Creek Apartments in El Paso, Texas in the total amount of $7.5 million. The Trust received net cash of $6.9 million. The remainder of the financing proceeds were used to fund escrows for replacements and repairs and to pay various closing costs associated with the financings. The mortgages bear interest at rates ranging from 8.66% to 10.25% per annum, require monthly payments of principal and interest and mature in February 2019, May 2004, June 2004 and January 2002, respectively.\nAlso in 1994, the Trust refinanced the mortgage debt secured by the Stone Oak Place Apartments in San Antonio, Texas, in the amount of $3.3 million. The Trust received net cash of $577,000 after the payoff of $2.5 million in existing mortgage debt that was scheduled to mature in April 1995. The remainder of the refinancing proceeds were used to fund escrows for replacements and repairs and to pay various closing costs associated with the refinancing. The new $3.3 million mortgage bears interest at 9.9% per annum, requires monthly principal and interest payments of $31,000 and matures in August 2004.\nIn 1994, the Trust purchased seven apartment complexes and one industrial warehouse facility for a total of $32.7 million. In connection with the acquisitions, the Trust either assumed existing mortgage debt or obtained new mortgage financing totaling $23.6 million. The mortgages bear interest at rates ranging from 5.9% to 9.6% per annum, require monthly payments of principal and interest totaling $176,000 and mature from December 1997 to July 2011.\nNOTE 8. DISTRIBUTIONS\nIn January 1993, the Trust's Board of Trustees approved the resumption of the payment of regular quarterly distributions to shareholders. In 1995 and 1994, the Trust paid distributions of $.40 per share of beneficial interest totaling $1.8 million in each year. In 1993, the Trust paid distributions of $.33 per share of beneficial interest totaling $1.5 million.\nThe Trust reported to the Internal Revenue Service that 100% of the distributions paid in 1995, 1994 and 1993 represented a return of capital.\nCONTINENTAL MORTGAGE AND EQUITY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 9. ADVISORY AGREEMENT\nBasic Capital Management, Inc. (\"BCM\" or the \"Advisor\") has served as advisor to the Trust since March 28, 1989. BCM is a company owned by a trust for the benefit of the children of Gene E. Phillips. Mr. Phillips served as a Trustee of the Trust until December 31, 1992, as director of BCM until December 22, 1989 and as Chief Executive Officer of BCM until September 1, 1992. Mr. Phillips serves as a representative of his children's trust which owns BCM and, in such capacity, has substantial contact with the management of BCM and input with respect to its performance of advisory services to the Trust.\nAt the Trust's annual meeting of shareholders held on March 7, 1995, the Trust's shareholders approved the renewal of the Trust's Advisory Agreement with BCM through the next annual meeting of the Trust's shareholders. Subsequent renewals of the Trust's Advisory Agreement with BCM require the approval of the Trust's shareholders.\nUnder the Advisory Agreement, the Advisor is required to formulate and submit annually for approval by the Trust's Board of Trustees a budget and business plan for the Trust containing a twelve-month forecast of operations and cash flow, a general plan for asset sales and acquisitions, lending, foreclosure and borrowing activity, and other investments. The Advisor is required to report quarterly to the Trust's Board of Trustees on the Trust's performance against the business plan. In addition, all transactions or investments by the Trust shall require prior approval by the Trust's Board of Trustees unless they are explicitly provided for in the approved business plan or are made pursuant to authority expressly delegated to the Advisor by the Trust's Board of Trustees. The Advisory Agreement also requires prior approval of the Trust's Board of Trustees for the retention of all consultants and third party professionals, other than legal counsel.\nThe Advisory Agreement provides for BCM to be responsible for the day-to-day operations of the Trust and to receive an advisory fee comprised of a gross asset fee of .0625% per month (.75% per annum) of the average of the gross asset value of the Trust (total assets less allowance for amortization, depreciation or depletion and valuation reserves) and an annual net income fee equal to 7.5% per annum of the Trust's net income.\nThe Advisory Agreement also provides for BCM to receive an annual incentive sales fee. BCM or an affiliate of BCM is to receive an acquisition commission for supervising the acquisition, purchase or long-term lease of real estate for the Trust. BCM or an affiliate of BCM is to receive a mortgage or loan acquisition fee with respect to the acquisition or purchase of any existing mortgage loan by the Trust. BCM or an affiliate of BCM is also to receive a mortgage brokerage and equity refinancing fee for obtaining loans to the Trust or refinancing on Trust properties and BCM is to receive reimbursement of certain expenses incurred by it, in the performance of advisory services to the Trust.\nCONTINENTAL MORTGAGE AND EQUITY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 9. ADVISORY AGREEMENT (Continued)\nThe Advisory Agreement requires BCM or any affiliate of BCM to pay to the Trust one-half of any compensation received from third parties with respect to the origination, placement or brokerage of any loan made by the Trust.\nUnder the Advisory Agreement (as required by the Trust's Declaration of Trust), all or a portion of the annual advisory fee must be refunded by the Advisor to the Trust if the Operating Expenses of the Trust (as defined in the Trust's Declaration of Trust) exceed certain limits specified in the Declaration of Trust. The effect of this limitation was to require that BCM refund $250,000 of the annual advisory fee for 1995. The operating expenses of the Trust did not exceed such limitation in 1994 and 1993.\nAdditionally, if the Trust were to request that BCM render services to the Trust other than those required by the Advisory Agreement, BCM or an affiliate of BCM will be separately compensated for such additional services on terms to be agreed upon from time to time. As discussed in NOTE 10. \"PROPERTY MANAGEMENT\", the Trust has hired Carmel Realty Services, Ltd. (\"Carmel\", Ltd.), an affiliate of BCM, to provide property management for the Trust's properties and, as discussed in NOTE 11. \"REAL ESTATE BROKERAGE\" the Trust has engaged Carmel Realty, Inc. (\"Carmel Realty\"), also an affiliate of BCM, on a non-exclusive basis, to provide brokerage services for the Trust.\nNOTE 10. PROPERTY MANAGEMENT\nCarmel, Ltd., an affiliate of BCM, provides property management services to the Trust for a fee of 5% or less of the monthly gross rents collected on the properties under its management. Carmel, Ltd. subcontracts with other entities for the property-level management services to the Trust at various rates. The general partner of Carmel, Ltd. is BCM. The limited partners of Carmel, Ltd. are (i) Syntek West, Inc. (\"SWI\"), of which Mr. Phillips is the sole shareholder, (ii) Mr. Phillips and (iii) a trust for the benefit of the children of Mr. Phillips. Carmel, Ltd. subcontracts the property- level management and leasing of twelve of the Trust's commercial properties and the industrial warehouse facilities owned by one of the real estate partnerships in which the Trust and NIRT are partners to Carmel Realty, which is owned by SWI. Carmel Realty is entitled to receive property and construction management fees and leasing commissions in accordance with the terms of its property-level management agreement with Carmel, Ltd.\nNOTE 11. REAL ESTATE BROKERAGE\nCarmel Realty, also an affiliate of BCM, provides brokerage services to the Trust on a non-exclusive basis. Carmel Realty is entitled to receive a commission for property acquisitions and sales, in accordance with a sliding scale of total fees to be paid by the Trust.\nCONTINENTAL MORTGAGE AND EQUITY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 12. ADVISORY FEES, PROPERTY MANAGEMENT FEES, ETC.\nFees and cost reimbursements to BCM, the Trust's advisor, and its affiliates:\n_________________________\n* Net of property management fees paid to subcontractors, other than Carmel Realty.\nNOTE 13. RENTS UNDER OPERATING LEASES\nThe Trust's operations include the leasing of commercial properties (office buildings, industrial facilities and shopping centers). The leases thereon expire at various dates through 2005. The following is a schedule of minimum future rents on non-cancelable operating leases as of December 31, 1995:\nNOTE 14. INCOME TAXES\nFor the years 1995, 1994 and 1993, the Trust has elected and qualified to be treated as a Real Estate Investment Trust (\"REIT\"), as defined in Sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the \"Code\"), and as such, will not be taxed for federal income tax purposes on that portion of its taxable income which is distributed to shareholders, provided that at least 95% of its REIT taxable income, plus 95% of its taxable income from foreclosure property as defined in Section 857 of the Code, is distributed. See NOTE 8. \"DISTRIBUTIONS.\"\nThe Trust had a loss for federal income tax purposes in 1995, 1994 and 1993; therefore, the Trust recorded no provision for income taxes.\nCONTINENTAL MORTGAGE AND EQUITY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 14. INCOME TAXES (Continued)\nThe Trust's tax basis in its net assets differs from the amount at which its net assets are reported for financial statement purposes, principally due to the accounting for gains and losses on property sales, the difference in the allowance for estimated losses, depreciation on owned properties and investments in joint venture partnerships. At December 31, 1995, the Trust's tax basis in its net assets exceeded its basis for financial statement purposes by $21.5 million. As a result, aggregate future income for income tax purposes will be less than such amount for financial statement purposes, and the Trust would be able to maintain its REIT status without distributing 95% of its financial statement income. Additionally, at December 31, 1995, the Trust had a tax net operating loss carryforward of $46 million expiring through 2010.\nAs a result of the Trust's election to be treated as a REIT for income tax purposes and of its intention to distribute its taxable income, if any, in future years, no deferred tax asset, liability or valuation allowance was recorded.\nNOTE 15. COMMITMENTS AND CONTINGENCIES\nOlive Litigation. In February 1990, the Trust, together with Income Opportunity Realty Investors, Inc., formerly Income Opportunity Realty Trust (collectively \"IORI\"), NIRT and TCI, three real estate entities with, at the time, the same officers, directors or trustees and advisor as the Trust, entered into a settlement of a class and derivative action entitled Olive et al. v. National Income Realty Trust et al. relating to the operation and management of each of the entities. On April 23, 1990, the court granted final approval of the terms of the settlement.\nOn May 4, 1994, the parties entered into a Modification of Stipulation of Settlement dated April 27, 1994 (the \"Modification\") which settled subsequent claims of breaches of the settlement which were asserted by the plaintiffs and modified certain provisions of the April 1990 settlement. The Modification was preliminarily approved by the court on July 1, 1994. Final court approval of the Modification was entered on December 12, 1994. The effective date of the Modification was January 11, 1995.\nThe Modification, among other things, provided for the addition of three new unaffiliated members to the Trust's Board of Trustees and sets forth new requirements for the approval of any transactions with affiliates until April 28, 1999. In addition, BCM, the Trust's advisor, Gene E. Phillips and William S. Friedman, the President and Trustee of the Trust until February 24, 1994, President of BCM until May 1, 1993 and director of BCM until December 22, 1989, agreed to pay a total of $1.2 million to the Trust, IORI, NIRT and TCI, of which the Trust's share is $750,000. As of March 1, 1996, the Trust had received payments totaling $594,000. The remaining $156,000 is to be paid in monthly installments through August 1, 1996.\nCONTINENTAL MORTGAGE AND EQUITY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 15. COMMITMENTS AND CONTINGENCIES (Continued)\nUnder the Modification, the Trust, IORI, NIRT, TCI and their shareholders released the defendants from any claims relating to the plaintiffs' allegations. The Trust, IORI, NIRT and TCI also agreed to waive any demand requirement for the plaintiffs to pursue claims on behalf of each of them against certain persons or entities. The Modification also requires that any shares of the Trust held by Messrs. Phillips, Friedman or their affiliates shall be (i) voted in favor of the reelection of all current members of the Trust's Board of Trustees that stand for reelection during the two calendar years following the effective date of the Modification and (ii) voted in favor of all new members of the Trust's Board of Trustees appointed pursuant to the terms of the Modification that stand for reelection during the three calendar years following the effective date of the Modification.\nPursuant to the terms of the Modification, certain related party transactions which the Trust may enter into prior to April 28, 1999, require the unanimous approval of the Trust's Board of Trustees. In addition, such related party transactions are to be discouraged and may only be entered into in exceptional circumstances and after a determination by the Trust's Board of Trustees that the transaction is in the best interests of the Trust and that no other opportunity exists that is as good as the opportunity presented by such transaction.\nFor purposes of the Modification requirements, the term \"related party transaction\" means and includes (i) any transaction between or among the Trust or IORI, NIRT or TCI or any of their affiliates or subsidiaries; (ii) any transaction between or among the Trust, its affiliates or subsidiaries and the Advisor, Mr. Phillips, Mr. Friedman or any of their affiliates; and (iii) any transaction between or among the Trust or any of its affiliates or subsidiaries and a third party with whom the Advisor, Mr. Phillips, Mr. Friedman or any of their affiliates has an ongoing or contemplated business or financial transaction or relationship of any kind, whether direct or indirect, or has had such a transaction or relationship in the preceding one year.\nThe Modification requirements for related party transactions do not apply to direct contractual agreements for services between the Trust and the Advisor or one of its affiliates, (including the Advisory Agreement, the Brokerage Agreement and the property management contracts). These agreements, pursuant to the specific terms of the Modification, require the prior approval by two-thirds of the Trustees of the Trust, and if required, approval by a majority of the Trust's shareholders. The Modification requirements for related party transactions also do not apply to joint ventures between or among the Trust and IORI, NIRT or TCI or any of their affiliates or subsidiaries and a third party having no prior or intended future business or financial relationship with Mr. Phillips, Mr. Friedman, the Advisor, or any affiliate of such parties. Such joint ventures may be entered into on the affirmative vote of a majority of the Trustees of the Trust.\nCONTINENTAL MORTGAGE AND EQUITY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 15. COMMITMENTS AND CONTINGENCIES (Continued)\nThe Modification also terminated a number of the provisions of the settlement, including the requirement that the Trust, IORI, NIRT and TCI maintain a Related Party Transaction Committee and a Litigation Committee of their respective Boards. The court retained jurisdiction to enforce the Modification.\nOther litigation. The Trust is also involved in various lawsuits arising in the ordinary course of business. The Trust's management is of the opinion that the outcome of these lawsuits would have no material impact on the Trust's financial condition, results of operations or liquidity.\nNOTE 16. QUARTERLY DATA\nThe following is a tabulation of the Trust's quarterly results of operations for the years 1995 and 1994.\nThe Trust purchased seven properties in 1995; two industrial facilities in the first quarter, an apartment complex in each of the second and third quarters, and two apartment complexes and an industrial facility in the fourth quarter.\nThe Trust purchased eight properties in 1994, two apartment complexes in each of the first and second quarters, two apartment complexes and one industrial facility in the third quarter and one apartment complex in the fourth quarter.\nCONTINENTAL MORTGAGE AND EQUITY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 16. QUARTERLY DATA (Continued)\nIn the second quarter, the Trust recognized a $577,000 gain on the sale of an industrial warehouse facility by Indcon and in the fourth quarter, the Trust recognized a $1.1 million gain on the settlement of a profit participation related to the payoff of one of the Trust's mortgage note receivables.\nNOTE 17. SUBSEQUENT EVENTS\nIn February 1996, the Trust funded a $1.5 million second lien mortgage secured by the Signature Athletic Club Building in Dallas, Texas. The note bears interest at 12% per annum and requires monthly interest only payments to the extent of available cash flow. Any accrued but unpaid interest is added to the principal balance of the note annually. In addition, the note requires quarterly principal payments equal to the excess property cash flow for the quarter. The note matures in October 1998 with an option to extend the note to December 2000. The Trust has also guaranteed the underlying $3.0 million first mortgage secured by the property. The Trust has an option to purchase a 50% interest in the partnership which owns the Signature Athletic Club building for $100 at any time. The option expires in December 2005.\nAt December 31, 1995, Rivertree Apartments in Hurst, Texas, was under contract for sale and was reclassified from properties held for investment to properties held for sale. In February 1996, the Trust completed the sale of the Rivertree Apartments for $1.8 million. In conjunction with the sale, the Trust provided $750,000 of purchase money financing in the form of a wraparound mortgage note. The Trust received cash of $959,000 after payment of various closing costs associated with the sale. The Trust will recognize a gain of approximately $378,000 on the sale.\nIn March 1996, the Trust purchased the Hampton Court Office Building, a 104,001 square foot office building in Dallas, Texas for $7.7 million. The Trust paid $1.1 million in cash and obtained new mortgage financing for the remainder of the purchase price. In conjunction with the financing the Trust established various escrow accounts in the amount of $1.5 million.\nCONTINENTAL MORTGAGE AND EQUITY TRUST SCHEDULE III REAL ESTATE AND ACCUMULATED DEPRECIATION December 31, 1995\nCONTINENTAL MORTGAGE AND EQUITY TRUST SCHEDULE III (Continued) REAL ESTATE AND ACCUMULATED DEPRECIATION December 31, 1995\nCONTINENTAL MORTGAGE AND EQUITY TRUST SCHEDULE III REAL ESTATE AND ACCUMULATED DEPRECIATION (Continued) December 31, 1995\n_____________________________\n(1) The aggregate cost for federal income tax purposes is $208,408.\n(2) An allowance for estimated losses has been provided to reduce the carrying value of this property to the Trust's estimate of fair value minus estimated costs of sale.\nSCHEDULE III (Continued)\nCONTINENTAL MORTGAGE AND EQUITY TRUST REAL ESTATE AND ACCUMULATED DEPRECIATION\nCONTINENTAL MORTGAGE AND EQUITY TRUST SCHEDULE IV MORTGAGE LOANS ON REAL ESTATE December 31, 1995\n- ------------------------\n(1) The aggregate cost for federal income tax purposes is $6,606. (2) An allowance for estimated losses has been provided to reduce the carrying value of this mortgage to the Trust's estimate of net realizable value of the collateral securing such note.\nSCHEDULE IV (Continued)\nCONTINENTAL MORTGAGE AND EQUITY TRUST MORTGAGE LOANS ON REAL ESTATE\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable.\n___________________________________\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. TRUSTEES, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT\nTrustees\nThe affairs of Continental Mortgage and Equity Trust (the \"Trust\" or the \"Registrant\") are managed by a Board of Trustees. The Trustees are elected at the annual meeting of shareholders or appointed by the incumbent Board of Trustees and serve until the next annual meeting of shareholders or until a successor has been elected or approved.\nThe Trustees of the Trust are listed below, together with their ages, terms of service, all positions and offices with the Trust or its advisor, Basic Capital Management, Inc. (\"BCM\" or the \"Advisor\") their principal occupations, business experience and directorships with other companies during the last five years or more. The designation \"Affiliated\", when used below with respect to a Trustee, means that the Trustee is an officer, director or employee of the Advisor or an officer or employee of the Trust. The designation \"Independent\", when used below with respect to a Trustee, means that the Trustee is neither an officer or employee of the Trust nor a director, officer or employee of the Advisor, although the Trust may have certain business or professional relationships with such Trustee as discussed in ITEM 13. \"CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - Certain Business Relationships\".\nJOHN P. PARSONS: Age 67, Trustee (Independent) (since January 1995).\nChairman and Chief Executive Officer (since 1984) of Pierpont Corporation; Director of Zentrum Holdings Limited (NZ) (since 1984), the Pickford Foundation (since 1980), International Divertissments, Ltd. (since 1986), and Lifehouse International, Ltd.(since 1990); and Director (since January 1995) of Income Opportunity Realty Investors, Inc., formerly Income Opportunity Realty Trust (collectively \"IORI\") and Transcontinental Realty Investors, Inc. (\"TCI\").\nBENNETT B. SIMS: Age 63, Trustee (Independent) (since April 1990).\nProducer (since January 1994) for Blue Train Pictures; Author (since 1964); Screen and Television Writer (since 1960); Independent Marketing Consultant (since 1980) for various companies; Professor of Dramatic Writing (since September 1987) at Tisch School of the Arts, New York University; Trustee (April 1990 to August 1994) of National Income Realty Trust (\"NIRT\"); Trustee (December 1992 to August 1994) of Vinland Property Trust (\"VPT\"); and Director (since April 1990) of IORI and TCI.\nITEM 10. TRUSTEES, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nTrustees (Continued)\nTED P. STOKELY: Age 62, Trustee (Independent) (since April 1990) and Chairman of the Board (since January 1995).\nGeneral Manager (since January 1995) of ECF Senior Housing Corporation, a nonprofit corporation; General Manager (since January 1993) of Housing Assistance Foundation, Inc., a nonprofit corporation; Part-time unpaid Consultant (since January 1993) and paid Consultant (April 1992 to December 1992) of Eldercare Housing Foundation (\"Eldercare\"), a nonprofit corporation engaged in the acquisition of low income and elderly housing; President (April 1992 to April 1994) of PSA Group (real estate management and consulting); Executive Vice President (1987 to 1991) of Key Companies Inc., a publicly traded company that develops, acquires and sells water and minerals; Trustee (April 1990 to August 1994) of NIRT; and Director (since April 1990) and Chairman of the Board (since January 1995) of IORI and TCI.\nMARTIN L. WHITE: Age 56, Trustee (Independent) (since January 1995).\nChairman and Chief Executive Officer (since 1993) of North American Trading Company Ltd.; President and Chief Operating Officer (since 1992) of Community Based Developers, Inc.; Development Officer and Loan Manager (1986 to 1992) of the City of San Jose, California; Vice President and Director of Programs (1967 to 1986) of Arpact, Inc., a government contractor for small business development and trade; and Director (since January 1995) of IORI and TCI.\nEDWARD G. ZAMPA: Age 61, Trustee (Independent) (since January 1995).\nGeneral Partner (since 1976) of Edward G. Zampa and Company; and Director (since January 1995) of IORI and TCI.\nBoard Committees\nThe Trust's Board of Trustees held 13 meetings during 1995. For such year, no incumbent Trustee attended fewer than 75% of the aggregate of (i) the total number of meetings held by the Board of Trustees during the period for which he had been a Trustee and (ii) the total number of meetings held by all committees of the Board of Trustees on which he served during the period that he served.\nThe Trust's Board of Trustees has an Audit Committee, the function of which is to review the Trust's operating and accounting procedures. The current members of the Audit Committee, all of whom are Independent Trustees, are Messrs. Parsons (Chairman), Stokely and White. The Audit Committee met twice during 1995.\nIn June 1995, the Trust's Board of Trustees authorized the creation of a Relationship with Advisor Committee, a Board Development Committee and\nITEM 10. TRUSTEES, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nBoard Committees (Continued)\na Corporate Vision Committee. The current members of the Relationship with Advisor Committee are Messrs. Parsons and Zampa. The Relationship with Advisor Committee reviews and reports to the Trust's Board of Trustees on the services provided to the Trust by the Advisor and its affiliates and the terms of any engagement or compensation of the Advisor or its affiliates. The Relationship with Advisor Committee met once in 1995. The Board Development Committee reviews and reports to the Trust's Board of Trustees on the membership, compensation and functions of the Board of Trustees. The current members of the Board Development Committee are Messrs. Sims and White. The Board Development Committee held no meetings in 1995. The Corporate Vision Committee is to review and report to the Trust's Board of Trustees on the Trust's short-term and long-term strategic objectives. As of March 15, 1996, the members had not been appointed to the Corporate Vision Committee.\nThe Trust's Board of Trustees does not have Nominating or Compensation Committees.\nExecutive Officers\nThe following persons currently serve as executive officers of the Trust: Randall M. Paulson, President; Bruce A. Endendyk, Executive Vice President; and Thomas A. Holland, Executive Vice President and Chief Financial Officer. Their positions with the Trust are not subject to a vote of shareholders. Their ages, terms of service, all positions and offices with the Trust or BCM, other principal occupations, business experience and directorships with other companies during the last five years or more are set forth below.\nRANDALL M. PAULSON: Age 49, President (since August 1995) and Executive Vice President (January 1995 to August 1995).\nPresident (since August 1995) of BCM, IORI and TCI and Executive Vice President (October 1994 to August 1995) of BCM and (January 1995 to August 1995) of IORI, TCI and Syntek Asset Management, Inc. (\"SAMI\"), the managing general partner of Syntek Asset Management, L.P. (\"SAMLP\"), which is the general partner of National Realty, L.P. (\"NRLP\") and National Operating, L.P. (\"NOLP\"); Director (since August 1995) of SAMI; Executive Vice President (since January 1995) of American Realty Trust, Inc. (\"ART\"); Vice President (1993 to 1994) of GSSW, LP, a joint venture of Great Southern Life and Southwestern Life; Vice President (1990 to 1993) of Property Company of America Realty, Inc.; President (1990) of Paulson Realty Group; President (1983 to 1989) of Johnstown Management Company; and Vice President (1979 to 1982) of Lexton-Ancira.\n[THIS SPACE INTENTIONALLY LEFT BLANK.]\nITEM 10. TRUSTEES, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nExecutive Officers (Continued)\nBRUCE A. ENDENDYK: Age 47, Executive Vice President (since January 1995).\nPresident (since January 1995) of Carmel Realty, Inc. (\"Carmel Realty\"), a company owned by Syntek West, Inc. (\"SWI\"); Executive Vice President (since January 1995) of BCM, SAMI, ART, IORI and TCI; Management Consultant (November 1990 to December 1994); Executive Vice President (January 1989 to November 1990) of Southmark Corporation (\"Southmark\"); President and Chief Executive Officer (March 1988 to January 1989) of Southmark Equities Corporation; and Vice President\/Resident Manager (December 1975 to March 1988) of Coldwell Banker Commercial\/Real Estate Services in Houston, Texas.\nTHOMAS A. HOLLAND: Age 53, Executive Vice President and Chief Financial Officer (since August 1995) and Senior Vice President and Chief Accounting Officer (July 1990 to August 1995).\nExecutive Vice President and Chief Financial Officer (since August 1995) and Senior Vice President and Chief Accounting Officer (July 1990 to August 1995) of BCM, SAMI, ART, IORI and TCI; Senior Vice President and Chief Accounting Officer (July 1990 to February 1994) of NIRT and VPT; Vice President and Controller (December 1986 to June 1990) of Southmark; Vice President- Finance (January 1986 to December 1986) of Diamond Shamrock Chemical Company; Assistant Controller (May 1976 to January 1986) of Maxus Energy Corporation (formerly Diamond Shamrock Corporation); Trustee (August 1989 to June 1990) of Arlington Realty Investors; and Certified Public Accountant (since 1970).\nOfficers\nAlthough not executive officers of the Trust, the following persons currently serve as officers of the Trust: Robert A. Waldman, Senior Vice President, General Counsel and Secretary; and Drew D. Potera, Treasurer. Their positions with the Trust are not subject to a vote of shareholders. Their ages, terms of service, all positions and offices with the Trust or\n[THIS SPACE INTENTIONALLY LEFT BLANK.]\nITEM 10. TRUSTEES, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nOfficers (Continued)\nBCM, other principal occupations, business experience and directorships with other companies during the last five years or more are set forth below.\nROBERT A. WALDMAN: Age 43, Senior Vice President and General Counsel (since January 1995), Vice President (December 1990 to January 1995) and Secretary (since December 1993).\nSenior Vice President and General Counsel (since January 1995); Vice President (December 1990 to January 1995) and Secretary (since December 1993) of IORI and TCI; Senior Vice President and General Counsel (since January 1995), Vice President (January 1993 to January 1995) and Secretary (since December 1989) of ART; Senior Vice President and General Counsel (since November 1994), Vice President and Corporate Counsel (November 1989 to November 1994) and Secretary (since November 1989) of BCM; Senior Vice President and General Counsel (since January 1995), Vice President (April 1990 to January 1995) and Secretary (since December 1990) of SAMI; Vice President (December 1990 to February 1994) and Secretary (December 1993 to February 1994) of NIRT and VPT; Director (February 1987 to October 1989) and General Counsel and Secretary (1985 to October 1989) of Red Eagle Resources Corporation (oil and gas); Assistant General Counsel, Senior Staff Attorney and Staff Attorney (1981 to 1985) of Texas International Company (oil and gas); and Staff Attorney (1979 to 1981) of Iowa Beef Processors, Inc.\nDREW D. POTERA: Age 36, Treasurer (since December 1990).\nTreasurer (since December 1990) of IORI and TCI; Treasurer (since August 1991) and Assistant Treasurer (December 1990 to August 1991) of ART; Vice President, Treasurer and Securities Manager (since July 1990) of BCM; Vice President and Treasurer (since February 1992) of SAMI; Treasurer (December 1990 to February 1994) of NIRT and VPT; and Financial Consultant with Merrill Lynch, Pierce, Fenner & Smith Incorporated (June 1985 to June 1990).\nIn addition to the foregoing officers, the Trust has several vice presidents and assistant secretaries who are not listed herein.\nCompliance with Section 16(a) of the Securities Exchange Act of 1934\nUnder the securities laws of the United States, the Trust's Trustees, executive officers, and any persons holding more than ten percent of the Trust's shares of beneficial interest are required to report their ownership of the Trust's shares and any changes in that ownership to the Securities and Exchange Commission (the \"Commission\"). Specific due dates for these reports have been established and the Trust is required to report any failure to file by these dates during 1995. All of these\nITEM 10. TRUSTEES, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nCompliance with Section 16(a) of the Securities Exchange Act of 1934 (Continued)\nfiling requirements were satisfied by its Trustees and executive officers and ten percent holders. In making these statements, the Trust has relied on the written representations of its incumbent Trustees and executive officers and its ten percent holders and copies of the reports that they have filed with the Commission.\nThe Advisor\nAlthough the Trust's Board of Trustees is directly responsible for managing the affairs of the Trust and for setting the policies which guide it, the day-to-day operations of the Trust are performed by a contractual advisor under the supervision of the Trust's Board of Trustees. The duties of the advisor include, among other things, locating, investigating, evaluating and recommending real estate and mortgage note investment and sales opportunities for the Trust. The advisor also serves as a consultant to the Trusts' Board of Trustees in connection with the business plan and investment policy decisions.\nBCM has served as the Trust's advisor since March 1989. BCM is a corporation of which Messrs. Paulson, Endendyk and Holland serve as executive officers. BCM is owned by a trust for the benefit of the children of Mr. Phillips. Prior to December 22, 1989, Mr. Phillips also served as a director of BCM, and until September 1, 1992, as Chief Executive Officer of BCM. Mr. Phillips serves as a representative of his children's trust which owns BCM and, in such capacity, has substantial contact with the management of BCM and input with respect to its performance of advisory services to the Trust.\nAt the Trust's annual meeting of shareholders held on March 7, 1995, the Trust's shareholders approved the renewal of the Trust's Advisory Agreement with BCM through the next annual meeting of the Trust's shareholders. Subsequent renewals of the Trust's Advisory Agreement with BCM require the approval of the Trust's shareholders.\nUnder the Advisory Agreement, the Advisor is required to formulate and submit annually for approval by the Trust's Board of Trustees a budget and business plan for the Trust containing a twelve-month forecast of operations and cash flow, a general plan for asset sales and acquisitions, lending, foreclosure and borrowing activity, and other investments, and the Advisor is required to report quarterly to the Trust's Board of Trustees on the Trust's performance against the business plan. In addition, all transactions or investments by the Trust shall require prior approval by the Trust's Board of Trustees unless they are explicitly provided for in the approved business plan or are made pursuant to authority expressly delegated to the Advisor by the Trust's Board of Trustees.\nThe Advisory Agreement also requires prior approval of the Trust's Board of Trustees for the retention of all consultants and third party professionals, other than legal counsel. The Advisory Agreement provides\nITEM 10. TRUSTEES, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nThe Advisor (Continued)\nthat the Advisor shall be deemed to be in a fiduciary relationship to the Trust's shareholders; contains a broad standard governing the Advisor's liability for losses by the Trust; and contains guidelines for the Advisor's allocation of investment opportunities as among itself, the Trust and other entities it advises.\nThe Advisory Agreement provides for BCM to be responsible for the day-to-day operations of the Trust and to receive an advisory fee comprised of a gross asset fee of .0625% per month (.75% per annum) of the average of the gross asset value of the Trust (total assets less allowance for amortization, depreciation or depletion and valuation reserves) and an annual net income fee equal to 7.5% per annum of the Trust's net income.\nThe Advisory Agreement also provides for BCM to receive an annual incentive sales fee equal to 10% of the amount, if any, by which the aggregate sales consideration for all real estate sold by the Trust during such fiscal year exceeds the sum of: (i) the cost of each such property as originally recorded in the Trust's books for tax purposes (without deduction for depreciation, amortization or reserve for losses), (ii) capital improvements made to such assets during the period owned by the Trust, and (iii) all closing costs, (including real estate commissions) incurred in the sale of such property; provided, however, no incentive fee shall be paid unless (a) such real estate sold in such fiscal year, in the aggregate, has produced an 8% simple annual return on the Trust's net investment including capital improvements, calculated over the Trust's holding period before depreciation and inclusive of operating income and sales consideration and (b) the aggregate net operating income from all real estate owned by the Trust for each of the prior and current fiscal years shall be at least 5% higher in the current fiscal year than in the prior fiscal year.\nAdditionally, pursuant to the Advisory Agreement, BCM or an affiliate of BCM is to receive an acquisition commission for supervising the acquisition, purchase or long-term lease of real estate for the Trust equal to the lesser of (i) up to 1% of the cost of acquisition, inclusive of commissions, if any, paid to nonaffiliated brokers or (ii) the compensation customarily charged in arm's-length transactions by others rendering similar property acquisition services as an ongoing public activity in the same geographical location and for comparable property; provided that the aggregate purchase price of each property (including acquisition fees and all real estate brokerage commissions) may not exceed such property's appraised value at acquisition.\nThe Advisory Agreement requires BCM or any affiliate of BCM to pay to the Trust one-half of any compensation received from third parties with respect to the origination, placement or brokerage of any loan made by the Trust; provided, however, that the compensation retained by BCM or any affiliate of BCM shall not exceed the lesser of (i) 2% of the amount of the loan committed by the Trust or (ii) a loan brokerage and commitment fee which is reasonable and fair under the circumstances.\nITEM 10. TRUSTEES, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nThe Advisor (Continued)\nThe Advisory Agreement also provides that BCM or an affiliate of BCM is to receive a mortgage or loan acquisition fee with respect to the acquisition or purchase of any existing mortgage loan by the Trust equal to the lesser of (i) 1% of the amount of the loan purchased or (ii) a loan brokerage or commitment fee which is reasonable and fair under the circumstances. Such fee will not be paid in connection with the origination or funding by the Trust of any mortgage loan.\nUnder the Advisory Agreement, BCM or an affiliate of BCM is also to receive a mortgage brokerage and equity refinancing fee for obtaining loans to the Trust or refinancing on Trust properties equal to the lesser of (i) 1% of the amount of the loan or the amount refinanced or (ii) a brokerage or refinancing fee which is reasonable and fair under the circumstances; provided, however, that no such fee shall be paid on loans from BCM or an affiliate of BCM without the approval of the Trust's Board of Trustees. No fee shall be paid on loan extensions.\nUnder the Advisory Agreement, BCM is to receive reimbursement of certain expenses incurred by it, in the performance of advisory services to the Trust.\nUnder the Advisory Agreement (as required by the Trust's Declaration of Trust), all or a portion of the annual advisory fee must be refunded by the Advisor to the Trust if the Operating Expenses of the Trust (as defined in the Trust's Declaration of Trust) exceed certain limits specified in the Declaration of Trust based on the book value, net asset value and net income of the Trust during such fiscal year. The effect of this limitation was to require that BCM refund $250,000 of the 1995 annual advisory fee. The operating expenses of the Trust did not exceed such limitation in 1994 or 1993.\nAdditionally, if the Trust were to request that BCM render services to the Trust other than those required by the Advisory Agreement, BCM or an affiliate of BCM will be separately compensated for such additional services on terms to be agreed upon from time to time. As discussed below, under \"Property Management\", the Trust has hired Carmel Realty Services, Ltd. (\"Carmel, Ltd.\"), an affiliate of BCM, to provide property management for the Trust's properties. Also as discussed below, under \"Real Estate Brokerage\" the Trust has engaged Carmel Realty, also an affiliate of BCM, on a non-exclusive basis, to perform brokerage services for the Trust.\nBCM may only assign the Advisory Agreement with the prior consent of the Trust.\nThe directors and principal officers of BCM are set forth below.\nMICKEY N. PHILLIPS: Director\nRYAN T. PHILLIPS: Director\nITEM 10. TRUSTEES, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nThe Advisor (Continued)\nRANDALL M. PAULSON: President\nMARK W. BRANIGAN: Executive Vice President\nOSCAR W. CASHWELL: Executive Vice President\nBRUCE A. ENDENDYK: Executive Vice President\nTHOMAS A. HOLLAND: Executive Vice President and Chief Financial Officer\nCOOPER B. STUART: Executive Vice President\nCLIFFORD C. TOWNS, JR Executive Vice President, Finance\nROBERT A. WALDMAN: Senior Vice President, Secretary and General Counsel\nDREW D. POTERA: Vice President, Treasurer and Securities Manager\nMickey N. Phillips is Gene E. Phillips brother and Ryan T. Phillips is Gene E. Phillips' son. Gene E. Phillips serves as a representative of the trust established for the benefit of his children which owns BCM and, in such capacity, Mr. Phillips has substantial contact with the management of BCM and input with respect to its performance of advisory services to the Trust.\nProperty Management\nSince February 1, 1990, affiliates of BCM have provided property management services to the Trust. Currently Carmel, Ltd. provides such property management services for a fee of 5% or less of the monthly gross rents collected on the properties under its management. Carmel, Ltd. subcontracts with other entities for the provision of the property-level management services to the Trust at various rates. The general partner of Carmel, Ltd. is BCM. The limited partners of Carmel, Ltd. are (i) SWI, of which Mr. Phillips is the sole shareholder, (ii) Mr. Phillips and, (iii) a trust for the benefit of the children of Mr. Phillips. Carmel, Ltd. subcontracts the property-level management and leasing of twelve of the Trust's commercial properties and the industrial warehouse facilities owned by one of the real estate partnerships in which the Trust and NIRT are partners to Carmel Realty which is a company owned by SWI. Carmel Realty is entitled to receive property and construction management fees and leasing commissions in accordance with the terms of its property-level management agreement with Carmel, Ltd.\nITEM 10. TRUSTEES, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nReal Estate Brokerage\nSince December 1, 1992, Carmel Realty has been engaged, on a non-exclusive basis to provide brokerage services for the Trust. Carmel Realty is entitled to receive a commission for property acquisitions and sales by the Trust in accordance with the following sliding scale of total fees to be paid by the Trust: (i) maximum fee of 5% on the first $2.0 million of any purchase or sale transaction of which no more than 4% would be paid to Carmel Realty or affiliates; (ii) maximum fee of 4% on transaction amounts between $2.0 million - - $5.0 million of which no more than 3% would be paid to Carmel Realty or affiliates; (iii) maximum fee of 3% on transaction amounts between $5.0 million - - $10.0 million of which no more than 2% would be paid to Carmel Realty or affiliates; and (iv) maximum fee of 2% on transaction amounts in excess of $10.0 million of which no more than 1 1\/2% would be paid to Carmel Realty or affiliates.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe Trust has no employees, payroll or benefit plans and pays no compensation to the executive officers of the Trust. The executive officers of the Trust who are also officers or employees of BCM, the Trust's Advisor, are compensated by the Advisor. Such executive officers of the Trust perform a variety of services for the Advisor and the amount of their compensation is determined solely by the Advisor. BCM does not allocate the cash compensation of its officers among the various entities for which it serves as advisor. See Item 10. \"TRUSTEES, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT - The Advisor\" for a more detailed discussion of the compensation payable to BCM by the Trust.\nThe only remuneration paid by the Trust is to the Trustees who are not officers or directors of BCM or its affiliated companies. The Independent Trustees (i) review the business plan of the Trust to determine that it is in the best interest of the Trust's shareholders, (ii) review the Trust's contract with the advisor, (iii) supervise the performance of the Trust's advisor and review the reasonableness of the compensation which the Trust pays to its advisor in terms of the nature and quality of services performed, (iv) review the reasonableness of the total fees and expenses of the Trust and (v) select, when necessary, a qualified independent real estate appraiser to appraise properties acquired by the Trust. Until January 1, 1995, the Independent Trustees received compensation in the amount of $6,000 per year, plus reimbursement for expenses. In addition, each Independent Trustee received (i) $3,000 per year for each committee of the Board of Trustees on which he served, (ii) $2,500 per year for each committee chairmanship, and (iii) $1,000 per day for any special services rendered by him to the Trust outside of his ordinary duties as Trustee, plus reimbursement of expenses.\nOn June 9, 1995, the Trust's Board of Trustees revised the compensation to be paid to Independent Trustees effective as of January 1, 1995. Each Independent Trustee shall receive compensation in the amount of $15,000 per year, plus reimbursement for expenses and the Chairman of the Board\nITEM 11. EXECUTIVE COMPENSATION (Continued)\nshall receive an additional $1,500 per year for serving in such position. In addition, each Independent Trustee shall receive an additional fee of $1,000 per day for any special services rendered by him to the Trust outside of his ordinary duties as Trustee, plus reimbursement of expenses.\nDuring 1995, $86,800 was paid to the Independent Trustees in total Trustees' fees for all services, including the annual fee for service during the period January 1, 1995 through December 31, 1995, and 1995 special service fees as follows: Geoffrey C. Etnire, $8,000; Harold Furst, Ph.D., $15,000; John P. Parsons, $15,000; Bennett B. Sims, $7,300; Ted P. Stokely, $11,500; Martin L. White, $15,000, and Edward G. Zampa, $15,000.\n[THIS SPACE INTENTIONALLY LEFT BLANK.]\nITEM 11. EXECUTIVE COMPENSATION (Continued)\nPerformance Graph\nThe following performance graph compares the cumulative total shareholder return on the Trust's shares of beneficial interest with the Standard & Poor's 500 Stock Index (\"S&P 500 Index\") and the National Association of Real Estate Investment Trusts, Inc. Hybrid REIT Total Return Index (\"REIT Index\"). The comparison assumes that $100 was invested on December 31, 1990 in the Trust's shares of beneficial interest and in each of the indices and further assumes the reinvestment of all dividends. Past performance is not necessarily an indicator of future performance.\n[COMPARISON OF FIVE YEAR GRAPH] [CUMULATIVE TOTAL RETURN]\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nSecurity Ownership of Certain Beneficial Owners. The following table sets forth the ownership of the Trust's shares of beneficial interest, both beneficially and of record, both individually and in the aggregate, for those persons or entities known by the Trust to be beneficial owners of more than 5% of its shares of beneficial interest as of the close of business on March 15, 1996.\n(1) Percentages are based upon 4,246,868 shares of beneficial interest outstanding at March 15, 1996.\nSecurity Ownership of Management. The following table sets forth the ownership of the Trust's shares of beneficial interest, both beneficially and of record, both individually and in the aggregate for the Trustees and executive officers of the Trust as of the close of business on March 15, 1996.\n* Less than 1%.\n(1) Percentage is based upon 4,246,868 shares of beneficial interest issued and outstanding at March 15, 1996.\n(2) Includes 1,630,065 shares owned by ART and 467,549 shares owned by BCM of which the executive officers of the Trust may be deemed to be beneficial owners by virtue of their positions as executive officers of ART and BCM. The Trust's executive officers disclaim beneficial ownership of such shares. Each of the directors of ART, may be deemed to be beneficial owners of the shares owned by ART by virtue of their positions as directors of ART. Each of the directors of BCM may be deemed to be beneficial owners of the\nITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT (Continued)\nshares owned by BCM by virtue of their positions as directors of BCM. The directors of ART and BCM disclaim such beneficial ownership.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nCertain Business Relationships\nIn February 1989, the Trust's Board of Trustees voted to retain BCM as the Trust's advisor. See ITEM 10. \"TRUSTEES, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT - The Advisor.\" BCM is a company of which Messrs. Paulson, Endendyk and Holland serve as executive officers. Gene E. Phillips served as a director of BCM until December 22, 1989 and as Chief Executive Officer of BCM until September 1, 1992. BCM is owned by a trust for the benefit of the children of Mr. Phillips. Mr. Phillips serves as a representative of his children's trust which owns BCM and, in such capacity, has substantial contact with the management of BCM and input with respect to its performance of advisory services to the Trust.\nSince February 1, 1991, affiliates of BCM have provided property management services to the Trust. Currently, Carmel, Ltd. provides such property management services. The general partner of Carmel, Ltd. is BCM. The limited partners of Carmel, Ltd. are (i) SWI, of which Mr. Phillips is the sole shareholder, (ii) Mr. Phillips and (iii) a trust for the benefit of the children of Mr. Phillips. Carmel, Ltd. subcontracts the property-level management and leasing of twelve of the Trust's commercial properties and the industrial warehouse facilities owned by one of the real estate partnerships in which the Trust and NIRT are partners to Carmel Realty, which is a company owned by SWI.\nPrior to December 1, 1992, affiliates of BCM provided brokerage services to the Trust and received brokerage commissions in accordance with the advisory agreement. Since December 1, 1992, the Trust has engaged, on a non-exclusive basis, Carmel Realty to perform brokerage services to the Trust. Carmel Realty is a company owned by SWI.\nThe Trustees and officers of the Trust also serve as directors and officers of IORI and TCI. The Trustees owe fiduciary duties to such entities as well as to the Trust under applicable law. IORI and TCI have the same relationship with BCM as the Trust. Mr. Phillips is a general partner of SAMLP, the general partner of NRLP and NOLP. BCM performs certain administrative functions for NRLP and NOLP on a cost-reimbursement basis. BCM also serves as advisor to ART. Mr. Phillips served as Chairman of the Board and as a director of ART until November 16, 1992. Messrs. Paulson, Endendyk and Holland serve as executive officers of ART.\nFrom April 1992 to December 31, 1992, Mr. Stokely was employed as a paid Consultant and since January 1, 1993 as a part-time unpaid Consultant for Eldercare, a nonprofit corporation engaged in the acquisition of low income and elderly housing. Eldercare has a revolving loan commitment from SWI, of which Mr. Phillips is the sole shareholder. Eldercare filed\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS (Continued)\nCertain Business Relationships (Continued)\nfor bankruptcy protection in July 1993, and was dismissed from bankruptcy on October 12, 1994. Eldercare again filed for bankruptcy protection in May 1995.\nRelated Party Transactions\nHistorically, the Trust has engaged in and may continue to engage in business transactions, including real estate partnerships, with related parties. The Trust's management believes that all of the related party transactions represented the best investments available at the time and were at least as advantageous to the Trust as could have been obtained from unrelated third parties.\nAs more fully described in ITEM 2. \"PROPERTIES - Real Estate,\" the Trust is engaged with NIRT in the Sacramento Nine and Indcon, L.P. partnerships.\nIn September 1990, the Trust's Board of Trustees authorized the purchase of up to $2.0 million of the common shares of ART through negotiated or open market transactions. The Trust's advisor also serves as advisor to ART and at March 15, 1996 ART owned approximately [38]% of the Trust's outstanding shares of beneficial interest. At December 31, 1995, the Trust owned 409,044 shares of ART common stock which the Trust had purchased in open market transactions in 1990 and 1991 at a total cost to the Trust of $1.6 million. At December 31, 1995, the market value of the ART shares was $3.0 million. See ITEM 2. \"PROPERTIES - Equity Investments in Real Estate Entities.\"\nIn December 1990, the Trust's Board of Trustees authorized the purchase of up to $1.0 million of the shares of beneficial interest of NIRT and up to $1.0 million of the shares of TCI common stock through negotiated or open market transactions. The Trustees of the Trust serve as directors of TCI. The officers of the Trust also serve as officers of TCI. BCM, the Trust's advisor, also serves as advisor to TCI. Until March 31, 1994, BCM also served as advisor to NIRT. At December 31, 1995, the Trust owned 84,580 shares of beneficial interest of NIRT at a total cost of $415,000 and 79,500 shares of TCI common stock at a total cost of $235,000 all of which the Trust had purchased in open market transactions in 1990 and 1991. At December 31, 1995, the market value of the NIRT shares was $941,000 and the market value of the TCI common stock was $795,000. See ITEM 2. \"PROPERTIES - Equity Investments in Real Estate Entities.\"\nIn 1995, the Trust paid BCM and its affiliates $1.3 million in advisory fees, $1.6 million in real estate brokerage commissions, $142,000 in mortgage brokerage and equity refinancing fees and $806,000 in property and construction management fees and leasing commissions (net of property management fees paid to subcontractors, other than Carmel Realty). In addition, also as provided in the Advisory Agreement, BCM received cost reimbursements from the Trust of $506,000 in 1995.\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS (Continued)\nRestrictions on Related Party Transactions\nThe Trust's Declaration of Trust provides that:\n\"The Trustees shall not...purchase, sell or lease any Real Properties or Mortgages to or from...the Advisor or any of [its] Affiliates,\" and that [t]he Trustees shall not...make any loan to...the Advisor or any of [its] Affiliates.\"\nThe Declaration of Trust further provides that:\n\"The Trust shall not purchase or lease, directly or indirectly, any Real Property or purchase any Mortgage from the Advisor or any affiliated Person, or any partnership in which any of the foregoing may also be a general partner, and the Trust will not sell or lease, directly or indirectly, any of its Real Property or sell any Mortgage to any of the foregoing Persons.\" The Declaration of Trust further provides that \"the Trust shall not directly or indirectly, engage in any transaction with any Trustee, officer or employee of the Trust or any director, officer or employee of the Advisor...or of any company or other organization of which any of the foregoing is an Affiliate, except for...[among other things] transactions with...the Advisor or Affiliates thereof involving loans, real estate brokerage services, real property management services, the servicing of Mortgages, the leasing of real or personal property, or other services, provided such transactions are on terms not less favorable to the Trust than the terms on which nonaffiliated parties are then making similar loans or performing similar services for comparable entities in the same area and are not entered into on an exclusive basis.\"\nThe Declaration of Trust further provides that:\n\"The Trustees shall not...invest in any equity Security, including the shares of other REITs for a period in excess of 18 months, except for shares of a qualified REIT subsidiary, as defined in Section 856(i) of the Internal Revenue Code, and regular or residual interests in REMICs...[or] acquire Securities in any company holding investments or engaging in activities prohibited by this Section...\"\nThe Declaration of Trust defines \"Affiliate\" as follows:\n\"As to any Person, any other Person who owns beneficially, directly or indirectly, 1% or more of the outstanding capital stock, shares, or equity interests of such Person or of any other Person which controls, is controlled by, or is under common control with, such Person or is an officer, retired officer, director, employee, partner, or trustee (excluding independent trustees not otherwise affiliated with the entity) of such Person or of any other Person which controls, is controlled by, or is under common control with, such Person.\"\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS (Continued)\nRestrictions on Related Party Transactions (Continued)\nFrom 1990 until January 1995, all related party transactions that the Trust entered into were required to be reviewed by the Related Party Transaction Committee of the Trust's Board of Trustees to determine whether such transactions were (i) fair to the Trust and (ii) were permitted by the Trust's governing documents. Each of the members of the Related Party Transaction Committee was a Trustee who was not an officer, director or employee of BCM, the Trust's advisor, and was not an officer or employee of the Trust. The Related Party Transaction Committee was terminated by the Trust's Board of Trustees on January 11, 1995.\nPursuant to the terms of the Modification of Stipulation of Settlement (the \"Modification\") in the Olive Litigation, as more fully discussed in ITEM 3. \"LEGAL PROCEEDINGS - Olive Litigation,\" which became effective on January 11, 1995, certain related party transactions which the Trust may enter into prior to April 28, 1999, require the unanimous approval of the Trust's Board of Trustees. In addition, such related party transactions are to be discouraged and may only be entered into in exceptional circumstances and after a determination by the Trust's Board of Trustees that the transaction is in the best interests of the Trust and that no other opportunity exists that is as good as the opportunity presented by such transaction.\nThe Modification requirements for related party transactions do not apply to direct contractual agreements for services between the Trust and the Advisor or one of its affiliates, (including the Advisory Agreement, the Brokerage Agreement and the property management contracts). These agreements, pursuant to the specific terms of the Modification, require the prior approval by two-thirds of the Trustees of the Trust, and if required, approval by a majority of the Trust's shareholders. The Modification requirements for related party transactions also do not apply to joint ventures between or among the Trust and IORI, NIRT or TCI or any of their affiliates or subsidiaries and a third party having no prior or intended future business or financial relationship with Mr. Phillips, Mr. Friedman, the Advisor, or any affiliate of such parties. Such joint ventures may be entered into on the affirmative vote of a majority of the Trustees of the Trust.\n[THIS SPACE INTENTIONALLY LEFT BLANK.]\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES, AND REPORTS ON FORM 8-K\n(a) The following documents are filed as part of this Report:\n1. Consolidated Financial Statements\nReport of Independent Certified Public Accountants\nConsolidated Balance Sheets - December 31, 1995 and 1994\nConsolidated Statements of Operations - Years Ended December 31, 1995, 1994 and 1993\nConsolidated Statements of Shareholders' Equity - Years Ended December 31, 1995, 1994 and 1993\nConsolidated Statements of Cash Flows - Years Ended December 31, 1995, 1994 and 1993\nNotes to Consolidated Financial Statements\n2. Financial Statement Schedules\nSchedule III - Real Estate and Accumulated Depreciation\nSchedule IV - Mortgage Loans on Real Estate\nAll other schedules are omitted because they are not applicable or because the required information is shown in the Consolidated Financial Statements or the notes thereto.\n3. Exhibits\nThe following documents are filed as Exhibits to this report:\nITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K (Continued)\n(b) Reports on Form 8-K:\nA Current Report on Form 8-K, dated November 30, 1995, was filed with respect to Item 2, \"Acquisition or Disposition of Assets\", which reports the acquisition of Willow Wick and Heritage on the River Apartments, which was amended on Form 8-K\/A, filed September 7, 1995.\nA Current Report on Form 8-K, dated December 28, 1995, was filed with respect to Item 2. \"Acquisition and Disposition of Assets\" which reports the acquisition of the Brookfield Corporate Center, which was amended on Form 8-K\/A, filed February 20, 1996.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated.\nCONTINENTAL MORTGAGE AND EQUITY TRUST\nEXHIBITS TO ANNUAL REPORT ON FORM 10-K\nFor the Year Ended December 31, 1995","section_15":""}
{"filename":"769017_1995.txt","cik":"769017","year":"1995","section_1":"Item 1. Business. ---------\nCopley Properties, Inc. (\"Copley\" or the \"Company\") was organized under the General Corporation Law of the State of Delaware on May 8, 1985 and intends to continue to qualify as a real estate investment trust (\"REIT\") under applicable provisions of the Internal Revenue Code of 1986, as amended. Copley acquires, develops, operates and owns commercial real estate, most of which is comprised of industrial buildings.\nAs of December 31, 1995, Copley owned, directly or partially through tenancy-in-common or joint venture ownership structures, 15 properties totaling over 2.5 million square feet of net rentable area. Industrial properties, including bulk distribution, research and development and light industrial space account for approximately 92% of the total net rentable area in Copley's portfolio. Over 86% of the net rentable area in Copley's portfolio is located in California and Arizona.\nIn light of the strong preference of investors in REITs for direct ownership of real estate by REITs, in the fall of 1993, the Company began the process of restructuring its joint venture investments to realign its legal ownership with the economic realities of each venture and to obtain operational control. The last of the Company's investments were restructured effective February 1996 through two separate exchange transactions (the \"February Exchanges\"). See below for more detailed information regarding these exchanges. Once the February Exchanges are consummated, Copley will own all except two of its investments either directly or through 100% controlled partnerships and will have operational control over all of its investments.\nAs of February 1996, Copley owned directly or through its two joint venture investments, 11 properties totaling over 2.0 million square feet of net rentable area. Industrial properties, including bulk distribution, research and development and light industrial space account for approximately 91% of the total net rentable area in Copley's portfolio. Over 87% of the net rentable area in Copley's portfolio is located in California and Arizona.\nA key element of Copley's strategy has been a concentrated focus on industrial real estate in the western United States. In evaluating specific real property investments, Copley considers such factors as (i) the geographic area and type of property in light of Copley's investment and diversification objectives; (ii) the proposed location, construction quality and design of the property; (iii) projected cash flow; (iv) potential for capital appreciation; (v) the terms of any proposed or existing tenant leases; (vi) the economic growth, tax and regulatory environment in the community in which the property is located; (vii) occupancy rates and demand for properties of similar type in the vicinity; (viii) prospects for liquidity through sales or refinancing; and (ix) if applicable, the experience, past performance and competence of Copley's proposed joint venture partner or property manager. As a general rule, Copley will not invest more than 25% of its total assets in a single property.\nAs discussed above, Copley has recently restructured a number of its investments which were originally made through joint venture arrangements. Copley anticipates that any future investments would be made through the acquisition by Copley of fee interests in real estate.\nCopley's By-Laws permit the directors, with the approval of a majority of the Independent Directors (as defined in the Company's By-Laws), to alter Copley's investment policies without approval of the stockholders, if in the future the directors determine that such a change is in the best interest of Copley and its stockholders. The methods of implementing Copley's investment policies may also vary as new investment and financing techniques are developed.\n- 3 -\nIn general, Copley has a policy of seeking to reduce the amount of its indebtedness. Under its By-Laws, Copley may not incur borrowings which, together with the amount of all then outstanding indebtedness, would exceed at the time of such borrowings, 300% of the net book assets of Copley, unless a majority of its Independent Directors determines that it is advisable to do so.\nAlthough Copley does not currently have plans to renovate, improve or further develop its real properties, it owns undeveloped land at its Sample\/I-95 Business Park property that it may develop or sell at some point in the future. In the opinion of the management of Copley, the properties are adequately covered by insurance.\nThe Company has an agreement with Copley Real Estate Advisors, Inc. (the \"Advisor\") pursuant to which the Advisor provides investment management and administrative services to the Company. See Note 9 of Notes to Financial Statements. The Company has no employees. Executive officers of the Advisor also serve as the executive officers of the Company but receive no remuneration from the Company.\nThe Company has an unsecured line-of-credit in the amount of $5,000,000 from Fleet Bank of Massachusetts, N.A., which has no outstanding balance as of December 31, 1995. This revolving line-of-credit bears interest at the Company's election at the prime rate, or the London InterBank Offered Rate (\"LIBOR\") plus 1.5%. The current line-of-credit agreement expires July 31, 1996.\nOn February 12, 1996, Copley and EastGroup Properties (\"EastGroup\") entered into a merger agreement (the \"Agreement\") whereby (i) Copley will merge with and into EastGroup, (ii) the separate corporate existence of Copley will cease, and (iii) EastGroup will become the surviving corporation (the \"Merger\").\nIn the Merger, each share of Copley's common stock will be converted into shares of beneficial interest of East Group with a value of $15.60 (subject to certain limitations described below). The value at which each share of Copley's common stock will be converted into EastGroup shares is subject to further adjustment in the event certain other cash distributions are made to Copley stockholders prior to the effective date of the Merger.\nThe value of EastGroup shares for purposes of calculating the ratio at which the Copley shares will be converted into EastGroup shares in the Merger will be the average of the closing price of EastGroup shares on the New York Stock Exchange on the 20 trading days immediately preceding the fifth trading day prior to the effective date of the Merger (the \"EastGroup Share Price\"); provided, however, that if such average closing price as calculated in - -------- ------- accordance with this sentence (i) is less than $20.25, the EastGroup Share Price shall be deemed to equal $20.25 or (ii) is greater than $23.00, the EastGroup Share Price shall be deemed to equal $23.00. Notwithstanding the foregoing, Copley shall have the right, waivable by it, to terminate the Agreement without liability if the average closing price of EastGroup shares on the New York Stock Exchange on the twenty (20) trading days immediately preceding the fifth trading day prior to either (A) the date on which the Form S-4 relating to the issuance of EastGroup shares is declared effective by the Securities and Exchange Commission or (B) the date on which the meeting of Copley's stockholders is to be held with respect to the Merger, is equal to or less than $18.25.\nThe Agreement has been unanimously approved by the Board of Directors of Copley and the Board of Trustees of EastGroup. The Merger is subject to various approvals by third parties and other closing conditions including approval by the stockholders of both companies.\n- 4 -\nFurther information regarding the Company's investments is set forth in tabular form at the end of this Item 1 and should be read in conjunction with the narrative. The schedules and narratives have been organized to provide information first, for those properties unaffected by the February Exchanges; second, for those properties which Copley will own 100% subsequent to the February Exchanges; and third, for those properties in which the Company will no longer have an interest after the February Exchanges.\n1. Property Data Summary at December 31, 1995\n2. Property Third-Party Debt Summary at December 31, 1995\n3. Invested Capital Priorities at December 31, 1995\n1. Broadway Industrial Center - ------------------------------\nOn March 31, 1994, the Company purchased an approximately 121,000 square foot industrial building located in Tempe, Arizona. The total purchase price was approximately $2,350,000. The Company acquired a 100% fee interest in the property on a direct ownership basis, rather than through a joint venture arrangement, and incurred no acquisition indebtedness. At the date of acquisition, Copley had entered into an agreement with The Hewson Company (\"Hewson\") which included both an on-going management arrangement and granted Hewson an interest in the property in lieu of an acquisition fee, which interest was payable upon the sale or refinancing of the property or termination of the management arrangement. In September 1995, Copley paid approximately $100,000 to buy out Hewson's interest in the property.\n*See Property Data Summary included at the end of this Item 1.\n2. Kingsview Industrial Center - -------------------------------\nOn July 14, 1995, the Company purchased an approximately 83,000 square foot industrial building located in Carson, California. The total purchase price was approximately $3,000,000. The Company acquired a 100% fee interest in the property on a direct ownership basis, rather than through a joint venture arrangement, and incurred no acquisition indebtedness.\n*See Property Data Summary included at the end of this Item 1.\n3. Los Angeles Corporate Center. - ---------------------------------\nThe Company owns a 100% interest in an office building in Monterey Park, California .\nAs of December 31, 1995, the building was 50% leased. In January 1996, the Company executed a lease agreement which increased the percentage leased to 100%.\n*See Property Data Summary included at the end of this Item 1.\n- 5 -\n4. University Business Center. - -------------------------------\nThe Company invested in a two-phase development of four research and development buildings in Santa Barbara, California. The Phase I buildings consist of two two-story research and development buildings containing an aggregate of approximately 133,000 square feet. The Phase II buildings consist of two two-story research and development buildings containing an aggregate of approximately 97,000 square feet.\nPrior to November 1, 1993, the Company owned a 50% interest in the joint venture owning the properties. All of the Company's capital contribution related to its 50% ownership interest was returned. On November 1, 1993, the Company purchased an additional 30% interest in the joint venture for approximately $1,990,000 plus closing costs, bringing the Company's ownership position to 80%. The Company also gained operational control of the joint venture.\nDuring 1993, the Company contributed additional capital to the joint venture of $150,000 for tenant improvements. The capital earns a preferred return of 12% and is required to be repaid over a three year period ending March, 1996. The balance of this capital contribution was $14,652 as of December 31, 1995. In February 1995, in conjunction with a refinancing, Copley contributed additional capital to the joint venture of $3,500,000 which earns a preferred return of 11% and is amortized over a 22.5 years.\nThe joint venture obtained loans from Connecticut General Life Insurance Company (\"CIGNA\"). One loan in the amount of $9,500,000 is secured by a first mortgage on the two research and development buildings in Phase I. The joint venture also obtained a second loan in the amount of $10,000,000 from CIGNA which is secured by a first mortgage of the Phase II buildings.\n*See Property Data Summary, Property Third-Party Debt Summary and Invested Capital Priorities included at the end of this Item 1.\n5. Huntwood Associates - -----------------------\nThe Company owned an equity interest in a joint venture formed to acquire three parcels of land within the Crocker South Industrial Park in Hayward, California and to construct thereon bulk distribution\/light industrial space. Prior to the end of 1993, the Company owned a 60% interest in the joint venture. As of December 31, 1993, the Company obtained operational control of the property and 100% ownership interest in all the joint venture's assets. Because of the high level of accrued guaranteed payments owed to the Company, the joint venture partner surrendered its 40% ownership interest in the joint venture to the Company at no cost.\nDevelopment of all the buildings has been completed. The Company currently owns seven buildings totaling approximately 514,400 square feet. In prior years, four buildings totaling 180,600 square feet were sold.\nThe joint venture obtained a loan from Massachusetts Mutual Life Insurance Company. The loan is secured by a first mortgage on certain of the land and buildings. The joint venture also obtained a construction loan from Wells Fargo Bank. This loan is secured by a first mortgage of certain of the land and buildings.\n*See Property Data and Property Third-Party Debt Summary included at the end of this Item 1.\n- 6 -\n6. Wiegman Associates. - -----------------------\nThe Company owns an interest in a joint venture which developed and now owns four bulk distribution\/light industrial buildings in Hayward, California. On December 31, 1993, the Wiegman Associates joint venture was restructured to (i) provide the Company with operating control, (ii) increase the Company's interest in the venture from 60% to 80% and (iii) convert the joint venture from a general partnership to a limited partnership. The joint venture agreement entitles the Company to a 12% per annum cumulative compounded return on its original capital contribution of $2,500,000. Any capital contributed after December 31, 1993 will receive a 9.5% priority cumulative compounded return. The Company made no additional investment in the property to acquire the additional 20% interest .\nThree of the buildings are encumbered by a loan from Massachusetts Mutual Life Insurance Company. The loan is secured by a first mortgage. The Company executed a master lease for 38,900 square feet of space at an annual rent of $126,036; the master lease expired December 25, 1995.\nThe property is also encumbered by a loan from Allstate Life Insurance Company. The loan is secured by a first mortgage of the remaining land and building.\n*See Property Data Summary, Property Third-Party Debt Summary and Invested Capital Priorities included at the end of this Item 1.\n7. Baygreen Industrial Park - -----------------------------\nOn October 26, 1993, the Company purchased Baygreen Industrial Park in Hayward, California for approximately $1,980,000. The Company acquired a 100% fee interest in the property on a direct ownership basis, rather than through a joint venture arrangement, and incurred no acquisition indebtedness. At the date of acquisition, Copley had entered into an agreement with Zelman Development Company (\"Zelman\") which included both an on-going management arrangement and granted Zelman an interest in the property in lieu of an acquisition fee, which interest was payable upon the sale or refinancing of the property or termination of the management arrangement. In October 1995, Copley paid approximately $200,000 to buy out Zelman's interest in the property.\nBaygreen Industrial Park consisted of four industrial buildings containing an aggregate of 80,400 square feet. As discussed below, two of the buildings were sold in 1994. As of December 31, 1995, the Company owns two buildings containing approximately 40,200 square feet.\nFollowing acquisition and refurbishment of the property, the Company received an unsolicited offer from an existing tenant to purchase one of the buildings (representing approximately 15,000 net rentable square feet) for a price of $47.00 per square foot. The sale of this building occurred in the fourth quarter of 1994. In addition, in conjunction with the lease of one of the buildings, a tenant requested and was granted an option to purchase one of the buildings (containing approximately 25,200 square feet) for approximately $47.60 per square foot. The purchase option was exercised and the building was sold in the fourth quarter of 1994. The Company made a loan to the purchaser of one of the buildings in the amount of $700,000; this loan bears interest at the fixed rate of 9% per annum, with interest only payable monthly in arrears through its expiration in January 1997 when the principal balance is due. The loan is secured by a first mortgage on the building. The Company recorded a gain totaling approximately $627,000 on the sale of the two buildings.\n*See Property Data Summary included at the end of this Item 1.\n- 7 -\n8. Sample\/I-95 Business Park - ----------------------------\nIn 1987, the Company acquired a 65% interest in a joint venture formed to acquire land in Pompano Beach, Florida and to construct industrial buildings thereon. The Company has completed construction of approximately 157,000 square feet. Approximately 345,000 square feet of space remains to be developed.\nDuring 1993, the Company obtained operational control of the property and as of January 6, 1994, 100% ownership interest in all of the joint venture's assets. Because of the high level of accrued guaranteed payments owed to the Company, the joint venture partner surrendered its 35% interest in the joint venture to the Company at no cost.\n*See Property Data Summary included at the end of this Item 1.\nProperties owned 100% by Copley subsequent to the February Exchanges - --------------------------------------------------------------------\n9. Metro Business Park - ------------------------\nPrior to August 1995, the Company owned a 50% general partnership interest in a limited partnership which owned five service center industrial buildings located in Phoenix, Arizona. Effective August 16, 1995, Copley entered into agreements with its partners to restructure the ownership of the investment as a tenancy-in-common. Copley contributed its capital and loans to the venture in return for a 69.03% interest in the Metro Business Park tenancy-in-common. Effective February 2, 1996, the Company exchanged its tenancy-in-common interest in Carson Industrial Center, including the note due from the joint venture partner, Central Distribution Center, West Side Business Park and the El Presidio Properties to gain 100% ownership of Metro Business Park and the East Dominguez Property. In addition, the Company paid approximately $138,000 to the co-tenants-in-common.\nThe property is encumbered by loans from State Farm Life Insurance Company and Allstate Life Insurance Company which are secured by first mortgages on portions of the land and buildings. Together, the loans encumber the entire property.\n*See Property Data Summary and Property Third-Party Debt Summary included at the end of this Item 1.\n10. Dominguez Properties - -------------------------\nPrior to August 1995, the Company owned a 55% general partnership interest in a limited partnership which owned four bulk distribution facilities in Carson (Los Angeles), California. Effective August 16, 1995, Copley entered into agreements with its partners to restructure the ownership of the investment as a tenancy-in-common for each of the four buildings. Copley received a 55% tenancy-in-common interest in each of the four Dominguez buildings. Three of the four buildings are located on El Presidio and contain approximately 165,400 square feet (the \"El Presidio Properties\"). The fourth building is located on East Dominguez Street and contains approximately 261,900 square feet (the \"East Dominguez Property\"). Effective February 2, 1996, the Company exchanged its tenancy-in-common interest in Carson Industrial Center, including the note due from the joint venture partner, Central Distribution Center, West Side Business Park and the El Presidio Properties to gain 100% ownership of Metro Business Park and the East Dominguez Property. In addition, the Company paid approximately $138,000 to the co-tenants-in-common, as discussed above.\n- 8 -\nThe East Dominguez Property is encumbered by a loan from Allstate Life Insurance Co. which is secured by a first mortgage. The El Presidio Properties are encumbered by mortgage loans from Aetna Life Insurance Company.\n*See Property Data Summary and Property Third-Party Debt Summary included at the end of this Item 1.\n11. Columbia Place. - --------------------\nPrior to August 1995, the Company owned a 50% general partnership interest in a limited partnership (the \"Partnership\") which was formed for the purpose of developing and owning a five-story office building ( \"Columbia Place\") located in Columbia, Maryland. Effective August 16, 1995, Copley entered into an agreement with its partner to restructure the ownership of the investment as a tenancy-in-common. Copley contributed its capital and loans to the partnership in return for a 78% interest in the Columbia Place tenancy-in- common. Effective February 1, 1996, the Company exchanged its tenancy-in-common interest in 270 Technology Park to gain 100% ownership of Columbia Place. In addition, the Company received $50,000 in cash and a secured promissory note of $180,000 bearing interest at 9.56%, maturing on February 1, 2000, with annual interest and principal payments of $56,250.\nColumbia Place is encumbered by a loan from American General Investment Corporation.\n*See Property Data Summary and Property Third-Party Debt Summary included at the end of this Item 1.\nProperties in which Copley will no longer have an ownership interest after the - ------------------------------------------------------------------------------ February Exchanges. - -------------------\n12. Central Distribution Center - --------------------------------\nPrior to August 1995, the Company owned a 50% interest in a joint venture which owned two bulk distribution industrial buildings in Phoenix, Arizona. Effective August 16, 1995, Copley entered into agreements with its partners to restructure the ownership of the investment as a tenancy-in-common. Copley contributed its capital and loans to the venture in return for a 57.38% interest in the Central Distribution Center tenancy-in-common. Effective February 2, 1996, the Company exchanged its tenancy-in-common interest in Carson Industrial Center, including the note due from the joint venture partner, Central Distribution Center, West Side Business Park and the El Presidio Properties to gain 100% ownership of Metro Business Park and the East Dominguez Property. In addition, the Company paid approximately $138,000 to the co-tenants-in-common, as discussed above.\nThe property is encumbered by a loan from Confederation Life Insurance Company that is secured by a first mortgage of the land and buildings and the property in the West Side Business Park described below.\n*See Property Data Summary and Property Third-Party Debt Summary included at the end of this Item 1.\n- 9 -\n13. West Side Business Park - -----------------------------\nPrior to August 1995, the Company owned a 50% interest in a joint venture which owned two bulk distribution\/light industrial buildings in Phoenix, Arizona. Effective August 16, 1995, Copley entered into agreements with its partners to restructure the ownership of the investment as a tenancy-in-common. Copley contributed its capital and loans to the venture in return for a 75.49% interest in the West Side Business Park tenancy-in-common with only a 57.38% allocation of the mortgage principal balance and debt service. Effective February 2, 1996, the Company exchanged its tenancy-in-common interest in Carson Industrial Center, including the note due from the joint venture partner, Central Distribution Center, West Side Business Park and the El Presidio Properties to gain 100% ownership of Metro Business Park and the East Dominguez Property. In addition, the Company paid approximately $138,000 to the co-tenants-in-common, as discussed above.\nThe property is also encumbered by a loan from Confederation Life Insurance Company which is secured by a first mortgage on the land and buildings and on the Central Distribution Center described above.\n*See Property Data Summary and Property Third-Party Debt Summary included at the end of this Item 1.\n14. Carson Industrial Center - ------------------------------\nThe Company owns a 50% tenancy-in-common interest in a bulk distribution industrial facility located in Carson (Los Angeles), California. In connection with the dissolution of the original joint venture and conversion to a tenancy-in-common ownership structure, the Company received a promissory note from its joint venture partner in the amount of $176,889. This note bears simple interest at the rate of 10% per annum. Interest is payable currently to the extent the maker receives cash flow distributions from the property; any interest not paid currently is accrued. As of December 31, 1995, interest of $4,422 was due on the note which was paid in January. Effective February 2, 1996, the Company exchanged its tenancy-in-common interest in Carson Industrial Center, including the note due from the joint venture partner, Central Distribution Center, West Side Business Park and the El Presidio Properties to gain 100% ownership of Metro Business Park and the East Dominguez Property. In addition, the Company paid approximately $138,000 to the co-tenants-in-common, as discussed above.\nThe property is encumbered by a loan from State Farm Life Insurance Company and is secured by a first mortgage of the land and building.\n*See Property Data Summary and Property Third-Party Debt Summary included at the end of this Item 1.\n15. 270 Technology Park. - --------------------------\nPrior to August 1995, the Company owned a 50% general partnership interest in a limited partnership which owned two research and development buildings located in Frederick, Maryland. Effective August 16, 1995, Copley entered into an agreement with its partner to restructure the ownership of the investment as a tenancy-in-common. Copley contributed its capital and loans to the venture in return for a 61% interest in the 270 Technology Park tenancy-in- common. Effective February 1, 1996, the Company exchanged its tenancy-in-common interest in 270 Technology Park to gain 100% ownership of Columbia Place. In addition, as discussed above, the Company received $50,000 in cash and a secured promissory note of $180,000 bearing interest at 9.56%, maturing on February 1, 2000, with annual interest and principal payments of $56,250.\n- 10 -\nThe buildings are encumbered by a first mortgage securing tax-exempt industrial revenue bonds with an outstanding balance of $3,713,011 as of December 31, 1995. The Company and its joint venture partner have guaranteed payments of principal and interest on the bonds. The Company's guarantee is limited to 50% of the obligations of the limited partnership and is in no case greater than $2,000,000. A similar guarantee was provided by The Manekin Corporation, a general partner of the partnership. As part of the exchange, the Company's guarantee was extinguished.\n*See Property Data Summary and Property Third-Party Debt Summary included at the end of this Item 1.\nProperties sold during 1995 - ---------------------------\n16. Park North Business Center (\"Park North\") - ----------------------------------------------\nIn 1985, the Company agreed to invest in a service center industrial development in DeKalb County, Georgia known as Park North Business Center. Nine service center industrial buildings were constructed on the 38.4 acres of land. In June 1995, the Company sold all of its interests and rights, including its ground lease position, related to the Park North investment for approximately $18,500,000. The Company recognized a gain of approximately $758,000 on the sale of this investment.\n17. Peachtree Corners Distribution Center. - --------------------------------------------\nThe Company owned a 100% fee interest in four bulk distribution industrial buildings in Norcross, Georgia. In November 1995, the Company sold its interests in the Peachtree Corners Distribution Center for approximately $10,000,000. The Company recognized a gain of approximately $1,806,000.\n- 11 -\nCopley Properties, Inc. - -------------------------------------------------------------------------------- Property Data Summary 12\/31\/95\n(1) As part of the February Exchanges, the Company relinquished its interest in the three El Presidio buildings of Dominguez Properties and increased its ownership in the East Dominguez building of Dominguez Properties to 100%.\n- 12 -\nCopley Properties, Inc. - -------------------------------------------------------------------------------- Property Third-Party Debt Summary 12\/31\/95 Wholly Owned and Tenancy-in-Common Properties\n- -------------------------------------------------------------------------------- All loans are non-recourse with exception of the guarantees discussed in Part I and in the notes to consolidated financial statements. Yield Maintenance: Usually requires a pre-payment penalty to be paid equal to the present value of the loan's original payments due over the return that could be earned by holding like maturity U.S. Treasuries. The exact formula varies from loan to loan. P = Prime Rate, L = LIBOR (London InterBank Offered Rate)\n- -------------------------------------------------------------------------------- Note (1): Extension of this loan's maturity date is being negotiated. Amortization was all excess cash flow after priority returns to partners. The Company exchanged its interest in this project, and was relieved of its obligations under this note, effective February 1, 1996 (see Item 1).\nCopley Properties, Inc. - -------------------------------------------------------------------------------- Invested Capital Priorities 12\/31\/95\n(1) Effective February 2, 1996, the Company exchanged its tenancy-in-common interest in Carson Industrial Center, including this note due from the co- tenant, Central Distribution Center, West Side Business Park and the El Presidio Properties to gain 100% ownership of Metro Business Park and the East Dominguez Property.\nThe remaining properties of the Company are either wholly owned, in which Invested Capital Priorities are not applicable, or tenancies-in-common in which the Invested Capital Priorities and accrued interest have been contributed to equity.\nCompetitive Market Conditions - -----------------------------\nIn 1995, market conditions generally improved in the markets in which the Company's properties are located. However, the recovery has been uneven across different regions and product types, reflecting changes in the regional economies. Following is a description of the markets in which the Company operates:\n. Both the Hayward and Los Angeles, California industrial markets in which the Company's industrial projects are located, improved over 1995 with vacancy rates on similar space declining and rental rates strengthening.\n. The San Gabriel Valley, California office market, in which the Company's Los Angeles Corporate Center project is located, weakened slightly over 1995, with net absorption slightly negative. However, in January 1996, the Company executed a 38,500 square foot lease with CashFlex, L.P. for the only vacant space in the project. The leases of the other two tenants in the project expire in 2000.\n. The Santa Barbara, California market for research and development space, in which the Company's University Business Center project is located, remained healthy as a result of its location, land prices and developmental controls imposed by the city. Vacancy rates remained low and rental rates were stable.\n. Both the Phoenix and Southwest Tempe, Arizona industrial markets in which the Company's industrial projects are located, improved over 1995 with vacancy rates on similar space declining and rental rates strengthening.\n. Both the suburban Frederick and Columbia, Maryland markets, in which the company's R&D and Office projects are located, improved slightly in 1995 with vacancy rates declining and rental rates remaining stable.\n. The Pompano Beach, Florida industrial market, in which the Company's Sample\/I-95 Business Park is located, remained solid in 1995. Vacancy rates for similar space remained low and rental rates were stable.\nThe Company believes that the information concerning the market conditions discussed above is accurate and that the sources from which it was obtained are reliable; however, the Company can not guarantee the accuracy of this information.\n- 15 -\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties. ------------\n- 16 -\nCopley Properties, Inc. - -------------------------------------------------------------------------------- Percentage Leased and 10% Tenants\nThe following table sets forth the occupancy rates for each of the last five years, the number of tenants occupying 10% or more of the developed square feet at the property as of the end of the year and the principal business of such tenants in the Company's properties at 12\/31\/95:\n(1) As part of the February Exchanges, the Company relinquished its interest in the three El Presidio buildings of Dominguez Properties and increased its ownership in the East Dominguez building of Dominguez Properties to 100%.\n- 17 -\nLease Expirations\nThe following table sets forth for all of the Company's properties for each of the next ten years (i) the number of leases that expire in each year (ii) the square feet covered by such leases expiring (iii) the annual rental represented by such leases and (iv) the percentage of total gross annual rental income expiring.\n(1) Represents annual straight-line rental revenue recognized in accordance with Generally Accepted Accounting Principles for leases expiring in each year shown.\n(2) Represents the annual rental of leases expiring in each year as a percentage of the total annual rental of all leases currently in place.\n- 18 -\nSignificant Properties - ----------------------\nThe following tables show, as of December 31, 1995, tenant lease expirations for the next ten years at properties representing approximately 10% or more of the total 1995 rental income of the Company's properties or approximately 10% or more of the total gross land and building assets of the Company's properties.\nThe tables set forth for each property specified below for each of the next ten years (i) the number of leases that expire in that year, (ii) the square feet covered by such leases expiring, (iii) the annual rental represented by such leases and (iv) percentage of total gross annual rental income expiring for the property based on December 31, 1995 rents.\nUniversity Business Center: - -----------------------------\n- 19 -\nSignificant Properties (Continued) - ----------------------------------\n(1) Represents annual straight-line rental revenue recognized in accordance with Generally Accepted Accounting Principles for leases expiring in each year shown.\n(2) Represents the annual rental of leases expiring in each year as a percentage of the total annual rental of all leases currently in place at the property.\n- 20 -\nThe following table sets forth the principal provisions of leases which represent more than 10% of the gross leasable area (GLA) of each property and the realty taxes for each property for the year ended December 31, 1995.\nThe following table sets forth the principal provisions of leases which represent more than 10% of the gross leasable area (GLA) of each property and the realty taxes for each property for the year ended December 31, 1995.\n(1) As part of the February Exchanges, the Company relinquished its interest in the three El Presidio buildings of Dominquez Properties and increased its ownership in the East Dominquez building of Dominquez Properties to 100%\nThe following table sets forth the average effective annual rent psf, for each of the last five years, for each of the Company's properties.\nThe following table sets forth the average effective annual rent psf, for each of the last five years, for each of the Company's properties.\n(1) As property was acquired on March 31, 1994, Net Effective Rent calculated from April through December. (2) As property was acquired in July 1995, Net Effective Rent calculated from July through December. (3) As two buildings were sold in early December 1994, Net Effective Rent is calculated as follows: $216,886\/[((50%*40,200)\/12)+((88%*80,400)*11\/12)] (4) The Recognized Rental Revenue includes income from the three El Presidio buildings of $754,816 in 1995. (5) Does not include impact of BDM lease termination payments.\nNet effective rent is calculated as: Recognized Rental Revenue\/Average Square Feet Occupied during the year. Average Square Feet Occupied equals: square feet x((beginning year occupancy + year end occupancy)\/2) Recognized rental revenue is the rental revenue recognized for financial statement purposes including operating expense reimbursements.\nFederal Tax Basis Information for Copley Properties, Inc.\nThe following table sets forth for each of the Company's significant properties the tax information as follows: (i) Federal tax bisis as of December 31, 1995; (ii) 1995 annual rate of depreciation; (iii) method of depreciation; and (iv) life claimed, with respect to each property or component thereof for purposes of depreciation for tax purposes.\n(1) DB = Declining Balance\n- 25 -\nItem 3.","section_3":"Item 3. Legal Proceedings. -----------------\nThe Company is not a party to, nor are any of its properties subject 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 security holders during the fourth quarter of the fiscal year covered by this Annual Report on Form 10-K.\n- 26 -\nItem 4a. Executive Officers of the Registrant ------------------------------------\nThe executive officers of the Company and their respective positions with the Company, principal occupations and business experience during the last five years and ages as of December 31, 1995 are as follows:\n(1)Effective February 29, 1996, Steven E. Wheeler resigned from the positions of Director, President and Chief Executive Officer, and Joseph W. O'Connor assumed the duties of President and Chief Executive Officer. The executive officers will serve in their respective capacities until their successors are elected and qualified.\n- 27 -\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters. ---------------------------------------------------------------------\nStock Price and Dividend Record\nThe Company's Common Stock is traded on the American Stock Exchange under the symbol \"COP\". As of December 31, 1995 there were approximately 2,500 beneficial shareholders with 652 shareholders of record of Common Stock and 1 shareholder of record of Class A Common Stock, Copley Real Estate Advisors, Inc. The following table sets forth the high and low prices of the Company's Common Stock for each fiscal quarter for the past eight quarters and dividends declared during each such quarter:\nWeighted Average Shares outstanding as of December 31, 1995 - 3,584,350\nWeighted Average Shares outstanding as of December 31, 1994 - 3,584,350\n- 28 -\nItem 6.","section_6":"Item 6. Selected Financial Data -----------------------\n- 29 -\nItem 7.","section_7":"Item 7. Management's discussion and analysis of financial condition ----------------------------------------------------------- and results of operations. --------------------------\n- 30 -\nCopley Properties, Inc. - --------------------------------------------------------------------------------\nManagement's Discussion and Analysis of Financial Condition and Results of Operations\n- -------------------------------------------------------------------------------- Liquidity and Capital Resources\nThe Company's assets consist primarily of investments in real estate. At December 31, 1995, several properties are owned directly by the Company; others are owned by joint ventures in which the Company is the managing general partner or structured as tenancies-in-common in which the Company is a co-tenant. As a co-tenant in its tenancy-in-common investments and a general partner in its joint venture investments, the Company is obligated to fund its proportionate share of operating deficits.\nAt December 31, 1995, the Company had cash and cash equivalents totaling $5,716,300. The Company also has a $5,000,000 bank line-of-credit which expires on July 31, 1996. The average outstanding balance on the line-of-credit during 1995 and 1994 was $2,091,644 and $3,402,000, respectively.\nDividends will continue to be paid from cash generated by operations. As more fully discussed under \"Results of Operations\" below, cash flow from operations was $3,450,436 in 1995, $5,295,756 in 1994 and $4,596,582 in 1993. The Company intends to distribute to its shareholders at least 95% of taxable income so as to maintain its qualification as a real estate investment trust under the Internal Revenue Code of 1986, as amended. The Company's policy is to pay dividends based on cash flow from operations, which usually exceeds taxable income. The quarterly dividend level was increased twice during 1994, from $.20 per share in the prior quarter to $.22 per share in January and raised again to $.25 per share in September. In 1995, the dividend was increased to $.27 per share in June.\nIn July 1995, the Company entered into an agreement to extend the maturity of the mortgage notes payable to Massachusetts Mutual Life Insurance Company which are secured by the Huntwood Associates and Wiegman Associates properties from January 1, 1996 to June 1, 1996 on the same terms and conditions as the original financings.\nIn June 1995, the Company entered into an agreement to extend the maturity of a mortgage note payable to Wells Fargo Bank which is secured by another portion of the Huntwood Associates property from June 15, 1995 to January 15, 1997 on the same terms and conditions as the original financing.\nA mortgage note payable, secured by the University Business Center property, matured and was refinanced in February 1995. A principal paydown of $3,500,000 was made in conjunction with the refinancing. The funds for the paydown were primarily obtained from a short-term mortgage loan of $3,250,000 secured by the Peachtree Corners Distribution Center, which in turn was retired as part of the closing when Peachtree was sold.\nDuring the second quarter of 1995, the Company retained Morgan Stanley & Co. Incorporated (Morgan Stanley) as its financial advisor to assess the strategic alternatives available to the Company in order to maximize shareholder value. In September 1995, Morgan Stanley recommended that the Company solicit the interest of third parties in merging with the Company or acquiring its stock or assets. Morgan Stanley also assisted the Company in the solicitation of interest of third parties. As discussed further in Note 14 to the accompanying financial statements, in February 1996, the Company entered into an Agreement and Plan of Merger under which the Company will be merged into EastGroup Properties. In the merger, each share of the Company's common stock will be converted into EastGroup shares of beneficial interest with a value of $15.60, subject to the limitations described below. The merger is subject to several conditions including approval by the shareholders of both the Company and EastGroup and registration of the shares to be issued with the Securities and Exchange Commission.\nResults of Operations\nAcquisitions and Dispositions\nIn November 1995, the Company sold its interest in the Peachtree Corners Distribution Center investment for a purchase price of approximately $10,000,000. After payment of selling expenses and the outstanding mortgage loan, the Company received net cash proceeds of approximately $7,626,000, including deposits of $125,000 and $1,165,000 received in March 1995 and June 1995. The outstanding principal balance of $2,250,000 on a $3,250,000 mortgage note payable which the buyer issued to the Company in February 1995 was retired as part of the closing. In July 1995, the Company made a payment to reduce the outstanding principal of this note by $1,000,000. The Company recognized a gain on the sale of approximately $1,806,000.\nIn July 1995, the Company purchased the Kingsview Industrial Center, an 83,000 square foot industrial building located in Carson, California, for approximately $3,000,000 in cash.\nIn June 1995, the Company sold all of its interests and rights, including its ground lease position, related to the Park North Business Center investment for approximately $18,500,000. Proceeds from the sale of approximately $12,900,000, net of the assumption of debt associated with the ground lease property, were used to pay off the mortgage notes payable to Wells Fargo Realty Advisors and the revenue bonds which were owed by the ground lessee and guaranteed by the Company. After settlement of the debt and payment of selling expenses, the Company received net cash proceeds of approximately $6,825,000, including a deposit of $125,000 received in March 1995. The Company recognized a gain of approximately $758,000.\nIn the fourth quarter of 1994, the Company sold two of the buildings at the Baygreen Industrial Park in separate transactions for proceeds of $1,782,925 and recognized gains totaling $626,931.\nIn March 1994, the Company purchased Broadway Industrial Park, an industrial building located in Tempe, Arizona, for approximately $2,350,000.\nRestructurings\nIn September 1995, the Company paid approximately $100,000 to terminate an incentive property management agreement related to Broadway Industrial Center and paid approximately $200,000 in October 1995 to terminate an incentive property management agreement related to Baygreen Industrial Park. The incentive property management agreements represented a contingent equity interest in the properties granted at the date of acquisition, payable upon sale, refinancing, or termination. Therefore, the termination fees paid have been recorded as acquisition costs and added to the Company's carrying value of the investments.\nIn August 1995, the Company entered into agreements with certain of its co- venture partners to restructure the ownership of the joint venture investments as tenancies-in-common. Effective February 1, 1996, the Company exchanged its co-tenant interest in the 270 Technology Park property to obtain 100% ownership of the Columbia Place property. Effective February 2, 1996, the Company exchanged its co-tenant interests in the Carson Industrial Center, Central Distribution Center, West Side Business Park and the three El Presidio buildings (comprising a portion of the Dominguez Properties) to obtain 100% ownership of the Metro Business Park tenancy-in-common and the remaining building in the Dominguez Properties tenancy-in-common. These transactions did not generate a material gain or a loss or have an impact on shareholders' equity.\nEffective January 1, 1994, the Company entered into a restructuring agreement giving the Company a controlling interest in three partnerships in the Park North Business Center investment (the \"Parknorth Partnerships\"). Under the restructuring, 100% ownership of the property was transferred to the Company on March 30, 1995. The remaining portion of the Park North Business Center investment included land that was leased under a long-term ground lease arrangement. As discussed above, the entire Park North Business Center investment was sold on June 30, 1995.\nSignificant Lease Transaction\nIn September 1994, M.O.R. XXXVI Associates Limited Partnership, a partnership in which the Company is a general partner (the \"Partnership\") and the owner of Columbia Place, modified the existing terms of its sole lease and mortgage loan agreements. BDM Federal, Inc. (\"BDM\"), the original tenant with a lease expiring in March 1998, desired to vacate the building and Ceridian Corporation (\"Ceridian\"), a new tenant, desired to occupy the building. BDM, Ceridian, and the Partnership entered into a series of agreements (the \"Agreements\") under which BDM is obligated for certain payments to the Partnership through March 1998. The payments are contingent on future events and are being recognized as income when the contingencies expire. In 1994, approximately $864,000 was recognized as additional income from BDM as a result of the transaction.\nCeridian entered into a lease with the Partnership which commenced September 1994 and expires December 2009, subject to earlier termination options in December 2004 and December 2006. Ceridian was responsible for all of its tenant improvements and chose to substantially re-fit this space. This resulted in the write-off by the Partnership of approximately $2,635,000 of tenant improvements and other capital costs.\nIn conjunction with the leasing transaction, the mortgage note payable to a third-party lender of approximately $10,490,000 was restructured. The interest rate was reduced from 10.125% to 8.875% per annum, effective December 1, 1994 and the maturity date was extended from May 1998 to December 2009. The maturity date may be accelerated if Ceridian exercises its termination options. The revised mortgage note requires monthly payments of principal and interest based on a twenty-year amortization schedule.\nThe Partnership's costs of the transaction have been capitalized and are being amortized over the life of the lease or loan as applicable.\nAsset Valuation\nThe estimated net realizable value of the undeveloped land at Sample\/I-95 Associates Business Park had declined significantly in prior years. In accordance with the Company's policy, the carrying value was reduced to approximate net realizable value, resulting in an investment valuation allowance of $900,000 in 1993. The value has remained stable during 1994 and 1995.\nInvestment Performance\nThe overall leased percentage for the portfolio was 98% at December 31, 1995, up from 97% a year earlier. Leases for 16% of the Company's square footage expired during 1995 and were largely renewed; leases for 26% of the Company's square footage are scheduled to expire in 1996. Management expects that occupancy will not be significantly affected by the upcoming expirations, as the demand for industrial space strengthens with the recovering economy; however, there can be no guarantee that the space will be leased or will be leased on favorable terms.\nExcluding the 1994 lease termination charges at Columbia Place and the valuation allowance on Sample\/I-95 in 1993, overall real estate operating results were $2,193,768 in 1995; $1,867,745 in 1994; and $1,319,667 in 1993. These changes between years reflect changes in the operating results of the underlying properties, as well as property acquisitions.\n1995 Results of Operations Compared to 1994\nThe improvement from the prior year is primarily due to a decrease in depreciation expense which resulted from the sale of the Park North Business Center on June 30, 1995; lower interest expense due to debt reductions at certain properties; income generated from Kingsview Industrial Center which was purchased in July 1995; and increased rental revenue at certain properties due to higher occupancy rates. These improvements were partially offset by a write- off of approximately $71,000 in rent receivable from a former tenant of the Huntwood Associates property; the expiration in the first quarter of 1995 of a lease representing approximately one-half the rentable space at the Los Angeles Corporate Center; and the loss of operating income generated from the Park North Business Center and Peachtree Corners properties which were sold during the year.\nCash flow from operations decreased by $1,845,320 between 1995 and 1994. The decrease is due primarily to the following factors: 1) under the terms of the new lease at Columbia Place, cash flow from rent in 1995 is less than in previous years; 2) cash from operations in the first quarter of 1994 benefited from the realization of cash upon conversion of the Park North Business Center property from a joint venture accounted for under the equity method to a wholly- owned property accounted for on a consolidated basis; 3) a significant lease expired at the Los Angeles Corporate Center in the first quarter of 1995; 4) the Park North Business Center was sold in the second quarter of 1995; and 5) professional fees increased as discussed below. These decreases in cash flow were partially offset by general improvement in operations at the other properties and the acquisition of Kingsview Industrial Center.\n1994 Results of Operations Compared to 1993\nA significant portion of the improvement in investment performance during 1994 is attributable to University Business Center and Peachtree Corners Distribution Center. These properties experienced notable improvement due to increases in occupancy as well as lease renewals in improved market conditions. The acquisitions of Baygreen Industrial Park in late 1993 and Broadway Industrial Center in early 1994 also contributed to the improvement. Interest expense decreased at Sample\/I-95 and Park North Business Center due to the retirement at maturity during 1994 of certain mortgage notes totaling approximately $6,600,000. Depreciation expense increased in 1994 primarily in connection with property acquisitions.\nCash flow from operations increased by $699,174 between 1994 and 1993. This increase, as with the increase in real estate operating results, is due mainly to the improved operating results of the properties, particularly University Business Center and Peachtree Corners Distribution Center. The difference between the improvement in cash flow from operations and the smaller improvement in real estate operating results is due to a number of factors including 1) the timing of receipt of rents which may differ from the period in which revenue is recognized, 2) the year-to-year change in depreciation expense which affects real estate operating results but not cash flow from operations, and 3) the year-to-year change in portfolio level expenses which affects cash flow from operations but not real estate operating results.\nPortfolio Expenses\nManagement advisory fees decreased by 37% in 1995 compared to 1994 and increased 19% in 1994 compared to 1993, which is consistent with the changes in cash flow from operations, as discussed above, upon which the management fee computation is based.\nProfessional fees for 1995 increased by approximately $756,000 compared to 1994 as a result of costs incurred by the Company related to its consideration of various strategic alternatives aimed at maximizing shareholder value and subsequent solicitation of proposals to acquire the Company or substantially all of its assets. Included in professional fees for the year ended December 31, 1995 is approximately $352,000 of investment advisory fees earned by Morgan Stanley and $324,000 in legal fees related to this process. Upon the consummation of the merger, the Company has committed to pay Morgan Stanley a transaction fee of $1.5 million, less the amounts previously paid.\nProfessional fees increased by $45,000 in 1994 over 1993 primarily due to increased utilization of outside counsel for routine legal services and an increase in auditing and accounting fees.\nFees paid to the Board of Directors in 1995, which are included in general and administrative expenses, increased by approximately $94,000 over 1994 due to increased frequency of meetings and an increase in the per meeting fee payable to each director which became effective during the second quarter of 1995.\nGeneral and administrative expenses increased by approximately $46,000 in 1994 compared to 1993, due primarily to an increase in franchise taxes.\nInterest expense for 1995 and 1994 was $184,562 and $210,241, respectively. The decrease in interest expense is the result of lower borrowings under the Company's line-of-credit. There were no borrowings or interest expense in 1993.\nIn late 1994, the Company commenced the marketing of additional equity on a private placement basis and incurred $501,227 in Deferred Financing Costs in connection with pursuing the private placement and arranging for an increased line-of-credit, which was contingent on additional equity. Discussions with potential investors did not produce an agreement on the terms of an equity investment and the Company wrote-off the Deferred Financing Costs in the quarter ended March 31, 1995.\nInflation\nBy their nature, real estate investments tend not to be adversely affected by inflation. Inflation may cause appreciation in the value of the Company's real estate investments over time if rental rates and replacement costs of properties increase. Declines in property values, over the past several years, due to market and economic conditions, have overshadowed the positive effect inflation may have on the value of the Company's investments.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data. --------------------------------------------\n- 37 -\nCOPLEY PROPERTIES, INC. ----------------------- INDEX TO FINANCIAL STATEMENTS AND SCHEDULES -------------------------------------------\nReport of Independent Accountants . . . . . . . . . . . . . . . 39\nFinancial Statements:\nConsolidated Balance Sheets - December 31, 1995 and 1994 . .40\nConsolidated Statements of Operations and Cumulative Deficit - Years ended December 31, 1995, 1994 and 1993 . . . . . . . 41\nConsolidated Statements of Cash Flows - Years ended December 31, 1995, 1994 and 1993 . . . . . . .42\nNotes to Consolidated Financial Statements . . . . . . . . .43\nFinancial Statements Schedules:\nSchedule III - Real Estate and Accumulated Depreciation at December 31, 1995 . . . . . . . . . . . . . . . . . . .59\nSchedule IV - Mortgage Loans on Real Estate at December 31, 1995 . . . . . . . . . . . . . . . . . . . 61\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- 38 -\nReport of Independent Public Accountants\nTo the Board of Directors Copley Properties, Inc.:\nWe have audited the accompanying consolidated balance sheets of Copley Properties, Inc. (a Delaware corporation) and subsidiaries as of December 31, 1995 and 1994, and the related statements of operations and cumulative deficit and cash flows for each of the three years in the period ended December 31, 1995. 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 Copley Properties, Inc. and subsidiaries as of December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, 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. Schedules III and IV are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic consolidated financial statements. These schedules have been subjected to the auditing procedures applied in our 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\nBoston, Massachusetts March 15, 1996\nCOPLEY PROPERTIES, INC. - ------------------------------------------------------------------------\nConsolidated Balance Sheets\n- ------------------------------------------------------------------------\nThe accompanying notes are an integral part of these consolidated financial statements.\nCOPLEY PROPERTIES, INC.\n- ------------------------------------------------------------------------\nConsolidated Statements of Operations and Cumulative Deficit\n- ------------------------------------------------------------------------\nThe accompanying notes are an integral part of these consolidated financial statements.\nCOPLEY PROPERTIES, INC. - -------------------------------------------------------------------------------- Consolidated Statements of Cash Flows - --------------------------------------------------------------------------------\nNoncash investing and financing activities (Notes 3 and 12)\nThe accompanying notes are an integral part of these consolidated financial statements.\nCOPLEY PROPERTIES, INC. - --------------------------------------------------------------------------------\nNotes to Consolidated Financial Statements - --------------------------------------------------------------------------------\n1 Organization and Business\nCopley Properties, Inc. (the Company), a Delaware corporation, was incorporated in May 1985 and operates as a qualified real estate investment trust under applicable provisions of the Internal Revenue Code of 1986, as amended. The Company acquires, develops, operates and owns industrial real estate. The Company currently owns and operates, either directly or through tenancy-in-common arrangements, 15 properties totaling over 2.5 million square feet of net rentable area. Copley Real Estate Advisors, Inc. (the Advisor) provides investment management and administrative services to the Company. The Advisor is an indirect wholly owned subsidiary of New England Investment Companies, L.P. (NEIC), a publicly traded limited partnership. New England Mutual Life Insurance Company is the principal unitholder of NEIC.\nAs described in Note 14, in February 1996, the Company entered into an Agreement and Plan of Merger, under which the Company will be merged into EastGroup Properties.\n2 Summary of Significant Accounting Policies\nBasis of Presentation ---------------------\nThe accompanying consolidated financial statements include the accounts of the Company and its consolidated joint ventures as of and subsequent to the date on which the Company acquired a controlling ownership interest therein. The Company has several tenancies-in-common, and previously had several other joint ventures, which are presented in these financial statements using the equity method, since control of the business is shared with the respective co-tenant. All interentity balances and transactions have been eliminated.\nUnder circumstances arising from the inability of certain of its venture partners to perform under joint venture agreements, the Company assumed control over the respective businesses. Upon restructuring, these investments have been classified as Properties in the consolidated balance sheets and any third-party mortgage financing is separately presented, and operating revenues and expenses are separately classified in property operations. Prior to restructuring, the real estate assets and third-party mortgage loans of joint ventures are considered in the investment balances and operating results are reported as share of investment earnings. The restructuring transactions do not affect the Company's net income (loss) or shareholders' equity.\nProperty --------\nProperty includes land and buildings wholly owned by the Company or owned by consolidated joint ventures. These investments are referred to herein as \"Properties\" and are stated at cost less accumulated depreciation. The Company's cost of a Property previously owned by a joint venture equals the Company's carrying value of the prior investment on the conversion date. It is the Company's policy to estimate the remaining useful life of real estate assets at the conversion date. This balance sheet caption also includes deferred leasing costs, incidental working capital items related to Properties, and the minority interest related to a consolidated joint venture.\nTenancies-in-Common, Joint Ventures and Secured Loans -----------------------------------------------------\nThe Company accounts for its investments in unconsolidated tenancies-in-common using the equity method, under which the cost of the investment is adjusted by the Company's share of the respective tenancy-in-common's results of operations and reduced by certain cash distributions received.\nThe Company has had investments in unconsolidated joint ventures which were also accounted for using the equity method as described above. In addition, the Company made loans to joint ventures in which the Company had an ownership interest.\nShare of real estate investment earnings (losses) in the accompanying consolidated statements of operations includes tenancy-in-common and joint venture earnings (losses) allocated to the Company. Allocations of tenancy-in- common earnings (losses) are made in accordance with the ownership interests of the respective co-tenants. Allocations of joint venture earnings (losses) were made to the Company's joint venture partners in accordance with the terms of the respective joint venture agreements as long as they had economic equity in the project. A joint venture partner is determined to have economic equity if the appraised value of the property exceeds the Company's total cash investment plus accrued preferential returns and interest thereon, or if the venture partner is entitled to current operating cash distributions.\nDepreciation and Capitalization -------------------------------\nMaintenance and repair costs are charged to operations as incurred. Significant improvements and renewals are capitalized. Depreciation is computed using the straight-line method based on the estimated useful lives of the buildings and improvements. Leasing and financing costs are also capitalized and amortized over the related agreement terms.\nRental Revenues ---------------\nRental revenues from certain operating leases with fixed rent increases or rent credits are recognized on a straight-line basis over the terms of the leases. The difference between straight-line rental revenues and cash rents received in accordance with the terms of the leases is recorded as accounts receivable.\nRealizability of Real Estate Investments ----------------------------------------\nThe carrying value of the Company's real estate investments is reduced to net realizable value, if lower. Since the Company's intention is to hold properties for long-term investment, net realizable value is measured by the recoverability of the investment carrying value through expected undiscounted future cash flows, net of the cost of third-party financing associated with the investment. As of December 31, 1995 and 1994, the estimated net realizable value of each real estate investment either exceeded or approximated its carrying value.\nIn March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long Lived Assets and for Long Lived Assets to Be Disposed Of\" (SFAS 121), which requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amount. SFAS 121 also addresses the accounting for long-lived assets that are expected to be disposed of. As required, the Company will adopt SFAS 121 in the first quarter of 1996. Based upon current circumstances, management believes adoption will not have any effect on the financial position of the Company.\nCash Equivalents and Short-term Investments -------------------------------------------\nCash equivalents and short-term investments are stated at cost, plus accrued interest, which approximates market. Such investments consist primarily of certificates of deposit and commercial paper. The Company considers all highly liquid debt instruments purchased with a maturity of 90 days or less to be cash equivalents; otherwise, they are classified as short-term investments.\nFinancial Instruments ---------------------\nMortgage notes payable and notes receivable are considered the Company's most significant financial instruments at December 31, 1995. Based on the interest rates on these notes, some of which are variable and several of which have recently been negotiated, the fair value of these instruments approximates their carrying values.\nPer Share Computations ----------------------\nNet income (loss) per share is computed by dividing net income (loss), after deducting any Class A dividends, by the weighted average number of shares outstanding during each year (3,584,350 in 1995, 1994 and 1993).\nUse of Estimates ----------------\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nReclassifications -----------------\nCertain reclassifications have been made to prior year amounts to conform with the 1995 presentation. There is no effect on net income (loss) or cash flow from operations.\n3 Real Estate Investments\nThe Company's real estate investments are either owned in their entirety or jointly through tenancies-in-common or joint ventures. Wholly owned property operations are under the oversight of local management companies. For jointly owned property, the Company's co-tenants or venture partners are responsible for day-to-day operating activities under separate property management agreements, and they are entitled to fees for such services. The joint venture agreements provide for the funding of cash flow deficits by the venture partners in proportion to ownership interests, and for the dilution of ownership interest in cases where a partner does not so contribute. Under the tenancy-in-common agreements, each co-tenant is responsible for funding its proportionate share of cash flow deficits.\nThe Company's cash investments in joint ventures are in two forms: a capital contribution generally subject to preferential cash distributions at a specified rate and to priority distributions with respect to sale or refinancing proceeds; and secured, interest-bearing loans to certain ventures. When converted to tenancy-in-common ownership, these loans and the corresponding accrued interest were classified as part of the Company's contribution to the capital of the new entity.\nAcquisitions ------------\nIn July 1995, the Company purchased the Kingsview Industrial Center, an 83,000 square foot industrial building located in Carson, California. The total purchase price was approximately $3,000,000.\nThe Company purchased an industrial building located in Tempe, Arizona, on March 31, 1994, which is referred to as Broadway Industrial Center. The total purchase price was approximately $2,350,000.\nSales -----\nIn November 1995, the Company sold its interest in the Peachtree Corners Distribution Center investment for a purchase price of approximately $10,000,000. After payment of selling expenses and the outstanding mortgage loan, the Company received net cash proceeds of approximately $7,626,000, including deposits of $125,000 and $1,165,000 received in March 1995 and June 1995. The outstanding principal balance of $2,250,000 on a $3,250,000 mortgage note payable which the buyer issued to the Company in February 1995 was retired as part of the closing. The loan had been secured by a first mortgage on the Peachtree Corners Distribution Center and bore interest at the rate of 10% per annum. In July 1995, the Company made a payment to reduce the outstanding principal by $1,000,000. The Company recognized a gain on the sale of approximately $1,806,000.\nIn June 1995, the Company sold all of its interests and rights, including its ground lease position, related to the Park North Business Center investment for approximately $18,500,000. Proceeds from the sale of approximately $12,900,000, net of the assumption of debt associated with the ground lease property, were used to pay off the mortgage notes payable to Wells Fargo Realty Advisors and the revenue bonds, which were owed by the ground lessee and guaranteed by the Company (Note 5). After settlement of the debt and payment of selling expenses, the Company received net cash proceeds of approximately $6,825,000, including a deposit of $125,000 received in March 1995. The Company recognized a gain of approximately $758,000.\nDuring 1994, the Company sold two buildings at the Baygreen Industrial Park. Proceeds from the sales totaled $1,782,925, including a $700,000 purchase money mortgage note. Under the terms of this note, interest only is due monthly at the rate of 9% per annum, and the note matures January 1, 1997. The note is included in Notes Receivable in the accompanying consolidated balance sheet at December 31, 1995 and 1994. The Company recognized a gain on these sales of approximately $627,000 in 1994.\nRestructurings --------------\nIn September 1995, the Company paid approximately $100,000 to terminate an incentive property management agreement related to Broadway Industrial Center and paid approximately $200,000 in October 1995 to terminate an incentive property management agreement related to Baygreen Industrial Park. The incentive property management agreements represented a contingent equity interest in the properties granted at the date of acquisition, payable upon sale, refinancing, or termination. Therefore, the termination fees paid have been recorded as acquisition costs and added to the Company's carrying value of the investments.\nIn August 1995, the Company entered into agreements with certain of its co- venture partners to restructure the ownership of their joint venture investments as tenancies-in-common between the Company and the respective co-ventures. Certain amounts previously recorded by the Company as loans to the joint ventures and corresponding accrued interest have been reclassified at book value, as part of the Company's capital contribution to its ownership interest in the tenancies-in-common. These transactions did not generate a gain or loss or have an impact on shareholders' equity. Subsequent to the establishment of the tenancies-in-common, the respective ownership interests of the Company and its co-tenants-in-common are substantially as follows:\nAs discussed further in Note 14, subsequent to December 31, 1995, the Company entered into agreements with its various co-tenants to exchange ownership interests such that the Company would have a 100% ownership interest in certain of the properties owned by the tenancies-in-common and no ownership interest in the others.\nAs of January 1, 1994, the ownership of three partnerships that were formed to own a portion of the Park North Business Center investment (the \"Parknorth Partnerships\") was restructured whereby the Company became the controlling venturer and increased its legal ownership percentage. On March 30, 1995, 100% ownership of the property owned by the Parknorth Partnerships was transferred to the Company. In addition, on March 30, 1995, the Company restructured its long- term ground lease arrangement within the Park North Business Center. As discussed under \"Sales,\" the entire Park North Business Center investment was sold on June 30, 1995.\nThe following is a summary of the real estate investment structures at December 31, 1995:\n(1) The Company has a note receivable of approximately $177,000 from its co-tenant which bears interest at 10% and is secured by the co-tenant's interest in the property. (2) The Company has a preferred capital investment which bears interest at 12%.\n4 Real Estate Assets and Liabilities\nThe following is a summary of the assets and liabilities underlying the Company's real estate investments:\nAs of December 31, 1994 assets of joint ventures exclude capitalized interest or preferred returns to the Company and liabilities of joint ventures exclude amounts owed to the Company in connection with secured loans, accrued interest thereon, or accrued preferred returns. As part of the conversion to tenancies- in-common as discussed in Note 3, these items were converted at book value to the Company's ownership interest.\n5 Mortgage Notes Payable\nMortgage notes payable on Properties are summarized below. They are collateralized by real estate and, in certain cases, the assignment of rents. The mortgage notes are generally non-recourse to the other assets of the Company.\nMortgage notes payable to third-parties, based on contractual terms in existence as of December 31, 1995, mature as follows:\n(1) Includes 100% of the joint venture debt.\n(2) Amounts represent 100% of the tenancies-in-common debt. The Company's share of notes payable is consistent with its respective ownership interest (Note 3) except at West Side Business Park where the Company's share of the obligation under the notes payable is 57.38%.\nMortgage notes payable at December 31, 1994 do not include revenue bonds at Park North Business Center owed by the ground lessee, repayment of which was guaranteed by the Company. The ground lease arrangement resulted from a transaction in which the Company purchased land in a portion of Park North Business Center for lease back to the seller for a term of 60 years. Contractual rent was $142,440 per annum. The Company's guarantee of the revenue bonds was extinguished in connection with the sale of the property in June 1995.\nThe Company guaranteed 50% of the outstanding obligation of the revenue bonds at 270 Technology Park up to a maximum of $2,000,000. The outstanding principal balance of the bonds at December 31, 1995 and 1994 was $3,713,011. As discussed in Note 14, subsequent to December 31, 1995, the Company exchanged its ownership interest in the 270 Technology Park property, and its guarantee of the revenue bonds was extinguished.\n6 Results of Real Estate Investments\nOperations ----------\nThe following is a summary of the operating results of the properties underlying the Company's real estate investments:\nFuture minimum rentals under non-cancelable operating leases are as follows:\nInvestment Valuation Allowance ------------------------------\nThe estimated net realizable value of the undeveloped land at Sample\/I-95 Business Park declined significantly in 1993. In accordance with the Company's policy, the carrying value was reduced to approximate estimated net realizable value, resulting in an investment valuation allowance of $900,000 in 1993.\nSignificant Lease Transactions ------------------------------\nIn September 1994, M.O.R. XXXVI Associates Limited Partnership, a partnership in which the Company is a general partner (the \"Partnership\") and the owner of Columbia Place, modified the existing terms of its sole lease and mortgage loan agreements. BDM Federal, Inc. (\"BDM\"), the original tenant with a lease expiring in March 1998, desired to vacate the building and Ceridian Corporation (\"Ceridian\"), a new tenant, desired to occupy the building. BDM, Ceridian, and the Partnership entered into a series of agreements (the \"Agreements\") under which BDM is obligated for certain payments to the Partnership through March 1998. The payments are contingent on future events and are being recognized as income when the contingencies expire. In 1994, approximately $864,000 was recognized as additional income from BDM as a result of the transaction.\nCeridian entered into a lease with the Partnership which commenced September 1994 and expires December 2009, subject to earlier termination options in December 2004 and December 2006.\nCeridian was responsible for the cost of all of its tenant improvements and chose to substantially re-fit this space. This resulted in the write-off by the Partnership of approximately $2,635,000 of tenant improvements and other capital costs in 1994.\nIn conjunction with the leasing transaction, the mortgage note payable to a third-party lender of approximately $10,490,000 was restructured. The interest rate was reduced from 10.125% to 8.875% per annum, effective December 1, 1994, and the maturity date was extended from May 1998 to December 2009. The maturity date may be accelerated if Ceridian exercises its termination options. The revised mortgage note requires monthly payments of principal and interest based on a 20-year amortization schedule.\nThe Partnership's costs of these transactions have been capitalized and are being amortized over the life of the lease or loan as applicable.\nIn January 1996, the Company executed a lease agreement which increased the occupancy of the Los Angeles Corporate Center property from 50% to 100%.\n7 Line-of-Credit\nAt December 31, 1995, the Company had an unsecured line-of-credit agreement with a bank which was due to expire on January 31, 1996. Under its terms, the Company could borrow up to $5,000,000 at the prime rate of interest or LIBOR plus 1.5%. The average outstanding balance on the line-of-credit during 1995 and 1994 was $2,091,644 and $3,402,000, respectively, and the weighted average interest rate was 7.85% and 6.18%, respectively. There were no borrowings in 1993.\nSubsequent to December 31, 1995, the bank agreed to extend the line-of-credit agreement to July 31, 1996. All other terms and conditions are unchanged.\n8 Shareholders' Equity\nIncrease in Authorized Shares -----------------------------\nThe total number of authorized shares of the Company was increased from 8,000,000 to 20,000,000 effective June 14, 1994.\nClass A Common Stock --------------------\nOn June 3, 1985, the Company sold one share of Class A Common Stock (par value of one dollar) to the Advisor for $50,000. As the holder of such share, the Advisor is entitled to receive 10% of the Company's net gain (as defined) from the disposition of properties, reduced by any accumulated net losses. Upon termination of the Advisory Agreement, the Company will have an option to purchase the share of Class A Common Stock for an amount equal to 10% of the net gain which would be realized by the Company had all of the real estate owned by the Company as of the date of termination been sold at its fair market value. If the Company does not elect to purchase the Class A Common Stock, such share will automatically convert to shares of common stock of the Company. See Note 14 for further discussion of the Class A Common Stock.\nShareholders' Rights Plan -------------------------\nThe Company's Board of Directors unanimously adopted a shareholders' rights plan on June 28, 1990 applicable to shareholders of record on July 19, 1990. The plan, as amended on September 20, 1995, provides for the dividend of a right to buy one share of common stock for a stated amount determined in accordance with the provisions of the plan for each share of common stock outstanding. Rights would initially become exercisable on the earlier of (1) the tenth day after the date on which a person has acquired beneficial ownership of 15% or more of the Company's common stock or (2) the tenth business day after a person commences a tender or exchange offer, the consummation of which would result in such person owning 30% or more of the Company's common stock.\n9 Management Advisory Fees\nThe Company has an agreement with the Advisor, pursuant to which the Advisor provides investment management and administrative services to the Company. Fees for these services totaled $451,863, $714,761 and $601,535 for 1995, 1994 and 1993, respectively, and are determined as:\na. A base fee of 7.5% of net cash flow (as defined in the Advisory Agreement) from sources other than short-term assets, as defined.\nb. An incentive fee of 5% of net cash flow (as defined in the Advisory Agreement) from sources other than short-term assets, as defined.\nc. A short-term investment fee of 0.25% of average annual short-term assets, as defined.\nAt December 31, 1995 and 1994, payments of the incentive fees totaling $2,573,917 and $2,473,054, respectively, have been deferred and become payable only after the Company has achieved a specified return to shareholders, or refinancing or sale proceeds are distributed to shareholders. Payment of the deferred fee would also become payable upon termination or resignation of the Advisor. See Note 14 for further discussion of the management advisory fee.\n10 Deferred Financing Costs\nIn 1994, the Company commenced the marketing of additional equity on a private placement basis and incurred $501,227 in Deferred Financing Costs in connection with pursuing the private placement and arranging for an increased line of credit, which was contingent on additional equity. Discussions with potential investors did not produce an agreement on the terms of an equity investment and the Company wrote off the Deferred Financing Costs in 1995.\n11 Income Taxes\nThe Company believes that it continues to qualify as a real estate investment trust under the Internal Revenue Code of 1986, as amended. The Company has distributed all of its taxable income for 1995, 1994 and 1993. Accordingly, no provision for income taxes has been made in the accompanying consolidated financial statements. For federal income tax purposes, the amounts distributed as dividends were ordinary income, except for $1.06 per share, $.17 per share and $.06 per share in 1995, 1994 and 1993, respectively, which relate to capital gains. No portion of the dividend in any of the years presented relate to a return of capital.\n12 Noncash Investing and Financing Activities\nThe restructuring of certain joint ventures, as more fully described in Note 3, resulted in the following noncash investing and financing activities:\n13 Professional Fees\nCertain professional fees are costs incurred by the Company related to its consideration of various strategic alternatives aimed at maximizing shareholder value and subsequent solicitation of proposals to acquire the Company. Included in professional fees for the year ended December 31, 1995 is approximately $352,000 of investment advisory fees earned by Morgan Stanley and Co. Incorporated (Morgan Stanley) and legal fees of $324,000 associated with this process.\n14 Subsequent Events\nMerger Agreement ----------------\nIn February 1996, the Company entered into an Agreement and Plan of Merger under which the Company will be merged into EastGroup Properties (EastGroup). In the merger, each share of the Company's common stock will be converted into EastGroup shares of beneficial interest with a value of $15.60, subject to the limitations described below.\nThe value of EastGroup shares for purposes of calculating the ratio at which the Company's shares will be converted into EastGroup shares in the merger will be the average of the closing price of EastGroup shares on the New York Stock Exchange on the 20 trading days immediately preceding the fifth trading day prior to the effective date of the merger (the \"EastGroup Stock Price\"); however, the EastGroup Stock Price will be deemed to equal $20.25 if the average price of EastGroup shares calculated above is less than or equal to $20.25, and $23.00 if the average price of EastGroup shares is greater than or equal to $23.00. The Company has the right, waivable by it, to terminate the merger agreement without liability if the average closing price of EastGroup shares on the New York Stock Exchange on the 20 trading days immediately preceding the fifth trading day prior to (i) the date on which the Securities and Exchange Commission declares EastGroup's Registration Statement with respect to the merger effective or (ii) the date on which the Company's stockholders' meeting with respect to the merger is held, is equal to or less than $18.25.\nThe merger is subject to several conditions including approval by the shareholders of both the Company and EastGroup and registration of the shares to be issued in the merger with the Securities and Exchange Commission. Upon the consummation of the merger, the Company has committed to pay Morgan Stanley a transaction fee equal to $1.5 million, against which approximately $350,000 of other fees and expenses previously paid to Morgan Stanley will be credited.\nUpon the event of merger, the Advisor agrees to the termination of the Advisory Agreement and relinquishment of its right to, and interest in, the Class A share in consideration of payment by the Company of 95% of the amount of the unpaid incentive advisory fees.\nFebruary Exchange of Interests ------------------------------\nEffective February 1, 1996, the Company exchanged its co-tenant interest in the 270 Technology Park property to obtain 100% ownership of the Columbia Place property. In addition, the Company received $50,000 in cash and a secured promissory note of $180,000 bearing interest at 9.56% and maturing on February 1, 2000, with annual interest and principal payments of $56,250. The note is secured by a second deed of trust on the 270 Technology Park property.\nEffective February 2, 1996, the Company exchanged its co-tenant interests in the Carson Industrial Center, Central Distribution Center, West Side Business Park and the three El Presidio buildings (comprising a portion of the Dominguez Properties) to obtain 100% ownership of the Metro Business Park tenancy-in- common and the remaining building in the Dominguez Properties tenancy-in-common. As part of the exchange, the Company paid $138,000 in cash and forgave its note receivable from its co-tenant in the Carson Industrial Center property of approximately $177,000.\nCOPLEY PROPERTIES, INC. REAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1995 SCHEDULE III\nCOPLEY PROPERTIES, INC. REAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1995 SCHEDULE III (Continued)\n(a) Represents liabilities to third-party lenders.\n(b) These Properties were converted to wholly owned properties during the fourth quarter of 1993 or the first quarter of 1994. Accumulated depreciation numbers are amounts from the date of conversion through December 31, 1995.\nCOPLEY PROPERTIES, INC.\nMORTGAGE LOANS ON REAL ESTATE\nDECEMBER 31, 1995\nSCHEDULE IV\n(a) The carrying amounts of this mortgage for both book and federal income tax purposes are the same as the amount listed above. The carrying amount of the mortgages approximates its face amount.\n(b) Reconciliation of the carrying value of mortgage loans:\n(1) Effective February 2, 1996, the Company exchanged its tenancy-in-common interest in Carson Industrial Center, including the note due from the co-tenant, Central Distribution Center, West Side Business Park and the El Presidio Properties to gain 100% ownership of Metro Business Park and the East Dominguez Property.\nCOPLEY PROPERTIES INC.\nINDEX TO JOINT VENTURE FINANCIAL STATEMENTS\nPage\nColumbia Place (a)..............................................63\n(a) These financial statements are for the year ended December 31, 1995.\nCOLUMBIA PLACE (A TENANCY-IN-COMMON)\nFINANCIAL REPORT\nDECEMBER 31, 1995\nCOLUMBIA PLACE (A TENANCY-IN-COMMON) ------------------------------------\nCONTENTS --------\nDECEMBER 31, 1995 -----------------\nINDEPENDENT AUDITOR'S REPORT ON FINANCIAL STATEMENTS 65\nFINANCIAL STATEMENTS\nBalance Sheet 66\nStatement of Income 67\nStatement of Partners' Equity 68\nStatement of Co-Tenants' Equity 68\nStatement Cash Flows 69-70\nNotes to Financial Statements 71-75\nWOLPOFF & COMPANY, LLP\nTo the Tenants Columbia Place (A Tenancy-in-Common) Columbia, Maryland\nINDEPENDENT AUDITOR'S REPORT ON FINANCIAL STATEMENTS ----------------------------------------------------\nWe have audited the balance sheet of Columbia Place (A Tenancy-in-Common) as of December 31, 1995, and M.O.R. XXXVI Associates Limited Partnership as of December 31, 1994, and the related statements of income, co-tenants' equity and cash flows for the years then ended (see Note 1). These financial statements are the responsibility of the tenants' 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 Columbia Place (A Tenancy-in- Common) as of December 31, 1995, and M.O.R. XXXVI Associates Limited Partnership as of December 31, 1994, and the results of its operations and cash flows for the years then ended (see Note 1), in conformity with generally accepted accounting principles.\n\/s\/ Wolpoff & Company, LLP\nWOLPOFF & COMPANY,LLP\nBaltimore, Maryland January 23, 1996\nCOLUMBIA PLACE (A TENANCY-IN-COMMON) ------------------------------------\nBALANCE SHEET -------------\nASSETS ------\nLIABILITIES AND TENANTS' EQUITY -------------------------------\nThe notes to financial statements are an integral part of this statement.\nCOLUMBIA PLACE (A TENANCY-IN-COMMON) ------------------------------------\nSTATEMENT OF INCOME -------------------\n_______________\nThe notes to financial statements are an integral part of this statement.\nM.O.R. XXXVI ASSOCIATES LIMITED PARTNERSHIP -------------------------------------------\nSTATEMENT OF PARTNERS' EQUITY -----------------------------\nCOLUMBIA PLACE (A TENANCY-IN-COMMON) ------------------------------------\nSTATEMENT OF CO-TENANTS' EQUITY -------------------------------\n- ------------\nThe notes to financial statements are an integral part of this statement.\nCOLUMBIA PLACE (A TENANCY-IN-COMMON) ------------------------------------\nSTATEMENT OF CASH FLOWS -----------------------\n______________\nThe notes to financial statements are an integral part of this statement.\nCOLUMBIA PLACE (A TENANCY-IN-COMMON) ------------------------------------\nSTATEMENT OF CASH FLOWS -----------------------\n_______________\nThe notes to financial statements are an integral part of this statement.\nCOLUMBIA PLACE (A TENANCY-IN-COMMON) ------------------------------------\nNOTES TO FINANCIAL STATEMENTS - CONTINUED -----------------------------------------\nDECEMBER 31, 1995 -----------------\nNote 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nOrganization ------------ The financial information presented herein represents the accounts of Columbia Place (the \"Property\"). On August 16, 1995, the partners of M.O.R. XXXVI Associates Limited Partnership entered into a tenancy-in- common agreement which effectively terminated the Partnership. Simultaneously, Copley Properties, Inc. and Manekin 36 Limited Partnership (collectively known as the \"co-tenants\") formed a co- tenancy and each own an interest in the property known as Columbia Place. The tenancy-in-common agreement provides for ownership interest of 78% for Copley Properties, Inc. and 22% for Manekin 36 Limited Partnership. Prior to August 16, 1995, Copley Properties, Inc. and Manekin 36 Limited Partnership were each 50% partners in M.O.R. XXXVI Associates Limited Partnership.\nPresentation ------------ The balance sheet as of December 31, 1994, is that of M.O.R. XXXVI Associates Limited Partnership and is presented for comparative purposes. Likewise, the operating statements for the limited partnership for 1994 are presented for comparative purposes. The 1995 operating statements for Columbia Place include the operations of the limited partnership through August 15, 1995.\nProperty -------- The tenants own and operate an office\/warehouse building in Columbia, Maryland containing approximately 115,000 square feet of leasable area, leased to the BDM Corporation. The building became operational in April 1988. In September 1994, BDM vacated and subleased the building to Ceridian Corporation. Ceridian has an option to lease contiguous property; this expansion parcel can accommodate a building of 54,000 square feet. See Note 7 for the terms of the sublease with Ceridian.\nRental Income ------------- Rental income is being recognized on a straight-line basis over the term of the lease. Excess of the rental income recognized over the amount stipulated in the lease is shown as deferred rent receivable.\nExpansion Parcel Costs and Related Interest and Taxes ----------------------------------------------------- Certain preliminary costs incurred pertaining to the expansion parcel of land described above were capitalized, and the amount is reflected as predevelopment costs. Interest and real property tax expenses pertaining to the undeveloped expansion parcel are being expensed as incurred. See Note 2 for related debt.\nDepreciation ------------ Building costs and tenant improvements were depreciated using the straight-line method over the estimated useful lives of 50 years through August 15, 1995. Effective August 16, 1995, depreciation is based on an estimated useful life of 30 years.\nEffective August 16, 1995, M.O.R. XXXVI Associates Limited Partnership was terminated upon execution of the tenancy-in-common agreement. As a result of this termination, the building and improvements were restated on the books to their net book value, and depreciation commenced as if the restated amount was placed in service on August 16, 1995.\nTenant Expenses\/Reimbursements ------------------------------ Certain reimbursed expenses such as property taxes, cleaning, utilities and HVAC are reflected net of tenant reimbursement.\nCOLUMBIA PLACE (A TENANCY-IN-COMMON) ----------------------------------- NOTES TO FINANCIAL STATEMENTS - CONTINUED ----------------------------------------- DECEMBER 31, 1995 -----------------\nNote 1 - Cash and Cash Equivalents ------------------------- (Cont.) Columbia Place considers all highly liquid debt instruments purchased with a maturity of 3 months or less to be cash equivalents.\nAmortization ------------ Various deferred costs are being amortized using the straight-line method as follows:\nIncome Taxes ------------ Prior to August 16, 1995, the Property was owned by M.O.R. XXXVI Associates Limited Partnership. Partnerships, as such, are not subject to income taxes. The individual partners and co-tenants are required to report their respective shares of income or loss and other tax items on their income tax returns.\nLoss on Disposal of Tenant Improvements --------------------------------------- Loss on disposal of tenant improvements of $2,516,787 in 1994 represents the estimated net book value of tenant improvements removed to prepare the space for Ceridian Corporation (see Note 7).\nNote 2 - MORTGAGES PAYABLE\nAmerican General Investment Corporation --------------------------------------- The property is encumbered by a nonrecourse mortgage held by American General Investment Corporation in the amount of $11,000,000. The terms of the loan were modified by an agreement effective December 1, 1994. Pertinent terms of the loan are as follows:\nMortgage Amount $11,000,000 Outstanding Balance, 12\/31\/95 $10,263,748 Principal Amortization to Date $736,252 Origination Date April 28, 1988 Annual Payment $1,171,500 - Old $1,119,509 - New Interest Rate 10.125% - Old 8.875% - New Maturity Date (20-Year Amortization) December 31, 2009 Balloon Payment Upon Maturity $4,508,804\nCOLUMBIA PLACE (A TENANCY-IN-COMMON) ------------------------------------ NOTES TO FINANCIAL STATEMENT - CONTINUED ---------------------------------------- DECEMBER 31, 1995 -----------------\nNote 2 - Under the terms of the loan modification agreement, a deposit of (Cont.) $15,000 was made into an interest bearing escrow account; additional deposits are required in an amount equal to all 1995 funds in excess of normal operating expenses and required principal and interest payments. This escrow account is to be used for payment of required principal and interest payments if operating cash flow is insufficient. Any funds remaining in the escrow account in excess of $15,000 plus accrued interest at January 1, 1996, will be applied to the outstanding principal balance.\nPrincipal maturities for the mortgage during the succeeding 5 years are as follows :\n1996 $217,299 1997 237,388 1998 259,335 1999 283,311 2000 309,903\nCopley Properties, Inc. (CPI) ----------------------------- The second mortgage previously held by Mercantile-Safe Deposit & Trust Company in the amount of $1,400,000 was assigned to Copley Properties, Inc. on October 31, 1986. In conjunction with the tenancy-in-common agreement dated August 16, 1995, CPI contributed the note and accrued interest as capital. Interest was payable monthly at the prime rate plus .5% per annum. The note was secured by a first mortgage lien on approximately 4.18 acres of land known as the \"expansion parcel\" which is adjacent to the office building. Interest incurred during 1995 and 1994 of $82,911 and $105,583, respectively, has been charged to operations. As of December 31, 1994, accrued interest payable on the second mortgage amounted to $41,781.\nNote 3 - RELATED PARTY TRANSACTIONS\nThe co-tenants have various arrangements under contract with Manekin Corporation, an entity affiliated with Manekin 36 Limited Partnership.\nManagement Fee -------------- The co-tenants have entered into an agreement with Manekin Corporation to act as management agent for the property. The management agreement, which expires on December 31, 1996, provides for a management fee equal to $1,800 per month.\nPayable, Affiliates ------------------- Columbia Place participates in a central disbursing cash account with various affiliated entities. As of December 31, 1995, funds used by the co-tenancy in excess of its cash balance amounted to $27,467. Also, distributions payable to Manekin 36 Limited Partnership amounted to $18,810 as of December 31, 1995 and 1994.\nNote 4 - TENANTS' EQUITY\nCapital Investment ------------------ During 1988, Copley Properties, Inc. provided equity in the amount of $1,225,000, in exchange for a 50% interest in M.O.R. XXXVI Limited Partnership. On August 15, 1995, Copley Properties, Inc. contributed the second mortgage of $1,400,000 plus accrued interest of $124,692.\nCOLUMBIA PLACE (A TENANCY-IN-COMMON) ------------------------------------ NOTES TO FINANCIAL STATEMENTS - CONTINUED ----------------------------------------- DECEMBER 31, 1995 -----------------\nNote 5 - TAX ACCOUNTING\nTax accounting varies from financial accounting. The following is a reconciliation of financial accounting income to tax basis income:\nNote 6 - ALLOCATION OF INCOME (LOSS)\nThe 1995 net income (loss) was allocated between the partnership and the co-tenancy.\nNote 7 - LEASES\nThe building was 100% leased to BDM Corporation under a 10-year lease term which commenced in April 1988. On September 1, 1994, BDM amended its lease and executed a lease\/sublease agreement which provided for the sublease of the building to Ceridian Corporation (Ceridian) for the remainder of its lease term. Upon expiration of BDM's lease term, Ceridian will continue to lease the building under the lease\/sublease agreement. The lease\/sublease agreement requires BDM to make payments to the co-tenants as follows:\nReimbursement of outlays made or to be made on behalf of BDM $ 841,777 -------------\nSublease Fee: Up-front payments 864,549 Monthly payments of $46,667 from 9\/1\/94 to 3\/31\/98 2,006,681 ------------- 2,871,230 -------------\nTotal $3,713,007 =============\nThe $864,549 payment was recognized as income in 1994 along with the 4 monthly payments for September through December 1994 ($186,668) totaling $1,051,217. Sublease fee payments made by BDM in 1995 totaled $560,004.\nCOLUMBIA PLACE (A TENANCY-IN-COMMON) ------------------------------------ NOTES TO FINANCIAL STATEMENTS - CONTINUED ----------------------------------------- DECEMBER 31, 1995 -----------------\nNote 7 - Ceridian's lease term is for a period of 15 years commencing on (Cont.) September 18, 1994, with free rent through December 31, 1994, and a cancellation option on December 31, 2006. The average annual rent (straight-line) for the term of the lease is $1,277,736.\nThe following is a schedule of future minimum lease payments to be received from Ceridian under the noncancelable operating lease\/sublease:\n1996 $ 1,056,669 1997 1,152,730 1998 1,371,461 1999 1,444,371 2000 1,444,371 2001 - 2006 8,666,224 --------------\n$ 15,135,826 ==============\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and --------------------------------------------------------------- Financial Disclosure. --------------------\nThe Company has nothing to report under this Item.\n- 76 -\nPART III --------\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors of the Registrant. ---------------------------\nThe following table sets forth certain information as of December 31, 1995, with respect to each director, including offices of the Company held by him, his principal occupation, the names of the other publicly-held companies for which he serves as a director, his age, the number of shares of Common Stock of the Company which he reported were beneficially owned by him and the percentage of all outstanding shares of Common Stock owned by him. Each person, other than Mr. Griefen and Mr. Wheeler, has been a director since 1985. Mr. Griefen has been a director since January 1, 1991, and Mr. Wheeler had been a director since July 14, 1993.\n- 77 -\n(1) Does not include 2,400 shares beneficially owned by a charitable trust of which Mr. Anthony is a trustee, as to which he disclaims beneficial ownership. (2) Does not include 7,500 shares of Common Stock and one share of Class A Common Stock beneficially owned by Copley Real Estate Advisors, Inc., of which Mr. O'Connor is an officer and director and Mr. Wheeler was an officer on December 31, 1995. (3) Effective February 29, 1996, Steven E. Wheeler resigned from the positions of Director, President and Chief Executive Officer, and Joseph W. O'Connor assumed the duties of President and Chief Executive Officer.\n- 78 -\nItem 11.","section_11":"Item 11. Executive Compensation. ----------------------\nThe officers of the Company receive no compensation for their services as employees of the Company. Each Independent Director (as defined in the Company's By-Laws) receives a fee of $12,500 per annum for services as a director plus $2,500 for each meeting of the Board of Directors or a committee of the Board attended in person, and $500 for each meeting of the Board of Directors or a committee of the Board attended by telephone. Messrs. Anthony, O'Connor and Wheeler received no compensation paid by Copley for their services as directors of the Company. The Company reimburses the directors and officers for their expenses incurred in connection with their duties as directors or officers of the Company.\n- 79 -\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management --------------------------------------------------------------\nThe following table sets forth, to best of the Company's knowledge, the beneficial owners of more than 5% of the Company's Common Stock and the stock ownership of all directors and officers of the Company as a group, both as of December 31, 1995:\n(1) According to the Schedule 13D filed by EastGroup Properties (\"EastGroup\") with the Company on September 15, 1995.\n(2) Includes 7,500 shares of Common Stock and one share of Class A Common Stock owned by Copley Real Estate Advisors, Inc., the Company's asset management advisor, with which some of the Company's directors and all of its officers are affiliated. Also includes 2,400 shares of Common Stock owned by a charitable trust of which a director of the Company is a trustee, as to which he disclaims beneficial ownership.\n- 80 -\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions ----------------------------------------------\nMessrs. O'Connor and Wheeler and all of the officers of the Company are employees of Copley Real Estate Advisors, Inc. (the \"Advisor\"), which provides the Company with advice with respect to the acquisition, holding and disposition of investments, acts as the Company's agent in making and disposing of investments and conducts the Company's day-to-day investment operations. During the fiscal year ended December 31, 1995, the Advisor earned fees for these services in the amount of $451,863; $272,579 was paid currently and $179,284 was deferred and becomes payable only after the Company has achieved a specified return to shareholders, or refinancing or sale proceeds are distributed to shareholders. Payment of the deferred fee would also become payable upon termination or resignation of the Advisor. Upon the event of Merger, the Advisor agreed to the termination of the Advisory Agreement and relinquishment of its right to, and interest in, the Class A share in consideration of payment by the Company of 95% of the amount of the unpaid incentive advisory fees. In addition, the Advisor was reimbursed $40,395 for out-of-pocket expenses.\n- 81 -\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 - The Financial Statements listed on the accompanying Index to Financial Statements and Schedules are filed as a part of this Annual Report.\n(2) Financial Statement Schedules - The Financial Statement Schedules listed on the accompanying Index to Financial Statements and Schedules are filed as part of this Annual Report.\n(3) Exhibits - The Exhibits listed in the accompanying Exhibit Index are filed as a part of this Annual Report and incorporated in this Annual Report as set forth in said Index.\n(b) Reports on Form 8-K. On October 6, 1995, the Company filed one current report on Form 8-K dated September 28, 1995, reporting item No. 5 \"Other Events,\" in which the Company reported that on September 20, 1995 it had amended the rights agreement between the Company and State Street Bank & Trust Company.\n- 82 -\nCOPLEY PROPERTIES, INC. -----------------------\nINDEX TO FINANCIAL STATEMENTS AND SCHEDULES -------------------------------------------\n(Information Required by Item 8 of Form 10-K)\nFINANCIAL STATEMENTS --------------------\nThe consolidated balance sheets as of December 31, 1995 and 1994, the related statements of operations and cumulative deficit and statements of cash flows for the years ended December 31, 1995, 1994, and 1993, together with the applicable report of independent public accountants, are included in Item 8.\nSCHEDULES ---------\nSchedule III - Real Estate and Accumulated Depreciation -- December 31, 1995\nSchedule IV - Mortgage Loans on Real Estate -- December 31, 1995\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- 83 -\nExhibit Index ------------- Exhibit Page Number Number - ------- ------\n2 Agreement and Plan of Merger dated as of * February 12, 1996 between Copley Properties, Inc. and EastGroup Properties.\n3 (i) Articles of Incorporation. Restated * Certificate of Incorporation of Copley Properties, Inc. dated June 24, 1985; Certificate of Amendment to the Certificate of Incorporation of Copley Properties, Inc. dated May 9, 1990; Certificate of Amendment to the Restated Certificate of Incorporation of Copley Properties, Inc. dated June 16, 1994.\n3 (ii) By-Laws. By-Laws of Copley Properties, Inc. as * amended to date.\n4 Rights Agreement dated as of June 28, 1990 * between Copley Properties, Inc. and State Street Bank & Trust Company as amended September 20, 1995.\n* Previously filed and incorporated herein by reference.\n- 84 -\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nCOPLEY PROPERTIES, INC.\nDate: March 15, 1996 By: \/s\/ Joseph W. O'Connor ----------------------- Joseph W. O'Connor 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- 85 -","section_15":""}
{"filename":"90721_1995.txt","cik":"90721","year":"1995","section_1":"Item 1. - Business\nSirco International Corp. (the \"Company\") designs, manufacturers and markets a broad line of soft luggage, sports bags, backpacks, children's bags, tote bags and related products. The Company's strategy is to produce a diverse line of high quality, fashionable products at competitive prices. The Company believes its ability to merchandise high quality products is facilitated by its creative design, manufacturing and sourcing capabilities. On March 20, 1995, the Company sold its handbag division, which manufactured and marketed a line of woman's handbags, to an entity controlled by the Company's former senior management. See \"Recent Events.\"\nThe Company sells its products under many trade names, including \"Action Luggage,\" \"Cross Trainer,\" \"Sirco Kids\" and \"Mondo,\" all of which are registered. In addition, the Company sells its products under certain trademarked names licensed from others, including \"Atlantic,\" \"Dunlop,\" \"Cherokee,\" \"Generra,\" \"Golds Gym\" and \"FILA.\" See \"License Agreements.\" During its past fiscal year, the Company began designing and manufacturing soft luggage and sports bags on a contract basis for unaffiliated retailers.\nVirtually all of the Company's products are manufactured by foreign suppliers in accordance with the Company's design specifications. During the fiscal year ended November 30, 1995, approximately 94.13% of the Company's products were manufactured in The People's Republic of China. The primary markets for the Company's products are the United States and Canada. Reference is hereby made to Note 9 of the Notes to Consolidated Financial Statements for information with respect to the amount of net sales, net income (loss) and identifiable assets of the Company's foreign operations. The Company engages in only one line of business and does not consider such business to be divided into \"industry segments.\"\nThe Company was incorporated in New York in 1964.\nRecent Events\nDuring the fiscal years ended November 30, 1995, 1994 and 1993, the Company experienced significant operating losses and reduced cash flow resulting primarily from the operation of its former handbag division. See Item 7. - Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nOn March 20, 1995, pursuant to a Stock Purchase Agreement, dated as of March 20, 1995, among Joel Dupre (the current Chairman of the Board and Chief Executive Officer of the Company), Pacific Million Enterprise, Ltd., a Hong Kong corporation, Cheng-Sen Wang and Albert H. Cheng (collectively, the \"Buyers\"), and Yashiro Company, Ltd. and Yashiro Co., Inc., corporations at that time controlled by Yutaka Yamaguchi, then the Chairman of the Board and Chief Executive Officer of the Company (collectively, the \"Yashiro Companies\"), the Buyers acquired from the Yashiro Companies an aggregate of 681,000 shares of Common Stock of the Company (constituting at the time of such purchase approximately 56.04% of the outstanding shares of Common Stock of the Company) for a purchase price of $1,532,230. Concurrently with such purchase, the Company entered into an Asset Purchase Agreement with Bueno of California, Inc., a Delaware corporation (\"Bueno\") and an affiliate of the Yashiro Companies, pursuant to which the Company sold to Bueno all of the assets relating to the Company's handbag division for an aggregate purchase price of $1,785,666. During the fiscal years ended November 30, 1995, 1994 and 1993, the Company's former handbag division had net sales of approximately $1,423,000, $9,182,000 and $9,805,000, respectively, which represented approximately 5.7%, 33.3% and 35.1%, respectively, of the Company's total net sales for those periods. See \"Item 11. Executive Compensation -- Change in Control of the Company.\"\nMarkets and Customers\nThe Company sells its products primarily to large national retail chain stores, including Target Stores, Sears Roebuck & Co., Inc., Kmart Corporation and Wal-Mart Stores, and to regional discount store chains, such as Shopko Stores, Inc., Bradlees Inc. and Caldor Corp. The Company also sells to department stores and other specialty stores, including J.C. Penney Co. Inc., Liberty House Inc., Macy's Northeast, Inc. and Mervyn's, and apparel chain stores, such as TJ Maxx\/Marshall's and Ross Stores, Inc. The Company also sells its products to sporting goods retailers, such as The Sports Authority and Sports Mart, and to warehouse clubs, such as Price Costco. The loss by the Company of several of these customers would have an adverse effect on the Company's profitability. However, the Company believes that these customers, if lost, could be partially, if not completely, replaced by others.\nDuring the fiscal years ended November 30, 1995, 1994 and 1993, sales to Target Stores represented approximately 25%, 22% and 20%, respectively, of net sales. No other customer accounted for more than 10% of net sales in any of such fiscal years.\nThe Company currently maintains showrooms in New York City and Toronto. The Company solicits business directly from its customers, using the services of both full-time sales persons and independent sales representatives. The independent sales representatives represent a number of manufacturers or wholesalers other than the Company, and are compensated on a commission basis, typically pursuant to the terms of a non-exclusive sales representative contract. The Company fills orders on the terms and conditions of standard purchase orders it receives from customers.\nThe Company's sales are seasonal and are governed by the peak retail seasons of Christmas, \"back-to-school\"\/fall and spring. As a result of the shipping deadlines of retailers designed to meet these peak seasons, the Company's sales are higher in the third and fourth quarters than in the first and second quarters of the Company's fiscal year.\nThe Company's percentage of sales by fiscal quarter for the fiscal years ended November 30, 1995, 1994 and 1993:\n1995 1994 1993 ------ ------ -----\nFirst fiscal quarter 19.5% 17.1% 18.0%\nSecond fiscal quarter 21.3 22.4 25.1\nThird fiscal quarter 31.9 33.0 26.6\nFourth fiscal quarter 27.3 27.5 30.3 ----- ----- -----\n100.0% 100.0% 100.0% ===== ===== =====\nDesign and Merchandising\nThe Company's licensed and branded products feature dynamic and colorful new styles that use innovative graphics and product designs and are constructed of quality fabrics and other materials. In order to continue to provide high-quality designs for both its licensed and non-licensed products, the Company established a design development center employing creative and merchandising professionals who work with state-of-the-art resources. In addition, the Company actively solicits participation from key customers in the development of specific products.\nThe Company's design and merchandising department, which includes five full-time employees and is based out of the Company's headquarters, emphasizes creativity and responsiveness to consumer preferences in the development of new products. The design and merchandising department, together with the Company's marketing personnel, evaluates the designs and fashion trends in the marketplace and applies these in its product development. The Company's design and marketing personnel frequently visit customers, suppliers and trade shows and conduct market research to identify developing consumer trends and new product ideas.\nThe Company's existing customer base continues to be a significant source of sales growth, and the Company remains committed to servicing their production and quality needs. Management believes that the Company's responsiveness to customer needs is widely recognized by retailers.\nLicense Agreements\nThe Company has licensing agreements with Airway Industries, Inc. (Atlantic), Dunlop Slazenger Corporation, The Generra Company, Cherokee Inc., FILA Sport S.p.A. (\"FILA\") and Gold's Gym International, Inc., and is in negotiations for license agreements with several other licensors of national reputation. Sales by the Company under trademarked names licensed from others accounted for approximately 65%, 49% and 53% of the Company's net sales during the fiscal years ended November 30, 1995, 1994 and 1993, respectively.\nThe Company's licenses generally entitle the Company to use the names, symbols and logos of the licensors on a non-exclusive basis in the manufacture and sale of the Company's products. All of the Company's licenses call for a royalty to be paid to the licensor based on a percentage of net sales. Royalties vary by product and licensor and generally range from 5.0% to 7.5%. Minimum payments are applied against royalty fees either over the term of the contract or annually, depending on the contract. In addition, the licenses generally require payments by the Company to certain promotional programs sponsored by the licensor.\nThe Company's license agreements generally have terms of three years. The terms of renewal options are negotiated and vary on a license-by-license basis. Historically, the Company's licenses have been renewed.\nIn February 1996, the Company entered into an amendment to its license agreement with FILA, pursuant to which the Company has agreed to terminate its marketing and sales of products incorporating the \"FILA\" name or trademark on February 9, 1996, and to terminate shipping of any such products to customers on June 30, 1996, subject to certain retained rights to liquidate any remaining inventories over 60 days. During the two fiscal years ended November 30, 1995 and 1994, the Company's net sales of \"FILA\" products amounted to approximately $5,314,000 and $1,357,000, respectively, which represented approximately 21.6% and 4.9%, respectively, of the Company's total net sales for those periods. The Company did not have any sales of \"FILA\" products during the year ended November 30, 1993. The Company expects that, upon termination of its license with FILA, a significant portion of the net sales of \"FILA\" product that would have been realized by the Company during the remaining 13 months of the original term of the FILA license agreement will be replaced by sales of other licensed products, including products incorporating the recently-licensed \"Gold's Gym\" and \"Generra\" names, symbols and logos.\nTrademarks\nThe Company sell products under proprietary trade names and logos, including \"Action Luggage,\" \"Cross Trainer,\" \"Mondo,\" and \"Sirco Kids,\" all of which are registered in the United States. The Company considers its trademarks to be of considerable value to its business and intends to protect them to the fullest extent practicable. The Company takes all reasonable measures to assure that any product bearing a Company-owned trademark or logo reflects the consistency and quality associated with its licensed products.\nSuppliers\nThe Company's products are produced by various manufacturers in The People's Republic of China, Taiwan, Thailand and Viet Nam. Although the simultaneous loss of several of these manufacturers would temporarily adversely affect the Company's business, the Company is of the opinion that generally these manufacturers could be replaced by others. The Company's business could also be adversely affected by a disadvantageous change in the exchange rate of the dollar with certain foreign currencies, by changes in tariffs or import restrictions, as well as political and economic conditions in the countries from which it imports.\nDuring the fiscal years ended November 30, 1994 and 1993, certain purchases by the Company's former handbag division were made from affiliates of the Company. During those years, the Company purchased in the aggregate approximately $9,000 and $221,000 of handbags and accessories from Yashiro Co., Inc. (\"Yashiro\"), representing approximately 0.1% and 1.6%, respectively, of the Company's total purchases during those years. No such purchases were made during the fiscal year ended November 30, 1995. Yutaka Yamaguchi, the former Chairman of the Board and Chief Executive Officer of the Company, was, at the time of such purchases, the President and a Director of Yashiro. The Company purchased the handbags and accessories from Yashiro under the terms of a long-term Product Supply Agreement with Yashiro (the \"Product Supply Agreement\"), that was terminated on March 20, 1995. The terms of the Product Supply Agreement permitted the Company to purchase goods from other suppliers. In addition, during the fiscal years ended November 30, 1995, 1994 and 1993, the Company purchased approximately $734,000, $3,489,000 and $2,858,000, respectively, of handbags and accessories from Lucci Creations, Ltd., a manufacturer of handbags (\"Lucci\"), representing approximately 6.5%, 23.6% and 21.3%, respectively, of the Company's total purchases during those periods. At the time of such purchases, approximately 45% of Lucci was owned by the same individuals that owned the Yashiro Companies. See \"Item 13. - Certain Relationships and Related Transactions.\"\nThe Company sold its former handbag division on March 20, 1995 (see \"Recent Events\"). As a result, the Company does not anticipate making any significant purchases in the future from either of the Yashiro Companies or Lucci. The Company does not have any contractual arrangements with its suppliers. Substantially all of the Company's purchasing is conducted through the use of standard purchase orders, a substantial portion of which are supported by trade letters of credit.\nFor the fiscal years ended November 30, 1995, 1994 and 1993, the Company's products were manufactured in the following countries:\n1995 1994 1993 ---- ---- ----\nChina 94.13% 79.57% 83.72%\nTaiwan 4.39 14.66 10.18\nThailand 1.24 5.71 4.50\nViet Nam 0.24 -- --\nJapan -- 0.06 1.60 ------ ------ ------\nTotal 100.00% 100.00% 100.00% ====== ====== ======\nCompetition\nThe Company experiences substantial competition in most of its product categories from a number of well established domestic and foreign distributors, some of which have greater financial resources than the Company. The Company believes the principal competitive factors affecting its business are styling, pricing and distribution. Increased competition by existing and future competitors could result in reductions in sales or prices of the Company's products that could materially adversely affect the Company's profitability. In addition, a substantial portion of the Company's products are sold under non-exclusive licensing agreements. Although the Company has been successful in obtaining and renewing such licenses, there can be no assurance that existing competitors will not obtain competing licenses in the future or that additional large, well-financed companies will not enter the licensed luggage, sport bag or backpack business. Because the Company imports its manufactured goods from overseas suppliers, delivery to its customers is dependent upon the timing of overseas manufacturing and shipping schedules, which may put the Company at a competitive disadvantage to domestic manufacturers.\nEmployees\nAt November 30, 1995, the Company employed 99 employees, of which 89 were employed on a full-time basis and 10 were employed on a part-time basis, and had approximately 32 independent sales representatives. At such date, approximately 16 of the Company's employees were employed in the Company's executive offices in Stamford, Connecticut, approximately 75 were employed in the Company's warehouse in La Mirada, California, one was employed in the Company's showroom facility in New York, New York, and approximately seven were employed in the Company's Canadian showroom and warehouse facilities in Ontario, Canada. The Company is not subject to any collective bargaining agreement and believes that its relationship with its employees is good.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. - Properties\nThe following table sets forth pertinent facts concerning the Company's material properties at February 15, 1996, all of which are owned or leased by either the Company or one of its subsidiaries:\n- ----------------- (1) The lease expires 10 years and six months following the date of substantial completion of the build out of these premises, which date by the terms of the lease must be no later than April 18, 1996.\n(2) The Company is required to pay its proportionate share of any increase during the term of the lease in real estate taxes and expenses of maintaining the premises computed on the basis of the percentage of the total square footage of the premises occupied by the Company.\n(3) Approximately 38,000 square feet of warehouse and office space has been subleased to Bueno through the end of the lease term at a rental rate of $10,000 per month.\nThe Company estimates that its owned and leased space is fully utilized for the purposes set forth in the table above under the caption \"Use,\" and believes that its properties are suitable and adequate for the business of the Company.\nItem 3.","section_3":"Item 3. - Legal Proceedings\nThe Company is not involved in any pending legal proceeding other than non-material ordinary routine litigation incidental to its business.\nItem 4.","section_4":"Item 4. - Submission of Matters To A Vote of Security Holders\nNot applicable.\nPart II\nItem 5.","section_5":"Item 5. - Market for the Company's Common Equity and Related Stockholder Matters\nThe Common Stock, $.10 par value (the \"Common Stock\"), of the Company is traded in the over-the-counter market and is quoted on the NASDAQ inter-dealer automated quotations system. The high and low bid quotations for each quarterly period of the Company's last two fiscal years are listed below:\nHigh Low ----- ----- Fiscal 1995 1st quarter 2 3\/4 2 1\/4 2nd quarter 2 1\/4 1 1\/2 3rd quarter 2 1 1\/4 4th quarter 2 1\/2 1 1\/2\nFiscal 1994 1st quarter 2 3\/4 2 3\/4 2nd quarter 3 2 3\/4 3rd quarter 2 3\/4 2 3\/4 4th quarter 2 3\/4 2 3\/4\n(The quotations set forth in the table above reflect inter-dealer prices, without retail mark-up, mark-down or commission, and may not necessarily represent actual transactions.)\nAs of February 15, 1996, there were 212 holders of record of the Common Stock.\nThe Company has not declared any cash dividends during the past fiscal year with respect to the Common Stock. The declaration by the Company of any cash dividends in the future will depend upon the determination of the Company's Board of Directors as to whether, in light of the Company's earnings, financial position, cash requirements and other relevant factors existing at the time, it appears advisable to do so.\nItem 6.","section_6":"Item 6. - Selected Financial Data\nThe following selected financial information has been taken from the consolidated financial statements of the Company. The information set forth below should be read in conjunction with \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and the financial statements and related notes included elsewhere in this Report.\nItem 7.","section_7":"Item 7. - Management's Discussion and Analysis of Financial Condition and Results of Operations\nFiscal Year 1995 Compared to Fiscal Year 1994\nNet sales for fiscal year 1995 decreased by approximately $2,787,000 to approximately $24,812,000 as compared to approximately $27,600,000 reported in fiscal 1994. The reduction in net sales is primarily attributable to the sale of the Company's handbag division on March 20, 1995, which division accounted for net sales of approximately $9,182,000 in fiscal 1994 as compared to approximately $1,423,000 through the date of its sale in fiscal 1995. This $7,759,000 decrease in fiscal year 1995 net sales was partially offset by increases in net sales for the Company's luggage and backpack divisions, which increased by approximately $2,871,000, and by increases in the Company's Canadian sales, which increased by approximately $2,263,000.\nAlthough the Company's net sales were lower in fiscal 1995 as compared to fiscal 1994, the Company's overall gross profit in fiscal 1995 increased by $63,000, and the Company's gross profit percentage improved from 22.0% in fiscal 1994 to 24.7% in fiscal 1995. The ability of the Company to increase its gross profit percentage and increase its overall gross profit is primarily attributed to the increased sales of the Company's luggage and backpack divisions and the Company's Canadian subsidiary, which have higher gross margins than the sales of the former handbag division.\nAfter extensive negotiations with FILA Sport S.P.A. (\"FILA\"), the Company and FILA entered into an agreement in February 1996 pursuant to which the Company will cease to ship products under the FILA license after June 30, 1996, subject to certain rights with respect to remaining inventories. The Company is no longer accepting sales orders for its FILA products. Net sales of the FILA products amounted to approximately $5,314,000 in fiscal 1995. The Company expects to ship approximately $6,000,000 of FILA product in fiscal 1996 prior to the June 30, 1996 expected cut off date. In order to maintain its sales levels in the future, the Company is currently pursuing new license agreements. The Company has recently entered into several new licenses and expects to enter into additional licenses in fiscal 1996; however, the Company's future net sales could be negatively impacted if sales from new licenses or increases in sales under existing licenses do not replace the lost FILA sales.\nSelling, warehouse, general and administrative expenses decreased by approximately $2,622,000 to approximately $6,276,000 in fiscal 1995 as compared to $8,898,000 in fiscal 1994. The reduction in the above expenses is primarily attributed to (i) the sale of the handbag division, resulting in cost and expense reductions aggregating approximately $1,600,000 in fiscal 1995, (ii) certain non-recurring charges aggregating approximately $930,000 in fourth-quarter of fiscal 1994 (described more fully below), and (iii) management's continuing effort to reduce operating costs.\nInterest expense increased by approximately $78,000 from approximately $789,000 in fiscal 1995 to approximately $867,000 in fiscal 1995. The increase in interest expense is primarily attributed to higher average outstanding borrowings during fiscal 1995. Of such increase, approximately $28,000 represents interest expense incurred in connection with the restrictive covenant and severance agreements entered into with the Company's former controlling shareholders.\nThe Company's sale of its former handbag division in the second quarter of fiscal 1995 resulted in a non-recurring loss of approximately $425,000. Miscellaneous income declined by approximately $693,000 in fiscal 1995 from approximately $1,023,000 in fiscal 1994 to approximately $330,000 in fiscal 1995. This decline was primarily attributable to a one-time income item in fiscal 1994 resulting from the reversal in fiscal 1994 of an accrued expense in the amount of approximately $620,000 related to a potential claim by a former tax-exempt bondholder.\nFiscal Year 1994 Compared to Fiscal Year 1993\nGross sales for fiscal year 1994 increased $272,000 to approximately $30,806,000 as compared to $30,534,000 reported in fiscal 1993. Gross profit for these same periods declined by approximately 8% to $6,067,000 in fiscal 1994 from $6,620,000 in fiscal 1993. Gross sales for the Company's United States operations increased by approximately $832,000; however, this increase was partially offset by sales decreases of approximately $560,000 reported by the Company's Canadian and Hong Kong Subsidiaries. The reduction in gross profit was primarily attributable to the operations of the Company's handbag division. As a result of a decline in sales volume of the handbag division, the Company reduced the selling prices of its handbag products in order to reduce inventory, which resulted in reduced gross profit margins. In addition, the significant decline in net sales experienced by the Company's former handbag division adversely impacted the Company's operating cash flow. In order to generate sufficient cash flow for operations, the Company reduced the selling prices of certain products in its luggage division, which resulted in lower gross profit margins.\nOther factors, to a lesser extent, also contributed to the decline in gross profit margins. During fiscal 1994, one of the principal suppliers to the Company's former handbag division experienced production problems, which delayed the Company's receipt of goods. As a result of the delay, the Company was unable to fill customer orders on a timely basis. In order to satisfy its customers, the Company substantially reduced the selling price of goods that were delivered late. Competitive pressures faced by the Company also resulted in the reduction by the Company of its selling prices in an attempt to maintain market share and sales volume. Gross profit margins were also affected by additional reserves (approximately $440,000, largely for customer chargebacks and sales credits) established in the fourth quarter of fiscal 1994.\nSelling, warehouse and general and administrative expenses increased 24% or $1,700,000 to approximately $8,900,000 in fiscal 1994 from approximately $7,200,000 in fiscal 1993. This increase in expenses was primarily caused by the following: (i) an increase in salaries of approximately $300,000, (ii) an increase in letter of credit fees of approximately $135,000 due to the additional utilization of the Yashiro credit line, (iii) an increase in factoring fees of approximately $60,000 due to an increase in domestic sales, (iv) an increase in bad debt expense and other allowances of approximately $135,000, (v) an increase in overseas travel expense of approximately $170,000, and (vi) the write-off of merchandise damage claims of approximately $200,000. In addition, the Company incurred, approximately $936,000 of non-recurring expenses in the fourth quarter of fiscal 1994, consisting of (i) the $125,000 reserve established for the Easement (as described below); (ii) a $275,000 allowance to provide for potential uncollectible amounts due from the sale of a former subsidiary; (iii) write-offs of approximately $170,000 related to the Company's Hong Kong subsidiary; (iv) a write-off in the amount of $192,000 of receivables arising out of damage claims against suppliers deemed uncollectible; (v) a write-off of approximately $103,000 due from Messrs. Takeshi Yamaguchi and Yutaka Yamaguchi relating to indebtedness that was deemed uncollectible in the fourth quarter; and (vi) $98,000 in other write-offs.\nDuring its fiscal year ended November 30, 1992, the Company sold to an unrelated third party certain real property for $1,300,000 in cash. The Company had retained certain rights under an easement relating to the real property (the \"Easement\"), which it later sold to another unrelated third party. During the fourth quarter of fiscal 1994, the Company determined that substantial doubt existed as to its ability to collect a portion of the remaining amounts due from the sale of the Easement and, accordingly, established a reserve of $125,000 to provide for potential uncollectible amounts.\nInterest expense in fiscal 1994 increased by approximately $160,000 over the interest expense in fiscal 1993. This change was caused primarily by increases in interest rates and loans payable.\nMiscellaneous income increased approximately $864,000 to $1,023,000 in fiscal 1994 from $159,000 in fiscal 1993. This increase is primarily attributable to the reversal of an accrued expense of $620,000 related to the claim by a former tax-exempt Bondholder.\nLiquidity and Capital Resources\nThe Company had cash and cash equivalents of approximately $176,000, and working capital of approximately $1,143,000 at November 30, 1995. During fiscal 1995, the Company's operating activities used cash flow of approximately $1,505,000, as compared to fiscal 1994, when operating activities used approximately $441,000, and fiscal 1993 when operating activities provided approximately $1,129,000 of cash flow.\nIn March 1995, the Company entered into an agreement with Yashiro, pursuant to which Yashiro has agreed to issue or cause to be issued, until March 20, 1997, unsecured trade letters of credit in an aggregate amount of up to the lesser of $1,200,000 or 35% of the book value of the Company's inventory. Yashiro charges the Company a handling fee of 3% for each letter of credit that is opened. The letter of credit facility enables the Company to maximize its purchasing ability, as it provides a credit facility in addition to the Company's factoring arrangement described below. At November 30, 1995, the Company was directly indebted to Yashiro for approximately $536,000. There was available approximately $664,000 under this facility at November 30, 1995, which amount has since been utilized. Interest is payable to Yashiro monthly at 2% above the prime rate.\nThe letter of credit facility with Yashiro will expire by its terms on March 20, 1997. The Company currently has no plans to replace this facility, as management expects that the Company's cash flows from its operations and factoring arrangement and credit terms available from vendors will provide the Company with sufficient liquidity.\nThe Company has an agreement with a factor pursuant to which the Company sells its accounts receivable to the factor on a pre-approved non-recourse basis. Under the terms of the agreement, the factor advances funds to the Company on the basis of invoice amounts. Interest on such advances is 1.75% per annum above the prime rate. Additionally, the factor provides inventory financing to the Company based on an advance rate of 50% of the inventory value. At November 30, 1995, the factor had advanced the Company $2,000,000 for inventory financing. Interest on such advances is 1.75% per annum above the prime rate. The Company also pays a factoring commission of .75% of each invoice amount, subject to a minimum of $96,000 per annum.\nOn August 1, 1995, the Company's Canadian subsidiary entered into a financing agreement with a Canadian bank that provided for a revolving loan in the amount of $525,000, with interest payable monthly at 1.25% above the Canadian prime rate. The proceeds of this loan are utilized by the Canadian subsidiary for purchasing inventory and financing day-to-day operations. The bank extended two term loans to the Canadian subsidiary, pursuant to the financing agreement, in amounts of approximately $368,000 and $105,000, with interest payable monthly at 1.50% and 2.00%, respectively, above the Canadian prime rate. Substantially all the assets of the Canadian subsidiary have been pledged as security for the revolving line of credit and the term loans. Additionally, the Company has agreed to subordinate its loan to its Canadian subsidiary to the amounts payable to the bank.\nThe Company presently anticipates that it will expend approximately $150,000 in capital expenditures during fiscal 1996. A substantial portion of the capital expenditures are related to the Company's new showroom in New York City.\nManagement believes that the Company's present sources of financing, combined with its present working capital and cash flow from operations will be sufficient to provide adequate liquidity to the Company and to fund all of its capital expenditures through the foreseeable future.\nItem 8.","section_7A":"","section_8":"Item 8. - Financial Statements and Supplementary Data\nThe financial statements and supplementary data to be provided pursuant to this Item 8 are included under 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 Company\nThe following table contains certain information regarding directors and executive officers of the Company now serving, all of whom were elected at the Annual Meeting of Shareholders of the Company held on August 17, 1995. Except for Mr. Hellige and Mr. Riss, all such directors and executive officers served at all times during fiscal year 1995.\nThe term of office of the directors is one year, expiring on the date of the next annual meeting and thereafter until their respective successors shall have been elected and shall qualify, or until their death, resignation or removal. Section 16(a) of the Exchange Act requires the Company's directors and executive officers, and persons who own more than ten percent (10%) of a registered class of the Company's equity securities (\"10% Stockholders\"), to file with the Securities and Exchange Commission (the \"Commission\") initial reports of ownership and reports of changes in ownership of Common Stock and other equity securities of the Company. Officers, directors and 10% Stockholders are required by Commission regulation to furnish the Company with copies of all Section 16(a) forms they file. Each of Mr. Eric Hellige and Paul Riss, directors of the Company, failed to file with the Commission on a timely basis their Form 3 reports. Mr. Smith, a director of the Company, failed to file with the Commission on a timely basis a Form 5 report with respect to the grant of certain options.\nItem 11.","section_11":"Item 11. - Executive Compensation\nSummary of Cash and Certain Other Compensation\nThe following table sets forth, for the fiscal years indicated, all compensation awarded to, earned by or paid to the chief executive officer (\"CEO\") of the Company (Mr. Joel Dupre, the Chairman of the Board and Chief Executive Officer of the Company since March 20, 1995; Mr. Yutaka Yamaguchi, the Chairman of the Board and Chief Executive Officer of the Company prior to March 20, 1995). For the three fiscal years ended November 30, 1995, no other executive officer of the Company had a salary and bonus which exceeded $100,000.\n- ---------------- (1) Mr. Dupre held the title of Executive Vice President of the Company during the fiscal year ended November 30, 1994. On March 29, 1995, in connection with the transactions contemplated by the Stock Purchase Agreement and the Asset Purchase Agreement (See \"Item 12.","section_12":"Item 12. - Security Ownership of Certain Beneficial Owners and Management\nThe following table sets forth, as of February 15, 1996, the names, addresses and number of shares of Common Stock beneficially owned by all persons known to the management of the Company to be beneficial owners of more than 5% of the outstanding shares of Common Stock, and the names and number of shares beneficially owned all directors of the Company and all executive officers and directors of the Company as a group (except as indicated, each beneficial owner listed exercises sole voting power and sole dispositive power over the shares beneficially owned):\n- ----------- (1) Includes 266,666 shares for which Mr. Dupre has the right to exercise sole voting control pursuant to a Voting Agreement dated as of May 1, 1995 (the \"Voting Agreement\") under which Pacific, Mr. Wang and Mr. Cheng granted Mr. Dupre the right to exercise sole voting control with respect to 133,333, 88,889, and 44,444 shares, respectively, held of record by them.\n(2) As a result of the Voting Agreement, Mr. Dupre, Pacific (together with Mr. Takada -- see Note 2), Mr. Wang and Mr. Cheng may be deemed to be a \"group\" within the meaning of Section 13d-3 of the Securities Exchange Act of 1934, and, therefore, deemed to beneficially own an aggregate of 681,000 shares of Common Stock.\n(3) Pacific has granted to Mr. Dupre an option to purchase all of the 133,333 shares it owns of record. By virtue of his ownership of 95% of the issued and outstanding shares of common stock of Pacific, Joseph Takada may be deemed to be the beneficial owner of all the shares of Common Stock beneficially owned by Pacific.\n(4) Mr. Cheng has granted to Mr. Dupre an option to purchase all of the 44,444 shares he owns of record.\n(5) Consists of 10,000 shares of Common Stock subject to an option that is exercisable within 60 days.\n(6) Herzog, Heine, Geduld, Inc. reported ownership of 66,931 shares of Common Stock pursuant to a Schedule 13G received by the Company in December 1991, as amended in January 1992.\nChange in Control of the Company\nOn March 20, 1995, pursuant to a Stock Purchase Agreement, dated as of March 20, 1995 (the \"Stock Purchase Agreement\"), among Joel Dupre, the current Chairman of the Board and Chief Executive Officer of the Company, Pacific Million Enterprise, Ltd., a Hong Kong corporation (\"Pacific\"), Cheng-Sen Wang and Albert H. Cheng (Mr. Cheng, Mr. Dupre, Pacific and Mr. Wang collectively, the \"Buyers\"), and the Yashiro Companies, the Buyers acquired an aggregate of 681,000 shares of Common Stock, then constituting approximately 56.04% of the issued and outstanding shares of Common Stock, for an aggregate purchase price of $1,532,230.\nMr. Dupre acquired 414,334 shares of Common Stock, then constituting approximately 34.10% of the issued and outstanding shares of Common Stock, in exchange for a cash payment of $400,001.50 and the issuance of a promissory note (the \"Promissory Note\") in the principal amount of $532,250 in favor of Yashiro, individually and as agent for Yashiro Company, Ltd. The Promissory Note bears interest at the rate of 10% per annum payable quarterly in arrears commencing on June 30, 1996, with principal payable in equal annual installments of $88,708.33 commencing on March 31, 1996. Mr. Dupre borrowed $200,000 of the cash portion of the purchase price from Mr. Wang, which loan is evidenced by a promissory note dated March 9, 1995, bearing interest at 10% per annum and maturing on March 31, 2000. Mr. Dupre borrowed an additional $200,000 from Mr. Cheng, which loan is evidenced by a promissory note dated March 13, 1995, bearing interest at 7 3\/4% per annum and maturing on March 31, 2000.\nPacific acquired 133,333 shares of Common Stock, then constituting approximately 10.97% of the issued and outstanding shares of Common Stock, for $299,999.25 in cash. The funds for the purchase price were obtained from Pacific's working capital. Mr. Wang acquired 88,889 shares of Common Stock, then constituting approximately 7.31% of the issued and outstanding shares of Common Stock, and Mr. Cheng acquired 44,444 shares of Common Stock, then constituting approximately 3.66% of the issued and outstanding shares of Common Stock, for cash payments of $200,000.25 and $99,999, respectively. The purchase prices were paid from Mr. Wang's and Mr. Cheng's respective personal funds.\nAs an inducement to the Yashiro Companies to enter into the Stock Purchase Agreement and to cause Bueno of California, Inc., a Delaware corporation (\"Bueno\") and an affiliate of the Yashiro Companies, to enter into the Asset Purchase Agreement described below and related agreements, Mr. Dupre executed and delivered to the Yashiro Companies a guaranty, dated March 20, 1995, pursuant to which Mr. Dupre guaranteed all of the obligations of the Company under the Letter of Credit Agreement, the Non-Competition Agreements and the Severance Agreement (each as defined below).\nIn addition, the Buyers entered into a Pledge Agreement, dated as of March 20, 1995 (the \"Pledge Agreement\"), with Bueno and Yashiro, on its own behalf and as agent for Yashiro Company, Ltd. Pursuant to the Pledge Agreement, the Buyers pledged their shares of Common Stock to Bueno and the Yashiro Companies as security for the payment of (i) all obligations of Mr. Dupre under the Promissory Note, (ii) all obligations of the Buyers under the Stock Purchase Agreement, (iii) all obligations of the Company under the Asset Purchase Agreement, (iv) all obligations of the Company under any agreement that is an exhibit to the Asset Purchase Agreement, including the Exclusive Purchasing Agreement, the Non-Competition Agreements and the Severance Agreement and (v) all obligations of the Buyers under the Pledge Agreement.\nConcurrently with the closing of the transactions contemplated by the Stock Purchase Agreement and the Asset Purchase Agreement, Takeshi Yamaguchi resigned from the Board of Directors and the office of President of the Company; Yutaka Yamaguchi resigned from the Board of Directors and the offices of Chairman of the Board and Chief Executive Officer; Neil Grundman resigned from the Board of Directors of the Company; and Tsuguya Saeki resigned from the offices of Executive Vice President and Chief Financial Officer of the Company. Pursuant to a Severance Agreement, dated as of March 20, 1995, with Takeshi Yamaguchi, the Company agreed to pay Mr. Yamaguchi $100,000 plus interest at the rate of 10% per annum on March 31, 1996 and $100,000 plus interest at a rate of 10% per annum on March 31, 1997. On March 29, 1995, the Board of Directors of the Company, consisting of Mr. Dupre, Ian Mitchell, Eric Smith and Douglas Turner, elected Mr. Dupre as the Chairman of the Board and Chief Executive Officer of the Company.\nConcurrently with the acquisition by the Buyers of the shares of Common Stock under the Stock Purchase Agreement, the Company and Bueno entered into an Asset Purchase Agreement, dated as of March 20, 1995 (the \"Asset Purchase Agreement\"), pursuant to which the Company sold to Bueno all of the assets relating to the Company's handbag division for a negotiated purchase price of $1,785,666, of which $86,168 was paid in cash and $1,699,498 was applied by the Company to the repayment of indebtedness of the Company to the Yashiro Companies. The aggregate indebtedness owed by the Company to the Yashiro Companies at the date of the acquisition was $2,238,506. The Yashiro Companies, which are affiliates of Bueno, are controlled by Messrs. Yutaka and Takeshi Yamaguchi.\nIn connection with the Asset Purchase Agreement, each of the Yashiro Companies, Yutaka Yamaguchi and Takeshi Yamaguchi entered into non-competition agreements with the Company (collectively, the \"Non-Competition Agreements\"). Pursuant to the terms of the Non-Competition Agreements, each of the Yashiro Companies and Messrs. Yutaka and Takeshi Yamaguchi agreed not to compete with the Company's luggage and related products business prior to the earlier of March 20, 2001 and the date of repayment in full of all amounts due under the Promissory Note (the \"Restricted Period\"). In consideration of their agreements not to compete, the Company is obligated to pay $60,000 to each of the Yashiro Companies and each of Messrs. Yutaka and Takeshi Yamaguchi, payable in three equal annual installments commencing on March 31, 1996. In addition, pursuant to a separate non-competition agreement, the Company agreed not to compete with Bueno in the handbag business during the Restricted Period.\nAlso in connection with the Asset Purchase Agreement, the Company entered into an Exclusive Purchasing Agreement, dated as of March 20, 1995, with Yashiro (the \"Exclusive Purchasing Agreement\"), pursuant to which the Company granted to Yashiro and its designees the exclusive right to purchase in Japan, at prices to be mutually agreed upon, any goods manufactured or purchased by the Company from unaffiliated vendors (the \"Vendors\"). Under the Exclusive Purchasing Agreement, Yashiro will pay a commission to the Company for all goods purchased by it or its designees equal to 5% of the purchase price of all such goods paid by the Company (or directly by Yashiro or its designees) to the Vendors. The Exclusive Purchasing Agreement will terminate on the date that all amounts due under the Promissory Note are repaid in full and all obligations of the Company, Mr. Dupre, Pacific, Mr. Wang or Mr. Cheng, as the case may be, under the Stock Purchase Agreement and the Asset Purchase Agreement and all agreements that are exhibits thereto are satisfied in full.\nIn addition, pursuant to a letter agreement (the \"Letter of Credit Agreement\"), Yashiro has agreed to issue, or cause to be issued, for the account of the Company, from time to time until March 20, 1997, one or more unsecured trade letters of credit in an aggregate amount of up to the lesser of $1,200,000 or 35% of the book value of all inventory owned by the Company. With respect to each letter of credit issued under the Letter of Credit Agreement, the Company will be obligated to pay an origination fee equal to 3% of the full amount of such letter of credit and a financing fee based upon the outstanding balance of any letter of credit equal to the base rate of interest announced publicly by Citibank, N.A. in New York, New York, from time to time, as its base rate plus two percent (2%).\nItem 13.","section_13":"Item 13. - Certain Relationships and Related Transactions\nJoseph Takada, the beneficial owner of approximately 10.18% of the outstanding shares of Common Stock, is the Managing Director of Ideal Pacific Ltd, the Company's manufacturing agent in Hong Kong (\"Ideal\"). During the fiscal year ended November 30, 1995, the Company paid aggregate commissions of approximately $315,000 to Ideal. Mr. Wang, the beneficial owner of approximately 6.79% of the outstanding shares of Common Stock, is the Managing Director of Kao-Lien Industrial Co., Ltd., the Company's manufacturing agent in Taiwan (\"Kao-Lien\"). During the fiscal year ended November 30, 1995, the Company paid aggregate commissions of approximately $287,000 to Kao-Lien. Albert Cheng, the beneficial owner of 3.39% of the outstanding shares of Common Stock, is the President of Constellation Enterprise Co., Ltd., (\"Constellation\"). During the fiscal year ended November 30, 1995, the Company purchased approximately $193,000 of luggage and backpack products from Constellation.\nEric M. Hellige, a director of the Company, is a member of Pryor, Cashman, Sherman & Flynn, counsel to the Company (\"Pryor, Cashman\"). Fees paid by the Company to Pryor, Cashman for legal services rendered during the fiscal year ended November 30, 1995 did not exceed 5% of such firm's or the Company's revenues.\nNeil Grundman, a former director of the Company, is a member of Olshan, Grundman, Frome & Rosenzweig, former counsel to the Company (\"Olshan\"). Fees paid by the Company to Olshan for legal services rendered during the fiscal year ended November 30, 1995 did not exceed 5% of such firm's or the Company's revenues.\nYashiro has made available to the Company a line of credit for financing trade letters of credit. See Item 7. - Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources. At November 30, 1995, the Company owed Yashiro approximately $536,000, which amount related to letter-of-credit financings bearing interest at prime plus 2% per annum. Amounts borrowed under the line of credit with Yashiro are repayable within 100 days after the delivery of the related goods. The Company paid Yashiro interest of approximately $122,000 during the fiscal year ended November 30, 1995. In addition to interest, Yashiro is paid a handling fee of 3% of the cost of the goods. Such handling fees amounted to approximately $245,000 during the fiscal year ended November 30, 1995. The Company is current in its obligations to Yashiro.\nIn 1993, the Company entered into a revolving bank credit agreement for up to $2,000,000 with Shinhan Bank (the \"Shinhan Facility\"). The Shinhan Facility expired on July 31, 1995, at which time all amounts became due and payable and were paid in full. The Shinhan Facility provided for the issuance of letters of credit in favor of the Company's foreign suppliers for the purchase of inventory, with interest payable monthly at prime plus 1%. Borrowings under the facility were repayable to Shinhan Bank within 180 days of shipment of the goods. Repayment of amounts due under the facility were secured by the personal guaranty of the Company's former Chairman, Mr. Yutaka Yamaguchi, and the Company's $500,000 certificate of deposit held by the bank as collateral. Mr. Yutaka Yamaguchi did not directly receive any compensation from the Company during the fiscal year ended November 30, 1995; however, Yashiro was paid a fee of $50,000 for all services provided to the Company by Mr. Yutaka Yamaguchi.\nFor the fiscal year ended November 30, 1995, the Company also purchased in the ordinary course of business, $734,000 of handbags and accessories (representing approximately 6% of total purchases by the Company for such year) from Lucci. At the time of such purchases, 45% of Lucci was owned by the same individuals that owned Yashiro Co. Ltd. and Yashiro, including Yutaka Yamaguchi.\nThe Company believes that all purchases from affiliated parties were on terms and at prices substantially similar to those available from unaffiliated third parties.\nPart IV\nItem 14.","section_14":"Item 14. - Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(a) 1. Financial Statements\nReference is hereby made to the Table of Contents to the Financial Statements and Schedules attached hereto.\n2. Financial Statement Schedules\nReference is hereby made to the Table of Contents to the Financial Statements and Schedules attached hereto.\n3. Exhibits\n(3)(a) Certificate of Incorporation, as amended, incorporated by reference to the Company's Registration Statement on Form S-1 filed with the Securities and Exchange Commission on August 27, 1969 under Registration Number 2-34436.\n(b) Certificate of Amendment of the Certificate of Incorporation, incorporated by reference to the Company's definitive proxy statement filed with the Securities and Exchange Commission in connection with the Company's Annual Meeting of Shareholders held in May, 1984.\n(c) Certificate of Amendment of Certificate of Incorporation, incorporated by reference to Exhibit 3(b) to the Company's Annual Report on Form 10-K for the year ended November 30, 1988.\n(d) Certificate of Amendment to the Certificate of Incorporation, incorporated by reference to Exhibit 3(e) to the Company's Annual Report on Form 10-K for the year ended November 30, 1994, as amended.\n(e) By-laws, as amended, incorporated by reference to the Company's Registration Statement on Form S-1 filed with the Securities and Exchange Commission on August 27, 1969 under Registration Number 2-34436.\n10(a) Asset Purchase Agreement, dated as of March 20, 1995, between the Company and Bueno of California, Inc., incorporated by reference to Exhibit 2(b) of the Company's Current Report on Form 8-K filed on April 4, 1995.\n(b) Non-Competition Agreement, dated as of March 20, 1995, between the Company and Yashiro Co., Ltd., incorporated by reference to Exhibit of the Schedule 13D filed on April 4, 1995 by Joel Dupre, Pacific Million Enterprise Ltd., Joseph Takada, Chen-Sen Wang and Albert H. Cheng with respect to the Company's Common Stock (the \"Schedule 13D\").\n(c) Non-Competition Agreement, dated as of March 20, 1995, between the Company and Yashiro Co., Inc., incorporated by referenced to Exhibit of the Schedule 13D.\n(d) Non-Competition Agreement, dated as of March 20, 1995, between the Company and Yutaka Yamaguchi, incorporated by reference to Exhibit of the Schedule 13D.\n(e) Non-Competition Agreement, dated as of March 20, 1995, between the Company and Takeshi Yamaguchi, incorporated by reference to Exhibit of the Schedule 13D.\n(f) Exclusive Purchasing Agreement, dated as of March 20, 1995, between the Company and Yashiro Co., Inc., incorporated by reference to Exhibit G of the Schedule 13D.\n(g) Letter of Credit Agreement, dated March 20, 1995, between the Company and Yashiro Co., Inc., incorporated by reference to Exhibit H of the Schedule 13D.\n(h) Severance Agreement, dated as of March 20, 1995, between the Company and Takeshi Yamaguchi, incorporated by reference to Exhibit K of the Schedule 13D.\n(i) Lease Agreement dated February 14, 1990 between Or-May-Broward Investment Company and the Company for property located in La Mirada, California, incorporated by reference to Exhibit 10(j) to the Company's Annual Report on Form 10-k for the year ended November 30, 1989.\n(j) Employment Agreement, dated as of September 1, 1992, between the Company and Gandolfo Verra, incorporated by reference to Exhibit 10(h) to the Company's Annual Report on Form 10-K for the year ended November 30, 1994, as amended.\n(k) Sirco International Corp. 1995 Stock Option Plan, incorporated by reference to Exhibit 10(i) to the Company's Annual Report on Form 10-K for the year ended November 30, 1994, as amended.\n(22) Subsidiaries of Company - The significant subsidiaries of Company, all of which are wholly-owned by Company and included in its consolidated financial statements, are as follows:\nName Country of Organization ---- ----------------------- Sirco Industries, Limited Hong Kong Sirco International Canada (Canada) Limited\n(23.1) Consent of Nussbaum Yates & Wolpow, P.C.\n(23.2) Consent of Ernst & Young LLP\n(23.3) Consent of Deloitte & Touche\n(27) Financial Data Schedule.\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 Company has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized on the 11th day of March, 1996.\nSIRCO INTERNATIONAL CORP. (Company)\nBy: \/s\/ Joel Dupre ----------------------- Joel Dupre, 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 Company and in the capacities and on the dates indicated.\nSignature Title Date - --------- ----- ----\n\/s\/ Joel Dupre - ------------------- Chairman and Chief March 11, 1996 Joel Dupre Executive Officer (Principal Executive Officer)\n\/s\/ Gandolfo Verra - ------------------ Controller and March 11, 1996 Gandolfo Verra Assistant Secretary (Principal Financial Officer)\n\/s\/ Eric M. Hellige - ------------------- Director and March 11, 1996 Eric M. Hellige Secretary\n\/s\/ Paul Riss - ------------------- Director March 11, 1996 Paul Riss\n\/s\/ Ian Mitchell - ------------------- Director March 11, 1996 Ian Mitchell\n\/s\/ Eric Smith - ------------------- Director March 11, 1996 Eric Smith\n\/s\/ Douglas Turner - ------------------- Director March 11, 1996 Douglas Turner\nFORM 10-K ITEM 14(a)(1) AND (2)\nSIRCO INTERNATIONAL CORP. AND SUBSIDIARIES\nLIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nThe following consolidated financial statements of Sirco International Corp. and Subsidiaries are included in item 8:\nConsolidated Balance Sheets - November 30, 1995 and 1994\nConsolidated Statements of Operations - Years ended November 30, 1995, 1994 and 1993\nConsolidated Statements of Stockholders' Equity - Years ended November 30, 1995, 1994 and 1993\nConsolidated Statements of Cash Flows - Years ended November 30, 1995, 1994 and 1993\nNotes to Consolidated Financial Statements - Years ended November 30, 1995, 1994 and 1993\nThe following consolidated financial statement schedules of Sirco International Corp. and Subsidiaries are included in Item 14(d):\nSchedule I - Condensed Financial Information of the Registrant (Parent)\nSchedule II - Valuation and Qualifying Accounts - Years ended November 30, 1995, 1994 and 1993\nAll other schedules are omitted because they are not required, are inapplicable, or the information is included in the financial statements or notes thereto.\nReport of Independent Auditors\nThe Board of Directors and Shareholders Sirco International Corp.\nWe have audited the accompanying consolidated balance sheet of Sirco International Corp. and subsidiaries as of November 30, 1995, and the related consolidated statements of operations, stockholders' equity, and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We did not audit the financial statements of Sirco International (Canada) Limited, subsidiary of Sirco International Corp., which statements reflect total assets of approximately $2,213,000 as of November 30, 1995, and net sales of approximately $3,660,000 for the year ended November 30, 1995. Those financial statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to data included for that subsidiary, is based solely on the report of the other auditors.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards required that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes 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 and the report of other auditors provide a reasonable basis for our opinion.\nIn our opinion, based on our audit and the report of the other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Sirco International Corp. and its subsidiaries as of November 30, 1995, and the consolidated results of their operations and their consolidated cash flows for the year then ended, in conformity with generally accepted accounting principles.\nWe have also audited Schedule I and Schedule II for the year ended November 30, 1995. In our opinion, these schedules present fairly, in all material respects, the information required to be set forth therein.\nNUSSBAUM YATES & WOLPOW, P.C.\nFebruary 12, 1996\nDeloitte & Touche [Company Logo] Chartered Accountants\n1 City Centre Drive Telephone: (905) 803-5100 Suite 1100 Facsimile: (905) 803-6101 Mississauga, Ontario, L5B 1M2\nAuditors' Report\nTo the Shareholder of Sirco International (Canada) Limited\nWe have audited the balance sheets of Sirco International (Canada) Limited as at November 30, 1995 and 1994 and the statements of operations, retained earnings and changes in financial position for each of the years in the three year period ended November 30, 1995. 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 whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.\nIn our opinion, these financial statements present fairly, in all material respects, the financial position of the Company as at November 30, 1995 and 1994 and the results of its operations and the changes in its financial position for each of the years in the three year period ended November 30, 1995 in accordance with generally accepted accounting principles.\n\/s\/Deloitte & Touche\nChartered Accountants\nDecember 18, 1995\nReport of Independent Auditors\nThe Board of Directors and Shareholders Sirco International Corp.\nWe have audited the accompanying consolidated balance sheet of Sirco International Corp. and subsidiaries as of November 30, 1994, and the related consolidated statements of operations, stockholders' equity, and cash flows for the years ended November 30, 1994 and 1993. Our audits also included the financial statement schedule for the years ended November 30, 1994 and 1993 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 based on our audits. We did not audit the financial statements of Sirco International (Canada) Limited, subsidiary of Sirco International Corp., which statements reflect total assets of approximately $1,335,000 as of November 30, 1994, and net sales of approximately $1,397,000 and $1,889,000 for the years ended November 30, 1994 and 1993, respectively. Those financial statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it related to data included for that subsidiary, is based solely on the report of other auditors.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits and the report of other auditors provide a reasonable basis for our opinion.\nIn our opinion, based on our audits and the report of other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Sirco International Corp. International Corp. and its subsidiaries at November 30, 1994, and the results of their operations and their cash flows for the years ended November 30, 1994 and 1993, in conformity with generally accepted accounting principles. Also, in our opinion, based on our audits and the report of other auditors, the related financial statement schedule, when considered in relation to the basic financial; statements taken as a whole, present fairly in all material respects information set forth therein.\n\/s\/ERNST & YOUNG LLP ERNST & YOUNG LLP\nNew York, New York February 17, 1995\nSIRCO INTERNATIONAL CORP. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS NOVEMBER 30, 1995 AND 1994\nSee accompanying notes to consolidated financial statements.\nSIRCO INTERNATIONAL CORP. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS (CONTINUED)\nNOVEMBER 30, 1995 AND 1994\nSee accompanying notes to consolidated financial statements.\nSIRCO INTERNATIONAL CORP. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF OPERATIONS\nYEARS ENDED NOVEMBER 30, 1995, 1994 AND 1993\nSee accompanying notes to consolidated financial statements.\nSIRCO INTERNATIONAL CORP. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY\nYEARS ENDED NOVEMBER 30, 1995, 1994 AND 1993\nSee accompanying notes to consolidated financial statements.\nSIRCO INTERNATIONAL CORP. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nYEARS ENDED NOVEMBER 30, 1995, 1994 AND 1993\n(Continued)\nSee accompanying notes to consolidated financial statements.\nSIRCO INTERNATIONAL CORP. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)\nYEARS ENDED NOVEMBER 30, 1995, 1994 AND 1993\nSee accompanying notes to consolidated financial statements.\nSIRCO INTERNATIONAL CORP. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED NOVEMBER 30, 1995, 1994 AND 1993\n1. Description of Business and Summary of Accounting Principles\nDescription of Business and Concentration of Credit Risk\nThe Company is a wholesaler of children's bags, tote bags, soft luggage and related products principally in the United States and Canada. The principal markets for the Company's products are the large national retail chain stores, department stores, specialty stores and sporting goods retailers. Prior to the sale of its handbag division on March 20, 1995, the Company also was a wholesaler of handbags (see Note 13).\nPrinciples of Consolidation\nThe consolidated financial statements include the accounts of the Company and its subsidiaries after elimination of significant intercompany balances and transactions. At November 30, 1995, approximately 56% of the common stock is owned by Joel Dupre, Joseph Takada and Albert Cheng, pursuant to their acquisition of such stock on March 20, 1995 from Yashiro Co., Inc. (\"Yashiro\") (see Note 13).\nRevenue Recognition\nRevenue is recognized upon the shipment of merchandise.\nInventories\nInventories, consisting primarily of finished goods purchased for resale, are stated at the lower of cost (first-in, first-out and average) or market.\nProperty, Plant and Equipment and Depreciation\nDepreciation is computed primarily by use of accelerated methods over the estimated useful lives of the assts. The estimated useful lives are 20 years for building, 5 to 10 years for machinery and equipment, life of lease for leasehold improvements, and 3 to 5 years for automobiles.\nForeign Currency Translation\nAssets and liabilities of the Company's foreign subsidiaries are translated at year-end exchange rates, and income and expenses are translated at average exchange rates prevailing during the year with the resulting adjustments accumulated in stockholders' equity.\nIncome Taxes\nEffective December 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS 109\"). As permitted under SFAS 109, the Company had elected not to restate the financial statements of prior years. Application of SFAS 109 resulted in the recognition of a net deferred tax asset as of December 1, 1993, of approximately $1,900,000 primarily due to net operating loss carryforwards, reserves for doubtful accounts, certain accrued expenses, capitalization of inventory costs, depreciation and the agreement to sell a subsidiary being treated as an installment sale for tax purposes (see Note 12). The Company also recorded a valuation allowance of approximately $1,900,000 due to uncertainty about the realizability of this asset. Therefore, there was no effect on the Company's financial statements as of December 1,1993 from the adoption of SFAS 109.\nIncome taxes have not been provided on undistributed earnings of foreign subsidiaries, which amount to approximately $2,650,000 as of November 30, 1995 because the Company expects to reinvest these earnings in the business of subsidiaries.\nLoss Per Share\nLoss per share is calculated based on the weighted average number of common shares outstanding.\nCash Equivalents\nThe Company considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents for purposes of the consolidated statement of cash flows.\nUse of Estimates\nIn preparing financial statements in conformity with generally accepted accounting principles, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities, the 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. Significant estimates are used in accounting for accounts receivable allowances, income taxes and investments in and advances to its subsidiary.\nFuture Effect of Recently Issued Accounting Pronouncement\nIn October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards 123, Accounting for Stock Based Compensation (SFAS 123). SFAS 123 requires entities to disclose the fair value of their employee stock options. Disclosure requirements are effective for the Company's fiscal year beginning December 1, 1996.\n2. Loans Payable to Financial Institutions\nOn October 31, 1995, the Company amended its factoring agreement (see Note 11) whereby it may borrow up to 50% of the value of its finished goods inventory. Interest under borrowings from the factor for inventory advances are at prime plus 1.75% per annum (10.5% at November 30, 1995). Borrowings are collateralized by the inventory. As of November 30, 1995, the Company had outstanding $2,000,000 of borrowings under this agreement.\nOn August 1, 1995, the Company's Canadian subsidiary entered into a financing agreement with a Canadian bank that provides for a revolving loan and letter of credit financing in the amount of the lesser of $525,000 or the sum of a percentage of accounts receivable (as defined), 50% of letters of credit outstanding, and 25% of eligible finished goods inventory (as defined) with interest payable monthly at 1.25% above the Canadian prime rate. As of November 30, 1995, $323,279 was outstanding under this agreement in direct borrowings. As of November 30, 1995 and 1994, there were outstanding letters of credit in the amount of $88,000 and $50,000, respectively. The bank also refinanced a real property mortgage of approximately $368,000 and a term loan of approximately $105,000. The mortgage is payable in monthly installments of approximately $3,500 including interest at 10.25% with a balloon payment of approximately $325,000 in the year 2000. The term loan bears interest at 1.5% above the Canadian prime rate and is due June 1996. Substantially all of the assets of the Canadian subsidiary have been pledged as collateral for the above loans. The Canadian subsidiary has agreed to certain financial covenants (current ratio, debt-to-equity ratio, debt service coverage) and not to pay dividends to the parent.\nThe Company had a prior bank credit agreement providing for a revolving line of credit at 1% above prime for up to $2,000,000 which expired on July 31, 1995 and was paid in full. The facility was secured by a $500,000 certificate of deposit and the personal guaranty of the Company's former chairman.\nIn fiscal 1994, the Company received two short-term advances of $600,000 and $350,000 from a factor (see Note 11) of which $350,000 was outstanding at November 30, 1994. Interest on these advances was payable at prime plus 2.5% per annum (9.75% at November 30, 1994). The second advance was repaid in February 1995.\n3. Income Taxes\nAt November 30, 1995, the Company had net operating loss carryforwards for Federal income tax purposes of approximately $3,500,000 expiring in the years 2001 through 2010. There is an annual limitation of approximately $187,000 on the utilization of approximately $2,800,000 of net operating loss carryforwards under the provisions of Internal Revenue Code Section 382.\nDeferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax assets and liabilities as of November 30, 1995 and 1994 are as follows:\nIncome tax expense consists of current domestic state and local taxes in 1993.\nThe following is a reconciliation of the tax provisions for the three years ended November 30, 1995 with the statutory Federal income tax rates:\n4. Pension Plans\nThe Company has a defined benefit plan covering substantially all of its domestic employees. The benefits provided are primarily based upon years of service and compensation, as defined. The Company's funding policy is to contribute annually the minimum amount required to cover the normal cost and to fund supplemental costs, if any, from the date each supplemental cost was incurred. Contributions were intended to provide not only for benefits attributed to service to date, but also for those expected to be earned in the future. Plan assets consist primarily of investments in marketable securities.\nEffective June 30, 1995, the plan was frozen, ceasing all benefit accruals and resulting in a plan curtailment. The Company recognized a curtailment gain of approximately $112,500 in accordance with Statement of Financial Accounting Standards No. 88 - \"Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits.\"\nNet periodic pension cost (exclusive of the curtailment gain in 1995) included the following components:\nFollowing is a summary of significant actuarial assumptions used:\nThe following table sets forth the Plan's funded status and amounts recognized in the Company's statement of financial position at:\n5. Long-Term Debt\nLong-term debt consists of the following:\nPrincipal payments are due as follows:\n6. Commitments\nThe Company conducts a substantial portion of its operations utilizing leased facilities. Rent expense, charged to operations, was $725,000, $825,000 and $924,000 in 1995, 1994 and 1993, respectively. In addition to the annual rent, the Company pays real estate taxes, insurance and other occupancy costs on its leased facilities. A portion of one warehouse facility is subleased to a subsidiary of Yashiro (see Note 8) under a lease which expires in May, 2000. Total future minimum sublease rentals amounted to $637,000 at November 30, 1995.\nThe minimum annual rental commitments exclusive of sublease rentals under operating leases that have remaining non-cancelable terms in excess of one year are approximately as follows:\nThe Company has entered into various licensing agreements under which it has obtained the right to market children's bags, tote bags and related products with trade names. The terms of such agreements vary, but range from 4 to 7 years through May 2000. The agreements provide for royalties based upon net sales with certain stated minimum annual amounts. The amount of future minimum royalties aggregate approximately $1,820,000. Royalty expense amounted to $937,000, $883,000 and $969,000 in 1995, 1994 and 1993, respectively. As of November 30, 1995 and 1994, approximately $480,000 and $110,000, respectively, had been accrued for unpaid royalties.\nThe Company has modified its agreement with a licensor whereby the Company will cease to ship its product under its license after June 30, 1996. Sales of this licensed product amounted to approximately 21% of the Company's net sales in 1995.\n7. Miscellaneous Income\nAccrued expenses at November 30, 1993 included $620,000 related to a claim by a former tax-exempt bondholder. Management believes that it is remote that the Company would be required to pay this claim and, accordingly, miscellaneous income for 1994 includes the reversal of this accrual.\n8. Related Party Transactions\nOn March 20, 1995, the Company entered into a Letter of Credit Agreement with Yashiro to provide for short-term financing for import purchases. Pursuant to this agreement, Yashiro has agreed to issue, until March 20, 1997, unsecured trade letters of credit in an aggregate amount of up to the lesser of $1,200,000, or 35% of the Company's inventory. Amounts borrowed under this agreement are repayable 100 days after delivery of the goods. In addition to interest, which is payable monthly at 2% above the prime rate, Yashiro is paid a handling fee of 3% of the cost of the goods. The Company, prior to March 20, 1995, had a product supply agreement with Yashiro whereby the Company was free to purchase goods from other suppliers if it could do so on more favorable terms. During 1995, 1994 and 1993, purchases from Yashiro were approximately $-0-, $9,000 and $221,000, respectively. The Company's liability to Yashiro was approximately $536,000 and $1,743,000 at November 30, 1995 and 1994. The liability at November 30, 1994 included a short-term line of credit of approximately $1,664,000, bearing interest at 7% per annum. In fiscal 1995, 1994 and 1993, interest and handling and other fees paid to Yashiro amounted to approximately $417,000, $300,000 and $188,000, respectively.\nAt November 30, 1993, the Company was due approximately $132,000 from Yashiro which primarily related to inventory returns and merchandise damage claims and was included in other current assets. Approximately $36,000 of such amounts were received in 1994, and the balance was written off as uncollectible in the fourth quarter of fiscal 1994. In addition, selling, warehouse, general and administrative expenses for the year ended November 30, 1994 includes $100,000 charged by Yashiro for services provided to the Company by an officer of Yashiro.\nDuring the years ended November 30, 1995, 1994 and 1993, the Company purchased approximately $734,000, $3,489,000 and $2,858,000, respectively, of handbags and accessories from an affiliate of Yashiro. In addition, approximately $21,000 was paid to this affiliate for services rendered during the year ended November 30, 1994.\nDuring the year ended November 30, 1995, the Company purchased approximately $193,000 of luggage and backpack products from a related party.\nDuring the years ended November 30, 1995, 1994 and 1993, the Company paid approximately $602,000, $245,000 and $393,000, respectively, as buying commissions to related parties.\nIncluded in short-term loans payable to related parties is a $35,000 demand loan from the Company's president that bears interest at 6%.\n9. Segment Reporting\n10. Sale of Real Property\nIn fiscal 1992, the Company sold real property for $1,300,000 in cash and the right to receive the consideration under an easement agreement that was assigned to the buyer. The present value of the consideration to be received under the easement agreement was recorded as a receivable in the accompanying financial statements. The net gain on this sale amounted to approximately $317,000. In the fourth quarter of fiscal 1994, the Company established a reserve of $125,000 due to doubts about the collectibility of the amount due from the buyer.\n11. Accounts Receivable and Major Customer\nThe Company has an agreement with a factor pursuant to which the Company sells substantially all of its accounts receivable on a pre-approved non-recourse basis. Under the terms of the agreement, the factor advances funds to the Company based on invoice amounts. Interest on such advances was payable at 2% in excess of the prime rate through October 31, 1995 and 1.75% in excess of the prime rate thereafter. The Company also paid a factoring commission of 1% (.75% after November 1, 1995) of the invoice amount subject to a minimum of $96,000 per annum.\nSubstantially all of the Company's accounts receivable that are not financed by the factor are not collateralized. The Company periodically reviews the status of its accounts receivable and, accordingly, establishes reserves for uncollectible accounts. In the fourth quarter of fiscal 1994, the Company established additional accruals for future credits totaling approximately $440,000. In addition, the Company wrote off merchandise damage claims of approximately $33,000 and uncollectible amounts related to a subsidiary of approximately $170,000 in the fourth quarter of fiscal 1994.\nSales to one customer amounted to 25%, 22%, and 20% of net sales in fiscal 1995, 1994 and 1993, respectively.\n12. Investment In and Advances to Subsidiary\nEffective July 15, 1992, the Company entered into an agreement to sell all of the stock of its then wholly-owned subsidiary, Sirco Leatherwares Limited (the \"Subsidiary\"). In exchange for the stock, the Company received a non-interest bearing $650,000 note. The note is guaranteed by an officer of the Subsidiary who is also an officer of the buyer. The agreement also requires the Company to forgive a portion of the amounts due to it from the Subsidiary. The Company's ability to collect the note receivable and the balance of the receivable from the Subsidiary is dependent upon cash flows from the Subsidiary's operations and\/or the buyer's ability to refinance the obligations. Under the terms of the agreement, the Company is also required to provide the Subsidiary (i) a $200,000 line of credit through 1997 and (ii) design and production services. As the risks and other incidents of ownership have not transferred to the buyer with sufficient certainty, this transaction has not been accounted for as a sale for accounting purposes.\nThe Company recorded a loss on this transaction in a prior year, as the present value of the amounts to be received under the note and the revised accounts receivable were less than (i) the carrying value of the Company's investment in the Subsidiary plus (ii) the amounts receivable from the Subsidiary.\nThe non-interest bearing $650,000 note received in exchange for stock in the Subsidiary is due in thirty-two equal quarterly installments of $20,213 beginning in August 1992. Payments are being received on a current basis.\nAlso, pursuant to the agreement to sell the Company's investment in the Subsidiary, the Subsidiary agreed to pay interest at 8.5% per annum on a receivable of approximately $720,000. This interest is payable quarterly commencing in August 1992. If the Subsidiary is not in default on the payment of interest, the Company will forgive a portion of the receivable, in amounts as defined, through May 1, 1998. An amount of $40,000 was forgiven in each of 1995, 1994 and 1993. The total amount forgiven will be $280,000. The remaining receivable of approximately $440,000 is payable in ten equal quarterly installments commencing in August 1998. Amounts outstanding after May 1, 1998 will bear interest at the prime rate.\nIn the fourth quarter of fiscal 1994, the Company established a reserve of $275,000 due to doubts about the collectibility of the amounts due from the subsidiary.\n13. Loss on Sale of Handbag Division\nOn March 20, 1995, the Company sold its handbag division to Bueno of California, Inc. (\"Bueno\"), a subsidiary of Yashiro. The Company and Bueno entered into an Asset Purchase Agreement pursuant to which the Company sold to Bueno all of the inventory relating to the Company's handbag division, and certain equipment relating to the Company's handbag division for $1,785,666, of which $86,168 was paid in cash and $1,699,448 was applied by the Company to the repayment of indebtedness of the Company to Yashiro. This sale resulted in a loss to the Company of $425,163. Net sales of the Company's handbag division for the years ended November 30, 1995 and 1994 were $1,423,000 and $9,182,000, and gross profits on these sales were $81,000 and 1,878,000, respectively.\nIn connection therewith, the Company has entered into six year non-competition agreements covering North America with Yashiro, another affiliate of Yashiro, Mr. Yutaka Yamaguchi and Mr. Taheshi Yamaguchi, former stockholders and\/or officers of the Company. Aggregate consideration to these parties is $240,000 payable in three annual installments of $80,000 including interest at 10% commencing March 31, 1996. The present value of the restrictive covenant ($198,350) is being amortized over the life of the agreement.\nIn addition, the Company has agreed to pay severance pay to Mr. Taheshi Yamaguchi in the amount of $200,000, payable in two annual installments of $100,000 plus interest at 10% per annum commencing March 31, 1996. This amount has been charged to operations in 1995.\n14. Stockholders' Equity\nOn August 17, 1995, the stockholders of the Company (i) approved an increase in the number of authorized shares of common stock from 3,000,000 shares to 10,000,000 shares; (ii) authorized the Company to issue 1,000,000 shares of preferred stock, par value $.10 per share, with rights and privileges to be determined by the board of directors; and (iii) approved the 1995 Stock Option Plan of the Company (the \"Plan\"). The Plan provides for the grant of incentive stock options, non-qualified stock options, tandem stock appreciation rights, and stock appreciation rights exercisable in conjunction with stock options to purchase up to an aggregate of 200,000 shares of common stock.\nThe above plan is accounted for under APB Opinion 25 and related Interpretations. On September 20, 1995 and October 4, 1995, the Company granted 10,000 non-qualified stock options each to a consultant and a director of the Company which are exercisable over a period not to exceed five years. On October 4, 1995, the Company granted 53,000 incentive stock options in varying amounts to seven employees which are exercisable commencing October 5, 1996 to October 4, 2000. The exercise price of each option equals the market price of the Company's stock on the dates of grant. Accordingly, no compensation cost has been recognized for the plan. Stock option transactions for the year ended November 30, 1995 are summarized below:\nSIRCO INTERNATIONAL CORP. AND SUBSIDIARIES\nSCHEDULE I\nCONDENSED FINANCIAL STATEMENTS OF THE REGISTRANT (PARENT) BALANCE SHEET\nNOVEMBER 30, 1995\n(Continued)\nSIRCO INTERNATIONAL CORP. AND SUBSIDIARIES\nSCHEDULE I (CONTINUED)\nCONDENSED FINANCIAL STATEMENTS OF THE REGISTRANT (PARENT) BALANCE SHEET\nNOVEMBER 30, 1995\nSIRCO INTERNATIONAL CORP. AND SUBSIDIARIES\nSCHEDULE I (CONTINUED)\nCONDENSED FINANCIAL STATEMENTS OF THE REGISTRANT (PARENT) STATEMENT OF OPERATIONS\nYEAR ENDED NOVEMBER 30, 1995\nSIRCO INTERNATIONAL CORP. AND SUBSIDIARIES\nSCHEDULE I (CONTINUED)\nCONDENSED FINANCIAL STATEMENTS OF THE REGISTRANT (PARENT) STATEMENT OF CASH FLOWS\nYEAR ENDED NOVEMBER 30, 1995\nSIRCO INTERNATIONAL CORP. AND SUBSIDIARIES\nSCHEDULE I (CONTINUED)\nCONDENSED FINANCIAL STATEMENTS OF THE REGISTRANT (PARENT) NOTES TO FINANCIAL STATEMENTS\nYEAR ENDED NOVEMBER 30, 1995\nMaturities of long-term debt is as follows:\n2. Dividends from Subsidiaries\nThere were no dividends paid to Sirco International Corp. by its consolidated subsidiaries.\n3. Commitments and Contingencies (Not Disclosed in the Consolidated Financial Statements)\nNone.\nSIRCO INTERNATIONAL CORP. AND SUBSIDIARIES\nSCHEDULE II\nVALUATION AND QUALIFYING ACCOUNTS\nYEARS ENDED NOVEMBER 30, 1995, 1994 AND 1993\n(1) A valuation allowance of $1,900,000 was established upon the adoption of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\", effective December 1, 1993.","section_15":""}
{"filename":"355622_1995.txt","cik":"355622","year":"1995","section_1":"ITEM 1. BUSINESS.\nGeneral\nRyan's Family Steak Houses, Inc., the Registrant (referred to hereafter as the \"Company\"), is a South Carolina corporation which operates a chain of restaurants located principally in the southern and midwestern United States. At March 6, 1996, 231 company-owned and 25 franchised Ryan's Family Steakhouse restaurants (concept only; referred to hereafter as \"Ryan's\" or \"Ryan's restaurant\") were in operation. The Company also operated 3 other restaurant concepts, consisting of 5 restaurants in total, on a test basis. Systemwide sales, which include sales by franchised restaurants, were approximately $560 million and $499 million in 1995 and 1994, respectively. Sales by all company-owned restaurants amounted to approximately $513 million in 1995 and $448 million in 1994. The Company, headquartered in Greer, South Carolina, was organized in 1977 and completed its initial public offering in 1982.\nThe following table indicates the number of company-owned restaurants opened each year, net of closings, and the total number of company-owned restaurants open at each year-end during the 5-year period ending 1995:\nOperations - Ryan's\nGeneral. A Ryan's restaurant is a family-oriented restaurant serving a wide variety of foods from its Mega Bar* as well as traditional \"steak house\" entrees, such as charbroiled USDA Choice steaks, hamburgers, chicken and seafood. The Mega Bar* includes, in addition to fresh and pre-made salad items, soups, cheeses, a variety of hot meats and vegetables, and hot yeast rolls prepared and baked daily on site. All entree purchases include a trip to a bakery bar. Bakery bars feature hot and fresh-from-the-oven cookies, brownies and other bakery products as well as various dessert selections, such as ice cream, frozen yogurt, fresh fruit, cakes, cobblers and several dessert toppings. All Ryan's also offer a variety of non-alcoholic beverages. During mid-1993, the Company modified the layout of the Mega Bar* to a scatter bar format. This format breaks the Mega Bar* into five island bars for easier customer access and more food variety. At the end of 1995, scatter bars had been installed in 208 Ryan's restaurants, or 92% of all company-owned Ryan's. Current plans for 1996 call for the installation of scatter bars in all remaining units by the end of the first quarter. All new Ryan's since mid-1993 have opened with scatter bars.\nEach Ryan's operates seven days a week. Typical hours of operation are 11:00 a.m. to 9:30 p.m. Sunday through Thursday and 11:00 a.m. to 10:30 p.m. Friday and Saturday. The average customer count per restaurant during 1995 was approximately 7,450 per week, and the average meal price (per person) was $5.90 (including beverage). Management believes that the average table turns over every 30 to 45 minutes.\nEach company-owned Ryan's is located in a free-standing brick building of approximately 10,000 to 11,500 square feet. While most Ryan's have interior brick walls, the interiors of the newer restaurants, commencing in August 1991, utilize sheet rock, wallpaper and oak paneling. The interior of most restaurants contains two or three dining rooms, seating approximately 300 to 500 persons in total, a customer ordering area and a kitchen. The focal points of the dining room are the centrally located scatter bars (referred to in the restaurants as the Mega Bar*) and bakery bar. An average Ryan's has parking for approximately 180 cars.\nRestaurant Management and Supervision. The Company emphasizes standardized operating and control systems together with comprehensive recruiting and training programs in order to maintain food and service quality. In each Ryan's restaurant, the management team consists of a general manager, a manager and two assistant managers. Management personnel begin employment at the manager trainee level and complete a formal five-week training program at the Company's management training center in Greer, South Carolina, prior to being placed in assistant manager positions.\nEach restaurant management team reports to an area supervisor. Area supervisors normally oversee the operations of four to eight restaurants and report to one of eight regional directors, a position that may be at the Vice President level and, in each case, reports to the Vice President-Operations. Communication and support from all corporate office departments are designed to assist the area supervisors and regional directors to respond promptly to local concerns.\nAll regional directors, area supervisors, general managers and managers participate in incentive bonus programs. Bonuses paid to restaurant management are based principally upon the monthly sales volume of their individual restaurant with deductions for excess spending of key expense items, such as food cost, payroll and cash shortages. The bonus program for area supervisors and regional directors is based principally upon same-store sales, profitability, \"hidden shopper\" (service feedback) scores and certain qualitative factors.\nAdvertising. The Company has not relied extensively on advertising, expending less than one percent of restaurant sales during each of the years 1995, 1994 and 1993. Nevertheless, advertising activities in 1995 were significantly increased from the prior years' levels as the Company ran advertising campaigns, consisting of both television and radio, in the Charleston, SC and Atlanta, GA markets. Newspaper ads and billboards were used in certain other markets. Management believes that the restaurant industry has become increasingly competitive over the past several years and that advertising will become an important factor in the development and retention of market share. Based on current budgets, an expansion of advertising expenditures in 1996 is expected with media campaigns planned for markets covering approximately one-third of all company-owned Ryan's.\nExpansion of Company-Owned Restaurants\nGeneral. At March 6, 1996, the Company owned and operated 231 Ryan's and five test concepts for a total of 236 restaurants. During the remainder of 1996, 23 to 25 additional Ryan's are scheduled to open, resulting in 28 to 30 new company-owned Ryan's in 1996. Target sites for these new restaurants are spread fairly evenly across the Company's current 21-state operating area. The Company opened 24 restaurants during 1995, including three test concepts, compared to 22 (including two test concepts) and 30 restaurants during 1994 and 1993, respectively. During 1995, 5 underperforming restaurants were closed compared to 4 and 1 closure during 1994 and 1993, respectively.\nTest Concepts. At March 6, 1996, the Company owned and operated five test restaurants, representing 3 different test concepts. Two restaurants, located in Greenville, SC and Myrtle Beach, SC, serve Tex- Mex fare; two restaurants, located in Plano, TX and Arlington, TX, are upscale western-style steakhouses; and one restaurant in Fairfield, OH (Cincinnati), serves classic Italian food in a buffet setting. All restaurants opened in late-1994 and early-1995. The Tex-Mex and upscale steakhouse concepts are considered to be casual-dining concepts. In contrast to a Ryan's, these concepts are characterized by full table and bar service and average checks (per person) ranging from $11 to $15. A Ryan's operates in a limited self-service format, no alcoholic beverages are served, and the average check amounted to $5.90 during 1995. The Italian buffet concept is also a limited self- service format, but serves alcoholic beverages (beer and wine) with a $7 average check. Further expansion of all 3 test concepts will be limited during 1996 while financial results are being evaluated.\nSite Selection. The Company employs a real estate manager and uses independent real estate brokers to locate potential new sites and to perform all preliminary site investigative work. Final approval is made by the Company's executive management. Important factors in site selection include population, demographics, proximity to both business and residential areas, traffic count and site accessibility. In addition, site selection for a Ryan's restaurant is also influenced by the general proximity to other Ryan's in order to optimize the efforts of the Company's area supervisors.\nConstruction. The Company presently engages non-affiliated, general contractors to construct most of its restaurants on a lump-sum contract basis. The Company requires performance and payment bonds on certain building and site work contracts, depending on the size and reputation of and Company history with the general contractor, and closely supervises and monitors the progress of all construction projects. Other new restaurants are built with the Company acting as the general contractor. New restaurants are generally completed approximately three to four months from the commencement of construction. The average cost of a new Ryan's (land, building and equipment) constructed in 1995 was approximately $2.0 million.\nRestaurant Opening. When a new Ryan's is opened, all restaurant management positions are staffed with personnel who have had prior management experience in another of the Company's restaurants. Prior to opening, all staff personnel at the new location undergo one week of intensive training conducted by a store opening team.\nFranchising\nWhile the Company has granted Ryan's franchises in the past, management has not actively pursued new franchisees in recent years in order to concentrate on the operation and development of company-owned restaurants. New franchises may be awarded to existing franchisees having good operating results or to new franchisees proposing to operate in regions significantly outside of the Company's existing or contemplated operating areas.\nThe following table indicates the number of franchised restaurants opened each year, net of closings, and the total number of franchised restaurants open at each year-end during the 5-year period ending 1995:\nThe present franchise agreements are for a period of 15 years, with two five-year renewal options, and provide for a continuing royalty to the Company of three to four percent of gross receipts. The agreements provide that the Company will furnish the franchisee all the necessary information to construct, equip, manage and operate a restaurant under the Ryan's Family Steak House name or derivative thereof. The agreements generally provide for the construction and operation of one restaurant with exclusive territorial protection within a one to five mile radius.\nThe franchise agreement with Family Steak Houses of Florida, Inc. (\"Family\") provides for exclusive territorial protection in certain Florida counties as long as a specified number of new Ryan's are opened. During the fourth quarter of 1993, Family informed the Company that it would be unable to pay its royalty fees from August through December 1993, and this nonpayment condition subsequently continued through the second quarter of 1994. In July 1994, an agreement was reached with Family regarding both past-due and future royalty fees. This agreement provided for a $236,000 cash payment by Family, the relinquishment of Family's exclusive development rights in certain counties in South Florida and the Florida panhandle (subject to first refusal and buy-back rights of Family), an $800,000 long-term note payable to the Company and a reduction in the royalty fee rate from 4.25% to 3% until April 30, 1997, at which time the rate will increase to 4%. The relinquishment of development rights was valued at $500,000 and treated as a partial write-off of Family's past-due royalty fees. In addition, the agreement with Family decreased the required number of Ryan's restaurants in operation to 24 through the end of 1996 and to 25 at the end of 1997. Pursuant to the agreement, the required number of restaurants in operation will then increase by 1 for each year after 1997. All required payments from Family to the Company subsequent to the agreement have been received in a timely manner. However, due to Family's payment history, the Company's accounting policy regarding Family's royalty fees was changed during 1994 to a cash basis. Accordingly, all royalty fees received thereafter, including payments required under the long-term note payable, have been recognized as revenue when received.\nSources and Availability of Raw Materials\nThe Company has a centralized purchasing program which is designed to ensure uniform product quality in all restaurants as well as reduced food, beverage and supply costs. The Company's management establishes contracts for approximately 85% of its food and other products from a variety of major suppliers under competitive terms. Purchases under these contracts are delivered to one of two warehouses operated by the Company's principal distributor and then delivered to the restaurants by the distributor. The distributor contracts for approximately 10% of the Company's products, with the remaining 5% (principally fresh produce) purchased locally by restaurant management. The beef used by the Company is obtained from four western suppliers based on price and availability of product. To ensure against interruption in the flow of beef supplies due to unforeseen or catastrophic events and to take advantage of favorable purchasing opportunities, the Company stockpiles two to six weeks supply of sirloin at the distributor. The Company believes that satisfactory sources of supply are generally available for all the items regularly used.\nWorking Capital Requirements\nWorking capital requirements for continuing operations are not significant. The Company's restaurant sales are primarily derived from cash sales, and inventories are purchased on credit and are rapidly converted to cash. Therefore, the Company does not maintain significant receivables or inventories.\nTrademarks and Service Marks\nThe Company has registered various trademarks and service marks, including \"Ryan's Family Steak House\" and \"Mega Bar,\" and their related designs with the United States Patent and Trademark Office. All trademarks and service marks have stated expiration dates ranging from September 1997 to August 2002. However, they are renewable for an unlimited number of additional 10-year terms at the option of the Company.\nThe Company currently operates a restaurant (see \"Expansion of Company-Owned Restaurants - Test Concepts\") located in Greenville, SC under the name of \"Caliente Grille.\" Under the terms of an agreement with Caliente Cab Restaurant Co., Inc., a New York corporation and owner of the \"Caliente\" service mark, the Company was granted a perpetual, fully paid-up license to use the \"Caliente\" name in connection with restaurant services only, and in connection with a single location in Greenville, SC.\nCompetition\nThe food service business is highly competitive and is often impacted by changes in the taste and eating habits of the public, economic conditions affecting spending habits, population and traffic patterns. The principal bases of competition in the industry are the quality and price of the food products offered. Location, speed of service and attractiveness of facilities are also important factors. Ryan's restaurants are in competition with many units operated or franchised by national, regional and local restaurant companies that offer steak or buffet-style meals. Although the Company believes that its price\/value to its customers places it in an excellent competitive posture, it should be noted that during the last few years many operators have upgraded their restaurants to more closely match the Ryan's format and particularly the Mega Bar*. The Company is also in competition with specialty food outlets and other food vendors.\nSeasonality\nThe Company's operations are subject to some seasonal fluctuations. Sales per restaurant generally increase during the spring and summer months and decline in the fall and winter months.\nResearch\nThe Company maintains ongoing research programs relating to the development of new products and evaluation of marketing activities. The Company's management staff includes a Director of Research and Development, whose responsibilities include enhancing and updating the Mega Bar* and entree selections. While research and development activities are important to the Company, past expenditures have not been and future expenditures are not expected to be material to the Company's financial results.\nCustomers\nNo material part of the Company's business is dependent upon a single customer or a specific group of customers.\nRegulation\nThe Company is subject to the Fair Labor Standards Act which regulates matters such as minimum wage requirements, overtime and other working conditions. A large number of the Company's restaurant personnel are paid at or near the minimum wage level, and, accordingly, changes in the federal minimum wage affect the Company's labor costs. Other changes to the minimum wage may also be legislated at the state level.\nThe Company's restaurants are constructed to meet local and state building code requirements and are operated in accordance with state and local regulations relating to the preparation and service of food.\nThe Company's franchise operations are subject to a variety of laws regulating franchising. The Federal Trade Commission has adopted a rule that imposes certain disclosure requirements on persons engaged in the business of offering franchises. Various states in which the Company has offered franchises have franchising laws that require registration prior to offering franchises for sale and\/or that regulate the rights of franchisees, including the circumstances under which franchises may be terminated. Management believes its operations are in material compliance with all applicable franchising laws and regulations.\nEnvironmental Matters\nWhile the Company is not aware of any federal, state or local environmental regulations which will materially affect its operations or competitive position or result in material capital expenditures, it cannot predict the impact of possible future legislation or regulation on its operations.\nEmployees\nAt March 6, 1996, the Company employed approximately 16,000 persons, of whom approximately 15,800 were restaurant personnel. The Company strives to maintain low turnover by offering all full-time employees a very competitive benefit package, which includes life and health insurance, vacation pay and a defined contribution retirement plan. Part-time employees who work at least 15 hours per week are eligible to participate in the Company's life and health insurance plans and also receive vacation pay.\nNone of the Company's employees are represented by a union. The Company has experienced no work stoppages attributable to labor disputes and considers its employee relations to be good.\nInformation as to Classes of Similar Products or Services\nThe Company operates in only one industry segment. All significant revenues and pre-tax earnings relate to retail sales of food to the general public through either Company-operated or franchised restaurants. At March 6, 1996, the Company had no operations outside the continental United States.\nInformation regarding the Company's restaurant sales and assets is included in the Company's financial statements, which are incorporated by reference into Part II, Item 8 of this Form 10-K.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company owns substantially all of its restaurant properties, each of which is a free-standing brick building that covers approximately 10,000 to 11,500 square feet, with seating for approximately 300 to 500 persons and parking for approximately 150 to 250 cars on sites of approximately 75,000 to 130,000 square feet. At March 6, 1996, all restaurant sites, except five properties under land leases, were owned by the Company.\nA listing of the number of Ryan's restaurant locations by state as of March 6, 1996 appears on page 23 of the Company's 1995 Annual Report to Shareholders and is incorporated herein by reference. A detail listing of Ryan's restaurant locations may be obtained without charge by writing to the Company's principal executive offices, Attention: Corporate Secretary. As noted above (see \"Expansion of Company-Owned Restaurants - Test Concepts\"), the Company also operates five test restaurants in Greenville and Myrtle Beach, SC; Plano and Arlington, TX; and Fairfield, OH.\nThe Company's corporate offices consist of two office buildings (30,000 square feet and 16,000 square feet) and a 20,000 square foot warehouse facility. These properties (land and building) are owned by the Company and located in Greer, SC.\nFrom time to time, the Company offers for sale excess land that was acquired in connection with its restaurant properties. Also, at March 6, 1996, four closed restaurant properties were offered for sale. The Company believes that the eventual disposition or nondisposition of all such properties will not materially affect its business or financial condition, taken as a whole.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nFrom time to time, the Company is a defendant in legal actions arising in the normal course of its business. The Company believes that, as a result of its legal defenses and insurance arrangements, none of these actions, if decided adversely, would have a material effect on its business or financial condition, taken as a whole.\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 regarding trading of the Company's common stock, quarterly market prices and dividends appears under \"Common Stock Data\" on page 22 of the Company's 1995 Annual Report to Shareholders and is incorporated herein by reference.\nAt March 6, 1996, the Company's common stock was held by approximately 20,000 stockholders of record through nominee or street name accounts with brokers.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nSelected financial data for the last five years is included in the \"Ten Year Financial Summary\" on pages 4 and 5 of the Company's 1995 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.\n\"Management's Discussion and Analysis of Financial Condition and Results of Operations\" is included on pages 6 through 10 of the Company's 1995 Annual Report to Shareholders and is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe Company's financial statements, unaudited quarterly financial information and the independent auditors' report are included on pages 11 through 20 of the Company's 1995 Annual Report to Shareholders and are incorporated herein by reference.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10.DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nThe information required under this item is incorporated herein by reference to the Ryan's Family Steak Houses, Inc. Proxy Statement for the Annual Meeting of Shareholders to be held April 25, 1996 under the headings \"Election of Directors,\" \"Executive Officers\" and \"Certain Beneficial Ownership of Common Stock - Compliance with Section 16(a) of the Securities Exchange Act.\"\nITEM 11.","section_11":"ITEM 11.EXECUTIVE COMPENSATION.\nThe information required under this item is incorporated herein by reference to the Ryan's Family Steak Houses, Inc. Proxy Statement for the Annual Meeting of Shareholders to be held April 25, 1996 under the headings \"Election of Directors - Compensation of Directors,\" \"Executive Compensation and Other Information,\" \"Compensation Committee Interlocks and Insider Participation,\" \"Report of the Compensation Committee and Stock Option Committee\" and \"Performance Graph.\"\nITEM 12.","section_12":"ITEM 12.SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe information required under this item is incorporated herein by reference to the Ryan's Family Steak Houses, Inc. Proxy Statement for the Annual Meeting of Shareholders to be held April 25, 1996 under the headings \"Election of Directors,\" \"Executive Officers\" and \"Certain Beneficial Ownership of Common Stock.\"\nITEM 13.","section_13":"ITEM 13.CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe information required under this item is incorporated herein by reference to the Ryan's Family Steak Houses, Inc. Proxy Statement for the Annual Meeting of Shareholders to be held April 25, 1996 under the headings \"Executive Compensation and Other Information - Deferred Compensation - Salary Continuation Agreements\" and \"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)1-2Financial statements filed as part of this Form 10-K are listed in the \"Index to Financial Statements\", at page 12.\n(a)3 Exhibits (numbered in accordance with Item 601 of Regulation S-K):\nExhibit # Description\n3.1 Articles of Incorporation, as amended through April 24, 1986, and Bylaws of the Company: Incorporated by reference to Exhibits 4(a) and 4(b) from the Registration Statement of the Company filed with the SEC on Form S-3 (Commission file no. 33- 7245).\n3.2 Articles of Amendment to the Articles of Incorporation, dated April 22, 1987: Incorporated by reference to Exhibit 3.2 to the Annual Report on Form 10-K for the period ended January 1, 1992 (Commission file no. 0-10943) (the \"1991 10-K\").\n3.3 Amendment to By-Laws of the Company, dated October 25, 1990: Incorporated by reference to Exhibit 3.3 to the 1991 10-K.\n3.4 Articles of Amendment to the Articles of Incorporation, dated May 25, 1989: Incorporated by reference to Exhibit 4.3 to the Registration Statement of the Company filed with the SEC on Form S- 8 (Commission file no. 33-53834).\n4.1 Specimen of Company common stock certificate: Incorporated by reference to Exhibit 4.1 to the 1991 10-K.\n4.2 See Exhibits 3.1, 3.2, 3.3, 3.4 and 4.1.\n*10.1 Ryan's Family Steak Houses, Inc. Incentive Stock Option Plan: Incorporated by reference to the Registration Statement of the Company filed with the SEC on Form S-8 (Commission file no. 2-83987).\n*10.2 Ryan's Family Steak Houses, Inc. 1987 Stock Option Plan: Incorporated by reference to Exhibit 4 to the Registration Statement of the Company filed with the SEC on Form S-8 (Commission file no. 33-15924).\n*10.3 Ryan's Family Steak Houses, Inc. 1991 Stock Option Plan: Incorporated by reference to Exhibit 4.4 to the Registration Statement of the Company filed with the SEC on Form S-8 (Commission file no. 33-53834).\n*10.4 Ryan's Employee Retirement Savings Plan, dated March 1, 1992: Incorporated by reference to Exhibit 10.4 to the 1991 10-K.\n*10.5 Salary Continuation Agreement, dated April 22, 1987, between the Company and Alvin A. McCall, Jr.; as amended on October 26, 1989: Incorporated by reference to Exhibit 10.5 to the 1991 10-K.\n*10.6 Salary Continuation Agreement, dated April 22, 1987, between the Company and Charles D. Way: Incorporated by reference to Exhibit 10.6 to the 1991 10-K.\n*10.7 Agreement and Plan of Restructuring: Incorporated by reference to Exhibit A to the Proxy Statement of the Company, dated March 25, 1993, filed with respect to the Annual Meeting of Shareholders to be held on April 28, 1993.\n*10.8 Split Dollar Agreement by and between the Company and Charles D. Way dated September 1, 1993: Incorporated by reference to Exhibit 10.8 to the Annual Report on Form 10-K for the period ended December 29, 1993 (Commission file no. 0-10943) (the \"1993 10-K\").\n*10.9 Split Dollar Agreement by and between the Company and G. Edwin McCranie dated November 12, 1993: Incorporated by reference to Exhibit 10.9 to the 1993 10-K.\n*10.10 Split Dollar Agreement by and between the Company and John C. Jamison dated November 12, 1993: Incorporated by reference to Exhibit 10.10 to the 1993 10-K.\n*10.11 Split Dollar Agreement by and between the Company and James R. Hart dated August 8, 1993: Incorporated by reference to Exhibit 10.11 to the 1993 10-K.\n*10.12 Split Dollar Agreement by and between the Company and Fred T. Grant, Jr. dated November 12, 1993: Incorporated by reference to Exhibit 10.12 to the 1993 10-K.\n*10.13 Split Dollar Agreement by and between the Company and Alan E. Shaw dated November 12, 1993: Incorporated by reference to Exhibit 10.13 to the 1993 10-K.\n*10.14 Executive Bonus Plan, commencing in 1994: Incorporated by reference to Exhibit 10.14 to the 1993 10-K.\n10.15 Agreement between Ryan's Properties, Inc. and Family Steak Houses of Florida, Inc. dated July 11, 1994 and as amended on October 17, 1994: Incorporated by reference to Exhibit 10.15 to the Annual Report on Form 10-K for the period ended December 28, 1994 (Commission file no. 0-10943).\n10.16 Ryan's Family Steak Houses, Inc. and Wachovia Bank of North Carolina, N.A., as Rights Agent, Shareholder Rights Agreement dated as of January 26, 1995: Incorporated by reference to Exhibit 2 to the report on Form 8-K filed with the Commission on February 9, 1995 (Commission file no. 0- 10943).\n13.1 Ryan's Family Steak Houses, Inc. 1995 Report to Shareholders.\n21.1 Subsidiaries of the Company.\n23.1 Consent of Independent Auditors' with respect to Form S-8.\n27 Financial Data Schedule (electronic filing only).\n99.1 Ryan's Family Steak Houses, Inc. Proxy Statement for the Annual Meeting of Shareholders, dated March 29, 1996.\n* This is a management contract or compensatory plan or arrangement.\n(b) The Registrant has neither filed nor been required to file any reports on Form 8-K during the quarter ended January 3, 1996.\n(c) The response to this portion of Item 14 is submitted as a separate section of this report.\n(d) 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.\nRYAN'S FAMILY STEAK HOUSES, INC. March 29, 1996\nBy:\/s\/Fred T. Grant, Jr. Fred T. Grant, Jr. 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.\nSignature Title Date\n\/s\/Charles D. Way Chairman, President and March 29, 1996 Charles D. Way Chief Executive Officer\n\/s\/G. Edwin McCranie Director and Executive March 29, 1996 G. Edwin McCranie Vice President\n\/s\/James D. Cockman Director March 29, 1996 James D. Cockman\n\/s\/Barry L. Edwards Director March 29, 1996 Barry L. Edwards\n\/s\/Brian S. MacKenzie Director March 29, 1996 Brian S. MacKenzie\n\/s\/Harold K. Roberts, Jr. Director March 29, 1996 Harold K. Roberts, Jr.\n\/s\/James M. Shoemaker, Jr. Director March 29, 1996 James M. Shoemaker, Jr.\n\/s\/Fred T. Grant, Jr. Vice President - Finance March 29, 1996 Fred T. Grant, Jr. (Principal Financial and Accounting Officer)\nRYAN'S FAMILY STEAK HOUSES, INC.\nThe following financial statements of the Registrant included in the Annual Report to Shareholders for the year ended January 3, 1996, are incorporated herein by reference. With the exception of the pages listed below and other information incorporated in this report on Form 10-K, the 1995 Annual Report to Shareholders is not deemed \"filed\" as part of this report.\nPage Reference in Annual Report\nIndependent Auditors' Report 20\nStatements of Earnings 11\nBalance Sheets 12\nStatements of Cash Flows 13\nNotes to Financial Statements 14-19\nAll financial statement schedules have been omitted since the required information is not applicable or the information required is included in the financial statements or the notes thereto.","section_15":""}
{"filename":"100885_1995.txt","cik":"100885","year":"1995","section_1":"ITEM 1. BUSINESS AND ITEM 2.","section_1A":"","section_1B":"","section_2":"","section_3":"ITEM 3. LEGAL PROCEEDINGS -----------------\nLABOR MATTERS - -------------\nThe General Counsel of the National Labor Relations Board (NLRB) is seeking a bargaining order remedy in 17 cases involving Overnite where a Teamsters local union lost a representation election. These cases are pending before a NLRB administrative law judge. A bargaining order remedy would require Overnite to recognize and bargain with the union as if the union had won instead of lost the election and would be warranted only if the following findings are made: (1) the petitioning Teamsters local had obtained valid authorization cards from a majority of the employees in an appropriate unit; (2) Overnite committed serious unfair labor practices; and (3) those unfair labor practices would preclude the holding of a fair election despite the application of less drastic remedies. Under NLRB case law, a bargaining order remedy would attach retrospectively to the date when, after a union with a showing of majority support demanded recognition, Overnite embarked on an unlawful course of conduct. In the event of such a retroactive effective bargaining order, Overnite would face back pay liability for losses in employee earnings due to unilateral changes in terms or conditions of employment, such as layoffs, reduced hours of work or less\nremunerative work assignments. Overnite believes it has substantial defenses to these cases and intends to aggressively defend them.\nMINERAL TITLE LITIGATION - ------------------------\nIn August 1994, the surface owners of portions of five sections of Colorado land that are subject to mineral reservations made by Resources' predecessor in title brought suit against Resources in the District Court of Weld County, Colorado to quiet title to minerals, including crude oil (in some of the lands) and natural gas. In September 1994, the case was removed to the U.S. District Court for the District of Colorado, but the plaintiffs are asking the District Court to remand the case back to the state court. Resources has filed a motion for summary judgment asking the District Court to rule as a matter of law that it owns the oil and gas and all minerals that are part of a severed mineral estate. No trial date is currently set. Similar claims were made under identical mineral reservations by Utah and Wyoming surface owners in cases litigated in the Federal courts of Utah and Wyoming between 1979 and 1987. In those cases, the Federal courts held as a matter of law that, under the laws of Utah and Wyoming, these mineral reservations unambiguously reserved oil and gas to UPRR and its successors. These holdings were affirmed by the United States Court of Appeals for the Tenth Circuit. While Resources believes that the rule of law applied by the Federal courts in Utah and Wyoming should also be applied under Colorado law, there are Colorado court decisions that could provide a basis for an alternative interpretation. The value of the disputed reserves in the properties subject to the lawsuit is estimated to be approximately $5 million. Approximately 400,000 acres of other lands in Weld County, Colorado are subject to mineral reservations that are in the same form as the reservations at issue in the present suit. An adverse interpretation of the reservations at issue is likely to implicate the mineral title in these other lands as well. In addition, over 2 million acres of lands elsewhere in Colorado are subject to the same forms of mineral reservations. Depending on the grounds of an adverse decision in the case, title to minerals held by Resources in some or all of these lands could also be affected, which might have the effect of significantly reducing Resources' interest in the Las Animas area of southeastern Colorado and the Denver-Julesburg Basin in eastern Colorado.\nENVIRONMENTAL MATTERS - ---------------------\nIn July 1995, the Butte County (Oroville, California) District Attorney advised that a civil penalty action would be filed against the Railroad for violations resulting from a derailment and spill of diesel fuel into the Feather River in Peo, California on April 14, 1995. In late July, the California Regional Water Quality Control Board also filed a separate penalty action seeking $40,000 for the same incident. This latter action was settled for $40,000. A further demand for penalties from the California Department of Fish and Game is expected but the amount of such demand is not determinable at this time.\nIn addition to the foregoing, Union Pacific and several of its subsidiaries have received notices from the EPA and state environmental agencies alleging that they are or may be liable under CERCLA, RCRA, and 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, including sites which are on the Superfund National\nPriorities 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 many of the superfund sites, the Corporation 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 Union Pacific's exposure has been reached although regulatory proceedings at the sites involved have not been formally terminated. Additional information on the Corporation's potential environmental costs is set forth under Other Matters on page 29 of the Annual Report.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ---------------------------------------------------\nNot applicable.\nEXECUTIVE OFFICERS OF THE REGISTRANT AND ---------------------------------------- PRINCIPAL EXECUTIVE OFFICERS OF SUBSIDIARIES --------------------------------------------\nEXECUTIVE OFFICERS OF THE REGISTRANT AND ---------------------------------------- PRINCIPAL EXECUTIVE OFFICERS OF SUBSIDIARIES (CONTINUED) --------------------------------------------------------\n- ---------------------------\n(1) Mr. Lewis has served as Chairman and Chief Executive Officer of Union Pacific since May 1994 and prior thereto was Chairman, President and Chief Executive Officer of Union Pacific. Mr. Lewis also became Chairman of Resources in August 1995 and served as Chairman of the Railroad during August and September 1991.\n(2) Mr. Davidson was elected President of Union Pacific effective May 1994 and Chief Operating Officer of Union Pacific effective November 1995. He was President and Chief Executive Officer of the Railroad in August and September 1991 until August 1995 and Chairman of the Railroad since then. Prior thereto, he served as Executive Vice President - Operations of the Railroad.\n(3) Mr. Matthews was elected to his present position effective April 1992. Prior thereto, he served as Senior Vice President - Finance of Union Pacific.\n(4) Mr. Billingsley was elected to his present position effective September 1995. Prior thereto, he served as Vice President and Controller of Union Pacific.\n(5) Mr. von Bernuth was elected to his present position effective September 1991. Prior thereto, he served as Vice President and General Counsel of Union Pacific.\n(6) Mr. Gremillion was elected to his present position effective February 1992. Prior thereto, he served as Director of Taxes of Union Pacific.\n(7) Ms. McAuliffe was elected to her present position effective December 1991. Prior thereto, she served as Director - Washington Affairs, Transportation and Tax of Union Pacific.\nEXECUTIVE OFFICERS OF THE REGISTRANT AND ---------------------------------------- PRINCIPAL EXECUTIVE OFFICERS OF SUBSIDIARIES (CONTINUED) --------------------------------------------------------\n(8) Mr. Smith was elected to his present position effective September 1995. From January through August 1995 he served as Vice President- Finance of the Railroad; from June 1993 through December 1994, he served as Vice President-Finance of USPCI; and from October 1990 through May 1993 he served as Assistant Controller-Planning and Analysis of Union Pacific.\n(9) Mrs. Swantak was elected to her present position effective September 1991. Prior thereto, she served as Corporate Secretary of Union Pacific.\n(10) Mr. Burns was elected to his present position effective August 1995. From April 1994 to August 1995 he served as Managing Director, North American Operations, Enron Capital and Trade Resources, and from October 1990 through March 1994 he served as Chairman and Chief Executive Officer, Enron Gas Pipeline Group.\n(11) Mr. Messman was elected President and Chief Executive Officer of Resources in August 1995. He served as President and Chief Executive Officer of Union Pacific Resources Company (which owned or managed all of the oil, gas and mining operations of Union Pacific prior to Resources' initial public offering) since May 1991, and concurrently served as Chairman of USPCI prior to January 1995. Prior to May 1991, he served as Chairman and Chief Executive Officer of USPCI.\n(12) Mr. Douglas was elected to his present position effective February 1995. From July 1993 through January 1995 he served as Senior Vice President - Finance and Administration of Overnite, and from March 1991 through June 1993 he served as Vice President - Finance of Overnite. Prior thereto, he served as Assistant Controller - Accounting of Union Pacific.\nPART II -------\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS -----------------------------------------------------------------\nInformation as to the markets in which Union Pacific's Common Stock is traded, the quarterly high and low prices for such stock, the dividends declared with respect to the Common Stock during the last two years, and the approximate number of stockholders of record at January 31, 1996, is set forth under Selected Quarterly Data and Stockholders and Dividends, appearing on page 49 of the Annual Report. Information as to restrictions on the payment of dividends with respect to the Corporation's Common Stock is set forth in Note 8 to Financial Statements, appearing on pages 43 and 44 of the Annual Report. Such information is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA -----------------------\nSelected Financial Data for Union Pacific for each of the last ten years are set forth under the Ten-Year Financial Summary, appearing on page 51 of the Annual Report. All 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 ---------------------------------------------------------------\nInformation as to Union Pacific's results of operations, cash flows, liquidity and capital resources, and other matters is set forth in the Financial Review, appearing on pages 22 through 31 of the Annual Report, and is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA -------------------------------------------\nThe Corporation's consolidated financial statements, accounting policy disclosures, notes to financial statements, business segment information and independent auditors' report are presented on pages 32 through 48 of the Annual Report. Selected quarterly financial data are set forth under Selected Quarterly Data, appearing on page 49 of the Annual Report. All 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 of Registrant.\nInformation as to the names, ages, positions and offices with Union Pacific, terms of office, periods of service, business experience during the past five years and certain other directorships held by each director or person nominated to become a director of Union Pacific is set forth in the Directors segments of the Proxy Statement and is incorporated herein by reference.\n(b) Executive Officers of Registrant.\nInformation concerning the executive officers of Union Pacific and its subsidiaries is presented in Part I of this Report under Executive Officers of the Registrant and Principal Executive Officers of Subsidiaries.\n(c) Section 16(a) Compliance.\nInformation concerning compliance with Section 16(a) of the Securities Exchange Act of 1934 is set forth in the Certain Relationships and Related Transactions segment of the Proxy Statement and is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION ----------------------\nInformation concerning remuneration received by Union Pacific's executive officers and directors is presented in the Compensation of Directors, Compensation Committee Interlocks and Insider Participation, Summary Compensation Table, Option\/SAR Grants Table, Option\/SAR Exercises and Year-End Value Table and Defined Benefit Plans segments of the Proxy Statement and is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT --------------------------------------------------------------\nInformation as to the number of shares of Union Pacific's equity securities beneficially owned as of February 9, 1996 by each of its directors and nominees for director, its five most highly compensated executive officers and its directors and executive officers as a group is set forth in the Directors and Security Ownership of Management segments of the Proxy Statement and is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ----------------------------------------------\nInformation on related transactions is set forth in the Certain Relationships and Related Transactions and Compensation Committee Interlocks and Insider Participation segments of the Proxy Statement and is incorporated herein by reference.\nPART IV -------\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K ---------------------------------------------------------------\n(a) (1) and (2) Financial Statements and Schedules ----------------------------------------------\nThe financial statements, accounting policy disclosures, notes to financial statements and independent auditors' report appearing on pages 32 through 48, inclusive, of Union Pacific's 1995 Annual Report to Stockholders are incorporated herein by reference.\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.\n(3) Exhibits ------------\nItems 10(m) through 10(ff) below constitute management contracts and executive compensation arrangements required to be filed as exhibits to this report.\n2(a) Agreement 2(a) and Plan of Merger, dated as of August 3, 1995, among the Corporation, UPRR, UP Acquisition Corporation (the Purchaser) and Southern Pacific, is incorporated herein by reference to Annex B to the Joint Proxy Statement\/Prospectus included in Union Pacific's Registration Statement on Form S-4 (No. 33-64707).\n3(a) Union Pacific's Revised Articles of Incorporation, as amended through April 17, 1992, are incorporated herein by reference to Exhibit 3(a) to Union Pacific's Report on Form 10-Q for the quarter ended March 31, 1992.\n3(b) Union Pacific's By-Laws, amended effective as of January 26, 1995, are incorporated herein by reference to Exhibit 3(b) to Union Pacific's Report on Form 10-K for the year ended December 31, 1994.\n4 Pursuant to various indentures and other agreements, Union Pacific has issued long-term debt; however, no such agreement has securities or obligations covered thereby which exceed 10% of Union Pacific's total consolidated assets. Union Pacific agrees to furnish the Commission with a copy of any such indenture or agreement upon request by the Commission.\n9 Voting Trust Agreement, dated as of August 3, 1995, among the Corporation, the Purchaser and Southwest Bank of St. Louis, is incorporated herein by reference to Annex K to the Joint Proxy Statement\/Prospectus included in Union Pacific's Registration Statement on Form S-4 (No. 33-64707).\n10(a) Shareholders Agreement, dated as of August 3, 1995, among the Corporation, the Purchaser, The Anschutz Corporation (TAC), Anschutz Foundation (the Foundation), and Mr. Philip F. Anschutz (Mr. Anschutz), is incorporated herein by referenced to Annex D to the Joint Proxy Statement\/Prospectus included in Union Pacific's Registration Statement on Form S-4 (No. 33-64707).\n10(b) Shareholders Agreement, dated as of August 3, 1995, among the Corporation, the Purchaser and The Morgan Stanley Leveraged Equity Fund II, L.P., is incorporated herein by reference to Annex E to the Joint Proxy Statement\/Prospectus included in Union Pacific's Registration Statement on Form S-4 (No. 33-64707).\n10(c) Shareholders Agreement, dated as of August 3, 1995, among the Corporation, the Purchaser and Southern Pacific, is incorporated herein by reference to Annex F to the Joint Proxy Statement\/Prospectus included in Union Pacific's Registration Statement on Form S-4 (No. 33-64707).\n10(d) Shareholders Agreement, dated as of August 3, 1995, among Resources, TAC, the Foundation and Mr. Anschutz, is incorporated herein by reference to Annex G to the Joint Proxy Statement\/Prospectus included in Union Pacific's Registration Statement on Form S-4 (No. 33-64707).\n10(e) Registration Rights Agreement, dated as of August 3, 1995, among the Corporation, TAC and the Foundation, is incorporated herein by reference to Annex H to the Joint Proxy Statement\/Prospectus included in Union Pacific's Registration Statement on Form S-4 (No. 33-64707).\n10(f) Registration Rights Agreement, dated as of August 3, 1995, among Resources, TAC and the Foundation, is incorporated herein by reference to Annex I to the Joint Proxy Statement\/Prospectus included in Union Pacific's Registration Statement on Form S-4 (No. 33-64707).\n10(g) Registration Rights Agreement, dated as of August 3, 1995, between the Purchaser and Southern Pacific, is incorporated herein by reference to Annex J to the Joint Proxy Statement\/Prospectus included in Union Pacific's Registration Statement on Form S-4 (No. 33-64707).\n10(h) Clarification of Anschutz Shareholders Agreement and Anschutz\/Spinco Shareholders Agreement is incorporated herein by reference to Exhibit 10.8 to Union Pacific's Registration Statement on Form S-4 (No. 33-64707).\n10(i) Clarification of Parent Shareholders Agreement is incorporated herein by reference to Exhibit 10.9 to Union Pacific's Registration Statement on Form S-4 (No. 33-64707).\n10(j) Clarification of Agreement and Plan of Merger is incorporated herein by reference to Exhibit 10.10 to Union Pacific's Registration Statement on Form S-4 (No. 33-64707).\n10(k) Agreement, dated September 25, 1995, among the Corporation, UPRR, MPRR and Southern Pacific, Southern Pacific Transportation Company (SPT), The Denver & Rio Grande Western Railroad Company (D&RGW), St. Louis Southwestern Railway Company (SLSRC) and SPCSL Corp. (SPCSL), on the one hand, and Burlington Northern Railroad Company (BN) and The Atchison, Topeka and Santa Fe Railway Company (Santa Fe), on the other hand, is incorporated by reference to Exhibit 10.11 to Union Pacific's Registration Statement on Form S-4 (No. 33-64707).\n10(l) Supplemental Agreement, dated November 18, 1995, between the Corporation, UPRR, MPRR and Southern Pacific, SPT, D&RGW, SLSRC and SPCSL, on the one hand, and BN and Santa Fe, on the other hand, is incorporated herein by reference to Exhibit 10.12 to Union Pacific's Registration Statement on Form S-4 (No. 33- 64707).\n10(m) The Executive Incentive Plan of Union Pacific Corporation, amended April 27, 1995, is incorporated herein by reference to Exhibit 10(a) to Union Pacific's Report on Form 10-Q for the quarter ended March 31, 1995.\n10(n) The 1982 Stock Option and Restricted Stock Plan of Union Pacific Corporation, as amended as of February 1, 1992, is incorporated herein by reference to Exhibit 10(c) to Union Pacific's Report on Form 10-K for the year ended December 31, 1991.\n10(o) The 1988 Stock Option and Restricted Stock Plan of Union Pacific Corporation, as amended as of February 1, 1992, is incorporated herein by reference to Exhibit 10(d) to Union Pacific's Report on Form 10-K for the year ended December 31, 1991.\n10(p) The Supplemental Pension Plan for Officers and Managers of Union Pacific Corporation and Affiliates, as amended and restated, is incorporated herein by reference to Exhibit 10(d) to Union Pacific's Report on Form 10-K for the year ended December 31, 1993.\n10(q) The Supplemental Pension Plan for Exempt Salaried Employees of Union Pacific Resources Company and Affiliates, as amended and restated, is incorporated by reference to Exhibit 10(e) to Union Pacific's Report on Form 10-K for the year ended December 31, 1993.\n10(r) Amendment to Supplemental Pension Plan for Exempt Salaried Employees of Union Pacific Resources Group Inc. and Affiliates, effect as of October 17, 1995.\n10(s) The Employment Agreement, dated as of January 30, 1986, between Union Pacific and Andrew L. Lewis, Jr., is incorporated herein by reference to Exhibit 10(e) to Union Pacific's Report on Form 10-K for the year ended December 31, 1985.\n10(t) The 1990 Retention Stock Plan of Union Pacific Corporation, as amended as of September 30, 1993, is incorporated herein by reference to Exhibit 10(e) to Union Pacific's Report on Form 10-Q for the quarter ended September 30, 1991 and Exhibit 10(b) to Union Pacific's Report on Form 10-Q for the quarter ended September 30, 1993.\n10(u) The 1992 Restricted Stock Plan for Non-Employee Directors of Union Pacific Corporation, as amended as of January 28, 1993, is incorporated herein by reference to Exhibit 10(a) to Union Pacific's Current Report on Form 8-K filed March 16, 1993.\n10(v) The 1993 Stock Option and Retention Stock Plan of Union Pacific Corporation, as amended April 21, 1995, is incorporated herein by reference to Exhibit 10(b) to Union Pacific's Report on Form 10-Q for the quarter ended March 31, 1995.\n10(w) The Pension Plan for Non-Employee Directors of Union Pacific Corporation, as amended January 25, 1996.\n10(x) The Executive Life Insurance Plan of Union Pacific Corporation, adopted August 2, 1994, is incorporated herein by reference to Exhibit 10 to Union Pacific's Report on Form 10-Q for the quarter ended June 30, 1994.\n10(y) The Union Pacific Corporation Stock Unit Grant and Deferred Compensation Plan for the Board of Directors, as amended January 25, 1996.\n10(z) Charitable Contribution Plan for Non-Employee Directors of Union Pacific Corporation.\n10(aa) Written Description of Other Executive Compensation Arrangements of Union Pacific Corporation is incorporated herein by reference to Exhibit 10(o) to Union Pacific's Report on Form 10-K for the year ended December 31, 1992.\n10(bb) Executive Incentive Plan of Resources is incorporated by reference to Exhibit 10.9 to the Registration Statement on Form S-1 (No. 33-95398) filed by Resources.\n10(cc) 1995 Stock Option and Retention Stock Plan of Union Pacific Resources Group Inc. is incorporated by reference to Exhibit 10.10 to the Registration Statement on Form S-1 (No. 33-95398) filed by Resources.\n10(dd) Form of Conversion Agreement is incorporated by reference to Exhibit 10.13(a) to the Registration Statement on Form S-1 (No. 33-95398) filed by Resources.\n10(ee) Conversion Agreement for Drew Lewis is incorporated herein by reference to Exhibit 10(d) to Union Pacific's Report on Form 10-Q for the quarter ended September 30, 1995.\n10(ff) Conversion Agreement for Jack L. Messman is incorporated herein by reference to Exhibit 10(e) to Union Pacific's Report on Form 10-Q for the quarter ended September 30, 1995.\n(11) Computation of earnings per share.\n(12) Computation of ratio of earnings to fixed charges.\n(13) Pages 5 through 53, inclusive, of Union Pacific's Annual Report to Stockholders for the year ended December 31, 1995, but excluding photographs set forth on pages 5 through 21, none of which supplements the text and which are not otherwise required to be disclosed in this Annual Report on Form 10-K.\n(21) List of Union Pacific's significant subsidiaries and their respective states of incorporation.\n(23) Independent Auditors' Consent.\n(24) Powers of attorney executed by the directors of Union Pacific.\n(27) Financial Data Schedule.\n(99) (a) Financial Statements for the Fiscal Year ended December 31, 1995 required by Form 11-K for the Union Pacific Corporation Thrift Plan - To be filed by amendment.\n(99) (b) Financial Statements for the Fiscal Year ended December 31, 1995 required by Form 11-K for the Union Pacific Fruit Express Company Agreement Employee 401(k) Retirement Thrift Plan - To be filed by amendment.\n(99) (c) Financial Statements for the Fiscal Year ended December 31, 1995 required by Form 11-K for the Skyway Retirement Savings Plan - To be filed by amendment.\n(99) (d) Financial Statements for the Fiscal Year ended December 31, 1995 required by Form 11-K for the Union Pacific Agreement Employee 401(k) Retirement Thrift Plan - To be filed by amendment.\n(99) (e) Financial Statements for the Fiscal Year ended December 31, 1995 required by Form 11-K for the Union Pacific Motor Freight Agreement Employee 401(k) Retirement Thrift Plan - To be filed by amendment.\n(b) Reports on Form 8-K -------------------\nOn January 23, 1996, the Corporation filed a Current Report on Form 8-K containing (i) an Indenture dated as of January 5, 1996 between the Corporation and Chemical Bank, (ii) historical financial statements for Southern Pacific as of December 31, 1994 and September 30, 1995, (iii) restated financial statements of the Corporation reflecting the discontinuation of Resources, (iv) pro forma financial statements as of September 30, 1995 for the Corporation and Southern Pacific and (v) a statement concerning the Corporation's consolidated income statement for the nine months ended September 30, 1995.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on this 22nd day of March, 1996.\nUNION PACIFIC CORPORATION\nBy \/s\/ Drew Lewis ------------------------------- (Drew Lewis, Chairman and Chief Executive Officer)\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below, on this 22nd day of March, 1996, by the following persons on behalf of the registrant and in the capacities indicated.\nPRINCIPAL EXECUTIVE OFFICER AND DIRECTOR:\n\/s\/ Drew Lewis ------------------------------- (Drew Lewis, Chairman, Chief Executive Officer and Director)\nPRINCIPAL FINANCIAL OFFICER AND DIRECTOR:\n\/s\/ L. White Matthews, III ------------------------------- (L. White Matthews, III, Executive Vice President - Finance and Director)\nPRINCIPAL ACCOUNTING OFFICER:\n\/s\/ Morris B. Smith ------------------------------- (Morris B. Smith, Vice President and Controller)\nSIGNATURES - (Continued)\nDIRECTORS:\nRobert P. Bauman* Richard J. Mahoney*\nRichard B. Cheney* Jack L. Messman*\nE. Virgil Conway* John R. Meyer*\nRichard K. Davidson* Thomas A. Reynolds, Jr.*\nSpencer F. Eccles* James D. Robinson, III*\nElbridge T. Gerry, Jr.* Robert W. Roth*\nWilliam H. Gray, III* Richard D. Simmons*\nJudith Richards Hope*\n* By \/s\/ Judy L. Swantak ----------------------------------- (Judy L. Swantak, Attorney-in-fact)\nEXHIBIT INDEX -------------\nItems 10(m) through 10(ff) below constitute management contracts and executive compensation arrangements required to be filed as exhibits to this report.\nExhibit Number --------------\n2(a) Agreement and Plan of Merger, dated as of August 3, 1995, among Union Pacific Corporation (the Corporation), Union Pacific Railroad Company (\"UPRR\"), UP Acquisition Corporation (the Purchaser) and Southern Pacific Rail Corporation (Southern Pacific), is incorporated herein by reference to Annex B to the Joint Proxy Statement\/Prospectus included in Union Pacific's Registration Statement on Form S-4 (No. 33-64707).\n3(a) Union Pacific's Revised Articles of Incorporation, as amended through April 17, 1992, are incorporated herein by reference to Exhibit 3(a) to Union Pacific's Report on Form 10-Q for the quarter ended March 31, 1992.\n3(b) Union Pacific's By-Laws, amended effective as of January 26, 1995, are incorporated herein by reference to Exhibit 3(b) to Union Pacific's Report on Form 10-K for the year ended December 31, 1994.\n4 Pursuant to various indentures and other agreements, Union Pacific has issued long-term debt; however, no such agreement has securities or obligations covered thereby which exceed 10% of Union Pacific's total consolidated assets. Union Pacific agrees to furnish the Commission with a copy of any such indenture or agreement upon request by the Commission.\n9 Voting Trust Agreement, dated as of August 3, 1995, among the Corporation, the Purchaser and Southwest Bank of St. Louis, is incorporated herein by reference to Annex K to the Joint Proxy Statement\/Prospectus included in Union Pacific's Registration Statement on Form S-4 (No. 33-64707).\n10(a) Shareholders Agreement, dated as of August 3, 1995, among the Corporation, the Purchaser, The Anschutz Corporation (TAC), Anschutz Foundation (the Foundation), and Mr. Philip F. Anschutz (Mr. Anschutz), is incorporated herein by referenced to Annex D to the Joint Proxy Statement\/Prospectus included in Union Pacific's Registration Statement on Form S-4 (No. 33- 64707).\n10(b) Shareholders Agreement, dated as of August 3, 1995, among the Corporation, the Purchaser and The Morgan Stanley Leveraged Equity Fund II, L.P., is incorporated herein by reference to Annex E to the Joint Proxy Statement\/Prospectus included in Union Pacific's Registration Statement on Form S-4 (No. 33- 64707).\n10(c) Shareholders Agreement, dated as of August 3, 1995, among the Corporation, the Purchaser and Southern Pacific, is incorporated herein by reference to Annex F to the Joint Proxy Statement\/Prospectus included in Union Pacific's Registration on FormS-4 (No. 33-64707).\n10(d) Shareholders Agreement, dated as of August 3, 1995, among Union Pacific Resources Group Inc. (Resources), TAC, the Foundation and Mr. Anschutz, is incorporated herein by reference to Annex G to the Joint Proxy Statement\/Prospectus included in Union Pacific's Registration Statement on Form S-4 (No. 33-64707).\n10(e) Registration Rights Agreement, dated as of August 3, 1995, among the TAC Corporation, and the Foundation, is incorporated herein by reference to Annex H to the Joint Proxy Statement\/Prospectus included in Union Pacific's Registration Statement on Form S-4 (No. 33-64707).\n10(f) Registration Rights Agreement, dated as of August 3, 1995, among Resources, TAC and the Foundation, is incorporated herein by reference to Annex I to the Joint Proxy Statement\/Prospectus included in Union Pacific's Registration Statement on Form S-4 (No. 33-64707).\n10(g) Registration Rights Agreement, dated as of August 3, 1995, between the Purchaser and Southern Pacific, is incorporated herein by reference to Annex J to the Joint Proxy Statement\/Prospectus included in Union Pacific's Registration Statement on Form S-4 (No. 33-64707).\n10(h) Clarification of Anschutz Shareholders Agreement and Anschutz\/Spinco Shareholders Agreement is incorporated herein by reference to Exhibit 10.8 to Union Pacific's Registration Statement on Form S-4 (No. 33-64707).\n10(i) Clarification of Parent Shareholders Agreement is incorporated herein by reference to Exhibit 10.9 to Union Pacific's Registration Statement on Form S-4 (No. 33-64707).\n10(j) Clarification of Agreement and Plan of Merger is incorporated herein by reference to Exhibit 10.10 to Union Pacific's Registration Statement on Form S-4 (No. 33-64707).\n10(k) Agreement, dated September 25, 1995, among the Corporation, UPRR, Missouri Pacific Railroad Company (MPRR) and Southern Pacific, Southern Pacific Transportation Company (SPT), The Denver & Rio Grande Western Railroad Company (D&RGW), St. Louis Southwestern Railway Company (SLSRC) and SPCSL Corp. (SPCSL), on the one hand, and Burlington Northern Railroad Company (BN) and The Atchison, Topeka and Santa Fe Railway Company (Santa Fe), on the other hand, is incorporated by reference to Exhibit 10.11 to Union Pacific's Registration Statement on Form S-4 (No. 33-64707).\n10(l) Supplemental Agreement, dated November 18, 1995, between the Corporation, UPRR, MPRR and Southern Pacific, SPT, D&RGW, SLSRC and SPCSL, on the one hand, and BN and Santa Fe, on the other hand, is\nincorporated herein by reference to Exhibit 10.12 to Union Pacific's Registration Statement on Form S-4 (No. 33-64707).\n10(m) The Executive Incentive Plan of Union Pacific Corporation, amended April 27, 1995, is incorporated herein by reference to Exhibit 10(a) to Union Pacific's Report on Form 10-Q for the quarter ended March 31, 1995.\n10(n) The 1982 Stock Option and Restricted Stock Plan of Union Pacific Corporation, as amended as of February 1, 1992, is incorporated herein by reference to Exhibit 10(c) to Union Pacific's Report on Form 10-K for the year ended December 31, 1991.\n10(o) The 1988 Stock Option and Restricted Stock Plan of Union Pacific Corporation, as amended as of February 1, 1992, is incorporated herein by reference to Exhibit 10(d) to Union Pacific's Report on Form 10-K for the year ended December 31, 1991.\n10(p) The Supplemental Pension Plan for Officers and Managers of Union Pacific Corporation and Affiliates, as amended and restated, is incorporated herein by reference to Exhibit 10(d) to Union Pacific's Report on Form 10-K for the year ended December 31, 1993.\n10(q) The Supplemental Pension Plan for Exempt Salaried Employees of Union Pacific Resources Company and Affiliates, as amended and restated, is incorporated by reference to Exhibit 10(e) to Union Pacific's Report on Form 10-K for the year ended December 31, 1993.\n10(r) Amendment to Supplemental Pension Plan for Exempt Salaried Employees of Union Pacific Resources Group Inc. and Affiliates, effect as of October 17, 1995.\n10(s) The Employment Agreement, dated as of January 30, 1986, between Union Pacific and Andrew L. Lewis, Jr., is incorporated herein by reference to Exhibit 10(e) to Union Pacific's Report on Form 10-K for the year ended December 31, 1985.\n10(t) The 1990 Retention Stock Plan of Union Pacific Corporation, as amended as of September 30, 1993, is incorporated herein by reference to Exhibit 10(e) to Union Pacific's Report on Form 10-Q for the quarter ended September 30, 1991 and Exhibit 10(b) to Union Pacific's Report on Form 10-Q for the quarter ended September 30, 1993.\n10(u) The 1992 Restricted Stock Plan for Non-Employee Directors of Union Pacific Corporation, as amended as of January 28, 1993, is incorporated herein by reference to Exhibit 10(a) to Union Pacific's Current Report on Form 8-K filed March 16, 1993.\n10(v) The 1993 Stock Option and Retention Stock Plan of Union Pacific Corporation, as amended April 21, 1995, is incorporated herein by reference to Exhibit 10(b) to Union Pacific's Report on Form 10-Q for the quarter ended March 31, 1995.\n10(w) The Pension Plan for Non-Employee Directors of Union Pacific Corporation, as amended January 25, 1996.\n10(x) The Executive Life Insurance Plan of Union Pacific Corporation, adopted August 2, 1994, is incorporated herein by reference to Exhibit 10 to Union Pacific's Report on Form 10-Q for the quarter ended June 30, 1994.\n10(y) The Union Pacific Corporation Stock Unit Grant and Deferred Compensation Plan for the Board of Directors, as amended January 25, 1996.\n10(z) Charitable Contribution Plan for Non-Employee Directors of Union Pacific Corporation.\n10(aa) Written Description of Other Executive Compensation Arrangements of Union Pacific Corporation is incorporated herein by reference to Exhibit 10(o) to Union Pacific's Report on Form 10-K for the year ended December 31, 1992.\n10(bb) Executive Incentive Plan of Resources is incorporated by reference to Exhibit 10.9 to the Registration Statement on Form S-1 (No. 33-95398) filed by Resources.\n10(cc) 1995 Stock Option and Retention Stock Plan of Union Pacific Resources Group Inc. is incorporated by reference to Exhibit 10.10 to the Registration Statement on Form S-1 (No. 33-95398) filed by Resources.\n10(dd) Form of Conversion Agreement is incorporated by reference to Exhibit 10.13(a) to the Registration Statement on Form S-1 (No. 33-95398) filed by Resources.\n10(ee) Conversion Agreement for Drew Lewis is incorporated herein by reference to Exhibit 10(d) to Union Pacific's Report on Form 10-Q for the quarter ended September 30, 1995.\n10(ff) Conversion Agreement for Jack L. Messman is incorporated herein by reference to Exhibit 10(e) to Union Pacific's Report on Form 10-Q for the quarter ended September 30, 1995.\n(11) Computation of earnings per share.\n(12) Computation of ratio of earnings to fixed charges.\n(13) Pages 5 through 53, inclusive, of Union Pacific's Annual Report to Stockholders for the year ended December 31, 1995, but excluding photographs set forth on pages 5 through 21, none of which supplements the text and which are not otherwise required to be disclosed in this Annual Report on Form 10-K.\n(21) List of Union Pacific's significant subsidiaries and their respective states of incorporation.\n(23) Independent Auditors' Consent.\n(24) Powers of attorney executed by the directors of Union Pacific.\n(27) Financial Data Schedule.\n(99) (a) Financial Statements for the Fiscal Year ended December 31, 1995 required by Form 11-K for the Union Pacific Corporation Thrift Plan - To be filed by amendment.\n(99) (b) Financial Statements for the Fiscal Year ended December 31, 1995 required by Form 11-K for the Union Pacific Fruit Express Company Agreement Employee 401(k) Retirement Thrift Plan - To be filed by amendment.\n(99) (c) Financial Statements for the Fiscal Year ended December 31, 1995 required by Form 11-K for the Skyway Retirement Savings Plan - To be filed by amendment.\n(99) (d) Financial Statements for the Fiscal Year ended December 31, 1995 required by Form 11-K for the Union Pacific Agreement Employee 401(k) Retirement Thrift Plan - To be filed by amendment.\n(99) (e) Financial Statements for the Fiscal Year ended December 31, 1995 required by Form 11-K for the Union Pacific Motor Freight Agreement Employee 401(k) Retirement Thrift Plan - To be filed by amendment.","section_15":""}
{"filename":"832091_1995.txt","cik":"832091","year":"1995","section_1":"ITEM 1. BUSINESS\nKrupp Insured Plus-III Limited Partnership (the \"Partnership\") is a Massachusetts limited partnership which was formed on March 21, 1988. The Partnership raised approximately $255 million through a public offering of limited partner interests evidenced by units of depositary receipts (\"Units\") and used the net proceeds primarily to acquire participating insured mortgages (\"PIMs\") and mortgage-backed securities (\"MBS\"). The Partnership considers itself to be engaged in only one industry segment, investment in mortgages.\nThe Partnership's investments in PIMs on multi-family residential properties consist of a MBS or an insured mortgage loan (collectively, the \"insured mortgage\") guaranteed or insured as to principal and basic interest and a participation feature that is not insured or guaranteed. The insured mortgages were issued or originated under or in connection with the housing programs of the Government National Mortgage Association (\"GNMA\"), the Federal National Mortgage Association (\"FNMA\") or the Federal Housing Administration (\"FHA\") under the authority of the Department of Housing and Urban Development (\"HUD\"). PIMs provide the Partnership with monthly payments of principal and interest on the insured mortgage and also provide for Partnership participation in the current revenue stream and in residual value, if any, as a result of a sale or other realization of the underlying property from the participation feature. The borrower conveys the participation rights to the Partnership through a subordinated promissory note and mortgage.\nThe Partnership also acquired MBS collateralized by single-family or multi-family mortgage loans issued or originated by GNMA, FNMA, the Federal Home Loan Mortgage Corporation (\"FHLMC\") or the FHA. FNMA, FHLMC and GNMA guarantee the principal and basic interest of the FNMA, FHLMC and GNMA MBS, respectively. HUD insures the pooled mortgage loans underlying the GNMA MBS and FHA mortgage loans.\nPrior to June 22, 1995 the Partnership could reinvest or commit for reinvestment principal proceeds or other realization of the mortgages in new mortgages, but following that date, the Partnership must distribute to the investors through quarterly, or possibly special distributions, proceeds received from prepayments or other realizations of mortgage assets.\nAlthough the Partnership will terminate no later than December 31, 2028 it is expected that the value of the PIMs generally will be realized by the Partnership through repayment or sale as early as ten years from the dates of the closings of the permanent loans and that the Partnership will realize the value of all of its other investments within that time frame thereby resulting in a dissolution of the Partnership significantly prior to December 31, 2028.\nThe Partnership's investments are not expected to be subject to seasonal fluctuations. However, the future performance of the Partnership will depend upon certain factors which can not be predicted. Such factors include interest rate fluctuation and the credit worthiness of GNMA, FNMA, HUD and FHLMC. Any ultimate realization of the participation features on PIMs is subject to similar risks associated with equity real estate investments, including: reliance on the owner's operating skills, ability to maintain occupancy levels, control operating expenses, maintain the property and obtain adequate insurance coverage; adverse changes in government regulations, real estate zoning laws, or tax laws; and other circumstances over which the Partnership may have little or no control.\nThe 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.\nAs of December 31, 1995, there were no personnel directly employed by the Partnership.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nNone.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThere are no material pending legal proceedings to which the Partnership is a party or to which any of its investments is the subject.\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\nThere currently is no established trading market for the Units.\nThe number of investors holding Units as of December 31, 1995 was approximately 12,000. One of the objectives of the Partnership is to provide quarterly distributions of cash flow generated by its investments in mortgages. The Partnership anticipates that future operations will continue to generate cash available for distributions.\nThe Partnership made the following distributions, in quarterly installments, to its Partners during the two years ended December 31, 1995 and 1994:\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 read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations and the Financial Statements and Financial Statement Schedule, which are included in Item 7","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nLiquidity and Capital Resources\nThe most significant demand on the Partnership's liquidity are quarterly distributions paid to investors of approximately $3.8 million in 1995. Funds used for investor distributions come from interest received on the PIMs, MBS, cash and cash equivalents net of operating expenses, and certain principal collections received on the PIMs and MBS. The cash generated by these items totaled approximately $16.8 million in 1995. The Partnership funds a portion of the distributions from principal collections, as a result, the capital resources of the Partnership will continually decrease. As the capital resources decrease, the total cash inflows to the Partnership will also decrease which will result in periodic adjustments to the quarterly distributions paid to investors.\nThe General Partners periodically review the distribution rate to determine whether an adjustment to the distribution rate is necessary based on projected future cash flows. In general, the General Partners try to set a distribution rate that provides for level quarterly distributions of cash available for distribution. To the extent quarterly distributions do not fully utilize the cash available for distribution and cash balances increase, the General Partners may adjust the distribution rate or distribute such funds through a special distribution.\nDuring December 1995 the Partnership agreed to a modification of the Royal Palm PIM. The Partnership received a reissued Federal National Mortgage Association (\"FNMA\") mortgage-backed security (\"MBS\") and increased its participation percentage in income and appreciation from 25% to 30%. During December 1995, the Partnership received its pro-rata share of a $90,644 principal payment and will receive interest only payments on the FNMA MBS at interest rates ranging from 6.25% to 8.775% per annum through maturity in 2006. Also, the Partnership will receive its pro-rata share of the $250,000\nprincipal payments due on December 1 of each of the next four years. As a result of the modification, the Royal Palm PIM will continue to provide the Partnership with a competitive yield, potential participation in future income and appreciation, and principal and interest from the FNMA MBS will continue to be guaranteed by FNMA.\nFor the first five years of the PIMs the borrowers are prohibited from repaying. For the second five years, the borrower can repay the loans incurring a prepayment penalty. The Partnership has the option to call certain PIMs by accelerating their maturity if the loans are not prepaid by the tenth year after permanent funding. The Partnership will determine the merits of exercising the call option for each PIM as economic conditions warrant. Such factors as the condition of the asset, local market conditions, interest rates and available financing will have an impact on this decision.\nAssessment of Credit Risk\nThe Partnership's investments in mortgages are guaranteed or insured by FNMA, FHLMC, GNMA and HUD and therefore the certainty of their cash flows and the risk of material loss of the amounts invested depends on the creditworthiness of these entities.\nFNMA is a federally chartered private corporation that guarantees obligations originated under its programs. FHLMC is a federally chartered corporation that guarantees obligations originated under its programs and is wholly-owned by the twelve Federal Home Loan Banks. These obligations are not guaranteed by the U.S. Government or the Federal Home Loan Bank Board. GNMA guarantees the full and timely payment of principal and basic interest on the securities it issues, which represent interests in pooled mortgages insured by HUD. Obligations insured by HUD, an agency of the U.S. Government, are backed by the full faith and credit of the U.S. Government.\nDistributable Cash Flow and Net Cash Proceeds from Capital Transactions\nShown below is the calculation of Distributable Cash Flow and Net Cash Proceeds from Capital Transactions as defined in Section 17 of the Partnership Agreement and the source of cash distributions for the year ended December 31, 1995 and the period from inception through December 31, 1995. The General Partners provide certain of the information below to meet requirements of the Partnership Agreement and because they believe that it is an appropriate supplemental measure of operating performance. However, Distributable Cash Flow and Net Cash Proceeds from Capital Transactions should not be considered by the reader as a substitute to net income as an indicator of the Partnership's operating performance or to cash flows as a measure of liquidity.\n(a) Represents all distributions paid in 1995 except the February 1995 distri-bution and includes an estimate of the distribution to be paid in February 1996. (b) Includes distribution to be paid in February 1996. (c) Limited Partners average per Unit return of capital as of February 1996 is $2.78 [$10.55 - $7.77]. Return of capital represents\nthat portion of distributions which is not funded from DCF such as proceeds from the sale of assets and substantially all of the principal collections received from MBS and PIMs.\nOperations\nThe following discussion relates to the operation of the Partnership during the years ended December 31, 1995, 1994 and 1993.\nNet income did not change materially during any of the three years in the periods ended December 31, 1995, primarily because the Partnership's investments in PIMs remained stable during these periods. Overall, the change in total interest income was not significant during the three years ended December 31, 1995. Participation interest received increased $242,000 or 80.1% during 1995 as compared to 1994 due to the Partnership receiving participation from 11 of the PIMs as compared to 8 PIMs in 1994. Interest income on MBS increased $248,000 in 1995 as compared to 1994 due primarily to the Partnership reinvesting approximately $12 million of principal collections in additional MBS to obtain the higher yields as compared to the available yields on short-term investments. These MBS acquisitions reduced cash available for short-term investment which resulted in a decline in interest income - other in 1995 as compared to 1994. Interest income on MBS decreased $162,000 or 6% during 1994 as compared to 1993 primarily as a result of significant prepayments caused by refinancings of the underlying mortgages during 1993 and the first half of 1994.\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 None.\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 Krupp Plus Corporation which is a General Partner of the Partnership and is the general partner of Mortgage Services Partners Limited Partnership, which is the other General Partner of the Partnership, is as follows:\nPosition with Name and Age Krupp Plus Corporation\nDouglas Krupp (49) Co-Chairman of the Board George Krupp (51) Co-Chairman of the Board Laurence Gerber (39) President Peter F. Donovan (42) Senior Vice President Robert A. Barrows (38) Treasurer and Chief Accounting Officer\nDouglas Krupp is Co-Chairman and Co-Founder of The Berkshire Group. Established in 1969 as the Krupp Companies, this real estate-based firm expanded over the years within its areas of expertise including investment program sponsorship, property and asset management, mortgage banking and healthcare facility ownership. Today, The Berkshire Group is an integrated real estate, mortgage and healthcare company which is headquartered in Boston with regional offices throughout the country. A staff of 3,400 are responsible for the more than $3 billion under management for institutional and individual clients. Mr. Krupp is a graduate of Bryant College. In 1989 he received an honorary Doctor of Science in Business Administration from this institution and was elected trustee in 1990. Mr. Krupp serves as Chairman of the Board and a Director of Berkshire Realty Company, Inc.(NYSE-BRI).\nGeorge Krupp is the Co-Chairman and Co-Founder of The Berkshire Group. Established in 1969 as the Krupp Companies, this real estate-based firm expanded over the years within its areas of expertise including investment program sponsorship, property and asset management, mortgage banking and healthcare facility ownership. Today, The Berkshire Group is an integrated real estate, mortgage and healthcare company which is headquartered in Boston with regional offices throughout the country. A staff of 3,400 are responsible for more than $3 billion under management for institutional and individual clients. Mr. Krupp attended the University of Pennsylvania and Harvard University. Mr. Krupp serves as Chairman of the Board and Trustee of Krupp Government Income Trust and Krupp Government Income Trust II.\nLaurence Gerber is the President and Chief Executive Officer of The Berkshire Group. Prior to becoming President and Chief Executive Officer in 1991, Mr. Gerber held various positions with The Berkshire Group which included overall responsibility at various times for: strategic planning and product development, real estate acquisitions, corporate finance, mortgage banking, syndication and marketing. Before joining The Berkshire Group in 1984, he was a management consultant with Bain & Company, a national consulting firm headquartered in Boston. Prior to that, he was a senior tax accountant with Arthur Andersen & Co., an international accounting and consulting firm. Mr. Gerber has a B.S. degree in Economics 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 also serves as President and a Director of Berkshire Realty Company, Inc. (NYSE-BRI) and President and Trustee of Krupp Government Income Trust and Krupp Government Income Trust II.\nPeter F. Donovan is President of Berkshire Mortgage Finance and directs the underwriting, servicing and asset management of a $2.5 billion multi- family loan portfolio. Previously, he was Senior Vice President of Berkshire Mortgage Finance and was responsible for all mortgage originations. Before joining the firm in 1984, he was Second Vice President, Real Estate Finance for Continental Illinois National Bank & Trust, where he managed a $300 million construction loan portfolio of commercial properties. Mr. Donovan received a B.A. from Trinity College and an M.B.A. degree from Northwestern University.\nRobert A. Barrows is Senior Vice President and Chief Financial Officer of Berkshire Mortgage Finance and Corporate Controller of The Berkshire Group. Mr. Barrows has held several positions within The Berkshire Group since joining the company in 1983 and is currently responsible for accounting and financial reporting, treasury, tax, payroll and office administrative activities. Prior to joining The Berkshire Group, he was an audit supervisor for Coopers & Lybrand L.L.P. in Boston. He received a B.S. degree from Boston College and is a Certified Public Accountant.\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, 1995, no person owned of record or was known by the General Partners to own beneficially more than 5% of the Partnership's 12,770,161 outstanding Units. The only interests held by management or its affiliates consist of its General Partner and Corporate Limited Partner interests.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation required under this Item is contained in Note F to the Partnership's Financial Statements presented 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 of this report.\n2. Financial Statement Schedules - see Index to Financial Statements and Schedule included under Item 8, Appendix A, on page of 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: (4) Instruments defining the rights of security holders including indentures:\n(4.1) Agreement of Limited Partnership dated as of June 22, 1988 [Exhibit A included in Amendment No. 1 of Registrant's Registration Statement on Form S-11 dated June 22, 1988 (File No. 33-21200)].*\n(4.2) Subscription Agreement whereby a subscriber agrees to purchase Units and adopts the provisions of the Agreement of Limited Partnership [Exhibit D included in Amendment No. 1 of Registrant's Registration Statement on Form S-11 dated June 22, 1988 (File No. 33-21200)].*\n(4.3) Copy of First Amended and Restated Certificate of Limited Partnership filed with the Massachusetts Secretary of State on June 22, 1988. [Exhibit 4.4 to Amendment No. 1 of Registrant's Registration Statement on Form S-11 dated June 22, 1988 (File No. 33-21200)].*\n(10) Material Contracts:\n(10.1) Revised form of Escrow Agreement [Exhibit 10.1 to Amendment No. 1 of Registrant's Registration Statement on Form S-11 dated June 22, 1988 (File No. 33-21200)] *\n(10.2) Form of agreement between the Partnership and Krupp Mortgage Corporation [Exhibit 10.2 to Registrant's Registration Statement on Form S-11 dated April 20, 1988 (File No. 33-21200)].*\nSundance Apartments\n(10.3) Prospectus for GNMA Pools No. 276431 (CS) and 276432 (PL) [Exhibit 19.1 to Registrant's Report on Form 10-Q for the quarter ended September 30, 1989 (File No. 0-17691)].*\n(10.4) Subordinated Multifamily Mortgage (including Subordinated Promissory Note) dated July 26, 1989 between Sundance Associates II, Ltd. and Krupp Insured Plus-III Limited Partnership [Exhibit 19.2 to Registrant's Report on Form 10-Q for the quarter ended September 30, 1989 (File No. 0-17691)].*\nWoodbine Apartments\n(10.5) Subordinated Multifamily Deed of Trust (including Subordinated Promissory Note) dated August 23, 1989 between Woodbine II Investors Limited Partnership and Krupp Insured Plus-III Limited Partnership [Exhibit 19.3 to Registrant's Report on Form 10-Q for the\nquarter ended September 30, 1989 (File No. 0- 17691)].*\n(10.6) Participation Agreement dated August 23, 1989 between The Krupp Mortgage Corporation (\"Mortgagee\") and Krupp Insured Plus-III Limited Partnership (the \"Participant\") [Exhibit 19.4 to Registrant Report on Form 10-Q for the quarter ended September 30, 1989 (File No. 0-17691)].*\n(10.7) Mortgage Note dated August 23, 1989 between Woodbine II Investors Limited Partnership and Krupp Mortgage Corporation. [Exhibit 19.5 to Registrant's Report on Form 10-Q for the quarter ended September 30, 1989 (File No. 0-17691)].*\n(10.8) Deed of Trust dated August 23, 1989 between Woodbine II Investors Limited Partnership and Krupp Mortgage Corporation. [Exhibit 19.6 to Registrant's Report on Form 10-Q for the quarter ended September 30, 1989 (File No. 0-17691)].*\nIronwood Apartments\n(10.9) Prospectus for GNMA Pool No. 272542(CS) and 272543(PN). [Exhibit 19.7 to Registrant's Report on Form 10-Q for the quarter ended September 30, 1989 (File No. 0-17691)].*\n(10.10) Subordinated Multifamily Mortgage (including Subordinated Promissory Note) dated July 18, 1989 between Ironwood Associates Limited Partnership and Krupp Insured Plus-III Limited Partnership. [Exhibit 19.8 to Registrant's Report on Form 10-Q for the quarter ended September 30, 1989 (File No. 0- 17691)].*\n(10.11) Mortgage Note dated July 18, 1989 between Ironwood Associates Limited Partnership and Krupp Mortgage Corporation. [Exhibit 19.9 to Registrant's Report on Form 10-Q for the quarter ended September 30, 1989 (File No. 0-17691)].*\n(10.12) Mortgage dated July 18, 1989 between Ironwood Associates Limited Partnership and Krupp Mortgage Corporation. [Exhibit 19.10 to Registrant's Report on Form 10-Q for the quarter ended September 30, 1989 (File No. 0-17691)].*\nCasa Marina Apartments\n(10.13) Prospectus for GNMA Pool No. 279699 (CS) and 279700 (PL) [Exhibit 19.11 to Registrant's Report on Form 10-Q for the quarter ended September 30, 1989 (File No. 0-17691)].*\n(10.14) Subordinated Multifamily Mortgage (including Subordinated Promissory Note) dated June 29, 1989 between Beaux Gardens Associates, LTD., a Florida\nlimited partnership and Krupp Insured Plus-II Limited Partnership. [Exhibit 19.12 to Registrant's Report on Form 10-Q for the quarter ended September 30, 1989 (File No. 0-17691)].*\n(10.15) Participation Agreement dated July 31, 1989 between Krupp Insured Plus-II Limited Partnership and Krupp Insured Plus-III Limited Partnership. [Exhibit 19.13 to Registrant's Report on Form 10-Q for the quarter ended September 30, 1989 (File No. 0-17691)].*\nRosewood Apartments\n(10.16) Prospectus for GNMA Pool No. 280647(CS) and 280648(PL) [Exhibit 10.16 to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 (File No. 0-17691).*\n(10.17) Security Deed Note, dated September 28, 1989 between Knight Davidson Rosewood I, a Georgia general partnership and Krupp Mortgage Corporation. [Exhibit 19.14 to Registrant's Report on Form 10-Q for the quarter ended September 30, 1989 (File No. 0- 17691)].*\n(10.18) Security Deed dated September 28, 1989 between Knight Davidson Rosewood I, a Georgia general partnership and Krupp Mortgage Corporation. [Exhibit 19.15 to Registrant's Report on Form 10-Q for the quarter ended September 30, 1989 (File No. 0- 17691)].*\n(10.19) Subordinated Multifamily Deed to Secure Debt (including Subordinated Promissory Note) dated September 28, 1989 between Knight Davidson RosewoodI, a Georgia general partnership and Krupp Insured Plus-III Limited Partnership. [Exhibit 19.16 to Registrant's Report on Form 10-Q for the quarter ended September 30, 1989 (File No. 0-17691)].*\nWindsor Court\n(10.20) Supplement to Prospectus for FNMA Pool No. MX-073006 [Exhibit 10.23 to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 (File No. 0-17691).*\n(10.21) Subordinated Multifamily Mortgage (including Subordinated Promissory Note) dated September 26, 1989 between Sexton 1986 Windsor-V, an Indiana limited partnership and Krupp Insured Plus-III Limited Partnership [Exhibit 10.24 to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 (File No. 0-17691).*\nPaddock Park II Apartments (10.22) Prospectus for FNMA Pool No. MX-073010 [Exhibit 19.1 to Registrants's Report on Form 10-Q for the quarter\nended March 31, 1990 (File No. 0-17691)].*\n(10.23) Subordinated Multifamily Mortgage (including Subordinated Promissory Note) dated February 21, 1990 between Paddock Park Ocala II, a Georgia limited partnership and Krupp Insured Plus-III Limited Partnership [Exhibit 19.2 to Registrants's Report on Form 10-Q for the quarter ended March 31,1990 (File No. 0-17691)].*\nHarbor Club Apartments\n(10.24) Prospectus for GNMA Pool No. 259237(CS) and 259238(PN). [Exhibit 19.3 to Registrants's Report on Form 10-Q for the quarter ended March 31,1990 (File No. 0-17691)].*\n(10.25) Subordinated Multifamily Mortgage (including Subordinated Promissory Note) dated January 30, 1990 between Ann Arbor Harbor Club, a Texas limited partnership and Krupp Insured Plus-III Limited Partnership. [Exhibit 19.4 to Registrants's Report on Form 10-Q for the quarter ended March 31,1990 (File No. 0-17691)].*\nMill Ponds Apartments\n(10.26) Prospectus for FNMA Pool No. MX-073012. [Exhibit 19.1 to Regi-strant's Report on Form 10-Q for the quarter ended June 30, 1990 (File No. 0-17691)].*\n(10.27) Multifamily Mortgage (including Subordinated Promissory Note) dated May 17, 1990 between State Bank of Countryside, Illinois and Krupp Insured Plus-III Limited Partnership. [Exhibit 19.2 to Registrants's Report on Form 10-Q for the quarter ended June 30, 1990 (File No. 0-17691)].*\nFriendly Hills Apartments\n(10.28) Multifamily Deed of Trust (including Subordinated Promissory Note) dated June 27, 1990 between Friendly Hills Apartments, Ltd., a New Jersey Limited Partnership and Krupp Insured Plus-III Limited Partnership. [Exhibit 19.3 to Registrants's Report on Form 10-Q for the quarter ended June 30, 1990 (File No. 0-17691)].*\n(10.29) Deed of Trust Note dated June 27, 1990 between Friendly Hills Apartments, Ltd., a New Jersey Limited Partnership and Krupp Insured Plus-III Limited Partnership. [Exhibit 19.4 to Regi-strant's Report on Form 10-Q for the quarter ended June 30, 1990 (File No. 0-17691)].*\nPaces Arbor\n(10.30) Prospectus for FNMA Pool No. MX-073015. [Exhibit 19.1 to Registrant's Report on Form 10-Q for the quarter ended September 30, 1990 (File No. 0- 17691)].*\n(10.31) Subordinated Multifamily Deed of Trust (including Subordinated Promissory Note) dated June 7, 1990 between Paces Arbor Apartments, Ltd., a North Carolina limited partnership and Krupp Insured Plus- III Limited Partnership. [Exhibit 19.2 to Registrant's Report on Form 10-Q for the quarter ended September 30, 1990 (File No. 0-17691)].*\nPaces Forest\n(10.32) Prospectus for FNMA Pool No. MX-073016. [Exhibit 19.3 to Registrant's Report on Form 10-Q for the quarter ended September 30, 1990 (File No. 0- 17691)].*\n(10.33) Subordinated Multifamily Deed of Trust (including Subordinated Promissory Note dated June 7, 1990 between Paces Forest Apartments Limited Partnership, a North Carolina limited partnership and Krupp Insured Plus-III Limited Partnership. [Exhibit 19.4 to Registrant's Report on Form 10-Q for the quarter ended September 30, 1990 (File No. 0-17691)].*\nFourth Ward\n(10.34) Prospectus for GNMA Pool No. 280969(CS) and 280970(PL). [Exhibit 19.5 to Registrant's Report on Form 10-Q for the quarter ended September 30, 1990 (File No. 0-17691)].* (10.35) Subordinated Multifamily Deed of Trust (including Subordinated Promissory Note) dated June 27, 1990 between The Fourth Ward Square Associates Limited Partnership and Krupp Insured Plus-III Limited Partnership. [Exhibit 19.6 to Registrant's Report on Form 10-Q for the quarter ended September 30, 1990 (File No. 0-17691)].*\nPaddock Club\n(10.36) Prospectus for GNMA Pool No. 280973(CS) and 280974(PL). [Exhibit 19.7 to Registrant's Report on Form 10-Q for the quarter ended September 30, 1990 (File No. 0-17691)].*\n(10.37) Subordinated Multifamily Mortgage (including Subordinated Promissory Note) dated August 2, 1990 between Paddock Club Tallahassee, A Limited Partnership, and Krupp Insured Plus-III Limited Partnership. [Exhibit 19.8 to Registrant's Report on Form 10-Q for the quarter ended September 30, 1990 (File No. 0-17691)].*\nMeridith Square (10.38) Prospectus for FNMA Pool No. MX-073019. [Exhibit 10.41 to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1990 (File No. 0- 17691)].*\n(10.39) Subordinated Multifamily Mortgage (including Subordinated Promissory Note) dated September 17, 1990 between BAND\/Carolina Associates Limited Partnership, a Virginia limited partnership and Krupp Insured Plus-III Limited Partnership. [Exhibit 10.42 to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1990 (File No. 0- 17691)].*\nPaddock Club Jacksonville\n(10.40) Prospectus for FNMA Pool No. MX-073020. [Exhibit 19.01 to Registrant's Report on Form 10-Q for the quarter ended March 31, 1991 (File No. 0-17691)].*\n(10.41) Subordinated Multifamily Mortgage (including Subordinated Promissory Note) dated December 20, 1991 between Paddock Club Jacksonville, a Georgia limited partnership and Krupp Insured Plus-III Limited Partnership. [Exhibit 19.02 to Registrant's Report on Form 10-Q for the quarter ended March 31, 1991 (File No. 0-17691)].*\nMarina Shores Apartments\n(10.42) Prospectus for GNMA Pool No. 280971(CS) and 280972(PL). [Exhibit 19.03 to Registrant's Report on Form 10-Q for the quarter ended March 31, 1991 (File No. 0-17691)].*\n(10.43) Subordinated Multifamily Deed of Trust (including Subordinated Promissory Note) dated June 27, 1990 between Marina Shores Associates One, a Virginia limited partnership and Krupp Insured Plus-III Limited Partnership. [Exhibit 19.04 to Registrant's Report on Form 10-Q for the quarter ended March 31, 1991 (File No. 0-17691)].*\n(10.44) Participation Agreement dated June 29, 1990 by and between Krupp Insured Plus-III Limited Partnership and Krupp Insured Mortgage Limited Partnership. [Exhibit 19.05 to Registrant's Report on Form 10-Q for the quarter ended March 31, 1991 (File No. 0- 17691)].*\nRoyal Palm Place\n(10.45) Prospectus for FNMA Pool No. MB-109057.+ (10.46) Subordinated Multifamily Mortgage dated March 20, 1991 between Royal Palm Place, Ltd., a Florida Limited Partnership and Krupp Insured Plus-III Limited\nPartnership. [Exhibit 19.2 to Registrant's Report on Form 10-Q for the quarter ended June 30, 1991 (File No. 0-17691)].* (10.47) Modification Agreement dated March 20, 1991, between Royal Palm Place, Ltd., and Krupp Insured Plus-III Limited Partnership. [Exhibit 19.3 to Registrant's Report on Form 10-Q for the quarter ended June 30, 1991 (File No. 0-17691)].*\n(10.48) Participation Agreement dated March 20, 1991 by and between Krupp Insured Plus-III Limited Partnership and Krupp Insured Plus Limited Partnership. [Exhibit 19.1 to Registrant's Report on Form 10-Q for the quarter ended September 30, 1991 (File No. 0- 17691)].*\n(10.49) Amended and Restated Subordinated Promissory Note by and between Royal Palm, Ltd. and Krupp Insured Plus- III Limited Partnership.+\n* Incorporated by reference + Filed herein\n(c) Reports on Form 8-K\nDuring the last quarter of the year ended December 31, 1995, 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 26th day of February, 1996.\nKRUPP INSURED PLUS-III LIMITED PARTNERSHIP\nBy: Krupp Plus Corporation, a General Partner\nBy: \/s\/George Krupp George Krupp, Co-Chairman (Principal Executive Officer) and Director of Krupp Plus 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 26th day of February, 1996.\nSignatures Title(s)\n\/s\/Douglas Krupp Co-Chairman (Principal Executive Officer) Douglas Krupp and Director of Krupp Plus Corporation, a General Partner.\n\/s\/ George Krupp Co-Chairman (Principal Executive Officer) George Krupp and Director of Krupp Plus Corporation, a General Partner.\n\/s\/ Laurence Gerber President of Krupp Plus Corporation, a Laurence Gerber General Partner.\n\/s\/ Peter F. Donovan Senior Vice President of Krupp Plus Peter F. Donovan Corporation, a General Partner.\n\/s\/ Robert A. Barrows Treasurer and Chief Accounting Officer Robert A. Barrows of Krupp Plus Corporation, a General Partner.\nAPPENDIX A\nKRUPP INSURED PLUS-III LIMITED PARTNERSHIP\nFINANCIAL STATEMENTS AND SCHEDULE ITEM 8 of FORM 10-K\nANNUAL REPORT TO THE SECURITIES AND EXCHANGE COMMISSION For the Year Ended December 31, 1995\nKRUPP INSURED PLUS-III LIMITED PARTNERSHIP\nINDEX TO FINANCIAL STATEMENTS AND SCHEDULE\nReport of Independent Accountants\nBalance Sheets at December 31, 1995 and 1994\nStatements of Income for the Years Ended December 31, 1995, 1994 and 1993\nStatements of Changes in Partners' Equity for the Years Ended December 31, 1995, 1994 and 1993\nStatements of Cash Flows for the Years Ended December 31, 1995, 1994 and 1993\nNotes to Financial Statements -\nSchedule IV - Mortgage Loans on Real Estate -\nAll other schedules are omitted as they are not applicable or not required, or the information is provided in the financial statements or the notes thereto.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Partners of Krupp Insured Plus-III Limited Partnership:\nWe have audited the financial statements and the financial statement schedule of Krupp Insured Plus-III Limited Partnership (the \"Partnership\") listed in the index on page of this Form 10-K. The financial statements and financial statement schedule are the responsibility of the General Partners of the Partnership. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the 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 the General Partners of the Partnership, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Krupp Insured Plus-III Limited Partnership as of December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995 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.\nBoston, Massachusetts January 27, 1996\nKRUPP INSURED PLUS-III LIMITED PARTNERSHIP\nThe accompanying notes are an integral part of the financial statements.\nKRUPP INSURED PLUS-III LIMITED PARTNERSHIP\nThe accompanying notes are an integral part of the financial statements. KRUPP INSURED PLUS-III LIMITED PARTNERSHIP\nThe accompanying notes are an integral part of the financial statements.\nKRUPP INSURED PLUS-III LIMITED PARTNERSHIP\nThe accompanying notes are an integral part of the financial statements.\nKRUPP INSURED PLUS-III LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS\nA. Organization\nKrupp Insured Plus-III Limited Partnership (the \"Partnership\") was formed on March 21, 1988 by filing a Certificate of Limited Partnership in The Commonwealth of Massachusetts. The Partnership issued all of the General Partner Interests to Krupp Plus Corporation and Mortgage Services Partners Limited Partnership in exchange for capital contributions aggregating $3,000. The Partnership terminates on December 31, 2028, unless terminated earlier upon the occurrence of certain events as set forth in the Partnership Agreement.\nThe Partnership commenced the public offering of Units on June 24, 1988 and completed its public offering having sold 12,770,161 Units for $254,686,736 net of purchase volume discounts of $716,484 as of June 22, 1990.\nB. Significant Accounting Policies\nThe Partnership uses the following accounting policies for financial reporting purposes, which differ in certain respects from those used for federal income tax purposes (Note G):\nPIMs\nThe Partnership carries its investments in PIMs at amortized cost as it has the ability and intention to hold these investments. Basic interest is recognized based on the stated rate of the Federal Housing Administration (\"FHA\") mortgage loan (less the servicer's fee) or the stated coupon rate of the Government National Mortgage Association (\"GNMA\") or Federal National Mortgage Association (\"FNMA\") MBS. Participation interest is recognized as earned and when deemed collectible by the Partnership.\nMBS\nAt December 31, 1995, the Partnership in accordance with the Financial Accounting Standards Board's Special Report on Statement 115, \"Accounting for Certain Investments in Debt and Equity Securities\", reclassified its MBS portfolio from held-to-maturity to available-for-sale. The Partnership carries its MBS at fair market value and reflects any unrealized gains (losses) as a separate component of Partners' Equity. Prior to December 31, 1995, the Partnership carried its MBS portfolio at amortized cost. The Partnership amortizes purchase premiums or discounts over the life of the underlying mortgages using the effective interest method.\nCash Equivalents\nThe Partnership includes all short-term investments with maturities of three months or less from the date of acquisition in cash and cash equivalents. The Partnership invests its cash primarily in deposits and money market funds with a commercial bank and has not experienced\nany loss to date on its invested cash.\nPrepaid Expenses and Fees\nPrepaid expenses and fees consist of prepaid acquisition fees and expenses and prepaid participation servicing fees paid for the acquisition and servicing of PIMs. The Partnership amortizes the prepaid acquisition fees and expenses using a method that approximates the effective interest method over a period of ten to twelve years, which represents the actual maturity or anticipated call date of the underlying mortgage. Acquisition expenses incurred on potential acquisitions which were not consummated were charged to operations. The Partnership amortizes prepaid participation servicing fees using a method that approximates the effective interest method over a ten year period beginning at final endorsement of the loan if a Department of Housing and Urban Development (\"HUD\") insured loan and at closing if a FNMA loan.\nIncome Taxes\nThe Partnership is not liable for federal or state income taxes because Partnership income is allocated to the partners for income tax purposes. If the Partnership's tax returns are examined by the Internal Revenue Service or state taxing authority and such an examination results in a change in Partnership taxable income, such change will be reported to the partners.\nEstimates and Assumptions\nThe preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the period. Actual results could differ from those estimates.\nC. PIMs\nThe Partnership has investments in eighteen PIMs. The Partnership's PIMs consist of a GNMA or FNMA MBS representing the securitized first mortgage loan on the underlying property or a sole participation interest in a first mortgage loan originated under the FHA lending program on the underlying property (collectively the \"insured mortgages\"), and participation interests in the revenue stream and appreciation of the underlying property above specified base levels. The borrower conveys these participation features to the Partnership generally through a subordinated mortgage (the \"Agreement\"). The Partnership receives guaranteed monthly payments of principal and interest on the GNMA and FNMA MBS and HUD insures the first mortgage loan underlying the GNMA MBS and the FHA mortgage loan. The borrower usually can not prepay the first mortgage loan during the first five years and usually may prepay the first mortgage loan thereafter subject to a 9% prepayment penalty in years six through nine, a 1% prepayment penalty in year ten and no prepayment penalty thereafter. The Partnership may receive interest related to its participation interests in the underlying property, however, these amounts are neither insured nor guaranteed.\nGenerally, the participation features consist of the following: (i) \"Minimum Additional Interest\" at a stated rate ranging from .5% to .75% per annum calculated on the unpaid principal balance of the first mortgage on the underlying property , (ii) \"Shared Income Interest\" ranging from 25% to 30% of the monthly gross rental income generated by the underlying property in excess of a specified base, but only to the extent that it exceeds the amount of Minimum Additional Interest received during such month, (iii) \"Shared Appreciation Interest\" ranging from 25% to 30% of any increase in Value of the underlying property in excess of a specified base. Payment of participation interest from the operations of the property is limited to 50% of net revenue or surplus cash as defined by FNMA or HUD, respectively. The aggregate amount of Minimum Additional Interest, Shared Income Interest and Shared Appreciation Interest payable on the maturity date by the underlying borrower generally cannot exceed 50% of any increase in value of the property. However, generally any net proceeds from the sale or refinancing of the underlying property will be available to satisfy any accrued but unpaid Shared Income or Minimum Additional interest.\nShared Appreciation Interest is payable when one of the following occurs: (1) the sale of the underlying property to an unrelated third party on a date which is later than five years from the date of the Agreement, (2) the maturity date or accelerated maturity date of the Agreement, or (3) prepayment of amounts due under the Agreement and the insured mortgage.\nUnder the Agreement, the Partnership, upon giving twelve months written notice, can accelerate the maturity date of the Agreement and insured mortgage to a date not earlier than ten years from the date of the Agreement for (a) the payment of all participation interest due under the Agreement as of the accelerated maturity date, or (b) the payment of all participation interest due under the Agreement plus all amounts due on the first mortgage note on the property.\nListed in the chart is a summary of the Partnership's PIM investments at December 31, 1995 and 1994:\n(a) Includes the Partnership's share of the Royal Palm Place PIM, in which the Partnership holds 73% of the $22,000,000 total PIM and an affiliate of the Partnership holds the remaining 27%. During December 1995 the Partnership agreed to a modification of the Royal Palm PIM. The Partnership received a reissued FNMA MBS with revised terms that included extending the maturity from 2001 to 2006. During December 1995, the Partnership received its pro-rata share of a $90,644 principal payment related to the modification. The FNMA MBS will provide the Partnership with monthly interest payments at interest rates ranging from 6.25% to 8.775% per annum through maturity, and the Partnership will receives its pro- rata share of $250,000 principal payments on December 1 of the following four years. In addition, the\nmodification changed the maturity of the subordinated promissory note to 2006, and increased the Shared Income and Appreciation Interest percentages from 25% to 30%.\n(b) Includes the Partnership's share of the Marina Shores PIM in which the Partnership holds 71% of the $21,200,000 total PIM and an affiliate of the Partnership holds the remaining 29%.\nThe underlying mortgages of the PIMs are collateralized by multi- family apartment complexes located in 9 states, primarily Florida and North Carolina. The apartment complexes range in size from 96 to 503 units.\nD. MBS\nAt December 31, 1995, the Partnership's MBS portfolio has an amortized cost of approximately $35,421,000 and unrealized gains and losses of approximately $1,278,000 and $6,000, respectively. At December 31, 1994, the Partnership's MBS portfolio had a market value of approximately $35,503,000 and unrealized gains and losses of $296,000 and $1,053,000, respectively. The MBS portfolio has a maturity dates ranging from 2010 to 2035.\nDuring the third quarter of 1994, the Partnership acquired $4,929,288 face value of Federal Home Loan Mortgage Corporation (\"FHLMC\") MBS for $4,872,241 having coupon rates of 8% per annum and maturities ranging from 2017 to 2024.\nOn August 14, 1995, the Partnership's construction-phase MBS achieved final endorsement and the Partnership funded its remaining commitment on this $8,209,800 face value MBS. During the construction-phase the MBS provided the Partnership with interest only payments at an interest rate of 8.125% per annum. The permanent MBS will provide the Partnership with monthly payments of principal and interest at an interest rate of 7.375% per annum.\nE. Partners' Equity\nUnder the terms of the Partnership Agreement, profits from Partnership operations and Distributable Cash Flow are allocated 97% to the Unitholders and Corporate Limited Partner (the \"Limited Partners\") and 3% to the General Partners.\nUpon the occurrence of a capital transaction, as defined in the Partnership Agreement, net cash proceeds and profits from the capital transaction will be distributed first, to the Limited Partners until they have received a return of their total invested capital, second, to the General Partners until they have received a return of their total invested capital, third, 99% to the Limited Partners and 1% to the General Partners until the Limited Partners receive an amount equal to any deficiency in the 11% cumulative return on their invested capital that exists through fiscal years prior to the date of the capital transaction, fourth, to the class of General Partners until they have received an amount equal to 4% of all amounts of cash distributed under all capital transactions and fifth, 96% to the Limited Partners and 4% to the General Partners. Losses from a capital transaction will be allocated 97% to the Limited Partners and 3% to the General Partners.\nAs of December 31, 1995, the following cumulative partner contributions and allocations have been made since inception of the Partnership:\nF. Related Party Transactions\nUnder the terms of the Partnership Agreement, the General Partners or their affiliates are paid an Asset Management Fee equal to .75% per annum of the value of the Partnership's actual and committed mortgage assets, payable quarterly. The General Partners may also receive an incentive management fee in the amount equal to .3% per annum on the Partnership's total invested assets provided the Unitholders have received their specified non-cumulative return on their Invested Capital. Total Asset Management Fees and Incentive Management Fees payable to the General Partners or their affiliates shall not exceed 10% of Distributable Cash Flow over the life of the Partnership.\nAdditionally, the Partnership reimburses affiliates of the General Partners for certain expenses incurred in connection with maintaining the books and records of the Partnership and the preparation and mailing of financial reports, tax information and other communications to the investors.\nG. Federal Income Taxes\nThe reconciliation of the net income reported in the accompanying statement of income with the net income reported in the Partnership's 1995 federal income tax return is as follows:\nNet income per statement of income $12,335,057\nAdd: Book to tax difference for amortization of prepaid expenses and fees 734,458\nNet income for federal income tax purposes $13,069,515\nThe allocation of the net income for federal income tax purposes for 1995 is as follows:\nPortfolio Income\nUnitholders $12,677,331 Corporate Limited Partner 99 General Partners 392,085\n$13,069,515\nDuring the years ended December 31, 1995, 1994 and 1993 the average per Unit net income to the Unitholders for federal income tax purposes was $.99, $.95 and $.97, respectively.\nH. Fair Value Disclosures of Financial Instruments\nThe Partnership uses the following methods and assumptions to estimate the fair value of each class of financial instrument:\nCash and cash equivalents\nThe carrying amount approximates the fair value because of the short maturity of those instruments.\nMBS\nThe Partnership estimates the fair value of MBS based on quoted market prices.\nPIMs\nThere is no established trading market for these investments. Management estimates the fair value of the PIMs using quoted market prices of MBS having the same stated coupon rate as the insured mortgages and the estimated value of the participation features. Management estimates the fair value of the participation features using the estimated fair value of the underlying properties. Management does not include in the estimated fair value of the participation features any fair value estimate arising from appreciation of the properties, because Management does not believe it can predict the time of realization of the appreciation feature with any certainty. Based on the estimated fair value determined using these methods and assumptions, the Partnership's investments in PIMs had gross unrealized gains and losses of $5,051,000 and $395,000 at December 31, 1995, respectively, and a gross unrealized loss of $7,769,000 at December 31, 1994.\nCommitments to Fund Construction Loans and Insured Mortgages\nAt December 31, 1994, the Partnership approximated the fair value of commitments to fund its construction-phase insured mortgage to be equal to the commitment amount of $1,029,667.\nAt December 31, 1995 and 1994, the Partnership estimates the fair values of its financial instruments as follows:\nKRUPP INSURED PLUS-III LIMITED PARTNERSHIP\n(a) The Participating Insured Mortgages (\"PIMs\") consist of either a mortgage-backed security (\"MBS\") issued and guaranteed by the Federal National Mortgage Association (\"FNMA\"), an MBS issued or guaranteed by the Government National Mortgage Association (\"GNMA\") or a sole participation interest in a first mortgage insured by the United States Department of Housing and Urban Development (\"HUD\") and a subordinated promissory note and mortgage or shared income and appreciation agreement with the underlying Borrower that conveys participation interests in the revenue stream and appreciation of the underlying property above certain specified base levels. (b) Represents the permanent interest rate of the GNMA or FNMA MBS or the HUD-insured first mortgage less servicers fee. The Partnership may also receive additional interest, consisting of (i) Minimum Additional Interest based on a percentage of the unpaid principal balance of the first mortgage on the property, (ii) Shared Income Interest based on a percentage of monthly gross income generated by the underlying property in excess of a specified base amount (but only to the extent it exceeds the amount of Minimum Additional Interest received during such month), (iii) Shared Appreciation Interest based on a percentage of any increase in the value of the underlying property in excess of a specified base value.\n(c) Minimum additional interest is at a rate of .5% per annum calculated on the unpaid principal balance of the first mortgage note. (d) Minimum additional interest is at a rate of .75% per annum calculated on the unpaid principal balance of the first mortgage note.\n(e) Shared income interest is based on 25% of monthly gross rental income over a specified base amount.\n(f) Shared income interest is based on 30% of monthly gross rental income over a specified base amount.\n(g) Shared appreciation interest is based on 25% of any increase in the value of the project over the specified base value.\n(h) Shared appreciation interest is based on 30% of any increase in the value of the project over the specified base value.\n(i) Shared appreciation interest is based on 35% of any increase in the value of the project over the specified base value.\n(j) The Partnership's GNMA MBS and HUD mortgage loans have call provisions, which allow the Partnership to accelerate their respective maturity date.\n(k) The normal monthly payment consisting of principal and interest is payable monthly at level amounts over the term of the GNMA MBS and the HUD direct mortgages. The normal monthly payment consisting of principal and interest for FNMA MBS is payable at level amounts based on a 35 year amortization and all remaining unpaid principal and accrued interest is due at the end of year ten. The GNMA MBS, FNMA MBS and HUD-insured first mortgage loans may not be prepaid during the first five years and may generally be prepaid subject to a 9% prepayment penalty in years six through nine, a 1% prepayment penalty in year ten and no prepayment penalty after year ten.\n(l) On April 7, 1992, the Partnership entered into an agreement which provided for a one-year reduction in the interest rate on the Harbor Club-Ann Arbor PIM from 8% to 6% for one year retroactive to February 1, 1992 and to 7% for the following year. In exchange for the reduction, the Minimum Additional Interest increased from .50% to .75% and the Shared Appreciation Interest Base decreased from $14,570,000 to $13,562,000.\n(m) During December 1995 the Partnership agreed to a modification of the Royal Palm PIM. The Partnership received a reissued FNMA MBS with revised terms that include extending the maturity from 2001 to 2006. During December 1995, the Partnership received its pro-rata share of a $90,644 principal payment. The FNMA MBS will provide the Partnership with monthly interest payments at interest rates ranging from 6.25% to 8.775% per annum through maturity, and the Partnership will receive its pro-rata share of $250,000 principal payments on December 1 of the following four years. In addition, the modification changed the maturity of the subordinated promissory note to 2006, and increased the Shared Income and Appreciation Interest percentages from 25% to 30%.\n(n) The approximate principal balance due at maturity for each PIM, listed below, is as follows:\nPIM Amount Meridith Square Apartments $ 4,562,000 Mill Ponds Apartments $ 9,655,000 Paces Arbor Apartments $ 3,275,000 Paces Forest Apartments $ 4,015,000 Paddock Club Apartments $ 7,913,000\nPaddock Park II Apartments $ 9,932,000 Royal Palm Place Apartments $14,766,010 Windsor Court Apartments $10,767,000\n(o) The aggregate cost of PIMs for federal income tax purposes is $151,465,652.\nA reconciliation of the carrying value of PIMs for each of the three years in the period ended December 31, 1995 is as follows:","section_15":""}
{"filename":"737000_1995.txt","cik":"737000","year":"1995","section_1":"Item 1. BUSINESS (a) General Development of Business. Dean Witter Cornerstone Fund III (the \"Partnership\") is a New York limited partnership formed to engage in the speculative trading of commodity futures contracts and other commodity interests, including, but not limited to, forward contracts on foreign currencies. The Partnership's net asset value per unit, as of December 31, 1995, was $2,508.68, representing an increase of 27.50 percent from the net asset value per unit of $1,967.64 at December 31, 1994. (b) Financial Information about Industry Segments. The Partnership's business comprises only one segment for financial reporting purposes, speculative trading of commodity futures contracts and other commodity interests. The relevant financial information is presented in Items 6 and 8. (c) Narrative Description of Business. The Partnership is in the business of speculative trading in commodity futures contracts and other commodity interests, pursuant to trading instructions provided by independent trading advisors. For a detailed description of the different facets of the Partnership's business, see those portions of the Partnership's latest Prospectus, dated May 2, 1994 together with the supplement to Prospectus and Disclosure Document dated August 7, 1995 (the \"Supplement\"), filed as part of the Registration Statement on Form S-1 (see \"Documents Incorporated by Reference\" Page 1), set forth on the next page.\nFacets of Business 1. Summary 1. \"Summary of the Prospectus\" (Pages 3-12 of the Prospectus and Page 1 of the Sup- plement).\n2. Commodity Markets 2. \"The Commodities Markets\" (Pages 164-172).\n3. Partnership's Commodity 3. \"Trading Policies\" (Pages Trading Arrangements and 68-69) and \"The Trading Policies Manager\" (Pages 73-74, and 120-145 of the Prospectus and Pages 12-13 and Pages T-12-T-16 of the Supplement).\n4. Management of the Part- 4. \"The Cornerstone Funds\" (Pages nership 30-61 of the Prospectus and Pages 1-3 of the Supplement). \"The General Partner\" Pages 160-162 of the Prospectus and Page 14 of the Supplement \"The Commodity Broker\" (Pages 162-164). \"The Limited Partnership Agreements\" (Pages 174-178).\n5. Taxation of the Partnership's 5. \"Federal Income Tax Aspects\" Limited Partners and \"State and Local Income Tax Aspects\" (Pages 182-189).\n(d) Financial Information About Foreign and Domestic Operations and Export Sales.\nThe Partnership has not engaged in any operations in foreign countries; however, the Partnership (through the commodity broker) enters into forward contract transactions where foreign banks are the contracting party and trades in commodity interest contracts on foreign exchanges.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES The executive and administrative offices are located within the offices of Dean Witter Reynolds Inc. (\"DWR\"). The DWR offices utilized by the Partnership are located at Two World Trade Center, 62nd Floor, New York, NY 10048. Item 3.","section_3":"Item 3. LEGAL PROCEEDINGS The General Partner, Demeter Management Corporation (\"Demeter\"), is not aware of any material pending legal proceedings to which the Partnership is a party or to which any of its assets are subject. Item 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 PARTNERSHIP UNITS AND RELATED SECURITY HOLDER MATTERS\nThere is no established public trading market for the Units of Limited Partnership Interest in the Partnership. The number of holders of Units at December 31, 1995 was approximately 6,747. No distributions have been made by the Partnership since it commenced trading operations on January 2, 1985. Demeter has sole discretion to decide what distributions, if any, shall be made to investors in the Partnership. No determination has yet been made as to future distributions. Limited Partnership Units were registered for sale to the public in certain Canadian provinces.\nItem 7.","section_6":"","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nLiquidity. The Partnership's assets are deposited in separate commodity trading accounts with DWR, the commodity broker, and are used by the Partnership as margin to engage in commodity futures contract trading. DWR holds such assets in either designated depositories or in securities approved by the Commodity Futures Trading Commission (\"CFTC\") for investment of customer funds. The Partnership's assets held by DWR may be used as margin solely for the Partnership's trading. Since the Partnership's sole purpose is to trade in commodity futures contracts and other commodity interests, it is expected that the Partnership will continue to own such liquid assets for margin purposes. The Partnership's investment in commodity futures contracts and other commodity interests may be illiquid. If the price for a futures contract for a particular commodity has increased or decreased by an amount equal to the \"daily limit\", positions in the commodity can neither be taken nor liquidated unless traders are willing to effect trades at or within the limit. Commodity futures prices have occasionally moved the daily limit for several consecutive days with little or no trading. Such market conditions could prevent the Partnership from promptly liquidating its commodity futures positions. There is no limitation on daily price moves in trading forward contracts on foreign currency. The markets for some world currencies have low trading volume and are illiquid which may prevent the Partnership from trading in potentially profitable markets or prevent the Partnership from promptly liquidating unfavorable positions in such markets and subjecting it to substantial losses. Either of these market conditions could result in restrictions on redemptions.\nMarket Risk. The Partnership trades futures, options and forward contracts in interest rates, stock indices, commodities and currencies. In entering into these contracts there exists a risk to the Partnership (market risk) that such contracts may be significantly influenced by market conditions, such as interest rate volatility, resulting in such contracts being less valuable. If the markets should move against all of the commodity interest positions held by the Partnership at the same time, and if the Trading Advisors were unable to offset commodity interest positions of the Partnership, the Partnership could lose all of its assets. The Partnership has established Trading Policies for liquidity and leverage which help control market risk. Both the Trading Advisors and Demeter monitor the Partnership's trading activities on a daily basis to ensure compliance with the Trading Policies. Demeter may (under terms of the Management Agreements) override the trading instructions of a Trading Advisor to the extent necessary to comply with the Partnership's Trading Policies. Credit Risk. In addition to market risk, the Partnership is subject to credit risk in that a counterparty may not be able to meet its obligations to the Partnership. The counterparty of the Partnership for futures contracts traded in the United States and most foreign exchanges on which the Partnership trades is the clearinghouse associated with such exchange. In general, clearinghouses are backed by the membership of the exchange and will act in the event of non-performance by one of its members or one of its members' customers, and as such, should significantly reduce this credit risk. In cases where the Partnership trades on exchanges where the clearinghouse is not backed by the membership or when the Partnership enters into off-exchange contracts with a counterparty, the sole recourse of the Partnership will be the\nclearinghouse or the counterparty as the case may be. With respect to futures contracts, DWR, in its business as an international commodity broker, constantly monitors the credit-worthiness of the exchanges and clearing members of the foreign exchanges with which it does business for clients, including the Partnership. If DWR believes that there was a problem with the credit-worthiness of an exchange on which the Partnership deals, it would so advise Demeter. With respect to forward contract trading, the Partnership trades with only those counterparties which Demeter, together with DWR, have determined to be creditworthy. As set forth in the Partnership's Trading Policies, in determining credit- worthiness, Demeter and DWR consult with the Corporate Credit Department of DWR. Currently, the Partnership deals solely with DWR as its counterparty on forward contracts. While DWR and Demeter monitor credit- worthiness and risk involved in dealing on the various exchanges and with counterparties, there can be no assurance that an exchange or counterparty will be able to meet its obligations to the Partnership. Capital Resources. The Partnership does not have, nor does it expect to have, any capital assets. Redemptions of additional Units in the future will impact the amount of funds available for investments in commodity futures, forward contracts on foreign currencies and other commodity interests in subsequent periods. As redemptions are at the discretion of Limited Partners, it is not possible to estimate the amount and therefore, the impact of future redemptions. Results of Operations. As of December 31, 1995, the Partnership's total capital was $46,949,674, a decrease of $52,779 from the Partnership's total capital of $47,002,453 at December 31, 1994. For the year ended December 31, 1995, the Partnership generated net income of\n$11,031,694, total subscriptions aggregated $49,000, and total redemptions aggregated $11,133,473. For the year ended December 31, 1995, the Partnership's total trading revenues including interest income were $16,882,940. The Partnership's total expenses for the year were $5,851,246 resulting in net income of $11,031,694. The value of an individual unit in the Partnership increased from $1,967.64 at December 31, 1994 to $2,508.68 at December 31, 1995. As of December 31, 1994, the Partnership's total capital was $47,002,453, a decrease of $9,154,240 from the Partnership's total capital of $56,156,693 at December 31, 1993. For the year ended December 31, 1994, the Partnership incurred a net loss of $5,680,495, total subscriptions aggregated $5,299,578, and total redemptions aggregated $8,773,323. For the year ended December 31, 1994, the Partnership's total trading revenues including interest income were $1,307,961. The Partnership's total expenses for the year were $6,988,456 resulting in a net loss of $5,680,495. The value of an individual unit in the Partnership decreased from $2,187.31 at December 31, 1993 to $1,967.64 at December 31, 1994. As of December 31, 1993, the Partnership's total capital was $56,156,693, a decrease of $4,143,394 from the Partnership's total capital of $60,300,087 at December 31, 1992. For the year ended December 31, 1993, the Partnership incurred a net loss of $2,829,361, total subscriptions aggregated $9,819,616, and total redemptions aggregated $11,133,649.\nFor the year ended December 31, 1993, the Partnership's total trading revenues including interest income were $4,632,967. The Partnership's total expenses for the year were $7,462,328 resulting in a net loss of $2,829,361. The value of an individual unit in the Partnership decreased from $2,297.22 at December 31, 1992 to $2,187.31 at December 31, 1993. The Partnership's overall performance record represents varied results of trading in different commodity markets. For a further description of results, refer to the letter to the Limited Partners in the accompanying 1995 Annual Report to Partners, incorporated by reference in this Form 10-K. The Partnership's gains and losses are allocated among its Limited Partners for income tax purposes. Item 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The information required by this Item appears in the attached 1995 Annual Report to Partners and is incorporated by reference in this Annual Report on Form 10-K. Item 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS OF THE REGISTRANT\nGeneral Partner Demeter, a Delaware corporation, was formed on August 18, 1977 to act as a commodity pool operator and is registered with the CFTC as a commodity pool operator and currently is a member of the National Futures Association (\"NFA\") in such capacity. Demeter is wholly-owned by Dean Witter, Discover & Co. (\"DWD\") and is an affiliate of DWR. DWD, DWR and Demeter may each be deemed to be \"promoters\" and\/or a \"parent\" of the Partnership within the meaning of the federal securities laws. Dean Witter Reynolds Inc. DWR is a financial services company which provides to its individual, corporate and institutional clients services as a broker in securities and commodity interest contracts, a dealer in corporate, municipal and government securities, an investment banker, an investment adviser and an agent in the sale of life insurance and various other products and services. DWR is a member firm of the New York Stock Exchange, the American Stock Exchange, the Chicago Board Options Exchange, and other major securities exchanges, and is a clearing member of the Chicago Board of Trade, the Chicago Mercantile Exchange, the Commodity Exchange Inc., and other major commodities exchanges. DWR is registered with the CFTC as a futures commission merchant and is a member of the NFA in such capacity. DWR is currently servicing its clients through a network of 350 branch offices with approximately 8,500 account executives servicing individual and institutional client accounts.\nDirectors and Officers of the General Partner The directors and officers of Demeter as of December 31, 1995 are as follows: Richard M. DeMartini, age 43, is the Chairman of the Board and a Director of Demeter. Mr. DeMartini is also the Chairman of the Board and a Director of Dean Witter Futures & Currency Management Inc. (\"DWFCM\"), a registered commodity trading advisor. Mr. DeMartini has served as President and Chief Operating Officer of Dean Witter Capital, a division of DWR since January 1989. From January 1988 until January 1989, Mr. DeMartini served as President and Chief Operating Officer of the Consumer Banking Division of DWD, and from May 1985 until January 1988 was President and Chief Executive Officer of the Consumer Markets Division of DWD. Mr. DeMartini currently serves as a Director of DWD and DWR, and has served as an officer of DWR for the past five years. Mr. DeMartini has been with DWD and its affiliates for 18 years. While Mr. DeMartini has extensive experience in the securities industry, he has no experience in commodity interests trading. Mark J. Hawley, age 52, is President and a Director of Demeter. Mr. Hawley joined DWR in February 1989 as Senior Vice President and Director of DWR's Managed Futures and Precious Metals Department. Mr. Hawley also serves as President of DWFCM. From 1978 to 1989, Mr. Hawley was a member of the senior management team at Heinold Asset Management, Inc., a commodity pool operator, and was responsible for a variety of projects in public futures funds. From 1972 to 1978, Mr. Hawley was a Vice President in charge of institutional block trading for the Mid-West at Kuhn Loeb & Co. Lawrence Volpe, age 48, is a Director of Demeter and DWFCM. Mr. Volpe joined DWR as a Senior Vice President and Controller in September\n1983, and currently holds those positions. From July 1979 to September 1983, he was associated with E.F. Hutton & Company Inc. and prior to his departure, held the positions of First Vice President and Assistant Controller. From 1970 to July 1979, he was associated with Arthur Anderson & Co. and prior to his departure he served as audit manager in the financial services division. Joseph G. Siniscalchi, age 50, is a Director of Demeter. Mr. Siniscalchi joined DWR in July 1984 as a First Vice President, Director of General Accounting. He is currently Senior Vice President and Controller of the Financial Markets Division of DWR. From February 1980 to July 1984, Mr. Siniscalchi was Director of Internal Audit at Lehman Brothers Kuhn Loeb, Inc. Laurence E. Mollner, age 54, is a Director of Demeter. Mr. Mollner joined DWR in May 1979 as Vice President and Director of Commercial Sales. He is currently Executive Vice President and Deputy Director of the Futures Markets Division of DWR. Edward C. Oelsner III, age 53, is a Director of Demeter. Mr. Oelsner joined DWR in March 1981 as a Managing Director in the Corporate Finance Department. He currently manages DWR's Retail Products Group within the Corporate Finance Department. While Mr. Oelsner has extensive experience in the securities industry, he has no experience in commodity interests trading. Robert E. Murray, age 35, is a Director of Demeter. Mr. Murray is currently a First Vice President of the DWR Managed Futures Division and is a Director and the Senior Administrative Officer of DWFCM. Mr. Murray graduated from Geneseo State University in May 1983 with a B.A. degree in Finance. Mr. Murray began at DWR in 1984 and is currently the Director of Product Development for the Managed Futures Division and is responsible\nfor the development and maintenance of the proprietary Fund Management System utilized by Demeter and DWFCM for organizing information and producing reports for monitoring investors' accounts. Patti L. Behnke, age 35, is Vice President and Chief Financial Officer of Demeter. Ms. Behnke joined DWR in 1991 as Assistant Vice President of Financial Reporting and is currently First Vice President and Director of Financial Reporting and Managed Futures Accounting in the Capital Markets division of DWR. From August 1988 to September 1990, Ms. Behnke was Assistant Controller of L.F. Rothschild & Co. and from September 1986 to August 1988, she was associated with Carteret Savings Bank as Assistant Vice President - Financial Analysis. From April 1982 to September 1986, Ms. Behnke was an auditor at Arthur Andersen & Co. Item 11.","section_11":"Item 11. EXECUTIVE COMPENSATION The Partnership has no directors and executive officers. As a limited partnership, the business of the Partnership is managed by Demeter which is responsible for the administration of the business affairs of the Partnership but receives no compensation for such services. Item 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT (a) Security Ownership of Certain Beneficial Owners - As of December 31, 1995 there were no persons as beneficial owners of more than 5 percent of the Units of Limited Partnership Interest in the Partnership. (b) Security Ownership of Management - At December 31, 1995, Demeter owned 382.103 Units of General Partnership Interest representing a 2.04 percent interest in the Partnership. (c) Changes in Control - None\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Refer to Note 2 - \"Related Party Transactions\" of \"Notes to Financial Statements\", in the accompanying 1995 Annual Report to Partners, incorporated by reference in this Form 10-K. In its capacity as the Partnership's retail commodity broker, DWR received commodity brokerage commissions (paid and accrued by the Partnership) of $3,499,743 for the year ended December 31, 1995.\nPART IV Item 14.","section_14":"Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) 1. Listing of Financial Statements The following financial statements and reports of independent public accountants, all appearing in the accompanying 1995 Annual Report to Partners, are incorporated by reference in this Form 10-K: - Report of Deloitte & Touche LLP, independent auditors, for the years ended December 31, 1995, 1994 and 1993.\n- Statements of Financial Condition as of December 31, 1995 and 1994.\n- Statements of Operations, Changes in Partners' Capital, and Cash Flows for the years ended December 31, 1995, 1994 and 1993.\n- Notes to Financial Statements. With exception of the aforementioned information and the information incorporated in Items 7, 8, and 13, the 1995 Annual Report to Partners is not deemed to be filed with this report.\n2. Listing of Financial Statement Schedules No financial statement schedules are required to be filed with this report. (b) Reports on Form 8-K No reports on Form 8-K have been filed by the Partnership during the last quarter of the period covered by this report. (c) Exhibits Refer to Exhibit Index on Page E-1 and E-2.\nSIGNATURES\nPursuant to the requirement 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.\nDEAN WITTER CORNERSTONE FUND III (Registrant)\nBY: Demeter Management Corporation, General Partner\nMarch 21, 1996 BY: \/s\/ Mark J. Hawley Mark J. Hawley, 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.\nDemeter Management Corporation.\nBY: \/s\/ Mark J. Hawley March 21, 1996 Mark J. Hawley, Director and President\n\/s\/ Richard M. DeMartini March 21, 1996 Richard M. DeMartini, Director and Chairman of the Board\n\/s\/ Lawrence Volpe March 21, 1996 Lawrence Volpe, Director\n\/s\/ Laurence E. Mollner March 21, 1996 Laurence E. Mollner, Director\n\/s\/ Joseph G. Siniscalchi March 21, 1996 Joseph G. Siniscalchi, Director\n\/s\/ Edward C. Oelsner III March 21, 1996 Edward C. Oelsner III, Director\n\/s\/ Robert E. Murray March 21, 1996 Robert E. Murray, Director\n\/s\/ Patti L. Behnke March 21, 1996 Patti L. Behnke, Chief Financial Officer\nEXHIBIT INDEX\nITEM METHOD OF FILING\n- - 3. Limited Partnership Agreement of the Partnership, dated as of December 7, 1983, as amended as (1) of May 11, 1984.\n- - 10. Management Agreement among the Partnership, Demeter Management Corporation and Sunrise Commodities Inc. dated as of November 15, 1983. (2)\n- - 10. Management Agreement among the Partnership, Demeter Management Corporation and Computerized Commodity Advisory Inc. dated as of June 18, 1986. (3)\n- - 10. Dean Witter Cornerstone Funds Exchange Agreement, dated as of May 31, 1984. (4)\n- - 10. Customer Agreement Between the Partnership and Dean Witter Reynolds Inc., dated as of May 31, 1984. (5)\n- - 13. December 31, 1995 Annual Report to Limited Partners. (6)\n(1) Incorporated by reference to Exhibit 3.01 to Partnership's Annual Report on Form 10-K for the fiscal year ended September 30, 1984.\n(2) Incorporated by reference to Exhibit 10.03 to the Partnership's Annual Report on Form 10-K for the fiscal year ended September 30, 1984.\n(3) Incorporated by reference to Exhibit 10.04 to the Partnership's Annual Report on Form 10-K for the fiscal year ended September 30, 1986.\n(4) Incorporated by reference to Exhibit 10.06 to the Partnership's Annual Report on Form 10-K for the fiscal year ended September 30, 1984.\n(5) Incorporated by reference to Exhibit 10.07 to the Partnership's Annual Report on Form 10-K for the fiscal year ended September 30, 1984.\n(6) Filed herewith.\nE-1\nCornerstone Funds\nDecember 31, 1995 Annual Report\n[LOGO] DEAN WITTER\nDEAN WITTER Two World Trade Center 62nd Floor NEW YORK, NY 10048 TELEPHONE (212) 392-8899\nCORNERSTONE FUNDS ANNUAL REPORT\nDear Limited Partner:\nThis marks the eleventh annual report for Cornerstone Funds II and III and the ninth for Cornerstone Fund IV. The Net Asset Value per Unit for the three Cornerstone Funds on December 31, 1995 was as follows:\nCornerstone Fund IV, the currency Fund, recorded net losses during January as a decline in the value of the U.S. dollar relative to most major world currencies resulted in losses. As January progressed, the advisors to the Fund reversed positions only to experience additional losses when the U.S. dollar strengthened sharply on January 31. Significant gains were recorded during February and March due to a trend higher in the value of the Japanese yen and most major European currencies relative to the U.S. dollar. As a result, trading gains were recorded from long positions in the Japanese yen, German mark, as well as the Swiss and French francs and Norwegian krone.\nIn April, Fund IV continued to record gains from the upward trend in the value of the Japanese yen relative to the U.S. dollar, as well as from transactions involving the Australian and New Zealand dollars. A reversal in the downward trend in the value of the U.S. dollar versus most major European currencies and the Japanese yen during May resulted in losses from transactions involving the German mark, French franc, Norwegian krone and\nJapanese yen. In June, small losses were recorded from transactions involving the Japanese yen, British pound and French franc as the value of most major world currencies moved in a trendless range versus the U.S. dollar and one another. These losses were partially offset by gains from trading in the German mark and Australian dollar.\nDuring July, Fund IV sustained losses as most foreign currencies, particularly the Australian and New Zealand dollars, as well as the German mark, continued to move in a trendless pattern relative to the U.S. dollar and one another. Trading gains were recorded during August as the Fund's previously established short positions in the Japanese yen profited from a sharp downward move in the value of the Japanese yen relative to the U.S. dollar. During September, the Fund recorded small net losses primarily as a result of a reversal in an upward move in the value of the U.S. dollar relative to most major European currencies, as well as the Japanese yen, on September 20 and 21. This sudden reversal resulted in losses from transactions involving the German mark, French franc and British pound. However, gains recorded from trading in the Japanese yen earlier in the month, offset a majority of Fund losses for the month.\nFund IV began the fourth quarter by recording net gains as the Fund's short yen positions profited from the continued decline of the Japanese yen relative to the U.S. dollar. Net losses were recorded during November due primarily to trendless movement in the value of world currencies, particularly the Australian dollar, German mark and French franc, relative to the U.S. dollar. Trading in the Japanese yen also resulted in losses as the previous downward trend in the value of the yen versus the U.S. dollar subsided during the month. During December, Fund IV recorded small net losses as the value of the British pound relative to the U.S. dollar moved sharply\nhigher late in the month. As a result, losses were recorded from the Fund's previously established short British pound positions. Trading gains from transactions involving the Japanese yen and German mark offset a majority of the losses experienced in the British pound.\nCornerstone Fund II, a diversified fund, recorded losses during January as a result of the aforementioned currency activity, as well as from trading in financial and agricultural futures. Fund II profited significantly during February and March as the value of most major world currencies relative to the U.S. dollar increased, resulting in profits for the Fund's long positions in major European currencies, as well as the Japanese yen. Additional gains were recorded from long positions in global bond futures positions as prices moved higher during this period as well as in crude oil futures trading.\nIn April, a continued upward trend in global financial futures prices resulted in gains for Fund II's previously established long stock index and bond futures positions. Additional gains were recorded for the Fund's long Japanese yen positions as the value of the yen continued to move higher versus the U.S. dollar. Small net losses were recorded during May as trading losses in traditional commodities, such as energy, agricultural and metals futures, as well as in currencies, more than offset gains recorded from long positions in global financial futures. During June, Fund II recorded small net losses as the previous upward trend in international interest rate futures prices pulled back during the month. These losses, coupled with smaller losses in the currency and agricultural futures markets, offset gains recorded in the energy and coffee futures markets.\nDuring July, Fund II posted net losses as a result of trading in both U.S. and international bond futures. Additional Fund losses were recorded in the currency markets as the value of most major world\ncurrencies moved in a narrow trading range relative to the U.S. dollar and one another. During August, losses were recorded in global bond futures, particularly in U.S. Treasury bond futures, as bond futures prices experienced a period of short-term volatile movement. These losses, coupled with losses recorded in soft commodities and silver futures, more than offset gains recorded from transactions involving the Japanese yen. Fund II also recorded losses in September due primarily to erratic price movement in global interest rate and stock index futures. Losses were also recorded in energy futures trading, as oil and gas prices reversed dramatically, and in metals futures trading, as both precious and base metals prices remained relatively trendless.\nSmall net losses were recorded during October as trendless price movement was commonplace in several of the markets traded by the Fund, including cotton, crude oil and overseas interest rate futures. However, trading profits were recorded from short Japanese yen positions, as well as from trading in the agricultural and metals markets. During November, profits were recorded as global bond futures prices increased during the month, resulting in gains in U.S., European and Japanese interest rate futures. Additional gains were recorded from short coffee futures positions as prices declined during the month. In December, Fund II was profitable primarily due to trading in the energy markets, as long positions in crude and heating oil profited from increasing oil prices, and in soft commodities, as gains were recorded as a result of trading in both sugar and coffee futures. Increasing soybean and corn prices during the month resulted in additional gains for the Fund's long soybean and corn futures positions.\nCornerstone Fund III, also a diversified fund, experienced losses during January due to trading in the currency, financial and agricultural markets. During February and March, significant gains were recorded as a\nresult of trading in the currency markets as the value of the U.S. dollar moved lower versus most world currencies. Strong gains were also recorded from long positions in global bond futures, as prices in these markets increased during this two month period.\nTrading in global financial futures was profitable during April and May as both U.S. and international interest rate futures prices continued to trend higher. Additional gains were recorded in stock index futures, specifically from trading Nikkei and S&P 500 Index futures. Small net gains were recorded during June as trading in base metals, energy and soft commodities futures more than offset trading losses recorded in international interest rate futures, currencies and livestock futures.\nDuring July, trading losses were recorded in financial futures as global interest rate futures prices retreated from their previous upward trend. Additional losses were recorded in Japanese stock index futures as a sharp reversal in Japanese stock prices resulted in losses for the Fund's previously established short Nikkei Index futures positions. In August, gains were recorded from short positions in the Japanese yen, as the value of the yen moved lower relative to the U.S. dollar, and from long positions in Nikkei Index and corn futures as prices in both of these markets moved higher. In September, net gains were recorded as long positions in Japanese, European and Australian interest rate futures profited from increasing global bond prices. Smaller gains in agricultural futures and soft commodities contributed to the Fund's gains for the month.\nNet losses were recorded during October due to losses in soft commodities trading as cotton and coffee prices moved in a trendless pattern, as well as from trading in currencies and global financial futures. During November, profits were recorded primarily from long positions in global interest rate\nand S&P 500 Index futures, as prices moved higher. Smaller gains were recorded in soft commodities and energy futures trading. Fund III ended 1995 with strong gains during December as a result of trading in energy futures as long gas and oil positions profited from a dramatic price move higher. Agricultural futures trading resulted in additional gains as long positions in corn, soybean meal and soybean futures also benefited from rising prices.\nOverall, each of the Cornerstone Funds was able to record significant profits during the calendar year of 1995. Cornerstone Funds II and III recorded profits primarily due to price trends in the global financial futures and currency markets. Cornerstone Fund IV profited as it was able to capitalize on currency trends in the first half of the year. Since their inception in 1985, Cornerstone Fund II has increased by 190.3% (a compound annualized return of 10.2%) and Cornerstone Fund III has increased by 157.3% (a compound annualized return of 9.0%). Cornerstone Fund IV, since its inception in 1987, has increased by 185.8% (a compound annualized return of 12.9%).\nShould you have any questions concerning this report, please feel free to contact Demeter Management Corporation at Two World Trade Center, 62nd Floor, New York, NY 10048 or your Dean Witter Account Executive.\nI hereby affirm, that to the best of my knowledge and belief, the information contained in this report is accurate and complete.\nSincerely,\n\/s\/ Mark J. Hawley Mark J. Hawley President Demeter Management Corporation General Partner\nDEAN WITTER CORNERSTONE FUNDS INDEPENDENT AUDITORS' REPORT\nThe Limited Partners and the General Partner of Dean Witter Cornerstone Fund II Dean Witter Cornerstone Fund III Dean Witter Cornerstone Fund IV:\nWe have audited the accompanying statements of financial condition of Dean Witter Cornerstone Fund II, Dean Witter Cornerstone Fund III and Dean Witter Cornerstone Fund IV (collectively, the \"Partnerships\") as of December 31, 1995 and 1994 and the related statements of operations, changes in partners' capital, and cash flows for each of the three years in the period ended December 31, 1995. These financial statements are the responsibility of the Partnerships' 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 Dean Witter Cornerstone Fund II, Dean Witter Cornerstone Fund III and Dean Witter Cornerstone Fund IV as of December 31, 1995 and 1994 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles.\n\/s\/ Deloitte & Touche LLP February 21, 1996 New York, New York\nDEAN WITTER CORNERSTONE FUND II STATEMENTS OF FINANCIAL CONDITION\nSTATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nThe accompanying notes are an integral part of these financial statements.\nDEAN WITTER CORNERSTONE FUND III STATEMENTS OF FINANCIAL CONDITION\nSTATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nThe accompanying notes are an integral part of these financial statements.\nDEAN WITTER CORNERSTONE FUND IV STATEMENTS OF FINANCIAL CONDITION\nSTATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nThe accompanying notes are an integral part of these financial statements.\nDEAN WITTER CORNERSTONE FUNDS\nSTATEMENT OF CHANGES IN PARTNERS' CAPITAL FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nDEAN WITTER CORNERSTONE FUNDS\nSTATEMENT OF CHANGES IN PARTNERS' CAPITAL FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nThe accompanying notes are an integral part of these financial statements.\nDEAN WITTER CORNERSTONE FUND II STATEMENTS OF CASH FLOWS\nThe accompanying notes are an integral part of these financial statements.\nDEAN WITTER CORNERSTONE FUND III STATEMENTS OF CASH FLOWS\nThe accompanying notes are an integral part of these financial statements.\nDEAN WITTER CORNERSTONE FUND IV STATEMENTS OF CASH FLOWS\nThe accompanying notes are an integral part of these financial statements.\nDEAN WITTER CORNERSTONE FUNDS NOTES TO FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nORGANIZATION--Dean Witter Cornerstone Fund II, Dean Witter Cornerstone Fund III and Dean Witter Cornerstone Fund IV (individually, a \"Partnership\", or collectively, the \"Partnerships\") are limited partnerships organized to engage in the speculative trading of commodity futures contracts and forward contracts on foreign currencies. The general partner for each Partnership is Demeter Management Corporation (the \"General Partner\"). The commodity broker is Dean Witter Reynolds Inc. (\"DWR\"). Both DWR and the General Partner are wholly-owned subsidiaries of Dean Witter, Discover & Co.\nThe General Partner is required to maintain a 1% minimum interest in the equity of each Partnership and income (losses) are shared by the General and Limited Partners based upon their proportional ownership interests.\nBASIS OF ACCOUNTING--The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts in the financial statements.\nREVENUE RECOGNITION--Commodity futures contracts and forward contracts on foreign currencies are open commitments until settlement date. They are valued at market and the resulting unrealized gains and losses are reflected in income. Monthly, DWR pays each Partnership interest income based upon 80% of its average daily Net Assets at a rate equal to the average yield on 13-Week U.S. Treasury Bills issued during such month. For purposes of such interest payments in Dean Witter Cornerstone Fund IV, Net Assets do not include monies due the Partnership on forward contracts and other commodity interests, but not actually received.\nNET INCOME (LOSS) PER UNIT--Net income (loss) per Unit is computed using the weighted average number of units outstanding during the period.\nEQUITY IN COMMODITY FUTURES TRADING ACCOUNTS-- The Partnerships' assets \"Equity in Commodity futures trading accounts\" consists of cash on deposit at DWR to be used as margin for trading and the net asset or liability related to unrealized gains or losses on open contracts. The asset or liability related to the unrealized gains or losses on forward contracts is presented as a net amount because each Partnership has a master netting agreement with DWR.\nDEAN WITTER CORNERSTONE FUNDS NOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nBROKERAGE COMMISSIONS AND RELATED TRANSACTION FEES AND COSTS--Brokerage commissions for each Partnership are accrued at 80% of DWR's published non- member rates on a half-turn basis.\nThrough March 31, 1995, brokerage commissions were capped at 1% per month of the adjusted Net Assets allocated to each trading program employed by a Trading Advisor. Effective April 1, 1995, the cap was reduced to 3\/4 of 1%.\nRelated transaction fees and costs are accrued on a half-turn basis.\nOPERATING EXPENSES--Each Partnership has entered into an exchange agreement pursuant to which certain common administrative expenses (i.e., legal, auditing, accounting, filing fees and other related expenses) are shared by each of the Partnerships based upon the number of Units of each Partnership outstanding during the month in which such expenses are incurred. In addition, the Partnerships incur monthly management fees and may incur incentive fees. The General Partner bears all other operating expenses.\nINCOME TAXES--No provision for income taxes has been made in the accompanying financial statements, as partners are individually responsible for reporting income or loss based upon their respective share of each Partnership's revenues and expenses for income tax purposes.\nDISTRIBUTIONS--Distributions, other than on redemptions of Units, are made on a pro-rata basis at the sole discretion of the General Partner. No distributions have been made to date.\nCONTINUING OFFERING--Through September 26, 1994, Units of each Partnership were offered at a price equal to 107.625% of the Net Asset Value per Unit as of the opening of business on the first day of the month, which price included a 5% selling commission and a 2.5% charge for expenses relating to the continuing offering of Units. These expenses were shared by the Partnerships. Any funds received by DWR as a result of the Continuing Offering Expense charges that were in excess of the Continuing Offering Expenses incurred, were contributed pro-rata to the Partnerships, as a contribution of capital to the Partnerships for which no Units were issued. On September 26, 1994, the Continuing Offering was discontinued.\nREDEMPTIONS--After an initial 180-day period, Limited Partners may redeem some or all of their Units at 100% of the Net Asset Value per Unit as of the last day of any month upon fifteen days advance notice by redemption form to the General Partner.\nDEAN WITTER CORNERSTONE FUNDS NOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nIf the proceeds of a redemption are reinvested in any of the Partnerships within 180 days, the General Partner will waive the selling commissions and continuous offering expense charges on the amount reinvested.\nEXCHANGES--On the last day of the first month, which occurs more than 180 days after a person first becomes a Limited Partner in any of the Partnerships, and the end of each month thereafter, Limited Partners may transfer their investment among the Partnerships (subject to certain restrictions outlined in the Limited Partnership Agreement) without paying additional charges.\nDISSOLUTION OF THE PARTNERSHIP--Each Partnership will terminate on September 30, 2025 regardless of its financial condition at such time, upon a decline in Net Assets to less than $250,000, a decline in the Net Asset Value per Unit to less than $250, or under certain other circumstances defined in the Limited Partnership Agreement.\n2. RELATED PARTY TRANSACTIONS\nEach Partnership pays brokerage commissions to DWR on trades executed on its behalf as described in Note 1. Each Partnership's cash is on deposit with DWR in commodity trading accounts to meet margin requirements as needed. DWR pays interest on these funds as described in Note 1.\n3. TRADING ADVISORS\nThe General Partner, on behalf of each Partnership, retains certain commodity trading advisors to make all trading decisions for the Partnerships. The trading advisors for each Partnership as of December 31, 1995 were as follows:\nDean Witter Cornerstone Fund II Abacus Asset Management Inc. John W. Henry & Co., Inc.\nDean Witter Cornerstone Fund III CCA Capital Management, Inc. Sunrise Capital Management\nDean Witter Cornerstone Fund IV John W. Henry & Co., Inc. Sunrise Capital Management\nEach trading advisor owns at least ten Units in its respective Partnership. Compensation to the trading\nDEAN WITTER CORNERSTONE FUNDS NOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nadvisors by the Partnerships consists of a management fee and an incentive fee as follows:\nMANAGEMENT FEE--The management fee is accrued at the rate of 1\/3 of 1% per month of the Net Assets under management by each trading advisor at each month end.\nINCENTIVE FEE--Each Partnership will pay an annual incentive fee equal to 15% of the \"New Appreciation\" in Net Assets as of the end of each annual incentive period ending December 31, except for Dean Witter Cornerstone Fund IV, which will pay incentive fees at the end of each annual incentive period ending May 31. Such incentive fee is accrued in each month in which \"New Appreciation\" occurs. In those months in which \"New Appreciation\" is negative, previous accruals, if any, during the incentive period will be reduced. In those instances in which a Limited Partner redeems an investment, the incentive fee (if earned through a redemption date) is to be paid on those redemptions to the trading advisor in the month of such redemption.\n4. FINANCIAL INSTRUMENTS\nThe Partnerships trade futures and forward contracts in interest rates, stock indices, commodities, currencies, petroleum and precious metals. Risk arises from changes in the value of these contracts and the potential inability of counterparties to perform under the terms of the contracts. There are numerous factors which may significantly influence the market value of these contracts, including interest rate volatility. At December 31, 1995 and 1994, open contracts were:\nDEAN WITTER CORNERSTONE FUNDS NOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nA portion of the amounts indicated as off-balance-sheet risk in forward foreign currency contracts is due to offsetting forward commitments to purchase and to sell the same currency on the same date in the future. These commitments are economically offsetting, but are not offset in the forward market until the settlement date.\nThe unrealized gains on open contracts are reported as a component of \"Equity in Commodity futures trading accounts\" on the Statements of Financial Condition and totaled at December 31, 1995 and 1994, respectively, $3,368,107 and $4,316,080 for Cornerstone II, $5,578,294 and $5,016,857 for Cornerstone III and $70,143 and $268,291 for Cornerstone IV.\nFor Cornerstone II, of the $3,368,107 net unrealized gain on open contracts at December 31, 1995, $3,448,812 related to exchange-traded futures contracts and ($80,705) related to off-exchange-traded forward currency contracts. Of the $4,316,080 net unrealized gain on open contracts at December 31, 1994, $4,296,011 related to exchange-traded futures contracts and $20,069 related to off-exchange-traded forward currency contracts.\nDEAN WITTER CORNERSTONE FUNDS NOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nFor Cornerstone III, net unrealized gain on open contracts at December 31, 1995 related entirely to exchange traded futures. Of the $5,016,857 net unrealized gain on open contracts at December 31, 1994, $5,788,691 related to exchange- traded futures contracts and ($771,834) related to off-exchange-traded forward currency contracts.\nFor Cornerstone IV, of the $70,143 net unrealized gain on open contracts at December 31, 1995, $534,487 related to exchange-traded futures contracts and $(464,344) related to off-exchange-traded forward currency contracts. The net unrealized gain on open contracts at December 31, 1994, related entirely to off-exchange-traded forward currency contracts.\nThe contract amounts in the above table represent the Partnership's extent of involvement in the particular class of financial instrument, but not the credit risk associated with counterparty nonperformance. The credit risk associated with these instruments is limited to the amounts reflected in the Partnerships' Statements of Financial Condition.\nExchange-traded contracts and off-exchange-traded forward currency contracts held by the Partnerships at December 1995 and 1994 mature as follows:\nThe Partnerships also have credit risk because the sole counterparty, with respect to most of the Partnerships' assets, is DWR. Exchange-traded futures contracts are marked to market on a daily basis, with variations in value settled on a daily basis. DWR, as the futures commission merchant of all of the Partnership's exchange-traded futures contracts, is required pursuant to regulations of the Commodity Futures Trading Commission to segregate from its own assets, and for the sole benefit of its commodity customers, all funds held by DWR with respect to exchange-traded futures contracts including an amount equal to the net\nDEAN WITTER CORNERSTONE FUNDS NOTES TO FINANCIAL STATEMENTS--(CONCLUDED)\nunrealized gain on all open futures contracts which funds totaled at December 31, 1995 and 1994 respectively, $31,506,001 and $31,866,995 for Cornerstone II, $47,872,659 and $48,673,471 for Cornerstone III, $105,462,448 and $111,508,180 for Cornerstone IV. With respect to the Partnership's off-exchange-traded forward currency contracts, there are no daily settlements of variations in value nor is there any requirement that an amount equal to the net unrealized gain on open forward contracts be segregated. With respect to those off- exchange-traded forward currency contracts, the Partnerships are at risk to the ability of DWR, the counterparty on all of such contracts, to perform.\nFor the year ended December 31, 1995 the average fair value of financial instruments held for trading purposes was as follows:\nDEAN WITTER REYNOLDS INC.\nTwo World Trade Center\n62nd Floor\nNew York, NY 10048 FIRST-CLASS MAIL ZIP + 4 PRESORT U.S. POSTAGE PAID BROOKLYN, NY PERMIT NO. 148","section_15":""}
{"filename":"350737_1995.txt","cik":"350737","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Registrant's executive offices and warehouse are located in Fort Lauderdale, Florida and held under a lease with an entity owned by officers of the Company which expires April 30, 1998. The lease covers approximately 12,000 square feet of office and warehouse space at an annual rental of approximately $84,000 including applicable sales taxes and subject to annual increases\/ decreases based on the prevailing prime lending rate. This space has been leased since 1988.\nIn November 1994 the Company leased approximately a 10,000 square foot building for manufacturing, warehousing and office space. The agreement calls for a one year rental renewable yearly for five years. The cancellation requires a one year notification. The annual rental is approximately $69,000 which can be increased at each annual lease anniversary for the change in the consumer price index for the Miami area.\nThe Kinpak facility contains approximately 50,000 square feet of office, plant and warehouse space located on approximately 20 acres of land (the \"Plant\") and also includes a leased 1.5 acre docking facility on the Alabama River located eleven miles from the Plant.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe Company is involved in two related lawsuits:\n1. Duane H. Newville and The Boden Co., d\/b\/a Adjust-A-Brush v. Star brite Distributing,Inc. (\"Star brite\") and Peter Dornau, Sr. (\"Dornau\"), pending in the United States District Court, Middle District of Florida was filed in 1994. In this action, Plaintiffs have sued Star brite and Dornau. This action arises out of Star brite's use of a product called Extend-A- Brush. Plaintiff seeks injunction relief and damages. Registrant and Dornau have filed a counterclaim for declaratory relief and antitrust violations. Registrant intends to pursue its counterclaim vigorously and to vigorously defend against the claim asserted by Plaintiffs.\n2. Star brite Distributing, Inc. v. The Boden Co., d\/b\/a Adjust-A-Brush (\"Boden\"), pending in the Circuit court in and for Pinellas County, Florida was filed in 1993. This action involves the break-up of a business arrangement whereby Star brite was to market adjustable brushes manufactured by Boden, to the marine industry. Star brite has sued Boden for damages and injunctive relief. Boden has filed a counterclaim against Star brite and Dornau, seeking damages and injunctive relief. Registrant intends to vigorously pursue its claims and vigorously defend against the asserted counterclaims. This case has been stayed pending the outcome of the related case set forth in paragraph (1) above.\nThe Registrant does not believe that the results of this litigation would have a material adverse effect on its future results of operations, and it has not accrued any amounts for loss contingencies in this litigation based on its evaluation of the merits thereof.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNone\nItem 5.","section_5":"Item 5. Market For the Registrant's Common Equity and Related Stockholder Matters\nA. The Registrant's Common Stock was sold to the public initially on March 26, 1981. The Common Stock of the Company is traded on the NASDAQ National Market System under the symbol OBCI. A summary of the trading ranges during each quarter of 1995 and 1994 is presented below.\nThe quotations reflect inter-dealer prices without retail mark-up, mark-down or commission and may not represent actual transactions.\nB. The approximate number of Common Stock owners was 600 at December 31, 1995. The aforementioned number was calculated from a list provided by the transfer agent and registrar and indications from broker dealers of shares held by them as nominee for actual shareholders.\nC. The Registrant has not paid any dividends since it has been organized.\nD. The Company has no other dividend policy except as stated in (C) directly above.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe following tables set forth selected financial data as of, and for the years ending December 31,\nPeter Dornau, a founder of the Company, has been President and a Director since 1973.\nJeffrey Tieger joined the Company in June 1977 as Vice President-Advertising.\nJulio DeLeon joined the Company in June 1988 as Corporate Controller. In 1994 the Board of Directors elected Mr. DeLeon to serve as Vice President of Finance.\nItem 11.","section_7":"","section_7A":"","section_8":"","section_9":"","section_9A":"","section_9B":"","section_10":"","section_11":"Item 11. Management Remuneration and Transactions\nThe information required by this section has been incorporated by reference to the Registrant's proxy statement in conjunction to the annual stockholder's meeting which shall be sent out to stockholders prior to 120 days past the Registrant's year end of December 31, 1995.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThe following table sets forth information at December 31, 1995 with respect to the beneficial ownership of the Registrant's Common Stock by holders of more than 5% of such stock and by all directors and officers of the Registrant as a group:\n*Includes Options to purchase 273,000 shares as follows:\nOn February 3, 1993 the Company granted Mr. Dornau an option to purchase 100,000 shares of the Company's common stock at $1.38 per share. The option expires 5 years from grant. The option was granted in consideration of Mr. Dornau personally guaranteeing $1,300,000 of bank loans to the Company. The option exercise price of $1.38 is 100% of the price of the Company's common stock on the date of grant.\nOn April 13, 1994 the Company granted Mr. Dornau a five year option for 150,000 shares at a price of $2.25 representing 100% of the price at the time of grant in consideration of his personally guaranteeing the Company's $1,500,000 loan from its commercial bank.\nPursuant to the Company's various stock option plans Mr. Dornau may exercise 23,000 shares within 60 days of the issuance of the Registrant's financial statements.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nOn April 4, 1988, the Company entered a five year lease with a five year option for approximately 12,000 square feet of office and warehouse facilities in Ft. Lauderdale, Florida from an entity owned by officers of the Registrant. The lease requires a minimum rental of $84,000 with provision for yearly increases based on the Consumer Price Index (base: March 1988=100) and has provision for real estate taxes, operating and maintenance charge pass through. Additionally, the annual rental can increase or decrease 7% annually for every 1% increase or decrease in the lessor's commercial bank's rate from a base of 8.5%.\nThe Registrant has rights to the \"Star brite\" name and products only for the United States and Canada as a condition to its original public offering. The President of the Registrant is the beneficial owner of three companies which market Star brite products outside the United States. Registrant has advanced monies to assist in such foreign marketing in order to establish an international trademark. As of December 31, 1995 and 1994 amounts owed to Registrant by the two companies was approximately $547,000 and $302,000, respectively. These amounts have been advanced by the Registran on open account with requirements of repayment between five and seven years. Advances bear interest at the rate of interest charged to the Registrant on its bank line of credit.\nA subsidiary of the Registrant currently uses the services of an entity which is owned by the President of the Registrant to conduct product research and development. The entity received $30,000 per year for the years 1995, 1994 and 1993 under such relationship.\nItem 14.","section_14":"Item 14. Exhibits and Financial Statement Schedules\nThe following documents are filed as a part of this report.\n(A) Consolidated Financial Statements.\n(i) Consolidated Balance Sheets, December 31, 1995 and 1994.\n(ii) Consolidated Statements of Income for each of the three years ended December 31, 1995, 1994, and 1993.\n(iii) Consolidated Statement of Shareholders' Equity for each of the three years ended December 31, 1995, 1994, and 1993.\n(iv) Consolidated Statements of Cash Flows for each of the three years ended December 31, 1995, 1994 and 1993.\n(v) Notes to Consolidated Financial Statements.\n(vi) Schedules for each of the three years Ended December 31, 1995, 1994 and 1993.\n(a) All other schedules are omitted because either they are not applicable or the required information is shown in the Consolidated Financial Statements or the Notes thereto.\n(B) Exhibits\n(3) Articles of Incorporation and by-laws are incorporated by reference to the Company's Registration statement on Form S-18 filed on March 26, 1981.\n(16.1) Letter re: change in certifying accountant incorporated by reference as filed with form 8-K dated September 26,1995.\n(22) Subsidiaries of the Registrant.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nOCEAN BIO-CHEM, INC. Registrant\nBy: \/S\/ PETER G. DORNAU\nPETER G. DORNAU Chairman of the Board ofDirectors and Chief Executive Officer\nMarch 28, 1996\nBy:\/S\/ PETER G. DORNAU PETER G. DORNAU Chief Financial Officer\nMarch 28, 1996\nSIGNATURES\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.\nBy:\/S\/ JEFFREY TIEGER JEFFREY TIEGER Director\nMarch 28, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has not sent an annual report or proxy material to security-holders as of this date. Subsequent to this filing the Registrant wil produce an annual report and proxy for its yearly security-holders meeting. Copies of such shall be sent to the SEC pursuant to current requirements.\nEXHIBIT (See 22)\nThe following is a list of the Registrant's subsidiaries:\nOCEAN BIO-CHEM INC. AND SUBSIDIARIES\nCONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1995, 1994 and 1993\nOCEAN BIO-CHEM, INC. AND SUBSIDIARIES\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1995, 1994 and 1993\nINFANTE, LAGO & COMPANY ILC CERTIFIED PUBLIC ACCOUNTANTS A. ROGER INFANTE, C.P.A. Biscayne Centre Suite 288 JESUS A. LAGO, JR., C.P.A. 11900 Biscayne Boulevard North Miami, Florida 33181 Telephone [305] 893-4341 Fax [305] 893-4507\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Shareholders and Directors Ocean Bio-Chem, Inc.\nWe have audited the accompanying consolidated balance sheet of Ocean Bio-Chem, Inc. (\"The Company\") and its subsidiaries as of December 31, 1995 and the related consolidated statements of income, shareholders' equity and cash flows for the year in the period ended December 31, 1995. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit. The consolidated financial statements of the Company as of and for the years ended December 31, 1994 and 1993 were audited by other auditors whose report dated February 22, 1995, expressed an unqualified opinion on those statement.\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 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 audit provides a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Ocean Bio-Chem, Inc. and its subsidiaries as of December 31, 1995 and the consolidated results of its operations and its cash flows for the year in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\n\/S\/ INFANTE, LAGO & COMPANY\nMay 11, 1996\nLEVI, RATTNER, CAHLIN & CO. Certified Public Accountants\nAllen S. Levi, C.P.A. Members of: Stephen J. Rattner, C.P.A American Institute of Richard A. Cahlin, C.P.A. Certified Public Accountants Florida Institute of Certified Public Accountants\nReport of Independent Certified Public Accountants\nShareholders and Board of Directors Ocean Bio-Chem, Inc. and Subsidiaries Fort Lauderdale, FL 33314\nWe have audited the accompanying consolidated balance sheet of Ocean Bio-Chem, Inc. and subsidiaries as of December 31, 1994, and the related consolidated statements of income, shareholders' 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.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above, present fairly, in all material respects, the consolidated financial position of Ocean Bio-Chem, Inc. and subsidiaries as of December 31, 1994, and the consolidated results of their operations and their consolidated cash flows for each of the two years in the period ended December 31, 1994, in conformity with generally accepted accounting principles.\n\/S\/ LEVI, RATTNER, CAHLIN & CO.\nMiami, Florida February 22, 1995\nDade (304) 937-2272 Broward (305) 921-2272 Fax (305) 937-4721 20590 W. Dixie Highway North Miami Beach, Florida 33180-1129\nThe accompanying notes are an integral part of these financial statements.\nNet income per share for the years prior to 1995 has been restated to reflect a 5% stock dividend distributed on April 15, 1995.\nThe accompanying notes are an integral part of these financial statements.\nThe accompanying notes are an integral part of these financial statements.\nThe Company had no cash equivalents at December 31, 1995, 1994 and 1993.\nThe accompanying notes are an integral part of these financial statements.\nOCEAN BIO-CHEM, INC. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1995, 1994, and 1993\nNote 1 - Organization and summary of significant accounting policies:\nOrganization - The Company was organized during November, 1973 under the laws of the state of Florida and operates as a manufacturer and distributor of products to the recreational vehicle and marine aftermarkets. On October 11, 1984, the Board of Directors approved a change in the corporate name to Ocean Bio-Chem,Inc.,(the parent corporation) from the former name Star Brite Corporation.\nPrinciples of consolidation - The consolidated financialstatements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.\nInventories - Inventories are primarily composed of finished goods and is stated at the lower of cost, using the first-in, first-out method, or market.\nPrepaid advertising and promotion - During the years ended December 31, 1995 and 1994, the Company introduced several new products in the marine and recreational vehicle aftermarket industries. In connection therewith, the Company produced new promotional items to be distributed over a period of time and increased its catalog advertising. The Company follows the policy of amortizing these costs over a one year basis. At December 31, 1995 and 1994, the accumulated cost of materials on hand and other deferred promotional costs that will be charged against subsequent years operations amounted to $23,396 and $29,528, respectively.\nOffice equipment and furnishings - Office equipment and furnishings are stated at cost. Depreciation is provided over thee stimated useful lives of the related assets. In 1993 the Company changed its depreciation policy to the straight line method over the accelerated methods previously used. The effect of such change has not been provided on the financial statements since they are not significant. Depreciation expense for the years ended December 31, 1995, 1994 and 1993 was $74,384, $58,683 and $22,547 respectively.\nProperty and Plant - On February 27, 1996, the Registrant purchased the assets of Kinpak, Inc., a subsidiary of Kinark, Inc. The assets consist of a plant facility of approximately 50,000 square feet on approximately 20 acres in Montgomery, Alabama. The facility has filling and blow-molding capacity. The cost of the facility was $1,850,000 including an assumption of debt of $990,000.\nIncome taxes - The Company and its subsidiaries file consolidated income tax returns. During February 1992, the Financial Accounting Standard Board issued Statement of Financial Accounting Standards 109, \"Accounting for Income Taxes.\" The statement is required to be implemented for fiscal years beginning after December 15, 1992. The application of SFAS 109 caused no material changes on the financial statements. There are no significant temporary differences.\nThe Components of income taxes are as follows: Year ended December 31,\nThe reconciliation of income tax expense at the statutory rate to the reported income tax expense is as follows:\nYear Ended December 31,\nTrademarks, trade names and patents - The Star brite trade name and trademark were purchased in 1980 for $880,000. The cost of trademarks and trade names is being amortized on a straight-line basis over the prescribed useful life of 40 years. The Registrant has two patents which it believes are valuable in limited product lines, but not material to its success or competitiveness in general. There are no capitalized costs for these two patents. The Registrant's trade name has been trademarked and the Registrant has had no incidents of infringement.\nEarnings per share - Earnings per share for the year ended December 31, 1995, 1994, and 1993 were calculated on the basis of 3,476,473, 3,278,241, and 3,240,378 weighted average common stock and common stock equivalent outstanding, respectively. The common stock equivalent consists of options to purchase common stock. The weighted average shares outstanding for the year ended 1994 and 1993 have been restated to reflect a 5% stock dividend given in 1995 and a 5% stock dividend given in 1994.\nTranslation of Canadian currency - The accounts of the Company's Canadian subsidiary are translated in accordance with Statement of Financial Accounting Standard No. 52, which requires that foreign currency assets and liabilities be translated using the exchange rates in effect at the balance sheet date. Results of operations are translated using the average exchange rates prevailing throughout the period. The effects of unrealized exchange rate fluctuations on translating foreign currency assets and liabilities into U.S. dollars are accumulated as the cumulative translation adjustment in shareholders' equity. Realized gains and losses from foreign currency transactions are included in net earnings for the period. Fluctuations arising from inter-company transactions that are of a long term in nature are accumulated as cumulative translation adjustments.\nReclassifications - Certain financial statement items for the years ended December 31, 1994 and 1993 have been reclassified to conform with the 1995 presentation.\nNote 2 - Office equipment and furnishings:\nThe Company's office equipment and furnishings consisted of the following:\nDuring 1992 the Company adopted an incentive stock option plan covering 200,000 shares of common stock. The following schedule shows the status of outstanding options under this plan.\nOCEAN BIO-CHEM, INC. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 1995, 1994, and 1993\nOn February 3, 1993 the Company granted the President an option to purchase 100,000 shares of the Company's common stock at $1.38 per share. The option expires in 5 years. The option exercise price is 100% of the price of the Company's common stock on the date of the grant. The options were granted to Mr. Dornau in connection with his guarantee of the Company's loan from its commercial bank.\nOn April 13, 1994 the Company granted Mr. Dornau an option to purchase 150,000 shares of the Company's common stock at $2.25 per share. The option expires in 5 years The option exercise price is 100% of the price of the Company's common stock on the date of the grant. The options were granted to Mr. Dornau in connection with the guarantee of the Company's current loan from its commercial bank.\nNote 11 - Major Customers\nThe Company has one major customer, Wal-mart. Sales to this customer represent approximately 20% of revenues. The Company enjoys good relations with this customer. However, the loss of this customer could have an adverse impact on the Company.","section_15":""}
{"filename":"310614_1995.txt","cik":"310614","year":"1995","section_1":"Item 1. Business - ----------------\nBalcor Equity Properties Ltd.-VIII (the \"Registrant\") is a limited partnership formed in 1979 under the laws of the State of Illinois. The Registrant raised $30,005,000 from sales of Limited Partnership Interests. The Registrant's operations consist exclusively of investment in and operation of income-producing real property, and all information included in this report relates to this industry segment.\nThe Registrant utilized the net offering proceeds to acquire thirteen real property investments. The Registrant has since disposed of eight of these properties. As of December 31, 1995, the Registrant owned the five properties described under \"Item 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties - ------------------\nAs of December 31, 1995, the Registrant owns the five properties described below:\nLocation Description of Property - -------- -----------------------\nSan Antonio, Texas Cedar Creek Apartment Complex - Phase I: a 176-unit apartment complex located on approximately five acres.\nSan Antonio, Texas Cedar Creek Apartment Complex - Phase II: a 216-unit apartment complex located on approximately six acres.\nColorado Springs, Colorado Greentree Village Apartment Complex: a 216-unit apartment complex located on approximately eight acres.\nSan Antonio, Texas Walnut Hills Apartment Complex - Phase I: a 192-unit apartment complex located on approximately eight acres.\nSan Antonio, Texas Walnut Hills Apartment Complex - Phase II: a 232-unit apartment complex located on approximately eight acres.\nIn the opinion of the General Partner, the Registrant has provided for adequate insurance coverage for its real estate investment properties.\nEach of the properties is held subject to mortgages.\nSee Notes to Financial Statements for other information regarding real property investments.\nItem 3.","section_3":"Item 3. Legal Proceedings - -------------------------\nProposed class action - ---------------------\nOn February 29, 1996, a proposed class action complaint was filed, Raymond Masri vs. Lehman Brothers, Inc., et al., Case No. 96\/103727 (Supreme Court of the State of New York, County of New York). The Registrant, additional limited partnerships which were sponsored by The Balcor Company, three limited partnerships sponsored by the predecessor of Lehman Brothers, Inc. (together with the Registrant and the affiliated partnerships, the \"Defendant Partnerships\"), Lehman Brothers, Inc. and Smith Barney Holdings, Inc. are defendants. The complaint alleges, among other things, common law fraud and deceit, negligent misrepresentation and breach of fiduciary duty relating to the disclosure of information in the offering of limited partnership interests in the Defendant Partnerships. The complaint seeks judgment for compensatory damages equal to the amount invested in the Defendant Partnerships by the proposed class plus interest accrued thereon; general damages for injuries arising from the defendants' actions; recovery from the defendants of all profits received by them as a result of their actions relating to the Defendant Partnerships; exemplary damages; attorneys' fees and other costs.\nThe defendants intend to vigorously contest this action. No class has been certified as of this date. Management of each of the defendants believes they have meritorious defenses to contest the claims. It is not determinable at this time whether or not an unfavorable decision in this action would have a material adverse impact on the Registrant.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders - ------------------------------------------------------------ No matters were submitted to a vote of the Limited Partners of the Registrant during 1995.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Stockholder - ------------------------------------------------------------------------- Matters - -------\nThere has not been an established public market for Limited Partnership Interests and it is not anticipated that one will develop; therefore, the market value of the Limited Partnership Interests cannot reasonably be determined. For information regarding distributions, see Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.\nAs of December 31, 1995, the number of record holders of Limited Partnership Interests of the Registrant was 3,042.\nItem 6.","section_6":"Item 6. Selected Financial Data - -------------------------------\nYear ended December 31, ---------------------------------------------------------- 1995 1994 1993 1992 1991 ---------- --------- ---------- ---------- ---------- Total income $6,043,472 $6,175,042 $5,290,545 $5,336,906 $5,129,643 Income (loss) before gain on sale of property and extraordinary item 135,417 414,158 (327,499) (567,448) (679,607) Net income (loss) 135,417 700,620 (327,499) 31,753 (679,607) Net income (loss) per LPI 4.47 23.12 (10.81) 1.05 (22.42) Total assets 12,335,453 15,387,316 15,170,384 14,278,492 16,312,664 Mortgage notes payable 15,212,762 15,320,720 15,419,064 13,226,872 14,570,999 Distributions per LPI 100.57(A) None None None None\n(A) This amount includes a distribution of original capital of $59.74 per Limited Partnership Interest.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and - ----------------------------------------------------------------------- Results of Operations - ---------------------\nOperations - ----------\nSummary of Operations - ---------------------\nDuring 1994, Balcor Equity Properties Ltd. - VIII (the \"Partnership\") received a repayment of its interest in the Sherwood Lake Apartments wrap-around note receivable and recognized the previously deferred gain. As a result, net income decreased during 1995 as compared to 1994 and the Partnership recognized net income during 1994 as compared to a net loss during 1993. Further discussion of the Partnership's operations is summarized below.\n1995 Compared to 1994 - ---------------------\nDue to higher average cash balances, primarily from the Sherwood Lakes Apartments wrap-around note receivable repayment received in November 1994, and higher interest rates earned on short-term investments, interest income on short-term investments increased during 1995 as compared to 1994.\nDuring November 1994, the Partnership's interest in Sherwood Lakes Apartments wrap-around note receivable was repaid. As a result of this repayment, the Partnership recognized interest income on wrap-around note receivable as well as the previously deferred gain on sale of property.\nThe outstanding short-term loans from the General Partner were repaid during 1994. Prior to this repayment, the Partnership recognized interest expense on short-term loans during 1994.\nThe Partnership incurred non-recurring legal, consulting, printing and postage costs in connection with two tender offers during 1995. As a result, administrative expenses increased during 1995 as compared to 1994.\n1994 Compared to 1993 - ---------------------\nRental rates and\/or average occupancy levels increased at all of the Partnership's five properties resulting in increases in rental and service income and property management fees during 1994 as compared to 1993.\nDue to higher average cash balances, primarily from the Sherwood Lakes repayment and higher interest rates earned on short-term investments, interest income on short-term investments increased during 1994 as compared to 1993.\nAs a result of the Sherwood Lakes Apartments wrap-around note receivable repayment in November 1994, the Partnership recognized interest income on wrap-around note receivable and the previously deferred gain on sale of property. No interest income was recognized in 1993 since the wrap-around note receivable had been placed on non-accrual status. For non-accrual loans, income is recorded only as cash payments are received from the purchaser.\nThe outstanding short-term loan from the General Partner was repaid during 1994, resulting in a decrease in interest expense on short-term loans during 1994 as compared to 1993.\nThe Partnership incurred refinancing fees in connection with the May 1993 mortgage loan refinancings on the Cedar Creek - Phases I and II and Walnut Hills - Phases I and II apartment complexes which are amortized over the term of the respective loan agreements. As a result, amortization of deferred expenses increased during 1994 as compared to 1993.\nIncreased accounting and portfolio management fees and data processing costs resulted in an increase in administrative expenses during 1994 as compared to 1993.\nLiquidity and Capital Resources - -------------------------------\nThe cash position of the Partnership decreased as of December 31, 1995 when compared to December 31, 1994. Operating activities include cash flow from the property operations and short-term investments, which was partially offset by the payment of administrative expenses. Financing activities consisted primarily of a distribution to the Limited Partners, and principal payments on mortgage notes payable.\nThe Partnership classifies the cash flow performance of its properties as either positive, a marginal deficit, or a significant deficit, each after consideration of debt service payments unless otherwise indicated. A deficit is considered significant if it exceeds $250,000 annually or 20% of the property's rental and service income. The Partnership defines cash flow generated from its properties as an amount equal to the property's revenue receipts less property related expenditures, which include debt service payments. During 1995 and 1994, four of the Partnership's five properties generated positive cash flow. The Walnut Hills - Phase I Apartments generated a marginal cash flow deficit during 1995 and 1994; however, the combined property operations of the Walnut Hills - Phase I and Phase II apartment complexes generated positive cash flow during the same periods.\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, improving operating performance, and seeking rent increases where market conditions allow.\nThe General Partner had previously advised limited partners that its strategy was to sell the Partnership's remaining assets over the next two to three years. The General Partner also stated that the timing of the liquidation could be lengthened or shortened due to changes in market conditions, economic factors, interest rates and unforeseen events. Since November 1995, the General Partner believes that the market for multifamily housing properties has become increasingly favorable to sellers of these properties. This belief is based on the results of the sales and marketing activities of the Partnership as described below and based upon the similar results of such activities by various other partnerships affiliated with the Partnership. These favorable market conditions are in part attributable to the increasing strength of the capital markets and the re-entry of REITs into the acquisition market. Since November 1995, the General Partner has entered into a letter of intent to sell one of the Partnership's five remaining properties, and, if the market remains favorable, intends to begin actively marketing more of the remaining properties for sale. If the current market conditions for sales remain favorable and the General Partner can obtain appropriate sales prices, the Partnership's liquidation strategy may be accelerated.\nEach of the Partnership's properties is owned through the use of third-party mortgage loan financing and, therefore, the Partnership is subject to the financial obligations required by such loans. See Note 5 of Notes to Financial Statements for information concerning outstanding balances, maturity dates, interest rates and terms related to each of these mortgage loans. As a result of the General Partner's efforts to obtain refinancing of existing loans with\nnew lenders, the Partnership has no third-party financing which matures prior to 2002.\nThe Partnership made a distribution of $100.57 per Interest in October 1995. This distribution reflects the resumption by the Partnership of distributions from Net Cash Receipts, a special distribution of $59.74 per Interest from Net Cash Proceeds related to the receipt by the Partnership of the repayment of its interest in a purchase money note received upon the sale of the Sherwood Lakes Apartments and a special distribution of $33.33 per Interest from Net Cash Receipts reserves.\nIn January 1996, the Partnership paid a distribution of $225,038 ($7.50 per Interest) to the holders of Limited Partnership Interests representing the quarterly distribution from Net Cash Receipts for the fourth quarter of 1995. Including the January 1996 distribution, Limited Partners have received distributions of Net Cash Receipts of $173.33 and Net Cash Proceeds of $142.24, totaling $315.57 per $1,000 Interest, as well as certain tax benefits. The Partnership does not anticipate that it will pay a distribution for the first quarter of 1996. In light of results to date and current market conditions, the General Partner does not anticipate that investors will recover all of their original investment.\nIn 1995, the Financial Accounting Standards Board issued Statement No. 121 \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of\" which establishes accounting standards for impairment of long-lived assets and long-lived assets to be disposed of. This statement has been adopted by the Partnership as of January 1, 1995, and did not have a material impact on the financial position or results of operations of the Partnership.\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 sale 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 return is summarized as follows:\nDecember 31, 1995 December 31, 1994 ----------------------- ------------------------- Financial Tax Financial Tax Statements Returns Statements Returns ---------- ---------- ----------- --------\nTotal assets $12,335,453 $14,268,357 $15,387,316 $17,613,469 Partners' (deficit)\ncapital accounts: General Partner (224,045) (181,585) (225,399) (220,802) Limited Partners (3,366,783) (1,476,343) (483,243) 1,738,312 Net income (loss): General Partner 1,354 39,217 7,006 349,105 Limited Partners 134,063 (197,052) 693,614 (362,706) Per Limited Part- nership Interest 4.47 6.57 23.12 (12.09)\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 BRI Partners-79, 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 ----- -------- Chairman, President and Chief Thomas E. Meador Executive Officer Senior Vice President Alexander J. Darragh Senior Vice President Josette V. Goldberg Senior Vice President Alan G. Lieberman Senior Vice President, Chief Brian D. Parker Financial Officer, Treasurer and Assistant Secretary Senior Vice President John K. Powell, Jr.\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. He is also Senior Vice President of American Express Company and is responsible for its real estate operations worldwide. 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.\nAlexander J. Darragh (February 1955) joined Balcor in September 1988 and is responsible for due diligence analysis and real estate advisory services for Balcor and American Express Company. He also has supervisory responsibility for Balcor's environmental matters. Mr. Darragh received masters' degrees in Urban Geography from Queen's University and in Urban Planning from Northwestern University.\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 MIS functions. 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 Balcor's property sales and capital markets functions. Mr. Lieberman is a Certified Public Accountant.\nBrian D. Parker (June 1951) joined Balcor in March 1986 and, as Chief Financial Officer and Chief Accounting Officer, is responsible for Balcor's financial, legal and treasury functions. He is a Director of The Balcor Company. 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 portfolio and asset management matters relating to Balcor's partnerships. Mr. Powell also has supervisory responsibility for Balcor's risk management and investor services functions. He received a Master of Planning degree from the University of Virginia. Mr. Powell 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.\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 1995.\nItem 11.","section_11":"Item 11. Executive Compensation - ------------------------------- The Registrant has not paid and does not propose to pay any remuneration to the executive officers and directors of BRI Partners-79, 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 8 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) The following entity is the sole Limited Partner which owns beneficially more than 5% of the outstanding Limited Partnership Interests of the Registrant:\nName and Amount and Address of Nature of Percent Beneficial Beneficial of Title of Class Owner Ownership Class - -----------------------------------------------------------------------------\nLimited WIG VIII 2,005.5 6.68% Partnership Partners Limited Interests Chicago, Partnership Illinois Interests\n(b) Neither BRI Partners-79 nor its officers or partners own any Limited Partnership Interests of the Registrant.\nRelatives and affiliates of the partners and officers of the General Partner do not own any additional 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- -------------------------------------------------------\n(a & b) See Note 3 of Notes to Financial Statements for information relating to the Partnership Agreement and the allocation of distributions and profits and losses.\nSee Note 8 of Notes to Financial Statements for information relating to transactions with affiliates.\n(c) No management person is indebted to the Registrant.\n(d) The Registrant has no outstanding agreements with any promoters.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement 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 of Limited Partnership previously filed as Exhibit 2(a) to Amendment No. 5 to the Registrant's Registration Statement on Form S-11 dated July 16, 1980 (Registration No. 2-63821) is incorporated herein by reference.\n(4) Certificate of Limited Partnership set forth as Exhibit 2(b) to Amendment No. 4 to the Registrant's Registration Statement on Form S-11 dated July 8, 1980 (Registration No. 2-63821) 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. 0-9541) are incorporated herein by reference.\n(27) Financial Data Schedule of the Registrant for 1995 is attached hereto.\n(b) Reports on Form 8-K: No reports on Form 8-K were filed during the quarter ended December 31, 1995.\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 EQUITY PROPERTIES LTD.-VIII\nBy: \/s\/Brian D. Parker ----------------------------------- Brian D. Parker Senior Vice President, and Chief Financial Officer (Principal Accounting and Financial Officer) of BRI Partners-79, the General Partner\nDate: March 28, 1996 --------------------\nPursuant to the requirements of the Securities Exchange Act of 1934, 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 BRI Partners-79, \/s\/Thomas E. Meador the General Partner March 28, 1996 - -------------------- -------------- Thomas E. Meador\nSenior Vice President, and Chief Financial Officer (Principal Accounting and Financial Officer) of BRI Partners-79, the \/s\/Brian D. Parker General Partner March 28, 1996 - -------------------- -------------- Brian D. Parker\nINDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE\nReport of Independent Accountants\nFinancial Statements:\nBalance Sheets, December 31, 1995 and 1994\nStatements of Partners' Deficit, for the years ended December 31, 1995, 1994 and 1993\nStatements of Income and Expenses, for the years ended December 31, 1995, 1994 and 1993\nStatements of Cash Flows, for the years ended December 31, 1995, 1994 and 1993\nNotes to Financial Statements\nFinancial Statement Schedule:\nIII - Real Estate and Accumulated Depreciation, as of December 31, 1995\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 Equity Properties Ltd.-VIII:\nWe have audited the financial statements and the financial statement schedule of Balcor Equity Properties Ltd.-VIII (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 Equity Properties Ltd.-VIII at December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, 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 20, 1996\nBALCOR EQUITY PROPERTIES, LTD. - VIII (An Illinois Limited Partnership)\nBALANCE SHEETS December 31, 1995 and 1994\nASSETS\n1995 1994 ------------- ------------- Cash and cash equivalents $ 542,128 $ 2,988,843 Escrow deposits - unrestricted 803,873 724,015 Escrow deposits - restricted 94,709 94,352 Accounts and accrued interest receivable 839 33,711 Prepaid expenses 63,360 Deferred expenses, net of accumulated amortization of $147,229 in 1995 and $93,393 in 1994 449,353 503,189 ------------- ------------- 1,954,262 4,344,110 ------------- ------------- Investment in real estate: Land 1,325,898 1,325,898 Buildings and improvements 20,518,019 20,518,019 ------------- ------------- 21,843,917 21,843,917 Less accumulated depreciation 11,462,726 10,800,711 ------------- ------------- Investment in real estate, net of accumulated depreciation 10,381,191 11,043,206 ------------- ------------- $ 12,335,453 $ 15,387,316 ============= =============\nLIABILITIES AND PARTNERS' DEFICIT\nAccounts payable $ 45,964 $ 77,177 Due to affiliates 19,344 49,347 Accrued liabilities, principally real estate taxes 551,280 548,122 Security deposits 96,931 100,592 Mortgage notes payable 15,212,762 15,320,720 ------------- ------------- Total liabilities 15,926,281 16,095,958\nLimited Partners' deficit (30,005 Interests issued and outstanding) (3,366,783) (483,243)\nGeneral Partner's deficit (224,045) (225,399) ----------- ----------- Total partner's deficit (3,590,828) (708,642) ------------- ------------- $ 12,335,453 $ 15,387,316 ============= =============\nThe accompanying notes are an integral part of the financial statements.\nBALCOR EQUITY PROPERTIES, LTD. - VIII (An Illinois Limited Partnership)\nSTATEMENTS OF PARTNERS' DEFICIT for the years ended December 31, 1995, 1994 and 1993\nPartners' Deficit Accounts -------------------------------------------- General Limited Total Partner Partners ------------- ------------ ---------------\nBalance at December 31, 1992 $ (1,081,763) $ (229,130) $ (852,633)\nNet loss for the year ended December 31, 1993 (327,499) (3,275) (324,224) ------------- ------------ --------------- Balance at December 31, 1993 (1,409,262) (232,405) (1,176,857)\nNet income for the year ended December 31, 1994 700,620 7,006 693,614 ------------- ------------ --------------- Balance at December 31, 1994 (708,642) (225,399) (483,243)\nCash distributions (A) (3,017,603) (3,017,603)\nNet income for the year ended December 31, 1995 135,417 1,354 134,063 ------------- ------------ --------------- Balance at December 31, 1995 $ (3,590,828) $ (224,045) $ (3,366,783) ============= ============ ===============\n(A) A distribution of $100.57 per Limited Partnership Interest was made in the fourth quarter of 1995.\nThe accompanying notes are an integral part of the financial statements.\nBALCOR EQUITY PROPERTIES, LTD. - VIII (An Illinois Limited Partnership)\nSTATEMENTS OF INCOME AND EXPENSES for the years ended December 31, 1995, 1994 and 1993\n1995 1994 1993 ------------- ------------ --------------- Income: Rental and service $ 5,861,649 $ 5,724,364 $ 5,271,564 Interest on short-term investments 181,823 43,253 18,981 Interest on wrap-around note receivable 407,425 ------------- ------------ --------------- Total income 6,043,472 6,175,042 5,290,545 ------------- ------------ ---------------\nExpenses: Interest on mortgage notes payable 1,448,914 1,463,776 1,419,454 Interest on short-term loans from affiliate 5,773 38,845 Depreciation 662,015 655,407 648,503 Amortization of deferred expenses 53,836 53,836 32,860 Property operating 2,478,862 2,424,097 2,398,046 Real estate taxes 555,297 545,503 534,618 Property management fees 279,931 286,031 262,846 Administrative 429,200 326,461 282,872 ------------- ------------ --------------- Total expenses 5,908,055 5,760,884 5,618,044 ------------- ------------ --------------- Income (loss) before gain on sale of property 135,417 414,158 (327,499)\nGain on sale of property 286,462 ------------- ------------ --------------- Net income (loss) $ 135,417 $ 700,620 $ (327,499) ============= ============ =============== Net income (loss) allocated to General Partner $ 1,354 $ 7,006 $ (3,275) ============= ============ =============== Net income (loss) allocated to Limited Partners $ 134,063 $ 693,614 $ (324,224) ============= ============ =============== Net income (loss) per Limited Partnership Interest (30,005 issued and outstanding) $ 4.47 $ 23.12 $ (10.81) ============= ============ ===============\nThe accompanying notes are an integral part of the financial statements.\nBALCOR EQUITY PROPERTIES, LTD. - VIII (An Illinois Limited Partnership)\nSTATEMENTS OF CASH FLOWS for the years ended December 31, 1995, 1994 and 1993\n1995 1994 1993 ------------- ------------ --------------- Operating activities: Net income (loss) $ 135,417 $ 700,620 $ (327,499) Adjustments to reconcile net income (loss)to net cash provided by operating activities: Gain on sale of property (286,462) Depreciation of properties 662,015 655,407 648,503 Amortization of deferred expenses 53,836 53,836 32,860 Net change in: Escrow deposits - unrestricted (79,858) (138,271) (373,551) Escrow deposits - restricted (42,817) (12,672) (30,839) Accounts and accrued interest receivable 32,872 (33,711) Prepaid expenses (63,360) Accounts payable (31,213) 22,474 (11,679) Due to affiliates (30,003) 11,936 (8,996) Accrued liabilities 3,158 13,580 393,159 Security deposits (3,661) (15,559) 16,680 ------------- ------------ --------------- Net cash provided by operating activities 636,386 971,178 338,638 ------------- ------------ --------------- Investing activities: Additions to properties (60,134) (133,077) Proceeds from wrap-around note receivable 1,792,575 ------------ --------------- Net cash provided by or used in investing activities 1,732,441 (133,077) ------------ --------------- Financing activities: Proceeds from issuance of mortgage notes payable 12,350,000 Payments of mortgage notes payable (10,025,572) Repayment of loans payable- affiliate (417,775) (1,361,965) Principal payments on mortgage notes payable (107,958) (98,344) (132,236) Funding of repair escrows (235,277) Releases of repair escrows 99,903 135,374 Releases of escrow deposits - restricted 42,460 109,822 102,860 Payment of deferred expenses (474,277) Distributions to Limited Partners (3,017,603) ------------- ------------ --------------- Net cash used in or provided by financing activities (3,083,101) (306,394) 358,907 ------------- ------------ --------------- Net change in cash and cash equivalents (2,446,715) 2,397,225 564,468 Cash and cash equivalents at beginning of period 2,988,843 591,618 27,150 ------------- ------------ --------------- Cash and cash equivalents at end of period $ 542,128 $ 2,988,843 $ 591,618 ============= ============ ===============\nThe accompanying notes are an integral part of the financial statements.\nBALCOR EQUITY PROPERTIES LTD.-VIII (An Illinois Limited Partnership)\nNOTES TO FINANCIAL STATEMENTS\n1. Nature of the Partnership's Business:\nBalcor Equity Properties Ltd.-VIII is engaged principally in the operation of residential real estate located in Texas and Colorado.\n2. Accounting Policies:\n(a) The preparation of the financial statements in conformity with generally accepted accounting principles requires the General Partner 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 vary from those estimates.\n(b) Depreciation expense is computed using straight-line and accelerated methods. Rates used in the determination of depreciation are based upon the following estimated useful lives:\nBuildings and improvements 15 to 33 years Furniture and fixtures 3 to 5 years\nMaintenance and repairs are charged to expense when incurred. Expenditures for improvements are charged to the related asset account.\nAs properties are sold, the related costs and accumulated depreciation are removed from the respective accounts. Any gain or loss on disposition is recognized in accordance with generally accepted accounting principles. Deferred gains on the sales of properties result from sales recorded under the installment method. Gains are recognized based on the gross profit percentage as future sales proceeds are collected.\n(c) Effective January 1, 1995 the Partnership adopted Statement of Financial Accounting Standards, No. 121 (SFAS 121), \"Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of\". Under SFAS 121, the Partnership records its investments in real estate at the lower of cost or fair value, and periodically assesses, but not less than on an annual basis, possible impairment to the value of its properties. The General Partner estimates the fair value of its properties by dividing the property's expected net operating income by a risk adjusted rate of return which considers economic and demographic conditions in the market. In the event the General Partner determines an impairment in value has occurred, and the carrying amount of the real estate asset will not be recovered, a provision is recorded to reduce the carrying basis of the property to its estimated fair value. The General Partner considers the method referred to above to result in a reasonable measurement of a property's fair value, unless other factors affecting the property's value indicate otherwise.\n(d) Deferred expenses consist of loan refinancing fees which are amortized over the terms of the respective agreements.\n(e) The Financial Accounting Standard Board's Statement No. 107, \"Disclosures About Fair Value of Financial Instruments\", requires disclosure of fair value\ninformation about financial instruments for which it is practicable to estimate that value. Since quoted market prices are not available for the Partnership's financial instruments, fair values have been based on estimates using present value techniques. These techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, may not be realized in immediate settlement of the instrument. Statement No. 107 does not apply to all balance sheet items and excludes certain financial instruments and all non-financial instruments such as real estate from its disclosure requirements.\n(f) Cash and cash equivalents include all unrestricted, highly liquid investments with an original maturity of three months or less.\n(g) Revenue is recognized on an accrual basis in accordance with generally accepted accounting principles.\n(h) The Partnership is not liable for Federal income taxes and each Partner recognizes his proportionate share of the Partnership income or loss in his tax return; therefore, no provision for income taxes is made in the financial statements of the Partnership.\n(i) Several reclassifications have been made to the previously reported 1994 and 1993 financial statements to conform with the classifications used in 1995. These reclassifications have not changed the 1994 and 1993 results.\n3. Partnership Agreement:\nThe Partnership was organized in February 1979. The Partnership Agreement provides for BRI Partners-79 to be the General Partner and for the admission of Limited Partners through the sale of up to 30,005 Limited Partnership Interests at $1,000 per Interest, all of which were sold on or prior to October 31, 1980, the termination date of the offering.\nThe Partnership Agreement provides that the General Partner will be allocated 1% of the profits and losses. To the extent Net Cash Receipts are distributed, the General Partner will be entitled to 10% of the Net Cash Receipts (9% being its management fee and 1% being its distributive share), which payment is subordinated to certain levels of return to holders of Interests as specified by the Partnership Agreement. There have been no cash payments made to the General Partner under these provisions.\nWhen and as the Partnership sells or refinances properties, the Net Cash Proceeds resulting therefrom which are available for distribution will be distributed only to holders of Interests until such time as holders of Interests have received an amount equal to their Original Capital plus certain levels of return, as specified by the Partnership Agreement. Only after such returns are made to the Limited Partners would the General Partner receive 15% of further distributed Net Cash Proceeds. There have been no cash payments made to the General Partner under these provisions.\n4. Wrap-around Note Receivable:\nIn January 1988, the Partnership sold (subject to the underlying debt obligations) the wrap-around note receivable previously received by the Partnership as a portion of the selling price of the Sherwood Lake Apartments. At closing, the Partnership retained a 21.6% interest in the note pursuant to\nthe terms of a participation agreement entered into by the Partnership and the purchaser of the note.\nThe purchaser of the property failed to make the balloon payment due in June 1991. As a result, foreclosure proceedings were commenced and shortly thereafter the purchaser of the property filed for protection under the U.S. Bankruptcy Code. In December 1993, a liquidation plan was confirmed by the bankruptcy court. In November 1994, the Partnership received $2,200,000 representing its participation in the wrap-around note. The repayment consisted of the Partnership's share of the principal balance of the note of $1,792,575 and interest income of $407,425. The Partnership also recognized a $286,462 deferred gain on sale.\n5. Mortgage Notes Payable:\nMortgage notes payable at December 31, 1995 and 1994 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\/95 12\/31\/94 Rate Date Payment Payment - ----------- ----------- ---------- ------- ------- -------- ------- Apartment Complexes: Cedar Creek Phase I $ 2,333,156 $ 2,350,562 9.38% 2003 $19,763 $2,138,000 Cedar Creek Phase II 2,775,228 2,795,931 9.38% 2003 23,507 2,543,000 Greentree Village 3,083,359 3,099,604 9.75% 2026 26,479 None Walnut Hills Phase I 5,125,345 5,164,476 9.26% 2002 42,977 4,767,000 Walnut Hills Phase II 1,895,674 1,910,147 9.26% 2002 15,896 1,763,000 ----------- -----------\nTotal $15,212,762 $15,320,720 =========== ===========\nAll of the Partnership's loans described above require current monthly payments of principal and interest.\nReal estate with an aggregate carrying value of $10,381,191 at December 31, 1995 was pledged as collateral for repayment of mortgage loans.\nFuture annual maturities of the above mortgage notes payable during each of the next five years are approximately as follows :\n1996 $ 119,000 1997 130,000 1998 143,000 1999 157,000 2000 172,000\nDuring the years ended December 31, 1995, 1994 and 1993, the Partnership incurred and paid interest expense on mortgage notes payable of $1,448,914, $1,463,776 and $1,419,454, respectively.\n6. Management Agreements:\nAs of December 31, 1995, all of the properties owned by the Partnership are under management agreements with a third-party management company. These management agreements provide for annual fees of 5% of gross operating receipts.\n7. 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 income for 1995 in the financial statements is $293,252 higher than the tax loss of the Partnership for the same period.\n8. Transactions with Affiliates:\nFees and expenses paid and payable by the Partnership to affiliates are:\nYear Ended Year Ended Year Ended 12\/31\/95 12\/31\/94 12\/31\/93 -------------- -------------- -------------- Paid Payable Paid Payable Paid Payable ------- ------ ------- ------ ------- -------\nProperty management fees None None $283,313 None $263,313 $22,346 Reimbursement of expenses to the General Partner, at cost: Accounting $34,886 $3,244 50,895 $18,653 47,708 3,941 Data processing 21,180 2,454 23,660 4,773 13,598 2,824 Investor communica- tions 5,217 None 17,584 4,864 17,915 1,480 Legal 15,472 2,769 6,703 3,202 6,139 507 Portfolio management 63,955 10,531 27,997 15,353 28,449 3,637 Other 1,994 346 18,156 2,502 7,851 648\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; however, the General Partner is reimbursed for expenses. The Partnership paid premiums to the deductible insurance program of $35,119, $49,714 and $25,901 for 1995, 1994 and 1993, respectively.\nAllegiance Realty Group, Inc., an affiliate of the General Partner, managed all of the Partnership's properties until the affiliate was sold to a third-party in November 1994.\nAs of December 31, 1993, the Partnership had loans from the General Partner totaling $417,775, which were repaid during 1994 with cash flow available from property operations. The Partnership incurred interest expense of $5,773 and\n$38,845, and paid interest expense of $7,801 and $46,898 in 1994 and 1993, respectively, on these loans.\n9. Fair Values of Financial Instruments:\nThe carrying amounts and fair values of the Partnership's financial instruments at December 31, 1995 are as follows:\nThe carrying value of cash and cash equivalents, accounts and accrued interest receivable, accounts payable and restricted escrow deposits approximates fair value.\nBased on borrowing rates available to the Partnership at the end of 1995 for mortgage loans with similar terms and maturities, the fair value of the mortgage notes payable approximates the carrying value.\n10. Subsequent Events:\n(a) In January 1996, the Partnership paid $225,038 to Limited Partners representing the quarterly distribution of available Net Cash Receipts of $7.50 per Interest for the fourth quarter of 1995.\n(b) On February 29, 1996, a proposed class action complaint was filed, Raymond Masri vs. Lehman Brothers, Inc., et al., Case No. 96\/103727 (Supreme Court of the State of New York, County of New York). The Partnership, additional limited partnerships which were sponsored by The Balcor Company, three limited partnerships sponsored by the predecessor of Lehman Brothers, Inc. (together with the Partnership and the affiliated partnerships, the \"Defendant Partnerships\"), Lehman Brothers, Inc. and Smith Barney Holdings, Inc. are defendants. The complaint alleges, among other things, common law fraud and deceit, negligent misrepresentation and breach of fiduciary duty relating to the disclosure of information in the offering of limited partnership interests in the Defendant Partnerships. The complaint seeks judgment for compensatory damages equal to the amount invested in the Defendant Partnerships by the proposed class plus interest accrued thereon; general damages for injuries arising from the defendants' actions; recovery from the defendants of all profits received by them as a result of their actions relating to the Defendant Partnerships; exemplary damages; attorneys' fees and other costs.\nThe defendants intend to vigorously contest this action. No class has been certified as of this date. Management of each of the defendants believes they have meritorious defenses to contest the claims. It is not determinable at this time whether or not an unfavorable decision in this action would have a material adverse impact on the Partnership.\nBALCOR EQUITY PROPERTIES LTD.-VIII (An Illinois Limited Partnership)\nBALCOR EQUITY PROPERTIES LTD.-VIII (An Illinois Limited Partnership)\nBALCOR EQUITY PROPERTIES LTD.-VIII (An Illinois Limited Partnership)\nNOTES TO SCHEDULE III\n(a) Consists of legal fees, appraisal fees, title costs and other related professional fees.\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 related.\n(c)Reconciliation of Real Estate --------------------------------\n1995 1994 1993 ---------- ---------- ---------- Balance at beginning of year $21,843,917 $21,783,783 $21,650,706 Additions during year: Improvements None 60,134 133,077 Deductions during year: Foreclosure of investment property None None None ----------- ----------- ----------- Balance at end of year $21,843,917 $21,843,917 $21,783,783 =========== =========== ===========\nReconciliation of Accumulated Depreciation ------------------------------------------\n1995 1994 1993 ---------- ---------- ---------- Balance at beginning of year $10,800,711 $10,145,304 $9,496,801 Depreciation expense for the year 662,015 655,407 648,503 Accumulated depreciation of foreclosed investment property None None None ----------- ----------- ----------- Balance at end of year $11,462,726 $10,800,711 $10,145,304 =========== =========== ===========\n(d) The aggregate cost of land for Federal income tax purposes is $1,627,607 and the aggregate cost of buildings and improvements for Federal income tax purposes is $10,133,138. The total of these is $11,760,745.\n(e) See description of mortgage notes payable in Note 5 of Notes to Financial Statements.\n(f) Depreciation expense is computed based upon the following estimated useful lives:\nBuildings and improvements 15 to 33 years Furniture and fixtures 3 to 5 years\n(g) The Greentree Village Apartments cash balance is restricted due to provisions of the HUD financing agreement.\n(h) This apartment complex was completed in stages from 1971 to 1979.\n(i) During 1986, these properties were acquired at a foreclosure sale.","section_15":""}
{"filename":"57497_1995.txt","cik":"57497","year":"1995","section_1":"Item 1. - BUSINESS\nThe Lamson & Sessions Co. (\"Company\"), founded in 1866, is a diversified manufacturer and supplier of a broad line of thermoplastic electrical, telecommunications and fluid drainage products for major domestic markets. The markets for thermoplastic conduit, related fittings and accessories, wiring devices and sewer pipe include: the construction, utility and telecommunications industries; municipalities, other government agencies, and contractors; and do-it-yourself home remodelers.\nIn November 1995, the Company completed the sale of its Valley-Todeco division which was engaged in the manufacture and sale of fasteners serving the aerospace industry. (Refer to Note J to the Consolidated Financial Statements.) Proceeds from the sale were utilized to reduce debt.\nPRINCIPAL PRODUCTS AND MARKETS\nThe Company is engaged in the manufacture and distribution of a broad line of thermoplastic electrical, telecommunication and engineered sewer products. In addition, the Company distributes a wide variety of consumer electrical wiring devices.\nAll of the Company's thermoplastic products compete with and serve as substitutes for similar metallic products, and its engineered sewer pipe products compete with and serve as substitutes for clay, concrete, ductile iron, asbestos cement and polyethylene products. The Company's thermoplastic products offer several advantages over these other products. Specifically, nonmetallic electrical conduit and related fittings and accessories are generally less expensive, lighter and easier to install than metallic products. Furthermore, thermoplastic conduit does not rust, corrode or conduct electricity. Thermoplastic sewer pipe weighs less than substitute products, is easier and more economical to install, does not degenerate due to sewer gases as do some competing products, and eliminates avoidable problems which can be caused by infiltration and exfiltration.\nFour markets are served, each of which has unique product and marketing requirements. These markets are: (i) Industrial, Residential, Commercial and Utility Construction (served by Carlon Electrical Products, \"Electrical\") -- contractors engaged in the installation of electrical systems in industrial, residential and commercial construction, and electric power utility projects; original equipment manufacturers who use components as subassemblies for their own products; and industrial companies who maintain or repair their own facilities; (ii) Consumer (served by Lamson Home Products, \"Home\") -- retail consumers of electrical products who perform \"do-it-yourself\" home repairs; and small electrical contractors; (iii) Telecommunications (served by Carlon Telecom Systems, \"Telecom\") -- cable TV, telephone and telecommunications companies; and (iv) Engineered Sewer Products (served by Lamson Vylon Pipe, \"Vylon\") -- various government and private builders of sewer and drainage systems.\nA breakdown of revenues as a percent of net sales related to significant classes of product by major market segment for 1995, 1994 and 1993, respectively is as follows:\nThe following summarizes the principal products used in each of the four markets:\nINDUSTRIAL, RESIDENTIAL, COMMERCIAL AND UTILITY CONSTRUCTION. The principal products sold to this market include rigid conduit, flexible electrical nonmetallic tubing, fittings and accessories, outlet boxes, and other products. Other products in this market also include thermoplastic spirally extruded liquidtight conduit, which is used by industrial companies and original equipment manufacturers requiring a watertight housing for electrical cable, and a broad line of industrial nonmetallic enclosures comprised of molded, non-corrosive boxes designed to enclose and protect devices such as electrical controls, switches and industrial control panels.\nTELECOMMUNICATIONS. The products included in this market are traditional smooth wall communication duct and spacers used by telecommunication and CATV industries to house telecommunications cable, multi-cell duct systems designed to protect underground fiber optic cables and allow future cabling expansion, and flexible conduit used inside buildings to protect communications cable.\nCONSUMER. The products included in this market are products such as light dimmers, fan speed controls, touch controls, door chimes, motion sensors and home security systems. In addition, the Company supplies this market with products such as outlet boxes, electrical conduit, liquidtight conduit and electrical fittings.\nENGINEERED SEWER PRODUCTS. Principal products utilized by this market include closed profile engineered sewer pipe used for direct burial and sliplining as well as traditional solid wall sewer and drain pipe used in residential construction of sanitary drainage systems, sewer main and highway underdrain available in diameters ranging from 4 to 48 inches.\nCOMPETITION\nEach of the four markets in which the Company is presently operating is highly competitive based on service, price and quality. Most of the competitors are either national or smaller regional manufacturers who compete with limited product offerings. Unlike a majority of the Company's competitors, the Company manufactures a broad line of thermoplastic products, complementary fittings and accessories, thus enabling it to offer its customers complete and integrated systems. The company believes that its products will continue to compete favorably. However, certain of the Company's competitors have greater financial resources than the Company, which could adversely affect the Company through price competition strategies.\nDISTRIBUTION\nThe Company distributes its products through a nationwide network of more than 175 manufacturers' representatives. Currently, 10 of these manufacturers' representatives inventory the Company's products. The Company has reduced the number of these inventory locations and has developed its own strategically located distribution centers.\nRAW MATERIALS\nThe Company is a large purchaser of pipe grade polyvinyl chloride resin and has historically been able to obtain adequate quantities.\nPATENTS AND TRADEMARKS\nThe Company owns various patents, patent applications, licenses, trademarks and trademark applications relating to its products and processes. While the Company considers that, in the aggregate, its patents, licenses and trademarks are of importance in the operation of its business, it does not consider that any individual patent, license or trademark, or any technically related group, is of such importance that termination would materially affect its business.\nSEASONAL FACTORS\nThe Company's four business units experience seasonality caused principally by a decrease in construction activity during the winter months. They are subject also to the economic cycles affecting the construction industry.\nMAJOR CUSTOMERS\nSales to Affiliated Distributors, a buying group not otherwise affiliated with the Company, totalled approximately 12% of net sales in 1995 and 1994. No customer exceeded 10% of net sales in 1993.\nBACKLOG\nDue to the nature of the Company's business, orders are generally filled within several weeks of order date. Therefore, statistics relative to order backlog are not indicative of the status of the Company's business at any point in time.\nRESEARCH AND DEVELOPMENT\nThe Company is engaged in an aggressive new product development program in an effort to introduce innovative applications for thermoplastic and consumer electrical products. The Company maintains a separate research and development center in Cleveland, Ohio to facilitate the introduction of value-added products and improved manufacturing processes. The Company sponsored research and development activity totalled $3.7 million, $3.4 million and $3.2 million in 1995, 1994 and 1993, respectively.\nENVIRONMENTAL REGULATIONS\nThe Company believes that its current operations and its use of property, plant and equipment conform in all material respects to applicable environmental laws and regulations presently in effect (Refer to Note C to the Consolidated Financial Statements). The Company has facilities at numerous geographic locations, which are subject to a range of federal, state and local environmental laws and regulations. Compliance with these laws has, and will, require expenditures on a continuing basis.\nEMPLOYEES\nAt fiscal years ended, the Company had the following employees:\n1995 1994 1993 ---- ---- ---- 1,048 1,325 1,425\nFOREIGN OPERATIONS\nThe net sales, operating earnings and assets employed outside the United States are not significant. Export sales were approximately 2% of consolidated net sales in 1995 and 1% in each of the two prior fiscal years and were made principally to countries in North America.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. - PROPERTIES\nThe Company owns or leases manufacturing and distribution facilities which are suitable and adequate for the production and marketing of its products. The Company owns executive and administrative offices which are located in Cleveland, Ohio and occupy 68,000 square feet in a suburban office complex. In addition, the Company leases 7,000 square feet of administrative offices in an office building near the Corporate headquarters. The Company also has research and development offices, located in Cleveland, Ohio, which occupy leased space of 27,000 square feet. The following is a list of the Company's manufacturing and distribution center locations:\nApproximate Square Feet ----------- Manufacturing Facilities (Owned): - ----------------------------------------\nWoodland, California 73,000\nHigh Springs, Florida 113,000\nClinton, Iowa 156,000\nBowling Green and Aurora, Ohio 205,000 (2 facilities)\nOklahoma City, Oklahoma 166,000\nNazareth, Pennsylvania 53,000\nPasadena, Texas 46,000\nDistribution Centers (Leased): - ----------------------------------------\nWoodland, California 41,000\nMontreal, Canada 20,000\nClinton, Iowa 56,000\nOklahoma City, Oklahoma 90,000\nAllentown, Pennsylvania 65,000\nThe Company presently utilizes substantially all of its facilities and operated in 1995 at approximately 77% of productive capacity.\nItem 3.","section_3":"Item 3. - LEGAL PROCEEDINGS\nThe Company is a party to various claims and matters of litigation incidental to the normal course of its business. Management believes that the final resolution of these matters will not have a material adverse effect on the Company's financial position.\nItem 4.","section_4":"Item 4. - SUBMISSION OF MATTERS TO SECURITY HOLDERS\nNone.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nJOHN B. SCHULZE\nChairman, President and Chief Executive Officer\nChairman, President and Chief Executive Officer since January 1990. Age 58.\nJAMES J. ABEL\nExecutive Vice President, Secretary, Treasurer and Chief Financial Officer\nExecutive Vice President, Secretary, Treasurer and Chief Financial Officer since September 1994. Previously was Executive Vice President, Treasurer and Chief Financial Officer February 1993 - September 1994. Previously was Senior Vice President, Treasurer and Chief Finan- cial Officer December 1990 - February 1993. Age 50.\nCHARLES E. ALLEN\nSenior Vice President\nSenior Vice President since September 1989. Age 55.\nMELVIN W. JOHNSON\nVice President\nVice President since February 1991. Pre- viously was Vice President -- Engineering January 1985 - January 1991. Age 59.\nMARK R. BUCK\nVice President - Carlon Electrical Products Vice President - Carlon Electrical Products since October 1983. Age 42.\nA. CORYDON MEYER\nVice President - Lamson Home Products Vice President - Lamson Home Products since March 1990. Age 41.\nNORMAN P. SUTTERER\nVice President - Carlon Telecom Systems Vice-President - Carlon Telecom Systems since February 1989. Age 46.\nPART II\nItem 5.","section_5":"Item 5. - MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS\nThe Company's Common Stock is traded on the New York Stock Exchange and Pacific Stock Exchange. High and low sales prices for the common stock are included in Note K to the Consolidated Financial Statements. No dividends were paid in 1995, 1994 or 1993. The approximate number of shareholders of record of the Company's Common Stock at February 1, 1996 was 2,128.\nItem 6.","section_6":"Item 6. - SELECTED FINANCIAL DATA FIVE-YEAR FINANCIAL SUMMARY\nItem 7.","section_7":"Item 7. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\nManagement's Discussion and Analysis - ------------------------------------\nDISCUSSION OF THE CONSOLIDATED STATEMENT OF OPERATIONS THE CONSOLIDATED STATEMENT OF OPERATIONS summarizes Lamson & Sessions' operating performance over the last three years. In 1995, the Company reported the highest net sales, excluding discontinued operations, since 1989. Carlon Telecom Systems experienced strong demand for products in 1995 leading the areas of growth experienced by the Company. In late 1995, the Company sold Valley Todeco, its aerospace fastener business (see Note J - to the Consolidated Financial Statements). This divestiture allowed the Company to retire subordinated debt and will enable the Company to focus on growth through acquisitions and new product development in the electrical products markets which it serves.\nNET SALES of $299 million for 1995 were 4% higher than net sales of $288 million in 1994. 1995 sales, excluding the aerospace fastener business sold during 1995, were $280 million compared to $269 million in adjusted 1994 sales. The 1995 adjusted sales increase consisted of a 24% increase for Carlon Telecom Systems, a 4% increase for Lamson Home Products, a 1% increase for Carlon Electrical Products, and a 12% decrease for Lamson Vylon Pipe. The sales increase consisted of overall price increases of nearly 10%, a 15% new product volume increase for Carlon Telecom Systems, offset by sales volume decreases in engineered sewer products and electrical fittings. Increased marketing efforts in engineered sewer products and electrical products are expected to reverse this negative trend. Net sales for 1994 were 11% higher than net sales of $260 million in 1993. Product mix improvements, resulting in higher average selling prices, were coupled with strong demand to generate the sales gains. Carlon Electrical Products and Carlon Telecom Systems emphasis on new products improved their product mix and achieved higher sales on lower volume in 1994 compared to 1993.\nGROSS MARGIN percentage increased 5% to nearly 19% of net sales in 1995, compared to 18% of net sales in 1994. This improvement reflects the Company's continuing progress in implementing operating efficiencies and improved product mix as evidenced by new product introductions in Carlon Telecom Systems and reduced rigid pipe sales. The Company experienced continued improvement in the aerospace fastener business prior to its sale in the fourth quarter. Also in the fourth quarter, gross margin was adversely affected by declining polyvinylchloride (PVC) resin costs. However, the Company's continued emphasis on non-commodity products is working to minimize the effect of highly variable PVC pricing. Gross margin percentage improved by 20% from 15% of net sales comparing 1994 and 1993. Increased manufacturing efficiencies in the aerospace fastener business (which was sold during 1995) and reduced rigid pipe sales improved 1994 margins.\nSELLING, GENERAL AND ADMINISTRATIVE EXPENSES held constant at 14% of sales in 1995 and 1994. However, excluding the aerospace fastener business, the Company experienced an increase in these expenses of nearly 6%, reflecting marketing efforts and higher sales commissions, as well as staffing costs associated with new product programs and related support functions. Selling, general and administrative expenses increased nominally from 1993 to 1994. The 1994 increase related to increased commission rates on higher margin products, promotional expenses, salary expenses and employee health care.\nINTEREST EXPENSE decreased 12% from 1994 to 1995. The decrease resulted from a rate reduction due to the restructuring of the Company's secured credit agreement, refinancing of Industrial Revenue Bonds and debt reduction using cash generated from operating cash flow and the sale of assets. Interest expenses increased 15% from 1993 to 1994. During that period, rising interest rates on the secured credit facility were partially offset by average lower borrowings resulting from the proceeds from the sale of the Company's truck frame unit.\nINCOME TAX BENEFIT of nearly $4 million was generated from a reduction in the valuation allowance placed on the Company's deferred tax assets due to continuing improvement in operating results and the outlook for sustained profitability. The company has no current income tax provision as it continues to be in a net operating loss carryforward position. No income tax provision was recorded in 1994.\nDiscussion of the Consolidated Statement of Financial Position THE CONSOLIDATED STATEMENT OF FINANCIAL POSITION shows Lamson & Sessions' financial position at year end, compared to the previous year end. The statement provides information to assist in assessing such factors as the Company's liquidity and financial resources. The 1995 current ratio decreased 4%, mainly due to the sale of the Company's aerospace business. The 1995 debt to equity ratio decreased significantly, to less than 1 down from 4 in 1994. Total debt decreased 44%, from $51 million to below $29 million, while equity increased 140% to nearly $31 million.\nACCOUNTS RECEIVABLE are primarily due from trade customers. Accounts Receivable declined nominally overall in 1995 from 1994. Excluding the sold aerospace fastener unit business from 1994, Accounts Receivable increased nearly $2 million due to higher fourth quarter sales, with corresponding 1995 days sales outstanding dropping nearly 1 day to 45 days compared to December 31, 1994.\nINVENTORIES decreased $11 million in 1995 from 1994. These results reflect the sale of the aerospace fastener business and reduced pricing in the fourth quarter as raw material costs fell.\nPREPAID EXPENSES AND OTHER increased nearly $6 million in 1995 from 1994. Nearly $4 million of the increase relates to the reduction of the valuation allowance on the Company's deferred tax asset. The remaining increase in other current assets relates to the amount receivable on the sale of the aerospace fastener business, pending resolution of certain contractual conditions, and increases in other non-trade receivables.\nLONG-TERM DEBT decreased $22 million during 1995. The outstanding revolving line of credit was significantly reduced and the final $11 million in 14% subordinated debt was retired two years prior to its maturity. Stronger cash flow from operations, augmented by the sale of the aerospace business and certain assets remaining from the 1994 sale of the truck frame business, facilitated the debt reduction.\nPOST-RETIREMENT BENEFITS AND OTHER LONG-TERM LIABILITIES decreased 19% from $36 million in 1994 to $29 million in 1995. The Company took several steps during the year to eliminate underfunding relating to several defined benefit pension plans. As a result, nearly $6 million of additional minimum liability was eliminated, with a corresponding increase in equity. The Company retained the pension plan liability, health care benefits for existing retirees and approximately $1.2 million of other liabilities of its aerospace fastener business which will be paid out over an extended period of time.\nDISCUSSION OF THE CONSOLIDATED STATEMENT OF CASH FLOWS THE CONSOLIDATED STATEMENT OF CASH FLOWS shows cash inflows and outflows from the Company's operating, investing and financing activities. Cash and cash equivalents remained comparable at year end 1995 compared to 1994. Significantly improved operating cash flow was generated in 1995 compared to 1994.\nCASH FLOWS FROM OPERATING ACTIVITIES - The Company generated over $19 million in cash from operations in 1995, an increase of 405% over the prior year. The primary sources of the operating cash increase were the 92% improvement, before tax benefit, in earnings from continuing operations and nearly $5 million in cash flow from inventory reductions. The Company generated nearly $4 million in cash from operations in 1994. 1994 cash flow from operations was approximately equal to 1993 cash flow from operations as improved continuing operations cash flow was offset by the loss in the discontinued truck frame business.\nCASH FLOWS FROM INVESTING ACTIVITIES - The Company generated $3 million in cash flow from 1995 investing activities. Cash receipts from the sale of a business unit exceeded the $11 million capital expenditures made by the Company. 1995 purchases of plant, property and equipment increased over the prior year as the Company continues to invest in projects which will reduce costs, provide efficiency in product development and more effectively utilize support functions. The Company generated over $10 million in cash flow from 1994 investing activities.\nCASH FLOWS FROM FINANCING ACTIVITIES - The Company used over $22 million of cash flow for 1995 financing activities. The Company retired $11 million in 14% subordinated debt in 1995. In addition, borrowings under the secured credit agreement were reduced nearly $11 million in 1995. The Company used $13 million of cash flow for 1994 financing activities. The company reduced borrowings on the secured credit agreement by $12 million in 1994.\nBased upon the Company's past performance and current expectations, management believes that internally generated cash flows and existing capacity under the secured credit agreement are adequate to fund the Company's 1996 cash needs for capital expenditures and general operating requirements.\nOutlook - -------\nThe Company's strong improvement in 1995 reflects efforts to pursue market and product opportunities that are expected to provide sustainable revenue and profit growth. Management believes that this positive trend will continue in 1996 based on current estimates for the year in construction spending, housing starts, interest rates and general economic improvement. The emphasis on growth is reflected in the continued investment in product development, improved business systems to facilitate cost reduction, organizational efficiency, and strong cash management.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CONSOLIDATED STATEMENT OF OPERATIONS\nTHE LAMSON & SESSIONS CO. AND SUBSIDIARIES (in thousands, except per share data)\nSee notes to consolidated financial statements.\nCONSOLIDATED STATEMENT OF CASH FLOWS\nTHE LAMSON & SESSIONS CO. AND SUBSIDIARIES\nSee notes to consolidated financial statements.\nCONSOLIDATED STATEMENT OF FINANCIAL POSITION\nTHE LAMSON & SESSIONS CO. AND SUBSIDIARIES\nDecember 30, 1995 and December 31, 1994 (Dollars in thousands)\nCONSOLIDATED STATEMENT OF FINANCIAL POSITION\nTHE LAMSON & SESSIONS CO. AND SUBSIDIARIES\nDecember 30, 1995 and December 31, 1994 (Dollars in thousands)\nSee notes to consolidated financial statements.\nCONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY\nTHE LAMSON & SESSIONS CO. AND SUBSIDIARIES\n(Dollars in thousands)\nSee notes to consolidated financial statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS THE LAMSON & SESSIONS CO. AND SUBSIDIARIES Three fiscal years ended December 30, 1995\nNOTE A--ACCOUNTING POLICIES\nORGANIZATION: The Company primarily is in one business segment and is engaged in the manufacture and distribution of a broad line of thermoplastic electrical, telecommunication and engineered sewer products. In addition, the Company distributes a wide variety of consumer electrical wiring devices. Products are sold primarily to national and regional electrical distributors, power utilities, regional Bell operating companies and other telecommunications providers, national and regional retailers, and government and private builders of sewer and drainage systems. Substantially all sales are made within North America. In 1995 and 1994, sales to a single customer totalled approximately 12% in each year. No customer exceeded 10% of net sales in 1993.\nFISCAL YEAR: The Company's fiscal year end is the Saturday closest to December 31.\nPRINCIPLES OF CONSOLIDATION AND PRESENTATION: The consolidated financial statements include the accounts of the Company and all domestic and foreign subsidiaries after elimination of significant intercompany items and transactions. Certain 1994 and 1993 items have been reclassified to conform with 1995 reporting classifications.\nINVENTORIES: Inventories are valued at the lower of first-in, first-out (FIFO) cost or market.\nPROPERTY AND DEPRECIATION: Property, plant and equipment are recorded at cost. For financial reporting purposes, depreciation and amortization are computed principally by the straight-line method over the estimated useful lives of the assets. Accelerated methods of depreciation are used for federal income tax purposes.\nINCOME TAXES: The Company accounts for income taxes using the provisions of Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes.\" Investment tax credits are recorded using the flow-through method.\nEARNINGS (LOSS) PER COMMON SHARE: Earnings (loss) per common share are based on the weighted average number of common shares and dilutive common share equivalents outstanding during the year.\nRESEARCH AND DEVELOPMENT COSTS: Research and development costs consist of company sponsored activities to develop new value-added products. Costs are expensed as incurred. R&D expenditures were $3,700,000, $3,400,000, and $3,200,000 in 1995, 1994 and 1993, respectively.\nADVERTISING EXPENDITURES: Advertising costs are expensed as incurred. Advertising expenditures were $3,200,000, $2,100,000, and $1,900,000 for 1995, 1994 and 1993, respectively.\nUSE OF ESTIMATES: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued THE LAMSON & SESSIONS CO. AND SUBSIDIARIES NOTE B--LONG-TERM DEBT Long-term debt consists of the following: (In thousands)\nThe Company's long-term $65,000,000 secured credit agreement was refinanced effective July 14, 1995. The agreement is secured by the Company's accounts receivable, inventory, and property, plant and equipment. The agreement consists of both term and revolving credit facilities with interest variable on both portions. The rate paid varies based on the Company's financial performance and the pricing option chosen. Borrowings under this agreement carry interest based on any of three pricing options (prime rate, LIBOR or commercial paper) plus the applicable spread. Interest is paid in accordance with the maturity of the pricing option selected. The term portion of this facility carried interest at 3.0% over the commercial paper rate (8.8%) at December 30, 1995 and requires quarterly principal payments of $750,000. The remaining revolving credit portion permits borrowings up to $50,000,000 at any time through December 31, 1999. The agreement provides for the payment of a commitment fee on the revolving line of credit of .375% per annum on the average daily unused commitment. In addition to amounts borrowed, letters of credit related to Industrial Revenue Bond financings and other contractual obligations total approximately $14,000,000 under the agreement.\nThe Company's 14% Senior Subordinated Notes were redeemed in full on December 1, 1995.\nThe Company's Industrial Revenue Bond financings include several issues due in annual installments from 1996 through 2023 with interest at variable rates ranging from 4% to 7.5%. The weighted average rate for these bonds in December 1995 was 5.4%. The Company maintains a letter of credit related to one of the Industrial Revenue Bonds for approximately $1,900,000 with a local bank. The Company's headquarter facility is subject to a mortgage payable in equal monthly installments through 2003 with interest at 8.625%.\nThe Company's credit agreements contain various restrictive covenants pertaining to maintenance of debt service, tangible net worth and certain other financial ratios.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued\nTHE LAMSON & SESSIONS CO. AND SUBSIDIARIES\nNOTE B--LONG-TERM DEBT--Continued\nThe aggregate minimum combined maturities of long-term debt for the years 1997 through 2000 are approximately $4,797,000, $4,041,000, $8,368,000 and $1,148,000, respectively, with $6,488,000 due thereafter.\nInterest expense includes $803,000, $850,000 and $767,000 for amortization of deferred financing cost in 1995, 1994 and 1993, respectively. Interest paid was $6,069,000, $6,847,000 and $8,229,000 in 1995, 1994 and 1993, respectively.\nRental expense related to operating leases was $3,470,000, $3,015,000 and $2,647,000 in 1995, 1994 and 1993, respectively. Aggregate future minimum payments related to operating leases with initial or remaining terms of one year or more for the years 1996 through 2000 and thereafter are $2,671,000, $1,790,000, $1,228,000, $686,000 and $622,000, respectively.\nNOTE C--DISCONTINUED OPERATIONS\nThe results of discontinued operations are reflected on a restated comparative basis as follows:\nDuring the first quarter of 1994, the Company entered into a definitive agreement to sell substantially all of the assets and certain liabilities (including prospective pension and benefit post-retirement obligations) of its Midland Steel Products Division for $16,430,000 resulting in a loss of $8,900,000 ($.67 per share) after related costs and expenses. Included in the loss on disposal is a curtailment loss of $1,140,000 related to net pension costs and a settlement gain of $650,000 related to post-retirement benefits other than pensions. The Company believes adequate provision has been made for all contractual obligations, environmental costs, and other obligations retained in the sale of the division. Included in 1994 and 1993 losses from operations is interest of $1,836,000 allocated on the basis of the Company's incremental borrowing rate applied on the net proceeds from the sale. The assets held for sale at the end of 1994 are comprised of land and building pending final resolution of certain contractual conditions. The sale of these assets was completed in the second quarter of 1995.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued\nTHE LAMSON & SESSIONS CO. AND SUBSIDIARIES\nNOTE D--PENSION PLANS\nThe Company sponsors defined benefit pension and defined contribution savings plans covering substantially all employees. Plans covering salaried employees provide benefits that are based on an employee's years of service and compensation during the five-year period prior to retirement. Plans covering hourly employees provide benefits of stated amounts for each year of service. The Company annually contributes amounts to the plans which are actuarially determined to provide sufficient assets to meet future benefit payment requirements.\nPension expense from continuing operations is comprised of the following:\nThe following table summarizes the funded status of the Company's defined benefit pension plans and the related amounts recognized in the Company's consolidated statement of financial position:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued\nTHE LAMSON & SESSIONS CO. AND SUBSIDIARIES\nNOTE D--PENSION PLANS--Continued\nAccrued expenses and other liabilities include the current portion of pension liabilities of $2,100,000 and $4,487,000 in 1995 and 1994, respectively. The discount rates used in determining pension expense were 8.0%, 7.25% and 8.5% in 1995, 1994 and 1993, respectively. The discount rates used for funded status information were 7.4% in 1995 and 8.0% in 1994. The change in the discount rate had the effect of increasing the accumulated benefit obligation by approximately $4,400,000. The long-term rates of return on assets used in determining the funded status information were 9.5% in 1995 and 1994. Plan assets consist primarily of fixed income and equity marketable securities, including Company securities with a fair market value at December 30, 1995 of $913,000. The salary progression assumption used in determining the funded status information was 5% in each year.\nNOTE E--POST-RETIREMENT BENEFITS OTHER THAN PENSIONS\nIn addition to providing pension benefits, the Company provides health care and life insurance benefits for certain of its retired employees. The Company accrues the estimated cost of retiree benefit payments, other than pensions, during the employees' active service period. The Company funds these benefit costs on a pay-as-you-go basis, with the retiree, in most instances, paying a portion of the costs.\nSummary information for the Company's plans is as follows:\nThe decrease in APBO is principally due to the reduction in the assumed health care cost trend rate. In addition, the Company remains contingently liable for post-retirement benefits of certain businesses previously sold.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued\nTHE LAMSON & SESSIONS CO. AND SUBSIDIARIES\nNOTE E--POST-RETIREMENT BENEFITS OTHER THAN PENSIONS--Continued\nThe components of periodic post-retirement benefit cost reflected in continuing operations are as follows:\nThe discount rate used in determining the APBO was 7.0% in 1995 and 7.5% in 1994. The assumed health care cost trend rate used in measuring the APBO was an average of 11% in 1995 and 14% in 1994, declining to an ultimate rate of 5.5% in 2007 and thereafter.\nIf the health care cost trend rate assumptions were increased by 1%, the APBO as of December 30, 1995 would increase by 7.5%. The effect of this change on periodic post-retirement benefit cost for 1995 would be an increase of 10.7%, or approximately $200,000.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued THE LAMSON & SESSIONS CO. AND SUBSIDIARIES\nNOTE F--LITIGATION\nThe Company is a party to various claims and matters of litigation incidental to the normal course of its business. Management believes that the final resolution of these matters will not have a material adverse effect on the Company's financial position.\nNOTE G--PREFERRED AND PREFERENCE STOCK\nThe Company has authorized 1,200,000 and 3,000,000 shares of Serial Preferred and Preference Stock, respectively, none of which is issued or outstanding at December 30, 1995.\nThe Company has reserved for issuance 200,000 shares of Cumulative Redeemable Serial Preference Stock, Series II, without par value, which is part of purchase rights related to each outstanding common share. None of these shares were issued in 1995 or 1994. The right associated with each common share entitles its holder to purchase from the Company or acquiring company, one one-hundredth of a share of preference stock at a price of $47 which is subject to adjustment. The rights become exercisable only if a person or group acquires beneficial ownership of 15% or more of the Company's common shares or takes certain other actions. In any such event, a 15% or more owner is prohibited from exercising the rights. When exercisable, the rights entitle each holder to purchase, according to the agreement, either the Company's common shares or stock in the acquiring entity worth twice the value of the then applicable purchase price. Under certain circumstances, the Company has the authority to exchange each right for one common share without payment required. Unless otherwise extended, the Company may redeem the rights in their entirety, at a price of one cent per right, at any time until the tenth calendar day following any public announcement that beneficial ownership of 15% or more has occurred in the Company's common shares, or upon certain other events, including Board of Directors approval of a merger. The rights expire on September 7, 1998.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued\nTHE LAMSON & SESSIONS CO. AND SUBSIDIARIES\nNOTE H--STOCK OPTIONS\nUnder the 1994 Nonemployee Directors Stock Option Plan, the Company is authorized to issue 60,000 non-qualified stock options. The options become exercisable one year after date of grant and expire at the end of ten years. Under the 1988 Incentive Equity Performance Plan, the Company is authorized to issue 1,150,000 incentive stock options (ISO's), non-qualified stock options, stock appreciation rights (SAR's), and restricted or deferred stock. Options generally become exercisable in part one year after date of grant and expire at the end of ten years. Options outstanding under the 1978 Non-Qualified Incentive Stock Option Plan have been granted for the purchase of common shares at prices ranging from $4.75 to $5.75 per share. No options are available for future grant under the 1978 Plan.\nA summary of the option transactions follows:\nAt December 30, 1995, there were 210,233 options available for future grant.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued\nTHE LAMSON & SESSIONS CO. AND SUBSIDIARIES\nNOTE I--INCOME TAXES\nA deferred federal tax benefit of $3,900,000 was recorded in the fourth quarter of 1995. There was no income tax expense or benefit recorded in 1994 or 1993. The Company has available net operating loss carryforwards totalling approximately $36,100,000 which expire in the years 2000 to 2008. The Company also has available general business tax credit carryforwards of $1,800,000 which expire through 2010, and alternative minimum tax credit carryforwards of approximately $900,000 which may be carried forward indefinitely.\nThe tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities are presented below:\nThe valuation allowance for net deferred tax assets decreased by $6,500,000. The reduction was the result of net changes in temporary differences and the reversal of $3,900,000 of valuation allowance based on improved operating results for 1995 and projected operating results for 1996.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued\nTHE LAMSON & SESSIONS CO. AND SUBSIDIARIES\nNOTE I -- INCOME TAXES -- Continued\nThe provision for income taxes is different than the amount computed using the applicable statutory federal income tax rate with the differences summarized below:\nIncome taxes paid in 1995 were $26,000. In 1994 and 1993, the Company received income tax refunds of $201,000 and $1,626,000, respectively.\nNOTE J--DISPOSITION OF BUSINESS\nDuring the fourth quarter, the Company sold its aerospace fastener business for approximately $11,700,000. Net sales for 1995 through the sale date and 1994 were $18,951,000 and $18,838,000, respectively. Operating results, corporate costs to prepare the business for sale, and anticipated future costs related to the business resulted in losses of approximately $3,000,000 in 1995 and $4,000,000 in 1994, respectively.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued\nTHE LAMSON & SESSIONS CO. AND SUBSIDIARIES\n(Dollars in thousands, except per share amounts)\nNOTE K--SUMMARY OF QUARTERLY RESULTS OF OPERATIONS--(UNAUDITED)\nPART IV\nThe Lamson & Sessions Co. and Subsidiaries\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES\n(In Thousands)\nREPORT OF INDEPENDENT AUDITORS\nBoard of Directors and Shareholders The Lamson & Sessions Co.\nWe have audited the accompanying consolidated statement of financial position of The Lamson & Sessions Co. and Subsidiaries as of December 30, 1995 and December 31, 1994, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three fiscal years in the period ended December 30, 1995. 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 The Lamson & Sessions Co. and Subsidiaries at December 30, 1995 and December 31, 1994, and the consolidated results of their operations and their cash flows for each of the three fiscal years in the period ended December 30, 1995, 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 Cleveland, Ohio January 18, 1996\nSTATEMENT OF MANAGEMENT'S RESPONSIBILITY ----------------------------------------\nWe have prepared the financial statements and other financial information contained in this Annual Report.\nThe management of Lamson & Sessions is primarily responsible for the integrity of this financial information. The financial statements were prepared in accordance with generally accepted accounting principles and necessarily include certain amounts based on management's reasonable best estimates and judgments, giving due consideration to materiality. Financial information contained elsewhere in this annual report is consistent with that contained in the financial statements.\nManagement is responsible for establishing and maintaining a system of internal control designed to provide reasonable assurance as to the integrity and reliability of financial reporting. The concept of reasonable assurance is based on the recognition that there are inherent limitations in all systems of internal control, and that the cost of such systems should not exceed the benefits to be derived therefrom.\nTo meet management's responsibility for financial reporting, we have established internal control systems which we believe are adequate to provide reasonable assurance that our assets are protected from loss. These systems produce data used for the preparation of published financial information and provide for appropriate reporting relationships and division of responsibility. All significant systems and controls are reviewed periodically by our internal auditors in order to ensure compliance, and by our independent auditors to support their audit work. It is management's policy to implement a high proportion of recommendations resulting from these reviews.\nThe Audit Committee of the Board of Directors, composed solely of outside directors, meets regularly with management, internal auditors, and our independent auditors to review accounting, auditing and financial matters. Both the independent auditors and the internal auditors have free access to the Audit Committee, with or without management, to discuss the scope and results of their audits and the adequacy of the system of internal controls.\n\/s\/ John B. Schulze - ------------------------------------- John B. Schulze Chairman of the Board, President and Chief Executive Officer\n\/s\/ James J. Abel - ------------------------------------- James J. Abel Executive Vice President, Secretary, Treasurer and Chief Financial Officer\nPART II\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) Directors\nThe information set forth under the caption \"Election of Directors\" in the Company's definitive proxy statement for its annual meeting of shareholders to be held April 26, 1996 is hereby incorporated by reference.\n(b) Executive Officers - See Part I\n(c) Compliance with Section 16 (a) of the Exchange Act.\nThe information set forth in the last paragraph under caption \"Election of Directors\" in the Company's definitive proxy statement for its annual meeting of shareholders to be held April 26, 1996 is hereby incorporated by reference.\nItem 11.","section_11":"Item 11. - EXECUTIVE COMPENSATION\nThe information set forth under the caption \"Executive Compensation\" in the Company's definitive proxy statement for its annual meeting of shareholders to be held April 26, 1996 is hereby incorporated by reference.\nItem 12.","section_12":"Item 12. - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information set forth under the captions \"Ownership of the Company's Common Shares,\" \"Election of Directors\" and \"Security Ownership of Management\" in the Company's definitive proxy statement for its annual meeting of shareholders to be held April 26, 1996 is hereby incorporated by reference.\nItem 13.","section_13":"Item 13. - CERTAIN RELATIONSHIPS AND RELATED TRANSACTION\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:\nConsolidated financial statements of The Lamson & Sessions Co. and Subsidiaries are included in Item 8 of this report:\n1. Financial Statements\nConsolidated Statement of Operations for Fiscal Years Ended 1995, 1994 and 1993.\nConsolidated Statement of Cash Flows for Fiscal Years Ended 1995, 1994 and 1993.\nConsolidated Statement of Financial Position at December 30, 1995 and December 31, 1994.\nConsolidated Statement of Shareholders' Equity for Fiscal Years Ended 1995, 1994 and 1993.\nNotes to Consolidated Financial Statements.\n2. Financial Statement Schedule\nSchedule II - Valuation and Qualifying Accounts and Reserves.\nAll other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and, therefore, have been omitted.\nExhibits - Management Contracts and Compensatory Plans are identified with an asterisk (*).\n3(a) Amended Articles of Incorporation of the Company (incorporated by reference to Exhibit 1 to the Company's Registration Statement on Form 8-A filed with the Securities and Exchange Commission on June 1, 1989).\n3(b) Amended Code of Regulations of the Company (incorporated by reference to Exhibit 3 (b) to the Company's Annual Report on Form 10-K for the year ended December 31, 1994).\n4(a) Specimen Certificate of Common Shares, without par value with Rights legend (incorporated by reference to Exhibit 3 to the Company's Registration Statement on Form 8-A filed with the Securities and Exchange Commission on June 1, 1989).\n4(e) Form of Rights Certificate (incorporated by reference to Exhibit 4(oo) to the Company's Registration Statement on Form 8-A filed with the Securities and Exchange Commission on August 25, 1988).\n4(g) Rights Agreement, amended and restated as of February 14, 1990, by and between the Company and National City Bank filed herewith.\n10(a) 1988 Incentive Equity Performance Plan (as amended on September 22, 1988, February 23, 1989, December 20, 1990 and April 24, 1992) (incorporated by reference to Exhibit 28 of the Company's Registration Statement, on Form S-8 and Form S-3 (Registration No. 33-54732) filed with the Securities and Exchange Commission on November 20, 1992).\n* 10(b) Form of Three-Year Employment Agreement between the Company and certain executive officers filed herewith.\n* 10(c) Form of Two-Year Employment Agreement between the Company and certain executive officers (incorporated by reference to Exhibit 10(c) to the Company's Annual Report on Form 10-K for the year ended December 31, 1994).\n* 10(d) Corporate Officers Incentive Compensation Plan (incorporated by reference to Exhibit 10(d) to the Company's Annual Report on Form 10-K for the year ended December 31, 1994).\n* 10(e) Form of Amended and Restated Supplemental Executive Retirement Agreement dated as of March 20, 1990 between the Company and certain of its executive officers filed herewith.\n* 10(f) The Company's Deferred Compensation Plan for Nonemployee Directors filed herewith.\n* 10(g) Form of Indemnification Agreement between the Company and the Directors and certain officers (incorporated by reference to Exhibit 10(g) to the Company's Annual Report on Form 10-K for the year ended December 31, 1994).\n* 10(h) The Company's Long Term Incentive Plan (incorporated by reference to Exhibit 10(k) to the Company's Quarterly Report on Form 10-Q for the period ended September 30, 1991).\n* 10(j) Mortgage and Security Agreement, dated October 29, 1993, between The Lamson & Sessions Co. and PFL Life Insurance Company (incorporated herein by reference to Exhibit 10(j) to the Company's Annual Report on Form 10-K for the year ended January 1, 1994).\n10(k) Asset Purchase Agreement between Iochpe-Maxion Ohio, Inc. and The Lamson & Sessions Co. dated as of May 4, 1994 (incorporated by reference to Exhibit 10 to the Company's Current Report on Form 8-K dated as of May 27, 1994).\n10(s) Amended and Restated Loan Agreement dated as of July 14, 1995 by and between the Company and General Electric Capital Corporation (incorporated by reference to Exhibit 10(g) to the Company's Quarterly Report on Form 10-Q for the period ended July 1, 1995, the \"GECC Loan Agreement\").\n10(t) Amendment No. 1 dated as of October 30, 1995, to the GECC Loan Agreement, filed herewith.\n10(u) Amendment No. 2 and Consent dated as of November 8, 1995, to the GECC Loan Agreement, filed herewith.\n11 Computation of Earnings Per Common Share filed herewith.\n21 Subsidiaries of the Registrant filed herewith.\n23 Consent of Independent Accountants filed herewith.\n24 Powers of Attorney filed herewith.\n27 Financial Data Schedule (Submitted for the SEC's Information) filed herewith.\n(b) Reports on Form 8-K\nThere were no reports on Form 8-K filed for the three months ended December 30, 1995.\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 included in Item 8.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf of the undersigned, thereunto duly authorized, on this 11th day of March 1996.\nTHE LAMSON & SESSIONS CO.\nBy \/s\/ James J. Abel ----------------------------------- James J. Abel Executive Vice President, Secretary, Treasurer and Chief Financial Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated as of March 11, 1996.\nSignature Title --------- -----\n\/s\/ John B. Schulze Chairman of the Board, President - ----------------------------- and Chief Executive Officer (Principal John B. Schulze Executive Officer)\n\/s\/ James J. Abel Executive Vice President, Secretary, James - ----------------------------- Treasurer and Chief Financial Officer J. Abel (Principal Financial Officer and Principal Accounting Officer)\n\/s\/ Francis H. Beam, Jr.* Director - ----------------------------- Francis H. Beam, Jr.\n\/s\/ Leigh Carter* Director - ----------------------------- Leigh Carter\n\/s\/ Martin J. Cleary* Director - ----------------------------- Martin J. Cleary\n\/s\/ John C. Dannemiller* Director - ----------------------------- John C. Dannemiller\n\/s\/ George R. Hill* Director - ----------------------------- George R. Hill\n\/s\/ A. Malachi Mixon III* Director - ----------------------------- A. Malachi Mixon III\n\/s\/ Kevin O'Donnell* Director - ----------------------------- Kevin O'Donnell\n\/s\/ D. Van Skilling* Director - ----------------------------- D. Van Skilling\n* The undersigned, by signing his name hereto, does sign and execute this Annual Report on Form 10-K pursuant to a Power of Attorney executed on behalf of the above named directors of The Lamson & Sessions Co. and filed herewith as Exhibit 24 on behalf of The Lamson & Sessions Co. and each such person.\nMarch 11, 1996\nBy \/s\/ James J. Abel ------------------------------------- James J. Abel, Attorney-in-fact\nEXHIBIT INDEX\nEXHIBIT INDEX","section_15":""}
{"filename":"712771_1995.txt","cik":"712771","year":"1995","section_1":"ITEM 1 BUSINESS .................................................. 1\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2 - PROPERTIES\nThe Bank's operations are located at six sites in Union Township, one in Springfield Township, one in Berkeley Heights, Union County, New Jersey and a new site in Madison, Morris County, New Jersey to open in May. The principal office is located at 2455 Morris Avenue, Union, Union County, New Jersey. The principal office is a two story building constructed in 1993.\nAll but three of the nine locations are owned by the Bank. The lease of the Five Points Branch located at 356 Chestnut Street, Union, New Jersey expires November 30, 1997 and is subject to renewal at the Bank's option. The Career Center Branch located in Union High School expires December 31, 2002 and is also subject to renewal at the Bank's option and the lease of the Madison office located at 300 Main Street, Madison, New Jersey expires June 6, 2005 and is subject to renewal at the Bank's option. (See the back inside cover of the 1995 Annual Report for a complete listing of all branches and locations. The Drive In\/walk Up located at 2022 Stowe Street, Union, New Jersey is adjacent to a part of the Main Office facility.)\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\nThe Corporation had no matter submitted to a vote of security holders during the fourth quarter of 1995.\n29 March 96 Center Bancorp, Inc. Form 10-K Page 10\nITEM 4 A-EXECUTIVE OFFICERS\nThe following table sets forth the name and age of each executive officer of the Parent Company, the period during which each such person has served as an officer of the Parent Company or the Bank and each such person's business experience (including all positions with the Parent Company and the Bank) for the past five years:\nPART II\nITEM 5","section_5":"ITEM 5 - MARKET INFORMATION FOR THE REGISTRANT'S STOCK AND RELATED STOCKHOLDER MATTERS\nThe information required by Item 5 of Form 10-K appears on page 28 of the 1995 Annual Report and is incorporated herein by reference. As of December 31, 1995, there were 629 holders of record of the Parent Company's Common Stock.\nITEM 6","section_6":"ITEM 6 - SELECTED FINANCIAL DATA\nThe information required by Item 6 of Form 10-K appears on pages 10 - 11 of the 1995 Annual Report and is incorporated herein by reference.\nITEM 7","section_7":"ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe information required by Item 7 of Form 10-K appears on pages 13 - 29 of the 1995 Annual Report and is incorporated herein by reference.\nITEM 8","section_7A":"","section_8":"ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe information required by Item 8 of Form 10-K appears on pages 30 - 49 of the 1995 Annual Report and is incorporated herein by reference.\nITEM 9","section_9":"ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES\nNone\n29 March 96 Center Bancorp, Inc. Form 10-K Page 11\nPART III\nITEM 10","section_9A":"","section_9B":"","section_10":"ITEM 10 - DIRECTORS OF THE REGISTRANT\nThe Corporation responds to this item by incorporating herein by reference the material responsive to such item in the Corporation's definitive proxy statement for its 1996 Annual Meeting of Stockholders.\nITEM 11","section_11":"ITEM 11 - EXECUTIVE COMPENSATION\nThe Corporation responds to this item by incorporating herein by reference the material responsive to such item in the Corporation's definitive proxy statement for its 1996 Annual Meeting of Stockholders.\nITEM 12","section_12":"ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe Corporation responds to this item by incorporating herein by reference the material responsive to such item in the Corporation's definitive proxy statement for its 1996 Annual Meeting of Stockholders.\nITEM 13","section_13":"ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe Corporation responds to this item by incorporating herein by reference the material responsive to such item in the Corporation's definitive proxy statement for its 1996 Annual Meeting of Stockholders.\n29 March 96 Center Bancorp, Inc. Form 10-K Page 12\nPART IV\nITEM 14","section_14":"ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8 -K\nA1. Financial Statements\nA2. Financial Statement Schedules\nAll Schedules have been omitted as inapplicable, or not required, or because the required information is included in the Consolidated Financial Statements or the notes thereto.\nA3. Exhibits\n3.1 Certificate of Incorporation of the Registrant is incorporated by reference to Exhibit 3.1 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1992\n3.2 Bylaws of the Registrant is incorporated by reference to Exhibit 3.2 to the Registrant's Annual Report on Form 10-K for the year ended December 31,\n10.2 Employment agreement between the Registrant and John J. Davis.\n10.3 The Registrant Employee Stock Option Plan is incorporated by reference to exhibit 10.3 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993\n10.4 The Registrant Outside Director Stock Option Plan is incorporated by reference to exhibit 10.3 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993\n29 March 96 Center Bancorp, Inc. Form 10-K Page 13\n10.5 Supplemental Executive Retirement Plans (\"SERPS\") are incorporated by reference to exhibit 10.5 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994\n10.6 Executive Split Dollar Life Insurance Plan is incorporated by reference to exhibit 10.5 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994\n10.7 Employment agreement between the Registrant and Anthony Weagley, dated as of January 1, 1996.\n10.8 Agreement and Plan of Merger, by and between the Registrant and Lehigh Savings Bank, S.L.A., dated as of February 14, 1996, as amended.\n10.9 Inducement Agreement, dated February 14, 1996 by and between the Registrant and the trustee under a trust agreement applicable to the majority shareholder of Lehigh Savings Bank, S.L.A.\n11.1 Statement regarding computation of per share earnings is omitted because the computation can be clearly determined from the material incorporated by reference in this Report.\n13.1 Registrant's Annual Report to Shareholders for the year ended December 31, 1995 (parts not incorporated by reference are furnished for information purposes only and are not to be deemed to be filed herewith.)\n21.1 Subsidiaries of the Registrant is incorporated by reference to exhibit 22.1 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1992\n23.1 Consent of KPMG Peat Marwick LLP\n27.1 Financial Data Schedule\nB. Reports on Form 8-K\nThere were no reports on Form 8-K filed by the Registrant during the fourth quarter of 1995.\n29 March 96 Center Bancorp, Inc. Form 10-K Page 14\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Center Bancorp, Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nCENTER BANCORP, INC.\n\/s\/ JOHN J. DAVIS ------------------------------------- John J. Davis President and Chief Executive Officer\nDated March 30, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the date indicated above:\n\/s\/ CHARLES P. WOODWARD \/s\/ HUGO BARTH, III - ------------------------------------- -------------------------------- Charles P. Woodward, Hugo Barth, III Director and Chairman of the Board Director\n\/s\/ ROBERT L. BISCHOFF \/s\/ ALEXANDER BOL - ------------------------------------- -------------------------------- Robert L. Bischoff Alexander Bol Director Director\n\/s\/ BRENDA CURTIS \/s\/ DONALD G. KEIN - ------------------------------------- -------------------------------- Brenda Curtis Donald G. Kein Director Director\n\/s\/ JOHN J. DAVIS \/s\/ HERBERT SCHILLER - ------------------------------------- -------------------------------- John J. Davis Herbert Schiller President and Chief Executive officer Director\n\/s\/ PAUL LOMAKIN, JR. \/s\/ STAN R. SOMMER - ------------------------------------- -------------------------------- Paul Lomakin, Jr. Stan R. Sommer Director Director\n\/s\/ WILLIAM THOMPSON \/s\/ ANTHONY C. WEAGLEY - ------------------------------------- -------------------------------- William Thompson Anthony C. Weagley Director Treasurer (Chief Accounting and Financial Officer)","section_15":""}
{"filename":"316769_1995.txt","cik":"316769","year":"1995","section_1":"Item 1. BUSINESS -------- GENERAL\nFirst Commercial Corporation (\"Registrant\" or the \"Company\") was created through a merger of Commercial Bankstock, Inc., and First National Bancshares, Inc., on July 31, 1983. The Company is the largest multi-bank holding company headquartered in Arkansas with its corporate offices located in the capital city of Little Rock. The Company offers a broad range of bank and bank-related services through its bank and nonbank subsidiaries and affiliates.\nThe Company provides service to its subsidiary banks in such areas as audit, loan review, credit administration, compliance, data processing, investment portfolio management, asset and liability management, human resources and training.\nCommercial Banking Subsidiaries - -------------------------------\nThe Company's principal source of income is derived from twenty-five commercial banking institutions. The Company directly owns thirteen institutions in the state of Arkansas, one institution in the state of Tennessee, one institution in the state of Louisiana, and in a joint venture with Arvest Bank Group, Inc., of Bentonville, Arkansas, the Company owns 50% of an institution in Norman, Oklahoma. The Company also owns a second-tier bank holding company, State First Financial Corporation, headquartered in Texarkana, Arkansas. State First Financial Corporation owns two institutions in the state of Arkansas and seven institutions in the state of Texas. All of the Company's bank subsidiaries offer a broad range of traditional commercial and consumer banking services to the markets and communities which they serve. Certain subsidiary banks additionally offer trust and fiduciary services and brokerage services.\nNonbank Subsidiaries and Affiliates - -----------------------------------\nFirst Commercial Mortgage Company offers mortgage financing throughout Arkansas and in Memphis, Tennessee, East Texas, Oklahoma, California and Mississippi, and conducts mortgage servicing on a nationwide basis. First Commercial Capital Management is an investment advisor and money manager for individuals, employee benefit plans, endowments, foundations and other funds. First Commercial Trust Company, N.A., provides a full range of personal trust, employee benefit, and corporate and public securities administrative services. First Commercial Investments, Inc., is a full service investment company which buys and sells stocks, bonds, U.S. Government securities, fixed and variable annuities, and municipal securities on behalf of its clients. Financial Fleet Services, Inc., is an equipment leasing company located in Little Rock, Arkansas, which serves customers throughout the United States. Commercial Capital Funding, Inc., is a factoring company headquartered in Dallas, Texas, which specializes in accounts receivable financing in all affiliate markets. The income and other operating results of the nonbank subsidiaries and affiliates as compared to the consolidated results of the Company are not substantial enough to require financial and other information concerning industry segments to be included in this Annual Report on Form 10-K.\nRecent Acquisitions - -------------------\nOn November 30, 1995, the Company acquired all the outstanding common stock of FDH Bancshares, Inc., in exchange for 1,349,215 Company common shares, restated for the 7% stock dividend declared November, 1995. FDH Bancshares, Inc., which was merged into the Company, was the parent company of Citizens First Bank, Little Rock, Arkansas; Citizens First Bank, El Dorado, Arkansas; Citizens First Bank, Fordyce, Arkansas; Citizens First Bank, Arkadelphia, Arkansas; and Springhill Bancshares, Inc., parent company of Springhill Bank & Trust Company, Springhill, Louisiana. FDH Bancshares, Inc., had approximately $375 million in assets, $206 million in loans, and $330 million in deposits. This transaction was accounted for as a purchase, and accordingly, the results of operations were consolidated with those of the Company from the date of acquisition. The assets and liabilities of FDH Bancshares, Inc., were adjusted to fair value at the purchase date, resulting in an excess cost over fair value of $14.7 million. Citizens First Bank, Little Rock, Arkansas, was merged into the Company's Little Rock bank affiliate, First Commercial Bank, N.A.\nOn November 30, 1995, the Company acquired all of the outstanding common stock of West-Ark Bancshares, Inc., Clarksville, Arkansas, parent company of Arkansas State Bank, in exchange for 689,106 Company common shares, restated for the 7% stock dividend declared November, 1995. This transaction was accounted for as a pooling-of-interests. The results of West-Ark Bancshares, Inc., are included in the consolidated financial statements for 1995, however, prior period financial data has not been restated due to immateriality. West- Ark Bancshares, Inc., had approximately $159 million in assets, $107 million in loans, and $146 million in deposits.\nForeign Operations - ------------------\nNeither the Company nor any of its subsidiary banks conducts foreign operations. Balances maintained in foreign countries amounted to $248,000 at December 31, 1995. There are no loans to foreign corporations, banks, financial institutions, governments, consumers or businesses, or involving real estate in a foreign country, nor does the Company hold any deposits from banks in foreign countries, or from foreign governments, official institutions, central banks or international institutions.\nCompetition - -----------\nThe activities engaged in by the Company and its subsidiaries are intensely competitive, and the Company competes for business with other financial services organizations, including other commercial banks, savings and loan associations, credit unions, brokerage firms, mortgage companies, leasing companies, finance companies, and a variety of financial services and advisory companies.\nThe Company's subsidiary banks actively compete with other banks and financial institutions in their efforts to obtain deposits and make loans. The principal areas of competition in the commercial banking industry are in the scope and type of services offered and in interest rates paid on interest- bearing and time deposits and charged on loans. Competition with other financial institutions is expected to increase, especially with the passage of\nthe Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, which authorizes interstate banking and is discussed below in greater detail.\nAccording to information obtained from the Arkansas Bankers Association, during 1995 there were approximately 29 multi-bank holding companies in Arkansas and approximately 104 additional single-bank holding companies. As of December 31, 1995, the Company was the largest multi-bank holding company headquartered in Arkansas with $5.4 billion in total assets and $4.6 billion in total deposits.\nEmployees - ---------\nAs of December 31, 1995, the Company and its subsidiaries and affiliates had a total of 2,724 full-time equivalent employees.\nREGULATION AND SUPERVISION\nRegulation and Supervision of Bank Holding Companies: - -----------------------------------------------------\nThe following summaries of statutes and regulations affecting bank holding companies do not purport to be complete. The summaries are qualified in their entirety by reference to the provisions of the statutes and regulations summarized.\nBank Holding Company Act of 1956, as Amended:\nThe Company is a bank holding company within the meaning of the Bank Holding Company Act of 1956, as amended (the \"Act\"), and is registered as such with the Board of Governors of the Federal Reserve System (the \"Board of Governors\".) As a bank holding company, the Company is required to file with the Board of Governors an annual report and such additional information as the Board of Governors may require pursuant to the Act. The Board of Governors may also make examination of the Company and each of its subsidiaries. The Act requires each bank holding company to obtain prior approval of the Board of Governors before it may acquire substantially all of the assets of any bank, or ownership or control of any voting shares of any bank, if, after such acquisition, it would own or control directly or indirectly, more than 5% of the voting shares of such bank. In no case, however, may the Board of Governors approve the acquisition by the Company of the voting shares of, or substantially all of the assets of, any bank located outside of Arkansas unless such acquisition is specifically authorized by the statutes or laws of the state in which the bank to be acquired is located or unless such acquisition occurs as a result of foreclosure of a debt previously contracted.\nWith certain exceptions, the Act further restricts non-banking acquisitions by registered bank holding companies to shares of companies whose activities the Board of Governors deems to be so closely related to banking, or managing or controlling banks, as to be proper incident thereto. In making such determinations, the Board of Governors is required to consider whether the performance of such activities by an affiliate can reasonably be expected to produce benefits to the public, such as increased competition or gains in efficiencies against the risk of possible adverse effects, such as undue concentration of resources, decreases in or unfair competition, conflicts of interest, or unsound banking practices.\nThe Board of Governors has determined by regulation that certain activities are permissible activities for bank holding companies and their affiliates, including making and servicing loans, operating an industrial loan institution, performing certain fiduciary functions, leasing real estate and personal property, making real estate and personal property appraisals, providing certain management consulting, investment and financial advice, acting as a futures commission merchant, performing certain data processing operations, acting as an insurance agent for certain types of insurance and underwriting credit life and disability insurance related to credit transactions within the particular holding company system, assisting tax preparation and planning, providing check guaranty services, operating a collection agency, operating a credit bureau, underwriting and dealing in government obligations and money market instruments, providing foreign exchange advisory services, arranging commercial real estate equity financing, promoting community development, handling money orders, savings bonds and travelers checks, providing securities brokerage, providing consumer financial counseling, operating savings associations, and providing courier services.\nUnder Section 106 of the 1970 amendments to the Act and regulations of the Board of Governors, a bank holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with any extensions of credit, or lease or sale of any property or the furnishing of such services.\nRisk-Based Capital Guidelines:\nIn January 1989, the Board of Governors issued final guidelines to implement what is commonly referred to as risk-based capital adequacy, whereby banking organizations with less risky asset bases will be allowed to maintain lower capital amounts to support these assets than those organizations having high-risk assets. The regulations currently require a risk-based capital ratio of 8%. The Company's December 31, 1995, risk-based capital ratio was 12.14%.\nFederal Reserve Act:\nUnder the Federal Reserve Act the Board of Governors has cease and desist powers over parent holding companies and nonbanking subsidiaries when actions of such holding companies and nonbanking subsidiaries would constitute a serious threat to the safety, soundness or stability of a subsidiary bank. The Board of Governors also has the authority to regulate debt obligations, other than commercial paper, issued by bank holding companies.\nThe Company is an \"affiliate\" of its subsidiary banking institutions and will be an \"affiliate\" of any other acquired banks within the meaning of the Federal Reserve Act. The Federal Reserve Act imposes certain restrictions on (i) loans by a subsidiary bank to its bank holding company or to any other affiliated companies, (ii) investments by a subsidiary bank in the stock or other securities of its bank holding company, and (iii) the use of stock or securities of the bank holding company as collateral for loans by a subsidiary bank to any borrower.\nThe Company is also subject to certain restrictions with respect to engaging in the business of issuing, floatation, underwriting, public sale, and distribution of securities.\nArkansas Regulation:\nIn addition to regulation by the Board of Governors, bank holding companies in Arkansas are subject to regulation by the State Bank Commissioner. Accordingly, regular examinations are performed and the filing of certain reports is required.\nIn 1983, the Arkansas Legislature passed legislation specifically authorizing the ownership of more than one bank by a bank holding company, subject to certain restrictions and conditions. Generally, such legislation permits multi-bank holding companies if: (i) all banks controlled by the bank holding company were chartered pursuant to an application filed before December 31, 1982, or were in existence for ten years, and (ii) all banks owned or controlled by the bank holding company have, in the aggregate, 10% or less of the total deposits held by all state and national banks having their principal offices within the State of Arkansas. The 10% restriction was modified to 12% effective June 30, 1984, and to 15% effective December 31, 1984. In 1993, the Arkansas Legislature increased the deposit limit to 25% of the total deposits held by all state and national banks having their principal offices within the State of Arkansas.\nIn 1988, the Arkansas Legislature enacted legislation making significant changes to Arkansas' interstate banking and branching laws. As of January 1, 1989, bank acquisitions between banks in Arkansas and banks in states within the Southern Regional Compact, which have reciprocal banking laws, are permitted. Arkansas banks acquired under the law must have been in existence for at least ten years. Under such legislation, branches could be located anywhere within the county of a bank's principal banking office. After December 31, 1993, branches could be established in contiguous counties to the county in which the principal office is located. After December 31, 1998, branches may be located anywhere in the state. A subparagraph to Arkansas Thrift Branching Legislation was enacted to apply the same branching restrictions to Arkansas thrifts.\nArkansas Usury Law:\nThe Arkansas usury law, which applies to all of the Company's Arkansas affiliates, currently limits interest rates on all credit classifications, other than single-family mortgages, to the lesser of 17% or the Federal Reserve Bank of St. Louis's discount rate plus 5%.\nTexas Regulation:\nThe Texas Banking Act permits an \"out-of-state\" bank holding company to acquire control of a bank located in the State of Texas, if such bank received a charter and was continually operated for at least five years prior to the acquisition, and subjects the \"out-of-state\" bank holding company to the supervision and regulation by the Banking Department of Texas.\nUnder the Texas Banking Act, a bank holding company cannot control more than 20% of the total deposits of all state and national banks domiciled in the State of Texas.\nGovernment Monetary Policy and Economic Controls:\nIn addition to the effect of general economic conditions, the earnings of the Company's subsidiary banks are affected by the fiscal and monetary policies of the Federal Reserve System, which attempts to regulate the national money supply so as to mitigate recessionary and inflationary pressures. The techniques used by the Federal Reserve System include setting the reserve requirements for banks and establishing the discount rate on banks' borrowings. The Federal Reserve System also conducts open market operations in United States government securities.\nThe policies of the Federal Reserve System have a direct effect on the amount of bank loans and deposits and the interest rates charged and paid thereon. The impact upon the future business and earnings of the subsidiary banks of current economic problems and policies of the Federal Reserve System, and other regulatory authorities designed to deal with these problems cannot be accurately predicted; however, such economic problems and policies can materially affect the revenues and net income of commercial banks.\nOther Regulatory Developments:\nOn August 9, 1989, the Financial Institutions Reform Recovery and Enforcement Act of 1989 (\"FIRREA\") was enacted. FIRREA provided $125 billion to liquidate insolvent savings and loan institutions and transferred savings and loan insurance coverage to the Federal Deposit Insurance Corporation (the \"FDIC\"). To facilitate this transfer, two separate funds were created under the FDIC (the Bank Insurance Fund and the Savings Association Insurance Fund). The primary effects of FIRREA on the Company are that (i) banking concerns are now allowed to acquire savings and loans and (ii) FDIC insurance premiums have increased significantly.\nIn December, 1991, the FDIC Improvement Act of 1991 (\"FDICIA\") was enacted. FDICIA contains numerous provisions increasing regulatory review of depository institutions' operations. The increased regulations include annual examinations by the depository institution's primary regulator and mandatory independent audits for all depository institutions with assets of $500 million or more. In addition, the institutions must establish independent audit committees composed solely of outside directors.\nEffective December 16, 1992, final rules regarding FDICIA's establishment of five capital levels, ranging from \"well capitalized\" to \"critically undercapitalized\" were adopted. If an institution's capital level falls below \"well capitalized,\" it becomes subject to increasing regulatory oversight and restrictions on banking activities. These regulations and restrictions increase at each lower capital level. In addition, FDIC insurance premiums are now, in part, based upon an institution's capital level. A financial institution is considered \"well capitalized\" if it is under no regulatory order or action and its leverage ratio is at least 5% and its Tier I and Total Risk- Based Capital ratios are at least 6% and 10%, respectively. The Company is considered \"well capitalized,\" as defined, with a leverage ratio of 7.31%, a Tier I Capital ratio of 11.31% and a Total Risk-Based Capital ratio of 12.14% at December 31, 1995.\nIn 1994, the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the \"Interstate Act\") was enacted. The Interstate Act addresses in distinct provisions four principal areas of interstate banking and branching activity: (i)interstate bank holding company acquisitions commencing one year after enactment; (ii) interstate bank mergers commencing June 1, 1997, except where the state has enacted a law opting-out of interstate bank mergers; (iii) de novo interstate bank branching commencing upon enactment; and (iv) interstate bank agency commencing one year after enactment. The Company believes enactment of the Interstate Act will result in a more common sense approach for banking consolidation and will benefit the Company's corporate strategy of expanding services to customers in its region.\nRegulation and Supervision of Subsidiary Banks: - -----------------------------------------------\nThe national bank subsidiaries of the Company are subject to regulation and supervision by the Office of the Comptroller of the Currency. The state bank subsidiaries of the Company that are located in the State of Arkansas are subject to regulation and supervision, including regular bank examinations, by the Arkansas State Bank Department. The state bank subsidiary of the Company that is located in the State of Louisiana is subject to regulation and supervision, including regular bank examinations, by the Louisiana Office of Financial Institutions. The Company and its subsidiaries are also subject to examinations and regulation by the Federal Reserve System under the provision of the Bank Holding Company Act of 1956, as amended.\nAll of the Company's subsidiary banks are members of the FDIC, which currently insures the deposits of each member bank up to a maximum of $100,000 per deposit relationship. For this protection, each bank pays a semi-annual statutory assessment and is subject to the rules and regulations of the FDIC and to examinations by the FDIC.\nEXECUTIVE OFFICERS OF THE COMPANY\nAs of December 31, 1995, the principal executive officers of the Company were as follows:\nJames R. Cobb, 54, serves as Chairman of the Board of First Commercial Bank, N.A., Little Rock, Arkansas, a position he assumed in 1995. Mr. Cobb has been employed by the Company and\/or its subsidiaries in various capacities since 1973.\nBill I. Crutchfield, 52, serves as Chairman, President and Chief Executive Officer of State First National Bank, Texarkana, Texas, a position he has held since 1987, and Executive Vice President of State First Financial Corporation, a position he assumed in 1994. Mr. Crutchfield has been associated with State First National Bank, Texarkana, Texas, and State First Financial Corporation, which were acquired by the Company in 1994, since 1979.\nJack Fleischauer, Jr., 47, serves as President and Chief Executive Officer of First Commercial Bank, N.A., Little Rock, Arkansas, which positions he assumed in May 1994. Prior to joining the Company, Mr. Fleischauer served as President and Chief Operating Officer of Worthen National Bank, Little Rock, Arkansas, lead bank for Worthen Banking Corporation, which position he assumed in 1991. Mr . Fleischauer joined the Company with over twenty years of banking experience.\nBarnett Grace, 51, serves as Chairman of the Board, President and Chief Executive Officer of the Company. Mr. Grace has been employed by the Company and\/or its subsidiaries since 1972. Mr. Grace assumed the position of President of the Company in 1988 and Chairman of the Board and Chief Executive Officer of the Company in 1990.\nEdwin P. Henry, 58, serves as Executive Vice President of the Company. Mr. Henry also serves as Executive Vice President of First Commercial Bank, N.A., Little Rock, Arkansas, and Chairman of the Affiliate Bank Management Group. Additionally, he serves as a director on several boards of directors of affiliate banks. Mr. Henry has been associated with the Company and\/or its subsidiaries since 1962.\nJ. French Hill, 39, serves as Executive Officer of the Company. Mr. Hill's areas of responsibility include Trust, Investment Banking and Bank Brokerage. Prior to joining the Company in March 1993, Mr. Hill served as a U.S. Treasury official and Special Assistant to President George Bush.\nClarence E. Hoover, 53, serves as Executive Officer of Operations and Management Information Services. Prior to joining the Company in December 1991, Mr. Hoover was employed with banking institutions in Virginia and Tennessee and possessed over thirty years of banking experience.\nDouglas Jackson, 58, serves as Senior Credit Officer of State First Financial Corporation. Mr. Jackson has been associated with the Company and\/or its subsidiaries since 1987.\nNeil S. West, 50, serves as President and Chief Executive Officer of State First Financial Corporation, a second-tier bank holding company consisting of nine banks in Arkansas and Texas, a position he assumed in May 1994. Mr. West also serves as Executive Officer of the Company with responsibility for the Company's Credit Administration Division, a position he assumed in August 1995.\nMr. West has been associated with the Company and\/or its subsidiaries since 1987, when he joined the Company with over fifteen years of banking experience.\nJ. Lynn Wright, 33, serves as Chief Financial Officer of the Company. Mr. Wright joined the Company in 1984 and served in various capacities with the Company's Finance Division before assuming his current position in July 1992.\nSTATISTICAL DISCLOSURE\nThe information required by Guide 3, \"Statistical Disclosure by Bank Holding Companies\", is contained in the Company's 1995 Annual Report on pages 13 through 29, which information is incorporated herein by reference.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES ----------\nThe principal offices of the Company and the following affiliates, First Commercial Bank, N.A., First Commercial Mortgage Company, First Commercial Trust Company, N.A., First Commercial Investments, Inc., and Financial Fleet Services, Inc., are located in the First Commercial Building at 400 West Capitol Avenue in downtown Little Rock, Arkansas. The Company and its affiliates lease approximately 226,000 combined square feet of space. The office space is held under long-term leases from First Commercial, Inc., a wholly owned subsidiary of First Commercial Bank, N.A.\nThe Company and its banking subsidiaries and affiliates maintain 131 banking locations throughout the States of Arkansas, Texas, Tennessee, Louisiana and Oklahoma. The majority of these offices are owned by the respective subsidiary and affiliate banks.\nFor information regarding lease commitments, See Note 15, Commitments and Contingencies, of the Notes to the Consolidated Financial Statements in the Company's 1995 Annual Report, which note is incorporated herein by reference.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS -----------------\nAEARTH DEVELOPMENT, INC., v. FIRST COMMERCIAL BANK, N.A. - -------------------------------------------------------- First Commercial Bank, N.A., a wholly owned subsidiary of Registrant, has been the defendant in litigation initiated in 1989 seeking approximately $200,000,000 in compensatory damages plus punitive damages. Plaintiffs in the litigation alleged fraudulent conspiracy, fraudulent misrepresentation, tortious interference with a business expectancy, breach of contract, willful breach of fiduciary duty, interference with performance of contract, securities law violations, conversion, prima facie tort and violations of the Federal Racketeer Influenced and Corrupt Organizations Act as a basis for trebled damages. In June of 1991, the matter was tried before a chancery judge in Chancery Court in Pulaski County, Arkansas, and on June 5, 1992, the complaint was dismissed and no damages were assessed against First Commercial Bank, N.A. Plaintiffs appealed this decision to the Supreme Court of Arkansas in July of 1992 alleging error for failure to try the case before a jury in Circuit Court. On July 18, 1994, the Supreme Court of Arkansas remanded the case to Circuit Court in Pulaski County, Arkansas, for jury trial. A jury trial was held, which concluded March 13, 1996, with the jury awarding plaintiffs a total of\n$12.5 million compensatory damages and $10.0 million punitive damages. The trial court has not yet entered a judgment on the verdict, but management of the Company and First Commercial Bank, N.A., intend to vigorously pursue an appeal of any judgment not in favor of First Commercial Bank, N.A. The ultimate legal and financial liability of the Company in connection with this matter cannot be estimated with certainty, but management, based on the advice of legal counsel that any judgment entered on the verdict will be reversed and dismissed in whole or in part or a new trial ordered in whole or in part, believes that the impact of this matter will not have a materially adverse effect on the Company's financial position. However, if any substantial loss were to occur as a result of this litigation it could have a material adverse impact upon results of operations in the fiscal quarter or year in which it were to be incurred, but the Company cannot estimate the range of any reasonably possible loss.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ---------------------------------------------------\nNo information is required in response to this Item as no matters were submitted to a vote of Registrant'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 STOCK AND RELATED STOCKHOLDER ------------------------------------------------------------ MATTERS -------\nThe information required by Item 201 of Regulation S-K is contained in the Management's Discussion & Analysis Section of the Company's 1995 Annual Report under the heading \"Dividend Policy\", which information is incorporated herein by reference.\nFor information on dividend restrictions see Note 4, Pledged Assets and Regulatory Restrictions, and Note 10, Long-term Debt, of the Notes to Consolidated Financial Statements in the Company's 1995 Annual Report, which notes are incorporated herein by reference.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA -----------------------\nThe information required by Item 301 of Regulation S-K is contained in the Management's Discussion & Analysis Section of the Company's 1995 Annual Report under the heading \"Six-Year Financial Summary\", which information is incorporated herein by reference.\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND --------------------------------------------------------------- RESULTS OF OPERATIONS ---------------------\nThe information required by Item 303 of Regulation S-K is contained in the Company's 1995 Annual Report on pages 13 through 29, which information is incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA -------------------------------------------\nThe information required by this Item and by Item 302 of Regulation S-K is contained in the Company's 1995 Annual Report on pages 30 through 52 and in the Management's Discussion & Analysis Section under the heading \"Selected Quarterly Operating Results\", respectively, which information is incorporated herein by reference.\nItem 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND --------------------------------------------------------------- FINANCIAL DISCLOSURE --------------------\nNo information is required in response to this Item.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT --------------------------------------------------\nThe information required by Item 401 of Regulation S-K is contained in the Company's 1996 Proxy Statement under the headings \"Election of Directors\" and \"Other Information\" on pages 3 through 6, which information is incorporated herein by reference. The information required by Item 405 of Regulation S-K is contained in the Company's 1996 Proxy Statement under the heading \"Compliance with Section 16(a) of the Securities Exchange Act of 1934\" on page 13, which information is incorporated herein by reference.\nThe information concerning the executive officers of the Registrant is contained in Part I, Item 1, of this report under the caption \"Executive Officers of the Company.\"\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION ----------------------\nThe information required by Item 402 of Regulation S-K is contained in the Company's 1996 Proxy Statement under the headings \"Compensation of Directors and Executive Officers,\" \"First Commercial Corporation's 1995 Compensation Committee Report on Executive Compensation,\" and \"Stock Performance Chart\" on pages 7 through 12, which information is incorporated herein by reference.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT --------------------------------------------------------------\nThe information required by Item 403 of Regulation S-K is contained in the Company's 1996 Proxy Statement under the headings \"Principal Holders of Shares\" and \"Election of Directors\" on pages 2 through 6, which information is incorporated herein by reference.\nPART IV\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ----------------------------------------------\nThe information required by Item 404 of Regulation S-K is contained in the Company's 1996 Proxy Statement under the headings \"Compensation Committee Interlocks and Insider Participation\" and \"Transactions with Management and Others\" on pages 9 and 13, respectively, which information is incorporated herein by reference.\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 Number(*) --------- Reports of Management and Independent Auditors 30\nConsolidated Statements of Income for the Years Ended December 31, 1995, 1994 and 1993 31\nConsolidated Balance Sheets as of December 31, 1995 and 1994 32\nConsolidated Statements of Stockholders' Equity for the Years Ended December 31, 1995, 1994 and 1993 33\nConsolidated Statements of Cash Flows for the Years Ended December 31, 1995, 1994 and 1993 34\nNotes to Consolidated Financial Statements 35 - 52\n(*) Page numbers refer to the Company's 1995 Annual Report, which pages are incorporated herein by reference.\n(2) Financial Statement Schedules:\nAll schedules are omitted for the reasons that they are not required or are not applicable, or the required information is shown in the consolidated financial statements or the notes thereto.\n(3) Executive Compensation Plans and Arrangements:\n1987 Incentive and Non-Qualified Stock Option Plan, as amended (filed as Exhibit 10(a) hereto.)\nNon-Qualified Deferred Compensation Plan (filed as Exhibit 10(b) hereto.)\nSupplemental Executive Retirement Plan for C. Barnett Grace (filed as Exhibit 10(c) hereto.)\n(b) Reports on Form 8-K:\nDuring the period covered by this report, Registrant filed two reports on Form 8-K. A report dated November 30, 1995, as amended by a report on Form 8-K\/A filed January 30, 1996, disclosed under Item 5 that the Company had completed the acquisition of FDH Bancshares, Inc., and West-Ark Bancshares, Inc. In addition, the Company prepared pro forma financial statements reflecting the acquisitions and filed such information as Exhibit 99 to such report on Form 8-K. Another report on Form 8-K, dated March 13, 1996, was filed by the Company to disclose under Item 5 that a jury found against First Commercial Bank, N.A., a subsidiary of the Company, in a trial held in Circuit Court in Pulaski County, Arkansas.\n(c) Exhibits:\nThe exhibits required to be filed by Item 601 of Regulation S-K are submitted as a separate section of this report under the caption \"Index to Exhibits.\"\n(d) Financial Statement Schedules:\nNot applicable.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nFIRST COMMERCIAL CORPORATION\nBy: \/s\/ Barnett Grace ------------------------- Barnett Grace Chairman of the Board Date: March 28, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, 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\/ Barnett Grace Chairman of the Board, President, March 28, 1996 - ---------------------------- Chief Executive Officer and Barnett Grace Director (Principal Executive Officer)\n\/s\/ J. Lynn Wright Chief Financial Officer March 28, 1996 - ---------------------------- (Principal Financial and J. Lynn Wright Accounting Officer)\nDirector March 28, 1996 - ---------------------------- John W. Allison\nDirector March 28, 1996 - ---------------------------- Truman Arnold\n\/s\/ William H. Bowen Director March 28, 1996 - ---------------------------- William H. Bowen\nDirector March 28, 1996 - ---------------------------- Peggy Clark\n\/s\/ Robert G. Cress Director March 28, 1996 - ---------------------------- Robert G. Cress\n\/s\/ Cecil W. Cupp, Jr. Director March 28, 1996 - ---------------------------- Cecil W. Cupp. Jr.\nDirector March 28, 1996 - ---------------------------- Frank D. Hickingbotham\nDirector March 28, 1996 - ---------------------------- Walter E. Hussman, Jr.\n\/s\/ Frederick E. Joyce, M.D. Director March 28, 1996 - ---------------------------- Frederick E. Joyce, M.D.\nDirector March 28, 1996 - ---------------------------- Jack G. Justus\n\/s\/ William M. Lemley Director March 28, 1996 - ---------------------------- William M. Lemley\n\/s\/ Charles H. Murphy, Jr. Director March 28, 1996 - ---------------------------- Charles H. Murphy, Jr.\nDirector March 28, 1996 - ---------------------------- Michael W. Murphy\n\/s\/ William C. Nolan, Jr. Director March 28, 1996 - ---------------------------- William C. Nolan, Jr.\n\/s\/ Sam C. Sowell Director March 28, 1996 - ---------------------------- Sam C. Sowell\n\/s\/ Paul D. Tilley Director March 28, 1996 - ---------------------------- Paul D. Tilley\nIndex to Exhibits\nExhibit Number Exhibit - -------------- ---------------------------------------------------------- 3(a)* Company's Second Amended and Restated Articles of Incorporation, as amended (3.1 in 33-33529).\n3(b)* Articles of Amendment to the Company's Second Amended and Restated Articles of Incorporation, as amended (3 in Form 8-K dated September 18, 1990, in 0-9676).\n3(c)* Articles of Amendment to the Company's Second Amended and Restated Articles of Incorporation, as amended (4.3 in 33-39084).\n3(d)* Articles of Amendment to the Company's Second Amended and Restated Articles of Incorporation, as amended (3(I) in Form 10-Q for the quarter ended September 30, 1993, in 0-9676).\n3(e)* Company's Bylaws as currently in effect (3(d) in Form 10-K for the fiscal year ended December 31, 1991, in 0-9676).\n10(a)* 1987 Incentive and Non-Qualified Stock Option Plan, as amended (10(c) in Form 10-K for the fiscal year ended December 31, 1992, in 0-9676).\n10(b)* Non-Qualified Deferred Compensation Plan, as amended (10(b) in Form 10-K for the fiscal year ended December 31, 1994, in 0-9676).\n10(c) Supplemental Executive Retirement Plan for C. Barnett Grace\n11 Computation of Earnings per Common Share.\n13 Company's Annual Report to Shareholders for the fiscal year ended December 31, 1995.\n21 Subsidiaries of Registrant.\n23(a) Consent of Ernst & Young LLP.\n23(b) Consent of KPMG Peat Marwick LLP.\n23(c) Consent of Baird, Kurtz & Dobson LLP (to be filed by amendment.)\n27 Financial Data Schedule\n99(a) Report of KPMG Peat Marwick LLP.\n99(b) Annual Report on Form 11-K for Stock Purchase Plan for employees of First Commercial Corporation (to be filed by amendment.) - ---------- * Document has been previously filed with the Securities and Exchange Commission and is incorporated herein by reference. (Exhibit numbers and file numbers appear in parenthesis.)","section_15":""}
{"filename":"55458_1995.txt","cik":"55458","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"Item 3. Legal Proceedings\nKerr-McGee Chemical Corporation (KMCC), a wholly owned subsidiary of the company, has been informed by the Environmental Protection Agency (EPA) that it is one of several companies against whom a civil action may be filed for the recovery of remediation costs incurred by the EPA at the Bayou Bonfouca Superfund site located at Slidell, Louisiana. KMCC never owned nor operated the site, nor disposed of any waste at the site. It is alleged that a former wood-treating subsidiary of American Creosoting Corporation (ACC) had owned the site at one time, but ACC sold it in 1958. The company acquired ACC in 1964. The company and the government have entered into an agreement in principle regarding the company's obligations at this site, and the company has established a reserve.\nThe company continues its efforts to obtain the necessary approvals to decommission a facility located in West Chicago, Illinois, which processed thorium ores and was closed in 1973. Currently, the State of Illinois has jurisdiction of this site, and the company has agreed to offsite disposal of the waste material.\nFor a discussion of contingencies, including a detailed discussion of the West Chicago matter, reference is made to the Environmental Matters section of Management's Discussion and Analysis and Note 13 to the Consolidated Financial Statements in the 1995 Annual Report to Stockholders, which discussion and note are incorporated by reference in Item 7 and Item 8, respectively.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNone submitted during the fourth quarter of 1995.\nExecutive Officers of the Registrant\nThe following is a list of executive officers, their ages, and their positions and offices as of January 1, 1996:\nName Age Office\nFrank A. McPherson 62 Chairman of the Board and Chief Executive Officer since 1983.\nLuke R. Corbett 48 President and Chief Operating Officer since 1995. President of Kerr-McGee Coal Corporation since 1995. President of Kerr-McGee China Petroleum Ltd. since 1994. President of Kerr-McGee Canada Ltd. since 1989. President of Kerr- McGee Oil (U.K.) PLC since 1987. Group Vice President from 1992 until 1995. Senior Vice President from 1991 until 1992. Vice President, Oil and Gas Exploration from 1987 until 1991.\nWayne T. Ewing 62 Senior Vice President since 1995. Executive Vice President of Marketing for Kerr-McGee Coal Corporation from 1993 until 1995. Executive consultant from 1990 until 1993.\nGeorge R. Hennigan 60 Senior Vice President since 1991. President of Kerr-McGee Chemical Corporation since 1991. Executive Vice President, Kerr-McGee Chemical Corporation from 1984 until 1991.\nJohn C. Linehan 56 Senior Vice President and Chief Financial Officer since 1987.\nTom J. McDaniel 57 Senior Vice President since 1986 and Secretary since 1989.\nRobert C. Scharp 48 Senior Vice President since 1991. Senior Vice President, Production, Exploration and Production Division since 1995. President of Kerr-McGee Coal Corporation from 1991 until 1995. Vice President of Operations for Kerr- McGee Coal Corporation from 1990 until 1991.\nMichael G. Webb 48 Senior Vice President since 1993. Senior Vice President, Exploration, Exploration and Production Division since 1992. Vice President, Exploration from 1992 to 1993. Vice President, North American Onshore Exploration from 1991 until 1992. Exploration Manager, Kerr-McGee Canada Ltd. from 1988 until 1991.\nR. G. Horner, Jr. 56 Vice President and General Counsel since 1986.\nJ. Michael Rauh 46 Vice President and Controller since 1987.\nDonald F. Schiesz 58 Vice President, Safety and Environment since 1994. Senior Vice President of Kerr-McGee Chemical Corporation from 1991 until 1994. Vice President and General Manager of the Pigment Division for Kerr-McGee Chemical Corporation from 1984 until 1991.\nThomas B. Stephens 51 Vice President and Treasurer since 1985.\nJean B. Wallace 41 Vice President, Human Resources since 1989.\nDale E. Warfield 52 Vice President, General Administration since 1994. Vice President, Materials Management and Transportation from 1991 until 1994. Director of Purchasing and Materials Management from 1990 until 1991.\nThere is no family relationship between any of the executive officers.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters\nInformation relative to the market in which the company's common stock is traded, the high and low sales prices of the common stock by quarters for the past two years, and the approximate number of holders of common stock is furnished in Note 29 to the Consolidated Financial Statements in the 1995 Annual Report to Stockholders, which note is incorporated by reference in Item 8.\nQuarterly dividends declared totaled $1.55 per share for the year 1995 and $1.52 per share for each of the years 1994 and 1993. Cash dividends have been paid continuously since 1941 and totaled $79 million in 1995, $78 million in 1994, and $73 million in 1993.\nItem 6.","section_6":"Item 6. Selected Financial Data\nInformation regarding selected financial data required in this item is presented in the schedule captioned \"Six-Year Financial Summary\" in the 1995 Annual Report to Stockholders and is incorporated herein by reference.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\n\"Management's Discussion and Analysis\" in the 1995 Annual Report to Stockholders is incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe following financial statements and supplementary data included in the 1995 Annual Report to Stockholders are incorporated herein by reference:\nReport of Independent Public Accountants\nConsolidated Statement of Income\nConsolidated Statement of Retained Earnings\nConsolidated Balance Sheet\nConsolidated Statement of Cash Flows\nNotes to Financial Statements\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 -\nFor information required under this section, reference is made to the \"Election of Directors\" section of the company's proxy statement for 1996 made in connection with its Annual Stockholders' Meeting to be held on May 14, 1996.\n(b) Identification of executive officers -\nThe information required under this section is set forth in the caption \"Executive Officers of the Registrant\" on pages 22 and 23 of this Form 10-K pursuant to Instruction 3 to Item 401(b) of Regulation S-K and General Instruction G(3) to Form 10-K.\n(c) Compliance with Section 16(a) of the 1934 Act -\nFor information required under this section, reference is made to the \"Compliance with Section 16(a) of the Securities Exchange Act of 1934\" section of the company's proxy statement for 1996 made in connection with its Annual Stockholders' Meeting to be held on May 14, 1996.\nItem 11.","section_11":"Item 11. Executive Compensation\nFor information required under this section, reference is made to the \"Executive Compensation and Other Information\" section of the company's proxy statement for 1996 made in connection with its Annual Stockholders' Meeting to be held on May 14, 1996.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nFor information required under this section, reference is made to the \"Security Ownership\" portion of the \"Election of Directors\" section of the company's proxy statement for 1996 made in connection with its Annual Stockholders' Meeting to be held on May 14, 1996.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nFor information required under this section, reference is made to the \"Election of Directors\" and \"Certain Relationships and Related Transactions\" sections of the company's proxy statement for 1996 made in connection with its Annual Stockholders' Meeting to be held on May 14, 1996.\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 Kerr- McGee Corporation and its subsidiary companies, included in the company's 1995 Annual Report to Stockholders, are incorporated by reference in Item 8:\nReport of Independent Public Accountants\nConsolidated Statement of Income for the Years Ended December 31, 1995, 1994, and 1993\nConsolidated Statement of Retained Earnings for the Years Ended December 31, 1995, 1994, and 1993\nConsolidated Balance Sheet at December 31, 1995 and 1994\nConsolidated Statement of Cash Flows for the Years Ended December 31, 1995, 1994, and 1993\nNotes to Financial Statements\n(a) 2. Financial Statement Schedules -\nReport of Independent Public Accountants on Financial Statement Schedule\nSchedule II - Valuation Accounts and Reserves for the Years Ended December 31, 1995, 1994, and 1993\nSchedules I, III, IV, and V are omitted as the subject matter thereof is either not present or is not present in amounts sufficient to require submission of the schedules in accordance with instructions contained in Regulation S-X.\n(a) 3. Exhibits -\nExhibit No.\n3.1 Restated Certificate of Incorporation of Kerr-McGee Corporation, filed as Exhibit 3.1 to the report on Form 10-Q for the quarter ended June 30, 1987, and incorporated herein by reference.\n3.2 Bylaws of Kerr-McGee Corporation, as amended, filed as Exhibit 3(b) to the report on Form 10-K for the year ended December 31, 1986, and incorporated herein by reference.\n4.1 Amended and Restated Rights Agreement dated as of July 11, 1989, filed as Exhibit 1 to the report on Form 8-K dated July 13, 1989, and incorporated herein by reference.\n4.2 The company agrees to furnish to the Securities and Exchange Commission, upon request, copies of each of the following instruments defining the rights of the holders of certain long-term debt of the company: the Indenture dated as of June 1, 1976, between the company and Citibank, N.A., as trustee, relating to the company's 8-1\/2% Sinking Fund Debentures due June 1, 2006; the Indenture dated as of November 1, 1981, between the company and United States Trust Company of New York, as trustee, relating to the company's 7% Debentures due November 1, 2011; the Note Agreement dated as of November 29, 1989, among the Kerr-McGee Corporation Employee Stock Ownership Plan Trust (the Trust) and several lenders, providing for a loan guaranteed by the company of $125 million to the Trust; the Facilities Agreement dated March 3, 1991, providing for borrowings of up to $65 million through September 3, 1993, by National Titanium Dioxide Company Limited (Cristal), a Saudi Arabian limited liability company (owned 25% by a wholly owned subsidiary of the company), and several banks with 25% of the loans guaranteed on a several basis by a wholly owned subsidiary; the $325 million Credit Agreement dated as of August 25, 1994, providing for a five- year revolving credit facility with a bullet maturity on the fifth anniversary of the execution of the Credit Agreement; the Revolving Credit Agreement dated as of October 16, 1992, and the first amendment to the Credit Agreement dated as of December 21, 1994, among Kerr-McGee Corporation, Kerr-McGee Oil (U.K.) PLC, and several banks providing for revolving credit of up to $230 million through December 31, 1999; and the Revolving Credit Agreement dated as of February 24, 1995 between Kerr-McGee China Petroleum Ltd., as borrower, and Kerr-McGee Corporation, as guarantor, and several banks providing for revolving credit of up to $105 million through February 24, 1998. The total amount of securities authorized under each of such instruments does not exceed 10% of the total assets of the company and its subsidiaries on a consolidated basis.\n4.3 Kerr-McGee Corporation Direct Purchase and Dividend Reinvestment Plan filed on Form S-3 effective August 19, 1993, Registration No. 33-66112, and incorporated herein by reference.\n10.1* Deferred Compensation Plan for Non- Employee Directors as amended and restated effective October 1, 1990, filed as Exhibit 10(1) to the report filed on Form 10-K for the year ended December 31, 1990, and incorporated herein by reference.\n10.2* Kerr-McGee Corporation Stock Deferred Compensation Plan for Non-Employee Directors as amended and restated effective August 1, 1995.\n10.3* Description of the company's Annual Incentive Compensation Plan.\n10.4* The Long Term Incentive Program as amended and restated effective May 9, 1995, filed as Exhibit 4.2 on Form 10-Q for the quarter ended March 31, 1995, and incorporated herein by reference.\n10.5* Benefits Restoration Plan as amended and restated effective September 13, 1989, filed as Exhibit 10(6) to the report on Form 10-K for the year ended December 31, 1992, and incorporated herein by reference.\n10.6* Kerr-McGee Corporation Executive Deferred Compensation Plan as amended and restated effective January 1, 1996.\n10.7* Kerr-McGee Corporation Supplemental Executive Retirement Plan as amended and restated effective May 3, 1994, filed as Exhibit 10.8 on Form 10-K for the year ended December 31, 1994, and incorporated herein by reference.\n10.8* Amended and restated Agreement, restated as of December 31, 1992, between the company and Frank A. McPherson filed as Exhibit 10(9) on Form 10-K for the year ended December 31, 1992, and incorporated herein by reference.\n10.9* Amended and restated Agreement, restated as of December 31, 1992, between the company and John C. Linehan filed as Exhibit 10(10) on Form 10-K for the year ended December 31, 1992, and incorporated herein by reference.\n10.10* Amended and restated Agreement, restated as of December 31, 1992, between the company and Luke R. Corbett filed as Exhibit 10(11) on Form 10-K for the year ended December 31, 1992, and incorporated herein by reference.\n10.11* Amended and restated Agreement, restated as of December 31, 1992, between the company and Tom J. McDaniel filed as Exhibit 10.13 on Form 10-K for the year ended December 31, 1994, and incorporated herein by reference.\n10.12* Amended and restated Agreement, as of December 31, 1992, between the company and George R. Hennigan filed as Exhibit 10(13) on Form 10-K for the year ended December 31, 1993, and incorporated herein by reference.\n10.13* Form of agreement, amended and restated as of December 31, 1992, between the company and certain executive officers not named in the Summary Compensation Table contained in the company's definitive Proxy Statement for the 1995 Annual Meeting of Stockholders, filed as Exhibit 10(14) on Form 10-K for the year ended December 31, 1992, and incorporated herein by reference.\n12 Computations of ratio of earnings to fixed charges.\n13 1995 Annual Report to Stockholders.\n21 Subsidiaries of the Registrant.\n23 Consent of Arthur Andersen LLP.\n24 Powers of Attorney.\n27 Financial Data Schedule (electronic filing only).\n*These exhibits relate to the compensation plans and arrangements of the company.\n(b) Reports on Form 8-K -\nNo reports on Form 8-K were filed by the Registrant during the quarter ended December 31, 1995.\nReport of Independent Public Accountants On Financial Statement Schedule\nTo Kerr-McGee Corporation:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in Kerr- McGee Corporation's 1995 Annual Report to Stockholders incorporated by reference in this Form 10-K, and have issued our report thereon dated February 16, 1996. Our report on the consolidated financial statements includes an explanatory paragraph with respect to the adoption of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,\" in 1995 as discussed in Note 3 to the financial statements. Our audit was made for the purpose of forming an opinion on those statements taken as a whole. The Schedule of Valuation Accounts and Reserves is the responsibility of the company's management and is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic consolidated financial statements. This schedule has been subjected to the auditing procedures applied in the 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.\n(ARTHUR ANDERSEN LLP) ARTHUR ANDERSEN LLP\nOklahoma City, Oklahoma, February 16, 1996\nSCHEDULE II\nKERR-McGEE CORPORATION AND SUBSIDIARY COMPANIES VALUATION ACCOUNTS AND RESERVES\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nKERR-McGEE CORPORATION\nBy: Frank A. McPherson* Frank A. McPherson, Chairman of the Board and Chief Executive Officer\nMarch 29, 1996 By: (John C. Linehan) Date John C. Linehan, Senior Vice President and Chief Financial Officer\nBy: (J. Michael Rauh) J. Michael Rauh, Vice President and Controller and Chief Accounting Officer\n* By his signature set forth below, John C. Linehan has signed this Annual Report on Form 10-K as attorney-in-fact for the officer noted above, pursuant to power of attorney filed with the Securities and Exchange Commission.\nBy: (John C. Linehan) John C. Linehan\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.\nBy: Bennett E. Bidwell* Bennett E. Bidwell, Director\nBy: E. H. Clark, Jr.* E. H. Clark, Jr., Director\nBy: Luke R. Corbett* Luke R. Corbett, Director\nBy: Martin C. Jischke* Martin C. Jischke, Director\nBy: Robert S. Kerr, Jr.* Robert S. Kerr, Jr., Director\nMarch 29, 1996 By: Frank A. McPherson* Date Frank A. McPherson, Director\nBy: William C. Morris* William C. Morris, Director\nBy: John J. Murphy* John J. Murphy, Director\nBy: John J. Nevin* John J. Nevin, Director\nBy: Farah M. Walters* Farah M. Walters, Director\n* By his signature set forth below, John C. Linehan has signed this Annual Report on Form 10-K as attorney-in-fact for the directors noted above, pursuant to power of attorney filed with the Securities and Exchange Commission.\nBy: (John C. Linehan) John C. Linehan","section_15":""}
{"filename":"855042_1995.txt","cik":"855042","year":"1995","section_1":"ITEM 1. BUSINESS\nAmeriSource Health Corporation, through its direct wholly-owned subsidiary AmeriSource Corporation (referred to interchangeably as \"AmeriSource\" and the \"Company\"), is the fifth largest full-service wholesale distributor of pharmaceutical products and related health care services in the United States. The Company services its customers nationwide through 19 drug distribution facilities and one specialty products distribution facility. AmeriSource is typically the primary source of supply to its customers and offers a broad range of services designed to enhance the operating efficiencies and competitive position of its customers and suppliers. The Company benefits from a diverse customer base that includes hospitals and managed care facilities (47%), independent community pharmacies including retail drug stores, nursing homes and clinics (35%) and chain drug stores including pharmacy departments of supermarkets and mass merchandisers (18%).\nOver the past five years, AmeriSource has achieved significant growth in revenues and operating income before unusual items. The Company's revenues have increased from $2.5 billion in fiscal 1990 to $4.7 billion in fiscal 1995, a compound annual growth rate of 13.5%, while operating income before unusual items and amortization increased from $43.8 million in fiscal 1990 to $98.0 million in fiscal 1995, a compound annual growth rate of 17.5%. The Company's growth is primarily the result of market share gains in existing markets, geographic expansion and overall industry growth.\nAmeriSource Health Corporation was incorporated in Delaware in 1988. The address of the principal executive office of the Company is P.O. Box 959, Valley Forge, Pennsylvania 19482. The telephone number is (610) 296-4480.\nBUSINESS STRATEGY\nOver the past five years, AmeriSource has significantly expanded its national presence as a leading, innovative wholesale distributor of pharmaceutical products and related health care services. The Company believes it is well-positioned to continue its revenue growth and increase operating income through the execution of the following key elements of its business strategy:\n. Expanding into New Geographic Markets. The Company believes that there are substantial opportunities to grow by expanding into new geographic areas through opening new distribution facilities and making selective, complementary acquisitions. Since October 1993, the Company has opened six new distribution facilities. In October 1993, the Company opened a facility in Dallas, Texas, and in November 1994, the Company opened two additional facilities in Portland, Oregon and Springfield, Massachusetts. In June 1995 the Company opened a new facility in Sacramento, California and in October 1995, a new facility in Phoenix, Arizona was opened. On December 1, 1995, the Company opened its newest facility in Orlando, Florida. Each of these new facilities began operations with an existing customer base in its regional marketplace. In addition, in July 1995, the Company acquired Newbro Drug Company, a regional wholesale pharmaceutical distributor based in Idaho Falls, Idaho. The Company believes that as industry consolidation pressures continue, additional opportunities may arise to selectively acquire additional local and regional drug wholesale companies facilitating expansion into new geographic areas and enhancement of its competitive position in existing markets.\n. Increasing Market Share in Existing Markets. The Company believes that it is well positioned to continue to grow in its existing markets by: (i) providing superior distribution services and specialty value-added programs which reduce its customers' cost of operations; (ii) maintaining its low cost operating structure to ensure that the Company's services are priced competitively in the marketplace; (iii) continuing to focus on the higher growth hospital and managed care market segment through the use of dedicated facilities and advanced information systems; and (iv) maintaining its decentralized operating structure to respond to customers' needs more quickly and efficiently and to ensure the continued development of local and regional management talent. These factors have allowed AmeriSource to compete effectively in the marketplace, generate above-average industry sales growth over the last two years and develop new customers, such as the federal government. For example, over the past two years the Company\nhas been awarded contracts to provide approximately 75% of the pharmaceuticals purchased by federal government hospital facilities nationwide. In addition, the Company continues to grow with its existing customers. The Company was selected by VHA Inc. as one of its three primary providers and has been chosen as the preferred provider for SunHealth. Both customers are among the nation's largest healthcare providers.\n. Continuing Growth of Specialty Services. The Company works closely with both customers and suppliers to develop an extensive range of specialty services. In addition to enhancing the Company's profitability, these services increase customer loyalty and strengthen the Company's overall role in the healthcare distribution channel. These services include:\n--ECHO(TM), the Company's proprietary software system, provides sophisticated ordering and inventory management assistance to its hospital and retail customers. In addition to facilitating the primary supply arrangement between the Company and its customers, ECHO(TM) enables the Company's customers to reduce their costs through ordering more efficiently, selecting from best price alternatives and maintaining formulary compliance. In fiscal 1995, the Company acquired Liberty Drug Systems, a software developer based in Greensboro, North Carolina. The technology acquired with this acquisition is being combined with the ECHO(TM) system to provide customers with a complete system for tracking usage, reordering products and managing records. Since the introduction of ECHO(TM) in early fiscal 1991, the Company has installed approximately 3,000 systems nationwide, and believes that its installed base of systems is one of the largest in the wholesale drug industry.\n--Family Pharmacy(R) enables small chain and independent community pharmacies to compete more effectively through: (i) innovative advertising, marketing and promotional campaigns; (ii) value-added merchandising programs including private label product lines; and (iii) enhanced access to pharmaceutical benefit programs of large health care groups, including third party payor programs. Family Pharmacy(R) has grown dramatically in recent years. With approximately 2,000 Family Pharmacy(R) member-stores, Family Pharmacy(R) in effect constitutes one of the largest drugstore chains in the United States.\n--The Company's Income Rx(R) program provides an integral value-added service to its hospital and retail pharmacist customers by continually reviewing the marketplace for generic products that offer the best price, quality and availability. With the increasing importance of generic pharmaceuticals this program represents a significant opportunity for growth and profitability. Revenues attributable to AmeriSource's sale of generic and multi-source pharmaceuticals (including through the Income Rx(R) program) have increased to approximately $500 million in fiscal 1995, more than twice what they were in fiscal 1992.\n--AmeriSource operates a pharmaceutical repackaging business that markets products through its Income RePax(R) program. Repackaging pharmaceuticals from bulk quantities into smaller units provides the Company's customers with lower product, inventory and dispensing (labor) costs.\n--The Company's Health Services Plus business distributes oncology and other specialty products to clinics and physician groups on a national basis. Rita Ann Distributors markets cosmetics and fragrances to chain drugstores and independent retail customers.\n. Maintain Low Cost Operating Structure. AmeriSource has the lowest operating cost structure among its four major national competitors. Over the past five years, the Company has significantly reduced operating expenses and investment in net working capital as a percentage of revenues. Specifically, the Company has reduced its selling and administrative expenses and depreciation as a percentage of revenues from 4.78% in fiscal 1990 to 3.61% in fiscal 1995. In addition, the Company continues to achieve productivity and operating income gains from continued investments in advanced management information systems, warehouse automation technology, and from operating leverage due to above industry average volume per facility. In fiscal 1995, the Company's average revenue per facility was $246 million compared to a calendar 1994 industry average of $213 million. The addition of new facilities was accomplished with minimal incremental investment in corporate overhead. As these facilities continue to expand in their regional markets, the Company believes that its growth and profitability will be further enhanced.\nINDUSTRY OVERVIEW\nThe Company has benefited from the significant growth of the full-service drug wholesale industry in the United States. Industry sales grew from $30 billion in 1990 to an estimated $52 billion in 1994. The factors contributing to this growth, and the sources of future growth for the industry, include (i) an aging population, (ii) the introduction of new pharmaceuticals, (iii) the increased use of outpatient drug therapies, (iv) a higher concentration of distribution through wholesalers by both manufacturers and customers, and (v) rising pharmaceutical prices.\nAging Population. The number of individuals over age 65 in the United States has grown 23% from approximately 26 million in 1980 to approximately 32 million in 1990 and is projected to increase an additional 9% to more than 35 million by the year 2000. This age group suffers from a greater incidence of chronic illnesses and disabilities than the rest of the population and is estimated to account for approximately two-thirds of total health care expenditures in the United States.\nIntroduction of New Pharmaceuticals. Traditional research and development as well as the advent of new research and production methods, such as biotechnology, continue to generate new compounds that are more effective in treating diseases. These compounds have been responsible for significant increases in pharmaceutical sales. The Company believes that ongoing research and development expenditures by the leading pharmaceutical manufacturers will contribute to continued growth of the industry.\nCost Containment Efforts. In response to rising health care costs, governmental and private payors have adopted cost containment measures that encourage the use of efficient drug therapies to prevent or treat diseases. While national attention has been focused on the overall increase in aggregate health care costs, the Company believes drug therapy has had a beneficial impact on overall health care costs by reducing expensive surgeries and prolonged hospital stays. Pharmaceuticals currently account for less than 9% of overall healthcare costs, and manufacturers' emphasis on research and development is expected to continue the introduction of cost effective drug therapies.\nHigher Concentration of Distribution Through Wholesalers. Over the past decade, manufacturers of pharmaceuticals have significantly increased the distribution of their products through wholesalers as the cost and complexity of maintaining inventories and arranging for delivery of pharmaceutical products has risen. Drug wholesalers offer their customers and suppliers more efficient distribution and inventory management. As a result, from 1980 to 1994, the percentage of pharmaceutical sales through wholesale drug distributors increased from approximately 57% to approximately 78%. Order processing, inventory management and product delivery by wholesale drug distributors allow manufacturers to allocate their resources to research and development, manufacturing and marketing their products. Customers benefit from this shift by having a single source of supply for a full line of pharmaceutical products as well as lower inventory costs, more timely and efficient delivery, and improved purchasing and inventory information. In addition, customers also benefit from the range of value-added programs developed by wholesale drug distributors that are targeted to the specific needs of these customers, which, in turn, reduce their costs and increase their operating efficiencies.\nPharmaceutical Price Increases By Drug Manufacturers. The Company believes that price increases by pharmaceutical manufacturers will continue to equal or exceed the overall Consumer Price Index. The Company believes that this increase will be due in large part to the relatively inelastic demand in the face of higher prices charged for patented drugs as manufacturers have attempted to recoup costs associated with the development, clinical testing and Food and Drug Administration (\"FDA\") approval of new products.\nAt the same time that sales through the wholesale drug industry have grown, the number of pharmaceutical wholesalers in the United States has decreased from 139 at the end of 1980 to approximately 48 as of December 1995. Industry analysts expect this consolidation trend to continue, with the industry's largest companies increasing their percentage of total industry sales.\nOPERATIONS\nDecentralized Structure. The Company believes that operating economies of scale exist principally at the distribution facility level. Beginning in fiscal 1989, the Company undertook an extensive consolidation program, which closed 17 of the 31 facilities open on October 1, 1988. During the course of this consolidation program, the Company continued to significantly increase its revenues in each fiscal year. During fiscal 1995, the Company's average revenue per facility was approximately $246 million, compared to the calendar 1994 industry average of $213 million. Five AmeriSource facilities each have annual volume of over $400 million and an additional five facilities each have annual volume in excess of $213 million, which provides the Company with continued opportunities for significant leverage of fixed overhead and other costs.\nTo expand into new geographic markets, AmeriSource has opened six new facilities since October 1993, and currently operates 19 drug wholesale distribution facilities and one specialty products distribution facility, organized into four regions across the United States. Several operating units of the Company have over 100 years of history in the business and are among the nation's first drug distribution businesses. Unlike its more centralized competitors, the Company is structured as an organization of locally managed profit centers. Management of each operating unit has fiscal responsibility for its unit, and each operating unit has an established executive, sales and operations staff. The operating unit's results, including earnings and asset management goals, have a direct impact on management compensation. The operating units utilize the Company's corporate staff for marketing, financial, legal and executive management resources and corporate coordination of asset and working capital management.\nSales and Marketing. The Company has an organization of over 200 sales professionals. A specially trained group of telemarketing\/customer service representatives makes regular contact with customers regarding special offers. Within the sales organization, there is also a field force of approximately 50 hospital representatives, including regional hospital directors. The Company's corporate marketing department works with manufacturer suppliers to develop national programs and promotions. Tailored to specific customer classes, these programs can be further customized at the operating unit level to adapt to local market conditions. The marketing department gathers and disseminates information to each operating unit's purchasing and sales organization in order to enhance their competitive effectiveness.\nFacilities. Each of the Company's operating units carries an inventory line necessary for its local market. The efficient distribution of small orders is possible through the extensive use of computerization and modern warehouse techniques. These include computerized warehouse product location, routing and inventory replenishment systems, gravity-flow racking, mechanized order selection and efficient truck loading and routing. The Company delivers its products on a scheduled basis, including on a daily basis where required. It utilizes a fleet of owned and leased vans and trucks and contract carriers. Night picking operations in its distribution facilities have further reduced delivery time. According to customer need, orders can be delivered in fewer than 24 hours.\nThe Company's 19 full service distribution facilities and one specialty products facility as of December, 1995, are organized into four regions throughout the United States. The following table presents certain information regarding the Company's operating units in the aggregate.\nCustomers and Markets. The Company has a diverse customer base that includes hospitals and managed care facilities, independent community pharmacies including retail drug stores, nursing homes and clinics and chain drug stores including pharmacy departments of supermarkets and mass merchandisers. The Company offers a broad range of services designed to enhance the operating efficiencies and competitive position of its customers and manufacturers. In addition, AmeriSource is typically the primary source of supply for its customers, delivering on a daily basis. The table below summarizes how the Company's customer sales mix has changed over the last five fiscal years.\nNo single customer represented more than 4% of the Company's total revenues during fiscal 1995 other than the federal government which, in the aggregate, accounted for approximately 10%. Excluding the federal government, the Company's top ten customers represented approximately 15% of total revenues during fiscal 1995. The Company believes it is less dependent on any single customer than its four largest competitors. A profile of each customer segment follows:\n. Hospitals and Managed Care Facilities. AmeriSource is one of the nation's top three distributors in serving the hospital and managed care market segment, which is currently the fastest growing customer segment in the industry. Because hospitals and managed care facilities purchase large volumes of high priced, easily handled pharmaceuticals, the Company benefits from quick turnover of both inventory and receivables and lower than average operating expenses. The Company intends to continue to focus on the higher growth hospital and managed care market segment through the use of dedicated facilities and advanced information systems such as ECHO(TM). As a percentage of total revenues, sales to hospitals and managed care facilities increased from 36% in fiscal 1991 to 47% in fiscal 1995, and have grown at a compound rate of 21.5% over this period.\n. Independents. Independent community pharmacy owners represent the largest segment of the industry and provide the greatest opportunity for the Company's value-added services. The Company's sales to independent customers have risen at a compound rate of 8.0% from fiscal 1991 through fiscal 1995 due to the general growth of this customer segment and to the success of the Company's customized marketing and merchandising programs, such as its Family Pharmacy(R) program.\n. Chains. This category includes chain drug stores, including pharmacy departments of supermarkets and mass merchandisers. The Company's sales to chains have risen at a compound rate of 12.0% from fiscal 1991 through fiscal 1995. This growth rate reflects the results from the Company entering into new contracts with several drug store chains.\nSuppliers. AmeriSource obtains pharmaceutical and other products from a number of manufacturers, none of which account for more than approximately 6% of its net sales in fiscal 1995. The five largest suppliers in fiscal 1995 accounted for approximately 23% of net sales. Historically, the Company has not experienced difficulty in purchasing desired products from suppliers. The Company has agreements with many of its suppliers which generally require the Company to maintain an adequate quantity of a supplier's products in inventory. The majority of contracts with suppliers are terminable upon 30 days notice by either party. The loss of certain suppliers could adversely affect the Company's business if alternative sources of supply were unavailable. The Company believes that its relationships with its suppliers are good.\nManagement Information Systems. The Company has continually invested in advanced management information systems and automated warehouse technology. In fiscal 1994, AmeriSource introduced its BOSS warehouse automation system, a paperless warehouse production program customized to AmeriSource's unique requirements. First installed at its Paducah, Kentucky distribution center, the second BOSS system will be installed at the Company's newly opened facility in Orlando, Florida. Under the BOSS system, merchandise is received, placed in inventory, retrieved and shipped utilizing customized radio frequency equipment. The Company's management information systems also provide for, among other things, electronic order entry by customers, invoice preparation and purchasing and inventory tracking. As a result of electronic order entry, the cost of receiving and processing orders have not increased as rapidly as sales volume. The Company's customized systems strengthen customer relationships by allowing the customer to lower its operating costs and by providing the basis for a number of the value-added services the Company provides to its customers, including marketing data, inventory replenishment, single-source billing, computer price updates and price labels. AmeriSource believes that its management information systems are capable of serving its needs for the foreseeable future.\nCOMPETITION\nThe Company engages in the wholesale distribution of pharmaceuticals, health and beauty aids and other products in a highly competitive environment. The Company competes with numerous national and regional distributors, some of which are larger and have substantially greater financial resources than the Company. The Company's national competitors include McKesson Corporation, Bergen Brunswig Corporation, Cardinal Health, Inc. and FoxMeyer Health Corporation. In addition, the Company competes with local distributors, direct-selling manufacturers and other specialty distributors. Competitive factors include price, service and delivery, credit terms, breadth of product line, customer support and marketing programs. There can be no assurance that the Company will not encounter increased competition in the future that could adversely affect the Company's business. The drug wholesale industry continues to undergo significant consolidation, with the number of wholesalers in the continental United States reduced from 139 at the end of 1980 to approximately 48 as of December 1995.\nEMPLOYEES\nAs of September 30, 1995, the Company employed approximately 2,600 persons, of which approximately 2,400 were full-time employees. Approximately 11% of full and part-time employees are covered by collective bargaining agreements. The Company believes that its relationship with its employees is good.\nREGULATORY MATTERS\nThe United States Drug Enforcement Administration, the FDA and various state boards of pharmacy regulate the distribution of pharmaceutical products and controlled substances, requiring wholesale distributors of these substances to register for permits and to meet various security and operating standards. As a wholesale distributor of pharmaceuticals and certain medical\/surgical products, the Company is subject to these regulations. The Company has received all necessary regulatory approvals and believes that it is in substantial compliance with all applicable wholesale distribution requirements.\nThe Company is aware that at its former Charleston, South Carolina distribution center there is evidence of residual soil contamination remaining from the fertilizer manufacturing process operated on that site over thirty years ago. The Company's environmental consulting firm conducted a soil survey and a groundwater study during fiscal 1994 and 1995. The results of the studies indicate that there is lead on-site at levels requiring further investigation and potential remediation. A preliminary engineering analysis was prepared by outside consultants during the third quarter of fiscal 1994, and indicated that if both soil and groundwater remediation are required, the most likely cost is estimated to be $4.1 million. Accordingly, a liability of $4.1 million was recorded during\nfiscal 1994 to cover future consulting, legal and remediation and ongoing monitoring costs. The Company is working with the appropriate state regulatory agency regarding further tests and potential site remediation. That negotiation, investigation and remediation could take several years and the actual costs may differ from the liability that has been recorded. The accrued liability ($3.9 million at September 30, 1995), which is reflected in other long-term liabilities on the Company's consolidated balance sheet, is based on the present estimate of the extent of contamination, choice of remedy, and enacted laws and regulations, including remedial standards; however, changes in any of these could affect the estimated liability. The Company is investigating the possibility of asserting claims against responsible parties for recovery of these costs. Whether or not any recovery may be forthcoming is unknown at this time, although the Company intends to vigorously enforce its rights and remedies.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nAs of December 1995, the Company conducted its business from office and operating unit facilities at 33 locations throughout the United States. In the aggregate, the Company's operating units occupy approximately 1.9 million square feet of office and warehouse space, of which approximately 782,000 square feet is owned and the balance is leased under lease agreements with expiration dates ranging from 1996 to 2009. The Company's 21 drug distribution facilities range in size from approximately 43,600 square feet to 213,000 square feet. Leased facilities are located in the following states: Arizona, California, Florida, Idaho, Kentucky, Massachusetts, Minnesota, New Jersey, North Carolina, Ohio, Oregon, Pennsylvania, Tennessee and Texas. Owned facilities are located in the following states: Georgia, Indiana, Kentucky, Maryland, Missouri, Ohio, Pennsylvania, Tennessee and Virginia. The Company utilizes a fleet of owned and leased vans and trucks, as well as contract carriers to deliver its products. The Company believes that its properties are adequate to serve the Company's current and anticipated needs without making capital expenditures materially higher than historical levels.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIn November 1993, the Company was named a defendant, along with six other wholesale distributors and twenty-four pharmaceutical manufacturers, in a series of purported class action antitrust lawsuits alleging violations of various antitrust laws associated with the chargeback pricing system. In addition, the Company is a party to a parallel suit filed in state court in Minnesota. The actions were originally filed in the United States District Court for the Southern District of New York, and have been transferred to the United States District Court for the Northern District of Illinois for consolidated and coordinated pretrial proceedings. In essence, these lawsuits all claim that the manufacturer and wholesaler defendants have combined, contracted and conspired to fix the prices charged to plaintiff independent retail pharmacies and class members for prescription brand name pharmaceuticals. Specifically, plaintiffs claim that the defendants use \"chargeback agreements\" to give some institutional pharmacies discounts that are not made available to retail drug stores. Plaintiffs seek injunctive relief, treble damages, attorneys' fees and costs. In October, 1994, the Company entered into a Judgement Sharing Agreement with other wholesaler and pharmaceutical manufacturer defendants. Under the Judgement Sharing Agreement: (a) the manufacturer defendants agreed to reimburse the wholesaler defendants for litigation costs incurred, up to an aggregate of $9 million; and (b) if a judgement is entered into against both manufacturers and wholesalers, the total exposure for joint and several liability of the Company is limited to the lesser of 1% of such judgement or $1 million. In addition, the Company has released any claims which it might have had against the manufacturers for the claims presented by the plaintiffs in these lawsuits. The Judgement Sharing Agreement covers the federal court litigation as well as the cases which have been filed in various state courts. The Company believes it has meritorious defenses to the claims asserted in these lawsuits and intends to vigorously defend itself in all of these cases.\nIn October 1995, a proceeding was instituted before the Massachusetts Board of Registration in Pharmacy (the \"Board\") against the Company. The Board alleges that the Company's application for the licensure of its facility in Springfield, Massachusetts submitted in September 1994 was inaccurate and insufficient. The Company is contesting this allegation. The Company cannot predict the outcome of the proceeding; however, it does not believe that the outcome will have a material adverse effect on its business or financial condition.\nThe Company is a party to various lawsuits arising in the ordinary course of business. The Company, however, does not believe that the outcome of these lawsuits, individually or in the aggregate, will have a material adverse effect on its business or financial condition.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\n(No response to this Item is required.)\nITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT\nThe following is a list of the Company's executive officers, their ages and their positions, as of December 8, 1995. Each executive officer serves at the pleasure of the Company's Board of Directors.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANTS' COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nSince April 10, 1995, the Company's Class A Common Stock has been traded over-the-counter in the National Market System of the National Association of Securities Dealers, Inc. (Nasdaq symbol ASHC). Prior to that date, there was no established public trading market for the Company's Class A Common Stock. As of December 8, 1995, there were 313 record holders of the Company's Class A Common Stock. The quarterly high and low closing prices for the Company's Class A Common Stock since April 1995 ranged from $24 1\/2 to $20 3\/4, respectively, in the third quarter and from $27 3\/4 to $19 3\/4, respectively, in the fourth quarter.\nThere is no established public trading market for the Company's Class B Common Stock. As of December 8, 1995, there were 11 record holders of the Company's Class B Common Stock.\nThe Company's Class C Common Stock was held by 14 holders of record as of December 8, 1995. The Class C Common Stock trades on a limited basis in the over-the-counter market, and information concerning the historical trading prices for the Class C Common Stock is not published by nationally-recognized independent sources.\nThe Company has not paid any cash dividends to its stockholders on any class of its Common Stock, and anticipates that for the forseeable future its earnings will be retained for use in its business. Payment of dividends is within the discretion of the Company's Board of Directors and will depend, among other factors, upon the Company's earnings, financial condition and capital requirements and the terms of the Company's financing agreements. A credit agreement between the Company and a syndicate of senior lenders provides a secured credit facility of $380 million, and restricts the Company's ability to make dividend payments unless certain financial tests are met.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe following table should be read in conjunction with the Consolidated Financial Statements, including the notes thereto, included elsewhere in this report.\n(a) Includes the effect of: the cumulative effect of accounting changes for income taxes of $33,399 and postretirement benefits other than pensions of $1,199; and the $180 million write-off of goodwill. (b) Represents selling and administrative expenses and depreciation, and excludes amortization and unusual items.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nAMERISOURCE HEALTH CORPORATION\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe following discussion should be read in conjunction with the Consolidated Financial Statements contained herein.\nRESULTS OF OPERATIONS\nYEAR ENDED SEPTEMBER 30, 1995 COMPARED WITH YEAR ENDED SEPTEMBER 30, 1994\nRevenues of $4.7 billion for the fiscal year ended September 30, 1995 represented an increase of 11.6% over revenues for the fiscal year ended September 30, 1994. The year-to-year revenue gains reflect increases across all customer groups, the impact of the Company's expansion into new geographic markets, especially in the northeastern and western United States, and price increases. During the fiscal year ended September 30, 1995, sales to hospitals increased 11%, sales to independent drug store customers increased 13%, and sales to the chain drug store customer group increased 11%, as compared with the prior fiscal year. During the twelve months ended September 30, 1995, sales to hospitals accounted for 47% of total revenues, while sales to independent drug stores represented 35% and sales to chain drug stores, 18% of the total.\nGross profit of $266.4 million for fiscal 1995 increased by 13.3% over 1994, primarily due to the increase in revenues. As a percentage of revenues, the Company's gross profit margin expanded to 5.70% from 5.62% in 1994. The gross profit margin improvement was a result of increased sales of higher margin generic drugs, the continued introduction of new marketing programs with manufacturers, and growth of higher margin specialty businesses, such as pharmaceutical packaging. Increased purchase discounts and a greater level of price increases from manufacturers resulting in greater inventory appreciation also benefited the gross profit margin.\nSelling and administrative expenses and depreciation for 1995 were $168.3 million compared to $149.1 million for 1994, an increase of 12.9%. The increase in 1995 is due primarily to increases in warehouse and delivery expenses relating to the volume increases, development expenses of value-added programs, and one-time costs associated with the opening of new distribution facilities in Springfield, Massachusetts, Portland, Oregon, Sacramento, California, and Phoenix, Arizona. As a result of these factors, selling and administrative expenses and depreciation increased slightly to 3.61% of revenues compared to 3.57% in fiscal 1994.\nThe decrease in amortization in fiscal 1995 was as a result of the write-off of the value of the excess of cost over net assets acquired (\"goodwill\") which the Company recorded in the third quarter of fiscal 1994.\nOperating income, excluding unusual items and amortization, of $98.0 million for fiscal 1995 increased 13.9% over fiscal 1994. As a percentage of revenues, the Company's operating margin, excluding unusual items and amortization, expanded to 2.10% in 1995 from 2.06% in 1994.\nInterest expense (excluding the amortization of deferred financing costs) for the year ended September 30, 1995 was $49.8 million, a decrease of $8.8 million, or 15.1% as compared with the year ended September 30, 1994. The decrease was due to the redemption, in January 1995, of the $166.1 million of 14 1\/2% senior subordinated notes, the redemption, in May 1995, of $74.3 million of 11 1\/4% senior debentures, and the lower average rates due to the implementation of the Receivables Program and the new revolving credit facility which has a lower interest rate than the previous facility. Average borrowings were $536 million during fiscal 1995 versus $562 million in 1994.\nIncome taxes provided of $17.3 million in fiscal 1995 were based upon an annual effective tax rate of 38%, which recognizes the utilization, for financial reporting purposes, of operating loss carryforwards. The provision for income taxes in fiscal 1994 represents the estimated taxes payable due to the application of the alternative minimum tax. The extraordinary charge of $25.2 million in 1995, net of a tax benefit of $7.2 million, relates to the amendment of the Credit Agreement, the redemption premium on the 14 1\/2% senior subordinated notes, the redemption premium on the 11 1\/4% senior debentures, and the consequent write-off of unamortized deferred financing fees. The extraordinary charge of $679,000 in 1994, net of a tax benefit of $23,000, relates to the purchase and retirement of an aggregate principal amount of $4.4 million of 14 1\/2% senior subordinated notes.\nYEAR ENDED SEPTEMBER 30, 1994 COMPARED WITH YEAR ENDED SEPTEMBER 30, 1993\nRevenues of $4.2 billion for the fiscal year ended September 30, 1994 represented an increase of 14.3% over the amount for the fiscal year ended September 30, 1993, reflecting real volume growth as well as the pass through to customers of price increases from manufacturers. As compared with the prior fiscal year, sales to hospitals grew by 27%, sales to chain drug stores, excluding brokerage business, increased by 8%, and sales to independent drug store customers increased by 4%. During 1994, sales to hospitals accounted for 47% of total revenues, while sales to independent drug stores represented 35% and sales to chain drug stores, 18% of the total.\nGross profit of $235.2 million for 1994 increased by 12.3% over 1993, primarily due to the increase in revenues. As a percentage of revenues, gross profit declined to 5.62% in 1994 from 5.72% in 1993. The reduction in the gross profit percentage resulted from continued industry price competition and increased sales to larger volume, lower margin customers, such as hospitals.\nSelling and administrative expenses and depreciation for 1994 were $149.1 million compared to $136.1 million for 1993, an increase of 9.5%. The cost increases reflect inflationary increases and increases in warehouse and delivery expenses which are variable with sales volume. Continued emphasis on cost containment programs as well as the economies associated with the significant revenue growth, reduced overall selling and administrative expenses and depreciation as a percentage of revenues to 3.57% in 1994 from 3.72% in 1993.\nOperating expenses in 1994 include a provision of $4.1 million to cover the expected environmental remediation costs at one of its former distribution centers. In addition, in the third quarter of fiscal 1994, the Company completed a detailed evaluation of the recovery of the recorded value of the excess of cost over net\nassets acquired (\"goodwill\") and concluded that projected operating results would not support the future recovery of the remaining goodwill balance. Accordingly, the Company wrote off the remaining goodwill balance of $179.8 million in the third quarter of fiscal 1994.\nOperating income, excluding unusual items and amortization, of $86.1 million for fiscal 1994 increased 17.4% over fiscal 1993. As a percentage of revenues, the Company's operating margin, excluding unusual items and amortization, expanded to 2.06% in 1994 from 2.00% in 1993.\nInterest expense which is payable currently (cash interest), principally related to the revolving credit facility and the senior subordinated notes, was $43.7 million in 1994 as compared with $42.4 million in 1993, an increase of 3.3%. The increase was as a result of higher interest rates on the Company's variable rate borrowings offset in part by lower variable rate borrowing levels and the reduction in principal amount of the senior subordinated notes. Interest expense in 1994 reflects reductions as a result of the purchase and retirement of an aggregate principal amount of $8.9 million of senior subordinated notes, which occurred during the fourth quarter of fiscal 1993 and first quarter of fiscal 1994. Interest expense in 1994 includes $621,000 paid to the holders of an aggregate of $165.7 million in principal amount of senior subordinated notes (see Note 5 of \"Notes to Consolidated Financial Statements\"). During 1994, the average outstanding debt level was $562 million at an average interest rate of 10.3%. In 1993, the comparable average outstanding debt level was $551 million at an average interest rate of 11.0%. The decrease in interest expense which is not currently payable (pay-in-kind interest) of $5.5 million was due to the refinancing in July 1993 of the 18% senior subordinated debentures, 18 1\/2% merger debentures, and 19 1\/2% junior subordinated debentures with the 11 1\/4% senior debentures. Interest expense in 1994 includes $4.0 million in amortization of financing fees as compared with $3.9 million in 1993.\nIncome taxes provided in 1994 and 1993 have been determined based on the alternative minimum tax system. As noted below, the Company changed its method of accounting for income taxes effective October 1, 1993. The extraordinary charge of $679,000, net of a tax benefit of $23,000, relates to the purchase and retirement of an aggregate principal amount of $4.4 million senior subordinated notes.\nEffective October 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (Statement 106) and Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (Statement 109). The Company recorded, as of October 1, 1993, a total of $34.6 million in noncash charges to net income for the effects of transition to these two new standards. The cumulative effect of the change in accounting for post retirement benefits other than pensions resulted in a noncash charge to net income of $1.2 million as of October 1, 1993. The cumulative effect of the change in accounting for income taxes resulted in a noncash charge to net income of $33.4 million as of October 1, 1993, principally related to the provision of deferred income taxes to reflect the tax consequences on future years of the difference between the tax and financial reporting bases of merchandise inventories.\nLIQUIDITY AND CAPITAL RESOURCES\nDuring the fiscal-year ended September 30, 1995, the Company's operating activities consumed $35.6 million in cash. The use of funds was primarily the result of the increases in restricted cash, accounts and notes receivable, and merchandise inventories, offset by an increase in accounts payable, accrued expenses and income taxes. Restricted cash represents amounts temporarily deposited in the Master Trust pursuant to the Receivables Program. The net increase in other working capital items was the result of opening distribution facilities in Springfield, Massachusetts, Portland, Oregon, and Sacramento, California. Operating cash uses during the year ended September 30, 1995 included $43.6 million in interest payments and $2.8 million in income tax payments.\nSubsequent to year-end, the Company opened new distribution facilities in Phoenix, Arizona and Orlando, Florida. Capital expenditures for fiscal 1995 were $13.7 million and relate principally to the opening of the five new distribution centers, continuing investments in management information systems, and warehouse improvements. During fiscal 1995, the Company acquired substantially all of the assets of LDS Liberty Drug Systems and Newbro Drug Company for approximately $4.9 million. Liberty Drug Systems provides pharmacy dispensing hardware and software systems in retail pharmacies. Newbro Drug Company is a full-service\nwholesale pharmaceutical distributor in Idaho. The Company intends to continue its investments in information systems and warehouse improvements and will continue to evaluate acquisitions and other business opportunities.\nIn December 1994, the Company sold substantially all of its receivables to ARC, pursuant to the Receivables Program. Pursuant to the Receivables Program, ARC will continuously transfer receivables to a master trust in exchange for, among other things, Certificates representing a right to receive a variable principal amount. Contemporaneous with the consummation of the Receivables Program, the Company amended its existing Credit Agreement with its senior lenders and redeemed in January 1995 all of the outstanding 14 1\/2% senior subordinated notes at a redemption price of 106% of the principal amount plus accrued interest through the redemption date totaling $176.2 million. In April 1995, the Company completed an initial public offering with the issuance of 7,590,000 common shares at $21.00 per share, the net proceeds of which (approximately $148.2 million) were used to redeem in May 1995 one-half of the 11 1\/4% senior debentures outstanding for 110% of the principal amount plus accrued interest through the date of redemption (approximately $84.4 million) and to pay down the Company's revolving credit facility. As a result of the public offering and the Company's financial results, the borrowing rate alternatives under the Credit Agreement was reduced by 1.0% to LIBOR plus 1.25% and the prime rate plus zero beginning in October 1995. The Company also incurred approximately $10.1 million in fees connected with the refinancings. At September 30, 1995, borrowings under the Company's $380 million revolving credit facility were $150 million (at an average interest rate of 7.6%) and borrowings under the $285 million Receivables Program were $210 million (at an average interest rate of 6.3%).\nAn increase in interest rates would adversely affect the Company's operating results and the cash flow available after debt service to fund operations and any expansion and, if permitted to do so under its revolving credit facility, to pay dividends on its capital stock.\nThe Company's operating results have generated sufficient cash flows which, together with borrowings under its debt agreements and credit terms from suppliers, have provided sufficient capital resources to finance working capital and cash operating requirements, fund capital expenditures, and interest currently payable on outstanding debt. The Company's primary ongoing cash requirements will be to fund payment of interest on indebtedness, finance working capital, and fund capital expenditures and routine business growth and expansion through new business opportunities. Future cash flows from operations and borrowings under the debt agreements are expected to be sufficient to fund the Company's ongoing cash requirements.\nThe Company is subject to contingencies pursuant to environmental laws and regulations at one of its former distribution centers that may require remediation efforts. In fiscal 1994, the Company accrued a liability of $4.1 million to cover future consulting, legal and remediation, and ongoing monitoring costs. The accrued liability, which is reflected in other long-term liabilities on the accompanying consolidated balance sheet, is based on an estimate of the extent of contamination and choice of remedy, existing technology, and presently enacted laws and regulations, however, changes in remediation standards, improvements in cleanup technology, and discovery of additional information concerning the site could affect the estimated liability in the future. The Company is investigating the possibility of asserting claims against responsible parties for recovery of these costs. Whether or not any recovery may be forthcoming is unknown at this time.\nIn fiscal 1994, the Company concluded that the carrying value of goodwill which was recorded at the time of the leveraged buyout transaction in 1988 (\"Acquisition\") could not be recovered from expected future operations and accordingly wrote-off its remaining goodwill balance of $179.8 million. In 1994, the Company determined its then poor operating results since the Acquisition and its expectations for future operating results were being adversely affected by its then current capital structure; price competition for market share; health care industry consolidation; the impact of group purchasing organizations; and health care reform on drug prices. As these factors became clear, the Company assessed the recoverability of its goodwill through projected operations. It was determined that unless the Company was able to develop successful strategic operating or financing initiatives which would change the assumptions used in those projections, those projections were the best estimate of the Company's projected performance given the Company's then existing high leverage and industry trends. More importantly, the projections indicated that the Company's long-term viability required modification of its then current capital structure to reduce indebtedness and increase its equity.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nREPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS\nTo the Board of Directors and Stockholders of AmeriSource Health Corporation\nWe have audited the accompanying consolidated balance sheets of AmeriSource Health Corporation (formerly AmeriSource Distribution Corporation) and subsidiaries as of September 30, 1995 and 1994, and the related consolidated statements of operations, changes in stockholders' equity, and cash flows for each of the three years in the period ended September 30, 1995. 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 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 respects, the consolidated financial position of AmeriSource Health Corporation and subsidiaries at September 30, 1995 and 1994 and the consolidated results of their operations and their cash flows for each of the three years in the period ended September 30, 1995, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nAs discussed in notes 4 and 7 to the consolidated financial statements, in 1994 the Company changed its methods of accounting for income taxes and postretirement benefits other than pensions.\nErnst & Young LLP\nPhiladelphia, Pennsylvania November 3, 1995\n[THIS PAGE INTENTIONALLY LEFT BLANK]\nAMERISOURCE HEALTH CORPORATION AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\n(DOLLARS IN THOUSANDS)\nASSETS\nAMERISOURCE HEALTH CORPORATION AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\n(DOLLARS IN THOUSANDS)\nLIABILITIES AND STOCKHOLDERS' EQUITY\nSee notes to consolidated financial statements.\nAMERISOURCE HEALTH CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF OPERATIONS\n(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)\nSee notes to consolidated financial statements.\nAMERISOURCE HEALTH CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY\n(DOLLARS IN THOUSANDS)\nSee notes to consolidated financial statements.\nAMERISOURCE HEALTH CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\n(DOLLARS IN THOUSANDS)\nSee notes to consolidated financial statements.\nAMERISOURCE HEALTH CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nSEPTEMBER 30, 1995\nNOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPrinciples of Consolidation\nThe accompanying consolidated financial statements include the accounts of AmeriSource Health Corporation, formerly AmeriSource Distribution Corporation, and its wholly-owned subsidiaries (the \"Company\") as of the dates and for the periods indicated. All intercompany transactions and balances have been eliminated in consolidation.\nBusiness\nThe Company is a wholesale distributor of pharmaceuticals and related health care products.\nCash Equivalents\nThe Company classifies highly liquid investments with original maturities of three months or less at date of purchase as cash equivalents.\nConcentrations of Credit Risk\nThe Company sells its merchandise inventories to a large number of customers in the health care industry including independent drug stores, chain drug stores, hospitals, mass merchandisers, clinics, and nursing homes. The Company's trade accounts receivable are exposed to credit risk, however, the risk is limited due to the diversity of the customer base and the customer base's wide geographic dispersion. The Company performs ongoing credit evaluations of its customers' financial condition. The Company maintains reserves for potential bad debt losses and such bad debt losses have been within the Company's expectations.\nMerchandise Inventories\nInventories are stated at the lower of cost or market. Cost is determined using the last-in, first-out (LIFO) method, which results in a matching of current costs and revenues. On a supplemental basis, if the first-in, first- out (FIFO) method of valuation had been used for determining costs, inventories would have been approximately $93,803,000 and $88,327,000 higher than the amounts reported at September 30, 1995 and 1994, respectively.\nDepreciation\nThe cost of property and equipment is depreciated over the estimated useful lives of the related assets by the straight-line method.\nRevenue Recognition\nThe Company recognizes revenues when products are delivered to customers. Additionally, the Company acts as an intermediary in the bulk shipment of pharmaceuticals from manufacturers to customers' warehouses, which have been excluded from revenues and totaled $107 million, $120 million, and $60 million in fiscal years 1995, 1994, and 1993, respectively. The service fees earned related to these bulk shipments are included in\nAMERISOURCE HEALTH CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED) revenues and were insignificant. Revenues and cost of goods sold in prior years have been reclassified to conform with the 1995 presentation for bulk shipments.\nReclassifications\nCertain prior-year amounts have been reclassified to conform with the current-year presentation.\nEarnings Per Share and Share Data\nEarnings (loss) per share is computed on the basis of the weighted average number of shares of common stock outstanding during the periods presented (18,295,000 for fiscal 1995 and 14,750,000 in fiscal 1994 and 1993) plus the dilutive effect of stock options (38,000 and 101,000 for the fiscal 1995 primary and fully diluted calculations, respectively). Share and per share amounts prior to April 1995 have been adjusted for the 2.95-for-1 stock split effected in conjunction with the Company's public offering (see Note 6).\nNOTE 2--ACQUISITIONS\nDuring fiscal 1995, the Company acquired substantially all of the assets of Newbro Drug Company, a wholesale pharmaceutical distributor located in Idaho Falls, Idaho and of Liberty Drug Systems, a North Carolina-based provider of pharmacy software and hardware. The aggregate purchase price for these acquisitions was approximately $4.9 million in cash, which approximated the fair value of the net tangible assets acquired. These acquisitions were accounted for by the purchase method and are included in the financial statements from their dates of acquisition. The pro forma effects on the Company's results of operations had these acquisitions occurred at the beginning of the periods presented are not material.\nNOTE 3--EXCESS OF COST OVER NET ASSETS ACQUIRED\nExcess of cost over net assets acquired (\"goodwill\") was recorded at the time of the leveraged buyout transaction (\"Acquisition\") in 1988. As of June 30, 1994, the Company determined it was unable to achieve the operating results projected at the time of the Acquisition. Since the Acquisition, the Company has been affected by price competition for market share within the industry, health care industry consolidation, and the impact of group purchasing organizations, managed care, and health care reform on drug prices. In fiscal 1994, the Company determined its then poor operating results since the Acquisition and its expectations for future operating results were being significantly affected by its then-current capital structure and fundamental changes in the market place in which the Company operates. As these factors became clear and in conjunction with the then recent increases in the interest rates, a detailed comprehensive evaluation of the Company's future prospects was prepared. The evaluation determined the Company's financial losses at that time were significantly affected by its highly leveraged capital structure, price sensitivity, aggressive pricing by better capitalized competitors, consolidations in the wholesale drug distribution industry and the impact of larger buying groups. Based on the then-current industry trends, interest rate trends and the health care reform environment, in the third quarter of fiscal 1994, the Company concluded that the projected operating results (\"the Projection\") would not support the future recovery of the remaining goodwill balance.\nThe methodology employed to assess the recoverability of the Company's goodwill was to project results of operations forward 36 years, which approximated the remaining amortization period of the goodwill balance at June 30, 1994. The Company then evaluated the recoverability of goodwill on the basis of those Projections.\nIt was determined that unless the Company was able to develop successful, strategic, operating, or financing initiatives which would change the assumptions used in the Projections, the projected future operating results based on those assumptions was the best estimate of the Company's projected performance given the Company's\nAMERISOURCE HEALTH CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 3--EXCESS OF COST OVER NET ASSETS ACQUIRED--(CONTINUED) then-existing high leverage and industry trends. As a result, the Company concluded that the carrying value of goodwill could not be recovered from expected future operations. Accordingly, the Company wrote off its remaining goodwill balance of $179.8 million in the third quarter of fiscal 1994. More importantly, the Projection indicated that the Company's long-term viability required modification of its then-current capital structure to reduce its indebtedness and increase its equity.\nNOTE 4--TAXES ON INCOME\nThe income tax provision (benefit) is as follows (in thousands):\nA reconciliation of the statutory federal income tax rate to the effective income tax rate is as follows:\nEffective October 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (Statement 109), which required a change in the method of accounting for income taxes from the deferred method to the liability method. In accordance with Statement 109, the Company recorded an adjustment of $33.4 million for the cumulative effect of adopting Statement 109 as of October 1, 1993. As permitted under Statement 109, prior-period financial statements have not been restated. The cumulative effect adjustment relates principally to the provision of deferred income taxes to reflect the tax consequences on future years of the difference between the tax and financial reporting basis of merchandise inventories.\nAMERISOURCE HEALTH CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 4--TAXES ON INCOME--(CONTINUED)\nDeferred income taxes reflect the future tax consequences of differences between the tax bases of assets and liabilities and their financial reporting amounts. Significant components of the Company's deferred tax liabilities (assets) are as follows (in thousands):\nThe valuation allowance for deferred tax assets was $17.6 million at October 1, 1993. For the fiscal years ended September 30, 1993, the deferred income tax provision (benefit) resulted from timing differences in the recognition of certain expenses for tax and financial reporting purposes. Due to limitations on the utilization of tax losses, the Company did not recognize any deferred income tax benefit in 1993. The principal components of deferred taxes in 1993 were as follows (in thousands):\nAn unused federal tax net operating loss carryover of $37 million, which will expire between 2008 and 2010 if not used, is available to offset future taxable income. In 1995, tax benefits of $6.2 million related to the exercise of employee stock options in connection with the Company's public offering of common stock described in Note 6, were recorded as capital in excess of par value. Additional tax benefits of approximately $13.9 million related to the exercise of these stock options will be recorded to capital in excess of par value when these tax benefits are realized by the Company.\nThe Company was subject to the alternative minimum tax for the fiscal year ended September 30, 1994. The alternative minimum tax is imposed at a 20% rate on the Company's alternative minimum taxable income which is determined by making statutory adjustments to the Company's regular taxable income. Net operating loss carryforwards were used to offset up to 90% of the Company's alternative minimum taxable income. The alternative minimum tax paid is allowed as an indefinite credit carryover against the Company's regular tax\nAMERISOURCE HEALTH CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 4--TAXES ON INCOME--(CONTINUED) liability in the future when the Company's regular tax liability exceeds the alternative minimum tax liability. As of September 30, 1995, the Company has a $7 million alternative minimum tax credit carryforward.\nIncome tax payments amounted to $2.8 million, $3.9 million, and $0.4 million in the fiscal years ended September 30, 1995, 1994, and 1993, respectively.\nNOTE 5--LONG-TERM DEBT\nReceivable Securitization Financing\nIn December 1994, the Company sold substantially all of its trade accounts and notes receivable (the \"Receivables\") to AmeriSource Receivables Corporation (\"ARC\"), a special-purpose, wholly-owned subsidiary, pursuant to a trade receivables securitization program (the \"Receivables Program\"). Contemporaneously, the Company entered into a Receivables Purchase Agreement with ARC, whereby ARC agreed to purchase on a continuous basis Receivables originated by the Company. Pursuant to the Receivables Program, ARC will transfer such Receivables to a master trust in exchange for, among other things, certain trade receivables-backed certificates (the \"Certificates\"). During the term of the Receivables Program, the cash generated by collections on the Receivables will be used to purchase, among other things, additional Receivables originated by the Company. Pursuant to the Receivables Program, on December 13, 1994, the Company sold $305 million in Receivables to ARC in exchange for cash and a subordinated note. ARC in turn transferred the Receivables to the master trust for the Certificates and a residual interest in the master trust. The Company has accounted for the transactions pursuant to the terms of the Receivables Purchase Agreement as a sale of Receivables from AmeriSource to ARC and as a financing transaction by ARC on the Company's consolidated financial statements. The assets and liabilities of the master trust have been consolidated with the Company at September 30, 1995.\nPursuant to the Receivables Program, the Company issued: (i) $175 million of Floating Rate Class A Trade Receivables Participation Certificates (\"Class A Certificates\") and (ii) $35 million of Floating Rate Class B Trade Receivables Participation Certificates (\"Class B Certificates\"), which represent fractional undivided interests in the Receivables and other assets of the master trust. The Class A Certificates bear interest at one month LIBOR plus .35% and the Class B Certificates, which are subordinated to the Class A Certificates, bear interest at one month LIBOR plus .70%. The Company has entered into two-year interest rate cap agreements, expiring in May 1997 which specify that the one-month LIBOR base rate will not be greater than 7.50% with respect to $175 million of Class A Certificate borrowings under the Receivables Program. In addition, the Company issued Floating Rate Revolving Principal Trade Receivables Participation Certificates (\"Revolving Certificates\"), pursuant to which investors may purchase up to $75 million of interests in the master trust, which Certificates will bear interest, at the Company's option, at either LIBOR plus .35% or the federal funds rate plus 1.00%. The Revolving Certificates will rank pari passu in right of payment with the Class A Certificates. There were no Revolving Certificates outstanding at September 30, 1995. The expected final payment date of amounts outstanding under the Receivables Program will be March 15, 2000, but earlier termination could occur upon the occurrence of certain defined events. In the event of a liquidation, losses on Receivables will first be absorbed by the residual certificate held by ARC and collections on Receivables will first be allocated to make payments of outstanding principal of the Certificates in accordance with their ratable interests in the assets of the master trust, after giving effect to the allocation of losses to the residual interest. Fees of $4.6 million incurred in connection with establishing the Receivables Program and interest rate cap agreements have been deferred and are being amortized on a straight-line basis over a period of two to five years. Class A Certificates of $175 million principal amount (at an interest rate of 6.2%) and Class B Certificates of $35 million principal amount (at an interest rate of 6.6%) were outstanding under the Receivables Program at September 30, 1995. The\nAMERISOURCE HEALTH CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 5--LONG-TERM DEBT--(CONTINUED) Company is required to pay a commitment fee of 1\/4 of 1% per annum on the average unused portion of the Certificates. Restricted cash of $14.6 million at September 30, 1995, represents amounts temporarily deposited in the master trust from collections on the Receivables, which are designated for specific purposes pursuant to the Receivables Program.\nRevolving Credit Agreement\nIn December 1994, the Company amended its existing credit agreement with a syndicate of senior lenders providing a senior secured facility of $380 million (the \"Credit Agreement\"). Among other things, the amendment (i) extended the term of the original credit agreement until January 3, 2000; (ii) provided interest rate stepdowns upon the occurrence of certain events; (iii) modified the borrowing base availability from inventory- and receivable-based to inventory-based; and (iv) increased the Company's ability to make acquisitions and pay dividends. An extraordinary loss of $3.4 million (less a $1.0 million tax benefit) was recorded during the fiscal year ended September 30, 1995 representing the write-off of the unamortized financing fees relating to the former revolving credit facility. In connection with the new revolving credit facility, the Company incurred approximately $5.5 million in financing fees which have been deferred and are being amortized on a straight-line basis over the five-year term of the Credit Agreement. The maximum amount that may be borrowed under the Credit Agreement is limited to the extent of a sufficient borrowing base (up to a maximum of $380 million), which is essentially 65% of eligible inventory in fiscal year 1995, 62.5% of eligible inventory in fiscal year 1996, and 60% of eligible inventory thereafter.\nThe Credit Agreement may be prepaid during its term, although such indebtedness may be subsequently reborrowed. The indebtedness under the Credit Agreement may be permanently repaid in full or reduced in part at any time at the option of the Company, without premium or penalty, upon prior written notice.\nAt the Company's option, borrowings under the Credit Agreement bear interest at a rate per annum determined as follows: (i) a LIBOR rate, plus an applicable margin (1.75% at September 30, 1995); or (ii) the applicable prime rate of interest plus an applicable margin (.50% at September 30, 1995). Interest on loans under the Credit Agreement is payable quarterly or, if earlier, at the end of the applicable interest period loan intervals. A portion of the net proceeds from the initial public offering (see Note 6) were used to pay down the Company's revolving credit facility. As a result of the public offering, and the Company's performance in 1995, the borrowing rate alternatives under the Credit Agreement was reduced to LIBOR plus 1.25% and the Prime rate plus zero beginning in October 1995.\nUnder the terms of the Credit Agreement, the Company granted the senior lenders a perfected first priority security interest in substantially all of the Company's assets (except accounts receivable and certain related assets), including, without limitation, real property, fixed assets, equipment, inventory, stock of subsidiaries, trademarks, and intangible assets, to secure its borrowings under the Credit Agreement. The Company is required to pay a commitment fee of 1\/4 of 1% per annum on the average unused portion of the Credit Agreement plus an annual administration fee. At September 30, 1995, the $150 million outstanding under the Credit Agreement bore interest at the rate of 7.6% per annum.\nSenior Subordinated Notes\nContemporaneously with the consummation of the Receivables Program and the execution of the Credit Agreement, the Company redeemed all of the outstanding 14 1\/2% senior subordinated notes at a redemption price\nAMERISOURCE HEALTH CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 5--LONG-TERM DEBT--(CONTINUED)\nSenior Subordinated Notes--(continued)\nof 106% of the principal amount plus accrued interest through the redemption date. In connection with the redemption of the 14 1\/2% senior subordinated notes, the Company recorded an extraordinary charge of $12.1 million (less a $3.4 million tax benefit) during the fiscal year ended September 30, 1995 relating to the write-off of unamortized deferred financing fees and premiums paid on the redemption.\nSenior Debentures\nOn July 26, 1993, the Company issued $126.5 million principal amount of 11 1\/4% Senior Debentures (\"Senior Debentures\") due 2005 in a public offering. Interest on the Senior Debentures is payable semiannually on January 15 and July 15 of each year. Through and including the semiannual payment due July 15, 1998, the Company may elect, at its option, to issue additional Senior Debentures in satisfaction of its interest payment obligations. The Senior Debentures are senior unsecured obligations of the Company and rank pari passu in right of payment with all senior borrowings of the Company and senior in right of payment to all subordinated indebtedness of the Company. The Senior Debentures are structurally subordinated to all indebtedness and other obligations of the Company. Substantially all the net proceeds from the Senior Debentures (approximately $122 million) were applied to redeem the 18% Senior Subordinated Debentures, 18 1\/2% Merger Debentures and 19 1\/2% Junior Subordinated Debentures of the Company. The debt refinancing resulted in an extraordinary charge of $12.8 million during the fiscal year ended September 30, 1993 relating to the redemption of the Merger Debentures and the write-off of deferred financing costs, net of a tax benefit of $3.2 million. In connection with the Senior Debentures, the Company incurred approximately $5.1 million in financing fees which have been deferred and are being amortized over the twelve-year life of the indebtedness. In conjunction with the initial public offering, the Company, in May 1995, redeemed one-half of the Senior Debentures outstanding for 110% of the principal amount plus accrued interest through the date of redemption (approximately $84.4 million), which resulted in an extraordinary charge of $9.6 million (less a $2.7 million tax benefit) related to the write-off of unamortized deferred financing fees and premiums paid on the redemption.\nThe indentures governing the Receivables Program, the Credit Agreement, and the Senior Debentures contain restrictions and covenants, as amended, which include limitations on incurrence of additional indebtedness, prohibition of indebtedness, restrictions on distributions and dividends to stockholders, the repurchase of stock and the making of certain other restricted payments, the issuance of preferred stock, the creation of certain liens, transactions with subsidiaries and other affiliates, and certain corporate acts such as mergers, consolidations, and the sale of substantially all assets. Additional covenants require compliance with financial tests, including current ratio, leverage, interest coverage ratio, fixed charge coverage, and maintenance of minimum net worth.\nInterest paid on the above indebtedness during the fiscal years ended September 30, 1995, 1994, and 1993 was $43.6 million, $46.1 million, and $39.7 million, respectively.\nTotal amortization of financing fees and expenses (included in interest expense) for the fiscal years ended September 30, 1995, 1994, and 1993 was $2.5 million, $4.0 million, and $3.9 million, respectively.\nAs of September 30, 1995, the Company's revolving credit facility and receivables securitization financing had fair values that approximated their carrying amounts. The fair value of the Senior Debentures was approximately $81 million and was based on a quoted value from brokers of 108.5%.\nAMERISOURCE HEALTH CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 6--STOCKHOLDERS' EQUITY\nIn April 1995, the Company issued 7,590,000 shares of Class A common stock in a public offering at $21.00 per share. The net proceeds from the offering of $148.2 million were used to reduce the Company's outstanding indebtedness (see Note 5). On a pro forma basis, income and earnings per share before extraordinary items for fiscal 1995 would have been $35.0 million and $1.57, respectively, if the public offering had occurred on October 1, 1994. The pro forma information assumes reduced interest expense and applicable income tax adjustments resulting from the application of the net proceeds from the offering and it assumes 22,271,936 shares of common stock outstanding for the year. The pro forma information does not necessarily reflect the actual results that would have occurred nor is it necessarily indicative of future results. In conjunction with the public offering, the Company's Board of Directors authorized a 2.95-for-1 stock split and, accordingly all references to earnings per share and share data in these financial statements have been restated to give effect to the stock split. Also, the Company eliminated all authorized shares of preferred stock, increased the authorized number of shares of Class A common stock to 50,000,000 and decreased the authorized number of shares of Class B common stock to 15,000,000.\nThe holders of the Class A common stock are entitled to one vote per share on all matters on which holders of Class A common stock are entitled to vote. The holders of the Class A common stock may elect at any time to convert any or all such shares into the Class B common stock on a share-for-share basis (but only to the extent that such record holder of Class A common stock shall be deemed to be required to convert such Class A common stock into Class B common stock pursuant to applicable law).\nThe rights of holders of Class B and Class C common stock and holders of Class A common stock are substantially identical and entitle the holders thereof to the same rights, privileges, benefits, and notices, except that holders of Class B and Class C common stock generally do not possess the right to vote on any matters to be voted upon by the stockholders of the Company, except as provided by law. Holders of Class B and Class C common stock may elect at any time to convert any and all of such shares into Class A common stock, on a share-for-share basis, to the extent the holder thereof is not prohibited from owning additional voting securities by virtue of regulatory restrictions.\nThe Class C common stock is subject to substantial restrictions on transfer and has certain registration and \"take-along\" rights. A share of Class C common stock will automatically be converted into a share of Class A common stock (a) immediately prior to its sale in a future public offering or (b) at such time as such share of Class C common stock has been sold publicly in a transaction that complies with maximum quantity limitations applicable to such sale until on or about March 31, 1996. Once a share of Class C common stock has been converted into Class A common stock, it will no longer be subject to any restrictions on transfer nor will it be entitled to the benefits of registration and take-along rights.\nDuring fiscal 1995, the Company issued 2,893,766 shares of Class A common stock upon the exercise of stock options (see Note 8), purchased as treasury stock 1,338,894 shares of Class B common stock from 399 Ventures Partners Inc., a wholly-owned indirect subsidiary of Citicorp pursuant to a prior agreement, and purchased as treasury stock 292,452 shares of Class A common stock from option holders to enable the holders to satisfy certain minimum tax withholding obligations. During fiscal 1994, 44,250 shares of Class A common stock were purchased as treasury stock.\nNOTE 7--PENSION AND OTHER BENEFIT PLANS\nThe Company provides a benefit for the majority of its employees under noncontributory defined benefit pension plans. For each employee, the benefits are based on years of service and average compensation. Pension costs, which are computed using the projected unit credit cost method, are funded on at least the minimum amount required by government regulations.\nAMERISOURCE HEALTH CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 7--PENSION AND OTHER BENEFIT PLANS--(CONTINUED)\nA summary of the components of net periodic pension cost charged to expense for the Company-sponsored defined benefit pension plans together with contributions charged to expense for a multi-employer union administered defined benefit pension plan the Company participates in follows (in thousands):\nThe following table sets forth (in thousands) the funded status and amount recognized in the consolidated balance sheets for the Company-sponsored defined benefit pension plans:\nAssumptions used in computing the funded status of the plans were as follows:\nPlan assets at September 30, 1995 are invested principally in listed stocks, corporate and government bonds, and cash equivalents.\nAdditionally, the Company sponsors the Employee Investment Plan, a defined contribution 401(k) plan, which covers salaried and certain hourly employees. Eligible participants may contribute to the plan up to 2% to\nAMERISOURCE HEALTH CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 7--PENSION AND OTHER BENEFIT PLANS--(CONTINUED) 6% of their regular compensation before taxes. The Company matches the employee contributions in an amount equal to 50% of the participants' contributions. An additional discretionary Company contribution in an amount not to exceed 50% of the participants' contributions may also be made depending upon the Company's performance. All contributions are invested at the direction of the employee in one or more funds. Employer contributions vest over a five-year period depending upon an employee's years of service. Costs of the plan charged to expense for the fiscal years ended September 30, 1995, 1994, and 1993 amounted to $0.9 million, $1.1 million, and $0.8 million, respectively.\nAs a result of special termination benefit packages previously offered, the Company provides medical, dental, and life insurance benefits to only a limited number of retirees and their dependents. These benefit plans are unfunded. Prior to October 1, 1993, the Company recognized the expenses for these plans on the cash basis. Effective October 1, 1993, pursuant to Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (Statement 106), the Company recognized the accumulated obligation related to these benefits resulting in a noncash charge to net income in 1994 of $1.2 million. The accumulated postretirement benefit obligation was $1.2 million as of September 30, 1995. The weighted average discount rate used in determining the accumulated postretirement benefit obligations was 7.25% and 7.75% at September 30, 1995 and 1994, respectively. The annual expense for such benefits is not material.\nNOTE 8--STOCK OPTION PLANS\nIn fiscal 1989, the Company adopted the AmeriSource Health Corporation and Subsidiaries Employee Stock Purchase Plan (the \"Purchase Plan\") to enable certain members of management to participate in the equity ownership of the Company. Pursuant to the Purchase Plan, management investors, on November 3, 1989, purchased options on 1,716,347 shares of the Company's Class A common stock which were exercisable at $.34 per share. Through fiscal 1993, 184,744 options were extinguished. The remaining 1,531,603 options outstanding under the Purchase Plan were exercised during fiscal 1995 in conjunction with the Company's public offering. No further awards will be granted under the Purchase Plan.\nIn fiscal 1990, the Company adopted the Partners Stock Option Plan (the \"Partners Plan\") to enable other employees of the Company to participate in the equity ownership of the Company. On March 2, 1991, options to acquire 368,160 shares of Class A common stock were granted at an exercise price of $.34 per share. The options under the Partners Plan became exercisable when they vested on September 30, 1994. Through fiscal 1993, 28,320 options were canceled. During fiscal 1995, 3,392 options were canceled, and the remaining 336,448 options were exercised. No further awards will be granted under the Partners Plan.\nIn fiscal 1992, the Company adopted the 1991 Stock Option Plan (the \"1991 Option Plan\") for the granting of nonqualified stock options to acquire up to an aggregate of 1,069,375 shares of Class A common stock. The options were granted to certain members of the Company's management at an exercise price of $.34 per share on April 8, 1992. During fiscal 1994, 29,500 options were extinguished. During fiscal 1995, 14,160 options were canceled and the remaining 1,025,715 options outstanding under the 1991 Option Plan were exercised in conjunction with the Company's public offering. No further awards will be granted under the 1991 Option Plan.\nDuring fiscal 1995, the Company adopted the AmeriSource Health Corporation 1995 Stock Option Plan (the \"1995 Option Plan\"), which provides for the granting of nonqualified stock options to acquire up to approximately 1.2 million shares of common stock to employees of the Company at a price not less than the fair market value of the common stock on the date the option is granted. The option terms and vesting periods are determined at the date of grant by a committee of the Board of Directors. Options expire six years after the date\nAMERISOURCE HEALTH CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 8--STOCK OPTION PLANS--(CONTINUED) of grant unless an earlier expiration date is set at the time of grant. During fiscal 1995, 895,000 options were granted under the 1995 Option Plan at an exercise price of $21.00 per share, and a 5-year vesting period; 7,500 options were subsequently canceled, leaving 887,500 options outstanding at September 30, 1995, none of which were exercisable.\nDuring fiscal 1995, the Company also adopted the AmeriSource Health Corporation Non-Employee Director Stock Option Plan (the \"Directors Plan\"), which provides for the grant of stock options to the Company's nonemployee directors. Under the Directors 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, except for the options under the initial grant, which are fully exercisable on the third anniversary of the grant. The total number of shares to be issued under the Directors Plan may not exceed 50,000 shares. During fiscal 1995, an initial grant of options under this plan were granted to purchase 20,000 shares of common stock at $21.00 per share, all of which were outstanding and none of which were exercisable at September 30, 1995.\nNOTE 9--LEASES\nThe costs of capital leases are included in property and equipment and the obligations therefor in other debt. Related amortization is included in depreciation. At September 30, 1995, future minimum payments totaling $31.2 million under noncancelable operating leases with remaining terms of more than one fiscal year were due as follows: 1996--$7.8 million; 1997--$7.0 million; 1998--$5.2 million; 1999--$3.2 million; 2000--$2.2 million; and thereafter (through 2009)--$5.8 million. In the normal course of business, operating leases are generally renewed or replaced by other leases.\nTotal rental expense was $7.6 million in fiscal 1995, $6.2 million in fiscal 1994, and $6.0 million in fiscal 1993.\nNOTE 10--LEGAL MATTERS AND CONTINGENCIES\nIn the ordinary course of its business, the Company becomes involved in lawsuits, administrative proceedings, and governmental investigations, including antitrust, environmental, product liability, and regulatory agency and other matters. In some of these proceedings, plaintiffs may seek to recover large and sometimes unspecified amounts and the matters may remain unresolved for several years. On the basis of information furnished by counsel and others, the Company does not believe that these matters, individually or in the aggregate, will have a material adverse effect on its business or financial condition.\nIn November 1993, the Company, along with six other wholesale distributors and twenty-four pharmaceutical manufacturers, were named as defendants in a series of purported class action antitrust lawsuits alleging violations of various antitrust laws associated with the chargeback pricing system. Plaintiffs seek injunctive relief, treble damages, attorneys' fees, and costs. In October 1994, the Company entered into a Judgement Sharing Agreement with other wholesaler and pharmaceutical manufacturer defendants. Under the Judgement Sharing Agreement (a) the manufacturer defendants agreed to reimburse the wholesaler defendants for litigation costs incurred, up to an aggregate of $9 million; and (b) if a judgement is entered into against both manufacturers and wholesalers, the total exposure for joint and several liability of the Company is limited to the lesser of 1% of such judgement or $1 million. In addition, the Company has released any claims that it might have had against the manufacturers for the claims presented by the plaintiffs in these lawsuits. The Judgement Sharing Agreement covers the federal court litigation as well as the cases which have been filed in various state courts. The Company believes it has meritorious defenses to the claims asserted in these lawsuits and intends to vigorously defend itself in all of these cases.\nAMERISOURCE HEALTH CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 10--LEGAL MATTERS AND CONTINGENCIES--(CONTINUED)\nThe Company is subject to contingencies pursuant to environmental laws and regulations at one of its former distribution centers that may require the Company to take remediation efforts. In fiscal 1994, the Company accrued $4.1 million to cover future consulting, legal, and remediation and ongoing monitoring costs. The accrued liability, which is reflected in other long-term liabilities on the accompanying consolidated balance sheet ($3.9 million at September 30, 1995), is based on an engineering analysis prepared by outside consultants and represents an estimate of the extent of contamination and choice of remedy, existing technology and presently enacted laws and regulations. However, changes in remediation standards, improvements in cleanup technology and discovery of additional information concerning the site could affect the estimated liability in the future. The Company is investigating the possibility of asserting claims against responsible parties for recovery of these costs. Whether or not any recovery may be forthcoming is unknown at this time, although the Company intends to vigorously enforce its rights and remedies.\nThe Company has received notices from the Internal Revenue Service asserting deficiencies in federal corporate income taxes for the Company's taxable years 1987 through 1991. The proposed adjustments indicate a net increase to taxable income for these years of approximately $24 million and relate principally to the deductibility of costs incurred with respect to the leveraged buyout transaction which occurred in 1988. The Company has analyzed these matters with tax counsel and believes it has meritorious defenses to the deficiencies asserted by the Internal Revenue Service. The Company will contest the asserted deficiencies through the administrative appeals process and, if necessary, litigation. The Company believes that any amounts assessed will not have a material effect on the financial statements of the Company.\nNOTE 11--NONRECURRING CHARGES\nThe nonrecurring charges in 1993 consisted of $1.3 million in losses on the disposal of three warehouses and charges of $1.0 million for the write-down to net realizable value of two additional warehouses no longer in operation which were designated for sale.\nAMERISOURCE HEALTH CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 12--OTHER INFORMATION (UNAUDITED)\nQUARTERLY FINANCIAL DATA (IN THOUSANDS, EXCEPT PER SHARE DATA)\n- -------- (1) Previously reported revenues have been restated to exclude the effect of bulk shipments to customers' warehouses as discussed in Note 1. (2) December 31, 1993 amounts reflect the cumulative effect of the accounting changes for postretirement benefits other than pensions and income taxes. June 30, 1994 amounts reflect the write-off of goodwill discussed in Note 3.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\n(No response to this Item is required.)\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nInformation regarding directors appearing under \"Election of Directors\" in the Company's Notice of Annual Meeting of Stockholders and Proxy Statement for the February 28, 1996 annual meeting of stockholders (the \"1996 Proxy Statement\") is incorporated herein by reference. The Company will file the 1996 Proxy Statement with the Commission pursuant to Regulation 14A within 120 days after the close of the fiscal year. Information regarding executive officers is set forth in Part I of this report.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nInformation regarding executive compensation appearing under \"Management, \"Compensation of Directors,\" \"Compensation Committee Interlocks and Insider Participation,\" \"Report of the Compensation Committee of the Board of Directors,\" and \"Stockholder Return Performance\" in the 1996 Proxy Statement is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nInformation regarding security ownership of certain beneficial owners and management appearing under \"Security Ownership of Certain Beneficial Owners and Management\" in the 1996 Proxy Statement is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nInformation appearing under \"Certain Relationships and Transactions\" in the 1996 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 (2) LIST OF FINANCIAL STATEMENTS AND SCHEDULES.\nFinancial Statements: The following consolidated financial statements are submitted in response to Item 14(a)(1):\nFinancial Statement Schedules: The following financial statement schedules are submitted in response to Item 14(a)(2) and Item 14(d):\nAll other schedules for which provision is made in the applicable accounting regulations of the SEC are not required under the related instructions or are inapplicable and, therefore, have been omitted.\n(a)(3) List of Exhibits.*\n- -------- * Copies of the exhibits will be furnished to any security holder of the Registrant upon payment of the reasonable cost of reproduction.\n(b) Reports on Form 8-K.\nRegistrant did not file a Current Report on Form 8-K during the fiscal quarter ended September 30, 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.\nAmeriSource Health Corporation\nDate: December 22, 1995 By: \/s\/ Kurt J. Hilzinger ---------------------------------- (KURT J. HILZINGER) VICE PRESIDENT, CHIEF FINANCIAL OFFICER AND TREASURER (PRINCIPAL FINANCIAL OFFICER AND PRINCIPAL ACCOUNTING OFFICER)\nPURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT HAS BEEN SIGNED BELOW ON DECEMBER 22, 1995 BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES INDICATED.\nSIGNATURE TITLE --------- -----\n\/s\/ John F. McNamara Chairman, President - ------------------------------------- and Chief (JOHN F. MCNAMARA) Executive Officer (Principal Executive Officer)\n\/s\/ Bruce C. Bruckmann Director - ------------------------------------- (BRUCE C. BRUCKMANN)\n\/s\/ Michael A. Delaney Director - ------------------------------------- (MICHAEL A. DELANEY)\n\/s\/ Richard C. Gozon Director - ------------------------------------- (RICHARD C. GOZON)\n\/s\/ Lawrence C. Karlson Director - ------------------------------------- (LAWRENCE C. KARLSON)\n\/s\/ George Strong Director - ------------------------------------- (GEORGE STRONG)\nDirector - ------------------------------------- (JAMES A. URRY)\n\/s\/ Barton J. Winokur Director - ------------------------------------- (BARTON J. WINOKUR)\nAMERISOURCE HEALTH CORPORATION AND SUBSIDIARIES\nSCHEDULE I--CONDENSED FINANCIAL INFORMATION OF REGISTRANT\nAMERISOURCE HEALTH CORPORATION\nCONDENSED BALANCE SHEETS (DOLLARS IN THOUSANDS)\nSee notes to condensed financial statements.\nS-1\nAMERISOURCE HEALTH CORPORATION AND SUBSIDIARIES\nSCHEDULE I--CONDENSED FINANCIAL INFORMATION OF REGISTRANT\nAMERISOURCE HEALTH CORPORATION CONDENSED STATEMENTS OF OPERATIONS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)\n---------------\nCONDENSED STATEMENTS OF CASH FLOWS (DOLLARS IN THOUSANDS)\nSee notes to condensed financial statements.\nS-2\nAMERISOURCE HEALTH CORPORATION\nFOOTNOTES TO THE CONDENSED FINANCIAL STATEMENTS\nNOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nThe accompanying condensed financial statements present the financial position, results of operations and cash flows of AmeriSource Health Corporation (the \"Company\") as of the dates and for the periods indicated in accordance with Rule 12-04 of Regulation S-X of the Securities Exchange Act of the Securities and Exchange Commission and, accordingly do not include the accounts of its wholly-owned subsidiaries. The Company's primary asset is its investment in and receivables from AmeriSource Corporation which is a wholly- owned subsidiary of the Company. Substantially all of the Company's operations are transacted by AmeriSource Corporation. The ability of the Company to pay its obligations depends on the operations of AmeriSource Corporation and its ability to pay dividends to the Company.\nThese condensed financial statements should be read in conjunction with the Consolidated Financial Statements of AmeriSource Health Corporation and Subsidiaries contained in Item 8 of this document for more information on long-term debt, stockholders' equity and other disclosures.\nNOTE 2--LONG-TERM DEBT\nIn July 1993, the Company issued $126.5 million principal amount of 11 1\/4% Senior Debentures due in 2005. Interest on the Senior Debentures is payable semiannually on January 15 and July 15 of each year. Through July 15, 1998, the Company may elect, at its option, to issue Senior Debentures in satisfaction of its interest payment obligations. The Senior Debentures are structurally subordinated to all indebtedness and other obligations of the Company. In connection with the Senior Debentures, the Company incurred approximately $5.1 million in financing fees which have been deferred and are being amortized over the twelve-year life of the indebtedness. In connection with the initial public offering described below, the Company redeemed one- half of the Senior Debentures outstanding which resulted in an extraordinary charge of $9.6 million (less a $2.7 million tax benefit) related to the write- off of unamortized deferred financing fees and premiums paid on redemption.\nNOTE 3--STOCKHOLDERS' EQUITY\nIn April 1995, the Company issued 7,590,000 shares of Class A common stock in a public offering at $21.00 per share. The net proceeds from the offering of $148.2 million (net of $1.3 million of issuance costs) were used to redeem a portion of the Senior Debentures ($81.7 million) described above and the remaining amounts were invested in AmeriSource Corporation, which were used to reduce its indebtedness. In conjunction with the initial public offering, the Company authorized a 2.95-for-1 stock split and, accordingly all references to earnings per share and share data in these condensed financial statements have been restated to give effect to the stock split.\nS-3\nAMERISOURCE HEALTH CORPORATION AND SUBSIDIARIES\nSCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS\n- -------- (1) Accounts written off during year, net of recoveries.\nS-4","section_15":""}
{"filename":"38984_1995.txt","cik":"38984","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nFremont General Corporation is a nationwide insurance and financial services holding company, operating select businesses in niche markets. The primary operating strategy of Fremont General is to build upon its core business units through acquisition opportunities and new business development. Fremont General's secondary strategy is to achieve income balance and geographic diversity among its business units in order to limit the exposure of Fremont General and its subsidiaries (\"Fremont General\" or \"the Company\") to industry, market and regional concentrations.\nThe Company is one of the largest mono-line workers' compensation insurers in the United States, with major market positions in California and Illinois, and a presence in Arizona, Indiana, Michigan and Wisconsin. For the year ended December 31, 1995, the Company's workers' compensation insurance premiums were evenly divided between the western and the mid-western regions. For the year ended December 31, 1995 and 1994, the Company had workers' compensation insurance premiums earned of $575 million and $401 million, respectively. See \"Insurance Operations.\" The Company recently expanded its workers' compensation insurance operations through the acquisition on February 22, 1995 of Casualty Insurance Company (\"Casualty\") and its wholly-owned subsidiary Workers' Compensation and Indemnity Company (\"WCIC\"). Casualty is the largest underwriter of workers' compensation insurance in Illinois with additional operations, directly or indirectly, in Indiana, Michigan and Wisconsin. Fremont General believes that this acquisition provides the Company with a national platform upon which to build its workers' compensation insurance business, while providing greater geographic diversification. See \"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\" and Note B of Notes to Consolidated Financial Statements. A.M. Best rates the Company's workers' compensation insurance subsidiaries on a consolidated basis as \"A-\" (Excellent). An \"A-\" rating is A.M. Best's fourth highest rating category out of fifteen rating categories ranging from \"A++\" (Superior) to \"F\" (In Liquidation).\nThe Company also has growing financial services operations engaged primarily in commercial and residential real estate lending in California and commercial finance lending, principally to small and middle market companies nationwide. The Company's financial services loan portfolio has grown from $536 million at December 31, 1991 to $1.5 billion at December 31, 1995. By engaging in several selected businesses which are geographically diverse the Company believes it can achieve greater stability in its operating results. Over the five years ended December 31, 1995, the Company's income before taxes grew at a compound annual rate of approximately 21% to $100 million in 1995. The Company's book value increased from $175 million at December 31, 1990 to $498 million at December 31, 1995. The Company's assets were $4.5 billion at December 31, 1995. See \"Financial Services Operations.\"\nManagement believes that ownership of the Company's Common Stock by employees has been an important element in the Company's success by enabling the Company to attract and retain the best available personnel for positions of substantial responsibility and to provide additional incentive and motivation to such individuals to promote the success of the Company. As of December 31, 1995, officers and directors of the Company, their families and the Company's ESOP beneficially owned approximately 30% of the Company's outstanding Common Stock.\nThe following Business section contains forward-looking statements which involve risks and uncertainties. The Company's actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth in this section and elsewhere in this Form 10-K.\nFremont General, a Nevada corporation, was incorporated in 1972.\nINSURANCE OPERATIONS\nWorkers' Compensation Insurance\nFremont Compensation Insurance Company and its subsidiaries (\"Fremont Compensation\") underwrites workers' compensation insurance principally in California and Illinois, with a smaller presence in Arizona, Indiana, Michigan, and Wisconsin. With the acquisition of Casualty in 1995, Fremont Compensation is one of the largest mono-line workers' compensation insurers in the United States. In 1995, Fremont\nCompensation's workers' compensation insurance premiums were evenly divided between the western and mid-western regions. The Company believes this geographic diversity mitigates potential fluctuations in earnings from cyclical downturns in various regional economies. A.M. Best rates the Company's workers' compensation insurance subsidiaries on a consolidated basis as \"A-\" (Excellent). In 1995, income before taxes from workers' compensation insurance operations was $85 million.\nWorkers' compensation is a statutory system which requires every employer to either purchase insurance or self-insure in order to provide its employees with medical care and other specified benefits for work-related injuries or illnesses. Compensation is payable regardless of who was at fault. Most employers provide for this potential liability by purchasing workers' compensation insurance from insurance carriers. There are four types of benefits payable under workers' compensation policies: medical benefits, vocational rehabilitation benefits, disability benefits and death benefits. The amounts of disability and death benefits payable for claims are established by statute, vocational rehabilitation benefits are provided with certain limitations in some jurisdictions, including California, and no dollar limitation is set forth for medical benefits. See \"Regulation -- Insurance Regulation.\"\nPremiums. Workers' compensation insurance premiums are based upon the policyholder's payroll and may be significantly affected by changes in general economic conditions which impact employment and wage levels, as well as by government regulation. Insurance premiums are also subject to supervision and regulation by the state insurance authority in each state. In July 1993, the California legislature enacted legislation to reform the workers' compensation system and to, among other things, adopt an open rating system through the repeal of the minimum rate law effective January 1, 1995. Illinois has been operating under an open rating system since 1982. In an open rating system, workers' compensation insurers are provided with advisory rates by job classification and each insurance company determines its own rates based in part upon its particular operating and loss costs. Although insurance companies are not required to adopt such advisory rates, companies in Illinois generally follow such rates. However, insurance companies in California have, since the adoption of an open rating system, generally set their premium rates below such advisory rates. Before January 1, 1995, California operated under a minimum rate law, whereby premium rates established by the California Department of Insurance were the minimum rates which could be charged by an insurance carrier. See \"Regulation -- Insurance Regulation.\" The repeal of the minimum rate law has resulted in lower premiums and lower profitability on the Company's California workers' compensation insurance policies due to increased price competition. The Company expects that the premiums earned in California will continue to decrease, principally due to price competition. In addition, the Company anticipates price competition to continue in Illinois, where an additional overall decrease in advisory rates of 13.6% was effective January 1, 1996. See \"Competition.\"\nUnderwriting and Loss Control. Prior to insuring a workers' compensation account, the Company's underwriting department reviews the employer's prior loss experience, safety record, credit history, operations, geographic location and employment classifications. The Company generally avoids industries and businesses involving hazardous conditions or high exposure to multiple injuries resulting from a single occurrence. The Company targets accounts that appear to have a strong work ethic among employees, long-term employees, and a genuine interest in the adoption of and adherence to loss control standards.\nThe loss control department participates in the initial underwriting process and provides continuing services while the policy is in force. In the initial underwriting phase, a Company loss control consultant will generally survey the employer's operations, review the employer's prior loss patterns and assess the extent to which such losses may be prevented. The loss control consultant will also meet with the employer's management to assess the extent to which management is committed to safety in the workplace. After the policy is issued, the loss control department provides continuing assistance to the employer in developing and maintaining safety programs and procedures, reviews periodic loss reports, attempts to identify weaknesses in the employer's loss control procedures and assists the employer in correcting these weaknesses.\nPolicyholders' Dividends. In 1995, the Company's workers' compensation insurance policies, both in California and those underwritten by Casualty, were predominately written as non-participating, which does not include provisions for the insurer to declare and pay dividends to a policyholder after the expiration of the\npolicy. In 1994 and prior, the Company's policies were predominately written as participating, thereby obligating the Company to consider the payment of dividends to a policyholder, based upon the policyholder's loss experience, the Company's overall loss experience and competitive conditions. This shift in policy type is due primarily to the increased competition in the California market which has resulted from the repeal of the minimum rate law, effective January 1, 1995. See \"Premiums\" and \"Regulation -- Insurance Regulation.\" The Company anticipates that this shift to non-participating policies will continue and be a characteristic element of the competitive environment.\nClaims Administration. The Company's policy is to settle valid claims promptly and to work closely with policyholders to return injured workers to the job quickly, while avoiding litigation if possible. Claims personnel communicate frequently with policyholders, injured employees and medical providers. The Company's policy is to control the number of cases assigned to its claims personnel, to identify and investigate questionable claims and to produce early and cost-effective case settlements of valid claims. As part of its \"zero tolerance\" program, the Company refuses to settle any claim that it believes to be fraudulent. In most claims litigated administratively, the Company utilizes its own non-lawyer hearing representatives and has found this practice to be significantly less expensive than using legal counsel.\nThe Company provides rehabilitation programs for insured employees and medical cost containment programs. The Company monitors medical care bills to determine if they are reasonable, audits hospital bills, reviews hospital utilization and becomes involved in the selection of treatment facilities.\nCompetition. The insurance industry is characterized by competition on the basis of price and service. Prior to January 1, 1995, minimum premium rates were prescribed for workers' compensation insurance in California by the Department of Insurance, and competition for underwriting such insurance in California had been based principally upon an insurance carrier's financial strength and history of paying policyholders' dividends. Secondary considerations included loss control and claims administration, the ability to respond promptly to agents and brokers, and commission schedules for agents and brokers. The repeal of the California minimum rate law effective January 1, 1995 has resulted in increased price competition which is adversely affecting the Company's results of operations for its workers' compensation insurance business in California. See \"Regulation -- Insurance Regulation.\" The Company recently expanded its workers' compensation operation through the acquisition on February 22, 1995 of Casualty, which underwrites workers' compensation insurance in several mid-western states, primarily in Illinois. Although Casualty is the largest underwriter of workers' compensation insurance in the Illinois market, based on the competitive nature of the insurance industry and the inherent risks associated with the Company entering into a new geographic market, there can be no assurance that Casualty will continue to maintain its market share in the future. In addition, advisory premium rates established by the National Council on Compensation Insurance, which workers' compensation insurance companies in Illinois generally tend to follow, decreased in 1995. An additional average overall decrease in such advisory rates of 13.6% went into effect on January 1, 1996. As a result, the Company anticipates price competition to continue in Illinois. Furthermore, state regulatory changes could affect competition in the states where the Company transacts insurance business. Although the Company is one of the largest writers of workers' compensation insurance in California and Illinois, certain of the Company's competitors are larger and have greater resources than the Company.\nMarketing. The Company markets its workers' compensation insurance products through more than 1,200 non-exclusive independent insurance agents and brokers, many of whom have been associated with the Company for more than 15 years. During 1995, the ten largest agents accounted for approximately 9% of the Company's workers' compensation insurance premiums written, and no single agent or broker accounted for more than 2% of premiums written.\nMedical Malpractice Insurance\nThe Company's medical malpractice insurance operation underwrites primarily standard professional liability insurance on a \"claims made\" basis in California. Coverage is provided for claims reported to the Company during the policy period arising from incidents that occurred at any time that the insured was covered by the policy. Fremont Indemnity Company, within which the medical malpractice insurance is\nwritten, is currently rated \"B++\" (Very Good) by A.M. Best. The Company offers coverage for individual medical doctors, anesthesiologists, podiatrists, as well as medical groups, community clinics, laboratories and miscellaneous medical clinics. The Company markets its policies exclusively through approximately 300 non-exclusive independent insurance agents and brokers. Revenues from this subsidiary were not significant in 1995, 1994 and 1993.\nReinsurance Ceded\nReinsurance is ceded primarily to reduce the liability on individual risks and to protect against catastrophic losses. The Company follows the industry practice of reinsuring a portion of its risks. For this coverage, the Company pays the reinsurer a portion of the premiums received on all policies.\nThe Company maintains excess of loss reinsurance treaties with various reinsurers for each of its insurance lines. Under the current workers' compensation reinsurance treaties, various reinsurers assume liability on that portion of the loss that exceeds $1 million per occurrence, up to a maximum of $199 million per occurrence. Further, in conjunction with the acquisition of Casualty, certain treaties were established between the Company and The Continental Insurance Company (\"Continental\") whereby certain liabilities of Casualty, which were not part of the business acquired, were ceded to Continental. For medical malpractice insurance, excess of loss reinsurance treaties cover claims and losses above $1 million, up to a maximum of $5 million. Although reinsurance makes the assuming reinsurer liable to the insurer to the extent of the reinsurance ceded, it does not legally discharge an insurer from its primary liability for the full amount of the policy liability. All of the foregoing reinsurance is with non-affiliated reinsurers. The Company believes that the terms of its reinsurance contracts are consistent with industry practice and, based on its review of the reinsurers' financial statements and reputations in the reinsurance marketplace, that its reinsurers are financially sound. The Company encounters disputes from time to time with its reinsurers, which, if not settled, are typically resolved in arbitration.\nThe Company's treaties are generally for annual terms. The Company has maintained reinsurance treaties with many of these same reinsurers for a number of years and believes that suitable alternative reinsurance treaties are readily obtainable at the present time. In general, the reinsurance agreements are of the treaty variety and cover all underwritten risks of types specified in the treaties. As of December 1995, The Continental Insurance Company and General Reinsurance Corporation were the only reinsurers that accounted for more than 10% of total amounts recoverable from all reinsurers on paid and unpaid losses.\nOperating Data\nSet forth below is certain information pertaining to the Company's workers' compensation insurance business as determined in accordance with GAAP for the years indicated. See \"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\" for a discussion of certain of this information.\n- --------------- (1) Includes net realized investment gains and interest expense.\nStatutory Combined Ratio. The following table reflects the combined ratios of the Company's insurance subsidiaries determined in accordance with statutory accounting practices, together with the property and\ncasualty industry-wide combined ratios after policyholders' dividends, as compiled by A.M. Best for the years indicated.\n- --------------- (1) Nationwide statutory combined ratio information for the workers' compensation insurance industry for 1991 through 1994 is from A.M. Best's Aggregates & Averages, Property-Casualty (1992 through 1995 editions).\nPremium-to-Surplus Ratio. Regulatory authorities regard the premium-to-surplus ratio as an important indicator of operating leverage, since the lower the ratio, the greater the insurer's ability to withstand abnormal loss experience. Guidelines established by the National Association of Insurance Commissioners (\"NAIC\") provide that a property and casualty insurer's premium-to-surplus ratio is satisfactory if it is below 3 to 1.\nThe following table sets forth the Company's consolidated ratio of net property and casualty premiums written during the period to policyholders' surplus on a statutory basis at the end of the period, for the periods indicated:\n- --------------- (1) Includes net written premium for Casualty and WCIC for the period January 1, 1995 through February 21, 1995, which was prior to the Company's acquisition of Casualty on February 22, 1995.\nLoss and Loss Adjustment Expense Reserves\nIn many cases, significant periods of time, ranging up to several years or more, may elapse between the occurrence of an insured loss, the reporting of the loss to the insurer, and the insurer's payment of that loss. To recognize liabilities for future unpaid losses, insurers establish reserves, which are balance sheet liabilities, representing estimates of future amounts needed to pay claims with respect to insured events that have occurred. Reserves are also established for loss adjustment expense reserves (\"LAE\") representing the estimated expenses of settling claims, including legal and other fees, and general expenses of administering the claims adjustment process.\nReserves for losses and LAE are based not only on historical experience but also on management's judgment of the effects of matters such as future economic and social forces likely to impact the insurer's experience with the type of risk involved, circumstances surrounding individual claims, and trends that may affect the probable number and nature of claims arising from losses not yet reported. Consequently, loss reserves are inherently subject to a number of highly variable circumstances.\nReserves for losses and LAE are revalued periodically using a variety of actuarial and statistical techniques for producing current estimates of expected claim costs. Claim frequency and severity and other economic and social factors are considered in the reevaluation process. A provision for inflation in the calculation of estimated future claim costs is implicit since reliance is placed on both actual historical data, which reflect past inflation, and on other factors which are judged to be appropriate modifiers of past experience. Adjustments to liabilities are reflected in operating results for the periods to which they are made.\nReconciliation of Loss and Loss Adjustment Expense Reserves. The following table shows in accordance with GAAP the reconciliation of the estimated liability for losses and LAE for the Company's property\nand casualty insurance subsidiaries (excluding discontinued operations) and the effect on income for each of the three years indicated.\nRECONCILIATION OF RESERVES FOR LOSSES AND LAE\n- --------------- (1) See \"Analysis of Loss and Loss Adjustment Expense Development\" below for discussion of the decrease in reserve estimates during 1994.\nAnalysis of Loss and Loss Adjustment Expense Development. The following table shows the cumulative amount paid against the previously recorded liability at the end of each succeeding year and the cumulative development of the estimated liability for the ten years ending December 31, 1995. Conditions and trends that have affected the development of these reserves and payments in the past will not necessarily recur in the future. Accordingly, it would not be appropriate to use this cumulative history to project future performance.\nThe re-estimated liability portion of the following table shows the year by year development of the previously estimated liability at the end of each succeeding year. The re-estimated liabilities are increased or decreased as more information becomes known about the frequency and severity of claims for individual years. The increases or decreases are reflected in the current year's operating earnings. Each column shows the reserve held at the indicated calendar year-end and cumulative data on re-estimated liabilities for the year and all prior years making up those calendar year end liabilities. The effect on income of the charge (credit) during the current period (i.e., the difference between the estimated liability at December 31 and the liability estimated one year later) is shown in the table above for each of three most recent years as \"Increase (decrease) in provision for insured events of prior years.\"\nCHANGES IN HISTORICAL RESERVES FOR LOSS AND LAE FOR THE LAST TEN YEARS GAAP BASIS AS OF DECEMBER 31, 1995\n- ---------------\n(1) Excludes $116,756,000 in loss and LAE payments on 1994 and prior years related to reserves acquired from Casualty.\nThe Company is required to maintain reserves to cover its estimated ultimate liability for losses and LAE with respect to reported and unreported claims incurred as of the end of each accounting period. These reserves do not represent an exact calculation of liabilities, but rather are estimates involving actuarial projections at a given time of what the Company expects the ultimate settlement and administration of claims will cost based on facts and circumstances then known, predictions of future events, estimates of future trends in claims' frequency and severity and judicial theories of liability as well as other factors. The Company regularly reviews its reserving techniques, overall reserve position and its reinsurance. In light of present facts and current legal interpretations, management believes that adequate provision has been made for loss reserves. In making this determination, management has considered its claims experience to date, loss development history for prior accident years, estimates of future trends of claims frequency and severity, and various external factors such as judicial theories of liability. However, establishment of appropriate reserves is an inherently uncertain process, and there can be no certainty that currently established reserves will prove adequate in light of subsequent actual experience. Subsequent actual experience has resulted and could result\nin loss reserves being too high or too low. Future loss development could require reserves for prior periods to be increased, which would adversely impact earnings in future periods.\nIn 1995, there was relatively insignificant development on 1994 and prior accident years of $1.4 million. In 1994, the Company decreased its losses and LAE reserves for 1993 and prior accident years by $17.2 million. This reserve decrease was partially offset by an increase in the liability for dividends to policyholders. Further, this reduction in reserves represents the recognition of a continued decrease in the frequency and severity of reported claims on 1994 and prior accident years. For the 1993 calendar year, losses and LAE development on 1992 and prior accident years was a relatively modest $4.1 million decrease in loss and LAE reserves. The Company is not able to determine with certainty the specific cause or causes of increases and decreases in claims experience that led to these changes in reserves but has reached its own conclusion based on a review of its internal data base and a subjective evaluation of external factors. The following discussion is a summary of the principal considerations that the Company evaluated in determining workers' compensation insurance reserve adjustments during 1994 and 1993.\nThe Company believes that a number of factors including the economic recession in California (including unemployment rates) in the early 1990's, primarily 1990 and 1991, led to increases in the occurrence and magnitude of post-employment stress claims submitted to the Company, including many fraudulent claims. These conditions mirrored those of the California workers' compensation industry in general as private workers' compensation insurers in California, including the Company, substantially increased loss reserves in calendar year 1992 for the 1990 and 1991 accident years. The effect of fraud on the industry during 1990 and 1991 is further supported by the impact of actions taken by the California legislature in 1992 to limit workers' compensation fraud. In connection with this legislation, the Company instituted its \"zero tolerance\" program and began to aggressively investigate and prosecute those attempting to defraud policyholders through filing and encouraging fraudulent workers' compensation insurance claims. Thus, while unemployment continued to remain high in California during 1992 the number of claims and loss ratios for the industry on the 1992 accident year declined. The Company believes the decline in claim frequency and severity, which continued into 1994, is due primarily to the anti-fraud legislation enacted in California and the anti-fraud campaigns thereafter undertaken by the Company and other members of the workers' compensation insurance industry. In 1993, the Company only partially recognized this decline in claim frequency and severity, due in part to a lack of sufficient information to confirm the continued trend in claim frequency and severity decreases. The significant reserve decrease in 1994 for losses and LAE on 1993 and prior accident years of $17.2 million represents the Company's additional recognition of these claim frequency and severity decreases, and reflects the results of the Company's review of statistical evidence that emerged in 1994 which further confirmed the claim frequency and severity decreases related to the 1993 and prior accident years.\nINVESTMENT PORTFOLIO\nThe Company manages its investments internally. The following portfolio information reflects the Company's continuing operations. See \"Discontinued Operations.\"\nThe following table reflects the amortized cost and fair value of fixed maturity investments and non-redeemable preferred equity securities by major category, as well as the amortized cost and fair value of cash and short-term investments on the dates indicated.\nAs of December 31, 1995, substantially all of the fixed maturity investments in the portfolio were rated investment grade. Using Standard and Poor's, Moody's and Fitch's rating services, 59% were rated \"A\" or higher, 40% were rated BBB and 1% were rated BB. As of December 31, 1995, these investment securities had an approximate fair value of $1.3 billion, which was higher than amortized cost by approximately $41 million. The Company does not currently plan or intend to invest in securities rated below investment grade.\nThe following table reflects the average cash and investment assets of the Company and its subsidiaries for the periods indicated.\nThe Company's general investment philosophy is to hold fixed income securities for long term investment. As a result of changing accounting and industry practice and management's evaluation of the investment portfolio, the Company has segregated its portfolio into investments held to maturity and those that would be available for sale in response to changing market conditions, liquidity requirements, interest rate movements and other investment factors. At December 31, 1995 and 1994, Company held securities having an amortized cost of $1.5 billion and $526 million, respectively, as available for sale. See \"Item 7. Management's Discussion and Analysis\" and Notes A and C of Notes to Consolidated Financial Statements.\nThe following table sets forth maturities in the fixed maturity and short-term investment portfolios at December 31, 1995:\nUsing Standard and Poor's, Moody's and Fitch's rating services, the following table sets forth the quality mix of the Company's fixed maturity investment portfolio at December 31, 1995:\nFINANCIAL SERVICES OPERATIONS\nReal Estate Lending\nIn 1990, the Company acquired Investors Bancor, a holding company for Fremont Investment & Loan (formerly Investors Thrift), a California thrift and loan from Tomar Financial Corporation for approximately $6.7 million. Fremont Investment & Loan (\"Fremont I & L\") serves more than 23,000 customers through its 12 branches, and its deposits are insured by the Federal Deposit Insurance Corporation (\"FDIC\"). See \"Regulation -- Thrift and Loan Regulation.\" Fremont I & L's operations are primarily engaged in commercial and residential real estate lending. Income before taxes from the real estate lending operation has increased significantly from $2.5 million in 1991 to $10.6 million in 1995. Assets of the real estate lending operation have grown from $278 million at the end of 1991 to $1.05 billion at the end of 1995, due to increased loan originations and to the purchase of loan portfolios from other financial institutions. Fremont I & L funds its lending activities through its deposits and capital. Deposits consists of full-paid investment certificates (which are similar to certificates of deposit) and installment investment certificates (which are similar to passbook accounts and money market accounts). Deposits totaled $926 million at December 31, 1995.\nThe ability of the Company to continue to originate loans, and of borrowers to repay outstanding loans, may be impaired by adverse changes in local or regional economic conditions which affect such areas or by adverse changes in the real estate market in those areas. Such events could also significantly impair the value of the underlying collateral. If the Company's collateral were to prove inadequate, the Company's results of operations could be adversely affected. In addition, the financial services industry is characterized by competition on the basis of price and service.\nLoan Origination. Fremont I & L originates loans through independent loan brokers and through its own loan agents. In 1994, Fremont I & L purchased an aggregate of $366 million in primarily California commercial real estate loan portfolios from financial institutions. Acquisition costs of purchased loan portfolios are significantly lower than if loans were originated by the Company. In 1995, no portfolios of commercial real estate loans were purchased, primarily due to increased competition which resulted in inadequate yields or unacceptable risk profiles for the portfolios considered. The Company originates and purchases loans primarily for its own portfolio rather than for resale to third parties. The Company performs an internal evaluation of the underlying collateral at the time each loan is purchased and applies strict underwriting guidelines that include conservative loan-to-value ratios.\nFremont I & L has primarily focused on the origination of commercial real estate loans secured by first trust deeds on income-producing properties in California. The real estate securing these loans include a wide variety of property types, such as small office buildings, small shopping centers, owner-user office\/warehouses and retail properties. Fremont I & L does not originate commercial real estate construction and development loans. The majority of the commercial real estate loans originated are adjustable rate loans and generally range between $1 to $5 million. As of December 31, 1995, the average loan size was $1,030,000 and the approximate average loan-to-value ratio was 66%, using the most current available appraised values and current balances outstanding. The total amount of commercial real estate loans outstanding at December 31, 1995 was $731 million or 81% of the loan portfolio. Loans secured by commercial real estate are generally considered to entail a higher level of risk than loans secured by residential real estate. Although the properties securing the Company's commercial real estate loans generally have good operating histories, there is no assurance that such properties will continue to generate sufficient funds to allow their owners to make full and timely mortgage loan payments. At December 31, 1995, Fremont I & L had forty-seven non-accrual commercial real estate loans totaling approximately $21.5 million and commercial real estate owned of approximately $4.4 million.\nFremont I & L also originates loans secured by single-family residences. At December 31, 1995, single family residential real estate secured loans, represented $166 million, or 18%, of Fremont I & L's loan portfolio. Substantially all of these loans are secured by first trust deeds. These loans have principal amounts primarily below $300,000, have maturities of nine to thirty years and are approved in accordance with lending policies approved by Fremont I & L's Board of Directors which includes standards covering, among other things, collateral value, loan to value and debt ratio. At December 31, 1995, the average single-family loan amount was $118,000, and the approximate average loan-to-value ratio was 74%, using appraised values at the time of loan origination and current balances outstanding.\nThe portfolio of Fremont I & L's loans receivable as of the dates indicated are summarized in the following table by type of primary collateral.\nFunding Sources. Fremont I & L obtains funds from depositors by offering full-paid investment certificates and installment investment certificates insured by the FDIC to the legal maximum through its 12 branches in California. Fremont I & L has typically offered higher interest rates to its depositors than do most full service financial institutions. At the same time, it has minimized the cost of maintaining these accounts by not offering transaction accounts or services such as checking, safe deposit boxes, money orders, ATM access and other traditional retail services. Fremont I & L generally effects deposit withdrawals by issuing checks rather than disbursing cash, which minimizes operating costs associated with handling and storing cash. Additional financing became available from the Federal Home Loan Bank of San Francisco effective January 1995. This financing is available at varying rates and terms. As of December 31, 1995, $170 million was available under the facility and no borrowings were outstanding.\nThe table below summarizes Fremont I & L's investment certificates as of December 31, 1995 which are stated in amounts of $100,000 or more, by maturity and by type.\nCommercial Finance\nThe Company's commercial finance subsidiary, Fremont Financial Corporation (\"Fremont Financial\"), provides working capital loans, primarily secured by accounts receivable and inventory, to small and middle market companies on a nationwide basis. Fremont Financial's total loan portfolio has grown from $189 million at December 31, 1991 to $569 million at December 31, 1995. This growth has been achieved through development of Fremont Financial's customer base through loan originations and through participation in syndicated loan transactions. In 1995, income before taxes from commercial finance was $22.8 million. The lending market has become increasingly competitive for small to middle market commercial borrowers. As a result, Fremont Financial has experienced decreasing yields on its commercial finance loans. In addition, adverse economic developments can negatively affect the Company's business and results of operations in a number of ways. Such developments can reduce the demand for loans, impair the ability of borrowers to pay loans and impair the value of the underlying collateral. Commercial finance loans made by Fremont Financial\nare primarily on a revolving short-term basis (generally two or three years) and secured by assets which primarily include accounts receivable, inventory, machinery and equipment and, to a lesser extent, real estate and other types of collateral. In addition, Fremont Financial also makes term loans secured primarily by equipment and real estate. The term loans originated in conjunction with revolving loans are cross-collateralized (i.e., the same collateral is used to support both the term loans and all the related revolving loans) and coterminous with the related revolving loan made to the same borrower. The term to maturity for the term loans is generally five to seven years; however, certain term loans are \"balloon loans\" that amortize over a longer period and therefore do not amortize fully before their respective maturities. Commercial loans also include secured loans originated and serviced by other asset-based lenders and participated in by Fremont Financial. As of December 31, 1995, the average outstanding commercial loan balance was $2.7 million. Loans outstanding to a single borrower generally range in size from $500,000 to $15,000,000.\nThe major avenue of growth for Fremont Financial remains the establishment of new lending relationships. The Company has a national presence with regional offices in Santa Monica, Chicago, New York and Atlanta, as well as eight other marketing offices across the country. To provide a stable source of funds to facilitate the continued expansion of its asset-based lending business, the Company, in 1993, established the Fremont Small Business Loan Master Trust (\"Fremont Trust\") for the purpose of securitizing the greater part of its commercial finance loan portfolio. The Fremont Trust is a master trust that can issue multiple series of asset-backed certificates which represent undivided interests in the Fremont Trust's assets (primarily commercial finance loans) and Fremont Financial will continue to service the loans thereunder. The proceeds from the sale of the initial series of asset-backed certificates (\"Series A\") under this program in April 1993 were $200 million bearing interest at the rate of LIBOR plus 0.47%. In November 1993, an additional $100 million of these certificates (\"Series B\") were sold bearing interest at the rate of LIBOR plus 0.5%. The securities issued in this program have a scheduled maturity of three and four years, but could mature earlier depending on fluctuations in outstanding balances of loans in the portfolio and other factors. During April 1995, the Company issued $30 million in subordinated variable rate asset-backed certificates, which mature in 2000, via a private placement. As of December 31, 1995, up to $500 million in additional publicly offered asset-backed certificates may be issued pursuant to a shelf registration statement to fund future growth in the commercial finance loan portfolio. In February 1996, $135 million in asset-backed certificates (\"Series C\") were issued which mature in 2000. The proceeds were used, in conjunction with existing cash, to retire the $200 million in Series A certificates. The Series B certificates are scheduled to mature in 1997. In December 1995, a commercial paper facility was established as part of the asset securitization program. This facility provides for the issuance of up to $150 million in commercial paper, dependent upon the level of assets within the asset securitization program. This facility, which expires in December 1998, had no amounts outstanding under it as of December 31, 1995. The commercial finance operation also has an unsecured revolving line of credit with a syndicated bank group that presently permits borrowings of up to $300 million, of which $185 million was outstanding as of December 31, 1995. This credit line is primarily used to finance assets which are not included in the Company's asset securitization program. This credit line expires August 1998.\nThe Company's customer base consists primarily of small to middle market manufacturers and distributors which generally require financing for working capital and debt restructuring. At December 31, 1995, the Company had approximately 195 loans outstanding in 34 states and the District of Columbia. Approximately 32% of total loans outstanding were made to companies based in California, and no other state accounted for more than 10% of total loans outstanding.\nAsset-based revolving loans permit a company to borrow from the lender at any time during the term of the loan agreement, up to the lesser of a maximum amount set forth in the loan agreement or a percentage of the value of the collateral which primarily secures such loans. Under an asset-based lending agreement, the borrower retains the credit and collection risk with respect to the collateral in which the lender takes a security interest. Cash collections are received as often as daily by or on behalf of the borrower after the loan is initially made. These collections are paid to the lender to reduce the loan balance.\nWhile consideration is given to the net worth and profitability of a client, asset-based loans are generally extended to borrowers who do not have bank sources of credit readily available and are based on the estimated liquidation value of the collateral pledged to secure the loan. The largest percentage of realized losses has resulted from fraud or collateral misrepresentations by the borrower. Fremont Financial seeks to protect itself\nagainst this risk through a comprehensive system of collateral monitoring and control. Fremont Financial's auditors perform auditing procedures of a borrower's books and records and physically inspects the collateral prior to approval and funding, as well as approximately every 90 days during the term of the loan. General economic conditions beyond the Company's control can and do impact the ability of borrowers to repay loans and also the value of the assets collateralizing such loans.\nOver the past four years, the majority of Fremont Financial's loans that have been liquidated have been fully repaid, as Fremont Financial attempts to work closely with the borrower through the liquidation to ensure repayment of the loan. Fremont Financial seeks to maintain conservative collateral valuations and perfection of security interests.\nFremont Financial primarily competes with commercial finance companies and banks, most of whom are larger and have greater financial resources than Fremont Financial. The principal competitive factors are the rates and terms upon which financing is provided and customer service. The lending market has become increasingly competitive for small to middle market commercial borrowers. As a result, Fremont Financial has experienced decreasing yields on its commercial finance loans.\nPremium Financing and Life Insurance\nThe Company finances property and casualty insurance premiums through its subsidiary, Fremont Premium Finance Corporation. This premium finance loan portfolio is collateralized by the unearned premiums of the underlying insurance policies. Revenues and operating income from this subsidiary were not significant in 1995, 1994 or 1993.\nPrior to January 1, 1996, the Company offered life insurance products, including annuities, credit life and disability insurance and term life insurance for consumers, through its subsidiary, Fremont Life Insurance Company. On December 31, 1995 and on January 1, 1996, the Company entered into reinsurance and assumption agreements with a reinsurer whereby assets and liabilities related to certain life insurance and annuity policies were ceded to the reinsurer. These reinsurance agreements are part of several other agreements which collectively act to significantly reduce the Company's life insurance operations. The effect on operations from these agreements is not expected to be material, and revenues and operating income from this subsidiary were not significant in 1995, 1994 or 1993.\nDISCONTINUED OPERATIONS\nThe Company's discontinued operations consist primarily of assumed treaty and facultative reinsurance business that was discontinued between 1986 and 1991. In 1990, the Company established a management group to actively manage the liquidation of this business. The liabilities associated with this business are long term in duration and therefore, the Company continues to be subject to claims being reported. Claims under these reinsurance treaties include professional liability, product liability and general liability which include environmental claims.\nThe Company supports these discontinued operations with $191 million in cash and investment grade fixed income securities, reinsurance recoverables of $54 million and other assets totaling $18 million. The Company estimates that the dedicated assets supporting these operations and all future cash inflows will be adequate to fund future obligations. However, should those assets ultimately prove to be insufficient, the Company believes that its property and casualty subsidiaries would be able to provide whatever additional funds might be needed to complete the liquidation without having a material adverse effect on the Company's consolidated financial position or results of operations. See Note M of Notes to Consolidated Financial Statements. The discontinued operations have investment portfolios which resemble the portfolios in the ongoing operations with regard to asset allocation, quality, performance and maturities.\nREGULATION\nInsurance Regulation\nThe Company's workers' compensation insurance operations are concentrated in California and Illinois, with additional writings in Arizona, Indiana, Michigan and Wisconsin. Insurance companies are subject to supervision and regulation by the state insurance authority in each state in which they transact business. Such supervision and regulation relate to numerous aspects of an insurance company's business and financial condition. The primary purpose of such supervision and regulation is the protection of policyholders rather than investors or shareholders of an insurer. The extent of such regulation varies, but generally derives from state statutes that delegate regulatory, supervisory and administrative authority to state insurance departments. Accordingly, the authority of the state insurance departments includes the establishment of standards of solvency which must be met and maintained by insurers, the licensing to do business of insurers and agents, the nature of and limitations on investments by insurers, premium rates for certain property and casualty insurance, and life and disability insurance, the provisions which insurers must make for current losses and future liabilities and the approval of policy forms. Additionally, most states require issuers to participate in assigned risk plans which provide insurance coverage to individuals or entities who are unable to obtain coverage from existing insurers in those states. The net profit or loss incurred in the administration of these plans is allocated back to participant insurers based on the insurers' relative market share (i.e. insurance premiums) in each state. State insurance departments also conduct periodic examinations of the affairs of insurance companies and require the filing of annual and other reports relating to the financial condition of insurance companies. The Company's multistate insurance operations require, and will continue to require, significant resources of the Company in order to continue to comply with the regulations of each state in which it transacts business.\nWorkers' Compensation Regulation. Illinois began operating under an open rating system in 1982 and California began operating under such a system effective January 1, 1995. In an open rating system, workers' compensation companies are provided with advisory rates by job classification and each insurance company determines its own rates based in part upon its particular operating and loss costs. Although insurance companies are not required to adopt such advisory rates, companies in Illinois generally follow such rates. However, insurance companies in California have, since the adoption of an open rating system, generally set their premium rates below such advisory rates. Before January 1, 1995, California operated under a minimum rate law, whereby premium rates established by the California Department of Insurance were the minimum rates which could be charged by an insurance carrier.\nIn July 1993, California enacted legislation to reform the workers' compensation insurance system and to, among other things, (i) reduce workers' compensation manual premium rates by 7% effective July 16, 1993 and (ii) adopt an open rating system through the repeal of the minimum rate law effective January 1, 1995. In addition to the July 1993 legislation, in December 1993, the California Insurance Commissioner reduced workers' compensation manual premium rates on new and renewal business an additional 12.7% effective January 1, 1994. In September 1994, California workers' compensation manual premium rates were further reduced by 16% effective October 1, 1994 on all business incepting on or after January 1, 1994.\nThe repeal of the minimum rate law on January 1, 1995 has resulted in lower premiums and lower profitability in the Company's California workers' compensation insurance business due to increased price competition. The Company believes that its acquisition of Casualty, with policies written primarily outside of California, has lessened the impact of the repeal of the minimum rate law by providing geographic diversity, which mitigates the impact of economic and regulatory changes within a regional marketplace.\nPrior to January 1, 1995, the Company's policies were predominately written as participating, thereby obligating the Company to consider the payment of dividends to policyholders. The ability of the Company's subsidiaries to pay policyholder dividends on workers' compensation insurance policies was subject to California regulations which stated in part that dividends under a workers' compensation policy could only be paid from surplus accumulated on workers' compensation policies issued in California. Beginning in 1995, the payment of policyholder dividends in respect of workers' compensation policies written in California is not limited. However, in 1995 the Company's workers' compensation insurance policies, both in California and Illinois, were predominately written as non-participating, which does not include provisions for dividend consideration. This shift in policy type\nis due primarily to the increased competition in the California market which has resulted from the repeal of the minimum rate law, effective January 1, 1995. The Company anticipates that this shift to non-participating policies will continue and be a characteristic element of the competitive environment. In addition, the Company's subsidiaries are required, with respect to their workers' compensation line of business, to maintain on deposit investments meeting specified standards that have an aggregate market value equal to the Company's loss reserves.\nInsurance Guaranty Association Laws. Under insolvency or guaranty fund laws in most states in which the Company's insurance subsidiaries operate, insurers doing business in those states can be assessed, up to the prescribed limits, for losses incurred by policyholders as a result of the insolvency of other insurance companies. The amount and timing of such assessments are beyond the control of the Company and generally have not had an adverse impact on the Company's earnings in years in which such assessments have been made. Premiums written under workers' compensation policies are subject to assessment only with respect to covered losses incurred by the insolvent insurer under workers' compensation policies. The Company believes it does not face any material exposure to guaranty fund assessments.\nHolding Company Regulation. The Company is subject to the California Insurance Holding Company System Regulatory Act (the \"Holding Company Act\"). This act, and similar laws in other states, require the Company to periodically file information with the California Department of Insurance and other state regulatory authorities, including information relating to its capital structure, ownership, financial condition and general business operations. Certain transactions between an insurance company and its affiliates, including sales, loans or investments which in any twelve month period aggregate at least 5% of its admitted assets or 25% of its statutory capital and surplus, also are subject to prior approval by the Department of Insurance.\nThe Holding Company Act also provides that the acquisition or change of \"control\" of a California domiciled insurance company or of any person who controls such an insurance company cannot be consummated without the prior approval of the Insurance Commissioner. In general, presumption of \"control\" arises from the ownership of voting securities and securities that are convertible into voting securities, which in the aggregate constitute 10% or more of the voting securities of a California insurance company or of a person that controls a California insurance company, such as Fremont General. The Liquid Yield Option(TM) Notes (\"LYONs\") constitute a security convertible into the voting Common Stock of the Company, and the shares of Common Stock into which a holder's LYONs are convertible and any other securities convertible into Common Stock must be aggregated with any other shares of Common Stock of the holder for purposes of determining the percentage ownership. A person seeking to acquire \"control,\" directly or indirectly, of the Company must generally file with the Insurance Commissioner an application for change of control containing certain information required by statute and published regulations and provide a copy of the application to the Company. The Holding Company Act also effectively restricts the Company from consummating certain reorganizations or mergers without prior regulatory approval.\nThe Holding Company Act also limits the ability of the Company's insurance subsidiaries to pay dividends to the Company. The act permits a property and casualty insurance company to pay dividends in any year which, together with other dividends or other distributions made within the preceding twelve months, do not exceed the greater of 10% of its statutory surplus or 100% of its net income as of the end of the preceding year, subject to a limit equal to prior year end unassigned funds less unrealized capital gains contained within unassigned funds. Larger dividends are payable only upon prior regulatory approval. Applicable regulations further require that an insurer's statutory surplus following a dividend or other distribution be reasonable in relation to its outstanding liabilities and adequate to its financial needs. Based upon restrictions presently in effect, the maximum amount available for payment of dividends by the Company's direct property and casualty subsidiaries during 1996 without prior regulatory approval is approximately $30 million. In addition, insurance regulations require that the Department of Insurance be given fifteen days advance notice of any dividend payment.\nOther Regulations. The NAIC has adopted a formula to calculate risk based capital (\"RBC\") of property and casualty insurance companies for inclusion in annual statements. The purpose of the RBC model is to help state regulatory authorities monitor the capital adequacy of property and casualty insurance companies by measuring several major areas of risk facing property and casualty insurers including underwriting, credit and investment risks. Companies having less statutory surplus than the RBC model calculates will be required to adequately address these risk factors and will be subject to varying degrees of\nregulatory intervention, depending on the level of capital inadequacy. As of December 31, 1995 the Company's insurance subsidiaries engaged in continuing operations exceed all RBC levels requiring any regulatory intervention.\nThrift and Loan Regulation\nFremont I & L is subject to supervision and regulation by the Department of Corporations of the State of California (the \"DOC\") and, as an insured institution, by the FDIC. Neither Investors Bancor nor Fremont I & L is regulated or supervised by the Office of Thrift Supervision, which regulates savings and loan institutions. Fremont General is generally not directly regulated or supervised by the DOC, the FDIC, the Federal Reserve Board or any other bank regulatory authority, except with respect to guidelines concerning its relationship with Investors Bancor and Fremont I & L. Such guidelines include (i) general regulatory and enforcement authority of the DOC and the FDIC over transactions and dealings between Fremont General and Fremont I & L, (ii) specific limitations regarding ownership of the capital stock of the parent company of any thrift and loan company, and (iii) specific limitations regarding the payment of dividends from Fremont I & L as discussed below. Fremont I & L is examined on a regular basis by both agencies.\nFederal and state regulations prescribe certain minimum capital requirements and, while Fremont I & L is currently in compliance with such requirements, the Company could in the future be required to make additional investments in Fremont I & L in order to maintain compliance with such requirements. Federal and state regulatory authorities have the power to prohibit or limit the payment of dividends by Fremont I & L. Future changes in government regulation and policy could adversely affect the thrift and loan industry, including Fremont I & L.\nThe FDIC conducted an examination of Fremont I & L as of August 31, 1994. The examination resulted in the FDIC requiring Fremont I & L to enter into a Memorandum of Understanding in January 1995 (\"the MOU\"). The MOU requires, among other things, that Fremont I & L: (a) maintain management acceptable to the FDIC, (b) maintain a ratio of Tier 1 capital as a percentage of average quarterly assets of at least 8.5%, (c) maintain an adequate reserve for loan losses, (d) reduce its dependence on volatile liabilities, (e) not pay cash dividends without the prior written consent of the FDIC, and (f) effect revisions and enhancements to certain policies and procedures, including lending, collection, reserve for loan losses, asset\/liability management and affiliate transaction policies and procedures.\nThe FDIC conducted another examination as of March 31, 1995, in conjunction with a DOC examination as of the same date. The FDIC's and DOC's reports issued as a result of this examination indicated that Fremont I & L's compliance with the MOU was satisfactory. The Company does not believe that the restrictions on Fremont I & L's ability to pay dividends imposed by the MOU or by federal or state law will adversely affect the ability of Fremont General to meet its obligations. However, no assurances can be given as to when, or if, the MOU will be terminated.\nCalifornia Law. The thrift and loan business conducted by Fremont I & L is governed by the California Industrial Loan Law and the rules and regulations of the Commissioner which, among other things, regulate the collateral requirements and maximum maturities of the various types of loans that are permitted to be made by California-chartered industrial loan companies, i.e., thrift and loan companies or investment and loans.\nSubject to restrictions imposed by applicable California law, Fremont I & L is permitted to make secured and unsecured consumer and non-consumer loans. The maximum term for repayment of loans made by thrift and loan companies range up to forty years and thirty days depending upon collateral and priority of secured position, except that loans with repayment terms in excess of thirty years and thirty days may not in the aggregate exceed 5% of total outstanding loans and obligations of the thrift. Consumer loans secured by real property with terms in excess of three years must be repayable in substantially equal periodic payments unless such loans are covered under the Garn-St. Germain Depository Institutions Act of 1982 (primarily single-family residential loans). Non-consumer loans may be repayable in unequal periodic payments during their respective terms. California law limits lending activities outside of California by thrift and loan companies to no more than 30% of total assets.\nCalifornia law contains extensive requirements for the diversification of the loan portfolios of thrift and loan companies. A thrift and loan with outstanding investment certificates may not, among other things, place more than 5% of its loans or other obligations in loans or obligations which are secured only partially, but not primarily, by real property; may not make any one loan secured primarily by improved real property which exceeds 20% of its paid-up and unimpaired capital stock and surplus not available for dividends; may not lend an amount in excess of 5% of its paid-up and unimpaired capital stock and surplus not available for dividends upon the security of the stock of any one corporation; may not make loans to, or hold the obligations of, any one person as primary obligor in an aggregate principal amount exceeding 20% of its paid-up and unimpaired capital stock and surplus not available for dividends; and may have no more than 70% of its total assets in loans which have remaining terms to maturity in excess of seven years and are secured solely or primarily by real property. At December 31, 1995, Fremont I & L was in compliance with all of these requirements.\nA thrift and loan generally may not make any loans to, or hold an obligation of, any of its directors or officers or any director or officer of its holding company or affiliates, except in specified cases and subject to regulation by the DOC. Further, a thrift and loan may not make any loan to, or hold an obligation of, any of its shareholders or any shareholder of its holding company or affiliates, except that this prohibition does not apply to persons who own less than 10% of the stock of a holding company or affiliate which is listed on a national securities exchange, such as Fremont General. Any person who wishes to acquire (i) 10% or more of the voting securities of a California thrift and loan company, or (ii) 10% or more of the voting securities of a holding company of a California thrift and loan company, such as the Company, must obtain the prior approval of the DOC. The LYONs are not voting securities of the Company, but the shares of Common Stock into which such LYONs are convertible constitute voting securities of the Company. Fremont I & L must also obtain prior written approval from the DOC before it may open or relocate any branch or loan production office or close a branch office.\nThe Industrial Loan Law prohibits an industrial loan company from having deposits at any time in an aggregate sum in excess of 20 times the aggregate amount of its paid-up unimpaired capital and such of its unimpaired surplus as is declared by its by-laws not to be available for cash dividends. Fremont I & L currently has an authorized ratio of deposits to such capital of 17 to 1.\nFederal Law. Fremont I & L's deposits are insured by the FDIC to the full extent permitted by law. As an insurer of deposits, the FDIC issues regulations, conducts examinations, requires the filing of reports and generally supervises the operations of institutions to which it provides deposit insurance. Fremont I & L is subject to the rules and regulations of the FDIC to the same extent as other financial institutions which are insured by that entity. The approval of the FDIC is required prior to any merger, consolidation or change in control or the establishment or relocation of any branch office of Fremont I & L. This supervision and regulation is intended primarily for the protection of the insured deposit funds. Prior written notice to the FDIC is required to close a branch office.\nFremont I & L is subject to federal risk-based capital adequacy guidelines which provide a measure of capital adequacy and are intended to reflect the degree of risk associated with both on- and off-balance sheet items, including residential real estate loans sold with recourse, legally binding loan commitments and standby letters of credit. A financial institution's risk-based capital ratio is calculated by dividing its qualifying capital by its risk-weighted assets. Financial institutions are generally expected to meet a minimum ratio of qualifying total capital to risk-weighted assets of 8%, of which at least 4% of qualifying total capital must be in the form of core capital (\"Tier 1\") -- common stock, noncumulative perpetual preferred stock, minority interests in equity capital accounts of consolidated subsidiaries and allowed mortgage servicing rights, less all intangible assets other than allowed mortgage servicing rights and eligible purchased credit card relationships. Supplementary capital (\"Tier 2\") consists of the allowance for loan and lease losses up to 1.25% of risk-weighted assets, cumulative perpetual preferred stock, long-term preferred stock (original maturity of at least 20 years), perpetual preferred stock, hybrid capital instruments, term subordinated debt and intermediate term preferred stock (original average maturity of five years or more). The maximum amount of Tier 2 capital which may be recognized for risk-based capital purposes is limited to 100% of Tier 1 capital (after any deductions for disallowed intangibles). The aggregate amount of term subordinated debt and intermediate term preferred stock that may be treated as Tier 2 capital is limited to 50% of Tier 1 capital. Certain other limitations and restrictions also apply. At December 31, 1994, the Tier 2 capital of Fremont I & L consisted of\napproximately $10.6 million of allowance for possible loan losses. As of December 31, 1995, Fremont I & L's allowance for possible loan losses for Tier 2 capital increased to $11.9 million. See \"Financial Services -- Real Estate Lending.\" The following table presents Fremont I & L's risk-based capital position at the dates indicated:\nThe FDIC has adopted a 3% minimum leverage ratio which is intended to supplement risk-based capital requirements and to ensure that all financial institutions continue to maintain a minimum level of core capital. A minimum leverage ratio of 3% is required for institutions which have been determined to be the highest of five categories used by regulators to rate financial institutions. All other institutions (including Fremont I & L) will likely be required to maintain leverage ratios of at least 100 to 200 basis points above the 3% minimum. It is improbable, however, that an institution with a 3% core capital-to-total assets ratio would be rated in the highest category since a strong capital position is so closely tied to the rating system. Therefore, the \"minimum\" leverage ratio is, for all practical purposes, significantly above 3%. The following table presents Fremont I & L's leverage ratio (the ratio of Tier 1 capital to the quarterly average of total assets) at the dates indicated:\nThe FDIC has designated Fremont I & L as a \"well-capitalized\" institution under the regulations promulgated under the Federal Deposit Insurance Corporation Improvement Act of 1991. A \"well-capitalized\" institution has a total risk-based capital ratio of at least 10%, has a Tier 1 risk-based capital ratio of at least 6.0%, has a leverage ratio of at least 5.0% and is not subject to any written agreement, order, capital directive or prompt corrective action directive issued by the FDIC under Section 8 or Section 38 of the Federal Deposit Insurance Act to meet and maintain a specific capital level for any capital measure. The total risk-based capital ratio is the ratio of qualifying total capital to risk-weighted assets and the Tier 1 risk-based capital ratio is the ratio of Tier 1 capital to risk-weighted assets. In August 1994, an additional $23 million was contributed to the capital of Fremont I & L to support the growth in the loan portfolio during 1994.\nAs a \"well-capitalized\" institution, Fremont I & L's annual FDIC insurance premiums were 23 cents per $100 of eligible domestic deposits in 1994. In 1995, this annual insurance premium rate was increased to 26 cents for the period January 1, 1995 through June 30, 1995, and then significantly decreased to 7 cents for the period July 1, 1995 through December 31, 1995. This rate has been further decreased to 3 cents effective for the period January 1, 1996 through June 30, 1996. The insurance premium payable is subject to semi-\nannual adjustment. The FDIC, by the first day of the month preceding each semi-annual period, is required to notify each insured institution of its assessment risk-classification upon which the insurance premium assessment for the following period will be based. The FDIC has the authority to assess to all insured institutions collectively, additional premiums to cover losses and expenses associated with insuring deposits maintained at financial institutions and for other purposes it deems necessary.\nLimitations on Dividends. Under California law, a thrift is not permitted to declare dividends on its capital stock unless it has at least $750,000 of unimpaired capital plus additional capital of $50,000 for each branch office maintained. In addition, no distribution of dividends is permitted unless: (i) such distribution would not exceed a thrift's retained earnings; (ii) any payment would result in violation of the approved maximum capital to thrift investment certificate ratio; or (iii) in the alternative, after giving effect to the distribution, the sum of a thrift and loan's qualified assets would be not less than 125% of certain of its liabilities, or with certain exceptions, current assets would be not less than current liabilities. In addition, a thrift and loan is prohibited from paying dividends from that portion of capital which its board of directors has declared restricted for dividend payment purposes. In policy statements, the FDIC has advised insured institutions that the payment of cash dividends in excess of current earnings from operations is inappropriate and may be cause for supervisory action. Under the Financial Institutions Supervisory Act and the Financial Institutions Reform, Recovery and Enforcement Act of 1989, federal regulators also have authority to prohibit financial institutions from engaging in business practices which are considered to be unsafe or unsound. It is possible that, depending upon the financial condition of Fremont I & L and other factors, such regulators could assert that the payment of dividends in some circumstances might constitute unsafe or unsound practices and could prohibit payment of dividends even though technically permissible.\nFremont I & L is also subject to federal consumer protection laws, including the Truth In Savings Act, the Truth in Lending Act, the Community Reinvestment Act and the Real Estate Settlement Procedures Act.\nCommercial Finance\nFremont Financial is licensed under the California Finance Lenders Law by the California Department of Corporations as a commercial finance lender and a personal property broker and holds certain other licenses.\nIntercompany Transactions\nThe payment of stockholders' dividends and the advancement of loans to the Company by its subsidiaries are and may continue to be subject to certain statutory and regulatory restrictions.\nEMPLOYEES\nAt December 31, 1995, the Company had 1,826 employees, none of whom is represented by a collective bargaining agreement. The Company believes its relations with employees are good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nSubstantially all facilities used by the Company are leased.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company and its subsidiaries and affiliates are parties to various legal proceeding, which in some instances include claims for punitive damages, all of which are considered routine and incidental to their business. The Company believes that ultimate resolution or settlement of such matters will not have a material adverse effect on its consolidated financial position.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Company's Common Stock is traded on the New York Stock Exchange (\"NYSE\") under the trading symbol \"FMT.\" The following table sets forth the high and low sales prices of the Company's Common Stock adjusted retroactively for a three for two stock split effective January 8, 1996 and a ten percent stock dividend distributed June 15, 1995 as reported as composite transactions on the NYSE and the adjusted cash dividends declared on the Company's Common Stock during each quarter presented.\nOn December 31, 1995, the closing sale price of the Company's Common Stock on the NYSE was $24.50 per share. There were 1,320 stockholders of record as of December 31, 1995.\nThe Company has paid cash dividends in every quarter since its initial public offering in 1977. While the Company intends to continue to pay dividends, the decision to do so is made quarterly by the Board of Directors and is dependent on the earnings of the Company, management's assessment of future capital needs, and other factors. As a holding company, Fremont General's ability to pay dividends to its stockholders is partially dependent on dividends from its subsidiaries. The ability of several of these subsidiaries to distribute dividends is subject to certain statutory and regulatory restrictions and various agreements, principally loan agreements, of the subsidiaries that restrict the ability of the respective subsidiaries to pay cash dividends or advance loans and other payments to the Company and is contingent upon the earnings of those subsidiaries. See Note J to Consolidated Financial Statements and \"Business -- Regulation.\"\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\n- --------------- (1) The Company acquired Casualty Insurance Company on February 22, 1995.\n(2) Adjusted for a three-for-two split of the Common Stock distributed on February 7, 1996 to stockholders of record at close of business on January 8, 1996; a ten percent stock dividend distributed June 1995; and a three-for-two split of the Common Stock effected June 1993.\n(3) Effective January 1994, FASB 115 changed the accounting treatment afforded the Company's investment portfolio wherein unrealized gains and losses on securities designated by the Company as available for sale are included, net of deferred taxes, as a component of stockholders' equity.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nGENERAL\nFremont General Corporation, a nationwide property and casualty insurance and financial services holding company, operates through its wholly-owned subsidiaries in select businesses in niche markets. The three core operating lines of business are workers' compensation insurance, real estate lending and commercial finance lending. Additionally, on a smaller scale, the Company is involved in underwriting various other insurance products. The primary operating strategy of the Company is to build upon its core business units through acquisition opportunities and new business development. The Company's secondary strategy is to achieve income balance and geographic diversity among its business units in order to limit the exposure of the Company to industry, market and regional concentrations.\nThe Company began its workers' compensation insurance operations in 1959 and continues to derive the majority of its revenues from this business. The Company's workers' compensation insurance business has grown through internal expansion, as well as through the acquisition of other workers' compensation insurance companies. In 1989, the Company restructured its workers' compensation insurance operations under a single management group. By consolidating duplicate offices and functions, this management group has increased efficiency and achieved substantial cost savings.\nMore recently, on February 22, 1995, the Company completed the acquisition of all outstanding stock of Casualty Insurance Company (\"Casualty\") and its wholly-owned subsidiary Workers' Compensation and Indemnity Company (\"WCIC\") from the Buckeye Union Insurance Company (\"Buckeye\"). Casualty underwrites workers' compensation insurance primarily in Illinois and several other mid-western states, as well as a modest amount through WCIC in California. Casualty currently is the largest underwriter of workers' compensation insurance in Illinois and has provided the Company with a significant presence in the mid- western region. The Casualty acquisition has provided geographic diversity within the Company's workers' compensation insurance business segment and the Company's 1995 revenues from workers' compensation insurance premiums were evenly divided between the west and mid-west regions. The Company believes this geographic diversity mitigates potential fluctuations in earnings from cyclical downturns in various regional economies.\nThe Company's balance sheet at December 31, 1995 has been significantly impacted by the acquisition of Casualty. The purchase price was $250 million, comprised of $225 million in cash and $25 million in a note payable to Buckeye. In addition, $6.5 million of costs were incurred in connection with the acquisition bringing the total cost to $256.5 million. The acquisition was treated as a purchase for accounting purposes and approximately ten months of Casualty's operating results are included in the Company's results of operations for the year ended December 31, 1995. At the acquisition date, the assets acquired and liabilities assumed, net of the purchase price and purchase accounting adjustments, are summarized in the following table:\nSince the date of acquisition, the Company has re-invested the short-term investments acquired into longer term investments. This accounts for the significant increase in the Company's fixed maturity and non-redeemable preferred stock portfolios for the year ended December 31, 1995. See Note B of Notes to Consolidated Financial Statements for additional information with respect to the acquisition of Casualty.\nIn July 1993, California enacted legislation to reform the workers' compensation insurance system and to, among other things, adopt an open rating system through the repeal of the minimum rate law effective January 1, 1995. The repeal of the minimum rate law has resulted in lower premiums and lower profitability on the Company's California workers' compensation insurance policies due to increased price competition. The Company expects that the premiums earned in California will continue to decrease, principally due to price competition. See \"Results of Operations -- Property and Casualty Insurance Operations -- Premiums.\" The Company believes that its acquisition of Casualty, with policies written primarily outside of California, has lessened the impact of the repeal of the minimum rate law by providing geographic diversity, which mitigates the impact of economic and regulatory changes within a regional marketplace. In Illinois, where Casualty underwrites the majority of its workers' compensation insurance premiums, price competition will continue to impact workers' compensation companies due to an overall average decrease in advisory rates of 13.6% which became effective January 1, 1996. Although insurance companies are not required to adopt such advisory rates, companies in Illinois generally follow such rates. See \"Results of Operations -- Property and Casualty Insurance Operations -- Workers' Compensation Regulation.\"\nIn 1990, the Company acquired Fremont Investment & Loan (formerly Investors Thrift), a California thrift and loan that now serves more than 23,000 customers through its 12 branches. The thrift and loan operations are primarily engaged in commercial and residential real estate lending. For commercial real estate loans, principal amounts primarily range between $1 to $5 million and for residential real estate loans, principal amounts are generally below $300,000. The Company's operating strategy is to pursue growth of the\nloan portfolio through origination of new loans and acquisition of loan portfolios that meet its underwriting guidelines applied to origination of new loans. Assets of the real estate lending operation grew from $278 million at the end of 1991 to $1.05 billion at the end of 1995, due primarily to increased loan originations and to the purchase of loan portfolios from other financial institutions. See \"Item 1. Business -- Financial Services Operations -- Real Estate Lending.\" The ability of the Company to continue to originate loans, and of borrowers to repay outstanding loans, may be impaired by adverse changes in local or regional economic conditions which affect such areas or by adverse changes in the real estate market in those areas. Such events could also significantly impair the value of the underlying collateral. If the Company's collateral were to prove inadequate, the Company's results of operations could be adversely affected.\nThe Company's commercial finance subsidiary, Fremont Financial Corporation (\"Fremont Financial\"), provides working capital loans, primarily secured by accounts receivable and inventory, to small and middle market companies on a nationwide basis. Fremont Financial's total loan portfolio grew from $189 million at December 31, 1991 to $569 million at December 31, 1995. This growth has been achieved through development of Fremont Financial's customer base through loan originations and through participation in syndicated loan transactions. See \"Item 1. Business -- Financial Service Operations -- Commercial Finance.\" The lending market has become increasingly competitive for small to middle market commercial borrowers. As a result, Fremont Financial has experienced decreasing yields on its commercial finance loans.\nAdverse economic developments can negatively affect the Company's business and results of operations in a number of ways. Such developments can reduce the demand for loans, impair the ability of borrowers to pay loans and impair the value of the underlying collateral.\nBetween 1986 and 1991, the Company discontinued its domestic treaty reinsurance business, its other primary and excess property and casualty insurance operations and the underwriting of all remaining assumed reinsurance. In 1990, a single management group was put in charge of all discontinued operations, and it is the intention of the Company to complete the liquidation of these operations by the commutation of liabilities and as claims are paid. See \"Item 1. Business -- Discontinued Operations\" and Note M of Notes to Consolidated Financial Statements.\nOn December 4, 1995, the Company announced a three-for-two stock split of its Common Stock for stockholders of record at January 8, 1996. The stock split was distributed on February 7, 1996.\nManagement's Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934. Actual results could differ materially from those projected in the forward-looking statements as a result of a variety of factors, including the risk factors set forth within Management's Discussion and Analysis of Financial Condition and Results of Operations and elsewhere herein.\nRESULTS OF OPERATIONS\nBy providing diverse insurance and financial services to small and medium-sized businesses, the Company has achieved growth in both revenues and net income during the three years ended December 31, 1995. Higher revenues and net income in 1995 were also achieved through the acquisition of Casualty. The\nfollowing table presents information for each of the three years in the period ended December 31, 1995 with respect to the Company's core business segments.\nThe Company generated revenues of $924 million for 1995, as compared to revenues of $653 million and $651 million for 1994 and 1993, respectively. Revenues were higher in 1995 as compared to 1994, due primarily to higher workers' compensation insurance premiums, net investment income and loan interest income. The higher workers' compensation insurance premiums and net investment income are due primarily to the acquisition of Casualty, partially offset by lower insurance premiums earned in California. See \"Property and Casualty Insurance Operations -- Premiums.\" Revenues between 1994 and 1993 were flat due primarily to the combined effects of higher loan interest, substantially offset by lower workers' compensation insurance premiums. Realized investment gains (losses) were $1,000, $(315,000) and $2,165,000 in 1995, 1994 and 1993, respectively.\nThe Company had net income of $68.0 million or $2.61 per share for 1995, as compared to $55.8 million or $2.16 per share and $42.7 million or $1.85 per share for 1994 and 1993, respectively. Income before taxes for 1995 was $100.3 million as compared to $81.6 million and $64.3 million for 1994 and 1993, respectively.\nWorkers' compensation insurance operations posted income before taxes of $85.0 million for 1995, as compared to $62.2 million for 1994 and $49.8 million for 1993. The 37% increase in income before taxes in 1995 is due primarily to the acquisition of Casualty, offset partially by lower income on the Company's California business. The 25% increase in income before taxes in 1994 is due primarily to the continued decline in the frequency and severity of reported claims incurred on the 1992 through 1994 accident years and lower than expected operating costs, offset partially by lower premiums. The combined ratio for 1995 was 100.4% compared to 97.6% and 101.6% for 1994 and 1993, respectively.\nThe Company's professional medical liability, corporate and other segment is composed principally of revenues and expenses that pertain to the Company's professional medical liability business (\"medical malpractice\"), as well as miscellaneous expenses associated with the Company's downstream property and casualty insurance holding company, Fremont Insurance Group, Inc., (\"Fremont Insurance Group\"). Medical malpractice revenues were flat at $34.3 million in 1995 as compared to $33.0 million for 1994. Medical malpractice revenues increased in 1994 from $29.2 million in 1993 due primarily to a shift in underwriting focus towards those medical specialties that had higher premiums. Income before taxes for the medical malpractice business was $5.2 million, $6.6 million and $10.2 million for 1995, 1994 and 1993, respectively. The decrease in income before taxes in 1995 and 1994, as compared to 1993, is due primarily to an increase in the frequency and severity of reported claims. Expenses of Fremont Insurance Group include\ninterest expense on debt and other obligations of $6.7 million, $5.5 million and $4.5 million, respectively, for 1995, 1994 and 1993, and overhead expenses of $2.2 million, $3.1 million and $3.3 million for the corresponding periods. Since the operations of Fremont Insurance Group consist primarily of interest expense and overhead expenses management does not expect it to operate at a profit.\nThe financial services business segment posted increases of 28% and 31% in income before taxes for 1995 and 1994, respectively. These increases are consistent with increases in financial services revenues and are due primarily to the significant growth in the average loan portfolio over the three year period ended December 31, 1995 from $783 million in 1993 to $1.5 billion in 1995. Contributing to this growth in the average loan portfolio is the acquisition of approximately $366 million in primarily commercial real estate loan portfolios which were completed during the last six months of 1994. This segment, which consists principally of real estate lending and commercial finance operations, recorded income before taxes of $35.7 million, $28.0 million and $21.5 million for 1995, 1994 and 1993, respectively.\nCorporate revenues consisted primarily of investment income, while corporate expenses consisted primarily of interest expense and general and administrative expense. The corporate loss before income taxes was $18.5 million, $7.7 million and $9.2 million for 1995, 1994 and 1993, respectively. The increase in the corporate loss before taxes in 1995 over 1994 was due primarily to increased interest expense and decreased investment income. The increase in interest expense is due primarily to additional debt incurred in the acquisition of Casualty, along with modest increases in administrative expenses. The decrease in corporate loss before taxes in 1994 compared to 1993 was primarily due to increased investment income and higher intercompany interest income from the Company's subsidiaries.\nIncome tax expense of $32.3 million, $25.8 million and $21.6 million for 1995, 1994 and 1993, respectively, represent effective tax rates of 32%, 32% and 34% on pretax income of $100.3 million, $81.6 million and $64.3 million for the corresponding periods. The Company's effective tax rates for all years presented are lower than the enacted federal income tax rate of 35%, due primarily to tax exempt investment income which reduces the Company's taxable income.\nProperty and Casualty Insurance Operations\nThe following table represents information with respect to the Company's property and casualty insurance operations:\nRevenues from the property and casualty insurance operations consist primarily of workers'compensation insurance premiums earned and net investment income. Expenses consist primarily of loss and loss adjustment expenses, policy acquisition costs, other operating costs and expenses and, for the years ended December 1994 and 1993, dividends to policyholders.\nPremiums. Premiums earned from the Company's workers' compensation insurance operations were $575.0 million in 1995, as compared to $401.5 million and $426.8 million in 1994 and 1993, respectively. Premiums were significantly higher in 1995 due primarily to the acquisition of Casualty, partially offset by lower premiums earned in California. For the year ended December 31, 1995, the Company's workers' compensation insurance premiums earned in its western region, consisting primarily of California, accounted for $292 million, or 51% of the Company's total workers' compensation insurance premiums earned for such period, representing a decrease of $109 million from 1994. This decrease was due primarily to the increased price competition resulting from California's adoption of an open rating system and the repeal of the minimum rate law. See \"Workers' Compensation Regulation.\" This increased price competition has led to (i) lower premium rates and (ii) a lower average policy size due to the Company's shift in focus to smaller employers.\nAdditionally, non-renewing polices have increased in 1995 which has also contributed to the lower premium volume in California. The increase in non-renewing polices occurs as a result of certain premium prices falling below required minimum pricing pursuant to the Company's underwriting standards. The Company expects that the premiums earned in California will continue to decrease, principally due to price competition. For the year ended December 31, 1995, the Company's workers' compensation insurance premiums earned in its mid- western region, consisting primarily of Illinois, accounted for $283 million, or 49% of the Company's total workers' compensation insurance premiums earned. In addition, the Company anticipates price competition to continue in Illinois, where an additional overall average decrease of 13.6% in advisory rates, which workers' compensation insurance companies in Illinois tend to follow, became effective January 1, 1996. Premiums were lower in 1994 as compared to 1993, due primarily to reductions in California workers' compensation manual premium rates which occurred in the last six months of 1993.\nNet Investment Income. Net investment income within the property and casualty insurance operations was $101.3 million, $62.2 million and $65.7 million in 1995, 1994 and 1993, respectively. Significantly higher invested assets, due primarily to the acquisition of Casualty, resulted in increased investment income in 1995 as compared to 1994 and 1993. The effects of lower invested assets and lower investment yields during 1994 resulted in net investment income levels lower as compared to 1993. See \"Item 1. Business -- Investment Portfolio.\"\nLoss and Loss Adjustment Expense. Workers' compensation loss and loss adjustment expenses (\"LAE\") were $436.7 million, $249.4 million and $300.5 million in 1995, 1994 and 1993, respectively. In addition, the ratio of these losses and LAE to workers' compensation insurance premiums earned was 75.9%, 62.1% and 70.4% in 1995, 1994 and 1993, respectively. The increase in incurred loss and LAE in 1995 as compared to 1994 is due primarily to the acquisition of Casualty, partially offset by lower incurred loss and LAE in California. Additionally, the increase in the loss and LAE ratio in 1995 as compared to 1994, is partially due to lower premiums on California policies which resulted from increased competition in 1995. See \"Premiums.\" The decrease in California premiums was greater than the decrease in California incurred loss and LAE, thereby resulting in a higher loss and LAE ratio. The negative impact on the Company's profitability resulting from the higher loss and LAE ratio has been mitigated to an extent by the elimination of dividends accrued on California workers' compensation business in 1995. The dividend elimination occurred as the majority of the workers' compensation policies written in 1995 were non-participating. This type of policy is not eligible for dividend consideration. See \"Dividends to Policyholders.\" The decrease in the loss ratio in 1994 as compared to 1993 is due primarily to the positive impacts of the continued decrease in the frequency and severity of reported claims on the 1992 and subsequent accident years, particularly in Southern California, which began in mid-1992. The Company attributes this reduction in claim frequency and severity to aggressive loss control and improved underwriting. Improved loss control has been achieved through a significant effort to reduce fraudulent workers' compensation claims by California law enforcement and regulatory authorities, the insurance industry and the Company under its \"zero tolerance\" program. Underwriting improvements were made to focus on businesses with stable work environments and less hazardous occupations. See \"Item 1. Business -- Insurance Operations -- Loss and Loss Adjustment Expense Reserves.\"\nThe Company regularly reviews its reserving techniques, overall reserve position and reinsurance. In light of present facts and current legal interpretations, management believes that adequate provisions have been made for loss reserves. In making this determination, management has considered its claims experience to date, loss development history for prior accident years and estimates of future trends of claims frequency and severity. However, establishment of appropriate reserves is an inherently uncertain process, and there can be no certainty that currently established reserves will prove adequate in light of subsequent actual experience. Subsequent actual experience has resulted and could result in loss reserves being too high or too low. Future loss development could require reserves for prior periods to be increased, which would adversely impact earnings in future periods.\nPolicy Acquisition Costs and Other Operating Costs and Expenses. The ratio of policy acquisition costs and other operating costs and expenses to premiums earned is referred to as the expense ratio, which was 24.5%, 23.4% and 21.3% in 1995, 1994 and 1993, respectively. The increase in this ratio in 1995 and 1994, as compared to 1993, was due primarily to higher agents' commission costs.\nDividends to Policyholders. In 1995 there were no dividends accrued. This is compared to $49.7 million and $45.2 million in dividends accrued in 1994 and 1993, respectively. The ratio of dividends accrued to workers' compensation insurance premiums earned therefore decreased to 0% in 1995 from 12.4% and 10.6% in 1994 and 1993, respectively. The significant decrease in dividends accrued is due in part to a change in the type of workers' compensation insurance policy written on and after January 1, 1995. In 1995, the Company's workers' compensation insurance policies, both in California and those underwritten by Casualty, were predominately written as non-participating, which does not include provisions for dividend consideration. In 1994 and prior, the Company's policies were predominately written as participating, thereby obligating the Company to consider the payment of dividends. This shift in policy type is due primarily to the increased competition in the California market which has resulted from the repeal of the minimum rate law, effective January 1, 1995. The Company anticipates that this shift to non-participating policies will continue and be a characteristic element of the competitive environment established by the July 1993 California legislation. See \"Workers' Compensation Regulation.\"\nVariability of Operating Results. The Company's profitability can be affected significantly by many factors including competition, the severity and frequency of claims, interest rates, regulations, court decisions, the judicial climate, and general economic conditions and trends, all of which are outside of the Company's control. These factors have contributed, and in the future could contribute, to significant variation of results of operations in different aspects of the Company's business from quarter to quarter and year to year. With respect to the workers' compensation insurance business, changes in economic conditions can lead to reduced premium levels due to lower payrolls as well as increased claims due to the tendency of workers who are laid off to submit workers' compensation claims. Legislative and regulatory changes can also contribute to variable operating results for workers' compensation insurance businesses. For example, in 1995, the Company experienced the negative impact of lower premiums and lower profitability on the Company's California workers' compensation business due to increased price competition resulting from legislation enacted in California in July 1993 which, among other things, repealed the minimum rate law effective January 1, 1995. See \"Workers' Compensation Regulation.\" The Company anticipates that its workers' compensation insurance premiums earned in California will continue to decrease as a result of this increased price competition, which could adversely affect the Company's results of operations and financial condition. See \"Premiums.\" Also, the establishment of appropriate reserves necessarily involves estimates, and reserve adjustments have caused significant fluctuations in operating results from year to year.\nWorkers' Compensation Regulation. Illinois began operating under an open rating system in 1982 and California began operating under such a system effective January 1, 1995. In an open rating system, workers' compensation companies are provided with advisory rates by job classification and each insurance company determines its own rates based in part upon its particular operating and loss costs. Although insurance companies are not required to adopt such advisory rates, companies in Illinois generally follow such rates. However, insurance companies in California have, since the adoption of an open rating system, generally set their premium rates below such advisory rates. Before January 1, 1995, California operated under a minimum rate law, whereby premium rates established by the California Department of Insurance were the minimum rates which could be charged by an insurance carrier.\nIn July 1993, California enacted legislation to reform the workers' compensation insurance system and to, among other things, (i) reduce workers' compensation manual premium rates by 7% effective July 16, 1993 and (ii) repeal the minimum rate law effective January 1, 1995. In addition to the July 1993 legislation, in December 1993, the California Insurance Commissioner reduced workers' compensation manual premium rates on new and renewal business an additional 12.7% effective January 1, 1994. In September 1994, California workers' compensation manual premium rates were further reduced by 16% effective October 1, 1994 on all business incepting on or after January 1, 1994.\nThe repeal of the minimum rate law on January 1, 1995 has resulted in lower premiums and lower profitability in the Company's California workers' compensation insurance business due to increased price competition. The Company believes that its acquisition of Casualty, with policies written primarily outside of California, has lessened the impact of the repeal of the minimum rate law by providing geographic diversity, which mitigates the impact of economic and regulatory changes within a regional marketplace. See \"Item 1. Business -- Regulation -- Insurance Regulation.\"\nFinancial Services\nThe Company's financial services operations are principally engaged in commercial and residential real estate lending through Fremont Investment & Loan and asset-based lending through Fremont Financial. The Company also has small life insurance and premium finance operations included in this segment. See Note P of Notes to Consolidated Financial Statements. Revenues consist principally of interest income and, to a lesser extent, life insurance premiums, fees and other income.\nThe following table presents information with respect to the Company's financial services operations:\nRevenues increased 39% in 1995 and 23% in 1994, due primarily to greater loan interest and fee revenue attributable to the growth in the average loan portfolios of the real estate lending and commercial finance operations from $1.1 billion in 1994 to $1.5 billion in 1995. Contributing to this growth in the average loan portfolio was the acquisition of approximately $366 million in primarily commercial real estate loan portfolios which were completed during the last six months of 1994. In 1995, no portfolios of commercial real estate loans were purchased, primarily due to increased competition which resulted in inadequate yields or unacceptable risk profiles for the portfolios considered.\nIncome before taxes in the financial services operations was $35.7 million, $28.0 million and $21.5 million for 1995, 1994 and 1993, respectively. The 28% increase in income before taxes in 1995 as compared to 1994 is due primarily to continued growth in the loan portfolios, offset partially by increases in the provision for loan losses and other expenses. The 31% increase in 1994 as compared to 1993, is due primarily to the growth in the loan portfolios and a lower provision for loan losses. See \"Item 1. Business -- Financial Services Operations.\"\nThe following table identifies the interest income, interest expense, average interest-bearing assets and liabilities, and interest margins for the Company's thrift and loan and commercial finance subsidiaries:\n- --------------- (1) Average loan balances include non-accrual loan balances.\nThe margin between the Company's interest income and cost of funds decreased in 1995 and 1994, due primarily to changes in the mix of loans in the real estate lending operation, as well as a decrease in the net margins in the commercial finance lending segment. In the real estate lending operation, the change in portfolio mix occurred under a corporate strategy which began in 1993, to shift away from high rate, high risk loans secured by personal property or junior liens on real estate, to lower yielding commercial and residential first trust deed real estate loans. The lower yields on the commercial and residential real estate portfolios are compensated for by the improved underlying collateral and by the improved lien position on the collateral. The net margins decreased in the commercial finance segment due primarily to increases in the credit quality of the loan portfolio which has resulted in lower net margins, as well as to an increase in the competitive environment.\nInterest rate sensitivity data for the Company's thrift and loan and commercial finance subsidiaries as of December 31, 1995 is presented in the table below. The relationships shown are for one day only and significant changes can occur in the sensitivity relationships as a result of market forces and management decisions. The interest rate gaps reported in the table arise when assets are funded with liabilities having different repricing intervals and to this degree earnings will be sensitive to interest rate changes. The Company\nattempts to match interest rate sensitive assets and liabilities to minimize the effect of fluctuations in interest rates.\nLoans Receivable and Reserve Activity. The following table shows loans receivable in the various financing categories and the percentages of the total represented by each category:\nThe following table illustrates the maturities of the Company's loans receivable:\nThe Company monitors the relationship of fixed and variable rate loans and interest bearing liabilities in order to minimize interest rate risk.\nAdverse economic developments can negatively affect the Company's business and results of operations in a number of ways. Such developments can reduce the demand for loans, impair the ability of borrowers to pay loans and impair the value of the underlying collateral.\nThe following table describes the asset classifications, loss experience and reserve reconciliation of the real estate lending and commercial finance operations as of or for the periods ended as shown below:\nNon-performing assets remained relatively stable at December 31, 1995 as compared to December 31, 1994, due primarily to a $11.6 million increase in non-accrual loans, more than offset by a $12.5 million decrease in REO assets. Of the increase in non-accrual loans, $8.9 million is represented by one loan in the\ncommercial finance operation. The collateral securing this loan is closely monitored by the Company and the Company believes it currently has adequate reserves in the allowance for possible loan losses to cover any potential loss on this loan. The decrease in REO assets during 1995 relates entirely to the real estate lending operation. At December 31, 1995, the balance in REO includes eight commercial real estate properties totaling $4.4 million. Non-performing assets increased $21.1 million at December 31, 1994 as compared to the prior year end due primarily to a $16.6 million increase in REO assets in the real estate lending operation.\nThe higher provision for loan losses in 1995 as compared to 1994 is consistent with the significant overall growth in average loans receivable. Charge-offs in 1995 as compared to 1994 decreased in the commercial finance operation and remained relatively stable in the real estate lending operation. In 1994 total charge-offs decreased from the prior year due to lower charge-offs in the commercial finance operation, partially offset by higher charge-offs in the real estate lending operation. The commercial finance charge-offs were unusually high in 1993 as the Company charged-off substantially all of the loans from the Company's terminated commercial mortgage banking operation. (These loans had already been provided for in the allowance for possible loan losses in prior years.) Higher charge-offs in the real estate lending operation in 1994 as compared to 1993 are consistent with the significant growth in the real estate loan portfolio in 1994. Overall, total charge-offs have decreased over the three years ended December 31, 1995 and these reductions occurred during a period in which loans receivable increased.\nIncluded in the reserves established with portfolio acquisitions in 1994 is $3.2 million in reserves relating to a $225 million commercial real estate loan portfolio acquisition by Fremont Investment & Loan which was completed in August 1994.\nLIQUIDITY AND CAPITAL RESOURCES\nThe property and casualty insurance operations must have cash and liquid assets available to meet their obligations to policyholders in accordance with contractual obligations, in addition to having the funds available to meet ordinary operating costs. These operations have several sources of funds to meet their obligations, including cash flow from operations, recoveries from reinsurance contracts and investment securities. By statute, the majority of the cash from these operations is required to be invested in investment grade securities to provide protection for policyholders. The Company invests in fixed income and preferred equity securities with an objective of providing a reasonable return while limiting credit and liquidity risk. The Company's investment portfolio had an unrealized gain (loss) of $33.2 million and $(107.9) million at December 31, 1995 and 1994, respectively.\nThe Company's thrift and loan subsidiary finances its lending activities primarily through customer deposits, which have grown from $747 million at December 31, 1994 to $926 million at December 31, 1995. In January 1995, Fremont Investment & Loan became eligible for financing through the Federal Home Loan Bank of San Francisco. This financing is available at varying rates and terms. As of December 31, 1995, $170 million was available under the facility and no borrowings were outstanding.\nThe Company's commercial finance operation funds its lending activities primarily through its asset securitization program, an unsecured revolving line of credit with a syndicated bank group and its capital. The asset securitization program was established to provide a stable and cost effective source of funds to facilitate the expansion of this business. The proceeds from the sale of the initial series of asset-backed certificates (\"Series A\") under this program in April 1993 were $200 million bearing interest at the rate of LIBOR plus 0.47%. In November 1993, an additional $100 million of these certificates (\"Series B\") were sold bearing interest at the rate of LIBOR plus 0.5%. The securities issued in this program have a scheduled maturity of three and four years, but could mature earlier depending on fluctuations in outstanding balances of loans in the portfolio and other factors. During April 1995, the Company issued $30 million in subordinated variable rate asset-backed certificates, which mature in 2000, via a private placement. As of December 31, 1995, up to $500 million in additional publicly offered asset-backed certificates may be issued pursuant to a shelf registration statement to fund future growth in the commercial finance loan portfolio. In February 1996, $135 million in asset-backed certificates (\"Series C\") were issued which mature in 2000. The proceeds were used, in conjunction with existing cash, to retire the $200 million in Series A certificates. The Series B\ncertificates are scheduled to mature in 1997. In December 1995, a commercial paper facility was established as part of the asset securitization program. This facility provides for the issuance of up to $150 million in commercial paper, dependent upon the level of assets within the asset securitization program. This facility, which expires in December 1998, had no amounts outstanding under it as of December 31, 1995. The commercial finance operation's unsecured revolving line of credit is with a syndicated bank group that presently permits borrowings of up to $300 million, of which $185 million was outstanding as of December 31, 1995. This credit line is primarily used to finance assets which are not included in the Company's asset securitization program. This credit line expires August 1998.\nAs a holding company, Fremont General pays its operating expenses, meets its other obligations and pays stockholders' dividends from its cash on hand, management fees paid by its subsidiaries and dividends paid by its subsidiaries. During 1995, stockholders' dividends totaling $12.6 million were paid. Stockholders' dividends declared aggregated $13.1 million, $11.5 million and $10.1 million during 1995, 1994 and 1993, respectively. Several of the Company's subsidiaries are subject to certain statutory and regulatory restrictions and various agreements, principally loan agreements, that restrict their ability to distribute dividends to the Company. The Company expects that during the next few years dividends from its subsidiaries will consist of dividends from its property and casualty subsidiaries and dividends on preferred stock of its thrift and loan holding company and commercial finance subsidiaries. The maximum amount available for payment of dividends by the property and casualty subsidiaries at December 31, 1995 without prior regulatory approval is approximately $30 million.\nTo facilitate general corporate operations, in August 1994 the Company obtained a revolving line of credit with a syndicated bank group that permitted borrowings of up to $150 million. In August 1995, the Company negotiated an increase of this line to $200 million, of which $85 million was outstanding as of December 31, 1995. In August 1997, this credit line converts to a term loan of up to $100 million, with scheduled semi-annual payments through August 2001. In addition, in July 1994 the Company replaced its internally financed loan to its Employee Stock Ownership Plan (\"ESOP\") with an external bank-financed loan totaling $11 million. The maximum principal amount of this loan was increased to $15 million in August 1995. The loan is due in seven equal annual installments commencing on April 1, 1996 and is secured by certain shares of the ESOP. The balance outstanding at December 31, 1995 was $6.6 million. The interest and principal payments are guaranteed by the Company. Interest is based on, at the Company's option, the bank's prime lending rate, LIBOR plus 1% or an applicable certificate deposit rate. The rate at December 31, 1995 was 6.69%.\nOn February 22, 1995, the Company completed the acquisition of Casualty which resulted in the disbursement of funds totaling $256.5 million, comprised of $231.5 million in cash and $25 million in a note payable to the seller. In September 1995, the note payable to the seller was refinanced using the Company's existing revolving line of credit. The cash used to fund the acquisition includes $55 million in borrowings under the Company's existing line of credit and the remainder from internally generated funds. See \"General. \"\nOn March 1, 1996, Fremont General Financing I, a statutory business trust (the \"Trust\") and consolidated wholly-owned subsidiary of the Company, sold $100 million of 9% Trust Originated Preferred SecuritiesSM (\"the Preferred Securities\") in a public offering. The Preferred Securities represent preferred undivided beneficial interests in the assets of the Trust. The proceeds from the sale of the Preferred Securities were invested in 9% Junior Subordinated Debentures of the Company (\"the Junior Subordinated Debentures\"). The $100 million Junior Subordinated Debentures are the sole asset of the Trust. The Preferred Securities will be redeemed upon maturity of the Junior Subordinated Debentures in 2026, subject to the election available to the Company to extend the maturity up to 2045, and they may be redeemed, in whole or in part, at any time on or after March 31, 2001 and under certain specified circumstances. The Junior Subordinated Debentures rank pari passu with the Company's $373,750,000 aggregate principal amount at maturity of Liquid Yield Option(TM) Notes due 2013, and subordinate and junior to all senior indebtedness of the Company. Payment of distributions out of cash held by the Trust, and payments on liquidation of the Trust or the redemption of the Preferred Securities are guaranteed by the Company. The Company will use the proceeds from the sale of the Junior Subordinated Debentures to reduce outstanding debt under the Company's revolving line of credit by approximately $50 million, with the remaining proceeds used for general corporate purposes.\nNet cash provided by operating activities of continuing operations was $39.5 million, $68.0 million and $85.1 million for the years ended December 31, 1995, 1994 and 1993, respectively. Net cash provided by continuing operations decreased in 1995 over 1994 due primarily to the following items: (i) a smaller net decrease in agents' balances and reinsurance recoverables; (ii) an increase in accrued investment income; (iii) a greater decrease in claims and policy liabilities; (iv) and higher policy acquisition costs deferred, net of amortization. These conditions were partially offset by higher net income, a net increase in other liabilities, net of other assets and a significant increase in the provision for deferred income taxes. The decreases in agents' balances and claims and policy liabilities are primarily due to lower premium volume in the Company's California workers' compensation insurance business. Higher policy acquisition costs deferred are due primarily to increases in annuity contract receipts in the Company's life insurance operation (see Notes F and P of Notes to Consolidated Financial Statements). The net increase in other liabilities, net of other assets, is due primarily to increased accruals for other operating costs. Net cash provided by continuing operations decreased in 1994 compared to the prior year due primarily to a decrease in claims and policy liabilities, partially offset by an increase in net income and a net decrease in agents' balances and reinsurance recoverables.\nNet cash used in investing activities was $514.0 million, $551.1 million and $448.1 million in 1995, 1994 and 1993, respectively. Net cash used in investing activities decreased in 1995 as compared to 1994, due primarily to a decrease in bulk loan purchases, net of loan repayments, in the real estate lending operation. This net decrease is due in part to $366 million in bulk commercial real estate loan purchases which the Company completed in 1994. The decrease in net loan purchases was offset partially by the acquisition of Casualty and an increase in investment purchases, net of sales, maturities, and calls. Net cash used in investing activities increased in 1994 as compared to 1993, due primarily to an increase in bulk loan purchases and loan originations, net of loan repayments, offset partially by a decrease in investment purchases, net of sales, maturities and calls.\nNet cash provided by financing activities was $483.0 million, $485.6 million and $346.7 million for 1995, 1994 and 1993, respectively. Net cash provided by financing activities decreased modestly in 1995 as compared to 1994, due primarily to a lower increase in thrift deposits partially offset by a net increase in short-term and long-term debt and an increase in annuity contract receipts. Repayments of short-term debt increased and proceeds from long-term debt increased primarily due to a reclassification of the commercial finance operation's credit line from short-term debt to long-term debt as of December 31, 1995. This reclassification was made pursuant to the terms of the credit line, which was renegotiated in August 1995. Net cash provided by financing activities increased in 1994 as compared to 1993, due primarily to an increase in net thrift deposits, partially offset by a net decrease in short-term and long-term debt. The 1993 year is additionally impacted by $40.8 million in proceeds from a public offering of the Company's Common Stock in July 1993.\nThe amortized cost of the Company's invested assets were $1.91 billion, $.99 billion, and $1.06 billion at December 31, 1995, 1994 and 1993, respectively. Contributing to the $.92 billion increase in the invested assets was approximately $512 million resulting from the Casualty acquisition and $199 million increase in net annuity receipts in the Company's life insurance operation. The modest decrease in 1994 as compared to 1993 is due primarily to a decrease in premium volume. As of July 1, 1995 the Company's held to maturity portfolio totaling $319.4 million was transferred to available for sale in accordance with the provisions of Financial Accounting Standards Board Statement 115 (\"FASB 115\"), \"Accounting for Certain Investments in Debt and Equity Securities.\" In addition, at this date there was a net unrealized gain of $9.9 million (net of deferred taxes of $5.3 million) on the held to maturity portfolio which was transferred to stockholders' equity. The transfer became necessary as the Company sold certain investment securities in July which were classified as held to maturity at June 30, 1995. These investment sales were part of an overall review and restructuring of the investment portfolio performed in conjunction with the investing of cash received in the acquisition of Casualty. This review and restructuring caused the Company to consider the appropriateness of the remaining held to maturity investments, which resulted in the reclassification.\nThe Company's property and casualty premium to surplus ratio for the year ended December 31, 1995 was 2.3 to 1, which is within industry guidelines. The FDIC has established certain capital and liquidity\nstandards for its member institutions, and Fremont Investment & Loan was in compliance with these standards as of December 31, 1995. See \"Item 1. Business -- Regulation -- Thrift and Loan Regulation.\" In August 1994 an additional $23 million was contributed to the capital of Fremont Investment & Loan to support the growth in the loan portfolio during 1994.\nThe Company believes that its existing cash, its bank lines of credit, revenues from operations and other available sources of liquidity will be sufficient to satisfy its liquidity needs for the next several years.\nThe Company's strategy is to expand its business to the extent possible without adversely impacting its loan portfolio and policyholder base. However, the Company's strategic model is not dependent on growth as a source of liquidity. While the level of revenues will obviously affect results of operations, the Company's liquidity is not dependent on future revenue growth.\nNEW ACCOUNTING STANDARDS\nIn March 1995, the Financial Accounting Standards Board (\"FASB\") issued Statement No. 121 (\"FASB 121\"), \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of \", which requires impairment losses to be recorded on long-lived assets used in operations, including intangible assets, when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amount. FASB 121 also addresses the accounting for long-lived assets that are expected to be disposed of. The Company will adopt FASB 121 in the first quarter of 1996 and, based on current circumstances, the effect of adoption will not be material.\nAlso, in 1995, the FASB issued Statement 123 (\"FASB 123\"), \"Accounting for Stock-Based Compensation\" that is effective for fiscal years beginning after December 15, 1995. FASB 123 establishes a method of accounting for stock-based compensation that is based on the fair value of stock options and similar instruments and encourages, but does not require, adoption of that method. The Company has elected to continue following Accounting Principles Board Opinion No. 25 for measuring compensation cost. Pursuant to FASB 123, the Company will disclose pro forma net income and earnings per share calculated as if the recognition and measurement provisions of the new standard had been adopted.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe Company's Consolidated Financial Statements, including supplementary data, are set forth in the \"Index\" on page 43 hereof.\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 subheadings \"Election of Directors,\" \"Executive Officers and Compensation,\" and the last paragraph under the subheading \"Principal and Management Stockholders\" in the Company's Proxy Statement for the 1996 Annual Meeting of Stockholders is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information set forth under the subheadings \"Election of Directors,\" \"Compensation of Directors,\" \"Officers and Compensation,\" \"Summary Compensation Table,\" \"Summary Compensation Table -- Explanations,\" \"Option\/SAR Grants in Last Fiscal Year,\" \"Option Exercises and Year-End Values Table\/Aggregate Option Exercises in Last Fiscal Year and Fiscal Year-End Option Values,\" \"Employment Agreements\" and \"Retirement and Other Benefit Plans, A-D\" in the Company's Proxy Statement for the 1996 Annual Meeting of Stockholders is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information set forth under the subheading \"Principal and Management Stockholders\" in the Company's Proxy Statement for the 1996 Annual Meeting of Stockholders is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information immediately following the caption \"Election of Directors\" and \"Employment Agreements\" in the Company's Proxy Statement for the 1996 Annual Meeting of Stockholders is incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a)(1) and (a)(2) and (d) FINANCIAL STATEMENTS AND SCHEDULES. Reference is made to the \"Index -- Consolidated Financial Statements and Financial Statements Schedules -- Annual Report on Form 10-K\" filed as part of this Annual Report.\n(a)(3) an (c) EXHIBITS.\n(b) REPORT ON FORM 8-K. None filed during the quarter ended December 31, 1995.\nFREMONT GENERAL CORPORATION\nCONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nANNUAL REPORT ON FORM 10-K ------------------------\nINDEX\nAll other schedules are omitted because of the absence of conditions under which they are required or because the necessary information is provided in the consolidated financial statements or notes thereto.\nREPORT OF INDEPENDENT AUDITORS\nStockholders and Board of Directors Fremont General Corporation\nWe have audited the accompanying consolidated balance sheets of Fremont General Corporation and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of income, cash flows and changes in stockholders' equity for each of the three years in the period ended December 31, 1995. 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 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 consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Fremont General Corporation and subsidiaries at December 31, 1995 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, 1995, 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, the Company made certain accounting changes in 1994.\nERNST & YOUNG LLP\nLos Angeles, California March 14, 1996\nFREMONT GENERAL CORPORATION AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\nSee notes to consolidated financial statements.\nFREMONT GENERAL CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF INCOME\nSee notes to consolidated financial statements.\nFREMONT GENERAL CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nSee notes to consolidated financial statements.\nFREMONT GENERAL CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY\nSee notes to consolidated financial statements.\nFREMONT GENERAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE A -- NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES\nFremont General Corporation, a nationwide insurance and financial services holding company, operates through its wholly-owned subsidiaries in select businesses in niche markets. The three core operating business lines are workers' compensation insurance, real estate lending and commercial finance lending. Additionally, on a smaller scale, various other insurance products are underwritten. Workers' compensation insurance has accounted for over 90% of property and casualty premiums earned. In 1995 workers' compensation premiums were evenly divided between the western region, primarily California, and the mid-west region, primarily Illinois. Prior to 1995, substantially all of the premium revenue was derived from the California market. Real estate lending represents over 50% of loan interest revenues (1994 -- 51%; 1993 -- 54%) and represents both commercial and residential lending secured by real estate located in California. Commercial finance accounts for substantially all of the remaining loan interest revenues (1994 -- 44%; 1993 -- 38%) and represents asset-based loans to middle market companies nationwide (32% in California), primarily secured by accounts receivable and inventory.\nThe accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles which, as to the subsidiary insurance companies, differ from statutory accounting practices prescribed or permitted by regulatory authorities. The significant accounting policies followed by Fremont General Corporation and subsidiaries (\"the Company\") that materially affect financial reporting are summarized below.\nConsolidation: The consolidated financial statements include the accounts and operations, after intercompany eliminations, of Fremont General Corporation and all subsidiaries. See Note M for the accounting treatment of discontinued operations.\nUse of Estimates: The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.\nInvestments: Fixed maturity investments represent bonds and redeemable preferred stocks that mature more than one year after the purchase date. Non-redeemable preferred stocks are equity securities, the majority of which include adjustable dividend yield provisions. As of January 1, 1994, the Company adopted the provisions of Financial Accounting Standards Board Statement 115 (\"FASB 115\"), \"Accounting for Certain Investments in Debt and Equity Securities.\" The cumulative effect as of January 1, 1994 of adopting FASB 115 was to increase stockholders' equity by $28,532,000 (net of deferred income taxes of $15,634,000) to reflect the net unrealized holding gains on securities classified as available for sale that were previously carried at amortized cost. There was no effect on net income.\nPremiums and discounts on investments are amortized using the interest method over the contractual lives of the investments. Adjustments for other-than-temporary market declines are recorded when determination of loss is probable and is reflected with a write-down of amortized cost to net realizable value. Short-term investments are carried at cost, which approximates their fair value. Realized investment gains and losses are included as a component of revenues based on specific identification of the investment sold.\nLoans: Loans are stated net of unearned income and allowance for possible loan losses. The allowance is increased by provisions charged against operations and reduced by loan amounts charged off by management. The allowance is maintained at a level considered adequate to provide for potential losses on loans based on management's evaluation of the loan portfolio. While management uses all available information to estimate the level of the allowance for credit losses, future additions may be necessary based on changes in the amounts and timing of future cash flows expected due to changes in collateral values supporting loans, general economic conditions and borrowers' financial conditions.\nFREMONT GENERAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nBeginning in 1995, the Company adopted FASB Statement No. 114 (\"FASB 114\"), \"Accounting by Creditors for Impairment of a Loan.\" Under FASB 114, the 1995 allowance for credit losses on loans that are identified for evaluation in accordance with the new standard are based on discounted cash flows using the loans' effective interest rate or the fair value of the collateral for collateral dependent loans. Prior to 1995, the allowance for credit losses on these loans was based on undiscounted cash flows or the fair value of the collateral for collateral dependent loans. The effect on net income was not material.\nManagement classifies loans as non-accrual when the collection of future interest is not assured by the borrower's financial condition and the value of underlying collateral and guarantees securing the loan. Subsequent collections on non-accrual loans are applied as a reduction of principal. The Company's charge-off policy is based on a monthly loan-by-loan review.\nLoans in process of foreclosure, repossessed assets, and in-substance foreclosures are included in the financial statements at the lower of cost or estimated realizable value (net of estimated costs to sell). Estimated realizable values are based on management's evaluation of numerous factors, including appraisals, sales of comparable assets and estimated market conditions.\nFurniture and Equipment: Furniture and equipment are included in other assets and are stated at cost, less accumulated depreciation. Leasehold improvements are amortized over the terms of the lease. Generally, depreciation is computed by the straight-line method over periods ranging from three to twelve years.\nPremium Income: Revenues from property and casualty premiums are recognized proportionately over the terms of the related policies. Direct property and casualty premiums earned but not billed at the end of each accounting period are estimated and accrued, and differences between such estimates and final billings are included in current operations. Revenues for universal life and investment-type insurance products consist of policy charges for the cost of insurance, policy initiation, administration and surrender fees and are included in other revenue. Premiums receivable and agents' balances and reinsurance recoverable on paid and unpaid losses include allowances for doubtful accounts of $11,147,000 and $6,959,000 at December 31, 1995 and 1994, respectively.\nLosses and Loss Adjustment Expenses: The estimated liabilities for losses and loss adjustment expenses include the accumulation of estimates for losses and claims reported prior to the balance sheet dates, estimates (based on projections of historical developments) of claims incurred but not reported and estimates of expenses for investigating and adjusting all incurred and unadjusted claims. Amounts reported are estimates of the ultimate costs of settlement, net of subrogation and salvage recoveries, which are necessarily subject to the impact of future changes in economic and social conditions. Management believes that, given the inherent variability in any such estimates, the aggregate reserves are within a reasonable and acceptable range of adequacy. Reserves are continually monitored and reviewed, and as settlements are made or reserves adjusted, differences are included in current operations.\nIncluded in the loss and loss adjustment expense liability recorded on the consolidated balance sheet at December 31, 1995 is $100,413,000 of workers' compensation accident and health permanent disability and death reserves which have been discounted at 5%. These reserves arise from the acquisition on February 22, 1995 of Casualty Insurance Company (\"Casualty\"), which is an Illinois domiciled insurance company (see Note B). The Company has continued the practice previously adopted by Casualty of discounting permanent disability loss reserves for both statutory accounting practices and generally accepted accounting principles.\nUnearned Premiums: Property and casualty insurance unearned premiums are calculated using the monthly pro rata basis.\nLife Insurance Benefits and Liabilities: Policyholder contract liabilities for universal life and investment-type products represent the premiums received plus accumulated interest, less mortality and other administrative charges under the contracts and before applicable surrender charges. Policy benefits and claims\nFREMONT GENERAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nthat are charged to expense include benefit claims incurred in excess of related policy account balances. Interest credited on such policies ranged from 4.5% to 6.5% at December 31, 1995. (See Notes F and P).\nDeferred Policy Acquisition Costs: Commissions, premium taxes and certain sales and underwriting expenses are capitalized and amortized as premiums are earned over the terms of the related property and casualty policies. Anticipated investment income is considered in determining if premium deficiencies exist. The costs of acquiring new and renewal life and annuity insurance contracts, principally commissions and certain variable selling expenses which vary with, and are primarily related to, the acquisition of new and renewal insurance contracts have been deferred. These deferred acquisition costs are being amortized over anticipated gross margins for such contracts.\nDividends to Policyholders: Dividends, if applicable, to policyholders on workers' compensation insurance contracts are accrued during the period in which the related premiums are earned.\nThrift Deposits: Thrift deposits consist primarily of investment certificates at the Company's California thrift and loan subsidiary. Such balances are credited with interest at rates ranging from 3.60% to 8.81% at December 31, 1995. The estimated fair value of the thrift deposits was $929,560,000 at December 31, 1995.\nIntangibles: The excess of the costs of acquisitions over net assets acquired (net of accumulated amortization: 1995 -- $17,513,000; 1994 -- $14,357,000) is being amortized over various periods ranging primarily from 7 to 25 years, which represents the estimated life of the intangible assets associated with such acquisitions. Additionally, the trade name acquired in the acquisition of Casualty (net of accumulated amortization: 1995 -- $326,000) is being amortized over 40 years. See Note B regarding intangibles related to the acquisition of Casualty.\nPer Share Data: Primary earnings per share data have been computed based on the weighted average number of common and common equivalent shares outstanding, which were as follows: 1995 -- 26,079,000, 1994 -- 25,823,000 and 1993 -- 23,039,000. The weighted average number of shares were adjusted retroactively for a 10% stock dividend distributed June 15, 1995 and a three-for-two stock split effected January 8, 1996. Stock options granted to certain key members of management are considered common stock equivalents for the computation of primary earnings per share.\nFor the computation of fully-diluted earnings per share, stock options (see Note J) and convertible securities (see Note I) had a dilutive effect of $0.44, $0.34 and $0.20 per share for 1995, 1994 and 1993, respectively. Fully-diluted earnings per share were computed based on 33,343,000, 33,034,000 and 28,243,000 weighted average number of shares outstanding for 1995, 1994 and 1993, respectively.\nCredit Risk: Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of temporary cash investments, fixed maturity securities, preferred stocks, mortgage and commercial finance loans and reinsurance recoverables. The Company places its temporary cash investments with high credit quality financial institutions and limits the amounts of credit exposure to any one financial institution. Concentrations of credit risk with respect to investments in fixed maturities, preferred stocks and commercial finance loans are limited due to the large number of such investments and their distribution across many different industries and geographics. Concentration of credit risk with respect to thrift and loan finance receivables is limited due to the large number of borrowers; however, substantially all thrift and loan finance receivables are from borrowers within the state of California. To minimize its exposure to significant losses from reinsurance insolvencies, the Company evaluates the financial condition of its reinsurers and monitors concentrations of credit risk arising from similar geographic regions, activities, or economic characteristics of the reinsurers. As of December 1995, Continental Insurance Company and General Reinsurance Corporation, were the only reinsurers that accounted for more than 10% of total amounts recoverable from all reinsurers on paid and unpaid losses. The remaining reinsurance recoverables were spread over 146 reinsurers.\nFREMONT GENERAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nFair Values of Financial Instruments: The Company uses various methods and assumptions in estimating its fair value disclosures for financial instruments. For fixed maturity investments and preferred stocks, fair values are determined from certain valuation services, as well as from quoted market prices. Loans receivable with variable rates, as well as thrift deposits for passbook and money market type accounts, are deemed to be at fair value. The fair values of thrift investment certificates, mortgage loans and other fixed rate loans are estimated using discounted cash flow analyses, using interest rates currently being offered for similar accounts or loans to borrowers with similar credit ratings.\nFor short-term debt, the carrying amount of the Company's borrowings approximates fair value. The fair value of the Company's long-term debt is based on quoted market prices for securities actively traded. For long-term debt not actively traded, and for bank borrowings, the fair value is estimated using discounted cash flow analyses, based on the Company's current incremental borrowing rates for similar types of borrowing arrangements.\nThe carrying amounts and fair values of the Company's financial instruments at December 31, 1995 are summarized in the following table:\nInsurance related financial instruments, other than those classified as investment contracts, are exempt from fair value disclosure requirements. The carrying amount of reinsurance paid recoverables approximates their fair value as they are expected to be realized within one year.\nNew Accounting Standards: In March 1995, the FASB issued Statement No. 121 (\"FASB 121\"), \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,\" which requires impairment losses to be recorded on long-lived assets used in operations, including intangible assets, when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amount. FASB 121 also addresses the accounting for long-lived assets that are expected to be disposed of. The Company will adopt FASB 121 in the first quarter of 1996 and, based on current circumstances, the effect of adoption will not be material.\nAlso in 1995, the FASB issued Statement 123 (\"FASB 123\"), \"Accounting for Stock-Based Compensation,\" that is effective for fiscal years beginning after December 15, 1995. FASB 123 establishes a method of accounting for stock-based compensation that is based on the fair value of stock options and similar instruments and encourages, but does not require, adoption of that method. The Company has elected to continue following Accounting Principles Board Opinion No. 25 for measuring compensation cost. Pursuant to FASB 123, the Company will disclose pro forma net income and earnings per share calculated as if the recognition and measurement provisions of the new standard had been adopted.\nReclassifications: Certain 1994 and 1993 amounts have been reclassified to conform to the 1995 presentation.\nFREMONT GENERAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE B -- ACQUISITION\nOn February 22, 1995 the Company, through its subsidiary Fremont Compensation Insurance Company, completed the acquisition of 100% of the outstanding common stock of Casualty Insurance Company (\"Casualty\") from the Buckeye Union Insurance Company (\"Buckeye\"). The purchase price paid by the Company was $250 million, comprised of $225 million in cash and $25 million in a note payable to Buckeye. In addition, $6.5 million of costs were incurred in connection with the acquisition bringing the total cost to $256.5 million. The acquisition, accounted for as a purchase, included approximately $45 million of costs in excess of net assets acquired which is being amortized over 25 years, and approximately $15 million of an intangible asset for the trade name which is being amortized over 40 years. Income from Casualty has been included in the consolidated income statement since February 22, 1995.\nCasualty, based in Chicago, Illinois and its California-based subsidiary, Workers' Compensation and Indemnity Company, underwrites workers' compensation insurance primarily in Illinois and California. Casualty is currently the largest underwriter of workers' compensation insurance in Illinois and is licensed in six states.\nThe following schedule summarizes certain proforma unaudited results of operations for the years ended December 31, 1995 and 1994, assuming the purchase of Casualty had been consummated as of January 1, 1994:\nFREMONT GENERAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nThe assets acquired and liabilities assumed, net of the purchase price, at the date of the acquisition of Casualty, are summarized in the following table:\nFREMONT GENERAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE C -- INVESTMENTS\nThe amortized cost and fair values of the fixed maturity investments and non-redeemable preferred stock by major category are summarized in the following table:\nFREMONT GENERAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nThe amortized cost and fair value of debt securities at December 31, 1995 by contractual maturity, are summarized in the following table:\nThe contractual maturities in the foregoing table may differ from actual maturities because certain borrowers have the right to sell or repay obligations with or without call or prepayment penalties.\nProceeds from sales of investments in debt securities and related realized gains and losses are summarized in the following table:\nInvestment income by major category of investments is summarized in the following table:\nThe Company relies on external rating agencies to establish quality ratings for its investments. The Company only purchases securities that are rated investment grade by at least one rating agency, but may hold investments that are subsequently downgraded to non-investment grade. As of December 31, 1995, all investments held by the Company are current as to principal and interest, with no investment in default. Included in investments is $27,794,000 of fixed maturity investments and $31,223,000 of non-redeemable preferred stock of Bankers Trust Company that in total exceeds 10% of stockholders' equity at December 31,\nFREMONT GENERAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n1995. Using Standard and Poor's, Moody's and Fitch's rating services, the quality mix of the Company's fixed maturity investment portfolio at December 31, 1995 is summarized in the following table:\nAs of July 1, 1995 the Company's held to maturity portfolio totaling $319.4 million was transferred to available for sale in accordance with the provisions of FASB 115. In addition, at this date there was a net unrealized gain of $9.9 million (net of deferred taxes of $5.3 million) on the held to maturity portfolio which was transferred to stockholders' equity. The transfer became necessary as the Company sold certain investment securities in July which were classified as held to maturity at June 30, 1995. These investment sales were part of an overall review and restructuring of the investment portfolio performed in conjunction with the investing of cash received in the acquisition of Casualty (see Note B). This review and restructuring caused the Company to consider the appropriateness of the remaining held to maturity investments, which resulted in the reclassification.\nThe par value of fixed maturity investments and cash totaling $834,433,000 at December 31, 1995 were on deposit with regulatory authorities in compliance with legal requirements related to the insurance operations.\nThe Company currently holds no derivative financial instruments subject to FASB Statement 119, \"Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments.\"\nNOTE D -- LOANS RECEIVABLE\nLoans receivable consist of commercial finance, commercial and residential real estate loans, and insurance premium notes receivable. Commercial finance loans are asset-based loans that are secured by the borrowers' eligible trade accounts receivable, inventories and equipment. Commercial and residential real estate loans are secured by real property. Insurance premium notes receivable are collateralized by security interests in return premiums.\nCommercial finance loans are stated at the unpaid balance of cash advanced net of allowance for possible loan losses of $12,554,000 and $12,464,000 at December 31, 1995 and 1994, respectively. The amount of cash advanced under these loans is based on stated percentages of the borrowers' eligible collateral. The majority of the loans are callable within 30 days at the option of the Company. Interest on the commercial loans is computed on the basis of daily outstanding balances times the contractual interest rate and is reported as earned income on the accrual method. Total loan balances on which income recognition has been suspended were $9,344,000 and $380,000 at December 31, 1995 and 1994, respectively. The 1995 balance consists of three loans, including one with a balance of $8,881,000. The 1994 balance consists of six loans.\nCommercial finance loans are shown net of participation by other financial institutions of $8,119,000 at December 31, 1995 and $9,764,000 at December 31, 1994. The participation agreements are generally made for a fixed percentage of the commercial loan balance and are made without recourse to the Company.\nThe Company's thrift and loan subsidiary generates primarily real estate loans. Commercial and residential real estate loans have terms ranging from one to thirty years. Finance charges are recognized as revenue over the life of the loan using the interest method. Loan origination fees and the related costs are deferred and amortized over the life of the loan using the interest method. The loans are net of allowance for\nFREMONT GENERAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\npossible loan losses of $17,498,000 and $14,391,000 at December 31, 1995, and 1994, respectively. Included in loans receivable are real estate loans which have been placed on non-accrual status totaling $23,544,000 and $21,454,000 at December 31, 1995 and 1994, respectively. Real estate acquired in foreclosure, which is classified under other assets, totaled $4,942,000 and $17,467,000 at December 31, 1995 and 1994, respectively, and is recorded at the lower of the carrying value of the loan or the estimated fair value less disposal costs.\nInsurance premium notes receivable mature within one year and are net of allowances for possible loan losses of $1,024,000 and $551,000 at December 31, 1995 and 1994, respectively. Interest income on these notes is recognized using the rule-of-seventy-eight method which results in approximately level interest rate yield over the life of the notes.\nActivity in the allowance for possible loan losses is summarized in the following table:\nAt December 31, 1995, the recorded investment in loans that are considered to be impaired under FASB 114 was $33,425,000, of which $32,889,000 were on a non-accrual basis. The Company's policy is to place on a non-accrual basis any loans deemed impaired under FASB 114 as the Company's loans are generally collateral dependent. As a result of charge-offs, these impaired loans do not necessarily have a related specific reserve for credit losses allocated to them. However, $18,427,000 of loans considered impaired do have an allowance that totaled $2,575,000. The average net investment in impaired loans during the year ended December 31, 1995 was $31,325,000 and no interest income has been recognized on loans classified as impaired during the year ended December 31, 1995.\nThe carrying amounts at December 31, 1995 and 1994 and estimated fair values at December 31, 1995 of loans receivable are summarized in the following table:\nFREMONT GENERAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE E -- CLAIM LIABILITIES FOR LOSSES AND LOSS ADJUSTMENT EXPENSES\nThe following table provides a reconciliation of the beginning and ending reserve balances for the Company's claim liabilities for losses and loss adjustment expenses (\"LAE\") on a net-of-reinsurance basis to the gross amounts reported in the Company's consolidated balance sheets.\nThe foregoing reconciliation shows that a $17 million redundancy in the December 31, 1993 reserve emerged in 1994. This redundancy resulted primarily from lower than previously estimated claim frequency and severity on workers' compensation claims incurred in 1993 and prior years.\nNOTE F -- REINSURANCE\nIn the normal course of business, the Company seeks to reduce the loss that may arise from catastrophes or other events that cause unfavorable underwriting results by reinsuring certain levels of risk in various areas of exposure with other insurance enterprises or reinsurers. Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policy.\nReinsurance contracts do not relieve the Company from its obligations to policyholders. The failure of reinsurers to honor their obligations could result in losses to the Company; consequently, allowances are established for amounts deemed uncollectible. The Company evaluates the financial condition and economic characteristics of its reinsurers to minimize its exposure to significant losses from reinsurer insolvencies.\nFREMONT GENERAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nThe effect of ceded reinsurance on property and casualty premiums are summarized in the following table:\nThe effect of ceded reinsurance on losses and loss adjustment expenses was a decrease (increase) in expenses of $19,651,000, $7,456,000 and $(12,427,000) for the three years ended December 31, 1995, 1994 and 1993, respectively.\nEffective December 31, 1995, the Company entered into a reinsurance and assumption agreement with a reinsurer whereby all of the Company's universal life insurance business was ceded to the reinsurer. This reinsurance agreement was entered into as of December 31, 1995 as part of several other agreements that became effective January 1, 1996. These agreements collectively act to significantly reduce the Company's life insurance operations. (See Note P). The effect of reinsurance on life insurance premiums and life insurance benefits was not significant for the three years ended December 31, 1995.\nNOTE G -- INCOME TAXES\nThe major components of income tax expense (benefit) are summarized in the following table:\nFREMONT GENERAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nA reconciliation of the effective federal tax rates in the consolidated statements of income with the prevailing federal income tax rate of 35% is summarized in the following table:\nThe deferred income tax balance includes the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and for income tax purposes. Details of the deferred tax expense (benefit) are summarized in the following table:\nNet payments made for federal and state income taxes were $13,429,000, $18,471,000 and $9,000,000 for 1995, 1994 and 1993, respectively.\nFREMONT GENERAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nThe components of the Company's deferred tax assets as of December 31, 1995 and 1994 are summarized in the following table:\nThe Company's principal deferred tax assets arise due to the discounting of loss reserves (which delays a portion of the loss reserve deduction for income tax purposes), the accrual of dividends to policyholders, certain life insurance benefits and liabilities, the provision for doubtful loan accounts and a portion of the unearned premiums. The effect of discounting the loss reserves for tax purposes is to effectively tax the future investment income stream associated with holding the investments necessary to support the reserves. Future investment income, irrespective of other operating income, should be sufficient to allow the future loss reserve deduction (i.e., the accretion of the discount for income tax purposes) to be utilized. Similarly, the recognition of the tax benefits in future periods associated with life insurance benefits and liabilities will be realized through future investment income to be earned on the underlying policies. With respect to the accrual of policyholders' dividends, the future periods will permit the recognition of the tax benefits associated with these accruals as the amounts are linked to future taxable income arising from existing policyholders of the Company.\nIn the Company's opinion, the deferred tax assets will be fully realized and no valuation allowance is necessary because the Company has the ability to generate sufficient future taxable income in both the insurance and financial services segments to realize the tax benefits.\nFREMONT GENERAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE H -- SHORT-TERM DEBT\nShort-term debt is summarized in the following table:\nThe commercial finance subsidiary has lines of credit with banks totaling $15,000,000 that expire September 30, 1996. Interest is based on the prime lending rate. At December 31, 1995, there were no outstanding advances under these lines of credit.\nNOTE I -- LONG-TERM DEBT\nLong-term debt is summarized in the following table:\nIn August 1995, the Company amended and restated an agreement on a $200,000,000 Revolving Credit Facility with several banks. Borrowings and repayments are at the option of the Company until the conversion date of August 31, 1997, at which time the facility converts to a term loan with a limit of $100 million that matures in 2001. Interest is based on, at the Company's option, the higher of the Federal Funds rate plus 1\/2% or the banks' prime lending rate plus an applicable margin, Eurodollar rates plus an applicable margin or by competitive bids by the banks. All applicable margins are based on the Company's credit rating. The rate at December 31, 1995 on the outstanding balance of $85,000,000 was 6.20%. A facility fee ranging from .25% to .45%, dependent on the Company's credit rating, is charged on the total facility. The facility fee rate during 1995 was .30%. The stock of a subsidiary insurance holding company has been pledged as collateral for this loan.\nDuring July 1994, the Fremont General Employee Stock Ownership Plan (\"ESOP\") borrowed $11,000,000 (see Note K) from a bank due in seven equal annual installments commencing on April 1, 1996.\nFREMONT GENERAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nThe maximum principal amount of this loan was increased to $15 million in August, 1995 and the term was extended to April 1, 2002. The note payable is secured by certain shares of the ESOP and the interest and principal payments are guaranteed by the Company. Interest is based on, at the Company's option, the bank's prime lending rate, LIBOR plus 1%, or an applicable certificate of deposit rate. The rate at December 31, 1995 was 6.69%.\nIn October 1993 the Company sold in a public offering an aggregate $373,750,000 principal amount at maturity of Liquid Yield Option Notes due October 12, 2013 (Zero Coupon-Subordinated) (the \"LYONs\") at an issue price of $372.42 for a total net proceeds to the Company of approximately $135,000,000. The yield to maturity is 5% with no periodic payments of interest. The LYONs are convertible into the Company's Common Stock at a price of $19.31 per share and are non-callable for 5 years.\nThe Variable Rate Asset Backed Certificates reflect the sale of certificates pursuant to the asset securitization program established in 1993 by a commercial finance subsidiary of the Company. The proceeds from the sale of the initial series of certificates (\"Series A\") under this program in April 1993 were $200 million bearing interest at the rate of LIBOR plus 0.47%. In November 1993, this subsidiary sold an additional $100 million principal amount of these certificates (\"Series B\") bearing interest at the rate of LIBOR plus 0.5%. The securities issued in this program have a scheduled maturity of three to four years but could mature earlier depending on fluctuations in outstanding balances of loans in the portfolio and other factors. In April 1995, $30 million principal amount of certificates which mature in 2000, bearing interest at the rate of LIBOR plus .95%, were sold via a private placement. In February 1996, $135 million in certificates (\"Series C\") were issued which mature in 2000. The proceeds were used, in conjunction with existing cash, to retire the $200 million in Series A certificates. In December 1995, a commercial paper facility was established as part of the asset securitization program. This facility provides for the issuance of up to $150 million in commercial paper, dependent upon the level of assets within the asset securitization program. This facility, which expires in December 1998, had no amounts outstanding under it as of December 31, 1995.\nThis subsidiary also has an unsecured revolving line of credit with a syndicated bank group that presently permits borrowings of up to $300 million, of which $185 million was outstanding as of December 31, 1995. This credit line which expires August 1998 replaced a short-term credit facility that expired in August, 1995. The weighted average interest rate at December 31, 1995 was 6.39%\nThe carrying amounts and the estimated fair values of long-term borrowings at December 31, 1995 are summarized in the following table:\nFREMONT GENERAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nThe aggregate amount of maturities on long-term debt and sinking fund requirements are summarized in the following table (thousands of dollars):\nTotal interest payments on all debt were $91,278,000, $49,294,000, and $37,433,000 in 1995, 1994 and 1993, respectively.\nNOTE J -- STOCKHOLDERS' EQUITY AND RESTRICTIONS\nOn December 4, 1995, the Board of Directors declared a three-for-two Common Stock split for stockholders of record on January 8, 1996 that was distributed on February 7, 1996. Also during 1995, a ten percent stock dividend was distributed June 15, 1995 to stockholders of record May 30, 1995.\nIn 1993 the Company distributed a three-for-two split of Common Stock and sold 3,094,000 shares of Common Stock in a public offering.\nThe Company is authorized to issue up to 2,000,000 shares of $.01 par value Preferred Stock; however none has been issued to date.\nConsolidated stockholders' equity is restricted by the provisions of certain long-term debt agreements. At December 31, 1995, the most restrictive loan covenants require the Company to maintain total stockholders' equity before FASB 115 adjustments of at least $375,000,000.\nThe Company has adopted a stock option plan for the benefit of certain key members of management. Under the plan, up to 2,681,000 shares are allocable to participants. Options are granted at exercise prices not less than the fair value of the stock on the date of grant. Upon the fifth anniversary of the date of the option grant and on each successive anniversary thereafter (until that option is either exercised or expires) the exercise price of each unexercised option is automatically reduced by one-sixth of the original option price, as reflected in the table below and a charge to compensation expense is recorded. Grantees vest at the rate of 25%\nFREMONT GENERAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nper year beginning on the first anniversary of the grant. The stock option activity is summarized in the following table:\nThe portion of the consolidated stockholders' equity represented by the Company's investment in its insurance subsidiaries and its thrift and loan subsidiary is subject to various laws and regulations, whereby amounts available for payment of dividends are restricted. Retained earnings and additional paid-in capital of the property and casualty companies currently available for dividend distribution is $29,941,000. No dividends are currently available from the thrift and loan subsidiary.\nNet income and stockholders' equity of domestic insurance subsidiaries, as filed with regulatory authorities on the basis of statutory accounting practices, are summarized in the following table:\nNOTE K -- EMPLOYEE BENEFIT PLANS\nThe Company sponsors a 401(k) Plan and a leveraged Employee Stock Ownership Plan (\"ESOP\"), both of which cover substantially all employees with at least one year of service. Contribution expense for these plans amounted to $11,015,000, $8,464,000 and $5,947,000 for 1995, 1994 and 1993, respectively, of which $8,656,000, $5,961,000 and $4,227,000 related to the ESOP. Cash contributions to the ESOP, which relate to 1995, 1994 and 1993, were $3,000,000, $4,375,000 and $4,147,000, respectively. The contributions, which are generally discretionary, are based on total compensation of the participants.\nFrom 1990 to 1994, the ESOP purchased 2,904,000 shares of the Company's Common Stock with funds provided by the Company in return for a note maturing in 2000 and bearing interest at 8%. In July 1994 the ESOP borrowed $11 million from a bank under a term loan due 2001 (See Note I). Proceeds from the loan were used to repay the note with the Company. The principal of the bank loan has been recorded as a liability of the Company. The maximum principal amount of this loan was increased to $15,000,000 in August, 1995 and the term was extended to April 1, 2002. Shares pledged as collateral are reported as unearned ESOP shares in the consolidated balance sheet. The annual contributions made by the Company to the ESOP are used to repay the loan. As the debt is repaid, shares are released from collateral and are allocated to participants based on total compensation. Dividends received by the ESOP on its investment in the Company's Common Stock, amounting to $374,000, $545,000 and $645,000 in 1995, 1994 and 1993,\nFREMONT GENERAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nrespectively, were additionally used to service these loans. Interest expense was $196,000 for the year ended December 31, 1995.\nAll shares held by the ESOP are considered outstanding for earnings per share purposes. Of the 2,814,000 shares of Company stock owned by the plan at December 31, 1995, 2,088,000 shares are allocated to participants and 726,000 shares are not allocated to participants. Unearned shares acquired prior to December 31, 1992 continue to be accounted for in accordance with the historical cost approach (AICPA Statement of Opinion 76-3). All of the unearned ESOP shares held as of December 31, 1995 were acquired prior to December 31, 1992.\nNOTE L -- COMMITMENTS AND CONTINGENCIES\nThe Company is a defendant in a number of legal actions arising primarily from claims made under insurance polices or in connection with previous reinsurance agreements. Those actions have been considered in establishing the Company's liabilities. Management and its legal counsel are of the opinion that the settlement of those actions will not have a material effect on the Company's financial position or results of operations.\nAn insurance subsidiary of the Company outsourced its data processing operation to Electronic Data Systems in 1992. Under terms of the contract, this subsidiary will pay a minimum $7,500,000 per year for a period of ten years, until 2002.\nTotal rental expense for 1995, 1994 and 1993, was $14,909,000, $9,115,000, and $8,926,000, respectively. The Company leases office facilities and certain equipment under non-cancelable operating leases, the terms of which range from one to ten years. Certain leases provide for an increase in the basic rental to compensate the lessor for increases in operating and maintenance costs. The leases also provide renewal options.\nUnder present leases, rental commitments are summarized in the following table (thousands of dollars):\nNOTE M -- DISCONTINUED OPERATIONS\nThe Company discontinued all of its assumed reinsurance operations, as well as certain other insurance operations, during the period 1986 to 1991. These operations consisted primarily of facultative and treaty reinsurance covering primary and excess property and casualty insurance coverages. All discontinued insurance operations are accounted for using the liquidation basis of accounting whereby all future cash inflows and outflows are considered in determining whether dedicated assets are sufficient to meet all future obligations.\nThe Company determines the adequacy of the assets dedicated to fund the liabilities of discontinued operations by: (i) estimating the ultimate remaining liabilities; (ii) discounting these liabilities using estimates of payment patterns and investment yields derived from the dedicated investment portfolio; and (iii) comparing this discounted estimate of liabilities to the dedicated assets.\nThe Company estimates that the dedicated assets (primarily cash, investment securities and reinsurance recoverables) supporting these operations and all future cash inflows will be adequate to fund future\nFREMONT GENERAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nobligations. However, should those assets ultimately prove to be insufficient, the Company believes that its property and casualty subsidiaries would be able to provide whatever additional funds might be needed to complete the liquidation without having a material adverse effect on the Company's consolidated financial position or results of operations.\nA statement of financial condition of the discontinued operations is summarized in the following table:\nThe amortized cost and fair value of cash and invested assets of the discontinued operations as of December 31, 1995 are summarized in the following table:\nThe average maturity of the fixed income portfolio was 5.10 years at December 31, 1995. The quality mix of the fixed maturity portfolio as of December 31, 1995 is summarized in the following table:\nAt December 31, 1995, all investments included in discontinued operations were current with respect to principal and interest. It is the Company's belief that the carrying value of the investments will be fully realized.\nFREMONT GENERAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE N -- OPERATIONS BY INDUSTRY SEGMENT\nThe following data for the years ended December 31, 1995, 1994 and 1993 provide certain information necessary for industry segment disclosure.\nFREMONT GENERAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n- --------------- * It is not practicable to allocate asset amounts among lines of business within the property and casualty insurance segment. Assets held for discontinued operations are excluded from the above table.\nNOTE O -- QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)\nThe revenues, net income, and net income per share for the quarters ended after March 31, 1995 are greater than all other quarters presented, due primarily to the acquisition of Casualty Insurance Company which was completed on February 22, 1995. (See Note B).\nNOTE P -- SUBSEQUENT EVENTS\nPublic Offering: On March 1, 1996, Fremont General Financing I, a statutory business trust (the \"Trust\") and consolidated wholly-owned subsidiary of the Company, sold $100 million of 9% Trust Originated Preferred Securities(SM) (\"the Preferred Securities\") in a public offering. The Preferred Securities represent preferred undivided beneficial interests in the assets of the Trust. The proceeds from the sale of the Preferred Securities were invested in 9% Junior Subordinated Debentures of the Company (\"the Junior Subordinated Debentures\"). The $100 million Junior Subordinated Debentures are the sole asset of the Trust.\nThe Preferred Securities will be redeemed upon maturity of the Junior Subordinated Debentures in 2026, subject to the election available to the Company to extend the maturity up to 2045, and they may be redeemed, in whole or in part, at any time on or after March 31, 2001 and under certain specified circumstances.\nThe Junior Subordinated Debentures rank pari passu with the Company's $373,750,000 aggregate principal amount at maturity of Liquid Yield Option Notes due 2013, and subordinate and junior to all senior indebtedness of the Company. Payment of distributions out of cash held by the Trust, and payments on liquidation of the Trust or the redemption of the Preferred Securities are guaranteed by the Company.\nFREMONT GENERAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nReinsurance: On January 1, 1996, the Company entered into a reinsurance and assumption agreement with a reinsurer whereby assets and liabilities related to certain life and annuity insurance polices, primarily investment-type contracts and credit life and accident and health, were ceded to the reinsurer. This reinsurance agreement is part of several other agreements which collectively act to significantly reduce the Company's life insurance operations (see Note F). The effect on operations from these agreements is not expected to be material.\nStockholders' Equity: During the first quarter of 1996, the Company completed a stock repurchase program. This program, previously announced on November 17, 1995, was initiated to fund stock-based management and employee benefit programs. A total of 819,300 shares (adjusted for the three-for-two stock split effected January 8, 1996) were purchased at a cost of $19,535,000.\nFREMONT GENERAL CORPORATION (PARENT COMPANY)\nSCHEDULE III -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT BALANCE SHEETS\n- ---------------\n* Eliminated in consolidation\nSee notes to condensed financial statements.\nFREMONT GENERAL CORPORATION (PARENT COMPANY)\nSCHEDULE III -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT STATEMENTS OF INCOME\n- --------------- * Eliminated in consolidation\nSee notes to condensed financial statements.\nFREMONT GENERAL CORPORATION (PARENT COMPANY)\nSCHEDULE III-CONDENSED FINANCIAL INFORMATION OF REGISTRANT STATEMENTS OF CASH FLOWS\nSee notes to condensed financial statements.\nFREMONT GENERAL CORPORATION (PARENT COMPANY)\nSCHEDULE III -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT NOTES TO CONDENSED FINANCIAL STATEMENTS\nNOTE 1 -- BASIS OF PRESENTATION\nIn the parent company financial statements, the parent's investment in subsidiaries is stated at cost plus equity in undistributed earnings of subsidiaries since date of acquisition. Parent company financial statements should be read in conjunction with the Company's consolidated financial statements.\nFREMONT GENERAL CORPORATION AND SUBSIDIARIES\nSCHEDULE V -- SUPPLEMENTARY INSURANCE INFORMATION\nFREMONT GENERAL CORPORATION AND SUBSIDIARIES\nSCHEDULE VI -- REINSURANCE\n- --------------- * Balance at end of year. Intercompany transactions have been eliminated.\nFREMONT GENERAL CORPORATION AND SUBSIDIARIES\nSCHEDULE VIII -- VALUATION AND QUALIFYING ACCOUNTS\n- --------------- (1) Reserves established with company and portfolio acquisitions.\n(2) Uncollectible accounts written off, net of recoveries and reclassifications.\nFREMONT GENERAL CORPORATION AND SUBSIDIARIES\nSCHEDULE X -- SUPPLEMENTAL INFORMATION CONCERNING PROPERTY\/CASUALTY INSURANCE OPERATIONS\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 28th day of March 1996.\nFREMONT GENERAL CORPORATION\nBy: \/s\/ JOHN A. DONALDSON -------------------------------- Title: Controller and chief Accounting Officer (Principal Accounting Officer)\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons in the capacities and on the dates indicated.\nINDEX TO EXHIBITS","section_15":""}
{"filename":"811119_1995.txt","cik":"811119","year":"1995","section_1":"Item 1. Business\nGENERAL - -------\nAmericold Corporation (\"Americold\" or the \"Company\") is the nation's largest supplier of refrigerated warehouse services for the frozen food industry. The Company also provides transportation management services for frozen food shippers. Services are provided through the Company's national network of 51 refrigerated warehouses and through the Company's refrigerated transportation management unit. The Company provides these and other services either separately or in conjunction with warehousing services. The Company also operates a limestone quarry, and previously operated a vital records center, which it closed during fiscal 1994.\nAmericold, an Oregon corporation, was founded in 1911, reincorporated in 1931 and, prior to 1984, operated as The Terminal Ice and Cold Storage Company and, subsequently, Termicold Corporation. In December 1982, Americold was acquired by Beatrice Companies, Inc. (\"Beatrice\"), which combined its public refrigerated warehouse facilities, operating under various names, with Americold. In December 1986, Americold was purchased (the \"Acquisition\") by a private group consisting of affiliates of Kelso & Company, Inc. (\"Kelso\"), certain institutional investors, and certain key employees and members of Americold's management (the \"Management Group\").\nSubsequent to the end of fiscal 1995, Americold Corporation solicited acceptances of a proposed prepackaged plan of reorganization (the \"Plan\") under Chapter 11 of the United States Bankruptcy Code from certain debtholders as a means of implementing the Company's plan for restructuring a portion of its outstanding indebtedness. On May 8, 1995, the Company received approval from the classes of debtholders entitled to vote on the Plan and, on May 9, 1995, filed the Plan as approved with the United States Bankruptcy Court for the District of Oregon. The Company is debtor-in-possession in the proceedings. See Part I, Item 3. - \"Legal Proceedings.\"\nAs used herein, the terms \"Americold\" or the \"Company\" refer to Americold Corporation and its subsidiaries unless the context indicates otherwise. All references to fiscal 1993, 1994 and 1995 refer to the years ended the last day of February 1993, 1994 and 1995, respectively.\nREFRIGERATED WAREHOUSES - -----------------------\nSince its founding in 1911, the Company has grown to become the largest owner and operator of refrigerated warehouses in the United States. The Company believes it supplies 16% of the total publicly available freezer storage space in the country, based on the most recent data (October 1993) published by the United States Department of Agriculture and the data most recently prepared by\nthe International Association of Refrigerated Warehousemen (the \"IARW\"). As of the last day of February 1995, the Company's network of 51 refrigerated warehouse facilities in fifteen states provided a total storage capacity of approximately 230.3 million cubic feet. Included in the Company's total of 230.3 million cubic feet of storage capacity is approximately 2.2 million cubic feet of storage capacity added as a result of the expansion of the Tomah, Wisconsin facility in August, 1994, and 2.3 million cubic feet added in Burley, Idaho in January 1995. Approximately 94% of the storage space operated by the Company is freezer space (zero degrees Fahrenheit and below), with the remaining space divided between cooler space (28 degrees Fahrenheit and above) and unrefrigerated dry storage space.\nMost of the Company's warehouses may be classified as combination production and distribution facilities, although some provide solely production or distribution services. Production facilities differ from distribution facilities in that they typically serve one or a small number of customers located nearby. These customers store large quantities of processed or partially processed products in the facility until they are further processed or shipped to the next stage of production or distribution. Distribution facilities primarily serve customers who store smaller quantities of a larger variety of finished products before they are shipped to end-users, such as food retailers and food service companies.\nDuring the past four years the Company has implemented new management systems and performance standards in its warehouses. The IBM AS400 warehouse management system was completed in December 1992 to tie together into a single network with common services all of the Company's locations. The Company believes that the standardization of systems and procedures has improved the quality and consistency of customer services, reduced costs and led to the overall enhancement of performance. To further integrate the Company's services, the Company, using new computer hardware and a combination of purchased and internally developed software, completed in March 1995 a transportation management system which is fully integrated with the Company's warehouse management system.\nThe Company has developed several services ancillary to its warehouse freezer operations and intends to continue developing and promoting such services as well as adding incremental freezer, cooler or dry space. Ancillary services include the use of electronic data interchange to receive and transmit product flow and status information to the Company's customers, and SUPERCOLD [registered trademark symbol] freezer storage provided at 11 of Americold's facilities for the preservation of products, such as ice cream, which require storage at temperatures as low as 20 degrees below zero (Fahrenheit). The Company also provides product repacking and preparation of products for shipment, and the leasing of warehouse space.\nREFRIGERATED TRANSPORTATION MANAGEMENT - --------------------------------------\nThe Company provides frozen food manufacturers with refrigerated transportation management services either separately or in\nconjunction with warehousing services. Integrated services allow frozen food manufacturers to contract with a single entity, the Company, for warehousing and transportation services to the manufacturer's ultimate customer. Transportation management services, which are provided under the Company's own ICC authority as a carrier or under ICC broker authority, include carrier and mode selection, routing, dispatch, carrier rate negotiations, carrier performance monitoring, claims management, freight payment and load consolidation. The actual freight transportation is performed by carriers who have negotiated rates with the Company. The Company does not own and does not intend to own significant transportation equipment.\nIn 1990, the Company united its freight consolidation activities conducted at various warehouses into a single unit, Americold Transportation Systems (\"ATS\"). Subsequently, in order to expand the business of ATS, the Company formed alliances with transportation providers and added staff resources and expertise in logistics. The Company now has the ability to utilize its network of IBM AS400 computers, its transportation management and communications software and its multiple warehouse locations to provide integrated warehousing and logistics services to its customers.\nIn addition to these integrated transportation management and warehousing services, the Company is working to develop services that include demand forecasting, \"flow-through logistics\" and \"channel cost economic modeling\" for its customers. Through its investment in Non-Stop Logistics Corporation (\"Non-Stop\"), a start-up venture, the Company is working to provide Non-Stop's advanced forecasting technology to Americold's customers. Non-Stop's forecasting technology is designed to be sufficiently accurate to allow customers to predict demand in advance and to send products to market area warehouses for rapid turn through the warehouses (\"flow-through logistics\"). Also through Non-Stop, the Company is working to provide channel cost economic modeling, which is a methodology used to identify and track accurately per-case costs of delivering products to individual markets. If Non-Stop is ultimately successful, the Company, through an agreement with Non-Stop, expects to be the principal provider of frozen storage, handling and transportation services in Non-Stop's flow-through environment. While there can be no assurance of Non-Stop's success, the Company believes that its association with Non-Stop will benefit the Company by providing it access to the latest cost-savings technology relating to food and packaged goods logistics.\nIn December 1994, the Company entered into an arrangement with one of its largest customers to provide transportation management services fully integrated with warehousing services. The customer has begun transferring responsibility for transportation management to the Company, and responsibility is expected to be fully transferred by August 1995. In addition, the Company is working with that customer and Non-Stop to develop a channel cost economic model, to provide forecasting services, and to develop an integrated logistics model. In February 1995, the Company signed a letter of intent with another customer to provide similar\ntransportation management services. The Company began providing services to this second customer in May 1995.\nREVENUES AND CUSTOMERS - ----------------------\nAmericold's net sales for fiscal 1993, 1994 and 1995 are detailed below by activity:\nNET SALES (Dollars in Millions)\nFiscal 1993 Fiscal 1994 Fiscal 1995 ------------ ------------ ------------- Amount % Amount % Amount % ------------- ------------ ------------- [S] [C] [C] [C] [C] [C] [C] Storage $101.0 51.5% $ 98.5 49.5% $103.4 48.0% Handling 60.3 30.8% 65.3 32.8% 70.7 32.9% Freezing 6.2 3.2% 6.5 3.3% 7.6 3.5% Leasing 9.5 4.8% 7.4 3.7% 7.0 3.3% Other 3.8 1.9% 3.4 1.7% 3.8 1.8% ------ ----- ------ ----- ----- ----- Net warehousing sales $180.8 92.2% $181.1 91.0% $192.5 89.5% Quarry sales 2.8 1.4% 5.2 2.6% 4.7 2.2% Vital record center sales 0.4 0.2% - - - - Transportation management services 12.1 6.2% 12.6 6.4% 18.0 8.3% ------ ----- ------ ----- ----- ----- Total net sales $196.1 100.0% $198.9 100.0% $215.2 100.0% ====== ====== ====== ====== ====== ======\nAmericold's customers consist primarily of national, regional and local frozen food processing firms, traders, wholesalers, retailers and food service organizations. Although the Company provides services to approximately 3,200 customers, in fiscal 1995 the 10 largest customers accounted for approximately 55% of total net sales. One customer of the Company, H. J. Heinz Co. and subsidiaries, accounted for approximately 21% of the Company's net sales in fiscal 1995. The Company believes that the risk to the Company of losing such large customers has been reduced in several cases through long-term storage and operating agreements and by the fact that services are provided to certain large customers in multiple locations.\nAt several locations, the Company's production warehouses are located adjacent to customers' processing facilities. Several of the Company's customers guarantee a minimum quantity of product to be stored in return for guaranteed space pursuant to long-term contracts. At several locations, the Company leases space to manufacturers or distributors on a long-term, fixed-rate basis. At a number of facilities, particularly those located adjacent to customers' processing facilities, a majority of, and in some cases virtually all, business is attributable to a single user of the\nfacility. Management has observed in the past, however, that to the extent products produced at locations adjoining the Company's facilities are commodities grown in the surrounding area, demand for the products has been more significant to the long-term sales and profitability of the facility than has been the viability of a single producer.\nSEASONALITY - -----------\nWarehousing sales are seasonal, depending upon the timing and availability of crops grown for frozen food production and the seasonal build-up of certain products for holiday consumption. The third quarter, ending each November 30, normally represents the strongest sales quarter. Capacity utilization at facilities varies from season to season, with average annual capacity utilization of approximately 70%. The Company generally keeps sufficient space available at individual warehouses to meet peak season demand.\nCOMPETITION - -----------\nAmericold operates in an environment in which location, customer mix, warehouse size, breadth of service, service performance and price are the principal competitive factors. Since frozen food manufacturers and distributors incur transportation costs which typically are significantly greater than warehousing costs, location is a major competitive factor. In addition, in certain locations, customers depend upon pooling shipments, which involves combining their products with the products of others destined for the same markets. In these cases, the mix of customers in a warehouse can significantly influence the cost of delivering products to markets. The size of a warehouse is important because large customers prefer to have all of the products needed to serve a given market in a single location and to have the flexibility to increase storage at that single location during seasonal peaks. The Company believes that customers generally will select a warehouse facility based upon the types of services available, service performance and price, if there are several warehouse locations which satisfy its transportation, customer mix and size requirements.\nAn additional competitive concern is that the Company's customers, many of which have substantially greater resources than the Company, may divert business from the public warehousing sector by building their own refrigerated warehouse facilities.\nCompetition is national, regional and local in nature. There are no significant barriers to entry, permitting a relatively large number of smaller competitors to enter the Company's markets. On the national level, Americold competes with United Refrigerated Services, Inc. (\"URS\"), United States Cold Storage, Inc., Millard Refrigerated Services and Christian Salvesen, Inc., which, according to statistics compiled by the IARW, accounted for approx- imately 6.3%, 4.2%, 2.7% and 2.2% of public freezer space, respectively, in 1993. On the regional and local level, there are many smaller warehouse operators that compete with the Company and,\naccording to data prepared by the IARW, warehouse operators who own or control less than 35 million cubic feet each of refrigerated space or freezer space accounted for approximately 71% of all public refrigerated storage space in 1993. The Company believes that competition from these local and regional competitors is significant because national competitors often do not compete in the same markets as the Company. The Company also believes, however, that if its strategy of integrating warehousing and transportation management services is successful, the economies of scale attendant to the movement of large quantities of diverse products through its national network of warehouses will create a marketing advantage not available to smaller competitors. Certain companies, such as GATX Corporation and Exel Logistics, Inc., provide transportation management services to local shippers, but not in conjunction with full service frozen food warehouse systems.\nKelso holds approximately 57% of the common equity of URS and, therefore, owns a controlling interest in both the Company and URS. Kelso has implemented procedures intended to address possible conflicts of interest that might arise from its investment in both URS and the Company. Kelso had considered on a preliminary basis the possibility of a business combination between the Company and URS. Kelso has terminated its consideration of such a business combination at this time.\nThe Company continues to look for opportunities to add warehouse locations and to expand its existing locations. While the Company has added approximately 24 million cubic feet of freezer space over the last seven years, and is currently in the process of constructing approximately ten million additional cubic feet, the public refrigerated warehouse industry has grown at a faster pace, adding approximately 340 million cubic feet of freezer space between 1987 and 1993 based on data prepared in October 1993 by the USDA. As a consequence, the Company's national market share of freezer space during such period decreased from approximately 18% to approximately 16%. Although some of the freezer space added by competitors has adversely affected the level of business at certain of the Company's warehouses, the majority has been in areas where the Company does not directly compete. The Company's ability to capitalize on significant business opportunities in the future, however, may be limited by its substantial leverage and restrictions in its debt agreements.\nORGANIZATION - ------------\nThe Company's operations are headquartered in Portland, Oregon, and the Company maintains an office in Gloucester, Massachusetts. The Company's warehouse facilities are organized into four districts. Each district is managed by a District Manager to whom the respective General Managers report. General Managers are responsible for one to five warehouses and are supported at the district and corporate levels by certain logistics, accounting, marketing, engineering, data processing and operational functions.\nSALES AND MARKETING - -------------------\nSales responsibility at the Company resides primarily with district and local management who are supported at the national level by the Company's executive and sales and marketing staff. Marketing is principally a corporate management function.\nIt is the responsibility of each warehouse's or group's management to understand and be responsive to the needs of its individual marketplace and to adapt sales efforts accordingly. Each General Manager actively engages in the sales effort. Although the Company operates nationally, prices charged by the Company tend to reflect local market conditions.\nLocal sales efforts are supplemented by the national corporate sales and marketing and logistics departments, which supplies sales support, logistics analysis, account pricing guidance and advertising, and monitors relationships with large district and national accounts. The Company employs two sales managers and a sales representative, all reporting to a director of sales in Portland, Oregon. These sales managers are located in California and Colorado, while the sales representative is located in Massachusetts. In addition, a primary sales development and pricing contact is assigned to each of the Company's top 100 accounts. Certain customers storing product in multiple facilities, but who are not among the Company's top 100 accounts, are also offered a similar contact.\nEMPLOYEES - ---------\nThe Company had approximately 1,889 employees as of February 28, 1995. A breakdown of employees by function is set forth below:\nEmployee Breakdown by Function\nNumber of Percentage Function Employees of Total - --------- --------- ----------\nWarehouse Operations 1,485 78.6% Transportation Management Services (ATS) 19 1.0% Sales and Marketing 4 0.2% Administration (Warehouse and Corporate) 381 20.2% ----- ----- Total 1,889 100.0% ====== ======\nApproximately 673 of the Company's employees are covered by union contracts. Currently, 26 facilities employ unionized labor, while 25 facilities are non-unionized. Union contracts for individual locations are with the local chapters of national unions, principally the International Brotherhood of Teamsters, and generally have staggered expiration dates. During the past three\nyears, there have been no strikes at the Company's facilities, and the Company believes its relationships with its employees are satisfactory.\nAs a result of the anticipated continued expansion in transportation management services offerings, the size of the ATS staff is expected to increase during fiscal 1996.\nPATENTS, LICENSES AND TRADEMARKS - --------------------------------\nThe Company's operations are not dependent upon any single or related group of patents, licenses, franchises or concessions. The Company's operations are also not dependent upon a single trademark or service mark, although the Company has registered the Americold [registered trademark symbol] and SUPERCOLD [registered trademark symbol] service marks with the United States Patent and Trademark Office.\nRESEARCH AND PRODUCT DEVELOPMENT - --------------------------------\nThe Company does not operate in an industry in which research and development plays an important role. The Company, therefore, has not made any material expenditure with regard to Company-sponsored research and development in the past three fiscal years, nor has it been involved in any material customer-sponsored research and development activities during that period. The Company, however, has made significant expenditures in developing and installing its new computer data processing support system, which integrates state of the art transportation management systems with the Company's warehouse management system. The Company also continues to pursue methods of reducing energy costs at its facilities.\nENVIRONMENTAL COMPLIANCE - ------------------------\nIn fiscal 1995, the Company completed its conversion of its last remaining freon-based cooling system to an ammonia-based system. The Company's capital expenditures, earnings and competitive position are not materially affected by 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 protection of the environment.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nAs of February 28, 1995, the Company owned or leased 51 facilities in 15 states. Although most of the facilities are owned by the Company, 13 facilities comprising approximately 10.2% of the Company's total cubic feet of storage space are leased or subleased by the Company under operating-type lease arrangements. Four facilities representing approximately 5.3% of the total cubic feet of storage space are leased, in whole or in part, under sale-and-leaseback or capitalized-type lease arrangements. Five facilities, or portions thereof, representing approximately 7.2% of the total cubic feet of storage space, are situated on leased land.\nCapacity utilization at facilities varies from season to season, with average annual capacity utilization of approximately 70%. All but five of the Company's owned warehouses are currently encumbered as security for the senior secured debt of the Company.\nThe Company's facilities are typically single-story concrete buildings constructed at dock height elevation, with very heavy insulation and vapor barrier protection. Refrigeration is typically supplied by screw-type compressors in ammonia-based cooling systems. Facilities are served by truck as well as by rail. In many instances buildings generally have sufficient land space surrounding them to afford ample area for truck parking and storage of unused pallets and equipment. Many facilities also have room for expansion.\nThe following table lists the 51 refrigerated warehouse properties owned or leased by the Company as of February 28, 1995. It also shows the 31 facilities that presently secure the Company's first mortgage bonds.\nREFRIGERATED WAREHOUSE FACILITIES\nTotal Storage Space (Cubic Type of Owned or Ft.\/Mil) Facility(*) Leased ------- -------- -------\nBurbank (W. Magnolia Blvd.), California 0.8 P\/D Owned Fullerton (S. Raymond Ave.), California 4.0 P\/D Leased(1) Los Angeles (Corona St.), California 0.7 D Leased(1) Los Angeles (Jesse St.), California 2.7 P\/D Owned(4) Oakland (E. 11th St.), California 1.9 D Leased(1) Pajaro (Salinas Rd.), California 0.8 P\/D Leased(1) San Francisco (Donner Ave.), California 2.5 D Leased(1) Turlock (5th St.), California 2.5 P\/D Owned(4) Turlock (S. Kilroy Rd.), California 3.0 P\/D Owned(4) Watsonville (W. Riverside Dr.), California 5.2 P\/D Owned(2)(4) Watsonville (Second St.), California 1.5 P\/D Leased(1) Watsonville (Hwy One), California 3.6 P\/D Leased(1) Denver (E. 50th St.), Colorado 2.8 P\/D Owned(2)\/ Leased(3)(4)\nDenver (N. Washington St.), Colorado 0.5 P\/D Leased(1) Bartow (U. S. Highway 17), Florida 1.2 P\/D Owned(2)(4) Plant City (S. Alexander St.), Florida 0.9 P\/D Owned Tampa (N. 50th St.), Florida 4.1 P\/D Owned\/ Leased(3) Tampa (S. Lois Ave.), Florida 0.4 D Owned Tampa (Shoreline Dr.), Florida 0.8 D Owned(2) Burley (U.S. Highway 30), Idaho 7.8 P\/D Owned(2)(6) Nampa (4th St. N.), Idaho 8.0 P Owned(4) Chicago (S. State St.), Illinois 2.9 P\/D Leased(1) Chicago (S. Blue Island Ave.), Illinois 2.9 P\/D Leased(1) Bettendorf (State St.), Iowa 8.9 P\/D Owned(4) Fort Dodge (Maple Dr.), Iowa 3.7 D Owned(4) Kansas City (Inland Dr.), Kansas 35.2 P\/D Owned(4) Portland (Read St.), Maine 1.8 P\/D Owned Boston (Widett Ci.), Massachusetts 3.1 P\/D Owned(4) Gloucester (E. Main St.), Massachusetts 1.9 P\/D Owned(4) Gloucester (Railroad Ave.), Massachusetts 0.3 P\/D Owned(4) Gloucester (Rogers St.), Massachusetts 2.8 P\/D Owned(4) Gloucester (Rowe Sq.), Massachusetts 2.4 P\/D Owned(4) Watertown (Pleasant St.), Massachusetts 4.7 P\/D Owned(4) Brooks (Brooklake Rd.), Oregon 4.8 P Owned(4) Hermiston (Westland Rd.), Oregon 4.0 P Owned(4) Hillsboro (W. Washington St.), Oregon 1.1 P\/D Leased(1)(7) Milwaukie (S. E. McLoughlin Blvd.), Oregon 4.7 D Owned(4) Ontario (N. E. First St.), Oregon 8.1 P Leased(5) Salem (Portland Rd. N.E.), Oregon 12.5 P\/D Owned(4) Woodburn (Silverton Rd.), Oregon 6.3 P\/D Owned(4) Fogelsville (Mill Rd.), Pennsylvania 14.0 D Owned\/ Leased(3)(4) Murfreesboro (Stephenson Dr.), Tennessee 2.9 P\/D Owned(4) Clearfield (South St.), Utah 8.6 P\/D Owned(4) Burlington (S. Walnut), Washington 4.7 P\/D Owned(4) Connell (W. Juniper St.), Washington 5.7 P Owned(4) Kent (S. 190th St.), Washington 1.0 D Leased(1) Moses Lake (Wheeler Rd.), Washington 7.3 P\/D Owned(4) Walla Walla (4-14th Ave. S.), Washington 3.1 P Owned(4) Wallula (Dodd Rd.), Washington 1.2 P\/D Owned(4)\nPlover (110th St.), Wisconsin 9.4 P\/D Owned(4) Tomah (Route 2), Wisconsin 4.6 P Owned(4) ----- 230.3 ===== ____________________________ (*) \"P\" designates a production facility. \"D\" designates a distribution facility. \"P\/D\" designates a facility that is used for both production and distribution. (1) Operating lease. (2) Building owned by the Company; land is leased. (3) Capitalized lease. (4) Security for Company's first mortgage bonds. See Note 7 to Consolidated Financial Statements. (5) Financing lease. (6) Security for mortgage payable. (7) Lease terminated May 1995.\nItem 3.","section_3":"Item 3. Legal Proceedings\nOn May 9, 1995, subsequent to the end of fiscal 1995, the Company filed a prepackaged plan of reorganization under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the District of Oregon (the \"Court\") (Case No. 395-33058elp11). The principal purpose of the Plan is to reduce the Company's short- term cash requirements with respect to payments due on its subordinated indebtedness and to adjust certain restrictive financial covenants and certain other provisions contained in the Amended and Restated Investment Agreement (the \"Old Investment Agreement\"), dated March 2, 1993, between the Company and Metropolitan Life Insurance Company (the \"Institutional Investor\"). On the filing date, the Plan had received approval from both of the classes of debtholders entitled to vote on the Plan.\nA hearing has been scheduled for June 19, 1995 to consider the motion of the Company requesting the Court (1) to approve the Company's Disclosure Statement dated April 14, 1995 and the Company's procedure for solicitation of votes to accept or reject the Plan, and (2) to confirm the Plan.\nFor additional information with respect to the Plan, see Part II, Item 7. - \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources.\"\nFrom time to time, the Company has been involved in litigation relating to claims arising out of its operations in the regular course of business. The Company has settled all of the material lawsuits and claims filed in connection with the Kansas City fire. The aggregate amount of all settlement payments for the litigation and claims related to the Kansas City fire did not exceed the amount of the Company's applicable insurance coverage and therefore no cash payment by the Company was required. After resolution of the lawsuits and claims, the Company applied the proceeds paid to the Company by the Company's insurance carriers in the third\nquarter of fiscal 1995. See Item 2, \"Management's Discussion and Analysis of Financial Condition and Results of Operations--Nine-Month Results,\" Form 10-Q dated January 17, 1995 for the quarter ended November 30, 1994.\nAs of May 9, 1995, the Company, excluding the above bankruptcy proceeding, is not 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. The Company maintains property, liability and warehouseman's legal liability insurance in amounts which it believes are consistent with industry practice and adequate for its operations.\nItem 4.","section_4":"Item 4. Submission Of Matters To a Vote Of Security Holders\nNo matter was submitted by the Company to a vote of stockholders during the fourth quarter of fiscal 1995.\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 not listed on a securities exchange or traded through an interdealer quotation system. There is no established public trading market for the Company's common stock. However, there are occasional trades through certain broker\/dealers.\nSTOCKHOLDERS - ------------\nAs of May 1, 1995, there were 4,860,934 shares of the Company's common stock outstanding, held by approximately 84 stockholders of record. See also response to Part III, Item 12.\nDIVIDENDS - ---------\nNo dividends have been declared by the Company on its common stock since the Acquisition. The Company's credit agreements restrict the payment of dividends on common stock, and it is the present policy of the Board of Directors that all available cash be used for the reduction of debt and for reinvestment in the Company's business.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe following table presents selected historical financial information. The information should be read in conjunction with the Company's Consolidated Financial Statements and related Notes, and Management's Discussion and Analysis of Financial Condition and Results of Operations as furnished below in Part II, Item 8 and Item 7, respectively. Dollars are in thousands, except per share data.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nINTRODUCTION - ------------ Subsequent to the end of fiscal 1995, Americold Corporation solicited acceptance of a proposed prepackaged plan of\nreorganization under Chapter 11 of the United States Bankruptcy Code from certain debtholders as a means of implementing the Company's plan for restructuring a portion of its outstanding indebtedness. On May 8, 1995, the Company received approval from the classes of debtholders entitled to vote on the Plan and, on May 9, 1995, filed the Plan as approved with the United States Bankruptcy Court for the District of Oregon. The Company is debtor-in-possession in the proceedings. See \" - Liquidity and Capital Resources.\"\nThe Company's operating results have been and will continue to be materially affected by the transactions related to the Acquisition. Operating results are affected by indebtedness incurred to finance the Acquisition and by the amortization of capitalized fees and expenses incurred in connection with such financing. For fiscal 1994 and 1995, interest expense, principally related to debt incurred to finance the Acquisition, totaled $55.4 million and $55.3 million, respectively, and the amortization of debt issuance costs totaled $1.2 million and $1.3 million, respectively.\nIn December 1991 a fire began at the Company's Kansas City, Kansas underground warehouse, the Company's largest warehouse facility. Due to its underground location, the fire took several months to extinguish. The fire was confined to an unrefrigerated area of the warehouse; however, a significant amount of product in the warehouse at the time of the fire sustained smoke damage.\nAs a result of the fire, the Company's warehousing activities in Kansas City have operated at a substantially reduced level, due to reduced warehouse volume and loss of public storage and lease customers. The fire also caused the Company to discontinue its vital record center storage operations. The Company abandoned 63% of its less productive dry storage space and 11% of its freezer space; however, the balance of the Kansas City, Kansas warehouse facility has been restored to substantially its pre-fire condition. The Company is, however, unable to predict its ability to return the facility to pre-fire operating volumes and profits. While the Company has had some success in rebuilding its public storage business, revenue from the lease of space to third parties remains significantly below pre-fire levels. The Company anticipates that the adverse effects of the Kansas City fire on operating results due to the loss of customers, especially lease customers, will continue for at least the next several years.\nIn December 1994, the Company entered into an arrangement with a major customer to provide transportation management services fully integrated with warehousing services for that customer. The contract is expected to be fully implemented by August 1995. In February 1995, the Company signed a letter of intent with a second\ncustomer to provide similar transportation management services which began in May 1995. The Company therefore expects that revenue related to its transportation management services activity may increase substantially in fiscal 1996. The amount of such revenue depends upon the transition process and other factors. In fiscal 1996, the Company does not expect the arrangements to have a material effect on income.\nHISTORICAL INCOME STATEMENT INFORMATION - ---------------------------------------\nThe following table sets forth, for the fiscal years ended the last day of February 1993, 1994 and 1995, respectively, certain consolidated financial data for the Company, expressed as a percentage of net sales, and the percentage changes in the dollar amount as compared to the prior period.\nRESULTS OF OPERATIONS - ---------------------\nNET SALES - The Company's net sales increased 8.2% from $198.9 million for fiscal 1994, to $215.2 million for fiscal 1995. Warehousing sales increased 6.3% from $181.1 million for fiscal 1994 to $192.5 million for fiscal 1995, primarily due to a 5.0% increase in storage revenue and an 8.3% increase in handling revenue. The increase in storage revenue resulted from an increase in storage volume of 5.0%. The increase in storage volume is due primarily to the increased storage of vegetables, which is attributable to a strong vegetable harvest in the Midwest in calendar 1994.\nThe increase in handling revenue resulted primarily from an 11.7% increase in volume of product handled. For fiscal 1994, 17.9 billion pounds of product were handled by the Company compared with 20.0 billion pounds in fiscal 1995. While handling volume increased 11.7%, handling revenue increased only 8.3% due to decreased special services revenue (classified by the Company as handling revenue), changes in product mix and other factors.\nNonwarehousing sales increased 27.5% from $17.8 million for fiscal 1994 to $22.7 million in fiscal 1995, due primarily to increased sales from ATS.\nNet sales for fiscal 1994 were 1.4% higher than fiscal 1993. The slight increase in warehousing sales was primarily the result of an increase in handling revenue which was offset by a decrease in storage revenue due to the reduction in certain frozen vegetable stock, attributable primarily to the flooding in the Midwestern United States in 1993. Nonwarehousing sales in fiscal 1994 increased primarily as a result of an increase in quarry sales, again due in part to the flooding, as the demand for quarry products increased.\nCOST OF SALES - Cost of sales increased $11.9 million or 9.4% from $126.3 million for fiscal 1994 to $138.1 million for fiscal 1995. Approximately $5.2 million of the increase was due to increased volume at ATS, which requires corresponding increases in transportation capacity purchased from carriers. The Company's transportation management services business is in the development stage and experienced losses of approximately $.8 million in fiscal 1995. Management expects the business to break even in fiscal 1996. Another $3.5 million of the increase in cost of sales was primarily attributable to increased warehouse payroll expense resulting from the increase in handling volume at the Company's facilities.\nCost of sales as a percentage of net sales increased from 63.5% in fiscal 1994 to 64.2% in fiscal 1995, as handling and ATS sales, which have high variable cost requirements, increased from 39.2% of total sales in fiscal 1994 to 41.2% in fiscal 1995.\nManagement has observed over the past several years a gradual shift in its warehousing business mix to reflect an increasing percentage of lower-margin handling revenue. However, management has not been able to determine the extent to which this shift has been due to the increased emphasis by customers on inventory turns, or due to dislocations caused by severe crop losses in the 1993 Midwest flooding. While management expects the underlying trend toward lower margins to continue due to the planned growth of the refrigerated transportation management business, the Company believes that such activity is likely to also include related increases in higher-margin storage business and a long-term increase in earnings due to higher volumes in all lines of business.\nCost of sales for fiscal 1994 was 6.2% higher than fiscal 1993 as a result of the increased handling volume at the Company's facilities, including the quarry.\nSELLING AND ADMINISTRATIVE EXPENSES - Selling and administrative expenses for fiscal 1994 were $27.1 million, as compared to $26.0 million for fiscal 1995, a decrease of 4.2%. The reduction primarily reflects a decrease of approximately $0.5 million in professional fees. The Company was able to reduce selling and administrative expenses in an environment of increasing sales due to an intensive program to reduce and restructure administrative activities.\nSelling and administrative expenses for fiscal 1994 were $27.1 million, a decrease of 0.4% from fiscal 1993. The decrease primarily reflects a decrease in administrative payroll and related fringe benefits.\nINTEREST EXPENSE - Interest expense decreased from $55.4 million for fiscal 1994 to $55.3 million for fiscal 1995, as a result of slightly lower average borrowings during the fiscal year.\nInterest expense increased from $51.9 million for fiscal 1993 to $55.4 million for fiscal 1994, resulting from both the $26.25 million net increase in the principal amount of first mortgage bonds outstanding, and from the new mortgage payable on the Burley, Idaho warehouse facility.\nGAIN ON INSURANCE SETTLEMENT - This one-time gain reflects the gain on insurance settlement of approximately $17.0 million related to\nthe Company's settlement with its insurance carriers of its first party claims for business interruption losses, property damage and out-of-pocket expenses incurred with respect to the Kansas City fire.\nINCOME - The Company's loss before income taxes, extraordinary item and cumulative effect of accounting changes for fiscal 1994 was $12.2 million, compared to income of $10.8 million in fiscal 1995. The increase in income reported in the more recent period is primarily the result of the insurance settlement referred to above.\nThe Company's loss before income taxes, extraordinary items and cumulative effects of accounting changes for fiscal 1993 was $5.7 million compared to a loss of $12.2 million for fiscal 1994. The principal reasons for the increased loss includes the increased interest expense and increased cost of sales, discussed above.\nEXTRAORDINARY LOSS - During the first quarter of fiscal 1994, the Company completed a debt refinancing transaction related to the first mortgage bonds which resulted in an extraordinary loss to the Company, net of taxes, of approximately $1.8 million due to the write-off of unamortized issuance costs.\nINFLATION - The Company's operations have not been, nor are they expected to be, materially affected by inflation or changing prices.\nNEW ACCOUNTING STANDARDS - Effective March 1, 1993, the Company implemented Financial Accounting Standards Board Statement of Financial Accounting Standard No. 106, \"Employer's Accounting for Postretirement Benefits Other Than Pensions\", and Statement No. 109, \"Accounting for Income Taxes.\" As a result of the implementation of these accounting standards, the Company's fiscal 1994 earnings were reduced by approximately $64.2 million.\nLIQUIDITY AND CAPITAL RESOURCES - -------------------------------\nLIQUIDITY\nOPERATING CASH FLOW - The Company relies primarily upon cash generated by operations to service debt and fund capital expenditures. Net cash flow from operating activities as reported in the Company's consolidated financial statements decreased from $18.5 million for fiscal 1994 to $12.7 million for fiscal 1995. The decrease is due primarily to an increase in trade receivables, resulting from increased sales and changes in the timing of certain cash collections, and from changes in the timing of the payment of interest and certain other items. Cash and cash equivalents\nincreased from $3.9 million at the end of fiscal 1994 to $33.2 million at the end of fiscal 1995 due primarily to the receipt of the insurance proceeds relating to the Kansas City fire.\nThe Company's working capital position at fiscal 1995 year-end was a negative $14.9 million. This position compares to a negative $7.5 million at fiscal 1994 year-end. The decrease in working capital was due primarily to an increase in accrued expenses and a decrease in other receivables. The increase in accrued expenses is a result of timing of certain payments, and the decrease in other receivables is due to the receipt of the insurance proceeds.\nSHORT-TERM CAPITAL RESOURCES - The commitment level at February 28, 1995 under the existing credit agreement (\"Existing Credit Agreement\") with the Company's principal bank (the \"Bank\") was $27.5 million, with a maximum of $20.0 million available for cash borrowing. The maximum amount of letters of credit permitted to be outstanding under the Existing Credit Agreement is $10.0 million. Any amount by which letters of credit outstanding exceed $7.5 million under the Existing Credit Agreement reduces the available cash borrowings by a like amount. In addition, the amount available for cash borrowings is subject to further limitation by the amount of eligible accounts receivable outstanding. Based upon letters of credit outstanding and eligible accounts receivable as of February 28, 1995, the Company had an available cash borrowing capacity of $16.3 million, of which no amount was borrowed. The Company had approximately $7.3 million of outstanding letters of credit, principally related to leasing and workers' compensation requirements.\nDEBT SERVICE REQUIREMENTS - Payments due on long-term debt in the first half of fiscal 1996 included an interest payment of $10.1 million paid on March 1, 1995 with respect to the first mortgage bonds, and a sinking fund payment of $28.75 million and an interest payment of $6.3 million due on May 1, 1995 with respect to the Company's 11% Senior Subordinated Debentures due 1997 (the \"Old Subordinated Debentures\"). As a result, the Company's estimated cash requirements for debt service in the first quarter of fiscal 1996 were approximately $45 million. The Company had available cash to make the March 1, 1995 interest payment on the first mortgage bonds and had cash and available borrowings under the Existing Credit Agreement to make the principal and interest payments with respect to the Old Subordinated Debentures on May 1, 1995. However, if the Company had made the required May 1, 1995 principal and interest payments on the Old Subordinated Debentures from available cash and borrowings under the Existing Credit Agreement, the Company believes that such payments would have created a default at the next measurement date (May 31, 1995) under the pro forma debt service covenant (as defined) contained in the\nOld Investment Agreement, and a default under the Existing Credit Agreement relating to an out-of-debt requirement as of June 30, 1995. Under such circumstances, the Institutional Investor and the Bank could declare the principal of and accrued but unpaid interest on all the first mortgage bonds and borrowings under the Existing Credit Agreement to be immediately due and payable. Upon such a declaration, such principal and interest and a premium thereon would be classified as a current liability. The Company therefore proposed the Plan to alleviate the Company's anticipated liquidity shortfall and to avoid defaulting under its various debt agreements.\nThe Plan provides, among other things, that:\n(i) each holder of the Company's Old Subordinated Debentures will receive, for each $1,000 principal amount of Old Subordinated Debentures, $1,000 of the Company's 15% Senior Subordinated Debentures due 2007 (the \"New Subordinated Debentures\"), and an amount in cash equal to 100% of the accrued but unpaid interest on the Old Subordinated Debentures up to but excluding the effective date of the Plan;\n(ii) the legal, equitable and contractual rights of each holder of the Company's 11.45% First Mortgage Bonds, Series A due 2002 (the \"Series A Bonds\"), and the Company's 11 1\/2% First Mortgage Bonds, Series B due 2005 (the \"Series B Bonds\") (collectively, the \"First Mortgage Bonds\"), under the Amended and Restated Indenture, dated as of March 9, 1993, will be left unaltered; and\n(iii) the Old Investment Agreement between the Company and the Institutional Investor will be superseded by the Second Amended and Restated Investment Agreement (the \"New Investment Agreement\"), which will contain certain financial and operating covenants that in some cases are less restrictive than those contained in the Old Investment Agreement, and pursuant to which (x) the Company will redeem $10.0 million in principal amount of the Company's Series A Bonds held by the Institutional Investor for an amount equal to 100% of the principal amount thereof, and (y) the Company will have the right, under certain circumstances, to redeem prior to scheduled maturity additional Series A Bonds without payment of any prepayment premium. The Company will also pay an agreement modification fee of $2.25 million to the Institutional Investor.\nThe Plan also provides that all pre-petition claims of the Company's secured lenders, trade creditors and employees will be paid in full.\nIn addition, the Company has negotiated an amended credit agreement (the \"New Credit Agreement\") with its Bank. The New Credit\nAgreement will become effective upon the confirmation and effectiveness of the Plan. The New Credit Agreement will provide an aggregate availability of $27.5 million, which may be used for any combination of letters of credit (up to $10.0 million) and revolving cash borrowings, subject to borrowing base limitations. The borrowing base for both cash borrowings and letter of credit amounts will equal 85% of eligible accounts receivable, plus 70% of the value of all real property mortgaged to the Bank, up to a maximum of $27.5 million. The New Credit Agreement will be secured by the Company's trade receivables and mortgages on certain of the Company's warehouse properties. Borrowings under the New Credit Agreement will mature on February 28, 1999. The New Credit Agreement eliminates the 30-day resting period (during which there may be no outstanding borrowings) for fiscal 1996 and requires only one such period for fiscal 1997. Two such periods will be required during fiscal 1998 and fiscal 1999. The New Credit Agreement also is expected to contain amendments of certain financial covenants contained in the existing credit agreement in light of the restructuring.\nThe Company believes the Plan will mitigate the Company's near-term financial vulnerability and increase the likelihood that the Company will realize the benefits of additional capital expenditures and its anticipated expansion of its refrigerated transportation management business. After the Plan, the Company's present level of cash flow from operations and escrowed funds is expected to be sufficient to cover all interest payments and planned capital expenditures for fiscal 1996. After the reorganization, however, the Company will remain highly leveraged and will continue to be subject to substantial principal and interest obligations with respect to its indebtedness.\nFunds provided from operations (gross operating margin plus depreciation, amortization and employee stock ownership plan expense) for fiscal 1993, 1994 and 1995 totaled $68.2 million, $65.9 million and $71.6 million, respectively. Interest expense, net of amortization of original issue discount, totaled $50.9 million, $54.2 million and $54.0 million, respectively.\nCAPITAL RESOURCES - Expenditures, including capital leases, for property, plant and equipment for fiscal years 1993, 1994 and 1995 totaled $17.7 million, $11.0 million and $14.3 million, respectively. Fiscal 1995 capital expenditures included approximately $6.7 million for the expansion of the Burley, Idaho, facility and the Tomah, Wisconsin facility. The balance of the fiscal 1995 capital expenditures included approximately $1.5 million in revenue enhancement or cost reduction expenditures, and approximately $4.8 million for routine replacements or betterments. The Company also acquired $1.1 million of assets under capital\nleases and $0.2 million under operating leases.\nBudgeted fiscal 1996 capital needs total approximately $35.4 million, including approximately $25.6 million for property development, expansions or acquisition. A portion, related primarily to material handling equipment, is expected to be leased on an operating or capital lease basis. The funding for the approximately $25.6 million of property expansions will principally come from the funds held in escrow pursuant to the Bond Indenture or from outside borrowings. As of February 28, 1995, the Company had approximately $20.7 million in escrowed funds reserved for capital expenditures. The Company continues to examine opportunities for expansion of its locations and services. Any escrowed funds not expended by March 1996 must be used to redeem First Mortgage Bonds. The Company's capital expenditures are substantially discretionary.\nThe Company has made a proposal to the trustee under the indenture relating to the First Mortgage Bonds to substitute approximately $4.8 million in cash as collateral for the property damaged in the Kansas City fire, although no agreement has been reached for such substitution. The Company has not reclassified any cash balance for the possible payment.\nThe Company, as part of its Kansas City, Kansas location, operates a limestone quarry. Subject to the completion of certain remaining due diligence items, the Company expects to dispose of this business during the first half of fiscal 1996. Net proceeds of the sale must, in accordance with the Company's existing debt agreements, be reinvested in warehouse properties or used to satisfy, in part, the mortgage obligation on the property.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe Company's consolidated financial statements as of the last day of February 1994 and 1995 and related information listed below, are set forth on pages 51 through 77-D of this report.\nTITLE PAGE --------- ----\nIndependent Auditors' Report 50\nConsolidated Balance Sheets as of the last day of February 1994 and 1995 52\nConsolidated Statements of Operations for years ended the last day of February 1993, 1994 and 1995 54\nConsolidated Statements of Common Stockholders' Deficit for years ended the last day of February 1993, 1994 and 1995 55\nConsolidated Statements of Cash Flows for years ended the last day of February 1993, 1994 and 1995 56\nNotes to Consolidated Financial Statements as of the last day of February 1994 and 1995 59\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nThe directors and executive officers of Americold as of May 1, 1995 are as follows:\nNAME AGE TITLE ---- --- -----\nRonald H. Dykehouse 53 Chairman of the Board, President, Chief Executive Officer and Director\nJoel M. Smith 51 Senior Vice President, Chief Financial Officer and Director\nJohn P. LeNeveu 48 Senior Vice President, Operations and Sales\nF. Stanley Sena 46 Senior Vice President, Administration and Technical Services\nJ. Roy Coxe 54 Senior Vice President, Logistics\nRonald A. Nickerson 58 Vice President, Operations\nLon V. Leneve 38 Vice President, Treasurer and Secretary\nFrank Edelstein 69 Director\nGeorge E. Matelich 38 Director\nJames C. Pigott 58 Director\nWilliam A. Marquard 74 Director\nRONALD H. DYKEHOUSE was named President of Americold Corporation in May 1990 and Chairman of the Board and Chief Executive Officer in June 1990. From 1989 to 1990, Mr. Dykehouse was a private investor and consultant. From 1986 to 1989, he was Executive Vice President and Chairman of the Food and Distribution Groups of Amfac Inc., a diversified holding company. Mr. Dykehouse is a past director of the National Frozen Foods Association and past Chairman of the American Frozen Food Institute.\nJOEL M. SMITH has been Senior Vice President and a director of the Company since December 1986. Mr. Smith has been the Chief Financial Officer of Americold since 1978 and a Vice President since 1984.\nJOHN P. LENEVEU was named Senior Vice President, Operations and Sales of Americold in July 1991. From 1988 to 1991, he was a management consultant with the Institute of Management Resources, an international management consulting company.\nF. STANLEY SENA has been Senior Vice President, Administration and Technical Services of the Company since August 1991. From 1986 to 1990, Mr. Sena was Vice President, Operations, Western Region, and from 1990 to 1991, Mr. Sena was Vice President, Operations of the Company.\nJ. ROY COXE was named Senior Vice President, Logistics, of Americold in December 1993. From 1991 to 1993, he was a management consultant with A. T. Kearney, Inc., an international management consulting company. Mr. Coxe was a vice president of Drake Sheahan Stewart Dougall and successors, a logistics and transportation consulting firm, from 1983 to 1991.\nRONALD A. NICKERSON has been Vice President, Operations since 1990. From 1987 to 1990, Mr. Nickerson was Vice President, Operations, Eastern Region, of the Company.\nLON V. LENEVE was named Vice President in September 1992, has been Treasurer of Americold since July 1988 and was appointed Secretary of the Company in February 1995. Mr. Leneve joined Americold in 1982 and was Controller from 1984 to 1988.\nFRANK EDELSTEIN was elected a director of the Company in 1986. He is currently a consultant to Kelso and Vice President of Gordon+Morris Group, Inc., an investment banking firm. Mr. Edelstein joined Kelso in 1987 and held the position of Vice President at Kelso until 1992. Mr. Edelstein is also a director of Ceradyne, Inc., IHOP Corporation and Arkansas Best Corporation.\nGEORGE E. MATELICH has been a director of the Company since December 1986. Mr. Matelich joined Kelso in 1985 as an Associate, served as a Vice President of Kelso from 1986 to 1990 and is currently a Managing Director of Kelso.\nJAMES C. PIGOTT was elected a director of Americold in June 1987. He is President of Pigott Enterprises, Inc., a private investment company. Mr. Pigott has been Chairman of the Board and Chief Executive Officer of Management Reports and Services, Inc., an accounting consulting firm since 1987. Mr. Pigott's other business activities include membership on the Board of Directors of PACCAR, Inc.\nWILLIAM A. MARQUARD was elected a director of Americold in June 1987. He is currently Chairman Emeritus of the Board of Directors of American Standard, Inc., and Chairman of the Board of Directors of Arkansas Best Corporation. Mr. Marquard is a director of Treadco, Inc., Mosler, Inc., Earle M. Jorgenson Company and Earthshell Container Corporation. He is also Vice Chairman of the Board of Directors of Kelso.\nAll directors hold office until the next annual meeting of shareholders of the Company or until their successors have been elected and qualified. The executive officers of the Company are chosen by the Board and serve at its discretion.\nFor their services on the Board of Directors of the Company, Messrs. Pigott, Marquard and Edelstein are paid $16,000 per year. Mr. Pigott receives $1,000 per year as Chairman of the Company's Audit Committee. Messrs. Pigott, Marquard and Edelstein also receive $600 per meeting attended. Directors who are also officers of the Company and Mr. Matelich do not receive additional compensation as directors of the Company. Directors are reimbursed\nfor out-of-pocket expenses incurred in connection with attendance at meetings.\nThe Compensation Committee for fiscal 1995 consisted of Mr. Matelich, Mr. Marquard and Mr. Pigott. The Audit Committee for fiscal 1995 consisted of Mr. Matelich, Mr. Edelstein and Mr. Pigott.\nOn December 23, 1992, Kelso and its chief executive officer, without admitting or denying the findings contained therein, consented to an administrative order in respect of a Securities and Exchange Commission (the \"Commission\") inquiry relating to the 1990 acquisition of a portfolio company by a Kelso affiliate. The order found that Kelso's tender offer filing in connection with the acquisition did not comply fully with the Commission's tender offer reporting requirements, and required Kelso and the chief executive officer to comply with these requirements in the future.\nSTOCKHOLDERS' AGREEMENT - -----------------------\nThe Company's Bylaws provide for one to twelve directors. The Board of Directors of the Company currently consists of six directors. Certain of the Company's shareholders have agreed, pursuant to the stockholders' agreement dated as of December 24, 1986, as amended (the \"Stockholders' Agreement\"), that two directors shall be designated by Kelso. The Stockholders' Agreement also provides for two directors who are not affiliates of Kelso, the Management Group or the Co-Investors, as defined in the Stockholders' Agreement. In addition, one director may be designated by Northwestern Mutual Life Insurance Company. Mr. Edelstein and Mr. Matelich have been designated by Kelso. Pursuant to the Stockholders' Agreement, Mr. Pigott and Mr. Marquard are deemed not to be affiliates of Kelso, the Management Group or the Co-Investors. Northwestern Mutual Life Insurance Company has not designated a director since May 1991. The Stockholders' Agreement also provides that prior to the occurrence of an initial public offering of at least 25% of the outstanding shares of common stock of the Company pursuant to an effective registration statement under the Securities Act, sales of shares of common stock by a member of the Management Group are subject to a right of first refusal granted to the Company and, in certain events, the non- management shareholders who are parties to the Stockholders' Agreement.\nItem 11.","section_11":"Item 11. Executive Compensation\nSUMMARY COMPENSATION TABLE - --------------------------\nThe following table sets forth information as to the compensation of the Chief Executive Officer and each of the other four most highly compensated executive officers of the Company as of the last day of February 1995 for services in all capacities to the Company for the years ended the last day of February 1993, 1994 and 1995.\nBENEFIT PLAN AND ARRANGEMENTS - -----------------------------\nMANAGEMENT INCENTIVE PLAN - The Company has a Management Incentive Plan (the \"MIP Plan\") to provide additional compensation to participants, including executive officers, upon the achievement of certain financial objectives of the Company and individual personal objectives of the Participants. The MIP Plan was replaced by the Stock Incentive Plan beginning with fiscal 1992, as described below, and reinstated by the Board of Directors on June 16, 1994, effective as of March 1, 1994. The MIP Plan is administered by the Compensation Committee of the Board of Directors (the \"Compensation Committee\") and is applicable to management employees of Americold and, at the option of the President of the Company, other employees of Americold. The financial objective award is 50% of the total award and is based on attainment of actual operating results as compared to financial targets. The financial objectives were established and approved by the Company based upon the annual business plan. The personal objective award is 50% of the total award and is based on attainment of both quantifiable and nonquantifiable goals established at the beginning of the MIP Plan year. Incentive compensation earned under the MIP Plan is computed as soon as possible after the close of the Company's fiscal year and payment is generally made within 60 days after the end of the\nfiscal year unless a deferred payment election has been filed with the Company in accordance with the terms of the Plan.\nThe Board of Directors authorized a separate $500,000 cash bonus award for both fiscal 1993 and 1994 payable under a format similar to the MIP Plan structure, which was paid in July 1994. Incentive compensation earned by the Company's executive officers for the fiscal year ended the last day of February 1993 and 1994 is included in the above Summary Compensation Table.\nAwards for fiscal 1995 have not been finalized.\nSTOCK INCENTIVE PLAN - On June 16, 1994, effective as of February 28, 1994, the Board of Directors authorized the suspension of the Company's Stock Incentive Plan (the \"SIP Plan\"), which was a long-term incentive plan intended to provide additional financial incentives to key employees, including executive officers of the Company. The award issued for fiscal 1992 under the SIP Plan prior to its suspension has been paid pursuant to the Plan provisions. No other awards were issued under the SIP Plan. The SIP Plan, which was authorized by the Board or Directors on September 19, 1991, was intended to replace the MIP Plan for the four-year period commencing March 1, 1991 and ending on February 28, 1995. However, due to the significant effects of the fire at the Company`s Kansas City, Kansas facility on the results of operations beginning in the second year of this four-year period, the Board reinstated the former MIP Plan, as described above, effective March 1, 1994.\nDistribution of awards earned under the SIP Plan were deferred until the end of the four-year period (February 28, 1995), although annual awards were achievable during each of the three fiscal years during which the SIP Plan was in effect.\nThe total amount of shares awarded under the SIP Plan prior to its suspension on February 28, 1994 was 106,123 shares. All of such awards were based upon the fiscal 1992 financial performance. Shares allocable to the individuals named in the Summary Compensation Table are as follows: Mr. Dykehouse, 16,659; Mr. Smith, 7,164; Mr. LeNeveu, 4,502; Mr. Sena, 6,335; and Mr. Coxe, 0.\nAll awards are intended to be made in common stock of the Company. Participants may elect, however, for a limited period after the end of the Plan, to receive cash in lieu of the stock awarded, if they have not elected to defer receipt of their award. Participants electing to receive cash will receive the cash bonus that they would have been awarded during the same award period (fiscal 1992) under the MIP Plan, plus interest on such amounts.\nThe total amount of stock awarded under the SIP Plan was determined by the difference between the actual financial results in each year and the targeted financial results for such year. Each partici- pant's share of the total stock awarded under the SIP Plan is based upon the individual's proportionate interest in the total cash bonus that would have been awarded to all participants under the MIP Plan. A maximum of 500,000 shares of common stock was available for issue under the Plan. The Plan generally requires that a participant must be employed at the end of the four-year period (March 1, 1995) in order for the participant's awards to vest. In April 1995, all awards under the plan were paid. All participants elected to receive cash in lieu of stock in the amounts previously disclosed plus interest.\nRETIREMENT PLAN - Americold has a noncontributory defined benefit retirement plan for salaried employees, including executive officers (the \"Retirement Plan\"). The Retirement Plan provides retirement benefits based on credited years of service and average monthly compensation for the highest five calendar years of the final 15 calendar years of employment or, if higher, the highest 60 consecutive months in the last 120 months of employment. A participant's retirement benefits vest after the participant has completed at least five years of Vesting Service.\nThe following table shows the approximate annual retirement benefits payable to employees for life from normal retirement date pursuant to the Retirement Plan before reduction for Social Security payments. The actual retirement benefit to employees is offset by Social Security benefits. Service credited under a former Beatrice retirement plan will be recognized by the Retirement Plan for purposes of determining the pension benefits payable under the Retirement Plan.\nEstimated years of credited service to date under the Retirement Plan for the individuals named in the Summary Compensation Table are as follows: Mr. Dykehouse, 4 years; Mr. Smith, 16 years; Mr. LeNeveu, 3 years; Mr. Sena, 25 years; and Mr. Coxe, 1 year. Estimated years of credited service at normal retirement date (age 65) under the Retirement Plan for the individuals named in the Summary Compensation Table are as follows: Mr. Dykehouse, 16 years; Mr. Smith, 26 years; Mr. LeNeveu, 20 years; Mr. Sena, 45 years; and Mr. Coxe, 12 years.\nYears of Service ------------------------------------------- Average Annualized Compensation 20 30 40 50 - ---------------- -------- -------- -------- --------\n$100,000 $ 30,000 $ 45,000 $ 60,000 $ 75,000 125,000 37,500 56,250 75,000 93,744 150,000 45,000 67,500 90,000 112,500 175,000 45,000 67,500 90,000 112,500 200,000 45,000 67,500 90,000 112,500 300,000 45,000 67,500 90,000 112,500\nIn addition to the above, certain individuals named in the Summary Compensation Table are entitled to a benefit calculated by using additional years of service credited under supplements to the Retirement Plan. Years of credited service under the supplements for the individuals named in the Summary Compensation Table as of the last day of February 1995 are as follows: Mr. Dykehouse, 0 years; Mr. Smith, 5 years; Mr. LeNeveu, 0 years; Mr. Sena, 0 years; and Mr. Coxe, 0 years. The annual amount to be received at normal retirement date pursuant to the supplements is estimated to be as follows: Mr. Dykehouse, $0 per annum; Mr. Smith, $5,906 per annum; Mr. LeNeveu, $0 per annum; Mr. Sena, $0 per annum; and Mr. Coxe, $0 per annum.\nA participant's retirement benefits (excluding any incremental benefit earned under any supplement) under the Retirement Plan plus 50% of Social Security benefits may not exceed 60% of his compensation at retirement after 40 years of service, subject to maximum dollar limitations. See Note 8 of Notes to Consolidated Financial Statements.\nEMPLOYEE STOCK OWNERSHIP PLAN - Americold established, effective March 1, 1987, an Employee Stock Ownership Plan, as amended January 1, 1994 (the \"ESOP\"), in which all qualifying employees of the Company not covered by collective bargaining arrangements are able to participate. It is contemplated that contributions on an annual basis will not exceed 15% of the aggregate total compensation of any participating employee. The Company may contribute cash as well as or in lieu of its stock. The consent of the Company's Board of Directors is required to authorize any contribution by Americold to the ESOP. Contributions are allocated among participants based on the ratio of each participant's compensation to the total compensation of all such participants, subject to certain limitations. The ESOP is intended to provide retirement funds to participants in addition to present pension benefits.\nBenefits under the ESOP vest based upon years of service as follows: 20% after three years of service, increased by 20% for each of the next four years with a maximum of 100% after seven years of service. A participant is 100% vested if employed by the Company on or after his 65th birthday, or if the participant incurs a total and permanent disability or dies while employed by the Company. The ESOP has the right to repurchase previously distributed shares from employees terminating their ESOP participation, using funds obtained through cash contributions by the Company. Participant forfeitures are allocated pro rata to remaining participants.\nParticipants are eligible for distribution of their capital accumulation in the ESOP at the normal retirement age of 65. The distribution will be made in whole shares of the Company's stock, cash or a combination of both, as determined by the Compensation Committee, provided the participant has not elected to be paid in stock.\nUpon termination of the ESOP, the ESOP's trust will be maintained until the capital accumulations of all participants have been distributed.\nNo ESOP contribution was declared for fiscal 1994 and no ESOP contribution has been declared for fiscal 1995.\nKEY EMPLOYEE STOCK OPTION PLAN - In 1987, Americold established a Key Employee Stock Option Plan (the \"Option Plan\"). The Option Plan permits the issuance of nonstatutory options to purchase up to 300,000 shares of common stock of the Company to directors, officers and other key employees of the Company. Of these, options to purchase up to 150,000 shares were reserved for issuance to the Management Group and options to purchase the remaining 150,000 shares are reserved for issuance to all eligible employees (including the Management Group) of the Company.\nAn individual exercising options under the Option Plan must become a party to the Stockholders' Agreement. The Option Plan is administered by the Compensation Committee. The Compensation Committee determines the recipients of options granted, the exercise price and the number of shares of common stock subject to each option. The Board of Directors may amend the Option Plan from time to time. The maximum term of each stock option is ten years. Options become exercisable at such time or times as the Compensation Committee may determine at the time of grant.\nIf the outstanding shares of common stock are changed into or exchanged for a different number or kind of shares of the Company\nor other securities of the Company, by reason of any merger, consolidation, recapitalization, reclassification, stock split-up, stock dividend or combination of shares, the Compensation Committee shall make an appropriate and equitable adjustment in the number and kind of shares as to which the unexercised portion of the option shall be exercisable, to the extent that after such event the optionee's right to a proportionate interest in the Company shall be maintained as if the option had already been exercised and the option shares were subject to such change or exchange. Such adjustment shall be made without change in the total price applicable to the unexercised portion of the option and with a corresponding adjustment in the exercise price per option share. Any such adjustment made by the Compensation Committee shall be final and binding upon the Company, the optionee and all other interested persons.\nIn the event of (i) dissolution or liquidation of the Company, (ii) a merger in which the Company is not the surviving corporation or (iii) a share exchange pursuant to which the outstanding shares of common stock of the Company are acquired by another corporation, then either (a) the Compensation Committee, upon authorization of the Board, shall make an appropriate and equitable adjustment in the number and kinds of securities covered by outstanding options, and such options shall be expressly assumed by the successor corporation, if any; or (b) in lieu of such adjustment, the Board shall provide a 30-day period immediately prior to such an event during which each optionee shall have the right to exercise the optionee's outstanding options, in whole or in part, without regard to the time the options have been outstanding or the vesting schedule provided for in any option agreement entered into pursuant to the Option Plan and all options not exercised shall expire at the end of the 30-day period.\nInformation with regard to the grant of options as of the last day of February 1995 under the Plan follows:\nNumber of Option Number Expiration Options Price Exercisable Date - ---------- ------- ----------- ----------\n93,795 $10.00 93,795 May 1998 100,000 $18.95 80,000 June 2000 30,000 $21.88 6,000 May 2003 30,000 $20.40 6,000 December 2003\nNo options were exercised during fiscal 1995. See Note 9 of Notes to Consolidated Financial Statements.\nOTHER ARRANGEMENTS - The Company entered into a two-year employment\nagreement with Mr. Dykehouse on May 14, 1990. Pursuant to the terms of the agreement, Mr. Dykehouse agreed to serve as the Chief Executive Officer of the Company. Further, Mr. Dykehouse agreed not to compete with the Company for a 12-month period following termination of his employment unless such termination is \"without cause,\" as defined in the employment agreement. Although the agreement has not been extended, certain provisions survive the expiration of the initial term of the agreement. If before June 26, 1995, Mr. Dykehouse's employment is terminated \"without cause,\" the Company has the right to purchase any shares of common stock acquired pursuant to the exercise of any options granted on June 26, 1990 at the fair market value of the shares, as determined in accordance with the Stockholders' Agreement. If before June 26, 1995, Mr. Dykehouse's employment is terminated voluntarily or \"for cause,\" the Company has the right to purchase any such shares at the price paid by Mr. Dykehouse, plus interest. The agreement also provided that Mr. Dykehouse would participate in the Americold Management Incentive Plan, subsequently replaced by the Stock Incentive Plan. Pursuant to an Agreement of Assumption dated June 26, 1990, Mr. Dykehouse has agreed to be bound by the Stockholders' Agreement.\nThe Company entered into a three-year employment agreement with Mr. Coxe on December 6, 1993. Mr. Coxe agreed to serve as the Senior Vice President, Logistics, of the Company. Further, Mr. Coxe has agreed not to compete with the Company for a 12-month period following termination of his employment unless such termination is \"without cause,\" as defined in the employment agreement. The agreement provides, among other conditions, that if during the term of the employment agreement Mr. Coxe's employment is terminated \"without cause,\" the Company will pay him a lump sum amount equal to one year's base compensation, or the balance of the salary, plus bonus, provided for through the then remaining term of the agreement, whichever is greater, plus any employee benefits accrued to the date of termination. The Company is not required to make any such payment if the termination is \"for cause,\" as defined. The employment agreement provides that Mr. Coxe will participate in any incentive plan otherwise offered to members of senior management. According to the provisions of his employment agreement, Mr. Coxe was awarded a minimum bonus of $55,500 with respect to fiscal 1995 on March 1, 1995.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThe following table sets forth information regarding the beneficial ownership of common stock as of May 1, 1995 by (i) each person known by the Company to own more than five percent of its common stock, (ii) each director of the Company, (iii) each named\nexecutive officer, (iv) all directors and officers as a group and (v) the Management Group:\n___________________\nThese persons are party to the Stockholders' Agreement which controls the voting by these shareholders for directors of the Company. See Part II, Item 10, \"Directors and Executive Officers of the Registrant\".\nMessrs. Schuchert, Nickell, Matelich and Wall may be deemed to share beneficial ownership of shares owned of record by KIA III, KIA II, Kelso Equity and Kelso & Company (Kelso & Company owns 23,600 shares) by virtue of their status as the general partners of Kelso Partners III, L.P. (the general partner of KIA III), Kelso Partners II, L.P. (the general partner of KIA II), and Kelso Equity and the controlling stockholders and officers of Kelso & Company. Messrs. Schuchert, Nickell, Matelich and Wall share investment and voting powers with respect to securities owned by the foregoing entities. Messrs. Schuchert, Nickell, Matelich and Wall disclaim beneficial ownership of such securities (other than the 23,600 shares owned by Kelso & Company).\nIncludes the following numbers of shares of common stock that may be acquired within 60 days after May 1, 1995 through the exercise of stock options granted pursuant to the Company's Option Plan:\n100,000 shares for Mr. Dykehouse; 8,278 shares for Mr. Smith; 12,000 shares for Mr. LeNeveu; 8,279 shares for Mr. Sena; 6,000 shares for Mr. Coxe; 145,595 for all directors and officers as a group; and 207,656 shares for the Management Group.\nThe shareholders of the Company listed above hold approximately 83% of the voting power of the Company's common stock and are able to elect all of the members of the Board of Directors and thereby control the Company.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThere are no reportable transactions or relationships.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(a) The following documents are filed as part of this report.\n1. FINANCIAL STATEMENTS PAGE -------------------- ----\nReference is made to Part II, Item 8 for the listing of the required financial statements filed with this report 24\n2. FINANCIAL STATEMENT SCHEDULES -----------------------------\nSchedule II - Valuation and Qualifying Accounts for years ended the last day of February 1993, 1994 and 1995 77-A\nAll other schedules are omitted because they are not applicable, or are not required, or because the required information is included in the Company's consolidated financial statements as of the last day of February 1994 and 1995 or notes thereto.\n3. EXHIBITS -------- (2) Plan of Reorganizaton, dated April 14, 1995\n(3) Articles of Incorporation and Bylaws\n(i) Second Restated Articles of Incorporation, as amended (filed as Exhibit (3)(i) to the Form 10-Q, dated October 11, 1989, for the quarter ended August 31, 1989, and incorporated herein by reference)\n(ii) Restated Bylaws, as amended, through March 26, 1991\n(4) Instruments defining the rights of security holders, including indentures\n(i) Articles IV, V and VI of the Second Restated Articles of Incorporation as amended (see Exhibit (3)(i))\n(ii) Articles I, II, V, VII and X of the Restated Bylaws as amended (see Exhibit (3)(ii))\n(iii) Second Restated Stockholders' Agreement dated as of December 24, 1986, as amended as of June 22, 1987 (filed as Exhibit (4)(iv) to the Form 10-K, dated May 27, 1988, for the fiscal year ended February 29, 1988 and incorporated herein by reference)\n(iv) Third Amendment dated May 22, 1990 to Stockholders' Agreement dated as of December 24, 1986, as amended as of June 22, 1987 (filed as Exhibit (4) to the Form 10-Q dated July 12, 1990, for the quarter ended May 31, 1990 and incorporated herein by reference)\n(v) Form of Amended and Restated Indenture relating to the First Mortgage Bonds (filed as Exhibit (4)(vi) to the Registration Statement on Form S-1 (Registration No. 33- 53584) filed with the Commission on March 2, 1993 and is incorporated herein by reference)\n(vi) Stock Pledge Agreement dated as of February 28, 1989, between Registrant and The Connecticut National Bank (filed as Exhibit (19)(iii) to the Form 10-Q, dated October 14, 1992, for the quarter ended August 31, 1992 and incorporated herein by reference)\n(vii) Stock Pledge Agreement dated as of February 28, 1989 between Registrant and United States National Bank of Oregon, acting as agent pursuant to Article IX of the Credit Agreement, as amended, dated as of April 30, 1987 (filed as Exhibit (19)(iv) to the Form 10-Q, dated October 14, 1992, for the quarter ended August 31, 1992 and incorporated herein by reference)\n(viii) Indenture dated as of May 1, 1987 between Registrant and United States Trust Company of New York, as Trustee (included as an exhibit to the Registration Statement on Form S-1 (Registration No. 33-12173) filed with the Commission on April 29, 1987 and incorporated herein by reference)\n(ix) Form of Amended and Restated Investment Agreement relating to the First Mortgage Bonds filed as Exhibit (4)(v) to the Registration Statement on Form S-1 (Registration No. 33-53584) (filed with the Commission on March 2, 1993 and incorporated herein by reference)\n(x) Form of Amended and Restated Security Agreement relating to the First Mortgage Bonds (filed as Exhibit (4)(xiv) to the Registration Statement on Form S-1 (Registration No. 33-53584) filed with the Commission on March 2, 1993 and incorporated herein by reference)\n(xi) Form of Senior Subordinated Debenture (included as part of Exhibit (4)(viii))\n(xii) Form of Mortgage, Assignment of Rents and Security Agreement dated as of June 15, 1987 (included as an exhibit to the Registration Statement on Form S-1 (Registration No. 33- 12173) filed with the Commission on April 29, 1987 and incorporated herein by reference)\n(xiii) Form of Series A Bond (included as part of Exhibit (4)(v))\n(xiv) Form of Series B Bond (included as part of Exhibit (4)(v))\n(xv) Form of Amended and Restated Cash Collateral Pledge Agreement relating to the First Mortgage Bonds (filed as Exhibit (4)(xix) to the Registration Statement on Form S-1 (Registration No. 33-53584) filed with the Commission on March 2, 1993 and incorporated herein by reference)\n(xvi) Form of Amended Stock Pledge Agreement relating to the First Mortgage Bonds (filed as Exhibit (4)(xx) to the Registration Statement on Form S-1 (Registration No. 33- 53584) filed with the Commission on March 2, 1993 and incorporated herein by reference)\n(xvii) Form of Amended Mortgage, Assignment of Rents and Security Agreement relating to the First Mortgage Bonds (filed as Exhibit (4)(xxi) to the Registration Statement on Form S-1 (Registration No. 33-53584) filed with the Commission on March 2, 1993 and incorporated herein by reference)\n(10) Material Contracts\n(i) Americold Corporation Key Employee Stock Option Plan, as amended, effective July 12, 1988 (filed as Exhibit (4)(i) to the Form 10-Q dated October 14, 1988, for the quarter ended August 31, 1988 and incorporated herein by reference)\n(ii) Form of Nonstatutory Stock Option Agreement, as amended, entered into between Registrant and certain employees pursuant to the Americold Corporation Key Employee Stock Option Plan (filed as Exhibit (4)(ii) to the Form 10-Q dated October 14, 1988, for the quarter ended August 31, 1988 and incorporated herein by reference)\n(iii) Form of Amended and Restated Investment Agreement relating to the First Mortgage Bonds (see Exhibit (4)(ix))\n(iv) Form of Amended and Restated Security Agreement relating to the First Mortgage Bonds (see Exhibit (4)(x))\n(v) Stock Pledge Agreement dated as of February 28, 1989, between Registrant and The Connecticut National Bank (see Exhibit (4)(vi))\n(vi) Stock Pledge Agreement dated as of February 28, 1989, between Registrant and United States National Bank of Oregon, a national banking association, acting as agent pursuant to Article IX of the Credit Agreement, as amended, dated as of April 30, 1987 (see Exhibit (4)(vii))\n(vii) Americold Corporation Management Incentive Plan (filed as Exhibit (10)(iii) to the Form 10-K, dated May 27, 1988, for the fiscal year ended February 29, 1988 and incorporated herein by reference)\n(viii) Form of Indemnity Agreement entered into between the Company and each of its officers and directors (filed as Exhibit (4)(x) to Form 10-K dated May 29, 1992 for the fiscal year ended February 29, 1992 and incorporated herein by reference)\n(ix) Second Restated Stockholders' Agreement, dated as of December 24, 1986, as amended as of June 22, 1987 (see Exhibit (4)(iii)\n(x) Third Amendment dated May 22, 1990 to Stockholders' Agreement dated as of December 24, 1986, as amended as of June 22, 1987 (see Exhibit (4)(iv))\n(xi) Indenture dated as of May 1, 1987 between the Company and United States Trust Company of New York, as Trustee (see Exhibit (4)(viii))\n(xii) Credit Agreement between the Company and United States National Bank of Oregon dated February 3, 1993 (filed as Exhibit (10)(xxii) to the Registration Statement on Form S-1 (Registration No. 33-53584) filed with the Commission on March 2, 1993 and incorporated herein by reference)\n(xiii) Form of Amended and Restated Indenture relating to the First Mortgage Bonds (see Exhibit (4)(v))\n(xiv) Form of Amended and Restated Cash Collateral Pledge Agreement relating to the First Mortgage Bonds (see Exhibit (4)(xv))\n(xv) Form of Amendment to Stock Pledge Agreement relating to the First Mortgage Bonds (see Exhibit (4)(xvi))\n(xvi) Indemnification Agreement dated October 31, 1991 between the Company and The First Boston Corporation (included as Exhibit (10)(xx) to the Registration Statement on Form S-2 (Registration No. 33-41963) filed with the Commission on July 31, 1991 and incorporated herein by reference)\n(xvii) Americold Stock Incentive Plan effective March 1, 1991 (filed as Exhibit(10)(xviii) to the Form 10-K dated May 29, 1992 for the fiscal year ended February 29, 1992 and incorporated herein by reference)\n(xviii) Employment Agreement dated May 14, 1990, between the Company and Ronald H. Dykehouse (filed as Exhibit (10)(i) to the Form 10-Q dated October 12, 1990 for the quarter ended August 31, 1990 and incorporated herein by reference)\n(xix) Employment Agreement dated May 14, 1992, between the Company and John P. LeNeveu (filed as Exhibit (19) to the Form 10-Q dated July 15, 1992 for the quarter ended May 31, 1992 and incorporated herein by reference)\n(xx) Master Lease Agreement dated February 28, 1989, between Registrant and Americold Services Corporation (filed as Exhibit (19)(vi) to the Form 10-Q, dated October 14, 1992, for the quarter ended August 31, 1992 and incorporated herein by reference)\n(xxi) Americold Transportation Systems Purchase of Joint Venture Interest, effective November 1, 1991, between Registrant and Superior Transportation Systems, Inc. (filed as Exhibit (19)(vii) to the Form 100-Q, dated October 14, 1992, for the quarter ended August 31, 1992 and incorporated herein by reference)\n(xxii) Lease dated May 15, 1992, between Registrant and Oregon Warehouse Partners, a Texas general partnership (lease agreement for Ontario, Oregon facility) (filed as Exhibit (19)(viii) to the Form 10-Q, dated October 14, 1992, for the quarter ended August 31, 1992 and incorporated herein by reference)\n(xxiii) Form of First Amendment to Master Lease Agreement between Registrant and Americold Services Corporation (filed as Exhibit (10)(xxxi) to the Registration Statement on Form S-1 (Registration No. 33-53584) filed with the Commission on March 2, 1993 and incorporated hereby by reference)\n(xxiv) Nonstatutory Stock Option Agreement dated May 19, 1993 between the Company and John P. LeNevue (filed as Exhibit (10)(i) to the Form 10-Q, dated January 13, 1994 for the quarter ended November 30, 1993, and incorporated herein by reference)\n(xxv) First Amendment, dated October 1, 1993, to the Credit Agreement between the Company and United States National Bank of Oregon dated February 3, 1993 (filed as Exhibit (10)(ii) to the Form 10-Q dated January 13, 1994 for the quarter ended November 30, 1993, and incorporated herein by reference)\n(xxvi) Employment Agreement dated December 6, 1993, between the Company and J. Roy Coxe (filed as Exhibit (10)(iii) to the Form 10-Q dated January 13, 1994 for the quarter ended November 30, 1993, and incorporated herein by reference)\n(xxvii) Nonstatutory Stock Option Agreement dated December 17, 1993 between the Company and J. Roy Coxe.\n(11) Statement regarding computation of per share earnings\n(21) Subsidiaries of the Registrant\n(23) Consent of KPMG Peat Marwick LLP\n(b) Reports on Form 8-K\nSubsequent to the end of the fiscal year, the following were filed:\n1. A Current Report on Form 8-K, dated April 14, 1995, was filed disclosing the distribution of a confidential disclosure statement to certain of its debtholders describing the Company's plan for restructuring certain of its outstanding indebtedness. The disclosure statement solicited acceptance of a proposed prepackaged plan of reorganization under Chapter 11 of the U. S. Bankruptcy Code as a means of implementing the restructuring.\n2. A Current Report on Form 8-K, dated May 9, 1995, was filed announcing that the Company's restructuring plan had received approval from both classes of debtholders entitled to vote on the plan and that the Company had filed the plan as approved as a prepackaged plan of reorganization under Chapter 11 of the U. S. Bankruptcy Code in the United States Bankruptcy Court for the District of Oregon on May 9, 1995.\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. AMERICOLD CORPORATION May 26, 1995\nBy: \/s\/ Ronald H. Dykehouse By: \/s\/ Joel M. Smith ------------------------ ------------------------ Ronald H. Dykehouse Joel M. Smith Chairman of the Board, Senior Vice President and President and Chief Financial Officer Chief Executive Officer (Principal Financial Officer)\nBy: \/s\/ Thomas R. Ferreira ------------------------ Thomas R. Ferreira Corporate Controller\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Company and in the capacities and on the dates indicated.\n\/s\/ Ronald H. Dykehouse - ------------------------------- May 24, 1994 Ronald H. Dykehouse, Director\n\/s\/ Joel M. Smith - ------------------------------- May 24, 1994 Joel M. Smith, Director\n\/s\/ Frank Edelstein - ------------------------------- May 24, 1994 Frank Edelstein, Director\n\/s\/ George E. Matelich - ------------------------------- May 24, 1994 George E. Matelich, Director\n\/s\/ James C. Pigott - ------------------------------- May 24, 1994 James C. Pigott, Director\n- ------------------------------- May 24, 1994 William A. Marquard, Director\nSupplemental Information to be Furnished With Reports Filed Pursuant to Section 15(d) of the Act by Registrants Which Have Not Registered Securities Pursuant to Section 12 of the Act.\nNo annual report covering the Company's last fiscal year or proxy statement with respect to any annual or other meeting of security holders has been sent to security holders. The Company does not solicit proxies.\nKPMG Peat Marwick LLP Telephone 503 221 6500 Suite 2000 Telefax 503 796 7650 1211 South West Fifth Avenue Portland, OR 97204\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Stockholders\nAmericold Corporation:\nWe have audited the consolidated financial statements of Americold Corporation as listed in the accompanying index (see item 8). In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule as listed in the accompanying index (see item 14). These consolidated financial statements and the financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and the financial statement schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Americold Corporation as of the last day of February 1994 and 1995, and the results of their operations and their cash flows for each of the years in the three-year period ended the last day of February 1995 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 Note 1 to the consolidated financial statements, Americold Corporation adopted the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" and No. 106,\n\"Employers' Accounting for Postretirement Benefits Other Than Pensions\" during the year ended the last day of February 1994.\nMember Firm of Klynveld Peat Marwick Goerdeler\nKPMG Peat Marwick LLP\nThe Board of Directors and Stockholders Americold Corporation The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. However, the Company's available cash and cash flow from operating activities will not be sufficient to allow the Company to meet its current debt service obligations and remain in compliance with its debt agreement covenants, which raise substantial doubt about its ability to continue as a going concern. As discussed in Note 16, the Company did not make a scheduled debt payment on May 1, 1995 and filed a pre-packaged petition under Chapter 11 of the United States Bankruptcy Code on May 9, 1995. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.\n\/s\/ KPMG Peat Marwick LLP\nPortland, Oregon May 12, 1995\nAMERICOLD CORPORATION Notes to Consolidated Financial Statements Last day of February 1994 and 1995\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nAccounting policies and methods of their application that significantly affect the determination of financial position, cash flows and results of operations are as follows:\n(a) BUSINESS DESCRIPTION\nAmericold Corporation (the Company) operates a nationwide network of 51 owned or leased refrigerated warehouse facilities in 15 states. The Company has a wholly-owned warehousing subsidiary, Americold Services Corporation.\nIn addition, the Company operates certain businesses in selected locations which are unrelated to the basic public refrigerated warehousing business; these include a limestone quarry and a transportation broker service. These businesses are not significant to the Company as a whole and are not required to be reported as separate industry segments.\n(b) PRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the accounts of Americold Corporation and its wholly-owned subsidiary. All significant intercompany transactions, profits, and balances have been eliminated.\n(c) PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment are stated at cost. Depreciation is generally provided on the straight-line method over the estimated useful lives of the respective assets ranging from 3 to 45 years for financial reporting purposes and on accelerated methods for income tax purposes where possible. Property held under capital leases (at capitalized value) is amortized on the straight-line method over its estimated useful life, limited generally by the lease period. The amortization of the property held under capital leases is included with depreciation expense. Estimated remaining useful lives are reviewed periodically for reasonableness and any necessary change is generally effected at the beginning of the accounting period in which the revision is adopted.\nMaintenance and repairs are expensed in the year incurred; major renewals and betterments of equipment and refrigerated facilities are capitalized and depreciated over the remaining life of the asset. (Continued) AMERICOLD CORPORATION Notes to Consolidated Financial Statements\n(d) COST IN EXCESS OF NET ASSETS ACQUIRED\nOn December 24, 1986, all the outstanding capital stock of the Company was acquired by a private group consisting of affiliates of Kelso & Company, Inc., certain institutional investors and certain key employees and members of the Company's management. The acquisition of the Company (the Acquisition) was accounted for as a purchase. An allocation of the purchase price was made to the acquired assets and liabilities based on their estimated fair market values at the date of acquisition. The unallocated purchase price is the Company's estimate of goodwill associated with the acquisition and is being amortized using the straight-line method over a period of 40 years.\nOn March 1, 1990, the Company acquired the warehousing business of an unrelated third party. The goodwill associated with the acquisition is being amortized using the straight-line method over a period of 15 years.\nThe Company assesses the recoverability of the goodwill by determining whether the amortization of the goodwill balance over its remaining useful life can be recovered through projected undiscounted future net income. The amount of goodwill impairment, if any, is measured based on projected discounted future net income using a discount rate reflecting the Company's current average cost of funds.\n(e) DEBT ISSUANCE COSTS\nDebt issuance costs incurred are amortized over the term of the related debt.\n(f) INCOME TAXES\nIn February 1992, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (Statement 109). Statement 109 requires a change from the deferred method of accounting for income taxes of APB Opinion 11 to the asset and liability method of accounting for income taxes. Under the asset and liability method of Statement 109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under Statement 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.\nEffective March 1, 1993, the Company adopted Statement 109 and has reported the cumulative effect of that change in the method of accounting for income taxes in the 1994 consolidated statement of operations (note 11).\n(Continued)\nAMERICOLD CORPORATION Notes to Consolidated Financial Statements\nPursuant to the deferred method under APB Opinion 11, which was applied in 1993 and prior years, deferred income taxes are recognized for income and expense items that are reported in different years for financial reporting 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.\n(g) POSTRETIREMENT BENEFITS OTHER THAN PENSIONS\nIn December 1990, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 106, \"Postretirement Benefits Other Than Pensions\" (Statement 106). Statement 106 requires the recognition of a liability for obligations for postretirement benefits expected to be provided to or for an employee to be accrued during the service lives of the employees. The Company previously expensed the cost of such benefits, which are principally health care, as claims were received.\nEffective March 1, 1993, the Company adopted Statement 106 and has reported the cumulative effect of that change in the method of accounting for postretirement benefits other than pensions in the 1994 consolidated statement of operations (note 8).\n(h) REVENUE RECOGNITION\nThe Company's revenues are primarily derived from services provided to customers in both handling and storing frozen products. Handling and storage revenue is based primarily upon the total weight of frozen product received into and held in storage and is recognized as earned, not as billed. Differences between revenue earned and revenue billed are recorded as deferred revenue. Approximately 50% of the handling revenue is deferred until the customers' products are delivered.\nThe Company's transportation management services revenues are primarily derived from freight services. Revenues are recognized upon delivery of freight.\n(i) INCOME (LOSS) PER SHARE\nIncome (loss) per common share is computed by dividing net income (loss), less preferred dividend requirements, by the weighted average number of common shares outstanding.\n(j) MAJOR CUSTOMERS\nConsolidated net sales to H.J. Heinz Co. and subsidiaries amounted to approximately $26.6 million, $35.8 million and $45.5 million in the years ended the last day of February 1993, 1994 and 1995, respectively. For the year ended the last day of February 1993, consolidated net sales to ConAgra, Inc. and subsidiaries amounted to approximately $21.3 million. No other customers accounted for 10% or more of consolidated sales.\n(Continued) AMERICOLD CORPORATION Notes to Consolidated Financial Statements\n(k) CASH AND CASH EQUIVALENTS\nThe Company considers all highly liquid investment instruments with a maturity of three months or less when purchased to be cash equivalents. There were cash equivalents of $-0- and $25.2 million as of the last day of February 1994 and 1995, respectively.\n(2) NET PROPERTY, PLANT AND EQUIPMENT\nNet property, plant and equipment consists of the following (in thousands): Last day of February ----------- 1994 1995 ---- ---- Land $ 31,476 $ 31,087 Refrigerated facilities, buildings and land improvements 426,275 433,667 Machinery and equipment 56,702 59,300 ------- ------- 514,453 524,054\nLess accumulated depreciation 138,681 156,806 ------- ------- Net property, plant and equipment $375,772 $367,248 ======= ======= (3) OTHER NONCURRENT ASSETS\nOther noncurrent assets consist of the following (in thousands):\nLast day of February ----------- 1994 1995 ---- ---- Restricted funds held by trustee (note 7) $ 21,899 $ 20,669 Real estate owned, less allowance for loss of $43 and $-0-, respectively 440 300 Security deposits 424 393 Other 3,398 5,012 ------- ------- $ 26,161 $ 26,374 ======= =======\n(Continued) AMERICOLD CORPORATION Notes to Consolidated Financial Statements\n(4) LEASES\nAssets under capital leases are included in net property, plant and equipment and consist of the following (in thousands):\nLast day of February ----------- 1994 1995 ---- ---- Land, refrigerated facilities, buildings and land improvements $ 7,140 $ 7,140 Machinery and equipment 4,255 4,249 ------- ------- 11,395 11,389\nLess accumulated depreciation 3,540 3,575 ------- ------- $ 7,855 $ 7,814 ======= =======\nFuture minimum lease payments under noncancelable leases for years ending after the last day of February 1995 are as follows (in thousands):\nYear ending the last Capital Operating day of February leases leases - -------------------- ------- --------- 1996 $1,826 $ 7,962 1997 1,548 6,798 1998 3,773 5,472 1999 522 4,626 2000 402 2,974 Thereafter 1,808 5,006 ------ ------ Total minimum lease payments 9,879 $32,838 ====== Less amounts representing interest 2,424 ------ Present value of net minimum lease payments $7,455 =====\nIncluded in expenses for the years ended the last day of February 1993, 1994 and 1995 are approximately $8.7 million, $9.1 million and $9.5 million, respectively, of rental expense net of sublease rentals for operating leases.\n(Continued) AMERICOLD CORPORATION Notes to Consolidated Financial Statements\n(5) ACCRUED EXPENSES\nAccrued expenses consist of the following (in thousands):\nLast day of February ----------- 1994 1995 ---- ----\nAccrued payroll $1,498 $ 4,226 Accrued vacation pay 2,345 2,504 Accrued taxes 837 1,043 Accrued employee stock ownership plan contribution - 750 Other 2,832 2,822 ----- ------\nTotal accrued expenses $7,512 $11,345 ===== ======\n(6) OTHER CURRENT LIABILITIES\nOther current liabilities consist of the following (in thousands):\nLast day of February ----------- 1994 1995 ---- ----\nWorkers' compensation $2,527 $1,227 Other 2,417 2,685 ----- -----\n$4,944 $3,912 ===== =====\n(Continued) AMERICOLD CORPORATION Notes to Consolidated Financial Statements\n(7) LONG-TERM DEBT\nLong-term debt consists of the following (in thousands) (see note 16):\nLast day of February ----------- 1994 1995 ---- ----\nCapital lease obligations (9.6% and 9.5% weighted average interest rate, respectively) $ 7,591 $ 7,455 Senior subordinated debentures - 11% fixed, due May 1, 1997 with mandatory sinking fund payments of $28,750 on May 1, 1995 and 1996 111,212 112,581 First mortgage bonds, Series A - 11.45% fixed, due June 30, 2002, interest payments only to January 1, 1999 with principal amortization commencing July 1, 1999 150,000 150,000 First mortgage bonds, Series B - 11.5% fixed, due March 1, 2005, interest payments only to September 1, 2003 with a mandatory sinking fund payment of $88,125 on March 1, 2004 176,250 176,250 Mortgage notes payable - various interest rates ranging from 9.0% to 13.6% requiring monthly principal and interest payments with maturities ranging from 2004 to 2017 24,565 27,941 ------- -------\nTotal long-term debt 469,618 474,227\nLess current maturities of long-term debt 2,281 31,315 ------- ------- Total long-term debt, less current maturities $467,337 $442,912 ======= =======\nOn July 2, 1987, the Company sold $300 million in first mortgage bonds. On March 9, 1993, the Company sold $176.25 million of the Company's 11.5% First Mortgage Bonds, Series B, due March 1, 2005. The Company used $150 million of the proceeds from the sale of the Series B bonds to purchase at par $150 million of outstanding first mortgage bonds. The remaining $150 million of such First Mortgage Bonds have been redesignated Series A First Mortgage Bonds (together with the Series B First Mortgage Bonds, the \"First Mortgage Bonds\"). The remaining net proceeds of approximately $22.3 million were placed in escrow with the Mortgage Bond Trustee (note 3). The bonds are secured by mortgages or deeds of trust on 31 of the Company's facilities.\n(Continued) AMERICOLD CORPORATION Notes to Consolidated Financial Statements\nOn February 3, 1993, the Company entered into a bank credit agreement with its principal bank. The bank credit agreement is secured by the Company's trade receivables. The bank credit agreement has an aggregate availability of $27.5 million consisting of $20 million maximum cash borrowings and $10 million of letter of credit funding. Any amount by which the letter of credit borrowings exceed $7.5 million reduces the available cash borrowing amount under the agreement by a like amount. Availability for cash borrowings is limited by a defined borrowing base advance formula established on the basis of reviews of trade receivables. The unused and available amount under the bank credit agreement was $16.3 million, of which no amount was borrowed as of the last day of February 1995. There were $7.3 million of letters of credit outstanding as of the last day of February 1995.\nThe senior subordinated debentures are presented as of the last day of February 1994 and 1995 net of the original issue discount of approximately $9.4 million and accumulated accretion of approximately $5.6 million and $7.0 million, respectively.\nThe Company entered into an investment agreement in connection with the issuance of the First Mortgage Bonds which, like the bank credit agreement, requires the Company to meet certain affirmative and restrictive covenants. Significant restrictive items include, among others, limitations on additional indebtedness, liens, dividends, capital expenditures, asset dispositions, lease commitments and investments. Also, certain \"pro-forma debt service\" ratios, net worth levels and senior debt to net worth ratios must be maintained.\nAs of the last day of February 1995, aggregate annual maturities of long-term debt are as follows (in thousands):\nYear ended the last day of February - -------------------\n1996 $ 31,315 1997 2,634 1998 5,169 1999 2,374 2000 2,583\n(8) EMPLOYEE BENEFIT PLANS\n(a) DEFINED BENEFIT PENSION PLANS\nThe Company has defined benefit pension plans which cover substantially all employees other than union employees covered by union pension plans under collective bargaining agreements. Benefits under these plans are based on years of credited service and compensation during the years preceding retirement or on years of credited service and established monthly benefit levels.\n(Continued) AMERICOLD CORPORATION Notes to Consolidated Financial Statements\nPension expense for all plans, including plans jointly administered by industry and union representatives totaled $1.5 million, $1.4 million and $1.4 million for years ended the last day of February 1993, 1994 and 1995, respectively. Actuarial valuations for defined benefit plans are performed as of the end of the plan year. The most recent actuarial valuations are as of the last day of February 1995.\nThe funded status of the Company's defined benefit pension plans and the accrued pension expense amounts recognized in the Company's consolidated financial statements, within other noncurrent liabilities, as of the last day of February 1994 and 1995 are as follows (in thousands):\n(Continued) AMERICOLD CORPORATION Notes to Consolidated Financial Statements\nNet periodic pension expense for the years ended the last day of February 1993, 1994 and 1995 includes the following components (in thousands):\nLast day of February -------------------------------- 1993 1994 1995 ---- ---- ----\nService cost - benefits earned during the period $ 1,005 $ 1,013 $ 1,107 Interest cost on projected benefit obligation 1,984 2,094 2,121 Actual return on plan assets (2,097) (2,202) (2,554) Net amortization and deferral (214) (233) (143) ------ ------ ------ Net periodic pension expense $ 678 $ 672 $ 531 ====== ====== ======\nActuarial assumptions used for determining pension expenses were:\nLast day of February -------------------------------- 1993 1994 1995 ---- ---- ----\nDiscount rate for interest cost 9.0% 8.0% 8.5% Rate of increase in future compensation levels 5.0 4.0 4.0 Expected long-term rate of return on plan assets 9.5 10.5 10.5\nPlan assets are assigned to several investment management companies and are invested in various equity and fixed fund investments in accordance with the Company's investment policy.\n(b) EMPLOYEE STOCK OWNERSHIP PLAN\nThe Company established an employee stock ownership plan, effective March 1, 1987, which is intended to provide qualifying employees an equity interest in the Company, as well as potential retirement benefits. The trust established under the plan is designed to invest primarily in the Company's stock. Contributions by the Company, in the form of common or preferred stock of the Company, or cash, or a combination thereof, may be made to the trustee on behalf of eligible participants for each plan year as determined by the Company's Board of Directors. Participating employees with vested benefits, upon retirement or termination, have the option of retaining the stock or selling it back to the Company at its fair market value.\n(c) POSTRETIREMENT BENEFITS OTHER THAN PENSIONS\nIn addition to providing retirement benefits, the Company provides certain health care and life insurance benefits for retired employees. These benefits are provided to substantially all employees other than certain union employees who have elected not to participate. Prior to 1994, the Company recognized the cost of providing retirement health benefits and life insurance benefits as the claims or premiums were incurred.\n(Continued)\nAMERICOLD CORPORATION Notes to Consolidated Financial Statements\nEffective March 1, 1993, the Company adopted Financial Accounting Standards Board Statement of Financial Accounting No. 106 (Statement 106), which required that the expected cost of providing such benefits be accrued over the years that the employee renders service, in a manner similar to the accounting for pension benefits. As permitted under Statement 106, the Company elected to recognize this change in accounting principle on the immediate recognition basis. The cumulative effect as of March 1, 1993 of adopting the standard resulted in a decrease in deferred taxes of approximately $1.5 million, an increase in accrued postretirement benefits of approximately $3.9 million, and a one-time non-cash charge to fiscal 1994 earnings of approximately $2.4 million.\nThe total of accumulated postretirement benefit obligation (APBO), which is an unfunded obligation, is as follows:\nMarch 1, February 28, February 28, 1993 1994 1995 -------- ------------ ------------ Retirees $2,538 $2,339 $2,314 Active employees 1,353 1,573 1,511 ----- ----- ----- Total APBO $3,891 $3,912 $3,825 ===== ===== =====\nThe components of net periodic postretirement expense for the year ended the last day of February are as follows (in thousands): 1994 1995 ---- ---- Service cost benefits earned in period $ 90 $104 Interest cost on APBO 329 313 Amortization of unamortized prior service cost - (22) --- --- $419 $395 === ===\nThe discount rate used to determine the APBO and net periodic expense as of March 1, 1993 was 9%, as of February 28, 1994 was 8.5%, and as of February 28, 1995 was 9%.\nFor fiscal 1995, an 11.75% increase in the medical cost trend rate was assumed. This rate decreases incrementally to 6% after nine years. A 1% increase in the medical trend rate would increase the APBO by $.1 million and increase the net periodic expense by a negligible amount. (Continued) AMERICOLD CORPORATION Notes to Consolidated Financial Statements\n(9) COMMON STOCKHOLDERS' EQUITY\nThe Company has reserved 300,000 shares of common stock for issuance under a stock option plan established in 1987. Under the plan, options are granted by the compensation committee of the Board of Directors to purchase common stock at a price not less than 85% of the fair market value on the date the option is granted.\nInformation with regard to the plan as of the last day of February 1995 follows:\nNumber of Shares Price Exercisable Expires - ---------------- ----- ----------- -------\n93,795 $10.00 93,795 May 1998 100,000 18.95 80,000 June 2000 30,000 21.88 6,000 May 2003 30,000 20.40 6,000 December 2003\nNo options had been exercised as of the last day of February 1995.\nThe Company had reserved 500,000 shares of common stock for issuance under a Stock Incentive Plan effective March 1, 1991. Under the terms of the plan, officers and key management employees can receive either common stock or cash in specified amounts depending upon the financial performance of the Company measured over a four-year period ending February 28, 1995. As of the last day of February 1995, no shares had been issued. Since inception of the plan, the Board has approved a total award of approximately 106,000 shares. Total expense accrued under this plan was approximately $1 million with no expense accrued for each of the years ended the last day of February 1993 and 1994. The Board suspended the plan effective February 28, 1994, and the Company issued shares previously awarded and paid cash for the specified amounts in March 1995.\n(10) PREFERRED STOCK\nThe Company contributes shares of its Series A, variable rate, cumulative preferred stock to the Americold Employee Stock Ownership Plan (ESOP). The preferred stock is redeemable by participants of the plan (note 8). As of the last day of February 1994 and 1995, dividends not declared on the Company's cumulative preferred stock total approximately $381 and $496, respectively. (Continued) AMERICOLD CORPORATION Notes to Consolidated Financial Statements\n(11) INCOME TAXES\nPrior to 1994, the Company provided for income taxes under APB 11. Effective March 1, 1993, the Company adopted Financial Accounting Standards Board Statement of Financial Accounting Standards No. 109 (Statement 109) which required a change in the method of providing for income taxes. As permitted under Statement 109, the Company elected to recognize this change in accounting principle on the immediate recognition basis. The cumulative effects as of March 1, 1993 of adopting Statement 109 were an increase in net fixed assets of approximately $31.2 million (the amount of a previous write-down of assets under APB No. 16 as a result of the purchase of the Company in December 1986, net of subsequent depreciation), an increase in deferred income taxes of $93 million, and a one-time, non-cash charge of approximately $61.8 million in fiscal 1994. Application of Statement 109 has reduced earnings before cumulative effect of accounting principle change by approximately $1.7 million and $2.0 million as a result of increased depreciation for the years ended the last day of February 1994 and 1995, respectively.\nThe provision (benefit) for income taxes consists of the following (in thousands):\n1993 1994 1995 ---- ---- ---- Federal: Current $ 275 $ 500 $2,867 Deferred 1,649 (1,557) 1,494 ----- ------ ----- 1,924 (1,057) 4,361 ----- ------ ----- State: Current 647 68 820 Deferred (116) (194) 46 ----- ------ ----- $2,455 $(1,183) $5,227 ===== ====== =====\n(Continued) AMERICOLD CORPORATION Notes to Consolidated Financial Statements\nFollowing is a reconciliation of the difference between income taxes computed at the federal statutory rate and the provision for income taxes (in thousands):\n1993 1994 1995 ---- ---- ---- Computed income tax expense (benefit) at federal statutory rate $(1,936) $(4,278) $3,777 State and local income taxes, net of federal income tax benefits 351 (418) 563 Adjustment to deferred tax assets and liabilities for changes in enacted rates - 2,627 _ Amortization of cost in excess of net assets acquired 861 886 887 Financial statement depreciation not deductible for income tax purposes 3,429 - - Other, net (250) - - ----- ------ ----- Provision (benefit) for income taxes $2,455 $(1,183) $5,227 ===== ====== =====\nDeferred income taxes for 1994 and 1995 reflect the impact of \"temporary differences\" between amounts of assets and liabilities for financial reporting purposes and such amounts as measured by tax laws. These temporary differences are determined in accordance with Statement 109 and are more inclusive in nature than \"timing differences\" as determined under previously applicable accounting principles.\n(Continued)\nAMERICOLD CORPORATION Notes to Consolidated Financial Statements\nDeferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the related amounts used for income tax purposes. Significant components of the Company's deferred tax liabilities and assets as of February 28, 1994 and 1995 are as follows (in thousands):\n1994 1995 ---- ---- Deferred tax liabilities: Property, plant and equipment, due to differences in depreciation and prior accounting treatment $(113,372) $(113,457) Other, net (1,481) (400) -------- -------- Total deferred tax liabilities (114,853) (113,857) -------- -------- Deferred tax assets: Receivables, due to allowance for doubtful accounts 388 123 Employee compensation and other benefits 2,382 1,742 Capital leases, net 2,019 1,936 Postretirement benefits other than pensions, due to accrual for financial reporting purposes 1,535 1,500 Net operating loss carryforwards 3,585 - Alternative minimum tax credit carryforwards 1,289 3,122 Other, net 417 656 -------- -------- Total deferred tax assets 11,615 9,079 -------- -------- Net deferred tax liability before valuation allowance (103,238) (104,778)\nDeferred tax asset valuation allowance (1,320) (1,320) -------- -------- Net deferred tax liability $(104,558) $(106,098) ======== ========\nThe valuation allowance for deferred tax assets as of March 1, 1993 was approximately $1.3 million. The valuation allowance is required to reduce the amount of deferred tax assets to an amount which will more likely than not be realized. (Continued) AMERICOLD CORPORATION Notes to Consolidated Financial Statements\nThe Omnibus Budget Reconciliation Act of 1993 resulted in a federal tax rate increase from 34% to 35% effective January 1, 1993. The tax rate increase resulted in additional income tax expense for the Company of $2.6 million during the year ended the last day of February 1994.\nAt February 28, 1995, the Company has an alternative minimum tax credit carryforward of approximately $3.1 million available to offset future regular taxes in excess of future alternative minimum taxes.\n(12) EXTRAORDINARY ITEM\nIn conjunction with the fiscal year 1994 retirement of the $150 million of first mortgage bonds as discussed in Note 7, unamortized issuance costs of approximately $3.0 million were written off, resulting in an extraordinary loss, net of taxes, of approximately $1.8 million.\n(13) DISCLOSURES ABOUT THE FAIR VALUE OF FINANCIAL INSTRUMENTS\nCASH, TRADE RECEIVABLES, OTHER RECEIVABLES, ACCOUNTS PAYABLE, AND ACCRUED EXPENSES\nThe carrying amount approximates fair value because of the short maturity of these instruments.\nLONG-TERM DEBT\nThe fair values of each of the Company's long-term debt instruments are based on (a) the amount of future cash flows associated with each instrument discounted using the Company's current borrowing rate for similar debt instruments of comparable maturity or (b) in the case of the first mortgage bonds - Series B and senior subordinated debentures, market price.\nAs of last day of February 1995 ------------------------------- Estimated fair Carrying market amount value -------- --------- Senior subordinated debentures $112,581 $ 88,550 First mortgage bonds - Series A 150,000 150,000 First mortgage bonds - Series B 176,250 160,388 Mortgage notes payable 27,941 27,941\n(Continued) AMERICOLD CORPORATION Notes to Consolidated Financial Statements\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.\n(14) GAIN ON INSURANCE SETTLEMENT\nGain on insurance settlement of approximately $17 million relates to the Company's settlement of its first party claims with its insurance carriers for business interruption, property damage and out-of-pocket expenses with respect to the December 1991 fire at the Company's Kansas City, Kansas warehouse facility.\nNo previous income recognition was determinable until the Company had settled all of the lawsuits and claims related to the fire. The settlement amounts have been used to reduce other receivables recorded as of the last day of February 1994 by $5.7 million.\n(15) CASH AND CASH EQUIVALENTS\nThe Company has made a proposal to the Trustee under the indenture related to its First Mortgage Bonds to substitute approximately $4.8 million in cash as collateral for the property cost of the Kansas City, Kansas warehouse facility, although no agreement has been reached for such substitution. The Company has not reclassified any cash balance for the possible payment.\n(16) SUBSEQUENT EVENTS\nOn May 9, 1995, the Company filed a proposed \"prepackaged\" plan of reorganization under Chapter 11 of the United States Bankruptcy Code (the Plan) in the United States Bankruptcy Court for the District of Oregon (the Court). The principal purpose of the Plan is to reduce the Company's short-term cash requirements with respect to payments due on its subordinated indebtedness and to adjust certain restrictive financial covenants and certain other provisions contained in the Amended and Restated Investment Agreement, dated March 2, 1993, between the Company and Metropolitan Life Insurance Company. On the filing date, the Plan had received approval from both classes of debtholders entitled to vote.\nA hearing is scheduled for June 19, 1995 at which the Court will consider the Company's motion requesting the Court to (1) approve the Company's Disclosure Statement dated April 14, 1995 and the Company's procedure for solicitation of votes to accept or reject the Plan, and (2) to confirm the Plan.\nPending the outcome of the bankruptcy case, the Company intends to operate its business in the ordinary course, and to pay all pre-petition claims of the Company's secured lenders, trade creditors and employees in full.\n(Continued) AMERICOLD CORPORATION Notes to Consolidated Financial Statements\nThe Plan also provides that:\n- Each holder of the Company's 11% Senior Subordinated Debentures due 1997 will receive a corresponding amount of the new 15% Senior Subordinated Debentures due 2007, and an amount in cash equal to the accrued but unpaid interest on the old Senior Subordinated Debentures through but excluding the effective date of the Plan. The new debentures will be immediately callable at par. The Company did not make the mandatory sinking fund payment on the 11% Debentures of approximately $28.75 million due May 1, 1995. The Company is currently out of compliance with certain covenants.\n- The Company's 11.45% First Mortgage Bonds, Series A due 2002 and its 11.5% First Mortgage Bonds, Series B due 2005, will remain unaffected. As part of the Plan, the Company will repurchase $10 million of the Series A Bonds due 2002 at par, will pay a modification fee of $2.25 million to the Metropolitan Life Insurance Company, and has the option to purchase, in whole or in part, additional Series A Bonds at par for a period of 18 months following the effective date.\n- The investment agreement between the Company and Metropolitan Life Insurance Company will be amended, subject to confirmation, to reflect the restructuring and will, in certain cases, contain covenants which are less restrictive than those contained in the existing investment agreement.\nThe Company's existing bank credit agreement will be extended and modified pending the confirmation of the Plan.\nThe Company retained a \"Financial Advisor\" for advice and assistance with respect to the evaluation of available alternatives related to refinancing or other restructuring of the Company's debt and debt repayment obligations, and implementation of its financing strategies, and otherwise to advise and assist the Company with respect to the Plan. Total fees approximating $2.1 million will be paid to the Financial Advisor. 77 SCHEDULE II -----------\nAMERICOLD CORPORATION\nValuation and Qualifying Accounts\nYears ended the last day of February 1993, 1994 and 1995\n(In Thousands)\nAMERICOLD CORPORATION FORM 10-K\nEXHIBIT INDEX\nExhibit Page - -------- ----\n(2) Plan of Reorganization 79\n(3) Restated Bylaws, as amended 124\n(11) Statement re Computation of Per Share Earnings 145\n(21) Subsidiaries of the Registrant 146\n(23) Consent of KPMG Peat Marwick LLP 147\n*(27) Financial Data Schedule","section_15":""}
{"filename":"39910_1995.txt","cik":"39910","year":"1995","section_1":"Item 1. Business . . . . . . . . . . . . . . . . . . . . . . 3 2. Properties . . . . . . . . . . . . . . . . . . . . . 4 3. Legal Proceedings . . . . . . . . . . . . . . . . . . 4 4. Submission of Matters to a Vote of Security Holders.. 4 5. Changes in Securities . . . . . . . . . . . . . . . 5\nPart II\nItem 6. Market for the Registrant's Common Stock and Related Security Holders' Matters . . . . . . . . 5 7. Five-Year Selected Financial Data . . . . . . . . . . 6 8. Management's Discussion and Analysis of Financial Condition and Results of Operations . . . . . . . . . 7 9. Financial Statements and Supplementary Data . . . . . . 8 10. Disagreements on Accounting and Financial Disclosure. . 16\nPart III\nItem 11. Directors and Executive Officers of the Registrant. . . 16 12. Management Remuneration and Transactions. . . . . . . . 16 13. Security Ownership of Certain Beneficial Owners and Management . . . . . . . . . . . . . . . . 17 14. Certain Relationships and Related Transactions . . . . . 17\nPart IV\nItem 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K . . . . . . . . . . . . . . . 18\nSIGNATURES. . . . . . . . . . . . . . . . . . . . 20\n- -------------------------------------------------------------------------------- Part 1\nItem 1 - Business\n(a) GAP Instrument Corp., organized in 1953, is a systems engineering oriented manufacturing organization, producing electromechanical\/ solid-state systems to satisfy specific military and commercial requirements for application on board ships, in aircraft, and at ground- based installations. These various systems are primarily servo mechanisms and state-of-the-art signal data-conversion equipment employed in load actuation, information readout display, and operation control.\nWhile utilizing the same disciplines to continue its efforts in the areas of test equipment and simulation equipment, GAP is attempting to find appropriate areas of diversification to convert form a military market to a commercial market.\n(b) GAP Instrument Corp.'s operations are classified as a single industry segment.\n(c) (1) (I) The principal market for GAP Instrument Corp.'s equipment has been the Department of Defense for military requirements. GAP Instrument Corp. deals with the Department of Defense directly in open competitive bidding and as a subcontractor to other major defense contractors on larger programs. The defense procurement business is very competitive.\n(II) Not applicable\n(III) The materials utilized in the equipment produced by GAP Instrument Corp. are obtained from standard sources within the United States. These include foundries, sheet metal shops, machine shops, component manufacturers, etc.\n(IV) None of the equipment or processes utilized by GAP Instrument Corp. are covered by patents, licenses, franchises, etc.\n(V) Not applicable.\n(VI) Manufacturing operations are scheduled to fulfill specific product orders under firm contracts primarily from the Department of Defense. GAP Instrument Corp. does not carry significant amounts of stock inventory.\n(VII) GAP Instrument Corp.'s present overall business is dependent on a single customer, the Department of Defense, which presently purchases, either directly or indirectly, approximately 80 percent in value of its products.\n- -------------------------------------------------------------------------------- (VIII) The dollar backlog of orders of GAP Instrument Corp. at December 31, 1995 was $116,000, compared to $48,000 in 1994. All of the 1995 year-end backlog is expected to be shipped in fiscal year 1996.\n(IX) A significant amount of the business is subject to termination of contracts at the election of the Department of Defense. However, such termination procedures usually provide for the recovery of incurred costs and related profit.\n(X) Item (c)(1)(I).\n(2) (I) Research and development expenses of $50,628 were recorded as prepaid expenses during 1994 for diversification into the telecommunications market. These were expensed during 1995.\n(II) Department of Defense.\n(III) None.\n(IV) The total number of personnel employed by GAP Instrument Corp. as of the end of fiscal year 1995 was 4.\n(d) GAP Instrument Corp. does not engage in material operations in foreign countries, nor is its business dependent on a domestic geographic location.\nItem 2","section_1A":"","section_1B":"","section_2":"Item 2 - Properties\n(a) On October 20, 1993 GAP Instrument Corp. moved into space at 100 Horse Block Rd., Yaphank. The rent is currently $1,000 per month on a month to month basis. Rent expense for 1995 was $28,600 for the Yaphank facility.\nItem 3","section_3":"Item 3 - Legal Proceedings\n(a) On September 24, 1993, GAP Instrument Corp. the Debtor filed partitions for relief under Chapter 11 of the federal bankruptcy laws in the United States Bankruptcy Court for the. Eastern District of New York. Under Chapter 11, certain claims against the Debtor in existence prior to the filing of the petitions for relief under the federal bankruptcy laws are stayed while the Debtor continues business operations as \"Debtor-in- Possession\". These claims are reflected in the December 31, 1994 balance sheet as \"Liabilities subject to Compromise.\" Additional claims (liabilities subject to compromise) may arise subsequent to the filing date resulting from rejection of executory contracts, including leases, and from the determination by the court (or agreed to by parties in interest) of allowed claims for contingencies and other disputed amounts. On October 2, 1995, the Company's Plan of Reorganization was approved by the United States Bankruptcy Court. Payments under the approved plan are reflected on the Balance Sheet as \"Liabilities under a Plan of Reorganization.\"\n(b) Amendment to the by-laws approved by New York State changed authorized shares from 4,000,000 to 104,000,000 shares, per approval by stockholders at a special meeting of stockholders December 28, 1993.\nItem 4","section_4":"Item 4 - Submission of Matters to a Vote of Security Holders\nOn 28 December 1993 a Special Meeting of Stockholders was held. resolutions were passed to authorize and empower the Board of directors to amend, alter, change, add to, repeal, or rescind any and all of the Bylaws, and that the authorized common stock of GAP Instrument Corporation be increased from its present amount thereof, to One Hundred Four Million (104,000,000) shares of par value of One Thousandth of a cent per share ($0.00001).\n- -------------------------------------------------------------------------------- Item 5","section_5":"Item 5 - Changes in Securities\nOn July 29, 1994, the Company issued an additional 93,000,000 shares. These shares went - with the approval of the U.S. Bankruptcy Court for Eastern New York - to resolve post-petition debt.\n30,000,000 shares to Advanced Logic Resources, Inc. 30,000,000 shares to Eloco Inc. 20,000,000 shares to Bruce Binnie 5,000,000 shares to Lawrence Monahan 2,000,000 shares to Robert Hood 2,000,000 shares to George Guttner 1,000,000 shares to John Medcie 1,000,000 shares to Alan G Binnie 1,000,000 shares to Letty A Norjen 1,000,000 shares to Michael Fasullo\nPART II\nItem 6","section_6":"Item 6 - Market for the Registrant's Common Stock and Related Security Holders' Matters\nAt December 31, 1995, GAP Instrument Corp. had issued and outstanding 98,678,423 shares of common stock held by 1,087 stockholders of record. 2,000 shares are claimed by two former officers which are not recognized by GAP Instrument Corp.. Market prices listed in the following tabulation were obtained from the National Quotation Bureau, Inc., and represent prices between dealers and do not include retail markup, markdown, or commission, and may not necessarily represent actual transactions.\n1995 1994\nBid Asked Bid Asked First Quarter N o Q u o t e N o Q u o t e Second Quarter N o Q u o t e N o Q u o t e Third Quarter N o Q u o t e N o Q u o t e Fourth Quarter N o Q u o t e N o Q u o t e\n- --------------------------------------------------------------------------------\n- -------------------------------------------------------------------------------- Item 8","section_7":"","section_7A":"","section_8":"Item 8 - Management's Discussion and Analysis of Financial Condition and Results of Operations Liquidity and Capital Resources\nGAP Instrument Corp. has primarily relied on its results from operations to provide working capital. Due to lack of working capital on September 23, 1993, GAP Instrument Corp. the Debtor filed partitions for relief under Chapter 11 of the federal bankruptcy laws in the United States Bankruptcy Court for the Eastern District of New York.\nIn order to continue operations, and pay post petition expenses, GAP Instrument Corp. issued, on July 29, 1994, 3,000,000 shares of common stock, and on October 31, 1995, 1,744,070 shares of common stock, to suppliers and key personnel.\nOn October 2, 1995 GAP Instrument Corp. emerged from Chapter 11 and is operating under a plan approved by the United States Bankruptcy Court for the Eastern District of New York and the creditors.\nRESULTS OF OPERATIONS\nOperating income (loss) for the years 1995 and 1994, were ($98,016) and ($154,677). Sales volume for the respective years were $258,439 and $332,312.\nGAP Instrument Corp. is fully aware that its military business over the next decade will continue to decline. Thus, GAP instrument Corp. entered the tele communications market as a Value Added Network for the Federal Government and as an Internet Service Provider (ISP) for Federal contractors.\nFederal tax loss carryforwards at December 31, 1995 are ($704,710) which will provide for future tax benefits relief in future years.\nThe dollar backlog of sales at December 31, 1995, 1994 and 1993 were $116,000, $48,500, and $123,885, respectively. All of the 1995 backlog will be shipped in 1996.\n- -------------------------------------------------------------------------------- Item 9","section_9":"Item 9 - Financial Statements and Supplementary Data\nPage\nBalance Sheets as of December 31, 1995 and 1994. 9\nStatements of Income (Loss) and Accumulated\nDeficit for the Years Ended December 31,\n1995, 1994 and 1993. . . . . . . . . . . . . 10\nStatements of Cash Flows for the Years\nEnded December 31, 1995, 1994 and 1993 . . . 11\nNotes to Financial Statements . . . . . . . . . 12\nIndependent Auditors Report . . . . . . . . . . 15\n- -------------------------------------------------------------------------------- GAP INSTRUMENT CORP. BALANCE SHEETS December 31, 1995 and 1994\nASSETS\nDecember 31, 1995 1994 ------------ ------------ Current Assets: Cash (overdraft) $ (1,553) $ 14,078 Accounts receivable ( Note 3) 61,777 13,491 Inventories, at lower of cost or market (Note 4) - 40,118 ------------ ------------ Total current assets 60,224 67,687\nFixed assets, at cost less accumulated depreciation (Note 5) 12,998 3,761 Other assets 8,110 112,561 ------------ ------------ Total assets $ 81,332 $ 184,009 ============ ============\nLIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)\nCurrent Liabilities: Liabilities subject to compromise(Note 2) $ - $ 554,705 Accounts payable 29,860 16,216 Liabilities resulting from Plan of Reorganization (Note 2) 47,194 - Accrued liabilities - 22,136 Accrued payroll and taxes 347 670 Due from officers (Note 3) 56,000 24,000 ----------- ------------ Total current liabilities 133,401 617,727\nLong-term debt Liabilities resulting from Plan of Reorganization (Note 2) 189,795 - ----------- ------------ Total long-term liabilities 189,795 - ----------- ------------ Total liabilities 323,196 617,727 ----------- ------------ Stockholders' Deficit: Common stock $ .00001 par value 1995 104,000,000 shares authorized; 98,678,423 shares outstanding 1995 987 - 96,934,353 shares outstanding 1994 - 969 Capital in excess of par value 3,341,815 3,341,833 Accumulated deficit (3,584,666) (3,776,520) ----------- ------------- Total stockholders' deficit (241,864) (433,718) ----------- ------------- Total Liabilities and Stockholders' Deficit $ 81,332 $ 184,009 =========== =============\nSee Independent Auditor's Report and Notes to Financial Statements.\n- -------------------------------------------------------------------------------- GAP INSTRUMENT CORP. STATEMENTS OF INCOME (LOSS) AND ACCUMULATED DEFICIT For the years ended December 31, 1995, 1994 and 1993\nSee Independent Auditor's Report and Notes to Financial Statements.\n- -------------------------------------------------------------------------------- GAP INSTRUMENT CORP. STATEMENTS OF CASH FLOWS For the years ended December 31,1995, 1994 and 1993\n1995 1994 1993 ---------- ---------- ---------- Cash Flows from Operating Activities: Net income (Loss) $ 191,855 ($162,202) ($438,457) Add (deduct) non-cash items: Depreciation and amortization 4,675 1,905 1,903 Gain from adoption of plan of reorganization (293,870) - - Add (deduct) other changes: Accounts receivable (48,286) 4,518 13,603 Inventories 40,118 4,072 83,248 Prepaid expenses - 2,217 8,161 Accounts payable 13,643 (16,888) 33,104 Accrued liabilities (22,136) 22,136 32,996 Accrued payroll and taxes (323) (32,326) 166,730 ---------- ---------- --------- Net Cash Provided (Used) by Operating Activities (114,324) (176,658) (112,517) ---------- ---------- ---------\nCash Flows from Investing Activities: Purchase of equipment and leasehold improvements (13,912) (1,348) - Principal payments on bankruptcy debt (23,846) - - Increase in other assets 104,451 (68,645) - Abandonment of leasehold improvements 8,954 ---------- ---------- --------- Cash Provided (Used) by Investing Activities (66,693) (69,963) 8,954 ---------- ---------- ---------\nCash Flows from Financing Activities: Shareholder loans 32,000 18,000 6,000 Issuance of Stock for Post-Petition Debt - 236,910 - Payment of Long-term debt - - 94,950 ---------- ---------- --------- Cash Provided (Used)from Financing Activities 32,000 254,910 100,950 ---------- ---------- ---------\nNet Increase (Decrease) in Cash (15,631) 8,289 (2,613)\nBeginning Cash 14,078 5,789 8,402 ---------- ---------- --------- Ending Cash (Overdraft) $ (1,553) $ 14,078 $ 5,789 ========== ========== =========\nIncome Taxes 404 - -\nSee Independent Auditor's Report and Notes to Financial Statements\n- -------------------------------------------------------------------------------- NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995 AND 1994\nNOTE 1 - BUSINESS DESCRIPTION\nGAP Instrument Corp., organized in 1953, is a systems engineering oriented manufacturing organization, producing electromechanical\/solid -state systems to satisfy specific military and commercial requirements for application on board ships, in aircraft, and at ground-based installations. These various systems are primarily servo mechanisms and state-of-the-art signal data-conversion equipment employed in load actuation, information readout display, and operation control.\nWhile utilizing the same disciplines to continue its efforts in the areas of test equipment and simulation equipment, GAP Instrument Corp is attempting to find appropriate areas of diversification to convert form a military market to a commercial market.\nNOTE 2 - PETITION FOR RELIEF UNDER CHAPTER 11\nOn September 24, 1993, GAP Instrument Corp. (the Debtor) filed petitions for relief under Chapter 11 of the federal bankruptcy laws in the United States Bankruptcy Court for the Eastern District of New York. Under Chapter 11, certain claims against the Debtor in existence prior to the filing of the petitions for relief under the federal bankruptcy laws are stayed while the Debtor continues business operations as Debtor-in- Possession. These claims are reflected in the December 31, 1994 balance sheets as \"Liabilities subject to Compromise\". Additional claims (liabilities subject to compromise) may come to light subsequent to the filing date resulting from rejection of executory contracts, including leases, and from the determination by the court or agreement by parties in interest. A plan of reorganization was approved on October 2, 1995. This plan calls for payments over the next five years in settlement of the compromised liabilities. These liabilities are reflected in the December 31,1995 Balance Sheet as \"Liabilities Resulting from Plan of Reorganization.\"\nNOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:\nThe following is a summary of the significant accounting policies of GAP Instrument Corp. Assets and liabilities, and revenues and expenses, are recognized on the accrual basis of accounting. GAP Instrument Corp. considers all highly liquid debt instruments with a maturity of three months or less to be cash equivalents. Accounts receivable are recorded when goods are shipped or when customer is registered(VAN service). Doubtful accounts are written-off when receivable is determined to be uncollectable - i.e., contract terminated. As of December 31, 1995 and 1994 no allowance for doubtful accounts was deemed necessary, as management does not anticipate any further probable losses.\nInventories are stated at the lower of cost (first in-first out) or market. Machinery and leasehold improvements are stated at cost less accumulated depreciation and are removed from the asset and accumulated depreciation accounts when disposed of. Ordinary repairs and maintenance are charged directly to expense as incurred. Losses were recognized in 1993 for the abandonment of leasehold improvements when GAP Instrument Corp moved.\n- -------------------------------------------------------------------------------- NOTES TO FINANCIAL STATEMENTS CONTINUED\nNet sales are recorded on the completed contract method of accounting. Sales orders normally require delivery dates of less than one year. The preparation of financial statements in conformity with generally accepted accounting principals 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. Liabilities resulting from the adoption of the plan of reorganization under Chapter 11 of the United States Bankruptcy Court are shown as \"Liabilities resulting from Plan of Reorganization.\" The payments under the Plan that are due with-in one year are shown in the current liabilities and those due later than one year are grouped with the long term liabilities. The balance sheet caption \"Liabilities Subject to Compromise\" are the liabilities as of the date of the Bankruptcy filing. See Note 2 above.\nOfficer loans are payable on demand and currently there is no interest being accrued.\nIncome taxes: During 1995 the Company adopted FAS 109 (Accounting for Income Taxes.)\nThis statement requires the use of the asset and liability approach in the recognition of deferred tax assets and liabilities for the expected future tax consequences of the event that have been recognized in the company's financial statements or tax return. If it is more likely than not that some portion or all of a deferred tax asset will not be realized, a valuation allowance is realized. Financial statements for prior years, have not been restated and the cumulative effect of the accounting change would not be material.\nNOTE 4 - INVENTORIES:\nInventories were carried on the FIFO basis.\nDecember 31, 1995 1994 1993\nRaw materials and components 0 35,258 $ 36,760\nWork in process 0 4,860 7,430 ------ --------- --------- 0 $ 40,118 $ 44.190 ====== ========= =========\nInventories of raw materials and components were written-off at December 31, 1995 due to obsolescence of inventories. Parts are currently purchased on a as needed only basis.\n- -------------------------------------------------------------------------------- NOTES TO FINANCIAL STATEMENTS CONTINUED\nNOTE 5 - FIXED ASSETS:\nFixed assets at December 31 consisted of the following:\n1995 1994 ---------- ---------- Production Equipment and leasehold improvements $ 5,730 $ 20,331 Administrative equipment 13,848 - ---------- ---------- 19,578 20,331 Less: Accumulated depreciation and amortization (6,580) (16,570) ---------- ---------- Fixed assets net of accumulated depreciation $ 12,998 $ 3,761 ========== ==========\nAssets are depreciated over five and ten year periods using the straight line depreciation method. Leasehold improvements are amortized over the remaining life of the lease. Depreciation and amortization expense for the years ended December 31, 1995, 1994 and 1993 was $4,675, 1,905, and $1,903, respectively. Leasehold improvements were abandoned when the Company moved its facilities. Depreciation is computed on the tax basis, MACRS. The difference between straight line and MACRS is not material.\nNOTE 6 - INCOME TAXES: The annual provision for income taxes differs from amounts computed applying the maximum US Federal income tax rate to the pre-tax income as follows:\n1995 1994 ---------- ---------- Computed tax at maximum rate $ 65,230 - State Income Tax, net of Federal tax effect 404 - Tax benefit of operating loss carryforward (65,634) - ---------- ---------- Provision for income taxes - -\nDeferred tax assets (liabilities) at December 31, 1995 and 1994 consist of the following: 1995 1994 ---------- ---------- Deferred tax assets $(704,710) $(896,565) Deferred tax assets valuation allowance 704,710 896,565 ---------- ---------- Net deferred tax assets - - ========== ==========\n- -------------------------------------------------------------------------------- NOTES TO FINANCIAL STATEMENTS CONTINUED\nNOTE 7 - BUSINESS SEGMENT REPORTING: Company operations are no longer a single industry segment, namely, system design and manufacture of electronic products used for data conversion and display instrumentation. Direct sales to United States Government Agencies or its prime contractors in 1995, 1994 and 1993, were $ 224,152, $246,000, and $205,354, respectively. The Company entered a new business segment, namely, telecommunications providing Value Added Network Services via the Internet for the Federal Government. 1995 sales for this business segment were $ 34,045.\nNOTE 8 - PER SHARE DATA: Earnings per share data are based on the average number of common shares outstanding during the year. Shares for convertible debt have been excluded in these computations since their inclusion is not material. The number of common shares outstanding for 1995 were 98,678,423, and for 1994 were 96,934,353 and for 1993 were 3,934,354.\nNOTE 9 - COMMITMENTS AND CONTINGENCIES: On October 20, 1993 the Company moved into facilities in Yaphank, currently rented at $3,200 per month on a month to month basics. Rent expense for 1995 was $28,600.\nNOTE 10 - GOING CONCERN There is substantial doubt about the ability of GAP Instrument Corp to continue as a going concern. As shown in the accompanying financial statements, the Company had net losses, before effects of extraordinary gain, of ($98,016), $(154,677), and $(415,457) during each of the three years ended December 31, 1995, 1994 and 1993, respectively and, as of those dates, had stockholders' (deficit) of $(241,864), $(433,718), and $(511,390), respectively. Management plans to expand its presence in the value added network area (VAN) in which management believes there is substantial growth opportunity.\nNOTE 11 - RELATED PARTY TRANSACTIONS GAP Instrument Corp rents its Yaphank facility from Advanced Logic Resources, Inc. which has 31.03% ownership percentage in the Company, at a rental of $3,200 per month on a month-to-month basis.\nNOTE 12 - FAIR VALUE OF FINANCIAL INSTRUMENTS GAP Instrument Corp, whose only financial instruments are cash, short-term trade receivables and payables and loans from stockholders', for which their carrying amounts approximate fair values. - -------------------------------------------------------------------------------- INDEPENDENT AUDITORS' REPORT\nTo the Board of Directors and Stockholders of GAP Instrument Corp\nWe have audited the accompanying balance sheet of GAP Instrument Corp (a New York corporation) as of December 31, 1995, and the related statements of income (loss) and accumulated deficit, and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. The financial statements of GAP Instrument Corp as of December 31, 1994 and 1993, were audited by other auditors whose report dated January 31, 1995, on those statements included explanatory paragraphs that described the Company's going concern issue.\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 GAP Instrument Corp as of December 31, 1995, and the results of its operations and its cash flows for the year then ended in conformity with generally accepted accounting principles.\nThe accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 10 to the financial statements, the Company has suffered recurring losses from operations and has a net capital deficiency that raise substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 10. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.\n\/s\/ SCHWAEBER SLOANE SCHULMAN & CO., PC\nGreat Neck NY April 29, 1996\n- -------------------------------------------------------------------------------- Item 10","section_9A":"","section_9B":"","section_10":"Item 10 - Disagreements on Accounting and Financial Disclosure NONE\nPart III\nItem 11","section_11":"Item 11 -Directors and Executive Officers of the Registrant\n* These shares are Beneficially owned by virtue of being a Director of Advanced Logic Resources, Inc. and Eloco, Inc.\n^ These shares are Beneficially owned by virtue of being a Director of Elcoc Inc.\nThe shares of Common Stock indicated above are the only securities of GAP Instrument Corp. owned by the directors and executive officers of the registrant.\nItem 12","section_12":"Item 12 -Management Remuneration and Transactions\nIn 1995, total remuneration for all Directors and Officers was $0\nItem 13","section_13":"Item 13 -Security Ownership of Certain Beneficial Owners and Management\nName and Address Amount Beneficially Owned Percent of Class - --------------------- --------------------------- ----------------- Eloco, Inc. Yaphank, NY 11980 30,036,732 shares 30.44\nAdvanced Logic Resources, Inc. Yaphank, NY 11980 30,620,000 shares 31.03\nAlan G. Binnie Ridge, NY 11961 21,604,055 shares 21.89\nLawrence Monahan 5,007,400 shares 5.07\nBeneficially owned securities of GAP Instrument Corp. held by all Directors and Officers of GAP Instrument Corp. as a group:\nAmount Beneficially Owned Percent of Class ---------------------------- ------------------ 65,664,132 66.54\n- -------------------------------------------------------------------------------- Item 14","section_14":"Item 14 - Certain Relationships and Related Transactions None\nPART IV\nItem 15","section_15":"Item 15 - Exhibits, Financial Statement Schedules and Reports on Form 8-K\n(1) Financial Statements: Reference is made to Part II, Item 9. (2) Exhibits Index: (3), (4) Reference is made to Form 10-K for 1980. (5), (9), (10), (11), (12), (13), (18), (19), (20), (22), (23), (24), (25), and (28) are not applicable.\n(3) Financial Statement Schedules for the Years Ended December 1995, 1994 and 1993:\nPage No.\nSupplementary Profit and Loss Information 19\n(4) Reports on Form 8-K: The Company filed a Report on Form 8K for the last quarter covered by these financial statements. The Company filed a Report on Form 8K subsequent to year end.\nSUPPLEMENTARY PROFIT AND LOSS INFORMATION\nCharged to Profit and Loss To Cost To Other of Sales Accounts Total ---------- ----------- ---------- Year ended December 1993: Maintenance and repairs $ 9,004 $ - $ 9,004 Depreciation and amortization of fixed assets 1,903 1,903\nTaxes other than income taxes: Payroll 7,783 6,330 14,113 Property - 7,799 7,799 Rents 60,918 26,108 87,026 ---------- ----------- ---------- $ 79,608 $40,237 $119,845 ========== =========== ==========\nYear ended December 31, 1994: Maintenance and repairs $ 2,681 - $ 2,681 Depreciation and amortization of fixed assets 1,905 - 1,905 Taxes other than income taxes: Payroll 2,248 2,248 Rents 6,000 7,000 13,000 ---------- ----------- ---------- $ 10,586 $ 9,248 $ 19,834 =========== ============ ==========\nYear ended December 31, 1995: Maintenance and repairs $ - 1,056 $ 1,056 Depreciation and amortization of fixed assets - 4,675 4,675 Taxes other than income taxes: Payroll 2,312 2,312 Rents 28,600 28,600 ----------- ------------ ---------- $ - $ 36,643 $ 36,643\n- --------------------------------------------------------------------------------\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\/ James M. Edwardson ______________________________________ Date May 1, 1996 James M. Edwardson Chairman of the Board of Directors, and Chief Operating Officer\n\/s\/ Robert Baer ______________________________________ Date May 1, 1996 Robert Baer President\n\/s\/ Letty A. Norjen ______________________________________ Date May 1, 1996 Letty A. Norjen Secretary and Director\n\/s\/ Deidre C. Morrison ______________________________________ Date May 1, 1996 Deirdre C. Morrison Treasurer"}
{"filename":"849869_1995.txt","cik":"849869","year":"1995","section_1":"Item 1. Business\nGeneral\nSilgan Holdings Inc. (\"Holdings,\" and, together with its subsidiaries, the \"Company\") is a Delaware corporation organized in April 1989, that, in June 1989, through certain mergers acquired all of the outstanding common stock of Silgan Corporation (\"Silgan\"). Holdings' principal asset is all of the outstanding capital stock of Silgan. Prior to June 30, 1989, Holdings did not engage in any business. Silgan is a Delaware corporation formed in August 1987 as a holding company to acquire interests in various packaging manufacturers. See \"Company History\" below.\nThe Company is a major manufacturer of a broad range of steel and aluminum containers for human and pet food. The Company also manufactures custom designed plastic containers for health, personal care, food, beverage, pharmaceutical and household chemical products in North America. In 1995, the Company had net sales of approximately $1.1 billion.\nOn August 1, 1995, Silgan's wholly owned subsidiary, Silgan Containers Corporation (\"Containers\"), acquired from American National Can Company (\"ANC\") substantially all of the assets of ANC's Food Metal and Specialty business (\"AN Can\") for approximately $349 million. See \"Company History\" below. AN Can manufactures and sells metal food containers and rigid plastic containers for a variety of food products and metal caps and closures for food and beverage products. The acquisition of AN Can has enabled the Company to diversify its customer base and geographic presence. The Company believes that the acquisition of AN Can will also result in the realization of cost savings for the Company. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\" On a pro forma basis after giving effect to the acquisition of AN Can, in 1995 the Company would have had net sales of approximately $1.4 billion.\nManagement believes that the Company is the sixth largest can producer and the largest food can producer in North America, as well as one of the largest producers in North America of custom designed plastic containers for health and personal care products. Silgan has grown rapidly since its inception in 1987 primarily as a result of acquisitions, but also through internally generated growth. In addition to the acquisition of AN Can in August 1995, Containers acquired the U.S. metal container manufacturing business of Del Monte Corporation (\"Del Monte\") in December 1993. See \"Company History\" below.\nThe Company's strategy is to continue to increase its share of the North American packaging market through acquisitions, as well as investment in internally generated opportunities. The Company intends to focus particular attention on those rigid metal and plastic container segments where operating synergies are likely.\nMetal Container Business\nManagement estimates that Containers is currently the sixth largest can producer and the largest manufacturer of metal food containers in North America. In 1995, Containers sold approximately 28% of all metal food containers used in the United States. On a pro forma basis after giving effect to the acquisition of AN Can, in 1995 Containers would have sold approximately 36% of all metal food containers sold in the United States. Although the food can industry in the United States is relatively mature in terms of unit sales growth, Containers, on a pro forma basis after giving effect to the acquisition of AN Can, has realized compound annual unit sales growth in excess of 16% since 1987. Types of containers manufactured include those for vegetables, fruit, pet food, meat, tomato based products, coffee, soup, seafood, evaporated milk and infant formula. Containers has agreements with Nestle Food Company (\"Nestle\") pursuant to which Containers\nsupplies substantially all of its metal container requirements, and an agreement with Del Monte pursuant to which Containers supplies substantially all of its metal container requirements. In addition to Nestle and Del Monte, Containers has multi-year supply arrangements with other customers. The Company estimates that approximately 80% of Containers' sales in 1996 will be pursuant to such supply arrangements. See \"Sales and Marketing\" below.\nContainers has focused on growth through acquisition followed by investment in the acquired assets to achieve a low cost position in the food can segment. Since its acquisition in 1987 of the metal container manufacturing division of Nestle (\"Nestle Can\"), Containers has invested approximately $131 million in its acquired manufacturing facilities and has spent approximately $307 million for the acquisition of additional can manufacturing facilities and equipment. As a result of these efforts and management's focus on quality and service, Containers has more than tripled its overall share of the food can segment in terms of unit sales, from a share of approximately 10% in 1987 to a share of approximately 36% in 1995, on a pro forma basis after giving effect to the acquisition of AN Can.\nContainers also manufacturers and sells certain specialty packaging items, including metal caps and closures, plastic bowls and paper containers primarily used by processors and packagers in the food industry. In 1995, the Company had sales of specialty items of approximately $37 million.\nPlastic Container Business\nManagement believes that Silgan's wholly owned subsidiary, Silgan Plastics Corporation (\"Plastics\"), is one of the leading manufacturers of custom designed, high density polyethylene (\"HDPE\") and polyethylene terephthalate (\"PET\") containers sold in North America for health and personal care products. HDPE containers manufactured by Plastics include personal care containers for shampoos, conditioners, hand creams, lotions, cosmetics and toiletries, household chemical containers for scouring cleaners, specialty cleaning agents, lawn and garden chemicals and pharmaceutical containers for tablets, laxatives and eye cleaning solutions. Plastics manufactures PET custom containers for mouthwash, liquid soap, skin care lotions, gastrointestinal and respiratory products, pourable and viscous salad dressings, condiments, instant coffees, premium water and liquor. See \"Products\" below.\nPlastics has grown primarily by strategic acquisition. From a sales base of $89 million in 1987, Plastics' sales have grown at a compound rate of 12% to $220 million in 1995. Plastics emphasizes value-added design, fabrication and decoration of custom containers. Plastics is aggressively pursuing opportunities in custom designed PET and HDPE containers for which the market has been growing principally due to consumer preferences for plastic containers. The Company believes it has equipment and technical expertise to take advantage of these growth segments.\nProducts\nMetal Container Business\nThe Company is engaged in the manufacture and sale of steel and aluminum containers that are used primarily by processors and packagers for human and pet food. Types of containers manufactured include those for vegetables, fruit, pet food, meat, tomato based products, coffee, soup, seafood, evaporated milk and infant formula. The Company does not produce cans for use in the beer or soft drink industries.\nPlastic Container Business\nThe Company is also engaged in the manufacture and sale of plastic containers primarily used for health, personal care, food, beverage (other than carbonated soft drinks), pharmaceutical and household chemical products. Plastic containers are produced by converting thermoplastic materials into containers ranging in size from 1\/2 to 96 ounces. Emphasis is on value-added design, fabrication and decoration of the containers. The Company designs and manufactures a wide range of containers for health and personal care products such as shampoos, conditioners, hand creams, lotions, cosmetics and toiletries, liquid soap, gastrointestinal and respiratory products, and mouthwash. Because these products are characterized by short product life and a demand for creative packaging, the containers manufactured for these products generally have more sophisticated designs and decorations. Food and beverage containers are designed and manufactured (generally to unique specifications for a specific customer) to contain products such as salad dressing, condiments, instant coffee, premium water and liquor. Household chemical containers are designed and manufactured to contain polishes, specialty cleaning agents, lawn and garden chemicals and liquid household products. Pharmaceutical containers are designed and manufactured (either in a generic or in a custom-made form) to contain tablets, solutions and similar products for the ethical and over-the-counter markets.\nManufacturing and Production\nAs is the practice in the industry, most of the Company's can and plastic container customers provide it with annual estimates of products and quantities pursuant to which periodic commitments are given. Such estimates enable the Company to effectively manage production and control working capital requirements. At December 31, 1995, Containers had approximately 80% of its projected 1996 sales under multi-year contracts. Plastics has purchase orders or contracts for containers with the majority of its customers. In general, these purchase orders and contracts are for containers made from proprietary molds and are for a duration of 2 to 5 years. Both Containers and Plastics schedule their production to meet their customers' requirements. Because the production time for the Company's products is short, the backlog of customer orders in relation to sales is not significant.\nMetal Container Business\nThe Company uses three basic processes to produce cans. The traditional three-piece method requires three pieces of flat metal to form a cylindrical body with a welded side seam, a bottom and a top. The Company uses a welding process for the side seam of three-piece cans to achieve a superior seal. High integrity of the side seam is further assured by the use of sophisticated electronic weld monitors and organic coatings that are thermally cured by induction and convection processes. The other two methods of producing cans start by forming a shallow cup that is then formed into the desired height using either the draw and iron process or the draw and redraw process. Using the draw and redraw process, the Company manufactures steel and aluminum two-piece cans, the height of which does not exceed the diameter. For cans the height of which is greater than the diameter, the Company manufactures steel two-piece cans by using a drawing and ironing process. Quality and stackability of such cans are comparable to that of the shallow two-piece cans described above. Can bodies and ends are manufactured from thin, high-strength aluminum alloys and steels by utilizing proprietary tool and die designs and selected can making equipment. The Company's manufacturing operations include cutting, coating, lithographing, fabricating, assembling and packaging finished cans.\nPlastic Container Business\nThe Company utilizes two basic processes to produce plastic bottles. In the blow extrusion molding process, pellets of plastic resin are heated and extruded into a tube of plastic. A two-piece metal mold is then closed around the plastic tube and high pressure air is blown into it causing a bottle to form in the mold's\nshape. In the injection blow molding process, pellets of plastic resin are heated and injected into a mold, forming a plastic preform. The plastic preform is then blown into a bottle-shaped metal mold, creating a plastic bottle.\nThe Company believes that its proprietary equipment for the production of HDPE containers is particularly well-suited for the use of PCR resins because of the relatively low capital costs required to convert its equipment to utilize multi-layer container construction.\nThe Company's decorating methods for its plastic products include (1) in-mold labeling which applies a paper or plastic film label to the bottle during the blowing process and (2) post-mold decoration. Post-mold decoration includes (i) silk screen decoration which enables the applications of images in multiple colors to the bottle, (ii) pressure sensitive decoration which uses a plastic film or paper label applied by pressure, (iii) heat transfer decoration which uses a plastic film or plastic coated paper label applied by heat, and (iv) hot stamping decoration which transfers images from a die using metallic foils. The Company has state-of-the-art decorating equipment, including, management believes, one of the largest sophisticated decorating facilities in the Midwest, which allows the Company to custom-design new products with short lead times.\nRaw Materials\nThe Company does not believe that it is materially dependent upon any single supplier for any of its raw materials and, based upon the existing arrangements with suppliers, its current and anticipated requirements and market conditions, the Company believes that it has made adequate provisions for acquiring raw materials. Although increases in the prices of raw materials have generally been passed along to the Company's customers, the inability to do so in the future could have a significant impact on the Company's operating margins.\nMetal Container Business\nThe Company uses tin plated and chromium plated steel, aluminum, copper wire, organic coatings, lining compound and inks in the manufacture and decoration of its metal can products. The Company's material requirements are supplied through purchase orders with suppliers with whom the Company, through its predecessors, has long-term relationships. If its suppliers fail to deliver under their arrangements, the Company would be forced to purchase raw materials on the open market, and no assurances can be given that it would be able to make such purchases at comparable prices or terms. The Company believes that it will be able to purchase sufficient quantities of steel and aluminum can sheet for the foreseeable future.\nPlastic Container Business\nThe raw materials used by the Company for the manufacture of plastic containers are primarily resins in pellet form such as HDPE-PCR and virgin HDPE and PET and, to a lesser extent, low density polyethylene, extrudable polyethylene terephthalate, polyethylene terephthalate glycol, polypropylene, polyvinyl chloride and medium density polyethylene. The Company's resin requirements are acquired through multi-year arrangements for specific quantities of resins with several major suppliers of resins. The price the Company pays for resin raw materials is not fixed and is subject to market pricing. The Company believes that it will be able to purchase sufficient quantities of resins for the foreseeable future.\nSales and Marketing\nThe Company markets its products in most areas of North America primarily by a direct sales force and through a large network of distributors. Because of the high cost of transporting empty containers, the Company generally sells to customers within a 300 mile radius of its manufacturing plants. See also \"Competition\" below.\nIn 1995, 1994 and 1993, the Company's metal container business accounted for approximately 80%, 76% and 71%, respectively, of the Company's total sales, and the Company's plastic container business accounted for approximately 20%, 24% and 29%, respectively, of the Company's total sales. On a pro forma basis after giving effect to the acquisition of AN Can, metal and plastic containers in 1995 would have accounted for approximately 84% and 16% of the Company's total sales, respectively. In 1995, 1994 and 1993, approximately 21%, 26% and 34%, respectively, of the Company's sales were to Nestle and in 1995 and 1994 approximately 15% and 21%, respectively, of the Company's sales were to Del Monte. On a pro forma basis after giving effect to the acquisition of AN Can, in 1995 approximately 17% and 11% of the Company's sales would have been to Nestle and Del Monte, respectively. No other customer accounted for more than 10% of the Company's total sales during such years.\nMetal Container Business\nManagement believes that the Company is currently the sixth largest can producer and the largest food can producer in North America. In 1995, Containers sold approximately 28% of all metal food containers in the United States. Containers has entered into multi-year supply arrangements with many of its customers, including Nestle and Del Monte. The Company estimates that approximately 80% of its metal container sales in 1996 will be pursuant to such arrangements.\nIn 1987, the Company, through Containers, and Nestle entered into supply agreements (the \"Nestle Supply Agreements\") pursuant to which Containers has agreed to supply Nestle with, and Nestle has agreed to purchase from Containers, substantially all of the can requirements of the former Carnation operations of Nestle for a period of ten years, subject to certain conditions. In 1995, sales of metal cans by the Company to Nestle were $236.0 million.\nThe Nestle Supply Agreements provide for certain prices and specify that such prices will be increased or decreased based upon cost change formulas set forth therein. The Nestle Supply Agreements contain provisions that require Containers to maintain certain levels of product quality, service and delivery in order to retain the Nestle business. In the event of a breach of a particular Nestle Supply Agreement, Nestle may terminate such Nestle Supply Agreement but the other Nestle Supply Agreements would remain in effect.\nIn 1994, the term of certain of the Nestle Supply Agreements (representing approximately 70% of the Company's 1995 unit sales to Nestle) was extended through 2001. Under these Nestle Supply Agreements, Nestle has the right to receive competitive bids under narrowly limited circumstances, and Containers has the right to match any such bids. In the event that Containers chooses not to match a competitive bid, Nestle may purchase cans from the competitive bidder at the competitive bid price for the term of the bid. The Company cannot predict the effect, if any, of such bids upon its financial condition or results of operations. The Company is currently engaged in discussions with Nestle regarding the pricing and the extension of the term for certain can requirements under these Nestle Supply Agreements. On a pro forma basis after giving effect to the acquisition of AN Can, such can requirements would have represented approximately 6% of the Company's 1995 sales.\nThe Company has also commenced discussions with Nestle with respect to the continuation beyond 1997 of the other Nestle Supply Agreements, which would have represented approximately 6% of the Company's sales in 1995 on a pro forma basis after giving effect to the acquisition of AN Can. Although the Company intends to make every effort to extend these Nestle Supply Agreements on reasonable terms and conditions, there can be no assurance that these Nestle Supply Agreements will be extended.\nOn December 21, 1993, Containers and Del Monte entered into a supply agreement (the \"DM Supply Agreement\"). Under the DM Supply Agreement, Del Monte has agreed to purchase from Containers, and Containers has agreed to sell to Del Monte, 100% of Del Monte's annual requirements for metal containers to be used for the packaging of food and beverages in the United States and not less than 65% of Del Monte's annual requirements of metal containers for the packaging of food and beverages at Del Monte's Irapuato, Mexico facility, subject to certain limited exceptions. In 1995, sales of metal containers by the Company to Del Monte were $159.4 million.\nThe DM Supply Agreement provides for certain prices for all metal containers supplied by Containers to Del Monte thereunder and specifies that such prices will be increased or decreased based upon specified cost change formulas.\nUnder the DM Supply Agreement, beginning in December 1998, Del Monte may, under certain circumstances, receive proposals with terms more favorable than those under the DM Supply Agreement from independent commercial can manufacturers for the supply of containers of a type and quality similar to the metal containers that Containers furnishes to Del Monte, which proposals shall be for the remainder of the term of the DM Supply Agreement and for 100% of the annual volume of containers at one or more of Del Monte's canneries. Containers has the right to retain the business subject to the terms and conditions of such competitive proposal.\nThe sale of metal containers to vegetable and fruit processors is seasonal and monthly revenues increase during the months of June through October. As is common in the packaging industry, the Company must build inventory and then carry accounts receivable for some seasonal customers beyond the end of the season. The acquisition of AN Can increased the Company's seasonal metal container business. Consistent with industry practice, such customers may return unused containers. Historically, such returns have been minimal.\nPlastic Container Business\nThe Company is one of the leading manufacturers of custom designed HDPE and PET containers sold in North America. The Company markets its plastic containers in most areas of North America through a direct sales force and through a large network of distributors. More than 70% of the Company's plastic containers are sold for health and personal care products, such as hair care, oral care, pharmaceutical and other health care applications. The Company's customers in these product segments include Helene Curtis Inc., Procter & Gamble Co., Avon Products, Inc., Andrew Jergens Inc., Chesebrough-Ponds USA Co., Dial Corp., Warner-Lambert Company and Pfizer Inc. The Company also manufactures plastic containers for food and beverage products, such as salad dressings, condiments, instant coffee and premium water and liquor. Customers in these product segments include Procter & Gamble Co., Kraft General Foods Inc. and General Mills, Inc.\nAs part of its marketing strategy, the Company has arrangements to sell some of its plastic products to distributors, which in turn sell such products primarily to small-size regional customers. Plastic containers sold to distributors are manufactured by using generic molds with decoration, color and neck finishes added to meet the distributors' individual requirements. The distributors' warehouses and their sales personnel enable the Company to market and inventory a wide range of such products to a variety of customers.\nPlastics has written purchase orders or contracts for containers with the majority of its customers. In general, these purchase orders and contracts are for containers made from proprietary molds and are for a duration of 2 to 5 years.\nCompetition\nThe packaging industry is highly competitive. The Company competes in this industry with other packaging manufacturers as well as fillers, food processors and packers who manufacture containers for their own use and for sale to others. The Company attempts to compete effectively through the quality of its products, pricing and its ability to meet customer requirements for delivery, performance and technical assistance. The Company also pursues market niches such as the manufacture of easy-open ends and special feature cans, which may differentiate the Company's products from its competitors' products.\nBecause of the high cost of transporting empty containers, the Company generally sells to customers within a 300 mile radius of its manufacturing plants. Strategically located existing plants give the Company an advantage over competitors from other areas, and the Company would be disadvantaged by the loss or relocation of a major customer. As of February 28, 1996, the Company operated 44 manufacturing facilities, geographically dispersed throughout the United States and Canada, that serve the distribution needs of its customers.\nMetal Container Business\nManagement believes that the metal food containers segment is mature. Some self-manufacturers have sold or closed can manufacturing operations and entered into long-term supply agreements with the new owners or with commercial can manufacturers. Of the commercial metal can manufacturers, Crown Cork and Seal Company, Inc. and Ball Corporation are the Company's most significant national competitors. As an alternative to purchasing cans from commercial can manufacturers, customers have the ability to invest in equipment to self-manufacture their cans.\nAlthough metal containers face continued competition from plastic, paper and composite containers, management believes that metal containers are superior to plastic and paper containers in applications where the contents are processed at high temperatures, where the contents are packaged in large or institutional quantities (14 to 64 oz.) or where long-term storage of the product is desirable. Such applications include canned vegetables, fruits, meats and pet foods. These sectors are the principal areas for which the Company manufactures its products.\nPlastic Container Business\nPlastics competes with a number of large national producers of health, personal care, food, beverage, pharmaceutical and household chemical plastic container products, including Owens-Brockway Plastics Products, a division of Owens-Illinois, Inc., Constar Plastics Inc., a subsidiary of Crown Cork and Seal Company, Inc., Johnson Controls Inc., Continental Plastics Inc. and Plastipak Packaging Inc. In order to compete effectively in the constantly changing market for plastic bottles, the Company must remain current with, and to some extent anticipate innovations in, resin composition and applications and changes in the manufacturing of plastic bottles.\nEmployees\nAs of December 31, 1995, the Company employed approximately 940 salaried and 4,170 hourly employees on a full-time basis, including approximately 1,400 employees who joined the Company on August 1, 1995 as a result of the acquisition of AN Can. Approximately 63% of the Company's hourly plant employees are represented by a variety of unions.\nThe Company's labor contracts expire at various times between 1996 and 2008. Contracts covering approximately 12% of the Company's hourly employees presently expire during 1996. The Company expects no significant changes in its relations with these unions. Management believes that its relationship with its employees is good.\nRegulation\nThe Company is subject to federal, state and local environmental laws and regulations. In general, these laws and regulations limit the discharge of pollutants into the air and water and establish standards for the treatment, storage, and disposal of solid and hazardous waste. The Company believes that all of its facilities are either in compliance in all material respects with all presently applicable environmental laws and regulations or are operating in accordance with appropriate variances, delayed compliance orders or similar arrangements.\nIn addition to costs associated with regulatory compliance, the Company may be held liable for alleged environmental damage associated with the past disposal of hazardous substances. Generators of hazardous substances disposed of at sites at which environmental problems are alleged to exist, as well as the owners of those sites and certain other classes of persons, are subject to claims under the Comprehensive Environmental Response, Compensation, and Liability Act of 1980 (\"CERCLA\") regardless of fault or the legality of the original disposal. Liability under CERCLA and under many similar state statutes is joint and several, and, therefore, any responsible party may be held liable for the entire cleanup cost at a particular site. Other state statutes may impose proportionate rather than joint and several liability. The federal Environmental Protection Agency or a state agency may also issue orders requiring responsible parties to undertake removal or remedial actions at certain sites. Pursuant to the agreement relating to the acquisition in 1987 of Nestle Can, the Company has assumed liability for the past waste disposal practices of Nestle Can. In 1989, the Company received notice that it is one of many potentially responsible parties (or similarly designated parties) for cleanup of hazardous waste at a site to which it (or its predecessor Nestle Can) is alleged to have shipped such waste and at which the Company's share of cleanup costs could exceed $100,000. See \"Legal Proceedings.\"\nPursuant to the agreement relating to the acquisition in 1987 from Monsanto Company (\"Monsanto\") of substantially all of the business and related fixed assets and inventory of Monsanto's plastic containers business (\"Monsanto Plastic Containers\"), Monsanto has agreed to indemnify the Company for substantially all of the costs attributable to the past waste disposal practices of Monsanto Plastic Containers. In connection with the acquisition from Del Monte of substantially all of the fixed assets and working capital of its container manufacturing business in the United States (\"DM Can\"), Del Monte has agreed to indemnify the Company for a period of three years for substantially all of the costs attributable to any noncompliance by DM Can with any environmental law prior to the closing, including all of the costs attributable to the past waste disposal practices of DM Can. In connection with the acquisition of AN Can, subject to certain limitations, ANC has agreed to indemnify the Company for a period of three years for the costs attributable to any noncompliance by AN Can with any environmental law prior to the closing, including costs attributable to the past waste disposal practices of AN Can.\nThe Company is subject to the Occupational Safety and Health Act and other laws regulating noise exposure levels and other safety and health concerns in the production areas of its plants.\nManagement does not believe that any of the matters described above individually or in the aggregate will have a material effect on the Company's capital expenditures, earnings, financial position or competitive position.\nResearch and Technology\nMetal Container Business\nThe Company's research, product development and product engineering efforts relating to its metal containers are currently conducted at its research centers at Oconomowoc, Wisconsin; Neenah, Wisconsin and at other plant locations. The Company is building a state-of-the-art research facility in Oconomowoc, Wisconsin in order to consolidate its two main research centers into one facility.\nPlastic Container Business\nThe Company's research, product development and product engineering efforts with respect to its plastic containers are currently performed by its manufacturing and engineering personnel located at its Norcross, Georgia facility. In addition to its own research and development staff, the Company participates in arrangements with three non-U.S. plastic container manufacturers that call for an exchange of technology among these manufacturers. Pursuant to these arrangements, the Company licenses its blow molding technology to such manufacturers.\nCompany History\nSilgan was organized in August 1987 as a holding company to acquire interests in various packaging manufacturers. On August 31, 1987, Silgan, through Containers, purchased from Nestle the business and related assets and working capital of Nestle Can for approximately $151 million in cash and the assumption of substantially all of the liabilities of Nestle Can. Also on August 31, 1987, Silgan, through Plastics, purchased from Monsanto substantially all the business and related fixed assets and inventory of Monsanto Plastic Containers for approximately $43 million in cash and the assumption of certain liabilities of Monsanto Plastic Containers. To finance these acquisitions and to pay related fees and expenses, Silgan issued common stock, preferred stock and senior subordinated notes and borrowed amounts under its credit agreement.\nDuring 1988, Containers acquired from The Dial Corporation its metal container manufacturing division known as the Fort Madison Can Company (\"Fort Madison\"), and from Nestle its carton manufacturing division known as the Seaboard Carton Division (\"Seaboard\").\nDuring 1989, Plastics acquired Aim Packaging, Inc. (\"Aim\") and Fortune Plastics, Inc. (\"Fortune\") in the United States, and Express Plastic Containers Limited (\"Express\") in Canada, to improve its competitive position in the HDPE container segment.\nHoldings was organized in April 1989 as a holding company to acquire all of the outstanding common stock of Silgan. On June 30, 1989, Silgan Acquisition, Inc. (\"Acquisition\"), a wholly owned subsidiary of Holdings, merged with and into Silgan, and Silgan became a wholly owned subsidiary of Holdings (the \"1989 Mergers\").\nIn 1989, the Company acquired the business and related assets of Amoco Container Company (\"Amoco Container\"). In November 1991, Plastics sold its nonstrategic PET carbonated beverage bottle business (the \"PET Beverage Sale\"), exiting that commodity business.\nIn 1992, Holdings and Silgan refinanced a substantial portion of their indebtedness (the \"Refinancing\") pursuant to a plan to improve their financial flexibility. The Refinancing included the public offering in June 1992 by Silgan of $135 million principal amount of its 11-3\/4% Senior Subordinated Notes due 2002 (the \"11- 3\/4% Notes\") and the public offering in June 1992 by Holdings of its 13-1\/4% Senior Discount Debentures due 2002 (the \"Discount Debentures\") for an aggregate amount of proceeds of $165.4 million. Additionally, in June 1992 Aim, Fortune and certain other subsidiaries of Plastics were merged into Plastics.\nOn December 21, 1993, Containers acquired from Del Monte substantially all of the fixed assets and certain working capital of Del Monte's container manufacturing business in the United States for a purchase price of approximately $73 million and the assumption of certain limited liabilities. To finance the acquisition, (i) Silgan, Containers and Plastics (collectively, the \"Borrowers\") entered into a credit agreement, dated as of December 21, 1993 (the \"1993 Credit Agreement\") with the lenders from time to time party thereto (the \"Banks\"), Bank of America National Trust and Savings Association, as Co-Agent, and Bankers Trust Company (\"Bankers Trust\"), as Agent, and (ii) Holdings issued and sold to Mellon Bank, N.A., as trustee for First Plaza Group Trust, a group trust established under the laws of the State of New York (\"First Plaza\"), 250,000 shares of its Class B Common Stock, par value $.01 per share (the \"Holdings Stock\"), for a purchase price of $60.00 per share and an aggregate purchase price of $15 million. Additionally, Silgan, Containers and Plastics borrowed term and working capital loans under the 1993 Credit Agreement to refinance and repay in full all amounts owing under their previous credit agreement.\nOn August 1, 1995, Containers acquired from ANC substantially all of the assets of ANC's Food Metal and Specialty business for a purchase price of approximately $349 million and the assumption of specific limited liabilities. To finance the acquisition, Silgan, Containers and Plastics (collectively, the \"Borrowers\") entered into a $675 million credit facility pursuant to a credit agreement, dated as of August 1, 1995 (the \"Credit Agreement\") with the lenders from time to time party thereto (the \"Banks\"), Bankers Trust, as Administrative Agent and Co-Arranger, and Bank of America Illinois, as Documentation Agent and Co-Arranger. Containers used funds borrowed under the Credit Agreement to finance in full the purchase price for its acquisition of AN Can and to refinance and repay in full all amounts owing under the 1993 Credit Agreement and Silgan's $50 million of Senior Secured Floating Rate Notes due 1997 (the \"Secured Notes\"). Additionally, Silgan has used borrowings under the Credit Agreement to make non-interest bearing advances to Holdings to enable Holdings to purchase $61.7 million face amount of the Discount Debentures, which Discount Debentures have been canceled.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nHoldings' and Silgan's principal executive offices are located at 4 Landmark Square, Stamford, Connecticut 06901. The administrative headquarters and principal places of business for Containers and Plastics are located at 21800 Oxnard Street, Woodland Hills, California 91367 and 14515 N. Outer Forty, Chesterfield, Missouri 63017, respectively. All of these offices are leased by the Company.\nThe Company owns and leases properties for use in the ordinary course of business. Such properties consist primarily of 30 metal container manufacturing facilities, 11 plastic container manufacturing facilities and 3 specialty packaging manufacturing facilities. Nineteen of these facilities are owned and 25 are leased by the Company. The leases expire at various times through 2020. Some of these leases provide renewal options.\nBelow is a list of the Company's operating facilities, including attached warehouses, as of February 28, 1996 for its metal container business:\nApproximate Building Area Location (square feet) -------- ------------- City of Industry, CA 50,000 (leased) Kingsburgh, CA 37,783 (leased) Modesto, CA 35,585 (leased) Modesto, CA 128,000 (leased) Modesto, CA 150,000 (leased) Riverbank, CA 167,000 San Leandro, CA 200,000 (leased) Stockton, CA 243,500 Broadview, IL 85,000 Hoopeston, IL 323,000 Rochelle, IL 175,000 Waukegan, IL 40,000 (leased) Woodstock, IL 160,000 (leased) Evansville, IN 188,000 Hammond, IN 160,000 (leased) Laporte, IN 144,000 (leased) Fort Madison, IA 66,000 Ft. Dodge, IA 49,500 (leased) Savage, MN 160,000 St. Paul, MN 470,000 West Point, MS 25,000 (leased) Mt. Vernon, MO 100,000 Northtown, MO 112,000 (leased) St. Joseph, MO 173,725 Edison, NJ 280,000 Crystal City, TX 26,045 (leased) Toppenish, WA 98,000 Vancouver, WA 127,000 (leased) Menomonee Falls, WI 116,000 Menomonie, WI 60,000 (leased) Oconomowoc, WI 105,200 Plover, WI 58,000 (leased) Waupun, WI 212,000\nIn addition to the above facilities, the Company intends to purchase from ANC its St. Louis, MO facility by June 1996.\nBelow is a list of the Company's operating facilities, including attached warehouses, as of February 28, 1996 for its plastic container business:\nApproximate Building Area Location (square feet) -------- -------------\nAnaheim, CA 127,000 (leased) Deep River, CT 140,000 Monroe, GA 117,000 Norcross, GA 59,000 (leased) Ligonier, IN 284,000 (leased) Ligonier, IN 193,000 Seymour, IN 406,000 Franklin, KY 122,000 (leased) Port Clinton, OH 336,000 (leased) Langhorne, PA 156,000 (leased) Mississauga, Ontario 80,000 (leased) Mississauga, Ontario 60,000 (leased)\nThe Company owns and leases certain other warehouse facilities that are detached from its manufacturing facilities. All of the Company's facilities are subject to liens in favor of the Banks.\nThe Company believes that its plants, warehouses and other facilities are in good operating condition, adequately maintained, and suitable to meet its present needs and future plans. The Company believes that it has sufficient capacity to satisfy the demand for its products in the foreseeable future. To the extent that the Company needs additional capacity, management believes that the Company can convert certain facilities to continuous operation or make the appropriate capital expenditures to increase capacity.\nItem 3.","section_3":"Item 3. Legal Proceedings\nAppraisal Petition Arising from 1989 Mergers. In connection with appraisal proceedings filed by certain former holders of 400,000 shares of stock of Silgan in respect of the 1989 Mergers, on June 15, 1995, the Delaware Court of Chancery awarded these former stockholders $5.94 per share, plus simple interest at a rate per annum of 9.5%. This award was less than the amount, $6.50 per share, that these former stockholders would have received in the 1989 Mergers. The right of these former stockholders to appeal the Chancery Court's decision has expired, and Silgan has tendered payment for such shares. Prior to the trial for the appraisal, Silgan and the former holders of 650,000 shares of Silgan's stock agreed to a settlement with respect to the value of such shares, and Silgan made payment in full in respect of such settlement.\nKatell\/Desert Complaint. With respect to a complaint filed by certain limited partners of The Morgan Stanley Leveraged Equity Fund, L.P. against a number of defendants, including Holdings and Silgan, the court dismissed all claims against Holdings and Silgan by memorandum opinion and order dated January 14, 1993. The court denied plaintiffs' motion to reargue the dismissal by order dated March 29, 1993. The plaintiffs' time to appeal the dismissal of the claims against Holdings and Silgan expired following the dismissal of the claims against certain other defendants in June 1995.\nSummer del Caribe. On October 17, 1989, the State of California, on behalf of the California Department of Health Services, filed a suit in the United States District Court for the Northern District of\nCalifornia against the owners and operators of a recycling facility operated by Summer del Caribe, Inc., Dale Summer and Lynn Rodich. The complaint also named 16 can manufacturing companies, including Silgan, that had sent small amounts of solder dross to the facility for recycling as \"Responsible Parties\" under the California Superfund statute. The Company is one of 16 defendant can companies participating in a steering committee. The steering committee has actively undertaken a feasibility study which was approved by the California Department of Toxic Substances in June 1994. The Company has agreed with the other can company defendants that its apportioned share of cleanup costs would be 6.72% of the total cost of cleanup. On March 14, 1995, the court approved the Consent Order settling the case and reaffirming the Company's 6.72% apportioned share of the cleanup costs. Although the total cost of cleanup has not yet been determined, the Company understands that the State of California's current worst case estimate of total cleanup costs for all parties is $5.5 million. The steering committee believes that the cost to remediate will be less than one-half the government's estimate. Accordingly, the Company believes its maximum exposure is not greater than 6.72% of $3 million, or approximately $202,000.\nOther. Other than the actions mentioned above, there are no other material pending legal proceedings to which the Company is a party or to which any of its properties are subject.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.... 13\nPART II .................................................................. 14 Item 5.","section_5":"Item 5. Market for Registrant's Common Stock and Related Stockholder Matters.................................... 14 Item 6.","section_6":"Item 6. Selected Financial Data................................ 14 Item 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.................... 17 Item 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data............ 28 Item 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.................... 28\nPART III .................................................................. 29 Item 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant..... 29 Item 11.","section_11":"Item 11. Executive Compensation................................. 33 Item 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management............................................. 37 Item 13.","section_13":"Item 13. Certain Relationships and Related Transactions......... 44\nPART IV .................................................................. 47 Item 14.","section_14":"Item 14. Exhibits, Financial Statements, Schedules, and Reports on Form 8-K.................................... 47\n-i-","section_15":""}
{"filename":"805583_1995.txt","cik":"805583","year":"1995","section_1":"ITEM 1. BUSINESS\nITEM 1 (a) GENERAL DEVELOPMENT OF BUSINESS\nThe Company is primarily engaged in the design, manufacture, marketing and sale of glass related and plastic molded products for the automotive industry. The Company also supplies glass coatings for the transportation, electronics and computer industries (either solely or through several joint ventures).\nDuring 1995, the Company continued to implement a strategic plan that will position the Company as one of the world's major automotive suppliers. As a result, the Company completed the disposition of three non-core businesses: Appliance Products, Heavy Truck Mirrors, and the Company's interest in a joint venture called OSD Envizion, which manufactured electronic lenses for welding helmets. In the fourth quarter of fiscal 1995, the Company completed an acquisition of an interest in Hohe GmbH & Co. KG (\"Hohe\"), a German limited partnership. Based in Collenberg, Germany, Hohe serves many of the main auto producers in Europe in exterior automotive mirrors, interior mirrors, door handles, automotive tooling and electronic components related to mirror systems. With the completion of the transaction, the Company and Hohe together have become the world's largest producer of automotive mirror systems.\nThrough the Company's joint venture with Asahi Glass Company, D&A Technology, Inc. (\"D&A\"), the Company provided substantially all the modular windows for General Motors' Saturn cars through the 1995 model year. Due to the loss of the Saturn business, the Company anticipates dissolving the joint venture in the first quarter of 1996 and acquiring Asahi's 40% interest in D&A. The operation will be reduced in size and maintained as a division in Tennessee. New modular window and sunroof business with other customers will begin to replace the Saturn programs currently produced at this operation. D&A represented 5% and 8% of the Company's combined consolidated net sales and net income in 1995.\nThe Company was incorporated in Michigan in 1936. The Company's corporate offices are located at 414 East Fortieth Street, Holland, Michigan, 49423, and its telephone number is (616) 786-7000. Unless otherwise noted or indicated by the context, the term \"Company\" includes Donnelly Corporation, its wholly owned subsidiaries and Donnelly Export Corporation, a shareholder Domestic International Sales Corporation under the Internal Revenue Code owned entirely by the holders of the Company's Class B Common Stock.\nITEM 1 (b) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS\nThe Company is primarily engaged in the research, design, development, manufacture, marketing and sale of interior and exterior rearview mirrors, interior lighting and interior trim products, and modular windows for world automotive markets. Excluding the contributions of various coatings related joint ventures, the Company's market focus is nearly exclusively automotive.\nITEM 1. (c)NARRATIVE DESCRIPTION OF BUSINESS\nPRODUCTS, SERVICES, MARKETS AND METHODS OF DISTRIBUTION\nAutomotive Products\nAutomotive Vision. The Company manufactures a wide range of interior and exterior rearview mirror products.\nInterior Rearview Mirrors. The Company began producing prismatic day\/night mirror glass in 1939 and has been a leading innovator of interior rearview mirrors in the United States since that time. The Company now supplies interior rearview mirror assemblies to General Motors Corporation, Ford Motor Company and Chrysler Corporation (the \"Big Three\" automakers), the North American facilities of foreign owned automakers (the \"New Automotive Manufacturers\") and North American joint ventures between the Big Three automakers and foreign automakers. Through Donnelly Mirrors, Limited (\"DML\"), its Irish subsidiary, the Company supplies interior rearview mirror assemblies to French automotive manufacturers. DML also manufactures and sells prismatic interior rearview mirror glass throughout Europe and to other foreign producers of complete interior rearview mirrors.\nThe Company has also developed complex modular interior mirror assemblies, including mirrors with added features such as lights, electronic compass and other features as specified by the customer. Lighted mirrors direct light down to the laps of the driver and passenger for reading or general lighting. Sales of lighted mirrors have increased significantly since their introduction in fiscal 1985.\nThe Company is developing and offering for sale, various electrochromic technologies for use in day\/night automotive mirror systems which automatically dim when headlights approach from the rear. Some of these electrochromic technologies have been the subject of litigation. See Item 3. The Company is also developing electronic vision systems for vehicles which make use of advanced sensors and video microchip technology to control dimmable interior and exterior mirror systems.\nExterior Rearview Mirrors and Exterior Trim. In 1987, the Company began manufacturing complete exterior rearview mirror assemblies for cars and trucks. Exterior mirror assemblies are more complex than base interior rearview mirror assemblies given that, among other things, they contain either manual or motorized actuators for remote adjustment. In addition, most new vehicles are equipped with two exterior mirrors. Accordingly, the per vehicle sales price of exterior mirror assemblies substantially exceeds that of interior rearview mirror assemblies. The Company supplies exterior rearview mirror assemblies to Honda of America, Ford and Mazda. Through Donnelly Vision Systems Europe and the recent acquisition of an interest in Hohe, the Company also supplies complete exterior rearview mirrors to all of the main European automotive customers.\nA new area of growth for the company arising out of established skills in automotive paint and plastic molding is the manufacture of exterior trim components. While still a small product line for the Company, the Company is now producing a wide variety of exterior door handles for Honda and Ford.\nThe Company manufactures and supplies flat and convex chrome-coated mirror glass to other manufacturers of exterior mirror assemblies. The product line supplies mirror components to other complete mirror manufacturers and to the Company's own internal complete mirror operation. This is a small product line that was relocated to Monterrey, Mexico in 1995.\nThe Company introduced a new mirror system innovation in 1993. Trademarked INTELLIGENT VISION(TM), this system combines a unique new electrochromic material with a video microchip which operates as a \"smart sensor\". This system permits the user to monitor light levels from behind the vehicle and automatically adjusts all three rearview mirrors independently to compensate for glare. It is expected that the INTELLIGENT VISION(TM) system will be available in 1998. This technology is the subject of patent litigation, see Item 3.\nInterior Lighting and Trim. The Company manufactures various interior trim products including dome lights, interior door lights, lighted and non- lighted grab handles and coat hooks. The Company's interior lighting products are based on both plastic molding and optics technology. While the Company entered this market relatively recently, it believes the market will expand due to automakers' desire to add value to their cars and the trend toward modularization of components. The Company believes automakers will increasingly seek the suppliers who can provide complete interior lighting and trim systems. The Company currently supplies these products to the Big Three automakers, Honda and Toyota and has orders from Nummi, Mercedes Benz and BMW.\nModular Windows. Modular windows consist of window glass and a plastic molding that encapsulates various components, such as the frame, grommet, trim and hardware. These windows offer improved quality, aerodynamics and performance at a competitive price to conventional window systems. Recent additions include hinged windows, \"flush surface\" windows that involve single sided encapsulation, bonding of hardware directly to glass and the incorporation of color matched body hardware into the window system. Its windows are used for rear and liftgate windows, quarter windows, aperture windows, fixed vent windows and windshields on over 40 current models, including vehicles produced by each of the Big Three automakers and certain of the New Automotive Manufacturers. Increasing use of modular windows by the Big Three reflects trends in the industry towards outsourcing, modularization and reliance on suppliers for design. Based upon the number of modular windows that have been specified and are being designed for future models, the Company expects continued expansion of the market for modular windows sold to the Big Three automakers and New Automotive Manufacturers.\nThrough the Company's joint venture with Asahi Glass Company, D&A Technology, Inc. (\"D&A\"), the Company provided substantially all the modular windows for General Motors' Saturn cars through the 1995 model year. Due to the loss of the Saturn business, the Company anticipates dissolving the joint venture in the first quarter of 1996 and acquiring Asahi's 40% interest in D&A. The operation will be reduced in size and maintained as a division in Tennessee. New modular window and sunroof business with other customers will begin to replace the Saturn programs currently produced at this operation. D&A represented 5% and 8% of the Company's combined consolidated net sales and net income in 1995.\nIn addition to its manufacturing facility in Holland, Michigan, the Company also has a modular window manufacturing facility in Mt. Sterling, Kentucky, which focuses on customers in that geographic area. Additionally, construction was completed on a facility in Langres, France to produce new windows systems for Chrysler.\nModular windows can be molded using polyvinyl chloride (\"PVC\") or a urethane reaction injection molding process (\"RIM\"). The PVC process is less expensive primarily because the material is less costly and does not require painting. PVC, however, if more difficult to mold, particularly for large windows. The Company believes that its ability to design and mold windows in either process and its expertise in PVC molding are significant competitive factors. Donnelly is also developing and using new polymers for window encapsulation.\nThe Company has licensed major automotive glass companies in Europe and Japan to manufacture modular windows for sale in foreign markets using the Company's technology.\nNon-Automotive Businesses\nThe Company is heavily committed to its core automotive businesses and it will remain the Company's central focus. However, the Company has developed a number of significant non-automotive businesses and relationships over the years. These activities developed from core technologies that had applications outside of the automotive industry.\nThe Company's non-automotive businesses have been structured to be operated independently from the Company's core automotive businesses.\nInformation Products. The Company's various, electrically conductive, transparent, thin-film, coated glass products are used in computer applications such as touch screens, contrast enhancement computer screens, computer face plates which shield the operator from terminal emissions and pen-interface electronic devices.\nOptics. A new focus at the Company, this small group is working to commercialize low cost, high quality, advanced diffractive optics in both automotive and non-automotive areas. This unique new optics development dramatically improves lighting and imaging systems.\nNon-Consolidated Joint Ventures\nDonnelly Applied Films Corporation (\"DAFC\"). DAFC is a major manufacturer of thin-film glass coatings used in the production of liquid crystal displays (LCD's). LCD's are widely used in watches, games, calculators and instrumentation. DAFC is located in Boulder, Colorado. The Company is currently exploring opportunities to exit this business. The Company is a fifty percent shareholder of DAFC.\nDonnelly Yantai Electronics Corporation, Ltd. This fifty percent owned venture produces glass coatings similar to those of DAFC for use in the domestic Chinese LCD market. This operation is located in the Yantai Peninsula of the People's Republic of China. Ownership of the Joint Venture will transfer to DAFC by the end of 1996.\nVLSI Vision Limited (\"VVL\"). The Company is working in partnership with VVL to produce electronic vision systems for the world automotive industry using an innovative video microchip developed by VVL. The Company and VVL have been collaborating to produce \"smart\" chips which can perform a variety of functions in a vehicle including control of advanced mirror systems, video displays, lighting control and security devices. In the fourth quarter VVL completed a public offering of its stock, which is now listed on the London Stock Exchange. The Company owns 32% of VVL, which is located in Edinburgh, Scotland.\nKAM Truck Components(\"KAM\"). In the second quarter of 1995, the Company sold 81% of its heavy truck mirror business, now KAM. KAM supplies GLARESTOPPER(R) solid state electrochromic mirrors for large trucks. The mirror permits truck drivers to manually adjust the glare of their mirrors by a range of up to ten times.\nHohe GmbH & Co. KG (\"Hohe\"). Effective April 1, 1995, the Company acquired an interest in Hohe GmbH & Co. KG (\"Hohe\"), a German limited partnership. Hohe, based in Collenberg, Germany, serves many of the main auto producers in Europe in exterior automotive mirrors, interior mirrors, door handles, automotive tooling, and electronic components related to mirror systems. The Company acquired 48 percent of the controlling general partnership interest and 66 percent of the limited partnership interest.\nMARKETING STAFF\nIn North America, the Company markets its automotive products through a sales force of approximately 22 people, who with approximately 139 members of the Company's engineering staff, work with its customers' design teams early in the design process. Sales of interior and exterior mirror glass are generally to mirror manufacturers while sales of the Company's other automotive products are generally to automakers.\nThe Company's wholly owned European subsidiaries employ 9 sales people, including three based in Japan, and also sell through a trading company in Japan.\nThe Company markets its non-automotive products through a sales force of 3 sales people and 19 engineers. The Company works with potential customers on the development of new applications for electronic information display products.\nNEW PRODUCT OR INDUSTRY SEGMENT INFORMATION\nThe Company has made significant investments in the development of solid- state, thin-film electrochromic technology that has potential for mirror and window applications. Electrochromic coatings allow the user to darken glass to the desired degree through the application of an electrical current to the coating.\nThe Company is committed to its Variable Light Control (VLC) Technology. These technologies allow the user to control the flow of light through, or the reflection of, light from glass.\nThe Company continues to market electrochromic day\/night automotive mirror systems which will automatically dim when headlights approach from the rear. This system has been the subject of litigation between the Company and Gentex Corporation for over five years. In March 1994, Gentex's final outstanding patent suit against the Company was dismissed in Federal Court in Grand Rapids, Michigan. In its decision dismissing this suit, the Court found that the Company's POLYCHROMIC(TM) electrochromic technology does not infringe the patent asserted by Gentex's patents. Apart from Gentex's appeal of this ruling there are no lawsuits outstanding by Gentex against the Company. However, litigation by the Company against Gentex is scheduled for trial in Feburary, 1996 and two other suits by the Company against Gentex have yet to be scheduled for trial. See Item 3.\nThe Company has continued to actively develop newer and more advanced electrochromic technologies for the automotive marketplace. The Company has developed or licensed a number of promising technologies and several are already available for commercial use. Electrochromic mirror systems are electrically dimmable to reduce the glare from the headlights of other cars approaching from the rear.\nThe Company's GLAREFREE(TM) electrochromic mirror technology offers several advantages over competing technology. It has already been purchased by Ford, Jaguar, Range Rover, General Motors and others. The Company believes last year's court decision, combined with the Company's new technology advances, has now opened this marketplace to competition.\nOther than its recent acquisition of Hohe, the Company has not otherwise made any public announcements of, or otherwise made public information about, a new product or industry segment which would require the investment of a material amount of the Company's assets or which otherwise would be material.\nSOURCES AND AVAILABILITY OF RAW MATERIALS\nGenerally, the Company has multiple sources of supply for the important materials and components used in its products. Where the Company only uses one source for an important material, it believes alternative sources are available or could be readily developed. Because of the commodity nature of common materials such as glass and plastics, the Company is somewhat vulnerable to price fluctuations in many of its material purchases.\nPATENTS, LICENSES, ETC.\nWhile the Company owns over 150 patents and considers them important, the Company as a whole is not dependent to any material extent upon any single patent or group of patents. The Company believes its manufacturing know-how, design of its own manufacturing equipment and development of manufacturing processes are more important than its patents. Certain technology of the Company is the subject of patent litigation. See Item 3.\nThe Company has licensed certain of its own patents and technology and has licenses under certain third party patents and technology.\nSEASONAL NATURE OF BUSINESS\nThe Company's net sales and net income are subject to significant quarterly fluctuations. These fluctuations are attributable primarily to customer shipment schedules which are tied to the production schedules of the Company's major automotive customers. The Company generally reports lower net sales and net income in the first half of its fiscal year than in the second half because domestic automotive production is generally lower during the first two quarters of the Company's fiscal year.\nWORKING CAPITAL PRACTICES\nThe Company does not believe that it, or industries which it serves in general, have any special practices or special conditions affecting working capital items that are significant for an understanding of the Company's business.\nIMPORTANCE OF LIMITED NUMBER OF CUSTOMERS\nIn 1995, approximately 71% of the Company's net sales were to the following major U.S. automobile manufacturers:\nFord Motor Company 22% Chrysler Corporation 18% General Motors Corporation 17% Honda of America Mfg., Inc. 14% --- Total 71%\nThe loss of any one of these customers would have a material adverse effect on the Company.\nBACKLOG OF ORDERS\nAs of July 1, 1995, and July 2, 1994, the Company's backlog of orders was approximately $80 million and $73 million respectively. The Company believes that all of its existing backlog will be delivered during the current fiscal year. The Company generally sells to automakers on the basis of long-term purchase contracts or one-year purchase orders, which generally provide for releases for approximately 30 to 90 days of production. Unshipped products under these releases and short-term purchase orders constitute the Company's backlog.\nGOVERNMENT CONTRACTS\nThe Company does not believe that any portion of its business is subject to renegotiation of profits or termination of contracts or sub-contracts at the election of the government.\nCOMPETITION\nAutomotive Products\nCompetition in the markets for the Company's automotive products is based on manufacturing capabilities, design, quality, cost and delivery. The Company believes that its historical emphasis on research and development and on product design, as well as its high quality ratings and close working relationships with its customers, are important competitive factors for the Company. Its international experience and relationships are also significant competitive factors in the increasingly global market. A number of the Company's competitors are divisions or subsidiaries of larger corporations, including vertically integrated glass companies, with greater financial resources than the Company and with well-established relationships with automakers. Changing technology and design, and modularization\/systems integration capabilities to improve product function and lower costs will continue to place pressure on the Company to be a cost competitive producer of quality, functional automotive products, or lose market share and growth opportunities to competitors who meet these demands.\nAutomotive Vision. The level and nature of competition involving the Company's automotive vision products are varied. The Company manufactures and sells interior and exterior mirror glass to other mirror manufacturers. Also, the Company manufactures and sells complete interior and exterior mirror assemblies and mirror subsystems to the automotive OEM's.\nInterior Rearview Mirrors. Competition in the U.S. market for interior rearview mirror assemblies and rearview mirror glass is limited. The Company knows of three competitors in the U.S. market: one in the market for base interior rearview mirror assemblies, and two in the added-feature mirror market (electrochromic and lighted mirrors). The Company has developed extensive skills and know-how in mirror glass and interior rearview mirror assembly manufacturing. The Company for many years has sold interior mirror glass to Japanese rearview mirror suppliers and now supplies complete interior rearview mirror assemblies to the U.S. facilities of Japanese automakers, a Korean automaker, and joint ventures between Japanese and U.S. automakers. The Company has several potential worldwide competitors for interior mirror glass sales in Japan and Europe. The Company believes each competitor has as a smaller market share than the Company. Also in Europe, the Company competes with several other manufacturers of complete interior rearview mirror assemblies.\nThe Company has one competitor in the U.S. market for automatic interior electrochromic mirrors. The Company and that competitor have been involved in patent litigation with respect to certain aspects of electrochromic technology. The litigation has had an adverse impact on the Company's ability to market interior electrochromic mirrors in the United States and Europe. See Item 3.\nExterior Rearview Mirrors. Approximately twelve U.S. companies manufacture exterior mirror assemblies for sale in the U.S. market for similar type assemblies currently made by the Company. The Company entered the exterior mirror assembly market in 1988 and today is a major supplier for these products to Honda Mfg and Ford Motor Co. The Company has many competitors worldwide, in the sale of exterior mirror glass. With the Company's recent acquisition of an interest in Hohe, the Company and Hohe together have become the world's largest producer of automotive mirror systems.\nThe Company and one competitor in the U.S. market have been involved in patent litigation with respect to certain aspects of automatic exterior electrochromic mirrors. The litigation has had an adverse impact on the Company's ability to market exterior electrochromic mirrors in the United States and Europe. See Item 3.\nInterior Lighting and Trim. There are many competitors in the market for interior lighting and trim products. The Company believes its close customer relationships, program management, technology and design capabilities and basic materials knowledge are significant competitive factors.\nModular Windows. The Company has many competitors in the domestic modular window market. Three competitors are major automotive glass manufacturers or are closely associated with automobile or glass manufacturers. The Company believes that the glass manufacturers could further vertically integrate into glass molding and that these companies would be significant competitors due to their size. However, the Company believes that it is still the major technology leader for glass encapsulation and metal bonding of attachments to glass.\nInformation Products\nThe Company believes it is the world's leading producer of coated bent glass for the CRT-based electronic display and interactive systems market. Competition in this segment is based on price, service and quality.\nRESEARCH AND DEVELOPMENT\nThe Company engages in extensive research and development. It believes its technical capabilities have resulted in the development of new and improved products.\nIn 1995, 1994, and 1993, research and development expenditures were $22,733,000, $21,362,000, and $15,889,000, respectively, or 5.9%, 6.3%, and 5.3% of the Company's total net sales for those years. While the Company has an active corporate research and development group, approximately 80% of the Company's total research and development expenditures is product specific and conducted by the Company's product engineers. Corporate research and development work is facilitated by advanced technology labs located in Holland, Michigan, and in Tucson, Arizona, where the Company maintains a close linkage with the faculty and students of the University of Arizona, and in Naas, Ireland.\nHUMAN RESOURCES\nThe Company believes its human resources are one of its fundamental strengths. The Company currently has approximately 2,935 employees in its Michigan, Arizona, Tennessee, Kentucky, Ireland, France, and Mexico facilities. Its domestic work force is non-union. While the Company considers its relationship with its employees to be favorable, massive organization changes during the past year have put a strain on employee relations. One manufacturing plant has received a petition for a UAW union election. This election is currently\nblocked because of a question before the National Labor Relations Board regarding the role of Donnelly's unique Equity Structure. It is uncertain at this time when these issues will be resolved.\nThe Company's work forces in Ireland and Mexico are unionized, as are the work forces of most companies in both Ireland and Mexico. The Company has no collective bargaining agreements in Ireland or Mexico, where non-economic terms of employment are governed by statute. The Company negotiates wages and benefits approximately annually with its Irish work force. The Company negotiates wages approximately annually and benefits approximately bi-annually with its work force in Mexico.\nThe Company has operated for over forty years under a participative management system. The Company believes that this approach has increased productivity by emphasizing individual employee opportunity and participation both in the operating decisions and in the Company's profitability. Furthermore, the Company believes this emphasis has resulted in enhanced long- term productivity, cost control and product quality and has helped the Company attract and retain capable employees.\nITEM 1 (d) INFORMATION ABOUT FOREIGN OPERATIONS\nDuring the last fiscal year, approximately 10% of combined consolidated net sales were derived from the operations of the Company's wholly-owned foreign subsidiaries. Approximately 8% of combined consolidated net sales were derived from export shipments from the Company's United States operations to customers in foreign countries. The Company has licensed major automotive glass companies in Europe and Japan to manufacture modular windows for sale in foreign markets using the Company's technology.\nExport revenues are foreign revenues produced by identifiable assets located in the United States. Foreign revenues are generated by identifiable assets at the Company's subsidiaries located in Ireland, France and Mexico. The Company operates two subsidiaries in Ireland, Donnelly Mirrors Limited and Donnelly Vision Systems Europe Limited, one in France, Donnelly EuroGlas Systems, and one in Mexico, Donnelly de Mexico, S.A.DE C.U. A summary of the Company's operations by geographic area follows:\nFluctuating exchange rates and other factors beyond the control of the Company, such as tariff and foreign economic policies, may affect future results of the Company's foreign operations.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company and its consolidated subsidiaries own or lease facilities which are located throughout the United States, Ireland, France and Mexico. The location, square footage and use of the most significant facilities at August 31, 1995, were as follows:\nLOCATION\nOwned Locations Square Footage Use Holland, Michigan (8) 864,000 Manufacturing, Warehouse, and Office Grand Haven, Michigan 133,000 Manufacturing, Warehouse, and Office Mt. Sterling, Kentucky 37,000 Manufacturing, Warehouse, and Office Naas, Ireland 84,000 Manufacturing, Warehouse, and Office Manorhamilton, Ireland 21,600 Manufacturing, Warehouse, and Office Monterrey, Mexico 40,000 Manufacturing, Warehouse, and Office\nLeased Locations Langres, France 40,000 Manufacturing, Warehouse, and Office Mt. Pleasant, Tennessee 50,000 Manufacturing, Warehouse, and Office Newaygo, Michigan 166,000 Manufacturing, Warehouse, and Office Leased Office and Warehouses (5) Holland and Detroit, Michigan; Tucson, Arizona; and Tokyo, Japan\nThe Company believes its facilities are modern, well-maintained and adequately insured. Because of its rapid growth in sales the Company is continually evaluating the need for additional office, manufacturing and warehouse space.\nAs of July 1, 1995, the Company had capital expenditures purchase commitments outstanding of approximately $13 million.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nPatent Litigation. Certain electrochromic mirror technology of the Company has been the subject of patent litigation between the Company and Gentex Corporation (\"Gentex\"). Following the settlement of prior litigation, Gentex filed another lawsuit against the Company on June 7, 1993. In this suit, Gentex alleged that the Company's solid polymer film electrochromic mirror infringed one of the Gentex patents involved in the prior litigation and that the Company has violated the injunction entered by the court in the previous litigation. Gentex sought unspecified damages and an injunction against further alleged infringement by the Company. On March 21, 1994, the Company's motion for summary judgement of non-infringement was granted and the lawsuit was dismissed. Gentex has filed an appeal of this ruling, which is currently pending.\nThe Company's lawsuit against Gentex, filed on July 8, 1993, remains outstanding. In this suit, the Company has alleged that Gentex's lighted electrochromic mirrors infringes three of the Company's patents and that all of Gentex's electrochromic mirrors infringe a fourth patent owned by the Company. The Company is seeking unspecified damages and injunction against further infringement by Gentex. A trial has been scheduled to begin in February 1996. The Company has filed a motion seeking a preliminary injunction against further infringement of one of its patents pending final resolution of the lawsuit; this motion has not yet been decided. Gentex filed several motions for summary judgement, alleging that the patents in question are invalid or not infringed, and that the Company is not entitled to certain damages. The Court granted Gentex's motion for summary judgment that two of the Donnelly patents relating to lighted mirrors are invalid. The Court denied Gentex's remaining motions and granted Donnelly's request to dismiss its claim under the third lighted mirror patent without prejudice. Donnelly believes that its lighted mirror patents are not invalid and has requested permission to file an immediate appeal on this issue.\nOn October 13, 1994, the Company filed a second lawsuit against Gentex, alleging that Gentex's inside and outside electrochromic mirrors infringe two additional patents owned by the Company which relate to the protection of electrochromic mirrors from ultraviolet radiation. The Company subsequently amended its complaint to allege that Gentex's inside and outisde electrochromic mirrors infringe a third pantent owned by the Company which also relates to the protection of electrochromic mirrors from ultraviolet radiation. The Company is seeking unspecified damages and an injunction against further infringement by Gentex. The Company has also filed a motion seeking a preliminary injunction against further infringement of two of these patents pending final resolution of the lawsuit. This motion has not yet been decided by the court, and no trial date has been set in the second lawsuit.\nOn June 23, 1995, Gentex filed a lawsuit against the Company seeking a declaration that three patents owned by the Company are invalid and not infringed by Gentex. The Company has responded by denying these allegations, and charging that two of the patents in question are infringed by certain of Gentex's electrochromic mirrors. The Company is seeking unspecified damages and an injunction against further infringement by Gentex. No trial date has been set in this lawsuit.\nOther Litigation. The Company and its subsidiaries are involved in certain other legal actions and claims, including environmental claims, arising in the ordinary course of business. Management believes (based on advice of legal counsel) that such litigation and claims will be resolved without 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 matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended July 1, 1995.\nPART II.\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS\nThe Common Shares are traded on the American Stock Exchange under the symbol DON. The following table sets forth for the fiscal periods indicating the high and low sale prices of the Common Shares, as reported by the American Stock Exchange, and dividends declared per share.\nAs of August 31, 1995, the Company had approximately 1,100 holders of record.\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\nRESULTS OF OPERATIONS\nGeneral\nDonnelly's net sales and net income are subject to significant quarterly fluctuations attributable primarily to production schedules of the Company's major automotive customers. These same factors cause quarterly results to fluctuate from year to year.\nComparison of 1995 to 1994\nDonnelly's sales were $383.3 million in 1995, an increase of 14% over the $337.3 million of sales in 1994. North American automotive production increased 5% over the previous year. New business in complete exterior mirrors, door handles, interior systems and modular systems, along with the strong automotive production levels all contributed to the stronger sales level. This growth occurred despite declining prices. Price reductions are expected to continue as products continue to be priced on a global basis.\nGross profit margin was 21.5% in 1995 compared to 21.8% in 1994. Kaizen (continuous improvement) programs being run throughout the Company, along with higher sales volumes are helping the Company offset price pressures from customers and significant increases in raw material costs. Although global pricing pressures are expected to continue, the Company is focused on reducing costs through improved product design as well as a strong commitment to Kaizen implementation. Business transitions are also being completed which should also positively impact gross profit moving forward.\nSelling, administrative and general expenses were $45.1 million or 11.8% of sales in 1995, an increase from 11.3% in 1994. Patent litigation costs were significantly higher in 1995 as the Company pursued actions to protect its intellectual property. Patent litigation costs are expected to remain high in 1996 with the scheduled trial in October (see Note 9).\nResearch and development expenses were $22.7 million or 5.9% of sales in 1995 compared to 6.3% in 1994. The Company is committed to developing new and innovative technologies that improve the function, quality and safety of automotive products and support new business for complete exterior mirrors and modular windows.\nIn the second quarter of 1995, the Company entered into a plan to restructure and sell certain nonautomotive businesses resulting in a pretax gain of $4.7 million. The restructuring plan was implemented in an effort to move the Company towards a much closer focus on its automotive business. The gain includes the sale of the appliance business, the liquidation of the Company's investment in OSD Envizion Company and the sale of 81% of the Company's heavy truck mirror business. These non-automotive businesses represented an insignificant portion of the Company's operations. Restructuring costs were also recognized to cover a severance program and other expenses associated with the restructuring plan.\nThe Company also restructured certain automotive operations resulting in a charge of $2.4 million in the second quarter, primarily for the write-down of operating assets due to the loss of Saturn's business at D&A Technology, Inc., the Company's joint venture with Asahi Glass Company. As a result, minority interest in net income of subsidiaries was $0.4 million in 1995 compared to $0.8 million in 1994. In the first quarter of fiscal 1996, the Company anticipates dissolving the joint venture and acquiring Asahi's 40% interest in D&A. The\noperation will be reduced in size and maintained as a division in Tennessee. New modular window and sunroof business with other customers will begin to replace the Saturn programs currently produced at this operation. D&A represented 5% and 8%, respectively, of the Company's combined consolidated net sales and net income in 1995.\nInterest expense increased to $5.0 million in 1995, from $3.5 million in 1994. Heavy capital spending and higher interest rates continued to drive interest expenses higher.\nRoyalty income was $3.8 million in 1995 compared to $1.4 million last year. The increase primarily resulted from royalty income associated with the appliance business sold to Gemtron Corporation. This royalty agreement is expected to continue through fiscal 1996. Included in other income is a $0.5 million gain on the sale of a warehouse facility in the fourth quarter of 1995.\nEquity in earnings (losses) of affiliated companies increased to $0.4 million in 1995, from a loss of $0.1 million in 1994. Improved earnings at Donnelly Applied Films Corporation and a slight profit from Hohe GmbH & Co. KG (see Note 12) for the two month period, ending May 31, 1995, more than offset expenses at VLSI Vision Limited associated with its start-up.\nThe Company had net income of $11.0 million in 1995, including a $2.0 million gain from the sale of businesses, net of restructuring costs, compared to $7.3 million in 1994. The increase in net income is the result of higher sales volumes, lower R&D costs as a percent of sales, higher royalty income, and improved equity earnings in affiliated companies. Results from foreign operations improved slightly, as improvements in Donnelly's Irish subsidiary exceed the start-up losses in Mexico and France.\nThe Company's financial performance in 1995 and 1994 has been impacted by unprecedented capital expenditures and expenses incurred in anticipation of meeting existing new customer orders. Projects requiring these costs include the construction and equipping of several new facilities, equipping modular systems for the new Chrysler minivan Program and transition costs associated with consolidating production equipment from older facilities into a new facility.\nComparison of 1994 to 1993\nDonnelly's sales increased 12.1% to $337.3 million in 1994, from $300.9 million in 1993. North American automotive production increased 9% over the same period. Sales growth occurred despite flat or declining pricing. A primary contributor of the sales growth included new complete exterior mirror business for both Ford and Mazda which began in the last half of 1994. Strong demand for modular windows, especially at Ford and Chrysler continued to boost sales. Interior mirror sales increased throughout the year in North America helping to offset the negative sales impact caused by the European recession. Sales increases of interior systems, information products and appliance products also helped the Company's sales increase outpace automotive production.\nGross profit margin decreased to 21.8% of sales in 1994, from 22.9% in 1993. This decrease resulted from: the European recession's impact on Donnelly Mirrors, Ltd. (DML) one of Donnelly's Irish subsidiaries; start-up costs associated with new complete exterior mirror production including a second shift paint operation; and business units undergoing significant transition costs.\nSelling, administrative and general expenses were $38.0 million or 11.3% of sales in 1994, a decrease from 12.3% in 1993. Patent litigation costs were significantly lower than last year.\nResearch and development expenses for 1994 were 6.3% of sales compared to 5.3% in 1993. The increase was primarily the result of significant development costs being incurred to support new business for Ford and Mazda complete exterior mirror systems in model years 1995 and beyond, along with the new Chrysler minivan modular window business which began in late 1995.\nA restructuring charge of $1.2 million was taken in the fourth quarter of 1994 to cover a severance program and other expenses associated with the restructuring of DML.\nInterest expense increased to $3.5 million in 1994, from $3.2 million in 1993. Lower interest rates helped to offset the impact of higher borrowing levels to support increased capital spending.\nThe Company had net income in 1994 of $7.3 million, compared to $7.9 million in 1993. Higher sales resulting from increased North American automotive production and new complete exterior mirror business, lower general and administrative expenses as a percent-of-sales, 1993's patent settlement, tax benefits associated with adopting SFAS 109 and retroactively reinstated research and development tax credits resulting from the new tax act helped to offset a number of unfavorable items, including: 1) a deep and prolonged recession in Europe along with a restructuring charge which impacted DML; 2) increased research and development expenditures to support new complete exterior mirror and modular window programs; 3) increased competition and a downturn in the demand for coated glass used in liquid crystal displays affected DAFC's performance and 4) postretirement health care costs associated with the adoption of SFAS 106.\nACQUISITION\nEffective April 1, 1995, the Company acquired an interest in Hohe GmbH & Co. KG (\"Hohe\"), a German limited partnership. Hohe, based in Collenberg, Germany, serves many of the main auto producers in Europe in exterior automotive mirrors, interior mirrors, door handles, automotive tooling, and electronic components related to mirror systems. With operations in Germany and Spain, Hohe's sales for the fiscal year ended March 31, 1995, were approximately $220 million.\nThe Company acquired 48 percent of the controlling general partnership interest and 66 2\/3 percent of the limited partnership interest for $3.6 million. Additionally, $14.3 million has been advanced to Hohe under a subordinated loan agreement. The Company expects to provide future advances to Hohe of approximately $15 million which will be financed through the Company's existing borrowing agreements. Amounts advanced to Hohe under the subordinated loan agreement provide for 10 percent interest per annum with no principal payments due until its maturity on April 1, 1998. Subsequent advances to Hohe will be subordinated to Hohe bank debt and provide for interest at 700 basis points above the Bundesbank discount rate, which was X% at June 30, 1995. In connection with the Company's acquisition of the Hohe interest, refinancing and additional loans of approximately $70 million are being provided to Hohe by several banks. The Company's interest in Hohe is stated at cost, adjusted for its equity in undistributed earnings from acquisition to May 31, 1995, the most recent date financial information is available. On July 1, 1995, the amount of the investment in Hohe included goodwill in the amount of $5 million which is being amortized over 15 years.\nThe terms of the transaction allow Donnelly to purchase the remaining ownership interest in Hohe through various options ranging from $3 million to $10 million. The remaining owners have an option to require the Company to buy their interests at any time based upon a formula which results in a price of up to $10 million.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company's current ratio was 1.7 at July 1, 1995 and 1.7 at July 2, 1994. Working capital was $40.5 million at July 1, 1995, compared to $36.4 million at July 2, 1994. This increase included higher customer tooling to be billed to support new programs and increased accounts receivable and inventories due to higher sales levels.\nCapital spending levels were $29.2 million in 1995, $35.3 million in 1994 and $17.0 million in 1993. Included in capital spending is $10.5 million financed by an operating sale-leaseback agreement. The Company also expects to provide additional subordinated loans to Hohe of approximately $15 million. In addition, construction of a $9.9 million manufacturing facility in Newaygo, Michigan was financed with government grants. Capital expenditures in 1995 supported a number of major programs throughout the Company. A wide range of expansion activities continued in the modular window and complete exterior mirror areas to support new business programs. A new facility was also constructed in France during 1995 to produce modular windows for the Chrysler minivan in Europe.\nThe Company expects its 1996 capital expenditures will be slightly reduced from the levels of 1995 as many of the major expansion programs are completed. The Company expects to finance its future growth through operational cash flow, its current revolving credit agreement and new senior notes of $20.0 million issued with an insurance company in July of 1995. The notes have a four to five month delayed takedown with principal payments commencing in fiscal 2001 until maturity in fiscal 2006.\nThe Company enters into interest rate swaps and foreign exchange contracts to manage exposure to fluctuations in interest and foreign currency exchange rates. The risk of loss to the Company in the event of nonperformance by any party under these agreements is not considered to be material.\nFINANCIAL ACCOUNTING STANDARDS BOARD (FASB) ISSUES\nEffective July 4, 1993, the Company adopted FASB Statement 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\", as explained in Note 7 to the combined consolidated financial statements. The impact of adopting this change increased postretirement health care costs by $1.1 million in 1994.\nEffective July 4, 1993, the Company adopted FASB Statement 109, \"Accounting for Income Taxes\", as explained in Note 8 to the combined consolidated financial statements. This change favorably affected 1994 earnings by $0.5 million, which is reported separately in the combined consolidated statements of income.\nIn March 1995, the FASB issued FASB Statement 121, \"Accounting for the Impairment of Long-Lived Assets.\" The Company is required to adopt this statement by its fiscal year ending in 1997. The new statement requires the Company to review long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Company does not expect the adoption of this statement to have a material impact on its financial position or results of operations.\nNo other recently issued FASB statements are expected to have a material impact on the Company.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nCOMBINED CONSOLIDATED STATEMENTS OF INCOME\nThe accompanying notes are an integral part of these statements.\nCOMBINED CONSOLIDATED BALANCE SHEETS\nThe accompanying notes are an integral part of these statements.\nCOMBINED CONSOLIDATED STATEMENTS OF CASH FLOWS\nThe accompanying notes are an integral part of these statements.\nCOMBINED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY\nThe accompanying notes are an integral part of these statements.\nNOTES TO THE COMBINED CONSOLIDATED FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF COMBINATION AND CONSOLIDATION\nThe combined consolidated financial statements include the accounts of Donnelly Corporation, Donnelly Export Corporation and all majority owned subsidiaries (the Company) after all significant intercompany balances, transactions and shareholdings have been eliminated. Investments in 20% to 50% owned companies are accounted for using the equity method of accounting. Cost in excess of net assets of acquired companies is being amortized on a straight-line basis over a 15 year period.\nVoting control of Donnelly Corporation and Donnelly Export Corporation is vested in the same shareholders and the corporations are under common management. Because of these relationships, the accounts of the two corporations are included in the financial statements as if they were a single entity.\nFOREIGN CURRENCY TRANSLATION\nExcept for the Company's subsidiary in Mexico whose functional currency is the United States dollar, financial statements of international companies are translated into United States dollar equivalents at exchange rates as follows:(1) balance sheet accounts at year-end rates; (2) income statement accounts at exchange rates weighted by the monthly volume of transactions occurring during the year. Translation gains and losses are reported as a separate component of shareholders' equity. For the Company's subsidiary in Mexico, where the dollar is the functional currency, translation gains or losses are reflected in net income. Other foreign currency transaction gains and losses included in other income are not material.\nCASH AND CASH EQUIVALENTS\nCash equivalents include all highly liquid investments with a maturity of three months or less when purchased.\nINVENTORIES\nInventories are stated at the lower of cost or market. Cost is determined by the last-in, first-out (LIFO) method, except for inventories of the majority owned subsidiaries which are valued using the first-in, first-out (FIFO) method.\nPROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment are stated at cost. Depreciation is provided primarily by the straight-line method. Depreciation is computed over the estimated useful lives of the assets as follows:\nYears Buildings 10 to 40 Machinery and equipment 3 to 12\nFor tax purposes, useful lives and accelerated methods are used as permitted by the taxing authorities.\nINCOME TAXES\nEffective July 4, 1993, deferred taxes reflect the differences between the financial statement and tax basis of assets and liabilities. Available tax credits are taken into income as reductions of current income tax provisions.\nINCOME PER SHARE OF COMMON STOCK\nIncome per share is computed by dividing net income, adjusted for preferred stock dividends, by the weighted average number of shares of Donnelly Corporation common stock outstanding, as adjusted for stock splits (7,744,042 in 1995, 7,716,923 in 1994 and 7,686,104 in 1993).\nFISCAL YEAR\nThe Company's fiscal year is the 52 or 53 week period ending the Saturday nearest June 30. Fiscal years 1995, 1994 and 1993 ended on July 1, July 2 and July 3, respectively, and included 52 weeks, 52 weeks and 53 weeks, respectively.\nRECLASSIFICATIONS\nCertain reclassifications have been made to prior year data to conform to the current year presentation.\n2. INVENTORIES\nInventories consist of:\nIf only the first-in, first-out method of inventory valuation had been used, inventories would have been $0.5 million and $0.6 million higher than reported at July 1, 1995 and July 2, 1994, respectively, and would have approximated replacement cost.\n3. DEBT AND OTHER FINANCING ARRANGEMENTS\nDebt consists of:\nThe Company has a $70 million Revolving Credit Agreement which expires July 16, 1997. Interest is at prime unless one of three alternative elections are made by the Company. It is the Company's intent to refinance $2.2 million in Senior Notes with the revolving credit agreement.\nThe $9.5 million industrial revenue bonds are secured by letters of credit which must be renewed annually. All industrial revenue bonds are collateralized by the purchased land, building and equipment.\nThe various borrowings subject the Company to certain restrictions relating to, among other things, minimum net worth, payment of dividends and maintenance of certain financial ratios. Retained earnings available for dividends at July 1, 1995, are $23.8 million.\nAnnual principal maturities consist of:\nIn July of 1995, the Company issued a $20 million note at an interest rate of 6.7% with an insurance company. The note has a 4 to 5 month delayed take down with principal payments commencing in fiscal 2001 until maturity in fiscal 2006.\nThe Company provides guarantees for up to $5.0 million of Donnelly Applied Films Corporation borrowings and also guarantees $7.3 million in municipal funding for the construction of the Company's Newaygo facility.\nInterest payments of $5.0 million, $3.7 million and $3.3 million were made in 1995, 1994 and 1993, respectively.\n4. FINANCIAL INSTRUMENTS\nThe Company has exposure to market risks from fluctuations in interest rates and uses interest rate swap agreements with major financial institutions to reduce those risks. The Company does not hold or issue financial instruments for trading purposes. At July 1, 1995, the Company had interest rate swaps with an aggregate notional amount of $60 million, $40 million of which are offsetting. These are used to convert $20 million of the Company's variable interest rate debt to fixed rates. The Company is currently paying a weighted average fixed rate of 7.99%, calculated on the notional amounts. These swap agreements have varied expirations through 2003. The notional amounts of interest rate swaps do not represent amounts exchanged by the parties and, thus are not a measure of the exposure to the Company through its use of these instruments. Net receipts or payments under the agreements are recognized as an adjustment to interest expense. The risk of loss to the Company in the event of nonperformance by any party under these agreements is not considered significant.\nThe Company's Irish subsidiary enters into foreign exchange contracts to hedge against changes in foreign currency exchange rates. The Company has foreign exchange contracts outstanding of $13.3 million and $10.3 million at July 1, 1995 and July 2, 1994, respectively. The foreign exchange contracts require the Company to exchange foreign currencies for Irish pounds and generally mature within 12 months.\n5. PREFERRED STOCK AND COMMON STOCK\nEach share of 7 1\/2% cumulative preferred stock is entitled to one vote for the election of the members of the Board of Directors not elected by the holders of Class A Common Stock, and all other matters at all shareholders' meetings whenever dividend payments are in arrears for four cumulative quarters. No arrearage existed at July 1, 1995. The preferred stock is redeemable in whole or in part, if called by the Company, at $10.50 per share. Additionally, there are 1,000,000 authorized shares of series preferred stock, no par value. At July 1, 1995 and July 2, 1994, no series preferred stock was outstanding.\nEach share of Class A Common Stock and Class B Common Stock is entitled to one vote and ten votes, respectively, at all shareholders' meetings. The holders of Class A Common Stock are entitled to elect one-quarter of the members of the Board of Directors. The remaining directors are elected by the holders of Class B Common Stock and any preferred stock entitled to vote.\n6. STOCK PURCHASE AND OPTION PLANS\nThe Company's Employees' Stock Purchase Plan permits the purchase in an aggregate amount of up to 437,800 shares of Class A Common Stock. Eligible employees may purchase stock at market value, or 90% of market\nvalue if the price is $8 per share or higher, up to a maximum of $5,000 per employee in any calendar year. The Company issued 22,771 shares in 1995 and 19,677 shares in 1994 under this plan.\nThe Company's Stock Option Plans permit the granting of either nonqualified or incentive stock options to certain key employees and directors to purchase an aggregate amount of up to 862,500 shares of the Company's Class A Common Stock. The options, which become exercisable twelve months after date of grant, expire ten years after date of grant. Although the plan administrator may establish the nonqualified option price at below market value at date of grant, incentive stock options may be granted only at prices not less than the market value.\nOptions have been granted to purchase common stock at prices ranging from $9.20 to $20.125 per share. A summary of option transactions follows:\nThe Company has reserved 408,725 shares for future grants at July 1, 1995.\n7. BENEFIT PLANS\nA. Pension Benefits\nThe Company sponsors defined benefit pension plans covering substantially all employees. Pension costs for the plans are funded in amounts which equal or exceed regulatory requirements. Benefits under these plans are based primarily on years of service and compensation.\nAssumptions and net periodic pension cost are as follows:\nThe increase in the net periodic pension cost in 1994 was primarily due to the change in the discount rate.\nThe funded status of the defined benefit pension plans is summarized below. The benefit obligation increase is primarily due to changing the discount rate from 8.25% to 7.75% as of July 1, 1995.\nB. Postretirement Health Care Benefits\nThe Company provides certain health care and life insurance benefits for eligible active and retired employees. The plan contains cost saving features such as deductibles, coinsurance and a lifetime maximum and is unfunded.\nPrior to July 4, 1993, the cost of providing these benefits was recognized as a charge to income in the period the claims were paid and was $0.2 million in 1993. Effective July 4, 1993, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" This Statement requires the accrual, during the employee's years of service, of the expected cost of providing those benefits to an employee and the employee's beneficiaries and covered dependents. The net transition obligation represents the difference between the accrued postretirement benefit costs prior to the adoption of SFAS No. 106 and the Plan's unfunded accumulated postretirement benefit obligation as of July 4, 1993. The net transition obligation of $7.9 million at July 4, 1993 is being amortized over 22 years.\nThe components of the net periodic postretirement benefit cost are as follows:\nThe postretirement benefit liability recognized in the balance sheet is as follows:\nThe actuarial calculation assumed a health care inflation rate of 13% in 1994, declining uniformly to 6% in 2000, and remaining level thereafter. The health care cost trend rate has an effect on the amounts reported. Increasing the assumed health care inflation rate by 1% would increase the accumulated postretirement benefit obligation by $0.6 million, and the net periodic postretirement benefit cost for the year by $40,000. The weighted average discount rate used in determining the accumulated postretirement benefit obligation was 7.75%.\n8. TAXES ON INCOME\nEffective July 4, 1993, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes\". The cumulative effect of this accounting change of $0.5 million is reported separately in the 1994 combined consolidated statement of income. Deferred income taxes under SFAS No. 109 reflect the impact of \"temporary differences\" between the amounts of assets and liabilities for financial reporting purposes and those amounts as measured by income tax laws. The tax effects of temporary differences which give rise to a significant portion of deferred tax assets (liabilities) are as follows:\nThe difference from the amount that would be computed by applying the federal statutory income tax rate to income before taxes on income is reconciled as follows:\nThe Company recognized a $0.6 million extraordinary tax benefit in 1993 from utilization of the net operating loss carryforward relating to previous start-up losses of D&A Technology, Inc.\nDeferred income taxes in 1993 were provided for significant timing differences in the recognition of revenue and expenses for tax and financial statement purposes, principally depreciation and pension costs.\nDeferred income taxes are not provided on cumulative undistributed earnings of the foreign subsidiaries and affiliates amounting to $0.7 million and $1.7 million at July 1, 1995 and July 2, 1994, respectively, the majority of which is intended to be permanently reinvested.\n9. COMMITMENTS AND CONTINGENCIES\nA. Patent Litigation\nCertain electrochromic mirror technology of the Company has been the subject of patent litigation between the Company and Gentex Corporation (\"Gentex\"). Following the settlement of prior litigation, Gentex filed another lawsuit against the Company on June 7, 1993. In this suit, Gentex alleged that the Company's solid polymer film electrochromic mirror infringed one of the Gentex patents involved in the prior litigation and that the Company has violated the injunction entered by the court in the previous litigation. Gentex sought unspecified damages and an injunction against further alleged infringement by the Company. On March 21, 1994, the Company's motion for summary judgement of non-infringement was granted and the lawsuit was dismissed. Gentex has filed an appeal of this ruling, which is currently pending.\nThe Company's lawsuit against Gentex, filed on July 8, 1993, remains outstanding. In this suit, the Company has alleged that Gentex's lighted electrochromic mirrors infringe three of the Company's patents and that all of Gentex's electrochromic mirrors infringe a fourth patent owned by the Company. The Company is seeking unspecified damages and injunction against further infringement by Gentex. A trial has been scheduled to begin in October 1995. The Company has filed a motion seeking a preliminary injunction against further infringement of one of its patents pending final resolution of the lawsuit. Gentex has filed several motions for summary judgement, alleging that the patents in question are invalid or not infringed, and that the Company is not entitled to certain damages. None of these motions have yet been decided by the court.\nOn October 13, 1994, the Company filed a second lawsuit against Gentex, alleging that Gentex's inside and outside electrochromic mirrors infringe two additional patents owned by the Company which relate to the protection of electrochromic mirrors from ultraviolet radiation. The Company is seeking unspecified damages and an injunction against further infringement by Gentex. The Company has also filed a motion seeking a preliminary injunction against further infringement of these two patents pending final resolution of the lawsuit. This motion has not yet been decided by the court, and no trial date has been set in the second lawsuit.\nOn June 23, 1995, Gentex filed a lawsuit against the Company seeking a declaration that three patents owned by the Company are invalid and not infringed by Gentex. The Company has not yet responded to these allegations. However, the Company believes that at least two of the patents in question are infringed by certain of Gentex's electrochromic mirrors. No trial date has been set in this lawsuit.\nB. Other Litigation\nThe Company and its subsidiaries are involved in certain other legal actions and claims, including environmental claims, arising in the ordinary course of business. Management believes (based on advice of legal counsel) that such litigation and claims will be resolved without material effect on the Company's financial position.\nC. Other\nAs of July 1, 1995, the Company had capital expenditure purchase commitments outstanding of approximately $13 million.\n10. LEASES\nThe Company leases various facilities and equipment. Rental expense charged to operations amounted to approximately $2.5 million for 1995, $2.5 million for 1994 and $2.5 million for 1993.\nFuture minimum lease payments consist of:\n11. GEOGRAPHIC INFORMATION AND MAJOR CUSTOMERS\nThe Company is primarily engaged in the research, design, development, manufacture, marketing and sale of interior and exterior rearview mirrors, interior lighting and interior trim products, and modular windows for world automotive markets. Excluding the contributions of various coatings related joint ventures, the Company's market focus is nearly exclusively automotive.\nExport revenues are foreign revenues produced by identifiable assets located in the United States. Foreign revenues are generated by identifiable assets at the Company's subsidiaries located in Ireland, France and Mexico. A summary of the Company's operations by geographic area follows:\nSales to major U.S. automobile manufacturers as a percent of the Company's net sales follows:\n12. BUSINESS ACQUISITION\nEffective April 1, 1995, the Company acquired an interest in Hohe GmbH & Co. KG (\"Hohe\"), a German limited partnership. Hohe, based in Collenberg, Germany, serves many of the main auto producers in Europe in exterior mirrors, interior mirrors, door handles, automotive tooling and electronic components related to mirror systems. With operations in Germany and Spain, Hohe's sales for the fiscal year ending March 31, 1995, were approximately $220 million.\nThe Company acquired 48 percent of the general partnership interest and 66 2\/3 percent of the limited partnership interest for $3.6 million. Additionally, $14.3 million has been advanced to Hohe under a subordinated loan agreement. The Company expects to provide future advances to Hohe for approximately $15 million which will be financed through the Company's existing borrowing agreements. Amounts advanced to Hohe under the subordinated loan agreement provide for 10 percent interest per annum with no principal payments due until its maturity on April 1, 1998. Subsequent advances to Hohe will be subordinated to Hohe bank debt and provide for interest at 700 basis points above the Bundesbank discount rate, which was 4% at June 30, 1995. In connection with the Company's acquisition of the Hohe interest, refinancing and additional loans of approximately $70 million are being provided to Hohe by several banks. The Company's interest in Hohe is stated at cost, adjusted for its equity in undistributed earnings from acquisition to May 31, 1995, the most recent date financial information is available. On July 1, 1995, the amount of the investment in Hohe included goodwill in the amount of $5 million which is being amortized over 15 years.\nThe terms of the transaction allow Donnelly to purchase the remaining ownership interest in Hohe through various options ranging from $3 million to $10 million. The remaining owners have an option to require the Company to buy their interests at any time based upon a formula which results in a price range of up to $10 million.\nThe unaudited results of operations and financial position of Hohe are summarized below:\n16. QUARTERLY FINANCIAL DATA - UNAUDITED\nThe impact of certain transactions on the 1995 quarterly results of operations is discussed in Note 13.\nMANAGEMENT'S RESPONSIBILITY FOR FINANCIAL REPORTING\nThe management of Donnelly Corporation is responsible for the preparation and integrity of the combined consolidated financial statements and all other information contained in this Annual Report. The financial statements were prepared in accordance with generally accepted accounting principles and include amounts that are based on management's informed estimates and judgements.\nIn fulfilling its responsibility for the integrity of financial information, management has established a system of internal accounting control which provides reasonable assurance that assets are properly safeguarded and accounted for and that transactions are executed in accordance with management's authorization and recorded and reported properly.\nThe financial statements have been audited by our independent public accountants, BDO Seidman, LLP, whose unqualified report is presented on the next page. The independent accountants provide an objective assessment of the degree to which management meets its responsibility for fairness of financial reporting. They regularly evaluate the internal control structure and perform such tests and other procedures as they deem necessary to reach and express an opinion on the fairness of the financial statements.\nThe Audit Committee of the Board of Directors, consisting solely of outside Directors, meets regularly with the independent public accountants and management to review and discuss the major audit findings, the adequacy of the internal control structure and quality of financial reporting. The independent accountants also have free access to the Audit Committee to discuss auditing and financial reporting matters with or without management present.\n\/s\/ J.Dwane Baumgardner - ----------------------------- J. Dwane Baumgardner, Ph.D. Chairman, Chief Executive Officer and President\n\/s\/ William R. Jellison - ----------------------------- William R. Jellison Vice President, Chief Financial Officer and Treasurer\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nDONNELLY CORPORATION HOLLAND, MICHIGAN\nWe have audited the combined consolidated balance sheets of Donnelly Corporation and subsidiaries as of July 1, 1995 and July 2, 1994, and the related combined consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended July 1, 1995. 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 combined consolidated financial statements referred to above present fairly, in all material respects, the financial position of Donnelly Corporation and subsidiaries as of July 1, 1995 and July 2, 1994, and the results of their operations and their cash flows for each of the three years in the period ended July 1, 1995, in conformity with generally accepted accounting principles.\nAs discussed in notes 7 and 8 to the combined consolidated financial statements, effective July 4, 1993, the Company changed its methods of accounting for postretirement health care benefits and income taxes, respectively.\n\/s\/ BDO Seidman, LLP - ----------------------------- BDO Seidman, LLP Grand Rapids, Michigan August 2, 1995\nITEM 9","section_9":"ITEM 9 CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable.\nPart III.\nITEM 10","section_9A":"","section_9B":"","section_10":"ITEM 10 DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nDirectors of Registrant. Information relating to the directors and director nominees of the registrant contained in the registrant's definitive Proxy Statement for its Annual Meeting of Shareholders to be held October 20, 1995, and filed pursuant to Regulation 14A, is incorporated by reference.\nExecutive Officers of Registrant. The Executive Officers of the Company are as follows:\nPositions and Year First Elected Name Age Offices Held Executive Officer\nJ. Dwane Baumgardner 54 Director, Chairman 1978 CEO, President John F. Donnelly, Jr. 42 Senior Vice President 1986 Bob J. Tennison 47 Senior Vice President 1994 James A. Knister 56 Senior Vice President 1972 William R. Jellison 37 Vice President, CFO 1991 Treasurer Maryam Komejan 44 Vice President, Corporate 1993 Secretary\nJohn F. Donnelly, Jr., is a descendant of Bernard P. Donnelly, Sr., the Company's founder, and is the brother of Joan E. Donnelly, a director of the Company. B. Patrick Donnelly, III, Joan E. Donnelly, Thomas E. Leonard, Gerald T. McNeive and Rudolph B. Pruden, all Directors of the Company, are descendants of, or are married to descendants of Bernard P. Donnelly. There are no other family relationships between or among the above-named executive officers. There are no arrangements or understandings between any of the above-named officers pursuant to which any of them was named an officer.\nDr. Baumgardner has been Chief Executive Officer and a director since 1982, Chairman of the Board since 1986 and President since 1994. John F. Donnelly, Jr. was elected Senior Vice President in fiscal 1993. Prior to that time he was Vice President from 1986 through 1993. Mr. Tennison joined Donnelly in August, 1994. Prior to joining Donnelly, Mr. Tennison was a division president at Hennessey Industries, Inc., a division of Danaher Corporation, from October 1991 to 1994; Director of Manufacturing at Sauer- Sundstrand from July 1990 to 1991; and President of Manufacturing Services International, a division of Perry Group, Inc. from 1987 to 1990. Mr. Knister has been a Senior Vice President since 1988. William R. Jellison has been CFO since 1994, Vice President since 1991 and Treasurer since 1988. Maryam Komejan has been Vice President since 1993 and Corporate Secretary since 1989. All terms of office are on an annual basis which will expire on October 20, 1995.\nITEM 11","section_11":"ITEM 11 EXECUTIVE COMPENSATION\nInformation relating to executive compensation is contained under the caption \"Executive Compensation\" in the Company's definitive Proxy Statement for its Annual Meeting of Shareholders to be held October 20, 1995 and the information within those sections is incorporated herein be reference.\nITEM 12","section_12":"ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe sections entitled \"Voting Securities and Principal Holders Thereof\", \"Nominees for Election as Directors\" and \"Securities Ownership of Management\" in the definitive Proxy Statement for the Company's Annual Meeting of Shareholders to be held October 20, 1995, and the information within those sections are incorporated by reference.\nITEM 13","section_13":"ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe section entitled \"Certain Transactions\" in the definitive Proxy Statement for the Company's Annual Meeting of Shareholders to be held October 20, 1995, and the information within that section is 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. The Registrant's financial statements, for the year ended July 1, 1995, together with the Report of Independent Accountants are set forth on pages 19-37 of this report, Item 8. 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 affiliates accounted for by the equity method have been omitted because they would not constitute a significant subsidiary.\n2. Financial Statement Schedules. The following are included in Part IV of this report for each of the years ended July 1, 1995, July 2, 1994 and July 3, 1993 as applicable:\nPage Report of Independent Certified Public Accountants on Schedules 42 Schedule II Valuation and Qualifying Accounts 43\nAll other schedules are not submitted because they are not applicable or because the required information is included in the financial statements or notes thereto.\n3. Exhibits. Reference is made to the Exhibit Index which is found on the last two pages of the body of this Form 10-K Annual Report preceding the exhibits.\n(b) REPORTS ON FORM 8-K\nThe Registrant filed Form 8-K, dated May 29, 1995, which has subsequently been amended, in the fourth quarter of the period covered by this report, relating to the acquisition of an interest in Hohe GmbH & Co. KG (\"Hohe\"), a German limited partnership. The filing included an English language summary of an Acquisition Agreement and related documents written in German between the Registrant, Donnelly GmbH, Hohe and other parties related to Hohe, dated May 25, 1995, consolidated financial statements of Hohe as of March 31, 1995 and 1994 (audited) and pro forma financial information of the Registrant\n(c) EXHIBITS\nThe response to this portion of Item 14 is submitted as a separate section of this report.\n(d) FINANCIAL STATEMENT SCHEDULES\nThe response to this section of Item 14 is submitted as a separate section of this report.\nSIGNATURES\nPursuant to the requirements of Section 13 (d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nDONNELLY CORPORATION\n\/s\/J. Dwane Baumgardner - ---------------------------------- 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 person on behalf of the Registrant in the capacity indicated. The person named below hereby appoints J. Dwane Baumgardner and William R. Jellison, and each of them severally, as his or her attorney in fact, to sign in his or her name and on his or her behalf, as a director or officer of the Registrant, and to file with the Commission any and all amendments to this report on Form 10-K.\n\/s\/J. Dwane Baumgardner \/s\/William R. Jellison - ----------------------------- ------------------------------ Chairman, Chief Executive Vice President, Chief Officer, and Director and Financial Officer and President Treasurer\n\/s\/Arnold F. Brookstone \/s\/B. Patrick Donnelly III - ----------------------------- ------------------------------ Director Director\n\/s\/Joan E. Donnelly \/s\/R. Eugene Goodson - ----------------------------- ------------------------------ Director Director\n\/s\/Thomas E. Leonard \/s\/Gerald T. McNeive - ----------------------------- ------------------------------ Director Director\n\/s\/Rudolph B. Pruden \/s\/Donald R. Uhlmann - ----------------------------- ------------------------------ Director Director\n\/s\/Glenn M. Walters - ----------------------------- Director\nDATE: September 22, 1995 Donnelly Corporation Annual Report - Form 10-K\nReport of Independent Certified Public Accountants on Financial Statement Schedule\nDonnelly Corporation Holland, Michigan\nThe audits referred to in our report dated August 2, 1995, relating to the combined consolidated financial statements of Donnelly Corporation and subsidiaries, which is contained in Item 8 of this Form 10-K, included the audit of the financial statement schedule listed in the accompanying index. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement schedule based on our audits.\nIn our opinion, such financial statement schedule presents fairly, in all material respects, the information set forth therein.\n\/s\/BDO SEIDMAN, LLP - ----------------------------- BDO Seidman, LLP Grand Rapids, Michigan August 2, 1995\nAnnual Report - Form 10-K\nExhibit Index\n3. Articles of Incorporation and Bylaws are incorporated by reference to Exhibit 3.1 and 3.2 of Registrant's Registration Statement on Form S-1, as amended, dated March 9, 1988, (Registration No. 33-17167) (\"S-1 Registration Statement:).\n4. A specimen stock certificate of the Class A Common Stock was filed as part of a Registration Statement on Form S-1 (Registration No. 33-17167) as Exhibit 4.1, and the same is hereby incorporated herein by reference.\n10.1 Nationwide Life Insurance Company Debt Agreement\n10.2 3rd Amendment to NBD Revolving Credit Loan Agreement\n10.3 An English language summary of an Acquisition Agreement and related documents written in German between the Registrant, Donnelly GmbH, Hohe GmbH & Co. KG (\"Hohe\") and other related parties, dated May 25, 1995, consolidated financial statements of Hohe as of March 31, 1995 and 1994 (audited) and pro forma financial information of the Registrant were filed as part of Form 8-K on June 9, 1995, which has been subsequently amended are are hereby incorporated herein by reference.\n10.4 Nationwide Life Insurance Company Debt Agreement was filed as part of Form 10-K for the fiscal year ending July 2, 1994 as Exhibit 10.1 and is hereby incorporated herein by reference.\n10.5 The NBD loan agreement was filed as part of Form 10-K for the fiscal year ending July 3, 1993 as Exhibit 10.1 and is hereby incorporated herein by reference.\n10.6 The Principal Mutual Debt Agreement was filed as part of Form 10-K for the fiscal year ending July 3, 1993 as Exhibit 10.2 and is hereby incorporated herein by reference.\n10.7 A Merger Agreement for the Merger of Donnelly Coated Corporation (\"DCC\") into Applied Coated Corporation, among Registrant, DCC, Applied Films Lab, Inc. and Cecil Vanalsburg, John Chapin, and Richard Condon, dated February 24, 1992, was filed as part of a Registration Statement on Form S-2 (Registration No. 33-47036) and Exhibit 10.7, and the same is hereby incorporated herein by reference.\n10.8 The form of Indemnity Agreement between Registrant and each of its directors was filed as a part of a Registration Statement on Form S-1 (Registration No. 33-17167) as Exhibit 10.8, and the same is hereby incorporated herein by reference.\n10.9 The Donnelly Corporation Stock Option Plan was filed as part of a Registration Statement on Form S-1 (Registration No. 33-17167) as Exhibit 10.9, and the same is hereby incorporated herein by reference.\n10.10 The Donnelly Corporation 1987 Employees' Stock Purchase Plan, including amendments was filed as part of a Registration Statement on Form S-8 (Registration No. 33-34746) as Exhibit 28.1, and the same is hereby incorporated herein by reference.\n10.11 A Joint Venture Agreement among Asahi Glass Company, Ltd., AP Technoglass Corporation and Registrant, dated July 20, 1989, was filed as part of a Registration Statement on Form S-2 (Registration No. 33-47036) as Exhibit 10.13, and the same is hereby incorporated herein by reference.\n10.12 The Donnelly Corporation Non Employee Director's Stock Option Plan was filed as part of a Registration Statement on Form S-8 (Registration No. 33- 55499) as Exhibit 99, and the same is hereby incorporated herein by reference.\n22. Schedule of Affiliates\n24. Consent of BDO Seidman, LLP, independent public accountants\n27. Financial Data Schedules","section_15":""}
{"filename":"109747_1995.txt","cik":"109747","year":"1995","section_1":"Item 1. Business.\nSouthern Security Life Insurance Company (\"the Company\") is a legal reserve life insurance company authorized to transact business in the states of Alabama, Florida, Georgia, Hawaii, Illinois, Kentucky, Louisiana, Michigan, Missouri, South Carolina, Tennessee and Texas. It was incorporated under Florida law in 1966 and was licensed and commenced business in 1969. The Company obtained authorization in the state of Illinois in 1995 and will continue the process of seeking authorization, directly or through acquisition, to transact business in additional states during 1996. During 1995, approximately 42% of the premium income of the Company was from business in force in its state of domicile. The Company's only industry segment is the ordinary life, accident and health and annuity business.\nThe Company at present writes primarily universal life policies with various companion riders. In the past it has written various forms of ordinary life insurance policies and annuity contracts. The Company's accident and health insurance business has never been a significant portion of the Company's business. It does not presently write industrial life or group life insurance other than through its participation as a reinsurer in the Servicemen's Group Life Insurance Program (\"SGLI\").\nThe Company introduced its first universal life product in 1986 and currently has two principal universal life products in force. These universal life products offer flexibility to the client as well as tax advantages, both currently and upon the death of the insured. These products allow the Company to better compete in the current market environment. In excess of 98% of the premiums written by the Company in 1994 and 1995, were for the universal life products.\n1995 continued as a rebuilding year for Southern Security.\nIn late 1995 the Company began negotiations with, and in early 1996 recruited, a new marketing director to reestablish the Company's marketing. As a result, the Company is introducing a new series of products designed for the seniors market. This new series targets the needs of senior citizens especially as they plan for their final expenses. A lead generation program has been designed specifically to support this new market. New field sales representatives are also being actively recruited for the product announcement in April of 1996.\nThe Company is continuing to support its traditional universal life marketing as well. To enhance this market the Company is establishing a lead generation program which is being coupled with a recruiting program for new sales agents to help rebuild the market. This will enhance the opportunities for the Company to\nexpand sales of its universal life products which are designed to provide an insurance program as well as a savings vehicle through the cash values of the policy.\nThe following table provides information (on a statutory basis) concerning the amount and percentage of premium income resulting from the principal lines of insurance written by the Company during the periods indicated:\n(1) A portion of each of the deposit term policies previously sold by the Company represents ordinary life insurance and the balance represents an individual annuity.\n(2) The 1994 and 1995 premium income for life insurance-ordinary are net of reductions of $2,512,000 and $2,105,768, respectively, in ceded premium paid to all reinsurers, including Mega Life.\n(The remainder of this page is intentionally left blank)\nThe following table gives information [on a generally accepted accounting principles basis] for the Company concerning operating ratios for the periods indicated:\n(The remainder of this page is intentionally left blank)\nThe following table provides information about the Company concerning changes in life insurance in force (shown in thousands -000 omitted) during the periods indicated (exclusive of accidental death benefits):\nThe Company invests and reinvests portions of its funds in securities which are permitted investments under the laws of the State of Florida, and part of its revenue is derived from this source. Generally, securities comprising permitted investments include obligations of Federal, state and local governments; corporate bonds and preferred and common stocks; real estate mortgages and certain leases. The following table summarizes certain information regarding the Company's investment activities:\n(1) Computed pursuant to valuations prescribed under generally accepted accounting principles.\n(2) Includes capital gains and net of capital losses.\n(3) Net of investment expense and before income taxes or extra ordinary terms.\n(4) Computed on an annualized basis. Represents ratio of net investment income to mean invested assets.\nThe Company continues its activities as a qualified lender under the Federal Family Educational Loan Program. Through this program the Company makes various types of student and parent loans available. All student loans made by the Company are guaranteed by the Federal Government. As it has in the past, the Company sells these student loans on a periodic basis to the Student Loan Marketing Association (\"SLMA\") thereby keeping these funds liquid.\nThe Company presently sells its policies on a general agency basis through a field force consisting of approximately 270 agents. All such agents are licensed as agents of, and sell for, the Company and are independent contractors who are paid exclusively on a commission basis for sales of the Company's policies. Some of the Company's agents are part-time insurance agents. Most of the Company's agents are associated with Insuradyne Corporation, a wholly-owned subsidiary of the Company's parent, Consolidare Enterprises, Inc. See \"Certain Relationships and Related Transactions\" in Part III of this Report.\nThe Company presently employs 37 persons, none of whom are covered under any collective bargaining agreements. The Company feels it has good relations with its employees.\nSection 624.408 of the Florida Statutes requires a stock life insurance company to maintain minimum surplus on a statutory basis at the greater of $1,500,000 or four percent (4%) of total liabilities. The Company's required statutory minimum surplus calculated in accordance with this section is approximately $1,800,000. If the capital and surplus of the Company computed on such basis should fall below that amount, then the Company's license to transact insurance business in the State of Florida, the Company's most significant market, could be revoked unless the deficiency is promptly corrected. As of December 31, 1995, the Company had statutory capital and surplus of $8,770,411, well in excess of the required minimum.\nThe Risk-Based Capital for Life and\/or Health Insurers Model Act (the \"Model Act\") was adopted by the National Association of Insurance Commissioners (NAIC) in 1992. The main purpose of the Model Act is to provide a tool for insurance regulators to evaluate the capital resources of insurers as related to the specific risks which they have incurred and is used to determine whether there is a need for possible corrective action. The Model Act or similar regulations may have been or may be enacted by the various states.\nThe Model Act provides for four different levels of regulatory action, each of which may be triggered if an insurer's Total Adjusted Capital is less than a corresponding \"level\" of Risk-Based Capital (\"RBC\").\nThe \"Company Action Level\" is triggered if an insurer's Total Adjusted Capital is less the 200% of its \"Authorized Control Level RBC\" (as defined in the Model Act), or less than 250% of its Authorized Control Level RBC and the insurer has a negative trend (\"the Company Action Level\"). At the Company Action Level, the insurer must submit a comprehensive plan to the regulatory authority of its state of domicile which discusses proposed corrective actions to improve its capital position.\nThe \"Regulatory Action Level\" is triggered if an insurer's Total Adjusted Capital is less than 150% of its Authorized Control Level RBC. At the Regulatory Action Level, the regulatory authority will perform a special examination of the insurer and issue an order specifying corrective actions that must be followed.\nThe \"Authorized Control Level\" is triggered if an insurer's Total Adjusted Capital is less than 100% of its Authorized Control Level RBC, and at that level the regulatory authority is authorized (although not mandated) to take regulatory control of the insurer.\nThe \"Mandatory Control Level\" is triggered if an insurer's Total Adjusted Capital is less than 70% of its Authorized\nControl level RBC, and at that level the regulatory authority must take regulatory control of the insurer. Regulatory control may lead to rehabilitation or liquidation of an insurer.\nBased on calculations using the NAIC formula as of December 31, 1995, the Company was well in excess of all four of the control levels listed.\nThe industry in which the Company is engaged is highly competitive. There are in excess of 850 life insurance companies licensed in Florida, where a substantial amount of the Company's premium income is produced, and there are comparable numbers of insurance companies licensed in Alabama, Georgia, Hawaii, Illinois, Kentucky, Louisiana, Michigan, Missouri, South Carolina, Tennessee and Texas. Many of the Company's competitors have been in business for longer periods of time, have substantially greater financial resources, larger sales organizations, and have broader diversification of risks. A large number of the Company's competitors engage in business in many states and advertise nationally while the Company conducts its business on a regional basis. The Company is not a significant factor in the life insurance business in any state where the Company does business.\nThe states of Alabama, Florida, Georgia, Hawaii, Illinois, Kentucky, Louisiana, Michigan, Missouri, South Carolina, Tennessee and Texas require that insurers secure and retain a license or a certificate of authority based on compliance with established standards of solvency and demonstration of managerial competence. The Company, like other life insurers, is subject to extensive regulation and supervision by state insurance regulatory authorities. Such regulation relates generally to such matters as minimum capitalization, the nature of and limitations on investments, the licensing of insurers and their agents, deposits of securities for the benefit and protection of policyholders, the approval of policy forms and premium rates, periodic examination of the affairs of insurance companies, the requirement of filing annual reports on a specified form and the provision for various reserves and accounting standards.\nThe Company reinsures or places a portion of its insured risks with other insurers. Reinsurance reduces the amount of risk retained on any particular policy and, correspondingly, reduces the risk of loss to the Company, thus giving it greater financial stability. Reinsurance also enables the Company to write more policies and policies in larger amounts than it would otherwise consider prudent. On the other hand, reinsurance potentially reduces earnings, since a portion of the premiums received must be paid to the insurers assuming the reinsured portion of the risk.\nThe Company currently cedes its new reinsurance to Businessmen's Assurance Company (\"BMA\") and the Reinsurance Company\nof Hanover, both of which are unaffiliated reinsurers. Under the terms of the reinsurance agreements, the Company cedes all risks in excess of the Company's current retention limits.\nThe Company currently retains a maximum of $75,000 on any one life and lesser amounts on substandard risks.\nReinsurance for policy amounts in excess of the Company's retention limits is ceded on a renewable term basis, under which the amount reinsured normally decreases annually by the amount of increase in the policy reserve. In addition, the Company has coinsurance agreements with several insurers, under which premiums are shared based upon the share of the risk assumed.\nThe Company remains directly liable to policyholders for the full amount of all insurance directly written by it, even though all or a portion of the risk is reinsured. Reinsurers, however, are obligated to reimburse the Company for the reinsured portion of any claims paid. Consequently, if any reinsurer becomes insolvent or is otherwise unable to make such reimbursement, the Company would suffer an unexpected loss. The Company has no reason to believe that any of its reinsurers will be unable to perform their obligations under existing reinsurance agreements.\nOn December 31, 1992, the Company entered into a Coinsurance Reinsurance Agreement with United Group Insurance Company (\"UGIC\"), now Mega Life. In this agreement, UGIC agreed to indemnify and the Company agreed to transfer risk to UGIC in the amount of 18% of all universal life premium paying polices which were in force on December 31, 1992. Mega Life is an A rated company with A.M. Best and is an authorized reinsurer in the State of Florida.\nAs a result of the 1992 agreement, the Company will continue to pay reinsurance premiums to Mega Life while receiving ceding commissions. As a part of the coinsurance agreement, Mega Life agreed to share in the expenses of death claims, surrenders, commissions, taxes and the funding of policy loans.\nUnder the terms of the agreement, Mega Life maintains a trust account with Sun Trust, a bank located in Orlando, Florida, which names the Company as the beneficiary. The trust is to remain in effect with deposits made by Mega Life on a periodic basis to maintain assets having a market value at least equal to 18% of the Company's ceded reserves, net of policy loans, on a statutory basis.\nThe Company does not assume any reinsurance at the present time other than its participation in SGLI.\nThe Company is required to establish policy benefit and other reserves which are calculated in accordance with statutory requirements and standards of actuarial practice and established at\namounts which, with additions from premiums to be received and assumed interest on policy reserves compounded annually, are believed to be sufficient to meet policy obligations as they mature. Life reserves for the Company are based upon the Commissioner's 1958 and 1980 Standard Ordinary Table of Mortality, with interest on policies computed at 3, 3-1\/2, 4 or 4-1\/2%. Annuity reserves are based on the 1937 Standard Annuity Table, with interest on policies computed at 3-1\/2 or 4%. Reserves on the annuity portion of the Company's deposit term policies are computed on the accumulation method. Reserves for universal life policies, which comprise most of the Company's insurance in force, have been valued by the California Method which was approved by the Florida Department of Insurance. Reserves under this method are the linear average of the policy account value and the policy cash surrender value (account value less the surrender charge).\nIn 1994, the Florida Department of Insurance issued a new regulation that required all companies who are not already using the CRVM method to phase into that method over a period of five years. As required, the Company has filed with the Department its plan to comply with the new regulation and implemented the plan beginning January 1, 1995. This has resolved the pending discussions with the Florida Insurance Department on the Company's reserving methods. The CRVM reserving method applies only to the Company's statutory financial statements. For the year 1995 the increase in the statutory reserve due to the implementation of this regulation was approximately $404,000.\nEstimation and provision for the cost of HIV-related claims covered under life and accident and health insurance policies of the Company have been made. The Company utilizes the services of KPMG Peat Marwick, LLP, consulting actuaries, in calculating such reserves.\nIn preparing generally accepted accounting principle Financial Statements, the cost of insurance and expense charges on universal life products are recognized as revenue. For \"Annuity Contracts\" with flexible terms, amounts received from policyholders are not recognized as revenue but are recorded as deposits in a manner similar to interest-bearing instruments. Accumulations on these universal life and annuity contracts are held as \"Policyholders' Account Balances.\" For all other policies (primarily whole-life) revenue and reserves are calculated using the net level premium method. Accumulation values for these types of policies are held as benefit reserves. See \"Future Policy Benefits\" in Note 1 of the Notes to Financial Statements included in this report.\nThe Company maintains its own policy files, prepares its own policy forms (with the assistance of its consulting actuaries), selects risks, calculates premiums, prepares premium notices, preauthorized checks and commission statements, and maintains all of its accounting records.\nThe Company is not affected by Federal, state or local provisions relating to discharge of materials into the environment. The Company has not spent a material amount of money during the last three fiscal years on research and development activities. The business of the Company is not seasonal in nature and is not dependent on the sources and availability of raw materials. The business of the Company is not dependent upon a single customer or a few customers, and no material portion of the Company's business is subject to renegotiation of profits or termination at the election of the Government.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nThe Company's corporate headquarters is located in a two story office building in Lake Mary, Florida which is owned by the Company. The Company occupies the entire second floor of the building. Of the remaining rentable space, 8,467 square feet were leased at year end and the remaining balance of 1,200 square feet was available for lease. Since year end, the Company has contracted to lease the remaining leasable space.\nItem 3.","section_3":"Item 3. Pending Legal Proceedings.\nLawsuits against the Company may have arisen in the course of the Company's business. However, contingent liabilities arising from litigation and other matters are not considered material in relation to the financial position of the Company.\nTo the best of the Company's knowledge, it has no potential or pending contingent liabilities that might be material to the Company's financial condition, results of operations or liquidity, pursuant to product and environmental liabilities. The Company maintains insurance coverage for unforeseen events and the insurance carriers, to the best of managements knowledge, have no solvency issues.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nDuring the fourth quarter of the Company's fiscal year, no matter was submitted to a vote of security holders.\nPART II\nItem 5.","section_5":"Item 5. Market for the Company's Common Stock and Related Stockholder Matters.\n(a) Principal Market and Stock Price. The principal market on which the Company's common stock is traded is the over-the-counter market. Trading information with respect to the Company's shares is available through the National Association of Securities Dealers Automated Quotation (NASDAQ) System under the symbol SSLI.\nThe table below presents the high and low market prices for the Company's common stock during the calendar quarters indicated, as quoted in the NASDAQ system. The quotations represent prices between dealers in securities and do not include retail markups, markdowns or commissions and do not necessarily represent actual transactions.\n(b) Approximate Number of Holders of Common Stock. There were 1,777 holders of record of the Company's Common Stock at December 31, 1995.\n(c) Dividends. The Company has paid no cash dividends to stockholders during the past two years, and it is not anticipated that any cash dividends will be paid at any time in the foreseeable future. The payment of dividends by the Company is subject to the regulation of the State of Florida Department of Insurance. Under such regulation an insurance company may pay dividends, without prior approval of the State of Florida Department of Insurance, equal to or less than the greater of (a) 10% of its accumulated capital gains (losses) (i.e. unassigned surplus) or (b) certain net operating profits and realized net capital gains of the Company, as defined in the applicable insurance statutes. In no case can such dividends be paid if the Company will have less than 115% of the minimum required statutory surplus as to policyholders after the dividend is paid. The maximum amount which the Company could pay as a dividend during 1996 pursuant to such regulation is $232,181.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nThe following table presents selected financial data (on a GAAP basis) concerning the Company and its financial results during the periods indicated.\n(The remainder of this page is intentionally left blank)\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation.\nOverview.\nThis analysis of the results of operations and financial condition of Southern Security Life should be read in conjunction with the Selected Financial Data and Financial Statements and Notes to the Financial Statements included in this report.\nIn recent years the Company has primarily issued one type of insurance product, universal life. Universal life provides insurance coverage with flexible premiums, within limits, which allow policyholders to accumulate cash values. These accumulated cash values are credited with tax-deferred interest, as adjusted by the Company on a periodic basis. Deducted from these cash accumulations are administrative charges and mortality costs. Should a policy surrender in its early years, the Company assesses a surrender fee against these same cash accumulations, based on issue age of the insured, smoker verses non-smoker status, sex of the insured and the duration of the policy at the time of surrender.\nPursuant to the accounting methods prescribed by Financial Accounting Standards No. 97 (FAS 97), premiums received from policyholders on universal life products are credited to policy- holder account balances, a liability, rather than income. Revenues, described herein as premium, on such products result from the mortality and administrative fees charged to policyholder balances in addition to surrender charges assessed at the time of surrender as explained above. Such costs of insurance, expense charges, and surrender fees are recognized as revenue as earned. In addition, the Company has adopted policy designs with the characteristic of having higher expense charges during the first policy year than in renewal years. Under FAS 97, the excess of these charges are reported as unearned revenue. The unearned revenue is then amortized into income over the life of the policy using the same assumptions and factors used to amortize capitalized acquisition costs. Interest credited to policyholder balances is shown as a part of benefit expenses.\nIn accordance with generally accepted accounting principles, certain costs directly associated with the issuance of new policies are deferred and amortized over the lives of the policies. These costs are defined as deferred policy acquisition costs and are shown in the asset section of the balance sheet of the Company. Capitalized acquisition costs are amortized over the life of the business at a constant rate, based on the present value of the estimated gross profits expected to be realized over the life of the business. FAS 97 requires that estimates of expected gross profits used as a basis for amortization be evaluated on a regular basis, and the total amortization to date be adjusted as a charge or credit to earnings if actual experience or other evidence\nsuggests that earlier estimates be revised. Thus, variations in the amortization of the deferred policy acquisition costs, from one period to the next, are a normal aspect of universal life insurance business and are generally attributed to the recognition of current and emerging experience in accordance with the principles of FAS 97.\nAnnuity products, of which the Company currently has a minor amount, are recorded in similar fashion to universal life products. Considerations received by the Company are credited to the annuity account balances which are shown as a liability in the balance sheet. Interest is credited to these accounts as well and shown as an expense of the Company. Income is derived primarily from surrender charges on this type product.\nAn additional source of income to the Company is investment revenue. The Company invests those funds deposited by policy- holders of universal life and annuity products in debt and equity securities in order to earn interest and dividend income, a portion of which is credited back to the policyholders. Interest rates and maturities of the Company's investment portfolio play a part in determining the interest rates credited to policyholders.\nProduct profitability is affected by several different factors, such as mortality experience ( actual versus expected), interest rate spreads (excess interest earned over interest credited to policyholders) and controlling policy acquisition costs and other costs of operation. The results of any one reporting period may be significantly affected by the level of death claims or other policyholder benefits incurred due to the Company's relatively small size.\n(The remainder of this page is intentionally left blank)\nThe following table sets forth certain percentages reflecting financial data and results of operations (a) for 1995, 1994 and 1993 premium and investment revenues and (b) for period to period increases and (decreases).\nResults of Operations.\nNew business written was 124, 189 and 330 million dollars in face value for 1995, 1994 and 1993, respectively. New business written declined again in 1995, as it did in 1994, as the Company continued its efforts to license new products and develop marketing distribution channels. Delays in obtaining admission of new products into various states has cost the Company anticipated sales as well as agency forces over the past two years. Yet, by year end 1995, some key marketing strategies were accomplished which have already begun to show a positive impact on 1996 production figures. One such marketing strategy included the hiring of a new marketing director. The new director, a seasoned insurance executive, brings to the Company a product expertise and market expansion knowledge that will enable the Company to accomplish its long term goals. Another key development was the creation of a lead generation program designed to provide new business leads in order to increase production.\nPremium income for 1995 was recorded at $9.4 million, for 1994 at $10.6 million and for 1993 at $12.3 million. This 1995 decline of 12% in premium income can be attributed somewhat to the decline in the Company's insurance in force and therefore an associated reduction in administrative and mortality fees. Surrender fees, another component of premium income, decreased by approximately 5% from 1994 due to the fact that the book of business is aging and as it does so, surrender fees decrease. 1994 in comparison with 1995 is much the same scenario as 1994 versus 1995, however surrender fees were greater. The new business decline of the past several years is having an impact on premium income. The balance of the decline in premium income for 1994 and 1995 is attributable to the amortization and unlocking for current and future experience of unearned premium into income. Unearned premium essentially represents the excess first year charges in the policy. With the advice and assistance of our consulting actuaries, each year the Company reviews its current experience rates for mortality, credited interest rates, lapse rates, surrender fees and the like, and adjusts its amortization of deferred acquisition costs and unearned premium to the appropriate levels for both the current experience and anticipated future experience. This is an on-going refinement process.\nIncreased investment in debt securities coupled with reduced expenses for student loan processing accounted for the 9% increase in investment income for the year 1995. The Company's investment in student loans is declining each year in response to increased costs designated by the government. This trend is expected to continue and show significant change in 1996.\nAnnuity, death and other benefits decreased only slightly in 1995 from the results of 1994. Death claims continued their trend of less than anticipated by the actuarial assumptions but were up slightly from 1994, however, well below the 1993 figures. A significant increase or decrease in death claims in any given year can have a marked impact on the results of operations in a small company. Surrender benefits were responsible for the slight improvement in this expense area. While death claims were up slightly, surrender benefits declined enough to compensate for the increase.\nThe amount of the amortization of deferred acquisition costs continued its 1994 trend, declining by approximately 5%. The amortization of deferred acquisition costs is a continuous refinement process which relates to current experience in connection with revenues, mortality gains and losses, credited interest rate spreads, expense charges and surrender charges. The change in the rate of amortization of both deferred acquisition costs and unearned premium liabilities is due to \"unlocking\" for current and future experience based on the results of the changing experience encountered as required under FAS 97.\nOperating expenses for the Company were $2.7 million. $3.2 million and $2.8 million for 1995, 1994 and 1993, respectively. In 1994, the Company settled litigation with a former employee and experienced the related costs of legal representation. After due consideration of the litigation delays the Company might encounter on the collection of these expenses from its insurers, the costs of settlement and associated legal expenses, estimated at between $500,000 and $600,000, were expensed in that same year. While the Company reasonably expects to receive reimbursement through its insurance carriers for a substantial portion of these expenses, estimated at $500,000, it has prudently established a receivable for only $100,000 due to litigation delays in receiving said funds. These expenses account for the 14% decrease in current year operating expenses in comparison with those of 1994. It can also be noted that the expenses have returned to their previous level of 1993.\nReinsurance premiums ceded for 1995 and 1994 were $2,112,884 and $2,508,749, respectively. Policy benefits were reduced due to reinsurance $405,345 and $679,622 for 1995 and 1994 respectively. Reinsurance commissions amounted to $397,253 for 1995 and $445,309 for 1994. In addition, under the terms of the Company's treaty with Mega Life (formerly United Group Insurance Company) expenses of $911,452 were transferred to the reinsurer for 1995 and $1,163,842 for 1994. The Company has also amortized the remaining $200,000 of deferred gain, under the aforementioned treaty, against deferred acquisition costs for 1995 (see Note 7).\nIncome, before income taxes, in 1995 was $1,274,903 compared to $1,543,979 in 1994 and $705,652 in 1993. The 1995 income declined 17% from prior year as a result of reduced premium income and level amortization expenses. 1993 income suffered from higher death benefit expenses than the following two years.\nLiquidity and Capital Resources.\nEffective January 1, 1994, the Company adopted Statement of Financial Accounting Standards No. 115 (\"SFAS 115\"), \"Accounting for Certain Investments in Debt and Equity Securities.\" SFAS 115 required that investments in all debt securities and those equity securities with readily determinable market values be classified into one of three categories: held-to-maturity, trading or available-for-sale. Classification of investments is based upon management's current intent. Debt securities which management has a positive intent and ability to hold until maturity are classified as securities held-to-maturity and are carried at amortized cost. Unrealized holding gains and losses on securities held-to-maturity, are not reflected in the financial statements. Debt and equity securities that are purchased for short-term resale are classified as trading securities. Trading securities are carried at market value, with unrealized holding gains and losses included in earnings. All other debt and equity securities not included in the\nabove two categories are classified as securities available-for-sale. Securities available-for-sale are carried at market value, with unrealized holding gains and losses reported as a separate component of stockholders' equity, net of tax and a valuation allowance against deferred acquisition costs. Adoption of this statement had no effect on the income of the Company.\nThe Company's insurance operations have historically provided adequate positive cash flow enabling the Company to continue to meet operational needs as well as increase its investment-grade securities to provide ample protection for policyholders.\nStudent loans are a service the Company makes available to the public as well as an investment. While the Company anticipates the seasonal demand for student loan funds and the subsequent sale of such loans to the Student Loan Marketing Association (SLMA), there are times when additional funds are required to meet demand for student loans until such time as the sale thereof to SLMA can be completed. In 1995 the Company renewed its $15,000,000 line of credit with SLMA in order to meet these seasonal borrowing requirements. The Company made several draws against this line of credit throughout the seasonal period. The Company anticipates continued borrowings to be made through this line of credit with SLMA to the extent that student loan borrowings are required for 1996. SLMA offers a more competitive rate of interest on such borrowings than the Company has been able to obtain through banks.\nThe following table displays pertinent information regarding the short-term borrowings of the Company as they relate to these credit lines:\nThe Company continued its association with University Support Services throughout 1995, for the purpose of making more student loan funds available without increased costs to the Company. This association aided in keeping borrowings to a minimum for 1995. The Company is currently in negotiations with another firm that would accomplish this same benefit to a greater extent.\nExcept as otherwise provided herein, management believes that cash flow levels in future periods will be such that the Company will be able to continue its prior growth patterns in writing life insurance policies, fund Federally insured student loans and meet normal operating expenses.\nThe National Association of Insurance Commissioners, in order to enhance the regulation of insurer solvency, issued a model law to implement risk-based capital (RBC) requirements for life insurance companies, which are designed to assess capital adequacy. Pursuant to the model law, insurers having less statutory surplus than required by the RBC calculation will be subject to varying degrees of regulatory action. While Florida, the Company's state of domicile, had yet to adopt the provisions of the RBC model law, the Company is monitoring their RBC results in anticipation of future adoption. At December 31, 1995, the Company had statutory surplus well in excess of any RBC action level requirements.\nThe Company recently executed a lease with a new tenant for the remaining 1200 square foot of rentable space on the first floor of the office building. The contract includes the build-out of the space to serve as office space. The Company has agreed to cover expenditures of the build-out and the lessee has agreed to rent the space for a five year period. The build-out is estimated to have a cost of $16,000. The Company, at this time, has no other material commitments for capital expenditures through the balance of this year.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\n(The remainder of this page is intentionally left blank)\nIndependent Auditors' Report -----------------------\nBoard of Directors Southern Security Life Insurance Company:\nWe have audited the accompanying financial statements of Southern Security Life Insurance Company as listed in the accompanying index under item 14(a). In connection with our audit of the financial statements, we have also audited the amounts included in the financial statement schedules as listed in the accompanying index under Item 14(a)2. These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Southern Security Life Insurance Company as of December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the years in the three year period ended December 31, 1995, 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(c) to the financial statements, 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,\" in 1994.\n\/S\/KPMG Peat Marwick LLP\nOrlando, Florida March 26, 1996\nSOUTHERN SECURITY LIFE INSURANCE COMPANY\nBalance Sheets\nDecember 31, 1995 and 1994\nSee accompanying notes to financial statements.\nSOUTHERN SECURITY LIFE INSURANCE COMPANY\nStatements of Income\nYears ended December 31, 1995, 1994, and 1993\nSOUTHERN SECURITY LIFE INSURANCE COMPANY\nStatements of Shareholders' Equity\nYears ended December 31, 1995, 1994 and 1993\nSOUTHERN SECURITY LIFE INSURANCE COMPANY\nStatements of Cash Flows\nYears ended December 31, 1995, 1994 and 1993\nSOUTHERN SECURITY LIFE INSURANCE COMPANY\nStatements of Cash Flows, Continued\nSOUTHERN SECURITY LIFE INSURANCE COMPANY\nNotes to Financial Statements\nDecember 31, 1995, 1994 and 1993\n(1) Nature of Business and Summary of Significant Accounting Policies ------------------------------------------------------ (a) Nature of Business --------------- The primary business purpose of Southern Security Life Insurance Company (the \"Company\") is the issuance of long duration universal life insurance contracts. Prior to 1986, the Company's business included traditional whole life and annuity contracts. The majority of the Company's business is conducted in the states of Florida (50%), Georgia (15%) and Texas (11%). None of the remaining eight states in which the Company is licensed to conduct business account for over 10% of the Company's total business.\nThe following is a description of the most significant risks facing life and health insurers and how the Company mitigates those risks:\nLegal\/Regulatory Risk is the risk that changes in the legal or regulatory environment in which an insurer operates will create additional expenses not anticipated by the insurer in pricing its products. That is, regulatory initiatives designed to reduce insurer profits, new legal theories or insurance company insolvencies through guaranty fund assessments may create costs for the insurer beyond those recorded in the consolidated financial statements. The Company seeks to mitigate this risk through geographic marketing of their insurance products.\nCredit Risk is the risk that issuers of securities owned by the Company will default or that other parties, including reinsurers, which owe the Company money, will not pay. The Company minimizes this risk by adhering to a conservative investment strategy, by maintaining sound reinsurance and by providing for any amounts deemed uncollectible.\nInterest Rate Risk is the risk that interest rates will change and cause a decrease in the value of an insurer's investments. This change in rates may cause certain interest-sensitive products to become uncompetitive or may cause disintermediation. The Company mitigates this risk by charging fees for nonconformance with certain policy provisions, by offering products that transfer this risk to the purchaser, and\/or by attempting to match the maturity schedule of its assets with the expected payouts of its liabilities. To the extent that liabilities come due more quickly than assets mature, an insurer would have to sell assets prior to maturity and potentially recognize a gain or loss.\n(b) Basis of Financial Statements ----------------------- The financial statements have been prepared on the basis of generally accepted accounting principles (\"GAAP\"), which vary from reporting practices prescribed or permitted by regulatory authorities.\n(Continued)\nSOUTHERN SECURITY LIFE INSURANCE COMPANY\nNotes to Financial Statements\n(1), Continued\n(c) Use of Estimates ------------- In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities. Actual results could differ significantly from those estimates.\nThe estimates susceptible to significant change are those used in determining the liability for future policy benefits and claims, deferred income taxes and deferred policy acquisition costs. Although some variability is inherent in these estimates, management believes that the amounts provided are adequate.\n(d) Investments --------- Effective January 1, 1994, the Company adopted Statement of Financial Accounting Standards No. 115 (\"SFAS 115\"), \"Accounting for Certain Investments in Debt and Equity Securities.\" SFAS 115 requires that investments in all debt securities and those equity securities with readily determinable market values be classified into one of three categories: held-to-maturity, trading or available-for-sale. Classification of investments is based upon management's current intent. Debt securities which management has a positive intent and ability to hold until maturity are classified as securities held-to-maturity and are carried at amortized cost. Unrealized holding gains and losses on securities held-to-maturity are not reflected in the financial statements. Debt and equity securities that are purchased for short-term resale are classified as trading securities. Trading securities are carried at fair value, with unrealized holding gains and losses included in earnings. All other debt and equity securities not included in the above two categories are classified a securities available-for-sale. Securities available-for-sale are carried at fair value, with unrealized holding gains and losses reported as a separate component of stockholders' equity, net of tax and a valuation allowance against deferred acquisition costs. At December 31, 1995 and 1994, the Company did not have any investments categorized as trading securities. Adoption of this statement had no effect on the income of the Company.\nThe Company's carrying value for investments in the held-to-maturity and available-for-sale categories is reduced to its estimated realizable value if a decline in the market value is deemed other than temporary. Such reductions in carrying values are recognized as realized losses and charged to income.\nInterest on fixed maturities and short-term investments is credited to income as it accrues on the principal amounts outstanding adjusted for amortization of premiums and discounts computed by the scientific method, which approximates the effective yield method. Realized gains and losses on disposition of investments are included in net income. The cost of investment sold is determined on the specific identification method. Dividends are recorded as income on the ex-dividend dates.\n(Continued)\nSOUTHERN SECURITY LIFE INSURANCE COMPANY\nNotes to Financial Statements\n(1), Continued\n(d), Continued\nPolicy loans and student loans are carried at the unpaid principal balance, less any amounts deemed to be uncollectible. The Company's policy is that policy loans are made for amounts in excess of the cash surrender value of the related policy. Accordingly, policy loans are fully collateralized by the related liability for future policy benefits for traditional insurance policies and by the policyholders' account balance for interest sensitive policies.\n(e) Cash and Cash Equivalents ---------------------- For purposes of the statements of cash flows, the Company considers all highly liquid debt instruments purchased with an original maturity of one month or less to be cash equivalents.\n(f) Deferred Policy Acquisition Costs --------------------------- The costs of acquiring new business, net of the effects of reinsurance, principally commissions and those home office expenses that tend to vary with and are primarily related to the production of new business, have been deferred. Deferred policy acquisition costs applicable to non-universal life policies are being amortized over the premium-paying period of the related policies in a manner that will charge each year's operations in direct proportion to the estimated receipt of premium revenue over the life of the policies. Premium revenue estimates are made using the same interest, mortality and withdrawal assumptions as are used for computing liabilities for future policy benefits. Acquisition costs relating to universal life policies are being amortized at a constant rate based on the present value of the estimated gross profit amounts expected to be realized over the life of the policies. Beginning January 1, 1994, deferred policy acquisition costs are adjusted to reflect the impact of unrealized gains and losses on fixed maturity securities available for sale.\nThe Company has performed several tests concerning the recoverability of deferred acquisition costs. These methods include those typically used by many companies in the life insurance industry. Further, the Company conducts a sensitivity analysis of its assumptions that are used to estimate the future expected gross profits, which management has used to determine the future recoverability of the deferred acquisition costs.\n(g) Depreciation ---------- Depreciation is being provided on the straight-line method over the estimated useful lives of the assets.\n(Continued)\nSOUTHERN SECURITY LIFE INSURANCE COMPANY\nNotes to Financial Statements\n(1), Continued\n(h) Future Policy Benefits ------------------ The liability for future policy benefits has been provided on a net level premium based upon estimated investment yields, withdrawals, mortality and other assumptions that were appropriate at the time the policies were issued. Such estimates are based upon industry data and the Company's past experience as adjusted to provide for possible adverse deviation from the estimates.\n(i) Recognition of Premium Revenue and Related Costs ----------------------------------------- Premiums are recognized as revenue as follows:\nUniversal life policies - premiums received from policyholders are reported as deposits. Cost of insurance, policy administration and surrender charges which are charged against the policyholder account balance during the period, are recognized as revenue as earned. Amounts assessed against the policyholder account balance that represent compensation to the Company for services to be provided in future periods are reported as unearned revenue and recognized in income using the same assumptions and factors used to amortize acquisition costs capitalized.\nAnnuity contracts with flexible terms - premiums received from policyholders are reported as deposits.\nAll other policies - recognized as revenue over the premium paying period.\n(j) Income Taxes ----------- 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. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.\n(k) Earnings Per Share --------------- Earnings per share are computed based on weighted average outstanding shares for each year.\n(l) Reclassification ------------- Certain amounts presented in the 1994 and 1993 financial statements have been restated to conform to the 1995 presentation.\n(Continued)\nSOUTHERN SECURITY LIFE INSURANCE COMPANY\nNotes to Financial Statements\n(2) Basis of Financial Statements ----------------------- The more significant generally accepted accounting principles applied in the preparation of financial statements that differ from life insurance statutory accounting practices prescribed or permitted by regulatory authorities (which are primarily designed to demonstrate solvency) are as follows:\n(a) Costs of acquiring new business are deferred and amortized, rather than being charged to operations as incurred.\n(b) The liability for future policy benefits and expenses is based on conservative estimates of expected mortality, morbidity, interest, withdrawals, and future maintenance and settlement expenses, rather than on statutory rates for mortality and interest.\n(c) The liability for policyholder funds associated with universal life and certain annuity contracts are based on the provisions of Statement of Financial Accounting Standards Statement No. 97, rather than on the statutory rates for mortality and interest.\n(d) Investments in securities are reported as described in note 1(c), rather than in accordance with valuations established by the National Association of Insurance Commissioners (\"NAIC\"). Pursuant to NAIC valuations, bonds eligible for amortization are reported at amortized value; other securities are carried at values prescribed by or deemed acceptable by NAIC including common stocks, other than stocks of affiliates, at market value.\n(e) Deferred income taxes, if applicable, are recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.\n(f) The statutory liabilities for the asset valuation reserve and interest maintenance reserve have not been provided in the financial statements.\n(g) Certain assets, principally receivables from agents and equipment, are reported as assets rather than being charged directly to surplus.\n(h) Expenses attributable to the public offering of the common shares have been reclassified from retained earnings to capital in excess of par.\n(i) Realized gains or losses on the sale or maturity of investments are included in the statement of income and not recorded net of taxes and amounts transferred to the interest maintenance reserve as required by statutory accounting practices.\n(Continued)\nSOUTHERN SECURITY LIFE INSURANCE COMPANY\nNotes to Financial Statements\n(2), Continued\n(j) Certain proceeds from a note payable (note 9) that are treated as shareholders' equity for statutory purposes are treated as a liability under generally accepted accounting principles.\n(k) Reinsurance assets and liabilities are reported on a gross basis rather than shown on a net basis as permitted by statutory accounting practices.\nA reconciliation of net income (loss) for the years ended December 31, 1995, 1994 and 1993 and shareholders' equity as of December 31, 1995 and 1994 between the amounts reported on a statutory basis and the related amounts presented on the basis of generally accepted accounting principles is as follows:\n(Continued)\nSOUTHERN SECURITY LIFE INSURANCE COMPANY\nNotes to Financial Statements\n(2), Continued\nUnder applicable laws and regulations, the Company is required to maintain minimum surplus as to policyholders, determined in accordance with regulatory accounting practices, in the aggregate amount of approximately $1,800,000.\nThe payment of dividends by the Company is subject to the regulation of the State of Florida Department of Insurance. A dividend may be declared and paid without prior Florida Insurance Commissioner's approval if the dividend is equal to or less than the greater of: (a) 10% of the Company's surplus as to policyholder's derived from realized net operating profits on its business and net realized capital gains; or (b) the Company's entire net operating profits and realized net capital gains derived during the immediately preceding calendar year, if the Company will have surplus as to policyholders equal to or exceeding 115% of the minimum required statutory surplus as to policyholders after the dividend is declared and paid. As a result of such restrictions, the maximum dividend payable by the Company during 1996 without prior approval is approximately $200,000.\nThe Risk-Based Capital (\"RBC\") for Life and\/or Health Insurers Model Act (the \"Model Act\") was adopted by the National Association of Insurance Commissioners (NAIC) in 1992. The main purpose of the Model Act is to provide a tool for insurance regulators to evaluate the capital of insurers. Based on calculations using the appropriate NAIC formula, the Company exceeded the RBC requirements at December 31, 1995.\n(3) Investments --------- (a) Equity Securities and Fixed Maturities ------------------------------- Equity securities consist of $1,715,386 and $1,380,761 of common stock at December 31, 1995 and 1994, respectively.\nUnrealized (depreciation) appreciation in investments in equity securities for the years ended December 31, 1995 and 1994 is $406,611 and $(108,809), respectively.\n(Continued)\nSOUTHERN SECURITY LIFE INSURANCE COMPANY\nNotes to Financial Statements\n(3), Continued\n(a), Continued\nThe amortized cost and estimated fair values of investments in debt securities are as follows:\n(Continued)\nSOUTHERN SECURITY LIFE INSURANCE COMPANY\nNotes to Financial Statements\n(3), Continued\n(a), Continued\n(Continued)\nSOUTHERN SECURITY LIFE INSURANCE COMPANY\nNotes to Financial Statements\n(3), Continued\n(a), Continued\nUnrealized (depreciation) appreciation of fixed maturities for years ending December 31, 1995, 1994 and 1993 is $2,779,872, $(2,534,413) and $351,427, respectively.\n(Continued)\nSOUTHERN SECURITY LIFE INSURANCE COMPANY\nNotes to Financial Statements\n(3), Continued\n(a), Continued\nThe amortized cost and estimated fair value of fixed maturities at December 31, 1995, by contractual maturity, are summarized 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.\nFixed maturity securities held-to-maturity:\n(Continued)\nSOUTHERN SECURITY LIFE INSURANCE COMPANY\nNotes to Financial Statements\n(3), Continued\n(a), Continued\nProceeds from sale of equity securities and fixed maturities available for sale and related realized gains and losses are summarized as follows:\nCertain of the fixed maturity securities classified as available for sale and held to maturity were called during the year ended December 31, 1995 resulting in the following realized gains and losses:\n1995 1994 ---- ---- Held to maturity: Gross realized gains $ 6 - Available for sale: Gross realized gains - 10,060 -- ----- $ 6 10,060 == ===== (b) Concentrations of Credit Risk ------------------------ At December 31, 1995 and 1994, the Company did not hold any unrated or less-than-investment grade corporate debt securities. The Company also invests in subsidized and nonsubsidized student loans totaling $4,403,061 and $4,837,123 at December 31, 1995 and 1994, respectively, which are guaranteed by the U.S. government. Subsequent to December 31, 1995, all of these loans were sold at their unpaid principal balance.\n(Continued)\nSOUTHERN SECURITY LIFE INSURANCE COMPANY\nNotes to Financial Statements\n(3), Continued\n(c) Investment Income ---------------- Net investment income for the years ended December 31, 1995, 1994 and 1993 consists of the following:\n(d) Investments on Deposit ------------------- In order to comply with statutory regulations, investments were on deposit with the Insurance Departments of certain states as follows:\n1995 1994 ---- ---- Florida $ 1,735,900 1,744,017 Alabama 100,000 100,000 South Carolina 304,696 305,356 Georgia 251,193 250,000 ------- ------- 2,391,789 2,399,373 ======= ======= Certain of these assets, totaling approximately $650,000 for each of the years ended December 31, 1995 and 1994, are restricted for the future benefit of policyholders in a particular state.\n(Continued)\nSOUTHERN SECURITY LIFE INSURANCE COMPANY\nNotes to Financial Statements\n(4) Deferred Policy Acquisition Costs --------------------------- Deferred policy acquisition costs at December 31, 1995, 1994 and 1993 consist of the following:\n(5) Property and Equipment ------------------- Property and equipment at December 31, 1995 and 1994 consists of the following:\n1995 1994 ---- ---- Land $ 982,027 982,027 Building and improvements 2,152,203 2,049,150 Furniture and equipment 1,013,268 1,025,436 ------- ------- 4,147,498 4,056,613 Less accumulated depreciation 1,270,317 1,232,443 ------- ------- $ 2,877,181 2,824,170 ======= =======\nDepreciation expense for the years ended December 31, 1995, 1994 and 1993 totaled $150,213, $148,355 and $163,400, respectively.\n(Continued)\nSOUTHERN SECURITY LIFE INSURANCE COMPANY\nNotes to Financial Statements\n(6) Future Policy Benefits ------------------ At December 31, 1995 and 1994, future policy benefits, exclusive of universal life and flexible term annuities, consist of the following:\n1995 1994 ---- ---- Life insurance $ 746,477 701,498 Annuities 296,242 332,490 Accident and health insurance 7,779 7,657 ------- ------- Total life insurance policies $ 1,050,498 1,041,645 ======= ======= Life insurance in-force aggregated approximately $1.3 billion and $1.5 billion at December 31, 1995 and 1994, respectively.\nMortality and withdrawal assumptions are based upon the Company's experience and actuarial judgment with an allowance for possible unfavorable deviations from the expected experience.\nThe mortality table used in calculating benefit reserves is the 1965-1970 Basic Select and Ultimate for males.\nFor non-universal life policies written during 1983 through 1988, interest rates used are 8.0 percent for policy years one through five, decreasing by .1 percent per year for policy years six through twenty, to 6.5 percent for policy years twenty-one and thereafter. For non-universal life policies written in 1982 and prior, interest rates vary, depending on policy type, from 7 percent for all policy years to 6 percent for policy years one through five and 5 percent for years six and thereafter. For universal life policies written since 1988, the interest rate used is a credited rate based upon the Company's investment yield plus 1 percent.\n(7) Reinsurance ---------- The Company routinely cedes and, to a limited extent, assumes reinsurance to limit its exposure to loss on any single insured. Ceded insurance is treated as a risk and liability of the assuming companies. As of December 31, 1995, ordinary insurance coverage in excess of $75,000 is reinsured; however, for some policies previously issued, the first $30,000, $40,000 or $50,000 was retained and the excess ceded. The retention limit for some substandard risks is less than $75,000. Reinsured risks would give rise to liability to the Company only in the event that the reinsuring company might be unable to meet its obligations under the reinsurance agreement in force, as the Company remains primarily liable for such obligations. Under these contracts, the Company has ceded premium of $525,662, $585,957 and $510,469 included in reinsurance ceded, and received recoveries of $204,171, $514,868 and $405,293 included in annuity, death and other benefits for the years ended December 31, 1995, 1994 and 1993, respectively.\n(Continued)\nSOUTHERN SECURITY LIFE INSURANCE COMPANY\nNotes to Financial Statements\n(7), Continued\nOn December 31, 1992, the Company entered into a reinsurance agreement ceding an 18% share of all universal life policies in force at December 31, 1992 as a measure to manage the future needs of the Company. The reinsurance agreement is a co-insurance treaty entitling the assuming company to 18% of all future premiums, while making the ceding company responsible for 18% of all future claims and policyholder loans relating to the ceded policies. In addition, the Company receives certain commission and expense reimbursements. Assets with a market value approximating the balance of policyholders' account balances less policy loans, on a statutory basis, ceded to the reinsurer are held in trust for benefit of the Company. The market value of those assets was $6,702,079 at December 31, 1995.\nAs of December 31, 1992, the Company ceded premiums of $5,240,058, equal to the 18% of net statutory reserves ceded on the effective date of the contract. In return, the Company received a commission and expense allowance of $2,497,370. The economic gain on the reinsurance transaction amounted to approximately $1,600,000, however, management deferred approximately $1,000,000 of the gain against deferred acquisition costs as a provision for the recoverability of such costs. Based upon management's and actuarial evaluation of such costs, approximately $200,000, $500,000 and $300,000 of the amount deferred was amortized against deferred acquisition costs during 1995, 1994 and 1993, respectively.\nFor the years ended December 31, 1995 and 1994, the Company ceded premiums of $675,770 and $758,956, included in reinsurance ceded, and received recoveries of $459,090 and $386,509, included in annuity, death and other benefits, respectively. The funds held in reinsurance treaties with reinsurer of $977,416 and $700,701 represent the 18% share of policy loans ceded to the reinsurer at December 31, 1995 and 1994, respectively.\n(8) Notes Payable ----------- The note payable of $1,400,553 and $891,823 at December 31, 1995 and 1994, respectively, secured by student loans equaling 115% of the unpaid principal balance, relates to advances under a $10,000,000 line of credit ($8,599,447 available to be drawn at December 31, 1995). The note bears interest at a variable rate, 6% at December 31, 1995 and matures on August 19, 1996.\nInterest expense relating to these notes payable during the three years ended December 31, 1995, 1994 and 1993 totaled $26,240, $60,864 and $73,924, respectively and is included in net investment income.\n(Continued)\nSOUTHERN SECURITY LIFE INSURANCE COMPANY\nNotes to Financial Statements\n(9) Note Payable to Related Party ------------------------ Note payable to related party consists of amounts due on demand to Consolidare Enterprises, Inc., the Company's majority shareholder. The note proceeds were obtained in December, 1988 and the note qualifies as shareholders' equity for statutory accounting purposes in accordance with Section 628.401 of the Florida Statutes. At December 31, 1995, the note bears interest at 9.0% percent (payable monthly); principal repayment is contingent upon the Company maintaining statutory surplus in excess of $1,750,000 and approval in advance by the Florida Department of Insurance. Interest expense relating to the balance of note payable to related party during 1995, 1994 and 1993 aggregated $90,000, $90,000 and $90,000, respectively.\n(10) Income Taxes ----------- As discussed in note 1(j), the Company adopted Statement 109 in 1992 and has applied the provisions of Statement 109 retroactively to January 1, 1991.\nIncome taxes for the years ended December 31, 1995, 1994 and 1993 is summarized as follows:\n1995 1994 1993 ---- ---- ---- Current: Federal $ 370,800 100,000 129,000 State 10,200 - 14,000 ------ ------ ------ 381,000 100,000 143,000 ------ ------ ------ Deferred: Federal (188,700) 387,000 (128,000) State (32,300) 43,000 (14,000) ------ ------ ------ (221,000) 430,000 (142,000) ------ ------ ------ $ 160,000 530,000 1,000 ====== ====== ======\n(Continued)\nSOUTHERN SECURITY LIFE INSURANCE COMPANY\nNotes to Financial Statements\n(10), Continued\nIncome tax expense for the years ended December 31, 1995, 1994 and 1993 differs from \"expected\" tax (computed by applying the U.S. federal income tax rate of 35% in 1995 and 1994 and 34% in 1993 to pretax income) as a result of the following:\nUnder tax laws in effect prior to 1984, a portion of a life insurance company's gain from operations was not currently taxed but was accumulated in a memorandum \"Policyholders' Surplus Account.\" As a result of the Tax Reform Act of 1984, the balance of the Policyholders' Surplus Account has been frozen as of December 31, 1983 and no additional amounts will be accumulated in this account. However, distributions from the account will continue to be taxed, as under previous law, if any of the following conditions occur:\n(a) The Policyholders' Surplus exceeds a prescribed maximum; or\n(b) Distributions, other than stock dividends, are made to shareholders in excess of Shareholders' surplus, as defined by prior law; or\n(c) The entity ceases to qualify for taxation as a life insurance company.\nAt December 31, 1995, the balance of the Policyholders' Surplus account aggregated approximately $236,000. The Company has not recorded deferred income taxes totaling approximately $80,000 relating to this amount as it has no plan to distribute the amounts in Policyholders' Surplus in the foreseeable future.\n(Continued)\nSOUTHERN SECURITY LIFE INSURANCE COMPANY\nNotes to Financial Statements\n(10), Continued\nThe Tax Reform Act of 1986 enacted a new separate parallel tax system referred to as the Alternative Minimum Tax (AMT) system. AMT is based on a flat rate applied to a broader tax base. It is calculated separately from the regular Federal income tax and the higher of the two taxes is paid. The excess of the AMT over regular tax is a tax credit, which can be carried forward indefinitely to reduce regular tax liabilities of future years. In 1995, 1994 and 1993, AMT exceeded regular tax by $62,600, $14,000 and $49,000, respectively. At December 31, 1995, the AMT tax credit available to reduce future regular tax totaled $333,600.\nThe principal elements of deferred income taxes consist of the following:\nThe tax effect of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 1995 and 1994 are presented below:\n(Continued)\nSOUTHERN SECURITY LIFE INSURANCE COMPANY\nNotes to Financial Statements\n(10), Continued\nThe net change in the total valuation allowance for the years ended December 31, 1995, 1994, and 1993 was an increase of $62,600, $14,000 and $49,000, respectively.\nIn assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Based upon the level of historical taxable income and projections for future taxable income over the periods which the deferred tax assets are deductible, management believes it is more likely than not the Company will realize the benefits of these deductible differences, net of the existing valuation allowances at December 31, 1995.\n(11) Related Party Transactions --------------------- The Company's general agent, Insuradyne Corporation, is a wholly-owned subsidiary of Consolidare Enterprise, Inc., which owns approximately fifty-nine percent (59%) of the Company's outstanding stock. The balances due (to) from affiliated insurance agency reflected in the accompanying balance sheets principally represent unearned commission advances paid to Insuradyne. The Company incurred commission expense to Insuradyne aggregating $422,121, $582,059 and $910,936, in 1995, 1994 and 1993, respectively. These amounts are included as components of acquisition costs deferred and related amortization. Insuradyne incurred insurance-related expenses aggregating $35,271, $192,332 and $230,478 in 1995, 1994 and 1993, respectively.\n(Continued)\nSOUTHERN SECURITY LIFE INSURANCE COMPANY\nNotes to Financial Statements\n(12) Agents' Incentive Stock Bonus Plan ----------------------------- The Company had an incentive bonus plan for agents that was adopted in 1983 and effective through December 31, 1990. Bonuses granted under the plan were vesting over a five year period commencing on the fifth anniversary date of the award. Once vested, the agent had the option to receive the bonus in cash or shares of common stock. The number of shares of common stock was determined on the date of the award as the number of whole shares equal to the award based on the applicable stock price on that date.\nThe first awards granted became fully vested during April, 1993. On November 17, 1993, the Board of Directors approved an amendment to the plan to provide an early payment option. The agents were given an increased award in exchange for settling the awards early. During 1994, a total award was distributed in the form of 63,295 shares of common stock, totaling $125,000 and cash of $3,336.\n(13) Disclosures About Fair Value of Financial Instruments ------------------------------------------- Statement of Financial Accounting Standards No. 107 Disclosures About Fair Value of Financial Instruments (SFAS 107) requires the Company to disclose estimated fair value information. The following methods and assumptions were used by the Company in estimating fair values of financial instruments as disclosed herein:\nCash and cash equivalents, short-term investments and policy and student loans: The carrying amount reported in the balance sheet for these instruments approximate their fair value.\nInvestment securities available-for-sale and held-to-maturity: Fair value for fixed maturity and equity securities is based on quoted market prices at the reporting date for those or similar investments.\n(Continued)\nSOUTHERN SECURITY LIFE INSURANCE COMPANY\nNotes to Financial Statements\n(13), Continued\nThe following table presents the carrying amounts and estimated fair values of financial instruments held at December 31, 1995 and 1994. The fair value of a financial instrument is the amount at which the instrument could be exchanged in a current transaction between willing parties.\n(14) Legal Proceedings --------------- Lawsuits against the Company have arisen in the normal course of the Company's business. However, contingent liabilities arising from litigation and other matters are not considered material in relation to the financial position of the Company.\nTo the best of the Company's knowledge, it has no potential or pending contingent liabilities that might be material to the Company's financial condition, results of operations or liquidity pursuant to product and environmental liabilities.\nSchedule I\nSOUTHERN SECURITY LIFE INSURANCE COMPANY\nSummary of Investments Other Than Investments in Related Parties\nDecember 31, 1995\nSee accompanying auditors' report.\nSchedule III\nSOUTHERN SECURITY LIFE INSURANCE COMPANY\nSupplementary Insurance Information\nDecember 31, 1995, 1994 and 1993\n(a)Amounts for reinsurance ceded included in the December 31, 1991 balances have not been reclassified out of future policy benefits and policyholders' account balance at December 31, 1993 to reflect the adoption of SFAS No. 113.\nSee accompanying auditors' report.\nSchedule IV\nSOUTHERN SECURITY LIFE INSURANCE COMPANY\nReinsurance\nDecember 31, 1995, 1994 and 1993\nSchedule IV Page 2 of 2\nSOUTHERN SECURITY LIFE INSURANCE COMPANY\nReinsurance\nDecember 31, 1995, 1994 and 1993\nSee accompanying auditors' report.\nItem 9.","section_9":"Item 9. Change in and 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 Company.\n(a) Directors. The following table lists the names and ages of all directors of the Company at December 31, 1995, states the date when service as a director of the Company began, and lists all other positions or offices with the Company presently held by each such person.\nAll Directors serve until the next Annual Meeting of Share holders and until their respective successors are duly elected and qualified. All of the Directors named in the table above are stock- holders of Consolidare Enterprises, Inc., which purchased effective control of the Company on May 3, 1978. Except for such affiliation with Consolidare Enterprises, Inc., there exists no arrangement or understanding between any Director and any other person or persons pursuant to which any of such Directors were selected as Directors of the Company.\n(b) Executive Officers. The following table lists the names and ages of the executive officers of the Company, the positions with the Company presently held by each such officer, and the period during which each has served as such: Position Commencement Name Age Held of Service\nThe Company has an executive compensation agreement with George Pihakis, President and Chief Executive Officer of the Company. The term of the agreement is automatically extended each year for an additional five year period unless either party gives notice of termination. The agreement provides for annual increases in Mr. Pihakis' compensation in such amounts as shall be determined by the Board of Directors.\nAt a meeting of the Company's Board of Directors in January of 1993, the base compensation payable to Mr. Pihakis under the agreement was raised to $244,800.\nExcept as set forth herein, the officers of the Company have no definite terms of office as such; they serve at the pleasure of the Board of Directors. The Board of Directors customarily elects officers annually.\n(c) Business Experience of Officers and Directors. The following is a brief account of the business experience of each executive officer and Director of the Company during the past five years or more:\nSamuel F. Brewer - Since July of 1990, Mr. Brewer has been the owner of Brewer Development Corporation, Inc., a food service company. From 1976 to present, Mr. Brewer has been owner and President of Brewer-Costin Inc. Insurance. From 1983 to 1989, Mr. Brewer served as the State Executive Director of the Georgia office of the Agricultural Stabilization and Conservation Services of the U.S. Department of Agriculture. Mr. Brewer is the brother-in-law of Ferris S. Ritchey, Jr., a director of the Company.\nNikki Clark - Ms. Clark has been employed by the Company since 1988. Since her employment by the Company, her duties have\nincluded responsibility for policyholder services, data processing services, agent advances and commissions, agent licensing matters and record keeping. In July of 1992, Ms. Clark was elected to the office of Vice President and Director of Financial Services for the Company. Ms. Clark is the daughter of Mr. George Pihakis, the President and Chief Executive Officer of the Company.\nA. Thomas Frank - Mr. Frank was the Chairman of the Board and the President of Medidentic, Inc., a financial consulting firm for physicians, from 1959 - 1989. Mr. Frank retired from this position in 1989.\nFrank A. Hulet - Mr. Hulet served as a consultant to Food-Mills, Inc. d\/b\/a Jayhawk Manufacturing Company, a manufacturer of food processing machinery located in Hutchinson, Kansas until he retired in 1992. From 1977 to 1983, Mr. Hulet served as Secretary\/ Treasurer and General Manager of Jayhawk Manufacturing Company.\nC. Wesley Johnson - For more than five years, Mr. Johnson had been manager of the Sacramento Field Office of the Fort Worth Division of General Dynamics Corporation, a diversified aerospace company. Mr. Johnson retired from this position in 1984.\nLewis E. Kassis - Mr. Kassis has for many years been the Chairman of the Board and part owner of Wholesale Cash & Carry (Grocers), Sacramento, California. He is also a partner of Kassis Enterprises, Country Club Lanes, Kassis Wholesale Co. and an officer of Kassis Building Co.\nRobert L. Martin - Mr. Martin is a rancher and cattlebroker. He is the owner of Robert Lee Martin Ranch and a partner in I. L. Martin Ranch, both of which are located in Jacksboro, Texas.\nCharles W. Mullenix - Dr. Mullenix is an ophthalmologist who has served for more than five years as President of Charles W. Mullenix and Richard B. O'Grady, S. C., Ophthalmologists, Glenview, Illinois.\nGeorge Pihakis - Mr. Pihakis has served as President and Chief Executive Officer of the Company since June of 1978. He is also the President of Insuradyne Corporation. Mr. Pihakis is the father of Ms. Nikki Clark, a Vice President and the Director of Financial Services for the Company.\nStephen L. Reck - Mr. Reck has been an FSA, Fellow of the Society of Actuaries, since 1972. He has been with Southern Security since 1993 serving as the Chief Actuary. His primary responsibility has been developing new products as the Company expands their marketing to other distribution outlets. Prior to joining Southern Security he was the President of Coastal States Life Insurance Company.\nFerris S. Ritchey, Jr. - Mr. Ritchey, an attorney, is the senior partner in the law firm of Ritchey & Ritchey, P. A., a position which he has occupied for more than five years. He is an officer of Bowlo-Mac, Inc., Super Bowl, Inc., Stonehenge, Inc., Vestavia Bowl, Inc., and P.R. Leasing Co., Inc. Mr. Ritchey is the brother-in-law of Samuel F. Brewer, a Director of the Company.\nTerri Seamon - Ms. Seamon has been an employee of the Company since August of 1985. Since her employment by the Company her duties have included chief accountant and controller. In July of 1992 Ms. Seamon was elected to the office of Vice President and Controller of the Company.\nDavid C. Thompson - Since April of 1978, Mr. Thompson has served as Executive Vice President and Chief Operating Officer and Treasurer of the Company. Since 1982, Mr. Thompson has served as Secretary of the Company. He also serves as Vice President of Consolidare Enterprises and is Vice President and Treasurer of Insuradyne Corporation. He is also the President of and a stock- holder in BBQ Rib Ranch, Inc. Mr. Thompson is a certified public accountant.\nFerd F. Weil, Sr. - Since April of 1990, Mr. Weil has served as a marketing consultant to Compass Bank, Birmingham, Alabama. From 1969 until April of 1990, Mr. Weil was a marketing consultant to the National Bank of Commerce, Birmingham, Alabama. Since 1978, Mr. Weil has served as President and Treasurer of Consolidare Enterprises, Inc., the Company's parent.\nLloyd C. Zobrist - Mr. Zobrist is a retired general contractor and real estate developer from Morton, Illinois. He is a partner in Zobrist Development Co., WRCL, Co., and Cross Creek Development Company and is Secretary\/Treasurer of N. Zobrist & Sons, Inc.\nExcept as otherwise noted above, no family relationships exist between any of the Directors or executive officers of the Company.\nNo officer or Director of the Company presently holds a directorship in any other company with a class of securities registered pursuant to Section 12 of the Securities Exchange Act or subject to the requirements of Section 15(d) of the Securities Exchange Act or any company registered as an investment company under the Investment Company Act of 1940.\nNo person named as an officer or Director of the Company has, during the past five years, filed a petition under the Bankruptcy Code, been convicted of a crime, or been enjoined from participating in activities related to securities or engaging in any type of business practice. Neither has any such person been the subject of any order suspending his right to engage in any securities related activity or finding any person so named to have violated any Federal or state securities laws.\n(d) Compliance with Section 16(a) of the Exchange Act. The Company has no class of securities registered pursuant to Section 12 of the Exchange Act.\nItem 11.","section_11":"Item 11. Executive Compensation.\n(a) Summary Compensation. The following summary compensation table is provided with respect to the Company's Chief Executive Officer and its Executive Vice President, who constitute all of the executive officers of the Company whose total annual salary and bonus exceed $100,000:\n(1) During 1995 this amount included $4,800 paid in the form of a Director's fee, $250 paid in the form of an Executive Committee Fee, $4,524 paid in the form of a car allowance. During 1994 this amount included $3,600 paid in the form of a Director's fee, $500 paid in the form of an Executive Committee Fee, and $4,524 paid in the form of a car allowance. During 1993 this amount included $3,600 paid in the form of a Director's fee, $750 paid in the form of an Executive Committee Fee, $4,980 paid in the form of a car allowance.\n(2) During 1995 this amount included $4,800 paid in the form of a\nDirector's Fee, $250 paid in the form of an Executive Committee Fee, $6,000 paid in the form of a car allowance, and $720 paid in the form of dues at a social club used exclusively for business purposes. During 1994 this amount included $3,600 paid in the form of a Director's fee, $500 paid in the form of an Executive Committee fee, $6,000 paid in the form of a car allowance and $600 paid in the form of dues at a social club used exclusively for business purposes. During 1993 this amount included $3,600 paid in the form of a Director's fee, $750 paid in the form of an Executive Committee fee, $6,000 paid in the form of a car allowance and $600 paid in the form of dues at a social club used exclusively for business purposes.\n(b) Perquisites. Executive officers of the Company who are employees of the Company are covered under a group life, group disability, and hospitalization plan that does not discriminate in favor of officers and that is generally available to all salaried employees. The Company does not have a pension, retirement or other deferred compensation plan, or any other similar arrangement.\n(c) Director's Fees and Other Fees. Directors of the Company receive a Director's fee of $4,800 per year for serving as Directors of the Company. Directors of the Company also receive the sum of $250 each for each committee meeting attended, if such committee meeting is not in conjunction with a meeting of the Company's Board of Directors held at the same time and place.\n(d) Employment Contracts. The Company has an executive compensation agreement with George Pihakis, President and Chief Executive Officer of the Company. The term of the agreement is automatically extended each year for an additional five year period unless either party gives notice of termination. The agreement provides for annual increases in Mr. Pihakis' compensation in such amounts as shall be determined by the Board of Directors. The base compensation payable to Mr. Pihakis under the agreement is $244,800.\n(e) Compensation Committee Interlocks and Insider Participation. The Executive Committee of the Company's Board of Directors makes recommendation to the Board of Directors concerning the compensation of the Company's executive officers. Subsequently, the Board of Directors makes all final decisions concerning such compensation. The Company's Executive Committee consists of Charles W. Mullenix, Ferris S. Ritchey, Jr., A. Thomas Frank, Ferd F. Weil, Lloyd C. Zobrist and George Pihakis, President and Chief Executive Officer.\n(f) Board Compensation Committee Report on Executive Compensation. In determining what level and type of compensation was made available to the Company's executive officers during 1995, the Executive Committee and Board of Directors considered the over- all performance of the Company and each officer's contribution to that performance. Specifically, in determining the compensation of Mr. Pihakis, the Company's President and Chief Executive Officer, the Executive Committee and Board of Directors considered his length of employment with the Company, his experience in the industry, the financial condition of the Company, payments received by other executive officers holding similar positions and performing similar duties, and other subjective criteria.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\n(a) The following table sets forth, as of December 31, 1995, information with respect to the only persons known by the Company to be the beneficial owner of more than 5% of the Company's outstanding voting securities:\nExecutive officers and directors of the Company are shareholders of Consolidare Enterprises, Inc., which was the owner of approximately 57% of the Company's voting securities at December 31, 1995. At December 31, 1995, approximately 62.8% of the issued and outstanding common shares of Consolidare Enterprises, Inc. was owned by directors and executive officers of Company. The following table sets forth information as to the common shares of Company's parent, Consolidare Enterprises, Inc., beneficially owned by all directors and executive officers of the Company at December 31, 1995.\n(1) Includes 70,645 shares registered in the name of Margaret Jeanne Frank, his wife.\n(2) Shares registered in the name of Frank and Virginia Hulet.\n(3) Shares registered in the name of Johnson Family Revocable Trust.\n(4) Shares registered in the name of Lewis and Helen Kassis Trust.\n(5) Shares attributed to Mr. Martin are registered in the name of his children.\n(6) 240,000 shares attributed to Mr. Mullenix are registered to the Mullenix Family Partnership. 75,548 shares are registered in the name of Mr. Mullenix and his wife, Mary Jane Mullenix.\n(7) Shares attributed to Mr. Pihakis are registered in the name of his wife, Dolores Pihakis. Mr. Pihakis disclaims any beneficial ownership of such shares.\n(8) Shares registered in the name of David C. and Patricia M. Thompson.\n(9) Shares registered in the name of Ferd and Helen Weil, Sr.\n(10) 141,799 Shares registered in the name of WRCL Company, of which Mr. Zobrist is a principal, and 11,751 shares are registered to Lloyd C. Zobrist, individually.\nIn addition to common stock, Consolidare Enterprises, Inc. has outstanding one additional class of securities, 14.25% Convertible Subordinated Debentures which are convertible into common shares of Consolidare.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nInsuradyne Corporation, a wholly-owned subsidiary of Consolidare Enterprises, Inc., serves as general agent for the Company, pursuant to a general agency agreement, which is terminable by either party with 30 days notice. In such capacity, Insuradyne receives a commission on the first year commissionable premium on certain of the Company's policies as well as a small renewal commission on certain other policies. In accordance with the Florida Insurance Code, a copy of the Company's General Agency Agreement with Insuradyne Corporation was filed with and approved by the Florida Department of Insurance. Management of the Company believes that the terms of its General Agency Agreement with Insuradyne are as favorable to the Company as terms which could be obtained from independent third parties. During 1995, gross commissions in the amount of $422,121 were earned by Insuradyne Corporation. At December 31, 1995, the Company owed $243,369 to Insuradyne as a result of commissions earned by Insuradyne but for which Insuradyne has not yet requested payment.\nNo Director or officer of the Company or any associates of any director or officer of the Company was indebted to the Company at December 31, 1995.\nThe Company continues to be indebted to its parent, Consolidare Enterprises, Inc., in the amount of $1,000,000, pursuant to a promissory note dated December, 1988, which bears interest at the annual rate of interest equal to the Prime Rate (as hereinafter defined) plus 2%, with such interest rate not to be less than 9% nor in excess of 11%. For purposes of this promissory note, \"Prime Rate\" is defined to mean the Prime Rate as announced by Compass Bank, Birmingham, Alabama, from time to time, as its prime rate (which interest rate is only a bench mark, is purely discretionary and is not necessarily the best or lowest rate charged borrowing customers). This promissory note is due on demand and is payable out of capital surplus in excess of $1,750,000, pursuant to Florida Statutes 628.401 (1990). Interest and principal can only be repaid upon the express written approval of the Florida Department of Insurance.\nOn December 31, 1995, approximately 62.8% of the issued and outstanding stock of Consolidare Enterprises, Inc. was owned by the directors and executive officers of the Company. See item 12 - Security Ownership of Certain Beneficial Owners and Management.\nFerris S. Ritchey, Jr., a Director and a member of the Executive Committee, is a member of the law firm of Ritchey & Ritchey, P.A., which serves as legal counsel to the Company on certain matters.\nPART IV\nItem 14.","section_14":"Item 14. Financial Statements, Exhibits filed and Reports on Form 8-K.\n(a) 1. Financial Statements Page Number\nThe following financial statements of Southern Security Life Insurance Company are included in Part II, Item 8:\nIndependent Auditors' Report............ 22\nBalance Sheets - December 31, 1995 and 1994........................... 23\nStatements of Income - years ended December 31, 1995, 1994 and 1993........ 25\nStatements of Shareholders' Equity - years ended December 31, 1995, 1994 and 1993.. 26\nStatements of Cash Flows - years ended December 31, 1995, 1994 and 1993........ 27\nNotes to Financial Statements........... 29\n2. Supplemental Schedules.\nRequired Financial Data - for the years ended December 31, 1995, 1994 and 1993 - included in Part II, Item 8:\nSchedule I - Summary of Investments - Other than Investments in Related Parties................................. 51\nSchedule III - Supplementary Insurance Information............................. 52\nSchedule IV - Reinsurance............... 53\nSchedules other than those listed above have been omitted because they are not applicable or because the required information is included in the financial statements and notes thereto or in Item 7 -Management's Discussion and Analysis of Financial Condition and Results of Operations.\n3. Exhibits\nExhibit Number Page Number\n3. Articles of Incorporation, as amended, and By-Laws, as amended (without exhibits) dated September 1994, incorporated by reference herein from From Exhibit 3(1) of the Annual Report of the Company filed on Form 10-K for the fiscal year ended December 31, 1994..... 76\n10. Executive Compensation Agree- ment between the Company and George Pihakis (without exhibits) incorporated by reference herein from Exhibit 10(B) of the Annual Report of the Company filed on Form 10-K for the fiscal year ended December 31, 1984................. 77\n10.A Revolving Financing Agreement between the Company and the Student Loan Marketing Association, dated as of August 19, 1995......................... 78\n10.B Reinsurance Agreement between the Company and United Group Insurance Company, dated as of December 31, 1992 incorporated by reference herein from Exhibit 10(B) of the Annual Report of the Company filed on Form 10-K for the fiscal year ended December 31, 1992............ 79\n10.C Agency Agreement between the Company and Insuradyne Corporation incorporated by reference herein from Exhibit 10(C) of the Annual Report of the Company filed on Form 10-K for the fiscal year ended December 31, 1993 80\n11. Statement Re Computation of Net Income per common share.................................... 81\n20. Definitive proxy materials for the Annual Meeting of Shareholders held July 15, 1995..... 82\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 Company has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nSOUTHERN SECURITY LIFE INSURANCE COMPANY\nBy: \/s\/George Pihakis George Pihakis President, Chief Executive Officer and Director\nBy: \/s\/David C. Thompson David C. Thompson Executive Vice President Secretary, Treasurer, Chief Operating Officer and Director\nDate: April 15, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following Director of the Company on the date indicated.\nSOUTHERN SECURITY LIFE INSURANCE COMPANY\nBy: \/s\/Samuel F. Brewer Samuel F. Brewer (Director) April 15, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following Director of the Company on the date indicated.\nSOUTHERN SECURITY LIFE INSURANCE COMPANY\nBy: \/s\/Alfred T. Frank Alfred T. Frank (Director) April 15, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following Director of the Company on the date indicated.\nSOUTHERN SECURITY LIFE INSURANCE COMPANY\nBy: \/s\/Frank A. Hulet Frank A. Hulet (Director) April 15, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following Director of the Company on the date indicated.\nSOUTHERN SECURITY LIFE INSURANCE COMPANY\nBy: \/s\/C. Wesley Johnson C. Wesley Johnson (Director) April 15, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following Director of the Company on the date indicated.\nSOUTHERN SECURITY LIFE INSURANCE COMPANY\nBy: \/s\/Robert Lee Martin Robert Lee Martin (Director) April 15, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following Director of the Company on the date indicated.\nSOUTHERN SECURITY LIFE INSURANCE COMPANY\nBy: \/s\/Dr. Charles W. Mullenix Dr. Charles W. Mullenix (Director) April 15, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following Director of the Company on the date indicated.\nSOUTHERN SECURITY LIFE INSURANCE COMPANY\nBy: \/s\/Ferris S. Ritchey, Jr. Ferris S. Ritchey, Jr. (Director) April 15, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following Director of the Company on the date indicated.\nSOUTHERN SECURITY LIFE INSURANCE COMPANY\nBy: \/s\/Ferd F. Weil, Sr. Ferd F. Weil, Sr. (Director) April 15, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following Director of the Company on the date indicated.\nSOUTHERN SECURITY LIFE INSURANCE COMPANY\nBy: \/s\/Lloyd C. Zobrist Lloyd C. Zobrist (Director) April 15, 1996\nSOUTHERN SECURITY LIFE INSURANCE COMPANY\nEXHIBIT 3\nEXHIBITS FILED WITH ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1994\nSOUTHERN SECURITY LIFE INSURANCE COMPANY\nEXHIBIT 10\nEXHIBITS FILED WITH ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1984\nSOUTHERN SECURITY LIFE INSURANCE COMPANY\nEXHIBIT 10.A\nREVOLVING FINANCING AGREEMENT BETWEEN THE COMPANY AND THE STUDENT LOAN MARKETING ASSOCIATION\nSOUTHERN SECURITY LIFE INSURANCE COMPANY\nEXHIBIT 10.B\nREINSURANCE AGREEMENT BETWEEN THE COMPANY AND UNITED GROUP INSURANCE COMPANY\nEXHIBIT FILED WITH ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1992\nSOUTHERN SECURITY LIFE INSURANCE COMPANY\nEXHIBIT 10.C\nAGENCY AGREEMENT BETWEEN THE COMPANY AND INSURADYNE CORPORATION\nEXHIBIT FILED WITH ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1993\nSOUTHERN SECURITY LIFE INSURANCE COMPANY\nEXHIBIT 11\nCOMPUTATION OF NET INCOME\nPER COMMON SHARE\n1995 1994 1993\nWeighted Average Shares Outstanding 1,907,989 1,907,989 1,844,694\nNet Income $1,114,903 $1,013,979 $704,652\nPer Share Amount $.58 $.53 $.38\nSOUTHERN SECURITY LIFE INSURANCE COMPANY\nEXHIBIT 20\nDEFINITIVE PROXY MATERIALS FOR THE ANNUAL MEETING","section_15":""}
{"filename":"797507_1995.txt","cik":"797507","year":"1995","section_1":"ITEM 1. BUSINESS\nGeneral\nProgressive Bank, Inc. (\"Progressive\", or, together with its wholly-owned subsidiary, the \"Company\") is a bank holding company that was organized under the laws of the State of New York on April 18, 1986 for the purpose of acquiring all of the issued and outstanding shares of Pawling Savings Bank (\"Pawling\") under a Plan of Reorganization. The reorganization was completed on October 17, 1986.\nPawling, a New York state-chartered stock savings bank, was organized in 1870 as a mutual savings bank and converted to stock form in 1984. Pawling currently conducts business through a network of 15 full service branch locations in six southern tier counties of New York State: Dutchess, Sullivan, Orange, Putnam, Ulster and Westchester. In 1993, the Company began originating loans in the Connecticut counties of Fairfield, Hartford, New Haven and Litchfield. In addition, originations of one-to-four family mortgage loans were expanded in 1995 to include the New York counties of Nassau, Suffolk and Rockland. Pawling provides a full range of community banking services to meet the needs of the communities it serves. Pawling is engaged principally in the business of attracting retail deposits from the general public and the business community and investing those funds in residential and commercial mortgages, consumer loans and securities.\nThe Company had net income of $6.8 million, or $2.50 per share, for the year ended December 31, 1995. Total assets at December 31, 1995 were $743.2 million. At December 31, 1995, the Company employed 250 people on a full-time equivalent basis.\nThe executive offices of both Progressive and Pawling are located at 1301 Route 52, Fishkill, New York 12524. The telephone number is (914) 897-7400.\nCompetition\nThe Company faces significant competition for both the loans it makes and the deposits it accepts. The Company's market area has a high density of financial institutions, many of which are branches of significantly larger non-local institutions which have greater financial resources than the Company, and all of which are competitors of the Company to varying degrees. The Company and its competitors are significantly affected by general economic and competitive conditions, particularly changes in market interest rates, government policies and actions of regulatory authorities.\nThe Company's competition for loans comes principally from savings banks, credit unions, savings and loan associations, commercial banks, mortgage banking companies and insurance companies. The Company competes successfully for loans primarily by emphasizing the quality of its loan services and by charging loan fees and interest rates that are generally competitive in its market area. Its most direct competition for deposits has historically come from savings banks, credit unions, savings and loan associations and commercial banks. Additionally, the Company faces competition for deposits from money market funds, stock and bond mutual funds, brokerage companies and insurance companies. Competition may eventually increase as a result of the lifting of restrictions on interstate operations of financial institutions. The anticipated impact of such legislation on the Company is not expected to be significant. The Company competes for deposits by offering a variety of customer services and deposit accounts at generally competitive interest rates.\nManagement considers the Company's reputation for financial strength, customer service and its community bank orientation as its major competitive advantage in attracting customers in its market area.\nPotential Impact of Changes in Interest Rates\nThe Company's profitability, like that of most financial institutions, is dependent to a large extent upon its net interest income, which is the difference between its interest and dividend income on earning assets, such as loans and securities, and its interest expense on interest-bearing liabilities, such as deposits. When the amount of interest-earning assets differs from the amount of interest-bearing liabilities expected to mature or reprice in a given period, a significant change in market rates of interest will affect net interest income. The Company manages its interest rate risk primarily by structuring its balance sheet to emphasize holding adjustable rate loans and mortgage-backed securities in its portfolio and maintaining a large base of core deposits. The Company has not used synthetic hedging instruments such as interest rate futures, swaps or options. See further discussion under \"Asset\/Liability Management\" on page 5 of this report.\nRegulation and Supervision\nCapital Requirements\nProgressive, as a registered bank holding company under the Bank Holding Company Act of 1956, as amended, is subject to regulation and supervision by the Federal Reserve Board (\"FRB\"). Accordingly, its activities are subject to certain limitations, and transactions between Pawling and Progressive are subject to certain restrictions. The FRB applies various guidelines in assessing the adequacy of capital in examining and supervising a bank holding company and in analyzing applications to the FRB. Under the current leverage capital guidelines, most banking companies must maintain Tier 1 capital between 4.0% and 5.0% of total assets. Tier 1 capital is comprised of common shareholders' equity, noncumulative perpetual preferred stock and minority interests in consolidated subsidiaries, less substantially all intangible assets, identified losses and investments in certain subsidiaries.\nThe FRB also has adopted a set of risk-based capital adequacy guidelines, which require the Company to maintain capital according to the risk profile of its asset portfolio and certain of its off-balance sheet items. The guidelines set forth a system for calculating risk-weighted assets by assigning assets (and credit-equivalent amounts for certain off-balance sheet items) to one of four broad risk-weight categories. The amount of risk-weighted assets is determined by applying a specific percentage (0%, 20%, 50% or 100%, depending on the level of credit risk) to the amounts assigned to each category. As a percentage of risk-weighted assets, a minimum ratio of 4.0% must be maintained for Tier 1 capital and 8.0% for total capital.\nAt December 31, 1995, Progressive's capital ratios exceeded the FRB's minimum regulatory capital guidelines as follows:\nPawling, as a New York state-chartered stock savings bank, is subject to regulation and supervision by the New York State Banking Department as its chartering agency and by the FDIC as its deposit insurer. Pawling derives its lending, investment and other powers from the applicable provisions of New York law and the regulations of the New York State Banking Board, subject to limitation or modification under applicable Federal law and regulations of such agencies as the FDIC or FRB. FDIC regulations require insured banks, such as Pawling, to maintain minimum levels of capital. The FDIC regulations follow, in substance, the leverage and risk-based capital guidelines adopted by the FRB for bank holding companies.\nAt December 31, 1995, Pawling's capital ratios exceeded the FDIC's minimum regulatory capital requirements as follows:\nDuring 1994, the Company announced two plans to repurchase in each case up to 5% of Progressive's outstanding common stock, to be used for general corporate purposes. The first repurchase was completed on November 9, 1994 and consisted of 147,000 shares at a total cost of $3.1 million or $21.21 per share. The second repurchase plan was completed on September 29, 1995 and consisted of 140,000 shares at a total cost of $3.3 million or $23.84 per share. On October 24, 1995, the Company announced a third plan to repurchase 134,000 shares. At December 31, 1995, 63,000 shares had been purchased under the third plan at a cost of $1.8 million or $28.41 per share. The Company considers its stock to be an attractive investment and believes these programs will increase shareholder value.\nFederal Deposit Insurance Corporation Improvement Act\nOn December 19, 1991, the Federal Deposit Insurance Corporation Improvement Act of 1991 (\"FDICIA\") became law. The provisions of FDICIA strengthen Federal supervision and examination of insured depository institutions, require prompt regulatory action when a depository institution experiences financial difficulties, mandate the establishment of a risk-based deposit insurance assessment system, and require imposition of numerous additional safety and soundness operational standards.\nFDICIA establishes a system of prompt corrective action applicable to undercapitalized institutions. The system is based on capital levels that are used to define five categories of banks -- well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. Under this system, the banking regulators are required to take certain supervisory actions with respect to undercapitalized institutions. The severity of these actions depends upon the institution's degree of under capitalization. Generally, subject to a narrow exception, FDICIA requires the banking regulators to appoint a receiver or conservator for an institution that is critically undercapitalized within 90 days after being considered critically undercapitalized. Well-capitalized institutions are defined as those with a leverage capital ratio over 5.0%, a Tier 1 risk-based capital ratio over 6.0%, and a total risk-based capital ratio over 10.0%. Pawling met the definition of a well-capitalized institution at December 31, 1995 with leverage, Tier 1 risk-based and total risk-based capital ratios of 8.35%, 14.78% and 16.03%, respectively.\nFDICIA also places restrictions on investments by and activities of insured state banks such as Pawling. State banks and their subsidiaries may not engage in activities that are not permissible for national banks or their subsidiaries unless the FDIC determines that the activity would pose no significant risk to the deposit insurance fund and the bank is in compliance with, and continues to comply with, applicable Federal capital standards. While national banks are not permitted to invest in equity securities, FDICIA contained a limited exception permitting the continued investment by certain state-chartered banks in equity securities listed on national securities exchanges and in shares of companies registered under the Investment Company Act of 1940. FDICIA requires, however, that such equity investments in the future not exceed 100% of a bank's Tier 1 capital; moreover, FDICIA allows the FDIC to further limit the amount of such equity security investments, based upon an institution's capital position and overall financial condition. The limitation imposed by FDICIA is not expected to affect Pawling since, at December 31, 1995, the amount invested by Pawling in such equity securities represented only 0.3% of its Tier 1 capital.\nAs required by FDICIA, each Federal banking agency has adopted uniform regulations prescribing standards for extensions of credit secured by real estate or made for the purpose of financing the construction of improvements on real estate. The FDIC regulation requires each bank to establish and maintain written internal real estate lending standards that are consistent with safe and sound banking practices and that are appropriate to the size of the institution and the nature and scope of its real estate lending activities. The Bank's policy is consistent with accompanying FDIC guidelines, which include loan-to-value ratio limits for various types of real estate loans. Institutions are permitted to make a limited number of loans that do not conform to these loan-to-value limits, provided the exceptions are reviewed and justified appropriately. Implementation of these new real estate lending standards did not have a significant effect on the Company's lending activities.\nFDICIA imposes additional reporting requirements on depository institutions with total assets of more than $500.0 million, such as Pawling. Among other things, management is required to prepare a report that contains assessments of (1) the effectiveness as of year end of the institution's internal control structure and procedures over financial reporting and (2) the institution's compliance during the year with certain designated safety and soundness laws and regulations (those applicable to insider transactions and dividend limitations). The institution is also required to engage an independent public accountant to (1) attest to management's assertion concerning internal controls over financial reporting and (2) perform certain agreed-upon procedures related to the designated laws and regulations. Institutions affected by these requirements must also have an audit committee composed entirely of independent outside directors.\nIn accordance with FDICIA, insured institutions are subject to a risk-based system for assessing Federal deposit insurance premiums after January 1, 1993. The risk-based assessment is based on the institution's placement by the FDIC into one of nine categories using a two-step process that considers the institution's capital ratios and overall risk profile. The risk-based premiums currently range from an annual rate of 0.00% to 0.27% of assessable deposits, which reflects a significant reduction from the previous period's rates of 0.23% to 0.31%. As a result of this reduction in rates in 1995, it is estimated that FDIC insurance expense for 1996 will be significantly lower than the previous year.\nAsset\/Liability Management\nThe Company's net interest income is an important component of its operating results. The stability of net interest income in changing interest rate environments depends on the Company's ability to manage effectively the interest rate sensitivity and maturity of its assets and liabilities. The Company's Asset\/Liability Management Committee develops and implements risk management strategies, and uses various risk measurement tools to evaluate the impact of changes in interest rates on the Company's asset\/liability structure and net interest income.\nThe Company's asset\/liability management goal is to maintain an acceptable level of interest rate risk to produce relatively stable net interest income in changing interest rate environments. Management's plan is directed at shortening the maturities of its interest-sensitive assets while seeking to lengthen the maturity of interest-bearing deposits. The plan includes: the use of additional adjustable rate lending products; the sale of certain newly originated fixed rate mortgages; lengthening the maturity of retail deposits by marketing and appropriately pricing longer term products; shortening the average maturity of the securities portfolio through the redeployment of maturing investments into adjustable rate securities and debt securities with maturities of no more than five years; and maintaining an appropriate balance between securities held to maturity and securities available for sale to provide management with flexibility to restructure the portfolio when conditions warrant. As economic conditions change, management will modify the plan as necessary.\nTo emphasize the origination of assets with a shorter duration, the Company's asset\/liability policy allows the following types of newly originated mortgage loans to be held in its portfolio: adjustable rate loans and bi-weekly loans. At December 31, 1995, $298.6 million or 62.1% of the mortgage loan portfolio had adjustable rates compared to $223.4 million or 52.5% at December 31, 1994 and $132.8 million or 33.4% at December 31, 1993. Despite the benefits of adjustable rate loans to an institution's interest rate risk management, they may pose potential additional credit risks, because when interest rates rise the underlying payments by the borrower rise, increasing the potential for default.\nOne measure of the Company's interest rate sensitivity is its interest sensitivity gap, or the difference between assets and liabilities scheduled to mature or reprice within a specified time frame. Shorter gaps are a measure of exposure to changes in interest rates for shorter intervals and longer gaps measure sensitivity over a longer interval. At December 31, 1995, the Company had a one-year gap of 3.74% of total assets; that is, it had an excess of interest-earning assets over interest-bearing liabilities maturing or repricing within one year. A positive gap may enhance earnings in periods of rising interest rates in that, during such periods, the interest income earned on assets may increase more rapidly than the interest expense paid on liabilities. Conversely, in a falling interest rate environment, a positive gap may result in a decrease in interest income earned on assets that is greater than the decrease in interest expense paid on liabilities. While a positive gap indicates the amount of interest-earning assets which may reprice before interest-bearing liabilities, it does not indicate the extent to which they reprice. Therefore, at times, a positive gap may not produce higher margins in a rising rate environment.\nDue to the limitations inherent in the gap analysis, management augments the asset\/liability management process by using simulation analysis. Simulation analysis estimates the impact on net interest income of changing the balance sheet structure and\/or interest rate environment. This analysis serves as an additional tool in meeting the Company's goal of maintaining relatively stable net interest income in varying rate environments.\nThe following table summarizes the Company's interest rate sensitive assets and liabilities at December 31, 1995 according to the time periods in which they are expected to reprice, and the resulting gap for each time period.\nPrepayments and scheduled payments have been estimated for the loan portfolio based on the Company's historical experience. Certain fixed rate loans are callable at any time at the Company's option. The majority of these loans are immediately callable and therefore are included in the \"Within One Year\" time period. Adjustable rate mortgage loans are assumed to reprice at the earlier of scheduled maturity or the contractual interest rate adjustment date. Non-accrual loans are included in the table at their original contractual maturities. Savings account repricings are based on the Company's historical repricing experience and management's belief that these accounts are not highly sensitive to changes in interest rates.\nLending Activities\nGeneral\nThe Company offers a variety of loan products to serve both consumer and commercial borrowers within its primary market area of Dutchess, Sullivan, Orange, Putnam, Ulster and Westchester counties in New York. In 1993, the Company began originating one-to-four family mortgage loans in Connecticut, primarily the counties of Fairfield and Litchfield. Originations of one-to-four family mortgage loans were expanded in 1995 to include the New York counties of Nassau, Suffolk and Rockland. Certain indirect automobile loans are also originated in the Albany, New York area.\nThe Company's mortgage lending activities include loans secured by one-to-four family homes, multi-family properties with five or more units, and commercial properties. Loans are made on existing properties and, to a lesser extent, on properties under construction. The Company satisfies a variety of consumer credit needs by providing home equity lines of credit, home improvement loans, automobile loans, mobile home loans, personal loans, student loans and unsecured lines of credit. Commercial loan products include secured and unsecured lines of credit, revolving credit, installment loans and term loans.\nThe Company's lending is subject to its written underwriting standards and to loan origination procedures, prescribed by management. Detailed loan applications are obtained to assist in determining the borrower's ability to repay. Additional information is obtained through credit reports, financial statements and confirmations. The Company accepts loan applications at all of its branch locations, from its mortgage origination staff, mortgage brokers, and through its commercial loan centers in Pawling, Poughkeepsie, Harriman and Ellenville. Residential mortgage, consumer and commercial loans are all serviced at the administrative headquarters in Fishkill.\nOne-to-four family residential mortgage loans up to $1,000,000 may be approved by a combination of certain senior lending officers. Commercial real estate loans up to $500,000 must be approved by Pawling's Loan Committee which is chaired by Pawling's President or Chief Lending Officer and which meets on a weekly basis. Pawling's Board of Directors approves residential mortgage loans in excess of $1,000,000, commercial mortgage loans in excess of $500,000, and loans which cause the total loans granted to any one borrower to exceed $1,500,000. Unsecured loans in excess of $250,000 must also be approved by Pawling's Board of Directors. In general, the Company has established a limit for any one loan of $1,000,000 and a limit for total loans to any one borrower of $3,000,000.\nLoan Portfolio Composition\nAt December 31, 1995, the Company's net loans of $531.7 million represented 71.5% of total assets. Approximately 73.3% of the loan portfolio consisted of residential mortgage loans (principally one-to-four family residential loans); 13.7% of commercial mortgage loans; 2.0% of construction and land loans; and 11.0% of other loans (principally automobile financing and mobile home loans). Of the total mortgage loan portfolio, $448.4 million, or 93.3%, represent loans of which the Company is in the first lien position.\nThe following table sets forth the contractual maturity or period to repricing of the loan portfolio at December 31, 1995. The table does not include estimated prepayments but does include scheduled repayments of principal. Loans that have adjustable rates are shown as being due in the period in which the interest rates are next subject to change or the scheduled maturity, whichever is earlier. Management believes that the actual period to repricing will be shorter than indicated in the table as a result of prepayments, although prepayments tend to be highly dependent on interest rate levels.\nThe following table sets forth, by type of interest rate, the dollar volumes of all loans contractually due in, and with a period to repricing of, more than one year at December 31, 1995.\nResidential Mortgage Lending\nThe Company, through its retail mortgage origination staff and its wholesale loan correspondents, actively solicits residential mortgage loan applications from new and existing customers, builders, and real estate brokers. All loans are then underwritten and serviced at the Fishkill Administration Headquarters. Traditionally, it was Pawling's policy to only make loans secured by properties located within its primary New York service area. Beginning in 1993, the Company expanded this policy to include additional markets in New York State and Connecticut.\nThe Company's commitments to originate residential mortgage loans are generally made for periods of up to 60 days from the date of approval. Longer commitment periods can be negotiated for special programs. Borrowers are offered the option to lock in the rate at the time of application or to lock in the rate in effect up to five days prior to the closing, depending on the mortgage program selected. Outstanding residential mortgage loan commitments amounted to $54.0 million at December 31, 1995.\nThe Company's loan-to-value policy, for owner occupied one-to-four family residences, is to lend up to 97% of the sales price or appraised value, whichever is less. Private mortgage insurance is required on mortgages with loan-to-value ratios above 80%. Acceptable loan-to-value ratios decrease for larger loans. The actual loan-to-value ratios and amounts are determined by secondary market investor guidelines and market conditions. On non-owner occupied residential properties, the Company generally makes loans of up to 75% of the sales price or appraised value, whichever is less. These loans are amortized with principal and interest due on a monthly basis. Residential mortgage loans are underwritten and approved to be held in the Company's own loan portfolio or to be sold to investors in the secondary market. Typically, the Company primarily holds in its portfolio adjustable rate mortgages which have a contractual maturity of up to 30 years.\nAs a result of selling mortgage loans in the secondary market while retaining the related servicing rights, the Company had under service $58.0 million in primarily fixed-rate mortgage loans for investors at December 31, 1995, for which the Company is paid a servicing fee. The Company is an approved seller\/servicer for the Federal National Mortgage Association (\"FNMA\") and the State of New York Mortgage Agency (\"SONYMA\"), and also participates in selected private secondary market programs.\nCommercial and Construction Mortgage Lending\nCommercial mortgage loans originated directly by the Company require a primary and secondary source of repayment, a net cash flow of at least 1.2 times debt service payments, and a loan-to-value ratio not greater than 70%.\nThe Company's construction mortgage loans are primarily originated for one-to-four family owner occupied residences, multi-family houses and, to a lesser extent, owner occupied commercial properties. Construction loans on pre-sold homes are classified in the Company's one-to-four family residential mortgage portfolio. Loan-to-value ratios vary by property type with residential construction not exceeding 80% and multi-family and commercial construction not exceeding 70%. In most cases, the Company continues as the permanent mortgage lender after construction is completed. Construction loans originated are usually for an initial term of 12 months after which the loan may be converted into a permanent loan providing for principal and interest payments. Disbursements are made during the construction period based on the percentage of work completed as determined by qualified inspectors.\nCommercial and construction mortgage loans may reduce interest rate risk in a rising rate environment, due generally to their shorter terms and variable interest rates, but may require a greater level of ongoing service and management due to a broader range of risks as compared to other residential mortgage lending. Specifically, the payment experience on loans secured by income producing properties is dependent on the successful management of these properties and may be subject to a greater extent to adverse conditions in the real estate market or the general economy. Construction loans involve additional risks since loan funds are advanced based upon the security of the property under construction and are otherwise subject to uncertainties in estimating construction costs and other unpredictable contingencies that may make it difficult to evaluate accurately the total loan funds required to complete the project.\nMortgage Lending Activity\nThe following is a summary of activity in the Company's mortgage loan portfolio for the years ended December 31. The table includes residential mortgage activity, as well as commercial and construction lending activity.\nConsumer Lending\nIn recent years, the Company has increased its emphasis on the origination of consumer loans to provide a greater variety of financial services and because these loans generally have shorter terms and higher rates of interest. The Company offers a variety of consumer loans, including personal loans, home equity lines of credit, fixed rate home equity loans, home improvement loans, mobile home loans, passbook or certificate account loans, indirect and direct automobile loans and student loans.\nConsumer loans generally involve more risk of collectibility than residential mortgage loans because of the type and nature of the collateral and, in certain cases, the absence of collateral. As a result, consumer loan collections are more dependent on the borrower's continuing financial stability, and thus are more likely to be affected by job loss, personal bankruptcy and adverse economic conditions.\nBusiness Lending\nThe Company offers a variety of commercial loan products to small businesses including installment and time notes, lines of credit, revolving credit and term loans. The Company promotes these products within its defined market area to companies with sales of typically less than $10.0 million per year. Commercial loans are underwritten based on the cash flow and financial condition of the borrowing business and applicable collateral. Repayment of these loans is guaranteed by the owners of the businesses in question and may be further collateralized by assets of those individual guarantors. The interest rates on business loans are generally variable rates that change with market conditions and are priced in relation to the \"prime rate\" or to interest rates on various treasury securities.\nLoan Interest Rates and Fees\nThe interest rates charged by the Company on its loans are determined by a comparison to competitive rates being offered in its market area, the availability of lendable funds, the Company's cost of funds, product costs, the demand for loans and portfolio concentration considerations. The Company's average interest rate earned on its loan portfolio was 8.75% for the year ended December 31, 1995, as compared to 8.55% for the year ended December 31, 1994.\nIn addition to the contractual rates of interest earned on loans, the Company receives fees related to existing loans which include late charges, loan modification fees, prepayment penalties and fees associated with the sale of credit life and disability insurance. The Company also receives origination and servicing fees as a result of sales of mortgage loans originated and serviced for others. In addition, Progressive generates settlement fees by providing loan related services to Pawling's borrowers. Income realized from these activities varies with the volume and type of loans made.\nLoan origination fees and certain direct origination costs are deferred and subsequently recognized as interest income, using the level yield method, over the contractual loan term. Amortization ceases when loans are placed on non-accrual status.\nAsset Quality\nIn 1995, the Company continued to emphasize residential mortgage and consumer lending. Mortgage loans secured by one-to-four family residential properties increased in 1995 by $48.1 million, or 14.9%, to $370.6 million at December 31, 1995, representing 68.6% of total loans. The Company plans to further diversify the loan portfolio's geographic distribution in 1996 by expanding to the Rockland County market through the acquisition of branches as further discussed on page 22.\nManagement continually reviews delinquent loans to adequately assess problem situations and to quickly and efficiently remedy these problems whenever possible. The Company's collection department contacts the borrower when a loan becomes delinquent. When a payment is not made within 15 days of the due date, a late notice and late charge is generated and assessed. After 60 days of delinquency, a notice is sent warning the borrower that foreclosure proceedings may commence. If the delinquency has not been cured within a reasonable period of time, the Company institutes appropriate action to foreclose the property. If the Company is the successful bidder at the foreclosure sale, the property is recorded as \"other real estate\". When the property is acquired, it is recorded at the lower of the recorded investment in the loan or the fair value of the property less the estimated costs to dispose of the property. All costs incurred in maintaining the property from the date of acquisition are expensed.\nThe Loan Review Committee of Pawling meets at least monthly or more frequently as deemed necessary to review all real estate loans of $250,000 and over which are more than 30 days delinquent; all delinquent construction loans; other mortgage loans and consumer loans which are 90 days or more delinquent; all other real estate properties; all loans in the process of foreclosure; and all classified loans. The results of this analysis are reported to the Board of Directors on a monthly basis.\nEffective January 1, 1995, the Company adopted the provisions of Statement of Financial Accounting Standards (\"SFAS\") No. 114, \"Accounting by Creditors for Impairment of a Loan,\" and its amendment, SFAS No. 118, \"Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures.\" These statements prescribe recognition criteria for loan impairment, generally relating to commercial and construction loans and measurement methods for impaired loans and all loans whose terms are modified in troubled debt restructuring subsequent to the adoption of these statements. A loan is considered to be impaired when, based on current information and events, it is probable that the lender will be unable to collect all principal and interest contractually due according to the original contractual terms of the loan agreement. The Company generally considers impaired loans to be commercial and construction non-accrual loans and loans restructured since January 1, 1995.\nSFAS No. 114 requires lenders to measure impaired loans based on (i) the present value of expected future cash flows discounted at the loan's effective interest rate, (ii) the loan's observable market price or (iii) the fair value of the collateral if the loan is collateral dependent. Generally, the Bank's impaired loans are considered to be collateral dependent. The Company considers estimated cost to sell, on a discounted basis, when determining the fair value of collateral in the measurement of impairment if the costs are expected to reduce the cash flows available to repay or otherwise satisfy the loan. An allowance for loan losses is maintained if the measure of an impaired loan is less than its recorded investment. Adjustments to the allowance are made through corresponding charges or credits to the provision for loan losses.\nIn addition, SFAS No. 114 makes significant changes to existing accounting principles applicable to in-substance foreclosures. In accordance with SFAS No. 114, a loan is classified as an in-substance foreclosure only when the Company has taken physical possession of the collateral regardless of whether formal foreclosure proceedings have taken place. Prior to the adoption of SFAS No. 114, in-substance foreclosured properties included those properties where the borrower had little or no equity in the property considering its fair value; where repayment was only to come from the operation or sale of the property; and where the borrower had effectively abandoned control of the property or it was doubtful that the borrower would be able to rebuild equity in the property.\nThe adoption of these statements did not have a significant effect on the Company's consolidated financial statements. At December 31, 1995, the Company's recorded investment in impaired commercial mortgage and construction loans totaled $3.2 million. The total impaired loans consist of (i) loans of $674,000 for which there was an allowance for loan losses of $110,000 determined in accordance with SFAS No. 114 and (ii) loans of $2.5 million for which there was no allowance as determined under SFAS No. 114 due to the adequacy of related collateral and historical charge-offs associated with these loans. The average recorded investment in impaired loans was $5.1 million for 1995. Interest income on impaired loans is recognized on a cash basis and was not significant for the year ended December 31, 1995.\nIn the fourth quarter of 1994, the Company decided to dispose of certain troubled assets on a bulk sale basis in order to accelerate the reduction in loan portfolio credit risk, enhance overall asset quality and better position the Company to achieve its strategic goals. These transactions resulted in the sale of assets totaling $9.9 million, which consisted of (i) non- performing mortgage loans of $3.4 million, (ii) performing mortgage loans of $4.8 million with relatively high credit risk, and (iii) other real estate owned of $1.7 million. The net sales proceeds totaled $5.8 million, resulting in losses of $4.1 million which were charged to the allowance for loan losses ($3.9 million) and the allowance for losses on other real estate ($218,000).\nThe following table sets forth information with respect to non-performing loans (non-accrual loans and loans greater than 90 days past due and still accruing) and other real estate, and certain asset quality ratios at or for the years ended December 31:\nThe provision for loan losses is a charge against income which increases the allowance for loan losses. The adequacy of the allowance for loan losses is evaluated periodically and is determined based on management's judgment concerning the amount of risk and potential for loss inherent in the portfolio. Management's judgment is based upon a number of factors including a review of non-performing and other classified loans, the value of collateral for such loans, historical loss experience, changes in the nature and volume of the loan portfolio, and current and prospective economic conditions. When doubt exists in the view of management as to the collectibility of the remaining balance of a loan, the Company will charge-off that portion deemed to be uncollectible. While management uses the best information available in establishing the allowance for loan losses, future adjustments may be necessary based on changes in economic and real estate market conditions and in the credit risk inherent in the loan portfolio.\nActivity in the allowance for loan losses for the years ended December 31 is summarized as follows:\nThe following table sets forth the allocation of the Company's allowance for loan losses by category of loans at December 31 for each of the past five years. The amount allocated to any category should not be interpreted as an indication of expected future charge-offs in that category. The allowance for loan losses consists of allocations for estimated losses on individual non-performing and other classified loans in the Company's portfolio, as well as a portion based on the Company's past loss experience, overall risk characteristics, and management's assessment of current economic and real estate market conditions.\nSecurities\nThe Company has authority to invest in a variety of debt and equity securities rated AA or better. Securities purchased by the Company conform to the statutory requirements of the New York State Banking Law, the rules and regulations of the Federal Deposit Insurance Corporation and the Federal Reserve Board's policy on investments. The Company can invest in securities such as United States Treasury obligations, securities of various government agencies, mortgage-backed securities, corporate obligations, municipal obligations, and a limited amount of preferred and common stock.\nManagement recommends and implements the Company's investment policy, subject to approval by the Board of Directors. The implementation of the policy is monitored and reviewed by the Board of Directors at its regularly scheduled meetings.\nEffective January 1, 1994, the Company changed its method of accounting for securities, upon adoption of Statement of Financial Accounting Standards (\"SFAS\") No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" Under SFAS No. 115, securities are classified as held to maturity securities, trading securities, or available for sale securities. Securities held to maturity are limited to debt securities for which the entity has the positive intent and ability to hold to maturity. Trading securities are debt and equity securities that are bought principally for the purpose of selling them in the near term. All other debt and equity securities are classified as available for sale. At December 31, 1995, the carrying values of securities available for sale totaled $106.9 million and securities held to maturity totaled $40.1 million.\nHeld to maturity securities are carried at amortized cost under SFAS No. 115, which is the same basis of accounting previously used by the Company for its debt securities held for investment. Available for sale securities are carried at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of shareholders' equity (net of taxes). Prior to the adoption of SFAS No. 115, available for sale securities were carried at the lower of cost or fair value in the aggregate, with net unrealized losses (if any) reported in earnings. The Company has no trading securities.\nIn November 1995, the Financial Accounting Standards Board released its Special Report, \"A Guide to the Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities\". The Special Report contained a unique provision that allowed entities to, as of a single date between November 15, 1995 and December 31, 1995, reassess the appropriateness of the classification of all securities held at that time. On November 30, 1995, as permitted by the Special Report, the Company made a one-time transfer of certain adjustable rate mortgage-backed securities with an amortized cost of $44.9 million and a fair value of $46.3 million, to the available for sale portfolio from held to maturity. The transfer was made primarily to enhance liquidity and provide greater flexibility in managing the Company's securities.\nEquity securities at December 31, 1995 and 1994 include Federal Home Loan Bank stock with a cost basis of $4.0 million and $891,000, respectively.\nThe following table summarizes the amortized cost and fair value of the Company's securities as of December 31:\nMortgage-backed securities represent participating interests in pools of first mortgage loans originated and serviced by the issuers of the securities. The Company principally purchases adjustable rate securities and balloon payment securities. Balloon payment securities, which have an expected average life of approximately two to four years, generally provide for principal amortization based on a thirty-year amortization schedule, with a balloon payment of the remaining principal at the end of a five- or seven-year period.\nThe following table summarizes the amortized cost and fair value of the Company's mortgage-backed securities at December 31:\nThe following table sets forth the amortized cost and weighted average yields of the Company's debt securities at December 31, 1995, by type of security and by remaining term to maturity. With respect to mortgage-backed securities, the table is based on contractual maturities and does not include estimated prepayments or scheduled repayments of principal. Management believes that the actual maturities will be substantially shorter than indicated as a result of prepayments and scheduled repayments, although prepayments tend to be highly dependent on interest rate levels.\nDeposits\nDeposits are the Company's principal source of funds. The Company attracts deposits from the general public and small businesses by offering a variety of deposit accounts at competitive rates. The Company's deposit accounts include day-of-deposit to day-of-withdrawal passbook savings accounts, personal and commercial checking accounts, money market accounts, NOW accounts, savings certificate accounts (\"time deposits\") and club accounts. The Company also offers tax deferred retirement savings accounts and savings certificate accounts of $100,000 or more (\"jumbo certificates\"). At December 31, 1995, the Company had $50.3 million in jumbo certificates, compared to $45.3 million at December 31, 1994 and $52.2 million at December 31, 1993. The Company does not solicit or accept brokered deposits.\nAt December 31, 1995, the dollar amount of jumbo certificates by remaining maturity dates and the weighted average interest rates were as follows:\nDeposit inflows and outflows are generally dependent on market conditions, interest rates, the general economic environment in the Company's market area and other competitive factors. The variety of accounts offered by the Company has enabled it to be more competitive in obtaining funds and to respond with more flexibility to changes in the interest rate environment. Management's policy is to review deposit interest rates at least weekly and to adjust appropriately based on the need for funds, competition and the effect on the net interest margin. The Company's interest costs on time and savings deposits may continue to trend upward in a higher interest rate environment.\nFixed rate, fixed term certificate of deposit accounts are generally a significant source of funds for the Company. At December 31, 1995, certificate accounts amounted to $347.5 million or 57.4% of total interest-bearing deposits, compared to $308.7 million or 53.4% at December 31, 1994 and $273.6 million or 52.5% at December 31, 1993. Certificates offered by the Company have maturities of 32 days or more, impose a minimum balance requirement of $1,000, and pay interest compounded on a daily basis.\nSavings deposits amounted to $154.4 million or 25.5% of the Company's total interest-bearing deposits at December 31, 1995, compared to $210.8 million or 36.5% at December 31, 1994 and $180.3 million or 34.6% at December 31, 1993. Savings deposits primarily consist of passbook savings accounts and statement savings accounts. Passbook and other savings accounts amounted to $104.1 million or 17.2% of the Company's total interest-bearing deposits at December 31, 1995, compared to $129.4 million or 22.4% at December 31, 1994 and $180.3 million or 34.6% at December 31, 1993. Passbook savings offered by the Company pay interest monthly, compounded on a daily basis, to accounts with a minimum average daily balance of $100. In 1994, the Company introduced a tiered statement savings account. The first tier has a minimum balance of $500 and earns interest if the account maintains a minimum average balance of $500 for the month. The second tier has a minimum balance of $25,000 and earns interest at a higher rate if the account maintains a minimum average balance of $25,000 for the month. There is a service charge incurred if the daily average balance falls below $500. Interest on all statement savings accounts is compounded daily and credited monthly. Statement savings accounts amounted to $50.4 million, or 8.3% of the Company's total interest-bearing deposits at December 31, 1995 and $81.4 million, or 14.1% at December 31, 1994.\nThe Company offers negotiable order of withdrawal (\"NOW\") accounts with unlimited check writing privileges. The minimum initial deposit required is $1,000. There is a service charge incurred if the daily average balance for the month falls below $1,000. Interest is compounded daily and credited at the end of the month, at the current rate determined by the Company, on accounts that have maintained a minimum average balance of $1,000. NOW accounts amounted to $22.8 million, or 3.8% of the Company's total interest-bearing deposits, at December 31, 1995, compared to $29.1 million, or 5.0%, at December 31, 1994 and $34.5 million, or 6.6%, at December 31, 1993.\nThe Company also offers a tiered money market account with limited check writing privileges. The first tier has a minimum balance of $2,500 and earns interest at the Company's money market rate if the account maintains a minimum average balance of $2,500 for the month. The second tier has a minimum balance of $25,000 and earns interest at a higher money market rate if the account maintains a minimum average balance of $25,000 for the month. There is a service charge incurred if the daily average balance falls below $2,500. Interest on all money market accounts is compounded daily and credited monthly. Money market accounts amounted to $80.3 million, or 13.3% of the Company's total interest-bearing deposits, at December 31, 1995, compared to $29.4 million, or 5.1%, at December 31, 1994 and $32.4 million, or 6.2%, at December 31, 1993.\nIn 1995, the Company introduced its first relationship banking product, Premier Banking. Premier Banking requires a minimum average balance of $1,500 in a checking account and offers higher rates on certain money market and certificate of deposit accounts, as well as reduced rates on a line of credit or a mortgage. In addition, various other services are free, including traveler's cheques, official checks and money orders. As of December 31, 1995, Premier Banking accounts totaled $58.1 million.\nThe following table presents the Company's interest-bearing deposits and related weighted average interest rates at December 31:\nThe Company also offers noninterest-bearing demand deposit accounts which include personal and business checking. Personal checking and business checking requires a minimum initial deposit of $10 and $100, respectively. Demand deposits amounted to $52.0 million at December 31, 1995 compared to $46.4 million at December 31, 1994 and $41.4 million at December 31, 1993.\nManagement believes the variety of deposit accounts offered by the Company allows it to compete for funds effectively. However, these sources of funds generally are interest rate sensitive and therefore can be more costly in a high interest rate environment. Although the Company will continue to carefully monitor deposit flows, the ability of the Company to control deposit flows will continue to be significantly affected by the general market rate environment and economic conditions.\nOther Sources of Funds\nAdditional sources of funds are interest and principal payments on loans and securities, and positive cash flows generated from operations. Interest and principal payments on loans are a relatively stable source of funds, while deposit inflows and outflows are significantly influenced by general market interest rates, economic conditions and competitive factors. Pawling is a member of the Federal Home Loan Bank of New York (\"FHLBNY\") and, at December 31, 1995, had immediate access to additional liquidity in the form of borrowings from the FHLBNY of $80.0 million. The Company also has access to the discount window of the Federal Reserve Bank. There were no borrowings under these arrangements in 1995 and 1994.\nSelected Ratios\nThe following is a summary of selected ratios for the years ended December 31:\nIncome Taxes\nWith certain exceptions, the Company is generally taxed in the same manner as other corporations. Progressive and Pawling file a consolidated Federal income tax return on a calendar year basis. The filing of a consolidated tax return has the effect of eliminating intercompany transactions in the computation of consolidated taxable income.\nUnder applicable provisions of the Internal Revenue Code of 1986 (the \"Code\") as amended, Pawling, as a savings institution, has benefited from provisions of the Code permitting it to take deductions for reasonable annual additions to the reserves for bad debts. There are two methods available to Pawling for computation of the bad debt deduction: the \"experience\" method and the \"percentage of taxable income\" method. Institutions must meet specified asset definition and other tests in order to benefit from the special bad debt deduction. The asset test requires that \"qualifying assets\" (generally including cash, obligations of the United States or an agency or instrumentality thereof or of a state or political subdivision thereof, residential real estate related loans, loans secured by savings accounts, and property used in the conduct of the institution's business) constitute at least 60.0% of total assets. Pawling's \"qualifying assets\" as of December 31, 1995 were 78.7% of total assets.\nThe experience method generally results in a bad debt deduction equal to actual bad debt losses (net loan charge-offs) for the current year. The deduction under the percentage of taxable income method is based on 8% of taxable income with certain adjustments. Pawling used the experience method in 1995, 1994 and 1993.\nPending Acquisition of Branches\nOn December 26, 1995, Pawling entered into a Purchase and Assumption Agreement (the \"Agreement\") with GreenPoint Bank (\"GreenPoint\") regarding the purchase by the Company of two branch offices in Rockland County, New York. Pursuant to the Agreement, the Company will purchase deposit liabilities of approximately $154.0 million. In addition, the Company will also purchase real estate and certain branch furniture, fixtures and equipment and will assume certain leasehold liabilities of GreenPoint. There will be no loans acquired in the transaction except for a small amount of passbook loans.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company presently has a network of 15 branch offices located in Dutchess, Sullivan, Orange, Putnam, Ulster and Westchester counties. Of these facilities, 8 are owned and 7 are leased. The Brewster branch has a long-term land lease, while the building is owned by the Company. Facilities are generally leased for a period of 5 to 20 years with renewal options. The termination of any short-term lease would not have a material adverse effect on the operations of the Company.\nThe following are the locations of Pawling's offices:\nAdministrative Headquarters 1301 Route 52 Fishkill, New York\nEllenville Branch 80 North Main Street Ellenville, New York\nVillage Branch 11 West Main Street Pawling, New York\nDover Plains Branch Route 22 Dover Plains, New York\nBrewster Branch Route 22 Brewster, New York\nLaGrange Branch Route 55 LaGrange, New York\nPawling Branch Route 22 Pawling, New York\nLiberty Branch Route 52 Liberty, New York\nMillbrook Branch Cors. Route 44 & 82 Millbrook, New York\nMonticello Branch Route 42 Monticello, New York\nRoscoe Branch 13 Broad Street Roscoe, New York\nPoughkeepsie Branch 4 Jefferson Place Poughkeepsie, New York\nNorth Salem Branch Cors. Route 116 & 124 North Salem, New York\nFishkill Branch Route 9 Fishkill, New York\nNewburgh Branch 200 Stony Brook Court Newburgh, New York\nRed Hook Branch 21 South Broadway Red Hook, New York\nHarriman Loan Center Triangle Plaza - Suite 19 Harriman, New York\nOwned Leased Land leased\/building owned\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIn August 1992, a shareholder of Progressive commenced an action against Progressive and its directors in New York Supreme Court seeking to declare void the March 8, 1991 retirement agreement entered into with E. Hale Mayer, the retiring Chairman of the Board and Chief Executive Officer of Progressive and its subsidiary, Pawling Savings Bank, and to recover monies paid thereunder. On March 25, 1994 the judge, upon a motion for summary judgement, ruled in favor of Progressive and its directors dismissing the complaint against them. The plaintiff appealed that decision. In February 1996, his appeal was denied.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nDuring the fourth quarter of 1995, there were no matters submitted to a vote of shareholders of Progressive.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS\nThe following information included in the Annual Report to Shareholders for the fiscal year ended December 31, 1995 (the \"Annual Report\"), is incorporated herein by reference: \"SHAREHOLDER INFORMATION - Common Stock\", which appears on page 52 of the Annual Report.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following information included in the Annual Report is incorporated herein by reference: \"SELECTED CONSOLIDATED FINANCIAL DATA\", which appears on page 5 of the Annual Report.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe following information included in the Annual Report is incorporated herein by reference: \"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF INCOME\", which appears on pages 7-21 of the Annual Report.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe following information included in the Annual Report is incorporated herein by reference: The consolidated balance sheets of Progressive Bank, Inc. and subsidiary as of December 31, 1995 and 1994, 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, 1995, together with the related notes and the independent auditors' report thereon, all of which appears on pages 22-50 of the Annual Report.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe following information included in the Proxy Statement is incorporated herein by reference: \"ELECTION OF DIRECTORS\", \"EXECUTIVE OFFICERS\", and \"OTHER INFORMATION ABOUT THE BOARD AND CERTAIN COMMITTEES\", which appears on pages 2, 3, 5, 6 and 7 of the Proxy Statement.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information included on page 8 of the Proxy Statement is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following information included in the Proxy Statement is incorporated herein by reference: \"VOTING SECURITIES\" and \"STOCK OWNERSHIP OF DIRECTORS AND OTHERS\", which appears on pages 1 and 4 of the Proxy Statement.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information included on pages 7 and 11 of the Proxy Statement is incorporated herein by reference: \"EXECUTIVE OFFICERS - Transactions With Management\".\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) Listed below are all financial statements and exhibits filed as part of this report:\n(1) The consolidated balance sheets of Progressive Bank, Inc. and subsidiary as of December 31, 1995 and 1994, 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, 1995, together with the related notes and the independent auditors' report thereon, appearing in the Annual Report on pages 22-50 are incorporated herein by reference.\n(2) Schedules omitted as they are not applicable\n(3) 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.\nPROGRESSIVE BANK, INC. (Registrant)\nBy: \/s\/ Peter Van Kleeck\nPeter Van Kleeck President & Chief Executive Officer\nDate: March 12, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, 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 13\nManagement's Discussion and Analysis of Financial Condition and Results of Operations\nGeneral\nThe financial condition and operating results of Progressive Bank, Inc. (\"Progressive,\" or, together with its subsidiary, the \"Company\") are primarily dependent upon the financial condition and operating results of its wholly-owned subsidiary, Pawling Savings Bank (\"Pawling\"). Progressive is a bank holding company whose principal asset is its investment in Pawling's common stock. Pawling is a New York state-chartered stock savings bank providing a full range of community banking services to individual and corporate customers. Progressive and Pawling are subject to the regulations of certain Federal and state agencies and undergo periodic examinations by those regulatory authorities.\nThe Company is engaged principally in the business of attracting retail deposits from the general public and the business community and investing those funds in residential and commercial mortgages, consumer loans and securities. The operating results of the Company depend primarily on its net interest income after provision for loan losses. Net interest income is the difference between interest and dividend income on earning assets, primarily loans and securities, and interest expense on deposits. Net income of the Company is also affected by other income, which includes service fees and net gain (loss) on securities and loans; other expense, which includes salaries and employee benefits and other operating expenses; and Federal and state income taxes.\nFinancial Condition\nTotal assets of the Company were $743.2 million at December 31, 1995 as compared to $696.3 million at December 31, 1994, an increase of $46.9 million or 6.7%. This increase was primarily funded by the $32.7 million or 5.2% increase in deposits from $624.3 million at December 31, 1994 to $657.0 million at December 31, 1995. Net loans totaled $531.7 million or 71.5% of total assets at December 31, 1995, and increased by $58.6 million or 12.4% during the year. Total securities increased by $19.4 million or 15.2% to $147.0 million at December 31, 1995, representing 19.8% of total assets at that date.\nThe $19.4 million increase in securities for the year consisted of a $63.0 million increase in securities available for sale, partially offset by a $43.6 million decrease in securities held to maturity. The increase in securities available for sale and the decrease in securities held to maturity primarily reflects the transfer of held to maturity securities, with an amortized cost of $44.9 million and a fair value of $46.3 million, to available for sale. This transfer as allowed by the FASB's \"Special Report\" consisted of adjustable rate mortgage-backed securities and is further discussed within note 2 to the consolidated financial statements. In addition, available for sale securities also increased due to the $19.2 million increase in U.S. Treasury securities primarily reflecting additional purchases of treasury notes.\nThe $58.6 million increase in net loans during 1995 was due primarily to increased loan originations which exceeded principal payments by $71.1 million, partially offset by loan sales of $12.3 million. The residential mortgage segment of the loan portfolio increased $49.8 million or 14.4% during 1995 from $346.1 million to $395.9 million. The commercial mortgage segment of the loan portfolio increased $7.4 million, or 11.2%, from $66.4 million at December 31, 1994 to $73.9 million at December 31, 1995. Other loans increased $1.2 million or 2.1% during 1995 from $57.9 million to $59.1 million, primarily due to increases in the business installment and mobile home loan categories, partially offset by the decline in automobile financings.\nThe $11.5 million increase in accrued expenses and other liabilities primarily reflects a $6.7 million increase due to the purchase of securities not settled at December 31, 1995 as well as a $3.8 million increase in income tax liabilities.\nThe $32.7 million increase in deposits during 1995 was primarily attributable to the $38.8 million increase in time deposits and the $51.0 million increase in money market accounts, partially offset by the decline in savings accounts of $56.4 million. These increases in time deposits and money market accounts were primarily due to selective marketing and aggressive pricing of these deposit products.\nShareholders' equity at December 31, 1995 was $68.7 million, an increase of $2.7 million or 4.1% from December 31, 1994. This increase primarily reflects net income of $6.8 million and an increase of $1.3 million resulting from the market value changes of securities available for sale, net of taxes, partially offset by treasury stock purchases of $3.9 million and cash dividends of $1.8 million. Shareholders' equity, as a percent of total assets, was 9.24% at December 31, 1995 compared to 9.47% at December 31, 1994. Book value per common share increased to $26.13 at December 31, 1995 from $24.00 a year earlier.\nResults of Operations\nYear Ended December 31, 1995 Compared to Year Ended December 31, 1994\nGeneral\nFor the year ended December 31, 1995, the Company's net income was $6.8 million or $2.50 per share as compared to $7.7 million or $2.66 per share for 1994. The $884,000 decrease in net income was primarily the result of a $5.1 million increase in income tax expense, a $1.3 million decrease in net interest income, and a $694,000 increase in other non-interest expense. These items were partially offset by a $3.2 million increase in other income due primarily to the improved results from the sale of securities and loans, a $1.6 million decrease in the net cost of other real estate, a $900,000 decrease in the provision for loan losses, and a $653,000 decrease in FDIC deposit insurance premium. The decrease in earnings per share resulting from the reduced net income in 1995 as compared to 1994 was partially offset by the Company's stock repurchase programs which resulted in the buyback of 146,000 shares in 1995.\nNet Interest Income\nNet interest income decreased $1.3 million, or 4.3%, to $27.8 million for 1995 compared to $29.1 million for 1994. The components of net interest income are interest and dividend income, which increased $5.3 million or 10.5%, and interest expense on deposits, which increased $6.5 million or 30.8%. The Company's interest rate spread narrowed by 50 basis points from 3.96% in 1994 to 3.46% in 1995, reflecting an 87 basis point increase in the average cost of interest-bearing liabilities, partially offset by the 37 basis point increase in the average yield on earning assets. The net interest margin also narrowed by 42 basis points from 4.51% in 1994 to 4.09% in 1995, primarily reflecting the narrower interest rate spread.\nInterest on loans increased $5.0 million, or 12.4%, primarily reflecting an increase in the volume of loans outstanding. The yields on loans were generally higher in 1995, despite the changing mix of the portfolio toward adjustable rate loans which generally have initial rates lower than comparable fixed rate loans. At December 31, 1995, adjustable rate loans represented approximately 56.4% of the loan portfolio compared to 48.5% at December 31, 1994 and 31.0% at December 31, 1993. These factors were partially offset by the positive effect on interest income of continued reductions in non-accrual loans. Loans on non-accrual status totaled $5.6 million at December 31, 1995 compared to $7.3 million at December 31, 1994 and $11.5 million at December 31, 1993.\nInterest on mortgage-backed securities increased $856,000, or 20.1%, primarily due to increases in the average yield earned on the portfolio due to purchases of securities with higher yields as well as upward adjustments on adjustable rate mortgage-backed securities.\nInterest and dividends on U.S. Treasury and agencies, corporate and other securities decreased by $1.6 million, or 31.4%, primarily reflecting a decrease in the average balance outstanding from $76.8 million in 1994 to $51.2 million in 1995. This decrease was primarily the result of maturities and, to a lesser degree, the effect of corporate securities being called prior to maturity. Funds provided by maturities and calls were generally used toward reinvestment into U.S. Treasury notes and purchases of mortgage-backed securities. The average rate earned on U.S. Treasury and agencies, corporate and other securities increased from 6.67% in 1994 to 6.86% in 1995 as a result of purchases of securities with higher yields as well as the sale of lower yielding securities during the fourth quarter of 1994.\nInterest on Federal funds sold and other earning assets increased $1.0 million due to an increase in the average balance outstanding from $22.9 million in 1994 to $35.2 million in 1995 as well as an increase in the rate earned to 5.85% in 1995 from 4.43% in 1994.\nThe $6.5 million increase in interest on interest-bearing liabilities was due primarily to an increase in the cost of funds as a result of the generally higher rate environment in 1995 as well as the shift in the mix of deposits from lower cost savings deposits to higher cost time and money market deposits. For the year ended December 31, 1995, average savings deposits decreased $22.1 million and average time deposits increased $59.3 million as compared to the previous year. Management's policy is to review deposit interest rates at least weekly and to adjust appropriately based on the need for funds, competition and the effect on the net interest margin. The Company's interest costs on time and savings deposits may begin to trend downward in a declining interest rate environment.\nProvision for Loan Losses\nThe provision for loan losses is a charge against income which increases the allowance for loan losses. The adequacy of the allowance for loan losses is evaluated periodically and is determined based on management's judgment concerning the amount of risk and potential for loss inherent in the portfolio. Management's judgment is based upon a number of factors including a review of non-performing and other classified loans, the value of collateral for such loans, historical loss experience, changes in the nature and volume of the loan portfolio, and current and prospective economic conditions. When doubt exists in the view of management as to the collectibility of the remaining balance of a loan, the Company will charge-off that portion deemed to be uncollectible.\nFor the year ended December 31, 1995, the provision for loan losses was $600,000, a reduction of $900,000 from the provision of $1.5 million in 1994. The lower provision primarily reflects the continued reduction in non-performing loans, and continued stable conditions in the local economy and most sectors of the real estate market. Non-performing loans declined to $5.8 million, or 1.07% of total loans, at December 31, 1995 from $7.4 million, or 1.53% of total loans, at December 31,1994. In addition, the ratio of the allowance for loan losses to non-performing loans increased to 139.39% at December 31, 1995 from 127.12% for the previous year.\nIn determining the allowance for loan losses, management also considers the level of slow paying loans, or loans where the borrower is contractually past due thirty to eighty-nine days or more, but has not yet been placed on non-accrual status. At December 31, 1995, slow paying loans amounted to $3.4 million as compared to $2.9 million at December 31, 1994.\nLoan loss provisions in future periods will continue to depend on trends in the credit quality of the Company's loan portfolio and the level of loan charge-offs which, in turn, will depend in part on the economic and real estate market conditions prevailing within the Company's lending region. If general economic conditions or real estate values deteriorate, the level of delinquencies, non-performing loans, and charge-offs may increase and higher provisions for loan losses may be necessary.\nOther Income\nSources of other income include deposit and other service fees, net gain (loss) on the sale of securities available for sale, net gain (loss) on sales of loans, and other non-interest income. For the year ended December 31, 1995, other income increased by $3.2 million to $3.3 million from $156,000 for 1994.\nDeposit service fees, the largest component of other income, increased by $209,000, or 11.1%, to $2.1 million for 1995 from $1.9 million for 1994. This was primarily the result of an increase in the amount of retail checking account fees collected in 1995. Other service fees remained relatively unchanged at $620,000 for 1995 from $644,000 for the previous year.\nNet gain on securities was $349,000 for the year ended December 31, 1995 compared to a net loss of $1.0 million for 1994. The net gain on securities in 1995 primarily reflects the gain of $538,000 recorded on the sale of equity securities in the fourth quarter of 1995. The net loss in 1994 primarily represents losses of $1.2 million on the sale of U.S. Treasury and agency securities of $22.9 million and other debt securities of $3.8 million, partially offset by gains of $168,000 on the sale of mortgage-backed securities of $8.2 million and equity securities of $781,000. The securities sold were classified as available for sale securities and primarily represented debt securities with longer maturities, low yielding equity securities, and mortgage-backed securities with low remaining principal balances. The 1994 sales were primarily made to restructure portions of the portfolio, to shorten maturities and improve yield. There were no sales of securities classified as held to maturity in either 1995 or 1994.\nNet gain on the sale of loans was $203,000 for the year ended December 31, 1995 compared to a net loss of $1.5 million for 1994. The net loss in 1994 primarily reflects the sale of seasoned conforming fixed rate mortgages that management decided to sell in the fourth quarter of 1994 as part of the Company's on-going effort to manage interest rate risk and increase liquidity. In addition, sales of mortgage loans in both years reflect the Company's current practice of selling newly originated fixed rate mortgage loans.\nOther Expense\nOther expense consists of general and administrative expenses incurred in managing the core business of the Company and the net costs associated with managing and selling other real estate properties. For the year ended December 31, 1995, other expense decreased by $1.4 million, or 6.8%, to $19.3 million from $20.7 million for 1994, primarily due to decreases in the net cost of other real estate and FDIC deposit insurance expense, partially offset by the increase in other non-interest expense.\nSalaries and employee benefits, the largest component of other expense, increased by $117,000, or 1.3%, to $9.1 million for the year ended December 31, 1995 from $8.9 million for 1994. The increase was primarily the hiring additional staff and normal merit and promotional salary increases, partially offset by lower medical insurance costs as a result of a change in insurance provider and a reduction in postretirement benefit expense.\nOccupancy and equipment costs increased $82,000, or 3.6%, to $2.4 million for the year ended December 31, 1995 from $2.3 million for 1994.\nThe net cost of other real estate decreased $1.6 million, or 82.3%, to $355,000 for the year ended December 31, 1995 from $2.0 million for the previous year, primarily reflecting a $925,000 reduction in the provision for losses as a result of the decline in the other real estate owned portfolio and management's assessment of the adequacy of the allowance for other real estate losses. The investment in other real estate properties (before the allowance for losses) declined substantially from $2.7 million at December 31, 1994 to $608,000 at December 31, 1995. The decline in the net cost of other real estate also includes a $1.1 million decrease in net holding costs, reflecting the smaller portfolio of properties in the current year.\nFDIC deposit insurance expense decreased $653,000, or 47.5%, to $721,000 for the year ended December 31, 1995 from $1.4 million for 1994.The significant decrease in FDIC deposit insurance expense primarily reflects the reduction of the insurance premium on Pawling's deposits.\nOther non-interest expense increased $694,000, or 11.4%, to $6.8 million for 1995 from $6.1 million for 1994. The increase primarily reflects a $1.0 million provision for probable losses which may result from the Nationar seizure as further discussed on page 17. The provision was partially offset by reduction of $631,000 in foreclosure and collection expense.\nIncome Tax Expense\nThe Company recognized income tax expense of $4.5 million in 1995, or 39.6% of pre-tax income for the year. For 1994, the Company recognized an income tax benefit of $628,000, consisting of a benefit of $3.5 million from a reduction in the valuation allowance for deferred tax assets, less a provision of $2.9 million or 40.8% of pre-tax income for the year.\nFor 1995, the Company reduced the valuation allowance on deferred tax assets by $174,000, primarily due to the utilization of capital loss carryforwards during the year. The valuation allowance applicable to the Company's Federal deferred tax asset was reduced by $1.3 million in 1994 commensurate with the increase during 1994 in Federal income taxes recoverable by loss carryback. In addition, the valuation allowance applicable to the Company's state deferred tax asset was reduced by $2.2 million in the fourth quarter of 1994. This latter reduction was based on management's reevaluation of the Company's prospects for future earnings considering factors such as (i) the reduction in non-performing assets and other higher-risk assets primarily attributable to the bulk sales in the fourth quarter of 1994, (ii) the reduction in interest rate risk attributable to the sale of primarily lower yielding fixed rate loans and securities in the fourth quarter of 1994, and (iii) the sustained level of recent historical pre-tax earnings, including the achievement of three consecutive years of consistent profitability. The state deferred tax asset has been recognized on the basis of expected earnings in future years, as the New York State tax law does not allow net operating loss carrybacks or carryforwards.\nThe Company's net deferred tax assets were $5.2 million at December 31, 1995, net of a remaining valuation allowance of $88,000. At December 31, 1994, the Company's net deferred tax assets were $6.3 million, net of a remaining valuation allowance of $262,000. Based on recent historical and anticipated future pre-tax earnings, management believes it is more likely than not that the Company will realize its net deferred tax assets. Management anticipates that the Company's near-term results of operations will not be significantly affected by further adjustments to the valuation allowance for deferred tax assets.\nYear Ended December 31, 1994 Compared to Year Ended December 31, 1993\nGeneral\nFor the year ended December 31, 1994, the Company's net income was $7.7 million or $2.66 per share as compared to $7.1 million or $2.41 per share for 1993. The $609,000 increase in net income was primarily the result of a $1.8 million decrease in net cost of other real estate and a $1.5 million decrease in income tax expense, partially offset by a $3.0 million decrease in other income. Net income for 1993 reflects a net charge of $363,000 for the cumulative effect of two changes in accounting principles.\nNet Interest Income\nThe rising interest rate environment and the Company's continued asset growth in 1994 combined to produce a stable level of net interest income for the year, although net interest margins were narrower in 1994 compared to 1993. Net interest income increased $26,000, or 0.1%, to $29.1 million for 1994 compared to $29.0 million for 1993. The components of net interest income are interest and dividend income, which decreased $34,000 or 0.1%, and interest expense on deposits, which decreased $60,000 or 0.3%. The Company's interest rate spread narrowed by 27 basis points from 4.23% in 1993 to 3.96% in 1994, reflecting a 46 basis point decline in the average yield on earning assets, partially offset by the 19 basis point decline in the average cost of deposits. The net interest margin also narrowed by 26 basis points from 4.77% in 1993 to 4.51% in 1994, primarily reflecting the narrower interest rate spread.\nThe $34,000 decrease in interest and dividend income was primarily the result of a $3.1 million decrease in interest and dividends earned on U.S. Treasury and agencies, corporate and other securities, partially offset by a $1.3 million increase in interest on mortgage-backed securities and a $1.3 million increase in interest on loans. The decline in interest on U.S. Treasury and agencies, corporate and other securities primarily reflects a $42.7 million decrease in the average balance due to sales, maturities and, to a lesser degree, the effect of corporate securities being called prior to maturity. Funds provided by sales, maturities and calls were generally used for loan originations and purchases of mortgage-backed securities. Interest on mortgage-backed securities increased primarily due to an increase in the average balance outstanding as the Company continued to emphasize the purchase of certain mortgage-backed securities in order to reduce interest rate risk, as well as increases in the yield earned on the portfolio. The increase in interest on loans was attributable to increases in the average balance outstanding, partially offset by a decrease in the weighted average rate earned on the portfolio. The lower yield primarily reflects mortgage originations at relatively low interest rates during 1993 and early 1994, partially offset by new originations at higher rates during the remainder of 1994. The lower yield also reflects the changing mix of the portfolio toward adjustable rate loans which generally provide higher returns in a rising rate environment but have initial rates lower than comparable fixed rate loans.\nThe $60,000 decrease in interest on deposits was due primarily to a decrease in the average rate paid on deposits as well as the continuing shift in the mix of deposits from higher-cost time deposits to lower-cost savings deposits.\nProvision for Loan Losses\nFor the year ended December 31, 1994, the provision for loan losses was $1.5 million as compared to $2.0 million for 1993. The $500,000 reduction primarily reflects the continued reduction in the Company's non-performing loans, and stabilization in the local economy and certain sectors of the real estate market. Non-performing loans declined to $7.4 million, or 1.53% of total loans, at December 31, 1994 from $11.6 million, or 2.59% of total loans, at December 31, 1993.\nIn determining the provision for loan losses, management also considers the level of slow paying loans, or loans where the borrower is contractually past due thirty days or more, but has not yet been placed on non-accrual status. At December 31, 1994, slow paying loans amounted to $2.9 million as compared to $6.3 million at December 31, 1993.\nOther Income\nFor the year ended December 31, 1994, other income decreased by $3.0 million to $156,000 from $3.1 million in 1993. Deposit service fees, the largest component of other income, decreased $103,000, or 5.2%, to $1.9 million for 1994 from $2.0 million for 1993. This was primarily the result of a reduction in the volume of retail checking account fees.\nNet loss on securities was $1.0 million for the year ended December 31, 1994 compared to a net gain of $184,000 for 1993. The net loss in 1994 primarily represents the sale of certain available for sale securities that primarily represented debt securities with longer maturities, low yielding equity securities, and mortgage-backed securities with lower remaining principal balances. The sales were primarily made to restructure portions of the portfolio and improve yield. Net loss on the sale of loans was $1.5 million for the year ended December 31, 1994 compared to a net gain of $169,000 for 1993. The net loss in 1994 primarily reflects the sale of seasoned conforming fixed rate mortgages that management decided to sell in the fourth quarter of 1994 as part of the Company's on-going effort to manage interest rate risk and increase liquidity.\nOther Expense\nFor the year ended December 31, 1994, other expense decreased by $1.1 million, or 5.2%, to $20.7 million from $21.8 million for 1993, primarily due to a decrease in the net cost of other real estate.\nSalaries and employee benefits, the largest component of other expense, increased $235,000, or 2.7%, to $8.9 million for 1994 from $8.7 million for 1993. The increase was primarily the result of hiring additional staff, normal merit and promotional salary increases, and higher fringe benefit expense.\nOccupancy and equipment costs decreased $121,000, or 5.1%, to $2.3 million for the year ended December 31, 1994 from $2.4 million for 1993.\nThe net cost of other real estate decreased $1.8 million, or 46.8%, to $2.0 million for 1994 from $3.8 million for the previous year, primarily reflecting a $1.3 million reduction in the provision for losses. The lower provision reflects the decline in the real estate portfolio and management's assessment of the adequacy of the allowance for other real estate losses.\nFDIC deposit insurance expense decreased $146,000, or 9.6%, to $1.4 million for 1994 from $1.5 million for 1993. This reflects lower assessment rates in 1994, partially offset by the effect of an increase in assessable deposits.\nOther non-interest expense increased $656,000, or 12.0%, to $6.1 million for 1994 from $5.4 million for 1993. This reflects a $279,000 increase in advertising expense due to additional marketing efforts and higher miscellaneous operating expenses.\nIncome Tax Expense\nThe Company adopted Statement of Financial Accounting Standards (\"SFAS\") No. 109, effective January 1, 1993. Among other things, SFAS No. 109 requires recognition of a valuation allowance for a deferred tax asset if, based on an analysis of available evidence, management determines that it is more likely than not that some portion or all of the deferred tax asset will not be realized. The valuation allowance is subject to ongoing adjustment based on changes in circumstances that affect management's judgment about the realizability of the deferred tax asset. Adjustments to increase or decrease the valuation allowance are charged or credited, respectively, to income tax expense. A valuation allowance of $6.3 million was established at January 1, 1993, upon adoption of SFAS No. 109.\nThe Company recognized an income tax benefit of $628,000 in 1994, consisting of a benefit of $3.5 million from a reduction in the valuation allowance for deferred tax assets less a tax provision of $2.9 million or 40.8% of pre-tax income for the year. For 1993, tax expense of $911,000 consisted of a provision of $3.5 million or 41.6% of pre-tax income for the year less a benefit of $2.6 million from a reduction in the valuation allowance for deferred tax assets.\nThe valuation allowance applicable to the Company's Federal deferred tax asset was reduced by $1.3 million in 1994 and $2.6 million in 1993 commensurate with the increases during those years in Federal income taxes recoverable by loss carryback. In addition, the valuation allowance applicable to the Company's state deferred tax asset was reduced by $2.2 million in the fourth quarter of 1994. This latter reduction was based upon management's reevaluation of the Company's prospects for future earnings considering factors such as (i) the reduction in non-performing assets and other higher-risk assets primarily attributable to the bulk sales in the fourth quarter of 1994, (ii) the reduction in interest rate risk attributable to the sale of primarily lower yielding fixed rate loans and securities in the fourth quarter of 1994, and (iii) the sustained level of recent historical pre-tax earnings, including the achievement of three consecutive years of consistent profitability. The state deferred tax asset has been recognized on the basis of expected earnings in the future years, as the New York State law does not allow net operating loss carrybacks or carryforwards.\nAsset Quality\nNon-performing assets are principally comprised of non-performing loans (non-accrual loans and loans greater than 90 days past due and still accruing) and other real estate properties. The Company's policy is to place a loan on non-accrual status with respect to interest income recognition when collection of the interest is uncertain. Generally, this occurs when principal or interest payments are 90 days or more past due, although interest accruals may continue in limited situations when loans are adequately secured and in the process of collection. The classification of a loan as non-accruing does not necessarily indicate that the principal and interest ultimately will be uncollectible. The Company's historical experience indicates that a portion of assets so classified will eventually be recovered. All non-performing loans are in various stages of workout, settlement or foreclosure. Other real estate includes properties acquired through foreclosure or deed in lieu of foreclosure and properties which have been effectively abandoned by the borrower.\nAt December 31, 1995, non-performing assets totaled $6.2 million, or 0.83% of total assets, compared to $9.7 million, or 1.39% of total assets, at December 31, 1994. The $3.5 million or 36.2% reduction in non-performing assets in 1995 consisted of a $1.6 million decrease in non-performing loans and a $1.9 million decrease in other real estate properties. These decreases reflect the Company's continuing efforts to workout loans and to sell other real estate on an asset-by-asset basis.\nIn the fourth quarter of 1994, the Company decided to dispose of certain troubled assets on a bulk sale basis in order to accelerate the reduction in loan portfolio credit risk, enhance overall asset quality and better position the Company to achieve its strategic goals. These transactions resulted in the sale of assets totaling $9.9 million, which consisted of (i) non-performing mortgage loans of $3.4 million, (ii) performing mortgage loans of $4.8 million with relatively high credit risk, and (iii) other real estate of $1.7 million. The net sales proceeds totaled $5.8 million, resulting in losses of $4.1 million which were charged to the allowance for loan losses ($3.9 million) and the allowance for losses on other real estate ($218,000).\nStability in the local economy and certain sectors of the real estate market in 1995 and 1994 contributed to positive trends in the Company's asset quality. The allowance for loan losses as a percentage of non-performing loans rose to 139.39% in 1995, compared to 127.12% in 1994 and 120.28% in 1993. As a percentage of total loans, the allowance for loan losses was 1.49% in 1995, compared to 1.95% in 1994 and 3.11% in 1993. These ratios reflect the ongoing improvement in asset quality, both in terms of the lower level of non-performing loans and the shift in portfolio mix toward lower risk residential mortgage and consumer loans.\nThe loan portfolio also includes certain restructured loans that are current in accordance with modified payment terms and, accordingly, are not included in the preceding table. These restructured loans are loans for which concessions, including reduction of interest rates to below-market levels or deferral of payments, have been granted due to the borrowers' financial condition. Restructured loans totaled $1.5 million, $1.8 million and $4.1 million at December 31, 1995, 1994 and 1993, respectively.\nAdditionally, at December 31, 1995, management has identified approximately $2.4 million in potential problem loans which represent loans having more than normal credit risk. Although these loans are currently performing at December 31, 1995, management believes that if economic conditions deteriorate in the Company's lending area, some of these loans could become non-performing in the future.\nEffective January 1, 1995, the Company adopted the provisions of SFAS No. 114, \"Accounting by Creditors for Impairment of a Loan,\" and its amendment, SFAS No. 118, \"Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures.\" These statements prescribe recognition criteria for loan impairment, generally relating to commercial and construction loans and measurement methods for impaired loans and all loans whose terms are modified in trouble debt restructuring subsequent to the adoption of these statements. A loan is considered to be impaired when, based on current information and events, it is probable that the lender will be unable to collect all principal and interest contractually due according to the original contractual terms of the loan agreement.\nSFAS No. 114 requires lenders to measure impaired loans based on (i) the present value of expected future cash flows discounted at the loan's effective interest rate, (ii) the loan's observable market price or (iii) the fair value of the collateral if the loan is collateral dependent. Generally, the Bank's impaired loans are considered to be collateral dependent. The Company considers estimated cost to sell, on a discounted basis, when determining the fair value of collateral in the measurement of impairment if the costs are expected to reduce the cash flows available to repay or otherwise satisfy the loan. An allowance for loan losses is maintained if the measure of an impaired loan is less than its recorded investment. Adjustments to the allowance are made through corresponding charges or credits to the provision for loan losses.\nIn addition, SFAS No. 114 makes significant changes to existing accounting principles applicable to in-substance foreclosures. In accordance with SFAS No. 114, a loan is classified as an in-substance foreclosure only when the Company has taken physical possession of the collateral regardless of whether formal foreclosure proceedings have taken place. Prior to the adoption of SFAS No. 114, in-substance foreclosed properties included those properties where the borrower had little or no equity in the property considering its fair value; where repayment was only to come from the operation or sale of the property; and where the borrower had effectively abandoned control of the property or it was doubtful that the borrower would be able to rebuild equity in the property.\nThe adoption of these statements did not have a significant effect on the Company's consolidated financial statements. At December 31, 1995, the Company's recorded investment in impaired commercial mortgage and construction loans totaled $3.2 million. The total impaired loans consist of (i) loans of $674,000 for which there was an allowance for loan losses of $110,000 determined in accordance with SFAS No. 114 and (ii) loans of $2.5 million for which there was no allowance determined under SFAS No. 114 due to the adequacy of related collateral and historical charge-offs associated with these loans. The average recorded investment in impaired loans was $5.1 million for 1995. Interest income on impaired loans is recognized on a cash basis and was not significant for the year ended December 31, 1995.\nLiquidity\nLiquidity is defined as the ability to generate sufficient cash flow to meet all present and future funding commitments. Management monitors the Company's liquidity position on a daily basis and evaluates its ability to meet depositor withdrawals and to make new loans and investments as opportunities arise. The Asset\/Liability Committee, consisting of members of senior management, is responsible for setting general guidelines to ensure maintenance of prudent levels of liquidity. The mix of liquid assets and various deposit products, at any given time, reflects management's view of the most efficient use of these sources of funds.\nThe Company's cash flows are classified according to their source-operating activities, investing activities, and financing activities. For 1995, net cash of $7.9 million was provided by operating activities. Net cash of $69.1 million was used in investing activities, which primarily consisted of disbursements for loan originations and security purchases, partially offset by loan principal collections, proceeds from sales of loans and proceeds from payments, maturities and calls of securities. Net cash provided by financing activities was $27.3 million, which consisted primarily of a net increase in deposits. Further details concerning the Company's cash flows are provided in the \"Consolidated Statements of Cash Flows\".\nOne measure used by the Company to assess its liquidity position is the primary liquidity ratio (defined as the ratio of cash and due from banks, Federal funds sold and securities maturing within one year to total assets). At December 31, 1995, the Company had a primary liquidity ratio of 8.21% as compared to 12.27% at December 31, 1994. The decline was primarily due to the $34.7 million decrease in Federal funds sold, partially offset by a $9.4 million increase in securities maturing within one year.\nAn important source of funds is Pawling's core deposit base. Management believes that a substantial portion of Pawling's deposits of $657.0 million at December 31, 1995 are core deposits. Core deposits are generally considered to be a highly stable source of liquidity due to the long-term relationships with deposit customers. Pawling recognizes the importance of maintaining and enhancing its reputation in the consumer market to enable effective gathering and retention of core deposits. The Company does not currently utilize brokered deposits as a source of funds.\nIn addition to the funding sources discussed above, the Company has the ability to borrow funds from several sources. Pawling is a member of the Federal Home Loan Bank of New York (\"FHLBNY\") and, at December 31, 1995, had immediate access to additional liquidity in the form of borrowings from the FHLBNY of $80.0 million. The Company also has access to the discount window of the Federal Reserve Bank.\nAt December 31, 1995, Pawling had outstanding loan commitments and unadvanced customer lines of credit totaling $72.8 million. These commitments do not necessarily represent future cash requirements since certain of these instruments may expire without being funded and others may not be fully drawn upon. The sources of liquidity discussed above are deemed by management to be sufficient to fund outstanding loan commitments and to meet the Company's other obligations.\nOn February 6, 1995, the Superintendent of Banks for the State of New York (the \"Superintendent\") seized Nationar, a check-clearing and trust company, freezing all of Nationar's assets. The Superintendent is now in the process of winding up the affairs of Nationar and liquidating its assets. The Company used Nationar for Federal funds transactions, as well as certain custodial and investment services. At the time of seizure, the Company had approximately $3.6 million in Federal funds sold and other deposits invested with Nationar.\nSubstantial uncertainties exist regarding amounts ultimately distributable to creditors of Nationar. These uncertainties include (i) the aggregate dollar amounts of claims asserted by creditors; (ii) the legal process and results of evaluation of claims, evaluation of asserted preferences, and resolution of contested claims; (iii) the amounts that will be realized on the assets of Nationar in its liquidation; and (iv) the legal and administrative expenses that will be incurred during the course of liquidation. The Superintendent has given preliminary indications that the assets may be inadequate to satisfy all claims of creditors in full.\nBased on the foregoing and a deficit in net shareholders' equity that was noted in a report issued by the Superintendent in April 1995, management, as advised by legal counsel, believes that there is reasonable likelihood that the Company will not recover all of its investments in Federal funds and other deposits at Nationar. As of December 31, 1995, the Company has reclassified the Federal funds sold to other assets and has provided a reserve of $1.0 million for probable loss of a portion of these Nationar assets. The Company will periodically review this reserve as developments occur, and future reserves may be required.\nThe foregoing events will not have any material effect on the Company's ability to meet their liquidity needs. Management is taking all steps necessary to recover the amounts owed to the Company by Nationar.\nCapital\nProgressive, as a bank holding company, is subject to regulation and supervision by the Federal Reserve Board (\"FRB\"). The FRB applies various guidelines in assessing the adequacy of capital in examining and supervising a bank holding company and in analyzing applications to the FRB. Under the current leverage capital guidelines, most banking companies must maintain Tier 1 capital of between 4.0% and 5.0% of total assets. Tier 1 capital is comprised of common shareholders' equity, noncumulative perpetual preferred stock and minority interests in consolidated subsidiaries, less substantially all intangible assets, identified losses and investments in certain subsidiaries.\nThe FRB also has adopted a set of risk-based capital adequacy guidelines, which require the Company to maintain capital according to the risk profile of its asset portfolio and certain off-balance sheet items. The guidelines set forth a system for calculating risk-weighted assets by assigning assets (and credit-equivalent amounts for certain off-balance sheet items) to one of four broad risk-weight categories. The amount of risk-weighted assets is determined by applying a specific percentage (0%, 20%, 50% or 100%, depending on the level of credit risk) to the amounts assigned to each category. As a percentage of risk-weighted assets, a minimum ratio of 4.0% must be maintained for Tier 1 capital and 8.0% for total capital.\nPawling, as a New York state-chartered stock savings bank, is subject to regulation and supervision by the New York State Banking Department as its chartering agency and by the FDIC as its deposit insurer. FDIC regulations require insured banks, such as Pawling, to maintain minimum levels of capital. The FDIC regulations follow, in substance, the leverage and risk-based capital guidelines adopted by the FRB for bank holding companies.\nDuring 1994, the Company announced two plans to repurchase in each case up to 5% of Progressive's outstanding common stock, to be used for general corporate purposes. The first repurchase was completed on November 9, 1994 and consisted of 147,000 shares at a total cost of $3.1 million or $21.21 per share. The second repurchase plan was completed on September 29, 1995 and consisted of 140,000 shares at a total cost of $3.3 million or $23.84 per share. On October 24, 1995, the Company announced a third plan to repurchase 134,000 shares. At December 31, 1995, 63,000 shares had been purchased under the third plan at a cost of $1.8 million or $28.41 per share. The Company considers its stock to be an attractive investment and believes these programs will increase shareholder value.\nAsset\/Liability Management\nThe Company's asset\/liability management goal is to maintain an acceptable level of interest rate risk to produce relatively stable net interest income in changing interest rate environments. Management continually monitors the Company's interest rate risk. Risk management strategies are developed and implemented by the Asset\/Liability Committee which uses various risk measurement tools to evaluate the impact of changes in interest rates on the Company's asset\/liability structure and net interest income.\nEarnings are susceptible to interest rate risk to the degree that interest-bearing liabilities mature or reprice on a different basis than interest-earning assets. These interest rate repricing \"gaps\" provide an indication of the extent that net interest income may be affected by future changes in interest rates. A one-year period is a common measurement interval of interest sensitivity known as the one-year gap. The Company's one-year gap as a percentage of total assets was 3.74% at December 31, 1995. A positive gap exists when the amount of interest-earning assets exceeds the amount of interest-bearing liabilities expected to mature or reprice in a given period. A positive gap may enhance earnings in periods of rising interest rates in that, during such periods, the interest income earned on assets may increase more rapidly than the interest expense paid on liabilities. Conversely, in a falling interest rate environment, a positive gap may result in a decrease in interest income earned on assets that is greater than the decrease in interest expense paid on liabilities. While a positive gap indicates the amount of interest-earning assets which may reprice before interest-bearing liabilities, it does not indicate the extent to which they will reprice. Therefore, at times, a positive gap may not produce higher margins in a rising rate environment.\nDue to limitations inherent in the gap analysis, management augments the asset\/liability management process by using simulation analysis. Simulation analysis estimates the impact on net interest income of changing the balance sheet structure and\/or interest rate environment. This analysis serves as an additional tool in meeting the Company's goal of maintaining relatively stable net interest income in varying rate environments.\nThe Company manages its interest rate risk primarily by structuring its balance sheet to emphasize holding adjustable rate loans and mortgage-backed securities in its portfolio and maintaining a large base of core deposits. The Company has not used synthetic hedging instruments such as interest rate futures, swaps or options.\nPrepayments and scheduled payments have been estimated for the loan portfolio based on the Company's historical experience. Certain fixed rate loans are callable at any time at the Company's option. The majority of these loans are immediately callable and therefore are included in the \"Within One Year\" time period. Adjustable rate mortgage loans are assumed to reprice at the earlier of scheduled maturity or the contractual interest rate adjustment date. Non-accrual loans are included in the table at their original maturities. Savings account repricings are based on the Company's historical repricing experience and management's belief that these accounts are not highly sensitive to changes in interest rates.\nImpact of Inflation\nThe consolidated financial statements and related consolidated financial information presented in this annual report have been prepared in conformity with generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on a financial institution's performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or in the same magnitude as the prices of goods and services.\nNew Accounting Standards\nIn May 1995, the Financial Accounting Standards Board (the \"FASB\") issued SFAS No. 121 \"Accounting for Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of.\" Various assets are excluded from the scope of SFAS No. 121, including financial instruments which constitute the majority of the Company's assets. For long-lived assets included in the scope of SFAS No. 121, such as premises and equipment, an impairment loss must be recognized when the estimate of total undiscounted future cash flows attributable to the asset is less than the asset's carrying amount. Measurement of the impairment loss is determined by reducing the carrying amount of the asset to its fair value. Long-lived assets to be disposed of such as other real estate or premises to be sold, are reported at the lower of carrying amount or fair value less costs to sell. The Company will adopt SFAS No. 121 in the first quarter of 1996. Management anticipates the adoption of SFAS No. 121 will not have a material effect on the Company's consolidated financial statements.\nIn May 1995, the FASB issued SFAS No. 122, \"Accounting for Mortgage Servicing Rights,\" which amends SFAS No. 65, \"Accounting for Certain Mortgage Banking Activities.\" SFAS No. 122 requires that entities recognize as separate assets, the rights to service mortgage loans for others, regardless of how those servicing rights are acquired. Additionally, SFAS No. 122 requires that the capitalized mortgage servicing rights be assessed for impairment based on the fair value of those rights, and that impairment, if any, be recognized through a valuation allowance. The Company will adopt SFAS No. 122 in the first quarter of 1996. The adoption of SFAS No. 122 will result in increased gains recognized on the sale of mortgage loans when servicing rights are retained, offset by the amortization of the capitalized mortgage servicing rights. Based on the current volume of mortgage loans sold on a servicing retained basis, management does not anticipate the adoption of SFAS No. 122 will have a material effect on the Company's consolidated financial statements.\nIn October 1995, the FASB issued SFAS No. 123, \"Accounting for Stock-Based Compensation,\" which establishes a fair value based method of accounting for employee stock options, such as the Company's stock option plans or similar equity instruments. Under SFAS No. 123, entities can recognize stock-based compensation expense in the basic financial statements using either (i) the intrinsic value based approach set forth in the APB Opinion No. 25 or (ii) the fair value based method introduced in SFAS No. 123. Entities electing to remain with the accounting in APB Opinion No. 25, must make pro forma disclosures of net income and earnings per share, as if the fair value based method of accounting defined in SFAS No. 123 had been applied. Under the method currently utilized by the Company (APB Opinion No. 25), compensation expense is determined based upon the option's intrinsic value, or the excess (if any) of the market price of the underlying stock at the measurement date over the amount the employee is required to pay. Under the fair value based method introduced by SFAS No. 123, compensation expense is based on the option's estimated fair value at the grant date and is generally recognized over the vesting period. Management anticipates that it will elect to measure stock-based compensation costs in accordance with APB Opinion No. 25 and will adopt the pro forma disclosure requirements of SFAS No. 123 in 1996.\nReport of Management\nThe accompanying consolidated financial statements of Progressive Bank, Inc. and subsidiary are the responsibility of and have been prepared by management in conformity with generally accepted accounting principles. These statements necessarily include some amounts that are based on best judgments and estimates. Other financial information in the annual report is consistent with that in the consolidated financial statements.\nManagement is responsible for maintaining a system of internal accounting control. The purpose of the system is to provide reasonable assurance that transactions are recorded in accordance with management's authorization, that assets are safeguarded against loss or unauthorized use, and that underlying financial records support the preparation of financial statements. The system includes written policies and procedures, selection of qualified personnel, appropriate segregation of responsibilities, and the ongoing internal audit function.\nThe independent auditors conduct an annual audit of the Company's consolidated financial statements to enable them to express an opinion as to the fair presentation of the statements. In connection with the audit, the independent auditors consider the internal control structure, to the extent they consider necessary to determine the nature, timing and extent of their auditing procedures. The independent auditors also prepare recommendations regarding internal controls and other accounting and financial related matters. The implementation of these recommendations by management is monitored directly by the Audit Committee of the Board of Directors.\n(signature) (signature) Peter Van Kleeck Robert Gabrielsen President and CEO Treasurer and CFO\nIndependent Auditors' Report\nThe Board of Directors and Shareholders Progressive Bank, Inc.:\nWe have audited the accompanying consolidated balance sheets of Progressive Bank, Inc. and subsidiary as of December 31, 1995 and 1994, 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, 1995. 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 Progressive Bank, Inc. and subsidiary as of December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1995 in conformity with generally accepted accounting principles.\nAs discussed in notes 1, 2, 8 and 11 to the consolidated financial statements, the Company changed its methods of accounting for income taxes and the cost of postretirement benefits in 1993, and its method of accounting for certain securities in 1994, to adopt the provisions of Financial Accounting Standards Board's Statement of Financial Accounting Standards Nos. 109 \"Accounting for Income Taxes,\" 106 \"Employer's Accounting for Postretirement Benefits Other Than Pensions\" and 115 \"Accounting for Certain Investments in Debt and Equity Securities,\" respectively.\n(signature) Albany, New York January 19, 1996\nNotes to Consolidated Financial Statements\n1. Summary of Significant Accounting Policies\nBasis of Presentation\nProgressive Bank, Inc. (\"Progressive\") is a bank holding company whose sole subsidiary is Pawling Savings Bank (\"Pawling\"). Collectively, these entities are referred to herein as the \"Company.\" Pawling is a New York state-chartered stock savings bank providing a full range of community banking services to individual and corporate customers. Progressive and Pawling are subject to the regulations of certain Federal and state agencies and undergo periodic examinations by those regulatory authorities.\nThe consolidated financial statements have been prepared in conformity with generally accepted accounting principles. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Material estimates that are particularly susceptible to near-term change include the allowances for losses on loans and other real estate, and the valuation allowance for deferred tax assets. The Company's accounting policies with respect to these estimates are discussed below.\nThe consolidated financial statements include the accounts of Progressive and Pawling. All significant intercompany accounts and transactions are eliminated in consolidation.\nFor purposes of reporting cash flows, cash equivalents are defined as Federal funds sold and other highly liquid instruments with an original term of three months or less.\nReclassifications are made whenever necessary to conform to the current year's presentation.\nSecurities\nEffective January 1, 1994, the Company changed its method of accounting for securities, upon adoption of Statement of Financial Accounting Standards (\"SFAS\") No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" Under SFAS No. 115, securities are classified as held to maturity securities, trading securities, or available for sale securities. Securities held to maturity are limited to debt securities for which the entity has the positive intent and ability to hold to maturity. Trading securities are debt and equity securities that are bought principally for the purpose of selling them in the near term. All other debt and equity securities are classified as available for sale.\nHeld to maturity securities are carried at amortized cost under SFAS No. 115, which is the same basis of accounting previously used by the Company for its debt securities held for investment. Available for sale securities are carried at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of shareholders' equity (net of taxes). Prior to the adoption of SFAS No. 115, available for sale securities were carried at the lower of cost or fair value in the aggregate, with net unrealized losses (if any) reported in earnings. The Company has no trading securities.\nNon-marketable equity securities (principally stock of the Federal Home Loan Bank) are included in the securities available for sale at cost as there is no readily available market value.\nPremiums and discounts on debt securities are recognized as adjustments to interest income. Realized gains and losses on sales of securities are determined using the specific identification method. Unrealized losses on held to maturity and available for sale securities are charged to earnings when the decline in fair value of a security is judged to be other than temporary.\nAllowance for Loan Losses\nThe allowance for loan losses is maintained at a level deemed adequate by management based on an evaluation of the known and inherent risks in the portfolio, past loan loss experience, estimated value of underlying collateral, and current and prospective economic conditions. The allowance is increased by provisions for loan losses charged to operations. Loan losses and recoveries of loans previously written-off are charged or credited to the allowance as incurred or realized, respectively.\nEffective January 1, 1995, the Company adopted the provisions of SFAS No. 114, \"Accounting by Creditors for Impairment of a Loan,\" and its amendment, SFAS No. 118, \"Accounting by Creditors for Impairment of a Loan- Income Recognition and Disclosures.\" These statements prescribe recognition criteria for loan impairment, generally relating to commercial and construction loans and measurement methods for impaired loans and all loans whose terms are modified in trouble debt restructuring subsequent to the adoption of these statements. A loan is considered to be impaired when, based on current information and events, it is probable that the lender will be unable to collect all principal and interest contractually due according to the original contractual terms of the loan agreement. The Company generally considers impaired loans to be commercial and construction non-accrual loans and loans restructured since January 1, 1995.\nSFAS No. 114 requires lenders to measure impaired loans based on (i) the present value of expected future cash flows discounted at the loan's effective interest rate, (ii) the loan's observable market price or (iii) the fair value of the collateral if the loan is collateral dependent. Generally, the Bank's impaired loans are considered to be collateral dependent. The Company considers estimated cost to sell, on a discounted basis, when determining the fair value of collateral in the measurement of impairment if the costs are expected to reduce the cash flows available to repay or otherwise satisfy the loan. An allowance for loan losses is maintained if the measurement of an impaired loan is less than its recorded investment. Adjustments to the allowance are made through corresponding charges or credits to the provision for loan losses.\nInterest and Fees on Loans\nInterest income is accrued monthly on outstanding loan principal balances unless management considers collection to be uncertain (generally, when principal or interest payments are ninety days or more past due). When loans are placed on non-accrual status, previously accrued but unpaid interest is reversed by charging interest income of the current period. Loans are returned to accrual status when collectibility is no longer considered uncertain.\nLoan origination fees and certain direct loan origination costs are deferred. The net fee or cost is amortized to interest income, using the level yield method, over the contractual loan term. Amortization ceases when loans are placed on non-accrual status and resumes when loans are returned to accrual status.\nOther Real Estate\nOther real estate consists of properties acquired through foreclosure or deed in lieu of foreclosure and properties securing loans classified as in-substance foreclosures. A property is initially recorded at the lower of the recorded investment in the loan or the fair value of the property, with any resulting write-down charged to the allowance for loan losses. Thereafter, an allowance for losses on other real estate is established if the cost of a property exceeds its current fair value less estimated sales costs. Fair value estimates are based on recent appraisals and other available information.\nThe Company adopted SFAS No. 114, effective January 1, 1995, which makes significant changes to existing accounting principles applicable to in-substance foreclosures. In accordance with SFAS No. 114, a loan is classified as an in-substance foreclosure only when the Company has taken physical possession of the collateral regardless of whether formal foreclosure proceedings have taken place. Prior to the adoption of SFAS No. 114, in-substance foreclosed properties included those properties where the borrower had little or no equity in the property considering its fair value; where repayment was only to come from the operation or sale of the property; and where the borrower had effectively abandoned control of the property or it was doubtful that the borrower would be able to rebuild equity in the property.\nHolding costs on properties ready for sale are included in current operations, while costs that improve such properties are capitalized.\nGains on sales of other real estate are credited to income and losses are charged against the allowance for losses on other real estate. Gain or loss is recognized upon disposition of the property and the transfer of the risks and rewards of ownership.\nPremises and Equipment\nLand is carried at cost. Buildings, furniture and equipment are carried at cost less accumulated depreciation. Depreciation expense is computed on a straight-line basis over the estimated useful lives of the related assets. Maintenance and repair costs are charged to operating expenses as incurred, while costs of significant renewals and betterments are capitalized.\nIncome Taxes\nEffective January 1, 1993, the Company changed its method of accounting for income taxes upon adoption of SFAS No. 109, \"Accounting for Income Taxes,\" and reported the cumulative effect of the accounting change in the 1993 consolidated statement of income. Under the asset and liability method required by SFAS No. 109, deferred taxes are recognized for the estimated future tax effects attributable to \"temporary differences\" and tax loss carryforwards. Temporary differences are differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities.\nUnder SFAS No. 109, a deferred tax liability is recognized for all temporary differences that will result in future taxable income. A deferred tax asset is recognized for all temporary differences that will result in future tax deductions and for all unused tax loss carryforwards, subject to reduction of the asset by a valuation allowance in certain circumstances. This valuation allowance is recognized if, based on an analysis of available evidence, management determines that it is more likely than not that some portion or all of the deferred tax asset will not be realized. The valuation allowance is subject to ongoing adjustment based on changes in circumstances that affect management's judgment about the realizability of the deferred tax asset. Adjustments to increase or decrease the valuation allowance are charged or credited, respectively, to income tax expense.\nDeferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax laws or rates is recognized in income in the period that includes the enactment date of the change.\nPostretirement Benefits\nEffective January 1, 1993, the Company changed its method of accounting for postretirement benefits upon adoption of SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" and reported the cumulative effect of the accounting change in the 1993 consolidated statement of income. Under SFAS No. 106, the cost of postretirement benefits is recognized on an accrual basis as such benefits are earned by active employees.\nNet Income Per Common Share\nNet income per common share is computed based on the weighted average number of shares outstanding during each period, adjusted for the effect of common stock equivalents when such adjustment results in a significant dilution of the per share data.\n2. Securities\nEquity securities at December 31, 1995 and 1994 include Federal Home Loan Bank stock with a cost basis of $4.0 million and $891,000, respectively.\nIn November 1995, the Financial Accounting Standards Board released its Special Report, \"A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities.\" The Special Report contained a unique provision that allowed entities to, as of a single date between November 15, 1995 and December 31, 1995, reassess the appropriateness of the classification of all securities held at that time. On November 30, 1995, as permitted by the Special Report, the Company made a one-time transfer of certain adjustable rate mortgage-backed securities with an amortized cost of $44.9 million and a fair value of $46.3 million, to the available for sale portfolio from held to maturity. The transfer was made primarily to enhance liquidity and provide greater flexibility in managing the Company's securities.\nThe Company's mortgage-backed securities are pass-through securities guaranteed by the Federal Home Loan Mortgage Corporation (\"FHLMC\") or the Federal National Mortgage Association (\"FNMA\"). Mortgage-backed securities held to maturity at December 31, 1995 and 1994 consisted of (i) FHLMC certificates with an amortized cost of $21.9 million and $44.1 million, respectively, and (ii) FNMA certificates with an amortized cost of $18.2 million and $39.6 million, respectively. At December 31, 1995, mortgage-backed securities held to maturity are principally five- and seven-year balloon payment securities. Mortgage-backed securities available for sale at December 31, 1995 are adjustable rate securities consisting of (i) FHLMC certificates with a fair value of $17.8 million, and (ii) FNMA certificates with a fair value of $27.1 million.\nThe net gain (loss) on the sale of securities available for sale includes gross realized gains and gross realized losses applicable to available for sale securities of approximately $379,000 and $30,000, respectively, in 1995 and $300,000 and $1.3 million, respectively, in 1994 and $197,000 and $13,000, respectively, in 1993.\n3. Loans\nMortgage loans are comprised of adjustable rate loans of $298.6 million and fixed rate loans of $182.0 million at December 31, 1995 ($223.4 million and $202.0 million, respectively, at December 31, 1994). Residential mortgage loans include home equity loans of $32.2 million and $28.7 million at December 31, 1995 and 1994, respectively. Construction loans are net of the unadvanced portion of such loans of $16.6 million and $15.3 million at December 31, 1995 and 1994, respectively.\nThe loan portfolio also includes certain restructured loans that are current in accordance with modified payment terms and, accordingly, are not included in the preceding table. These restructured loans are loans for which concessions, including reduction of interest rates to below-market levels or deferral of payments, have been granted due to the borrowers' financial condition. Restructured loans totaled $1.5 million, $1.8 million and $4.1 million at December 31, 1995, 1994 and 1993, respectively. There were no commitments to lend additional funds to borrowers with restructured loans at December 31, 1995.\nIf interest payments on non-accrual and restructured loans at December 31 had been made during the respective years in accordance with the original contractual loan terms, additional interest income of approximately $489,000, $1.0 million and $1.5 million would have been recognized in 1995, 1994 and 1993, respectively.\nThe Company originates loans primarily in the New York counties of Dutchess, Sullivan, Orange, Putnam, Ulster and Westchester. In 1993, the Company began originating loans in the Connecticut counties of Fairfield, Hartford, New Haven and Litchfield. The ability of borrowers to make principal and interest payments in the future will depend upon, among other things, the level of overall economic activity and the real estate market conditions prevailing within the Company's lending region.\nIn 1994, the Company completed bulk sales of (i) non-performing mortgage loans of $3.4 million and (ii) performing mortgage loans of $4.8 million with relatively high credit risk. The net sales proceeds totaled $4.3 million, resulting in losses of $3.9 million which were charged against the allowance for loan losses. There were no bulk sales in 1995 or 1993.\nEffective January 1, 1995, the Company adopted Statement of Financial Accounting Standards (\"SFAS\") No. 114, \"Accounting by Creditors for Impairment of a Loan\" and its amendment, SFAS No. 118, \"Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures.\"\nThe adoption of these statements did not have a significant effect on the Company's consolidated financial statements. At December 31, 1995, the Company's recorded investment in impaired commercial mortgage and construction loans totaled $3.2 million. The total impaired loans consist of (i) loans of $674,000 for which there was an allowance for loan losses of $110,000 determined in accordance with SFAS No. 114 and (ii) loans of $2.5 million for which there was no allowance determined under SFAS No. 114 due to the adequacy of related collateral and historical charge-offs associated with these loans. The average recorded investment in impaired loans was $5.1 million for 1995. Interest income on impaired loans is recognized on a cash basis and was not significant for the year ended December 31, 1995.\nCertain mortgage loans originated by the Company have been sold without recourse in the secondary market. The net realized gain (loss) on these sales was $203,000, ($1.5) million and $169,000 in 1995, 1994 and 1993, respectively. The net loss in 1994 primarily reflects the sale of seasoned fixed rate mortgages. Other realized gains and losses during the three-year period relate to the Company's current practice of selling newly originated fixed rate mortgage loans. At December 31, 1995, mortgage loans held for sale had a cost basis of $891,000 which approximated fair value. There were no mortgage loans held for sale at December 31, 1994.\nThe Company generally retains the servicing rights on loans sold. The principal balances of loans serviced for others, which are not included in the consolidated balance sheets, were $58.0 million and $49.1 million at December 31, 1995 and 1994, respectively.\nIn May 1995, the Financial Accounting Standards Board (\"FASB\") issued SFAS No. 122, \"Accounting for Mortgage Servicing Rights,\" which amends SFAS No. 65, \"Accounting for Certain Mortgage Banking Activities.\" SFAS No. 122 requires that entities recognize as separate assets, the rights to service mortgage loans for others, regardless of how those servicing rights are acquired. Additionally, SFAS No. 122 requires that the capitalized mortgage servicing rights be assessed for impairment based on the fair value of those rights, and that impairment, if any, be recognized through a valuation allowance. The Company will adopt SFAS No. 122 in the first quarter of 1996. The adoption of SFAS No. 122 will result in increased gains recognized on the sale of mortgage loans when servicing rights are retained, offset by the amortization of the capitalized mortgage servicing rights. Based on the current volume of mortgage loans sold on a servicing retained basis, management does not anticipate the adoption of SFAS No. 122 will have a material effect on the Company's consolidated financial statements.\n4. Other Real Estate\n5. Premises and Equipment\nIn May 1995, the FASB issued SFAS No. 121 \"Accounting for Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of.\" Various assets are excluded from the scope of SFAS No. 121, including financial instruments which constitute the majority of the Company's assets. For long-lived assets included in the scope of SFAS No. 121, such as premises and equipment, an impairment loss must be recognized when the estimate of total undiscounted future cash flows attributable to the asset is less than the asset's carrying amount. Measurement of the impairment loss is determined by reducing the carrying amount of the asset to its fair value. Long-lived assets to be disposed of such as other real estate or premises to be sold, are reported at the lower of carrying amount or fair value less costs to sell. The Company will adopt SFAS No. 121 in the first quarter of 1996. Management anticipates the adoption of SFAS No. 121 will not have a material effect on the Company's consolidated financial statements.\n6. Savings and Time Deposits\nTime deposits issued in amounts of $100,000 or more amounted to approximately $50.3 million and $45.3 million at December 31, 1995 and 1994, respectively. Interest expense on time deposits over $100,000 amounted to approximately $2.7 million, $2.3 million and $3.0 million in 1995, 1994 and 1993, respectively.\n7. Other Non-Interest Expense\n8. Income Taxes\nAs discussed in note 1, the Company adopted SFAS No. 109 effective January 1, 1993. The cumulative effect of the accounting change, in the amount of $709,000, has been reported as a separate credit to earnings in the 1993 consolidated statement of income.\nThe valuation allowance applicable to the Company's Federal deferred tax asset was reduced by $174,000 in 1995 primarily due to the utilization of the capital loss carryforwards during the year.\nThe valuation allowance applicable to the Company's Federal deferred tax asset was reduced by $1.3 million in 1994 and $2.6 million in 1993 commensurate with the increases during those years in Federal income taxes recoverable by loss carryback. In addition, the valuation allowance applicable to the Company's state deferred tax asset was reduced by $2.2 million in the fourth quarter of 1994. This latter reduction was based on management's reevaluation of the Company's prospects for future earnings considering factors such as (i) the reduction in non-performing assets and other higher-risk assets primarily attributable to the bulk sales in the fourth quarter of 1994, (ii) the reduction in interest rate risk attributable to the sale of primarily lower yielding fixed rate loans and securities in the fourth quarter of 1994, and (iii) the sustained level of recent historical pre-tax earnings, including the achievement of three consecutive years of consistent profitability. The state deferred tax asset has been recognized on the basis of expected earnings in future years, as the New York State tax law does not allow net operating loss carrybacks or carryforwards.\nThe Company's deferred tax assets were $5.2 million at December 31, 1995, net of a remaining valuation allowance of $88,000. Based on recent historical and anticipated future pre-tax earnings, management believes it is more likely than not that the Company will realize its net deferred tax assets.\nIf certain definition tests and other conditions are met, Pawling is allowed a special bad debt deduction in determining its taxable income, based upon either specified experience formulas or a percentage of taxable income (currently 8.0% for Federal income tax purposes). For income tax purposes, bad debt reserves are maintained equal to the excess of tax bad debt deductions over actual losses. At December 31, 1995, Pawling's tax bad debt reserves were $9.4 million, including $8.8 million for which deferred tax liabilities have not been recognized since the Company does not expect that these reserves will become taxable in the foreseeable future. Events that would result in taxation of these reserves include (i) reductions in the reserves for purposes other than tax bad debt losses (including reductions for certain distributions to shareholders) and (ii) failure to maintain a minimum 60.0% ratio of qualifying assets to total assets for tax purposes. The unrecognized deferred tax liability applicable to the tax bad debt reserves was $3.7 million at December 31, 1995.\n9. Regulatory Matters\nCapital Requirements\nUnder the minimum leverage capital regulations of the Federal Deposit Insurance Corporation (the \"FDIC\"), most banks are required to maintain a ratio of Tier 1 capital to total assets of between 4.0% and 5.0%. At December 31, 1995, Pawling had a Tier 1 capital ratio of approximately 8.35% of total assets, thereby satisfying the minimum leverage capital requirement.\nThe FDIC regulations also require ratios of Tier 1 capital and total capital to risk-weighted assets of at least 4.0% and 8.0%, respectively. Risk-weighted assets are calculated by assigning assets (and credit-equivalent amounts for certain off-balance sheet items) to one of four broad risk-weight categories. The amount of risk-weighted assets is determined by applying a specified percentage (0%, 20%, 50% or 100%, depending on the level of credit risk) to the amounts assigned to each category. Pawling satisfied these capital requirements at December 31, 1995 with a Tier 1 capital ratio of approximately 14.78% of risk-weighted assets and a total capital ratio of approximately 16.03% of risk-weighted assets.\nProgressive is subject to the leverage capital and risk-based capital guidelines of the Federal Reserve Board (the \"FRB\"), which are similar to the FDIC requirements. Progressive complied with the FRB guidelines at December 31, 1995 with a leverage capital ratio of approximately 9.08% of total assets, a Tier 1 capital ratio of approximately 16.05% of risk-weighted assets, and a total capital ratio of approximately 17.30% of risk-weighted assets.\nDividend Restrictions\nDividend payments by Progressive must be within certain guidelines of the FRB which provide, among other things, that dividends generally should be paid only from current earnings. Pawling's ability to pay dividends to Progressive is also subject to various restrictions. Under New York State Banking Law, dividends may be declared and paid only from Pawling's net profits, as defined. The approval of the Superintendent of Banks of the State of New York is required if the total of all dividends declared in any calendar year will exceed the net profit for the year plus the retained net profits of the preceding two years. At December 31, 1995, Pawling's retained net profits available for dividends of the preceding two years were $8.7 million.\nReserve Requirements\nPawling is required to maintain reserves (primarily in the form of cash on hand and Federal Reserve Bank balances) with respect to certain types of deposit liabilities. Reserves maintained at December 31, 1995 and 1994 were $2.8 million and $2.1 million, respectively.\n10. Stock Option Plans\nThe Company has established stock option plans for certain of its employees and directors. Under the plans, the option exercise price may not be less than the fair market value of the common stock at the date of the grant.\nOptions under the employees' incentive stock option plan are generally exercisable any time within ten years of the date of grant. In 1995, 73,166 shares were granted of which 14,000 vest in 1996 and 17,000 in 1997. Unexercised options automatically expire 90 days from the date of termination of an employee's continuous employment by the Company. At December 31, 1995, options for the purchase of 65,191 shares were exercisable under this plan at a weighted average exercise price of $22.15 per share.\nDuring 1992, the Company adopted a new non- qualified stock option plan for directors. All outstanding options granted under the prior stock option plan for directors were canceled. A second non-qualified directors' option plan was adopted in 1993 and was approved by the shareholders in 1994. Pursuant to the plans, which have ten-year terms, options vest and become fully exercisable six months after the date of grant. At December 31, 1995, options for the purchase of 77,500 shares were exercisable under these plans at a weighted average exercise price of $14.21 per share.\nAt December 31, 1995, shares available for future grant totaled 50,584 for the employees' plan and 38,600 for the directors' plans.\nIn October 1995, the FASB issued SFAS No. 123, \"Accounting for Stock-Based Compensation,\" which establishes a fair value based method of accounting for employee stock options, such as the Company's stock option plans or similar equity instruments. Under SFAS No. 123, entities can recognize stock-based compensation expense in the basic financial statements using either (i) the intrinsic value based approach set forth in the APB Opinion No. 25 or (ii) the fair value based method introduced in SFAS No. 123. Entities electing to remain with the accounting in APB Opinion No. 25, must make pro forma disclosures of net income and earnings per share, as if the fair value based method of accounting defined in SFAS No. 123 had been applied. Under the method currently utilized by the Company (APB Opinion No. 25), compensation expense is determined based upon the option's intrinsic value, or the excess (if any) of the market price of the underlying stock at the measurement date over the amount the employee is required to pay. Under the fair value based method introduced by SFAS No. 123, compensation expense is based on the option's estimated fair value at the grant date and is generally recognized over the vesting period. Management anticipates that it will elect to measure stock-based compensation costs in accordance with APB Opinion No. 25 and will adopt the pro forma disclosure requirements of SFAS No. 123 in 1996.\n11. Employee Benefits\nPension Benefits\nThe Company maintains a non-contributory defined benefit pension plan which covers substantially all employees who meet certain age and length of service requirements. Benefits are based on the employees' years of accredited service and their average annual three years' earnings, as defined by the plan. Plan benefits are funded through Company contributions at least equal to the amounts required by applicable regulations.\nA discount rate of 7.5% and a rate of increase in future compensation levels of 5.5% were used in determining the actuarial present value of the projected benefit obligation at December 31, 1995 (8.25% and 6.0%, respectively, at December 31, 1994 and 7.0% and 5.5%, respectively, at December 31, 1993). The expected long-term rate of return on plan assets was 8.0% for 1995, 1994 and 1993.\nIn 1994, the Company implemented a non-qualified, unfunded retirement and severance plan for members of the Board of Directors. Under this plan, each member leaving the Board after at least five years of service is entitled to a benefit consisting of the annual retainer fee at the time of departure multiplied by the director's number of years of service, up to 15 years. The cost of this plan was $95,000 for both 1995 and 1994. The accumulated benefit obligation was $470,000 in 1995 and $460,000 in 1994.\nPostretirement Benefits\nThe Company also provides certain postretirement benefits. Under the current plan, as amended, substantially all Company employees become eligible for postretirement benefits if they meet certain age and length of service requirements. As discussed in note 1, the Company adopted SFAS No. 106 effective January 1, 1993. SFAS No. 106 requires accrual of the cost of postretirement benefits as they are earned by active employees. The Company recognized the full amount of its accumulated benefit obligation as of January 1, 1993, in the amount of $1.8 million, as a charge to earnings. The after-tax charge of $1.1 million has been reported in the 1993 consolidated statement of income as the cumulative effect of a change in accounting principle.\nThe accumulated postretirement benefit obligation was determined using discount rates of 7.5% and 8.25% at December 31, 1995 and 1994, respectively. At December 31, 1995, the assumed rate of increase in future health care costs was 10.5% for 1996, gradually decreasing to 5.5% in the year 2005 and remaining at that level thereafter. Increasing the assumed health care cost trend rate by 1.0% in each future year would increase the accumulated benefit obligation as of December 31, 1995 by $96,500 and the service cost by $2,400 for the year then ended.\n401(k) Savings Plan\nIn July 1993, the Company implemented a defined contribution plan established under Section 401(k) of the Internal Revenue Code, pursuant to which eligible employees may elect to contribute up to 8.0% of their compensation. The Company makes contributions equal to 50% of the first 5.0% of a participant's contribution for non-highly compensated employees and 50% of the first 3.0% for highly-compensated employees. Voluntary and matching contributions are invested, in accordance with the participant's direction, in one or a number of investment options including a fund consisting of shares of Progressive's common stock. Employee contributions vest immediately, while employer contributions vest ratably over a five-year period beginning after the first year of participation. Savings plan expense amounted to $92,000 for 1995, $79,000 for 1994, and $34,000 for 1993.\n12. Commitments and Contingencies\nOff-Balance Sheet Financial Instruments\nThe Company's financial instruments with off-balance sheet risk consist of loan origination commitments, unadvanced lines of credit and standby letters of credit. These instruments involve various degrees of credit risk, interest rate risk and liquidity risk. The Company's exposure to credit loss is represented by the contractual amounts of the instruments. The Company does not utilize off-balance sheet financial instruments for trading purposes.\nThe following paragraphs describe the valuation methods used by the Company to estimate fair values.\nSecurities\nThe fair values of securities were based on market prices or dealer quotes.\nLoans\nFor valuation purposes, the loan portfolio was segregated into its significant categories such as residential mortgages, commercial mortgages and consumer loans. These categories were further analyzed, where appropriate, based on significant financial characteristics such as type of interest rate (fixed or adjustable) and payment status (performing or non-performing). Fair values were estimated for each component using a valuation method selected by management.\nThe fair values of performing residential mortgage and consumer installment loans were estimated based on current secondary market prices or current interest rates for similar loans, adjusted judgmentally for differences in loan characteristics. The fair values of performing commercial mortgage and construction loans were estimated by discounting the anticipated cash flows from the respective portfolios. Estimates of the timing and amount of these cash flows considered factors such as future loan prepayments and credit losses. The discount rates reflected current market rates for loans with similar terms to borrowers of similar credit quality.\nThe fair values of non-performing loans were based on management's analysis of available market information, recent collateral appraisals and other borrower- specific information.\nDeposit Liabilities\nIn accordance with SFAS No. 107, the fair values of deposit liabilities with no stated maturity (demand, NOW, savings and money market accounts) are equal to the carrying amounts payable on demand. The fair values of time deposits represent contractual cash flows discounted using interest rates currently offered on deposits with similar characteristics and remaining maturities. While at December 31, 1995 and 1994, the fair value indicated that time deposits could be settled for an amount less than their carrying value, depositors have the right to withdraw funds at carrying value less a penalty, prior to contractual maturity. The Company does not consider the amount of penalties associated with such early withdrawals to be material and accordingly, at December 31, 1995 and 1994, the fair values of time deposits is estimated to be the carrying value.\nAs required by SFAS No. 107, these estimated fair values do not include the value of core deposit relationships which comprise a significant portion of the Company's deposit base. Management believes that the Company's core deposit relationships provide a relatively stable, low-cost funding source which has a substantial intangible value separate from the deposit balances.\nOther Financial Instruments\nThe other financial assets and financial liabilities shown in the preceding table have fair values that approximate the respective carrying amounts because the instruments are payable on demand or have short-term maturities and present relatively low credit risk and interest rate risk.\nFair values of the loan origination commitments, unadvanced lines of credit and standby letters of credit described in note 12 were estimated based on an analysis of the interest rates and fees currently charged to enter into similar transactions, considering the remaining terms of the instruments and the creditworthiness of the potential borrowers. At December 31, 1995 and 1994, the fair values of these financial instruments were not significant.\nThe Company has no derivative investment products as defined in SFAS No. 119 \"Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments,\" at December 31, 1995 and 1994, nor has the Company ever invested in such vehicles. Therefore, the disclosures as required by SFAS No. 119 are not presented except as it relates to the fair value disclosures in this note.\n14. PARENT COMPANY CONDENSED FINANCIAL INFORMATION\nThese quotations represent prices between dealers and do not include retail markup, markdown or commission. They do not necessarily represent actual transactions.\nA quarterly cash dividend of $0.20 per common share was paid in the fourth quarter of 1995. Quarterly cash dividends of $0.15 per common share were declared and paid in the first, second and third quarters of 1995. Quarterly cash dividends of $0.10 per common share were declared and paid in the second, third and fourth quarters of 1994. A quarterly cash dividend of $0.075 per common share was declared and paid in the first quarter of 1994.\nExhibit 22\nSubsidiaries of Registrant\nThe Registrant only has one subsidiary, Pawling Savings Bank.\nExhibit 24\nConsent of Independent Certified Public Accountants\nThe Board of Directors and Shareholders Progressive Bank, Inc.:\nWe consent to incorporation by reference in the registration statements (Nos. 33-10235 and 33-64888) on Forms S-8 of Progressive Bank, Inc. of our report dated January 19, 1996, relating to the consolidated balance sheets of Progressive Bank, Inc. and subsidiary as of December 31, 1995 and 1994, 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, 1995, which report appears in the December 31, 1995 annual report on Form 10-K of Progressive Bank, Inc. Our report refers to a change in the method of accounting for income taxes and postretirement benefits in 1993 and for certain securities in 1994.\n\/s\/ KPMG Peat Marwick LLP\nAlbany, New York March 16, 1996\nFinancial Data Statement\n[ARTICLE] 9 [MULTIPLIER] 1000","section_15":""}
{"filename":"796812_1995.txt","cik":"796812","year":"1995","section_1":"Item 1. Business.\nGeneral\nVictoria Creations, Inc. (\"Victoria\" or the \"Company\") is one of the leading designers, manufacturers and distributors of costume jewelry throughout the United States and also exports such products, principally to Japan and western Europe. Victoria produces a broad range and assortment of costume jewelry, including relatively expensive, high quality items sold under the Bijoux Givenchy(R), Richelieu(R) and Karl Lagerfeld(R) trade names and private label jewelry for major department and chain stores. The Company markets its costume jewelry primarily to department and chain stores and to a lesser extent to direct marketing distributors. In addition, Victoria has established a factory direct business to design and manufacture unique and proprietary costume-jewelry type items for certain customers.\nThe Company was incorporated in 1962 and, until March 1984, was privately owned. Effective March 8, 1984, the Company was purchased by Jonathan Logan, Inc. (\"Logan\") which in turn was acquired by United Merchants and Manufacturers, Inc. (\"UM&M\") effective September 1, 1984. Effective September 11, 1986, UM&M sold 17% of the outstanding shares of Common Stock of the Company in a public offering, thus reducing UM&M's ownership to 83% of the outstanding Common Stock of the Company. On December 30, 1992, the Company sold 300,000 shares of its authorized, but previously unissued, Common Stock to certain key employees, which sale increased the number of shares of Common Stock outstanding and, thereby, reduced UM&M's ownership to 79.8% of the outstanding Common Stock of the Company. UM&M's Common and Preferred Stocks are traded on the New York Stock Exchange. See Item 12 below.\nSelected Financial Data\nThe following information has been derived from audited financial statements. The information below is qualified by reference to, and should be read in conjunction with, the financial statements, related notes thereto and \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" contained elsewhere herein.\n(000 omitted) ------------------------------------------- for the Year Ended June 30 ------------------------------------------- 1995 1994 1993 1992 1991 ------- ------- ------- ------- ------- Income Statement Data: Net sales................ $49,863 $42,569 $42,179 $39,789 $40,992 Operating income (loss).. 2,009 (537) (1,701) (4,534) (6,197) Loss before income taxes. (1,288) (2,027) (4,137) (7,388) (9,057) Net loss................. (1,313) (2,054) (4,177) (7,428) (9,107) Net loss per share ...... (0.17) (0.26) (0.55) (0.99) (1.21)\n(000 omitted) ------------------------------------------- At June 30 ------------------------------------------- 1995 1994 1993 1992 1991 ------- ------- ------- ------- ------- Balance Sheet Data: Working capital..............$19,900 $23,897 $ 5,110 $12,273 $15,447 Total assets................. 47,951 50,673 50,756 50,283 53,926 Notes payable\/long-term debt. 11,090 13,391 18,915 10,951 9,654 Due to Parent Company........ 23,461 24,493 17,977 21,893 18,740 Stockholders' equity......... 8,032 9,345 11,399 15,538 22,966 - -------------\nThe Company has paid no cash dividends since the date of its incorporation. There were 7,500,000 shares of Common Stock outstanding during the periods prior to December 30, 1992; thereafter there were 7,800,000 shares outstanding.\nSeasonality\nThe Company believes that, to some extent, the seasonality of its business is the result of retail clothing seasonal buying patterns and certain traditional gift-giving holidays, such as Valentine's Day, Mother's Day and the holidays which occur in December. See Note N of Notes to Financial Statements for financial information by fiscal quarter.\nDescription of Principal Products\nBijoux Givenchy. Bijoux Givenchy, marketed under an exclusive licensing arrangement, is a very prestigious, high quality and upscale jewelry line and is sold principally to department stores. The principal products marketed under the Bijoux Givenchy trade name are earrings, necklaces, pins and bracelets which are manufactured in the Company's facility located in Warren, Rhode Island. These items are made principally of cast metal with precious metal finishes applied by electroplating. Certain of the products are set with decorative stones and\/or have color highlights. The pieces reflect positively the Company's capabilities and high quality standards in design, model making and manufacturing. Retail selling prices for items in the line generally range from $15 to $125 per item. The Bijoux Givenchy line is geared to be highly fashionable and, as a result, is continuously being changed and updated. However, certain items in the line, including signature jewelry, have become basic items. The Company has created a separate Bijoux Givenchy line, with more explicit designer logo identification, for the Japanese and other international markets. The Bijoux Givenchy line's direct worldwide competitors are lines marketed under the Anne Klein, Yves St. Laurent and Christian Dior names.\nUnder the licensing agreement with Givenchy, the Company has exclusive worldwide marketing rights for the Bijoux Givenchy trade name through 1999, while Givenchy retains final approval of design. Under the terms of the agreement which commenced in 1975, the Company is obligated to pay a royalty on all sales under the Bijoux Givenchy trade name with minimum royalties for each fiscal year. Royalty payments historically have far exceeded the minimum in every year.\nRichelieu. Richelieu, founded in 1882 and acquired by Victoria in 1979, is believed by the Company to be the oldest company in the costume jewelry business. Richelieu imports simulated pearls from independent suppliers and markets them principally to major department and chain stores and, beginning in fiscal 1993, through the Army and Air Force Exchange System worldwide. Products include necklaces, earrings, bracelets and pins made primarily with \"pearls\". Retail selling prices for items in the line are from $7.50 to $110 per item.\nRichelieu simulated pearls assume the appearance of natural pearls. Alabaster glass pearls are hand-made of high quality lampen beads by independent suppliers to the Company. These beads are covered with a sealer and then coated with pearl essence. After the \"pearl\" is coated, a dulling process is applied in order to achieve the look of a cultured pearl. A sealer coat is the last application to the \"pearl\" ensuring its lasting quality. The \"pearls\" are then hand knotted on silk thread.\nApproximately one-half of Richelieu's business is in basic products: strand \"pearls\" and basic earrings. The other half of the Richelieu business is more fashion oriented with different colored, sized or shaped \"pearls\" being introduced yearly. Richelieu is one of the two largest distributors of simulated pearls in the United States.\nR. J. Design. During the year ended June 30, 1993, the Company established a design and marketing group, R. J. Design, to capitalize on the design and manufacturing capabilities available at the Company's Warren, Rhode Island, facility. The group produces unique, proprietary items for sale to selected customers. The items include specialty lines of costume jewelry, costume-jewelry type articles and specialty recognition-award pieces of costume jewelry such as compacts for solid fragrance and powder, pins, earrings and necklaces. The items are primarily made of cast metal and brass with precious metal finishes and are generally decorated with high quality components.\nPrivate Label. Victoria has designed and manufactured private label costume jewelry for J. C. Penney Company, Inc. (\"J. C. Penney\") since 1972. During the 1993 fiscal year, J. C. Penney and the Company collaborated in developing a new costume jewelry line to support J. C. Penney's brand of women's ready to wear apparel, \"Worthington\". In the fourth quarter of the 1993 fiscal year, the Company made the initial shipments of Worthington costume jewelry to J. C. Penney. Worthington is a tailored line of merchandise, including earrings, necklaces, bracelets and pins, that has a variety of fashion themes and is distributed to approximately 1,100 J. C. Penney stores nationwide. The items are made of cast metal with precious metal finishes, some with decorative stones and\/or color highlights, and \"pearls\". Retail selling prices for items in the line are $5 to $50 per item. As a result of the success of the Worthington line, the Company was selected J. C. Penney's \"Jewelry Supplier of the Year\" for calendar year 1993. The Company is currently instituting several private label programs for other U. S. department store chains, capitalizing on the opportunity to market value-driven and styling-differentiated classic, tailored product marketed under store brand labels.\nKarl Lagerfeld. During fiscal 1988, the Company acquired a license to manufacture and distribute high quality, specially designed, luxury costume jewelry under the Karl Lagerfeld trade name. Principal products include necklaces, earrings, pins and bracelets made of cast metal with precious metal finishes, some with decorative stones and\/or color highlights. Under the agreement, the Company is obligated to pay a royalty of 10% on all of its sales under the Lagerfeld trade name. The Karl Lagerfeld collection is sold in boutiques and stores with discriminating clientele. Retail prices range from $25 to $350 per item.\nDesign and Production\nVictoria's designers identify, on an ongoing basis, fashion trends for the coming seasons. Costume jewelry is developed and screened with product merchandisers.\nIn the case of the Worthington line, the Company and J. C. Penney conceive, sample and finalize the line. After approval, model stock selections are created and presented to the jewelry department managers of individual J. C. Penney stores by the Company's sales staff, who then write orders.\nThe Company's two designer brands, Givenchy and Karl Lagerfeld, are developed in conjunction with the Paris, France studio of each designer. Initial design concepts are created in Paris and are related to the designers' runway apparel collections presented throughout the year.\nThe manufacturing process is labor intensive. The Company currently employs approximately 463 people solely in its design and production department and believes that its manufacturing efficiency is attributable in large part to the many years of experience and expertise of these employees.\nVictoria manufactures at a plant in Warren, Rhode Island. The Company also makes use of local outside contractors to do preliminary manufacturing such as linking, gluing and polishing. The Company believes that its facilities are adequate for current and projected production requirements.\nIn general, the raw materials and supplies that Victoria requires are commodity goods that can be provided by many suppliers. The Company does not generally enter into long-term commitments with its suppliers and contractors.\nMarketing and Distribution\nVictoria's sales and marketing organization for department store and mass merchandiser business is headquartered at the Company's showroom in New York City, with a staff of approximately 45 people, including certain regional sales representatives. In addition, the Company has a regional sales office in Los Angeles with a sales staff totaling approximately 32 people. Costume jewelry lines are shown five times a year at jewelry\nmarkets in New York. The major shows are in May, for fall season buying, and in November, for spring season buying. After new lines are shown at the seasonal marketing shows, it is the responsibility of sales executives to contact buyers and merchandise managers to obtain orders and projections of future seasons' needs. Regional sales managers and associates manage various accounts and are responsible for handling returns and customer inquiries, setting up advertising and promotions and reordering. The regional sales and marketing executives also generate new business by visiting potential customers throughout the United States. In addition to the Company's sales staff, a separate sales and service group of approximately 21 independent representatives, working in conjunction with the Company's personnel, services the J. C. Penney account.\nUnder Victoria's cooperative advertising policy, Victoria bears, to a limited extent, a portion of department stores' local advertising costs relative to the amount of advertising of the Company's products included therein.\nVictoria's products are exported to markets throughout the world, primarily to Japan and western Europe and to a lesser extent to Australia, Canada, Mexico and the Near East. In addition, the Company sells to duty-free shops throughout the world. During the years ended June 30, 1995, 1994 and 1993, export sales were approximately 9%, 9% and 13% of sales, net of returns, respectively.\nSignificant Customers\nIn 1995, the Company's products were sold to approximately 400 customers, including most major department stores in the United States. During the year ended June 30, 1995, sales to one of the Company's customers, J. C. Penney, accounted for approximately 30% of the Company's total sales, net of returns. The Company has no contractual relationships with its principal customers. Goods are shipped against orders received from time to time on customary payment terms.\nBacklog\nThe Company does not believe that the dollar amount of unfilled orders is significant to an understanding of the Company's business due to the generally short time between receipt of a customer order and shipment of the product.\nCompetition\nThe costume jewelry industry is highly fragmented and includes many small firms. The Company believes it is one of the largest manufacturers of costume jewelry in the United States. Within the industry, there are manufacturers that focus on low-margin, basic items and those that emphasize higher-margin (and higher risk) items geared to be highly fashionable. The Company believes that only a few companies, of which Victoria is one, combine manufacturing and marketing capabilities for both basic and high fashion items.\nVictoria competes on the basis of design, quality, reliability as a supplier, service to a customer and price. Its major direct competitors are Monet, Anne Klein division of Swank, Inc., Liz Claiborne, Inc. and Napier, Inc.\nEmployees\nAs of June 30, 1995, the Company employed full time approximately 600 people, none of whom is represented by a labor union. Of these employees, approximately 43 are involved in management and administration, 10 in design, 453 in manufacturing and shipping and 94 in marketing and customer service. Of the Company's employees at June 30, 1995, 172 were salaried and 428 were paid on an hourly basis. The Company believes that its relationship with its employees is good.\nExecutive Officers of the Registrant\nSet forth below are the names, ages, present positions and business experience during the last five years of all current Executive Officers of the Company. Officers are appointed to serve until the meeting of the Board of Directors following the next Annual Meeting of Stockholders and until their successors have been elected and have qualified.\nName Age Present Position Business Experience - ---- --- ---------------- ------------------- Uzi Ruskin 50 Chairman of the Chairman, President, Company and Chief Executive and Director Chief Operating Officer of UM&M; Chairman of the Company since October 1993\nPatricia Stensrud 47 President and Chief Executive of the Company Executive Officer of since 1990. Executive the Company and Vice President - Sales Director and Marketing of the Company from June 1992 to July 1993; President and Chief Executive Officer of the Company since July 1993\nRichard M. Andreoli 39 Executive Vice Executive of the Company President and since 1982. Senior Vice Chief Operating President - Operations Officer of the of the Company from Company and September 1991 to May Director 1992; Executive Vice President - Operations of the Company since May 1992; Chief Operating Officer of the Company since July 1993\nNorman R. Forson 66 Senior Vice President Senior Vice President and Treasurer of the and Controller of UM&M Company since 1987\nEdgar L. Brinkworth 52 Vice President and Vice President and Controller of the Controller of the Company Company since 1987\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nThe following table lists the location of the Company's facilities, all of which are leased. Lease Square Expiration Location Feet Dates -------- -------- --------- Warren, RI (Manufacturing facility)............ 40,000 June 1996 Warwick, RI (Offices, warehousing and distribution)................ 35,000 June 1996 Providence, RI (warehouse)..................... 15,000 July 1996 New York, NY (Offices and showroom)............ 17,100 July 2013 (Showroom)........................ 2,800 March 2001 Los Angeles, CA (Showroom)..................... 1,100 Feb 1996\nThe Company leases its Warren, Rhode Island and Warwick, Rhode Island facilities from UM&M under leases expiring in June 1996 at a total cost of $325,000 a year (subject to annual cost-of-living adjustments). See Item 13 below.\nThe Company's manufacturing facility, based on a one shift a day operation, operated at approximately 85% of capacity during the year ended June 30, 1995.\nThe Company believes that each of its facilities is well maintained and properly equipped for its purpose.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nThe Company is a defendant in various lawsuits. It is not expected that these suits will result in judgements which in the aggregate would have a material adverse effect on the Company's financial position; accordingly, no such lawsuit is described herein.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nNone\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters.\nThe Company's Common Stock trades in the over-the-counter market. The stock is currently quoted on the OTC Bulletin Board operated by National Association of Securities Dealers, Inc. The approximate number of holders of the Common Stock of the Company at August 31, 1995 was 500. The following table sets forth the high and low bid prices of the Company's Common Stock. The market quotations may reflect inter-dealer prices, without retail mark-up or mark-down or commission, and may not necessarily represent actual transactions. Market Quotations ------------------ Fiscal Year Fiscal Quarter Ended High Low ----------- -------------------- -------- -------- 1995 June 30, 1995 $ 0.50 $ 0.28125 March 31, 1995 0.875 0.375 December 31, 1994 1.0625 0.375 September 30, 1994 0.625 0.15625\n1994 June 30, 1994 $ 0.0626 $ 0.0625 March 31, 1994 0.1875 0.0625 December 31, 1993 0.25 0.0625 September 30, 1993 0.1875 0.0625\nThe Company has never declared nor paid a cash dividend on its Common Stock, and the Company's Board of Directors presently intends to retain any earnings for use in the business.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nThe information required by the Item is found in Part I, Item 1.\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 on page.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nSee index on page.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.\nNone.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant.\nInformation required under this item regarding the Directors of the Registrant is contained in the Registrant's 1995 Proxy Statement, pursuant to Regulation 14A, which is incorporated herein by reference.\nInformation required under this item regarding the Executive Officers of the Registrant is found in Part I, Item 1.\nItem 11.","section_11":"Item 11. Executive Compensation. Information required under this item is contained in the Registrant's 1995 Proxy Statement, pursuant to regulation 14A, which is incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management. Information required under this item is contained in the Registrant's 1995 Proxy Statement, pursuant to regulation 14A, which is incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions. Information required under this item is contained in the Registrant's 1995 Proxy Statement, pursuant to regulation 14A, which 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. and 2. Financial Statements and Schedules - See \"Index to Financial Statements, Schedules and Management's Discussion and Analysis\" on page.\nItem 14(a) 3. Exhibits (3) Articles of Incorporation and Bylaws.\n(3) 1. Composite Certificate of Incorporation. Incorporated by reference to Exhibit 3 (a) to the Registration Statement of the Registrant on Form S-1, File No. 33-7125. Amendment dated May 24, 1993 incorporated by reference to Form 10-K filed by the Registrant for the year ended June 30, 1993.\n(3) 2. Bylaws. Incorporated by reference to Exhibit 3 (b) to the Registration Statement of the Registrant on Form S-1, File No. 33-7125.\n(4) Instruments defining the rights of security holders, including indentures.\n(4) 1. 1986 Stock Option Plan. Incorporated by reference to Exhibit 10(m) to the Registration Statement of the Registrant on Form S-1, File No. 33-7125.\n(10) Material Contracts. (see Exhibit Index, Page E-1)\n(27) Financial Data Schedule (See Exhibit Index, Page E-1)\n(99) (1) Secured Promissory Note and (2) Loan and Security Agreement from Registrant to Foothill Capital Corporation dated as of June 28, 1994 (which were in effect during fiscal 1995) are incorporated herein by reference to Registrant's Report on Form 8-K filed July 14, 1994.\n(99) (3) Secured Promissory Note and (4) Loan and Security Agreement from Registrant to Foothill Capital Corporation dated as of July 31, 1995, which supersede the instruments of the same name in (99) (1) and (2) above, are filed herewith.\nItem 14(b) Reports on Form 8-K during last fiscal quarter. None\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 behalf by the undersigned, thereunto duly authorized.\nDated: September 28, 1995 VICTORIA CREATIONS, INC. (Registrant)\nBy \/s\/ Norman R. Forson Norman R. Forson Senior Vice President, Treasurer and Secretary\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 Accounting Officer and a majority of the Board of Directors, on behalf of the Registrant and in the capacities and on the dates indicated:\n\/s\/ Patricia Stensrud President and Chief September 28, 1995 Patricia Stensrud Executive Officer and Director (Principal Executive Officer)\n\/s\/ Edgar L. Brinkworth Vice President and September 28, 1995 Edgar L. Brinkworth Controller (Principal Accounting Officer)\n\/s\/ Richard M. Andreoli Executive Vice President September 28, 1995 Richard M. Andreoli and Chief Operating Officer and Director\n\/s\/ Sidney O. Margolis Director September 28, 1995 Sidney O. Margolis\n\/s\/ Judith A. Nadzick Assistant Secretary and September 28, 1995 Judith A. Nadzick Director\n\/s\/ Paul B. Markovits Director September 28, 1995 Paul B. Markovits\n\/s\/ Uzi Ruskin Chairman and Director September 28, 1995 Uzi Ruskin\n\/s\/ Robert J. Swartz Director September 28, 1995 Robert J. Swartz\n\/s\/ Thomas J. Tisch Director September 28, 1995 Thomas J. Tisch\nVICTORIA CREATIONS, INC.\nFORM 10-K\nINDEX TO FINANCIAL STATEMENTS, SCHEDULES AND MANAGEMENT'S DISCUSSION AND ANALYSIS\nPage Statement of Operations for the three years ended June 30, 1995 .....\nManagement's Discussion and Analysis of Financial Condition and Results of Operations .........................................\nBalance Sheet as of June 30, 1995 and 1994 ..........................\nStatement of Cash Flows for the three years ended June 30, 1995 ...............................................\nNotes to Financial Statements........................................\nIndependent Auditors' Report.........................................\nSchedules have been omitted because they are inapplicable or because the required information is included in the financial statements and notes thereto.\nVICTORIA CREATIONS, INC.\nStatement of Operations (000 omitted)\nYEAR ENDED JUNE 30 ------------------------------ 1995 1994 1993 --------- --------- ---------\nNet sales .............................. $49,863 $42,569 $42,179\nCost of goods sold ..................... 28,085 23,744 24,165 --------- --------- --------- Gross Profit $21,778 $18,825 $18,014\nSelling, general and administrative expenses............... 19,049 18,642 18,995 Amortization of goodwill ............. 720 720 720 --------- --------- --------- Operating Income (Loss) $2,009 ($537) ($1,701)\nOther income (expense): Interest expense - Notes D and G...... (3,347) (1,574) (2,546) Royalty income........................ 50 84 110 --------- --------- --------- Loss before Income Taxes ($1,288) ($2,027) ($4,137)\nProvision for income taxes - Note F..... 25 27 40 --------- --------- --------- Net Loss ($1,313) ($2,054) ($4,177) ========= ========= =========\nAverage common shares outstanding - Note A................................. 7,800 7,800 7,650\nNet Loss per Share - Note A ($0.17) ($0.26) ($0.55)\nSee notes to financial statements.\nVICTORIA CREATIONS, INC.\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Not Covered by Report of Independent Certified Public Accountants)\nThe Company is a 79%-owned subsidiary of United Merchants and Manufacturers, Inc. (\"UM&M\" or \"Parent Company\").\nResults of Operations\nNet sales of the Company increased 17% to $49.9 million for the fiscal year ended June 30, 1995 from the net sales of $42.6 million for the year ended June 30, 1994. Sales of both the Company's branded label merchandise, Givenchy, Richelieu and Lagerfeld, and private label business increased during the current year compared with last year. Sales in both the domestic and the international markets reflected increases. The Company attributes the increases to strong product performance at retail, improvement in service levels, technological advances and development of new customers. Unit sales for the current year increased; offset somewhat by slightly lower average unit selling prices as total volume of private label merchandise increased relative to total volume of branded merchandise which is sold at higher average unit prices.\nNet sales in the fiscal year ended June 30, 1994 increased by 1% to $42.6 million from $42.2 million in fiscal 1993. The increase in the 1994 fiscal year resulted from increased net sales in the first and third quarters of that fiscal year. Sales in the fourth quarter were approximately equal to those of the same quarter of the 1993 year even though the 1993 year's fourth quarter included shipments for an initial launch of a new (for the Company) label for the Company's largest customer. Consumer interest remained strong for the Company's branded label merchandise. Sales of the Company's private label merchandise increased over those of the prior fiscal year. R. J. Design, the Company's factory-direct design and manufacturing business which is focused on providing unique, proprietary products to certain customers, also showed sales increases in the 1994 fiscal year over the 1993 year. Overall, unit sales and average unit price increased slightly during the 1994 fiscal year versus the 1993 fiscal year.\nCost of goods sold, as a percentage of net sales, remained approximately the same for the 1995 fiscal year as those of the year ended June 30, 1994 as the Company continued its emphasis on manufacturing and purchasing efficiencies. The resulting gross profit for fiscal 1995 increased by 16% over that of the 1994 year. The Company's sales of out-of-season merchandise (which is sold at lower than the Company's normal margins) for the current year were 20% less than those of the 1994 fiscal year as management continued to emphasize improved forecasting to reduce the amount of such merchandise available to be sold through off-price channels.\nWhile net sales increased in the 1994 fiscal year over the 1993 year, cost of goods sold decreased 2%, reflecting the Company's emphasis on manufacturing and purchasing efficiencies. The resulting gross profit for the current year increased 5% over that of the year ended June 30, 1993. The disposal of out-of-season merchandise during fiscal 1994 was at a lower rate than during the prior year.\nWhile net sales increased by 17% in the current fiscal year, selling, general and administrative expenses increased only 2% during the current year compared to those of the year ended June 30, 1994 as a result of continuing efforts to control such costs through strict budgetary and spending restraints. As a percentage of net sales, selling, general and administrative expenses for the 1995 year decreased by 6 percentage points from those of the 1994 fiscal year.\nThe exercise of strict budgeting controls and spending restraints resulted in a decrease of 2% in selling, general and administrative expenses during the fiscal 1994 year compared to those in fiscal 1993. On an absolute basis, selling, general and administrative expenses decreased by $0.4 million in fiscal 1994.\nAlthough average borrowings, other than from the Parent Company, were lower during the current year, interest expense increased $1,773,000 for the year ended June 30, 1995 from that of the prior year. The increase was due to the significantly higher interest rate during the current year on the secured loans. The Parent Company waived the interest on the amount due to it for the 1995 fiscal year. If the Parent Company had not waived the interest due to it, interest expense for the 1995 fiscal year would have been approximately $2.4 million greater than the interest expense reflected in the statement of operations.\nInterest expense for the year ended June 30, 1994 was $972,000 lower than that reported for fiscal 1993. The decrease was due to the waiving of interest by the Parent Company on the amount due to it for the entire fiscal year. If the Parent Company had not waived the interest due to it, interest expense for the 1994 fiscal year would have been approximately $1.5 million greater than the interest expense reflected in the statement of operations.\nSee Note F of Notes to Financial Statements for information regarding income taxes.\nLiquidity and Capital Resources\nThe Company has generally met its capital requirements from internally generated funds and borrowings from its Parent Company and, until June 30, 1994, from its factor. On June 30, 1994, the Company repaid its indebtedness to its factor by borrowing from another lender and its Parent Company.\nShort term needs for working capital are currently being borrowed under a revolving loan from the above mentioned lender. Effective July 31, 1995, the Company renegotiated its borrowing arrangements with this lender. See Note O of Notes to Financial Statements for details of the refinancing, including the increased borrowings and reduced interest rate.\nThe Company does not anticipate substantial increased needs for long-term borrowings.\nWorking capital was $19.9 million at June 30, 1995, and $23.9 million at June 30, 1994. The Company's current ratio of 4.7 to 1 at June 30, 1995 is deemed adequate for the Company's present financial position and needs.\nVICTORIA CREATIONS, INC. Balance Sheet (000 omitted) ------------------- JUNE 30 ------------------- 1995 1994 --------- --------- ASSETS Current Assets: Cash............................................... $638 $72 Receivables - Note B............................... 7,242 8,359 Inventories - Notes A and C........................ 16,430 17,994 Other current assets............................... 958 916 --------- --------- Total Current Assets $25,268 $27,341 Plant and Equipment: Machinery and equipment............................ $3,233 $3,239 Leasehold improvements............................. 1,913 1,889 --------- --------- $5,146 $5,128 Less accumulated depreciation...................... 4,035 3,812 --------- --------- Net Plant and Equipment $1,111 $1,316 Other Assets: Goodwill - Note A.................................. $20,709 $21,430 Other.............................................. 863 586 --------- --------- Total Other Assets $21,572 $22,016 --------- --------- $47,951 $50,673 ========= =========\nLIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Accounts payable................................... $4,284 $2,315 Accrued expenses and other liabilities............. 1,084 1,129 --------- --------- Total Current Liablilties $5,368 $3,444\nLong-term debt - Note D............................. 11,090 13,391\nDue to Parent Company - Note G...................... 23,461 24,493\nStockholders' Equity - Notes E and J: Common stock, $0.01 par value, authorized 10 million shares, outstanding 7.8 million shares.................... $58 $58 Additional paid-in capital......................... 32,998 32,998 Retained earnings (deficit)........................ (25,024) (23,711) --------- --------- Total Stockholders' Equity $8,032 $9,345 --------- --------- $47,951 $50,673 ========= ========= See notes to financial statements.\nVICTORIA CREATIONS, INC. Statement of Cash Flows (000 omitted)\nYEAR ENDED JUNE 30 ------------------------------ 1995 1994 1993 --------- --------- ---------\nOperating Activities: Net loss ............................... ($1,313) ($2,054) ($4,177) Add back items not requiring cash in the current period: Depreciation and amortization....... 995 1,026 1,057 Decrease (Increase) in Current Assets: Receivables........................... 1,117 (920) (3,449) Inventories........................... 1,564 165 2,055 Other current assets.................. (42) (172) 107 Increase (Decrease) in Current Liabilities: Accounts payable...................... 1,969 723 562 Accrued expenses and other liabilities (45) 256 2 Other - net ............................ (277) 75 6 --------- --------- --------- Net Cash Provided by (Used for) Operating Activities $3,968 ($901) ($3,837)\nInvesting Activities: Additions to plant and equipment ....... ($129) ($170) ($171) Dispositions of plant and equipment..... 60 3 0 --------- --------- --------- Net Cash Used for Investing Activities ($69) ($167) ($171)\nFinancing Activities: Notes payable .......................... ($2,301) ($5,524) $7,964 Due to Parent Company .................. (1,032) 6,516 (3,916) Proceeds from sale of Common Stock...... 0 0 38 --------- --------- --------- Net Cash Provided by (Used for) Financing Activities ($3,333) $992 $4,086 --------- --------- --------- Net Increase (Decrease) in Cash $566 ($76) $78\nCash at beginning of period .............. 72 148 70 --------- --------- --------- Cash at End of Period .................... $638 $72 $148 ========= ========= =========\n---------- Supplemental disclosure: Cash payments for: Interest ............................. $3,317 $1,574 $1,259 Income taxes ......................... 25 27 40\nSee notes to financial statements.\nVICTORIA CREATIONS, INC. NOTES TO FINANCIAL STATEMENTS\nThe Company is a 79%-owned subsidiary of United Merchants and Manufacturers, Inc. (the \"Parent Company\").\nNOTE A - Summary of Significant Accounting Policies\nInventories are valued at the lower of cost (first-in, first-out method) or market.\nPlant and equipment are carried at cost. Depreciation and amortization are computed using the straight-line method over the following range of estimated useful lives:\nMachinery and equipment............... 3 to 10 years Leasehold improvements................ 5 to 10 years\nGoodwill arose as the result of the purchase price paid by the Parent Company to acquire the Company in 1984 in excess of the fair value of the net assets at the date of acquisition. The goodwill is being amortized by the straight-line method over 40 years. In evaluating the recoverability of goodwill, management gives consideration to a number of factors, including brand recognition, market share, operating systems and the creative and technical skills of the Company as a whole. Accumulated amortization of goodwill amounted to $7,305,000 and $6,585,000 at June 30, 1995 and 1994, respectively.\nNet loss per share is computed based on the weighted average number of shares of Common Stock outstanding during the periods. See Note E.\nNOTE B - Receivables\nThe amounts shown as receivables in the balance sheet are net of allowances of $2,415,000 as of June 30, 1995 and $990,000 as of June 30, 1994.\nNOTE C - Inventories\nInventories consist of: (000 omitted) ------------------ June 30, ------------------ 1995 1994 -------- -------- Raw materials................................... $ 5,120 $ 5,551 Work in process................................. 484 705 Finished goods.................................. 10,826 11,738 -------- -------- $ 16,430 $ 17,994 ======== ========\nNote D - Notes Payable\/Long-Term Debt\nThe amount borrowed as notes payable\/long-term debt fluctuates based on the Company's cash availability or requirements.\nOn June 30, 1994, the Company repaid its indebtedness to its senior secured lender by borrowing $13 million from another lender and approximately $5.6 million from its Parent Company. The borrowing from the other lender consisted of $2 million under a secured promissory note and the balance under a revolving loan and security agreement. These borrowings are secured by substantially all of the Company's assets, are due June 30, 1996, may be prepaid without premium or penalty and bear interest at the rate of 2% a month. See Note O - Subsequent Event regarding refinancing of this long-term debt.\nPrior to June 30, 1994, notes payable amounts were borrowed from a factor. The amount outstanding was secured by the Company's receivables and inventory and interest was charged at 2% a year over a bank's reference rate.\nSelected information with regard to the long-term debt (1995) and the notes payable to the factor (1994) is as follows: (000 omitted) ------------------ Year Ended June 30 ------------------ 1995 1994 -------- -------- Maximum amount outstanding (at any month end)........ $ 17,167 $ 17,963 Average amount outstanding during period............. 13,945 16,403 Interest paid........................................ 3,347 1,565 Weighted average interest rate during period - (based on average amount outstanding)............... 24.0% 9.5%\nNOTE E - Stockholders' Equity\nOn December 30, 1992, as an incentive to certain of its key employees, the Company sold 300,000 shares of its authorized, but previously unissued, Common Stock to those employees. The sale of these shares increased the number of outstanding shares of Common Stock from 7.5 million to 7.8 million. The shares are not registered under the Securities Act of 1933, as amended. These unregistered shares were sold for cash at a value, based on market quotations of the Company's publicly-traded Common Stock, of $0.125 a share.\nThe only other changes in stockholders' equity during the three years ended June 30, 1995 have been the addition of net losses to retained earnings (deficit).\nNOTE F - Income Taxes\nThrough December 30, 1992, the results of operations of the Company were included in the consolidated Federal and certain state income tax returns of the Parent Company. The provision for income taxes was computed based on the earnings (loss) as reflected in the financial statements, using applicable Federal and state income tax law and rates, as if the Company were filing separate income tax returns. The amount which would have been payable to the applicable taxing authorities was paid to the Parent Company.\nEffective December 30, 1992, as a result of the sale of Common Stock (see Note E above), the Parent Company's ownership of the Company dropped below the percentage required for consolidation for income tax purposes and, therefore, the results of operations of the Company are no longer included in consolidated Federal and certain state income tax returns of the Parent Company.\nThe provision for income taxes for each of the three years ended June 30, 1995 consists of state and local taxes. As a result of losses for these years, no provision for Federal income taxes was made.\nA reconciliation of the United States statutory Federal corporate income tax rate to the effective rate of the provision for income taxes is as follows: Year Ended June 30, ---------------------------- 1995 1994 1993 -------- -------- -------- Statutory rate (benefit)................... (34.0)% (34.0)% (34.0)% Decrease in taxes arising from effect of: State and local income taxes, net of Federal tax benefit..................... 1.3 0.9 0.6 Amortization of goodwill................. 19.0 12.1 5.9 Losses not resulting in tax benefit...... 15.6 22.3 28.5 -------- -------- -------- Effective rate............................. 1.9 % 1.3 % 1.0 % ======== ======== ========\nAt June 30, 1995, the Company had unused net operating loss carryforwards of approximately $37.6 million, of which $3.6 million expires in 2003, $11.3 million in 2005, $10.0 million in 2006, $9.4 million in 2007, $1.8 million in 2008, $1.1 million in 2009 and $0.4 million in 2010.\nNOTE G - Related Party Transactions\nPrior to 1991, the Parent Company acted as a banker for the Company. The Company would borrow from the Parent Company funds necessary to meet operational and capital needs, and lend funds to the Parent Company when the Company had excess funds available. During the 1991 fiscal year, the Company established separate credit facilities and no longer relies on the Parent Company to be its banker. The Company currently owes the Parent Company for borrowings, for interest expense on amounts due, for rent and for amounts paid by the Parent Company on behalf of the Company which were not reimbursed by the Company. The Company is charged interest on its net outstanding balance with the Parent Company at the annual rate paid by the Parent Company on its borrowings; however the Parent Company has waived the interest due to it for the fourth quarter of fiscal 1993 and for the 1994 and 1995 fiscal years. There is no repayment schedule for this debt.\nSelected information with regard to the amount due to Parent Company is as follows: (000 omitted) ------------------ Year Ended June 30 ------------------ 1995 1994 -------- -------- Maximum amount outstanding (at any month end)........ $24,421 $24,493 Average amount outstanding during period............. 24,050 18,846 Interest paid to Parent Company ..................... 0 0 Weighted average interest rate during period (interest paid divided by average amount outstanding)......... 0% 0%\n- ---------- Note - The Parent Company waived interest on the amount due to it for the three months ended June 30, 1993 and for the years ended June 30, 1994 and 1995.\nThe Company leases two buildings from the Parent Company at a total cost of $325,000 a year (subject to annual cost-of-living adjustments). The Company pays all expenses of the buildings on a triple net lease basis.\nPrior to their sale in January 1995, the Parent Company owned and operated certain retail outlet stores. During the seven months ended January 31, 1995 and the fiscal year ended June 30, 1994, sales to the Parent Company's retail outlet stores were approximately $189,000 and $702,000, respectively.\nUnder a service agreement, the Parent Company performs certain limited administrative functions, including data processing services, for the Company. These functions were performed by the Company prior to its acquisition. The Company believes that if it were to resume responsibility for these services, the additional cost to the Company would be minimal. Accordingly, the Parent Company has not charged the Company for these services.\nNOTE H - Commitments and Contingencies\nRental expense for real property, machinery and equipment was $1,073,000, $1,006,000, and $1,068,000 for the years ended June 30, 1995, 1994 and 1993, respectively. These amounts include rent paid to the Parent Company for the lease of two buildings (see Note G above).\nAt June 30, 1995, minimum rental commitments under non-cancellable operating leases (including leases with the Parent Company), primarily for real property, machinery and equipment, are as follows:\nYear ending (000 June 30, omitted) ----------- -------- 1996................................................... $ 973 1997................................................... 608 1998................................................... 590 1999................................................... 614 2000................................................... 617 Thereafter............................................. 9,375\nUnder the present terms of certain agreements, the Company is obligated to pay royalties based on sales of certain product lines with minimum royalty payments of $767,500 in the year ending June 30, 1996, $802,500 in 1997, $837,500 in 1998, $641,250 in 1999 and $213,750 in the first six months of fiscal 2000.\nNOTE I - Supplemental Information\n(000 omitted) ---------------------------- Year ended June 30 ---------------------------- 1995 1994 1993 -------- -------- -------- Advertising expense....................... $ 2,598 $ 2,215 $ 2,221 Royalty expense........................... 1,540 1,304 1,401\nNOTE J - Stock Options\n1986 Stock Option Plan:\nThe 1986 Stock Option Plan provides for the granting of options to officers and other key employees to purchase an aggregate of 550,000 shares (as amended by the Company's Board of Directors on December 15, 1994, subject to approval by stockholders of the Company at the next Annual Meeting) of Common Stock of the Company. Such options are required to have an exercise price of not less than fair market value of the shares on the date the option is granted. Some or all of the options may be granted as \"incentive stock options\" within the meaning of the Internal Revenue Code of 1954, as amended.\nTransactions under this Plan for the three years ended June 30, 1995 are as follows: (000 omitted) ------------- Number of Total Shares Price per Share Price -------- ------------------ -------- Outstanding at June 30, 1992, 1993 and 1994.................. 100,000 $ 0.34375 $ 34 Granted.......................... 442,000 1.00 442 Cancelled........................ (25,000) 1.00 (25) -------- -------- Outstanding at June 30, 1995..... 517,000 $ 451 ======== ======== Exercisable at: June 30, 1994................... 50,000 June 30, 1995................... 75,000 Available for future grant: June 30, 1994................... 100,000 June 30, 1995................... 33,000\nOther Options:\nOn July 7, 1986, the Company granted to the Parent Company an option to purchase 800,000 shares of Common Stock of the Company at $10.80 a share. The option is exercisable in whole or part until August 31, 1996.\nAs of June 30, 1992 and 1993, an executive of the Company held options to purchase 250,000 shares of Common Stock of the Company at prices ranging from $5.25 to $1.125 a share. During fiscal 1994, the executive ceased to be an employee of the Company and the options were cancelled.\nNOTE K - Retirement Savings Plan\nThe Company has a Retirement Savings Plan which includes the salary deferral feature afforded by Section 401(k) of the Internal Revenue Code. The Plan covers substantially all employees of the Company. Under the Plan, covered employees may make pre-tax contributions of up to 10% of salary (but not to exceed the Internal Revenue Service limits in any one year) to their Plan account. For those employees whose annual salary is less than $40,000, the Company contributes a matching amount equal to 20% of the employee's contribution at the time of the employee's contribution. For those employees whose annual salary is $40,000 or greater, the Company makes no contribution. During the years ended June 30, 1995, 1994 and 1993, the Company's contributions to, and expenses of, the Plan were $47,000, $40,000 and $70,000, respectively.\nNOTE L - Business Segment\nThe Company consists of one business segment, the design, manufacture and distribution of costume jewelry.\nNOTE M - Major Customers\nDuring the years ended June 30, 1995, 1994 and 1993, one customer's purchases amounted to approximately 30%, 30% and 29%, respectively, of the Company's sales, net of returns.\nNOTE N - Quarterly Results (Unaudited)\nThe following summarizes the quarterly operating results of the Company for the years ended June 30, 1994 and 1993.\n(000 omitted) ------------------------------------------------ Quarter Ended -------------------------------------- Sep 30 Dec 31 Mar 31 June 30 Total -------- -------- -------- -------- -------- Year ended June 30, 1995: Net sales........... $ 14,744 $ 12,713 $ 11,204 $ 11,202 $ 49,863 Gross profit........ 7,114 5,157 4,816 4,691 21,778 Net earnings (loss). 1,012 (977) (766) (582) (1,313) Net earnings (loss) per share.......... 0.13 (0.13) (0.10) (0.07) (0.17)\nYear ended June 30, 1994: Net sales........... $ 11,108 $ 9,616 $ 10,593 $ 11,252 $ 42,569 Gross profit........ 5,390 3,305 4,925 5,205 18,825 Net earnings (loss). 165 (2,066) (100) (53) (2,054) Net earnings (loss) per share.......... 0.02 (0.26) (0.01) (0.01) (0.26)\nNOTE O - Subsequent Event\nRefinancing - Effective July 31, 1995, the Company renegotiated its borrowing arrangements with its current lender. Under the terms of the amended agreements, the lender loaned to the Company additional funds of approximately $8.3 million, increasing the Company's total indebtedness to the lender to approximately $17.9 million, and reduced the interest rate paid on the Company's indebtedness to the lender from 24% to prime rate plus 3 1\/2%, or currently 12 1\/4% a year. Of the additional borrowing, $2.0 million was used to meet working capital needs and the remainder was used to reduce the Company's indebtedness to its Parent Company to approximately $16.7 million. The new arrangements consist of a $5.0 million term loan due June 15, 2000 and a revolving loan, based on the Company's eligible accounts receivable and inventories, having a term ending on June 15, 1998. The revolving loan will be renewed automatically for successive one year periods thereafter unless terminated by either party upon thirty days notice. The debt is classified as long-term in the accompanying balance sheet.\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors, Victoria Creations, Inc.:\nWe have audited the balance sheets of Victoria Creations, Inc. as of June 30, 1995 and 1994 and the related statements of operations and cash flows for each of the years in the three-year period ended June 30, 1995. 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 Victoria Creations, Inc. as of June 30, 1995 and 1994, and the results of its operations and its cash flows for each of the years in the three-year period ended June 30, 1995, in conformity with generally accepted accounting principles.\nKPMG Peat Marwick LLP\nNew York, New York October 11, 1995","section_15":""}
{"filename":"858877_1995.txt","cik":"858877","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nCisco Systems, Inc. develops, manufactures, markets and supports high-performance, multiprotocol internetworking systems that link geographically dispersed local-area and wide-area networks (LANs and WANs) to form a single, seamless information infrastructure. Cisco products include a wide range of routers, LAN and Asynchronous Transfer Mode (ATM) switches, dial-up access servers, and network management software solutions. The common thread running through these products is the Cisco Internetwork Operating System (Cisco IOS(TM)) software, which today provides the native intelligence for more than 450,000 installed Cisco units and is an integral part of the products of more than two dozen global partners.\nWhen Cisco shipped its first commercial multiprotocol router in 1986, it created a new part of the information technology industry - internetworking. Since then the market has changed greatly, and Cisco has kept pace with that change. In addition to enhancing its core business of routers, the Company has developed or acquired technology and products in all major categories of internetworking, including LAN switching, ATM, and network access for remote offices and mobile workers, incorporating the Cisco IOS software across all product lines. These changes have allowed Cisco to continue to grow at or above the rate of the overall market and to maintain leading market share in all the segments in which it participates.\nThe Cisco IOS software is a sophisticated suite of networking capabilities that provides network connectivity, security and interoperability for all of today's standard data protocols, media access methods and products from leading Information Service vendors. This software resides at the heart of Cisco's internetworking products and within the hardware of more than two dozen vendor partners including Alcatel, Cabletron Systems, Compaq Computers, LanOptics, NEC, Northern Telecom and Sun Microsystems. Cisco's modular hardware and software architecture allows products to be configured in a wide variety of ways to suit customers' specific needs.\nThe Company expanded the Cisco IOS feature set by moving aggressively into new markets and technologies. These include a range of remote access products, as well as switching products. In 1994 the Company introduced the CiscoFusion(TM) architecture, which blends the capabilities of today's routed internetworks with the emerging technologies of ATM, LAN workgroup switches and virtual LANs.\nCisco sells its products in approximately 75 countries through a combination of direct sales, distributors, and direct and indirect resellers. Cisco's worldwide Original Equipment Manufacturer (OEM) customers and resellers include Alcatel, AT&T, British Telecom, Cabletron Systems, Digital Equipment Corporation, Ericsson, Hewlett-Packard, MCI, NEC Corporation, Olivetti, Siemens, Sprint, Unisys and US West. Cisco has established technology partnerships with a number of companies to address specialized segments of the internetworking marketplace, and has partnered with leading WAN technology and service providers to offer flexible options to customers. The Company offers customer service and support through Technical Assistance Centers in California, North Carolina, Australia and Belgium, and provides onsite hardware maintenance on a worldwide basis through IBM, AT&T, and Hewlett-Packard.\nBeginning in fiscal year 1994, Cisco began entering new markets and broadening its product offerings through a series of acquisitions. The following acquisitions have been, or soon will be, integrated into the ATM, Access, or Workgroup business units, which are more fully described later in the \"Products\" section of this report.\nIn September 1993, the Company acquired Crescendo Communications, Inc. (\"Crescendo\"), a privately held networking company that provides high-performance workgroup solutions. The Company issued approximately 3,400,000 shares of common stock for all the outstanding stock of Crescendo in a transaction accounted for as a pooling of interests. The Company also assumed options and warrants to purchase Crescendo stock of which the options remain outstanding to purchase approximately 280,000 shares of the Company's common stock.\nIn August 1994, the Company purchased Newport Systems Solutions(TM), Inc. (\"Newport\"), a privately held networking company providing software-based routers for remote network sites. The Company issued approximately 3,300,000 shares of common stock for all the outstanding stock of Newport in a transaction also accounted for as a pooling of interests. In addition, the Company assumed options to purchase Newport stock that remain outstanding as options to purchase approximately 190,000 shares of the Company's common stock.\nIn December 1994, the Company acquired Kalpana(R), Inc. (\"Kalpana\"), a privately held manufacturer of Ethernet switches. Under the terms of the agreement, the Company issued approximately 6,800,000 shares of common stock for all the outstanding stock of Kalpana in a transaction also accounted for as a pooling of interests. In connection with this transaction, the Company assumed options to purchase Kalpana stock that remain outstanding as options to purchase approximately 500,000 shares of the Company's common stock.\nIn January 1995, the Company acquired substantially all of the assets and assumed the liabilities of LightStream(R) Corporation (\"LightStream\") for $120,000,000 in cash and related acquisition costs of approximately $500,000. LightStream was a developer of enterprise-class ATM switching technology. This acquisition was accounted for as a purchase.\nIn September 1995, the Company acquired Combinet Inc. (\"Combinet\"), a privately held manufacturer of remote access networking products. The Company issued approximately 1,750,000 shares of common stock for all the outstanding stock of Combinet in a transaction also accounted for as a pooling of interests. In addition, the Company assumed options and warrants to purchase Combinet stock that remain outstanding as options to purchase approximately 250,000 shares of the Company's common stock.\nAdditionally, in September 1995, the Company acquired Internet Junction, Inc., a developer of Internet gateway software that connects desktop users with the Internet. The Company issued 81,000 shares of stock for the net assets of Internet Junction in a transaction accounted for as a purchase.\nOn September 27, 1995, the Company entered into an agreement to acquire Grand Junction Networks, Inc., a privately held manufacturer and the inventor of Fast Ethernet (100BaseT) and Ethernet desktop switching products. The agreement calls for the Company to issue approximately 5,000,000 shares to acquire all the equity of Grand Junction, including outstanding options and warrants. The transaction is subject to several closing conditions and, if consummated, will be accounted for as a pooling of interests.\nThe Company expects to make future acquisitions where it believes that it can acquire new products and channels of distribution or otherwise rapidly enter new or emerging markets. Mergers and acquisitions of high-technology companies are inherently risky, and no assurance can be given that the foregoing or any future acquisitions will be successful and will not adversely affect the Company's financial condition or results of operations.\nCisco was incorporated in California in December 1984. The Company's executive offices are located at 170 West Tasman Drive, San Jose, California 95134, and its telephone number at that location is (408)526-4000. As used in this Form 10-K, the terms \"Cisco\" and \"the Company\" refer to Cisco Systems, Inc., and its subsidiaries.\nPRODUCTS\nCisco's breadth of product offerings and modular system design enable the Company to configure media interfaces, protocol software and port capacity to match customer needs for networks of varying sizes and complexity. Many of the Company's products, particularly its core products, are expandable, offering customers the option to upgrade their internetworks with existing equipment as their needs grow.\nIn May 1995, Cisco created five internal business units that reflect the Company's major product groups. Each of the five business units - Core, ATM Enterprise, Access, Workgroup and InterWorks - has its own marketing and engineering staffs. The Cisco IOS software and network management products support all five business units, serving as the foundation upon which Cisco's internetworking solutions are built.\nCORE\nCisco's core routing strength is provided by the Cisco 7000 family, which includes the high-end Cisco 7500 series, the Cisco 7000 and the compact Cisco 7010. The Cisco 7000 family offers users connectivity to ATM networks, channelized T1\/E1 connections, mainframe attachment, and a unique packet-switching architecture that easily handles the demands of large internetworks running many diverse protocols and applications. With the March 1995 introduction of a new Fast Ethernet Interface Processor (FEIP), the Cisco 7000 became the industry's only router family to support all three of the key high-bandwidth networking technologies on the market. The Cisco 7000 series has supported 100-Mbps Fiber Distributed Data Interface (FDDI) since early 1993 and 155-Mbps ATM since June 1994.\nATM\nATM has gained wide acceptance by customers as the strategic technology of choice for long-term networking decisions. Cisco Systems is the first internetworking vendor to offer a complete, end-to-end ATM solution, including enterprise ATM switches, workgroup\/campus ATM switches, ATM interface cards for internetwork routers and LAN switches, and ATM adapters for desktop systems and servers. The LightStream 2020 enterprise ATM multiservice switch provides LAN and WAN internetworking for campus environments or global networks. The LightStream 100 workgroup\/campus ATM switch supports up to 16 155-Mbps ATM interfaces.\nACCESS\nCisco's access routers are designed to improve productivity by extending the enterprise network beyond the boundaries of corporate headquarters to regional sales groups, small satellite offices and individual telecommuters.\nThe Cisco 4000 series delivers a high-performance, modular solution that can expand to meet the needs of large offices and regional sites. The Cisco 2500 series is available in 13 models customized for the needs of small branch offices. The Cisco 1000 series provides low-cost remote LAN attachment to corporate networks or Internet services for small offices and home offices. The AS5100 dial-up access server enables the large-scale deployment of telecommuting over standard telephone lines, integrating routing and modem-based technologies. All Cisco access products can be centrally configured and managed from headquarters, reducing the need for internetworking expertise in the field.\nWORKGROUP\nCisco's LAN switching products include the Catalyst(TM) and Kalpana families. Cisco's Catalyst family of LAN switches link network resources with maximum modularity, performance and flexibility in LAN switching, and include embedded Cisco IOS functionality to meet future needs as switched internetworks evolve. The newest member of the Catalyst family, the Catalyst 5000, delivers dedicated bandwidth to users through multiple-media switching options such as 10-Mbps Ethernet, 100-Mbps Ethernet, and ATM with future capability for switched FDDI and switched Token Ring. The Kalpana EtherSwitch family is a high-performance stackable switching platform. The Kalpana ProStack, also announced this year, consists of the EtherSwitch Pro16 and ProStack Matrix, and allows users to expand network capacity as bandwidth demands dictate. High-speed connectivity to routers or other switches is achieved with Fast Ethernet and ATM modules. Switch management is achieved through the CiscoWorks(TM) software, a comprehensive suite of network management applications.\nINTERWORKS\nA major area of market opportunity is the integration of legacy networks built around large-scale IBM computers and their networking framework called Systems Network Architecture (SNA). To address this market, Cisco has a separate business unit, InterWorks, which focuses on integrating the large number of SNA-based computing environments with newer multiprotocol networks. Cisco has a comprehensive suite of capabilities for this market, including TCP\/IP encapsulation of SNA data; integrated Synchronous Data Link Control (SDLC) support; mixed-media bridging, translation and conversion; enhanced data link switching; Frame Relay connectivity; Token Ring router interfaces and switching; Advanced Peer-to-Peer Networking (APPN); and direct channel attachment of Cisco 7000 routers to IBM mainframes.\nThe CiscoWorks Blue network management support enables operators visibility into and control over Cisco routers from either IBM NetView operator consoles or Simple Network Management Protocol (SNMP) network management stations.\nNETWORK MANAGEMENT\nThe CiscoWorks software is a suite of standards-based applications that allow users to manage their Cisco devices from a single integrated console. CiscoWorks software provides applications for internetworking products in three major areas: monitoring and diagnostics; troubleshooting and administration tasks; and a management series for implementation and change to administration tasks and planning and optimization for offline analysis of network traffic patterns and trends. CiscoWorks supports the HP OpenView, NetView AIX, SunNet Manager and Microsoft Windows platforms.\nCUSTOMERS AND MARKETS\nCisco's customers include corporations of all sizes, utilities, educational and research institutions, and government agencies. Internetworking needs are influenced most strongly by the size and complexity of a customer's information systems, and therefore Cisco's business is not concentrated in any particular industry.\nAn important trend influencing demand for the Company's products is the worldwide phenomenon of the Internet. The Internet is a network of networks, consisting of thousands of subnetworks and computer resources linked together. Cisco's high-performance routers are widely used in the \"backbone\" infrastructure of the Internet, and the Company believes that 80 percent or more of all routers on the Internet are its products. In addition, the demand by companies, institutions and individuals for access to the Internet is spurring demand for remote access, switching and routing products of all kinds. The Company also benefits from the Internet phenomenon through its alliance relationships with numerous Internet service providers.\nAnother significant factor affecting internetworking is the global trend toward deregulated telecommunications and the resulting increase in use of higher-performance telecommunications services. Cisco has alliance relationships with a majority of the world's telecommunications carriers.\nCisco is the first U.S.-based manufacturer to receive self-certification approval from the British Approvals Board for Telecommunications, which allows Cisco to more quickly bring products to the European Union.\nThe Company markets its internetworking products in the United States primarily through its direct sales force and resellers, and internationally, through distributors, Value-Added Resellers (\"VARs\"), OEMs, resellers, and its direct sales force in subsidiary companies. In addition, the Company sells to system integrators, both domestic and international, who resell the Company's internetworking products along with other computer and communications equipment. This multiple-channel approach allows customers to select the one that addresses their specific needs and provides the Company with broad coverage of worldwide markets.\nAt September 25, 1994, the Company's worldwide direct sales organization consisted of 1375 individuals, including managers, sales representatives, and technical support personnel. The Company has approximately 69 field sales offices providing coverage in the following metropolitan areas: Atlanta, Boston, Chicago, Cincinnati, Cleveland, Dallas, Denver, Durham, Honolulu, Houston, Indianapolis, Los Angeles, Miami, New Orleans, New York, Orlando, Phoenix, Pittsburgh, Portland (Oregon), Princeton, Salt Lake City, San Antonio, San Diego, San Francisco, San Jose, Seattle, St. Louis, and Washington, D.C., among others.\nThe Company's international sales are currently being made through multiple channels including approximately 75 international distributors and resellers in Africa, Asia, Australia, Canada, Europe, Latin America, Mexico and South America. The international distributors provide system installation, technical support, and follow-on service to local customers. Generally, the Company's international distributors have nonexclusive, country-wide agreements. International sales through the various channels, including the Company's subsidiaries, accounted for approximately 39.0% of total sales in fiscal 1993, 41.9% in fiscal 1994, and 42.4% in fiscal 1995. Sales to international customers and distributors generally have been made in United States dollars.\nThe Company has sales support subsidiaries worldwide. New subsidiaries formed in fiscal 1995 include Brazil, Korea, South Africa, Sweden, Switzerland, and Venezuela. No individual subsidiary has had direct sales that have been material to date.\nPatterns of both revenue growth and types of products sold are affected by various conditions in geographic regions. As a general rule, adoption of internetworking technology in Europe tends to be 1 to 2 years behind the United States, while Japan follows another 1 to 2 years later. Less-developed economies tend to lag even farther in technology adoption, although the Company has noted a recent tendency in some newly opened Eastern European economies to leapfrog intermediate technologies and purchase products with the most advanced technology. In November 1994, Cisco announced a joint venture with 13 leading Japanese technology companies to expand the internetworking market in Japan.\nBACKLOG\nThe Company's backlog on September 24, 1995, was approximately $278,800,000 compared with an approximate backlog of $88,200,000 at September 25, 1994. The Company includes in its backlog only orders confirmed with a purchase order for products to be shipped within six months to customers with approved credit status. Because of the generally short cycle between order and shipment, and occasional customer changes in delivery schedules or cancellation of orders (which are made without significant penalty), the Company does not believe that its backlog as of any particular date is necessarily indicative of actual net sales for any future period.\nCOMPETITION\nThe networking market is characterized by rapid growth, technological change, and a convergence of technologies. These market factors represent both an opportunity and at the same time a competitive threat to Cisco.\nThe Company faces competition from customers it licenses technology to and suppliers that it transfers technology from. The inherent nature of networking is such that Cisco must compete, and at the same time, co-operate with these companies. At a minimum these relationships exist to achieve interoperability. Optimally, these relationships are synergistic and mutually beneficial, resulting in growth for the industry.\n3Com, Alantec, Ascend, Bay Networks, Cabletron, Fore, IBM, and Shiva exemplify companies that compete with Cisco. Some companies compete across all of Cisco's product lines, while others do not offer as wide a breadth of networking solutions.\nCisco estimates that it competes with over 70 vendors in Access, over 40 vendors in Core, over 50 vendors in Workgroup, over 30 vendors in ATM, and over 40 vendors in InterWorks. Cisco expects that the overall number of vendors will grow in these markets because of its attractive growth opportunities. The Company also expects that overall increases to the number of competitors will be partially offset by mergers and acquisitions, as companies seek synergies and market presence.\nOver the past year, the networking industry has experienced some consolidation. This has primarily been achieved through mergers and acquisitions, and to a lesser extent, through joint technology agreements. Remaining competitors are broadening their product offerings and attempting to strengthen their positions in emerging and high-growth markets including remote access, high-speed switching, and ATM technologies.\nThe principal competitive factors in the market for internetworking products are performance, price, value-added features, reliability, conformance to industry standards, service, and market presence. The Company promotes its CiscoFusion architecture and Cisco IOS software as providing the premier internetworking solutions in the industry. These solutions offer many competitive advantages in the areas described above. Cisco believes that it will continue to provide solutions that offer competitive advantages and exceed end-users' buying criteria in the computer networking market.\nRESEARCH AND DEVELOPMENT\nThe market for the Company's products is characterized by rapidly changing technology, evolving industry standards, and frequent new product introductions. Management believes that the Company's future success depends in large part upon its ability to continue to enhance its existing products and to develop new products that maintain technological competitiveness. The Company closely monitors, through electronic mail and onsite visits by engineering personnel, customers' needs for additional products, and works actively with innovators of internetworking products, including universities, laboratories, and corporations. The Company intends to remain dedicated to industry standards and to continue to support important protocol standards as they emerge.\nThe Company is focusing development efforts around its five internal business units in the following areas: high-speed switching and ATM technologies, remote access and ISDN connectivity, improving overall system performance, expanding its network management capabilities, and IBM and WAN services connectivity. Cisco's development efforts continue to be guided by its CiscoFusion architecture announced in 1994, with the Cisco IOS software serving as the underlying common thread. There can be no assurance, however, that the Company's product development efforts will result in commercially successful products, or that the Company's products will not be rendered obsolete by changing technology or new product announcements by others. The Company has announced several new products, including a wide range of remote access products and a new line of high-end routers. Although the Company has announced its expected shipment dates for some of these products, schedules for high-technology products are inherently difficult to predict, and there can be no assurance that the Company will achieve its expected initial shipments dates of these or any other new or enhanced products developed by the Company. Because timely availability of new and enhanced products and their acceptance by customers are critical to the success of the Company, delays in availability of these products or lack of market acceptance of such products could have a material adverse effect on the Company.\nIn fiscal 1995, 1994, and 1993, the Company's research and development expenditures were $164,819,000, $88,753,000, and $44,254,000, respectively. All of the Company's expenditures for research and development costs, including purchased research and development of $95,760,000 in fiscal 1995, have been expensed as incurred.\nMANUFACTURING\nThe Company's manufacturing operations consist primarily of quality assurance of materials, components and subassemblies, final assembly, and test. The Company presently uses a variety of independent third-party contract assembly companies to perform printed circuit board assembly, in circuit test, and product repair. The Company installs its proprietary software on electronically programmable memory chips installed in its systems in order to configure products to customer needs and to maintain quality control and security. The manufacturing process enables the\nCompany to configure the hardware and software in unique combinations to meet a wide variety of individual customer requirements. The Company uses automated testing equipment and \"burn-in\" procedures, as well as comprehensive inspection, testing, and statistical process control to assure the quality and reliability of its products. The Company's manufacturing processes and procedures are ISO 9001 certified. To date, the Company has not experienced significant customer returns of its products.\nPATENTS, INTELLECTUAL PROPERTY AND LICENSING\nThe Company generally relies upon patents, copyright, trademark, and trade secret laws to establish and maintain its proprietary rights in its technology and products. However, it may be technologically possible for competitors to reverse-engineer the Company's products. Because the internetworking industry is characterized by rapid technological change, the Company believes that its success is more dependent upon its expertise in internetworking than its proprietary rights.\nThe Company has, from time to time, established strategic distribution and technology transfer relationships with other companies involved in the computer and communications industries. The Company intends to continue to explore strategic relationships and expects to enter into other such relationships in the future.\nThe Company has a program to file applications for and obtain patents in the United States and in selected foreign countries where a potential market for the Company's products exists. The Company has been issued several patents; other patent applications are currently pending.\nThere can be no assurance that any of these patents would be upheld as valid if litigated or that any patent applications will result in issued patents. While the Company believes that its patents and applications have value, it also believes that its competitive position depends primarily on the innovative skills, technological expertise and management abilities of its employees.\nMany of the Company's products are designed to include software or other intellectual property licensed from third parties. From time to time, the Company receives notices from third parties regarding patent claims. While it may be necessary in the future to seek or renew licenses relating to various aspects of its products, the Company believes that based upon past experience and standard industry practice, such licenses generally could be obtained on commercially reasonable terms.\nBecause of the existence of a large number of patents in the networking field and the rapid rate of issuance of new patents, it is not economically practical to determine in advance whether a product or any of its components infringe patent rights of others. In the event of any infringement, the Company believes that based upon industry practice, any necessary license or rights under such patents may be obtained on terms that would not have a material adverse effect on the Company's financial condition or its results of operations. However, there can be no assurance in this regard.\nOTHER RISK FACTORS\nThe Company's business and stock is subject to a number of risks. Some of those risks are described below. Other risks are presented elsewhere in this report. See, in particular, the last four paragraphs of \"Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations - Comparison of 1994 and 1995.\"\nPotential Fluctuations in Quarterly Results\nThe Company's operating results may be subject to quarterly fluctuations as a result of a number of factors. These factors include the integration of people, operations, and products from acquired businesses and technologies; increased competition, which the company expects; the introductions and market acceptance of new products, including high-speed switching and ATM technologies; variations in sales channels, product costs, or mix of products sold; the timing of orders and manufacturing lead times; and changes in general economic conditions, any of which could have an adverse impact on operations and financial results. For example, in the second quarter of fiscal 1995, the Company acquired substantially all of the assets of LightStream and incurred an expense of approximately $95 million associated with purchased research and development, which resulted in net income being significantly lower than in the prior quarter. Additionally, the dollar amount of large orders for the Company's products have been increasing, and therefore the operating results for a quarter could be materially adversely affected if a number of large orders are either not received or are delayed, due for example, to cancellations, delays or deferrals by customers. Further, the Company's expense levels are required, in part, to generate future revenues. If revenue levels are below expectations, operating results are likely to be adversely affected. Net income may be disproportionately affected by a reduction in revenues because a proportionately smaller amount of the Company's expenses varies with its revenues.\nDependence on New Product Development; Rapid Technological and Market Change\nThe markets for the Company's products are characterized by rapidly changing technology, evolving industry standards, frequent new product introductions and evolving methods of building and operating networks. The Company's operating results will depend to a significant extent on its ability to continue to successfully introduce new products on a timely basis and to reduce costs of existing products. In particular, in August 1992, the Company broadened its product line by introducing its first network access product. Since that time, sales of these products, which are generally lower priced and carry lower margins than the Company's core products, have increased more rapidly than sales of the core products. In addition, in 1994, Cisco announced its CiscoFusion architecture, that provides a method of merging router-based networks with emerging technologies such as Asynchronous Transfer Mode and LAN switches. While some elements of the CiscoFusion architecture have been introduced, others are still in development. The success of these and other new products is dependent on several factors, including proper new product definition, product cost, timely completion and introduction of new products, differentiation of new products from those of the Company's competitors and market acceptance of these products. The Company has addressed the need to develop new products through its internal development efforts and through joint developments with other companies and through acquisitions. Acquisitions involve numerous risks, including difficulties in the assimilation of the operations, technologies and products of the acquired companies, the diversion of management's attention from other business concerns, risks of entering markets in which the Company has no or limited direct prior experience and where competitors in such markets have stronger market positions, and the potential loss of key employees of the acquired company. There can be no assurance that the Company will successfully identify new product opportunities and develop and bring new products to market in a timely manner, or that products or technologies developed by others will not render the Company's products or technologies obsolete or noncompetitive. The failure of the Company's new product development efforts could have a\nmaterial adverse effect on the Company's business and results of operations.\nManufacturing Risks\nAlthough the Company generally uses standard parts and components for its products, certain components are presently available only from a single source or limited sources. The Company has generally been able to obtain adequate supplies of all components in a timely manner from existing sources, or where necessary, from alternative sources of supply. A reduction or interruption in supply or a significant increase in the price of one or more components would adversely affect the Company's operating results and could damage customer relationships. For example, recent shortages in the supply of semiconductors has resulted in price increases and has limited the Company's ability to obtain price reductions with respect to such components. These developments could result in lower gross margins. The Company expects that it will continue to be dependent on single or limited source supplier relationships in the future.\nVolatility of Stock Price\nThe Company's Common Stock has experienced substantial price volatility, particularly as a result of variations between the Company's actual or anticipated financial results and the published expectations of analysts and as a result of announcements by the Company and its competitors. In addition, the stock market has experienced extreme price and volume fluctuations that have affected the market price of many technology companies in particular and that have often been unrelated to the operating performance of these companies. These broad market fluctuations, as well as general economic and political conditions, may adversely affect the market price of the Company's Common Stock.\nEMPLOYEES\nAs of September 24, 1995, the Company employed 4086 persons, including 427 in manufacturing, 1092 in domestic sales and marketing, 525 in customer service, 1016 in engineering, 405 in finance and administration, and 621 employees in international locations. The Company also employs a number of temporary and contract employees, and during fiscal 1995 the Company employed between 473 and 742 such people at any one time.\nNone of the employees is represented by a labor union, and the Company considers its relations with its employees to be positive. The Company has experienced no work stoppages.\nCompetition for technical personnel in the Company's industry is intense. To date, the Company believes that it has been successful in recruiting qualified employees, but there is no assurance that it will continue to be as successful in the future. The Company believes that its future success depends in part on its continued ability to hire, assimilate, and retain qualified personnel.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's principal corporate offices are located at sites in Santa Clara and San Jose, California. The Santa Clara facilities are leased through December 1996 and have approximately 120,000 square feet of office space. The Company's main headquarters are situated on 46 acres of leased land in San Jose, California. Eight buildings are located at this site, one of which is the Company's manufacturing facility. The San Jose headquarters consist of approximately 825,000 square feet of leased office space at the\npresent time. To meet its anticipated needs at its main headquarters, the Company has leased an additional 36 acres of land at two nearby sites where it will eventually lease facilities to be constructed on each site. Construction has started at one of the sites on a series of office buildings which, when completed, will have approximately 575,000 square feet. Occupancy is expected to begin prior to the end of calendar 1996.\nIn addition to the California facilities, the Company leases approximately 45 acres of land in Research Triangle Park, North Carolina, where the InterWorks Business Unit, as well as a Technical Assistance Center, telesales, and various other support functions, are located. One building of approximately 80,000 square feet has been constructed and is currently occupied under a lease that expires in July 1999. A 120,000-square-foot building at this location is currently under construction and should be occupied before the end of the 1996 fiscal year. This site can accommodate one additional building.\nThe Company's ATM Business Unit occupies approximately 50,000 square feet of leased office space in Billerica, Massachusetts.\nThe Company also leases various small offices throughout the U.S. and on a worldwide basis. See Note 6 to the Consolidated Financial Statements for additional information regarding the Company's obligations under leases.\nManagement believes that suitable additional space will be available to accommodate expansion of the Company's operations on commercially reasonable terms.\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 security holders during the fourth quarter of the fiscal year covered by this report.\nEXECUTIVE OFFICERS AND DIRECTORS OF THE REGISTRANT\n- ------- (1) Member of the Executive Committee (2) Member of the Compensation\/Stock Option Committee (3) Member of the Audit Committee (4) Member of the Nomination Committee (5) Member of the Acquisition Committee\nTRANSFER AGENT AND REGISTRAR INDEPENDENT ACCOUNTANTS Bank of Boston Coopers & Lybrand L.L.P. 50 Royal Street Ten Almaden Boulevard Canton, MA 92021 San Jose, CA 95113\nLEGAL COUNSEL Brobeck, Phleger & Harrison 2200 Geng Road Palo Alto, CA 94303\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nSTOCK MARKET INFORMATION\nPrice range of the Company's common stock that reflects the two-for-one splits effective March 1993 and March 1994:\nCisco Systems' common stock (Nasdaq symbol CSCO) is traded on the Nasdaq National Market. The table above reflects the range of high and low closing prices for each period indicated. The Company has never paid cash dividends on the common stock and has no present plans to do so. There were approximately 4917 shareholders of record on October 2, 1995.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nFIVE YEARS ENDED JULY 30, 1995 (In thousands, except per-share amounts)\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nComparison of 1994 and 1995:\nNet sales grew from $1,243.0 million in 1994 to $1,978.9 million in 1995. The 59.2% increase in net sales during the year was primarily a result of increasing unit sales of the Cisco 7010, the Cisco 7000, and the Cisco 2500 product family, sales of new products including the Cisco 4500, as well as the initial market acceptance of the Company's high-speed switching products. These increases were partially offset by decreasing unit sales of the Company's older product lines, comprising the AGS+ as well as the Cisco 2000 and Cisco 3000 product families. Sales to international customers were 42.4% of net sales in 1995 compared with 41.9% in 1994. This moderate increase reflects the Company's continued expansion into new geographic markets.\nGross margins increased from 66.8% of net sales in 1994 to 67.4% in 1995. Gross margins have improved as a result of several factors, including lower material costs achieved through volume and prompt payment discounts, certain manufacturing overhead efficiencies, and a decrease in warranty expenses from 2.0% of net sales in 1994 to 1.5% in 1995. This was partially offset by the continued shift in revenue mix to the Company's lower-margin remote access products. In the future, the Company expects its gross margins to decrease, because it believes that the market for lower-margin remote access and high-speed switching products will continue to increase at a faster rate than the market for the Company's higher- margin router products. The Company is attempting to improve manufacturing efficiencies, but there can be no assurance that it will be able to do so, or that any efficiencies attained will be sufficient to maintain gross margins.\nResearch and development expenses increased $76.1 million from 1994 to 1995, an increase from 7.1% of net sales in 1994 to 8.3% in 1995. The increase reflects the Company's ongoing research and development efforts, including the further development of its CiscoFusion architecture, as well as the acquisition of technologies to bring a broad range of products to market in a timely fashion. A significant portion of the increase was due to the addition of new personnel, primarily from hiring and to a lesser extent through acquisitions, as well as higher material costs for prototypes and depreciation on new equipment. All of the Company's research and development costs are expensed as incurred. The Company is primarily developing new technologies internally, and because of this, research and development as a percentage of sales is expected to increase. When appropriate, the Company may acquire other businesses or license technology from other businesses as an alternative to internal research and development.\nSales and marketing expenses increased $148.9 million in 1995, an increase from 16.6% to 17.9% of net sales. The increase in these expenses resulted from an increase in the size of the Company's direct sales force and its commissions, additional marketing programs to support the launch of new products, the entry into new markets both domestic and international, and expansion of distribution channels.\nGeneral and administrative expenses rose $29.0 million from 1994 to 1995 which represents an increase from 3.8% of net sales in 1994 to 3.9% in 1995. The increase in these expenses reflects increased personnel costs, implementation of the Company's new information system, and the amortization of goodwill since the date of the acquisition of the assets and assumption of the liabilities of LightStream (see note 2).\nThe amount expensed to purchased research and development arose from the acquisition of the assets and assumption of the liabilities of LightStream (see note 2).\nInterest and other income, net, was $21.4 million in 1994 and $36.1 million in 1995. Interest income rose as a result of additional investment income on the Company's increasing investment balances.\nDuring March 1995, the Financial Accounting Standards Board issued Statement No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of,\" which requires the Company to review for impairment long-lived assets, certain identifiable intangibles, and goodwill related to those assets whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In certain situations, an impairment loss would be recognized. Statement No. 121 will be effective for the Company's fiscal year 1997. The Company has studied the implications of the statement, and based on its initial evaluation, does not expect it to have a material impact on the Company's financial condition or results of operations.\nFuture Growth Subject to Risks\nThe Company's growth is dependent upon market growth and its ability to enhance its existing products and introduce new products on a timely basis. The Company must also maintain its ability to manage any such growth effectively. In this regard, in May 1995 the Company completed an internal reorganization, which it believes will better enable it to address its markets. No assurance can be given that this reorganization will achieve its objectives. Failure to manage growth effectively could materially and adversely affect the Company's business and operating results. The Company's growth and ability to meet customer demand also depend, in part, on its ability to have stable supplies of parts from its suppliers. Many of these parts, particularly semiconductor parts, may be in short supply. An inability to obtain these parts could have a material and adverse affect on the Company's growth.\nThe Company expects that in the future, its net sales will grow at a slower rate than was experienced in previous periods and that on a quarter-to-quarter basis, the Company's growth in net sales may be significantly lower than its historical quarterly growth rate. The Company has been experiencing longer sales cycles for its core products resulting from larger order sizes and believes that some customers may be deferring purchases in order to complete detailed reviews of their overall network plans. In addition, in response to customer demand, the Company has, from time to time, reduced its product manufacturing lead times and its backlog of orders. To the extent that backlog is reduced during any particular period, it would result in more variability and less predictability in the Company's quarter-to-quarter net sales and operating results.\nThe Company also expects that gross margins may be adversely affected by increases in material or labor costs, heightened price competition, and by changes in channels of distribution or in the mix of products sold. In particular, the Company broadened its product line by introducing its first network access product in August 1992. Since that time, sales of these products, which are generally lower-priced and carry lower gross margins than the Company's core products, have increased more rapidly than the sales of the core products.\nThe Company also expects that its operating margins may decrease as it continues to hire additional personnel and to increase other operating\nexpenses to support its business. The results of operations for 1995 are not necessarily indicative of results to be expected in future periods, and the Company's operating results may be subject to quarterly fluctuations as a result of a number of factors. These factors include the integration of people, operations, and products from acquired businesses and technologies; increased competition, which the Company expects; the introduction and market acceptance of new products, including high-speed switching and ATM technologies; variations in sales channels, product costs, or mix of products sold; the timing of orders and manufacturing lead times; and changes in general economic conditions, any of which could have an adverse impact on operations and financial results.\nComparison of 1993 and 1994:\nNet sales grew from $649.0 million in 1993 to $1,243.0 million in 1994. The 91.5% increase in net sales during the year was primarily a result of increasing unit sales of the Cisco 3000, the Cisco 4000, and the Cisco 7000, sales of new products including the Cisco 2500 and the Cisco 7010, and growth in sales of add-on boards, which provide increased functionality. Sales to international customers were 41.9% of net sales in 1994, compared with 39.0% in 1993. This increase reflects the Company's continued expansion into new geographic markets.\nGross margins decreased from 67.6% of net sales in 1993 to 66.8% in 1994. Gross margins decreased as a result of the increasing unit sales of lower-margin products, principally the Cisco 3000 and the Cisco 4000, and from the sales of new products, primarily the Cisco 2500. Warranty expenses increased slightly from 1.7% of net sales in 1993 to 2.0% in 1994, reflecting the new product introductions. In the future, the Company expects its gross margins to decrease, because the Company believes that the market for lower-margin remote access and high-speed switching products will increase at a faster rate than the market for the Company's higher-margin router products. Decreases could be partially offset by various measures employed to lower the cost of raw materials purchased.\nResearch and development expenses increased $44.5 million from 1993 to 1994, primarily as a result of additions to engineering personnel, including Crescendo Communications personnel, depreciation on new engineering equipment, material costs for prototypes, and increased facilities expenses. These expenses increased from 6.8% of net sales in 1993 to 7.1% in 1994. All of the Company's research and development costs are expensed as incurred. The Company is primarily developing new technologies internally, and because of this, research and development as a percentage of sales is expected to increase. When appropriate, the Company may acquire other businesses or license technology from other businesses as an alternative to internal research and development.\nSales and marketing expenses increased $96.1 million in 1994 as a result of increased marketing and sales personnel and support costs, including commissions, in both the U.S. and the Company's international subsidiaries. Sales and marketing expenses decreased slightly as a percentage of net sales, from 16.9% in 1993 to 16.6% in 1994. However, management expects sales expenditures to increase as a percentage of net sales as the Company penetrates new markets.\nGeneral and administrative expenses rose $26.5 million from 1993 to 1994, which represents an increase from 3.2% of net sales in 1993 to 3.8% in 1994. The increase in these expenses was due primarily to increased personnel costs, legal and tax fees as the Company expands internationally, costs associated with the Crescendo acquisition, and charitable contributions.\nInterest and other income, net, was $11.6 million in 1993 and $21.4 million in 1994. Interest income rose as a result of additional investment income on the Company's increasing investment balances.\nInternational operating income as a percentage of net international sales decreased from 4.8% in 1993 to 1.5% in 1994. International operating income consists of net operating income of the Company's international subsidiaries, which have various distribution arrangements with the Company. The decrease from 1993 to 1994, in percentage terms, can be attributed to a shifting mix of intercompany arrangements and higher organizational expenditures associated with expanding international operations through new and existing entities.\nLIQUIDITY AND CAPITAL RESOURCES\nCash, short-term investments, and investments increased by $289.1 million from 1994 to 1995, primarily as a result of cash generated by operations, cash received in connection with the exercise of employee stock options, and proceeds received from minority shareholders in the Company's Japanese subsidiary (see note 7). The increase was partially offset by the cash paid to acquire the assets and assume the liabilities of LightStream (see note 2) and repurchases of the Company's common stock.\nAccounts receivable rose 61.7% from 1994 to 1995, while sales grew by 59.2%. Days sales outstanding in receivables were 56 days at the end of the year, versus 59 days at July 31, 1994. Inventories increased 155.1% from 1994 to 1995 because of production planning associated with higher sales levels. In addition, inventory levels were unusually low at July 31, 1994 because of the planned delay in raw material receipts to accommodate the manufacturing operations move to the Company's new headquarters. As a result, inventory turnover decreased from 16.1 turns at July 31, 1994 to 13.0 turns at July 30, 1995.\nAccounts payable increased 42.6% from 1994 to 1995 because of increases in capital expenditures, operating expenses, and material purchases to support the growth in net sales. The 82.8% increase in accrued payroll and related expenses is primarily a result of personnel additions made during the year. Other accrued liabilities increased by 61.2% from 1994 to 1995, primarily because of increases in the warranty accrual and deferred service contracts.\nAt July 30, 1995, the Company had a line of credit totaling $100.0 million, which expires April 1998. There have been no borrowings under this agreement.\nThe Company has entered into certain lease arrangements in San Jose, California, and Research Triangle Park, North Carolina, where it has established its headquarters operations and certain research and development and customer support activities. In connection with these transactions, the Company pledged $173.1 million of its investments as collateral for certain obligations of the leases. The restricted investments balance will continue to increase as the Company phases in operations at these lease sites.\nUnder the Company's ongoing stock repurchase program, shares have been purchased periodically and retired. During the year ended July 30, 1995, the Company purchased and retired approximately 2.1 million shares for an aggregate price of $69.9 million. As of July 30, 1995, the Company was authorized to repurchase up to an additional 4.9 million shares of its common stock in the open market or through privately negotiated transactions.\nThe Company's management believes that its current cash and equivalents, short-term investments, line of credit, and cash generated from operations will satisfy its expected working capital and capital expenditure requirements through 1996.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nCISCO SYSTEMS, INC.\nCONSOLIDATED BALANCE SHEETS (In thousands)\nThe accompanying notes are an integral part of these financial statements.\nCISCO SYSTEMS, INC.\nCONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per-share amounts)\nThe accompanying notes are an integral part of these financial statements.\nCISCO SYSTEMS, INC.\nCONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (In thousands)\nThe accompanying notes are an integral part of these financial statements.\nCISCO SYSTEMS, INC.\nCONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)\nThe accompanying notes are an integral part of these financial statements.\nCISCO SYSTEMS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except exercise prices and percentages)\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nFiscal Year. The Company's fiscal year is the 52 or 53 weeks ending on the last Sunday in July. The fiscal years ended July 30, 1995, July 31, 1994, and July 25, 1993 comprised 52, 53, and 52 weeks, respectively.\nPrinciples of Consolidation. The consolidated financial statements include the accounts of Cisco Systems, Inc. and its subsidiaries. All significant intercompany accounts and transactions have been eliminated.\nCash and Equivalents. The Company considers all highly liquid investments purchased with a maturity of less than three months to be cash equivalents. Substantially all of its cash and equivalents are maintained with two major financial institutions.\nShort-Term Investments. The Company's short-term investments comprise U.S., state, and municipal government obligations, and foreign and corporate obligations. These investments are carried at market value and have maximum maturities of one year. Prior to adoption of Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\", in fiscal year 1995, the Company's short-term investments were carried at cost, which approximated market value at July 31, 1994. Nearly all short-term investments are held in the Company's name and maintained with one large financial institution.\nInventories. Inventories are stated at the lower of cost or market. Cost is computed using standard cost, which approximates actual cost on a first-in, first-out basis.\nInvestments. Investments consist of U.S., state, and municipal government obligations, foreign and corporate obligations, and corporate securities with maturities of more than one year. These investments are carried at market value. Prior to adoption of Statement No. 115 in fiscal year 1995, the Company's investments were carried at cost, which approximated market value at July 31, 1994. Investments are held in the Company's name and maintained with one large financial institution.\nRestricted Investments. Restricted investments consist of U.S. governmental obligations with maturities of more than one year. These investments are carried at market value at July 30, 1995 and are restricted as to withdrawal (see Note 6). Prior to adoption of Statement No. 115 in fiscal year 1995, the Company's restricted investments were carried at cost, which approximated market value at July 31, 1994. Restricted investments are held in the Company's name and maintained with one large financial institution.\nRevenue Recognition. The Company recognizes product revenue upon shipment of product. Revenue from service obligations is deferred and recognized over the lives of the contracts.\nDepreciation and Amortization. Property and equipment are stated at cost and depreciated on a straight-line basis over the estimated useful lives of the assets. Such lives vary from two and one-half to five years.\nCISCO SYSTEMS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except exercise prices and percentages)\nIncome Taxes. The Company accounts for income taxes using the liability method to calculate deferred income taxes. The realization of deferred tax assets is based on historical tax positions and expectations about future taxable income.\nComputation of Net Income Per Common Share. Net income per common share is computed using the weighted average number of common and dilutive common equivalent shares outstanding during the period. Dilutive common equivalent shares consist of stock options.\nForeign Currency Translation. The Company's international subsidiaries use their local currencies as their functional currencies. Assets and liabilities are translated at exchange rates in effect at the balance sheet date and income and expense accounts at average exchange rates during the year. Resulting translation adjustments are recorded directly to a separate component of shareholders' equity.\nForward Exchange Contracts. The Company enters into forward exchange contracts to minimize the short-term impact of foreign currency fluctuations on the asset and liability positions of its international subsidiaries. Gains and losses on these contracts are recognized in net income in the period in which exchange rate changes occur.\nRecent Accounting Pronouncements. During March 1995, the Financial Accounting Standards Board issued Statement No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,\" which requires the Company to review for impairment long-lived assets, certain identifiable intangibles, and goodwill related to those assets whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In certain situations, an impairment loss would be recognized. Statement No. 121 will be effective for the Company's fiscal year 1997. The Company has studied the implications of the statement, and, based on its initial evaluation, does not expect it to have a material impact on the Company's financial condition or results of operations.\nCISCO SYSTEMS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except exercise prices and percentages)\n2. BUSINESS COMBINATIONS\nIn September 1993, the Company acquired Crescendo Communications, Inc., a networking company that provides high-performance workgroup solutions. The Company issued approximately 3400 shares of common stock for all the outstanding stock of Crescendo in a transaction that was accounted for as a pooling of interests. The Company also assumed options and warrants to purchase Crescendo stock of which the options remain outstanding to purchase approximately 280 shares of the Company's common stock.\nOn August 8, 1994, the Company acquired Newport Systems Solutions, Inc., a privately held networking company providing software-based routers for remote network sites. The Company issued approximately 3300 shares of common stock for all the outstanding stock of Newport in a transaction also accounted for as a pooling of interests. The Company also assumed options to purchase Newport stock that remain outstanding as options to purchase approximately 190 shares of the Company's common stock.\nOn December 6, 1994, the Company acquired Kalpana, Inc., a privately held manufacturer of Ethernet switches. Under the terms of the agreement, the Company issued approximately 6800 shares of common stock for all the outstanding stock of Kalpana in a transaction also accounted for as a pooling of interests. In connection with this transaction, the Company assumed options to purchase Kalpana stock that remain outstanding as options to purchase approximately 500 shares of the Company's common stock.\nThe aggregated historical operations of Crescendo, Newport and Kalpana are not material to the Company's consolidated operations and financial position. Therefore, prior period statements have not been restated.\nEffective January 11, 1995, the Company acquired substantially all of the assets and assumed the liabilities of LightStream Corporation for $120,000 in cash and related acquisition costs of approximately $500. LightStream was a developer of enterprise-class Asynchronous Transfer Mode (ATM) switching technology.\nThe acquisition was accounted for as a purchase. Accordingly, the results of operations of the acquired business and the fair market values of the acquired assets and assumed liabilities were included in the Company's financial statements as of the effective date.\nThe purchase price was allocated to the acquired assets and assumed liabilities based on fair market values as follows:\nCISCO SYSTEMS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except exercise prices and percentages)\nThe amount allocated to purchased research and development was determined through known valuation techniques in the high-technology communications industry. Amounts allocated to goodwill will be amortized on a straight-line basis over periods ranging from two to five years.\nThe following summary, prepared on a pro forma basis, combines the results of operations as if LightStream had been acquired as of the beginning of the periods presented. The summary includes the impact of certain adjustments such as goodwill amortization and estimated changes in interest income due to cash outlays associated with the transaction and the related income tax effects (in thousands, except per-share amounts):\nThe pro forma results are not necessarily indicative of what actually would have occurred if the acquisition had been in effect for the entire periods presented. In addition, they are not intended to be a projection of future results and do not reflect any synergies that might be achieved from the combined operations.\nCISCO SYSTEMS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except exercise prices and percentages)\n3. BALANCE SHEET DETAIL\nInventories:\nCISCO SYSTEMS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except exercise prices and percentages)\n4. INVESTMENTS\nEffective August 1, 1994, the Company adopted Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" This statement requires the Company to classify debt and equity securities into one of three categories: held-to-maturity, trading, or available-for-sale. At July 30, 1995, substantially all of the Company's investments were classified as available-for-sale, and the difference between the cost and fair market value of those securities, net of the tax effect, is shown as a separate component of shareholders' equity.\nThe following table summarizes the Company's securities at July 30, 1995:\nGross realized gains and losses on the sale of securities are calculated using the specific identification method and were not material to the Company's consolidated results of operations.\n5. LINE OF CREDIT\nOn May 22, 1995, the Company entered into a syndicated credit agreement under the terms of which a syndication of banks has committed a maximum of $100,000 on an unsecured basis for cash borrowings and letters of credit. The commitments made under this agreement expire on April 30, 1998. During the commitment period, the Company is obligated to pay annual fees of approximately $150. Outstanding borrowings under these arrangements bear interest at the London Interbank Offered Rate plus .31%, or other alternative rates. The agreement specifies various financial covenants, including a variable floor on tangible net worth, all of which the Company has met. There have been no borrowings under this agreement.\n6. COMMITMENTS\nLEASES\nThe Company leases office space for its U.S. and international sales offices. The Company also leases buildings at its headquarters in Santa Clara and San Jose, California. The Santa Clara lease expires December 1996.\nCISCO SYSTEMS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except exercise prices and percentages)\nIn February 1993, the Company entered into an agreement to lease 46 acres of land located in San Jose, California, where it has established its headquarters operations. In July 1994, the Company entered into an agreement to lease 45 acres of land located in Research Triangle Park, North Carolina, where it expanded certain research and development and customer support activities. In February and April 1995, the Company entered into agreements to lease an additional 36 acres of land in San Jose, California, where it will further expand its headquarters operations. All of the leases have initial terms of five years and options to renew for an additional five years, subject to certain conditions.\nAt any time during the terms of these land leases, the Company may purchase the land. If the Company elects not to purchase the land at the ends of the leases, the Company has guaranteed a residual value of approximately $55.9 million.\nIn May 1993, August 1994, and May 1995, the Company entered into agreements to lease certain buildings to be constructed on the land described above. The lessors of the buildings have committed to fund up to a maximum of $114.0 million (subject to reductions based on certain conditions in the lease) for the construction of the buildings, with the portion of the committed amount actually utilized to be determined by the Company. Rent obligations for the buildings will commence on varying dates and will expire at the same time as the land leases. The Company has an option to renew the building leases for an additional five years, subject to certain conditions.\nThe Company may, at its option, purchase the buildings during the terms of the leases at approximately the amount expended by the lessors to construct the buildings. If the Company does not exercise the purchase options at the ends of the leases, the Company will guarantee a residual value of the buildings as determined at the lease inception date of each agreement (approximately $69.3 million at July 30, 1995).\nAs part of the above lease transactions, the Company restricted $173.1 million of its securities as collateral for specified obligations of the lessor under the leases. These securities will be restricted as to withdrawal and will be managed by the Company subject to certain limitations, under its investment policy. In addition, the Company must maintain a minimum consolidated tangible net worth of $750.0 million.\nFuture annual minimum lease payments under all noncancelable operating leases as of July 30, 1995, are as follows:\nCISCO SYSTEMS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except exercise prices and percentages)\nRent expense totaled $19,157, $12,399, and $7,243 for 1995, 1994, and 1993, respectively.\nFORWARD EXCHANGE CONTRACTS\nThe Company enters into forward exchange contracts to reduce its exposure to potentially adverse changes in foreign currency exchange rates. The contracts hedge certain balance sheet exposures and intercompany balances against future movements in foreign exchange rates. The Company does not hold these financial instruments for trading purposes. Foreign exchange contracts outstanding, primarily in European, Canadian, and Australian currencies, amounted to $44.5 million and $21.8 million at July 30, 1995 and July 31, 1994, respectively. Gains and losses on the contracts are included in other income, which offset foreign exchange gains or losses from revaluation of intercompany balances. The maturity dates of the contracts outstanding at July 30, 1995 extended to approximately one month.\nThe Company's forward exchange contracts contain an element of risk that the other parties may be unable to meet the terms of the agreements. However, the Company minimizes such risk exposure by limiting the other parties to major financial institutions. In addition, the amount of agreements entered into with any one party is also monitored. Management does not expect any significant losses as a result of default by the other parties.\n7. MINORITY INTEREST\nIn October 1994, the Company's Japanese subsidiary, Nihon Cisco Systems, K.K., completed the sale of preferred stock to a group of outside investors in a private placement. Aggregate proceeds to Nihon Cisco Systems, K.K. were approximately $40.5 million. The investors received 26.8% of the voting rights. The Company retains ownership of all issued and outstanding common stock of its subsidiary, amounting to 73.2% of the voting rights. Each share of preferred stock is convertible into one share of common stock at any time, at the option of the holder.\n8. SHAREHOLDERS' EQUITY\nThe Company's common stock was split two-for-one on March 5, 1993 and March 4, 1994. All applicable share and per-share data in these financial statements have been restated to give effect to these stock splits.\nUnder the terms of the Company's Articles of Incorporation, the Board of Directors may determine the rights, preferences, and terms of the Company's authorized preferred stock.\nCISCO SYSTEMS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except exercise prices and percentages)\n9. EMPLOYEE STOCK PURCHASE PLAN\nThe Company has an Employee Stock Purchase Plan (the Purchase Plan) under which 4800 shares of common stock have been reserved for issuance. Eligible employees may designate not more than 10% of their cash compensation to be deducted each pay period for the purchase of common stock under the Purchase Plan, and participants may purchase not more than $25 worth of common stock in any one calendar year. On the last business day of each calendar quarter, shares of common stock are purchased with the employees' payroll deductions over six months, at a price per share of 85% of the lesser of the market price of the common stock on the purchase date or the market price on the first day of the period. The Purchase Plan will terminate no later than January 3, 2000. In 1995, 1994, and 1993, 579, 387, and 344 shares were issued under the Purchase Plan, respectively. At July 30, 1995, 2142 shares were available for issuance under the Purchase Plan.\n10. STOCK OPTION PLANS\nThe Company established a Stock Option Plan in 1987 under which it has reserved a total of 91,640 shares of common stock for issuance to employees, officers, directors, consultants, and independent contractors. Both incentive and nonqualified stock options have been granted at prices not less than fair market value at the date of grant as determined by the Board of Directors. Although the Board has the authority to set other terms, the options are generally 25% exercisable one year from the date of grant and then ratably over the following 36 months.\nA summary of option activity follows:\nAt July 30, 1995, approximately 9287 outstanding options were exercisable. Options granted for approximately 4000 shares reflected in the 1995 fiscal year are subject to shareholder approval of a 19,000 increase to the number of shares made available for issuance under the plan.\nCISCO SYSTEMS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except exercise prices and percentages)\nThe Company has, in connection with the acquisition of Crescendo, Newport, and Kalpana, assumed the stock option plans of each acquired company. A total of 2,237 shares of the Company's common stock has been reserved for issuance under those assumed plans.\n11. EMPLOYEE BENEFIT PLAN\nThe Company has adopted a plan to provide retirement and incidental benefits for its employees, known as the Cisco Systems, Inc. 401(k) Plan (the Plan). As allowed under Section 401(k) of the Internal Revenue Code, the Plan provides tax deferred salary deductions for eligible employees.\nEmployees may contribute from 1% to 15% of their annual compensation to the Plan, limited to a maximum amount as set by the Internal Revenue Service. The Company matches employee contributions dollar for dollar, up to a maximum of $1.5 per year. In addition, the Plan provides for discretionary contributions as determined by the Board of Directors. Such contributions to the Plan are allocated among eligible participants in the proportion of their salaries to the total salaries of all participants. Company matching contributions to the Plan totaled $3,456 in 1995, $1,796 in 1994, and $1,015 in 1993. No discretionary contributions were made in 1995, 1994, or 1993.\n12. INCOME TAXES\nThe provision for income taxes consists of:\nThe Company paid income taxes of $240.7 million, $164.3 million, and $63.3 million, in 1995, 1994, and 1993, respectively.\nCISCO SYSTEMS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except exercise prices and percentages)\nThe items accounting for the difference between income taxes computed at the federal statutory rate and the provision for income taxes follow:\nThe components of the deferred income tax provision are as follows:\nThe components of the deferred income tax assets follow:\nThe noncurrent portion of the deferred income tax assets, which totaled $11,405 at July 30, 1995, and $6,054 at July 31, 1994, is included in other assets.\nThe Company's income taxes currently payable for both federal and state purposes have been reduced by the tax benefit derived from the disqualifying dispositions of incentive and nonqualified stock options. This benefit, which totaled $55,756 in 1995 and $35,654 in 1994, was credited directly to common stock.\nCISCO SYSTEMS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except exercise prices and percentages)\n13. GEOGRAPHIC INFORMATION AND MAJOR CUSTOMERS\nThe Company operates in a single industry segment encompassing the design, development, manufacture, marketing, and technical support of internetworking products and services.\nIn 1995, 1994, and 1993, no customers accounted for 10% or more of the Company's net sales.\nInternational sales, primarily in Europe, the Pacific region, and Canada, were $838.3 million in 1995, $520.5 million in 1994, and $252.9 million in 1993. Export sales, primarily to these regions, were $661.6 million in 1995, $376.2 million in 1994, and $166.3 million in 1993.\nSummarized financial information by geographic region for 1995, 1994, and 1993 is as follows:\n14. SUBSEQUENT EVENT\nOn August 10, 1995, the Company entered into an agreement to acquire Combinet Inc., a privately held manufacturer of remote access networking products. The agreement calls for the Company to issue approximately 2000 shares to acquire all the equity of Combinet, including outstanding options and warrants. The transaction is subject to several closing conditions and, if consummated, will be accounted for as a pooling of interests.\nREPORT OF INDEPENDENT ACCOUNTANTS\nBoard of Directors and Shareholders Cisco Systems, Inc. San Jose, California\nWe have audited the accompanying consolidated balance sheets of Cisco Systems, Inc. and its subsidiaries as of July 30, 1995 and July 31, 1994 and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended July 30, 1995. 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 Cisco Systems, Inc. and its subsidiaries as of July 30, 1995 and July 31, 1994, and the consolidated results of their operations and their cash flows for each of the three years in the period ended July 30, 1995 in conformity with generally accepted accounting principles.\n\/s\/Coopers & Lybrand L.L.P.\nSan Jose, California August 15, 1995\nSUPPLEMENTARY FINANCIAL DATA\n1995 AND 1994 BY QUARTER (Unaudited) (in thousands, except per-share amounts)\n(In thousands, 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 information regarding Directors appearing under the caption \"Election of Directors\" in the Company's proxy statement to be mailed to Shareholders on or before October 2, 1995, is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information appearing at the end of Part I and under the caption \"Executive Compensation\" in the Company's proxy statement to be mailed to Shareholders on or before October 2, 1995, is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information appearing under the captions \"Election of Directors\" and \"Ownership of Securities\" in the Company's proxy statement to be mailed to Shareholders on or before October 2, 1995, is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information appearing under the caption \"Ownership of Securities\" and \"Certain Relationships and Related Transactions\" in the Company's proxy statement to be mailed to Shareholders on or before October 2, 1995, is incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) 1. Financial Statements\nThe financial statements listed in Item 14(a) are filed as part of this annual report.\n2. Financial Statement Schedules\nThe financial statement schedules listed in Item 14(a) are filed as part of this annual report.\n3. Exhibits\nThe exhibits listed in the accompanying Index to Exhibits are filed or incorporated by reference as part of this annual report.\n(b) Reports on Form 8-K\nNo reports on Form 8-K were filed during the fourth quarter of fiscal 1995.\nSIGNATURES\nPursuant to the requirements of the Securities Act of 1933, the Registrant has duly caused this Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of San Jose, State of California on this 17th day of October, 1995.\nCisco Systems, Inc.\n\/s\/ John T. Chambers ------------------------------------- (John T. Chambers, President and Chief Executive Officer)\nPursuant to the requirements of the Securities Act of 1933, this Report on Form 10-K has been signed by the following persons in the capacities and on the dates indicated.\nCISCO SYSTEMS, INC.\n-------------\nAND FINANCIAL STATEMENT SCHEDULES\nITEM 14(A)\nAll other schedules have been omitted since the required information is not present in amounts sufficient to require submission of the schedules, or because the information required is included in the consolidated financial statements or notes thereto.\nREPORT OF INDEPENDENT ACCOUNTANTS\nOur report on the consolidated financial statements of Cisco Systems, Inc. and its subsidiaries is included on page 37 of this Form 10-K. In connection with our audits of such financial statements, we have also audited the related financial statement schedule listed in the index on page 41 of this Form 10-K.\nIn our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.\n\/s\/ Coopers & Lybrand L.L.P.\nSan Jose, California August 15, 1995\nCISCO SYSTEMS, INC.\nSCHEDULE II VALUATION AND QUALIFYING ACCOUNTS (In thousands)\n(1) Deductions principally relate to charges for standards changes.\nITEM 15.","section_15":"ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.\n(a) The following exhibits are filed herewith.\n(b) The following financial statement schedules are filed herewith\n- -------------- * Previously filed with registrant's registration statements (File #33-32778)\n** Previously filed with registrant's Form 8-K dated October 8, 1993\n+ Previously filed with registrant's Form 8-K dated December 9, 1994\n++ Previously filed with registrant's Form 8-K dated January 25, 1995\n# Previously filed with registrant's Form 8-K dated August 19, 1994\n## Previously filed with registrant's Proxy statement dated October 2,"}
{"filename":"743366_1995.txt","cik":"743366","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nRegistrant owns a fee interest in five mini-storage facilities and a thirty percent (30%) interest in a joint venture with DSI Realty Income Fund IX, an affiliated California limited partnership, owning a sixth mini-storage facility, none of which are subject to long-term indebtedness. Additional information is set forth in Registrant's letter to its Limited Partners regarding the Annual Report, attached hereto as Exhibit 2, and incorporated by this reference. The following table sets forth information as of December 31, 1995 regarding properties owned by the Partnership.\nLocation Size of Net Rentable No. of Completion Parcel Area Rental Units Date\nStockton, CA 2.88 acres 48,017 560 2\/11\/85\nPittsburg, CA 1.91 acres 30,483 383 6\/01\/85\nEl Centro, CA 1.42 acres 24,818 276 4\/01\/85\nHuntington Beach, CA 3.28 acres 62,192 601 6\/14\/85\nLompoc, CA 2.24 acres 47,472 438 2\/28\/85\nAurora, CO* 4.6 acres 86,676 887 9\/05\/85 - ---------- *The Partnership has a 30% fee interest in this facility. DSI Realty Income Fund IX, a California Limited Partnership, (an affiliated partnership) owns a 70% fee interest in this facility.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nRegistrant 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\nNone.\nPART II\nItem 5.","section_5":"Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nRegistrant, a publicly-held limited partnership, sold 24,000 limited partnership units during its offering and currently has 957 limited partners of record. There is no intention to sell additional limited partnership units nor is there a market for these units.\nAverage cash distributions of $11.25 per Limited Partnership Unit were declared and paid each quarter for the year ended December 31, 1995 and $10.62 per quarter for the year ended December 31, 1994. It is Registrant's expectations that distributions will continue to be paid in the future.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA FOR THE YEARS ENDED DECEMBER 31, 1995, 1994, 1993, 1992, AND 1991. -------------------------------------------------------------------- 1995 1994 1993 1992 1991 ---- ---- ---- ---- ----\nREVENUES $1,636,156 $1,604,279 $1,590,386 $1,527,667 $1,455,524\nCOSTS AND EXPENSES 1,196,068 1,169,399 1,157,938 1,123,453 1,113,426\nEQUITY IN EARNINGS OF REAL ESTATE JOINT VENTURE 116,421 93,634 89,210 62,063 49,287 ---------- ---------- ---------- ---------- ----------\nNET INCOME $ 556,509 $ 528,514 $ 521,658 $ 466,277 $ 391,385 ========== ========== ========== ========== ==========\nTOTAL ASSETS $5,245,858 $5,785,750 $6,270,148 $6,664,785 $7,056,887 ========== ========== ========== ========== ==========\nNET CASH PROVIDED BY OPERATING ACTIVITIES $1,136,519 $ 937,601 $1,060,688 $ 976,982 $ 814,471 ========== ========== ========== ========== ==========\nCASH DISTRIBUTIONS PER $500 LIMITED PARTNERSHIP UNIT $ 45.00 $ 42.50 $ 40.00 $ 35.00 $ 35.00 ========== ========== ========== ========== ==========\nNET INCOME PER LIMITED PARTNERSHIP UNIT $ 22.96 $ 21.80 $ 21.52 $ 19.23 $ 16.14 ========== ========== ========== ========== ==========\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nRESULTS OF OPERATIONS\n1995 COMPARED TO 1994\nTotal revenues increased from $1,604,279 in 1994 to $1,636,156 in 1995, while total expenses increased from $1,169,399 to $1,196,068 and income from the real estate joint venture increased from $93,634 to $116,421. As a result, net income increased from $528,514 in 1994 to $556,509 in 1995. The slight increase in rental revenues is due to higher occupancy levels partially offset by lower unit rental rates. Average occupancy levels for the Partnership's five mini-storage facilities increased from 84.2% for the year ended December 31, 1994, to 85.6% for the year ended December 31, 1995. The Partnership is continuing its marketing efforts to attract and keep new tenants in its various mini-storage facilities. The approximate $11,000 (2.5%) increase in operating expenses was primarily due to an increase in maintenance and repair and office expenses partially offset by a decrease in yellow page advertising costs. General and administrative expenses remained relatively constant. The General Partners' incentive management fee increased approximately $6,000 (5.8%) as a result of an increase in cash available for distribution on which this fee is based. The increase in income from the real estate joint venture was the result of higher occupancy and unit rental rates. Average occupancy of the joint venture was 89% in 1995 compared to 83% in 1994.\n1994 COMPARED TO 1993\nTotal revenues increased from $1,590,386 in 1993 to $1,604,279 in 1994, while total expenses increased from $1,157,938 to $1,169,399 and income from the real estate joint venture increased from $89,210 to $93,634. As a result, net income increased from $521,658 in 1993 to $528,514 in 1994. The slight increase in rental revenues is due to higher unit rental rates which are offset to some extent by a slightly lower average occupancy level. Average occupancy levels for the Partnership's five mini-storage facilities decreased from 85.6% for the year ended December 31, 1993, to 84.2% for the year ended December 31, 1994. The Partnership continued to increase rental rates where market conditions made such increases feasible. The Partnership is continuing its marketing efforts to attract and keep new tenants in its various mini-storage facilities. Operating expenses remained stable. The approximate $7,000 (4.6%) increase in general and administrative expenses can be attributed primarily to higher professional fees. The General Partners' incentive management fee increased approximately $4,000 (4.0%) as a result of an increase in cash available for distribution on which this fee is based. The increase in income from the real estate joint venture was the result of higher unit rental rates partially offset by a lower average occupancy percentage experienced by the joint venture's mini-storage facility. Average occupancy of the joint venture was 83% in 1994 compared to 91% in 1993.\nLIQUIDITY AND CAPITAL RESOURCES\nNet cash provided by operating activities increased approximately $199,000 (21.2%) in 1995 compared to 1994, primarily due to an increase in net income and a reduction in receivables. Net cash provided by operating activities decreased approximately $123,000 (11.6%) in 1994 compared to 1993.\nCash used in financing activities, as set forth in the statements of cash flows, has been limited to distributions paid to the partners. The General Partners determined that effective with the third quarter 1994 distribution which was paid on October 15, 1994, distributions to the limited partners would be increased to an amount which yields 9% annual return on the capital contributed by the limited partners from an annual return of 8% paid in the prior year.\nCash used in investing activities, as set forth in the statements of cash flows, has consisted solely of acquisitions of equipment for the Partnership's mini storage properties. The Partnership has no material commitments for capital expenditures.\nThe General Partners plan to continue their policy of funding the continuing improvement and maintenance of Partnership properties with cash generated from operations. The Partnership's financial resources appear to be adequate to meet its needs for the next twelve months.\nThe General Partners are not aware of any environmental problems which could have a material adverse effect upon the financial position of the Partnership.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nAttached hereto as Exhibit l is the information required to be set forth as Item 8, Part II hereof.\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'S GENERAL PARTNER\nThe General Partners of Registrant are the same as when the Partnership was formed, i.e., DSI Properties, Inc., a California corporation, and Diversified Investors Agency. As of December 31, 1995, Messrs. Robert J. Conway and Joseph W. Conway, each of whom own approximately 41.63% of the issued and outstanding capital stock of DSI Financial, Inc., a California corporation, together with Mr. Joseph W. Stok, currently comprise the entire Board of Directors of DSI Properties, Inc.\nMr. Robert J. Conway is 62 years of age and is a licensed California real estate broker, and since 1965 has been President and a member of the Board of Directors of Diversified Securities, Inc., and since 1973 President, Chief Financial Officer and a member of the Board of Directors of DSI Properties, Inc. Mr. Conway received a Bachelor of Science Degree from Marquette University with majors in Corporate Finance and Real Estate.\nMr. Joseph W. Conway is age 66 and has been Executive Vice President, Treasurer and a member of the Board of Directors of Diversified Securities, Inc. since 1965 and since 1973 the Vice President, Treasurer and member of the Board of Directors of DSI Properties, Inc. Mr. Conway received a Bachelor of Arts Degree from Loras College with a major in Accounting.\nMr. Joseph W. Stok is age 72 and has been a member of the Board of Directors of DSI Properties, Inc. since 1994, a Vice President of Diversified Securities, Inc. since 1973, and an Account Executive with Diversified Securities, Inc. since 1967.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION (MANAGEMENT REMUNERATION AND TRANSACTIONS)\nThe information required to be furnished in Item 11 of Part III is contained in Registrant's Financial Statements for its fiscal year ended December 31, 1995, which together with the report of its independent auditors, Deloitte & Touche LLP, is attached hereto as Exhibit 1 and incorporated herein by this reference. In addition to such information:\n(a) No annuity, pension or retirement benefits are proposed to be paid by Registrant to any of the General Partners or to any officer or director of the corporate General Partner;\n(b) No standard or other arrangement exists by which directors of the Registrant are compensated;\n(c) The Registrant has not granted any option to purchase any of its securities; and\n(d) The Registrant has no plan, nor does the Registrant presently propose a plan, which will result in any remuneration being paid to any officer or director upon termination of employment.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nAs of December 31, 1995, no person of record owned more than 5% of the limited partnership units of Registrant, nor was any person known by Registrant to own of record and beneficially, or beneficially only, more than 5% thereof. The balance of the information required to be furnished in Item 12 of Part III is contained in Registrant's Registration Statement on Form S-11, previously filed pursuant to the Securities Act of 1933, as amended, and which is incorporated herein by this reference. The only change to the information contained in said Registration Statement on Form S-11 is the fact that Messrs. Benes and Blakley have retired and Messrs. Robert J. Conway and Joseph W. Conway equity interest in DSI Financial, Inc., parent of DSI Properties, Inc., has increased. Please see information contained in Item 10 hereinabove.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required to be furnished in Item 13 of Part III is contained in Registrant's Financial Statements for its fiscal year ended December 31, 1995, attached hereto as Exhibit l and 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)(l) Attached hereto and incorporated herein by this reference as Exhibit l are Registrant's Financial Statements and Supplemental Schedule for its fiscal year ended December 31, 1995, together with the reports of its independent auditors, Deloitte & Touche LLP. See Index to Financial Statements and Supplemental Schedule.\n(a)(2) Attached hereto and incorporated herein by this reference as Exhibit 2 is Registrant's letter to its Limited Partners regarding its Annual Report for its fiscal year ended December 31, 1995.\n(b) No reports on Form 8K were filed during the fiscal year ended December 31, 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.\nDSI REALTY INCOME FUND VIII by: DSI Properties, Inc., a California corporation, as General Partner\nBy_____________________________ Dated: March 28, 1996 ROBERT J. CONWAY, President (Chief Executive Officer, Chief Financial Officer, and Director)\nBy____________________________ Dated: March 28, 1996 JOSEPH W. CONWAY (Executive Vice President 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 date indicated.\nDSI REALTY INCOME FUND VIII by: DSI Properties, Inc., a California corporation, as General Partner\nBy:__________________________ Dated: March 28, 1996 ROBERT J. CONWAY, President, Chief Executive Officer, Chief Financial Officer, and Director\nBy___________________________ Dated: March 28, 1996 JOSEPH W. CONWAY (Executive Vice President and Director)\nDSI REALTY INCOME FUND VIII\nCROSS REFERENCE SHEET\nFORM 1O-K ITEMS TO ANNUAL REPORT\nPART I, Item 3. There are no legal proceedings pending or threatened.\nPART I, Item 4. Not applicable.\nPART II, Item 5. Not applicable.\nPART II, Item 6. The information required is contained in Registrant's Financial Statements for its fiscal year ended December 31, 1995, attached as Exhibit l to Form 10-K.\nPART II, Item 8. See Exhibit l to Form 10-K filed herewith.\nPART II, Item 9. Not applicable.\nEXHIBIT l DSI REALTY INCOME FUND VIII (A California Real Estate Limited Partnership)\nSELECTED FINANCIAL DATA FIVE YEARS ENDED DECEMBER 31, 1995 - --------------------------------------------------------------------------------\n1995 1994 1993 1992 1991\nREVENUES $1,636,156 $1,604,279 $1,590,386 $1,527,667 $1,455,524\nCOSTS AND EXPENSES $1,196,068 1,169,399 1,157,938 1,123,453 1,113,426\nEQUITY IN EARNINGS OF REAL ESTATE JOINT VENTURE 116,421 93,634 89,210 62,063 49,287 ---------- ---------- ---------- ---------- ---------- NET INCOME $ 556,509 $ 528,514 $ 521,658 $ 466,277 $ 391,385 ========== ========== ========== ========== ========== TOTAL ASSETS $5,245,858 $5,785,750 $6,270,148 $6,664,785 $7,056,887 ========== ========== ========== ========== ========== NET CASH PROVIDED BY OPERATING ACTIVITIES $1,136,519 $ 937,601 $1,060,688 $ 976,982 $ 814,471 ========== ========== ========== ========== ========== CASH DISTRIBUTIONS PER $500 LIMITED PARTNERSHIP UNIT $ 45.00 $ 42.50 $ 40.00 $ 35.00 $ 35.00 ========== ========== ========== ========== ========== NET INCOME PER LIMITED PARTNERSHIP UNIT $ 22.96 $ 21.80 $ 21.52 $ 19.23 $ 16.14 ========== ========== ========== ========== ==========\nThe following are reconciliations between the operating results and partners' equity per the financial statements and the Partnership's income tax return for the year ended December 31, 1995.\nOperating Partners' Results Equity\nPer financial statements $ 556,509 $ 4,635,650 Excess tax depreciation 144,635 924,452 Accrued property taxes 13,459 143,545 Deferred rental revenues 266,768 Accrued incentive management fees 80,713 Acquisition costs capitalized for tax purposes 2,080 Accrued distributions to partners (6,000) 41,918 Other 272,728 ----------- ----------- Per Partnership income tax return $ 708,603 $ 6,367,854 =========== =========== Net taxable income per $500 limited partnership unit $ 29.53 ===========\nDSI REALTY INCOME FUND VIII (A California Real Estate Limited Partnership)\nINDEX TO FINANCIAL STATEMENTS AND SUPPLEMENTAL SCHEDULE\nPage\nFINANCIAL STATEMENTS:\nIndependent Auditors' Report\nBalance Sheets at December 31, 1995 and 1994\nStatements of Income for the Three Years Ended December 31, 1995\nStatements of Changes in Partners' Equity for the Three Years Ended December 31, 1995\nStatements of Cash Flows for the Three Years Ended December 31, 1995\nNotes to Financial Statements\nSUPPLEMENTAL SCHEDULE:\nIndependent Auditors' Report\nSchedule XI - Real Estate and Accumulated Depreciation\nSCHEDULES OMITTED:\nFinancial statements and schedules not 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 named above, or in the notes thereto.\nINDEPENDENT AUDITORS' REPORT To the Partners of DSI Realty Income Fund VIII:\nWe have audited the accompanying balance sheets of DSI Realty Income Fund VIII, a California Real Estate Limited Partnership (the \"Partnership\") as of December 31, 1995 and 1994, and the related statements of income, changes in partners' equity, and cash flows for each of the three years in the period ended December 31, 1995. These financial statements are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, such financial statements present fairly, in all material respects, the financial position of DSI Realty Income Fund VIII at December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles.\nJanuary 31, 1996\nDELOITTE & TOUCHE LONG BEACH, CALIFORNIA\nDSI REALTY INCOME FUND VIII (A California Real Estate Limited Partnership)\nBALANCE SHEETS DECEMBER 31, 1995 AND 1994 - --------------------------------------------------------------------------------\nASSETS 1995 1994\nCASH AND CASH EQUIVALENTS $ 445,657 $ 424,960\nPROPERTY, At cost (net of accumulated depreciation of $5,061,631 in 1995 and $4,582,064 in 1994) (Notes 1, 2 and 3) 4,318,209 4,772,863\nINVESTMENT IN REAL ESTATE JOINT VENTURE (Notes 1,2, and 6) 417,666 466,245\nRECEIVABLE FROM GENERAL PARTNERS (Note 4) 100,000\nOTHER ASSETS (Note 5) 64,326 21,682 ----------- ----------- TOTAL $ 5,245,858 $ 5,785,750 =========== ===========\nLIABILITIES AND PARTNERS' EQUITY\nLIABILITIES: Distribution due to partners $ 272,727 $ 272,727 Incentive management fee payable to general partners (Note 4) 279,255 272,715 Property management fees payable (Note 1) 6,308 7,380 Customer deposits and other liabilities 51,918 62,878 ----------- ----------- Total liabilities 610,208 615,700 ----------- ----------- PARTNERS' EQUITY (Notes 1 and 4): General partners (61,424) (56,080) Limited partners (24,000 limited partnership units outstanding at December 31, 1995 and 1994) 4,697,074 5,226,130 ------------ ----------- Total partners' equity 4,635,650 5,170,050 ------------ ----------- TOTAL $ 5,245,858 $ 5,785,750 ============ ===========\nSee accompanying notes to financial statements.\nDSI REALTY INCOME FUND VIII (A California Real Estate Limited Partnership)\nSTATEMENTS OF INCOME THREE YEARS ENDED DECEMBER 31, 1995 - --------------------------------------------------------------------------------\n1995 1994 1993\nREVENUES: Rental revenues $1,619,839 $1,592,249 $1,583,788 Interest income 16,317 12,030 6,598 ---------- ---------- ---------- Total revenues 1,636,156 1,604,279 1,590,386 ---------- ---------- ---------- EXPENSES: Depreciation (Note 2) 479,566 469,134 469,134 Operating expenses (Note 1) 450,010 438,840 438,704 General and administrative 157,203 158,088 150,766 General partners' incentive management fee (Note 4) 109,289 103,337 99,334 ---------- ---------- ---------- Total expenses 1,196,068 1,169,399 1,157,938 ---------- ---------- ----------\nINCOME BEFORE EQUITY IN INCOME OF REAL ESTATE JOINT VENTURE 440,088 434,880 432,448\nEQUITY IN INCOME OF REAL ESTATE JOINT VENTURE (Notes 1,2 and 6) 116,421 93,634 89,210 __________ __________ _________\nNET INCOME $ 556,509 $ 528,514 $ 521,658 ========== ========== ========== AGGREGATE NET INCOME ALLOCATED TO (Note 4): Limited partners $ 550,944 $ 523,229 $ 516,441 General partners 5,565 5,285 5,217 ---------- ---------- ---------- TOTAL $ 556,509 $ 528,514 $ 521,658 ========== ========== ========== NET INCOME PER LIMITED PARTNERSHIP UNIT (Notes 2 and 4) $ 22.96 $ 21.80 $ 21.52 ========== ========== ==========\nSee accompanying notes to financial statements.\nDSI REALTY INCOME FUND VIII (A California Real Estate Limited Partnership)\nSTATEMENTS OF CHANGES IN PARTNERS' EQUITY THREE YEARS ENDED DECEMBER 31, 1995 - --------------------------------------------------------------------------------\nGeneral Limited Partners Partners Total\nBALANCE AT JANUARY 1, 1993 ($46,582) $ 6,166,460 $ 6,119,878\nNet income 5,217 516,441 521,658\nDistributions (Note 4) (9,697) (960,000) (969,697) ------- ---------- ---------- BALANCE AT DECEMBER 31, 1993 (51,062) 5,722,901 5,671,839\nNet income 5,285 523,229 528,514\nDistributions (Note 4) (10,303) (1,020,000) (1,030,303) ------- ---------- ----------- BALANCE AT DECEMBER 31, 1994 (56,080) 5,226,130 5,170,050\nNet income 5,565 550,944 556,509\nDistributions (Note 4) (10,909) (1,080,000) (1,090,909) ------- ----------- ----------- BALANCE AT DECEMBER 31, 1995 ($61,424) $ 4,697,074 $ 4,635,650 ======= =========== ===========\nSee accompanying notes to financial statements.\nDSI REALTY INCOME FUND VIII (A California Real Estate Limited Partnership)\nSTATEMENTS OF CASH FLOWS THREE YEARS ENDED DECEMBER 31, 1995 - --------------------------------------------------------------------------------\n1995 1994 1993\nCASH FLOWS FROM OPERATING ACTIVITIES: Cash received from customers $ 1,619,839 $ 1,592,249 $ 1,583,789 Cash paid to suppliers and employees (664,637) (811,644) (665,706) Cash received from real estate joint venture 165,000 144,966 136,007 Interest received 16,317 12,030 6,598 ----------- ----------- ------------ Net cash provided by operating activities 1,136,519 937,601 1,060,688\nCASH FLOWS FROM FINANCING ACTIVITIES - Distributions to partners (1,090,909) (1,000,000) (939,394)\nCASH FLOWS FROM INVESTING ACTIVITIES - Purchase of property (24,913) (5,510) (4,347) ----------- ----------- ------------ NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 20,697 (67,909) 116,947\nCASH AND CASH EQUIVALENTS, AT BEGINNING OF YEAR 424,960 492,869 375,922 ----------- ----------- ------------ CASH AND CASH EQUIVALENTS, AT END OF YEAR $ 445,657 $ 424,960 $ 492,869 =========== =========== ============ RECONCILIATION OF NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES: Net income $ 556,509 $ 528,514 $ 521,658 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 479,566 469,134 469,134 Equity in earnings of real estate joint venture (116,421) (93,634) (89,210) Distributions from real estate joint venture 165,000 144,964 136,007 Changes in assets and liabilities: Receivable from general partners 100,000 (100,000) Other assets (42,643) 1,535 Incentive management fee payable to general partners 6,540 (19,727) 17,624 Property management fees payable (1,072) (146) 1,501 Customer deposits and other liabilities (10,960) 6,961 3,974 ----------- ----------- ------------ NET CASH PROVIDED BY OPERATING ACTIVITIES $ 1,136,519 $ 937,601 $ 1,060,688 =========== =========== ============\nSee accompanying notes to financial statements.\nDSI REALTY INCOME FUND VIII (A California Real Estate Limited Partnership)\nNOTES TO FINANCIAL STATEMENTS THREE YEARS ENDED DECEMBER 31, 1995\n1. GENERAL\nDSI Realty Income Fund VIII, a California Real Estate Limited Partnership (the \"Partnership\"), has two general partners (DSI Properties, Inc. and Diversified Investors Agency) and limited partners owning 24,000 limited partnership units, which were purchased for $500 a unit. The general partners have made no capital contribution to the Partnership and are not required to make any capital contribution in the future. The Partnership has a maximum life of 50 years and was formed on April 23, 1984 under the California Uniform Limited Partnership Act for the primary purpose of acquiring and operating real estate.\nThe Partnership owns five mini-storage facilities located in Stockton, Pittsburgh, El Centro, Huntington Beach, and Lompoc, California. The Partnership has also entered into a joint venture with DSI Realty Income Fund IX through which the Partnership has a 30% interest in a mini-storage facility in Aurora, Colorado (see Note 6).\nAll facilities were acquired from Dahn Corporation (\"Dahn\"). Dahn is not affiliated with the Partnership. Dahn is affiliated with other partnerships in which DSI Properties, Inc. is a general partner. The mini-storage facilities are operated for the Partnership by Dahn under various agreements which are subject to renewal annually. Under the terms of the agreements, the Partnership is required to pay Dahn a property management fee equal to 6% of gross revenue from operations, as defined.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nCash and Cash Equivalents - The Partnership classifies its short-term investments purchased with an original maturity of three months or less as cash equivalents.\nProperty and Depreciation - Property is recorded at cost and is comprised primarily of mini-storage facilities. Depreciation is provided for using the straight-line method over an estimated useful life of 15 years.\nIncome Taxes - No provision has been made for income taxes in the accompanying financial statements. The taxable income or loss of the Partnership is allocated to each partner in accordance with the terms of the Agreement of Limited Partnership. Each partner's tax status, in turn, determines the appropriate income tax for its allocated share of the Partnership taxable income or loss.\nInvestment in Real Estate Joint Venture - The Partnership accounts for its 30% interest in the Aurora, Colorado facility using the equity method of accounting (see Note 6).\nNet Income per Limited Partnership Unit - Net income per limited partnership unit is computed by dividing net income allocated to the limited partners by the weighted average number of limited partnership units outstanding during each year (24,000 in 1995, 1994 and 1993).\nEstimates - The preparation of financial statements in conformity with generally accepted accounting principles requires the Partnership's management to make estimates and assumptions that affect the reported amounts of 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.\n3. PROPERTY\nAs of December 31, 1995 and 1994, the total cost of property and accumulated depreciation are as follows:\n1995 1994 Land $ 2,305,310 $ 2,305,310 Buildings and improvements 7,074,530 7,049,617 ----------- -----------\nTotal 9,379,840 9,354,927 Less accumulated depreciation (5,061,631) (4,582,064) ----------- ----------\nProperty, net $ 4,318,209 $ 4,772,863 =========== ===========\n4. ALLOCATION OF PROFITS AND LOSSES\nUnder the Agreement of Limited Partnership, the general partners are to be allocated 1% of the net profits or losses from operations and the limited partners are to be allocated the balance of the net profits or losses from operations in proportion to their limited partnership interests. The general partners are also entitled to receive a percentage, based on a predetermined formula, of any cash distribution from the sale, other disposition, or refinancing of a real estate project.\nIn addition, the general partners are entitled to receive an incentive management fee for supervising the operations of the Partnership. The fee is to be paid in an amount equal to 9% per annum of the cash available for distribution, as defined. Payment of incentive management fees earned by the general partners during the years 1986 through 1988 is subordinated to the limited partners' receipt of an annual cumulative, noncompounded return equal to 9.1% of their capital contributions. Incentive management fee payable to general partners at December 31, 1995 and 1994 is $279,255 and $272,715, respectively.\nIn December 1994, subordinated incentive management fees in the amount of $100,000 were distributed to the general partners in error. The amount, which reflected as receivable from general partners in the 1994 financial statements, was repaid in full on February 27, 1995, with interest at a rate of approximately 5%.\n5. OTHER ASSETS\nIn September 1995, the Huntington Beach mini-storage facility was damaged by fire. Only 30 of the 601 units were effected. A claim for $43,600 has been filed with the facility's insurance company and is included in other assets at December 31, 1995. It is anticipated that 100% of the reconstruction costs, less the deductible, will be reimbursed.\n6. INVESTMENT IN REAL ESTATE JOINT VENTURE\nThe Partnership is involved in a joint venture (the Buckley Road facility) which owns a mini-storage facility in Aurora, Colorado. Under the terms of the joint venture agreement, the Partnership is entitled to 30% of the profits and losses of the venture and owns 30% of the mini-storage as a tenant in common with DSI Realty Income Fund IX (\"Fund IX\"), which has the remaining 70% interest in the venture. The agreemnet specifies that DSI Properties, Inc. (a general partner in both the Partnership and Fund IX) shall make all decisions relating to the activities of the joint venture and the management of the property. Summarized financial information of the Buckley Road facility is as follows:\n1995 1994 ASSETS: Cash $ 15,199 $ 9,673\nProperty: Land 586,500 586,500 Building 2,565,446 2,561,859 ----------- ----------- Total 3,151,946 3,148,359 Less accumulated depreciation (1,752,566) (1,582,962) ----------- ----------- Property - net 1,399,380 1,565,397 ----------- ----------- Other assets 8,995 8,995 ----------- -----------\nTOTAL $ 1,423,574 $ 1,584,065 =========== ===========\nLIABILITIES AND PARTNERS' EQUITY Liabilities 28,124 26,685 Partner's equity 1,395,450 1,557,380 ----------- ----------- TOTAL $ 1,423,574 $ 1,584,065 =========== ===========\n1995 1994 1993\nINCOME STATEMENT DATA: Rental revenues $707,333 $640,098 $633,691 Less operating expenses 319,264 327,985 336,771 -------- -------- -------- Net income $388,069 $312,113 $296,920 ======== ======== ========\nProperty is stated at cost; depreciation is provided for using the straight-line method over the estimated useful life of 15 years.\nINDEPENDENT AUDITORS' REPORT To the Partners of DSI Realty Income Fund VIII:\nWe have audited the financial statements of DSI Realty Income Fund VIII (the \"Partnership\") as of December 31, 1995 and 1994, and for each of the three years in the period ended December 31, 1995, and have issued our report thereon dated January 31, 1996; such report is included elsewhere in this Form 10-K. Our audits also included the financial statement schedule of DSI Realty Income Fund VIII, listed in Item 14. This financial statement schedule is the responsibility of the Partnership's management. Our responsibility is to express an opinion based on our audits. In our opinion, such financial statements 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.\nJanuary 31, 1996\nDELOITTE & TOUCHE LONG BEACH, CALIFORNIA\nDSI REALTY INCOME FUND VIII (A California Real Estate Limited Partnership)\nREAL ESTATE AND ACCUMULATED DEPRECIATION - --------------------------------------------------------------------------------\nReal Estate Accumulated at Cost Depreciation\nBalance at January 1, 1993 $ 9,345,070 $3,643,797 Additions 4,347 469,134 ----------- ---------- Balance at December 31, 1993 9,349,417 4,112,931 Additions 5,510 469,134 ----------- ---------- Balance at December 31, 1994 9,354,927 4,582,065 Additions 24,913 479,566 ----------- ---------- Balance at December 31, 1995 $ 9,379,840 $5,061,631 =========== ==========\nThe total cost at the end of the period for Federal income tax purposes was approximately $9,437,000.\nEXHIBIT 2\nMarch 28, 1996\nANNUAL REPORT TO LIMITED PARTNERS OF\nDSI REALTY INCOME FUND VIII\nDear Limited Partner:\nThis report contains the Partnership's balance sheets as of December 31, 1995 and 1994, and the related statements of income, changes in partners' equity and cash flows for each of the three years in the period ended December 31, 1995 accompanied by an independent auditors' report. The Partnership owns five mini-storage facilities, plus a 30% interest in a sixth mini-storage facility on a joint venture basis with an affiliated Partnership, DSI Realty Income Fund IX, a California Limited Partnership. The Partnership's properties were each purchased for all cash and funded solely from subscriptions for limited partnership interests without the use of mortgage financing.\nYour attention is directed to the section entitled Management's Discussion and Analysis of Financial Condition and Results of Operations for the General Partners' discussion and analysis of the financial statements and operations of the Partnership.\nAverage occupancy levels for each of the Partnership's six properties for the years ended December 31, 1995 and December 31, 1994 were as follows:\nLocation of Property Average Occupancy Average Occupancy Levels for the Levels for the Year Ended Year Ended Dec. 31, 1995 Dec. 31, 1994\nEl Centro, CA 82% 73%\nLompoc, CA 91% 91%\nPittsburg, CA 85% 87%\nStockton, CA 84% 85%\nHuntington Beach, CA 86% 85%\nAurora, CO* 89% 83% - ---------\n*The Partnership owns a 30% fee interest in this facility.\nWe will keep you informed of the activities of DSI Realty Income Fund VIII as they develop. If you have any questions, please contact us at your convenience at (310) 424-2655.\nIf you would like a copy of the Partnership's Annual Report on Form 10-K for the year ended December 31, 1995 which was filed with the Securities and Exchange Commission (which report includes the enclosed Financial Statements), we will forward a copy of the report to you upon written request.\nVery truly yours,\nDSI REALTY INCOME FUND VIII By: DSI Properties, Inc.\nBy___________________________ ROBERT J. CONWAY, President","section_15":""}
{"filename":"9263_1995.txt","cik":"9263","year":"1995","section_1":"Item 1. Business -----------\nMichael Baker Corporation (\"Baker\" or \"the Registrant\") was founded in 1940 and organized as a Pennsylvania corporation in 1946. Today, through its operating subsidiaries and joint ventures, Baker provides engineering, construction, and operations and technical services worldwide. Effective January 1, 1995, the Registrant reorganized into five market-focused business units (segments)--Buildings, Civil, Energy, Environmental and Transportation-- from its former three operating groups (Engineering, Construction, and Operations & Maintenance).\nInformation regarding the amounts of revenue, operating profit and identifiable assets attributable to the Registrant's newly restated industry segments is contained in Note 4 to the consolidated financial statements, which are included within Exhibit 13.1 to this Form 10-K. Such information is incorporated herein by reference.\nAccording to the annual listings published in 1995 by ENGINEERING NEWS RECORD magazine, Baker ranks 46th among U.S. design firms, 12th among transportation design firms, 81st among global design firms, 93rd among U.S. construction contractors, 190th among international construction contractors and 64th among U.S. construction management at-risk firms. In addition, according to an annual listing published in 1995 by GOVERNMENT EXECUTIVE magazine, Baker ranks 152nd among government contractors. The rankings were based on 1994 revenues, except for the government contractor ranking which was based on 1994 contract awards.\nBusiness Units ----------------\nBUILDINGS. The Buildings unit consolidated the former Construction Group's general construction, construction management and design-build division with the former Engineering Group's facility planning and design unit to pursue the growing design-build market. The following are the principal services provided by the Buildings unit: o Architecture o Engineering o Planning o Construction management and consulting o Design-build o General construction\nCIVIL. The Civil unit combined the Registrant's civil engineering and water resources division with its military operations & maintenance service division, Baker Support Services, Inc. (\"BSSI\"). This unit has consolidated Baker's military infrastructure work in planning and operations & maintenance, to improve its ability to market to, and serve, the U.S. Department of Defense, a major Baker client. The following list comprises the primary services provided by the Civil unit: o Engineering, planning, design and program management o Geographic information systems o Photogrammetric mapping o Waste\/wastewater systems development o Water resources management o Military facilities planning and program management o Military base operations support o Fiber-optic cable engineering o Design-build-operate\nENERGY. The Energy unit comprises Baker\/MO Services, Inc. (\"Baker\/MO\") and Baker\/OTS, Inc. (\"Baker\/OTS\"). This unit focuses on providing operations & maintenance and technical services within the domestic and international energy industry. Baker\/MO provides specialized services to the oil and gas, utility, and petrochemical industries, while Baker\/OTS provides operations and technical services to major international oil and gas producers. The major services provided by the Energy unit are as follows: o Facility operations and maintenance o Operations analysis o Equipment maintenance and overhaul o Training programs o Pipeline development and design o Technical consulting and personnel o Engineering and construction management o Design-build-operate oil & gas facilities\nENVIRONMENTAL. The Environmental unit continues to operate in its pre-1995 form, but became a separate business unit in 1995. The principal services provided by the Environmental unit include: o Site characterization o Remediation design and construction management o Air quality management o Process safety management o Human health\/ecological risk assessment o Occupational health and safety compliance o Environmental regulation compliance, audits and permitting o Groundwater\/wastewater treatment o Facility design-build-operate\nTRANSPORTATION. The Transportation unit merged the engineering capabilities in highways, bridges, transit, aviation and rail, with the heavy and highway construction capabilities of the former Construction Group. This merger has enhanced the Registrant's existing capabilities to serve transportation clients, created a strong construction management team, and positioned Baker to serve the evolving design-build and privatization markets. The major services provided by the Transportation unit are the following: o Planning o Design o Construction o Construction management and inspection o Program management for surface and air transportation o Design-build-operate\nDomestic and Foreign Operations -------------------------------\nApproximately 95% of the Registrant's total contract revenues are derived from work performed within the United States. Of those domestic-based revenues, the majority comprises engineering and construction work performed in the Northeast region of the U.S. The Registrant's international-based revenues are derived primarily from Baker\/OTS and relate to operations and technical services performed outside the U.S. Baker\/OTS provides the majority of its services in the Middle East and Africa.\nFunded and Unfunded Backlog ---------------------------\nThe Registrant's funded backlog, which comprises that portion of uncompleted work represented by signed contracts and for which the procuring agency has appropriated and allocated the funds to pay for the work, was $300 million at December 31, 1995 vs. $283 million at December 31, 1994. Total backlog, which incrementally includes that portion of contract value for which options are still to be exercised (unfunded backlog), was $508 million at December 31, 1995 vs. $468 million at December 31, 1994.\nThere is not necessarily a correlation between the foregoing figures and the Registrant's annual total contract revenues. In the case of multi-year contracts, total contract revenues are spread over several years and correspond to the timing of the contract rather than the Registrant's fiscal year. Many multi-year contracts, particularly with agencies of the U.S. government, provide for optional renewals on the part of the customer. The Registrant's experience has been that these optional contract renewals have generally been exercised. Funded backlog generally is highest during the last quarter of each of the Registrant's fiscal years because that corresponds to the first quarter of the U.S. government's fiscal year, which is when many such government contract renewals occur.\nCustomers ---------\nNo individual contract accounted for more than 10% of the Registrant's total contract revenues in 1995, 1994 or 1993; however, several contracts with the State of Illinois provided 10.5% and 13.5% of the Registrant's total contract revenues in 1995 and 1994, respectively. Several contracts with the U.S. Department of Navy also provided 10.9%, 12.1% and 10.9% of the Registrant's 1995, 1994 and 1993 total contract revenues, respectively.\nCompetitive Conditions ----------------------\nThe Registrant's business is highly competitive with respect to all principal services it offers. Baker competes with numerous firms which provide some or all of the services provided by the Registrant. The competitive conditions in the Registrant's businesses relate to the nature of the contracts being pursued. Public-sector contracts, consisting mostly of contracts with federal and state governmental entities, are generally awarded through a competitive bidding process, subject to the contractors' qualifications, licensure and demonstrated abilities. The Baker business units employ extensive cost estimating, scheduling and other computerized techniques for the preparation of these competitive bids. Private-sector contractors compete on the bases of qualifications and licensure, quality of performance, price of services and other related factors. Such private-sector contracts are generally awarded on a negotiated basis.\nThe Registrant believes that the principal competitive factors (in various orders of importance) in the areas of services it offers are quality of service, reputation, experience, technical proficiency and cost of service. The Registrant believes that it is well positioned to compete effectively by emphasizing its full range of professional services.\nSeasonality -----------\nBased upon the Registrant's experience, total contract revenues and net income during the first and fourth quarters from engineering and construction-related services tend to be lower than the remaining quarters due to winter weather conditions, particularly for projects in the Northeast and Midwest regions of the United States.\nPersonnel -----------\nAt December 31, 1995, the Registrant employed approximately 3,100 persons, broken down by business unit as follows:\nBuildings unit--470 Environmental unit--210 Civil unit--1,210 Transportation unit--610 Energy unit--570 Corporate staff--30\nNone of the Registrant's engineering employees are represented by labor unions; however, its construction personnel are generally covered by collective bargaining agreements, as are certain BSSI employees in the Civil unit. Currently, the Registrant considers its relationships with labor unions to be good.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties ---------- The principal office of the Registrant is located at the Airport Office Park, 420 Rouser Road, Coraopolis, Pennsylvania 15108, at which approximately 122,000 square feet of office space is leased for use by the Registrant's Buildings, Environmental and Transportation units and, to a much lesser extent, by its corporate staff. The Registrant owns a 75,000 square foot office building located in Beaver County, Pennsylvania, which is situated on a 175 acre site and utilized as the principal office of the Registrant's Civil unit.\nThe Registrant leases an aggregate of approximately 388,000 square feet of office-related floor space, including the principal office. The space leased by business unit is as follows:\nThe Buildings unit leases approximately 66,000 square feet in: Orlando, Florida Coraopolis, Pennsylvania Chicago, Illinois Pittsburgh, Pennsylvania\nThe Civil unit leases approximately 89,000 square feet in: Baltimore, Maryland Dallas, Texas Jackson, Mississippi Alexandria, Virginia Vestal, New York Virginia Beach, Virginia\nThe Energy unit leases approximately 28,000 square feet in: Cypress, Texas Middlesex, United Kingdom Abu Dhabi, United Arab Emirates\nEnvironmental Unit leases approximately 49,000 square feet in: Merrillville, Indiana Coraopolis, Pennsylvania Princeton, New Jersey\nThe Transportation unit leases approximately 132,000 square feet in: Anchorage, Alaska Coraopolis, Pennsylvania Phoenix, Arizona Gibsonia, Pennsylvania Fort Smith, Arkansas Harrisburg, Pennsylvania Tampa, Florida Pittsburgh, Pennsylvania Chicago, Illinois Richmond, Virginia Princeton, New Jersey Virginia Beach, Virginia Elmsford, New York Charleston, West Virginia\nThe Corporate staff utilizes approximately 24,000 square feet of leased space in Coraopolis and New Brighton, Pennsylvania.\nItem 3.","section_3":"Item 3. Legal Proceedings ----------------- The Registrant has been named as a defendant or co-defendant in legal proceedings wherein substantial damages are claimed. Such proceedings are not uncommon to the Registrant's business. After consultations with counsel, management believes that the Registrant has recognized adequate provisions for these proceedings and their ultimate resolutions will not have a material adverse effect on the consolidated financial position or annual results of operations of the Registrant. The most significant of these proceedings are discussed below.\nIn 1987, a lawsuit was brought in the Supreme Court of the State of New York, Bronx County, by the Dormitory Authority of the State of New York against a number of parties, including the Registrant and one of its wholly-owned subsidiaries, that asserts breach of contract and alleges damages of $13 million. The Registrant, which was not a party to the contract underlying the lawsuit, contends that there is no jurisdiction with respect to the Registrant and that it cannot be held liable for any conduct of the subsidiary. Both the Registrant and the subsidiary are contesting liability issues and have filed cross-claims and third-party claims against the other entities involved in the project.\nIn September 1991, the Registrant, through a newly formed subsidiary, Baker Mellon Stuart Construction, Inc. (\"BMSCI\", formerly Mellon Stuart Construction, Inc.), acquired certain assets and contracts from Federal Street Construction Co., Inc. (\"FSC\"), which thereafter continued to perform services under various contracts that were not acquired by BMSCI. On May 11, 1992, a public body that had contracted with FSC in 1989 to construct a $38 million project filed a lawsuit in state court in Illinois (County of Cook v. Mellon Stuart Company, et al., Circuit Court, Illinois) against FSC and its surety alleging various claims in connection with the contract. This contract was not acquired by BMSCI, but the plaintiff also named the Registrant, BMSCI and another subsidiary as defendants based upon a legal theory of successor liability by virtue of the sale of certain assets and contracts to BMSCI by FSC. On November 15, 1995, a motion was granted ordering that the settlement agreement between FSC and the public body was entered into in good faith, and the case against the Registrant and its subsidiaries was dismissed without prejudice.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders ---------------------------------------------------\nNo matters were submitted to a vote of the Registrant's security holders during the fourth quarter of 1995.\nExecutive Officers of the Registrant - ------------------------------------\nThe following represents a listing of executive officers of the Registrant as of December 31, 1995.\nCHARLES I. HOMAN - Age 52; President, Chief Executive Officer and a Director of the Registrant since October 1994. Mr. Homan previously served as Executive Vice President of the Registrant from 1990 through September 1994, and as President of Michael Baker, Jr., Inc., a subsidiary of the Registrant, from 1983 through September 1994. He has been employed by the Registrant in various capacities since 1965. Mr. Homan has also served as a director of Century Financial Corporation since 1994.\nJ. ROBERT WHITE - Age 53; Executive Vice President, Chief Financial Officer and Treasurer of the Registrant since July 1994, and a Director since August 1994. Prior to joining the Registrant, Mr. White served 21 years in various capacities with Westinghouse Electric Corp., most recently as Assistant Director of Investor Relations from 1989 through June 1994.\nDONALD J. NELSON - Age 51; Executive Vice President of the Registrant from 1991 until his resignation in January 1996. Mr. Nelson previously served as a Director from 1984 through April 1994, and as Chief Financial Officer of the Registrant from 1987 through April 1994. He had been employed by the Registrant in various capacities since 1965.\nDONALD P. FUSILLI, Jr. - Age 44; Executive Vice President of the Registrant since 1991 and President of Baker\/MO Services, Inc., a subsidiary of the Registrant, since May 1995. Mr. Fusilli previously served as General Counsel and Secretary of the Registrant from 1986 through August 1994. He has been employed by the Registrant in various capacities since 1973.\nJOHN C. HAYWARD - Age 48; Executive Vice President of the Registrant since January 1995 and President of Michael Baker Jr., Inc. since October 1994. Mr. Hayward previously served as Senior Vice President of Michael Baker Jr., Inc. from 1989 through September 1994. He has been employed by the Registrant in various capacities since 1974.\nANDREW P. PAJAK - Age 46; Executive Vice President of the Registrant since January 1995 and President of Baker Environmental, Inc., a subsidiary of the Registrant, since 1990. Mr. Pajak previously served as Senior Vice President of Baker Environmental, Inc. from 1988 through 1990. He has been employed by the Registrant in various capacities since 1981.\nEDWARD L. WILEY - Age 52; Executive Vice President of the Registrant since January 1995 and Executive Vice President of Michael Baker Jr., Inc. since October 1994. Mr. Wiley previously served as Senior Vice President of Michael Baker Jr., Inc. from 1989 through September 1994. He has been employed by the Registrant in various capacities since 1968.\nGLENN S. BURNS - Age 46; Executive Vice President of the Registrant and President of BMSCI since May 1995. Mr. Burns previously served as Vice President, General Counsel and Secretary of the Registrant from August 1994 to October 1995 and as Assistant General Counsel from 1991 through August 1994. Prior to 1991 and at the time of the acquisition of certain assets and contracts of FSC by BMSCI, Mr. Burns served as General Counsel for FSC.\nH. JAMES MCKNIGHT - Age 51; Vice President, General Counsel and Secretary of the Registrant since September 1995. Mr. McKnight previously served as counsel to International Technology Corporation from February 1995 through September 1995, and was a self-employed consultant from November 1992 through February 1995. Prior to being self-employed, Mr. McKnight was Vice President, General Counsel and Secretary for Vectura Group, Inc.\nExecutive officers of the Registrant serve at the pleasure of the Board of Directors and are elected by the Board annually for a term of office extending through the election and qualification of their successors.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Stock and Related Security ------------------------------------------------------------ Holder Matters ---------------\nInformation relating to the market for the Registrant's Common Stock and other matters related to the holders thereof is set forth in the \"Supplemental Financial Information\" section of Exhibit 13.1 to this Form 10-K. Such information is incorporated herein by reference.\nThe Registrant's present policy is to retain any earnings to fund the operations and growth of the Registrant. The Registrant has not paid any cash dividends since 1983 and has no plans to do so for the foreseeable future. The declaration and payment of dividends is currently limited to $2 million through May 31, 1998, by the Registrant's secured credit agreement with Mellon Bank, N.A.\nAt March 15, 1996, the Registrant had 1,595 Common Stock holders and 730 Series B Common Stock holders.\nItem 6.","section_6":"Item 6. Selected Financial Data -----------------------\nA summary of selected financial data for the Registrant, including each of the last five fiscal years in the period ended December 31, 1995, is set forth in the \"Selected Financial Data\" section of Exhibit 13.1 to this Form 10-K. Such summary 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 Registrant's financial condition, cash flows and results of operations is set forth in the \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" section of Exhibit 13.1 to this Form 10-K. Such discussion 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 February 16, 1996, except as to Notes 6 and 12, which are as of March 22, 1996, are set forth within Exhibit 13.1 to this Form 10-K. Such financial statements and the \"Supplemental Financial Information\" section, which follows within the same exhibit, are incorporated herein by reference. The report of Arthur Andersen LLP on the consolidated financial statements for the year ended December 31, 1993, is dated February 14, 1994, and attached hereto as Exhibit 99.3.\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 --------------------------------------------------\nInformation relating to the Directors of the Registrant appears beneath the caption \"Election of Directors\" in the Registrant's definitive Proxy Statement which will be distributed in connection with the 1996 Annual Meeting of Shareholders and which will be filed with the Securities and Exchange Commission pursuant to Regulation 14A. Information relating to compliance with Section 16(a) of the Securities Exchange Act of 1934 appears beneath the caption \"Directors and Officers\" of such Proxy Statement. Such information is incorporated herein by reference. Information relating to the executive officers of the Registrant is set forth in Part I of this Report under the caption \"Executive Officers of the Registrant.\" Such information is incorporated herein by reference.\nItem 11.","section_11":"Item 11. Executive Compensation ----------------------\nInformation relating to executive compensation appears beneath the caption \"Directors and Officers\" in the Registrant's definitive Proxy Statement which will be distributed in connection with the 1996 Annual Meeting of Shareholders and which will be filed with the Securities and Exchange Commission pursuant to Regulation 14A. Such information is incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management --------------------------------------------------------------\nInformation relating to the ownership of equity securities by beneficial owners of 5% or more of the common stock of the Registrant and by management has been set forth under the caption \"Stock Ownership of Certain Beneficial Owners and Management\" in the Registrant's definitive Proxy Statement which will be distributed in connection with the 1996 Annual Meeting of Shareholders and which will be filed with the Securities and Exchange Commission pursuant to Regulation 14A. Such information is incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions ----------------------------------------------\nInformation concerning certain relationships and transactions between the Registrant and its directors and officers appears beneath the caption \"Directors and Officers\" in the Registrant's definitive Proxy Statement which will be distributed in connection with its 1996 Annual Meeting of Shareholders and which will be filed with the Securities and Exchange Commission pursuant to Regulation 14A. Such information is incorporated herein by reference.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K ---------------------------------------------------------------\n(a)(1) The following financial statements are incorporated in Item 8 of Part II of this Report by reference to the consolidated financial statements within Exhibit 13.1 to this Form 10-K:\nConsolidated Balance Sheet as of December 31, 1995 and 1994\nConsolidated Statement of Income for the three years ended December 31, 1995\nConsolidated Statement of Cash Flows for the three years ended December 31, 1995\nConsolidated Statement of Shareholders' Investment for the three years ended December 31, 1995\nNotes to Consolidated Financial Statements\nReport of Independent Accountants (Price Waterhouse LLP)\nThe report of Arthur Andersen LLP on the consolidated financial statements for the year ended December 31, 1993, is attached hereto as Exhibit 99.3.\n(a)(2) Financial Statement Schedule for the three years ended December 31, 1995:\nSchedule II - Valuation and Qualifying Accounts\nReport of Independent Accountants on Financial Statement Schedule for the two years ended December 31, 1995 (included as Exhibit 99.2 to this Form 10-K)\nReport of Independent Public Accountants on Financial Statement Schedule for the year ended December 31, 1993 (included within Exhibit 99.3 to this Form 10-K)\nAll other schedules are omitted because they are not applicable or the required information is shown in the consolidated financial statements or notes thereto.\n(a)(3) The following exhibits are included herewith as a part of this Report:\n(b) The Registrant filed no reports on Form 8-K during the fourth quarter of 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.\nMICHAEL BAKER CORPORATION\nDated: March 28, 1996 By \/s\/ Charles I. Homan -------------------- Charles I. Homan, 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:\nANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1995 EXHIBITS","section_15":""}
{"filename":"92122_1995.txt","cik":"92122","year":"1995","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), Southern Development and other direct and indirect subsidiaries. SEI designs, builds, owns and operates power production and delivery 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 under \"New Business Development.\" Communications provides digital wireless communications services to SOUTHERN's operating affiliates and also markets these services to the public within the Southeast. Southern Nuclear provides services to the Southern electric system's nuclear plants. Southern Development explores, develops and markets energy management services and other business lines relating to SOUTHERN's core business of generating and distributing energy.\nSEGCO owns electric generating units with an aggregate capacity of 1,019,680 kilowatts at Plant Gaston on the Coosa River near Wilsonville, Alabama, and ALABAMA and GEORGIA are each entitled to one-half of SEGCO's capacity and energy. ALABAMA acts as SEGCO's agent in the operation of SEGCO's units and furnishes coal to SEGCO as fuel for its units. SEGCO also owns three 230,000 volt transmission lines extending from Plant Gaston to the Georgia state line at which point connection is made with the GEORGIA transmission line system.\nThe SOUTHERN System\nThe transmission facilities of each of the operating affiliates and SEGCO are connected to the respective company's own generating plants and other sources of power and are interconnected with the transmission facilities of the other operating affiliates and SEGCO by means of heavy-duty high voltage lines. (In the case of GEORGIA's integrated transmission system, see Item 1 - BUSINESS - \"Territory Served\" herein.)\nOperating contracts covering arrangements in effect with principal neighboring utility systems provide for capacity exchanges, capacity purchases and sales, transfers of economy energy and other similar transactions.\nI-1\nAdditionally, 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, Southern Development 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, if approved, 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 subsidiaries.\nSEI's primary business focus is international and domestic cogeneration, the independent power market, and the privatization and development of generation, transmission and distribution facilities in the international market. During 1995, SEI also entered the business of power marketing.\nReference is made to Note 15 to the financial statements of SOUTHERN in Item 8 herein for additional information regarding SOUTHERN's business segments and geographic areas.\nIn September 1995, SOUTHERN acquired SWEB, one of the United Kingdom's 12 regional electric distribution companies, for approximately $1.8 billion. SWEB's main business is the distribution of electricity to customers in the Southwest of England. Based in Bristol, SWEB serves approximately 1.3 million customers in an area roughly the size of Connecticut, with almost 2 million residents. SWEB is also a supplier of electricity to franchise customers in its authorized area and to customers in the competitive second-tier market. Through its 7.7% equity investment in Teesside Power Limited, a combined cycle gas turbine plant with a capacity of 1,875 megawatts, SWEB is involved in power generation. In addition, SWEB is involved in certain non-regulated activities which include gas supply and telecommunications. For additional information regarding the acquisition of SWEB, reference is made to Note 14 to SOUTHERN's financial statements in Item 8 herein.\nI-2\nSee Item 2","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nElectric Properties\nThe operating affiliates and SEGCO, at December 31, 1995, operated 33 hydroelectric generating stations, 32 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 (1) ------------------------------------------------------------ (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 (2) Gaston Unit 5 Wilsonville, AL 880,000 Miller Birmingham, AL 2,532,288 (3) --------- 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 750,924 (4) Wansley Carrollton, GA 925,550 (5) Yates Newnan, GA 1,250,000 --------- GEORGIA Total 9,541,174 ---------\nCrist Pensacola, FL 1,045,000 Lansing Smith Panama City, FL 305,000 Scholz Chattahoochee, FL 80,000 Daniel Pascagoula, MS 500,000 (6) Scherer Unit 3 Macon, GA 204,500 (4) --------- 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 (6) Greene County Demopolis, AL 200,000 (2) ----------- MISSISSIPPI Total 1,859,500 -----------\n----------------------------------------------------------------\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 (7) ------------ Total Fossil Steam 21,700,243 ------------\nNuclear Steam Farley Dothan, AL (ALABAMA) 1,720,000 ------------ Hatch Baxley, GA 816,630 (8) Vogtle Augusta, GA 1,060,240 (9) ------------ GEORGIA Total 1,876,870 ------------ Total Nuclear Steam 3,596,870 ------------\nCombustion Turbines Greene County Demopolis, AL (ALABAMA) 400,000 ----------- Arkwright Macon, GA 30,580 Atkinson Atlanta, GA 78,720 Bowen Cartersville, GA 39,400 McDonough Atlanta, GA 78,800 McIntosh Units 1,2,3,4,7,8 Effingham County, GA 480,000 McManus Brunswick, GA 481,700 Mitchell Albany, GA 118,200 Robins Warner Robins, GA 160,000 Wilson Augusta, GA 354,100 Wansley Carrollton, GA 26,322 (5) ----------- GEORGIA Total 1,847,822 -----------\nLansing Smith Unit A (GULF) Panama City, FL 39,400\nChevron Cogenerating Station Pascagoula, MS 147,292 (10) 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 (7) ----------- Total Combustion Turbines 2,774,054 ----------- Hydroelectric 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 Rocky Mountain Rome, GA 215,256 (11) 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 ----------- GEORGIA Total 1,077,736 ----------- Total Hydroelectric Facilities 2,660,461 -----------\nTotal Generating Capacity 30,731,628 =========== ---------------------------------------------------------------\nNotes: (1) For additional information regarding facilities jointly-owned with non-affiliated parties, see Item 2 - PROPERTIES - \"Jointly-Owned Facilities\" herein. (2) Owned by ALABAMA and MISSISSIPPI as tenants in common in the proportions of 60% and 40%, respectively. (3) Excludes the capacity owned by AEC. (4) Capacity shown for GEORGIA is 8.4% of Units 1 and 2 and 75% of Unit 3. Capacity shown for GULF is 25% of Unit 3. (5) Capacity shown is GEORGIA's portion (53.5%) of total plant capacity. (6) Represents 50% of the plant which is owned as tenants in common by GULF and MISSISSIPPI. (7) SEGCO is jointly-owned by ALABAMA and GEORGIA. (See Item 1 - BUSINESS herein.) (8) Capacity shown is GEORGIA's portion (50.1%) of total plant capacity. (9) Capacity shown is GEORGIA's portion (45.7%) of total plant capacity. (10) Generation is dedicated to a single industrial customer. (11) Capacity shown is GEORGIA's portion (25.4%) of total plant capacity. OPC operates the plant.\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 27,419,700 kilowatts and occurred in August 1995. This amount excludes demand served by capacity retained by MEAG and Dalton and excludes demand associated with power purchased from OPC and SEPA by its preference customers. At that time, 29,596,100 kilowatts were supplied by SOUTHERN system generation and 2,176,400 kilowatts (net) were sold to other parties through net purchased and interchanged power. The reserve margin for the Southern electric system at that time was 9.4%. For additional information on peak demands, reference is made to Item 6 SELECTED FINANCIAL DATA herein.\nI-19\nALABAMA and GEORGIA will incur significant costs in decommissioning their nuclear units at the end of their useful lives. (See Item 1 - BUSINESS \"Regulation - Atomic Energy Act of 1954\" and Note 1 to SOUTHERN's, ALABAMA's and GEORGIA's financial statements in Item 8 herein.)\nOther Electric Generation Facilities\nThrough special purpose subsidiaries, SOUTHERN owns interests in or operates independent power production facilities and foreign utility companies. The generating capacity of these utilities (or facilities) at December 31, 1995, was as follows:\nI-20\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.\nIn connection with the joint ownership arrangements for Plant Vogtle, GEORGIA has remaining commitments to purchase declining fractions of MEAG's capacity and energy until December 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 from non-affiliates in GEORGIA's Statements of Income in Item 8 herein.\nIn December 1988, GEORGIA and OPC entered into a joint ownership agreement for the Rocky Mountain plant under which GEORGIA agreed to retain its present investment in the project and OPC agreed to finance, complete and operate the facility. The plant went into commercial operation in 1995. GEORGIA's net investment in the plant is approximately $190 million, and GEORGIA's ownership is 25.4 percent. Reference is made to Note 3 to SOUTHERN's and GEORGIA's financial statements in Item 8 herein for additional information regarding the Rocky Mountain plant.\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 by the end of 1996, and will be constructed, operated, and maintained by FPC. GEORGIA will have a one-third interest in the 150-megawatt unit, with use 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.\nSale of Property\nReference is made to Note 6 to SOUTHERN's and GEORGIA's financial statements in Item 8 herein for information regarding the sale completed in 1995 of GEORGIA's remaining ownership interest in Plant Scherer Unit 4.\nI-21\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, 1991 to December 31, 1995, the operating affiliates, SEGCO, SCS, Southern Nuclear, Communications and SEI recorded gross property additions and retirements as follows:\n================================================== Gross Property Additions Retirements --------------- ------------- (in millions) ALABAMA (1) $2,290 $ 357 GEORGIA (2) 2,850 1,864 GULF 350 125 MISSISSIPPI 433 82 SAVANNAH 179 16 SEGCO 60 14 SCS 111 122 Southern Nuclear 17 4 Communications 162 - SEI 154 6 - - -------------------------------------------------- SOUTHERN system $6,606 $2,590 ==================================================\nNotes: (1) Includes approximately $62 million attributable to sale of 8.2% interest in Plant Miller Units 1 and 2 to AEC in 1992. (2) Includes approximately $691 million attributable to 1991 through 1995 sales of Plant Scherer Unit 4 to FP&L and JEA.\nI-22\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)\nReference is made to Note 3 to SOUTHERN's financial statements in Item 8 herein under the caption \"Stockholder Suit.\"\n(2) SOUTHERN and Subsidiaries v. Commissioner of the IRS (U.S. Tax Court)\nIn 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 $25 million and $31 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's 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.\n(3) ALABAMA, GEORGIA and MISSISSIPPI v. TVA, et al. (U.S. District Court for the Northern District of Alabama)\nOn January 12, 1996, ALABAMA, GEORGIA and MISSISSIPPI filed an action seeking to enjoin the TVA from violating a 1959 act which prohibits the TVA from selling power outside the area that was being served by it in 1957. LG&E Power Marketing, Inc. (LPM), also a defendant, has entered into an agreement with TVA for the sale of power purchased by LPM from TVA to organizations outside the TVA's statutorily defined service territory, which the plaintiffs contend is in violation of the 1959 act.\n(4) GEORGIA has been designated as a potentially responsible party under the Comprehensive Environmental Response, Compensation and Liability Act with respect to a site in Brunswick, Georgia.\nReference is made to Note 3 to SOUTHERN's and GEORGIA's financial statements in Item 8 herein under the captions \"Georgia Power Potentially Responsible Party Status\" and \"Certain Environmental Contingencies,\" respectively.\nSee Item 1 - BUSINESS - \"Construction Programs,\" \"Fuel Supply,\" \"Regulation - - - Federal Power Act\" and \"Rate Matters\" as well as Note 3 to each registrant's financial statements in Item 8 herein for a description of certain other administrative and legal proceedings discussed therein.\nAdditionally, each of the operating affiliates, SEI, SCS, Southern Nuclear, Southern Development 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.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\nI-23\nEXECUTIVE OFFICERS OF SOUTHERN\n(Identification of executive officers of SOUTHERN is inserted in Part I in accordance with Regulation S-K, Item 401(b), Instruction 3.) The ages of the officers set forth below are as of December 31, 1995.\nA. W. Dahlberg Chairman, President and Chief Executive Officer Age 55 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 47 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 51 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 56 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 47 Elected in 1995; President and Chief Executive Officer of MISSISSIPPI from 1991 to 1995. 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, Chief Financial Officer and Treasurer Age 56 Elected in 1986; responsible primarily for all aspects of financing for SOUTHERN. He has served as Executive Vice President of SCS since 1986.\nThomas G. Boren Vice President Age 46 Elected in 1995; President and Chief Executive Officer of SEI since 1992. He previously served as Senior Vice President of GEORGIA from 1989 to 1992.\nBill M. Guthrie Vice President Age 62 Elected in 1991; serves as Chief Production Officer for the SOUTHERN system. Senior Executive Vice President of SCS effective January 1994 and Executive Vice President of ALABAMA since 1988. He also serves as Executive Vice President of GEORGIA and Vice President of GULF, MISSISSIPPI and SAVANNAH.\nW. G. Hairston, III Age 51 President and Chief Executive Officer of Southern Nuclear since 1993. He has also served as Executive Vice President of GEORGIA since 1989.\nEach of the above is currently an officer of SOUTHERN, except Mr. Hairston, serving a term running from the last annual meeting of the directors (July 17, 1995) for one year until the next annual meeting or until his successor is elected and qualified.\nI-24\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 $21-1\/2 $19-3\/8 Second Quarter 22-7\/8 20-1\/8 Third Quarter 24 21-1\/8 Fourth Quarter 25 22-3\/4\nFirst Quarter $22 $18-1\/2 Second Quarter 20-1\/2 17-3\/4 Third Quarter 20 17 Fourth Quarter 21 18-1\/4 -------------------------------------------\nThere is no market for the other registrants' common stock, all of which is owned by SOUTHERN. On February 29, 1996, the closing price of SOUTHERN's common stock was $23-7\/8.\n(b) Number of SOUTHERN's common stockholders at December 31, 1995: 225,739\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 1995 1994 ----------------------------------------------------\nSOUTHERN First $201,866 $191,262 Second 203,060 191,262 Third 203,061 191,475 Fourth 203,178 192,758\nALABAMA First 71,900 66,500 Second 69,500 67,000 Third 69,300 66,900 Fourth 74,300 67,600\nGEORGIA First 113,900 106,600 Second 110,200 107,200 Third 109,700 107,200 Fourth 117,700 108,300\nGULF First 11,700 10,900 Second 11,300 11,000 Third 11,300 11,000 Fourth 12,100 11,100\nMISSISSIPPI First 9,900 8,500 Second 9,600 8,500 Third 9,600 8,500 Fourth 10,300 8,600\nSAVANNAH First 4,400 4,100 Second 4,300 4,100 Third 4,300 4,100 Fourth 4,600 4,000 ----------------------------------------------------\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 29.5(cent) for each quarter of 1994 and 30.5(cent) for each quarter of 1995. The dividend paid on SOUTHERN's common stock for the first quarter of 1996 was raised to 31.5(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, 1995, were as follows:\n- - --------------------------------------------- Retained Restricted Earnings Amount -------------------------- (in millions) ALABAMA $1,161 $ 807 GEORGIA 1,570 897 GULF 180 101 MISSISSIPPI 157 118 SAVANNAH 105 62 Consolidated 3,483 1,990 - - ---------------------------------------------\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-39 through II-50.\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-126 through II-140.\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-246 through II-258.\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION\nSOUTHERN. Reference is made to information under the heading \"Management's Discussion and Analysis of Results of Operations and Financial Condition,\" contained herein at pages II-8 through II-15.\nALABAMA. Reference is made to information under the heading \"Management's Discussion and Analysis of Results of Operations and Financial Condition,\" contained herein at pages II-54 through II-60.\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-144 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 1995 FINANCIAL STATEMENTS\nItem 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nII-4\nTHE SOUTHERN COMPANY AND SUBSIDIARY COMPANIES\nFINANCIAL SECTION\nII-5\nMANAGEMENT'S REPORT The Southern Company and Subsidiary Companies 1995 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 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 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.\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, Chief Financial Officer, and Treasurer\nFebruary 21, 1996 II-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, 1995 and 1994, 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, 1995. These financial statements are the responsibility of the company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements (pages II-16 through II-38) referred to above present fairly, in all material respects, the financial position of The Southern Company and subsidiary companies as of December 31, 1995 and 1994, and the results of their operations and their cash flows for the periods stated, in conformity with generally accepted accounting principles.\n\/s\/ Arthur Andersen LLP\nAtlanta, Georgia February 21, 1996\nII-7\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION The Southern Company and Subsidiary Companies 1995 Annual Report\nRESULTS OF OPERATIONS\nEarnings and Dividends\nThis year's financial performance continues to support The Southern Company's goal to become America's Best Diversified Utility. The core business of selling electricity in the Southeast remained strong, while the non-core business expanded both internationally and domestically. The financial results for 1995 demonstrate a very successful year with several records being set. Net income of $1.1 billion and earnings per share of $1.66 for 1995 both established record highs. Southern Company common stock reached an all-time high closing price of 24 5\/8, surpassing the previous record of 23 3\/8 set in 1993. Continued cost controls and the strong demand for electricity were the dominant forces that favorably affected earnings in 1995.\nCosts related to the work force reduction programs implemented in 1995 and 1994 decreased earnings by 2 cents and 9 cents per share, respectively. These costs are expected to be recovered through future savings in approximately two years following each program's implementation. Additional non-operating or non-recurring items affected earnings in 1995 and 1994. After excluding these items in both years, 1995 earnings from operations were $1.1 billion -- or $1.71 per share -- an increase of $108 million compared with 1994. The non-operating items that affected earnings were as follows:\nConsolidated Earnings Net Income Per Share --------------- ---------------- 1995 1994 1995 1994 --------------- ---------------- (in millions) Earnings as reported $1,103 $ 989 $1.66 $1.52 - - --------------------------------------------------------------------- Work force reduction programs 17 61 .02 .09 Sale of facilities (12) (28) (.02) (.04) Demand-side costs 17 - .03 - Environmental cleanup 5 5 .01 .01 Miscellaneous 5 - .01 - - - --------------------------------------------------------------------- Total non-operating 32 38 .05 .06 - - --------------------------------------------------------------------- Earnings from operations $1,135 $1,027 $1.71 $1.58 ===================================================================== Amount and percent change $108 10.6% $0.13 8.2% - - ---------------------------------------------------------------------\nIn 1995, non-operating items -- both positive and negative -- had an impact on earnings, which resulted in a net reduction of $32 million. These items were: (1) Costs associated with work force reduction programs implemented primarily in 1995 decreased earnings. (2) The last in a series of four separate transactions to sell Plant Scherer Unit 4 to two Florida utilities increased earnings. (3) Georgia Power's demand-side conservation costs that were not recovered from customers decreased earnings. (4) Environmental-cleanup costs decreased earnings.\nIn 1994, earnings were $989 million or $1.52 per share -- down 5 cents from the per share amount reported in 1993. Earnings in 1994 were significantly affected by costs related to work force reduction programs and milder than normal temperatures.\nDividends paid on common stock during 1995 were $1.22 per share or 30 1\/2 cents per quarter. During 1994 and 1993, dividends paid per share were $1.18 and $1.14, respectively. In January 1996, The Southern Company board of directors raised the quarterly dividend to 31 1\/2 cents per share or an annual rate of $1.26 per share.\nAcquisitions\nSouthern Electric International (Southern Electric) owns and manages international and domestic non-core businesses for The Southern Company. Southern Electric acquired several businesses in late 1994 and in 1995. These businesses have been included in the consolidated statements of income since the date of acquisition and not reflected in prior periods. These acquisitions account for a significant portion of the amount of change in revenues and certain expenses from year to year. Therefore to facilitate discussing the results of operations, Southern Electric's 1995 variances are shown separately. These variances are predominantly acquisition related and require no further explanation. II-8\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) The Southern Company and Subsidiary Companies 1995 Annual Report\nRevenues\nOperating revenues increased in 1995 and decreased in 1994 as a result of the following factors:\nIncrease (Decrease) From Prior Year ------------------------------ 1995 1994 1993 ------------------------------ Retail -- (in millions) Change in base rates $ - $ 3 $ 3 Sales growth 177 153 104 Weather 143 (177) 198 Fuel cost recovery and other 134 (107) 199 ------------------------------------------------------------- Total retail 454 (128) 504 ------------------------------------------------------------- Sales for resale -- Within service area 39 (87) 38 Outside service area (90) (108) (184) ------------------------------------------------------------- Total sales for resale (51) (195) (146) Southern Electric 458 131 54 Other operating revenues 22 - 4 ------------------------------------------------------------- Total operating revenues $883 $(192) $ 416 ============================================================= Percent change 10.6% (2.3)% 5.2% -------------------------------------------------------------\nRetail revenues of $7.6 billion in 1995 increased 6.4 percent from last year, compared with a decrease of 1.8 percent in 1994. Under fuel cost recovery provisions, fuel revenues generally equal fuel expense -- including the fuel component of purchased energy -- and do not affect net income.\nSales for resale revenues within the service area were $399 million in 1995, up 11 percent from the prior year. This increase resulted primarily from the prolonged hot summer weather, which increased the demand for electricity. Revenues from sales for resale within the service area were $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.\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.\n1995 1994 1993 --------------------------------- (in millions) Capacity $237 $276 $350 Energy 151 176 230 ------------------------------------------------------ Total $388 $452 $580 ======================================================\nCapacity revenues decreased in 1995 and 1994 because the amount of capacity under contract declined, as scheduled, by some 100 megawatts and 400 megawatts, respectively. 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 1995 and the percent change by year were as follows:\nPercent Change ---------------------------- (billions of Amount kilowatt-hours) 1995 1995 1994 1993 ------------- ---------------------------- Residential 39.1 9.2% (2.6)% 9.5% Commercial 35.9 5.5 3.8 5.9 Industrial 51.7 2.7 3.2 1.9 Other 0.9 2.1 3.8 4.6 ----------- Total retail 127.6 5.4 1.6 5.3 Sales for resale -- Within service area 9.5 16.2 (38.5) 9.5 Outside service area 9.1 (15.1) (13.5) (25.2) ----------- Total 146.2 4.4 (3.4) 2.1 ===================================================================\nThe rate of increase in 1995 retail energy sales was fostered by the impact of weather. Residential energy sales surged upward as a result of hotter-than-normal summer weather in 1995, compared with the extremely mild summer of 1994. 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 1996 through 2006.\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 continued to decrease in 1995 and 1994, primarily as a result of the scheduled decline in megawatts of capacity under contract.\nII-9\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) The Southern Company and Subsidiary Companies 1995 Annual Report\nExpenses\nTotal operating expenses of $7.3 billion for 1995 increased $712 million compared with the prior year. Core business expenses increased $322 million, and Southern Electric comprised the remainder. The costs to produce and deliver electricity for the core business in 1995 increased by $120 million to meet higher energy demands. Depreciation expenses and property taxes increased by $78 million as a result of additional utility plant being placed into service. The amortization of deferred expenses related to Plant Vogtle increased by $49 million in 1995 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 1994, operating expenses of $6.6 billion declined 2.1 percent compared with 1993. The decrease was attributable to less energy being sold. Total production costs were down $297 million. However, costs related to the 1994 work force reduction programs increased operating expenses by $100 million. Also, a $39 million increase in the amortization of deferred Plant Vogtle expenses compared with the amount in 1993 contributed to offset the decrease in 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 nuclear generating units. The amount and sources of generation and the average cost of fuel per net kilowatt-hour generated -- within the core business service area -- were as follows:\n1995 1994 1993 --------------------------- Total generation (billions of kilowatt-hours) 147 142 144 Sources of generation (percent) -- Coal 77 75 78 Nuclear 17 19 17 Hydro 4 5 4 Oil and gas 2 1 1 Average cost of fuel per net kilowatt-hour generated (cents) -- Coal 1.73 1.80 1.90 Nuclear 0.56 0.56 0.54 Oil and gas 3.37 3.99 4.34 Total 1.53 1.56 1.67 - - --------------------------------------------------------------\nFuel and purchased power costs of $2.6 billion in 1995 increased $282 million compared with 1994. Core business increased $73 million and Southern Electric increased $209 million. The operating companies' customer demand for electricity rose by 4.7 billion kilowatt-hours more than in 1994. The additional cost to meet the demand was offset slightly by a lower average cost of fuel per net kilowatt-hour generated. Fuel and purchased power expenses of $2.3 billion in 1994 decreased 10 percent compared with the prior year because of lower energy demands and a lower average cost of fuel per net kilowatt-hour generated.\nFor 1995, income taxes increased $84 million compared with the prior year. Core business income taxes increased $65 million, and Southern Electric accounted for the remainder. The increase was attributable to additional taxable income from operations. For 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.\nTotal gross interest charges and preferred stock dividends increased $39 million from amounts reported in the previous year. These costs for core business continued to decline by $12 million, but Southern Electric interest charges increased by $51 million. The decline is attributable to lower interest rates and continued refinancing activities in 1995. In 1994, these costs were $765 million -- down $66 million or 8.0 percent. As a result of favorable market conditions, $1.1 billion in 1995, $1.0 billion in 1994, and $3.0 billion in 1993 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. II-10\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) The Southern Company and Subsidiary Companies 1995 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 energy sales growth to a less regulated more competitive environment, with non-core business becoming more significant.\nWork force reduction programs were implemented in 1995 and 1994 that reduced earnings by $17 million and $61 million, respectively. These actions will assist in efforts to control growth in future operating expenses.\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 weather, competition, changes in contracts with neighboring utilities, energy conservation practiced by customers, the elasticity of demand, 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 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 enhances 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. Also, electricity sales for resale rates are being driven down by wholesale transmission access and numerous potential new energy suppliers, including power marketers and brokers. The Southern Company is aggressively working to maintain and expand its share of wholesale sales in the Southeastern power markets.\nAlthough 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. New federal legislation is being discussed, and legislation allowing customer choice has already been introduced in Florida and Georgia. 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 by seeking new markets that evolve with the changing regulation.\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 -- founded in 1981 -- is focusing on international and domestic cogeneration, the independent power market, and the privatization of generating and distribution facilities in the international market. In late 1995, South Western Electricity (SWEB) was acquired for approximately $1.8 billion. For additional information on this acquisition, see Note 14 to the financial statements. This British electric distribution utility and other investments made by Southern Electric should increase the opportunities for future earnings growth. At December 31, 1995, Southern Electric's total assets amounted to $5.0 billion.\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.\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.\nII-11\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) The Southern Company and Subsidiary Companies 1995 Annual Report\nThe staff of the Securities and Exchange Commission has questioned certain of the current accounting practices of the electric utility industry -- including The Southern Company's -- regarding the recognition, measurement, and classification of decommissioning costs for nuclear generating facilities in the financial statements. In response to these questions, the Financial Accounting Standards Board (FASB) has decided to review the accounting for liabilities related to closure and removal of long-lived assets, including nuclear decommissioning. If the FASB issues new accounting rules, the estimated costs of closing and removing The Southern Company's nuclear and other facilities may be required to be recorded as liabilities in the Consolidated Balance Sheets. Also, the annual provisions for such costs could increase. Because of the company's current ability to recover closure and removal costs through rates, these changes would not have a significant adverse effect on results of operations. See Note 1 to the financial statements under \"Depreciation and Nuclear Decommissioning\" for additional information.\nThe Southern 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.\"\nThe operating companies are subject to the provisions of FASB Statement No. 71, Accounting for the Effects of Certain Types of Regulation. In the event that a portion of a company's operations is no longer subject to these provisions, the company would be required to write off related regulatory assets and liabilities, and determine if any other assets have been impaired. See Note 1 to the financial statements under \"Regulatory Assets and Liabilities\" for additional information.\nNew Accounting Standards\nThe FASB has issued Statement No. 121, Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed of. This statement requires that long-lived assets be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount for an asset may not be recoverable. This statement also imposes stricter criteria for regulatory assets by requiring that such assets be probable of future recovery at each balance sheet date. The Southern Company adopted the new rules January 1, 1996, with no material effect on the financial statements. However, this conclusion may change in the future as competitive factors influence wholesale and retail pricing in the utility industry.\nThe FASB has issued Statement No. 123, Accounting for Stock-Based Compensation. This statement establishes a fair value based method of accounting for employee stock options. This method provides for a compensation cost to be charged to results of operations at the grant date. However, the statement allows companies to continue following the accounting prescribed by Accounting Principles Bulletin Opinion No. 25. Opinion No. 25 generally requires compensation cost to be recognized only for the excess of the quoted market price at the grant date over the price that an employee must pay to acquire the stock. The Southern Company has elected to continue with Opinion No. 25.\nFINANCIAL CONDITION\nOverview\nThe Southern Company's financial condition continues to remain strong. Both earnings per share and market price per share set new record levels in 1995. Earnings from operations continued to increase in 1995 and exceeded $1.1 billion. Based on this performance, in January 1996, The Southern Company board of directors increased the common stock dividend for the fifth consecutive year.\nIn 1995, Southern Electric acquired SWEB for approximately $1.8 billion. For more information on the purchase of this British electric distribution utility, see Note 14 to the financial statements.\nAnother major change in The Southern Company's financial condition was gross property additions of $1.4 billion to utility plant. The majority of funds needed for gross property additions since 1992 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, 1995, the credit risk for derivatives outstanding was not material. See Note 1 to the financial statements under \"Financial Instruments\" for additional information.\nII-12\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) The Southern Company and Subsidiary Companies 1995 Annual Report\nCapital Structure\nThe Southern Company achieved a ratio of common equity to total capitalization - - -- including short-term debt -- of 42.4 percent in 1995, compared with 44.4 percent in 1994, and 43.8 percent in 1993. The company's goal is to maintain the common equity ratio generally within a range of 40 percent to 45 percent.\nDuring 1995, the subsidiary companies sold $375 million of first mortgage bonds and, through public authorities, $732 million of pollution control revenue bonds. The companies continued to reduce financing costs by retiring higher-cost bonds. Retirements, including maturities, of bonds totaled $1.3 billion during 1995, $973 million during 1994, and $2.5 billion during 1993. Retirements of preferred stock totaled $1 million a year during 1995 and 1994 and $516 million during 1993. As a result, the composite interest rate on long-term debt decreased from 8.2 percent at December 31, 1992, to 7.1 percent at December 31, 1995. During this same period, the composite dividend rate on preferred stock declined from 7.3 percent to 6.5 percent.\nIn 1995, The Southern Company raised $174 million from the issuance of new common stock under the company's various stock plans. An additional $103 million of new common stock was issued through a public offering in early 1995. At the close of 1995, the company's common stock had a market value of 24 5\/8 per share, compared with a book value of $13.10 per share. The market-to-book value ratio was 188 percent at the end of 1995, compared with 160 percent at year-end 1994 and 184 percent at year-end 1993.\nCapital Requirements for Construction\nThe construction program of The Southern Company is budgeted at $1.5 billion for 1996, $1.4 billion for 1997, and $1.3 billion for 1998. The total is $4.2 billion for the three years. Actual construction costs may vary from this estimate because of changes in such factors as: business conditions; environmental regulations; nuclear plant regulations; 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 for the operating companies will be fully recovered.\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 600 megawatts of capacity is planned to be completed by 1998 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 $996 million will be required by the end of 1998 for present sinking fund requirements and maturities of long-term debt. Also, the 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 -- has significantly impacted The Southern Company. Specific reductions in sulfur dioxide and nitrogen oxide emissions from fossil-fired generating plants are required in two phases. Phase I compliance began in 1995 and initially affected 28 generating units of The Southern Company. As a result of the company's compliance strategy, an additional 22 generating units were brought into compliance with Phase I requirements. Phase II compliance is required in 2000, and all fossil-fired generating plants 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.\nII-13\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) The Southern Company and Subsidiary Companies 1995 Annual Report\nThe Southern Company achieved Phase I sulfur dioxide compliance at the affected plants by switching to low-sulfur coal, which required some equipment upgrades. This compliance strategy resulted in unused emission allowances being banked for later use. Compliance with nitrogen oxide emission limits was achieved by the installation of new control equipment at 22 of the original 28 affected generating units. Construction expenditures for Phase I compliance totaled approximately $320 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 units as required to meet 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 1 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.\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.\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 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 required nitrogen oxide controls, above Title IV requirements, on some Georgia Power plants. The EPA along with 37 states is conducting studies to evaluate the benefits of regional controls in meeting the ozone standards. Final attainment rules, based on modeling studies, could require installation of additional controls for nitrogen oxide emissions to meet the 1999 deadline in Atlanta or as part of any regional controls if enacted. A decision on new requirements is expected in 1997. 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 during 1996. 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 is evaluating the need to revise the ambient air quality standards for particulate matter 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 1996, 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 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\nII-14\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) The Southern Company and Subsidiary Companies 1995 Annual Report\nany 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, $8 million, and $41 million in 1995, 1994, and 1993, 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 Bruswick, Georgia.\nSeveral major pieces of environmental legislation are being considered for reauthorization or amendment by Congress. These include: the Clean Air Act; 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.\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\nThe Southern Company may require additional equity capital in 1996. The amount and timing of additional equity capital to be raised in 1996 -- 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 1996 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 companies 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.\nTo meet short-term cash needs and contingencies, The Southern Company had approximately $772 million of cash and cash equivalents and $2.8 billion of unused credit arrangements with banks at the beginning of 1996.\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 1998.\nII-15\nII-16\nII-17\nII-18\nII-19\nII-20\nII-21\nNOTES TO FINANCIAL STATEMENTS The Southern Company and Subsidiary Companies 1995 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), The Southern Development and Investment Group (Southern Development), and other direct and indirect subsidiaries. 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 provides digital wireless communications services to the operating companies and also markets these services to the public within the Southeast. Southern Electric designs, builds, owns, and operates power production and delivery 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. Southern Development 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. The preparation of financial statements in conformity with generally accepted accounting principles requires the use of estimates, and the actual results may differ from those estimates. All material intercompany items have been eliminated in consolidation.\nCertain prior years' data presented in the consolidated financial statements have been reclassified to conform with current year presentation.\nRegulatory Assets and Liabilities\nThe operating companies are 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 operating companies 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:\n1995 1994 ------------------------ (in millions) Deferred income taxes $1,386 $1,454 Deferred Plant Vogtle costs 308 432 Premium on reacquired debt 295 298 Demand-side programs 79 97 Department of Energy assessments 73 79 Vacation pay 74 70 Deferred fuel charges 49 51 Postretirement benefits 53 41 Work force reduction costs 56 15 Deferred income tax credits (936) (987) Storm damage reserves (23) (53) Other, net 98 108 - - ----------------------------------------------------------------- Total $1,512 $1,605 =================================================================\nIn the event that a portion of the operating companies' operations is no longer subject to the provisions of Statement No. 71, the companies would be required to write off related regulatory assets and liabilities. In addition, the operating companies would be required to determine any impairment to other assets, including plant, and write down the assets, if impaired, 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 1995, uncollectible accounts continued to average less than 1 percent of revenues.\nII-22\nNOTES (continued) The Southern Company and Subsidiary Companies 1995 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 $140 million in 1995, $152 million in 1994, and $137 million in 1993. 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. Although disposal was scheduled to begin in 1998, 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 respective remaining liability at December 31, 1995, under this law to be approximately $40 million and $31 million, respectively. These obligations are recorded in the Consolidated Balance Sheets.\nDepreciation and Nuclear Decommissioning\nDepreciation of the original cost of depreciable utility plant in service is provided primarily by using composite straight-line rates, which approximated 3.3 percent in 1995, 3.2 percent in 1994, and 3.3 percent in 1993. 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 and removal of other 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 a specific facility as of the site study year, and ultimate cost is the estimate to decommission a specific facility as of retirement date. The estimated costs of decommissioning - - -- both site study costs and ultimate costs -- at December 31, 1995, 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 $489 $294 $233 Non-radiated structures 89 41 52 - - -------------------------------------------------------------------- Total $578 $335 $285 ==================================================================== (in millions) Ultimate costs: Radiated structures $1,504 $781 $1,018 Non-radiated structures 274 111 230 - - -------------------------------------------------------------------- Total $1,778 $892 $1,248 ====================================================================\nII-23\nNOTES (continued) The Southern Company and Subsidiary Companies 1995 Annual Report\nPlant Plant Plant Farley Hatch Vogtle ---------------------------- (in millions) Amount expensed in 1995 $18 $11 $9\nAccumulated provisions: Balance in external trust funds $108 $56 $36 Balance in internal reserves 49 30 13 - - ----------------------------------------------------------------- Total $157 $86 $49 =================================================================\nSignificant assumptions: 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. All of Alabama Power's decommissioning costs are approved for ratemaking. For Georgia Power, only the costs to decommission the radioactive portion of the plants are included in cost of service. Alabama Power and Georgia Power expect their respective state public service commission 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 NRC requirements, or changes in the assumptions used in making estimates.\nIncome Taxes\nThe Southern Company uses the liability method of accounting for deferred income taxes and 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.\nPlant Vogtle Phase-In Plans\nIn 1987 and 1989, the Georgia Public Service Commission (GPSC) ordered that the allowed costs of Plant Vogtle, a two-unit nuclear facility of which Georgia Power owns 45.7 percent, be phased into rates under plans that meet the requirements of 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. 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. Each GPSC order called for recovery of deferred costs within 10 years. 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:\n1995 1994 1993 ------------------------------ (in millions) Deferred capacity buybacks $ - $ 10 $ 38 Amortization of deferred costs (124) (85) (74) - - ----------------------------------------------------------------- Net amortization (124) (75) (36) Effect of adoption of FASB Statement No. 109 - - 160 Deferred costs at beginning of year 432 507 383 - - ----------------------------------------------------------------- Deferred costs at end of year $308 $432 $507 =================================================================\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. In 1995 and 1994, the amount deferred was exceeded by the amortization of amounts previously deferred by $50 million and $1 million, respectively. The projected net amortization of the deferred expense is $62 million in 1996 and $57 million in 1997.\nII-24\nNOTES (continued) The Southern Company and Subsidiary Companies 1995 Annual Report\nAllowance for Funds Used During Construction (AFUDC)\nAFUDC represents the estimated debt and equity costs of capital funds that are necessary to finance the construction of new facilities. While cash is not realized currently from such allowance, it increases the revenue requirement over the service life of the plant through a higher rate base and higher depreciation expense. The composite rates used by the operating companies to calculate AFUDC during the years 1993 through 1995 ranged from a before-income-tax rate of 3.6 percent to 9.8 percent. AFUDC, net of income tax, as a percent of consolidated net income was 1.6 percent in 1995, 2.3 percent in 1994, and 1.7 percent in 1993.\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\nDerivative financial instruments are used by The Southern Company to manage its interest rate and foreign currency exposures. Gains and losses arising from effective hedges of existing assets, liabilities, or firm commitments are deferred and recognized when the offsetting gains and losses are recognized on the related hedged items. Losses realized on termination of interest rate swap contracts are deferred and amortized over the terms of the related new debt agreements. At December 31, 1995, the credit risk for derivatives outstanding was not material.\nThe Southern Company hedges its exposure to fluctuations in interest rates by entering into swap agreements that allow the company to effectively convert its outstanding variable-rate debt into fixed rates. During 1995, the company terminated the swap contracts in place at December 31, 1994, incurring a loss on termination of approximately $32 million, which is being amortized over the life of the related new fixed-rate debt agreements. At December 31, 1995, six interest rate swap agreements were in place.\nThe Southern Company hedges its net investment in South Western Electricity (SWEB) through forward contracts involving Pounds Sterling. The company regularly monitors its foreign currency exposure, and ensures that hedge contract amounts do not exceed the amount of the underlying exposure. At December 31, 1995, the status of outstanding derivative contracts was as follows:\nYear Of Maturity or Notional Unrealized Type Termination Amount Gain (Loss) - - --------------------- -------------- --------------------------- (in millions) Interest rate swaps 1999-2006 $308 $(9) Foreign currency forwards 1996 389 - - - -----------------------------------------------------------------------\nIn accordance with FASB Statement No. 107, Disclosure About Fair Value of Financial Instruments, The Southern Company's financial instruments that the carrying amount did not approximate fair value at December 31 were as follows:\nCarrying Fair Amount Value -------------------------- (in millions) Long-term debt: At December 31, 1995 $8,668 $8,935 At December 31, 1994 7,674 7,373 Preferred securities: At December 31, 1995 100 114 - - -----------------------------------------------------------------\nThe fair value for long-term debt and preferred securities were based on either closing market price or closing price of comparable instruments.\nII-25\nNOTES (continued) The Southern Company and Subsidiary Companies 1995 Annual Report\nMaterials and Supplies\nGenerally, materials and supplies include the cost of transmission, distribution, and generating plant materials. Materials are charged to inventory when purchased and then expensed or capitalized to plant, as appropriate, when installed.\n2. RETIREMENT BENEFITS\nPension Plan\nThe system companies have defined benefit, trusteed, pension plans that cover substantially all regular employees. Benefits are based on one of the following 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\nIn the United States, The Southern Company provides certain medical care and life insurance benefits for retired employees. Substantially all employees may become eligible for these benefits when they retire. 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.\nFASB Statement No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions, requires that medical care and life insurance benefits for retired employees be accounted for on an accrual basis using a specified actuarial method, \"benefit\/years-of-service.\" In October 1993, the GPSC ordered Georgia Power to phase in the adoption of Statement No. 106 to cost of service over a five-year period, whereby one-fifth of the additional costs was expensed in 1993 and the remaining costs were deferred. An additional one-fifth of the costs is being 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.\nFunded Status and Cost of Benefits\nThe following tables show actuarial results and assumptions for pension and postretirement 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: Pension ----------------------- 1995 1994 ----------------------- (in millions) Actuarial present value of benefit obligation: Vested benefits $2,643 $1,593 Non-vested benefits 97 68 - - ------------------------------------------------------------------ Accumulated benefit obligation 2,740 1,661 Additional amounts related to projected salary increases 705 638 - - ------------------------------------------------------------------ Projected benefit obligation 3,445 2,299 Less: Fair value of plan assets 4,725 3,171 Unrecognized net gain (1,025) (789) Unrecognized prior service cost 60 64 Unrecognized transition asset (126) (139) - - ------------------------------------------------------------------ Prepaid asset recognized in the Consolidated Balance Sheets $ 189 $ 8 ==================================================================\nPostretirement Benefits ---------------------------- 1995 1994 ---------------------------- (in millions) Actuarial present value of benefit obligation: Retirees and dependents $394 $375 Employees eligible to retire 63 40 Other employees 392 459 - - ------------------------------------------------------------------ Accumulated benefit obligation 849 874 Less: Fair value of plan assets 205 140 Unrecognized net loss (gain) 85 3 Unrecognized prior service cost (4) - Unrecognized transition obligation 292 500 - - ------------------------------------------------------------------ Accrued liability recognized in the Consolidated Balance Sheets $271 $231 ==================================================================\nIn 1995, the system companies announced a cost sharing program for postretirement benefits. The program establishes limits on amounts the companies\nII-26\nNOTES (continued) The Southern Company and Subsidiary Companies 1995 Annual Report\nwill pay to provide future retiree postretirement benefits. This change reduced the 1995 accumulated postretirement benefit obligation by approximately $186 million.\nThe weighted average rates assumed in the actuarial calculations were:\n1995 1994 1993 -------------------------------- Discount 7.3% 8.0% 7.5% Annual salary increase 4.8 5.5 5.0 Long-term return on plan assets 8.5 8.5 8.5 - - ---------------------------------------------------------------\nAn additional assumption used in measuring the accumulated postretirement benefit obligation was a weighted average medical care cost trend rate of 9.8 percent for 1995, decreasing gradually to 5.3 percent through the year 2005 and remaining at that level thereafter. An annual increase in the assumed medical care cost trend rate of 1 percent would increase the accumulated benefit obligation at December 31, 1995, by $73 million and the aggregate of the service and interest cost components of the net retiree cost by $16 million.\nComponents of the plans' net costs are shown below:\nPension ----------------------------- 1995 1994 1993 ----------------------------- (in millions) Benefits earned during the year $ 79 $ 77 $ 76 Interest cost on projected benefit obligation 193 160 156 Actual (return) loss on plan assets (730) 75 (432) Net amortization and deferral 412 (351) 186 - - -------------------------------------------------------------------- Net pension cost (income) $ (46) $(39) $(14) ====================================================================\nOf the above net pension income, $30 million in 1995, $29 million in 1994, and $9 million in 1993 were recorded in operating expenses, and the remainder was recorded in construction and other accounts.\nPostretirement Benefits --------------------------- 1995 1994 1993 --------------------------- (in millions) Benefits earned during the year $ 28 $ 31 $ 27 Interest cost on accumulated benefit obligation 67 64 56 Amortization of transition obligation 27 27 28 Actual (return) loss on plan assets assets (23) 2 (12) Net amortization and deferral 12 (10) 5 - - ------------------------------------------------------------------ Net postretirement costs $111 $114 $104 ==================================================================\nOf the above net postretirement costs, $78 million in 1995, $77 million in 1994, and $64 million in 1993 were charged to operating expenses. In addition, $11 million in 1995, $18 million in 1994, and $21 million in 1993 were deferred, and the remainder was charged to construction and other accounts.\nWork Force Reduction Programs\nThe system companies have incurred additional costs for work force reduction programs. The costs related to these programs were $42 million, $112 million, and $35 million for the years 1995, 1994, and 1993, respectively. In addition, certain costs of these programs were deferred and are being amortized in accordance with regulatory treatment. The unamortized balance of these costs was $56 million at December 31, 1995.\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\nII-27\nNOTES (continued) The Southern Company and Subsidiary Companies 1995 Annual Report\nadequately 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. In June 1995, for the second time, the trial court dismissed the suit. The plaintiffs once again have filed an appeal. This action is still pending.\nGeorgia Power Potentially Responsible Party Status\nIn January 1995, Georgia Power and four other unrelated entities were notified by the Environmental Protection Agency (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. As of December 31, 1995, Georgia Power had recorded approximately $4 million in expenses associated with the site. 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. However, based on the nature and extent of Georgia Power's activities relating to the site, management believes that the company's portion of these costs should not be material.\nGeorgia Power Investment in Rocky Mountain\nIn its 1985 financing order, the GPSC concluded that completion of the Rocky Mountain pumped storage hydroelectric plant 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 plant. 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 plant. However, full recovery of Georgia Power's costs depends on the GPSC's treatment of the plant's costs and the disposition of the plant's capacity output. In the event the GPSC does not allow full recovery of the plant costs, then the portion not allowed may have to be written off. In 1995, the plant went into commercial operation. At December 31, 1995, Georgia Power's net investment in the plant was approximately $190 million.\nThe final outcome of this matter cannot now be determined. Accordingly, no provision for any write-down of the investment in the plant has been made.\nFERC Reviews Equity Returns\nIn May 1991, the FERC ordered that hearings be conducted concerning the reasonableness of the operating companies' 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 was substantially from October 1994 through December 1995. In November 1995, a FERC administrative law judge issued an opinion that the FERC staff failed to meet its burden of proof, and therefore, no change in the equity return was necessary. The FERC staff has filed exceptions to the administrative law judge's opinion, and the matter is pending before the FERC.\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 $120 million at December 31, 1995. However, management believes that rates are not excessive and that refunds are not justified.\nAlabama Power Rate Adjustment Procedures\nIn November 1982, the Alabama Public Service Commission (APSC) adopted rates that provide for periodic adjustments based upon Alabama Power's earned return on end-of-period retail common equity. The rates also provide for adjustments to recognize the placing of new generating facilities in retail service. Both increases and decreases have been placed into effect since the adoption of these rates. The rate adjustment procedures allow a return on common equity range of 13.0 percent to 14.5 percent and limit increases or decreases in rates to 4 percent in any calendar year.\nII-28\nNOTES (continued) The Southern Company and Subsidiary Companies 1995 Annual Report\nIn June 1995, the APSC issued a rate order granting Alabama Power's request for gradual adjustments to move toward parity among customer classes. This order also calls for a moratorium on any periodic retail rate increases (but not decreases) until July 2001.\nIn December 1995, the APSC issued an order authorizing Alabama Power to reduce balance sheet items -- such as plant and deferred charges -- at any time the company's actual base rate revenues exceed the budgeted revenues. In accordance with this order, Alabama Power reduced the unamortized balance of premium on reacquired debt by $10 million in 1995.\nThe ratemaking procedures will remain in effect until the APSC votes to modify or discontinue them.\nGeorgia Power Retail Rate Plan\nOn February 16, 1996, the GPSC approved a rate plan recommended by the GPSC staff that concludes the GPSC's review of Georgia Power's earnings initiated in early 1995 and addressed the company's proposed alternative retail rate plan. Under the three-year plan, effective January 1, 1996, Georgia Power's earnings will be evaluated against a retail return on common equity range of 10 percent to 12.5 percent. Earnings in excess of 12.5 percent will be used to accelerate the amortization of regulatory assets or accelerate the depreciation of electric plant. At its option, Georgia Power may also accelerate amortization or depreciation of assets while within the allowed return on common equity range. The company is required to absorb cost increases of approximately $29 million annually during the plan's three-year operation, including $14 million annually of accelerated depreciation of electric plant. During the plan's operation, Georgia Power will not file for a general base rate increase unless its projected retail return on equity falls below 10 percent. On July 1, 1998, Georgia Power is required to file a general rate case. In response, the GPSC would be expected to either continue the rate plan or adopt a different one.\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 such rate riders except through general rate case proceedings and that those procedures had not been followed. Georgia Power suspended collection of the demand-side conservation costs and appealed the court's decision to the Georgia Court of Appeals. In December 1993, the GPSC approved Georgia Power's request for an accounting order allowing Georgia Power to defer all current unrecovered and future costs related to these programs, pending the resolution of the recovery of such costs.\nAfter the Georgia Court of Appeals upheld the legality of the rate riders, Georgia Power resumed collection under the riders in December 1994. In August 1995, the GPSC ordered Georgia Power to discontinue the demand-side conservation programs by the end of 1995. However, Georgia Power's rate riders will continue in effect until costs deferred are collected. Under the new retail rate plan, approved February 16, 1996, Georgia Power will expense approximately $29 million of deferred program costs over a three-year period that will not be recovered under the rate riders.\n4. CONSTRUCTION PROGRAM\nThe system companies are engaged in continuous construction programs, currently estimated to total some $1.5 billion in 1996, $1.4 billion in 1997, and $1.3 billion in 1998. These estimates include AFUDC of $22 million in 1996, $22 million in 1997, and $25 million in 1998. 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, 1995, 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 600 megawatts is planned to be completed by 1998. In addition, significant construction will continue related to transmission and distribution facilities and the upgrading and extension of the useful lives of generating plants.\nII-29\nNOTES (continued) The Southern Company and Subsidiary Companies 1995 Annual Report\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, INVESTMENTS, AND COMMITMENTS\nGeneral\nThe Southern Company may require additional equity capital in 1996. The amount and timing of additional equity capital to be raised in 1996 -- 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 is often utilized and the amounts available are discussed below. The 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 has substantial investments in production and delivery facilities in the United States and various international markets. The most recent acquisition was SWEB, and for additional information see Note 14. Southern Electric's total assets were $5.0 billion at December 31, 1995. The consolidated financial statements reflect investments in majority-owned or controlled subsidiaries on a consolidated basis and other investments on an equity basis.\nBank Credit Arrangements\nAt the beginning of 1996, unused credit arrangements with banks totaled $2.8 billion, of which approximately $1.5 billion expires at various times during 1996 and 1997; $16 million expires in February 1998; $73 million expires in May 1998; $400 million expires in June 1998; $300 million expires in July 1998; $300 million expires in November 1998; and $56 million expires in December 1998. Also, $136 million expires in the years 1999 through 2002.\nGeorgia Power's revolving credit agreements of $60 million, all of which remained unused as of December 31, 1995, expire May 1, 1998. 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's revolving credit agreements of $20 million, of which $13 million remained unused as of December 31, 1995, expire May 31, 1998. 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, 1998, is under revolving credit arrangements with several banks that provide 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, $100 million, $135 million, and $165 million available credit are currently dedicated to the exclusive use of The Southern Company, 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.\nThe Southern Company has $300 million of revolving credit agreements expiring July 1, 1998, and $300 million of revolving credit agreements expiring November 30, 1998, all of which remained unused at December 31, 1995. These agreements allow short-term borrowings to be converted into term loans, payable in 12 equal quarterly installments, with the first installment due at the end of the first calendar quarter after the applicable termination date or at an earlier date at The Southern Company's option. In connection with these credit arrangements, The Southern Company agrees to pay commitment fees based on the unused portions of the commitments or to maintain compensating balances with the banks.\nII-30\nNOTES (continued) The Southern Company and Subsidiary Companies 1995 Annual Report\nMississippi Power's revolving credit agreements of $40 million, all of which remained unused as of December 31, 1995, expire December 1, 1998. 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 $16 million remained unused as of December 31, 1995, expire December 31, 1998. These agreements allow short-term borrowings to be converted into terms 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.\nSouthern Electric's revolving credit agreements of $212 million, of which $151 million remained unused as of December 31, 1995, expire at various times from 1998 through 2002. These agreements allow for short-term borrowings with various terms and conditions. These agreements require payment of commitment fees based on the unused portions of the commitments.\nA portion of the $2.8 billion unused credit arrangements with banks -- discussed earlier -- is allocated to provide liquidity support to the companies' variable rate pollution control bonds. At December 31, 1995, the amount of credit lines allocated was $692 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 The Southern Company, Alabama Power, and Georgia Power, through commercial paper programs that have the liquidity support of committed bank credit arrangements.\nAssets Subject to Lien\nEach of The Southern Company's subsidiaries is organized as a legal entity, separate, and apart from The Southern Company and its other subsidiaries. The subsidiary 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. There are no agreements or other arrangements among the subsidiary companies under which the assets of one company have been pledged or otherwise made available to satisfy obligations of The Southern Company or any of its subsidiaries.\nFuel and Purchase Power Commitments\nTo supply a portion of the fuel requirements of the generating plants, The Southern 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. Also, The Southern Company has entered into various long-term commitments for the purchase of electricity. Total estimated long-term obligations at December 31, 1995, were as follows:\nPurchased Year Fuel Power - - ----------- ----------------------------- (in millions) 1996 $ 1,914 $ 495 1997 1,656 427 1998 1,482 155 1999 1,093 161 2000 728 166 2001 and thereafter 6,078 1,943 - - ------------------------------------------------------------- Total commitments $12,951 $3,347 =============================================================\nII-31\nNOTES (continued) The Southern Company and Subsidiary Companies 1995 Annual Report\nOperating Leases\nThe Southern Company has operating lease agreements with various terms and expiration dates. These expenses totaled $17 million, $15 million, and $11 million for 1995, 1994, and 1993, respectively. At December 31, 1995, estimated minimum rental commitments for noncancelable operating leases were as follows:\nYear Amounts - - -------- ---------------- (in millions) 1996 $ 22 1997 20 1998 19 1999 19 2000 20 2001 and thereafter 252 - - --------------------------------------------------------------- Total minimum payments $352 ===============================================================\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, and the city of Dalton, Georgia. 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.\nIn 1995, Georgia Power completed the sale of Unit 4 of Plant Scherer to Florida Power & Light Company (FP&L) and Jacksonville Electric Authority (JEA). FP&L owns approximately 76.4 percent of the unit, with JEA owning the remainder. Georgia Power operates and maintains the unit.\nAt December 31, 1995, 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% $3,295 $730 Plant Hatch (nuclear) 50.1 842 394 Plant Miller (coal) Units 1 and 2 91.8 712 281 Plant Scherer (coal) Units 1 and 2 8.4 112 39 Plant Wansley (coal) 53.5 297 132 Rocky Mountain (pumped storage) 25.4 200 10 - - ------------------------------------------------------------------\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 by the end of 1996, and will be constructed, operated, and maintained by FPC. Georgia Power will have an approximate interest of 33 percent 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.\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.\n7. LONG-TERM POWER SALES AGREEMENTS\nThe operating companies have 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\nII-32\nNOTES (continued) The Southern Company and Subsidiary Companies 1995 Annual Report\ngenerally 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)\n1995 $237 $ - $237 1994 257 19 276 1993 312 38 350\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 1,600 megawatts of capacity is scheduled to be sold annually through 1999. Thereafter, these sales will decline to some 1,500 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.\n8. 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, 1995, the tax- related regulatory assets and liabilities were $1.4 billion and $936 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:\n1995 1994 1993 --------------------------- (in millions) Total provision for income taxes: Federal -- Currently payable $567 $598 $421 Deferred -- current year 184 67 224 -- reversal of prior years (111) (75) (51) Deferred investment tax credits 1 - (20) - - ------------------------------------------------------------------- 641 590 574 - - ------------------------------------------------------------------- State -- Currently payable 90 86 64 Deferred -- current year 26 15 39 -- reversal of prior years (12) (11) (3) - - ------------------------------------------------------------------- 104 90 100 - - ------------------------------------------------------------------- International 24 5 3 - - ------------------------------------------------------------------- Total 769 685 677 Less income taxes charged (credited) to other income (36) (26) (57) - - ------------------------------------------------------------------- Federal and state income taxes charged to operations $805 $711 $734 ===================================================================\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:\n1995 1994 ----------------------- (in millions) Deferred tax liabilities: Accelerated depreciation $2,795 $2,637 Property basis differences 2,175 1,647 Deferred plant costs 100 141 Other 247 271 - - ------------------------------------------------------------------- Total 5,317 4,696 - - ------------------------------------------------------------------- Deferred tax assets: Federal effect of state deferred taxes 107 104 Other property basis differences 273 278 Deferred costs 118 79 Pension and other benefits 66 63 Other 192 225 - - ------------------------------------------------------------------- Total 756 749 - - ------------------------------------------------------------------- Net deferred tax liabilities 4,561 3,947 Portion included in current assets, net 50 60 - - ------------------------------------------------------------------- Accumulated deferred income taxes in the Consolidated Balance Sheet $4,611 $4,007 ===================================================================\nII-33\nNOTES (continued) The Southern Company and Subsidiary Companies 1995 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 $38 million in 1995, $42 million in 1994, and $36 million in 1993. At December 31, 1995, 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:\n1995 1994 1993 ------------------------------ Federal statutory rate 35.0% 35.0% 35.0% State income tax, net of federal deduction 3.4 3.3 3.7 Non-deductible book depreciation 1.6 1.8 1.9 Difference in prior years' deferred and current tax rate (1.1) (1.5) (1.3) Other 0.3 0.3 (1.1) - - ---------------------------------------------------------------------- Effective income tax rate 39.2% 38.9% 38.2% ======================================================================\nThe Southern Company files a consolidated federal income tax return. Under a joint consolidated income tax agreement, each subsidiary's current and deferred tax expense is computed on a stand-alone basis. Tax benefits from losses of the parent company are allocated to each subsidiary based on the ratio of taxable income to total consolidated taxable income.\n9. 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, 1995, a total of 69 million shares was reserved for issuance pursuant to the Dividend Reinvestment and Stock Purchase Plan, the Employee Savings Plan, the 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. As of December 31, 1995, some 200 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 the 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 1994 and 1995 is summarized below:\nShares Average Subject Option Price To Option Per Share ----------------------------------- 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 Options granted 1,161,174 21.63 Options canceled (8,088) 21.63 Options exercised (413,391) 14.34 - - --------------------------------------------------------------------- Balance at December 31, 1995 2,476,299 $19.87 ===================================================================== Shares reserved for future grants: At December 31, 1993 3,714,444 At December 31, 1994 3,268,001 At December 31, 1995 2,114,915 - - --------------------------------------------------------------------- Options exercisable: At December 31, 1994 793,989 At December 31, 1995 831,227 - - ---------------------------------------------------------------------\nCommon Stock Dividend Restrictions\nThe income of The Southern Company is derived primarily from equity in earnings of its subsidiaries. At December 31, 1995, consolidated retained earnings included $3.1 billion of undistributed retained earnings of the subsidiaries. Of this amount, $2.0 billion was restricted against the payment by the subsidiary companies of cash dividends on common stock under terms of bond indentures or charters.\nII-34\nNOTES (continued) The Southern Company and Subsidiary Companies 1995 Annual Report\n10. PREFERRED SECURITIES\nIn December 1994, Georgia Power Capital, L.P., of which Georgia Power is the sole general partner, issued $100 million of 9 percent mandatorily redeemable preferred securities. The sole asset of Georgia Power Capital is $103 million aggregate principal amount of Georgia Power's 9 percent Junior Subordinated Deferrable Interest Debentures due December 19, 2024. Georgia Power considers that the mechanisms and obligations relating to the preferred securities, taken together, constitute a full and unconditional guarantee by Georgia Power of Georgia Power Capital's payment obligations with respect to the preferred securities.\n11. OTHER LONG-TERM DEBT\nDetails of other long-term debt at December 31 are as follows:\n1995 1994 -------------------- (in millions)\nObligations incurred in connection with the sale by public authorities of tax-exempt pollution control revenue bonds: Collateralized -- 4.375% to 9.375% due 2000-2025 $1,466 $1,179 Variable rates (3.5% to 6.1% at 1\/1\/96) due 2011-2025 639 412 Non-collateralized -- 7.25% due 2003 1 1 6.75% to 10.6% due 2015-2020 277 828 5.8% due 2022 10 10 Variable rates (3.25% to 3.75% at 1\/1\/96) due 2019-2022 132 85 - - ---------------------------------------------------------------- 2,525 2,515 - - ---------------------------------------------------------------- Capitalized lease obligations 147 148 - - ---------------------------------------------------------------- Notes payable: 4.15% to 13% due 1995-1998 107 179 6.31% to 11% due 1999-2008 404 170 Adjustable rates (4% to 7% at 1\/1\/96) due 1995-1998 129 119 Adjustable rates (7.5% to 9.18% at 1\/1\/96) due 1999-2000 165 130 Adjustable rate (7.7 % at 1\/1\/96) due 2000 926 - - - ---------------------------------------------------------------- 1,731 598 - - ----------------------------------------------------- ---------- Total $4,403 $3,261 ================================================================\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 $122 million and $126 million at December 31, 1995 and 1994, respectively. At December 31, 1995, the composite interest rates for buildings and other were 9.7 percent and 11.3 percent, respectively. Sinking fund requirements and\/or serial maturities through 2000 applicable to other long-term debt are as follows: $264 million in 1996; $99 million in 1997; $42 million in 1998; $23 million in 1999; and $56 million in 2000.\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:\n1995 1994 ----------------- (in millions) Bond improvement fund requirements $ 43 $ 48 Less: Portion to be satisfied by certifying property additions 18 46 Reacquired bonds - - - - ------------------------------------------------------------------ Cash sinking fund requirements 25 2 First mortgage bond maturities and redemptions 220 130 Other long-term debt maturities (Note 11) 264 97 - - ------------------------------------------------------------------ Total $509 $229 ==================================================================\nThe first mortgage bond improvement (sinking) fund requirements amount to 1 percent of each outstanding series of bonds authenticated under the indentures prior to January 1 of each year, other than those issued to collateralize pollution control and other obligations. The requirements may be satisfied by depositing cash or reacquiring bonds, or by pledging additional property equal to 166 2\/3 percent of such requirements.\nII-35\nNOTES (continued) The Southern Company and Subsidiary Companies 1995 Annual Report\n13. NUCLEAR INSURANCE\nUnder the Price-Anderson Amendments Act of 1988, Alabama Power and Georgia Power maintain agreements of indemnity with the NRC that, together with private insurance, cover third-party liability arising from any nuclear incident occurring at the companies' nuclear power plants. The act 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 taxes, for Alabama Power and Georgia Power -- based on its ownership and buyback interests -- is $159 million and $162 million, respectively, per incident but not more than an aggregate of $20 million per company 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 $10 million and $12 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 $21 million and $24 million, respectively. The maximum replacement power assessments are $8 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.\nII-36\nNOTES (continued) The Southern Company and Subsidiary Companies 1995 Annual Report\n14. ACQUISITION\nIn 1995, Southern Electric acquired SWEB for approximately $1.8 billion. This British utility distributes electricity to some 1.3 million customers.\nThe acquisition has been accounted for under the purchase method of accounting. The acquisition cost exceeded the preliminary estimate of the fair market value of net assets by $333 million. This amount is considered goodwill and will be amortized on a straight-line basis over 40 years. The preliminary estimate of net assets may be revised in 1996.\nSWEB has been included in the consolidated financial statements since September 1995. The following unaudited pro forma results of operations for the years 1995 and 1994 have been prepared assuming the acquisition of SWEB, effective January 1994, and assuming 100 percent short-term debt financing. Eventually, the short-term borrowings will be replaced by a combination of long-term debt and equity. The pro forma results are not necessarily indicative of the actual results that would have been realized had the acquisition occurred on the assumed date, nor are they necessarily indicative of future results. Pro forma operating results are for information purposes only and are as follows:\n15. SEGMENT INFORMATION\nThe Southern Company's principal business segment -- or its core business -- is the five electric utility operating companies, which provide electric service in four Southeastern states. The other reportable business segment is Southern Electric, which owns and operates power production and delivery facilities in the United States and various international markets. Financial data for business segments and geographic areas are as follows:\nBusiness Segments\nII-37\nNOTES (continued) The Southern Company and Subsidiary Companies 1995 Annual Report\nGeographic Areas\nII-38\nII-39\nII-40A\nII-40B\nII-41\nII-42A\nII-42B\nII-43\nII-44A\nII-44B\nII-44C\nII-45\nII-46A\nII-46B\nII-46C\nII-47\nII-48A\nII-48B\nII-48C\nII-49\nII-50A\nII-50B\nII-50C\nALABAMA POWER COMPANY\nFINANCIAL SECTION\nII-51\nManagement's Report Alabama Power Company 1995 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.\nIn 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\nFebruary 21, 1996\nII-52\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, 1995 and 1994, and the related statements of income, retained earnings, and cash flows for each of the three years in the period ended December 31, 1995. 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-61 through II-78) referred to above present fairly, in all material respects, the financial position of Alabama Power Company as of December 31, 1995 and 1994, and the results of its operations and its cash flows for the periods stated, in conformity with generally accepted accounting principles.\n\/s\/ Arthur Andersen LLP\nBirmingham, Alabama February 21, 1996\nII-53\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Alabama Power Company 1995 Annual Report\nRESULTS OF OPERATIONS\nEarnings\nAlabama Power Company's 1995 net income after dividends on preferred stock was $361 million, representing a $4.6 million (1.3 percent) increase from the prior year. This improvement can be attributed to an increase in retail energy sales of 4.7 percent from 1994 levels. This was primarily due to the extreme summer weather during 1995, especially when compared to the mild weather of 1994. This improvement was partially offset by a 2.6 percent increase in operating costs.\nIn 1994, earnings were $356 million, representing a 2.8 percent increase from the prior year. This increase was due to lower operating expenses which decreased 3.0 percent from the previous year. This improvement was partially offset by reduced capacity sales to nonterritorial utilities. Net income was also impacted by the mild weather in 1994.\nThe return on average common equity for 1995 was 13.61 percent compared to 13.86 percent in 1994, and 13.94 percent in 1993.\nRevenues\nTotal revenues for 1995 were $3.0 billion, reflecting a 3.1 percent increase from 1994. The following table summarizes the principal factors that affected operating revenues for the past three years:\nIncrease (Decrease) From Prior Year ---------------------------------------- 1995 1994 1993 ------------- ------------ ------------- (in thousands) Retail -- Change in base rates $ 990 $ -- $ -- Unbilled adjustment -- 28,000 -- Sales growth 18,174 45,304 24,960 Weather 54,888 (39,964) 58,536 Fuel cost recovery and other 35,235 (84,344) 96,437 --------------------------------------------------------------- Total retail 109,287 (51,004) 179,933 --------------------------------------------------------------- Sales for Resale -- Non-affiliates 15,380 (9,345) (43,686) Affiliates (37,032) (17,213) 23,887 --------------------------------------------------------------- Total sales for resale (21,652) (26,558) (19,799) Other operating revenues 1,997 5,095 635 --------------------------------------------------------------- Total operating revenues $89,632 $(72,467) $160,769 --------------------------------------------------------------- Percent change 3.1% (2.4)% 5.6% ---------------------------------------------------------------\nRetail revenues of $2.5 billion in 1995 increased $109 million (4.6 percent) from the prior year, compared with a decrease of $51 million (2.1 percent) in 1994. The hot weather during the summer of 1995 and higher fuel cost recovery were the primary reasons for the increase in retail revenues over 1994. The mild weather during 1994 and lower fuel cost recovery contributed to the decrease in retail revenues from 1993. Fuel revenues, which increased in 1995, generally represent the direct recovery of fuel expense, including the fuel component of purchased energy, and therefore have no effect on net income.\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\nII-54\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Alabama Power Company 1995 Annual Report\ncontracts. Energy is generally sold at variable cost. These capacity and energy components, as well as the components of the sales to affiliated companies, were:\n1995 1994 1993 ------------------------------------------- (in thousands)\nCapacity $158,825 $165,063 $187,062 Energy 209,376 222,579 233,253 ---------------------------------------------------------- Total $368,201 $387,642 $420,315 ----------------------------------------------------------\nCapacity revenues from non-affiliates remained relatively constant in 1995 and 1994. 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.\nKilowatt-hour (KWH) sales for 1995 and the percent change by year were as follows:\nKWH Percent Change ------------------------------------------- 1995 1995 1994 1993 ------------------------------------------- (millions)\nResidential 14,383 9.1% (1.7)% 9.2% Commercial 10,043 4.1 3.4 6.4 Industrial 19,863 2.0 3.2 1.8 Other 187 0.5 1.1 2.8 ---------- Total retail 44,476 4.7 3.3 5.1 Sales for resale - Non-affiliates 8,046 18.8 (5.2) (14.8) Affiliates 6,705 (20.5) 4.3 12.1 ---------- Total 59,227 2.6% 2.4% 3.0% - - -----------------------------------------------------------------\nThe rate of increase in 1995 retail energy sales was fostered by the impact of weather. Residential energy sales surged upward as a result of hotter-than-normal summer weather in 1995, compared with the mild summer of 1994. The gains in commercial and industrial sales reflect the strength of business and economic conditions in the company's service area.\nExpenses\nTotal operating expenses of $2.4 billion for 1995 were up $60 million or 2.6 percent compared with 1994. The major components of this increase include $27 million in purchased power, $43 million in other operation expenses, $11 million in depreciation and amortization, and $7 million in income taxes offset by decreases in fuel costs and maintenance expenses of $10 million and $19 million, respectively.\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.\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-------------------------- 1995 1994 1993 ------------------------- Total generation (billions of kilowatt-hours) 58 57 55 Sources of generation (percent) -- Coal 73 68 70 Nuclear 19 23 22 Hydro 8 9 8 Average cost of fuel per net kilowatt-hour generated (cents) -- Coal 1.71 1.92 2.11 Nuclear 0.50 0.49 0.51 Total 1.48 1.56 1.73 - - -------------------------------------------------------------- Note: Oil & Gas comprise less than 0.5% of generation.\nFuel expense decreased in 1995 by $10 million or 1.3 percent. This decrease resulted from lower average cost of fuel consumed. 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.\nThe increase in purchased power is primarily attributable to the exceptionally hot summer weather. Purchased power consists primarily of purchases from the affiliates of the Southern electric system. Purchased power\nII-55\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Alabama Power Company 1995 Annual Report\ntransactions 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. KWH purchases from affiliates increased 18 percent from the prior year.\nOther operation expenses increased 9.4 percent in 1995 following a 2.5 percent decrease in 1994. This increase over 1994 is primarily attributable to the 1995 expenses not reflecting the positive impact of the amortization of the Gulf States Utilities settlement which expired in 1994.\nThe decrease in maintenance expenses for 1995 reflects the establishment in September 1994 of a Natural Disaster Reserve. This also caused the increase in 1994 maintenance expenses over 1993. See Note 1 to the financial statements under \"Natural Disaster Reserve\" for additional information.\nDepreciation and amortization expense increased 3.6 percent in 1995. This increase reflects additions to utility plant. The amount for 1994 was virtually unchanged from the previous year because of lower average depreciation rates effective January 1994 and offsetting growth in depreciable plant in service.\nIncome tax expense increased 3.0 percent and 8.2 percent in 1995 and 1994, respectively. These increases are primarily attributable to higher taxable income.\nThe company contributed $11.5 million to the Alabama Power Foundation, Inc. in 1995, which represents a decrease of $2.0 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 rose in 1995 to $265 million, an increase of 12.2 percent. This increase results from (i) interest on interim obligations which rose due to higher average interest rates on an increased average amount of short-term debt outstanding and (ii) amortization of debt discount, premium, and expense, net pursuant to an APSC order. See Note 3 to the financial statements under \"Retail Rate Adjustment Procedures\" for additional details. The decline in net interest charges in 1994 by $23 million (9.0 percent) reflects the benefits from refinancing.\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 energy sales growth 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 weather, competition, changes in contracts with neighboring utilities, energy conservation practiced by customers, the elasticity of demand, 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 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 enhances 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. Also, electricity sales for resale rates are being driven down by wholesale transmission access and numerous potential new energy suppliers, including power\nII-56\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Alabama Power Company 1995 Annual Report\nmarketers and brokers. The company is aggressively working to maintain and expand its share of wholesale sales in the Southeastern power markets.\nAlthough 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. New federal legislation is being discussed, and legislation allowing customer choice has already been introduced in Florida and Georgia. 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 by seeking new markets that evolve with the changing regulation.\nThe addition of four combustion turbine generating units 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 periodically within certain limitations based on earned retail rate of return compared with an allowed return. In June 1995, the APSC issued an order granting the company's request for gradual adjustments to move toward parity among customer classes. This order also calls for a moratorium on any periodic retail rate increases (but not decreases) until 2001.\nIn December 1995, the APSC issued an order authorizing the company to reduce balance sheet items - - -- such as plant and deferred charges -- at any time the company's actual base rate revenues exceed the budgeted revenues. See Note 3 to the financial statements for information about this and other regulatory matters.\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 Financial Accounting Standards Board (FASB) has decided to review the accounting for liabilities related to closure and removal of long-lived assets, including nuclear decommissioning. If the FASB issues new accounting rules, the estimated costs of closing and removing the company's nuclear and other facilities may be required to be recorded as liabilities in the Balance Sheets. Also, the annual provisions for such costs could increase. Because of the company's current ability to recover closure and removal costs through rates, these changes should not have a significant adverse effect on results of operations. See Note 1 to the financial statements under \"Depreciation and Nuclear Decommissioning\" 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.\"\nThe company is subject to the provisions of 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, and determine if any other assets have been impaired. See Note 1 to the financial statements under \"Regulatory Assets and Liabilities\" for additional information.\nNew Accounting Standards\nThe FASB has issued Statement No. 121, Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed of. This statement requires that long-lived assets be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount for an asset may not be recoverable. This statement also imposes stricter criteria for regulatory assets by requiring that such assets be probable of future recovery at each balance sheet date. The company adopted the new rules January 1, 1996, with no material effect on the financial statements. However, this conclusion may change in the future as competitive factors influence wholesale and retail pricing in the utility industry.\nII-57\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Alabama Power Company 1995 Annual Report\nFINANCIAL CONDITION\nOverview\nThe company's financial condition remained stable in 1995. 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 $552 million in 1995. The majority of funds needed for gross property additions for the last several years 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 -- including short-term debt -- was 45.0 percent in 1995, compared with 45.9 percent in 1994, and 46.5 percent in 1993.\nIn 1995, the company issued through public authorities, $131.5 million of pollution control revenue refunding bonds. Composite financing rates as of year-end for 1993 through 1995 were as follows:\n1995 1994 1993 -------------------------------- Composite interest rate on long-term debt 7.02% 7.39% 7.35% Composite dividend rate on preferred stock 6.04% 6.23% 5.80% ----------------------------------------------------------------\nThe company's current securities ratings are as follows:\nDuff & Standard Phelps Moody's & Poor's ---------------------------------- First Mortgage Bonds A+ A1 A+ Preferred Stock A a2 A ------------------------------------------------------------\nCapital Requirements\nCapital expenditures are estimated to be $491 million for 1996, $446 million for 1997, and $479 million for 1998. The total is $1.4 billion for the three years. Actual capital costs may vary from this estimate because of factors such as changes in business conditions; revised load growth projections; changes in environmental regulations; changes in the existing nuclear plant to meet new regulatory requirements; increasing cost of labor, equipment, and materials; and 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 addition of combustion turbine peaking units of approximately 320 megawatts of capacity is planned in 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 $110 million will be required by the end of 1998 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 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 -- has significantly impacted the Southern electric system. Specific reductions in sulfur dioxide and nitrogen oxide emissions from fossil-fired generating plants are required in two phases. Phase I compliance began in 1995 and affected 28 generating units in the Southern electric system. As a result of The Southern Company's compliance strategy, an additional 22 generating units were brought into compliance with Phase I requirements. Phase II compliance is required in 2000, and all fossil-fired generating plants will be affected.\nII-58\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Alabama Power Company 1995 Annual Report\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 achieved Phase I sulfur dioxide compliance at the affected plants by switching to low-sulfur coal, which required some equipment upgrades. This compliance strategy resulted in unused emission allowances being banked for later use. Compliance with nitrogen oxide emission limits was achieved by the installation of new control equipment at 22 of the original 28 affected generating units. Construction expenditures for Phase I compliance totaled approximately $320 million through 1995 for The Southern Company, of which the company's portion was approximately $32 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 Phase II limits. Therefore, during the period 1996 to 2000, current compliance strategy could require total estimated construction expenditures of approximately $150 million for The Southern Company, of which the company's portion is approximately $96 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 1 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.\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.\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 during 1996. 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 is evaluating the need to revise the ambient air quality standards for particulate matter 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 1996, 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\nII-59\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Alabama Power Company 1995 Annual Report\nadditional 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. 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 Air Act; 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.\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 corporate charter. The company's coverages are at a level that would permit any necessary amount of security sales at current interest and dividend rates.\nAs required by the Nuclear Regulatory Commission and as ordered by the APSC, the company has established external trust funds for nuclear decommissioning costs. 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-60\nII-61\nII-62\nII-63\nII-64\nII-65\nII-66\nNOTES TO FINANCIAL STATEMENTS Alabama Power Company 1995 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), The Southern Development and Investment Group (Southern Development), and other direct and indirect subsidiaries. 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 provides digital wireless communications services to the operating companies and also markets these services to the public within the Southeast. Southern Electric designs, builds, owns and operates power production and delivery 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. Southern Development 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 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. The preparation of financial statements in conformity with generally accepted accounting principles requires the use of estimates, and the actual results may differ from those estimates.\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:\n1995 1994 ----------------------- (in thousands) Deferred income taxes $436,837 $451,886 Premium on reacquired debt 89,967 101,620 Department of Energy assessments 40,282 42,996 Vacation pay 29,458 20,442 Work force reduction costs 48,402 3,664 Deferred income tax credits (386,038) (405,256) Natural disaster reserve (17,959) (28,750) Other, net 39,172 45,956 ================================================================ Total $280,121 $232,558 ================================================================\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, if impaired, to their fair value.\nRevenues and Fuel Costs\nThe company accrues revenues for services rendered but unbilled at the end of each fiscal period. Fuel costs are expensed as the fuel is used. The company's electric rates include provisions to adjust billings for fluctuations in fuel and the energy component of purchased power costs. Revenues are adjusted for differences between recoverable fuel costs and amounts actually recovered in current rates.\nII-67\nNOTES (continued) Alabama Power Company 1995 Annual Report\nThe company has a diversified base of customers. No single customer or industry comprises 10 percent or more of revenues. In 1995, 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 $54 million in 1995, $65 million in 1994, and $62 million in 1993. The company has a contract with the U.S. Department of Energy (DOE) that provides for the permanent disposal of spent nuclear fuel. Although disposal was scheduled to begin in 1998, 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, 1995, under this law to be approximately $40 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 1995 and 1994, and 3.3 percent in 1993. 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 and removal of other 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. 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 costs of decommissioning -- both site study costs and ultimate costs -- at December 31, 1995, for Plant Farley were as follows:\nPlant Farley ---------------- Site study basis (year) 1993\nDecommissioning periods: Beginning year 2017 Completion year 2029 ----------------------------------------------------------- (in millions) Site study costs: Radiated structures $ 489 Non-radiated structures 89 =========================================================== Total $ 578 =========================================================== (in millions) Ultimate costs: Radiated structures $ 1,504 Non-radiated structures 274 =========================================================== Total $ 1,778 ===========================================================\nII-68\nNOTES (continued) Alabama Power Company 1995 Annual Report\n(in millions) Amount expensed in 1995 $ 18 -----------------------------------------------------------\nAccumulated provisions: Balance in external trust funds $108 Balance in internal reserves 49 =========================================================== Total $157 ===========================================================\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 NRC requirements, or changes in the assumptions used in making estimates.\nIncome Taxes\nThe company uses the liability method of accounting for deferred income taxes and 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.\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 7.1 percent in 1995, 7.9 percent in 1994, and 7.8 percent in 1993. AFUDC, net of income tax, as a percent of net income after dividends on preferred stock was 1.7 percent in 1995 and 1.5 percent in both 1994 and 1993.\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 for which the carrying amount did not approximate fair value at December 31 was as follows:\nLong-Term Debt ------------------------- Carrying Fair Year Amount Value ----------- ---------- (in millions)\n1995 $2,451 $2,577 1994 2,446 2,323 ------------------------------------------------------------\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.\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, 1995, the accumulated provision amounted to $18.0 million. This balance is down from the December 31, 1994 balance of $28.8 million, due to charges related primarily to Hurricane Opal, somewhat offset by a $10 million accrual to partially replenish the reserve. Regulatory treatment allows the\nII-69\nNOTES (continued) Alabama Power Company 1995 Annual Report\ncompany to accrue $250 thousand per month, until the maximum accumulated provision of $32 million is attained. However, in December 1995, the APSC approved higher accruals to restore the reserve to its authorized level whenever the balance in the reserve declines below $22.4 million.\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 one of the following formulas: years of service and final average pay or years of service and a flat-dollar benefit. Primarily, 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. 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.\nFASB Statement No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions, 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.\"\nFunded Status and Cost of Benefits\nThe following tables show actuarial results and assumptions for pension and postretirement 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 ----------------------- 1995 1994 ------------- --------- (in millions) Actuarial present value of benefit obligations: Vested benefits $ 604 $ 522 Non-vested benefits 25 18 - - ------------------------------------------------------------------ Accumulated benefit obligation 629 540 Additional amounts related to projected salary increases 173 174 - - ------------------------------------------------------------------ Projected benefit obligation 802 714 Less: Fair value of plan assets 1,256 1,059 Unrecognized net gain (331) (251) Unrecognized prior service cost 21 23 Unrecognized transition asset (45) (51) - - ------------------------------------------------------------------ Prepaid asset recognized in the Balance Sheets $ 99 $ 66 ==================================================================\nPostretirement Benefits ---------------------- 1995 1994 ---------------------- (in millions) Actuarial present value of benefit obligation: Retirees and dependents $ 103 $ 96 Employees eligible to retire 31 22 Other employees 104 119 ----------------------------------------------------------- Accumulated benefit obligation 238 237 Less: Fair value of plan assets 89 61 Unrecognized net loss 23 - Unrecognized transition obligation 72 120 ----------------------------------------------------------- Accrued liability recognized in the Balance Sheets $ 54 $ 56 ===========================================================\nIn 1995, the system companies announced a cost sharing program for postretirement benefits. The program establishes limits on amounts the company will pay to provide future retiree postretirement benefits. This change reduced the 1995 accumulated postretirement benefit obligation by approximately $41 million.\nII-70\nNOTES (continued) Alabama Power Company 1995 Annual Report\nThe weighted average rates assumed in the actuarial calculations were:\n1995 1994 1993 -------------------------------\nDiscount 7.3% 8.0% 7.5% Annual salary increase 4.8 5.5 5.0 Long-term return on plan assets 8.5 8.5 8.5 ----------------------------------------------------------\nAn additional assumption used in measuring the accumulated postretirement benefit obligation was a weighted average medical care cost trend rate of 9.8 percent for 1995, decreasing gradually to 5.3 percent through the year 2005 and remaining at that level thereafter. An annual increase in the assumed medical care cost trend rate of 1 percent would increase the accumulated benefit obligation as of December 31, 1995, by $20 million and the aggregate of the service and interest cost components of the net retiree cost by $4 million.\nComponents of the plans' net income are shown below:\nPension -------------------------------------------------------------- 1995 1994 1993 ----------------------------- (in millions) Benefits earned during the year $ 21.2 $ 20.8 $ 20.6 Interest cost on projected benefit obligation 54.3 51.2 50.4 Actual (return) loss on plan assets (236.3) 23.5 (146.3) Net amortization and deferral 136.9 (116.2) 63.3 ============================================================== Net pension income $(23.9) $(20.7) $(12.0) ==============================================================\nOf the above net pension income, $(17.1) million in 1995, $(15.7) million in 1994, and $(8.9) million in 1993 were recorded in operating expenses, and the remainder was recorded in construction and other accounts.\nPostretirement Benefits -------------------- 1995 1994 1993 -------------------- (in millions)\nBenefits earned during the year $ 7 $ 8 $ 7 Interest cost on accumulated benefit obligation 18 18 16 Amortization of transition obligation 7 6 6 Actual (return) loss on plan assets (10) 1 (5) Net amortization and deferral 5 (4) 2 ============================================================= Net postretirement costs $ 27 $ 29 $ 26 =============================================================\nOf the above net postretirement costs recorded, $22.7 million in 1995, $23 million in 1994, and $22 million in 1993 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 $14.3 million, $8.2 million and $16.1 million for the years 1995, 1994 and 1993, respectively. In addition, certain costs of these programs were deferred and are being amortized in accordance with regulatory treatment. The unamortized balance of these costs was $48.4 million at December 31, 1995.\n3. LITIGATION AND REGULATORY MATTERS\nRetail Rate Adjustment Procedures\nIn November 1982, the APSC adopted rates that provide for periodic adjustments based upon the company's earned return on end-of-period retail common equity. The rates also provide for adjustments to recognize the placing of new generating facilities in retail service. Both increases and decreases have been placed into effect since the adoption of these rates. The rate adjustment procedures allow a return on common equity range of 13.0 percent to 14.5 percent and limit increases or decreases in rates to 4 percent in any calendar year.\nIn June 1995, the APSC issued a rate order granting the company's request for gradual adjustments to move toward parity among customer classes. This order\nII-71\nNOTES (continued) Alabama Power Company 1995 Annual Report\nalso calls for a moratorium on any periodic retail rate increases (but not decreases) until July 2001.\nIn December 1995, the APSC issued an order authorizing the company to reduce balance sheet items -- such as plant and deferred charges -- at any time the company's actual base rate revenues exceed the budgeted revenues. In accordance with this order, the company reduced the unamortized balance of Premium on reacquired debt by $10 million in 1995.\nThe ratemaking procedures will remain in effect until the APSC votes to modify or discontinue them.\nFERC Reviews Equity Returns\nIn May 1991, the FERC ordered that hearings be conducted concerning the reasonableness of the operating companies' 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 was substantially from October 1994 through December 1995. In November 1995, a FERC administrative law judge issued an opinion that the FERC staff failed to meet its burden of proof, and therefore, no change in the equity return was necessary. The FERC staff has filed exceptions to the administrative law judge's opinion, and the matter is pending before the FERC.\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 $120 million at December 31, 1995 for the Southern Company, of which the company's portion would be approximately $53 million. However, management believes that rates are not excessive, and that refunds are not justified.\n4. CAPITAL BUDGET\nThe company's capital expenditures are currently estimated to total $491 million in 1996, $446 million in 1997, and $479 million in 1998. The estimates include AFUDC of $7 million in 1996, $6 million in 1997, and $9 million in 1998. 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, 1995, 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 320 megawatts is planned to be completed in 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.\nII-72\nNOTES (continued) Alabama Power Company 1995 Annual Report\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 least twice; and for the issuance of additional preferred stock, that gross income available for interest cover pro forma annual interest charges and preferred stock dividends at least one and one-half times. 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, 1998. 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 require 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 $353.5 million which expire at various times during 1996 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, 1995, the company had regulatory approval to have outstanding up to $530 million of short-term borrowings. In February 1996, such regulatory approval was increased to $750 million.\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 at December 31, 1995, were as follows:\nYear Amounts - - ---- -------------- (in millions)\n1996 $ 866 1997 852 1998 853 1999 672 2000 402 2001 - 2013 3,790 ========================================================= Total commitments $7,435 =========================================================\nOperating Leases\nThe company has entered into coal rail car rental agreements with various terms and expiration dates. At December 31, 1995, estimated minimum rental commitments for noncancellable operating leases were as follows:\nII-73\nNOTES (continued) Alabama Power Company 1995 Annual Report\nYear Amounts - - ---- -------------------- (in millions) 1996 $ 2.8 1997 2.8 1998 2.9 1999 2.9 2000 2.9 2001 and thereafter 56.5 =============================================================== Total minimum payments $70.8 ===============================================================\n6. 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 $71 million in 1995, $74 million in 1994 and $86 million in 1993, and is included in \"Purchased power from affiliates\" in the Statements of Income.\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, 1995, the capitalization of SEGCO consisted of $54 million of equity and $78 million of long-term debt on which the annual interest requirement is $5.0 million. SEGCO paid dividends totaling $7.6 million in 1995, $11.6 million in 1994, and $11.3 million in 1993, of which one-half of each was paid to the company. SEGCO's net income was $8.1 million, $7.2 million, and $8.3 million for 1995, 1994 and 1993, respectively.\nThe company's percentage ownership and investment in jointly-owned generating plants at December 31, 1995, follows:\nTotal Megawatt Company Facility (Type) Capacity Ownership ------------------- ------------ -------------\nGreene 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.\nCompany Accumulated Facility Investment Depreciation - - --------------------- -------------- ----------------- (in millions) Greene County $ 90 $ 41 Plant Miller Units 1 and 2 712 281 - - -------------------------------------------------------------\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:\nUnit Other Year Power Long-Term Total ---------------------------------------------------------- (in millions) 1995 $ 157 $ - $ 157 1994 152 7 159 1993 144 15 159 ----------------------------------------------------------\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,\nII-74\nNOTES (continued) Alabama Power Company 1995 Annual Report\napproximately 1,200 megawatts of capacity is scheduled to be sold through 1999. Thereafter, these sales 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 wholesale customers. Under the terms of the contracts, the company received payments from AMEA representing the net present value of the revenues associated with the respective capacity entitlements, discounted at effective annual rates of 9.96 percent and 11.19 percent for the 1986 and 1991 contracts, respectively. These payments are being recognized as operating revenues and the discounts are being amortized to other interest expense as scheduled capacity is made available over the terms of the contracts.\nIn order to secure AMEA's advance payments and the company's performance obligation under the contracts, the company issued and delivered to an escrow agent first mortgage bonds representing the maximum amount of liquidated damages payable by the company in the event of a default under the contracts. No principal or interest is payable on such bonds unless and until a default by the company occurs. As the liquidated damages decline under the contracts, a portion of the bonds equal to the decreases are returned to the company. At December 31, 1995, $137.5 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, 1995, the tax-related regulatory assets and liabilities were $437 million and $386 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:\n1995 1994 1993 -------------------------------- (in thousands) Total provision for income taxes: Federal -- Currently payable $166,105 $219,494 $149,680 Deferred -- current year 43,493 (48,153) 9,636 reversal of prior years (15,817) 15,932 19,653 Deferred investment tax credits (75) (1) (2,106) ---------------------------------------------------------------- 193,706 187,272 176,863 ---------------------------------------------------------------- State -- Currently payable 18,108 20,565 14,297 Deferred -- current year 5,117 (4,067) 1,898 reversal of prior years (91) 3,676 3,913 ---------------------------------------------------------------- 23,134 20,174 20,108 ---------------------------------------------------------------- Total 216,840 207,446 196,971 Less income taxes credited to other income (14,142) (16,834) (10,239) ---------------------------------------------------------------- Federal and state income taxes charged to operations $230,982 $224,280 $207,210 ================================================================\nThe tax effects of temporary differences between the carrying amounts of assets and liabilities in the financial statements and their respective tax bases, which give rise to deferred tax assets and liabilities, are as follows:\nII-75\nNOTES (continued) Alabama Power Company 1995 Annual Report\n1995 1994 - - -------------------------------------------------------------- (in millions) Deferred tax liabilities: Accelerated depreciation $ 780 $734 Property basis differences 491 513 Premium on reacquired debt 31 38 Fuel clause underrecovered 5 4 Other 37 26 - - -------------------------------------------------------------- Total 1,344 1,315 - - -------------------------------------------------------------- Deferred tax assets: Capacity prepayments 35 36 Other deferred costs 26 27 Postretirement benefits 25 24 Accrued nuclear outage costs - 7 Unbilled revenue 13 13 Other 43 44 - - -------------------------------------------------------------- Total 142 151 - - -------------------------------------------------------------- Net deferred tax liabilities 1,202 1,164 Portion included in current assets (liabilities), net (10) 17 - - -------------------------------------------------------------- Accumulated deferred income taxes in the Balance Sheets $1,192 $1,181 ==============================================================\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 $12 million in 1995 and $13 million in 1994 and 1993. At December 31, 1995, 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:\n1995 1994 1993 -------------------------- Federal statutory rate 35.0% 35.0% 35.0% State income tax, net of federal deduction 2.5 2.2 2.3 Non-deductible book depreciation 1.6 1.6 1.6 Differences in prior years' deferred and current tax rates (1.8) (2.9) (1.6) Other (1.4) (0.7) (2.9) ============================================================== Effective income tax rate 35.9% 35.2% 34.4% ==============================================================\nThe Southern Company files a consolidated federal income tax return. Under a joint consolidated income tax agreement, each subsidiary's current and deferred tax expense is computed on a stand-alone basis. Tax benefits from losses of the parent company are allocated to each subsidiary based on the 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: 1995 1994 -------------------------- (in thousands) Obligations incurred in connection with the sale of tax-exempt pollution control revenue bonds by public authorities- Collateralized - 5.5% to 6.5 % due 2023-2024 $223,040 $223,040 Variable rates (5.0% to 6.0% at 1\/1\/96) due 2015-2017 89,800 89,800 Non-collateralized - 7.25% due 2003 1,000 1,000 7.4% to 9.375% due 2014-2016 21,000 152,500 5.8% due 2022 9,800 9,800 Variable rates (5.3% to 6.0% at 1\/1\/96) due 2022 131,500 - - - ------------------------------------------------------------- 476,140 476,140 Capitalized lease obligations 8,963 9,754 ============================================================= Total $485,103 $485,894 =============================================================\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 1995 Annual Report\nThe company has capitalized certain office building leases and a street light lease. 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 $5.6 million and $6.2 million at December 31, 1995 and 1994, respectively. The estimated aggregate annual maturities of other long-term debt through 2000 are as follows: $0.9 million in 1996, $1.0 million in 1997, $1.0 million in 1998, $1.2 million in 1999 and $1.1 million in 2000.\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:\n1995 1994 ---------------------- (in thousands) Bond improvement fund requirements $20,047 $ 20,047 Less: Portion to be satisfied by certifying property additions - 20,047 ------------------------------------------------------------ Cash sinking fund requirements $20,047 $ - First mortgage bond maturities and redemptions 63,750 - Other long-term debt maturities (Note 9) 885 796 ============================================================ Total $84,682 $ 796 ============================================================\nThe annual first mortgage bond improvement fund requirement is 1 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 1996 requirement of $20.0 million was satisfied by the deposit of cash in 1996. Also in 1996 are first mortgage bond maturities and redemptions of $64 million and maturities of $885 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 $10 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 1995 Annual Report\nthat policy. The maximum annual assessments per incident under current policies for the company would be $21 million for excess property damage and $8 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.\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, 1995, retained earnings of $807 million 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 1995 and 1994 are as follows:\nNet Income After Dividends Quarter Operating Operating on Preferred Ended Revenues Income Stock ---------------- ---------------------------------------------- (in thousands)\nMarch 1995 $646,771 $122,949 $ 65,328 June 1995 753,053 157,685 88,926 September 1995 938,284 233,322 167,938 December 1995 686,666 111,362 38,702\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 ----------------------------------------------------------------\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-84C\nII-85\nII-86A\nII-86B\nII-86C\nII-87\nII-88A\nII-88B\nII-88C\nII-89\nII-90A\nII-90B\nII-90C\nALABAMA POWER COMPANY OUTSTANDING SECURITIES AT DECEMBER 31, 1995\nFirst Mortgage Bonds Amount 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 Amount Interest Amount Series Issued Rate Outstanding Maturity - - -------------------------------------------------------------------------------- (Thousands) (Thousands) 1978 $ 5,600 7-1\/4% $ 1,000 5\/1\/03 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 1995 50,000 Variable 50,000 5\/1\/22 1995 81,500 Variable 81,500 10\/1\/22 ============= ============== $ 480,740 $ 476,140 ============= ==============\nPreferred Stock Shares 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 1995\nPollution Control Bonds Principal Interest Series Amount Rate - - -------------------------------------------------------------------------------- (Thousands) 1985 $ 50,000 9-3\/8% 1985 81,500 9-1\/4% =========== $ 131,500 ===========\nII-92\nGEORGIA POWER COMPANY\nFINANCIAL SECTION\nII-93\nMANAGEMENT'S REPORT Georgia Power Company 1995 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 six 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.\n\/s\/ H. Allen Franklin\nH. Allen Franklin President and Chief Executive Officer\n\/s\/ Warren Y. Jobe Warren Y. Jobe Executive Vice President, Treasurer and Chief Financial Officer\nFebruary 21, 1996\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, 1995 and 1994, 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, 1995. 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-125) referred to above present fairly, in all material respects, the financial position of Georgia Power Company as of December 31, 1995 and 1994, and the results of its operations and its cash flows for the periods stated, in conformity with generally accepted accounting principles.\n\/s\/ Arthur Andersen LLP\nAtlanta, Georgia February 21, 1996\nII-95\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Georgia Power Company 1995 Annual Report\nRESULTS OF OPERATIONS\nEarnings\nGeorgia Power Company's 1995 earnings totaled $609 million, representing an $83 million (15.9 percent) increase over 1994. Earnings for 1994 were reduced by a $55 million after-tax charge related to work force reduction programs. Excluding the charge related to the 1994 work force reduction programs, earnings for 1995 increased 4.8 percent over 1994 primarily due to higher retail energy sales and lower interest charges, partially offset by higher operating expenses. Earnings for 1994 declined from the prior year not only because of the work force reduction charge but also because of lower retail energy sales due to mild weather. The summer of 1993 was exceptionally hot in comparison.\nRevenues\nThe following table summarizes the factors impacting operating revenues for the 1993-1995 period:\nIncrease (Decrease) From Prior Year ----------------------------------- 1995 1994 1993 ----------------------------------- Retail - (in millions) Sales growth $110 $ 67 $ 45 Weather 69 (128) 126 Fuel cost recovery 66 (35) 76 Demand-side programs 36 (12) 15 ----------------------------------------------------------------- Total retail 281 (108) 262 - - ------------------------------------------------------------------ Sales for resale - Non-affiliates (61) (183) (106) Affiliates 16 (1) (6) - - ------------------------------------------------------------------ Total sales for resale (45) (184) (112) - - ------------------------------------------------------------------ Other operating revenues 7 3 4 - - ------------------------------------------------------------------ Total operating revenues $243 ($289) $154 - - ------------------------------------------------------------------ Percent change 5.8% (6.5)% 3.6% - - ------------------------------------------------------------------\nRetail revenues of $4.0 billion in 1995 increased $281 million (7.6 percent) over the prior year, compared with a decrease of $108 million (2.8 percent) in 1994. Sales growth, reflecting continued expansion of Georgia's economy, and the hot summer of 1995, compared to the milder-than-normal weather during the summer of 1994, were the primary reasons for the increase in retail revenues. Retail revenues were down in 1994 from the prior year primarily due to hot summer weather in 1993.\nFuel 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 1995 and 1994. Revenues 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:\n1995 1994 1993 ------------------------------- (in millions) Capacity $53 $ 84 $152 Energy 45 82 113 - - -------------------------------------------------------------- Total $98 $166 $265 ==============================================================\nContractual unit power sales to Florida utilities for 1995 and 1994 are down primarily due to scheduled reductions that corresponded with the sales to these utilities of portions of Plant Scherer Unit 4 in June 1995 and June 1994. The amount of capacity under these contracts declined by 155 megawatts and 427 megawatts in 1995 and 1994, respectively. In 1996, the contracted capacity will decline another 75 megawatts.\nSales to municipalities and cooperatives in Georgia increased in 1995 due to higher summer demand resulting from the hot weather; however, such sales 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 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.\nII-96\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Georgia Power Company 1995 Annual Report\nKilowatt-hour (KWH) sales for 1995 and the percent change by year were as follows:\nPercent Change ---------------------------- KWH 1995 1994 1993 ---------------------------------------- (in billions) Residential 17.3 10.4% (5.8)% 11.5% Commercial 19.8 5.9 2.5 5.9 Industrial 25.3 3.9 3.0 2.9 Other 0.5 2.0 5.0 5.7 ------- Total retail 62.9 6.2 0.4 6.1 ------- Sales for resale - Non-affiliates 6.6 (17.3) (44.3) (9.8) Affiliates 2.8 (10.4) 0.9 (8.8) ------- Total sales for resale 9.4 (15.4) (36.4) (9.7) ------- Total sales 72.3 2.8 (8.0) 2.1 ======= - - -----------------------------------------------------------------\nResidential, commercial and industrial energy sales growth in 1995 reflected continued expansion of Georgia's economy, hot summer weather, and an increase in customers served. The 1994 sales decline in the residential class was primarily the result of milder-than-normal summer weather in 1994. However in 1994, industrial and commercial sales were positively impacted by continued improvement in economic conditions. Assuming normal weather, sales to retail customers are projected to grow approximately 2 percent annually on average during 1996 through 1998.\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:\n1995 1994 1993 --------------------------- Total generation (billions of kilowatt-hours) 64 62 64 Sources of generation (percent) -- Coal 73.7 74.8 76.9 Nuclear 22.6 21.9 20.0 Hydro 3.0 3.1 2.8 Oil and gas 0.7 0.2 0.3 Average cost of fuel per net kilowatt-hour generated (cents) -- Coal 1.67 1.67 1.75 Nuclear 0.60 0.63 0.58 Oil and gas * * * Total 1.44 1.44 1.52 - - ---------------------------------------------------------------\n* Not meaningful because of minimal generation from fuel source.\nFuel expense increased 3.5 percent in 1995 because of higher generation which stemmed from greater demand. Fuel 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.\nPurchased power expense has decreased significantly since 1993, reflecting declining contractual capacity purchases from the co-owners of Plant Vogtle. Purchased power expense decreased $36 million in 1995 and $156 million in 1994. The declines in 1995 and 1994 also resulted from decreased purchases from affiliated companies, and in 1994 from decreased energy purchases from territorial wholesale customers. The declines in Plant Vogtle contractual capacity purchases did not have a significant impact on earnings in 1995 and 1994 since these costs are being levelized over six years under the terms of the 1991 Georgia Public Service Commission\nII-97\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Georgia Power Company 1995 Annual Report\n(GPSC) retail rate order. The levelization is reflected in the amortization of deferred Plant Vogtle costs in the Statements of Income. See Note 3 to the financial statements under \"Plant Vogtle Phase-In Plans\" for additional information.\nThe Company has incurred expenses for separation benefits associated with its work force reduction programs. These expenses were $11 million in 1995 and $82 million in 1994.\nOther operation and maintenance (O&M) expenses increased 12.2 percent in 1995 primarily as a result of the recognition of costs associated with demand-side option programs and increased maintenance expenses. The demand-side option program costs were offset in part by increases in retail revenues. During 1995, the Company expensed an additional $58 million of demand-side option program and other related costs, as compared to 1994, of which approximately $29 million was not collected through rate riders. See Note 3 to the financial statements under \"Demand-Side Conservation Programs\" for additional information on the recovery of these program costs. Other O&M expenses decreased 4.5 percent in 1994 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 and pension costs during 1994.\nDepreciation and amortization increased $43 million in 1995 primarily due to additional plant investment, accelerated amortization of software costs, and an increase in nuclear decommissioning expenses.\nTaxes other than income taxes increased 5.2 percent in 1995 and 1.0 percent in 1994, reflecting primarily higher ad valorem taxes and in 1995, higher franchise taxes paid to municipalities as a result of increased sales.\nIncome tax expense fluctuates directly with earnings.\nOther income (expense), net decreased in 1995 primarily due to an increase in charitable contributions.\nInterest expense decreased $51 million (14.6 percent) and $61 million (14.7 percent) in 1995 and 1994, respectively, due primarily to refinancing of long-term debt. The Company refinanced $505 million and $510 million of securities in 1995 and 1994, respectively. The Company also retired $264 million of long-term debt with the proceeds from the 1995 and 1994 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.\nBeginning January 1, 1996, the Company will operate under a three-year retail rate plan. The plan, which was approved by the GPSC on February 16, 1996, concludes a GPSC review of the Company's earnings and addresses an alternative rate plan proposed by the Company. Under the plan, the Company's earnings will be evaluated against a retail return on common equity range of 10 percent to 12.5 percent. Earnings in excess of 12.5 percent will be used to accelerate the amortization of regulatory assets or depreciation of electric plant. At its\nII-98\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Georgia Power Company 1995 Annual Report\noption, the Company may also recognize accelerated amortization or depreciation of assets within the allowed return on common equity range. The Company is required to absorb cost increases of approximately $29 million annually during the plan's three-year operation, including $14 million annually of accelerated depreciation of electric plant. During the plan's operation, the Company will not file for a general base rate increase unless its projected retail return on common equity falls below 10 percent. Under the approved plan, on July 1, 1998 the Company will make a general rate case filing in response to which the GPSC would be expected either to continue the rate plan or adopt a different one.\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 1996 through 1998.\nThe addition of four combustion turbine generating units and the Rocky Mountain pumped storage hydroelectric plant in 1995 and the scheduled addition of one jointly owned combustion turbine unit in 1996, will increase related O&M and depreciation expenses. In addition, the Company has entered into a four-year purchase power agreement to meet peaking needs whereby the Company will purchase 400 megawatts of capacity beginning in 1996 and declining to 200 megawatts of capacity in 1998. Capacity payments are projected to be $6 million in 1996 and 1997 and $3 million in 1998 and 1999. The Company has also entered into a 30-year purchase power agreement whereby the Company will buy electricity during peak periods from a planned 300 megawatt cogeneration facility starting in June 1998. Capacity and fixed O&M payments are projected to be $13 million in 1998.\nWork force reduction programs implemented in 1994 and 1995 will assist in efforts to control growth in future operating expenses.\nAs discussed in Note 3 to the financial statements, regulatory uncertainties exist related to the Rocky Mountain pumped storage hydroelectric plant. In the event the GPSC does not allow full recovery of the plant's costs, then the portion not allowed may have to be written off. The Company's net investment in the plant is approximately $190 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.\nDuring 1995, the Company sold its remaining interest in Unit 4 of Plant Scherer to two Florida utilities. This transaction coincided with scheduled reductions in capacity revenues from Florida utilities under contractual unit power sales contracts of approximately $22 million in 1995 and an additional $7 million in 1996. See Notes 6 and 7 to the financial statements for additional information.\nDuring 1994 and 1995, Oglethorpe Power Corporation (OPC) gave the Company notice of its intent to decrease its purchases of capacity under a power supply agreement by 250 megawatts in September 1996 and an additional 250 megawatts in September 1997. As a result, the Company's capacity revenues from OPC will decline approximately $8 million in 1996, an additional $25 million in 1997, and an additional $18 million in 1998.\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 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.\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\nII-99\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Georgia Power Company 1995 Annual Report\nAct 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 enhances 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. Also, electricity sales for resale rates are being driven down by wholesale transmission access and numerous potential new energy suppliers, including power marketers and brokers. The Company is aggressively working to maintain and expand its share of wholesale sales in the Southeastern power markets. 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. New federal legislation is being discussed and legislation allowing customer choice has been introduced in Georgia. 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 connected load may choose their electricity supplier. In addition, the bulk power market has become very competitive as utilities, IPPs and cogenerators seek to supply future capacity needs. Competition can create new business opportunities, but it increases risk and has the potential to adversely affect earnings.\nThe 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, and determine if any other assets have been impaired. 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 liabilities related to closure and removal of long-lived assets, including nuclear decommissioning. If the FASB issues new accounting rules, the estimated costs of closing and removing the Company's nuclear and other facilities may be required to be recorded as liabilities in the Balance Sheets. Also, the annual provisions for such costs could increase. Because of the Company's current ability to recover closure and removal costs through rates, these changes would not have a significant adverse effect on results of operations. See Note 1 to the financial statements under \"Depreciation and Nuclear Decommissioning\" for additional information.\nNew Accounting Standards\nThe FASB has issued Statement No. 121, Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of. This statement requires that long-lived assets be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. This statement also imposes stricter criteria for regulatory assets by requiring that such assets be probable of future recovery at each balance sheet date. The Company adopted this standard January 1, 1996 with no material effect on the financial statements. However, this conclusion may change in the future as competitive factors influence wholesale and retail pricing in this industry.\nII-100\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Georgia Power Company 1995 Annual Report\nFINANCIAL CONDITION\nOverview\nThe principal changes in the Company's financial condition in 1995 were gross utility plant additions of $480 million, which included the commercial operation of four combustion turbine units (cumulatively, 320 megawatts of capacity) and all three units of the Rocky Mountain pumped storage hydroelectric plant (the Company's ownership interest is approximately 70 megawatts of capacity per unit). In addition, the cost of capital was lowered through the refinancing or retirement of $1.0 billion 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 1995, the Company continued to lower its financing costs by refinancing higher-cost issues. New issues during 1993 through 1995 totaled $2.7 billion and retirement or repayment of securities totaled $3.4 billion. The retirements included the redemption of $131 million, $133 million, and $253 million in 1995, 1994, and 1993, respectively, of first mortgage bonds with the proceeds from the Plant Scherer Unit 4 sales. Composite financing rates for long-term debt and preferred stock for the years 1993 through 1995, as of year-end, were as follows:\n1995 1994 1993 --------------------------------- Composite interest rate on long-term debt 6.57% 7.14% 7.86% Composite preferred stock dividend rate 6.73 7.11 6.76 - - ----------------------------------------------------------------\nThe Company's current securities ratings are as follows:\nDuff & Standard & Phelps Moody's Poor's ------------------------------------ First Mortgage Bonds AA- A1 A+ Preferred Stock A a2 A Unsecured Bonds A+ A2 A Commercial Paper D1+ P1 A1 - - -----------------------------------------------------------------\nLiquidity and Capital Requirements\nCash provided from operations increased by $281 million in 1995, primarily due to increased revenues and a decrease in interest payments.\nThe Company estimates that construction expenditures for the years 1996 through 1998 will total $530 million, $537 million and $529 million, respectively. Investments in transmission and distribution facilities, enhancements to existing generating plants, and additions of a combustion turbine generating plant and equipment to comply with the provisions of the Clean Air Act are planned.\nCash requirements for sinking fund requirements, redemptions announced, and maturities of long-term debt are expected to total $283 million during 1996 through 1998.\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 1996 through 1998, the amount to be funded totals $24 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 $31 million as of December 31, 1995. 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 $975 million of unused credit\nII-101\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Georgia Power Company 1995 Annual Report\narrangements with banks at the beginning of 1996. See Note 9 to the financial statements under \"Bank Credit Arrangements\" for additional information.\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 amended by Congress. Title IV of the Clean Air Act -- the acid rain compliance provision of the law -- is having a significant impact on the operating companies of The Southern Company, including Georgia Power. Specific reductions in sulfur dioxide and nitrogen oxide emissions from fossil-fired generating plants are required in two phases. Phase I compliance began in 1995 and initially affected 28 generating units in the Southern electric system. As a result of The Southern Company's compliance strategy, an additional 22 generating units were brought into compliance with Phase I requirements. 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 designed to use allowances as a compliance option.\nThe Southern Company achieved Phase I sulfur dioxide compliance at the affected units by switching to low-sulfur coal, which has required some equipment upgrades. This compliance strategy resulted in unused emission allowances being banked for later use. Compliance with nitrogen oxide emission limits was achieved by the installation of new control equipment at 22 of the original 28 affected generating units. Construction expenditures for Georgia Power's Phase I compliance totaled approximately $165 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 $45 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 1 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.\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.\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 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\nII-102\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Georgia Power Company 1995 Annual Report\nnitrogen oxide controls, above Title IV requirements, on some of the Company's plants. The EPA along with 37 states is conducting studies to evaluate the benefits of regional controls in meeting the ozone standards. Final attainment rules, based on modeling studies, could require installation of additional controls for nitrogen oxide emissions to meet the 1999 deadline or as part of any regional controls if enacted. A decision on new requirements is expected in 1997. 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 during 1996. 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 is evaluating the need to revise the ambient air quality standards for particulate matter 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 1996, 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 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 in 1995 and 1994, and $32 million in 1993. Additional sites may require environmental remediation for which the Company may be liable for a portion of or all required cleanup costs. See Note 3 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 the status of sites listed on the State of Georgia's hazardous site inventory.\nSeveral major pieces of environmental legislation are being considered for reauthorization or amendment by Congress. These include: the Clean Air Act; 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 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 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 1995 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), Southern Nuclear Operating Company (Southern Nuclear), The Southern Development and Investment Group (Southern Development), and other direct and indirect subsidiaries. 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). SCS provides, at cost, specialized services to The Southern Company and subsidiary companies. Southern Communications provides digital wireless communications services to the operating companies and also markets these services to the public within the Southeast. Southern Electric designs, builds, owns, and operates power production and delivery 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. Southern Development 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 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 (GAAP) and complies with the accounting policies and practices prescribed by the respective regulatory commissions. The preparation of financial statements in conformity with GAAP requires the use of estimates, and the actual results may differ from these estimates.\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:\n1995 1994 -------------------- (in millions) Deferred income taxes $ 872 $ 920 Deferred income tax credits (410) (433) Deferred Plant Vogtle costs 308 432 Premium on reacquired debt 174 165 Demand-side program costs 79 97 Corporate building lease 49 48 Postretirement benefits 53 41 Vacation pay 36 41 Inventory conversions (31) (39) Department of Energy assessments 33 36 Other, net 36 52 ============================================================== Total $1,199 $1,360 ==============================================================\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, if impaired, to their fair value.\nII-110\nNOTES (continued) Georgia Power Company 1995 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.\nThe Company has a diversified base of customers. No single customer or industry comprises 10 percent or more of revenues. In 1995, 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 $86 million in 1995, $87 million in 1994, and $75 million in 1993. 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 at December 31, 1995, to be approximately $31 million. This obligation is recorded 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 1995 and 3.1 percent in 1994 and 1993. See Note 3 under \"Retail Rate Plan\" for additional information. 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 and removal of other 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.\nThe site 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 the retirement\nII-111\nNOTES (continued) Georgia Power Company 1995 Annual Report\ndate. The estimated costs of decommissioning -- both site study costs and ultimate costs at December 31, 1995 -- based on the Company's ownership interests -- were as follows:\nPlant Plant Hatch Vogtle -------------------- Site study basis (year) 1994 1994\nDecommissioning periods: Beginning year 2014 2027 Completion year 2027 2038 - - ------------------------------------------------------------ (in millions) Site study costs: Radiated structures $294 $233 Non-radiated structures 41 52 ============================================================ Total $335 $285 ============================================================ (in millions) Ultimate costs: Radiated structures $781 $1,018 Non-radiated structures 111 230 - - ------------------------------------------------------------ Total $892 $1,248 ============================================================\n(in millions) Amount expensed in 1995 $11 $ 9\nAccumulated provisions: Balance in external trust funds $56 $36 Balance in internal reserves 30 13 ============================================================ Total $86 $49 ============================================================\nSignificant assumptions: Inflation rate 4.4% 4.4% Trust earnings 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 included in cost of service are based on the higher of the costs to decommission the radioactive portions of the plants based on 1994 site studies or the NRC minimum funding requirements. 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 the assumed date of decommissioning; changes in NRC requirements; changes in the assumptions used in making estimates; changes in regulatory requirements; changes in technology; and changes in costs of labor, materials, and equipment.\nIncome Taxes\nThe Company uses the liability method of accounting for deferred income taxes and 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.\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. 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.\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 1995, 1994 and 1993, the average AFUDC rates were 6.53 percent, 6.18 percent and 4.96 percent, respectively. The increase in 1994 is primarily the result of the higher short-term borrowing rates. AFUDC, net of taxes, as a percentage of net income after dividends on preferred stock, was less than 2.5 percent for 1995, 1994, and 1993.\nII-112\nNOTES (continued) Georgia Power Company 1995 Annual Report\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 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 financial instruments for which the carrying amounts did not approximate fair value at December 31 are as follows:\nCarrying Fair Amount Value -------------------------- Long-term debt: (in millions) At December 31, 1995 $3,378 $3,487 At December 31, 1994 3,838 3,697 Preferred Securities: At December 31, 1995 100 114 - - ---------------------------------------------------------------\nThe fair values for securities 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.\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 one of the following 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 the FERC. During 1995 and 1994, the Company funded $21 million and $22 million, respectively, to the qualified trusts. Amounts funded are primarily invested in debt and equity securities.\nFASB Statement No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions, requires that medical care and life insurance benefits for retired employees be accounted for on an accrual basis using a specified actuarial method, \"benefit\/years-of-service.\" In October 1993, the GPSC ordered 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 cost was expensed in 1993, and the remaining additional costs were 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.\nII-113\nNOTES (continued) Georgia Power Company 1995 Annual Report\nFunded Status and Cost of Benefits\nThe following tables show actuarial results and assumptions for pension and postretirement 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 --------------------- 1995 1994 --------------------- Actuarial present value of (in millions) benefit obligations: Vested benefits $ 830 $ 689 Non-vested benefits 43 32 - - --------------------------------------------------------------- Accumulated benefit obligation 873 721 Additional amounts related to projected salary increases 290 294 - - --------------------------------------------------------------- Projected benefit obligation 1,163 1,015 Less: Fair value of plan assets 1,688 1,419 Unrecognized net gain (465) (371) Unrecognized prior service cost 26 28 Unrecognized transition asset (52) (58) =============================================================== Prepaid asset recognized in the Balance Sheets $ 34 $ 3 ===============================================================\nPostretirement Benefits --------------------- 1995 1994 --------------------- (in millions) Actuarial present value of benefit obligation: Retirees and dependents $214 $203 Employees eligible to retire 16 7 Other employees 188 229 - - --------------------------------------------------------------- Accumulated benefit obligation 418 439 Less: Fair value of plan assets 81 52 Unrecognized net loss (gain) 44 (1) Unrecognized transition obligation 186 301 =============================================================== Accrued liability recognized in the Balance Sheets $107 $ 87 ===============================================================\nIn 1995, the Company announced a cost sharing program for postretirement benefits. The program establishes limits on amounts the Company will pay to provide future postretirement benefits. This change reduced the 1995 accumulated postretirement benefit obligation by approximately $97 million.\nThe weighted average rates used in actuarial calculations were:\n1995 1994 1993 ------------------------------- Discount 7.3% 8.0% 7.5% Annual salary increase 4.8 5.5 5.0 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 9.8 percent for 1995, decreasing gradually to 5.3 percent through the year 2005 and remaining at that level thereafter. An annual increase in the assumed medical care cost trend rate of 1 percent would increase the accumulated benefit obligation as of December 31, 1995, by $39 million and the aggregate of the service and interest cost components of the net postretirement cost by $8 million.\nThe components of the plans' net costs are shown below:\nPension ----------------------------- 1995 1994 1993 ----------------------------- (in millions) Benefits earned during the year $ 33 $ 34 $ 33 Interest cost on projected benefit obligation 78 71 69 Actual (return) loss on plan assets (317) 35 (194) Net amortization and deferral 185 (160) 84 ================================================================ Net pension cost $ (21) $ (20) $ (8) ================================================================\nNet pension costs were negative in 1995, 1994 and 1993. Of net pension amounts recorded, $15 million in 1995 and 1994, and $6 million in 1993 were recorded as a\nII-114\nNOTES (continued) Georgia Power Company 1995 Annual Report\nreduction to operating expense, and the remainder was recorded as a reduction to construction and other accounts.\nPostretirement Benefits -------------------------- 1995 1994 1993 -------------------------- (in millions) Benefits earned during the year $13 $15 $14 Interest cost on accumulated benefit obligation 34 33 29 Amortization of transition obligation 16 15 15 Actual (return) loss on plan assets (8) 1 (4) Net amortization and deferral 4 (3) 2 ================================================================== Net postretirement cost $59 $61 $56 ==================================================================\nOf the above net postretirement benefit costs recorded, $33 million in 1995, $28 million in 1994, and $21 million in 1993 were charged to operating expenses. In addition, $11 million in 1995, $18 million in 1994, and $21 million in 1993 were 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 these programs were $11 million and $82 million for the years 1995 and 1994, respectively. Additionally, in 1994, the Company recognized $8 million for its share of costs associated with SCS's work force reduction program.\n3. REGULATORY AND LITIGATION MATTERS\nRetail Rate Plan\nOn February 16, 1996, the GPSC approved a rate plan recommended by the Commission staff which concludes the GPSC's review of the Company's earnings initiated in early 1995 and addresses the Company's proposed alternative retail rate plan. Under the three-year plan effective January 1, 1996, the Company's earnings will be evaluated against a retail return on common equity range of 10 percent to 12.5 percent. Earnings in excess of 12.5 percent will be used to accelerate the amortization of regulatory assets or depreciation of electric plant. At its option, the Company may also recognize accelerated amortization or depreciation of assets within the allowed return on common equity range. The Company is required to absorb cost increases of approximately $29 million annually during the plan's three-year operation, including $14 million annually of accelerated depreciation of electric plant. During the plan's operation, the Company will not file for a general base rate increase unless its projected retail return on common equity falls below 10 percent. Under the approved plan, on July 1, 1998 the Company will make a general rate case filing in response to which the GPSC would be expected either to continue the rate plan or adopt a different one.\nRocky Mountain Plant Status\nIn its 1985 financing order, the GPSC concluded that completion of the Rocky Mountain pumped storage hydroelectric plant 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 plant. In 1988, the Company and OPC entered into a joint ownership agreement for OPC to assume responsibility for the construction and operation of the plant, as discussed in Note 6. However, full recovery of the Company's costs depends on the GPSC's treatment of the plant's costs and disposition of the plant's capacity output. In the event the GPSC does not allow full recovery of the plant's costs, then the portion not allowed may have to be written off. AFUDC accrued on the Rocky Mountain plant was not credited to income or included in the plant's cost since December 1985. In 1995, the plant went into commercial operation. At December 31, 1995, the Company's net investment in the plant was approximately $190 million, and the Company's ownership was 25.4 percent.\nThe final outcome of this matter cannot now be determined. Accordingly, no provision for any write-down of the investment in the plant has been made.\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\nII-115\nNOTES (continued) Georgia Power Company 1995 Annual Report\ncosts 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.\nAfter the Georgia Court of Appeals upheld the legality of the rate riders, the Company resumed collection under the rate riders in December 1994. In August 1995, the GPSC ordered the Company to discontinue its current demand-side conservation programs by the end of 1995. The rate riders will remain in effect until costs deferred are collected.\nUnder the Retail Rate Plan approved February 16, 1996, the Company will recognize approximately $29 million of deferred program costs over a three-year period which will not be recovered through the riders.\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.\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 ended in December 1995. In November 1995, a FERC administrative law judge issued an opinion that the FERC staff failed to meet its burden of proof, and therefore no change in the equity return was necessary. The FERC staff has filed exceptions to the administrative law judge's opinion, and the matter remains pending before the FERC.\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 $49 million at December 31, 1995. However, management believes that rates are not excessive, and that refunds are not justified.\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. As of December 31, 1995, the Company has recognized $3.5 million in expenses associated with this site. 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. However, based on the nature and extent of the Company's activities relating to the site, management believes that the Company's portion of these costs should not be material.\nIn compliance with the Georgia Hazardous Site Response Act of 1993, 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 $10 million in expenses through December 31, 1995 for the anticipated clean-up cost for 18 sites that the Company plans\nII-116\nNOTES (continued) Georgia Power Company 1995 Annual Report\nto 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 $2.4 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 listed sites were required to be remediated, the Company could incur expenses of up to approximately $15 million in additional clean-up costs and construction expenditures of up to approximately $100 million to develop new waste management facilities or install additional pollution control devices.\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 the FERC denied such request in July 1995. In September 1995, OPC appealed the FERC's decision on this issue to the Court of Appeals for the District of Columbia Circuit.\nIn 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.\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: 1995 1994 1993 ----------------------------- (in millions) Deferred costs at beginning of year $432 $507 $383 - - ---------------------------------------------------------------- Deferred capacity buyback expenses - 10 38 Amortization of previously deferred costs (124) (85) (74) - - ---------------------------------------------------------------- Net amortization (124) (75) (36) - - ---------------------------------------------------------------- Effect of adoption of FASB Statement No. 109 - - 160 ================================================================ Deferred costs at end of year $308 $432 $507 ================================================================\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\nII-117\nNOTES (continued) Georgia Power Company 1995 Annual Report\naverage 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, 1995, the remaining amount to be collected was $2.4 million.\n4. COMMITMENTS\nConstruction Program\nWhile the Company has no new baseload generating plants under construction, the construction of one jointly owned combustion turbine peaking unit is planned to be completed in 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 $530 million in 1996, $537 million in 1997, and $529 million in 1998. These estimated additions include AFUDC of $12 million in 1996, $14 million in 1997, and $15 million in 1998. The estimates for property additions for the three-year period include $67 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 fossil and nuclear fuel commitments at December 31, 1995 were as follows:\nMinimum Year Obligations ---------------------- (in millions) 1996 $ 831 1997 678 1998 534 1999 321 2000 231 2001 through 2010 1,624 =============================================================== Total minimum obligations $4,219 ===============================================================\nAdditional commitments for coal and for nuclear fuel will be required in the future to supply the Company's fuel needs.\nPurchase Power Commitments\nIn connection with the joint ownership arrangement for Plant Vogtle, discussed in Note 6, the Company has made commitments to purchase declining fractions of OPC's and MEAG's capacity and energy from this plant. 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 $76 million, $129 million and $183 million in 1995, 1994, and 1993, respectively. The current projected Plant Vogtle capacity payments for the next five years are: $70 million in 1996, $59 million per year in 1997 through 1999, and $60 million in 2000. 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.\nII-118\nNOTES (continued) Georgia Power Company 1995 Annual Report\nAs discussed in Note 3, the Plant Vogtle declining capacity buyback expense is being levelized over a six-year period which began in October 1991.\nThe Company and an affiliate, Alabama 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 1,020 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:\n1995 1994 1993 --------------------------------- (in millions) Energy $44 $43 $60 Capacity 29 33 30 ============================================================== Total $73 $76 $90 ============================================================== Kilowatt-hours 2,391 2,429 3,352 - - --------------------------------------------------------------\nAt December 31, 1995, 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.\nThe Company has entered into a 30-year purchase power agreement, scheduled to begin in June 1998, for electricity during peaking periods from a planned 300 megawatt cogeneration facility. Payments are subject to reductions for failure to meet minimum capacity output. Total estimated capacity and fixed operation and maintenance (O&M) payments are as follows:\nFixed Year Capacity O&M Total ----------------------------------------- (in millions) 1998 $ 10 $ 3 $ 13 1999 11 4 15 2000 11 4 15 2001 and beyond 178 157 335 ================================================================ Total $210 $168 $378 ================================================================\nOperating Leases\nThe Company has entered into coal rail car rental agreements with various terms and expiration dates. These expenses totaled $12 million, $13 million, and $8 million for 1995, 1994, and 1993, respectively. At December 31, 1995, estimated minimum rental commitments for noncancelable operating leases were as follows:\nYear Amounts ------------------- (in millions) 1996 $ 11 1997 10 1998 10 1999 10 2000 10 2001 and beyond 126 ========================================================= Total minimum payments $177 =========================================================\n5. NUCLEAR 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\nII-119\nNOTES (continued) Georgia Power Company 1995 Annual Report\noccurring 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. The 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, excluding any applicable state premium taxes, -- based on its ownership and buyback interests - - -- is $162 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 is limited to $12 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 $24 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.\n6. FACILITY SALES AND JOINT OWNERSHIP AGREEMENTS\nThe 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 Company, an affiliate.\nAdditionally, in 1995 the Company completed the last 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. FP&L now owns approximately 76.4 percent of the unit, with JEA owning the remainder.\nII-120\nNOTES (continued) Georgia Power Company 1995 Annual Report\nThe Scherer Unit 4 transactions were as follows:\nClosing Date Percent After-Tax 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 3, the Company owns 25.4 percent of the Rocky Mountain pumped storage hydroelectric plant, which began commercial operation in 1995. OPC owns the remainder, and is the operator of the plant.\nThe Company owns six of eight 80 megawatt combustion turbine generating units and 75 percent of the related common facilities at Plant McIntosh. Savannah Electric and Power Company, an affiliate, owns the remainder and operates the plant. Four of the Company's six units began commercial operation during 1994, and the remaining two units began commercial operation in 1995.\nIn 1994, the Company and Florida Power Corporation (FPC) entered into a joint ownership agreement regarding a 150 megawatt combustion turbine unit to be constructed at Intercession City, Florida, near Orlando. The unit is scheduled to begin commercial operation by the end of 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.\nAt December 31, 1995, the Company's percentage ownership and investment (exclusive of nuclear fuel) in jointly owned facilities in commercial operation, were as follows:\nTotal Nameplate Company Facility (Type) Capacity Ownership - - ----------------------------------------------------------------- (megawatts) Plant 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 Plant McIntosh Common Facilities N\/A 75.0 (combustion-turbine) Rocky Mountain 848 25.4 (pumped storage) - - -----------------------------------------------------------------\nAccumulated Facility (Type) Investment Depreciation - - ----------------------------------------------------------------- (in millions) Plant Vogtle (nuclear) $3,295* $730 Plant Hatch (nuclear) 842 394 Plant Wansley (coal) 297 132 Plant Scherer (coal) Units 1 and 2 112 39 Unit 3 541 135 Plant McIntosh Common Facilities (combustion-turbine) 19 ** Rocky Mountain (pumped storage) 200 10 - - ----------------------------------------------------------------\n* Investment net of write-offs. ** Less than $1 million.\nII-121\nNOTES (continued) Georgia Power Company 1995 Annual Report\n7. LONG-TERM POWER SALES AGREEMENTS\nThe Company and the operating subsidiaries of The Southern Company have long-term contractual agreements for the sale of capacity and energy to non-affiliated utilities located outside the system's service area. These agreements consist of firm unit power sales pertaining to capacity from specific generating units. The Company also had agreements for non-firm sales, which expired in 1994, 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:\nYear Unit Power Sales Non-firm Sales - - ----------------------------------------------------------------- (in millions) (megawatts) (in millions) (megawatts) 1995 $ 53 248 $ - - 1994 75 403 9 101 1993 135 830 17 200 - - -----------------------------------------------------------------\nUnit power from specific generating plants is being sold to FP&L, FPC, JEA, and the City of Tallahassee, Florida. Under these agreements, the Company sold approximately 248 megawatts of capacity in 1995 and is scheduled to sell approximately 173 megawatts of capacity in 1996. Thereafter, these sales will decline to an estimated 159 megawatts and remain at that level through 1999. After 2000, capacity sales will decline to approximately 103 megawatts -- unless reduced by FP&L, FPC, and JEA -- until the expiration of the contracts in 2010.\nLong-term non-firm power of 200 megawatts was sold by the Southern system in 1994 to FPC, of which the Company's share was 101 megawatts, under a contract that expired at the end of 1994. Sales under these long-term non-firm power sales agreements were made from available power pool energy, and the revenues from the sales were shared by the operating affiliates.\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, 1995, the tax-related regulatory assets were $872 million and the tax-related regulatory liabilities were $410 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:\n1995 1994 1993 ------------------------------ Total provision for income taxes: (in millions) Federal: Currently payable $349 $306 $223 Deferred - Current year 84 86 181 Reversal of prior years (55) (57) (40) Deferred investment tax credits 1 (1) (18) - - ----------------------------------------------------------------- 379 334 346 - - ----------------------------------------------------------------- State: Currently payable 60 52 41 Deferred - Current year 15 15 31 Reversal of prior years (8) (10) (3) - - ----------------------------------------------------------------- 67 57 69 - - ----------------------------------------------------------------- Total 446 391 415 - - ------------------------------------------------------------------ Less: Income taxes charged (credited) to other income (3) (8) (37) ================================================================= Federal and state income taxes charged to operations $449 $399 $452 =================================================================\nII-122\nNOTES (continued) Georgia Power Company 1995 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:\n1995 1994 -------------------- (in millions) Deferred tax liabilities: Accelerated depreciation $1,630 $1,541 Property basis differences 1,074 1,085 Deferred Plant Vogtle costs 100 141 Premium on reacquired debt 70 68 Deferred regulatory costs 38 48 Fuel clause underrecovered - 9 Other 29 23 - - ------------------------------------------------------------------ Total 2,941 2,915 - - ------------------------------------------------------------------ Deferred tax assets: Other property basis differences 239 250 Federal effect of state deferred taxes 97 94 Other deferred costs 83 79 Disallowed Plant Vogtle buybacks 25 26 Accrued interest 13 10 Fuel clause overrecovered 6 - Other 18 13 - - ------------------------------------------------------------------ Total 481 472 - - ------------------------------------------------------------------ Net deferred tax liabilities 2,460 2,443 Portion included in current assets 51 35 ================================================================== Accumulated deferred income taxes in the Balance Sheets $2,511 $2,478 ==================================================================\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 $22 million in 1995, $25 million in 1994, and $19 million in 1993. At December 31, 1995, all investment tax credits available to reduce federal income taxes payable had been utilized.\nA reconciliation of the federal statutory tax rate to the effective income tax rate is as follows:\n1995 1994 1993 ----------------------------- Federal statutory rate 35% 35% 35% State income tax, net of federal deduction 4 4 4 Non-deductible book depreciation 2 3 3 Difference in prior years' deferred and current tax rate (1) (1) (1) Other - - (1) ================================================================ Effective income tax rate 40% 41% 40% ================================================================\nThe Southern Company and its subsidiaries file a consolidated federal income tax return. Under a joint consolidated income tax agreement, each subsidiary's current and deferred tax expense is computed on a stand-alone basis. Tax benefits from losses of the parent company are allocated to each subsidiary based on the ratio of taxable income to total consolidated taxable income.\n9. 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, 1995, retained earnings of $897 million 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, 1995, the ratio as defined was 50.2 percent.\nII-123\nNOTES (continued) Georgia Power Company 1995 Annual Report\nPreferred Securities\nIn December 1994, Georgia Power Capital, L.P., of which the Company is the sole general partner, issued $100 million of 9 percent mandatory redeemable preferred securities. The sole asset of Georgia Power Capital is $103 million aggregate principal amount of Georgia Power's 9 percent Junior Subordinated Deferrable Interest Debentures due December 19, 2024. The Company considers that the mechanisms and obligations relating to the preferred securities, taken together, constitute a full and unconditional guarantee by the Company of Georgia Power Capital's payment obligations with respect to the preferred securities.\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 $1.5 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 $146 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:\nMaturity Interest Rates 1995 1994 - - -------------------------------------------------------------- (in millions) 2000 4.375% $ 50 $ - 2004-2005 5% to 5.70% 143 85 2006-2008 6.375% to 6.75% 12 12 2011-2015 10.125% to 10.6% & Variable 10 515 2016-2019 6% to 9.375% 282 282 2021-2025 5.40% to 7.25% & Variable 1,181 784 ============================================================== Total pollution control bonds $ 1,678 $1,678 ==============================================================\nBank Credit Arrangements\nAt the beginning of 1996, the Company had unused credit arrangements with banks totaling $975 million, of which $514.7 million expires at various times during 1996, $60.3 million expires at May 1, 1998, and $400 million expires at June 30, 1998.\nThe $400 million expiring June 30, 1998, is under revolving credit arrangements with several banks providing the Company, Alabama Power Company, and The Southern Company up to a total credit amount of $400 million. To provide liquidity support for commercial paper programs, $165 million, $135 million, and $100 million are currently dedicated to the Company, Alabama Power Company, and The Southern Company, respectively. However, the allocations can be changed among the borrowers by notifying the respective banks.\nDuring the term of the agreements expiring in 1998, 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 $975 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, 1995, were $475 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 1995.\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\nII-124\nNOTES (continued) Georgia Power Company 1995 Annual Report\nlong-term debt. At December 31, 1995 and 1994, the Company had a capitalized lease obligation for its corporate headquarters building of $87 million and $88 million, respectively, with an interest rate of 8.1 percent. The maturity of this capital lease obligation through 2000 is approximately as follows: $336 thousand in 1996, $365 thousand in 1997, $395 thousand in 1998, $429 thousand in 1999, and $672 thousand in 2000.\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, 1995, and 1994, the interest and lease amortization deferred on the Balance Sheets are $49 million and $48 million, respectively.\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:\n1995 1994 ----------------- (in millions) First mortgage bond maturity $150 $130 Other long-term debt - 37 ================================================================ Total $150 $167 ================================================================\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, reacquiring bonds, or by pledging additional property equal to 1 2\/3 times the requirement. The Company currently plans to satisfy its 1996 improvement fund requirement by depositing cash with the trustee or 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.\n10. QUARTERLY FINANCIAL DATA (UNAUDITED)\nSummarized quarterly financial information for 1995 and 1994 is as follows:\nNet Income After Dividends on Operating Operating Preferred Quarter Ended Revenues Income Stock - - ------------------------------------------------------------------- (in millions) March 1995 $ 974 $207 $ 116 June 1995 1,075 230 149 September 1995 1,374 337 245 December 1995 982 177 99\nMarch 1994 $ 992 $157 $ 58 June 1994 1,030 227 140 September 1994 1,213 331 233 December 1994 927 179 95 - - -------------------------------------------------------------------\nEarnings in 1994 declined by $55 million as a result of work force reduction programs recorded primarily in the first quarter.\nThe Company's business is influenced by seasonal weather conditions.\nII-125\nII-126\nII-127A\nII-127B\nII-127C\nII-128\nII-129A\nII-129B\nII-129C\nII-130\nII-131A\nII-131B\nII-131C\nII-132\nII-133A\nII-133B\nII-133C\nII-134\nII-135A\nII-135B\nII-135C\nII-136\nII-137A\nII-137B\nII-137C\nGEORGIA POWER COMPANY OUTSTANDING SECURITIES AT DECEMBER 31, 1995\nFirst Mortgage Bonds Amount Interest Amount Series Issued Rate Outstanding Maturity - - -------------------------------------------------------------------------------- (Thousands) (Thousands) 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 1992 100,000 8-5\/8% 60,368 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 1995 75,000 7.70% 75,000 5\/1\/25 ============= ============== $ 1,755,000 $ 1,715,368 ============= ==============\nPollution Control Bonds Amount Interest Amount Series Issued Rate Outstanding Maturity - - -------------------------------------------------------------------------------- (Thousands) (Thousands) 1995 $ 50,000 4-3\/8% $ 50,000 11\/1\/00 1992 38,800 5.70% 38,800 9\/1\/04 1993 46,790 5-3\/8% 46,790 3\/1\/05 1995 57,000 5% 57,000 9\/1\/05 1976 40,800 6-3\/4% 1,920 11\/1\/06 1977 24,100 6.40% 1,940 6\/1\/07 1978 21,600 6-3\/8% 8,060 4\/1\/08 1991 10,450 Variable 10,450 7\/1\/11 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 6.25% 8,500 7\/1\/19 1991 51,345 7.25% 51,345 7\/1\/21 1991 10,125 6.25% 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 5.90% 10,000 12\/1\/24 1994 7,000 5.90% 7,000 12\/1\/24 1995 73,535 6.10% 73,535 4\/1\/25 1995 75,000 Variable 75,000 4\/1\/25 1995 45,000 Variable 45,000 7\/1\/25 1995 40,000 Variable 40,000 7\/1\/25 1995 71,580 6% 71,580 7\/1\/25 1995 35,585 Variable 35,585 9\/1\/25 1995 30,000 Variable 30,000 9\/1\/25 1995 27,000 Variable 27,000 9\/1\/25 ============= ============== $ 1,752,610 $ 1,678,030 ============= ==============\nII-138\nGEORGIA POWER COMPANY OUTSTANDING SECURITIES AT DECEMBER 31, 1995 (Continued)\nSubsidiary Obligated Mandatorily Redeemable Preferred Securities(1) Preferred Securities Interest Amount Series Outstanding Rate Outstanding - - -------------------------------------------------------------------------------- (Thousands) 1994 4,000,000 9% $ 100,000\nPreferred Stock Shares Dividend Amount Series Outstanding Rate Outstanding - - -------------------------------------------------------------------------------- (Thousands) (2) 14,090 $5.00 $ 1,409 1953 100,000 $4.92 10,000 1954 433,774 $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 ------------- ------------ 21,027,864 $ 692,787 ============= ============\n(1) Issued by Georgia Power Capital, L.P., and guaranteed to the extent Georgia Power Capital has funds by GEORGIA. (2) Issued in exchange for $5.00 preferred outstanding at the time of company formation.\nII-139\nGEORGIA POWER COMPANY\nSECURITIES RETIRED DURING 1995\nFirst Mortgage Bonds Principal Interest Series Amount Rate - - ------------------------------------------------------------------------------ (Thousands) 1989 $ 36,157 9.23% 1992 130,000 5-1\/8% 1992 100,000 8-3\/4% 1992 39,632 8-5\/8% 1992 100,000 Variable 1992 100,000 Variable =========== $ 505,789 ===========\nPollution Control Bonds Principal Interest Series Amount Rate - - ------------------------------------------------------------------------------ (Thousands) 1976 $ 20 6-3\/4% 1977 20 6.40% 1978 70 6-3\/8% 1985 148,535 10-1\/8% 1985 156,580 10-1\/2% 1985 100,000 10.60% 1985 99,585 10-1\/2% ----------- $ 504,810 ===========\nII-140\nGULF POWER COMPANY\nFINANCIAL SECTION\nII-141\nMANAGEMENT'S REPORT Gulf Power Company 1995 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 consolidated 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\nFebruary 21, 1996\nII-142\nREPORT OF INDEPENDENT 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, 1995 and 1994, 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, 1995. 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, 1995 and 1994, and the results of its operations and its cash flows for the periods stated, in conformity with generally accepted accounting principles.\n\/s\/ Arthur Andersen LLP\nAtlanta, Georgia February 21, 1996\nII-143\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Gulf Power Company 1995 Annual Report\nRESULTS OF OPERATIONS\nEarnings\nGulf Power Company's 1995 net income after dividends on preferred stock was $57.2 million, an increase of $2 million over the prior year. This improvement is primarily attributable to higher retail revenues due to exceptionally hot summer weather and lower interest charges on long-term debt. This improvement was partially offset by higher maintenance expenses and reduced capacity revenues from non-affiliated utilities under long-term contracts. Costs related to a work force reduction program implemented in the fourth quarter of 1995 decreased earnings by $4.3 million. These costs are expected to be recovered through future savings over approximately two years.\nIn 1994, earnings were $55.2 million, representing an increase of $0.9 million compared to the prior year. Earnings in 1994 were significantly affected by lower financing costs, an increase in customers, and milder than normal temperatures. Also, earnings decreased approximately $3.0 million, reflecting the first full year of lower industrial sales due to the Company's largest industrial customer, Monsanto, installing its own cogeneration facility in August, 1993.\nThe return on average common equity for 1995 was 13.27 percent, a slight increase from the 13.15 percent return earned in 1994.\nRevenues\nOperating revenues increased in 1995 and decreased in 1994 as a result of the following factors:\nIncrease (Decrease) From Prior Year ------------------------------------- 1995 1994 1993 ------------------------------------- (in thousands) Retail -- Change in base rates $ - $ - $ 1,571 Sales growth 3,647 7,126 7,671 Weather 9,749 (4,631) 4,049 Regulatory cost recovery and other 22,502 8,938 (3,079) - - ----------------------------------------------------------------- Total retail 35,898 11,433 10,212 - - ----------------------------------------------------------------- Sales for resale-- Non-affiliates (5,698) (6,098) 2,131 Affiliates 1,266 (5,813) (909) - - ----------------------------------------------------------------- Total sales for resale (4,432) (11,911) 1,222 Other operating revenues 8,798 (3,851) 806 - - ----------------------------------------------------------------- Total operating revenues $40,264 $(4,329) $12,240 ================================================================= Percent change 7.0% (0.7)% 2.1% - - -----------------------------------------------------------------\nRetail revenues of $519 million in 1995 increased $35.9 million or 7.4 percent from last year, compared with an increase of 2.4 percent in 1994 and 2.2 percent in 1993. Residential and commercial revenues surged upward as a result of hotter-than-normal summer weather in 1995, compared with the extremely mild summer of 1994. The Company set an all-time peak demand for energy in 1995.\nThe increase in regulatory cost recovery and other retail revenue is primarily attributable to the recovery of increased fuel costs. Regulatory cost recovery and other includes recovery provisions for fuel expense and the energy component of purchased power costs; energy conservation costs; purchased power capacity costs; 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.\nII-144\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Gulf Power Company 1995 Annual Report\nSales for resale were $79 million in 1995, decreasing $4.4 million or 5.3 percent from 1994. Revenues 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 under these long-term contracts were as follows:\n1995 1994 1993 ---------------------------------------- (in thousands) Capacity $25,870 $30,926 $33,805 Energy 18,598 18,456 21,202 ============================================================ Total $44,468 $49,382 $55,007 ============================================================\nCapacity revenues decreased in 1995 and 1994, reflecting the scheduled 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 increase in other operating revenues for 1995 is primarily due to increased amounts collected to recover newly-imposed county franchise fees. These collections are also included in taxes other than income taxes and have no impact on earnings. Other changes for 1995 and the change in 1994 are primarily attributable to adjustments in the 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 1995 and percent changes in sales since 1993 are reported below.\nKWH Percent Change ------------ --------------------------- 1995 1995 1994 1993 ------------ --------------------------- (millions) Residential 4,014 7.0% 1.1% 3.2% Commercial 2,708 6.3 4.8 2.7 Industrial 1,795 (2.8) (9.0) (6.9) Other 17 (0.1) - - ------------ Total retail 8,534 4.5 (0.3) 0.4 Sales for resale Non-affiliates 1,397 (1.6) (2.8) 2.0 Affiliates 759 (13.1) (15.2) (14.8) ------------ Total 10,690 2.2 (2.1) (1.1) ==================================================================\nRetail sales increased in 1995 due to hot summer weather, a 0.9 percent increase in residential customers, and a 2.2 percent increase in commercial customers. Industrial sales were lower due to the reclassification of a major customer from the industrial to commercial class and temporary production delays of other industrial customers. In 1994, retail sales decreased from the prior year primarily due to mild summer weather and a decline in sales in the industrial class, which reflected the loss of Monsanto and a lengthy shutdown of another major customer.\nIn 1995, energy sales for resale to non-affiliates decreased 1.6 percent and are predominantly related to unit power sales under long-term contracts to Florida utilities. Energy sales to affiliated companies vary from year to year as mentioned previously.\nExpenses\nTotal operating expenses for 1995 increased $41.3 million or 8.5 percent from 1994. The increase is due to higher fuel and purchased power expenses, higher maintenance expenses, and higher taxes other than income taxes, offset by lower depreciation and amortization expenses. In 1994, total operating expenses decreased $4.0 million or 0.8 percent from 1993 primarily due to decreased fuel and purchased power expenses, offset by an increase in other operation expenses and taxes.\nFuel and purchased power expenses for 1995 increased $30.1 million or 15.5 percent from 1994. The change reflects the increase in generation due to the extreme weather conditions during the summer of 1995 and slightly higher fuel\nII-145\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Gulf Power Company 1995 Annual Report\ncosts. In 1994, fuel and purchased power expenses declined $13.4 million or 6.5 percent from 1993 reflecting the decrease in generation due to the mild weather and the lower cost of fuel.\nThe amount and sources of generation and the average cost of fuel per net kilowatt-hour generated were as follows:\n1995 1994 1993 ----------------------------- Total generation (millions of kilowatt-hours) 9,828 9,559 9,558 Sources of generation (percent) Coal 99.5 99.8 99.4 Oil and gas .5 .2 .6 Average cost of fuel per net kilowatt-hour generated (cents) Coal 2.08 2.00 2.03 Oil and gas 3.56 6.93 4.50 Total 2.09 2.01 2.05 - - ------------------------------------------------------------------\nIn 1995, other operation expenses decreased $0.5 million or 0.4 percent from the 1994 level. The decrease is primarily attributable to a $9.4 million reduction in the amortization costs of coal buyouts and renegotiation of coal supply contracts. This was offset by a $7 million accrual for benefits to be provided by the Company under a work force reduction program implemented during the fourth quarter of 1995. These costs are further discussed in Notes 2 and 5 to the financial statements under \"Work Force Reduction Programs\" and \"Fuel Commitments,\" respectively. In 1994, other operation expenses increased $4.7 million due to additional costs related to the buyouts and renegotiation of coal supply contracts and the Company's pro rata share of affiliated companies' work force reduction costs.\nMaintenance expense in 1995 increased $5.2 million or 11.2 percent from the prior year. This is attributable to higher power production maintenance related to non-recurring items and higher distribution maintenance. In 1994, maintenance expense remained relatively flat reflecting no major changes in the scheduling of maintenance of production facilities.\nDepreciation and amortization expenses decreased $1.5 million or 2.7 percent from 1994. The change is attributable to property which was fully amortized by December 1994. Refer to Note 1 to the financial statements under \"Depreciation and Amortization\" for further discussion.\nFederal and state income taxes increased $0.1 million or 0.3 percent in 1995 due to a slight increase in taxable income. Taxes other than income taxes increased $7.9 million or 18.9 percent due to an increase in county franchise fees as mentioned previously. In 1994, federal income taxes increased $1.2 million 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. Changes in gross receipt taxes and franchise fee collections, which are collected from customers, have no impact on earnings.\nIn 1995, interest expense decreased $2.5 million or 7.8 percent below the prior year. The decline is mainly attributable to lower interest on long-term debt reflecting a lower average principal balance outstanding. The decrease in interest on long-term debt was partially offset by an increase in interest on notes payable as a result of a higher average amount of short-term notes outstanding. Interest expense in 1994 decreased $3.8 million or 10.5 percent under the prior year. The decrease was a result of refinancing some of the Company's higher-cost securities.\nEffects of Inflation\nThe Company is subject to rate regulation and income tax laws that are based on the recovery of historical costs. Therefore, inflation creates an economic loss because the Company is recovering its cost of investments in dollars that have less purchasing power. While the inflation rate has been relatively low in recent years, it continues to have an adverse effect on the Company because of the large investment in long-lived utility plant. Conventional accounting for historical cost does not recognize this economic loss nor the partially offsetting gain that arises through financing facilities with fixed-money obligations, such as long-term debt and preferred stock. Any recognition of inflation by regulatory authorities is reflected in the rate of return allowed.\nII-146\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Gulf Power Company 1995 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 energy sales growth to a less regulated more competitive environment.\nA work force reduction program was implemented in the fourth quarter of 1995 that reduced earnings by $4.3 million. This action will assist in efforts to control growth in future operating expenses.\nThe Florida Public Service Commission (FPSC) approved the Company's request in December to increase the amount of its annual accrual to the accumulated provision for property damage account from $1.2 million to $3.5 million due to significant hurricane-related charges to the account during 1995. The approved accrual increase is intended to restore the account balance to a reasonable level within five years. Refer to Note 1 to the financial statements under \"Provision for Property Damage\" for further discussion.\nFuture earnings in the near term will depend upon growth in energy sales, which is subject to a number of factors. Traditionally, these factors have included weather, competition, changes in contracts with neighboring utilities, energy conservation practiced by customers, the elasticity of demand, 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 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 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. Also, electricity sales for resale rates are being driven down by wholesale transmission access and numerous potential new energy suppliers, including power marketers and brokers. The Company is aggressively working to maintain and expand its share of wholesale sales in the Southeastern power markets.\nCurrently, 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. Potential new federal legislation is being discussed, and legislation allowing customer choice has already been introduced in Florida. 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 by seeking new markets that evolve with the changing regulation.\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 was the loss in 1993 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 FPSC has set conservation goals for the Company, beginning in 1995, which require programs to reduce 154 megawatts of summer peak demand and 65,000 KWH of sales by the year 2004. In 1995, the FPSC approved the Company's programs to accomplish these goals. The Company can experience net growth as long as the filed programs achieve the intended reductions in peak demand and KWH sales. 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.\nII-147\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Gulf Power Company 1995 Annual Report\nOn September 27, 1995, the Company filed a petition with the FPSC which seeks approval for a new optional Commercial\/Industrial Service (CIS) rider, which would be applicable to the rate schedules serving the Company's largest and most at-risk customers who are able to show they have viable alternatives for electric power supply. The CIS rider would provide the flexibility needed to enable the Company to offer its services in a more competitive manner to these customers. The FPSC approval process is expected to take approximately 8 months.\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.\"\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 and determine if any other assets have been impaired. See Note 1 to the financial statements under \"Regulatory Assets and Liabilities\" for additional information.\nNew Accounting Standards\nThe FASB has issued Statement No. 121, Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of. This statement requires that long-lived assets be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount for an asset may not be recoverable. This statement also imposes stricter criteria for regulatory assets by requiring that such assets be probable of future recovery at each balance sheet date. The Company adopted the new rules January 1, 1996, with no material effect on the financial statements. However, this conclusion may change in the future as competitive factors influence wholesale and retail pricing in the utility industry.\nFINANCIAL CONDITION\nOverview\nThe principal changes in the Company's financial condition during 1995 were gross property additions of $63.1 million and an increase of $27 million in notes payable. Funds for the property additions were provided by internal sources. The increase in short-term notes payable is primarily attributable to a $22 million note issued in relation to a payment made to a coal supplier for a new arrangement under an existing coal contract. See the Statements of Cash Flows and Note 5 to the financial statements under \"Fuel Commitments\" for further details.\nFinancing Activities\nThe Company continued to lower its financing costs by retiring issues in 1995. Retirements, including maturities during 1995, totaled $1.8 million of first mortgage bonds, $0.1 million of pollution control bonds, $13.3 million of bank notes and other long-term debt, and $1 million of preferred stock. (See the Statements of Cash Flows for further details.)\nComposite financing rates for the years 1993 through 1995 as of year end were as follows:\n1995 1994 1993 ------------------------------ Composite interest rate on long-term debt 6.5% 6.5% 7.1% Composite preferred stock dividend rate 6.4% 6.6% 6.5% - - ----------------------------------------------------------------\nThe composite interest rate on long-term debt remained constant at 6.5% from 1994 primarily due to no new issues or refinancings during 1995. The decrease in the composite interest rate from 1993 to 1994 reflects the Company's efforts to refinance higher-cost debt. The decrease in the composite preferred dividend rate in 1995 is primarily due to a decrease in dividends on the Company's adjustable rate preferred stock, reflecting lower interest rates.\nII-148\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Gulf Power Company 1995 Annual Report\nCapital Requirements for Construction\nThe Company's gross property additions, including those amounts related to environmental compliance, are budgeted at $209 million for the three years beginning in 1996 ($71 million in 1996, $67 million in 1997, and $71 million in 1998). The estimates of property additions for the three-year period include $9 million committed to meeting the requirements of the Clean Air Act, the cost of which is expected to be recovered through the Environmental Cost Recovery Clause (ECRC), 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 changes in business conditions; 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 for the Company will be fully recovered. The Company does not have any baseload generating plants under construction, and current energy demand forecasts do not indicate a need for any additional baseload facilities until well into the future. 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 $109 million will be required by the end of 1998 in connection with maturities of long-term debt. 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 -- has significantly impacted the Company. Specific reductions in sulfur dioxide and nitrogen oxide emissions from fossil-fired generating plants are required in two phases. Phase I compliance began in 1995 and initially affected 28 generating units of The Southern Company. As a result of The Southern Company's compliance strategy, an additional 22 generating units were brought into compliance with Phase I requirements. Phase II compliance is required by 2000, and all fossil-fired generating plants 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 recovery mechanism. 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 ECRC.\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 achieved Phase I sulfur dioxide compliance at the affected plants by switching to low-sulfur coal, which required some equipment upgrades. This compliance strategy resulted in unused emission allowances being banked for later use. Compliance with nitrogen oxide emission limits was achieved by the installation of new control equipment at 22 generating units. Construction expenditures for Phase I compliance totaled approximately $320 million for The Southern Company, including approximately $50 million for the Company 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 units as required to meet Phase II limits. Therefore, during the period 1996 to 2000, the current compliance strategy could\nII-149\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Gulf Power Company 1995 Annual Report\nrequire total construction expenditures of approximately $150 million for The Southern Company, including approximately $10 million for the Company. 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.\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 2 percent in 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 in 1996. 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 is evaluating the need to revise the ambient air quality standards for particulate matter 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 1996, 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. Additional sites may require environmental remediation for which the Company may be liable for a portion or all required cleanup costs. For additional information, see Note 3 to the financial statements under \"Environmental Cost Recovery.\"\nSeveral major pieces of environmental legislation are being considered for reauthorization or amendment by Congress. These include: the Clean Air Act; 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 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 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-150\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Gulf Power Company 1995 Annual Report\nSources of Capital\nAt December 31, 1995, the Company had $0.7 million of cash and cash equivalents and $25 million of unused committed lines of credit with banks to meet its short-term cash needs. See Note 5 to the financial statements under \"Bank Credit Arrangements\" for additional information.\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 Gulf Power Company 1995 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), The Southern Development and Investment Group (Southern Development), and other direct and indirect subsidiaries. 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. Gulf Power Company provides electric service to the Northwest Panhandle of Florida. 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 provides digital wireless communications services to the operating companies and also markets these services to the public within the Southeast. Southern Electric designs, builds, owns and operates power production and delivery 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. Southern Development 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. The preparation of financial statements in conformity with generally accepted accounting principles requires the use of estimates, and the actual results may differ from those estimates.\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:\n1995 1994 ------------------------ (in thousands) Current & deferred coal contract costs $ 46,535 $ 40,690 Deferred income taxes 29,093 30,433 Deferred loss on reacquired debt 17,015 18,494 Environmental remediation 5,789 7,800 Vacation pay 4,419 4,172 Regulatory clauses under recovery, net 632 1,042 Deferred income tax credits (67,481) (71,964) Deferred storm charges 7,502 - Accumulated provision for property damage - (11,522) Other, net (1,510) (2,691) - - ---------------------------------------------------------------- Total $ 41,994 $ 16,454 ================================================================\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, if impaired, to their fair values.\nII-159\nNOTES (continued) Gulf Power Company 1995 Annual Report\nRevenues and Regulatory Cost Recovery Clauses\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 periodically adjust billings for fluctuations in fuel and the energy component of purchased power costs. The Company also has similar cost recovery clauses for energy conservation costs, purchased power capacity costs, and environmental compliance costs. Revenues are adjusted monthly for differences between recoverable costs and amounts actually reflected in current rates.\nThe Company has a diversified base of customers. No single customer or industry comprises 10 percent or more of revenues. In 1995, uncollectible accounts continued to average significantly less than 1 percent of revenues.\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 3.6 percent in 1995 and 3.8 percent in 1994 and 1993. 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. Also, the provision for depreciation expense includes an amount for the expected cost of removal of facilities. The decrease in 1995 is attributable to property which was fully amortized by December 1994.\nIncome Taxes\nThe Company uses the liability method of accounting for deferred income taxes and 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. The Company is included in the consolidated federal income tax return of The Southern Company. See Note 8 for further information related to income taxes.\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 1995, 1994, and the second half of 1993 and 8.03 percent for the first half of 1993. AFUDC amounts for 1995, 1994, and 1993 were $223 thousand, $1.1 million, and $966 thousand, respectively. The decrease in 1995 is primarily due to the completion of major construction projects at Plant Daniel at the end of 1994.\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 1995 Annual Report\nFinancial Instruments\nIn accordance with FASB Statement No. 107, Disclosure About Fair Values of Financial Instruments, financial instruments of the Company, for which the carrying amounts do not approximate fair value, are shown in the table below as of December 31:\n---------------------------- Carrying Fair Amount Value ---------------------------- (in thousands) Long-term debt $354,924 $365,305 - - -------------------------------------------------------------\n---------------------------- Carrying Fair Amount Value ---------------------------- (in thousands) Long-term debt $369,832 $355,019 Preferred stock subject to mandatory redemption 1,000 1,030 - - -------------------------------------------------------------\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.\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 $1.7 million and $2.5 million at December 31, 1995 and 1994, respectively, is included in miscellaneous current liabilities in the accompanying Balance Sheets.\nProvision for Property Damage\nThe Company is self-insured for the full cost of storm and other damage to its transmission and distribution property. At December 31, 1995, in accordance with the FPSC's order, the accumulated provision for property damage had a negative balance of $7.5 million as the result of charges for expenses relating to Hurricanes Erin and Opal. The negative balance was reclassified to deferred storm charges in the accompanying Balance Sheets. The FPSC approved the Company's request in December to increase the amount of its annual accrual to the accumulated provision for property damage account from $1.2 million to $3.5 million, effective October 1, 1995. The approved accrual increase is intended to restore the account balance to a reasonable level within five years. The FPSC also ordered the Company to file within six months a study addressing the appropriate accumulated provision account balance and annual accrual amount. At December 31, 1994, the accumulated provision for property damage amounted to $11.5 million. The expense of repairing damages from major storms and other uninsured property damages are charged to the provision account.\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 one of the following 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 1995 Annual Report\nPostretirement Benefits\nThe Company provides certain medical care and life insurance benefits for retired employees. Substantially all employees may become eligible for these benefits when they retire. Trusts are funded to the extent deductible under federal income tax regulations or to the extent required by the Company's regulatory commissions. Amounts funded are primarily invested in equity and fixed-income securities. FASB Statement No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions, 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.\"\nFunded Status and Cost of Benefits\nThe following tables show actuarial results and assumptions for pension and postretirement 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 ------------------------- 1995 1994 ------------------------- (in thousands) Actuarial present value of benefit obligation: Vested benefits $ 87,652 $ 73,552 Non-vested benefits 4,284 3,016 - - ------------------------------------------------------------------ Accumulated benefit obligation 91,936 76,568 Additional amounts related to projected salary increases 29,073 29,451 - - ------------------------------------------------------------------ Projected benefit obligation 121,009 106,019 Less: Fair value of plan assets 180,980 151,337 Unrecognized net gain (48,438) (36,599) Unrecognized prior service cost 2,578 2,802 Unrecognized transition asset (7,187) (8,034) - - ------------------------------------------------------------------ Prepaid asset recognized in the Balance Sheets $ 6,924 $ 3,487 ==================================================================\nPostretirement Benefits\n--------------------------- 1995 1994 --------------------------- (in thousands) Actuarial present value of benefit obligation: Retirees and dependents $ 9,759 $10,800 Employees eligible to retire 4,921 4,043 Other employees 17,646 19,639 - - ---------------------------------------------------------------- Accumulated benefit obligation 32,326 34,482 Less: Fair value of plan assets 7,050 5,740 Unrecognized net loss (gain) 1,538 (458) Unrecognized transition obligation 7,437 15,520 - - ---------------------------------------------------------------- Accrued liability recognized in the Balance Sheets $16,301 $13,680 ================================================================\nIn 1995, the Company announced a cost sharing program for postretirement benefits. The program establishes limits on amounts the Company will pay to provide future retiree postretirement benefits. This change reduced the 1995 accumulated postretirement benefit obligation by approximately $7.1 million.\nThe weighted average rates assumed in the actuarial calculations were:\n1995 1994 1993 ----------------------------- Discount 7.3% 8.0% 7.5% Annual salary increase 4.8% 5.5% 5.0% Long-term return on plan assets 8.5% 8.5% 8.5% - - ---------------------------------------------------------------\nAn additional assumption used in measuring the accumulated postretirement benefit obligation was a weighted average medical care cost trend rate of 9.8 percent for 1995, decreasing to 5.3 percent through the year 2005 and remaining at that level thereafter. An annual increase in the assumed medical care cost trend rate of 1 percent would increase the accumulated benefit obligation at December 31, 1995, by $2.5 million and the aggregate of the service and interest cost components of the net retiree cost by $610 thousand.\nII-162\nNOTES (continued) Gulf Power Company 1995 Annual Report\nComponents of the plans' net costs are shown below:\nPension ------------------------------------ 1995 1994 1993 ------------------------------------ (in thousands) Benefits earned during the year $ 3,867 $ 3,775 $ 3,710 Interest cost on projected benefit obligation 8,042 7,484 7,319 Actual (return) loss on plan assets (33,853) 3,721 (20,672) Net amortization and deferral 19,619 (17,054) 8,853 - - ------------------------------------------------------------------ Net pension cost (income) $ (2,325) $(2,074) $ (790) ==================================================================\nOf the above net pension amounts, pension income of $1.8 million in 1995, $1.5 million in 1994, and $601 thousand in 1993 were recorded in operating expenses, and the remainder was recorded in construction and other accounts.\nPostretirement Benefits -------------------------------- 1995 1994 1993 -------------------------------- (in thousands) Benefits earned during the year $1,259 $1,362 $1,166 Interest cost on accumulated benefit obligation 2,520 2,535 2,339 Amortization of transition obligation 853 854 854 Actual (return) loss on plan (1,268) 129 (731) assets Net amortization and deferral 742 (591) 310 - - ------------------------------------------------------------------- Net postretirement cost $4,106 $4,289 $3,938 ===================================================================\nOf the above net postretirement costs recorded, $3.1 million in 1995 and 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 implemented a voluntary work force reduction program in the fourth quarter of 1995 and recorded $7 million in December for the total cost related to the program. These costs are expected to be recovered through future savings over approximately two years. The Company has also incurred its pro rata share for the costs of affiliated companies' programs. The costs related to these programs were $1 million, $1.3 million, and $109 thousand for the years 1995, 1994, and 1993, 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 operating companies' 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. In 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 was substantially from October 1994 through December 1995. In November 1995, a FERC administrative law judge issued an opinion that the FERC staff failed to meet its burden of proof, and therefore, no change in the equity return was necessary. The FERC staff has filed exceptions to the administrative law judge's opinion, and the matter remains pending before the FERC.\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 $120 million for The Southern Company, including approximately $8 million for the Company at December 31, 1995. However, management believes that rates are not excessive and that refunds are not justified.\nII-163\nNOTES (continued) Gulf Power Company 1995 Annual Report\nFPSC Review of Earnings\nAs a result of an investigation of Gulf's 1995 earnings by the FPSC, Gulf presented a 1995 earnings proposal, which required deferring any jurisdictional revenues contributing to annual earnings in excess of a 12.75% jurisdictional-adjusted return on equity. The proposal was approved by the FPSC in August 1995. Gulf was to petition the FPSC to determine the disposition of any deferred revenues by April 1996. Based on 1995 actual results, no revenues were deferred.\nEnvironmental Cost Recovery\nIn April 1993, the Florida Legislature adopted legislation for an Environmental Cost Recovery Clause (ECRC), 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 recovery mechanism. Such environmental costs include operation and maintenance expense, emission allowance expense, depreciation, and a return on invested capital.\nOn January 12, 1994, the FPSC approved the Company's initial petition under the ECRC for recovery of environmental costs that were projected to be incurred from July 1993 through September 1994. Since this initial period, recovery under the ECRC has been determined semi-annually and includes a true-up of the prior period and a projection of the ensuing six month period. During 1995 and 1994, the Company recorded ECRC revenues of $11.8 million and $7.2 million, respectively.\nAt December 31, 1995, the Company's liability for the estimated costs of environmental remediation projects for known sites was $5.8 million. These estimated costs are expected to be expended during the period 1996 to 1999. These projects have been approved by the FPSC for recovery through the ECRC discussed above. Therefore, the Company recorded $2.0 million in current assets and $3.8 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 $71 million in 1996, $67 million in 1997, and $71 million in 1998. 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, 1995, significant purchase commitments were outstanding in connection with the construction program. The Company does not have any new baseload 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, pollution control 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, 1995, the Company had $20 million in revolving credit lines that expire May 31, 1998, $5 million in revolving credit lines subject to renewal June 1, 1997, and $21.5 million of lines of credit with banks subject to renewal June 1 of each year, of which $25 million remained unused. In connection with these credit lines, the Company has agreed to pay commitment fees and\/or to\nII-164\nNOTES (continued) Gulf Power Company 1995 Annual Report\nmaintain compensating balances with the banks. The compensating balances, which represent substantially all of the cash of the Company except for daily working funds and like items, are not legally restricted from withdrawal. In addition, the Company has bid-loan facilities with fourteen major money center banks that total $250 million, of which $37 million was committed at December 31, 1995.\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 at December 31, 1995, were as follows:\nYear Fuel ------- --------------- (in millions) 1996 $ 125 1997 126 1998 95 1999 86 2000 80 2001 - 2007 557 ------------------------------------------------------- Total commitments $1,069 =======================================================\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. The remaining unamortized amount was $1.5 million at December 31, 1995.\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 $23 million at December 31, 1995.\nIn 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, 1994, and the first quarter of 1995.\nIn December 1995, the Company made a payment of $22 million to a coal supplier under an arrangement to lower the cost of future coal and\/or to suspend the purchase of coal under an existing contract for 25 months. This amount is to be amortized to expense on a per ton basis during 1996, 1997, and the first quarter of 1998.\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.\nLease Agreements\nIn 1989, the Company and Mississippi Power jointly entered into a twenty-two year operating lease agreement for the use of 495 aluminum railcars. In 1994, a second lease agreement for the use of 250 additional aluminum railcars was entered into 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 was $1.7 million in 1995 and $1.2 million in 1994 and 1993. The Company's annual lease payments for 1996 through 2000 will be approximately $1.7 million and after 2000, lease payments total approximately $22.4 million. The Company has the option after three years from the date of the original contract on the second lease agreement to purchase the 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.\nII-165\nNOTES (continued) Gulf Power Company 1995 Annual Report\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, an operating affiliate, jointly own Plant Scherer Unit No. 3. Plant Scherer is 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, 1995, the Company's percentage ownership and its investment in these jointly owned facilities were as follows:\nPlant Scherer Plant Unit No. 3 Daniel (coal-fired) (coal-fired) ------------------------------ (in thousands) Plant In Service $185,755(1) $222,515 Accumulated Depreciation $49,982 $97,033 Construction Work in Progress $288 $683\nNameplate Capacity (2) (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\nThe Company and the other operating affiliates have 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. The unit power sales 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:\nOther Unit Long- Year Power Term Total - - ---------- ------------------------------------ (in thousands) 1995 $25,870 $ - $25,870 1994 29,653 1,273 30,926 1993 31,162 2,643 33,805 - - ----------------------------------------------------------\nUnit power from specific generating plants of The Southern Company is currently 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, 210 megawatts of net dependable capacity were sold by the Company during 1995, 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 $25.4 million in 1995, $29.3 million in 1994, and $39.5 million in 1993, or 4.1 percent, 5.1 percent, and 6.8 percent of operating revenues, respectively.\nII-166\nNOTES (continued) Gulf Power Company 1995 Annual Report\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, 1995, the tax-related regulatory assets to be recovered from customers were $29.1 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, 1995, the tax-related regulatory liabilities to be refunded to customers were $67.5 million. These liabilities are attributable to deferred taxes previously recognized at rates higher than current enacted tax law and to unamortized investment tax credits.\nAt December 31, 1995, the Company's current federal and state income taxes accrued, including the current portion of deferred income taxes, were equal to a debit balance of $4.2 million as a result of the early settlement of taxes owed. This amount was reclassified to current assets to reflect the tax prepayment and will be used to satisfy taxes accrued during 1996.\nDetails of the federal and state income tax provisions are as follows:\n1995 1994 1993 ---------------------------------- (in thousands) Total provision for income taxes: Federal-- Currently payable $29,018 $34,941 $24,354 Deferred--current year 23,172 18,556 26,396 --reversal of prior years (23,116) (24,787) (22,102) - - ------------------------------------------------------------------ 29,074 28,710 28,648 - - ------------------------------------------------------------------ State-- Currently payable 4,778 5,907 3,950 Deferred--current year 3,313 2,549 3,838 --reversal of prior years (2,979) (3,304) (2,785) - - ------------------------------------------------------------------ 5,112 5,152 5,003 - - ------------------------------------------------------------------ Total 34,186 33,862 33,651 Less income taxes charged (credited) to other income 121 (95) 921 - - ------------------------------------------------------------------ Federal and state income taxes charged to operations $34,065 $33,957 $32,730 ==================================================================\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:\n1995 1994 ----------------------- (in thousands) Deferred tax liabilities: Accelerated depreciation $146,926 $146,686 Property basis differences 19,976 18,468 Coal contract buyouts 3,838 6,896 Property insurance 3,039 - Other 10,573 11,846 - - ------------------------------------------------------------------- Total 184,352 183,896 - - ------------------------------------------------------------------- Deferred tax assets: Federal effect of state deferred taxes 10,212 9,732 Postretirement benefits 5,494 4,383 Property insurance - 5,200 Other 6,313 7,566 - - ------------------------------------------------------------------- Total 22,019 26,881 - - ------------------------------------------------------------------- Net deferred tax liabilities 162,333 157,015 Less current portion, net (12) 5,334 - - ------------------------------------------------------------------- Accumulated deferred income taxes in the Balance Sheets $162,345 $151,681 ===================================================================\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 1995, 1994 and 1993. At December 31, 1995, 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:\n1995 1994 1993 ----------------------------- Federal statutory rate 35% 35% 35% State income tax, net of federal deduction 4 4 3 Non-deductible book depreciation 1 1 1 Difference in prior years' deferred and current tax rate (3) (2) (2) Other (2) (2) (1) - - --------------------------------------------------------------- Effective income tax rate 35% 36% 36% ===============================================================\nThe Company and the other subsidiaries of The Southern Company file a consolidated federal tax return. Under a joint consolidated income tax agreement, each subsidiary's current and deferred tax expense is computed\nII-167\nNOTES (continued) Gulf Power Company 1995 Annual Report\non a stand-alone basis. Tax benefits from losses of the parent company are allocated to each subsidiary based on the ratio of taxable income to total consolidated taxable income.\n9. POLLUTION CONTROL OBLIGATIONS AND OTHER LONG-TERM DEBT\nDetails of pollution control bonds and other long-term debt at December 31 are as follows:\n1995 1994 -------------------------- (in thousands) Obligations incurred in connection with the sale by public authorities of tax-exempt pollution control revenue bonds: Collateralized 6% due 2006* $ 12,075 $ 12,200 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 22,000 Variable Rate Remarketable daily 20,000 20,000 - - --------------------------------------------------------------- $169,630 $169,755 - - --------------------------------------------------------------- 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 12,074 16,388 - - --------------------------------------------------------------- 37,074 50,388 - - --------------------------------------------------------------- Total $206,704 $220,143 ===============================================================\n* Sinking fund requirement applicable to the 6 percent pollution control bonds is $200 thousand for 1996 with increasing increments periodically 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.\nThe 5.39 percent and 5.72 percent notes payable were 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). The estimated annual maturities of the notes payable through 2000 are as follows: $29.6 million in 1996, $4.9 million in 1997, $2.6 million in 1998, and none in 1999 and 2000.\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 at December 31 is as follows:\n1995 1994 ---------------------- (in thousands) Bond improvement fund requirement $ 1,750 $ 1,750 Less: Portion to be satisfied by cash or certifying property additions - 1,750 - - --------------------------------------------------------------- Cash sinking fund requirement 1,750 - Current portion of notes payable 29,598 13,314 (Note 9) Pollution control bond maturity 200 125 (Note 9) - - --------------------------------------------------------------- Total $31,548 $13,439 ===============================================================\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.\nII-168\nNOTES (continued) Gulf Power Company 1995 Annual Report\n11. COMMON STOCK DIVIDEND RESTRICTIONS\nThe Company's first mortgage bond indenture contains various common stock dividend restrictions which remain in effect as long as the bonds are outstanding. At December 31, 1995, retained earnings of $101 million were 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, 1995, the ratio was 48.7 percent.\n12. QUARTERLY FINANCIAL DATA (Unaudited)\nSummarized quarterly financial data for 1995 and 1994 are as follows:\nNet Income After Dividends Operating Operating on Preferred Quarter Ended Revenues Income Stock - - ------------------------------------------------------------------ (in thousands) March 31, 1995 $140,918 $19,503 $10,880 June 30, 1995 153,057 23,390 14,096 Sept. 30, 1995 184,251 35,187 26,588 Dec. 31, 1995 140,851 13,082 5,590\nMarch 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 - - ------------------------------------------------------------------\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-175C\nII-176\nII-177A\nII-177B\nII-177C\nII-178\nII-179A\nII-179B\nII-179C\nII-180\nII-181A\nII-181B\nII-181C\nGULF POWER COMPANY OUTSTANDING SECURITIES AT DECEMBER 31, 1995\nFirst Mortgage Bonds Amount 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% 930 9\/1\/08 1991 50,000 8-3\/4% 50,000 12\/1\/21 ------------ ------------ $ 175,000 $ 150,930 ============ ============\nPollution Control Bonds Amount Interest Amount Series Issued Rate Outstanding Maturity - - -------------------------------------------------------------------------------- (Thousands) (Thousands) 1976 $ 12,500 6% $ 12,075 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 $ 169,630 ============ ===========\nPreferred Stock Shares 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 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 ============ =========== 2,831,026 $ 89,602 ============ ===========\nII-182\nGULF POWER COMPANY\nSECURITIES RETIRED DURING 1995\nFirst Mortgage Bonds Principal Interest Series Amount Rate - - -------------------------------------------------------------------------------- (Thousands) 1978 $ 1,750 9%\nPollution Control Bonds Principal Interest Series Amount Rate - - -------------------------------------------------------------------------------- (Thousands) 1976 $ 125 6%\nPreferred Stock Principal 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 1995 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\/ Dwight H. Evans Dwight H. Evans President and Chief Executive Officer\n\/s\/ Michael W. Southern Michael W. Southern Vice President, Secretary, Treasurer and Chief Financial Officer\nFebruary 21, 1996\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, 1995 and 1994, 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, 1995. 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, 1995 and 1994, and the results of its operations and its cash flows for the periods stated, in conformity with generally accepted accounting principles.\n\/s\/ Arthur Andersen LLP Atlanta, Georgia February 21, 1996\nII-186\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Mississippi Power Company 1995 Annual Report\nRESULTS OF OPERATIONS\nEarnings\nMississippi Power Company's net income after dividends on preferred stock for 1995 totaled $52.5 million, an increase of $3.4 million over the prior year. This improvement is attributable primarily to increased energy sales and a rate increase under the Environmental Compliance Overview Plan (ECO Plan) of $3.7 million annually which became effective in May 1995.\nA comparison of 1994 to 1993 reflects an increase in 1994 earnings of $6.7 million. Earnings in 1994 increased due to higher energy sales and increases in retail and wholesale rates.\nIn July 1993, a retail rate increase of $6.4 million annually became effective under the Company's Performance Evaluation Plan (PEP). Effective April 1994, retail rates increased by $7.6 million annually under the ECO Plan. Also, effective in April 1994 was a $3.6 million wholesale rate increase.\nRevenues\nThe following table summarizes the factors impacting operating revenues for the past three years:\nIncrease (Decrease) from Prior Year ----------------------------------- 1995 1994 1993 ----------------------------------- (in thousands) Retail -- Change in base rates (PEP and ECO Plan) $ 2,694 $9,314 $ 5,079 Sales growth 4,045 9,560 5,606 Weather 4,513 1,752 4,735 Fuel cost recovery and other 3,806 6,594 15,028 ------------------------------------------------------------- Total retail 15,058 27,220 30,448 ------------------------------------------------------------- Sales for resale -- Non-affiliates 3,698 4,611 3,298 Affiliates (1,847) (5,981) 5,464 ------------------------------------------------------------- Total sales for resale 1,851 (1,370) 8,762 Other operating revenues 482 (1,571) 1,226 ------------------------------------------------------------- Total operating revenues $17,391 $24,279 $40,436 ============================================================= Percent change 3.5% 5.1% 9.3% -------------------------------------------------------------\nRetail revenues of $410 million in 1995 increased 3.8 percent over the prior year, compared with increases of 7.4 percent and 9.0 percent in 1994 and 1993, respectively. The increase in retail revenues for 1995 was a result of growth in energy sales of 6.7% and 6.2% to commercial and residential customers, respectively, due to above normal summer temperatures. Additionally in 1995, an increase in the number of customers and a retail rate increase from the ECO Plan had a positive effect on retail revenues. A comparison of retail revenues of 1994 to 1993 reflects an increase resulting from growth in energy sales and customers and retail and wholesale rate increases. Changes in base rates reflect rate changes made under the PEP and ECO Plan.\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\nII-187\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Mississippi Power Company 1995 Annual Report\nfuel expenses are offset with corresponding changes in fuel revenues and have no effect on net income.\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 13.1 percent in 1995 and 7.8 percent in 1994 with the related revenues rising 16.7 percent and 14.0 percent, respectively. The customer demand experienced by these utilities is determined by factors very similar to Mississippi Power's.\nSales for resale to 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:\n1995 1994 1993 ------------------------------------- (in thousands) Capacity $ 268 $ 1,965 $ 4,191 Energy 3,627 8,473 12,120 ========================================================== Total $3,895 $10,438 $16,311 ==========================================================\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 1995 and the percent change for the last three years:\nAmount Percent Change (millions of ----------- ------------------------------ kilowatt-hours) 1995 1995 1994 1993 ---------- ------------------------------ Residential 2,041 6.2% (0.4)% 6.9% Commercial 2,242 6.7 8.6 6.8 Industrial 3,813 (0.9) 6.2 2.5 Other 39 1.1 (0.5) 0.3 ---------- Total retail 8,135 2.9 5.1 4.7 Sales for resale -- Non-affiliates 2,493 (2.4) 0.4 (5.3) Affiliates 244 39.7 (59.2) 52.2 ---------- Total 10,872 2.2% 1.3% 3.3% ================================================================\nTotal retail energy sales in 1995 increased, compared to the previous year, due to both weather influences and the continued improving economy within the Company's service area, related primarily to the casino industry. In 1994, the most notable factor that increased commercial energy sales above the 1993 level was the establishment of casinos within the Company's service area. While the Company expects the number of new casinos to slow appreciably, it anticipates continued growth in ancillary services such as lodging, food, transportation, etc. Also, energy demand is expected to grow as a result of a larger and more fully employed population.\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 1995 increased from 1994 due to higher fuel expenses, increased other operation expenses and increased depreciation and amortization. Expenses in 1994 were higher than 1993 primarily because of higher taxes and an increase in maintenance expenses and depreciation and amortization.\nFuel costs constitute the single largest expense for Mississippi Power. These costs increased in 1995 due to a 13.0% increase in generation caused by higher demand for energy throughout the Southern electric system. Further, this\nII-188\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Mississippi Power Company 1995 Annual Report\nincreased demand for energy resulted in higher purchased power costs from the non-affiliates and lower purchased power costs from the affiliates of the Southern electric system. Fuel expenses in 1994, compared to 1993, were lower due to decreased generation reflecting lower 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 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:\n1995 1994 1993 ------------------------------ Total generation (millions of kilowatt-hours) 8,368 7,408 7,836 Sources of generation generation (percent) -- Coal 58 56 64 Gas 15 10 7 Oil * * * Purchased Power 27 34 29 Average cost of fuel per net kilowatt-hour generated (cents) -- Coal 1.58 1.67 1.66 Gas 2.32 2.56 2.99 Oil 6.21 4.15 2.85 Total average cost of energy supply 1.53 1.55 1.58 - - -------------------------------------------------------------- * Not meaningful because of minimal generation from the fuel source.\nOther operation expenses increased in 1995 due to an increase in generation, emission allowance expenses of $2.6 million and an increase in costs associated with work force reduction programs. (See Note 2 to the financial statements for information on these work force reduction programs.) This increase in expenses was offset by a decrease in maintenance costs for 1995, when compared to 1994. In 1994, work force reduction programs contributed to the increase in other operation expenses above the recorded 1993 level.\nDepreciation and amortization increased in 1995, compared to 1994, due to additional plant investments. In 1994, depreciation and amortization expenses rose above 1993 primarily due to the addition in May 1994 of a 75 megawatt combustion turbine unit.\nIn 1995, taxes other than income taxes rose above the amount recorded for 1994 due to higher municipal franchise taxes. Taxes other than income taxes increased in 1994, when compared to 1993, because of higher ad valorem taxes, which are property based, and municipal franchise taxes, which are revenue based.\nThe change in income taxes between 1995 and 1994 reflects the change in operating income. The increase in income taxes in 1994 when compared to 1993 mirrored the increase in operating income.\nEffects of Inflation\nMississippi Power is subject to rate regulation and income tax laws that are based on the recovery of historical costs. Therefore, inflation creates an economic loss because the Company is recovering its costs of investments in dollars that have less purchasing power. While the inflation rate has been relatively low in recent years, it continues to have an adverse effect on the Company because of the large investment in long-lived utility plant. Conventional accounting for historical costs does not recognize this economic loss nor the partially offsetting gain that arises through financing facilities with fixed-money obligations, such as long-term debt and preferred stock. Any recognition of inflation by regulatory authorities is reflected in the rate of return allowed.\nFuture Earnings Potential\nThe results of operations for the past three years are not necessarily indicative of future earnings potential. The level of future earnings depends on numerous factors ranging from regulatory matters to energy sales growth to a less regulated more competitive environment. Expenses are subject to constant review and cost control programs. 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\nII-189\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Mississippi Power Company 1995 Annual Report\nefficiency, and aggressively controlling the construction budget. Operating revenues will be affected by any changes in rates under the PEP, the Company's performance based ratemaking plan, and the ECO Plan. PEP has proven to be a stabilizing force on electric rates, with only moderate changes in rates taking place.\nThe ECO Plan, provides for recovery of costs associated with environmental projects approved by the Mississippi Public Service Commission (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.\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 weather, competition, changes in contracts with neighboring utilities, energy conservation practiced by customers, the elasticity of demand, 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, and determine if any other assets have been impaired. See Note 1 to the financial statements under \"Regulatory Assets and Liabilities,\" for additional information.\nNew Accounting Standards\nThe FASB has issued Statement No. 121, Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of. This statement requires that long-lived assets be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount for an asset may not be recoverable. This statement also imposes stricter criteria for regulatory assets by requiring that such assets be probable of future recovery at each balance sheet date. The Company adopted the new rules January 1, 1996, with no material effect on the financial statements. However, this conclusion may change in the future as competitive factors influence wholesale and retail pricing in the utility industry.\nII-190\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Mississippi Power Company 1995 Annual Report\nFINANCIAL CONDITION\nOverview\nThe principal changes in Mississippi Power's financial condition during 1995 were gross property additions to utility plant of $68 million. Funding for gross property additions and other capital requirements came primarily from earnings and other operating cash flows and from the sale of first mortgage bonds and pollution control bonds. The Statements of Cash Flows provide additional details.\nFinancing Activity\nMississippi sold $30 million of first mortgage bonds and $10.6 million of pollution control bonds during 1995. Retirements, including maturities during 1995, primarily related to other long-term debt, totaled some $42 million of securities. (See the Statements of Cash Flows for further details.) Composite financing rates for the years 1993 through 1995 as of year-end were as follows:\n1995 1994 1993 ----------------------------- Composite interest rate on long-term debt 6.63% 6.44% 6.57%\nComposite preferred stock dividend rate 6.58% 6.58% 6.58% -----------------------------------------------------------\nCapital Structure\nAt year-end 1995, the Company's ratio of common equity to total capitalization, excluding long-term debt due within one year, was 50.8 percent, compared to 48.7 percent in 1994. The increase in equity ratio in 1995 is attributed to a decrease in long-term debt and additional retained earnings.\nCapital Requirements for Construction\nThe Company's projected construction expenditures for the next three years total $182 million ($67 million in 1996, $62 million in 1997, and $53 million in 1998). The major emphasis within the construction program will be on upgrading existing facilities. Also included in the estimates for property additions for the three-year period is $5.3 million committed to meeting the requirements of Clean Air Act regulations. Revisions may be necessary because of factors such as changes in business conditions, 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 $92.3 million will be required by the end of 1998 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 -- has significantly impacted 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 are required in two phases. Phase I compliance began in 1995 and initially affected 28 generating plants in the Southern electric system. As a result of The Southern Company's compliance strategy, an additional 22 generating units were brought into compliance with Phase I requirements. Phase II compliance is required in 2000, and all fossil-fired generating plants 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 achieved Phase I sulfur dioxide compliance at the affected plants by switching to low-sulfur coal, which has required some equipment upgrades. This compliance strategy resulted in unused emission\nII-191\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Mississippi Power Company 1995 Annual Report\nallowances being banked for later use. Compliance with nitrogen oxide emission limits was achieved by installation of new control equipment at 22 of the original 28 affected generating units. Construction expenditures for Phase I compliance totaled approximately $320 million through 1995 for The Southern Company, of which Mississippi Power's portion was 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 Phase II limits. Therefore, during the period 1996 to 2000, current compliance strategy for The Southern Company could require total estimated 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 the annual revenue requirement is limited to 2 percent of retail revenues. However, the plan also provides for carryover of any amount over the 2 percent limit into the next year's revenue requirement. Mississippi Power's management believes that the ECO Plan provides for recovery of the Clean Air Act costs. Under the ECO Plan, the Company had annual retail rate increases of $2.6 million, $7.6 million and $3.7 million in the years 1993, 1994 and 1995, respectively. On January 29, 1996, the Company filed the ECO Plan with the MPSC requesting an annual retail rate decrease of $3.0 million.\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 during 1996. 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 is evaluating the need to revise the ambient air quality standards for particulate matter 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 1996, 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 was investigated for potential remediation. The remedial investigation has been concluded and is pending approval by the\nII-192\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Mississippi Power Company 1995 Annual Report\nMississippi Department of Environmental Quality. In recognition of probable further study and remediation, the Company in 1995 recorded a liability and a deferred debit (regulatory asset) of $1.8 million, including feasibility study costs. The Company recognizes such costs as they are incurred and recovers them under the ECO Plan as provided in the Company's 1995 ECO order. 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.\nSeveral major pieces of environmental legislation are being considered for reauthorization or amendment by Congress. These include: the Clean Air Act; 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.\nSources of Capital\nAt December 31, 1995, 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 1995.\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\n11-194\nII-195\nII-196\nII-197\nII-198\nII-199\nNOTES TO FINANCIAL STATEMENTS Mississippi Power Company 1995 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 (Southern Development), and other direct and indirect subsidiaries. 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 provides digital wireless communications services to the operating companies and also markets these services to the public within the Southeast. Southern Electric designs, builds, owns, and operates power production and delivery 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. Southern Development 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. The preparation of financial statements in conformity with generally accepted accounting principles requires the use of estimates and the actual results may differ from those estimates.\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)\n1995 1994 ------------------------- Deferred income taxes $23,384 $25,036 Vacation pay 4,715 4,588 Work force reduction costs 7,286 11,286 Deferred fuel charges 1,546 10,068 Premium on reacquired debt 8,509 9,571 Deferred environmental costs 1,713 - Property damage reserve (12,018) (10,905) Deferred income tax credits (43,266) (45,832) Other, net (2,658) (3,383) ================================================================ Total $(10,789) $ 429 ================================================================\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, if impaired, to 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\nII-200\nNOTES (continued) Mississippi Power Company 1995 Annual Report\nfluctuations in costs for ad valorem taxes and certain qualifying environmental costs. 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 comprises 10 percent or more of revenues. In 1995, 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 1995 and 1994, and 3.1 percent in 1993. 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 removal of other facilities.\nIncome Taxes\nMississippi Power uses the liability method of accounting for deferred income taxes and 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.\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 8.0 percent in 1995, 6.9 percent in 1994, and 6.8 percent in 1993. AFUDC (net of income taxes), as a percent of net income after dividends on preferred stock, was 1.2 percent in 1995, and 3.5 percent in 1994 and 1993.\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, 1995, the fair value of long-term debt was $355 million and the carrying amount was $346 million. At December 31, 1994, the fair value of long-term debt was $331 million and the carrying amount was $348 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 1995 Annual Report\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 $1.5 million in 1995, $1.1 million in 1994 and $1.5 million in 1993. 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. Effective January 1995, regulatory treatment by the MPSC allowed a maximum accumulated provision of $18 million. As of December 31, 1995, the accumulated provision amounted to $12.0 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 one of the following 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. Trusts are funded to the extent required by the Company's regulatory commissions. Amounts funded are primarily invested in debt and equity securities.\nFASB Statement No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions, 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.\nFunded Status and Cost of Benefits\nThe following tables show actuarial results and assumptions for pension and postretirement 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 ------------------------ 1995 1994 ------------------------ (in thousands) Actuarial present value of benefit obligation: Vested benefits $91,322 $80,603 Non-vested benefits 4,264 2,966 -------------------------------------------------------------- Accumulated benefit obligation 95,586 83,569 Additional amounts related to projected salary increases 28,545 27,292 -------------------------------------------------------------- Projected benefit obligation 124,131 110,861 Less: Fair value of plan assets 170,481 145,598 Unrecognized net gain (47,034) (37,485) Unrecognized prior service cost 2,868 3,109 Unrecognized transition asset (6,001) (6,635) -------------------------------------------------------------- Prepaid asset (accrued liability) recognized in the Balance Sheets $(3,817) $(6,274) ==============================================================\nPostretirement Benefits ------------------------ 1995 1994 ------------------------ (in thousands) Actuarial present value of benefit obligation: Retirees and dependents $22,575 $22,833 Employees eligible to retire 1,709 774 Other employees 17,908 22,851 ------------------------------------------------------------ Accumulated benefit obligation 42,192 46,458 Less: Fair value of plan assets 8,700 6,608 Unrecognized net loss (gain) 4,160 1,751 Unrecognized transition obligation 7,044 18,668 ------------------------------------------------------------ Accrued liability recognized in the Balance Sheets $22,288 $19,431 ============================================================\nII-202\nNOTES (continued) Mississippi Power Company 1995 Annual Report\nIn 1995, The Southern Company's subsidiaries announced a cost sharing program for postretirement benefits. The program establishes limits on amounts the companies will pay to provide future retiree postretirement benefits. This change reduced the Company's 1995 accumulated postretirement benefit obligation by approximately $10.5 million.\nThe weighted average rates assumed in the above actuarial calculations were:\n1995 1994 1993 --------------------------------- Discount 7.3% 8.0% 7.5% Annual salary increase 4.8 5.5 5.0 Long-term return on plan assets 8.5 8.5 8.5 ------------------------------------------------------------\nAn additional assumption used in measuring the accumulated postretirement benefit obligation was a weighted average medical care cost trend rate of 9.8 percent for 1995, decreasing gradually to 5.3 percent through the year 2005 and remaining at that level thereafter. An annual increase in the assumed medical care cost trend rate of 1 percent would increase the accumulated benefit obligation as of December 31, 1995, by $3.3 million and the aggregate of the service and interest cost components of the net retiree cost by $0.8 million.\nComponents of the plans' net cost are shown below:\nPension -------------------------------- 1995 1994 1993 -------------------------------- (in thousands) Benefits earned during the year $ 3,636 $ 3,780 $ 3,792 Interest cost on projected benefit obligation 8,434 7,503 7,296 Actual (return) loss on plan assets (32,232) 3,244 (20,017) Net amortization and deferral 18,650 (16,048) 8,741 ============================================================== Net pension income $ (1,512) $ (1,521) $ (188) ==============================================================\nOf the above net pension income, $(1.1) million in both 1995 and 1994, and $(170) thousand in 1993 were recorded in operating expenses, and the remainder was recorded in construction and other accounts.\nPostretirement Benefits --------------------------------- 1995 1994 1993 --------------------------------- (in thousands) Benefits earned during the year $1,525 $1,760 $1,448 Interest cost on accumulated benefit obligation 3,442 3,251 2,811 Amortization of transition obligation over 20 years 1,027 1,043 1,051 Actual (return) loss on plan assets (1,436) 132 (814) Net amortization and deferral 851 (575) 343 ================================================================== Net postretirement costs $5,409 $5,611 $4,839 ==================================================================\nOf the above net postretirement costs recorded, $3.9 million in 1995, $4.4 million in 1994, and $3.9 million in 1993 were charged to operating expense.\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. The Company expensed $4.0 million and $3.0 million of the cost of these programs in 1995 and 1994, respectively.\n3. LITIGATION AND REGULATORY MATTERS\nRetail Rate Adjustment Plans\nMississippi Power's retail base rates are set under a Performance Evaluation Plan (PEP). In January 1994, the MPSC approved PEP-2. 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\nII-203\nNOTES (continued) Mississippi Power Company 1995 Annual Report\nperformance-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 1995 and 1994, there were no increases under PEP-2.\nFERC Reviews Equity Returns\nIn May 1991, the FERC ordered that hearings be conducted concerning the reasonableness of the operating companies' 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 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 was from October 1994 through December 1995. In November 1995, a FERC administrative law judge issued an opinion that the FERC staff failed to meet its burden of proof, and therefore, no change in the equity return was necessary. The FERC staff has filed exceptions to the administrative law judge's opinion, and the matter remains pending before the FERC.\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 $2.0 million at December 31, 1995. However, management believes that rates are not excessive, and that refunds are not justified.\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. In November 1995, the MPSC ordered a change in accounting treatment allowing emission allowance expenses to be recovered through the Company's fuel adjustment clause, and emission allowance inventory costs to be recovered through PEP-2 rather than through the ECO Plan. Under the ECO Plan any increase in the annual revenue requirement is limited to 2 percent of retail revenues. However, the plan also provides for carryover of any amount over the 2 percent limit into the next year's revenue requirement. The ECO Plan has resulted in annual retail rate increases, the latest being an increase of $3.7 million, effective in May 1995 which included $1.6 million of 1994 carryover. On January 29, 1996, the Company filed the ECO Plan with the MPSC requesting an annual retail rate decrease of $3.0 million.\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. A currently owned site where manufactured gas plant operations were located prior to the Company's ownership was investigated for potential remediation. The remedial investigation has been concluded and is pending approval by the Mississippi Department of Environmental Quality. In recognition of probable further study and remediation, the Company in 1995 recorded a liability and a deferred debit (regulatory asset) of $1.8 million, including feasibility study costs. The Company recognizes such costs as they are incurred and recovers them under the ECO Plan as provided in the Company's 1995 ECO order. 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.\n4. CONSTRUCTION PROGRAM\nMississippi Power is engaged in continuous construction programs, the costs of which are currently estimated to total some $67 million in 1996, $62 million in 1997, and $53 million in 1998. These estimates include AFUDC of $1.3 million in\nII-204\nNOTES (continued) Mississippi Power Company 1995 Annual Report\n1996, and $0.3 million in both 1997 and 1998.\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.\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.\nAt December 31, 1995, 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 agreements expiring at various dates during 1996 and in 1998. The agreements expiring December 1, 1998, 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 1995.\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 1995 use fees collected under this agreement, net of related expenses, amounted to $3.8 million each year, and are included with other income, net, in the Statements of Income. For more 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 $1.7 million in 1995 and $1.2 million in both 1994 and 1993. The Company's annual lease payments for 1996 through 2000 will be approximately $1.7 million and after 2000, lease payments total approximately $22.4 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 $227 million at December 31, 1995.\nII-205\nNOTES (continued) Mississippi Power Company 1995 Annual Report\nAdditional 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 to match costs with the savings achieved. The remaining unamortized amount of Mississippi Power's share of payments to the suppliers totaled $1.5 million at December 31, 1995.\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, 1995, Mississippi Power's percentage ownership and investment in these jointly owned facilities were as follows:\nCompany's Generating Total Percent Gross Accumulated Plant Capacity Ownership Investment Depreciation --------------------------------------------------------------- (Megawatts) (in thousands) Greene County 500 40% $ 57,957 $ 31,201\nDaniel 1,000 50% 222,367 94,172 ---------------------------------------------------------------\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 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. 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:\nOther Year Unit Power Long-Term Total ------------------------------------------------------------ (in thousands) 1995 $ 268 $ - $ 268 1994 660 1,305 1,965 1993 1,571 2,620 4,191\nIn 1994, long-term non-firm power of 200 megawatts was sold by the Southern electric system to Florida Power Corporation (FPC) 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, 1995, the tax-related regulatory assets to be recovered from customers were $23 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, 1995, the tax-related regulatory liabilities to be refunded to customers were $43 million. These liabilities are attributable to deferred taxes previously recognized at rates higher than current enacted tax law and unamortized investment tax credits.\nII-206\nNOTES (continued) Mississippi Power Company 1995 Annual Report\nDetails of the federal and state income tax provisions are shown below:\n1995 1994 1993 --------------------------------- (in thousands) Total provision for income taxes Federal -- Currently payable $32,546 $26,072 $15,842 Deferred --current year 5,122 6,313 5,158 --reversal of prior years (7,039) (5,161) (820) --------------------------------------------------------------- 30,629 27,224 20,180 --------------------------------------------------------------- State -- Currently payable 3,426 3,978 2,945 Deferred --current 2,270 1,669 1,339 --reversal of prior years (833) (1,258) (638) -------------------------------------------------------------- 4,863 4,389 3,646 --------------------------------------------------------------- Total 35,492 31,613 23,826 Less income taxes charged to other income 1,006 227 1,158 --------------------------------------------------------------- Federal and state income taxes charged to operations $34,486 $31,386 $22,668 ===============================================================\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:\n1995 1994 ----------------------------- (in thousands) Deferred tax liabilities: Accelerated depreciation $145,093 $138,281 Basis differences 10,815 11,645 Coal contract buyouts 145 3,851 Other 16,478 17,908 ------------------------------------------------------------- Total 172,531 171,685 ------------------------------------------------------------- Deferred tax assets: Other property basis differences 25,951 27,375 Pension and other benefits 7,356 5,386 Property insurance 4,551 4,171 Unbilled fuel 3,039 3,649 Other 7,103 7,009 ------------------------------------------------------------- Total 48,000 47,590 ------------------------------------------------------------- Net deferred tax liabilities 124,531 124,095 Portion included in current assets, net 5,180 5,410 ------------------------------------------------------------- Accumulated deferred income taxes in the Balance Sheets $129,711 $129,505 =============================================================\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 $1.5 million in 1995, 1994 and 1993. At December 31, 1995, all investment tax credits available to reduce federal income taxes payable had been utilized.\nII-207\nNOTES (continued) Mississippi Power Company 1995 Annual Report\nA reconciliation of the federal statutory income tax rate to the effective income tax rate is as follows:\n1995 1994 1993 ----------------------------- Total effective tax rate 38% 37% 33% State income tax, net of federal income tax benefit (3) (3)% (3) Tax rate differential - 1 4 Other - - 1 ------------------------------------------------------------- Statutory federal tax rate 35% 35% 35% =============================================================\nMississippi Power and the subsidiaries of The Southern Company file a consolidated federal income tax return. Under a joint consolidated income tax agreement, each subsidiary's current and deferred tax expense is computed on a stand-alone basis. Tax benefits from losses of the parent company are allocated to each subsidiary based on the ratio of taxable income to total consolidated taxable income.\n9. OTHER LONG-TERM DEBT\nDetails of other long-term debt are as follows:\nDecember 31, 1995 1994 --------------------- (in thousands) Obligations incurred in connection with the sale by public authorities of tax-exempt pollution control revenue bonds: 5.8$% due 2007 $ 970 $ 980 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 Variable due 2025 10,600 - ------------------------------------------------------------ 73,745 63,155 ------------------------------------------------------------ Notes payable: 4.15% to 7.50% due 1995 - 40,689 Variable rates (5.88% to 5.89% at 1\/1\/95) due 1995 - 20,000 Variable rates (5.85% to 6.015% at 1\/1\/96) due 1996 55,000 35,000 ------------------------------------------------------------ 55,000 95,689 ------------------------------------------------------------ Total $128,745 $158,844 ============================================================\nPollution control obligations represent installment or lease purchases of pollution control facilities financed by application of funds derived from sales by public authorities of tax-exempt revenue bonds. Mississippi Power has authenticated and delivered to the Trustee a like principal amount of first mortgage bonds as security for obligations under collateralized installment agreements. The principal and interest on the first mortgage bonds will be payable only in the event of default under these agreements. The 5.8% Series of pollution control obligations has a cash sinking fund requirement of $10 thousand annually through 1997 and $20 thousand annually in 1998, 1999 and 2000. The $55 million in notes payable is all due in 1996.\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:\n1995 1994 -------------------- (in thousands) Bond improvement fund requirements $ 2,219 $ 1,931\nLess: Portion to be satisfied by certifying property additions - 1,431 ------------------------------------------------------------- Cash improvement fund requirements 2,219 500 Pollution control bond cash sinking fund requirements (Note 9) 10 10 Current portion of notes payable (Note 9) 55,000 40,689 ============================================================= Total $57,229 $41,199 =============================================================\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, 1995, some $118 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.\nII-208\nNOTES (continued) Mississippi Power Company 1995 Annual Report\n12. QUARTERLY FINANCIAL DATA (UNAUDITED)\nSummarized quarterly financial data for 1995 and 1994 are as follows:\nNet Income After Dividends Quarter Operating Operating On Ended Revenues Income Preferred Stock -------------------------------------------------------------------\nMarch 1995 $109,572 $15,729 $ 9,269 June 1995 128,504 22,193 14,737 September 1995 157,119 28,517 22,161 December 1995 121,358 12,171 6,364\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\nMississippi Power's business is influenced by seasonal weather conditions and the timing of rate changes.\nII-209\nII-210\nII-211A\nII-211B\nII-211C\nII-212\nII-213A\nII-213B\nII-213C\nII-214\nII-215A\nII-215B\nII-215C\nII-216\nII-217A\nII-217B\nII-217C\nII-218\nII-219A\nII-219B\nII-219C\nII-220\nII-221A\nII-221B\nII-221C\nMISSISSIPPI POWER COMPANY OUTSTANDING SECURITIES AT DECEMBER 31, 1995\nFirst Mortgage Bonds Amount 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% 45,447 5\/1\/21 1993 35,000 7.45% 35,000 6\/1\/23 1995 30,000 6-7\/8% 30,000 12\/1\/25 =========== =========== $ 225,000 $ 220,447 =========== ===========\nPollution Control Bonds Amount Interest Amount Series Issued Rate Outstanding Maturity - - -------------------------------------------------------------------------------- (Thousands) (Thousands) 1977 $ 1,000 5.80% $ 970 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 1995 10,600 Variable 10,600 7\/1\/25 =========== =========== $ 73,775 $ 73,745 =========== ===========\nPreferred Stock Shares 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 1995\nFirst Mortgage Bonds Principal Interest Series Amount Rate - - -------------------------------------------------------------------------------- (Thousands) 1991 $ 1,625 9-1\/4%\nPollution Control Bonds Principal 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 1995 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.\nIn 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\nFebruary 21, 1996\nII-225\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Board of Directors of Savannah Electric and Power Company:\nWe have audited the accompanying balance sheets and statements of capitalization of Savannah Electric and Power Company (a Georgia corporation and a wholly owned subsidiary of The Southern Company) as of December 31, 1995 and 1994, and the related statements of income, retained earnings, and cash flows for each of the three years in the period ended December 31, 1995. 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-245) referred to above present fairly, in all material respects, the financial position of Savannah Electric and Power Company as of December 31, 1995 and 1994, and the results of its operations and its cash flows for the periods stated, in conformity with generally accepted accounting principles.\n\/s\/ Arthur Andersen LLP\nAtlanta, Georgia February 21, 1996\nII-226\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Savannah Electric and Power Company 1995 Annual Report\nRESULTS OF OPERATIONS\nEarnings\nSavannah Electric and Power Company's net income after dividends on preferred stock for 1995 totaled $23.4 million, representing a $1.3 million increase over the prior year. This 5.8 percent improvement in earnings over 1994 is principally the result of increased retail energy sales, primarily attributable to exceptionally hot summer weather.\nIn 1994, earnings were $22.1 million, representing a $0.6 million (3.0 percent) increase from the prior year. This increase was primarily due to a decrease in operating expenses, offset somewhat by an increase in interest expense.\nRevenues\nTotal revenues for 1995 were $225.7 million, reflecting a 6.6 percent increase compared to 1994. The following table summarizes revenue increases and decreases compared to prior years: Increase (Decrease) From Prior Years -------------------------------------- 1995 1994 1993 -------------------------------------- Retail -- (in thousands) Change in base rates $ - $ - $(1,450) Sales growth 1,068 7,884 5,980 Weather 6,232 (6,589) 4,567 Fuel cost recovery and other 6,177 (9,214) 12,404 ------------------------------------------------------------------- Total retail 13,477 (7,919) 21,501 ------------------------------------------------------------------- Sales for resale-- Non-affiliates (2,935) (1,235) (1,800) Affiliates 754 4,013 928 ------------------------------------------------------------------- Total sales for resale (2,181) 2,778 (872) ------------------------------------------------------------------- Other operating revenues 2,648 (1,516) 52 ------------------------------------------------------------------- Total operating revenues $13,944 $(6,657) $20,681 =================================================================== Percent change 6.6% (3.0)% 10.5% -------------------------------------------------------------------\nRetail revenues increased 6.7 percent in 1995, compared to a decrease of 3.8 percent in 1994. The increase in 1995 retail revenues is attributable to hot summer weather, an increase in the number of customers served, higher demand in the industrial sector, and an increase in fuel cost recovery revenues. Industrial energy sales were higher primarily because a major customer performed maintenance on its cogeneration facility during 1995 and purchased replacement energy from the Company. Under the Company's fuel cost recovery provisions, fuel revenues--including purchased energy--generally equal fuel expense and have no effect on earnings. The $2.6 million increase in other operating revenues reflects a decrease in the demand-side management rider in October 1994 and an increase in demand-side management program costs during 1995. Revenues from demand-side management riders (included in retail revenues) recover demand-side management program costs and have little impact on earnings. See Note 3 to the financial statements for further information on the Company's demand-side management programs.\nThe decrease in 1994 retail revenues as compared to 1993 resulted from mild summer weather, reduced industrial energy sales, and substantially lower fuel cost recovery revenues, offset somewhat by customer growth.\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 continued to decrease in 1995 and 1994 primarily as a result of the scheduled decline in megawatts of capacity under contract. The capacity and energy components were as follows:\n1995 1994 1993 ------------------------------------ (in thousands) Capacity $ 3 $ 448 $ 978 Energy 1,250 3,052 4,262 - - --------------------------------------------------------- Total $ 1,253 $3,500 $5,240 =========================================================\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 1995 Annual Report\nChanges in revenues are influenced heavily by the amount of energy sold each year. Kilowatt-hour sales for 1995 and the percent change by year were as follows:\nPercent Change ------------------------------ KWH 1995 1994 1993 --------- ------------------------------ (in millions) Residential 1,402 8.0% (2.3)% 9.2% Commercial 1,100 5.1 2.9 6.5 Industrial 887 11.0 (6.4) (0.8) Other 126 5.4 3.1 5.2 --------- Total retail 3,515 7.7 (1.6) 5.5 Sales for resale - Non-affiliates 87 (56.5) (18.4) (32.7) Affiliates 64 (31.5) 23.4 100.3 --------- Total 3,666 3.1% (2.2)% 2.6% =========\n=================================================================\nExpenses\nTotal operating expenses for 1995 were $187.5 million, reflecting an $11.8 million increase over 1994. Major components of this increase include $6.8 million in fuel, $3.6 million in other operation, $1.1 million in maintenance, and $1.1 million in depreciation and amortization, partially offset by a $2.6 million reduction in purchased power from affiliates. The increase in fuel expense is primarily attributable to the exceptionally hot summer weather, which not only increased generation but also necessitated greater use of more costly gas-fired sources of generation. The increase in other operation expense is due to increased expenses related to demand-side management programs and employee incentive compensation programs. The increase in maintenance expense reflects maintenance performed at Plants Kraft and McIntosh during 1995, and the increase in depreciation and amortization reflects the completion in 1994 of two combustion turbine units.\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 discussed above. Interest expense increased $1.9 million primarily due to the sale in June 1993 of $45 million of first mortgage bonds.\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, the average cost of purchased power per net kilowatt-hour, and the total average cost of energy supply were as follows:\n1995 1994 1993 -------------------------- Total energy supply (millions of kilowatt-hours) 3,908 3,768 3,863 Sources of energy supply (percent) -- Coal 24 18 21 Oil - 1 2 Gas 6 1 3 Purchased Power 70 80 74 Average cost of fuel per net kilowatt-hour generated (cents) -- Coal 1.77 2.19 2.02 Oil 5.14 3.89 4.11 Gas 3.76 5.19 4.87 Average cost of purchased power per net kilowatt- hour (cents) 2.02 1.92 2.00 Total average cost of energy supply 2.07 2.02 2.12 ===============================================================\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\nII-228\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Savannah Electric and Power Company 1995 Annual Report\nthe 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 energy sales growth 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 weather, competition, changes in contracts with neighboring utilities, energy conservation practiced by customers, the elasticity of demand, 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 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 to sell electricity to other utilities. This enhances 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.\nAlthough 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. New federal legislation is being discussed, and legislation allowing customer choice has already been introduced in Georgia. 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 by seeking new markets that evolve with the changing regulation.\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 and determine if any other assets have been impaired. 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 affect 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). As part of the Company's most recent rate settlement in 1992, it was informally agreed that the Company's earned rate of return on common equity should be 12.95 percent. The Company is currently undergoing an earnings review by the GPSC, and to date, the GPSC has made no determination.\nIn August 1995, the GPSC ordered the phase out of the Company's demand-side management programs effective December 31, 1995 and the elimination of demand-side management rate riders effective October 1, 1995. The Company will refund to customers approximately $0.2 million which had been overcollected from the rate riders as of December 31, 1995.\nNew Accounting Standards\nThe FASB has issued Statement No. 121, Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of. This statement requires that long-lived assets be reviewed for impairment whenever events or\nII-229\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Savannah Electric and Power Company 1995 Annual Report\nchanges in circumstances indicate that the carrying amount for an asset may not be recoverable. This statement also imposes stricter criteria for regulatory assets by requiring that such assets be probable of future recovery at each balance sheet date. The Company adopted the new rules January 1, 1996, with no material effect on the financial statements. However, this conclusion may change in the future as competitive factors influence wholesale and retail pricing in the utility industry.\nFINANCIAL CONDITION\nOverview\nThe principal change in the Company's financial condition in 1995 was the addition of $27 million to utility plant. The funds needed for gross property additions are currently provided from operating activities, principally from earnings and non-cash charges to income such as depreciation and deferred income taxes. See Statements of Cash Flows for additional information.\nCapital Structure\nAs of December 31, 1995, the Company's capital structure consisted of 47.1 percent common equity, 9.8 percent preferred stock and 43.1 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 48 percent, preferred stock at 10 percent and debt at 42 percent.\nIn May 1995, the Company issued $15 million of first mortgage bonds maturing in 2025 and $20 million of term notes maturing in 1998. Maturities and retirements of long-term debt were $29 million in 1995, $5 million in 1994 and $4 million in 1993.\nThe composite interest rates and dividend rate for the years 1993 through 1995 as of year-end were as follows:\n1995 1994 1993 ------------------------------- Composite interest rates on long-term debt 7.5% 8.0% 8.0% Preferred stock dividend rate 6.6% 6.6% 6.6% ===============================================================\nThe Company's current securities ratings are as follows: Standard Moody's & Poor's ------------------------\nFirst Mortgage Bonds A1 A+ Preferred Stock \"a2\" A ===============================================================\nCapital Requirements for Construction\nThe Company's projected construction expenditures for the next three years total $86 million ($33 million in 1996, $30 million in 1997, and $23 million in 1998). Actual construction costs may vary from this estimate because of factors such as changes in: business conditions; environmental regulations; 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 $21.7 million will be needed by the end of 1998 for maturities of long-term debt and present sinking fund requirements.\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--has significantly impacted the Company and other subsidiaries of The Southern Company. Specific reductions in sulfur dioxide and nitrogen oxide emissions from fossil-fired generating plants are required in two phases. Phase I compliance began in 1995 and initially affected 28 generating units of The Southern Company. As a result of The Southern Company's compliance strategy, an additional 22 generating units, which included four of the Company's units, were brought into compliance with Phase I requirements. Phase II compliance is required in 2000, and all fossil-fired generating plants will be affected.\nIn 1995, the Environmental Protection Agency (EPA) began issuing annual sulfur dioxide emission allowances through the allowance trading program. An\nII-230\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Savannah Electric and Power Company 1995 Annual Report\nemission 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 achieved Phase I sulfur dioxide compliance at the affected plants by switching to low-sulfur coal, which required some equipment upgrades. This compliance strategy resulted in unused emission allowances being banked for later use. Compliance with nitrogen oxide emission limits was achieved by the installation of new control equipment at 22 of the original 28 affected generating units. Construction expenditures for Phase I compliance totaled approximately $320 million through 1995 for The Southern Company, of which the Company's portion was approximately $2 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 Phase II limits. Therefore, during the period 1996 to 2000, current compliance strategy could require total estimated construction expenditures of approximately $150 million for The Southern Company, of which the Company's portion is approximately $4.1 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 0.7 percent in annual revenue requirements from customers could be necessary to fully recover the Company's costs 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.\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.\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 during 1996. 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 is evaluating the need to revise the ambient air quality standards for particulate matter 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 1996, 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 1995 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 Air Act; 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.\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\nAt December 31, 1995, the Company had $0.9 million of cash and $20.5 million of unused short-term credit arrangements with banks to meet its short-term cash needs. Revolving credit arrangements of $20 million, which expire December 31, 1998, are also used to meet short-term cash needs and to provide additional interim funding for the Company's construction program. Of the revolving credit arrangements, $16 million remained unused at December 31, 1995.\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 earnings 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-232\nII-233\nII-234\nII-235\nII-236\nII-237\nNOTES TO FINANCIAL STATEMENTS Savannah Electric and Power Company 1995 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), The Southern Development and Investment Group (Southern Development) and other direct and indirect subsidiaries. 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 provides digital wireless communications services to the operating companies and also markets these services to the public within the Southeast. Southern Electric designs, builds, owns, and operates power production and delivery 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. Southern Development 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. The preparation of financial statements in conformity with generally accepted accounting principles requires the use of estimates, and the actual results may differ from those estimates.\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:\n1995 1994 --------------------------- (in thousands) Deferred income taxes $ 21,557 $ 23,521 Premium on reacquired debt 5,316 3,295 Deferred income tax credits (24,419) (25,487) - - --------------------------------------------------------------- Total $ 2,454 $ 1,329 ===============================================================\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, if impaired, 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 the energy component of 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 1995, uncollectible accounts continued to average less than 1 percent of revenues.\nII-238\nNOTES (continued) Savannah Electric and Power Company 1995 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 1995, 1994 and 1993. 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 removal of certain facilities.\nIncome Taxes\nThe Company, which is included in the consolidated federal income tax return filed by The Southern Company, uses the liability method of accounting for deferred income taxes and 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.\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 7.42 percent in 1995, 8.04 percent in 1994 and 8.77 percent in 1993.\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 AFUDC. 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 financial instruments that the carrying amounts did not approximate fair value at December 31 were as follows:\nLong-Term Debt -------------------------- Carrying Fair Year Amount Value - - ---- -------------------------- (in millions) 1995 $154 $165 1994 157 153 ==============================================================\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.\nStorm Damage Reserve\nIn December 1995, in response to a request by the Company, the GPSC issued an order allowing the Company to establish a Storm Damage Reserve. As of December 31, 1995, the accumulated provision amounted to $0.3 million. Regulatory treatment by the GPSC allows the Company to accrue up to $0.6 million per year.\nII-239\nNOTES (continued) Savannah Electric and Power Company 1995 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. Trusts are funded to the extent deductible under federal income tax regulations and to the extent required by the GPSC and the FERC. Amounts funded are primarily invested in debt and equity securities.\nFASB Statement No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions, 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.\nFunded Status and Cost of Benefits\nThe following tables show actuarial results and assumptions for pension and postretirement 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 ------------------------ 1995 1994 ------------------------ (in thousands) Actuarial present value of benefit obligation: Vested benefits $38,169 $35,227 Non-vested benefits 2,585 2,069 - - ---------------------------------------------------------------- Accumulated benefit obligation 40,754 37,296 Additional amounts related to projected salary increases 7,786 7,393 - - ---------------------------------------------------------------- Projected benefit obligation 48,540 44,689 Less: Fair value of plan assets 36,836 27,165 Unrecognized net loss 9,606 10,950 Unrecognized prior service cost 1,375 1,510 Unrecognized net transition obligation 532 621 Adjustment required to recognize additional minimum liability 3,727 5,688 - - ---------------------------------------------------------------- Accrued liability recognized in the Balance Sheets $ 3,918 $10,131 ================================================================\nThe weighted average rates assumed in the actuarial calculations for the pension plan were:\n1995 1994 1993 ------------------------ Discount 7.25% 8.00% 7.50% Annual salary increase 4.75 5.25 4.75 Long-term return on plan assets 8.75 9.00 9.25 ============================================================\nIn accordance with Statement No. 87, an additional liability related to under-funded accumulated benefit obligations was reflected at December 31, 1995 and December 31, 1994. Corresponding net-of-tax balances of $0.1 million and $0.5 million were recognized as separate components of Common Stock Equity in the 1995 and 1994 Statements of Capitalization.\nII-240\nNOTES (continued) Savannah Electric and Power Company 1995 Annual Report\nPostretirement Benefits ------------------------ 1995 1994 ------------------------ (in thousands) Actuarial present value of benefit obligation: Retirees and dependents $13,560 $10,994 Employees eligible to retire 1,471 884 Other employees 5,966 8,485 - - ------------------------------------------------------------- Accumulated benefit obligation 20,997 20,363 Less: Fair value of plan assets 1,443 393 Unrecognized net loss 5,719 3,197 Unrecognized transition obligation 9,135 13,021 - - ------------------------------------------------------------- Accrued liability recognized in the Balance Sheets $ 4,700 $ 3,752 =============================================================\nIn 1995, the Company announced a cost sharing program for postretirement benefits. The program establishes limits on amounts the Company will pay to provide future retiree postretirement benefits. This change reduced the 1995 accumulated postretirement benefit obligation by approximately $3.1 million.\nThe weighted average rates assumed in the actuarial calculations for the postretirement benefit plans were:\n1995 1994 ------------------ Discount 7.25% 8.00% Annual salary increase 4.75 5.50 Long-term return on plan assets 8.50 8.50 ===========================================================\nAn additional assumption used in measuring the accumulated postretirement benefit obligation was a weighted average medical care cost trend rate of 9.8 percent for 1995, decreasing gradually to 5.3 percent through the year 2005 and remaining at that level thereafter. An annual increase in the assumed medical care cost trend rate of 1 percent would increase the accumulated benefit obligation at December 31, 1995, by $1.3 million and the aggregate of the service and interest cost components of the net postretirement cost by $0.2 million.\nComponents of the plans' net costs are shown below:\nPension ------------------------------ 1995 1994 1993 ------------------------------ (in thousands) Benefits earned during the year $1,188 $1,192 $1,188 Interest cost on projected benefit obligation 3,395 3,279 2,741 Actual (return) loss on plan assets (5,791) 27 (2,199) Net amortization and deferral 4,125 (1,474) 716 - - -------------------------------------------------------------------- Net pension cost $2,917 $3,024 $2,446 ====================================================================\nOf the above net pension costs, $2.4 million in 1995, $2.6 million in 1994 and $2.0 million in 1993 were recorded in operating expenses, and the remainder was recorded in construction and other accounts.\nPostretirement Benefits ------------------------------ 1995 1994 1993 ------------------------------ (in thousands) Benefits earned during the year $ 504 $ 632 $ 443 Interest cost on accumulated benefit obligation 1,638 1,492 1,134 Amortization of transition obligation 723 723 723 Actual (return) loss on plan assets (34) 6 - Net amortization and deferral 93 111 - - - -------------------------------------------------------------------- Net postretirement costs $2,924 $2,964 $2,300 ====================================================================\nOf the above net postretirement costs, $2.4 million in 1995, $2.4 million in 1994 and $1.8 million in 1993 were recorded in 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 1995, 1994 and 1993 were $0.4 million, $0.4 million and $1.0 million, respectively. The 1993 benefit costs reflect a one-time expense related to employees who were part of the work force reduction program.\nII-241\nNOTES (continued) Savannah Electric and Power Company 1995 Annual Report\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\nRates to retail customers served by the Company are regulated by the GPSC. As part of the Company's most recent rate settlement in 1992, it was informally agreed that the Company's earned rate of return on common equity should be 12.95 percent. The Company is currently undergoing an earnings review by the GPSC, and to date, the GPSC has made no determination.\nIn August 1995, the GPSC ordered the phase out of the Company's demand-side management programs effective December 31, 1995 and the elimination of demand-side management rate riders effective October 1, 1995. The Company will refund to customers approximately $0.2 million which had been overcollected from the rate riders as of December 31, 1995.\n4. CONSTRUCTION PROGRAM\nThe Company is engaged in a continuous construction program, currently estimated to total $33 million in 1996, $30 million in 1997 and $23 million in 1998. The estimates include AFUDC of $1.0 million in 1996, $0.9 million in 1997 and $0.2 million in 1998. 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. The Company does not have any new baseload generating plants under construction. However, construction related to transmission and distribution facilities and the upgrading and extension of the useful lives of generating plants will continue.\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, preferred stock and capital contributions from The Southern Company.\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.\nBank Credit Arrangements\nAt the beginning of 1996, unused credit arrangements with five banks totaled $20.5 million and expire at various times during 1996.\nThe Company's revolving credit arrangements of $20 million, of which $16 million remained unused as of December 31, 1995, expire December 31, 1998. These agreements allow short-term borrowings to be converted into term loans, payable in 12 equal quarterly installments, with the first installment due at the end of the first calendar quarter after the applicable termination date or at an earlier date at the Company's option.\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.\nII-242\nNOTES (continued) Savannah Electric and Power Company 1995 Annual Report\nOperating Leases\nThe Company has rental agreements with various terms and expiration dates. Rental expenses totaled $1.3 million for 1995 and $1.5 million for 1994 and 1993. The Company entered into a 22.5 year lease agreement effective December 1, 1995 for 100 new aluminum rail cars at an annual cost of approximately $0.5 million. The rail cars are used to transport coal to the Company's generating plants.\nAt December 31, 1995, estimated future minimum lease payments for non-cancelable operating leases were as follows:\nAmounts -------------------- (in millions) 1996 $1.6 1997 1.4 1998 1.1 1999 0.5 2000 0.5 2001 and thereafter 8.4 =============================================================\n6. LONG-TERM POWER SALES AGREEMENTS\nThe operating subsidiaries of The Southern Company, including the Company, have 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 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:\nUnit Other Year Power Long-Term Total - - ----------- ----------------------------------------- (in thousands) 1995 $3 $ - $ 3 1994 3 445 448 1993 2 976 978 ===============================================================\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, 1995, the tax-related regulatory assets and liabilities were $22 million and $24 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:\n1995 1994 1993 -------------------------------- (in thousands) Total provision for income taxes Federal -- Currently payable $10,427 $11,736 $11,663 Deferred -- current year 5,290 2,106 1,906 -- reversal of prior years (1,661) (755) (1,383) - - ----------------------------------------------------------------- 14,056 13,087 12,186 - - ----------------------------------------------------------------- State -- Currently payable 1,941 2,064 2,049 Deferred -- current year 695 188 119 -- reversal of prior years 35 86 (35) - - ----------------------------------------------------------------- 2,671 2,338 2,133 - - ----------------------------------------------------------------- Total 16,727 15,425 14,319 Less income taxes charged (credited) to other income (651) (864) (1,117) - - ----------------------------------------------------------------- Federal and state income taxes charged to operations $17,378 $16,289 $15,436 =================================================================\nThe tax effects of temporary differences between the carrying amounts of assets and liabilities in the financial statements and their respective tax bases, which give rise to deferred tax assets and liabilities, are as follows:\nII-243\nNOTES (continued) Savannah Electric and Power Company 1995 Annual Report\n1995 1994 --------- ---------- Deferred tax liabilities: (in thousands) Accelerated depreciation $62,822 $57,830 Property basis differences 11,330 12,956 Other 1,511 2,449 - - ---------------------------------------------------------------- Total 75,663 73,235 - - ---------------------------------------------------------------- Deferred tax assets: Pension and other benefits 3,660 4,816 Other 3,818 3,959 - - ---------------------------------------------------------------- Total 7,478 8,775 - - ---------------------------------------------------------------- Net deferred tax liabilities 68,185 64,460 Portions included in current assets, net 5,967 6,326 - - ---------------------------------------------------------------- Accumulated deferred income taxes in the Balance Sheets $74,152 $70,786 ================================================================\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 1995, 1994 and 1993. At December 31, 1995, 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:\n1995 1994 1993 ---------------------------- Federal statutory tax rate 35% 35% 35% State income tax, net of federal income tax benefit 4 4 4 Other - - (1) ------------------------------------------------------------- Effective income tax rate 39% 39% 38% =============================================================\nThe Southern Company files a consolidated federal income tax return. Under a joint consolidated income tax agreement, each subsidiary's current and deferred tax expense is computed on a stand-alone basis. Tax benefits from losses of the parent company are allocated to each subsidiary based on the 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. 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 May 1995, the Company issued $15 million of first mortgage bonds maturing in 2025 and $20 million of term notes maturing in 1998. Using the proceeds from such sales, the Company redeemed in June 1995 all of its remaining outstanding 9 1\/4% Series First Mortgage Bonds due October 2019.\nThe sinking fund requirements of first mortgage bonds were satisfied by cash redemption in 1994 and 1995. Sinking fund requirements and\/or maturities through 2000 applicable to long-term debt are as follows: $1.4 million in 1996; $0.2 million in 1997; $20.1 million in 1998; and no requirements in 1999 and 2000.\nDetails of pollution control obligations and other long-term debt at December 31 are as follows:\n1995 1994 --------------------- (in thousands)\nCollateralized obligations incurred in connection with the sale by public authorities of tax-exempt pollution control revenue bonds -- Variable rate (5.15% at 1\/1\/96) due 2016 $ 4,085 $ 4,085 6 3\/4% due 2022 13,870 13,870 Capital lease obligations -- Combustion turbine equipment - 980 Transportation fleet 485 508 Notes Payable -- 6.04% due 1995 - 3,500 6.035% due 1995 - 5,000 Variable rate (5.85% at 1\/1\/96) due 1998 15,000 Variable rate (5.84% at 1\/1\/96) due 1998 5,000 - - ---------------------------------------------------------------- Total $38,440 $27,943 ================================================================\nII-244\nNOTES (continued) Savannah Electric and Power Company 1995 Annual Report\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 leased combustion turbine generating equipment under a non-cancelable lease that expired in 1995. In December 1995, the Company exercised its option to purchase this equipment. The Company currently 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 sinking fund requirements and scheduled maturities and redemptions of long-term debt due within one year at December 31 is as follows:\n1995 1994 ---------------------- (in thousands) Bond sinking fund requirement $1,200 $1,350 Less: Portion to be satisfied by certifying property additions - - - - -------------------------------------------------------------------- Cash sinking fund requirement 1,200 1,350 Other long-term debt maturities (Note 9) 207 1,229 - - -------------------------------------------------------------------- Total $1,407 $2,579 ====================================================================\nThe first mortgage bond improvement (sinking) fund requirements amount 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 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. In January 1996, the Company satisfied its 1996 sinking fund requirement of $1.2 million by cash redemption.\n11. COMMON STOCK DIVIDEND RESTRICTIONS\nThe Company's Charter and Indenture contain certain limitations on the payment of cash dividends on preferred and common stocks. At December 31, 1995, approximately $62 million of retained earnings was restricted against the payment of cash dividends on common stock under the terms of the Indenture.\n12. QUARTERLY FINANCIAL INFORMATION (Unaudited)\nSummarized quarterly financial data for 1995 and 1994 are as follows (in thousands):\nNet Income After Operating Operating Dividends on Quarter Ended Revenue Income Preferred Stock - - ------------------- ------------ ------------ -------------------\nMarch 1995 $46,743 $ 6,468 $ 2,420 June 1995 57,673 9,920 6,041 September 1995 73,449 16,438 12,693 December 1995 47,864 5,452 2,241\nMarch 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 =================================================================\nThe Company's business is influenced by seasonal weather conditions and a seasonal rate structure, among other factors.\nII-245\nII-246\nII-247A\nII-247B\nII-247C\nII-248\nII-249A\nII-249B\nII-249C\nII-250\nII-251A\nII-251B\nII-251C\nII-252\nII-253A\nII-253B\nII-253C\nII-254\nII-255A\nII-255B\nII-255C\nII-256\nII-257A\nII-257B\nII-257C\nSAVANNAH ELECTRIC AND POWER COMPANY OUTSTANDING SECURITIES AT DECEMBER 31, 1995\nFirst Mortgage Bonds Amount Interest Amount Series Issued Rate Outstanding Maturity - - -------------------------------------------------------------------------------- (Thousands) (Thousands) 1993 $ 20,000 6-3\/8% $ 20,000 7\/1\/03 1991 30,000 9-3\/8% 29,400 7\/1\/21 1992 30,000 8.30% 30,000 7\/1\/22 1993 25,000 7.40% 25,000 7\/1\/23 1995 15,000 7-7\/8% 15,000 5\/1\/25 ============ =========== $ 120,000 $ 119,400 ============ ===========\nPollution Control Bonds Amount 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 Shares Dividend Amount Series Outstanding Rate Outstanding - - ---------------------------------------------------------------------- (Thousands) 1993 1,400,000 6.64% $ 35,000\nSECURITIES RETIRED DURING 1995\nFirst Mortgage Bonds Principal Interest Series Amount Rate - - ---------------------------------------------------------------------- (Thousands) 1989 $ 28,950 9-1\/4% 1991 300 9-3\/8% ============ $ 29,250 ============\nII-258\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 1996 annual meeting of stockholders. The ages of directors and executive officers in Item 10","section_9A":"","section_9B":"","section_10":"Item 10 set forth below are as of December 31, 1995.\nItem 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANTS\nALABAMA\nIdentification of directors of ALABAMA.\nElmer B. Harris (1) President and Chief Executive Officer Age 56 Served as Director since 3-1-89\nBill M. Guthrie Executive Vice President Age 62 Served as Director since 12-16-88\nWhit Armstrong (2) Age 48 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 71 Served as Director since 2-26-93\nA. W. Dahlberg (2) Age 55 Served as Director since 4-22-94\nPeter V. Gregerson, Sr. (2) Age 67 Served as Director since 10-22-93\nCarl E. Jones, Jr. (2) Age 55 Served as Director since 4-22-88\nWallace D. Malone, Jr. (2) Age 59 Served as Director since 6-22-90\nWilliam V. Muse (2) Age 56 Served as Director since 2-26-93\nJohn T. Porter (2) Age 64 Served as Director since 10-22-93\nGerald H. Powell (2) Age 69 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 58 Served as Director since 4-22-88\nWilliam J. Rushton, III (2) Age 66 Served as Director since 9-18-70\nJames H. Sanford (2) Age 51 Served as Director since 8-1-83\nJohn C. Webb, IV (2) Age 53 Served as Director since 4-22-77\nJohn W. Woods (2) Age 64 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 28, 1995) 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.\nIdentification of executive officers of ALABAMA.\nElmer B. Harris (1) President, Chief Executive Officer and Director Age 56 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 52 Served as Executive Officer since 12-3-91\nCharles D. McCrary Executive Vice President Age 44 Served as Executive Officer since 1-1-91\n(1) Previously served as executive officer of ALABAMA from 1979 to 1985.\nEach of the above is currently an executive officer of ALABAMA, serving a term running from the last annual meeting of the directors (April 28, 1995) 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.\nIdentification of certain significant employees. None.\nFamily relationships. None.\nBusiness experience.\nElmer B. Harris - Elected in 1989; Chief Executive Officer. Director of SOUTHERN and AmSouth Bancorporation.\nBill M. Guthrie - Elected in 1988; also served since 1991 as Chief Production Officer of SOUTHERN system and from 1991 to 1994 as Executive Vice President and Chief Production Officer of SCS. Elected Senior Executive Vice President and Chief Production Officer of SCS effective 1994. Also serves as 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, Protective Life Corporation and Equifax, Inc. and a nominee for election as a director of SunTrust Banks, Inc.\nPeter V. Gregerson, Sr. - Chairman Emeritus of Gregerson's Foods, Inc. (retail groceries), Gadsden, Alabama.\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.\nIII-2\nWilliam V. Muse - President of Auburn University. He previously served as President of the University of Akron from 1984 to 1992. Director of Alabama National Bancorporation, Shoal Creek, Alabama.\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.\nJames H. Sanford - Chairman, 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 - Effective January 1996, Chairman, AmSouth Bancorporation (multi-bank holding company), Birmingham, Alabama. He previously served as Chairman and Chief Executive Officer of AmSouth Bancorporation. 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.\nInvolvement in certain legal proceedings. None.\nIII-3\nGEORGIA\nIdentification of directors of GEORGIA.\nH. Allen Franklin President and Chief Executive Officer Age 51 Served as Director since 1-1-94\nWarren Y. Jobe Executive Vice President, Treasurer and Chief Financial Officer Age 55 Served as Director since 8-1-82\nBennett A. Brown (1) Age 66 Served as Director since 5-15-80\nA. W. Dahlberg (1) Age 55 Served as Director since 6-1-88\nWilliam A. Fickling, Jr. (1) Age 63 Served as Director since 4-18-73\nL. G. Hardman III (1) Age 56 Served as Director since 6-25-79\nJames R. Lientz, Jr. (1) Age 52 Served as Director since 7-21-93\nWilliam A. Parker, Jr. (1) Age 68 Served as Director since 5-19-65\nG. Joseph Prendergast (1) Age 50 Served as Director since 1-20-93\nHerman J. Russell (1) Age 65 Served as Director since 5-18-88\nGloria M. Shatto (1) Age 64 Served as Director since 2-20-80\nWilliam Jerry Vereen (1) Age 55 Served as Director since 5-18-88\nCarl Ware (1) (2) Age 52 Served as Director since 2-15-95\nThomas R. Williams (1) Age 67 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 17, 1995) 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 GEORGIA acting solely in their capacities as such.\nIdentification of executive officers of GEORGIA.\nH. Allen Franklin President, Chief Executive Officer and Director Age 51 Served as Executive Officer since 1-1-94\nWarren Y. Jobe Executive Vice President, Treasurer, Chief Financial Officer and Director Age 55 Served as Executive Officer since 5-19-82\nWilliam C. Archer, III Executive Vice President - External Affairs Age 47 Served as Executive Officer since 4-6-95\nIII-4\nW. G. Hairston, III Executive Vice President - Nuclear Age 51 Served as Executive Officer since 6-1-93\nGene R. Hodges Executive Vice President - Customer Operations Age 57 Served as Executive Officer since 11-19-86\nWilliam P. Bowers Senior Vice President - Marketing Age 39 Served as Executive Officer since 9-22-95\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 55 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\nFred D. Williams Senior Vice President - Wholesale Power Marketing Age 51 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 17, 1995) for one year until the next annual meeting or until his successor is elected and qualified, except for Mr. Bowers 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 GEORGIA acting solely in their capacities as such.\nIdentification of certain significant employees. None.\nFamily relationships. None.\nBusiness experience.\nH. Allen Franklin - President and Chief Executive Officer since 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 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, Protective Life Corporation and Equifax, Inc. and a nominee for election as a director of SunTrust Banks, Inc.\nWilliam A. Fickling, Jr. - Chairman of the Board, Chief Executive Officer and President of Beech Street Corporation (provider of managed care services).\nL. G. Hardman III - Chairman of the Board of The 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 1994. Chairman, Wachovia Bank of South Carolina, and Director, Wachovia Bank of North Carolina. 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 and National Service Industries.\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.\nWilliam C. Archer, III - Executive Vice President - External Affairs since September 1995. Senior Vice President - External Affairs from April 1995 to September 1995. Vice President - Human Resources for SCS from 1992 to 1995. Vice President - Northern Region from March 1992 to August 1992 and Vice President - Metro Region from 1990 to March 1992.\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.\nWilliam P. Bowers - Senior Vice President - Marketing since September 1995. Vice President - Retail Sales and Service from 1992 to 1995 and Vice President - Marketing 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 1994. Senior Vice President Administrative Services from 1992 to 1994 and Vice President - Northern Region from 1990 to 1992.\nFred D. Williams - Senior Vice President - Wholesale Power Marketing since August 1995. Senior Vice President Bulk Power Markets from 1992 to August 1995. Vice President - Bulk Power Markets from 1984 to 1992. In addition, he was elected Senior Vice President - Wholesale Power Marketing of SCS in August 1995 and Senior Vice President of ALABAMA in February 1996.\nInvolvement in certain legal proceedings. None.\nIII-6\nGULF\nIdentification of directors of GULF.\nTravis J. Bowden President and Chief Executive Officer Age 57 Served as Director since 2-1-94\nReed Bell, Sr., M.D. (1) Age 69 Served as Director since 1-17-86\nPaul J. DeNicola (1) Age 47 Served as Director since 4-19-91\nFred C. Donovan (1) Age 55 Served as Director since 1-18-91\nW. D. Hull, Jr. (1) Age 63 Served as Director since 10-14-83\nC. W. Ruckel (1) Age 68 Served as Director since 4-20-62\nJ. K. Tannehill (1) Age 62 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 27, 1995) 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.\nIdentification of executive officers of GULF.\nTravis J. Bowden President, Chief Executive Officer and Director Age 57 Served as Executive Officer since 2-1-94\nF. M. Fisher, Jr. Vice President - Employee and External Relations Age 47 Served as Executive Officer since 5-19-89\nJohn E. Hodges, Jr. Vice President - Customer Operations Age 52 Served as Executive Officer since 5-19-89\nG. Edison Holland, Jr. Vice President - Power Generation\/Transmission and Corporate Counsel Age 43 Served as Executive Officer since 4-25-92\nA. E. Scarbrough Vice President - Finance Age 59 Served as Executive Officer since 9-21-77\nEach of the above is currently an executive officer of GULF, serving a term running from the last annual meeting of the directors (July 21, 1995) 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 GULF acting solely in their capacities as such.\nIdentification of certain significant employees. None.\nFamily relationships. None.\nIII-7\nBusiness 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 since 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 SunTrust 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 1989 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 Merrick 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 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.\nA. E. Scarbrough - Elected Vice President - Finance in 1980; responsible for all accounting and financial services of GULF.\nInvolvement in certain legal proceedings. None.\nIII-8\nMISSISSIPPI\nIdentification of directors of MISSISSIPPI.\nDwight H. Evans President and Chief Executive Officer Age 47 Served as Director since 3-27-95\nPaul J. DeNicola (1) Age 47 Served as Director since 5-1-89\nEdwin E. Downer (1) Age 64 Served as Director since 4-24-84\nRobert S. Gaddis (1) Age 64 Served as Director since 1-21-86\nWalter H. Hurt, III (1) Age 60 Served as Director since 4-6-82\nAubrey K. Lucas (1) Age 61 Served as Director since 4-24-84\nGeorge A. Schloegel (1) Age 55 Served as Director since 7-26-95\nPhilip J. Terrell (1) Age 42 Served as Director since 2-22-95\nN. Eugene Warr (1) Age 60 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 4, 1995) for one year until the next annual meeting or until a successor is elected and qualified, except for Mr. Schloegel 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.\nIdentification of executive officers of MISSISSIPPI.\nDwight H. Evans President, Chief Executive Officer and Director Age 47 Served as Executive Officer since 3-27-95\nH. E. Blakeslee Vice President - Customer Services and Marketing Age 55 Served as Executive Officer since 1-25-84\nF. D. Kuester Vice President - Power Generation and Delivery Age 45 Served as Executive Officer since 3-28-94\nDon E. Mason Vice President - External Affairs and Corporate Services Age 54 Served as Executive Officer since 7-27-83\nMichael W. Southern Vice President, Secretary, Treasurer and Chief Financial Officer Age 43 Served as Executive Officer since 1-1-95\nEach of the above is currently an executive officer of MISSISSIPPI, serving a term running from the last annual meeting of the directors (April 26, 1995) 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 an officer, other than any arrangements or understandings with officers of MISSISSIPPI acting solely in their capacities as such.\nIdentification of certain significant employees. None.\nIII-9\nFamily relationships. None.\nBusiness experience.\nDwight H. Evans - President and Chief Executive Officer since March 1995. He previously served as Executive Vice President of GEORGIA from 1989 to 1995.\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.\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.\nGeorge A. Schloegel - President of Hancock Bank and Hancock Bank Securities Corporation. Vice Chairman of Hancock Holding Company. Director of Hancock Bank - - - Mississippi, Hancock Bank - Louisiana and First National Bank of Denham Springs, Louisiana.\nPhilip J. Terrell - Superintendent of Pass Christian Public School District and adjunct professor at William Carey College.\nN. Eugene Warr - Retailer (Biloxi and Gulfport, Mississippi). He previously served as Vice Chairman of the Board of SouthTrust Bank of Mississippi, formerly The Jefferson Bank, Biloxi, Mississippi, from 1977 to 1995.\nH. E. Blakeslee - Elected Vice President in 1984. Primarily responsible for business development, rates and wholesale marketing, technical research, district operations and the customer services center.\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 external affairs, corporate communications, security, risk management 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, materials and information resources. 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.\nInvolvement in certain legal proceedings. None.\nIII-10\nSAVANNAH\nIdentification of directors of SAVANNAH.\nArthur M. Gignilliat, Jr. President and Chief Executive Officer Age 63 Served as Director since 9-1-82\nHelen Quattlebaum Artley (1) Age 68 Served as Director since 5-17-77\nPaul J. DeNicola (1) Age 47 Served as Director since 3-14-91\nBrian R. Foster (1) Age 46 Served as Director since 5-16-89\nWalter D. Gnann (1) Age 60 Served as Director since 5-17-83\nRobert B. Miller, III (1) Age 50 Served as Director since 5-17-83\nArnold M. Tenenbaum (1) Age 59 Served as Director since 5-17-77\nFrederick F. Williams, Jr. (1) Age 68 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 16, 1995) 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.\nIdentification of executive officers of SAVANNAH.\nArthur M. Gignilliat, Jr. President, Chief Executive Officer and Director Age 63 Served as Executive Officer since 2-15-72\nW. Miles Greer Vice President - Marketing and Customer Services Age 52 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 44 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 (July 19, 1995) 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.\nIdentification of certain significant employees. None.\nFamily relationships. None.\nBusiness experience.\nArthur M. Gignilliat, Jr. - Elected President and Chief Executive Officer in 1984. Director of Savannah Foods and Industries, Inc.\nHelen Quattlebaum Artley - Homemaker and Civic Worker.\nIII-11\nPaul J. DeNicola - President and Chief Executive Officer of SCS since 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 Building Systems, Inc.\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.\nInvolvement in certain legal proceedings. None.\nIII-12\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nSummary 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 1995 for each of the operating affiliates (ALABAMA, GEORGIA, GULF, MISSISSIPPI and SAVANNAH).\nIII-13\nIII-14\nIII-15\nIII-16\nIII-17\nIII-18\nIII-19\nIII-20\nIII-21\nIII-22\nIII-23\nIII-24\nDEFINED BENEFIT OR ACTUARIAL PLAN DISCLOSURE\nPension Plan Table. The following table sets forth the estimated combined annual pension benefits under the pension and supplemental defined benefit plans in effect during 1995 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, 1995, 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 10 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 1995 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 10 years credited to both Mr. Bowden and Mr. Holland pursuant to individual supplemental pension agreements.\nIII-26\nAs of December 31, 1995, the applicable compensation levels and years of accredited service are presented in the following table:-\nDeferred 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 10 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- - -------------------- 2 The plan benefits are subject to the maximum benefit limitations set forth in Section 415 of the Internal Revenue Code.\nIII-27\nCompensation of Directors.\nStandard Arrangements. The following table presents compensation paid to the directors, during 1995 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 is based upon length of service and varies from 75 to 100 percent of the annual retainer fee in effect on the date of retirement. Payments continue for the greater of the lifetime of the participant or 10 years.\nOther Arrangements. No director received other compensation for services as a director during the year ending December 31, 1995 in addition to or in lieu of that specified by the standard arrangements specified above.\nEmployment Contracts and Termination of Employment and Change in Control Arrangements.\nNone.\nReport on Repricing of Options.\nNone.\nIII-28\nAdditional 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, served as Chairman and Chief Executive Officer of AmSouth Bancorporation during 1995.\nIII-29\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nSecurity 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.\nSecurity 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, 1995. 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, 1995.\nIII-30\nIII-31\nIII-32\nIII-33\nIII-34\nIII-35\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nALABAMA\nTransactions with management and others.\nMr. Whit Armstrong is President, Chairman and Chief Executive Officer of The Citizens Bank, Enterprise, Alabama; Mr. Carl E. Jones, Jr. is Chairman and Chief Executive Officer of First Alabama Bank, Mobile, Alabama; Mr. Wallace D. Malone is Chairman and Chief Executive Officer of SouthTrust Corporation, Birmingham, Alabama, and Mr. John W. Woods is Chairman of AmSouth Bancorporation, Birmingham, Alabama, and during 1995, Mr. Woods also served as Chief Executive Officer of AmSouth Bancorporation. During 1995, these banks furnished a number of regular banking services in the ordinary course of business to ALABAMA. ALABAMA intends to maintain normal banking relations with all the aforesaid banks in the future.\nCertain business relationships. None.\nIndebtedness of management. None.\nTransactions with promoters. None.\nGEORGIA\nTransactions with management and others.\nMr. L. G. Hardman III is Chairman of the Board of The First National Bank of Commerce, Georgia; Mr. James R. Lientz, Jr. is President of NationsBank of Georgia, Atlanta, Georgia; Mr. G. Joseph Prendergast is Chairman of Wachovia Bank of Georgia, N.A., Atlanta, Georgia; and Mr. Herman J. Russell is Chairman of the Board of Citizens Trust Bank, Atlanta, Georgia. During 1995, 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 1995, GEORGIA leased a building from Riverside Manufacturing Co. for approximately $75,000. Mr. William J. Vereen is Chief Executive Officer, President, Treasurer and Director of Riverside Manufacturing Co.\nCertain business relationships. None.\nIndebtedness of management. None.\nTransactions with promoters. None. GULF\nTransactions with management and others.\nMr. W. D. Hull, Jr. is Vice Chairman of SunTrust Bank, West Florida, Panama City, Florida, and Mr. C. W. Ruckel is Chairman of the Board of The Vanguard Bank and Trust Company, Valparaiso, Florida. During 1995, these banks furnished a number of regular banking services in the ordinary course of business to GULF. GULF intends to maintain normal banking relations with the aforesaid banks in the future.\nThe firm of Beggs & Lane, P.A. serves as local counsel for GULF and received from GULF approximately $1,034,573 for services rendered. Mr. G. Edison Holland, Jr. is a partner in the firm and also serves as Vice President - Power Generation\/Transmission and Corporate Counsel of GULF.\nCertain business relationships. None.\nIndebtedness of management. None.\nTransactions with promoters. None.\nMISSISSIPPI\nTransactions with management and others.\nMr. Robert S. Gaddis is President of Trustmark National Bank, Laurel, Mississippi; Mr. George A. Schloegel is President of Hancock Bank, Gulfport, Mississippi; and during 1995, Mr. N. Eugene Warr served as Vice Chairman of the Board of SouthTrust Bank of Mississippi, Biloxi, Mississippi. During 1995, these banks furnished a number of regular banking services in the ordinary course of business to MISSISSIPPI. MISSISSIPPI intends to maintain normal banking relations with the aforesaid banks in the future.\nIII-36\nCertain business relationships. None.\nIndebtedness of management. None.\nTransactions with promoters. None.\nSAVANNAH\nTransactions with management and others.\nMr. Brian R. Foster is President and Chief Executive Officer of NationsBank of Georgia, N.A., in Savannah, Georgia. During 1995, this bank furnished a number of regular banking services in the ordinary course of business to SAVANNAH. SAVANNAH intends to maintain normal banking relations with the aforesaid bank in the future.\nCertain business relationships. None.\nIndebtedness of management. None.\nTransactions 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 1995, SOUTHERN filed the following Current Reports on Form 8-K and Form 8-K\/A:\nForm 8-K filed October 3, 1995: Items reported: Item 2 Item 7 Financial statements filed: SWEB Consolidated Balance Sheet at March 31, 1995 SWEB Consolidated Profit and Loss Account Statement for the Year Ended March 31, 1995 SWEB Consolidated Statement of Cash Flows for the Year Ended March 31, 1995\nForm 8-K\/A filed November 20, 1995: Item reported: Item 7 Financial statements filed: SOUTHERN and Subsidiary Companies Condensed Balance Sheet at September 30, 1995, incorporated by reference to Form 10-Q for the Quarter Ended September 30, 1995\nSOUTHERN and Subsidiary Companies Pro Forma Condensed Consolidated Statements of Income (Unaudited) for the Nine Months Ended September 30, 1995 and for the Twelve Months Ended December 31, 1995\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 22, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, 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, Chief Financial Officer and Treasurer (Principal Financial and Accounting Officer)\nDirectors: John C. Adams Elmer B. Harris A. D. Correll William A. Parker, Jr. Paul J. DeNicola William J. Rushton, III Jack Edwards Gloria M. Shatto H. Allen Franklin Gerald J. St. Pe' Bruce S. Gordon Herbert Stockham L. G. Hardman III\nBy: \/s\/Wayne Boston (Wayne Boston, Attorney-in-fact)\nDate: March 22, 1996\nPursuant to the requirements of Section 13 or 15(d) of the 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 22, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, 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 and Chief Financial Officer (Principal Financial Officer)\nDavid L. Whitson Vice President and Comptroller (Principal Accounting Officer)\nDirectors: Whit Armstrong William V. Muse Philip E. Austin John T. Porter 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 Carl E. Jones, Jr. John Cox Webb, IV Wallace D. Malone, Jr. John W. Woods\nBy: \/s\/Wayne Boston (Wayne Boston, Attorney-in-fact)\nDate: March 22, 1996\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 22, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, 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)\nCliff S. Thrasher Vice President, Comptroller and Chief Accounting Officer (Principal Accounting Officer)\nDirectors: Bennett A. Brown G. Joseph Prendergast A. W. Dahlberg Herman J. Russell William A. Fickling, Jr. Gloria M. Shatto L. G. Hardman III William Jerry Vereen James R. Lientz, Jr. Thomas R. Williams\nBy: \/s\/Wayne Boston (Wayne Boston, Attorney-in-fact)\nDate: March 22, 1996\nPursuant to the requirements of Section 13 or 15(d) of the 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 22, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, 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, Sr., M.D. 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 22, 1996\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: Dwight H. Evans, President and Chief Executive Officer\nBy: \/s\/Wayne Boston (Wayne Boston, Attorney-in-fact)\nDate: March 22, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, 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.\nDwight H. Evans 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 George A. Schloegel Robert S. Gaddis Philip J. Terrell Walter H. Hurt, III N. Eugene Warr\nBy: \/s\/Wayne Boston (Wayne Boston, Attorney-in-fact)\nDate: March 22, 1996\nPursuant to the requirements of Section 13 or 15(d) of the 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 22, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, 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 Arnold M. Tenenbaum Brian R. Foster Frederick F. Williams, Jr. Walter D. Gnann\nBy: \/s\/Wayne Boston (Wayne Boston, Attorney-in-fact)\nDate: March 22, 1996\nIV-4\nExhibit 21. Subsidiaries of the Registrants.*\nJurisdiction of Name of Company Organization ------------------------------------------------ --------------------- Alabama Power Company Alabama Alabama Power Capital Trust I Delaware Alabama Property Company Alabama Southern Electric Generating Company Alabama Georgia Power Company Georgia Piedmont-Forrest Corporation Georgia Georgia Power L.P. Holdings Corp. Georgia Georgia Power Capital, L.P. Delaware Southern Electric Generating Company Alabama Gulf Power Company Maine Mississippi Power Company Mississippi Savannah Electric and Power Company Georgia SEI Holdings, Inc. Delaware ------------------------------------------------ ---------------------\n*This list omits certain subsidiaries pursuant to paragraph (b)(21)(ii) of Regulation S-K Item 601.\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 21, 1996 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, 33-51433, 33-54415, 33-57951, 33-58371, and 33-60427.\n\/s\/Arthur Andersen LLP\nAtlanta, Georgia March 20, 1996\nIV-6\nARTHUR ANDERSEN LLP\nExhibit 23(b)\nCONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS\nAs independent public accountants, we hereby consent to the incorporation of our reports dated February 21, 1996 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 Nos. 33-49653 and 33-61845.\n\/s\/Arthur Andersen LLP\nBirmingham, Alabama March 20, 1996\nIV-7\nARTHUR ANDERSEN LLP\nExhibit 23(c)\nCONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS\nAs independent public accountants, we hereby consent to the incorporation of our reports dated February 21, 1996 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 Nos. 33-49661 and 33-60345.\n\/s\/Arthur Andersen LLP\nAtlanta, Georgia March 20, 1996\nIV-8\nARTHUR ANDERSEN LLP\nExhibit 23(d)\nCONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS\nAs independent public accountants, we hereby consent to the incorporation of our reports dated February 21, 1996 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\nAtlanta, Georgia March 20, 1996\nIV-9\nARTHUR ANDERSEN LLP\nExhibit 23(e)\nCONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS\nAs independent public accountants, we hereby consent to the incorporation of our reports dated February 21, 1996 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\nAtlanta, Georgia March 20, 1996\nIV-10\nARTHUR ANDERSEN LLP\nExhibit 23(f)\nCONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS\nAs independent public accountants, we hereby consent to the incorporation of our reports dated February 21, 1996 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 No. 33-52509.\n\/s\/Arthur Andersen LLP\nAtlanta, Georgia March 20, 1996\nIV-11\nARTHUR ANDERSEN LLP\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 21, 1996. Our audits were made for the purpose of forming an opinion on those statements taken as a whole. The schedule listed under Item 14(a)(2) herein as it relates to The Southern Company and its subsidiaries (page S-2) is the responsibility of The Southern Company's management and is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic consolidated financial statements. This schedule has been subjected to the auditing procedures applied in the audits of the basic consolidated financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic consolidated financial statements taken as a whole.\n\/s\/Arthur Andersen LLP\nAtlanta, Georgia February 21, 1996\nIV-12\nARTHUR ANDERSEN LLP\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 21, 1996. Our audits were made for the purpose of forming an opinion on those statements taken as a whole. The schedule listed under Item 14(a)(2) herein as it relates to Alabama Power Company (page S-3) is the responsibility of Alabama Power 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.\n\/s\/Arthur Andersen LLP\nBirmingham, Alabama February 21, 1996\nIV-13\nARTHUR ANDERSEN LLP\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 21, 1996. Our audits were made for the purpose of forming an opinion on those statements taken as a whole. The schedule listed under Item 14(a)(2) herein as it relates to Georgia Power Company (page S-4) is the responsibility of Georgia Power 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.\n\/s\/Arthur Andersen LLP\nAtlanta, Georgia February 21, 1996\nIV-14\nARTHUR ANDERSEN LLP\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 21, 1996. Our audits were made for the purpose of forming an opinion on those statements taken as a whole. The schedule listed under Item 14(a)(2) herein as it relates to Gulf Power Company (page S-5) is the responsibility of Gulf Power 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.\n\/s\/Arthur Andersen LLP\nAtlanta, Georgia February 21, 1996\nIV-15\nARTHUR ANDERSEN LLP\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 21, 1996. Our audits were made for the purpose of forming an opinion on those statements taken as a whole. The schedule listed under Item 14(a)(2) herein as it relates to Mississippi Power Company (page S-6) is the responsibility of Mississippi Power 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.\n\/s\/Arthur Andersen LLP\nAtlanta, Georgia February 21, 1996\nIV-16\nARTHUR ANDERSEN LLP\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 21, 1996. Our audits were made for the purpose of forming an opinion on those statements taken as a whole. The schedule listed under Item 14(a)(2) herein as it relates to Savannah Electric and Power Company (page S-7) is the responsibility of Savannah Electric and Power 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.\n\/s\/Arthur Andersen LLP\nAtlanta, Georgia February 21, 1996\nIV-17\nINDEX TO FINANCIAL STATEMENT SCHEDULES\nSchedule Page\nII Valuation and Qualifying Accounts and Reserves 1995, 1994 and 1993 The Southern Company and Subsidiary Companies............ S-2 Alabama Power Company.................................... S-3 Georgia Power Company.................................... S-4 Gulf Power Company....................................... S-5 Mississippi Power Company................................ S-6 Savannah Electric and Power Company...................... S-7\nSchedules I through V not listed above are omitted as not applicable or not required. Columns omitted from schedules filed have been omitted because the information is not applicable or not required.\nS-1\nTHE SOUTHERN COMPANY AND SUBSIDIARY COMPANIES SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (Stated in Thousands of Dollars)\nS-2\nALABAMA POWER COMPANY SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (Stated in Thousands of Dollars)\nS-3\nGEORGIA POWER COMPANY SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (Stated in Thousands of Dollars)\nS-4\nGULF POWER COMPANY SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (Stated in Thousands of Dollars)\nS-5\nMISSISSIPPI POWER COMPANY SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (Stated in Thousands of Dollars)\nS-6\nSAVANNAH ELECTRIC AND POWER COMPANY SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (Stated in Thousands of Dollars)\nS-7\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(1) Underwriting Agreements\nGEORGIA\n* (c) - Distribution Agreement dated November 29, 1995 between GEORGIA and Lehman Brothers Inc.; Donaldson, Lufkin & Jenrette Securities Corporation; J. P. Morgan Securities Inc.; Salomon Brothers Inc and Smith Barney Inc. relating to $300,000,000 First Mortgage Bonds Secured Medium-Term Notes.\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\nas 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).)\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.)\nGULF\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.)\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 May 1, 1995. (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\nCertificate 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, in Certificate of Notification, File No. 70-8443, as Exhibit E, in GEORGIA's Form 10-K for the year ended December 31, 1994, File No. 1-6468, as Exhibits 4(c)2 and 4(c)3, in Certificate of Notification, File No. 70-8443, as Exhibit C, in Certificate of Notification, File No. 70-8443, as Exhibit C and in Form 8-K dated May 17, 1995, File No. 1-6468, as Exhibit 4.)\n* (c) 2 - Supplemental Indenture dated as of July 1, 1995, between GEORGIA and Chemical Bank, as Trustee.\n* (c) 3 - Second Supplemental Indenture dated as of July 1, 1995, between GEORGIA and Chemical Bank, as Trustee.\n* (c) 4 - Supplemental Indenture dated as of September 1, 1995, between GEORGIA and Chemical Bank, as Trustee.\n* (c) 5 - Second Supplemental Indenture dated as of September 1, 1995, between GEORGIA and Chemical Bank, as Trustee.\n* (c) 6 - Supplemental Indenture dated as of October 15, 1995, between GEORGIA and Chemical Bank, as Trustee.\n(c) 7 - Indenture dated as of December 1, 1994, between GEORGIA and Trust Company Bank, as Trustee and indentures supplemental thereto through that dated as of December 15, 1994. (Designated in Certificate of Notification, File No. 70-8461, as Exhibits E and 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 February 1, 1996. (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, in Certificate of Notification, File No. 70-8229, as Exhibits E and F, in Form 8-K dated January 17, 1996, File No. 0-2429, as Exhibit 4 and in Certificate of Notification, File No. 70-8229, as Exhibit A.)\nMISSISSIPPI\n(e) - Indenture dated as of September 1, 1941, between MISSISSIPPI and Bankers Trust Company, as Successor Trustee, and indentures supplemental thereto through December 1, 1995. (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),\n33-5414 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, in Form 8-K dated March 8, 1994, File No. 0-6849, as Exhibit 4, in Certificate of Notification, File No. 70-8127, as Exhibit C and in Form 8-K dated December 5, 1995, File No. 0-6849, as Exhibit 4.)\nSAVANNAH\n(f) - Indenture dated as of March 1, 1945, between SAVANNAH and Bank of New York, New York, as Trustee, and indentures supplemental thereto through May 1, 1995. (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), in Form 8-K dated July 22, 1993, File No. 1-5072, as Exhibit 4 and in Form 8-K dated May 18, 1995, 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 - Service Contract dated as of December 12, 1994, between SCS and Mobile Energy Services Company, Inc. (Designated in SOUTHERN's Form 10-K for the year ended December 31, 1994, File No. 1-3526, as Exhibit 10(a)58.)\n(a) 6 - 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) 7 - Agreement dated as of January 27, 1959, Amendment No. 1 dated as of October 27, 1982 and Amendment No. 2 dated November 4, 1993 and effective June 1, 1994, among SEGCO, ALABAMA and GEORGIA. (Designated in Registration No. 2-59634 as Exhibit 5(c), in GEORGIA's Form 10-K for the year ended December 31, 1982, File No. 1-6468, as Exhibit 10(d)(2) and in ALABAMA's Form 10-K for the year ended December 31, 1994, File No. 1-3164, as Exhibit 10(b)18.)\n(a) 8 - 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) 9 - 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) 10 - 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) 11 - 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) 12 - 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) 13 - 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) 14 - 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) 15 - 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) 16 - 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) 17 - 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) 18 - Alvin W. Vogtle Nuclear Units Number One and Two Purchase, Amendment, Assignment and Assumption Agreement dated as of November 16, 1983, between GEORGIA and MEAG. (Designated in GEORGIA's Form 10-K for the year ended December 31, 1983, File No. 1-6468, as Exhibit 10(k)(4).)\n(a) 19 - 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) 20 - 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) 21 - 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) 22 - 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) 23 - 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) 24 - 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) 25 - 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) 26 - 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) 27 - Plant Robert W. Scherer Purchase, Sale and Option Agreement dated as of May 15, 1980, between GEORGIA and MEAG. (Designated in Form U-1, File No. 70-6481, as Exhibit B-1.)\n(a) 28 - 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) 29 - 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) 30 - 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) 31 - 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 and Amendment No. 1 dated as of June 15, 1994. (Designated in Form U-1, File No. 70-7843, as Exhibit B-1 and in SOUTHERN's Form 10-K for the year ended December 31, 1994, File No. 1-3526, as Exhibit 10(a)60.)\n(a) 32 - Plant Robert W. Scherer Unit No. Four Operating Agreement by and among GEORGIA, FP&L and JEA, dated as of December 31, 1990 and Amendment No. 1 dated as of June 15, 1994. (Designated in Form U-1, File No. 70-7843, as Exhibit B-2 and in SOUTHERN's Form 10-K for the year ended December 31, 1994, File No. 1-3526, as Exhibit 10(a)61.)\n(a) 33 - 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) 34 - 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) 35 - Unit Power Sales Agreement dated July 19, 1988, between FPC and ALABAMA, GEORGIA, GULF, MISSISSIPPI, SAVANNAH and SCS. (Designated in SAVANNAH's Form 10-K for the year ended December 31, 1988, File No. 1-5072, as Exhibit 10(d).)\n(a) 36 - 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) 37 - 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) 38 - 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) 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.)\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.)\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 - 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) 59 - 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) 60 - 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) 61 - The Southern Company Productivity Improvement Plan, Amended and Restated effective January 1, 1995.\n* (a) 62 - The Southern Company Executive Productivity Improvement Plan, effective January 1, 1995.\n* (a) 63 - The Southern Company Employee Savings Plan, Amended and Restated effective July 3, 1995 and First Amendment and Second Amendment thereto.\n* (a) 64 - The Southern Company Employee Stock Ownership Plan, Amended and Restated effective April 1, 1995 and First Amendment thereto.\n(a) 65 - Pension Plan For Employees of ALABAMA, Amended and Restated effective as of January 1, 1989. (Designated in SOUTHERN's Form 10-K for the year ended December 31, 1994, File No. 1-3526, as Exhibit 10(a)69.)\n(a) 66 - Pension Plan For Employees of GEORGIA, Amended and Restated effective as of January 1, 1989. (Designated in SOUTHERN's Form 10-K for the year ended December 31, 1994, File No. 1-3526, as Exhibit 10(a)70.)\n(a) 67 - Pension Plan For Employees of SCS, Amended and Restated effective as of January 1, 1989. (Designated in SOUTHERN's Form 10-K for the year ended December 31, 1994, File No. 1-3526, as Exhibit 10(a)71.)\n* (a) 68 - First Amendment to the Pension Plan for Employees of SCS, effective as of January 1, 1995.\n(a) 69 - The Southern Company Performance Pay Plan, Amended and Restated effective January 1, 1993. (Designated in SOUTHERN's Form 10-K for the year ended December 31, 1994, File No. 1-3526, as Exhibit 10(a)72.)\n* (a) 70 - First Amendment and Second Amendment to The Southern Company Performance Pay Plan.\n* (a) 71 - Supplemental Benefit Plan for ALABAMA.\n* (a) 72 - Supplemental Benefit Plan for GEORGIA.\n* (a) 73 - Supplemental Benefit Plan for SCS and SEI.\n(a) 74 - The Deferred Compensation Plan for the Directors of The Southern Company. (Designated in SOUTHERN's Form 10-K for the year ended December 31, 1994, File No. 1-3526, as Exhibit 10(a)76.)\n* (a) 75 - First Amendment and Second Amendment to The Deferred Compensation Plan for the Directors of The Southern Company.\n(a) 76 - The Southern Company Outside Directors Pension Plan. (Designated in SOUTHERN's Form 10-K for the year ended December 31, 1994, File No. 1-3526, as Exhibit 10(a)77.)\n* (a) 77 - The Southern Company Deferred Compensation Plan.\n(a) 78 - The Southern Company Outside Directors Stock Plan. (Designated in Registration No. 33-54415 as Exhibit 4(c).)\n* (a) 79 - First Amendment to The Southern Company Outside Directors Stock Plan.\n* (a) 80 - Outside Directors Stock Plan for Subsidiaries of The Southern Company and First Amendment thereto.\n(a) 81 - 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) 82 - Second Amendment to The Southern Company Executive Stock 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)6 herein.\n(b) 3 - Agreement dated as of January 27, 1959, Amendment No. 1 dated as of October 27, 1982 and Amendment No. 2 dated November 4, 1993 and effective June 1, 1994, among SEGCO, ALABAMA and GEORGIA. See Exhibit 10(a)7 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)33 herein.\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)34 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)35 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)36 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)37 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)38 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.\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 - Operating Agreement for the Joseph M. Farley Nuclear Plant between ALABAMA and Southern Nuclear dated as of December 23, 1991. See Exhibit 10(a)58 herein.\n* (b) 19 - The Southern Company Productivity Improvement Plan, Amended and Restated effective January 1, 1995. See Exhibit 10(a)61 herein.\n* (b) 20 - The Southern Company Executive Productivity Improvement Plan, effective January 1, 1995. See Exhibit 10(a)62 herein.\n* (b) 21 - The Southern Company Employee Savings Plan, Amended and Restated effective July 3, 1995 and First Amendment and Second Amendment thereto. See Exhibit 10(a)63 herein.\n* (b) 22 - The Southern Company Employee Stock Ownership Plan, Amended and Restated effective April 1, 1995 and First Amendment thereto. See Exhibit 10(a)64 herein.\n(b) 23 - Pension Plan For Employees of ALABAMA, Amended and Restated effective as of January 1, 1989. See Exhibit 10(a)65 herein.\n(b) 24 - The Southern Company Performance Pay Plan, Amended and Restated effective January 1, 1993. See Exhibit 10(a)69 herein.\n* (b) 25 - First Amendment and Second Amendment to The Southern Company Performance Pay Plan. See Exhibit 10(a)70 herein.\n* (b) 26 - Supplemental Benefit Plan for ALABAMA. See Exhibit 10(a)71 herein.\n* (b) 27 - The Southern Company Deferred Compensation Plan. See Exhibit 10(a)77 herein.\n(b) 28 - The Southern Company Outside Directors Pension Plan. See Exhibit 10(a)76 herein.\n* (b) 29 - Outside Directors Stock Plan for Subsidiaries of The Southern Company and First Amendment thereto. See Exhibit 10(a)80 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)6 herein.\n(c) 3 - Agreement dated as of January 27, 1959, Amendment No. 1 dated as of October 27, 1982 and Amendment No. 2 dated November 4, 1993 and effective June 1, 1994, among SEGCO, ALABAMA and GEORGIA. See Exhibit 10(a)7 herein.\n(c) 4 - Joint Committee Agreement dated as of August 27, 1976, among GEORGIA, OPC, MEAG and Dalton. See Exhibit 10(a)8 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)9 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)10 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)11 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)12 herein.\n(c) 9 - Plant Hal Wansley Operating Agreement dated as of March 26, 1976, between GEORGIA and OPC. See Exhibit 10(a)13 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)14 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)15 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)16 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)17 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)18 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)19 herein.\n(c) 16 - Plant Hal Wansley Operating Agreement dated as of August 27, 1976, between GEORGIA and MEAG. See Exhibit 10(a)20 herein.\n(c) 17 - Integrated Transmission System Agreement dated as of August 27, 1976, between GEORGIA and Dalton. See Exhibit 10(a)21 herein.\n(c) 18 - Integrated Transmission System Agreement dated as of August 27, 1976, between GEORGIA and MEAG. See Exhibit 10(a)22 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)23 herein.\n(c) 20 - Plant Hal Wansley Operating Agreement dated as of April 19, 1977, between GEORGIA and Dalton. See Exhibit 10(a)24 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)25 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)26 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)27 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)28 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)29 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)30 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 and Amendment No. 1 dated as of June 15, 1994. See Exhibit 10(a)31 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 and Amendment No. 1 dated as of June 15, 1994. See Exhibit 10(a)32 herein.\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)33 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)34 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)35 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)36 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)37 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)38 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.\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.)\n(c) 54 - Nuclear Services Agreement between Southern Nuclear and GEORGIA dated as of October 31, 1991. See Exhibit 10(a)59 herein.\n(c) 55 - Nuclear Managing Board Agreement among GEORGIA, OPC, MEAG and Dalton dated as of November 12, 1990. See Exhibit 10(a)60 herein.\n* (c) 56 - The Southern Company Productivity Improvement Plan, Amended and Restated effective January 1, 1995. See Exhibit 10(a)61 herein.\n* (c) 57 - The Southern Company Executive Productivity Improvement Plan, effective January 1, 1995. See Exhibit 10(a)62 herein.\n* (c) 58 - The Southern Company Employee Savings Plan, Amended and Restated effective July 3, 1995 and First Amendment and Second Amendment thereto. See Exhibit 10(a)63 herein.\n* (c) 59 - The Southern Company Employee Stock Ownership Plan, Amended and Restated effective April 1, 1995 and First Amendment thereto. See Exhibit 10(a)64 herein.\n(c) 60 - Pension Plan For Employees of GEORGIA, Amended and Restated effective as of January 1, 1989. See Exhibit 10(a)66 herein.\n(c) 61 - The Southern Company Performance Pay Plan, Amended and Restated effective January 1, 1993. See Exhibit 10(a)69 herein.\n* (c) 62 - First Amendment and Second Amendment to The Southern Company Performance Pay Plan. See Exhibit 10(a)70 herein.\n* (c) 63 - Supplemental Benefit Plan for GEORGIA. See Exhibit 10(a)72 herein.\n* (c) 64 - The Southern Company Deferred Compensation Plan. See Exhibit 10(a)77 herein.\n(c) 65 - The Southern Company Outside Directors Pension Plan. See Exhibit 10(a)76 herein.\n* (c) 66 - Outside Directors Stock Plan for Subsidiaries of The Southern Company and First Amendment thereto. See Exhibit 10(a)80 herein.\nGULF\n(d) 1 - Service contracts dated as of January 1, 1984 and Amendment No. 1 dated as of September 6, 1985, between SCS and ALABAMA, GEORGIA, GULF, MISSISSIPPI, SEGCO and SOUTHERN. See Exhibit 10(a)1 herein.\n(d) 2 - Interchange contract dated October 28, 1988, effective January 1, 1989, between ALABAMA, GEORGIA, GULF, MISSISSIPPI, SAVANNAH and SCS. See Exhibit 10(a)6 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)29 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)30 herein.\n(d) 5 - 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(d) 6 - 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)33 herein.\n(d) 7 - 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)34 herein.\n(d) 8 - Unit Power Sales Agreement dated July 19, 1988, between FPC and ALABAMA, GEORGIA, GULF, MISSISSIPPI, SAVANNAH and SCS. See Exhibit 10(a)35 herein.\n(d) 9 - Amended Unit Power Sales Agreement dated July 20, 1988, between FP&L and ALABAMA, GEORGIA, GULF, MISSISSIPPI, SAVANNAH and SCS. See Exhibit 10(a)36 herein.\n(d) 10 - Amended Unit Power Sales Agreement dated August 17, 1988, between JEA and ALABAMA, GEORGIA, GULF, MISSISSIPPI, SAVANNAH and SCS. See Exhibit 10(a)37 herein.\n(d) 11 - 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) 12 - Unit Power Sales Agreement dated December 8, 1990, between Tallahassee and ALABAMA, GEORGIA, GULF, MISSISSIPPI, SAVANNAH and SCS. See Exhibit 10(a)38 herein.\n(d) 13 - 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) 14 - 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* (d) 15 - The Southern Company Productivity Improvement Plan, Amended and Restated effective January 1, 1995. See Exhibit 10(a)61 herein.\n* (d) 16 - The Southern Company Executive Productivity Improvement Plan, effective January 1, 1995. See Exhibit 10(a)62 herein.\n* (d) 17 - The Southern Company Employee Savings Plan, Amended and Restated effective July 3, 1995 and First Amendment and Second Amendment thereto. See Exhibit 10(a)63 herein.\n* (d) 18 - The Southern Company Employee Stock Ownership Plan, Amended and Restated effective April 1, 1995 and First Amendment thereto. See Exhibit 10(a)64 herein.\n(d) 19 - Pension Plan For Employees of GULF, Amended and Restated effective as of January 1, 1989. (Designated in GULF's Form 10-K for the year ended December 31, 1994, File No. 0-2429, as Exhibit 10(d)18.)\n(d) 20 - The Southern Company Performance Pay Plan, Amended and Restated effective January 1, 1993. See Exhibit 10(a)69 herein.\n* (d) 21 - First Amendment and Second Amendment to The Southern Company Performance Pay Plan. See Exhibit 10(a)70 herein.\n* (d) 22 - Supplemental Benefit Plan for GULF.\n* (d) 23 - The Southern Company Deferred Compensation Plan. See Exhibit 10(a)77 herein.\n(d) 24 - The Southern Company Outside Directors Pension Plan. See Exhibit 10(a)76 herein.\n* (d) 25 - Outside Directors Stock Plan for Subsidiaries of The Southern Company and First Amendment thereto. See Exhibit 10(a)80 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)6 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)33 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)34 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)35 herein.\n(e) 6 - Amended Unit Power Sales Agreement dated July 20, 1988, between FP&L and ALABAMA, GEORGIA, GULF, MISSISSIPPI, SAVANNAH and SCS. See Exhibit 10(a)36 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)37 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)38 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, 1995. See Exhibit 10(a)61 herein.\n* (e) 15 - The Southern Company Executive Productivity Improvement Plan, effective January 1, 1995. See Exhibit 10(a)62 herein.\n* (e) 16 - The Southern Company Employee Savings Plan, Amended and Restated effective July 3, 1995 and First Amendment and Second Amendment thereto. See Exhibit 10(a)63 herein.\n* (e) 17 - The Southern Company Employee Stock Ownership Plan, Amended and Restated effective April 1, 1995 and First Amendment thereto. See Exhibit 10(a)64 herein.\n(e) 18 - Pension Plan For Employees of MISSISSIPPI, Amended and Restated effective as of January 1, 1989. (Designated in MISSISSIPPI's Form 10-K for the year ended December 31, 1994, File No. 0-6849, as Exhibit 10(e)18.)\n(e) 19 - The Southern Company Performance Pay Plan, Amended and Restated effective January 1, 1993. See Exhibit 10(a)69 herein.\n* (e) 20 - First Amendment and Second Amendment to The Southern Company Performance Pay Plan. See Exhibit 10(a)70 herein.\n* (e) 21 - Supplemental Benefit Plan for MISSISSIPPI.\n* (e) 22 - The Southern Company Deferred Compensation Plan. See Exhibit 10(a)77 herein.\n(e) 23 - The Southern Company Outside Directors Pension Plan. See Exhibit 10(a)76 herein.\n* (e) 24 - Outside Directors Stock Plan for Subsidiaries of The Southern Company and First Amendment thereto. See Exhibit 10(a)80 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)6 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)35 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)36 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)37 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)38 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.\n* (f) 11 - The Southern Company Productivity Improvement Plan, Amended and Restated effective January 1, 1995. See Exhibit 10(a)61 herein.\n* (f) 12 - The Southern Company Executive Productivity Improvement Plan, effective January 1, 1995. See Exhibit 10(a)62 herein.\n* (f) 13 - The Southern Company Employee Savings Plan, Amended and Restated effective July 3, 1995 and First Amendment and Second Amendment thereto. See Exhibit 10(a)63 herein.\n* (f) 14 - The Southern Company Employee Stock Ownership Plan, Amended and Restated effective April 1, 1995 and First Amendment thereto. See Exhibit 10(a)64 herein.\n(f) 15 - Employees' Retirement Plan of SAVANNAH, Amended and Restated effective January 1, 1989. (Designated in SAVANNAH's Form 10-K for the year ended December 31, 1994, File No. 1-5072, as Exhibit 10(f)15.)\n* (f) 16 - First Amendment to the Employees' Retirement Plan of SAVANNAH.\n* (f) 17 - Supplemental Executive Retirement Plan of SAVANNAH, Amended and Restated effective January 1, 1996.\n(f) 18 - Deferred Compensation Plan for Key Employees of SAVANNAH. (Designated in SAVANNAH's Form 10-K for the year ended December 31, 1994, File No. 1-5072, as Exhibit 10(f)17.)\n* (f) 19 - First Amendment to the Deferred Compensation Plan for Key Employees of SAVANNAH.\n(f) 20 - The Southern Company Performance Pay Plan, Amended and Restated effective January 1, 1993. See Exhibit 10(a)69 herein.\n* (f) 21 - First Amendment and Second Amendment to The Southern Company Performance Pay Plan. See Exhibit 10(a)70 herein.\n(f) 22 - The Southern Company Outside Directors Pension Plan. See Exhibit 10(a)76 herein.\n(f) 23 - Deferred Compensation Plan for Directors of SAVANNAH. (Designated in SAVANNAH's Form 10-K for the year ended December 31, 1994, File No. 1-5072, as Exhibit 10(f)20.)\n* (f) 24 - Outside Directors Stock Plan for Subsidiaries of The Southern Company and First Amendment thereto. See Exhibit 10(a)80 herein.\n(21) *Subsidiaries of Registrants - Contained herein at page IV-5.\n(23) Consents of Experts and Counsel\nSOUTHERN\n* (a) - The consent of Arthur Andersen 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.\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.\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 21, 1996, File No. 1-3526, as Exhibit 27.)\nALABAMA\n(b) - Financial Data Schedule. (Designated in Form 8-K dated February 21, 1996, File No. 1-3164, as Exhibit 27.)\nGEORGIA\n(c) - Financial Data Schedule. (Designated in Form 8-K dated February 21, 1996, File No. 1-6468, as Exhibit 27.)\nGULF\n(d) - Financial Data Schedule. (Designated in Form 8-K dated February 21, 1996, File No. 0-2429, as Exhibit 27.)\nMISSISSIPPI\n(e) - Financial Data Schedule. (Designated in Form 8-K dated February 21, 1996, File No. 0-6849, as Exhibit 27.)\nSAVANNAH\n(f) - Financial Data Schedule. (Designated in Form 8-K dated February 21, 1996, File No. 1-5072, as Exhibit 27.)","section_15":""}
{"filename":"4438_1995.txt","cik":"4438","year":"1995","section_1":"Item 1. BUSINESS\nAmelco Corporation (the \"Company\") was organized in 1967 to become the parent of existing operating companies. The Company, through its subsidiaries, engages in specialty construction work (primarily electrical and mechanical construction). Construction operations are conducted in the western continental United States, Hawaii and Guam.\nOPERATIONS\nThe Company's contracting subsidiaries primarily act as specialty contractors, and are capable of providing the full range of services in the construction and installation of electrical and mechanical systems. These activities are performed in the commercial and industrial construction market, primarily in connection with the construction, rebuilding or renovation of commercial buildings, industrial plants, convention buildings, wastewater treatment plants, hotels, hospitals, hydroelectric dams, refineries, power generating facilities, security systems, highway lighting and military facilities.\nOver the years, profit has been dependent upon management's ability to accurately estimate costs to be incurred on projects which are competitively bid and to effectively control costs of work in progress. Costs ultimately incurred are affected by the incidence of such events and conditions as labor shortages, time extensions, weather, latent geological conditions, delays caused by others and fluctuations in the prices of materials. Because of the large number of variables affecting costs (many of which are not controllable), increased revenues in a particular accounting period do not necessarily result in increased operating profits; losses may occur even when revenues increase.\nThe subsidiaries operate in a highly competitive industry. They compete with numerous other local, regional and national contractors, both smaller and larger than the subsidiaries, none of which are considered to be dominant in the construction markets in which the subsidiaries operate. Substantially all of the subsidiaries' construction contracts are awarded on the basis of competitive bidding. Because of the degree of competition in the industry, which is primarily based on the price of construction services rendered, there is a greater likelihood that the subsidiaries will be an unsuccessful bidder rather than a successful bidder.\nSubstantially all of the construction contracts have been fixed-price contracts. Substantially greater risks are involved in fixed-price contracts than in cost-plus-fee and target-estimate contracts since the contractor assumes responsibility for completing the work for the contract price regardless of ultimate costs. The ability of the subsidiaries to mitigate these risks is largely dependent upon management's ability to accurately estimate construction costs at the time of bid preparation and to effectively manage and control costs of work in progress during the course of contract performance.\nThe Company has no major customers, the loss of which would have a material adverse impact on the Company.\nIn connection with these contracting activities, the subsidiaries, from time to time, assert claims for compensation in excess of the contract price because of delays, owner-caused changed conditions or interruptions, improper or revised specifications or disagreements with respect to the contracted scope of work. Claims for additional compensation may arise in any accounting period and may or may not be material to operations. All costs of construction which give rise to a claim are expensed in the period in which they were incurred. However, the amount of any claim is not recognized as revenue until a settlement has been concluded. Claim settlements in 1995 and 1994 were not significant. Income from claim settlements in fiscal 1993 approximated $366,000. Various other claims have been filed. No assurance can be given that such claims will be allowed nor is the extent of any potential recovery presently estimable.\nThe subsidiaries have numerous suppliers for materials and equipment, none of which are individually dominant, and have experienced no significant difficulty in obtaining the materials needed to pursue the contracted work.\nThe backlog of uncompleted contracting work was approximately $87,661,000 on contracts in force as of September 30, 1995, compared with $122,084,000 as of September 30, 1994, inclusive of the Company's proportionate share of contract backlog from joint ventures amounting to $40,000 and $4,425,000 at September 30, 1995 and 1994, respectively. The Company estimates that 75% of the September 30, 1995 backlog will be substantially completed during fiscal 1996. Contracting backlog at any given time is subject to change due to modifications to the projects concerned. While backlog is an indication of future revenues, no assurance can be given that earnings will be realized from performance of contracts reflected in the backlog.\nThe Company, through its subsidiaries, participates in joint venture arrangements from time to time where the joint venturers undertake to bid and complete, if awarded, a construction contract. These arrangements typically provide for the sharing of profit or losses in the same relationship as the capital contributions of the joint venturers and joint and several responsibility for contract performance. In fiscal 1995, a subsidiary of the Company had three separate joint venture\narrangements which provided for equity participations ranging from 49% to 50%. Projects under these joint venture arrangements, including a joint venture with Industrial Construction, an Idaho-based specialty contractor, are substantially complete at September 30, 1995. Further information on joint venture participations is contained in note 10 to the consolidated financial statements in Item 8, Part II of this report, which is incorporated herein by reference.\nThe Company's Hawaii - based contracting subsidiaries perform various maintenance and repair services relating primarily to electrical and air-conditioning installations. Revenues derived from maintenance and repair services are not material to the consolidated financial statements.\nEmployees: As of September 30, 1995, the Company had approximately 526 employees, of whom approximately 450 were engaged in operational activities and approximately 76 were in supervisory, administrative and clerical positions. Portions of the construction work for which the Company is responsible are carried out by subcontractors who separately employ additional personnel. The number of employees engaged in operational activities fluctuates continuously based upon the number and size of projects. A number of labor unions represent employees, of which local unions of the International Brotherhood of Electrical Workers are considered to be dominant. No one union is the sole bargaining agent.\nEmployee benefits for non-bargaining employees include a 401(k) plan and group medical, dental, disability and life insurance programs.\nEnergy, Supply, Production and Environmental Matters:\nThe Company is not in an energy intensive business.\nThe Company experienced no significant problems in fiscal 1995 relating to the availability or price of construction materials.\nConstruction operations are primarily located in Hawaii and the western continental United States and, therefore, are not normally subject to the effects of significant seasonal variations.\nThe Company's operations are such that compliance with environmental legislation and regulations is not a significant factor. The Company, to some extent, benefits from construction work resulting from compliance with environmental requirements by other industries.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nThe following table summarizes properties occupied by the Company and its subsidiaries. All properties utilized in construction operations have combined uses as offices and warehouses. Management believes that these facilities are in good ondition, well maintained and adequate to serve the needs of the Company:\n(1) In addition to office and warehouse facilities for the Los Angeles construction operations, this property houses the corporate offices of the Company. This property is presently being rented from a related party on a quarter-to-quarter basis pending management's evaluation of alternative office requirements.\n(2) This property serves as the central office for the Hawaii construction operations. This leasehold property has been pledged as collateral for short-term debt of the Company. The lease expires in 2029.\n(3) This property has been pledged as security for an eight-year $2,000,000 mortgage loan obtained by the Company in August 1993. Further information with respect to the mortgage is provided in note 4 to the consolidated financial statements in Item 8, Part II of this report, which is incorporated herein by reference.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nThere are no material legal proceedings to which the Company or any of its subsidiaries are a party which would, in management's opinion, have a material impact on the consolidated financial statements taken as a whole.\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 the names and ages of the Company's executive officers, together with all positions and offices held with the Company by such executive officers. Officers are appointed by the Board of Directors to serve at the pleasure of the Board.\nPART II\nItem 5.","section_5":"Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe only equity securities outstanding are shares of common stock, without par value, which are traded over-the-counter. During each quarter of the last two fiscal years, high and low bid prices for common stock, as reported by a stockbroker, were as follows:\nThe reported bid price on December 1, 1995 was 2-1\/2.\nThese quotations were provided by a single stockbroker (Abel-Behnke Corporation) known to make a market in the Company's common stock and reflect bids only, without retail markup, markdown or commission and may not necessarily represent actual transactions.\nThe Company has paid cash dividends on its common stock of $0.10, $0.15, $0.25, $0.15, $0.25 and $0.25 on February 15, 1995, March 25, 1994, February 12, 1993, March 16, 1992, November 15, 1990 and September 25, 1989, respectively. The payment of dividends requires the consent of the Company's bonding surety and its bank. Future dividends, if any, are dependent on the profitability of the Company and are not assured.\nAs of December 1, 1995, the approximate number of holders of record of the Company's common stock was 315.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA\nTotal construction revenue includes the Company's proportionate share of revenue from construction joint ventures amounting to $6,661,000, $5,854,000, $2,513,000, $2,283,000 and $7,139,000 in fiscal 1995, 1994, 1993, 1992 and 1991, respectively.\nAdditional information on dividends is contained in Item 5, Part II which is incorporated herein by reference.\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nCAPITAL RESOURCES AND LIQUIDITY\nCash balances increased by $1,173,000 in 1995. Working capital increased by $610,000 to $11,161,000 in 1995 representing an increase of 5.8% from the previous year. These changes reflect the increase in the Company's contracting volume in fiscal 1995 and the related increase in current assets. The changes included an increase in contract and trade receivables which increased by $1,449,000. Billings in excess of costs and recognized profits on uncompleted contracts also increased by $970,000\nalthough this was offset by an increase in costs and recognized profits in excess of billings on uncompleted contracts of $135,000. In addition, the Company's investment in joint ventures decreased by $1,042,000 in fiscal 1995 consisting of distributions to the joint venture partners.\nFinancing activities in 1995 provided $813,000 of cash, consisting of cash provided by short-term borrowings under the Company's line of credit of $900,000 and net funds provided by a short-term note payable for insurance premiums of $102,000. This increase was offset by the repayment of long-term debt amounting to $45,000 and the payment of a $144,000 dividend to stockholders in February 1995.\nInvesting activities consumed cash of $539,000, primarily for the acquisition of plant and equipment aggregating $380,000, purchase of real estate held for investment of $200,000 and a decrease in minority interest of $16,000. This was partially offset by cash received from notes receivable aggregating $42,000 and proceeds from sale of assets of $15,000.\nThe Company's backlog of future construction work at September 30, 1995 approximated $87,661,000, inclusive of the Company's proportionate share of contract backlog from joint venture participations aggregating $40,000. Geographically, contract backlog approximating $57,731,000 is in California, $11,185,000 is in Hawaii and Guam and $18,745,000 is in other states.\nThe Company continues to maintain short-term working capital lines of credit amounting to $6,000,000. These credit facilities are primarily used to fund short-term cash needs resulting from customer payment periods which are frequently longer than payment periods for the Company's vendors. Management believes that the present liquidity of the Company together with the availability of the lines of credit are adequate to provide the working capital to fund the Company's operations in 1996 and beyond.\nThe Company's short-term lines of credit are indexed to the prime rate. Although the Company has mitigated its exposure to interest rate movements by the addition of long-term fixed rate debt in 1993, further significant changes in the prime rate, either up or down, may have a significant impact on the Company.\nThe Company's operations are such that significant investment in property, plant and equipment is not required. Capital expenditures in 1996 should consist primarily of replacement or renovation of existing equipment and are not expected to be significant.\nThe Financial Accounting Standards Board recently issued Statements of Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and Assets to be Disposed of\" and No. 123, \"Accounting for Stock Based Compensation\" which are required to be adopted by the\nCompany in fiscal year 1997. It is believed that the adoption of these standards will not have a material effect on the Company's financial statements.\nRESULTS OF OPERATIONS\nFiscal 1995 Compared to 1994\nConsolidated revenues increased by $12,090,000 in 1995. The change reflects an increase in revenue of approximately $19.1 million in California which was partially offset by decreases in revenue approximating $4.9 million in Hawaii and Guam and $2.1 million in other western U.S. states. Changes in revenue volume reflect primarily the degree of success in bidding on new work as well as the scheduling requirements of the customer, and are not necessarily indicative of revenue volume or profitability in future periods. There are no major contracts which were completed in 1995 or which will be completed in 1996 upon which the Company is dependent.\nGross profit increased from $9,285,000 in 1994 to $10,073,000 in fiscal 1995. Gross profit as a percentage of revenues decreased from 8.1% in 1994 to 8.0% in 1995. The change reflects primarily a decrease in gross profits on construction work in the Hawaii operations which was offset by increased profits from joint venture participations in 1995. Gross margins applicable to California operations were largely unchanged in the current year. The Company and its subsidiaries have experienced highly competitive conditions in the industrial and commercial construction markets in which it does business. This is expected to continue in the near future. Management's ability to enhance profit margins in its business is largely limited to its ability to identify profitable bidding opportunities, estimate accurately during the intial bidding stage and upon award, to effectively manage jobsite labor and material installation.\nGeneral and administrative expenses increased from $7,848,000 in 1994 to $8,338,000 in 1995. However, as a percentage of revenue, general and administrative expense decreased from 6.9% in 1994 to 6.6% in 1995. The change reflects primarily the additional costs of project management and administrative staff, together with related office support expenses, incurred during the current year in response to the higher levels of construction operations.\nInterest income increased by $58,000 in 1995 as compared to the previous year due primarily to higher levels of cash maintained in interest bearing accounts in the current year. Interest expense decreased by $10,000 in 1995 due primarily to lower levels of borrowings under the Company's lines of credit offset by changes in the bank prime rates which increased from 7.75% to 8.75% at September 30, 1994 and 1995, respectively. Changes in other components of other income and expense from the prior year were not significant.\nFiscal 1994 Compared to 1993\nConsolidated revenues increased by $18,577,000 in 1994. The change reflects increases in revenue approximating $5.4 million in Hawaii and Guam, $10.9 million in California and $2.3 million in other western U.S. states. The growth in revenue is largely a result of an acceleration in construction work put in place in the 4th fiscal quarter, primarily in California.\nGross profit decreased from $9,993,000 in the prior period to $9,285,000 in fiscal 1994. Gross profit as a percentage of revenues decreased from 10.5% in 1993 to 8.1% in 1994. The decrease results from a combination of the continued highly competitive conditions in the industrial and commercial construction market and the Company's focus on procurement of larger projects as a prime contractor. In addition, the Company recorded unanticipated cost increases approximating $.6 million on a construction project in Hawaii which was completed in 1994 and $1.0 million on a construction contract in California. Management is presently negotiating a claim for additional compensation on the California project which, if approved, will be reflected in the year a settlement is obtained. General and administrative expenses decreased from $8,476,000 in the previous period to $7,848,000 in 1994. The change primarily results from a reduction in the number of administrative and office staff positions as well as transfers of office personnel to field positions.\nInterest expense increased by $152,000 in 1994. The change reflects approximately $132,000 of additional interest arising from the long-term mortgage note obtained in August 1993, higher short-term interest rates in 1994 and an increase in the utilization of the Company's line of credit. Changes in other components of other income and expense from the prior year were not significant.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nAmelco Corporation and Subsidiaries: Independent Auditor's Report Consolidated Balance Sheets - September 30, 1995 and 1994 Consolidated Statements of Earnings - Years ended September 30, 1995, 1994 and 1993 Consolidated Statements of Stockholders' Equity - Years ended September 30, 1995, 1994 and 1993 Consolidated Statements of Cash Flows - Years ended September 30, 1995, 1994 and 1993 Notes to Consolidated Financial Statements\nAMELCO CORPORATION AND SUBSIDIARIES Consolidated Financial Statements September 30, 1995 and 1994 (With Independent Auditors' Report Thereon)\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Stockholders Amelco Corporation:\nWe have audited the consolidated financial statements of Amelco Corporation and subsidiaries as listed in the accompanying index. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Amelco Corporation and subsidiaries as of September 30, 1995 and 1994 and the results of their operations and their cash flows for each of the years in the three-year period ended September 30, 1995 in conformity with generally accepted accounting principles.\nAs discussed in note 1 to the consolidated financial statements, the Company changed its method of accounting for income taxes to adopt the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes,\" effective October 1, 1993.\nDecember 15, 1995\nAMELCO CORPORATION AND SUBSIDIARIES Consolidated Balance Sheets September 30, 1995 and 1994\nAMELCO CORPORATION AND SUBSIDIARIES Consolidated Balance Sheets, continued September 30, 1995 and 1994\nSee accompanying notes to consolidated financial statements.\nAMELCO CORPORATION AND SUBSIDIARIES Consolidated Statements of Earnings Three years ended September 30, 1995\nSee accompanying notes to consolidated financial statements.\nAMELCO CORPORATION AND SUBSIDIARIES Consolidated Statements of Stockholders' Equity Three years ended September 30, 1995\nSee accompanying notes to consolidated financial statements.\nAMELCO CORPORATION AND SUBSIDIARIES Consolidated Statements of Cash Flows Three years ended September 30, 1995 Increase (Decrease) in Cash and Cash Equivalents\n(Continued)\nAMELCO CORPORATION AND SUBSIDIARIES Consolidated Statements of Cash Flows, Continued Increase (Decrease) in Cash and Cash Equivalents\nSee accompanying notes to consolidated financial statements.\nAMELCO CORPORATION\nAND SUBSIDIARIES\nNotes to Consolidated Financial Statements\nSeptember 30, 1995 and 1994\n(1) Summary of Significant Accounting Policies\nCompany's Activities and Operating Cycle\nAmelco Corporation (the \"Company\") was organized in 1967 to become the parent of existing operating companies. The Company, through its subsidiaries, engages in specialty construction work, primarily electrical and mechanical construction. Work is generally performed under fixed-price contracts and is undertaken by the Company's subsidiaries alone, with subcontractors or in partnership with other contractors through joint ventures.\nThe length of the construction contracts varies, but typically ranges from one to two years. In accordance with the operating cycle concept, the Company and its subsidiaries classify all contract-related assets and liabilities as current items.\nBasis of Consolidation\nThe consolidated financial statements include the accounts of the Company and all subsidiaries. The consolidated statements of earnings includes the accounts of the Company, all subsidiaries and its prorata share of the results of operations from its joint ventures. All significant intercompany transactions have been eliminated in consolidation.\nReclassifications\nCertain accounts in the 1994 and 1993 financial statements have been restated to conform with the 1995 format. These reclassifications have no effect on net income as previously reported.\nRevenue Recognition on Long-Term Construction Contracts\nIncome from construction operations and joint venture participations is recorded using the percentage-of-completion method of accounting. Under this method, that portion of the total contract price which is allocable, on the basis of the Company's estimate of the percentage of completion, to contract costs incurred and work performed is accrued. Recognition of profits is deferred until work on the contract has reached a state of completion sufficient for management to reasonably forecast the ultimate realizable profit. If estimated total costs on any contract or joint venture participation indicate a loss, the Company provides currently for the total loss anticipated on the contract. For long-term contracts which extend over one or more years, revisions in cost and profit estimates during the course of the work are reflected in the accounting period in which facts requiring the revision become known.\nContract costs includes all direct material, labor and subcontract costs and those indirect costs related to contract performance, such as indirect labor, tools, supplies, repairs and depreciation cost. General and administrative costs are charged to expense as incurred.\nThe asset \"costs and estimated earnings in excess of billings on uncompleted contracts\" represents revenues recognized in excess of amounts billed. The liability \"billings in excess of costs and estimated earnings on uncompleted contracts\" represents billings in excess of revenues recognized.\nIncome from claims for additional contract compensation is recorded upon settlement of the disputed amount. Income from claim settlements in fiscal 1993 approximated $366,000. Claim settlements in 1995 and 1994 were not significant. Certain subsidiaries of the Company had\noutstanding claims and claims in process of being filed at September 30, 1995. The extent of recovery, if any, on these pending claims is not presently estimable.\nCash Equivalents\nFor purposes of the consolidated statements of cash flows, the Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.\nCash balances at September 30, 1995 and 1994 include approximately $1,616,000 and $1,098,000, respectively, in short-term time deposits maintained in lieu of retention which will be released upon completion of the related construction projects. Interest income on these deposits are credited to the Company.\nInventories\nInventories are stated at the lower of cost (primarily first-in, first-out) or market (net realizable value).\nDepreciation and Amortization\nThe Company and its subsidiaries provide for depreciation and amortization of property, plant and equipment using the straight-line method based on the estimated useful lives of the assets or, if applicable, the remaining terms of the leases, whichever is shorter.\nThe cost and accumulated depreciation applicable to assets sold or otherwise disposed of are eliminated from the asset and accumulated depreciation accounts. Gain or loss on disposition is reflected in other income or expenses.\nIncome Taxes\nEffective October 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\", which requires recognition of deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax liabilities and assets are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted rates in effect for the year in which the differences are expected to reverse. Prior to fiscal 1994, the Company had followed Statement of Financial Accounting Standards No. 96, \"Accounting for Income Taxes\". This new method of accounting was adopted prospectively at the beginning of fiscal 1994 and no prior periods were restated.\nEarnings per Share\nEarnings per share is based on the weighted average number of common shares outstanding during the year.\n(2) Note Receivable from Related Party\nThe Company has a note receivable from Halau Corporation which is owned by three principal stockholders and two officers of the Company. The promissory note is payable over 30 years with quarterly principal and interest payments of $87,000 computed at 9.5% per annum and is secured by a deed of trust on real estate and a security interest in the corporate assets of the Buyer.\n(3) Receivables\nContract receivables represent only those amounts which actually have been billed for work performed. Contract retentions at September 30, 1995 are collectible upon the owners' approval\nof contract performance. Based upon anticipated contract completion dates, these retainages are expected to be collected as follows during the fiscal years ending September 30:\n(4) Long-Term Debt and Short-Term Credit Facilities Long-term debt consists of the following at September 30, 1995 and 1994:\nAt September 30 1995, annual maturities of long-term debt for the next five years are as follows:\nShort-Term Notes Payable:\nAt September 30, 1995, the Company had $102,000 outstanding under a short-term note payable which is to be repaid in nine equal monthly installments bearing a fixed interest rate of 8.75% per annum.\nShort-Term Credit Facilities\nThe Company has a $2,000,000 revolving line of credit with a bank for working capital purposes. At September 30, 1995, the Company had outstanding borrowings of $900,000 under this line. There were no borrowings under this line at September 30, 1994. Borrowings under this line are secured by accounts receivable, inventory, contract rights, furniture, fixtures and equipment and leasehold property of the Company's operations in Hawaii. Advances under the line bear interest at the bank's prime rate of interest (8.75% at September 30, 1995). The Company also has a $250,000 line of credit for the issuance of letters of credit. There were no letters of credit outstanding at September 30, 1995. These credit arrangements are subject to renewal by the bank in March 1996.\nAmelco Industries (Industries), a wholly owned contracting subsidiary of the Company, has a $4,000,000 revolving line of credit with a bank for working capital purposes. There were no borrowings under this line at September 30, 1995 and 1994. Borrowings under this agreement\nbear interest at 3\/8% over the prime rate and are secured by receivables and retentions of Industries and a corporate guarantee by the Company. The line of credit is subject to renewal by the bank in February 1996.\nInterest Paid\nInterest payments made during fiscal years 1995, 1994 and 1993 totaled $317,000, $327,000 and $162,000, respectively.\n(5) Income Taxes\nIncome tax expense for the years ended September 30, 1995, 1994 and 1993 is comprised of the following components:\nNet income taxes paid for fiscal years 1995, 1994 and 1993 were $1,122,000, $692,000 and $674,000, respectively.\nSignificant components of the Company's deferred income tax assets (liabilities) at September 30, 1995 and 1994 are as follows:\nThe valuation allowance for deferred tax assets as of September 30, 1995 and 1994 was $148,000 and $108,000, respectively. The net change in the total valuation allowance for the year ended September 30, 1995 was an increase of $40,000. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible.\nIncome tax expense differed from the amounts computed by applying the U.S. Federal income tax rate of 34% in 1995, 1994 and 1993 to earnings before income taxes as follows:\n(6) Employee Retirement Plans\nThe Company and its subsidiaries contribute to multiemployer pension plans, primarily defined benefit plans, as required by collective bargaining agreements. Amounts charged to construction cost and contributed to these plans in 1995, 1994 and 1993 aggregated $1,567,000, $1,839,000 and $974,000, respectively.\nThe Company sponsors a defined contribution plan. All qualified nonbargaining U.S. employees of the Company are eligible to participate in the plan and may make voluntary contributions to the plan subject to certain limitations and restrictions. The amount of voluntary contributions and investment income thereon is fully vested and nonforfeitable; however, the interest of each participant in the Company's contributions and earnings on investments, less expenses, is vested in accordance with the plan. There is 100% vesting at retirement, disability or death of a participant.\nUnder the terms of the plan, the accumulated balance of vested benefits in each participant's account is paid to the individual upon termination, retirement or death. Payment may be made in lump sum or in annual installments over a period not to exceed the participant's life expectancy. Any amounts forfeited upon termination or retirement are used to reduce future contributions of the Company in accordance with the plan.\nThe Company's contribution under the defined contribution plan is a percentage of each employee's contribution. Amounts charged to general and administrative expense by the Company related to the plan for the years ended September 30, 1995, 1994 and 1993 were $40,000, $41,000 and $39,000, respectively.\n(7) Leases\nOperating Leases\nThe Company and its subsidiaries lease various properties and equipment under long-term agreements which expire at varying dates through 2029, including a lease of land on which an office building and warehouse have been constructed. Real property leases generally provide for the Company to pay for taxes, maintenance and insurance applicable to the leased properties, and certain of these leases provide for renegotiation of annual rentals at specified dates.\nAt September 30, 1995, minimum rental obligations under noncancelable operating leases (primarily real property) in excess of one year are as follows:\nRent expense on operating leases, including leases less than one year, for 1995, 1994 and 1993 was $2,104,000, $1,437,000 and $1,206,000, respectively.\nThe Company and its subsidiaries have leased certain owned real property to others including primarily a lease of land and improvements under a noncancelable lease which expires in 2000. The lease provides for the lessee to pay for taxes, maintenance and insurance applicable to the leased property and at the end of the fixed term, provides an option to the lessee to extend for four successive terms of five years each at a rent to be agreed upon. At September 30, 1995, minimum future lease rentals to be received by the Company are as follows:\n(8) Litigation\nThere are various lawsuits pending against and claims being pursued by the Company and its subsidiaries arising out of the normal course of business. It is management's present opinion that the outcome of these proceedings will not have a material effect on the Company's consolidated financial statements taken as a whole.\n(9) Minority Interest\nMinority interest represents the minority stockholders' proportionate share of the equity and the income or loss of an 89% owned consolidated subsidiary. The Company purchased a 79% interest in this contracting company in August 1992 for $79,000 and acquired an additional 10% interest in March 1995 for $15,000.\n(10) Investment in and Advances to Joint Ventures\nThe Company has interests in various construction joint ventures with other parties under arrangements which provide for the sharing of profits or losses ranging from 49% to 50%. Investments in these joint ventures are stated at cost plus the equity in undistributed earnings. Combined financial information of the joint ventures in summary form as of and for the years ended September 30, 1995, 1994 and 1993 follows:\nThe Company's proportionate share of revenues and operating income from these construction joint ventures has been included in the consolidated statements of earnings.\n(11) Costs and Estimated Earnings on Uncompleted Contracts\nItem 9.","section_9":"Item 9. CHANGES IN ACCOUNTANTS OR 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 required by this item with respect to directors will be contained in the Company's 1996 Proxy Statement and is incorporated herein by reference.\nInformation concerning the executive officers of the Company is provided following Item 4, Part I and is incorporated herein by reference.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION\nInformation required by this item will be contained in the Company's 1996 Proxy Statement and is incorporated herein by reference.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation required by this item will be contained in the Company's 1996 Proxy Statement and is incorporated herein by reference.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation required by this item will be contained in the Company's 1996 Proxy Statement and is incorporated herein by reference.\nPART IV\nItem 14.","section_14":"Item 14. EXHIBITS, FINANCIAL STATEMENTS, AND REPORTS ON FORM 8-K\n(A) 1. Consolidated Financial Statements - Included in Item 8, Part II of this Form 10-K Amelco Corporation and Subsidiaries: Independent Auditor's Report Consolidated Balance Sheets - September 30, 1995 and 1994 Consolidated Statements of Earnings - Years ended September 30, 1995, 1994 and 1993 Consolidated Statements of Stockholders' Equity - Years ended September 30, 1995, 1994 and 1993 Consolidated Statements of Cash Flows - Years ended September 30, 1995, 1994 and 1993 Notes to Consolidated Financial Statements\n(B) Report on Form 8-K - None.\nSchedules Omitted: Schedules are omitted because they are not required or are not applicable.\n(C) 3. Exhibits -\nExhibit (3) (3.1) Articles of Incorporation effective November 8, 1988 incorporating the Registrant in the State of California filed as Exhibit 3(iii)a to Form 10-K for the year ended September 30, 1989 are incorporated herein by reference.\n(3.2) Bylaws of the Registrant relating to the incorporation in the State of California effective November 8, 1988 filed as Exhibit 3(iii)b to Form 10-K for the year ended September 30, 1989 are incorporated herein by reference.\n(4) Instruments defining the rights of security holders, including indentures - Reference is made to the Articles of Incorporation and Bylaws filed as Exhibit (3).\n(9) Voting trust agreement - none.\n(10) Material Contracts -\n(10.1) Memorandum of Employment Agreement between Amelco Corporation and Samuel M. Angelich dated May 31, 1990 filed as Exhibit (10.1) to Form 10-K for the year ended September 30, 1990 is incorporated herein by reference.\n(10.2) Death Benefit Agreement between Amelco Corporation and Samuel M. Angelich dated May 31, 1990 filed as Exhibit (10.2) to Form 10-K for the year ended September 30, 1990 is incorporated herein by reference.\n(10.3) Option Agreement between Amelco Corporation and Samuel M. Angelich dated May 31, 1990 filed as Exhibit (10.3) to Form 10-K for the year ended September 30, 1990 is incorporated herein by reference.\n(10.4) Memorandum of Employment Agreement between Amelco Corporation and Mark S. Angelich dated September 21, 1989 filed as Exhibit (10.4) to Form 10-K for the year ended September 30, 1990 is incorporated herein by reference.\n(10.5) Real Property Lease Agreement between the Trustees Under the Will and Estate of Samuel M. Damon and Amelco Corporation dated April 24, 1979 filed as Exhibit (10.5) to Form 10-K for the year ended September 30, 1990 is incorporated herein by reference.\n(10.6) Credit Terms and Conditions Agreement between Amelco Corporation and Imperial Bank dated March 4, 1988 filed as Exhibit (10.6) to Form 10-K for the year ended September 30, 1990 is incorporated herein by reference.\n(10.7) First Amendment to Credit Terms and Conditions Agreement between Amelco Corporation and Imperial Bank dated February 17, 1989 filed as Exhibit (10.7) to Form 10-K for the year ended September 30, 1990 is incorporated herein by reference.\n(10.8) Credit Agreement between Amelco Corporation and Bank of Hawaii dated June 26, 1989 filed as Exhibit (10.8) to Form 10-K for the year ended September 30, 1990 is incorporated herein by reference.\n(10.9) Agreement for Purchase and Sale of Real Property between Amelco Industries and Halau Corporation dated August 30, 1991 filed as Exhibit (10.9) to Form 10-K for the year ended September 30, 1991 is incorporated herein by reference.\n(10.10) Lease Agreement between Halau Corporation and Amelco Industries dated September 20, 1991 filed as Exhibit (10.10) to Form 10-K for the year ended September 30, 1991 is incorporated herein by reference.\n(10.11) Lease Agreement between Halau Corporation and Amelco Industries dated October 1, 1993 filed as Exhibit (10.11) to Form 10-K for the year ended September 30, 1993 is incorporated herein by reference.\n(10.12) Death Benefit Agreement between Amelco Corporation and Samuel M. Angelich dated March 7, 1994 is filed herein as Exhibit (10.12).\n(10.13) Credit Agreement between Amelco Industries and Imperial Bank dated February 28, 1994 is filed herein as Exhibit (10.13).\n(10.14) Amendment to Credit Agreement between Amelco Corporation and Bank of Hawaii dated May 16, 1990 is filed herein as Exhibit (10.14).\n(10.15) Second Amendment to Credit Agreement between Amelco Corporation and Bank of Hawaii dated February 25, 1994 is filed herein as Exhibit (10.15)\n(11) Statement re computation of per share earnings - not applicable.\n(12) Statements re computation of ratios - not applicable.\n(13) Annual report to security holders - not applicable.\n(18) Letter re change in accounting principles - not applicable.\n(19) Previously unfiled documents - none.\n(22) Subsidiaries of the Registrant - Exhibit 22.\n(23) Published report regarding matters submitted to vote of security holders - none.\n(24) Consents of experts and counsel - not applicable.\n(25) Power of attorney - not applicable.\n(27) Financial Data Schedule (EDGAR version 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.\nAMELCO CORPORATION (Registrant)\nDate: December 27, 1995 By \/s\/ Patrick T. Miike -------------------------------------- Patrick T. Miike Vice President - Finance and Treasurer (Principal Financial and Accounting Officer of the Registrant)\nPursuant to the requirement of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.","section_15":""}
{"filename":"357264_1995.txt","cik":"357264","year":"1995","section_1":"Item 1. Business 13 a) General Description of Business Operations commenced as Santa Barbara National Bank with one office and 18 employees in 1960. The Company was formed in 1982. The Bank (name changed to Santa Barbara Bank & Trust) became the principal subsidiary of the Company, and has grown to 15 banking offices and trust, escrow, and real estate offices. Two of the banking offices were added in the merger with Community Bank of Santa Ynez Valley on March 31, 1989. In 1995, three banking offices were opened in Ventura county. A second subsidiary, SBBT Service Corporation, was formed in 1988.\nThe Bank continued its pattern of growth in 1995 with significant increases in assets and deposits. b) Financial Information about Industry Segments There are no identifiable industry segments. c) Narrative Description of Business 13-37 As of December 31, 1995, the Company had the equivalent of approximately 500 employees engaged to provide banking and trust services to the local community, including correspondent services to other local banks.\nFor most of its banking products, the Company faces competition in its market area from branches of most of the major California money banks, some of the state-wide savings and loan associations, and other community banks and savings and loans. For some of its products, the Company faces competition from other non-bank financial service companies, especially securities firms.\nd) Financial Information about Foreign and Domestic Operations and Export Sales The Company does not have any foreign business operations or export sales of our own. However, it does provide financial services including wire transfers, currency exchange, letters of credit, and loans to other businesses involved in foreign trade.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties 44,48, The Company maintains executive and administrative 55 offices at leased premises at 1021 Anacapa Street, Santa Barbara, California. Of the 15 branch banking offices, all or a portion of 12 are leased. The office space used by the Real Estate and Escrow departments is owned, and space is leased for the Trust, and Management Information Services, and Loan Servicing departments.\nItem 3.","section_3":"Item 3. Legal Proceedings There are no material legal proceedings pending.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders No matters were submitted during the fourth quarter of the fiscal year covered by this report.\nPART II Item 5.","section_5":"Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters a) Market Information 37,58 b) Holders There are approximately 1,588 holders of stock as of March 1, 1996. c) Dividends 37,41 Dividends are currently declared four times 58 a year, and the Company expects to follow the same policy in the future. Item 6.","section_6":"Item 6. Selected Financial Data 58 Item 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation 13-37 Item 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data 38-57 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 Directors 4-5 Executive Officers 7 Item 11.","section_11":"Item 11. Executive Compensation 9-15 Item 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management 8 Item 13.","section_13":"Item 13. Certain Relationships and Related Transactions 24\nPART IV Item 14.","section_14":"Item 14. Exhibits, Financial Statements, and Reports on Form 8-K\na) The following documents are filed as a part of this Report:\n1) Financial Statements: Consolidated Balance Sheets as of December 31, 1995 and 1994 39 Consolidated Statements of Income for the years ended December 31, 1995, 1994, and 1993 40 Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 1995, 1994, and 1993 41 Consolidated Statements of Cash Flows for the years ended December 31, 1995, 1994, and 1993 42\n2) Financial Statement Schedules:\nThe following schedules and information are included in the Footnotes to the above Financial Statements or in Management's Discussion and Analysis of Financial Condition and Results of Operations, both of which are included in the Annual Report: Interest Rate Sensitivity 16 Distribution of Average Assets, Liabilities, and Shareholders' Equity and Related Interest Income, Expense, and Rates 18 Volume and Rate Variance Analysis of Net Interest Income 19 Maturity Distribution and Yield Analysis of the Securities Portfolios 20 Loan Portfolio Analysis by Category 24 Maturity and Sensitivities of Selected Loan Types to Changes in Interest Rates 25 Risk Elements: Non-Accrual, Past Due and Restructured Loans 28 Potential Problem Loans 29 Foreign Loans 29 Summary of Loan Loss Experience 26 Foregone Interest on Non-Accrual Loans 29 Detailed Deposit Summary 31 Maturity Distribution of Time Certificates of Deposit of $100,000 or More 31 Return on Equity and Assets, Operating and Capital Ratios 58 Short-term Borrowings 51\nb) No reports on Form 8-K were filed during the fourth quarter of the fiscal year ended December 31, 1995.\nc) Exhibits - See exhibits listed in \"Exhibit Index\"\nd) Financial statement schedules required by Regulation S-X which are excluded from the annual report to shareholders- Not Applicable\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 by the undersigned, thereunto duly authorized. Santa Barbara Bancorp\nBy \/s\/David W. Spainhour 3\/27\/96 David W. Spainhour date President Director\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Company and in the capacities and on the dates indicated.\n\/s\/ Donald M. Anderson 3\/27\/96 \/s\/ David W. Spainhour 3\/27\/96 Donald M. Anderson date David W. Spainhour date Chairman of the Board President Director Director\n\/s\/ William S. Thomas 3\/27\/96 \/s\/ Donald Lafler 3\/27\/96 William S. Thomas date Donald Lafler date Vice Chairman Senior Vice President Chief Operating Officer Chief Financial Officer\n\/s\/ Frank H. Barranco, M.D. 3\/27\/96 \/s\/ Edward E. Birch 3\/27\/96 Frank H. Barranco, M.D. date Edward E. Birch date Director Director\n\/s\/ Richard M. Davis 3\/27\/96 \/s\/ Anthony Guntermann 3\/27\/96 Richard M. Davis date Anthony Guntermann date Director Director\n\/s\/ Dale E. Hanst 3\/27\/96 \/s\/ Harry B. Powell 3\/27\/96 Dale E. Hanst date Harry B. Powell date Director Director\nEXHIBIT INDEX TO SANTA BARBARA BANCORP FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 1995\nExhibit Number Description\n2 Plan of acquisition, reorganization, arrangement, liquidation or succession**\n3 Articles of incorporation and bylaws\n3.1 Restated Articles of Incorporation of Santa Barbara Bancorp (filed as Exhibit 3(i) to the Company's Form S-4, File No. 33-19181, and is incorporated herein by reference thereto).\n3.2 Certificate of Amendment of Articles of Incorporation of the Company as filed with the California Secretary of State on January 24, 1996.***\n3.3 Amended and Restated Bylaws of the Company dated September 25, 1991 (filed as \"Other Information\" to the Company's form 10-Q for the quarter ended September 30, 1991, File No. 0-11113, and is incorporated herein by reference thereto).\n3.4 Amendment No. One to Bylaws of the Company as adopted by the Board of Directors on October 24, 1995.***\n4 Instruments defining rights of security holders - The rights of security holders are defined by applicable law and in the Bylaws of the Company-see Exhibit 3.2 above.\n9 Voting trust agreement**\n10 Material contracts\n10.1 Compensation Plans and Agreements:\n10.1.1 Santa Barbara Bancorp Restricted Stock Option Plan (previously filed as Exhibit 4.1 to Post-Effective Amendment No. One to the Company's Registration Statement on Form S-8, filed with the Commission on June 13, 1995, File No. 33-48724, incorporated herein by this reference).\n10.1.2 Santa Barbara Bancorp Director Stock Option Plan (previously filed as Exhibit 4.2 to Post-Effective Amendment No. One to the Company's Registration Statement on Form S-8, filed with the Commission on June 13, 1995, File No. 33-48724, incorporated herein by this reference).\n10.1.3 Santa Barbara Bancorp Stock Option Plan (previously filed as Exhibit 4.2 of the Company's Registration Statement on Form S-8, filed with the Commission on October 28, 1991, File No. 33-43560, incorporated herein by this reference).\n10.1.4 Santa Barbara Bank & Trust Incentive and Investment and Salary Savings Plan, as amended through December 31, 1991 (previously filed with the Commission as Exhibit 10.1.4 to the Company's annual report on Form 10-K on March 29, 1993, File No. 0-11113, incorporated herein by this reference).\n10.1.5 First Amendment to Santa Barbara Bank & Trust Incentive & Investment and Salary Savings Plan executed April 27, 1994.***\n10.1.6 Second Amendment to Santa Barbara Bank & Trust Incentive & Investment and Salary Savings Plan executed June 17, 1994.***\n10.1.7 Third Amendment to Santa Barbara Bank & Trust Incentive & Investment and Salary Savings Plan executed December 28, 1994.***\n10.1.8 Fourth Amendment to Santa Barbara Bank & Trust Incentive & Investment and Salary Savings Plan executed March 2, 1995.***\n10.1.9 Santa Barbara Bank & Trust Employee Stock Ownership Plan and Trust, as amended and restated through July 6, 1995 (previously filed with the Commission as Exhibit 4.1 to the Post-Effective Amendmentr No. One to the Company's Registration Statement on Form S-8, filed with the Commission on July 10, 1995, File No. 33-43560, incorporated herein by this reference).\n10.1.10 First Amendment to Santa Barbara Bank & Trust Employee Stock Ownership Plan and Trust executed February 24, 1995.***\n10.1.11 Description of Group Term Life and Accidental Death and Dismemberment Benefits and of Payment of Membership Dues (previously filed with the Commission as Exhibit 10.1.7 to the Company's annual report on Form 10-K on March 29, 1993, File No. 0-11113, incorporated herein by this reference).\n10.1.12 Santa Barbara Bank & Trust Key Employee Retiree Health Plan dated December 29, 1992 (previously filed with the Commission as Exhibit 10.1.8 to the Company's annual report on Form 10-K on March 16, 1994, File No. 0-11113, incorporated herein by this reference).\n10.1.13 First Amendment to Trust Agreement of Santa Barbara Bank & Trust Voluntary Beneficiary Association, executed July 23, 1993.***\n10.1.14 Santa Barbara Bank & Trust Retiree Health Plan (Non-Key Employees) dated December 29, 1992 (previously filed with the Commission as Exhibit 10.1.9 to the Company's annual report on Form 10-K on March 16, 1994, File No. 0-11113, incorporated herein by this reference).\n10.1.15 Santa Barbara Bank & Trust Second Amended and Restated Flexmaster Plan adopted effective October 1, 1991.***\n10.2.0 Securities and Insurance Service Agreement\n10.2.1 IRA Custodial Agreement.\n11 Statement re computation of per share earnings***\n12 Statement re computation of ratios**\n13 Annual report to security-holders\n16 Letter re change in certifying accountant**\n18 Letter re change in accounting principles**\n21 Subsidiaries of the registrant\n22 Published report regarding matters submitted to vote of security-holders**\n23 Consents of experts and counsel:\n23.1 Consent of Independent Public Accountants\n23.2 Consent of Independent Public Accountants\n24 Power of attorney**\n27 Financial Data Schedules\n99 Additional exhibits-Notice of Annual Meeting of Shareholders and Proxy Statement for Annual Meeting occurring April 23, 1996 filed with the Commission on March 15, 1995,\nFile No. 0-11113, incorporated herein by this reference.\n* Shareholders may obtain a copy of any exhibit by writing to: Clare McGivney, Corporate Services Administrator Santa Barbara Bancorp P.O. Box 1119 Santa Barbara, CA 93102 ** Not applicable *** Filed herewith\nExhibit 3.2\nCERTIFICATE OF AMENDMENT OF ARTICLES OF INCORPORATION OF SANTA BARBARA BANCORP\nDavid W. Spainhour and Jay D. Smith certify that:\n1. They are the president and secretary, respectively, of SANTA BARBARA BANCORP, a California corporation.\n2. Article Third of the Articles of Incorporation of this Corporation is amended in its entirety to read as follows:\n\"THIRD: AUTHORIZED STOCK\nThis Corporation is authorized to issue only one class of shares of stock, designated as common stock. The total number of such shares which this Corporation is authorized to issue is twenty million (20,000,000). Upon the amendment of this Article to read as set forth herein, every two (2) outstanding shares of common stock of this Corporation shall be converted into three (3) shares of common stock. No fractional shares shall be issued in connection with such stock split. In lieu thereof, the Corporation shall pay to each shareholder of record who otherwise would receive a fractional share a cash amount equal to product obtained by multiplying the fractional share otherwise issuable to such shareholder by the mean between the closing bid price and the closing asked price per share as reported by NASDAQ as of January 23, 1996, or on the next most recent prior date on which trades of the Corporation's common stock are reported by NASDAQ.\"\n3. The foregoing amendment to the Articles of Incorporation of this Corporation has been duly approved by the board of directors of this Corporation.\n4. The foregoing amendment to the Articles of Incorporation of this Corporation is not required to be approved by a vote of the shareholders pursuant to Section 902(c) of the California Corporations Code.\nEach of the undersigned declares under penalty of perjury under the laws of the State of California that the statements contained in the foregoing certificate are true and correct of his own knowledge, and that this declaration was executed on this 16th, day of January, 1996, at Santa Barbara, California.\nDavid W.Spainhour, President\nJay D. Smith, Secretary\nExhibit 3.4\nCERTIFICATE OF RESOLUTION\nSANTA BARBARA BANCORP\nSanta Barbara, California\nAMENDMENT NUMBER ONE TO BYLAWS\nThis is to certify that I am the duly elected, qualified and acting Secretary of the above-named Corporation and that by resolution of the Board of Diretors of the Corporation duly adopted at the meeting held on October 24, 1995, Sections 2.10 and 2.11 of the Bylaws of the Corporation were added to read in as follows:\n2.10 Shareholder Action Without a Meeting.\n2.10.1 Written Consents. Unless otherwise provided in the Articles of Incorporation, any action which may be taken at any annual or special meeting of the shareholders, other than the election of directors, may be taken without a meeting and without prior notice if a consent in writing, setting forth the action so taken, shall be signed by the holders of outstanding shares having not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting at which all shareholders entitled to vote thereon were present and voted.\n2.10.2 Notice of Written Consent. Unless the consents of all shareholders entitled to vote have been solicited in writing, prompt notice of any corporate action approved by shareholders without a meeting by less than unanimous written consent shall be given, in accordance with Section 601(b) of the California General Corporation Law, to those shareholders entitled to vote who have not consented in writing. Such notice must be given at least ten (10) days before the consummation of any action authorized by such approval if the action involves (i) a contract or other transaction with an interested director, governed by Section 310 of the California General Corporation Law, (ii) the indemnification of any present or former agent of the Corporation within the meaning of Section 317 of the California General Corporation Law, (iii) any reorganization within the meaning of the California General Corporation Law, or (iv) a plan of distribution in dissolution other than in accordance with the rights of any outstanding preferred shares as provided in California General Corporation Law Section 2007.\n2.10.3 Election of Directors by Written Consent. A director may be elected at any time to fill a vacancy (other than a vacancy resulting from the removal of a director) not filled by the Board by the written consent of persons holding a majority of the outstanding shares entitled to vote for the election of directors, and any required notice of any such election shall promptly be given as provided in Section 2.10.2, above. Directors may not otherwise be elected without a meeting unless a consent in writing, setting forth the action so taken, is signed by all of the persons who would be entitled to vote for the election of directors.\n2.10.4 Record Date. In order that the Company may determine the stockholders entitled to consent to corporate action by written consent without a meeting, the Board of Directors may fix a record date, which record date shall not precede the date upon which the resolution fixing the record date is adopted by the Board of Directors, and which date shall not be more than ten (10) days after the date upon which the resolution fixing the record date is adopted by the Board of Directors. Any stockholder of record seeking to have the stockholders authorize or take corporate action by written consent shall, by written notice (the \"Notice\") to the Secretary of the Corporation, request the Board of Directors to fix a record date. In the absence of other Notice, or action by the Board of Directors, the delivery to the Corporation of any written consent by any stockholder seeking to have the stockholders authorize or take corporate action by written consent shall be deemed to be the stockholder's delivery of the Notice to the Corporation. The Board of Directors shall promptly, but in all event within ten (10) days after the date on which such a request is received, adopt a resolution fixing the record date. If no record date has been fixed by the Board of Directors within ten (10) days of its receipt of the Notice, when no prior action by the Board of Directors is required by applicable law, the record date shall be the day on which the Notice is delivered to the Corporation. If no record date has been fixed by the Board of Directors and prior action by the Board of Directors is required by applicable law, the record date for determining stockholders entitled to consent to corporate action in writing without a meeting shall be at the close of business on the date on which the Board of Directors adopts the resolution taking such prior action.\n2.10.5 Duration of Consents. Consents to corporate action (a) shall be effective only on delivery to the Corporation of the original or a certified copy of the consent and (b) shall be valid for a maximum of sixty (60) days after the date of the earliest dated consent delivered to the Corporation in the manner provided in this Section 2.10.\n2.10.6 Revocation of Consents. Consents may be revoked at any time prior to the time that written consents of the number of shares required to authorize the proposed action have been filed with the Secretary of the Corporation. Consents may be revoked by written notice delivered to any of (a) the Corporation, (b) the shareholder or shareholders soliciting consents or soliciting revocations in opposition to action by consent proposed by the Corporation (the \"Soliciting Shareholders\"), or (c) a proxy solicitor or other agent designated by the Corporation or the Soliciting Shareholders. A revocation of a consent shall be effective upon receipt by the applicable person.\n2.10.7 Inspectors of Election. Within three (3) business days after the delivery of any consents to the Corporation or the determination by the Board of Directors that the Corporation should seek corporate action by written consent, as the case may be, the Secretary shall engage independent inspectors of elections (the \"Inspectors\") for the purpose of performing a ministerial review of the validity of the consents and revocations. The cost of retaining inspectors of election shall be borne by the Corporation.\n2.10.8 Procedures for Counting. Consents and revocations shall be delivered to the Inspectors upon receipt by the Corporation, the Soliciting Shareholders or their proxy solicitors or other designated agents. As soon as consents and revocations are received, the Inspectors shall review the consents and revocations and shall maintain a count of the number of valid and unrevoked consents. The Inspectors shall keep such count confidential and shall not reveal the count to the Corporation, the Soliciting Shareholder or their representatives or any other entity except in connection with the Preliminary Report or the Final Report. As soon as practicable, the Inspectors shall issue a preliminary report (the \"Preliminary Report\") to the Corporation and the Soliciting Shareholders stating: (i) the number of valid consents; (ii) the number of valid revocations; (iii) the number of valid and unrevoked consents; (iv) the number of invalid consents; (v) the number of invalid revocations; and (vii) whether, based on their preliminary count, the requisite number of valid and unrevoked consents has been obtained to authorize or take the action specified in the consents.\n2.10.9 Inspectors' Final Report. Unless the Corporation and the Soliciting Shareholders shall agree to a shorter or longer period, the Corporation and the Soliciting Shareholders shall have forty-eight (48) hours after the Inspectors' delivery of the Preliminary Report to review the Preliminary Report and copies of the consents and revocations and to advise the Inspectors and the opposing party in writing as to whether they intend to challenge the Preliminary Report of the Inspectors. If no written notice of an intention to challenge the Preliminary Report is received within such 48-hour period, the Inspectors shall issue to the Corporation and the Soliciting Shareholders their final report (the \"Final Report\") containing the information from the Inspectors' determination with respect to whether the requisite number of valid and unrevoked consents was obtained to authorize and take the action specified in the consents. If the Corporation or the Soliciting Shareholders issue written notice of an intention to challenge the Inspectors' Preliminary Report within such 48-hour period, a challenge session shall be scheduled by the Inspectors as promptly as practicable. A transcript of the challenge session shall be recorded by a certified court reporter. Following completion of the challenge session, the Inspectors shall as promptly as practicable issue their Final Report to the Soliciting Shareholders and the Corporation. The Final Report shall contain the information included in the Preliminary Report, plus all changes, if any, in the vote total as a result of the challenge and a certification of whether the requisite number of valid and unrevoked consents was obtained to authorize or take the action specified in the consents. A copy of the Final Report of the Inspectors shall be included in the Corporation's records in which the proceedings of meetings of shareholders are maintained.\n2.10.10 Further Review. If the Inspectors state in the Final Report that the requisite number of valid and unrevoked consents was not obtained to authorize or take the action specified in the consents, the party soliciting the consents thereafter may make one additional request in accordance with the provisions of Section 2.10.8 hereof that the Inspectors again review the consents and revocations and issue a further Preliminary Report and Final Report.\n2.10.11 Notice to Shareholders. The Corporation shall give prompt notice to the shareholders of the results of any consent solicitation or the taking of the corporate action without a meeting and by less than unanimous written consent.\n2.10.12 Content of Consents; Delivery of Consents. Each written consent shall bear the date of signature of each shareholder who signs the consent and a clear statement of the name of the shareholder who signs the consent. Consents and revocations of consent shall be delivered to the Corporation or any other person by hand or by certified or registered mail, return receipt requested. Consents shall be effective upon receipt by the corporation and revocations shall be effective to a party under Section 2.10.6 hereof. Other notices and requests delivered under this Section 2.10 may be delivered personally, by facsimile or other form of electronic transmission that provides for confirmation of receipt, or by certified or registered United States mail, return receipt requested, and, if properly addressed, shall be deemed delivered (a) on the date of delivery, if delivery was made personally or by transmission by facsimile or other form of electronic transmission, or (b) on the fifth (5th) business day after the date on which deposited with the United States Postal Service.\n2.10.13 Severability. Each term and provision of this Section 2.10 shall be valid and enforceable to the fullest extent permitted by law. If independent counsel to the Corporation delivers to the Corporation a written opinion stating, or a court of competent jurisdiction determines, that this Section 2.10, or any portion thereof, or the application thereof to any person or circumstance is illegal or unenforceable with respect to any corporate action to be taken by written consent for which a consent has been delivered to the Corporation, then this Section 2.10, or such portion thereof, as the case may be, shall after the date of such delivery of such opinion or such determination be null and void in total or with respect to such person or circumstance, as the case may be, and the remainder of this Section 2.10 or the application thereof to persons or circumstances other than those to which it is held invalid or unenforceable, shall not be affected thereby.\n2.11 Shareholder Proposals.\n2.11.1 Consideration of Proposals. At any annual or special meeting of shareholders, only such business shall be conducted as shall have been properly brought before the meeting. The provisions of this Section 2.11 shall control the determination of whether a proposal by any shareholder, in his or her capacity as a shareholder, for action by the shareholders of the Corporation has been properly brought before the meeting. Notwithstanding anything in these Bylaws to the contrary, no business shall be conducted at any meeting of shareholders except in accordance with the procedures of this Section 2.11.\n2.11.2 Submission of Proposal. To be properly brought before an annual meeting of shareholders or any special meeting of shareholders noticed and called other than on behalf of the proposing shareholder, any proposal for action by the shareholders submitted by a shareholder of the Corporation shall be made in writing and shall be delivered or mailed to the Secretary of the Corporation at its principal place of business not less than twenty (20) days nor more than fifty (50) days prior to scheduled date of the meeting; provided that if less than thirty (30) days' notice of the meeting is given to the shareholders, such proposal shall be mailed or delivered to the Secretary of the Corporation not later than the close of business on the Seventh (7th) day following the day on which notice of the meeting was mailed to the shareholders. To be properly brought before any special meeting of shareholders noticed and called on behalf of the proposing shareholder, all proposals for action submitted by such requesting shareholders shall be made in writing and shall be delivered or mailed to the Secretary of the Corporation at its principal place of business simultaneously with such shareholder(s) submission of their request for the meeting. Notwithstanding the foregoing, any shareholder may submit for consideration at a meeting any proposal which is directly related to a matter which is specifically identified in the written notice of the meeting as a matter on which action by the shareholders will be requested at the meeting.\n2.11.3 Content of Submission. A shareholder's notice to the Secretary of the Corporation requesting that a proposal for action be submitted for consideration at any meeting of shareholders shall set forth as to the matter which the shareholder proposes to bring before the meeting: (a) a brief description of the business desired to be brought before the meeting and the reasons for conducting such business at the meeting; (b) the name and address, as they appear on the Corporation's books of the shareholder proposing such business; (c) the class and number of shares of stock of the Corporation owned by the shareholder beneficially and of record; (d) any material interest of the shareholder in the business proposed to be brought before the meeting; and (e) any other information that is required by law to be provided by the shareholder in the shareholder's capacity as a proponent of a shareholder proposal.\n2.11.4 Number of Proposals. No shareholder, other than the shareholder(s) on whose behalf the meeting is noticed and called, may submit more than one (1) proposal for consideration at any one (1) meeting of the shareholders of the Corporation.\n2.11.5 Federal Rules. Nothing in this Section shall be deemed to limit or waive the application of, or the need for any shareholder to comply with, any of the provisions of Section 14 of the Securities Exchange Act of 1934 and the Rules promulgated thereunder applicable to the inclusion of any shareholder proposal in any proxy statement or form of proxy used by the Corporation in connection with any meeting of shareholders.\n2.11.6 Chairperson's Statement. The Chairperson of the meeting shall, if the facts warrant, determine and declare to the meeting that business was not properly brought before the meeting and in accordance with the provisions of this Section and, if the Chairperson so determines, shall so declare to the meeting and any such business not properly brought before the meeting shall not be transacted.\nI hereby certify that the foregoing resolution now stands on record on the books of said Corporation, and has not been modified, repealed or set aside in any manner, and is now in full force and effect.\nDated at Santa Barbara, California\nNovember 7, 1995 Jay Donald Smith Secretary\nExhibit 3.5\nCERTIFICATE OF RESOLUTION\nSANTA BARBARA BANCORP\nSanta Barbara, California\nAMENDMENT NUMBER TWO TO BYLAWS\nThis is to certify that I am the duly elected, qualified and acting Secretary of the above-named Corporation and that by resolution of the Board of Diretors of the Corporation duly adopted at the meeting held on December 19, 1995, Section 3.2.1 of the Bylaws of the Corporation was amended as follows:\nAuthorized Number. The number of directors who may be authorized to serve on the Board of Directors of the Corporation shall be no less than seven (7) nor more than thirteen (13). Until a different number within the foregoing limits is specified in an amendment to this Section 3.2.1 duly adopted by the Board of Directors or the shareholders, the exact number of authorized directors shall be nine (9).\nI hereby certify that the foregoing resolution now stands on record on the books of said Corporation, and has not been modified, repealed or set aside in any manner, and is now in full force and effect.\nDated at Santa Barbara, California\nJanuary 18, 1996 Jay Donald Smith Secretary\nExhibit 10.1.5\nFIRST AMENDMENT\nTO\nSANTA BARBARA BANK & TRUST\nINCENTIVE & INVESTMENT AND SALARY SAVINGS PLAN\nTHIS FIRST AMENDMENT (the \"First Amendment\") is made and entered into, effective on the dates set forth below, by and between SANTA BARBARA BANK & TRUST, a California corporation (\"Employer\"), and SANTA BARBARA BANK & TRUST, a California corporation (\"Trustee\"), with reference to the following facts:\nRECITALS:\nA. The Employer sponsors the Santa Barbara Bank & Trust Incentive & Investment and Salary Savings Plan (the \"Plan\"), pursuant to that certain Plan document executed December 31, 1991 (the \"Plan Document\").\nB. The Trustee serves as the Trustee of the trust established under the Plan.\nC. The Employer and the Trustee desire to execute this First Amendment in order to modify the amount of the Employer's matching contribution under the Plan.\nAGREEMENT:\nNOW, THEREFORE, the parties hereto, intending to be legally bound, do hereby agree as follows:\n1. AMENDMENT TO SECTION 4.1(b)\nSection 4.1(b) of the Plan Document is hereby amended in its entirety to read as follows:\n\"(b) On behalf of each Participant who is eligible to share in matching contributions for the Plan Year, a matching contribution equal to the sum of (i) one-hundred percent (100%) of that portion of the Participant's Deferred Compensation up to three percent (3.0%) of the Participant's Compensation, plus (ii) fifty percent (50%) of that portion of the Participant's Deferred Compensation in excess of three percent (3.0%) of Compensation and up to six percent (6.0%) of Compensation; provided, in no event shall the amount of the matching contribution under this Section 4.1(b) on behalf of any Participant in any Plan Year exceed four and one-half percent (4.5%) of the Participant's Compensation for the Plan Year. The aggregate matching contribution under this Section 4.1(b) shall be deemed to be an Employer Non-Elective Contribution.\n2. MISCELLANEOUS\n2.1 Ratification. Except as expressly modified by this First Amendment, the Plan Document is hereby ratified and confirmed and remains in full force and effect.\n2.2 Effective Date. The Effective Date of this First Amendment shall be January 1, 1994.\nIN WITNESS WHEREOF, the parties hereto have executed this First Amendment, effective on the date set forth above.\n\"EMPLOYER:\"\nSANTA BARBARA BANK & TRUST, a California corporation\nBy: Name: Jay D. Smith Title: Secretary\nApril 27, 1994 Date\n\"TRUSTEE:\"\nSANTA BARBARA BANK & TRUST, a California corporation\nBy Name: Janice Kroekel Title: Assistant Vice President\nApril 27, 1994 Date\nExhibit 10.1.6\nSECOND AMENDMENT\nTO\nSANTA BARBARA BANK & TRUST\nINCENTIVE & INVESTMENT AND SALARY SAVINGS PLAN\nTHIS SECOND AMENDMENT (the \"Second Amendment\") is made and entered into, effective on the date set forth below, by and between SANTA BARBARA BANK & TRUST, a California corporation, in its capacity as an Employer (\"Employer\"), and SANTA BARBARA BANK & TRUST, a California corporation, in its capacity as Trustee of the Plan described below (\"Trustee\"), with reference to the following facts:\nRECITALS:\nA. The Employer sponsors the Santa Barbara Bank & Trust Incentive & Investment and Salary Savings Plan (the \"Plan\") pursuant to that certain Plan document executed December 31, 1991, as previously amended by that certain First Amendment dated effective January 1, 1994 (as so amended, the \"Plan Document\").\nB. The Trustee serves as the Trustee of the Trust established under the Plan.\nC. The Employer and the Trustee desire to execute this Second Amendment in order to shorten the eligibility period for Eligible Employees to make salary reduction contributions, and receive Employer matching contributions, under the so-called \"Salary Savings\" portion of the Plan.\nAGREEMENT:\nNOW, THEREFORE, the parties hereto, intending to be legally bound, do hereby agree as follows:\n1. AMENDMENT TO SECTION 3.1\nThe current Paragraph of Section 3.1 of the Plan Document is hereby amended in its entirety to read as follows:\n\"3.1 Conditions of Eligibility.\n(a) Subject to Sections 3.1(b) and 3.1(c), below, each Eligible Employee who commences employment prior to January 1, 1990, and has attained age 16 shall be eligible to participate hereunder as of the date he has satisfied such requirements. Each Eligible Employee who commences employment with the Employer after December 31, 1989, and prior to January 1, 1991, and who has completed one (1) Year of Service and has attained age 16 shall be eligible to participate hereunder as of the date he has satisfied such requirements. Each Eligible Employee who commences employment with the Employer after December 31, 1990, and who has completed one (1) Year of Service and has attained age 18 shall be eligible to participate hereunder as of the date he has satisfied such requirements.\n(b) Notwithstanding the provisions of Section 3.1(a) above, effective July 1, 1994, each Eligible Employee who has attained age 18 and completed ninety (90) days of employment with the Employer shall be eligible to (a) make Deferred Compensation contributions to the Plan in accordance with Section 4.2, below, and (b) receive Employer's Matching Contributions with respect to such Deferred Compensation in accordance with Section 4.1(b), below; provided, such Eligible Employee shall not be eligible to receive an allocation of the discretionary Employer's Non-Elective Contribution under Section 4.1(c), below, until such Eligible Employee has completed one (1) Year of Service with the Employer in accordance with Section 3.1(a), above, and commenced participation in accordance with Section 3.1(c), below.\n(c) An Eligible Employee who has satisfied the participation requirements of this Section 3.1 shall commence participation in the Plan at the time specified in Section 3.3, below.\"\n2. MISCELLANEOUS\n2.1 Ratification. Except as expressly modified by this Second Amendment, the Plan Document is hereby ratified and confirmed and remains in full force and effect.\n2.2 Effective Date. The Effective Date of this Second Amendment shall be July 1, 1994.\nIN WITNESS WHEREOF, the parties hereto have executed this Second Amendment, effective on the date set forth above.\n\"EMPLOYER\":\nSANTA BARBARA BANK & TRUST, a California corporation\nBy Jay D. Smith Senior Vice President\nJune 17, 1994 Date\n\"TRUSTEE\":\nSANTA BARBARA BANK & TRUST, a California corporation\nBy Janice Kroekel Assistant Vice President\nJune 17, 1994 Date\nExhibit 10.1.7\nTHIRD AMENDMENT\nTO\nSANTA BARBARA BANK & TRUST\nINCENTIVE & INVESTMENT AND SALARY SAVINGS PLAN\nTHIS THIRD AMENDMENT (the \"Third Amendment\") is made and entered into, effective on the dates set forth below, by and between SANTA BARBARA BANK & TRUST, a California corporation, in its capacity as an employer (the \"Employer\"), and SANTA BARBARA BANK & TRUST, a California corporation, in its capacity as trustee of the Plan described below (the \"Trustee\"), with reference to the following facts:\nRECITALS:\nA. The Employer sponsors the Santa Barbara Bank & Trust Incentive & Investment and Salary Savings Plan (the \"Plan\"), pursuant to that certain Plan document executed December 31, 1991, as previously amended by that certain First Amendment dated effective January 1, 1994, and that certain Second Amendment dated effective July 1, 1994 (as so amended, the \"Plan Document\").\nB. The Trustee serves as the Trustee of the Trust established under the Plan.\nC. The Plan previously has been amended and restated to reflect the requirements of the Tax Reform Act of 1986 and certain subsequent legislation, and since the date of that amendment and restatement, there have been further developments in legislation, case law, and administrative pronouncements that require and permit the Plan to be amended further.\nD. The Employer desires to adopt this Third Amendment in order to amend the Plan to reflect such matters.\nAMENDMENT:\nNOW, THEREFORE, the parties hereto, intending to be legally bound, do hereby agree as follows:\n1. DIRECT ROLLOVERS\nPursuant to Rev. Proc. 93-12, 1993-1 C.B. 479, the Plan is hereby amended to include the following language:\n\"Notwithstanding any other provision of the Plan to the contrary:\n1. This Article applies to distributions made on or after January 1, 1993. Notwithstanding any provision of the Plan to the contrary that would otherwise limit a distributee's election under this Article, a distributee may elect, at the time and in the manner prescribed by the Plan Administrator, to have any portion of an eligible rollover distribution paid directly to an eligible retirement plan specified by the distributee in a direct rollover.\n2. Definitions. For purposes of this Article:\n2.1 Eligible Rollover Distribution: An eligible rollover distribution is any distribution of all or any portion of the balance to the credit of the distributee, except that an eligible rollover distribution does not include: any distribution that is one of a series of substantially equal periodic payments (not less frequently than annually) made for the life (or life expectancy) of the distributee or the joint lives (or joint life expectancies) of the distributee and the distributee's designated beneficiary, or for a specified period of ten years or more; any distribution to the extent such distribution is required under Section 401(a)(9) of the Code; and the portion of any distribution that is not includable in gross income (determined without regard to the exclusion for net unrealized appreciation with respect to employers securities).\n2.2 Eligible Retirement Plan: An eligible retirement plan is an individual retirement account described in Section 408(a) of the Code, an individual retirement annuity described in Section 408(b) of the Code, an annuity plan described in Section 403(a) of the Code, or a qualified trust described in Section 401(a) of the Code, that accepts the distributee's eligible rollover distribution. However, in the case of an eligible rollover distribution to the surviving spouse, an eligible retirement plan is an individual retirement account or individual retirement annuity.\n2.3 Distributee: A distributee includes an employee or former employee. In addition, the employee's or former employee's surviving spouse and the employee's or former employee's spouse or former spouse who is the alternate payee under qualified domestic relations order, as described in Section 414(p) of the Code, are distributees with regard to the interest of the spouse or former spouse.\n2.4 Direct Rollover: A direct rollover is a payment by the Plan to the eligible retirement plans specified by the distributee.\"\n2. 411(a)(11) WAIVERS\nPursuant to Rev. Proc. 93-47, 1993-2 C.B. 578, and notwithstanding any provision of the Plan to the contrary, the following language is hereby added to the Plan:\n\"If a distribution is one to which Sections 401(a)(11) and 417 of the Internal Revenue Code do not apply, such distribution may commence less than 30 days after the notice required in Section 1.411(a)-11(c) of the Income Tax Regulations is given, provided that (1) the Plan Administrator clearly informs the participant that the participant has a right to a period of at least 30 days after receiving the notice to consider the decision of whether or not to elect a distribution (and, if applicable, a particular distribution option), and (2) the participant, after receiving the notice, affirmatively elects a distribution.\"\n3. $150,000 COMPENSATION LIMIT\nPursuant to Rev. Proc. 94-13, 1994-3 I.R.B. 18, and notwithstanding any provision of the Plan to the contrary, the Plan is hereby amended to include the following language:\n\"In addition to other applicable limitations set forth in the Plan, and notwithstanding any other provision of the Plan to the contrary, for Plan Years beginning on or after January 1, 1994, the annual compensation of each employee taken into account under the Plan shall not exceed the OBRA '93 annual compensation limit. The OBRA '93 annual compensation limit is $150,000, as adjusted by the Commissioner for increases in the cost of living in accordance with section 401(a)(17)(B) of the Internal Revenue Code. The cost-of-living adjustment in effect for a calendar year applies to any period, not exceeding 12 months, over which compensation is determined (determination period) beginning in such calendar year. If a determination period consists of fewer than 12 months, the OBRA '93 annual compensation limit will be multiplied by a fraction, the numerator of which is the number of months in the determination period, and the denominator of which is 12.\nFor Plan Years beginning on or after January 1, 1994, any reference in this Plan to the limitation under section 401(a)(17) of the Code shall mean the OBRA '93 annual compensation limit set forth in this provision.\nIf compensation for any prior determination period is taken into account in determining an employee's benefits accruing in the current Plan Year, the compensation for that prior determination period is subject to the OBRA '93 annual compensation limit in effect for that prior determination period. For this purpose, for determination periods beginning before the first day of the first Plan Year beginning on or after January 1, 1994, the OBRA '93 annual compensation limit is $150,000.\n4. PLAN AMENDMENTS\nNotwithstanding any provision of the Plan to the contrary, this Plan may be amended by action of the Board of Directors of the Employer or such Committee to which the Board may delegate from time to time the authority and responsibility for adopting such amendments, and any amendment approved by such persons may be executed by any authorized agent of the Employer.\n5. MISCELLANEOUS\n5.1 Ratification. Except as expressly set forth above, the Plan, as previously amended and restated to reflect the requirements of the Tax Reform Act of 1986 and certain subsequent legislation, and as further amended by the First Amendment and the Second Amendment, remains in full force and effect.\n5.2 Effective Date. The provisions described above are effective on the date(s) prescribed in connection with each such provision, and to the extent no date is so prescribed the provisions of this Third Amendment shall be effective on the first day of the Plan Year in which this amendment is executed by the Employer and Trustee.\nIN WITNESS WHEREOF, the parties hereto have executed this Amendment, effective on the dates set forth above.\n\"EMPLOYER:\"\nSANTA BARBARA BANK & TRUST, a California corporation\nBy Name: Jay D. Smith Title: Secretary\nDecember 28, 1994 Date\n\"TRUSTEE:\"\nSANTA BARBARA BANK & TRUST, a California corporation\nBy Name: Janice Kroekel Title: Assistant Vice President\nDecember 28, 1994 Date\nExhibit 10.1.8\nFOURTH AMENDMENT\nTO\nSANTA BARBARA BANK & TRUST\nINCENTIVE AND INVESTMENT AND SALARY SAVINGS PLAN\nTHIS FOURTH AMENDMENT (the \"Fourth Amendment\") is made and entered into, effective on the date set forth below, by and between SANTA BARBARA BANK & TRUST, a California corporation (in its capacity as \"Employer\"), and SANTA BARBARA BANK & TRUST, a California corporation (in its capacity as \"Trustee\"), with reference to the following facts:\nRECITALS:\nA. The Employer sponsors that certain Incentive and Investment and Salary Savings Plan pursuant to that certain document executed December 31, 1991, as amended by that First Amendment dated effective January 1, 1994, that certain Second Amendment dated effective July 1, 1994, and that certain Third Amendment executed December 28, 1994 (as so amended, the \"Plan\").\nB. The Employer desires to amend the Plan in order to clarify the manner in which the Plan shall reallocate amongst participants an amount which cannot be allocated to a particular participant in a Plan Year by reason of the limits imposed by Section 415 of the Internal Revenue Code (the \"Code\").\nAGREEMENTS:\nNOW, THEREFORE, the parties hereto, intending to be legally bound, do hereby agree as follows:\n1. AMENDMENT TO SECTION 4.10\nSection 4.10 of the Plan is hereby modified and amended to read in its entirety as follows:\n\"4.10 Adjustment For Excessive Annual Additions.\n(a) For purposes of this Section 4.10, the term:\n(1) \"Excess Amount\" shall mean, for each Participant in each limitation year, the excess, if any, of (i) the \"annual additions\" which would be credited to his account under the terms of the Plan without regard to the limitations of Section 415, over (ii) the maximum \"annual additions\" permitted by Code Section 415, as determined pursuant to Section 4.9, above.\n(2) \"Section 415 Suspense Account\" shall mean an unallocated account equal to the sum of \"excess amounts\" for all Participants in the Plan during the limitation year, determined after such excess amounts have been reallocated to all Participants to the extent permitted by Section 415 and in accordance with the provisions of Section 4.10(b), below. The amount allocated to the Section 415 Suspense Account shall not share in any earnings or losses of the Trust Fund.\n(b) If the \"annual additions\" under this Plan would cause the maximum \"annual additions\" to be exceeded for any Participant by reason of (i) the allocation of Forfeitures, (ii) a reasonable error in estimating a Participant's Compensation, (iii) a reasonable error in determining the amount of elective deferrals (within the meaning of Code Section 402(g)(3)) that may be made with respect to any Participant under the limits imposed on such deferrals, or (iv) other facts and circumstances to which Treasury Regulations Section 1.415-6(b)(6) shall be applicable, then the Administrator shall:\n(1) Allocate and reallocate such excess amounts to other Participants in accordance with Section 4.4, above, but subject to the limits on \"annual additions\" imposed by Section 4.9, above;\n(2) Allocate to the Section 415 Suspense Account any \"excess amount\" remaining after application of Paragraph (1), above; and\n(3) Allocate and reallocate the Section 415 Suspense Account in the next limitation year (and, if the amount in that Section 415 Suspense Account is not fully allocated in the next limitation year, then in succeeding limitation years) to all Participants in the Plan before any Employer or Employee contributions which would constitute annual additions are made to the Plan for such limitation year, and reduce Employer contributions to the Plan for such limitation year by the amount of the Section 415 Suspense Account allocated and reallocated during such limitation year.\n(c) The Plan may not distribute excess amounts, other than voluntary Employee contributions, to Participants or Former Participants.\"\n2. MISCELLANEOUS\n2.1 Ratification. Except as expressly amended by the First Amendment, the Second Amendment, the Third Amendment, and this Fourth Amendment, the Plan is hereby ratified, confirmed, and approved, and remains in full force and effect.\n2.2 Effective Date. The effective date of this Fourth Amendment shall be January 1, 1995.\nIN WITNESS WHEREOF, the parties hereto have executed this Fourth Amendment, effective on the date set forth above.\n\"EMPLOYER\":\nSANTA BARBARA BANK & TRUST, a California corporation\nBy Name: Jay D. Smith Title: Secretary\nMarch 2, 1995 Date\n\"TRUSTEE\":\nSANTA BARBARA BANK & TRUST, a California corporation\nBy Name: Janice Kroekel Title: Assistant Vice President\nMarch 2, 1995 Date\nExhibit 10.1.10\nFIRST AMENDMENT\nTO\nEMPLOYEE STOCK OWNERSHIP PLAN AND TRUST\nOF\nSANTA BARBARA BANK & TRUST\nTHIS FIRST AMENDMENT (the \"First Amendment\") is made and entered into, effective on the date set forth below, by and between SANTA BARBARA BANK & TRUST, a California corporation, as Employer (the \"Employer\"), and SANTA BARBARA BANK & TRUST, a California corporation, as Trustee (the \"Trustee\"), with reference to the following facts:\nRECITALS:\nA. The Employer sponsors an Employee Stock Ownership Plan and Trust (the \"ESOP\") pursuant to that certain plan document executed June 28, 1994 (the \"Plan\").\nB. The ESOP is implementing certain procedures to satisfy the \"required diversification\" rules of Internal Revenue Code (\"IRC\") Section 401(a)(28).\nC. In order to provide the Trustee sufficient flexibility to satisfy those rules in a manner that is in the best interests of plan participants, the Employer desires to amend the Plan in a manner described below.\nAMENDMENT:\nNOW, THEREFORE, the parties hereto, intending to be legally bound, do hereby agree and amend the Plan as follows:\n1. AMENDMENT TO SECTION 4.6.1\nSubparagraph C of Section 4.6.1 of the Plan is hereby amended in its entirety to read as follows:\n\"C. The Trustee shall satisfy the diversification direction of the Qualified Participant under this Section 4.6.1 by either (1) distributing to the Qualified Participant, within ninety (90) days after the end of the period in which the Participant may make a diversification election under this Section 4.6.1, either such number of shares of Company Stock which the Participant has elected to diversify, or cash in an amount equal to the fair market value of such shares of Company Stock (determined as of the last Anniversary Date prior to the date of the distribution), provided, any such shares of Company Stock distributed to a Qualified Participant shall be subject to the \"put option\" requirements of Section 7.11, below; or (2) offering within the Trust at least three distinct investment options (in accordance with Treasury Regulations implementing Code Section 401(a)(28)) in which an amount equal to the fair market value of the number of shares of Company Stock which the Qualified Participant has elected to diversify shall be invested during the ninety-day period after the period in which the Qualified Participant may elect a diversification election pursuant to this Section 4.6.1, or (3) transferring to another qualified retirement plan sponsored by the Employer the number of shares of Company Stock which the Qualified Participant elects to diversify (or an amount representing the fair market value of those shares as of the last Anniversary Date preceding the date of the transfer), and offering in that other plan at least three distinct investment options (in accordance with Treasury Regulations implementing Code Section 401(a)(28)) into which the proceeds from the sale of the designated number of shares of the Company Stock (or an amount of cash representing the fair market value) shall be invested during the 90-day period following the period in which the Participant may make a diversification election pursuant to this Section 4.6.1.\"\n2. MISCELLANEOUS\n2.1 Ratification. Except as expressly modified by this First Amendment, the Plan is hereby ratified and confirmed and remains in full force and effect.\n2.2 Effective Date. The effective date of this First Amendment shall be January 1, 1995.\n(Signatures appear on the following page.)\nIN WITNESS WHEREOF, the parties hereto have executed this First Amendment, effective on the date set forth above.\nEMPLOYER\":\nSANTA BARBARA BANK & TRUST, a California corporation\nBy Name: Jay D. Smith Title: Secretary\nFebruary 24, 1995 Date\n\"TRUSTEE\":\nSANTA BARBARA BANK & TRUST, a California corporation\nBy:\nName: Janice Kroekel Title: Assistant Vice President\nFebruary 24, 1995 Date\nExhibit 10.1.13\nFIRST AMENDMENT\nTO\nTRUST AGREEMENT\nOF\nSANTA BARBARA BANK & TRUST\nVOLUNTARY EMPLOYEES' BENEFICIARY ASSOCIATION\nTHIS FIRST AMENDMENT (the \"First Amendment\") is made and entered into, effective on the date set forth below, by and between SANTA BARBARA BANK & TRUST, a California corporation, in its capacity as the Employer establishing the Trust described below (the \"Bank\"), and SANTA BARBARA BANK & TRUST, a California corporation, in its capacity as Trustee under the Trust Agreement described below (the \"Trustee\"), with reference to the following facts:\nRECITALS:\nA. The Bank and the Trustee executed that certain Trust Agreement of Santa Barbara Bank & Trust Voluntary Employees' Beneficiary Association dated effective December 29, 1992 (the \"Trust Agreement\"), establishing a trust (the \"Trust\") intended to qualify as a \"Voluntary Employees' Beneficiary Association\" (\"VEBA\") under Internal Revenue Code (\"Code\") Section 501(c)(9).\nB. The Bank desires to amend the Trust Agreement, in the manner reflected below, in order to permit certain portions of contributions made by the Bank to the Trust to be returned to the Bank on the occurrence of the circumstances described below.\nC. The Bank intends that this Amendment not be effective unless the Internal Revenue Service determines that this Amendment would not cause the Trust to fail to qualify as a VEBA under Code Section 501(c)(9).\nAGREEMENTS:\nNOW, THEREFORE, the parties hereto, intending to be legally bound, do hereby agree as follows:\n1. AMENDMENT TO SECTION 8.3\nSection 8.3 of the Trust Agreement is amended to read as follows:\n\"8.3 Prohibited Reversion and Inurement. Except to the extent the Bank may make a good faith mathematical or other computational error in determining the amount of its contribution in any Plan Year and except as otherwise provided in Section 9.1, below, under no circumstances shall any assets or net earnings of the Trust, either during the existence of the Trust or at the termination thereof:\n8.3.1 Reversion. Revert to the Bank or be applied to or for the benefit of the Bank (except to the extent the Trust Fund is applied to pay the cost of Coverage pursuant to the Plan); or\n8.3.2 Inurement. Otherwise be paid to, or inure to the benefit of, any private individual, shareholder or other person, except through the payment of the cost of Coverage pursuant to the Plan and the costs of administering the Trust.\"\n2. AMENDMENT TO SECTION 9.1\nSection 9.1 of the Trust Agreement is amended to read as follows:\n9.1 Qualification and Initial Contribution. The Bank and the Trustee shall cooperate in preparing and submitting to the Internal Revenue Service all documents that may be necessary to obtain from the Internal Revenue Service a letter determining that the Trust, in operation with the Plan, constitutes a VEBA and the Trust is exempt from federal income taxes under Section 501(a) of the Code.\n9.1.1 Amendment. The Bank and the Trustee shall execute any amendment to this Agreement that may be necessary to obtain such determination letter, and any such amendment shall have retroactive effect to the extent necessary to ensure the qualification of the Trust as a tax-exempt VEBA as of the effective date of this Agreement.\n9.1.2 Initial Contribution. The Bank and the Trustee acknowledge and agree that all contributions made by the Bank to the Trust for the period ended December 31, 1992, have been made on condition that the Trust promptly obtain such favorable determination letter. If the Trust shall fail to qualify as a tax-exempt VEBA with respect to the period ended December 31, 1992, then all such contributions shall be returned to the Bank.\n9.1.3 Subsequent Contribution. The Bank and the Trustee acknowledge and agree that all contributions made by the Bank to the Trust are made on condition that such contributions are deductible by the Bank under Section 419 of the Code. If a deduction is not allowable under that Section for any portion of any such contribution for the taxable year of the Bank with respect to which a contribution is made, then the non-deductible portion of such contribution shall be returned to the Bank if the Bank demands such portion within one year following (a) the last day of the Bank's taxable year with respect to which such contribution was made, or (b) if later, the date on which the Internal Revenue Service disallows a deduction for all or any portion of such contribution; provided, no portion of the earnings on such excess contribution may be returned to the Bank, and any losses attributable to such excess contribution shall reduce the amount which otherwise would have been returned to the Bank under this Section 9.1.3.\n3. MISCELLANEOUS\n3.1 Ratification. Except as amended by this First Amendment, the Trust Agreement is valid and effective and remains in full force and effect.\n3.2 Effective Date. This Amendment shall be effective only if the Internal Revenue Service determines that this Amendment shall not adversely affect the qualification of the Trust as a VEBA under Code Section 501(c)(9). If the Internal Revenue Service makes that determination, then this Amendment shall be effective on the later of December 29, 1992, or any subsequent date which the Internal Revenue Service determines to be the earliest date as of which this Amendment may be effective.\nIN WITNESS WHEREOF, the parties hereto have executed this First Amendment, effective on the date set forth above.\n\"TRUSTEE\" \"BANK\"\nSANTA BARBARA BANK & TRUST, SANTA BARBARA BANK & TRUST, a California corporation a California corporation\nName: Janice Kroekel Name: Jay D. Smith Title: Assistant Vice President Title: Secretary Date: July 23, 1993 Date: July 23, 1993\nExhibit 10.1.15\nSANTA BARBARA BANK & TRUST\nSECOND AMENDED AND RESTATED FLEXMASTER PLAN\nOctober 1, 1991\nSECOND AMENDED AND RESTATED FLEXMASTER PLAN\nOF\nSANTA BARBARA BANK & TRUST\nTHIS AMENDED AND RESTATED FLEXMASTER PLAN is adopted by SANTA BARBARA BANK & TRUST, a California corporation (the \"Bank\"), with reference to the following facts:\nRECITALS:\nA. The Bank previously adopted an Amended and Restated Cafeteria Plan (the \"Cafeteria Plan\"), effective May 1, 1991, in order to provide its employees an option to elect either to receive the entire amount of their compensation from the Bank in cash, or to direct the Bank to apply a portion of that compensation to purchase certain benefits.\nB. The Bank now desires to amend and restate the Cafeteria Plan in order to reflect the addition of other nontaxable benefits available under such plan.\nPLAN:\nNOW, THEREFORE, the Bank, intending to be legally bound, hereby adopts the following Plan:\n1. DEFINITIONS\nFor purposes of this Plan, each of the following terms shall have the meaning set forth below:\n1.1 \"Annual Earnings\" means, with respect to each Participant for each Plan Year, the amount of taxable wages paid by the Bank to the Participant during the twelve-month period ending on the July 31st immediately preceding the commencement of such Plan Year, as rounded upward to the next higher multiple of One Thousand Dollars ($1,000.00).\n1.2 \"Bank\" means Santa Barbara Bank & Trust, a California corporation.\n1.3 \"Change in Family Status\" means the occurrence of any one or more of the following events:\n1.3.1 Marriage; Divorce. The marriage or divorce of the Participant;\n1.3.2 Death. The death of the spouse or other dependent of the Participant;\n1.3.3 Birth; Adoption. The birth or adoption of a child of the Participant;\n1.3.4 Termination or Commencement of Employment. The Participant's spouse terminates employment or commences employment with a new employer;\n1.3.5 Change of Employment Status. The Participant or the Participant's spouse switches from a part-time to a full-time employment status or from a full-time to a part-time employment status; or\n1.3.6 Change in Health Coverage. There is a significant change in the health coverage of the Participant or the spouse of the Participant that is available as a result of the employment of the Participant's spouse.\n1.4 \"Class Multiple\" means the Participant's multiple as determined under the table set forth below:\nThen the Participant's Class Class No. If the Participant is: Multiple is:\n1 A President, Executive 3 Vice-President, or Senior Vice-President\n2 An employee who has 10 2 or more years of service with the Bank\n3 An employee who has at 1.5 least 5 but less than 10 years of service with the Bank\n4 An employee who has less 1 than 5 years of service\n1.5 \"Code\" means the Internal Revenue Code of 1986, as amended from time to time, and any reference to any section of the Code shall be deemed to include a reference to any comparable or succeeding provision of any legislation that amends, supplements, or replaces such section.\n1.6 \"Commencement Date\" means the first day on which an Employee first performs any service for the Bank in the capacity as a common law employee of the Bank.\n1.7 \"Component Benefit Plans\" means (a) the Dental Care Plans, (b) the Dependent Care Reimbursement Plan, (c) the Dependent Life Insurance Plans, (d) the Employee Life and Accidental Death and Disability Plans, (e) the Health Care Reimbursement Plan, (f) the Long- Term Disability Insurance Plans, and (g) the Medical Insurance Plans.\n1.8 \"Dental Care Plans\" means the group dental care plans under which the Bank provides group dental coverage to its Employees and their dependents, as the same may be amended from time to time. As of the Effective Date of this Plan, the Bank sponsors the following Dental Care Plans: (a) Santa Barbara Bank & Trust Direct Reimbursement Dental Plan (Plan No. 514); and (b) Dental Net (Plan No. 516).\n1.9 \"Dependent Care Assistance Plan\" means the Santa Barbara Bank & Trust Dependent Care Assistance Plan, under which the Bank reimburses its Employees for certain dependent care expenses, as the same may be amended from time to time.\n1.10 \"Dependent Life Insurance Plans\" means the group life insurance plans under which the Bank provides life insurance coverage for the dependents of its Employees, as the same may be amended from time to time.\n1.11 \"Effective Date\" means October 1, 1991.\n1.12 \"Election Form\" means a form, as prescribed by the Plan Administrator, on which a Participant may elect, inter alia, to receive nontaxable benefits under one or more of the Component Benefits Plans.\n1.13 \"Employee\" means any individual who is a common law employee of the Bank.\n1.14 \"Employee Life and Accidental Death and Dismemberment Plans\" means the group life and accidental death and dismemberment insurance plans under which the Bank provides life and accidental death and dismemberment coverage to its employees, as the same may be amended from time to time.\n1.15 \"Employer Contribution\" means, for each Participant in each Plan Year, a dollar amount equal to the sum of (a) the Fixed Health Contribution, plus (b) the Variable Contribution. Such Employer Contribution represents the amount (other than Salary Reduction Contributions) which the Employer shall contribute to this Plan for each Participant in each Plan Year.\n1.16 \"Fixed Health Contribution\" means a dollar amount which the Bank elects to contribute to the Plan in each Plan Year for each Participant, as determined and announced by the Bank prior to the beginning of such Plan Year. Commencing October 1, 1991, and continuing until changed by the Bank, the Fixed Health Contribution shall be Three Thousand Eighteen Dollars ($3,018.00).\n1.17 \"Health Care Reimbursement Plan\" means the Santa Barbara Bank & Trust Health Care Reimbursement Plan, under which the Bank reimburses its Employees for certain medical expenses, as the same may be amended from time to time.\n1.18 \"Highly Compensated Employee\" means a \"highly compensated employee,\" as that term is defined in Section 414(q) of the Code.\n1.19 \"Key Employee\" means a \"key employee,\" as that term is defined in Section 416(i)(1) of the Code.\n1.20 \"Long-Term Disability Insurance Plans\" means the group long-term disability insurance plans, under which the Bank provides group long-term disability coverage to Bank employees, as the same may be amended from time to time.\n1.21 \"Medical Insurance Plans\" means the group medical insurance plans under which the Bank provides group medical coverage to its Employees and their dependents, as the same may be amended from time to time. As of the effective date of this Plan, the Bank sponsors the following Medical Insurance Plans: (a) CaliforniaCare Plan (Plan No. 507); (b) Enhanced CaliforniaCare Plan (Plan No. 519) (c) the Freedom Plan (Plan No. 513); and (d) the Prudent Buyer Plan (Plan No. 515).\n1.22 \"Participant\" means each Employee who satisfies the requirements of participation set forth in Section 2.1 of this Plan.\n1.23 \"Participant's Account\" means the account established for each Participant by the Bank pursuant to Section 3.1, below.\n1.24 \"Plan\" means this \"Santa Barbara Bank & Trust Amended and Restated FlexMaster Plan,\" as the same may be amended from time to time in accordance with Section 5, below.\n1.25 \"Plan Administrator\" means the Bank, or such person or committee as the Bank may appoint from time-to-time to supervise the administration of the Plan.\n1.26 \"Plan Year\" means each period of twelve consecutive months commencing on each October 1 and ending on September 30 in the immediately subsequent calendar year.\n1.27 \"Salary Reduction Contribution\" means the amount of compensation, if any, that the Participant has elected to contribute to the Plan. The maximum amount of Salary Reduction Contributions by a Participant in any Plan Year shall not exceed the excess, if any, of (a) the cost of benefits which the Participant elects to receive under Component Benefit Plans in such Plan Year, over (b) the amount of the Employer Contribution in that year.\n1.28 \"Variable Contribution\" means the sum of the Life\/AD&D Credit Amount, and (b) the LTD Credit Amount. For purposes of this Section 1.28, the terms:\n1.28.1 \"Life\/AD&D Credit Amount\" shall be equal to the product determined by multiplying:\nA. The lesser of (1) the product determined by multiplying (a) the Participant's Class Multiple, times (b) the amount of the Participant's Annual Earnings, or (2) Four Hundred Thousand Dollars ($400,000); times\nB. The Participant's credit factor, as determined under the table set forth below, with the Participant's age being determined as of the July 31st immediately preceding the first day of the Plan Year for which the credit factor is being determined:\nParticipant's Age Credit Factor\nLess than 26 .00152 26-29 .00126 30-34 .00152 35-39 .00206 40-44 .00282 45-49 .00414 50-54 .00690 55-59 .01098 60-64 .01352 65-69 .02286 70 or more .06078\n1.28.2 \"LTD Credit Amount\" shall mean the product determined by multiplying:\nA. The lesser of (1) the amount of the Participant's Annual Earnings, or (2) Two Hundred Fifty-Seven Thousand One Hundred Forty-Three Dollars ($257,143.00); times\nB. The Participant's credit factor, as determined under the table set forth below, with the Participant's age being determined as of the July 31st immediately preceding the first day of the Plan Year for which the credit factor is being determined:\nParticipant's Age Credit Factor\nLess than 26 .0011 26-29 .0012 30-34 .0018 35-39 .0024 40-44 .0034 45-49 .0048 50-54 .0063 55-59 .0072 60-64 .0065 65-69 .0040 70 or more .0031\n2. PARTICIPATION\n2.1 Eligibility to Participate. An Employee shall be eligible to participate in the Plan if the Employee (a) customarily works at least twenty-one (21) hours per week for the Bank, and (b) has completed ninety (90) days of employment with the Bank.\n2.2 Commencement of Participation. An Employee who has satisfied the conditions set forth in Section 2.1, above, may commence participation in the Plan effective on the later of (a) the Effective Date of this Plan, or (b) the first day of the first calendar month beginning after the Employee satisfies the conditions to eligibility set forth in Section 2.1, above.\n2.3 Termination of Participation. A Participant will cease to be a Participant as of the earlier of:\n2.3.1 Plan Termination. The date on which the Plan terminates; or\n2.3.2 Eligibility Conditions. The date on which the Participant fails to satisfy the conditions to eligibility set forth in Section 2.1, above; provided, if a Participant who remains employed by the Bank fails to satisfy the conditions to eligibility set forth in Section 2.1, above, because such Participant begins working for the Bank fewer than twenty-one hours per week, then (a) such Participant shall remain a Participant and the Participant's election pursuant to Section 3.3, below, shall remain in effect for the remainder of the Plan Year, and (b) such Participant's status as a Participant shall cease automatically, effective on the first day of the next succeeding Plan Year, unless the Participant once again has satisfied the conditions to eligibility described in Section 2.1, above.\n2.4 Reinstatement of Participant. A person who has ceased to be a Participant under Section 2.3, above, once again shall become a Participant only after satisfying the conditions to eligibility set forth in Section 2.1, above.\n3. OPTIONAL BENEFITS\n3.1 Credits to Participant's Account. The Bank shall establish for each Participant under this Plan a Participant's Account, to which the Bank shall credit:\n3.1.1 Employer Contribution. The amount of the Employer Contribution for each Plan Year; and\n3.1.2 Salary Reduction Contributions. The amount of Salary Reduction Contributions which the Participant elects to make to the Plan for such Plan Year.\n3.2 Application of Account Credits. The amount credited to each Participant's Account shall be applied in each Plan Year as follows:\n3.2.1 Core Benefits. First, subject to Section 3.2.3, below, such amount shall be applied toward the purchase of:\nA. Long-term disability insurance coverage for such Participant, under such of the Long-Term Disability Insurance Plans as is selected by the Participant, in an amount equal to fifty percent (50%) of such Participant's Annual Earnings for such Plan Year;\nB. Life and accidental death and dismemberment insurance coverage for the Participant under such of the Employee Life and Accidental Death and Dismemberment Plans as is selected by the Participant, in an amount equal to the lesser of (1) $50,000, or (2) one hundred percent (100%) of the Participant's Annual Earnings for such Plan Year; and\nC. The premium cost of coverage for the Participant under such Medical Insurance Plan and Dental Care Plan as are selected by the Participant; provided, if the Participant presents to the Bank evidence satisfactory to the Bank establishing that the Participant receives insurance coverage under a medical insurance plan or dental care plan other than those sponsored by the Bank, then no portion of the amount credited to the Participant's Account shall be applied toward the purchase of coverage under one of the corresponding plans sponsored by the Bank. 3.2.2 Election. Thereafter, subject to Section 3.2.3, below, the remaining balance of such Participant's Account after application of Section 3.2.1, above, shall be applied, in accordance with the Participant's designation on the Election Form for such Plan Year, either:\nA. To pay the Participant additional taxable compensation during such Plan Year;\nB. To provide the Participant additional nontaxable benefits under one or more of the Component Benefit Plans; or\nC. To provide the Participant such combination of additional taxable compensation and nontaxable benefits under one or more of the Component Benefit Plans as the Participant desires.\n3.2.3 Failure to Elect. Notwithstanding the provisions of Sections 3.2.1 and 3.2.2, above, if for any Plan Year a Participant fails to complete and return an Election Form to the Plan Administrator on or before the date specified by the Plan Administrator, then:\nA. The Participant shall be deemed to have elected, and the amount credited to the Participant's Account shall be applied, to purchase (a) long-term disability insurance coverage for such Participant, under one of the Long-Term Disability Insurance Plans, in an amount equal to fifty percent (50%) of the Participant's Annual Earnings for the Plan Year; (b) Life and Accidental Death and Dismemberment Insurance coverage for the Participant, under one of the Employee Life and Accidental Death and Dismemberment Plans, in an amount equal to the lesser of $50,000 or one hundred percent (100%) of the Participant's Annual Earnings for the Plan Year; and\nB. The Participant shall not be entitled to receive any other benefits under this Plan or any Component Benefit Plan for such Plan Year, and shall forfeit, to the extent not necessary to purchase the benefits described in subparagraph A, above, all amounts credited to the Participant's Account for such Plan Year.\n3.3 Election Procedure. The election described in Section 3.2.2, above, shall be made at the time, and in the manner, set forth in this Section 3.3.\n3.3.1 Annual Election. Prior to the commencement of each Plan Year, the Plan Administrator shall provide an Election Form to each Employee who is expected to be a Participant as of the first day of the next ensuing Plan Year. On the Election Form, each such Employee shall (a) specify the amount, if any, of Salary Reduction Contributions which the Employee shall make during the ensuing Plan Year, and (b) authorize and direct the Bank as to the manner in which amounts credited to the Participant's Account shall be applied by the Bank pursuant to Section 3.2.2, above, during the ensuing Plan Year.\nA. The amount of the reduction in the Employee's compensation for the next ensuing Plan Year initially shall be not less than the difference between (1) the amount of the cost of the optional benefits selected by the Employee pursuant to Section 3.2.2, above, for such Plan Year, and (2) the amount of the Employer Contribution. During the Plan Year such reduction shall be adjusted automatically in the event there is a change in the cost of a benefit provided by a third- party insurance company under one of the Component Benefit Plans, and the Bank elects to require Participants to bear that increase.\nB. Each Election Form must be completed and returned to the Plan Administrator on or before such date as the Plan Administrator shall specify, which date shall be prior to the first day of the Plan Year to which the Election Form is to apply.\n3.3.2 New Participant. As soon as practicable before each Employee becomes a Participant, the Plan Administrator shall provide an Election Form to the Employee. Such Election Form must be completed and returned to the Plan Administrator on or before such date as the Plan Administrator shall specify, which date shall be prior to the first day of the first pay period to which any reduction in the Participant's compensation is to apply.\n3.4 Duration of Election. Each election made pursuant to Sections 3.2.2 and 3.3, above, shall continue to apply as set forth in this Section 3.4.\n3.4.1 General Rule. Except as otherwise provided in Sections 3.4.2 and 3.4.3, below, each such election shall be irrevocable and shall remain effective until the last day of the Plan Year to which it relates.\n3.4.2 Voluntary Revocation. A Participant voluntarily may elect to revoke any election previously made in accordance with Section 3.4, above, if the benefit being purchased by the Bank in accordance with such election is provided by an independent third-party provider under a Medical Insurance Plan or Dental Care Plan; and:\nA. Both (1) the cost of that coverage changes significantly during the Plan Year, and (2) the Participant makes a new election to receive such coverage from another third-party provider, if any, offering similar coverage through this Plan;\nB. Both (1) the extent of such coverage is significantly curtailed or ceases during the Plan Year, and (2) the Participant makes a new election to receive such coverage from another third-party provider, if any, offering similar coverage through this Plan; or\nC. Both (1) there is a Change in Family Status and with respect to the Participant, and (2) any new election which the Participant makes is consistent with such Change in Family Status.\n3.4.3 Mandatory Termination. A Participant's election under Section 3.4, above, shall be terminated:\nA. Automatically when the Participant ceases to be a Participant, provided, in accordance with Section 2.3.2, above, the election of a Participant who remains employed by the Bank but no longer works at least twenty-one (21) hours per week for the Bank on a customary basis shall be revoked automatically effective on the first day of the first Plan Year next following the date on which the Participant begins working less than twenty-one (21) hours per week;\nB. Automatically upon the termination of this Plan;\nC. Automatically if the benefit which the Participant has designated in the Participant's Election Form no longer is offered under this any of the Component Benefit Plans; and\nD. At such time as, and to the extent which, the Plan Administrator reasonably determines is necessary to ensure that the Plan will not be treated as a discriminatory cafeteria plan under Section 125 of the Code. Any such termination or modification by the Plan Administrator shall be applied under rules uniformly applicable to all similarly situated Participants. Such action may include, without limitation, modification of elections made by Highly Compensated Employees or by Key Employees.\n3.5 Maximum Employer Contribution. Notwithstanding any other provision of this Plan to the contrary, the Bank shall not be obligated to contribute toward the purchase of any optional benefit elected by a Participant pursuant to Section 3.2.2, above, any amount in excess of the sum of (a) the Employer Contribution and (b) the Participant's Salary Reduction Contribution.\n3.6 Appeals Procedure. If a claim for benefits under this Plan is partially or fully denied by the Plan Administrator, then the Participant may request a review of that decision by submitting to the Bank, not later than sixty (60) days after receiving notice of the Plan Administrator's decision, a written request for review of the decision. Within sixty (60) days of receiving such application, the Bank shall review the application, hold such hearings as, in the sole discretion of the Employer, it deems appropriate, and advise the Participant, in writing, of its decision. If the decision on review is not provided within such sixty (60) day period, then the application for appeal shall be deemed to be denied.\n3.7 Description of Nontaxable Benefits. The costs, extent, requirements for participation, and other terms and conditions of the benefits which a Participant may elect to receive under Section 3.2, above, shall be those which are set forth in the Bank's Component Benefit Plans, as the same may be amended from time to time.\n4. ADMINISTRATION\n4.1 Duties of Plan Administrator. The Plan Administrator shall administer the Plan in accordance with its terms, for the exclusive benefit of Participants, in a manner which ensures that the Plan satisfies the rules applicable to qualified \"cafeteria plans\" under Section 125 of the Code.\n4.2 Powers of Plan Administrator. The Plan Administrator shall have full power and authority to administer and carry into effect the terms and conditions of the Plan, subject to applicable requirements of law. Such power shall include, but not be limited to, the power:\n4.2.1 Revoke Elections. To modify or revoke, for the purpose of ensuring that the Plan does not violate the nondiscrimination rules applicable to cafeteria plans, an election made by a Participant under this Plan;\n4.2.2 Rules and Regulations. To make and enforce such reasonable rules and regulations as the Plan Administrator deems necessary or proper for the efficient administration of the Plan, including the establishment of any claims procedures that may be required by applicable provisions of law;\n4.2.3 Interpretation. To interpret in good faith the terms and conditions of this Plan;\n4.2.4 Resolution. To resolve all questions concerning the Plan and the eligibility of any Employee to participate in the same; and\n4.2.5 Agents. To appoint and retain such agents, counsel, accountants, consultants, and other persons as may be necessary or appropriate to assist in the administration of the Plan.\n4.3 Records. The Plan Administrator shall establish and maintain such records as are necessary or appropriate to the efficient administration of the Plan. Each Participant, upon reasonable advance notice to the Plan Administrator, shall be entitled to inspect such of those records as pertain to that Participant.\n4.4 Filing. The Plan Administrator shall timely file all forms required to be filed with respect to the Plan pursuant to Section 6039D of the Code, each successor provision of the Code, and all counterpart provision of California law.\n4.5 Indemnification. The Bank shall indemnify, defend, and hold the Plan Administrator free and harmless from and against any and all liabilities, damages, costs and expenses, including reasonable attorneys' fees, occasioned by any actions which the Plan Administrator takes, or fails to take, in good faith, in connection with the administration of the Plan.\n5. AMENDMENT AND TERMINATION\nThe Plan may be amended or terminated at any time by a written instrument executed by the Board of Directors of the Bank, or its designee.\n6. MISCELLANEOUS\n6.1 No Employment Rights. Neither the adoption and maintenance of this Plan, nor any express or implicit provision of this Plan, shall be deemed:\n6.1.1 Contract. To constitute a contract between the Bank and any person, or to be a consideration for or an inducement or condition of, the employment of any person;\n6.1.2 Right. To give any person the right to be retained in the employ of the Bank;\n6.1.3 Discharge. To interfere with the right of the Bank to discharge any Employee (including any Participant) at any time; or\n6.1.4 Continuing Employment. To give the Bank the right to require an Employee to remain in the employ in the Bank, or to interfere with an Employee's right to terminate his employment at any time.\n6.2 Enforceability; Exclusive Benefit. Subject to the provisions of Section 6.1, above, the Bank:\n6.2.1 Legally Enforceable. Represents that the rights created in this Plan in favor of its Employees are intended to be legally enforceable; and\n6.2.2 Exclusive Benefit. Agrees to administer this Plan for the exclusive benefit of its Employees. 6.3 Interpretation. As used in this Plan, the masculine, feminine, and neuter gender and the singular and plural numbers each shall be deemed to include the other whenever the context indicates or requires. The captions to various sections of this Plan are for convenience and reference purposes only, and shall not affect in any way the meaning or interpretation of this Plan.\n6.4 Governing Law. This Plan shall be construed, administered, and enforced in accordance with the laws of the State of California, and in such manner as is necessary to permit the Plan to continue to be qualified as a \"cafeteria plan\" which satisfies the requirements of Section 125 of the Code.\nIN WITNESS WHEREOF, the Bank has caused this Plan to be adopted, effective on the Effective Date.\nSANTA BARBARA BANK & TRUST, a California corporation\nBy_________________________________ Name: Janice Kroekel Title: Assistant Vice President\nDate: May 1, 1991\nExhibit 11.0 SANTA BARBARA BANCORP AND SUBSIDIARIES\nSANTA BARBARA BANCORP 1995 ANNUAL REPORT\nCore Values\nExceed Customer Expectations\nFoster Employee Commitment\nMaximize Shareholder Return\nSupport Our Communities\nVision To be the financial services provider of choice in the communities and markets we serve through exceptional employees delivering legendary customer service.\nMission To identify our customers' financial needs and exceed their expectations in the delivery of quality products and services in a responsible and ethical manner to assure the maximization of our shareholders' return. To partner with the communities we serve to provide enduring economic value and sustainable quality of life.\nTo Our Shareholders & Friends\nFor the first time in thirty years, your company, Santa Barbara Bancorp, is not reporting a record earnings year. Earnings were impacted by our expansion into Ventura County, third quarter loan loss provisions related to two large problem loans, and a last-minute IRS rule change that resulted in diminished demand for, and loan losses on, Refund Anticipation Loans (RAL's). Earnings for the fourth quarter of 1995, however, were the highest ever recorded, up 5.2% over earnings for the same quarter in 1994. We firmly believe that 1995 was a watershed year in the history of our institution. The initiatives begun last year will lay the foundation for the next thirty years of success.\nOur competitive strategy declares that the Company will be differentiated in the markets we serve as the financial services provider of choice, offering a broad array of financial products and measurably superior service.\nThis focused and aggressive strategy led the Company to pursue a three- pronged approach in 1995 to assure future competitiveness. The first, and most visible, was the geographic expansion of our franchise to the communities of Ventura, Camarillo and Oxnard in Ventura County, which is described in the following section. The second initiative was internally known as the Credit Project, and the third initiative was directed at the enhancement of our sales and marketing function in the Trust & Investment Services Division.\nPhotograph of three individuals with caption: William S. Thomas, Jr., President, Chief Executive Officer, SBB&T; David W. Spainhour, Chairman of the Board, SBB&T; Donald M. Anderson, Chairman of the Board, Bancorp.\nThe first of the three initiatives, geographic expansion, began in earnest with the opening of the Camarillo office in February, 1995. In April, the Ventura and Oxnard offices opened in temporary facilities until September, 1995, when their permanent quarters were completed. The combined deposits of the three offices exceeded $55 million by year-end and achieved profitability in October, 1995. Loan activity was high, and trust and investment management business was excellent.\nThe Credit Project was a major event in 1995. The addition to staff of experienced loan review personnel was accomplished along with the strengthening of the credit administration area. The commercial loan function was reorganized into the Community Banking Group, the Business Banking Group, and the Private Clients Group. This is discussed in the next three sections.\nThe changes in Trust & Investment Services were significant as well. Research indicated that our existing clients were pleased with the level of personal service and attention they receive from our trust administrators and staff. The performance of our portfolio managers for investments and real estate has been outstanding. The identified need in the Trust & Investment Services area was to communicate our expertise to prospective clients, cultivate referrals and generate new customers. The structure and staff to accomplish this sales and marketing effort are now in place.\nWe are confident that 1996 and the years that follow will benefit from this investment. As our Company's success continues to grow, we hope to continue our expansion, offering the values of community banking to local markets throughout the Central Coast.\nWe thank our dedicated employees who each day add new meaning to our commitment to legendary customer service.\nAs always, our success is your success. Thank you for your loyal support of your Company.\nWilliam S. Thomas, Jr., President, Chief Executive Officer, SBB&T\nDavid W. Spainhour, Chairman of the Board, SBB&T\nDonald M. Anderson Chairman of the Board, Bancorp\nCaption to two photographs: (Left) The largest affordable housing project ever developed in Santa Barbara was a partnership between the owners, Bill and Margie Wagner, Sr., the Santa Barbara Redevelopment Agency, and Santa Barbara Bank & Trust. Ugo L. Melchiori, left, was the general contractor. The El Patio Garden development consists of 113 two, three, and four- bedroom apartments, all of which are designated as \"affordable\" units. Both the Wagners and Mr. Melchiori have been Bank customers for over 25 years. The La Cumbre and Main Offices serve their needs.\n(Right) Was it a stop for a cup of coffee that encouraged the multimillion dollar flower industry to grow and flourish in the Carpinteria Valley? Perhaps so. After five generations of growing flowers in Holland, four van Wingerden family brothers came to the United States to grow flowers here. They were told that the north county was the ideal area to locate, however, when they made that coffee stop and saw the lands of Carpinteria, it was all they had hoped for and more. Case Van Wingerden, Jr., of Westland Floral, representing the second U.S. generation, has one million square feet of growing area under glass and with a staff of 50 employees, raises chrysanthemums sold to florists and supermarkets nationwide. The Carpinteria Office accommodates his needs, along with uncles, brothers, and nephews in the floral industry.\nPositioned For Growth In The Retail Market\nIn 1995, we undertook a major expansion into Ventura County, which opened up a highly promising new market for the Bank and positioned us for significant growth in 1996. With First Interstate Bank's acquisition of the Bank of A. Levy, Ventura County's leading independent bank, the need for a strong, service-oriented community bank became clear. SBB&T opened its Camarillo office in February, followed in April by office openings in Oxnard and Ventura. We recognized that central to the success of these efforts was the selection of a core of highly-trained, committed employees, dedicated to their community and conversant with the local market. All of our new employees, most of whom were formerly with the Bank of A. Levy, met these criteria, bringing with them a level of expertise and enthusiasm that greatly expedited the transition phase.\nWithin six months, our first-year goal of $36 million in deposits for all three offices was met and exceeded, with deposits reaching $55 million by the end of 1995. In October, the offices achieved profitability on our initial investment.\nSBB&T's adherence to a policy of commitment to community service provided a strong basis for our success in Ventura County. Bank officers routinely express their interest and involvement in the community through their volunteer activities in the Chamber of Commerce, Rotary, Lions Clubs, YMCA, symphony boards and other service organizations. At the same time, donations to programs benefiting youth and arts programs helped to consolidate our position as a caring, service-oriented bank with strong ties to the local community.\nRapid changes in the financial industry, fueled by mergers and consolidations, continue to create challenging opportunities for SBB&T in the retail banking sector. To address these changes, consumer lending has been restructured, creating additional support for traditional products and adding the capability to make indirect loans. Residential real estate loan origination became a priority business line, with our loan representatives now producing at the level required to maintain our number one position in this market.\nPhotograph of two individuals at a winery. Caption: In 1970, Richard Sanford, wine grower, became a Bank customer and also planted his first vines in the Santa Ynez Valley on what became a 125 acre vineyard and he also became a Bank customer. With an annual production of 40 thousand cases of consistently award winning wines, demand now requires international distribution. A Sanford chardonnay wine is served to first class passengers on British Airways and a variety of wines have been served at several White House occasions. Tom Prendiville, right, is the Bank's Commercial Loan Officer who services the winery financial needs. The company accounts are maintained at the Buellton Office.\nIn both Santa Barbara and Ventura Counties, we are responding to intensified competition in the marketplace through a more aggressive sales and business development stance. In tandem with that, we recognize the need to stay abreast of technological changes in the financial industry, adopting those technologies and products that best meet our customers' needs. Our intention is to maintain our competitive edge in the market area where we already excel, while seeking out and expanding our customer base in other areas. To this end, we undertook a restructuring of our offices in 1995 that resulted in an increased focus on business development and greater operational efficiency without sacrificing our goal of exceeding customer expectations in the delivery of our products and services.\nGroups of offices were reorganized by area, each one overseen by a business development manager whose responsibility is to assist in generating new business in that area. Sales goals set in mid-1995 for both the calling program, which targets potential new customers, and for referrals to other departments within the Bank were well exceeded by the end of the year.\nThese efforts were greatly aided by the installation of a new wide-area computer network which links communications and data processing among all the offices. Employees can access data through more than 350 terminals in our bank-wide system, which also facilitates the opening of new accounts with on-screen visuals, graphs and growth charts. A customer\/prospect database maintains up-to-date information on potential customers and allows us to track and evaluate our calling and sales efforts. Sophisticated market research based on customer-base profitability models supports these sales efforts. Our product managers are constantly researching the technology market for new applications and products to enhance customer service and increase operating efficiency.\nIn-laid text box reads: Reader polls conducted by Santa Barbara County's two leading newspapers have consistently ranked SBB&T as the area's \"Best Bank.\"\nWhile refining our efforts to maintain and improve customer service at the office level, we are responding to customer desires for the convenience of electronic transactions. Last year our ATM network expanded to include new installations at the Camarillo and Solvang factory outlet malls. The implementation of a new debit card program allows customers to access their checking accounts at merchant locations. In 1995, we completed the infrastructure that will support an array of electronic banking functions, and this year we will be exploring those areas further.\nPhotograph of two individuals with unbrellas outside of the Camrosa Water District. Caption reads: Well water from the Camrosa Water District is supplied to 26,000 domestic and agricultural users covering 30 square miles of the greater Camarillo area. Richard Hajas is the District General Manager, and Jan Gibson is the Camarillo Office Manager where the accounts are maintained.\nAt the foundation of these new initiatives is an emphasis on personal customer service. We believe that the basis for our success in the face of unprecedented competition is building and maintaining relationships with our customers. From the first-time borrower to the sophisticated investor, our approach continues to be customer-focused. Our employees are committed to getting to know our customers, discovering their needs and meeting those needs.\nPhotograph of woman and two miniature horses. Caption: Quicksilver Ranch celebrates the arrival of the year's first foal. This day-old miniature horse will soon be joined by many others destined for show rings throughout the Western states or to become a gentle and affectionate pet of new owners. Santa Ynez Valley ranch owners Aleck & Louise Stribling receive financial services from our Solvang Office.\nIn 1995, we achieved the number one position in residential real estate lending, we extended our financial service network into Ventura County, and we consolidated our position as the leading independent bank in Santa Barbara County. The Bank enjoys a clear dominance of the market in this county, with a market share of 27% for retail deposits, twice that of the next leading bank. Our strong capital position, our reputation for exemplary service and the breadth of our product capabilities have firmly positioned the Bank to examine further expansion possibilities. Wells Fargo's acquisition of First Interstate Bank, and the resulting closure of branch offices, may present further opportunities for expansion within Ventura and Santa Barbara Counties. In the months ahead, we will also be looking northward to communities that closely match ours in terms of demographics and a need for banking services that revolve around our core values of commitment to employee, customer, community and shareholder. We expect that expansion will be gradual and undertaken in partnership with other financial institutions that share our institutional culture and values.\nBusiness Banking: Positioned for Market Expansion\nIn market surveys conducted by the Bank last year, 44% of business people named SBB&T as the bank with the best customer service. The same surveys also indicated that there were opportunities to expand our lending relationships to identified market segments in the business community. As a result, our commercial lending group saw a reconfiguration to better accommodate specific categories of customers. A new Business Banking Division was formed to oversee the Bank's commercial lending activities. As a corollary, a Community Banking Division is being established to be of assistance to smaller and start- up businesses.\nAdditions to staff and leadership in the Credit Administration and Lending Divisions have added specific, long-term experience in the business banking field. A Trade Finance Department was added to serve the needs of companies conducting all or part of their business in other countries. In addition to foreign currency exchange and letter of credit facilities required for Trade Finance, other new products and services, such as accounts receivable financing and PC-based cash management, have rounded out our ability to offer exemplary customer service. The result of these initiatives is a highly-refined focus on meeting the needs of the business community.\nIn a move to enhance efficiency and flexibility, our Employee Benefits Trust Group forged an alliance with the PlanMember Services Program. This alliance, which includes a marketing and sales component, will allow us to offer clients a wider choice of investments and services for their IRA's and company retirement plans.\nOur business development efforts are directed toward the retention of existing relationships and the cultivation of new prospects. We are constantly refining the focus of our prosect calling program to pursue those market segments that represent the highest potential opportunities.\nIn-laid text box reads: More businesses use SBB&T for their financial needs than the next four banks combined.\nThe key elements are now in place for improving our penetration in the lending markets we serve in 1996. Our goal is to aggressively seek the opportunity to bid on every transaction. We are proud of our reputation as the bank for business in the communities we serve.\nPhotograph of two individuals outside of the Santa Barbara Mission. Caption reads: On that memorable morning of April 21, 1782, the site of El Real Presidio de Santa Barbara was dedicated marking the founding of the pueblo of Santa Barbara. Yet it was four years later that Presidio workmen were reassigned to begin construction of the mission, one of a chain of 21 missions to be constructed. Its dedication was on December 4, 1786. The Santa Barbara Mission we see today, the fourth to be constructed on the site, is considered to be the \"Queen of the Mission,\" and is the only California Mission operated by the Franciscan Order from its conception to this very day. The Franciscan Friars' account is at the Main Office.\nPositioned For Growth In The Management Of Wealth\nIn 1995, the Trust & Investment Services Division instituted new and streamlined procedures to increase efficiency and provide customers with the broadest possible array of financial services. The division is the largest on the Central Coast and is the only trust & investment division in coastal California to offer full-service capabilities under one roof between Los Angeles and San Francisco.\nA dedicated Trust & Marketing Sales Department was established to actively solicit new business through a variety of efforts, including media campaigns, seminars, public presentations and on-going calling efforts. Media advertising was designed to publicize the superior investment performance and the capacities of our skilled portfolio managers. Our accounts actively participated in the robust markets for both stocks and bonds, and our staff continues to focus on fully understanding the divergent objectives of our clients.\nThe start-up this year of a Retail Investment Services Group, administered through the Trust & Investment Services Division, provides for investment counseling and sales of mutual funds, annuities and asset allocation models through all of the Bank's offices. By December, after less than a year of operation, the new group was running at a break-even pace, with profits expected in 1996.\nPhotograph of outdoor scene. Caption reads: The Ventura County Museum of History and Art featured a two-month photo exhibit called \"Isla de los Vaqueros: the Ranching History of Santa Rosa Island\" which was sponsored by the Bank. The museum account is maintained at the Ventura Office.\nPhotograph of dancer. Caption reads: Santa Barbara, California's Fiesta City, celebrated its first Old Spanish Days Fiesta in 1924. This annual event of pageantry, mercados, street dances, parades, rodeos, and feasting is the state's largest five-day event and beckons visitors worldwide. The organization is a longtime Main Office customer.\nIn 1995, the Trust Real Estate Management Group was awarded the Accredited Management Organization designation by the Institute of Real Estate Management, a distinction currently accorded to only one other bank nationwide. The designation was based on criteria in the areas of experience, integrity and fiscal responsibility. In the same year, the real estate group applied for and received a corporate broker's license, which will allow for greater flexibility in handling properties not held in trust or in the Bank's name. We currently have the only trust division in our market area capable of offering in-house property management services.\nAn integral part of the Trust and Investment Services Division is a trust tax capability. An improved and upgraded computer system facilitates monthly updating of records and has resulted in our continuing to produce the earliest returns of any area trust division. The in-house availability of a trust tax capability, at a time when most major banks are outsourcing this service, assures our clients of the most comprehensive and individualized service possible.\nIn-laid text box reads: Our team of financial advisors is not positioned to offer investment management services equal to or better than any other provider.\nThe Private Clients Division formed last year, and administered under the Trust & Investment Services Division, is staffed by experienced officers who can facilitate multiple bank activities for their clients, such as trust and investment management, as well as depository and lending activities. The Private Clients Division combines those elements that have served our commercial borrowers well for the past thirty years with new iniatives and skills in the areas of investment and wealth management. This division represents a continuation of our tradition of superlative service to some of the Bank's most long-standing and valued customers. Clients within this division receive highly personalized service from our private client personnel, who ensure that SBB&T has the opportunity to fulfill all of their banking needs.\nSBB&T's reputation for stability and our long-term credibility within the community provide the mainstay of our response to increasing competition in the private client field. Our staff of private bankers, with many years of cumulative experience in the Bank, successfully combine business acumen and technology to provide more rapid decision making and greater personalized service than the larger, regional banks.\nWhile we have sought out and embraced new technologies that advance efficiency and customer convenience, we believe that our success lies in our truly legendary customer service delivered by exceptional employees. In a marketplace increasingly dedicated to technology, customers will see a clear differentiation in levels of service offered by the major banks as opposed to independent banks such as SBB&T. Our reputation throughout the state for legendary customer service, combined with our breadth of products, including trust and investment services, real estate and private banking, is a strong factor in our belief that we will continue to grow our franchise.\nPhotograph of three individuals standing in lemon field. Caption reads: (Top) Eighteen million pounds of lemons plus avocados, oranges, grapefruit and kiwis are harvested annually on the Leavens Ranches which total 1,200 acres. Paul and daughter Leslie meet with Vice President Lee Draughton, a responsive Commercial Lending Officer, who is supported by a lending philosophy to serve the agriculture industry. Accounts are located at the Ventura Office.\nPhotograph of fire engine, two youngsters and a fire dog. Caption reads:(Middle) \"Sheriff's Day at the Ranch\" is a fundraising event for the Sheriff and Fire Departments which attract over 5,000 people. The Bank sponsored the Children's Fire Theatre where youngsters learned fire safety in the home and met Sparky the Fire Dog. The La Cumbre Office maintains the account.\nPhotograph of two individuals working with a computer. Caption reads:(Right) The Bank is a founding member of the newly formed Systems & Software Consortium, Inc. which is composed of members from business, academia, and government. Its purpose is to play a helpful supporting role in the growth of a significant high technology industry in Ventura and Santa Barbara Counties. Michael Ditmore, President and CEO (standing) confers with Dr. Mark Schniepp, Director of the University of California Santa Barbara Economic Forecast Project. The account relationship is maintained at the Magnolia Office.\nPhotograph of Jonathan Winters. Caption reads: Jonathan Winters: Actor, author, artist, makes weekly visits to the Montecito Village Office.\nOFFICERS AND DIRECTORS\nBOARD OF DIRECTORS\nDONALD M. ANDERSON Chairman of the Board-Bancorp DAVID W. SPAINHOUR Chairman of the Board - SBB&T WILLIAM S. THOMAS, JR President, Chief Exec. Officer EDWARD E. BIRCH, Ph. D. Exec. Vice President College Advance. Westmont College RICHARD M. DAVIS Retired Div. Mgr., Gen. Tel. ANTHONY GUNTERMANN Certified Public Acct. DALE E. HANST Attorney at Law HARRY B. POWELL Retired Business Exec. FRANK BARRANCO, M.D. Retired DANIEL B. TURNER Director Emeritus\nEXECUTIVE ADMINISTRATION\nDONALD M. ANDERSON Chairman of the Board-Bancorp DAVID W. SPAINHOUR Chairman of the Board - SBB&T WILLIAM S. THOMAS, JR. President, Chief Exec. Officer DAVID A. ABTS Exec. V.Pres., Ret. Bank.\/Support Svs. JOHN J. McGRATH Sr. Vice Pres., Chief Credit Officer JAY D. SMITH Sr. Vice Pres., Gen. Coun. & Corp. Sec. KENT M. VINING Sr. Vice Pres., Strat. Plan. Officer DONALD LAFLER Sr. Vice Pres., Chief Financial Officer CATHERINE STEINKE Sr. Vice Pres., Dir. of Human Res.\nADMINISTRATION\nVICE PRESIDENTS MICHAEL CONLEY SHARON E. GREEN JERRY HELTON EDWIN C. HOLT DEL HOOVER MARK A. HUBERT H. GEORGE KALLUSKY CHRIS LEM HAZEL MARCUS MICHAEL MURPHY CYNTHIA PLAHN SHERRELL REEFER DAVE RISTIG JOYCE SPEZMAN-MARGOLIN KIM TAUFER AL TODD GARY TURNER RICH TURNER\nASST. VICE PRESIDENTS TERRY BALL BRAD BROWN DEBRA CARTER TERRY CAVAZOS NICOLE DINKELACKER RITA DUBOIS KIM EVANS MIKE FITZGIBBON ROGER JANES KERRY KELLEY JANICE NICCUM KROEKEL ROY MARTINEZ SCOTT MATTHEW CLARE MCGIVNEY KEVIN QUIGLEY MARGARET ROGERS BRIAN ROSS TERRY SLATON MARK S. STANLEY RALPH STROHBACH MARY TREBBIN\nOFFICERS SHERRY BAKER PHILIP BERRY PATRICIA BOUCHER DAVID BRIAN DANI CARAM MICHELLE DREXLER-HALL NANCY DUNCAN MARYLOU FAVELA COSMO FEDELE WENDY MIRBOD MARCIA NIESSEN JULIE PUGH BRIAN ROSS SHIRLEY SCALES TERRI SLATON CAROLYN SNYDER JOE STRONKS QUYEN URICK\nCREDIT ADMINISTRATION\nPERRY RITENOUR Sr. Vice Pres., Cred. Admin.\nVICE PRESIDENTS PAUL MISTELE LARRY PAPKIN\nLOAN ADJUSTMENTS\nSUSAN MARSHALL Vice Pres. IRENE TERRY Asst. Vice Pres. JULIA FOX Officer\nLOAN SERVICES\nPAMELA J. GEREMIA Vice Pres., Mgr. ASST. VICE PRESIDENTS BARBARA ALMEIDA ANN M. MARKONIS CHARLENE RAY KAREN CLEMOW\nOLGA MEDINA Officer\nESCROW\nPAMELA MARTIN Asst. Vice Pres., Mgr.\nOFFICERS DIANE NORIAN DIANE PALACIO\nLENDING\nSTEPHEN J. MIHALIC Sr. Vice Pres., Chief Lend. Of.\nCOMMERCIAL LENDING\nVICE PRESIDENTS GERALD O. COWAN Sr. Vice President LINDA CABLE DONALD DUNCAN MICHAEL FLOYD MICHAEL R. KIRKWOOD PHIL MORREALE THOMAS PRENDIVILLE BERNARD M. WITTKINS JOHN H. WURZEL\nCOMMUNITY LENDING\nWILLIAM ENHOLM Vice Pres., Mgr.\nREAL ESTATE INDUSTRIES\nDONALD RAPP Vice President BRUCE I. WENNERSTROM Sr. Vice President\nREAL ESTATE CHARLES BROWNING Vice Pres., Mgr. TERRY SWANN Vice Pres.\nASST. VICE PRESIDENTS JANICE BAXTER CYNTHIA EYANSON TERI GAUTHIER ELIZABETH HEITMANN ALICE MADRID DONALD MCMAHON THOMAS SLATER\nCONSUMER LOANS\nGERALD J. LUKIEWSKI Vice Pres., Mgr. ROBERT CURRY Vice Pres. DON ENDERBY Asst. Vice President DAWN MOORE Officer\nPRIVATE CLIENT GROUP\nJOHN F. MURPHY Sr. Vice President, Mgr. RICHARD B. WELCH Sr. Vice President\nVICE PRESIDENTS ROY GASKIN GARY HARRIS\nTRUST & INVESTMENTS\nDONALD E. BARRY Sr. Vice Pres., Trust & Inv. Mgr. JOHN ZIEGLER Sr. Vice President\nVICE PRESIDENTS JOHN BRINKER JEAN BUBRISKI CHRIS COLBERT ANTHONY FIELDHOUSE WILLIAM HOPKINS BARRY HUNTER JANICE JOHNSON WENDY PENKE PAULETTE POSCH KATHERINE SCHOMER ALICE SYKES FRANK TABAR JIM WILLIAMS\nASST. VICE PRESIDENTS KAREN BAILEY-SHIFFMAN DAVID COVELL NICKIE FURNIER CRANDALL MIKE KELLY JUDITH MILAM MICHAEL MORGAN BARBARA PETRONIS SALLY SYLVIA\nOFFICERS WARREN BITTERS MILTON BURTON TEREASE CANN JEANINE KARCZEWSKI CATHERINE MOAKLEY ROBERT RAMIREZ\nRETAIL BANKING\nALFRED J. ROTELLA Vice Pres., Mgr.\nOUR GANG SERVICES\nPAMELA HOLST Vice Pres., Mgr. FRANCES JIMENEZ Asst. Vice President MARJORIE KOCHER Officer\nSANTA BARBARA AREA\nJOANNE FUNARI Vice President Area Business Dev. Mgr.\nMAIN OFFICE\nLISA DANIEL Vice Pres., Mgr. EMMA TORRES Vice Pres.\nASST. VICE PRESIDENTS SANDRA COCKLIN LORETTA GARDNER\nOFFICERS KELLY SILVA TRACY TALBOT MOONSOOK WATERS\nCOTTAGE OFFICE\nDORIS WENGLER Asst. Vice President, Mgr. MARGIE FAIRGRAY Officer\nMESA OFFICE\nTHOMAS TURNER Asst. Vice President, Mgr.\nOFFICERS VICTORIA WILLIAMS MICHAEL DOMINGUEZ\nSAN ROQUE OFFICE\nMARY YOST Asst. Vice President, Mgr.\nOFFICERS LISA VARGAS JENNIFER WELCH\nGOLETA AREA\nLYNNETTE DAVIS Vice President Area Business Dev. Mgr.\nGOLETA\/FAIRVIEW OFFICE\nLISA HERNANDEZ Vice Pres., Mgr. CAROL THOMAS Vice President MARY LOUISE LISCOMBE Officer\nLA CUMBRE OFFICE\nLISA NEWBERRY Asst. Vice Pres., Mgr.\nOFFICERS DAVID HALL DIANNE NOCKEY\nMAGNOLIA OFFICE\nSCOTT HANSEN Asst. Vice President, Mgr.\nOFFICERS JUSTIN LENGNER MARTHA MERA\nMONTECITO CARPINTERIA AREA\nANGELA KRABLIN Vice President Area Business Dev. Mgr.\nMONTECITO OFFICE\nOFFICERS DEBBIE JIMENEZ JAMES VOPELAK\nCARPINTERIA OFFICE\nCHRISTINE DEVRIES Asst. Vice President, Mgr.\nOFFICERS CHRISTOPHER O'CONNOR THOMAS WHITTAKER\nMONTECITO VILLAGE OFFICE\nLINDA COWAN Vice President, Manager\nOFFICERS ROSEMARY BERTKA DEBORAH WILSON\nSANTA YNEZ AREA\nCHUCK PIRA Vice President Area Business Dev. Mgr.\nSOLVANG OFFICE\nOFFICERS SHIRLEY BROWN CHERYL REYNOLDS PEGGY CHAMBLIN\nBUELLTON OFFICE\nSUSAN JENSEN Officer\nVENTURA AREA\nSUZANNE CHADWICK Vice President Area Business Dev. Mgr.\nVENTURA OFFICE\nELIZABETH SEITZ Asst. Vice President, Mgr. LEE DRAUGHON Vice President, Loan Officer KIM FERTIG Vice President, Loan Officer JUDY FRAZIER Vice Pres., Trust Admin. KENNETH HELMS Asst. Vice President DONNA DE LOS SANTOS Officer\nOXNARD OFFICE\nKIMBERLEY GIBAS Asst. Vice President, Mgr.\nOFFICERS ROSEMARY COLBERN DANIELLE NAVAS\nCAMARILLO OFFICE\nJANICE GIBSON Asst. Vice President, Mgr.\nOFFICERS SHARIE QUARRY AMY WHITNEY\nSanta Barbara Bancorp and Subsidiaries 1995 FINANCIAL STATEMENTS AND INFORMATION\nTable of Contents Page Management's Resposibility for Financial Reporting 12 Management's Discussion and Analysis of Financial Condition and Results of Operations 13 Report of Independent Public Accountants 38 Consolidated Balance Sheets 39 Consolidated Statements of Income 40 Consolidated Statements of Changes in Shareholders' Equity 41 Consolidated Statements of Cash Flows 42 Notes to Consolidated Financial Statements 43 Selected Annual and Quarterly Financial Data 58\nMANAGEMENT'S RESPONSIBILITY FOR FINANCIAL REPORTING\nThe Management of Santa Barbara Bancorp is responsible for the preparation, integrity, and fair presentation of the Company's annual financial statements and related financial data contained in this report. With the exception that some of the information in Management's Discussion and Analysis of Financial Condition and Results of Operations is presented on a tax-equivalent basis to improve comparability, all information has been prepared in accordance with generally accepted accounting principles and, as such, includes certain amounts that are based on Management's best estimates and judgments.\nThe consolidated financial statements presented on pages 38 through 41 have been audited by Arthur Andersen LLP, who have been given unrestricted access to all financial records and related data, including minutes of all meetings of shareholders, the Board of Directors, and committees of the Board. Management believes that all representations made to Arthur Andersen LLP during the audit were valid and appropriate.\nManagement is responsible for establishing and maintaining an internal control structure over financial reporting. Two of the objectives of this internal control structure are to provide reasonable assurance to Management and the Board of Directors that transactions are properly authorized and recorded in our financial records, and that the preparation of the Company's financial statements and other financial reporting is done in accordance with generally accepted accounting principles.\nManagement has made its own assessment of the effectiveness of the Company's internal control structure over financial reporting as of December 31, 1995, in relation to the criteria described in the report, Internal Control--Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission.\nThere are inherent limitations in the effectiveness of any internal control structure, including the possibility of human error and the circumvention or overriding of controls. Accordingly, even an effective internal control structure can provide only reasonable assurance with respect to reliability of financial statements. Furthermore, the effectiveness of any internal control structure can vary with changes in circumstances. Nonetheless, based on its assessment, Management believes that as of December 31, 1995, Santa Barbara Bancorp's internal control structure was effective in achieving the objectives stated above.\nThe Board of Directors is responsible for reviewing and monitoring the policies and practices employed by Management in preparing the Company's financial reporting. This is accomplished through its Audit Committee, which is comprised of directors who are not officers or employees of the Company. The Committee reviews accounting policies, control procedures, internal and independent audit reports, and regulatory examination reports with Management, the Company's internal auditors, and representatives of Arthur Andersen LLP. Both the Company's internal auditors and the representatives of Arthur Andersen LLP have full and free access to the Committee to discuss any issues which arise out of their examinations without Management present.\nsignature David W. Spainhour President and Chief Executive Officer Santa Barbara Bancorp\nsignature William S. Thomas, Jr. President and Chief Executive Officer Santa Barbara Bank & Trust\nsignature Donald Lafler Senior Vice President and Chief Financial Officer Santa Barbara Bancorp and Santa Barbara Bank & Trust\nSanta Barbara Bancorp and Subsidiaries\nManagement's Discussion and Analysis of Financial Condition and Results of Operations.\nOverview of the Earnings, Financial Condition, and Business of the Company\nSummary Results\nTotal assets, loans, deposits and equity of Santa Barbara Bancorp all grew in 1995, both in terms of their average balances for the year and from period end to period end. This growth occurred in part due to the Company's expansion into adjacent Ventura County, where three new branch offices were opened. However, net income decreased compared to the prior year for the first time in 30 years. Among the reasons for the decrease are the additional expenses incurred to open the new offices, a higher than expected level of losses resulting from the tax refund anticipation loan (\"RAL\") program, increased provisioning for potential loan losses on several large credits, and a higher cost of funds. Each of these is explained in more detail below in the relevant section of this discussion.\nAs economic recovery continued to be elusive, the inability of some borrowers to repay loans according to their contractual terms has increased the amount of non-performing assets compared to the amount at the end of 1994. However, they still represented less than eight tenths of one percent of total assets. This is less than the average for peer banks (Note A).\nBusiness of the Company\nSanta Barbara Bancorp (the \"Bancorp\") is a California bank holding company incorporated in 1982 that is headquartered in the city of Santa Barbara. The Bancorp on its own has a few operations, but these are very insignificant in comparison to those of its major subsidiary, Santa Barbara Bank & Trust (the \"Bank\"). Unless otherwise stated, \"Company\" refers to the consolidated entity and to the Bank when the context indicates. \"Bancorp\" refers to the parent company only.\nThe Bank first opened for business in March, 1960, as Santa Barbara National Bank, and became a state-chartered bank in May, 1979, changing its name to Santa Barbara Bank & Trust. The Bank operates ten banking offices along the southern Santa Barbara County coastline, two offices in the county's central Santa Ynez Valley, and three offices in adjacent Ventura County: one in Camarillo, one in Oxnard, and one in the City of Ventura. A full range of banking services are offered to households, professionals, and small to medium size businesses.\nThe Bancorp's other operating subsidiary, SBBT Service Corporation (the \"ServiceCorp\"), provides correspondent bank services, such as check processing to other financial institutions throughout the Central Coast of California.\nThe remainder of this discussion is to assist readers of the accompanying financial statements by providing information on the environment in which the Company operates, the risks for a financial institution in this environment, the strategies adopted by the Company to address these risks, and the results of these strategies. Each of these elements will be addressed as they relate to the major asset and liability components of the Company's balance sheets, and the major income and expense categories of the Company's statements of income and to significant changes therein. Lastly, it is intended to provide insight into Management's assessment of the operating trends over the last several years and its expectations for 1996.\nExternal Factors Impacting the Company\nThe major external factors impacting the Company include economic conditions, regulatory considerations, and trends in the banking and financial services industries.\nEconomic Conditions\nFrom a national perspective, the most significant economic factors impacting the Company in the last three years have been the actions of the Federal Reserve Board (\"the Fed\") to raise or lower short-term interest rates to manage the pace of growth in the economy--raising rates to slow the pace and forestall inflation, lowering rates to spur growth and avoid recession. These changes impact the Company as market rates for loans, investments and deposits respond to the Fed's actions.\nThe local economy appears to be experiencing some recovery. New companies are establishing their headquarters in the area. While heavy rains in early 1995 caused extensive damage in the Company's market area, reservoirs are filled and the severe drought of the last several years is over. This positively impacts tourism which has long been important to the communities in the Company's market area and has brought an end to water hookup moratoria which slowed housing growth. The local governments have generally been perceived to be inclined towards environmentalism and slow-growth. However, at both the state and local levels more attention is now being paid to the need to create a supportive business climate in order to maintain a healthy, sustainable economy.\nRegulatory Considerations\nThe Company is impacted by changes in the regulatory environment. As a state-chartered commercial bank, the Bank is regulated by the California State Department of Banking. The Bancorp, as a bank holding company, the Bank, as a member of the Federal Reserve Bank (the \"FRB\"), and the ServiceCorp, as a non-bank subsidiary of a bank holding company, are all regulated by the FRB. The Bank became a member of the Federal Reserve System in 1995 to simplify regulatory issues. Prior to becoming a member, the Bank's primary Federal regulator was the FDIC.\nChanges in regulation impact the Company in different ways. The FRB requires that the Company maintain cash reserves with it equal to a percentage of the Company's transaction deposits. The FRB may increase or decrease the percentage of deposits that must be held at the FRB to impact the amount of funds available to commercial banks to lend to their customers as a means of stimulating or slowing economic activity.\nThe Company is also impacted by minimum capital requirements. These rules are discussed below in the section entitled \"Capital Adequacy.\"\nA third recent regulatory change impacting the Company is the Federal Deposit Insurance Corporation Improvement Act of 1991 (\"FDICIA\") which became effective in 1992. Among the changes this legislation has brought to the banking industry are new requirements relating to the audit committees of Boards of Directors, to internal controls over financial reporting, and to the measurement and management of interest rate risk. The actions which the various banking agencies can take with respect to financial institutions which fail to maintain adequate capital and comply with other requirements of the act are discussed below in the section titled \"Regulation.\"\nTrends in the Banking and Financial Services Industries\nAmong the major trends within the banking and financial services industry over the last several years has been the continuing consolidation through mergers and seizures. 1995 saw a continuation of this trend as a number of large mergers and takeovers were announced across the country. In the Company's market area, the acquisition of the largest community bank in Ventura County, Bank of A. Levy, was completed by First Interstate Bancorp, which was itself later in the year to become the target of a hostile acquisition by Wells Fargo. This process of consolidation is expected to continue, and Management expects that, as in the past, it will provide the opportunity for the Company to gain both \"in-market\" market share from customers not satisfied with the new institution chosen for them and the opportunity for expansion into new geographic markets.\nBanks once had an almost exclusive franchise for deposit products and provided the majority of business financing. With deregulation in the 1980's, other kinds of financial institutions began to offer competing products. Also, increased competition in consumer financial products has come from companies not typically associated with the banking and financial services industry such as AT&T and General Motors. Community banks, including the Company, are working to offset this trend by developing new products that capitalize on the service quality that a local institution can offer. Among these are new residential loan products and programs for the sale of mutual funds and annuities to retail customers through the Company's Trust & Investment Services Division.\nRisk Management\nThe Company sees the process of addressing the potential impacts of these external factors as part of its management of risk. In addition to common business risks such as disasters, theft, and loss of market share, the Company is subject to special types of risk due to the nature of its business. New and sophisticated financial products are continually appearing with different types of risk which need to be defined. Also, the risks associated with existing products must periodically be reassessed. The Company cannot operate risk-free and make a profit. Instead, the process of risk definition and reassessment allows the Company to select the level of risk and the corresponding level of reward that is appropriate to the current economic conditions.\nThe special risks related to financial products are credit risk, market risk, mismatch risk, and basis risk. Credit risk is discussed in the sections related to loans. The nature of each of the other risks will be explained in the next secion. The effective management of these risks is the backbone of the Company's business strategy.\nNET INTEREST MARGIN AND CHANGES IN THE RELATIVE PROPORTIONS OF ASSETS AND LIABILITIES\nThe Company earns income from two sources. The primary source is through the management of its financial assets and liabilities and the second is by charging fees for services provided. The first involves functioning as a financial intermediary. The Company takes in funds from depositors or other creditors and then either loans the funds to borrowers or invests those funds in securities or other financial instruments. Fee income is discussed in other sections of this analysis.\nNet interest income is the difference between the interest income and fees earned on loans and investments and the interest expense paid on deposits and other liabilities. The amount by which interest income will exceed interest expense depends on two factors: the volume of earning assets compared to the volume of interest bearing deposits and liabilities, and the interest rate earned on those interest earning assets compared with the interest rate paid on those interest bearing deposits and liabilities.\nNet interest margin is net interest income expressed as a percentage of earning assets. To maintain its net interest margin, the Company must manage the relationship between interest earned and paid, and that relationship is subject to the following types of risks that are related to changes in interest rates.\nMarket Risk Relating to Fixed Rate Instruments\nThe market values of assets or liabilities on which the interest rate is fixed will increase or decrease with changes in market interest rates. If the Company invests funds in a fixed-rate long-term security and then interest rates rise, the security is worth less than a comparable security just issued because the older security pays less interest than the newly issued security. If the older security had to be sold, the Company would have to recognize a loss. Correspondingly, if interest rates decline after a fixed rate security is purchased, its value increases. Therefore, while the value changes regardless of which direction interest rates move, the adverse exposure to \"market risk\" is primarily due to rising interest rates. This exposure is lessened by managing the amount of fixed rate assets and by keeping maturities relatively short. However, these steps must be balanced against the need for adequate interest income because variable rate and shorter term fixed rate securities generally earn less interest than longer term fixed rate securities.\nNote 14 to the financial statements discloses the carrying amounts and fair values of the Company's financial assets and liabilities as of the end of 1995 and 1994. Other than a relatively small difference due to credit quality issues pertaining to loans, the difference between the carrying amount and the fair value is a measure of how much more or less valuable the Company's financial instruments are to it than when acquired. The excess of fair values over carrying amounts at the end of 1995 is $20.7 million compared with a deficit of $7.8 million at the end of 1994. Most of this $28.5 million relative appreciation is related to securities as shown in Note 2 to the financial statements. The Company has a large portfolio of municipal securities. These longer term notes had unrealized gains of $15.9 million at the end of 1995, having increased in value with the steady decline in interest rates during the latter half of 1995, compared to unrealized gains of only $8.3 million at December 31, 1994. Also shown in Note 2, the U.S. Treasury and agency securities in the held-to-maturity portfolio had net unrealized gains of $1.6 million at December 31, 1995 as compared to net unrealized losses of $13.1 million at December 31, 1994.\nThere is market risk relating to the Company's fixed-rate or term liabilities as well as its assets. For liabilities, the adverse exposure to market risk is to lower rates because the Company must continue to pay the higher rate until the end of the term of the certificate. However, because the amount of fixed rate liabilities is significantly less than the fixed rate assets, and because the average maturity is substantially less than for the assets, the market risk is not as great. The difference between the carrying amount and the fair value in the table in Note 14 shows the impact of declining rates on the term deposits. They are worth $3.5 million more to customers at December 31, 1995 than they were when issued because they are paying higher than current market rates. However, this is much less than the $20.7 million by which the Company's assets are worth more to it than when acquired because they too are paying higher rates than are currently available for comparable assets.\nMismatch Risk\nThe second interest-related risk arises from the fact that when interest rates change, the changes do not occur equally in the rates of interest earned and paid because of differences in the contractual terms of the assets and liabilities held. The Company has a large portion of its loan portfolio tied to its base lending rate. If the base lending rate is lowered because of general market conditions, e.g., other banks are lowering their lending rates, these loans will be repriced. If the Company were at the same time to have a large proportion of its deposits in long-term fixed rate certificates, net interest income would decrease immediately. Interest earned on loans would decline while interest expense would remain at higher levels for a period of time because of the higher rate still being paid on the deposits.\nA decrease in net interest income could also occur with rising interest rates if the Company had a large portfolio of fixed rate loans and securities funded by deposit accounts on which the rate is steadily rising. This exposure to \"mismatch risk\" is managed by matching the maturities and repricing opportunities of assets and liabilities. This is done by varying the terms and conditions of the products that are offered to depositors and borrowers. For example, if many depositors want longer-term certificates while most borrowers are requesting loans with floating interest rates, the Company will adjust the interest rates on the certificates and loans to try to match up demand. The Company can then partially fill in mismatches by purchasing securities with the appropriate maturity or repricing characteristics.\nOne of the means of monitoring this matching process is by use of a table like Table 1, titled \"Interest Rate Sensitivity.\" The table shows the extent to which the maturities or repricing opportunities of the major categories of assets and liabilities are matched. This table is sometimes called a \"gap\" report, because it shows the gap between assets and liabilities repricing or maturing in each of a number of periods. The gap is stated in both dollars and as a percent of total assets. The Company's target is to have a gap as a percentage of total assets of no more than 10% plus or minus in any of the three periods within one year, with the emphasis on the first two periods.\nThe first measuring period shown in the table covers assets and liabilities that mature or reprice within the three months following December 31, 1995. This is the most critical period because there is little time to correct a mismatch that is having an adverse impact on income. For example, if the Company had a significant positive gap-- assets significantly exceeded liabilities--and interest rates dropped suddenly, the Company would have to wait for more than three months before enough deposits could be repriced to offset the lower earnings on the assets.\nAs of year-end 1995, the Company had a very small positive gap in this first period. Assets exceeded liabilities by 0.60% of total assets, well within the target range of 10%. There is some arbitrariness in the assignment of deposit accounts that reprice at the option of the Company to specific time periods. For the purposes of this table, the Company has made the assumption that some of the money market accounts will reprice within three months, but this will be governed by market conditions rather than contractual terms.\nIn the next period, after three months but within six months, there is also an excess of assets over liabilities, but again the mismatch is within the target range of the Company.\nFor the third period, after six months but within one year, liabilities substantially exceed assets. However, this excess is also due to some assumptions the Company makes with respect to its deposits. NOW accounts, money market accounts, and passbook savings accounts may be repriced at any time, and thus by their contractual terms would ordinarily be placed in the first period--within three months. However, depositors do not expect the rate on these accounts to change with each slight movement of market interest rates, so Management does not normally expect to reprice these accounts more often than every six months to a year. These accounts are therefore placed in the third period--after six months but within one year. In practice, however, if interest rates were to rise or fall precipitously, these accounts would be repriced as often as necessary to protect the net interest margin while remaining competitive in the market place. Management is therefore not taking any specific steps to lessen the gap for this period, other than reviewing the assumptions about repricing frequency on a continuing basis in light of current market conditions.\nIf these accounts were placed in the first period, the gap for this third period would be slightly positive and the gap for the first period would be about negative 19%, outside the target range for the period. This presentation would show the Company benefiting in the short term by falling rates more than is likely to be the case because there are practical limits to how much and how frequently interest rates can be dropped on deposit accounts even if the Company is permitted to do so.\nThe cumulative dollar gap and cumulative gap as a percentage of total assets is also shown in the table. It is important to take note of the cumulative gap amounts if they are additive or magnify the gaps for the individual period. Because cumulative gaps through the third period are offsetting, no additional considerations apply than explained above for the individual periods.\nThe periods of over one year are the least critical because more steps can be taken to mitigate the adverse effects of any interest rate changes. The Company does attempt to loosely match its long-term municipal bond holdings with long-term IRA certificates of deposit. However, much of the rest of the assets in this category are highly liquid U.S. Treasury notes. As part of the Liquidity Portfolio as explained in \"Securities\" below, these would be sold if interest rates rise in order to achieve a repricing.\nBasis Risk\nThe third interest-related risk arises from the fact that interest rates rarely change in a parallel or equal manner. The interest rates associated with the various assets and liabilities differ in how often they change, the extent to which they change, and whether they change sooner or later than other interest rates. For example, while the repricing of a specific asset and a specific liability may fall in the same period of the gap report, the interest rate on the liability may rise one percent in response to rising market rates while the asset increases only one-half percent. While evenly matched in the gap report, the Company would suffer a decrease in net interest income. This exposure to \"basis risk\" is the type of interest risk least able to be managed, but is also the least dramatic. Avoiding concentration in only a few types of assets or liabilities is the best insurance that the average interest received and paid will move in tandem, because the wider diversification means that many different rates, each with their own volatility characteristics, will come into play.\nNet Interest Income and Net Economic Value Simulations\nA gap report can show mismatches in the maturities and repricing opportunities of assets and liabilities, but has limited usefulness in measuring or managing market risk and basis risk. To assess the extent of these risks in both its current position and the potential results of positions it might take in the future, the Company uses a computer model to simulate the impact of different interest rate scenarios on net interest income and on net economic value. Net economic value or the market value of portfolio equity is defined as the difference between the market value of financial assets and liabilities. These hypothetical scenarios include both sudden and gradual interest rate changes, and changes in both directions.\nAsset\/Liability Management\nThe Company monitors asset and deposit levels, developments and trends in interest rates, its liquidity and capital adequacy, and marketplace opportunities. It responds to all of these to protect and enhance net interest income while managing risks within acceptable levels. This process, known as asset\/liability management, is carried out by changing the maturities and relative proportions of the various types of loans, investments, deposits and other borrowings in the ways described above.\nTable 2, \"Distribution of Average Assets, Liabilities and Shareholders' Equity and Related Interest Income, Expense and Rates,\" sets forth the daily average balances for the major asset and liability categories, the related income or expense where applicable, and the resultant yield or cost attributable to the average earning assets and interest-bearing liabilities. Average balances for the year are used in the table rather than the end of the year amounts shown in the balance sheets of the accompanying financial statements. When comparing year to year, the use of average balances more accurately reflects growth patterns since these balances are not significantly impacted by period-end transactions. The amount of interest earned or paid for the year is also directly related to the average balances and not to what the balances happened to be on the last day of the year.\nChanges in the dollar amount of interest earned or paid will vary from one year to the next because of changes in the average balances (\"volume\") of the various earning assets and interest-bearing liability accounts and changes in the interest rates applicable to each category. Table 3, \"Volume and Rate Variance Analysis of Net Interest Income,\" analyzes the difference in interest earned and paid on the major categories of assets and liabilities in terms of the effects of volume and rate changes for the periods indicated.\nEach of the major categories of assets and liabilities will be discussed below, with a description of the reason for significant changes in the balances, how they impacted the net interest income and margin, and how they fit in with the overall asset\/liability strategy for managing risk.\nAs mentioned above, the Company carefully monitors its net interest income and its net interest margin. As might be expected, as the Company has grown and has had more earning assets, net interest income generally has increased. However, whether the net interest margin increases or decreases depends on how well the Company has managed interest rate risks, product pricing policy, product mix, and also on external trends and developments.\nAs shown in Table 2, the net interest margin increased from 5.59% in 1993 to 5.64% in 1994, as the average rate earned on assets increased 16 basis points while the average rate paid for liabilities increased by only 11 basis points. In 1995, the average rate earned increased by only 20 basis points while the average rate paid for liabilities increased by 69 basis points, resulting in a decline in the net interest margin to 5.15%. Table 3 shows the volume and rate variance analysis of net interest income for 1995 compared to 1994, and 1994 compared to 1993. This analysis computes the proportion of the change in net interest income due to changes in the balances from one year to another and the proportion due to changes in rates between the two years.\nThere are always steps that the Company can take to increase its net interest margin. Among these steps would be to increase the average maturity of its securities portfolios because longer term instruments normally earn a higher rate; to emphasize fixed rate loans because they earn more than variable rate loans; to purchase lower rated securities; and to lend to less creditworthy borrowers. However, as noted above, banking is a process of balancing risks, and each of these alternative tactics involve more risk. The first two involve more market risk, the second two more credit risk. Management intends to continue to use a balanced approach.\nNon-earning Assets\nFor a bank, non-earning assets are those assets like cash reserves, equipment, and premises which do not earn interest. This ratio is watched carefully by Management because it represents the efficiency with which funds are used. Tying up funds in non-earning assets lessens the amount of interest that may be earned. Non-earning assets averaged 6.66% of total average assets in 1993. This was higher than usual for the Company. The major reason for this increase was Other Real Estate Owned (\"OREO\"). During 1993, foreclosure action was taken on one large loan resulting in the addition of over $9 million in OREO. Though only $2.0 million of the properties obtained in this foreclosure remained unsold at December 31, 1993, carrying it as OREO during most of the year significantly impacted the average balance of non-earning assets. Similarly, the expected foreclosure on another loan resulted in $5 million being carried as OREO for a portion of 1993, before the loan was eventually paid.\nWith most of these properties disposed of in 1993, the average balance of OREO was only $1.9 million in 1994 compared with $11.0 million in 1993. This aggressive approach to disposing of foreclosed property allowed average non-earning assets to drop to 5.72% of assets in 1994. In 1995, average non-earning assets dropped to 5.55%. The Company's ratio compares very favorably to its peers. As of September 30, 1995, the average ratio of non-earning assets to total assets for all FDIC banks, regardless of size, was 15.72%. Using the Company's average asset size and average rate of 5.95% earned in 1995 on money market investments, having an extra 10.17% of assets earning interest meant the Company had $109.8 million more in earning assets compared with its peers and earned $6.5 million in pre-tax income on those assets. These additional earnings are somewhat offset by higher lease expense, additional equipment cost, and occasional losses taken on quick sales of foreclosed property. Overall, however, Management believes that these steps give the Company an earnings advantage. This efficient use of assets also allows the Company to produce a given amount of revenue at substantially less risk than its competition. There is less risk because additional deposits or borrowings do not have to be obtained to fund the assets generating the revenue.\nSECURITIES\nThe major components of the earning asset base for 1995 were the securities portfolios, the loan portfolio and the Company's holdings of money market instruments. The structure and detail within these portfolios are very significant to an analysis of the financial condition of the Company. The loan and money market instrument portfolios will be covered in later sections of this discussion.\nSFAS 115 and the Establishment of Two Portfolios\nUpon implementation of SFAS 115 on December 31, 1993, the Company classified its securities into two portfolios, the \"Earnings\" or held- to-maturity portfolio, and the \"Liquidity\" or available-for-sale portfolio.\nThe Earnings Portfolio consists only of securities purchased with the intention and ability to hold to maturity, to be sold only in event of concerns with the issuer's creditworthiness, a change in tax law that eliminates their tax-exempt status, or other infrequent situations as permitted by SFAS 115. Securities in the Earnings Portfolio would not be sold because of changes in market rates, liquidity needs, or asset\/liability management concerns. The Earnings Portfolio consists of long-term tax-exempt obligations, and U.S. Treasury and agency securities with maturities normally up to five years from date of purchase.\nThe Liquidity Portfolio consists of securities which might be sold for liquidity needs and asset\/liability concerns, and will be sold if their market value deteriorates to a predetermined point because of higher interest rates. The Liquidity Portfolio consists of U.S. Treasury and agency securities with original maturities normally up to two years from date of purchase.\nPrior to adoption of SFAS 115, the Company followed a policy of selling securities which had declined in value due to increases in market interest rates. While this resulted in immediate losses, it permitted the reinvestment of the proceeds in higher yielding securities. The Company was able to take a tax deduction for the loss in the year of the sale, but the taxes on the increased income were spread out over the life of the new security, for a net economic benefit to earnings. After adoption of SFAS 115, the Company continued to follow this policy for the Liquidity Portfolio, but could not sell securities from the Earnings Portfolio because of their held-to-maturity classification.\n\"Window of Opportunity\" Period to Reassess and Reclassify\nAs discussed in Note 2 to the financial statements, in November 1995, the FASB permitted a one time, \"window of opportunity\" period lasting until December 31, 1995 to reassess the classification of securities and reclassify them from held-to-maturity to available-for-sale without calling into question the ability or intent to hold to maturity the securities remaining in the held-to-maturity classification.\nAs was the case with other financial institutions, the Company had discovered after the implementation of SFAS 115 that it had significantly less flexibility to use its securities for asset\/liability management purposes when they were classified as held-to-maturity. The Company could not sell securities that had declined in value because of increases in interest rate in order to reinvest the proceeds at higher rates. Similarly, if the Company desired to change the average maturity of securities to create more complementary matching characteristics with other assets and liabilities by selling some securities and repurchasing others in new maturity ranges, it was unable to sell the ones which were causing the mismatch because they had been classified as held-to- maturity.\nTherefore, in this \"window of opportunity\" period, the Company reviewed its securities and concluded that there were opportunities to achieve more flexibility and better maturity balance by reclassifying certain securities with maturities in crowded maturity zones from its Earnings Portfolio (held-to-maturity) to its Liquidity Portfolio (available-for- sale), then selling those securities and purchasing other securities with different maturities. On November 29, 1995, the Company transferred $144 million of U.S. Treasuries from its Earnings Portfolio to its Liquidity Portfolio. The Company then sold $94 million of those securities at an aggregate net loss of $77,000 and started purchasing other securities into targeted, less crowded maturity zones. The objective is to achieve, over time, a better maturity balance in both the Liquidity and Earnings Portfolios, establishing relatively level amounts in each maturity range.\nIn addition to achieving more flexibility, the Company also established a $50 million Discretionary Portfolio of securities which while classified as available-for-sale were not currently needed for liquidity or asset\/liability management. However, because of their classification, should liquidity or asset\/liability management considerations make their sale advisable, such sales are permitted. The portfolio will be accounted for like the Liquidity Portfolio because the securities will be classified as \"available-for-sale\" but they will be managed more like securities in the Earnings Portfolio and will not be automatically sold if their market values deteriorate to a predetermined point because of higher interest rates. This will result in some additional capital volatility as unrealized gains and losses for these securities are recognized in the separate component of capital. Securities in the Discretionary Portfolio will normally have maturities up to three years from date of purchase. In Note 2 to the financial statements, they are all included in the amounts shown for available-for-sale securities.\nPlanned Amortization Class (\"PAC's\") Securities\nIn December 1995, the Company began to investigate the advisability of purchasing short-term, high-quality, planned amortization class securities. These securities are specialized portions of larger collateralized mortgage obligation pools. The objective is to achieve increased yields with high-quality, short-term securities other than just U.S. Treasuries and agencies. These PAC securities with the underlying mortgages guaranteed by U.S. agencies currently yield 40 to 50 basis points more than U.S. Treasuries of the same maturity range. When acquired, they will be classified as available-for-sale and placed in either the Discretionary or Liquidity Portfolio. As of December 31, 1995, no PAC's had been acquired; subsequently, the Company has acquired some PAC bonds, all of which have been classified into the Discretionary Portfolio. Management intends to purchase approximately $30 million of these securities.\nPurposes Served by the Securities Portfolios\nThe securities portfolios of the Company serve several purposes: 1) they (primarily the Liquidity Portfolio) provide liquidity to even out cash flows from the loan and deposit activities of customers; 2) the deposits of public agencies and trust customers must be secured by certain assets of the Company as required by law, and portions of any of the securities portfolios may be used for this function; 3) they are a large base of assets, the maturity and interest rate characteristics of which can be changed more readily than the loan portfolio to better match changes in the deposit base and other funding sources of the Company; 4) they (primarily the Earnings Portfolio) are an alternative interest-earning use of funds when loan demand is light; and, 5) they may provide partially tax -exempt income.\nLiquidity and Portfolio Distribution: The first purpose listed above, liquidity, is provided through proceeds arising from the outright sale of securities, the maturity of securities, and repurchase agreements involving securities. Although securities in the Earnings Portfolio (held-to-maturity) may not be sold without calling into question the Company's intent to hold the remaining securities in the Earnings Portfolio to maturity, securities in the Liquidity and Discretionary Portfolios (both available-for-sale) can be sold to provide liquidity when needed. Maturing securities also provide liquidity irrespective of the portfolio in which held; to best achieve this, the combined portfolios should be of an adequate size and have staggered maturities. In assessing the adequacy of the size of the portfolios and managing the maturity schedule, the Company also looks at the combination of bankers acceptances and Federal funds sold. Liquidity can also be achieved by repurchase agreements. Under these arrangements, certain types of securities can be sold under agreements to repurchase in order to obtain short-term, temporary liquidity.\nIt is expected that the Earnings Portfolio will stay relatively stable as a percentage of assets through the reinvestment of maturing securities. The relative amounts of securities maintained in the Discretionary and the Liquidity Portfolios should change based on expected liquidity needs. The Company's investment and liquidity policies direct that if the ratio of loans to assets increases, then most new purchases will have relatively short maturities and would be made for the Liquidity Portfolio so that funds will be available as needed. When loans are decreasing as a percentage of total assets, most new purchases would be made for the Discretionary Portfolio to obtain higher yields.\nPledging: The legal requirements for securing specific deposits by pledging certain of the Company's securities, the second purpose of the portfolio, may only be satisfied by certain types of securities. A large proportion of the deposits may be secured by state and municipal securities, but some can only be secured by U.S. Treasury securities, so holding a minimum amount of these securities will always be necessary.\nMatching: As discussed above, a major concern in managing interest rate risk is matching the maturities and\/or repricing characteristics of assets and liabilities so that changes in interest rates will affect both sides of the balance sheet equally. The Company tries to better meet the needs of loan customers by being flexible in offering a variety of maturity and repricing terms for the funds they borrow from the Company. Their decisions, however, will not always match the maturity and repricing decisions made by the deposit customers. Because the Company can select from a wide variety of securities which have different maturities and repricing terms, the securities portfolios may be used to obtain the desired overall matching.\nThis use of the portfolios for matching is also available only if there are frequent maturities that provide cash to reinvest. With a little over 23% of the combined portfolios made up of long-term tax-exempt securities, it is necessary for most of the remaining portion of the portfolio to be invested in securities with shorter maturities; the maturity of most purchases in the last two years has been in the 1 to 3 year range.\nAlternative to Loans: When loan demand is not sufficient to keep up with the inflow of funds from depositors, the funds may be invested in securities. There is generally less credit risk with securities than with loans, but the yields are also lower. The securities purchased for this purpose are placed in the Earnings or Discretionary Portfolios.\nTable 4 sets forth the amounts and maturity ranges of the securities at December 31, 1995. The weighted average yields (using taxable equivalent adjustments in calculating the yields of state and municipal securities- - -Note B) of the securities are also shown. The average yields on the taxable securities (U.S. Treasury and agency securities) are significantly lower than the average rates earned from loans as shown in Table 2. Because of this, securities are purchased for earnings only when loan demand is weak.\nTax-Exempt Securities: Prior to 1986, much of the income from the securities now included in the Earnings Portfolio had the additional advantage of being tax-exempt through investment in state and municipal bonds.\nThe average yields for tax-exempt securities reported in Table 4 are significantly higher than for taxable securities, but this advantage is not readily available since the passage of the Tax Reform Act of 1986 (\"TRA\"). Certain provisions of this act disallow a deduction for income tax purposes for the portion of the interest expense paid on deposits and other liabilities that fund most tax-exempt securities now purchased.\nHowever, certain issues of municipal securities may still be purchased with the tax advantages available before TRA. Such securities, because they can only be issued in very limited amounts, are generally issued only by small municipalities, and the Company must do a careful credit evaluation to ascertain that the municipality has a diverse and healthy tax base from which to repay the debt. In reviewing securities for possible purchase, management must also ascertain that they have desirable maturity characteristics, and that the amount of tax-exempt income they generate will not be enough to trigger the Alternative Minimum Tax or the tax advantage could be lost. In the last several years the Company has been able to identify some securities that met all of these criteria and purchased $3.7 million in 1995, $9.7 million in 1994, and $2.6 million in 1993. The Company expects any purchases in coming years to be of about the same magnitude, and expects to be able to continue to earn approximately $7 million per year in tax-exempt income.\nPortfolio Turnover, Unrealized Gains and Losses, and Securities Losses\nAs shown in the accompanying consolidated statements of cash flows there is a relatively large turnover in the securities portfolios. The purchase of relatively short-term securities both to provide liquidity and to minimize market risk, as explained above, is part of the reason for the high turnover in the Company's securities portfolios. The reclassification and sale of $94 million of U.S. Treasuries for maturity restructuring during the FASB 115 \"window of opportunity\" period in November 1995, also as explained above, is another part of the reason.\nTurnover from sales will also result from the Company following its \"stop loss\" policy of liquidating taxable fixed rate securities with a remaining maturity of over one year if they have declined in fair value by a specified amount, while holding securities that have appreciated in fair value because of declining rates. With the adoption of SFAS 115, only the securities in the Liquidity Portfolio are subject to sale for this reason.\nIn 1994, as short-term interest rates increased substantially, many of the available-for-sale securities were sold because their established stop-loss points were reached. In fact, a number of the securities purchased during 1994 with the proceeds of maturing or sold securities were themselves sold as their stop-loss points were in turn passed. These sales caused $1.19 million in realized pre-tax losses.This loss offsets some of the Company's taxable income thereby providing an immediate tax benefit and the proceeds permitted the Company to increase its average earning rate by purchasing new securities at the higher rates.\nThere are a few exceptions to this stop-loss policy. The tax advantage of holding gains and selling losses is minimal on securities with a remaining maturity of less than one year, so these securities and securities expected to be called within a year are not sold even if they are below their stop-loss point. Secondly, securities purchased with a maturity selected to match a specific liquidity need may be exempted because they are going to be held to maturity to meet that need.\nOther Effects of Interest Rate Changes on the Securities Portfolios\nThe Company does not have a trading portfolio. That is, it does not purchase securities on the expectation that interest rates will decrease and thereby allow subsequent sale at a gain. Instead, if the purposes mentioned above are to be met, purchases must be made throughout interest rate cycles. Rather than anticipate the direction of changes in interest rates, the Company's investment policy directs that securities' maturities (other than for municipal securities) be approximately equally spaced into quarterly maturity zones within the respective portfolios (Earnings, Discretionary and Liquidity).\nHedges, Derivatives, and Other Disclosures\nThe Company has not made use of interest rate swaps or other forms of off-balance sheet hedging, but expects to establish policies and procedures in 1996 to permit limited types and amounts of off-balance sheet hedges to help manage interest rate risk.\nThe Company did not purchase any derivative securities in 1995, but as noted above has started in early 1996 to acquire up to $30 million of high-quality, short-term planned amortization class securities. The Company has purchased several structured notes issued by U.S. agencies, but, as described in Note 2 of the accompanying financial statements, they are step-up bonds that pay an increased interest rate if not called. They are not indexed nor have contingent terms other than whether the issuer will decide to call them.\nThe Company has not purchased any securities arising out of a highly leveraged transaction, and its investment policy prohibits the purchase of any securities of less than investment grade or so-called \"junk bonds.\"\nMoney Market Instruments--Federal Funds Sold and Bankers' Acceptances\nCash in excess of amounts immediately needed for operations is generally lent to other financial institutions as Federal funds sold. Excess cash expected to be available for longer periods is generally used to purchase short-term U.S. Treasury securities or bankers' acceptances. Average Federal funds sold and bankers' acceptances as a percentage of average earning assets tends to vary based on changes and differences in short-term market rates. While the acceptances of only highly rated financial institutions are utilized, acceptances have some amount of risk above that of U.S. Treasury securities, and the Company therefore requires that there be a reasonable spread in the yields between the bankers' acceptances and U.S. Treasury securities to justify the assumption of that additional risk.\nThe average balance of bankers' acceptances held during 1995 was $54.4 million and the amount at year-end was $139 million. These figures are higher than the comparable balances for 1993 or 1994, primarily because a large proportion of the proceeds from the sale of the securities as a result of the SFAS window of opportunity were invested in bankers' acceptances. One purpose of the sale and reinvestment as explained above was to better balance the maturities in the securities portfolios. The Company could not immediately purchase securities in the right maturity ranges and so temporarily invested the funds in bankers' acceptances until suitable Treasury and agency securities were available.\nLOAN PORTFOLIO\nTable 5 sets forth the distribution of the Company's loans at the end of each of the last five years.\nThe amounts shown in the table for each category are net of the deferred or unamortized loan origination, extension, and commitment fees and origination costs for loans in that category. The total amounts for these net fees are shown at the bottom of the table. These deferred amounts are amortized over the lives of the loans to which they relate.\nThe year-end balance for all loans had increased about $35 million from the end of 1993 to the end of 1994 and about $59 million from the end of 1994 to the end of 1995. Economic recovery, the expansion into the Ventura County market, and new calling programs centered on potential commercial customers, were all reasons for the growth.\nResidential mortgages showed the largest growth in 1995. More variety in the kinds and terms of loans offered to customers and more aggressive pricing resulted in an expanded share of the residential real estate mortgage market. Most of these loans are 1-4 family adjustable rate mortgage loans, which generally have low initial \"teaser\" rates. While these loans have interest rate \"caps,\" nearly all can be repriced to a market rate of interest within a reasonable time. A few loans have payment caps which would result in negative amortization if interest rates rise appreciably.\nDuring 1995, the Company entered into indirect financing agreements with a number of local automobile dealers whereby the Company purchases loans dealers have made to customers. While automobile dealers frequently provide financing to customers through manufacturers' finance subsidiaries, some customers prefer loan terms that are not included in the standard packages. Other customers are purchasing used cars not covered by the manufacturers' programs. Based on parameters agreed to by the Company, the dealer makes the loan to the customer and then sells the loan to the Company. This program is neither a factoring or flooring arrangement. The individual customers are the borrowers and thus there is no large concentration of credit risk. There were approximately $1.7 million of such loans included in the consumer loan total as of December 31, 1995. The Company expects to reach a balance of $12 million of these loans by the end of 1996.\nThe same interest rate and liquidity risks that apply to securities are also incurred in lending activity. Long-term fixed rate loans are subject to market risk. The table in Note 14 to the financial statements shows only a very slight difference between the carrying amount of loans and their market value. This occurs because the majority of the loans made by the Company either amortize monthly or have relatively short maturities and, except for the consumer loans and the municipal obligations, most have floating rates of interest. The floating rates are generally tied to the Company's base lending rate or to another market rate indicator, which serve to lessen the risk to the Company from increases in interest rates. The Company sells any of the fixed rate real estate loans that are salable in the secondary market as a means of limiting market risk.\nTable 6 shows the maturity of selected loan types outstanding as of December 31, 1995, and shows the proportion of fixed and floating rate loans for each type. Net deferred loan origination, extension, and commitment fees are not shown in the table. There is no maturity or interest sensitivity associated with the fees because they have been collected in advance.\nThe amortization and short maturities also help to maintain the liquidity of the portfolio and reduce credit risk, but they result in lower interest income if rates are falling. At present, Management prefers to incur market risk from longer maturities in the securities portfolios, and avoid such risk in the loan portfolio.\nTax Refund Anticipation Loans (\"RAL's\") and Refund Transfers\nThe Company has been providing RAL's for the last four tax years. The taxpayer requests a loan through a tax preparer, with the expected refund as the source of repayment. The Company does not earn interest based on the amount of the loan or the length of time it is outstanding. Instead, the Company collects a fee for each loan. After withholding the loan fee due to the Company (the withheld fee is recognized as income only after the loan is collected), the Company advances to the taxpayer the amount of the refund due on the taxpayer's return up to specified amounts based on certain criteria. Each taxpayer signs an agreement permitting the Internal Revenue Service (the \"IRS\") to pay their refund to the Company to pay off the loan. Any amount due the taxpayer above the amount of the RAL is sent by the Company to the taxpayer when received from the IRS.\nFor the 1993 tax season, almost $45 million was lent to over 42,000 taxpayers. The collected fees amounted to just over $1 million. The pre- tax earnings after losses from these loans was about $412,000, and the average loan was outstanding for 20 days.\nThe program was expanded in 1994. About 150,000 loans were made, totaling $230 million. The fees earned were $4.8 million and net charge- offs were $2.4 million (1.03% of total loans), resulting in net fee income after losses of $2.4 million.\nAs is more fully discussed below, approximately $75.5 million was lent to about 75,600 taxpayers in 1995. Fees earned on the loans totaled $3.2 million with net loan charge-offs through year-end totaling $4.0 million.\nLosses are higher for RAL's than for most other loan types, but were substantially greater in 1995 than in previous years. The tax preparers participating in the program are located across the country and few of the taxpayers have any customer relationships with the Company other than these RAL's. Many taxpayers make use of the service because they do not have a permanent mailing address at which to receive their refund. Therefore, if there is a problem with the return such that the IRS rejects, partially disallows, or disregards the request of the taxpayer to remit the refund to the Company, collection efforts may be less effective than with local customers.\nThe Company has taken several steps to minimize losses from these loans. Preparers are screened before they are allowed to submit their electronic filings, procedures have been defined for the preparers to follow to ensure that the agreement signed by the taxpayer is a valid loan, and the preparers' IRS reject rates are monitored very carefully. If rejects are above normal, they are dropped from the program. If rejects are below expectations, they are paid an incentive fee.\nThrough the 1994 filing season, the Company only extended the loans to the taxpayer after receiving an acknowledgement from the IRS that it has run several preliminary computer checks on the taxpayer for such items as a valid Social Security number and that there are no outstanding liens from the IRS against the taxpayer. However, for the 1995 filing season, the IRS eliminated that acknowledgement. To reduce the additional credit risk, the Company ran credit checks on all taxpayers who were new to the program in the 1995 filing year. While helpful, this step was not sufficient to mitigate a change made in IRS procedures during the tax filing season after the Company had made a large amount of loans. The IRS placed a moratorium on electronic payment of refunds which had a significant portion related to the Earned Income Tax Credit (\"EIC\"). Without confirmation, and with significant uncertainty regarding whether the IRS would reimburse the Company for loans related to EIC, the Company began to restrict loans only to those taxpayers who met certain credit standards, and excluded the EIC related portion of any refund from the amount which it would lend. However, losses resulted from the loans the Company had already made.\nThe Company had raised fees for the season to cover the additional expenses associated with credit checks. Also, fewer taxpayers qualified for loans with the restrictions implemented after the IRS change. These factors reduced the number of loans and the associated fees.\nThe Company instituted substantial collection efforts as soon as the problems were recognized and approximately 1,900 customers representing $900,000 in loans are making payments. In addition, the Company has entered into cooperative agreements with the other banks making RAL's in 1996. Under these agreements, if a taxpayer owing money to one bank from a prior year applies for a loan from another bank, that second bank will repay the delinquent amount to the first bank before remitting the refund to the taxpayer. From the beginning of 1996 to the date of the preparation of this discussion, just over $1 million has been recovered in delinquent loans from prior years. Additional amounts are expected to be recovered.\nMany taxpayers not qualifying for loans in 1995 still had their returns filed electronically and received their refunds more quickly by having the refund sent electronically by the IRS to the Company. The Company then prepared a check or authorized the tax preparer to issue a check to the taxpayer. The Company earned approximately $1.6 million in fees for this refund transfer service, which helped to offset the losses and the cost of collection efforts. The net result for the program in 1995 was a pre-tax loss of about $683,000. This figure includes only the recoveries received during 1995, with the large amount of recoveries on 1995 loans (about $921,000) received in 1996 to be reported with 1996 operating results.\nThe balances outstanding during each tax filing season are included in the average balance for consumer loans shown in Table 2, but there are no such loans included in the balance sheets as of December 31, 1995 or 1994 because all loans not collected from the IRS are charged-off before year-end. The fees earned on the loans are included in the accompanying income statements for 1995, 1994, and 1993 within interest and fees on loans. The fees earned on the refund transfers are included in other service charges, commissions, and fees.\nALLOWANCE FOR LOAN LOSSES\nCredit risk is inherent in the business of extending loans to individuals, partnerships, and corporations. The Company sets aside an allowance or reserve for loan losses through charges to earnings. The charges are shown in the income statements as provision for loan losses. All specifically identifiable and quantifiable losses are immediately charged off against the allowance.\nDetermination of Adequacy and the Allocation Process The Company formally assesses the adequacy of the allowance on a quarterly basis. An important step in this assessment and in managing credit risk is to periodically grade all of the larger loans, all of the delinquent loans, and other loans for which there is a question of repayment. A significant portion of all other loans are also graded. A portion of the allowance is then allocated to the delinquent or otherwise questionable loans in an amount sufficient to cover Management's estimate of the loss that might exist in them. A portion of the allowance is also allocated to the remainder of the loans based on the latest grading of their quality. Relatively more is allocated to those loans which, while currently performing according to their terms, are in categories that have characteristics which lead Management to conclude that there is inherently more risk of problems in the future.\nThe implementation by the Company of Statements of Financial Accounting Standards No. 114, Accounting by Creditors for Impairment of a Loan (\"SFAS 114\") and No. 118, Accounting by Creditors for Impairment of a Loan--Income Recognition and Disclosures (\"SFAS 118\") on January 1, 1995 is discussed in Note 1 to the financial statements. The statements specify how lenders must determine the amount of the allowance that must be recorded for certain types of loans that are impaired. Valuation allowances established in accordance with the provisions of these statements are included in the allocation process outlined above.\nThere are limitations to any grading process. The first is that it is impracticable to grade every loan every quarter. Therefore, it is possible that some of the smaller currently performing loans not recently graded will not be as strong as their last grading and an insufficient portion of the allowance will have been allocated to them. The second limitation is that grading must be done without knowing whether all relevant facts are at hand. Delinquent borrowers may deliberately or inadvertently omit important information from reports or conversations with lenders regarding their financial condition and the strength of repayment sources. The third limitation is that even for experienced reviewers, grading loans and estimating possible losses involve judgments about the present situation and the impact of potential future events. Eventual losses therefore may differ from the most recent estimate. Because of these limitations, the Company assumes that there are losses inherent in the current portfolio which will be sustained, but which have not been identified to date. It therefore maintains the allowance at an amount larger than the total that is allocated as described above.\nTo the extent that the allowance is insufficient to cover the amounts allocated and its estimate of unidentified losses, Management records additional provision for loan loss. If the allowance is greater than appears to be required, less provision expense will be recorded.\nThe allowance allocation shown in Table 8, \"Allocation of the Allowance for Loan Losses,\" should not be interpreted as an indication of the specific amounts or specific loan categories in which charge-offs did or may ultimately occur. There is no allocation of allowance to RAL's because all loans unpaid were charged-off prior to year-end, yet there inevitably will be losses in 1996 for these loans. At the bottom of the table is the ratio of the allowance for loan losses to total loans for each year.\nLoan Losses\nTable 7, \"Summary of Loan Loss Experience,\" shows the additions to, charge-offs against, and recoveries for the Company's allowance for loan losses. Also shown is the ratio of charge-offs to average loans for each of the last five years. This ratio has been adversely impacted in the last several years by problems with two large relationships and with the higher charge-offs in the RAL program.\nThe larger ratio for the Company in 1993 was due to $3.3 million in charge-offs associated with one large loan in order to recognize the decline in the value of the real estate that secured it. The Company subsequently had to foreclose on the property, adding OREO of about $9 million. During 1993, the Company was able to sell most of the property it had taken in foreclosure with no further net loss, and recognized a gain when the remaining property was sold in 1994.\nIn 1995, the Company charged-off $4.5 million from various loans made to one borrower. Although the loan is secured by collateral from which some recovery is expected, the uncertainty regarding the amount and timing of recovery led Management to charge-off all of one $4.2 million loan and portions of a series of smaller loans. Foreclosure proceedings were delayed by bankruptcy and the actions of other creditors, but have been initiated whenever possible.\nApproximately $4.0 million, $2.4 million, and $588,000 of the net charge-offs (charge-offs less recoveries) for 1995, 1994, and 1993, respectively, are related to the RAL's. The reasons for these charge- offs are explained earlier in this discussion on page 25.\nThere are very few banks in the country that have RAL programs, so comparability with the net charge-off ratio of other institutions is lost unless the RAL net charge-offs are eliminated. If the Company had not had the RAL program, the ratio of net charge-offs to average loans would have been 1.21% in 1995, 0.22% in 1994, and 1.03% in 1993. These ratios compare with the net charge-off ratios for the Company's FDIC peers of 0.60% for the first nine months of 1995, 0.54% for 1994, and 0.92% for 1993. The portion of the Company's 1995 and 1993 ratios related to the two large charge-offs were 0.84% and 0.70%, respectively.\nNONACCRUAL, PAST DUE, AND RESTRUCTURED LOANS\nTable 9 summarizes the Company's nonaccrual and past due loans for the last five years.\nPast Due Loans: Included in the amounts listed above as 90 days or more past due are commercial and industrial, real estate, and all types of consumer loans. These loans are well secured and in the process of collection. These figures do not include loans in nonaccrual status.\nNonaccrual Loans: If there is reasonable doubt as to the collectibility of principal or interest on a loan, the loan is placed in nonaccrual status, i.e., the Company stops recognizing income from the interest on the loan and reverses any uncollected interest that had been accrued but not received. These loans may or may not be collateralized, but collection efforts are being pursued.\nNoncurrent loans increased during 1995 to a high of $15.4 million at the end of the second quarter. Charge-offs and repayments by the borrowers account for the decrease to $9.4 million at year-end. The ratio of noncurrent loans to total loans of 1.68% is higher than its FDIC peers' ratio of 1.15%.\nManagement strengthened the credit adminsitration, review, and analysis functions by hiring additional staff in 1994 and 1995. Secondly, Management established a Special Assets Committee which has given increased attention to the larger problem loans. All delinquent loans are reviewed by the Committee and action plans formulated for collection or charge-off.\nBased on current information available from the loan grading process and because the change in emphasis from RAL's to refund transfers means less credit risk, Management expects that charge-offs will be lower during 1996 than in 1995. However, undoubtedly some portion of the balance of nonaccrual loans will have to be charged off, and some borrowers now current in their payments will become delinquent.\nInterest income from nonaccrual loans in the portfolio at year-end that was not recognized is shown below:\nRestructured Loans: The Company did not have any restructured loans at the end of 1991 or 1992. The only restructured loans at the end of 1993, 1994, and 1995 are reported above in the total of nonaccrual loans.\nPotential Problem Loans: From time to time, Management has reason to believe that certain borrowers may not be able to repay their loans within the parameters of the present repayment terms, even though, in some cases, the loans are current at the time. These loans are regarded as potential problem loans, and a portion of the allowance is allocated as discussed above to cover the Company's exposure to loss should the borrowers indeed fail to perform according to the terms of the notes. This class of loans does not include loans in a nonaccrual status or 90 days or more delinquent but still accruing, which are shown in Table 9.\nAt year-end 1995, these loans amounted to $13,767,000 or 2.46% of the portfolio. The corresponding amounts for 1994 and 1993 were $32,561,000 or 6.52% of the portfolio and $18,729,000 or 4.03% of the portfolio, respectively. The 1995 amount is comprised of loans of all types. $4.2 million of the allowance for loan losses--an average of 30% of the outstanding balance--has been allocated to these loans to cover potential losses.\nOTHER LOAN PORTFOLIO INFORMATION\nOther information about the loan portfolio is presented that may be helpful to readers of the financial statements follows.\nForeign Loans: The Company does not have nor has it ever had any foreign loans in its loan portfolio.\nLoan Sales: During the last several years, the Company has sold most of the fixed-rate single family mortgage loans it originates as well as selected other portfolio loans. These loans are made to accommodate the borrower, but are sold to mitigate the market risk inherent in fixed rate assets. Servicing is not generally retained. When it is, the Company earns a fee. The sales are made without recourse, that is, the purchaser cannot look to the Company in the event the borrower does not perform according to the terms of the note.\nParticipations: Occasionally, the Company will sell or purchase a portion of a loan from another bank. Banks usually sell a portion of a loan as a means of staying within the bank's maximum limit for loans to any one borrower. A portion of another bank's loan may be purchased by the Company as an accommodation to a smaller bank unable to lend the whole amount under its regulatory lending limit to its borrower, but this would be done only if the loan also represents a good investment for the Company. In these cases, the Company conducts its own independent credit review prior to committing to purchase.\nLoan to Value Ratio: The Company follows a policy of not loaning more than 65% to 90% of the value of the collateral for construction and development loans depending on the type of the project. The limits are 75% of the value of commercial property and no more than 80% of residential property for its real estate loans. The Company generally does not make use of credit enhancements like loan insurance to exceed these amounts. The above ratios are sometimes exceeded when the loan is being originated for sale to another institution that does lend at higher ratios and the sale is immediate, when the exception is temporary, or when other special circumstances apply. There are no specific loan to value ratios for other commercial, industrial or agricultural loans not secured by real estate. Adequacy of the collateral is established based on the individual borrower and the purpose of the loan. Consumer loans may have maximum loan to collateral ratios based on the loan amount, the nature of the collateral, and other factors.\nLoan Concentrations: The concentration profile of the Company's loans is discussed in Note 16 to the accompanying consolidated financial statements. The Company's one material concentration of loans to borrowers engaged in similar activities at year-end 1995 is for real estate construction and development.\nA majority of the $21 million in construction and development loans have been made to developers. However, these projects include a wide variety of properties--single family, small and large apartment complexes, condominiums, commercial offices, and industrial and retail space--and they are geographically dispersed throughout the Company's market area.\nThese loans are generally payable upon sale or refinancing of the property, but also have a maturity date irrespective of sale or refinance. With slower sales in the real estate market, some of the properties have not sold or refinanced before the maturity date. The Company may extend the maturity date for a fee after a new review of the loan and the borrower's efforts to sell.\nMortgage Servicing Rights: In May, 1995, the FASB issued Statement of Accounting Standards No. 122, Accounting for Mortgage Servicing Rights. This statement requires companies engaged in mortgage banking activities to recognize the rights to service mortgage loans for others as separate assets. This statement is effective for fiscal years beginning after December 15, 1995. The Company adopted this statement on January 1, 1996.\nThe Company sells some of the mortgage loans that it originates. Most are sold \"servicing released\"--the purchaser takes over the collection of the payments. However, some are sold with \"servicing retained\"--the Company continues to receive the payments from the borrower and forwards the funds to the purchaser. The Company earns a fee for this service. For loans originated for sale, the statement requires that a portion of the investment in the loan be ascribed to the right to receive this fee for servicing and that this value be recorded as a separate asset. The Company anticipates no material impact on its financial statements from the implementation of this statement.\nDEPOSITS\nAn important component in analyzing net interest margin is the composition and cost of the deposit base. Net interest margin is improved to the extent that growth in deposits can be focused in the lower cost core deposit accounts--demand deposits, NOW accounts, and savings. The average daily amount of deposits by category and the average rates paid on such deposits is summarized for the periods indicated in the Table 11.\nThe average rate paid on deposits declined significantly from 3.79% in 1992 to 2.89% in 1993, but increased in 1994 to 3.09% and to 3.93% in 1995. The Fed pushed rates up sharply during 1994 and only gradually dropped them in 1995. The average rate was also impacted by a significant change in the product mix during the last three years reflecting both a customer choice to shorten the maturities of their accounts so as to be able to reinvest should interest rates turn up, and a choice by the Company to encourage shortening so that interest paid would decrease as rates were falling. There was a general practice among banks, which the Company also followed, of lowering the rates on the time deposit categories more than on the transaction and savings account categories.\nThe Company's transaction and savings account categories continued to increase as a percentage of total deposits in 1995 as they had in 1993 and 1994. The most dramatic growth was in the Personal Money Master accounts. When introduced by the Company in 1990, these accounts had an interest rate indexed to the 3-month Treasury bill. Balances grew substantially from an average balance of $69.1 million in 1993 to $131.7 million in 1994 as the rate paid increased from 3.06% at the beginning of 1994 to 5.07% by November. After proper notice was given to depositors, the Company changed the rate paid to an administered rate (the same way all other non-term deposits are priced) instead of a rate indexed to the Treasury bill. Despite the change to an administered rate, balances continued to grow in 1995 to an average of $201.4 million, with $224.7 million at year-end, when the rate was 4.15%.\nPotentially, the most volatile deposits in a financial institution are the large certificates of deposit over $100,000. Because the deposits exceed the FDIC insurance limit, depositors often select only the shortest maturities. Nonetheless, many institutions have tried to fund their growth by means of large certificates of deposit. This usually requires a \"money desk,\" a separate department devoted to procuring these deposits by offering premium rates. The aim is to invest the funds in longer-term assets which earn the higher rates. The hazard in this practice arises from the mismatch of maturity terms. If interest rates rise, the bank would need to immediately match the higher interest rates, or the deposits would migrate to another institution. Meanwhile, as discussed above, if interest rates go up, fixed-rate loans and securities lose a portion of their value. If the deposits cannot be retained, the bank would eventually be forced to liquidate the assets at a loss.\nThe Company, however, has not found its over $100,000 certificates to be very volatile because it does not solicit any deposits from brokers, nor has it encouraged these certificates by paying premium interest rates. It has been the Company's experience that large depositors have placed their funds with the Company because they are confident in its financial strength and stability. This is also suggested by the lack of any significant shortening of maturities of these larger certificates beyond the general customer trend to shorten their deposit maturities.\nSeveral courses of action would be available should the Company experience an outflow of funds in this category. Among the most likely scenarios would be a sale of some of the securities in the Liquidity Portfolio followed by an effort to replace these lost deposits with growth in the other retail deposit products. This course of action is unlikely to result in a negative impact on earnings for the Company because, while the cost of acquiring and servicing the transaction deposits is higher than for certificates, the interest rate paid will be lower.\nSECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE AND FEDERAL FUNDS PURCHASED\nSecurities sold under agreements to repurchase (\"repos\") are a form of borrowing that is secured by some of the securities in the Company's portfolios. Some banks use these agreements to borrow from other banks in order to provide temporary liquidity. In contrast, the Company provides these instruments in amounts over $100,000 to business customers for their cash management. Like the rate paid on Federal funds purchased, the interest rate paid on repos is tied to the Federal funds sold rate. The average rate paid in 1995 increased to 5.01% from 3.26% in 1994 and 2.90% during 1993. The average balance for these arrangements varies with economic activity as these customers have more or less cash to invest. The average balance borrowed during 1995 increased slightly from $9.4 million in 1994, but the outstanding balance at year-end 1995 was $21.9 million, the highest month-end balance since 1990.\nFederal funds purchased are a form of overnight borrowing from other banks. The Company purchases funds each day to accommodate other local community banks on the Central Coast that have excess cash to invest overnight. The related interest expense is tied to the rate that the Company receives for its excess cash sold as Federal funds to larger financial institutions. During the last three years, the Company has occasionally purchased additional funds from money center banks to meet liquidity needs, especially during the RAL season. The average balance was $16.6 million in 1995, compared to $14.3 million in 1994, and $12.7 million for 1993. Management does not anticipate that the Company will need to borrow funds during 1996 because with the shift in emphasis from loans to refund transfers, the program does not create any need for temporary funds. The average balance for 1996 will therefore depend on the amount of excess cash placed with the Company by the other banks.\nOTHER REAL ESTATE OWNED\nReal property owned by the Company which was acquired in foreclosure proceedings is termed Other Real Estate Owned or OREO.\nTable 13 summarizes the OREO activity during 1995:\nThe Company follows an aggressive policy of selling collateral it has acquired in foreclosure. The total at year-end to be disposed of is only 0.15% of total assets, compared with 0.13% held by its FDIC peers as a percentage of their total assets.\nAs part of the loan application process, the Company reviews all real estate collateral for possible problems from contamination by hazardous waste. This is reviewed again before any foreclosure proceedings are initiated.\nOTHER OPERATING INCOME\nAt over $7.0 million in 1995, trust fees remain the largest component of other operating income. Fees increased by $571,000 over 1994. The market value of assets under administration--on which the majority of fees are based--increased from $926 million at the start of 1993 to $1.4 billion at the end of 1995.\nThe Trust and Investment Services Division began selling annuities and mutual funds to customers in 1995 and earned $183,000 in fees from these sales. The Company provides assistance to customers to determine what investments would best match their financial goals and helps the customers allocate their funds according to the customers' risk tolerance and need for diversification. The funds and annuities are not operated by the Company, but instead are managed by registered investment companies. Fees for managing employee benefit trust business increased $107,000 or 15% in 1995.\nIncluded within other service charges, commissions and fees are service fees arising from the processing of merchants' credit card deposits, escrow fees, and a number of other fees charged for special services provided to customers. In 1995, this category of income increased substantially because it included $1.6 million in fees earned for refund transfers. As explained in the discussion on RAL's on page 27, many of the taxpayers not qualifying for loans still had their refunds sent by the IRS to the Company which then issued the refund check more quickly than would the IRS. The Company earned fees for this service. Management expects that this will provide a significant source of income in 1996 as well.\nThe Company continues to work on increasing other income and fees because it is an important potential contributor to profitability. In late 1994, after a thorough evaluation of the cost and value of the services and a comparison of the Company's fees with other financial institutions, Management raised most fees and began charging new fees for a number of services. Similar evaluations and fee schedule revisions will be done in 1996.\nOTHER OPERATING EXPENSE\nTotal other operating expenses have increased over the last three years as the Company has grown, but as a percentage of average earning assets, these expenses have remained relatively steady at 4.11%, 4.09%, and 4.16%, for 1995, 1994, and 1993, respectively. These ratios are quite favorable compared to the average ratio of 4.30% for its FDIC peer group for the first nine months of 1995, especially when two important factors are considered.\nThe first is that it is exceptional for a financial institution the size of the Company to have such a large trust division. The expenses of this division (approximately $4.02 million in 1995) are included in the general category of other operating expenses (the numerator of the ratio), but the only earning assets associated with the division (the denominator of the ratio) are trust customer funds deposited with the Company, which averaged $82.6 million in 1995.\nThe second factor is the high proportion of premises leased rather than owned by the Company. There is increased lease expense, but, as noted above, by not committing funds to the purchase of premises, the Company is able to substantially increase its net interest income.\nAs indicated in Note 12 to the consolidated financial statements, the Company benefited in 1995, and the ratio of other operating expenses to earning assets is lower, due to a significant reduction in FDIC deposit premiums.\nWithin the whole category of other operating expense, salary and benefit expenses have increased 15.3% from 1993 to 1995 compared to a 13.5% increase in average earning assets for the same period. The number of staff has increased for several reasons. Four additional branch offices have been opened since the start of 1993. Additional credit review and administrative personnel were hired as mentioned on page 29, and other personnel were hired for the new services in the Trust and Investment Services Division. A number of temporary employees were hired for collection efforts in the RAL program.\nNet occupancy and equipment expense have increased slightly from 1993 to 1995 because of some renovation of branch offices, cost of living increases on leases, and the opening of the new offices.\nThe Company incurred approximately $2.5 million in direct operating expenses related to the new offices and personnel in the Ventura County expansion. In general, these expenses will increase in 1996 as the offices are open for the full year. Additional expenses were incurred in the administrative and support areas of the Company for the startup activities. A much smaller proportion of these will recur in 1996 unless additional offices are opened or operations initiated.\nCAPITAL RESOURCES\nBy the current regulatory definitions, the Company is \"well- capitalized,\" the highest rating of the five categories defined under FDICIA.\nCapital Adequacy Standards\nThe primary measure of capital adequacy is based on the ratio of capital to risk weighted assets. This method of measuring capital adequacy is meant to accomplish several ends: 1) to establish capital requirements that are more sensitive to the differences in risk associated with various assets; 2) to explicitly take into account off-balance sheet exposure in assessing capital adequacy; and, 3) to minimize disincentives to holding liquid, low-risk assets. The Company, as a bank holding-company, is required by the FRB to maintain a risk-based capital ratio of at least 8.00%. At the end of 1995, the Company's ratio was 17.67%. The Bank is also subject to the requirement to maintain a risk- based capital ratio of 8.00%. The Bank's ratios have always been slightly higher than the Company's, and at the end of 1995, its ratio was 17.79%. The ServiceCorp has no minimum capital requirements.\nThe risk-based capital ratio is strongly impacted by the management of the investment portfolio because the U.S. Treasury securities are assigned a zero risk weighting and other instruments in which the Company has often placed a significant amount of funds--U.S. Agency securities, State and Municipal securities, Federal funds sold, and bankers' acceptances--have a 20% risk weighting. The Company's ratio decreased from 19.28% for year-end 1994 to 17.97% for year-end 1995 because Treasury securities were 23% of total assets at the end of 1994 and 16% at the end of 1995.\nThe Company is trying to increase loans as a percentage of total assets in order to increase net interest income. Except for most 1-4 family residential loans, loans are risk-weighted at 100%. If Management's projections for loan growth are reached in 1996, the Company's ratio may decrease slightly, but Management does not anticipate any reason whatsoever why minimum standards will not continue to be significantly exceeded.\nFuture Sources and Uses of Capital\nThe Company expects sustained growth in capital resources. Net income has provided $36.3 million in capital in the last three years. Of this amount, $11.8 million, or 32.5% was distributed in dividends.\nIn addition to the capital generated from the operations of the Bank, over the years a significant source of capital growth has been the exercise of employee stock options. The extent of the growth from this source in any one year depends on a number of factors, among them the current stock price in relation to the price at the time options were granted and the number of options that would expire if not exercised sometime during the year. In 1995, the increase to capital from the exercise of options (net of shares surrendered as payment for exercises and taxes) was $454,000 or 6.5% percent of the net growth in shareholders' equity in this year.\nAt December 31, 1995, there were approximately 412,000 options outstanding and exercisable at less than the current market price, with an average exercise price of $12.33. This represents a potential addition to capital of $5.1 million, if all options were exercised with cash. However, employees are permitted to exercise options by trading shares of stock already owned. This \"swapping\" of shares reduces the amount of new equity created when options are exercised. Therefore, some amount less than the $5.1 million in new capital is likely to result from the exercise of options, and they are likely to be exercised over a number of years.\nThere are no material commitments for capital expenditures or \"off- balance sheet\" financing arrangements as of the end of 1995, except as reported in Note 16 to the consolidated financial statements. State law limits the amount of dividends that may be paid by a bank to the lesser of the bank's retained earnings or the total of its undistributed net income for the last three years. For the Bank, this would mean approximately $26.1 million more could have been transferred as dividends to the Bancorp in 1995, subject to regulatory capital requirements. The primary need for funds to be transferred to the Bancorp is for the payment of dividends to its shareholders. Management expects that the amount of dividends to be transferred to the Bancorp from the Bank will be in the range of $4 to $6 million per year.\nTender Offer\nAs disclosed in Note 9 to the accompanying consolidated financial statements, in 1993 the Company purchased approximately 155,000 shares of its stock under the terms of a formal tender offer. The Company paid $3.3 million for the stock tendered, which was accounted for as a retirement of shares and reduction of capital. As explained in the tender offer, this action was taken: 1) to provide shareholders with larger holdings an opportunity to sell shares if they had not been able to because the market was not able to absorb larger blocks; 2) because the significant earnings growth over the last several years had resulted in an accumulation of capital in excess of current needs, and 3) to reduce the outstanding shares in anticipation of the issuance of new shares upon the exercise of employee stock options.\nREGULATION\nThe Company is strongly impacted by regulation. The Company and its subsidiaries may engage only in lines of business that have been approved by their respective regulators, and cannot open, close, or relocate offices without their approval. Disclosure of the terms and conditions of loans made to customers and deposits accepted from customers are both heavily regulated as to content. The Company and the Bank must file periodic reports with the various regulators to keep them informed of their financial condition and operations as well as their compliance with all the various regulations. The FRB and the California State Department of Banking conduct periodic examinations of the Company and the Bank to verify that the reporting is accurate and to ascertain that the Company and the Bank are in compliance with regulations.\nFDICIA became effective in 1992. FDICIA requires banks to meet new capitalization standards, follow stringent outside audit rules, and establish stricter internal controls. There are also new requirements to ensure that the Audit Committee of the Board of Directors is independent.\nThe Bank is required by the provisions of the federal Community Reinvestment Act (\"CRA\"), to make significant efforts to ensure that access to banking services is available to every segment of the community. The Company was last examined in late 1992 by the FDIC for compliance with this act and was given the highest possible rating of \"Outstanding.\"\nThe FRB may take action against a bank holding company or a bank that it regulates should it make a finding that the financial institution has failed to maintain adequate capital. This action has usually taken the form of restrictions on the payment of dividends to shareholders, requirements to obtain more capital from investors, and restrictions on operations. The FDIC may also take action against a bank that it finds is not acting in a safe and sound manner. Management has received no indication from either regulatory agency that would in any way suggest that they are contemplating any such finding, and given the strong capital position of the Company and the Bank, it expects no such finding to be made in the foreseeable future.\nIMPACT OF INFLATION\nInflation has been moderate for the last several years and has had little or no impact on the financial condition and results of operations of the Company during the periods discussed here.\nLIQUIDITY\nSufficient liquidity is necessary to handle fluctuations in deposit levels, to provide for customers' credit needs, and to take advantage of investment opportunities as they are presented in the market place. As indicated in the Consolidated Statements of Cash Flows included with the accompanying consolidated financial statements, the principal sources of liquidity for the Company have been interest payments received on loans and investments, proceeds from the maturity or sale of securities and bankers' acceptances, and the growth in deposits.\nTo manage the Company's liquidity properly, however, it is not enough merely to have large cash inflows; they must be timed to coincide with anticipated outflows. Also, the available cash on hand or cash equivalents must be sufficient to meet the exceptional demands that can be expected from time to time relating to natural catastrophes such as flood, earthquakes, and fire.\nThe timing of inflows and outflows is accomplished by making adjustments to the mix of the assets and the liabilities so that maturities are well matched. The timing of liquidity sources and demands is well-matched when there are approximately the same amount of short-term liquid assets as volatile, large liabilities, and the maturities of the remaining longer-term assets are not concentrated in any single time period.\nA means of computing liquidity using this concept of matching maturities, and one that is similar to that used by bank regulators, is to compute the difference between the short-term, liquid assets and the volatile, large liabilities. Liquidity is positive if short-term, liquid assets exceed volatile, large liabilities and negative if they are less. The difference is then divided by the sum of net loans and long-term securities to determine the relative size of any mismatch. The formula reads as follows:\nShort-term, Volatile, Liquid Assets -- Large Liabilities - --------------------------------------- = Liquidity Ratio Net Loans and Long-term Securities\nOf those assets currently held, the Company considers its short-term liquid assets to consist of U.S. Treasury and Agency securities with a remaining term to maturity of two years or less, Federal funds sold, and bankers' acceptances. In the Company's asset\/liability management framework, bankers' acceptances are used only as an alternative to 6- month U.S. Treasury securities, rather than as loans, and since only the highest rated bankers' acceptances are purchased, they are highly liquid over their 6-month terms. Cash on hand and at the FRB is not included among liquid assets because the Company maintains only the minimum amounts required by Federal regulations of these non-earning assets. In other words, this cash is not available to meet liquidity needs like funding loans, purchasing assets, or covering large withdrawals, so it is not counted as liquid.\nThe volatile, large liabilities are time deposits over $100,000, Federal funds purchased, repurchase agreements, and other borrowed funds. While balances held in demand and passbook accounts are immediately available to depositors, they are generally the result of stable business or customer relationships with inflows and outflows usually in balance over relatively short periods of time. Therefore, for the purposes of this kind of analysis, they are not considered volatile.\nAs of December 31, 1995, this ratio was a positive 29.4%. This means that there is a substantial excess of short-term, liquid assets to handle any sudden withdrawals of large, volatile liabilities. This positive 29.4% compares with ratios for year-end 1994 and 1993 of 15.8% and 21.0%, respectively. Liquidity has increased from year-end 1994 to year-end 1995 even though the large, volatile liabilities and the net loans have increased because the short-term, liquid assets have increased even more. This occurred because many of the longer-term securities were sold as part of the restructuring of the portfolios described on page 21 and reinvestment in longer term securities had not occurred by year-end.\nToo little liquidity results in lost opportunities and difficulties in meeting commitments. Excessive liquidity generally results in less income because the shorter, liquid assets usually do not pay as high an interest rate as the longer-maturing assets. However, because of the partially inverted yield curve that prevailed during the second half of 1995, it would be necessary to purchase securities with 2 to 5 years remaining maturity to earn as much as overnight funds. The Company purchased some longer-term securities during this period, However, because the Company manages its liquidity along with considerations of the three types of interest risk, Management has been reluctant to invest a large portion of the excess liquidity in instruments with longer than a two year maturity because of the depreciation that would result when interest rates begin to rise.\nAs explained in the section above titled \"Securities,\" as interest rates fall, the Company's investment policy leads it to purchase securities with available cash rather than sell it as Federal funds. However, such a shift into securities does not occur all at once; the Company staggers its purchases to ensure a range of maturities and to avoid a concentration of securities at similar interest rates. The first consideration helps to maintain liquidity through frequent maturities and the latter avoids having to sell at one time a large amount of securities classified as available-for-sale under the \"stop-loss\" practice described above should interest rates start to rise again.\nThe large amount of loans showing in Table 6 should not be considered a significant source of liquidity. The maturity dates of many of these loans are scheduled renewals.\nINCOME TAX EXPENSE\nAs indicated in Note 1 to the accompanying consolidated financial statements, the Company adopted Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (\"SFAS 109\") at the beginning of 1993. As was the case under the former standard, income tax expense continues to be the sum of two components, the current tax expense or provision and the deferred expense or provision. Current tax expense is the result of applying the current tax rate to taxable income, just as it was under the former method, but the new standard changes the method by which the deferred income tax provision is computed.\nThe deferred provision is intended to account for the fact that income on which the Company pays taxes with its returns differs from pre-tax income in the accompanying consolidated income statements because some items of income and expense are recognized in different years for income tax purposes than in the financial statements. For example, the Company is only permitted to deduct from taxable income on its Federal tax return actual net loan charge-offs, irrespective of the amount of provision for loan loss (bad debt expense) it recognized in its financial statements. This causes what is termed a \"temporary difference\" because eventually, as loans are charged-off, the Company will be able to deduct for taxes what has already been recognized as an expense in the financial statements. Another example is the accretion of discount on certain securities. For its financial statements, the Company recognizes income as the discount is accreted, but for its tax return, the Company can defer the recognition of income until the cash is received at the maturity of the security. The first example causes a deferred tax asset to be created because the Company has recognized as an expense for its current financial statements an item that it will be able to deduct from its taxable income in a future year. The second example causes a deferred tax liability, because the Company has been able to delay until a subsequent year the paying of tax on an item of current year financial statement income.\nSFAS 109 requires that the Company measure all its deferred tax assets and liabilities at the end of each year and the difference between the net asset or liability at the beginning of the year and the end of the year is the deferred tax provision for the year. Prior to 1993, the Company had been computing its deferred provision by a different method which was then in accordance with generally accepted accounting principles. Therefore, an initial adjustment had to be recognized to bring its net deferred asset up to the amount that was computed under the new standard. This adjustment of $620,000 is shown on the consolidated statement of income for 1993 as the cumulative effect of a change in accounting principle.\nMost of the Company's temporary differences involve recognizing substantially more expenses in its financial statements than it has been allowed to deduct for taxes, and therefore the Company has a net deferred tax asset. Deferred tax assets are dependent for realization on past taxes paid, against which they may be carried back, or future taxable income, against which they may be offset. The Company has had and expects to have in the future sufficient taxable income each year to make it very likely that it will be able to realize the benefit of this deferred tax asset. If there were a question about the Company's ability to realize the benefit from the asset, then, under the provisions of SFAS 109, it would have to record a valuation allowance against the asset to reflect the uncertainty. Given the amount and nature of the Company's deferred assets, the past taxes paid, and the likelihood of future taxable income, realizability is assured and no valuation allowance needs to be provided.\nThe amounts of the two components, the amounts of the various deferred tax assets and liabilities, and the tax effect of the principal temporary differences between taxable income and pre-tax financial statement income are shown in Note 8 to the accompanying financial statements.\nTo ensure that all corporations with substantial income for financial reporting purposes (\"book income\") pay some Federal income tax, Congress established the Alternative Minimum Tax (\"AMT\") as a second parallel tax system. Under AMT provisions, there is a limitation on how great the difference may be between book income and taxable income. If the difference is too great, a portion of the book income not normally taxable is nonetheless added to taxable income and the total is multiplied by the AMT tax rate for comparison with the regular tax computation. With its tax return, the Company is required to pay the greater of the Federal tax liability computed under the regular tax system or that computed using the special rules of the AMT.\nThe Company has substantial differences between book income and taxable income due to the temporary differences noted above and due to permanent differences like the tax-exempt income from state and municipal securities. These differences were sufficient in 1995 to trigger the AMT rate. The lowest effective tax rate for the Company occurs at the point that the regular tax computation and the AMT computation result in the same tax amount. The Company therefore tries to stay very close to this crossover point. In these circumstances, the Company carefully considers the impact of new purchases of tax-exempt securities and other transactions which might cause the AMT to come into effect. The Company had anticipated sufficient taxable income in 1995 to avoid AMT, but the lower amounts of income and additional expenses noted in various sections of this discussion resulted in a small amount of AMT to be paid. This amount is deductible as a tax credit in future years to the extent that taxes computed under the regular tax provisions exceed taxes computed under the AMT provisions.\nCOMMON STOCK PRICES AND DIVIDENDS\nStock prices and cash dividends declared for the last eight quarters are shown on page 58 in \"Selected Annual and Quarterly Financial Data.\" The stock prices shown represent only trades known to the Company or its transfer agent. The stock is not listed on an exchange, but offers to buy and sell, and trading volume are reported on the NASDAQ electronic bulletin board under the symbol SABB.\nThe Board of Directors periodically increases the dividend rate in acknowledgement that earnings have been increasing by a sufficient amount to ensure adequate capital and also provide a higher return to shareholders. For the years 1995, 1994, and 1993, the Company has declared dividends which were 40.3%, 30.8%, and 28.0%, respectively, of its net income. The most recent information for the Company's peers shows an average payout ratio of 28.8%.\nNOTE A\nAs of September 30, 1995, for all FDIC banks with an asset size of $1 billion to $10 billion, non-performing assets represented 9.23% of their equity capital and 0.87% of their total assets. For banks of all sizes in the FDIC's Western region, they represented 13.59% of equity capital and 1.18% of total assets.\nIn various places throughout this discussion, comparisons will be made between ratios for the Company and for its FDIC peers. For 1995, the peer group generally is all FDIC banks with an asset size of $1 billion to $10 billion, and the information set forth above is reported in or calculated from information reported in the FDIC Quarterly Banking Profile, Third Quarter 1995, which is the latest issue available. This publication also reports some statistics by all banks within a geographical region. When relevant, the statistic for the Western region is cited. The publication does not report some of the statistics cited in this analysis by the separate size-based peer groups or by geographical region. In these instances, the figure cited is for all FDIC banks regardless of size.\nThe peer information for the dividend payout ratio is reported in the Bank Holding Company Performance Report received from the FRB for the 3rd Quarter of 1995.\nNOTE B\nFor Tables 2 and 4, the yield on tax-exempt state and municipal securities has been computed on a taxable equivalent basis. To compute the taxable equivalent yield for these securities one must first add to the actual interest earned an amount such that if the resulting total were fully taxed, the after-tax income would be equivalent to the actual tax-exempt income. This taxable equivalent income is then divided by the average balance to obtain the taxable equivalent yield. The dollar amount of the adjustment is shown at the bottom of Table 2 as \"Taxable equivalent income included in interest income from nontaxable securities and loans.\"\nNOTE C\nFor purposes of Table 2, loans in a nonaccrual status are included in the computation of average balances in their respective loan categories.\nNOTE D\nFor purposes of the amounts in Table 3 relating to the volume and rate analysis of net interest margin, the portion of the change in interest earned or paid that is attributable to changes in rate is computed by multiplying the change in interest rate by the prior year's average balance. The portion of the change in interest earned or paid that is attributable to changes in volume is computed by multiplying the change in average balances by the prior year's interest rate. The portion of the change that is not attributable either solely to changes in volume or changes in rate is prorated on a weighted basis between volume and rate.\nNOTE E\nFor purposes of Tables 2 and 3, non-origination loan fees and net origination fees amortized in accordance with Statement of Financial Accounting Standards No. 91, Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases, are included in interest income.\nNOTE F\nIn Table 1, the net deferred loan origination, commitment, and extension fees and the allowance for loan losses are included in the column titled \"Noninterest bearing or non-repricing items.\"\nSanta Barbara Bancorp and Subsidiaries REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Shareholders and the Board of Directors\nWe have audited the accompanying consolidated balance sheets of SANTA BARBARA BANCORP (a California corporation) and Subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of income, changes in shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1995. These financial statements are the responsibility of Santa Barbara Bancorp'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 Santa Barbara Bancorp and Subsidiaries as of December 31, 1995 and 1994, and the results of their operations and cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\nAs explained in the Accompanying Notes to the consolidated financial statements, the Company adopted Statement of Financial Accounting Standards No. 109 effective January 1, 1993 and Statement of Financial Accounting Standards No. 115 effective December 31, 1993.\nhandwritten signature: Arthur Andersen LLP\nLos Angeles, California February 2, 1996\n1. SUMMARY OF SIGNIFICANT POLICIES\nNature of Operations\nSANTA BARBARA BANCORP (the \"Company\") is a bank holding company organized under the laws of California. Its principal subsidiary, Santa Barbara Bank & Trust (the \"Bank\") provides a full range of commercial banking and trust management services to individuals and business enterprises. Its offices are located in Central and Southern Santa Barbara County and in Western Ventura County. The banking services include making commercial, consumer, and commercial and residential real estate loans. Deposits are accepted for checking, interest-bearing checking (\"NOW\"), money-market, savings, and time accounts. The bank also offers safe deposit boxes; travelers checks, money orders, and cashiers checks; and escrow services. A wide range of wealth management services are offered through the Bank's Trust and Investment Services division. The Company's other subsidiary, SBBT Service Corporation, provides correspondent services to other local area financial institutions.\nBasis of Presentation\nThe accounting and reporting policies of the Company and its subsidiaries are in accordance with generally accepted accounting principles (\"GAAP\") and conform to practices within the banking industry. The consolidated financial statements include the accounts of the Company and its subsidiaries, after eliminating significant intercompany balances and transactions.\nThe preparation of consolidated financial statements in accordance with GAAP requires Management to make certain estimates and assumptions which affect the amounts of reported assets and liabilities as well as contingent assets and liabilities as of the date of these financial statements. These estimates and assumptions also affect the reported amounts of revenues and expenses during the reporting period(s). Although Management believes these estimates and assumptions to be reasonably accurate, actual results may differ.\nSecurities\nDebt obligations of the U.S. Treasury, U.S. agencies, and of states and municipalities are purchased with the intent to hold to maturity. However, the Company occasionally sells securities prior to maturity in order to limit losses if interest rates rise, or to restructure the portfolio to better match the maturity and interest rate characteristics of liabilities.\nThe Company implemented Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities (\"SFAS 115\"), as of December 31, 1993. This statement requires the Company to classify its securities into one of three categories. Securities for which the Company has the positive intent and ability to hold until maturity are classified as held-to-maturity securities. Securities which might be sold prior to maturity because of interest rate changes, to meet liquidity needs, or to better match the repricing characteristics of funding sources are classified as available-for-sale. If the Company were to purchase securities principally for the purpose of selling them in the near term for a gain, they would be classified as trading securities. The Company holds no securities that should be classified as trading securities.\nIn accordance with the provisions of SFAS 115, the Company's securities classified as held-to-maturity are carried at amortized historical cost. This is the purchase price increased by the accretion of discounts or decreased by the amortization of premiums using the effective interest method. Discount is accreted and premium is amortized over the period to maturity of the related securities, or to an earlier call date, if appropriate.\nThe interest income from securities that are classified as available- for-sale is recognized in the same manner as for securities that are classified as held-to-maturity, including the accretion of discounts and the amortization of premiums. However, unlike the securities that are classified held-to-maturity, securities classified available-for-sale are reported on the consolidated balance sheets for the years ended December 31, 1995 and 1994 at their fair value. The net unrecognized gain or loss for these securities is reported on the consolidated balance sheets as a separate component of equity, net of the tax effect.\nLoans, Fees, and Allowance for Loan Losses\nLoans are carried at amounts advanced to the borrowers less principal payments collected. Interest on loans is accrued on a simple interest basis, except where serious doubt exists as to the collectibility of the loan, in which case the accrual of income is discontinued and uncollected income is subtracted from interest earned.\nLoan origination and commitment fees, offset by certain direct loan origination costs, are deferred and recognized over the contractual life of the loan as an adjustment to the interest earned. The net unrecognized fees represent unearned revenue, and they are reported as reductions of the loan principal outstanding, or additions to the loan principal if the deferred costs are greater than deferred fees.\nThe Company implemented Statements of Financial Accounting Standards No. 114, Accounting by Creditors for Impairment of a Loan (\"SFAS 114\") and No. 118, Accounting by Creditors for Impairment of a Loan--Income Recognition and Disclosures (\"SFAS 118\") on January 1, 1995. The pronouncements apply to certain types of loans made by the Company and require the Company to establish a valuation allowance for any of those loans which are impaired. A loan is to be identified as impaired when it is probable that interest and principal will not be collected according to the contractual terms of the loan agreement.\nThe amount of the valuation allowance for impaired loans is determined by comparing the recorded investment in each loan with its value measured by one of three methods: (1) the expected future cash flows are estimated and then discounted at the effective interest rate; (2) by the loan's observable market price if it is of a kind for which there is a secondary market; or (3) by valuing the underlying collateral. A valuation allowance is established for any amount by which the recorded investment exceeds the value of the impaired loan. If the value of the loan as determined by one of the above methods exceeds the recorded investment in the loan, no valuation allowance for that loan is established.\nThe provisions of SFAS 114 permit the valuation allowance for impaired loans to be determined on a loan-by-loan basis or by aggregating loans with similar risk characteristics. Because the number of loans classified as impaired is relatively small and because special factors apply to each, the Company has determined the valuation allowance as of December 31, 1995 on a loan-by-loan basis.\nWhen a borrower is not making payments as contractually required by the note, the Company must decide whether it is appropriate to continue to accrue interest. The criteria used in making this decision are very similar to the definition of impairment. Therefore, the Company expects that most impaired loans will be on nonaccrual status. As with other nonaccrual loans, any uncollected interest for impaired loans is written off against interest income from other loans of the same type in the current period and no further interest income is recognized until all recorded amounts of principal are recovered in full or until circumstances have changed such that the loan is no longer regarded as impaired.\nThere are some loans that are classified as impaired because of doubt regarding collectibility of interest and principal according to the contractual terms, but which are both fully secured by collateral and current in their interest and principal payments. These impaired loans are not classified as nonaccrual.\nThe Company also provides an allowance for losses for (1) loans that are not covered by SFAS 114 and SFAS 118; (2) loans which while covered by the statements, are not identified as impaired; and (3) losses inherent in loans of all types which have not been specifically identified as of the period end. The valuation allowance determined in accordance with SFAS 114 and the allowance for other loan losses are reported together as Allowance for Loan Loss in the accompanying consolidated balance sheet as of December 31, 1995 and in Note 4. The allowance for loan losses is maintained at a level considered adequate to provide for losses that can reasonably be anticipated. However, the allowance is based on estimates, and ultimate losses may vary from the current estimates. These estimates are reviewed periodically and, as adjustments become necessary, they are reported in earnings in the periods in which they become known.\nImplementing SFAS 114 and SFAS 118 has not had a material impact on the financial statements of the Company. Under the procedures followed before implementation, the loans that have been identified as impaired during 1995 would have had a portion of the general allowance for loan loss allocated to them in an amount approximately the same as that established under the provisions of these statements.\nPremises and Equipment\nPremises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is charged against income over the estimated useful lives of the assets, usually by the use of accelerated methods in the early years, switching to the straight-line method in later years. Leasehold improvements are amortized over the terms of the leases or the estimated useful lives of the improvements, whichever is shorter. Generally, the estimated useful lives of other items of premises and equipment are as follows:\nBuildings and improvements 10-25 years Furniture and equipment 5-7 years\nIncome Taxes\nThe Company is required to use the accrual method of accounting for tax return purposes as well as for financial reporting purposes. However, there are several items of income and expense which are recognized in different periods for tax return purposes than for financial reporting purposes. Appropriate provisions have been made in the financial statements for deferred taxes in recognition of these temporary differences.\nThe Company adopted Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (\"SFAS 109\") as of the beginning of 1993. The statement requires an asset and liability approach for financial accounting and reporting for income taxes, a change from the prior approach. The effect on income for the years prior to adoption had to be recognized by either of two means. The first was by recognizing the effect on all prior years as a cumulative effect from a change in accounting principle in the year of adoption. The second was by restating the financial statements for one or more prior years to conform to the provisions of the statement, with the effect on earlier years that were not restated being recognized as a cumulative effect in the earliest year restated. The Company elected to implement the statement by the first means, and consequently recognized a gain in 1993 of $620,000 as the cumulative effect of a change in accounting principle.\nTrust Fees\nTrust fees for customary services are generally based on the market value of customer assets, and an estimate of the fees is accrued monthly. Fees for unusual or infrequent services are recognized when the fee can be determined.\nEarnings Per Share\nEarnings per common share are based on the weighted average number of shares outstanding during each year retroactively restated for stock dividends and stock splits. Subsequent to December 31, 1995, but prior to the publication of these statements, the Board of Directors of the Company declared a 3-for-2 stock split. In situations such as this, Securities and Exchange Commission rules require the restatement of the numbers of shares and earnings per share in the annual report as if the split had occurred before the end of the year. Consequently, restated for the 3-for-2 stock split, the weighted average number of shares outstanding used in computing earnings per share was 7,677,057 in 1995, 7,646,839 in 1994, and 7,783,623 in 1993. The only potential common stock equivalents for the Company are shares issuable on the exercise of outstanding options. Even if all of the outstanding stock options had been exercised, there would be no material dilutive effect for any of the years presented and therefore they have been excluded from the computation.\nStatement of Cash Flows\nFor purposes of reporting cash flows, cash and cash equivalents include cash and due from banks and Federal funds sold. Federal funds are sold for only one day at a time.\nPostretirement Health Benefits\nThe Company provides eligible retirees with postretirement health care and dental benefit coverage. These benefits are also provided to the spouses and dependents of retirees on a shared cost basis. Benefits for retirees and spouses are subject to deductibles, copayment provisions, and other limitations. The expected cost of such benefits is charged to expense during the years that the employees render service.\nOther Real Estate Owned\nOther real estate owned (\"OREO\") represents real estate acquired through foreclosure or deed in lieu of foreclosure. OREO is carried at the lower of the outstanding balance of the loan before acquisition or its fair value less estimated costs to sell. If the outstanding balance of the loan is greater than the fair value less estimated disposal costs at the time of the acquisition, the difference is charged-off against the allowance for loan loss. Any senior debt to which other real estate owned is subject is included in the carrying amount of the property and an offsetting liability is reported along with other borrowings.\nDuring the time the property is held, all related carrying costs are expensed as incurred and additional decreases in the fair value are charged to other operating expense in the period in which they become known. Expenditures related to improvements are capitalized to the extent that they are realizable through increases in the fair value of the properties. Increases in the fair value may be recognized as reductions of OREO operating expense to the extent that they represent recoveries of amounts previously written-down. Gains in excess of the fair value at the time of foreclosure are recognized only when the property is sold.\nOREO that has been acquired through foreclosure or deed in lieu was $1,785,000 and $856,000 as of December 31, 1995 and 1994, respectively.\nReclassifications\nCertain amounts in the 1994 and 1993 financial statements have been reclassified to be comparable with classifications used in the 1995 financial statements.\n2. SECURITIES\nA summary of debt securities at December 31, 1995 and 1994 is as follows:\nIn November, 1995, the Financial Accounting Standards Board (\"the FASB\") issued a guide to implementing SFAS 115. The guide permitted holders of debt securities a onetime opportunity to transfer securities from their held-to-maturity classification to available-for-sale without calling into question the holder's ability and intent to hold to maturity any securities still classified as held-to-maturity. Under this \"window-of- opportunity,\" the Company transferred securities with an amortized cost of $144 million, from the held-to-maturity classification to available- for-sale. The unrealized gains and losses on these securities totaled $683,000 and $986,000, respectively. $94 million of these reclassified securities were sold prior to December 31, 1995.\nThe amortized cost and estimated fair value of debt securities at December 31, 1995 and 1994, by contractual maturity, are shown in the next table. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.\nDuring 1994 and 1995, the Company transferred four of its U.S. agency securities from available-for-sale classification to held-to-maturity. The securities, when purchased in 1993 and 1994, had one or more call dates. The terms of the securities provided that if they were not called, the interest rate on the securities would increase, or \"step up,\" consequently the bonds are termed \"step bonds.\" At the time of purchase, interest rates were such that Management expected that they would be called. When interest rates increased during 1994, it would have been more expensive for the issuer to refinance the debt at current interest rates and none of the securities has been called. With circumstances changed, Management decided to classify them as held-to- maturity. The notes were transferred at their fair value. This was $4,802,000 for the one transferred in 1994 and $29,296,000 for the ones transferred in 1995. The unrealized loss on the first security at the time of transfer was $187,000 and for the three later ones was $704,000. Under the provisions of SFAS 115, the sum of these amounts (net of tax effect) remained in the special component of equity for unrealized gains and losses on securities available-for-sale to be amortized over the remaining term of the securities. The tax effect is reported as a portion of the deferred tax asset in Note 8.\nAs of December 31, 1995, two have reached their final steps at 4.50% and 6.61%. The first has one remaining call date. The other two notes, currently earning 5.15% and 5.00%, each have two more call dates in 1996, with step-ups of 1.00% at each call date if they are not called. Only the interest rate on these notes is contingent, all principal is paid at maturity unless at a sooner call date. There is no circumstance under which the interest rates paid on these notes will decline. At current interest rate levels, the step-up rates are close to what would appear to make it advantageous for the issuers to call the notes at the next available call. However, such other considerations as costs of refinancings and other circumstances unknown to the Company, may lead the issuers to leave the notes outstanding.\nThe proceeds received from sales or calls of debt securities and the gross gains and losses that were recognized for the years ended December 31, 1995 and 1994 are shown in the next table. Because the identification of the securities as held-to-maturity or available-for- sale under the provisions of SFAS 115 did not take place until December 31, 1993, it is not possible to distinguish to which portfolio the proceeds, gains, and losses from sales or calls that occurred during the year of 1993 relate. Consequently, the amounts for 1993 relate to the whole portfolio. Similarly, in the Consolidated Statements of Cash Flow, the proceeds from sales, maturities, and calls, and the purchases of securities, are reported only for the entire securities portfolio.\nThe Company was required in 1995 to purchase stock in the FRB as a condition of becoming a member. The shares purchased are reported as equity securities.\nSecurities with a book value of approximately $286,547,000 at December 31, 1995 and $161,050,000 at December 31, 1994 were pledged to secure public funds, trust deposits and other borrowings as required or permitted by law.\n3. LOANS\nThe loan portfolio consists of the following:\nThe amounts above are shown net of deferred loan origination, commitment, and extension fees of $2,139,000 for 1995 and of $2,038,000 for 1994.\nRefund Anticipation Loans\nThe Company makes tax refund anticipation loans. Taxpayers desiring to receive their income tax refunds early borrow from the Company and the Internal Revenue Service later sends the refund to the Company. The funds advanced are generally paid within several weeks. Therefore, the costs to process the loans are greater in comparison to the cost of funds than they are for other types of loans. Consequently, the Company has a set fee for this service which does not vary by the amount of funds advanced or the length of time that the loan is outstanding. Nonetheless, the fees are reported in the statements of income as interest income, and totaled $3,253,000 for 1995, $4,791,000 for 1994, and $1,048,000 for 1993. The loans are all made during the tax filing season of January through April of each year. Any loans for which repayment has not been received after 90 days from the expected payment date are charged off. Consequently, there were no refund anticipation loans included in the above table of outstanding loans at December 31, 1995 or 1994.\nImpaired Loans\nThe following table discloses information about the loans classified as impaired under the provisions of SFAS 114 and SFAS 118 and the valuation allowance related to them as of and for the year ended December 31, 1995 (in thousands):\nLoans identified as impaired $ 13,295 Impaired loans for which a valuation allowance has been determined $ 13,295 Impaired loans for which no valuation allowance has been determined $ -- Amount of valuation allowance $ 4,766 Average amount of recorded investment in impaired loans for the year $ 22,149 Interest recognized during the period for loans identified as impaired at December 31, 1995 $ 246 Interest received in cash during the period for loans identified as impaired at December 31, 1995 $ 221\nThe valuation allowance disclosed above is included in the allowance for loan loss reported in the following note.\n4. ALLOWANCE FOR LOAN LOSSES\nThe following summarizes the changes in the allowance for loan losses:\nThe ratio of losses to total loans made from the tax refund anticipation loans are higher than arise from other loans. For these loans, the provision for loan loss, the loans charged-off, and the loans recovered are reported separately from the corresponding amounts for all other loans.\n5. CASH AND DUE FROM BANKS\nIncluded within cash and due from banks are the reserves that all depository institutions are required by law to maintain on transaction deposits. The average cash reserve balances required by the Federal Reserve Bank to be maintained by the Bank were approximately $19.4 million in 1995 and $18.5 million in 1994.\n6. PREMISES AND EQUIPMENT\nPremises and equipment consist of the following:\nDepreciation and amortization on fixed assets included in other operating expenses totaled $2,041,000 in 1995, $1,614,000 in 1994, and $1,143,000 in 1993.\n7. Deposits\nDeposits consisted of the following:\nInterest expense by deposit type consisted of:\n8. INCOME TAXES\nThe provisions (benefits) for income taxes related to operations, the tax benefit related to stock options that is credited directly to shareholders' equity, and the change in the method of accounting for taxes described in Note 1 are as follows:\nThe current provision for income taxes includes credits of $41,000, $495,000, and $19,000 related to net securities losses for 1995, 1994, and 1993, respectively.\nAlthough not affecting the total provision, actual income tax payments may differ from the amounts shown as current as a result of the final determination as to the timing of certain deductions and credits.\nThe total tax provision differs from the Federal statutory rate of 34 percent for the reasons shown in the table at the top of the next column.\nBecause certain items of income and expense are not recognized in the same year in the financial statements of the Company as in its Federal and California tax returns, deferred assets and liabilities are created. As of December 31, 1995 and 1994, included within other assets on the balance sheet are net deferred tax assets of $6,334,000 and $8,066,000, respectively. The net deferred tax assets as of December 31, 1995 and 1994 and the change in the tax effect of the principal temporary differences for the year ending that date are disclosed in the table at the bottom of this page.\nThe tax effect of the unrealized loss on securities available for sale is recorded directly to equity. Therefore, it is a component of the deferred tax asset or liability, the change in which does not impact the tax provision. Hence there is no entry in the columns labled \"Tax Effect\" in the table below for the change.\nManagement believes a valuation allowance is not needed to reduce any deferred tax asset because there is sufficient taxable income within the carryback periods or expected to be generated from operations to realize all material amounts.\n9. SHAREHOLDERS' EQUITY\nThe Company has three stock option plans. These plans offer key employees and directors an opportunity to purchase shares of the Company's common stock. The first is the Directors Stock Option Plan, established in 1986 for directors of the Company. Only non-qualified options may be granted under this plan. The second is the Restricted Stock Option Plan for employees established in January, 1992. Either incentive or non-qualified options may be granted under this plan. Stock acquired by the exercise of options granted under this plan may not be sold for five years after the date of the grant or two years after the date options are exercised, whichever is later. The third plan is the Stock Option Plan for employees established in 1983. All options approved under this plan have been granted and the plan is active now only for the exercise of options held by employees.\nThe following information is presented concerning the stock option plans as of December 31, 1995, 1994, and 1993 (adjusted for stock splits and stock dividends):\nAll options outstanding were granted with an option price set at 100% of the market value of the Company's common stock on the date of the grant. The grants for most of the employee options specify that they are exercisable in cumulative 20% annual installments and will expire 5 years from the date of grant. The Board has granted some options which are exercisable in cumulative 10% annual installments and expire 10 years from the date of grant. The options granted under the directors' plan are exercisable in 6 months.\nThe option plans permit employees and directors to pay the exercise price of options they are exercising with shares of stock they already own. The owned shares are surrendered to the Company at current market value. Shares with a current market value of $824,000, $1,011,000, and $184,000 were surrendered in the years ended December 31, 1995, 1994, and 1993, respectively. These surrendered shares are included with other retire shares in the Consolidated Statements of Changes in Shareholders' Equity.\nIn October 1995, the FASB issued Statement of Accounting Standards No. 123, Accounting for Stock-Based Compensation (\"SFAS 123\"). Under the accounting method that has been in effect prior to the effective date of this statement, if options are granted at an exercise price equal to the market value of the stock at the time of the grant, no compensation expense is recognized. SFAS 123 establishes a second accounting method for employee stock options under which issuers would record compensation expense for the \"fair value\" of the options at the time of the grant. This compensation expense is based on option models that attribute value to the options based on the length of their term, the volatility of the stock price in past periods, and other factors. Under this method, the Company would recognize compensation expense regardless of whether the officer or director exercised the options. In SFAS 123, the FASB has indicated its preference for the new method in SFAS, however, the statement permits entities to retain the prior method. The Company believes that the prior method better reflects the motivation for its issuance of stock options--that they are incentives for future performance rather than compensation for past performance. In adopting SFAS 123 on January 1, 1996, the Company has chosen to continue to account for its stock option plans in accordance with the prior method. SFAS 123 requires entities that elect to retain the prior method to present pro forma disclosures of net income and earnings per share as if the new method had been applied. The Company will include these disclosures with its financial statements for the year ending December 31, 1996.\nIn October 1993, the Company offered to purchase about 4.8% of the then outstanding shares of common stock from its shareholders. Provision was made in the offer to purchase additional tendered shares at the Company's option. At the close of the offer on November 15, 1993, about 3.0% of the outstanding shares were purchased by the Company. The purchase of $3.3 million was financed from operating funds paid by the Bank to the Company as a dividend. These shares were outstanding for most of 1993. This resulted in a higher balance of weighted average shares outstanding for 1993 used in the computation of earnings per share than in 1994 and 1995.\nIn March 1990, the Company's Employee Stock Ownership Plan (\"ESOP\") purchased 289,406 shares (adjusted for stock dividends) from the Company. The purchase of the shares by the ESOP was financed partially by a loan from another commercial bank. This loan was guaranteed by the Company. Generally accepted accounting principles require that the outstanding amount of such a loan be shown on the Company's balance sheet both among liabilities and as an offset to shareholders' equity. Interest and principal payments were made by the ESOP from dividends received on Company stock held for employees and from funds received from the Company as part of its regular contribution to employee retirement plans. The balance of the note at December 31, 1992 was $1,400,000. This remaining balance was paid in January 1993, and this transaction is reported in the Consolidated Statements of Changes in Shareholders' Equity for the year ended December 31, 1993.\n10. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE AND FEDERAL FUNDS PURCHASED\nThe Company sells certain of its securities under agreements to repurchase at a later date at a set price. The following information is presented concerning these transactions:\nThe Bank purchased Federal funds from correspondent banks as detailed in the next table:\n11. OTHER BORROWINGS\nIncluded in other borrowings are Treasury Tax and Loan demand notes issued to the U.S. Treasury and miscellaneous other borrowings such as the senior debt on other real estate owned as explained in Note 1. There was $210,000 in such senior debt at December 31, 1995, but none at December 31, 1994.\nDuring the course of 1995 and 1994, the Company borrowed funds for liquidity purposes from the discount window at the Federal Reserve Bank, but there were no such borrowings at December 31 of either year.\n12. OTHER OPERATING INCOME AND EXPENSE\nThe largest items included in other service charges, commissions, and fees, are listed in the table below. The gains on loan sales arise primarily from the recognition of origination fees that have not been amortized by the time of sale. The refund transfer fees are earned for the electronic transmission of tax refunds to customers or to their tax preparer to facilitate earlier receipt of the refund. The credit card rebate is a fee paid by the purchaser of the Company's credit card portfolio for the continuing use of the cards by the Company's customers.\nOf the amounts included in other operating expense, the largest items in 1995 were credit card clearing fees and consultant expense. Consultants include the Company's independent accountants, attorneys, and other management consultants used for special projects. In 1993 and 1994, FDIC deposit insurance premiums were the largest item. During 1995, however, the FDIC Bank Insurance Fund reached the statutory maximum and the FDIC reduced the premium expense for the second half of the year to a very low rate and refunded the excess paid in the first half of the year.\nThe amounts for these income and expense categories included in the statements of income are as follows:\n13. EMPLOYEE BENEFIT PLANS\nThe Company has two defined-contribution profit sharing plans. The first is the Incentive and Investment and Salary Savings Plan. This plan has two components. The first component, the Incentive and Investment Plan, was established in 1966, and provides for contributions by the Company in accordance with a formula. The formula defines the contribution as 10% of pre-tax profits prior to this employer contribution, reduced by the matching contributions paid to the Salary Savings component of the Plan and the contributions made to the ESOP. In 1993, the Company contributed an extra amount to the ESOP for the purpose of paying off the loan it incurred for the purchase of stock. Consequently, no contribution was made to the Incentive and Investment portion of the plan. In 1994 and 1995, all profit-sharing contributions in excess of the 401(k) employer match were directed to the Incentive and Investment Plan.\nThe other component, the Salary Savings Plan, is authorized under Section 401(k) of the Internal Revenue Code. An employee may defer up to 10% of pre-tax salary in the plan up to a maximum dollar amount set each year by the Internal Revenue Service. Effective January 1, 1994, the Company matches 100% of the first 3% of the employee's deferral and 50% of the next 3%, but not more than 4.5% of the employee's total compensation. Through 1993, the Company had matched 50% of the employee's deferral up to 6% of the employee's compensation. This led to a maximum match of 3%. In 1995, 1994, and 1993 the employer's matching contributions were $597,000, $554,000, and $287,000, respectively.\nThe second plan is the ESOP, which was initiated in January 1985. As of December 31, 1995, the ESOP held 782,265 shares at an average cost of $9.09 per share.\nIn 1993, the Company made contributions to the ESOP of $1,404,000. $1,400,000 of the contribution was used to pay off the remaining balance of the note and $4,000 was used for the payment of interest.\nTotal contributions to the profit sharing plans were $1,294,000 in 1995, $1,884,000 in 1994, and $1,691,000 in 1993.\n14. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS\nStatement of Financial Accounting Standards No. 107, Disclosures about Fair Value of Financial Instruments (\"SFAS 107\") requires companies to disclose the fair value of those financial instruments for which it is practicable to estimate that value and the methods and significant assumptions used to estimate those fair values. This must be done irrespective of whether or not the instruments are recognized on the balance sheets of the Company. In the case of financial instruments for which it is not practicable to estimate the fair value, the Company is required to disclose information pertinent to estimating the fair value such as interest rates and maturity, and also state the reasons why it is not practicable to estimate fair value.\nIn SFAS 107, the FASB states that the \"[f]air values of financial instruments depict the market's assessment of the present value of net future cash flows directly or indirectly embodied in them, discounted to reflect both current interest rates and the market's assessment of the risk that the cash flows will not occur.\" The information about fair value is said to better enable \"investors, creditors, and other users to assess the consequences of an entity's investment and financing strategies, that is, to assess its performance.\"\nNonetheless, there are several factors which users of these financial statements should keep in mind regarding the fair values disclosed in this note. First, the statement acknowledges that there are uncertainties inherent in the process of estimating the fair value of financial instruments. Secondly, the statement covers only financial instruments, not other assets like premises, the fair value of which might differ significantly from the amounts at which they are carried in an entity's financial statements. Thirdly, the Company must exclude from its estimate of the fair value of deposit liabilities any consideration of its on-going customer relationships which provide stable sources of investable funds. Lastly, the statement does not address means of evaluating an entity's performance in areas other than the management of financial instruments, for example the ability to generate noninterest income and the control of noninterest expense. For these reasons, users are advised not to regard the disclosure of the fair market value of financial instruments as in any way equivalent to a valuation of the Company as a whole.\nThe following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:\nCash\nThe face value of cash is its fair value.\nSecurities and bankers' acceptances\nFor securities and bankers' acceptances, fair value equals quoted market price, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities. Because of the implementation of SFAS 115 as explained in Note 1, a portion of the securities portfolio is carried at fair value.\nLoans\nThe fair value of loans is estimated by discounting the future contractual 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. These contractual cash flows are adjusted to reflect estimates of uncollectible amounts.\nDeposit liabilities\nThe fair value of demand deposits, money market accounts, and savings accounts is the amount payable on demand as of December 31 of each year. The fair value of fixed-maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities.\nRepurchase agreements, Federal funds purchased, and other borrowings\nFor these short-term instruments, the carrying amount is a reasonable estimate of their fair value.\nCommitments to extend credit, standby letters of credit, and financial guarantees written\nThe fair value of guarantees and letters of credit is based on fees currently charged for similar agreements. The Company seldom charges fees for loan commitments. The Company does not believe that these commitments have a fair value within the context of SFAS 107 because generally fees are not being charged, the use of the commitment is at the option of the potential borrower, and the commitments are being written at rates comparable to current market rates.\nThe Company has no financial instruments covered by the statement for which it is not practicable to estimate a fair value.\nThe carrying amount and estimated fair values of the Company's financial instruments as of December 31, 1995 and 1994 are as follows:\n15. Other Postretirement Benefits\nWith the adoption of Statement of Accounting Standards No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions (\"SFAS 106\") as of the beginning of 1992, the Company recognizes the net present value of the estimated future cost of providing health insurance benefits to retirees as those benefits are earned rather than when paid. To formalize the terms for the provision of these benefits, the Company established the Retiree Health Plan.\nUnder the provisions of the Retiree Health Plan, all eligible retirees may purchase health insurance coverage through the Company. The cost of this coverage is that amount which the Company pays under the basic coverage plan provided for current employees. Based on a formula involving date of retirement, age at retirement, and years of service prior to retirement, the Plan provides that the Company will contribute a portion of the cost for the retiree, varying from 60% to 100% at the time the employee retires, with the stipulation that the cost of the portion paid by the Company shall not increase by more than 5% per year.\nThe statement defines the Company's accumulated postretirement benefit obligation (\"APBO\"). This obligation is the actuarial net present value of the obligation for fully eligible plan participants' expected postretirement benefits plus the portion of the expected postretirement benefit obligation for other active plan participants attributed to service as an employee.\nThis obligation must be remeasured each year because it changes with each of the following factors: 1) the number of employees working for the Company; 2) the average age of the employees working for the Company; 3) increases in expected health care costs; 4) the amount of earnings anticipated on plan assets; and 5) prevailing interest rates. In addition, because the obligation is measured on a net present value basis, the passage of each year brings the eventual payment of benefits closer, and therefore causes the obligation to increase. The following table shows the amount of the APBO, the fair value of the plan assets held by the Retiree Health Plan, and the accrued postretirement benefit cost as of December 31, 1995 and 1994:\nThe accrued postretirement benefit costs of $435,000 and $223,000 are included within accrued interest payable and other liabilities in the consolidated balance sheets for December 31, 1995 and 1994, respectively.\nEach year the Company is required to recognize a portion of the change in the APBO. This portion is called the net periodic postretirement benefit cost (the \"NPPBC\"). The NPPBC, included with the cost of other benefits in the Consolidated Statements of Income is made up of several components as shown in the next table.\nThe first component is service cost, which is the net present value of the portion of the expected postretirement benefit obligation for active plan participants attributed to service for that year. The second is interest cost, which is the increase in the accumulated postretirement benefit obligation that results from the passage of another year. That is, because the benefit obligation for each employee is one more year closer to being paid, the net present value increases. The third component, return on assets, is the income earned on any investments that have been set aside to fund the benefits. This return is an offset to the other components.\nThe fourth component, amortization cost, arises because significant estimates and assumptions about interest rates, trends in health care costs, employee turnover, and earnings on assets are used in measuring the APBO each year. Actual experience may differ from the estimates and assumptions may change. Both of these cause increases or decreases in the APBO or the value of plan assets. In the last several years, changes in the discount rate used in measuring the APBO at one year-end and the NPPBC for the next year have had significant impact. The following table discloses the discount rates that have and will be used:\nFor Determining For Measuring the NPPBC for Discount the APBO at the Year Ended Rate Used December 31 December 31 8.90% 1992 1993 7.12% 1993 1994 8.73% 1994 1995 7.06% 1995 1996\nThe discount rate is selected each year by reference to the current rates of investment grade corporate bonds. Higher discount rates lower the APBO at the end of the year and the NPPBC to be recognized for the following year, while lower rates raise both.\nRather than the whole amount of the change in the APBO being recognized in the year after it arises, the statement provides for gains or losses arising from these changes in experience and\/or assumptions to be recognized through amortization over the average remaining service lives of the employees. Amortization over time is used because many of these changes may be partially or fully reversed in subsequent years as further changes in experience and\/or assumptions occur.\nAt the time of implementing the statement, the Company fully recognized the net present value of the benefits earned by employees for prior service. Had the Company not recognized this amount, a portion of it would be included in the NPPBC as a fifth component.\nAmong the significant estimates or assumptions used in determining the APBO are the rate of earnings on assets which will be available to offset the other components and the annual increase in medical insurance premiums. While the discount rate used in the present value computation of the APBO has fluctuated with market rates, the Company has continued to use 7.0% as its estimate of the long-term rate of return on plan assets. As noted above, the Retiree Health Plan provides for the Company's contribution for insurance premiums to be limited to an annual increase of 5%. Should insurance premiums increase at a higher rate, the retirees will need to contribute a larger portion of the total premium cost. Therefore, 5% has been set as the assumed cost trend rate for health care. Because of this limitation, an increase in the actual cost of health care will have no impact on the APBO.\nUnder the provisions of SFAS 106, employers are allowed wide discretion as to whether and how they set aside funds to meet the obligation they are recognizing. Under the provisions of the current Internal Revenue Code, only a portion of this funding may be deducted by the employer. The funded status of the plan is shown in the previous table as the excess of the APBO over plan assets.\nThe Company established a Voluntary Employees' Beneficiary Association (\"VEBA\") to hold the assets that will be used to pay the benefits for participants of the plan other than key executive officers. Most of the plan assets have been invested in insurance policies on the lives of various employees of the Company.\nThe current funding policy of the Company is to contribute assets to the VEBA sufficient to pay the costs of current medical premiums of retirees and the costs of the life insurance premiums. Proceeds from the life policies payoffs will fund benefits and premiums in the future.\nAs of December 31, 1995, the VEBA was underfunded by $420,000. The APBO related to the key employees of $299,000 is totally unfunded.\n16. COMMITMENTS AND CONTINGENCIES\nThe Company leases several office locations and substantially all of the office leases contain multiple five-year renewal options and provisions for increased rentals, principally for property taxes and maintenance. As of December 31, 1995, the minimum rentals under non-cancelable leases for the next five years and thereafter are as follows:\nTotal net rentals for premises included in other operating expenses are $2,127,000 in 1995, $1,801,000 in 1994, and $1,552,000 in 1993.\nThe Company is currently leasing space from a partnership in which a director has an interest. The original terms of the lease were negotiated with the assistance of two independent, outside appraisers, and the lease was approved by the Board of Directors of the Company. The Company exercised its option to renew the lease in 1989. In 1994, the Company renegotiated the lease to receive other rights such as additional lease option periods and a right of first refusal to purchase the building if it is offered for sale. The nominal monthly rent increased to obtain these benefits, but the actual outlay was reduced in order for the Company to be reimbursed for advancing the partnership's share of seismic improvements made to the leased property in 1994. The above schedule of lease commitments includes the terms of the current agreement. Management believes the terms of the revised lease are comparable with terms which would be available with unaffiliated third parties and the terms were also approved by the Company's Board of Directors.\nIn the normal course of business to meet the financing needs of its customers, the Company is a party to financial instruments with \"off- balance sheet\" risk. These financial instruments consist of commitments to extend credit and standby letters of credit.\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. The Company almost never charges fees in connection with loan commitments. Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The Company charges a fee for these letters of credit.\nThe standby letters of credit involve, to varying degrees, exposure to credit risk in excess of the amounts recognized in the statement of financial position. This risk arises from the possibility of the failure of the customer to perform according to the terms of a contract that would cause a draw on a standby letter of credit by a third party. To minimize the risk, the Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. The decision as to whether collateral should be required is based on the circumstances of each specific commitment or conditional obligation. Because of these practices, Management does not anticipate any significant losses will arise from such draws.\nChanges in market rates of interest for those few commitments and undisbursed loans which have fixed rates of interest represent a possible cause of loss by the contractual requirement to lend money at a rate that is no longer as great as the market rate at the time the loan is funded. To minimize this risk, if rates are quoted in a commitment, they are generally stated in relation to the Company's base lending rate which varies with prevailing market interest rates. Fixed-rate loan commitments are not usually made for more than 3 months.\nThe maximum exposure to credit risk is represented by the contractual notional amount of those instruments. As of December 31, 1995 and 1994, the contractual notional amount of these instruments are as follows:\nSince many of the commitments are expected to expire without being drawn upon, the amounts above do not necessarily represent future cash requirements.\nThe Company has concentrated its lending activity almost exclusively with customers within Santa Barbara and Ventura Counties. The business customers are in widely diversified industries, and there is a large consumer component to the portfolio. The largest concentration of loans is to real estate developers, but the nature of the properties is quite varied: 1-4 family residential, multifamily residential, and commercial buildings of various kinds. Continued increases in interest rates may cause delay in the sale or lease of some of these properties, and the Company has considered this in evaluating the adequacy of the allowance for loan loss.\nThe Company has a trust department that has fiduciary responsibility for the assets that it holds on behalf of its trust customers. These assets are not owned by the Company and accordingly are not reflected in the accompanying consolidated balance sheets.\nThe Company is involved in various litigation of a routine nature which is being handled and defended in the ordinary course of the Company's business. In the opinion of management, the resolution of this litigation will not have a material impact on the Company's financial position.\n17. SANTA BARBARA BANCORP\nSanta Barbara Bancorp is the parent company and sole owner of the Bank. However, there are legal limitations on the amount of dividends which may be paid by the Bank to the Company. At December 31, 1995, the Bank could have declared dividends of approximately $28.9 million to the Company. Federal law also restricts the Bank from extending credit to the Company by making any such extensions of credit subject to strict collateral requirements. The condensed financial statements of the parent company only are presented on this and the following page.\nIN MEMORIUM: George H. Clyde 1918-1996 A founding member of the Bank Board of Directors\nThe members of the Board of Directors extend a cordial invitation to attend the Annual Meeting of Shareholders to be held Tuesday, April 23, 1996 at 2 PM at the Lobero Theatre in Santa Barbara.\nTo Our Shareholders:\nOur communications with you is important to us. Throughout the year we will continue to mail our publications summarizing pertinent information about the Bank and its financial performance.\nShareholders with inquiries about stock ownership, changes of address, transfer or re-registration activity, dividend payments, etc., may call or write to me for information. Securities analysts, portfolio managers, representatives of financial institutions or other interested parties seeking financial and operating information are also invited to contact me for information about the Bank.\nBest Wishes,\nClare M. McGivney, Ph. D. Assistant Vice President, Corporate Services Administrator, and Assistant Corporate Secretary Santa Barbara Bancorp 1021 Anacapa St. (or) P.O. Box 1119 Santa Barbara, CA 93102 (805) 564-6302\nConcept and Design: H. George Kallusky, SBB&T, Vice President Typography: Karyn Young Designs Lithography: Haagen Printing and Offset Photography: Wm. B. Dewey Photography Line Drawing Art: Brennen McElhaney Front Cover: OAK TREE COUNTRY, oil, 12\" x 16\" Ted Goerschner, original member of Oil Painters of America\nExhibit 21 SUBSIDIARIES OF REGISTRANT\nSanta Barbara Bank & Trust, a California corporation, doing business under name of Santa Barbara Bank & Trust\nSBBT Service Corporation, a California corporation, doing business under name of SBBT Service Corporation\nExhibit 23.1 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS\nAs independent public accountants, we hereby consent to the use of our report dated February 2, 1996, included in this Form 10-K. It should be noted that we have not audited any financial statements of Santa Barbara Bancorp and Subsidiaries subsequent to December 31, 1995, or performed any audit procedures subsequent to the date of our report.\n(Handwritten signature)\nARTHUR ANDERSEN LLP Los Angeles, California February 2, 1996\nExhibit 23.2\nCONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS\nAs independent public accountants, we hereby consent to the incorporation of our report dated February 2, 1996, incorporated by reference in this Form 10-K, into Santa Barbara Bancorp's previously filed Form S-8 Registration Statements File Nos. 33-5493, 2-83293 and 33-43560 and 33-48724.\n(Handwritten signature)\nARTHUR ANDERSEN LLP Los Angeles, California March 27, 1996","section_15":""}
{"filename":"801550_1995.txt","cik":"801550","year":"1995","section_1":"ITEM 1. BUSINESS\nOVERVIEW\nDVI, Inc. (\"DVI\" or \"the Company\") is a specialty finance company whose core business is financing higher cost diagnostic imaging, radiation therapy and other types of sophisticated medical equipment by outpatient healthcare centers, groups of physicians and hospitals. The Company has extensive expertise in making large loans to healthcare providers in markets underserved by most banks and finance companies. By servicing the equipment financing needs of these healthcare providers and the corresponding need for equipment manufacturers to arrange financing for their customers, the Company has established a niche leadership position among independent finance companies serving the medical industry. In addition to equipment financing, a small but growing part of the Company's business is making working capital loans to outpatient healthcare providers secured by their medical receivables and other collateral.\nVirtually all of the Company's equipment loans are structured on a fixed interest rate basis such that the full cost of the equipment and all financing costs are repaid during the financing term, which typically is five years. The Company's risk management strategy is to minimize risks associated with the residual value of equipment and of loan prepayments and to minimize its exposure to interest rate fluctuations. A high percentage of the Company's equipment loans are structured as notes secured by equipment or direct financing leases with a bargain purchase option for the equipment user; however, the Company structures a few of its equipment loans such that it retains a residual interest in the equipment.\nIn the past two years, the Company has grown substantially. In fiscal 1995, the Company's loan origination volume increased approximately 107% to $338.0 million from $163.0 million for fiscal 1994. Loan origination volume increased approximately 178% to $163.0 million in fiscal 1994 as compared to $58.6 million for fiscal 1993. The Company's net financed receivables increased approximately 73% to $405.3 million at June 30, 1995 from $234.8 million at June 30, 1994. The Company's net financed receivables increased approximately 100% to $234.8 million at June 30, 1994 from $117.5 million at June 30, 1993.\nThe Company uses asset securitization and other structured finance techniques to permanently fund most of its equipment loans and since 1991 has funded $414.8 million of equipment loans in this manner. The Company's ability to securitize loans has improved significantly in recent years which enabled it to securitize loans in the public market in fiscal 1995. Access to the public securitization market has lowered the Company's relative funding costs and expanded the Company's access to funding.\nGROWTH STRATEGY\nThe Company's growth strategy is to increase the size of its loan portfolio by expanding its share of the diagnostic imaging and radiation therapy equipment financing markets and by generating financing opportunities in other areas of the healthcare industry. The principal components of this strategy are as follows:\no Maximize the value of its relationships with equipment manufacturers. The Company established a close working relationship with four of the six largest manufacturers of diagnostic imaging equipment by meeting their needs to arrange financing for the higher cost equipment they sell to non-hospital healthcare providers. The Company intends to continue to fulfill those needs and place greater emphasis on financing the lower cost patient treatment devices these manufacturers produce such as ultrasound, nuclear medicine and X-ray equipment, and on financing equipment for their hospital customers.\no Originate medical equipment loans on a wholesale basis. A growing part of the Company's equipment financing business is purchasing loans or leases originated by regional medical equipment finance companies and medical equipment manufacturers (collectively, \"Originators\"). The Company uses its securitization capabilities and its expertise in analyzing healthcare credits to service Originators that often need access to sources of permanent financing for the loans they originate.\no Generate additional business through its existing customer base. The Company enjoys relationships with a large number of users of sophisticated medical equipment. The Company believes its existing\ncustomers, particularly those that are expanding to provide additional healthcare services, can be a continuing source of equipment and medical receivable financing business. The Company's growth strategy in medical receivables financing is to focus on its existing customer base because it believes this will enable it to build this area of its business with comparatively little added expense and comparatively less risk.\no Establish equipment financing relationships with manufacturers of patient treatment devices. The Company intends to use its reputation as a medical equipment financing specialist and its ability to finance a wide range of healthcare providers to establish its presence in the patient treatment device market. The Company's objective is to build relationships with manufacturers of sophisticated patient treatment devices such as surgical lasers.\nHEALTHCARE FINANCING INDUSTRY\nCompetitors in the healthcare financing business include equipment manufacturers that sell and finance their products, leasing subsidiaries of national and regional commercial banks and other leasing and financing companies. Competition among providers of equipment financing varies based on the type of healthcare provider being financed and the acquisition cost of the equipment. When hospitals acquire capital equipment directly (i.e., they accept full financial liability), competitors are numerous as lenders generally can make credit decisions based on audited financial statements that normally reflect a financial condition that is strong relative to the cost of the equipment being acquired. The competition is similar when physician specialists such as radiologists are acquiring relatively inexpensive equipment (i.e., $200,000 or less). Many banks and finance companies are willing to make loans of this amount to physician specialists based solely on their personal net worth. Specialty finance companies, such as the Company, typically provide financing for borrowers other than those described above.\nCompetition in medical receivable financing is similar to that in medical equipment financing. Medical receivable financing is readily available for most hospitals and for physicians seeking relatively small amounts of funding. However, for outpatient healthcare providers seeking funding in excess of approximately $500,000, the principal sources of financing generally are limited to specialty finance companies or factoring companies that purchase receivables at a discount. The Company's strategy in medical receivables financing is to differentiate itself from many of its competitors by offering loans secured by medical receivables rather than purchasing receivables.\nMedical equipment financing providers often compete on the basis of relationships with manufacturers of the equipment being financed. General Electric Medical Systems and Siemens Medical Systems (which according to published sources together have approximately 40 to 50% of the U.S. market for diagnostic imaging equipment) have captive equipment financing subsidiaries. The four remaining major manufacturers of diagnostic imaging equipment depend largely on relationships with financing providers, such as the Company, to finance the sale of their products.\nSALES AND MARKETING\nThe Company generates most of its financing opportunities from two sources: (i) medical equipment manufacturers that use third parties to finance the sale of their products; and (ii) healthcare providers with whom the Company's sales organization has relationships. Generally, medical equipment manufacturers refer customers to the Company for financing because the Company has the ability to understand and measure the creditworthiness of the customer's business and provide the financing necessary for the completion of the equipment sale. The Company often assists the customer in preparing a comprehensive business and financial plan that generally includes a demographic study of the equipment user's market, an analysis of the local competition and the effect of managed care on the market and the specific requirements for regulatory compliance and working capital. The Company's sales force of financing specialists work with the equipment user, the manufacturer and the Company's credit department to formulate this business and financial plan.\nThe Company established a close working relationship with four of the six largest manufacturers of diagnostic imaging equipment by meeting their needs to arrange financing for the higher cost equipment they sell to non-hospital healthcare providers. These manufacturers are Hitachi Medical Systems America, Philips Medical Systems, Picker International and Toshiba America Medical Systems. The Company believes these relationships afford it a competitive edge over other providers of medical equipment financing. Since the January 1993 acquisition of MEF Corp., the Company has\nreorganized its sales force with a view to increasing the volume of business it conducts with those companies principally by focusing on the lower cost equipment sold by those companies.\nThe Company has a sales unit dedicated to its wholesale loan origination program (\"Wholesale Program\"). The Company purchases equipment loans from Originators that generally do not have access to cost effective permanent funding for their loans. The Company initiated the Wholesale Program in June 1994 and during the year ended June 30, 1995, the Company purchased an aggregate of $63.3 million of equipment loans from six Originators. The Company believes that it has an opportunity to increase the volume of loans it buys in this manner because the number of companies that finance Originators has declined in the past few years.\nIn addition to financing medical equipment, the Company also makes working capital loans under revolving lines of credit for outpatient healthcare providers that are secured by their receivables from payors such as insurance companies, large self-insured companies and governmental programs such as Medicare, and other collateral. These lines of credit are secured by (i) specific receivables due the provider that the Company has analyzed to determine the amount and likelihood of collection, (ii) the overall receivables portfolio of the healthcare provider and (iii) other forms of credit enhancement such as cash collateral, letters of credit and guarantees. The Company's two medical receivable loan specialists assist the Company's equipment loan sales force in originating medical receivables loans. The medical receivable loan business entails significant risks and capital requirements.\nThe Company is expanding into the patient treatment device market. The Company believes its ability to finance a wide range of healthcare providers and meet the equipment financing needs of major manufacturers of diagnostic imaging equipment will help it build relationships with patient treatment device manufacturers. To establish relationships with patient treatment device manufacturers, the Company expects to train the manufacturer's sales personnel in the use of equipment financing as a sales tool and to provide equipment financing programs that make these device manufacturers more competitive. The Company believes the patient treatment device market is more diverse than the diagnostic imaging market because of the larger number of manufacturers and types of products and the greater price range of those products. The patient treatment device manufacturers targeted by the Company produce relatively high cost treatment products such as surgical lasers.\nThe Company's sales and marketing organization consists of 26 healthcare finance specialists located in various parts of the U.S. These individuals generally have a credit industry and\/or medical equipment background. The Company generally locates sales personnel in geographic areas where they have knowledge of the local market. The Company believes that sales personnel who understand local economic and political trends are a valuable component of its credit underwriting process.\nCAPITAL RESOURCES AND TRANSACTION FUNDING\nThe Company obtains initial funding for most of its equipment loans through warehouse facilities. Funds borrowed through these facilities are repaid when the Company permanently funds its equipment loans through securitization or other limited recourse permanent funding programs, including loan sales. Typically, equipment loans will be held in warehouse facilities for 30 to 180 days before they are permanently funded. To protect its interest rate spreads during periods in which it has borrowed funds under its warehouse facilities, the Company sometimes employs a hedging strategy to mitigate the impact of changes in interest rates.\nWarehouse Facilities. At September 26, 1995, the Company had an aggregate maximum of $337.7 million potentially available under various warehouse facilities of which it had borrowed an aggregate of $169.6 million. These facilities are provided by a syndicate of banks that participate in a revolving credit arrangement and by two investment banking firms that the Company uses for securitization. The funds obtained through these warehouse facilities are borrowed on a floating interest rate and full recourse basis.\nSince the Company uses securitization as its primary source of permanent funding, the Company requires a substantial warehousing capacity. To be cost efficient, securitization must cover a relatively large and diverse portfolio of equipment loans. One of the basic requirements of the credit rating agencies that rate the notes issued in securitizations relates to borrower concentration and requires that no single credit (borrower) may constitute a significant portion of the pool of equipment loans being securitized (in the Company's case, the limit is generally about 3%). Because the Company's equipment loans are often in the $2.0 million range, it must generally accumulate in excess of $60 million in loans for each\nsecuritization. The credit rating agencies also have other concentration guidelines such as equipment type and the geographic location of the obligors. These strict requirements mean that not all of the equipment loans held in the Company's warehouse facilities at any point in time can be placed in one securitization.\nPermanent Funding Program. Since 1991, the most important source of permanent funding for the Company has been securitization and other forms of structured finance. Securitization is a process in which a pool of equipment loans (in the Company's case, typically 100 to 150) are transferred to a special-purpose financing vehicle which issues notes to investors. In the Company's case, the vehicle usually is an indirect wholly owned special purpose subsidiary, with the result that the subsidiary's assets and liabilities are consolidated with the Company's for financial accounting purposes. Principal and interest on the notes are paid from the cash flows produced by the loan pool, and the notes are secured by a pledge of the assets in the loan pool as well as by other collateral for other credit enhancement. In the Company's case, equipment loans funded through securitization must be credit enhanced to receive an investment grade credit rating. Credit enhancement can be provided in a number of ways, including cash collateral, letters of credit, a subordinated \"strip\" of transactions or an insurance policy. Typically, securitizations sponsored by the Company are enhanced through a combination of some or all of these methods.\nThe Company continually seeks to improve the efficiency of financing these transactions by reducing up front costs and minimizing the cash requirements of the Company. The Company may consider alternative structures, including senior\/subordinated tranches, and alternative forms of credit enhancement, such as letters of credit and surety bonds. The transaction expenses of each securitization and other forms of structured financing will depend on market conditions, costs of securitization and the availability of credit enhancement options to the Company. The Company expects to continue to use securitization and other forms of structured financing, on both a public and private basis, as its principal source of permanent funding for the foreseeable future.\nThe Company's financing strategy is to obtain permanent funding for most of its equipment loans through securitization and to sell the remainder of its equipment loans. Under current market conditions, the Company believes funding equipment loans through securitization is more cost effective than selling loans. However, the Company sells certain of its loans to reduce borrower concentration and to manage the Company's leverage. When the Company sells loans, it often is required to provide credit enhancement in a lesser amount than required when it uses securitization.\nHedging Strategy. The Company's equipment loans are all structured on a fixed interest rate basis. When the Company originates equipment loans, it bases its pricing in part on the \"spread\" it expects to achieve between the interest rate it charges its equipment loan customers and the effective interest cost it will pay when it permanently funds those loans. Increases in interest rates between the time the loans are originated and the time they are permanently funded could narrow, eliminate or result in a negative spread between the interest rate the Company realizes on its equipment loans and the interest rate that the Company pays under its warehouse facilities. To protect itself against that risk, the Company sometimes uses a hedging strategy. When the Company hedges against this risk, it does so either by assuming a short position in U.S. Treasury obligations of similar maturities to the specific equipment loans being held for securitization, or by entering into Treasury \"lock\" or \"swap\" transactions under which the Company will either pay to or receive from a counterparty funds in amounts calculated by reference to price movements of U.S. Treasury obligations of similar maturities to the respective equipment loans. The Company believes this strategy can help hedge against the interest rate risk associated with a portfolio of fixed rate equipment loans prior to permanent funding.\nMedical Receivable Financing. Until recently, the Company has funded its medical receivable financing business using its own working capital. During the fiscal quarter ended December 31, 1994, the Company's Revolving Credit Agreement was with a syndicate of banks lead by NatWest Bank, N.A. amended to permit the Company to use up to $7.0 million of the availability under the facility to fund loans to outpatient healthcare providers that are secured by medical receivables. The Company is seeking to develop new sources of funding for its medical receivable financing business, including several structured finance techniques.\nContinuing Need for Capital. The Company's ability to maintain and build its financing businesses is dependent on its continued ability to obtain the substantial amounts of warehouse and permanent debt financing it requires. In addition, in order to sustain continued growth, the Company will require significant amounts of additional capital. Because of its holding company structure, the Company can seek to satisfy its requirements for additional long-term debt and\/or equity\ncapital by issuing equity or debt securities at the parent company level and then contributing the proceeds of those financings to DVI Financial Services Inc. or DVI Business Credit Corporation (which are the Company's principal operating subsidiaries and the obligors under the Company's various warehouse facilities).\nOTHER BUSINESS ACTIVITIES\nGeneral. In 1991, the Company initiated a strategy to participate in the healthcare services business by making investments in emerging healthcare service companies and developing or acquiring healthcare facilities that it operated on a direct basis. Subsequent to the acquisition of Medical Equipment Finance Corporation (\"MEF Corp.\") in January 1993, the Company withdrew from this area to redirect capital, management and other resources invested in the healthcare services business to support the growth of the Company's financial services business. In March 1995, the Company sold its equity interest in SMT Health Services, Inc., a provider of mobile diagnostic imaging services.\nInvestments. In October 1991, the Company purchased an equity interest in Healthcare Imaging Services, Inc.(\"HIS\"), a company which provides diagnostic imaging and lithotripsy services in the northeast U.S. HIS's common stock is traded on the Nasdaq National Market under the symbol HISS. As of June 30, 1995, the Company owned approximately 17% of the common shares of HIS. The 800,000 common shares of HIS owned by the Company are carried on the Company's consolidated balance sheet at estimated fair value. As of June 30, 1995, the Company also owned approximately 8% of the common shares of Diagnostic Imaging Services, Inc. (\"DIS\"), a California corporation that owns and operates medical imaging facilities in Southern California. DIS's common stock is traded on the Nasdaq National Market under the symbol DIAM. The Company acquired these shares as a result of the September 1994 merger of DIS with and into IPS Health Care, Inc. (\"IPS\"). The 730,768 common shares of DIS owned by the Company are carried at estimated fair value on the Company's consolidated balance sheet. The Company initially made its investment in IPS, a diagnostic imaging service company, in 1992. In addition, the Company holds two seats on the Board of Directors of DIS.\nAs part of its strategy to operate exclusively as a financial services company, the Company intends to divest its equity interests in HIS and DIS and reduce its credit exposure to both companies. During the three-month period ended June 30, 1994, the Company completed a series of steps which significantly diminished its influence over HIS. Under arrangements made with HIS, the Company agreed to allow existing equipment loans between the Company and HIS to be refinanced through third parties and to terminate its first right of refusal for the financing of any future equipment acquisition with HIS. In addition, upon completion of such refinancing, the Company agreed to relinquish its seats on the Board of Directors of HIS and to sell the common shares it owned in HIS. During the refinancing period, the Company agreed to vote its common shares consistent with HIS's management.\nDiscontinued Operations. In June 1993, the Company adopted a formal plan to discontinue its healthcare services segment that consisted of seven outpatient healthcare facilities which it operated or managed on a direct basis and one facility which was in the developmental stage and not yet in operation. At the end of fiscal 1993, the Company established a reserve for the divestiture of the operations and recorded a loss on discontinued operations and disposal of discontinued operations. As of June 30, 1994, the Company had disposed of or entered into definitive agreements to sell six of these outpatient healthcare facilities, had written off the investment and assets of the remaining two, and recorded an additional $3.1 million after-tax charge in excess of the amounts of estimated losses reported as of June 30, 1993 for the disposition of this segment of the Company's business.\nCOMPETITION\nThe financing of sophisticated medical equipment is highly competitive. The Company competes with equipment vendors which sell and finance sales of their own equipment, finance subsidiaries of national and regional commercial banks and equipment leasing and financing companies. Many of the Company's competitors have significantly greater financial and marketing resources than the Company. In addition, the competition in the new markets recently targeted by the Company, specifically equipment financing in the hospital market, the patient treatment device market and medical receivable financing market, may be greater than the levels of competition historically experienced by the Company. There can be no assurance that the Company will be able to compete successfully in any or all of its targeted markets.\nGOVERNMENT REGULATION\nGeneral. The Company's equipment financing business, while generally not directly subject to government regulation, is indirectly affected by regulation in several ways. The operation of certain types of diagnostic imaging and patient treatment equipment is regulated by federal, state and\/or local authorities. For example, a shared service provider or healthcare provider using equipment financed by the Company may be required to obtain and maintain approvals from governmental authorities in order to service other healthcare providers with whom it has entered into service agreements. Failure by the Company's customers to comply with these requirements could adversely affect their ability to meet their obligations to the Company. The ability of the Company's equipment financing customers to satisfy their obligations to the Company could also be adversely affected by changes in regulations which limit or prohibit the referral of patients by physicians who have invested in healthcare facilities financed by the Company. Several of the regulatory factors impacting the Company's business are discussed below.\nCertificate of Need Regulation. Many states regulate the acquisition of medical equipment or the provision of new services through Certificate of Need or similar programs. The Company believes these requirements have had a limited effect on its business, although there can be no assurance that future changes in those laws will not adversely affect the Company. Additionally, repeal of existing regulations of this type in jurisdictions where the Company's customers have met the specific requirements could adversely affect the Company since such customers could face increased competition. In addition, there is no assurance that expansion of the Company's equipment financing business within the hospital market will not be increasingly affected by regulations of this type.\nMedicare-Medicaid Fraud and Abuse Statutes. The Department of Health and Human Services (\"HHS\") has increased its enforcement efforts under the Medicare-Medicaid Fraud and Abuse Statutes in cases where physicians own an interest in a facility to which they refer their patients for treatment or diagnosis. These statutes prohibit the offering, payment, solicitation or receipt of remuneration directly or indirectly as an inducement to refer patients for services reimbursable in whole or in part by the Medicare-Medicaid programs. HHS has taken the position that distributions of profits from corporations or partnerships to physician investors who refer patients to the entity for a procedure which is reimbursable under Medicare (government-assisted medical care for the aged) or Medicaid (government-assisted medical care for the poor) may be a form of remuneration for referrals which is prohibited by the statute. HHS has also published safe harbor guidelines which describe the requirements which must be met to ensure that distributions of profits to a physician who has invested in an equity security issued by a business to which he or she refers patients does not violate the Medicare-Medicaid fraud and abuse statute.\nFurther Regulation of Physician Self-Referral. Additional regulatory attention has been directed toward physician-owned healthcare facilities and other arrangements whereby physicians are compensated, directly or indirectly, for referring patients to such healthcare facilities. In 1988, legislation entitled the \"Ethics in Patient Referrals Act\" (H.R. 5198) was introduced which would have prohibited Medicare payments for all patient services performed by an entity in which a patient's referring physician had an investment interest. As enacted, the law prohibited only Medicare payments for patient services performed by a clinical laboratory. The Comprehensive Physician Ownership and Referral Act (H.R. 345), which was enacted by Congress in 1993 as part of the Deficit Reduction Package, is more comprehensive than H.R. 5198 and covers additional medical services including medical imaging, radiation therapy, physical rehabilitation and others. A variety of existing and pending state laws currently limit the extent to which a physician may profit from referring patients to a facility in which that physician has a proprietary or ownership interest. Many states also have laws similar to the Medicare fraud and abuse statute which are designed to prevent the receipt or payment of consideration in connection with the referral of a patient. The Company believes that as a result of these legislative initiatives, demand for new medical equipment by the outpatient healthcare facilities (which in many cases are owned by referring physicians who are directly affected by the legislation) has diminished.\nEMPLOYEES\nAs of September 15, 1995, the Company had 111 full-time employees consisting of 7 executive officers, 26 sales and sales management personnel, and 78 administrative, accounting and technical personnel. None of the Company's employees are covered by a collective bargaining agreement, and management believes that its relations with its employees are good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company owns no real property and leases all of its offices. The Company's principal executive offices are located in Doylestown, Pennsylvania. In total, the Company leases an aggregate of approximately 32,000 square feet of office space in California, Georgia, Minnesota, New York, Ohio and Pennsylvania. The Company believes that the present facilities are adequate to meet its foreseeable needs.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is not a party to any pending litigation or legal proceedings, or to the best of its knowledge any threatened litigation or legal proceedings, which, in the opinion of management, individually or in the aggregate, would have a material adverse effect on its results of operations or financial condition.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThere were no matters submitted to a vote of security holders during the three months ended June 30, 1995.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nAs of June 30, 1995, the executive officers of DVI were:\nDAVID L. HIGGINS is the Company's Chief Executive Officer and Chairman. From the inception of the Company until September 1994, Mr. Higgins served as the Company's President, Chief Executive Officer and Chairman. Mr. Higgins was also the President and Chief Executive Officer of Delta Health, Inc. (\"Delta Health\"), the predecessor company to DVI which he founded in 1985, and which was acquired by the Company in 1986. Prior to founding Delta Health, Mr. Higgins managed the North America sales and service operations of Elscint, Inc. (\"Elscint\"), for two years. Elscint is a full-line manufacturer of diagnostic imaging equipment based in Israel. Previously, Mr. Higgins held a similar position for one year with Xonics Medical Systems, Inc. (\"Xonics\"), which was acquired by Elscint in 1982. Xonics was also a full-line manufacturer of medical imaging equipment. Mr. Higgins presently serves on the Board of Directors of HIS.\nMICHAEL A. O'HANLON is the Company's President and Chief Operating Officer and has served as such since September 1994. Previously, Mr. O'Hanlon served as Executive Vice President of DVI since joining the Company in March 1993. Mr. O'Hanlon also serves on the Executive Committee of DVI, and is President of DVI Financial Services, Inc. His responsibilities also include the corporate finance functions of the Company. Prior to joining the Company, Mr. O'Hanlon served as President and Chief Executive Officer of Concord Leasing, Inc. (\"Concord Leasing\") for nine years. Concord Leasing provides medical, aircraft, shipping and industrial equipment financing. U.S. Concord, Inc. a subsidiary, provides equipment financing for the medical imaging industry. Previously, Mr. O'Hanlon was a Senior Executive with Pitney Bowes Credit Corporation. Mr. O'Hanlon received his Master of Science degree from the University of Connecticut and his Bachelor of Business Administration from the Philadelphia College of Textiles and Science. Mr. O'Hanlon became a director of DVI in November 1993.\nANTHONY J. TUREK is a Senior Vice President and the Chief Credit Officer of DVI. Mr. Turek has served in that capacity since March 1988. Mr. Turek also serves on the Executive Committee of DVI. Prior to joining the Company, Mr. Turek was Vice President, Commercial Banking at Continental Illinois National Bank (\"CINB\") in Chicago from 1968 to 1988. For the five years prior to joining DVI, Mr. Turek managed the equipment leasing and transportation divisions of CINB. Prior responsibilities included management positions in the Special Industries, Metropolitan and National Divisions of CINB. Before his employment with CINB, Mr. Turek was a Trust Officer with Bank of America. Mr. Turek received his Bachelor of Science degree from Iowa State University and his Masters of Science degree from the University of Missouri.\nJOHN P. BOYLE is a Vice President and Chief Accounting Officer of the Company. Mr. Boyle joined the Company in January 1995. His primary responsibility is managing the Company's accounting, tax and financial reporting functions. Before joining the Company, Mr. Boyle spent seventeen years of his professional career in senior finance and accounting positions with financial services organizations. He spent the initial five years of his career with Peat Marwick Mitchell & Co. in Philadelphia. Mr. Boyle is a General Securities Principal and a CPA with almost twenty years of experience in financial services industry. Beyond his accounting\nEXECUTIVE OFFICERS OF THE REGISTRANT (CONTINUED)\nbackground, he has extensive experience in credit and corporate finance matters. Mr. Boyle holds a Bachelor of Arts degree from Temple University.\nCYNTHIA J. COHN has been a Vice President of DVI since October 1988 and Executive Vice President of DVI Business Credit since January 1994. She is responsible for all sales and marketing functions of DVI Business Credit. Ms. Cohn has been employed by the Company in a sales and management capacity since July 1986. Ms. Cohn also handles certain shareholder relation functions for the Company. She served as an Assistant Vice President from July 1987 to October 1988. Prior to joining the Company, Ms. Cohn served as Research Coordinator for Cantor, Fitzgerald Co., Inc., a stock brokerage firm, from February 1983 to July 1986, where she was responsible for development and coordination of that firm's research product for both institutional and retail clientele. She holds a Bachelor of Arts degree from Ithaca College. Ms. Cohn is the daughter of Gerald L. Cohn, a Director of the Company.\nDOMINIC A. GUGLIELMI is a Vice President of DVI and the Group Managing Director of DVI Financial Services Inc., and has served as such since the acquisition of MEF Corp. by DVI in January 1993. Prior to joining the Company, Mr. Guglielmi served as the President of the Healthcare Division of U.S. Concord, Inc. for five years where he was responsible for sales, marketing, documentation, credit\/collections, financial budgeting and all aspects of strategic planning. Previously, Mr. Guglielmi held management positions with General Electric Credit Corporation and Pitney Bowes Credit Corporation. Mr. Guglielmi holds a Bachelor of Arts degree from LaSalle University.\nRICHARD E. MILLER is a Vice President of the Company who joined the Company in April 1994. His primary responsibility is to manage the Company's sales organization of financing specialists that interface directly with the Company's customers. Before joining the Company, he served for six years as Vice President Sales for Toshiba America Medical Systems, a major distributor of medical imaging equipment. Previously, Mr. Miller was National Sales Manager for Thomsen CGR, a French manufacturer of medical imaging equipment, which was acquired by General Electric Medical Systems. He also previously served in sales management with General Electric Medical Systems. Mr. Miller has a Bachelor of Arts degree from Eastern University.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nPrice Range of Common Stock\nThe following table sets forth high and low last reported sales prices per share of Common Stock on the New York Stock Exchange, Inc. for the periods indicated.\nDIVIDEND POLICY\nThe Company has not declared or paid any cash dividends since its inception, and the Company anticipates that any future earnings will be retained for investment in corporate operations. Any declaration of dividends in the future will be determined in light of the conditions affecting the Company at that time, including, among other things, its earnings, financial condition, capital requirements, level of debt and the terms of any contractual limitations on dividends. The Company's principal warehouse facility prohibits DVI Financial Services, the Company's principal operating subsidiary, from paying cash dividends. In addition, the agreement with respect to the Company's 9-1\/8% Convertible Subordinated Notes due 2002 (the \"Convertible Subordinated Notes\") places limitations on the payment of dividends by the Company and its subsidiaries.\nAs of June 30, 1995, there were approximately 2,450 beneficial holders of the Company's Common Stock.\nITEM 6.","section_6":"ITEM 6. SUMMARY CONSOLIDATED FINANCIAL AND OPERATING INFORMATION (IN THOUSANDS, EXCEPT PER SHARE DATA)\nThe Company has not declared or paid any cash dividends since its inception. (See Dividend Policy.)\n(See Notes 2, 3 and 15 to the accompanying Consolidated Financial Statements for discussion of discontinued operations and acquisitions and the effect on operations therefrom and earnings per share calculation.)\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nGENERAL\nEquipment Financing. For accounting purposes, the Company classifies equipment loans it originates as notes secured by equipment, direct financing leases or operating leases. Notes secured by equipment and direct financing leases are generally those transactions in which the obligor has substantially all of the benefits and risks of ownership of the equipment. Operating leases are generally those which only provide for the rental of the asset. The different classifications can result in accounting treatments that provide substantially different income and costs during the transaction term. Direct financing leases and notes secured by equipment are reflected on the Company's balance sheet as \"investment in direct financing leases and notes secured by equipment.\" For statement of operations purposes, those transactions result in amortization of finance income over the transaction term in the amounts computed using the interest method.\nThe Company enters into two types of direct financing lease transactions, which are referred to as \"conditional sales agreements\" and \"fair market value transactions.\" Conditional sales agreements and notes secured by equipment represent those transactions in which no residual interest in the underlying equipment is retained by the Company. Fair market value transactions are those transactions in which the Company retains a residual interest in the equipment. This residual interest is recorded on the Company's books as an estimate of the projected value of the financed equipment at the end of the transaction term. At the inception of notes secured by equipment and direct financing lease transactions, \"unearned income\" represents the amount by which the gross transaction receivables, initial direct costs and the nominal estimated residual value (on fair market value transactions) exceed equipment cost.\nSubsequent to the January 1993 acquisition of MEF Corp., the Company significantly reduced its emphasis on entering into fair market value transactions and adopted a strategy to reduce the dollar amount of residual valuation on its balance sheet. As of June 30, 1995, residual valuation decreased to $3.6 million from $6.2 million at June 30, 1993, and from 5.3% of net financed receivables as of June 30, 1993 to 0.9% at June 30, 1995. Accordingly, during this period the percentage of the Company's equipment financing transactions structured as loans and conditional sales agreements have increased significantly. The Company believes that loans and conditional sales agreements will constitute a high percentage of its equipment financing transactions in the future.\nLeases and contracts for the rental of equipment which do not meet the criteria of direct financing leases are accounted for as operating leases. Equipment under an operating lease or a rental contract is recorded on the balance sheet at the Company's cost under the caption of \"equipment on operating leases\" and depreciated on a straight-line basis over the estimated useful life of the equipment.\nThe Company has classified income under the categories of \"amortization of finance income,\" \"receivables finance income,\" \"gain on sale of financing transactions\" and \"other income.\" Amortization of finance income consists of the interest component of payments received on notes secured by equipment (or medical receivables) and direct financing leases, and is calculated using the interest method whereby the income is reported over the term of the transactions. \"Gain on sale of financing transactions\" consists of gains recognized when the Company permanently funds transactions through whole loan sales. \"Receivables financing income\" consists primarily of purchased receivables income and income from the billing and collecting of medical receivables. The Company withdrew from the business of billing, collecting and purchasing medical receivables late in fiscal 1994, but will continue to record income as the receivables outstanding as of such date are collected by the third parties that the Company hired to service these accounts. On an ongoing basis, the Company evaluates the collectibility of these receivables and records a provision for amounts deemed uncollectible. In the event the aggregate uncollected amounts with respect to receivables the Company purchased exceeds amounts reserved for losses with respect thereto, the Company will record a loss. \"Other income\" consists primarily of late charges, dividends on investment in investee's preferred stock and income from operating leases.\nNotes secured by equipment and direct financing lease transactions are all noncancelable \"net\" transactions under which the obligor must make all scheduled payments, maintain the equipment, insure the equipment against casualty loss and pay all equipment related taxes. In fair market value transactions, at the end of the initial financing term, the obligor has the option either to purchase the equipment for its fair market value, extend the financing term under renegotiated\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED\nGENERAL (CONTINUED)\npayments or return the equipment to the Company. If the equipment is returned to the Company, the Company must sell or lease the equipment to another user.\nIn accordance with generally accepted accounting principles (\"GAAP\"), in transactions classified as notes secured by equipment and direct financing leases that the Company permanently funds through securitization or other structured finance transactions whereby the Company treats the funds received as debt, income is deferred and recognized using the interest method over the respective terms of the transactions. If an obligor under a transaction defaults, the Company may not receive all or a portion of the unamortized income associated with the transaction.\nMedical Receivable Financing. A small portion of the Company's business is providing lines of credit under which the Company makes full recourse loans to outpatient healthcare providers that are secured by medical receivables and other collateral. The respective interest and fee income from these loans are recognized over the terms of the lines of credit which are typically one to three years and are recorded as amortization of finance income.\nDiscontinued Operations. In June 1993, the Company announced its decision to dispose of seven outpatient healthcare facilities which it operated or managed on a direct basis and one facility which was in the developmental stage and not yet in operation. At June 30, 1993, the Company established a reserve for the divestiture of the operations and recorded a loss on discontinued operations and disposal of discontinued operations of $1.9 million net of tax. This estimate was based on certain assumptions as to the likely timing of the divestitures, the estimated proceeds to be received upon the sale of certain of the facilities and the financial results of those operations pending divestiture. These operations have been reflected as discontinued operations in the Company's financial statements at June 30, 1993 and 1994. The pre-tax loss from discontinued operations of $3.3 million at June 30, 1993 was comprised of $2.6 million relating to actual and estimated losses from operations of this segment through the date of disposition and $720,000 relating to estimated losses to be incurred upon the disposition of the segment's net assets.\nAt June 30, 1994, the Company had disposed of or entered into definitive agreements to sell six of these outpatient healthcare facilities and had written off the investment in and assets of the remaining two. In connection with the disposal of these facilities, the Company retained certain assets and liabilities of these facilities, primarily accounts receivable and accounts payable. The Company's results of operations for fiscal 1994 include an additional $3.1 million net after tax change in estimate in the amounts reported as of June 30, 1993 for the disposition of this segment of the Company's operations. The change in estimate was comprised almost entirely of a change in the estimate, in the quarter ended June 30, 1994, in the estimated proceeds from the disposition of underlying healthcare operations assets which included goodwill, other intangibles, equipment and other assets. The change in estimate reflects the complete disposal or write-off of the discontinued operations segment.\nRESULTS OF OPERATIONS\nImpact of Financing Strategies on Results of Operations\nThe Company's financing strategy is to obtain permanent funding for most of its equipment loans through securitization and to sell the remainder to reduce borrower concentration and to manage the Company's leverage. When funding loans through securitization, the issuer generally can structure the securitization so that the proceeds received are treated either as borrowed funds (i.e., debt on the issuer's financial statements) or funds it receives as a result of the sale of the underlying equipment loans. The accounting method to report finance income differs significantly depending on which of the two structures the issuer uses. When the proceeds received are treated as long-term debt, the issuer reports finance income over the term of the equipment loans that are funded. When the proceeds are treated as funds received from the sale of equipment loans, the income is generally reported at the time the equipment loans are funded. The Company uses the first alternative to recognize finance income when it sponsors a securitization; this means the Company treats the proceeds received as long-term debt on its financial statements and reports the finance income on its subordinated interest over the term of the equipment loans that are funded. When the Company sells loans, it generally\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED\nRESULTS OF OPERATIONS, (CONTINUED)\nrecognizes the unamortized finance income at the time the funding takes place; however, it may recognize servicing and\/or interest income on its subordinated interest over the remaining term of the equipment loans sold. Since the Company permanently funds most of its equipment loans by securitization or other forms of structured finance and therefore reports the finance income from these equipment loans over approximately five years, its near-term reported earnings are comparatively lower than they would be if the Company sold all of the loans.\nOver the past two years the Company has focused its strategy on increasing its market share. There can be no assurance that the Company's historical growth rate or current profitability can be sustained in the future. Additionally, the Company's expense levels are based in part on its expectations as to future financing volumes and the Company may be unable to adjust spending in a timely manner to compensate for a decrease in demand for financing of medical equipment. Accordingly, operating results may be adversely impacted. Fluctuations in operating results may also result in volatility in the price of the Company's stock. The Company believes that general economic conditions have not had a material adverse effect on the Company's recent operating results. There can be no assurances, however, that economic conditions will not have a material adverse effect on the Company in the future.\nYear Ended June 30, 1995 Compared to Year Ended June 30, 1994\nThe Company originated $338.0 million of loans for the year ended June 30, 1995, as compared to $163.0 million for the year ended June 30, 1994, an increase of 107%. This increase resulted from increased funding capacity and efficiency and improvements in sales and marketing capabilities, including the implementation of the Wholesale Program. Of this $175.0 million increase, $63.3 million represented loan originations under the Wholesale Program. The Company experienced an 82% increase in its average net financed receivables to $320.1 million for the year ended June 30, 1995, from $176.1 million for the year ended June 30, 1994. Average net financed receivables is calculated based on period beginning and period ending balances.\nAmortization of finance income increased 87% to $34.3 million for the year ended June 30, 1995 from $18.3 million for the year ended June 30, 1994. The increase was primarily a result of the overall increase in the size of the Company's net financed receivables.\nReceivables financing income decreased 76% to $355,000 in fiscal 1995 from $1.5 million in fiscal 1994 due primarily to the fact that the Company discontinued its billing and collecting of medical receivables operations late in fiscal 1994.\nThe gain on sale of financing transactions, net increased 907% to $3.0 million for the year ended June 30, 1995 compared with a gain of $302,000 for the same period in the prior year. The increase relates to the Company's need to fund certain loans through whole loan sales to manage borrower concentrations.\nOther income, which consists primarily of late charges and other fees, dividends on investment in investee's preferred stock and operating lease income increased 52% to $1.3 million in fiscal 1995 as compared to $883,000 in fiscal 1994. The increase is due primarily to the preferred stock dividend and an increase in miscellaneous fees partially offset by a decrease in operating lease income.\nFor the year ended June 30, 1995, interest expense increased 160% to $22.9 million from $8.8 million during the same period in the prior year. For the year ended June 30, 1995, the Company's average indebtedness (calculated based on period beginning and period ending balances) increased 94% to $285.9 million from $147.3 million during the same period in the prior year. The increase in interest expense and average indebtedness is primarily a result of the growth of the Company's loan portfolio. As a percentage of total finance and other income, interest expense was 59% in the year ended June 30, 1995 compared to 42% in the same period a year earlier. The increase in interest expense as a percent of total finance and other income is primarily the result of (a) increased short-term interest rates when utilizing variable interest rate warehouse facilities including the Bank Revolving Credit Agreement for interim funding purposes\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED\nRESULTS OF OPERATIONS, (CONTINUED)\nas well as (b) increased long-term interest rates when utilizing asset securitization for permanent funding purposes.\nMargins earned were $16.2 million for the year ended June 30, 1995, as compared to $12.1 million for the year ended June 30, 1994, an increase of 34%. The increase was primarily a result of the overall increase in the size of the Company's loan portfolio.\nSelling, general and administrative expense (\"SG&A\") increased 18% to $9.2 million for the year ended June 30, 1995 from $7.8 million for the year ended June 30, 1994. The increase primarily reflects additional personnel, and other costs associated with the growth in the Company's business. As a percentage of total finance and other income, SG&A was 23% for the year ended June 30, 1995 versus 37% for the same period last year. The percentage decrease in SG&A is a result of the Company's ability to increase the volume of transactions entered into and thus the size of its loan portfolio without a proportionate increase in SG&A.\nThe Company's SG&A includes the provision for doubtful accounts. That provision was $1.3 million for the year ended June 30, 1995 as compared to $1.7 million for the same period the previous year. On a quarterly basis, the Company evaluates the collectibility of its receivables and records a provision for amounts deemed uncollectible. In the opinion of management, the provisions are adequate based on current trends in the Company's delinquencies and losses.\nThe Company's net earnings were $4.1 million or $.61 per share for the year ended June 30, 1995 as compared to net earnings from continuing operations of $2.3 million or $.34 per share in the prior year.\nThe Company's cash and cash equivalents at June 30, 1995 and June 30, 1994 were $2.0 million and $1.7 million, respectively. The increase was attributable to the uninvested proceeds from the Company's most recent securitization. The following describes the changes from June 30, 1994 to June 30, 1995 in the items which had the most significant impact on the Company's cash flow during the year ended June 30, 1995.\nThe Company's net cash used in operating activities was $1.9 million during the year ended June 30, 1995 compared to $18.7 million net cash provided by operations for the year ended June 30, 1994. The increase in cash utilization during the year ended June 30, 1995 stems largely from a reduction in the Company's accounts payable from June 30, 1994 by $17.8 million. The decrease in accounts payable, which consists primarily of amounts due manufacturers of equipment that the Company has financed, stems from payments made to these manufacturers during the year ended June 30, 1995.\nThe Company's net cash used in investing activities increased to $174.2 million during the year ended June 30, 1995 as compared to $119.6 million for the year ended June 30, 1994. This increase is attributed primarily to cash used to acquire equipment and to finance notes secured by equipment of $319.0 million during the year ended June 30, 1995 compared to $149.0 million for the year ended June 30, 1994. These uses of cash were offset by $161.4 million and $34.6 million of receipts in excess of amounts included in income and proceeds from sales of financing transactions for the same periods.\nThe Company's net cash provided by financing activities was $176.4 million during the year ended June 30, 1995 up from $100.5 million for the year ended June 30, 1994. This results from a net increase in the Company's borrowings under warehouse facilities of $120.6 million for the year ended June 30, 1995 as compared to a $10.6 million net decrease in borrowings under warehouse facilities for the year ended June 30, 1994.\nYear Ended June 30, 1994 Compared to Year Ended June 30, 1993\nThe Company originated $163.0 million of loans in fiscal 1994, as compared to $58.6 million in fiscal 1993, an increase of 178%. The increase from period to period was primarily because the Company expanded its equipment financing capabilities as a result of its acquisition of MEF Corp. in January 1993. The Company's average net financed\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED\nRESULTS OF OPERATIONS, (CONTINUED)\nreceivables increased 73% to $176.1 million for the period ended June 30, 1994, from $101.5 million for the period ended June 30, 1993. The Company experienced a decrease in its residual valuation to $3.7 million at June 30, 1994, from $6.2 million at June 30, 1993. The decrease stems primarily from the Company's sale of residuals totalling $1.2 million and the Company's strategy to reduce the number of loans in its portfolio in which residual values are recorded.\nAmortization of finance income increased 69% to $18.3 million for fiscal 1994 from $10.8 million for fiscal 1993. Although the Company's net financed receivables increased significantly, the amortization of finance income did not increase on a proportionate basis due to four factors: (i) the Company's strategy to originate equipment loans in which residual positions are not retained reduced the Company's rate of return on the respective transactions; (ii) the Company has narrowed the interest rate spread between the Company's costs of funding its equipment loans and the interest rates charged its customers; (iii) the volume of equipment loans originated in fiscal 1994 was greater in the second half of the year than in the first half; and (iv) the interest rates under the Company's warehouse facilities increased during the year which increased interest expense and thus reduced margins.\nReceivables financing income increased to $1.5 million in fiscal 1994 from $1.3 million in fiscal 1993. Although the Company's notes collateralized by medical receivables portfolio increased significantly, receivable financing income did not increase on a proportionate basis primarily because the increase in the Company's volume of medical receivables financing transactions occurred late in fiscal 1994. Consequently, receivables financing income as a percent of the notes collateralized by medical receivables was reduced.\nGain on sale of financing transactions, net declined 73% to $302,000 in fiscal 1994 from $1.1 million in fiscal 1993 due to the reduction in the number and dollar amount of equipment loans funded through whole loan sales and the increased use of securitization to obtain permanent funding for the Company's equipment loans.\nOther income, which consists of late charges, operating lease income, management income and other miscellaneous items decreased 55% to $883,000 in fiscal 1994 from $2.0 million for fiscal 1993. This decrease was due to a decline in net operating lease income. Net operating lease income declined 74% to $359,000 in fiscal 1994 from $1.4 million in fiscal 1993 as a result of the Company's strategy to reduce its originations of operating leases and the expiration of two substantial transactions near the end of fiscal 1993.\nInterest expense increased 76% to $8.8 million in fiscal 1994 from $5.0 million in fiscal 1993. For fiscal 1994, the Company's average indebtedness increased 92% to $147.3 million from $76.7 million during fiscal 1993. This increase stems primarily from an increase in the average outstanding balance of long-term debt during fiscal 1994 as compared to fiscal 1993. As a percentage of total finance and other income, interest expense was 42% for fiscal 1994 as compared to 33% in fiscal 1993. The increase in interest expense as a percent of total finance and other income is principally the result of: (i) the Company narrowing the interest rate spread between the cost of its funding and the interest rate charged its customers; (ii) the interest rates under the Company's warehouse facilities increasing during the year; and (iii) the Company's strategy to originate equipment loans in which residual positions are not retained reducing the Company's rate of return and thus its income on the respective equipment loans. Consequently, as a percentage of finance and other income, interest expense increased in fiscal 1994.\nMargins earned were $12.1 million in fiscal 1994 as compared to $10.2 million in fiscal 1993, an increase of 19%. The increase in fiscal 1994 over fiscal 1993 was primarily a result of the overall increase in the size of the Company's loan portfolio.\nSG&A increased 37% to $7.8 million in fiscal 1994 from $5.7 million in fiscal 1993. The largest component of this increase is a $1.4 million increase in the Company's provision for doubtful accounts which in fiscal 1994 was attributable to the growth of the Company's loan portfolio. The increase also reflects costs associated with additional personnel and related costs incurred in connection with the Company's acquisition of MEF Corp. during fiscal 1993, the acquisition of Medical Device Capital Company during fiscal 1994 and the expansion of its medical receivable\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED\nRESULTS OF OPERATIONS, (CONTINUED)\nfinancing business in fiscal 1994.\nEquity in net losses of investees increased 375% to $242,000 in fiscal 1994 from $51,000 in fiscal 1993. The increase in net losses of investees is primarily attributable to greater losses incurred by the Company's investees in the first half of fiscal 1994 than in fiscal 1993. See \"Business -- Other Business Activities.\"\nThe Company's net earnings from continuing operations were $2.3 million, or $.34 per share, for fiscal 1994 as compared to $2.6 million, or $0.39 per share, for fiscal 1993 a decrease of 12%. After giving effect to its discontinued operations, the Company's loss was $885,000, or $0.13 per share, for fiscal 1994 versus net earnings of $658,000, or $0.10 per share, for fiscal 1993. The Company's net earnings from continuing operations did not increase in fiscal 1994 despite the growth of its loan portfolio and the increase in finance and other income.\nLIQUIDITY AND CAPITAL RESOURCES\nGeneral\nThe Company's equipment financing business requires substantial amounts of capital and borrowings. The Company obtains warehouse funding from commercial and investment banks. The Company's warehouse borrowings are recourse obligations, while the Company's permanent funding is obtained principally on a limited recourse basis. In the case of limited recourse funding, the Company retains some risk of loss because it shares in any losses incurred and\/or it may forfeit the residual interest the Company has in the underlying financed assets (if any) should defaults occur.\nA substantial portion of the Company's debt represents permanent funding of equipment loans obtained on limited recourse basis and is structured so that the cash flow from the underlying loans services the debt. Most of the Company's warehouse borrowings are used to temporarily fund the equipment loans and are repaid with the proceeds obtained from the permanent funding and cash flow from the underlying transactions.\nAs a result of the rapid growth of the Company's equipment financing business, the amount of warehouse and permanent funding it requires has significantly increased. To meet its requirements for increased warehouse funding, the Company has expanded its warehouse facilities with banks, and has obtained warehouse facilities with investment banking firms the Company uses for its securitizations. To meet its requirement for increased permanent funding, the Company has enhanced its ability to fund equipment loans by both securitization and whole loan sales. If suitable sources of both warehouse and permanent funding are not available in the future, the Company's growth will be constrained and it may be forced to use less attractive funding sources in order to ensure its liquidity.\nWorking capital financing for equipment financing customers is occasionally provided by the Company where the loan is adequately secured by acceptable collateral (typically accounts receivable) and the Company's other credit criteria are satisfied.\nIn June 1994, the Company completed a $15.0 million private placement of Convertible Subordinated Notes. The Convertible Subordinated Notes (i) are convertible into shares of Common Stock at $10.60 per share at the discretion of the noteholders; (ii) bear interest at a rate of 9 1\/8% payable in quarterly installments of interest only; and (iii) mature in June 2002. The proceeds generated from the placement were utilized by the Company to repay a portion of the existing debt under its principal warehouse facility and on a limited basis to fund medical receivables loans. The agreement with respect to the Convertible Subordinated Notes contains, among other things, limitations on the Company's ability to pay dividends and to make certain other kinds of payments. That agreement also prohibits the Company from incurring additional indebtedness unless certain financial ratio tests are met. As of June 30, 1995, $500,000 aggregate principal of the Convertible Subordinated Notes had been converted into 47,169 shares of Common Stock.\nIn August 1995, the Company completed an offering of 2,875,000 shares of its common stock for which it received\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED\nLIQUIDITY AND CAPITAL RESOURCES, (CONTINUED)\nnet proceeds of $29.7 million.\nThe Company believes that its present warehouse and permanent funding sources are sufficient to fund the Company's current needs for its equipment financing business. However, the Company will have to expand both its warehouse and permanent funding capacity as well as to get into commercial paper programs and other means of unsecured debt financing vehicles to meet the Company's projected growth of its equipment financing business. In addition, the growth of the Company's medical receivable financing business is dependent on the Company's ability to obtain suitable funding for that business. Continued expansion of the Company's business and its continued use of securitizations will also require additional capital that the Company may seek to obtain from public offerings and\/or private placements of equity securities and\/or additional long-term debt financing. If the Company is unable to continue to increase its capital base, its ability to expand its financing business will be significantly constrained.\nWarehouse Facilities\nAt September 26, 1995, the Company had available an aggregate of $337.7 million under various warehouse facilities. The Company's primary warehouse facility, a revolving credit agreement with a syndicate of banks (the \"Bank Revolving Credit Agreement\"), provides the Company with $81.5 million in borrowing capacity. Borrowings under the Bank Revolving Credit Agreement bear interest at the Company's option at either a rate equal to 25 basis points over the Prime rate established by NatWest Bank N.A. (NatWest) or a rate of interest that varies from 150 to 180 basis points over the 30, 60 or 90-day LIBOR rate based on the Company's leverage ratio from time to time as defined in the Bank Revolving Credit Agreement. The Bank Revolving Credit Agreement is renewable annually at the bank syndicate's discretion. However, the Bank Revolving Credit Agreement provides that if the banks elect not to renew the facility at the end of its stated term, December 31, 1995, the outstanding loans automatically convert to four-year amortizing term loans at slightly higher interest rates.\nThe Bank Revolving Credit Agreement requires the Company to limit all of its borrowings to specified levels determined by ratios based on the Company's tangible net worth and, under certain circumstances, to use specified percentages of internally generated funds to pay for equipment purchases. The Bank Revolving Credit Agreement also restricts the payment of dividends by DVI Financial Services to the Company under certain circumstances. In addition, the amount of funds available at any given time under the Bank Revolving Credit Agreement is constrained by the amount, type and payment status of the Company's equipment loans. If, at any time, a significant amount of the Company's loans were to become delinquent, the availability of credit under the Bank Revolving Credit Agreement would be reduced and, under other circumstances, the Company could be required to prepay a portion of the amounts outstanding under the Bank Revolving Credit Agreement. Since the Bank Revolving Credit Agreement was established, the only collateral that was eligible for borrowing purposes was equipment loans. To fund the growth of its medical receivable financing business, the Company requested that the banks participating in the Bank Revolving Credit Agreement begin to allow the Company to use the credit facility to fund medical receivable loans. During the quarter ended December 31, 1994, the banks agreed to permit borrowings by the Company of up to $7.0 million collateralized by medical receivables.\nThe Company also has a $75.0 million interim funding facility with Prudential Securities Realty Funding Corporation (the \"Prudential Facility\"). This interim funding facility is available for certain transactions which are to be securitized under specified terms and bear interest at a rate equal to 75 basis points over the 30, 60 or 90-day LIBOR rate. The Prudential Facility also allows the Company to borrow up to $4.3 million in special advances that bear interest at a rate equal to 150 basis points over the 30-day LIBOR until October 31, 1995. The $4.3 million of special advances were repaid in August 1995. Borrowings under the Prudential Facility, including the special advances, are secured by (i) certain equipment loans and the equipment financed thereunder, (ii) the Company's interest in certain asset-backed notes, and (iii) the Company's rights to receive funds from certain securitized equipment loans. All borrowings under the Prudential Facility mature on October 31, 1995. The Company has a second facility with Prudential, which provides the Company with $5.5 million in warehouse funding to make medical receivables loans to approved borrowers. Borrowings under the $5.5 million\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED\nLIQUIDITY AND CAPITAL RESOURCES, (CONTINUED)\nPrudential Facility bear interest at a rate equal to the Prime rate established by Morgan Guaranty Trust Company of New York. The borrowings are secured by medical receivables loans originated by the Company and the underlying receivables. This facility matures on November 30, 1995.\nThe Company has a $75.0 million interim funding facility with ContiTrade Services Corporation (the \"Conti Facility\") which provides the Company with warehouse financing for certain equipment loans to be securitized or otherwise permanently funded through the Conti Facility. Borrowings under this facility bear interest at a rate equal to 150 basis points over the 30 or 60-day LIBOR rate which is fixed to the related funding period. This facility matures on October 31, 1995.\nIn July 1995, the Company obtained a $100.0 million interim funding facility with Union Bank of Switzerland which provides the Company with warehouse financing for certain equipment loans to be securitized. Borrowings under this facility are secured by certain equipment loans and the equipment financed thereunder. Borrowings under this facility bear interest at a rate equal to 90 basis points over a 30, 60 or 90-day LIBOR rate which is fixed to the related funding period. This facility matures on November 27, 1995.\nThe Company's use of securitization significantly affects its need for warehouse facilities. When using securitization, the Company is required to hold loans in warehouse facilities until a sufficient quantity is accumulated to meet the various requirements of the credit rating agencies and others involved, and to make a securitization cost effective. Generally, loans totalling $50 to $100 million will be placed in each securitization pool.\nWhen the Company borrows funds through warehouse facilities, it is exposed to a certain degree of risk caused by interest rate fluctuations. Although the Company's equipment loans are structured and permanently funded on a fixed interest rate basis, it uses warehouse facilities until permanent funding is obtained. Because funds borrowed through warehouse facilities are obtained on a floating interest rate basis, the Company uses hedging techniques to protect its interest rate margins during the period that warehouse facilities are used. The Company's sole reason for using hedging techniques is to offset the loss that occurs when loans are funded on an interim basis and interest rates rise causing the Company's interest rate margins on the loans to decline. Therefore, gains or losses generated through hedging techniques only benefit the Company to the extent they offset the corresponding reduction in margin due to rising interest rates until the loans are permanently funded. The Company's primary hedging technique is to assume short positions in U.S. Treasury obligations of comparable maturities to the life of its loans. To the extent hedging gains or losses resulting from U.S. Treasury contracts are significant, the resulting cash payments or receipts may impact the Company's liquidity.\nPermanent Funding Methods\nThe Company has completed seven securitizations or other structured finance transactions totalling $414.8 million, including two public debt issues of $75.7 million and $90.0 million and five private placements of debt and whole loan sales totalling $249.1 million. In January 1994, the Company filed a $350 million registration statement (Registration No. 33-74446) with the Commission to provide for the future issuance of securitized debt in a series of transactions pursuant to the Commission's \"shelf\" registration rule. The registration statement was declared effective by the Commission on June 23, 1994. The $75.7 and $90.0 million public debt issues were the two initial fundings under the $350 million shelf registration. The Company expects to continue to use securitization, on both a public and private basis, as its principal means to permanently fund its loans for the foreseeable future, except when issues of borrower concentration exist that warrant the sale of loans.\nThe Company's use of securitization significantly affects its liquidity and capital requirements due to the amount of time required to assemble a portfolio of loans to be securitized. When using securitization, the Company is required to hold loans until a sufficient quantity is accumulated so as to attract investor interest and allow for a cost effective placement. This increases the Company's exposure to changes in interest rates and temporarily reduces its warehouse facility liquidity.\nGenerally, the Company does not have binding commitments for permanent funding, either through securitization\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED\nLIQUIDITY AND CAPITAL RESOURCES, (CONTINUED)\nor whole loan sales. The Company has non-binding agreements with investment banking entities to fund future equipment loans through securitization. While the Company expects to be able to continue to obtain the permanent funding it requires for its equipment financing business, there can be no assurance that it will be able to do so. If, for any reason, any of these types of funding were unavailable in the amounts and on terms deemed reasonable by the Company, the Company's equipment financing activities would be adversely affected. The Company believes cash flows generated from operations and its warehouse facilities are sufficient to meet its near-term obligations.\nINCOME TAX ISSUES\nHistorically, the Company has deferred a substantial portion of its federal and state income tax liability because of its ability to obtain depreciation deductions from transactions structured as fair market value leases. Over the past 18 months, the proportion of transactions originated by the Company structured as fair market value leases has declined significantly, and the Company expects that trend to continue. In addition, the Company disposed of a portion of its equipment residual portfolio in fiscal 1994 and may continue to do so in future periods. As a result, the Company expects that in future periods its ability to defer its income tax liability will correspondingly decline. Additionally, the Company believes its effective tax rate will increase in future periods as a result of higher state tax rates in certain regions in which the Company conducts its business.\nINFLATION\nThe Company does not believe that inflation has had a material effect on its operating results during the past three years. There can be no assurance that the Company's business will not be affected by inflation in the future.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe following consolidated financial statements of the Company and its subsidiaries are filed on the pages listed below, as part of Part II, Item 8.\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS\nINDEPENDENT AUDITORS' REPORT\nBoard of Directors and Shareholders DVI, Inc. and Subsidiaries\nWe have audited the accompanying consolidated balance sheets of DVI, Inc. and its Subsidiaries (the \"Company\") as of June 30, 1995 and 1994, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended June 30, 1995. 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, such consolidated financial statements present fairly, in all material respects, the financial position of DVI, Inc. and its Subsidiaries as of June 30, 1995 and 1994, and the consolidated results of their operations and their cash flows for each of the three years in the period ended June 30, 1995 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.\nDELOITTE & TOUCHE LLP\nCosta Mesa, California September 26, 1995\nDVI, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\nASSETS\nThe accompanying notes are an integral part of these consolidated financial statements.\nDVI, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\nLIABILITIES AND SHAREHOLDERS' EQUITY\nThe accompanying notes are an integral part of these consolidated financial statements.\nDVI, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF OPERATIONS\nThe accompanying notes are an integral part of these consolidated financial statements.\nDVI, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY\nThe accompanying notes are an integral part of these consolidated financial statements.\nDVI, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\n(Continued)\nDVI, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)\nDuring the year ended June 30, 1995, $500,000 of Convertible Subordinated Notes was converted into common stock.\nUnrealized gains on available-for-sale investments including restricted short-term investments and investments in investees total $1,061,548, net of deferred taxes of $768,707, as of June 30, 1995.\nThe accompanying notes are an integral part of these consolidated financial statements.\nDVI, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)\nDuring the year ended June 30, 1994 the following noncash transactions occurred in conjunction with the disposal of the Company's healthcare operations segment (See Note 3).\nSee Note 6 for discussion of additional noncash transactions.\nThe accompanying notes are an integral part of these consolidated financial statements.\nDVI, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1. GENERAL\nDVI, Inc. (the \"Company\" or \"DVI\") is engaged in the business of providing equipment financing and related services for users of diagnostic imaging, radiation therapy and other medical technologies. The Company's customer base consists principally of outpatient healthcare providers, physician groups and hospitals. By the terms of the underlying financing contracts, the Company's customers are generally considered in default if payment on a contract has not been received. Equipment under direct financing leases and notes secured by equipment serve as collateral for unpaid contract payments. Receivables under medical receivables financing transactions serve as collateral for unpaid contract payments.\nNOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nConsolidation Policy - The consolidated financial statements include the accounts of DVI and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated.\nCash Equivalents - Cash equivalents include highly liquid securities with original maturities of 90 days or less.\nInvestment in Direct Financing Leases and Notes Secured by Equipment - At contract commencement, the Company records the gross contract receivable, initial direct costs, estimated residual value of the financed equipment, if any, and unearned income. At June 30, 1995 and 1994, unamortized initial direct costs amounted to $6,878,083 and $5,444,135, respectively. Initial direct costs are amortized over the life of the contract on the interest method which reflects a constant effective yield. Receivables from Sale of Leases and Notes Secured by Equipment - The receivables from sale of leases and notes secured by equipment primarily relate to the sale of financing transactions which were complete as of the end of the respective period.\nReceivables from Sale of Leases and Notes Secured by Equipment - The receivables from sale of leases and notes secured by equipment primarily relate to the sale of financing transactions which were complete as of the end of the respective period.\nPatient Service Accounts Receivable - Patient service accounts receivable relate to billings for services performed by the Company's discontinued healthcare segment of its business (See Note 3). The receivables have been stated at their estimated net realizable value at June 30, 1995 and 1994.\nNotes Collateralized by Medical Receivables - Notes collateralized by medical receivables consist of notes receivable resulting from working capital and other loans made to entities in the healthcare industry and receivables purchased from unrelated entities. The purchased receivables are stated at the lower of the Company's cost or the estimated collectible value.\nEquipment on Operating Leases - Leases which do not meet the criteria for direct financing leases are accounted for as operating leases. Equipment on operating leases are recorded at cost and depreciated on a straight-line basis over the estimated useful life of the equipment. Rental income is recorded monthly on a straight-line basis. Initial direct costs directly associated with operating leases are deferred and amortized over the lease term on a straight-line basis.\nFurniture and Fixtures - Furniture and fixtures are stated at cost less accumulated depreciation and are depreciated using the straight-line method over their estimated useful lives (generally five years).\nShort-Term Investments, Restricted and Investments in Investees - The Company has 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 investments in debt and equity securities into three categories: held to maturity, trading and available-for-sale. Debt securities that are purchased with 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 reclassified from available-for-sale or 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. At June 30, 1995, the Company has only available-for-sale securities. Equity securities classified as available-for-sale securities are reported at estimated fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of equity, net of deferred taxes. The cumulative effect of the adoption of the new statement was not significant.\nThe investments in investees consist of common and nonvoting preferred equity interests in unconsolidated subsidiaries. Prior to fiscal 1994, the Company accounted for its investments in the common stock of these subsidiaries using the equity method of accounting. Subsequent to fiscal 1993, when the Company no longer exerted significant influence over the investees, the Company began accounting for the investees utilizing the cost method. During the year ended June 30, 1994, the investment in the common stock of one investee was written down to zero to reflect the Company's cumulative share of equity losses in the investee and the investment in the preferred stock of this investee was recorded at the lower of cost or estimated realizable value.\nDVI, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, (CONTINUED)\nNOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, (CONTINUED)\nAs of June 30, 1995, the Company's investments in common stock are classified as available for sale and carried at estimated fair value. (See Note 6.)\nGoodwill - Goodwill at June 30, 1995 and 1994 represents the estimated excess contingent purchase price over the net tangible assets stemming from the acquisition of Medical Equipment Finance Corporation (\"MEF Corp.\"). (See Note 15.) Goodwill relating to the acquisition of MEF Corp. is being amortized over a fifteen year period. The Company evaluates the recoverability of its goodwill separately for each applicable business acquisition at each balance sheet date. The recoverability of goodwill is determined by comparing the carrying value of the goodwill to the estimated operating income of the related entity on an undiscounted cash flow basis. Should the carrying value of the goodwill exceed the estimated operating income for the expected period of benefit, an impairment for the excess is recorded at that time.\nOther Assets - Other assets consist of prepaid financing costs and equipment held for sale or release which is stated at the lower of cost or its net realizable value.\nDebt Issuance Costs - Debt issuance costs related to securitizations and convertible subordinated notes are offset against the related debt and are being amortized over the life of the notes using the interest method.\nAmortization of Finance Income - Amortization of finance income primarily consists of the interest component of payments received on notes secured by equipment (or medical receivables) and direct financing leases and is calculated using the interest method so as to approximate a level rate of return on the net investment. It also includes servicing fees earned for billing and collecting services related to the asset securitizations (See Note 8) and a gain on sale of residual interests of $799,661 during the fiscal year ended June 30, 1994.\nReceivables Financing Income - Receivables financing income is primarily related to income generated from receivable purchases and income from billing\/collecting activities which the Company has curtailed. Income from medical receivables purchases is recognized ratably as collections are made.\nGain on Sale of Financing Transactions - Gains arising from the sale of direct financing leases and investments in notes secured by equipment occur when the Company obtains permanent funding through the whole loan sale of a transaction to a third party. Subsequent to a sale, the Company has no or limited remaining interest in the transaction or equipment and no obligation to indemnify the purchaser in the event of a default on the transaction by the obligor, except when the sale agreement provides for participation in defined excess interest spreads or limited recourse in which the Company guarantees reimbursement under the agreement up to a specific maximum, which is of nominal value. Upon consummation of the sale transaction, the Company records a provision for anticipated losses under recourse provisions. Consequently, in the event of default by the obligor, the lender would exercise its rights under the lien with limited or no further recourse against the Company, notwithstanding any facts or circumstances that might promulgate the lender's assertion under representations and warranties made by the Company.\nOther Income - Other income consists primarily of late charges, dividends on investments in investee's preferred stock and income from operating leases.\nTaxes on Income - The Company accounts for taxes under Statement of Financial Accounting Standards No. 109 (\"SFAS 109\"), Accounting for Income Taxes. Deferred taxes on income result from temporary differences between the reporting of income for financial statement and tax reporting purposes. Such differences arise principally from recording hedging gains and losses and from lease transactions in which the operating lease method of accounting is used for tax purposes and the financing lease method, as described above, is used for financial statement purposes. Under the operating lease method, leased equipment is recorded at cost and depreciated over the useful life of the equipment and lease payments are recorded as revenue when earned.\nNet Earnings (Loss) Per Share - Net earnings (loss) per share is based on the modified treasury stock method, except when the results of this method are anti-dilutive. In fiscal 1995, 1994 and 1993, net earnings (loss) per share is calculated using the weighted average common shares outstanding during the year because the results of the modified treasury stock method were antidilutive. For the quarters ended June 30, 1995 and March 31, 1995, fully diluted net earnings per share is calculated using the modified treasury stock method as the exercise of stock options, warrants and the conversion of the subordinated\nDVI, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, (CONTINUED)\nNOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, (CONTINUED)\nnotes has a dilutive effect on earnings per share.\nRecent Accounting Developments - The Company adopted SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of, as of July 1, 1994. The impact of the adoption did not have a material impact on the Company's operations.\nIn May 1993, the Financial Accounting Standards Board (FASB) issued SFAS No. 114, Accounting by Creditors for Impairment of a Loan. SFAS No. 114 indicates that a creditor should evaluate the collectibility of both contractual interest and contractual principal when assessing the need for a loss accrual. The Company must apply SFAS No. 114 in fiscal year 1996. The Company does not believe that application of SFAS No. 114, as amended, will have a material impact on its operations.\nReclassifications - Certain amounts as previously reported have been reclassified to conform to the year ended June 30, 1995 presentation.\nNOTE 3. DISCONTINUED OPERATIONS\nOn June 30, 1993, the Company formally adopted a plan to divest substantially all of its healthcare operations.\nThe following table presents net revenues, losses and selected balance sheet information relating to the healthcare operations segment as of, and for the years ended, June 30, 1994 and 1993.\nIn June 1993, the Company adopted a formal plan to discontinue its DVI Healthcare Operations segment consisting of seven outpatient healthcare facilities which it operated or managed on a direct basis and one facility which was in the developmental stage and not yet in operation. At June 30, 1993, the Company established a reserve for the divestiture of the operations and recorded a loss on discontinued operations and disposal of discontinued operations of $1.9 million net of tax. This estimate was based on certain assumptions as to the likely timing of the divestitures, the estimated proceeds to be received upon the sale of certain of the facilities and the financial results of those operations pending divestiture. These operations have been reflected as discontinued operations in the Company's financial statements at June 30, 1993 and 1994. The pre-tax loss from discontinued operations of $3.3 million at June 30, 1993 was comprised of $2.6 million relating to actual and estimated losses from operations of this segment through the date of disposition and approximately $700,000 relating to estimated losses to be incurred upon the disposition of the segment's net assets.\nAt June 30, 1994, the Company had disposed or entered into definitive agreements to sell five of these outpatient healthcare facilities and had written off the investment and assets of the remaining two. In connection with the disposal of these facilities, the Company retained certain assets and liabilities of these facilities, primarily accounts receivable and accounts payable. The change in estimate reflects the complete disposal or write-off of the discontinued operations segment.\nNOTE 4. CASH AND SHORT-TERM INVESTMENTS, RESTRICTED\nCash and short-term investments, restricted consist of cash, certificates of deposit and U.S. treasury obligations - available for sale maintained by the Company which are pledged as collateral for certain limited recourse borrowings related to direct financing leases, notes secured by equipment and operating leases. The estimated fair value and the amortized cost of U.S. Treasury obligations - available for sale as of June 30, 1995 is $10,260,303. There were no sales of U.S. Treasury\nDVI, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, (CONTINUED)\nNOTE 4. CASH AND SHORT-TERM INVESTMENTS, RESTRICTED, (CONTINUED)\nobligations during the year ended June 30, 1995.\nNOTE 5. INVESTMENT IN DIRECT FINANCING LEASES AND NOTES SECURED BY EQUIPMENT AND EQUIPMENT ON OPERATING LEASES\nReceivables in installments are receivable in monthly installments of varying amounts and are collateralized by the underlying equipment. Receivables from operating leases relate to noncancellable operating leases and are receivable in monthly installments of varying amounts. Information regarding scheduled collections for direct financing leases, notes secured by equipment and operating leases are as follows:\nResidual valuation represents the estimated amount to be received at contract termination from the disposition of equipment financed under direct financing leases and notes secured by equipment. Amounts to be realized at contract termination depend on the fair market value of the related equipment and may vary from the recorded estimate. Residual values are reviewed on an annual basis to determine if the equipment's fair market value is below its recorded value.\nDuring the year ended June 30, 1995, the Company sold receivables to third parties realizing gains of approximately $3.0 million. In connection with the sales, the Company retained subordinated interests in the receivables. Under the purchase agreement, the Company is required to fund any losses on the receivables up to its subordinated interests. The Company maintains an allowance for estimated losses related to its subordinated interests.\nAt June 30, 1995, direct financing lease receivables amounting to $264.6 million are assigned as collateral for the long-term debt (See Note 8).\nNOTE 6. INVESTMENTS IN INVESTEES\nAt June 30, 1995, the Company held investments in two entities, Healthcare Imaging Services, Inc. (\"HIS\") and Diagnostic Imaging Services, Inc. (\"DIS\") totalling approximately 17% and 8%, respectively, of the outstanding common stock of each entity. In September 1994, IPS Health Care, Inc., the Company's original investee, merged with DIS, an unaffiliated company, which reduced the Company's common stock ownership from approximately 22% to 10%. At that time, the Company began accounting for its investment in DIS on a cost basis. In March 1995, the Company sold its stock in SMT Health Services Inc., a provider of mobile diagnostic imaging services. The Company's investments in common stock of these unconsolidated entities have historically been accounted for using the equity method of accounting because the Company maintained significant influence over the investees.\nAs a part of the Company's overall strategy to operate exclusively as a financial services company, the Company initiated a process to divest of its interests in these investees. As a part of this process, during each of the three months ended December 31, 1993 and March 31, 1994, the Company completed a series of steps which significantly diminished its influence over SMT and HIS, respectively. These steps included, among other things, arrangements with both SMT and HIS to have all existing financing transactions between DVI and the related entity refinanced through third party lenders and relinquishment by DVI of\nDVI, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, (CONTINUED)\nNOTE 6. INVESTMENTS IN INVESTEES, (CONTINUED)\nits first right of refusal to finance all future equipment purchases made by the entities. The Company also agreed that, upon completion of the refinancings, it would relinquish its representation on the respective investees' Boards of Directors and sell the common shares it owns in each investee. Finally, during the refinancing process, DVI agreed to vote its common shares consistent with each of the investees' management. As a result of the Company's significant decline in influence over HIS and SMT, the Company's investments in those entities have been accounted for on a cost basis since January 1, 1994 for SMT and April 1, 1994 for HIS. Had the Company continued to account for these investees on the equity method, the net loss for the year ended June 30, 1994 would have increased by $236,000 before offsetting any losses due to mark to market adjustments. Prior to these dates, the Company accounted for its investments in HIS and SMT under the equity method due to factors that existed which the Company believes yielded it significant influence on the operating and financial policies of these investees. These factors included the Company providing a significant portion of the investees' equipment financing, the Company's right of first refusal to finance all the investees' equipment purchases and the Company's representation on the investees' Boards of Directors allowing voting power relating to mergers, major dispositions of assets and liquidations. During the year ended June 30, 1995, the Company sold its investment in SMT for proceeds equal to its cost of $827,989. The Company's investment in the equity of the common stock of IPS continued to be accounted for under the equity method until September 1994 when the Company's ownership of IPS declined to approximately 10% and its influence over IPS declined significantly, at which time the Company began to account for this investment on a cost basis.\nSubsequent to the Company's initial investment in IPS, the Company made additional investments in common and preferred stock of IPS, financed various leasing transactions for Magnetic Resonance Imaging (\"MRI\") and other equipment and entered into several restructuring agreements with IPS as follows:\nIn August 1992, due to severe cash flow difficulties experienced by IPS, the Company restructured certain debt of IPS. The restructuring of debt included, among other things, the reduction of interest rates on four transactions, extension of payment terms on certain direct finance lease receivables, the transfer of direct patient billing and collection process to a wholly owned subsidiary of the Company, the issuance of a working capital line of credit to IPS, an agreement for IPS to provide consulting services to DVI, and the appointment of two of the Officers of the Company to IPS's Board of Directors. At the same time, the Company acquired 730,768 shares of restricted IPS common stock from persons affiliated with the Company in exchange for $137,019 which represented the fair value of the common stock as agreed to by the parties.\nIn September 1992, one of the Company's wholly owned subsidiaries acquired 700,000, 725,000 and 420,000 shares of IPS's Series B, C and D convertible preferred stock, respectively for $1.00 per share. On November 12, 1992, an additional 637,000 shares of Series E convertible preferred stock were acquired from IPS for $1.00 per share. The preferred stock, with an aggregate value of $2,482,000, was issued in exchange for cash of $1.12 million, exchange of debt of $725,000 and imaging equipment valued at $637,000.\nIn September 1994, following the completion of the merger agreement between IPS and DIS, the Company entered into an Agreement for the Exchange of Stock and Assets. The agreement provided for the exchange of all the then outstanding preferred stock of IPS owned by the Company for a new series of DIS preferred stock (Series F). The agreement also provided for the exchange of certain debt with a carrying value of $4 million, assumption by the Company of certain assets and liabilities of IPS valued at approximately $164,000, the return of certain equipment under leases with IPS to the Company valued at approximately $2,164,000 and the issuance of Series G preferred stock of DIS valued at $2,000,000. The Company did not record a gain or loss on any of the restructuring transactions.\nThe Series F and G preferred stock have liquidation preferences at $1.00 per share, are redeemable at the option of DIS at $1.00 per share plus accrued dividends, are convertible into common stock of DIS at $2.42 per share for Series F and $1.00 per share for Series G, and are entitled to annual cumulative dividends ranging from $.05 per share to $.10 per share. In addition, the majority shareholder of DIS has the right to repurchase the Series F and G preferred stock for $4,482,000 through September 2001.\nThe Company's common stock investments in HIS and DIS are classified as available-for-sale and have a total cost of\nDVI, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, (CONTINUED)\nNOTE 6. INVESTMENTS IN INVESTEES, (CONTINUED)\n$1,341,377 and a total estimated fair value of $3,171,632 which resulted in an unrealized gain of $1,830,255 as of June 30, 1995. There were no sales of HIS or DIS investments during the year ended June 30, 1995.\nNOTE 7. BORROWINGS UNDER WAREHOUSE FACILITIES\nThe Company's primary credit facility, pursuant to a revolving credit agreement with a syndicate of banks (the \"Bank Revolving Credit Agreement\"), provides for the borrowings of up to $81.5 million. Borrowings under this facility bear interest at the Company's option at either 25 basis points over the Prime rate established by NatWest Bank N.A. or a rate of interest that varies from 150 to 180 basis points over the 30, 60 or 90-day LIBOR rate based on the Company's leverage ratio from time to time as defined in the Bank Revolving Credit Agreement. The Bank Revolving Credit Agreement is renewable annually at the bank syndicate's discretion. The credit agreement also provides that if the banks elect not to renew the facility at the end of its stated term, then outstanding loans automatically convert to four-year amortizing term loans at slightly higher interest rates. The Bank Revolving Credit Agreement prohibits the Company from paying dividends other than dividends payable solely in shares of the Company's common stock and limits borrowings to specified levels determined by ratios based on the Company's tangible net worth and, under certain circumstances, to use specified percentages of internally generated funds to pay for equipment purchases. As of June 30, 1995, the Company was in compliance with the financial covenants.\nThe Company also has a $75.0 million interim funding facility with Prudential Securities Realty Funding Corporation (the \"Prudential Facility\"). This interim funding facility is available for certain transactions which are to be securitized under specified terms and bear interest at a rate equal to 75 basis points over the 30, 60 or 90-day LIBOR rate. The Prudential Facility also allows the Company to borrow up to $4.3 million in special advances that bear interest at a rate equal to 150 basis points over the 30-day LIBOR until October 31, 1995. The $4.3 million in special advances was repaid in August 1995. Borrowings under the Prudential Facility, including the special advances, are secured by (i) certain equipment loans and the equipment financed thereunder, (ii) the Company's interest in certain asset-backed notes and (iii) the Company's rights to receive funds from certain securitized equipment loans. All borrowings under the Prudential Facility mature on October 31, 1995. The Company has a second facility with Prudential, which provides the Company with $5.5 million in warehouse funding to make loans secured by medical receivables to approved borrowers. Borrowings under the $5.5 million Prudential Facility bear interest at a rate equal to the Prime rate established by Morgan Guaranty Trust Company of New York. The borrowings are secured by medical receivables loans originated by the Company and the underlying receivables. This facility matures on November 30, 1995.\nThe Company has a $75.0 million interim funding facility with ContiTrade Services Corporation (the \"Conti Facility\") which provides the Company with warehouse financing for certain equipment loans to be securitized or otherwise permanently funded through the Conti Facility. Borrowings under this facility bear interest at a rate equal to 150 basis points over the 30 or 60-day LIBOR rate which is fixed to the related funding period. This facility matures on October 31, 1995.\nAt June 30, 1995, the Company had available an aggregate of $268.0 million in interim funding facilities of which $155.2 million was utilized.\nIn July 1995, the Company obtained a $100.0 million interim funding facility with Union Bank of Switzerland which provides the Company with warehouse financing for certain equipment loans to be securitized. Borrowings under this facility are secured by certain equipment loans and the equipment financed thereunder and bear interest at a rate equal to 90 basis points over a 30, 60 or 90-day LIBOR rate which is fixed to the related funding period.\nNOTE 8. LONG-TERM DEBT\nThe discounted receivables are payable to financial institutions, relate to the discounting of direct financing lease obligations and notes secured by equipment primarily on a limited or nonrecourse basis, and are collateralized by the underlying equipment receivables (See Note 5).\nFuture annual maturities of discounted receivables, net of capitalized issuance costs of $3,976,212 are as follows:\nYEAR ENDING JUNE 30,\nDVI, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, (CONTINUED)\nNOTE 7. BORROWINGS UNDER WAREHOUSE FACILITIES (CONTINUED)\nAll of the discounted receivables have been permanently funded through four asset securitizations which were initiated during fiscal years 1992 through 1995. Debt under these securitizations are limited recourse, bear interest at rates ranging between 5.34% to 7.81% and are serviced by the Company. The agreements require that the Company comply with certain servicing requirements as defined in the related securitization agreements, require limited cash collateral (See Note 4) or residual interests and contain various recourse provisions. (See Note 13.)\nIn June 1994, the Company completed a $14,112,000, net of issuance costs totalling $888,000, private placement of Convertible Subordinated Notes. The Convertible Subordinated Notes are convertible into common shares at $10.60 per share at the discretion of the noteholders, bear interest at a rate of 9 1\/8% payable in quarterly installments of interest only and mature in June 2002. During the year ended June 30, 1995, $500,000 of these notes were converted into 47,169 shares of common stock of the Company.\nNOTE 9. INCOME TAXES\nThe provision for income taxes is comprised of the following:\nA reconciliation of the provision for income taxes to the amount of income tax expense that would result from applying the federal statutory rate (35%) to earnings from continuing operations is as follows:\nThe major components of the Company's net deferred tax liabilities of $4,717,059 and $2,329,205 at June 30, 1995 and 1994, respectively, are as follows:\nDVI, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, (CONTINUED)\nNOTE 9. INCOME TAXES, (CONTINUED)\nNOTE 10. SHAREHOLDERS' EQUITY\nPrior to June 30, 1994, the Company issued warrants to purchase a total of 80,000 common shares at prices between $7.625 and $8.375 per share to all non-employee Directors of the Company and warrants to purchase up to 35,000 common shares at $8.50 per share to an unrelated party. Additionally, in fiscal 1992, the Company issued warrants to purchase up to 200,000 shares of the Company's common stock at $18.00 per share to an underwriter as compensation for investment banking services. No compensation expense was recognized as a result of this transaction. The warrants vest at various dates through November 1996 and expire at various dates through 2003. At June 30, 1995, warrants for 402,000 common shares were exercisable and none of the warrants had been exercised.\nIn February 1991, the Company issued 575,000 units at $10.50 per unit (consisting of 575,000 shares of the Company's common stock and redeemable warrants to purchase 575,000 shares of the Company's common stock at $12.00 per share) to the public for total proceeds of $6,037,500 before net offering costs of $999,875. As of June 30, 1995, none of these warrants had been exercised. The warrants expire in February 1996, and are redeemable by the Company provided certain conditions are met. In addition, the underwriter has an option to purchase an additional 50,000 units at $12.60 per share. The underwriter's option is exercisable during a three-year period commencing February 7, 1993. In 1991, the Company also issued warrants to purchase 50,000 common shares at $12.00 per share to another underwriter.\nIn June 1994, the Company issued convertible subordinated notes to related and unrelated parties which are convertible at the option of the holder into 1,415,094 shares of common stock at $10.60 per share. As of June 30, 1995, $500,000 of these notes were converted into 47,169 shares of common stock (See Notes 8 and 12). Had the conversion occurred at July 1, 1994, the impact on the earnings of the Company for the year ended June 30, 1995 would have been insignificant.\nNOTE 11. STOCK OPTION PLAN\nThe Company has a stock option plan which currently provides for the granting of options to employees to purchase up to 1,250,000 shares of the Company's common stock at the fair market value at the date of grant. Options granted under the plan generally vest over three to five years from the date of grant and expire ten years after the date of the grant. Any unexercised options are canceled ninety days subsequent to the termination of the employee and are returned to the plan.\nDVI, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, (CONTINUED)\nNOTE 11. STOCK OPTION PLAN, (CONTINUED)\nThe following table summarizes the activity under the plan for the periods indicated:\nAs of June 30, 1995, options to purchase 279,318 shares were exercisable.\nNOTE 12. RELATED PARTY TRANSACTIONS\nThe Company's principal executive offices located in Doylestown, Pennsylvania are leased from a party related to a shareholder\/director of the Company. The lease commenced in December 1994 and the Company recorded rent expense under this lease of $33,544 for the year ended June 30, 1995.\nAt June 30, 1995 and 1994, receivables in installments from investees totalled $8,254,953 and $16,427,684, respectively.\nDuring the years ended June 30, 1995 and 1994, the Company entered into various agreements with investees which are described in Note 6.\nDuring the year ended June 30, 1994, the Company issued convertible subordinated notes totalling $9,550,000 to related parties (See Notes 8 and 10).\nIn June 1995, the Company and former shareholders of MEF Corp., some of whom are also officers of the Company, entered into an agreement to set the purchase price of MEF Corp. (See Note 15.)\nNOTE 13. COMMITMENTS AND CONTINGENCIES\nFacility Leases - The Company leases its facilities under noncancelable operating leases with terms in excess of one year. The lease for the Company's principal facility expires in June 2005. Rent expense for the years ended June 30, 1995, 1994 and 1993 amounted to $497,818, $462,731, and $715,246, respectively. Future minimum lease payments under these leases are as follows:\nDVI, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, (CONTINUED)\nNOTE 13. COMMITMENTS AND CONTINGENCIES, (CONTINUED)\nCommitments - Under certain limited recourse agreements, the Company may be required to provide for losses incurred on uncollected lease receivables previously collateralized. At June 30, 1995, the maximum contingent liability under the limited recourse agreements amounted to $35,432,155. This contingent liability, however, could be offset by any proceeds received from the resale or remarketing of available equipment financed under the agreements.\nLitigation - The Company is involved in litigation both as a plaintiff and defendant in matters arising out of the Company's normal business activities. Management does not expect the outcome of these lawsuits to have a material adverse effect on the consolidated financial statements of the Company.\nNOTE 14. BENEFIT PLANS\nThe Company maintains and administers an Employee Savings Plan pursuant to Internal Revenue Code Section 401(k). The Plan provides for discretionary contributions as determined by the Company's Board of Directors. The Company contributed $38,751, $48,673 and $21,493 to the Plan during the years ending June 30, 1995, 1994 and 1993, respectively.\nNOTE 15. ACQUISITIONS\nIn January 1993, the Company acquired the outstanding shares of Medical Equipment Finance Corporation (\"MEF Corp.\"), which had only intangible assets at the date of acquisition. Under the terms of the original purchase agreement, the purchase price was payable before October 15, 1998 in cash or common stock of DVI, as elected by the Company. As initially structured, the purchase price was to be determined as a percentage of the after-tax earnings of the acquired entity during the sixty-six month period following the date of acquisition, consequently, no amounts were recorded at the date of acquisition. At June 30, 1994, no amounts were earned under the contract, however, at that time the Company accrued $2 million as costs in excess of net assets acquired (goodwill) which represents the Company's estimate of the minimum amount to be payable to former shareholders of MEF Corp. Had the acquisition occurred on July 1, 1992, the impact on the operations of the Company would not have been significant.\nDuring the year ended June 30, 1994, management entered into negotiations with the former shareholders of MEF Corp. to revise certain terms of the purchase agreement. In June 1995, the Company and the former shareholders of MEF Corp. agreed, subject to stockholder approval and an increase in the authorized capital stock of the Company, to set the purchase price of MEF Corp. at 400,000 shares of the Company's common stock valued at $4.65 million. The Company will record additional goodwill of $2.65 million at the time shareholder approval is obtained. Had the revised purchase agreement been finalized on July 1, 1992, net income would have decreased by $73,970, $73,970 and $112,636 and earnings per share would have been reduced $0.011, $0.011 and $0.017 for the years ended June 30, 1995, 1994 and 1993, respectively.\nDuring the year ended June 30, 1994, the Company acquired additional shares of IPS Health Care, Inc. preferred stock. (See Note 6.)\nDVI, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, (CONTINUED)\nNOTE 16. ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS\nIn accordance with Statement of Financial Accounting Standards No. 107 (\"SFAS 107\"), Disclosures About Fair Value of Financial Instruments, a summary of the estimated fair value of the Company's consolidated financial instruments at June 30, 1995 and 1994 is presented below. The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is necessary to interpret market data to develop the estimated fair values. 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 market assumptions and\/or estimation methodologies may have a material effect on the estimated fair value amounts.\nThe carrying values of cash and cash equivalents, cash and short-term investments, restricted, receivables from sale of leases and notes secured by equipment, patient service accounts receivable, notes collateralized by medical receivables, accounts payable, other accrued expenses, short-term bank borrowings and convertible subordinated notes approximate fair values at June 30, 1995 and 1994.\nThe methods and assumptions used to estimate the fair values of other financial instruments are summarized as follows:\nReceivable in installments:\nThe fair value of the financing contracts was estimated by discounting expected cash flows using the current rates at which loans of similar credit quality, size and remaining maturity would be made as of June 30, 1995 and 1994. The Company believes that the risk factor embedded in the entry-value interest rates applicable to performing loans for which there are no known credit concerns results in a fair valuation of such loans on an entry-value basis. In accordance with SFAS 107, the Company has excluded receivables from lease contracts of approximately $199.3 million and $141.6 million as of June 30, 1995 and 1994, respectively, from the receivable in installments fair value calculation. Additionally, the receivable in installments - related parties balances relates exclusively to lease receivables and has therefore been excluded from the Company's fair value calculation.\nDiscounted receivables:\nThe fair value of discounted receivables, related to the securitization of leases and notes, was estimated by discounting future cash flows using rates currently available for debt with similar terms and remaining maturities.\nThe fair value estimates presented herein were based on information available as of June 30, 1995 and 1994. Although the\nNOTE 16. ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS, CONTINUED\nDVI, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, (CONTINUED)\nCompany is not aware of any factors that would significantly affect the estimated fair values, such values have not been updated since June 30, 1995; therefore, current estimates of fair value may differ significantly from the amounts presented herein.\nNOTE 17. QUARTERLY FINANCIAL DATA (UNAUDITED)\nThe following is a summary of the quarterly results of operations for the fiscal years ended June 30, 1995 and 1994:\nDVI, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, (CONTINUED)\nNOTE 18. HEDGING TRANSACTIONS\nThe Company's equipment financing transactions are all structured on a fixed interest rate basis. The Company funds these transactions using variable rate interim funding facilities until permanent funding is obtained, generally through asset securitization. Because funds are borrowed through interim funding facilities, the Company uses hedging techniques to protect its interest rate margins during the period that interim funding facilities are used. The Company's strategies are to hedge its portfolio by either assuming a short position in Treasury notes of comparable maturity or entering into Treasury lock transactions whereby the Company will either pay or receive funds based on price movements of Treasury notes having a comparable maturity to the Company's fixed rate portfolios. The Company believes this strategy hedges its portfolio of fixed rate equipment financing contracts while waiting for permanent securitization funding thus stabilizing the Company's weighted average borrowing rate. The Company has not altered its underlying asset structure through hedging activities but does have liabilities to cover its hedging position in the event there is an upward movement in interest rates and a corresponding decline in the value of the Treasury notes in which it has taken short positions or contracts.\nDuring the year ended June 30, 1994, the Company did not utilize derivative financial instruments. During the year ended June 30, 1995, the Company commenced its hedging program by entering into and closing out $193 million of contracts. On June 30, 1995, the Company had no outstanding hedging positions.\nSCHEDULE OF TREASURY SHORTS AND TREASURY LOCKS\nNOTIONAL AMOUNTS\nWhen the Company's hedging activities are matched to specific borrowings relating to securitizations, gains or losses from hedging positions are reflected as a decrease or increase in the interest expense and thus the gain or loss is spread over the remaining term of the transactions securitized. As of June 30, 1995, the Company had deferred hedging losses of $1.75 million associated with transactions securitized and deferred hedging losses of $1.84 million associated with anticipated securitization transactions. Gains and losses from hedging are reflected as an increase or decrease in the gain on sale proceeds when transactions are funded through whole loan sales. At June 30, 1995, the Company had no unrealized hedging losses.\nNOTE 19. COMPENSATION AGREEMENTS\nIn June 1995, the Company agreed in principle to adopt an employee incentive plan (the \"Plan\"). Under the Plan the Company has agreed to issue, subject to stockholder approval and an increase in the authorized capital stock of the Company, an aggregate of 200,000 shares of common stock of the Company (the \"Incentive Shares\") to certain of its employees if the last sale price of the Company's common stock is $16.00 per share or higher for 30 consecutive calendar days at any time before December 31, 1998, provided that any such employee must be employed by the Company during the above-described 30-day period in order to receive any Incentive Shares under this agreement. The Company has agreed that, if there is an event or series of events that constitutes a sale of the Company at any time prior to December 31, 1998 and the consideration to be received for each share of common stock of the Company in such sale of the Company is $13.00 or higher, the Company will issue the Incentive Shares to the employees. If the criteria for the issuance of the Company's common stock are met, the Company will record compensation expense equal to the fair value of the common shares issued.\nNOTE 20. SUBSEQUENT EVENT\nDVI, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, (CONTINUED)\nIn August 1995, the Company completed an offering of 2,875,000 shares of its common stock for which it received net proceeds of $29.7 million.\nDVI, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, (CONTINUED)\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND 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 regarding the Company's Directors is incorporated herein by reference to the Company's definitive proxy statement filed not later than October 28, 1995, with the Securities and Exchange Commission pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended. Information regarding the Company's Executive Officers is set forth in Part I of this Form 10-K.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by Item 402 of Regulation S-K is incorporated herein by reference to the Company's definitive proxy statement filed not later than October 28, 1995 with the Securities and Exchange Commission pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required by Item 403 of Regulation S-K is incorporated herein by reference to the Company's definitive proxy statement filed not later than October 28, 1995, with the Securities and Exchange Commission pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by Item 404 of Regulation S-K is incorporated herein by reference to the Company's definitive proxy statement filed not later than October 28, 1995, with the Securities and Exchange Commission pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(A) LIST OF DOCUMENTS FILED AS PART OF THIS REPORT:\n(1) Financial Statements:\nSee Index to Consolidated Financial Statements included as part of this Form 10-K at Page 22.\n(2) Financial Statement Schedules:\nAll other schedules are omitted because of the absence of conditions under which they are required or because all material information required to be reported is included in the consolidated financial statements and notes thereto.\n(3) Exhibits:\nSee Index to Exhibits as part of Item 8 of this Form 10-K on Pages 48.\n(B) REPORTS ON FORM 8-K:\nThere were no reports on Form 8-K filed during the fourth quarter of the fiscal year ended June 30, 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 amendment to be signed on its behalf by the undersigned, thereunto duly authorized.\nDVI, INC. (Registrant)\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Company and in the capacities and on the dates indicated.\nDVI, INC. AND SUBSIDIARIES\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS\n(1) Activity and balances in the allowance for doubtful accounts are net of amounts from the Company's discontinued operations segment as the related receivables are presented at their net realizable value (See Note 2 to the accompanying consolidated financial statements).\nEXHIBIT INDEX\nEXHIBIT NO. DESCRIPTION ----------- -----------\n1 Form of Underwriting Agreement between the Underwriters and Registrant.(1)\n4.1 Certificate of Incorporation of the Company.(2)\n4.2 By-Laws of the Company.(2)\n4.3 Form of Common Stock Certificate.(2)\n10.1 DVI Financial Services Inc. Employee Savings Plan.(3)\n10.2 Amended 1986 Incentive Stock Option Plan.(4)\n10.3 Purchase Agreement dated as of October 22, 1991, by and among DMR Associates, L.P., HIS Acquisition, Inc. and DVI Financial Services Inc.(5)\n10.4 Direct Stock Option Agreements, dated as of October 16, 1990, between the Company and each of the Company's directors other than Mr. Higgins.(5)\n10.5 Amended and Restated Letter Agreement dated December 15, 1991, between the Company and W.I.G. Securities Limited Partnership regarding investment banking services.(5)\n10.6 Warrant dated April 27, 1992, executed by the registrant on behalf of W.I.G. Securities Limited Partnership.(5)\n10.7 Indemnification Agreement by and between DVI Health Services Corporation and Anthony J. Turek, dated as of August 16, 1992.(6)\n10.8 Indemnification Agreement by and between DVI Health Services Corporation and David L. Higgins, dated as of August 16, 1992.(6)\n10.9 Stock Purchase Agreement between DVI Health Services Corporation and David L Higgins, dated August 20, 1992.(6)\n10.10 Stock Purchase Agreement between DVI Health Services Corporation and Sidney Luckman, dated August 20, 1992.(6)\n10.11 Stock Purchase Agreement between DVI Health Services Corporation and Hazelton National Bank, as trustee of certain trusts for the benefit of Cynthia J. Cohn and Shelly Cohn Schmidt, dated August 20, 1992.(6)\n10.12 Stock Purchase Agreement between DVI Healthcare Operations, Inc. and IPS HealthCare Inc., dated October 30, 1992.(6)\n10.13 Stock Purchase Agreement between DVI Healthcare Operations, Inc. and IPS HealthCare, Inc., dated October 30, 1992.(6)\n10.14 Stock Purchase Agreement between DVI Healthcare Operations, Inc. and IPS HealthCare, Inc. dated November 12, 1992.(6)\n10.15 Stock Purchase Agreement between DVI Health Services Corporation and MEFC Partners L.P., dated as of January 6, 1993 (the \"MEFC Agreement\").(6)\n10.16 First Amended and Restated Loan Agreement dated as of March 28, 1995, between DVI Financial Services Inc., the Banks signatory thereto and NatWest Bank N.A., as Agent, Prefunding Lender and a Bank.(1)\n10.17 Amended and Restated Interim Loan and Security Agreement, dated as of September 13, 1994, between Prudential Securities Realty Funding Corporation and DVI Financial Services Inc. (the \"Prudential Facility\").(1)\n10.18 Amendment to the Prudential Facility, dated as of January 9, 1995.(1)\n10.19 Second Amendment to the Prudential Facility, dated as of March 10, 1995.(1)\n10.20 Third Amendment to the Prudential Facility, dated as of March 31, 1995.(1)\n10.29 Credit Extension Confirmation and Amendment to the Conti Facility, dated June 30, 1995, among ContiTrade Service Corporation, DVI Financial Services Inc., the Registrant, ContiTrade Services L.L.C. and Bankers Trust Comapny, as custodian.(1)\n10.30 Amendment No. 1 to the MEFC Agreement dated as of June , 1995.(1)\n21 Subsidiaries and sub-subsidiaries\n27 Financial Data Schedule\n- ------------------ (1) Filed previously as an Exhibit to the Company's Registration Statement on Form S-1 (Registration No. 33-60547) and by this reference incorporation herein.\n(2) Filed previously as an Exhibit to the Company's Registration Statement on Form S-3 (Registration No. 33-84604) and by this reference incorporated herein.\n(3) Previously filed.\n(4) Filed previously as an Exhibit to the Company's Registration Statement on Form S-18 (Registration No. 33-8758) and by this reference incorporated herein.\n(5) Filed previously as an Exhibit to the Company's Form 10-K (Registration No. 0-16271) for the year ended June 30, 1990 and by this reference incorporated herein.\n(6) Filed previously as an Exhibit to the Company's Registration Statement on Form S-2 (Registration No. 33-46664) and by this reference is incorporated herein.\n(7) Filed previously as an Exhibit to the Company's Form 10-K (Registration No. 0-16271) for the year ended June 30, 1993 and by this reference is incorporated herein.\n(8) Filed previously as an Appendix to the Company's Consent Statement dated as of December 29, 1994 and by this reference is incorporated herein.\n(9) Filed previously as an Exhibit to the Company's Form 10-K\/A-1 (File No. 0-16271) for the year ended June 30, 1994 and by this reference is incorporated herein.","section_15":""}
{"filename":"778107_1995.txt","cik":"778107","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nSandy Corporation, (the \"Company\"), is a full-service performance improvement company that provides training, communication, and marketing support products and services for major corporations. The Company was incorporated under the laws of the State of Michigan in 1971. The Company provides many products and services to groups, divisions, and departments within General Motors Corporation (\"GM\"), which accounted for approximately 49%, 53%, and 57% of the Company's revenue during the fiscal years ended August 31, 1995, 1994, and 1993, respectively. The Company provides services to groups, divisions, and departments within Ford Motor Company (\"Ford\"), which accounted for approximately 32%, 31%, and 21% of the Company's revenue during the fiscal years ended August 31, 1995, 1994, and 1993, respectively. Loss of revenue for services provided to either of the above entities could have a material adverse impact on the Company's revenue and results of operations.\nPRODUCTS AND SERVICES\nThe Company's products and services are specifically designed to provide the Company's clients with enhanced management and employee performance and, thereby, competitive advantage. The Company's clients principally operate in the automotive industry. Other clients over the years have included companies involved in communications, computer\/electronics, consumer non-durable products, health care, home appliance, hotel, manufacturing, motorcycle, and retail industries. The Company offers expertise primarily in management education, customer satisfaction enhancement, sales training, product training, technical training, quality systems, process improvement, and marketing services, and utilizes its expertise in these areas to deliver training programs and related services through a wide range of media, such as audio, televised and printed materials, classroom instruction, conferences, meetings, and seminars.\nThe Company's business is often conducted through an integrated process that progresses from consulting research and analysis, to the design and development of business solutions, to the implementation of those solutions by a variety of methods and media and to the evaluation (when appropriate) of the effectiveness of those programs. Although not all projects require each of these four performance improvement services, many projects require one or a combination of these services which may overlap substantially. Clients are generally offered the full range of the Company's services. These activities are described in greater detail below.\n1. Research and Analysis. The Company's account executives, consultants, and planners work closely with clients to analyze strategic objectives, which may include improved business processes, customer satisfaction, market share, professionalism, profitability, productivity, or other goals. The Company then works to define the level of human and process performance that would help achieve such objectives.\n2. Design and Development of Performance Improvement Solutions. The Company's instructional systems designers, researchers, writers, and subject matter experts design curriculum or marketing materials and program content to meet client needs. These individuals have specialized capabilities and expertise in several functional areas, which include among others:\nCustomer Satisfaction Education -- the teaching of standards based, customer-sensitive performance approaches to retail and wholesale employees, which can take the form of classroom instruction or media-based courses, measurement, and reinforcement programs.\nCustomer Satisfaction Tools -- glove-box portfolios that assist in developing improved customer handling, relations, and retention during the delivery process and throughout the ownership period.\nCultural Change Processes -- the application of analysis instruments for determining specific needs and the introduction of systemic approaches toward envisioning and reaching elevated goals and objectives.\nManagement Education -- the improvement of management skills in such areas as strategy, planning, directing, monitoring, motivating, and evaluating results.\nSales Training -- the improvement of the front-line salesperson by teaching fundamentals and advanced specific techniques of the sales transaction.\nProduct Training -- teaching salespeople about their products to enable them to present and sell features, benefits, and competitive advantages to customers. This training is at times related to point-of-purchase video and other means of visual support to help the customer understand product technologies and values not readily observable on the salesroom floor.\nTechnical Training -- teaching technicians the principles of problem diagnosis, product repair and maintenance, and customer satisfying behaviors.\nProcess Improvement -- the analysis of business processes, using techniques such as process mapping; the identification of \"best practices\" through benchmarking; the creation of performance standards; and employee involvement concepts.\nSales Promotion -- the development of marketing support tools and aids. These often are designed to reinforce training principles and sales activities that are focused on customer satisfaction and performance improvement.\nThe skills described above can be combined into an integrated system when a client desires coordinated improvement in performance at a number of organizational levels and\/or geographically-dispersed sales and customer service locations.\n3. Implementation. The Company's staff assists in the selection and design of appropriate methods for delivery of the client's program. The Company is experienced in the delivery of training and information through a variety of communication media, such as television, print, and audio media, classroom training, publications, self-directed learning systems, and customer satisfaction products and services.\nThe Company's media capabilities include:\nVideo -- this medium has applicability in a number of training situations, particularly when communication speed, equipment portability, and equipment affordability are important.\nConferences, Meetings, and Seminars -- the Company designs and produces conferences and meetings for its clients, which combine various elements of motivation and business information.\nSlides, Audio, and Printed Materials -- the Company utilizes these traditional communication media in a number of business applications. Computer generated slides permit fast turnaround of visual material, and lightweight slidefilm cassette equipment makes this instructional method particularly useful for retrieval at a work station. Audiocassettes are useful in a number of contexts, including making better use of automotive travel time. Printed publications are a relatively inexpensive means of reaching a wide audience.\nSatellite Television -- the Company believes that developing and producing programming for satellite television communication represents an area of business opportunity, as corporations increasingly consider using live, interactive satellite networks linking their headquarters, operating units, branch offices, and other locations.\nClassroom -- The Company conducts classes and other courses in Sales, Service, and Parts Operations. This includes seminars for sales and service advisors, dealer operations, internal control, management development, inventory management, and customer satisfaction techniques, many of which are delivered at client sites.\n4. Evaluation. When engaged to do so, the Company will evaluate the results of the training and communication programs developed for its clients. Toward that end, the Company has developed and used procedures and survey materials which embody a number of instructional and operational criteria.\nThe Company buys various raw materials and contracts with various suppliers in connection with the production of the physical elements (such as microcomputer diskettes, videocassettes, videodiscs, audio tapes, slides, and printed materials) of its teaching, training, and communication systems and products. Substantially all of such raw materials and physical elements are generally available from a number of suppliers.\nCOMPETITION\nThe Company provides a broad range of services and products which compete with many other businesses in various commercial categories, such as consulting companies, employee training firms, marketing services companies, and other training and communications specialists. Most major corporate customers have internal facilities and also engage outside firms to provide consulting, training, and\/or communication assistance. In addition, the Company competes with numerous organizations, some of which are substantially larger than the Company, which provide consulting, training, and\/or communication products and services. The Company also competes with advertising agencies, incentive fulfillment, and marketing services organizations which in many cases have well established relationships with the Company's clients or potential clients. The Company believes there are no dominant companies in any of the markets in which it competes. The Company believes the major competitive factors with respect to its products and services are quality, value, creativity, and client service.\nThe automotive industry is the major industry in which the Company competes. The Company's revenues from services provided to this industry are dependent on such factors as new product introductions and the industry's attention to process improvement and customer satisfaction.\nMARKETING\nThe Company markets its custom products and services to clients through a staff of account executives, who are assigned to different client and industry groups. These account executives provide in-depth support to the various groups, departments, and divisions which comprise the Company's clients, make proactive recommendations and\/or bid on new projects for existing clients, and solicit new clients. Services to clients are generally provided pursuant to project purchase orders or other contractual arrangements.\nServices are generally provided on a fixed price basis under individual purchase orders, many of which are obtained on a bid basis. Included are service and technical training, customer satisfaction training, management training, sales training, business meetings, sales promotion, and marketing services.\nProducts and services for major corporate customers principally include companies in the automotive industry. Over the years, the Company has also served clients in the communications, consumer non-durable products, computer\/electronics, healthcare, home appliance, hotel, manufacturing, motorcycle, and retail industries. They are provided on a custom project basis through account executives who are responsible for developing and servicing accounts in such industries.\nIn addition to the Company's headquarters in Troy, Michigan, the Company also maintains an office in Irvine, California, to serve its clients in the western United States.\nAt August 31, 1995, the Company had a backlog of orders of $39,402,000, as compared to $38,386,000 at August 31, 1994 and $41,903,000 at August 31, 1993. Of the $39,402,000 in backlog at August 31, 1995, approximately $27,100,000 is expected to be recognized in revenue over the next 12 months. Of the total backlog at August 31, 1994 and August 31, 1993, the amount of revenue that was expected to be recognized in revenue over the next 12 months was\n$24,700,000 and $23,895,000, respectively. Virtually all of the Company's orders are subject to cancellation at the option of the client.\nPERSONNEL\nAs of August 31, 1995, the Company had 157 full-time employees. In addition, the Company employs a number of part-time employees and engages a number of independent contractors in connection with the production and delivery of its products and services. During fiscal year 1995, the Company's direct payroll costs for its full-time employees were approximately $10,894,000; the Company also paid $645,000 to part-time employees.\nNone of the Company's full-time employees are currently represented by any labor union. Management believes that employee relations are generally good.\nIn its production of live and recorded performances, the Company engages various artists and other production personnel. Such engagements are typically made pursuant to various union contracts to which the Company is a party or with which the Company otherwise complies.\nMERGER WITH AUTOMATIC DATA PROCESSING, INC.\nOn August 22, 1995, the Company signed a definitive merger agreement with Automatic Data Processing, Inc. (\"ADP\") (NYSE:AUD) valued at approximately $30 million. If the merger is consummated, the Company's shareholders will receive approximately $12 worth of ADP stock for each share of the Company's stock. The exchange ratio will be determined by the average of the daily closing sale prices of ADP common stock for the ten consecutive full trading days prior to the completion of the merger, but the ratio will not adjust more than 10% up or down from 5.441 Sandy shares for each ADP share.\nThe merger, intended to qualify as a tax-free \"pooling of interests\" transaction, is subject to approval by the Company's shareholders. The final exchange ratio is subject to pricing adjustment based upon ADP's stock price for a period immediately prior to the closing. The Company is preparing a proxy statement for shareholder consideration.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company entered into a lease agreement for its Troy, Michigan, headquarters, effective February 1, 1994, with the landlord, 1500 Limited Partnership, a limited partnership owned by certain shareholders of the Company, which include William H. Sandy, the George J. Forrest Trust, Alan V. Kidd, Alan M. Sandy, Lewis G. Sandy, and certain other shareholders of the Company. The agreement was approved by the disinterested members of the Company's Board of Directors. The lease, which will expire on May 31, 2006, covers approximately 63,000 square feet. The lease provides for gross lease payments by the Company ranging from $94,000 to $102,000 per month over the lease term, plus increases in certain operating costs on a pass-through basis. The lease provides a $500,000 allowance for building improvements paid by the Partnership over the lease term and another $100,000 for improvements after February 1, 2000. There are no options to renew the lease after May, 2006. Sandy's option (which option would have been exercisable through September 1, 1995) under Section 36 of the Lease to reduce the size of the leased premises by up to approximately 7.6% has been waived.\nIn connection with the proposed merger with ADP, the lease agreement, dated February 1, 1994, between Sandy and 1500 Limited Partnership pertaining to Sandy's Troy, Michigan headquarters (the \"Lease\") will be amended effective at the closing date in the following manner: (i) an additional improvements allowance of $200,000 will be made available to the corporation surviving the merger (the \"Surviving Corporation\") immediately after the closing date and until December 31, 1996; (ii) the availability of the last $100,000 of the improvements allowance under the Lease will be accelerated from February 1, 2000 to the closing date so that the $100,000 allowance will be available immediately after the closing date and until December 31, 1996; (iii) the Surviving Corporation will be permitted to self-insure under Sections 11.2, 11.3, 11.4, and 11.5 of the Lease in accordance with ADP's standard policy. In connection with the effectiveness of such amendment to the Lease, ADP will guarantee the Surviving Corporation's obligations under the Lease after the closing date.\nIn June, 1992, the Company sublet approximately 14,000 square feet of its corporate office space to Henry Ford Health System and Henry Ford Health System\/In-Vitro Fertilization of Australia Partnership. These sublease agreements were terminated as of February 1, 1994, in conjunction with the new corporate headquarters' lease agreement.\nThe Company leases approximately 10,000 square feet of space in Irvine, California pursuant to a lease that expires in January, 1998. This facility is used as office\/conference space for the professional staff that permanently reside in California.\nThe above-noted leased properties are presently adequate to meet the Company's facility needs with sufficient excess capacity to meet normal customer demands. Although the Company has no renewal options for any of its facilities, management believes that the same or substitute facilities may be obtained at comparable costs.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company has no significant litigation pending against it.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matters were submitted to shareholders during the fourth quarter ended August 31, 1995.\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 American Stock Exchange. Its trading symbol is SDY.\nSandy Common Stock Sales Prices and Dividends\nConsent was obtained from Comerica Bank for declaration and payment of dividends during fiscal 1995 and fiscal 1994.\nIn connection with the proposed merger with ADP, the Company is not permitted to declare, set aside, or pay any dividend or other distribution in respect of its capital stock during the period from the date of the Merger Agreement (August 22, 1995) until the termination of the Merger Agreement.\nThe number of shareholders of record as of October 18, 1995 was 202.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe table below sets forth selected consolidated financial data of the Company and should be read in conjunction with the Consolidated Financial Statements and Notes thereto included elsewhere in this Report. The selected financial data as of August 31, 1995, 1994, 1993, 1992 and 1991 and for each of the years then ended are derived from the Company's financial statements for such years.\n(1) Based on weighted average common and common equivalent shares. See Note H of Notes to Consolidated Financial Statements.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nFISCAL 1995 COMPARED TO FISCAL 1994\nServices revenue for fiscal 1995 was $40,912,000 compared to $33,102,000 in fiscal 1994, a $7,810,000 or 23.6% increase. The services revenue increase was primarily due to increases in customer relationship training, process change and re-engineering principles training, seminar-based retail training, and other retail consulting services for an expanded automotive client base. This increase was delivered through increased classroom training participation, regional meetings and conferences, and the use of the Company's wide range of media capabilities. The Company believes this increase is due in part to the intensified recognition by new and existing automotive clients of the strategic relationship between customer care, process re-engineering and competitive advantage.\nProducts revenue for fiscal 1995 was $9,336,000 compared to $9,764,000 in fiscal 1994, a $428,000 or 4.4% decrease. Products revenue was impacted by a reduction in the average price per unit for some of the Company's products as a result of the Company entering into a long-term agreement, as well as a reduction in units shipped caused by reduced vehicle production at another of the Company's automotive clients.\nThe Cost of Services as a percent of services revenue for fiscal year 1995 was 75.7%, which is comparable to the fiscal 1994 percent of 75.6%.\nThe Cost of Products as a percent of products revenue decreased in fiscal 1995 to 85.6% from 87.6% in fiscal 1994. The principal reasons for this decrease are production efficiencies realized in fiscal 1995 and first year program development costs incurred in the prior year. The rate of decline in Cost of Products in the future is not expected to continue at the rate realized in the current year.\nAccount Service Expense in fiscal 1995 increased approximately $1,374,000, or 39.2%, to $4,877,000, compared to $3,503,000 in fiscal 1994. This increase is primarily due to increased payroll and related expenses for new staff required to support higher revenue volume and increased proposal activity.\nGeneral and Administrative expenses in fiscal 1995 increased approximately $210,000, or 6.2%, to $3,585,000 from $3,375,000 in fiscal 1994. The increase is primarily attributable to research and development expenses for client-based information systems, enhanced media capabilities, and internal process development.\nTotal Account Service Expense and General and Administrative expense as a percent of total revenue increased in fiscal 1995 to 16.8% from 16.0% in fiscal 1994.\nOperating Income in fiscal 1995 of $2,835,000 compared to $2,423,000 in fiscal 1994 is an improvement of $412,000 or 17%. This is due to increased revenues and slightly higher profit margins, partially offset by higher Account Service Expense and General and Administrative expenses.\nFISCAL 1995 COMPARED TO FISCAL 1994 - CONTINUED\nInterest Income, predominately from tax-exempt investments, was $243,000 in fiscal 1995 compared to $141,000 in fiscal 1994. This increase is due to the Company's improved cash position throughout fiscal 1995 and higher short-term interest rates in the current year.\nOther Expense of approximately $650,000 in fiscal 1995 represents valuation and other related expenses due to merger proposals from Automatic Data Processing, Inc. (NYSE:AUD) and Westcott Communications, Inc. (NASDAQ:WCTV). In August, 1995, the Company signed a definitive merger agreement with Automatic Data Processing, Inc. The Company expects to incur additional merger expenses in excess of $200,000 through the completion of the transaction.\nIncome Taxes increased $154,000 in fiscal 1995 to $1,044,000 from $890,000 in fiscal 1994. This increase is due to higher income before taxes and merger related expenses in fiscal 1995 and no tax benefit recorded for merger related expenses.\nFISCAL 1994 COMPARED TO FISCAL 1993\nServices revenue for fiscal 1994 was $33,102,000 compared to $28,046,000 in fiscal 1993, a $5,056,000 or 18.0% increase. The services revenue increase was primarily due to increases in process improvement, retail training, consulting services, and customer satisfaction education services for an expanded automotive client base. The Company believes the increase in these services is due in large part to improved conditions in the automotive industry and the increased importance clients have placed on customer satisfaction and competitive advantage.\nProducts revenue for fiscal 1994 was $9,764,000 compared to $6,930,000 in fiscal 1993, a $2,834,000 or 40.9% increase. The products revenue growth was due to increased unit volume associated with the inclusion of the Company's products in a wider range of vehicles. This was partially offset by a decrease in the average price per unit due to a reduction in the average content in the Company's products.\nThe Cost of Services for fiscal year 1994 was $25,011,000 (75.6% of sales), an increase of $4,397,000 or 21.3% compared to $20,614,000 (73.5% of sales) in fiscal 1993. The principal reason for the increase in Cost of Services as a percent of sales is lower profitability on some of the Company's projects for automotive clients, offset partially by improved efficiencies within the Company's creative staff.\nThe Cost of Products for fiscal year 1994 was $8,553,000 (87.6% of sales), an increase of $2,662,000 or 45.2% compared to $5,891,000 (85.0% of sales) in fiscal 1993. The principal reason for the increase in Cost of Products as a percent of sales is lower margins as part of obtaining a long-term contract.\nAccount Service Expense of $3,503,000 in fiscal 1994 decreased by $200,000 or 5.4% from fiscal 1993. The decrease was primarily due to lower proposal expenditures in fiscal 1994.\nFISCAL 1994 COMPARED TO FISCAL 1993 - CONTINUED\nGeneral and Administrative expenses of $3,375,000 in fiscal 1994 increased by $431,000 or 14.6% from fiscal 1993. The increase is primarily attributable to additional expenses for outside services related to marketing, potential acquisitions, and other consulting services.\nThe Operating Income in fiscal 1994 of $2,423,000 compared to $1,822,000 in fiscal 1993 is an improvement of $601,000. This is due to increased revenues and lower Account Service Expense, partially offset by lower profit margins and higher General and Administrative expenses.\nInterest Income was $141,000 in fiscal 1994 compared to $118,000 in fiscal 1993. This increase is due to a higher average level of investment and higher short-term interest rates in the latter part of fiscal 1994.\nIncome Taxes of $890,000 in fiscal 1994 increased by $272,000 compared to $618,000 in fiscal 1993. The increase is primarily due to higher income before taxes.\nLIQUIDITY AND CAPITAL RESOURCES\nDuring fiscal 1995, operating activities generated $4,280,000 in cash as compared to fiscal 1994 when these activities used $482,000 in cash. The increase in cash flows from operating activities is primarily due to improved cash collections on the Company's higher revenue base and an increase in accounts payable and accrued expenses, partially offset by the funding of a previously accrued employee benefit.\nCash used in investing activities was $42,000 in fiscal 1995, a decrease of $200,000 from fiscal 1994. This decrease is due to funds used for a term loan agreement with a third party supplier in the prior year.\nDuring fiscal 1995, the Company's financing activities used $512,000 in cash as compared to $325,000 in fiscal 1994. In fiscal 1995, the Company used $306,000 to repurchase a portion of shares issued upon exercise of stock options, as allowed for in the stock option agreement, to satisfy the Company's income tax withholding obligation with respect to the stock options. This was partially offset by $160,000 in proceeds from the exercise of these stock options.\nAt August 31, 1995, the Company had working capital of approximately $11,382,000, including a cash balance of $8,870,000. The Company's primary need for cash is to support its ongoing operating activities. The Company's primary sources of liquidity are cash provided from operations and a $7,500,000 line of credit arrangement at Comerica Bank. The Company believes that such sources are adequate to meet its cash and working capital needs.\nLIQUIDITY AND CAPITAL RESOURCES - CONTINUED\nUnder the line of credit arrangement which expires on December 31, 1995, Company borrowings bear interest at prime plus .25%. The Company is subject to certain financial covenants under this arrangement. These covenants include requirements to maintain minimum levels of working capital and tangible net worth, maximum debt to net worth ratios, and restrictions on the declaration of dividends. The Company has met all of these financial covenants and received consent from Comerica Bank for declaration and payment of dividends at a quarterly rate of four cents during fiscal 1995.\nEFFECT OF INFLATION\nThe Company does not believe that inflation has had a material effect on the results of its operations in the past three fiscal years.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nINDEX\nINDEPENDENT AUDITORS' REPORT\nBoard of Directors Sandy Corporation Troy, Michigan\nWe have audited the accompanying consolidated balance sheets of Sandy Corporation as of August 31, 1995 and 1994, and the related consolidated statements of earnings, changes in stockholders' equity and cash flows for each of the three years in the period ended August 31, 1995. 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, such consolidated financial statements present fairly, in all material respects, the financial position of Sandy Corporation as of August 31, 1995 and 1994, and the results of its operations, changes in stockholders' equity and its cash flows for each of the three years in the period ended August 31, 1995, in conformity with generally accepted accounting principles.\nDeloitte & Touche LLP\nDetroit, Michigan October 18, 1995\nSANDY CORPORATION CONSOLIDATED BALANCE SHEETS\nSANDY CORPORATION CONSOLIDATED STATEMENTS OF EARNINGS\nSee notes to consolidated financial statements.\nSANDY CORPORATION CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY\nYears ended August 31, 1995, 1994 and 1993\nSee notes to consolidated financial statements.\nSANDY CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS\nSANDY CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS\nSee notes to consolidated financial statements.\nSANDY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED AUGUST 31, 1995, 1994, AND 1993\nNOTE A - SUMMARY OF ACCOUNTING POLICIES\nPrinciples of consolidation\nThe consolidated financial statements include the accounts of Sandy Corporation (parent company) and its wholly owned Canadian subsidiary, Sandy Corporation of Canada. All material intercompany transactions and profits have been eliminated.\nCash\nThe Company considers all securities with a maturity of three months or less at date of purchase to be cash.\nInventories\nInventories represent finished goods and are stated at the lower of cost (first-in, first-out method) or market, net of a reserve for obsolete inventory of approximately $152,000, $172,000, and $118,000 at August 31, 1995, 1994, and 1993, respectively.\nLeasehold improvements and equipment\nLeasehold improvements, equipment, furniture, and fixtures are stated at cost. Depreciation expense is computed using the straight-line and accelerated methods over periods from 3 to 15 years. Leasehold improvements are amortized over the term of the related leases.\nAccretion\nA deferred gain, which arose from the sale and leaseback of the office building, was recognized ratably over the 10 years ending August 31, 1993.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nRevenue recognition and billings\nThe Company recognizes revenue with respect to services performed on a project basis as expenses are incurred. The Company recognizes revenue from product sales when the items are shipped. Amounts so recognized are accumulated in unbilled accounts receivable and billed periodically or at completion of the contract, depending upon the terms of the client's purchase order. Unbilled receivables are expected to be collected within one year.\nProposal costs\nThe Company defers a portion of proposal costs based upon management's estimate of realizability utilizing historical successful bid award rates. These costs are expensed when the related revenue is recognized if the proposal is sold or when it no longer appears the Company will be awarded the work. The deferred proposal costs amounted to $47,000 and $39,000 at August 31, 1995 and 1994, respectively.\nEarnings per share\nComputation of earnings per share for all periods presented is based on the weighted average shares and equivalents outstanding.\nIncome Taxes\nThe Company accounts for income taxes using the asset and liability approach. Deferred income taxes are provided for temporary differences in reporting income and expenses for income tax and financial statement purposes and for the differences between the tax basis of assets and liabilities and their reported amounts in the financial statements.\nRecent Accounting Pronouncements\nIn December 1991, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 107, \"Disclosures About Fair Value of Financial Instruments\". The pronouncement will not affect the operating results or financial position of the Company. The Company does not expect the future implementation of this pronouncement to produce fair values significantly different from the values included in the Company's financial statements. The Company will be required to adopt this statement for its fiscal year ending August 31, 1996.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nNOTE B - ALLOWANCE FOR DOUBTFUL ACCOUNTS\nNOTE C - NOTES PAYABLE TO BANK\nThe Company had available at August 31, 1995, a $7,500,000 line of credit at 0.25% over the prime rate (8.75% at August 31, 1995). Advances under the line are unsecured subject only to certain financial covenants. These covenants include requirements to maintain minimum levels of working capital and tangible net worth, maximum debt to net worth ratios, and restrictions on the declaration of dividends. This line of credit arrangement expires on December 31, 1995. There were no borrowings under the line of credit at August 31, 1995 or August 31, 1994.\nNOTE D - INCOME TAXES\nThe provision for income taxes differs from the expected tax of $825,000 in 1995, $872,000 in 1994, and $660,000 in 1993 as computed by applying the United States federal income tax rate to income before income taxes for the following reasons:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nThe components of income taxes are:\nDeferred tax assets (liabilities) are comprised of the following at August 31, 1995 and August 31, 1994:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nNOTE E - RELATED PARTY TRANSACTIONS AND LONG-TERM DEBT\nThe Company entered into a lease agreement for its Troy, Michigan headquarters, effective February 1, 1994, with the Landlord, 1500 Limited Partnership, a partnership comprised of certain shareholders of the Company. The lease provides a $500,000 allowance for building improvements paid by the partnership over the lease term, $100,000 of which was received by the Company in fiscal 1994, and another $100,000 for improvements after February 1, 2000. The lease will expire on May 31, 2006. Rent expense pertaining to the building amounted to $1,130,000, $1,076,000, and $1,001,000 for the years ended August 31, 1995, 1994, and 1993, respectively.\nIn connection with the merger discussed in Note J, the lease agreement will be amended effective at the closing date in the following manner: (i) an additional improvements allowance of $200,000 will be made available to the corporation surviving the merger between Sandy Corporation and Automatic Data Processing, Inc. (the \"Surviving Corporation\") immediately after the closing date and until December 31, 1996; (ii) the availability of the last $100,000 of the improvements allowance under the lease will be accelerated from February 1, 2000 to the closing date so that the $100,000 allowance will be available immediately after the closing date and until December 31, 1996. In connection with the effectiveness of such amendment to the lease, Automatic Data Processing, Inc., will guarantee the Surviving Corporation's obligations under the lease after the closing date. However, in the event the merger is not effectuated on or before January 31, 1996, this Amendment will be null and void.\nNOTE F - COMMITMENTS\nAt August 31, 1995, aggregate minimum lease payments under non-cancelable operating leases for office space and various equipment having initial or remaining terms of more than one year were as follows:\nFiscal year ending August 31:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nRental for the operating leases, including rent expense for the building as disclosed in Note E, amounted to $1,905,000, $1,807,000, and $1,648,000 for the years ended August 31, 1995, 1994, and 1993, respectively. Sublease revenue related to these operating leases was approximately $0, $140,000, and $229,000 in 1995, 1994, and 1993, respectively.\nThe Company entered into an employment contract with its Chief Executive Officer effective November 4, 1985. Payments for the first 10 years under the contract consist of a base amount of $210,000 annually plus an annual adjustment for inflation and, based upon total organizational performance, supplemental compensation not to exceed 150% of the base amount for each year of active employment. Upon completion of active employment, the employee will consult for a period of five years, during which time the annual payments will decline from 90% to 60% of the average of the final three years total compensation. Effective August 31, 1994, the Agreement was amended to provide for certain payments to be made by the Company in lieu of annual retirement benefit payments that were originally scheduled to be paid at the end of the consulting period. The amended Agreement required a payment of $652,650, which was made in September 1994, and $91,820, which was made on August 31, 1995, in lieu of all future retirement payments. The cost of the retirement benefit in 1995, 1994, and 1993 amortized as a level percent of compensation over 10 years, was approximately $92,000, $87,000, and $83,000, respectively, before the related tax benefit.\nThe Agreement was amended in connection with the execution of the merger agreement on August 22, 1995, as discussed in Note J, to provide that the Chief Executive Officer's active employment period will end on the date of the closing of the merger and, as a result, the five-year consulting period will begin on the closing date. The amended Agreement also requires the Company to make a payment of $1,475,000 to the Chief Executive Officer on the closing date, in lieu of all future consulting payments, bonuses (except the fiscal 1995 bonus that will be paid separately) or other benefits due under the amended Agreement.\nThe Company has a Profit Sharing Plan covering substantially all full-time employees who have completed one year of service and are employed on the last day of the calendar year. Contributions thereunder, which are not material, are in such amounts as the Company's Board of Directors shall determine at its discretion.\nAt August 31, 1995, the Company had purchase order commitments of approximately $4,100,000 relating to projects in process.\nNOTE G - MAJOR CUSTOMERS\nRevenue from various entities within General Motors Corporation accounted for approximately 49%, 53%, and 57% of the Company's total revenue in fiscal 1995, 1994, and 1993, respectively. Revenue from Ford Motor Company accounted for 32%, 31%, and 21% of the Company's total revenue in fiscal 1995, 1994, and 1993, respectively.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nNOTE H - STOCK OPTION PLANS\nIn fiscal years 1986 and 1990, the Company approved the 1985 Performance Incentive Plan (\"1985 Plan\") and the 1989 Performance Incentive Plan (\"1989 Plan\"), respectively. Under the 1985 Plan, 200,000 shares of the Company's common stock were reserved for issuance upon the exercise of options to be granted, and under the 1989 Plan, 150,000 shares were reserved for issuance upon the exercise of options to be granted. Under both the 1985 Plan and the 1989 Plan, options may be granted with exercise prices equal to the fair market value of the Company's common stock on the dates the options are granted or a percentage of the fair market value, as determined by a committee of the Board of Directors. Options can be granted under the 1985 Plan until November 3, 1995 and until November 21, 1999 under the 1989 Plan. During 1994, options to purchase common stock at $4.63 per share were granted to certain employees. At August 31, 1995, all 38,000 of these options remain unexercised. During 1995, options to purchase common stock at $6.75 per share were granted to certain employees. At August 31, 1995, all 50,000 of these options remain unexercised.\nIn September 1988, the Company entered into a nonqualified stock option agreement with an officer of the Company which allowed for the purchase of 100,000 shares of common stock at $2.00 per share. This option expired on August 1, 1995. During fiscal 1989, 40,000 of these shares became exercisable. During fiscal years 1990 through 1992, an additional 20,000 of these shares became exercisable in each year. During 1992, 20,000 of these options were exercised, and the remaining 80,000 of these options were exercised during 1995. (See Note I.)\nOn September 1, 1992, in conjunction with the amendment and extension of this officer's employment agreement, the Company entered into an amended nonqualified stock option agreement with this officer which allows for the purchase of an additional 50,000 shares of common stock. This option expires on September 1, 1999. The option price for 30,000 of these options is $8.25 per share which was the fair market value at the date of grant. These options are exercisable in annual increments of 10,000 shares from September 1, 1993 through September 1, 1995. The option price for the remaining 20,000 of these options is $11.38, which was the fair market value of the Company's common stock on September 1, 1995. These options become exercisable in annual increments of 10,000 shares on September 1, 1996 and September 1, 1997. However, in the event of a \"change in control\" as defined in the officer's employment agreement, the option price for all 50,000 shares will be $8.25 per share.\nIn conjunction with the merger agreement discussed in Note J, in the event of a \"change of control\" or \"disposition\" of the Company, as defined in the various stock option agreements, all outstanding options, as described above, become immediately exercisable into ADP shares.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nIn 1995, the Company and its shareholders approved the Sandy Corporation Directors' Stock Option Plan (\"Directors' Plan\"). Under the Directors' Plan, 20,000 shares of the Company's common stock were reserved for issuance upon the exercise of options to be granted. Options may be granted under the Directors' Plan with exercise prices equal to the fair market value of the Company's common stock on the dates the options are granted. Options granted under the Directors' Plan are 100% exercisable on the date of grant and may be exercised for a period of 10 years after the date of grant, if not sooner terminated. Options can be granted under the Directors' Plan until October 24, 2004.\nOn October 25, 1994, the Company entered into nonqualified stock option agreements with four of the Company's directors which allowed for the purchase of 2,000 shares of common stock at $6.56 per share, which was the fair market value on date of grant, for each of the four directors. These options were exercisable on the date of grant, and they expire on October 24, 2004. At August 31, 1995, all 8,000 of these options remain unexercised.\nNOTE I - STOCK REPURCHASE PROGRAM\nIn October 1993, the Company authorized the repurchase of up to 60,000 shares of the Company's stock. During 1994, the Company repurchased 4,700 shares.\nDuring 1995, as part of the September 1988 nonqualified stock option agreement with an officer of the Company discussed in Note H, the Company repurchased 26,609 of the 80,000 shares of common stock issued upon exercise of the stock options. These shares were purchased, as allowed for in the nonqualified stock option agreement, to satisfy the Company's obligation to remit the officer's income tax liability due upon exercise of the options.\nNOTE J - MERGER AGREEMENT WITH AUTOMATIC DATA PROCESSING, INC.\nOn August 22, 1995, the Company signed a definitive merger agreement with Automatic Data Processing, Inc., (\"ADP\") valued at approximately $30 million. The Company's shareholders will receive approximately $12 worth of ADP stock for each share of the Company's stock. The Agreement is subject to certain conditions, as described in the Merger Agreement. It is expected the transaction will close before the end of December 1995. Other Expense of approximately $650,000 represents merger related expenses incurred in the current year. The Company expects to incur additional merger expenses of approximately $230,000 through December, 1995, which is the expected completion date of the transaction.\nSANDY CORPORATION QUARTERLY CONSOLIDATED STATEMENTS OF EARNINGS (Unaudited)\nSANDY CORPORATION QUARTERLY CONSOLIDATED STATEMENTS OF EARNINGS (Unaudited)\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III.\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe directors and executive officers of the Company are listed below. The Company's Board of Directors appoints the Company's officers, who serve until the meeting of the Board following the next annual meeting or until their successors are appointed and qualified.\nMr. William H. Sandy has served as the Chairman of the Board of Directors of the Company, Chief Executive Officer of the Company and a Director of the Company since its inception in June 1971. Prior to August 8, 1988, Mr. Sandy also served as President of the Company. William H. Sandy is the father of Alan M. Sandy and Lewis G. Sandy, M.D.\nMr. Ketchledge was appointed President and Chief Operating Officer in August 1988 and has served as a Director of the Company since 1988. Prior to joining the Company, Mr. Ketchledge had been President of Austin-Rover Cars of North America from April 1985 up to the time of that company's sale to overseas interest in May 1988. Prior to that time Mr. Ketchledge was employed by United States Volkswagen\/Audi operation, Volkswagen of America, Inc. from 1966 to 1985 holding a variety of senior executive positions.\nMr. Bennett was appointed Group Vice President in November 1989. He has worked for the Company since September 1, 1987 and has served as Group Vice President of the Professional Staff, President of Marketing Educational Services, and Vice President of the Company. Mr. Bennett was employed by GM from August 1964 to August 1987 and served in a number of managerial positions within the various divisions of GM.\nMr. Gugala was appointed Group Vice President of General Motors Divisions in November 1990. He has worked for the Company since July 1976 and has served as Research Director and Account Director, and in a variety of automotive contact responsibilities. Prior to joining the Company, he was an instructional designer for Creative Universal, Inc.\nMr. Kidd has served as a Vice President of the Company, a Director of the Company and as its Secretary since its inception in June 1971. He has also served as a Senior Vice President since December 1974. Mr. Kidd has been primarily engaged in planning and program development.\nMr. Alan M. Sandy has served as a Director of the Company since 1986 and as a Vice President of the Company since November 1990. From September 1986 to November 1990, Mr. Alan M. Sandy served as Account Director of the Company. He previously served in various planning and marketing capacities with the Company, which he joined in September 1982.\nMr. Strickland was appointed Group Vice President of Professional Staff in November 1989. He has worked for the Company since June 23, 1980 and has served in various creative and marketing capacities, including Vice President of Marketing for the Chevrolet Account and most recently as Senior Vice President of New Business Development. Prior to joining the Company, he spent nine years at Ford Motor Company in Sales Training, Business Development, and in Television and Film Communications.\nMr. White was appointed Group Vice President of Business Development in October, 1993. He has worked for the Company since November, 1980 and has served as Vice President, Senior Vice President of Information Systems and Consulting, and Senior Vice President of Business Development. Prior to joining the Company, he was a consultant with Deloitte & Touche (formerly Touche Ross and Company).\nMr. Zimmerman was appointed Group Vice President and Chief Financial Officer in July 1994. Prior to joining the Company, Mr. Zimmerman had been Senior Vice President of Finance and Treasurer of Software Alternatives, Inc., and served in various consulting capacities from May 1990 until July 1994. Prior to that time, Mr. Zimmerman served as Treasurer of Champion Spark Plug Company from May 1983 through May 1990. From 1971 until 1983, Mr. Zimmerman was employed by Questor Corporation, a worldwide consumer products company, serving as Treasurer from 1977.\nMr. Burstein has served as a Director of the Company since 1985. He is a Partner with the law firm of Honigman Miller Schwartz and Cohn, Detroit, Michigan, which firm serves as general counsel to the Company.\nMr. Forrest has served as a Director of the Company since its inception in June 1971. He served as Chief Financial Officer of the Company for a number of years and retired from the positions of Senior Vice President and Treasurer of the Company in February 1987. He has worked since that time as a consultant.\nMr. Lorsch has served as a Director of the Company since 1987. He is a Senior Associate Dean of the Harvard Business School and has been Chairman of the Harvard Business School's Executive Education Program for the last five years. He is also a Director of the Brunswick Corporation.\nMr. Lewis G. Sandy, M.D., has served as a Director of the Company since 1994. He has served as Vice President of The Robert Wood Johnson foundation, a charitable foundation, and as Director of General Internal Medicine-Facility Group Practice of the Robert Wood Johnson Medical School, since 1991. Prior to that time, he served as Health Center Director of the Harvard Community Health Plan.\nMr. Sheehy has served as a Director of the Company since 1986. He has served as a Partner of Sphere Capital Partners since 1987. From 1985 until 1987, Mr. Sheehy served as Associate Director of Bear, Stearns & Co., Inc., an investment banking firm. Mr. Sheehy is also a Director, the Secretary and Treasurer of Greater Pacific Food Holdings, Inc. and a Director of Sphere Capital Advisors, Ltd., First Australia Fund, Inc., First Australia Prime Income Fund, Inc., First Australia Prime Income Investment Co., Ltd. and The First Commonwealth Fund, Inc.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nSUMMARY COMPENSATION TABLE\nThe following table sets forth information for each of the fiscal years ended on August 31 of 1995, 1994 and 1993 concerning the compensation of the Company's Chief Executive Officer and each of the Company's other four most highly compensated executive officers (collectively, the \"named executive officers\") whose annual salary and bonus exceeded $100,000.\n(1) Non-cash compensation did not exceed the lesser of $50,000 or 10% of the individual cash compensation of any executive officer.\n(2) In fiscal 1995, Mr. Sandy's Employment and Consulting Agreement was amended such that Mr. Sandy relinquished his right to receive certain retirement payments which the Company was obligated to begin paying him following the completion of a five-year consulting term, which consulting term was to commence upon the expiration of Mr. Sandy's employment with the Company. In return, as authorized by the disinterested members of the Company's Board of Directors, the Company paid Mr. Sandy $744,470, the amount accrued by the Company with respect to such obligation.\n(3) Includes gain of $765,000 on exercise of stock options.\n(4) Includes premiums paid in connection with a split dollar life insurance arrangement.\nOPTION GRANTS IN THE LAST FISCAL YEAR\nThe following table provides details regarding stock options granted to the named executive officers in the last fiscal year. In addition, in accordance with SEC rules, hypothetical gains that would exist for the respective options are shown. These gains are based on assumed rates of annual compounded stock price appreciation of 5% and 10% from the date the options were granted over the full option term. Of course, actual gains, if any, on stock option exercises and stock accruals are dependent on the future performance of the Common Stock and overall stock market conditions. There can be no assurance that the amounts reflected in the table will be achieved.\n(1) In accordance with SEC rules, these columns show gains that might exist for the option over the life of the option, a period of nine years. This valuation is hypothetical; if the stock price does not increase above the exercise price, compensation to the named executive officers will be zero. A 5% or 10% annually compounded increase in the Company's stock price from the date of grant to the end of the 9-year option term would result in stock prices of $10.47 and $15.92 per share, respectively.\n(2) The option becomes exercisable on October 31, 1997.\nAGGREGATED OPTION EXERCISES IN THE LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES\nThe following table sets forth information concerning stock options exercised by the named executive officers during the fiscal year ended August 31, 1995, as well as the value of unexercised options held by such persons on August 31, 1995. This table also includes the number of shares covered by both exercisable and non-exercisable stock options as of the last day of the fiscal year. Finally, the values for in-the-money options (which represent the positive spread between the exercise price of any existing stock options and $11.375 per share, representing the closing price of the Common Stock as reported by the American Stock Exchange on the last day of fiscal year 1995) are also included.\nCOMPENSATION OF DIRECTORS\nThe current standard arrangement for compensation of directors is as follows: officers of the Company who are directors do not receive any additional compensation for services as a director. Each director who is not an officer of the Company receives a director fee in the annual amount of $12,000 plus $1,300 for each board meeting attended ($1,800 per meeting if the director resides outside of Michigan). There are four regularly scheduled board meetings per year. An additional sum of $200 per meeting is paid for attendance at a committee meeting if such meeting falls on a day on which a meeting of the entire Board of Directors is not held.\nThe Board of Directors of the Company formed a Special Committee on March 30, 1995, consisting of Mr. Sheehy, who acted as chairman, Mr. Forrest and Mr. Lorsch, to review merger proposals from Westcott Communications and ADP. The members of the Special Committee earned compensation for their services of $2,500 per meeting. Mr. Burstein also served on the Special Committee initially, but resigned shortly after the Special Committee's formation. In addition, Messrs. Sheehy and Burstein earned $20,000 and $15,000, respectively, from the Company for their services in negotiating the Company's merger agreement with ADP. In total, Messrs. Sheehy, Forrest, Lorsch and Burstein earned $47,500, $27,500, $27,500 and $20,000, respectively, for services rendered as Special Committee members or otherwise in connection with the ADP transaction in fiscal 1995.\nEMPLOYMENT ARRANGEMENTS\nThe Company entered into an Employment and Consulting Agreement with William H. Sandy, the Chairman and Chief Executive Officer of the Company, effective November 4, 1985 (the \"Employment and Consulting Agreement\"). Under the terms of the Employment and Consulting Agreement, upon completion of his active employment with the Company, Mr. Sandy is to serve as a consultant to the Company for a period of five years. The Employment and Consulting Agreement was amended on August 22, 1995 in connection with the execution of the Merger Agreement, dated August 22, 1995 between the Company, ADP and ADP Mergerco, Inc. relating to the merger of the Company with and into ADP Mergerco, Inc. (the \"Merger\"). The amended Employment and Consulting Agreement provides that Mr. Sandy's active employment period will end on the date of the closing of the Merger (the \"Closing Date\"), and, as a result, the five-year consulting period will begin on the Closing Date. The amended Employment and Consulting Agreement also requires the Company to make a payment of $1,475,000 to Mr. Sandy on the Closing Date, in lieu of all future consulting payments, bonuses (except the fiscal 1995 bonus that will be paid separately to Mr. Sandy) or benefits to become due to Mr. Sandy or to his wife, Marjorie M. Sandy, under the amended Employment and Consulting Agreement. Amounts paid to Mr. Sandy pursuant to his employment agreement in fiscal 1995, 1994 and 1993 are set forth in the summary compensation table above.\nThe Company has entered into an employment agreement with Raymond A. Ketchledge, effective as of September 1, 1994. Under the agreement, the Company is to employ Mr. Ketchledge until he is terminated under one of the events described below. The employment agreement provides for a minimum base salary of $264,000 adjusted each September 1, plus certain supplemental compensation (based on the Company's profits) and cost of living adjustments. The employment agreement also provides for, among other things, the use by Mr. Ketchledge of a new leased automobile at the Company's expense, certain death and disability benefits and a split dollar life insurance arrangement pursuant to which the Company pays $15,000 per year in annual premiums during the term of the employment agreement. The employment agreement may be terminated by the Company upon the death of Mr. Ketchledge, upon his permanent disability or for cause. The Company may also terminate the employment agreement for any other reason upon written notice to Mr. Ketchledge in which event Mr. Ketchledge would be entitled to certain severance benefits. Amounts paid to Mr. Ketchledge pursuant to the employment agreement and to a predecessor employment agreement in fiscal 1995, 1994 and 1993 are set forth in the summary compensation table above.\nThe Company has also entered into employment agreements with several of its other executive officers. Pursuant to those employment agreements, each such officer is entitled to severance payments equal to one year's salary upon termination by the Company without cause, and each such officer has agreed not to compete with the Company for one year following the termination of the executive's employment, if such termination is by the officer or by the Company with cause.\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\nExcept for William H. Sandy, all the members of the Compensation Committee are non-employee directors of the Company. George J. Forrest, a director of the Company and a member of the Compensation Committee, was employed by the Company from its inception in June, 1971 until his retirement in February, 1987, serving for a number of years as the Company's Chief Financial Officer.\nNo executive officer of the Company serves as a member of the board of directors or on the compensation committee of a corporation for which any of the Directors on the Compensation Committee or the Board of Directors is an executive officer.\nRichard J. Burstein, a director of the Company and a member of the Compensation Committee, is a partner of the law firm of Honigman Miller Schwartz and Cohn. The Company used the services of this firm during fiscal 1995 and continues to use the firm's services as to certain matters in fiscal 1996. Work done for the Company in fiscal 1995 accounted for less than one percent of Honigman Miller Schwartz and Cohn's annual revenues.\nREPORT OF COMPENSATION COMMITTEE\nINTRODUCTION\nDecisions on compensation of the Company's executives are made by the five members of the Compensation Committee (the \"Committee\") of the Board. The members of the Committee are Messrs. John T. Sheehy (Chairman), Richard J. Burstein, George J. Forrest, Jay W. Lorsch and William H. Sandy.\nGENERAL POLICIES\nThe overall objective of the Committee with respect to compensation of executive officers is to provide a compensation program that is intended to attract, retain and reward key management personnel who contribute to the long term success of the Company and to motivate executives to achieve goals which support business strategies and business objectives of the Company.\nTo achieve these objectives, key management employees other than William H. Sandy and Raymond A. Ketchledge are paid salaries and bonuses based on corporate performance and individual initiative and achievements. Mr. Sandy's compensation is determined pursuant to an employment agreement dated November 1, 1985 (as amended), and Mr. Ketchledge's compensation is determined pursuant to an employment agreement effective September 1, 1994. Accordingly, the Committee is not involved in determining their compensation on an annual basis.\nSALARIES\nIndividual salary determinations of the Company's key management employees are based on experience and sustained performance and by reference to the salary levels which the Committee believes are prevalent in the Company's industry.\nBONUSES\nUnder the Company's bonus program, the Committee establishes a bonus pool pursuant to a formula which has historically been established annually, prior to the beginning of the fiscal year. Employees other than Mr. William H. Sandy and Mr. Ketchledge participate in the bonus pool. Awards of bonuses to particular employees are made with the recommendations of Mr. William H. Sandy and Mr. Ketchledge, and are based on each participant's contribution to the Company's business results.\nSTOCK OPTION PROGRAM\nThe Committee believes that stock ownership by executives and stock-based performance compensation arrangements foster an interest in the enhancement of shareholder value and thus align management's interests with that of the shareholders. Thus, beginning in fiscal 1994, the Committee began relying less on cash bonuses and also awarding stock options to key employees in amounts reflecting the participant's position and ability to influence the Company's overall performance. The Committee is utilizing vesting periods to encourage key employees to continue in the employ of the Company, and granting options with a term of 10 years to provide a long-term incentive. Generally, the exercise price of the options will be the fair market value of the underlying shares on the date of the grant. Thus, such options will have value only if the price of the underlying shares increases.\nOTHER COMPENSATION\nAt various times in the past the Company has adopted certain broad-based employee benefit plans in which key management employees have been permitted to participate and has adopted certain health expense and automotive plans. Benefits under these plans are not directly or indirectly tied to Company performance.\nCHIEF EXECUTIVE OFFICER COMPENSATION\nAs indicated above, Mr. William H. Sandy's compensation is determined pursuant to an employment agreement dated as of November 1, 1985 (as amended). The Committee thus is not involved in the determination of Mr. Sandy's annual compensation. The Committee did, however, review and approve the amendments to Mr. Sandy's employment agreement discussed above under \"Employment Arrangements\".\nBY THE COMPENSATION COMMITTEE:\nJohn T. Sheehy (Chairman) Richard J. Burstein George J. Forrest Jay W. Lorsch William H. Sandy\nPERFORMANCE GRAPH\nThe following graph compares the yearly cumulative total shareholder return (i.e., the change in share price plus the cumulative amount of dividends, assuming dividend reinvestment, divided by the initial share price, expressed as a percentage) on the Company's common stock, with the cumulative yearly total return of the Standard & Poor's 500 Composite Index and with a selected peer group for the past five years. The peer group consists of the 21 companies within the SIC Code 874 in November, 1993, which includes management consulting companies.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following table sets forth certain information with respect to the beneficial ownership of Common Stock (i) by each person who is known by the Company to own beneficially more than 5% of the Shares of Common Stock, (ii) by each of the Company's Directors, (iii) by each of the named executive officers, and (iv) by all the named executive officers and directors, as a group.\n________________________ * Less than 1%. (1) \"Beneficial Ownership\" is deemed to include shares for which an individual, directly or indirectly, has or shares voting or investment power, or both.\n(2) Includes 2,000 shares that the individual would have the right to acquire within 60 days of October 18, 1995 pursuant to stock options exercisable within such period. (3) Includes 55,500 shares held by George J. Forrest as trustee for the benefit of George J. Forrest under a trust agreement dated April 28, 1978. Does not include 129,900 shares beneficially owned by adult children of Mr. Forrest. (4) Includes 30,000 shares that Mr. Ketchledge would have the right to acquire within 60 days of October 18, 1995 pursuant to stock options exercisable by him within such period. (5) Includes 430,422 shares held by William H. Sandy under a trust agreement dated November 25, 1978; 12,300 shares owned outright by William H. Sandy; and 7,800 shares owned by Marjorie M. Sandy (Mr. Sandy's wife). Because of his voting power under the shareholder agreement described under \"Certain Relationships and Related Transactions\" William H. Sandy may be deemed to be the beneficial owner of a total of 1,035,070 shares (44.5% of the shares outstanding). Mr. William H. Sandy's address is 1500 W. Big Beaver Road, Troy, Michigan 48084. (6) Includes 155,800 shares owned directly by Mr. Cohen and 70,000 shares owned by S.A.C. Capital Management, L.P., a limited partnership in which Mr. Cohen is a general partner. Mr. Cohen's address is 520 Madison Avenue, 7th Floor, New York, NY 10022. This information is taken from Schedule 13D, as filed with the Securities and Exchange Commission, Washington, D.C., on April 11, 1995.\nAll directors and officers as a group beneficially owned 789,023 shares (33.5%) of Common Stock as of October 18, 1995, including 38,000 shares subject to stock options which may be exercised within 60 days of October 18, 1995.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe Company entered into an Employment and Consulting Agreement with William H. Sandy, the Chairman and Chief Executive Officer of Sandy, effective November 4, 1985. Under the terms of the Employment and Consulting Agreement, upon completion of his active employment with Sandy, Mr. Sandy is to serve as a consultant to Sandy for a period of five years. The Employment and Consulting Agreement was amended as of August 31, 1994 such that Mr. Sandy relinquished his right to receive certain payments which the Company was obligated to begin paying him following the completion of a five-year consulting term, which consulting term was to commence upon the expiration of Mr. Sandy's employment with the Company. In return, as authorized by the disinterested members of the Company's Board of Directors, the Company paid Mr. Sandy $744,470, the amount accrued by the Company with respect to such obligation. The Employment and Consulting Agreement was further amended in connection with the execution of the Merger Agreement on August 22, 1995 to provide that Mr. Sandy's active employment period will end on the date of the closing of the Merger, and, as a result, the five-year consulting period will begin on the Closing Date. The amended Employment and Consulting Agreement also requires Sandy to make a payment of $1,475,000 to Mr. Sandy on the Closing Date, in lieu of all future consulting payments, bonuses (except the fiscal 1995 bonus that has been paid separately to Mr. Sandy) or benefits to become due to Mr. Sandy or to his wife, Marjorie M. Sandy, under the amended Employment and Consulting Agreement.\nIn connection with the Merger, the lease agreement, dated February 1, 1994, between the Company and 1500 Limited Partnership pertaining to the Company's Troy, Michigan headquarters (the \"Lease\") has been amended effective as of the Closing Date, in the following manner: (i) an additional improvements allowance of $200,000 will be made available to the corporation surviving the Merger (the \"Surviving Corporation\") immediately after the Closing Date and until December 31, 1996; (ii) the availability of the last $100,000 of the improvements allowance under the Lease will be accelerated from February 1, 2000 to the Closing Date so that the $100,000 allowance will be available immediately after the Closing Date and until December 31, 1996; (iii) the Surviving Corporation will be permitted to self-insure under Sections 11.2, 11.3, 11.4 and 11.5 of the Lease in accordance with ADP's standard policy. In connection with the effectiveness of such amendment to the Lease, ADP will guarantee the Surviving Corporation's obligations under the Lease after the Closing Date. 1500 Limited Partnership is a Michigan limited partnership owned by, among others, certain directors of Sandy or their affiliates, including William H. Sandy, the George J. Forrest Trust, Alan V. Kidd, Alan M. Sandy and Lewis G. Sandy. The Lease, which will expire on May 31, 2006, provides for gross lease payments by Sandy ranging from $94,000 to $102,000 per month over the Lease term, plus increases in certain operating costs on a pass through basis. The Company's option (which option would have been exercisable through September 1, 1995) under Section 36 of the Lease to reduce the size of the leased premises by up to approximately 7.6% has been waived. There are no options to renew the Lease after May 31, 2006.\nOn August 22, 1995, William H. Sandy, the Chairman and Chief Executive Officer of Sandy, executed a voting agreement (the \"Voting Agreement\") and an irrevocable proxy agreement (as subsequently amended, the \"Irrevocable Proxy Agreement\") in favor of ADP. Pursuant to the Voting Agreement, Mr. Sandy has irrevocably committed until November 26, 1995 to vote in favor\nof the Merger (i) 362,900 shares of Sandy Common Stock beneficially owned by him and (ii) 564,548 shares of Sandy Common Stock (plus up to an additional 20,000 shares if certain outstanding stock options are exercised prior to November 26, 1995) not beneficially owned by Mr. Sandy to the extent that he has the right and authority as the \"Representative\" to vote such shares under the Shareholder Agreement, dated November 4, 1985, among certain shareholders of Sandy (the \"Shareholder Agreement\"). Pursuant to the Irrevocable Proxy Agreement, ADP has been granted an irrevocable proxy to vote in favor of the Merger 79,822 shares of Sandy Common Stock beneficially owned by Mr. Sandy which are not subject to the terms of the Voting Agreement. In addition, commencing November 26, 1995 (the date on which the Shareholder Agreement expires in accordance with its terms), the Irrevocable Proxy Agreement will confer on ADP an irrevocable proxy to vote in favor of the Merger the 362,900 shares of Sandy Common Stock beneficially owned by Mr. Sandy which were theretofore subject to the terms of the Voting Agreement.\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 consolidated financial statements of Sandy Corporation are incorporated in Part II, Item 8 in this Form 10-K.\n2. FINANCIAL STATEMENT SCHEDULES\nFinancial Statements and Schedules Omitted:\nSchedules are omitted because they are not required under instructions contained in Regulation S-X or because the information called for is shown in the financial statements and notes thereto.\n3. EXHIBITS\nThe Exhibit Index on pages 36, 37, 38, and 39 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:\nThere were no reports on Form 8-K filed during the three months ended August 31, 1995.\n3.EXHIBITS\n10.8 Tax Indemnification Agreement in connection with the termination of the Subchapter Selection, incorporated by reference from Exhibit 10.20 to Sandy Corporation's registration statement on Form S-1 (File No. 33-445), effective November 19, 1985.\n10.9 Amendment to Employment Agreement with William H. Sandy, incorporated by reference from Exhibit 10.16 to Sandy Corporation's annual report on Form 10-K for fiscal 1986 (File No. 1-8996).\n10.10 Amendment to 1985 Sandy Corporation's Performance Incentive Plan, incorporated by reference from Exhibit 10.17 to Sandy Corporation's annual report on Form 10-K for fiscal 1987 (File No. 1-8996).\n10.11 Non-qualified stock option agreement with Raymond A. Ketchledge effective as of September 1, 1988, incorporated by reference from Exhibit 10.18 to Sandy Corporation's annual report on Form 10-K for fiscal 1988 (File No. 1-8996).\n10.12 Loan Letter Agreement dated November 22, 1991, from Comerica Bank to William Sandy, Chairman, Raymond Ketchledge, President and Peter Steffes, Group Vice President and Chief Financial Officer, concerning the Company's $7,500,000 secured loan commitment, incorporated by reference from Exhibit 10.27 to Sandy Corporation's annual report on Form 10-K for fiscal 1991 (File No. 1-8996).\n10.13 Non-qualified stock option agreement with Raymond A. Ketchledge effective as of September 1, 1992, incorporated by reference from Exhibit 10.32 to Sandy Corporation's annual report on Form 10-K for fiscal 1992 (File No. 1-8996).\n10.14 Letter from Comerica Bank to Peter E. Steffes, dated October 21, 1992, regarding Comerica's consent to the declaration of a common stock dividend, incorporated by reference from Exhibit 10.36 to Sandy Corporation's annual report on Form 10-K for fiscal 1992 (File No. 1-8996).\n10.15 Letter of notification dated November 12, 1992, from Comerica Bank to Peter E. Steffes concerning changes to Revolving Credit Loan Agreement by and between Sandy Corporation and Comerica Bank, incorporated by reference from Exhibit 10.37 to Sandy Corporation's annual report on Form 10-K for fiscal 1992 (File No. 1-8996).\n10.16 Amended and Restated Revolving Credit Agreement, dated June 23, 1993, by and between Sandy Corporation and Comerica Bank, incorporated by reference from Exhibit 10.37 to Sandy Corporation's annual report on Form 10-K for fiscal 1993 (File No. 1-8996).\n10.17 Lease agreement dated February 1, 1994, between Sandy Corporation and 1500 Limited Partnership concerning office facilities at 1500 West Big Beaver Road, Troy, Michigan, incorporated by reference from Exhibit 10(a) to Sandy Corporation's quarterly report on Form 10-Q for the quarter ended February 28, 1994 (File No. 1-8996).\n10.18 1989 Sandy Corporation Performance Incentive Plan, incorporated by reference from Exhibit 10.29 to Sandy Corporation's annual report on Form 10-K for fiscal 1994 (File No. 1-8996).\n10.19 First Amendment to Amended and Restated Revolving Credit Loan Agreement, dated August 30, 1994, by and between Sandy Corporation and Comerica Bank, incorporated by reference from Exhibit 10.30 to Sandy Corporation's annual report on Form 10-K for fiscal 1994 (File No. 1-8996).\n10.20 Letter from Comerica Bank dated June 20, 1994, regarding Comerica's consent to the declaration of a common stock dividend, incorporated by reference from Exhibit 10.31 to Sandy Corporation's annual report on Form 10-K for fiscal 1994 (File No. 1-8996).\n10.21 Amendment to Employment and Consulting Agreement with William H. Sandy, dated August 31, 1994, incorporated by reference from Exhibit 10.32 to Sandy Corporation's annual report on Form 10-K for fiscal 1994 (File No. 1-8996).\n10.22 Supplemental Income Benefit Agreement with Raymond A. Ketchledge effective as of November 1, 1994, incorporated by reference from Exhibit 10.33 to Sandy Corporation's annual report on Form 10-K for fiscal 1994 (File No. 1-8996).\n10.23 Stock Option Agreement with Alan Sandy effective as of October 27, 1993, incorporated by reference from Exhibit 10.34 to Sandy Corporation's annual report on Form 10-K for fiscal 1994 (File No. 1-8996).\n10.24 Stock Option Agreement with Alan Kidd effective as of October 27, 1993, incorporated by reference from Exhibit 10.35 to Sandy Corporation's annual report on Form 10-K for fiscal 1994 (File No. 1-8996).\n10.25 A form of employment agreement between Sandy Corporation and its Group Vice Presidents, incorporated by reference from Exhibit 10(a) to Sandy Corporation's quarterly report on Form 10-Q for the quarter ended November 30, 1994 (File No. 1-8996).\n10.26 Employment Agreement with Raymond A. Ketchledge effective as of September 1, 1994, incorporated by reference from Exhibit 10(a) to Sandy Corporation's quarterly report on Form 10-Q for the quarter ended February 28, 1995 (File No. 1-8996).\n10.27 Sandy Corporation Director Stock Option Plan as adopted by the Board of Directors on October 25, 1994, incorporated by reference from Exhibit 10(b) to Sandy Corporation's quarterly report on Form 10-Q for the quarter ended February 28, 1995 (File No. 1-8996).\n10.28 Second Amendment to Amended and Restated Revolving Credit Loan Agreement, dated May 4, 1995, by and between Sandy Corporation and Comerica Bank, incorporated by reference from Exhibit 10(a) to Sandy Corporation's quarterly report on Form 10-Q for the quarter ended May 31, 1995 (File No. 1-8996).\n10.29 Third Amendment to Employment and Consulting Agreement with William H. Sandy, dated August 22, 1995.\n10.30 Amendment to the Lease Agreement, dated August 22, 1995, between Sandy Corporation and 1500 Limited Partnership concerning office facilities at 1500 West Big Beaver Road, Troy, Michigan.\n10.31 Agreement and Plan of Merger dated August 22, 1995, by and among ADP Mergerco, Inc., Automatic Data Processing, Inc., and Sandy Corporation.\n10.32 Voting Agreement between William H. Sandy, Marjorie M. Sandy, and Automatic Data Processing, Inc., dated August 22, 1995.\n10.33 Irrevocable Proxy Agreement between William H. Sandy, Marjorie M. Sandy, and Automatic Data Processing, Inc., dated August 22, 1995.\n10.34 Letter from Comerica Bank dated October 17, 1995, regarding Comerica's consent to the declaration of a common stock dividend.\n22.1 Subsidiaries of the Registrant, incorporated by reference from Exhibit 22.1 to Sandy Corporation's registration statement on Form S-1 (File No. 33-445), effective November 19, 1985.\n27 Financial Data Schedule for the year ended August 31, 1995.\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 November 3, 1995.\nSANDY CORPORATION (Registrant)\nBy: -------------------------------- William H. Sandy, 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 November 3, 1995.\nSignature Capacity - --------- --------\n- ----------------------------- Director Jay W. Lorsch\n- ----------------------------- Director Alan M. Sandy\n- ----------------------------- Director Lewis G. Sandy, M.D.\n- ----------------------------- Director John T. Sheehy","section_15":""}
{"filename":"354452_1995.txt","cik":"354452","year":"1995","section_1":"Item 1. Business\nGeneral\nPlasma-Therm, Inc., together with its subsidiary, (the \"Company\") is engaged in the design and production of thin film etching and deposition manufacturing equipment. The Company sells this equipment directly to manufacturers in the semiconductor, compound semiconductor, thin film head, photomask, microeletectromechanical systems (MEMS) and flat panel display industries. The Company's products are marketed, together with service and technical support, by the Company's direct sales force, its Japanese distributor and independent domestic and foreign manufacturer's representatives. The Company's business was founded in 1975.\nRecent Developments\nIn late 1995, the Company began shipping its newest product the Versalock(TM) 700 thin film etching and deposition system. The Versalock(TM) 700 is a natural extension of its Shuttlelock(R) Series of plasma processing systems. All processes developed on the Company's Shuttlelock(R) chamber platform can be transferred directly to the Versalock(TM) 700 system. The Versalock(TM) 700 is the Company's second cluster tool style system and its first where multiple product generations will be developed on the same substrate handling platform. The Versalock(TM) 700 is perceived by management to be a potential source of growth in revenue and income, although such growth cannot be assured. See \"Product Lines\".\nDuring 1995, the Company developed a proprietary Inductively Coupled Plasma (ICP) source. This ICP source provides high density, high performance plasma processing. The ICP source increases the technical performance of the Company's products and allows the Company to offer the affected products at favorable margins and competitive prices. Incorporation of the ICP capability into the 790 Series, the Shuttlelock(R) and the Versalock(TM) product lines is ongoing. The development of this source represents innovation in basic technology brought to market in a compressed time frame.\nIn August 1995, the Company purchased approximately six acres for the purposes of building a new manufacturing facility to meet its future capacity requirements. Construction on the facility began in September and is expected to be completed in June 1996. The Company's entire operations will be based in the new 60,000 sq. ft. facility. The entire assembly and test area will be contained in a class 10,000 to class 1,000 clean room. Additionally, the Company's demonstration and applications laboratories will be housed in a class 100 clean room. These clean room manufacturing and demonstration areas are necessary to address the cleanliness requirements of the Company's customer base. The design of the new building will accommodate increased production capacity and is expected to improve efficiencies due to enhanced manufacturing flow. The land and the building design will also accommodate a 30,000 sq. ft. expansion for future growth.\nThe Company secured financing for the construction of the facility in August 1995 (see Notes 5 and 8 to the Consolidated Financial Statements for further detail).\nIn September, the Company signed an exclusive distributorship agreement with Hakuto Co., Ltd. replacing its current Japanese distributor, Nissin Hi- Tech, Inc.\/Nissin Electric Co., Ltd. The new distributorship arrangement is considered favorable by the Company since it provided similar terms as the previous agreement and permitted Hakuto Co., Ltd. to hire many of the former distributor's employees.\nThe Company's revolving credit facility was modified in November 1995. The amount available for borrowing was increased from $2 million to $3 million. All loan covenants are identical to the previous loan document.\nPlasma-Therm Product Lines\nThe Company manufactures various product lines that perform thin film etching and deposition. Several products utilize batch processing in which wafers or substrates are placed into the plasma chamber and processed simultaneously. Also, the Company's products permit single wafer or substrate processing.\nThe Company's thin film etching systems provide a combination of Reactive Ion Etching (RIE), Plasma- Etching (PE), Electron Cyclotron Resonance (ECR), and Inductively Coupled Plasma (ICP) capability, which permits advanced process applications for Gallium Arsenide, Indium Phosphide, Chrome, Quartz, Silicon Dioxide, Amorphous Silicon, Silicon, Indium Tin Oxide, Molybdenum, Aluminum, Aluminum Oxide and various other materials.\nThe Company also offers Plasma Enhanced Chemical Vapor Deposition (PECVD) systems for depositing Amorphous Silicon, Silicon Nitride, Silicon Dioxide, diamond-like carbon and other materials.\nThe Company's plasma systems are divided into two groups. The core group consists of three products lines: (1) 790 Series, (2) Shuttlelock(R) Series, and (3) the 7000 Series. The second or automated group of products consists of the Versalock(TM) 700 and Clusterlock(R) 7000 Series. These groups of products permit our customers to go from research and development to pilot production and then on to high volume manufacturing, utilizing the Company as their primary supplier.\nThe three core product lines are marketed as related products to a wide range of industries (see Item 1, Business, General). They are modular in design with components that are largely interchangeable. The automated group of products are targeted specifically to high volume manufacturers of thin film heads, compound semiconductors and flat panel displays.\nIn addition to plasma systems, the Company produces specialty power subsystems and devices.\n790 Series\nThe 790 Series RIE\/PECVD plasma system was introduced in 1992. The 790 Series has been widely accepted in the marketplace as the successor to the System VII 70 and 700 Series. The 790's advanced 80486 control system coupled with increased flexibility has significantly improved its marketability. This past year the 790 Series was outfitted with the Company's proprietary Inductively Coupled Plasma (ICP) source, making it what the Company believes to be the first commercially available non-loadlocked ICP based plasma system. The 790 Series is primarily used for advanced research and development and pilot production of compound semiconductor devices.\nShuttlelock(R) Series\nThe Shuttlelock(R) Series RIE, PECVD, and ECR plasma systems continue to be the Company's most successful products. The Shuttlelock(R) Series enhanced 80486 control system and other unique features, continues to provide excellent marketability. The Shuttlelock(R) is a loadlocked single or dual chamber plasma processing system. The loadlock allows the processing chambers to remain under vacuum, thus permitting increased process integrity. The Shuttlelock(R) is used for pilot production and production of compound semiconductor devices, opto- electronics, photomasks, microelectromechanical (MEMS) systems and thin film head manufacturing.\n7000 Series\nThe 7000 Series RIE and PECVD systems were originally introduced in 1987. This series of manually loaded plasma systems is unique, featuring 24 inch diameter electrode areas. This makes the product attractive for use on either large area substrates or large load batches of medium or small substrates. In 1995 the 7000 Series was re-engineered and updated to bring the product up to levels of performance and cost comparable with the Company's newer products. The upgrades included improvements to the electrical design, the computer control system and the gas control system, as well as updated packaging and aesthetics. These upgrades were made as a result of increased interest in the 7000 Series from the market and will enable this product to be produced with higher performance and reduced cost.\nVersalock(TM) 700 Series\nThe Versalock(TM) 700 Series RIE, PECVD, and ICP plasma systems are among the Company's newest products and are a natural extension of the Shuttlelock(R) Series. All processes developed using the Company's Shuttlelock(R) chamber platform can be transferred directly to the Versalock(TM) 700 system. The Versalock(TM) 700 is the Company's first plasma system platform where multiple product generations will be developed using the same substrate handling mechanisms. The Versalock(TM) 700 has a central handler (square loadlock) that permits up to three processing modules. The Versalock(TM) 700 is available with manual or cassette-to-cassette capability allowing it to meet advanced research and development and or volume production requirements of the compound semiconductor, thin film head, photomask, microelectromechanical (MEMS) system, and flat panel display markets.\nClusterlock(R) 7000 Series\nThe Clusterlock(R) 7000 (CLR-7000) Series flat panel display plasma processing system was introduced in late 1993. The CLR-7000 system was designed to penetrate the flat panel display manufacturing industry. The CLR-7000 is used by manufacturers of flat panel displays during the micro-structure formation process. This formation process is essential in the production of flat panel displays for notebook computers, personal computers, work stations, avionics and marine navigation equipment. The potential exists for flat panel displays to be used for televisions in the future.\nThe CLR-7000 offers a multi-chamber system configuration that combines cassette-to-cassette vacuum transfer and \"Class One\" cleanliness with reduced contamination, high throughput (yield) and ultimately lower costs of ownership.\nSpecialty Power Subsystems and Devices\nThe Company's wholly-owned subsidiary, Magnetran, Inc., is in the business of manufacturing transformers, reactors, power centers and related components. These products are used by manufacturers of induction melting furnaces, RF power supplies and AM\/FM broadcast transmitters.\nManufacturing and Supplies\nThe Company designs and develops a substantial portion of its systems' components. The Company has multiple potential commercial sources for all of its components and sub-assemblies that it acquires from outside vendors, although it often uses a single vendor for a given item to achieve consistency, favorable pricing and dependable close relationships. The Company maintains a significant inventory due to lengthy lead times of certain components, aggressive customer delivery requirements and the need to provide quality parts and service to its customers.\nPatents and Trademarks\nThe Company believes that its success is generally less dependent upon patent protection than on the scientific and engineering skills which are applied to its products. The Company believes that licenses for products or processes that are developed in the future could be valuable components of its business strategy and intends to grant or seek such licenses and agreements and seek possible patent protection, wherever it deems appropriate.\nResearch and Development\nThe market served by the Company is characterized by rapid and constant technological change. There is no assurance that the Company's current products will be viable for extended time periods. Accordingly, the Company spends substantial resources for research and product development directed toward improving existing products and developing new products.\nDuring fiscal years ended November 30, 1995, 1994, and 1993, the Company spent approximately $2,570,000, $2,266,000 and $1,466,000, respectively, for research and product development.\nNo assurance can be given that the Company will be technologically or commercially successful in these or in any other research and product development efforts. As of November 30, 1995, 28 employees were engaged primarily in research and product development activities.\nMarketing, Sales and Service\nIn the United States, the Company sells its products through a combination of direct sales (West Coast, Southwest, Mid-Atlantic, Northeast) and one manufacturer's representative. Service is provided directly with locations in Vermont, New Jersey, Michigan, Minnesota, Texas, Florida, California, Arizona and Idaho.\nA substantial portion of the Company's markets is outside of the United States. In Japan, the Company distributes its products exclusively through its distributor, Hakuto Co., Ltd., located in Tokyo. Hakuto purchases the Company's products for resale for its own account and provides sales and service through several locations in Japan.\nSales of the Company's products in Europe are handled through a network of manufacturer's representatives managed by the Company's direct sales office located in Horsham, England. Service is provided by locations in England and Ireland.\nIn the Far East (other than in Japan), sales are handled exclusively by manufacturer's representatives. Far Eastern service is supported by the manufacturer's representatives and the Company directly.\nThe Company's marketing efforts include the operation of a process demonstration laboratory in Florida. The Company's exclusive Japanese distributor, Hakuto Co., Ltd. operates a system demonstration facility. Process and demonstration laboratories are used to demonstrate system performance on customer wafers and substrates as part of the sales process, as well as in research and development.\nThe following table sets forth the estimated percentages of revenues represented by the Company's principal areas of activity for the periods indicated:\nA substantial amount of equipment is sold by the Company with applications support and warranties of the systems' ability to perform the desired process within specified limits. In substantiating those warranties, the Company offers customers the opportunity to perform tests on the customers' sample wafers and substrates in the Company's process laboratories. The warranty period ranges from four months to one year from date of shipment, depending on the type of product.\nSales to Nissin Hi-Tech, Inc.\/Nissin Electric Co., Ltd. amounted to 7%, 13% and 8% of total revenues in 1995, 1994 and 1993 respectively. Nissin Hi-Tech was the Company's Japanese distributor until August 1995.\nBacklog\nThe Company's backlog, as of November 30, 1995 was approximately $12,000,000 as compared to approximately $4,700,000 as of November 30, 1994, (revenue recognized on a percentage of completion basis in 1994 has been excluded from the backlog amounts). Backlog orders consist solely of those items for which a delivery schedule has been specified and to which the customer has assigned a purchase order number. Orders generally are subject to cancellation by the customer upon payment of charges which vary depending on the nature of the order and the timing of the cancellation. It is expected that substantially all of the November 30, 1995 backlog will be shipped during fiscal year 1996.\nCompetition\nCore Products\nThe Company experiences substantial competition in marketing all of its core products. Competition comes mainly from Oxford Plasma Technology and Surface Technology Systems based in Europe and SamCo Corporation located in Japan. Due to the Company's locally available Applications Laboratory and substantially larger service organization and installed base, it maintains competitive advantages in selling its products in the United States. Conversely, the Company experiences significantly greater competition in Europe and Japan because of its competitors' locations.\nAutomated Products\nThe Company experiences global competition for the CLR-7000 flat panel display manufacturing system. Several competitors include Tokyo Electron LTD (TEL), ULVAC and Applied Komatsu Technology. In addition, Lam Research has announced plans to enter the market in 1996. The competition for the Versalock(TM) 700 system is Surface Technology Systems, Anelva and Ulvac.\nPrincipal competitive factors include system performance, cost of ownership, size of installed base, diversity of product line and overall customer support. The Company's competitors have more experience with complex high-volume manufacturing, broader name recognition, substantially larger customer bases and greater financial, technical, and marketing resources. Therefore, there can be no assurance that the Company's competitors will not develop systems and features that are superior to the Company's.\nEmployees\nAs of November 30, 1995, the Company had 148 full-time employees, 117 of whom are employed in Florida, 20 in New Jersey, with the remaining 11 located in its sales and service offices in the United States. Of such employees, 21 are executive or administrative, 22 are sales and service, 77 are manufacturing and 28 are research and development personnel. Management believes that in general, its employee relations are good. The Company currently does not have any collective bargaining agreements.\nExecutive Officers of the Company and Key Employees\nExecutive Officers\nThe executive officers of the Company are as follows:\nName Age Position\nRonald H. Deferrari 55 Chief Executive Officer, Treasurer, Chairman of the Board\nRonald S. Deferrari 32 President, Chief Operating Officer\nDiana M. DeFerrari 33 Vice President of Administration, Secretary\nCurtis A. Barratt 40 Vice President of Technology, Chief Technical Officer\nStacy L. Wagner 32 Vice President of Finance, Controller\nDavid R. Anderson 34 Operations Manager _________________________ Ronald H. Deferrari is the founder of the Company and the father of Ronald S. Deferrari and Diana M. DeFerrari. Mr. Deferrari served as President of the Company since its formation in 1975 until Ronald S. Deferrari became President in 1995.\nRonald S. Deferrari was named President in June 1995 and has been employed with the Company in various capacities since 1983. Mr. Deferrari was appointed Chief Operating Officer in 1993. Prior to his current position, he was Executive Vice President and Director of Sales and Marketing.\nDiana M. DeFerrari was named Vice President of Administration in February 1995 and has been employed with the Company for six years. Ms. DeFerrari was appointed Secretary of the Corporation in May 1994. Prior to her current position, she was Director of Administration since 1992 and has worked in related capacities since 1990. Ms. DeFerrari holds a Masters Degree in Business Administration.\nCurtis A. Barratt was named Vice President of Technology and Chief Technical Officer in July 1995 and has been with the Company for over five years. Prior to his current position, Mr. Barratt was Director of Technology and Manager of Process Applications. Mr. Barratt holds a B.S. in Chemistry and has had numerous publications in the field of microelectronic device fabrication, many of which directly involve the use of plasma processing.\nStacy L. Wagner, CPA, was named Vice President of Finance in June 1995 and has been with the Company as Controller since July 1993. Prior to working at Plasma-Therm, Ms. Wagner was Audit Supervisor\/Manager for Grant Thornton for over two years.\nDavid R. Anderson has been Operations Manager for the last five years. Mr. Anderson has worked for the Company since 1985 in various manufacturing and customer service positions.\nOther Key Employees\nEdmond A. Richards, PE, Age 45, Director of Engineering since 1994, has been employed with the Company for twenty years. Since 1991 Mr. Richards has held various engineering management positions and prior to this, he served as General Manager of the Company for 11 years. Mr. Richards holds a B.S. in Electrical Engineering.\nDr. David J. Johnson, Age 55, Process Scientist, has fifteen years experience in the plasma processing field and has been employed with Plasma- Therm since 1979. He is a widely acknowledged expert in the area of metal etching for the manufacture of silicon integrated circuits and complements this with knowledge and publications in virtually every aspect of plasma processing.\nDr. Christopher Constantine, Age 41, Applications Manager, has been employed with the Company since 1984. He has acquired considerable experience working in the ECR and ICP plasma processes after an extensive career in traditional parallel plate plasmas, and is widely acknowledged for his expertise.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company's executive offices, manufacturing and product development facilities are located in leased premises, aggregating approximately 55,800 square feet in St. Petersburg, Florida. Since October 1995, when the lease term of its facilities expired, the Company began leasing the facilities on a month-to- month basis and will continue leasing on a month-to- month basis until the completion of the construction of the new facility which is anticipated to be in June 1996 (see below). The monthly rental amount is approximately $41,000. In March, 1995 the Company executed a real estate lease for additional space, included in the total square footage above, for approximately $2,100 per month which expires in March 1996. Upon expiration, the Company will continue to lease the space on a month-to-month basis until the completion of the new facility. The leases require the Company to pay its share of real estate taxes and operating expenses.\nThe Company is in the process of constructing a 60,000 square foot building in St. Petersburg, Florida. The Company will conduct all its operations in the new facility. At November 30, 1995, approximately $2,200,000, including $786,000 for land, has been incurred. Total anticipated costs upon completion approximate $4,750,000. In August, 1995 the Company executed a promissory note for $3,375,000 with its bank for the construction of the facility. In June, 1996, the maturity date of the construction phase and the anticipated completion date, the note converts to a five year term loan, amortized over a fifteen year period. Equal payment of principal and interest will be payable monthly at a fixed interest rate based on the weekly average yield of U.S. Treasury securities plus 200 basis points. The interest rate will be determined upon conversion. In addition, the Company anticipates acquiring approximately $500,000 in furniture, fixtures, and equipment which is expected to be financed through a lease.\nMagnetran, Inc., the Company's subsidiary, entered into a 5 year gross lease, with the Company's Chief Executive Officer, commencing on November 1, 1994, for approximately 17,750 square feet in Voorhees, New Jersey. The premises are leased at an aggregate annual base rental of $86,841, which escalates 3% annually. After the initial term of the lease, Magnetran has an option to renew for five years with a 3% increase each year. The Company believes that the terms of the lease are generally as favorable to it as could be obtained from unaffiliated third parties. The aggregate rentals paid to the Chief Executive Officer for all leases for the years ended November 30, 1995, 1994 and 1993 were approximately $87,000, $225,500 and $240,300, respectively.\nItem 3.","section_3":"Item 3. Legal Proceedings\nNo material litigation is pending.\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 Stockholder Matters\nThe Company's Common Stock is traded in the over-the-counter market and is quoted on NASDAQ small capitalization market under the symbol PTIS. The following table sets forth the range of high and low closing bid quotations for the Common Stock for fiscal 1994 and fiscal 1995 as reported by NASDAQ. These quotes are believed to be representative interdealer quotations, without retail mark-up, mark-down or commission, and may not necessarily represent actual transactions. As of January 16, 1996, the average of the closing bid and ask price of the Company's Common Stock was $2.41.\nFiscal 1994 High Bid Low Bid\nFirst quarter $4-7\/16 $2-7\/16 Second quarter 4-1\/4 1-15\/16 Third quarter 6-5\/8 3-3\/16 Fourth quarter 5-7\/8 4-1\/4\nFiscal 1995 High Bid Low Bid\nFirst quarter $9-1\/16 $4-1\/2 Second quarter 5-5\/8 3-1\/4 Third quarter 4-15\/16 3-1\/2 Fourth quarter 5-5\/16 2-9\/16\nAs of January 16, 1996, there were 747 record holders of the shares of Common Stock.\nThere have been no dividends declared. The Company entered into a new loan agreement with NationsBank of Florida, N.A. (NationsBank) in November 1995. That agreement contains covenants which relate to the Company's operating performance and financial condition. In addition, the loan agreement requires prior consent from the lender before declaring any cash dividends. Under the most restrictive covenant, none of the Company's retained earnings at November 30, 1995 are free of limitations on payment of cash dividends. For the foreseeable future, the Company anticipates that any net earnings will continue to be retained by the Company as working capital.\nItem 7.","section_6":"","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nFinancial Position, Liquidity and Capital Requirements\nThe Company's cash position increased by $2,432,868 from November 30, 1994 to November 30, 1995. Working capital at November 30, 1995 was $16,875,126, which is an increase of $6,485,010 over November 30, 1994. The increase in working capital was partially due to the completion of a private placement offering of 1,500,000 shares of the Company's Common Stock in December 1994, raising net cash of approximately $5,759,000. A portion of the proceeds from the private placement have been used for working capital requirements, including inventory which increased $2,613,513. Furthermore, an increase in sales contributed significantly to the increase in working capital. As a result of the increase in sales, accounts receivable has increased $3,156,551. In summary, an increase in inventory and accounts receivable which is the result of an increase in sales, and the proceeds from the private placement account primarily for the increase in working capital.\nUses of cash during fiscal 1995 included the repayment of $486,564 of notes payable and capital lease obligations. In addition, the Company has incurred $2,656,835 in capital expenditures. Approximately $232,000 of the capital expenditures relate to computer hardware to be used in conjunction with the manufacturing and financial software which the Company is currently in the process of purchasing. Total cost of the software and additional hardware approximates $500,000 which will be financed through a capital lease. The financing is expected to be completed in the first quarter of 1996. Approximately $2,203,000 of capital expenditures relate to the initial costs associated with the construction of the new building including $786,017 for land. Total anticipated costs upon completion approximate $4,750,000. The construction is being financed through a promissory note with the Company's bank. During the construction phase, interest is payable monthly at the bank's prime rate on the outstanding balance. In June,\n1996, the maturity date of the construction phase and anticipated completion date, the note converts to a five year term loan, amortized over a fifteen year period. Equal payments of principal and interest will be payable monthly at a fixed interest rate based on the weekly average yield on U.S. Treasury securities plus 200 basis points. The interest rate will be determined upon conversion. In addition, the Company anticipates acquiring approximately $500,000 of furniture, fixtures, and equipment which is expected to be financed through a lease.\nIn November 1995, the Company increased its existing line of credit with its bank to $3,000,000 which is due May 19, 1997. Interest is payable monthly at the bank's prime rate. The line is collateralized by accounts receivable and the bank has a security interest in the proceeds for the collection of accounts receivable in the Company's depository accounts.\nThe Company has extensive ongoing capital requirements for research and development, the repayment of debt, capital equipment and inventory. The Company believes that its current cash reserves, together with the proceeds of the private placement, working capital expected to be generated by operations and additional funds available under its line of credit, should be sufficient to meet its capital requirements for the immediate future. Should order input exceed projected 1996 levels, additional working capital may be required.\nThe Company believes that inflation has had no material impact upon its operations.\nResults of Operations\nComparison of Fiscal 1995 and Fiscal 1994\nFor fiscal 1995, the Company reported sales of $29,611,625, 27% higher than sales of $23,318,465 for fiscal 1994. The increase in sales was attributable to higher product demand, increase in Clusterlock(R) 7000 sales and sales of the newly introduced Versalock(TM) product line.\nCost of products sold of $19,152,542 for fiscal 1995 is 65% of net sales, compared to 62% in the prior year. The increase relates primarily to lower margins on Clusterlock(R) 7000 orders. The initial Clusterlock(R) 7000 sales were taken at lower margins to enable the Company to gain market share. In addition, the planned recognition of approximately $550,000 for field service costs (principally warranty costs for both the Clusterlock(R) 7000 sales and the Company's other product lines) and a write-off of slow- moving inventory of approximately $336,000 contributed to higher cost of products sold.\nResearch and development expenses for fiscal 1995 were $2,569,700 compared to $2,266,133 in fiscal 1994, which are 9% and 10% of net sales, respectively. Although the percentage of research and development expense to net sales has decreased slightly, total dollars spent has increased. As new product lines continue to be introduced, total dollars expended on research and development are expected to increase.\nSelling and administrative expense for the year ended November 30, 1995 was $6,175,072, up from $4,638,163 for the year ended November 30, 1994 which is 21% and 20% of net sales, respectively. In 1995 additional expenditures were incurred related to the evaluation, initial purchase and implementation of new manufacturing and financial computer software. These expenditures are expected to continue through the first half of 1996.\nIncome before income taxes for fiscal 1995 was $1,802,258, a slight decrease of $149,630 from $1,951,888 earned in fiscal 1994. The decrease is due primarily to a 3% increase in cost of products sold, as discussed above.\nNet income per share was $.10 and $.22 for the years ended November 30, 1995 and 1994, respectively. Net income per share, before the cumulative effect of change in accounting principle in 1994 was $.18. Furthermore, the $332,475 reduction of the income tax valuation allowance discussed in the Comparison of Fiscal 1994 and Fiscal 1993, which reduced income tax expense for 1994, had the effect of increasing income before the cumulative effect from $.14 to $.18 per share. The remaining $.04 decrease from fiscal 1994 to fiscal 1995 is primarily the result of a slight decrease in income before income taxes discussed above and an increase of shares of common stock outstanding as a result of the private placement offering in December 1995 discussed previously, for the sale of 1,500,000 shares.\nStatement of Financial Accounting Standards (SFAS) No. 123 \"Accounting for Stock-Based Compensation\" has been issued by the Financial Accounting Standards Board in October 1995. Management has the option to continue using the accounting method promulgated by the Accounting Principals Board No. 25 \"Accounting for Stock Issued to Employees\" to measure compensation as it relates to stock options granted or to adopt the method prescribed by SFAS No. 123. Management has not completely analyzed the provisions of SFAS No. 123; accordingly, management has not determined whether or not SFAS No. 123's accounting recognition provisions will be adopted or APB No. 25's method will be continued (see Note 1 to the Consolidated Financial Statements).\nComparison of Fiscal 1994 and Fiscal 1993\nThe Company's Clusterlock7000 flat panel display manufacturing system was introduced to the market in late 1993. The first two production units of the system were shipped to a customer in October and November of 1994. The Company had orders for three additional systems from three other customers which were shipped in 1995. This product line has represented and will represent a significant investment of the Company's resources.\nDue to the long duration of the initial manufacturing cycle, the Company used the percentage of completion method of revenue recognition on certain initial Clusterlock 7000 orders, to better match revenue and expense. For Clusterlock 7000 orders with shorter manufacturing cycles, the Company recognized revenue when the product was shipped, as it did with all its other products. For fiscal 1994, the Company reported sales of $23,318,465, 42% higher than sales of $16,400,749 for fiscal 1993. The increase in sales was attributable to higher product demand and to sales of the newly introduced Clusterlock7000 product line to manufacturers of flat panel displays and increased capital spending by the semiconductor industry.\nCost of products sold of $14,451,365 for fiscal 1994 is 62% of net sales, compared to 67% in the prior year. The reduction related to the lowering of manufacturing costs associated with the Company's products, resulting from a combination of manufacturing efficiency, improved product design and lower material costs. At November 30, 1994, the Company recognized an additional provision of approximately $143,000 for field service costs (principally warranty costs related to Clusterlock7000 sales in 1994), which have occurred subsequent to November 30, 1994. A similar provision was not considered necessary for the Company's other products at November 30, 1994 and 1993, because the amounts were deemed to be insignificant.\nResearch and development expenses for fiscal 1994 were $2,266,133 compared to $1,465,628 in the fiscal 1993, which were 10% and 9% of net sales, respectively. The increase was due primarily to the Company's new Clusterlock7000 product line, which accounted for $1,234,190 of such expenses in 1994 and only $235,194 in 1993.\nSelling and administrative expense for the year ended November 30, 1994 was $4,638,163, up from $3,733,221 for the year ended November 30, 1993. Although actual expenses increased, selling and administrative expense as a percentage of net sales decreased from 23% to 20% in fiscal 1994 compared to the same period in 1993.\nIncome before income taxes for fiscal 1994 was $1,951,888, a $1,733,140 increase from $218,748 earned in fiscal 1993. The increase was due primarily to a 42% increase in revenue and a 5% decrease in cost of products sold, as discussed above.\nThe Company adopted, effective December 1, 1993, Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes\".\nThe cumulative effect of adopting SFAS No. 109 as of December 1, 1993 was to increase net income by $350,000. This amount represented the recording of additional deferred tax assets related to tax credit carryforwards of approximately $750,000, net of a valuation allowance for $400,000. The valuation allowance was subsequently reduced to $67,525 at November 30, 1994 as the uncertainties related to the Company's ability to use the tax credits were substantially eliminated by November 30, 1994 (see Note 7 to the Financial Statements which includes a more detailed comparison of the 1994 and 1993 income tax provision).\nNet income per share was $.22 and $.03 for the years ended November 30, 1994 and 1993 respectively. Net income per share, before the cumulative effect of change in accounting principle in 1994 and extraordinary item in 1993, was $.18 for fiscal 1994, up from $.02 for fiscal 1993. The $332,475 reduction of the income tax valuation allowance discussed above, which reduced income tax expense for 1994, had the effect of increasing income before the cumulative effect from $.14 to $.18 per share.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nIndex\nPage\nAccountants' Report 18\nConsolidated Financial Statements\nBalance Sheets - November 30, 1995, and 1994 19\nStatements of Income - Years Ended November 30, 1995, 1994, and 1993 21\nStatements of Shareholders' Equity - Years Ended November 30, 1995, 1994, and 1993 22\nStatements of Cash Flows - Years Ended November 30, 1995, 1994, and 1993 23\nNotes to the Financial Statements 25\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nShareholders and Board of Directors Plasma-Therm, Inc.\nWe have audited the accompanying consolidated balance sheets of Plasma-Therm, Inc. and Subsidiary as of November 30, 1995 and 1994, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended November 30, 1995. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Plasma-Therm, Inc. and Subsidiary as of November 30, 1995 and 1994, and the consolidated results of their operations and their consolidated cash flows for each of the three years in the period ended November 30, 1995 in conformity with generally accepted accounting principles.\nAs discussed in Note 2 to the financial statements, effective December 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 \"Accounting for Income Taxes\".\nGRANT THORNTON LLP\nTampa, Florida January 10, 1996\nPLASMA-THERM, INC. AND SUBSIDIARY\nCONSOLIDATED BALANCE SHEETS\nNovember 30,\nSee accompanying notes to these consolidated financial statements.\nPLASMA-THERM, INC. AND SUBSIDIARY\nCONSOLIDATED BALANCE SHEETS\nSee accompanying notes to these consolidated financial statements.\nPLASMA-THERM, INC. AND SUBSIDIARY\nCONSOLIDATED STATEMENTS OF INCOME\nYear Ended November 30,\nSee accompanying notes to these consolidated financial statements.\nPLASMA-THERM, INC. AND SUBSIDIARY\nCONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY\nThree Years Ended November 30, 1995\nSee accompanying notes to these consolidated financial statements.\nPLASMA-THERM, INC. AND SUBSIDIARY\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nYear Ended November 30,\nSee accompanying notes to these consolidated financial statements.\nPLASMA-THERM, INC. AND SUBSIDIARY\nCONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED\nYear Ended November 30,\nSUPPLEMENTAL CASH FLOW INFORMATION\nThe following is supplemental cash flow information for the years ended November 30:\nSee accompanying notes to these consolidated financial statements.\nPLASMA-THERM, INC. AND SUBSIDIARY\nNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS\nThree Years Ended November 30, 1995\nNote 1 Summary of Significant Accounting Policies\nPlasma-Therm, Inc., a Florida corporation, together with its subsidiary, (the \"Company\") is engaged in the design and production of semiconductor and flat panel display manufacturing equipment. The Company sells this equipment directly to manufacturers in the semiconductor, thin film head, computer, flat panel display, telecommunications and other industries. The Company's products are marketed, together with service and technical support, by the Company's domestic sales force, its Japanese distributor and independent domestic and foreign manufacturer's representatives.\nPrinciples of Consolidation\nThe consolidated financial statements include the accounts of Plasma-Therm, Inc. and its wholly-owned subsidiary, Magnetran, Inc.. All significant intercompany transactions and balances have been eliminated.\nUse of Estimates in Financial Statements\nIn preparing financial statements in conformity with generally accepted accounting principles, management makes estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. While actual results could differ from those estimates, management does not expect the variances, if any, to have a material effect on the financial statements.\nCash Equivalents\nFor purposes of the consolidated statements of cash flows, the Company considers all highly liquid investments purchased with maturities of three months or less to be cash equivalents. The Company utilizes an overnight automated investment account for sweeping of funds. The overnight investment account is held in repurchase agreements backed by U.S. government securities.\nAccounts Receivable and Bad Debts\nThe Company considers accounts receivable to be fully collectible; accordingly, no allowance for doubtful accounts is required. If amounts become uncollectible, they will be charged to operations when that determination is made. Bad debts have not been material.\nInventories\nInventories are stated at the lower of cost or market. Cost was determined using the first-in, first-out (FIFO) method for substantially all inventories. PLASMA-THERM, INC. AND SUBSIDIARY\nNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS\nThree Years Ended November 30, 1995\nNote 1 Summary of Significant Accounting Policies - Continued\nProperty, Plant and Equipment\nProperty, plant and equipment are stated at cost. Depreciation and amortization of property and equipment is provided by generally using the straight-line method over the useful lives of the related assets (machinery and equipment principally over five years) or, for leasehold improvements, the lesser of the useful life or the related lease term. For income tax purposes, leasehold improvements and certain equipment are amortized and depreciated over a longer period of time than for book purposes (see Note 8).\nRevenue and Cost Recognition\nSales of the Company's products are generally recognized upon shipment, except for the first orders related to the Clusterlock(R)7000 systems in 1994, which initially had a longer manufacturing cycle than the other products. In order to better match revenues and expenses, the Company used the percentage of completion method of revenue recognition for these initial Clusterlock(R)7000 orders. Sales related to subsequent Clusterlock(R)7000 orders have shorter manufacturing cycles similar to the Company's other products, and therefore have been recognized upon shipment.\nRevenue recognized on the percentage of completion is measured by total costs incurred to date to estimated total cost for each order. Costs include all direct material and labor costs and those indirect costs related to performance, such as indirect labor, supplies, tools, repairs and depreciation costs. Selling and administrative costs are charged to expense as incurred.\nThe liability \"billings in excess of costs and estimated earnings on uncompleted contracts\" represents billings in excess of revenue recognized.\nField Service Costs (Principally Warranty)\nField service costs related principally to warranty are accrued upon the shipment of the products. With the introduction of certain significant new products and increased production, management anticipates that warranty costs, which historically have been insignificant, will increase. Accordingly, management, using historical experience, industry experience and other factors, has recorded a warranty provision during 1995 and 1994. Such amounts provided will possibly be revised in the future as the Company's historical experience further develops. Management, at this time, does not believe that these revisions, if any, will have a material effect on the financial statements.\nResearch and Development\nResearch and development costs are expensed as incurred.\nPLASMA-THERM, INC. AND SUBSIDIARY\nNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS\nThree Years Ended November 30, 1995\nNote 1 Summary of Significant Accounting Policies - Continued\nIncome Per Share\nEarnings per share is computed based on the weighted average number of shares of common stock adjusted for the conversion of dilutive common stock equivalents. The primary and fully dilutive income per share are the same for all periods presented. The following is the weighted average outstanding share information.\nDeferred Offering Costs\nDeferred offering costs of $86,878 at November 30, 1994 consisted of legal and accounting fees and other costs associated with the Company's private placement which was subsequently closed in December 1994 (see Note 6). Accordingly, these costs were offset against the proceeds of the offering and were charged to additional paid-in capital in fiscal 1995.\nReclassifications\nCertain reclassifications have been made to the 1994 financial statements to conform to the 1995 presentation.\nAccounting for Stock-Based Compensation\nStatement of Financial Accounting Standards (SFAS) No. 123 \"Accounting for Stock-Based Compensation\" has been issued by the Financial Accounting Standards Board in October, 1995. As it relates to stock options granted to employees, SFAS No. 123 permits companies to continue using the accounting method promulgated by the Accounting Principals Board (APB) No. 25 \"Accounting for Stock Issued to Employees\" to measure compensation or to adopt the fair value based method prescribed by SFAS No. 123. If APB No. 25's method is continued, proforma disclosures are required as if SFAS No. 123 accounting provisions were followed. SFAS No. 123's accounting recognition method can be adopted subsequent to the issuance of the Statement in October 1995, with a mandatory implementation date of December 1, 1996, and would pertain to stock option awards granted or modified or settled for cash after the date of adoption. If the Company elects to continue using the method under APB No. 25, SFAS No. 123's proforma disclosures are required after December 1, 1996. Management has not completely analyzed the provisions PLASMA-THERM, INC. AND SUBSIDIARY\nNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS\nThree Years Ended November 30, 1995\nNote 1 Summary of Significant Accounting Policies - Continued\nof SFAS No. 123; accordingly, management has not determined whether or not SFAS No. 123's accounting recognition provisions will be adopted or APB No. 25's method will be continued. In addition, management has not yet determined the potential effect that SFAS No. 123 accounting provisions, if adopted, will have on the Company's financial statements.\nNote 2 Change In Accounting Principle for Income Taxes\nThe Company adopted, effective December 1, 1993, Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes\". Under the liability method specified by SFAS 109, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax basis of assets and liabilities as measured by the enacted tax rates which will be in effect when these differences reverse. Deferred tax expense is the result of changes in deferred tax assets and liabilities. The principal types of differences between assets and liabilities for financial statement and tax return purposes are accumulated depreciation, vacation accrual and stock options. A deferred tax asset is recorded primarily for cumulative investment tax credits being carried forward for tax purposes.\nThe deferred method, used in years prior to 1994, required the Company to provide for deferred tax expense based on certain items of income and expense, which were reported in different years in the financial statements and the tax returns as measured by the tax rate in effect for the year the difference occurred.\nThe cumulative effect of adopting SFAS No. 109, as of December 1, 1993, was to increase net income by $350,000. This amount represents the recording of additional deferred tax assets related to tax credit carryforwards of approximately $750,000, net of a valuation allowance for $400,000. Factors that management considered in deriving the additional deferred tax asset and valuation allowance included the Company's historical taxable income patterns and expected future taxable income through the period that the tax credit carryforwards expire (see Note 7). In this determination, greater weight was given to the two most recent years' (fiscal 1992 and 1993) average taxable income of approximately $335,000.\nUnder the previous accounting method of accounting for income taxes (APB No. 11), the income tax provision for 1994 would have been approximately $432,000 which differs from that determined under SFAS No. 109 of approximately $93,000. The principal difference in the accounting methods is that SFAS No. 109 has provided an earlier recognition of the tax credit carryforwards than provided by APB No. 11, as can be seen by the deferred tax asset recorded when SFAS No. 109 was adopted. PLASMA-THERM, INC. AND SUBSIDIARY\nNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS\nThree Years Ended November 30, 1995\nNote 2 Change In Accounting Principle for Income Taxes - Continued\nThe valuation allowance of $400,000 established December 1, 1993 relating to tax credit carryforwards, was subsequently reduced to $67,525 at November 30, 1994, reducing income tax expense for 1994 by the difference of $332,475. Factors that management considered in deriving the valuation allowance at November 30, 1994 were the same as discussed in paragraph three above. The average taxable income used in the determination discussed above was updated to reflect the taxable income for 1994 which was not previously known.\nThe average taxable income for 1994 and 1993 was approximately $1,000,000 with taxable income for 1994 of approximately $1,700,000. Management's current business plan and budgets for 1995 provided further justification for the reduction of the valuation allowance at November 30, 1994.\nNote 3 Inventories\nInventories consist of the following:\nNovember 30, 1995 1994\nRaw materials $5,066,621 $3,418,811 Work-in-process 2,825,789 2,874,373 Finished goods 1,940,443 926,156 $9,832,853 $7,219,340\nNote 4 Costs and Estimated Earnings on Uncompleted Contracts\nNote 5 Short-Term and Long-Term Borrowings\nLine of Credit\nIn November 1995, the Company increased its existing\nPLASMA-THERM, INC. AND SUBSIDIARY\nNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS\nThree Years Ended November 30, 1995\nline of credit with its bank to $3,000,000. The term of the line of credit agreement is through May 19, 1997, and for a period of sixty (60) consecutive days during the term of the loan, the Company must repay the principal below $100. Interest is payable monthly at the bank's prime rate (8.75% at November 30, 1995). The line is collateralized by accounts receivable and the bank has a security interest in the proceeds for the collection of accounts receivable in the Company's depository accounts. The unused balance on the line of credit at November 30, 1995 and 1994 was $1,000,000.\nNotes Payable\nNotes payable consist of the following:\nPLASMA-THERM, INC. AND SUBSIDIARY\nNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS\nThree Years Ended November 30, 1995\nNote 5 Short-Term and Long-Term Borrowings - Continued\nIn August, 1995 the Company executed a promissory note for $3,375,000 with its bank for the construction of its new manufacturing facility. During the construction phase, interest is payable monthly at the bank's prime rate (8.75% at November 30, 1995) on the outstanding balance. The outstanding balance at November 30, 1995 is $752,132 (see Note 8).\nOn June 14, 1996, the completion of the construction phase, the note converts to a five year term loan, amortized over a fifteen year period. Equal payments of principal and interest will be payable monthly at a fixed interest rate based on the weekly average yield of U.S. Treasury securities plus 200 basis points. The interest rate will be determined upon conversion. The loan is collateralized by the land, the building and its contents.\nAggregate maturities of notes payable for five years following November 30, 1995 are as follows:\n1996 $ 343,647 1997 193,004 1998 28,736 1999 31,353 2000 34,210 2001 and thereafter 621,182 $1,252,132\nThe Company is subject to the bank agreement described above. Under the most restrictive covenant, none of the Company's consolidated retained earnings is free of limitation for payment of cash dividends at November 30, 1995.\nCapitalized Leases\nThe Company conducts a portion of its operations utilizing leased equipment consisting of primarily computer equipment. For financial statement purposes, minimum lease rentals relating to the equipment have been capitalized.\nPLASMA-THERM, INC. AND SUBSIDIARY\nNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS\nThree Years Ended November 30, 1995\nNote 5 Short-Term and Long-Term Borrowings - Continued\nThe related assets and obligations have been recorded using the Company's incremental borrowing rate at the inception of the leases. The leases, which are non-cancelable, expire in 1999. The following is a schedule of leased property under capital leases:\nThe following is a schedule by years of future minimum lease payments under capital leases together with the present value of the net minimum lease payments as of November 30, 1995:\nNote 6 Shareholders' Equity\nPrivate Placement\nThe Company completed a private placement offering of its Common Stock in December 1994, raising $6,375,000 from the sale of 1,500,000 shares. Costs, including commissions, associated with the offering were approximately $616,000. Part of these proceeds were used to pay off the Company's line of credit balance of $1,000,000 at November 30, 1994. PLASMA-THERM, INC. AND SUBSIDIARY\nNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS\nThree Years Ended November 30, 1995\nNote 6 Shareholders' Equity - Continued\nIncrease in Authorized Shares of Common Stock\nIn June, 1995, the Company's shareholders approved an amendment to the Company's Articles of Incorporation increasing the number of authorized shares of Common Stock from 12,000,000 to 25,000,000.\nObligations under Section 16(b) of the Securities Exchange Act of 1934\nIn 1995, two officers of the Company inadvertently incurred obligations to the Company of approximately $16,000 and $69,000, respectively, under Section 16(b) of the Securities Exchange Act of 1934 arising out of grants of options to them under the Company's 1988 Stock Option Plan and the sale of shares they acquired on the exercise of options within a six month period. The obligations were paid back to the Company in full.\n1995 Stock Incentive Plan\nIn June 1995, the Company's shareholders approved the 1995 Stock Incentive Plan (the Plan). The Plan authorizes the granting of both incentive stock options and non-qualified stock options up to a total of 1,000,000 shares, increased annually by an additional number of shares equal to 1% of the number of shares outstanding on the last day of each fiscal year, commencing November 30, 1995, provided that the maximum aggregate number of shares to be issued shall not exceed 3,000,000. The option price for non-qualified stock options may be less than, equal to, or greater than the fair market value on the date the option is granted, whereas for incentive stock options, the price will be at least 100% of the fair market value. Compensation expense, representing the difference between the exercise price and the fair market value at date of grant, is recognized over the vesting or service period. Stock option activity under the 1995 Plan was as follows:\nPLASMA-THERM, INC. AND SUBSIDIARY\nNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS\nThree Years Ended November 30, 1995\nNote 6 Shareholders' Equity - Continued\nOption prices per share for options exercisable as of November 30, 1995 ranged from $2.09 to $4.00.\n1988 Stock Option Plan\nThe 1988 Stock Option Plan authorized the granting of both incentive stock options and non-qualified stock options up to a total of 850,000 shares of the Company's common stock to employees and directors. Upon adoption of the 1995 Stock Incentive Plan no additional options were or will be granted under the 1988 Plan. At November 30, 1995, 50,000 shares of common stock have been reserved under this plan for the outstanding options remaining at November 30, 1995. Under the 1988 Plan non-qualified stock options were granted at less than the fair market value of the Company's common stock. Compensation expense, representing the difference between the exercise price and the fair market value at date of grant, was recognized over the vesting or service period (e.g. currently six months to one year after the date of grant). In 1995 and 1994 income taxes payable was reduced and paid-in-capital was increased by approximately $151,000 and $232,000, respectively, related to an incremental tax benefit associated with the stock options exercised during the year. Stock option activity was as follows under the 1988 Plan:\nIncentive Stock Option Plan\nThe Incentive Stock Option Plan authorizes the granting of options to purchase 200,000 shares of the Company's common stock. The Plan expired on September 15, 1991, and therefore no\nPLASMA-THERM, INC. AND SUBSIDIARY\nNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS\nThree Years Ended November 30, 1995\nNote 6 Shareholders' Equity - Continued\nfurther options may be granted under this Plan. At November 30, 1995, 13,000 shares of common stock have been reserved under this plan for the outstanding options remaining as of November 30, 1995. For the three years ended November 30, 1995, the activity under the Incentive Stock Plan was as follows:\nOption prices are $1.50 a share, the equivalent of the market price on the dates the options were granted and all options are exercisable for each year presented.\nCommon Stock Warrants\nIn connection with the Company's borrowing from its former primary bank, the Company's Chief Executive Officer (CEO) executed a limited guarantee of the Company's indebtedness which was released in 1989. The Company agreed to compensate the Company's CEO for giving such guarantee by issuing to him a warrant expiring in April 2002, for the purchase of 500,000 shares of the Company's common stock at a purchase price per share of $.875. In accordance with the anti-dilution provisions contained in the above warrants, the exercise price of the warrants was adjusted as a result of the spin-off of the Company's subsidiary in 1992. The adjusted conversion price of the warrants is $.7721 per share. Warrants totaling 100,000 were exercised in April 1995 for $77,210.\nIn conjunction with previous financing agreements, two warrants expiring in 1995 were issued to an investment company in November 1988 and June 1989 to purchase 50,000 and 100,000 shares of common stock, respectively, at a price of $1.25 per share. In accordance with the anti-dilution provisions contained in the above warrants, the exercise price of the warrants was adjusted as a result of the spin-off of the Company's subsidiary in 1992. The adjusted conversion price of the warrants is $1.1029 per share. Both warrants were exercised in February 1995 for $165,435. As a result of the exercise of these warrants, in 1995 income taxes payable was reduced and paid-in capital was increased by approximately $285,000 related to an incremental tax benefit associated with the exercise of the warrants.\nPLASMA-THERM, INC. AND SUBSIDIARY\nNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS\nThree Years Ended November 30, 1995\nNote 7 Income Taxes\nEffective December 1, 1993, the Company changed its method of accounting for income taxes from the deferred method to the liability method (see Note 2). As permitted by SFAS No. 109, the financial statements for 1993 have not been restated.\nThe provisions for income taxes consist of the following:\nPLASMA-THERM, INC. AND SUBSIDIARY\nNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS\nThree Years Ended November 30, 1995\nNote 7 Income Taxes - Continued\nThe income tax provision reconciled to the tax computed at the statutory Federal rate of 34% is as follows:\nThe components of deferred income tax expense for 1993 are as follows:\nNovember 30,\nAccrued expenses $ 19,800 Depreciation (30,800) Compensation (8,200)\n$ (19,200) PLASMA-THERM, INC. AND SUBSIDIARY\nNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS\nThree Years Ended November 30, 1995\nNote 7 Income Taxes - Continued\nThe deferred tax asset consists of the following:\nFactors that management considered in deriving the valuation allowance at November 30, 1994 are discussed in Note 2 to the financial statements and are similar to those used for 1995, with taxable income factor for 1995 being approximately $1,400,000.\nFor income tax purposes at November 30, 1995, there were no net operating loss carryforwards and approximately $332,000 of capital loss carryforwards. These capital loss carryforwards expire between 1996 and 1997. At November 30, 1995, there are investment tax and research and development tax credit carryforwards of approximately $220,000 for tax purposes and such credits expire as follows: $28,000 in 1999 and $192,000 in 2000.\nThe extraordinary item reported for 1993 resulted from the tax effect of the net operating loss carryforward for book purposes generated in 1991.\nNote 8 Commitments\nOperating Leases\nThe Company conducts a majority of its operations from leased facilities. Since October 1995, when the lease term of its Florida corporate and manufacturing facilities expired, the Company began leasing the facilities on a month-to-month basis and will do so until the completion of the construction of the new facility which is anticipated to be in June 1996 (see below). The monthly rental amount is approximately $41,000. In March, 1995 the Company executed a real estate lease for additional space for $2,141 per month which expires in March 1996. Upon expiration, the Company will continue to lease the space on a month-to-month basis until the\nPLASMA-THERM, INC. AND SUBSIDIARY\nNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS\nThree Years Ended November 30, 1995\nNote 8 Commitments - Continued\ncompletion of the new facility. The leases require the Company to pay its share of real estate taxes and operating expenses. Also, the Company uses machinery and equipment under non-cancelable operating leases expiring through 1998.\nIn addition, the Company leased approximately 48,360 square feet in New Jersey where the Company's subsidiary, Magnetran, Inc. resides. The leases expired October 31, 1994. The premises were leased from the CEO of the Company at an aggregate base rental of $135,207 for 1994. In addition to the minimum base rent, the Company paid taxes, insurance and maintenance relating to the leased properties. Magnetran, Inc. entered into a 5 year gross lease, with the Company's CEO, commencing November 1, 1994 for approximately 17,750 square feet in New Jersey. The premises are leased at an aggregate annual base rental of $86,841, which escalates 3% annually. After the initial term of the lease, Magnetran has an option to renew for five years with a 3% increase each year. The aggregate rentals paid to the CEO for all leases for the years ended November 30, 1995, 1994, and 1993 were approximately $87,000, $225,500 and $240,300, respectively.\nThe future minimum rental payments required under operating leases that have an initial or remaining non-cancelable lease term in excess of one year are as follows:\nYear ended November 30,\n1996 $165,030 1997 117,624 1998 106,046 1999 89,595\nTotal minimum lease payments $478,295\nThe total rental expense for all operating leases was $398,529, $605,197 and $563,589 for the years ended November 30, 1995, 1994 and 1993, respectively.\nNew Facility - Construction Costs to Complete\nAt November 30, 1995, the Company has incurred approximately $2,200,000, including $786,000 for land for the construction of the new manufacturing facility. Total anticipated costs upon completion approximate $4,750,000. In addition, the Company anticipates acquiring approximately $500,000 of furniture, fixtures, and equipment which is expected to be financed through a lease.\nPLASMA-THERM, INC. AND SUBSIDIARY\nNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS\nThree Years Ended November 30, 1995\nNote 8 Commitments -Continued\nPurchase Commitment\nThe Company is currently in the process of acquiring manufacturing software and related hardware for approximately $500,000 which is expected to be financed through a capital lease.\nNote 9 Affiliate Transactions\nDuring 1992 the Company loaned RF Power Products (RFPP, a former subsidiary which was spun off in 1992) $200,000 in a secured, subordinated loan to be repaid in equal monthly installments of $5,000 commencing May 1993 through August 1996. Interest at the prime rate plus 1% is to be paid monthly. The remaining balance at November 30, 1995 is $45,000 and included in prepaid expenses and other.\nDuring 1995, 1994 and 1993, the Company had sales to and purchases from RFPP, respectively, as follows: $844,000 and $942,000 in 1995; $551,000 and $708,000 in 1994; and $598,000 and $378,000 in 1993, respectively. At November 30, 1995, 1994 and 1993, the Company's accounts receivables and payables included the following amounts related to RFPP, respectively, as follows: $197,000 and $247,000 at 1995; $86,000 and $129,000 at 1994 and $155,000 and $64,000 at 1993.\nThe Company's CEO currently owns approximately 12% of RFPP shares which he received via the spin-off.\nNote 10 Segment Information\nCustomer Sales\nIn 1994 approximately 18% of consolidated net sales were to one customer. Additionally, in 1995, 1994 and 1993, 7%, 13% and 8%, respectively, of consolidated net revenues were from the Company's former distributor in Japan. In 1995 total revenues from the Company's new Japanese distributor were approximately $238,000.\nPLASMA-THERM, INC. AND SUBSIDIARY\nNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS\nThree Years Ended November 30, 1995\nNote 11 Defined Contribution Plan\nThe Company has a defined contribution plan which is qualified under Section 401(k) of the Internal Revenue Code. This plan covers substantially all employees over the age of twenty-one. The plan consists of an employee elective contribution and a company matching contribution for each eligible participant. The Company's matching contribution is specified by the Company's Board of Directors, is discretionary and can change from year to year. Forfeitures resulting from a terminated participant's failure to be fully vested in the Company's matching contribution will be used to reduce future contributions of the Company. The Company's contribution for this plan for 1995, 1994 and 1993 was $18,459, $11,596 and $8,217, respectively.\nItem 9.","section_9":"Item 9. Disagreements on Accounting and Financial Disclosure\nNot Applicable\nPART III\nExcept for the information regarding executive officers called for by Item 401 of Regulation S-K, which is included in Item 1, \"Executive Officers of the Company,\" Items 10, 11, 12 and 13 are hereby incorporated by reference to the Company's definitive proxy statement for its Annual Meeting of Stockholders presently scheduled for April 30, 1996, which proxy statement will be filed pursuant to Regulation 14A not later than 120 days after the end of the Company's fiscal year, in accordance with General Instruction G(3) to Form 10-K.\nPART IV\nItem 14.","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\nA. The following documents are filed as part of this Form 10-K:\n(1) Consolidated Financial Statements\nThe index to the Consolidated Financial Statements of the Company is included on page 17 in Part II, Item 8.\n(2) Financial Statement Schedules\n(a) Schedule I - Condensed Financial Information - Plasma-Therm, Inc. (Parent Only)\n(b) Schedule II - Valuation and Qualifying Accounts\nAll other schedules are omitted either because the schedule is inapplicable or the required information is included elsewhere in the Financial Statements.\n(3) Reports on Form 8-K\nNo reports on Form 8-K were filed by the Company during the quarter ended November 30, 1995.\n(4) Exhibits\nExhibit No. Description of Exhibits\n3.1* Articles of Incorporation of the Registrant, as amended May 6, 1994 (Exhibit 3.1 to the 1994 Form 10-K).\n3.2* By-laws of the Registrant (Exhibit 3.2 to the 1994 Form 10-K).\n3.3* Amendment to the Company's Articles of Incorporation (Exhibit 3.1 to the May 31, 1995 Form 10-Q\/A).\n4.1* Notes and Warrant Agreements dated July 1, 1980 and February 17, 1981, and amendments thereto, between the Registrant and Atalanta Investment Company, Inc. and related consents (Exhibits 3.3, 3.4 and 3.5 to the 1981 Registration Statement, Exhibit 3.5.1 to Amendment No. 1 to the Registration Statement No. 2-73281-NY filed on July 20, 1981 {the \"1981 Registration Statement\"} and Exhibit 4.3 to the Registration Statement No. 2-82980 filed on April 11, 1983 {the \"1983 Registration Statement\"}).\n4.2* Amendment, dated November 1, 1988, to the Note and Warrant Agreements between the Registrant and Atalanta Investment Company (Exhibit 4.2 to the Registrant's Annual Report Form 10-K for the year ended November 30, 1988 {the \"1988 Form 10-K\"}).\n4.3* Amendment, dated July 21, 1989 to the Note and Warrant Agreements between the Registrant and Atalanta Investment Company (Exhibit 4.3 to Registrant's Annual Report on Form 10-K for the year ended November 30, 1989 {the \"1989 Form 10-K\"}).\n4.4* Warrant dated as of July 24, 1987 between the Registrant and Ronald Deferrari (Exhibit 4.6 to the Registrant's Annual Report on Form 10-K for the year ended November 30, 1987 {the \"1987 Form 10-K\"}).\n4.5* Stock Option Plan of the Registrant, dated December 1,1988. (Exhibit 4.4 to the 1988 Form 10-K).\n4.6* 1995 Stock Incentive Plan of the Registrant, dated June 14, 1995 (Exhibit 4 to the 1995 Form S-8).\n4.7* Form of stock certificate (Exhibit 4.6 to the 1994 Form 10-K).\n10.1* Employment Agreement dated May 3, 1994 between the Registrant and Ronald H. Deferrari (Exhibit 10.1 to the 1994 Form 10-K).\n10.2* Amendment to Employment Agreement between the Company and Ronald H. Deferrari, dated 6\/26\/95 (Exhibit 10.30 to the August 31, 1995 Form 10-Q). 10.3* Employment Agreement dated May 3, 1994 between the Registrant and Diana M. DeFerrari (Exhibit 10.2 to the 1994 Form 10-K).\n10.4* Employment Agreement between the Company and Diana M. DeFerrari, dated February 9, 1995 (Exhibit 10.1 to the May 31,1995 Form 10-Q\/A).\n10.5* Employment Agreement dated May 18, 1994 between the Registrant and Ronald S. Deferrari (Exhibit 10.3 to the 1994 Form 10-K).\n10.6* Amendment to Employment Agreement between the Company and Ronald S. Deferrari, dated 6\/26\/95 95 (Exhibit 10.31 to the August 31, 1995 Form 10-Q).\n10.7* Lease dated as of November 1, 1994 between Magnetran, Inc., and Ronald H. Deferrari for property located at 136 Route 73, Voorhees, New Jersey.\n10.8* Lease dated as of April 23, 1990 and Supplement Agreement #1 thereto dated as of June 6, 1990 between the Registrant and Rouse & Associates - 9500 International Court Limited Partnership for property located at 9509 International Court, St. Petersburg, Florida (Exhibit 10.13 to the 1990 Form 10-K).\n10.9* Lease dated as of June 6, 1990 between the Registrant and Rouse & Associates - 9500 International Court Limited Partnership for property located at 9501 International Court, St. Petersburg, Florida (Exhibit 10.14 to the 1990 Form 10-K).\n10.10* Lease dated as of October 30, 1990 between the Registrant and Rouse & Associates - 9500 International Court Limited Partnership for property located at 9721 International Court, St.Petersburg, Florida (Exhibit 10.14 to the 1991 Form 10-K).\n10.11* Lease dated as of July 17, 1991 between the Registrant and Rouse & Associates - 9500 International Court Limited Partnership for property located at 9537 International Court North, St. Petersburg, Florida (Exhibit 10.15 to the 1991 Form 10-K).\n10.12* Supplemental Agreement #4 dated June 7, 1994 between Teachers Insurance and Annuity Association Inc. and the Registrant for property located at 9509 International Court, St. Petersburg, Florida.\n10.13* Supplemental Agreement #3 dated June 7, 1994 between Teachers Insurance and Annuity Association Inc. and the Registrant for property located at 9501 International Court, St. Petersburg, Florida. 10.14* Supplemental Agreement #3 dated June 7, 1994 between Teachers Insurance and Annuity Association Inc. and the Registrant for property located at 9721 International Court, St. Petersburg, Florida.\n10.15* Supplemental Lease Agreement #2 dated July 17, 1991 between the Registrant and Rouse and Associates - 9500 International Court Limited Partnership for property located at 9509 International Court, St. Petersburg, Florida (Exhibit 10.12 to the 1993 Form 10-K).\n10.16* Supplemental Lease Agreement #1 dated July 17, 1991 between the Registrant and Rouse and Associates - 9500 International Court Limited Partnership for property located at 9501 International Court, St. Petersburg, Florida (Exhibit 10.13 to the 1993 Form 10-K).\n10.17* Supplemental Lease Agreement #1 dated July 17, 1991 between the Registrant and Rouse and Associates - 9500 International Court Limited Partnership for property located at 9721 International Court, St. Petersburg, Florida (Exhibit 10.14 to the 1993 Form 10-K).\n10.18* Supplemental Agreement #2 dated June 7, 1994 between Teachers Insurance and Annuity Association Inc. and the Registrant for property located at 9537 International Court, St. Petersburg, Florida.\n10.19* Loan Agreement dated January 19, 1995 between the Registrant and NationsBank of Florida, N.A. (including Revolving Credit Agreement, Security Agreement, Term Promissory Note and Line of Credit Note), (Exhibit 10.16 to the 1994 Form 10-K).\n10.20* Promissory Note dated August 14, 1995 between the Registrant and NationsBank of Florida, N.A. (Exhibit 10.23 to the August 31, 1995 Form 10-Q).\n10.21* Mortgage, Assignment of Rents and Security Agreement dated August 14, 1995 between the Registrant and NationsBank of Florida, N.A. (Exhibit 10.24 to the August 31, 1995 Form 10-Q).\n10.22* Environmental Indemnity Agreement dated August 14, 1995 between the Registrant and NationsBank of Florida, N.A. (Exhibit 10.25 to the August 31, 1995 Form 10-Q).\n10.23* Amendment (to Amended and Restated Revolving Credit Agreement between Plasma-Therm, Inc. and NationsBank of Florida, N.A., dated January 19, 1995) dated August 14, 1995 between the Registrant and NationsBank of Florida, N.A. (Exhibit 10.26 to the August 31, 1995 Form 10-Q). 10.24* Construction Loan Agreement dated August 14, 1995 between the Registrant and NationsBank of Florida, N.A. (Exhibit 10.27 to the August 31, 1995 Form 10-Q).\n10.25* Collateral Assignment of General Construction Contract, Subcontracts, Plans and Specifications and Permits dated August 14, 1995 between the Registrant and NationsBank of Florida, N.A. (Exhibit 10.28 to the August 31, 1995 Form 10-Q).\n10.26* Collateral Assignment of Professional Agreements and Plans and Specifications dated August 14, 1995 between the Registrant and NationsBank of Florida, N.A. (Exhibit 10.29 to the August 31, 1995 Form 10-Q).\n10.27 Third Future Advance Promissory Note dated November 17, 1995 between the Registrant and NationsBank of Florida, N.A.\n10.28 Third Consolidation Line of Credit Promissory Note dated November 17, 1995 between the Registrant and and NationsBank of Florida, N.A.\n10.29 Future Advance Consolidation and Modification Agreement dated November 17, 1995 between the Registrant and NationsBank of Florida, N.A.\n10.30 Second Amendment (to Amended and Restated Revolving Credit Agreement) dated November 17, 1995 between the Registrant and NationsBank of Florida, N.A.\n10.31 Amendment to Amended and Restated Security Agreement dated November 17, 1995 between the Registrant and NationsBank of Florida, N.A.\n10.32* Distributorship Agreement between the Registrant, Nissin Hi-Tech and Itoman & Co., dated August 1, 1989 (Exhibit 10.16 to the 1989 Form 10-K).\n10.33* December 11, 1990 Amendment to the Distributorship Agreement between the Registrant, Nissin Hi-Tech and Itoman & Co. (Exhibit 10.20 to the 1990 Form 10-K).\n10.34* License Agreement dated August 9, 1990 by and among the Registrant, Nissin Hi-Tech, Inc. and Plasma-Therm International, Inc. (Exhibit 10.21 to the 1990 Form 10-K).\n10.35* Loan Documents from RF Power Products, Inc. to Registrant: Loan Agreement dated April 24, 1992; Promissory Note dated April 24, 1992; Security Agreement dated April 24, 1992; Subordination Agreement dated January 25, 1993 (Exhibit 10.24 to the 1992 Form 10-K). 10.36* Registrant's 401(k) Savings Plan Summary Plan Description dated July 1, 1992 (Exhibit 10.25 to the 1992 Form 10-K).\n10.37* January 27, 1993 Amendment to the Distributorship Agreement between Nissin Hi-Tech, Inc., Nissin Electric Co., Ltd. and the Registrant and January 27, 1993 Amendment to the License Agreement between Nissin Hi-Tech, Inc., Nissin Electric Co., Ltd. and the Registrant. (This Exhibit amends Exhibits 10.17, 10.18, 10.19.)\n10.38 Distributorship Agreement between the Registrant and Hakuto Co., Ltd., dated August 1, 1995.\n11. Statement RE: Computation of per share earnings.\n22. Subsidiary of the Registrant.\n24. Consent of Grant Thornton LLP.\n27. Financial Data Schedule (for SEC use only).\n* Incorporated by reference.\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.\nPLASMA-THERM, INC.\n\/s\/ RONALD H.DEFERRARI Ronald H.Deferrari, Chairman of the Board and Treasurer\nDate: January 29, 1996\nPursuant to 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 on the dates indicated.\nBy: \/s\/ RONALD H. DEFERRARI Ronald H. Deferrari, Chairman of the Board and Treasurer (Principal Executive Officer and Principal Financial Officer)\nDate: January 29, 1996\nBy: \/s\/ A.S. GIANOPLUS A.S. Gianoplus, Director\nDate: January 29, 1996\nBy: \/s\/ STACY WAGNER Stacy Wagner, Vice President of Finance and Controller\nDate: January 29, 1996\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS ON THE SCHEDULES\nBoard of Directors Plasma-Therm, Inc.\nIn connection with our audit of the consolidated financial statements of Plasma-Therm, Inc. and Subsidiary referred to in our report dated January 10, 1996, which is included in the Annual Report on Form 10- K for the years ended November 30, 1995, we have also audited Schedule I for the year ended November 30, 1993, and Schedule II for each of the three years in the period ended November 30, 1995. In our opinion, the schedules present fairly, in all material respects, the information required to be set forth therein.\nGRANT THORNTON LLP\nTampa, Florida January 10, 1996\nPLASMA-THERM, INC. AND SUBSIDIARY\nSchedule I - Condensed Financial Information Plasma-Therm, Inc. (Parent Only)\nYear Ended November 30, 1993\nCONDENSED STATEMENT OF INCOME\nCosts and expenses Selling and administrative $118,607 Interest expense 0 Other income, net (3,620)\n114,987\nIncome (loss) before equity in net of subsidiaries (114,987)\nEquity in net income of subsidiaries 348,135\nNet income $233,148\nCONDENSED STATEMENT OF CASH FLOWS\nCash from operating activities ($53,780)\nCash flows from investing activities 10,691\nCash flows from financing activities 40,000\nDecrease in cash ($3,089)\nNote:\nSchedule I is not applicable as of or for the years ended November 30, 1995 and 1994. In prior years Plasma-Therm, Inc. had a signicantly wholly owned subsidiary (Plasma-Therm I.P., Inc.) which had a bank agreement which restricted its dividends and advances to its parent. As a result of the latter, Schedule I was required for 1993 and 1992. In 1994 the parent and subsidary merged together and the debt agreement in essence reverted directly to the parent, Plasma-Therm, Inc.\nPLASMA-THERM, INC. AND SUBSIDIARY\nSchedule I - Condensed Financial Information - Continued -- Plasma-Therm, Inc. (Parent Only)\nNotes to Condensed Financial Statements\nThe notes to the consolidated financial statements should be read in conjunction with these condensed financial statements.\nIncome taxes: Substantially all of the consolidated income tax expense or benefit is related to the operating Company's subsidiaries in 1993. See the notes to consolidated financial statements.\nPLASMA-THERM, INC. AND SUBSIDIARY\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS\nExhibit 22\nSUBSIDIARY OF THE REGISTRANT\nState or Other Name Jurisdiction of Incorporation\nMagnetran, Inc. New Jersey\nExhibit 24\nCONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nWe have issued our reports dated January 10, 1996, accompanying the consolidated financial statements and schedules of Plasma-Therm, Inc. and Subsidiary included in the Annual Report on Form 10-K of Plasma-Therm, Inc. and Subsidiary for the year ended November 30, 1995. We hereby consent to the incorporation by reference of said reports in the Registration Statements of Plasma-Therm, Inc. and Subsidiary on Form S-3 (File No. 33-88836, effective February 1, 1995) and Forms S-8 (File No. 2-97920, effective June 11, 1985, File No. 33-29104, effective June 22, 1989 and File 33-60375, effective June 14, 1995).\nGRANT THORNTON LLP\nTampa, Florida January 10, 1996","section_15":""}
{"filename":"72633_1995.txt","cik":"72633","year":"1995","section_1":"Item 1. Business.\n(a) General Development of Business. --------------------------------\nRegistrant (the \"Trust\") is a trust which, on behalf of the owners of beneficial interest in the Trust (called the \"certificate holders\" or \"unit owners\"), holds overriding royalty rights covering gas and oil production in certain concessions or leases in the Federal Republic of Germany. The rights are held under contracts with local German exploration and development subsidiaries of Mobil Corp., Exxon Corp., and Royal Dutch Group. Under these contracts, the Trust receives various percentage royalties on the proceeds of the sales of certain products from the areas involved. At the present time, royalties are received for sales of natural gas, casinghead gas, crude oil, distillate and sulfur. See Item 2","section_1A":"","section_1B":"","section_2":"Item 2. Properties. -----------\nThe properties of Trust, which the Trust and Trustees hold pursuant to the Trust Agreement on behalf of the unit owners, are overriding royalty rights on sales of gas, sulfur and oil under certain concessions or leases in the Federal Republic of Germany. The actual leases or concessions are held either by Mobil Oil A.G. (\"Mobil\"), the German operating subsidiary of Mobil Corp. or by Oldenburgische Erdol Gesellschaft (\"OEG\"). The Oldenburg concession (1,398,000 acres), covering virtually the entire former State of Oldenburg, is the major source of royalty income for the Trust. Within this concession Mobil and BEB Erdgas und Erdol GmbH (\"BEB\"), a joint venture of Exxon Corp. and the Royal Dutch Group, carry out all exploration, drilling, production and sales activities.\nUnder one series of rights covering the western part of the Oldenburg concession (approximately 662,000 acres), the Trust receives a royalty payment of 4% on gross receipts from sales by Mobil of natural gas, casinghead gas, crude oil and condensate. The Trust also receives from Mobil a 2% royalty on gross receipts of sales of sulfur obtained as a by-product of sour gas produced from the western part of Oldenburg. The payment of the sulfur royalty is conditioned upon sales by Mobil of sulfur at a selling price above an agreed upon base price. This base price is adjusted annually by an inflation index. When the average selling price falls below the adjusted base price, no royalties are payable. No payments were received under this sulfur royalty during fiscal 1995.\nUnder another series of rights covering the entire Oldenburg concession and pursuant to an agreement with OEG (the \"OEG Agreement\"), the Trust receives royalties at the rate of 0.6667% on gross receipts from sales of natural gas, casinghead gas, crude oil, condensate and sulfur (removed during the processing of sour gas) less 50% of an escalating cost base. This cost base is recomputed annually based on indexes reflecting changes in certain prices within Germany. This system will be revised in 2002 unless the escalating cost base diverges significantly from the actual production costs, in which case the system will be revised in 1999. In either case, the revised system will provide that 50% of field handling, treatment and transport costs, as reported for state governmental royalty purposes, will be deducted from gross sales receipts prior to the royalty calculation.\nThe Trust also holds through Mobil a 2% royalty interest in oil and gas sales from acreage in Bavaria, and a 0.2117% royalty under the net interest of the Bayerische Mineral Industries A.G. (\"BMI\"), a subsidiary of Mobil, in concessions in Bavaria. The net interest of BMI ranges from 16-1\/2 to 100% of the sales, depending on geographic region or area. Due to the low level of royalty income under this agreement, reserves from this area in Bavaria will not be included in reserve calculations for this report year.\nIn addition to the areas of Oldenburg and Bavaria, the Trust also holds overriding royalties on 21 leases in other areas of northwest Germany ranging in size from 185 to 25,000 acres and totalling 73,214 acres. The rates of overriding royalties vary from 1.83% to 6.75%. At the present time all but one of these 21 leases are in the non-producing category. Due to the low level of income and the intermittent gas production from the single producing lease, reserves from this lease will not be included in reserve calculations for this report year.\nThe following is a schedule of royalty income for the fiscal year ended October 31, 1995 by geographic area and operating company:\nBy Geographic Area: ------------------- Area Royalty Income ---- -------------- Western Oldenburg $ 10,382,980 Eastern Oldenburg $ 1,978,153 Non-Oldenburg Areas $ 116,655\nBy Operating Company: --------------------- Company Royalty Income ------- -------------- Mobil Oil A.G. $ 9,075,834 OEG $ 3,399,839 Bayerische Mineral Industries A.G. $ 2,115\nExhibit 99 to this Report is a report dated December 21, 1995 which summarizes certain production data and the estimated net proved producing reserves as of October 1, 1995, based on the limited information available, for the Oldenburg area in which the Trust now holds overriding royalty rights. That report (the \"Davis Report\") was prepared by Ralph E. Davis Associates, Inc., 3555 Timmons Lane, Suite 1105, Houston, Texas 77027 (\"Davis Associates\"). Davis Associates is an independent petroleum and natural gas consulting organization specialized in analyzing hydrocarbon reserves. In order to permit timely filing of this Report, the information has been prepared for the 12-month period ending September 30, 1995, which is a date prior to the end of the fiscal year of the Trust. The use of this earlier date is consistent with the periods covered in prior Annual Reports.\nIn connection with the information in the Davis Report, note should be taken of the limited nature of the information available to the Trust. Pursuant to the arrangements under which the Trust holds royalty rights and due to the fact that the Trust is not considered an operating company within Germany, it has no access to the operating companies' proprietary information concerning producing field reservoir data. The Trustees have been advised that publication of such information is not required under applicable law in Germany and that the royalty rights do not give rise to the right to require or compel production of such information. Past efforts to obtain such information voluntarily have not been successful. The information made available to the Trust by the operating companies does not include any of the following: reserve estimates, capitalized costs, production cost estimates, revenue projections, producing\nfield reservoir data (including pressure data, permeability, porosity and thickness of producing zone) or other similar information. The limited nature of the information available to the Trust makes impossible the calculation of the following: proved undeveloped future net recoverable oil and gas by appropriate geographic areas, total gross and net productive wells, availability of oil and gas from the present reserve, contract supply for one year or acreage concentration.\nThe Trust has the authority to audit the operating companies' sales and production from the royalty areas. The Trust also has access to published materials in Germany from W.E.G. (a German organization equivalent to the American Petroleum Institute or the American Gas Association). Given the limited nature of the information available, the statistical information reflected in the Davis Report is based upon extrapolations and projections. While these are deemed appropriate and suitable by Davis Associates and by the Trustees themselves, they may vary from statistical projections which could be made if reservoir production information normally available for domestic producing companies were published or made available. In the opinion of the Trustees, the nature of the information available makes it inappropriate to make projections or estimates of proved or probable reserves of any category or class other than the estimated net proved producing reserves described in the Davis Report.\nTable I of the Davis Report is comprised of a schedule of estimated net proved producing reserves of the Trust's royalty properties, computed as of October 1, 1995 and a five year schedule of gas, sulfur and oil sales for the 12 months ended September 30, 1995, 1994, 1993, 1992 and 1991 computed from quarterly sales reports of operating companies received by the Trust during such periods.\nItem 3.","section_3":"Item 3. Legal Proceedings. ------------------\nManagement of the Trust has been advised of certain claims or proceedings relating to disputed ownership of units of beneficial interest where replacement certificates had previously been issued for allegedly lost predecessor corporate certificates. While the Trust or its transfer agent may be named in some of these proceedings, coverage under unlimited, open penalty indemnity bonds previously issued is in effect for these disputed units. For that reason and upon advice of counsel, management of the Trust believes that these pending litigations will not have any material effect on the operation of the Trust or the funds available for distribution to unit owners.\nAs previously reported, on November 20, 1986, the Escheator for the State of Delaware commenced an action in the Delaware Court of Chancery. The proceeding, brought under the escheat laws of Delaware, sought issuance to the Escheator of certificates for units of beneficial interest which are issuable in exchange for certain unexchanged shares of predecessor corporate entities, as well as unpaid dividends and distributions attributable thereto and interest thereon. On October 25, 1988, the Court entered an Order granting the Trust's motion to dismiss the Escheator's complaint to the extent that it asserted a claim to a present entitlement under Delaware law to such property. The Court permitted the Escheator to seek modification of the Court's prior orders concerning the Trust to make the property subject to escheat after the statutory period of dormancy. On February 15, 1990, the Delaware Escheator made such a motion, but no further proceedings had since taken place pursuant to that motion. In July, 1991, the Delaware General Assembly adopted amendments to the Delaware escheat laws which, if controlling, would have resulted in the period of dormancy, with respect to the property in issue, having already expired. While other provisions of the law might have provided a basis for the Court to again conclude that the period of dormancy had not commenced, there could be no assurance that such an interpretation would have prevailed, and the property might have been immediately subject to escheat. Even if the Court concluded that the period of dormancy had not yet begun, the Escheator could seek modification of the Court's prior orders. In either case, funds otherwise available for distribution to unit owners would have been required for payments to the Escheator in amounts which would have resulted in reduced or no funds being available for some period of time for regular distribution payments. In response to suggestions from counsel for the Escheator and in order to avoid the attendant costs and uncertainty of further litigation, the Trustees discussed the feasibility of settling the pending litigation. On December 7, 1995, as a result of these settlement discussions, attorneys for the Trust and the Delaware Attorney General representing the Escheator filed a joint petition in the Delaware Chancery Court seeking approval for a settlement of the litigation on negotiated terms. The settlement requires approval of the Court after opportunity for public hearing. The Court has appointed a Solicitor ad litem to represent the interests of the unlocated shareholders and set a hearing date for February 26, 1996. See Exhibit 99.2 contained in this report for the complete text of the Notice of Joint Petition for Approval of Settlement of Pending Litigation.\nAs of December 7, 1995 there were a total of 875,946 authorized but unissued units reflecting the unexchanged shares of the Trust's predecessor corporations. If the proposed settlement is approved, 760,560 units out of this total will be issued to the Escheator in three installments. Within thirty (30) days after the Court's order approving the settlement\nbecomes final and non-appealable, one-half of these units (380,280) will be issued to the Escheator. Subject to reductions for intervening claims, an additional 50% of the remaining units will be issued in the year 2000 and the remainder in the year 2005. These units reflect the unexchanged shares of the predecessor corporations to the Trust which are registered in the names of unknown owners, unlocated owners with a Delaware or non- U.S. address of record and brokerage firms or other nominees with insufficient records to establish beneficial ownership. As these units are issued, they will be entitled to regular quarterly payment of distributions by the Trust.\nUnder the terms of the settlement, the Trust would not be required to make payments of arrearages of Company dividends or Trust distributions to the Escheator with respect to the units issued. Claims received prior to the year 2005 from previously unlocated owners would be paid jointly by the Escheator and the Trust under a formula provided in the settlement, with claimant owners entitled to receive both units and arrears payments. Following the initial issuance and continuing until the second issuance in the year 2000, the Trust and the Escheator would each be responsible for 50% of any claim submitted. Following the second issuance and continuing until the final issuance in the year 2005, the Trust would be responsible for 25% of any claim submitted and the Escheator would be responsible for 75%. At all stages of this settlement following the initial issuance and continuing until the final issuance in 2005, the Escheator's liability will be limited to the total value of units and distributions it has received. Any claims in excess of this amount will be paid by the Trust. After the final issuance in the year 2005, no further payments of arrearages of Company dividends or Trust distributions would be required to be paid to shareholders subject to this settlement and the contingent liability for such possibility, described in Note 3 to Financial Statements contained herein, would no longer be applicable.\nTo make it possible to address within this settlement all unlocated shareholders, the Trust is seeking Court approval to permit the Trust to enter into similar settlement procedures with other states covering the authorized but unissued units that were not subject to the litigation (115,386 units as of December 7, 1995). See the Current Reports on Form 8-K filed on November 26, 1986, November 1, 1988 and December 11, 1995 (including Exhibits describing petition terms) and Note 3 to Financial Statements contained herein.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders. ----------------------------------------------------\nInapplicable.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant Trust's Units of Beneficial Interest and Related Certificate Holder Matters. -----------------------------------------------------\nThe Trust's units of beneficial interest (\"Units\") are traded on the New York Stock Exchange (the \"Exchange\") under the symbol NET. In addition, the Midwest Stock Exchange and the Boston Exchange have granted unlisted trading privileges in the Trust Units.\nUnder the Trust Agreement, the Trustees distribute to unit owners, on a quarterly basis, the net royalty income after deducting expenses.\nThe following table presents the high and low closing sales prices for the quarterly periods ended in fiscal 1995 and 1994 as reported by the Exchange as well as the cash distributions paid to unit owners by quarter for the past two fiscal years.\nFiscal Year 1995\nLow High Distributions Quarter Ended Sales Sales Per Unit - ---------------- -------- -------- ------------- January 31, 1995 12 1\/2 14 7\/8 .31 April 30, 1995 12 3\/8 14 5\/8 .42 July 31, 1995 13 14 3\/4 .35 October 31, 1995 12 5\/8 13 5\/8 .35\nFiscal Year 1994\nLow High Distributions Quarter Ended Sales Sales Per Unit - ---------------- -------- -------- ------------- January 31, 1994 15 17 1\/4 .27 April 30, 1994 15 1\/4 16 7\/8 .36 July 31, 1994 15 1\/2 16 7\/8 .16 October 31, 1994 12 7\/8 16 .22\nThe quarterly distributions to unit owners represent their undivided interest in royalty payments from sales of gas, oil and sulfur during the previous quarter. Each unit owner is entitled to recover a portion of their investment in these royalty rights through a cost depletion allowance. The percentage of cost depletion allowance recommended by the Trust's independent petroleum and natural gas consultants for calendar 1995 is 9.343%. Specific details relative to your interest in the Trust's income and expenses are included on page 3 of the 1995 Annual Report under \"Note to Unit Owners\" and have been sent in a separate letter to all unit owners registered at any time during 1995.\nThe Trust maintains no reserve to cover any payments which might be required if the holders of shares of stock of the predecessor Corporation or Company, who have not yet exchanged those shares for Units, should surrender them for exchange. See Item 7 and Note 3 to the Financial Statements in Item 8 of this Report.\nAs of January 2, 1996, there were 2,124 Unit owners of record, which figure does not include the owners of unexchanged shares of stock in the Corporation or the Company (a total of 613 record holders). The owners of shares of stock in the Corporation are entitled under Section 3.10 of the Trust Agreement to receive Units upon presentation of those shares or other evidences of ownership thereof. The owners of unexchanged shares of stock in the Company, for whom a nominee of the Bank of New York acts as agent under a shareholder agency agreement, are entitled to receive Units upon presentation of those shares or other evidences of ownership thereof.\nITEM 6.","section_6":"ITEM 6. Selected Financial Data -----------------------\nNorth European Oil Royalty Trust\nSelected Financial Data (Cash Basis) For Five Years Ended October 31, 1995\nGerman gas, oil and sulfur royalties received $12,477,788 $ 9,476,252 $10,718,289 $13,458,150 $13,026,234 =========== =========== =========== =========== =========== Net Income on a cash basis $11,941,675 $ 8,777,422 $10,248,982 $12,870,740 $12,517,318 =========== =========== =========== =========== =========== Net Income per unit on a cash basis (a) $1.43 $1.06 $1.24 $1.55 $1.51 ===== ===== ===== ===== ===== Units of beneficial interest outstanding at end of year (a) 8,313,984 8,312,898 8,298,216 8,294,538 8,291,568\nCash distributions paid or to be paid: Dividends and distributions per unit paid to former unlocated shareholders $ .00 $ .05 $ .01 $ .01 $ .01 Distributions per unit paid or to be paid to certificate holders 1.43 1.01 1.22 1.55 1.49 ----- ----- ----- ----- ----- $1.43 $1.06 $1.23 $1.56 $1.50 ===== ===== ===== ===== ===== Total assets at end of year $ 2,951,228 $ 1,848,274 $ 2,733,049 $3,000,624 $ 3,743,724 =========== =========== =========== ========== ===========\n(a) Net income per unit on a cash basis was calculated based on the number of units of beneficial interest outstanding at the end of the year.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. -------------------------------------------------\nGeneral - -------\nThe Trust is a passive fixed investment trust which holds overriding royalty rights, receives income under those rights from certain operating companies, pays its expenses and distributes the remaining net funds to its unit owners. The Trust is not involved in any business or extractive operations of any kind in the areas over which it holds royalty rights and is precluded from any such involvement by the Trust Agreement. There are no requirements, therefore, for capital resources with which to make capital expenditures or investments in order to continue the receipt of royalty revenues by the Trust.\nThe Trust does not conduct any active business operations and has only limited need of funds for its own administrative services. These funds are used to pay Trustees' fees (computed under the Trust Agreement and based upon a percentage of royalties received), the remuneration fixed by the Trustees for the Managing Trustee and the Managing Director, professional fees paid to consultants, legal advisors and auditors, transfer agent fees, and secretarial and other general office expenses.\nAnother requirement for funds by the Trust relates to the occasional necessity of making lump sum payments of arrearages of dividends of a corporate predecessor and distributions previously declared by the Trust. Such payments are required when owners of shares of stock in predecessor corporate entities, who have not previously presented their shares for conversion to units of beneficial interest in the Trust, make such a presentation or furnish properly documented affidavits of loss and obtain an unlimited, open penalty bond. As indicated in Note 3 to the Financial Statements, if presentation were made with respect to all predecessor corporate shares which have not been previously presented, a total of $26,368,222 would be required for arrearage payments. Depending on the number of such shares presented or claims filed, payment of such arrearages would likely require a reduction or deferral of distributions which otherwise would be made on presently outstanding units.\nThe Trust has no means of assuring continued income from overriding royalty rights at their present level or otherwise. Economic and political factors which are not foreseeable may have an impact on Trust income. The effect of changing economic conditions on the demand for energy throughout the world and future prices of oil and gas cannot be accurately projected.\nThe relatively small amounts required for administrative expenses of the Trust limit the possible effect of inflation on its financial prospects. Continued price inflation would be reflected in sales prices, which, with sales volumes, form the basis on which the royalties paid to the Trust are computed. In addition, fluctuations in the mark\/dollar exchange rate have an impact on domestic energy prices within Germany and on the amount of dollars received upon conversion. The impact of inflation or deflation on energy prices in Germany is delayed by the use in certain long-term gas sales contracts of a deferred \"trailing average\" related to light fuel oil prices.\nFiscal 1995 versus Fiscal 1994 - ------------------------------\nFor fiscal 1995 the Trust's royalty income of $12,477,788 was 31.6% higher than the previous year. A combination of increased sales from the higher royalty area of western Oldenburg and a strong Deutsche mark yielded the increased royalties. In contrast to the prior year, when the partial shutdown of the Grossenkneten desulfurization plant significantly affected the amount of royalties received in the third and fourth quarters, no such unusual or extended interruption of production occurred during fiscal 1995. Since last year's partial shutdown affected production of saleable gas from the higher royalty western portion of Oldenburg to a greater degree, in 1995 the increase in production and sales was slanted toward gas from the west. Total gas sales of 76.8 billion cubic feet from the higher royalty western area increased by 15.45% while gas sales of 183.8 billion cubic feet for all of Oldenburg only increased by 2.4%. In addition, the continued strength of the Deutsche mark throughout the year contributed to the amount of dollars received by the Trust upon the transfer of funds from Germany. For the year, the average value of the Deutsche mark increased from 60.3 cents to 69.2 cents, an improvement of 14.6%. While gas prices, which averaged 1.46 Pfennigs per Kwh, declined somewhat from the prior year (1.65% and 3.9% for western and overall Oldenburg respectively), the negative effect of that decline was easily offset by the increases in sales and exchange rates.\nThere have been no payments under the Mobil sulfur royalty, since the most recent sulfur price of DM 91 per metric ton is well below the threshold for the resumption of royalty payments. The world sulfur situation looks to deteriorate further as a result of world wide over supply and continued increases in the removal of sulfur from petroleum products for environmental compliance.\nTrust expenses of $612,682 showed a decrease of nearly 18%, reflecting a reduction in legal expenses as well as the absence of audit expenses in the off year of the biennial audit cycle of the operating companies in Germany. The increase in interest\nincome to $76,569 reflects both the increase of funds available for investment as well as somewhat higher rates available through the exclusive use of Treasury bills for short term investments.\nDuring fiscal 1995 and 1994 respectively, an additional 1,086 and 14,682 Trust units were issued and $31,701 and $412,306 were paid to former unlocated shareholders of North European Oil Corporation and North European Oil Company who presented shares for exchange or filed properly documented affidavits of loss and obtained an unlimited, open penalty indemnity bond.\nFiscal 1994 versus Fiscal 1993 - ------------------------------\nFor fiscal 1994 the Trust's total royalty income of $9,476,252 was 11.6% lowerthan the previous year. There are four primary factors that affect the level of royalties: the amount of gas sales, the gas prices, the geographic source of sales and the exchange rates. This year, as in last year, a fifth factor of business interruption was added. The year commenced on a strong note with both the first and second quarters showing increases in all factors except for exchange rates when compared to the prior year's quarter. During the third and fourth quarters all the factors affecting royalties reversed themselves. Where previously the amount of gas sales, gas prices and geographic source of sales showed increases, they now showed declines. The previous declines in exchange rates now showed increases. The basis for this reversal was the fifth factor of business interruption, which involved an extended shutdown at the Grossenkneten desulfurization plant from April 25 to July 25, 1994. During this shutdown, production was reduced to between one third and two thirds of normal levels. The rationale behind the shutdown was three fold: conduct normal annual maintenance, install additional tail gas clean up units to address lingering environmental concerns and overhaul and update control system for the entire plant. The effects of this shutdown on the Trust's royalty stream and subsequent distributions were significant. The first six months of fiscal 1994 showed distributions of 63 cents per unit compared to 57 cents per unit for fiscal 1993, an increase of 10.5%. The final six months of fiscal 1994 showed distributions of 38 cents per unit compared to 65 cents per unit for fiscal 1993, a decrease of 41.5%. In average for the year the four factors affecting royalties showed decreases or were unchanged. Under the higher royalty agreement with Mobil covering sales of gas from western Oldenburg, sales declined by 11.85%, prices and exchange rates were unchanged. Because the combined royalty rate in effect on these sales is seven times greater than the royalty in effect on sales from eastern Oldenburg, any decline in sales from the west has an exaggerated effect on Trust royalties. Under the lower royalty agreement covering the entire Oldenburg\narea, sales declined by 3.6%, gas prices by 3.1% and the exchange rate by 1.5%.\nDespite the improvement in sulfur prices from $24.00 in the first quarter to $63.00 per metric ton in the fourth quarter, the threshold level for the resumption of royalties under the agreement with Mobil has not been reached. Until the overabundance of sulfur on the world market is reduced, the Trust will receive only minor amounts of royalties from sulfur.\nTrust expenses showed an increase of nearly 45% reflecting increased legal expenses relating to escheat matters. Interest income increased slightly, despite the reduced amount of funds available, because of the gradually increasing interest rates in effect.\nDuring fiscal 1994 and 1993, respectively, an additional 14,682 and 3,687 Trust Units were issued and $412,306 and $97,121 were paid to former unlocated shareholders of North European Oil Corporation and North European Oil Company who presented shares for exchange or filed properly documented affidavits of loss and obtained an unlimited, open penalty indemnity bond.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data --------------------------------------------\nNORTH EUROPEAN OIL ROYALTY TRUST -------------------------------- INDEX TO FINANCIAL STATEMENTS AND SCHEDULE ------------------------------------------ Page Number ----------- Report of Independent Public Accountants\nFinancial Statements:\nStatements of Assets, Liabilities and Trust Corpus as of October 31, 1995 and 1994\nStatements of Income and Expenses on a Cash Basis for the Years Ended October 31, 1995, 1994 and 1993\nStatements of Undistributed Earnings for the Years Ended October 31, 1995, 1994 and 1993\nStatements of Changes in Cash and Cash Equivalents for the Years Ended October 31, 1995, 1994 and 1993\nNotes to Financial Statements -\nSchedules are omitted because they are not applicable or not required or because the required information is included in the financial statements or notes thereto.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ----------------------------------------\nTo North European Oil Royalty Trust:\nWe have audited the accompanying statements of assets, liabilities and trust corpus of North European Oil Royalty Trust as of October 31, 1995 and 1994 and the related statements of income and expenses on a cash basis, undistributed earnings and changes in cash and cash equivalents for each of the three years in the period ended October 31, 1995. 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 accounting standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nThe accounts of the Trust are maintained on the cash basis of accounting under which income is not recorded until collected instead of when earned, and expenses are recorded when paid instead of when incurred. Thus, the accompanying financial statements are not intended to present financial position and results of operations in conformity with generally accepted accounting principles which requires the use of the accrual basis of accounting (see Note 1).\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the assets, liabilities and trust corpus of North European Oil Royalty Trust as of October 31, 1995 and 1994, and its income and expenses, undistributed earnings and changes in cash and cash equivalents for each of the three years in the period ended October 31, 1995, all on the cash basis of accounting.\nAs discussed in Note 3, the Trust has a contingent liability relating to unclaimed units and distributions. No reserves are established or reflected in the fanancial statements for the possibility that funds would be required to satisfy such claims.\n\/s\/ Arthur Andersen LLP\nRoseland, New Jersey November 8, 1995\nNORTH EUROPEAN OIL ROYALTY TRUST --------------------------------\nSTATEMENTS OF ASSETS, LIABILITIES AND TRUST CORPUS (NOTE 1) ----------------------------------------------------------- OCTOBER 31, 1995 AND 1994 -------------------------\nASSETS 1995 1994 ------ ------------ ------------\nCurrent Assets -- Cash and cash equivalents (Note 1) $2,951,227 $1,848,273\nProducing gas and oil royalty rights (Note 1) 1 1 ------------ ------------ $2,951,228 $1,848,274 ============ ============\nLIABILITIES AND TRUST CORPUS ----------------------------\nCurrent liabilities -- Cash distributions payable to unit owners, paid November 1995 and 1994 $2,909,894 $1.828,838\nContingent liability (Note 3)\nTrust corpus (Notes 1 and 2) 1 1\nUndistributed earnings (Note 1) 41,333 19,435 ------------ ------------ $2,951,228 $1,848,274 ============ ============\nThe accompanying notes to financial statements are an integral part of these statements.\nNORTH EUROPEAN OIL ROYALTY TRUST --------------------------------\nSTATEMENTS OF INCOME AND EXPENSES ON A CASH BASIS (NOTE 1) ---------------------------------------------------------- FOR THE YEARS ENDED OCTOBER 31, 1995, 1994 AND 1993 ---------------------------------------------------\n1995 1994 1993 ------------ ------------ ------------ German gas, oil and sulfur royalties received $12,477,788 $ 9,476,252 $10,718,289\nInterest income 76,569 45,798 44,768\nTrust expenses ( 612,682) ( 744,628) ( 514,075) ------------ ------------ ------------ Net income on a cash basis $11,941,675 $ 8,777,422 $10,248,982 ============ ============ ============\nNet income per unit on a cash basis $1.43 $1.06 $1.24 ======= ======= =======\nCash distributions paid or to be paid: Dividends and distributions per unit paid or to be paid to former unlocated shareholders (Note 3) $ .00 $ .05 $ .01\nDistributions per unit paid or to be paid to unit owners (Note 4) 1.43 1.01 1.22 ------- ------- ------- $1.43 $1.06 $1.23 ======= ======= =======\nThe accompanying notes to financial statements are an integral part of these statements.\nNORTH EUROPEAN OIL ROYALTY TRUST --------------------------------\nSTATEMENTS OF UNDISTRIBUTED EARNINGS (NOTE 1) --------------------------------------------- FOR THE YEARS ENDED OCTOBER 31, 1995, 1994 AND 1993 ---------------------------------------------------\n1995 1994 1993 ------------ ------------ ------------ Balance, beginning of year $ 19,435 $ 43,897 $ 14,589\nNet income on a cash basis 11,941,675 8,777,422 10,248,982 ------------ ------------ ------------ 11,961,110 8,821,319 10,263,571 ------------ ------------ ------------ Less: Dividends and distributions paid to former unlocated shareholders (Note 3) 30,781 412,306 97,847\nCurrent year distributions paid or to be paid to unit owners (Note 4) 11,888,996 8,389,578 10,121,827 ------------ ------------ ------------ 11,919,777 8,801,884 10,219,674 ------------ ------------ ------------ Balance, end of year $ 41,333 $ 19,435 $ 43,897 ============ ============ ============\nThe accompanying notes to financial statements are an integral part of these statements.\nNORTH EUROPEAN OIL ROYALTY TRUST --------------------------------\nSTATEMENTS OF CHANGES IN CASH AND CASH EQUIVALENTS (NOTE 1) ----------------------------------------------------------- FOR THE YEARS ENDED OCTOBER 31, 1995, 1994 AND 1993 ---------------------------------------------------\n1995 1994 1993 ------------ ------------ ------------ Sources of cash and cash equivalents: German gas, oil and sulfur royalties received $12,477,788 $ 9,476,252 $10,718,289\nInterest income 76,569 45,798 44,768 ------------ ------------ ------------ 12,554,357 9,522,050 10,763,057 Uses of cash and cash equivalents: Payment of Trust expenses 612,682 744,628 514,075 Distributions and dividends paid (Note 3) 10,838,721 9,662,197 10,516,557 ------------ ------------ ------------ 11,451,403 10,406,825 11,030,632 ------------ ------------ ------------ Net increase (decrease) in cash and cash equivalents during the year 1,102,954 ( 884,775) ( 267,575)\nCash and cash equivalents, beginning of year 1,848,273 2,733,048 3,000,623 ------------ ------------ ------------ Cash and cash equivalents, end of year $ 2,951,227 $ 1,848,273 $ 2,733,048 ============ ============ ============\nThe accompanying notes to financial statements are an integral part of these statements.\nNORTH EUROPEAN OIL ROYALTY TRUST --------------------------------\nNOTES TO FINANCIAL STATEMENTS ----------------------------- OCTOBER 31, 1995, 1994 AND 1993 -------------------------------\n(1) Summary of significant accounting policies: ----------------------\nBasis of accounting - ---------------------\nThe accounts of North European Oil Royalty Trust (the \"Trust\") are maintained on a cash basis except for distributions to be paid to unit owners (those distributions approved by the Trustees for the Trust). In the opinion of the Trustees, the use of the cash basis provides a more meaningful presentation to unit owners of the results of operations of the Trust.\nProducing gas and oil royalty rights - --------------------------------------\nThe rights to certain gas and oil royalties in Germany were transferred to the Trust at their net book value by North European Oil Company (the \"Company\") (see Note 2). The net book value of the royalty rights has been reduced to one dollar ($1) in view of the fact that any remaining net book value of royalty rights is de minimis relative to annual royalties received and distributed by the Trust and does not bear any meaningful relationship to the fair value of such rights or the actual amount of proved producing reserves.\nFederal and state income taxes- -------------------------------\nThe Trust, as a grantor trust, is exempt from Federal and state income taxes under a private letter ruling issued by the Internal Revenue Service.\nCash and cash equivalents- -------------------------- Included in cash and cash equivalents are amounts deposited in bank accounts and amounts invested in certificates of deposit and U. S. Treasury bills with maturities of three months or less.\nNet income per unit on the cash basis- --------------------------------------\nNet income per unit on the cash basis is based upon the number of units outstanding at the end of the period (see Note 3). As of October 31, 1995, 1994 and 1993, there were 8,313,984, 8,312,898 and 8,298,216 units of beneficial interest outstanding, respectively.\n(2) Formation of the Trust: -----------------------\nThe Trust was formed on September 10, 1975. As of September 30, 1975, the Company was liquidated and the remaining assets and liabilities of the Company, including its royalty rights, were transferred to the Trust.\n(3) Contingent liability: ---------------------\nThe Trust serves as fiduciary for certain unlocated or unknown shareholders of North European Oil Corporation (the \"Corporation\") and of North European Oil Company, corporate predecessors of the Trust. From the liquidation of the Company to October 31, 1994, 717,836 Trust units were issued in exchange for Corporate or Company shares and dividends of $352,959 and distributions of $4,130,993 were paid to former unlocated Corporation and Company shareholders. For the year ended October 31, 1995, 1,086 units were issued in exchanges and dividends of $271 and distributions of $31,430 were paid to former unlocated Corporation and Company shareholders.\nAs of October 31, 1995, 876,606 units remain that could be issued to unlocated or unknown Corporation and Company shareholders and $487,894 in dividends and $25,880,328 in distributions would be payable if all such shares were exchanged. The amount of attributable distributions will increase as further distributions of the Trust are made and it is possible that claims by such unlocated shareholders would require substantial payments to a level where reduced or no funds would be available for some period of time for regular distribution payments. On the basis of their experience with such claims, the Trustees believe that it is unlikely that payments for such claimants would be required in substantial amounts in any one period of time.\nOn November 20, 1986, the Escheator for the State of Delaware commenced an action in the Delaware Court of Chancery seeking issuance, under Delaware escheat statutes, of\ncertificates for units of beneficial interest which are issuable in exchange for certain unexchanged Corporate or Company shares as well as unpaid dividends and distributions. Following partial resolution of the suit in 1988, discussions for possible settlement of the proceeding were suggested by representatives for the Escheator. On December 7, 1995, as a result of these discussions, attorneys for the Trust and the Delaware Attorney General representing the Escheator filed a joint petition in the Delaware Chancery Court seeking approval for a settlement of the litigation on negotiated terms. The settlement requires approval of the Court after opportunity for public hearing. The Court has appointed a Solicitor ad litem to represent the interests of the unlocated shareholders.\nAs of December 7, 1995 there were a total of 875,946 authorized but unissued units reflecting the unexchanged shares of the Trust's predecessor corporations. If the proposed settlement is approved, 760,560 units will be issued to the Escheator in three installments as follows: within thirty (30) days after the Court's order approving the settlement becomes final and non-appealable, one-half of these units (380,280) will be issued to the Escheator; subject to reductions for subsequent exchanges, an additional 50% of the remaining units will be issued in the year 2000; and the remainder in the year 2005. As these units are issued and become outstanding, they will be entitled to receive the ordinary distributions of the Trust.\nUnder the terms of the settlement, the Trust would not be required to make payments of arrearages of Company dividends or Trust distributions to the Escheator with respect to the units issued. Claims for the issuance of units and the payment of prior dividends and distributions received before the year 2005 from previously unlocated shareholders would be paid jointly by the Escheator and the Trust under a formula provided in the settlement, with claimant owners entitled to receive both units and arrears payments. Until the final issuance of units in 2005, the Escheator's liability will be limited to the total value of units and distributions it has received. Any claims in excess of this amount will be paid by the Trust. After the final issuance of units in the year 2005, no further payments of arrearages of Company dividends or Trust distributions would be required to be paid to shareholders subject to this settlement and the contingent liability for such possibility described above would no longer be applicable.\nThis settlement also permits the Trust to seek to apply the same or similar settlement procedures to the authorized but unissued units that were not subject to the litigation (115,386 units as of December 7, 1995). Any additional issuances that occur as in the course of subsequent settlements with respect to these units would involve some additional dilution.\n(4) Quarterly results (unaudited): ------------------------------\nThe table below summarizes the quarterly results and distributions of the Trust for the years ended October 31, 1995 and 1994.\n1995 Quarter --------------------------------------- 1st 2nd 3rd 4th Year ---------- ---------- ---------- ---------- ------------- Royalties received $2,760,129 $3,633,648 $3,056,999 $3,027,012 $12,477,788 Net income on a cash basis 2,590,726 3,476,434 2,952,057 2,922,458 11,941,675 Net income per unit on a cash basis .31 .42 .35 .35 1.43 Current year cash distributions paid or to be paid 2,576,998 3,491,943 2,910,161 2,909,894 11,888,996 Current year cash distributions per unit .31 .42 .35 .35 1.43\n1994 Quarter --------------------------------------- 1st 2nd 3rd 4th Year ---------- ---------- ---------- ---------- ------------- Royalties received $2,579,218 $3,114,996 $1,843,579 $1,938,459 $ 9,476,252 Net income on a cash basis 2,380,956 2,963,754 1,661,147 1,771,565 8,777,422 Net income per unit on a cash basis .29 .36 .20 .21 1.06 Current year cash distributions paid or to be paid 2,241,709 2,988,967 1,330,064 1,828,838 8,389,578 Current year cash distributions per unit .27 .36 .16 .22 1.01\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. ------------------------------------------------\nInapplicable.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant. ---------------------------------------------------\nThe identity, business experience, relationships, and other information about the Trustees as set forth under the caption \"Election of Trustees\" in Registrant's definitive Proxy Statement, dated January 11, 1996, as filed with the Commission, are incorporated herein by reference in accordance with Instruction G(3) to Form 10-K. See \"Executive Officers of the Trust\" under Item 1 for information concerning the executive officers of the Trust.\nItem 11.","section_11":"Item 11. Executive Compensation. -----------------------\nThe information about remuneration of the Trustees and Management as set forth under the caption \"Management Compensation\" in Registrant's definitive Proxy Statement, dated January 11, 1996, as filed with the Commission, is incorporated herein by reference in accordance with Instruction G(3) to Form 10-K.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management. ---------------------------------------------------\nThe information about security ownership of certain beneficial owners and Management as set forth in the introduction to and under the caption \"Election of Trustees\" in Registrant's definitive Proxy Statement dated January 11, 1996, as filed with the Commission, is incorporated herein by reference in accordance with Instruction G(3) to Form 10-K.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions. -----------------------------------------------\nThe information about certain relationships and related transactions as set forth under the captions \"Election of Trustees\" and \"Management Compensation\" in Registrant's definitive Proxy Statement, dated January 11, 1996 as filed with the Commission, is incorporated herein by reference in accordance with Instruction G(3) to Form 10-K.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K. ----------------------------------------------------\n(a) The following is a list of the documents filed as part of this report:\n1. Financial Statements\nIndex to Financial Statements and Schedule for the Years Ended October 31, 1995, 1994 and 1993\nReport of Independent Public Accountants\nStatements of Assets, Liabilities and Trust Corpus as of October 31, 1995 and 1994\nStatements of Income and Expenses on a Cash Basis for the Years Ended October 31, 1995, 1994 and 1993\nStatements of Undistributed Earnings for the Years Ended October 31, 1995, 1994 and 1993\nStatements of Changes in Cash and Cash Equivalents for the Years Ended October 31, 1995, 1994 and 1993\nNotes to Financial Statements\n2. Exhibits\nThe Exhibit Index following the signature page lists all exhibits filed with this report or incorporated by reference.\n(b) No Current Report on Form 8-K was filed during the last quarter of the period covered by this Report but one was filed on December 11, 1995 to reflect information concerning the joint petition to settle pending litigation brought by Delaware State Escheator.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Trust has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nNORTH EUROPEAN OIL ROYALTY TRUST\nDated: January 11, 1996 By: \/s\/ John H. Van Kirk ------------------------------- John H. Van Kirk, Managing Trustee\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nDated: January 11, 1996 \/s\/ John H. Van Kirk ------------------------------- John H. Van Kirk, Trustee\nDated: January 11, 1996 \/s\/ Robert P. Adelman ------------------------------- Robert P. Adelman, Trustee\nDated: January 11, 1996 \/s\/ Robert J. Castle ------------------------------- Robert J. Castle, Trustee\nDated: January 11, 1996 \/s\/ Willard B. Taylor ------------------------------- Willard B. Taylor, Trustee\nExhibit Index -------------\nExhibit Page - ------- ----\n(3) Trust Agreement, dated September 10, 1975, amended May 13, 1976, and February 10, 1981, (incorporated by reference to Exhibit 4(i) to Form 10-Q for the quarter ended April 30, 1981 (File No. 0-8378)).\n(10.1) Agreement with OEG, dated April 2, 1979, exhibit to Current Report on Form 8-K, filed May 11, 1979 (incorporated by reference as Exhibit 1 to Current Report on Form 8-K, filed May 11, 1979 (File No. 0-8378)).\n(10.2) Agreement with Mobil Oil, A.G. concerning sulfur royalty payment, dated March 30, 1979, (incorporated by reference to Exhibit 3 to Current Report on Form 8-K, filed May 11, 1979 (File No. 0-8378)).\n(22) There are no parents and no subsidiaries of the Trust.\n(99.1) Report and Production Summary Information 35 for Twelve Months Ended September 30, 1995, by Ralph E. Davis Associates, Inc.\n(99.2) Notice to Unit Owners of hearing date and terms 45 of the Joint Petition for Approval of Settlement of Pending Litigation on Form 8-K, filed December 11, 1995.","section_15":""}
{"filename":"716457_1995.txt","cik":"716457","year":"1995","section_1":"ITEM 1 - BUSINESS\nFrontier Financial Corporation (FFC) is a Washington corporation which was incorporated in 1983 and is registered as a bank holding company under the Bank Holding Company Act of 1956. As part of a plan of reorganization consummated following the close of business September 30, 1983, FFC acquired all of the stock of Frontier Bank (the Bank), issuing its common stock in an exchange for the Bank's common stock on a share-for-share basis. FFC has two subsidiaries; the Bank, which is engaged in a general banking business and in businesses related to banking, and FFP, Inc., a nonbank corporation which leases property and equipment to the Bank.\nThe Bank\nThe Bank is a state-chartered banking association with its principal office located in Everett, Snohomish County, Washington. It was founded in September, 1978 by Robert J. Dickson and local business persons. The Bank is an \"insured bank\" as defined in the Federal Deposit Insurance Act.\nThe Bank engages in general banking business, including the acceptance of demand, time and savings deposits and the making of loans. As of December 31, 1995, the Bank conducted its business operations out of 16 offices located in Snohomish and King Counties, of which four offices are located in Everett, one office each is located in Arlington, Snohomish, Smokey Point, Lake Stevens, Marysville, Lynnwood, Mill Creek, Edmonds, Stanwood, Bothell, Woodinville and Monroe.\nBanking Services\nThe Bank provides a full range of consumer banking services including savings accounts, checking accounts, installment and commercial lending, safe deposit facilities, time deposits and other consumer and business related financial services. In addition to consumer oriented activities, the Bank maintains a strong commercial lending program, servicing businesses headquartered in the Bank's principal market area. At the end of 1983, the Bank began to offer a discount brokerage service to its customers. In September of 1984, the Bank opened its Real Estate Division, offering a broad range of home, construction and commercial long-term financing. The Trust Department opened for business in March of 1985. This department offers a full array of trust services to its customers. In May 1988, the Bank opened a Private Banking Office to give personal service to upscale customers. In August 1989, the Bank acquired, through a merger, three banking offices of Citizens Bank of Snohomish County, and a real estate origination department. In January 1991, the Bank opened an office in Mill Creek, providing a full range of consumer banking services.\nIn March 1991, the Bank opened an Insurance and Investment Center which markets annuities, life insurance products, and mutual funds to Bank customers and the general public. In July 1992, the Bank opened its Stanwood office. In November 1992, the Bank acquired through merger, Edmonds National Bank, which had one office. In July 1993, the Bank acquired through merger, The Bank of Northshore, which had two offices located in Bothell and Woodinville, King County, Washington. This merger marked the first time the Bank branched outside of Snohomish County. In June 1995, the Bank opened an office in Monroe, providing a full range of consumer banking services.\nEmployees\nAt December 31, 1995, the Bank had 281 full and part time employees. The Bank considers its relations with employees to be very good.\nCompetition\nAll phases of the Bank's activities are highly competitive. The Bank competes actively with national and state banks, mutual savings banks, savings and loan associations, finance companies, credit unions, brokerage houses, and other financial institutions operating in its service area. Some of these financial institutions have greater resources than those of the Bank. On December 31, 1995, the Bank had total assets of $735.2 million and deposits of $641.2 million.\nSupervision and Regulation\nFFC, as a bank holding company, is subject to regulation under the Bank Holding Company Act of 1956 (the Act), as amended, and is registered with the Board of Governors of the Federal Reserve System. FFC is required to file quarterly reports with the Federal Reserve, and is subject to their examination.\nThe Act requires prior approval of the Board of Governors before acquiring substantially all the assets of, or direct or indirect ownership or control of, more than 5% of the voting shares of any bank.\nThe Act also prohibits the acquisition by a bank holding company of the assets or shares of a bank located outside the state in which the principal operations of the banking subsidiaries are conducted unless such acquisition is specifically authorized by the laws of the state in which the Bank to be acquired is located. The Act does not place territorial restrictions on the activities of nonbank subsidiaries of bank holding companies.\nUnder the Act, FFC is prohibited, with certain exceptions, from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company which is not a bank, and from engaging in any business other than banking, except that FFC may engage in, and may own shares of companies engaged in certain businesses determined by the Board of Governors to be so closely related to banking so \"as to be a proper incident thereto\". Such related businesses include, by determination of the Board of Governors, the making or acquiring of loans or extensions of credit such as would be made by a mortgage, finance, credit card or factoring company; leasing of personal property where the leasing arrangements are functionally equivalent to extensions of credit; and acting as an insurance agent or broker of insurance directly related to extensions of credit of the Bank or other closely related businesses. The Act, however, prohibits tie-in arrangements in connection with the extension of credit or provision of services.\nThe Bank, as a state chartered bank, is subject to supervision, examination and regulation by the State Supervisor of Banking and the Federal Deposit Insurance Corporation (the FDIC). The deposits of the Bank are insured by the FDIC to the extent provided by law.\nVarious requirements and restrictions under the laws of the United States and the State of Washington affect the operations of the Bank. Federal regulations include requirements to maintain reserves against deposits, restrictions on interest which may be paid on business demand deposits, limitations on the nature and the amount of loans which may be made and the interest that may be charged thereon, restrictions relating to investments or other activities, limitations based on capital and surplus, and limitations on payments of dividends. The approval of the Supervisor is required to pay dividends which exceed the Bank's net profits for that year plus its retained net profits for the preceding two years. Federal law also restricts the amount which can be loaned to the Corporation or any of its nonbank subsidiaries to 10% of the Bank's capital stock and surplus, and restricts the total of such loans to 20% of the Bank's capital stock and surplus.\nThe Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA) became effective on August 9, 1989. Among other things, this far reaching legislation: 1) phased in significant increases in the FDIC insurance premiums by 1993; 2) created two deposit insurance pools within the FDIC, one to insure commercial and savings bank deposits and the other to insure savings associations deposits; 3) permitted bank holding companies to acquire healthy savings associations; 4) permitted commercial banks that meet certain housing related asset requirements to secure advances and other financial services from their local Federal Home Loan Bank; 5) created the Resolution Trust Corporation to pay the cost of resolving insolvent savings associations financed by the taxpayers and the savings associations; 6) restructured the federal regulatory agencies for savings associations; 7) required higher minimum capital levels for savings associations; and 8) has greatly enhanced the regulator's enforcement powers by removing procedural barriers, sharply increasing the civil and criminal penalties for violating statutes and regulations, and providing increased appropriations to the Justice Department to finance prosecutions for crimes against depository institutions.\nOn December 19, 1991, the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) was enacted. FDICIA substantially revises the depository institution regulatory and funding provisions in the Federal Deposit Insurance Act and makes revisions to several other federal banking statutes. Among other things, FDICIA requires the Federal Banking Regulators to take prompt corrective action in respect to depository institutions that do not meet minimum capital requirements. The FDICIA created regulations establishing five capital tiers: \"Well Capitalized\"; \"Adequately Capitalized\"; \"Under-Capitalized\"; \"Significantly Under-Capitalized\"; and \"Critically Under-Capitalized\". Under the regulations, a depository institution would be considered Well Capitalized if it maintains a leverage ratio of at least five percent and a risk-based Tier I capital ratio of at least six percent and a risk-based total capital ratio of at least ten percent, and is not otherwise designated to be in troubled condition. Also, a depository institution will be deemed Under-Capitalized if it fails to meet any applicable minimum capital measure; Significantly Under-Capitalized if it is significantly below such measure; and Critically Under-Capitalized if it fails to meet a level of tangible equity of two percent of total assets. If a depository institution is neither Well Capitalized nor Under-Capitalized, it will be considered Adequately Capitalized. A depository institution may be deemed to be in a capitalization category that is lower than is indicated by its actual capital position if it receives an unsatisfactory examination rating.\nThe FDICIA generally prohibits a depository institution from making any capital distribution, including the payment of dividends or payment of any management fee to its holding company, if the depository institution would thereafter be Under-Capitalized. Under-Capitalized depository institutions are subject to restrictions on borrowing from the Federal Reserve System. In addition, Under-Capitalized depository institutions are subject to growth limitations and are required to submit capital restoration plans. A depository institution holding company must guarantee the capital plan up to the amount equal to the lesser of five percent of the depository institution's assets at the time it becomes Under-Capitalized or the amount of the capital deficiency when the institution fails to comply with the plan. The Federal Banking Agencies may not accept a capital plan without determining, among other things, if the plan is based on realistic assumptions and is likely to succeed in restoring the depository institution's capital. If a depository institution fails to submit an acceptable plan, it is treated as if it is Significantly Under-Capitalized.\nSignificantly Under-Capitalized 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 the cessation of receipt of deposits from correspondent banks. Critically Under-Capitalized depository institutions are subject to employment of a receiver or a conservator.\nThe FDICIA also required the FDIC to revise its risk-based capital guidelines by June 19, 1993 to take into account interest rate risk, concentration of credit risk, and risk associated with nontraditional activities. It also required the guidelines to reflect the actual performance and expected risk of loss of multi-family mortgages. These provisions affect the capital standing of all institutions, and may result in a need for increased capital.\nAs of December 31, 1995, the Bank was Well Capitalized, and maintained a leverage ratio of 8.81%, a risk-based Tier I capital ratio of 11.07%, and a risk-based total capital ratio of 12.33%.\nThe Corporation's common stock is registered under Section 12(g) of the Securities Exchange Act of 1934 and the Corporation is subject to the periodic reporting and proxy solicitation requirements, as well as other requirements of federal and state securities law.\nEffect of Governmental Policies\nThe Bank is affected not only by general economic conditions, but also by the monetary and fiscal policies of the United States Government and various agencies, particularly the Federal Reserve System. In its role of implementing its monetary policy, the Federal Reserve Board has the power to regulate the national supply of bank credit through such methods as open market operations in the United States Government securities markets, control of the discount rate on member bank borrowings, and establishment of reserve requirements against bank deposits. These means are used in varying combinations and have an influence over the growth of bank loans, investments, and deposits. They may also affect interest rates charged on loans or paid on deposits.\nThe nature and timing of future changes in monetary policies and their impact on the Bank are not predictable. As a consequence of extensive regulation of commercial banking activities in the United States, the Bank's business is particularly susceptible to being affected by Federal legislation and regulations which may have the effect of increasing the cost of doing business or limiting permissible activities.\nFFP, Inc.\nOn April 4, 1988, the Corporation formed a new subsidiary corporation called FFP, Inc. The purpose of this corporation is to purchase and lease property and equipment to the Bank. The reason for this approach was to preclude placing nonearning assets on the books of the Bank or the Corporation.\nIt is intended that future purchases of fixed assets will be made by FFP, Inc. The assets of FFP, Inc. as of December 31, 1995 are the premises and equipment of the Bank's Lynnwood, Stanwood, Administrative, Monroe, Smokey Point and Snohomish offices. At this time, it is not anticipated that FFP, Inc. will engage in any other type of business.\nSTATISTICAL DISCLOSURE INDEX\nThe schedules listed below set forth the statistical information relating to Frontier Financial Corporation and subsidiaries (unless otherwise stated) in accordance with Guide 3. This information should be read in conjunction with the consolidated financial statements.\nAnalysis of Investment Securities\nThe Aggregate amortized recorded values of investment securities at December 31 are as follows:\nMaturity Distribution of Investment Securities\nThe following table sets forth the maturities of investment securities at December 31, 1995. Taxable equivalent values are used in calculating yields assuming a tax rate of 34%.\nTypes of Loans\nMajor classifications of loans, net of deferred loan fees, at December 31 are as follows:\nLoan Maturities and Sensitivity to Changes in Interest Rates\nThe following table shows the amounts and maturity analysis of loans outstanding as of December 31, 1995. Also, the amounts are classified as to fixed and variable rate sensitivity for amounts due after one year.\nLoans maturing after one year with:\nIt is not uncommon to rollover loans at the maturity period, provided that the rate and terms of the loan conform to the current policy.\nLoan Administration\nThe Bank provides revolving lines of credit to many of its borrowers. Such lines are approved by the Director's Loan Committee (\"Loan Committee\") or other administrative level committee or person if the amount exceeds the lending units authorized loan limit.\nCredit Review personnel, under the direction of the Credit Administrator, examine the loan portfolio regularly. Reports are made by the Senior Vice-President\/Credit Administrator to senior management and the Loan Committee, and follow-up corrective action is monitored. Problem loan reports are prepared for management review on a regular basis.\nCertain problem loans are placed on a nonaccrual basis in conformance with defined policy. The Loan Committee regularly reviews information reports on classified and delinquent loans. Comparative summaries of delinquent loans are also provided on a regular basis to senior management and to the Board of Directors.\nManagement closely monitors the adequacy of the loan loss reserve and an analysis is performed four times a year. The allowance is maintained at a level deemed sufficient to meet potential losses.\nThe reviews, examinations and actions described above are in addition to the periodic examinations by federal and state regulatory agencies, as well as the Bank's internal audit department and the Bank's outside public accounting firm.\nImpaired Assets (Previously referred to as Nonperforming Assets)\nLoans are placed in a nonaccrual status when, in the opinion of management, the collection of additional interest is doubtful, or when the loan becomes ninety (90) days past due in principal or interest. When a loan is placed on a nonaccrual status, all interest previously accrued but not collected is reversed and charged against interest income. Income on nonaccrual loans is then recognized only to the extent cash is received and where the future collection of principal is probable. Accruals are resumed only when the loan is brought current, or when, in the opinion of management, the borrower has demonstrated the ability to resume payments of principal and interest on a regular basis.\nThe dollar amount of loans placed in nonaccrual or past due 90 days or more as a percentage of total loans was .87%, .57% and .44% for year-end 1995, 1994 and 1993 respectively. These loans have a variety of situations, some of which may lead to foreclosure or involve a bankruptcy case. Others may continue payment as the borrower's financial situation improves. A very small amount represents federally insured loans. The rise at year end 1995 occurred primarily as a result of two particular borrowers which, together, constituted $4.0 million, or 91% of total nonaccruing loans. While these loans appear adequately secured by real estate, it was nonetheless felt prudent to place them in nonaccrual.\nManagement monitors these loans on a frequent basis and conducts aggressive collection efforts, unless constraints are placed on the Bank by the bankruptcy courts. These efforts are directed toward the best long-term results for the Bank, and to the extent reasonable, to the borrower as well.\nLoans past due 90 days or more and nonaccruing loans on which the accrual of interest has been discontinued as of December 31st are as follows:\n(In thousands)\nThere are certain amounts of interest collected on the above loans and included in income, and amounts that have not been accrued which are indicated in the table below:\nRestructured loans are those loans that had problems in the past, and a concession was made in the interest rate, principal amount, and\/or the repayment schedule has been modified to the extent that there has been tangible impairment of value. These loans are monitored on a regular basis for performance.\nThe recorded value of restructured loans at year-end for the last five years was insignificant, and therefore not shown.\nThe Bank originates commercial, commercial real estate, mortgage and installment loans primarily in Snohomish and north King Counties. Loan growth in 1995 was at a somewhat slower pace than previous years. Total loans as of December 31, 1995 and 1994 were $505.0 and $470.5 million, respectively. The percent of the growth in net loans for year-end 1995 was 7.2%, or an addition of $34.0 million in net loans during 1995.\nThe area's economy is diversified with trade, high-tech, military and service industries. Military personnel assigned to the new Everett Naval facility began arriving in the later part of 1995, and it is expected that continuing increases in personnel will serve to further diversify and stabilize the local economy. While management estimates that the loan portfolio is reasonably diversified, the quality of the portfolio is related to the strength and stability of real estate values which are controlled by the local economy.\nThe Boeing Company continues to be one of the major employers in Snohomish County. The labor strike in the fourth quarter of 1995 slowed retail sales growth during the time, but it would appear that this slowing and concerns over the past downsizing at Boeing were somewhat mitigated by the increased diversification of the local economy. However, concern still persists regarding the employment stability of Boeing, and, accordingly, management will continue to exercise caution in the execution of the Bank's lending activities.\nA concern on the national level is the continued negotiations on balancing the federal budget. The government shut downs in the last quarter 1995 combined with the uncertainty of reaching a compromise over the federal deficit may have adverse effects on the credit and equity markets, which could affect consumer and business confidence locally.\nOther Real Estate Owned\nAs of December 31, 1995, the Bank had four parcels of other real estate owned (OREO) on its books, which totaled $.6 million. One parcel is under a contingent earnest money agreement to purchase, and one other parcel is sold under the equivalent of the instalment sale method. The remaining two parcels are pending sale. No losses are expected on sales of OREO which are recorded at the lower of cost or fair value, less estimated costs to sell. No particular trends are noted at this time.\nThe table below shows the book value of OREO at December 31st:\nSummary of Loan Loss Experience\nThe following table provides an analysis of net losses by loan type for the last five years:\nIt is the policy of Frontier Financial Corporation and its subsidiary to charge-off any loan or portion of a loan that is deemed uncollectible in the ordinary course of business. The entire allowance for possible loan losses is available to absorb such charge-offs.\nIn the opinion of management, if a loan represents a long-term liquidation project, particularly when the liquidation is under the control of the bankruptcy courts, a decision may be made to write off the asset. Many charge-offs will ultimately have recoveries in full or significant part, and some are currently under repayment programs.\nFor fiscal year-end 1995, the Bank experienced the lowest level of net losses to average total loans in the last five years. This low level is attributed to the Bank's recoveries during 1995 of several significant charge-offs. All of the major dollar recoveries were from charge-offs that occurred in prior years.\nAs indicated by the chart showing the \"Summary of Loan Loss Experience\", the Bank has recovered a significant portion of its charged-off loans for fiscal years 1995 and 1994. The chart also indicates that the Bank's net charge-offs for fiscal years 1992 and 1993 were substantially higher. The higher level for those fiscal years is primarily attributed to loans acquired through acquisition.\nCharged-off loans that continue to be actively pursued for collection as of fiscal year-end 1995, total $3.4 million. While additional recoveries are expected, the amounts and timing cannot be determined with certainty.\nBased on certain characteristics of the portfolio, potential losses can be anticipated for major loan categories. In the following table, the allowance for possible loan losses at year-end, for the last five years, has been allocated among major loan categories based primarily on their historical net charge-off experience, along with consideration of factors such as quality, volume, anticipated economic conditions, and other business considerations.\nHistorical net charge-offs are not necessarily accurate indicators of future losses since net charge-offs vary from period to period due to economic conditions and other factors that cannot be accurately predicted. Thus, an evaluation based on historical loss experience of individual loan categories is only one of many factors considered by management in evaluating the adequacy of the overall allocation, and in determining the amount of the provision for possible loan losses. Other factors are the continuing level of nonperforming loans, credit concentrations, and uncertain economic conditions. At December 31, 1995, based on current economic conditions, the total of the allocation for possible loan losses is, in management's opinion, adequate to provide for future losses. However, a worsening of the economy in the Bank's market area could negatively affect loan performance and underlying collateral values. The full impact of such a trend on the condition of the Bank cannot be estimated.\nCredit Concentrations\nAt year-end 1995, 16.8% of the Bank's loan portfolio was in residential and commercial construction and land development projects centered in Snohomish and King Counties. Management has established a Real Estate Review Committee which meets periodically to monitor local economic conditions, and the performance of borrowers in this industry. The chart below indicates the amount of those loans, and as a percent of total loans for the period:\nDeposits\nFor the average amount of deposits and rates paid on such deposits for years ended December 31, 1995, 1994, and 1993 please refer to page 32 of Annual Report to Shareholders.\nMaturities of time certificates of deposit over $100,000 at year end 1995, are shown below:\nSignificant Financial Ratios\nRatios for the years ended December 31, 1995, 1994 and 1993 are as follows:\nBorrowings\nFor information regarding average balances and yields, please refer to page 32 of 1995 Annual Report to Shareholders.\nLong-Term Debt\nFor detailed information relating to long term debt, please refer to Note 9, page 15, of 1995 Annual Report to Shareholders.\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2 - PROPERTIES\nThe Bank's Evergreen Way Office (previously the Main Office) is a two story building constructed in 1979, and owned by the Bank. This building has approximately 13,000 square feet, and is fully utilized by the Bank.\nThe Bank's first branch, the Downtown Everett Office, opened in 1980 in rented facilities at 2831 Wetmore Ave, was relocated in 1994 one block from its previous location. FFP, Inc. has entered into a long term lease with a director of the Bank who owns the property located at 2831 Colby Ave. The Bank utilizes 12,000 square feet, all of the main floor of the building.\nThe Bank owns the Arlington Office premises which consists of a single story building with approximately 3,000 square feet. Contiguous to the Arlington Office is a parcel of land on which five apartments are located. The Bank owns these apartments. The Arlington Office was acquired through merger with The Bank of Arlington in August, 1982. The Bank of Arlington had one office.\nFFC owned the property previously occupied by the Trust Department, Private Banking, and the Insurance & Investment Center, located at 2612 Wetmore Avenue, Everett, Washington. In 1994, these departments combined operations in the new facility located at 2831 Colby with the Downtown Everett Office. The property at 2612 Wetmore has been disposed of. In September 1985, a drive-up facility was constructed on this site to serve the Downtown Everett community, and will remain in operation at the same location.\nFFP owns property in Snohomish, which is rented by the Bank for its Snohomish Office. There are also eight apartments on the property. Currently a mobile banking facility is being utilized by the Bank. In the second quarter of 1996, the construction of a permanent building will begin which will occupy most all of the property. Completion is expected by September 1996. All of the new facility will be occupied by the Bank.\nFFP, Inc. owns the property in Lynnwood, which is rented by the Bank for its Lynnwood Office. The office opened for business in June 1988, and has approximately 3,200 square feet. The office is located on Highway 99, which is heavily traveled.\nThe South Point Office of the Bank has been relocated approximately 100 yards from its previous location, and renamed the Main Office of the Bank. This office is now located on the ground floor of the financial center constructed in 1993 (please see next page).\nThe Bank acquired the Marysville Office by merger with Citizens Bank of Snohomish County in August 1989. This building has approximately 5,000 square feet, and is fully utilized by the Bank. On the same property are two buildings, which are presently rented to other business concerns. The Bank owns the land and the buildings.\nThe Smokey Point Office was also added to the branch network by the same merger in August 1989. This office was relocated within a few blocks of the original site in June 1995. FFP owns the land and building and leases it to the Bank. The office has 3,500 square feet and is fully utilized by the Bank.\nThe Bank also acquired its Lake Stevens Office by the same merger. The Bank owns the building, but leases the land from nonaffiliates. The building is a mobile facility type construction, and has 1,800 square feet, which is fully utilized by the Bank.\nThe Bank's Mill Creek Office is located approximately five miles east of Lynnwood, Washington. The office was opened in January 1991, and has 2,600 square feet, all being utilized by the Bank. The property and building are leased from nonaffiliates.\nIn July 1992, the Bank opened its Stanwood Office in leased quarters. In 1994, FFP constructed a new facility in the immediate area, on land purchased. The building has 3,500 square feet, and is fully utilized by the Bank.\nIn November 1992, the Bank acquired its Edmonds Office by merger with Edmonds National Bank. This building has approximately 11,300 square feet and is fully utilized by the Bank. The land is being leased by the Bank from nonaffiliates, but the Bank owns the building.\nIn May 1993, FFP completed construction of a financial center in south Everett, to house the Main Office of the Bank and the Executive Offices of the Corporation. The three story building has approximately 42,100 square feet and is fully utilized by the Bank and Corporation. The building houses all of the operations functions of the Bank, including the data processing center and the real estate loan center.\nIn July 1993, the Bank acquired the Bothell Office through merger with The Bank of Northshore. This office, previously the Main Office of the Bank of Northshore, has approximately 1,800 square feet, and is fully utilized by the Bank. Both the land and building are owned by the Bank.\nThe Bank acquired its Woodinville Office through the same merger. This office has approximately 1,300 square feet, and is one of three suites in an office building. The Bank is renting the office from nonaffiliates.\nIn 1994, FFP purchased property located at 201 West Main St. in Monroe, Washington. This property is leased to the Bank for its Monroe Office which was opened in June 1995. The building has 3,500 square feet, and is fully utilized by the Bank.\nAs of December 31, 1995, the Bank had sixteen branch offices, including the Main Office.\nITEM 3","section_3":"ITEM 3 - LEGAL PROCEEDINGS\nThere are no material legal proceedings.\nITEM 4","section_4":"ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matters were submitted to security holders during the fourth quarter of 1995.\nPART II\nITEM 5","section_5":"ITEM 5 - MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nPlease see 1995 Annual Report to Shareholders, page 30 and 31.\nITEM 6","section_6":"ITEM 6 - SELECTED FINANCIAL DATA (In thousands, except per share data)\nFINANCIAL HIGHLIGHTS\nNM=Not Meaningful\nITEM 7","section_7":"ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nPlease see 1995 Annual Report to Shareholders, pages 23 through 33.\nITEM 8","section_7A":"","section_8":"ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nITEM 9","section_9":"ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10","section_9A":"","section_9B":"","section_10":"ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF FRONTIER FINANCIAL CORPORATION\nPlease see pages 3 thru 6 of 1996 Proxy Statement.\nITEM 11","section_11":"ITEM 11 - EXECUTIVE COMPENSATION\nPlease see pages 6 thru 8 of 1996 Proxy Statement.\nITEM 12","section_12":"ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nPlease see page 5 of 1996 proxy statement.\nITEM 13","section_13":"ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nPlease see page 8 of 1996 Proxy Statement; and, Note 13, page 18 of 1995 Annual Report to Shareholders; and Page 22 of this Form 10-K report.\nPART IV\nITEM 14","section_14":"ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) The following documents are filed as part of the report:\n1. Financial Statements.\nFinancial statements required by Item 8 of this report are incorporated by reference, from the Annual Report to Shareholders, attached hereto as an exhibit.\n2. Financial Statement Schedules.\nAdditional financial statement schedules filed with this report are included in Item 14(d) and are as follows:\nSchedule I - Amounts Receivable from Certain Persons\nSchedules other than those listed above are omitted because of the absence of the condition under which they are required or because the information called for is included in the financial statements or notes thereto.\n3. Exhibits.\n(3) Articles of Incorporation and By-Laws are incorporated herein by reference to Exhibits 3(a) and 3(b) to Registration on Form S-14, File No. 2-82420.\n(11) Statement Regarding Computation of Earnings Per Share.\n(13) Annual Report to Shareholders for the year ended December 31, 1995. (Pages 1 to 33, inclusive)\n(21) Subsidiaries of Registrant is incorporated by reference from Part I, page 1 thru 5 of this report.\n(27) Financial Data Schedule (This exhibit is included only in the electronic EDGAR filing version of this Form 10-K. The Financial Data Schedule is not a separate financial statement, but a schedule that summarizes certain standard financial information extracted directly from the financial statements in this filing.)\n(b) Reports on Form 8-K:\nNo Form 8-K's were filed, nor required to be filed for any event during the fourth quarter ended December 31, 1995.\n(c) Exhibits - See list of exhibits set forth above at Item 14(a)3.\n(d) Financial Statement Schedules:\nSchedules required to be filed in response to this portion of Item 14 are listed above in Item 14(a)1 and 2. The report of independent public accountants covering these items is included on page 23 of this Form 10-K.\nSCHEDULE I\nFRONTIER FINANCIAL CORPORATION AND SUBSIDIARIES\nAMOUNTS RECEIVABLE FROM CERTAIN PERSONS\nMOSS ADAMS LLP\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Board of Directors and Shareholders Frontier Financial Corporation\nWe have audited the consolidated financial statements and related financial statement schedules of Frontier Financial Corporation and subsidiaries listed in item 14 (a) 1 and 2 of the Annual Report on Form 10-K of Frontier Financial Corporation for the year ended December 31, 1995. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Frontier Financial Corporation and subsidiaries as of December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles. 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 the information required to be included therein.\nAs discussed in Note 1 to the financial statements, in 1994 the Corporation changed its method of accounting for investment securities.\n\/s\/ MOSS ADAMS LLP\nEverett, Washington January 22, 1996\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nFRONTIER FINANCIAL CORPORATION\nMarch 20, 1996 \/s\/ Robert J. Dickson Date ---------------------------------------- Robert J. Dickson President & Chief Executive Officer\nMarch 20, 1996 \/s\/ James F. Felicetty Date ---------------------------------------- James F. Felicetty Secretary\/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:\nMarch 20, 1996 \/s\/ Robert J. Dickson ---------------------------------------- Robert J. Dickson, Director\nMarch 20, 1996 \/s\/ David A. Dujardin ---------------------------------------- David A. Dujardin, Director\nMarch 20, 1996 \/s\/ Edward D. Hansen ---------------------------------------- Edward D. Hansen, Director\nMarch 20, 1996 \/s\/ William H. Lucas ---------------------------------------- William H. Lucas, Director\nMarch 20, 1996 \/s\/ James H. Mulligan ---------------------------------------- James H. Mulligan, Director\nMarch 20, 1996 \/s\/ Alwyn L. Nelson --------------------------------------- Alwyn L. Nelson, Director\nMarch 20, 1996 \/s\/ Edward J. Novack ---------------------------------------- Edward J. Novack, Secretary of the Board\nMarch 20, 1996 \/s\/ J. Donald Regan ---------------------------------------- J. Donald Regan, Director\nMarch 20, 1996 \/s\/ Roger L. Rice ---------------------------------------- Roger L. Rice, Director\n---------------------------------------- Roy A. Robinson, Director\nMarch 20, 1996 \/s\/ William J. Robinson ---------------------------------------- William J. Robinson, Director\nMarch 20, 1996 \/s\/ Edward C. Rubatino ---------------------------------------- Edward C. Rubatino, Chairman of the Board\nMarch 20, 1996 \/s\/ Arthur W. Skotdal ---------------------------------------- Arthur W. Skotdal, Director\nEXHIBIT INDEX\nEXHIBIT NUMBER - ------- 11 Computation of Earnings Per Share.\n13 Frontier Financial Corporation and Subsidiaries 1995 Annual Report to Shareholders","section_15":""}
{"filename":"4977_1995.txt","cik":"4977","year":"1995","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 1994, AFLAC transferred 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 13-19 (Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A)) and page 13-32 (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 operates principally in the United States and 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, supplemental general medical expense plans and a living benefit life plan. 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, and several U.S. territories and foreign countries. The Company's only significant foreign operation is AFLAC Japan, which accounted for 85% of the Company's total revenues in 1995.\nOn February 13, 1996, the board of directors declared a three-for-two stock split to shareholders of record as of February 29, 1996, payable on March 18, 1996. Share and per-share amounts have been adjusted to reflect this split.\nInsurance premiums and investment income from insurance operations are the major sources of revenues. The Company's consolidated premium income was $6.1 billion for 1995, $5.2 billion for 1994 and $4.2 billion for 1993.\nI-1\nThe following table sets forth consolidated premiums earned by class offered by AFLAC in Japan and the United States for the three years ended December 31.\n(In thousands) 1995 1994 1993 ---------- ---------- ---------- Premiums earned: Health insurance $ 6,037,206 $ 5,148,406 $ 4,192,259 Life and other insurance 17,937 15,149 14,488 ---------- ---------- ---------- Total U.S. and Japan premiums earned $ 6,055,143 $ 5,163,555 $ 4,206,747 ========== ========== ==========\nThe following table sets forth the changes in annualized premiums in force for AFLAC health insurance for the years ended December 31.\n(In thousands) 1995 1994 1993 ---------- ---------- ---------- Annualized premiums in force, at beginning of year $ 5,578,987 $ 4,460,076 $ 3,628,961 New issues including policy conversions 965,321 922,773 801,937 Change in unprocessed policies (107,287) 212,058 154,684 Lapses and surrenders (408,366) (347,020) (302,690) Other (11,676) (129,932) (143,432) Foreign currency translation adjustment (179,096) 461,032 320,616 ---------- ---------- ---------- Annualized premiums in force, at end of year $ 5,837,883 $ 5,578,987 $ 4,460,076 ========== ========== ==========\nINVESTMENTS AND INVESTMENT RESULTS\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 $2.6 billion and $820.9 million at December 31, 1995 and 1994, respectively. For additional information regarding SFAS No. 115, see Exhibit 13, page 13-34 (Note 3 of Notes to the Consolidated Financial Statements).\nThe Company's investments (including cash) were $20.0 billion at December 31, 1995. Since December 31, 1994, total investments, including unrealized gains on fixed-maturity securities, increased $4.1 billion, or 25.3%. AFLAC Japan investments increased $3.6 billion (24.7%), while AFLAC U.S. investments increased $416.3 million (33.1%). Since December 31, 1994, total investments, excluding unrealized gains on fixed-maturity securities,\nI-2\nhave increased $2.3 billion, or 15.2%. AFLAC Japan investments increased $2.0 billion (14.7%), while AFLAC U.S. investments increased $265.4 million (20.3%). Net investment income of $1.0 billion in 1995 continued to be a growing source of revenues and earnings for the Company, increasing $186.1 million in 1995 over 1994 and $149.6 million in 1994 over 1993. It is generally AFLAC's policy to invest in high-grade investments, principally in government, and high-quality 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 investment strategy. The Company has streamlined and integrated the organizational structure of investment operations into a single functional unit and has set specific worldwide criteria regarding credit quality, liquidity, compliance with regulatory requirements and conformance to product needs.\nINVESTMENTS - JAPAN\nDuring 1995, 90.3% of AFLAC Japan's yen cash flow available for investment was allocated to yen-denominated fixed-maturity securities, while the remaining 9.7% was invested in dollar-denominated securities. Of the total amount invested in yen-denominated securities in 1995, 26.0% was invested in Japanese government bonds at a yield of 3.84%, 33.7% was invested in the longer-dated private sector at a rate of 5.07%, 6.0% was invested in municipal bonds at a rate of 3.95%, and the remaining 24.6% was invested in assorted sectors of yen-denominated fixed-maturity securities at an average rate of 4.19%.\nAt year-end 1995, Japanese government bonds accounted for 37.7% of AFLAC Japan's total investments (at amortized cost). 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 1995, which provide a better match of asset and liability durations, and these instruments accounted for 20.3% of total investments in Japan at year-end. At the end of the year, municipal securities represented 5.3% of the total investments, while utility bonds represented 18.1%. Other assorted sectors accounted for 11.1%, and dollar-denominated securities represented 7.5% of AFLAC Japan's total investments.\nThe Company increased its commitment to the dollar-denominated portfolio of AFLAC Japan's invested assets during 1995. AFLAC Japan added $307.9 million to this portfolio at an average yield of 7.55%. AFLAC Japan's dollar-denominated portfolio represented 7.5% of total investments in Japan, or $1.3 billion at the end of 1995, compared with $951.3 million at the end of 1994. Investments in dollar-denominated fixed-maturity securities provide certain tax and yield advantages to the Company.\nThe Company continued to avoid the Japanese equity and investment real estate markets in 1995. AFLAC Japan's equity portfolio accounted for only .1% of invested assets at year-end, and the Company does not expect this\nI-3\nportion to increase in 1996. 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 total investments at year-end.\nINVESTMENTS - U.S.\nProfits repatriated from AFLAC Japan to AFLAC U.S. totaled $140.5 million in 1995, up from $132.9 million in 1994. Of the $140.5 million in 1995, $21.2 million was transferred to the Parent Company. 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 future profit repatriation to continue to have a positive impact on its consolidated net earnings.\nAFLAC U.S. continued to focus on purchasing securities that emphasize safety and liquidity. AFLAC U.S. maintained its overall investment quality throughout the year. Almost half of the fixed-maturity portfolio was rated \"AA\" or better at the end of the year.\nIncluding profit repatriation, AFLAC U.S. invested $660.7 million in 1995. Of that amount, approximately 46.3% was invested in U.S. government or agency securities at an average yield to maturity of 7.82%, 42.4% was invested in corporate fixed-maturity securities at 7.66%, and 5.1% was allocated to various other sectors at an average yield of 7.17%. We also added approximately $41.1 million, or 6.2% of total funds available for investment, to the AFLAC U.S. equity portfolio.\nAt the end of 1995, fixed-maturity securities continued to dominate AFLAC U.S. total investments. Fixed-maturity securities represented 85.0% of total investments at the end of the year. Within that category, U.S. government and agency securities accounted for 17.7% of the holdings, while corporate securities were 58.9%. Equity investments made up 5.7% of total investments. 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 13-15 to 13-19 (discussions relating to Balance Sheet and Cash Flow) and pages 13-34 to 13-41 (Notes 3 and 4 of Notes to the Consolidated Financial Statements), which are incorporated herein by reference.\nINSURANCE - JAPAN\nThe following table sets forth AFLAC Japan's premiums earned by product line for the last three years ended December 31.\n(In thousands) 1995 1994 1993 ---------- ---------- ---------- Premiums earned: Cancer expense $ 4,752,338 $ 4,054,697 $ 3,259,705 Other accident and health 440,635 316,395 224,555 Life insurance 2,378 - - ---------- ---------- ---------- Total AFLAC Japan premiums earned $ 5,195,351 $ 4,371,092 $ 3,484,260 ========== ========== ========== I-4\nThe following table sets forth the changes in annualized premiums in force for AFLAC Japan health insurance for the years ended December 31:\n(In thousands) 1995 1994 1993 ---------- ---------- ---------- Annualized premiums in force, at beginning of year $ 4,718,783 $ 3,672,594 $ 2,914,428 New issues including policy conversions 690,170 680,879 576,127 Change in unprocessed policies (105,496) 209,392 157,142 Lapses and surrenders (200,507) (163,047) (145,567) Other (23,075) (142,067) (150,152) Foreign currency translation adjustment (179,096) 461,032 320,616 ---------- ---------- ---------- Annualized premiums in force, at end of year $ 4,900,779 $ 4,718,783 $ 3,672,594 ========== ========== ==========\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 insurance 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 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).\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. This plan is offered with several riders, providing death benefits 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.\nIn 1995, the Company introduced two other products in Japan. The first product is an improved medical expense policy. It is similar to hospital indemnity insurance products in the United States and provides cash benefits to policyholders when they are hospitalized. The market for medical expense coverage in Japan is very competitive, but the Company believes the revised policy will give AFLAC Japan's agents greater flexibility in product offerings.\nAFLAC Japan also introduced a new living benefit life plan. This product is a life insurance policy that provides lump-sum benefits when policyholders experience heart attack, cancer or stroke. The Company is offering this product in two forms - as a stand-alone policy or as a rider to the cancer plan. Marketing efforts for living benefit life primarily focus on the sale of the rider. Introduction of the rider began in late\nI-5\n1995. AFLAC Japan sold more than 406,000 living benefit life riders in the last four months of the year. Sales of the rider for the year exceeded $77 million in new annualized premium. The Company anticipates very strong results from this new product in 1996, its first full year of availability.\nDue to the continued low level of available investment yields in Japan, the Ministry of Finance has permitted insurers to increase premium rates on new policy issues in recent years. AFLAC Japan increased premium rates by an average of 16% on all cancer policy sales made after July 1, 1994. Premium rates on care policy new issues were increased by an average of 10% in both November 1993 and 1995. As a result of continuing low yields, the Company expects to increase premium rates on all new policy issues by an additional 10% beginning in the second half of 1996.\nAGENCY FORCE - JAPAN\nThe development of a \"corporate agency\" system has been important to the growth of AFLAC Japan. Affiliated corporate agencies are formed when companies establish subsidiary businesses to sell AFLAC products to their employees, suppliers and customers. These agencies help AFLAC Japan reach the employees of almost all of Japan's large corporations. AFLAC has no ownership interest in these corporate agencies.\nAFLAC products are also sold through independent corporate agencies and individual agencies that are not affiliated with large companies. At December 31, 1995, there were 5,224 agencies in Japan with 20,375 licensed agents. Agents' activities are principally limited to insurance sales, with policyholder service functions handled by the main office in Tokyo and 47 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, unique marketing system (see Agency Force), low-cost operations and product expertise developed in the United States. AFLAC has been very successful in the sale of cancer expense policies in Japan, with over 12.2 million cancer policies in force at December 31, 1995.\nDuring 1994, the governments of Japan and the United States held a series of trade talks. The U.S.-Japan Framework Agreement negotiations discussed 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 Japanese insurers, operate in the third sector.\nI-6\nIn 1996, the Japanese government will adopt a framework for long-term deregulation of the financial services businesses in Japan. The principles upon which deregulation of the Japanese insurance industry is based are: to promote competition and to enhance efficiency through deregulation and liberalization; to preserve soundness; and to secure fairness and equity in business operations. As Japan begins gradually deregulating the insurance industry, the marketplace should become more competitive; however, the ultimate changes and their effects on AFLAC Japan are not presently determinable. But, due to the Company's unique marketing distribution system and low-cost operations in Japan, AFLAC believes it should not be directly affected by deregulation in Japan in the immediate future.\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.\nREGULATION AND REMITTANCE OF FUNDS - JAPAN\nPayments are made from AFLAC Japan to the Parent Company for management fees, and to AFLAC U.S. for allocated expenses and remittances of earnings. These payments totaled $179.5 million in 1995, $167.9 million in 1994 and $133.4 million in 1993. Management fees paid to the Parent Company are largely based on expense allocations.\nA portion of AFLAC Japan annual earnings, as determined on a Japan statutory accounting basis, can be remitted each year to AFLAC U.S. after satisfying various conditions imposed by Japanese regulatory authorities for protecting policyholders and obtaining remittance approvals from such authorities. These conditions include compliance with risk-based capital guidelines for Japanese insurers. Profit remittances to the United States can fluctuate due to changes in the amounts of Japanese regulatory earnings. Among other items, factors affecting regulatory earnings include Japanese regulatory accounting practices and fluctuations in currency translations of AFLAC Japan's U.S. dollar-denominated investments into yen. 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.\nJapan statutory accounting practices differ in many respects from U.S. generally accepted accounting principles. Under Japan statutory accounting practices, policy acquisition costs are charged off immediately, policy benefit and claim reserving methods are different, deferred income tax liabilities are not recognized, and investment securities are generally carried at cost.\nAs part of the deregulation process, the Japanese Ministry of Finance (MOF) is developing new solvency regulations and standards that represent a form of risk-based capital requirements. AFLAC Japan must meet these\nI-7\nrequirements 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 to adversely affect the repatriation of funds from Japan in the foreseeable future.\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 pages I-12 and I-13 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:\n(In thousands - unaudited) 1995 1994 ---------- ---------- Net assets on GAAP basis $ 1,817,106 $ 1,564,938 Elimination of deferred policy acquisition costs (2,067,409) (1,951,549) Reduction in carrying value of fixed- maturity investments for fair value and foreign exchange adjustments (2,613,600) (978,855) Adjustment to policy liabilities 2,205,072 500,952 Elimination of deferred income taxes 1,211,187 1,223,368 Reduction in premiums receivable (237,929) (227,270) Other, net 98,378 97,041 ---------- --------- Net assets on Japanese regulatory accounting basis $ 412,805 $ 228,625 ========== =========\nFor additional information regarding AFLAC Japan's operations, see Exhibit 13, pages 13-8 to 13-11 (AFLAC Japan section of MD&A) and pages 13- 32 and 13-50 (Notes 2 and 10 of Notes to the Consolidated Financial Statements), which are incorporated herein by reference.\nEMPLOYEES - JAPAN\nAFLAC Japan employed 1,571 full-time and 157 part-time employees at December 31, 1995. AFLAC Japan considers its employee relations to be excellent.\nI-8\nINSURANCE - U.S.\nThe following table sets forth AFLAC U.S. premiums earned by product line for the last three years ended December 31.\n(In thousands) 1995 1994 1993 -------- -------- -------- Premiums earned: Cancer expense $ 402,789 $ 384,943 $ 369,256 Other accident and health 441,444 392,371 338,743 Life insurance 15,559 15,149 14,488 -------- -------- -------- Total AFLAC U.S. premiums earned $ 859,792 $ 792,463 $ 722,487 ======== ======== ========\nThe following table sets forth the changes in annualized premiums in force for AFLAC U.S. health insurance for the years ended December 31.\n(In thousands) 1995 1994 1993 --------- --------- --------- Annualized premiums in force, at beginning of year $ 860,204 $ 787,482 $ 714,533 New issues including policy conversions 275,151 241,894 225,810 Change in unprocessed policies (1,791) 2,666 (2,458) Lapses (207,859) (183,973) (157,123) Other 11,399 12,135 6,720 --------- --------- --------- Annualized premiums in force, at end of year $ 937,104 $ 860,204 $ 787,482 ========= ========= =========\nHEALTH INSURANCE PLANS - U.S.\nAFLAC's insurance is supplemental in nature and is designed for people who already have major medical or primary insurance 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, statewide 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 four different cancer plans in the United States that vary by benefit amount and type. All four 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, surgery and a \"wellness\" benefit applicable toward certain diagnostic tests such as mammograms, pap smears, flexible sigmoidoscopy, etc. Two of the plans currently offered contain benefits that reimburse the insured for nursing services, anesthesia, prosthesis, blood, plasma, second\nI-9\nsurgical opinion, ambulance, transportation, family lodging, extended care facility, bone marrow transplant and hospice. The remaining two plans make these benefits available as an optional schedule of benefits rider. AFLAC also issues several riders, including one that increases the amount of the first occurrence benefit on each rider anniversary date until the covered person reaches age 65 or until internal cancer is diagnosed. AFLAC periodically introduces new forms of coverage, revising benefits and related premiums based upon the anticipated needs of the policyholders and AFLAC's claim experience.\nAFLAC offers an accident and disability policy to protect against losses resulting from accidents. The accident portion of the policy includes lump sum benefits for accidental death, dismemberment and specific injuries. Fixed benefits for hospital confinement, emergency treatment, follow-up treatments, ambulance, transportation, family lodging, wellness, prosthesis, medical appliances and physical therapy are also provided. Optional disability riders are available to the primary insured only and include choices of a sickness disability rider, on-the-job disability rider and off-the-job disability rider. These benefits are payable up to a maximum benefit period of one year and for one disability at a time.\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 and 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, 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.\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 1995 monthly average number of U.S. agents actively producing business was 6,121, compared with 5,489 in 1994 and 5,110 in 1993.\nI-10\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 in the payroll market, with premiums generally paid by the employee. 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 this method lowers distribution costs.\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.\nDuring 1995 and 1994, 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 1995, AFLAC's U.S. premiums collected were $846.4 million, 7.1% of which was collected in Florida, 6.8% in both Georgia and Texas, 5.6% 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\nI-11\nand 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. Conversely, any reduction of coverages, such as increased deductibles and copayments, by other insurers or governmental programs could favorably affect AFLAC's business opportunities.\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 13-12 to 13-14 (AFLAC U.S. section of MD&A), 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\nI-12\nregulatory authorities, and periodic examinations of the financial, market conduct, and other affairs of insurance companies. In addition, the National Association of Insurance Commissioners (NAIC) is currently working on regulatory initiatives relating to investments, reinsurance, dividend restrictions, revision of the risk-based capital formula, recodification of statutory accounting principles and other related matters.\nFor further information concerning state regulatory and dividend restrictions, see Exhibit 13, page 13-50 (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 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.\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. AFLAC's NAIC risk-based capital ratio continues to reflect a very strong statutory capital and surplus position.\nCurrently, four states have laws, regulations or regulatory practices that either prohibit the sale of specified 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.\nI-13\nThe Company continues to monitor developments concerning possible changes to the U.S. health care system at both the federal and state levels. The future of health care changes and its impact on AFLAC U.S. cannot be readily predicted at this time.\nEMPLOYEES - U.S.\nIn its U.S. insurance operations, the Company employed 1,613 full-time and 39 part-time employees at December 31, 1995. The Company considers its employee relations to be excellent.\nOTHER OPERATIONS\nAt December 31, 1995, the AFLAC Broadcast Division operated seven network-affiliated television stations with total assets of $159.6 million. The Broadcast Division employed 554 full-time and 123 part-time employees at December 31, 1995. The Broadcast Division considers its employee relations to be excellent.\nThe Broadcast Division produced increased revenues and earnings during 1995 as compared with 1994. Revenues increased 5.1%, to $81.6 million. Pretax earnings before interest expense rose 10.4%, to $19.0 million. Stations benefited from advertising related to 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 (Other Operations section of MD&A), which is incorporated herein by reference.\nThe Company's other operations employed 332 full-time and four part- time employees at December 31, 1995; 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 administrative office buildings located nearby. AFLAC New York also occupies leased office space in Albany, New York.\nIn Tokyo, Japan, AFLAC owns an 11-story administrative office building, which was completed in April 1994. AFLAC also leases office space in Tokyo,\nI-14\nalong with regional sales offices located throughout the country, and owns a training and computer facility in Tokyo. For further information concerning the building in Japan, see Exhibit 13, pages 13-18, (discussion concerning cash flow) and 13-55 (Note 12 of Notes to the Consolidated Financial Statements), which are incorporated herein by reference. Other foreign affiliates of the Company also occupy leased office space.\nThe Broadcast Division owns land, buildings, transmission towers and other broadcast equipment in the cities where its seven television stations are located.\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. Some of this litigation is pending in Alabama, where large punitive damages bearing little relation to the actual damages sustained by plaintiffs have been awarded against other companies, including insurers, in recent years. During 1995, the Company settled certain litigation in Alabama related to an ancillary line of business. However, the settlement was not material to the Company's consolidated net earnings for the year. Although the final results of any litigation cannot be predicted with certainty, the Company believes the outcome of the litigation still pending will 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\nThere were no matters submitted to the security holders for a vote in the fourth quarter ended December 31, 1995.\nI-15\nITEM 4A. EXECUTIVE OFFICERS OF THE COMPANY NAME PRINCIPAL OCCUPATION (*) AGE - ------------------- ------------------------------------- --- Daniel P. Amos Chief Executive Officer of the 44 Company and AFLAC, Vice Chairman of the Company; President of the Company since August 1991\nPaul S. Amos Chairman of the Board of the Company 69 and AFLAC.\nWilliam J. Bugg, Jr. Senior Vice President, Corporate 56 Actuary of AFLAC\nMonthon Chuaychoo Vice President, Financial Services, of 52 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 48 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, 47 of the Company and AFLAC since August 1993; Vice President and Controller of the Company until August 1993, and of AFLAC from June 1991 to August 1993\nNorman P. Foster Executive Vice President, Corporate 61 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\nI-16\nDavid Halmrast Senior Vice President, Corporate 56 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\nKenneth S. Janke Jr. Senior Vice President, Investor 37 Relations, of the Company since August 1993; Vice President, Investor Relations, of the Company until August\nAkitoshi Kan Senior Vice President, AFLAC Japan, 48 Accounting, Corporate Planning, Audit, and Legal Affairs since January 1995; Vice President, AFLAC Japan Accounting Department, from 1992 through 1994; Manager, AFLAC Japan, Accounting Department, until 1992\nKyoichi Kasuya Vice President, Chief Actuary, AFLAC 58 Japan, since 1992; General Manager, AFLAC Japan, Actuarial Department, until 1992\nNobuo Kawamura Senior Vice President, AFLAC Japan, 51 Underwriting, Policy Maintenance, Premium Accounting, Customer Service, Administration Support since January 1992; Deputy Director of Marketing, AFLAC Japan, until 1992\nJoseph P. Kuechenmeister Senior Vice President, Director 54 of Marketing of AFLAC\nJoey M. Loudermilk Senior Vice President, General Counsel 42 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 until May 1992\nI-17\nHidefumi Matsui President, AFLAC Japan, since January 51 1995, Executive Vice President of AFLAC Japan, from January 1992 to 1995; Senior Vice President, Director of Marketing, AFLAC Japan, until January 1992\nMinoru Nakai President of AFLAC International, Inc., 54 since October 1991; Senior Vice President, U.S.-Japan Operations, of AFLAC, until October 1991\nYoshiki Otake Chairman, AFLAC Japan, since January 56 1995, Vice Chairman of AFLAC International Inc., since October 1991, President of AFLAC Japan from October 1991 until 1995; Executive Vice President of AFLAC from January 1991 until October 1991\nThomas L. Paul President of AFLAC Broadcast Group, Inc.; 66 Vice President, Corporate Development, of the Company until 1993\nE. Stephen Purdom Executive Vice President of AFLAC since 48 October 1994; Senior Vice President, Medical Director of AFLAC until October 1994, and also Medical Director, Columbus Clinic, Columbus, GA until September 1994\nTsuneo Shioiri Senior Vice President, Director of Sales 57 Administration, AFLAC Japan, since January 1992; Deputy Director of Marketing, AFLAC Japan, until 1992\nJoseph W. Smith, Jr. Senior Vice President, Chief Investment 42 Officer of AFLAC since August 1991; Senior Vice President, Investments of AFLAC, until August 1991\nGary L. Stegman Senior Vice President, Assistant Chief 46 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. I-18\nPART II\nPursuant to General Instruction G to Form 10-K, Items 5 through 8 are incorporated by reference from the Company's 1995 Annual Report to Shareholders, the appropriate sections of which are included herein as Exhibit 13. Exhibit 13 Annual Report Pages Pages __________ _____________\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE COMPANY'S COMMON 13-1; 13-2; 1; 24; EQUITY AND RELATED SHAREHOLDER 13-48 46 (Note 9); MATTERS (Note 9) and 50\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 13-19 AND RESULTS OF OPERATIONS\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND 13-20 to 34 - 50 SUPPLEMENTARY DATA 13-58\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 1996 Annual Meeting of Shareholders, which was filed with the Securities and Exchange Commission on March 1, 1996, 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 18 - 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 Page(s) ----------- Included 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 13-20 - each of the years in the three-year 13-21 period ended December 31, 1995 Consolidated Balance Sheets, at December 13-22 - 31, 1995 and 1994 13-23 Consolidated Statements of Shareholders' 13-24 - Equity, for each of the years in the 13-25 three-year period ended December 31, Consolidated Statements of Cash Flows, 13-26 - for each of the years in the three-year 13-27 period ended December 31, 1995 Notes to the Consolidated Financial 13-28 to Statements 13-55 Report of Independent Auditors 13-57\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, 1995 Schedule II - Condensed Financial Information of IV-7 - Registrant, at December 31, 1995 IV-11 and 1994 and for each of the years in the three-year period ended December 31, 1995 Schedule IV - Reinsurance, for each of the IV-12 years in the three-year period ended December 31, 1995\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. 10.1.2* - AFLAC Incorporated Amended 1985 Stock Option Plan, as amended August 8, 1995 - incorporated by reference from Form 10-Q for September 30, 1995, Commission file number 1-7434, Accession No. 0000004977-95-000023, Exhibit 10. 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 - incorporated by reference from 1994 Form 10-K, Commission file number 1-7434, Accession No. 0000004977-95-000006, Exhibit 10.3.1. 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 - incorporated by reference from 1994 Form 10-K, Commission file number 1-7434, Accession No. 0000004977-95-000006, Exhibit 10.5.\nIV-2\n10.6* - 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. 10.8* - American Family Life Assurance Company of Columbus Employment Agreement with Hidefumi Matsui, dated January 1, 1995 - incorporated by reference from 1994 Form 10-K, Commission file number 1-7434, Accession No. 0000004977-95-000006, Exhibit 10.8. 10.9* - American Family Life Assurance Company of Columbus Employment Agreement with Dr. E. Stephen Purdom, dated October 25, 1994 - incorporated by reference from 1994 Form 10-K, Commission file number 1-7434, Accession No. 0000004977-95-000006, Exhibit 10.9. 10.10* - AFLAC Incorporated Employment Agreement with Paul S. Amos, dated August 1, 1995 - incorporated by reference from form 10-Q for September 30, 1995, Commission file number 1-7434, Accession No. 0000004977-95-000023, Exhibit 10.1. 13.0 - Selected information from the AFLAC Incorporated Annual Report to Shareholders for 1995. 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. 23.3 - Consent of independent auditor, KPMG Peat Marwick LLP, to Form S-3 Registration Statement No. 33-64535 with respect to the AFL Stock 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*Management contract or compensatory plan or agreement.\n(b) REPORTS ON FORM 8-K\nThere were no reports filed on Form 8-K for the quarter ended December 31, 1995.\nIV-3\n(c) EXHIBITS FILED WITH CURRENT FORM 10-K\n13.0 - Selected information from the AFLAC Incorporated Annual Report to Shareholders for 1995. 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. 23.3 - Consent of independent auditor, KPMG Peat Marwick LLP, to Form S-3 Registration Statement No. 33-64535 with respect to the AFL Stock Plan. 27.0 - Financial Data Schedule (electronic filing only).\nIV-4\nINDEPENDENT AUDITORS' REPORT ON FINANCIAL STATEMENT SCHEDULES\nThe Shareholders and Board of Directors AFLAC Incorporated:\nUnder date of January 29, 1996, we reported on the consolidated balance sheets of AFLAC Incorporated and subsidiaries as of December 31, 1995 and 1994, 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, 1995, as contained in the 1995 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 1995. 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 29, 1996\nIV-5\nSCHEDULE I AFLAC INCORPORATED AND SUBSIDIARIES Summary of Investments - Other than Investments in Related Parties December 31, 1995\n(In thousands) Amount in Fair Balance Type of Investment Cost Value Sheet ----------------------- ----------- ----------- ---------- Securities available for sale: Fixed maturities: Bonds: United States Government and government agencies and authorities $ 497,357 $ 519,761 $ 519,761 States, municipalities and political subdivisions 872,673 962,966 962,966 Foreign governments 6,809,934 8,201,769 8,201,769 Public utilities 3,272,635 3,735,385 3,735,385 Convertibles 29,749 33,465 33,465 All other corporate bonds 5,622,395 6,221,660 6,221,660 ---------- ---------- ---------- Total fixed maturities available for sale 17,104,743 19,675,006 19,675,006 ---------- ---------- ---------- Equity securities: Common stocks: Public utilities 3,264 3,698 3,698 Banks, trusts and insurance companies 7,033 9,297 9,297 Industrial, miscellaneous and all other 70,615 95,067 95,067 ---------- ---------- ---------- Total equity securities 80,912 108,062 108,062 ---------- ---------- ---------- Total securities available for sale 17,185,655 19,783,068 19,783,068\nMortgage loans on real estate 22,213 28,825 22,213 Policy loans 1,230 1,230 1,230 Other long-term investments 2,113 2,113 2,113 Short-term investments 232,201 232,201 232,201 ---------- ---------- ---------- Total investments $17,443,412 $20,047,437 $20,040,825 ========== ========== ==========\nIV-6\nSCHEDULE II CONDENSED FINANCIAL INFORMATION OF REGISTRANT\nCondensed Balance Sheets AFLAC Incorporated (Parent Only) (In thousands) December 31, 1995 1994 ---------- ---------- Assets: Investments: Investments in subsidiaries* $ 2,573,606 $ 1,988,329 Other investments: Money market funds 17,346 2,489 Mortgage loans and other 2,548 2,468 ---------- ---------- Total investments 2,593,500 1,993,286 Due from subsidiaries* 3,910 9,574 Other receivables 4,478 4,851 Property and equipment, net 9,231 8,961 Other 1,291 267 ---------- ---------- Total assets 2,612,410 2,016,939 ========== ========== Liabilities and Shareholders' Equity: Liabilities: Cash overdraft 160 82 Due to subsidiaries* 1,237 714 Notes payable (note A) 272,158 111,970 Employee and beneficiary benefit plans 147,319 117,145 Income taxes, primarily deferred 33,577 25,399 Other 23,818 9,862 Commitments and contingencies (note B) ---------- ---------- Total liabilities 478,269 265,172 ---------- ---------- Shareholders' equity: Common stock of $.10 par value: Authorized 175,000; issued 156,358 shares in 1995 and 155,999 shares in 1994 15,636 15,600 Additional paid-in capital 196,928 192,899 Unrealized foreign currency translation gains 213,319 174,091 Unrealized gains on securities available for sale 482,787 228,844 Retained earnings (note D) 1,577,605 1,277,487 Treasury stock (351,117) (135,776) Notes receivable for stock purchases (1,017) (1,378) ---------- ---------- Total shareholders' equity 2,134,141 1,751,767 ---------- ---------- Total liabilities and shareholders' equity $ 2,612,410 $ 2,016,939 ========== ==========\n* Eliminated in consolidation. See the accompanying Notes to Condensed Financial Statements. IV-7\nSCHEDULE II CONDENSED FINANCIAL INFORMATION OF REGISTRANT\nCondensed Statements of Earnings AFLAC Incorporated (Parent Only) (In thousands)\nYears ended December 31, 1995 1994 1993 ---------- ---------- ---------- Revenues: Dividends from subsidiaries* $ 82,343 $ 109,533 $ 71,268 Management and service fees from subsidiaries* 30,509 26,391 30,357 Other income from subsidiaries, principally rental and interest* 196 683 992 Other income 1,069 1,327 (620) --------- --------- --------- Total revenues 114,117 137,934 101,997 --------- --------- --------- Operating expenses: Interest expense - subsidiaries* 30 22 162 Interest expense - others 8,419 6,070 3,362 Capitalized interest - (2,419) (3,250) Other operating expenses 70,921 65,635 53,595 --------- --------- --------- Total operating expenses 79,370 69,308 53,869 --------- --------- --------- Earnings before income taxes, equity in undistributed earnings of subsidiaries and cumulative effect of accounting changes 34,747 68,626 48,128\nIncome tax expense (note C) 8,583 874 1,063 --------- --------- --------- Earnings before equity in undistributed earnings of subsidiaries and cumulative effect of accounting changes 26,164 67,752 47,065\nEquity in undistributed earnings of subsidiaries 322,893 225,038 196,824 --------- --------- --------- Earnings before cumulative effect of accounting changes 349,057 292,790 243,889\nCumulative effect on prior years of accounting changes (including a $46,100 credit related to subsidiaries) (note F) - - 11,438 --------- --------- --------- Net earnings $ 349,057 $ 292,790 $ 255,327 ========= ========= =========\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, 1995 1994 1993 ---------- ---------- ---------- Cash flows from operating activities: Net earnings $ 349,057 $ 292,790 $ 255,327 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 (322,893) (225,038) (196,824) Deferred income taxes 8,178 (578) (300) Employee and beneficiary benefit plans 30,174 32,700 18,195 Other, net 17,017 4,307 190 --------- --------- --------- Net cash provided by operating activities 81,533 104,181 65,150 --------- --------- --------- Cash flows from investing activities: Net (increase) decrease in other investments (14,325) 18,998 (14,703) Additional capitalization of subsidiaries - (3,592) - Additions to property and equipment, net - - (75) --------- --------- --------- Net cash (used)\/provided by investing activities (14,325) 15,406 (14,778) --------- --------- --------- Cash flows from financing activities: Proceeds from borrowings 198,250 84,000 - Principal payments under debt obligations (11,507) (26,541) (11,419) Proceeds from exercise of stock options 3,235 2,163 6,975 Dividends paid to shareholders (48,939) (44,928) (40,057) Purchases of treasury stock (224,204) (131,734) (1,325) Treasury stock reissued 9,693 2,761 - Net change in amount due to\/from subsidiaries 6,186 (5,331) (3,866) Other, net - - (1,072) --------- --------- --------- Net cash used by financing activities (67,286) (119,610) (50,764) --------- --------- --------- Net change in cash (78) (23) (392) Cash (overdraft) at beginning of year (82) (59) 333 --------- --------- --------- Cash (overdraft) at end of year $ (160) $ (82) $ (59) ========= ========= ========= 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, 1995 and 1994 follows:\n(In thousands) 1995 1994 -------- --------\n2.71% unsecured, yen-denominated notes payable to banks under reducing revolving credit agreement, due annually, July 1996 through July 2001........................................ $ 230,695 $ - 5.965% unsecured notes payable to banks, due semiannually through 1997.................... 39,167 49,000 8.3% note payable, due monthly through 1997, secured by equipment............................. 2,296 3,970 Unsecured notes payable to banks under revolving credit and term-loan agreement, variable interest rate (6.75% at December 31, 1994), refinanced into the 2.71% notes payable in 1995.. - 50,000 6.63% short-term note payable to bank under unsecured line of credit......................... - 9,000 -------- -------- Total notes payable $ 272,158 $ 111,970 ======== ========\nThe aggregate maturities of the notes payable for each of the five years after December 31, 1995, are as follows:\n(In thousands)\n1996............................................ 59,934 1997............................................ 58,427 1998............................................ 38,449 1999............................................ 38,449 2000............................................ 38,449\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 $23.8 million as of December 31, 1995, and are not included in the accompanying condensed balance sheet.\nIV-10\nIn addition, the Parent Company has also guaranteed repayment of bank borrowings by its subsidiary, AFLAC. The related outstanding loan balance at December 31, 1995, was $1.0 million.\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 relating to both the years under examination and subsequent years. Management does not agree with the proposed tax issues and is vigorously contesting them. The Company filed a formal protest with the IRS during 1995. Although the final outcome is uncertain and will likely take several years to resolve, the Company believes that 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 13-45, Note 8 of the Notes to the Consolidated Financial Statements.\n(D) DIVIDEND RESTRICTIONS\nSee Exhibit 13, pages 13-50 and 13-51 (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) 1995 1994 1993 -------- -------- -------- Cash payments during the year for: Interest on debt obligations $ 7,807 $ 6,302 $ 3,588 Income taxes 406 400 -\nIn 1993, non-cash investing activities included issuance of common stock for purchase of a company amounting to $8.7 million. For further information see Note 9, Other, page 13-49 of Exhibit 13.\n(F) ACCOUNTING CHANGES\nFor information concerning the cumulative effect of new accounting standards adopted in 1995, 1994, and 1993, see page 13-30 of Exhibit 13, Note 1, section on Accounting Changes Adopted, of Notes to the Consolidated Financial Statements.\nIV-11\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the 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 26, 1996 By \/s\/ PAUL S. AMOS ------------------------ ---------------------------------- (Paul S. Amos) Chairman of the Board 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 and on the dates indicated.\n\/s\/ DANIEL P. AMOS Chief Executive Officer, MARCH 26, 1996 - ------------------------ President and Vice ----------------- (Daniel P. Amos) Chairman of the Board of Directors\n\/s\/ KRISS CLONINGER, III Executive Vice President, MARCH 26, 1996 - ------------------------ Chief Financial Officer ----------------- (Kriss Cloninger, III) and Treasurer\n\/s\/ NORMAN P. FOSTER Executive Vice President, MARCH 26, 1996 - ------------------------ Corporate Finance ----------------- (Norman P. Foster)\nIV-13\n\/s\/ J. SHELBY AMOS, II Director MARCH 26, 1996 - ------------------------------ ----------------- (J. Shelby Amos, II)\n\/s\/ MICHAEL H. ARMACOST Director MARCH 26, 1996 - ------------------------------ ----------------- (Michael H. Armacost)\n\/s\/ M. DELMAR EDWARDS, M.D. Director MARCH 26, 1996 - ------------------------------ ----------------- (M. Delmar Edwards, M.D.)\n\/s\/ GEORGE W. FORD, JR. Director MARCH 26, 1996 - ------------------------------ ----------------- (George W. Ford, Jr.)\n\/s\/ CESAR E. GARCIA Director MARCH 26, 1996 - ------------------------------ ----------------- (Cesar E. Garcia)\n\/s\/ JOE FRANK HARRIS Director MARCH 26, 1996 - ------------------------------ ----------------- (Joe Frank Harris)\n\/s\/ ELIZABETH J. HUDSON Director MARCH 26, 1996 - ------------------------------ ----------------- (Elizabeth J. Hudson)\n\/s\/ KENNETH S. JANKE, SR. Director MARCH 26, 1996 - ------------------------------ ----------------- (Kenneth S. Janke, Sr.)\nIV-14\n\/s\/ CHARLES B. KNAPP Director MARCH 26, 1996 - ------------------------------ ----------------- (Charles B. Knapp)\n\/s\/ HISAO KOBAYASHI Director MARCH 26, 1996 - ------------------------------ ----------------- (Hisao Kobayashi)\n\/s\/ YOSHIKI OTAKE Director MARCH 26, 1996 - ------------------------------ ----------------- (Yoshiki Otake)\n\/s\/ E. STEPHEN PURDOM Director MARCH 26, 1996 - ------------------------------ ----------------- (E. Stephen Purdom)\n\/s\/ BARBARA K. RIMER Director MARCH 26, 1996 - ------------------------------ ----------------- (Barbara K. Rimer)\n\/s\/ HENRY C. SCHWOB Director MARCH 26, 1996 - ------------------------------ ----------------- (Henry C. Schwob)\n\/s\/ J. KYLE SPENCER Director MARCH 26, 1996 - ------------------------------ ----------------- (J. Kyle Spencer)\n\/s\/ GLENN VAUGHN, JR. Director MARCH 26, 1996 - ------------------------------ ----------------- (Glenn Vaughn, Jr.)\nIV-15\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. 10.1.2* - AFLAC Incorporated Amended 1985 Stock Option Plan, as amended August 8, 1995 - incorporated by reference from Form 10-Q for September 30, 1995, Commission file number 1-7434, Accession No. 0000004977-95-000023, Exhibit 10. 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 - incorporated by reference from 1994 Form 10-K, Commission file number 1-7434, Accession No. 0000004977-95-000006, Exhibit 10.3.1. 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 - incorporated by reference from 1994 Form 10-K, Commission file number 1-7434, Accession No. 0000004977-95-000006, Exhibit 10.5.\nIV-16\n10.6* - 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. 10.8* - American Family Life Assurance Company of Columbus Employment Agreement with Hidefumi Matsui, dated January 1, 1995 - incorporated by reference from 1994 Form 10-K, Commission file number 1-7434, Accession No. 0000004977-95-000006, Exhibit 10.8. 10.9* - American Family Life Assurance Company of Columbus Employment Agreement with Dr. E. Stephen Purdom, dated October 25, 1994 - incorporated by reference from 1994 Form 10-K, Commission file number 1-7434, Accession No. 0000004977-95-000006, Exhibit 10.9. 10.10* - AFLAC Incorporated Employment Agreement with Paul S. Amos, dated August 1, 1995 - incorporated by reference from Form 10-Q for September 30, 1995, Commission file number 1-7434, Accession No. 0000004977-95-000023, Exhibit 10.1. 13.0 - Selected information from the AFLAC Incorporated Annual Report to Shareholders for 1995. 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. 23.3 - Consent of independent auditor, KPMG Peat Marwick LLP, to Form S-3 Registration Statement No. 33-64535 with respect to the AFL Stock 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*Management contract or compensatory plan or agreement.\nIV-17\nExhibits Filed with Current Form 10-K:\n13.0 - Selected information from the AFLAC Incorporated Annual Report to Shareholders for 1995. 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. 23.3 - Consent of independent auditor, KPMG Peat Marwick LLP, to Form S-3 Registration Statement No. 33-64535 with respect to the AFL Stock Plan. 27.0 - Financial Data Schedule (electronic filing only).\nIV-18","section_15":""}
{"filename":"106640_1995.txt","cik":"106640","year":"1995","section_1":"ITEM 1. BUSINESS.\nGENERAL\nWhirlpool Corporation, the leading worldwide manufacturer and marketer of major home appliances, was incorporated in 1955 under the laws of Delaware as the successor to a business that traces its origin to 1898. As used herein, and except where the context otherwise requires, the term \"Company\" includes Whirlpool Corporation and its consolidated subsidiaries. All currency figures are in U.S. dollars.\nRECENT DEVELOPMENTS\nIn 1995 the Company began executing the restructuring announced in November 1994. In Europe, the shift from a country focused sales, marketing, and support functions to a pan-European and trade channel focused organization is proceeding as planned. In the United States, the streamlining of the manufacturing and technology organization is also on schedule. It is anticipated that the restructuring will result in annual cost savings of approximately $150 million by 1997.\nIn October, the Company's Asian operation received Chinese government approval of a joint venture agreement to manufacture and market window and split air conditioners with Shenzhen Petrochemical Holdings Co. Ltd. The joint venture fulfills a key element of Whirlpool's strategy in China of focusing on the top four major domestic-appliance categories in that market: refrigerators, washing machines, microwave ovens, and air conditioners.\nDuring 1995 the Company's North American operations completed construction of a new facility for the production of gas and electric cooking ranges in Tulsa, Oklahoma, and a small appliance manufacturing facility in Greenville, Ohio. These facilities will begin production in 1996.\nFINANCIAL INFORMATION RELATING TO BUSINESS SEGMENTS, FOREIGN AND DOMESTIC OPERATIONS AND EXPORT SALES\nThe Company operates predominantly in the business segments classified as Major Home Appliances and Financial Services.\nDuring 1995, the Company's U.S. operations sold product into Canada, Mexico, Latin America, Asia, and Europe. However, export sales by the Company's U.S. operations were less than 10 percent of gross revenues.\nFor certain other financial information concerning the Company's business segments and foreign and domestic operations, see Notes 1 and 15 of the Notes to Consolidated Financial Statements in the Company's Annual Report to Stockholders (the \"Annual Report\"), which is incorporated herein by reference.\nPRODUCTS AND SERVICES\nThe Company manufactures and markets a full line of major home appliances and related products for home and commercial use and provides certain inventory, consumer, and other financial services. The Company's principal products and financial services are as follows:\nMajor Home Appliances:\nHome laundry appliances: automatic and semi-automatic washers; automatic dryers; coin-operated laundry machines; and combination washer-dryer units.\nHome refrigeration and room air conditioning equipment: refrigerator- freezers; upright and chest freezers; room air conditioners; dehumidifiers; and residential, commercial, and component ice makers.\nHome cooking appliances: free-standing and set-in ranges; built-in ovens and surface cooking units; microwave ovens; countertop cooking units; and range hoods.\nOther home appliances, products, and services: dishwashers; residential trash compactors; food waste disposers; portable appliances; hot water dispensers; water filtration products; oil radiators; water heaters; component parts, replacement parts, repair services and warranty contracts; and product kits.\nFinancial Services:\nWhirlpool Financial Corporation (\"WFC\") provides inventory financing and factoring services, including stocking and display programs for retailers and distributors that market products manufactured by the Company plus other manufacturers. It also provides consumer financing services for retail sales, principally through Whirlpool Financial National Bank (\"WFNB\"), which offers consumer credit card programs. WFC also continues to manage down its aerospace financing and leasing portfolios.\nThe Company purchases a portion of its product requirements from other manufacturers for resale by the Company. The Company purchases all of its requirements of range hoods, food waste disposers, upright and chest freezers (North America), hand mixers, and food processors and certain other miscellaneous products from other manufacturers for resale by the Company.\nFor certain information with respect to each class of similar products which accounted for 10 percent or more of the Company's consolidated revenue in 1995, 1994, and 1993, see Revenue Information in the Annual Report, which is incorporated herein by reference.\nMajor home appliances are marketed and distributed in the United States under the WHIRLPOOL, KITCHENAID, ROPER, ESTATE, CHAMBERS, and COOLERATOR brand names through Company-owned sales branches primarily to retailers and builders. KITCHENAID portable appliances are sold to retailers either directly or through an independent representative organization. The Company sells product to the builder trade both directly and through contract distributors. Major home appliances are manufactured and\/or distributed in Canada under the INGLIS, ADMIRAL, SPEED QUEEN, WHIRLPOOL, ESTATE, ROPER, and KITCHENAID brand names. Refrigerator-freezers, laundry products, room air conditioners, residential trash compactors, residential and component ice makers, cooking products, dishwashers, and other products are sold in limited quantities by the Company to other manufacturers and retailers for resale in North America under their respective brand names.\nThe Company has been the principal supplier of home laundry appliances to Sears, Roebuck and Co. (\"Sears\") for almost 80 years. The Company is also the principal supplier to Sears of residential trash compactors and dehumidifiers and a major supplier to Sears of dishwashers, room air conditioners, and home refrigeration equipment. The Company also supplies Sears with certain other products for which the Company is not currently a major supplier. Sales of such other products to Sears are not significant to the Company's business. The Company supplies products to Sears for sale under Sears' KENMORE and SEARS brand names. Sears has also been a major outlet for the Company's WHIRLPOOL and KITCHENAID brand names since 1989. Sales to Sears are made without underlying merchandise agreements.\nIn Europe, Whirlpool Europe markets and distributes its major home appliances through regional networks under a number of brand names. In 1990, Whirlpool Europe began an estimated $110 million program to introduce the WHIRLPOOL brand name to the European marketplace. Whirlpool Europe also markets products under the BAUKNECHT, IGNIS, and LADEN brand names. In certain Eastern European countries, products bearing the WHIRLPOOL and IGNIS brand names are presently sold through independent distributors. Whirlpool Europe also has company-owned sales subsidiaries in Hungary, Poland, the Czech Republic, Slovakia, and Greece and a representative office in Russia. Pursuant to the Company's joint venture agreement with Philips N.V. (\"Philips\"), except for certain limited exceptions and subject to certain phase-out provisions, neither Philips nor\nany subsidiary of Philips may engage directly or indirectly in the major domestic appliance business anywhere in the world until January 2, 1999.\nWhirlpool Europe also sells products carrying the WHIRLPOOL, BAUKNECHT, IGNIS, ALGOR, and FIDES brand names to the Company's wholly-owned sales companies in Asia and\/or Latin America (Whirlpool Asia Appliance Group and the Latin America Appliance Group) and to independent distributors and retailers in Africa and the Middle East.\nIn Asia, the Company markets and distributes its major home appliances through four operating regions: the Greater China region, based in Hong Kong, which includes the Peoples Republic of China and Hong Kong; the South Asia region, based in Delhi, which includes India, Pakistan, and other surrounding markets; the North Asia region, which includes Japan, Korea, the Philippines, and Taiwan; and the Southeast Asia--Australia region, which includes Southeast Asia, Australia, and New Zealand. The North Asia and Southeast Asia--Australia regions are based in Singapore. The Company markets and sells its products in Asia under the WHIRLPOOL, KITCHENAID, ROPER, IGNIS, BAUKNECHT, SMC, NARCISSUS, SNOWFLAKE, RAYBO, TVS, and KELVINATOR brand names.\nWHIRLPOOL FINANCIAL CORPORATION\nWhirlpool Financial provides diversified financial services to businesses and consumers throughout the United States and Canada and factoring, inventory, and display financing activities in Europe, Mexico, and Argentina. WFC conducts its business through three divisions: the Inventory Finance Division, which provides floorplan financing and display programs to retailers; the Consumer Finance Division, which provides installment financing and, through WFNB, WFC's credit card bank, consumer credit card programs; and the International Division, operated through Whirlpool Financial Corporation International, Whirlpool Financial Latin America Inc., and Whirlpool Financial Corporation Overseas, wholly owned subsidiaries of WFC, which provide factoring, inventory, and display financing for retailers of products of Whirlpool Europe, Whirlpool Argentina, and Vitromatic, Whirlpool's joint venture company in Mexico. Inventory financing represents the largest segment of WFC's business, providing services for manufacturers, distributors, and retailers in the appliance, consumer electronics, outdoor power equipment, residential heating and cooling equipment, and music industries. As previously mentioned, WFC is phasing-out its aerospace financing and leasing portfolios.\nCOMPETITION\nThe major home appliance business is a highly competitive industry. The Company believes that, in terms of units sold annually, it is the largest United States manufacturer of home laundry appliances and one of the largest United States manufacturers of home refrigeration and room air conditioning equipment and dishwashers. The Company estimates that during 1995 there were approximately five United States manufacturers of home laundry appliances, 15 United States manufacturers of home refrigeration and room air conditioning equipment, and four United States manufacturers of dishwashers. Competition in the North American major home appliance business is based on a wide variety of factors, including principally product features, price, product quality and performance, service, warranty, advertising, and promotion.\nThe Company believes that Whirlpool Europe, in terms of units sold annually, is one of the three largest manufacturers and marketers of major home appliance products in Europe. The Company estimates that during 1995 there were approximately 35 Western European manufacturers of major home appliances, the majority of which manufacture a limited range of products for a specific geographic region. In recent years, there has been significant merger and acquisition activity as manufacturers seek to broaden product lines and expand geographic markets, and the Company believes that this trend will continue. The Company believes that, with Whirlpool Europe, it is in a favorable position relative to its competitors because it has an experienced Western European\nsales network, balanced sales throughout the Western European market under well-recognized brand names, manufacturing facilities located in different countries, and the ability to customize its products to meet the specific needs of diverse consumer groups. Competition in the European major home appliance business is based on a wide variety of factors, including principally product features, price, product quality and performance, service, warranty, advertising, and promotion. With respect to microwave ovens, Western European manufacturers face competition from manufacturers in Asia, primarily Japan and South Korea.\nIn Asia, the major domestic appliance market is characterized by rapid growth and is dominated primarily by Asian diversified industrial manufacturers whose significant size and scope of operations enable them to achieve economies of scale. The Company estimates that during 1995 there were approximately 50 Asian manufacturers of major home appliances. Competition in the Asian home appliance business is based on a wide variety of factors, including principally local production capabilities, product features, price, product quality, and performance.\nThe Company believes that, together with its Brazilian affiliates, it is well-positioned in the Latin American appliance market due to its ability to offer a broad range of products under well-recognized brand names such as WHIRLPOOL, BRASTEMP, CONSUL and SEMER to meet the specific requirements of consumers in the region. The Company estimates that during 1995 there were approximately 65 manufacturers of home appliances in the region. Competition in the Latin American home appliance business is based on a wide variety of factors, including principally product features, price, product quality and performance, service, warranty, advertising, and promotion. In Latin America there are trends toward privatization of government-owned businesses and a liberalization of investment and trade restrictions.\nAs a result of its global expansion, the Company believes it may have a competitive advantage by reason of its ability to share engineering breakthroughs across regions, transfer best practices, and economically purchase raw materials and component parts in large volumes.\nThe financial services industry is an intensely competitive business. Factors affecting competition include new entrants into a market experiencing only moderate growth and the continuing pressure to improve investment returns in the financial services industry. With respect to inventory financing, there has been a trend toward consolidation resulting in five dominant companies in the United States market. In terms of total assets, WFC is the smallest of these companies. WFC believes it has a competitive advantage due to its strong relationship with the Company and other distribution networks. In the inventory finance business, WFC's strategy is to exploit niches within the consumer durables retail market. In consumer finance, WFC utilizes the same retailer relationships to address the needs of their consumers through private label credit card programs. The consumer finance market is highly fragmented with numerous competitors, none of which has a dominant market share.\nEMPLOYEES\nThe Company and its consolidated subsidiaries had approximately 45,435 employees as of December 31, 1995.\nOTHER INFORMATION\nThe Company owns minority equity interests in certain Brazilian manufacturers of major home appliances and components (Multibras and Embraco) and has a controlling interest in a sales and marketing joint venture (the South American Sales Company) with Multibras. The Company also has a majority interest in joint venture companies in Argentina and Slovakia. Both companies manufacture home appliances for sale and distribution in their home and surrounding markets. In China, the Company has majority interests in joint venture companies that manufacture microwave ovens, refrigeration products, air conditioners, and automatic washing machines.\nThe companies manufacture appliances for sale and distribution in their home countries and for export. In India, the Company has majority interests in companies that produce refrigeration products and washing machines for the Indian market. The Company also has minority equity interests in a Mexican manufacturer of home appliances and components and a Taiwan marketer and distributor of home appliances. For additional information regarding the Company's affiliated companies, see the discussion contained in Note 5 of the Notes to Consolidated Financial Statements in the Annual Report which is incorporated herein by reference. In addition, the Company furnishes engineering, manufacturing and marketing assistance to certain foreign manufacturers of home laundry and refrigeration equipment and other major home appliances for negotiated fees.\nThe Company's interests outside the United States and Western Europe are subject to risks which may be greater than or in addition to those risks currently present in the United States and Western Europe. Such risks may include high inflation, the need for governmental approval of and restrictions on certain financial and other corporate transactions and new or continued business operations, government price controls, restrictions on the remittance of dividends, interest, royalties, and other payments, and the convertibility of local currencies, restrictions on imports and exports, duties, political and economic developments and instability, the possibility of expropriation, uncertainty as to the enforceability of commercial rights and trademarks, and various types of local participation in ownership. In Brazil, the Company's minority equity interests earned profits in 1994 and 1995 due to cost control, productivity improvements, and an increase in consumer demand. However, issues such as economic volatility and exchange rate changes continue to affect consumer purchasing power and the appliance industry as a whole.\nThe Company is generally not dependent on any one source for raw materials or purchased components essential to its business. In those areas where a single supplier is used, alternative sources are generally available and can be developed within the normal manufacturing environment. While there are pricing pressures on some materials and significant demand for certain components, it is believed that such raw materials and components will be available in adequate quantities to meet anticipated production schedules.\nPatents presently owned by the Company are considered, in the aggregate, to be important to the conduct of the Company's business. The Company is licensed under a number of patents, none of which individually is considered material to its business. The Company is the owner of a number of trademarks and the U.S. and foreign registrations thereof. The most important for its North American operations are the trademarks WHIRLPOOL, KITCHENAID, ROPER and INGLIS. Whirlpool Europe, through its subsidiaries, is also the owner of a number of trademarks and the foreign registrations thereof. The most important trademarks owned by Whirlpool Europe are BAUKNECHT, IGNIS and LADEN. The most important trademark for the Company's European, Asian, and Latin American operations is WHIRLPOOL. The most important trademark licensed to the Company's subsidiaries is the trademark PHILIPS and the Philips shield emblem, which can be used exclusively on major home appliances by such subsidiaries until July 31, 1998. In the event of a change in control of the Company, Philips has the option to terminate the use by the Company's subsidiaries of the trademark PHILIPS and the Philips shield emblem.\nThe Company believes that its business, in the aggregate, is not seasonal. Certain of its products, however, sell more heavily in some seasons than in others. In the United States, room air conditioners and dehumidifiers are generally produced and sold heavily in the first half of each year. Portable appliances and microwave ovens tend to sell more heavily in the second half of each year. In Europe, clothes dryers are sold more heavily in the winter. In Asia, refrigerators tend to sell more heavily in summer, while demand for washers is greater in winter. In South America, refrigerators and room air conditioners sell more heavily in the second half of the year.\nBacklogs of the Company's products are filled and renewed relatively frequently in each year and are not significant in relation to the Company's annual sales.\nExpenditures for Company-sponsored research and engineering activities relating to the development of new products and the improvement of existing products are included in Note 1 of the Notes to Consolidated Financial\nStatements in the Annual Report, which is incorporated herein by reference. Customer-sponsored research activities relating to the development of new products, services or techniques, or the improvement of existing products, services, or techniques are not material.\nThe Company's manufacturing facilities are subject to numerous laws and regulations designed to protect or enhance the environment, many of which require federal, state, or other governmental licenses and permits with regard to wastewater discharges, air emissions, and hazardous waste management. These laws are continually changing and, as a general matter, are becoming more restrictive. The Company's policy is to comply with all such laws and regulations.\nThe Company believes that it is in compliance in all material respects with all presently applicable federal, state, local, and other provisions relating to environmental protection in the countries in which it has manufacturing operations. Capital expenditures and expenses attributable to compliance with such provisions worldwide amounted to approximately $57 million in 1993, $78 million in 1994, and $58 million in 1995. The Company anticipates that such capital expenditures and expenses will aggregate approximately $47 million in 1996. Much of the increase in 1994 and 1995 is attributable to taxes on chloroflourocarbons (\"CFCs\") (which were eliminated from the Company's products in the United States prior to December 31, 1995) and a decision to broaden the definition of environmental costs to include investments in product development to meet or exceed anticipated energy and\/or water regulations. The Company is using a global environmental management process to achieve its goals of producing environmentally compatible products, better integrating environmental considerations into the Company's product design and employee training, improving the Company's ability to report and monitor its management of environmental, health, and safety affairs, and reducing its worldwide emissions of certain chemicals.\nThe entire United States appliance industry, including the Company, must contend with adoption of stricter governmental energy and environmental standards to be phased in over the next several years. These include the general phaseout of CFCs used in refrigeration and energy standards rulemakings for all major appliances produced by the Company. Enactment of Federal energy standards is uncertain at this time due to funding and rulemaking restrictions being considered for the Department of Energy by the U.S. Congress. Compliance with these various standards as they become effective will require some product redesign although the standard levels were anticipated in current projects.\nIn Europe, the Company met the December 31, 1994 deadline for the elimination of CFCs in its products. As in the United States, Whirlpool Europe is also dealing with anticipated regulations and rules regarding improved efficiency and energy usage for its products. The Company believes it is well positioned to field products that comply with these anticipated regulations. In most Asian countries, the Company has until 2010 to eliminate CFCs from its products. Whirlpool's Asian operations are also well positioned to meet anticipated efficiency and energy usage regulations.\nThe Company has been notified by state and federal environmental protection agencies of its possible involvement in a number of so-called \"Superfund\" sites in the United States. However, the Company does not presently anticipate any material adverse effect upon the Company's earnings or financial condition arising out of the resolution of these matters or the resolution of any other known governmental proceeding regarding environmental protection matters. The Company is in the process of performing environmental assessments of its European facilities acquired as a result of the Company's purchase of the Major Domestic Appliance division of Philips. Remedial plans are being prepared to address contamination found during the evaluation. The majority of anticipated remediation costs are covered by an indemnity agreement with Philips and the Company does not presently anticipate any material adverse effect upon the Company's earnings or financial condition arising out of the resolution of these matters. The Company is also in the process of evaluating several recently acquired facilities in India and China. The Company does not presently anticipate any material adverse effect upon the Company's earnings or financial condition from the environmental condition of these facilities.\nThe following table sets forth the names of the Company's executive officers at December 31, 1995, the positions and offices with the Company held by them at such date, the year they first became officers, and their ages at December 31, 1995:\nEach of the executive officers named above was elected to serve in the office indicated until the first meeting of the Board of Directors following the annual meeting of stockholders in 1996 and until his successor is chosen and qualified or until his earlier resignation or removal.\nEach of the executive officers of the Company has held the position set forth in the table above or has served the Company in various executive or administrative capacities for at least the past five years, except for:\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe principal executive offices of Whirlpool Corporation are located in Benton Harbor, Michigan. At December 31, 1995, the principal manufacturing and service operations of the Company were carried on at 34 locations worldwide, 20 of which are located in 10 countries outside the United States. The Company occupied a total of approximately 35 million square feet devoted to manufacturing, service, administrative offices, warehouse, distribution, and sales space. Over 10 million square feet of such space is occupied under lease. In general, all such facilities are well maintained, suitably equipped, and in good operating condition. In 1995, construction of new manufacturing plants in Tulsa, Oklahoma, and Greenville, Ohio, were completed, with full operations scheduled to begin in 1996.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nAs of, and during the quarter ended, December 31, 1995, there were no material pending legal proceedings to which the Company or any of its subsidiaries was a party or to which any of their property was subject.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nThere were no matters submitted to a vote of security holders in the fourth quarter of 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nThe Company's common stock is traded on the New York Stock Exchange, the Chicago Stock Exchange, and The London Stock Exchange.\nAt March 4, 1996, the number of holders of record of the Company's common stock was approximately 11,579.\nHigh and low sales prices (as reported on the New York Stock Exchange composite tape) and cash dividends declared and paid for the Company's common stock for each quarter during the years 1994 and 1995 are set forth in Note 16 of the Notes to Consolidated Financial Statements in the Annual Report, which is herein incorporated by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe selected financial data for the five years ended December 31, 1995 with respect to the following line items shown under the \"Eleven Year Consolidated Statistical Review\" in the Annual Report is incorporated herein by reference and made a part of this report: Total revenues; earnings from continuing operations before accounting change; earnings from continuing operations before accounting change per share of common stock; dividends paid per share of common stock; total assets; and long-term debt. See the material incorporated herein by reference in response to Item 7","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nThe Management's Discussion and Analysis of Results of Operations and Financial Condition in the Annual Report is incorporated herein by reference and made a part of this report.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe consolidated financial statements of the Company in the Annual Report are incorporated herein by reference and made a part of this report. Supplementary financial information regarding quarterly results of operations (unaudited) for the years ended December 31, 1995 and 1994 is set forth in Note 16 of the Notes to Consolidated Financial Statements. For a list of financial statements and schedules filed as part of this report, see the \"Index to Financial Statements and Financial Statement Schedule(s)\" beginning on page.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nInformation with respect to directors of the Company is incorporated herein by reference to the information under the caption \"Directors and Nominees for Election as Directors\" in the Company's proxy statement for the 1996 annual meeting of stockholders (SEC File No. 1-3932) (the \"Proxy Statement\"). Information with respect to executive officers of the Company is set forth in Part I of this report.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nInformation with respect to compensation of executive officers and directors of the Company is incorporated herein by reference to the information under the captions \"Executive Compensation\" and \"Compensation of Directors\" in the Proxy Statement.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP.\nInformation with respect to security ownership by the only person(s) known to the Company to beneficially own more than 5 percent of the Company's stock and by each director of the Company and all directors and elected officers of the Company as a group is incorporated herein by reference to the information under the caption \"Security Ownership\" in the Proxy Statement.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nNone.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE(S), AND REPORTS ON FORM 8-K.\n(a) The following documents are filed as a part of this report:\n1. The financial statements listed in the \"Index to Financial Statements and Financial Statement Schedule(s).\"\n2. The financial statement schedule listed in the \"Index to Financial Statements and Financial Statement Schedule(s).\"\n3. The exhibits listed in the \"Index to Exhibits.\"\n(b) Reports on Form 8-K filed during the fourth quarter of 1995.\n1. A Current Report on Form 8-K for December 13, 1995 pursuant to Item 5 - -\"Other Events\" announced the election of John P. Cunningham as Executive Vice President and Chief Financial Officer for the company.\n(c) Exhibits.\n1. The following exhibits are included herein:\n(11) Computation of per share earnings.\n(12) Computation of the ratios of earnings to fixed charges.\n2. The response to this portion of Item 14 is submitted as a separate section of this report.\n(d) Financial Statement Schedule(s).\nThe response to this portion of Item 14 is submitted as a separate section of this report.\nSIGNATURES\nPURSUANT TO THE REQUIREMENTS OF SECTION 13 OF THE SECURITIES EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.\nWhirlpool Corporation (Registrant)\n\/s\/ John P. Cunningham By:__________________________________ John P. Cunningham (Principal Financial Officer) 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.\nJanice D. Stoney\n\/s\/ Daniel F. Hopp *By:___________________________\nDaniel F. Hopp\nANNUAL REPORT ON FORM 10-K\nITEMS 14(A) (1) AND (2) AND 14(D)\nINDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE(S)\nYEAR ENDED DECEMBER 31, 1995\nWHIRLPOOL CORPORATION AND CONSOLIDATED SUBSIDIARIES\nThe following consolidated financial statements of the registrant and its consolidated subsidiaries, set forth in the Annual Report, are incorporated herein by reference in Item 8:\nConsolidated balance sheets--December 31, 1995 and 1994\nConsolidated statements of earnings--Three years ended December 31,\nConsolidated statements of cash flows--Three years ended December 31,\nNotes to consolidated financial statements\nThe following reports of independent auditors and consolidated financial statement schedules of the registrant and its consolidated subsidiaries are submitted herewith in response to Items 14(a) (2) and 14(d):\nIndividual financial statements of the registrant's affiliated foreign companies, accounted for by the equity method, have been omitted since no such company individually constitutes a significant subsidiary. Summarized financial information relating to the affiliated companies is set forth in Note 5 of the Notes to Consolidated Financial Statements incorporated by reference herein.\nCertain schedules for which provisions are 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.\nREPORT OF INDEPENDENT AUDITORS\nThe Stockholders and Board of Directors Whirlpool Corporation Benton Harbor, Michigan\nWe have audited the consolidated financial statements of Whirlpool Corporation and subsidiaries listed in the Index at Item 14(a)(1) of the annual report on Form 10-K of Whirlpool Corporation for the year ended December 31, 1995. 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 Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We did not audit the financial statements of the Brazilian affiliates used as the basis for recording the Company's equity in their net earnings, as presented in Note 5 to the consolidated financial statements. The financial statements of those affiliates were audited by other auditors whose reports have been furnished to us, and our opinion, insofar as it relates to the amount included for the Brazilian affiliates, 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 and the reports of the other auditors provide a reasonable basis for our opinion.\nIn our opinion, based on our audits and the reports of the other auditors, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Whirlpool Corporation and subsidiaries at December 31, 1995 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, 1995, 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, in 1993 the Company changed its method of accounting for postretirement benefits other than pensions.\nChicago, Illinois January 31, 1996\n[LETTERHEAD PRICE WATERHOUSE]\nReport of Independent Accountants\nJanuary 19, 1996\nTo the Board of Directors and Stockholders Brasmotor S.A.\n1 We have audited the consolidated balance sheets of Brasmotor S.A. and its subsidiaries as of December 31, 1995 and 1994 and the related consolidated statements of income, of movement in stockholders' equity and of cash flows for the years then ended, expressed in U.S. dollars (not presented herein). Such audits were made in conjunction with our audits of the financial statements expressed in local currency on which we issued an unqualified opinion dated January 19, 1996. 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 Whirlpool Argentina S.A. used as the basis for recording the Company's equity in its net earnings, as presented in Note 4 to the consolidated financial statements. The financial statements of that affiliate were audited by other auditors whose reports have been furnished to us, and our opinion, insofar as it relates to the amounts included for Whirlpool Argentina S.A., is based solely on the reports of the other auditors.\n2 We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\n3 As stated in Note 1, Whirlpool Corporation has prescribed that accounting principles generally accepted in the United States of America be applied in the preparation of the consolidated financial statements of Brasmotor S.A. and its subsidiaries to be included in Whirlpool's consolidated financial statements. Brazil has a highly inflationary economy. Accounting principles generally accepted in the United States of America require that financial statements of a company denominated in the currency of a country with a highly inflationary economy be remeasured into a more stable currency unit for purposes of consolidation. Accordingly, the accounts of Brasmotor S.A. and its Brazilian subsidiaries, which are maintained in reais, were remeasured and adjusted into U.S. dollars for the financial statements prepared in accordance with accounting principles generally accepted in the United States of America on the bases stated in Note 1.\nJanuary 19, 1996 [LOGO PRICE WATERHOUSE] Brasmotor S.A.\n4 In our opinion, based on our audits and the report of the other auditors, the consolidated financial statements expressed in U.S. dollars audited by us are presented fairly, in all material respects, on the bases stated in Note 1 and discussed in the preceding paragraph.\n\/s\/ Price Waterhouse\n[LETTERHEAD PRICE WATERHOUSE]\nReport of Independent Accountants\nJanuary 19, 1996\nTo the Board of Directors and Stockholders Empresa Brasileira de Compressores S.A. - EMBRACO\n1 We have audited the consolidated balance sheets of Empresa Brasileira de Compressores S.A. - EMBRACO and its subsidiaries as of December 31, 1995 and 1994 and the related consolidated statements of income, of movement in stockholders' equity and of cash flows for the years then ended, expressed in U.S. dollars (not presented herein). Such audits were made in conjunction with our audits of the financial statements expressed in local currency on which we issued an unqualified opinion dated January 19, 1996. 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.\n2 We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\n3 As stated in Note 1, Whirlpool Corporation has prescribed that accounting principles generally accepted in the United States of America be applied in the preparation of the consolidated financial statements of Empresa Brasileira de Compressores S.A. - EMBRACO and its subsidiaries to be included in Whirlpool's consolidated financial statements. Brazil has a highly inflationary economy. Accounting principles generally accepted in the United States of America require that financial statements of a company denominated in the currency of a country with a highly inflationary economy be remeasured into a more stable currency unit for purposes of consolidation. Accordingly, the accounts of Empresa Brasileira de Compressores S.A. - EMBRACO and its Brazilian subsidiaries, which are maintained in reais, were remeasured and adjusted into U.S. dollars for the financial statements prepared in accordance with accounting principles generally accepted in the United States of America on the bases stated in Note 1.\nJanuary 19, 1996 [LOGO PRICE WATERHOUSE] Empresa Brasileira de Compressores S.A. - EMBRACO\n4 In our opinion, the consolidated financial statements expressed in U.S. dollars audited by us are presented fairly, in all material respects, on the bases stated in Note 1 and discussed in the preceding paragraph.\n\/s\/ Price Waterhouse\n[LETTERHEAD PRICE WATERHOUSE]\nReport of Independent Accountants\nJanuary 19, 1996\nTo the Board of Directors and Stockholders Multibras S.A. Eletrodomesticos\n1 We have audited the consolidated balance sheets of Multibras S.A. Eletrodomesticos and its subsidiaries as of December 31, 1995 and 1994 and the related consolidated statements of income, of movement in stockholders' equity and of cash flows for the years then ended, expressed in U.S. dollars (not presented herein). Such audits were made in conjunction with our audits of the financial statements expressed in local currency on which we issued an unqualified opinion dated January 19, 1996. 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.\n2 We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\n3 As stated in Note 1, Whirlpool Corporation has prescribed that accounting principles generally accepted in the United States of America be applied in the preparation of the consolidated financial statements of Multibras S.A. Eletrodomesticos and its subsidiaries to be included in Whirlpool's consolidated financial statements. Brazil has a highly inflationary economy. Accounting principles generally accepted in the United States of America require that financial statements of a company denominated in the currency of a country with a highly inflationary economy be remeasured into a more stable currency unit for purposes of consolidation. Accordingly, the accounts of Multibras S.A. Eletrodomesticos and its Brazilian subsidiaries, which are maintained in reais, were remeasured and adjusted into U.S. dollars for the financial statements prepared in accordance with accounting principles generally accepted in the United States of America on the bases stated in Note 1.\nJanuary 19, 1996 [LOGO PRICE WATERHOUSE] Multibras S.A. Eletrodomesticos\n4 In our opinion, the consolidated financial statements expressed in U.S. dollars audited by us are presented fairly, in all material respects, on the bases stated in Note 1 and discussed in the preceding paragraph.\n\/s\/ Price Waterhouse\nSCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS\nWHIRLPOOL CORPORATION AND SUBSIDIARIES\nYEARS ENDED DECEMBER 31, 1995, 1994, AND 1993\n(MILLIONS OF DOLLARS)\n- -------- Note A--The amounts represent accounts charged off, less recoveries of $5 in 1995, $1 in 1994, and $6 in 1993.\nNote B--The amounts represent accounts charged off, less recoveries of $2 in 1995, and $1 in 1994 and 1993.\nNote C--The amounts represent accounts charged off, less recoveries of $1 in 1995, 1994, and 1993.\nNote D--Charges include employee related severance and relocation, disposal of fixed assets and translation adjustments.\nEXHIBIT 11--STATEMENT RE: COMPUTATION OF EARNINGS PER SHARE\nWHIRLPOOL CORPORATION AND SUBSIDIARIES\n(MILLIONS OF DOLLARS EXCEPT EARNINGS PER SHARE)\n- -------- * Since the fully diluted net earnings per share is anti-dilutive, the primary net earnings per share is presented.\nEXHIBIT 12--STATEMENT RE: COMPUTATION OF THE RATIOS OF EARNINGS TO FIXED CHARGES\nWHIRLPOOL CORPORATION AND SUBSIDIARIES\nEXHIBIT 12--STATEMENT RE: COMPUTATION OF THE RATIOS OF EARNINGS TO FIXED CHARGES\nWHIRLPOOL CORPORATION AND SUBSIDIARIES\nANNUAL REPORT ON FORM 10-K\nITEMS 14(A)(3) AND 14(C)\nINDEX TO EXHIBITS\nYEAR ENDED DECEMBER 31, 1995\nThe following exhibits are submitted herewith or incorporated herein by reference in response to Items 14(a)(3) and 14(c):\nE-1\n- -------- *This information appears only in the manually signed originals of the Form 10-K and conformed copies with exhibits.\nE-2","section_15":""}
{"filename":"820083_1995.txt","cik":"820083","year":"1995","section_1":"ITEM 1. DESCRIPTION OF BUSINESS.\n(a) General Development of Business\nThe Registrant is a California Limited Partnership formed as of August 3, 1987 with an initial capitalization of $100 to purchase, own, operate, lease, and sell equipment used in the containerized cargo shipping industry. The Registrant commenced offering units representing limited partnership interests (Units) to the public on October 26, 1987 in accordance with its Registration Statement and ceased to offer such Units as of October 26, 1989. The Registrant raised a total of $29,491,080 from the offering.\nSee Item 10 herein for a description of the Registrant's General Partners.\n(b) Financial Information About Industry Segments\nInapplicable.\n(c) Narrative Description of Business\n(c)(1)(i) A container leasing company generally, and the Registrant specifically, is an operating business comparable to a rental car business. A customer can lease a car from a bank leasing department for a monthly charge which represents the cost of the car, plus interest, amortized over the term of the lease; or the customer can rent the same car from a rental car company at a much higher daily lease rate. The customer is willing to pay the higher daily rate for the convenience and value-added features provided by the rental car company, the most important of which is the ability to pick up the car where it is most convenient, use it for the desired period of time, and then drop it off at a location convenient to the customer. Rental car companies compete with one another on the basis of lease rates, availability of cars, and the provision of additional services. They generate revenues by maintaining the highest lease rates and the highest utilization factors that market conditions will allow, and by augmenting this income with proceeds from sales of insurance, drop-off fees, and other special charges. A large percentage of lease revenues earned by car rental companies are generated under corporate rate agreements wherein, for a stated period of time, employees of a participating corporation can rent cars at specific terms, conditions and rental rates. Buying the cars at fleet prices and selling them in the secondary market are also key elements to the successful operation of a rental car business.\nContainer leasing companies and the Registrant operate in a similar manner by owning and leasing a worldwide fleet of new and used transportation containers to international shipping companies hauling various types of goods among numerous trade routes. Each container is normally subject to drop-off and other special handling fees in addition to a daily rental rate, and all lessees must either provide physical damage and liability insurance or purchase a damage waiver from the Registrant, in which case the Registrant agrees to pay the cost of repairing any physical damage to containers caused by lessees. Container leasing companies compete with one another on the basis of lease rates, availability of equipment and services provided. Revenues and profits are generated by maintaining the highest lease rates and the highest equipment utilization factors allowed by market conditions. Rental revenues from containers result primarily under master leases which are comparable to the corporate rate agreements used by rental car companies. The master leases provide that container leasing customers, for a specified period of time, may rent containers at specific terms, conditions and rental rates. Although the terms of the master lease governing each container do not vary, the number of containers in use can vary from time to time within the term of the master lease. The terms and conditions of the master lease are similar to a\n\"triple net lease\" wherein the lessee pays a daily rental rate for the entire time the container is in his possession (whether or not he is actively using it), is responsible for any damage, and must insure the container against liabilities. Rental car companies usually purchase only new cars, but since containers are completely standardized, a used container in serviceable condition usually rents for the same rate as a new one although the purchase price is lower. The Registrant also sells containers in the course of its business if opportunities arise or at the end of the container's useful life. See \"Business of the Partnership\" in Registrant's Prospectus, as supplemented.\n(c)(1)(ii) Inapplicable.\n(c)(1)(iii) Inapplicable.\n(c)(1)(iv) Inapplicable.\n(c)(1)(v) Inapplicable.\n(c)(1)(vi) Inapplicable.\n(c)(1)(vii) No single lessee had rental billing for the year ended December 31, 1995 which was 10% or more of the total rental billing of the Registrant.\n(c)(1)(viii) Inapplicable.\n(c)(1)(ix) Inapplicable.\n(c)(1)(x) There are approximately 70 container leasing companies of which the top ten control approximately 94% of the total equipment held by all container leasing companies. The top three container leasing companies control approximately 59% of the total equipment held by all container leasing companies. Genstar, which controls approximately 28% of the equipment held by container leasing companies, is dominant in the industry. Textainer Equipment Management Limited, an Associate General Partner of the Registrant and the manager of its marine container equipment, is the fourth largest container leasing company and controls approximately 8% of the equipment held by all container leasing companies. The Registrant alone is not a material participant in the worldwide container leasing market. The principal methods of competition are price and the provision of worldwide service to the international shipping community.\n(c)(1)(xi) Inapplicable.\n(c)(1)(xii) Inapplicable.\n(c)(1)(xiii) The Registrant has no employees. Textainer Financial Services Corporation (TFS), the Managing General Partner of the Registrant, is responsible for the overall management of the Business of the Registrant and has 24 employees. Textainer Equipment Management Limited (TEM), an Associate General Partner, is responsible for the management of the leasing operations of the Registrant and has a total of 149 employees.\n(d) Financial Information About Foreign and Domestic Operations and Export Sales.\nThe Registrant is involved in the leasing of shipping containers to international shipping companies for use in world trade and approximately 14.18%, 16.63%, and 14.58%, respectively, of the Registrant's rental revenue during years ended December 31, 1995, 1994, and 1993, respectively, was derived from operations sourced or terminated domestically. These percentages do not reflect the proportion of the Partnership's income from operations generated from the domestic market. Substantially all of the Partnership's income from operations is\nderived from assets employed in foreign operations. See \"Business of the Partnership\" and \"Risk Factors\" in the Registrant's Prospectus, as supplemented.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nAs of December 31, 1995, the Registrant owned the following types and quantities of shipping equipment:\nAs of December 31, 1995, approximately 88% of these shipping and domestic storage containers were on lease to international shipping companies and to the varied users of its domestic storage containers, and the balance were being stored at a large number of storage depots located worldwide.\nFor information about the Registrant's property, see \"Business of the Partnership\" in the Registrant's Prospectus, as supplemented.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nNeither the Registrant nor the managing general partner is subject to any legal proceedings.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS.\nInapplicable.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\n(a) Market Information.\n(a)(1)(i) The units of limited partnership interest in the Registrant are not publicly traded and there is no established trading market for such Units. The Registrant has a program whereby Limited Partners may redeem Units for a specified redemption price.\n(a)(1)(ii) Inapplicable.\n(a)(1)(iii) Inapplicable.\n(a)(1)(iv) Inapplicable.\n(a)(1)(v) Inapplicable.\n(a)(2) Inapplicable.\n(b) Holders.\n(b)(1) As of January 1, 1996, there were 2,101 holders of record of limited partnership interests in the Registrant.\n(b)(2) Inapplicable.\n(c) Dividends.\nInapplicable.\nFor details of the distributions which are made quarterly by the Registrant to its limited partners, see Item 6, \"Selected Financial 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 RESULTS OF OPERATIONS.\nThe Financial Statements contain information which will assist in evaluating the financial condition of the Partnership for the years ended December 31, 1995, 1994 and 1993. Please refer to the Financial Statements and Notes thereto in connection with the following discussion.\nLIQUIDITY AND CAPITAL RESOURCES\nFrom October 1987 until October 1989 the Partnership was involved in the offering of limited partnership interests to the public. On October 26, 1989, the Partnership's offering of limited partnership interests was closed at $29,491,080.\nThe Partnership has set up a program whereby limited partners may redeem units for a specified redemption value. The redemption price is set by formula and varies depending on length of time the units are outstanding. Up to 2% of the Partnership's outstanding units may be redeemed each year, although the 2% limit may be exceeded at the Managing General Partner's discretion. All redemptions\nare subject to the Managing General Partner's good faith determination that payment for the redeemed units will not (i) cause the Partnership to be taxed as a corporation, (ii) impair the capital or operations of the Partnership, or (iii) impair the ability of the Partnership to pay distributions in accordance with its distribution policy. The Partnership paid $9,553 for the redemption of 1,250 units for the year ended December 31, 1995 and $13,511 for the redemption of 1,525 units for the equivalent period in 1994. The Partnership has used cash flow from operations to pay for the redeemed units. Although payments for redeemed units decrease the cash available for reinvestment in equipment, the Partnership believes that the redemption of units may have a positive effect on the remaining limited partners because the future income and losses attributable to the redeemed units will now be allocated to the remaining limited partners on a pro rata basis.\nPrior to its distribution or reinvestment in additional equipment, the Partnership invests working capital and cash flow from operations in short-term, highly liquid investments. It is the policy of the Partnership to maintain a minimum working capital reserve in an amount which is the lesser of (i) 1% of capital contributions or (ii) $100,000. At December 31, 1995, the Partnership's cash of $492,266 was primarily invested in a market-rate account.\nDuring the year ended December 31, 1995, the Partnership declared cash distributions to limited partners pertaining to the fourth quarter of 1994 and the first three quarters of 1995, in the amount of $2,871,656. These distributions represent 9% of original capital (measured on an annualized basis) on each unit pertaining to the fourth quarter of 1994 and 10% of original capital (measured on an annualized basis) on each unit for the first through the third quarters of 1995. On a cash basis, all of those distributions were from operations. On a GAAP basis, $240,553 of these distributions were a return of capital and the balance was from net earnings.\nFor the year ended December 31, 1995, the Partnership had net cash provided by operating activities of $4,529,450 compared with net cash provided by operating activities of $3,495,637 for the equivalent period in 1994. This increase was primarily attributable to an increase in rental income of 5% and a decrease in direct container expenses of 22%. Rental revenue increased due to higher utilization rates and average fleet size. Direct container expenses decreased mainly due to decreases in storage and maintenance and repair costs as a result of higher utilization. The average collection period of accounts receivable improved slightly from 137 days in 1994 to 133 days in 1995.\nWhile net cash from operating activities has improved, the Partnership's principal lessees, shipping lines, are currently anticipating over-capacity, due to the delivery of new ships. This over-capacity may cause shipping lines to reduce freight rates, which could affect the profitability of their business, resulting in the possibility of delays in the remittance of rental payments, pressure on container rental rates, and in extreme cases, bankruptcy of some shipping lines.\nNet cash used in investing activities (the purchase and sale of rental equipment) for the year ended December 31, 1995 was $1,755,314 and was fairly consistent with net cash used in investing activities of $1,745,117 for equivalent period of 1994.\nRESULTS OF OPERATIONS\nThe Partnership's operations, which consist of rental income, container depreciation, direct container expenses, management fees, and reimbursement of administrative expenses were directly related to the size of the container fleet (\"inventory\") during the years ended December 31, 1995, 1994 and 1993. The following is a summary of the equipment (in units) available for lease during those periods:\nRental income and direct container expenses are affected by lease utilization percentages for the equipment which were 90%, 88% and 81% on average during the years ended December 31, 1995, 1994 and 1993, respectively.\nThe following is a comparative analysis of the results of operations for the years ended December 31, 1995, 1994 and 1993.\nThe Partnership's income from operations for the years ended December 31, 1995 and 1994 was $2,446,530 and $1,617,978, respectively, on rental income of $6,478,921 and $6,158,415, respectively. The increase in rental income of $320,506, or 5% from the year ended December 31, 1994 to 1995 was primarily attributable to income from container rentals, the major component of total revenue, which increased by $304,969, or 6%, from 1994 to 1995. Income from container rentals is largely dependent upon three factors: equipment available for lease (average inventory), average on-hire (utilization) percentage, and average daily rental rates. Average inventory increased 2%, average on-hire utilization increased by two percentage points and average daily rental rates were fairly stable from the year ended December 31, 1994 to the year ended December 31, 1995. The General Partners do not expect the increase in utilization to continue over the short-term, because utilization began to decrease in the last quarter of 1995 and has continued to decline for all Equipment types owned by the Partnership in the first quarter of 1996. Utilization and\/or rental rates may also be affected by economic factors relating to the Partnership's lessees. As noted above, the Partnership's principal lessees, shipping lines, are currently anticipating over-capacity, which may adversely affect rental payments and\/or rates. Any growth in rental rates has also been restrained by quantity rate discounts granted to the Partnership's larger container lessees.\nThe Partnership's income from operations for the years ended December 31, 1994 and 1993 was $1,617,978 and $1,444,941, respectively, on rental income of $6,158,415 and $5,994,130, respectively. The increase in rental income of $164,285, or 3% from the year ended December 31, 1993 to 1994 was primarily attributable to rental income from container rentals, the major component of total revenue, which increased by $163,827 from 1993 to 1994. Average inventory increased 3.6%, average daily rental rates decreased 5% and average on-hire utilization increased 8.6%, from the year ended December 31, 1993 to the year ended December 31, 1994.\nSubstantially all of the Partnership's rental income was generated from the leasing of the Partnership's containers under short-term operating leases. There were seven direct financing leases at December 31, 1995, 1994 and 1993.\nThe balance of rental income consists of other lease-related items, primarily income from charges to the lessees for handling and returning containers less credits granted to the lessees for leasing containers from less desirable locations (location income), income from handling and returning marine containers and income from charges to lessees for a damage protection plan. For the year ended December 31, 1995, the total of these other revenue items increased by $15,537 or 2% over the equivalent period in 1994. The primary cause of the increase in other revenue was location income, which increased by $107,567, tempered by decreases in handling income of $48,507 and damage protection plan income of $39,964. The increase in location income is largely due to higher demand, which drives drop-off charges on recovery accounts and pickup charges on new units. The decrease in revenue from lessees under the damage protection plan was primarily due to the cancellation of this coverage by a large lessee. Handling income decreased primarily due to increased utilization and a decrease in per unit charges to lessees for handling and returning containers. For the year ended December 31, 1994, the total of these other revenue items increased slightly over the equivalent period in 1993, primarily due to an increase in charges to the lessees of $58,847 for pickup of containers in prime locations.\nDirect container expenses, excluding bad debt expense, decreased by $243,372, or 22% from the year ended December 31, 1994 to the same period in 1995. The primary components of this decrease were costs incurred for storage (which decreased by $69,415), maintenance and repair costs (which decreased by $59,760) and expenses accrued under the damage protection plan (which decreased by $54,921). Storage costs declined due to higher utilization rates in the year ended December 31, 1995 compared to\nthe same period in 1994. Maintenance and repair costs decreased due to fewer units being returned which required repairs and a lower average cost to repair units in the year ended December 31, 1995 compared to the equivalent period in 1994.\nDirect container expenses, excluding bad debt expense, decreased by $260,770, a 19% decrease from the year ended December 31, 1993 to the same period in 1994. The primary components of this decrease were lower costs incurred for storage, repositioning and repair expenses. Storage costs decreased due to an increase in average on-hire (utilization) percentage from 81% during the year ended December 31, 1993 to 88% during the year ended December 31, 1994. Repositioning costs decreased by $33,532 from the year ended December 31, 1993 to the year ended December 31, 1994 due to a reduced need to relocate equipment to more desirable locations because of improved utilization.\nBad debt expense decreased by $200,727 from the year ended December 31, 1994 to the equivalent period in 1995 due to lower specific reserve requirements in the year ended December 31, 1995 (primarily for two specific lessees which did not need significant additional reserves in 1995). Bad debt expense increased by $319,561 from the year ended December 31, 1993 to the same period in 1994 due to an increase in the bad debt reserve for several lessees.\nDepreciation expense decreased by $105,472 or 5% from the year ended December 31, 1994 to the same period in 1995. Similarly, depreciation expense decreased by $103,251 or 5% from the year ended December 31, 1993 to the same period in 1994. These decreases were primarily attributable to certain equipment, acquired used, which has now been fully depreciated.\nManagement fees to affiliates were $17,677 higher in the year ended December 31, 1995 than in the same period of 1994, primarily due to an increase in incentive management fees resulting from a higher distribution rate to limited partners. Incentive management fees are based on the distributions made to general and limited partners; these distributions ranged from 9% and 10% during 1995 as compared to 8% to 8.75% during 1994.\nManagement fees to affiliates were $18,473 lower in the year ended December 31, 1994 than in the same period of 1993, primarily due to lower incentive management fees. Distributions made to general and limited partners were reduced from 12% to 8% effective July 1993. The distribution rate increased from 8% in the last half of 1993 to 8.25% in the first quarter of 1994, 8.5% the second quarter and 8.75% the third quarter.\nGeneral and administrative costs to affiliates increased by 4%, or $14,441, in the year ended December 31, 1995 compared to the same period in 1994. The increase was primarily the result of an increase in overhead costs allocable to the Partnership due to its larger fleet size. General and administrative costs to affiliates increased by 17%, or $58,103 in the year ended December 31, 1994 compared to the same period in 1993, primarily due to an increase of 14% in the per unit rate of overhead costs allocated by TEM.\nOther income (expense) includes a gain on sales of equipment of $213,088 for the year ended December 31, 1995 compared to a gain of $169,914 for the equivalent period ended 1994. Interest income decreased by $3,131 from the twelve-month period ended December 31, 1994 to the comparable period in 1995. Interest expense decreased by $7,786 from the year ended December 31, 1994 to the same period ended 1995, due to termination of the credit facility.\nFor the year ended December 31, 1994, other income (expense) includes a gain on sales of equipment of $169,914 compared to a gain of $121,884 for the equivalent period ended 1993. Interest income decreased by $1,729 from the twelve-month period ended December 31, 1993 to the comparable period in 1994. Interest expense decreased by $2,701 from the year ended December 31, 1993 to the same period ended 1994.\nNet earnings per limited partnership unit increased from $1.20 to $1.79 per unit from the year ended December 31, 1994 to the same period in 1995, reflecting the increase in net earnings from $1,791,968\nto $2,668,349 for the respective periods. Similarly, net earnings per limited partnership unit increased from $1.04 to $1.20 per unit from the year ended December 31, 1993 to the year ended December 31, 1994, reflecting the increase in net earnings from $1,569,929 in 1993 to $1,791,968 in 1994.\nAlthough substantially all of the Partnership's income from operations is derived from assets employed in foreign operations, virtually all of this income is denominated in United States dollars. The Partnership is engaged in the international marine transportation industry and its containers are generally operated on the international high seas rather than on domestic waterways. As described in the prospectus under the caption \"Business Risks: Economic Factors Affecting Profitability\", the Partnership's Equipment is subject to the risk of war or other political, economic or social occurrence where the Equipment is used, which may result in the loss of Equipment which, in turn, may have a material impact on the Partnership's results of operations and financial condition. The General Partners are not aware of any conditions which would result in such risk materializing.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA.\nAttached pages 10 to 22.\nIndependent Auditors' Report\nThe Partners TCC Equipment Income Fund:\nWe have audited the accompanying balance sheets of TCC Equipment Income Fund (a California limited partnership) as of December 31, 1995 and 1994, and the related statements of earnings, partners' capital and cash flows for the years ended December 31, 1995, 1994 and 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 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 TCC Equipment Income Fund as of December 31, 1995 and 1994, and the results of its operations, its partners' capital, and its cash flows for the years ended December 31, 1995, 1994 and 1993, in conformity with generally accepted accounting principles.\nKPMG Peat Marwick LLP\nSan Francisco, California March 27, 1996\nTCC EQUIPMENT INCOME FUND (A CALIFORNIA LIMITED PARTNERSHIP)\nBALANCE SHEETS December 31, 1995 and 1994\nSee accompanying notes to financial statements\nTCC EQUIPMENT INCOME FUND (A CALIFORNIA LIMITED PARTNERSHIP)\nSTATEMENTS OF EARNINGS Years ended December 31, 1995, 1994 and 1993\nSee accompanying notes to financial statements\nTCC EQUIPMENT INCOME FUND (A CALIFORNIA LIMITED PARTNERSHIP)\nSTATEMENTS OF PARTNERS' CAPITAL Years ended December 31, 1995, 1994 and 1993\nSee accompanying notes to financial statements\nTCC EQUIPMENT INCOME FUND (A CALIFORNIA LIMITED PARTNERSHIP)\nSTATEMENTS OF CASH FLOWS Years ended December 31, 1995, 1994 and 1993\nSee accompanying notes to financial statements\nTCC EQUIPMENT INCOME FUND (A CALIFORNIA LIMITED PARTNERSHIP)\nSTATEMENTS OF CASH FLOWS -- CONTINUED Years ended December 31, 1995, 1994 and 1993\nSUPPLEMENTAL DISCLOSURES:\nSupplemental schedule of non-cash investing and financing activities:\nThe following table summarizes the amounts of equipment purchases, distributions to partners, and proceeds from sale of container rental equipment which had not been paid or received by the Partnership as of December 31, 1995, 1994, 1993 and 1992, resulting in differences in amounts recorded and amounts of cash disbursed or received by the Partnership, as shown in the Statements of Cash Flows.\nThe following table summarizes the amounts of equipment purchases, distributions to partners, and proceeds from sale of container rental equipment recorded by the Partnership and the amounts paid or received as shown in the Statements of Cash Flows for the years ended December 31, 1995, 1994 and 1993.\nSee accompanying notes to financial statements\nTCC EQUIPMENT INCOME FUND (A CALIFORNIA LIMITED PARTNERSHIP)\nNOTES TO FINANCIAL STATEMENTS Years ended December 31, 1995, 1994 and 1993\nNOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\n(a) NATURE OF OPERATIONS\nTCC Equipment Income Fund (TEIF or the Partnership), a California limited partnership, was formed on August 3, 1987 to engage in the business of owning, leasing and selling both new and used equipment related to the international containerized cargo shipping industry, including, but not limited to, containers, marine vessels, trailers, and other container-related equipment (the Equipment). TEIF offered units representing limited partnership interests (Units) to the public until October 26, 1989, the close of the offering period, when a total of 1,474,559 Units had been purchased for a total of $29,491,180.\nTextainer Financial Services Corporation (TFS) is the managing general partner of the Partnership (prior to its name change on April 4, 1994, TFS was known as Textainer Capital Corporation). TFS is a wholly-owned subsidiary of Textainer Capital Corporation (TCC) (prior to its name change on April 4, 1994, TCC was known as Textainer (Delaware), Inc.). Textainer Equipment Management Limited (TEM) (prior to being redomiciled on December 20, 1994, TEM was known as Textainer Equipment Management N.V.) and Textainer Limited (TL) are associate general partners of the Partnership. The managing general partner and the associate general partners are collectively referred to as the General Partners and are commonly owned by Textainer Group Holdings Limited (TGH). The General Partners also act in this capacity for other limited partnerships. Textainer Acquisition Services Limited (TAS) is an affiliate of the General Partners which performs services relative to the acquisition of Equipment outside the United States on behalf of the Partnership. TCC Securities Corporation (TSC), a licensed broker and dealer in securities and an affiliate of the General Partners, was the managing sales agent for the offering of Units for sale. The General Partners manage and control the affairs of the Partnership.\n(b) BASIS OF ACCOUNTING\nThe Partnership utilizes the accrual method of accounting. Revenue is recorded when earned according to the terms of the container rental contracts. These contracts are typically for a one-year term and are classified as operating leases, or direct financing leases if they so qualify under Statement on Financial Accounting Standards No. 13: \"Accounting for Leases\". Certain estimates and assumptions were made by the Partnership's management that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.\n(c) CASH EQUIVALENTS\nFor purposes of the Statements of Cash Flows, the Partnership considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.\n(d) CONTAINER RENTAL EQUIPMENT\nThe Equipment is carried at the lower of cost of the assets purchased, which includes acquisition fees, or the estimated recoverable value of such assets. Depreciation of new equipment is computed using the straight-line method over its estimated useful life of 12 years to a 28% salvage value. Used equipment is depreciated based upon its estimated remaining useful life at the date of acquisition (from 2 to 11 years). When assets are retired or otherwise\nTCC EQUIPMENT INCOME FUND (A CALIFORNIA LIMITED PARTNERSHIP)\nNOTES TO FINANCIAL STATEMENTS--CONTINUED\ndisposed of, the cost and related accumulated depreciation are removed from the accounts and any resulting gain or loss is recognized in income for the period.\nIn March 1995, the Financial Accounting Standards Board issued Statement No. 121, \"Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed\" (SFAS 121). The Company adopted SFAS 121 during 1995. In accordance with SFAS 121, the Company periodically reviews the carrying value of the Equipment to expected future market conditions for the purpose of assessing the recoverability of the recorded amounts. There were no reductions to the carrying value of the Equipment made during 1995.\n(e) NATURE OF INCOME FROM OPERATIONS\nAlthough substantially all of the Partnership's income from operations is derived from assets employed in foreign operations, virtually all of this income is denominated in United States dollars. The Partnership's customers are international shipping lines that transport goods on international trade routes. Once the Equipment is on-hire with a lessee, the partnership has no way of knowing its location. The domicile of the lessee is not indicative of where the lessee is transporting the Equipment. The Partnership's business risk in its foreign operations lies with the creditworthiness of the lessees rather than the geographic location of the Equipment or the domicile of the lessees.\n(f) ALLOCATION OF NET EARNINGS AND PARTNERSHIP DISTRIBUTIONS\nIn accordance with the Partnership Agreement, net earnings or losses, syndication and offering costs and partnership distributions are allocated 1% to the General Partners and 99% to the limited partners, with the exception of gains on sales of containers. Such gains are allocated to the General Partners to the extent that their capital accounts' deficits exceed the portion of syndication and offering costs allocated to them. On termination of the Partnership, the General Partners shall be allocated gross income equal to their allocations of syndication and offering costs.\nActual cash distributions to the limited partners differ from the allocated net earnings as presented in these financial statements because cash distributions are based on cash available for distribution. Cash distributions are paid to the general and limited partners on a quarterly basis in accordance with the provisions of the Partnership Agreement.\n(g) INCOME TAXES\nThe Partnership is not subject to income taxes. Accordingly, no provision for income taxes has been made. The Partnership files federal and state information returns only. Taxable income or loss is reportable by the individual partners.\n(h) ACQUISITION FEES\nIn accordance with the Partnership Agreement, acquisition fees are paid to the General Partners or TAS equal to 5% of the Equipment purchase price (see note 2). These fees are capitalized as part of the cost of the Equipment.\n(i) DAMAGE PROTECTION PLAN\nThe Partnership offers a Damage Protection Plan (the Plan) to lessees of its Equipment. Under the terms of the Plan, the Partnership earns additional revenues on a daily basis and, as a result, has agreed to bear certain repair costs. It is the Partnership's policy to recognize revenue when earned and to provide a reserve sufficient to cover the Partnership's obligation\nTCC EQUIPMENT INCOME FUND (A CALIFORNIA LIMITED PARTNERSHIP)\nNOTES TO FINANCIAL STATEMENTS--CONTINUED\nfor estimated repair costs. At December 31, 1995 and 1994, this reserve was equal to $129,304 and $145,061, respectively.\n(j) WARRANTY CLAIM\nDuring 1992 and 1995, the Partnership settled warranty claims against an equipment manufacturer. The Partnership will amortize the settlement amounts over the remaining estimated useful life of the applicable equipment (seven years), reducing maintenance and repair costs over that time. At December 31, 1995 and 1994, the unamortized portion of the settlement amounts was equal to $323,707 and $172,400, respectively, and was included in accrued liabilities.\n(k) LIMITED PARTNERS' PER UNIT SHARE OF NET EARNINGS AND DISTRIBUTIONS\nLimited partners' per unit share of both net earnings and distributions were computed using the weighted average number of units outstanding during each year of the Partnership's operations which was 1,472,471, 1,474,143 and 1,474,554 during the years ended December 31, 1995, 1994 and 1993, respectively.\n(l) REDEMPTIONS\nThe following redemption offerings were consummated by the Partnership during the years ended 1995 and 1994:\nThe redemption price is fixed by formula and varies depending on the length of time the units are outstanding.\n(m) FAIR VALUE OF FINANCIAL INSTRUMENTS\nTo meet the reporting requirements of Financial Accounting Standards Board Statement No. 107, \"Disclosures about Fair Value of Financial Instruments,\" the Company calculates the fair value of financial instruments and includes this additional information in the notes to the financial statements when the fair value is different than the book value of those financial instruments. At December 31, 1995, the fair value of the Company's financial instruments approximates the related book value of such instruments.\n(n) RECLASSIFICATIONS\nCertain reclassifications, not affecting net earnings, have been made to prior year amounts in order to conform with the 1995 financial statement presentation.\nTCC EQUIPMENT INCOME FUND (A CALIFORNIA LIMITED PARTNERSHIP)\nNOTES TO FINANCIAL STATEMENTS--CONTINUED\nNOTE 2. TRANSACTIONS WITH AFFILIATES\nDuring the offering period, the Partnership paid a managing sales agent fee to TSC of up to 9% of the gross proceeds from the sale of limited partnership units, from which TSC paid commissions to independent participating broker\/dealers who participated in the offering. Additionally, the Partnership reimbursed the General Partners and TSC for certain organizational and offering costs, incurred in connection with the organization of the Partnership, up to a maximum of 5% of gross proceeds raised as allowed in the Partnership Agreement. These amounts, which totaled $3,606,105 were deducted as syndication and offering costs in the determination of net limited partnership contributions. Organization expenses, which resulted from the formation of the Partnership, were capitalized as organization costs and were fully amortized in 1993.\nAs part of the operation of the Partnership, the Partnership is to pay to the General Partners (or TAS) an incentive management fee, an acquisition fee, an equipment management fee and an equipment liquidation fee. These fees are for various services provided in connection with the administration and management of the Partnership. The Partnership capitalized $121,692, $110,963 and $88,430 of equipment acquisition fees as part of Equipment costs during the years ended December 31, 1995, 1994 and 1993, respectively, and incurred $124,286, $106,996, and $124,121 of incentive management fees during the same periods. No equipment liquidation fees were paid in 1995, 1994 or 1993.\nThe Equipment of the Partnership is managed by TEM. Prior to selling its storage fleet in 1995 (note 6), TEM had entered into an agreement with its 100%-owned subsidiary, Textainer Storage Services (TSS) to manage storage containers. In its role as manager, TEM has authority to acquire, hold, manage, lease, sell and dispose of the Partnership's Equipment. TEM holds, for the payment of direct operating expenses, a reserve of cash that has been collected from leasing operations; such cash is included in the amount due from affiliates at December 31, 1995 and 1994. Subject to certain reductions, TEM receives a monthly equipment management fee equal to 7% of gross lease revenues attributable to operating leases and 2% of gross lease revenues attributable to full payout net leases. Such fee is either retained by TEM or, prior to the sale of its storage fleet, such fees allocable to TSS were passed through by TEM for services rendered. In 1995, 1994 and 1993, equipment management fees totaled $434,760, $434,373, and $435,721, respectively. The Partnership's Equipment is or was leased by TEM and TSS to third party lessees on operating master leases, spot leases and term leases. The majority of the Partnership's leases are operating leases with limited lives and no purchase option.\nCertain indirect general and administrative costs incurred in performing administrative services necessary to the operation of the Partnership are borne by TEM (and, prior to the sale of the Partnership's storage fleet in 1995, TSS), and are allocated to the Partnership based on the ratio of the Partnership's interest in managed Equipment to the total equipment managed by TEM or TSS for the period. Indirect general and administrative costs allocated to the Partnership were $351,895, $338,611 and $306,557 for the years ended December 31, 1995, 1994 and 1993, respectively.\nTFS also incurred general and administrative costs of $66,155, $64,998 and $38,949 during 1995, 1994 and 1993 respectively, which were reimbursed by the Partnership.\nThe General Partners, or TAS, may acquire Equipment in their own name and hold title on a temporary basis for the purpose of facilitating the acquisition of such Equipment for the Partnership. The Equipment may then be resold to the Partnership on an all-cash basis at a price equal to the actual cost, as defined in the Partnership Agreement. In addition, the General Partners, or TAS, are entitled to an acquisition fee for any Equipment resold to the Partnership.\nTCC EQUIPMENT INCOME FUND (A CALIFORNIA LIMITED PARTNERSHIP)\nNOTES TO FINANCIAL STATEMENTS--CONTINUED\nAt December 31, due from and to affiliates are comprised of:\nIncluded in the amounts due to TFS is $435,000 in loans used to facilitate equipment purchases. All other amounts receivable from and payable to affiliates were incurred in the ordinary course of business between the Partnership and its affiliates and represent timing differences in the accrual and payment of expenses and fees described above or in the accrual and payment of net rental revenues from TEM and TSS.\nPrior to July 1994, it was the policy of the Partnership and the General Partners to charge interest on intercompany balances outstanding for more than one month. Interest was charged at the prime rate plus 2%. As of July 1994, this policy was changed so that the Partnerships are not charged interest on intercompany balances except for loans on equipment purchases. The Partnership incurred interest expense of $3,529, $3,704 and $8,543, respectively, on intercompany balances payable to TFS and TEM for the years ended December 31, 1995, 1994 and 1993.\nNOTE 3. RENTALS UNDER OPERATING LEASES\nThe following is a schedule by year of minimum future rentals receivable on noncancelable operating leases as of December 31, 1995:\nNOTE 4. DIRECT FINANCING LEASES\nDuring 1990, the Partnership purchased and in turn leased 100 refrigerated containers for an eight-year term. The lease agreement provides the lessee with an option to purchase the containers for $1 at the expiration of the lease term. The total receivable over the term of the lease from inception is $2,980,440.\nDuring 1992, the Partnership converted 32 containers to two three-year term direct financing leases. The total receivable over the terms of the leases from inception is $42,270.\nDuring 1993, the Partnership converted 15 containers to one 23-month term, one two-year term and two three-year term direct financing leases. The total receivable over the terms of the leases from inception is $19,865.\nTCC EQUIPMENT INCOME FUND (A CALIFORNIA LIMITED PARTNERSHIP)\nNOTES TO FINANCIAL STATEMENTS--CONTINUED\nDuring 1994, the Partnership converted 24 containers to four three-year term direct financing leases and one six-month term direct financing lease. The total receivable over the terms of the leases from inception is $56,323.\nDuring 1995, the Partnership converted two containers to one three-year term direct financing lease. The total receivable over the terms of the lease from inception is $3,395.\nThe components of the net investment in direct financing leases as of December 31, 1995 and 1994 are as follows:\nThe following is a schedule by year of minimum lease payments receivable under the direct financing leases as of December 31, 1995:\nRental income for the years ended December 31, 1995, 1994, and 1993 includes $134,609, $169,855 and $191,299, respectively, of income from direct financing leases.\nNOTE 5. INCOME TAXES\nAt December 31, 1995, 1994 and 1993, there were temporary differences of $9,157,373, $10,529,060 and $8,239,633, respectively between the financial statement carrying value of certain assets and liabilities and the federal income tax bases of such assets and liabilities. The reconciliation of net income for financial statement purposes to net income (loss) for federal income tax purposes for the years ended December 31, 1995, 1994 and 1993 is as follows:\nTCC EQUIPMENT INCOME FUND (A CALIFORNIA LIMITED PARTNERSHIP)\nNOTES TO FINANCIAL STATEMENTS--CONTINUED\nNOTE 6. SALE OF STORAGE FLEET\nIn August 1995, the Partnership sold its container storage fleet, managed by TSS, to an unrelated purchaser. The proceeds from the sale were $19,780 compared to the Partnership's cost basis in the equipment of $15,293. The resulting gain from the sale was $4,487. The Partnership has invested the proceeds from the sale into marine container rental equipment.\nITEM 9","section_9":"ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nThere have been none.\nPART III\nITEM 10","section_9A":"","section_9B":"","section_10":"ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe Registrant has no officers or directors.\nAs described in the Prospectus, the Registrant's three original partners were TCC, TEM and TI which have comprised the Textainer Group. Effective October 1, 1993, the Textainer Group streamlined its organization by forming a new holding company, Textainer Group Holdings Limited (TGH), and the shareholders of the underlying companies which include the General Partners have accepted shares in TGH in exchange for their shares in the individual companies. Textainer Financial Services Corporation (TFS) is the managing general partner of the Partnership (prior to its name change on April 4, 1994, TFS was known as Textainer Capital Corporation). TFS is a wholly-owned subsidiary of Textainer Capital Corporation (TCC) (prior to its name change on April 4,1994, TCC was known as Textainer (Delaware) Inc.). Textainer Equipment Management Limited (TEM) is an associate general partner of the Partnership. Textainer Inc. (TI) was an associate general partner of the Partnership through September 30, 1993 when it was replaced in that capacity by Textainer Limited (TL) pursuant to a corporate reorganization effective October 1, 1993 which caused TFS, TEM and TL to fall under the common ownership of Textainer Group Holdings Limited. (The managing general partner and associate general partners are collectively referred to as the General Partners). Pursuant to this restructuring, TI has transferred substantially all of its assets including all of its rights and duties as associate general partner to TL. This transfer is effective from October 1, 1993. The end result is that TFS, TEM and TL now serve as General Partners for the Registrant and are wholly-owned or substantially-owned subsidiaries of TGH. The General Partners also act in this capacity for three other limited partnerships as of December 31, 1995. Textainer Acquisition Services Limited (TAS) is an affiliate of the General Partners which performs services relative to the acquisition of Equipment outside the United States on behalf of the Partnership. TCC Securities Corporation (TSC), a licensed broker and dealer in securities and an affiliate of the General Partners, was the managing sales agent for the offering of Units for sale.\nTFS, as the Managing General Partner, is responsible for managing the administration and operation of the Registrant, and for the formulation and administration of investment policies.\nTEM, an Associate General Partner, manages all aspects of the operation of the Registrant's Equipment.\nTL, an Associate General Partner, owns a fleet of container rental equipment which is managed by TEM. TL provides advice to the Partnershp regarding negotiations with financial institutions, manufacturers and equipment owners, and regarding the terms upon which particular items of Equipment are acquired.\nCompliance with Section 16(a) of the Securities Exchange Act of 1934.\nSection 16(a) of the Securities Exchange Act of 1934 requires the Partnership's general partners, policy-making officials and persons who own more than ten percent of the Units to file reports of ownership and changes in ownership with the Securities and Exchange Commission. Copies of these reports must also be furnished to the Partnership.\nBased solely on a review of the copies of such forms furnished to the Partnership or on written representations that no forms were required to be filed, the Partnership believes that with respect to its most recent fiscal year ended December 31, 1995, all Section 16(a) filing requirements were complied with, except that Philip K. Brewer, Laura J. Cashion and Ernest J. Furtado all filed their initial statement of beneficial interest on Form 3 late. None of the foregoing failed to file or filed late any reports of transactions in the Units.\nThe directors and executive officers of the General Partners are as follows:\nNeil I. Jowell is Director and Chairman of TGH, TFS, TCC, TL and TEM and a member of the Investment Advisory Committee (see \"Committees\" below). He has served on the Board of Trencor Ltd. since 1966 and as Chairman since 1973. He is also a director of Mobile Industries, Ltd. (1969 to present), an Affiliate of Trencor, and a non-executive director of Forward Corporation Ltd. (1993 to present). Trencor is a publicly traded diversified industrial group listed on the Johannesburg Stock Exchange. its business is the leasing, owning, managing and financing of marine cargo containers worldwide and the manufacture and export of containers for international markets. In South Africa, it is engaged in manufacturing, transport, trading and exports of general commodities. Trencor also has an interest in Forward Corporation Ltd., a publicly traded holding company listed on the Johannesburg Stock Exchange. It has interests in industrial and consumer businesses operating in South Africa and abroad. Mr. Jowell became affiliated with the General Partners and its affiliates when Trencor became, through its beneficial ownership in two controlled companies, a major shareholder of the Textainer Group in 1992. Mr. Jowell has over 36 years' experience in the transportation industry. He holds an M.B.A. degree from Columbia University and a B.Com.L.L.B. from the University of Cape Town.\nJames E. Hoelter is President and Chief Executive Officer of TGH and TL, Vice President of TFS and TCC, and a director of TGH, TFS, TCC, TEM, TL and TSC. As President and Chief Executive Officer of TGH, Mr. Hoelter is responsible for overseeing the management of, and coordinating the activities of, TFS, TEM and TL. He is also responsible for overseeing TEM's equipment management operations. In addition, Mr. Hoelter is Chairman of the Credit Committee, the Investment Advisory Committee and the Equipment Investment Committee (see \"Committees\", below). Prior to joining the Textainer Group in 1987, Mr. Hoelter was president of Intermodal Equipment Associates (\"IEA\") in San\nFrancisco, California, from the company's inception in 1979 until 1987. Mr. Hoelter co-founded IEA and directed its sponsorship of ten public and private investment programs, which provided more than $100 million of equity from 10,000 investors. From 1976 to 1978, Mr. Hoelter was Vice President - North America for Trans Ocean Ltd., San Francisco, a marine container leasing company, where he was responsible for all leasing operations in that area. From 1971 to 1976, he was associated with Itel Corporation, San Francisco, where he held a number of positions, the most recent of which was director of financial leasing for Itel's Container Division. Mr. Hoelter received his B.B.A. in business administration from the University of Wisconsin, where he currently serves as a member of its Business School's Dean's Advisory Board, and his M.B.A. from the Harvard Graduate School of Business Administration.\nJohn A. Maccarone is President and CEO of TEM and a director of TGH, TL, TEM, TFS, TCC and TSC. In this capacity he is responsible for the performance of TEM's worldwide fleet of marine cargo containers. Additionally, he is a member of the Equipment Investment Committee, the Credit Committee and the Investment Advisory Committee (see \"Committees\", below). Mr. Maccarone was instrumental in cofounding IEA with Mr. Hoelter and held a variety of executive positions with IEA from 1979 until 1987, when he joined the Textainer Group. Mr. Maccarone was previously a Director of Marketing for Trans Ocean Leasing Corporation in Hong Kong with responsibility for all leasing activities in Southeast Asia. From 1969 to 1977, Mr. Maccarone was a marketing representative for IBM Corporation. He holds a B.S. degree in Engineering Management from Boston University and an M.B.A. from Loyola University of Chicago.\nSusan L. Fiddaman is President, Chief Executive Officer of TFS, TCC and TSC and a director of TFS, TCC and TEM. In this capacity Mrs. Fiddaman is responsible for the organization, marketing and aftermarket support of TFS' investment programs. She is also President and Chief Executive Officer of TFS. Additionally, she is a member of the Equipment Investment Committee and the Investment Advisory Committee (see \"Committees\", below). Prior to joining Textainer in January 1989, Mrs. Fiddaman was a branch manager and OSJ from 1985 through 1988 for the financial planning firm Investment Management and Research, Inc. in Palo Alto, California. Between 1983 and 1985, she was president of PLM Securities Corp. in San Francisco, and between 1979 and 1983, she was a senior vice president of Fox Financial Corporation in Foster City, California. Mrs. Fiddaman holds an M.B.A. from Pepperdine University and a B.A. in English Literature from the University of California at Berkeley.\nJohn R. Rhodes is Executive Vice President and Chief Financial Officer of TGH, TL, TEM, TFS and TCC and a director of TEM, TFS and TCC. In this capacity he is responsible for all accounting, financial management, and reporting functions for the Textainer Group. He is also a member of the Credit Committee, the Equipment Investment Committee and Investment Advisory Committee (see \"Committees\", below). Prior to joining Textainer in November 1987, Mr. Rhodes was vice president of finance for Greenbrier Capital Corporation in San Francisco, a trailer leasing and management company, from 1986 to 1987; from 1981 to 1985, he was employed by Gelco Rail Services, an intermodal refrigerated trailer company in San Francisco, first in the capacity of vice president and controller and then as senior vice president and general manager. Mr. Rhodes' earlier business affiliations include serving as vice president and general manager of Itel Capital Corporation and as senior accountant with Arthur Andersen & Co., both in San Francisco. He is a Certified Public Accountant and holds a B.A. in economics from Stanford University and an M.B.A. in accounting from Golden Gate University.\nAlex M. Brown is a director of TGH, TFS, TCC, TL, TEM and TSC. Additionally, he is a member of the Equipment Investment Committee and the Investment Advisory Committee (see \"Committees\", below). Mr. Brown became affiliated with the Textainer Group in April 1986. From August 4, 1987 until October 1993, he was President and Chief Executive officer of Textainer, Inc. and the Chairman of the Textainer Group. From June 1993 to present, Mr. Brown has been Chief Executive Officer of AAF, a company affiliated with Trencor Ltd. AAF is a publicly listed company on the London Stock Exchange and is involved in manufacturing and leasing modular buildings and construction scaffolding. Mr. Brown is Chairman of WACO International Corporation, which is based in Cleveland, Ohio. WACO manufactures, rents and erects scaffolding and other associated construction products throughout the USA. Mr. Brown was the managing director of Cross County Leasing in England from 1984 until it was acquired by Textainer in 1986.\nHarold J. Samson is a director of TGH, TL and TSC and is a member of the Investment Advisory Committee (see \"Committees\", below). Mr. Samson served as a consultant to various securities firms since 1981 to 1989. From 1974 to 1981 he was Executive Vice President of Foster & Marshall, Inc., a New York Stock Exchange member firm based in Seattle. Mr. Samson was a director of\nIEA from 1979 to 1981. From 1957 to 1984 he served as Chief Financial Officer in several New York Stock Exchange member firms. Mr. Samson holds a B.S. in Business Administration from the University of California, Berkeley and is a California Certified Public Accountant.\nAnthony C. Sowry is Vice President - Operations and Acquisitions for TEM. Mr. Sowry supervises all international container operations and maintenance and technical functions for the fleets under management. In addition, he is responsible for the acquisition of all new and used containers for the Textainer Group. He began his affiliation with TEM in 1988 and previously served as Fleet Quality Control Manager for Textainer Inc. from 1982 through March 1988. He is also a member of the Credit Committee and the Equipment Investment Committee (see \"Committees\", below). From 1980 to 1982, he was operations manager for Trans Container Services in London; and from 1978 to 1982, he was a technical representative for Trans Ocean Leasing, also in London. He received his B.A. degree in business management from the London School of Business. Mr. Sowry is a member of the Technical Committee of the International Institute of Container Lessors and a certified container inspector.\nDavid A. Cornelius is based in Singapore and is Vice President - Far East for TEM, in which capacity he is responsible for coordinating all leasing activities in the Pacific Rim. Mr. Cornelius has held numerous positions within TEM over the past twelve years including South Pacific Area Manager in New Zealand, Marketing Director -Western Americas, Canada and Mexico, Director of Refrigerated Container marketing, Director of Capital Markets, and most recently Marketing Director - North Europe. Mr. Cornelius is a graduate of Lynfield College in Auckland, New Zealand.\nJens W. Palludan is based in New York and is Vice President - Americas\/Africa\/Australia for TEM, responsible for coordinating all leasing activities in North and South America, Africa and Australia\/New Zealand. Mr. Palludan spent his career from 1969 through 1992 with Maersk Line of Copenhagen, Denmark in a variety of key management positions in both Denmark and overseas. .His most recent post prior to joining TEM in 1993 was General Manager, Equipment and Terminals, where he was responsible for a fleet of over 200,000 TEUs. Mr. Palludan holds an M.B.A. from the Centre European D'Education Permanente, Fontainebleau, France.\nRobert S.A. Goodall is based in London and is Vice President - Europe\/Middle East\/India for TEM, in which capacity he is responsible for coordinating all leasing activities in these three areas of operation. Mr. Goodall joined TEM in September 1994. Previously, Mr. Goodall spent his career from July 1990 until August 1994 with Tiphook Container Rental, during which time he held numerous senior marketing positions within the company. He was responsible for setting up their green field operation in North America, which he successfully ran from inception for three years. Mr. Goodall also spearheaded a quality program within the company which received ISO accreditation for the Tank Container operation and associated business areas. Mr. Goodall has spent nearly sixteen years in the container leasing and transport industry. Mr. Goodall graduated from Bloxham College, Oxfordshire and Business Studies at West London College.\nRobert D. Pedersen is based in San Francisco and is Senior Vice President - Marketing for TEM, responsible for worldwide sales and marketing related activities. Mr. Pedersen is also in charge of TEM's refrigerated container marketing program, and is a member of the Credit Committee (see \"Committees\" below). He joined TEM in 1991 as Regional Vice President for the Americas Region. Mr. Pedersen has extensive experience in the industry having held a variety of positions with Maersk Line, a container shipping line (from 1978 to 1984), XTRA, a container lessor (1985 to 1988) and Klinge Cool, a manufacturer of refrigerated container cooling units (1989 to 1991), where he was worldwide sales and marketing director. Mr. Pedersen is a graduate of the A.P. Moller shipping and transportation program and Merkonom Business School in Copenhagen, majoring in Company Organization..\nStefan Mackula is Vice President - Equipment Resale for TEM, in which capacity he coordinates the worldwide sale of equipment into secondary markets. Mr. Mackula also served as Vice President - Marketing for TEM, in which capacity he was responsible for coordinating all leasing activities in Europe, Africa, and the Middle East. He joined TEM in 1983 as Leasing Manager for the United Kingdom. Prior to joining TEM, Mr. Mackula held, beginning in 1972, a variety of positions in the international container shipping industry.\nErnest J. Furtado is Vice President, Finance and Assistant Secretary of TGH, TEM and TL, in which capacity he is responsible for all accounting, financial management, and reporting functions for TGH, TEM and TL. Prior to joining Textainer in May 1991, Mr. Furtado was controller for Itel Instant\nSpace and manager of accounting for Itel Containers International Corporation, both in San Francisco, from 1984 to 1991. Mr. Furtado's earlier business affiliations include serving as audit manager for Wells Fargo Bank and as senior accountant with John F. Forbes & Co., both in San Francisco. He is a Certified Public Accountant and holds a B.S. in business administration from the University of California at Berkeley and an M.B.A. in information systems from Golden Gate University.\nRichard G. Murphy is Vice President, Financial Administration for TEM. Mr. Murphy is responsible for all credit and risk management functions for TEM and supervises the administrative aspects of equipment acquisitions. He is a member of and acts as secretary to the Credit and Equipment Investment Committees (see \"Committees\", below). He previously served as Director of Credit and Risk Management from 1989 to 1991 and as Controller from 1988 to 1989. Prior to the takeover of the management of the Interocean Leasing Ltd. fleet by TEM in 1988, Mr. Murphy held various positions in the accounting and financial areas with that company from 1980, acting as Chief Financial Officer from 1984 to 1988. Prior to 1980, he held various positions with firms of public accountants in the U.K. Mr. Murphy is an Associate of the Institute of Chartered Accountants in England and Wales and holds a Bachelor of Commerce degree from the National University of Ireland.\nJanet S. Ruggero is Vice President, Administration and Marketing Services for TEM. Ms. Ruggero is responsible for the tracking and billing of fleets under TEM management, including direct responsibility for ensuring that all data is input in an accurate and timely fashion. She assists the marketing and operations departments by providing statistical reports and analyses and serves on the Credit Committee (see \"Committees\", below). Prior to joining Textainer in 1986, Ms. Ruggero held various positions with Gelco CTI over the course of 15 years, the last one as Director of Marketing and Administration for the North American Regional office in New York City. She has a B.A. in education from Cumberland College.\nDr. Adnan Z. Abou Ayyash is a director of TGH and TL. Since 1974 he has been General Manager and Chief Executive Officer of one of the largest firms of consulting engineers in Saudi Arabia, Rashid Engineering. Dr. Adnan Abou Ayyash holds a B.S. degree in Civil Engineering from the American University of Beirut, as well as M.S. and Ph.D. degrees in Civil Engineering from the University of Texas.\nSheikh Isam K. Kabbani is a director of TGH and TL. He is Chairman and principal stockholder of the IKK Group, Jeddah, Saudi Arabia, a manufacturing and trading group which is active both in Saudi Arabia and internationally. In 1959 Sheikh Isam Kabbani joined the Saudi Arabian Ministry of Foreign Affairs, and in 1960 moved to the Ministry of Petroleum for a period of ten years. During this time he was seconded to the Organization of Petroleum Exporting Countries (OPEC). After a period as Chief Economist of OPEC, in 1967 he became the Saudi Arabian member of OPEC's Board of Governors. In 1970 he left the ministry of Petroleum to establish his own business, the National Marketing Group, which has been his principal business activity for the past 17 years. Sheikh Kabbani holds a B.A. degree from Swarthmore, College, Pennsylvania, and an M.A. degree in Economics and International Relations from Columbia University.\nS. Arthur Morris is a director of TGH, TL and TEM. He is a founding partner in the firm of Morris and Kempe, Chartered Accountants (1962-1977) and currently functions as a correspondent member of a number of international accounting firms through his firm Arthur Morris and Company (1978 to date). He is also President and director of Continental Management Limited (1977 to date). Continental management Limited is a Bermuda corporation that provides corporate representation, administration and management services; and corporate and individual trust administration services. Mr. Morris has over 30 years experience in public accounting and serves on numerous business and charitable organizations in the Cayman Islands and Turks and Caicos Islands. Mr. Morris became a director of TL in 1993.\nDudley R. Cottingham is Assistant Secretary and a director of TGH, TL and TEM. He is a partner with Arthur Morris and Company (1977 to date) and a Vice President and director of Continental Management Limited (1978 to date), both in the Cayman Islands and Turks and Caicos Islands. Continental management Limited is a Bermuda corporation that provides corporate representation, administration and management services; and corporate and individual trust administration services. Mr. Cottingham has over 20 years experience in public accounting with responsibility for a variety of international and local clients. Mr. Cottingham became a director of TL in 1993.\nJames S. McCaffrey is Vice President - Finance of TFS and TCC. In this capacity he is responsible for all accounting, financial management, and reporting functions for TFS. He is a member of and acts as secretary to the Investment Advisory Committee (see \"Committees\" below). Prior to joining Textainer in July 1993, Mr. McCaffrey was vice president of finance for Meridian Point Properties, a real estate syndication and management company, from 1985 to 1993; from 1983 to 1985 he was employed by Trans-west Capital as controller and chief financial officer. Mr. McCaffrey's earlier business affiliations include serving as manager of financial reporting for Fox and Carskadon Financial Corporation and as a senior accountant with Arthur Andersen & Co. Mr. McCaffrey is a Certified Public Accountant and holds a B.S. in business administration and mathematics from Southern Oregon State College.\nLaura J. Cashion is Controller of TFS and TCC. In this capacity, she is responsible for all accounting, financial management and reporting functions for TFS. Prior to joining Textainer in August 1995, Ms. Cashion was employed by Ross Systems, Inc., a software company, from 1991 to 1995, first in the capacity of Finance Manager and then as North American Controller. From 1986 to 1991, she was employed by Ernst and Young as an audit manager. From 1983 to 1986, Ms. Cashion held various positions with Vesteq Financial Corporation, a real estate syndication and management company. Ms. Cashion is a Certified Public Accountant and holds a B.S. in business administration from California State University, Hayward.\nJeanene K. Gomes is Assistant Secretary of TFS and TCC and Secretary and Compliance Officer of TFS and TCC. Ms. Gomes is responsible for administering the public partnerships sponsored by the Textainer Group. Ms. Gomes is responsible for ensuring that all data relating to investor accounts is input, monitored, and stored in a timely manner and in accordance with the limited partnership agreement for each of the partnerships as well as state and federal securities regulations. Ms. Gomes oversees all communications with the limited partners and as such directly supervises all personnel in performing this function. As compliance officer for TFS, Ms. Gomes is responsible for ensuring compliance with all securities regulations. Ms. Gomes also serves on the Investor Advisory Committee. Ms. Gomes holds five securities licenses and was, prior to joining Textainer in 1989, the compliance officer for CIS Investment Corporation, a broker-dealer.\nPhilip K. Brewer is Senior Vice President - Capital Markets of TL. Mr. Brewer is responsible for optimizing the capital structure of and identifying new sources of finance for Textainer. Prior to joining Textainer in 1996, Mr. Brewer worked at Bankers Trust from 1990 to 1996, starting as a Vice President in Corporate Finance and ending as Managing Director and Country Manager for Indonesia; from 1989 to 1990, he was Vice President in Corporate Finance at Jarding Fleming; from 1987 to 1989, he was Capital Markets Advisor to the United States Agency for International Development; and from 1984 to 1987 he was an Associate with Drexel Burnham Lambert in New York. Mr. Brewer holds an M.B.A. in Finance from the Graduate School of Business at Columbia University, and a B.A. in Economics and Political Science from Colgate University.\nCOMMITTEES\nThe Managing General Partner has established the following three committees to facilitate decisions involving credit and organizational matters, negotiations, documentation, management and final disposition of Equipment for the Partnership and for future programs which may be organized by the Textainer Group:\nEquipment Investment Committee. The Equipment Investment Committee will review the equipment leasing programs of the Partnership on a regular basis with emphasis on matters involving equipment purchases, the equipment mix in the Partnership's portfolio, equipment remarketing issues, and decisions regarding ultimate disposition of assets. The members of the committee are James E. Hoelter (Chairman), John A. Maccarone, Susan L. Fiddaman, John R. Rhodes, Anthony C. Sowry, Richard G. Murphy (Secretary), Alex M. Brown and Neil I. Jowell.\nCredit Committee. The Credit Committee will establish credit limits for every lessee and potential lessee of Equipment and periodically review these limits. In setting such limits, the Credit Committee will consider such factors as customer trade routes, country, political risk, operational history, credit references, credit agency analyses, financial statements, and other information. The members of the Credit Committee are James E. Hoelter (Chairman), John A. Maccarone, Richard G. Murphy (Secretary), Janet S. Ruggero, John R. Rhodes, Anthony C. Sowry and Robert D. Pedersen.\nInvestment Advisory Committee. The Investment Advisory Committee will review investor program operations on at least a quarterly basis, emphasizing matters related to cash distributions to investors, cash flow management, portfolio management, and liquidation. The Investment Advisory Committee is organized with a view to applying an interdisciplinary approach, involving management, financial, legal and marketing expertise, to the analysis of investor program operations. The members of the Investment Advisory Committee are James E. Hoelter (Chairman), John A. Maccarone, Susan L. Fiddaman, James S. McCaffrey (Secretary), John R. Rhodes, Jeanene K. Gomes, Harold S. Samson, Alex M. Brown and Neil I. Jowell.\nThe above committees are not intended to relieve the General Partners of their fiduciary duty to the Partnership.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe Registrant has no executive officers and does not reimburse TFS, TEM or TL for the remuneration payable to their executive officers.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\n(a) Security Ownership of Certain Beneficial Owners.\nThere is no person or \"Group\" who is known to the Registrant to be the beneficial owner of more than five percent of the outstanding units of limited partnership investment of the Registrant.\n(b) Security Ownership of Management.\nAs of January 1, 1996:\n(c) Changes in Control.\nInapplicable\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\n(a) Transactions with Management and Others.\nAt December 31, due from and to affiliates are comprised of:\nIncluded in the amounts due to TFS is $435,000 in loans used to facilitate equipment purchases. All other amounts receivable from and payable to affiliates were incurred in the ordinary course of business between the Partnership and its affiliates and represent timing differences in the accrual and payment of expenses and fees described above or in the accrual and payment of net rental revenues from TEM and TSS.\nIn addition, the Registrant paid or will pay the following amounts to the General Partners:\nAcquisition Fees in connection with the purchase of equipment on behalf of the Registrant:\nManagement fees in connection with the operations of the Registrant:\nReimbursement for administrative costs in respect of the operations of the Registrant:\n(b) Certain Business Relationships.\nInapplicable.\n(c) Indebtedness of Management\nInapplicable.\n(d) Transactions with Promoters\nInapplicable.\nSee the \"Compensation of Affiliates\" section of the Registrant's Prospectus, as supplemented, and the Notes to Financial Statements in Item 8.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.\n(a) 1. Audited financial statements of the Registrant for the year ended December 31, 1995 are contained in Item 8 of this Report.\n2. Financial Statement Schedules.\n(i) Independent Auditors' Report on Supplementary Schedule.\n(ii) Schedule II - Valuation and Qualifying Accounts.\n3. Exhibits Incorporated by reference\n(i) The Registrant's Prospectus as contained in Post-effective Amendment No. 2 to the Registrant's Registration Statement (No. 33-16447), as filed with the Commission on November 30, 1988, as supplemented by Supplement No. 6 as filed with the Commission under Rule 424(b)(3) of the Securities Act of 1933 on October 16, 1989.\n(ii) The Registrant's limited partnership agreement, Exhibit A to the Prospectus.\n(b) During the year ended 1995, no reports on Form 8-K have been filed by the Registrant.\nIndependent Auditors' Report on Supplementary Schedule\nThe Partners TCC Equipment Income Fund:\nUnder the date of March 27, 1996, we reported on the balance sheets of TCC Equipment Income Fund (the Partnership) as of December 31, 1995 and 1994, and the related statements of earnings, partners' capital and cash flows for the years ended December 31, 1995, 1994 and 1993, which are included in the 1995 annual report on Form 10-K. In connection with our audits of the aforementioned financial statements, we also audited the related financial statement schedule as listed in Item 14. This financial statement schedule is the responsibility of the Partnership's management. Our responsibility is to express an opinion on this financial statement schedule based on our audits.\nIn our opinion, such schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.\nKPMG Peat Marwick LLP\nSan Francisco, California March 27, 1996\nTCC EQUIPMENT INCOME FUND (A CALIFORNIA LIMITED PARTNERSHIP)\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nTEXTAINER EQUIPMENT MANAGEMENT FUND A California Limited Partnership\nBy Textainer Financial Services Corporation The Managing General Partner\nBy \/s\/John R. Rhodes ------------------------------- John R. Rhodes Executive Vice President\nDate: March 27, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of Textainer Financial Services Corporation, the Managing General Partner of the Registrant, in the capacities and on the dates indicated:\nSignature Title Date\n\/s\/Susan L. Fiddaman President March 27, 1996 - ----------------------- (Principal Executive Officer) Susan L. Fiddaman and Director\n\/s\/John R. Rhodes Executive Vice President March 27, 1996 - ----------------------- (Principal Financial and John R. Rhodes Accounting Officer), Secretary and Treasurer\n\/s\/James E. Hoelter Vice President and Director March 27, 1996 - -----------------------\n\/s\/John A. Maccarone Director March 27, 1996 - ----------------------- John A. Maccarone\n\/s\/James S. McCaffrey Vice President and Director March 27, 1996 - ----------------------- James S. McCaffrey\nEXHIBIT INDEX\nExhibit 27 Financial Data Schedule","section_15":""}
{"filename":"719581_1995.txt","cik":"719581","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nRegistrant owns a fee interest in six mini-storage facilities, none of which are subject to long-term indebtedness. Additional information is set forth in Registrant's letter to its Limited Partners regarding the Annual Report, attached hereto as Exhibit 2, and incorporated by this reference. The following table sets forth information as of December 31, 1995 regarding properties owned by the Partnership.\nLocation Size of Net Rentable No. of Completion Parcel Area Rental Units Date\nChico, CA 1.97 acres 39,580 366 9\/05\/84\nFairfield, CA 2.29 acres 40,668 442 8\/31\/84\nFt.Collins, CO 2.49 acres 57,284 603 3\/27\/85\nLaVerne, CA 2.78 acres 50,652 523 8\/21\/84\nRiverside, CA 2.92 acres 60,011 567 12\/12\/84\nLittleton, CO 3.071 acres 43,380 404 11\/01\/85\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nRegistrant 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\nNone.\nPART II\nItem 5.","section_5":"Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nRegistrant, a publicly-held limited partnership, sold 24,000 limited partnership units during its offering and currently has 956 limited partners of record. There is no intention to sell additional limited partnership units nor is there a market for these units.\nAverage cash distributions of $10.00 per Limited Partnership Unit were declared and paid each quarter for the years ended December 31, 1995 and $9.06 per Limited Partnership Unit for the year ended December 31, 1994.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA FOR THE YEARS ENDED DECEMBER 31, 1995, 1994, 1993, 1992, AND 1991. -------------------------------------------------------------------- 1995 1994 1993 1992 1991 ---- ---- ---- ---- ----\nREVENUES $1,857,684 $1,845,486 $1,824,454 $1,729,775 $1,657,306\nCOSTS AND EXPENSES 1,397,768 1,359,766 1,316,766 1,304,100 1,299,755 ---------- ---------- ---------- ---------- ----------\nNET INCOME $ 459,916 $ 485,720 $ 507,688 $ 425,675 $ 357,551 ========== ========== ========== ========== ==========\nTOTAL ASSETS $4,697,315 $5,219,802 $5,586,962 $6,016,083 $6,495,166 ========== ========== ========== ========== ==========\nNET CASH PROVIDED BY OPERATING ACTIVITIES $ 970,822 $ 992,128 $ 921,052 $ 878,099 $ 832,298 ========== ========== ========== ========== ==========\nCASH DISTRIBUTIONS PER $500 LIMITED PARTNERSHIP UNIT $ 40.00 $ 36.25 $ 35.00 $ 35.00 $ 35.00 ========== ========== ========== ========== ==========\nNET INCOME PER LIMITED PARTNERSHIP UNIT $ 18.97 $ 20.03 $ 20.94 $ 17.56 $ 14.75 ========== ========== ========== ========== ==========\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nRESULTS OF OPERATIONS\n1995 COMPARED TO 1994\nTotal revenues increased from $1,845,486 in 1994 to $1,857,684 in 1995, while total expenses increased from $1,359,766 to $1,397,768 resulting in a decrease in net income from $485,720 to $459,916. The approximate $8,000 (0.4%) increase in rental revenues can be attributed to higher unit rental rates as average occupancy rates remained relatively constant at 83.5% and 83.3% for the years ended December 31, 1995 and 1994, respectively. The Partnership is continuing its advertising campaign to attract and keep new tenants in its various mini-storage facilities. The approximate $28,000 (4.8%) increase in operating expenses was due primarily to an increase in maintenance and repair, salaries and wages and office expense partially offset by a decrease in yellow page advertising costs. General and administrative expense remained relatively constant. The General Partners' incentive management fee decreased approximately $3,000 (3.1%) as a result of the decrease in cash available for distribution on which this fee is based.\n1994 COMPARED TO 1993\nTotal revenues increased from $1,824,454 in 1993 to $1,845,486 in 1994, while total expenses increased from $1,316,766 to $1,359,766 resulting in a decrease in net income from $507,688 to $485,720. The approximate $16,000 (0.9%) increase in rental revenues can be attributed to higher unit rental rates as average occupancy rates decreased. Occupancy levels for the Partnership's six mini-storage facilities averaged 83.3% for the year ended December 31, 1994, and 84.8% for the year ended December 31, 1993. The Partnership continued to increase rental rates where the market conditions made such increases feasible. The Partnership is continuing its advertising campaign to attract and keep new tenants in its various mini-storage facilities. The approximate $30,000 (5.4%) increase in operating expenses was due primarily to an increase in yellow page advertising costs, maintenance and repair, salaries and wages and real estate tax expense. The approximate $6,000 (3.7%) increase in general and administrative expense was primarily a result of higher professional fees. The General Partners' incentive management fee increased approximately $7,000 (7.7%) as a result of the increase in cash available for distribution on which this fee is based.\nLIQUIDITY AND CAPITAL RESOURCES\nNet cash provided by operating activities decreased by approximately $21,000 (2.1%) in 1995 compared to 1994 primarily due to the decrease in net income and customer deposits and other liabilities. Net cash provided by operating activities increased by approximately $71,000 (7.7%) in 1994 compared to 1993 primarily due to the absence of payments of accrued property management fee liabilities, which were all paid in 1993. Payment of this fee had been deferred in prior years in order to maximize cash available for distribution to the Limited Partners. In 1993, the Partnership paid all of the current year's fees, as well as a portion of the fees deferred in prior years. The General Partners anticipate that the property management fee will be paid on a current basis in the future without adversely affecting cash available for distribution.\nCash used in financing activities, as set forth in the statements of cash flows, has consisted solely of cash distributions to partners. The General Partners determined that effective with the fourth quarter 1994 distribution which was paid on January 15, 1995, distributions to the limited partners would be increased to an amount which yields an 8% annual return on the capital contributed by the limited partners from an annual return of 7% paid in the prior years.\nCash used in investing activities, as set forth in the statements of cash flows, has consisted solely of acquisitions of equipment for the Partnership's mini-storage facilities. The Partnership has no material commitments for capital expenditures.\nThe General Partners plan to continue their policy of funding the continuing improvement and maintenance of Partnership properties with cash generated from operations. The Partnership's financial resources appear to be adequate to meet its needs for the next twelve months.\nThe General Partners are not aware of any environmental problems which could have an adverse material effect upon the financial position of the Partnership.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nAttached hereto as Exhibit l is the information required to be set forth as Item 8, Part II hereof.\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'S GENERAL PARTNER\nThe General Partners of Registrant are the same as when the Partnership was formed, i.e., DSI Properties, Inc., a California corporation, and Diversified Investors Agency. As of December 31, 1995, Messrs. Robert J. Conway and Joseph W. Conway, each of whom own approximately 41.63% of the issued and outstanding capital stock of DSI Financial, Inc., a California corporation, together with Mr. Joseph W. Stok, currently comprise the entire Board of Directors of DSI Properties, Inc.\nMr. Robert J. Conway is 62 years of age and is a licensed California real estate broker, and since 1965 has been President and a member of the Board of Directors of Diversified Securities, Inc., and since 1973 President, Chief Financial Officer and a member of the Board of Directors of DSI Properties, Inc. Mr. Conway received a Bachelor of Science Degree from Marquette University with majors in Corporate Finance and Real Estate.\nMr. Joseph W. Conway is age 66 and has been Executive Vice President, Treasurer and a member of the Board of Directors of Diversified Securities, Inc. since 1965 and since 1973 the Vice President, Treasurer and member of the Board of Directors of DSI Properties, Inc. Mr. Conway received a Bachelor of Arts Degree from Loras College with a major in Accounting.\nMr. Joseph W. Stok is age 72 and has been a member of the Board of Directors of DSI Properties, Inc. since 1994, a Vice President of Diversified Securities, Inc. since 1973, and an Account Executive with Diversified Securities, Inc. since 1967.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION (MANAGEMENT REMUNERATION AND TRANSACTIONS)\nThe information required to be furnished in Item 11 of Part III is contained in Registrant's Financial Statements for its fiscal year ended December 31, 1995, which together with the report of its independent auditors, Deloitte & Touche LLP, is attached hereto as Exhibit 1 and incorporated herein by this reference. In addition to such information: (a) No annuity, pension or retirement benefits are proposed to be paid by Registrant to any of the General Partners or to any officer or director of the corporate General Partner;\n(b) No standard or other arrangement exists by which directors of the Registrant are compensated;\n(c) The Registrant has not granted any option to purchase any of its securities; and\n(d) The Registrant has no plan, nor does the Registrant presently propose a plan, which will result in any remuneration being paid to any officer or director upon termination of employment.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nAs of December 31, 1995, no person of record owned more than 5% of the limited partnership units of Registrant, nor was any person known by Registrant to own of record and beneficially, or beneficially only, more than 5% thereof. The balance of the information required to be furnished in Item 12 of Part III is contained in Registrant's Registration Statement on Form S-11, previously filed pursuant to the Securities Act of 1933, as amended, and which is incorporated herein by this reference. The only change to the information contained in said Registration Statement on Form S-11 is the fact that Messrs. Benes and Blakley have retired and Messrs. Robert J. Conway and Joseph W. Conway equity interest in DSI Financial, Inc., parent of DSI Properties, Inc., has increased. Please see information contained in Item 10 hereinabove.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required to be furnished in Item 13 of Part III is contained in Registrant's Financial Statements for its fiscal year ended December 31, 1995, attached hereto as Exhibit l and 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)(l) Attached hereto and incorporated herein by this reference as Exhibit l are Registrant's Financial Statements and Supplemental Schedule for its fiscal year ended December 31, 1995, together with the reports of its independent auditors, Deloitte & Touche LLP. See Index to Financial Statements and Supplemental Schedule.\n(a)(2) Attached hereto and incorporated herein by this reference as Exhibit 2 is Registrant's letter to its Limited Partners regarding its Annual Report for its fiscal year ended December 31, 1995.\n(b) No reports on Form 8K were filed during the fiscal year ended December 31, 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.\nDSI REALTY INCOME FUND VII by: DSI Properties, Inc., a California corporation, as General Partner\nBy_____________________________ Dated: March 28, 1996 ROBERT J. CONWAY, President (Chief Executive Officer, Chief Financial Officer, and Director)\nBy____________________________ Dated: March 28, 1996 JOSEPH W. CONWAY (Executive Vice President 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 date indicated.\nDSI REALTY INCOME FUND VII by: DSI Properties, Inc., a California corporation, as General Partner\nBy:__________________________ Dated: March 28, 1996 ROBERT J. CONWAY, President, Chief Executive Officer, Chief Financial Officer, and Director\nBy___________________________ Dated: March 28, 1996 JOSEPH W. CONWAY (Executive Vice President and Director)\nDSI REALTY INCOME FUND VII\nCROSS REFERENCE SHEET\nFORM 1O-K ITEMS TO ANNUAL REPORT\nPART I, Item 3. There are no legal proceedings pending or threatened.\nPART I, Item 4. Not applicable.\nPART II, Item 5. Not applicable.\nPART II, Item 6. The information required is contained in Registrant's Financial Statements for its fiscal year ended December 31, 1995, attached as Exhibit l to Form 10-K.\nPART II, Item 8. See Exhibit l to Form 10-K filed herewith.\nPART II, Item 9. Not applicable.\nEXHIBIT l\nDSI REALTY INCOME FUND VII (A California Real Estate Limited Partnership)\nSELECTED FINANCIAL DATA FIVE YEARS ENDED DECEMBER 31, 1995 - --------------------------------------------------------------------------------\n1995 1994 1993 1992 1991\nREVENUES $1,857,684 $1,845,486 $1,824,454 $1,729,775 $1,657,306\nCOSTS AND EXPENSES $1,397,768 1,359,766 1,316,766 1,304,100 1,299,755 ---------- ---------- ---------- ---------- ---------- NET INCOME $ 459,916 $ 485,720 $ 507,688 $ 425,675 $ 357,551 ========== ========== ========== ========== ========== TOTAL ASSETS $4,697,315 $5,219,802 $5,586,962 $6,016,083 $6,495,166 ========== ========== ========== ========== ========== NET CASH PROVIDED BY OPERATING ACTIVITIES $ 970,822 992,128 $ 921,052 $ 878,099 $ 832,298 ========== ========== ========== ========== ========== CASH DISTRIBUTIONS PER $500 LIMITED PARTNERSHIP UNIT $ 40.00 $ 36.25 $ 35.00 $ 35.00 $ 35.00 ========== ========== ========== ========== ========== NET INCOME PER LIMITED PARTNERSHIP UNIT $ 18.97 $ 20.03 $ 20.94 $ 17.56 $ 14.75 ========== ========== ========== ========== ==========\nThe following are reconciliations between the operating results and partners' equity per the financial statements and the Partnership's income tax return for the year ended December 31, 1995.\nOperating Partners' Results Equity\nPer financial statements $ 459,916 $ 4,137,707 Excess tax depreciation 111,718 299,852 Accrued property taxes (1,003) (70,000) Deferred rental revenues 67,065 Accrued incentive management fees 221,117 Fixed asset adjustments 218,274 Accrued distributions to partners 242,415 ----------- ----------- Per Partnership income tax return $ 570,631 $ 5,116,430 =========== =========== Taxable income per $500 limited partnership unit $ 23.78 ===========\nDSI REALTY INCOME FUND VII (A California Real Estate Limited Partnership)\nINDEX TO FINANCIAL STATEMENTS AND SUPPLEMENTAL SCHEDULE\nPage\nFINANCIAL STATEMENTS:\nIndependent Auditors' Report\nBalance Sheets at December 31, 1995 and 1994\nStatements of Income for the Three Years Ended December 31, 1995\nStatements of Changes in Partners' Equity for the Three Years Ended December 31, 1995\nStatements of Cash Flows for the Three Years Ended December 31, 1995\nNotes to Financial Statements\nSUPPLEMENTAL SCHEDULE:\nIndependent Auditors' Report\nSchedule XI - Real Estate and Accumulated Depreciation\nSCHEDULES OMITTED:\nFinancial statements and schedules not 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 named above, or in the notes thereto.\nINDEPENDENT AUDITORS' REPORT To the Partners of DSI Realty Income Fund VII:\nWe have audited the accompanying balance sheets of DSI Realty Income Fund VII, a California Real Estate Limited Partnership (the \"Partnership\") as of December 31, 1995 and 1994, and the related statements of income, changes in partners' equity, and cash flows for each of the three years in the period ended December 31, 1995. These financial statements are the responsibility of the Partner ship'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, such financial statements present fairly, in all material respects, the financial position of DSI Realty Income Fund VII at December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\nJanuary 31, 1996 DELOITTE & TOUCHE LLP LONG BEACH, CALIFORNIA\nDSI REALTY INCOME FUND VII (A California Real Estate Limited Partnership)\nBALANCE SHEETS DECEMBER 31, 1995 AND 1994 - --------------------------------------------------------------------------------\nASSETS 1995 1994\nCASH AND CASH EQUIVALENTS $ 470,517 $ 486,497\nPROPERTY, At cost (net of accumulated depreciation of $5,596,143 in 1995 and $5,072,536 in 1994) (Notes 1, 2 and 3) 4,195,138 4,701,643\nOTHER ASSETS 31,660 31,662 ----------- ----------- TOTAL $ 4,697,315 $ 5,219,802 =========== ===========\nLIABILITIES AND PARTNERS' EQUITY\nLIABILITIES: Distribution due partners (Note 4) $ 242,424 $ 242,426 Incentive management fee payable to general partners (Note 4) 230,287 232,726 Property management fees payable (Note 1) 7,833 7,095 Customer deposits and other liabilities 79,064 90,064 ----------- ----------- Total liabilities 559,608 572,311 ----------- ----------- PARTNERS' EQUITY (Notes 1 and 4): General partners (66,391) (61,293) Limited partners (24,000 limited partnership units outstanding at December 31, 1995 and 1994) 4,204,098 4,708,784 ------------ ----------- Total partners' equity 4,137,707 4,647,491 ------------ ----------- TOTAL $ 4,697,315 $ 5,219,802 ============ ===========\nSee accompanying notes to financial statements.\nDSI REALTY INCOME FUND VII (A California Real Estate Limited Partnership)\nSTATEMENTS OF INCOME THREE YEARS ENDED DECEMBER 31, 1995 - --------------------------------------------------------------------------------\n1995 1994 1993\nREVENUES: Rental revenues $1,844,164 $1,836,372 $1,820,633 Interest income 13,520 9,114 3,821 ---------- ---------- ---------- Total revenues 1,857,684 1,845,486 1,824,454 ---------- ---------- ---------- EXPENSES: Depreciation (Note 2) 523,607 509,306 509,308 Operating expenses (Note 1) 613,328 585,686 555,483 General and administrative 166,268 167,443 161,465 General partners' incentive management fee (Note 4) 94,565 97,331 90,510 ---------- ---------- ---------- Total expenses 1,397,768 1,359,766 1,316,766 ---------- ---------- ---------- NET INCOME $ 459,916 $ 485,720 $ 507,688 ========== ========== ========== AGGREGATE NET INCOME ALLOCATED TO (Note 4): Limited partners $ 455,317 $ 480,863 $ 502,611 General partners 4,599 4,857 5,077 ---------- ---------- ---------- TOTAL $ 459,916 $ 485,720 $ 507,688 ========== ========== ========== NET INCOME PER LIMITED PARTNERSHIP UNIT (Notes 2 and 4) $ 18.97 $ 20.03 $ 20.94 ========== ========== ==========\nSee accompanying notes to financial statements.\nDSI REALTY INCOME FUND VII (A California Real Estate Limited Partnership)\nSTATEMENTS OF CHANGES IN PARTNERS' EQUITY THREE YEARS ENDED DECEMBER 31, 1995 - --------------------------------------------------------------------------------\nGeneral Limited Partners Partners Total\nBALANCE AT JANUARY 1, 1993 ($53,955) $ 5,435,310 $ 5,381,355\nNet income 5,077 502,611 507,688\nDistributions (Note 4) (8,484) (840,000) (848,484) ------- ---------- ---------- BALANCE AT DECEMBER 31, 1993 (57,362) 5,097,921 5,040,559\nNet income 4,857 480,863 485,720\nDistributions (Note 4) (8,788) (870,000) (878,788) ------- ---------- ----------- BALANCE AT DECEMBER 31, 1994 (61,293) 4,708,784 4,647,491\nNet income 4,599 455,317 459,916\nDistributions (Note 4) (9,697) (960,003) (969,700) ------- ----------- ----------- BALANCE AT DECEMBER 31, 1995 ($66,391) $ 4,204,098 $ 4,137,707 ======= =========== ===========\nSee accompanying notes to financial statements.\nDSI REALTY INCOME FUND VII (A California Real Estate Limited Partnership)\nSTATEMENTS OF CASH FLOWS THREE YEARS ENDED DECEMBER 31, 1995 - --------------------------------------------------------------------------------\n1995 1994 1993\nCASH FLOWS FROM OPERATING ACTIVITIES: Cash received from customers $ 1,844,164 $ 1,836,372 $ 1,813,041 Cash paid to suppliers and employees (886,862) (853,358) (895,810) Interest received 13,520 9,114 3,821 ----------- ----------- ------------ Net cash provided by operating activities 970,822 992,128 921,052\nCASH FLOWS FROM FINANCING ACTIVITIES - Distributions to partners (969,700) (848,484) (848,484)\nCASH FLOWS FROM INVESTING ACTIVITIES - Additions to property (17,102) (18,067) (8,776) ----------- ----------- ------------ NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (15,980) 125,577 63,792\nCASH AND CASH EQUIVALENTS, AT BEGINNING OF YEAR 486,497 360,920 297,128 ----------- ----------- ------------ CASH AND CASH EQUIVALENTS, AT END OF YEAR $ 470,517 $ 486,497 $ 360,920 =========== =========== ============ RECONCILIATION OF NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES: Net income $ 459,916 $ 485,720 $ 507,688 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 523,607 509,306 509,308 Changes in assets and liabilities: Other assets 1,499 (7,619) Incentive management fee payable to general partners (2,439) (10,061) 14,670 Property management fees payable 738 (1,336) (106,995) Customer deposits and other liabilities (11,000) 7,000 4,000 ----------- ----------- ------------ NET CASH PROVIDED BY OPERATING ACTIVITIES $ 970,822 $ 992,128 $ 921,052 =========== =========== ============\nSee accompanying notes to financial statements.\nDSI REALTY INCOME FUND VII (A California Real Estate Limited Partnership)\nNOTES TO FINANCIAL STATEMENTS THREE YEARS ENDED DECEMBER 31, 1995\n1. GENERAL\nDSI Realty Income Fund VII, a California Real Estate Limited Partnership (the \"Partnership\"), has two general partners (DSI Properties, Inc. and Diversified Investors Agency) and limited partners owning 24,000 limited partnership units that were purchased for $500 a unit. The general partners have made no capital contribution to the Partnership and are not required to make any capital contribution in the future. The Partnership has a maximum life of 50 years and was formed on August 1, 1983 under the California Uniform Limited Partnership Act for the primary purpose of acquiring and operating real estate.\nThe Partnership has acquired six mini-storage facilities located in Chico, Fairfield, La Verne, and Riverside, California and Ft. Collins and Littleton, Colorado. All facilities were purchased from Dahn Corporation (\"Dahn\"). Dahn is not affiliated with the Partnership. Dahn is affiliated with other partnerships in which DSI Properties, Inc. is a general partner. The mini-storage facilities are operated for the Partnership by Dahn under various agreements that are subject to renewal annually. Under the terms of the agreements, the Partnership is required to pay Dahn a property management fee equal to 5% of gross revenue from opera tions, as defined.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nCash and Cash Equivalents - The Partnership classifies its short-term investments purchased with an original maturity of three months or less as cash equivalents.\nProperty and Depreciation - Property is recorded at cost and is comprised primarily of mini-storage facilities. Depreciation is provided for using the straight-line method over an estimated useful life of 15 years for the facilities.\nIncome Taxes - No provision has been made for income taxes in the accompanying financial statements. The taxable income or loss of the Partnership is allocated to each partner in accordance with the terms of the Agreement of Limited Partnership. Each partner's tax status, in turn, determines the appropriate income tax for its allocated share of the Partnership taxable income or loss.\nNet Income per Limited Partnership Unit - Net income per limited partnership unit is computed by dividing net income allocated to the limited partners by the weighted average number of limited partnership units outstanding during each year (24,000 in 1995, 1994 and 1993).\nEstimates - The preparation of financial statements in conformity with generally accepted accounting principles requires the Partnership's management to make estimates and assumptions that affect the reported amounts of 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.\n3. PROPERTY\nAt December 31, 1995 and 1994, the total cost of property and accumulated depreciation are as follows:\n1995 1994 Land $ 2,089,800 $ 2,089,800 Buildings and improvements 7,701,481 7,684,379 ----------- -----------\nTotal 9,791,281 9,774,179 Less accumulated depreciation (5,596,143) (5,072,536) ----------- ----------\nProperty, net $ 4,195,138 $ 4,701,643 =========== ===========\n4. ALLOCATION OF PROFITS AND LOSSES\nUnder the Agreement of Limited Partnership, the general partners are to be allocated 1% of the net profits or losses from operations and the limited partners are to be allocated the balance of the net profits or losses from operations in proportion to their limited partnership interests. The general partners are also entitled to receive a percentage, based on a predetermined formula, of any cash distribution from the sale, other disposition, or refinancing of a real estate project.\nThe general partners are entitled to receive an incentive management fee for supervising the operations of the Partnership equal to 9% per annum of the cash available for distribution on a cumulative basis. Payment of the incentive management fees earned by the general partners during the fiscal years 1986 through 1988 was subordinated to the limited partners' receipt of an annual cumulative noncompounded return equal to 9.l% of their capital contributions. Incentive management fee payable to general partners at December 31, 1995 and 1994 is $230,287 and $232,726, respectively.\nINDEPENDENT AUDITORS' REPORT To the Partners of DSI Realty Income Fund VII:\nWe have audited the financial statements of DSI Realty Income Fund VII (the \"Partnership\") as of December 31, 1995 and 1994, and for each of the three years in the period ended December 31, 1995, and have issued our report thereon dated January 31, 1996; such report is included elsewhere in this Form 10-K. Our audits also included the financial statements schedule of DSI realty Income Fund VII, listed in Item 14. This financial statement schedule is the responsibility of the Partnership'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.\nJanuary 31, 1996\nDSI REALTY INCOME FUND VII (A California Real Estate Limited Partnership)\nREAL ESTATE AND ACCUMULATED DEPRECIATION - --------------------------------------------------------------------------------\nReal Estate Accumulated at Cost Depreciation\nBalance at January 1, 1993 $ 9,747,336 $4,053,922 Additions 8,776 509,308 ----------- ---------- Balance at December 31, 1993 9,756,112 4,563,230 Additions 18,067 509,306 ----------- ---------- Balance at December 31, 1994 9,774,179 5,072,536 Additions 17,102 523,607 ----------- ---------- Balance at December 31, 1995 $ 9,791,281 $5,596,143 =========== ==========\nThe total cost at the end of the period for Federal income tax purposes was approximately $9,992,000.\nEXHIBIT 2\nMarch 28, 1996\nANNUAL REPORT TO LIMITED PARTNERS OF\nDSI REALTY INCOME FUND VII\nDear Limited Partner:\nThis report contains the Partnership's balance sheets as of December 31, 1995 and 1994, and the related statements of income, changes in partners' equity and cash flows for each of the three years in the period ended December 31, 1995 accompanied by an independent auditors' report. The Partnership owns six mini-storage facilities. The Partnership's properties were each purchased for all cash and funded solely from subscriptions for limited partnership interests without the use of mortgage financing.\nYour attention is directed to the section entitled Management's Discussion and Analysis of Financial Condition and Results of Operations for the General Partners' discussion and analysis of the financial statements and operations of the Partnership.\nAverage occupancy levels for each of the Partnership's six properties for the years ended December 31, 1995 and December 31, 1994 were as follows:\nLocation of Property Average Occupancy Average Occupancy Levels for the Levels for the Year Ended Year Ended Dec. 31, 1995 Dec. 31, 1994\nChico, California 87% 83%\nFairfield, California 84% 88%\nFt. Collins, Colorado 81% 82%\nLaVerne, California 84% 84%\nLittleton, Colorado 86% 85%\nRiverside, California 79% 78%\nWe will keep you informed of the activities of DSI Realty Income Fund VII as they develop. If you have any questions, please contact us at your convenience at (310) 424-2655.\nIf you would like a copy of the Partnership's Annual Report on Form 10-K for the year ended December 31, 1995 which was filed with the Securities and Exchange Commission (which report includes the enclosed Financial Statements), we will forward a copy of the report to you upon written request.\nVery truly yours,\nDSI REALTY INCOME FUND VII By: DSI Properties, Inc.\nBy___________________________ ROBERT J. CONWAY, President","section_15":""}
{"filename":"753237_1995.txt","cik":"753237","year":"1995","section_1":"ITEM 1. BUSINESS\nI. GENERAL\nBailey Corporation (the \"Company\") is a manufacturer of molded and painted plastic exterior components for North American original equipment manufacturers (\"OEMs\") of cars, light trucks, sport utility vehicles and mini-vans. The Company has experienced significant sales growth since fis- cal 1991 through expansion of its product line by working closely with customers in the development of new components, the redesign of existing components and through significant acquisitions in fiscal 1992, 1993 and 1994.\nIn June 1992 the Company acquired the assets and business of Trans- plastics, Inc. (the \"Conneaut Acquisition\"); in July 1993 the Company ac- quired the assets and business of Contour Technologies (\"Contour\"), a di- vision of The Boler Company. (\"Boler\"); and effective July 31, 1994, the Company acquired the assets and business of Premix\/E.M.S. Inc. (the \"Pre- mix\/EMS Acquisition\").\nThe Company's products (\"components\") include grille opening panels and reinforcements, bumper covers, body side moldings and claddings, fair- ings, fender extensions, wheel lips, spoilers and, as a result of the Pre- mix\/EMS Acquisition, molded bumper beams and larger body panels such as hoods, sunroofs, doors and liftgates.\nThe Company is generally selected to supply a component two to four years in advance of production. Once selected, the Company usually sup- plies the component on a sole source basis for the life of a vehicle model, which has typically ranged from three to four years for cars and seven to ten years for light trucks, sport utility vehicles, and mini- vans.\nThe Company's business strategy is to capitalize on trends in the au- tomotive industry including (i) increased use of a variety of plastic com- ponents to reduce vehicle weight and cost, (ii) increased outsourcing by OEMs of component engineering and design, and (iii) efforts by OEMs to re- duce the number of their component suppliers. These trends are increasing competitive pressures on many smaller companies that do not possess a full range of manufacturing, engineering, and design capabilities. The Compa- ny's response to these trends has been to place emphasis on efforts to achieve internal growth and to pursue its acquisition strategy.\nII. THE NORTH AMERICAN AUTOMOBILE INDUSTRY\nThe North American OEM supply industry with regard to passenger cars and light trucks is composed of two distinct markets, the original equip- ment market and the service market. The Company's sales of components into the original equipment market are made to OEMs for the use on new vehicles and its sales to the service market are made to OEMs for resale to their dealers as replacement components. For fiscal year 1995, most of the Com- pany's sales were to the original equipment market. Industry factors which affect the Company's current and future competitiveness, as well as its growth and performance, include trends in the automotive market, changing policies of OEMs with respect to suppliers, and developments in technology and materials.\nTRENDS IN THE AUTOMOTIVE MARKET\nThe overall market for cars, light trucks, sport utility vehicles, and mini-vans in North America is large and cyclical, and considerable growth or decline routinely occurs within specific vehicle model lines. In par- ticular, light truck, sport utility vehicle, and mini-van sales have grown rapidly. The Company's components for Ford's F-Series trucks, Ranger pick- up truck, the Explorer, the Mercury Villager van, and the Nissan Quest van are examples of this trend. The Company believes it will continue to be well positioned as a supplier of components to OEMs in this high-growth market.\nCHANGING POLICIES REGARDING SUPPLIERS\nCertain developments have substantially altered the competitive envi- ronment for OEM suppliers, including increased outsourcing by OEMs of com- ponent engineering and design and efforts by OEMs to reduce the number of their component suppliers.\nOutsourcing. Outsourcing by OEMs provides a major source of potential growth for component suppliers. Domestic OEMs are continuing to increase outsourcing to qualified suppliers for the manufacture, engineering, and design of plastic components. OEMs benefit from such outsourcing because outside suppliers generally have significantly lower cost structures than the OEM divisions which would otherwise supply the components.\nReduction of Supplier Base; Competitive Selection Process. Starting in the 1980's, North American OEMs began to reduce the number of suppliers from whom they purchased components, granting long-term sole source agree- ments to a limited number of suppliers. This reduction is one of a number of strategies OEMs initiated to control vehicle costs. The criteria for selection and retention as a supplier now include not only cost, quality, and responsiveness, but also certain full-service capabilities including, among others, engineering and design. See \"Business Strategy -- Engineer- ing and Design Capability.\"\nCompetition for business within the Company's industry generally con- sists of a competitive selection process in which the OEM approaches one or a few suppliers for an intended component with a conceptual design of the component and target pricing. After discussions with each potential supplier concerning its ability to manufacture, engineer, and design the component, the OEM selects one supplier to work in conjunction with the OEM's design team to design and develop a component which will satisfy the OEM's quality standards and target pricing. OEMs also have rigorous pro- grams for evaluating and rating suppliers, which encompass quality, cost control, reliability of delivery, new technology implementation, and over- all management.\nUSE OF PLASTICS\nThe combined pressures of cost reduction and fuel economy have caused OEMs to concentrate on developing and employing lower cost, lighter mate- rials. As a result, plastic content in cars, light trucks, sport utility vehicles, and mini-vans has increased significantly. Plastics are now com- monly used in such structural components as grille opening reinforcements and in such nonstructural components as exterior and interior trim, door panels, instrument panels, grilles, bumpers, duct systems, tail lights, and fluid reservoirs. Increasingly, automobile content requires large plastic injection molded assemblies for both the exterior and interior. Moreover, further advances in molding and painting technologies are im- proving the performance and appearance of molded plastic components. The Company believes that use of plastics for exterior trim and other exterior applications will continue to increase.\nIII. BUSINESS STRATEGY\nThe Company's business strategy is to supply an increasing number of components for new vehicles manufactured by its existing OEM customers as well as to expand its OEM customer base. The Company believes a principal source for continued growth and increased market share lies in capitaliz- ing on its engineering and design capabilities and its status as a manu- facturer of high quality components for North American OEMs. To pursue its growth objective, the Company follows a business strategy based upon the following elements.\nHIGH QUALITY PRODUCTS\nThe Company emphasizes the importance of product quality to all of its employees and provides ongoing training in its quality assurance methods. The Company has made substantial investments in advanced design equipment, machinery, and production techniques. The Company uses advanced testing equipment and methods including Statistical Process Control (\"SPC\") to continue to improve quality standards across all product lines. SPC is a quality assurance method developed to avoid producing defective products by monitoring key stages of the manufacturing process to identify and cor- rect deviations from established manufacturing process parameters, rather than merely testing for defects at the end of production.\nENGINEERING AND DESIGN CAPABILITY\nIn the past several years, the Company has increased its commitment to component engineering and design in response to the evolving purchasing policies of Ford and, to a lesser degree, other North American OEMs. These OEMs have focused increasingly on shortening design cycles and reducing design and production costs, and have involved component suppliers earlier in the process of designing a vehicle. The Company has invested substan- tial resources in developing engineering and design capabilities to meet these new demands, including expanding its Dearborn, Michigan, design cen- ter where the Company's sales professionals and engineers provide sophis- ticated engineering and design services to its customers from the clay model stage of the design process through actual component manufacture.\nRELIABLE AND TIMELY DELIVERY\nAs OEMs have moved to just-in-time inventory management, the timeli- ness and reliability of shipments by their suppliers have become increas- ingly important. The Company believes it has established a reputation as a highly reliable and timely supplier able to meet its customers' demanding delivery requirements.\nSTRATEGIC ACQUISITIONS\nIncreased outsourcing by OEMs of component engineering and design and efforts by OEMs to reduce the number of their component suppliers have in- creased competitive pressures for many smaller companies that do not pos- sess a full range of manufacturing, engineering, and design capabilities. Although not competitive as stand-alone operations, certain of these smaller companies could, if combined with the Company, enhance the overall competitiveness of the Company. The Company intends to continue to con- sider acquisitions of companies which will further the Company's objec- tives of broadening its product line, establishing or expanding relation- ships with additional OEMs and expanding the Company's manufacturing capa- bilities.\nIV. PRODUCTS AND CUSTOMERS\nThe Company produces injection and compression molded exterior plastic components for North American OEMs of cars, light trucks, sport utility vehicles, and mini-vans. The Company's products must meet or exceed the increasingly exacting color, weatherability, and durability standards set by its customers. The Company believes that its success in being selected as a supplier is a result of, among other things, its ability to manufac- ture, engineer, and design high quality components. The Company's primary products include grille opening panels and reinforcements, bumper covers, body side moldings and claddings, fairings, fender extenders, wheel lips, spoilers, molded bumper beams and larger body panels such as hoods, sun- roofs, doors and liftgates.\nV. SERVICE MARKET\nThe service market consists of components manufactured for sale by OEMs to their dealers as replacement components. Prior to the Conneaut Ac- quisition, the Company only manufactured a given component for the service market if it had previously manufactured that component for the original equipment market. With the Conneaut Acquisition, the Company now manufac- tures certain components for the service market which it had not previ- ously manufactured for the original equipment market.\nVI. ENGINEERING, DESIGN, AND MARKETING\nThe Company's sales of molded plastic components have grown, in part, as a result of increased outsourcing by OEMs of component engineering and design. In recent years, the Company has significantly expanded its capa- bilities for providing complete engineering and design services to support its product line. Because molded plastic components must be designed at an early stage of the model development cycle, the Company is increasingly given the opportunity to participate earlier in the product planning pro- cess. This has resulted in opportunities to identify a broader range of components which could be manufactured by the Company.\nSales of the Company's products are generally made directly by the Company's sales and engineering staff headquartered in Dearborn, Michigan. In addition, sales to certain customers are made via a sales representa- tive organization. The Company also has field representatives at Ford's manufacturing plants in Atlanta, Georgia; Avon Lake, Ohio; Chicago, Illi- nois; Dearborn, Michigan; Kansas City, Missouri; and Louisville, Kentucky.\nVII. MANUFACTURING\nThe Company's manufacturing facilities are as follows:\nSee Item 2, \"Properties.\" The molding departments include resin mixing and molding compound preparation as well as mold and tool maintenance and refurbishment functions. The painting departments include equipment to prime and finish coat the wide range of component shapes and sizes that make up the Company's product lines. The secondary and assembly operations include trimming, attachment of hardware, and various final processing ac- tivities. At each of the Company's plants, operations are supported by production planning, purchasing, manufacturing, engineering, quality as- surance, and human resources staff.\nVIII. RAW MATERIALS AND MATERIAL SUPPLIERS\nThe Company produces components using a variety of processes and raw materials. The Company's raw materials include fiberglass reinforced poly- ester, thermoplastic polyolefin (\"TPO\"), polyethylene terephthalate (\"PET\"), thermoplastic polyurethane (\"TPU\"), a variety of compounds for the preparation of sheet molding compounds (\"SMC\"), as well as paints and hardware items. The Company has at least two active suppliers for each of the raw materials it uses and believes there is an adequate supply of these raw materials.\nIX. COMPETITION\nThe molded plastic exterior component industry is highly competitive. The Company competes with many component suppliers, several of whom are larger and have greater financial resources than the Company. In addition, the Company's OEM customers design and manufacture some components and could decide to increase this production, thereby reducing opportunities for the Company. The Company competes primarily on the basis of manufac- turing, engineering, and design capability, product quality, cost, deliv- ery, and customer service.\nX. EMPLOYEES\nAs of October 1, 1995, the Company had a total of 1,668 employees. Of that total 1,290 are hourly and 378 are salaried. Hourly employees at two of the Company's facilities (Seabrook, NH and Lancaster, OH) are covered by collective bargaining agreements with the UAW, which expire in 1999 and 1997, respectively. The Company considers relations with its employees to be good.\nXI. ENVIRONMENTAL MATTERS\nFrom time to time, the Company has been subject to claims asserted against it by regulatory agencies for environmental matters relating to the generation and disposal of hazardous substances and wastes. Some of these claims related to properties or business lines acquired by the Com- pany after a release had occurred. In each known instance, however, the Company believes that the claims asserted against it, or obligations in- curred by it, will not result in a material adverse effect upon the Compa- ny's financial position or results of operations. Nonetheless, there can be no assurance that activities at these facilities or facilities acquired in the future, or changes in environmental laws and regulations, will not result in additional environmental claims being asserted against the Com- pany or additional investigations or remedial actions being required.\nThe Company has been notified of its status as a potentially responsi- ble party (\"PRP\") at the ReSolve Superfund site in North Dartmouth, Massa- chusetts, at the Solvents Recovery Services site in Southington, Connecti- cut, and at the Old Southington Landfill Superfund site in Southington, Connecticut, at the Spectron, Inc. site in Elkton, Maryland, and at the Hazardous Waste Disposal Inc. site in Farmingdale, New York. At all five sites, the Company and all other PRPs are jointly and severally liable for all remediation costs under applicable hazardous waste laws. Therefore, the Company's proportionate share is subject to increase upon the insol- vency of other PRPs.\nWith respect to the ReSolve site, the Company and its immediate prede- cessor, USM Corporation's Bailey division (in the name of Emhart Corpora- tion), have been named as PRPs for wastes sent to the site during the 1970s. Although the Company cooperated with USM in litigation against USM's insurers to obtain indemnification for costs incurred by the Company and USM at the site, the Company did not obtain any recovery in that ac- tion, which was recently settled. Recent estimates provided by the PRP group responsible for the site's remediation indicate that the Company's potential liability for clean-up efforts at the site is approximately $300,651 for which the Company is fully reserved and it has posted a let- ter of credit in favor of the PRP group. The assessment paid by the Com- pany for the fiscal period July 1, 1994 through June 30, 1995 was $32,748, the payment of which was charged to the previously established reserve. The group voted not to impose an annual assessment for the fiscal period extending from July 1, 1995 through June 30, 1996. The recent discovery of the presence of contaminants in a form not currently susceptible of short- term remediation, however, has created uncertainty about the future scope and cost of clean-up efforts at this site, and a possibility that the ul- timate cost of remediation may be higher than previously estimated. The Company is unable to predict what, if any, effect this recent discovery may have on the Company.\nOn June 18, 1992, the Company received notice from the Environmental Protection Agency (the \"EPA\") that it was a PRP under the federal Super- fund law with respect to the Solvents Recovery Services of New England Site in Southington, Connecticut (the \"SRSNE Site\"). Based upon a volumet- ric ranking dated July 7, 1993, the waste allocated to the Company repre- sents 0.11593% of the total identified waste at the SRSNE Site. Under the terms of a settlement with Emhart, the Company agreed to assume liability for wastes sent to the SRSNE Site by USM's Seabrook, New Hampshire facil- ity and Emhart agreed to assume liability for wastes sent by USM's Ames- bury, Massachusetts facility. The identified PRPs have organized a group to negotiate with the EPA, and the Company has joined that group. The group has successfully negotiated with the EPA to reduce the total esti- mated cost of the initial removal action at the SRSNE Site from an origi- nal estimate of $14 million down to a current estimate of approximately $4 million. The total estimated cost of long-term remediation at the SRSNE Site is not yet known.\nIn January 1994, the Company received a Notice of Potential Liability for the Old Southington Landfill Superfund Site (the \"OSL Site\") located in Southington, Connecticut. The EPA alleged that because the Amesbury, Massachusetts facilities of USM Corporation sent spent solvents to the SRSNE Site for recycling prior to 1968, it was also liable for cleanup of the OSL Site because still bottoms and other waste from the SRSNE Site had been disposed of at the OSL Site. Both the Company and USM\/Emhart received notices of liability for the share of OSL Site costs allocated to USM Cor- poration (Amesbury, Massachusetts). The Company and Emhart entered into a settlement agreement under which Emhart will assume sole responsibility for all cleanup costs, imposed by the EPA, arising out of the alleged lia- bilities of USM Corporation's Bailey division (Amesbury, Massachusetts) for the OSL Site.\nIn June 1989, the EPA notified the Company that it was a PRP under the federal Superfund law for the Spectron, Inc. site located in Elkton, Mary- land. A group of PRPs (\"Steering Committee\") entered into an agreement with the EPA to fund and conduct a $2.8 million emergency response action to remove stored wastes at the site. The Steering Committee also entered into a separate agreement to pay the government's past costs associated with the site, approximately $635,000. There are several thousand PRPs at this site, with most being small generators with low dollar exposure. In December 1989, nearly 800 entities, including the Company, that sent small quantities of waste to the site participated on a cash-out basis in the settlement for past costs and the removal action, and the Company's allo- cated share was $8,061.90. Participation in the cash-out settlement gives the Company protection against contribution claims from third parties for the first phase of the site cleanup (\"Phase I\").\nIn August 1990, a separate PRP group (\"Phase II PRP Group\") was formed and negotiated an agreement with the EPA to remediate contaminated seeps on the site and perform a limited privately-funded remedial investigation\/ feasibility study for the site (the so-called Phase II activities). The Company was not asked to join the Phase II PRP Group because that group determined that the companies that paid for Phase I of the cleanup (the so-called \"Spectron customers\" because they sent their waste to the site primarily during the time period when it was owned and operated by Spec- tron, Inc.) would not be asked to make any financial contributions toward Phase II until the Galaxy customers (so-called because they did business with the site during the time period when it was owned by the Galaxy com- pany) have paid out an amount per gallon equal to that paid by the Spec- tron parties. An additional investigation was conducted as part of the Phase II activities to determine the nature and extent of a new form of contamination discovered on the site; additional design work will be com- menced soon.\nIn October 1995, the Company received a notice from the EPA that it was a PRP that has liability for conducting a Remedial Investigation\/Fea- sibility Study (\"RI\/FS\") at the Spectron site. The Company has sixty days in which to decide whether to participate with a group of other PRPs in making a good faith offer to the EPA for performance of the RI\/FS. In con- nection with this, the Company may have an opportunity to enter into a de minimis party cash out settlement with the EPA and the other PRPs. No es- timate can be made at this time as to the amount of the Company's liabil- ity at the Spectron site.\nIn 1995, the New York Department of Environmental Conservation (\"DEC\") notified the Company that it was named a responsible party under the Envi- ronmental Conservation Law of the State of New York with respect to the Hazardous Waste Disposal, Inc. site located in Farmingdale, New York. The site was allegedly used to store, treat and dispose of hazardous and toxic materials between 1979 and 1981. Various investigations have been under- taken to date. DEC is looking to the named parties to perform a Remedial Investigation\/Feasibility Study and then a cleanup of the site as war- ranted. The scope of the ultimate cleanup may depend, in large part, on whether the site is viewed as a source of contamination of the nearby Fairchild Republic Site. At this time, two hazardous waste manifests have been produced by DEC which suggest that USM Corporation's Bailey division (Seabrook, New Hampshire) shipped two-55 gallon drums of polyol to the site in January 1981. Based on available information, the Company's in- volvement at the site appears to be de minimis. Additional investigations have been undertaken to determine: (1) whether there are any other enti- ties that shipped wastes to the site between 1979 and 1981; and (2) whether any of the named parties actually shipped more than was originally attributed to them. The results to date do not suggest that the Company's ranking at the site will change significantly. The Company has demanded that Emhart Corporation assume the defense of this claim. Emhart Corpora- tion has taken the Company's demand for defense and indemnification under advisement. In doing so, Emhart Corporation has taken the position that it did not receive \"prompt written notice\" of the claim.\nThe Company also faces the possibility of liability if it is deemed a successor to TransPlastics with respect to wastes generated and disposed of by TransPlastics when it owned the Conneaut property. TransPlastics has been identified as a PRP at the Millcreek site in Millcreek Township, Pennsylvania, and at the New Lyme site located in Dodgeville, Ashtabula County, Ohio, two sites currently undergoing remediation. TransPlastics also received notice of a potential third party claim in connection with the Huth Oil Site in Cleveland, Ohio. The Company did not agree to assume any environmental liabilities of TransPlastics and no claim has been as- serted against the Company in connection with those liabilities. Further, under the terms of the Conneaut Acquisition agreement, TransPlastics and its parent companies must indemnify the Company and BTP for any liability arising out of any such claim. Nevertheless, there can be no assurance that TransPlastics and its parent companies will have sufficient assets to satisfy the Company's potential liability for the remediation and any dam- ages to third parties caused by the contamination.\nThe Company also faces potential liability in connection with the Con- tour Acquisition. An environmental site assessment completed by Boler de- termined that the ground water at the Contour facility in Hillsdale, Mich- igan, was contaminated with chlorinated solvents as a result of past site activities. The ground water contamination plume has migrated onto adja- cent properties. In addition, Contour is listed as a PRP for a number of off-site disposal locations. The Contour Acquisition Purchase and Sale Agreement, however, requires Boler to indemnify the Company for any envi- ronmental liabilities which arise in connection with use of the property prior to closing. In addition, Boler has executed a remediation agreement in which it agreed to remediate, at its own expense, the identified ground water contamination at the Hillsdale, Michigan, facility. If Boler has in- sufficient resources to complete remediation of any contamination for which it has indemnified the Company or otherwise becomes insolvent, the Company could incur successor liability for the costs of remediation and any damages to third parties.\nThe Company also has potential liability in connection with contamina- tion at certain property in Cuba, Missouri, which had been leased by the Company from 1985 to 1992. The landlord has undertaken to remediate this property at its own expense. The Company has negotiated the termination of all obligations of the Company with respect to the lease.\nAs a result of the environmental investigation conducted as part of its due diligence during the acquisition of the three Premix\/E.M.S. Inc. facilities, the Company identified a number of environmental concerns. Premix\/E.M.S. Inc., as part of the acquisition agreement, agreed to pursue and address these concerns, most of which it has completed. Pursuant to the acquisition agreement, the Company performed certain post-acquisition investigations which appeared to confirm the presence of subsurface con- tamination, of which it has informed Premix\/E.M.S. Inc. Under the acquisi- tion agreement, Premix\/E.M.S. Inc. is obligated to undertake necessary re- mediation of this problem, if in fact any is required. Premix\/E.M.S. Inc. has entered into an Environmental Indemnification Agreement for the bene- fit of the Company and has granted to the Company certain limited rights of offset against the Convertible Debenture. The shareholders of Premix- \/E.M.S. Inc. have also severally undertaken to reimburse the Company in certain limited circumstances, to the extent of distributions received by them from Premix\/E.M.S. Inc., and to the extent that Premix\/E.M.S. Inc. does not directly satisfy its indemnification obligations.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's manufacturing operations are performed at seven plants located in Seabrook, New Hampshire; Conneaut, Ohio; Hillsdale, Michigan; Madison, Indiana; Lancaster, Ohio; Hartford City, Indiana; and Portland, Indiana. The Seabrook plant is owned by the Company and consists of an ap- proximately 390,000 square foot building. The Company's executive offices are located in the Seabrook plant. The Conneaut plant is leased by the Company and consists of an approximately 183,000 square foot building. The Hillsdale plant is owned by the Company and consists of an approximately 119,000 square foot building. The Madison plant is owned by the Company and consists of a 71,000 square foot building. The Lancaster plant is owned by the Company and consists of an approximately 156,000 square foot building. The Hartford City plant is owned by the Company and consists of an approximately 116,000 square foot building. The Portland plant is owned by the Company and consists of an approximately 120,000 square foot build- ing. The Dearborn engineering and design center is leased by the Company and consists of approximately 9,500 square feet of office space.\nThe Company believes that its facilities and equipment are in good condition and, including planned additions to and refurbishment of machin- ery and equipment, its existing facilities will be adequate for the fore- seeable future.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nOther than the matters set forth in Item 2, Section XI (\"Environmental Matters\") above, the following is the only material pending legal proceed- ing to which the Company is a party or as to which any of its property is subject.\nSUNA ET AL. V. BAILEY CORPORATION\nOn June 2, 1994, the Company was served with a summons and complaint with respect to Vicki Match Suna and Lori Rosen v. Bailey Corporation, a purported class action suit brought in the United States District Court for the District of New Hampshire. The complaint alleged that the Company violated Rule 10b-5 of the Securities Exchange Act of 1934 by a purported dissemination of misleading information as to its financial position in connection with the purchase and sale of its securities. The Company was successful in having the complaint dismissed, and also in rebuffing the plaintiffs' attempt to file an amended complaint. The Court allowed the plaintiffs to make one more attempt, however, and on September 1, 1995 a second amended complaint was filed. The Company intends to move to dismiss this complaint also and the action in its entirety. If this effort is un- successful, the Company intends vigorously to assert defenses which it be- lieves to be meritorious. The complaint does not specify an amount of dam- ages and the proceeding is still in its infancy. The extent of any expo- sure of the Company, therefore, cannot be determined at this time.\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 has been quoted on the NASDAQ-National Market System (\"NASDAQ- NMS\") under the trading symbol \"BAIB\" since July 1, 1993. Prior to that time, the Common Stock was quoted on the NASDAQ-Small Cap Market and traded on the Boston Stock Exchange.\nThe following table sets forth, on a fiscal quarterly basis, the high and low closing sale price for the period from the beginning of the fiscal quarter ended October 30, 1993 through the close of fiscal year 1995 on NASDAQ-NMS:\nAs of October 23, 1995, there were 563 record holders of Common Stock.\nThe Company has never paid cash dividends on the Common Stock. The Company intends to retain all earnings for general corporate purposes and does not anticipate paying cash dividends on the Common Stock in the fore- seeable future. The Company's credit agreement with its principal bank lender does not permit the payment of cash dividends on the capital stock of the Company without the lender's prior consent.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nBAILEY CORPORATION AND SUBSIDIARIES FOR THE FISCAL YEARS ENDED 1995, 1994, 1993, 1992 AND 1991 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)\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 the percentage relationships of certain categories of costs and expenses to net sales for the fiscal years presented:\n1995 COMPARED TO 1994\nThe Company made the Premix\/EMS Acquisition effective July 31, 1994, and the Contour Acquisition on July 1, 1993. Accordingly, the historical results of operations exclude the Premix\/EMS Acquisition for 1994 and 1993 and include the Contour Acquisition for one month in 1993.\nNet sales in fiscal 1995 increased $59.9 million, or 55.3 % to $168.2 million, compared to $108.3 million in fiscal 1994. The increased sales are net of planned price decreases that were effected during the year. Contributing to the sales increase was $55.3 million of sales of the product lines purchased in the Premix\/EMS Acquisition; $9.6 million from 27 new components introduced during the year; and $5.9 million from higher unit deliveries of 33 components carried over from the prior year. These higher sales were offset by $10.9 million of lower sales of 50 components carried over from the prior year. The most significant products in this category were 6 components for the Ford Tempo\/Topaz which phased out of production early in the year, and 23 components for the Taurus\/Sable which phased out at the beginning of the fourth quarter contributing to a substantially lowered level of sales in the fourth fiscal quarter and a net reduction for the full fiscal year.\nThe new product introductions during the year were primarily for the restyled 1995 Ford Explorer sport utility vehicle and new models of the Channel Master satellite dishes which accounted for 74.3% and 20.1%, respectively, of the $9.6 million of new component sales.\nGross profit in fiscal 1995 increased 5.5%, to $16.8 million compared to $15.9 million in the prior year. This increase was primarily due to the sales volume increase resulting from the acquired Premix\/EMS operations. As a percentage of net sales, however, gross profit for fiscal 1995 declined to 10.0% compared to 14.7% in fiscal 1994. The comparatively lower gross margin was primarily attributable to (a) the lower average gross margin associated with the product lines acquired in the Premix\/EMS Acquisition; (b) new product launch costs; (c) under-utilization of manufacturing capacity particularly during the second half of the fiscal year; (d) planned price decreases effected during the year, and (e) the gradual replacement during the year of more mature product lines with newly introduced lower margin components.\nSelling, general and administrative expenses in fiscal 1995 increased $6.0 million, or 64.3%, to $15.3 million compared to $9.3 million in fiscal 1994. The year-to-year increase was principally due to the addition of selling and administrative expenses associated with the acquired Premix\/EMS operations and in part due to planned increases in design engineering and program management functions. As a percentage of net sales, selling, general and administrative expenses increased to 9.1% in fiscal 1995 compared to 8.6% in fiscal 1994.\nInterest expense in fiscal 1995 increased $2.2 million, or 135%, to $3.9 million compared to $1.7 million in fiscal 1994. The increase was due to the additional interest associated with $23.0 million of debt issued to finance the purchase of the Premix\/EMS acquisition and increased utilization of the Company's revolving line-of-credit.\nBefore provision for income taxes, the Company incurred a loss of $2.4 million for the fiscal year ended July 30, 1995 compared to pre-tax income of $5.0 million for the prior year. Accordingly, the Company was able to avail itself of income tax benefits attributable to the fiscal 1995 net operating loss carried back to prior years. The benefit thus recognized was at an effective rate of 33% compared to a tax expense rate of 44% for fiscal 1994.\nFor the fiscal year ended July 30, 1995, the Company incurred a net loss of $1.6 million, or $.29 per share, compared to net income of $2.8 million, or $.52 per share in fiscal 1994. This negative operating performance for fiscal 1995 was most pronounced in the fourth quarter. For the fourth quarter ended July 30, 1995, on sales of $34.3 million the Company incurred a net loss of $4.2 million or $.77 per share. These adverse operating results were caused by the stretching out of new product launching activities, greater than planned acquisition assimilation costs, certain raw material cost increases and a shortfall in sales during the final four months of the year.\n1994 COMPARED TO 1993\nThe Company made the Premix\/EMS Acquisition effective July 31, 1994, and the Contour Acquisition on July 1, 1993. Accordingly, the historical results of operations exclude the Premix\/EMS Acquisition for both 1994 and 1993 and include the Contour Acquisition for one month in 1993.\nNet sales in fiscal 1994 increased $16.9 million, or 18.5% to $108.3 million, compared to $91.4 million in fiscal 1993. The increased sales are net of planned price decreases that were effected during the year. Contributing to the sales increase was $12.1 million from 19 new components introduced during the year; $17.0 million of sales of the product line purchased in the Contour Acquisition; and $2.5 million from higher unit deliveries of 27 components carried over from the prior year. These increases were offset by a $10.7 million decline in sales resulting from a reduction in unit deliveries of 39 components carried over from the prior year.\nThe new product introductions during the year were primarily for the new 1994 Ford Mustang and the new Thunderbird which accounted for 61.0% and 38.6% of the $12.1 million of new component sales, respectively. The sales decline in carryover products was primarily associated with the Tempo\/Topaz, Taurus\/Sable and Explorer which were lower in fiscal 1994 compared to fiscal 1993 by 32.3%, 14.2% and 13.0%, respectively.\nGross profit in fiscal 1994 increased $1.5 million, or 10.7%, to $15.9 million compared to $14.4 million in the prior year. This increase was primarily due to increased sales compared to fiscal 1993. As a percentage of net sales, gross profit for fiscal 1994 declined to 14.7% compared to 15.7% in fiscal 1993. The reduction in gross margin was primarily attributable to (a) planned price decreases effected during the year; (b) comparatively lower sales of components for the Tempo\/Topaz, Explorer and Taurus\/Sable programs which, as more mature products, had provided a greater contribution to manufacturing margins; (c) under-utilized capacity during most of the year at the Hillsdale and Madison facilities; and (d) product launch costs associated with the start-up of the Ford Mustang and Thunderbird programs and the transfer of production of the Mercury Villager and Nissan Quest components to one of the facilities purchased in the Contour Acquisition.\nThe negative impact on gross margin for fiscal 1994 resulting from the foregoing factors was nevertheless offset by several planned manufacturing productivity improvements effected during the year. These included (a) material usage reductions and labor efficiencies gained from additions to robotics in both molding and painting processes; (b) revisions to fixtures used in some operations; (c) improvements in packaging; and (d) changes in material handling techniques.\nSelling, general and administrative expenses in fiscal 1994 increased $1.9 million, or 26.4%, to $9.3 million compared to $7.4 million in fiscal 1993. The year-to-year increase was principally due to planned additions to design engineering, marketing, program management and senior management functions. As a percentage of net sales, selling, general and administrative expenses increased to 8.6% in fiscal 1994 compared to 8.0% in fiscal 1993.\nInterest expense in fiscal 1994 decreased $265,000, or 13.9%, to $1.6 million compared to $1.9 million in fiscal 1993. The decrease was due to a lower average amount of short-term borrowings and long-term debt outstanding during fiscal 1994 compared to the prior year.\nThe Company's effective tax rate was 44.4% for fiscal 1994 compared to 40.0% for fiscal 1993. The higher rate for fiscal 1994 is due to (a) the adoption by the Company during the year of Financial Accounting Standards Board Statement 109 which resulted in a one-time, non-tax deductible charge of $84,000 and (b) the recognition during the year of a non-tax deductible charge of $300,000 related to an environmental settlement.\nNet income in fiscal 1994 decreased $299,000 to $2.8 million ($.52 per fully diluted share) compared to $3.1 million ($.73 per fully diluted share) in fiscal 1993. As a percentage of net sales, net income in fiscal 1994 was 2.6% compared to 3.4% in fiscal 1993. Fully diluted per share amounts reflect a 27.9% increase in shares outstanding, calculated on a weighted average of 5,356,000 shares outstanding in fiscal 1994 compared to 4,187,000 shares outstanding in fiscal 1993.\nLIQUIDITY AND CAPITAL RESOURCES\nAt the inception of the fiscal year ended July 30, 1995 the Company acquired substantially all of the assets of Premix\/E.M.S. Inc. for an aggregate purchase price of $34.5 million. The acquisition was financed via issuance to the Sellers of a $7.0 million secured promissory note plus a $9.0 million convertible debenture, payment in cash of $9.9 million, and the assumption of $8.6 million of current liabilities. In connection with the Acquisition, the Company negotiated an amended credit agreement with a bank which, with amendments, provided a new $8.0 million term loan, a revolving line-of-credit of $24.0 million and an equipment lease line-of-credit of $2.5 million. By subsequent amendment, $4.0 million of the revolver was carved out into a 3-year fixed maturity note.\nDuring the fiscal year ended July 30, 1995, the Company operated at an expanded level primarily due to the addition of the sales volume and facilities purchased in the Premix\/EMS Acquisition. The increased operating rate required increased investments in inventories and reimbursable automation equipment. Meanwhile planned capital expenditures plus assets acquired under capitalized leases totaled $9.0 million. Also, during the last four months of the fiscal year, sales declined as certain higher-margin products phased out while launching of new products with associated start-up costs stretched out over protracted schedules. Meanwhile, higher than planned acquisition assimilation costs were incurred and several raw material suppliers posted price increases. As a result, operations generated a $4.2 million net loss in the fourth quarter.\nFaced with the reduced level of operating performance during the fourth quarter, the Company accelerated measures to curtail costs and expenses. In this connection, during August, 1995, the Company announced a temporary phasing down of operations at its Portland, Indiana production facility and the transfer of production to other Company plants to improve facility utilization. This plant deactivation is planned for an interim period until product engineering and development projects related to 1997 and 1998 programs are ready to be started into production.\nAs a result of the foregoing, at July 30, 1995 total capitalization amounted to $52.0 million with long-term debt at $33.1 million, or 63.7%, and stockholders' equity of $18.9 million, or 36.3% of total capitalization. Meanwhile, during July 1995 a fixed asset note due July 1, 1996 in the amount of $5.0 million became a current liability thereby contracting net working capital with the result that at July 30, 1995, the Company's current ratio was .95 to 1.\nWith these conditions developing, as of the end of the fourth quarter, there were instances of non-compliance with technical covenants of the Company's bank credit agreement. The bank has issued waivers and mutually satisfactory amended covenants are being determined for subsequent periods.\nFaced with contraction of liquidity, the Company put in place for fiscal year 1996 operating plans, budgets and expenditure curtailments so as to operate within prospective financial resources. These measures have begun to show progress with the outlook that the Company anticipates that cash flow and credit availability will be adequate to meet requirements including debt retirement obligations for the next twelve months.\nCOSTS AND EXPENSES RELATED TO PROTECTION OF THE ENVIRONMENT\nDuring fiscal 1995 the Company incurred costs and expenses, satisfied certain liabilities and made capital expenditures in connection with on-going management of compliance with environmental laws and regulations and in response to mandated contributions to the remediation of contaminated sites as to which it has been identified as a potentially responsible party (\"PRP\"). The expenses of on-going compliance in fiscal 1995 amounted to approximately $598,000 and consisted primarily of the removal of hazardous wastes generated at the Company's operating facilities, monitoring, testing and reporting activities, depreciation of control equipment and legal expense related to environmental matters. These expenses in fiscal 1994 and 1993 were approximately $637,000 and $669,000, respectively. In addition, as of May 1994, the Company incurred a one-time charge of $300,000 as the cost of full and final settlement of claims in the State of New Hampshire related to alleged instances of non-compliance with certain hazardous waste handling regulations.\nAt July 30, 1995, and July 31, 1994, the Company's environmental accruals totaled $289,000 and $322,000, respectively. The Company's fiscal 1995 share of mandated payments as a PRP for remediation of off-site locations amounted to approximately $33,000, which was charged to previously accrued liabilities. The Company believes that it has identified its potential environmental exposures that are of a material nature and has accrued the low end of the range of its likely exposure. The Company does not believe that any additional liability relating to identified sites is material to its liquidity, financial position or results of operations.\nDuring fiscal 1996 the Company expects that on-going costs of compliance with environmental regulations will be approximately $725,000. Capital expenditures related to environmental matters in fiscal 1996 are expected to be approximately $650,000.\nCLASS ACTION LITIGATION\nIn July 1994, the Company was served with a summons and complaint with respect to a purported class action suit brought in the United States District Court for the District of New Hampshire. The complaint alleged that the Company violated Rule 10b-5 of the Securities and Exchange Act of 1934 by a purported dissemination of misleading information as to its financial position in connection with the purchase and sale of its securities. The Company was successful in having the complaint dismissed, and sought to rebuff the plaintiff's attempt to file an amended complaint. However, the Court allowed the plaintiffs to make one more attempt and on September 1, 1995, a second amended complaint was filed. The Company has moved to dismiss this amended complaint and the action in its entirety. The Court's decision is pending. Since the complaint does not specify an amount of damages and the proceeding is still in its early stages, the extent of the Company's exposure cannot be determined at this time. However, should this action proceed, the Company intends to vigorously assert defenses which it believes to be meritorious.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nBAILEY CORPORATION AND SUBSIDIARIES INDEX TO FINANCIAL STATEMENTS AND 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 included in the financial statements or notes thereto.\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Stockholders BAILEY CORPORATION AND SUBSIDIARIES\nWe have audited the accompanying consolidated balance sheets of Bailey Corporation and subsidiaries as of July 30, 1995, and July 31, 1994, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the years in the three-year period ended July 30, 1995. 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 financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consoli- dated 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 Bailey Corporation and subsidiaries as of July 30, 1995 and July 31, 1994, and the results of their operations and their cash flows for each of the years in the three-year period ended July 30, 1995, in conformity with generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.\nKPMG PEAT MARWICK LLP\nBoston, Massachusetts October 25, 1995\nBAILEY CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS JULY 30, 1995 AND JULY 31, 1994 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)\nSee accompanying notes to consolidated financial statements.\nBAILEY CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE FISCAL YEARS ENDED 1995, 1994 AND 1993 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)\nSee accompanying notes to consolidated financial statements.\nBAILEY CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE FISCAL YEARS ENDED 1995, 1994 AND 1993 (IN THOUSANDS)\nSee accompanying notes to consolidated financial statements.\nBAILEY CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE FISCAL YEARS ENDED 1995, 1994 AND 1993 (IN THOUSANDS)\nSee accompanying notes to consolidated financial statements.\nBAILEY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR FISCAL YEARS ENDED 1995, 1994 AND 1993\n(1) SIGNIFICANT ACCOUNTING POLICIES\nBusiness Operations\nBailey Corporation (the \"Company\") is a manufacturer of high quality molded plastic exterior components for sale to automobile manufacturers. Customers include original equipment manufacturers and other suppliers to the automobile industry in the United States and Canada.\nFiscal Year\nThe fiscal year of the Company ends on the nearest Sunday prior to or at July 31. All references herein to 1995, 1994, and 1993 mean the fiscal years ended July 30, 1995, July 31, 1994, and July 31, 1993, respectively.\nPrinciples of Consolidation\nThe consolidated financial statements include the accounts of the Com- pany and its wholly owned subsidiaries. All significant intercompany transactions and balances are eliminated in consolidation.\nInventories\nInventories are stated at the lower of cost (determined on a first-in, first-out basis) or market (net realizable value).\nDepreciation and Amortization\nDepreciation and amortization is provided on a straight-line basis over the estimated useful lives of owned assets. Assets held under capital leases are depreciated over their respective lease term. The following is a summary of estimated useful lives:\nGoodwill\nGoodwill consists principally of excess purchase price over fair mar- ket value of net assets acquired, and is being amortized over 40 years using the straight-line method.\nDeferred Tooling, Design and Pre-production Costs\nUnreimbursed costs incurred in excess of reimbursements for customer- owned tooling are recorded as deferred tooling costs. Costs incurred for the design of components to be built for customers are recorded as de- ferred design, engineering and pre-production costs. These costs are amortized based on units produced in each year over the term of production contracts (generally 3 to 5 years) to which the tooling, design and pre-production costs relate.\nReimbursable Deferred Automation\nIn connection with production programs, the Company purchases automa- tion equipment for which it is reimbursed by the customer on a per piece shipped basis. Amounts estimated to be reimbursed in the succeeding twelve months are classified as current. Reimbursements estimated to be received beyond one year are included in other assets. Imputed interest on such re- imbursements are recognized as shipments are made. Title to the equipment reverts to the customer upon completion of the production program.\nEarnings per Share\nEarnings per share are calculated by dividing net income by the weighted average common shares outstanding during each period, including the dilutive effect of warrants and options outstanding during the period. Fully diluted earnings per share also include the assumed conversion of convertible debt. In fiscal 1995 warrants, options and convertible debt were anti-dilutive, and accordingly, have not been included in the calcu- lation.\nIncome Taxes\nAmounts in the financial statements related to income taxes are calcu- lated using the principles of Financial Accounting Standards Board State- ment No.109, \"Accounting for Income Taxes\" (FAS 109). Prepaid and deferred taxes reflect the impact of temporary differences between the amounts of assets and liabilities recognized for financial reporting purposes and the amounts recognized for tax purposes. These deferred balances are measured by applying currently enacted tax rates. A valuation allowance reduces de- ferred tax assets when it is \"more likely than not\" that some portion or all of the deferred tax assets will not be recognized.\nPrior to the adoption of the provisions of Statement No. 109, the Com- pany accounted for income taxes under the deferred method (APB 11). APB 11 required deferred income taxes to be recognized for income and expense items reported in different years for financial reporting and income tax purposes using current tax rates. Under the deferred method, deferred taxes are not adjusted for subsequent changes in tax rates.\nRevenue Recognition\nSales are recognized upon shipment of products to customers.\n(2) BUSINESS ACQUISITIONS\nEffective July 31, 1994, the Company acquired substantially all of the assets of Premix\/EMS Inc. (the \"Premix\/EMS Acquisition\"), a manufacturer of automotive molded plastic exterior components, for an aggregate pur- chase price of $34,484,000, subject to post-closing adjustments. Payment consisted of a secured five year promissory note in the principal amount of $7,000,000, bearing interest annually at a floating prime rate; a five- year convertible debenture in principal amount of $9,000,000, bearing in- terest at a fixed rate of 8% per annum, and convertible into Bailey Corpo- ration common stock at $10 per share; cash of $9,855,000 less $480,000 held pending satisfaction of certain conditions (in fiscal 1995, this amount was fully paid); and assumption of certain liabilities totaling $8,629,000. The acquisition has been accounted for as a purchase with the purchase price allocated over the estimated fair value of the assets and liabilities assumed, resulting in goodwill of $3,227,000 at July 31, 1994.\nThe determination of the final purchase price was subject to a post- closing audit which was completed in fiscal year 1995. As a result of the audit and receipt of final appraisals of the fair market value of the net assets acquired, the entire amount of goodwill was reclassified to machin- ery and equipment in the fourth quarter. Additionally, the Company has un- successfully sought recovery of a portion of the purchase price and has instituted arbitration procedures with the sellers. It is anticipated that the arbitration process will be resolved in the second quarter of fiscal 1996. Should any of the purchase price be recovered, it will reduce the recorded values of the acquired property, plant and equipment.\nOn July 1, 1993, the Company acquired certain assets totaling $7,801,000 and assumed certain liabilities totaling $1,580,000 of the Con- tour Technologies Division of the Boler Company (the \"Contour Acquisi- tion\"), a manufacturer of automotive plastic parts. Payment consisted of a fixed asset note in the principal amount of $5,047,000 payable on July 1, 1996 with certain extension provisions (Note 8), bearing interest at 8% per annum; and a working capital note in the principal amount of $1,174,000 bearing interest at 8% and payable weekly from the proceeds of the acquired accounts receivable. The acquisition has been accounted for as a purchase with the purchase price allocated over the fair value of the assets acquired and liabilities assumed. The operating results of Contour Technologies have been included in the consolidated operating results since the date of acquisition.\nThe following unaudited pro forma summary presents the consolidated results of operations assuming that the Premix\/EMS Acquisition occurred at the beginning of fiscal 1994, after giving effect to certain adjustments, including interest expense on the acquisition debt and related income tax effects. The pro forma results have been prepared for comparative purposes only and do not purport to be indicative of what would have occurred had the Premix\/EMS Acquisition been made as of that date or of results which may occur in the future.\n(3) INVENTORIES\nInventories consist of the following (in thousands):\n(4) PREPAID EXPENSES AND OTHER CURRENT ASSETS\nPrepaid expenses and other current assets consist of the following (in thousands):\n(5) PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment is stated at cost and consists of the following (in thousands):\nIncluded in property, plant and equipment is equipment held under cap- italized leases. This equipment has a cost basis of $5,685,000 and $4,237,000 at July 30, 1995, and July 31, 1994, respectively. Accumulated depreciation relating to this equipment amounted to $1,874,000 and $1,443,000 at July 30, 1995, and July 31, 1994, respectively.\nDepreciation expense, including amortization of capitalized leases, was $5,256,000, $3,108,000, $2,341,000, in fiscal 1995, 1994, and 1993, respectively.\n(6) OTHER ASSETS\nOther assets consist of the following (in thousands):\nAmortization of goodwill amounted to $12,000 in each of the fiscal years 1995, 1994, and 1993.\n(7) SHORT-TERM DEBT\nShort-term debt consists of the revolving credit facility which car- ried a balance of $9,360,000 and $3,846,000 at July 30, 1995, and July 31, 1994, respectively.\nIn connection with the Premix\/EMS Acquisition (Note 2), the Company renegotiated its credit agreement with a bank. The agreement consists of a term note with an initial advance of $8,000,000 (Note 8). Additionally, the Company maintains a revolving credit facility with a maximum avail- ability of $24,000,000, subject to certain limitations based on the levels of accounts receivable and inventory.\nOn July 28, 1995, the Company elected to issue a $4,000,000 Fixed Ma- turity Carve Out Note under the existing credit agreement which reclassi- fied $4,000,000 of outstanding borrowings under the revolving credit fa- cility to long term debt. The Fixed Maturity Carve Out Note is due in its entirety on August 1, 1998, provided that no event of default has occurred prior to the due date.\nObligations to the bank are secured by substantially all assets of the Company. The term note bears interest at the bank's prime rate (8.75% at July 30, 1995) plus 0.5%. The revolving credit facility and the Fixed Ma- turity Carve Out Note bear interest at the bank's prime rate. The credit agreement includes, among other provisions, restrictive covenants relating to the maintenance of certain financial and earnings ratios, prohibits the payment of cash dividends, and restricts the incurrence of additional debt, except with approval of the bank. As of July 30, 1995 as to certain of these covenants there were conditions of non-compliance by the Company. The bank has issued waivers and has agreed to determine mutually satisfac- tory covenants for subsequent periods.\n(8) LONG-TERM DEBT\nLong term debt outstanding consists of the following (in thousands):\nAggregate principal payments due over the next five years (and there- after) are as follows for the fiscal years ending (in thousands):\n(9) OTHER LONG-TERM LIABILITIES\nOther long-term liabilities consist of the following (in thousands):\n(10) PENSION PLANS\nThe Company has various retirement plans covering substantially all employees. The Company maintains five defined benefit pension plans cover- ing certain full-time hourly and salaried employees. After meeting certain qualifications, an employee acquires a vested right to future benefits. The benefits payable under the plans are generally determined on the basis of the employees' length of service and earnings. For all plans, the Com- pany's funding policy is to make at least the minimum annual contributions required by Federal law and regulation.\nThe components of net pension cost are as follows (in thousands):\nThe funded status of the defined benefit plans was as follows (in thousands):\nAn additional liability of $1,848,000 and $1,635,000 related to cer- tain plans has been included in other long-term liabilities at July 30, 1995 and July 31, 1994, respectively, to reflect the required minimum lia- bility for unrecognized prior service costs. As a result of recording this additional liability the Company recorded a reduction to stockholders' eq- uity of $403,000 at July 30, 1995, and an adjustment of $306,000 at July 31, 1994, net of applicable deferred income taxes. In addition, an intan- gible asset in the amount of $1,173,000 and $1,309,000 has been included in other assets at July 30, 1995, and July 31, 1994, respectively, to re- flect the allowable asset recognizable up to the amount of unrecognized prior service costs.\nThe weighted-average assumed discount rate and rate of return on plan assets was 8% and 8.5% in 1995 and 1994. The expected rate of increase in compensation levels used was 4.5% for both 1995 and 1994.\nPlan assets consist principally of cash and cash equivalents, listed common stocks, debentures, and fixed income securities.\nOn December 31, 1992, a salaried pension plan was frozen and no fur- ther service liability will accrue under the plan. Effective January 1, 1993, a defined contribution plan was established whereby eligible employ- ees may contribute up to 10% of their salary, with a dollar-for-dollar match by the Company of up to 2% of an employee's salary. The Company re- corded expense under this plan of $286,000, $220,000 and $148,800 for 1995, 1994 and 1993, respectively.\nDuring fiscal year 1994 the Company and the Union agreed to tempo- rarily freeze benefit accruals of the Bailey Hourly Pension Plan in con- sideration for providing an increasing schedule of benefit levels during the course of the bargaining agreement. The schedule of increasing monthly benefit levels for each year of service is as follows for retirements occurring on or after:\n(11) INCOME TAXES\nAs of August 1, 1993, the Company adopted Financial Accounting Stan- dards Board Statement 109. The cumulative effect of this change in ac- counting for income taxes was immaterial and was included in selling, gen- eral and administrative expenses in the consolidated statement of opera- tions for the year ended July 31, 1994. Prior years' financial statements have not been restated to apply the provisions of Statement 109.\nTotal income tax expense (benefit) for the years ended July 30, 1995 and July 31, 1994 was allocated as follows (in thousands):\nIncome tax expense (benefit) from operations consists of (in thou- sands):\nThe differences between the statutory Federal rate and the effective tax rate are as follows:\nFor the year ended July 31, 1993, deferred income tax expense of $672,000 resulted in differences in the recognition of income and expense for income tax and financial reporting purposes. The sources and tax ef- fects of those timing differences are presented below (in thousands):\nThe tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at July 30, 1995, and July 31, 1994 are presented below (in thousands):\nManagement believes the Company will obtain the full benefit of State net operating loss carryforwards and other temporary differences recorded as deferred tax assets on the basis of its evaluation of the Company's an- ticipated profitability over the period of years that the temporary dif- ferences are expected to become tax deductions. It believes that suffi- cient book and taxable income will be generated to realize the benefit of these tax assets. This assessment of profitability takes into account the Company's expected future earnings based on automotive supply contracts awarded for parts to be produced beginning with the 1997 model year. Man- agement also considered the fact that the Company has alternative minimum tax credit carryforwards available to reduce future regular income taxes, if any, over an indefinite period.\n(12) STOCKHOLDERS' EQUITY\nPublic Offering\nIn September, 1993, the Company completed a public offering of 1,076,600 shares of its $.10 par value common stock. The net proceeds from the offering of $10,596,000 were used to reduce short-term borrowings, pay down certain long-term debt, retire the subordinated debentures payable to related parties, and to fund working capital requirements.\nPrivate Placement\nDuring April 1993, the Company raised $3,125,000, before expenses, from the private placement of 312,500 shares ($1,875,000) of the Company's common stock, $.10 par value per share (the \"Common Stock\"), and $1,250,000 of 9% Convertible Subordinated Notes maturing in the year 2000 (the \"9% Notes\"). The 9% Notes are convertible into Common Stock at $10.00 per share. In addition to the aforementioned issuance of 312,500 shares of Common Stock, the Company issued 14,166 shares of its Common Stock in pay- ment of a fee in connection with the private placement.\nCommon Stock Warrants\nIn addition to warrants issued with subordinated debentures issued in June 1992, the Company, in connection with a financing agreement in 1988, issued a warrant to a lender to purchase 115,794 shares of common stock at $.0033 per share. The estimated value of this warrant at the time of issu- ance was $175,000, which was recorded as a liability. The warrant was sub- ject to certain put and call provisions, which expired on June 30, 1992. Therefore the amount of the expired put option was transferred to addi- tional paid-in capital in 1992. On August 5, 1993, 115,794 shares of com- mon stock were issued pursuant to the exercise of these warrants. At July 30, 1995, 62,500 warrants remain outstanding relating to the subordinated debentures issued in June 1992.\nStock Option Plans\nIn April 1986, the Company adopted an incentive stock option plan (\"the 1986 plan\"). The Company has reserved 200,000 shares of common stock for distribution under the 1986 plan. Options to purchase common stock under the 1986 plan will be exercisable during a period not to exceed ten years from the date the options are granted with option prices of not less than 100% of the fair market value of the stock on the respective date of grant, or 110% of the fair market value if granted to persons owning more than 10% of the outstanding stock.\nOn November 2, 1994, 10,000 options were granted under the 1986 plan at equivalent exercise prices and vesting periods as the non-qualified stock options discussed below.\nThe following is a summary of option activity under the 1986 plan for 1995, 1994, and 1993:\nAt July 30, 1995, options for 89,038 shares were exercisable in accor- dance with provisions of the incentive plan.\nOn November 2, 1994, the Company granted 293,000 non-qualifiied stock options to key employees at an exercise price equivalent to the fair mar- ket value on the date of grant ($7.18). Up to 25% of the options are exer- cisable on the grant date with all remaining options vesting ratably over three years. In the event of a change of control of the company, 100% of the grant may be exercised immediately. The options expire on November 2, 2002, or ninety days after employment terminates, whichever date is ear- lier. Subsequent to November 2, 1994, 55,000 options were cancelled as a result of termination of the employees' employment. As of July 30, 1995, 238,000 options were outstanding with 59,500 exercisable.\nIn connection with a four-year employment agreement with an officer of a subsidiary, on June 26, 1992 the Company granted options to purchase 120,000 shares of the Company's common stock, exercisable for 30,000 shares immediately and an additional 30,000 shares on each anniversary of the employment agreement. The options are exercisable at $4.75 per share as determined by the agreement. In fiscal year 1994, 60,000 shares were exercised. No shares were exercised in fiscal year 1995. Therefore 60,000 shares were outstanding and exercisable at July 30, 1995.\nDuring 1994 the Company granted two option agreements to two officers of the Corporation. The first agreement granted options to purchase 50,000 shares of the Company's common stock at $6.125 per share (market value on date of issuance), exercisable for 12,500 shares immediately and an addi- tional 12,500 shares on each anniversary of the agreement. The second agreement granted options to purchase 100,000 shares of the Company's com- mon stock at $11 per share (market value on date of issuance), exercisable for 25,000 shares immediately and an additional 25,000 shares on each an- niversary of the agreement. No shares have been purchased under these agreements.\n(13) MAJOR CUSTOMERS\nSales to third parties are concentrated in a few major customers and consisted of the following percentages of the Company's total net sales:\n(14) RELATED PARTY TRANSACTIONS\nCertain nonemployee directors provided consulting services to the Com- pany totaling $288,000, $298,000, and $280,000 in 1995, 1994, and 1993, respectively.\nInterest payments made to related parties on subordinated debentures which were retired in the first quarter of fiscal 1994 amounted to $15,000 and $63,000 in fiscal years 1994 and 1993, respectively.\nIn July 1993 the Company negotiated an agreement with Rall Leasing, a partnership which includes certain officers and directors who are also stockholders of Bailey, to terminate the Company's entire obligation under a real property lease in exchange for $230,000, thereby releasing it from all obligations under the lease. Charges to operations under this lease were $292,000 in 1993 (including the settlement).\n(15) COMMITMENTS AND CONTINGENCIES\nThe Company is subject to a variety of legal proceedings, contractual obligations and environmental issues, arising out of the conduct of its business, which are pending or threatened.\nEnvironmental Costs\nThe Company and its immediate predecessor, USM's Bailey Division, have been named as potentially responsible parties (\"PRP\") at the Resolve Su- perfund site and at the Solvents Recovery Services site. At both sites, the Company and all other PRP's are jointly andseverally liable for all remediation costs under applicable environmental laws. The Company is pur- suing indemnification from USM and\/or USM's insurers for some of its costs associated with the remediation efforts at both sites.\nThe Company also faces potential environmental liability relating to the Conneaut, Contour and Premix\/EMS Acquisitions if the former owners cannot fulfill the environmental obligations relating to their ownership. For each acquisition the Company has been indemnified for environmental obligations arising prior to its ownership as part of the acquisition agreements. Additionally, part of the purchase consideration for the Con- neaut Acquisition was escrowed and the right to offset debt issued by the Company in connection with the Contour and Premix\/EMS Acquisitions exists to specifically cover environmental obligations of the former owners.\nThe Company's policy is to accrue environmental costs of a non-capital nature when it is both probable that a liability has been incurred and the amount can be reasonably estimated. On-going costs of compliance with en- vironmental laws are charged to expense when incurred. Where the estimate is a range and no amount within the range is a better estimate than any other amount, the Company accrues the minimum amount in the range. The re- liability and precision of the environmental accruals are affected by nu- merous factors, such as different stages of site evaluation, the allocation of responsibility among PRP's and the assertion of additional claims. The Company adjusts its accruals as new remediation requirements are defined, as information becomes available permitting reasonable estimates to be made, and to reflect new and changing facts. At July 30, 1995, and July 31, 1994, the Company's environmental accruals totalled $289,000 and $322,000, respectively and related to its share of mandated payments as a PRP for remediation of the Resolve site. The Company believes it has iden- tified and accrued for its material likely environmental exposures and that any additional liability relating to identified sites is immaterial to its liquidity, financial position and results of operations.\nDuring fiscal 1995 and 1994, the Company paid approximately $33,000 and $370,000, respectively, for mandated payments as a PRP for remediation of the Resolve site which was charged against previously accrued liabili- ties. Additionally, in May 1994, the Company settled alleged waste han- dling violations through payment of a $300,000 fine. The settlement re- solved all claims by the state of New Hampshire arising out of a 1990 re- view.\nLitigation\nIn June 1994, the Company was served with a summons and complaint with respect to a purported class action suit brought in the United States Dis- trict Court for the District of New Hampshire. The complaint alleged that the Company violated Rule 10b-5 of the Securities Exchange Act of 1934 by a purported dissemination of misleading information as to its financial position in connection with the purchase and sale of its securities. The Company was successful in having the complaint dismissed, and also in re buffing the plaintiff's attempt to file an amended complaint. The Court allowed the plaintiffs to make one more attempt, however, and on September 1, 1995, a second amended complaint was filed. The Company intends to move to dismiss this complaint as well, and the action in its entirety. If this effort is unsuccessful, the Company intends to vigorously assert defenses which it believes to be meritorious. The complaint does not specify an amount of damages and the proceeding is still in its infancy. Accordingly, the extent of any exposure of the Company cannot be determined at this time.\nThe Company is also involved in other litigation arising in the normal course of business. Management does not believe that such litigation will have a material impact on its financial position or results of operations.\nDevelopment Joint Venture\nThe Company has entered into a joint venture for the development of certain non-automotive plastic products. The joint venture, a limited lia- bility company named Rail Pak, LLC (the Venture), is 60% owned by the Com- pany and 40% by an unrelated third party corporation. Under the agreement, the Company has committed to providing limited technical support and to funding initial product development up to $300,000 (Phase I) and at the option of the Company, at its sole discretion, may either elect to con- tinue funding for production (Phase II) or may surrender its interests in the venture with no remaining liability. During the fiscal year ended July 30, 1995, the Company funded the venture in the cash amount of $240,000 and is committed to an additional $60,000 of funding to the Venture for Phase I. Due to the uncertainty of continuation of the Venture on the part of the Company, Phase I costs are expensed as engineering costs in the Company's financial accounts. In the event that the Company elects to pro- ceed with funding Phase II (the production phase), the accounts of the Venture will be included in the Company's consolidated financial state- ments.\nNonemployee Directors' Retirement Agreements\nIn October 1994, four nonemployee directors rescinded existing agree- ments issued during fiscal 1994 in exchange for new retirement agreements, the terms of which are under negotiation. The new agreements are expected to provide a maximum benefit of $60,000 per year for five years after re- tirement from the board, plus lifetime participation in the Company's healthcare plan.\nLeases\nThe Company leases certain office facilities, machinery and equipment and automobiles under operating leases with unexpired terms ranging from one to five years. Payments due under operating leases over the next five years are as follows for the fiscal years ending (in thousands):\nRent expense under operating leases was $911,000, $589,000, and $453,000, for the fiscal years ended 1995, 1994 and 1993, respectively.\nLetters of Credit\nAt July 30, 1995, the Company was contingently liable for $1,096,000 related to letters of credit outstanding which guarantee various trade ac- tivities.\n(16) SUPPLEMENTAL CASH FLOW INFORMATION\nSelected cash payments and noncash activities were as follows:\n(17) QUARTERLY FINANCIAL DATA (UNAUDITED)\n(in thousands, except per share data)\n(18) SUBSEQUENT EVENTS\nPortland Plant Shutdown\nOn August 3, 1995, the Company announced its intention to temporarily curtail operations in its Portland, Indiana, manufacturing facility. The Company does not expect any material costs to be incurred relating to this curtailment. Losses to be recognized in connection with the curtailment will be recognized in the first quarter of fiscal 1996.\nStockholder Rights Plan\nOn September 28, 1995, the Board of Directors of the Company adopted a stockholder rights plan. Under the plan, the Company declared a dividend of one Right for each outstanding share of common stock, par value $.10 per share. The Rights will be issued to the holders of record of shares of Common Stock outstanding on September 28, 1995, and with respect to shares of Common Stock issued thereafter until the Distribution Date (as defined in the Rights Agreement) and, in certain circumstances, with respect to shares of Common Stock issued after the Distribution Date. Each Right, when it becomes exercisable as defined in the Rights Agreement, would initially entitle the registered holder to purchase from the Company one share of Common Stock at an exercise price of $28. The Rights expire September 28, 2005 and, under certain conditions, may be redeemed by the Company at a price of $.01 per Right. The Rights have no voting privileges and are not currently separable from the Common Stock.\nThe Rights are not currently exercisable, but would become exercisable if certain events occurred relating to a person or group (the \"Acquiring Person\") acquiring or attempting to acquire 15% or more of the outstanding shares of Common Stock. Upon the occurrence of such an event, each right (except the Rights beneficially owned by the Acquiring Person, which become null and void) entitles its holder to purchase for $28 the economic equivalent of Common Stock, or in certain circumstances, securities of the Acquiring Person, or its affiliate, worth twice as much. The description and terms of the Rights are set forth in a Rights Agreement dated as of September 28, 1995 between the Company and State Street Bank and Trust Company, as Rights Agent.\nBAILEY CORPORATION AND SUBSIDIARIES SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS FOR THE FISCAL YEARS ENDED 1995, 1994 AND 1993 (IN THOUSANDS)\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable.\nPART III\nIn accordance with Paragraph (3) of General Instruction G to Form 10- K, Part III of this Report is omitted because the registrant will file with the Securities and Exchange Commission not later than 120 days after the end of the fiscal year ended July 30, 1995, a definitive proxy state- ment pursuant to Regulation 14A involving the election of directors, which proxy statement is incorporated herein by reference.\nPART IV\nITEM 14.","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) Financial Statements, Financial Statement Schedules, and Exhibits.\n1. Financial Statements. See Item 8 for the Financial Statements of the Company filed as a part hereof. (Exhibits omitted)\n2. Financial Statement Schedules. See Item 8 for the Financial Statement Schedules of the Company filed as a part hereof.\n3. Exhibits. Pursuant to Rule 12b-32 and General Instruction G, the following Exhibits are required to be filed with this Report by Item 14 above and are incorporated by reference from the reference source cited in the Exhibit Index below, are filed herewith, or are not applicable.\n(b) Reports on Form 8-K.\nOn October 2, 1995, the Company filed a Current Report on Form 8-K with the Securities and Exchange Commission (\"SEC\") to report the adoption by the Company on September 28, 1995 of a stockholder rights plan.\nThe Company filed with the SEC Quarterly Reports on Form 10-Q for each of the quarters ended October 30, 1994, January 29, 1995, and April 30, 1995, in each case within 45 days of the end of the respective quarter.\nSIGNATURES\nPURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THERETO DULY AUTHORIZED.\nBAILEY CORPORATION\nDated: October 26, 1995 By: \/s\/ ROGER R. PHILLIPS\nROGER R. PHILLIPS CHAIRMAN OF THE BOARD, PRESIDENT AND CHIEF EXECUTIVE OFFICER AND SECRETARY (PRINCIPAL EXECUTIVE OF- FICER)\nDated: October 26, 1995 By: \/s\/ LEONARD J. HEILMAN\nLEONARD J. HEILMAN EXECUTIVE VICE PRESIDENT -- FINANCE AND ADMINISTRATION, TREASURER AND ASSISTANT SECRETARY (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.\nDated: October 26, 1995 By: \/s\/ ROGER R. PHILLIPS\nROGER R. PHILLIPS DIRECTOR, CHAIRMAN OF THE BOARD, PRESIDENT, CHIEF EXECUTIVE OFFICER AND SECRETARY\nDated: October 26, 1995 By: \/s\/ E GORDON YOUNG\nE GORDON YOUNG DIRECTOR\nDated: October 26, 1995 By: \/s\/ LOUIS T. ENOS\nLOUIS T. ENOS DIRECTOR\nDated: October 26, 1995 By: \/s\/ ALLAN B. FREEDMAN\nALLAN B. FREEDMAN DIRECTOR\nDated: October 26, 1995 By: \/s\/ JOHN G. OWENS\nJOHN G. OWENS DIRECTOR\nDated: October 26, 1995 By: \/s\/ WILLIAM A. TAYLOR\nWILLIAM A. TAYLOR DIRECTOR\nEXHIBIT INDEX","section_15":""}
{"filename":"833210_1995.txt","cik":"833210","year":"1995","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":"97579_1995.txt","cik":"97579","year":"1995","section_1":"Item 1. Business.\nTexfi Industries, Inc. (\"the Company\") was incorporated in Delaware in 1963. The Company manufactures and markets a diverse line of textile and apparel products from a variety of raw materials, including natural and synthetic materials. The Company's offices are located at 5400 Glenwood Avenue, Suite 215, Raleigh, North Carolina 27612, telephone (919) 783-4736.\nThe Company's operations include three divisions: Texfi Blends, Texfi Narrow Fabrics, and Kingstree Knit Apparel. The following discusses each of the Company's three operating divisions and how they contributed to the Company's consolidated 1995 operating performance.\nThe Texfi Blends Division is the Company's largest division operating three manufacturing facilities which are located in Rocky Mount and Fayetteville, North Carolina and Jefferson, Georgia and combine to provide 845,000 square feet manufacturing facilities. The division's sales and marketing headquarters are in New York City, with branch offices or agents in other major cities throughout the United States and Europe. The Texfi Blends Division contributed 60% of total Company fiscal 1995 sales by manufacturing products made from textured polyester, flame-retardant polyester, and blends of polyester, rayon, and wool. These products are sold worldwide to the menswear, womenswear and childrenswear apparel, uniform, home furnishings, and export markets.\nThe Kinsgtree Knit Apparel Division operates 676,000 square feet of manufacturing facilities located in Haw River, North Carolina; Andrews, Kingstree, Lane, and Olanta, South Carolina and Midway, Georgia. It has sales offices in Haw River and Charlotte, North Carolina, as well as agents in major cities throughout the United States. This division offers knit apparel made to customer specifications in basic and fashion colors and a broad range of styles and sizes. In addition to basic T-shirts, products include pocket T's, tank tops, fleece tops, as well as hooded, striped, solid-dyed, print, double-collar\/double-sleeve, long-sleeve T's. These products are marketed to the branded private label, promotional and garment dyeing markets as well as direct to retailers, screen printers and distributors. Kingstree Knit Apparel also commission knits, dyes and finishes fleece and jersey fabrics for other apparel manufacturers. By emphasizing quality, quick response, innovation and outstanding customer service, the Company believes this division effectively competes in the fast-paced, fashion-oriented private label apparel business. Kingstree Knit Apparel contributed 28% of the Company's fiscal 1995 sales.\nThe Texfi Narrow Fabrics Division operates 319,000 square feet of manufacturing facilities in Asheboro and Graham, North Carolina. It maintains a sales office in Asheboro, North Carolina and agents in several United States cities. Texfi Narrow Fabrics contributed 12% of total Company fiscal 1995 sales by manufacturing products from polyester, nylon and rubber which are sold domestically to the intimate apparel, insert apparel, medical and automotive markets.\nFrom its inception through 1984, the Company was engaged in manufacturing fabrics made of textured polyester. The decline in consumer demand for polyester knitwear prompted the Company to terminate its knit fabric manufacturing operations in 1984 and restrict production to finished woven fabrics. From 1986 until 1992, the Company's business strategy was to broaden its customer base primarily through the acquisition of other textile operations. These acquisitions allowed the Company to expand its operations into new products such as yarn, greige woven fabrics, narrow fabrics (primarily elasticized) and knitted apparel fabrics (primarily cotton t-shirts). While the Company was able to diversify its products and increase its revenues as a result of these acquisitions, many of these operations proved to be unprofitable and resulted in substantially increased debt.\nDuring the first quarter of 1995, management decided to discontinue operations at its High Point, North Carolina Highland Yarns (\"Highland\") facility and its Jefferson, Georgia diaper and corduroy facilities. The Company discontinued operations and sold the fixed assets and inventory related to its Marion, North Carolina greige goods operation during the second fiscal quarter of 1995. These discontinuances and dispositions generated $17.5 million in charges which are recorded as a loss from discontinued operations. Because the Highland assets are recorded at the approximate net value expected to be received from liquidation, management does not anticipate any additional future losses related to these discontinued operations. As of November 3, 1995, the Company held $1.5 million in Highland fixed assets which will be disposed of through orderly liquidation during fiscal 1996.\nPRODUCT GROUPS\nThe Company's manufactures three basic product groups:\n* woven finished fabrics for the apparel, home furnishings and export markets; * knitted apparel (primarily T-shirts) for the private label and retail markets * narrow knitted and woven fabrics for the intimate apparel and insert apparel markets, as well as automotive accessories and medical applications;\nThe approximate percentage of total revenue contributed by each of the Company's product groups is as follows:\n1995 1994 1993 ------ ------ ------ Woven finished fabrics 60.4 61.9 60.3 Knitted apparel (primarily t-shirts) 27.9 25.6 28.5 Narrow fabrics 11.7 12.5 11.2 ------ ------ ------ 100.0 100.0 100.0 ====== ====== ======\nSEASONALITY\nDuring 1995 and 1994, the Company's business exhibited seasonality, primarily due to temporary plant shutdowns during the Christmas\/New Year's holiday season. As a result, sales have been and are expected to be lower during the first quarter of the fiscal year while working capital requirements increase in anticipation of higher second quarter sales. Working capital is comprised chiefly of inventories and accounts receivable. Inventories are reported at the lower of cost or market value with cost being determined primarily by the first-in, first-out method. Market value is based on replacement cost or net realizable value, as appropriate. The majority of accounts receivable are due from certain financial institutions with whom the Company has entered into factoring agreements. The Company may be advanced funds in amounts not to exceed 90% of eligible accounts receivables plus 50% of eligible inventories not to exceed a maximum of $10,000,000. All advances have been netted against total factored receivables to comprise part of working capital.\nBACKLOG\nAt November 3, 1995, the Company had a $57,267,000 backlog of orders believed to be firm, as compared to a $61,030,000 backlog at October 28, 1994. The decrease is attributable to the discontinuance and disposition of previously discussed operations. The comparative backlog for the Company's three ongoing operations actually increased from $43,037,000 as of the end of the 1994 fiscal year. The current backlog of orders is expected to be filled prior to the end of fiscal 1996.\nCUSTOMERS\nIn fiscal 1995, the Company's products were sold to more than 1,000 customers, which were primarily domestic manufacturers of apparel and home furnishings, as well as medical suppliers and retailers. Sales to the 10 largest customers represented approximately 24% of total sales, but no one customer accounted for more than 7% of total sales. The Company does not believe that the loss of any one of its customers would have a material adverse effect on the Company.\nMARKETING\nThe Company's products are sold through a sales force of 29 full-time, salaried account executives and 39 independent, commissioned sales representatives who may sell products of other manufacturers, including some competitors of the Company. The Company maintains sales offices in New York City, as well as in Asheboro, Charlotte, and Haw River, North Carolina. The Company's production is determined in large part by customer contracts which are received by its sales force. As part of its marketing effort, the Company continually works to develop new products and processes and improve existing products and processes, but expenditures for these activities are not financially identifiable.\nIn order to improve its customer service capabilities, the Company has begun utilizing computerized networks with many of its customers in order to provide \"quick response\" to customer requirements for more competitive product deliveries. By providing these customers with certain direct inventory information, the customers' inventory requirements can be reduced and their inventory carrying costs lowered accordingly.\nCOMPETITION\nThe textile and apparel industry is highly competitive with a large number of domestic and foreign manufacturers, none of which dominates the market for any of the Company's product lines. The Company competes on the basis of styling, price, product performance and customer service.\nU.S. producers, including the Company, are significantly affected by competition from foreign manufacturers. Rules under the recently enacted General Agreement on Trade and Tariffs (\"GATT\") would eliminate restrictions on imports of textiles and apparel after a ten-year transition period. The North American Free Trade Agreement (\"NAFTA\") between the United States, Canada and Mexico has created the world's largest free-trade zone. The Agreement contains safeguards which were sought by the U.S. textile industry, including a rule of origin requirement that products be processed in one of the three countries in order to benefit from NAFTA. There can be no assurance that either NAFTA or GATT will not adversely affect the Company.\nBecause of the absence of published information regarding sales of competing products by other manufacturers, some of which are privately owned companies or divisions or subsidiaries of large companies, it is not possible to determine precisely the market shares of the Company and its competitors for the Company's various products.\nSOURCES OF RAW MATERIALS\nThe Company purchases from outside suppliers natural and synthetic fibers, rubber, dyes and chemicals for use in its fabric manufacturing operations. The Company purchases virtually all of its textured polyester yarns from the leading independent domestic supplier of such yarns. Fabrics for its apparel manufacturing operations are supplied by the Company's own fabric manufacturing operations. The Company has not experienced a significant shortage of raw materials and believes that such supplies will continue to be available.\nEMPLOYEES\nAs of November 3, 1995, the Company had approximately 3,200 employees with whom it considers its relationship to be good.\nRESEARCH AND DEVELOPMENT\nAlthough the Company pursues improvements in the quality, style and performance of its products, research and development expenditures have not accounted for a material portion of the Company's total operating costs.\nGOVERNMENTAL REGULATION\nThe Company believes that it is in substantial compliance with federal, state and local provisions regulating the release of materials into the environment, or otherwise relating to the protection of the environment.\nThe existence of groundwater contaminants primarily of a type often found in commonly used industrial solvents was discovered at one of the Company's facilities. This facility has not been operated by the Company since 1980 and has been sold to another party. The State of North Carolina has issued a permit to discharge treated groundwater, and treatment systems have been installed to complete groundwater remediation. The Company's cost to monitor and maintain the treatment system will be approximately $54,000 annually until the site is remediated. In addition, there may be other potential environmental conditions at the site to be addressed, and the remedial plan does not cover these conditions; however, management does not believe that the cost of taking corrective action will have a material adverse effect on the Company's financial condition.\nThe Company has instituted a corporate policy statement on safety and environmental affairs to ensure that the Company and its divisions comply with federal, state and local regulatory standards relating to safety and environmental pollution controls. Included in this policy is a requirement for periodic compliance audits at each of the Company's facilities. The Company believes that costs to be expended now or in the future to ensure compliance with environmental and safety regulations will not have a material adverse impact on the financial condition of the Company.\nSEGMENT INFORMATION\nFinancial information as to industry segments is contained in Note 13 of the Notes to the Consolidated Financial Statements which is included in Item 8 of this document.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nThe following table sets forth the location and general character of the principal operating facilities of the Company, which contain approximately 1,840,000 square feet of floor space. All of these plants are in good operating condition and, except as indicated below, owned by the Company. The plants of the Texfi Blends and Texfi Narrow Fabrics Divisions operate three full eight-hour shifts per workday on a five-, six- or seven-day-per-week basis, depending upon market conditions and customer needs. Due to the nature of the production process for the Company's apparel products, its Kingstree Knit Apparel Division sewing plants operate on a single-eight hour shift, 5 day per week basis whereas its Haw River, North Carolina fabric facility operates shifts similar to the other divsions' fabric manufacturing facilities. The Company believes that its facilities are suitable for their present use and that it has adequate production capacity to support anticipated sales growth for fiscal 1996.\nLocation of Plant Purpose Square Feet\nRocky Mount, NC Weaving, dyeing and finishing 448,000 of synthetic and blended fabrics\nHaw River, NC Knitting, dyeing and finishing of 320,000 cotton and cotton-blended fabrics\nFayetteville, NC Weaving, dyeing and finishing of 218,000 polyester fabrics\nGraham, NC Manufacturing of woven narrow 204,000 fabrics (primarily elasticized)\nJefferson, GA Yarn spinning and weaving 179,000\nGeorgetown, SC Knitted apparel distribution 133,000 center\nAsheboro, NC Manufacturing of knitted narrow 115,000 fabrics (primarily elasticized)\nOlanta, SC Manufacturing of knitted apparel 73,000\nAndrews, SC Manufacturing of knitted apparel 65,000\nMidway, GA (1) Manufacturing of knitted apparel 50,000\nLane, SC (1) Manufacturing of knitted apparel 20,000\nKingstree, SC(1) Manufacturing of knitted apparel 15,000\n(1) Leased facility\nItem 3.","section_3":"Item 3. Legal Proceedings.\nThe Company is a party as plaintiff or defendant to various legal actions which arose during the normal course of business. In the opinion of management, final disposition of these actions will not have a material effect on the Company's financial condition and results of operations.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nNot applicable.\nItem 4A. Executive Officers of the Registrant.\nAll Positions and Offices with Name Age the Registrant Presently Held\nRichard L. Kramer 46 Chairman of the Board of Directors William L. Remley 45 Chief Executive Officer, Vice Chairman of the Board of Directors Andrew J. Parise, Jr. 48 President, Chief Operating Officer Dane L. Vincent 39 Chief Financial Officer, Treasurer Gerald A. Rubinfeld 52 President, Texfi Blends Division Michael A. Miller 49 President, Kingstree Knit Apparel Division Donnie K. Cantrell 46 President, Texfi Narrow Fabrics Division Tim L. Courtney 56 Vice President, Administration Thomas M. Gilreath 53 Corporate Controller, Assistant Secretary Braxton Schell 71 Secretary\nMr. Richard L. Kramer was appointed Chairman of the Board of Directors on November 1, 1994. He had previously served as Vice Chairman of the Board of Directors since May 24, 1994. Mr. Kramer is Chairman of Mentmore Holdings Corporation, Chairman of Sunderland Holdings Corp., Chairman of Republic Properties Corporation, Chairman of CPT Holdings, Inc. and Chairman of Weldotron Corp.\nMr. William L. Remley was appointed Chief Executive Officer and Vice Chairman of the Board of Directors on November 1, 1994. He has served as a Director since May 24, 1994. Mr. Remley is President of Mentmore Holdings Corporation, President of CPT Holdings, Inc., President of Sunderland Industrial Holdings Corp., Director of Republic Properties Corporation and President of Weldotron Corporation.\nMr. Andrew J. Parise, Jr. was appointed President and Chief Operating Officer of the Company on November 1, 1994. He previously served as the Ccmpany's Blends Division President from 1992 to 1995 and the division's Executive Vice President from 1990 to 1992. He has been with the Company in various sales and operations positions since 1977.\nMr. Dane L. Vincent was appointed Chief Financial Officer during December 1995 after previously serving as Vice President of Finance and Treasurer from December 1994. Mr. Vincent joined the Company in 1989 as Financial Accounting Manager after a career in public accounting, where he worked for Ernst & Young and other accounting firms.\nMr. Gerald A. Rubinfeld was appointed President of the Blends Division in 1995. He joined the Company in 1984 as the menswear Marketing Manager and held various marketing positions prior to his appointment.\nMr. Michael A. Miller was appointed President of the Kinsgtree Knit Apparel Division in 1992. He served as Executive Vice President and Chief Financial Officer of the Company from 1988 to 1992 and served as the Company's Treasurer from 1981 to 1992. Mr. Miller served as Vice President-Finance of the Company from 1982 to 1988 and as a Director from 1986 to 1992.\nMr. Donnie K. Cantrell was appointed President of the Texfi Narrow Fabrics Division in 1995. He joined the Company as the Vice-President of Marketing in 1990 after a 23 year career with Miliken & Co. Prior to promotion to his current position, Mr. Cantrell was the division's General Manager.\nMr. Tim L. Courtney was appointed Vice President of Administration in 1994. He joined the Company's Lively Knits Division (since disbanded) in 1966 and served in a variety of positions with the Company, including Director of Fiber and Yarn Procurement and VP of Marketing Services for the Blends Division.\nMr. Thomas M. Gilreath was appointed Corporate Controller and Assistant Secretary in 1994. He joined the Company in 1986 after spending more than 20 years in a variety of accounting positions with the Crompton company and with the Bigelow Sanford Carpet Company. Prior to his current position Mr. Gilreath was Vice President\/Corporate Controller at the Texfi's Blends Division.\nMr. Braxton Schell, an attorney, is a partner in the Greensboro, North Carolina, law firm of Schell Bray Aycock Abel & Livingston L.L.P., which serves as general counsel to the Company. He has served as Secretary since 1963 and was elected a Director in 1970. He also is a director of Kenan Transport Company and Flagler System, Inc.\nItem 4(b). Other Information\nNot applicable.\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 New York Stock Exchange. The approximate number of holders of record as of January 12, 1996 was 1,117.\nThe following table sets forth the high and low sales prices for the Common Stock on the NYSE composite tape for the period indicated.\nQuarter First Second Third Fourth\n1995 Fiscal Year: High 3 3-3\/8 3-1\/8 3-1\/8 Low 2-3\/8 2-1\/2 2-3\/4 2-3\/8\n1994 Fiscal Year: High 5-1\/8 4-1\/8 3-3\/4 3-3\/8 Low 3-3\/8 3-3\/8 2-3\/4 2-3\/4\nThe Company did not pay dividends on its Common Stock in either fiscal 1995 or 1994 and does not intend to do so in the foreseeable future.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nT E N - Y E A R R E V I E W O F P E R F O R M A N C E\n(Dollar amounts in thousands except per share data and the number of employees)\n*Per share data has been restated to give effect to a 4-for-3 stock split effective July 23, 1987.\nFor the years presented, there were no dividends paid to common stockholders.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation.\nM A N A G E M E N T ' S D I S C U S S I O N A N D A N A L Y S I S O F R E S U L T S O F O P E R A T I O N S A N D F I N A N C I A L C O N D I T I O N\nResults of Operations Results of operations for 1994 and 1993 have been restated to reflect the discontinuance of certain operations as follows:\n-- The discontinuance of the Company's Highland Mills (\"Highland\") yarn and Jefferson Mills (\"Jefferson\") diaper and corduroy fabric production during the Company's first fiscal quarter of 1995, and\n-- The discontinuance and sale of the Company's Marion Fabrics (\"Marion\") greige goods business during the second fiscal quarter of 1995.\nFiscal Year 1995 Compared with Fiscal Year 1994 Net sales for fiscal 1995 increased to $257.5 million from $218.1 million, an increase of $39.4 million or 18%. This increase resulted from improved sales at each of the Company's three divisions: $20.5 million in finished fabrics, $16.0 million in apparel, and $2.9 million in narrow fabrics. The finished fabrics division improved primarily as a result of increased demand and delivery of many of the division's synthetic fabrics to the junior girls, women's wear and export markets. Apparel sales increased primarily as a result of the division's continued emphasis on selling primarily to customers in the \"private label\" and retail areas of the T-shirt business.\nCost of goods sold (\"CGS\"), as a percentage of net sales, decreased from 90.1% to 88.8% in 1995. This decrease resulted primarily from a combination of changes in the product mix at the appparel division to products with higher margins and a reduction in volume-related operating costs within both the finished fabrics and narrow fabrics divisions. These improvements were partially offset by increased raw material costs, primarily cotton and synthetic yarns.\nSelling, general and administrative expenses (\"SG&A\") as a percentage of sales decreased from 6.6% in the prior year to 6.3% in 1995. This decrease is primarily a result of the Company's success in keeping the fixed portion of these costs relatively constant (approximately 70% of SG&A is fixed in nature) as the Company increased its 1995 sales volume when compared to 1994.\nFinancial information as to industry segments is contained in Note 13 of the Notes to the Consolidated Financial Statements.\nInterest expense increased $1.4 million during 1995 when compared with 1994 despite the Company reducing total debt and factor advances by approximately $25 million primarily during its second and third fiscal quarters of 1995. Interest expense rose primarily due to increases in the prime rate of interest and other comparable interest rate measures, which occurred throughout late fiscal 1994 and fiscal 1995.\nOther income decreased to $22,000 in 1995 as compared to $1.6 million in 1994 which included receipt of approximately $1.5 million for the settlement of a lawsuit.\nDuring fiscal 1995, the Company recorded charges totaling $17.5 million to discontinue its Highland, Jefferson and Marion operations. These charges included a loss on disposal of operations totaling $15.3 million which is comprised of the following: $9.8 million in property, plant and equipment, $3.1 million in accounts and notes receivable, $1.2 million in inventory, and $1.2 million in other various costs. As of the end of fiscal 1995, the Company has disposed of all of the assets and liabilities relating to these discontinued operations except for $1.5 million of net property, plant and equipment at Highland which will be liquidated during fiscal\n1996 at a price approximating net book value. These discontinued operations generated $21.8 million in sales, $22.4 million in CGS, and $1.6 million in SG&A during fiscal 1995, as compared to $64.8 million, $66.1 million, $4.9 million and $200,000 of sales, CGS, SG&A, and other expense, respectively, in the prior fiscal year.\nAs discussed more fully in Note 9 of the Consolidated Financial Statements, as of November 3, 1995, net operating loss carryforwards of approximately $44.8 million remain to offset future taxable income.\nFiscal Year 1994 Compared with Fiscal Year 1993 Net sales for fiscal 1994 decreased to $218.1 million compared to net sales of $237.3 million in 1993. This $19.2 million (8.1%) decrease resulted from the decreased sales of finished fabrics ($24.4 million) which offset increased sales of knit apparel (primarily T-shirts) ($4.5 million) and narrow fabrics ($721,000). The decreased sales of finished fabrics resulted primarily from the continued weakness of the retail market for apparel made from synthetic finished fabrics, primarily polyester and rayon. The increased sales of knit apparel resulted from the Company's change of its product mix from basic T-shirts to more fashion and value-added products as well as improved market conditions in the overall T-shirt market.\nCGS, as a percentage of net sales, increased from 89.6% in 1993 to 90.1% in 1994. This increase resulted from a combination of changes in product mix and selling prices, increases in raw material costs, primarily cotton, and other volume-related operating costs, and fixed manufacturing costs increasing as a percentage of sales.\nSG&A decreased from 6.9% to 6.6% as a percentage of sales for fiscal 1994 compared with fiscal 1993. This decrease resulted primarily from the Company's efforts to reduce or maintain fixed SG&A expenses, primarily salaries and benefits, at their 1993 levels.\nInterest expense increased approximately $523,000 (5.1%) from $10.2 million in 1993 to $10.7 million. This increase resulted primarily from the redemption of $5.1 million of preferred stock with a portion of the proceeds from the issuance of $34.5 million of Senior Subordinated Debentures due August 1, 1999 (\"8.75% Debentures\") during the fourth quarter of fiscal 1993. In addition, increases in the prime rate of interest from 6% to 7.75% during fiscal 1994 along with corresponding increases in other comparable interest rate measures resulted in increased interest on the Company's variable rate debt and factor advances. These increases offset decreases in interest which resulted from the Company reducing its debt obligations by $7.3 million in 1994 as reflected on the statement of cash flows.\nOther income totaled $1.6 million in 1994 as compared to other expense of $2.0 million in 1993. This change was due to nonrecurring charges ($2.1 million) in 1993 and income ($1.5 million) in 1994 for the settlement of various lawsuits.\nCapital Resources and Liquidity During 1995 and 1994, the Company's business exhibited seasonality, primarily due to temporary plant shutdowns during the Christmas\/New Year's holiday season. As a result, sales have been and are expected to be lower during the first quarter of the fiscal year while working capital requirements increase in anticipation of higher second quarter sales. Working capital is comprised chiefly of accounts receivable and inventory. Traditionally, the Company has maintained financing capacity for working capital and other general corporate purposes under certain factoring agreements and other comparable short-term borrowing arrangements. The Company may be advanced funds in amounts not to exceed 90% of eligible accounts receivable plus 50% of eligible inventories, not to exceed a maximum of $10 million. The amounts reported on the balance sheet as \"Due From Factor\" represent accounts receivable with factors net of advances. As of November 3, 1995, the Company had approximately $11.0 million of funds available under its factoring arrangements.\nAs of November 3, 1995, working capital equaled $4.2 million, a decrease of $8 million from the fiscal year ended October 28, 1994. This decrease in working capital is due primarily to decreases in inventory ($14.0 million) and accounts receivable ($1.2 million) which more than offset decreases in current maturities of long-term debt ($3.0 million) and accounts payable ($2.8 million) and increases in property, plant and equipment held for disposal ($1.5 million). Reductions in inventories and accounts receivable resulted primarily from the discontinuance of certain Company operations as previously discussed.\nThe Company's operating activities generated $13.0 million in net cash during the 1995 fiscal year. Adjustments to the fiscal year net loss of $16.9 million included non-cash transactions of $12.3 million and the net loss on disposition of property, plant and equipment of $9.4 million. In addition, while reductions in inventories, prepaid and other assets provided $14.4 million, increases in receivables and decreases in liabilities required $6.2 million. Cash flows generated by operations when combined with the $9.4 million in net proceeds from the sale of property, plant and equipment were applied to reduce long-term debt and subordinated debentures totaling $20.0 million and purchase property, plant and equipment and intangibles approximating $3.1 million.\nDuring the second quarter of fiscal 1995, the Company sold its discontinued Marion Fabrics greige goods operations for approximately $10.7 million, which included all property, plant and equipment and inventory related to the Marion, N.C. plant. During the fourth quarter of fiscal 1995, the Company incurred an additional $2.0 million loss on discontinued operations, primarily due to default by the purchaser of Marion Fabrics on the $2 million subordinated note received in conjunction with the sale cash proceeds. The note receivable was sold to affiliates of the purchaser for $400,000 after reduction by $330,000 for certain post-closing adjustments.\nOn October 29, 1990, the Company obtained a $40 million credit facility, which has been fully funded. Borrowings under the credit facility bear interest, at the Company's option, at either prime plus 1% or an alternative rate based upon LIBOR or CD rates. The facility balance outstanding at the end of the 1995 fiscal year totaling $18 million is payable in monthly installments through the end of fiscal 1997. The credit facility places limitations on the Company's rental expense, additional indebtedness, acquisitions, capital expenditures and sale or disposal of assets. The Company is also required to maintain a stated amount of working capital and tangible net worth as well as certain financial ratios, including stated ratios of assets to current liabilities and of earnings to fixed charges. This facility has been periodically amended as follows: (i) to make the restrictive covenants less restrictive in order that the Company would remain in compliance with all covenant requirements, (ii) defer and reduce principal payments to assist the Company in meeting its cash demands, (iii) provide for the applicable interest rate margin on the prime, CD and LIBOR rates of interest to be changed within a certain range based on the ratio of the Company's senior debt plus factor advances to earnings before interest, taxes, depreciation and amoritzation and raise the margin associated with the CD and LIBOR rates of interest, and (iv) effect certain other changes. The Company is in compliance with all of the facility's covenant requirements.\nAs of November 3, 1995 the Company has approximately $2.7 million of its Series C Debentures outstanding. The annual interest rate of these debentures may be adjusted at the sole discretion of the Company on April 1st of each year until maturity in the year 2000. The Series C Debentures are redeemable on April 1st of each year, in whole or in part, at the option of the holder or the Company for the principal amount thereof plus accrued interest through the date of redemption.\nOn September 8, 1993, the Company issued $34.5 million in principal amount of Senior Subordinated Debentures due August 1, 1999 (\"8 3\/4% Debentures\"). The 8 3\/4% Debentures, which cannot be called prior to their maturity date, are unsecured obligations but contain covenants that place limitations on the use of proceeds from disposal of assets and on the incurrence of additional indebtedness and senior indebtedness (as defined in the indenture) if such indebtedness would exceed stated ratios of capitalization and earnings after such incurrence. Under the most restrictive of these covenants, the Company may not incur additional indebtedness if, after giving effect to such incurrence, the aggregate amount of indebtedness of the Company would\nexceed 75% of the sum of all indebtedness and stockholders' equity. Advances under the Company's factoring agreements are not considered indebtedness for the purpose of these covenants. The Company is currently prohibited by this covenant from incurring aditional indebtedness because of the 1995 reduction in common stockholders' equity primarily resulting from the $17.5 million charges to record discontinued operations.\nNet proceeds from the issue of the 8 3\/4% Debentures was $33.5 million (net $1.0 million issue costs). These funds were used to redeem all outstanding shares of preferred stock ($5.1 million) and all outstanding Series A and Series B Debentures ($8.4 million), repay long-term debt ($8.1 million) and reduce factor advances ($11.9 million).\nThe Company has significant lease obligations that are classified as operating leases and therefore are not reflected in the balance sheet. The aggregate future minimum lease payments under these leases for their initial or remaining noncancellable terms were $10.7 million as of November 3, 1995, including $3.2 million for fiscal 1996. The Company plans to place into service $7.7 million of machinery and equipment during fiscal 1996. This equipment primarily will increase fabric dyeing and finishing capacity and further automate the inspection process at the Company's finished fabrics division as well as increase knit apparel production sewing capacity. Management anticipates that approximately $7.3 million of the $7.7 million of equipment will be placed into service through a committed operating lease line and thus excluded from the Company's balance sheet.\nManagement believes cash flows from operations and funds available under factoring agreements will provide the Company with sufficient sources of funds to meet its 1996 cash needs and, assuming no significant deterioration in current market conditions, for the foreseeable future.\nEnvironmental Matters and Litigation In 1992 the Company adopted a corporate policy statement on safety and environmental affairs to ensure that the Company and its divisions comply with all federal, state and local regulatory standards relating to safety and environmental pollution controls. Included in this policy is a requirement for periodic compliance audits at each of the Company's facilities. The Company has addressed and continues to address certain environmental conditions and potential conditions at a former plant site. The Company believes that costs to be expended now or in the future to ensure compliance with environmental and safety regulations will not have a material adverse impact on the financial statements of the Company.\nThe Company is also involved in various litigation arising during the ordinary course of business. The final resolution of these matters cannot be determined; however, it is management's opinion these matters will not have a material adverse effect on the Company's financial position and future liquidity.\nInflation The Company believes that inflation affects its business to an extent no greater than it affects the textile and apparel industries generally and the economy as a whole.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nC O N S O L I D A T E D S T A T E M E N T S O F O P E R A T I O N S\nFor the fiscal years ended November 3, 1995, October 28, 1994 and October 29, (Dollar amounts in thousands except per share data)\nSee notes to consolidated financial statements.\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\nNovember 3, 1995 and October 28, 1994 (Dollar amounts in thousands)\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 O M M O N S T O C K H O L D E R S ' E Q U I T Y\nFor the fiscal years ending November 3, 1995, October 28, 1994 and October 29, (Dollar amounts in thousands)\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\nFor the fiscal years ended November 3, 1995, October 28, 1994 and October 29, (Dollar Amounts in thousands)\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\nNovember 3, 1995, October 28, 1994 and October 29, 1993\n1. Summary of Significant Accounting Policies\nA. Principles of Consolidation The consolidated financial statements include the accounts of the divisions of Texfi Industries, Inc. and one wholly-owned inactive subsidiary (the \"Company\"). Intercompany transactions and profits and losses have been eliminated.\nB. Fiscal Year The Company's operations are based on a fifty-two, fifty-three week fiscal year ending on the Friday closest to October 31. The 1995 fiscal year includes 53 weeks while the 1994 and 1993 fiscal years each consist of 52 weeks.\nC. Reclassifications Certain amounts have been reclassified to conform with the 1995 presentation and reflect discontinued operations. There is no effect on net income or common stockholders' equity.\nD. Accounts Receivable -- Factored The Company has entered into factoring agreements with several financial institutions whereby it may assign certain receivables generally without recourse as to credit risk. As a result, these factored receivables are shown net of funds borrowed in advance of collection on such sales. The Company may be advanced funds in amounts not to exceed 90% of eligible accounts receivable plus 50% of eligible inventories, not to exceed a maximum of $10 million. Gross factor receivables and advances equaled $51.5 million and $44.5 million, respectively, at November 3, 1995 and $59.2 million and $49.2 million, respectively, at October 28, 1994. Concentration of credit risk is limited due to the large number of customers to which the Company sells its products (no one customer accounted for more than 7% of the Company's 1995 sales or 4% of the Company's 1994 sales) and the use of several factors to assign the invoices for sales to its customers. The Company generally requires no collateral for its accounts receivable. Interest paid on factor advances in 1995, 1994 and 1993 was $4,676,000, $3,150,000 and $3,535,000, respectively.\nE. Inventories Inventories are stated at the lower of cost or market value. Cost is determined primarily on the basis of the first-in, first-out method. Market value is based on replacement cost or net realizable value, as appropriate.\nF. Property, Plant and Equipment Property, plant and equipment is stated at cost. For financial statement purposes, depreciation is determined primarily by the straight-line method. For income tax purposes, the straight-line and accelerated methods are used. Interest costs incurred in the construction or acquisition of property, plant and equipment are capitalized.\nG. Revenue Recognition Sales are recorded upon shipment or designation of specific goods for later shipment at customers' request with related risk of ownership passing to such customers.\nH. Income Taxes The Company accounts for income taxes using the liability method. Deferred tax liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities as measured by the enacted rates which will be in effect when these temporary differences reverse. Deferred tax expense results from the change in the liability accounts for deferred taxes. Investment tax credits are accounted for by the flow-through method as a reduction of federal income tax expense.\nI. Amortization of Goodwill Goodwill, which represents the excess of the cost of purchased companies over the fair value of their net assets at dates of acquisition, is being amortized on the straight-line method over 40 years. The carrying value of goodwill is reviewed if the facts and circumstances suggest that goodwill may be impaired. Should this review indicate that goodwill will not be recoverable, the Company would reduce the recorded goodwill by an appropriate amount.\nJ. Earnings Per Common Share Primary earnings per common share are based on the average number of shares of common stock and common stock equivalents of dilutive stock options outstanding during the year.\nFully diluted earnings per common share are computed assuming conversion of the 11 1\/4% Convertible Senior Subordinated Debentures into common stock as of the beginning of the year, and the interest expense thereon, net of income taxes, was added to net income.\nK. Discontinued Operations During the first quarter of 1995, the Company discontinued its commodity yarn, corduroy and diaper fabric production. During the second quarter of 1995, the Company discontinued and sold its greige goods manufacturing facility. Operating losses for these operations totaling $6.24 million ($.77 per share) and $2.52 million ($.33 per share), in 1994 and 1993, respectively, have been reclassified in the Consolidated Statements of Operations. As of November 3, 1995, property, plant and equipment related to discontinued operations which will be disposed of by orderly liquidation during the 1996 fiscal year are as follows (in thousands):\nDuring the fourth quarter of 1993, the Company discontinued its retail operations and classified $721,000 of 1993 operating losses as loss from operations of discontinued operations in the Consolidated Statement of Operations.\nL. Cash Equivalents The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents.\n2. Inventories\nInventories at November 3, 1995 and October 28, 1994 are summarized as follows:\n[CAPTION]\n3. Property, Plant and Equipment\nProperty, plant and equipment at November 3, 1995 and October 28, 1994 consists of the following:\n[CAPTION]\n4. Long-term Debt, Pledged Assets and Notes Payable\nLong-term debt at November 3, 1995 and October 28, 1994 consists of the following:\n[CAPTION]\nPayments due on long-term debt during each of the five succeeding years and thereafter are listed below:\nCertain long-term debt agreements contain various covenants and restrictions, including (a) provisions relating to maintenance of working capital, certain financial ratios, and a specified minimum total of net worth and subordinated debt, as defined, and (b) restrictions on additional borrowings and the purchase, sale and lease of real and personal property.\nInterest paid on debt, other than debentures, in 1995, 1994 and 1993 was $2,504,000, $2,885,000, and $3,220,000, respectively.\n5. Subordinated Debentures\nDebentures outstanding at November 3, 1995 and October 28, 1994 consist of the following:\n[CAPTION]\nOn September 8, 1993, the Company issued $34.5 million in principal amount of Senior Subordinated Debentures due August 1, 1999 (\"8 3\/4% Debentures\"). The 8 3\/4% Debentures, which cannot be called prior to their maturity date, are unsecured obligations but contain covenants that place limitations on the use of proceeds from disposal of assets and on the incurrence of additional indebtedness and senior indebtedness (as defined in the indenture) if such indebtedness would exceed stated ratios of capitalization and earnings after such incurrence. Under the most restrictive of these covenants, the Company may not incur additional indebtedness if after giving effect to such incurrence, the aggregate amount of indebtedness of the Company would exceed 75% of the sum of all indebtedness and stockholders' equity. Advances under the Company's factoring agreements are not considered indebtedness for the purpose of these covenants. The Company is currently prohibited by this covenant from incurring additional indebtedness because of the 1995 reduction in common stockholders' equity primarily from the $17.5 million charge to record discontinued operations.\nNet proceeds from the issue of the 8 3\/4% Debentures totaled $33.5 million (net $1.0 million issue costs). These funds were used to redeem all outstanding shares of preferred stock ($5.1 million) and all outstanding Series A and Series B Debentures ($8.4 million), repay long-term debt ($8.1 million) and reduce factor advances ($11.9 million).\nIn April 1990, the Company issued $7.1 million in principal amount of Subordinated Extendible Debentures due April 1, 2000, Series C (11%) (the \"Series C Debentures\") in an underwritten public offering. The annual interest rate of the Series C Debentures may be adjusted at the sole discretion of the Company on April 1, 1995 and on each April 1 thereafter until maturity in 2000. The Company reset the interest rate on the Series C Debentures to 13% for the period April 1, 1995 through March 31, 1996. The Series C Debentures were redeemable on April 1, 1995 and will be redeemable on each April 1 thereafter until maturity, in\nwhole or in part, at the option of the holder or the Company for the principal amount thereof plus accrued interest through the date of redemption. On April 1, 1995, $4.4 million of Series C Debentures were redeemed at the holders' option.\nThe 11 1\/4% Convertible Senior Subordinated Debentures due October 1, 1997 are convertible at any time prior to maturity into common stock of the Company at $6.69 per share (subject to antidilutive provisions of the indenture). Interest is payable semiannually. The 11 1\/4% Debentures are not subject to a sinking fund while the Company maintains a positive, tangible net worth. The payment of the principal and interest on the 11 1\/4% Debentures is subordinated in right of payment to the prior payment in full of all senior indebtedness of the Company as defined in the indenture.\nInterest paid on subordinated debentures in 1995, 1994 and 1993 was $3,984,000, $3,886,000 and $2,214,000, respectively.\n6. Stock Options and Stock Purchase Rights\nAt November 3, 1995, options to purchase previously unissued shares of common stock were outstanding under stock option plans. Payment for shares purchased upon exercise of an option granted under these plans may be made either in cash or in common stock of the Company.\nInformation with respect to stock options outstanding is as follows:\nOptions on 53,390 shares, 239,880 shares and 232,407 shares were exercisable at November 3, 1995, October 28, 1994 and October 29, 1993, respectively. Under the plans, 564,184 shares, 491,611 shares and 378,769 shares of common stock were available for the granting of additional options at November 3, 1995, October 28, 1994 and October 29, 1993, respectively.\nEffective July 22, 1988, the Board of Directors of the Company adopted a Rights Agreement and approved the distribution to stockholders of record on August 9, 1988 of one Preferred Share Purchase Right (\"Right\") for each outstanding share of the Company's common stock. Each Right, when exercisable, generally entitles common stockholders to purchase one one-hundredth of a share of a new series of preferred stock, designated as Series A Junior Participating Preferred Stock, at a price of $30. The Rights will generally be exercisable and transferable apart from the Company's common stock upon acquisition by a person or group of 30% or more of the Company's common stock (amended by the Board of Directors in 1994 to change 15% to 30%), the announcement of a tender offer for 20% or more of the Company's common stock or a determination by the Board of Directors that any holder of 12% or more of the Company's common stock is an \"adverse person.\" The Rights will expire on August 9, 1998, unless such date is extended by the Company's Board of Directors or the Rights are redeemed prior to that time.\n7. Common Stockholders' Equity\nAt November 3, 1995, shares of common stock were reserved for possible issuance as follows:\nPrimary and fully diluted earnings (loss) per common share have been computed on the basis of weighted average number of shares of common stock and common stock equivalents (when not antidilutive) outstanding as follows:\n8. Redeemable Preferred Stock\nIn October of 1993, the Company redeemed all outstanding shares of its preferred stock and all of the outstanding Series A and Series B Subordinated Debentures with a portion of the net proceeds of its September 8, 1993 issue of 8 3\/4% Senior Subordinated Debentures due August 1, 1999 (Note 5).\n9. Income Taxes\nAs of November 3, 1995, the Company had net operating loss carryforwards of $44.8 million for income tax purposes which are available through the year 2010. For financial reporting purposes, a valuation allowance of $15.7 million has been recognized to offset the deferred tax asset related to these carryforwards. The Company has Alternative Minimum Tax credits totaling $377,000 and Investment Tax credits of $29,000 available to reduce income taxes payable in future periods. The Investment Tax credits expire during 1996 through 2001.\nDeferred income tax expense results from temporary differences related primarily to net operating loss carryforwards. Significant components of the Company's deferred tax asset as of November 3, 1995 and October 28, 1994 are as follows:\n[CAPTION]\nIncome taxes paid in 1995, 1994 and 1993 were $-0-, $-0-, and $465,000, respectively.\n10. Employee Benefit Plans\nThe Company maintains a defined contribution plan (401(k)) covering substantially all employees who have completed six months of service. The plan requires the Company to match up to $150 per year for each participating employee's contributions. Discretionary Company contributions are determined annually by the Board of Directors based on results of operations. These discretionary contributions may either match employee amounts or represent fixed amounts. The Company contributed approximately $146,000, $215,000, and $304,000 in 1995, 1994 and 1993, respectively.\n11. Rental Expense and Lease Obligations\nRental expense is summarized as follows:\n[CAPTION]\nFuture obligations for minimum rentals under operating leases and capital leases that have initial or remaining noncancellable lease terms in excess of one year at November 3, 1995 and rentals to be received under noncancellable subleases are as follows:\nCertain operating leases contain renewal options ranging from one to five years and\/or contain purchase options, generally approximating fair market value.\n12. Contingent Liabilities and Commitments\nThe Company is involved in various litigation arising during the ordinary course of business. The final outcome of this litigation cannot be determined; however, it is management's opinion that the final resolution of these matters will not have a material adverse effect on the Company's financial position and future liquidity.\n13. Industry Segments\nThe Company operates in two industry segments: the manufacture and sale of textiles and the manufacture and sale of apparel. Within the textile segment, the Company is engaged primarily in the development, production and sale of finished fabrics and elastic narrow fabrics for the home furnishing, automotive, medical and various apparel markets. Within the apparel segment, the Company is engaged principally in the development, production and sale of T-shirts. Sales by these product groups accounted for 60.4%, 11.7%, and 27.9%, respectively, of total 1995 sales; 61.9%, 12.5%, and 25.6%, respectively, of total 1994 sales; and 60.3%, 11.2% and 28.5%, respectively, of total 1993 sales to unaffiliated customers.\nThe following summarizes certain information on industry segments:\n[CAPTION]\n(1) Balances for fiscal 1994 and 1993 have been restated to exclude discontinued operations.\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, appearing under the heading \"Election of Directors\" on pages 5 through 8 of the Registrant's definitive proxy statement for the Annual Meeting of Stockholders to be held on March 12, 1996, is incorporated herein by reference. Information regarding executive officers is included as Item 4A in Part I of this document.\nItem 11.","section_11":"Item 11. Executive Compensation.\nInformation with respect to executive compensation, appearing under the heading \"Executive Compensation\" on pages 8 through 16 of the Registrant's definitive proxy statement for the Annual Meeting of Stockholders to be held on March 12, 1996, 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, appearing under the headings \"Security Ownership of Certain Beneficial Owners\" and \"Security Ownership of Management\" on pages 1 through 5 of the Registrant's definitive proxy statement for the Annual Meeting of Stockholders to be held on March 12, 1996, 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, appearing under the headings \"Employment and Other Related Agreements\" and \"Certain Transactions\" on pages 15 and 16 of the Registrant's definitive proxy statement for the Annual Meeting of Stockholders to be held on March 12, 1996, 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) Financial Statements and Schedule\nThe financial statements and supplemental schedule listed in the accompanying index to financial statements and schedule are filed as part of this document.\n(3) Exhibits\nExhibits to this report are listed in the accompanying index to exhibits.\n(b) No reports on Form 8-K were filed during the Company's 1995 fourth fiscal quarter.\nSIGNATURES\nPursuant to the requirements of Sections 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nTEXFI INDUSTRIES, INC.\nDate: February 1, 1996 By:s\/Richard L. Kramer ------------------- Richard L. Kramer Chairman of the Board 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 and on the dates indicated.\nFORM 10-K -- ITEMS 8, 14(a)(1) and (2) and ITEM 14(d)\nTEXFI INDUSTRIES, INC.\nINDEX TO FINANCIAL STATEMENTS AND SCHEDULE\nI - Report of Independent Auditors Relating to Consolidated Financial Statements and Supplemental Schedule of Texfi Industries, Inc.\nII - Valuation and Qualifying Accounts\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 consolidated financial statements or in the notes thereto.\nREPORT OF ERNST & YOUNG LLP INDEPENDENT AUDITORS\nStockholders and Board of Directors Texfi Industries, Inc.\nWe have audited the accompanying consolidated balance sheets of Texfi Industries, Inc. and subsidiary as of November 3, 1995 and October 28, 1994 and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended November 3, 1995. Our audits also included the financial statement schedule listed in the Index as 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 Texfi Industries, Inc. and subsidiary at November 3, 1995 and October 28, 1994 and the consolidated results of their operations and their cash flows for each of the three years in the period ended November 3, 1995, 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 AND YOUNG LLP\nRaleigh, North Carolina December 7, 1995\nSCHEDULE II\nTEXFI INDUSTRIES, INC. Analysis of Valuation and Qualifying Accounts for the Fiscal Years Ended November 3, 1995, October 28, 1994 and October 29, 1993 (Amounts in thousands)\nFiscal Year 1995 1994 1993 ------ ------ ----- RESERVES DEDUCTED FROM ASSETS TO WHICH THEY APPLY:\nAllowance for doubtful accounts and claims: Balance at beginning of year .............. $4,287 $3,616 $1,491\nNet additions charged to income: Doubtful accounts........................ 526 384 2,514 Claims and allowances.................... 2,670 2,184 561 ------ ----- ----- 3,196 2,568 3,075 Deductions for accounts written off as uncollectible (net of recoveries) ....... 6,121 1,897 950 ------ ----- -----\nBalance at end of year .................... $1,362 $4,287 $3,616 ====== ====== ======\nTEXFI INDUSTRIES, INC.\nINDEX TO EXHIBITS\n*2(a) Asset Purchase Agreement dated as of February 10, 1995, by and between Registrant and Marion, Inc. filed as Exhibit 2(a) to Registrant's Form 8-K Current Report dated March 31, 1995.\n*2(b) Amendment to Asset Purchase Agreement dated as of February 10, 1995, filed as Exhibit 2(b) to Registrant's Form 8-K Current Report dated March 31, 1995.\n*2(c) Assignment and Assumption of Asset Purchase Agreement dated as of March 31, 1995 by and between Marion, Inc. and Decotech, L.C., filed as Exhibit 2(c) to Registrant's Form 8-K Current Report dated March 31, 1995.\n*2(d) Subordinated Promissory Note dated March 31, 1995 from Decotech, L.C. in the principal amount of $2,000,000, filed as Exhibit 2(d) to Registrant's Form 8-K Current Report dated March 31, 1995.\n*2(e) Subordinated Promissory Note dated March 31, 1995 from Decotech, L.C. in the principal amount of $300,000 filed as Exhibit 2(e) to Registrant's Form 8-K Current Report dated March 31, 1995.\n*2(f) Subordination Agreement dated as of March 31, 1995 by and between BNY Financial Corporation, Decotech, L.C. and Registrant with respect to $2,000,000 promissory note, filed as Exhibit 2(f) to Registrant's Form 8-K Current Report dated March 31, 1995.\n*2(g) Subordination Agreement dated as of March 31, 1995 by and between BNY Financial Corporation, Decotech, L.C. and Registrant with respect to $300,000 promissory note, filed as Exhibit 2(g) to Registrant's Form 8-K Current Report dated March 31, 1995.\n2(h) Agreement dated as of September 8, 1995 between Registrant and Decotech, L.C.\n2(i) Note Purchase Agreement dated as of September 8, 1995 between Registrant, Decotech, L.C. and Deco General Partnership.\n*3(a)(1) Restated Certificate of Incorporation of Registrant dated August 13, 1969, filed as Exhibit (3)(a)(1) to Registrant's Form 10-K Annual Report for the fiscal year ended October 31, 1980.\n*3(a)(2) Certificate of Amendment of Certificate of Incorporation of Registrant dated March 16, 1972, filed as Exhibit (3)(a)(2)to Registrant's Form 10-K Annual Report for the fiscal year ended October 31, 1980.\n*3(a)(3) Certificate of Amendment of Certificate of Incorporation of Registrant dated March 27, 1978, filed as Exhibit (3)(a)(3) to Registrant's Form 10-K Annual Report for the fiscal year ended October 31, 1980.\n*3(a)(4) Certificate of Amendment of Certificate of Incorporation of Registrant dated May 19, 1986, filed as Exhibit 4.4 to Registrant's Form S-8 Registration Statement (No. 33-14697).\n*3(a)(5) Certificate of Amendment of Certificate of Incorporation of Registrant dated March 20, 1987, filed as Exhibit 4.5 to Registrant's Form S-8 Registration Statement (No. 33-14697).\n*3(a)(6) Certificate of Amendment of Certificate of Incorporation of Registrant dated September 28, 1987, filed as Exhibit 4(a)(6) to Registrant's Form S-2 Registration Statement (No. 33-16794).\n*3(a)(7) Certificate of Designations of Registrant dated November 20, 1987, filed as Exhibit 4(a)(7) to Registrant's Form S-2 Registration Statement (No. 33-16794).\n*3(a)(8) Certificate of Designations of Registrant dated March 8, 1988, filed as Exhibit 4(a)(8) to Registrant's Form S-2 Registration Statement (No. 33-20131).\n*3(a)(9) Certificate of Designations of Registrant dated August 4, 1988, filed as Exhibit 4(d)(9) to Registrant's Form 10-Q Quarterly Report for the fiscal quarter ended July 29, 1988.\n*3(b)(1) Bylaws of Registrant, filed as Exhibit 4.6 to Registrant's Form S-8 Registration Statement (No. 33-14697).\n*3(b)(2) Amendment to Bylaws of Registrant, filed as Exhibit 4(b)(2) to Registrant's Form S-2 Registration Statement (No. 33-16794).\n*3(b)(3) Amendment to Bylaws of Registrant adopted by Registrant's Board of Directors on January 18, 1991, filed as Exhibit 3(b)(3) to Registrant's Form 10-K Annual Report for the fiscal year ended November 2, 1990.\n*3(b)(4) Amendment to Bylaws of Registrant adopted by Registrant's Board of Directors on August 31, 1994, filed as Exhibit 4(b)(4) to Registrant's Form 10-Q Quarterly Report for the fiscal quarter ended July 29, 1994.\n*3(b)(5) Amendment to Bylaws of Registrant adopted by Registrant's Board of Directors on September 7, 1994, filed as Exhibit 4(b)(5) to Registrant's Form 10-Q Quarterly Report for the fiscal quarter ended July 29, 1994.\n*4(a)(1) Indenture between Registrant and Rhode Island Hospital Trust National Bank, Trustee, with a copy of Subordinated Debentures due April 1, 1995, Series A, Subordinated Debentures due April 1, 1995, Series B and Subordinated Extendible Debentures due April 1, 2000, Series C attached, filed as Exhibit 4(f) to Registrant's Form S-2 Registration Statement (No. 33-32485).\n*4(a)(2) First Supplemental Indenture between Registrant and Rhode Island Hospital Trust National Bank, Trustee, with a revised Subordinated Debenture due April 1, 1995, Series B attached, filed as Exhibit 4 to Registrant's Form 8-K Current Form dated May 16, 1990.\n*4(a)(3) Indenture dated October 1, 1991 between Registrant and First National Bank of Boston, Trustee, with copy of 11-1\/4% Convertible Senior Subordinated Debenture due October 1, 1997, filed as Exhibit 4(a)(1) to Registrant's Form 10-K Annual Report for the fiscal year ended November 1, 1991.\n*4(a)(4) Indenture dated September 8, 1993 between Registrant and First Union National Bank of North Carolina, Trustee, with copy of 8-3\/4% Senior Subordinated Debenture due August 1, 1999, filed as Exhibit 4(c)(2) to Registrant's Form 10-Q Quarterly Report for the fiscal quarter ended July 30, 1993.\n*4(b)(1) Specimen Common Stock ($1 par value) certificates, filed as Exhibit 4.01 to Amendment No. 2 to Registrant's Form S-1 Registration Statement (No. 2-41653).\n*4(c)(1) Rights Agreement dated July 22, 1988 between Registrant and First Union National Bank of North Carolina, as Rights Agent, filed as Exhibit 1 to Registrant's Form 8-K Current Form dated July 22, 1988.\n*4(c)(2) Form of Rights Certificate, filed as Exhibit B to Exhibit 1 to Registrant's Form 8-K Current Form dated July 22, 1988.\n*4(c)(3) Amendment to Rights Agreement between Registrant and First Union National Bank of North Carolina dated October 31, 1988, filed as Exhibit 4(e)(3) to Registrant's Form S-2 Registration Statement (No. 33-32485).\n*4(c)(4) Second Amendment to Rights Agreement dated May 24, 1994 between Registrant and First Union National Bank of North Carolina, as Rights Agent, filed as Exhibit 4(e)(4) to Registrant's Form 10-Q Quarterly Report for the fiscal quarter ended April 29, 1994.\n*4(c)(5) Third Amendment to Rights Agreement dated December 16, 1994 between Registrant and First Union National Bank of North Carolina, as Rights Agent, filed as Exhibit 4(c)(5) to Registrant's Form 10-K Annual Report for the fiscal year ended October 28, 1994.\n*4(d)(1) Loan Agreement dated October 29, 1990 between Registrant and NCNB National Bank of North Carolina, filed as Exhibit 2(a) to Registrant's Form 8-K Current Form dated November 12, 1990.\n*4(d)(2) First Amendment to Loan Agreement dated March 14, 1991 between Registrant and NCNB National Bank of North Carolina, filed as Exhibit 19(a)(1) to Registrant's Form 10-Q Quarterly Report for the fiscal quarter ended May 3, 1991.\n*4(d)(3) Second Amendment to Loan Agreement dated March 28, 1991 between Registrant and NCNB National Bank of North Carolina, filed as Exhibit 19(a)(2) to Registrant's Form 10-Q Quarterly Report for the fiscal quarter ended May 3, 1991.\n*4(d)(4) Third Amendment to Loan Agreement dated May 29, 1991 between Registrant and NCNB National Bank of North Carolina, filed as Exhibit 19(a)(3) to Registrant's Form 10-Q Quarterly Report for the fiscal quarter ended May 3, 1991.\n*4(d)(5) Fourth Amendment to Loan Agreement dated June 14, 1991 between Registrant and NCNB National Bank of North Carolina, filed as Exhibit 19(a)(4) to Registrant's Form 10-Q Quarterly Report for the fiscal quarter ended May 3, 1991.\n*4(d)(6) Fifth Amendment to Loan Agreement dated January 28, 1992 between Registrant and NCNB National Bank of North Carolina, filed as Exhibit 4(e)(6) to Registrant's Form 10-K Annual Report for the fiscal year ended November 1, 1991.\n*4(d)(7) Sixth Amendment to Loan Agreement dated November 4, 1992 between Registrant and NationsBank of North Carolina, N.A. (formerly NCNB National Bank of North Carolina), filed as Exhibit 4(e)(7) to Registrant's Form 10-K Annual Report for the fiscal year ended October 30, 1992.\n*4(d)(8) Seventh Amendment to Loan Agreement dated December 22, 1992 between Registrant and NationsBank of North Carolina, N.A. (formerly NCNB National Bank of North Carolina), filed as Exhibit 4(e)(8) to Registrant's Form 10-K Annual Report for the fiscal year ended October 30, 1992.\n*4(d)(9) Eighth Amendment to Loan Agreement dated August 25, 1993 between Registrant and NationsBank of North Carolina, N.A. (formerly NCNB National Bank of North Carolina), filed as Exhibit 4(g)(9) to Registrant's Form S-2 Registration Statement (No. 33-66678).\n*4(d)(10) Ninth Amendment to Loan Agreement dated October 29, 1993 between Registrant and NationsBank of North Carolina, N.A. (formerly NCNB National Bank of North Carolina), filed as Exhibit 4(f)(10) to Registrant's Form 10-K Annual Report for the fiscal year ended October 29, 1993.\n*4(d)(11) Tenth Amendment to Loan Agreement dated April 28, 1994 between Registrant and NationsBank of North Carolina, N.A. (formerly NCNB National Bank of North Carolina), filed as Exhibit 4(f)(11) to Registrant's Form 10-Q Quarterly Report for the fiscal quarter ended April 29, 1994.\n*4(d)(12) Eleventh Amendment to Loan Agreement dated October 28, 1994 between Registrant and NationsBank of North Carolina, N.A. (formerly NCNB National Bank of North Carolina) filed as Exhibit 4(d)(12) to Registrant's Form 10-K Annual Report for the fiscal year ended October 28, 1994.\n*4(d)(13) Twelfth Amendment to Loan Agreement dated January 27, 1995 between Registrant and NationsBank of North Carolina, N.A. (formerly NCNB National Bank of North Carolina), filed as Exhibit 4(d)(13) to Registrant's Form 10-Q Quarterly Report for the fiscal quarter ended January 27, 1995.\n*4(d)(14) Thirteenth Amendment to Loan Agreement dated April 28, 1995 between Registrant and NationsBank of North Carolina, N.A. (formerly NCNB National Bank of North Carolina),filed as Exhibit 4(f)(14) to Registrant's Form 10-Q Quarterly Report for the fiscal quarter ended April 28, 1995.\n*4(d)(15) Fourteenth Amendment to Loan Agreement dated July 28, 1995 between Registrant and NationsBank of North Carolina, N.A. (formerly NCNB National Bank of North Carolina)filed as Exhibit 4(f)(15) to Registrant's Form 10-Q Quarterly Report for the fiscal quarter ended July 28, 1995.\n4(d)(16) Fifteenth Amendment to Loan Agreement dated November 3, 1995 between Registrant and NationsBank of North Carolina, N.A. (formerly NCNB National Bank of North Carolina).\nManagement contract or compensatory plan or arrangement (Exhibits 10(a)(1) through 10(a)(23))\n*10(a)(1) Supplemental Retirement Agreement dated September 1, 1981 between Registrant and Joseph H. Hamilton, filed as Exhibit 10(b) to Registrant's Form 10-K Annual Report for the fiscal year ended October 30, 1981.\n*10(a)(2) 1987 Nonqualified Stock Option Plan, as adopted by Registrant's Board of Directors on December 16, 1987 and approved March 8, 1988 at a meeting of Registrant's Stockholders, filed as Exhibit 4(c)(11) to Registrant's Form 10-Q Quarterly Report for the fiscal quarter ended April 29, 1988.\n*10(a)(3) Form of 1987 Nonqualified Stock Option Agreement, filed as Exhibit 4(c)(12) to Registrant's Form 10-Q Quarterly Report for the fiscal quarter ended April 29, 1988.\n*10(a)(4) Resolutions amending the 1987 Nonqualified Stock Option Plan, as adopted by Registrant's Board of Directors on January 8, 1991 and Registrant's Stockholders on March 12, 1991, filed as Exhibit 10(a)(9) to Registrant's Form 10-K Annual Report for the fiscal year ended November 1, 1991.\n*10(a)(5) Resolutions amending the 1987 Nonqualified Stock Option Plan, as adopted by Registrant's Board of Directors on January 12, 1993 and Registrant's Stockholders on March 9, 1993, filed as Exhibit 19(f) to Registrant's Form 10-Q Quarterly Report for the fiscal quarter ended April 30, 1993.\n10(a)(6) Resolution amending the 1987 Nonqualified Stock Option Plan, as adopted by Registrant's Board of Directors on September 6, 1995.\n10(a)(7) Form of 1987 Nonqualified Stock Option Agreements dated May 18, 1995 between William L. Remley and Andrew J. Parise, Jr. and Registrant.\n*10(a)(8) Directors' Deferred Stock Compensation Plan as adopted by Registrant's Board of Directors on July 14, 1989, filed as Exhibit 19 to Registrant's Form 10-Q Quarterly Report for the fiscal quarter ended July 28, 1989.\n*10(a)(9) Resolutions amending the Directors' Deferred Stock Compensation Plan as adopted by Registrant's Board of Directors on November 30, 1994 and Registrant's Stockholders on March 14, 1995, filed as Exhibit 10(a)(7) to the Registrant's Form 10-Q Quarterly Report for the fiscal quarter ended April 28, 1995.\n10(a)(10) Resolution amending Directors' Deferred Stock Compensation Plan, as adopted by the Directors' Deferred Stock Compensation Committee of Registrant's Board of Directors on September 6, 1995.\n*10(a)(11) 1990 Executive Stock Purchase Plan, dated January 9, 1990, filed as Exhibit 4(d)(16) to Registrant's Form 10-Q Quarterly Report for the fiscal quarter ended February 2, 1990.\n*10(a)(12) Resolutions amending the 1990 Executive Stock Purchase Plan, as adopted by Registrant's Board of Directors on March 9, 1993, filed as Exhibit 19(g) to Registrant's Form 10-Q Quarterly Report for the quarter ended April 30, 1993.\n10(a)(13) Resolution amending 1990 Executive Stock Purchase Plan, as adopted by Registrant's Board of Directors on September 6, 1995.\n*10(a)(14) 1990 Restricted Incentive Stock Plan, dated January 9, 1990, filed as Exhibit 4(d)(17) to Registrant's Form 10-Q Quarterly Report for the fiscal quarter ended February 2, 1990 (terminated in 1995 except as to previously issued stock).\n*10(a)(15) Employment Agreement dated November 1, 1991 between Registrant and L. Terrell Sovey, Jr., filed as Exhibit 10(a)(21) to Registrant's Form 10-K Annual Report for the fiscal year ended October 30, 1992.\n10(a)(16) Letter Agreement dated March 20, 1995 between Registrant and L. Terrell Sovey, Jr.\n*10(a)(17) Employment Agreement dated November 17, 1992 between Registrant and Michael A. Miller, filed as Exhibit 10(a)(26) to Registrant's Form 10-K Annual Report for the fiscal year ended October 30, 1992.\n*10(a)(18) Amendment to Employment Agreement dated January 29, 1993 between Registrant and Michael A. Miller, filed as Exhibit 19(d) to Registrant's Form 10-Q Quarterly Report for the fiscal quarter ended April 30, 1993.\n*10(a)(19) Employment Agreement dated October 31, 1994 between Registrant and Andrew J. Parise, Jr., filed as Exhibit 10(a)(23) to Registrant's Form 10-K Annual Report for the fiscal year ended October 28, 1994.\n*10(a)(20) Description of Registrant's 1994 Management Incentive Compensation Plan adopted by Registrant's Board of Directors on February 15, 1994, filed as Exhibit 10(a)(24) to Registrant's Form 10-K Annual Report for the year ended October 28, 1994 (terminated as to Messrs. Remley, Parise, Vincent, Courtney and Gilreath in 1995).\n*10(a)(21) Description of Registrant's Target Ownership Program adopted by Registrant's Board of Directors on February 15, 1994, filed as Exhibit 10(a)(25) to Registrant's From 10-K Annual Report for the fiscal year ended October 28, 1994 (terminated in 1995).\n*10(a)(22) Employment Agreement dated April 1, 1995 between Registrant and William L. Remley, filed as Exhibit 10(a)17 to Registrant's Form 10-Q Quarterly Report for the fiscal quarter ended April 28, 1995.\n10(a)(23) Performance Incentive Plan adopted by Registrant's Board of Directors on September 6, 1995.\n*10(b)(1) Deed of Trust and Security Agreement dated September 15, 1989 between Elastex, Inc., Eugene M. Anderson, Jr. and BarclaysAmerican\/Commercial, Inc., filed as Exhibit 10(e)(4) to Registrant's Form S-2 Registration Statement (No. 33-32485).\n*10(b)(2) First Supplement to Deed of Trust dated September 15, 1989 among Elastex, Inc., Eugene M. Anderson, Jr. and BarclaysAmerican Commercial, Inc., filed as Exhibit 10(e)(5) to Registrant's Form S-2 Registration Statement (No. 33-32485).\n*10(b)(3) Assignment of Leases and Rents dated September 15, 1989 by Elastex, Inc. in favor of BarclaysAmerican\/Commercial, Inc., filed as Exhibit 10(e)(6) to Registrant's Form S-2 Registration Statement (No. 33-32485).\n*10(b)(4) Security Agreement (Equipment and Machinery) dated July 24, 1987 by Elastex, Inc. in favor of BarclaysAmerican\/ Commercial, Inc., filed as Exhibit 10(e)(7) to Registrant's Form S-2 Registration Statement (No. 33-32485).\n*10(b)(5) Amendment to Security Agreement dated September 15, 1989 between Elastex, Inc. and BarclaysAmerican\/Commercial, Inc., filed as Exhibit 10(e)(8) to Registrant's Form S-2 Registration Statement (No. 33-32485).\n*10(b)(6) Term Loan Agreement dated October 30, 1992 between Registrant and Barclays Commercial Corporation, filed as Exhibit 10(c)(9) to the Registrant's Form 10-K Annual Report for the fiscal year ended October 30, 1992.\n*10(b)(7) Amendment to Term Loan Agreement dated August 25, 1993 between Registrant and Barclays Commercial Corporation, filed as Exhibit 10(c)(10) to Registrant's Form S-2 Registration Statement (No. 33-66678).\n*10(b)(8) Amendment to Term Loan Agreement dated December 29, 1993 between Registrant and Barclays Commercial Corporation, filed as Exhibit 10(b)(11) to Registrant's Form 10-K Annual Report for the fiscal year ended October 29, 1993.\n*10(b)(9) Amendment to Term Loan Agreement dated May 25, 1994 between Registrant and The CIT Group\/BCC, Inc. (formerly Barclays Commercial Corporation), filed as Exhibit 10(b)(12) to Registrant's Form 10-Q Quarterly Report for the fiscal quarter ended April 29, 1994.\n*10(b)(10) Amendment to Term Loan Agreement dated October 28, 1994 between Registrant and The CIT Group\/BCC, Inc. (formerly Barclays Commercial Corporation), filed as Exhibit 10(b)(13) to Registrant's Form 10-K Annual Report for the fiscal year ended October 28, 1994.\n*10(b)(11) Amendment to Term Loan Agreement dated January 27, 1995 between Registrant and The CIT Group\/BCC, Inc. (formerly Barclays Commercial Corporation) filed as Exhibit 10(b)(14) to Registrant's Form 10-Q Quarterly Report for the fiscal quarter ended January 27, 1995.\n*10(b)(12) Inventory Security Agreement dated February 1, 1995 between Registrant and The CIT Group\/Commercial Services, Inc. (formerly Barclays Commercial Corporation), filed as Exhibit 10(b)(15) to the Registrant's Form 10-Q Quarterly Report for the fiscal quarter ended January 27, 1995.\n*10(b)(13) Inventory Security Agreement dated March 31, 1995 between Registrant and The CIT Group\/Commercial Services, Inc. (formerly Barclays Commercial Corporation), filed as Exhibit 10(b) (17) to Registrant's Form 10-Q Quarterly Report for the fiscal quarter ended April 28, 1995.\n*10(b)(14) Amendment to Term Loan Agreement dated April 28, 1995 between Registrant and The CIT Group\/BCC, Inc. (formerly Barclays Commercial Corporation), filed as Exhibit 10(b)(15) to Registrant's Form 10-Q Quarterly Report for the fiscal quarter ended April 28, 1995.\n*10(b)(15) Amendment to Term Loan Agreement dated July 28, 1995 between Registrant and The CIT Group\/BCC, Inc. (formerly Barclays Commercial Corporation), filed as Exhibit (10)(a)(1) to Registrant's Form 10-Q Quarterly Report for the fiscal quarter ended July 28, 1995.\n10(b)(16) Amendment to Term Loan Agreement effective November 3, 1995 between Registrant and The CIT Group\/BCC, Inc. (formerly Barclays Commercial Corporation).\n*10(b)(17) Security Agreement dated October 30, 1992 between Registrant and Barclays Commercial Corporation, filed as Exhibit 10(c)(11) to Registrant's Form 10-K Annual Report for the fiscal year ended October 30, 1992.\n*10(b)(18) First Supplement to Deed of Trust and Security Agreement dated October 30, 1992 between Registrant and Barclays Commercial Corporation, filed as Exhibit 10(c)(12) to Registrant's Form 10-K Annual Report for the fiscal year ended October 30, 1992.\n*10(b)(19) Second Supplement to Deed of Trust and Security Agreement dated October 30, 1992 between Registrant and Barclays Commercial Corporation, filed as Exhibit 10(c)(13) to Registrant's Form 10-K Annual Report for the fiscal year ended October 30, 1992.\n*10(b)(20) Modification of Deed to secure Debt dated October 30, 1992 between Registrant and Barclays Commercial Corporation, filed as Exhibit 10(c)(14) to Registrant's Form 10-K Annual Report for the fiscal year ended October 30, 1992.\n*10(b)(21) Master Loan and Security Agreement dated June 1, 1993 between Registrant and BOT Financial Corporation and related Promissory Note dated June 4, 1993 between Registrant and BOT Financial Corporation, filed as Exhibit 19(h) to Registrant's Form 10-Q Quarterly Report for the fiscal quarter ended April 30, 1993.\n*10(b)(22) Loan Schedule No. 2 to Master Loan and Security Agreement and related Promissory Note and Supplemental Security Agreement dated July 30, 1993 between Registrant and BOT Financial Corporation, filed as Exhibit 10(b)(19) to Registrant's Form 10-K Annual Report for the fiscal year ended October 29, 1993.\n*10(b)(23) Loan Schedule No. 3 to Master Loan and Security Agreement and related Promissory Note and Supplemental Security Agreement dated October 29, 1993 between Registrant and BOT Financial Corporation, filed as Exhibit 10(b)(20) to Registrant's Form 10-K Annual Report for the fiscal year ended October 29, 1993.\n*10(b)(24) Master Loan and Security Agreement dated June 1, 1993 between Registrant and KeyCorp. Leasing Ltd. and related Promissory Note dated June 4, 1993 between Registrant and KeyCorp. Leasing Ltd., filed as Exhibit 19(i) to Registrant's Form 10-Q Quarterly Report for the fiscal quarter ended April 30, 1993.\n10(c)(1) Loan Agreement dated October 29, 1990 and Amendments thereto between Registrant and NCNB National Bank of North Carolina, incorporated by reference as Exhibits 4(d)(1) through 4(d)(16) hereto.\n*10(c)(2) Future Advance Deed of Trust and Security Agreement (Fayetteville, NC, property) dated October 29, 1990 between Registrant and NCNB National Bank of North Carolina, filed as Exhibit 2(b) to the Registrant's Form 8-K Current Form dated November 12, 1990.\n*10(c)(3) Future Advance Deed of Trust and Security Agreement (Rocky Mount, NC property) dated October 29, 1990 between Registrant and NCNB National Bank of North Carolina, filed as Exhibit 2(c) to Registrant's Form 8-K Current Form dated November 12, 1990.\n*10(c)(4) Amended and Restated Security Agreement dated May 29, 1991 between Registrant and NCNB National Bank of North Carolina, filed as Exhibit 10(c)(5) to Registrant's Form 10-K Annual Report for the fiscal year ended October 29, 1993.\n*10(d)(1) Stock and Option Purchase Agreement dated May 24, 1994 between Registrant and Chadbourne Corporation, filed as Exhibit 10(d)(1) to Registrant's Form 10-Q Quarterly Report for the fiscal quarter ended April 29, 1994.\n11 Computation of Earnings Per Share\n21 Subsidiary of Registrant\n23 Consent of Ernst & Young LLP, Independent Auditors\n27 Financial Data Schedule - ----------------------------------\n*Incorporated by reference to previous filing.","section_15":""}
{"filename":"752431_1995.txt","cik":"752431","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nNetwork Equipment Technologies, Inc. (\"N.E.T.\" or \"the Company\") is a leading supplier of multiservice backbone networks for information-intensive organizations and network service providers worldwide. The Company is headquartered in Redwood City, California, has more than 1,100 employees and has installed networks in over 50 countries. The Company was incorporated in California in 1983 and reincorporated in Delaware in 1987. Its common stock is traded on the New York Stock Exchange.\nFor over a decade, N.E.T. has manufactured and supported products for wide-area networks (\"WANs\"). Many network service providers and end-user organizations in the world use N.E.T.(TM) solutions to provide cost-effective and reliable digital communications services. Integrating data, voice, video and image applications on packet- and circuit-switching platforms, N.E.T. products support a wide range of technologies for LAN internetworking and WAN communications. Designed for reliability, flexibility and compliance with national and international standards, N.E.T. products are backed by an extensive service and support infrastructure.\nINDUSTRY BACKGROUND\nIn the early 1980s there were several fundamental developments in the market for telecommunications products and services. These changes began in the United States, and included significant opportunities created by deregulation of the telecommunications industry and availability of high-capacity leased digital transmission lines, referred to as \"circuits\". Many countries have since experienced similar changes in their telecommunications environment.\nReliable transmission of voice and data traffic is of great importance to major businesses and government agencies. For many of these organizations, loss of applications capability due to failed communications networks could result in a significant loss of revenue or failure of a critical mission. By the mid 1980s, some of these organizations began to move their high-volume, critical applications away from public networks and application-specific networks and onto integrated private networks. Such WANs, or backbone networks, constructed around fully-dedicated circuits to achieve greater reliability and cost savings, quickly became critical to the success of these enterprises.\nThese developments encouraged the growth of the enterprise -- or private -- network segment of the WAN market. Products, often referred to as \"bandwidth managers\", became available to manage the increasing amounts of bandwidth. The enterprise network segment grew rapidly during the mid to late 1980s, and generally refers to communications solutions whereby equipment is owned and managed by enterprises and is located on their premises.\nDuring the early 1990s, with the increasing availability of high-bandwidth switched digital services such as Integrated Services Digital Network (\"ISDN\") and frame relay, demand grew for enterprise network platforms to manage switched services in conjunction with enterprise networks -- referred to as providing \"bandwidth-on-demand\". The availability of these advanced carrier services, along with Virtual Private Networks for voice and Managed Data Networks for data, has blurred the line between public and private networks, making hybrid networking (a mix of public and private solutions) more common.\nIn response to the expanding requirements for bandwidth managers to support multiple technologies, application types, and services on a single communications platform, multiservice platforms have been developed. Such platforms enable the construction of multiservice backbone networks. Multiservice backbone networks enable users to avoid being restricted or \"locked-in\" to a single technology or type of application. Multiservice platforms provide flexibility that enables the customization of a network to meet current needs and allows the addition of technologies and applications in the future.\nThe public network segment of the WAN market includes equipment owned, and services provided, by carriers. Public network equipment is generally located on carriers' premises (such as central offices) and is used to offer a wide variety of services, ranging from traditional telephone services to sophisticated value- added services for businesses using high-speed digital switching and transmission technology. There is a trend towards greater use of carrier offerings by enterprises and, as a result, equipment demand is shifting from that of pure enterprise network equipment, as described above, to public network equipment which also supports enterprise network requirements. In general, the branch or department within the carrier organizations that is responsible for the provision of network services to businesses is referred to as a network service provider. Network service providers focus on the provision of advanced business services and are increasingly involved in data networking -- as opposed to the traditional carrier organization that provides telephone services to the general public and is more concerned with voice provisioning, and also sells communications equipment and transmission bandwidth (by leasing dedicated lines) to businesses.\nIn addition, there exists an increasing demand on the part of customers for \"outsourcing\" portions of their enterprise networks. This means they are asking carriers, systems integrators, or outsourcers to take ownership of and to manage communications equipment and services that provide the benefits of traditional private networks while shifting the responsibilities associated with daily network operations. Carriers, or more specifically their outsourcing or network service provisioning groups, may also be involved in the selection, procurement and provisioning of the transmission services required for such networks. As a result, network service providers are playing a larger and larger role in the industry as they expand to provide enterprise network solutions which were previously handled \"internally\" by enterprises.\nWithin the public and enterprise network solutions markets, there is further segmentation that accounts for variations in opportunities on a regional and capacity-related basis. For example, the increasing \"internationalization\" or \"globalization\" of businesses and an increasing liberalization of carrier services around the world have propelled the industry toward a worldwide focus requiring products designed to meet various national and international standards.\nFrom a capacity-related perspective, there is a trend towards using higher-bandwidth digital services, as high capacity optical fiber becomes the backbone of carrier networks. This extends demand for bandwidth management capabilities to broadband network equipment. At the same time, and at the other end of the scale, the benefits which have been realized by larger, central sites are being desired by smaller, branch sites of information-intensive organizations. Consequently, access equipment is one of the most rapidly growing segments of the WAN equipment market.\nThe proliferation of local area networks (\"LANs\") that interconnect computers within an office building has created a demand for connectivity solutions that promote communications between LANs. The connectivity of LANs, whether locally (within a single building) or across the wide area (throughout a geographically-dispersed enterprise), is referred to as LAN internetworking. In the 1990s the proportion of traffic on the WAN which originates from LANs has been increasing steadily. The Company believes this trend will continue as more and more powerful computing takes place at the desktop, and the increasing globalization of enterprise activities results in users becoming less sensitive to distance considerations and more accustomed to sharing data between geographically-remote locations.\nFor the LAN, LAN internetworking and WAN equipment markets, Asynchronous Transfer Mode (\"ATM\", a specific form of cell-relay technology) is increasingly viewed as the fundamental networking technology of the future. As a result, the evolution and implementation of ATM technology and standards related to that technology are expected to have a significant impact on the entire networking industry.\nIn summary, the explosion of communications technology and capacity, creative utilization of that technology by competitors and users, increasingly assertive participation of carriers in the business communications market, and significant growth in international markets have all combined to dramatically increase the complexity of the markets in which N.E.T. competes. The Company does not anticipate that this increasing complexity will abate anytime in the foreseeable future. During the last decade, competition has steadily increased as the networking market has grown and the importance of networking to enterprises has increased. As a result, N.E.T. feels that the industry today is more competitive than ever (see \"Competition\" below).\nCOMPANY STRATEGY\nN.E.T. currently focuses on two strategic markets in which the Company has demonstrated success to date and believes there are continuing opportunities in the future. The Company targets wide-area multiservice backbone networks in information-intensive organizations and network service providers worldwide. The Company's strategy is to focus its products, support and distribution capabilities to address the needs of network planners, managers, and users in both of these enterprise and carrier market segments.\nThe Company believes that information-intensive organizations have a wide range of communications requirements that determine their wide-area networking needs. The diversity of requirements is enormous and includes the following cases along with many variations: very dense communications traffic among relatively few key locations or \"network hubs\"; light communications traffic from many locations distant from the network's hubs; and interconnection of LANs to WANs. The Company's sales strategy includes reaching the top 1,000 communications users worldwide by employing a highly-trained direct sales force in the U.S. and the U.K., as well as leveraging sales through additional distribution channels worldwide. As part of the sales process, N.E.T. or distributor personnel consult extensively with customers concerning their network requirements. Company personnel also provide support and training to customers and distributors of the Company's products. In addition, the Company believes that organizations beyond the top 1,000 users represent an increasing percentage of the potential users of its currently available and planned products, particularly those in the broadband and access environments. As a result, the Company is increasingly directing its distribution and its product teams to reach and meet the needs of such potential customers. For existing clients, the Company's sales strategy includes the provision of a migration path to evolve their multiservice backbone networks to incorporate ATM technology as appropriate in the future.\nFailure to keep pace with technological developments, marketing programs and distribution capabilities of competitors would negatively affect the Company's performance. The Company relies on non-exclusive distribution agreements with a number of partners, outlined under \"Marketing and Distribution\" below.\nTo address the needs of network planners, managers, and users in both the enterprise and carrier market segments, the Company's product strategy is to provide sophisticated transmission, network management and connectivity platforms as wide-area network solutions. N.E.T.'s core multiservice platform and frame-relay product lines provide solutions designed to optimize use of T1, E1, T3, and E3 transmission elements of the network. Its access and low-end networking products provide cost-effective connectivity from smaller locations with lighter traffic requirements, and its broadband switch family provides transmission management solutions targeted at T1, fractional T3, T3, and OC-3 traffic for major enterprises and cellular network providers. N.E.T.'s internetworking products enhance connectivity and interoperability among devices that transmit information between LANs across WANs. Interwoven into many aspects of this product strategy is the migration to, and incorporation of, ATM technology and support for ATM carrier services. With all of its communications products, the Company develops and supports network management products to enhance operator visibility into network conditions, permitting greater control and management of networks.\nN.E.T. believes it must continue to focus its product lines to meet the needs of its strategic markets. This may be done either through internal development, the acquisition of technology or association with entities whose technologies or product offerings complement its own. The Company has entered into a number of agreements relating to the development, license or purchase of technology to extend the reach and functionality of the Company's product lines, and will continue to do so as deemed appropriate by management. A recent example of the Company's strategy to complement its platforms offerings from other vendors is the strategic partnership with Cascade Communications Corporation (\"Cascade\"). This includes joint marketing and distribution of Cascade's frame-relay switches with N.E.T.'s families of frame-relay products and multiservice platforms. Through this agreement, N.E.T. can offer customers an extended range of frame-relay products backed by N.E.T. service.\nN.E.T.'s service strategy is to provide superior support for its own products described above, as well as for products from other vendors, such as Cascade, when appropriate. The Company provides a wide range of service and support options for all of its products including installation, a choice of different hardware and software maintenance programs, upgrades and repairs, technical assistance (performed over the telephone or by dialing into clients' networks), and training for many categories of network staff. Also, N.E.T. has performed a significant amount of systems integration business recently, and its strategy includes leveraging the experience gained to extend this aspect of its service business.\nThe Company's service strategy includes supporting its customers among the top 1,000 communications users worldwide by employing a trained N.E.T. service and support organization in the U.S. and the U.K., as well as leveraging service and support capabilities of authorized service agents, many of whom are also authorized to sell N.E.T.'s products, around the world. In addition, the Company is developing appropriate service and support capabilities via third-party agreements to address the requirements of organizations beyond the top 1,000 users.\nA high level of continuing client support is integral to the Company's strategy of providing long-term support and developing long-term relationships with customers (see \"Customer Service and Support\" below). The Company's strategic relationships involve links with equipment manufacturers and resellers, global carriers and network service providers in the enterprise and carrier arenas worldwide. Objectives of these relationships vary, ranging from technology licensing agreements to joint product development plans and sales and marketing programs (see \"Marketing and Distribution\" below).\nPRODUCTS\nThe Company maintains an engineering and manufacturing organization that is responsible for all of the Company's products. The main product lines include IDNX(R) multiservice platforms, FrameXpress(TM) frame-relay nodes, SONET Transmission Manager(TM) (STM(TM)) broadband switches, and NetOpen(TM) network management systems, all of which are described below. Access and low-end networking products are provided within multiservice and frame-relay product lines as well as N.E.T.'s SPX(TM) and ADNX(R) product families. In addition, the Company is developing ATM products for the WAN that will interoperate with and become members of the multiservice product family. Information regarding N.E.T.'s ATM in the WAN architecture will be made available later this year.\nN.E.T.'s multiservice, frame-relay and broadband networks are designed to take advantage of distributed network intelligence. This means that all platforms are equipped with a high degree of intelligence that enables each node to communicate with other family members, make decisions and take appropriate action regarding the state of the network and applications being supported on it without reference to any external network controlling processor. In this way, networks can be designed to prevent a single point of failure (such as could occur at the workstation of an external network controlling processor) and can benefit from rapid response times provided by the nodes' up-to-date network knowledge and local nodal processing.\nAll N.E.T. networking nodes perform multiplexing and routing (including automatic re-routing) and all have sophisticated network intelligence. Multiplexing is the process of aggregating streams of voice, data, image and\/or video from multiple sources for transmission over circuits. Routing refers to the selection of the path that most efficiently utilizes the network depending on the priority of the transmission, the condition of the network and the volume of network traffic. Rapid re-routing is the ability to dynamically route existing network traffic around a failed circuit fast enough to keep the end-to-end connection intact. Network intelligence involves data collection, analysis, decision making and presentation of information to allow the user to view, control and manage the network's multiplexing, routing and other functions to its fullest operational and economic potential. Such intelligent nodes can pass information about the network to N.E.T.'s network management systems that are based on industry-standard workstations and provide further storage and processing capacity to enable the display and analysis of conditions and parameters within the network.\nThe IDNX multiservice platform family allows users of voice, data, image and video communications to achieve full potential from wide-area networks in a highly cost-effective manner. This family incorporates packet- and circuit-switching designed to manage both traffic types in the most efficient way. N.E.T.'s multiservice platforms offer a wide range of interfaces to customers' equipment (e.g., Ethernet LANs, Token Ring LANs, frame-relay access devices or \"FRADs\", computers, private branch exchanges or \"PBXs\", and video devices) while supporting different types of applications and carrier services. These platforms support T1, E1, T3, and E3 transmission speeds and the family includes devices for low-end networking and WAN access. The Company's multiservice backbone networks can be configured and automatically reconfigured in a wide variety of complex network topologies including point-to-point, ring, star and fully interconnected mesh to accommodate clients' evolving requirements. Unlike most time division multiplexing bandwidth managers, N.E.T.'s multiservice platforms use efficient bandwidth allocation algorithms, assigning bandwidth only as necessary to accommodate specific user requirements, rather than wasting valuable bandwidth by allocating it in predetermined segments.\nIntegral to these multiservice platforms is N.E.T.'s Packet Exchange (\"PX\") family that provides support for internetworking activities and switched services. There are three main product types:\n- - LAN\/WAN Exchange(TM) (\"LWX\") router module provides multiprotocol routing with concurrent bridging support to interconnect geographically dispersed LANs over a WAN. It is compatible with Cisco Systems, Inc. routers and supports connections to local Ethernet or Token Ring interfaces, as well as to remote LWX modules, standalone routers, packet-switching services or IBM controllers;\n- - Frame Relay Exchange(TM) (\"FRX\") is a frame-relay switching node and access device that can provide frame-relay access to bridges, routers (including the LWX), front-end processors, or other devices that support the frame-relay DTE interface. The FRX allows the integration of traffic from many different sources onto a consolidated frame-relay backbone, and provides an efficient, effective transport mechanism for a variety of traffic types. It can also connect to public frame-relay networks;\n- - ISDN Exchange(TM) (\"ISDNX(TM)\") server module supports Integrated Service Digital Network (\"ISDN\") circuit switching and routing capabilities and enables a variety of devices such as PBXs, video codecs, routers, and front-end processors to connect to the IDNX platform via an industry-standard Primary Rate Interface (\"PRI\"). The signaling capabilities of the ISDNX provide an intelligent connection and offer ISDN services to the attached ISDN device.\nThe FrameXpress family of scalable, standards-based products is designed to provide frame-relay solutions ranging from high-speed backbone switching to remote stand-alone access. The FrameXpress platform uses the same data and internetworking modules as N.E.T.'s multiservice platform, but is designed to address the needs of more data-intensive customers. Members of the FrameXpress family are compatible with public and private frame-relay network standards, and the integral routing and bridging capabilities allow use of these products both as integrated routers and frame switches. N.E.T. markets a comprehensive frame-relay product line which combines products from other vendors, such as Cascade and Sync Research, Inc., with the Company's own internally-developed FrameXpress family. For very concentrated data applications, N.E.T. resells Cascade's high-capacity B-STDX(TM) switch that provides high port-density configurations. For smaller locations, N.E.T. markets Sync Research's FrameNode(TM) FRAD that provides branch offices with WAN access.\nThe STM family of broadband network switches is designed to provide advanced networking functionality for broadband communications. The STM node provides fast switching of wideband and broadband circuits utilizing a low delay SONET switching matrix. With its broadband switching capacity, intelligent networking, inverse multiplexing, and compliance with T1, fractional T3, T3, and OC-3 carrier services, this broadband node is designed to accommodate hybrid public\/private networking. The STM provides high service availability and simplifies network management and operation through end-to-end connection management and dynamic connection re-route and restoration. STM broadband networks provide effective, reliable, and flexible wide-area communications infrastructures capable of supporting mainframe channel extension, high-speed router, CAD\/CAM, and other applications requiring high-capacity transport. Also traffic from T1 based devices, such as videos, PBXs, routers and T1 multiplexers can be integrated.\nOther network products developed and marketed by the Company include SPX statistical multiplexers that provide low-capacity networking for low- to medium-volume data networks and ADNX\/48 Integrated Access Multiplexers that cost-effectively combine LAN traffic with voice, synchronous data and video over a single T1 or fractional T1 transmission line.\nN.E.T. offers a range of network management products as well as service and support arrangements. The Company's network management products enhance a customer's ability to control and monitor its network and to diagnose and respond to changes or failures in equipment and transmission resources in the network. Network management products are designed to allow organizations to increase the productivity and responsiveness of their telecommunications staff and network, thereby increasing efficiency and reducing cost.\nN.E.T. offers three main network management products for IDNX multiservice and FrameXpress frame-relay networks:\n- - NetOpen 5000 network management system is a multi-user real-time monitoring, control and management system for the Company's multiservice platforms and access products. The user interface presents color graphic representations of the network topology and network elements;\n- - NetOpen\/Circuit Manager gives clients the ability to software partition their physical backbone network into multiple, independent virtual networks. This allows a single, enterprise-wide physical network to appear to users as a group of small independent networks, but provides greater economies of scale;\n- - Expert Fault Management System (\"EFMS\") is a software application that uses expert systems technology to automatically monitor multiservice backbone network activity and to detect problems in transmission lines, multiservice platforms and other devices in the network. EFMS automatically performs diagnostic procedures to determine the source of detected problems, makes repair recommendations and creates a record of the foregoing.\nFrameXpress frame-relay networks can also be managed using industry-standard SNMP (\"Simple Network Management Protocol\") management systems. Furthermore, N.E.T. offers two additional network management products specifically for FrameXpress frame-relay networks:\n- - FrameXpress Node Manager is a graphical management tool that enables network managers to remotely review network events and make network modifications;\n- - FrameXpress Accountant gathers and stores information about network usage, enabling this data to be accessed for detailed traffic analysis activities such as billing and capacity planning.\nN.E.T. also offers the choice of two network management products for STM broadband networks:\n- - Node Operations Console (\"NOC\") facilitates the configuration, control and monitoring of all STM network nodes. The NOC system provides monitoring, reporting and control capabilities using a simple windowing user interface with pull-down menus and preset forms;\n- - Broadband Operations System (\"BOS\") provides a color graphical representation of STM nodes and network. The views provide a dynamic, graphical representation of object states that change color to reflect alarm conditions. The graphical views simplify frequently used network operations tasks.\nThe commercial availability of all of the Company's products and services in a timely manner and their acceptance by customers are important to the future success of the Company. There can be no assurance that customer acceptance of products and services will be achieved or maintained. Substantial delays in such availability or the failure to achieve or maintain acceptance would materially and adversely affect the Company's operating results and financial condition.\nMARKETING AND DISTRIBUTION\nMarketing and Distribution Strategy. As noted above, N.E.T.'s marketing strategy focuses on enterprise and carrier organizations with extensive voice, data, image and video communications needs. Enterprise organizations include banks and other financial institutions, airlines, retail chains, manufacturers and government agencies. Carrier organizations include telephone companies around the world, value-added network suppliers and cellular network service providers. Increasingly, the Company has been supplying its products to network service providers and systems integrators as customers and prospects turn to them to provide network services and management.\nN.E.T. markets products by means of its own direct sales organization in the U.S. and the U.K. and through distributors worldwide. Although these channels and their distribution capabilities are extensive, their levels of sales activity and knowledge of N.E.T. products vary widely over time and on a geographic basis. N.E.T. maintains subsidiaries which focus on sales to the U.S. government (N.E.T. Federal, Inc.), and the European market (N.E.T. Europe Ltd. and N.E.T. Europe SA).\nThe Company expects to face development and distribution challenges as it expands its product and service offerings, introducing new technologies or product architectures as part of the evolution of its current products and the introduction of its next generation products. Failure to sustain acceptance of current products and services while introducing new or enhanced products and services would impact the Company's ability to leverage its products as they are introduced, and could negatively affect the Company's performance.\nSales to the U.S. Government. N.E.T.'s wholly owned subsidiary, N.E.T. Federal, Inc., markets the Company's products and services to United States governmental entities both directly and through collaborative government contracting and subcontracting arrangements. It has entered into several contracts under which it provides its products and services to various government agencies (the \"Government Contracts\"). The Government Contracts encompass varying periods, but most may be terminated by such government agencies at their convenience or at annual intervals. In fiscal 1995, 1994, and 1993, sales, systems integration and other services to the U.S. Government accounted for 28%, 28%, and 24%, respectively, of N.E.T.'s revenue. These amounts include sales, which amounted to 19%, 20% and 17% of revenue for fiscal years 1995, 1994 and 1993, respectively, under a contract with the Department of Defense under which various government agencies (to date, primarily the Air Force) can order products, installation and service from N.E.T.\nRelationship with IBM. N.E.T. entered into an agreement with International Business Machines Corporation (\"IBM\") in June 1987 (the \"IBM Agreement\"). Pursuant to the IBM Agreement, as amended, IBM has non-exclusive, worldwide marketing, installation and service rights for current and future releases of N.E.T.'s IDNX multiservice products and certain related products. IBM also resells STM products in the U.S. IBM has been marketing N.E.T.'s products under the N.E.T. label, but pursuant to the IBM Agreement it has the right to market such products under the IBM label at any time. Under the IBM Agreement and other agreements, IBM licensed to N.E.T. several of its technologies, including Advanced-Peer-to-Peer Networking (\"APPN\"), Data Link Switching, Split-Bridge Routing, Token Ring Network Bridge Program technology and IBM LAN Network Manager Agents. IBM and N.E.T. also have engaged in coordinated development to enhance the integration of IDNX products into the IBM NetView(TM) environment. IBM is not obligated to purchase any products under the IBM Agreement. The IBM Agreement's initial term of five years has been extended until June 11, 1996 and may be renewed for four additional consecutive one year terms. IBM may terminate the IBM Agreement upon six months notice and payment of certain sums to N.E.T. IBM may at any time cancel orders it has placed pursuant to the IBM Agreement subject to payment of certain sums to N.E.T. and may sell competing products. IBM is also an end-user customer of N.E.T.'s products under the IBM Agreement. In fiscal 1995, 1994, and 1993 IBM accounted for 8%, 11%, and 15%, respectively, of N.E.T.'s revenue.\nNo other single customer account was responsible for ten percent or more of revenue during fiscal 1993, 1994, or 1995.\nInternational Sales. N.E.T. has established subsidiaries in the United Kingdom (N.E.T. Europe Ltd.) and France (N.E.T. Europe SA), with sales offices in other European countries, through which it markets and supports its products to the regions of Europe, the Middle East and Africa. The Company also markets and supports its products from offices in the U.S. to the regions of Asia Pacific and Latin America. International sales represented 28%, 22% and 25% of the Company's revenue in fiscal 1995, 1994 and 1993, respectively. Government ownership or control of the telecommunications industries and regulatory standards in some foreign countries could be a substantial barrier to the introduction of communications products for use in private or hybrid networks in such countries. Financial information regarding foreign operations and export sales is discussed in the Segment Information footnote in the Notes to Consolidated Financial Statements in the Company's 1995 Annual Report filed as Exhibit 13.1 to this report on page 25.\nRelationship with Ericsson. In December 1989, the Company entered into a systems integration and distribution agreement with Ericsson Business Networks AB of Sweden (\"Ericsson\"). Under this agreement, as amended, Ericsson has the non-exclusive right to purchase, resell, distribute and license the Company's IDNX products and network management software worldwide. Ericsson is responsible for providing all service and support for the N.E.T. products it markets. Under the agreement, the Company and Ericsson share a development committee to coordinate product development. The Company also appointed certain Ericsson affiliates as non-exclusive distributors of the Company's products. In fiscal year 1995, sales to Ericsson and its affiliates grew substantially and Ericsson and N.E.T. discontinued joint funding of product development.\nThe Company has entered into distribution and technology agreements with many other companies, including Cascade Communications Corporation and Datacraft Asia.\nThe Company's relationships with network service providers further expand the availability of N.E.T. products. These relationships include joint marketing agreements with both AT&T, BT Concert and MCI, and a systems integration agreement with Bell Atlantic Network Integration. The Company's products are offered by other network service providers around the world, such as US WEST and Southwestern Bell in the U.S., and France Telecom, Telia and Tele-Danmark in Europe.\nIn recent years, the Company has experienced decreases in first quarter revenues versus the preceding fourth quarter and this trend is expected to continue. Historically, the majority of the Company's revenues in each quarter results from orders received and shipped in that quarter. Because of these ordering patterns and potential delivery schedule changes, the Company does not believe that backlog is indicative of future revenue levels. For further information, please refer to \"Business Environment and Risk Factors\" in \"Management's Discussion and Analysis\" on page 16 of the Company's 1995 Annual Report.\nCUSTOMER SERVICE AND SUPPORT\nA high level of continuing customer service is integral to the Company's strategy of providing long-term support and developing long-term relationships with customers. N.E.T. trains customer personnel to operate its products and, in some cases, to perform routine maintenance and repair of these systems. Service at customers' facilities may be handled either by N.E.T. personnel operating out of N.E.T.'s service locations or by IBM, Ericsson, other distributors or third-party service organizations who are trained by and under contract with N.E.T. Customers may choose from among various hardware and software maintenance plans and agreements. Customers around the world can access one of N.E.T.'s three Technical Assistance Centers, located on east and west coasts of the U.S. and in the U.K. Technical assistance is fee-based, staffed year-round and available 24 hours a day. N.E.T. products are generally sold with limited warranties on equipment and software ranging in length from 90 days to two years that, when sold by N.E.T. to end-users, generally commence upon completion of installation or acceptance. Certain products have different warranty periods and conditions. A significant amount of the Company's revenues and profits are generated by its service, systems integration and support offerings. Gross margin on service and other revenue has and will continue to fluctuate as a result of changes in mix between systems integration services and other service revenue. There can be no assurance that customer acceptance of such current and future offerings will be maintained or achieved. If it is not, the Company's operating results would be materially and adversely affected.\nCOMPETITION\nDuring the past decade, the communications industry in general, including the specific segments within which N.E.T. competes, has experienced unprecedented growth and increasing complexity. This intensely competitive industry is characterized by advances in technology that frequently result in the introduction of new products and services with improved performance characteristics. Hence, the Company focused its competitive strategy to leverage its core competencies and targets two strategic markets: multiservice backbone networks for information-intensive enterprises and network service providers worldwide. However, many of the Company's current and potential competitors possess more extensive engineering, manufacturing, and marketing capabilities in addition to greater financial, technological, distribution and personnel resources than those of N.E.T. The Company believes that the principal competitive factors in its markets are product features, distribution capabilities, quality and reliability, reputation and long-term prospects, service and support, and price. The Company believes that it currently competes favorably with respect to many of these factors. Failure to keep pace with technological advances or other competitive factors would adversely affect the Company's competitive position and future revenue levels and operating results.\nIn both the public and enterprise communications equipment markets, N.E.T. competes with other communications equipment vendors. High-end bandwidth managers, which may be based on circuit-, packet-, frame-, or cell-switching, compete directly with N.E.T.'s multiservice platforms and are available from WAN communications equipment vendors such as Ascom Timeplex, General DataComm, Newbridge Networks, and StrataCom.\nData traffic has become an increasingly significant component of enterprise and carrier networking. As more and more data traffic originates on LANs, dedicated single-service solutions (using internetworking or frame-relay technologies) have become an alternative to the Company's multiservice solutions. Thus, N.E.T.'s frame-relay product line has been developed to address the special needs of this market segment. Within this data-networking market segment, the Company competes with router vendors such as Cisco Systems and Bay Networks with respect to internetworking solutions, and competes with other digital communications equipment vendors such as StrataCom and Cascade Communications with respect to frame-relay implementations. The increasing importance of frame relay for WAN data transport is reflected in the growing number of subscribers to frame-relay services. N.E.T. provides solutions which allow enterprises or network service providers to build frame-relay networks that are compatible with carrier service offerings and enable users to take advantage of public services to consolidate LAN and legacy data into, and along with, frame-relay traffic. The Company has strengthened its position in the frame-relay market recently through its strategic partnership with Cascade (see Company Strategy and Products sections above).\nAs the market for products implementing ATM technology evolves it is expected that the Company's ATM WAN product line, currently under development, will face significant competition. N.E.T. plans to introduce networking solutions that will enable the construction of enterprise- or carrier-owned networks that will comply with, and enable customers to leverage the benefits of, public ATM services. In the WAN segment of the ATM marketplace, the Company expects to continue its historic competition with WAN communications equipment vendors such as General DataComm and Newbridge Networks as well as Cascade Communications and StrataCom. Although there are numerous companies offering ATM LAN products, the Company does not expect to compete directly with the majority of these companies. For example, N.E.T. does not expect to compete directly with intelligent hub vendors such as 3Com, Cabletron Systems, IBM\/Chipcom, Bay Networks, and Ungermann-Bass, nor with the router vendors such as Cisco Systems and Bay Networks in their historical markets. However, N.E.T. does expect to compete with these companies, in addition to other ATM LAN switch vendors such as Fore Systems and Whittaker, to the extent their offerings address the same markets as the Company's products and services.\nN.E.T. addresses the low-end networking and network access markets with cost-effective devices within the Company's multiservice and frame-relay product lines in addition to product families dedicated to the needs of branch offices. A large number of companies have products addressing the requirements of the rapidly growing network access segment that focuses on branch-office connectivity. Now internetworking vendors, intelligent hub manufacturers and WAN communications equipment suppliers may be seen joining the traditional suppliers of access devices to compete for sales of integrated access products.\nThe Company's broadband products face competition from makers of equipment designed for high-capacity networks such as Ascom Timeplex, Newbridge Networks, T3plus Networking, and Tellabs.\nSince enterprise WANs can serve as a substitute for certain carrier network offerings, including Software Defined Networks (\"SDN\") and virtual private network offerings of AT&T, the RBOCs, and other carriers, N.E.T.'s solutions compete with those of the carriers. Most of these carriers enjoy substantially greater marketing resources and customer recognition than N.E.T. Changes in regulatory policies and taxes may affect the relative cost-effectiveness of using private networks as compared to common carrier offerings which could significantly affect or enhance the ability of the common carriers to compete with N.E.T. for enterprise WANs.\nAlthough carriers, systems integrators and outsourcers offer alternative solutions to enterprise backbone networks, N.E.T. also markets its products to these suppliers. The Company provides communications equipment that is used by such suppliers to construct WAN backbones from which they can offer advanced services. For example, a growing number of carriers are joining forces to provide Value-Added Network (\"VAN\") services, and a number of the VAN service providers (such as AT&T Business Communications Services, BT Concert, Eunetcom, Infonet Services, and Sprint International) are N.E.T. customers. Therefore, the Company believes that it is in a position to provide equipment to VANs. In addition, some systems integrators such as EDS and Perot Systems and outsourcers such as Advantis (a subsidiary of IBM and Sears) and BT Concert also use N.E.T. equipment to facilitate their business offerings.\nIBM is not prohibited by the IBM Agreement from manufacturing, marketing or servicing products that compete directly with N.E.T.'s IDNX or other products. N.E.T.'s operating results could be adversely affected if IBM announced the availability of such products. IBM also offers maintenance agreements for products it distributes, which compete with those of the Company.\nAs discussed below under \"Government Regulation\", the RBOCs are currently prohibited by the AT&T divestiture decree from manufacturing telecommunications equipment or customer premises equipment. Competition from AT&T, the RBOCs, or other common carriers or service providers, or from other competitors as discussed above, could cause a severe reduction in selling prices or volumes for multiservice platforms and other communications products or services, which would have a material adverse affect on the Company's operating results and financial condition.\nMANUFACTURING\nN.E.T. manufactures its products from components and assemblies designed to meet the Company's quality and reliability requirements. The Company also resells certain complementary products that are manufactured by outside vendors. To date, N.E.T. has not experienced any significant delays in the delivery of material or products from either subcontractors or vendors. Some components, assemblies, subassemblies and products are currently available only from a single source. Although N.E.T. believes alternative sources or substitutes for most of such components and products are available or could be developed if necessary, any delay or difficulties in developing such alternatives or substitutes could result in shipment delays and adversely affect operating results. The N.E.T. manufacturing process consists of the production of mechanical and electrical sub-assemblies as well as custom system assembly. N.E.T. uses custom fabricated printed circuit boards and subassemblies, standard and custom integrated circuits, custom power supplies and mechanical hardware purchased from outside suppliers. Certain relatively simple fabrication, assembly, and test processes are performed by subcontractors in the United States and East Asia; final assembly and testing of N.E.T. products are performed at the Company's Redwood City, California facilities. Availability limitations, price increases or business interruptions could adversely impact the Company's revenue, margins or earnings.\nThe Company has initiated a Total Quality Management process and is focusing efforts on enhancing the quality of products and services delivered to customers worldwide, in addition to process improvement throughout the Company. This includes activities to improve the quality of supplied components, subassemblies and internal processes. The Company has completed the ISO 9000 International Quality System certification process for its operations worldwide. N.E.T. is certified to ISO 9001, which covers quality standards for design and development, production, installation, and servicing. In addition, N.E.T. has received TickIT certification for complying with quality standards for software development.\nThe Company has entered into software escrow arrangements and has granted to certain customers manufacturing rights that are exercisable by the customer in limited circumstances, such as upon material default by the Company of its obligations under its agreement with such customers.\nThe Company seeks to maintain inventory in quantities sufficient to ship product quickly (normally within 15 to 60 days) after receipt of order. Many of N.E.T.'s customer agreements provide that delivery dates may be rescheduled or orders cancelled, although in certain circumstances a charge may be assessed upon rescheduling or cancellation. If large orders do not close when forecasted, near term demand for products weakens or the Company experiences significant delivery schedule changes, its operating results would be adversely affected. Because of this and other factors, including the Company's generally short delivery cycle, N.E.T. does not believe that backlog at any specific time is indicative of actual revenues that will be recognized in any succeeding period.\nRESEARCH AND DEVELOPMENT\nN.E.T. engages in research and development (\"R&D\") to develop new products and enhancements to existing products as technology permits and markets evolve. N.E.T.'s development efforts are focused on N.E.T.'s two strategic market segments, providing multiservice platforms for information-intensive enterprises and network service providers worldwide. Product priorities include those intended to enable N.E.T. to occupy a competitive position in ATM WAN solutions; to enhance the carrier-compatibility of certain products; and to introduce product enhancements which meet the evolving requirements of specific markets and distribution channels.\nManagement believes that product and technology leadership are keys to long-term success in an industry and market that evolves as rapidly as networking does today. N.E.T. believes that its future operating results will depend on its ability to continue to enhance existing products as well as to develop and timely bring to\nmarket new products or products acquired from third parties that satisfactorily meet market needs. There can be no assurance that N.E.T.'s product development efforts will result in commercially successful products, that N.E.T.'s products will not be rendered obsolete by changing technology, or that available, recently announced or planned products will be successful.\nResearch and development expense increased by $0.2 million (0.6%) in fiscal year 1995 to a total of $33.9 million, from $33.7 million in fiscal year 1994 and $32.2 million in fiscal year 1993. In addition, $2.0 million, $2.7 million and $3.4 million in fiscal 1995, 1994 and 1993, respectively, of software development costs were capitalized in accordance with FAS 86 and have since been partially amortized or written-down to net realizable value. For further information, please refer to the Notes to Consolidated Financial Statements in the Company's 1995 Annual Report. R&D expense as a percentage of revenue decreased from 14.2% of revenue in fiscal year 1994 to 12.0% of revenue in fiscal year 1995. Management plans to continue funding research and development efforts at levels necessary to advance product programs. While it is management's intention to continue to focus these development efforts, research and development spending is expected to increase in fiscal 1996 while decreasing as a percentage of planned revenue.\nGOVERNMENT REGULATION\nGovernment regulatory policies are likely to continue to have a major impact on N.E.T.'s business by affecting the availability of voice and data communications services and equipment, the prices and terms of the competitive offerings of AT&T and the other common carriers, and the ability of the RBOCs directly to manufacture and market equipment and services that compete with N.E.T.'s offerings (see \"Competition\" above).\nThe RBOCs are currently prohibited by the AT&T divestiture decree from manufacturing telecommunications equipment or customer premises equipment. From time to time, proposals have been made to the U.S. Department of Justice, in Congress and the courts to remove the decree restrictions. Legislative proposals are currently being considered in Congress which would remove or substantially modify the manufacturing restrictions. A bill that would allow the RBOCs to engage in the design, development, and fabrication of all types of telecommunications equipment, including customer premises equipment, has been passed by the United States Senate. N.E.T. is unable to predict the outcome or the timing of any final action on this subject. If any such proposal is adopted, N.E.T. could be materially and adversely affected by direct competition with the RBOCs.\nIn addition, N.E.T. customers usually obtain network services from common carriers such as AT&T, MCI, RBOCs, PTTs, PTOs or their affiliates. These carriers are subject to varying degrees of public utility-type government regulation of the rates and terms of their services. In the U.S., decisions at the federal and state level have, in some instances, provided AT&T, the RBOCs, and other carriers with increased flexibility in structuring and pricing their services. Changes in the rates or terms of carrier-provided service and equipment offerings may affect the demand for enterprise network products and services, including those provided by N.E.T. Similarly, regulatory policies of foreign governments may affect the demand for and ability of N.E.T. to market its products outside the United States. As an example, within the European Union (\"EU\") there exists a telecom authority which requires member country PTTs in Europe to adopt or offer certain transmission services and behaviors. These changes might significantly affect the demand for or useability of enterprise network solutions which N.E.T. provides.\nThe FCC and foreign governments require that N.E.T.'s products comply with certain rules and regulations, including technical rules designed to prevent harm to the telephone network and avoid interference with radio-based communications. The Company believes it complies with or is exempt from all applicable rules and regulations with respect to the sale of its existing products in the United States and in certain foreign countries. Failure to comply with FCC or similar governmental requirements may result in the disconnection of installed equipment from common carrier-provided circuits. Any delays in complying with FCC or foreign requirements with respect to future products could delay their introduction or affect the Company's ability to produce and market its products. Sales to the U.S. Government are subject to compliance with applicable regulations (e.g., Federal Acquisition Regulations).\nPATENTS AND LICENSES\nN.E.T. has obtained patents on inventions relating to its products and has applied for others. Issued patents in the U.S. expire on dates ranging from December 7, 2004 to March 6, 2012 and in foreign countries, they expire from December 1, 2004 to December 4, 2010. While possession of patents and copyrights could impede other companies from introducing products competitive with the Company's products, N.E.T. believes that its success does not depend primarily on the ownership of intellectual property rights, but primarily on its innovative skills, technical competence and marketing abilities and, accordingly, that patents, copyrights and trade secrets will not constitute an assurance of N.E.T.'s future success.\nPursuant to the IBM Agreement, IBM received a royalty-free license to certain present and future N.E.T. patents. In addition, the Company has entered into a patent cross-license agreement with AT&T covering certain of AT&T's and the Company's patents. Pursuant to the agreement, the Company made a $3 million initial payment to AT&T in fiscal 1992, which amount was capitalized and amortized over the life of the agreement, and made additional payments that were not material. The agreement expired in March 1995.\nBecause of the existence of a large number of third-party patents in the telecommunications field and the rapid rate of issuance of new patents, some of the Company's products, or the use thereof, could infringe third-party patents. Allegations of such infringement have been made in the past, and additional allegations may be made in the future. If any such infringement exists, the Company believes that, based upon historical industry practice, it or its customers should be able to obtain any necessary licenses or rights under such patents on terms which would not be materially adverse to the Company. However, there can be no assurance in this regard.\nThe Company regards elements of its software and engineering as proprietary and relies upon non-disclosure obligations, copyright laws and software licensing agreements for protection. Despite these restrictions, it is possible that competitors may obtain information that N.E.T. regards as proprietary. Some of the technology incorporated in certain of the Company's products is licensed from third parties. In the event of termination or expiration of the licensing agreements for such technology, the Company's ability to market those products could be adversely affected.\nEMPLOYEES\nAs of March 31, 1995, the Company had 1,189 employees. Of the Company's total employees, 149 were in Finance and Administration, 218 were in Engineering and Research and Development, 221 were in Field Service and Training, 133 were in Marketing, 310 were in Sales and 158 were in Manufacturing and Quality Assurance. None of the Company's domestic employees are represented by a collective bargaining agreement. The Company's French employees are governed by a national collective bargaining agreement applicable to all employers and employees in its industry. The Company has never experienced any work stoppage. The Company believes that its employee relations are good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nN.E.T. leases approximately 287,000 square feet of office, research and development, and manufacturing space in a modern industrial park in Redwood City, California, which is leased until October 1998. N.E.T. also leases sales and service offices at other locations in the United States, France, Germany, Norway, Uruguay and the United Kingdom. The Company believes that its facilities are, in all material respects, suitable, and adequate for its anticipated needs.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is not aware of any material legal proceedings pending or threatened against it at this time. The Company's federal income tax returns for certain prior years are under examination by the Internal Revenue Service (\"IRS\"). The IRS has proposed certain adjustments which related substantially to the timing (years) of tax deductions. The Company does not agree with the IRS position on these matters and is contesting the proposed adjustments through the IRS appeals process. In the opinion of management, any adjustments that may result from the ultimate resolution of these matters will not have a material affect on the Company's financial condition or results of operations.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\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 executive officers of the Company and their ages at June 1, 1995, are as follows:\nRoger A. Barney joined the Company in October 1987 as Vice President of Human Resources, and in 1992 became Vice President of Human Resources and Corporate Services. Prior to joining the Company, Mr. Barney held numerous management positions, including Director of Human Resources for Verbatim Corporation. He also founded his own management consulting business, which he ran from 1983 to 1987.\nJerry L. Davis joined the Company in January 1984 as the Director of Quality and Service. In 1989 he was appointed Vice President of Quality and Service, and in 1990 as Vice President and General Manager of Worldwide Client Support. Prior to that time, Mr. Davis was the National Service Manager for International Remote Imaging Systems where he developed their service operations. He also spent 12 years with G.D. Searle as a Regional Service Manager.\nJ. Robert Forkish is one of the founders of the Company, and from 1983 to 1991 was the principal software architect for the company's IDNX product line and Vice President of Strategic Marketing. From 1991 to 1994, Mr. Forkish worked as an independent networking consultant for numerous companies. He rejoined the Company in May of 1994, and today serves as the Company's Vice President and Chief Technology Officer.\nJoseph J. Francesconi has served as a Director and as President and Chief Executive Officer since March 1994. From 1977 until he joined the Company, Mr. Francesconi served in a number of management capacities at Amdahl Corporation, a leading mainframe manufacturer, most recently as Executive Vice President. Prior to joining Amdahl Corporation, Mr. Francesconi spent 12 years with IBM Corporation.\nCraig M. Gentner joined the Company in July 1989 as Vice President, Finance. In July 1990 Mr. Gentner was appointed Vice President, Chief Financial Officer, and Corporate Secretary, and in May of 1992 he was appointed Senior Vice President. From 1985 to 1989 Mr. Gentner was employed by Xidex, a manufacturer of computer peripheral products, most recently as Senior Vice President and Chief Financial Officer.\nDavid P. Owen joined the Company in April 1990 as Senior Technology Analyst, and in 1994 became Vice President of Corporate Development and Strategy. Prior to joining the Company, Mr. Owen was Director of Product Marketing at StrataCom. In 1983, he founded the fast packet development organization at Packet Technologies, StrataCom's predecessor company, and is a co-holder of several fast packet patents. Prior to that Mr. Owen spent 15 years at Control Data in a variety of product strategy, architecture and software development positions.\nRaymond E. Peverell was appointed Senior Vice President, Sales and Marketing in January of 1993. From 1983 to 1992, Mr. Peverell was employed by Tandem Computers, Inc. holding various positions, his last being Vice President, Strategic Partnership Development. Prior to 1983, Mr. Peverell held several positions over a 12 year span, with Burroughs Corporation.\nG. Michael Schumacher, Senior Vice President of Engineering, joined the Company in January 1995. Prior to joining the Company, Mr. Schumacher was Vice President and General Manager of the UNIX Systems Division of Unisys Corporation from 1993 to 1994. He also served at Mentor Graphics as General Manager of front-end CAE Tools from 1991 to 1993, and at Solbourne Computers as the Vice President of Engineering from 1989 through 1990.\nCharles S. Shiverick, Vice President of Operations, joined the Company in March 1993 as Senior Director of Corporate Quality. Since 1989 Mr. Shiverick held various senior management positions with ADAPTIVE Corporation, a former subsidiary of the Company, most recently as Vice President, Business Development and Quality. Mr. Shiverick spent 22 years at IBM Corporation in a variety of management positions.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe information required by Item 5 of Form 10-K is set forth in the section captioned \"Common Stock Dividends and Price Range\" at page 32 of the Registrant's 1995 Annual Report to Stockholders (\"Annual Report\") and is incorporated herein by reference. At March 31, 1995, there were 735 stockholders of record of the Company.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe information required by Item 6 of Form 10-K is set forth in the section captioned \"Five Year Financial Summary\" at page 12 of the Registrant's 1995 Annual Report and is incorporated herein by reference.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe information required by Item 7 of Form 10-K is set forth in the section captioned \"Management's Discussion and Analysis\" at pages 13 through 17 of the Registrant's 1995 Annual Report and is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe information required by Item 8 of Form 10-K is set forth in the sections captioned \"Quarterly Financial Data\" and \"Five Year Financial Summary\" at page 12 of the Registrant's 1995 Annual Report and the consolidated financial statements and independent auditor's report thereon at pages 18 to 31 of the Registrant's 1995 Annual Report.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable.\nPART III\nCertain information required by Part III is omitted from this Form 10-K because the Company will file its definitive proxy statement (the \"Proxy Statement\") pursuant to Regulation 14A within 120 days after the end of its fiscal year covered by this Report, and certain information included in the Proxy Statement is incorporated by reference into this Part 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 with respect to directors is incorporated by reference from the section captioned \"Election of Directors\" in the Proxy Statement.\nThe information regarding executive officers required by this Item 10 is set forth in Item 4 of Part I of this Form 10-K.\nThe information required by Item 405 of Regulation S-K is incorporated by reference from the section captioned \"Compliance with Section 16(a) of the Securities Exchange Act of 1934\" in the Proxy Statement.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by Item 11 of Form 10-K is incorporated by reference from the information contained in the sections captioned \"Election of Directors: Board Committees, Meetings, and Remuneration\" and \"Executive Compensation and Related Information\" in the Proxy Statement.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required by Item 12 of Form 10-K is incorporated by reference from the information contained in the section captioned \"Stock Ownership\" in the Proxy Statement.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by Item 13 of Form 10-K is incorporated herein by reference from the information obtained in the section captioned \"Executive Compensation and Related Information\" of the Proxy Statement.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) (1) Financial Statements -- See Index to Financial Statements and Financial Statement Schedule at page 20 of this Report.\n(2) Financial Statement Schedule -- See Index to Financial Statements and Financial Statement Schedule at page 20 of this Report.\n(3) Exhibits -- See Exhibit Index at page 17 of this Report.\n(b) The Registrant filed no reports on Form 8-K during the fourth quarter of the fiscal year ended March 31, 1995.\nEXHIBIT INDEX\nNOTES\n(1) Incorporated by reference from the corresponding Exhibit (or the Exhibit identified in parentheses) previously filed as an Exhibit in the Registrant's Annual Report on Form 10-K (Commission File No. 0-15323) for the fiscal year ended March 31, 1987 filed with the Securities and Exchange Commission on June 29, 1987.\n(2) Incorporated by reference from the corresponding Exhibit (or the Exhibit identified in parentheses) previously filed as an Exhibit in the Registrant's Annual Report on Form 10-K (Commission File No. 0-15323) for the fiscal year ended March 31, 1988 filed with the Securities and Exchange Commission on June 29, 1988.\n(3) Incorporated by reference from the corresponding Exhibit (or the Exhibit identified in parentheses) previously filed as an Exhibit in the Registrant's Annual Report on Form 10-K (Commission File No. 0-15323) for the fiscal year ended March 31, 1989 originally filed with the Securities and Exchange Commission on May 1, 1989.\n(4) Incorporated by reference from the corresponding Exhibit (or the Exhibit identified in parentheses) previously filed as an Exhibit in the Registrant's Form 8 Amendment No. 1 to Annual Report on Form 10-K (Commission File No. 0-15323) for the fiscal year ended March 31, 1989 filed with the Securities and Exchange Commission on July 25, 1989.\n(5) Incorporated by reference from the corresponding Exhibit (or the Exhibit identified in parentheses) previously filed as an Exhibit in the Registrant's Registration Statement on Form S-8 (Nos. 33-33013 and 33-33063) filed with the Securities and Exchange Commission on January 19, 1990.\n(6) Incorporated by reference from the corresponding Exhibit (or the Exhibit identified in parentheses) previously filed as an Exhibit in the Registrant's Annual Report on Form 10-K (Commission File No. 0-15323) for the fiscal year ended March 31, 1990 filed with the Securities and Exchange Commission on June 29, 1990.\n(7) Incorporated by reference from the corresponding Exhibit (or the Exhibit identified in parentheses) previously filed as an Exhibit in the Registrant's Annual Report on Form 10-K (Commission File No. 0-15323) for the fiscal year ended March 31, 1991 filed with the Securities and Exchange Commission on June 28, 1991.\n(8) Incorporated by reference from the corresponding Exhibit (or the Exhibit identified in parentheses) previously filed as an Exhibit in the Registrant's Annual Report on Form 10-K (Commission File No. 0-15323) for the fiscal year ended March 31, 1993 filed with the Securities and Exchange Commission on June 25, 1993.\n(9) Incorporated by reference from the corresponding Exhibit (or the Exhibit identified in parentheses) previously filed as an Exhibit in the Registrant's Registration Statement on Form S-8 (No. 33-68860) filed with the Securities and Exchange Commission on September 15, 1993.\n(10) Incorporated by reference from the similarly numbered Exhibit previously filed as an Exhibit to Registrant's Annual Report on Form 10-K (No. 0-15323) filed with the Securities and Exchange Commission on June 27, 1994.\n* A management contract or compensatory plan required to be filed as an Exhibit to Form 10-K.\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.\nNETWORK EQUIPMENT TECHNOLOGIES, INC. (Registrant)\nDate: June 21, 1995 By: \/s\/ Joseph J. Francesconi ------------------------------- Joseph J. Francesconi President, Chief Executive Officer and Director\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nAND FINANCIAL STATEMENT SCHEDULE\nFINANCIAL STATEMENTS\n*Incorporated herein by reference from information contained on pages 18 through 31 of the Registrant's 1995 Annual Report to Stockholders.\nFINANCIAL STATEMENT SCHEDULE\nAll other schedules are omitted because they are not required, are not applicable, or the information is included in the consolidated financial statements or notes thereto.\nSeparate financial statements of the Registrant are omitted because the Registrant is primarily an operating company and all subsidiaries included in the consolidated financial statements filed, in the aggregate, do not have a minority equity interest and\/or long-term indebtedness to any person outside the consolidated group in an amount which together exceeds 5% of total consolidated assets at March 31, 1995.\nINDEPENDENT AUDITORS' REPORT\nNETWORK EQUIPMENT TECHNOLOGIES, INC.:\nWe have audited the consolidated financial statements of Network Equipment Technologies, Inc. and subsidiaries as of March 31, 1995 and 1994, and for each of the three years in the period ended March 31, 1995, and have issued our report thereon dated April 19, 1995; such financial statements and report are included in your 1995 Annual Report to Stockholders and are incorporated herein by reference. Our audits also included the financial statement schedule of Network Equipment Technologies, Inc. listed in the accompanying index to financial statements and financial statement schedule. The 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\nSan Jose, California April 19, 1995\nNETWORK EQUIPMENT TECHNOLOGIES, INC.\nSCHEDULE II\nVALUATION AND QUALIFYING ACCOUNTS (IN THOUSANDS)\n- ---------------\n(1) Amount represents additions to accounts receivable allowances which were charged primarily to revenue.\nS-1","section_15":""}
{"filename":"750457_1995.txt","cik":"750457","year":"1995","section_1":"ITEM 1. BUSINESS\nRWB Medical Income Properties 1 Limited Partnership (the Partnership), is a Louisiana limited partnership organized on July 7, 1984. A Registration Statement filed with the Securities and Exchange Commission became effective on October 11, 1984 and the offering of $25,000,000 units of limited partnership interests (the Units) commenced on or about that date. The offering period was terminated on June 30, 1986, upon the sale of 22,895 Units for an aggregate purchase price of $22,895,000.\nThe purpose of the Partnership is to invest primarily in existing, improved, medically related, income-producing commercial properties, such as medical office buildings and nursing homes. As of December 31, 1995, the Partnership owned two nursing home properties, with a total of 354 beds, which it operated. The Partnership employed approximately 300 full time employees at March 5, 1996. During the year ended December 31, 1995, the Partnership sold a 180 bed nursing home. The property had been leased to another operator through April 30, 1995 when the Partnership acquired the operator's interest in a stock purchase. On September 1, 1995 the nursing home real estate was sold. The operating results of this facility for 1995 are reflected as a discontinued rental operation.\nBusiness Strategy\nThe Partnership owns real property investments, primarily healthcare related, and operates the properties until such time as a sale or other disposition appears to be advantageous to the Limited Partners. Factors such as potential capital appreciation, industry trends, cash flow and federal income tax consequences to the Limited Partners will be considered before Partnership property dispositions are made.\nLong Term Care Industry\nThe long term care industry is composed of many facilities offering services to subacute, skilled, assisted living, and personal care residents. The Partnership's nursing homes are considered to be in the skilled segment of the industry, although several of its homes offer subacute services. Subacute services have allowed many providers to expand their services and at the same time become more profitable. In addition, providers have taken advantage of these higher returns to consolidate their operations either through initial public offerings or through merging with one another. Subacute care, however, cannot be offered in all nursing homes. Many companies have established different criteria, including minimum population levels, in order to operate a subacute program in a profitable manner. This is necessary due to the shorter lengths of stay of patients and the need to obtain more and more admissions to fill the shorter stay beds. Even with higher costs in the nursing and service departments, nursing home industry subacute care is considered to be more cost effective in caring for patients than hospital care.\nHistorically, nursing homes have derived their revenues from Medicare, Medicaid and private pay patients. In the past few years, the industry has seen an increase in private insurance patients and to a greater extent, contractual services from Health Maintenance Organizations (HMO's) and Preferred Provider Organizations (PPO's).\nThe industry has always faced an increasing challenge in staffing its facilities. This is particularly true with regard to Registered Nurses, Licensed Practical Nurses and Certified Nurse Aides. Depending upon the geographic area, the Partnership competes with hotels, motels and restaurants for other employees, including dietary and housekeeping workers. Approximately fifty percent of Partnership operating costs are composed of employee salaries and benefits. From time to time, the Federal government has proposed increasing the minimum wage. Any increase in the minimum wage would adversely impact nursing home providers and would have to be supported by increases in Medicare and Medicaid reimbursement rates.\nThe Federal government has been discussing these very programs as it looks for ways to down size government. The Medicaid program could be impacted through block grant programs. Such a change would cap the federal funding of the program. If this were the case, and the State wished to retain the current level of services, significant additional funding would have to be found. This is particularly true if the OBRA regulations were not\nrepealed. The Medicare program is being examined for possible changes including implementing cost limits on ancillary services (such as therapy programs, equipment and diagnostic services), capital cost reductions, a continued freeze of the routine cost limits and perhaps a prospective payment system. The potential impact of such changes, either alone or in combination, cannot be determined at this time.\nThe Partnership owns nursing facilities in the States of Florida and Alabama. At present, each of these states' reimbursement programs reimburse the nursing facilities based upon historical costs. Each state has developed a wait and see attitude toward program changes until such time as the Federal government acts.\nInformation regarding industry segments is not applicable for the Partnership business.\nSeasonality\nThe Partnership's revenue and operating income fluctuates from quarter to quarter and tend to be higher in the third and fourth quarter of each fiscal year. This seasonality is due primarily to the state Medicaid programs in which the Partnership operates, rate increases which tend to take effect in such quarters and census levels.\nSERVICES PROVIDED\nRoutine Services\nAll of the nursing homes operated by the Partnership are licensed as skilled care facilities by the appropriate state regulatory agencies. Routine services include the provision of skilled care services and assistance with activities of daily living, depending upon the needs of each resident. Subacute care, including ventilator and therapy services, may also be provided as specified by each resident's physician. Skilled nursing care is rendered 24 hours per day by registered or licensed nurses and certified nurses aides.\nAncillary Services\nThe Partnership provides a variety of rehabilitative services at its facilities for its residents. These services include physical, speech, occupational, and respiratory therapies. The Partnership continues to expand these services as warranted by the needs of the residents and the requirements of third-party payor programs.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Partnership originally purchased five medically related commercial properties. At December 31, 1995, two properties were owned by the Partnership. They are:\nThe Partnership has sold the following properties:\n(1) The facility was leased to an outside organization through December 16, 1992, as indicated in Footnote 2 of the financial statements. On December 17, 1992, the lessee was declared in default and the Partnership assumed operations. Effective January 1, 1993, the Partnership leased the Merrillville facility to another lessee (as indicated in notes 2 and 4 of the financial statements). On May 1995, the Partnership purchased the stock of Atrium Living Centers of Indiana, Inc. and canceled the 1993 lease. The Partnership operated the facility as Lakecrest Nursing Home until the real estate was sold on September 1, 1995.\nA description of the Partnership's purchase and sale of the properties is disclosed in Notes 1(f), 2, 3, 4, 5 and 9 of Notes to Financial Statements.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThere are no material pending legal actions against the Partnership. As noted in the financial statements note 10, however, the Partnership does have certain contingent liabilities.\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 PARTNERSHIP UNITS AND RELATED SECURITY HOLDER MATTERS\nThere is no established public trading market for the Partnership Units. There were 2,027 limited partners as of March 4, 1996. Distributions paid per limited partner unit for each quarter in the last five years are incorporated by reference from Item 6","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nSelected financial data for the period January 1, 1991 to December 31, 1995 is shown below:\n(000's omitted except for per share data and distributions)\nQuarterly Financial data for the period January 1, 1993 to December 31, 1995 (000's omitted)\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nLiquidity and Capital Reserves\nCash and equivalent balances totaled $876,850 at December 31, 1995, a decrease of $450,463 from the previous year. Cash provided from operations decreased to $99,372 during the year from $2,327,655 from 1994. This decrease was primarily due to lower collections on resident accounts receivable, particularly Medicaid and managed care and the effect of the Lakecrest Nursing Home operations. With the sale of the Lakecrest facility completed, it is anticipated that cash from operations will improve in future periods.\nPayments for capital expenditures were $501,500 including approximately $250,000 for the Lakecrest facility. In 1996, the Partnership expects to incur costs of approximately $350,000 for similar expenditures. The cash flow from operations will determine when these expenditures are made.\nDuring 1995, the Partnership paid regular distributions to its limited partners totaling $60.00 per unit and equaling a 6% return on the initial investment of $1,000 per unit. In addition, the Partnership distributed $113.56 per unit which represented a portion of the sale proceeds of the Lakecrest Nursing Home. Although the Partnership expects to make distributions to its limited partners based upon cash flow generated from operations after considering cash required for debt obligations, necessary improvements to its properties and working capital reserves, no assurances can be given that distributions will be made in the future.\nThe Partnership has a $500,000 line of credit available to it should the need arise. At the present time, the Managing General Partner believes the Partnership has adequate working capital and does not believe it will be necessary to borrow additional funds.\nResults of Operations\nFiscal Year 1995 Compared to 1994\nThe Partnership's net loss for the year ended December 31, 1995 was $901,714, compared to a profit of $842,577 in the previous year. The loss included a loss on disposal of the rental operation of the Lakecrest Nursing Home of $1,575,134. Operating income for the twelve months ended December 31, 1995 was $998,254, as compared to $874,261 for the previous year. Total revenue increased to $13,529,775 in 1995, an increase of $1,166,000 over 1994. This increase of 9.4% was due to improved routine services rates as well as substantially higher ancillary services provided to residents.\nOperating expenses increased $1,041,895 over 1994 due to increased wages paid to employees, increased cost of supplies for nursing care and higher contracted services, primarily for ancillary services.\nOther income (expenses) reflects higher interest expense due to the fluctuation of the prime rate during the year.\nFiscal Year 1994 Compared to 1993\nNet income for the year ended December 31, 1994 was $842,577 as compared to $1,179,398 for the year ended December 31, 1993. The decrease in earnings was due to lower than expected margins in the Southpoint Manor operation caused primarily by the increase in labor costs and ancillary service expenses. It is expected much of this expense will benefit ongoing operations as the facility builds its reputation to treat more acute patients.\nRevenues increased $466,216 while expenses increased $924,117 between years. As stated previously, labor costs and ancillary service expenses increased substantially during the year. In addition, plant operation repairs and maintenance costs increased $73,232 over 1993 due to exterior painting and sealing of the structure. General and Administrative costs were $89,489 under the 1993 level due to excellent results from the workers compensation program at Southpoint Manor, partially offset by higher administrative salary costs. Employee health and welfare costs in 1993 included vacation pay accruals which have been allocated in 1994 to the various departments. Providers fees declined during 1994 due to changes implemented by the state.\nFiscal Year 1993 Compared to 1992\nNet income increased in 1993 to $1,179,398 from $869,156 in the previous year. The 1992 results included a loss of $208,889 on the sale of two of the Partnership's properties.\nNet patient service revenues during 1993 increased $824,341 over the prior year primarily due to higher subacute revenues billed from its Southpoint Manor ventilator program. Rental Income for 1993 was $330,000 while 1992 Rental Income and Direct Financing lease income totaled $623,167. The decrease is attributed to lower rental income recorded from the Partnership's Merrillville lease and the sale of two properties in 1992.\nTotal operating expenses increased $544,829 due to higher ancillary expense connected with the operation of the subacute program at Southpoint Manor, and higher salaries paid to nursing personnel. Cost of rental expense declined $140,363 due to the sale of two properties in 1992. The decrease in general and administrative expense is attributed to cost associated with the 1992 operation of the Merrillville property offset by higher insurance charges, and cost reimbursements.\nDepreciation and amortization expense was $156,274 higher in 1993 than 1992 due to depreciation taken on the Merrillville Indiana property for the full year.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe financial statements and supplementary data required by Regulation S-X are included in this Form 10-K commencing on page.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThere were no changes of auditors for the Partnership during the fiscal year 1995 and 1994.\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. RWB Management Corp. (RWBMC), a Louisiana corporation , is the Managing General Partner of the Partnership. The directors and executive officers of RWBMC as of December 31, 1995 are listed below. Directors serve for one year or until the next annual meeting of stockholders of RWBMC or until their successors are elected and qualified. RWBMC is a wholly-owned subsidiary of QualiCorp, Inc., a Louisiana corporation. The directors and executive officers of QualiCorp, Inc. are also listed\nbelow. The relationship of the Managing General Partner to its Affiliates is described under the caption \"Conflicts of Interest\" at pages 28 through 30 of the Prospectus, which pages are specifically incorporated by reference herein.\nThe executive officers of RWBMC and QualiCorp, Inc. are as follows:\nMr. DeBlois and Mr. Stoddard are Directors of RWBMC and Qualicorp, Inc. There are no family relationships among any of the above officers and\/or directors.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe Partnership has no officers or directors. No director or officer of the Managing General Partner received any remuneration from the Partnership for the three years ended December 31, 1995. The Partnership paid to Qualicorp, Inc., the parent of RWBMC, the Managing General Partner $166,077 in 1995 as reimbursement for administrative expenses (primarily salaries) incurred during the year.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nNo person or group is known by the Partnership to own beneficially more than 5% of the outstanding units of the Partnership.\nNo executive officers and directors of RWBMC owned any units in the Partnership at December 31, 1993. RWBMC held 23 units in the Partnership at December 31, 1995. QualiCorp, Inc., parent of RWBMC, the Partnership's Managing General Partner, held 73 units in the Partnership at December 31, 1995.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nQualicorp Inc., the parent of RWBMC, charged the following amounts for management fees and administrative expenses to the Partnership during the periods shown:\nUnder the Partnership Agreement, the General Partners are entitled to participate in distributions of the Partnership's Cash Flow as described under the caption \"Management Compensation\" at pages 24 through 26 of the Prospectus. Cash distributions of $103,400, $103,397, and $103,400, were made to the General Partners during 1995, 1994, and 1993 respectively. The General Partners also share in the Partnership's net profits and net losses.\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 Partnership's financial statements and supplementary information appear in a separate section of this Form 10-K commencing on pages referenced below:\n2. Exhibits:\n3-A. The Prospectus of the Registrant dated October 11, 1984 as supplemented August 8, 1985, August 14, 1985, October 2, 1985 and November 21, 1985 and filed pursuant to Rule 424(b) under the Securities Act of 1933 and Preliminary Supplement and Amendment Number 5 dated November 29, 1985 is hereby incorporated herein by reference.\n3-B. Amended and Restated Articles of Limited Partnership set forth as Exhibit A to the Prospectus, incorporated herein by reference.\n(b) No reports on Form 8-K have been filed during the fourth quarter of the fiscal year ended December 31, 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 in the city of Atlanta, state of Georgia.\nRWB MEDICAL INCOME PROPERTIES 1 LIMITED PARTNERSHIP\nRWB MANAGEMENT CORP. Managing General Partner\nBy: \/s\/ John H. Stoddard Date: March 15, 1996 -------------------- John H. Stoddard President, Director, Chief Financial Officer and Principal Accounting Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nName ---- Position Date -------- ---- [S] [C] [C] \/s\/ John M. DeBlois Chairman of the Board March 15, 1996 - ------------------- John M. DeBlois\n\/s\/ John H. Stoddard President, Director, March 15, 1996 - -------------------- Chief Financial Officer John H. Stoddard and Principal Accounting Officer\nSELF & MAPLES, P.A.\nCertified Public Accountants\nOneonta, Alabama 35121\n[LETTERHEAD]\nINDEPENDENT AUDITOR'S REPORT\nTo the Partners RWB Medical Income Properties 1 Limited Partnership\nWe have audited the accompanying balance sheets of RWB Medical Income Properties 1 Limited Partnership as of December 31, 1995 and 1994 and the related statements of operations, partners' capital and cash flows for each of the three years in the three-year period ended December 31, 1995. 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 audits to obtain a reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as 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 RWB Medical Income Properties 1 Limited Partnership as of December 31, 1995 and 1994 and the results of its operations and its cash flows for each of the the years in the three-year period ended December 31, 1995 in conformity with generally accepted accounting principles.\n\/s\/ Self & Maples, P.A.\nJanuary 26, 1996 Oneonta, Alabama\nRWB MEDICAL INCOME PROPERTIES 1 LIMITED PARTNERSHIP\nBALANCE SHEETS DECEMBER 31, 1995 AND 1994\nThe accompanying notes are an integral part of these statements.\nRWB MEDICAL INCOME PROPERTIES 1 LIMITED PARTNERSHIP\nSTATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994, AND 1993\nThe accompanying notes are an integral part of these statements.\nRWB MEDICAL INCOME PROPERTIES 1 LIMITED PARTNERSHIP\nSTATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994, AND 1993\nThe accompanying notes are an integral part of these statements.\nSupplemental schedule of noncash investing and financing activities:\nThe accompanying notes are an integral part of these statements.\nRWB MEDICAL INCOME PROPERTIES 1 LIMITED PARTNERSHIP\nSTATEMENTS OF PARTNERS' CAPITAL FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nThe accompanying notes are an integral part of these statements.\nRWB MEDICAL INCOME PROPERTIES 1 LIMITED PARTNERSHIP\nNOTES TO FINANCIAL STATEMENTS\nNote 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\n(a) Organization\nRWB Medical Income Properties 1 Limited Partnership (the Partnership) is a Louisiana partnership formed on July 7, 1984 to invest primarily in income-producing, health care related properties, such as doctors' office buildings and nursing homes. The Partnership currently is operating and holding for investment purposes income-producing nursing homes. The Partnership Offering (Offering) as represented by the Partnership Prospectus (Prospectus) dated October 11, 1984, provided for the sale of 25,000 Partnership units at a price of $1,000 per unit. The Partnership's first closing on the sale of units was March 20, 1985. The Offering closed on June 30, 1986.\n(b) Allocation of Net Profits and Net Losses\nNet profits and net losses shall be determined and allocated as of December 31 of each year as follows:\n- Net profits (losses) (exclusive of net profits (losses) attributable to the sale or disposition of Partnership properties) are allocated 93% to the limited partners and 7% to the general partners.\n- Net profits attributable to the sale or disposition of a Partnership property shall be allocated as follows:\n- First, prior to giving effect to any distributions of proceeds from the transaction, to the general partners and the limited partners with negative balances in their capital accounts pro rata in proportion to such respective negative balances;\n- Second, to the general partners in an amount necessary to make the balances in their respective capital accounts equal to 15% of the sales proceeds remaining following allocation to the limited partners of an amount equal to their original capital contribution; and\n- Third, the balance, if any, to the limited partners.\n- Net losses attributable to the sale or disposition of a Partnership property shall be allocated in a manner similar to above, except that limited and general partner\nRWB MEDICAL INCOME PROPERTIES 1 LIMITED PARTNERSHIP\nNOTES TO FINANCIAL STATEMENTS\naccounts would be reduced pro rata to the amount of their respective capital investments, then, pro rata to zero, and for any remaining loss, 93% to the limited partners and 7% to the general partners. A minimum of 1% of losses shall be allocated to the general partner.\n(c) Principles of Consolidation\nThe financial statements for the year ended December 31, 1995 consolidate the accounts of the Partnership and its wholly owned subsidiary, Lakecrest Nursing Home, Inc. from May 1, 1995 (see Note 9). All material intercompany transactions have been eliminated.\n(d) Cash Distributions\nCash distributions shall be made quarterly within 45 days of the end of the quarter. Cash flow shall be distributed 93% to the limited partners and 7% to the general partners. Sale or financing proceeds shall be distributed 100% to the limited partners to the extent of their original capital contribution and then the remainder shall be distributed 85% to the limited partners and 15% to the general partners.\n(e) Per Unit Information\nLimited partnership information per unit is based on the number of partnership units outstanding of 22,895 in 1995, 1994 and 1993. Federal taxable income per unit outstanding is not necessarily reflective of a limited partner's actual per unit amount due to different tax allocations with respect to tax-exempt partners.\n(f) Land, Building and Related Personal Property\nLand, building and related personal property are stated at cost. Depreciation of buildings is provided over their estimated useful lives ranging from twenty to forty years on the straight- line method. Equipment and other personal property are depreciated primarily over five to seven years on the straight-line method.\n(g) Amortization\nDeferred financing costs are amortized over the life of the loan using the straight-line method. Deferred lease commission costs were amortized over the lives of the leases through the dates the properties were sold (see Note 2).\nRWB MEDICAL INCOME PROPERTIES 1 LIMITED PARTNERSHIP\nNOTES TO FINANCIAL STATEMENTS\n(h) Income Taxes\nIncome is allocated to the individual partners and, therefore, no income taxes have been provided for in these financial statements.\n(i) Patient Service Revenues\nPatient service revenue is recorded at the nursing homes' established rates with contractual adjustments ($7,184,277 in 1995, $5,391,261 in 1994 and $4,157,574 in 1993) and provision for uncollectible accounts, bad debts ($217,721 in 1995, $(40,657) in 1994, and $57,896 in 1993) and other discounts deducted to arrive at net patient service revenue.\nNet patient revenue includes amounts estimated by management to be reimbursable by Medicare, Medicaid and other third-party programs under the provisions of cost and prospective payment reimbursement formulas in effect. Amounts received under these programs are generally less than the established billing rates of the nursing homes and the difference is reported as a contractual adjustment and deducted from gross revenue. The nursing homes recognize estimated final settlements due from or to third-party programs currently. Final determination of amounts earned is subject to audit by the intermediaries. Differences between estimated provisions and final settlement will be reflected as charges or credits to operating revenues in the year the cost reports are finalized.\n(j) Cash Equivalents Policy\nFor purposes of the statement of cash flows, the Partnership considers all highly liquid debt instruments with an original maturity of three months or less to be cash equivalents.\n(k) Uninsured Cash Balances\nThe Partnership maintains cash balances in several banks. Cash accounts at banks are insured by the FDIC for up to $100,000. Amounts in excess of insured limits were approximately $291,859 at December 31, 1995 and $1,071,820 at December 31, 1994. A portion of commingled funds discussed in Note 7., may be at risk, but the amount in excess of FDIC limits related to the Partnership is not determinable.\nRWB MEDICAL INCOME PROPERTIES 1 LIMITED PARTNERSHIP\nNOTES TO FINANCIAL STATEMENTS\n(l) Uses of Estimates\nManagement uses estimates and assumptions in preparing financial statements. Those estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported revenues and expenses.\nNote 2. PROPERTY, PLANT AND EQUIPMENT\nOn September 3, 1986, the Partnership purchased Four Freedoms Manor Nursing Home, now known as Southpoint Manor, a 230 bed skilled nursing home in Miami Beach, Florida, for $7,350,000 plus capitalized acquisition costs and fees of $504,602.\nOn October 1, 1986, the Partnership purchased Merry Wood Nursing Home, a 124 bed skilled nursing home in Elmore, Alabama, for $3,643,294. Merry Wood was leased to Merrywood Nursing Home, Inc., under a ten year lease with two five year renewal options. On January 1, 1991, the Partnership purchased the stock of Merrywood Nursing Home, Inc. for $1. The transaction was accounted for as a purchase. Effective July 1, 1992 Merrywood Nursing Home, Inc. was merged with the Partnership. The lease agreement with Merrywood Nursing Home, Inc., described in the preceding paragraph, was terminated in conjunction with the merger.\nOn December 17, 1985, the Partnership purchased Merrillville Convalescent Center (Merrillville), a 180 bed skilled nursing home in Merrillville, Indiana for $5,376,348. Until December 17, 1992, Merrillville was leased under two twenty year leases which were accounted for as capital leases (see Note 4). One lease was for the building, equipment and related land, and the other was for land adjacent to the nursing home (17.9 acres). On December 17, 1992, the lessor was declared to be in default on the lease and the Partnership assumed operations of the facility. The value of the net investment in direct financing lease along with unamortized deferred lease commissions was allocated to the cost of land, building and equipment at the termination of this lease. No gain or loss was recognized related to the termination of the lease. Effective January 1, 1993 the Partnership leased the Merrillville facility under an operating lease (see Note 4). Effective September 1, 1995, the Partnership sold the facility (see Note 9).\nA summary of property, plant, equipment and accumulated depreciation at December 31, 1995 and 1994 is as follows:\nRWB MEDICAL INCOME PROPERTIES 1 LIMITED PARTNERSHIP\nNOTES TO FINANCIAL STATEMENTS\nNote 3. NOTES RECEIVABLE\nThe Articles of Limited Partnership state that no General Partner shall have the authority to cause the Partnership to make loans other than in connection with the purchase, sale or disposition of partnership property. The General Partner believes the following loans were necessary to preserve the Partnership's assets. The first loan described was made in order to remove the bankrupt manager of the Partnership's property. The second loan was made to finance needed improvements and operations neglected by an insolvent lessee.\nThe first note is from the manager of one of the nursing homes owned by the Partnership. The note requires monthly payments of $6,616 through July of 1996 and bears interest at 8%. These moneys were loaned as part of an acquisition and financing agreement dated May 23, 1991, whereby the Partnership contracted with a replacement manager of the Partnership's facility located in Miami Beach, Florida (Southpoint Manor). As part of the agreement, the Partnership agreed to retain the manager of the Southpoint Manor facility for a period of no less than thirty-six (36) months in consideration for its agreement to manage the facility and in consideration for its agreement to pay certain sums to the former management company.\nOutstanding receivables related to this note totaled $45,102 and $117,701 at December 31, 1995 and 1994, respectively.\nThe second note was from the lessee of the Merrillville, Indiana facility. The lessee agreed to continue to operate the facility and make the improvements necessary to meet certification requirements if the Partnership would provide current operating capital and suspend required lease payments (see Note 4). The loan, as amended, was a $1,500,000 revolving credit agreement that was to accrue interest at prime plus 1% with payments of principal and interest deferred until July 1, 1995. The receivable related to this note totaled $734,346 at December 31, 1994. In May of 1995\nRWB MEDICAL INCOME PROPERTIES 1 LIMITED PARTNERSHIP\nNOTES TO FINANCIAL STATEMENTS\nthe Partnership purchased the stock of the lessee corporation (Note 9), and forgave the note receivable.\nA third note in the amount of $1,000,000 from the purchaser of the Merrillville, Indiana facility was accepted by the Partnership in September 1995 (see Note 9). This note, made in conjunction with the sale of the facility, bears interest at 9%, and calls for payments of interest only through August 31, 1996, at which time the note is due and payable.\nNote 4. PROPERTY LEASES\nMerrillville was accounted for as a capital lease until December 17, 1992 as explained in Note 2. Bad debt expense related to Merrillville's deferred financing lease was recorded in the amount of $110,879 in 1993 in addition to $405,784 written off in prior years.\nEffective January 1, 1993 the Partnership leased the Merrillville facility under an operating lease which provided for monthly rental payments of $55,000. The lease, however, allowed the tenant to leave the monthly lease payments unpaid until August 15, 1993 with no interest or penalties, to allow the tenant to correct the operating deficiencies of the prior tenant (see Note 2).\nRental income for Merrillville's lease was $220,000 in 1995, and $660,000 in 1994 and 1993. Interest totaling $74,628 was accrued in 1994 and interest of $15,837 and penalties of $6,600 were assessed related to this receivable in 1993. Rental receivables totaled $1,026,210 at December 31, 1994. Collectibility of some of this rental income and related penalties and interest was considered doubtful and, accordingly, reserves of $272,447 in 1994 and $341,218 in 1993 were charged to bad debt expense. Loans for operating expenses, as explained in Note 3., were made to the Lessee. The Partnership has other contractual agreements, as explained in Note 8, with entities that shared common ownership with the lessee of the Merrillville facility.\nEffective May 1, 1995, the Partnership purchased the stock of the lessee of the Merrillville facility as part of a plan to discontinue rental operations. In September 1995 the Partnership sold the Merrillville facility and terminated the lease (Note 9).\nNote 5. MORTGAGE NOTES PAYABLE AND CAPITALIZED LEASE OBLIGATIONS\nMortgage notes and capitalized leases at December 31, 1995, and 1994 are summarized as follows:\nRWB MEDICAL INCOME PROPERTIES 1 LIMITED PARTNERSHIP\nNOTES TO FINANCIAL STATEMENTS\nThe mortgage note is secured by the Southpoint and Merry Wood real estate owned by the Partnership. The General Partner has guaranteed the debt, as well as pledged its stock and partnership interest. The management companies (see Note 8) have also guaranteed the debt and entered into a negative pledge agreement whereby they will not pledge, transfer or encumber their stock while the loan is outstanding. All management fees are subordinate to the debt.\nThe aggregate annual maturities of mortgage notes payable and capital lease obligations are as follows:\nNote 6. INCOME TAXES\nNo provision for income taxes is made in the financial statements since taxable income is reported in the income tax returns of its partners. Differences between the net income as reported in the financial statements and Federal taxable income arise from the nature and timing of certain revenue and expense items. The\nRWB MEDICAL INCOME PROPERTIES 1 LIMITED PARTNERSHIP\nNOTES TO FINANCIAL STATEMENTS\nfollowing is a reconciliation of reported net income and Federal taxable income:\nNote 7. RELATED PARTY TRANSACTIONS\nQualiCorp, Inc., the parent of RWB Management Corp. (the Managing General Partner of the Partnership), charged the Partnership property management fees totaling $121,266 in 1995, $132,776 in 1994 and $116,624 in 1993. QualiCorp charged the Partnership administrative expenses totaling $166,077 in 1995, $179,086 in 1994, and $166,880 in 1993.\nDetails of the amounts due to affiliates at December 31 are as follows:\nDuring the year, the General Partners established a pooled investment account in which the General Partners and the partnerships in which they act as general partners could participate. This account was used by those entities to invest overnight cash balances, and borrow funds when an entity needed temporary access to funds. Each entity received its share of interest earned monthly, and was charged interest on any funds borrowed.\nThe Articles of Limited Partnership of the partnerships involved state that no General Partner shall have the authority to cause those partnerships to make loans other than in connection with the\nRWB MEDICAL INCOME PROPERTIES 1 LIMITED PARTNERSHIP\nNOTES TO FINANCIAL STATEMENTS\npurchase, sale or disposition of partnership property. The Articles of Limited Partnership of those partnerships also state that the partnerships' funds may not be commingled with any other entities' funds except as necessary for the operation of those partnerships.\nAt December 31, 1995, the Partnership had borrowed $51,783 from the other entities, and had earned net interest of $14,967 from this arrangement.\nNote 8. CONTRACTUAL AGREEMENTS\nOn June 20, 1991, the Partnership entered into a management agreement whereby the Manager is required to perform certain services for the Southpoint facility. The agreement had an initial three-year term and was extended for three additional years in 1994. Fees were based on 6% of gross collected operating revenues not to exceed 6% of the gross collected operating revenues from July 1, 1990 to July 1, 1991 and increased by an inflation factor in 1992 and thereafter. Management fees charged to the Partnership were $461,653 in 1995, $443,897 in 1994, and $430,968 in 1993.\nOn July 1, 1992, the Partnership entered into a management agreement whereby the Manager is required to perform certain services for the Merry Wood facility. The agreement had an initial five-year term with one additional five-year option. Fees were based on 5% of gross collected operating revenues, excluding revenues solely attributed to reimbursement for provider taxes. Management fees charged to the Partnership were $176,247 in 1995 and $172,603 in 1994.\nThe management agreements were amended on January 1, 1995. The amendment calls for a fixed monthly management fees of $38,471 at Southpoint and $14,687 at Merry Wood, with a cost of living factor equal to the greater of 4% per annum or the increase in the Consumer Price Index or such other measure mutually agreeable to the parties. The agreements expire December 31, 1998. Both agreements contained termination on sale clauses that were amended to base the fee on a sum equal to the discounted present value of the monthly management fee as of the date of termination of the agreement times the number of months remaining in the management agreement discounted to the date of termination at an annual interest rate of ten percent (10%).\nThe above agreements are with entities that are commonly owned. The property manager who owes the Partnership the first of the notes receivable described in Note 3 along with the lessor of the Merrillville, Indiana property who, prior to being purchased by the Partnership (Note 9), owed the Partnership the second note receivable described in Note 3 and the unpaid lease payments\nRWB MEDICAL INCOME PROPERTIES 1 LIMITED PARTNERSHIP\nNOTES TO FINANCIAL STATEMENTS\ndescribed in Note 4, are or were commonly owned with the above entities. Additionally, the seller of the equipment purchased at Merrillville as described in Note 9, is commonly owned with the above entities.\nNote 9. DISCONTINUED OPERATIONS\nEffective May 1, 1995, the Partnership purchased the stock of the lessee, now known as Lakecrest Nursing Home, Inc. for $500. The Partnership took over operations with the intent of selling the facility and discontinuing all rental activities. The transaction is accounted for as a purchase. In June 1995, the Partnership purchased various items of equipment that had been leased by Lakecrest Nursing Home, Inc. for $218,855. As explained in Note 8, the Partnership has other contractual agreements, with entities that shared common ownership with the lessee of the Merrillville facility. On September 1, 1995, the Partnership sold the Merrillville facility in exchange for a total of $5,000,000, payable with $4,000,000 in cash and note receivable of $1,000,000 (Note 3). The results of operations are consolidated for the period from May 1, 1995 to December 31, 1995, and are included in the loss on disposal of rental operations. Pro forma results of operations for December 31, 1995 and 1994 as though the Partnership and Lakecrest Nursing Home, Inc. had combined at the beginning of 1994 would have been stated as follows:\nLoss on disposal of rental operations reflects the loss related to operations subsequent to April 30, 1995 totaling $336,183 on revenues of 1,414,947 and loss on sale of assets totaling $1,238,951.\nNote 10. CONTINGENCIES\nThe Partnership maintains insurance or reserves which it believes are adequate to meet the needs of the Partnership. While the Partnership has been named as a defendant in several lawsuits, nothing has come to the attention of the Partnership which leads it to believe that it is exposed to a risk of material loss not covered by insurance or reserves.\nThe on-site waste water treatment plant at the Merry Wood Lodge facility has had numerous operational difficulties since it was installed, which has caused the effluent to exceed the limits of\nRWB MEDICAL INCOME PROPERTIES 1 LIMITED PARTNERSHIP\nNOTES TO FINANCIAL STATEMENTS\nthe facility's permit. The Partnership is evaluating proposals to build a new waste water treatment plant to avoid liability associated with provisions of the Federal Clean Water Act. The expected cost of constructing the new plant is estimated to be about $92,000.\nNote 11. MAJOR SOURCES OF REVENUE\nThe Partnership provides patient care services under various third party agreements. The principal sources of revenue under these contracts are derived primarily through the Medicaid and Medicare programs, as well as contracts with private pay patients who do not qualify for assistance from the other programs. The percentage of the Joint Venture's income from each of these sources for the years ended December 31, 1995, 1994, and 1993 is as follows:\nThe percentage attributable to private pay patients includes only amounts due for services where the primary payer is a private source. The Medicaid and Medicare percentages include amounts due from those programs as well as the patient's financial responsibility incurred under these contracts.\nSELF & MAPLES, P.A. CERTIFIED PUBLIC ACCOUNTANTS\nONEONTA, ALABAMA 35121\nAMERICAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS THOMAS E. SELF, C.P.A. DON MAPLES, C.P.A. ALABAMA SOCIETY B. MARTIN COPELAND, C.P.A. OF CERTIFIED PUBLIC ACCOUNTANTS ------------- ------------ CONNIE T. HARVEY, C.P.A. 1601 2ND AVENUE EAST RANDY M. JOHNSTON, C.P.A. P.O. BOX 489 ROGER D. LOGGINS, C.P.A. ONEONTA, ALABAMA 35121 MARK S. SIMS, C.P.A. ------------ LINDA ROMBERG YORK, C.P.A. TELEPHONE: (205) 625-3472 GWIN E. DAVIS, P.A. TELECOPIER: (205) 274-0182 ROYCE E. GARGUS, P.A.\nINDEPENDENT AUDITOR'S REPORT ON ADDITIONAL INFORMATION\nTo the Partners RWB Medical Income Properties 1 Limited Partnership\nOur report on our audits of the basic financial statements of RWB Medical Income Properties 1 Limited Partnership for 1995 appears on page 1. Those audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The Schedule of Valuation and Qualifying Accounts and Reserves for Allowances for Doubtful Accounts, Schedule of Consolidated Supplementary Income Statement Information, and Schedule of Real Estate and Accumulated Depreciation are presented for purposes of additional analysis and are not required parts of the basic financial statements. Such information has been subjected to the auditing procedures applied to the audits of the basic financial statements, and in our opinion, is fairly stated in all material respects in relation to the financial statements taken as a whole.\n\/s\/ Self & Maples, P.A.\nJanuary 26, 1996 Oneonta, Alabama\nRWB MEDICAL INCOME PROPERTIES 1 LIMITED PARTNERSHIP SCHEDULE VIII VALUATION AND QUALIFYING ACCOUNTS AND RESERVES FOR ALLOWANCES FOR DOUBTFUL ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994, AND 1993\nRWB MEDICAL INCOME PROPERTIES 1 LIMITED PARTNERSHIP SCHEDULE X CONSOLIDATED SUPPLEMENTARY INCOME STATEMENT INFORMATION FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nRWB MEDICAL INCOME PROPERTIES 1 LIMITED PARTNERSHIP SCHEDULE XI REAL ESTATE AND ACCUMULATED DEPRECIATION FOR THE YEAR ENDED DECEMBER 31, 1995\n(A) The initial cost to the Partnership represents the original purchase price of the properties. (B) The aggregate cost of real estate owned at December 31, 1995 for Federal Income tax purposes was approximately $13,454,968 (C) Reconciliation of real estate owned at December 31, 1995, 1994, and 1993:\n(D) Reconciliation of accumulated depreciation:","section_15":""}
{"filename":"96277_1995.txt","cik":"96277","year":"1995","section_1":"Item 1. Business - ------- --------\nGeneral - -------\nTambrands Inc. (the \"Company\") has been manufacturing and marketing menstrual tampons, which are sold under the trademark TAMPAX(R), since 1936. It is the leading manufacturer and marketer of tampons in the world. The Company operates in one business segment, personal care products. In recent years, the Company has focused on its core TAMPAX tampon business worldwide, has expanded its international operations and has placed an increased emphasis on the development and marketing of new products. The Company has manufacturing operations in seven countries. In 1995, TAMPAX tampons were sold in over 150 countries. The Company's eight largest markets are the United States, the United Kingdom, France, Canada, Spain, CIS (principally Russia and Ukraine), Italy and Belgium.\nThe Company was incorporated under the laws of the State of Delaware in 1936. The Company's principal executive offices are located at 777 Westchester Avenue, White Plains, New York 10604 (telephone number 914-696-6000).\nRecent Developments - -------------------\nIn the fourth quarter of 1995, the Company relaunched an upgraded version of its original product, the TAMPAX flushable applicator tampon, in the United States, Canada, Latin America and parts of Asia\/Pacific. The relaunched product contained significant product enhancements and redesigned, contemporary packaging. In October 1995, the Company announced the U.S. introduction in the first quarter of 1996 of a new product, TAMPAX NATURALS(TM), the only nationally available tampon or pad to be made of 100% cotton. This tampon is made of all natural components and has a flushable, biodegradable applicator.\nIn February 1996, Tambrands Limited, the Company's principal U.K. subsidiary, entered into an agreement with the U.K. subsidiary of Molnlycke AB for Tambrands Limited to distribute Molnlycke's sanitary pad and panty-liner products on an agency basis in the United Kingdom.\nIn February 1996, Anne M. Busquet and Janet Hill were elected to the Company's Board of Directors. Mrs. Busquet is President of American Express Relationship Services, a unit of American Express Travel Related Services (diversified financial services) and Mrs. Hill is Vice President of Alexander & Associates, Inc. (management consulting).\nEffective December 31, 1995, Susan J. Riley was appointed Senior Vice President - Chief Financial Officer. Also during 1995, Michael S. Krause was appointed Senior Vice President - Global\nOperations, and Janey M. Loyd was appointed Vice President - Business Development.\nIn December 1991, the Company announced a program to restructure its worldwide manufacturing operations to improve efficiency and reduce costs. This program has been completed and included workforce reductions and the consolidation of facilities.\nIn June 1993, the Company announced that it would provide a $30 million charge ($20 million after-tax) to provide for restructuring of manufacturing and administrative operations and the cost of management changes, including the adoption of a consolidated international management strategy. This program has included workforce reductions and the consolidation of facilities. This program has been completed, with the exception of certain severance payments under committed severance plans, which will be substantially complete by the end of 1996. See Note 6, \"Restructuring and Other Charges,\" included in the Notes to Consolidated Financial Statements incorporated by reference in item 8 of Part II hereof.\nThe Company's 1995 capital spending programs related to investments in equipment to improve product quality and productivity, modernize production facilities and manufacture and launch new products. See \"Management's Discussion and Analysis of Results of Operations and Financial Condition\" incorporated by reference in item 7 of Part II hereof. The Company intends to continue its efforts to achieve productivity improvements in order to eliminate excess cost and time from the supply chain and generate funds for reinvestment in growth opportunities.\nProducts - --------\nMenstrual tampons represent all of the Company's net sales. The Company's largest selling tampon is the TAMPAX flushable applicator tampon, which first became commercially available in 1936 and was upgraded and relaunched in 1995.\nIn addition to this tampon and the new TAMPAX NATURALS tampon, which was introduced in the United States in the first quarter of 1996, the Company manufactures and sells several other tampon products. In 1994, the Company introduced nationally in the United States the new TAMPAX SATIN TOUCH(R) tampon. This tampon offers the ease and comfort of a plastic applicator but has an all- paper applicator that is flushable and biodegradable. SATIN TOUCH is a rounded- end product with a patented, high gloss surface. It was introduced nationally in Canada in 1993 and in Puerto Rico and several Caribbean locations in 1995. In 1994, the Company\nintroduced the new TAMPAX SATIN(R) tampon in France. This tampon is similar to the SATIN TOUCH tampon and was introduced in 1995 in Spain and Belgium and in Denmark and Finland under the trademark TAMPAX SILKS(TM).\nIn 1994, the Company introduced nationally in the United Kingdom its TAMPAX TAMPETS(R) tampon. This non-applicator tampon has been sold in Ireland since 1993 and was introduced in 1995 in Australia, Israel and Portugal. A non-applicator tampon was also introduced in Canada under the trademark TAMPAX SOLOS(TM) during 1995.\nTAMPAX tampons with plastic applicators are sold in the United States and Canada and, since 1995, in Brazil. TAMPAX COMPAK(R) tampons, with a compact all-plastic applicator, are sold in France, the United Kingdom and several other European countries, as well as in the United States, Canada and several other smaller markets. The Company began marketing an improved COMPAK tampon in 1996 with a shorter tampon and applicator, and a perforated wrapper for applicator disposal.\nIn 1994, the Company introduced nationally in the United States the new TAMPAX LITES(R) tampon. This tampon, which was introduced in New Zealand in 1995, is especially designed for use on days of light menstruation, when other tampons might be too absorbent for comfortable use. The Company sells TAMPAX comfort shaped flushable applicator tampons, with an all-paper rounded-end applicator and a slimmer design than the Company's original flushable applicator product, in the United States, Australia, New Zealand and Japan.\nThe Company continues to evaluate the possible introduction of its existing products in additional markets, as well as additional new products and product enhancements.\nMarketing and Sales - -------------------\nMarketing operations are conducted either directly by the Company and its subsidiaries, or by third-party brokers or sales agents and distributors. Sales are made directly to grocery, discount and drug stores and other comparable outlets, as well as to wholesalers and distributors in those trades. Sales to discount stores, including mass merchandisers and club stores, have been increasing as a percentage of total sales. For the years 1994 and 1995, Wal- Mart, together with its affiliated stores, accounted for approximately 10.3% and 11.1%, respectively, of the Company's net sales worldwide. No single customer (including distributors) of the Company and its subsidiaries accounted for 10% or more of total net sales prior to 1994. The marketplace for consumer products is becoming increasingly global and currently is characterized by growing trade consolidation and expansion across geographic\nborders. A small number of significant customers are financed through highly leveraged capital structures, making them particularly sensitive to market interest rate changes and other economic variables. This situation has not had a material effect on the Company's net sales or operating income in 1995 or prior years.\nSubstantially all sales involve extensions of credit. Credit terms generally are consistent with terms typically extended under local industry practices. In the United States and Canada, the Company typically offers discounts of 2% and 1%, respectively, if payment is received within 30 or 20 days, respectively. In the United Kingdom and most other European markets, discounts generally are not offered and payment terms range from 30 to 90 days. In other markets, credit terms with longer collection periods are common, and in some developing markets discounts for prompt payment are offered. Default rates by the Company's customers in the United States have been at or below industry averages, based on information from the Credit Research Foundation.\nIn the United States, the Company's internal sales management group directly handles sales to certain large customer accounts. These sales have been increasing as a percentage of total sales. Other sales in the United States and sales in Belgium, Canada, France and the Netherlands are handled through third-party sales brokers, who also may sell other branded consumer products but generally do not carry products that compete with the products of the Company and its subsidiaries. Sales are conducted in the Czech Republic, Poland, Russia, Ukraine and the United Kingdom by the Company's subsidiaries and in the People's Republic of China by its joint venture. Sales are conducted in other countries through third-party distributors and agents. Sales forces of the Company's subsidiaries in the Czech Republic, Poland, Russia, Ukraine and the United Kingdom distribute or act as broker with respect to certain household consumer products for several other companies. Revenues from these sales are increasing as a percentage of the Company's operating income.\nThe Company believes that the trend by retailers and distributors to reduce inventories and the related adverse impact on shipments will continue in future periods. However, the rate of inventory reduction slowed in 1995, as it had in 1994, from the rate of reduction experienced in 1993. The size of inventories at the trade level varies from month to month, sometimes considerably, due to a number of factors. Trade inventories of the Company's products at the end of 1995 and continuing into the beginning of 1996, as estimated by the Company, were higher than on average during 1995, primarily as a result of bonus pack shipments at the end of 1995 and reductions in market share discussed below under \"Competition\".\nMedia advertising is important to the overall success of the TAMPAX tampon brand. In the United States, Canada and Europe, the Company focuses its advertising on women aged 12-34, using a variety of media, including television and print advertisements. In 1996, the Company intends to continue with its aggressive support of the TAMPAX tampon franchise with heightened levels of advertising and promotional activities. The increase in spending is intended primarily to support the Company's new products. The Company's advertising execution is handled on a worldwide basis by one agency, BBDO Worldwide Inc.\nThe Company also seeks to attract and retain customers through its teen education program, which is designed to help female teenagers understand the various forms of sanitary protection and promotes trial usage of TAMPAX tampons. In developing markets, like Russia and China, the Company uses sampling with young women and physician awareness programs. In the Company's largest markets, the Company conducts school education programs that include videos, lecturers and booklets.\nCompetition - -----------\nHighly competitive conditions prevail in the feminine protection industry for external pads and menstrual tampons, which are directly competitive in both performance and price, the principal methods of competition.\nIn the United States, there are four other manufacturers whose sales, directly or through subsidiaries, are significant in the total sanitary protection market: Johnson & Johnson, Kimberly-Clark Corporation, Playtex Family Products Corporation and The Procter & Gamble Company. Each of these corporations manufactures and sells external pads or menstrual tampons or both. Each makes and sells products other than external pads and tampons, and the total sales of all products by and the capitalization of each of Johnson & Johnson, Kimberly- Clark and Procter & Gamble are substantially greater than the total sales and capitalization of the Company. These factors may be helpful to the respective competitive positions of these companies in the feminine protection industry. Substantially all of the tampons manufactured by the above-mentioned four companies are sold under these companies' brand names. In addition, there is a small private label segment of the industry. Management believes that the TAMPAX tampon's leading market share position in the U.S. tampon category (approximately 50.5% in dollars and 53.7% in units for the year 1995, according to Nielsen Marketing Research) and strong brand loyalty among consumers (as verified by household panel data obtained by Nielsen Marketing Research), are positive factors in the Company's ability to compete in the feminine protection industry. (Information obtained from Nielsen represents Nielsen estimates only.) During 1995, the level of competitive activity continued to increase in the United States, particularly in the areas of new product introductions and price discounting.\nThe tampon category and TAMPAX market share softened in the United States in the fourth quarter of 1995. Management believes that the preparation for the launch of the new TAMPAX NATURALS product was a significant factor in this softening, which has continued into the first quarter of 1996. The Company reduced its fourth-quarter U.S. advertising and promotional activity while awaiting the full distribution of the TAMPAX NATURALS product.\nHighly competitive conditions prevail in virtually all foreign markets. Competition tends to be fragmented and regional in nature in most of those markets, but tampons produced by, or under license from, Johnson & Johnson and Playtex, and external pads produced by, or under license from, Johnson & Johnson, Kimberly-Clark and Procter & Gamble, are sold in many of the foreign markets where the Company does business. During 1995, Johnson & Johnson marketed applicator tampons manufactured by Playtex in a number of foreign markets where the Company does business. Competitive activity remained at high levels in Europe in 1995. This activity included the continued aggressive marketing of several external pad products.\nManagement anticipates that the worldwide market for consumer products will continue to be highly competitive and sensitive to price.\nRaw Materials - -------------\nThe principal raw materials used in the Company's business are cotton and rayon for tampons, paper and plastic for tampon applicators, and paperboard for cartons and containers. Most of these raw materials are readily available in the market from many sources. The Company experienced an escalation in 1995 in the cost of many of its raw and packaging materials, including cotton, pulp and paper. Based on the current downward trend of pulp and paper prices, management expects these costs to decline somewhat through the latter part of 1996.\nTrademarks and Patents - ----------------------\nThe Company, directly or through its subsidiaries, owns a number of trademarks, trademark registrations and trademark applications in the United States and other countries, which, in the opinion of management, are significant. The Company's trademark registrations vary in duration and are typically renewable by the Company. Certain features of TAMPAX tampons are the subject of U.S. and foreign patents or patent applications owned by the Company. In management's opinion, certain of these\npatents are significant. The duration of the Company's patents ranges from 3 to 18 years (i.e., the patents have expiration dates ranging from the year 1999 ---- to the year 2014).\nResearch and Development - ------------------------\nThe Company maintains a research and development laboratory at its facility in Palmer, Massachusetts. Management believes that developing better protecting and more comfortable and convenient products, and products which are environmentally sound, is important to maintaining the Company's competitive position. Research is directed toward these goals. The Company's research and development expenditures have approximated 2% of net sales in each of the past three years.\nEmployees - ---------\nHeadcount reductions occurred as a result of the restructuring programs announced in 1991 and 1993. At December 31, 1995, the Company and its subsidiaries employed approximately 3,400 persons.\nForeign and Domestic Operations; Export Sales - ---------------------------------------------\nThe information regarding foreign and domestic operations of the Company and its subsidiaries set forth on page under the caption \"Segment and Geographic Information\" in the Notes to Consolidated Financial Statements is incorporated herein by reference.\nOver the past three years, sales by the Company's foreign operations accounted for approximately one-half of total unit sales.\nIn 1995, sales between geographic areas and export sales of the Company were not significant.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties - ------ ----------\nDomestic Properties - -------------------\nThe Company owns and operates three manufacturing plants in the United States, located in Auburn, Maine; Claremont, New Hampshire; and Rutland, Vermont. Product and process research and development, and certain accounting, data processing and sales and logistics operations are conducted at the Company's Technical Center, located in Palmer, Massachusetts. This facility is a testing center for the development of new products and for the application of advanced manufacturing technology to the Company's products. The Company owns each of these plants and the Technical\nCenter. The Company leases headquarters office space in White Plains, New York.\nThe Company's production machinery and equipment and the properties owned by it described above are held free and clear of encumbrances.\nDuring the last fiscal year, the Company's domestic plants were suitable and adequate for the Company's requirements. The Company's domestic plants operate principally on a three-shift basis, and management believes that these plants have sufficient additional capacity to satisfy the anticipated requirements of the Company.\nForeign Properties - ------------------\nThe Company's foreign subsidiaries own and operate manufacturing plants in France, Ireland, Russia, Ukraine and the United Kingdom. The joint venture in the People's Republic of China, in which the Company has an 80% interest, has contractual rights to use a manufacturing plant there. The Company's subsidiary in Brazil owns a manufacturing plant there which it has leased to another company. The lease has expired and the Company is attempting to sell the plant. The Company's foreign subsidiaries lease office space in Brazil, Canada, France, Mexico, Switzerland and in several other countries. The Company's subsidiary in the United Kingdom leases office space there for the Company's international headquarters.\nThe production machinery and equipment and properties owned by the Company's foreign subsidiaries described above are held free and clear of encumbrances.\nDuring the last fiscal year, the foreign facilities of the Company's subsidiaries were suitable and adequate for the Company's requirements. In general, these foreign manufacturing facilities operate on a three-shift basis, and management believes that these facilities have sufficient additional capacity to satisfy the anticipated requirements of the Company.\nItem 3.","section_3":"Item 3. Legal Proceedings - ------ -----------------\nThe Company or a subsidiary is a defendant in a small number of product liability lawsuits based on allegations that toxic shock syndrome (\"TSS\") was contracted through the use of tampons. A small number of pre-suit claims involving similar TSS allegations have also been asserted. The damages alleged vary from case to case and often include claims for punitive damages. One TSS lawsuit, filed in the United States District Court for the District of Kansas and served on the Company in July 1994, purported to be a federal class action on behalf of all women who had contracted TSS through the use of tampons. In March 1996, the District Court denied plaintiffs' motion for class certification in this lawsuit.\nThe Company and three of its former officers were named as defendants in certain shareholder lawsuits filed in 1993 in the United States District Court for the Southern District of New York and consolidated under the caption In Re Tambrands Inc. Securities Litigation. The parties stipulated to the - ------------------------------------------- certification of the consolidated lawsuit as a class action on behalf of all purchasers of the Company's common stock during the period December 14, 1992 through April 28, 1993. The complaint alleged that the Company's disclosures during the class period contained material misstatements and omissions concerning its anticipated future earnings and thereby allegedly violated Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934. In November 1995, the court approved a settlement of this litigation and dismissed the action against all defendants.\nThe Company was a nominal defendant in three purported shareholder derivative lawsuits filed in the Supreme Court of the State of New York for Westchester County and consolidated in October 1993 into a single action. Named collectively in the consolidated complaint as individual defendants were the Company's directors (other than Mrs. Busquet, Mr. Fogarty and Mrs. Hill), certain former directors and three of its former officers. The complaint alleged that the officer-defendants exposed the Company to liability in the shareholder class action described in the preceding paragraph and misappropriated corporate opportunities by trading in the Company's stock on the basis of nonpublic information. One of the former officers was also alleged to have received improper reimbursements from the Company for alleged personal expenses. The director-defendants were alleged to have acquiesced in the aforesaid alleged violations and to have received excessive compensation. The complaint sought to recover on behalf of the Company an unspecified amount of damages from the individual defendants. No relief was sought against the Company. In September 1994, the Court granted the defendants' motion to dismiss the complaint for failure to make a demand upon the Board of Directors. Plaintiffs have appealed the dismissal.\nThe Company is involved, either as a named defendant or as the result of contractual indemnities, in certain litigation arising out of the operations of certain divested subsidiaries.\nThere are certain other legal proceedings pending against the Company arising out of its normal course of business in which claims for monetary damages are asserted.\nWhile it is not feasible to predict the outcome of these legal proceedings and claims with certainty, management is of the belief that any ultimate liabilities in excess of provisions therefor will not individually or in the aggregate 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 - ------ ---------------------------------------------------\nNo matters were submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this report.\nManagement of the Registrant - ----------------------------\nThe names and ages of all executive officers of the Company, the current office held by each, and the period during which each has served as such are set forth in the following table:\nPeriod Served Name Age Current Office In Current Office ---- --- -------------- ----------------- Edward T. Fogarty 59 President and 1994 to date Chief Executive Officer (1)\nMichael S. Krause 55 Senior Vice President - 1995 to date Global Operations (2)\nMichael K. Lorelli 44 Executive Vice 1994 to date President and President, North America\/Latin America (3)\nThomas J. Mason 51 Group Vice President- 1994 to date International (4)\nSusan J. Riley 37 Senior Vice President - 1995 to date Chief Financial Officer\nThomas Soper, III 46 Senior Vice President- 1994 to date Corporate Human Resources and Communications (5)\nJerome B. Wainick 55 Vice President-Research 1990 to date and Development\n(1) Mr. Fogarty has served as an officer of the Company since May 1994. From prior to March 1991 until May 1994, he was employed by Colgate-Palmolive Company as President - USA\/Canada\/Puerto Rico.\n(2) Mr. Krause has served as an officer of the Company since August 1995. From January 1995 until July 1995, he was employed by the Snacks Division of The Quaker Oats Company as Vice President - Supply Chain. From February 1994 until August 1994, he was employed by Stella Foods Inc. as Executive Vice President - Supply Chain. From prior to March 1991 until February 1994, he was employed by Goody Products, Inc. as Senior Vice President - Operations.\n(3) Mr. Lorelli has served as an officer of the Company since October 1994. From January 1993 until October 1994, he was employed by Pizza Hut International, a division of PepsiCo, Inc., as President. From prior to March 1991 until December 1992, he was employed by Pepsi-Cola East, a division of PepsiCo, Inc., as President.\n(4) Mr. Mason has served as an officer of the Company since October 1994. From May 1992 until September 1994, he was employed\nby Dole Packaged Foods, a division of Dole Food Co., as President. From prior to March 1991 until May 1992, he was employed by Kraft General Foods as Executive Vice President and General Manager, Specialty Products.\n(5) Mr. Soper has served as an officer of the Company since October 1994. From prior to March 1991 until September 1994, he was employed by Alexander & Alexander Services Inc. (a provider of risk management, insurance brokerage and human resource management consulting services) as Senior Vice President - Corporate Human Resources.\nEach executive officer is appointed by the Board of Directors to serve until the first meeting of directors following the annual meeting of shareholders of the Company. Except as indicated in the footnotes above, the principal occupation and employment during the past five years of each of the above-named executive officers have been as an officer or other member of management of the Company or one or more of its subsidiaries.\nPART II -------\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related - ------- -------------------------------------------------- Shareholder Matters -------------------\nThe Company's Common Stock is traded on the New York and Pacific Stock Exchanges. The following table provides quarterly dividend and Common Stock price range information for the years 1994 and 1995:\n(a) Reflects trading on the New York Stock Exchange.\nAs of March 15, 1996, there were 6,962 holders of record of the Company's Common Stock.\nItem 6.","section_6":"Item 6. Selected Financial Data - ------ -----------------------\nThe information required by this item is set forth in a separate section of this Annual Report on Form 10-K under the caption \"Selected Financial Data\" appearing on page and is incorporated herein by reference.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Results of - ------- -------------------------------------------------- Operations and Financial Condition ----------------------------------\nThe information required by this item is set forth in a separate section of this Annual Report on Form 10-K under the caption \"Management's Discussion and Analysis\" beginning on page and is incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data - ------- -------------------------------------------\nThe information required by this item is set forth in a separate section of this Annual Report on Form 10-K as indicated in the \"Index to Financial Information\" appearing on page and is incorporated herein by reference.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on - ------- ------------------------------------------------ Accounting and Financial Disclosure -----------------------------------\nNone.\nPART III --------\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant - -------- --------------------------------------------------\nThe information relating to nominees for election as directors of the Company set forth under the caption \"Election of Directors\" in the Company's definitive Proxy Statement for the annual meeting of shareholders to be held on April 23, 1996 is incorporated herein by reference.\nThe information on executive officers set forth under the first two paragraphs of the caption \"Management of the Registrant\" beginning on page 10 hereof is incorporated herein by reference.\nItem 11.","section_11":"Item 11. Executive Compensation - -------- ----------------------\nThe information regarding executive compensation set forth under the captions \"Information Regarding the Board of Directors - Compensation of Directors\" and \"Executive Compensation and Other Information\" in the Company's definitive Proxy Statement for the annual meeting of shareholders to be held on April 23, 1996 is incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and - -------- ---------------------------------------------------- Management ----------\nThe information regarding the security ownership of certain beneficial owners and management set forth under the caption \"Security Ownership by Management and Others\" in the Company's definitive Proxy Statement for the annual meeting of shareholders to be held on April 23, 1996 is incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions - -------- ----------------------------------------------\nThe information pertaining to certain relationships and related transactions set forth under the captions \"Information Regarding the Board of Directors - Compensation of Directors\" and \"Executive Compensation and Other Information - Compensation Committee Interlocks and Insider Participation\" in the Company's definitive Proxy Statement for the annual meeting of shareholders to be held on April 23, 1996 is incorporated herein by reference. The services performed for the Company by Doherty, Wallace,\nPillsbury & Murphy, P.C. were on terms no less favorable to the Company than if such services had been provided by unaffiliated parties.\nPART IV -------\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, - ------- ---------------------------------------- and Reports on Form 8-K -----------------------\n(a) Documents filed as part of this report\n1. Financial Statements\nThe list of financial statements set forth under the caption \"Index to Financial Information\" on page is incorporated herein by reference.\n2. Financial Statement Schedules\nThe list of financial statement schedules set forth under the caption \"Index to Financial Information\" on page is incorporated herein by reference. All other schedules have been omitted, as the required information is inapplicable or the information is presented in the financial statements or related notes.\n3. Exhibits\nExhibit Number Description ------- -----------\n3(1) Certificate of Incorporation of the Company, as amended through April 28, 1987, filed April 30, 1987 as Exhibit 4(a) to the Company's Form S-8 Registration Statement (Reg. No. 33- 13902), incorporated herein by reference.\n3(2) Certificate of Amendment of Certificate of Incorporation of the Company, dated April 24, 1990, filed May 15, 1990 as Exhibit 4(2) to the Company's Report on Form 10-Q for the quarter ended March 31, 1990, incorporated herein by reference.\n3(3) Certificate of Amendment of Certificate of Incorporation of the Company, dated April 28, 1992, filed May 15, 1992 as Exhibit 4(2) to the Company's Report on Form 10-Q for the quarter ended March 31, 1992, incorporated herein by reference.\n3(4) By-Laws of the Company, as amended, filed as Exhibit 3(4) to the Company's Report on Form 10-K for the year 1994, incorporated herein by reference.\n4(1) Description of the rights of security holders set forth in the Certificate of Incorporation of the Company, as amended through April 28, 1987, filed April 30, 1987 as Exhibit 4(a) to the Company's Form S-8 Registration Statement (Reg. No. 33- 13902), incorporated herein by reference.\n4(2) Description of the rights of security holders set forth in the Certificate of Amendment of Certificate of Incorporation of the Company, dated April 28, 1992, filed May 15, 1992 as Exhibit 4(2) to the Company's Report on Form 10-Q for the quarter ended March 31, 1992, incorporated herein by reference.\n4(3) Rights Agreement, dated as of October 24, 1989, between the Company and First Chicago Trust Company of New York, which includes the Form of Right Certificate as Exhibit A and the Summary of Rights to Purchase Common Shares as Exhibit B, filed October 27, 1989 as Exhibit 1 to the Company's Form 8- A Registration Statement, incorporated herein by reference.\n4(4)(a) Indenture dated as of December 1, 1993 between the Company and Citibank, N.A., as trustee, relating to the Company's Medium-Term Note Program, filed March 31, 1994 as Exhibit 4(4)(a) to the Company's Form 10-K Report for the year ended December 31, 1993, incorporated herein by reference.\n4(4)(b) Form of Floating Rate Debt Security, filed December 16, 1993 as Exhibit 4-a to the Company's Report on Form 8-K, incorporated herein by reference.\n4(4)(c) Form of Fixed Rate Debt Security, filed December 16, 1993 as Exhibit 4-b to the Company's Report on Form 8-K, incorporated herein by reference.\nManagement Contracts and Compensatory Plans and Arrangements (Exhibits 10(1) - 10(22)) ------------------------\n10(1)(a) 1981 Long Term Incentive Plan, as amended through November 4, 1988, filed as Exhibit 10(1)(a) to the Company's Report on Form 10-K for the year 1988, incorporated herein by reference.\n10(1)(b) Amendment to 1981 Long Term Incentive Plan, dated as of February 27, 1990, filed as Exhibit 10(1)(b) to the Company's Report on Form 10-K for the year 1989, incorporated herein by reference.\n10(1)(c) Amendment to 1981 Long Term Incentive Plan, effective as of June 25, 1991, filed as Exhibit 10(1)(c) to the Company's Report on Form 10-K for the year 1991, incorporated herein by reference.\n10(1)(d) Amendment to 1981 Long Term Incentive Plan, effective as of June 23, 1992, filed as Exhibit 10(1)(d) to the Company's Report on Form 10-K for the year 1992, incorporated herein by reference.\n10(1)(e) Amendment to 1981 Long Term Incentive Plan, effective as of February 23, 1993, filed as Exhibit 10(1)(e) to the Company's Report on Form 10-K for the year 1992, incorporated herein by reference.\n10(1)(f) Addendum to 1981 Long Term Incentive Plan, filed April 30, 1987 as Exhibit 28(a) to the Company's Form S-8 Registration Statement (Reg. No. 33-13902), incorporated herein by reference.\n10(2)(a) 1981 Incentive Stock Option Plan, as amended through April 30, 1987, filed April 30, 1987 as Exhibit 28(a) to the Company's Form S-8 Registration Statement (Reg. No. 33-13902), incorporated herein by reference.\n10(2)(b) Amendment to 1981 Incentive Stock Option Plan, dated as of February 27, 1990, filed as Exhibit 10(2)(b) to the Company's Report on Form 10-K for the year 1989, incorporated herein by reference.\n10(2)(c) Amendment to 1981 Incentive Stock Option Plan, effective as of June 23, 1992, filed as Exhibit 10(2)(c) to the Company's Report on Form 10-K for the year 1992, incorporated herein by reference.\n10(2)(d) Amendment to 1981 Incentive Stock Option Plan, effective as of February 23, 1993, filed as Exhibit 10(2)(d) to the Company's Report on Form 10-K for the year 1992, incorporated herein by reference.\n10(3)(a) 1991 Stock Option Plan, filed as Exhibit 10(3) to the Company's Report on Form 10-K for the year 1990, incorporated herein by reference.\n10(3)(b) First Amendment to 1991 Stock Option Plan, effective as of July 1, 1991, filed as Exhibit 10(3)(b) to the Company's Report on Form 10-K for the year 1991, incorporated herein by reference.\n10(3)(c) Second Amendment to 1991 Stock Option Plan, effective as of July 1, 1991, filed as Exhibit 10(3)(c) to the Company's Report on Form 10-K for the year 1991, incorporated herein by reference.\n10(3)(d) Third Amendment to 1991 Stock Option Plan, effective as of June 23, 1992, filed as Exhibit 10(3)(d) to the Company's Report on Form 10-K for the year 1992, incorporated herein by reference.\n10(3)(e) Fourth Amendment to 1991 Stock Option Plan, effective as of February 23, 1993, filed as Exhibit 10(3)(e) to the Company's Report on Form 10-K for the year 1992, incorporated herein by reference.\n10(3)(f) Fifth Amendment to 1991 Stock Option Plan, effective as of February 23, 1993, filed as Exhibit 10(3)(f) to the Company's Report on Form 10-K for the year 1992, incorporated herein by reference.\n10(3)(g) Addendum to 1991 Stock Option Plan, filed as Exhibit 10(3)(g) to the Company's Report on Form 10-K for the year 1992, incorporated herein by reference.\n10(3)(h) Sixth Amendment to 1991 Stock Option Plan, effective as of February 1, 1994, filed as Exhibit 10(3)(h) to the Company's Report on Form 10-K for the year 1993, incorporated herein by reference.\n10(4)(a) 1989 Restricted Stock Plan, as amended through December 31, 1990, filed as Exhibit 10(4) to the Company's Report on Form 10-K for the year 1990, incorporated herein by reference.\n10(4)(b) Amendment to 1989 Restricted Stock Plan, effective as of February 23, 1993, filed as Exhibit 10(4)(b) to the Company's Report on Form 10-K for the year 1992, incorporated herein by reference.\n10(5) Supplemental Executive Retirement Plan, effective July 1, 1986, as amended and restated effective July 1, 1994, filed as Exhibit 10(6) to the Company's Report on Form 10-Q for the quarter ended June 30, 1994, incorporated herein by reference.\n10(6) Trust Agreement between the Company and The Northern Trust Company, dated as of October 31, 1988, filed as Exhibit 10(6) to the Company's Report on Form 10-K for the year 1988, incorporated herein by reference.\n10(7) Pension Plan for Non-Employee Directors, filed as Exhibit 10(10) to the Company's Report on Form 10-K for the year 1990, incorporated herein by reference.\n10(8)(a) 1992 Directors Stock Incentive Plan, filed as Exhibit 10(11) to the Company's Report on Form 10-K for the year 1991, incorporated herein by reference.\n10(8)(b) First Amendment to 1992 Directors Stock Incentive Plan, effective as of August 18, 1992, filed as Exhibit 10(8)(b) to the Company's Report on Form 10-K for the year 1992, incorporated herein by reference.\n10(8)(c) Second Amendment to 1992 Directors Stock Incentive Plan, effective as of February 23, 1993, filed as Exhibit 10(8)(c) to the Company's Report on Form 10-K for the year 1992, incorporated herein by reference.\n10(8)(d) Third Amendment to the 1992 Directors Stock Incentive Plan, effective as of August 24, 1993, filed as Exhibit 10(3) to the Company's Report on Form 10-Q\/A for the quarterly period ended September 30, 1993, incorporated herein by reference.\n10(8)(e) Fourth Amendment to Tambrands Inc. 1992 Directors Stock Incentive Plan, effective as of April 28, 1994, filed as Exhibit 10(7) to the Company's Report on Form 10-Q for the quarter ended June 30, 1994, incorporated herein by reference.\n10(8)(f) Fifth Amendment to the Tambrands Inc. 1992 Directors Stock Incentive Plan, effective as of September 1, 1994, filed as Exhibit 10(4) to the Company's Report on Form 10-Q for the\nquarter ended September 30, 1994, incorporated herein by reference.\n10(9)(a) Employment Protection Agreement between the Company and Mr. Edward T. Fogarty, dated as of May 31, 1994, filed as Exhibit 10(1) to the Company's Report on Form 10-Q for the quarter ended June 30, 1994, incorporated herein by reference;\n10(9)(b) Employment Protection Agreement between the Company and Mr. Michael K. Lorelli, dated as of August 31, 1994, filed as Exhibit 10(2) to the Company's Report on Form 10-Q for the quarter ended September 30, 1994, incorporated herein by reference;\n10(9)(c) Employment Protection Agreement between the Company and Mr. Thomas J. Mason, dated as of October 18, 1994, filed herewith;\n10(9)(d) Employment Protection Agreement between the Company and Mr. Thomas Soper, III, dated as of August 29, 1994, filed herewith;\nThe Company has agreements similar to the agreements listed as Exhibits 10(9)(c) and 10(9)(d) with its other executive officers.\n10(10) Resolution of the Board of Directors of the Company with respect to the compensation of the Chairman of the Board, adopted on April 25, 1995, filed as Exhibit 10(2) to the Company's Report on Form 10-Q for the quarter ended June 30, 1995, incorporated herein by reference.\n10(11) Resolution of the Board of Directors of the Company with respect to the compensation of the Board, adopted on December 13, 1994, filed as Exhibit 10(11) to the Company's Report on Form 10-K for the year 1994, incorporated herein by reference.\n10(12) 1995 Directors Stock and Deferred Compensation Plan, effective as of July 1, 1995, included as Exhibit A to the Company's Proxy Statement, dated March 10, 1995, for the annual meeting of shareholders held on April 25, 1995, incorporated herein by reference.\n10(13) Executive Severance Program of the Company, filed as Exhibit 10(15) to the Company's Report on Form 10-K for the year 1989, incorporated herein by reference.\n10(14) 1981 Annual Incentive Plan of the Company, as amended through March 30, 1995, filed as Exhibit 10(1) to the Company's Report on Form 10-Q for the quarter ended March 31, 1995, incorporated herein by reference.\n10(15) Letter Agreement between the Company and Mr. Edward T. Fogarty, dated as of April 25, 1994, filed as Exhibit 10(1) to the Company's Report on Form 10-Q for the quarter ended June 30, 1994, incorporated herein by reference.\n10(16) Letter Agreement between the Company and Mr. Michael K. Lorelli, dated as of August 30, 1994, filed as Exhibit 10(1) to the Company's Report on Form 10-Q for the quarter ended September 30, 1994, incorporated herein by reference.\n10(17) Letter Agreement between the Company and Mr. Thomas Soper, III, dated as of August 29, 1994, filed as Exhibit 10(17) to the Company's Report on Form 10-K for the year 1994, incorporated herein by reference.\n10(18) Letter Agreement between the Company and Mr. Thomas J. Mason, dated as of October 18, 1994, filed as Exhibit 10(18) to the Company's Report on Form 10-K for the year 1994, incorporated herein by reference.\n10(19) Letter Agreement between the Company and Mr. Michael S. Krause, dated as of July 5, 1995, filed as Exhibit 10(1) to the Company's Report on Form 10-Q for the quarter ended September 30, 1995, incorporated herein by reference.\n10(20) Restricted Stock Agreement between the Company and Mr. Edward T. Fogarty, dated May 31, 1994, filed as Exhibit 10(3) to the Company's Report on Form 10-Q for the quarter ended June 30, 1994, incorporated herein by reference.\n10(21) Stock Option Agreement between the Company and Mr. Edward T. Fogarty, dated May 31, 1994, filed as Exhibit 10(4) to the Company's Report on Form 10-Q for the quarter ended June 30, 1994, incorporated herein by reference.\n10(22) Early Retirement Agreement between the Company and Mr. Raymond F. Wright, dated as of August 1, 1995, filed as Exhibit 10(2) to the Company's Report on Form 10-Q for the quarter\nended September 30, 1995, incorporated herein by reference.\n10(23)(a) Commercial Paper Dealer Agreement between the Company and Merrill Lynch Money Markets, Inc., dated November 18, 1992, filed as Exhibit 10(15) (a) to the Company's Report on Form 10-K for the year 1992, incorporated herein by reference.\n10(23)(b) Letter Agreement between the Company and the First National Bank of Chicago, dated as of November 18, 1992, filed as Exhibit 10(15)(b) to the Company's Report on Form 10-K for the year 1992, incorporated herein by reference.\n10(23)(c) Amended and Restated Credit Agreement by and among the Company, Tambrands Limited, the signatory banks thereto and The Bank of New York, as agent, dated as of September 6, 1994, filed as Exhibit 10(5) to the Company's Report on Form 10-Q for the quarter ended September 30, 1994, incorporated herein by reference.\n10(23)(d) Amendment No. 1, dated as of May 5, 1995, to the Amended and Restated Credit Agreement, dated as of September 6, 1994, by and among the Company, Tambrands Limited, the signatory banks thereto and The Bank of New York, as agent, filed as Exhibit 10(3) to the Company's Report on Form 10-Q for the quarter ended June 30, 1995, incorporated herein by reference.\n12 Computation of Ratio of Earnings to Fixed Charges, filed herewith.\n21 Subsidiaries of the Company, filed herewith.\n23 Independent Auditors' Consent, filed herewith.\n24 Powers of attorney, filed herewith.\n27 Financial Data Schedules, filed herewith (in electronic format only).\n(b) Reports on Form 8-K\nThe Company filed a Report under Item 5 of Form 8-K on October 27, 1995 in order to file a press release, issued by the Company on October 25, 1995, which contained the Company's third-quarter 1995 results.\nTAMPAX, COMPAK, LITES, TAMPAX NATURALS, NATURAL GLIDE, SATIN, SATIN TOUCH, TAMPAX SILKS, SOLOS and TAMPETS are trademarks of Tambrands Inc.\nSIGNATURES ----------\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nTAMBRANDS INC.\nDate: March 28, 1996 By \/s\/ EDWARD T. FOGARTY ------------------------- Edward T. Fogarty 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\/ EDWARD T. FOGARTY President and Chief March 28, 1996 - --------------------------- Executive Officer EDWARD T. FOGARTY and Director (Principal Executive Officer)\n\/s\/ SUSAN J. RILEY Senior Vice March 28, 1996 - --------------------------- President-Chief SUSAN J. RILEY Financial Officer (Principal Financial Officer and Principal Accounting Officer)\n\/s\/ HOWARD B. WENTZ, JR. Chairman and March 28, 1996 - --------------------------- Director HOWARD B. WENTZ, JR.\n* - --------------------------- Director March 28, 1996 LILYAN H. AFFINITO\nSignature Title Date --------- ----- ----\n* - --------------------------- Director March 28, 1996 ANNE M. BUSQUET\n* - --------------------------- Director March 28, 1996 PAUL S. DOHERTY\n* - --------------------------- Director March 28, 1996 JANET HILL\n* - --------------------------- Director March 28, 1996 ROBERT P. KILEY\n* - --------------------------- Director March 28, 1996 JOHN LOUDON\n* - --------------------------- Director March 28, 1996 RUTH M. MANTON\n* - --------------------------- Director March 28, 1996 JOHN A. MEYERS\n* - --------------------------- Director March 28, 1996 H.L. TOWER\n* - --------------------------- Director March 28, 1996 ROBERT M. WILLIAMS\n*By \/s\/ EDWARD T. FOGARTY ------------------------ Edward T. Fogarty Attorney-in-Fact\nINDEX TO FINANCIAL INFORMATION ------------------------------\nPage Reference ---------\nSelected Financial Data................................\nManagement's Discussion and Analysis of Results of Operations and Financial Condition..........\nFinancial Statements:\nConsolidated Statements of Earnings for the years ended December 31, 1995, 1994 and 1993....................\nConsolidated Statements of Cash Flows for the years ended December 31, 1995, 1994 and 1993....................\nConsolidated Balance Sheets as of December 31, 1995 and 1994..........................\nNotes to Consolidated Financial Statements...........................................\nIndependent Auditors' Report on Consolidated Financial Statements....................\nFinancial Statement Schedule:\nII Valuation and Qualifying Accounts...........\nIndependent Auditors' Report on Financial Statement Schedule.........................\nSupplementary Financial Information and Quarterly Data for the years ended December 31, 1995 and 1994 ....................\nTAMBRANDS INC. Selected Financial Data ($ In Thousands, Except Per Share Amounts)\n(a) Results and related financial data for 1995 include the Litigation charge and for 1993 and 1991 include Restructuring and other charges.\nMANAGEMENT'S DISCUSSION AND ANALYSIS\nRESULTS OF OPERATIONS\n1995 vs. 1994\nConsolidated Net sales for 1995 were $683.1 million, an increase of 6% from 1994. The increase was primarily due to higher unit sales in the United States, Russia\/Ukraine, Canada, Latin America and in Europe with the exception of the United Kingdom. The overall increase in unit sales was principally attributable to the strengthening of the tampon category and Tampax market shares over the prior year in our core markets, with the exception of the United Kingdom where the category has declined but has recently shown improvement. Strong unit sales were augmented by foreign exchange gains but somewhat offset by lower average prices in the United States due to changes in the sales mix.\nGross profit as a percent of Net sales was 66% for 1995 vs. 68% in 1994. The margin reduction in the current year is principally due to a change in the mix of product and package sizes, increasing costs of raw and packaging materials, and manufacturing start-up costs in the United States associated with the fourth-quarter 1995 relaunch of the Tampax flushable line and the production of Tampax Naturals, which will be launched in early 1996. This reduction is partially offset by productivity improvements resulting from our capital spending program.\nMarketing, selling and distribution expenses were up 2% compared with the prior year. The increase is primarily due to unfavorable foreign exchange translations and higher marketing expenditures partially offset by lower fourth-quarter advertising and promotional activity in anticipation of the Tampax Naturals launch in the United States.\nAdministrative and general expenses were 1% lower than last year primarily a result of management's continuing efforts to contain overhead costs. A reduction in the United States was partially offset by higher costs in international markets due to management changes and the growing businesses in Russia and Ukraine.\nOperating income of $160.4 million was 6% higher than the prior year. The increased sales volume was partially mitigated by the factors reducing Gross profit discussed above.\nInterest, net and other expense decreased slightly in 1995 compared to 1994. A reduction in realized foreign exchange losses was partially offset by higher interest expense resulting from higher average interest rates and overall higher borrowing levels.\nIn the second quarter of 1995, the Company provided $11.4 million for several legal proceedings related to previously divested non-tampon businesses and for settlement of a securities class action filed in 1993.\nThe effective tax rate for 1995 was 38.6%, compared to 36.7% for 1994. The higher effective tax rate in 1995 was due primarily to the litigation charge, the cost of which is not fully deductible for tax purposes. Exclusive of the litigation charge, the current effective tax rate would have been 37.5% for 1995.\n1995 Earnings per share were $2.33 compared to $2.43 in 1994. The principal reason for the decline is due to the litigation charge that the Company took in the second quarter. Exclusive of the litigation charge, Earnings per share would have been $2.57 compared to $2.43 in 1994.\nOutlook\nThe Company anticipates that the worldwide market for consumer products will continue to be highly competitive and sensitive to price. However, management will continue to evaluate price increase opportunities as appropriate. The Company expects the current level of advertising and promotional activities and new product introductions by competitors to remain strong, along with continued activity in the private label sector.\nIn the United States, the Company relaunched an upgraded version of its original Tampax tampon line in the fourth quarter of 1995. On October 2, the Company announced the U.S. introduction of a new product, Tampax Naturals, the only nationally available tampon or pad to be made of 100% cotton. Tampax Naturals will be launched in the first quarter of 1996. The preparation for the launch of our new Tampax Naturals product was a significant factor in the softening of the tampon category and Tampax market share in the fourth quarter. The Company reduced its fourth-quarter U.S. advertising and promotional activity while awaiting the full distribution of this new product. In 1996, the Company intends to proceed with its aggressive support of the Tampax tampon franchise with heightened levels of advertising and promotional activities and product line innovations in the United States and international markets.\nThe cost of manufacturing will continue to be impacted by the escalation of raw material and packaging costs that occurred in 1995. The Company intends to continue with productivity initiatives to help mitigate the effect of these cost increases. Based on the current downward trend of pulp and paper prices, management expects these costs to decline somewhat through the latter part of 1996.\n1994 vs. 1993\nConsolidated Net sales for 1994 were $644.5 million, an increase of 5% from 1993. The increase was primarily due to higher worldwide unit sales, principally in the United States, driven by stabilization of retail trade inventories and the successful launch of two new products, Tampax Satin Touch and Tampax Lites. Sales volumes were also favorable in Europe where new products were launched in both the United Kingdom and France and in the developing markets of Russia and Ukraine.\nGross profit as a percent of Net sales was 68% for 1994, up from 67% in 1993. The increase in margin reflected the impact of higher sales volume along with the Company's continued support of its worldwide manufacturing efficiency programs and its capital expenditures for productivity improvements.\nMarketing, selling and distribution expenses were up 16% compared with the prior year. The higher spending was primarily attributable to increased advertising and promotions worldwide to support the Tampax tampon franchise. This higher brand support was partially offset by reductions in overhead spending. In the United States, the Company regained market share throughout 1994 in the growing tampon category. Total year market share recovered to within 1% of 1993.\nA 14% savings was experienced in Administrative and general expenses, principally due to the consolidation of international management units and on- going overhead reduction programs.\nIncreased sales volume combined with overhead savings was partially offset by increased brand support spending. This resulted in a 4% net improvement in Operating income versus 1993, exclusive of the 1993 restructuring charge.\nInterest, net and other reflected a significant increase in expense in 1994 compared to 1993. Foreign exchange transactions resulted in costs in the current year versus gains in 1993. Additionally, interest expense was higher reflecting an increase in the Company's debt level and higher average interest rates.\nThe effective tax rate for 1994 was 36.7% compared to 37.9% in 1993. The higher effective tax rate in 1993 was primarily due to the restructuring charge, the cost of which was not fully deductible for tax purposes. Exclusive of the restructuring charge, the 1993 effective tax rate was 36.8%.\n1994 Earnings per share were $2.43 in comparison to $1.64 in 1993. Earnings per share were the same as the prior year before the impact of the restructuring charge and adoption of SFAS No. 112 in 1993. The increase in Earnings per share was greater than that of Net earnings because fewer shares were outstanding on average in 1994 due to the Company's share repurchase program.\nFINANCIAL CONDITION\nCash Flows from Operating Activities\n1995 Cash flows from operating activities were $101.9 million compared to $128.9 for 1994. The principal reasons for the decline in Cash flows from operating activities versus the prior year were lower accrued liabilities caused by timing of promotional programs, higher accounts receivable due to strong December shipments and the build of inventories for the Russia\/Ukraine developing markets and the U.S. launch of Naturals.\nOver the past three years, Cash flows from operating activities were $359.5 million. These funds were used for the payment of dividends, capital expenditures and the repurchase of Common Stock for treasury purposes.\nCapital Expenditures\nThe 1995 capital spending programs related to investments in equipment to improve product quality and productivity, modernize production facilities and manufacture and launch new products. Over the past three years, the Company spent $128.9 million on capital improvements. 1996 spending levels are expected to approximate those of 1995.\nLiquidity and Capital Resources\nDuring 1995, the Company continued to utilize its strong debt rating and a favorable financial climate to take advantage of low U.S. interest rates through short-term bank credit lines and a commercial paper program. Additionally, the Company maintains a $150 million medium-term note program of which $70 million was outstanding at December 31, 1995.\nCash flows from operations and the ability to borrow from a variety of sources will provide the Company with the liquidity to continue the investments necessary to meet the Company's long-term strategic goals.\nThe Company also utilizes cash resources to enhance shareholder value through the payment of dividends and its stock repurchase program. In 1995, cash dividends of $65.3 million were paid. During the year, the Company spent $4.3 million in its Common Stock repurchase program. Since 1989, 7,720,300 shares have been repurchased.\nCONSOLIDATED STATEMENTS OF EARNINGS\nTambrands Inc. and subsidiaries\nYEARS ENDED DECEMBER 31 (in thousands, except per share amounts) 1995 1994 1993 -------- -------- -------- Net Sales $683,092 $644,513 $611,465 Cost of products sold 231,625 206,111 201,706 -------- -------- -------- Gross profit 451,467 438,402 409,759 Selling, administrative and general expenses: Marketing, selling and distribution 238,558 233,753 202,031 Administrative and general 52,546 53,034 61,378 Restructuring and other charges - - 30,042 -------- -------- -------- 291,104 286,787 293,451 -------- -------- -------- Operating Income 160,363 151,615 116,308 Interest, net and other (9,632) (9,864) 2,344 Litigation charge (11,396) - - -------- -------- -------- Earnings before provision for income taxes and cumulative effect of accounting change 139,335 141,751 118,652 Provision for income taxes 53,813 52,022 44,950 -------- -------- -------- Earnings Before Cumulative Effect of Accounting Change 85,522 89,729 73,702 Cumulative effect of accounting change - - (10,252) -------- -------- -------- Net Earnings $ 85,522 $ 89,729 $ 63,450 ======== ======== ======== Average number of shares outstanding 36,671 36,992 38,632\nPer Share Earnings before cumulative effect of accounting change $ 2.33 $ 2.43 $ 1.91 Cumulative effect of accounting change - - (0.27) -------- -------- -------- Net earnings $ 2.33 $ 2.43 $ 1.64 ======== ======== ======== Dividends $ 1.78 $ 1.70 $ 1.56 -------- -------- --------\nSee accompanying notes to consolidated financial statements.\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nTambrands Inc. and subsidiaries\nYEARS ENDED DECEMBER 31 (in thousands) 1995 1994 1993 -------- -------- -------- Cash Flows from Operating Activities Net earnings $ 85,522 $ 89,729 $ 63,450 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation and amortization 25,667 24,284 18,372 Deferred income taxes 2,158 4,557 (3,400) Cumulative effect of accounting change - - 10,252 Litigation charge 4,425 - - Restructuring and other charges (3,587) (10,417) 14,946 Change in: Accounts receivable (14,737) (2,224) 21,485 Inventories (8,326) 1,503 537 Prepaid expenses and other current assets (591) (1,901) (81) Taxes on income 8,350 5,925 3,426 Accounts payable and accrued expenses 2,974 17,415 (256) -------- -------- -------- Net cash provided by operating activities 101,855 128,871 128,731 -------- -------- -------- Cash Flows from Investing Activities Capital expenditures (44,778) (38,470) (45,636) Proceeds from sales of property, plant and equipment 108 2,093 3,686 Proceeds from sales of marketable securities - 639 1,164 -------- -------- -------- Net cash used in investing activities (44,670) (35,738) (40,786) -------- -------- -------- Cash Flows from Financing Activities Payment of dividends (65,274) (62,721) (60,154) Purchase of shares for treasury (4,326) (71,118) (57,946) Short-term debt changes (17,448) 6,149 (18,308) Reduction of medium-term obligations (1,094) - - Proceeds from medium-term obligations 24,091 29,983 30,000 Proceeds from exercise of stock options and other 5,307 2,422 12,432 -------- -------- -------- Net cash used in financing activities (58,744) (95,285) (93,976) -------- -------- -------- Effect of exchange rate changes on cash (1,182) 730 (658) -------- -------- -------- Net decrease in cash and cash equivalents (2,741) (1,422) (6,689) Cash and cash equivalents at beginning of year 13,876 15,298 21,987 -------- -------- -------- Cash and cash equivalents at end of year $ 11,135 $ 13,876 $ 15,298 ======== ======== ======== Supplemental Cash Flow Information Income taxes paid $ 44,756 $ 49,500 $ 49,567 Interest paid 9,188 4,573 4,574 -------- -------- --------\nSee accompanying notes to consolidated financial statements.\nCONSOLIDATED BALANCE SHEETS\nTambrands Inc. and subsidiaries\nYEARS ENDED DECEMBER 31 (in thousands, except per share amounts) 1995 1994 -------- -------- Assets Current assets Cash and cash equivalents $ 11,135 $ 13,876 Accounts receivable, net 98,047 80,593 Inventories 46,736 37,957 Deferred taxes on income 17,724 18,892 Prepaid expenses 12,289 14,385 Other current assets 13,982 11,433 -------- -------- Total current assets 199,913 177,136 Property, plant and equipment, net 216,122 194,315 Intangible and other assets 6,014 7,624 -------- -------- Total assets $422,049 $379,075 ======== ======== Liabilities and Shareholders' Equity Current liabilities Short-term borrowings $ 55,063 $ 70,517 Accounts payable 48,498 31,530 Accrued expenses 73,330 80,381 Taxes on income 27,078 20,732 -------- -------- Total current liabilities 203,969 203,160 Medium-term obligations 80,889 59,983 Deferred taxes on income 22,537 21,450 Postemployment benefits 11,682 12,468 -------- -------- Total liabilities 319,077 297,061\nShareholders' equity Common Stock, authorized 300,000,000 shares, par value $.25 per share; issued 43,547,938 shares 10,887 10,887 Retained earnings 476,252 457,071 Cumulative foreign currency translation adjustment (14,223) (13,621) Treasury stock (368,543) (371,016) Unamortized value of restricted stock and pension costs (1,401) (1,307) -------- -------- Total shareholders' equity 102,972 82,014 -------- -------- Total liabilities and shareholders' equity $422,049 $379,075 ======== ========\nSee accompanying notes to consolidated financial statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nTambrands Inc. and subsidiaries\n(dollar amounts in thousands, except per share amounts)\nNOTE 1\nACCOUNTING POLICIES\nThe consolidated financial statements are prepared in accordance with generally accepted accounting principles in the United States. Where alternatives exist, the choices selected are described below.\nPrinciples of Consolidation\nThe consolidated financial statements include the accounts of Tambrands Inc. and all majority owned subsidiaries (the \"Company\"). All significant intercompany accounts and transactions are eliminated.\nForeign Currency Translation\nFor most foreign subsidiaries, the local currency is the functional currency and gains or losses resulting from translation are accumulated in a separate component of Shareholders' equity. For subsidiaries operating in highly inflationary economies, the U.S. dollar is the functional currency. In such cases, working capital items are translated using current exchange rates and all other balance sheet items are remeasured at historical exchange rates. Any gains or losses from remeasurement are included in earnings.\nCash Equivalents\nHighly liquid investments with a maturity of three months or less when purchased are considered to be cash equivalents.\nInventories\nInventories are stated at the lower of cost or market. Cost is determined using the LIFO method for all domestic inventories. All other inventories are stated at FIFO.\nDepreciation\nDepreciation is computed on the straight-line and accelerated methods over the useful lives of the assets.\nIntangibles\nIntangible assets are amortized on a straight-line basis over periods not exceeding 40 years.\nFinancial Instruments\nThe Company utilizes derivative financial instruments, principally options and forward contracts, for the purpose of reducing its exposure to adverse fluctuations in foreign exchange rates. These contracts hedge actual and anticipated transactions and balances for periods consistent with the Company's committed and expected exposures. Gains and losses on hedges of existing assets or liabilities are included in the carrying amounts of those assets or liabilities and are recognized in income as part of those carrying amounts. Gains and losses on contracts that do not qualify as hedges are recognized in earnings. Unamortized option premiums are deferred and amortized over the period being hedged. The Company does not hold or issue financial instruments for trading purposes.\nAdvertising Costs\nAdvertising costs are charged to earnings as incurred.\nEarnings Per Share\nEarnings per share of Common Stock are based on the average number of shares outstanding during each period. Outstanding stock options do not have a significant dilutive effect.\nEstimates and Assumptions\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities 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.\nNew Accounting Standards\nIn March 1995, Statement of Financial Accounting Standards (SFAS) No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of\" was issued. In October 1995, SFAS No. 123, \"Accounting for Stock-Based Compensation\" was issued. Management believes that adoption of these Statements will not have a material impact on the Company's financial position and results of operations. These Statements are effective for fiscal years beginning after December 15, 1995.\nReclassifications\nCertain reclassifications have been made to prior years' financial statements to conform to the 1995 presentation.\nNOTE 2\nBALANCE SHEET COMPONENTS\nThe components of certain balance sheet accounts at December 31 are as follows: 1995 1994 -------- -------- Accounts receivable, net Accounts receivable trade $ 93,603 $ 77,235 Less allowance for doubtful accounts 1,667 1,456 -------- -------- 91,936 75,779 Other 6,111 4,814 -------- -------- $ 98,047 $ 80,593 ======== ======== Other current assets Spare parts inventory $ 10,460 $ 8,753 Other 3,522 2,680 -------- -------- $ 13,982 $ 11,433 ======== ======== Inventories Raw materials $ 17,952 $ 12,967 Finished goods 28,784 24,990 -------- -------- $ 46,736 $ 37,957 ======== ======== Current cost of LIFO inventories $ 30,834 $ 30,617 Stated value of LIFO inventories 15,098 14,713 -------- -------- Excess of current cost over stated value $ 15,736 $ 15,904 ======== ========\n1995 1994 --------- --------- Property, plant and equipment, net (at cost) Buildings, leaseholds and improvements $ 63,972 $ 56,522 Machinery, equipment and fixtures 245,931 230,333 Land 3,802 3,808 Construction in progress 39,724 23,794 -------- -------- 353,429 314,457 Less accumulated depreciation 137,307 120,142 -------- -------- $216,122 $194,315 ======== ======== Intangible and other assets Cost $ 12,983 $ 14,066 Less accumulated amortization 6,969 6,442 -------- -------- $ 6,014 $ 7,624 ======== ======== Accrued expenses Promotions $ 20,032 $ 27,723 Salaries and benefits 25,067 25,480 Litigation reserves 5,180 - Restructuring reserves 3,916 5,205 Other liabilities 19,135 21,973 -------- -------- $ 73,330 $ 80,381 ======== ========\nNOTE 3\nSTATEMENT OF EARNINGS INFORMATION 1995 1994 1993 -------- -------- -------- Interest, net and other Net financing: Interest income $ 1,124 $ 1,304 $ 983 Interest expense (9,206) (7,645) (4,890) -------- -------- -------- (8,082) (6,341) (3,907) Net realization on foreign currency transactions (1,743) (3,449) 6,551 Other 193 (74) (300) -------- -------- -------- $ (9,632) $ (9,864) $ 2,344 ======== ======== ======== Depreciation $ 25,127 $ 23,545 $ 17,570 Advertising 63,272 66,484 48,309 Research and development 12,204 10,735 9,881\nNOTE 4\nBENEFIT PLANS\nThe Company maintains several non-contributory pension plans covering domestic and foreign employees who meet certain minimum service and age requirements and provides supplemental non-qualified retirement benefits to non-employee directors, certain officers and key employees. Pensions are based upon earnings of covered employees during their periods of credited service. The Company's funding policy for its pensions is to make the annual contributions required by applicable regulations.\nThe following table sets forth the funded status of the plans and the amounts recognized in the accompanying financial statements.\n1995 1994 -------- -------- Plan assets at fair value, primarily stocks and bonds $107,897 $ 86,950 Actuarial present value of benefit obligations: Vested benefits 101,510 87,645 Nonvested benefits 6,510 4,749 -------- -------- Accumulated benefit obligation 108,020 92,394 Effect of projected future salary increases 9,883 7,949 -------- -------- Projected benefit obligation 117,903 100,343 -------- -------- Projected benefit obligation in excess of plan assets 10,006 13,393 Deferred actuarial adjustments (203) 412 Deferred prior service cost (2,913) (3,527) -------- -------- Accrued pension cost included in accrued expenses $ 6,890 $ 10,278 ======== ========\nAt December 31, 1995 and 1994, the accumulated benefit obligation of the domestic plans exceeded plan assets by $8,460 and $9,962, respectively.\nThe net cost of pensions included in the Statements of earnings consists of:\n1995 1994 1993 -------- -------- -------- Service cost: benefits earned during the period $ 3,940 $ 5,045 $ 4,940 Interest cost on projected benefit obligation 8,389 8,093 7,288 Actual return on plan assets (19,493) 3,375 (12,703) Net amortization and deferral 11,900 (10,289) 6,697 -------- -------- -------- $ 4,736 $ 6,224 $ 6,222 ======== ======== ========\nIn 1995 and 1994, the discount rates used to determine the projected benefit obligation for the domestic plans were 7.25% and 8.5%, respectively, and the rates of increase in future compensation were 4.5% and 5%, respectively. For the international plans, the discount rates used to determine the projected benefit obligation ranged from 7.5% to 8% in 1995 and was 9% in 1994, and the rates of increase in future compensation ranged from 5% to 6% and 5.5% to 6% in 1995 and 1994, respectively. Expected long-term rates of return on plan assets ranged from 8.5% to 10% in 1995 and 8.5% to 9.25% in 1994. Prior service costs arising from plan amendments are amortized on a straight-line basis over the average remaining service period of employees expected to receive benefits under each plan.\nAs of January 1, 1993, the Company adopted SFAS No. 112, \"Employers' Accounting for Postemployment Benefits,\" recognizing a charge to earnings of $16,000, amounting to $10,252 after tax or $0.27 per share. In 1992, the Company recognized the full amount of its estimated accumulated postretirement benefit obligation in accordance with the provisions of SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" The incremental annual cost of accounting for postretirement and postemployment benefits under the new accounting methods is not material. The actuarial assumptions used to measure the cost of postretirement benefits are consistent with those used to measure the cost of the pension plans.\nThe Company also sponsors a defined contribution 401(k) savings plan available to domestic employees who meet certain minimum age and service requirements. The plan, which is funded principally with the Company's Common Stock, includes provision for a discretionary contribution by the Company of up to 2% of each employee's covered earnings based on Company performance.\nNOTE 5\nINCOME TAXES\nProvision for income taxes for the years ended December 31 has been made as follows:\n1995 1994 1993 -------- -------- -------- Current tax expense United States $ 45,597 $ 47,866 $ 44,558 Foreign 6,058 (401) 3,792 -------- -------- -------- 51,655 47,465 48,350 Deferred tax expense United States 754 6,699 (3,915) Foreign 1,404 (2,142) 515 -------- -------- -------- 2,158 4,557 (3,400) -------- -------- -------- $ 53,813 $ 52,022 $ 44,950 ======== ======== ========\nProvision has not been made for income taxes on foreign subsidiaries' unremitted earnings to the extent that such earnings have been reinvested in the business; any U.S. income taxes payable on the distribution of available earnings should generally be offset by credits for foreign taxes paid.\nReconciliation of the statutory federal income tax rates to the Company's effective tax rates for the years ended December 31 are as follows:\n1995 1994 1993 ---- ---- ---- Statutory federal tax rate 35.0% 35.0% 35.0% State taxes-net of federal benefit 3.5 4.3 3.9 Rate differential on foreign income (3.7) (2.3) (2.3) Effect of litigation charge 1.1 - - Effect of restructuring charge - - 1.1 Other differences 2.7 (0.3) 0.2 ---- ---- ---- Effective tax rate 38.6% 36.7% 37.9% ==== ==== ====\nDuring 1995 and 1994, Shareholders' equity was credited for $343 and $76, respectively, for tax benefits relating to compensation expense for tax purposes in excess of the amounts recognized for financial reporting purposes.\nDeferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse.\nThe components of the net deferred tax assets (liabilities) for the years ended December 31 are as follows:\n1995 1994 -------- -------- Deferred tax assets: Employee benefits $ 5,620 $ 5,320 Postemployment benefits 4,098 4,208 Intercompany transactions 4,588 4,785 Accrued liabilities 4,446 5,579 Other 4,271 4,830 -------- -------- 23,023 24,722 -------- -------- Deferred tax liabilities: Property, plant and equipment 21,351 19,307 Safe harbor leases 5,973 6,816 Other 512 1,157 -------- -------- 27,836 27,280 -------- -------- $ (4,813) $ (2,558) ======== ========\nNOTE 6\nRESTRUCTURING AND OTHER CHARGES\nIn 1993, the Company announced a program to restructure its worldwide operations to improve efficiency and reduce costs. Its previous investments in technology enabled it to operate with reduced manufacturing and administrative overhead and fewer employees. As a result, the Company provided $30,042, or $20,273 after tax, for this restructuring and the cost of management changes caused by the adoption of a consolidated international management strategy. During 1995, the reserve was reduced by $1,289 comprised primarily of international severance payments. At December 31, 1995, the remaining accrual of $3,916 related primarily to committed severance plans which will be substantially complete by December 31, 1996.\nNOTE 7\nCOMMITMENTS AND CONTINGENCIES\nThe Company's lease of its headquarters in White Plains, New York and European headquarters in the United Kingdom are non-cancelable operating leases. Future minimum lease payments under operating leases with terms in excess of one year amount to $4,407 in 1996, $3,752 in 1997, $3,087 in 1998, $2,164 in 1999 and $1,890 in 2000. Rent expense in 1995, 1994 and 1993 amounted to $5,029, $4,270 and $5,027, respectively.\nThe Company has been named in product liability litigation and claims arising from the alleged association of tampons with Toxic Shock Syndrome. The cases seek compensatory and punitive damages in various amounts.\nThe Company and certain of its former officers were named as defendants in a securities class action filed in 1993. In November 1995, the court approved a settlement of this litigation and dismissed the action against all defendants. The Company is involved, either as a named defendant or as the result of contractual indemnities, in several legal proceedings related to previously divested non-tampon businesses. Included in these are a patent infringement action and an environmental matter. In the second quarter of 1995, the Company provided for $11,396 ($8,686 after tax) for expenses related to the class action and other legal proceedings described in this paragraph.\nThere are certain other legal proceedings pending against the Company arising out of its normal course of business in which claims for monetary damages are asserted.\nWhile it is not feasible to predict the outcome of these legal proceedings and claims with certainty, management is of the belief that any ultimate liabilities in excess of provisions therefor will not individually or in the aggregate have a material adverse effect on the Company's financial position or results of operations.\nNOTE 8\nOBLIGATIONS\nThe Company's Short-term borrowings consist of commercial paper and notes payable bearing interest at prevailing market rates and supported by bank lines of credit amounting to $120,000 and $150,000 at December 31, 1995 and 1994, respectively. Commercial paper borrowings at December 31, 1995 and 1994 were $42,672 and $57,201, with average annual year-end interest rates of 5.6% and maturities through the second quarter of the subsequent year. Notes payable at December 31, 1995 and 1994 totaled $10,419 and $13,316 at average annual rates outstanding throughout the year of 7% and 5.7%, respectively. Commitment fees to secure the lines of credit are not material.\nDuring 1995, the Company entered into $14,104 of medium-term obligations. At December 31, 1995, there were $12,869 outstanding of which $1,972 was payable within the next year. These obligations carry interest rates ranging from 7% to 7.9% and have various maturities through June 2003.\nAt December 31, 1995 and 1994, there were $70,000 and $60,000 of unsecured notes outstanding, respectively. At the end of both years, the notes carried interest rates ranging from 4.7% to 7.4% and had maturities ranging from January 1997 to May 2004.\nThe annual maturities on all medium-term obligations through the next five years amount to $1,972 in 1996, $12,147 in 1997, $2,319 in 1998, $32,501 in 1999 and $11,737 in 2000.\nThe terms of the Company's financing arrangements include various covenants which provide, among other things, for limitations on liens and the maintenance of a minimum debt service ratio. The Company was in compliance with such covenants at December 31, 1995.\nNOTE 9\nFINANCIAL INSTRUMENTS\nAs part of its risk management program, the Company minimized its exposure to foreign currency fluctuation through the use of forward exchange and option contracts. The Company does not enter into financial instruments for trading or speculative purposes. The agreements entered into are short-term in nature with maturities less than one year and the Company primarily acts as a buyer. The counterparties to these contracts are major financial institutions and the Company does not have significant exposure to any specific one. Management believes that credit risk of loss is remote and in any event would be immaterial.\nThe Company had forward exchange contracts with notional values of $7,846 and $18,883 at December 31, 1995 and 1994, respectively. The carrying value of these contracts approximated market. At December 31, 1995, the Company had foreign currency options with notional values of $30,373 and an estimated fair value of $322. At December 31, 1994, the Company had foreign currency options with notional values of $31,958 and an estimated fair value of $915. The unamortized premiums are amortized to income over the option periods and amounted to $432 and $520 at December 31, 1995 and 1994, respectively.\nThe Company only enters into forward exchange contracts which match the periods of the underlying transactions being hedged. The maximum loss on foreign currency options is the amount of premiums paid for those options. Therefore, the Company has no material exposure through the use of any of these financial instruments.\nAt December 31, 1995, medium-term notes were carried at the discounted value of $69,992 and medium-term obligations were carried at $12,869; both carrying values approximated market. At December 31, 1994, medium-term notes were carried at the discounted value of $59,983 and had an estimated fair value of $54,500.\nNOTE 10 SHAREHOLDERS' EQUITY\nThe changes in Shareholders' equity for the years ended December 31, 1995, 1994 and 1993 are as follows:\nCommon Stock\nThe Company has 300 million authorized shares of Common Stock. Changes in outstanding shares for the years ended December 31 are as follows:\n1995 1994 1993 ---------- ---------- ---------- Shares outstanding at beginning of year 36,674,030 38,292,952 39,162,634 Purchased for treasury (99,700) (1,718,700) (1,187,100) Issued for stock option and other employee plans from treasury 147,989 99,778 317,418 ---------- ---------- ---------- Shares outstanding at end of year 36,722,319 36,674,030 38,292,952 ---------- ---------- ---------- Shares held in treasury at end of year 6,825,619 6,873,908 5,254,986 ---------- ---------- ----------\nStock Option Plans\nThe Company has stock option plans which provide for the granting of options to directors, officers and key employees to purchase shares of its Common Stock within ten years, at prices equal to or greater than the fair market value on the date of grant.\nActivity for the years 1995, 1994 and 1993 is as follows:\nAt December 31, 1995 and 1994, respectively, there were options for 1,823,593 and 1,290,051 shares exercisable at exercise prices of $48.95 and $52.73 and there were 2,442,356 and 2,299,071 shares available for granting options.\nNOTE 11\nSEGMENT AND GEOGRAPHIC INFORMATION\nThe Company operates in one industry segment, personal care products. The Company markets these products around the world. Sales are made and credit is granted to drug, grocery, variety and discount stores and other comparable outlets, as well as to wholesalers and distributors in those trades. A small number of significant customers are financed through highly leveraged capital structures, making them particularly sensitive to market interest rate changes and other economic variables.\nFor the years ended December 31, 1995 and 1994, the Company had a significant customer that accounted for 11.1% and 10.3%, respectively, of the Company's Net sales. No single customer accounted for 10% or more of Net sales in prior years.\nIn the geographic summary that follows, certain overhead costs are allocated to the geographic areas based on the anticipated benefit to be derived by the area. Restructuring and other charges of $30,042 reduced 1993 Operating income of the United States, Europe, Other international and Unallocated items, net by $2,237, $16,921, $1,781 and $9,103, respectively.\nInformation for the years ended December 31 are as follows:\n1995 1994 1993 -------- -------- -------- Net sales United States $391,011 $381,975 $363,337 Europe 210,567 195,748 182,854 Other international 81,514 66,790 65,274 -------- -------- -------- $683,092 $644,513 $611,465 ======== ======== ======== Operating income United States $134,194 $142,931 $142,399 Europe 43,530 27,112 31,347 Other international 14,135 10,314 2,114 Unallocated items, net (31,496) (28,742) (29,510) Restructuring and other charges - - (30,042) -------- -------- -------- $160,363 $151,615 $116,308 ======== ======== ======== Identifiable assets at December 31 United States $237,054 $212,346 $197,546 Europe 169,665 152,295 153,016 Other international 15,330 14,434 11,836 -------- -------- -------- $422,049 $379,075 $362,398 ======== ======== ========\nINDEPENDENT AUDITORS' REPORT\nTo the Board of Directors and Shareholders of Tambrands Inc.:\nWe have audited the accompanying consolidated balance sheets of Tambrands Inc. and subsidiaries as of December 31, 1995 and 1994 and the related consolidated statements of earnings and cash flows for each of the years in the three-year period ended December 31, 1995. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Tambrands Inc. and subsidiaries as of December 31, 1995 and 1994 and the results of their operations and cash flows for each of the years in the three-year period ended December 31, 1995, in conformity with generally accepted accounting principles.\nAs discussed in the notes to the consolidated financial statements, the Company changed its method for accounting for postemployment benefits in 1993.\n\/s\/ KPMG Peat Marwick LLP\nStamford, Connecticut January 23, 1996\nSCHEDULE II\nTAMBRANDS INC. AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n($ in thousands)\n1995 1994 1993 --------- --------- --------\nReserve deducted in the balance sheet from the asset to which it applies\nAllowance for doubtful accounts:\nBalance at beginning of period $1,456 $1,453 $1,560\nAdditions charged to cost and expenses 353 93 556\nReclassification of unrecoverable promotional 53 11 (144) allowance & other\nWrite-off of bad debts (195) (101) (519)\n------- ------ ------ Balance at end of period $1,667 $1,456 $1,453 ======= ====== ======\nINDEPENDENT AUDITORS' REPORT ----------------------------\nThe Board of Directors and Shareholders Tambrands Inc.:\nUnder date of January 23, 1996, we reported on the consolidated balance sheets of Tambrands Inc. and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of earnings and cash flows for each of the years in the three-year period ended December 31, 1995, as contained in the annual report on Form 10-K for the year 1995. Our report refers to a change in accounting for postemployment benefits in 1993. In connection with our audits of the aforementioned consolidated financial statements, we also have audited the related financial statement schedule as listed in Item 14(a)2 of the annual report on Form 10-K for the year 1995. 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, the financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.\n\/s\/ KPMG Peat Marwick LLP\nStamford, Connecticut January 23, 1996\nSUPPLEMENTARY FINANCIAL INFORMATION AND QUARTERLY DATA (unaudited)\n(a) Includes the 1995 Litigation charge as described in the notes to the consolidated financial statements.\nINDEX TO EXHIBITS -----------------\nExhibit Number Description - ------- -----------\n10(9)(c) Employment Protection Agreement between the Company and Mr. Thomas J. Mason, dated as of October 18, 1994.\n10(9)(d) Employment Protection Agreement between the Company and Mr. Thomas Soper, III, dated as of August 29, 1994.\n12 Computation of Ratio of Earnings to Fixed Charges.\n21 Subsidiaries of the Company.\n23 Independent Auditors' Consent.\n24 Powers of attorney.\n27 Financial Data Schedules (in electronic format only).\nThe Company will furnish a copy of any exhibit to a shareholder requesting such exhibit in writing upon payment by the shareholder of a fee representing the Company's reasonable expenses in furnishing such exhibit.","section_15":""}
{"filename":"6383_1995.txt","cik":"6383","year":"1995","section_1":"ITEM 1 - BUSINESS - - -----------------\nGENERAL -------\nAndersen Group, Inc. is referred to herein as the \"Company\" or the \"Registrant\".\nThe Registrant was incorporated under the laws of the State of Connecticut in 1951.\nAGI historically has conducted operations in several, highly diverse segments. These segments have included dental distribution and manufacture and electronics manufacturing and supply businesses, communications electronics, medical products and services and video products.\nFollowing the divestiture of the Registrant's medical products and services operation in February 1990, the Registrant established a formal plan to divest its remaining communications electronics operation, Microtime, Inc., presently known as AGI Technology, Inc. (Microtime). Microtime was carried as a discontinued operation in the Company's Consolidated Financial Statements from fiscal 1990 until its assets and liabilities were sold in October 1992 to Digital F\/X, Inc. (DF\/X) at their book value for consideration consisting of preferred stock and subordinated notes of DF\/X. On February 28, 1991, the Registrant acquired The J.M. Ney Company (Ney) by merging Ney into a wholly-owned subsidiary of the Registrant. Ney, which is the Company's primary operating subsidiary, operates in the dental and electronics industry segments. During fiscal 1994, Ney created two new subsidiaries, Ney Dental International, Inc. and Ney Ultrasonics Inc. to hold the businesses associated with Ney's dental and ultrasonics divisions, respectively.\nIn April 1993, the Company, through a newly formed subsidiary, New Microtime Inc. (New Microtime), signed a Participation and Option Agreement with DF\/X to manage and reacquire certain assets and liabilities of its former subsidiary Microtime, as well as certain assets and liabilities of the Broadcast Division of DF\/X (into which DF\/X had placed the assets of Microtime). In September 1993, prior to a bankruptcy filing by DF\/X, New Microtime exercised its option to purchase all of the Broadcast Division assets of DF\/X and entered into an agreement which was approved by the U.S. Bankruptcy Court in December 1993. In October 1994, New Microtime acquired certain assets of the Graphics Systems Division (GSD) of The Grass Valley Group, Inc. (Grass Valley). The acquired product lines were integrated with the other products sold by New Microtime. The combined entity began operating under the name Digital GraphiX, Incorporated (DGI) in January 1995. On May 2, 1995, DGI issued an additional 64,800 shares of common stock to certain DGI employees and securityholders of the Company at $5.00 per share. As a result of this offering, the Company's equity interest in DGI has been reduced to 19%. The financial impact of these transactions is described further in Items 7 and 8 below and in Note 17 to the Company's Consolidated Financial Statements for the fiscal year ended February 28, 1995. The Company's Consolidated Financial Statements include the operating results of DGI from the date of its inception in April 1993 through February 28, 1995. However, as a result of the sale of DGI stock, at February 28, 1995, the DGI balance sheet has not been consolidated. As of February 28, 1995, the activities of DGI are being accounted for in the Company's video segment.\nThe Registrant operates in three business segments: Dental, Electronics and Video products. Each of these segments is discussed more fully below.\nDENTAL SEGMENT --------------\nNey Dental International, Inc. (NDI), a wholly owned subsidiary of Ney, develops, manufactures and distributes a range of materials, equipment and merchandise for distribution and sale to the dental laboratory health care market. NDI's principal product line is precious metal casting alloys which are sold to dentists and dental laboratories for use in the fabrication of crowns, bridges and other restorative forms used in the restoration and reconstruction of teeth. Precious metal alloys are preferred for certain dental crown and bridge applications because they are easy to shape, biocompatible, strong, and do not corrode or crack. Although various less costly alternatives exist, acceptance of\nsuch alternatives has been slow due to concerns regarding the reliability of such products. NDI's product line consists of over 30 different alloys such as Option, Ultima Lite, Bio Ney and Ney-Oro B-2 that are manufactured by Ney's electronics division according to specific formulas that include precious metals such as gold, platinum, palladium and silver. NDI maintains an active metallurgical research and development effort. In the past fiscal year, NDI introduced a palladium-free alloy with a high precious metal content to meet a growing European demand. Further, alloys which have been designed to meet the Japanese Industrial Standard (JIS) have resulted in increased penetration of the Japanese market.\nNDI's strategy has been to offer a complete line of products to dental laboratories. As a result, NDI manufactures, develops and sells equipment, including vacuum porcelain and bench-top burnout furnaces, dental laboratory handpieces and commercial ultrasonic cleaners for use in dental, scientific and industrial laboratories and the jewelry manufacturing industry. Merchandise and supplies, such as surveyors and Neyvest, which are manufactured by outside suppliers, are also sold to dental laboratories. ISO 9001 certification, the international quality standard, was achieved in June 1993 for the manufacture of the equipment product line. This certification has helped NDI increase its market share.\nNDI sells to approximately 3,500 customers throughout the United States and foreign countries. Sales in the United States of precious metal alloys are made through a field sales force and telemarketing staff, while equipment is sold primarily through dealers. Export sales account for approximately 45% of total sales. Most export sales are made in Europe through Neyco Dental A.G., an affiliated subsidiary.\nNo customer in the Dental segment accounted for more than 10% of the Company's sales in fiscal 1995.\nNDI presently holds 16 patents and is also licensed under a number of patents. The Registrant believes that neither the possible denial of any patent applications, the possible determination that any of the patents which have been granted to NDI could be invalid, or the possible cancellation of any of its existing license agreements would have a material adverse effect on NDI.\nTrademarks of NDI include Ney, Ney-Oro, SMG, Option, Lunar, Bio Ney, Ultima Lite, Acclaim, Radiant, Sequel, Centurion, Ovation and Neyvest. In all, NDI maintains approximately 25 U.S. and foreign trademarks related to precious metal alloys.\nThe products of NDI are normally shipped directly from inventory within two days and, accordingly, backlog is not meaningful.\nNDI operates in a highly competitive marketplace with a number of substantial domestic competitors, including Argen, Williams Dental Company, Inc. (a subsidiary of Ivoclar Dental Anstelt, based in Liechtenstein); Jeneric\/Pentron, Inc. (a subsidiary of Customedix Corporation); and J.F. Jelenko & Company. The largest foreign supplier is Degussa A.G., which is based in Frankfurt, Germany. Although some of its competitors have significantly greater resources than NDI, the Company believes that it competes favorably with its competitors on the terms of quality, delivery, service and price.\nELECTRONICS SEGMENT -------------------\nThe Company's electronics industry segment is comprised of Ney's electronics division (the Electronics Division) and Ney Ultrasonics Inc., a manufacturer of industrial ultrasonic cleaning equipment which is a wholly owned subsidiary of Ney (collectively, the Electronics Segment).\nElectronics Division --------------------\nThe Electronics Division is a full-service, precious metal and parts supplier to automotive, medical, industrial electronics, military and semi-conductor manufacturers. The fully integrated approach of the Electronics Division includes fabrication and manufacture of its precious metal alloys, design, engineering and metallurgical support.\nThe metallurgical capabilities include stamping, wire drawing, rolling from ingot to foil, precision turning, injection and insert molding, and refining.\nThe Electronics Division specializes in the engineering and manufacture of precious metal alloy contacts and contact assemblies aimed at low amperage applications. Electrical contacts made of precious metals are considered extremely dependable as the materials are inert and highly resistant to corrosion and wear. In developing a finished contact or assembly, the Electronics Division's technical staff works closely with its customer, typically on an engineer-to-engineer level, in order to design a product that meets all of the metallurgical, electronic, thermodynamic and other performance specifications required by the customer's applications. The Electronics Division designs and builds the necessary molds and tools as well as designs and manufactures the end product. By controlling the total process the Division is allowed a competitive advantage over other companies in technology, cost and response time. The Electronics Division carries the ISO 9001 certification for manufacture of its products, including those which are sold to NDI.\nThe Electronics Division business has limited direct competition with regard to the manufacture of low amperage precious contacts and contact assemblies due to the inherent risks which accompany the engineering and manufacture of precious metals (high start-up and inventory costs, theft, etc.). While some facilities offer similar products, the Company believes that these operations lack the vertical integration to compete across the entire spectrum of products. The Electronics Division also faces indirect competition from companies such as Engelhard Corporation and Johnson Matthey, Inc., companies with significantly greater resources, which are involved in higher volume production of standard precious metal alloys.\nNey Ultrasonics Inc. --------------------\nNey Ultrasonics Inc. has focused on working with high-end electronic, semi-conductor and computer customers to validate the advanced capabilities of patented ultrasonic cleaning technology and to obtain increased market penetration.\nThe U.S. Clean Air Act of 1990 mandated the phase-out of the use of ozone-depleting solvents by January 1996. Historically, these solvents have been extensively used by industry for precision cleaning. As a result, Ney Ultrasonics now faces growth prospects during the next few years as its ultrasonic cleaners are used to replace existing equipment which utilize ozone depleting chemicals. Ney Ultrasonics is the exclusive licensee, pursuant to a license agreement which expires in 2005, of the patented ultrasonic technology used in its products, EnviroSONIK\/TM\/ and SweepSONIK2\/TM\/, which the Company believes are at a competitive advantage to other ultrasonic equipment.\nNey Ultrasonics competes with a number of national and regional companies on the basis of cleaning performance, price and delivery.\nThe Electronics Segment sells to more than 800 customers, with approximately 88% of its sales being made to customers in the United States. The Electronics Segment sales are made domestically through both field sales and manufacturer's representatives located in key geographic markets. Internationally, the Segment sells through independent distributors and original equipment manufacturers.\nThe Electronics Segment's backlog at April 30, 1995 and April 30, 1994 was approximately $4,224,000 and $4,160,000, respectively. Although a portion of the orders included in the backlog are ultimately not released for manufacture and delivery, due to cancellations, the Company anticipates, based on prior experience, that the entire backlog at April 30, 1995, less cancelled orders, will be realized in the next twelve months.\nNo customer in the Electronics segment accounted for more than 10% of the Company's sales in fiscal 1995.\nVIDEO SEGMENT -------------\nAs discussed above under Item 1, Business-General, the Company's equity interest in DGI was reduced to 19% from 100% on May 2, 1995.\nDGI (formerly known as New Microtime Inc.) designs, manufactures and distributes graphics systems equipment, digital video effects equipment (DVE), compositing and graphics workstations and video signal processing equipment for use in live broadcast, cable, industrial and post production markets.\nDGI has a direct sales force, which is augmented by various distribution channels that sells all products except the GSD products. The GSD products are sold by Grass Valley, the Company's non-exclusive worldwide distributor pursuant to a two year Distribution Agreement. Export sales account for approximately 18% of the DGI sales. During fiscal 1995 approximately 40% of DGI's sales were made to Grass Valley.\nDGI owns several patents related to its products and both licenses others and is licensed under a number of patents. Additionally, several patents are pending with the U.S. and foreign patent offices related to its IMPACT system and Composium II workstation.\nThe Registrant believes that because of the rapid pace of technological change in the industry, legal protection of its proprietary information is less significant to the competitive position of DGI than such factors as DGI's strategy, knowledge, ability and experience of its personnel, new product development, market recognition and ongoing product maintenance and support. Without legal protection, however, it may be possible for unauthorized third parties to copy aspects of DGI products or technology or to obtain and use information that DGI regards as proprietary, In addition, the laws of some foreign countries do not protect proprietary rights in products and technology to the same extent as do the laws of the United States. Although DGI continues to implement protective measures and intends to defend its proprietary rights vigorously, there can be no assurance that these efforts will be successful. The failure or inability of DGI to protect effectively its proprietary information could have a material adverse effect on its business.\nDGI currently holds certain U.S. and foreign trademarks, including the marks IMPACT, Graphics Factory and Composium.\nBacklog at April 30, 1995 and 1994 was approximately $1,126,000 and $642,000, respectively. The increase in backlog is attributable to the GSD products which were acquired in October 1994. Although a portion of the orders included in the backlog is ultimately not released for manufacture and delivery, due to cancellations, DGI anticipates that the entire backlog less the portion relating to canceled orders at April 30, 1995 will be realized in the next twelve months.\nDGI products are sold in a highly competitive marketplace with a substantial number of domestic competitors. The chief competitors to DGI's GSD products (GF-Halo, TypeDeko, Presto and Pronto) are products sold by Chyron, Abekas and ASTON. Although Grass Valley also has the capability of competing with the GSD products, it has agreed to limit its competition until October 1996 pursuant to a non-competition agreement.\nFor the DVE and composition products (IMPACT and Composium II), DGI's chief competitors are Abekas, Sony Pinnacle, Quantel and Grass Valley. Competing products to Composium II are sold by Quantel, a U.K. based company, SoftImage and Discreet Logic (with its \"Flame\" product). Although some of its competitors have significantly greater resources than DGI, the Company believes that DGI competes favorably in terms of price, service and product performance. See Business - General above for discussion of transactions involving this business during the fiscal year 1995.\nSee Note 16 to the Company's Consolidated Financial Statements contained in Item 8 for the fiscal year ended February 28, 1995, for information about the operations of the Registrant's business segments and the Registrant's foreign operations.\nOTHER BUSINESSES OF THE REGISTRANT - - ----------------------------------\nOn May 10, 1994, the Company's subsidiary, Clear Cellular Holdings, Inc. (Clear), sold its 34% interest in a partnership which owned a cellular communications license to Centennial Cellular Corporation (Centennial). The partnership interest was sold for a combination of cash and Centennial stock.\nIn addition, on August 23, 1994, the Company sold its general partnership interest in MidSouth Cellular L.P. (MidSouth), a nonwireline cellular telephone franchise, to Centennial for Centennial stock. Oliver R. Grace, Jr., Chairman and Director of the Company, also owned an investment in the partnership. See Item 7 and 13 below for further discussion of the terms of these transactions and for a description of Mr. Grace, Jr.'s interest in this transaction.\nThe Registrant also owns substantially all of the common stock of Seratronics, Inc. of Nevada (Seratronics), an unconsolidated subsidiary. Seratronics is located in Walnut Creek, California and is in the business of manufacturing, marketing and selling dialyzer rinse and re-use machines for use in the end stage renal disease market. The Registrant's investment in Seratronics, as recorded on its books, is de minimis. Seratronics is presently a defendant in litigation with Althin CD Medical, Inc. See Item 3 below and Note 18 to the Registrant's Consolidated Financial Statements contained in Item 8 for further discussion.\nRESEARCH AND DEVELOPMENT - - ------------------------\nDuring fiscal years 1995, 1994, and 1993, research and development expenditures totaled approximately $3,545,000 and $3,167,000, and $2,590,000, respectively.\nSOURCES AND AVAILABILITY OF RAW MATERIALS AND COMPONENTS - - --------------------------------------------------------\nThe Company purchases its raw materials and the components used in the manufacture of its products from a number of domestic suppliers and generally is not dependent upon any single supplier. The Company believes that its sources of supply are adequate for its continuing needs.\nCOMPLIANCE WITH ENVIRONMENTAL PROTECTION LAWS - - ---------------------------------------------\nManagement of the Company believes that the Company and its operating subsidiaries are in material compliance with applicable federal, state and local environmental regulations. Compliance with these regulations has not in the past had any material effect on the Company's capital expenditures, consolidated statements of operations or competitive position, nor does the Company anticipate that compliance with existing regulations will have any such effect in the near future.\nEMPLOYEES - - ---------\nAs of April 28, 1995, the Registrant, including all subsidiaries, had 376 full-time employees and 9 part-time employees, including 62 full time employees and 3 part time employees of DGI. Subsequent to the sale of DGI Common Stock on May 2, 1995, the Company had 314 full time and 6 part time employees. None of these employees are represented by a labor union, and the Registrant is not aware of any organizing activities. Neither the Registrant nor any of its subsidiaries has experienced any significant work stoppage due to any labor problems. The Registrant considers its employee relations to be satisfactory.\nEXECUTIVE OFFICERS OF THE REGISTRANT - - ------------------------------------\nThe Executive Officers of the Company and certain significant employees of its subsidiaries are as follows:\nExcept as set forth below, all of the officers have been associated with the Company in their present positions for more than the past five years. None of the executive officers of the Company are related to any of the Directors. Mr. Grace, Jr. is the brother of John S. Grace and Gwendolyn Grace, each of whom are members of the Company's Board of Directors.\nMr. Grace, Jr. has been a Director of the Company since 1986 and Chairman since March 1990. He has also been President of AG Investors, Inc., one of the Company's subsidiaries, since 1992. Mr. Grace, Jr. is a general partner of The Anglo American Security Fund L.P., and serves as a director of Republic Automotive Parts, Inc.\nMr. Volinski joined Ney in June 1990 as Controller. He was promoted to Treasurer of Ney in May 1991 and was promoted to Chief Financial Officer of the Company in June 1993. From June 1989 until joining Ney, Mr. Volinski served as corporate Controller for SecurityLink, a security alarm company. From 1986 through 1989, Mr. Volinski was an Audit Manager for Coopers & Lybrand.\nMr. Travers, III joined the Company in 1983. He was promoted to Assistant Secretary in June 1993. From 1990 until being promoted to Assistant Secretary he was the Company's Director of Law and Taxation. From 1986 to 1990 he was Assistant Controller for the Company.\nMr. Wolfe, Jr. was named President of NDI in 1994. Since October 1987, Mr. Wolfe, Jr. served as Vice President of Ney's Dental Division.\nMr. Cerny has served as General Manager of Ney's Electronics division since joining the Company in April 1993. From 1988 until joining Ney, Mr. Cerny served as Director of Operations (1990-1993) and Director of Sales & Marketing (1988 to 1990) for the Materials Technology Division of Johnson Matthey, Inc., a precious metals fabricator.\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2 - PROPERTIES - - -------------------\nThe Company moved its administrative offices to the headquarters of Ney in 1992. Ney owns two buildings, totaling 100,000 square feet within a 19 acre industrial park in Bloomfield, Connecticut. This site contains the principal operations of the Electronics Division and Ney's general administrative offices. Ney also owns a 50,000 square foot building in Yucaipa, California, on 7.5 acres. This building contains the manufacturing operations for dental equipment, including vacuum porcelain furnaces, burnout ovens, handpeices and commercial ultrasonic cleaners.\nThe Company also owns a 108,000 square foot building located in Bloomfield, Connecticut. The Registrant leases portions of this facility to its subsidiaries NDI, Ney Ultrasonics and its former subsidiary, Digital GraphiX, as well as to third parties. See Note 9 to the Company's Consolidated Financial Statements contained in Item 8 for a discussion of the indebtedness related to this property. The Registrant believes that its plants and properties, and the production capacities thereof, are suitable and adequate for its business needs of the present and immediately foreseeable future.\nITEM 3","section_3":"ITEM 3 - LEGAL PROCEEDINGS - - --------------------------\nANLAB Matter - - ------------\nAs previously reported, the Company's subsidiary, ANLAB, Inc. (ANLAB) (formerly known as Andersen Laboratories, Inc.) brought suit in Connecticut Superior Court in the Judicial District of Hartford\/New Britain in February 1993 against Andersen Laboratories, Inc. (Andersen Laboratories) (formerly known as ALIOC, Inc.) to collect on a Promissory Note (Note) in the stated principal amount of $500,000. This Note, which had been issued by Andersen Laboratories to ANLAB as partial consideration for the sale of the ANLAB assets to Andersen Laboratories in January 1989, accrued interest on the unpaid balance at the rate of 10.5% per year. Andersen Laboratories filed its answer, special defenses and counterclaims on August 13, 1993 alleging that, among other things, ANLAB had breached certain representations and warranties contained in that certain asset sale and purchase agreement by and among ALIOC, Inc., Andersen Laboratories, Inc. and Andersen Group, Inc. dated as of August 29, 1988 (the Asset Sale and Purchase Agreement) thereby making the Note unenforceable against Andersen Laboratories and making ANLAB liable to Andersen Laboratories for money damages of an unspecified amount.\nOn September 14, 1993 Andersen Laboratories filed a motion to implead the Company as a party to the action, which was opposed by ANLAB. After briefing and argument, on December 7, 1993 the Court denied Andersen Laboratories' motion to implead the Company as a party to the action. As a result, Andersen Laboratories commenced an action against the Company in Connecticut Superior Court in the Judicial District of Hartford\/New Britain which alleged, among other things, that the Company had breached certain representations and warranties contained in the Asset Sale and Purchase Agreement and thereby made the Company liable to Andersen Laboratories for money damages of an unspecified amount.\nOn December 15, 1994, ANLAB settled its dispute with Andersen Laboratories. Andersen Laboratories paid $540,000 to ANLAB for cancellation of the Note and all parties exchanged mutual releases and withdrew the pending actions.\nSeratronics Matter - - ------------------\nAlthin CD Medical, Inc. (Althin) filed a complaint against the Company's subsidiary Seratronics in August 1992, that was substantially amended in January 1995, in the U.S. District Court for the Southern District of Florida, asserting various claims, including breach of contract for failure to pay royalties arising out of a License Agreement with Althin's predecessor, CD Medical, Inc., and claims arising out of the management of Seratronics' business by Fresenius U.S.A., Inc. Althin has claimed money damages of not less than $300,000. Seratronics has denied all claims and has filed counterclaims against Althin alleging misuse by Althin of know-how and technology licensed exclusively to Seratronics and breach of Althin's covenant of good faith and fair dealing with Seratronics. The case is presently in the discovery phase. Seratronics intends to strongly defend these claims and to vigorously assert its counterclaims. The ultimate outcome of the litigation discussed above or the necessity for any provision for liability\nwhich may result cannot presently be determined. See Note 18 to the Company's Consolidated Financial Statements for the fiscal year ended February 28, 1995 contained in Item 8.\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 Registrant's Common Stock is traded on The Nasdaq Stock Market under the symbol (ANDR) with quotes supplied by the National Market System of the National Association of Securities Dealers, Inc. (NASDAQ).\nThe number of record holders of the Registrant's Common Stock on May 19, 1995 was 754. During fiscal year 1995 the Registrant did not pay any cash dividends. The Company's high and low sales prices for the common equity, for each full quarterly period within the two most recent fiscal years, is included below. The stock prices shown were obtained from NASDAQ. They represent prices between dealers and do not include retail markups, markdowns or commissions and may not necessarily represent actual transactions.\nThe Indenture relating to the Company's 10 1\/2% Convertible Subordinated Debentures contains a covenant which restricts payment of dividends on, or repurchases or redemptions of, the Company's capital stock (Restrictive Covenants). As a result of the losses incurred in fiscal years 1993, 1994 and 1995 and redemptions or repurchases of the Company's Series A Cumulative Convertible Preferred Stock (Preferred Stock) in fiscal 1992 and 1993, the Company has been precluded from paying dividends on its capital stock since approximately April 15, 1993, by the Restrictive Covenants. In light of recent operating results, the Company believes that it is doubtful that it will be able to generate sufficient earnings to permit the Company to pay dividends on or to redeem (on a mandatory or voluntary basis) or repurchase shares of the Company's common or Preferred Stock unless the Company realizes a significant gain from one or more sales of all or a portion of its assets.\nITEM 6","section_6":"ITEM 6 - SELECTED FINANCIAL DATA - - --------------------------------\nThe following table summarizes certain financial data with respect to the Company and is qualified in its entirety by the Consolidated Financial Statements of the Company for the fiscal year ended February 28, 1995 contained in Item 8.\n\/1\/ The Company acquired The J.M. Ney Company on February 28, 1991 and as such its results have been included in net sales for years 1992-1995.\n\/2\/ Included in 1994 and 1995 are the results of Digital GraphiX.\nITEM 7","section_7":"ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - - ---------------------------------------------------------\nRESULTS OF OPERATIONS - - ---------------------\n1995 vs. 1994 - - -------------\nFor the year ended February 28, 1995, the Company's net sales totaled $63,407,000, an increase of $8,937,000 or 16.4% from $54,470,000 for the year ended February 28, 1994.\nIn 1995, net sales for the Company's Dental segment were $37,984,000, an increase of $2,970,000, or 8.5%, from $35,014,000 in 1994. The growth in sales principally reflects strong results in the Company's domestic market, which increased by $1,839,000 and in the international markets which increased by $1,131,000. Domestic and international unit alloy sales increased by 10.2% and 4.3%, respectively, from the prior year. Also, a significant portion of the Company's dental products has a large precious metal component, principally gold and palladium. During the year, the price of palladium increased, with a corresponding increase in average selling prices (ASPs). Sales of dental equipment increased 8.3% over the prior year due primarily to the continued growth in shipments of the Company's Centurion vacuum porcelain furnace.\nThe Electronics Segment, which consists of the Electronics Division and Ney Ultrasonics, and includes electronic connectors and components, precious metal materials and industrial ultrasonic cleaners, had net sales in 1995 of $18,425,000, a 21.8% increase from $15,126,000 in the prior year. The Electronics Division sales increased approximately $2,944,000, or 26.4%, to $14,079,000. While sales to each of five markets of the Electronics Division grew by at least 10%, the medical market expanded by approximately $1.5 million or 175%. Precious metal materials and parts supplied to the dental implant industry is responsible for most of this growth. Sales of industrial ultrasonic cleaners increased 8.9% to $4,346,000. The phase in of federal requirements to eliminate the use of ozone-depleting chemicals, has caused the growth of this product line.\nSales in the Company's Video segment were $6,998,000, a 59.0% increase from the prior year. On October 19, 1994 the Company's video products subsidiary acquired the Graphics Systems Division of The Grass Valley Group, Inc. (see Liquidity and Capital Resources below and Item 1; Business - General). The current year operating results include $2,793,000 of sales which are related to this newly acquired product line. Offsetting these additional sales was a slight reduction in sales of certain previously existing products resulting from a decrease in demand due to continued competition and technological advances in the marketplace.\nInvestment and other income for 1995 totaled $3,443,000, an increase of $1,884,000, or 120.8%, from the prior year. The results for the current year include a one-time gain of $3,223,000 from the sale of the Company's investments in two cellular telephone partnerships. However, during the prior year the Company generated approximately $610,000 more of capital gains on sales of portfolio securities and $305,000 of additional rental income from its 1280 Blue Hills Avenue, Bloomfield, Connecticut facility.\nOn May 10, 1994 the Company sold its 34% partnership interest in the nonwireline cellular telephone license in the North Carolina 3 Rural Service Area to Centennial Cellular Corporation (Centennial) for a combination of cash and Centennial Common Stock. All of the Centennial Common stock acquired by the Company in the transaction was immediately sold. The Company recognized a gain of $1,316,000 on this sale from its original investment of $2,090,000 made in August 1991. On August 23, 1994 the Company sold its 9.6% general partnership interest in MidSouth Cellular L.P. (MidSouth), a nonwireline cellular telephone franchise to Centennial for a combination of cash and stock. Under terms of the sale agreement, the cash consideration received by the Company was utilized to satisfy certain liabilities of MidSouth. A portion of the Company's share of the common stock received was sold on the open market; however, the Company continues to hold 40,113 shares. The Company recognized a gain of $1,907,000 on the sale of its MidSouth interest which had been acquired in 1992 for approximately $2.7 million.\nCost of sales, as a percentage of net sales, was 70.2% for 1995, as compared to 69.0% for 1994. The Dental segment's cost of sales increased to 71.8% from 71.3% in 1994. The increase in palladium prices and a corresponding increase in ASPs resulted in lower gross margin percentages for the segment's precious metal-based products, contributing, in part, to the increase of cost of sales. In addition, continued competition in the segment's domestic markets has resulted in pressure on ASPs and gross margins.\nThe Electronics Segment's cost of sales, as a percentage of net sales, decreased to 69.8% for 1995, as compared to 71.2% in the prior year. Increased sales of precious metal materials helped absorb fixed overhead costs and decreased the cost of goods sold percentage.\nThe Video segment's cost of sales as a percentage of net sales at 63.9% increased from 42% for the prior year. Included in the prior year were sales of consignment inventory obtained at a reduced cost from DF\/X (See Discontinued Operation below for a further discussion).\nSelling, general and administrative expenses for 1995 totaled $17,991,000, an increase of $1,207,000 from $16,784,000 in 1994. As a percentage of net sales, these expenses decreased to 28.4% in 1995 from 30.8% in 1994. The Company has been able to maintain its administrative cost level while continuing to increase its sales.\nResearch and development expenses for 1995 were $3,545,000, as compared to $3,167,000 in 1994. The Company's commitment to product development in its Electronics, Dental and Video segments will likely result in keeping future research and development expenditures at nearly 6.0% of sales.\nInterest expense decreased to $1,447,000 in 1995 from $1,463,000 in 1994. The slight decrease reflects reduced interest expense associated with the repayment of $4,042,000 in outstanding indebtedness in 1995. This was substantially offset by a three percentage point increase in short-term borrowing rates.\nFor 1995, the loss from continuing operations before income taxes and extraordinary gain was $651,000, a decrease of $2,307,000 from a loss of $2,958,000 in fiscal 1994. This was primarily attributable to the gains on the sale of the cellular investments which were offset by additional losses from the Video segment.\nFor 1995, the Company had an income tax benefit from continuing operations of $284,000, as compared to a benefit of $1,975,000 in 1994. The decreased benefit primarily reflects lower operating losses in 1995. The income tax benefit represents the effective income tax rate for the fiscal year, including adjustments to the Company's deferred income tax liability for prior years' taxes.\nLoss from continuing operations before extraordinary items for 1995 was $367,000, a reduction of $616,000 from the loss of $983,000 in 1994.\nDuring fiscal 1993, the Company recorded a loss from discontinued operations, net of an income tax benefit, of $2,342,000 (see Discontinued Operation below).\nDuring 1995, the Company retired $823,000 of the Company's 10 1\/2% Convertible Subordinated Debentures and the remaining $2,976,000 of the Company's 11% Subordinated Notes, which resulted in an extraordinary after-tax loss of $21,000. In 1994, after-tax gains totaled $115,000.\nNet loss for 1995 was $388,000, as compared to net loss of $868,000 in 1994, a decrease of $480,000 which is principally attributable to the reasons discussed above.\nPreferred stock dividends, including accretion, decreased to $587,000 in 1995, as compared to $600,000 in 1994, as the result of stock conversions during the past two years.\nFor 1995, loss applicable to common shares was $975,000, as compared to a loss of $1,468,000 in 1994.\n1994 vs. 1993 - - -------------\nFor the year ended February 28, 1994, the Company's net sales totaled $54,470,000, an increase of $8,967,000 from $45,503,000 for the year ended February 28, 1993. Included in net sales for fiscal 1994 is $4,400,000 of commission and sales revenue from the Company's Video segment.\nIn 1994, net sales for the Company's Dental segment were $35,014,000, an increase of $3,552,000, or 11.3%, from $31,462,000 in 1993. The growth in sales principally reflects strong results in the Company's domestic markets, which increased by $2,203,000 and in the international markets which increased by $1,349,000. An increase in gold and palladium prices led to a corresponding increase in average selling prices (ASPs). Worldwide, unit alloy sales were consistent with the prior year. Sales of dental equipment increased $787,000 over the prior year due primarily to the introduction of the Company's new Centurion vacuum porcelain furnace.\nThe Electronics Segment had net sales in 1994 of $15,126,000, a 7.9% increase from $14,019,000 in the prior year. Sales of electronic connectors and components increased approximately $130,000, or 1.2%, to $11,135,000. An increase in medical and automotive market sales more than offset the continued decline in military and defense-related sales.\nSales of industrial ultrasonic cleaners increased 32.4% to $3,991,000. Market acceptance of the Company's EnviroSONIK product line, coupled with ongoing federal regulation and market requirements to eliminate the use of ozone-depleting chemicals, accounted for the increase.\nInvestment and other income for 1994 totaled $1,559,000, a decrease of $29,000, or 1.8%, from the prior year. During the year, the Company's total cash and marketable securities declined by $4,986,000 to $2,625,000, with an associated decrease in investment income. However, during the year the Company generated approximately $800,000 of capital gains on sales of portfolio securities to offset decreased investment income.\nCost of sales, as a percentage of net sales, was 69.0% for 1994, as compared to 68.5% for 1993. The Dental segment's cost of sales increased to 71.3% from 70.2% in 1993. The increase in precious metal prices and a corresponding increase in ASPs resulted in lower gross margin percentages for the segment's precious metal-based products, contributing, in part, to the increase in cost of sales. International sales, which typically result in higher gross margins, constitute a smaller percentage of the segment's total sales in 1994. In addition, continued competition in the segment's domestic markets resulted in pressure on ASPs and gross margins.\nThe Electronics Segment's cost of sales, as a percentage of net sales, increased to 71.2% for 1994, as compared to 64.8% in the prior year. To gain further market acceptance, the EnviroSONIK product line was sold at prices generating low gross margin percentages. This strategy was found necessary due to the softening and delay of government regulations regarding the use of ozone-depleting chemicals.\nThe Video segment's cost of sales as a percentage of sales was 42%. Through December 1993 the segment was selling consignment inventory obtained at a reduced cost from DF\/X (See Discontinued Operation below).\nSelling, general and administrative expenses for 1994 totaled $16,784,000, an increase of $3,370,000 from $13,414,000 in 1993. As a percentage of net sales, these expenses increased to 30.8% in 1994 from 29.5% in 1993. In addition to the inclusion of the Video segment, the Company initiated numerous sales and marketing programs, primarily in the international dental market, which contributed to this increase. Higher legal costs due to a settled lawsuit were also responsible for this change.\nResearch and development expenses for 1994 were $3,167,000, as compared to $2,590,000 in 1993. As a percentage of net sales, these expenses increased to 5.8% in 1994 from 5.7% in 1993. The Company's commitment to product development in its Electronics, Dental and Video segments will likely result in keeping future research and development expenditures at this level.\nInterest expense decreased to $1,463,000 in 1994 from $1,641,000 in 1993. The decrease reflects reduced interest expense associated with the repayment of $1,258,000 in outstanding indebtedness in 1994.\nFor 1994, the loss from continuing operations before income taxes and extraordinary gain was $2,958,000, an increase of $827,000 from a loss of $2,131,000 in fiscal 1993.\nFor 1994, the Company had an income tax benefit from continuing operations of $1,975,000, as compared to a benefit of $1,655,000 in 1993. The increased benefit primarily reflects higher operating losses in 1994.\nLoss from continuing operations before extraordinary item for 1994 was $983,000, an increase of $507,000 from the loss of $476,000 in 1993.\nDuring fiscal 1993, the Company recorded a loss from discontinued operations, net of an income tax benefit, of $2,342,000 (See Discontinued Operation below).\nDuring 1994, the Company retired $1,160,000 of the Company's 10 1\/2% Convertible Subordinated Debentures, which resulted in an extraordinary after-tax gain of $115,000. In 1993, similar after-tax gains totaled $133,000.\nNet loss for 1994 was $868,000, as compared to net loss of $2,685,000 in 1993.\nPreferred stock dividends, including accretion, decreased to $600,000 in 1994, as compared to $670,000 in 1993, as the result of redemptions in 1993 and conversions in 1994 and 1993.\nFor 1994, loss applicable to common shares was $1,468,000, as compared to a loss of $3,355,000 in 1993.\nLIQUIDITY AND CAPITAL RESOURCES - - -------------------------------\nAt February 28, 1995, the Company's cash, short-term investments and marketable securities totaled $4,889,000, an increase of $2,264,000 from $2,625,000 at February 28, 1994. The marketable securities were invested principally in non-investment grade, high-yield municipal bonds, Centennial common stock and the common stock of certain financial institutions. During the fiscal year ended February 28, 1995, the Company sold its two investments in cellular telephone partnerships in exchange for proceeds of $7,511,000 and 40,113 shares of Centennial Common stock. As discussed below, a portion of the proceeds was utilized to repay indebtedness and to increase the working capital of the Dental and Electronics segments. The increase in cash, short-term investments and marketable securities is attributable to the remaining proceeds from the sale of the Company's cellular investments.\nThe Company utilized $3,706,000 of the proceeds from the cellular sales to redeem a portion of its long-term indebtedness. In the second quarter, the Company repurchased $823,000 of its 10 1\/2% convertible subordinated debentures for approximately $744,000 and $131,000 of its 11% subordinated notes payable, at approximately 95% of face value, in open market transactions. On September 26, 1994 the Company redeemed the remainder of its outstanding 11% subordinated notes payable in the principal amount of $2,838,000. At February 28, 1995, the Company's outstanding indebtedness and redeemable cumulative convertible preferred stock totaled $22,921,000, as compared to $26,865,000 at the end of fiscal 1994.\nOn October 19, 1994 New Microtime acquired certain assets of the Graphics Systems Division (GSD) of The Grass Valley Group, Inc. (Grass Valley) in exchange for three year 7.5% promissory notes totalling $2,035,000 and a minimum royalty fee of $600,000 payable over three years. The acquired product lines were integrated with other products sold by New Microtime. In January 1995, the combined entity began operating under the name Digital GraphiX (DGI). Grass Valley is continuing to sell its former GSD products as DGI's worldwide non-exclusive master distributor.\nAt February 28, 1995 Ney had $3,200,000 in outstanding borrowings against its $8.5 million demand revolving credit facility. The proceeds from this facility have been utilized primarily to fund inventories and receivables. This facility is secured by certain of Ney's receivables and precious metal inventories.\nThe Indenture relating to the Company's 10 1\/2% Convertible Subordinated Debentures contains covenants restricting payment of dividends on or repurchases or redemptions of the Company's capital stock. As the result of the losses incurred in fiscal years 1993, 1994 and 1995, the Company is currently prohibited by such covenants from making payments on its common or Preferred Stock. The Company will only be permitted to pay dividends on or redeem the Preferred Stock or the common stock to the extent cumulative \"consolidated net income\" (as defined) earned after the 1995 fiscal year exceeds $2,452,674. Further, the Company is prohibited under the Indenture relating to its 1979 and 1983 Industrial Development Bonds (IDB Indenture) from issuing additional \"long-term debt\" with certain exceptions (as defined in the IDB Indenture), unless (1) its average annual \"pre-tax income\" for the three preceding fiscal years (as defined in the IDB Indenture), shall have equaled at least 1.6 times the sum of the annual \"interest charges\" (as defined in the IDB Indenture) or (2) its pre-tax income for a twelve calendar month period, ended not more than six months prior to the issuance of the additional long-term debt, shall have equaled at least three times the sum of the annual interest charges on such long-term debt. As a consequence of the losses in previous years, this prohibition will remain in effect until sufficient income is generated to satisfy the test.\nAdditional financings or restructurings of existing financing obligations will be necessary to fund the Company's capital and financial commitments in future periods. The Company believes that funds from operations, sale of existing investments or businesses and potential future refinancings will be sufficient to meet its anticipated working capital and debt service requirements for the foreseeable future, but there can be no assurance as to the consumation of these future events or the terms thereof.\nDISCONTINUED OPERATION - - ----------------------\nIn fiscal 1993 the Company sold its digital video effects subsidiary at book value for preferred stock and notes issued by the buyer, Digital F\/X, Inc. (DF\/X). The Company recorded a pre-tax charge of $1,220,000 for severance, legal and shut down costs at the time of sale and in April 1993 established a reserve of $3,000,000 against its investment in DF\/X as a consequence of deteriorating operations at DF\/X.\nIn January 1994, in conjunction with a filing by DF\/X for protection under Chapter 11 of the United States Bankruptcy Code and a settlement of pending litigation between DF\/X and the Company, the Company's New Microtime Inc. subsidiary acquired the Broadcast Division of DF\/X, including the assets of its former video effects subsidiary, and made a $470,000 payment to the bankruptcy estate of DF\/X. The Company's investment in DF\/X preferred stock and notes and the $470,000 payment, an aggregate of $4,280,163 at February 28, 1994, has been allocated to the acquired assets, and New Microtime's results of operations have been consolidated in the Company's fiscal 1994 Consolidated Financial Statements. As discussed above, New Microtime acquired the Graphics System Division of Grass Valley on October 19, 1994 and changed its name to Digital GraphiX in January 1995. On May 2, 1995 DGI completed the sale of 64,800 shares of its stock which reduced AGI's ownership in DGI to 19%; as such its assets and liabilities are shown as Investment in Digital GraphiX in the Company's Consolidated Financial Statements for the fiscal year ended February 28, 1995.\nITEM 8","section_7A":"","section_8":"ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - - ----------------------------------------------------\nThe financial statement schedules are filed as part of Part IV, Item 14, of this Annual Report on Form 10-K.\nThe Registrant's consolidated financial statements are set forth below.\nThe following table summarizes certain financial data with respect to the Company and is qualified in its entirety by the Company's Consolidated Financial Statements for the fiscal year ended February 28, 1995 contained in this Item.\n\/1\/ Net sales and revenues for 1994 has been revised to reflect the operations of Digital GraphiX, which had previously been reflected as a discontinued operation. See Note 17 to the Company's Consolidated Financial Statements for the fiscal year ended February 28, 1995 contained in this Item.\nANDERSEN GROUP, INC. Consolidated Statements of Operations Years ended February 28, 1995, 1994 and 1993\nSee accompanying notes to consolidated financial statements.\nANDERSEN GROUP, INC. Consolidated Balance Sheets Years Ended February 28, 1995 and 1994\nSee accompanying notes to consolidated financial statements.\nANDERSEN GROUP, INC. Consolidated Statements of Cash Flows Years ended February 28, 1995, 1994 and 1993\nSee accompanying notes to consolidated financial statements.\nANDERSEN GROUP, INC. Consolidated Statements of Common and Other Stockholders' Equity Years ended February 28, 1995, 1994 and 1993\nSee accompanying notes to consolidated financial statements.\nANDERSEN GROUP, INC. Notes to Consolidated Financial Statements Years ended February 28, 1995, 1994 and 1993\n(1) Nature of Business ------------------\nAndersen Group, Inc. (the Company) is a diversified holding company. Its subsidiaries manufacture dental alloys and equipment, electronic components, industrial ultrasonic cleaners and digital video effects and graphics equipment.\n(2) Summary of Significant Accounting Policies ------------------------------------------\nPrinciples of Consolidation ---------------------------\nThe Company's financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation.\nCash and Cash Equivalents -------------------------\nCash and cash equivalents include funds held in investments with an original maturity of three months or less.\nMarketable Securities ---------------------\nThe Company accounts for its investment portfolio in accordance with Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities (SFAS 115). The effect of adopting SFAS 115 in 1994 was not material. Investments are categorized as trading, available-for-sale or held-to-maturity. Unrealized gains and losses on trading and available-for-sale securities are recorded in the statement of operations and stockholders' equity, respectively. Held-to-maturity investments are recorded as amortized costs. The investment portfolios of February 28, 1995 and 1994 have been categorized as trading securities. The February 28, 1995 investments consist of approximately $1.52 million of marketable securities and $.68 million of debt securities. The February 28, 1994 investments consist primarily of debt securities.\nInventories -----------\nInventories are stated at the lower of cost or market. Cost is determined using the last-in, first-out (LIFO) method for precious metals and at standard costs which approximate the first-in, first-out (FIFO) and average cost methods for the balance of the inventories.\nProperty, Plant and Equipment -----------------------------\nProperty, plant and equipment, including capital leases, are stated at cost and depreciated using the straight-line method over the estimated useful life of the respective assets, as follows:\nBuildings and improvements 10 - 50 years Machinery and equipment 5 - 10 years Furniture and fixtures 3 - 10 years\nUnamortized Discounts ---------------------\nUnamortized discounts on redeemable convertible cumulative preferred stock and subordinated notes payable are accreted using the effective interest method.\nIncome Taxes ------------\nIn February 1992, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (SFAS 109). Under the asset and liability method utilized under 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 values. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under SFAS 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.\nThe Company adopted SFAS 109 during fiscal 1993. The effect of adopting this new standard was not material.\nEarnings Per Share ------------------\nEarnings per share is computed based on the weighted average number of common and common equivalent shares outstanding. Fully diluted net loss per share assumes full conversion of all convertible securities into common stock at the later of the beginning of the year or date of issuance, unless anti-dilutive. For 1995, 1994 and 1993, the effect has been anti-dilutive.\nOff-Balance Sheet Hedging -------------------------\nThe Company has entered into foreign currency and precious metal forward contracts as a hedge against foreign currency exposures and precious metal fluctuations for firm price deliveries, respectively. These contracts limit the Company's exposure to both favorable and unfavorable currency or precious metals price fluctuations.\nFinancial Statement Reclassifications -------------------------------------\nCertain reclassifications have been made to the 1994 and 1993 financial statements in order to conform with the 1995 presentation.\n(3) Inventories -----------\nInventories consist of the following:\nAt February 28, 1995 and 1994, inventories valued at LIFO cost comprised 54% and 47% of total inventories, respectively.\n(4) Sale of Cellular Partnership Interests --------------------------------------\nOn May 10, 1994 the Company's subsidiary, Clear Cellular Holdings, Inc. (\"Clear\") sold its interest in a partnership which owned a cellular communications license to Centennial Cellular Corporation (Centennial). The partnership interest was sold for a combination of cash and Centennial stock. The Centennial stock was immediately remarketed in an open market block transaction. Overall, Clear\nreceived $3,316,075 in net proceeds from the partnership interest sale and has an additional $170,000 in escrow subject to a post close review.\nOn August 23, 1994 the Company sold its general partnership interest in MidSouth Cellular L.P. (MidSouth), a nonwireline cellular telephone franchise to Centennial. The Company received 281,507 shares of Centennial stock, of which 222,895 shares were sold for $16.69 per share in an open market block transaction and 18,500 shares were sold at $16.48 per share. The Company continues to hold 40,112 shares of Centennial common stock of which 6,845 shares remain in escrow subject to a post close review.\nExcluding the remaining amounts in escrow, the Company has recorded gains from the sale of these cellular partnership interests totalling $3,223,076, which is included in investment and other income.\n(5) Property, Plant and Equipment -----------------------------\nProperty, plant and equipment consists of the following:\nDepreciation and amortization expense was $1,976,751, $3,164,966, and $3,098,146 in 1995, 1994 and 1993, respectively.\nAt February 28, 1995 and 1994, property, plant and equipment includes assets acquired under a capital lease, which will expire in 1998, for certain machinery and equipment of $567,106 with a related allowance for depreciation of $325,815 and $212,394, respectively.\n(6) Short-term Debt ---------------\nThe Company's major subsidiary, The J.M. Ney Company (\"Ney\"), has an $8.5 million demand revolving credit facility with a commercial bank of which $3,200,000 was outstanding at February 28, 1995. The facility is secured by certain of Ney's receivables and precious metal inventories. Interest is at the bank's prime rate, 9% at February 28, 1995 or at LIBOR plus 1.75% if the borrowing level is fixed for a period of time. The facility contains covenants which establish certain minimum financial operating ratios for Ney and a specified equity level for the Company.\n(7) Accrued Liabilities -------------------\nAccrued liabilities consist of the following:\n(8) Redeemable Cumulative Convertible Preferred Stock -------------------------------------------------\nRedeemable cumulative convertible preferred stock is subject to annual mandatory redemption from legally available funds of 160,000 shares at $18.75 per share, or $3,000,000, commencing in March 1996. At the Company's option, shares may be redeemed beginning in March 1993 through February 1996 at escalating prices from $17.75 to $18.75 per share. The Company may make open market purchases, however, it is currently precluded from doing so as discussed below and in Note 9.\nQuarterly dividend payments, ranging from $.1875 to $.4375 per share, are paid based upon the operating income of Ney, as defined. As discussed in Note 9, the Company continues to be restricted from paying dividends since April 15, 1993 until specified cumulative earnings are reached. At February 28, 1995 and 1994 the Company had accrued approximately $884,000 and $447,000, respectively, for payment of prior dividends.\nThe preferred shares increase in carrying value at a rate of $.26 per share per year and, as such, approximately $150,000, $153,000 and $173,000 of accretion has been recorded as part of the preferred dividend requirement in the Consolidated Statements of Operations for 1995, 1994 and 1993, respectively.\nThe preferred shares are convertible into the Company's common stock at any time at a rate of 1.875 shares of common stock for each preferred share. At February 28, 1995, 1,104,443 shares of common stock have been reserved for conversion.\n(9) Long-term Debt --------------\nLong-term debt consists of the following:\nOn September 26, 1994 the Company redeemed all $2,838,000 of its outstanding principal amount 11% subordinated notes payable, due February 1998 at their face value.\nThe Company has a master lease line of credit totaling $1,500,000 of which $567,106 has been utilized and $273,300 and $455,000 remained outstanding at February 28, 1995 and 1994, respectively. The line is secured by the underlying leased equipment. Interest is at rates ranging from 8.2% to 8.5%. Repayments are on a monthly basis with interest through 1998.\nThe terms of the convertible subordinated debentures call for the annual liquidation of $834,000 face value of debentures, either through open market purchases or mandatory sinking fund payments. Such open market purchases have reduced mandatory sinking fund payments to $19,000 for fiscal 1996. The Company may make an additional optional sinking fund payment of $834,000.\nThe debentures are convertible into common stock of the Company at any time prior to maturity, unless previously redeemed, at $16.17 per share, subject to adjustment under certain conditions. At February 28, 1995, 404,948 shares of common stock were reserved for conversion.\nCertain of the debt agreements contain restrictive covenants which establish minimum tangible net worth requirements and limit, among other things, mergers or consolidations, sales of assets, additional long term debt, payments of dividends and stock repurchases. Under the terms of one of the agreements, the Company has been restricted from repurchasing stock or paying dividends since April 15, 1993 until such time as the Company's cumulative earnings, as defined, reach specified amounts.\nMaturities of long-term debt for each of the five years ending February 28\/29 are as follows:\n(10) Income Taxes ------------ Income tax benefit (expense) consists of the following:\nThe difference between the actual income tax benefit (expense) and the income tax benefit (expense) computed by applying the statutory Federal income tax rate of 34% to loss before taxes is attributable to the following:\nA deferred income tax (expense) benefit results from temporary differences in the recognition of income and expense for income tax and financial reporting purposes. The principal components of the net deferred asset (liability) which give rise to this deferred income tax (expense) benefit for the years ended February 28, 1995 and 1994 are as follows:\nAt February 28, 1995 and 1994 the Company's valuation allowance is primarily attributable to State operating loss carryforwards that expire in 1998 and 1999. These allowances reflect uncertainties as to the realization of sufficient income and income tax in the future upon which the State operating loss carryforwards may be utilized. The Company has not established a valuation reserve for its Federal operating loss and credit carryforwards, and reasonably expects that the sale of certain assets, investment securities and certain real property, will generate sufficient income to fully utilize the Federal operating loss and credit carryforwards.\nAt February 28, 1995, the Company had $3,652,500 of Federal operating loss carryforwards and $537,278 of Federal credit carryforwards which expire in the years 2009, and 1999 through 2002, respectively. In addition, the Company has State operating loss carryforwards of $4,909,958, which expire in the years 1998 and 1999.\n(11) Stock Option Plan -----------------\nThe Company's incentive stock option plan provides for option grants to directors and key employees at prices equal to at least 100% of the stock's fair market value at date of grant. Options are generally exercisable one year after grant. The Company has reserved 150,000 shares of common stock for the exercise of stock options. At February 28, 1995, the Company had 72,700 options available for issue under the plan.\nActivity under the plan is as follows:\nAt February 28, 1995, 77,300 options were exercisable.\n(12) Retirement Plans ----------------\nThe Company maintains both noncontributory defined benefit and defined contribution plans, which collectively cover substantially all full-time employees. The defined contribution plans are funded annually through contributions in amounts that can be deducted for Federal income tax purposes. Benefits payable under all plans are based upon years of service and compensation levels.\nThe plan assets, which are managed by third-party trustees, include equity securities, government and corporate debt securities and other fixed income obligations.\nThe following table sets forth the actuarially determined funded status of the Company's defined benefit plan and amounts recognized in the Company's consolidated balance sheets:\nFor fiscal years 1995, 1994 and 1993, the projected benefit obligations and pension income were determined using the following components:\nNet pension income for the Company's funded defined benefit plan for 1995, 1994 and 1993 includes the following components:\nThe Company also has a supplemental defined benefit plan which covers a former senior executive of Ney. There are no assets held by the plan. The Company's policy is to contribute amounts to the plan as needed to fund benefit payments to the participant. Benefits are based upon years of service, compensation levels and benefits earned under the company-wide defined benefit plan. At February 28, 1995 and 1994, the actuarially determined status of the plan and the amount recognized in the balance sheet was a vested accumulated and projected benefit obligation of $307,142 and $331,172, respectively.\nFor fiscal years 1995, 1994 and 1993, respective discount rates of 7.5%, 7.5% and 8.5% were used for determining the projected benefit obligation.\nPension expense for Ney's supplemental defined benefit plan includes the following components:\nPension expense for all defined contribution plans totaled $157,077, $121,322, and $233,268 in 1995, 1994 and 1993, respectively.\n(13) Post-Retirement Benefit Obligations -----------------------------------\nDuring 1993, the Company amended its retiree health care plan to include only those retirees currently in the plan and discontinued the benefit for current employees. This change resulted in a reduction in the liability and recognition of a gain of $538,596 in the year ended February 28, 1993.\nThe Company's cost of its unfunded retiree health care plan for 1995 and 1994 was approximately $56,000 and $59,500, respectively, including interest. At February 28, 1995 and 1994, the accumulated benefit obligation for post-retirement benefits was approximately $792,000 and $843,000, respectively. At February 28, 1995, 32 retirees were receiving benefits under this plan.\nThe accumulated estimated benefit obligation was determined using the unit credit method and an assumed discount rate of 7.5% at February 28, 1995 and 1994. At February 28, 1995 and 1994, the accumulated benefit obligation was compiled using an assumed health care cost trend rate of 11%, gradually declining to 6% in the year 2000 and thereafter over the projected payout period of the benefits.\nThe estimated effect on the present value of the accumulated benefit obligation at March 1, 1995 of a 1% increase each year in the health care cost trend rate used would result in an estimated increase of approximately $53,000 in the obligation.\n(14) Leases ------\nThe Company leases various manufacturing and office facilities and equipment under lease agreements\nexpiring through August 1998. The leases are accounted for as operating leases. In addition, the Company earns rental income from office space leased to tenants under operating leases expiring through August 1996.\nFuture minimum lease payments and rental income under the terms of the leases for each of the years ending February 28\/29, are as follows:\nLease expense and rental income are as follows:\n(15) Restructuring Charge --------------------\nDuring 1993, the Company restructured the management of the operations of its subsidiaries, resulting in the payment of severance and related benefits to former employees. This management restructuring resulted in a pre-tax charge of $949,795.\n(16) Business Segments and Export Sales ----------------------------------\nIn 1995, the Company operates in three business segments: Dental, Electronic and Video. Operating income consists of net sales, less cost of sales and selling, general and administrative expenses directly allocated to the industry segments. Corporate expenses consist of administrative costs not directly attributable to a specific industry segment and interest expense. Corporate revenues consist of investment and other income not attributable to a specific industry segment. Corporate identifiable assets include marketable securities and short-term investments, and assets not directly attributable to a specific industry segment.\nSummarized financial information for each business segment is as follows:\nExport sales for the years ended February 28, 1995, 1994, and 1993 were $20,662,000, $19,650,000 and $16,371,000, respectively.\n(17) Investment in Digital GraphiX - Subsequent Event ------------------------------------------------\nOn May 2, 1995, Digital GraphiX, Incorporated (DGI) (formerly New Microtime Inc.), previously a wholly owned subsidiary of the Company, issued an additional 64,800 shares of common stock to certain employees and securityholders of the Company at $5.00 per share. As a result of this offering, the Company's interest has been reduced to 19%. DGI will utilize the proceeds from the offering for working capital purposes.\nThe Company's consolidated financial statements include the operating results of DGI from the date of inception in April, 1993 through February 28, 1995. As of February 28, 1995 the DGI balance sheet has not been consolidated. The investment in DGI at February 28, 1995 is comprised of a 7.5% $2.9 million note receivable, discounted to $2.3 million to reflect a market rate interest, representing the inter-company balance reduced by $.5 million of net liabilities of DGI resulting in a net balance of $1.8 million. Interest is payable monthly with the principal due October, 1997. The Company has not\nrecorded any gain related to the May 2, 1995 sale of stock by the subsidiary, which will be considered along with the discount in the Company's future valuation of the note receivable and equity interest.\nDGI was formed in April 1993 as a wholly owned subsidiary. Andersen Group had previously been in the video graphics marketplace for nearly twenty years with its majority-owned subsidiary, Microtime, Inc., which sold video signal processing equipment, including time base correctors, frame synchronizers and, later, digital video effects equipment. The Microtime, Inc. assets were sold to Digital F\/X, Inc. (DF\/X) in October 1992 for a combination of subordinated notes and preferred stock. The assets which DF\/X bought from AGI were put into the DF\/X Broadcast Division. When this Division did not perform financially as well as expected, AGI reached an agreement with DF\/X to manage its Broadcast Division through AGI's wholly-owned subsidiary, New Microtime. The management arrangement included an option by New Microtime to purchase the DF\/X Broadcast Division assets under certain conditions. This option was exercised in September, 1993 prior to DF\/X's bankruptcy filing.\nThis Agreement, which was approved by the U.S. Bankruptcy Court in December 1993, confirmed the transfer of title of the DF\/X Broadcast assets free and clear of all liens, claims and encumbrances arising out of DF\/X's operation of the division, including claims of DF\/X trade and other creditors, for forgiveness of debt and an additional payment of $470,000 to the debtor's estate. The net assets acquired were valued at approximately $2.4 million and consisted primarily of inventory, equipment, licenses, patents and trademarks.\nOn October 19, 1994 New Microtime acquired certain assets of the Graphics Systems Division (GSD) of The Grass Valley Group, Inc. (Grass Valley) in exchange for three year 7.5% promissory notes totalling $2,035,000 and a minimum royalty of $600,000 payable over three years. The acquired product lines were integrated with the other products sold by New Microtime. The combined entity began operating under the name Digital GraphiX in January, 1995. Grass Valley is continuing to sell its former GSD products as DGI's worldwide non-exclusive master distributor.\n(18) Contingencies -------------\nAlthin CD Medical, Inc. (Althin) has filed a complaint against the Company's subsidiary Seratronics, Inc. of Nevada in the U.S. District Court for the Southern District of Florida, asserting various claims including breach of contract for failure to pay royalties arising out of a License Agreement with Althin's predecessor, CD Medical, and claims arising out of the management of Seratronics' business by Fresenius U.S.A., Inc. Althin has claimed money damages of at least $300,000. Seratronics has denied all claims or owing any additional liability for royalties and has filed counterclaims against Althin alleging misuse by Althin of know-how and technology licensed exclusively to Seratronics and breach of Althin covenants of good faith and fair dealings with Seratronics. The case is presently in the discovery phase. Seratronics intends to strongly defend these claims and to vigorously assert its counterclaims. The ultimate outcome of the litigation discussed above or the necessity for any provision for liability which may result cannot presently be determined.\nKPMG Peat Marwick LLP\nIndependent Auditors' Report\nThe Stockholders and Board of Directors Andersen Group, Inc.:\nWe have audited the accompanying consolidated balance sheets of Andersen Group, Inc. and subsidiaries as of February 28, 1995 and 1994, and the related consolidated statements of operations, common and other stockholders' equity and cash flows for each of the years in the three-year period ended February 28, 1995. 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 Andersen Group, Inc. and subsidiaries at February 28, 1995 and 1994, and the results of their operations and their cash flows for each of the years in the three-year period ended February 28, 1995, in conformity with generally accepted accounting principles.\n\/s\/ KPMG Peat Marwick LLP\nSpringfield, Massachusetts May 3, 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 information required by this Item for Directors is set forth below. The information required for Executive Officers is incorporated by reference to the section in Part I, Item 1 - Business, entitled \"Executive Officers of the Registrant.\"\nOLIVER R. GRACE, JR., age 41, has been a Director of the Company since 1986 and Chairman since March 29, 1990. He has also been President of AG Investors, Inc., one of the Company's subsidiaries, since 1992. Mr. Grace, Jr. is a General Partner of The Anglo American Security Fund L.P., and serves as a Director of Republic Automotive Parts, Inc. Mr. Grace, Jr. is the brother of John S. Grace and Gwendolyn Grace.\nFRANCIS E. BAKER, age 65, has been a Director of the Company and President and Chief Executive Officer of the Company since 1959. Mr. Baker also serves as a Director of Connecticut Water Services, Inc. and Fresenius USA, Inc.\nPETER N. BENNETT, age 59, has been a Director of the Company since 1992. He is a private investor and financial consultant.\nEDWARD K. CONKLIN, age 53, has been a Director of the Company since 1991. He is Chairman of the Board and Vice President of Forth, Inc.\nJOSEPH F. ENGELBERGER, age 69, has been a Director of the Company since 1975. He has been Chairman of Transitions Research Corporation since 1984. Mr. Engelberger serves as a Director of Information International, Inc. and EDO Corporation.\nRICHARD H. GORDON, age 53, has been a Director of the Company since 1990. He is the President of Richard Gordon Interests, a Director of Northeast Savings, F.A., and a Director of the International Tennis Hall of Fame. Mr. Gordon serves as a Trustee for Avon Old Farms School, Connecticut College and Ohio Wesleyan University.\nJOHN S. GRACE, age 37, has been a Director of the Company since 1990. He is the Chairman of Sterling Grace Corporation, and a General Partner of The Anglo American Security Fund L.P. John S. Grace is the brother of Oliver R. Grace, Jr. and Gwendolyn Grace.\nGWENDOLYN GRACE, age 43, was appointed to the Board of Directors in 1992. She is a private investor. Gwendolyn Grace is the sister of Oliver R. Grace, Jr. and John S. Grace.\nLOUIS A. LUBRANO, age 61, has been a Director of the Company since 1983 and is currently Managing Director of Stires and Company, Inc., a position he has held since 1991. Mr. Lubrano was previously the Director of the NASDAQ Forum from March 1990 to March 1991, Managing Director of Home Group Capital Markets, Inc. from February 1989 to February 1990, and President of the investment banking firm of Gabelli & Company, Inc. from April 1986 to February 1989. Mr. Lubrano also serves as a Director of Graham-Field Health Products, Inc.\nJAMES J. PINTO, age 43, has been a Director of the Company since 1988. He is currently Chairman and a Director of National Capital Management Corporation, a position he has held since 1989. Mr. Pinto also serves as a Director of Biscayne Holdings, Inc.\nCompliance with Section 16(a) of the Exchange Act\nSection 16(a) of the Securities Exchange Act of 1934 requires the Company's officers and directors, and persons who own more than ten percent of its Common Stock (Insiders), to file reports of ownership and changes in ownership with the Commission and the National Association of Securities Dealers, Inc. Insiders are required by the regulations of the Commission to furnish the Company with copies of all Section 16(a) forms that they file.\nBased solely on its review of the copies of such forms received by it or written representations from certain reporting persons that no such forms were required for those persons, the Company believes that during fiscal year 1995 all filing requirements applicable to insiders were complied with.\nITEM 11","section_11":"ITEM 11 - EXECUTIVE COMPENSATION - - --------------------------------\nThe following information is given regarding the annual and long-term compensation paid or to be paid to the Chief Executive Officer and the four other most highly compensated executive officers of the Company with respect to the fiscal years 1995, 1994 and 1993. Pursuant to the Securities and Exchange Commission (Commission) regulations, information is also provided with respect to Mr. Acker, who served as President of Digital GraphiX, Incorporated (f\/k\/a New Microtime Inc.) for the first seven months of fiscal 1995.\nSUMMARY COMPENSATION TABLE\n- - ----------------------- (a) Includes amounts of compensation deferred, at the employees option, pursuant to the Company's 401(k) plan. (b) Consists of contributions made by the Company in respect of its money purchase pension plan, 401(k) plan and The J.M. Ney Company Profit Sharing Plan. For 1995 and 1994, no contributions were made by the Company in respect of the Money Purchase Pension Plan. In 1993 the Company made a contribution to the Money Purchase Plan for the benefit of Mr. Baker in the amount of $13,732. Contributions by the Company in respect of its 401(k) plan for 1995, 1994 and 1993, respectively, were: $1,352, $3,164 and $2,182 for Mr. Baker; $145, $1,921 and $0 for Mr. Grace, Jr.; $1,780, $1,293 and $1,409 for Mr. Wolfe, Jr.; $729, $0 and $0 for Mr. Cerny; $1,229, $1,171 and $1,078 for Mr. Volinski and none for Mr. Acker. For 1995 and 1994, no contributions were made by the Company in respect of The J.M. Ney Company Profit Sharing Plan. In 1993 the Company made a contribution of $386 to the J.M. Ney Company Profit Sharing Plan for the benefit of Mr. Wolfe, Jr. and $172 for Mr. Volinski. (c) Includes a contribution made by the Company in respect of a Special Executive Retirement Plan in the amount of $50,000. (d) Mr. Cerny joined the Company on April 23, 1993. All Other Compensation for Mr. Cerny in 1994 includes $39,379 of relocation expenses and $2,565 for personal use of a Company provided automobile. (e) Mr. Volinski was appointed Chief Financial Officer of the Company on June 24, 1993. Previously, he was Chief Financial Officer for The J.M. Ney Company. (f) Mr. Acker joined the Company on May 10, 1993. He was terminated in September 1994. All Other Compensation for Mr. Acker in 1995 consists of six months of severance pay pursuant to his employment agreement.\nOPTIONS GRANTED IN FISCAL 1995\nNo stock options were granted in fiscal 1995 to the individuals named in the Summary Compensation Table.\nAGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR END OPTION VALUES\n(1) The shares underlying the unexercised options become exercisable on April 27, 1995 and 1996 in the amounts of 1,667 and 1,666 shares, respectively.\nPension Benefits\nThe following tables set forth the estimated aggregate annual benefit payable upon retirement or at normal retirement age for each level of remuneration specified at the listed years of service. The pension benefits are based on calendar year earnings and are payable in the form of a life annuity. For calendar 1994, the maximum annual compensation limit for determining pension benefits was $150,000.\nTable I is applicable only to employees of The J.M. Ney Company (Ney) who had made prior contributions to the pension plan and were considered active participants prior to February 28, 1991.\nTable II is applicable to all other employees of the Company and its subsidiaries including employees of Ney who had not made prior contributions to the pension plan and were not considered active participants prior to February 28, 1991.\nAn individual's pension benefits are equal to the greater of the following two calculations: (A) 1.25% of final average earnings (average annual earnings for the five consecutive years of highest earnings in the employee's last 10 years of employment), determined on the earlier of February 29, 1996 or the date of such member's termination of employment, or (B) the sum of the individual's accrued pension benefit at 12\/31\/93 calculated pursuant to (A) above and the individual's compensation for the year (up to a maximum of $150,000) multiplied by 1.25% multiplied by the number of years of service since 12\/31\/93.\nFor calendar year 1994, compensation taken into account under the qualified pension plan for any individual in any year was limited to $150,000.\nPension benefits are not reduced on account of social security benefits received by the employee. Average earnings is the sum of the amounts shown in the columns labeled \"Salary\" and \"Bonus\" in the Summary Compensation Table. The executive officers named in the Summary Compensation Table have the following years of credited service for pension plan purposes: Mr. Wolfe, Jr. - 9 years.\nAn individual's pension benefits are equal to the greater of the following two calculations: (A) .75% of final average earnings (average annual earnings for the five consecutive years of highest earnings in the employee's last 10 years of employment), plus .50% of final average earnings in excess of covered compensation (average of Social Security wage base) multiplied by the employee's years of service as a qualified employee (up to a maximum of 40 years), or (B) the sum of the individual's accrued pension benefit at 12\/31\/93, calculated pursuant to (A) above, and the individual's compensation for the year (up to a maximum of $150,000) multiplied by the percentages in (A) above multiplied by the number of years of service since 12\/31\/93.\nDuring calendar year 1994, compensation taken into account under the qualified pension plan for any individual in any year was limited to $150,000.\nPension benefits are not reduced on account of social security benefits received by the employee. Average earnings is the sum of the amounts shown in the columns labeled \"Salary\" and \"Bonus\" in the Summary Compensation Table. For purposes of this table, the amount used for covered compensation is the average of the covered compensation for each of the individuals named in the Summary Compensation Table. The executive officers named in the Summary Compensation Table have the following years of credited service for pension plan purposes: Mr. Baker - 9 years; Mr. Grace, Jr. - 2 years; Mr. Volinski - 4 years; Mr. Cerny - - - 1 year; Mr. Acker - none.\nDirector Compensation\nAll non-employee directors receive $6,000 per year, $500 for attendance at each Board meeting and reimbursement of expenses. Additionally, John S. Grace receives compensation of $15,000 annually as a member of the Executive Committee, and Louis A. Lubrano receives compensation of $2,000 for serving as Chairman of the Audit Committee.\nEmployment Agreements\nMessrs. Wolfe, Jr. and Cerny have employment agreements which, among other things, provide for severance pay in the event of involuntary termination.\nMr. Wolfe, Jr. is entitled to six months severance in the event of termination of Mr. Wolfe's employment for any reason other than cause as such term is defined in the agreement. In addition, Mr. Wolfe, Jr. was granted the right to receive a stock option equal to one percent (1%) of the outstanding stock of Ney Dental International, Inc. on March 1,\n1994. To date, the stock option has not been granted because the terms of the stock option plan, including the price of the option, have not been established. The Company may, however, at its option, provide equivalent benefits to Mr. Wolfe, Jr. in the form of non-equity compensation.\nMr. Cerny's employment agreement provides that in the event of termination for other than cause, the Company, at its option, will provide Mr. Cerny with twelve months of notice or salary and fringe benefits or any combination thereof. In the event of a change in control of The J.M. Ney Company, the Company has agreed to provide Mr. Cerny with one year severance including fringe benefits.\nReport of Compensation Committee\nThe Compensation Committee of the Board, consisting of Messrs. Engelberger (Chairman), Gordon, Lubrano and Pinto, each of whom are independent, non-employee directors, is responsible for reviewing the Company's executive compensation program and policies each year and determining the compensation of the senior executive officers. The Committee's determination on compensation of the Chief Executive Officer and other executive officers is reviewed with and approved by the entire Board.\nThe fiscal 1995 base pay of the Company's executive officers was determined primarily on the basis of the Committee's overall assessment of the executive officer's performance and competitive market data on salary levels. The Committee's overall policy regarding compensation of the Company's executive officers is to provide competitive salary levels and compensation incentives that attract and retain individuals of outstanding ability in key positions that recognize individual performance and the performance of the Company relative to the performance of other companies of comparable size, complexity and quality, and that support both the short-term and long-term goals of the Company. The executive compensation program includes elements which, taken together, constitute a flexible and balanced method of establishing total compensation for senior management.\nCompensation paid to the Company's executive officers for fiscal year 1995 consisted primarily of salary, contributions made by the Company in respect of its 401(k) Plan and, with respect to Mr. Baker, a contribution made by the Company in respect of a Special Executive Retirement Plan. Each executive officer's salary is determined on the basis of the individual's responsibilities and performance and a comparison with salaries paid by competitors of the Company, the other primary components of executive compensation are directly related to corporate and business unit performance. In light of the Committee's increasing emphasis on performance-related compensation and the failure of the Company to reach certain predetermined performance goals, no stock option grants were awarded in fiscal year 1995.\nThe Committee established the compensation of Francis E. Baker, the President and Chief Executive Officer of the Company, for fiscal 1995 using the same criteria used to determine compensation for other executive officers. Mr. Baker's fiscal year 1995 base pay was determined based upon the Committee's overall assessment of Mr. Baker's performance and competitive market data on salary levels. Again, using competitive market data, the Committee agreed to make a payment of $50,000 to Mr. Baker's Special Executive Retirement Plan.\nBecause of the Company's financial performance, Mr. Baker's annual salary was reduced to $200,000 from $220,000 effective January 1, 1995. In addition, the salary and Director's fee for the Company's Chairman, Mr. Oliver R. Grace, Jr., was also reduced effective January 1, 1995 to $85,000 from $100,000.\nMr. Baker's incentive compensation was to be determined by reference to the Company's fiscal year 1995 audited earnings before provision for interest, taxes, depreciation and amortization, as reduced by certain adjustments. In light of the Company's financial performance during fiscal year 1995, no incentive compensation payment was made to Mr. Baker.\nIt is the opinion of the Committee that the aforementioned compensation structures provide features which properly align the Company's executive compensation with corporate performance and the interests of its shareholders and which offer competitive opportunities in the marketplace.\nThe Compensation Committee\nJ.F. Engelberger, Chairman R.H. Gordon L.A. Lubrano J.J. Pinto\nPerformance Graph\nThe following graph compares the performance of the Company for the periods indicated with the performance of the National Association of Securities Dealers Automated Quotation (NASDAQ) Composite Stock Index (NASDAQ Composite) and the performance of the NASDAQ Industrial Composite Stock Index (Peer Group). The comparative five year total returns assume a $100 investment made on February 28, 1990 with dividends reinvested. The Andersen Group, Inc. stockholder return shown on the following graph is not necessarily indicative of future stock performance.\n[GRAPH APPEARS HERE]\nCOMPARATIVE FIVE YEAR TOTAL RETURNS AMONG ANDERSEN GROUP INC., NASDAQ COMPOSITE AND PEER GROUP (NASDAQ INDUSTRIALS)\nITEM 12","section_12":"ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - - ------------------------------------------------------------------------\nThe following table sets forth information regarding the beneficial ownership of Common Stock, as of May 8, 1995 by each director, by each named executive officer of the Company described in \"Executive Compensation\", by persons who beneficially own 5% or more of the outstanding shares of Common Stock, and by all directors and officers of the Company as a group. The beneficial ownership information described and set forth below is based on information furnished by the specified persons and is determined in accordance with Rule 13d-3 under the Securities Exchange Act of 1934, as amended. It does not constitute an admission of beneficial ownership for any other purpose.\n- - ------------ (1) Francis E. Baker does not own any shares of Common Stock directly. The figure set forth in the above table includes 10,400 shares of Common Stock with respect to which Mr. Baker has shared voting power as co-trustee under the Oliver Grace Grandchildren Trust U\/R dated December 27, 1976 and 4,638 shares which such Trust owns by virtue of its ability to convert $75,000 principal amount of 10 1\/2% convertible subordinated debentures (Convertible Debentures) to Common Stock within a 60-day period. Mr. Baker disclaims beneficial ownership of such shares held in trust. Also included in the figure set forth in the above table are 30,000 shares of Common Stock which may be issued to Mr. Baker within 60 days hereof upon the exercise of his existing exercisable stock\noptions. In addition to the shares reported above, Mr. Baker is the settlor of four irrevocable trusts each dated March 31, 1970 and created for the benefit of certain of his children. Shawmut Bank, N.A. acts as trustee under each of these trusts, which hold an aggregate of 68,306 shares of Common Stock. Mr. Baker does not exercise any control over these four trusts and disclaims beneficial ownership.\n(2) The Estate of Oliver R. Grace, Sr. (Estate) has direct beneficial ownership of an aggregate of 101,596 shares of Common Stock.\n(3) Lorraine G. Grace has beneficial ownership of 131,317 shares of Common Stock. Of this amount, 13,638 shares are held by Mrs. Grace directly; 2,475 shares are held by Mrs. Grace, as trustee of a trust for the benefit of her children; 13,608 shares are held by virtue of the ability of Mrs. Grace to convert $220,000 principal amount of Convertible Debentures to Common Stock within a 60-day period; and 101,596 shares are held by virtue of Mrs. Grace's appointment as executrix of the Estate.\n(4) Oliver R. Grace, Jr. has beneficial ownership of an aggregate of 168,743 shares of Common Stock. Of this amount, 55,686 shares are held by Oliver R. Grace, Jr. directly, including 40,136 shares by virtue of Mr. Grace's ability to convert $649,000 principal amount of Convertible Debentures within a 60-day period and 11,250 shares by virtue of Mr. Grace's ability to convert 6,000 shares of Series A Cumulative Convertible Redeemable Preferred Stock of the Company, without par value (Preferred Stock) to Common Stock within a 60-day period; 7,592 shares are held by Carolyn Grace, the spouse of Oliver R. Grace, Jr., of which 7,112 shares are held by Mrs. Grace by virtue of her ability to convert $115,000 principal amount of Convertible Debentures within a 60-day period; 58,144 shares are held by virtue of the ability of The Anglo American Security Fund L.P. (of which Oliver R. Grace, Jr. is a general partner) to convert $940,000 principal amount of Convertible Debentures to Common Stock within a 60-day period; and 42,321 shares are held by virtue of the ability of Sterling Grace Capital Management, L.P. (of which Oliver R. Grace, Jr. is a limited partner) to convert 22,571 shares of the Preferred Stock to Common Stock within a 60-day period. Mr. Grace, Jr. has stock options to acquire an additional 5,000 shares of Common Stock. Oliver R. Grace, Jr. disclaims beneficial ownership of all shares owned by his spouse, by him as trustee for the benefit of family members, by The Anglo American Security Fund, L.P. and by Sterling Grace Capital Management, L.P. described herein.\n(5) John S. Grace has beneficial ownership of 126,736 shares of Common Stock. Of this amount, 15,850 are owned by John S. Grace directly; 58,144 shares are held by virtue of the ability of The Anglo American Security Fund L.P. (of which John S. Grace is a general partner) to convert $940,000 principal amount of Convertible Debentures to Common Stock within a 60-day period; 7,421 shares are held by virtue of Mr. Grace's ability to convert $120,000 principal amount of Convertible Debentures to Common Stock within a 60-day period; and 42,321 shares are held by virtue of the ability of Sterling Grace Capital Management, L.P. (John S. Grace is Chairman of Sterling Grace Corporation, General Partner of Sterling Grace Capital Management) to convert 22,571 shares of the Preferred Stock to Common Stock within a 60-day period. Mr. Grace has a stock option to acquire an additional 3,000 shares of Common Stock. John S. Grace disclaims beneficial ownership of all shares held by trustees for the benefit of members of his family and The Anglo American Security Fund L.P.\n(6) Represents less than one percent (1.0%) of the Common Stock.\n(7) Peter N. Bennett owns 300 shares of Common Stock directly. The figure set forth in the table includes the ability of Mr. Bennett to convert 85,150 shares the Preferred Stock to 159,656 shares of Common Stock within a 60-day period.\n(8) The Ney Profit Sharing Savings Plan Trust owns 183,333 shares of Common Stock directly.\n(9) The Estate of Paul S. Ney does not own any shares of Common Stock directly. The figure set forth in the table represents the ability of the Estate of Paul S. Ney to convert 76,260 shares the Preferred Stock to 142,987 shares of Common Stock within a 60-day period.\n(10) Joseph F. Engelberger has beneficial ownership of 7,475 shares of Common Stock of which 2,475 shares are held directly. Mr. Engelberger has stock options to acquire 5,000 shares of Common stock within a 60-day period.\n(11) Louis A. Lubrano has beneficial ownership of 6,855 shares of Common Stock of which 1,855 shares are held by virtue of Mr. Lubrano's ability to convert $30,000 principal amount of Convertible Debentures to Common Stock within a 60-day period. Mr. Lubrano has stock options to acquire 5,000 shares of Common Stock within a 60-day period.\n(12) James J. Pinto has beneficial ownership of 13,000 shares of Common Stock, of which 8,000 shares are held directly. Mr. Pinto has stock options to acquire 5,000 shares of Common Stock within a 60-day period.\n(13) Richard H. Gordon does not own any shares of Common Stock directly. The figure set forth in the table represents a stock option to acquire 3,000 shares of Common Stock within a 60-day period.\n(14) Edward K. Conklin does not own any shares of Common Stock directly. The figure set forth in the table above includes 11,250\nshares by virtue of his ability to convert 6,000 shares of the Preferred Stock to Common Stock within a 60-day period, 49,988 shares by virtue of the ability of Shawmut Bank, N.A., as trustees under the Edward K. Conklin Trust for the benefit of Anne A. Conklin to convert 26,660 shares of the Preferred Stock to common stock within a 60-day period, and 3,000 shares by virtue of Mr. Conklin's right to exercise an option to acquire 3,000 shares of Common Stock within a 60-day period.\n(15) H. George Wolfe, Jr. does not own any shares of Common Stock directly. The figure set forth in the table above includes 750 shares by virtue of his ability to convert 400 shares of the Preferred Stock to Common Stock, without par value, of the Company within a 60-day period, and 1,000 shares by virtue of Mr. Wolfe's right to exercise an option to acquire 1,000 shares of Common Stock within a 60-day period.\n(16) Ronald N. Cerny does not own any shares of Common Stock directly. The figure set forth in the table represents a stock option to acquire 5,000 shares of Common Stock within a 60-day period.\n(17) Jack E. Volinski does not own any shares of Common Stock directly. The figure set forth in the table represents a stock option to acquire 1,000 shares of Common Stock within a 60-day period.\nITEM 13","section_13":"ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - - --------------------------------------------------------\nCellular Investments - - --------------------\nIn May 1992, the Company made an investment in Cellular Holdings L.P. (Cellular Holdings), a limited partnership which owns and operates three rural nonwireline cellular telephone franchises in Louisiana and Mississippi. Oliver R. Grace, Jr., Chairman and director of the Company, contributed all of the assets and liabilities of two Louisiana franchises to Cellular Holdings in exchange for approximately 65% of the partnership equity in Cellular Holdings and 80% of the capital stock of its corporate general partner. Cellular Holdings acquired the Mississippi franchise for $1,800,000 in cash, a $1,350,000 note of Cellular Holdings and approximately 20% of the partnership equity. The Company provided $1,800,000 to Cellular Holdings for application to the purchase price of the Mississippi franchise and start-up and operating costs in exchange for approximately 15% of the partnership equity. In addition, the Company advanced approximately $200,000 for costs related to the organization of Cellular Holdings.\nThe relative equity in Cellular Holdings received by the Company and Mr. Grace, Jr. was determined after negotiation by the Independent Committee of the Company's Board. One of the cellular franchises contributed by Mr. Grace, Jr. was acquired by him for $1,200,000 in July, 1991 and was valued by the Independent Committee at that price for purposes of determining equity in Cellular Holdings. Mr. Grace, Jr. was awarded the other franchise in the Federal Communications Commission lottery of rural franchises. The Independent Committee received three appraisals of the value of this franchise, ranging from $4,400,000 to $8,900,000 from independent appraisers recognized in the cellular telephone industry. The Independent Committee valued this franchise at $6,500,000, which fell below the midpoint of the range of appraisals received. The Independent Committee also considered that Mr. Grace, Jr. had advanced approximately $800,000 toward construction and operating costs to the Louisiana franchises which remained outstanding at the closing. The Committee further considered the terms of the financing described below, which were set forth in a nonbinding letter of intent at the time of the closing.\nOn December 11, 1992, Cellular Holdings, the Company and Mr. Grace, Jr. entered into agreements with Media Communications Partners II Limited Partnership and other investors (Investors) and MidSouth Management Investors Corp. (MMI) providing for financing of up to $10,500,000 for construction and operation of the cellular franchises and acquisition of additional cellular franchises. Under the agreements, the Company's and Mr. Grace, Jr.'s limited partnership interests in Cellular Holdings were contributed to MidSouth Cellular L.P. (MidSouth) and Mr. Grace, Jr.'s interest in the general partner of Cellular Holdings and certain receivables from Cellular Holdings to the Company and Mr. Grace, Jr. were contributed to the General Partner of MidSouth. In exchange for such contributions, the Company received limited partnership interests providing for a preferred return of $2,566,710 plus distributions equal to 10% per annum on such amount until repaid, and 9.6% of the remaining equity (Common Equity) in MidSouth after payment of debt and the preferred interests and 12.47% of the capital stock of the general partner of MidSouth; and Mr. Grace, Jr. received limited partnership interests providing for a preferred return of $7,934,353 plus distributions equal to 10% per annum on such amount until repaid, and 29.75% of the Common Equity in MidSouth, and 38.53% of the capital stock in the general partner of MidSouth. In addition, at the closing, Cellular Holdings repaid to Mr. Grace, Jr. $202,143 in\nrespect of advances previously made by Mr. Grace, Jr. for construction and operating costs. The Investors and MMI provided initial financing aggregating approximately $4,000,000 in the form of loans to MidSouth and its general partner and purchases of the balance of the general partner's capital stock and the balance of the Common Equity limited partnership interests in MidSouth. MMI also entered into a management agreement to manage MidSouth and the cellular franchises.\nThe Independent Committee reviewed the terms of the Midsouth financing transaction in the Spring of 1992 and approved the final terms of the transaction in December 1992. The Committee considered in particular that the determination of the relative interests of the Company and Mr. Grace, Jr. in Midsouth was made on the basis of the valuation of their respective investments in Cellular Holdings (which was previously reviewed and approved by the Committee) and cash advanced to Cellular Holdings for construction and operating costs.\nOn August 23, 1994, the Company, Mr. Grace, Jr., the Investors and MMI sold their respective interests in MidSouth, as well as their interests in the general partner of MidSouth and Cellular Holdings, to Centennial Cellular Corp. (Centennial) for an aggregate purchase price of $44,500,000, payable in cash and shares of Centennial Class A Common Stock. The Company, Mr. Grace, Jr., the Investors and MMI applied the purchase price to payment of indebtedness and other obligations of MidSouth, its general partner and their subsidiaries, to the payment of preferred equity plus accrued preferred return thereon and then to distributions on the Common Equity of MidSouth and its general partner, all in accordance with the terms of MidSouth's partnership agreement. In addition, the Company and Mr. Grace, Jr., were each paid a fee by MidSouth equal to $150,000 in connection with the early termination of the financing arrangements with the Investors. The aggregate sale proceeds received by the Company was $4,461,894, all paid in shares of Centennial Class A Common Stock. A portion of such shares was sold by the Company on the open market on August 23, 1994, however, the Company continues to hold approximately 40,113 of such shares. The aggregate sale proceeds received by Mr. Grace, Jr., consisted of a cash payment of $200,000 and an additional amount of $13,528,070 paid in shares of Centennial Class A Common Stock. Mr. Grace's interest was transferred in a merger with a Centennial subsidiary qualifying as a tax-free reorganization under the Internal Revenue Code of 1986, as amended.\nDigital GraphiX Offering - - ------------------------\nOn February 27, 1995 the Company's subsidiary, Digital GraphiX, Incorporated (formerly known as New Microtime Inc.) (DGI) offered for sale to certain securityholders of the Company (AGI Securityholders) and to certain employees of DGI 64,800 shares of DGI Common Stock (Offering), at a price of $5.00 per share (Offering Price).\nConsummation of the Offering to AGI Securityholders was conditioned upon the purchase by DGI employees pursuant to the Offering of a minimum of 16,000 shares of DGI common stock by the employees. In addition, three directors of the Company, Francis E. Baker, Peter N. Bennett and Oliver R. Grace, Jr. (Standby Parties) who are AGI Securityholders, agreed to purchase all shares offered pursuant to the Offering and at the Offering Price which remained unsold at the expiration date thereof. Francis E. Baker is the President and Chief Executive Officer, and a director of the Company. Mr. Baker is also the Chairman of the DGI Board of Directors. Peter N. Bennett is a director of the Company. Oliver R. Grace, Jr. is Chairman of the Company's Board of Directors and a director of DGI.\nThe Offering, closed on May 2, 1995, and was oversubscribed. As a result the Standby Parties were not required to fulfill their standby commitment. Each, however, was entitled to and did subscribe for DGI shares on the same basis as the other AGI Securityholders.\nAt the completion of the Offering, Messrs. Baker, Bennett and Grace, Jr. own 3,581, 4,774 and 4,799 shares of DGI, respectively. Their ownership percentage in DGI approximates 4.5%, 6.0% and 6.0%, respectively. As a result of the Offering the Company's ownership percentage of DGI has been reduced from 100% to 19%.\nThe Boards of Directors of DGI and the Company determined the Offering Price by relying, in part, on an opinion of The Barlow Company, Ltd., to the effect that the Offering Price was fair from a financial point of view.\nPART IV -------\nITEM 14","section_14":"ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K - - -------------------------------------------------------------------------\n(a) 1. Consolidated Financial Statements applicable to the Registrant contained in Item 8:\nNote: Schedules other than those listed above, are omitted as not ---- applicable, not required, or the information is included in the consolidated financial statements or notes thereto.\n(a) 3. Exhibits required by Item 601 of Regulation S-K:\nExhibit No. Description - - ------- -----------\n3.1 Amended and Restated Certificate of Incorporation and By-Laws of the Registrant, incorporated herein by reference to Exhibit 3.1 to the Registrant's Annual Report on Form 10-K for the year ended February 29, 1992 (Commission File No. 0-1460).\n4.1 Indenture of Trust dated as of November 1, 1979 between the Connecticut Development Authority and the Hartford National Bank and Trust Company (predecessor to The Connecticut National Bank and Shawmut Bank, N.A.), as Trustees incorporated herein by reference to the Exhibit filed with the Registrant's Quarterly Report on Form 10-Q for the quarter ended November 25, 1979 (Commission File Number 0-1460).\n4.2 Indenture, dated as of October 15, 1982, between the Registrant and Hartford National Bank and Trust Company (predecessor to The Connecticut National Bank and Shawmut Bank, N.A.), as Trustee, in respect of $10,000,000, aggregate principal amount, 10-1\/2% Convertible Subordinated Debentures Due 2002, incorporated herein by reference to Exhibit 4.8 to the Registrant's Registration Statement on Form S-4 (Commission File No. 33-38646).\n10.1 Letter Agreement, dated as of February 17, 1981, between the Registrant and L.F. Rothschild, Unterberg, Towbin incorporated herein by reference to Exhibit A to the Registrant's current report on Form 8-K filed with the Commission on March 4, 1981 (Commission File Number 0-1460).\n10.2 Group Annuity Contract, dated as of January 1, 1975, between Travelers Insurance Company and the Registrant relating to retirement benefits incorporated herein by reference to Exhibit 10.3 of the Registrant's Annual Report on Form 10-K for the year ended February 28, 1981 (Commission File Number 0-1460).\n10.3 Andersen Group Individual Retirement Plan, January 1, 1989, as amended, incorporated herein by reference to Exhibit 10.3 to the Registrant's Registration Statement on Form S-4 (File No. 33-38646) effective January 31, 1991.\n10.3a Amendment 1992-1 to the Andersen Group Individual Retirement Plan referred to in Exhibit 10.3 hereof, incorporated herein by reference to Exhibit 10.3a to the Registrant's Annual Report on Form 10-K for the year ended February 28, 1993 (Commission File No. 0-1460).\n10.4 Money Purchase Pension Plan Agreement, dated as of February 25, 1979, between the Registrant and the Andersen Group, Inc. Pension Plan (Trust) incorporated herein by reference to Exhibit 10.3 of the Registrant's Annual Report on Form 10-K for the year ended February 28, 1981 (Commission File Number 0-1460).\n10.5 Amendments to the Money Purchase Pension Plan Agreement referred to in Exhibit 10.4 hereof, incorporated herein by reference to Exhibit 10.5 to the Registrant's Registration Statement on Form S-4 (File No. 33-38646) effective January 31, 1991.\n10.5a Amendments 1993-1 and 1991-1 to the Money Purchase Pension Plan Agreement, incorporated herein by reference to Exhibit 10.5a of the Registrant's Annual Report on Form 10-K for the year ended February 28, 1993 (Commission File No. 0-1460).\nExhibit No. Description - - ------- -----------\n10.6 Loan Agreement dated as of November 1, 1979, between the Registrant and the Connecticut Development Authority incorporated herein by reference to the Exhibit filed with the Registrant's Quarterly Report on Form 10-Q for the quarter ended November 25, 1979 (Commission File No. 0-1460).\n10.7 Security Agreement, dated as of November 9, 1979, between the Registrant and the Connecticut Development Authority incorporated herein by reference to the Exhibit filed with the Registrant's Quarterly Report on Form 10-Q for the quarter ended November 25, 1979 (Commission File No. 0-1460).\n10.8 Mortgage Deed, dated as of November 9, 1979 between the Registrant and the Connecticut Development Authority incorporated herein by reference to the Exhibit filed with the Registrant's Quarterly Report on Form 10-Q for the quarter ended November 25, 1979 (Commission File No. 0-1460).\n10.9 Guaranty and Indemnification Agreement, dated as of November 1, 1979, between the Registrant and American Re-Insurance Company incorporated herein by reference to the Exhibit filed with the Registrant's Quarterly Report on Form 10-Q for the quarter ended November 25, 1979 (Commission File No. 0-1460).\n10.10 Loan Agreement, dated December 20, 1983, between the Connecticut Development Authority and the Registrant, incorporated herein by reference to Exhibit 10.10 to the Registrant's Registration Statement on Form S-4 (File No. 33-38646) effective January 31, 1991.\n10.11 Security Agreement, dated December 20, 1983, between the Registrant and the Connecticut Development Authority, incorporated herein by reference to Exhibit 10.11 to the Registrant's Registration Statement on Form S-4 (File No. 33-38646) effective January 31, 1991.\n10.12 Construction and Open-End Mortgage Deed from the Registrant to the Connecticut Development Authority and assigned to the Connecticut National Bank, dated December 20, 1983, incorporated herein by reference to Exhibit 10.12 to the Registrant's Registration Statement on Form S-4 (File No. 33-38646) effective January 31, 1991.\n10.13 Incentive and Non-Qualified Stock Option Plan adopted December 14, 1988, incorporated herein by reference to Exhibit 10.17 to the Registrant's Registration Statement on Form S-4 (File No. 33-38646) effective January 31, 1991.\n10.14 Agreement and Plan of Merger, dated as of November 30, 1990, by and among Andersen Group, Inc., Ney Acquisition, Inc. and The J.M. Ney Company, incorporated herein by reference, filed as Exhibit 2.1 to the Registrant's Registration Statement on Form S-4 (File No. 33-38646) effective January 31, 1991.\n10.15 Agreement of Purchase and Sale of Assets dated October 5, 1992 among Microtime, Inc., Digital F\/X Inc. and Andersen Group, Inc., incorporated by reference, filed as Exhibit 2.1 to the Registrant's Form 8-K dated October 6, 1992 (Commission File No. 0-1460).\nExhibit No. Description - - ------- -----------\n10.16 Amendment to Agreement of Purchase and Sale of Assets dated January 14, 1993 among AGI Technology, Inc. (f\/k\/a Microtime, Inc.), Andersen Group, Inc. and Digital F\/X Inc. referred to in Exhibit 10.16 hereof, incorporated herein by reference to Exhibit 10.22a to the Registrant's Annual Report on Form 10-K for the year ended February 28, 1993 (Commission File No. 0-1460).\n10.17 Limited Partnership Agreement of Midsouth Cellular L.P. dated as of November 18, 1992, incorporated herein by reference to Exhibit 10.23 of the Registrant's Annual Report on Form 10-K for the year ended February 28, 1993 (Commission File No. 0-1460).\n10.18 Investment Agreement by and among Media\/Communications Partners II Limited Partnership, Kilby Capital Company, Inc., Chestnut Street Partners, Inc. and Media\/Communications Investors Limited Partnership; Midsouth Management Investors Corp.; Midsouth Cellular Corp.; and Midsouth Cellular L.P. dated as of November 18, 1992, incorporated herein by reference to Exhibit 10.24 of the Registrant's Annual Report on Form 10-K for the year ended February 28, 1993 (Commission File No. 0-1460).\n10.19 Securityholders' Agreement by and among Midsouth Cellular Corp.; Midsouth Cellular L.P.; Media\/Communications Partners II Limited Partnership, Kilby Capital Company, Inc., Chestnut Street Partners, Inc. and Media\/Communications Investors Limited Partnership; Midsouth Management Investors Corp.; George D. Crowley, Jr., Brian McTernan, John D. Fujii, James J. Walter, Jr. and Janice P. Mercer, Andersen Group, Inc.; Iowa Cellular Corporation; Louisiana Cellular Corporation; and Oliver R. Grace, Jr., dated as of November 18, 1992, incorporated herein by reference to Exhibit 10.25 of the Registrant's Annual Report on Form 10-K for the year ended February 28, 1993 (Commission File No. 0-1460).\n10.20 Capital Contribution Agreement dated as of December 11, 1992, between Louisiana Cellular Corporation, Iowa Cellular Corporation, Andersen Group, Inc., Oliver R. Grace, Jr., Midsouth Cellular L.P. and Midsouth Cellular Corp., incorporated herein by reference to Exhibit 10.26 of the Registrant's Annual Report on Form 10-K for the year ended February 28, 1993 (Commission File No. 0-1460).\n10.21 Agreement for Confirmatory Acquisition and for settlement by and between Digital F\/X, Inc. and New Microtime Inc. dated as of November 9, 1993, incorporated herein by reference to Exhibit 10.22 of the Registrant's Annual Report on Form 10-K for the year ended February 28, 1995 (Commission File No. 0-1460).\n10.22 Purchase Agreement by and among Centennial Cellular Corp., Clear Communications Partnership, Clear Communications Systems, Inc. and Clear Cellular Holdings, Inc. dated as of February 28, 1994, incorporated herein by reference to Exhibit 10.23 of the Registrant's Annual Report on Form 10-K for the year ended February 28, 1995 (Commission File No. 0-1460).\n10.23 The Ney Profit Sharing Savings Plan, January 1, 1993, as amended, incorporated herein by reference to Exhibit 10.24 of the Registrant's Annual Report on Form 10-K for the year ended February 28, 1995 (Commission File No. 0-1460).\n10.24 Retirement Plan for Employees of The J.M. Ney Company, October 1, 1991, incorporated herein by reference to Exhibit 10.25 of the Registrant's Annual Report on Form 10-K for the year ended February 28, 1995 (Commission File No. 0-1460).\nExhibit No. Description - - ------- -----------\n10.25 Deferred Compensation Agreement, entered into as of September 30, 1992, by and between the Registrant and Francis E. Baker, incorporated herein by reference to Exhibit 10.26 of the Registrant's Annual Report on Form 10-K for the year ended February 28, 1995 (Commission File No. 0-1460).\n10.26 Employment Agreement, dated as of March 28, 1994, between The J.M. Ney Company and H. George Wolfe, Jr., incorporated herein by reference to Exhibit 10.29 of the Registrant's Annual Report on Form 10-K for the year ended February 28, 1995 (Commission File No. 0-1460).\n10.27 Letter Agreement, dated March 7, 1993, between the Registrant and Ronald N. Cerny, incorporated herein by reference to Exhibit 10.30 of the Registrant's Annual Report on Form 10-K for the year ended February 28, 1995 (Commission File No. 0-1460).\n10.28 LA3, LA4, Miss 8 Systems Agreement, incorporated herein by reference to Exhibit 10.1 of the Registrant's Quarterly Report on Form 10-Q for the Quarter ended August 31, 1994 (Commission File No. 0-1460).\n10.30 LA3, LA4, Miss8 Partnership Interest Purchase Agreement, incorporated herein by reference to Exhibit 10.2 of the Registrant's Quarterly Report on Form 10-Q for the Quarter ended August 31, 1994 (Commission File No. 0-1460).\n10.31 LA3, LA4, Miss8 Stock Purchase Agreement, incorporated herein by reference to Exhibit 10.3 of the Registrant's Quarterly Report on Form 10-Q for the Quarter ended August 31, 1994 (Commission File No. 0-1460).\n10.32 Acquisition Agreement by and among The Grass Valley Group, Inc., Tektronix, Inc., New Microtime Inc. and Andersen Group, Inc. dated as of September 9, 1994, incorporated herein by reference to Exhibit 10.1 of the Registrant's Quarterly Report on Form 10-Q for the Quarter ended November 30, 1994 (Commission File No. 0-1460).\n10.33 First Amendment to the Agreement by and among The Grass Valley Group, Inc., Tektronix, Inc., New Microtime Inc. and Andersen Group, Inc. dated as of September 9, 1994, incorporated herein by reference to Exhibit 10.2 of the Registrant's Quarterly Report on Form 10-Q for the Quarter ended November 30, 1994 (Commission File No. 0-1460).\n10.34 Letter Agreements, dated February 23, 1995 and March 20, 1995, between the Registrant and Ronald N. Cerny.*\n21. Subsidiaries of the Registrant.*\n(b) Reports on Form 8-K\nNo reports on Form 8-K were filed by the Company during the last quarter of the fiscal year ended February 28, 1995.\n*Filed 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.\nANDERSEN GROUP, INC. Date: May 19, 1995 - - -------------------- Registrant\n\/s\/ Francis E. Baker \/s\/ Jack E. Volinski - - ------------------------------- ------------------------------- Francis E. Baker Jack E. Volinski President Chief Financial Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nKPMG Peat Marwick LLP\nIndependent Auditors' Report\nThe Stockholders and Board of Directors Andersen Group, Inc.:\nUnder date of May 3, 1995, we reported on the consolidated balance sheets of Andersen Group, Inc. and subsidiaries as of February 28, 1995 and 1994, and the related consolidated statements of operations, common and other stockholders' equity, and cash flows for each of the years in the three-year period ended February 28, 1995, which are included in the annual report on Form 10-K for the year 1995. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related consolidated financial statement schedule as listed in the accompanying index under Part IV, Item 14. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement schedule based on our audits.\nIn our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.\n\/s\/ KPMG Peat Marwick LLP\nSpringfield, Massachusetts May 3, 1995\n- - -------------------------------------------------------------------------------- ANDERSEN GROUP, INC. SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS - - --------------------------------------------------------------------------------\na) Write offs net of recoveries. b) Offset of discontinued operation losses.\nEXHIBIT INDEX -------------","section_15":""}
{"filename":"809940_1995.txt","cik":"809940","year":"1995","section_1":"ITEM 1. BUSINESS\nNot Applicable.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nResidential Mortgage Pass-Through Certificates:\nThe series of residential mortgage pass-through certificates (as hereinafter defined in Item 5(b)), do not own any physical property. Title to real estate will only be acquired upon default of the mortgagors under the mortgage loans.\nCommercial Mortgage Pass-Through Certificates:\nFor Mortgage Pass-Through Certificates, Series 1994- M1, information regarding the mortgaged properties securing the mortgage loans is set forth in the Prospectus Supplement. Title to real estate will only be acquired upon default of the mortgagors under the mortgage loans.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThere are no material pending legal proceedings that involve any Series of Certificates, the Trustee, the Master Servicer or the Registrant with respect to any Series of Certificates nor is the Registrant aware of any proceedings known to be contemplated by governmental authorities.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThere have been no matters submitted to a vote of certificate holders.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\n(a) There is no established public trading market for the Certificates representing interests in conventional mortgage loan or manufactured housing contract pools established by the Registrant.\n(b) At December 29, 1995, the number of holders of record of each outstanding series of certificates (\"Series of certificates\"), for which a Form 15 has not been filed, were as follows:\n(c) Not Applicable.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nNot Applicable.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nNot Applicable\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nNot Applicable\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 (for each Series for which a form 15 has not been filed)\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\n(a) Not Applicable\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) Commercial Pass-Through Certificates - Annual Statements of Compliance: Reports of each Series of Certificates, for which a Form 15 has not been filed, prepared by the Master Servicers' independent public accountants, will be filed with the Current Reports on Form 8-K in the earliest month possible.\n(b) Reports on Form 8-K related to the Series of Certificates were filed on November 21, 1995, November 29, 1995, December 1, 1995, December 14, 1995, and January 25, 1996.\n(c) 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.\nMERRILL LYNCH MORTGAGE INVESTORS, INC.\nBy: \/s\/ Richard M. Fuscone Name: Richard M. Fuscone Title: President and Chairman of the Board Dated: March 27, 1996\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nBy: \/s\/ John C. Qua Name John C. Qua Title: Treasurer and Director Dated: March 27, 1996\nBy: \/s\/ Michael M. McGovern Name: Michael M. McGovern Title: Secretary and Director Dated: March 27, 1996\nEXHIBIT INDEX\nEXHIBIT 27 FINANCIAL DATA SCHEDULE EXHIBIT 99.1 SERVICER'S CERTIFICATION EXHIBIT 99.2 SERVICER'S CERTIFICATION EXHIBIT 99.3 SERVICER'S CERTIFICATION EXHIBIT 99.3 SERVICER'S CERTIFICATION EXHIBIT 99.4 SERVICER'S CERTIFICATION EXHIBIT 99.5 SERVICER'S CERTIFICATION","section_15":""}
{"filename":"713975_1995.txt","cik":"713975","year":"1995","section_1":"ITEM 1 - BUSINESS \t SUN BANCORP, INC. (SUN) is a holding company incorporated under the laws of Pennsylvania and registered under the Bank Holding Company Act of 1956, as amended, on November 26, 1982. SUN acquired the Snyder County Trust Company in June 1983 and The Watsontown National Bank in November 1987. On December 1, 1993, the two banks merged into one bank under the legal title of Sun Bank (Bank). The banks continue to do business as Snyder County Trust Company, Incorporated as Sun Bank and Watsontown Bank, Incorporated as Sun Bank. SUN also owns the Pennsylvania SUN Life Insurance Company, a credit life and disability insurance company formed in 1993. In 1995, SUN entered into a limited partnership with the Susquehanna Valley Development Group, Inc. for the purpose of building, owning and operating an affordable elderly apartment complex in Mifflinburg, PA. As part of the agreement, SUN is able to recognize tax credits from this economic development project. \t\t \tSun Bank, a state-chartered bank regulated by Pennsylvania Banking Law, provides full service commercial and retail banking services primarily in central Pennsylvania. Sun Bank operates six banking offices and one trust services office serving Snyder, Union, Northumberland and Lycoming Counties. At December 31, 1995, Sun Bank had total assets of $318,659,000 and total stock- holders' equity of $35,190,000. Net income for 1995 was $5,629,000. \t \tThe Bank offers a wide range of services including demand deposit accounts, savings accounts, Christmas and all-purpose clubs, time certificates of deposit, and individual retirement accounts, as well as commercial loans, consumer loans, mortgage loans, and safe deposit services. The Bank also operates a trust department that provides full fiduciary services. Also, eight Automated Teller Machines (ATMs) throughout the service area provide 24-hour banking service. Sun Bank's activities are such that the loss of one single customer or a few customers would not have a material adverse effect on its operations. Additionally, the Bank's business is not seasonal in nature nor does it engage in foreign transactions. The majority of the loan portfolio is comprised of residential real estate loans and consumer loans which generally are low-risk. The Bank's deposits are insured by the Federal Deposit In- surance Corporation (FDIC) in the amount allowed by law.\n\tThe Pennsylvania SUN Life Insurance Company provides credit life and dis- ability insurance to Sun Bank's credit customers. Pennsylvania SUN Life is subject to supervision and regulation by the Arizona Department of Insurance, the Insurance Department of the Commonwealth of Pennsylvania, and the Board of Governors of the Federal Reserve Bank. At December 31, 1995, Pennsylvania SUN Life had total assets of $446,000 and total stockholders' equity of $213,000. Net income for 1995 was $23,000.\n\tCompetition continues to heighten in the financial services industry not only among banks but with savings and loan associations, credit unions, discount brokerage firms, insurance companies, and other nonbank financial service providers. Changing regulatory and economic conditions affect SUN's ability to compete effectively in its market area. Most of the competition is centered around the setting of interest rates to be charged on loans and rates paid on deposits, fees on deposit accounts and customer service. SUN's management feels it competes effectively in its market area.\n\tSUN is subject to regulation and supervision by the Board of Governors of the Federal Reserve Bank and the Pennsylvania Department of Banking. SUN files quarterly and annual reports with the Federal Reserve Bank (FRB) of Phila- delphia and periodic on-site exams of SUN are done by the FRB. Regular exam- inations of the Bank are conducted by the FDIC and the Pennsylvania Department of Banking. \t SUN and the Pennsylvania SUN Life Insurance Company do not have any employees. At December 31, 1995, the Bank employed 113 persons. The Bank offers a variety of benefit programs and feels its relationship with its employees is good.\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2 - PROPERTIES\n\tSUN's corporate office is located in Sun Bank's main banking office. SUN owns all of its properties with the exception of an off-site ATM, Item 8 listed below, which is rented from Weis Markets, Inc., Sunbury, Pennsylvania. In 1995, SUN purchased parcels of land in Northumberland and Liverpool for the purpose of building branches on these sites in the future. The branch in Northumberland is scheduled to be in operation in the fall of 1996. SUN also purchased an existing branch location in Shamokin Dam formerly owned by Swineford National Bank. This site will be replacing our current branch office in Shamokin Dam in April 1997. All properties are in good condition and adequate for the bank's purposes. The following is a list of the banking offices, the addresses, and a brief description of each office.\n\tOffice\t\t\t\t Address\t\t\t\t Description 1. Main\t\t \t2-16 South Market Street Brick structure \t \t\t\tSelinsgrove, Pennsylvania 17870\n2. Shamokin Dam\t \tRoutes 11 & 15\t\t\t\t \tBrick structure \t \t\t\tShamokin Dam, Pennsylvania 17876\n3. New Berlin\t \tMarket & Plum Streets\t\t\t \tBrick structure \t\t \t\tNew Berlin, Pennsylvania 17855\n4. Sunbury\t\t\t 11 South Second Street\t\t \t\tBrick structure \t\t\t \tSunbury, Pennsylvania 17801\n5. Middleburg\t\t Route 522 & Dock Hill Road\t\t\t \tBrick structure \t\t\t \tMiddleburg, Pennsylvania 17842\n6. Trust Division\t 100 West Pine Street\t\t\t\t \tBrick structure \t\t\t\tSelinsgrove, Pennsylvania 17870\n7. Automated Teller\t \t108 West Pine Street\t\t\t\t\t Brick structure Machine\t\t\t Selinsgrove, Pennsylvania 17870\t\t\n8. Automated Teller\t\t 700 North Broad Street\t\t \t\tBrick structure Machine\t\t \tSelinsgrove, Pennsylvania 17870\n9. Watsontown\t \t300 Main Street\t\t\t \t\tBrick structure \t\t\t\t Watsontown, Pennsylvania 17777\n10. Northumberland\t \t96 Duke Street\t\t\t\t \tLand \t\t\t \tNorthumberland, Pennsylvania 17857\n11. Liverpool\t \t\tRts. 11 & 15 South Land \t\t\t\t Liverpool, Pennsylvania 17045\n12. Shamokin Dam\t\t 200 S. Susquehanna Trail\t\t\t\t Brick structure \t\t\t\t Shamokin Dam, Pennsylvania 17876\nITEM 3","section_3":"ITEM 3 - LEGAL PROCEEDINGS\n\tVarious legal actions arise against the Corporation in the normal course of business. In the opinion of management and counsel, when such actions currently pending or threatened have been resolved, they should not have a material adverse effect on the business or financial condition of the Corporation.\nITEM 4","section_4":"ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS \tNot applicable\nPART II\nITEM 5","section_5":"ITEM 5 - MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED \t \t \t SECURITY HOLDER MATTERS\n\tOn April 1993, the common stock of SUN BANCORP, INC. began trading publicly on the NASDAQ national market system under the symbol SUBI. Prior to this date, the stock was not traded on an established stock exchange; however, it was traded on the over-the-counter market. As of March 7, 1996, SUN had approx- imately 1,348 holders of its common stock.\n\tThe payment of dividends by SUN is at the discretion of the Board of Directors and to the extent funds are legally available for that purpose. SUN may not pay dividends in any year in excess of the total of the current year's net income and the retained net income of the prior two years without the approval of the Federal Reserve Bank. Additionally, bank regulations limit the amount of dividends that may be paid to SUN by the subsidiary bank without prior approval from the regulatory agencies.\n\tAdditional stock information is incorporated by reference to Stockholder Information found on page 36 of the 1995 Annual Report to Stockholders.\nITEM 6","section_6":"ITEM 6 - SELECTED FINANCIAL DATA\n\tThis item is incorporated by reference to information under the heading Five Year Financial Highlights on page 23 of the 1995 Annual Report to Stockholders.\nITEM 7","section_7":"ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION \t AND RESULTS OF OPERATIONS\n\tThis item is incorporated by reference to Management's Discussion and Analysis on pages 24 through 35 of the 1995 Annual Report to Stockholders.\nITEM 8","section_7A":"","section_8":"ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\n\tThis item is incorporated by reference to the Consolidated Financial State- ments, Notes to Consolidated Financial Statements and Report of Independent Certified Public Accountants set forth on pages 4 through 22 of the 1995 Annual Report to Stockholders.\nITEM 9","section_9":"ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON \t\t \t ACCOUNTING AND FINANCIAL DISCLOSURE\n\tNone\nPART III\nITEM 10","section_9A":"","section_9B":"","section_10":"ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT\n\tInformation concerning directors and executive officers of the Registrant is incorporated herein by reference to Board of Directors on page 6 of the Cor- poration's 1996 Proxy Statement.\n\tInformation regarding disclosure of delinquent filers pursuant to Item 405 of Regulation 5-K is incorporated herein by reference to Compliance with Securities and Exchange Act on page 20 of the Corporation's 1996 Proxy Statement.\nITEM 11","section_11":"ITEM 11 - EXECUTIVE COMPENSATION\n\tInformation relating to management remuneration and compensation is incor- porated herein by reference to Executive Compensation and Other Information on page 13 of the 1996 Proxy Statement.\nITEM 12","section_12":"ITEM 12 - SECURITY OWNERSHIP OR CERTAIN BENEFICIAL OWNERS AND \t\t \t MANAGEMENT\n\tThis information is incorporated by reference to Security Ownership of Directors and Executive Officers of the Corporation on page 11 of the 1996 Proxy Statement.\nITEM 13","section_13":"ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\n\tThis information is incorporated by reference to footnote 12 on page 17 of the 1995 Annual Report to Stockholders and under the heading of Transactions with Management on page 20 of the 1996 Proxy Statement.\nPART IV\nITEM 14","section_14":"ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON \t\t \t FORM 8-K\n(a) (1) The following consolidated financial statements and report of in- dependent certified public accounts of SUN BANCORP, INC. and subsidiaries included in the Annual Report to Stockholders for the year ended December 31, 1995 are incorporated by \t\t \t reference in Part II, Item 8:\n\t Consolidated Balance Sheets - December 31, 1995 and 1994\n\t Consolidated Statements of Income - Years Ended December 31, 1995, 1994 and 1993\n\t Consolidated Statements of Stockholders' Equity - Years Ended December 31, 1995, 1994 and 1993\n\t Consolidated Statements of Cash Flows - Years Ended December 31, 1995, 1994 and 1993\n\t Notes to Consolidated Financial Statements\n\t Report of Independent Certified Public Accountants\n(2) All schedules applicable to the Registrant are shown in the re- spective financial statements or the notes thereto. Financial statement schedules not included are omitted because the information is not required under the related instructions or it is inappli- cable.\n(3) Exhibits \t\t 3(i) The Articles of Incorporation of the Corporation are in- corporated herein by reference to Exhibit 3 to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1993 (Commission File Number 0-14745).\n\t 3(ii) The By-Laws, as amended and restated, are incorporated herein by reference to Exhibit 3 to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1993 (Commission File Number 0-14745).\n\t 13 Annual Report to Stockholders of SUN BANCORP, INC. for the year ended December 31, 1995 is filed herewith. Such report, except for those portions thereof which are expressly incorporated by reference herein, is furnished \t \t\t for information of the Securities and Exchange Commission only and it is not considered \"filed\" as part of the Form 10-K filing.\n22 Subsidiaries of the Registrant are filed herewith.\n23 Published Report Regarding Matters Submitted To Vote Of Security Holders is filed herewith, the 1996 Proxy Statement of SUN BANCORP, INC.\n(b) \tNo reports on Form 8-K were required to be filed during the fourth quarter of 1995.\n(c) \tExhibits - the required exhibits are included under Item 14(a) (3) of the Form 10-K.\n(d) \tFinancial statement schedules are omitted because the required informa- tion is not applicable or is included elsewhere herein. \t\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, SUN BANCORP, INC. 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 SUN BANCORP, INC.\t \t\t\t\t\t\t\t (Registrant)\t\t\n\t\t\t\t\t\tBy: \t\/s\/ Fred W. Kelly, Jr. \t\t\t\t\t\t\t President & Chief Executive Officer\n\t\t\t\t\t\tDate:\t 3\/25\/96\nName Date\n\/s\/ Fred W. Kelly, Jr. 3\/25\/96 President, Chief Executive Officer and Director\n\/s\/ Jeffrey E. Hoyt 3\/25\/96 Vice President, Principal Financial Officer and Chief Acccounting Officer\n\/s\/ Max E. Bingaman 3\/25\/96 Director\n\/s\/ Raymond C. Bowen 3\/25\/96 Director\n\/s\/ David R. Dieck 3\/25\/96 Director\n\/s\/ Louis A. Eaton 3\/25\/96 Director\n\/s\/ Dr. Robert E. Funk 3\/25\/96 Director\n\/s\/ Robert A. Hormell 3\/25\/96 Director\n\/s\/ George F. Keller 3\/25\/96 Director\n\/s\/ Lehman B. Mengel 3\/25\/96 Director\n\/s\/ Marlin T. Sierer 3\/25\/96 Director\n\/s\/ Jerry A. Soper 3\/25\/96 Director\n\/s\/ Dennis J. Van 3\/25\/96 Director","section_15":""}
{"filename":"277509_1995.txt","cik":"277509","year":"1995","section_1":"Item 1. Business.\nFederal Signal Corporation, founded in 1901, was reincorporated as a Delaware Corporation in 1969. The company is a manufacturer and worldwide supplier of safety, signaling and communications equipment, fire trucks, rescues, aerial access platforms, street sweeping and vacuum loader vehicles, parking control equipment, custom on-premise signage, carbide cutting tools, precision punches and related die components.\nProducts produced and services rendered by Registrant and its subsidiaries (referred to collectively as \"Registrant\" herein, unless context otherwise indicates) are divided into groups (business segments) as follows: Safety Products, Sign, Tool and Vehicle. This classification of products and services is based upon Registrant's historical divisional structure established by management for the purposes of internal control, marketing and accounting.\nDevelopments, including acquisitions of businesses, considered significant to the company or individual segments are described under the following discussions of the applicable groups.\nThe Financial Review sections, \"Consolidated Results of Operations,\" \"Group Operations\" and \"Financial Position and Cash Flow,\" and Note M - Segment Information contained in the Proxy Statement for the Annual Meeting of Shareholders to be held on April 17, 1996 are incorporated herein by reference.\nSafety Products Group\nThe Safety Products Group includes the Signal Products Division, Aplicaciones Tecnologicas VAMA S.L., acquired in May, 1992, Justrite Manufacturing, acquired in May, 1994, and Federal APD. The Signal Products Division consists of Emergency Products, Electrical Products, Federal Warning Systems and Commercial Products.\nSafety Products Group products manufactured by Registrant consist of: (1) a variety of visual and audible warning and signaling devices used by private industry, federal, state and local governments, building contractors, police, fire and medical fleets, utilities and civil defense; (2) safety containment products for handling and storing hazardous materials used by a wide variety of industrial and laboratory customers as well as military agencies and municipal, state and federal governments; and (3) parking, revenue control, and access control equipment and systems for parking facilities, commercial businesses, bridge and pier installation and residential developments.\nThe visual and audible warning and signaling devices include emergency vehicle warning lights, electromechanical and electronic vehicle sirens and industrial signal lights, sirens, horns, bells and solid state audible signals, audio\/visual emergency warning and evacuation systems, including weather and nuclear power plant warning notification systems and fire alarm system panels and devices.\nIn May 1994, the Registrant acquired the principal operating assets and assumed the principal operating liabilities of Justrite Manufacturing Company for cash. Justrite is an Illinois-based manufacturer of safety equipment for the storage, transfer, use and disposal of flammable and hazardous materials.\nThe safety containment products offered by Justrite include safety cabinets for flammables and corrosives; safety and dispenser cans; waste receptacles and disposal cans; spill control pallets and overpacks; and hazardous material storage buildings, lockers, pallets and platforms. These products are designed in accordance with various regulatory codes and standards, and meet agency approvals such as FM and UL.\nParking, revenue control, and access control equipment and systems include parking and security gates, card access readers, ticket issuing devices, coin and token units, fee computers, various forms of electronic control units and personal computer-based revenue and access control systems.\nWarning and signaling products, which account for the principal portion of the group's business, are marketed to both industrial and governmental users. Products are sold to industrial customers through manufacturers' representatives who sell to approximately 1,400 wholesalers. Products are also sold to governmental customers through more than 900 active independent distributors as well as through original equipment manufacturers and direct sales. International sales are made through the Registrant's independent foreign distributors or on a direct basis.\nBecause of the large number of Registrant's products, Registrant competes with a variety of manufacturers and suppliers and encounters varying competitive conditions among its different products and encounters different classes of customers. Because of the variety of such products and customers, no meaningful estimate of either the total number of competitors or Registrant's overall competitive position can be made. Generally, competition is intense as to all of Registrant's products and, as to most such products, is based on price, including competitive bidding, on product reputation and performance, and on product servicing. Although some competitors in certain product lines are larger than Registrant, the Registrant believes it is the leading supplier of particular products.\nIn May 1992, the Registrant acquired all of the outstanding shares of Aplicaciones Tecnologicas VAMA S.L. for cash and an earnout to be based upon future profitability of the company for a five-year period. VAMA is a leading European manufacturer of emergency vehicular signaling products located in Barcelona, Spain.\nIn December 1995, the Registrant acquired the principal operating assets of the Target Tech brand of warning lights for cash. Target Tech, located in Washington, is the domestic market leader in amber signaling products for construction and work vehicles.\nThe backlogs of orders of Safety Products Group products believed to be firm at December 31, 1995 and 1994 were $15.7 million and $14.0 million, respectively. Almost all of the backlogs of orders at December 31, 1995 are reasonably expected to be filled within the current fiscal year.\nSign Group\nThe Sign Group, operating principally under the name \"Federal Sign\" designs, engineers, manufactures, installs and maintains illuminated and non-illuminated sign displays, for both sale and lease. Registrant additionally provides sign repair services and also enters into maintenance service contracts, usually over three to five-year periods, for signs it manufactures as well as for signs produced by other manufacturers. Its operations are oriented to custom designing\nand engineering of commercial and industrial signs or groups of signs for its customers.\nThe sale and lease of signs and the sale of maintenance contracts are conducted primarily through Registrant's direct sale organization which operates from its twenty-three principal sales and manufacturing facilities located strategically throughout the continental U.S. Customers for sign products and services consist of local commercial businesses, as well as major national and multi-national companies.\nThe Sign Group's markets improved during 1995 with growth coming from many of its national and multi-national customers, as well as growth in the casino gaming industry. This growth, combined with the results of the aggressive restructuring programs implemented over the last few years, resulted in an improvement in operating income of 54% in 1995 versus 1994.\nA large number of Registrant's displays are leased to customers for terms of typically three to five years with both the lease and the maintenance portions of many such contracts then renewed for successive periods.\nRegistrant is nationally a principal producer of high-end custom and custom- quantity signs. The registrant has modified its marketing strategies to focus on a narrower market segment to which it can provide a more unique set of services. As a result of this change, the Registrant estimates that it now has approximately 100 regional and national competitors. Competition for sign products and services is intense and competitive factors consist largely of quality, prices, project and program management capabilities, aesthetic and design considerations, and maintenance services.\nTotal backlog at December 31, 1995, applicable to sign products and services was approximately $61.4 million compared to approximately $57.0 million at December 31, 1994. A significant part of Registrant's sign products and services backlog relates to sign maintenance contracts since such contracts are usually performed over long periods of time. At December 31, 1995, the Sign Group had a backlog of approximately $41.4 million compared to approximately $39.8 million at December 31, 1994, represented by in-service sign maintenance contracts. With the exception of the sign maintenance contracts, most of the backlog orders at December 31, 1995 are reasonably expected to be filled within the current fiscal year.\nTool Group\nTool Group products are produced by the Registrant's wholly-owned subsidiaries including: Dayton Progress Corporation, Schneider Stanznormalien GmbH, acquired in 1992, Jamestown Punch and Tooling, Inc., Manchester Tool Company, Dico Corporation, acquired in 1992, and Bassett Rotary Tool Company.\nDayton Progress Corporation manufactures and purchases for resale an extensive variety of consumable die components for the metal stamping industry. These components consist of piercing punches, matched die matrixes, punch holders or retainers and many other products related to a metal stamper's needs. Registrant also produces a large variety of consumable precision metal products for customers' nonstamping needs, including special heat exchanger tools, beverage container tools, powder compacting units and molding components.\nIn March 1992, Dayton Progress Corporation acquired for cash the assets of Schneider Stanznormalien GmbH, a German manufacturer of precision punch and die\ncomponents. This acquisition gives Dayton Progress manufacturing capabilities on the European continent and provides greater access to European markets.\nIn October 1991, Dayton Progress Corporation acquired for cash and stock all of the outstanding shares of Container Tooling Corporation. Container Tool manufactures and distributes body punch tooling used in the production of aluminum and steel beverage cans. The product complements Dayton Progress' tab- top tooling product line. In October 1994 the Container Tool operations were relocated to Dayton Progress' facilities in Dayton, Ohio.\nJamestown Punch and Tooling, Inc. manufactures an extensive line of consumable special die components for the metal stamping and plastic molding industries in addition to a variety of precision ground high alloy parts. Sales are made on both a direct basis and through a limited distributor organization.\nManchester Tool Company manufactures consumable carbide insert tooling for cutoff and deep grooving metal cutting applications.\nIn November 1992, Manchester Tool Company acquired for cash all of the outstanding shares of Dico Corporation, a manufacturer of polycrystalline diamond and cubic boron nitride cutting tools. This product line complements Manchester Tool's carbide insert products and allows for entry into new market niches within general business areas already served.\nBassett Rotary Tool Company is a manufacturer of round consumable carbide cutting tools. Its products are medium to high precision in their manufacture and at times are quite complex in their configuration. The products represent a narrow band of the much broader cutting tool industry and require a high level of manufacturing skill.\nBecause of the nature of and market for the Registrant's products, competition is great at both domestic and international levels. Many customers have some ability to produce the product themselves, but at a cost disadvantage. Major market emphasis is placed on quality of product and level of service.\nTool Group products are labor intensive with the only significant outside cost being the purchase of the tool steel, carbide and diamond raw material, as well as items necessary for manufacturing. Inventories are maintained to assure prompt service to the customer with the average order for standard tools filled in less than one week for domestic shipments and within two weeks for interna tional shipments.\nTool Group customers include metal and plastic fabricators and tool and die shops throughout the world. Because of the nature of the products, volume depends mainly on repeat orders from customers numbering in the thousands. These products are used in the manufacturing process of a broad range of items such as automobiles, appliances, construction products, electrical motors, switches and components and a wide variety of other household and industrial goods. Almost all business is done with private industry.\nRegistrant's products are marketed in the United States, and many international markets, principally through industrial distributors. Foreign manufacturing facilities, as well as sales and distribution offices, are located in Weston, Ontario; Tokyo, Japan; Warwickshire, England; and Frankfurt, Germany.\nOrder backlogs of the Tool Group as of December 31, 1995 and December 31, 1994 were $7.7 million and $9.5 million, respectively. All of the backlogs of\norders at December 31, 1995 are expected to be filled within the current fiscal year.\nVehicle Group\nThe Vehicle Group is composed of Emergency One, Inc., Bronto Skylift Oy Ab acquired in August, 1995, Superior Emergency Vehicles, Ltd., acquired in 1991, Elgin Sweeper Company, Vactor Manufacturing, Inc., acquired in 1994, Guzzler Manufacturing, Inc., acquired in 1993, and Ravo International.\nEmergency One, Inc. is a leading manufacturer of fire trucks and rescue vehicles including four and six-wheel drive rescue trucks, tankers, pumpers, aerial ladder trucks, and airport rescue and fire fighting vehicles (each of aluminum construction for rust-free operation and energy efficiency).\nIn December 1991, Emergency One acquired for cash all of the outstanding shares of Frontline Corporation, a manufacturer and distributor of ambulances and rescue trucks. The acquisition of Frontline Corporation complemented Emergency One's product line and enabled Emergency One to provide a complete product line of fire trucks, fire apparatus, emergency support and ambulance vehicles for distribution through Emergency One's domestic and international dealer network. The company was merged into Emergency One in January 1994.\nIn August 1995, The Registrant acquired for cash, Bronto Skylift Oy Ab, located in Tampere, Finland. Bronto is a manufacturer of vehicle-mounted aerial access platforms for fire rescue and heavy duty industrial markets. The acquisition offers an excellent fit with Emergency One as both companies expand their worldwide product offering.\nIn December 1991, Emergency One acquired for cash, Superior Emergency Vehicles, Ltd., a manufacturer and distributor of a full range of fire truck bodies primarily for the Canadian market. In addition to increased manufacturing capacity, the acquisition of Superior Emergency Vehicles, Ltd. provides greater access to the Canadian market.\nElgin Sweeper Company is the leading manufacturer in the United States of self-propelled street cleaning vehicles. Utilizing three basic cleaning methods (mechanical sweeping, vacuuming and recirculating air), Elgin's products are primarily designed for large-scale cleaning of curbed streets and other paved surfaces.\nIn June 1994, the Registrant acquired the principal operating assets and assumed the principal operating liabilities of Peabody Myers Corporation (\"Vactor\") for cash. Vactor Manufacturing, Inc. is an Illinois-based manufacturer of municipal combination catch basin\/sewer cleaning vacuum trucks. This acquisition provides a significant expansion of the Registrant's offering of municipal equipment and enhances the domestic and international dealer networks of both Elgin Sweeper and Vactor.\nIn March 1993, Elgin Sweeper Company acquired, principally for cash, all of the outstanding shares of Guzzler Manufacturing, Inc. Guzzler is an Alabama- based manufacturer and marketer of waste removal vehicles, using vacuum technology, for worldwide industrial and environmental markets. The acquisition of Guzzler Manufacturing, Inc. complemented Elgin Sweeper Company's product distribution and provided for increased exposure to the industrial marketplace for both Elgin and Guzzler.\nRavo International, a Netherlands-based street sweeper manufacturer, is a leading European manufacturer and marketer of self-propelled street and sewer cleaning vehicles. Utilizing the vacuuming cleaning method, Ravo's products are primarily designed for cleaning of curbed streets and other paved surfaces.\nAll of the Vehicle Group companies also sell accessories and replacement parts for their products. Ravo International also provides after-market service and support for its products in the Netherlands.\nSome products and components thereof are not manufactured by Registrant but are purchased for incorporation with products of Registrant's manufacture.\nA majority of Vehicle Group sales are made to domestic and overseas municipalities and other governmental units. Vacuum loader vehicles produced by Guzzler are principally sold to industrial customers. Worldwide sales are principally conducted by domestic and international dealers, in most areas, with some sales being made on a direct-to-user basis.\nRegistrant competes with several domestic and foreign manufacturers and due to the diversity of products offered, no meaningful estimate of either the number of competitors or Registrant's relative position within the market can be made, although Registrant does believe it is a major supplier within these product lines. Registrant competes with numerous foreign manufacturers principally in international markets.\nAt December 31, 1995, the Vehicle Group backlogs were $166.7 million compared to $180.5 million at December 31, 1994. The backlogs at December 31, 1995, included approximately $16.9 million of backlog attributable to Bronto Skylift, which was acquired in August 1995. A substantial majority of the orders in the backlogs at December 31, 1995 are reasonably expected to be filled within the current fiscal year. Approximately $6.4 million of the backlogs at December 31, 1995 and $24.0 million of the backlogs at December 31, 1994 represent the remaining funded portion of a subcontract to build P-23 airport rescue and fire fighting vehicles for the U.S. Air Force. Production of vehicles under this subcontract is expected to be completed in 1996.\nAdditional Information\nRegistrant's sources and availability of materials and components are not materially dependent upon either a single vendor or very few vendors.\nRegistrant owns a number of patents and possesses rights under others to which it attaches importance, but does not believe that its business as a whole is materially dependent upon any such patents or rights. Registrant also owns a number of trademarks which it believes are important in connection with the identification of its products and associated goodwill with customers, but no material part of Registrant's business is dependent on such trademarks.\nRegistrant's business is not materially dependent upon research activities relating to the development of new products or services or the improvement of existing products and services, but such activities are of importance as to some of Registrant's products. Expenditures for research and development by the Registrant were approximately $7.0 million in 1995, $7.0 million in 1994 and $5.6 million in 1993.\nNote M - Segment Information, presented in the Registrant's Proxy Statement for the Annual Meeting of Shareholders to be held on April 17, 1996, contains\ninformation concerning the Registrant's foreign sales, export sales and operations by geographic area, and is incorporated herein by reference.\nCertain of the Registrant's businesses are susceptible to the influences of seasonal buying or delivery patterns. The Registrant's businesses which tend to have lower sales in the first calendar quarter compared to other quarters as a result of these influences are signage, street sweeping, outdoor warning, other municipal emergency signal products, parking systems and aerial access platform manufacturing operations.\nNo material part of the business of Registrant is dependent either upon a single customer or very few customers. The Registrant is in substantial 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. These provisions have had no material adverse impact upon capital expenditures, earnings or competitive position of the Registrant and its subsidiaries. The Registrant employed 6,015 people in ongoing businesses at the close of 1995. The Registrant believes relations with its employees have been satisfactory.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nAs of March 1, 1996, the Registrant utilized twenty-nine principal manufacturing plants located primarily throughout North America, as well as ten in Europe and one in the Far East. In addition, there were thirty-six sales and service\/warehouse sites, with thirty-three being domestically based and three located overseas. About half of the manufacturing plants are owned, whereas all the sales and service\/warehouse sites are leased.\nIn total, the Registrant devoted approximately 1,585,000 square feet to manufacturing and 955,000 square feet to service, warehousing and office space, as of March 1, 1996. Of the total square footage, approximately 30% is devoted to the Safety Products Group, 14% to the Sign Group, 11% to the Tool Group and 45% to the Vehicle Group. Approximately 61% of the total square footage is owned by the Registrant, with the remaining 39% being leased.\nAll of the Registrant's properties, as well as the related machinery and equipment, are considered to be well-maintained, suitable and adequate for their intended purposes. In the aggregate, these facilities are of sufficient capacity for the Registrant's current business needs.\nCapital expenditures for the years ended December 31, 1995, 1994, and 1993 were $15.7 million, $11.1 million, and $10.1 million, respectively. Registrant anticipates total capital expenditures in 1996 will be approximately 30% to 50% greater than 1995 amounts.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nThe Registrant is subject to various claims, other pending and possible legal actions for product liability and other damages and other matters arising out of the conduct of the Registrant's business. The Registrant believes, based on current knowledge and after consultation with counsel, that the outcome of such claims and actions will not have a material adverse effect on the Registrant's consolidated financial position or the results of operations.\nOn December 29, 1995, the company settled a lawsuit with Duravision, Inc. and Manufacturers Product Research Group of North America, Inc. for $6.7 million.\nAs a result of the settlement, the company recorded a net after-tax charge to income of $4.2 million, or $.09 per share. The charge, included in other income and expense, was recorded in the fourth quarter of 1995. The resolution of this case will have no effect on the company's future operating performance as it involved a discontinued product line. The company is actively seeking recoveries from its original trial counsel.\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 three months ended December 31, 1995.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Stock and Related Security Holder Matters.\nFederal Signal Corporation's Common Stock is listed and traded on the New York Stock Exchange under the symbol FSS. Market price range and dividend per share data listed in Note N - Selected Quarterly Data (Unaudited) contained in the Registrant's Proxy Statement for the Annual Meeting of Shareholders to be held on April 17, 1996 is incorporated herein by reference. As of March 1, 1996, there were 5,450 holders of record of the Registrant's common stock.\nCertain long-term debt agreements impose restrictions on Registrant's ability to pay cash dividends on its common stock. All of the retained earnings at December 31, 1995, were free of any restrictions.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nSelected Financial Data contained in the Registrant's Proxy Statement for the Annual Meeting of Shareholders to be held on April 17, 1996 is incorporated herein by reference.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nThe Financial Review sections \"Consolidated Results of Operations,\" \"Group Operations,\" \"Financial Services Activities,\" and \"Financial Position and Cash Flow\" contained in the Registrant's Proxy Statement for the Annual Meeting of Shareholders to be held on April 17, 1996 are incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nThe consolidated financial statements and accompanying footnotes of the Registrant and the report of the independent auditors set forth in the Registrant's Proxy Statement for the Annual Meeting of Shareholders to be held on April 17, 1996 are incorporated herein by reference.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.\nNone.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant.\nThe information under the caption \"Election of Directors\" contained in the Registrant's Proxy Statement for the Annual Meeting of Shareholders to be held on April 17, 1996 is incorporated herein by reference.\nThe following is a list of the Registrant's executive officers, their ages, their business experience and their positions and offices as of March 1, 1996:\nJoseph J. Ross, age 50, was elected Chairman, President and Chief Executive Officer in February, 1990. Previously he served as President and Chief Executive Officer since December 1987 and as Chief Operating Officer since July 1986.\nJohn A. DeLeonardis, age 48, was elected Vice President-Taxes in January 1992. He first joined the company as Director of Tax in November 1986.\nHenry L. Dykema, age 56, joined the Registrant as Vice President and Chief Financial Officer in January 1995. Mr. Dykema was self-employed from September 1993 to December 1994 and served as Vice President-Finance and Chief Financial Officer of Kennametal, Inc. from October 1989 to August 1993.\nRobert W. Racic, age 47, was elected Vice President and Treasurer in April 1984.\nRichard L. Ritz, age 42, was elected Vice President and Controller in January 1991. He was appointed Controller effective November 1985.\nKim A. Wehrenberg, age 44, was elected Vice President, General Counsel and Secretary effective October 1986.\nThese officers hold office until the next annual meeting of the Board of Directors following their election and until their successors shall have been elected and qualified.\nThere are no family relationships among any of the foregoing executive officers.\nItem 11.","section_11":"Item 11. Executive Compensation.\nThe information contained under the caption \"Executive Compensation\" of Registrant's Proxy Statement for the Annual Meeting of Shareholders to be held April 17, 1996 is incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nThe information contained under the caption \"Security Ownership of Certain Beneficial Owners\" of Registrant's Proxy Statement for the Annual Meeting of Shareholders to be held April 17, 1996 is incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nThe information contained under the caption \"Executive Compensation\" of Registrant's Proxy Statement for the Annual Meeting of Shareholders to be held April 17, 1996 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 of Federal Signal Corporation and Subsidiaries included in the Registrant's Proxy Statement for the Annual Meeting of Shareholders to be held on April 17, 1996 are filed as a part of this report and are incorporated by reference in Item 8:\nConsolidated Balance Sheets -- December 31, 1995 and 1994\nConsolidated Statements of Income -- Years ended December 31, 1995, 1994 and 1993\nConsolidated Statements of Cash Flows -- Years ended December 31, 1995, 1994 and 1993\nNotes to Consolidated Financial Statements\n2. Financial Statement Schedules\nThe following consolidated financial statement schedule of Federal Signal Corporation and Subsidiaries, for the three years ended December 31, 1995, is filed as a part of this report in response to Item 14(d):\nSchedule II -- Valuation and qualifying accounts\nAll other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore, have been omitted.\n3. Exhibits\n3. a. Restated Certificate of Incorporation of Registrant and Certificate of Amendment, filed as Exhibit (3)(a) to Registrant's Form 10-K for the year ended December 31, 1991, is incorporated herein by reference.\nb. By-laws of Registrant, filed as Exhibit (3)(b) to Registrant's Form 10-K for the year ended December 31, 1991, is incorporated herein by reference.\n4. a. Rights Agreement, filed as Exhibit (4)(a) to Registrant's Form 10-K for the year ended December 31, 1993, is incorporated herein by reference.\nb. The Registrant has no long-term debt agreements for which the related outstanding debt exceeds 10% of consolidated total assets as of December 31, 1995. Copies of debt instruments for which the related debt is less than 10% of consolidated total assets will be furnished to the Commission upon request.\n10. a. 1988 Stock Benefit Plan, filed as Exhibit (10)(a) to Registrant's Form 10-K for the year ended December 31, 1991, is incorporated herein by reference.\nb. Corporate Management Incentive Bonus Plan, filed as Exhibit (10)(b) to Registrant's Form 10-K for the year ended December 31, 1994, is incorporated herein by reference.\nc. Supplemental Pension Plan.\nd. Executive Disability, Survivor and Retirement Plan.\ne. Supplemental Savings and Investment Plan, filed as Exhibit (10)(f) to Registrant's Form 10-K for the year ended December 31, 1993, is incorporated herein by reference.\nf. Employment Agreement with Joseph J. Ross, filed as Exhibit (10)(g) to Registrant's Form 10-K for the year ended December 31, 1994, is incorporated herein by reference.\ng. Change of Control Agreement with Kim A. Wehrenberg, filed as Exhibit (10)(h) to Registrant's Form 10-K for the year ended December 31, 1994, is incorporated herein by reference.\nh. Director Deferred Compensation Plan, filed as Exhibit (10)(j) to Registrant's Form 10-K for the year ended December 31, 1992, is incorporated herein by reference.\ni. Director Retirement Plan, filed as Exhibit (10)(k) to Registrant's Form 10-K for the year ended December 31, 1992, is incorporated herein by reference.\n11. Computation of net income per common share\n13. 1995 Proxy Statement for the Annual Meeting of Shareholders to be held April 17, 1996. Such report, except for those portions thereof which are expressly incorporated by reference in this Form 10-K, is furnished for the information of the Commission only and is not to be deemed \"filed\" as part of this filing.\n21. Subsidiaries of the Registrant\n23. Consent of Independent Auditors\n27. Financial Data Schedule\n(b) Reports on Form 8-K\nNo reports on Form 8-K were filed for the three months ended December 31, 1995.\n(c) and (d)\nThe response to this portion of Item 14 is being submitted as a separate section of this report.\nOther Matters\nFor the purposes of complying with the amendments to the rules governing Form S-8 (effective July 13, 1990) under the Securities Act of 1933, the undersigned Registrant hereby undertakes as follows, which undertaking shall be incorporated by reference into Registrant's Registration Statements on Form S-8 Nos. 33-12876, 33-22311, 33-38494, 33-41721 and 33-49476, dated April 14, 1987, June 26, 1988, December 28, 1990, July 15, 1991 and June 9, 1992, respectively:\nInsofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the Registrant pursuant to the foregoing provisions, or otherwise, the Registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a director, officer or controlling person of the Registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the Registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue.\nSignatures\nPursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nFEDERAL SIGNAL CORPORATION\nBy: Joseph J. Ross March 27, 1996 Chairman, President, Chief Executive Officer and Director\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below, on March 27, 1996, by the following persons on behalf of the Registrant and in the capacities indicated.\nHenry L. Dykema Walter R. Peirson Vice President and Chief Director Financial Officer\nRichard L. Ritz J. Patrick Lannan, Jr. Vice President and Controller Director\nJames A. Lovell, Jr. Director\nThomas N. McGowen, Jr. Director\nRichard R. Thomas Director","section_15":""}
{"filename":"12659_1995.txt","cik":"12659","year":"1995","section_1":"ITEM 1. BUSINESS.\nGENERAL DEVELOPMENT OF BUSINESS\nH&R Block, Inc. is a diversified services corporation that was organized in 1955 under the laws of the State of Missouri (the \"Company\"). It is the parent corporation in a two-tier holding company structure following a 1993 corporate restructuring. The second-tier holding company is H&R Block Group, Inc., a Delaware corporation and the direct owner of all of the shares of the Company's primary operating subsidiary corporations. Such primary operating subsidiaries consist of CompuServe Incorporated, H&R Block Tax Services, Inc., and Block Financial Corporation. Developments within each of these segments of the Company during fiscal year 1995 are described in the section below entitled \"Description of Business.\"\nDuring the year ended April 30, 1995, the Company was not involved in any bankruptcy, receivership or similar proceedings or any material reclassifications, mergers or consolidations and the Company did not acquire or dispose of any material amount of assets otherwise than in the ordinary course of business.\nOn April 4, 1995, the Company acquired SPRY, Inc., a private Washington corporation and a provider of Internet access applications for the office, home and publishing markets (\"SPRY\"). The transaction involved the acquisition by a wholly- owned subsidiary of the Company of all of the outstanding SPRY common and preferred stock in exchange for 401,768 shares of the Company's Delayed Convertible Preferred Stock valued at $54.2 million and cash, including acquisition expenses, of $41.8 million. Additionally, management stock options for 98,900 shares of SPRY common stock were converted to stock options for 51,828 shares of the Company's Delayed Convertible Preferred Stock, valued at approximately $5.6 million. The acquisition was accounted for as a purchase and the Company recorded a charge to earnings of $83.5 million for purchased research and development in connection with the acquisition. Following the end of fiscal year 1995, the Company contributed the stock of SPRY to H&R Block Group, Inc.\nEach of the shares of Delayed Convertible Preferred Stock, without par value, issued by the Company in connection with the acquisition of SPRY, is convertible on or after April 5, 1998, into four shares of Common Stock of the Company, subject to adjustment in certain events. The holders of the shares of Delayed Convertible Preferred Stock are not entitled to receive dividends and such shares have no voting rights associated therewith.\nSPRY has become the Internet Services Division of CompuServe Incorporated, although it remains a separate legal entity at this time. Such Division is described in the portion of the section below entitled \"Description of Business\" pertaining to CompuServe Incorporated.\nAfter the close of fiscal year 1995, the Company sold MECA Software, Inc. (\"MECA\"), a Delaware corporation involved in developing, publishing and marketing personal productivity software products, to Bank of America, N.T. & S.A., and NationsBank, N.A. (Carolinas) for $35 million, subject to certain closing adjustments. MECA's primary product is Managing Your Money (trademark), computer software designed to assist individuals in managing personal finances. The Company has retained ownership of the TaxCut (trademark) and Small Business Attorney (trademark) software products.\nOn April 12, 1995, Thomas M. Bloch submitted his resignation as President and Chief Executive Officer of the Company, effective August 31, 1995, in order to pursue a number of non- business alternatives. A search committee consisting of three members of the Board of Directors was appointed to assist in the process of selecting a new Chief Executive Officer of the Company.\nFINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS\nThe information required by Item 101(b) of Regulation S-K relating to financial information about industry segments is contained in the Notes to Consolidated Financial Statements in the Company's annual report to security holders for the fiscal year ended April 30, 1995, and is hereby incorporated by reference.\nNUMBER OF EMPLOYEES\nThe Company, including its subsidiaries, has approximately 3,900 regular full-time employees. The highest number of persons employed by the Company during the fiscal year ended April 30, 1995, including seasonal employees, was approximately 91,000.\nDESCRIPTION OF BUSINESS\nCOMPUSERVE INCORPORATED (\"COMPUSERVE\")\nGENERALLY. The Company's computer services segment is comprised of CompuServe Incorporated, its subsidiaries and SPRY, Inc. CompuServe, the information services and computer communications subsidiary based in Columbus, Ohio, operates through three major divisions - CompuServe Information Services, CompuServe Network Services and CompuServe Internet Services (SPRY). CompuServe became a wholly-owned subsidiary of the Company in May 1980 and is presently a wholly-owned subsidiary of H&R Block Group, Inc. From its origins as a computer time- sharing firm, CompuServe has become a leading provider of computer-based information and communications services to businesses and individual owners of personal computers. In addition, the acquisition of SPRY in April 1995 was designed to place CompuServe at the forefront of the Internet industry.\nCompuServe's largest division is its Information Services Division. The CompuServe Information Service, the online service for personal computer owners, provides subscribers with access to data services and interactive communication through the use of networked mainframes, servers and personal computers. The world- wide customer base of the online services operated by CompuServe and its international licensee and distributors grew to approximately 3.2 million subscribers at the end of fiscal year 1995, compared to approximately 1.9 million at the end of the previous year. Exclusive of such licensee and distributors, the customer base at fiscal year end was approximately 2.1 million, an increase of 55% over the number of subscribers at the end of fiscal year 1994. Of the 2.1 million subscribers, more than 300,000 are located in Europe, an increase from approximately 100,000 European subscribers at the end of fiscal year 1994.\nCompuServe has licensed its core technology and network model relating to its online service into Japan. The Japanese licensee operates its own online service based on the CompuServe technology and model, and pays CompuServe royalties. CompuServe also has arrangements with various distributors in Japan, Australia, Mexico and other parts of the world whose main function is to generate customers for the CompuServe Information Service. While such overseas customers enter into contracts with CompuServe, they generally initiate their connection with the CompuServe Information Service through the distributors' telecommunications networks. CompuServe pays royalties to such distributors for the business that they generate and the associated support services that they provide to CompuServe members in the countries in which they operate.\nAmong the many services accessible through CompuServe's information system are online shopping services, stock market related services and airline reservation services. Customers can also play computer games, conduct research, send and receive messages, access the Internet and exchange helpful tips about computer use through special interest bulletin boards called \"Forums\" simply by connecting their personal computers to an ordinary telephone line.\nThrough its Information Services Division, CompuServe has also developed a wide range of business services that enable companies to link their employees with the information needed to conduct business. The services include electronic mail, internal corporate information systems for diverse applications, and a host of business-related databases. Electronic mail and other communications systems provided by CompuServe allow business users flexible, two-way access to information in operating areas such as sales, marketing, investment research and information management. Through the use of these systems, suppliers and customers are able to access information easily and securely through personal computers and computer terminals.\nThe Internet Services Division of CompuServe is a leader in the Internet commercialization industry. This Division resulted from the Company's acquisition in April 1995 of SPRY, Inc., the Seattle-based developer of Internet access systems. SPRY's skills in the development of Internet access software and in offering Internet business solutions are being combined with CompuServe's skills in the online and network industries to form a source for consumer Internet access, online content development, software development, online information design, Web server integration, network access and security management. The Internet Services Division produces \"Internet In A Box\" and \"Mosaic In A Box,\" two popular products for consumers and businesses that provide access to the Internet through Windows computer formats.\nCompuServe's Network Services Division provides the infrastructure that supports the CompuServe Information Service and CompuServe Internet Services, as well as value-added packet data network, frame relay and local area network services to corporations and many other diverse organizations. CompuServe's highly sophisticated and efficient telecommunications network links CompuServe subscribers and system users to each other, to CompuServe's central computer facilities or to other computer centers and data bases distributed across the country and around the world. By the end of fiscal year 1995, CompuServe had more than 430 points-of-presence worldwide and more than 42,000 dial ports through which members and customers connect to CompuServe's network and services.\nThe Network Services Division offers its customers a fast and reliable data communications system that can be customized to meet their particular requirements. The number of clients of the Network Services Division totalled 750 at the end of fiscal year 1995, an increase from the 586 clients at the end of fiscal year 1994. Major products of the Division include X.25, RLA (remote LAN access) and FRAME-Net (trademark) frame relay services.\nOne of the many applications for which the CompuServe network is utilized by its customers relates to point-of-sale transactions. CompuServe is a leading provider of value-added telecommunications services for point-of-sale authorization of credit card purchases. Using the CompuServe network, a merchant can pass a customer's card through a computer terminal and determine almost instantly whether the card is valid.\nEarly in fiscal year 1995, CompuServe disposed of CompuServe Data Technologies, a division that marketed database management software, and Collier-Jackson, Inc., a subsidiary of CompuServe that marketed newspaper management and financial software.\nFollowing the end of fiscal year 1995, Robert J. Massey, formerly Executive Vice President, Network Services Division, was elected President and Chief Executive Officer of CompuServe. Mr. Massey succeeded Maurice A. Cox, Jr., who resigned in order to form a venture capital investment company in Ohio.\nSERVICE MARKS, TRADEMARKS, PATENTS OR COPYRIGHTS. CompuServe claims ownership of the following trademarks and service marks registered on the principal register of the United States Patent and Trademark Office:\nCompuServe B Protocol The Electronic Mall WINCIM B+ Protocol FRAME-Net Forum The Source CB Simulator Alumni Advantage CompuServe Information Manager MacNav InfoPlex\nCompuServe also owns or claims numerous unregistered service marks or trademarks.\nCompuServe will receive its first patent in fiscal year 1996. The patent will cover technology CompuServe invented for seamlessly switching computer transactions among the various servers and mainframe computers that CompuServe operates. CompuServe presently holds no other patents on its technology, although several are presently pending. CompuServe is licensed by others to use various software programs and technology which it uses in various ways in its business.\nCOMPETITIVE CONDITIONS. The online information, Internet commercialization and value-added network services businesses are highly competitive and consist of a large number of companies. In terms of subscriber base, CompuServe is one of the largest providers of worldwide online information services. CompuServe has two significant competitors in the United States in the online information services industry, as well as numerous smaller competitors. In addition, several large U.S. companies have entered the online information services marketplace, or are about to enter such marketplace. Principal methods of competition in the online industry are price, content, ease of use and customer service.\nThe value-added network services industry is highly fragmented and no single supplier can be considered to occupy a dominant position in the industry. CompuServe's Internet Services Division competes with many Internet access providers, most of which operate in limited geographic areas. The Internet Services Division also competes with software and publishing companies that develop Internet applications and online content.\nH&R BLOCK TAX SERVICES, INC. (\"TAX SERVICES\")\nGENERALLY. The income tax return preparation and related services segment is the original core business of the Company. The services of this segment are provided to the public through a system of offices operated by Tax Services or by others to whom Tax Services has granted franchises. References in this section to \"Tax Services\" include H&R Block Tax Services, Inc., and its subsidiaries involved in the income tax return preparation business, and references in this section to \"H&R Block\" include both Tax Services and its franchisees.\nTax Services provides income tax return preparation services, electronic filing services and other services relating to income tax return preparation in many parts of the world. For U.S. returns, H&R Block offers a refund anticipation loan service in conjunction with its electronic filing service. H&R Block also markets its knowledge of how to prepare income tax returns through its income tax training schools. These schools teach taxpayers how to prepare their own income tax returns, as well as provide Tax Services with a source of trained income tax return preparers. During the 1995 fiscal year, 118,316 students enrolled in H&R Block's basic and advanced income tax courses, compared to 133,458 students during fiscal year 1994.\nTAXPAYERS SERVED. H&R Block served 17,060,000 taxpayers worldwide during fiscal year 1995, a decrease from the 18,107,000 taxpayers served in fiscal year 1994. \"Taxpayers served\" includes taxpayers for whom H&R Block prepared income tax returns as well as taxpayers for whom Block provided only electronic filing services.\nThe decrease in the number of taxpayers served by H&R Block in fiscal year 1995 primarily related to H&R Block's electronic filing and refund anticipation loan (\"RAL\") services. Under the 1995 RAL program, Tax Services' electronic filing customers who meet certain eligibility criteria are offered the opportunity to apply for loans from Beneficial National Bank in amounts based upon the customer's anticipated federal income tax refunds. Income tax return information is simultaneously transmitted by H&R Block to the Internal Revenue Service and the lending bank. Within a few days after the date of filing, a check in the amount of the loan, less the bank's transaction fee and H&R Block's tax return preparation fee and electronic filing fee, is received by the RAL customer. The Internal Revenue Service (\"IRS\") then directly deposits the participating customer's actual federal income tax refund into a designated account at the bank in order for the loan to be repaid.\nPrior to the 1995 tax season, the IRS used a Direct Deposit Indicator (\"DDI\") to notify the electronic filer after receiving the taxpayer's electronically filed tax return that the taxpayer's request for direct deposit of the refund would be honored. The bank offering the RAL relied on the DDI to minimize loan losses and the DDI, therefore, enabled such bank to make RALs under relatively favorable terms to taxpayers. In October\n1994, the IRS announced that it was eliminating the DDI for the 1995 tax season in an effort to curb fraudulent tax refund claims. During the 1995 tax season, the IRS made further changes to its electronic return processing systems and procedures to crack down on taxpayer fraud believed to be associated with the earned income tax credit (\"EITC\") claimed on returns. These changes resulted in delays in the IRS's issuance of refunds associated with the EITC. In reaction to the IRS changes, more stringent criteria were adopted in the loan approval process, the bank's transaction fee increased in many cases and, during much of the tax season, RALs were not made available on the portion of a refund amount attributable to the EITC. Consequently, fewer customers chose to apply for RALs and have their returns electronically filed. H&R Block experienced a 21% decline in fiscal year 1995 in the number of returns filed electronically.\nTAX RETURN PREPARATION. During the 1995 income tax filing season (January 3 through April 30), H&R Block offices prepared approximately 15,059,000 individual United States and Canadian income tax returns, compared to the preparation of 15,181,000 such returns in fiscal year 1994. About 12,918,000 of the returns prepared in fiscal 1995 were United States returns, constituting 12% of an Internal Revenue Service estimate of total U.S. individual income tax returns filed during that time period. Tax Services and its franchisees prepared approximately 2,141,000 Canadian returns filed with Revenue Canada during the 1995 income tax filing season, compared with 2,144,000 Canadian returns prepared in the previous year. H&R Block also prepares U.S. income tax returns in other countries and Australian tax returns in Australia. The returns prepared at offices in countries outside of the United States and Canada constituted 2.6% of the total returns prepared by H&R Block in the last fiscal year. The following table shows the approximate number of income tax returns prepared at H&R Block offices in the United States and Canada during the last five tax filing seasons:\nTax Season Ended April 30 (in thousands) -------------------------------------- 1991 1992 1993 1994 1995 ------ ------ ------ ------ ------ Returns prepared (U.S. and Canada) 14,589 15,179 15,189 15,181 15,059\nDuring the tax season, most H&R Block offices are open from 9:00 a.m. to 9:00 p.m. weekdays and from 9:00 a.m. to 5:00 p.m. Saturdays and Sundays. Office hours are often extended during peak periods. Most tax preparation business is transacted on a cash basis. The procedures of Tax Services have been developed so that a customer's tax return is prepared in his or her presence, in most instances in less than one hour, on the basis of information furnished by the customer. In all company-owned offices and most franchised offices, tax returns are prepared with the assistance of a computer. After the customer's return has been initially prepared, he or she is advised of the amount of his or her tax due or refund. The return, however, is\nretained and reviewed for theoretical accuracy. After completion of this review and after copies of the return have been made, the return is presented to the customer for signature and filing. These post-preparation procedures must be modified somewhat for customers who desire to have their returns electronically filed (see \"Electronic Filing,\" below). If an H&R Block preparer makes an error in the preparation of a customer's tax return that results in the assessment of any interest or penalties on additional taxes due, while H&R Block does not assume the liability for the additional taxes, it guarantees payment of the interest and penalties.\nEXECUTIVE TAX SERVICE. In addition to its regular offices, H&R Block offers tax return preparation services at Executive Tax Service offices in the United States and Canada. Appealing to taxpayers with more complicated returns, Executive Tax Service stresses the convenience of appointments, year-round tax service from the same preparer and private office interviews. The number of Executive Tax Service offices increased from 515 in fiscal year 1994 to 528 in 1995. In fiscal 1995, the number of Executive Tax Service clients increased to approximately 552,800, compared to approximately 513,700 in 1994. Tax Services plans to continue to expand the Executive Tax Service segment of its tax return preparation business.\nELECTRONIC FILING. Electronic filing reduces the amount of time required for a taxpayer to receive a federal tax refund and provides assurance to the client that the return, as filed with the Internal Revenue Service, is mathematically accurate. If the customer desires, he or she may have his or her refund deposited by the Treasury Department directly into his or her account at a financial institution designated by the customer. As reported above under \"Taxpayers Served,\" eligible electronic filing customers may also apply for refund anticipation loans at Tax Services' offices through Beneficial National Bank. Tax Services and its franchisees filed approximately 5,941,000 tax returns electronically in 1995, compared to 7,559,000 in fiscal 1994. Approximately 2,325,000 refund anticipation loans were processed in 1995 by H&R Block, compared to 5,554,000 in 1994.\nIn 1995, H&R Block offered a service to transmit state income tax returns electronically to state tax authorities in 28 states (compared to 18 states in fiscal 1994) and plans to continue to expand this program as more states make this filing alternative available to their taxpayers. H&R Block also offered the electronic filing of U.S. income tax returns at offices located in Europe and the electronic filing of Australian and Canadian income tax returns at its offices in Australia and Canada, respectively.\nCASH BACK. In Canada, the Company and its franchisees offer a refund discount (\"Cash Back\") program to their customers. The procedures which H&R Block must follow in conducting the program are specified by Canadian law. In accordance with current Canadian regulations, if a customer's tax return indicates that such customer is entitled to a tax refund, a check is issued by\nH&R Block to the customer for an amount which is equal to the sum of (1) 85% of that portion of the anticipated refund which is less than or equal to $300 and (2) 95% of that portion of the refund in excess of $300. The customer assigns to H&R Block the full amount of the tax refund to be issued by Revenue Canada. The refund check is then sent by Revenue Canada directly to H&R Block and deposited by H&R Block in its bank account. In accordance with the law, the discount is deemed to include both the tax return preparation fee and the fee for tax refund discounting. This program is financed by short-term borrowing. The number of returns discounted under the Cash Back program decreased from 663,951 in fiscal year 1994 to 638,203 in fiscal year 1995.\nOWNED AND FRANCHISED OFFICES. Most H&R Block offices are similar in appearance and usually contain the same type of furniture and equipment, in accordance with the specifications of Tax Services. Free-standing offices are generally located in business and shopping centers of large metropolitan areas and in the central business areas of smaller communities. All offices are open during the tax season. During the balance of the year only a limited number of offices are open, but through telephone listings, H&R Block personnel are available to provide service to customers throughout the entire year.\nIn fiscal year 1995, H&R Block also operated 954 offices in department stores, including 777 offices in Sears, Roebuck & Co. stores operated as \"Sears Income Tax Service by H&R Block.\" During the 1995 tax season, the Sears' facilities constituted approximately 8.0% of the tax office locations of H&R Block. Tax Services has entered into a new license agreement with Sears under which Tax Services will continue to operate in Sears locations throughout the United States. Such license agreement expires on December 31, 2004. Tax Services believes its relations with Sears to be excellent and that both parties to the license arrangement view the operations thereunder to date as satisfactory.\nOn April 15, 1995, there were 9,703 H&R Block offices in operation principally in all 50 states, the District of Columbia, Canada, Australia and Europe, compared to 9,577 offices in operation on April 15, 1994. Of the 9,703 offices, 4,660 were owned and operated by Tax Services and 5,043 were owned and operated by independent franchisees. Of such franchised offices, 3,435 were owned and operated by \"satellite\" franchisees of Tax Services (described below), 919 were owned and operated by \"major\" franchisees (described below) and 689 were owned and operated by satellite franchisees of major franchisees. From time to time, Tax Services has acquired the operations of existing franchisees and it will continue to do so if future conditions warrant such acquisitions and satisfactory terms can be negotiated.\nTwo types of franchises have principally been granted by the tax services segment of the Company. \"Major\" franchisees entered into agreements with the Company (primarily in the Company's early years) covering larger cities and counties and providing for the payment of franchise royalties based upon a percentage of gross revenues of their offices. Under the agreements, the Company granted to each franchisee the right to the use of the name \"H&R Block\" and provided a Policy and Procedure Manual and other supervisory services. Tax Services offers to sell furniture, signs, advertising materials, office equipment and supplies to major franchisees. Each major franchisee selects and trains the employees for his or her office or offices. Since March 1993, HRB Royalty, Inc., a wholly-owned subsidiary of Tax Services, has served as the franchisor under the major franchise agreements.\nIn smaller localities, Tax Services has granted what it terms \"satellite\" franchises. A satellite franchisee receives from Tax Services signs, designated equipment, specialized forms, local advertising, initial training, and supervisory services and, consequently, pays Tax Services a higher percentage of his or her gross tax return preparation and related service revenues as a franchise royalty than do major franchisees. Many of the satellite franchises of Tax Services are located in cities with populations of 15,000 or less. Some major franchisees also grant satellite franchises in their respective areas.\nIt has always been the policy of Tax Services to grant tax return preparation franchises to qualified persons without an initial franchise fee; however, the policy of Tax Services is to require a deposit to secure compliance with franchise contracts.\nSEASONALITY OF BUSINESS. Since most of the customers of Tax Services file their tax returns during the period from January through April of each year, substantially all of Tax Services' revenues from income tax return preparation, related services and franchise royalties are received during this period. As a result, Tax Services operates at a loss through the first nine months of its fiscal year. Historically, such losses primarily reflect payroll of year-round personnel, training of income tax preparers, rental and furnishing of tax offices, and other costs and expenses relating to preparation for the following tax season.\nSERVICE MARKS AND TRADEMARKS. HRB Royalty, Inc., a Delaware corporation and a wholly-owned subsidiary of Tax Services, claims ownership of the following service marks registered on the principal register of the United States Patent and Trademark Office:\nH&R Block in Two Distinct Designs The Income Tax People H&R Block Income Tax and Design Income Tax Saver Executive (when used in connection with the preparation of income tax returns for others) Rapid Refund H&R Block and Design Accufile\nIn addition, HRB Royalty, Inc., claims ownership of the following unregistered service marks and trademarks:\nAmerica's Largest Tax Service Nation's Largest Tax Service\nTax Services has a license to use the trade names, service marks and trademarks of HRB Royalty, Inc., in the conduct of the business of Tax Services.\nCOMPETITIVE CONDITIONS. The tax return preparation and electronic filing business is highly competitive. Tax Services considers its primary source of tax return preparation competition to be the individual who prepares his own tax return. In addition, there are a substantial number of tax return preparation firms. Many of these firms and many firms not otherwise in the tax return preparation business are involved in providing electronic filing and refund anticipation loan services to the public. Commercial tax return preparers and electronic filers are highly competitive with regard to price, service and reputation for quality. Tax Services believes that in terms of the number of offices and tax returns prepared it is the largest tax return preparation firm in the United States. Tax Services also believes that in terms of the number of offices and tax returns electronically filed in fiscal year 1995, it is the largest provider of electronic filing services in the United States.\nBLOCK FINANCIAL CORPORATION (\"BFC\")\nGENERALLY. Block Financial Corporation, a Delaware corporation and a subsidiary of H&R Block Group, Inc., was incorporated in May 1992 and such corporation and its subsidiaries are involved in the following businesses:\n(1) financial services delivered by technology and financial service delivery technology; and\n(2) financial services associated with H&R Block Tax Services, Inc.\nBFC is developing technology that will deliver financial services online through existing commercial online services, the Internet or directly through leased networks. Such services could include home banking, electronic bill payment and\/or discount brokerage services. BFC expects to focus its future efforts on the development of these technology products.\nDuring fiscal year 1995, the operations of Legal Knowledge Systems, Inc., the developer of TaxCut (trademark) personal income tax return preparation software, were combined with BFC. Following the end of fiscal year 1995, BFC sold MECA Software, Inc., the publisher of the Managing Your Money (trademark) personal finance software. BFC's software business will continue to develop and market TaxCut (trademark), as well as market its Small Business Attorney (trademark) software product. Content associated with these software products are expected to form the basis for future online services.\nIn excess of 108,000 credit cards were issued by the end of fiscal year 1995 under a co-branding agreement between BFC and Columbus Bank and Trust Company, Columbus, Georgia. A majority of BFC's credit card portfolio consists of CompuServe gold cards. During fiscal year 1995, BFC introduced the Conductor service on CompuServe, a national online electronic credit card statement that provides the cardholder with access to transaction records and credit availability and the ability to download transactions into a personal financial software program. BFC owns an industrial loan company chartered in the State of Utah and has applied for FDIC insurance. Upon receiving such insurance, the industrial loan company may become a direct issuer of bank cards.\nThe decision by the Internal Revenue Service to eliminate the Direct Deposit Indicator in connection with refund anticipation loans (see the subsection entitled \"Taxpayers Served\" under \"H&R Block Tax Services, Inc.,\" above), resulted in the decision by BFC not to invest in refund anticipation loans (\"RALs\") during the 1995 tax season. In 1993 and 1994, BFC purchased interests in a trust to which certain RALs made by Mellon Bank (DE) National Association to H&R Block tax customers in the United States were sold.\nFranchise Partner, Inc., a subsidiary of BFC, offers to franchisees of either H&R Block Tax Services, Inc. or one of its subsidiary corporations lines of credit with reasonable interest rates under a program designed to better enable the franchisees to refinance existing business debt, expand or renovate offices or meet off-season cash flow needs. A franchise equity line of credit is secured by the franchise itself.\nDuring fiscal year 1995, BFC provided property and casualty insurance coverage to franchisees of the Tax Services segment through Companion Insurance, Ltd., a captive insurance company domiciled in Bermuda. At May 1, 1995, the operations of such entity were transferred to H&R Block Tax Services, Inc.\nCOMPETITIVE CONDITIONS. The financial services, software, credit card and lending businesses are highly competitive and consist of a large number of companies. No single supplier can be considered to occupy a dominant position in any of the businesses in which BFC competes.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe executive offices of both the Company and H&R Block Tax Services, Inc., are located at 4410 Main Street, Kansas City, Missouri, in a three-story building owned by Tax Services that was constructed in 1963 and expanded in 1965, 1973 and 1981. The building is again being expanded, with the completion of a new four-story addition expected during fiscal year 1996. Most other offices of Tax Services (except those in department stores) are operated in premises held under short-term leases providing fixed monthly rentals, usually with renewal options.\nCompuServe's executive offices are located in an office complex in Columbus, Ohio, owned by CompuServe. CompuServe also owns and occupies two other buildings in the Columbus area. Construction of a new multi-building corporate facility in the Columbus area is underway and CompuServe plans to take occupancy during fiscal year 1996. CompuServe leases office space in other buildings in the Columbus area and in a number of other locations in the United States and Europe. CompuServe owns SC30M computer systems purchased from Systems Concepts, Inc., and has assembled several SC-30 and SC-40 processors on-site via an agreement with such firm. CompuServe also owns central processors manufactured by Digital Equipment Corporation and located in its two main computer centers.\nThe executive offices of Block Financial Corporation are located in leased offices at 4435 Main Street, Kansas City, Missouri.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThere are no material legal proceedings pending by or against the Company or any of its subsidiaries.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNo matters were submitted to a vote of security holders, through the solicitation of proxies or otherwise, during the fourth quarter of the fiscal year ended April 30, 1995.\nITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT.\nThe names, ages and principal occupations (for the past five years) of the executive officers of the Company, each of whom has been elected to serve at the discretion of the Board of Directors of the Company, are:\nNAME AND AGE OFFICE(S) - -------------------- --------------------------- Henry W. Bloch (72) Chairman of the Board since August 1992; Chairman of the Board and Chief Executive Officer from August 1989 through July 1992; Member of the Board of Directors since 1955.\nThomas M. Bloch (41) President and Chief Executive Officer since August 1992; President and Chief Operating Officer from August 1989 through July 1992; Member of the Board of Directors since 1983. See Note 1.\nWilliam P. Anderson (46) Senior Vice President and Chief Financial Officer since September 1994; Vice President, Corporate Development and Chief Financial Officer from August 1992 until September 1994; Vice President, Corporate Development from December 1991 until August 1992; See Note 2.\nRobert L. Arnold (52) Vice President and Director of Internal Audit since February 1986.\nOzzie Wenich (52) Vice President, Finance and Treasurer since October 1994; Vice President, Corporate Controller and Treasurer from March 1994 until October 1994; Vice President and Corporate Controller from September 1985 until March 1994.\nNote 1: On April 12, 1995, Mr. Thomas Bloch announced his resignation as President and Chief Executive Officer, effective August 31, 1995.\nNote 2: Mr. Anderson was a partner in KPMG Peat Marwick, accounting firm, from 1984 until December 1991, in Atlanta, Georgia, serving in various capacities, including responsibility for the firm's national corporate finance consulting practice.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS.\nThe information called for by this item is contained in the Company's annual report to security holders for the fiscal year ended April 30, 1995, under the heading \"Common Stock Data,\" and is hereby incorporated by reference. The Company's Common Stock is traded principally on the New York Stock Exchange. The Company's Common Stock is also traded on the Pacific Stock Exchange. On June 12, 1995, there were 37,514 stockholders of the Company.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe information called for by this item is contained in the Company's annual report to security holders for the fiscal year ended April 30, 1995, under the heading \"Selected Financial Data,\" and is hereby incorporated by reference.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nThe information called for by this item is contained in the Company's annual report to security holders for the fiscal year ended April 30, 1995, under the headings \"Management's Discussion and Analysis of Results of Operations\" and \"Management's Discussion and Analysis of Liquidity and Capital Resources,\" and is hereby incorporated by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe information called for by this item and listed at Item 14(a)1 is contained in the Company's annual report to security holders for the fiscal year ended April 30, 1995, and is hereby incorporated by reference.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nThere has been no change in the registrant's accountants during the two most recent fiscal years or any subsequent interim time period.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nThe information called for by this item is contained in the Company's definitive proxy statement to be filed pursuant to Regulation 14A not later than 120 days after April 30, 1995, in the section titled \"Election of Directors\" and in Item 4a of Part I of this report, and is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe information called for by this item is contained in the Company's definitive proxy statement to be filed pursuant to Regulation 14A not later than 120 days after April 30, 1995, in the sections entitled \"Directors' Meetings, Compensation and Committees\" and \"Compensation of Executive Officers,\" and is incorporated herein by reference, except that information contained in the section entitled \"Compensation of Executive Officers\" under the subtitles \"Performance Graph\" and \"Compensation Committee Report on Executive Compensation\" is not incorporated herein by reference and is not to be deemed \"filed\" as part of this filing.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe information called for by this item is contained in the Company's definitive proxy statement to be filed pursuant to Regulation 14A not later than 120 days after April 30, 1995, in the section titled \"Election of Directors\" and in the section titled \"Information Regarding Security Holders,\" and is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe information called for by this item is contained in the Company's definitive proxy statement to be filed pursuant to Regulation 14A not later than 120 days after April 30, 1995, in the section titled \"Election of 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 of H&R Block, Inc., and subsidiaries are incorporated by reference from the Company's annual report to security holders for the year ended April 30, 1995:\nPAGE ---- Consolidated Statements of Earnings 19 Consolidated Balance Sheets 20 Consolidated Statements of Cash Flows 21 Notes to Consolidated Financial Statements 22 Quarterly Financial Data 27 Independent Auditors' Report 29\n2. FINANCIAL STATEMENT SCHEDULES\nIndependent Auditors' Report\nSchedule VIII - Valuation and Qualifying Accounts\nSchedules not filed herewith are either not applicable, the information is not material or the information is set forth in the financial statements or notes thereto.\n3. EXHIBITS\n3(a) Restated Articles of Incorporation of H&R Block, Inc., as amended, filed as Exhibit 4(a) to the Company's quarterly report on Form 10-Q for the quarter ended October 31, 1991, are incorporated herein by reference.\n3(b) Bylaws of H&R Block, Inc., as amended.\n4(a) Conformed copy of Rights Agreement dated as of July 14, 1988 between H&R Block, Inc., and Centerre Trust Company of St. Louis, filed on August 9, 1993 as Exhibit 4(c) to the Company's Registration Statement on Form S-8 (File No. 33-67170), is incorporated herein by reference.\n4(b) Copy of Amendment to Rights Agreement dated as of May 9, 1990 between H&R Block, Inc. and Boatmen's Trust Company.\n4(c) Copy of Second Amendment to Rights Agreement dated September 11, 1991 between H&R Block, Inc. and Boatmen's Trust Company.\n4(d) Copy of Third Amendment to Rights Agreement dated May 10, 1995 between H&R Block, Inc. and Boatmen's Trust Company.\n4(e) Form of Certificate of Designation, Preferences and Rights of Participating Preferred Stock of H&R Block, Inc.\n4(f) Form of Certificate of Designation, Preferences and Rights of Delayed Convertible Preferred Stock of H&R Block, Inc.\n10(a) The Company's 1984 Long-Term Executive Compensation Plan, as amended (terminated as of September 8, 1993, except with respect to awards then outstanding thereunder), filed as Exhibit 28(a) to the Company's quarterly report on Form 10-Q for the quarter ended October 31, 1991, is incorporated herein by reference.\n10(b) The Company's 1993 Long-Term Executive Compensation Plan, filed as Exhibit 10 to the Company's quarterly report on Form 10-Q for the quarter ended October 31, 1993, is incorporated herein by reference.\n10(c) The H&R Block Long-Term Performance Program, as amended, filed as Exhibit 10(c) to the Company's annual report on Form 10-K for the fiscal year ended April 30, 1994, is incorporated herein by reference.\n10(d) The H&R Block Deferred Compensation Plan for Directors, as amended, filed as Exhibit 10 to the Company's quarterly report on Form 10-Q for the quarter ended July 31, 1994, is incorporated herein by reference.\n10(e) The H&R Block Deferred Compensation Plan for Executives, as amended (Amendments 1 through 5), filed as Exhibit 10(e) to the Company's annual report on Form 10-K for the fiscal year ended April 30, 1994, is incorporated herein by reference.\n10(f) The H&R Block Supplemental Deferred Compensation Plan for Executives, filed as Exhibit 10(f) to the Company's annual report on Form 10-K for the fiscal year ended April 30, 1994, is incorporated herein by reference.\n10(g) Amendment No. 1 to The H&R Block Supplemental Deferred Compensation Plan for Executives, filed as Exhibit 10(a) to the Company's quarterly report on Form 10-Q for the quarter ended October 31, 1994, is incorporated herein by reference.\n10(h) The Amended and Restated H&R Block, Inc. Retirement Plan for Non-Employee Directors.\n10(i) The Company's 1989 Stock Option Plan for Outside Directors, as amended, filed as Exhibit 28(b) to the Company's quarterly report on Form 10-Q for the quarter ended October 31, 1991, is incorporated herein by reference.\n10(j) Employment Agreement between HRB Management, Inc. and William F. Evans, filed as Exhibit 10(b) to the Company's quarterly report on Form 10-Q for the quarter ended October 31, 1994, is incorporated herein by reference.\n11 Statement re Computation of Per Share Earnings.\n13 Those portions of the annual report to security holders for the fiscal year ended April 30, 1995 which are expressly incorporated by reference in this filing.\n21 Subsidiaries of the Company.\n23 The consent of Deloitte & Touche LLP, Certified Public Accountants, is located immediately after the signature pages contained in this filing.\n27 Financial Data Schedule.\n(b) Reports on Form 8-K.\nThe Company did not file any current reports on Form 8-K during the fourth quarter of the year ended April 30, 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.\nH&R BLOCK, INC.\nJune 21, 1995 By\/s\/ Thomas M. Bloch -------------------------- Thomas M. Bloch, 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.\nSIGNATURE TITLE - ------------------------ -------------------------\n\/s\/ Thomas M. Bloch President, Chief - ------------------------ Executive Officer and Thomas M. Bloch Director (principal executive officer)\n\/s\/ G. Kenneth Baum Director - ------------------------ G. Kenneth Baum\n\/s\/ Henry W. Bloch Director - ------------------------ Henry W. Bloch\n\/s\/ Robert E. Davis Director - ------------------------ Robert E. Davis\n\/s\/ Donna R. Ecton Director - ------------------------ Donna R. Ecton\n\/s\/ Henry F. Frigon Director - ------------------------ Henry F. Frigon\n\/s\/ Roger W. Hale Director - ------------------------ Roger W. Hale\n(Signed as to each on June 21, 1995)\nSIGNATURE TITLE - ------------------------ ------------------------\n\/s\/ Marvin L. Rich Director - ------------------------ Marvin L. Rich\n\/s\/ Frank L. Salizzoni Director - ------------------------ Frank L. Salizzoni\n\/s\/ Morton I. Sosland Director - ------------------------ Morton I. Sosland\n\/s\/ William P. Anderson Senior Vice President - ------------------------ and Chief Financial William P. Anderson Officer (principal financial officer)\n\/s\/ Ozzie Wenich Vice President, Finance - ------------------------ and Treasurer (principal Ozzie Wenich accounting officer)\n(Signed as to each on June 21, 1995)\nINDEPENDENT AUDITORS' CONSENT\nWe consent to the incorporation by reference in Post-Effective Amendment No. 4 to Registration Statement No. 33-185 of H&R Block, Inc. and subsidiaries (relating to shares of Common Stock issued under the 1984 Long-Term Executive Compensation Plan) on Form S-8, Registration Statement No. 33-33889 of H&R Block, Inc. and subsidiaries (relating to shares of Common Stock issuable under the 1989 Stock Option Plan for Outside Directors) on Form S-8 and Registration Statement No. 33-54985 of H&R Block, Inc. and subsidiaries (relating to shares of Common Stock issued under the 1993 Long-Term Executive Compensation Plan) on Form S-8 of our reports dated June 20, 1995, appearing in and incorporated by reference in this Annual Report on Form 10-K of H&R Block, Inc. and subsidiaries for the year ended April 30, 1995.\n\/s\/ Deloitte & Touche LLP - ------------------------- Kansas City, Missouri July 28, 1995\nINDEPENDENT AUDITORS' REPORT\nBoard of Directors and Stockholders H&R Block, Inc. Kansas City, Missouri\nWe have audited the consolidated financial statements of H&R Block, Inc. and subsidiaries as of April 30, 1995 and 1994 and for each of the three years in the period ended April 30, 1995, and have issued our report thereon dated June 20, 1995; such consolidated financial statements and report are included in your 1995 Annual Report to Stockholders and are incorporated herein by reference. Our audits also included the financial statement schedule of H&R Block, Inc. and subsidiaries, listed in Item 14. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.\n\/s\/ Deloitte & Touche LLP - ------------------------- Kansas City, Missouri June 20, 1995","section_15":""}
{"filename":"773281_1995.txt","cik":"773281","year":"1995","section_1":"ITEM 1. BUSINESS. -------- General - ------- PS Partners VI, Ltd. (the \"Partnership\") is a publicly held limited partnership formed under the California Revised Limited Partnership Act. Commencing in October 1985, 150,000 units of limited partnership interest (the \"Units\") were offered to the public in an interstate offering. The offering was completed in June 1986.\nThe Partnership was formed to invest in and operate existing self-service facilities offering storage space for personal and business use (the \"mini- warehouses\") and to invest up to 40% of the net proceeds of the offering in and operate existing office and industrial properties. The Partnership's investments were made through general partnerships with Storage Equities, Inc., now known as Public Storage, Inc. (\"PSI\"), a real estate investment trust organized as a corporation under the laws of California. For tax administrative efficiency, the original general partnerships with PSI were consolidated into a single general partnership effective December 31, 1990.\nIn 1995, there was a series of mergers among Public Storage Management, Inc. (which was the Partnership's mini-warehouse operator), Public Storage, Inc. and their affiliates (collectively, \"PSMI\"), culminating in the November 16, 1995 merger (the \"PSMI Merger\") of PSMI into Storage Equities, Inc. In the PSMI Merger, Storage Equities, Inc.'s name was changed to Public Storage, Inc. and it acquired substantially all of PSMI's United States real estate operations and became the operator of the Partnership's mini-warehouse properties.\nThe Partnership's general partners (the \"General Partners\") are PSI and B. Wayne Hughes (\"Hughes\"). PSI became a co-general partner in September 1993, when PSI acquired the interest of PSI Associates, Inc. (\"PSA\"), an affiliate of PSMI, relating to PSA's general partner capital contribution in the Partnership. Hughes has been a general partner of the Partnership since its inception. Hughes is the chairman of the board and chief executive officer of PSI, and Hughes and members of his family (the \"Hughes Family\") is the major shareholder of PSI. The Partnership is managed, and its investment decisions are made by Hughes and the executive officers and directors of PSI. The limited partners of the Partnership have no right to participate in the management or conduct of its business affairs.\nThe Partnership's mini-warehouse properties are managed by PSI and the Partnership's commercial properties are managed by Public Storage Commercial Properties Group, Inc. (\"PSCP\"), pursuant to Management Agreements. PSI has a 95% economic interest and the Hughes Family has a 5% economic interest in PSCP. PSI believes that it is the largest operator of mini-warehouse facilities in the United States.\nPSI's current relationship with the Partnership includes (i) the joint ownership of 32 of the Partnership's 34 properties, (ii) PSI is a co-general partner along with Hughes, who is chairman of the board and chief executive officer of PSI, (iii) as of February 29, 1996, PSI owned approximately 51.11% of the Partnership's limited partnership units and (iv) PSI is the operator of the Partnership's mini-warehouse facilities and owns approximately 95% of the Partnership's commercial property operator (PSCP).\nInvestments in Facilities - -------------------------\nThe Partnership owns interests in 34 properties; 32 of such properties are held in a general partnership comprised of the Partnership and PSI. The Partnership purchased its last property in November, 1986. Reference is made to the table in Item 2","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES. ----------\nThe following table sets forth information as of December 31, 1995 about properties owned by the Partnership. Thirty-two of these properties were acquired jointly with PSI and were contributed to a general partnership comprised of the Partnership and PSI.\n(a) Business Park\nWeighted average occupancy levels for the mini-warehouse and business park facilities were 88% and 97%, respectively, in both 1995 and 1994. In 1995, the monthly realized rent per square foot for the mini-warehouse and business park facilities averaged $.60 and $.54, respectively, compared to $.58 and $.50, respectively, in 1994.\nSubstantially all of the Partnership's facilities were acquired prior to the time that it was customary to conduct environmental investigations in connection with property acquisitions. During the fourth quarter of 1995, an independent environmental consulting firm completed environmental assessments on the Partnership's properties to evaluate the environmental condition of, and potential environmental liabilities of, such properties. Based on the assessments, the Partnership believes that it is probable that it will incur costs totaling $217,000 (in addition, approximately $46,000 was expended for the assessments) for known environmental remediation requirements, for which the Partnership has accrued and expensed at the end of 1995. The Partnership expects to expend these funds over the next twelve months. Although there can be no assurance, the Partnership is not aware of any environmental contamination of any of its property sites which individually or in the aggregate would be material to the Partnership's overall business, financial condition, or results of operations.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS. -----------------\nNo material legal proceeding is pending against 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 fourth quarter of 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE PARTNERSHIP'S COMMON EQUITY AND RELATED STOCKHOLDER ------------------------------------------------------ ----------- MATTERS. -------\nThe Partnership has no common stock.\nThe Units are not listed on any national securities exchange or quoted on the NASDAQ System, and there is no established public trading market for the Units. Secondary sales activity for the Units has been limited and sporadic. The General Partners monitor transfers of the Units (a) because the admission of the transferee as a substitute limited partner requires the consent of the General Partners under the Partnership's Amended and Restated Agreement of Limited Partnership, (b) in order to ensure compliance with safe harbor provisions to avoid treatment as a \"publicly traded partnership\" for tax purposes and (c) because PSI has purchased Units. However, the General Partners do not have information regarding the prices at which all secondary sale transactions in the Units have been effectuated. Various organizations offer to purchase and sell limited partnership interests (including securities of the type such as the Units) in secondary sales transactions. Various publications such as The Stanger Report summarize and report information (on a monthly, bimonthly or less frequent basis) regarding secondary sales transactions in limited partnership interests (including the Units), including the prices at which such secondary sales transactions are effectuated.\nIn addition, Dean Witter Reynolds Inc., the dealer-manager for the Partnership's initial offering of Units, has certain information with regard to sale transactions in the Units.\nExclusive of the General Partners' interest in the Partnership, as of December 31, 1995, there were approximately 3,082 record holders of Units.\nIn July 1995, PSI completed a cash tender offer in which PSI acquired 19,088 of the 150,000 outstanding limited partnership units in the Partnership at $281 per Unit. PSI completed an additional cash tender offer in August 1995, in which PSI acquired an additional 4,712 units in the Partnership at $281 per Unit. As of February 29, 1995, PSI owned 76,670 Units in the Partnership (51.11% of the outstanding Units).\nThe Partnership makes quarterly distributions of all \"Cash Available for Distribution\" and will make distributions of all \"Cash from Sales or Refinancing.\" Cash Available for Distribution is cash flow from all sources less cash necessary for any obligations or capital improvements or reserves.\nReference is made to Items 6 and 7 hereof for information on the amount of such distributions.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA. ------------------------\n(a) One of the Partnership's properties was foreclosed upon by the mortgage lenders, reducing assets and mortgage notes payable by $4,680,000. The net loss in 1992 includes a non-recurring loss upon foreclosure of this property of $2,256,000, resulting in a $2,233,000 loss allocable to the limited partners, or $14.89 per unit. (b) Limited Partners' per unit data is based on the weighted average number of units outstanding during the period (150,000 units). (c) The General Partners distributed, concurrent with the distributions for the fourth quarter of 1991, a portion of the operating reserve of the Partnership estimated to be $4.00 per Unit.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND --------------------------------------------------------------- RESULTS OF OPERATIONS. ----------------------\nResults of Operations - ---------------------\nYEAR ENDED DECEMBER 31, 1995 COMPARED TO YEAR ENDED DECEMBER 31, 1994:\nThe Partnership's net income in 1995 was $2,077,000 compared to net income of $2,097,000 in 1994, representing a decrease of $20,000. The decrease was primarily a result of increases in environmental costs and depreciation expenses, partially offset by increased property operating results.\nNet operating income (rental income less cost of operations and management fees and excluding depreciation expense) increased by $389,000 or 5%, as rental income increased by $450,000 or 4%, and cost of operations (including management fees and excluding depreciation expense) increased by $61,000.\nRental income for the Partnership's mini-warehouse operations was $10,700,000 in 1995 compared to $10,368,000 in 1994, representing an increase of $332,000, or 3%. The increase in rental income was primarily attributable to increased rental rates at the mini-warehouse facilities. The monthly average realized rent per square foot for the mini-warehouse facilities was $.60 in 1995 compared to $.58 in 1994. The weighted average occupancy levels at the mini- warehouse facilities remained stable at 88% in both 1995 and 1994. Costs of operations (including management fees) increased $49,000 to $3,955,000 in 1995 from $3,906,000 in 1994. Accordingly, for the Partnership's mini-warehouse operations, property net operating income increased by $283,000 or 5% from $6,462,000 in 1994 to $6,745,000 in 1995.\nRental income for the Partnership's business park operations was $1,912,000 in 1995 compared to $1,794,000 in 1994, representing an increase of $118,000 or 7%. The increase in rental income was primarily attributable to increased rental rates. The monthly average realized rent per square foot for the business park facilities was $.54 in 1995 compared to $.50 in 1994. The weighted average occupancy level at the business park facilities remained stable at 97% in both 1995 and 1994. Cost of operations (including management fees) increased $12,000 to $882,000 in 1995 from $870,000 in 1994. Accordingly, for the Partnership's business park facilities, property net operating income increased by $106,000 or 10% from $924,000 in 1994 to $1,030,000 in 1995.\nSubstantially all of the Partnership's facilities were acquired prior to the time that it was customary to conduct environmental investigations in connection with property acquisitions. During the fourth quarter of 1995, an independent environmental consulting firm completed environmental assessments on the Partnership's properties to evaluate the environmental condition of, and potential environmental liabilities of, such properties. Based on the assessments, the Partnership believes that it is probable that it will incur costs totaling $217,000 (in addition, approximately $46,000 was expended for the assessments) for known environmental remediation requirements, for which the Partnership has accrued and expensed at the end of 1995. The Partnership expects to expend these funds over the next twelve months. Although there can be no assurance, the Partnership is not aware of any environmental contamination of any of its property sites which individually or in the aggregate would be material to the Partnership's overall business, financial condition, or results of operations.\nMinority interest in income was $2,234,000 in 1995 compared to $2,173,000 in 1994, representing an increase of $61,000, or 3%. This increase was primarily the result of improved operations at the Partnership's mini-warehouse facilities which are owned jointly with PSI.\nYEAR ENDED DECEMBER 31, 1994 COMPARED TO YEAR ENDED DECEMBER 31, 1993:\nThe Partnership's net income in 1994 was $2,097,000 compared to net income of $2,005,000 in 1993, representing an increase of $92,000, or 5%. This increase was primarily due to improved property operations at the Partnership's mini- warehouse facilities partially offset by reduced property operations at the Partnership's business park facilities combined with an increase in minority interest in income for those properties held jointly with PSI.\nProperty net operating income (rental income less cost of operations and management fees and excluding depreciation expense) increased approximately $196,000 or 3% in 1994 compared to 1993, as rental income increased by $419,000 or 4%, and cost of operations (including management fees) increased by $223,000 or 5%.\nRental income for the Partnership's mini-warehouse operations was $10,368,000 in 1994 compared to $9,859,000 in 1993, representing an increase of $509,000, or 5%. The increase in rental income was primarily attributable to increased occupancy levels at the mini-warehouse facilities combined with increased rental rates. The weighted average occupancy levels at the mini- warehouse facilities were 88% in 1994 compared to 87% in 1993. The monthly average realized rent per square foot for the mini-warehouse facilities was $.58 in 1994 compared to $.56 in 1993. Costs of operations (including management fees) increased $208,000 or 6%, to $3,906,000 in 1994 from $3,698,000 in 1993. Accordingly, for the Partnership's mini-warehouse operations, property net operating income increased by $301,000 or 5% from $6,161,000 in 1993 to $6,462,000 in 1994.\nRental income for the Partnership's business park operations was $1,794,000 in 1994 compared to $1,884,000 in 1993, representing a decrease of $90,000 or 5%. The decrease in rental income was primarily attributable to reduced rental rates. The weighted average occupancy level at the business park facilities was 97% in both 1994 and 1993. The monthly average realized rent per square foot for the business park facilities was $.50 in 1994 compared to $.53 in 1993. Cost of operations (including management fees) increased $15,000 or 2% to $870,000 in 1994 from $855,000 in 1993. Accordingly, for the Partnership's business park facilities, property net operating income decreased by $105,000 or 10% from $1,029,000 in 1993 to $924,000 in 1994.\nMinority interest in income was $2,173,000 in 1994 compared to $2,089,000 in 1993, representing an increase of $84,000, or 4%. This increase was primarily the result of improved operations at the Partnership's mini-warehouse facilities which are owned jointly with PSI.\nLiquidity and Capital Resources - -------------------------------\nThe Partnership has adequate sources of cash to finance its operations, both on a short-term and long-term basis, primarily by internally generated cash from property operations and existing cash reserves. At December 31, 1995, the Partnership had cash and cash equivalents totaling $2,054,000.\nCash flows from operating activities ($7,763,000 for the year ended December 31, 1995) have been sufficient to meet all current obligations of the Partnership. Total capital improvements were $1,045,000, $1,122,000, and $844,000 in 1995, 1994 and 1993, respectively. The increase in 1995 verses 1993 is mostly due to various repair and refurbishment projects, including work on parking lot and driveway, heating, ventilation, and air conditioning units, roof, and paint at the Signal Hill, California and Tempe, Arizona business park facilities for approximately $335,000. The increase in 1994 verses 1993 is due to the installation of new air conditioning systems at two of the Houston, Texas mini-warehouse facilities for approximately $375,000. During 1996, the Partnership anticipates approximately $833,000 of capital improvements (including PSI's joint venture share of $193,000). During 1995, the Partnership's property manager commenced a program to enhance the visual appearance of the mini-warehouse facilities managed by it. Such enhancements will include new signs, exterior color schemes, and improvements to the rental offices. Included in the 1996 capital improvement budget are estimated costs of $145,000 for such enhancements.\nThe Partnership expects to continue making quarterly distributions. Total distributions paid to the General Partners and the limited partners (including per Unit amounts) for 1995 and prior years were as follows:\nThe Partnership, in prior years, made distributions based on anticipated operating cash flows. Beginning in the second quarter of 1989, the distribution level was lowered to a level supported by current operating cash flow after capital improvements and scheduled debt service. The General Partners distributed, concurrently with the distributions for the fourth quarter of 1991, a portion of the operating reserve of the Partnership and adjusted the on-going distribution level. The operating reserve that was distributed was estimated at $4.00 per Unit.\nThe 1996 distribution level is estimated to be $23.80 per Unit, assuming no material change in property operations.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. -------------------------------------------\nThe Partnership's financial statements are included elsewhere herein. Reference is made to the Index to Consolidated Financial Statements and Financial Statement Schedules in Item 14(a).\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 PARTNERSHIP. ---------------------------------------------------\nThe Partnership has no directors or executive officers.\nThe Partnership's General Partners are PSI and B. Wayne Hughes. PSI, acting through its directors and executive officers, and Mr. Hughes manage and make investment decisions for the Partnership. The Partnership's properties are operated by PSI and PSCP, a subsidiary of PSI.\nThe names of all directors and executive officers of PSI, the offices held by each of them with PSI, and their ages and business experience during the past five years are as follows:\nB. Wayne Hughes, age 62, a general partner of the Partnership, has been a director of PSI since its organization in 1980 and was President and Co-Chief Executive Officer from 1980 until November 1991 when he became Chairman of the Board and sole Chief Executive Officer. Mr. Hughes has been a director of Storage Properties, Inc. (\"SPI\"), a real estate investment trust whose investment adviser is PSI, since 1989. Since 1990, Mr. Hughes has been Chairman of the Board of Public Storage Properties X, Inc., Public Storage Properties XI, Inc., Public Storage Properties XII, Inc., Public Storage Properties XIV, Inc., Public Storage Properties XV, Inc., Public Storage Properties XVI, Inc., Public Storage Properties XVII, Inc., Public Storage Properties XVIII, Inc., Public Storage Properties XIX, Inc., Public Storage Properties XX, Inc., Partners Preferred Yield, Inc., Partners Preferred Yield II, Inc. and Partners Preferred Yield III, Inc. (collectively, the \"Public Storage Properties REITs\"), real estate investment trusts organized by affiliates of PSMI. Mr. Hughes has been active in the real estate investment field for over 25 years.\nHarvey Lenkin, age 59, became President and a director of PSI in November 1991. He has been President of the Public Storage Properties REITs since 1990. He was President of PSMI from January 1978 until September 1988, when he became Chairman of the Board of PSMI and assumed overall responsibility for investment banking and investor relations. In 1989, Mr. Lenkin became President and a director of SPI.\nRonald L. Havner Jr., age 38, a certified public accountant, became an officer of PSI in 1990, Chief Financial Officer in November 1991 and Senior Vice President of PSI in November 1995. He was an officer of PSMI from 1986 to 1995 and Chief Financial Officer of PSMI and its affiliates from 1991 to November 1995. Mr. Havner has been an officer of SPI since 1989 and Chief Financial Officer of SPI since November 1991. He has been a Vice President of the Public Storage Properties REITS since 1990 and was Controller from 1990 to November 1995 when he became Chief Financial Officer.\nHugh W. Horne, age 51, has been a Vice President of PSI since 1980 and was Secretary of PSI from 1980 until February 1992 and became Senior Vice President of PSI in November 1995. He was an officer of PSMI from 1973 to November 1995. Mr. Horne has been a Vice President of SPI since 1989 and of the Public Storage Properties REITs since 1993. He is responsible for managing all aspects of property acquisition for PSI.\nObren B. Gerich, age 56, a certified public accountant and certified financial planner, has been a Vice President of PSI since 1980 and became Senior Vice President of PSI in November 1995. He was Chief Financial Officer of PSI until November 1991. Mr. Gerich was an officer of PSMI from 1975 to November 1995. Mr. Gerich has been Vice President and Secretary of SPI since 1989 and was Chief Financial Office of SPI until November 1991. He has been Vice President and Secretary of the Public Storage Properties REITS since 1990 and was Chief Financial Officer until November 1995.\nMarvin M. Lotz, age 53, has had overall responsibility for Public Storage's mini-warehouse operations since 1988. He became a Senior Vice President of PSI in November 1995. Mr. Lotz was an officer of PSMI with responsibility for property acquisitions from 1983 until 1988.\nMary Jayne Howard, age 50, has had overall responsibility for Public Storage's commercial property operations since December 1985. She became a Senior Vice President of PSI in November 1995.\nDavid Goldberg, age 46, joined PSMI's legal staff in June 1991, rendering services on behalf of PSI and PSMI. He became a Senior Vice President and General Counsel of PSI in November 1995. From December 1982 until May 1991, he was a partner in the law firm of Sachs & Phelps, then counsel to PSI and PSMI.\nJohn Reyes, age 35, a certified public accountant, joined PSMI in 1990 and has been the Controller of PSI since 1992. He became a Vice President of PSI in November 1995. From 1983 to 1990, Mr. Reyes was employed by Ernst & Young.\nSarah Hass, age 40, became Secretary of PSI in February 1992. She became a Vice President of PSI in November 1995. She joined PSMI's legal department in June 1991, rendering services on behalf of PSI and PSMI. From 1987 until May 1991, her professional corporation was a partner in the law firm of Sachs & Phelps, then counsel to PSI and PSMI, and from April 1986 until June 1987, she was associated with that firm, practicing in the area of securities law. From September 1979 until September 1985, Ms. Hass was associated with the law firm of Rifkind & Sterling, Incorporated.\nRobert J. Abernethy, age 55, is President of American Standard Development Company and of Self-Storage Management Company, which develop and operate mini- warehouses. Mr. Abernethy has been a director of PSI since its organization. He is a member of Johns Hopkins University and of the Los Angeles County Metropolitan Transportation Authority and a former member of the board of directors of the Metropolitan Water District of Southern California.\nDann V. Angeloff, age 60, is President of the Angeloff Company, a corporate financial advisory firm. The Angeloff Company has rendered, and is expected to continue to render, financial advisory and securities brokerage services for PSI. Mr. Angeloff is the general partner of a limited partnership that owns a mini-warehouse operated by PSI and which secures a note owned by PSI. Mr. Angeloff has been a director of PSI since its organization. He is a director of Compensation Resource Group, Datametrics Corporation, Nicholas\/Applegate Growth Equity Fund, Nicholas\/Applegate Investment Trust, Royce Medical Company, Seda Specialty Packaging Corp., and SPI.\nWilliam C. Baker, age 62, became a director of PSI in November 1991. From April 1993 through May 1995, Mr. Baker was President of Red Robin International, Inc., an operator and franchiser of casual dining restaurants in the United States and Canada. Since January 1992, he has been Chairman and Chief Executive Officer of Carolina Restaurant Enterprises, Inc., a franchisee of Red Robin International, Inc. From 1976 to 1988, he was a principal shareholder and Chairman and Chief Executive Officer of Del Taco, Inc., an operator and franchiser of fast food\nrestaurants in California. Mr. Baker is a director of Santa Anita Realty Enterprises, Inc., Santa Anita Operating Company and Callaway Golf Company.\nUri P. Harkham, age 47, became a director of PSI in March 1993. Mr. Harkham has been the President and Chief Executive Officer of the Jonathan Martin Fashion Group, which specializes in designing, manufacturing and marketing women's clothing, since its organization in 1976. Since 1978, Mr. Harkham has been the Chairman of the Board of Harkham Properties, a real estate firm specializing in buying and managing fashion warehouses in Los Angeles and Australia.\nBerry Holmes, age 65, is a private investor. Mr. Holmes has been a director of PSI since its organization. He was President and a director of Financial Corporation of Santa Barbara and Santa Barbara Savings and Loan Association through 1983 and was a consultant with Santa Barbara Savings and Loan Association during 1984. Mr. Holmes is a director of SPI.\nPursuant to Articles 16 and 17 of the Partnership's Amended and Restated Agreement of Limited Partnership (the \"Partnership Agreement\"), a copy of which is included in the Partnership's prospectus included in the Partnership's Registration Statement, File No. 2-98968, 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 partner and a majority vote of the limited partners, or (iii) removal by a majority vote of the limited partners.\nEach director of PSI serves until he resigns or is removed from office by PSI, and may resign or be removed from office at any time with or without cause. Each officer of PSI serves until he resigns or is removed by the board of directors of PSI. Any such officer may resign or be removed from office at any time with or without cause.\nThere have been no events under any bankruptcy act, no criminal proceedings, and no judgments or injunctions material to the evaluation of the ability of any director or executive officer of PSI during the past five years.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION. ----------------------\nThe Partnership has no subsidiaries, directors or officers. See Item 13 for a description of certain transactions between the Partnership and the General Partners and their affiliates.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. --------------------------------------------------------------\n(a) At February 29, 1996, the following entities owned 5% or more of the Units of the Partnership:\nThe Partnership is not aware of any other beneficial owners of more than 5% of the Units.\nIn July 1995, PSI completed a cash tender offer in which PSI acquired 19,088 of the 150,000 outstanding limited partnership units in the Partnership at $281 per Unit. PSI completed an additional cash tender offer in August 1995, in which PSI acquired an additional 4,712 units in the Partnership at $281 per Unit.\n(b) The Partnership has no officers and directors.\nThe General Partners (or their predecessor-in-interest) have contributed $747,000 to the capital of the Partnership representing 1% of the aggregate capital contributions and as a result participate in the distributions to the limited partners and in the Partnership's profits and losses in the same proportion that\nthe general partners' capital contribution bears to the total capital contribution. Information regarding ownership of the Units by PSI, a General Partner, is set forth under section (a) above.\n(c) The Partnership knows of no contractual arrangements, the operation of the terms of which may at a subsequent date result in a change in control of the Partnership, except for articles 16, 17 and 21.1 of the Partnership's Amended Certificate and Agreement of Limited Partnership, a copy of which is included in the Partnership's prospectus included in the Partnership's Registration Statement File No. 2-98968. Those articles provide, in substance, that the limited partners shall have the right, by majority vote, to remove a general partner and that a general partner may designate a successor with the consent of the other general partner and a majority of the limited partners.\nThe Partnership owns interests in 34 properties, 32 of such properties are held in a general partnership comprised of the Partnership and PSI. Under the terms of the partnership agreement relating to the ownership of the properties, PSI has the right to compel a sale of each property at any time after seven years from the date of acquisition at not less than its independently determined fair market value provided the Partnership receives its share of the net sales proceeds solely in cash. As of December 31, 1995, PSI has the right to require the Partnership to sell all of the joint venture properties on these terms.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. ---------------------------------------------- The Partnership Agreement provides that the General Partners and their affiliates are entitled to the following compensation:\n1. Incentive distributions equal to 10% of Cash Flow from Operations. 2. Provided the limited partners have received distributions equal to 100% of their investment plus a cumulative 8% per year (not compounded) on their investment (reduced by distributions other than from Cash Flow from Operations), subordinated incentive distributions equal to 15% of remaining Cash from Sales or Refinancings. 3. Provided the limited partners have received distributions equal to 100% of their capital contributions plus a cumulative 6% per year (not compounded) on their investment (reduced by distributions other than distributions from Cash Flow from Operations), brokerage commissions at the lesser of 3% of the sales price of a property or 50% of a competitive commission.\nDuring 1995, approximately $401,000 was paid to PSI with respect to items 1, 2, and 3 above. The Partnership owns interests in 34 properties; 32 of such properties are held in a general partnership comprised of the Partnership and PSI.\nThe Partnership has Management Agreements with PSI (as successor-in- interest to PSMI) and PSCP. Under the Management Agreements, the Partnership pays PSI (and previously paid PSMI) a fee of 6% of the gross revenues of the mini-warehouse spaces operated for the Partnership, and pays PSCP a fee of 5% of the gross revenues of the Partnership's non-mini-warehouse space. During 1995, the Partnership paid or accrued fees of $560,000 to PSMI, $82,000 to PSI, and $96,000 to PSCP pursuant to the Management Agreements.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K. ---------------------------------------------------------------\n(a) List of Documents filed as part of the Report. 1. Financial Statements: See Index to Consolidated Financial Statements and Financial Statement Schedules. 2. Financial Statement Schedules: See Index to Consolidated Financial Statements and Financial Statement Schedules. 3. Exhibits: See Exhibit Index contained herein.\n(b) Reports on Form 8-K: None\n(c) Exhibits: See Exhibit Index contained herein.\nPS PARTNERS VI, LTD., A CALIFORNIA LIMITED PARTNERSHIP INDEX TO EXHIBITS\n3.1 Amended and Restated Agreement of Limited Partnership. Previously filed with the Securities and Exchange Commission as an Exhibit to the Storage Equities, Inc. Registration Statement No. 33-43750 and incorporated herein by reference.\n10.1 Amended Management Agreement dated February 21, 1995 between Storage Equities, Inc. and Public Storage Management, Inc. Previously filed with the Securities and Exchange Commission as an exhibit to the Partnership's Annual Report on Form 10-K for the year ended December 31, 1994, and incorporated herein by reference.\n10.2 Amended Management Agreement dated February 21, 1995 between Storage Equities, Inc, Inc. and Public Storage Commercial Properties Group, Inc. Previously filed with the Securities and Exchange Commission as an exhibit to the Partnership's Annual Report on Form 10-K for the year ended December 31, 1994, and incorporated herein by reference.\n10.3 Participation Agreement dated as of October 18, 1985, among Storage Equities, Inc., the Partnership, Public Storage, Inc., B. Wayne Hughes and Kenneth Q. Volk, Jr. Previously filed with the Securities and Exchange Commission as an exhibit to Storage Equities, Inc.'s Annual Report on Form 10-K dated November 30, 1985 and incorporated herein by reference.\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 Partnership has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nPS PARTNERS VI, LTD., a California Limited Partnership Dated: March 25, 1996 By: Public Storage, Inc., General Partner\nBy: \/s\/ B Wayne Hughes --------------------------------------- B. Wayne Hughes, Chairman of the Board\nBy: \/s\/ B Wayne Hughes --------------------------------------- B. Wayne Hughes, 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 Partnership in the capacities and on the dates indicated.\nPS PARTNERS VI, LTD. a California Limited Partnership\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\n(Item 14 (a))\nAll other schedules have been omitted since the required information is not present or not present in amounts sufficient to require submission of the schedule, or because the information required is included in the consolidated financial statements or the notes thereto.\nReport of Independent Auditors\nThe Partners PS Partners VI, Ltd., a California Limited Partnership\nWe have audited the consolidated balance sheets of PS Partners VI, Ltd., a California Limited Partnership, as of December 31, 1995 and 1994 and the related consolidated statements of operations, partners' equity, and cash flows for each of the three years in the period ended December 31, 1995. 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 PS Partners VI, Ltd., a California Limited Partnership, at December 31, 1995 and 1994, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, 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\nLos Angeles, CA March 11, 1996\nPS PARTNERS VI, LTD., a California Limited Partnership CONSOLIDATED BALANCE SHEETS December 31, 1995 and 1994\nSee accompanying notes.\nPS PARTNERS VI, LTD., a California Limited Partnership CONSOLIDATED STATEMENTS OF INCOME For the years ended December 31, 1995, 1994, and 1993\nSee accompanying notes.\nPS PARTNERS VI, LTD., a California Limited Partnership CONSOLIDATED STATEMENTS OF PARTNERS' EQUITY For the years ended December 31, 1995, 1994, and 1993\nSee accompanying notes.\nPS PARTNERS VI, LTD., a California Limited Partnership CONSOLIDATED STATEMENTS OF CASH FLOWS For the years ended December 31, 1995, 1994, and 1993\nSee accompanying notes.\nPS PARTNERS VI, LTD., a California Limited Partnership CONSOLIDATED STATEMENTS OF CASH FLOWS For the years ended December 31, 1995, 1994, and 1993 (Continued)\nSee accompanying notes.\nPS PARTNERS VI, LTD., a California Limited Partnership NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1995\n1. Summary of Significant Accounting Policies and Partnership Matters ------------------------------------------------------------------\nDescription of Partnership --------------------------\nPS Partners VI, Ltd., a California Limited Partnership (the \"Partnership\") was formed with the proceeds of an interstate public offering. PSI Associates II, Inc. (\"PSA\"), an affiliate of Public Storage Management, Inc., organized the Partnership along with B. Wayne Hughes (\"Hughes\"). In September 1993, Storage Equities, Inc,, now known as Public Storage, Inc. (\"PSI\"), a California corporation, acquired the interest of PSA relating to its general partner capital contribution in the Partnership and was substituted as a co-general partner in place of PSA.\nIn 1995, there was a series of mergers among Public Storage Management, Inc. (which was the Partnership's mini-warehouse operator), Public Storage, Inc. and their affiliates (collectively, \"PSMI\"), culminating in the November 16, 1995 merger (the \"PSMI Merger\") of PSMI into Storage Equities, Inc. In the PSMI merger, Storage Equities, Inc.'s name was changed to Public Storage, Inc., and it acquired substantially all of PSMI's United States real estate operations, and became the operator of the Partnership's mini-warehouse properties.\nThe Partnership has invested in existing mini-warehouse storage facilities which offer self-service storage spaces for lease, usually on a month-to-month basis, to the general public. The Partnership has also invested in an existing office building and two business park facilities which offer industrial and office space for lease.\nThe Partnership has ownership interests in 34 properties; 32 of which are owned jointly through 14 general partnerships (the \"Joint Ventures\") with PSI. For tax administrative efficiency, the Joint Ventures were subsequently consolidated into a single general partnership. The Partnership is the managing general partner of the Joint Ventures, with ownership interests in the Joint Ventures ranging from 50% to 90%.\nBasis of Presentation ---------------------\nThe consolidated financial statements include the accounts of the Partnership and the Joint Ventures. PSI's ownership interest in the Joint Ventures is shown as minority interest in general partnerships in the accompanying consolidated balance sheets. All significant intercompany balances and transactions have been eliminated.\nMinority interest in income represents PSI's share of net income with respect to the Joint Ventures. Under the terms of the partnership agreements all depreciation and amortization with respect to each Joint Venture is allocated solely to the Partnership until the limited partners recover their initial capital contribution. Thereafter, all depreciation and amortization is allocated solely to PSI until it recovers its initial capital contribution. All remaining depreciation and amortization is allocated to the Partnership and PSI in proportion to their ownership percentages. No amounts have been allocated to PSI with respect to this provision.\nUnder the terms of the partnership agreements, PSI has the right to compel the sale of each property in the general partnerships at any time after seven years from the date of acquisition at not less than its independently determined fair market value provided the Partnership receives its share of the net proceeds solely in cash. PSI's right to require the Partnership to sell all of the properties owned jointly with the Partnership became exercisable during 1993.\nDepreciation and Amortization -----------------------------\nThe Partnership depreciates the buildings and equipment on the straight- line method over estimated useful lives of 25 and 5 years, respectively. Leasing commissions relating to business park properties are expensed when incurred.\nPS PARTNERS VI, LTD., a California Limited Partnership NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1995\n1. Summary of Significant Accounting Policies and Partnership Matters ------------------------------------------------------------------ (continued) -----------\nRevenue Recognition -------------------\nProperty rents are recognized as earned.\nAllocation of Net Income ------------------------\nThe General Partners' share of net income consists of an amount attributable to their 1% capital contribution and an additional percentage of cash flow (as defined, see Note 2) which relates to the General Partners' share of cash distributions as set forth in the Partnership Agreement. All remaining net income is allocated to the limited partners.\nPer Unit Data -------------\nPer unit data is based on the number of limited partner units (150,000) outstanding during the periods presented.\nEnvironmental Cost ------------------\nSubstantially all of the Partnership's facilities were acquired prior to the time that it was customary to conduct environmental investigations in connection with property acquisitions. During the fourth quarter of 1995, an independent environmental consulting firm completed environmental assessments on the Partnership's properties to evaluate the environmental condition of, and potential environmental liabilities of, such properties. Based on the assessments, the Partnership believes that it is probable that it will incur costs totaling $217,000 (in addition, approximately $46,000 was expended for the assessments) for known environmental remediation requirements, for which the Partnership has accrued and expensed at the end of 1995. The Partnership expects to expend these funds over the next twelve months. Although there can be no assurance, the Partnership is not aware of any environmental contamination of any of its property sites which individually or in the aggregate would be material to the Partnership's overall business, financial condition, or results of operations.\nCash Distributions ------------------\nThe Partnership Agreement provides for quarterly distributions of cash flow from operations (as defined). Cash distributions per limited partner unit were $23.80, $23.80 and $19.40 for 1995, 1994 and 1993, respectively.\nCash and Cash Equivalents -------------------------\nFor financial statement purposes, the Partnership considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents.\n2. General Partners' Equity ------------------------\nThe General Partners have a 1% interest in the Partnership. In addition, the General Partners have a 10% interest in cash distributions attributable to operations, exclusive of distributions attributable to sales and refinancing proceeds.\nProceeds from sales and refinancings will be distributed entirely to the limited partners until the limited partners recover their investment plus a cumulative 8% annual return (not compounded); thereafter, the General Partners have a 15% interest in remaining proceeds.\n3. Related Party Transactions --------------------------\nPSI operates the Partnership's mini-warehouses for a \"management fee\" equal to 6% of gross revenue (as defined) and Public Storage Commercial Properties Group, Inc. operates the commercial properties for a \"management fee\" equal to 5% of gross revenue (as defined).\nPS PARTNERS VI, LTD., a California Limited Partnership NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1995\n3. Related Party Transactions (continued) --------------------------------------\nPSI has a 95% economic interest, and Hughes and family members of Hughes have a 5% economic interest in PSCP.\n4. Taxes Based on Income ---------------------\nTaxes based on income are the responsibility of the individual partners and, accordingly, the Partnership's consolidated financial statements do not reflect a provision for such taxes.\nTaxable net income was $1,724,000, $1,557,000 and $1,507,000 for the years ended December 31, 1995, 1994 and 1993, respectively. The difference between taxable income and book income is primarily related to timing differences in depreciation expense.\nPS PARTNERS VI, LTD. SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION\nPS PARTNERS VI, LTD. SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION\nPS PARTNERS VI, LTD. SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION\nPS PARTNERS VI, LTD. A CALIFORNIA LIMITED PARTNERSHIP REAL ESTATE RECONCILIATION SCHEDULE III (CONTINUED)\n(a) The following is a reconciliation of cost and related accumulated depreciation.\nGROSS CARRYING COST RECONCILIATION\nACCUMULATED DEPRECIATION RECONCILIATION\n(b) The aggregate cost of real estate for Federal income tax purposes is $90,062,000.","section_15":""}
{"filename":"203248_1995.txt","cik":"203248","year":"1995","section_1":"ITEM 1. Business.\nIntroduction\nSouthern Union Company (\"Southern Union\" and together with its subsidiaries, the \"Company\") was incorporated under the laws of the State of Delaware in 1932. The Company's principal line of business is the distribution of natural gas as a public utility through Southern Union Gas and Missouri Gas Energy, each of which is a division of Southern Union. Southern Union Gas, head- quartered in Austin, Texas, serves approximately 498,000 residen- tial, commercial, industrial, agricultural and other customers in Texas (including the cities of Austin, Brownsville, El Paso, Galveston and Port Arthur) and Oklahoma. Missouri Gas Energy, headquartered in Kansas City, Missouri, serves approximately 478,000 customers in central and western Missouri (including the cities of Kansas City, St. Joseph, Joplin and Monett). See \"Missouri Acquisition.\"\nSubsidiaries of Southern Union have been established to support and expand natural gas sales and to capitalize on the Company's gas energy expertise. These subsidiaries market natural gas to end-users, sell natural gas as a vehicular fuel, operate intra- state and interstate natural gas pipeline systems, sell commer- cial gas air conditioning and other gas-fired engine-driven applications and convert vehicles to operate on natural gas. By providing \"one-stop shopping,\" the Company can serve its various customers' specific energy needs, which encompass substantially all of the natural gas distribution and sales businesses from natural gas sales to specialized energy consulting services. Certain subsidiaries also own or hold interests in real estate and other assets, which are primarily used in the Company's utility business. See \"Company Operations.\"\nThe Company is a sales and market-driven energy company whose management is committed to achieving profitable growth of its natural gas energy businesses in an increasingly competitive business environment. Management's strategies for achieving these objectives principally consist of: (i) promoting new sales opportunities and markets for natural gas; (ii) enhancing finan- cial and operating performance; and (iii) expanding the Company through development of existing systems and selective acquisition of new systems. Management develops and continually evaluates these strategies and the Company's implementation of them by applying their experience and expertise in analyzing the energy industry, technological advances, market opportunities and general business trends. Each of these strategies, as imple- mented throughout the Company's businesses, reflects the Com- pany's commitment to its core natural gas utility business. Central to all of the Company's businesses and strategies is the sale and transportation of natural gas.\nThe Company has a goal of selected growth and expansion, pri- marily in the natural gas industry. To that extent, the Company intends to consider, when appropriate, and if financially prac- ticable to pursue, the acquisition of other natural gas distri- bution or transmission businesses. The nature and location of any such properties, the structure of any such acquisitions, and the method of financing any such expansion or growth will be determined by management and the Southern Union Board of Directors.\nMissouri Acquisition\nOn January 31, 1994, Southern Union purchased certain Missouri natural gas distribution operations (the \"Missouri Acquisition\") which Southern Union operates as Missouri Gas Energy. The acquisition was accounted for as a purchase. Earnings from operations of Missouri Gas Energy have been included in the Com- pany's statement of consolidated operations since February 1, 1994.\nAt closing, Southern Union paid approximately $400,300,000 in cash, based on account balances as of December 31, 1993. The final purchase price, which was determined through post-closing adjustments and subsequent arbitration, was approximately $401,600,000. The Missouri Acquisition was financed through the sale of $475,000,000 of 7.60% Senior Notes due 2024 (the \"Senior Debt Securities\") completed on January 31, 1994 and net proceeds from a $50,000,000 common stock subscription rights offering (the \"Rights Offering\") completed on December 31, 1993. See \"Man- agement's Discussion and Analysis of Financial Condition and Results of Operations (\"MD&A\") -- Liquidity and Capital Resources\" and \"Long-Term Debt\" in the Notes to the Consolidated Financial Statements.\nAs a result of the Missouri Acquisition, the Company nearly doubled the number of customers served by its natural gas dis- tribution system and became one of the top 15 gas utilities in the United States, as measured by number of customers. In addi- tion, the Missouri Acquisition lessens the sensitivity of the Company's operations to weather risk and local economic condi- tions by diversifying operations into a different geographic area.\nThe approval of the Missouri Acquisition by the Missouri Public Service Commission (\"MPSC\") was subject to the terms of a stipu- lation and settlement agreement (the \"MPSC Stipulation\") among Southern Union, Western Resources, Inc. (the \"seller\" of the Missouri properties), the MPSC Staff and others. Among other things, the MPSC Stipulation: (i) provides that the Company attain a total debt to total capital ratio that does not exceed Standard and Poor's Corporation's Utility Financial Benchmark ratio for the lowest investment grade (BBB) investor-owned natural gas distribution company (which currently is approxi- mately 58%) in order for Missouri Gas Energy to implement any general rate increase; (ii) prohibits Missouri Gas Energy from implementing a general rate increase in Missouri before January 31, 1997 except in certain unusual events; (iii) required the seller to contribute an additional $9,000,000 to the quali- fied defined benefit plan assets transferred to the Company; (iv) requires the Company to contribute an additional $3,000,000 to the Company's qualified defined benefit plan for the benefit of Missouri Gas Energy's employees and retirees; and (v) requires Missouri Gas Energy to reduce rate base by $30,000,000 (amortized over a ten-year period on a straight-line basis) to compensate rate payers for rate base reductions that were eliminated as a result of the Missouri Acquisition. The Company has subsequently attained the financial benchmark ratio described above. See \"Business -- Changes in Capital Structure.\"\nSouthern Union assumed certain liabilities of the seller with respect to the Missouri properties, including certain liabilities arising from certain specified contracts assigned to Southern Union at closing, including gas supply and transportation con- tracts, office equipment and real estate leases, liabilities arising from certain contracts entered into by the seller in the ordinary course of business, certain liabilities that have arisen or may arise from the operation of Missouri Gas Energy, and liabilities for certain accounts payable of the seller pertaining to Missouri Gas Energy.\nSouthern Union and the seller also entered into an Environmental Liability Agreement (the \"Environmental Liability Agreement\") at the closing of the Missouri Acquisition. The Environmental Liability Agreement provides for a tiered approach to the allo- cation of certain liabilities under environmental laws that may exist or arise with respect to Missouri Gas Energy. At the present time, and based upon information available to management, the Company believes that the costs of any remediation efforts that may be required for Missouri Gas Energy for which it may ultimately have responsibility will not exceed the aggregate amount subject to substantial sharing by the seller. The Com- pany believes that it will be able to obtain substantial reim- bursement or recovery for any environmental liabilities from other potentially responsible third parties, under insurance or through rates charged to customers. See \"Commitments and Con- tingencies\" in the Notes to the Consolidated Financial State- ments.\nPursuant to the terms of an Employee Agreement with the seller, after the closing of the Missouri Acquisition, Southern Union employed certain employees of the seller involved in the opera- tion of Missouri Gas Energy (\"Continuing Employees\"). Under the terms of the Employee Agreement, the assets and liabilities under the seller's qualified defined benefit plans attributable to Continuing Employees and certain retired Missouri employees (\"Retired Employees\") were transferred to a qualified defined benefit plan of Southern Union that for at least two years will provide benefits to Continuing Employees and Retired Employees substantially similar in aggregate to those provided for under the seller's qualified defined benefit plans. Southern Union amended its qualified defined benefit plan to cover the Con- tinuing Employees and Retired Employees and provide Continuing Employees and Retired Employees with certain welfare, separation and other benefits.\nOther Acquisitions and Divestitures\nDuring July 1995, Southern Union Company entered into a letter of intent to sell Western Gas Interstate Company (\"WGI\"), a wholly- owned subsidiary of the Company, exclusive of certain WGI assets in El Paso, Texas and WGI's Del Norte interconnect operation which transmits natural gas into Mexico, and to sell certain gas distribution operations of Southern Union Gas in the panhandle areas of Texas and Oklahoma for approximately $14,800,000. The sale is subject to approval by the Federal Regulatory Energy Commission (\"FERC\") and the Oklahoma Corporation Commission and must be reported to the Railroad Commission of Texas.\nIn September 1993, the Company acquired the Rio Grande Valley Gas Company (\"Rio Grande\") for approximately $30,500,000 (the \"Rio Grande Acquisition\"). Rio Grande currently serves approximately 75,000 customers in the south Texas counties of Willacy, Cameron and Hidalgo which includes 32 towns and cities along the Mexico border, including Harlingen, McAllen and Brownsville (the southernmost city in the continental U.S.). The Company initially funded the purchase with borrowings from its revolving credit facility which were subsequently repaid with proceeds from the sale of the Senior Debt Securities and the Rights Offering. See \"MD&A -- Liquidity and Capital Resources.\"\nIn July 1993, the Company acquired the natural gas distribution facilities serving the city of Eagle Pass, Texas (the \"Eagle Pass Acquisition\"), for approximately $2,000,000. In May 1993, the Company acquired the natural gas distribution facilities of Berry Gas Company (the \"Berry Gas Acquisition\") serving the Texas cities and towns of Nome, Raywood, Hull and Devers for approxi- mately $274,000. Combined, these operations serve approximately 4,400 customers.\nIn February 1993, Southern Union Exploration Company (\"SX\"), a former wholly-owned subsidiary of Southern Union, entered into a purchase and sale agreement pursuant to which it sold substan- tially all of its oil and gas leasehold interests and associated production for approximately $22,000,000, effective January 1, 1993. The Company recorded a book loss on the sale of approxi- mately $4,400,000 as of December 31, 1992. In connection with the sale, the Company recorded an income tax liability of approximately $6,960,000 resulting from the recognition of a tax basis gain of approximately $18,800,000.\nChanges in Capital Structure\nOn May 17, 1995, Southern Union Financing I (the \"Subsidiary Trust\"), a consolidated wholly-owned subsidiary of Southern Union, issued $100,000,000 of 9.48% Trust Originated Preferred Securities (the \"Preferred Securities\"). In connection with the Subsidiary Trust's issuance of the Preferred Securities and the related purchase by Southern Union of all of the Subsidiary Trust's common securities (the \"Common Securities\"), Southern Union issued to the Subsidiary Trust $103,092,800 principal amount of its 9.48% Subordinated Deferrable Interest Notes, due 2025 (the \"Subordinated Notes\"). The sole assets of the Subsidiary Trust are and will be the Subordinated Notes. The interest and other payment dates on the Subordinated Notes correspond to the distribution and other payment dates on the Preferred Securities and the Common Securities. Under certain circumstances, the Subordinated Notes may be distributed to holders of the Preferred Securities and holders of the Common Securities in liquidation of the Subsidiary Trust. The Sub- ordinated Notes are redeemable at the option of the Company on or after May 17, 2000, at a redemption price of $25 per Subordinated Note plus accrued and unpaid interest. The Preferred Securities and the Common Securities will be redeemed on a pro rata basis to the same extent as the Sub- ordinated Notes are repaid, at $25 per Preferred Security and Common Security plus accumulated and unpaid distribu- tions. Southern Union's obligations under the Subordinated Notes and related agreements, taken together, constitute a full and unconditional guarantee by Southern Union of payments due on the Preferred Securities. As of June 30, 1995, 4,000,000 shares of Preferred Securities were outstanding.\nSouthern Union has the right under the Subordinated Notes to defer interest payment periods up to 20 consecutive quarters, and, as a consequence, quarterly distributions on the Preferred Securities may be deferred (but will continue to accrue with interest thereon at a per annum rate of 9.48% compounded quar- terly) by the Subsidiary Trust during any such extended interest payment period. If interest payments are deferred by Southern Union, Southern Union: (i) may not pay cash dividends, or redeem, purchase or acquire, or make a liquidation payment with respect to, any of its capital stock or the capital stock of any sub- sidiary of Southern Union; and (ii) shall not make any payment of interest, principal or premium, if any, on or repay, repurchase or redeem any debt securities issued by Southern Union that rank pari passu with or junior to the subordinate debentures.\nThe issuance of the Preferred Securities was part of a $300,000,000 shelf registration filed with the Securities and Exchange Commission on March 29, 1995. Southern Union may sell a combination of preferred securities of financing trusts and senior and subordinated debt securities of Southern Union of up to $196,907,200 (the remaining shelf) from time to time, at prices determined at the time of any offering. The net proceeds from the $100,000,000 Preferred Securities offering have been used to repurchase $35,000,000 of 7.60% Senior Debt Securities through July 1995. The remaining proceeds will be used to repurchase additional long-term debt, provide working capital for seasonal needs or for other business opportunities. See \"Preferred Securities of Subsidiary Trust\" and \"Long-Term Debt\" in the Notes to the Consolidated Financial Statements.\nThe following table sets forth the summary capitalization of the Company.\nJuly 31, 1995 June 30, 1995 Amount Percent Amount Percent ------ ------- ------ ------- (thousands, except percentages)\nShort-term debt (1)........ $ 2,370 $ 770 ======== ========\nLong-term debt Senior notes............. 440,000 460,000 First mortgage bonds and other.............. 2,503 2,503 -------- -------- 442,503 57.7% 462,503 58.7%\nCompany-obligated Preferred Securities of Trust(2)..... 100,000 13.0 100,000 12.7 Common stockholders' equity................... 223,966 29.3 225,664 28.6 -------- ----- -------- ----- Total capitalization....... $766,469 100.0% $788,167 100.0% ======== ===== ======== =====\n- ---------------------\n(1) Includes amounts payable under the revolving credit facility and long-term debt due within one year. The outstanding balance under the revolving credit facility at July 31, 1995 and June 30, 1995 was $1,600,000 and zero, respectively. (2) See \"Preferred Securities of Subsidiary Trust\" in the Notes to the Consolidated Financial Statements.\nCompany Operations\nThe Company's principal line of business is the distribution of natural gas through its Southern Union Gas and Missouri Gas Energy divisions. Southern Union Gas provides service to a num- ber of communities and rural areas in Texas, including the municipalities of Austin, Brownsville, El Paso, Galveston, Harlingen, McAllen and Port Arthur, as well as several communi- ties in the Oklahoma panhandle. Missouri Gas Energy provides service to various cities and communities in central and western Missouri including Kansas City, St. Joseph, Joplin and Monett. The Company's gas utility operations are generally seasonal in nature, with a significant percentage of its annual revenues and earnings occurring in the traditional winter heating season.\nWestern Gas Interstate Company operates interstate pipeline sys- tems principally serving the Company's gas distribution properties in the El Paso, Texas area and in the Texas and Oklahoma panhandles. During 1993, WGI received approval in its restructuring and rate case dockets from the FERC which allowed WGI to implement services pursuant to FERC Order No. 636. WGI is now providing unbundled transportation service for those gas volumes entering the pipeline's transportation system. WGI also transported approximately 16,400 million cubic feet (MMcf) to the city of Juarez, Mexico and the Samalayuca Power Plant in north Mexico in fiscal 1995. The sale of WGI, exclusive of its Del Norte interconnect operation and various assets in El Paso, is pending. See \"Business -- Other Acquisitions and Divestitures.\"\nSouthern Transmission Company (\"Southern\"), a wholly-owned sub- sidiary of Southern Union, owns and operates approximately 121 miles of intrastate pipeline. Southern's system connects the cities of Lockhart, Luling, Cuero, Shiner, Yoakum, and Gonzales, Texas, as well as an industrial customer in Port Arthur, Texas. Southern also owns a transmission line which supplies gas to the community of Sabine Pass, Texas and manages and operates 419 miles of transmission lines in the Rio Grande Valley of Texas.\nMercado Gas Services Inc. (\"Mercado\"), a wholly-owned subsidiary of Southern Union, markets natural gas to large volume customers. Mercado's sales and purchasing activities are made through short- term contracts. These contracts and business activities are not subject to direct rate regulation.\nSouthern Union Econofuel Company (\"Econofuel\"), a wholly-owned subsidiary of Southern Union, markets and sells natural gas for natural gas vehicles (\"NGVs\") as an alternative fuel to gasoline. Econofuel owns fuel dispensing equipment in Austin, El Paso, Port Arthur, and Galveston, Texas, located at independent retail fuel stations for NGVs. These stations primarily serve fleet and governmental vehicles which have been manufactured or converted to operate on natural gas. In 1991, Econofuel and Natural Gas Development Company, Inc. of California formed a joint venture that, in 1992, opened the Natural Gas Vehicle Technology Centers, L.L.P. (the \"Tech Center\") in Austin, Texas. The Tech Center converts gasoline-driven vehicles to operate using natural gas. In August 1994, the Tech Center became the first facility in the United States to receive certification from Ford Motor Company as a \"Qualified Vehicle Modifier.\"\nSouthern Union Energy Products and Services Company (\"SUEPASCO\"), a wholly-owned subsidiary of Southern Union, markets and sells commercial gas air conditioning, irrigation pumps and other gas- fired engine-driven applications and related services.\nSouthern Union Energy International, Inc. (\"International\"), a wholly-owned subsidiary of Southern Union, seeks to participate in energy related projects internationally.\nThe Company also holds investments in commercially developed real estate as well as undeveloped tracts of land through Southern Union's wholly-owned subsidiary, Lavaca Realty Company (\"Lavaca Realty\").\nCompetition\nSouthern Union Gas and Missouri Gas Energy are not currently in significant direct competition with any other distributors of natural gas to residential and small commercial customers within their service areas. However, in recent years, certain large volume customers, primarily industrial and significant commercial customers, have had opportunities to access alternative natural gas supplies and, in some instances, delivery service from pipe- line systems. The Company has offered transportation arrange- ments to customers who secure their own gas supplies. These transportation arrangements, coupled with the efforts of Southern Union's unregulated marketing subsidiary, Mercado, enable the Company to provide competitively priced gas service to these large volume customers. In addition, the Company has success- fully used flexible rate provisions, when needed, to retain cus- tomers who may have access to alternative energy sources.\nAs energy providers, Southern Union Gas and Missouri Gas Energy have historically competed with alternative energy sources, par- ticularly electricity and also propane, coal, natural gas liquids and other refined products available in the Company's service areas. At present rates, the cost of electricity to residential and commercial customers in the Company's service areas generally is higher than the effective cost of its natural gas service. There can be no assurances, however, that future fluctuations in gas and electric costs will not reduce the cost advantage of natural gas service. The cost of expansion for peak load requirements of electricity in some of Southern Union Gas' ser- vice areas has historically provided opportunities to allow energy switching to natural gas pursuant to integrated resource planning techniques. Electric competition has responded by offering equipment rebates and incentive rates.\nCompetition between the use of fuel oil and natural gas, particu- larly by industrial, electric generation and agricultural custo- mers, has increased as oil prices have decreased. While competition between such fuels is generally more intense outside the Company's service areas, this competition affects the nation- wide market for natural gas. Additionally, the general economic conditions in its service areas continue to affect certain custo- mers and market areas, thus impacting the results of the Com- pany's operations.\nGas Supply\nThe low cost of natural gas service is dependent upon the Com- pany's ability to contract for natural gas using favorable mixes of long-term and short-term supply arrangements and favorable transportation contracts. The Company has been directly acquiring its gas supplies since the mid-1980s when interstate pipeline systems opened their systems for transportation service. The Company has the organization, personnel and equipment neces- sary to dispatch and monitor gas volumes on a daily and even hourly basis to ensure reliable service to customers.\nThe Company's experience has been of major benefit in the post- FERC Order No. 636 procurement environment. FERC Order No. 636 required the \"unbundling\" of services offered by interstate pipe- line companies. As a result, gas purchasing and transportation decisions and associated risks have been shifted from the pipe- line companies to the gas distributors. The increased demands on distributors to effectively manage their gas supply in an environment of volatile gas prices provides an advantage to dis- tribution companies such as the Company that have demonstrated a history of contracting favorable and efficient gas supply arrangements in an open market system.\nThe majority of Southern Union Gas' 1995 gas requirements for utility operations were delivered under long-term transportation contracts through five major pipeline companies. All of Missouri Gas Energy's 1995 gas requirements were delivered under short- and long-term transportation contracts through three pipeline companies. These contracts have various expiration dates ranging from 1996 through 2013. Southern Union Gas also purchases sig- nificant volumes of gas under long-term and short-term arrange- ments with suppliers. The amounts of such short-term purchases are contingent upon price. Southern Union Gas and Missouri Gas Energy both have firm supply commitments for all areas that are supplied with gas purchased under short-term arrangements. Missouri Gas Energy also holds contract rights to over 16 billion cubic feet (\"Bcf\") of storage capacity to assist in meeting peak demands.\nGas sales and\/or transportation contracts with interruption pro- visions, whereby large volume users purchase gas with the under- standing that they may be forced to shut down or switch to alternate sources of energy at times when the gas is needed for higher priority customers, have been utilized for load management by Southern Union and the gas industry as a whole for many years. In addition, during times of special supply problems, curtail- ments of deliveries to customers with firm contracts may be made in accordance with guidelines established by appropriate federal and state regulatory agencies. There have been no supply-related curtailments of deliveries to Southern Union Gas or Missouri Gas Energy utility sales customers during the last ten years.\nThe following table shows, for each of the Company's principal utility service areas, the percentage of gas utility revenues and sales volume for the year ended June 30, 1995 and the average cost per Mcf of gas in 1995.\nPercent Percent of Gas of Gas Utility Average Utility Sales Cost Service Area Revenues Volume Per Mcf ------------ -------- ------- -------\nSouthern Union Gas Austin and South Texas............ 13 11 $2.21 El Paso and West Texas............ 13 17 1.81 Rio Grande Valley................. 6 3 4.17 Other............................. 8 7 2.43 --- --- 40 38 Missouri Gas Energy................. 60 62 2.95 --- --- 100 100 === ===\nThe Company is committed under various agreements to purchase certain quantities of gas in the future. At June 30, 1995, the Company has purchase commitments for nominal quantities of gas at fixed prices. These fixed price commitments have an annual value of approximately $2,500,000 for Southern Union Gas. Missouri Gas Energy currently does not have any fixed price commitment con- tracts for the 1995\/1996 winter heating season. At June 30, 1995, the Company also had purchase commitments for certain quan- tities of gas at variable, market-based prices. These market- based price commitments have an annual value of approximately $37,000,000 for Southern Union Gas and $66,000,000 for Missouri Gas Energy. The Company's purchase commitments may extend over a period of several years depending upon when the required quantity is purchased. The Company has purchase gas tariffs in effect for all its utility service areas that provide for recovery of its purchase gas costs.\nUtility Regulation and Rates\nThe Company's rates and operations are subject to regulation by federal, state and local authorities. In Texas, municipalities have primary jurisdiction over rates within their respective incorporated areas. Rates in adjacent environs and appellate matters are the responsibility of the Railroad Commission of Texas. Rates in Oklahoma are regulated by the Oklahoma Corpora- tion Commission. In Missouri, rates are established by the MPSC on a system-wide basis. The FERC and the Railroad Commission of Texas have jurisdiction over rates, facilities and services of WGI and Southern, respectively.\nThe Company holds non-exclusive franchises with varying expira- tion dates in all incorporated communities where it is necessary to carry on its business as it is now being conducted. In the five largest cities in which the Company's utility customers are located, such franchises expire as follows: Kansas City, Missouri in 1997; El Paso, Texas in 2000; Austin, Texas in 2006; and Port Arthur, Texas in 2013. The franchise in St. Joseph, Missouri is perpetual. The Company fully expects these fran- chises to be renewed upon their expiration.\nGas service rates are established by regulatory authorities to permit utilities to recover operating, administrative and finance costs, and the opportunity to earn a return on equity. Gas costs are billed to customers through purchase gas adjustment clauses which permit the Company to adjust its sales price as the cost of purchased gas changes. This is important because the cost of natural gas accounts for a significant portion of the Company's total expenses. The appropriate regulatory authority must receive notice of such adjustments prior to billing implementa- tion.\nThe Company must support any service rate changes to its regula- tors using a historic test year of operating results adjusted to normal conditions and for any known and measurable revenue or expense changes. Because the rate regulatory process has certain inherent time delays, rate orders may not reflect the operating costs at the time new rates are put into effect.\nThe monthly customer bill contains a fixed service charge, a usage charge for service to deliver gas, and a charge for the amount of natural gas used. While the monthly fixed charge pro- vides an even revenue stream, the usage charge increases the Com- pany's annual revenue and earnings in the traditional heating load months when usage of natural gas increases. The majority of the Company's rate increases in Texas and Oklahoma in recent years have resulted in increased monthly fixed charges which help stabilize earnings. Weather normalization clauses, now in place in Austin and Galveston and two other service areas in Texas, also help stabilize earnings.\nOn February 10, 1993, the Company's South Texas service area received an annualized rate increase of $777,000. On July 1, 1993, rates for Austin were changed to provide: (i) an approxi- mate $1,700,000 annual base revenue increase; (ii) new and increased fees that add approximately $250,000 annually; and (iii) weather normalization clause revisions. On October 15, 1993, Missouri Gas Energy's rates increased by $9,750,000 annually. On November 1, 1993, El Paso rates changed to provide an approximate annual revenue increase of $463,000. Other rate increases in 1993 throughout Southern Union Gas service terri- tories aggregated $204,000 annually.\nDuring the year ended June 30, 1995 and the six-month period ended June 30, 1994, the Company did not file for any rate increases in any of its service areas other than several annual cost of service adjustments. In addition to the regulation of its utility and pipeline businesses, the Company is affected by numerous other regulatory controls, including, among others, pipeline safety requirements of the U. S. Department of Trans- portation, safety regulations under the Occupational Safety and Health Act, and various state and federal environmental statutes and regulations. The Company believes that its operations are in compliance with applicable safety and environmental statutes and regulations.\nStatistics of Gas Utility and Related Operations\nThe following table provides the number of gas utility customers served as of:\nJune 30, December 31, 1995 1994 1993 ------- ------- ------------\nSouthern Union Gas: Austin and South Texas....... 156,043 153,757 153,096 El Paso and West Texas....... 171,691 168,350 168,361 Galveston and Port Arthur.... 51,943 52,329 52,953 Panhandle and North Texas.... 32,111 31,652 32,821 Rio Grande Valley............ 78,501 77,832 79,616 ------- ------- ------- 490,289 483,920 486,847 ------- ------- ------- Missouri Gas Energy: Kansas City, Missouri Metropolitan Area.......... 368,440 362,147 -- St. Joseph, Joplin, Monett and others................. 102,714 100,732 -- ------- ------- ------- 471,154 462,879 -- ------- ------- ------- Total........................ 961,443 946,799 486,847 ======= ======= =======\nSouthern Union Gas, Mercado, WGI and Southern. The following - --------------------------------------------- table shows certain operating statistics of the Company's gas distribution, transportation, marketing and transmission opera- tions in Texas and Oklahoma:\nYear Ended ------------------------------- June 30, December 31, ----------------- 1995 1994 1993 -------- -------- ------------\nAverage number of gas sales customers served (a): Residential................... 457,821 432,474 391,154 Commercial.................... 29,584 28,593 26,814 Industrial and irrigation..... 383 722 774 Public authorities and other.. 2,798 2,522 2,309 Pipeline and marketing........ 450 273 182 -------- -------- -------- Total average customers served...................... 491,036 464,584 421,233 ======== ======== ======== Gas sales in millions of cubic feet (Mmcf): Residential................... 21,567 23,852 22,171 Commercial.................... 9,925 10,173 9,545 Industrial and irrigation..... 2,113 2,216 2,615 Public authorities and other.. 3,209 2,959 2,938 Pipeline and marketing........ 7,596 7,482 6,934 -------- -------- -------- Gas sales billed............ 44,410 46,682 44,203 Net change in unbilled gas sales..................... (10) (18) 656 -------- -------- -------- Total gas sales............. 44,400 46,664 44,859 ======== ======== ========\nGas sales revenues (thousands of dollars): Residential................... $117,843 $137,135 $117,954 Commercial.................... 41,626 47,020 41,219 Industrial and irrigation..... 6,641 8,848 9,206 Public authorities and other.. 7,877 10,943 10,592 Pipeline and marketing........ 16,409 17,759 16,247 -------- -------- -------- Gas revenues billed......... 190,396 221,705 195,218 Net change in unbilled gas sales revenues................ (204) (2,018) 4,141 -------- -------- -------- Total gas sales revenues.... $190,192 $219,687 $199,359 ======== ======== ========\nGas sales margin (thousands of dollars) (b):................ $ 96,808 $ 95,136 $ 88,975 ======== ======== ========\nGas sales revenue per thousand cubic feet (Mcf) billed (c): Residential................... $ 5.464 $ 5.750 $ 5.320 Commercial.................... 4.194 4.622 4.318 Industrial and irrigation..... 3.143 3.992 3.520 Public authorities and other.. 2.455 3.698 3.605 Pipeline and marketing........ 2.160 2.374 2.343\nWeather effect: Degree days (d)............... 1,669 1,950 2,025 Percent of normal, based on 30 year average (e)........... 78% 90% 90%\nGas transported in millions of cubic feet (Mmcf).......... 38,128 24,461 22,750 Gas transportation revenues (thousands of dollars)........ $ 10,881 $ 7,393 $ 6,485\n- ---------------------------\n(a) Increase in the average customers served in 1995 and 1994 is due to the Rio Grande and Eagle Pass Acquisitions in Septem- ber 1993 and July 1993, respectively, involving a total of approximately 78,000 customers. (b) Gas sales margin is equal to gas sales revenues less pur- chased gas costs. (c) Fluctuations in gas price billed between each period reflect changes in the average cost of purchased gas and the effect of rate adjustments. (d) \"Degree days\" are a measure of the coldness of the weather experienced. A Degree day is equivalent to each degree that the daily mean temperature for a day falls below 65 degrees Fahrenheit. The decrease in 1995 and 1994 actual Degree days was impacted by warmer than normal weather and the tem- perate climate of Rio Grande acquired in September 1993. (e) Information with respect to weather conditions is provided by the National Oceanic and Atmospheric Administration. Percentages of normal are computed based on the weighted average volumes of gas sales billed.\nMissouri Gas Energy. The following table shows certain operating - ------------------- statistics of the gas distribution and transportation operations in Missouri:\nFive Year Months Ended Ended Year Ended ----------------------- June 30, June 30, June 30, December 31, 1995(a) 1994(a) 1994(a) 1993 -------- -------- --------- ------------\nAverage number of gas sales customers served: Residential....... 410,291 410,934 400,222 396,755 Commercial........ 59,087 58,830 57,300 57,330 Industrial........ 296 254 257 260 -------- -------- -------- -------- Total average customers served.......... 469,674 470,018 457,779 454,345 ======== ======== ======== ========\nGas sales in millions of cubic feet (Mmcf): Residential....... 41,354 21,569 45,407 47,244 Commercial........ 18,863 10,023 21,363 22,669 Industrial........ 241 26 143 309 -------- -------- -------- -------- Gas sales billed.......... 60,458 31,618 66,913 70,222 Net change in unbilled gas sales............. (19) (6,059) (104) (58) -------- -------- -------- -------- Total gas sales. 60,439 25,559 66,809 70,164 ======== ======== ======== ========\nGas sales revenues thousands of dollars): Residential....... $186,716 $108,871 $234,360 $215,806 Commercial........ 77,101 47,257 102,036 95,520 Industrial........ 1,731 458 1,480 2,015 -------- -------- -------- -------- Gas sales revenues billed. 265,548 156,586 337,876 313,341 Net change in unbilled gas sales revenues.... (740) (28,564) (1,210) 3,818 -------- -------- -------- -------- Total gas sales revenues.. $264,808 $128,022 $336,666 $317,159 ======== ======== ======== ========\nGas sales margin (thousands of dollars) (b)........ $116,353 $ 41,445 $103,191 $106,687 ======== ======== ======== ========\nGas sales revenue per thousand cubic feet (Mcf) billed:(c) Residential....... $ 4.515 $ 5.048 $ 5.161 $ 4.568 Commercial........ 4.087 4.715 4.776 4.214 Industrial........ 7.183 17.615 10.350 6.521\nWeather effect: Degree days (d)... 4,779 1,916 5,277 5,608 Percent of normal, based on 30-year average: (e).... 90% 93% 100% 106%\nGas transported in millions of cubic feet (Mmcf)....... 30,464 11,673 29,498 28,064 Gas transportation revenues (thousands of dollars).......... $ 8,336 $ 2,568 $ 6,614 $ 6,676\n- --------------------------\n(a) Missouri Gas Energy was acquired by the Company on January 31, 1994 and, therefore, is consolidated with the Company as of that date. The Company included Missouri Gas Energy in its results of operations beginning February 1, 1994. The increase in the average number of customers served in 1994 is due to the seasonality of the Company's business in which a greater number of customers are served during the winter-heating season. (b) Gas sales margin is equal to gas sales revenues less pur- chased gas. (c) Fluctuations in gas price billed between each period reflect changes in the average cost of purchased gas and the effect of rate adjustments. (d) \"Degree days\" are a measure of the coldness of the weather experienced. A Degree day is equivalent to each degree that the daily mean temperature for a day falls below 65 degrees Fahrenheit. (e) Information with respect to weather conditions is provided by the National Oceanic and Atmospheric Administration. Percentages of normal are computed based on the weighted average volumes of gas sales billed.\nInvestments in Real Estate\nLavaca Realty owns a commercially developed tract of land in the central business district of Austin, Texas, containing a combined 11-story office building, parking garage, drive-through bank and mini-bank facility (\"Lavaca Plaza\"). Approximately 49% of the office space at Lavaca Plaza is used in the Company's business while 51% is leased to non-affiliated entities. Lavaca Realty also owns a commercially developed tract of land in Austin, Texas that is used exclusively in the Company's business. Other real estate investments held at June 30, 1995 include two small com- mercial tracts in downtown Austin, 11 acres of undeveloped land in Dallas, Texas, 42 acres of undeveloped land in Denton, Texas and eight acres of undeveloped land in San Antonio, Texas. The real estate located in Denton and San Antonio was sold subsequent to June 30, 1995. The Company is attempting to sell all remaining undeveloped real estate. Lavaca Realty also owns approximately 36,000 square feet of improved property in Kansas City, Missouri, which is leased to a non-affiliated entity.\nEmployees\nAs of August 11, 1995, the Company has 1,743 employees, of whom 1,443 are paid on an hourly basis, 278 are paid on a salary basis and 22 are paid on a commission basis. Of the 1,443 hourly paid employees, approximately 57% are represented by unions. Of those employees represented by unions, 82% are employed by Missouri Gas Energy.\nIn May 1994, the Company announced an early retirement program for certain employees of Missouri Gas Energy with an election period from May 20 to June 23, 1994. Of an eligible 133 employees, 81 accepted the 1994 early retirement program. In January 1993, the Company provided an early retirement program to certain of the Company's employees with an election period from January to March 1993. Of an eligible 109 employees, 75 accepted the 1993 early retirement program.\nFrom time to time the Company may be subject to labor disputes; however, such disputes have not previously disrupted its busi- ness. The Company believes that its relations with its employees are good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. Properties.\nSee Item 1, \"Business,\" for information concerning the general location and characteristics of the important physical properties and assets of the Company.\nSouthern Union Gas has 8,584 miles of mains, 3,694 miles of ser- vice lines and 307 miles of transmission lines. Missouri Gas Energy has 7,093 miles of mains, 3,720 miles of service lines and 71 miles of transmission lines. WGI has 217 miles of transmis- sion lines and 48 miles of gathering lines. Southern has 137 miles of transmission lines. The Company considers its systems to be in good condition and to be well-maintained, and it has continuing replacement programs based on historical performance and system surveillance.\nPursuant to a 1989 MPSC order, Missouri Gas Energy is engaged in a major gas safety program in its service territories. This pro- gram includes replacement of company- and customer-owned gas service and yard lines, the movement and resetting of meters, the replacement of cast iron mains and the replacement and cathodic protection of bare steel mains (the \"Missouri Safety Program\"). In recognition of the significant capital expenditures associated with this safety program, the MPSC permits the deferral, and sub- sequent recovery through rates, of depreciation expense, property taxes and associated carrying costs, related to the Missouri Safety Program. Missouri Gas Energy was required to continue the Missouri Safety Program and has deferred depreciation expense, property taxes and carrying costs of approximately $4,154,000 and $600,000 for 1995 and 1994, respectively.\nITEM 3.","section_3":"ITEM 3. Legal Proceedings.\nSee \"Commitments and Contingencies\" and \"Acquisitions and Divestiture -- Missouri Gas Energy\" in the Notes to Consolidated Financial Statements for discussions of the Company's legal pro- ceedings.\nITEM 4.","section_4":"ITEM 4. Submission of Matters to a Vote of Security Holders.\nThere were no matters submitted to a vote of security holders of Southern Union during the quarter ended June 30, 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. Market for the Registrant's Common Stock and Related Stockholder Matters.\nMarket Information\nOn March 6, 1995, Southern Union's common stock began trading on the New York Stock Exchange under the symbol \"SUG.\" Prior to March 6, 1995, Southern Union's common stock was traded on the American Stock Exchange under the same symbol. On May 25, 1994 the Company's Board of Directors declared a 5% stock dividend, paid on June 30, 1994 to stockholders of record on June 14, 1994. On February 11, 1994 the Company's Board of Directors declared a three-for-two stock split distributed in the form of a 50% stock dividend on March 9, 1994 to stockholders of record on February 23, 1994.\nThe high and low sales prices (adjusted for the June 30 and March 9, 1994 distributions) for shares of Southern Union common stock since July 1, 1993 are set forth below:\n$\/Share --------------- High Low ------ ------\nJuly 1 to September 22, 1995.................. 19 1\/2 17 1\/4\n(Quarter Ended) June 30, 1995................................. 19 1\/4 16 3\/8 March 31, 1995................................ 17 7\/8 15 1\/2 December 31, 1994............................. 18 1\/4 16 3\/8 September 30, 1994............................ 18 3\/8 16 5\/8\n(Quarter Ended) June 30, 1994................................. 19 16 1\/4 March 31, 1994................................ 23 3\/8 16 1\/2 December 31, 1993............................. 20 1\/8 12 5\/8 September 30, 1993............................ 14 1\/8 11 7\/8\nHolders\nAs of September 22, 1995, there were 278 holders of record of Southern Union's common stock. This number does not include per- sons whose shares are held of record by a bank, brokerage house or clearing agency, but does include any such bank, brokerage house or clearing agency.\nThere were 11,518,622 shares of Southern Union's common stock outstanding on September 22, 1995 of which 6,532,345 shares were held by non-affiliates.\nDividends\nSouthern Union paid no cash dividends on its common stock in fis- cal 1995, 1994 or 1993. Provisions in certain of Southern Union's long-term notes and its bank revolving credit facility limit the payment of cash or asset dividends on capital stock. Under the most restrictive provisions in effect, Southern Union may not declare or pay any cash or asset dividends on its common stock or acquire or retire any of Southern Union's common stock, unless no event of default exists and the Company meets certain financial ratio requirements. See \"Business -- Changes in Capital Structure.\"\nOn March 9, 1994 Southern Union distributed a 50% stock dividend. On June 30, 1994 Southern Union paid a 5% stock dividend. The June 30, 1994 stock dividend was consistent with the decision of Southern Union's Board of Directors, as announced in February 1994, to commence regular stock dividends of approximately 5% each year in conjunction with annual meetings of stockholders. The specific amount and declaration, record and distribution dates for an annual stock dividend will be determined by the Board and announced at a date that is not expected to be later than the annual stockholders meeting each year. The next stock dividend is expected to be a 5% stock dividend declared in con- nection with the Company's annual meeting of stockholders to be held on November 7, 1995. A portion of the June 14, 1994 distri- bution was characterized as a distribution of capital due to the level of the Company's retained earnings available for distribu- tion as of the date of declaration.\nITEM 6.","section_6":"ITEM 6. Selected Financial Data.\nYears Ended June 30, Years Ended December 31, -------------------- ------------------------------ 1995(a) 1994(a)(b) 1993(b)(c) 1992(c) 1991(c) ---------- ---------- ---------- --------- --------- (thousands of dollars, except per share amounts)\nTotal operating revenues.. $ 480,046 $374,516 $209,005 $192,445 $200,261 Earnings from con- tinuing opera- tions..... 16,069 8,378 7,733 6,391 4,673 Earnings from con- tinuing opera- tions per share of common stock (d). 1.40 .85 .83 .47 .26 Total assets.... 1,002,502 897,712 416,207 377,167 369,783 Common stock- holders' equity.... 225,664 208,975 201,938 148,003 147,356 Short-term debt...... 770 889 40,655 14,360 2,385 Long-term debt, ex- cluding current maturi- ties...... 462,503 479,048 89,019 109,464 110,482 Redeemable preferred stock..... -- -- -- 24,900 25,000 Company- obligated manda- torily redeem- able pre- ferred securi- ties of subsidi- ary trust..... 100,000 -- -- -- --\nAverage customers served..... 960,710 660,425 421,233 394,199 428,077\n- ------------------\n(a) Missouri Gas Energy, a division of Southern Union head- quartered in Kansas City, Missouri, was acquired on January 31, 1994 and was accounted for as a purchase. Missouri Gas Energy assets were included in the Company's consolidated balance sheet at January 31, 1994 and its results of operations were included in the Company's con- solidated results of operations beginning February 1, 1994. For these reasons, the consolidated results of operations of the Company for the period subsequent to the acquisition are not comparable to prior periods. See \"Business -- Missouri Acquisition.\" (b) During 1994, the Company changed its fiscal year-end from December 31 to June 30. The Company believes the new fiscal year more closely conforms its financial condition and results of operations to its natural business cycle. The consolidated results of operations for the year ended June 30, 1994 and the year ended December 31, 1993 include the effects of the following which occurred in the two quar- ters in common during the six-month period ended December 31, 1993: (i) a non-recurring adjustment of approximately $2,489,000 to reverse a tax reserve upon the final settlement of prior period federal income tax audits; (ii) a pre-tax gain of approximately $494,000 on the sale of undeveloped real estate; and (iii) the write-off of approxi- mately $357,000 of acquisition-related costs as a result of the termination of negotiations for various acquisitions. (c) The Company completed the Berry Gas, Eagle Pass and Rio Grande acquisitions during 1993 and the Nixon acquisition in 1992. In addition, during 1991 the Company completed the South Texas, Brazos River and Andrews acquisitions and the sale of its Arizona gas utility operations. For these rea- sons, 1993, 1992 and 1991 results of operations are not com- parable between periods. (d) Earnings per share in 1994, 1993, 1992 and 1991 were com- puted based on the weighted average number of shares of com- mon stock outstanding during the year adjusted for the 5% stock dividend distributed on June 30, 1994 and the 50% stock dividend distributed on March 9, 1994.\nITEM 7.","section_7":"ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nIntroduction\nThe Company's principal line of business is the distribution of natural gas as a public utility through Southern Union Gas and, subsequent to January 31, 1994, Missouri Gas Energy, each of which is a division of the Company. Missouri Gas Energy was acquired on January 31, 1994 and was accounted for as a purchase. Accordingly, the operating results of Missouri Gas Energy have been included in the consolidated results of operations subse- quent to the date of acquisition. In addition, during 1993 the Company completed the Rio Grande, Berry Gas and Eagle Pass Acquisitions, which were also accounted for as purchases. See \"Acquisitions and Divestitures\" in the Notes to Consolidated Financial Statements. For these reasons, the results of opera- tions of the Company for the periods subsequent to those acquisi- tions are not comparable to those periods prior to the acquisitions nor are the 1995 results of operations comparable with prior periods.\nSouthern Union Gas, which accounted for approximately 39% of the Company's total revenues for the year ended June 30, 1995, serves approximately 498,000 residential, commercial, industrial, agri- cultural and other customers in the States of Texas (including the cities of Austin, Brownsville, El Paso, Galveston and Port Arthur) and Oklahoma. Missouri Gas Energy, which accounted for approximately 57% of the Company's total revenues for the year ended June 30, 1995, serves approximately 478,000 customers in central and western Missouri, including Kansas City, St. Joseph, Joplin and Monett. In addition, the Company operates interstate and intrastate natural gas pipeline systems, markets natural gas to end users and markets and sells natural gas for natural gas vehicles. The Company also holds investments in real estate and other assets.\nOn May 25, 1994, Southern Union's Board of Directors declared a 5% stock dividend distributed on June 30, 1994 to stockholders of record on June 14, 1994. A portion of the 5% stock dividend was characterized as a distribution of capital due to the level of the Company's retained earnings available for distribution as of the date of declaration. The 5% stock dividend was consistent with the Board of Directors decision announced in February 1994 to commence regular stock dividends of approximately 5% annually. Also in February 1994, Southern Union's Board of Directors declared a three-for-two stock split distributed in the form of a 50% stock dividend on March 9, 1994 to stockholders of record on February 23, 1994. Unless otherwise stated, all per share data included in this Management's Discussion and Analysis of Finan- cial Condition and Results of Operations (\"MD&A\") and in the accompanying consolidated financial statements and notes to the consolidated financial statements have been restated to give effect to the stock split and stock dividend.\nIn May 1994, the Board of Directors changed the Company's fiscal year-end from December 31 to June 30. The new fiscal year more closely conforms the reporting of the Company's financial condi- tion and results of operations to its seasonal business cycle. The comparison of consolidated results or operations for the year ended June 30, 1994 and the year ended December 31, 1993 include the effects of the following items that occurred in the two quar- ters in common during the six-month period ended December 31, 1993: (i) a non-recurring adjustment of approximately $2,489,000 to reverse a tax reserve upon the final settlement of prior period federal income tax audits; (ii) a pre-tax gain of approxi- mately $494,000 on the sale of undeveloped real estate; and (iii) the write-off of approximately $357,000 of acquisition-related costs as a result of the termination of negotiations for various acquisitions. All references in this MD&A to years 1995, 1994 and 1993 reflect the twelve months ended June 30, 1995, June 30, 1994 and December 31, 1993, respectively.\nSeveral of the Company's business activities are subject to regu- lation by federal, state or local authorities. Thus, the Com- pany's financial condition and results of operations have been dependent upon the receipt of adequate and timely adjustments in rates. Gas service rates, which consist of a monthly fixed charge and a gas usage charge, are established by regulatory authorities and are intended to permit utilities to recover operating, administrative and financing costs and to have the opportunity to earn a return on equity. The monthly fixed charge provides a base revenue stream while the usage charge increases the Company's revenues and earnings in colder weather when natural gas usage increases.\nThe Company's revenues and earnings are primarily dependent upon gas sales volumes and gas service rates. Gas purchase costs generally do not directly affect the Company's earnings as such costs are usually passed through to customers pursuant to pur- chase gas adjustment clauses. Accordingly, while changes in the cost of gas may cause the Company's operating revenues to fluc- tuate, operating margin (defined as operating revenues less gas purchase costs) is generally not affected by increases or decreases in the cost of gas.\nGas sales volumes fluctuate as a function of seasonal weather impact and the size of the Company's customer base, which is affected by competitive factors in the industry as well as econo- mic development and residential growth in its service areas. The primary factors that affect the distribution and sale of natural gas are the seasonal nature of gas use, adequate and timely rate relief from regulatory authorities, competition from alternative fuels, competition within the gas business for industrial custo- mers and volatility in the supply and price of natural gas.\nIn recent years weather variances experienced during the tradi- tional heating load months have significantly impacted the Com- pany's results of operations. The average temperatures in Southern Union Gas' service areas during the past several winter seasons have been much warmer than normal. To mitigate the impact of these seasonal variances, Southern Union Gas has requested and received approval for weather normalization clauses in Austin, Galveston and in two other service areas in Texas. These clauses allow for rate adjustments that help stabilize cus- tomers' monthly bills and the Company's earnings from the varying effects of weather.\nResults of Operations\nNet Earnings Available for Common Stock\nThe Company recorded net earnings available for common stock of $16,069,000 for the year ended June 30, 1995 compared to $8,378,000 in 1994, an increase of 92%. Net earnings per common share, based on weighted average shares outstanding were $1.40 in 1995 compared to $.85 in 1994. Net earnings available for common stock in 1993 were $6,890,000 or $.83 per share based on weighted average shares outstanding.\nNet earnings between reporting periods were primarily affected by the January 31, 1994 acquisition of Missouri Gas Energy and the September 30, 1993 acquisition of Rio Grande. These acquisitions collectively contributed approximately $8,887,000 or 55% in 1995 and $880,000 or 11% in 1994 to net earnings after deductions for allocated corporate expenses, interest and income taxes. Rate increases also affect comparability between periods. Rate increases included: a $777,000 annualized increase in the Com- pany's South Texas service area effective February 10, 1993; a $1,950,000 annualized increase in Austin effective July 1, 1993; and a $463,000 annualized increase in El Paso effective November 1, 1993.\nThe Company's net earnings in 1995 and 1994 were positively impacted by the elimination of preferred stock dividends due to the retirement of Southern Union's Series A 10% Cumulative Pre- ferred Stock begun in March and completed in June 1993. This was partially offset in 1995 by the issuance of $100,000,000 of 9.48% Trust Originated Preferred Securities which impacted net earnings by $753,000 in 1995.\nAs previously noted, Missouri Gas Energy's results of operations were included in the consolidated operating results of the Com- pany subsequent to January 31, 1994. Accordingly, the Company's 1994 results of operations do not include Missouri Gas Energy's operations for December 1993 or January 1994, two of the coldest months of Missouri's winter-heating season. In addition, Missouri Gas Energy's rate structure collects a greater per- centage of its margin during the winter-heating season months than does Southern Union Gas. This results in a significant timing difference occurring between the collection of revenues in the winter months to recover annual costs and the actual incur- rence of these costs throughout the year. Thus, Missouri Gas Energy's contribution to the Company's results of operations in 1994 were not significant.\nOperating Revenues\nTotal operating revenues in 1995, 1994 and 1993 were $480,046,000, $374,516,000 and $209,005,000, respectively. Reve- nues are affected by the level of sales volumes, customer base and the pass-through of increases or decreases in the Company's gas purchase costs through its purchase gas adjustment clauses. Operating revenues increased $105,530,000, or approximately 28%, in 1995, primarily due to the acquisition of Missouri Gas Energy, which contributed operating revenues of $274,862,000 or 57% of total operating revenues in 1995 and $143,502,000 or 38% of total operating revenues in 1994. The Company's average customer base served in 1995 and 1994 was approximately 961,000 and 660,000, respectively. The increase in the average customer base from 1994 to 1995 primarily is the result of consolidating Missouri Gas Energy's operations with the Company for the full twelve months of 1995 as compared with only five months in 1994. Gas sales volume increased to 104,839 MMcf in 1995 from 72,223 MMcf in 1994, while the average cost of gas decreased to $2.31 per Mcf in 1995 from $2.92 per Mcf in 1994. The increase in volume is attributable to growth in the average customer base as a result of the acquisition of Missouri Gas Energy. The decrease in the average cost of gas primarily is the result of decreases in average spot market gas prices throughout the Company's distribu- tion system as a result of competitive pricing within the indus- try which was impacted by warmer than normal weather throughout the Company's service territories. The Texas and Oklahoma ser- vice areas experienced 78% of normal weather in 1995 compared to 90% of normal in 1994. Weather in the Missouri service area decreased from 93% of normal in 1994 to 90% of normal in 1995.\nOperating revenues increased $165,511,000, or approximately 79%, in 1994, primarily due to an increase in over a half a million customers resulting from the Missouri, Rio Grande, Berry Gas and Eagle Pass Acquisitions. Revenues from these acquisitions were approximately $167,692,000 in 1994. The average customer base served in 1994 and 1993 was approximately 660,000 and 421,000, respectively. The increase in the average customer base was pri- marily the result of the Missouri Gas Energy acquisition. Operating revenues also increased due to receipt of rate increases in 1993, described above, and by a 19% increase in the average cost of gas from $2.46 per Mcf in 1993 to $2.92 per Mcf in 1994.\nGas Sales and Transportation Volumes\nGas sales volumes billed in 1995, 1994 and 1993 totaled 104,868 MMcf, 78,300 MMcf and 44,203 MMcf, respectively, at an average Mcf sales price of $4.35, $4.83 and $4.42, respectively. Gas sales volumes fluctuate as a function of weather and customer base. The increase in gas sales volumes is due principally to the increase in gas sales subsequent to the Missouri Acquisition and the Rio Grande Acquisition. Gas sales volumes billed by these acquired operations were 63,861 MMcf in 1995 and 34,512 MMcf in 1994. Gas sales volumes are also directly impacted by the weather patterns in the Company's service areas. The Texas and Oklahoma service areas averaged 28% warmer than normal in 1995 and 11% warmer than normal in both 1994 and 1993, while the Missouri service area was 11% warmer than normal in 1995 and 8% warmer than normal in the five months ended June 30, 1994. The average sales price per Mcf varied between periods as a result of variations in contracted and spot market gas prices, which are effected by competitive factors in the industry.\nGas transportation volumes in 1995, 1994 and 1993 totaled 68,592 MMcf, 36,134 MMcf and 22,750 MMcf, respectively, at an average transportation rate per Mcf of $.28, $.28 and $.29 respectively. Transportation volumes increased in 1995 as compared to 1994 as a result of the Missouri Acquisition, which contributed 30,464 MMcf in 1995, and by an increase in WGI's transported volumes into Mexico from 8,500 MMcf in 1994 to 16,400 MMcf in 1995. Transpor- tation volumes increased in 1994 as compared to 1993 as a result of 11,673 MMcf transported by Missouri Gas Energy in 1994.\nGas Purchase Costs\nGas purchase costs in 1995, 1994 and 1993 were $241,839,000, $211,127,000 and $110,384,000, respectively. The increase in gas purchase costs in 1995 and 1994 was due to the Missouri Acquisi- tion contributing $147,799,000 or 61% of gas purchase costs in 1995 and $86,577,000 or 41% in 1994. These increases were partially offset by a decrease in both the average spot market price of natural gas as well as a decrease in gas sales volumes in the Company's Texas and Oklahoma service territories, previously discussed. The average spot market price of natural gas per million British thermal units (\"MMBtu\") in 1995, 1994 and 1993 was $1.43, $1,90 and $1.96, respectively. The average gas purchase cost, including both spot purchases and contract pur- chases, was $2.31 per Mcf in 1995, $2.92 per Mcf in 1994 and $2.46 per Mcf in 1993. The decrease in average gas purchase cost in 1995 as compared to 1994 was due to a 25% decrease in the average spot market price of natural gas due to competitive pricing during the unusually warm 1994\/1995 winter season as dis- cussed above. The increase in average gas purchase cost in 1994 as compared to 1993 was due to certain previously negotiated fixed price gas supply contracts with certain suppliers to the Missouri operations assigned to the Company in the Missouri Acquisition.\nOperating, Maintenance and General Expenses\nOperating, maintenance and general expenses were $104,072,000, $79,667,000 and $50,076,000 in 1995, 1994, and 1993, respec- tively. The Missouri and Rio Grande Acquisitions contributed combined operating, maintenance and general expenses of $60,546,000, $32,814,000 and $1,779,000 for 1995, 1994 and 1993, respectively. The operating, maintenance and general expenses of Southern Union Gas, excluding Rio Grande, decreased in both 1995 and 1994 as a result of efforts to reduce costs and improve operating efficiencies, including approximately $1,444,000 in savings in 1994 from the reduction in payroll expenses as a result of the Company's 1993 early retirement program finalized in April 1993.\nTaxes\nFederal and state income tax expense in 1995, 1994 and 1993 was $10,974,000, $5,185,000 and $3,855,000, respectively. The in- crease in income taxes in 1995 and 1994 primarily is a result of an increase in pre-tax income attributable to the Company's re- vent acquisitions. Income taxes in both 1994 and 1993 were im- pacted by reductions related to amended prior year federal income tax returns and non-taxable income items included with \"other income\" related to the reversal of a tax reserve recorded in September 1993, discussed below. In July 1993 the Company paid the Internal Revenue Service (\"IRS\") approximately $1,266,000 in settlement for federal income taxes and interest related to the tax years 1984 through 1989. The Company had previously esti- mated and accrued an amount for the tax deficiencies and related interest and, as a result of the settlement with the IRS for a lesser amount, a non-recurring adjustment was recorded to reverse the tax reserve in excess of the payment made. The reversal of the reserve had no impact on liquidity or cash flows due to the non-cash impact of this adjustment. See \"Taxes on Income\" in the Notes to Consolidated Financial Statements.\nTaxes other than income taxes reflect various state and local business and payroll related taxes. The state and local business taxes are generally based on gross receipts and investments in property, plant and equipment and fluctuate accordingly.\nDepreciation and Amortization Expense\nDepreciation and amortization expense in 1995, 1994 and 1993 was $32,373,000, $21,919,000 and $14,416,000, respectively. The increase in depreciation expense of $10,454,000 in 1995 and $7,503,000 in 1994 was primarily attributable to the acquisition of gas distribution systems, previously discussed.\nEffective January 1, 1994, the Company revised its estimate of the amortization period of additional purchase cost assigned to utility plant to its standard policy of forty years. As a result of this change, amortization expense for 1994 was reduced by approximately $478,000, with a corresponding increase to net earnings, or $.05 per average common share. See \"Change in Accounting Estimate\" in the Notes to Consolidated Financial Statements.\nOther Income and Expenses, Net\nOther expenses, net in 1995, 1994 and 1993 were $35,073,000, $18,470,000 and $8,176,000, respectively. The increase in other expenses of approximately $16,603,000 in 1995 and $10,294,000 in 1994 is principally due to an increase in interest expense on long-term debt of approximately $13,880,000 in 1995 and $12,033,000 in 1994. The increased interest expense on long-term debt is due to the issuance of the Senior Debt Securities which were used, in part, to fund the Missouri Acquisition and to repay and refinance certain outstanding debt of the Company. See \"Long-Term Debt\" in the Notes to Consolidated Financial State- ments.\nAs a result of the issuance of the Preferred Securities in 1995, the Company recorded dividends on preferred securities of sub- sidiary trust of approximately $1,159,000 in 1995. See \"Business - -- Changes in Capital Structure\" and \"Preferred Securities of Subsidiary Trust\" in the Notes to the Consolidated Financial Statements.\nOther income of $5,970,000 in 1995 included rental income from Lavaca Realty of approximately $2,647,000; approximately $2,619,000 related to the deferral of interest expense associated with the Missouri Gas Energy Safety Program (see \"Utility Regula- tion and Rates\" in the Notes to the Consolidated Financial State- ments); investment interest and interest on notes receivable of approximately $960,000; and approximately $244,000 from gas appliance merchandising. This was partially offset by approxi- mately $750,000 for the write-down to estimated fair market value of certain real estate held for sale.\nOther income increased in 1994 over 1993 by approximately $1,423,000. Other income increased by approximately $500,000 as a result of gas appliance merchandising related to the acquisi- tion of the gas distribution systems, previously discussed. Rental income earned by Lavaca Realty increased by approximately $450,000 in 1994 as compared to 1993. In addition, Missouri Gas Energy recorded other income in 1994 of approximately $276,000 related to the deferral of interest expense associated with the Missouri Gas Energy Safety Program.\nAs a result of the change in the Company's year-end to June 30, both the 1994 and 1993 results of operations were impacted by the recording of a non-recurring adjustment of approximately $2,489,000 to reverse a tax reserve upon the final settlement of prior period federal income tax audits as previously discussed. The reversal of the reserve had no impact on liquidity or cash flows due to the non-cash impact of this adjustment. Other income and expense items recorded during the period in common in 1994 and 1993 included the recognition of a pre-tax gain of approximately $494,000 on the sale of undeveloped real estate and the write-off of approximately $357,000 of acquisition-related costs as a result of the termination of negotiations for various acquisitions.\nOther income items recorded in 1993 also included rental income from Lavaca Realty of approximately $1,835,000; interest income on notes receivable of approximately $830,000; and a pre-tax gain of approximately $494,000 on the sale of undeveloped real estate.\nInterest expense on short-term debt was $1,787,000, $1,412,000 and $1,836,000 in 1995, 1994 and 1993, respectively. The average short-term debt outstanding during 1995, 1994 and 1993 was $27,159,000, $26,369,000 and $33,021,000, respectively, at an average interest rate of 6.5%, 5.1% and 5.3%, respectively. The variance in the average amounts outstanding coupled with a general fluctuation in interest rates resulted in the change in other interest expense in each of the years.\nLiquidity and Capital Resources\nThe Company's liquidity is impacted by its ability to generate funds from operations and to access capital markets. The gas utility operations are seasonal in nature with a significant per- centage of the Company's annual revenues and earnings occurring in the traditional heating-load months. This seasonality results in a high level of cash flow needs during the peak winter-heating season months, resulting from the required payments to natural gas suppliers in advance of the receipt of cash payments from the Company's customers. The Company has historically used its revolving credit facility and internally-generated funds to pro- vide funding for its seasonal working capital, continuing con- struction and maintenance programs and operational requirements.\nOperating Activities\nNet cash generated from operating activities in 1995, 1994 and 1993 was $41,642,000, $95,329,000 and $15,017,000 respectively. The change in net cash generated from operations in each of these years was primarily impacted by the Missouri Gas Energy Acquisi- tion and the Rio Grande Acquisition in which net working capital assets of $50,999,000 were acquired in 1994. Subsequent to these acquisitions, significant collections on accounts receivable and payments on accounts payable have occurred. Additionally, these acquisitions have contributed to increased net earnings of the Company in 1995 and 1994.\nAt June 30, 1995 and 1994, the Company's primary sources of liquidity included cash, cash equivalents and short-term invest- ments of $58,597,000 and $5,881,000, respectively, and borrowings available under its $100,000,000 revolving credit facility, as described below. No amounts under the revolving credit facility were outstanding at June 30, 1995 or 1994.\nFinancing Activities\nOn May 17, 1995, Southern Union Financing I (the \"Subsidiary Trust\"), a consolidated wholly-owned subsidiary of Southern Union, issued $100,000,000 of 9.48% Trust Originated Preferred Securities (the \"Preferred Securities\"). In connection with the Subsidiary Trust's issuance of the Preferred Securities and the related purchase by Southern Union of all of the Subsidiary Trust's common securities (the \"Common Securities\"), Southern Union issued to the Subsidiary Trust $103,092,800 principal amount of its 9.48% Subordinated Deferrable Interest Notes, due 2025 (the \"Subordinated Notes\"). The sole assets of the Subsidiary Trust are and will be the Subordinated Notes. The interest and other payment dates on the Subordinated Notes correspond to the distribution and other payment dates on the Preferred Securities and the Common Securities. Under certain circumstances, the Subordinated Notes may be distributed to holders of the Preferred Securities and holders of the Common Securities in liquidation of the Subsidiary Trust. The Sub- ordinated Notes are redeemable at the option of the Company on or after May 17, 2000, at a redemption price of $25 per Subordinated Note plus accrued and unpaid interest. The Preferred Securities and the Common Securities will be redeemed on a pro rata basis to the same extent as the Sub- ordinated Notes are repaid, at $25 per Preferred Security and Common Security plus accumulated and unpaid distribu- tions. Southern Union's obligations under the Subordinated Notes and related agreements, taken together, constitute a full and unconditional guarantee by Southern Union of pay- ments due on the Preferred Securities. As of June 30, 1995, 4,000,000 shares of Preferred Securities were outstanding.\nSouthern Union has the right under the Subordinated Notes to extend interest payment periods up to 20 consecutive quarters, and, as a consequence, quarterly distributions on the Preferred Securities may be deferred (but will continue to accrue with interest thereon at a rate of 9.48% per annum compounded quar- terly) by the Subsidiary Trust during any such extended interest payment period. If interest payments are deferred by Southern Union, the Company: (i) may not pay cash dividends, or redeem, purchase or acquire, or make a liquidation payment with respect to, any of its capital stock or the capital stock of any sub- sidiary of Southern Union; and (ii) shall not make any payment of interest, principal or premium, if any, on or repay, repurchase or redeem any debt securities issued by Southern Union that rank pari passu with or junior to the subordinate debentures.\nThe issuance of the Preferred Securities was part of a $300,000,000 shelf registration filed with the Securities and Exchange Commission on March 29, 1995. Southern Union may sell a combination of preferred securities of financing trusts and senior and subordinated debt securities of Southern Union of up to $196,907,200 (the remaining shelf) from time to time, at prices determined at the time of any offering. The net proceeds from the $100,000,000 Preferred Securities offering have been used to repurchase $35,000,000 of 7.60% Senior Debt Securities through July 1995. The remaining proceeds will be used to repur- chase additional long-term debt, provide working capital for sea- sonal needs or for other business opportunities. See \"Preferred Securities of Subsidiary Trust\" and \"Long-Term Debt\" in the Notes to the Consolidated Financial Statements.\nOn April 28, 1995, Southern Union entered into an amendment to their existing $100,000,000 revolving credit facility (the \"Revolving Credit Facility\") underwritten by Texas Commerce Bank, N.A. and syndicated to four additional banks. The amended Revolving Credit Facility eliminates certain covenants, is uncollaterized and has no borrowing base limitations as long as the Company's Senior Debt Securities meet certain rating criteria. Borrowings under the Revolving Credit Facility are available for Southern Union's working capital and letter of credit requirements. The Revolving Credit Facility can also be used in part, but not to exceed $40,000,000, to fund acquisitions and capital expenditures. The Revolving Credit Facility contains certain financial covenants that, among other things, restrict cash or asset dividends, share repurchases, certain investments and additional debt. The facility expires on December 31, 1997 but may be extended annually for periods of one year beginning on September 30, 1994 with the consent of each of the banks. The revolving credit facility is subject to a commitment fee based on the rating of the Company's Senior Debt Securities. As of June 30, 1995 the commitment fee was an annualized .1875% on the unused balance. No amounts were outstanding under the Revolving Credit Facility at June 30, 1995 and 1994 as well as at September 22, 1995.\nOn January 31, 1994, the Company completed the sale of $475,000,000 Senior Debt Securities. In addition, on December 31, 1993 Southern Union completed the Rights Offering to its existing stockholders to subscribe for and purchase 2,000,000 pre-split and pre-dividend shares of the Company's common stock, par value $1.00 per share, at a pre-split and pre-dividend price of $25.00 per share for net proceeds of $49,351,000. The net proceeds from the sale of the Senior Debt Securities, together with the net proceeds from the Rights Offering and working capital from operations, were used to: (i) fund the Missouri Acquisition; (ii) repay approximately $59,300,000 of borrowings under the revolving credit facility used to fund the Rio Grande Acquisition and repurchase all outstanding preferred stock; (iii) refinance, on January 31, 1994, $10,000,000 aggregate principal amount of 9.45% Senior Notes due January 31, 2004, and $25,000,000 aggregate principal amount of 10% Senior Notes due January 31, 2012 and the related premium of approximately $10,400,000 resulting from the early extinguishment of such notes; (iv) refinance, on March 2, 1994, $50,000,000 aggregate principal amount of 10.5% Sinking Fund Debentures due May 15, 2017 and the related premium of approximately $3,300,000 resulting from the early extinguishment of such debentures; and (v) refinance, on May 16, 1994, $20,000,000 aggregate princi- pal amount of 10 1\/8% Notes.\nThe Company's effective rate under the current debt structure is approximately 7.8% (including interest and the amortization of debt issuance costs and redemption premiums on refinanced debt).\nIn March 1993, Southern Union retired 68,000 shares of the Series A 10% Cumulative Preferred Stock (\"Preferred Stock\") at $103 per share for $7,004,000. In April 1993, Southern Union retired 77,000 shares of Preferred Stock at $102 per share for $7,854,000. In June 1993, Southern Union retired 4,000 shares of Preferred Stock at $103.50 per share for $414,000 and the remaining outstanding 100,000 shares at par for $10,000,000.\nInvesting Activities\nAs previously discussed, Southern Union acquired Missouri Gas Energy on January 31, 1994. At closing, Southern Union paid approximately $400,300,000 in cash, based on account balances as of December 31, 1993. The final purchase price, which was deter- mined through post-closing adjustments and subsequent arbitra- tion, was approximately $401,600,000. See \"Contingencies\" in the Notes to the Consolidated Financial Statements. The Missouri Acquisition was financed through the sale of $475,000,000 of Senior Debt Securities completed on January 31, 1994, and net proceeds from the sale of $50,000,000 of common stock in the Rights Offering completed on December 31, 1993. See \"Long-Term Debt\" in the Notes to the Consolidated Financial Statements.\nThe additional purchase cost assigned to utility plant as a result of the Missouri Acquisition of approximately $68,000,000 consists of approximately $44,200,000 of excess purchase price over the historical book carrying value of the net assets acquired and approximately $23,800,000 of accruals for certain liabilities assumed and preacquisition contingencies which have been incurred or estimates of amounts that will be incurred in the future. The accruals reflect actual or estimated amounts for: (i) employee severance and other costs associated with an early retirement program for employees of Missouri Gas Energy of approximately $11,200,000; (ii) underwriting, legal and accounting fees associated with the Missouri Acquisition; and (iii) other preacquisition contingencies. Amortization of the additional purchase cost assigned to utility plant is provided on a straight-line basis over forty years.\nIn September 1993, the Company completed the Rio Grande Acquisi- tion for approximately $30,500,000. Rio Grande presently serves approximately 75,000 customers in the south Texas counties of Willacy, Cameron and Hidalgo, including the cities of Harlingen, McAllen and Brownsville (the southernmost city in the continental U.S.). The Company initially funded the purchase with borrowings from its Revolving Credit Facility. The Rio Grande Acquisition was accounted for as a purchase.\nIn July 1993, the Company completed the Eagle Pass Acquisition for approximately $2,000,000. During May 1993, the Company com- pleted the Berry Gas Acquisition which system serves the Texas cities and towns of Nome, Raywood, Hull and Devers for approxi- mately $274,000. Combined, these operations collectively serve approximately 4,400 customers. These acquisitions were also accounted for as purchases.\nIn March 1993, Southern Union Exploration Company (\"SX\"), pursu- ant to a purchase and sale agreement entered into in February 1993, sold substantially all of its oil and gas leasehold interests and associated production, for $22,000,000 effective January 1, 1993.\nIn July 1995, Southern Union Company entered into a letter of intent to sell WGI, exclusive of certain WGI assets in El Paso, Texas and WGI's Del Norte interconnect operation which transmits natural gas into Mexico, and to sell certain gas distribution operations of Southern Union Gas in the panhandle areas of Texas and Oklahoma for approximately $14,800,000. The sale is subject to approval by the FERC and the Oklahoma Corporation Commission and must be reported to the Railroad Commission of Texas. These operations will remain consolidated with those of the Company until the sale has received regulatory approval.\nDuring 1995, 1994 and 1993, the Company expended approximately $554,157,000 on capital projects including acquisitions. Of that total, $112,556,000 was incurred on normal expansion of its dis- tribution system as well as relocation and replacement. For 1995 and 1994, the Company spent approximately $63,139,000 and $41,300,000 for capital expenditures, respectively, exclusive of the acquisitions of natural gas distribution properties, which was used for normal distribution system replacement and expan- sion. Capital expenditures included $24,476,000 and $9,505,000 related to the Missouri Safety Program in 1995 and 1994, respec- tively. See \"Utility Regulation and Rates\" in the Notes to Con- solidated Financial Statements.\nOther Matters\nContingencies\nThe Company has been named as a potentially responsible party in a special notice letter from the United States Environmental Pro- tection Agency for costs associated with removing hazardous sub- stances from the site of a former coal gasification plant in Vermont. The Company also assumed responsibility for certain environmental matters in connection with the Missouri Acquisi- tion. See \"Commitments and Contingencies\" in the Notes to Consolidated Financial Statements.\nRegulatory\nThe Company is continuing to pursue certain changes to rates and rate structures that are intended to reduce the sensitivity of earnings to weather including weather normalization clauses and higher minimum monthly service charges.\nOn February 10, 1993, the Company's South Texas service area received an annualized rate increase of $777,000. On July 1, 1993, rates for Austin were changed to provide: (i) an approxi- mate $1,700,000 base revenue increase; (ii) new and increased fees that will add approximately $250,000 annually; and (iii) weather normalization clause revisions. On November 1, 1993, El Paso rates changed to provide an approximate revenue increase of $463,000. These rate increases contributed significantly to Southern Union Gas' earnings in 1994. In addition, on October 5, 1993, the MPSC issued a rate order increasing Missouri Gas Energy's natural gas rates by $9,750,000 annually effective October 15, 1993. Southern Union Gas also received several annual cost of service adjustments in fiscal 1995 and 1994.\nPursuant to a 1989 MPSC order, Missouri Gas Energy is engaged in a major gas safety program in its service territories. This pro- gram includes replacement of company- and customer-owned gas ser- vice and yard lines, the movement and resetting of meters, the replacement of cast iron mains and the replacement and cathodic protection of bare steel mains (the \"Missouri Safety Program\"). In recognition of the significant capital expenditures associated with this safety program, the MPSC permits the deferral, and sub- sequent recovery through rates, of depreciation expense, property taxes and associated carrying costs, related to the Missouri Safety Program. Missouri Gas Energy was required to continue the Missouri Safety Program and has deferred depreciation expense, property taxes and carrying costs of approximately $4,154,000 and $600,000 for 1995 and 1994, respectively.\nAccounting Pronouncements\nIn March 1995, the Financial Accounting Standards Board (\"FASB\") issued Statement of Financial Accounting Standards (\"SFAS\") No. 121, Accounting for the Impairment of Long-Lived Assets and for ---------------------------------------------------------- Long-Lived Assets To Be Disposed Of, which is effective for - ----------------------------------- fiscal years beginning after December 15, 1995. SFAS No. 121 requires that long-lived assets, identifiable intangibles, capital leases and goodwill be reviewed for impairment whenever events occur or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. In addi- tion, SFAS No. 121 requires that regulatory assets meet the recovery criteria of SFAS No. 71, Accounting for the Effects of ----------------------------- Certain Types of Regulation, on an ongoing basis in order to con- - --------------------------- tinue to defer applicable costs. SFAS No. 121 will be imple- mented by Southern Union in 1996 and is not expected to have an impact on the Company since the carrying amount of all assets, including regulatory assets, is considered recoverable. However, as the Company enters a more competitive environment, some assets could potentially be subject to impairment, thereby necessitating write-downs or write-offs, which could have a material adverse effect on the Company's future results of operations and finan- cial position.\nThe Company adopted the provisions of SFAS No. 112, Employers' ---------- Accounting for Postemployment Benefits, as of January 1, 1994. - -------------------------------------- This statement requires that the cost of benefits, such as dis- ability and health care continuation coverage provided to former or inactive employees after employment but before retirement, be accrued if attributable to an employee's previously rendered ser- vice. The Company had previously recognized such postemployment benefit costs when paid and was allowed recovery in rates as pay- ments were incurred. Consequently, the Company records a regula- tory asset and related liability to the extent it intends to file rate applications to include such costs in rates and such costs are considered probable of recovery.\nThe Company also adopted the provisions of SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than - ------------------------------------------------------------- Pensions,\" effective as of January 1, 1993. SFAS No. 106 - -------- requires an accrual of postretirement medical and other benefit liabilities on an actuarial basis during the years an employee provides services as compared to the pay-as-you-go method. The Company, excluding Missouri Gas Energy, records a regulatory asset for the difference between the postretirement costs cur- rently included in rates and SFAS No. 106 expense to the extent the Company files, or intends to file, a rate application to include SFAS No. 106 expense in rates. The Company believes that it is probable that the relevant regulatory authorities will allow such expenses in future rates. The Company's adoption, except for Missouri Gas Energy, of the provisions of SFAS No. 106 resulted in a transition obligation of approximately $9,328,000 which was subsequently reduced to $4,084,000 at June 30, 1994, primarily as a result of certain plan amendments in 1993. The Company amortizes the transition obligation over the allowed 20- year period. Consequently, earnings were not adversely impacted by the adoption of this statement.\nThe seller of the Missouri operations also adopted the provisions of SFAS No. 106 as of January 1, 1993 and filed an application with the MPSC for an order permitting the deferral of SFAS No. 106 expense and proposed inclusion in the future computation of cost of service the actual SFAS No. 106 expense and an income stream generated from a corporate-owned life insurance (\"COLI\") owned by the seller. To the extent SFAS No. 106 expense exceeds income from the COLI program, this excess would be deferred (as allowed by the FASB Emerging Issues Task Force Issue No. 92-12) and offset by income generated through the deferral period by the COLI program. Subsequent to the Missouri Acquisition, the Com- pany filed an application with the MPSC for an order to permit the deferral of SFAS No. 106 expense and also proposes the inclu- sion in the future computation of cost of service the actual SFAS No. 106 expense and income stream generated from a COLI. As a result of the MPSC's approval of the application, Missouri Gas Energy has recorded a regulatory asset and a liability repre- senting the accumulated benefit obligation as of June 30, 1995 and 1994.\nThe U.S. House of Representatives is currently considering a proposal which would phase-out the tax deductibility of interest on loans under a COLI. The current proposal, if passed, would be effective on January 1, 1996 and would phase-out the deduc- tion over a five-year period. The Company anticipates to the extent that the COLI, as impacted by the Legislature, does not offset the SFAS No. 106 expense, the Company would be able to recover the shortfall in rates.\nITEM 8.","section_7A":"","section_8":"ITEM 8. Financial Statements and Supplementary Data.\nReference is made to the Consolidated Financial Statements of Southern Union and its consolidated subsidiaries beginning with the index thereto on page.\nITEM 9.","section_9":"ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. Directors and Executive Officers of Registrant.\nThere is incorporated in this Item 10 by reference the informa- tion in the Company's definitive proxy statement for the 1995 Annual Meeting of Stockholders under the captions \"Election of Directors,\" \"Executive Officers Who Are Not Directors\" and \"The Board of Directors.\"\nITEM 11.","section_11":"ITEM 11. Executive Compensation.\nThere is incorporated in this Item 11 by reference the informa- tion in the Company's definitive proxy statement for the 1995 Annual Meeting of Stockholders under the captions \"Management Compensation,\" \"Board of Directors Report on Executive Compensa- tion,\" \"Company Performance Chart\" and \"Certain Relationships.\"\nITEM 12.","section_12":"ITEM 12. Security Ownership of Certain Beneficial Owners and Management.\nThere is incorporated in this Item 12 by reference the informa- tion in the Company's definitive proxy statement for the 1995 Annual Meeting of Stockholders under the caption \"Security Ownership.\"\nITEM 13.","section_13":"ITEM 13. Certain Relationships and Related Transactions.\nThere is incorporated in this Item 13 by reference the informa- tion in the Company's definitive proxy statement for the 1995 Annual Meeting of Stockholders under the caption \"Certain Rela- tionships.\"\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 Index on -------------------- page for a list of all financial statements filed as part of this Report.\n(a)(2) Financial Statement Schedules. Reference is made to the ----------------------------- Index on page for a list of all financial statement schedules filed as a part of this Report.\n(a)(3) Exhibits. Reference is made to the Exhibit Index on -------- pages E-1, E-2 and E-3 for a list of all exhibits filed as a part of this Report.\n(b) Reports on Form 8-K. Southern Union filed no current ------------------- reports on Form 8-K during the three months ended June 30, 1995.\nSOUTHERN UNION COMPANY\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nPage(s) -------\nConsolidated financial statements:\nReport of independent accountants.....................\nStatement of consolidated operations -- years ended June 30, 1995 and 1994 and December 31, 1993........\nConsolidated balance sheet -- June 30, 1995 and 1994..\nStatement of consolidated cash flows -- years ended June 30, 1995 and 1994 and December 31, 1993........\nNotes to consolidated financial statements............\nFinancial statement schedules:\nAll schedules are omitted as the required information is not applicable or the information is presented in the consolidated financial statements or related notes.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Stockholders and Board of Directors of Southern Union Company:\nWe have audited the consolidated financial statements of Southern Union Company and Subsidiaries listed in the index on page of this Form 10-K. These financial statements are the responsi- bility 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 finan- cial position of Southern Union Company and Subsidiaries as of June 30, 1995 and 1994, and the consolidated results of their operations and their cash flows for each of the three years ended June 30, 1995 and 1994 and December 31, 1993 in conformity with generally accepted accounting principles.\nAs discussed in the notes to the consolidated financial state- ments, the Company changed its method of accounting for postemployment benefits effective January 1, 1994.\nCOOPERS & LYBRAND L.L.P.\nAustin, Texas September 5, 1995\nSOUTHERN UNION COMPANY AND SUBSIDIARIES STATEMENT OF CONSOLIDATED OPERATIONS\nYears Ended ----------------------------------- June 30, December 31, 1995 1994 1993 -------- -------- ------------ (thousands of dollars, except shares and per share amounts)\nOperating revenues.......... $480,046 $374,516 $209,005 Gas purchase costs.......... 241,839 211,127 110,384 -------- -------- -------- Operating margin.......... 238,207 163,389 98,621 -------- -------- -------- Operating expenses: Operating, maintenance and general............. 104,072 79,667 50,076 Taxes, other than on income.................. 39,646 29,770 14,365 Depreciation and amortization............ 32,373 21,919 14,416 -------- -------- -------- Total operating expenses.............. 176,091 131,356 78,857 -------- -------- -------- Net operating revenues.. 62,116 32,033 19,764 -------- -------- --------\nOther income (expenses): Interest on long-term debt.................... (37,448) (23,568) (11,535) Other interest............ (2,436) (1,896) (2,212) Dividends on preferred securities of subsid- iary trust.............. (1,159) -- -- Other, net................ 5,970 6,994 5,571 -------- -------- -------- Total other expenses, net................... (35,073) (18,470) (8,176) -------- -------- --------\nEarnings before income taxes..................... 27,043 13,563 11,588\nFederal and state income taxes..................... 10,974 5,185 3,855 -------- -------- --------\nEarnings before preferred dividends................. 16,069 8,378 7,733\nPreferred dividends......... -- -- (843) -------- -------- --------\nNet earnings available for common stock.......... $ 16,069 $ 8,378 $ 6,890 ======== ======== ========\nNet earnings per common share..................... $ 1.40 $ .85 $ .83 ======== ======== ========\nWeighted average shares outstanding...............11,478,591 9,865,967 8,286,260 ========== ========= =========\nSee accompanying notes to the consolidated financial statements.\nSOUTHERN UNION COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET\nASSETS\nJune 30, ----------------------- 1995 1994 ---------- ---------- (thousands of dollars)\nProperty, plant and equipment: Plant in service...................... $ 882,769 $ 819,656 Construction work in progress......... 14,670 15,390 ---------- --------- 897,439 835,046 Less accumulated depreciation and amortization........................ (303,327) (279,120) ---------- --------- 594,112 555,926 Additional purchase cost assigned to utility plant, net of accumulated amortization of $16,561,000 and $12,342,000, respectively........... 154,534 167,374 ---------- ---------\nNet property, plant and equipment... 748,646 723,300 ---------- ---------\nCurrent assets: Cash and cash equivalents............. 39,015 5,881 Short-term investments................ 19,582 -- Accounts receivable, billed and unbilled............................ 35,465 48,273 Inventories, principally at average cost................................ 23,561 30,374 Deferred gas purchase costs due from customers........................... 7,641 -- Prepayments and other................. 1,349 1,621 ---------- ---------\nTotal current assets................ 126,613 86,149 ---------- ---------\nDeferred charges........................ 114,167 74,367\nReal estate............................. 10,742 11,983\nOther................................... 2,334 1,913\n---------- ---------\nTotal................................. $1,002,502 $ 897,712 ========== ==========\nSee accompanying notes to the consolidated financial statements.\nSOUTHERN UNION COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET (Continued)\nSTOCKHOLDERS' EQUITY AND LIABILITIES\nJune 30, ----------------------- 1995 1994 ---------- ---------- (thousands of dollars)\nCommon stockholders' equity: Common stock, $1 par value; authorized 50,000,000 shares; issued 11,570,247 shares at June 30, 1995...................... $ 11,570 $ 11,497 Premium on capital stock............. 198,819 198,272 Less treasury stock: 51,625 shares at cost............................ (794) (794) Retained earnings.................... 16,069 -- ---------- ---------\nTotal common stockholders' equity.. 225,664 208,975\nCompany-obligated mandatorily redeemable preferred securities of subsidiary trust holding solely $103,093,000 principal amount of 9.48% subordinated notes of Southern Union due 2025.............. 100,000 --\nLong-term debt......................... 462,503 479,048 ---------- ---------\nTotal capitalization............... 788,167 688,023\nCurrent liabilities: Long-term debt due within one year... 770 889 Accounts payable..................... 28,784 39,039 Federal, state and local taxes....... 6,310 8,706 Accrued interest..................... 15,194 15,579 Customer deposits.................... 14,166 13,029 Deferred gas purchase costs due to customers....................... -- 15,271 Other................................ 13,621 18,027 ---------- ---------\nTotal current liabilities.......... 78,845 110,540 ---------- ---------\nDeferred credits and other liabilities.......................... 99,434 69,437\nAccumulated deferred income taxes...... 36,056 29,712\nCommitments and contingencies.......... -- --\n---------- ---------\nTotal.............................. $1,002,502 $ 897,712 ========== =========\nSee accompanying notes to the consolidated financial statements.\nSOUTHERN UNION COMPANY AND SUBSIDIARIES STATEMENT OF CONSOLIDATED CASH FLOWS\nYears Ended -------------------------------- June 30, December 31, ------------------ ------------ 1995 1994 1993 -------- -------- ------------ (thousands of dollars)\nCash flows from operating activities: Net earnings................ $ 16,069 $ 8,378 $ 7,733 Adjustments to reconcile net earnings to net cash flows from operating activities: Depreciation and amortization............. 32,373 21,919 14,416 Deferred income taxes..... 5,909 8,943 1,368 Provision for bad debts... 4,162 2,897 478 Other, net................ (957) (1,316) (1,573) Changes in assets and liabilities, net of acquisitions and dis- positions: Decrease (increase) in accounts receivable, billed and unbilled.... 11,051 63,059 (1,967) Decrease in accounts payable................ (7,225) (4,152) (7,514) Increase (decrease) in taxes and other liabilities............ (7,187) 6,518 6,812 Increase (decrease) in customer deposits...... 1,137 (75) (3,214) Decrease in deferred gas purchase costs......... (22,537) (4,586) (1,473) Decrease (increase) in inventories............ 7,975 (9,240) 673 Decrease (increase) in other accounts......... 902 2,984 (722) -------- -------- -------- Net cash flows from operating activities. 41,642 95,329 15,017 -------- -------- -------- Cash flows from investing activities: Additions to property, plant and equipment....... (67,442) (38,237) (18,532) Acquisition of operations, net of cash received...... (750) (440,666) (35,559) Increase in short-term investments, net.......... (19,582) -- -- Increase (decrease) in customer advances......... 725 (3,079) 718 Increase (decrease) in deferred charges and credits................... (3,868) 5,603 (993) Proceeds from sale of discontinued operation.... -- -- 16,493 Proceeds from notes receivable................ -- 6,368 -- Other, net................. 1,801 (644) (1,979) -------- -------- -------- Net cash flows used in investing activities..... (89,116) (470,655) (39,852) -------- -------- -------- Cash flows from financing activities: Repayment of debt.......... (16,212) (107,052) (938) Net borrowings (payments) under revolving credit facility.................. -- (28,200) 6,200 Issuance of debt........... -- 475,000 -- Premium on early extinguishment of debt.... -- (13,715) -- Debt issuance cost......... -- (5,450) -- Proceeds from rights offering, net............. -- 49,351 49,351 Proceeds from issuance of preferred securities of subsidiary trust.......... 100,000 -- -- Issuance cost of preferred securities of subsidiary trust..................... (3,799) -- -- Redemption of preferred stock including related premiums.................. -- -- (25,272) Other, net................. 619 (905) (1,677) -------- -------- -------- Net cash flows from financing activities..... 80,608 369,029 27,664 -------- -------- -------- Increase (decrease) in cash and cash equivalents........ 33,134 (6,297) 2,829 Cash and cash equivalents at beginning of year........... 5,881 12,178 89 -------- -------- -------- Cash and cash equivalents at end of year................. $ 39,015 $ 5,881 $ 2,918 ======== ======== ========\nSee accompanying notes to the consolidated financial statements.\nSOUTHERN UNION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nJune 30, 1995 and 1994 and December 31, 1993\nSUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nOperations and Principles of Consolidation\nSouthern Union Company (\"Southern Union\" and, together with its wholly-owned subsidiaries, the \"Company\"), is an investor-owned public utility primarily engaged in the distribution and sale of natural gas to residential, commercial, industrial, agricultural and other customers as a public utility in the states of Texas, Missouri and Oklahoma. See \"Acquisitions and Divestitures.\" Subsidiaries of Southern Union also market natural gas to end- users, sell natural gas as a vehicular fuel, operate intrastate and interstate natural gas pipeline systems, sell commercial gas air conditioning and other gas-fired engine-driven applications and convert vehicles to operate on natural gas. Certain subsidi- aries own or hold interests in real estate and other assets, which are primarily used in the Company's utility business. Sub- stantial operations of the Company are subject to regulation.\nThe consolidated financial statements include the accounts of Southern Union and its wholly-owned subsidiaries. All significant intercompany accounts and transactions are eliminated in consoli- dation. All dollar amounts in the tables in the notes to con- solidated financial statements, except per share amounts, are stated in thousands unless otherwise indicated. Certain reclas- sifications have been made to prior years' financial statements to conform with the current year's presentation.\nProperty, Plant and Equipment\nUtility plant in service and construction work in progress are stated at original cost of construction, less contributions in aid of construction, which includes, where appropriate, payroll- related costs such as taxes, pensions, other employee benefits, general and administrative costs and an allowance for funds used during construction. Gain or loss is recognized upon the dispo- sition of significant utility properties and other property con- stituting operating units. Gain or loss from minor dispositions of property is charged or credited to accumulated depreciation and amortization. The Company capitalizes the cost of signifi- cant internally-developed computer software systems.\nAcquisitions are recorded at the historical book carrying value of utility plant. Additional purchase cost assigned to utility plant is the excess of the purchase price over the book carrying value of the net assets acquired. In general, the Company has not been allowed direct recovery of additional purchase cost assigned to utility plant in rates. Periodically, the Company evaluates the carrying value of its additional purchase cost assigned to utility plant by comparing the anticipated future operating income from the businesses giving rise to the addi- tional purchase cost with the unamortized balance.\nIn March 1995, the Financial Accounting Standards Board (\"FASB\") issued Statement of Financial Accounting Standards (\"SFAS\") No. 121, Accounting for the Impairment of Long-Lived Assets and for ---------------------------------------------------------- Long-Lived Assets To Be Disposed Of, which is effective for fis- - ----------------------------------- cal years beginning after December 15, 1995. SFAS No. 121 requires that long-lived assets, identifiable intangibles, capital leases and goodwill be reviewed for impairment whenever events occur or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. In addi- tion, SFAS No. 121 requires that regulatory assets meet the recovery criteria of SFAS No. 71, Accounting for the Effects of ----------------------------- Certain Types of Regulation, on an ongoing basis, in order to - --------------------------- continue to defer applicable costs. SFAS No. 121 will be imple- mented by Southern Union in 1996 but is not expected to have an impact on the Company since the carrying amount of all assets, including regulatory assets, is considered recoverable. As the Company enters a more competitive environment, some assets could potentially be subject to impairment, thereby necessitating write-downs or write-offs, which could have a material adverse effect on the Company's future results of operations and finan- cial position.\nSOUTHERN UNION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nDepreciation and Amortization\nDepreciation of utility plant is provided at an average straight-line rate of approximately 3% per annum of the cost of such depreciable properties less applicable salvage. Franchises are amortized over their respective lives. Depreciation and amortization of other property is provided at straight-line rates estimated to recover the costs of the properties, after allowance for salvage, over their respective lives. Amortization of addi- tional purchase cost assigned to utility plant is provided on a straight-line basis over forty years unless the Company has obtained, or filed to obtain, a specific provision in a rate application providing for the recovery of this amortization in rates collected from customers over a different period. In those cases where the Company's regulators have provided for, or are expected to provide for, the recovery of the amortization of additional purchase cost assigned to utility plant in rates, the Company's policy is to utilize the amortization period which fol- lows the rate recovery period. See \"Change in Accounting Esti- mate.\"\nLong-Term Debt\nDebt issuance costs and premiums on the early extinguishment of debt are amortized over the lives of the new or replacement debt issues.\nGas Utility Revenues and Gas Purchase Costs\nGas utility customers are billed on a monthly-cycle basis. The related cost of gas is matched with cycle-billed revenues through operation of purchased gas adjustment provisions in tariffs approved by the regulatory agencies having jurisdiction.\nThe Company recognizes an estimate of unbilled revenues on a monthly-cycle basis which include sales from the cycle-billing dates to the end of the month, unbilled gas purchase costs and revenue-related taxes. The accrual for unbilled revenues is included in operating revenues in the statement of consolidated operations.\nEmployee Postretirement Benefits\nThe Company, excluding Missouri Gas Energy, records a regulatory asset for the difference between the postretirement costs cur- rently included in rates and postretirement expense to the extent the Company has filed, or intends to file, a rate application to include such expense in rates and it is probable that the regula- tor will allow this expense in future rates. Subsequent to the Missouri Acquisition (as hereinafter defined), the Company filed an application with the Missouri Public Service Commission (\"MPSC\") for an order to permit the deferral of postretirement expense and also proposed the inclusion in rates billed to custo- mers in the future for the actual postretirement expense and income stream generated from a company-owned life insurance (\"COLI\") plan. As a result of the MPSC's approval of the appli- cation, Missouri Gas Energy has recorded a regulatory asset and a liability representing the accumulated benefit obligation as of June 30, 1995 and 1994. The U.S. House of Representatives is currently considering a proposal which would phase-out the tax deductibility of interest on loans under a COLI. The current proposal, if passed, would be effective on January 1, 1996 and would phase-out the deduction over a five-year period. The Company anticipates to the extent that the COLI, as impacted by the Legislature, does not offset the SFAS No. 106 expense, the Company would be able to recover the shortfall in rates.\nPostemployment Benefits\nThe Company adopted the provisions of SFAS No. 112, Employers' ---------- Accounting for Postemployment Benefits, as of January 1, 1994. - -------------------------------------- This statement requires that the cost of benefits, such as dis- ability and health care continuation coverage provided to former or inactive employees after employment but before retirement, be accrued if attributable to an employee's previously rendered ser- vice. The Company had previously recognized such postemployment\nSOUTHERN UNION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nbenefit costs when paid and was allowed recovery in rates as pay- ments were incurred. Consequently, the Company records a regula- tory asset and related liability to the extent it intends to file rate applications to include such costs in rates and such costs are considered probable of recovery.\nTaxes on Income\nThe Company accounts for income taxes utilizing the liability method which bases the amounts of current and future tax assets and liabilities on events recognized in the financial statements and on income tax laws and rates existing at the balance sheet date.\nCash Flows and Credit Risk\nCash Flows. The Company considers all highly liquid investments - ---------- with an original maturity of three months or less to be cash equivalents. Short-term investments are highly liquid invest- ments with maturities of more than three months when purchased, and are carried at cost, which approximates market. The Company places its temporary cash investments with a high credit quality financial institution which, in turn, invests the temporary funds in a variety of high-quality short-term financial securities.\nCredit Risk. Concentrations of credit risk in trade receivables - ----------- are limited due to the large customer base with relatively small individual account balances. In addition, Company policy requires a deposit from certain customers. The Company has recorded an allowance for doubtful accounts totaling approxi- mately $2,100,000 and $1,600,000 at June 30, 1995 and 1994, respectively.\nFair Value of Financial Instruments\nThe carrying amount reported in the balance sheet for cash and cash equivalents, short-term investments, accounts receivable and accounts payable approximates its fair value. The fair value of the Company's long-term debt is estimated using current market quotes and other estimation techniques.\nInventories\nInventories are stated at cost and consist of gas in underground storage and materials and supplies. Gas in underground storage of approximately $15,427,000 and $23,099,000 at June 30, 1995 and 1994, respectively, consists of approximately 9,701,000 and 10,834,000 MMBtu's, respectively.\nEarnings Per Share\nEarnings per common share is based on net earnings available for common stock using the weighted average shares outstanding during each period. Fully diluted earnings per share are not presented because the relevant stock options and warrants are not signifi- cant.\nCHANGE IN FISCAL YEAR\nOn May 25, 1994, Southern Union's Board of Directors approved a change in the Company's fiscal year-end from December 31 to June 30. The new fiscal year more closely conforms the reporting of the Company's financial condition and results of operations to its seasonal business cycle.\nSOUTHERN UNION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nACQUISITIONS AND DIVESTITURES\nMissouri Gas Energy\nMissouri Asset Purchase Agreement. On July 9, 1993, Southern - --------------------------------- Union entered into an Agreement for the Purchase of Assets (the \"Missouri Asset Purchase Agreement\") with Western Resources, Inc. (\"Western Resources\" or the \"seller\" of the Missouri properties), pursuant to which Southern Union purchased certain Missouri natural gas distribution operations (the \"Missouri Acquisition\") which Southern Union operates as Missouri Gas Energy, a division of Southern Union headquartered in Kansas City, Missouri. The acquisition was consummated on January 31, 1994 and was accounted for as a purchase. The assets of Missouri Gas Energy were included in the consolidated balance sheet of the Company at January 31, 1994 and income from operations of Missouri Gas Energy has been included in the Company's statement of consoli- dated operations since February 1, 1994. Missouri Gas Energy serves approximately 478,000 customers in central and western Missouri, including Kansas City, St. Joseph, Joplin and Monett.\nPurchase Price. At closing, Southern Union paid approximately - -------------- $400,300,000, based on account balances as of December 31, 1993. The final purchase price, which was determined through post- closing adjustments and subsequent arbitration was approximately $401,600,000. See \"Contingencies\". The Missouri Acquisition was financed through the sale of $475,000,000 of 7.60% Senior Notes due 2024 (the \"Senior Debt Securities\") completed on January 31, 1994 and net proceeds from a $50,000,000 common stock subscrip- tion rights offering (the \"Rights Offering\") completed on December 31, 1993. See \"Long-Term Debt\" and \"Stockholders Equity.\"\nMissouri Public Service Commission. The approval of the Missouri - ---------------------------------- Acquisition by the Missouri Public Service Commission (\"MPSC\") was subject to the terms of a stipulation and settlement agree- ment (the \"MPSC Stipulation\") among Southern Union, the seller, the MPSC Staff and others. Among other things, the MPSC Stipula tion: (i) provides that the Company attain a total debt to total capital ratio that does not exceed Standard and Poor's Corpora- tion's Utility Financial Benchmark ratio for the lowest invest- ment grade (BBB) investor-owned natural gas distribution company (which currently is approximately 58%) in order for Missouri Gas Energy to implement any general rate increase; (ii) prohibits Missouri Gas Energy from implementing a general rate increase in Missouri before January 31, 1997 except in certain unusual events; (iii) required the seller to contribute an additional $9,000,000 to Missouri Gas Energy's employees' and retirees' qualified defined benefit plan assets transferred to the Company; (iv) requires the Company to contribute an additional $3,000,000 to the Company's qualified defined benefit plan for the benefit of Missouri Gas Energy's employees and retirees in excess of the minimum required contribution under the Internal Revenue Code, Section 412, as determined by the plan's actuary; and (v) requires Missouri Gas Energy to reduce rate base by $30,000,000 (amortized over a ten year period on a straight-line basis) to compensate rate payers for rate base reductions that were elimi ated as a result of the Missouri Acquisition.\nLiabilities Assumed. Southern Union assumed certain liabilities - ------------------- of the seller with respect to the Missouri properties, including certain liabilities arising from certain specified contracts assigned to Southern Union at closing, including gas supply and transportation contracts, office equipment leases and real estate leases, liabilities arising from certain contracts entered into by the seller in the ordinary course of business, certain liabilities that have arisen or may arise from the operations of Missouri Gas Energy, and liabilities for certain accounts payable of the seller pertaining to Missouri Gas Energy. See \"Commit- ments and Contingencies.\"\nEmployees. Pursuant to the terms of an Employee Agreement with\n- --------- the seller, after the closing of the Missouri Acquisition, Southern Union employed certain employees involved in the opera tion of Missouri Gas Energy (\"Continuing Employees\"). Under the terms of the Employee Agreement, the assets and liabilities of the seller's qualified defined benefit plans attributable to Con- tinuing Employees and certain retired Missouri employees (\"Retired Employees\") were transferred to a qualified defined benefit plan of Southern Union that for at least two years will provide benefits to Continuing Employees and Retired Employees substantially similar in aggregate to those provided by the seller's qualified defined benefit plans. Southern Union amended its qualified defined benefit plan to cover\nSOUTHERN UNION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nthe Continuing Employees and Retired Employees and provide Con- tinuing Employees and Retired Employees with certain welfare, separation and other benefits.\nAdditional Purchase Cost Assigned to Utility Plant. The addi- - -------------------------------------------------- tional purchase cost assigned to utility plant as a result of the Missouri Acquisition is approximately $68,000,000 consisting of approximately $44,200,000 of excess purchase price over the his torical book carrying value of the net assets acquired and approximately $23,800,000 of accruals for certain liabilities assumed and preacquisition contingencies which have been incurred or estimates of amounts that will be incurred in the future. The accruals reflect actual or estimated amounts for: (i) employee severance and other costs associated with an early retirement program offered to certain employees of Missouri Gas Energy in 1994 of approximately $11,200,000; (ii) underwriting, legal and accounting fees associated with the Missouri Acquisition; and (iii) other preacquisition contingencies. Amortization of the additional purchase cost assigned to utility plant is provided on a straight-line basis over forty years.\nRio Grande Valley\nIn September 1993, the Company acquired the Rio Grande Valley Gas Company (\"Rio Grande\") for approximately $30,500,000. The Rio Grande system currently serves approximately 75,000 customers in the south Texas counties of Willacy, Cameron and Hidalgo. Rio Grande's service area includes 32 towns and cities along the Mexico border, including Harlingen, McAllen and Brownsville (the southernmost city in the continental U.S.). The Company initially funded the Rio Grande purchase with borrowings from its revolving credit facility which were subsequently repaid with proceeds from the sale of the Senior Debt Securities and the Rights Offering. The assets of Rio Grande were included in the Company's consolidated balance sheet at September 30, 1993 and the earnings from operations of Rio Grande has been included in the Company's statement of consolidated operations since October 1, 1993. The acquisition was accounted for using the purchase method. The additional purchase cost assigned to utility plant of approximately $12,000,000 reflects the excess of the purchase price over the historical book carrying value of the net assets acquired. The additional purchase cost assigned to utility plant is amortized on a straight-line basis over forty years.\nOther Acquisitions and Divestitures\nIn July 1993, the Company acquired the natural gas distribution facilities serving the city of Eagle Pass, Texas for approxi- mately $2,000,000. In May 1993, the Company acquired the natural gas distribution facilities of Berry Gas Company which serves the Texas cities and towns of Nome, Raywood, Hull and Devers for approximately $274,000. Combined, these operations collectively serve approximately 4,400 customers. These acquisitions were accounted for as purchases.\nIn February 1993, Southern Union Exploration Company (\"SX\"), a former wholly-owned subsidiary of Southern Union, entered into a purchase and sale agreement to sell substantially all of its oil and gas leasehold interests and associated production for approximately $22,000,000, which sale was completed on March 31, 1993, effective January 1, 1993. SX, engaged in the development and production of oil and gas, held varying interests in pro- ducing oil and gas wells located primarily in New Mexico and Texas. The Company accounted for SX as a business held for sale wherein adjustments were made to reflect the valuation of this business to an estimated net realizable value. At December 31, 1992, the Company recorded a book loss on future disposal of $4,400,000. In addition, the Company recorded a tax liability of approximately $6,960,000 resulting from the recognition of a tax basis gain of approximately $18,800,000.\nThe results of operations of the Company for the periods subse- quent to these acquisitions and divestiture are not comparable to those periods prior to the acquisitions and divestiture nor are the 1995 and 1994 results of operations comparable with previous periods.\nSOUTHERN UNION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nDuring July 1995, Southern Union Company entered into a letter of intent to sell Western Gas Interstate Company (\"WGI\"), a wholly- owned subsidiary of the Company, exclusive of certain WGI assets in El Paso, Texas and WGI's Del Norte interconnect operation which transmits natural gas into Mexico, and to sell certain gas distribution operations of Southern Union Gas in the panhandle areas of Texas and Oklahoma for approximately $14,800,000. The sale is subject to approval by the Federal Regulatory Energy Com- mission (\"FERC\") and the Oklahoma Corporation Commission and must be reported to the Railroad Commission of Texas.\nPRO FORMA CONDENSED STATEMENT OF CONSOLIDATED OPERATIONS\nThe following unaudited pro forma condensed statement of consoli- dated operations for the twelve months ended June 30, 1994 is presented as though the following events had been consummated as of July 1, 1993: (i) the Missouri and Rio Grande Acquisitions; (ii) the sale of the Senior Debt Securities; (iii) the completion of the Rights Offering; and (iv) the refinancing of certain short-term and long-term debt. The pro forma financial informa- tion is not necessarily indicative of the results which would have actually been obtained had the acquisitions of Missouri Gas Energy and Rio Grande, the Rights Offering, the sale of Senior Debt Securities or the refinancings been completed as of the assumed date for the periods presented or which may be obtained in the future.\nThe pro forma condensed statement of consolidated operations includes adjustments that are based on assumptions and estimates made by the Company's management regarding anticipated efficiencies resulting from the combined operations, reductions in costs planned by management, accruals for certain preacquisi- tion contingencies and the fair market value of certain assets acquired in the Missouri Acquisition.\nTwelve Months Ended June 30, 1994 ------------------- (unaudited)\nOperating revenues........................... $ 604,962 Gas purchase costs........................... 360,706 ---------- Operating margin........................... 244,256 Operating expenses........................... 195,045 ---------- Net operating revenues....................... 49,211 Interest on long-term debt................... (37,345) Other income, net............................ 4,663 ---------- Earnings before income taxes............... 16,529 Federal and state income taxes............... 6,281 ---------- Net earnings available for common stock...... $ 10,248 ==========\nNet earnings per common share................ $ .90 ==========\nWeighted average shares outstanding.......... 11,433,000 ==========\nCHANGE IN ACCOUNTING ESTIMATE\nOn February 6, 1990, Southern Union and SU Acquisition, Inc. com- pleted a cash merger in accordance with an agreement among Southern Union, Metro Mobile CTS, Inc., and SU Acquisition, Inc. This merger was accounted for as a purchase and resulted in the recording of additional purchase cost assigned to utility plant of approximately $94,000,000. At the time of the merger, the Company had anticipated the inclusion of this additional purchase price in future rates. Accordingly, amortization of the addi- tional purchase cost assigned to utility plant had been provided on a straight-line basis over thirty years which was consistent with the period over which rate recovery was requested. Subse- quent to the merger, the Company filed rate applications with several of its significant regulatory jurisdictions requesting the inclusion of the additional purchase cost assigned to utility plant in rates. Since such requests for rate recovery have not yet been granted, the Company revised its estimate of the amortization period of additional\nSOUTHERN UNION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\npurchase cost assigned to utility plant to its standard policy of forty years. As a result of this change, amortization expense for the year ended June 30, 1994 was reduced by approximately $478,000, with a corresponding increase to net earnings, or $.05 per average common share.\nOTHER INCOME\nOther income, net in 1995, 1994 and 1993 was $5,970,000, $6,994,000 and $5,571,000, respectively.\nOther income of $5,970,000 in 1995 included: rental income from Lavaca Realty Company (\"Lavaca Realty\"), the Company's real estate subsidiary, of approximately $2,647,000; approximately $2,619,000 related to the deferral of interest expense associated with the Missouri Gas Energy Safety Program (see \"Utility Regula- tion and Rates\"); investment interest and interest on notes receivable of approximately $960,000; and approximately $244,000 from gas appliance merchandising. This was partially offset by approximately $750,000 for the write-down to estimated fair market value of certain real estate held for sale.\nAs a result of the change in the Company's year-end to June 30, certain other income items are included in both the 1994 and 1993 results of operations. In September 1993, the Company recorded a non-recurring accounting adjustment of approximately $2,489,000 to reverse a tax reserve upon the final settlement of prior period federal income tax audits and the filing of amended federal income tax returns. In July 1993, the Company paid the Internal Revenue Service (\"IRS\") approximately $1,266,000 in settlement for federal income taxes and interest related to the tax years 1984 through 1989. The Company had previously esti- mated and accrued an amount for the tax deficiencies and related interest and, as a result of the settlement with the IRS for a lesser amount, a non-recurring adjustment was recorded to reverse the tax reserve in excess of the payment made. The reversal of the reserve had no impact on liquidity or cash flows due to the non-cash impact of this adjustment. Other items recorded during the period in common to both 1994 and 1993 were a pre-tax gain of approximately $494,000 on the sale of undeveloped real estate and the write-off of approximately $357,000 of acquisition-related costs as a result of the termination of negotiations related to various acquisitions.\nOther income of $6,994,000 recorded in 1994 also included: rental income from Lavaca Realty of approximately $2,200,000; investment interest and interest on notes receivable of approxi- mately $950,000; approximately $500,000 from gas appliance merchandising; and approximately $276,000 related to the deferral of interest expense associated with the Missouri Gas Energy Service Line Replacement Program.\nOther income of $5,571,000 recorded in 1993 also included: rental income from Lavaca Realty of approximately $1,835,000; interest on notes receivable of approximately $830,000; and a pre-tax gain of approximately $494,000 on the sale of undeveloped real estate.\nCASH FLOW INFORMATION\n1995 1994 1993 ---------- ---------- ----------\nCash paid during the year for: Interest................. $ 38,987 $ 12,001 $ 12,820 Income taxes............. 2,533 5,820 9,691\nNon-cash assets (liabilities) acquired: Working capital.......... $ -- $ 50,999 $ (718) Property, plant and equipment, net......... 750 385,650 36,376 Other noncurrent assets.. -- 46,988 72 Noncurrent liabilities... -- (42,971) (171) -------- -------- -------- $ 750 $440,666 $ 35,559 ======== ======== ========\nSOUTHERN UNION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nExcluded from the statement of consolidated cash flows were the following effects of non-cash investing and financing activities:\n1995 1994 1993 ---------- ---------- ----------\nPension liability adjustment to retained earnings....... $ -- $ -- $ 2,051 ======== ======== ========\nOther obligations incurred... $ -- $ 2,354 $ 588 ======== ======== ========\nPROPERTY, PLANT AND EQUIPMENT\nA financial classification for utility plant in service at June 30, 1995 and 1994 was as follows:\nJune 30, ---------------------- 1995 1994 ---------- ----------\nDistribution............................ $831,401 $770,268 General................................. 70,713 63,966 Intangible.............................. 8,512 10,803 Transmission............................ 11,194 10,765\nProduction and gathering................ 2,618 2,716 -------- -------- Total utility plant................... 924,438 858,518 Less contributions in aid of construction.......................... (41,669) (38,862) -------- -------- Plant in service...................... 882,769 819,656 Construction work in progress........... 14,670 15,390 -------- -------- 897,439 835,046 Less accumulated depreciation and amortization.......................... (303,327) (279,120) -------- -------- 594,112 555,926 Additional purchase cost assigned to utility plant, net.................... 154,534 167,374 -------- --------\nNet property, plant and equipment..... $748,646 $723,300 ======== ========\nREAL ESTATE\nIn February 1993, Southern Union entered into a settlement agree- ment with the Resolution Trust Corporation (\"RTC\") with respect to Southern Union's former subsidiary, First Bankers Trust & Savings Association. As part of the settlement, in return for payment by the Company of $4,792,000, the RTC: dismissed a $6,174,000 judgment for specific performance of a contract to purchase real estate; canceled notes in the principal amount of $1,600,000; permitted the Company to terminate a $2,000,000 letter of credit; deeded the Company a 21-acre tract in Austin, Texas; and released certain other claims asserted in the settled litigation. This settlement had no impact on earnings since the Company had previously recorded a reserve for the related loss contingency. Subsequently, the Company sold this land for approximately $794,000 resulting in an after-tax gain of approxi- mately $320,000.\nSOUTHERN UNION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nSTOCKHOLDERS' EQUITY\nThe changes in common stockholders' equity and cumulative pre- ferred stock were as follows:\nCommon Stockholders' Equity ------------------------------------------- Trea- Cumulative Common Premium sury Preferred Stock, on Stock, Retained Stock $100 $1 Par Capital at Earnings Stated Value Stock Cost (Deficit) Total Value ------- -------- ------ --------- --------- ----------\nBalance January 1, 1993...... $ 5,289 $144,748 $(794) $ (1,240) $148,003 $ 24,900 Net earn- ings.... -- -- -- 7,733 7,733 -- Dividends on pre- ferred stock.,, -- -- -- (843) (843) -- Rights Offering for 2,000,000 shares of common stock... 2,000 47,351 -- -- 49,351 -- Exercise of stock options. 17 199 -- -- 216 -- Pension liability adjust- ment.... -- -- -- (2,051) (2,051) -- Redemp- tion of preferred stock... -- -- -- (471) (471) (24,900) ------- -------- ----- -------- -------- -------- Balance Decem- ber 31, 1993...... $ 7,306 $192,298 $(794) $ 3,128 $201,938 $ -- ======= ======== ===== ======== ======== ========\nBalance at July 1, (see \"Change in Fiscal Year\").... $ 5,302 $144,902 $(794) $ 1,744 $151,154 $ -- Net earn- ings.... -- -- -- 8,378 8,378 -- Rights offering for 2,000,000 shares of common stock... 2,000 47,351 -- -- 49,351 -- Three- for-two stock split... 3,628 (3,628) -- -- -- -- Stock divi- dend.... 545 9,524 -- (10,069) -- -- Exercise of stock options. 22 186 -- -- 208 -- Stock issuance costs and other... -- (63) -- (53) (116) -- ------- -------- ----- -------- -------- -------- Balance June 30, 1994...... 11,497 198,272 (794) -- 208,975 --\nNet earn- ings.... -- -- -- $ 16,069 $ 16,069 $ -- Exercise of stock options. 73 547 -- -- 620 -- ------- -------- ----- -------- -------- -------- Balance June 30, 1995...... $11,570 $198,819 $(794) $ 16,069 $225,664 $ -- ======= ======== ===== ======== ======== ========\nStock Dividend and Split\nOn May 25, 1994, Southern Union's Board of Directors declared a 5% stock dividend, distributed on June 30, 1994 to stockholders of record on June 14, 1994. A portion of the 5% stock dividend was characterized as a distribution of capital due to the level of the Company's retained earnings available for distribution as of the declaration date. The June 1994 stock dividend was consis- tent with the Board of Directors' decision in February 1994 to commence regular stock dividends of approximately 5% annually. In addition, on February 11, 1994, the Board of Directors declared a three-for-two stock split distributed in the form of a 50% stock dividend on March 9, 1994, to stockholders of record on February 23, 1994. Unless otherwise stated, all per share data included in the accompanying consolidated financial statements and in these Notes to Consolidated Financial Statements have been restated to give effect to the stock dividend and stock split.\nRights Offering\nOn December 31, 1993, Southern Union consummated a Rights Offering to its existing stockholders to subscribe for and pur- chase 2,000,000 pre-split and pre-dividend shares of the Com- pany's common stock, par value $1.00 per share, at a pre-split and pre-dividend price of $25.00 per share for net proceeds of $49,351,000. The proceeds from\nSOUTHERN UNION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nthe Rights Offering, together with the proceeds from the sale of the Senior Debt Securities, were used to fund the Missouri and Rio Grande Acquisitions and to retire or refinance certain out- standing debt. See \"Acquisitions and Divestitures\" and \"Long- Term Debt.\"\nCommon Stock\nThe Company has an incentive stock option plan (the \"1982 Plan\") pursuant to which the ability to grant options expired on December 31, 1991. Under the terms of the 1982 Plan, options to purchase up to an aggregate of 787,500 post-split and post- dividend shares of common stock were granted to officers and key employees at prices not less than fair market value on the date of grant. Options granted under the 1982 Plan are exercisable for periods of ten years from the date of grant or such lesser period as may be designated for particular options, and become exercisable after a specified time from the date of grant in cumulative annual installments. Upon exercise of an option, the 1982 Plan permitted the Company to elect, instead of issuing shares, to make a cash payment equal to the difference at the date of exercise between the option price and the market price of the shares as to which such option is being exercised.\nThe 1992 Long-Term Stock Incentive Plan (the \"1992 Long-Term Plan\") was approved at the annual meeting of stockholders held on May 12, 1993. Under the 1992 Long-Term Plan, options to purchase 819,000 post-split and post-dividend shares may be granted to officers and key employees at prices not less than the fair mar- ket value on the date of grant. Options granted under the 1992 Long-Term Plan are exercisable for periods of ten years from the date of grant or such lesser period as may be designated for particular options, and become exercisable after a specified period of time from the date of grant in cumulative annual installments. The 1992 Long-Term Plan also allows for the granting of stock appreciation rights, dividend equivalents, performance shares and restricted stock.\nInformation regarding the 1982 Plan and the 1992 Long-Term Plan, as adjusted for the stock dividend and stock split, is summarized below:\n1982 Long-Term Plan Plan -------- ---------\nOutstanding January 1, 1993................. 384,300 241,763 Exercised................................. (20,475) (5,513) Canceled.................................. (14,175) (6,300) ------- ------- Outstanding December 31, 1993............... 349,650 229,950 Granted................................... -- 222,075 Exercised................................. (20,475) -- ------- ------- Outstanding June 30, 1994................... 329,175 452,025 Exercised................................. (72,075) (1,103) Canceled.................................. -- (2,837) ------- ------- Outstanding June 30, 1995................... 257,100 448,085 ======= =======\nAverage price of options exercised during the year ended: 1993...................................... $ 7.78 $ 10.13 1994...................................... $ 7.78 -- 1995...................................... $ 8.44 $ 10.13\nSOUTHERN UNION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nAt June 30, 1995 and 1994 and December 31, 1993, options under the 1982 Plan for 209,850, 222,075 and 204,750 shares were exercisable at prices ranging from $7.78 to $8.73. At June 30, 1995 and 1994 and December 31, 1993, options for 136,552, 40,320 and 40,320 shares ranging from $8.71 to $17.63 were exercisable under the 1992 Long-Term Plan. No shares were available for future option grants under the 1982 Plan at June 30, 1995 and 1994 and December 31, 1993. There were 364,299, 361,462 and 583,537 shares available for future option grants under the 1992 Long-Term Plan at June 30, 1995 and 1994 and December 31, 1993, respectively. The shares granted in the year ended June 30, 1994 were repriced on April 4, 1994 from an originally granted exercise price of $21.82 per share to a new exercise price of $17.63 per share.\nOn February 10, 1994, Southern Union granted to Fleischman and Walsh L.L.P., legal counsel to the Company, a warrant which was also repriced amended on April 4, 1994 and which expires on February 10, 2004, to purchase up to 39,375 shares of Common Stock at an exercise price of $17.63, as adjusted for the 5% stock dividend and three-for-two stock split.\nRetained Earnings\nUnder the most restrictive provisions in effect, as a result of the sale of Senior Debt Securities, Southern Union will not declare or pay any cash or asset dividends on common stock (other than dividends and distributions payable solely in shares of its common stock or in rights to acquire its common stock) or acquire or retire any shares of Southern Union's common stock, unless no event of default exists and the Company meets certain financial ratio requirements. In addition, Southern Union's charter relating to the issuance of preferred stock limits the payment of cash or asset dividends on capital stock.\nCumulative Preferred Stock\nDuring March 1993, Southern Union retired 68,000 shares of the Series A 10% Cumulative Preferred Stock (\"Preferred Stock\") at $103 per share for $7,004,000. In April 1993, Southern Union retired 77,000 shares of Preferred Stock at $102 per share for $7,854,000. In June 1993, Southern Union retired 4,000 shares of Preferred Stock at $103.50 per share for $414,000 and the remaining outstanding 100,000 shares at par for $10,000,000.\nPREFERRED SECURITIES OF SUBSIDIARY TRUST\nOn May 17, 1995, Southern Union Financing I (the \"Subsidiary Trust\"), a consolidated wholly-owned subsidiary of Southern Union, issued $100,000,000 of 9.48% Trust Originated Preferred Securities (the \"Preferred Securities\"). In connection with the Subsidiary Trust's issuance of the Preferred Securities and the related purchase by Southern Union of all of the Subsidiary Trust's common securities (the \"Common Securities\"), Southern Union issued to the Subsidiary Trust $103,092,800 principal amount of its 9.48% Subordinated Deferrable Interest Notes, due 2025 (the \"Subordinated Notes\"). The sole assets of the Subsidiary Trust are and will be the Subordinated Notes. The interest and other payment dates on the Subordinated Notes correspond to the distribution and other payment dates on the Preferred Securities and the Common Securities. Under certain circumstances, the Subordinated Notes may be distributed to holders of the Preferred Securities and holders of the Common Securities in liquidation of the Subsidiary Trust. The Sub- ordinated Notes are redeemable at the option of the Company on or after May 17, 2000, at a redemption price of $25 per Subordinated Note plus accrued and unpaid interest. The Preferred Securities and the Common Securities will be redeemed on a pro rata basis to the same extent as the Sub- ordinated Notes are repaid, at $25 per Preferred Security and Common Security plus accumulated and unpaid distribu- tions. Southern Union's obligations under the Subordinated Notes and related agreements, taken together, constitute a full and unconditional guarantee by Southern Union of pay- ments due on the Preferred Securities. As of June 30, 1995, 4,000,000 shares of Preferred Securities were outstanding.\nSOUTHERN UNION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nLONG-TERM DEBT\nFirst mortgage bonds, debentures and other long-term debt outstanding, including current maturities, were as follows:\nJune 30, ---------------------- 1995 1994 ---------- ---------- First mortgage bonds: 11.5% due 2000 -- collateralized by certain utility plant in service..... $ 1,200 $ 1,700 Other long-term debt: 7.60% Senior notes due 2024............ 460,000 475,000 Other.................................. 2,073 3,237 -------- -------- Total long-term debt..................... $463,273 $479,937 ======== ========\nThe maturities of long-term debt for each of the next five years ended June 30 are: 1996 -- $770,000; 1997 -- $812,000; 1998 -- $824,000; 1999 -- $467,000; 2000 -- $400,000; and thereafter -- $460,000,000.\nOn June 29, 1995 $5,000,000 of Senior Debt Securities at $993 per $1,000 note were repurchased and on June 30, 1995 $10,000,000 at $995 per $1,000 note were repurchased with proceeds from the Pre- ferred Securities. Subsequent to year-end, an additional $20,000,000 of Senior Debt Securities were repurchased at prices ranging from $963 to $985 per $1,000 note. No significant gains or losses were recognized on these transactions.\nOn January 31, 1994, Southern Union completed the sale of the Senior Debt Securities. The net proceeds from the sale of the Senior Debt Securities, together with the net proceeds from the Rights Offering and working capital from operations, were used to: (i) fund the Missouri Acquisition; (ii) repay approximately $59,300,000 of borrowings under the $100,000,000 revolving credit facility used to fund the Rio Grande Acquisition and repurchase all outstanding Preferred Stock; (iii) refinance, on January 31, 1994, $10,000,000 aggregate principal amount of 9.45% notes due January 31, 2004 and $25,000,000 aggregate principal amount of 10% notes due January 31, 2012 and the related premium of approximately $10,400,000 resulting from the early extinguishment of such notes; (iv) refinance, on March 2,1994, $50,000,000 aggregate principal amount of 10.5% Sinking Fund Debentures due May 15, 2017 and the related premiums of approximately $3,300,000 resulting from the early extinguishment of such debentures; and (v) refinance, on May 16, 1994, $20,000,000 aggregate principal amount of 10-1\/8% notes.\nThe Senior Debt Securities traded at approximately $995 and $993 (per $1,000 note) on June 30 and September 22, 1995, respec- tively, as quoted by a major brokerage firm. The carrying amount of long-term debt at June 30, 1995 and 1994 was $463,273,000 and $479,937,000, respectively. The fair value of long-term debt at June 30, 1995 and 1994 was $460,973,000 and $419,137,000, respectively.\nNotes Payable\nThe Company has availability under a $100,000,000 revolving credit facility with a three-year term (the \"facility\") under- written by Texas Commerce Bank, N.A. and syndicated to four addi- tional banks. Borrowings under the facility are available for Southern Union's working capital, letter of credit requirements and other general corporate purposes. On April 28, 1995, Southern Union entered into an amendment to the facility. The amended facility eliminates certain covenants, is uncol- lateralized and has no borrowing base limitations as long as the Company's Senior Debt Securities meet certain rating criteria. The Company may use up to $40,000,000 of this facility to finance future acquisitions. This facility contains covenants with respect to financial parameters and ratios, total debt limita- tions, restrictions as to dividend payments, stock reacquisi- tions, certain investments and additional liens. The facility expires on December 31, 1997 but may be extended annually for periods of one year beginning on September 30, 1994 with the con- sent of each of the banks. The revolving credit facility is sub- ject to a commitment fee based on the rating of the Company's Senior Debt Securities. As of June 30, 1995 the commitment fee was an annualized .1875% on\nSOUTHERN UNION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nthe unused balance. The interest rate on borrowings on the revolving credit facility is calculated based on a formula using the LIBOR and prime interest rates. The average interest rate under the revolving credit facility was 6.5% and 5.1% for the year ended June 30, 1995 and 1994, respectively. No balance was outstanding under the facility as of June 30, 1995 and 1994.\nEMPLOYEE BENEFITS\nDefined Benefit Plan\nThe Company maintains two trusteed non-contributory defined bene- fit retirement plans which cover substantially all employees. Benefits are based on years of service and the employee's compen- sation during the last ten years of employment. Plan A covers those Company employees who are not employed by Missouri Gas Energy and Plan B covers those employees who are employed by Missouri Gas Energy. The Company funds the plans' cost in accordance with federal regulations, not to exceed the amounts deductible for income tax purposes. The plans' assets are invested in cash, bond and stock funds.\nThe components of net pension expense of Plan A for the years ended June 30, 1995 and 1994 and December 31, 1993 consisted of the following:\n1995 1994 1993 -------- -------- --------\nService cost of benefits earned during the year.................. $ 1,220 $ 1,233 $ 1,067 Interest cost on projected benefit obligations.............. 2,394 2,269 2,358 Actual return on plan assets....... (2,768) 14 (1,099) Net amortization and deferral...... 949 (1,633) (632) ------- ------- ------- Net pension expense................ $ 1,795 $ 1,883 $ 1,694 ======= ======= =======\nPlan B did not exist prior to January 31, 1994. The components of net pension expense of Plan B for the year ended June 30, 1995 and five-month period ended June 30, 1994 consisted of the following:\nFive Months Year Ended Ended June 30, 1995 June 30, 1994 ------------- -------------\nService cost of benefits earned during the year........... $ 1,125 $ 550 Interest cost on projected benefit obligations.............. 7,289 2,957 Actual return on plan assets....... (10,318) 3,303 Net amortization and deferral...... 3,363 (6,464) -------- ------- Net pension expense................ $ 1,459 $ 346 ======== =======\nWith respect to Plan A, the actuarial computations for the deter- mination of accumulated and projected benefit obligations, at June 30, 1995, using the projected unit credit actuarial cost method, assumed a discount rate of 7.5% and a weighted average annual salary increase of 5.62% over the average remaining ser- vice lives of employees. A discount rate of 8.25% and 7.5% and a weighted average annual salary increase of 5.8% were assumed as of June 30, 1994 and December 31, 1993, respectively. An expected long-term rate of return on plan assets of 8% was assumed in all periods presented. The discount rate assumption as of June 30, 1995 and 1994 and the salary increase assumption as of June 30, 1994 for Plan B were identical to Plan A. A weighted average annual salary increase of 5.8% was assumed for Plan B as of June 30, 1995.\nAs a result of decreasing the discount rate effective January 1, 1994, from 9% to 7.5%, the provisions of SFAS No. 87, Employers ---------- Accounting for Pensions required the recognition in the balance - ----------------------- sheet of an additional minimum liability representing the excess of accumulated benefits over plan assets. A corresponding amount was recognized\nSOUTHERN UNION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nas an intangible asset to the extent of any unrecognized prior service cost and any remainder as a reduction of stockholders' equity. Accordingly, at December 31, 1993, the Company recorded a liability of $4,917,000, an intangible asset of $1,809,000 and a reduction in stockholders' equity of $2,051,000, net of an income tax benefit of $1,057,000. These amounts were subse- quently reversed during the last quarter of the fiscal year ended June 30, 1994 as a result of increasing the discount rate, effective July 1, 1994, from 7.5% to 8.25%.\nThe following is a reconciliation of the funded status of the pension plans and accrued retirement plan liabilities as of June 30, 1995 and 1994:\nPlan A Plan B ------------------ ------------------ June 30, June 30, June 30, June 30, 1995 1994 1995 1994 -------- -------- -------- -------- Actuarial present value of benefit obligations: Vested benefits..... $ 25,893 $ 21,521 $ 87,542 $ 82,876 Nonvested benefits.. 1,107 983 2,138 1,262 -------- -------- -------- -------- Accumulated benefit obligations........... 27,000 22,504 89,680 84,138 Effect of future salary increases............. 7,731 5,262 5,203 6,235 -------- -------- -------- -------- Projected benefit obligation............ 34,731 27,766 94,883 90,373 Plan assets at fair value................. (26,624) (23,364) (92,884) (90,285) -------- -------- -------- -------- Projected benefit obligations in excess of plan assets................ 8,107 4,402 1,999 88 Unrecognized net transition asset...... 621 719 -- -- Unrecognized prior service cost.......... (1,796) (1,733) -- -- Unrecognized net gain (loss)................ (4,838) (1,249) (1,808) 258 -------- -------- -------- -------- Accrued retirement plan liabilities...... $ 2,094 $ 2,139 $ 191 $ 346 ======== ======== ======== ========\nPrior service cost is being amortized on a straight-line basis over the average remaining expected future service of partici- pants present at the time of amendment.\nDuring the six-month period ended June 30, 1994, the Company recorded an accrual and associated increase in the additional purchase cost assigned to utility plant of approximately $11,200,000 reflecting employee severance and other special early termination benefit costs associated with an early retirement program for employees of Missouri Gas Energy. As of June 30, 1995 the accrued balance was $9,905,000. Of an eligible 133 employees, 81 accepted the 1994 early retirement program. In addition, during 1993, the Company completed an early retirement program for certain of the Company's employees. Of an eligible 109 employees, 75 accepted the 1993 early retirement program which resulted in the Company recognizing expenses of approxi- mately $702,000 associated with special termination benefits.\nThe Company also maintains a supplemental non-contributory defined benefit retirement plan which covers certain employees whose annual earnings exceed $50,000. The purpose of the supple- mental plan is to provide part or all of those defined benefit plan benefits which are not payable to certain employees under the primary plan. The net pension cost of the supplemental plan for the years ended June 30, 1995 and 1994 and December 31, 1993 was not significant.\nPursuant to the terms of an Employee Agreement with the seller of Missouri Gas Energy, Southern Union employed certain employees of the seller involved in the operation of the Missouri business (\"Continuing Employees\") after the closing of the Missouri Acquisition. Under the terms of the Employee Agreement, the assets and liabilities under the seller's qualified defined bene- fit plans attributable to Continuing Employees and retired Missouri employees (\"Retired Employees\") were transferred to a separate qualified defined benefit plan of Southern Union that will provide benefits to Continuing Employees and Retired Employees substantially similar to those provided for under the seller's qualified defined benefit plans (referred to as Plan B above). Southern Union amended its qualified defined benefit plan to create a separate plan to cover the Continuing Employees and Retired Employees and provide Continuing\nSOUTHERN UNION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nEmployees and Retired Employees with certain other benefits. In addition, pursuant to the MPSC Stipulation, the Company is required to contribute approximately $3,000,000 to the Company's employee's qualified defined benefits plan applicable to Missouri Gas Energy's employees and retirees earlier than what would be required under the Internal Revenue Code, Section 412, as deter- mined by the plan's actuaries. As of June 30, 1995 the Company has contributed approximately $1,600,000 of such amount.\nDefined Contribution Plan\nThe Company provides a Savings Plan available to all employees. Under the provisions of the plan, the Company contributes $.50 for each $1.00 contributed by a participant up to 7% of the employees' salary. Company contributions are 100% vested after six years of continuous service. Company contributions to the plan during 1995, 1994 and 1993, were approximately $1,344,000, $859,000 and $374,000, respectively. The increase in contribu- tions in 1995 and 1994 is mainly attributable to the Missouri Acquisition whose employees were allowed to participate effective February 1, 1994.\nPostretirement Benefits Other than Pensions\nThe Company, excluding Missouri Gas Energy, adopted the provision of SFAS No. 106, Employers' Accounting for Postretirement Bene- ---------------------------------------------- fits Other Than Pensions, effective as of January 1, 1993 which - ------------------------ resulted in a transition obligation of approximately $9,328,000 which was subsequently reduced primarily as a result of certain plan amendments during 1993. The balance at June 30, 1995 and 1994 was $3,860,000 and $4,084,000, respectively. The Company, excluding Missouri Gas Energy, amortizes the remaining transition obligation over an allowed 20-year period. SFAS No. 106 requires an accrual of postretirement medical and other benefit liabilities on an actuarial basis during the years an employee provides services. The Company, excluding Missouri Gas Energy, records a regulatory asset for the difference between the postretirement cost currently included in rates and the SFAS No. 106 expense to the extent the Company, excluding Missouri Gas Energy, has filed, or intends to file, a rate application to include SFAS No. 106 expense in rates and it is probable that the regulator will allow such expense in future rates. The total postretirement costs deferred and recorded as a regulatory asset by the Company, excluding Missouri Gas Energy, at both June 30, 1995 and 1994 were approximately $18,000.\nThe seller of Missouri Gas Energy adopted the provisions of SFAS No. 106 as of January 1, 1993. To mitigate the impact of SFAS No. 106 expense, the seller filed an application with the MPSC, which was approved, for an order permitting the deferral of SFAS No. 106 expense and proposed inclusion in rates collected in the future of the actual SFAS No. 106 expense and an income stream generated from a COLI. To the extent SFAS No. 106 expense exceeds income from the COLI program, this excess would be deferred (as allowed by the FASB Emerging Issues Task Force Issue No. 92-12) and offset by income generated through the deferral period by the COLI program. Missouri Gas Energy has recorded a regulatory asset and related liability of approximately $41,200,000 and $38,300,000 representing the accumulated benefit obligation at June 30, 1995 and 1994, respectively. Addi- tionally, the State of Missouri recently passed legislation which provides for prospective recognition by the MPSC of postretire- ment medical and benefit costs on an accrual basis. Thus, to the extent that Missouri Gas Energy's COLI does not offset its SFAS 106 liability such expenses should be recoverable in future rates.\nThe significant features of the substantive plan include the payment for life of a portion of the medical benefit costs for individuals (and their dependents) who are: (i) employees or retirees of Missouri Gas Energy; (ii) non-Missouri Gas Energy retirees who retired prior to January 1, 1993; and (iii) non- Missouri Gas Energy employees (and their dependents) who elected to retire during the first quarter of 1993. For active non- Missouri Gas Energy employees hired prior to January 1, 1993, benefits are provided only to retirees and only until eligibility for Medicare (age 65). The cost-sharing provisions for medical care benefits include an escalation in the non-Missouri Gas Energy retirees' share of claims obligations that is expected to follow the trend of claims net of Medicare reimbursements. The non-Missouri Gas Energy employees substantive plan was amended during 1993 to substantially modify the cost-sharing provisions to decrease the employer's share of expected future claims and make certain other plan changes. The\nSOUTHERN UNION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nsubstantive plan for Missouri Gas Energy employees and retirees provides payment of a portion of the medical benefit costs for individuals and their dependents. The cost sharing provisions include an escalation in the Missouri Gas Energy retirees share of claims that is expected to follow the trend of claims net of Medicare, subject to an overall limit on employer expenditures.\nThe funding policy for the non-Missouri Gas Energy plan is to pay claims as they arise from a tax-exempt trust through 1999. In addition, contributions are currently being made to a separate account within the pension plan to accumulate assets sufficient to fund claims arising after 1999. The funding policy for the Missouri Gas Energy plan is to pay claims as they arise through a tax exempt trust. Assets held in the tax-exempt trust include primarily short-term obligations. Assets held in the separate account within the retirement plan include cash, bond and stock funds. Non-benefit liabilities are limited to expenses asso- ciated with plan operation and administration.\nThe components of net postretirement benefit cost consisted of the following:\nNon-Missouri Gas Energy\n--------------------------------------- Year Ended June 30, Year Ended ------------------- 1995 1994 December 31, 1993 -------- -------- -----------------\nService cost of benefits earned during the year....... $ 22 $ 32 $ 36 Interest cost on benefit obligations... 227 378 609 Actual return on plan assets................ (21) (11) (4) Amortization of transi- tion obligation....... 224 224 349 ----- ------ ------ Net postretirement benefit cost.......... 452 623 990 Regulatory deferrals.... -- -- (501) ----- ------ ------ Net expense............. $ 452 $ 623 $ 489 ===== ====== ======\nMissouri Gas Energy -------------------------------- Year Ended Five Months Ended June 30, 1995 June 30, 1994 ------------- -----------------\nService cost of benefits earned during the period ended........................ $ 281 $ 127 Interest cost on benefit obligations.................. 3,162 1,251 Net amortization and deferral.. -- 892 ------- ------- Net postretirement benefit cost......................... 3,443 2,270 Regulatory deferrals........... (1,319) (1,815) ------- ------- Net expense.................... $ 2,124 $ 455 ======= =======\nThe following is a reconciliation of the funded status of the Company's postretirement benefit plans and accrued postretirement liabilities as of June 30, 1995 and 1994.\nJune 30, ------------------ 1995 1994 -------- --------\nAccumulated postretirement benefit obligation: Retirees................................ $37,211 $37,121 Other fully eligible participants....... 1,249 1,243 Other active participants............... 5,475 4,403 ------- ------- Accumulated benefit obligation.............. 43,935 42,767 Plan assets at fair value................... (305) (272) ------- ------- Accumulated benefit obligations in excess of plan assets............................ 43,630 42,495 Unrecognized net transition obligation...... (3,860) (4,084) Unrecognized net gain....................... 3,833 3,807 ------- ------- Accrued postretirement benefit cost......... $43,603 $42,218 ======= =======\nSOUTHERN UNION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nFor purposes of computing the 1995 and 1994 net periodic cost, the assumed health care cost trend rate used to measure expected cost benefits covered by the plan was 10% per year for seven years, gradually decreasing thereafter to 7% in year 18 of the projection. For purposes of the June 30, 1995 benefit obliga- tions, the health care cost trend rate was 8% for the first year and 10% for year two through five, thereafter decreasing by .25% per year, reaching 7% in year 18 of the projection. For pur- poses of the June 30, 1994 benefit obligations, the health care cost trend rate was 10% for the first seven years of the projec- tion, thereafter decreasing by .25% per year, reaching 7% in year 18 of the projection.\nThe weighted average assumed discount rate was 8.25% for purposes of the year ended June 30, 1995 net periodic cost. The weighted average assumed discount rate was 7.5% for purposes of the six- month period ended June 30, 1994 net periodic cost and the December 31, 1993 computation of the accumulated postretirement benefit obligation. The weighted average assumed discount rate was 7.5% and 8.25% for purposes of the 1996 and 1995 net periodic costs, respectively. The June 30, 1995 and 1994 weighted average assumed discount rate was 7.5% and 8.25%, respectively, for the accumulated postretirement benefit obligation. The weighted average expected long-term rate of return on plan assets was assumed to be 8% on an after tax basis. In addition, prior ser- vice cost is amortized on a straight-line basis over the average remaining years of service to full eligibility for benefits of the active plan participants.\nA one percentage point increase in the assumed health care cost trend rates for each future year would increase the aggregate of the service and interest cost components of the net periodic postretirement health care benefit cost by approximately $276,000 and would increase the accumulated postretirement benefit obliga- tion for health care benefits by approximately $3,025,000.\nPostemployment Benefits\nThe Company adopted the provisions of SFAS No. 112, Employers' ---------- Accounting for Postemployment Benefits, as of January 1, 1994. - -------------------------------------- This statement requires that the cost of benefits, such as dis- ability and health care continuation coverage provided to former or inactive employees after employment but before retirement, be accrued if attributable to an employee's previously rendered service. The Company had previously recognized such postemployment benefit costs when paid and was allowed recovery in rates as payments were incurred. Consequently, the Company has recorded a regulatory asset to the extent it intends to file rate applications to include such costs in rates and such recovery is probable. As of both June 30, 1995 and 1994, the adoption of SFAS No. 112 has resulted in the recognition of a regulatory asset and a related liability of approximately $1,100,000.\nSOUTHERN UNION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nTAXES ON INCOME\nThe components of taxes on income relating to continuing operations were as follows:\nYear Ended June 30, 1995 ------------------------------ Current Deferred Tax Tax Total ------- -------- -------\nFederal.......................... $ 4,694 $ 5,218 $ 9,912 State............................ 371 691 1,062 ------- ------- ------- $ 5,065 $ 5,909 $10,974 ======= ======= =======\nYear Ended June 30, 1994 ------------------------------ Current Deferred Tax Tax Total ------- -------- -------\nFederal.......................... $(3,592) $ 8,389 $ 4,797 State............................ (166) 554 388 ------- ------- ------- $(3,758) $ 8,943 $ 5,185 ======= ======= =======\nYear Ended December 31, 1993 ------------------------------ Current Deferred Tax Tax Total ------- -------- -------\nFederal.......................... $ 2,417 $ 1,368 $ 3,785 State............................ 70 -- 70 ------- ------- ------- $ 2,487 $ 1,368 $ 3,855 ======= ======= =======\nDeferred credits and other liabilities also include $701,000 and $737,000 of unamortized deferred investment tax credit as of June 30, 1995 and 1994, respectively.\nDeferred income taxes result from temporary differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities. The source of these differences and the tax effect of each is as follows:\nJune 30, December 31, ---------------------- 1995 1994 1993 ---------- ---------- ------------\nDeferred tax assets: Postretirement benefits.. $ 791 $ 464 $ 1,513 Note receivable.......... -- -- 921 Bad debt reserves........ 713 450 -- Estimated alternative minimum tax credit..... 2,044 -- -- Insurance accruals....... 558 1,071 540 Other.................... 555 360 571 -------- -------- -------- Total deferred tax assets................. 4,661 2,345 3,545 -------- -------- -------- Deferred tax liabilities: Property, plant and equipment.............. (31,234) (23,175) (21,004) Unamortized debt expense. (6,333) (6,505) (1,372) Other.................... (2,263) (1,889) (559) -------- -------- -------- Total deferred tax liabilities............ (39,830) (31,569) (22,935) -------- -------- -------- Net deferred tax liability. (35,169) (29,224) (19,390) Less current tax asset..... 887 488 219 -------- -------- -------- Accumulated deferred income taxes............. $(36,056) $(29,712) $(19,609) ======== ======== ========\nSOUTHERN UNION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nOn August 10, 1993, the United States Congress passed and the President signed into law, the Omnibus Budget Reconciliation Act of 1993 (the \"Act\"). Among other provisions in the Act, effec- tive January 1, 1993, the corporate federal income tax rate was increased to 35% on corporate taxable income in excess of $10,000,000. Total income tax expense differed from the amount computed by applying the applicable federal income tax rate of 35% in 1995, 1994 and 1993 to earnings before taxes on income as follows:\nYear Ended --------------------------------- June 30, December 31, ------------------ 1995 1994 1993 -------- -------- ------------\nComputed \"expected\" tax expense..................... $ 9,465 $ 4,747 $ 4,056 Changes in taxes resulting from: State income taxes, net of federal income tax benefit............. 690 254 46 Amortization of acquisition adjustment.. 920 941 1,060 Amortization of excess deferred income taxes... (175) (190) (191) Adjustments to tax reserve................. -- (615) (1,095) Other..................... 74 48 (21) ------- ------- -------- Actual tax expense............ $10,974 $ 5,185 $ 3,855 ======= ======= ========\nUTILITY REGULATION AND RATES\nPursuant to a 1989 MPSC order, Missouri Gas Energy is engaged in a major gas safety program in its service territories. This pro- gram includes replacement of company- and customer-owned gas ser- vice and yard lines, the movement and resetting of meters, the replacement of cast iron mains and the replacement and cathodic protection of bare steel mains (the \"Missouri Safety Program\"). In recognition of the significant capital expenditures associated with this safety program, the MPSC permits the deferral, and sub- sequent recovery through rates, of depreciation expense, property taxes and associated carrying costs, related to the Missouri Safety Program. Missouri Gas Energy was required to continue the Missouri Safety Program and has deferred depreciation expense, property taxes and carrying costs of approximately $4,154,000 and $600,000 for 1995 and 1994, respectively.\nThe continuation of the Missouri Safety Program will result in significant levels of future capital expenditures. The Company estimates incurring capital expenditures of approximately $20,021,000 in fiscal 1996 related to this program.\nUnder the order of the FERC docket Nos. RP 94-296 and PR 95-3, Williams Natural Gas Company, a supplier of gas to Missouri Gas Energy, is allowed recovery of certain unrecovered deferred gas costs of approximately $27,700,000. These costs were related to gas deliveries prior to April 30, 1994. Missouri Gas Energy filed a mechanism to recover these costs under case GR 95-33 with the MPSC which was approved and allows recovery of these costs from its Missouri customers. The receivable and liability associated with these costs have been recorded as a deferred charge and a deferred liability, respectively, on the balance sheet as of June 30, 1995.\nLEASES\nThe Company leases certain facilities, equipment and office space under cancelable and noncancelable operating leases. The minimum annual rentals under operating leases for the next five years ended June 30 are as follows: 1996 -- $6,147,000; 1997 -- $5,030,000; 1998 -- $3,499,000; 1999 -- $2,613,000; 2000 -- $2,051,000; and thereafter $10,215,000. Rental expense was approximately $7,268,000, $3,605,000 and $2,061,000 for the years ended June 30, 1995 and 1994 and December 31, 1993.\nSOUTHERN UNION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nCOMMITMENTS AND CONTINGENCIES\nSouthern Union is aware of the possibility that it may become a defendant in an action brought by the United States Environmental Protection Agency (\"EPA\") under 42 U.S.C. Section 9607(a) for reimbursement of costs associated with removing hazardous sub- stances from the site of a former coal gasification plant (the \"Pine Street Canal Site\") in Burlington, Vermont. This knowledge arises out of the existence of a prior action, United States v. ---------------- Green Mountain Power Corp., et al, Civil No. 88-307 (D. Vt.), in - --------------------------------- which Southern Union became involved as a third-party defendant in January 1989. Green Mountain Power was an action under 42 U.S.C. Section 9607(a) by the federal government to recover clean-up costs associated with the \"Maltex Pond\", which is part of the Pine Street Canal Site. Two defendants in Green Mountain Power, Vermont Gas Systems and Green Mountain Power Corp., claimed that Southern Union is the corporate successor to People's Light and Power Corporation, an upstream corporate parent of Green Mountain Power Corp. during the years 1928-1931. Green Mountain Power was settled without admission or determina- tion of liability with respect to Southern Union by order dated December 26, 1990. The EPA has since conducted studies of the clean-up costs for the remainder of the Pine Street Canal Site, but the ultimate costs are unknown at this time. On November 30, 1992, Southern Union was named as a potentially responsible party in a special notice letter from the EPA. The Company has denied liability for any clean-up costs for various reasons, including the fact that it is not a successor to any entity that owned or operated the site in question. Should Southern Union be made party to any action seeking recovery of remaining clean-up costs, the Company intends to vigorously defend against such an action. The Company has made demands of the appropriate insurers that they assume the defense of and liability for any such claim that may be asserted. The Company does not believe the outcome of this matter will have a material adverse effect on its financial position, results of operations or cash flows.\nSouthern Union and Western Resources entered into an Environ- mental Liability Agreement (the \"Environmental Liability Agree- ment\") at the closing of the Missouri Acquisition. Subject to the accuracy of certain representations made by Western Resources in the Missouri Asset Purchase Agreement, the Environmental Liability Agreement provides for a tiered approach to the alloca- tion of certain liabilities under environmental laws that may exist or arise with respect to Missouri Gas Energy. The Environmental Liability Agreement contemplates Southern Union first seeking reimbursement from other potentially responsible parties, or recovery of such costs under insurance or through rates charged to customers. To the extent certain environmental liabilities are discovered by Southern Union prior to January 31, 1996, and are not so reimbursed or recovered, Southern Union will be responsible for the first $3,000,000, if any, of out-of-pocket costs and expenses incurred to respond to and remediate any such environmental claim. Thereafter, Western Resources would share one-half of the next $15,000,000 of any such costs and expenses, and Southern Union would be solely liable for any such costs and expenses in excess of $18,000,000. Missouri Gas Energy owns or is otherwise associated with a number of sites where manufactured gas plants were previously operated. These plants were commonly used to supply gas service in the late 19th and early 20th cen turies, in certain cases by corporate predecessors to Western Resources. By-products and residues from manufactured gas could be located at these sites and at some time in the future may require remediation by the EPA or delegated state regulatory authority. By virtue of notice under the Missouri Asset Purchase Agreement and its preliminary, non-invasive review, the Company became aware prior to closing of eleven such sites in the service territory of Missouri Gas Energy. Based on information reviewed thus far, it appears that neither Western Resources nor any predecessor in interest ever owned or operated at least three of those sites. Subsequent to the closing of the Missouri Acquisi- tion, as a result of an environmental audit, the Company has discovered the existence of possibly six additional sites in the service territory of Missouri Gas Energy. Southern Union has so informed Western Resources. The Company does not know if any of these additional sites were ever owned or operated by Western Resources or any of its predecessors in interest. Western Resources has informed the Company that it was notified in 1991 by the EPA that it was evaluating one of the sites (in St. Joseph, Missouri) for any potential threat to human health and the environment. Western Resources has also advised the Company, as of September 15, 1994, the EPA had not notified it that any further action may be required. Evaluation of the remainder of the sites by appropriate federal and state regulatory authorities may occur in the future. At the present time and based upon information available to management, the Company believes that the costs of any remediation efforts that may be required for\nSOUTHERN UNION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nthese sites for which it may ultimately have responsibility will not exceed the aggregate amount subject to substantial sharing by Western Resources.\nOn June 1, 1994 Southern Union filed two lawsuits in the United States District Court for the Western District of Missouri, one against The Bishop Group, Ltd. and related entities (\"The Bishop Group\"), the other against both The Bishop Group and Western Resources. The primary subject of the lawsuits were certain gas transportation and supply agreements for the Missouri properties. Disputed purchase price items under the Missouri Asset Purchase Agreement (the \"Purchase Agreement\") were also made part of the litigation with Western Resources. The Bishop Group had responded with claims for damages and alleged a preliminary com- putation of damages in the range of $196,000,000 to $270,000,000 against Southern Union and Western. The litigation against The Bishop Group was dismissed February 24, 1995 as a result of a settlement between The Bishop Group and Southern Union with no material adverse affect on the Company's financial position, results of operations or cash flows. The issues involving disputed purchase price items in the litigation against Western Resources were resolved by court-ordered arbitration. Pursuant to the arbitrator's decision on April 17, 1995, Southern Union made an additional payment of $3,300,000 plus interest in final payment of the purchase price. The only remaining issues in the litigation are the Company's claims for damages against Western Resources for fraudulent misrepresentation, breach of contract, breach of covenant and other grounds. Southern Union is seeking damages in excess of $50,000,000. Trial by jury is currently scheduled for November 1995.\nSouthern Union and its subsidiaries are parties to other legal proceedings that its management considers to be the normal kinds of actions to which an enterprise of its size and nature might be subject, and not to be material to the Company's overall business or financial condition, results of operations or cash flows.\nIn the Missouri Acquisition, the Company assumed the Missouri portion of certain obligations related to a 1990 settlement of a Wyoming Tight Sands anti-trust claim. To secure the refund of the settlement proceeds, the MPSC authorized the establishment of an independently administered trust to collect cash receipts under the Tight Sands settlement and repay credit-facility bor- rowings used for the lump sum payment. In the event the trust does not receive cash payments from the gas suppliers as provided by the Tight Sands settlement agreements, the Company is com- mitted to pay its applicable portion of the amount owed the lender of the credit-facility borrowings. The Company's allo- cable unpaid portion of the amount the trust owes the lender at June 30, 1995 was approximately $8,204,000.\nThe Company is committed under various agreements to purchase certain quantities of gas in the future. At June 30, 1995, the Company has purchase commitments for nominal quantities of gas at fixed prices. These fixed price commitments have an annual value of approximately $2,500,000 for Southern Union Gas. Missouri Gas Energy currently does not have any fixed price commitment con- tracts for the 1995\/1996 winter heating season. At June 30, 1995, the Company also has purchase commitments for certain quantities of gas at variable, market-based prices. These market-based priced commitments have an annual value of approxi- mately $37,000,000 for Southern Union Gas and $66,000,000 for Missouri Gas Energy. The Company's purchase commitments may extend over a period of several years depending upon when the required quantity is purchased. The Company has in place pur- chase gas tariffs on file in all jurisdictions that provide for full recovery of its purchase costs.\nThe Company had standby letters of credit outstanding of $2,947,000 and $4,947,000 at June 30, 1995 and 1994, respec- tively, which guarantee payment of various insurance premiums, state taxes and gas purchases.\nSOUTHERN UNION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nTRANSITION PERIOD INFORMATION\nThe Company's Statement of Consolidated Operations for the six- month periods ended June 30, 1994 and 1993 appear below.\nSTATEMENT OF CONSOLIDATED OPERATIONS\nSix Months Ended June 30, ------------------------- 1994(a) 1993\n------------- ---------- (unaudited) (thousands of dollars, except shares and per share amounts)\nOperating revenues................... $ 268,964 $ 104,236 Gas purchase costs................... 154,274 53,530 --------- --------- Operating margin................... 114,690 50,706 --------- ---------\nOperating expenses: Operating, maintenance and general. 53,383 23,793 Taxes, other than on income........ 22,811 7,405 Depreciation and amortization...... 14,284 6,782 --------- -------- Total operating expenses......... 90,478 37,980 --------- -------- Net operating revenues........... 24,212 12,726 --------- --------\nOther income (expenses): Interest on long-term debt......... (17,836) (5,803) Other, net......................... 1,774 (748) --------- -------- Total other expenses, net........ (16,062) (6,551) --------- -------- Income before income taxes........... 8,150 6,175\nFederal and state income taxes....... 3,259 1,929 --------- --------\nEarnings before preferred dividends.. 4,891 4,246 Preferred dividends.................. -- (843) --------- -------- Net earnings available for common stock.............................. $ 4,891 $ 3,403 ========= ========\nEarnings (loss) per common share..... $ .43 $ .41 ========= ========\nWeighted average shares outstanding........................ 11,438,396 8,253,052 ========== =========\n- --------------------------\n(a) Missouri Gas Energy was acquired on January 31, 1994 and Rio Grande was acquired on September 30, 1993. Accordingly, the operating results of Missouri Gas Energy and Rio Grande were included in the Company's consolidated results of operations subsequent to the dates of acquisition.\nSOUTHERN UNION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nThe Company's Condensed Statements of Consolidated Cash Flows for the six-month periods ended June 30, 1994 and 1993 appear below.\nCONDENSED STATEMENT OF CONSOLIDATED CASH FLOWS\nSix Months Ended June 30, ------------------------- 1994(a) 1993 ------------- ---------- (unaudited) (thousands of dollars)\nNet cash flows from operating activities....................... $ 101,177 $ 17,090 --------- --------\nCash flows from investing activities: Additions to property, plant and equipment................ (28,133) (6,424) Acquisition of operations, net of cash received......... (405,292) (274) Purchase of and improvements to real estate............... -- (906) Proceeds from sale of discontinued operation....... -- 16,273 Other, net..................... 6,215 (1,261) --------- -------- Net cash flows (used in) provided by investing activities................. (427,210) 7,408 --------- --------\nCash flows from financing activities: Repayment of debt.............. (106,846) (478) Issuance of debt............... 475,000 14,489 Premiums on early extinguish- ment of debt................. (13,715) -- Debt issuance costs............ (5,439) -- Net payments under revolving credit facility.............. (20,100) -- Exercise of common stock options....................... 96 167 Redemption of preferred stock.. -- (25,370) Payment of dividends on preferred stock.............. -- (843) Other, net..................... -- (374) --------- -------- Net cash flows from (used in) financing activities... 328,996 (12,409) --------- -------- Increase in cash and cash equivalents...................... 2,963 12,089 Cash and cash equivalents at beginning of period.............. 2,918 89 --------- -------- Cash and cash equivalents at end of period........................ $ 5,881 $ 12,178 ========= ========\n- --------------------------\n(a) Missouri Gas Energy was acquired on January 31, 1994 and Rio Grande was acquired on September 30, 1993. Accordingly, the operating results of Missouri Gas Energy and Rio Grande were included in the Company's consolidated results of operations subsequent to the dates of acquisition.\nSOUTHERN UNION COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nQUARTERLY OPERATIONS (UNAUDITED)\nYear Ended Quarter Ended ----------------------------------------- June 30, 1995 September 30 December 31 March 31 June 30 Total - ------------- ------------ ----------- -------- ------- --------\nTotal operating revenues.... $69,114 $145,497 $181,370 $84,065 $480,046 Operating margin...... 40,289 67,863 81,621 48,434 238,207 Net operating revenues.... (956) 19,460 34,562 9,050 62,116 Net earnings (loss) available for common stock....... (6,168) 6,558 16,153 (474) 16,069 Net earnings (loss) per common share....... (.54) .57 1.41 (.04) 1.40\nYear Ended Quarter Ended -------------------------------------------- June 30, 1994(1) September 30 December 31 March 31(2) June 30 Total - ---------- ------------ ----------- ----------- ------- --------\nTotal operating revenues... $31,087 $ 74,465 $175,454 $93,510 $374,516 Operating margin..... 16,751 31,947 67,695 46,996 163,389 Net operating revenues... (625) 8,445 23,477 736 32,033 Net earnings (loss) available for common stock...... (1,254) 4,742 9,954 (5,064) 8,378 Net earnings (loss) per common share....... (.15) .57 .87 (.44) .85\nYear Ended Quarter Ended ----------------------------------------- December 31, 1993 March 31 June 30 September 30 December 31 Total - ------------ -------- ------- ------------ ----------- --------\nTotal operating revenues.... $67,026 $36,427 $ 31,087 $ 74,465 $209,005 Operating margin...... 31,095 18,828 16,751 31,947 98,621 Net operating revenues.... 11,252 692 (625) 8,445 19,764 Earnings (loss) before preferred dividends... 5,169 (924) (1,254) 4,742 7,733 Net earnings (loss) available for common stock....... 4,575 (1,173) (1,254) 4,742 6,890 Net earnings (loss) per common share....... .55 (.14) (.15) .57 .83\n- ---------------------------\n(1) On May 25, 1994, the Company's Board of Directors approved a change in the Company's fiscal year-end from December 31 to June 30. See Change in Fiscal Year.\n(2) Missouri Gas Energy was purchased effective January 31, 1994. See Acquisitions and Divestitures.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Southern Union has duly caused this report to be signed by the undersigned, thereunto duly authorized, on September 20, 1995.\nSOUTHERN UNION COMPANY\nBy PETER H. KELLEY ------------------------ Peter H. Kelley President and Chief Operating Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of Southern Union and in the capacities indicated as of September 20, 1995.\nSignature\/Name Title -------------- -----\nGEORGE L. LINDEMANN* Chairman of the Board, Chief Executive Officer and Director\nJOHN E. BRENNAN* Director\nFRANK W. DENIUS* Director\nAARON I. FLEISCHMAN* Director\nKURT A. GITTER, M.D.* Director\nPETER H. KELLEY Director - --------------- Peter H. Kelley\nADAM M. LINDEMANN* Director\nROGER J. PEARSON* Director\nGEORGE ROUNTREE, III* Director\nDAN K. WASSONG* Director\nRONALD J. ENDRES Senior Vice President - Administration - ---------------- Ronald J. Endres and Chief Financial Officer\nDAVID J. KVAPIL Vice President and Controller - --------------- David J. Kvapil (Principal Accounting Officer)\n*By PETER H. KELLEY ------------------ Peter H. Kelley Attorney-in-fact\nEXHIBIT INDEX\nExhibit Filed No. Description Herein - ------- -------------------------------------------------- ------\n3(a) Restated Certificate of Incorporation of Southern Union Company. (Filed as Exhibit 3(a) to Southern Union's Transition Report on Form 10-K for the year ended June 30, 1994 and incorporated herein by reference.)\n3(b) Southern Union Company Bylaws, as amended. (Filed as Exhibit 3(b) to Southern Union's Transition Report on Form 10-K for the year ended June 30, 1994 and incorporated herein by reference.)\n4(a) Specimen Common Stock Certificate. (Filed as Exhibit 4(a) to Southern Union's Annual Report on Form 10-K for the year ended December 31, 1989 and incorporated herein by reference.)\n4(b) Indenture between Chase Manhattan Bank, N.A., as trustee, and Southern Union Company dated January 31, 1994. (Filed as Exhibit 4.1 to Southern Union's Current Report on Form 8-K dated February 15, 1994 and incorporated herein by reference.)\n4(c) Officers' Certificate dated January 31, 1994 setting forth the terms of the 7.60% Senior Debt Securities due 2024. (Filed as Exhibit 4.2 to Southern Union's Current Report on Form 8-K dated February 15, 1994 and incorporated herein by reference.) 4(d) Certificate of Trust of Southern Union Financing I. (Filed as Exhibit 4-A to Southern Union's Regis- tration Statement on Form S-3 (No. 33-58297) and incorporated herein by reference.)\n4(e) Certificate of Trust of Southern Union Financing II. (Filed as Exhibit 4-B to Southern Union's Regis- tration Statement on Form S-3 (No. 33-58297) and incorporated herein by reference.)\n4(f) Certificate of Trust of Southern Union Financing III. (Filed as Exhibit 4-C to Southern Union's Registration Statement on Form S-3 (No. 33-58297) and incorporated herein by reference.)\n4(g) Form of Amended and Restated Declaration of Trust of Southern Union Financing I. (Filed as Exhibit 4-D to Southern Union's Registration Statement on Form S-3 (No. 33-58297) and incorporated herein by reference.)\n4(h) Form of Subordinated Debt Securities Indenture among Southern Union Company and The Chase Manhattan Bank, N. A., as Trustee. (Filed as Exhibit 4-G to Southern Union's Registration State- ment on Form S-3 (No. 33-58297) and incorporated herein by reference.)\n4(i) Form of Supplemental Indenture to Subordinated Debt Securities Indenture with respect to the Subor- dinated Debt Securities issued in connection with the Southern Union Financing I Preferred Securities. (Filed as Exhibit 4-H to Southern Union's Regis- tration Statement on Form S-3 (No. 33-58297) and incorporated herein by reference.)\n4(j) Form of Southern Union Financing I Preferred Security (included in 4(g) above.) (Filed as Exhibit 4-I to Southern Union's Registration State- ment on Form S-3 (No. 33-58297) and incorporated herein by reference.)\n4(k) Form of Subordinated Debt Security (included in 4(i) above.) (Filed as Exhibit 4-J to Southern Union's Registration Statement on Form S-3 (No. 33-58297) and incorporated herein by reference.)\n4(l) Form of Guarantee with respect to Southern Union Financing I Preferred Securities. (Filed as Exhibit 4-K to Southern Union's Registration Statement on Form S-3 (No. 33-58297) and incorporated herein by reference.)\n4(m) The Company is a party to other debt instruments, none of which authorizes the issuance of debt securities in an amount which exceeds 10% of the total assets of the Company. The Company hereby agrees to furnish a copy of any of these instru- ments to the Commission upon request.\n10(a) Revolving Credit Agreement, Revolving Note and Loan Documents between Southern Union Company and the Banks named therein dated September 30, 1993. (Filed as Exhibit 99.2 to Southern Union's Current Report on Form 8-K dated October 13, 1993 and incorporated herein by reference.)\n10(b) First Amendment to Revolving Credit Agreement, Revolving Notes and Loan Documents dated as of November 15, 1993. (Filed as Exhibit 10.1 to Southern Union's Registration Statement on Form S-3 (No. 33-70604) and incorporated herein by reference.)\n10(c) Second Amendment to Revolving Credit Agreement dated August 31, 1994. (Filed as Exhibit 10(c) to Southern Union's Transition Report on Form 10-K for the year ended June 30, 1994 and incorporated herein by reference.)\n10(d) Third Amendment to Revolving Credit Agreement dated April 28, 1995. (Filed as Exhibit 10.1 to Southern Union's Quarterly Report on Form 10-Q for the quar- ter ended March 31, 1995 and incorporated herein by reference.)\n10(e) Asset Purchase Agreement between Southern Union Company and Western Resources, Inc. dated July 9, 1993. (Filed as Exhibit 10.1 to the Company's Current Report on Form 8-K dated July 12, 1993 and incorporated herein by reference.)\n10(f) Southern Union Company 1982 Incentive Stock Option Plan and form of related Stock Option Agreement. (Filed as Exhibits 4.1 and 4.2 to Form S-8, File No. 2-79612 and incorporated herein by reference.) (1)\n10(g) Form of Indemnification Agreement between Southern Union Company and each of the Directors of Southern Union Company. (Filed as Exhibit 10(i) to Southern Union's Annual Report on Form 10-K for the year ended December 31, 1986 and incorporated herein by reference.)\n10(h) Southern Union Company 1992 Long-Term Stock Incen- tive Plan. (Filed as Exhibit 10(i) to Southern Union's Annual Report on Form 10-K for the year ended December 31, 1992 and incorporated herein by reference.)(1)\n10(i) Southern Union Company Director's Deferred Compen- sation Plan. (Filed as Exhibit 10(g) to Southern Union's Annual Report on Form 10-K for the year ended December 31, 1993 and incorporated herein by reference.)(1)\n10(j) Southern Union Company Supplemental Deferred Compen- sation Plan. (Filed as Exhibit 10(h) to Southern Union's Annual Report on Form 10-K for the year ended December 31, 1993 and incorporated herein by reference.)(1)\n10(k) Form of warrant granted to Fleischman and Walsh L.L.P. (Filed as Exhibit 10(j) to Southern Union's Transition Report on Form 10-K for the year ended June 30, 1994 and incorporated herein by reference.)\n10(l) Renewal Promissory Note Agreement between Peter H. Kelley and Southern Union Company dated May 31, 1995.\n11 Computation of Per Share Earnings.\n21 Subsidiaries of Southern Union Company.\n23 Consent of Independent Accountants.\n24 Power of Attorney with Respect to Certain Signatures.\n27 Financial Data Schedule.\n- ---------------------\n(1) Indicates a Management Compensation Plan.","section_15":""}
{"filename":"355766_1995.txt","cik":"355766","year":"1995","section_1":"ITEM 1. FINANCIAL STATEMENTS\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS\nSHOWBIZ PIZZA TIME, INC.:\nSHOWBIZ PIZZA TIME, INC. CONSOLIDATED BALANCE SHEETS JUNE 30, 1995 AND DECEMBER 30, 1994 (THOUSANDS, EXCEPT SHARE DATA)\nSee notes to consolidated financial statements.\nSHOWBIZ PIZZA TIME, INC. CONSOLIDATED STATEMENTS OF EARNINGS (UNAUDITED) (THOUSANDS, EXCEPT PER SHARE DATA)\nSee notes to consolidated financial statements.\nSHOWBIZ PIZZA TIME, INC. CONSOLIDATED STATEMENTS OF EARNINGS (UNAUDITED) (THOUSANDS, EXCEPT PER SHARE DATA)\nSee notes to consolidated financial statements.\nSHOWBIZ PIZZA TIME, INC. CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (UNAUDITED) (THOUSANDS, EXCEPT PER SHARE DATA)\nSee notes to consolidated financial statements.\nSHOWBIZ PIZZA TIME, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (THOUSANDS)\nSee notes to consolidated financial statements.\nSHOWBIZ PIZZA TIME, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SIX MONTHS ENDED JUNE 30, 1995 AND JULY 1, 1994 (UNAUDITED)\n1. INTERIM FINANCIAL STATEMENTS:\nIn the opinion of management, the accompanying financial statements for the periods ended June 30, 1995 and July 1, 1994 reflect all adjustments (consisting only of normal recurring adjustments except as referred to in Note 5) necessary to present fairly the Company's financial condition, results of operations and cash flows.\nCertain information and footnote disclosures normally included in the consolidated financial statements prepared in accordance with generally accepted accounting principles have been omitted. The unaudited consolidated financial statements referred to above should be read in conjunction with the financial statements and notes thereto included in the Company's Form 10-K filed with the Securities and Exchange Commission for the year ended December 30, 1994. Results of operations for the periods ended June 30, 1995 and July 1, 1994 are not necessarily indicative of the results for the year.\n2. EARNINGS PER COMMON AND COMMON EQUIVALENT SHARE:\nEarnings per common and common equivalent share were computed based on the weighted average number of common and common equivalent shares outstanding during the period. Net income available per common share has been adjusted for the items indicated below, and earnings per common and common equivalent share were computed as follows (thousands, except per share data):\nSHOWBIZ PIZZA TIME, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SIX MONTHS ENDED JUNE 30, 1995 AND JULY 1, 1994 (UNAUDITED)\n3. INCOME TAXES:\nIncome taxes have been provided at the expected annual federal tax rate during the year (35% for 1995) plus an estimated provision for state income taxes and state franchise taxes.\n4. SUPPLEMENTAL CASH FLOW INFORMATION:\n5. SIGNIFICANT TRANSACTIONS:\nDuring the second quarter of 1995, the Company refinanced its previous credit facility of $30.8 million expiring January 1996 with an increased facility of $33 million. The new credit facility consists of certain term notes totalling $18 million with annual interest of 10.02% maturing in 2001, and certain term notes totalling $10 million with annual interest equal to the London Interbank Offered Rate (\"LIBOR\") plus 3.5% maturing in 2000. In addition, the Company has a $5 million line of credit with annual interest provided at prime plus 1\/2 %, or at the Company's option, LIBOR plus 3% and matures June 1997. No amount is outstanding under the line of credit at June 30, 1995. The Company is required to comply with certain ratio tests during the terms of the loan agreements.\nDuring the first quarter of 1995, the Company changed its estimate of the useful lives of certain fixed assets as follows:\nSHOWBIZ PIZZA TIME, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SIX MONTHS ENDED JUNE 30, 1995 AND JULY 1, 1994 (UNAUDITED)\n5. SIGNIFICANT TRANSACTIONS (CONT.):\nAs a result of this change, income before income taxes increased $576,000, net income was increased $346,000 and earnings per share increased $.03 in the second quarter of 1995. In the first six months of 1995, income before income taxes increased approximately $1.1 million, net income increased $685,000 and earnings per share increased $.05.\nDuring the first quarter of 1995, the Company's Chairman of the Board and Chief Executive Officer forfeited 60,000 shares of unvested common stock of the Company previously awarded to him under the Company's stock grant plan. As a result of this forfeiture, deferred compensation and capital in excess of par value were reduced by approximately $1.7 million. Amortization of the remaining deferred compensation is provided by the straight-line method over the remaining term of the employment agreement.\nItem 2:","section_1A":"","section_1B":"","section_2":"Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations\nRESULTS OF OPERATIONS\nSecond Quarter 1995 Compared to Second Quarter 1994\nRevenues for the second quarter of 1995 decreased 2.5% to $62.4 million from $64.0 million in the second quarter of 1994 primarily due to the sale of the Company's Monterey's Tex-Mex Cafe restaurants effective May 5, 1994. Revenues from the Company's Monterey's Tex-Mex Cafe restaurants were $1.5 million in the second quarter of 1994. Revenue generated by the Company's Chuck E. Cheese's restaurants declined slightly to $62.4 million in the second quarter of 1995 from $62.5 million in 1994 due to a decline in comparable store sales of 2.4% between the periods.\nThe Company incurred an operating loss of $1.4 million in the second quarter of 1995 compared to operating income of $2.5 million in the second quarter of 1994. Included in operating income in 1994 is a gain of $5.5 million related to the sale of the Company's Monterey's Tex-Mex Cafe restaurants and a $1.9 million loss associated with the valuation of fixed assets used in certain Chuck E. Cheese's restaurants. The decline in comparable store sales and operating margins in the Company's Chuck E. Cheese's restaurants also contributed to the decline in operating income. A material portion of operating costs are fixed resulting in an erosion of operating margins at lower sales levels.\nA summary of the results of operations of the Company as a percentage of revenues for the two quarters is shown below.\nRevenues\nRevenues from the Company's Chuck E. Cheese's restaurants declined to $62.4 million in the second quarter of 1995 from $62.5 million in the second quarter of 1994 primarily due to a decline of 2.4% in comparable store sales of such restaurants which were opened during all of the second quarters of both 1995 and 1994. The Company opened one new restaurant in the first quarter of 1995 and 12 new restaurants throughout 1994. Management believes that several factors may have contributed to the comparable store sales decline including increased competition and to a lesser extent, the impact of newly opened Company restaurants on comparable store sales of existing restaurants in certain markets. Menu prices were comparable between the two periods.\nCosts and Expenses\nCosts and expenses as a percentage of revenues increased to 102.3% in the second quarter of 1995 from 96.0% in the second quarter of 1994.\nCost of sales increased as a percentage of revenues to 53.7% in the second quarter of 1995 from 51.8% in the comparable period of 1994. Cost of food, beverage, prize and merchandise items for Chuck E. Cheese's restaurants as a percentage of restaurant sales decreased to 18.4% in the second quarter of 1995 from 18.5% in the second quarter of 1994 primarily due to an increase in game sales as a percentage of total restaurant sales. Labor expenses for Chuck E. Cheese's restaurants as a percentage of restaurant sales increased to 32.1% during the second quarter of 1995 from 30.3% in the second quarter of 1994 primarily due to increased labor rates, reduced management turnover and the decline in the comparable store sales.\nSelling, general and administrative expenses as a percentage of revenues decreased to 17.9% in the second quarter of 1995 from 19.1% in the comparable period of 1994 primarily due to a decline in corporate overhead costs.\nDepreciation and amortization expenses as a percentage of revenues decreased to 8.8% in the second quarter of 1995 from 9.6% in the second quarter of 1994. Preopening expense declined due to the write-off of all unamortized preopening expense in the fourth quarter of 1994 resulting from a change in the estimated future benefit of such expenses. Depreciation expense declined due to the sale of Monterey's Tex-Mex Cafe restaurants in May 1994 and a change effected in the first quarter of 1995 in the estimated useful lives of certain fixed assets based on a review of historical asset utilization. As a result of this change, depreciation expense decreased approximately $576,000 in the second quarter of 1995.\nOther operating expenses increased as a percentage of revenues to 21.7% in the second quarter of 1995 from 21.0% in the second quarter of 1994 primarily due to increased rent costs as a percentage of revenues and the decline in comparable store sales.\nThe Company had a loss on property transactions of $110,000 in the second quarter of 1995 compared to a net gain on property transactions of $3.5 million in the second quarter of 1994. In the second quarter of 1994, the Company recognized a gain of $5.5 million from the sale of substantially all of the assets of its Monterey's Tex-Mex Cafe restaurants on May 5, 1994. The gain was partially offset by a loss of approximately $1.9 million in the second quarter of 1994. The loss was a result of the Company's decision to close one Chuck E. Cheese's restaurant and the decline in fair value of the fixed assets of eight Chuck E. Cheese's restaurants due to the Company's decision not to renew the leases as a result of the deterioration of site characteristics. The Company will consider possible relocation of some of the restaurants. The Company provided for a loss on property transactions of approximately $110,000 in the second quarter of 1995 compared to a loss of $100,000 in the second quarter of 1994 due to the replacement of certain assets in conjunction with the enhancement of facilities and entertainment packages of restaurants.\nOperating Income (Loss)\nAs a result of the changes in revenues and expenses discussed above, the Company had an operating loss of $1.4 million in the second quarter of 1995 compared to operating income of $2.5 million in the second quarter of 1994. Included in operating income are the operations of Monterey's Tex-Mex Cafe restaurants through May 5, 1994. Operating income in the second quarter of 1994 for Monterey's Tex-Mex Cafe restaurants was $5.6 million, including a gain on property transactions of $5.5 million.\nNet Income (Loss)\nInterest expense increased to $740,000 in the second quarter of 1995 from $430,000 in the second quarter of 1994 due primarily to an increase in interest rates and the Company's average outstanding debt since the second quarter of 1994. The Company had a net loss of $1.2 million in the second quarter of 1995 compared to net income of $1.2 million in the second quarter of 1994 due to the changes in revenues and expenses discussed above. The Company's primary and fully diluted loss per share was $.10 per share in the second quarter of 1995 compared to earnings per share of $.10 per share in the second quarter of 1994.\nFirst Six Months of 1995 Compared to First Six Months of 1994\nRevenues decreased 3.9% to $135.0 million in the first six months of 1995 from $140.4 million in the comparable period of 1994. Revenues generated by the Company's Chuck E. Cheese's restaurants increased to $135.0 million in the first six months of 1995 from $134.2 million in the first six months of 1994 due to the net addition of one Company restaurant in the first six months of 1995 and 12 new restaurants in 1994. Comparable store sales from the Company's Chuck E. Cheese's restaurants declined 2.8% between the periods. Revenues from the Company's Monterey's Tex-Mex Cafe restaurants were $6.2 million in the first six months of 1994.\nOperating income decreased to $3.3 million in the first six months of 1995 from $8.3 million in the first six months of 1994. Included in operating income in 1994 is a gain of $5.5 million related to the sale of the Company's Monterey's Tex-Mex Cafe restaurants and a $1.9 million loss associated with the valuation of fixed assets used in certain Chuck E. Cheese's restaurants. The decline in comparable store sales and operating margins in the Company's Chuck E. Cheese's restaurants also contributed to the decline in operating income. A material portion of operating costs are fixed resulting in an erosion of operating margins at lower sales levels.\nA summary of the results of operations of the Company as a percentage of revenues for the six month periods is shown below.\nRevenues\nRevenues from the Company's Chuck E. Cheese's restaurants increased to $135.0 million in the first six months of 1995 from $134.2 million in the first six months of 1994 primarily due to new restaurant development which occurred throughout 1994 and January 1995. Comparable store sales of such restaurants which were open during all of the first six months of both 1995 and 1994 declined by 2.8% between the two periods. Management believes that several factors may have contributed to the comparable store sales decline including increased competition and to a lesser extent, the impact of newly opened restaurants on comparable store sales of existing restaurants in certain markets. Menu prices were comparable between the two periods.\nCosts and Expenses\nCosts and expenses as a percentage of revenues increased to 97.5% in the first six months of 1995 from 94.1% in the first six months of 1994.\nCost of sales increased as a percentage of revenues to 52.6% in the first six months of 1995 from 50.7% in the comparable period of 1994. Cost of food, beverage, prize and merchandise items for Chuck E. Cheese's restaurants as a percentage of restaurant sales decreased to 18.2% in the first six months of 1995 from 18.3% in the first six months of 1994 primarily due to an increase in game sales as a percentage of total restaurant sales. Labor expenses for Chuck E. Cheese's restaurants as a percentage of restaurant sales increased to 31.2% during the first six months of 1995 from 29.1% in the first six months of 1994 primarily due to increased labor rates, reduced management turnover and the decline in the comparable store sales.\nSelling, general and administrative expenses as a percentage of revenues decreased to 16.6% in the first six months of 1995 from 17.3% in the comparable period of 1994 primarily due to a reduction in corporate overhead expenses.\nDepreciation and amortization expenses as a percentage of revenues decreased to 8.0% in the first six months of 1995 from 8.9% in the comparable period of 1994. Preopening expense declined due to the write-off of all unamortized preopening expense in the fourth quarter of 1994 resulting from a change in the estimated future benefit of such expenses. Depreciation expense declined due to the sale of Monterey's Tex-Mex Cafe restaurants in May 1994 and a change effected in the first quarter of 1995 in the estimated useful lives of certain fixed assets based on a review of historical asset utilization. As a result of this change, depreciation expense decreased approximately $1.1 million in the first six months of 1995.\nOther operating expenses increased as a percentage of revenues to 20.3% in the first six months of 1995 from 19.7% in the first six months of 1994 primarily due to increased rent as a percentage of revenues and the decline in comparable store sales. This was slightly offset by a decrease in insurance costs as a percentage of revenues between the periods.\nThe Company had a net loss on property transactions of $39,000 in the first six months of 1995 compared to a net gain on property transactions of $3.5 million in the first six months of 1994. In the first six months of 1994, the Company recognized a gain of $5.5 million from the sale of substantially all of the assets of its Monterey's Tex-Mex Cafe restaurants on May 5, 1994. The gain was partially offset by a loss of approximately $1.9 million in the first six months of 1994. The loss was a result of the Company's decision to close one Chuck E. Cheese's restaurant and the decline in fair value of the fixed assets of eight Chuck E. Cheese's restaurants due to the Company's decision not to renew the leases as a result of the deterioration of site characteristics. The Company will consider possible relocation of some of the restaurants. The Company provided for a loss on property transactions of approximately $139,000 in the first six months of 1995 compared to a loss of $100,000 in the first six months of 1994 due to the replacement of certain assets in conjunction with the enhancement of facilities and entertainment packages of restaurants. In the first six months of 1995, the Company recognized a gain of $100,000 related to the sale of assets held for resale.\nOperating Income\nAs a result of the changes in revenues and expenses discussed above, operating income declined to $3.3 million in the first six months of 1995 from $8.3 million in the first six months of 1994. Included in operating income are the operations of Monterey's Tex-Mex Cafe restaurants through May 5, 1994. Operating income in the first six months of 1994 for Monterey's Tex-Mex Cafe restaurants was $5.9 million, including a gain on property transactions of $5.5 million.\nNet Income\nInterest expense increased to $1.5 million in the first six months of 1995 from $792,000 in the first six months of 1994 due primarily to an increase in interest rates and the Company's average outstanding debt between the periods. The Company's net income decreased to $1.4 million in the first six months of 1995 from $4.7 million in the first six months of 1994 due to the changes in revenues and expenses discussed above. The Company's primary and fully diluted earnings per share decreased to $.10 per share in the first six months of 1995 from $.37 per share in the first six months of 1994.\nFINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES\nCash provided by operations decreased to $16.9 million in the first six months of 1995 from $18.3 million in the comparable period of 1994. Cash outflows from investing and financing activities for the first six months of 1995 were $13.8 million and $800,000, respectively. The Company's primary requirements for cash relate to planned capital expenditures and debt service. The Company expects that it will satisfy such requirements from cash provided by operations and funds available under its line of credit or additional borrowings.\nIn June 1995, the Company refinanced its previous credit facility of $30.8 million expiring in January 1996 with an increased facility of $33 million. The new credit facility consists of certain term notes totalling $18 million with annual interest of 10.02% maturing in 2001, and certain term notes totalling $10 million with annual interest equal to the London Interbank Offered Rate (\"LIBOR\") plus 3.5% maturing in 2000. In addition, the Company has obtained a $5 million line of credit due June 1997 with interest provided at prime plus 1\/2%, or at the Company's option, LIBOR plus 3%. The Company is currently in negotiations for additional borrowings between $5 and $7 million. The Company is required to comply with certain financial ratio tests during the terms of the loan agreements.\nThe Company believes that the success of its facility and entertainment enhancement program in addition to new restaurant development will continue to be significant factors in its ability to generate increased revenues over the foreseeable future. The Company continues to evolve and expand its efforts to significantly enhance its Chuck E. Cheese's locations. This \"repositioning\" program is being carried out on a market by market basis and involves: an improved exterior identity, a facility upgrade, an expanded free ball-crawl with tubes and tunnels suspended from or reaching to the ceiling, and an enhancement of the variety and number of games and rides offered to its guests. The Company completed 21 restaurants under this program in 1994 and has currently completed an additional 27 restaurants during 1995. The average sales growth in these restaurants during the periods following their repositioning compared to the same periods of the prior year has increased approximately 20% after giving effect to average sales trends experienced during the three month periods prior to their repositioning. The Company currently intends to reposition substantially all of the Company restaurants by the end of 1996. The Company anticipates that the repositioning of the remaining restaurants will cost on the average approximately $300,000 per restaurant. However, this amount can vary significantly at a particular restaurant depending on the several factors, including the restaurant's square footage, date of the most recent remodel and the existing assets at the restaurant. In the event certain site characteristics considered essential to the success of a restaurant deteriorate, the Company will consider closing the restaurant or relocating the restaurant to a more desirable site.\nThe Company is implementing several strategies designed to strengthen the sales vitality of its existing unit base in what management believes is a competitive market. The Company is refining its marketing plan; the Company has accelerated its commitment of capital to existing stores; and the Company is currently limiting its 1995 new restaurant development to ensure that the sales vitality of the Company's existing restaurant base is given immediate priority. The Company believes that certain operating costs could increase as a result of implementing its strategies designed to strengthen existing unit sales. If the declines in comparable store sales of the Company's Chuck E. Cheese's restaurants experienced since 1992 continue to be experienced over a longer term, an adverse impact on the Company's operating margins and results of operations could continue.\nThe Company is involved in a number of lawsuits. The Company presently believes that it will continue to incur expense to defend against and resolve such litigation, and anticipates that it will satisfy such expense with cash flow from operations. (Refer to Item 1. Legal Proceedings).\nThe Company believes it will realize substantial benefit from utilization of approximately $73 million in net operating loss carryforwards to reduce its federal income tax liability. Such net operating loss carryforwards expire from years 1999 through 2002. Although the use of such carryforwards could, under certain circumstances, be limited, the Company is presently unaware of the occurrence of any event which would result in the imposition of such limitation. The Company has adopted an amendment to its Restated Articles of Incorporation which is intended to prevent changes in ownership of its common stock that would cause such limitation. In addition, the Company has investment tax credit, job tax credit and alternative minimum tax credit carryforwards of approximately $7 million expiring from years 1997 through 2008. Tax credit carryforwards can be utilized by the Company only after all net operating loss carryforwards have been realized. If the Company's results of operations continue to decline, a portion of the net operating loss and tax credit carryforwards could expire prior to utilization resulting in a charge against income. Taxable income for the five years ending December 30, 1994 was $62 million. Based on the early results of the repositioned restaurants and the Company's current plans to reposition substantially all of its Company owned restaurants by the end of 1996, the Company projects future taxable income levels sufficient to realize its net operating loss and tax credit carryforwards prior to their expiration after considering an allowance of $1.1 million for the estimated expiration of tax credit carryforwards in 1997.\nPART II - OTHER INFORMATION\nItem 1. Legal Proceedings.\nIn December 1991, the Company, The Hallwood Group Incorporated, (\"Hallwood\"), Integra-A Hotel and Restaurant Company (\"Integra\"), and their individual directors were named defendants in two separate but related lawsuits brought in the 14th and 134th District Courts of Dallas County, Texas. In April 1993, the Company and its two directors who are also employees of the Company, were dismissed as defendants in the lawsuit brought in the 134th District Court by an Integra common stockholder. Integra owned approximately 90% of the outstanding Common Stock of the Company prior to Integra's distribution of such Common Stock in December 1988 (the \"1988 Distribution\") to its shareholders of record. The plaintiffs in the remaining lawsuit constituted certain holders of warrants, options and preferred stock of Integra who sought to serve as representatives of proposed classes of other holders of such securities. The plaintiffs alleged that the Company (i) violated Texas statutes related to securities fraud and the fraudulent transfer of assets, (ii) committed common law fraud, and (iii) breached fiduciary and other duties to the plaintiffs. As amended, this suit sought recision of the 1988 distribution actual damages in excess of $184 million, and punitive damages in excess of $500 million. Although, the Company believes that the claims made against it were without merit, the Company has settled the lawsuit. The Court on June 26, 1995 issued an order for final judgement that approved the settlement of the suit and dismissed it with prejudice.\nIn May 1994, Hermitage Hotel, Ltd., L. P., filed a lawsuit against the Company, Hallwood and certain directors of the Company in the 101st District Court of Dallas County, Texas. The lawsuit sought recovery on behalf of plaintiff under theories of successor liability, tortious interference with contract, fraud, negligent representation and breach of contract. The plaintiff was seeking approximately $10.2 million in actual damages, $30 million in exemplary damages, attorneys' fees and court costs. Although, the Company believes that the claims made against it in this suit were without merit, the Company settled this suit and on June 28, 1995, the Court issued an agreed order of dismissal, with prejudice.\nIn June 1993, the Company was named as a nominal defendant in a shareholders' derivative action in the 68th Judicial District Court in Dallas County, Texas in which three of the Company's executive officers, four of the Company's outside directors and Hallwood were named defendants. The plaintiffs in this lawsuit have alleged the individual defendants (i) breached their fiduciary duties to stockholders, (ii) committed constructive fraud and (iii) unjustly enriched themselves as a result of alleged violations of federal securities laws and illegal insider trading between July 13, 1992 and June 11, 1993. The Company has agreed in principle to the settlement of this lawsuit subject to final documentation and court approval.\nIn July 1993, the Company was named a defendant in a lawsuit brought in the Circuit Court for Davidson County, Nashville, Tennessee by Third National Bank in Nashville, as Trustee pursuant to a municipal bond issuance of $6.4 million made in 1980, for which Integra executed a guaranty. The plaintiff has alleged that Integra's guaranty of the municipal bond issuance was binding on successors of Integra and that the Company is the legal successor to Integra. The plaintiff is seeking to recover a judgement against the Company in the full amount of its claim against Integra, which is unspecified, as well as attorneys' fees and costs. In April 1994, the court dismissed the plaintiff's complaint for failure to state a claim upon which relief can be granted. Plaintiff has appealed the dismissal to the 6th Circuit Court of Appeals, which affirmed the dismissal, by an order and opinion dated June 27, 1995. The Company believes the allegations made in this suit to be without merit and will offer a vigorous defense in in any further appeal by the plaintiff.\nIn January 1994, the Company was named a defendant in a lawsuit brought in the Supreme Court of the State of New York, County of Queens, by Big Six Towers, Inc., in its purported capacity as a landlord to the Company with regard to a restaurant\/entertainment center location in Queens County, New York which the Company had contracted to lease from the plaintiff. The plaintiff has alleged that the Company has breached the lease and is seeking total damages in excess of $4.0 million against the Company. The Company believes it validly terminated the lease in question pursuant to an agreement with the plaintiff and believes the allegations made in this suit to be without merit and therefore intends to vigorously defend this lawsuit.\nCertain other pending legal proceedings exist against the Company which the Company believes are not material in amount or have arisen in the ordinary course of its business.\nItem 2. Changes in Securities.\nNone to report during quarter for which this report is filed.\nItem 3.","section_3":"Item 3. Defaults Upon Senior Securities.\nNone to report during quarter for which this report is filed.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nOn June 8, 1995, at the Company's annual meeting of shareholders, the Company's shareholders re-elected Richard M. Frank (7,163,648 shares in favor and 68,509 shares withheld) and Anthony J. Gumbiner (7,163,647 shares in favor and 68,509 shares withheld) as Class I Directors. The Company's shareholders also allegedly elected Joshua S. Friedman (7,205,370 shares in favor and 5,184 shares withheld) as a Class I Director, replacing Michael H. Magusiak (7,163,646 shares in favor and 68,509 shares withheld). The outcome of the alleged election of Joshua S. Friedman has been challenged in a lawsuit filed in a District Court located in Jefferson County, Kansas. The claims raised in this lawsuit assert that there were voting irregularities and inconsistent positions taken by the inspectors of election regarding the counting of proxies. Charles A. Crocco, Jr., Robert L. Lynch, Louis P. Neeb, Cynthia I. Pharr, J. Thomas Talbot, and Brian M. Troup continue to serve as Directors.\nAlso, on June 8, 1995, at the Company's annual meeting of shareholders, the Company's shareholders approved an increase in the number of shares available for grant under the 1988 Option Plan from 1,348,025 to 1,848,025 (5,604,951 shares in favor, 2,897,772 shares against and 1,135,361 shares abstaining).\nFinally, on June 8, 1995, at the Company's annual meeting of shareholders, the Company's shareholders approved the adoption of a Formula Stock Option Plan (6,625,052 shares in favor, 1,865,551 shares against and 1,147,481 shares abstaining). The Formula Stock Option Plan provides for the granting of nonqualified stock options to non-employee directors of the Company or its Affiliates (as defined in the Formula Stock Option Plan).\nItem 5.","section_5":"Item 5. Other Information.\nNone to report during quarter for which this report is filed.\nItem 6.","section_6":"Item 6. Exhibits and Reports on Form 8-K.\na) EXHIBITS\nB) REPORTS ON FORM 8-K\nThe Company filed a Form 8-K dated May 5, 1995, reporting that its Board of Directors had adopted amendments to the Company's Bylaws requiring that advance notice be given to the Company in the event a stockholder desires to nominate a person for election to the Board of Directors or to transact any other business at an annual meeting of stockholders. Included in such Form 8-K was the announcement that the Company's Board of Directors determined to notify the recordholders of more than 4.75% of the Company's common stock that the Company intends to enforce, prospectively, the existing provisions in its Restated Articles of Incorporation generally restricting the transfer of any shares of the Company's common stock to a holder of more than 4.75% of the value of the outstanding capital stock or the transfer of shares of common stock which would result in the intended transferee owning in excess of 4.75% of the value of the outstanding capital stock.\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.\nSHOWBIZ PIZZA TIME, INC.\nDated: August 14, 1995 By:\/s\/ Larry G. Page -------------------------- Larry G. Page Executive Vice President and Chief Financial Officer\nEXHIBIT INDEX","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":"830158_1995.txt","cik":"830158","year":"1995","section_1":"ITEM 1. BUSINESS.\nSeafield Capital Corporation (Seafield or Registrant), was organized in Missouri as BMA Properties, Inc. in 1974 as a 100% owned subsidiary of Business Men's Assurance Company of America (which was incorporated in 1909). In 1988, BMA Properties, Inc. was renamed BMA Corporation, and on June 1, 1988, became the parent company. Registrant changed its name in 1991 from BMA Corporation to Seafield Capital Corporation. Registrant is a holding company whose subsidiaries operate primarily in the healthcare and insurance services areas. Registrant implemented this new strategic business focus after the insurance operations were sold during 1990. Various operating subsidiaries of Registrant provide risk-appraisal laboratory testing services to the insurance industry, clinical testing services to the healthcare industry, and comprehensive cancer treatment management. In addition, Seafield has investments in early-stage healthcare services companies. Seafield, either directly or through subsidiaries, also holds interests in energy investments, marketable securities and real estate. Seafield had 18 employees as of December 31, 1995. None of the employees is represented by a labor union and Seafield believes its relations with employees are good. See Item 7 and Note 6 of Notes to Consolidated Financial Statements for additional segment information.\n* * *\nThe following list shows the Registrant and each subsidiary corporation of which Registrant owns a majority interest, together with the ownership percentage and state or country of incorporation.\nSEAFIELD CAPITAL CORPORATION (Missouri) LabOne, Inc. (Delaware) 82% Lab One Canada Inc. (Canada) 100% Response Oncology, Inc. (Tennessee) 56% Pyramid Diagnostic Services, Inc. (Delaware) 74% BMA Resources, Inc. (Missouri) 100% Scout Development Corporation (Missouri) 100% Scout Development Corporation of New Mexico (Missouri) 100% Carousel Apartment Homes, Inc. (Georgia) 100%\nINSURANCE SERVICES\nThe following businesses are considered to be in the insurance services segment: LabOne, Inc. (insurance segment), Agency Premium Resource, Inc. (APR), and International Underwriting Services, Inc. (IUS). APR and IUS were sold during 1995.\nLABONE, INC.\nThe Registrant's laboratory testing activities are conducted through LabOne, Inc. (LabOne), a subsidiary which was 82% owned by the Registrant and 18% publicly held at December 31, 1995. LabOne is a publicly-traded stock (NASDAQ-LABS). LabOne, together with its wholly-owned subsidiary Lab One Canada Inc. (hereinafter collectively referred to as LabOne), is the largest provider of laboratory services to the insurance industry in the United States and Canada. In 1994, LabOne expanded its testing offerings to include the clinical and substance abuse markets. LabOne provides high- quality laboratory services to insurance companies, physicians and employers nationwide.\nLabOne provides risk-appraisal laboratory services to the insurance industry. The tests performed by LabOne are specifically designed to assist an insurance company in objectively evaluating the mortality and morbidity risks posed by policy applicants. The majority of the testing is performed on specimens of individual life insurance policy applicants. LabOne also provides testing services on specimens of individuals applying for individual and group medical and disability policies.\nLabOne also provides clinical testing services to the healthcare industry to aid in the diagnosis and treatment of patients. Additionally, LabOne is certified by the Substance Abuse and Mental Health Services Administration (SAMHSA) to perform substance abuse testing services for federally regulated employers and is currently marketing these services throughout the country to both regulated and nonregulated employers. See the Healthcare Segment following for additional information regarding LabOne's clinical and substance abuse testing services.\nLabOne's Insurance Applicant Testing Services\nIn order to establish the appropriate level of premium payments or to determine whether to issue a policy, an insurance company requires objective means of evaluating the insurance risk posed by policy applicants. Because decisions of this type are based on statistical probabilities of mortality and morbidity, an insurance company generally requires quantitative data reflecting the applicant's general health. Standardized laboratory testing, tailored to the needs of the insurance industry and reported in a uniform format, provides an insurance company with an efficient means of evaluating the mortality and morbidity risks posed by policy applicants. The use of standardized urinalysis and blood testing has proven a cost-effective alternative to individualized physician examinations, which utilize varying testing procedures and reports.\nStandardized laboratory testing can also be used to verify responses on a policy application to such questions as whether the applicant is a user of tobacco products, certain controlled substances or certain prescription drugs. Insurance companies generally offer a premium discount for nonsmokers and often rely on testing to determine whether an applicant is a user of tobacco products. Cocaine use has been associated with increased risk of accidental death and cardiovascular disorders, and as a result of the increasing abuse in the United States and Canada, insurance companies are testing a greater number of policy applicants to detect its presence. Therapeutic drug testing also detects the presence of certain prescription drugs that are being used by an applicant to treat a life-threatening medical condition that may not be revealed by a physical examination.\nLabOne's insurance testing services consist of certain specimen profiles that provide insurance companies with specific information that may indicate liver or kidney disorders, diabetes, the risk of cardiovascular disease, bacterial or viral infections and other health risks. LabOne also offers tests to detect the presence of antibodies to human immunodeficiency virus (HIV), nicotine, cocaine and certain medications associated with life-threatening medical conditions that may not be revealed by a routine physical examination.\nInsurance specimens are normally collected from individual insurance applicants by independent paramedical personnel using LabOne's custom- designed collection kits and containers. These kits and containers are delivered to LabOne's laboratory via overnight delivery services or mail, coded for identification and processed according to each client's specifications. Results are generally transmitted to the insurance company's underwriting department that same evening.\nThe following table summarizes LabOne's revenues from services provided to the insurance and healthcare (clinical and substance abuse testing) markets:\nYear ended December 31, 1995 1994 1993 ------------ ------------ ------------ (Dollars in thousands)\nInsurance $ 52,544 92% $ 60,260 99% $ 69,378 100% Healthcare 4,485 8% 466 1% -- 0% ------ ------ ------ Total $ 57,029 $ 60,726 $ 69,378 ====== ====== ======\nLabOne - Operations\nLabOne's operations are designed to facilitate the testing of a large number of specimens and to report the results to its clients, generally within 24 hours of receipt of specimens.\nLabOne has internally developed, custom-designed laboratory and business processing systems. These systems enable each client company to customize its own testing and reflex requirements by several parameters to satisfy its particular needs. It is a centralized network system that provides an automated link between LabOne's testing equipment, data processing equipment and the client's computer systems. This system offers LabOne's clients the ability to customize their testing activities to best meet their needs.\nLabOne, as the result of the number of tests it has performed over the past several years, has compiled and maintains a large statistical database of test results. These summary statistics are useful to the actuarial and underwriting departments of an insurance client in comparing that client's test results to the results obtained by LabOne's entire client base. Company-specific and industry-wide reports are frequently distributed to clients on subjects such as coronary risk analysis, cholesterol and drugs of abuse.\nLabOne considers the confidentiality of its test results to be of primary importance and has established procedures to ensure that results of tests remain confidential as they are communicated to the client that requested the tests.\nSubstantially all of the reagents and materials used by LabOne in conducting its testing are commercially purchased and are readily available from multiple sources.\nLabOne - Regulatory Affairs\/Quality Improvement\nThe objective of the Regulatory Affairs\/Quality Improvement department is to ensure that accurate and reliable test results are released to clients. This is accomplished by incorporating both internal and external quality assurance programs in each area of the laboratory. In addition, quality assurance specialists share the responsibility with all LabOne employees of an ongoing commitment to quality and safety in all laboratory operations. Internal quality and education programs are designed to identify opportunities for improvement in laboratory services and to meet all required safety training and education issues. These programs ensure reliable and confidential test results.\nProcedure manuals in all areas of the laboratory help maintain uniformity and accuracy, and meet regulatory guidelines. Tests on control samples with known results are performed frequently to maintain and verify accuracy in the testing process. Complete documentation provides record keeping for employee reference and meets regulatory requirements. All employees are thoroughly trained to meet standards mandated by OSHA in order to maintain a safe work environment. Superblind(trademark) controls are used to challenge every aspect of service at LabOne. Specimens requiring special handling are evaluated and verified by control analysis personnel. A computer edit program is used to review and verify clinically abnormal results, and all positive HIV antibody and drugs of abuse records.\nAs an external quality assurance program, LabOne participates in a number of proficiency programs established by the College of American Pathologists, the American Association of Bioanalysts and the Centers for Disease Control.\nLabOne is accredited by the College of American Pathologists and is licensed under the Clinical Laboratory Improvement Amendments (CLIA) of 1988. LabOne has additional licenses for HIV and substance abuse testing from the State of Kansas and all other states where such licenses are required. LabOne is certified by SAMHSA to perform testing to detect drugs of abuse in federal employees and in workers governed by federal regulations.\nLabOne - Technology Development\nThe technology development department evaluates new commercially available tests and technologies or develops new assays and compares them to competing products in order to select the most accurate laboratory procedures. Total technology development expenditures are not considered significant to LabOne as a whole.\nLabOne - Sales and Marketing\nLabOne's client base currently consists primarily of insurance companies in the United States and Canada. LabOne believes that its ability to provide prompt and accurate results on a cost-effective basis and its responsiveness to customer needs have been important factors in maintaining existing business.\nAll of LabOne's sales representatives for the insurance market have significant business experience in the insurance industry or clinical laboratory-related fields. These representatives call on major clients several times each year, usually meeting with a medical director or vice president of underwriting. An important part of LabOne's marketing effort is directed toward providing its existing clients and prospects with information pertaining to the actuarial benefits of, and trends in, laboratory testing. LabOne's sales representatives and its senior management also attend underwriters' and medical directors' meetings sponsored by the insurance industry.\nThe sales representatives for the healthcare industry are experienced in that market and currently work in the geographic areas which they represent. Marketing efforts are directed at insurance carriers, as well as self-insured companies and other organizations nationwide.\nSubstance abuse marketing efforts are primarily directed at Fortune 1000 companies, occupational health clinics and third party administrators. LabOne's strategy is to offer quality service at competitive prices. The sales force focuses on the ability of LabOne to offer multiple reporting methods, next flight out options, dedicated client service representatives and reporting of negative results before 8:00 a.m.\nLabOne - Legislation and Regulation\nIn the past, legislation was introduced in several states that, if enacted, may restrict or ban all AIDS-related testing for insurance purposes in those states. The introduction of legislation to restrict or ban all AIDS- related testing does not ensure its passage into law. There can be no assurance, however, that such legislation will not be enacted in the future.\nA few states have enacted legislation or regulations which have had the effect of reducing or eliminating the volume of laboratory tests requested by medical insurers in those states. It is likely that the trend will continue as more states enact legislation relating to health care and medical insurance.\nThe Food and Drug Administration (FDA) may exert broader regulatory control over LabOne's business and all testing laboratories. The areas of possible increased control that could impact LabOne's business include (1) whether FDA premarket notification or clearance may be required for LabOne's continued commercial distribution and use of a blood and urine specimen collection kit, and (2) a draft FDA compliance policy guide stating that certain products routinely used by laboratories may require FDA approval or clearance. See Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - TRENDS.\nLabOne - Competition\nLabOne believes that the insurance laboratory testing market is approximately a $100 million industry. LabOne currently controls over half the market, with three other main competitors, Osborn Laboratories, Inc., Clinical Reference Laboratory and GIB Laboratories, maintaining a majority of the remaining market. The insurance laboratory testing industry continues to be increasingly competitive. The primary focus of the competition has been on pricing. This continued competition has resulted in a decrease in LabOne's average price per test. It is anticipated that prices will continue to decline in 1996.\nAlthough competition has dramatically increased in the past few years, LabOne has maintained its position as the market leader. LabOne believes its leading position in the insurance laboratory testing market is due in part to its focused commitment of resources to the life and health insurance industry. LabOne has continued to maintain its market leadership through the client relationships that it has developed over its 24-year history, its reputation for providing quality products and services at competitive prices, and its battery of tests which are tailored specifically to insurance companies' needs.\nThe clinical laboratory testing market is a $40 billion industry which is highly fragmented and very competitive. LabOne faces competition from numerous independent clinical laboratories and hospital or physician owned laboratories. Many of LabOne's competitors are significantly larger and have substantially greater financial resources than LabOne. LabOne is currently working to establish a sound client base in this environment.\nLabOne's business plan is to be the premier low-cost provider of high- quality laboratory services to self-insured companies and insurance companies in the healthcare market. LabOne feels that its superior quality and centralized, low-cost operating structure enables it to compete effectively in this market.\nLabOne competes in the substance abuse testing market nationwide. LabOne's major competitors are the three major clinical chains, LabCorp, Corning Clinical Laboratories and Smith Kline Beecham Laboratories, who collectively constitute approximately two-thirds of the substance abuse testing market.\nLabOne - Foreign Markets\nIn 1977, LabOne opened Head Office Reference Laboratory Limited, a subsidiary, in Toronto, Canada. During 1994, LabOne consolidated all Canadian laboratory testing into the Kansas laboratory. In 1995, the name was changed to Lab One Canada, Inc., and LabOne continues to market insurance testing services to Canadian clients, with laboratory testing performed in the United States.\nThe following table summarizes the revenue, profit and assets applicable to LabOne's domestic operations and its subsidiary, Lab One Canada, Inc.\nYear ended December 31, 1995 1994 1993 ---- ---- ---- (In millions)\nSales: United States $50.8 $53.0 $59.8 Canada 6.2 7.7 9.6\nOperating Profit: United States 2.1 5.8 14.1 Canada 0.3 1.1 2.6\nIdentifiable Assets: United States 64.4 71.3 75.9 Canada 5.7 5.5 5.2\nLabOne - Employees\nAs of March 1, 1996, LabOne had 509 full-time employees, representing a decrease of 49 employees from the same time in 1995. None of LabOne's employees is represented by a labor union. LabOne believes its relations with employees are good.\nAGENCY PREMIUM RESOURCE, INC.\nAgency Premium Resource, Inc. (APR) is an insurance premium finance company serving independent insurance agents. APR provides premium financing for the commercial customers of these independent insurance agents. On May 31, 1995, Seafield sold APR. See Item 7 and Note 1 to Consolidated Financial Statements for additional information.\nINTERNATIONAL UNDERWRITING SERVICES, INC.\nInternational Underwriting Services, Inc. (IUS) offers turnkey policyholder and underwriting services. This subsidiary operates only within the life and health insurance industry and provides some or all of the following services to its customers: product design, underwriting of applicants, policy issuance, policy service, premium collection and payment of commissions. On July 17, 1995, Seafield sold IUS. See Item 7 and Note 1 to Consolidated Financial Statements for additional information.\nHEALTHCARE SERVICES\nThe following operating businesses are considered to be in the healthcare services segment: Response Oncology, Inc., LabOne, Inc. (healthcare segment) and Pyramid Diagnostic Services, Inc.\nRESPONSE ONCOLOGY, INC.\nThe Registrant owns approximately 56% of Response Oncology, Inc. (Response). On November 2, 1995, Response changed its name from Response Technologies, Inc. Response's common stock trades on the NASDAQ National Market System under the symbol ROIX.\nResponse is a comprehensive cancer management company. Response provides advanced cancer treatment services under the direction of over 350 independent oncologists; manages the practices of oncologists with whom Response has affiliated; and conducts clinical cancer research on behalf of pharmaceutical manufacturers.\nResponse - Cancer Treatment Services\nResponse provides advanced cancer treatments and related services, principally on an outpatient basis, through its IMPACT(registered trademark) (IMPlementing Advanced Cancer Treatments) Centers. Each IMPACT Center provides its Medical Directors\/Cancer Specialists with a fully integrated delivery system for implementation of advanced cancer protocols. As of February 15, 1996, Response owned or operated in joint ventures with hospitals, 43 IMPACT Centers in 21 states, providing advanced treatment capabilities and facilities to over 350 medical oncologists. Commencing in 1995, Response shifted its emphasis from wholly-owned IMPACT Centers typically located away from hospitals in close proximity to suburban oncology practices to joint ventures with hospitals which provide the physical facilities wherein the IMPACT Center is operated.\nEach IMPACT Center is staffed by experienced oncology nurses, pharmacists, laboratory technologists, and other support personnel to deliver outpatient services under the direction of private practicing oncologists. IMPACT Center services include preparation and collection of stem cells, administration of high-dose chemotherapy, reinfusion of stem cells and delivery of broadbased supportive care. IMPACT Center personnel extend the support mechanism into the patient's home, further reducing the dependence on hospitalization. The advantages of this system to the physician and patient include (i) convenience of the local treatment facility; (ii) specialized on-site laboratory and pharmacy services, including home pharmacy support; (iii) access to Response's clinical trials program to provide ongoing evaluation of current cancer treatment; (iv) specially trained medical and technical staff; (v) patient education and support materials through computer, video and staff consultation; and (vi) reimbursement assistance.\nResponse - Oncology Practice Management Services\nResponse announced during the year ended December 31, 1995, its plans to engage in physician practice management within the specialty of medical oncology and hematology.\nOn January 2, 1996, Response acquired the assets of, and entered into a long-term management services agreement with Oncology Hematology Group of South Florida, P.A. (the Group). The Group, consisting of nine physicians, is located on the campus of Baptist Hospital in Miami, Florida. Under the management services agreement, Response receives a management fee to manage the non-medical aspects of the practice and to coordinate practice enhancement opportunities with the physicians. Improvements are expected through a professional focus on management and managed care relationships, economies of scale, and the addition of new services. The Group is Response's first physician group under such a practice management relationship.\nAs of February 15, 1996, Response had announced the receipt of two additional non-binding letters of intent for physician practice management relationships, and that it was in early negotiations with several additional groups.\nIn late 1995, Response contracted with an independent physician association of oncologists in Palm Beach, Broward, Dade and Monroe Counties in South Florida for the purpose of marketing the services of such oncologists to managed care organizations.\nResponse - Cancer Research Services\nResponse also utilizes its database to provide various types of data to pharmaceutical companies regarding the use of their products. The IMPACT Center network and Response's database make Response ideally suited to this process. Response is currently participating in several projects with pharmaceutical manufacturers to furnish data in connection with FDA applications for post-FDA approval marketing studies. Revenue from these contracts helps to underwrite Response's clinical trials expenses. Such relationships with pharmaceutical companies may allow Response earlier access to drugs and therapies.\nResponse - Competition\nAs a result of growing interest among oncologists and the more widely recognized efficacy of high-dose chemotherapy treatments, the competitive environment in the field is starting to heighten. Most community hospitals with a commitment to cancer treatment are evaluating their need to provide high-dose treatments, and other entities are competing with Response in providing high-dose services similar to those offered by Response.\nSuch competition has long been contemplated by Response, and is indicative of the evolution of this field. While Response believes that the demand for high-dose chemotherapy services is sufficiently large to support several significant providers of these services, it is subject to increasing competitive risks from these entities.\nIn addition, Response is aware of at least two competitors specializing in the management of oncology practices, and several healthcare companies with established operating histories and significantly greater resources than Response are also providing at least some management services to oncologists. There are certain other companies, including hospitals, large group practices, and outpatient care centers, that are expanding their presence in the oncology market and may have access to greater resources than Response. Furthermore, organizations specializing in home and ambulatory infusion care, radiation therapy, and group practice management compete in the oncology market.\nResponse's revenue depends on the continued success of its affiliated physician groups. These physician groups face competition from several sources, including sole practitioners, single and multi-specialty groups, hospitals and managed care organizations.\nResponse - Government Regulation\nResponse's services are subject to federal and state licensing requirements in each of the states in which it operates. In order to maintain such licensure, Response must comply with applicable regulations and is subject to periodic compliance inspections by healthcare regulators. Response is, to the best of management's knowledge, in compliance with applicable state and federal licensing requirements.\nThe law regulating healthcare providers varies among states. Accordingly, Response approaches its network expansion on a state by state basis in order to determine whether the institution and operation is feasible under the laws of the target state. Healthcare regulation is a rapidly evolving area of law. There can be no assurance that Response's ability to open or operate its treatment facilities will not be adversely affected by changes in applicable federal or state law (such as certificate of need laws) or by administrative interpretation of existing law.\nSome protocols which Response may desire to implement may be subject to regulatory approval by the Food and Drug Administration (FDA) due to the drugs or combination of drugs used in the protocols. In most instances, such approval will be sought by manufacturers of the drugs; however, Response may occasionally participate in such an approval process.\nThe majority of patients referred to the Centers are covered by a third party insurer. Response receives very little of its revenue from Medicare since patients eligible for Medicare generally are not medically eligible by virtue of their age for high-dose treatment protocols.\nResponse believes that its method of compensating its Medical Directors complies with the federal Medicare anti-kickback law and the Stark self- referral law and similar state regulations. Such regulations at the federal level prohibit any form of compensation to physicians intended to induce the referral of Medicare or Medicaid patients and the referral of such patients to an entity for designated health services in which the physician has a financial relationship. Certain states have enacted broader regulations precluding such referrals with respect to non-Medicare and Medicaid payers. Response believes that it has structured its compensation arrangements with its Medical Directors pursuant to federal \"safe harbor\" regulations, and in compliance with applicable state regulations. However, there can be no assurance that future government regulations will not impact Response's compensation arrangements with its Medical Directors. Response would attempt to restructure its Medical Director payments in a manner which complies with any future regulation.\nResponse - Business History and Past Operations\nResponse was incorporated in Tennessee in 1984. In fiscal 1989, after Response had suffered losses since incorporation of over $30 million, Response adopted a plan of restructuring and reorganization of its business operations away from patient-funded research activities to the development and operation of outpatient cancer centers specializing in technology advanced cancer treatment programs for oncologists.\nResponse - Liability Exposure\nLike all companies operating in the healthcare industry, Response faces an inherent risk of exposure to liability claims. While Response has taken what it believes to be appropriate precautions, there can be no assurance that it will avoid significant liability exposure. Response has obtained liability insurance, but there can be no assurance that it will be able to continue to obtain coverage at affordable rates or that such coverage will be adequate in the event of a successful liability claim. Since inception, Response has not incurred any professional or general liability claims or losses, and as of December 31, 1995, Response was not aware of any pending claims.\nResponse - Employees\nAs of February 15, 1996, Response employed approximately 340 persons, approximately 309 of whom were full-time employees. The employees are not covered by any collective bargaining agreements. Response believes that its labor relations are good.\nLABONE, INC.\nLabOne provides clinical testing services to the healthcare industry to aid in the diagnosis and treatment of patients. LabOne has established a network of LabOne Service Centers (LSCs) for the collection of specimens for testing. Additionally, LabOne has contracted with hospitals, clinics, parameds and occupational medical facilities nationwide to collect specimens for LabOne.\nLabOne is certified by the Substance Abuse and Mental Health Services Administration (SAMHSA) to perform substance abuse testing services for federally regulated employers and is currently marketing these services throughout the country to both regulated and nonregulated employers. LabOne's rapid turnaround and multiple testing options help clients reduce downtime for affected employees and meet mandated drug screening guidelines.\nLabOne's Clinical Patient Testing\nLabOne's clinical testing services are provided to the healthcare industry to aid in the diagnosis and treatment of patients. LabOne operates only one highly automated and centralized laboratory, which has significant economic advantages over other conventional laboratory competitors. LabOne markets its clinical testing services to the payers of healthcare-- insurance companies and self-insured groups through Lab Card(trademark), a Laboratory Benefits Management (LBM) program.\nThe Lab Card Program provides laboratory testing at a reduced rate as compared to traditional laboratories. It uses a unique benefit design that shares the cost savings with the patient, creating an incentive for the patient to help direct laboratory work to LabOne. Under the Program, the patient incurs no out-of-pocket expense when the Lab Card is used, and the insurance company or self-insured group receives substantial savings on its laboratory charges.\nLabOne began offering laboratory testing services to the healthcare industry in May 1994. Clinical laboratory tests generally are requested by physicians and other health care providers to diagnose and monitor diseases and other medical conditions through the detection of substances in blood and other specimens. Laboratory testing is generally categorized as either clinical testing, which is performed on bodily fluids including blood and urine, or anatomical pathology testing, which is performed on tissue. Clinical and anatomical pathology tests are frequently performed as part of regular physical examinations and hospital admissions in connection with the diagnosis and treatment of illnesses. The most frequently requested tests include blood chemistry analyses, blood cholesterol level tests, urinalyses, blood cell counts, PAP smears, and AIDS-related tests.\nClinical specimens are collected at LabOne's approved network of draw sites or at the physician's office. LabOne's couriers pick up the specimens and deliver them to local airports for express transport to the Kansas laboratory. Specimens are coded for identification and processed. LabOne's testing menu includes the majority of tests requested by its clients. Tests not performed in-house are sent to reference laboratories for testing and results are entered into LabOne's computer system along with all other completed results.\nIn 1994, LabOne signed an agreement with PCS Health Systems (PCS), a subsidiary of Eli Lilly, to market an integrated and fully managed system of laboratory testing and administration services for payers and health plans throughout the United States. The result of this agreement is a program called Lab Card, which offers both payers and the covered population substantial cost savings on high-quality laboratory testing services. Lab Card utilizes PCS' point of service, real-time eligibility verification system. The laboratory testing is performed at LabOne's centralized testing facility in Kansas.\nLabOne's Substance Abuse Testing Services\nLabOne has provided quality substance abuse testing results to the insurance industry for over 20 years. Certification by SAMHSA enables LabOne to offer these services to the entire market including federally regulated industries. LabOne began offering substance abuse testing services to the broader market in April 1994.\nSpecimens for substance abuse testing are typically collected by independent agencies who use LabOne's forms and collection supplies. Specimens are sealed with bar-coded, tamper-evident seals and shipped overnight to LabOne. Automated systems monitor the specimens throughout the screening and confirmation process. Negative results are available immediately after testing is completed. Initial positive specimens are verified by the gas chromatography\/mass spectrometry method and results are generally available within 24 hours. Results are then transmitted electronically to the client's secured computer, printer or fax machine.\nPYRAMID DIAGNOSTIC SERVICES, INC.\nThe Registrant acquired a 52% ownership position in Pyramid Diagnostic Services, Inc. (Pyramid) in 1992. The original $4 million purchase price included newly-issued shares, thereby providing expansion financing to Pyramid. Pyramid ultimately expanded to nine pharmacies which distributed radiopharmaceuticals and related services to nuclear medicine departments, clinics and hospitals. During 1993, Registrant acquired an additional 18% ownership position for $332,000. In 1994, Registrant's ownership increased by 5% (ownership totaled 74%) with a $l million investment.\nPyramid entered bankruptcy proceedings in early October 1995 as a result of an adverse $6 million judgment entered in a lawsuit against Pyramid. Pyramid's bankruptcy proceedings are expected to be finalized in 1996. The impact on Registrant's results of operations was the September 1995 write- off of Registrant's investment in Pyramid by recording a pre-tax expense of approximately $3.3 million and a corresponding tax benefit of $2.1 million resulting in an after-tax $1.2 million charge to earnings. See Item 7 and Note 1 of Notes to Consolidated Financial Statements for additional information.\nOTHER BUSINESSES\nBMA RESOURCES, INC.\nBMA Resources, Inc. (Resources) holds the Registrant's energy investments. No new energy investments are being made, and it has been the Registrant's intent to maximize cash flow from Resources to be deployed in healthcare and insurance services. The investments include oil and gas working interests, oil and gas partnerships and a stock investment in an unconsolidated affiliate. The oil and gas primarily consists of partnership interests in Texas gulf coast oil and gas wells and leasehold interests. Resources has an approximate 35% equity interest in Syntroleum, Inc. which owns a patented process to convert natural gas into heavier hydrocarbons, including fuels and industrial waxes. With a completed proof of concept, Syntroleum is pursuing commercialization of the process.\nTENENBAUM & ASSOCIATES, INC.\nTenenbaum & Associates, Inc. (TAI) was a full service real estate, personal property and sales and use tax consulting firm providing tax consulting services on a contingency basis. TAI's core business was commercial real estate.\nOn May 31, 1995, TAI sold certain assets to Ernst & Young U.S. LP. TAI retained its accounts receivable as of May 31, 1995. The agreement provides for Ernst & Young to continue the work-in-process on current accounts (where formal or informal tax valuation protests have been filed but not yet resolved). Ernst & Young will earn a fee for collecting the current accounts and will participate in net cash collected on certain accounts after third party costs and Ernst & Young's fees. During June 1995, TAI distributed its remaining assets to shareholders and filed for dissolution.\nDISCONTINUED OPERATIONS\nREAL ESTATE\nThe Registrant holds real estate through a wholly-owned subsidiary, Scout Development Corporation. Real estate holdings as of December 31, 1995 consisted of approximately 1,200 acres of partially developed and undeveloped land in seven locations, three residential development projects, a multi-story parking garage and a community shopping center. Real estate assets are located in the following states: Florida, Kansas, Nevada, New Mexico, Oklahoma, Texas, and Wyoming, all of which are listed for sale.\nDuring 1992, the Registrant's board of directors approved a plan for the discontinuance of real estate operations. Management observed that the overall real estate environment indicated continuing signs of weakness. After reviewing sales activity and appraisals in 1992, the Registrant believed it was an appropriate time to discontinue real estate operations and sell the remaining real estate assets as soon as practicable. See Item 7 and Note 13 of the Notes to Consolidated Financial Statements for additional information on discontinued real estate operations.\nThe location and use of each majority owned property is listed in Schedule III. In addition, the Registrant has a 49.9% investment in a joint venture that owns a shopping center in Gillette, Wyoming.\nOnly two properties, one of which is 100% owned and the 49.9% joint venture referenced above, are categorized as commercial properties. Registrant's net asset value of these two projects at December 31, 1995 was $1.9 million.\nThe 100% owned commercial property consists of an 850-space parking garage located in downtown Reno, Nevada. The building contains a total of 144,500 square feet of leasable parking space. Parking revenue totaled approximately $744,000 or $875 per space or $5.15 per square foot in 1995. In addition, 8,258 square feet located on the ground floor of the garage is leased to a retail tenant under a 15-year lease. Revenue from the retail lease during 1995 was $133,800 or $16.20 per square foot. In addition to basic rent, the retail tenant is responsible for its prorata share of real estate taxes and insurance. During 1995, $5,200 was collected from the retail tenant for taxes and insurance.\nThe joint venture commercial property consists of a retail shopping center containing approximately 163,000 square feet of net leaseable area. At the end of 1995, the center was 75% occupied. Rental revenue totaled $686,000 for 1995. The average annual gross rental per occupied square foot was $6.10. In addition to rental revenue, tenants are responsible for their share of common area maintenance (CAM). During 1995, CAM collections from tenants totaled $77,000.\nInformation regarding real estate debt is summarized in Note 13 of the Notes to Consolidated Financial Statements. The detailed information is as follows:\nBalance at Property Description Rate Maturity 12-31-95 - -------------------------------------------------------------------------- (In thousands) Gillette, WY shopping center IRB 7.750% 2016 $ 6,300 Olathe, KS vacant land Mortgage 8.625% 1997 1,289 ------ Total $ 7,589 ======\nIn management's opinion, the real estate properties are adequately covered by insurance with coverages for real and personal property, commercial general liability, commercial crime, garagekeepers legal liability, earthquake, flood, windstorm and hail.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nProperties of Registrant\nRegistrant has a long-term lease for approximately 13,674 square feet of office space at 2600 Grand Boulevard in the Crown Center complex in Kansas City, Missouri. This lease is for a ten year term which began April 1, 1992. Registrant's real estate subsidiary holds diversified types of properties for sale or investment purposes in various geographical locations. In certain cases, projects were developed on a joint venture basis with one or more joint venture partners. Title to property in such cases may be held jointly with such partners or in the name of the venture. Rights and obligations with respect to such properties are governed by the terms of the joint venture agreement. Registrant's real estate is described in greater detail in Items 1, 7 and Schedule III. The Registrant and subsidiaries lease office space, equipment, land and buildings under various noncancelable leases that expire over the next several years. See Note 8 of the Notes to Consolidated Financial Statements for additional information.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nSeafield received a notice during 1992 of proposed adjustments from the Internal Revenue Service (IRS) with respect to 1986-87 federal income taxes. Later, the IRS determined to include 1988-90 as a part of its review. In May 1995, the IRS issued a revised notice of proposed adjustments to 1986-87 taxes in response to Seafield's protest filed in 1992. This revised notice reduced the previously proposed tax of approximately $17 million to $13.5 million. In June 1995, the IRS issued proposed adjustments to 1988-1989 federal income taxes. Additional proposed taxes for these years are $182,000. Also, during 1995 the IRS issued tentative proposed federal income tax adjustments for the 1990 year totaling approximately $16 million. In early 1996, the IRS reduced the $16 million tentatively proposed tax adjustments for the 1990 year to approximately $7 million. The IRS has used these proposed increases in federal income taxes to deny Seafield a 1990 claim for refund of $7.6 million. Resolution of these matters is not expected during 1996. Seafield believes that it has meritorious defenses to many of the substantive issues raised by the IRS, and adequate accruals for income tax liabilities.\nIn 1986, a lawsuit was initiated in the Circuit Court of Jackson County, Missouri by Seafield's former insurance subsidiary (i.e., Business Men's Assurance Company of America) against Skidmore, Owings & Merrill (\"SOM\") which is an architectural and engineering firm, and a construction firm to recover costs incurred to remove and replace the facade on the former home office building. Because the removal and replacement costs had been incurred prior to the sale of the insurance subsidiary, Seafield negotiated with the buyer for an assignment of the cause of action from the insurance subsidiary. Thus, any recovery will be for the benefit of Seafield and all costs incurred in connection with the litigation will be paid by Seafield. Any ultimate recovery will be recognized as income when received and would be subject to income taxes. In September 1993, the Missouri Court of Appeals reversed a $5.7 million judgment granted in 1992 in favor of Seafield; the Court of Appeals remanded the case to the trial court for a jury trial limited to the question of whether or not the applicable statute of limitations barred the claim. The Appeals Court also set aside $1.7 million of the judgment originally granted in 1992. A new trial is expected in the second quarter of 1996. The only remaining defendant is SOM; settlement arrangements with other defendants have resulted in payments to plaintiff which have offset legal fees and costs to date of approximately $400,000. None of the prior or future legal fees or costs are recoverable from the remaining defendant, even if the judgment in plaintiff's favor is ultimately upheld. Future legal fees and costs can not reliably be estimated.\nIn 1988, a lawsuit was initiated in the United States District Court for the District of New Mexico against Seafield's former insurance subsidiary by Lyon Development Company and Jeanne Lyon, d\/b\/a Lyon and Associates Realty, its former partners in the Quail Run real estate project in Santa Fe, New Mexico. The plaintiffs alleged that the project partnership agreement was improperly terminated, thus denying them an ongoing interest in the project, and the loss of their exclusive real estate brokerage arrangement. The plaintiffs were seeking approximately $11 million in actual damages and unspecified punitive damages based upon alleged breaches of contract and fiduciary duty and economic compulsion. After a trial in July 1994, the jury returned a verdict absolving Seafield of any liability. Subsequent to the trial, the judge awarded Seafield approximately $250,000 in connection with marketing expenses which the plaintiffs were to have repaid, and approximately $64,000 in legal costs, with interest until paid. Total legal fees and costs incurred by Seafield and its former insurance subsidiary have aggregated approximately $3.6 million. In February 1996, the United States Court of Appeals for the Tenth Circuit affirmed the jury's verdict in Seafield's favor, reversed the trial judge's award for marketing expenses, and affirmed the trial judge's award of legal costs. A bond posted by one of the plaintiffs\/counter defendants secures payment of the legal costs awarded by the trial judge and affirmed by the Court of Appeals. Because the Quail Run project was retained by Seafield in connection with the sale of its former insurance subsidiary, Seafield defended the lawsuit under an indemnification arrangement with the purchaser of the former insurance subsidiary; all costs incurred and any judgments rendered in favor of the plaintiff have been and will be for the account of Seafield.\nIn the opinion of management, after consultation with legal counsel and based upon current available information, none of these lawsuits is expected to have a material adverse impact on the consolidated financial position or results of operations of Seafield.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS.\nNone.\nEXECUTIVE OFFICERS OF REGISTRANT.\nFollowing is a list of all executive officers of Registrant as of March 1, 1996, together with certain related information. There are no arrangements or understandings among any such persons and any other persons pursuant to which any was selected as an officer. All such persons serve at the discretion of the board of directors. Served as Executive Officer with Name Age Position with Registrant Registrant Since - --------------------------------------------------------------------------- S.K. Fitzwater 49 Vice President, Chief Accounting 1990 Officer and Secretary (see note 1 below)\nW.T. Grant II 45 Chairman and Chief Executive Officer 1980 (see note 2 below)\nP.A. Jacobs 54 President and Chief Operating Officer 1980 (see note 3 below)\nJ.R. Seward 43 Executive Vice President and 1989 Chief Financial Officer (see note 4 below)\nJ.T. Clark 39 President and Chief Executive Officer 1996 of Response Oncology, Inc. (see note 5 below)\nW.H. West, M.D. 48 Chairman of Response Oncology, Inc. 1993 (see note 6 below)\nExcept as noted below, each executive officer of Registrant has held the executive position noted with Registrant or similar positions with its former insurance subsidiary as his principal occupation for the last five years.\n1. Steven K. Fitzwater has been Vice President and Chief Accounting Officer since August 1990. On April 1, 1993, he assumed the additional duties of Secretary of the Registrant. Formerly, he was Director of Financial Accounting.\n2. William T. Grant II became Chairman of the Board and Chief Executive Officer in May 1993. He had been President and Chief Executive Officer since 1986. In October 1995, he also became the Chairman, President and Chief Executive Officer of LabOne, Inc. He is the son of W.D. Grant and the brother-in-law of John C. Gamble, both of whom are Directors of Registrant.\n3. P. Anthony Jacobs became President and Chief Operating Officer in May 1993. He had been Executive Vice President and Chief Operating Officer since 1990.\n4. James R. Seward became Executive Vice President and Chief Financial Officer in May 1993. He had been Senior Vice President and Chief Financial Officer since August 1990.\n5. Response Oncology, Inc. (Response) is 56% owned by the Registrant. Effective February 1996, Registrant's board of directors designated Joseph T. Clark as an Executive Officer of Registrant because Response was determined to constitute a principal business unit of Registrant and Mr. Clark became Chief Executive Officer of Response in January 1996. Mr. Clark is not a corporate officer of Registrant. Mr. Clark is President and Chief Executive Officer of Response. Prior to 1996, Mr. Clark served as Response's President since February 1993. Mr. Clark was formerly the Executive Vice President and Chief Operating Officer of Response from May 1989 to February 1993 and Secretary of Response from September 1988 to February 1993.\n6. Response Oncology, Inc. (Response) is 56% owned by the Registrant. Effective February 1993, the Registrant's board of directors designated Dr. William H. West as an Executive Officer of the Registrant because Response was determined to constitute a principal business unit of the Registrant and Dr. West was then Response's Chief Executive Officer. Dr. West continues as Chairman of the Board of Response, but after January 1996 is no longer its Chief Executive Officer. Dr. West is not a corporate officer of the Registrant. Prior to January 1993, Dr. West was President and Chief Executive Officer of Response.\nPART II.\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nRegistrant's common stock is traded in the national over-the-counter market and is listed in the NASDAQ National Market System maintained by the National Association of Securities Dealers. As of February 28, 1996, the outstanding shares were held by 1,916 stockholders of record. High and low sales prices for each quarter of 1995 and 1994 are included in the table of quarterly financial data in Note 14 of the Notes to Consolidated Financial Statements. Also set forth in the table are quarterly dividends paid per share. Registrant's payment of future dividends will be at the discretion of its board of directors and can be expected to be dependent upon a number of factors, including future earnings, financial condition, cash needs and general business conditions. The dividend-paying capabilities of subsidiaries may be restricted as to their transfer to the parent company.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nDecember 31, 1995 1994 1993 1992 1991 - -------------------------------------------------------------------------- (In thousands except share and per share amounts) REVENUES $ 119,544 124,278 129,867 111,332 85,240 ===============================================\nOPERATING EARNINGS Earnings (loss) from continuing operations $ (748) (1,872) 5,618 4,168 7,909 Loss from discontinued real estate operations (6,600) (2,904) -- (7,214) (2,464) Gain on disposal of discontinued insurance operations -- -- -- 4,265 -- Cumulative effect to January 1, 1992 of change in method of accounting for income taxes -- -- -- 3,352 -- ----------------------------------------------- Net earnings (loss) $ (7,348) (4,776) 5,618 4,571 5,445 ===============================================\nPER SHARE OF COMMON STOCK Earnings (loss) from continuing operations $ (.12) (.29) .82 .55 .94 Loss from discontinued real estate operations (1.02) (.46) -- (.95) (.29) Gain on disposal of discontinued insurance operations -- -- -- .56 -- Cumulative effect of accounting change -- -- -- .44 -- ----------------------------------------------- Net earnings (loss) $ (1.14) (.75) .82 .60 .65 =============================================== Cash dividends $ 1.20 1.20 1.20 1.20 1.20 Book value $ 28.96 31.50 33.52 34.00 34.61\nAverage shares outstanding 6,454,068 6,847,559 8,429,565 during the year 6,374,952 7,589,043\nShares outstanding 6,461,061 6,733,245 7,727,850 end of year 6,378,261 6,706,165\nTotal assets $ 222,972 245,387 273,570 280,514 317,089 Long-term debt $ -- 8 18 1,013 2,902\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nRESULTS OF OPERATIONS\nIntroductory remarks about results of operations\nSeafield Capital Corporation (Seafield or Registrant) began a transformation process from an insurance company to a holding company with a new focus in late 1990. Seafield's principal assets consisted of a majority ownership of LabOne, Inc., interests in several venture capital investments, a significant amount of cash, and real estate investments. The strategy of Seafield was deployment of resources into developing businesses that provide services to the healthcare and insurance industries. The sources of cash for these investments were the proceeds from the sale of the insurance company, gains on securities transactions, the discontinuance of the real estate operations and the sale of other assets that did not support the strategic focus.\n1995 Compared to 1994\nInsurance Services Segment:\nThe following businesses are considered to be in the insurance services segment: risk-appraisal laboratory testing for the life and health insurance industries, underwriting and policy administration services and insurance premium finance services.\nLabOne, Inc. (LabOne), an 82% owned subsidiary of Seafield, is a publicly- traded company (NASDAQ-LABS). LabOne changed its name from Home Office Reference Laboratory, Inc. in February 1994. LabOne provides high-quality laboratory and substance abuse testing services to insurance companies, physicians and employers nationwide.\nLabOne provides risk-appraisal laboratory services to the insurance industry. The tests performed by LabOne are specifically designed to assist an insurance company in objectively evaluating the mortality and morbidity risks posed by policy applicants. The majority of the testing is performed on specimens of individual life insurance policy applicants. Testing services are also provided on specimens of individuals applying for individual and group medical and disability policies.\nLabOne's total revenues decreased approximately 6% in 1995 to $57 million from $60.7 million in 1994 due to decreases in insurance laboratory and kit revenue, partially offset by increases in healthcare (clinical and substance abuse testing) laboratory revenues. Insurance laboratory revenues declined due to decreases in the volume and price of tests performed. The total number of insurance applicants tested by LabOne during 1995 decreased 10% as compared to 1994. This decline was due to market competition, a reduction in the total number of life insurance applications written in the industry, and regulations restricting the use of laboratory testing for underwriting of medical insurance. Average revenue per applicant declined 5% primarily due to a decrease in prices as a result of continued competitive pressures. During the fourth quarter 1994, LabOne initiated a price stabilization plan. The purpose of the plan was to increase prices by promoting service. The initial result of this action was a slight increase in the average revenue per applicant. However, prices subsequently declined during 1995.\nLabOne's total cost of sales increased $900,000 (3%) in 1995 as compared to the prior year. This increase is due to increases in payroll and outside lab services related to clinical and substance abuse testing and LabOne Service Center (LSC) expenses. LSC expenses increased due to the LSC expansion as well as a write-off for closing non-performing locations. These were partially offset by decreases in Lab One Canada expenses due to closing the laboratory in 1994. Lab One Canada continues to market testing services with laboratory testing performed in the United States.\nIn September 1995, LabOne reduced staff by 7% resulting in additional expenses of $500,000. The work force reduction was considered necessary to improve the cost structure of insurance testing operations and meet clients' requirements for lower cost laboratory services. It is expected the annual savings from the reduction in staff and LSC locations will result in labor savings and reduced LSC operating expenses of $2.4 million.\nLabOne's selling, general and administrative expenses decreased $100,000 in 1995 as compared to the prior year primarily due to expenses related to the one-time restructuring charge of $1.6 million incurred in 1994. (See 1994 Compared to 1993.) Depreciation and maintenance expenses also declined in 1995. These declines were partially offset by increases in commission, bad debt and third party billing expenses. The above factors reduced LabOne's 1995 insurance segment operating income by $1.3 million to $12.4 million.\nAgency Premium Resource, Inc. (APR) is an insurance premium finance company serving independent insurance agents in 21 states. APR provides premium financing for the commercial customers of these independent insurance agents. On May 31, 1995 Seafield sold APR receiving approximately $800,000 in cash and $9.2 million in US Treasury Bills that matured in June 1995. In 1995, APR's revenues consolidated by Seafield decreased to $1.6 million from $3.7 million in 1994, reflecting the May 1995 sale of this subsidiary. Correspondingly, consolidated costs and expenses decreased to approximately $500,000 from $1.3 million in 1994. Prior to the sale, APR had increased its securitized receivables by $1.5 million in 1995 compared with $4 million in 1994. See Notes 1 and 5 of Consolidated Financial Statements for additional information.\nInternational Underwriting Services, Inc. (IUS), offers turnkey policyholder and underwriting services. This subsidiary operated only within the life and health insurance industry and provided some or all of the following services to its customers: product design, underwriting of applicants, policy issuance, policy service, premium collection and payment of commissions. On July 17, 1995, Seafield sold IUS receiving approximately $2.1 million in cash. In 1995, IUS's revenues consolidated by Seafield decreased to $1.8 million from $3.3 million in 1994, reflecting the July 1995 sale of this subsidiary. Correspondingly, consolidated costs and expenses decreased to approximately $1.6 million from $3.2 million in 1994. See Note 1 to Consolidated Financial Statements for additional information.\nHealthcare Services Segment:\nThe following businesses are included in the healthcare services segment: an integrated cancer management company, clinical and substance abuse laboratory testing services, and radiopharmaceuticals and related nuclear medicine services.\nResponse Oncology, Inc. (Response), a 56%-owned subsidiary of Seafield, is a publicly-traded company (NASDAQ-ROIX). Response is an integrated cancer management company that offers patients a complete network of cancer care resources from the time of initial diagnosis. Response positioned itself as a beneficiary of healthcare reform by (i) emphasizing cost-effective cancer treatments, primarily through the use of outpatient facilities and incorporation of the most recent technological advancements, and (ii) being a national healthcare provider focused on uniform delivery of complex cancer technologies in the management of potentially curable cancers. Response's commitment to its clinical trials program provides a mechanism to monitor treatment outcomes, improve future treatment regimens, and provide a means of objectively selecting patients most likely to benefit from such treatments. Finally, Response's expanding national network of Centers facilitates relationships with the insurance industry to manage these intensive and complex therapies in a cost-effective manner.\nAt December 31, 1995, Response's network consisted of 27 wholly owned IMPACT Centers. While fully staffed and equipped stand-alone IMPACT Centers are appropriate for many medical centers, other communities have hospitals with existing capacity in their outpatient cancer treatment centers, providing an alternative to the stand-alone IMPACT Center. By joining the hospital's staff and facilities with Response's protocols, databasing and expertise, Response and such hospitals are able to jointly market and provide high-dose therapies. At December 31, 1995, there were 14 such hospital affiliate programs. For hospital-affiliated Centers, Response offers two types of business structures. The first structure entails a management relationship with the hospital whereby a management fee is paid to Response. The second structure entails a joint ownership with the hospital of a newly created entity, whereby profits from the entity accrue to Response and the hospital. Response anticipates that additional hospital-affiliate centers will become operational in 1996.\nResponse recorded net earnings of $2.3 million compared to a loss of $2.3 million for the year ended December 31, 1994. The significant improvement in operations in 1995 compared to 1994 is attributable to increased revenues from the increased referrals of high-dose chemotherapy patients, including the establishment of additional IMPACT Centers, principally in joint venture with hospitals, and the further development of physician investigator studies for the pharmaceutical industry. Revenues increased $6 million, or 16%, from 1994 to 1995. In addition to an approximate $2 million increase in net revenues from services to patients to $33.6 million in 1995, sales of pharmaceuticals to physicians increased by $3.3 million to $9.8 million, and revenues from physician investigator studies in 1995, the first year of significant revenues generated from this source, amounted to $665,000.\nResponse's operating expenses increased $1.1 million or 4% from 1994 to 1995. Operating expenses consist primarily of payroll costs, pharmaceutical and laboratory expenses, medical director fees, rent expense and other operational costs. These expenses are expected to display a high degree of variability in proportion to Center revenues. Operating expenses as a percentage of net revenue were 74% and 83% for the years ended 1995 and 1994, respectively. This decrease is primarily attributable to operating efficiencies at higher levels of center activity and certain fixed operating expenses being spread over a larger revenue base. Response's lab and pharmacy expense, which represents the largest component of operating expenses, increased $1.7 million or 10% from 1994 to 1995. The increase is primarily due to an increase in patient referrals and pharmaceutical supply expense related to sales to physicians. A reduction in medical director fees and other operating expenses of $528,000 was realized during 1995.\nResponse's general and administrative costs increased $1.2 million or 29% from 1994 to 1995. Salaries and benefits, which represent the largest component of general and administrative expenses, were $3.3 million in 1995 and $2.2 million in 1994. The increase is primarily due to management incentive compensation relative to significant improvement in operations and general increases in salaries and benefits. General and administrative costs as a percentage of net revenue were 12% and 11% in 1995 and 1994, respectively.\nResponse's depreciation expense decreased $140,000 from 1994 to 1995. The decrease is primarily attributable to many prior capital expenditures becoming fully depreciated. Amortization expense decreased $249,000 from 1994 to 1995 due to the startup costs of many Centers being fully amortized after a two year operational period. The provision for doubtful accounts decreased $422,000 from 1994 to 1995. The provision as a percentage of net revenue was 5% and 7% for 1995 and 1994, respectively. The decrease is attributable to a higher proportion of contracted patient accounts, improved collections performance and an increase in revenues from physician sales, hospital management fees, and contract research for which collection is more certain. Collection experience in 1995 and 1994 may not be indicative of future periods.\nLabOne expanded into the clinical laboratory testing market in May 1994. LabOne's clinical testing services are provided to the healthcare industry to aid in the diagnosis and treatment of patients.\nLabOne's clinical and substance abuse laboratory testing revenues were $4.5 million during 1995, as compared to $500,000 in 1994. LabOne's total cost of sales for all services increased $900,000 (3%) in 1995 as compared to 1994. This increase is due to increases in payroll, outside lab services related to clinical and substance abuse testing and LabOne Service Center (LSC) expenses. LSC expenses increased due to the LSC expansion as well as a write-off for closing non-performing locations. Healthcare cost of sales was $8.6 million during 1995, as compared to $4 million in 1994. Healthcare overhead expenses were $5.8 million during 1995, as compared to $3.1 million in 1994. LabOne's 1995 healthcare segment operating loss increased by $3.3 million to $9.9 million.\nAnother healthcare subsidiary, Pyramid Diagnostic Services, Inc. (Pyramid), incurred a loss of $768,000 for the first nine months of 1995 compared to a loss of $572,000 for the twelve months of 1994. Pyramid entered bankruptcy proceedings in early October 1995 as a result of an adverse $6 million judgment entered in a lawsuit against Pyramid. Pyramid's bankruptcy proceedings are expected to be finalized in 1996. The impact on Seafield's results of operations was the September 1995 write-off of Seafield's investment in Pyramid by recording a pre-tax expense of approximately $3.3 million and a corresponding tax benefit of $2.1 million resulting in an after-tax $1.2 million charge to earnings. Included with the Pyramid write-off was $2.3 million of goodwill. Seafield consolidated Pyramid's nine months 1995 revenues of $7.6 million compared to $6.4 million of revenues in 1994. Expenses consolidated in 1995 were $7.7 million compared to $6.2 million in 1994. See Note 1 of Notes to Consolidated Financial Statements for additional information.\nOther Segment:\nSeafield's oil and gas subsidiary contributed revenues of $2 million in 1995 as compared to $3.1 million in 1994. Variances in the oil and gas prices nationally impact operating results. Additionally, various oil and gas partnerships production decreased in 1995.\nThe other segment's revenues and expenses in 1995 and 1994 included the operating results of a real estate, personal property, sales and use taxes consulting subsidiary--Tenenbaum and Associates, Inc. (TAI). On May 31, 1995, TAI sold certain assets to Ernst & Young U.S. LP. TAI retained its accounts receivable as of May 31, 1995. The agreement provides for Ernst & Young to continue the work-in-process on current accounts (where formal or informal protests have been filed but not yet resolved). Ernst & Young will earn a fee for collecting the current accounts and will participate in net cash collected on certain accounts after third party costs and Ernst & Young's fees. During June 1995, TAI distributed its remaining assets to shareholders and filed for dissolution.\nConsolidated revenues in 1995 for TAI were $5.3 million compared to $8.9 million in 1994 while TAI expenses consolidated in 1995 were $4.1 million compared to $9.2 million in 1994. The decreases primarily reflect five months of operation in 1995 compared with twelve months in 1994. See Note 1 of Notes to Consolidated Financial Statements for additional information.\nInvestment Income - Net:\nOther investments contributing earnings include venture capital and liquidity investments. The return on short-term investments is included in the investment income line in the consolidated statements of operations. Investment income totaled $4.4 million in 1995 and $2.9 million in 1994. Investment income was lower in 1994 primarily resulting from approximately $2.2 million of unrealized holding losses recorded on trading securities that were impacted by interest rate changes. See Notes 1 and 9 of Notes to Consolidated Financial Statements for additional investment information.\nTaxes:\nThe consolidated effective tax rates were primarily impacted by tax benefits on subsidiary dispositions and non-deductibility of goodwill amortization. See Note 10 of Notes to Consolidated Financial Statements for additional tax information.\nOther Income\/(Loss):\nThe major components of other income\/(loss) in 1995 included $1.1 million of losses on subsidiary dispositions and a $3.4 million provision for Pyramid's bankruptcy compared to $67,000 of other income in 1994.\nConsolidated Results:\nThe combined effect of the above factors resulted in a 1995 net loss from continuing operations of $748,000 compared with a $1.9 million net loss from continuing operations in 1994.\n1994 Compared to 1993\nInsurance Services Segment:\nLabOne's total revenues decreased approximately 12% in 1994 to $60.7 million from $69.4 million in 1993, primarily due to a decrease in laboratory revenue. Laboratory testing revenue decreased as the result of an 8% decrease in the number of applicants tested and a 7% decrease in the average revenue per applicant. Average revenue per applicant decreased primarily due to a decrease in prices as a result of continued competitive pressures. The total volume of applicants tested decreased primarily due to a decline in the number of life insurance applications written in the industry. Insurance kit revenue decreased $900,000 due to lower sales volumes.\nLabOne's total cost of sales decreased 3%, or $900,000 in 1994 from the prior year. This is primarily due to decreases in insurance kit expenses, depreciation and amortization expense, and net postage expense. Insurance kit expenses decreased due to the lower sales volumes. These decreases were partially offset by increases in payroll and healthcare expansion expenses.\nLabOne's total selling, general and administrative expenses increased $2.1 million (9%) in 1994 due primarily to expenses related to the third quarter restructuring charge of $1.6 million, which includes charges for consolidating Canadian laboratory operations into the Kansas facility and for severance payments resulting from elimination of several insurance testing administrative positions. These changes resulted in future annual cost savings of $1.7 million due to elimination of Canadian laboratory payroll and a reduction in depreciation and U.S. administrative payroll expenses. The above factors reduced LabOne's 1994 insurance segment operating income by $3.2 million to $13.7 million.\nAPR's insurance premium finance services operations experienced continued growth in both profitability and volume of premiums financed in 1994. New premium contracts financed totaled $74.8 million in 1994, a 22% increase from the $61.5 million financed in 1993. The number of contracts written in 1994 was 13,409 compared to 10,277 in 1993. In 1994, APR's revenues consolidated by Seafield increased to $3.7 million from $3.4 million in 1993. Consolidated APR costs and expenses in 1994 approximated 1993's $1.3 million. In July 1993, APR entered into an extendible two-year agreement whereby it can sell undivided interests in a designated pool of accounts receivable on an ongoing basis. As collections reduce accounts receivable in the pool, additional sales may be made up to the maximum. During 1994, the maximum allowable amount of receivables to be sold was increased to $30 million from $22 million. At December 31, 1994, receivables sold totaled $23 million compared to $19 million at December 31, 1993. See Notes 1 and 5 of Notes to Consolidated Financial Statements for additional information regarding securitization of receivables.\nIUS's underwriting and policy administration operating revenues increased by 63% in 1994. IUS's 1994 revenues consolidated by Seafield increased to $3.2 million from $2 million in 1993. Consolidated IUS costs and expenses increased to approximately $3.2 million from $2.6 million in 1993. While new business development was positive, this subsidiary's 1994 loss approximated its 1993 loss. Additional staffing costs were incurred for business that did not develop as anticipated. See Note 1 of Notes to Consolidated Financial Statements for additional information.\nHealthcare Services Segment:\nResponse reported a net loss of $2.3 million in 1994 compared to net earnings of $700,000 in 1993. Several specific factors contributed to the loss in 1994. Response treated fewer candidates with metastatic breast cancer, many of whose clinical profiles indicated that they were not likely to sufficiently benefit from high-dose treatment. Metastatic breast cancer patients have historically comprised a significant portion of Response's patient base. Response believes that the use of its data to redirect poor risk patients from high-dose treatments is unprecedented in the field and will lead to more favorable relationships with third party payors.\nOne of Response's most active centers experienced a temporary downturn in utilization during the first half of the year. Such undulations in activity among cancer practices are not uncommon, and the affected Center's operations returned to normal levels during the latter part of the year.\nResponse also experienced losses from special situations at several Centers which are not expected to recur. The IMPACT Center in Dayton, Ohio ceased operations due to an unfavorable Certificate of Need ruling by the state. The Dayton Center had a net loss from operations of approximately $280,000 during 1994. The IMPACT Center of Atlanta, Georgia was converted to a hospital managed Center during 1994. The operating loss from this Center was approximately $126,000 in 1994. Response also realized a loss of $168,000 during the development stage of a Center in Seattle, Washington which did not open. The loss primarily related to payroll costs for a nurse coordinator and an operating lease for space. Newer Centers yielded total losses of $91,000 in 1994.\nResponse's revenues increased $555,000 or 1% from 1993 to 1994. Patient referrals in 1994 failed to increase in line with Response's Center capacity due to Response's decision to discontinue treatment for certain metastatic breast cancer patients, resulting in a marginal increase in revenue.\nResponse's operating expenses increased $2 million or 7% from 1993 to 1994. Operating expenses as a percentage of revenues were 83% in 1994 and 79% in 1993. The increase in 1994 is primarily attributable to increases in pharmaceutical sales to physicians. Response provides a wholesaler service to physicians; therefore, revenue from these sales has a lower margin than IMPACT Center revenue. Physician sales were $6.5 million in 1994 and $4.3 million in 1993. Lab and pharmacy expense, which represents the largest component of operating expenses, increased $1.8 million or 12% from 1993 to 1994. The increase is primarily due to pharmaceutical supply expense related to sales to physicians. In addition, increases in salaries and benefits from the hiring of Center coordinators at hospital affiliate programs and other operational personnel also contributed to the increase in operating expenses in 1994.\nResponse's general and administrative costs increased $1.4 million or 48% from 1993 to 1994. Salaries and benefits, which represent the largest component of general and administrative expenses, were $2.2 million in 1994 and $1.6 million in 1993. General and administrative costs as a percentage of revenues were 11% in 1994 and 8% in 1993. The increase in 1994 is due to greater investments in the corporate infrastructure, primarily medical and scientific management, during a period of minimal revenue growth.\nResponse's depreciation expense increased $371,000 from 1993 to 1994. The increase is primarily attributable to capital expenditures related to the establishment of new Centers. Amortization expense decreased $163,000 from 1993 to 1994 due to the startup costs of many Centers being fully amortized after a two year operational period. The provision for doubtful accounts increased $58,000 from 1993 to 1994. The provision as a percentage of net revenue was 7% for both periods. Significant bad debt recoveries were also experienced during 1993. Response's collection experience in 1994 and 1993 may not be indicative of future periods.\nLabOne announced in 1993 its intentions to expand into the clinical laboratory testing market. LabOne's clinical testing services are provided to the healthcare industry to aid in the diagnosis and treatment of patients.\nLabOne's healthcare laboratory testing generated revenue of $500,000 during 1994. Cost of sales expenses related to the healthcare expansion were $4 million in 1994. Selling, general and administrative expenses related to the healthcare expansion were $3.1 million in 1994. LabOne's healthcare segment incurred an operating loss in 1994 of $6.7 million--the startup year of clinical and substance abuse testing operations.\nPyramid's nine pharmacies distributed radiopharmaceuticals and related services to nuclear medicine departments, clinics and hospitals. Pyramid's revenues and expenses both increased approximately 100% in 1994 reflecting a doubling in the number of pharmacies. Revenues were $6.3 million in 1994 and $3.2 million in 1993 while expenses were $6.2 million in 1994 and $3.1 million in 1993. See Note 1 of Notes to Consolidated Financial Statements for additional information.\nOther Segment:\nSeafield's oil and gas subsidiary contributed revenues of $3.1 million in 1994 as compared to $4.7 million in 1993. After debt retirements in 1993, Seafield's cash flow from oil and gas investments was $800,000 in 1993 and $1.7 million in 1994. On January 1, 1993, Seafield increased its ownership position from 50% to 79% in a real estate, personal property, sales and use taxes consulting firm. Other revenues in 1994 and 1993 included $8.9 million and $9.5 million, respectively, by the tax consulting firm. Prior to 1993, this subsidiary was accounted for by the equity method. See Note 1 of Notes to Consolidated Financial Statements for additional information.\nInvestment Income - Net:\nOther investments contributing earnings include venture capital and liquidity investments. The return on short-term investments is included in the investment income line in the consolidated statements of operations. Investment income totaled $2.9 million in 1994, a decrease from $10.2 million in 1993. Investment income decreased as a result of $4.4 million in realized gains in 1993 when Seafield liquidated its position in a trading portfolio and approximately $2.2 million of unrealized holding losses recorded in 1994 on trading securities that were impacted by interest rate changes. See Notes 1 and 9 of Notes to Consolidated Financial Statements for additional investment information.\nTaxes:\nThe consolidated effective tax rates in 1994 were primarily impacted by tax benefits not available for subsidiary losses and goodwill amortization. See Note 10 of Notes to Consolidated Financial Statements for additional tax information.\nOther Income\/(Loss):\nThe other income in 1994 was $67,000 which compared with a $2.4 million loss in 1993. The 1993 loss primarily consisted of a $1.5 million provision for expected litigation costs.\nConsolidated Results:\nThe combined effect of the above factors resulted in a 1994 net loss from continuing operations of $1.9 million compared with earnings of $5.6 million from continuing operations in 1993.\nReal Estate - discontinued operations\nIn June 1992, Seafield's board of directors approved a plan for the discontinuance of real estate operations. After reviewing sales activity and appraisals in 1992, Seafield believed it was an appropriate time to discontinue real estate operations and sell the remaining real estate assets as soon as practicable.\nAs a result of the decision to discontinue real estate, a $6 million after- tax provision for estimated write-downs and costs through final disposition was included in the 1992 financial statements as a loss from discontinued real estate operations. An additional $2.9 million after-tax loss provision was recorded in 1994 for a sales contract signed in January 1995. During 1995's fourth quarter, an additional $6.6 million valuation allowance was recorded. The increased allowance reflects values based on recent sales transactions of undeveloped land parcels in Texas and sales activities at a residential project in New Mexico. Real estate's net assets have decreased from approximately $80 million at discontinuance to $42 million at December 31, 1995. Net cash proceeds of approximately $28 million have been generated from real estate since its discontinuance in 1992. See Item 1 and Note 13 of Notes to Consolidated Financial Statements for additional information concerning discontinued real estate operations.\nIn 1995, real estate sales included the sale of: 27 residential units or lots in Florida, New Mexico and Texas ($7.8 million), 304 acres of land in Kansas, Missouri and Texas ($2.7 million), and the sale of a partnership interest in a commercial building located in Colorado ($425,000). In 1994, real estate sales included the sale of: 47 residential units or lots in Florida, New Mexico, and Texas ($10.4 million), and land in California ($500,000). In 1993, real estate sales included the sale of: 84 residential units or lots in Florida, New Mexico, and Texas ($15.9 million), land in Tennessee ($360,000) and a partnership interest in an apartment complex in Georgia ($850,000).\nRemaining real estate holdings include residential land, undeveloped land, single-family housing, and commercial structures located in the following states: Florida, Kansas, Nevada, New Mexico, Oklahoma, Texas and Wyoming, all of which are listed for sale.\nListed below is the status of the discontinued real estate operations as of December 31, 1995:\nLand: North Ft. Worth, TX 297 acres sold, 554 acres listed for sale West Ft. Worth, TX 212 acres listed for sale Houston, TX 1 acre sold, 30 lots sold, 370 acres and 37 lots listed for sale Olathe, KS 4 acres sold, 17.5 acres listed for sale Tulsa, OK 12 acres listed for sale\nLand Lease: Honolulu, HI sold San Diego, CA sold Nashville, TN sold\nCommercial: Reno, NV contract expired, relisted for sale Denver, CO sold Gillette, WY listed for sale\nResidential: Juno Beach, FL last 2 units substantially complete, listed for sale Juno Beach, FL last unit complete and 8 marina slips, listed for sale Santa Fe, NM last 23 units substantially complete, listed for sale with 12 of 59 units under contract Mazatlan, Mexico final sales remittance received in 1995\nThe net real estate asset amounts are influenced from period to period by several factors including seasonal sales cycles for projects in Florida and New Mexico, a decision at the end of 1993 to accelerate the build-out of the New Mexico project and construction on the final three houses in Florida. The accelerated build-out is substantially completed.\nPublicly-Traded Subsidiaries\nSeafield has investments in two majority-owned entities that are publicly- traded, LabOne and Response. At December 31, 1995, based on the market prices of publicly-traded shares of these two subsidiaries, pretax unrealized gains of approximately $130 million on these investments were not reflected in either Seafield's book value or stockholders' equity.\nLIQUIDITY AND CAPITAL RESOURCES\nOn December 31, 1995 at the holding company level, Seafield had available for operations approximately $39.9 million in cash and short-term investments with an additional $5.1 million in long-term securities. Primarily as a result of asset dispositions, Seafield's working capital increased $13 million during 1995 to $46 million at December 1995.\nOn a consolidated basis, Seafield and its subsidiaries (primarily LabOne with $37.1 million) had $83.2 million in cash and short-term investments at December 31, 1995. Current assets totaled approximately $121.6 million while current liabilities totaled $12.2 million. Net cash used by continuing operations totaled $911,000 in 1995 compared with $16.5 million cash provided in 1994. The decrease primarily reflects an $11.8 million net increase during 1995 (funds used) in trading portfolios while 1994's decrease in these trading portfolios provided $2 million in funds.\nIn August 1990, Seafield's board of directors rescinded a previous authorization and passed a new authorization of up to $70 million for the acquisition of Seafield and LabOne common stock. Up to $20 million of this authorization could be utilized to purchase LabOne stock.\nIn January 1994, Seafield's board of directors approved an additional $8.4 million authorization necessary to complete an acquisition of 382,350 Seafield shares for $13 million. During 1995, treasury stock issued for exercised options totaled 82,800 shares. During 1993, Seafield retired 1,304,420 shares being held as treasury shares.\nIn 1993, Seafield's board of directors approved an additional $5 million for the purchase of LabOne's stock. In 1994, Seafield expended $722,000 to acquire 44,200 shares of LabOne stock resulting in a total of 1,462,200 shares of LabOne's stock acquired under the board authorizations at a cost of $17.3 million. No acquisitions of LabOne stock were made during 1995. At December 31, 1995, the remaining aggregate authorization totals $7.7 million.\nSeafield is primarily a holding company. Sources of cash are investment income and sales, borrowings and dividends from subsidiaries. The dividend paying capabilities of subsidiaries may be restricted as to their transfer to the parent company. The primary uses of cash for Seafield are investments, subsidiary stock purchases and dividends to shareholders.\nSeafield received a notice during 1992 of proposed adjustments from the Internal Revenue Service (IRS) with respect to 1986-87 federal income taxes. Later, the IRS determined to include 1988-90 as a part of its review. In May 1995, the IRS issued a revised notice of proposed adjustments to 1986-87 taxes in response to Seafield's protest filed in 1992. This revised notice reduced the previously proposed tax of approximately $17 million to $13.5 million. In June 1995, the IRS issued proposed adjustments to 1988-1989 federal income taxes. Additional proposed taxes for these years are $182,000. Also, during 1995 the IRS issued tentative proposed federal income tax adjustments for the 1990 year totaling approximately $16 million. In early 1996, the IRS reduced the $16 million tentatively proposed tax adjustments for the 1990 year to approximately $7 million. The IRS has used these proposed increases in federal income taxes to deny Seafield a 1990 claim for refund of $7.6 million. Resolution of these matters is not expected during 1996. Seafield believes that it has meritorious defenses to many of the substantive issues raised by the IRS, and adequate accruals for income tax liabilities.\nIn 1988, LabOne's board of directors authorized LabOne to enter the market from time to time for the purpose of acquiring shares of LabOne's common stock in an amount not to exceed $25 million. As of December 31, 1995, LabOne had acquired 2,099,235 shares of LabOne as treasury stock at a total cost of $22.7 million, leaving $2.3 million for potential future stock purchases. No shares have been purchased since 1990.\nLabOne paid quarterly dividends during 1995, 1994 and 1993. As an 82% owner, Seafield received $7.7 million of cash as dividends from LabOne in 1995. LabOne's working capital position declined from $48.6 million at December 31, 1994 to $44.2 million at December 31, 1995. This decrease is the result of dividends paid and capital additions exceeding cash provided by operations and net maturities of long-term investments. LabOne's cash and investments totaled $37.6 million at December 31, 1995 and LabOne expects to fund operations, capital asset additions, treasury stock purchases, if any, and future dividend payments from a combination of cash flow, cash reserves and short-term borrowings. LabOne had no short-term borrowings during 1995 and an unsecured $5 million line of credit available for general corporate purposes with no debt restrictions. LabOne's line of credit has a stated rate equivalent to the prime rate which was 8.5% at December 31, 1995.\nResponse's working capital at December 31, 1995 was $15.7 million with current assets of $20.6 million and current liabilities of $4.9 million. Cash and cash equivalents and short-term investments represent $4.6 million of Response's current assets. As of December 31, 1995, Response has a $2.5 million revolving bank line of credit secured by eligible accounts receivable, bearing interest at the bank's prime rate plus one percent, or 9.5% at December 31, 1995. Primarily as a result of positive cash flow from operating activities, Response had no borrowings under its line of credit as of December 31, 1995. The maximum outstanding during 1995 was $828,000 at a rate of 10%.\nResponse had no material commitments for capital expenditures at December 31, 1995. Capital expenditures of $1.3 million during the year ended December 31, 1995 were primarily associated with the expansion of Response's network of IMPACT and hospital-based centers. The capital expenditures were funded with cash from operations. Response is committed to future minimum lease payments under operating leases totaling $5.1 million for administrative and operational facilities.\nResponse announced during the year ended December 31, 1995, its plans to engage in physician practice management within the specialty of medical oncology and hematology.\nOn January 2, 1996, Response acquired the assets of, and entered into a long-term management services agreement with Oncology Hematology Group of South Florida, P.A. (the Group). The total consideration was approximately $12.1 million, approximately $5.3 million of which was paid in cash, approximately $6 million paid in the form of Response's long-term unsecured interest-bearing amortizing promissory note and the balance being paid over 16 calendar quarters at the rate of $50,000 per quarter. The Group, consisting of nine physicians, is located on the campus of Baptist Hospital in Miami, Florida. Under the management services agreement, Response receives a management fee to manage the non-medical aspects of the practice and to coordinate practice enhancement opportunities with the physicians. Improvements are expected through a professional focus on management and managed care relationships, economies of scale, and the addition of new services. The Group is Response's first physician group under such a practice management relationship.\nAs of February 15, 1996, Response had announced the receipt of two additional non-binding letters of intent for physician practice management relationships, and that it was in early negotiations with several additional groups.\nResponse is currently evaluating means of optimally financing the anticipated acquisitions, and it is contemplated that such acquisitions will be financed through combinations of debt and equity.\nTRENDS\nThe following is LabOne's analysis of certain existing trends that have been identified as potentially affecting future financial results of LabOne. Due to the potential for a rapid rate of change in any number of factors associated with the insurance and healthcare laboratory testing industries, it is difficult to quantify with any degree of certainty LabOne's future volumes, sales or net earnings.\nIn the last several years there has been a decline in the number of life insurance applications written in the industry. In addition, the insurance laboratory testing industry continues to be highly competitive. The primary focus of the competition has been on pricing. LabOne continues to maintain its market leadership by providing quality products and services at competitive prices. Management expects that prices and volume may continue to decline during 1996 due to competitive pressures and a reduction in the number of life insurance applications written. These trends may have a continuing material impact on earnings from operations.\nDuring December 1994, the FDA gave premarket approval to Epitope, Inc. with respect to its specimen collection kit for oral fluid HIV-1 antibody testing. In December 1995, Epitope announced that the FDA had issued a letter stating that the oral fluid Western Blot test was approvable as a confirmation for the oral fluid HIV-1 antibody test. If approved, this may allow for the initial screen and the Western Blot confirmation test to be performed on the same specimen. Due to the lower collection expense associated with oral fluid collection devices, the potential exists for an expansion of the testing market. Currently, there are approximately 13.5 million individual life insurance policies sold in the United States annually. However, laboratory services are provided on only approximately 4.5 million of these policy applicants. The non-invasive nature of oral specimen collection allows for low-cost agent collection, making testing much more affordable on smaller face value insurance policies. Conversely, the device also has the potential to cannibalize part of the existing blood and urine testing market. The net impact of oral fluid testing cannot be determined at this time.\nThere are companies currently developing and seeking FDA approval for home HIV test products. If approved, these products would allow individuals to confidentially determine their HIV status prior to applying for insurance. To avoid accepting these high-risk policies, the insurance company may elect to lower the threshold at which laboratory tests are requested to prevent writing policies on HIV positive applicants. Most insurance laboratory testing is performed on policies of $100,000 or greater, representing about one-third of all policy applicants. The $25,000 to $99,999 range represents approximately one-quarter of current insurance policy applicants. If the FDA does approve any home testing kit for HIV, the potential exists for a significant expansion of laboratory testing for lower policy amounts.\nLabOne entered the clinical and SAMHSA-certified substance-abuse testing markets during 1994. LabOne continues to add new customers in both fields. LabOne's Lab Card program covered approximately 280,000 lives at December 31, 1995, including The Guardian Life Insurance Company of America (The Guardian) and Principal Healthcare of Kansas City (Principal). The Guardian has stated its intention to roll out the Lab Card program in 16 states covering approximately 500,000 additional lives starting in the second or third quarter 1996.\nRECENTLY ISSUED ACCOUNTING STANDARDS Statement of Financial Accounting Standards No. 114 \"Accounting by Creditors for Impairment of a Loan\" and No. 118 \"Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures\" have been implemented for the year ending December 31, 1995. The adoption of these standards has had no significant impact on Seafield's financial position or results of operations.\nStatement of Financial Accounting Standards No. 121 \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of\" has been implemented for the year ending December 31, 1995. The adoption of this standard has had no significant impact on Seafield's financial position or results of operations.\nStatement of Financial Accounting Standards No. 123 \"Accounting for Stock- Based Compensation\" is required to be implemented for fiscal years beginning after December 15, 1995. Seafield does not plan to adopt an optional accounting treatment based on the estimated fair value of employee stock options allowed by Statement No. 123. However, presentation of pro forma disclosures of net earnings and earnings per share as if the optional accounting method had been utilized will be required.\nNo other recently issued accounting standards presently exist which will require adoption in future periods.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nSee Item 14(a).\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 Proxy Statement relating to Annual Officers of the Company Meeting of Shareholders to be held May 8, 1996, under the caption \"Election of Directors - Nominees and Directors whose terms expire in 1997 and 1998.\"\nItem 11.","section_11":"Item 11. Executive Compensation Proxy Statement relating to Annual Meeting of Shareholders to be held May 8, 1996, under the captions \"Election of Directors - Compensation of Executive Officers.\"\nItem 12.","section_12":"Item 12. Security Ownership of Proxy Statement relating to Annual Certain Beneficial Meeting of Shareholders to be held Owners and Management May 8, 1996, under the captions \"Election of Directors - Security Ownership of Management and Security Ownership of Certain Beneficial Owners.\"\nItem 13.","section_13":"Item 13. Certain Relationships Proxy Statement relating to Annual and Related Meeting of Shareholders to be held Transactions May 8, 1996, under the caption \"Election of Directors - Certain Transactions.\"\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.\n(a)(1) Financial Statements Independent Auditors' Report Consolidated Balance Sheets - December 31, 1995 and 1994 Consolidated Statements of Operations - Years ended December 31, 1995, 1994 and 1993 Consolidated Statements of Stockholders' Equity - Years ended December 31, 1995, 1994 and 1993 Consolidated Statements of Cash Flows - Years ended December 31, 1995, 1994 and 1993 Notes to Consolidated Financial Statements\n(2) Financial Statement Schedules II. Valuation and Qualifying Accounts and Reserves - Years ended December 31, 1995, 1994 and 1993 III. Real Estate and Accumulated Depreciation - December 31, 1995\nAll other schedules are omitted because they are not applicable or the information is given in the financial statements or notes thereto.\nPortions of Registrant's Proxy Statement for use in connection with the Annual Meeting of Shareholders to be held on May 8, 1996 are incorporated by reference into Part III of this report, if such Proxy Statement is filed with the Securities and Exchange Commission on or before April 30, 1996. If such Proxy Statement is not filed by such date, the information required to be presented in Part III will be filed as an amendment to this report.\n(3) Exhibits required by Item 601 of Regulation S-K (see Index to Exhibits in paragraph (c) infra.)\n(b) Reports on Form 8-K. A Form 8-K current report dated October 30, 1995 was filed with the Commission reporting under Other Events a news release regarding the Registrant's announcement that Registrant's subsidiary, Response Technologies, Inc., announced plans to effect a one-for-five reverse stock split of its common stock; delist its common stock from the American Stock Exchange (Amex:RTK) and begin trading on the NASDAQ National Market System under the symbol ROIX starting Thursday, October 26, 1995; and change its name from \"Response Technologies, Inc.\" to \"Response Oncology, Inc.\" In addition, Response announced that it retained Smith Barney Inc. to assist in the development of a physician practice acquisition and management strategy, including the development of financing alternatives for such contemplated acquisitions.\nAdditionally, in the October 30, 1995 Form 8-K under Other Events, Registrant's subsidiary, LabOne, Inc., announced that Bert Hood resigned his position as Chairman, President and Chief Executive Officer of LabOne, and that W. Thomas Grant II, Chairman of the Board and Chief Executive Officer of Registrant, would fill the vacancies left by Hood.\n(c) Index to Exhibits (Exhibits follow the Schedules);\n2.1 Stock Purchase Agreement between Response Oncology, Inc. and stockholders of Oncology Hematology Group of South Florida (filed as Exhibit 99.1 to Registrant's Form 8-K\/A filed January 17, 1996 (File No. 0-16946) and incorporated herein by reference).\n3.1 Registrant's Articles of Incorporation, as amended (filed as Exhibit 3.1 to Amendment No. 1 to Registrant's Registration Statement on Form S-4, filed April 8, 1988 (File No. 33-20298) and incorporated herein by reference).\n3.2 Amendment to Registrant's Articles of Incorporation, effective May 15, 1991, (filed as Exhibit 3(b) to Registrant's Annual Report on Form 10-K for the year ended December 31, 1991 (File No. 0-16946) and incorporated herein by reference).\n3.3 Registrant's Bylaws, as amended (filed as Exhibit 3(c) to Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 (File No. 0-16946) and incorporated herein by reference).\n4.1 Form of Rights Agreement dated April 5, 1988, between Registrant and Morgan Shareholder Services Trust Company, as Rights Agent (filed as Exhibit 4.1 to Amendment No. 1 to Registrant's Registration Statement on Form S-4, filed April 8, 1988 (File No. 33-20298) and incorporated herein by reference).\n4.2 Form of Certificate of Serial Designation of Series A Preferred Stock (filed as Exhibit 4.2 to Amendment No. 1 to Registrant's Registration Statement on Form S-4, filed April 8, 1988, (File No. 33-20298) and incorporated herein by reference).\n4.3 Amendment No. 1 to the Rights Agreement, dated November 14, 1988, between Registrant and Morgan Shareholder Services Trust Company, as Rights Agent (filed as Exhibit 1 to the Registrant's current report on Form 8-K filed November 18, 1988 (File No. 0-16946) and incorporated herein by reference).\n4.4 Amendment No. 2 to the Rights Agreement, dated May 15, 1991, between Registrant and First Chicago Trust Company of New York, as Rights Agent (filed as Exhibit 4(d) to Registrant's Annual Report on Form 10-K for the year ended December 31, 1991 (File No. 0-16946) and incorporated herein by reference).\n4.5 Notice and Agreement Respecting Removal of Rights Agent and Appointment of Successor Rights Agent (filed as Exhibit 4(e) to Registrant's Annual Report on Form 10-K for the year ended December 31, 1991 (File No. 0-16946) and incorporated herein by reference).\n10.1 Registrant's 1984 Stock Option Incentive Plan, as amended (filed as Exhibit 10(b) to Registrant's Annual Report on Form 10-K for the year ended December 31, 1990 (File No. 0-16946) and incorporated herein by reference).**\n10.2 Amendment to Registrant's 1984 Stock Option Incentive Plan, effective August 17, 1992 (filed as Exhibit 10(b) to Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 (File No. 0-16946) and incorporated herein by reference).**\n10.3 * Amendment to Registrant's 1984 Stock Option Incentive Plan, effective August 2, 1995.**\n10.4 Registrant's 1989 Stock Option and Incentive Plan (filed as Exhibit 28 to Registrant's Registration Statement on Form S-8 filed April 17, 1989 (File No. 33-28150) and incorporated herein by reference).**\n10.5 Amendment to Registrant's 1989 Stock Option and Incentive Plan, effective February 20, 1991 (filed as Exhibit 10(d) to Registrant's Annual Report on Form 10-K for the year ended December 31, 1990 (File No. 0-16946) and incorporated herein by reference).**\n10.6 Amendment to Registrant's 1989 Stock Option and Incentive Plan, effective January 20, 1995 (filed as Exhibit 10.5 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1994 (File No. 0-16946) and incorporated herein by reference).**\n10.7 * Amendment to Registrant's 1989 Stock Option and Incentive Plan, effective August 2, 1995.**\n10.8 Registrant's 1991 Non-Employee Directors' Stock Option Plan and form of Stock Option Agreement, effective May 15, 1991 (filed as Exhibit 10(e) to Registrant's Annual Report on Form 10-K for the year ended December 31, 1991 (File No. 0-16946) and incorporated herein by reference).***\n10.9 Amendment No. 1 to Registrant's 1991 Non-Employee Directors' Stock Option Plan, dated November 10, 1993 (filed as Exhibit 10.6 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1993 (File No. 0-16946) and incorporated herein by reference).***\n10.10 * Amendment to Registrant's 1991 Non-Employee Directors' Stock Option Plan, effective August 2, 1995.***\n10.11 Registrant's Stock Purchase Plan, as amended (filed as Exhibit 10(e) to Registrant's Annual Report on Form 10-K for the year ended December 31, 1990 (File No. 0-16946) and incorporated herein by reference).***\n10.12 Amendment to Registrant's Stock Purchase Plan, effective May 15, 1991 (filed as Exhibit 10(g) to Registrant's Annual Report on Form 10-K for the year ended December 31, 1991 (File No. 0-16946) and incorporated herein by reference).***\n10.13 Amendment to Registrant's Stock Purchase Plan effective August 17, 1992 (filed as Exhibit 10(h) to Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 (File No. 0-16946) and incorporated herein by reference).***\n10.14 * Amendment to Registrant's Stock Purchase Plan effective August 2, 1995.***\n10.15 Supplemental Retirement Agreement between the Registrant and P. Anthony Jacobs, President of Registrant (filed as Exhibit 10(i) to Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 (File No. 0-16946) and incorporated herein by reference).**\n10.16 Consulting Agreement, dated as of August 1, 1990, First Amendment to Consulting Agreement, dated as of January 1, 1992, and Second Amendment to Consulting Agreement, dated as of January 1, 1993, each between the Registrant and W.D. Grant, director of the Registrant (filed as Exhibit 10(j) to Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 (File No. 0-16946) and incorporated herein by reference).***\n10.17 Form of Supplemental Retirement Agreement between the Registrant and certain corporate\/executive officers (filed as Exhibit 10(k) to Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 (File No. 0-16946) and incorporated herein by reference).**\n10.18 Nonrecourse Promissory Note from William H. West, M.D., an executive officer of Registrant, to Registrant and related Stock Pledge Agreement, both dated July 21, 1992 (filed as Exhibit 10(l) to Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 (File No. 0-16946) and incorporated herein by reference).\n10.19 Form of Termination Compensation Agreement between the Registrant and corporate\/executive officers (filed as Exhibit 10(g) to Registrant's Annual Report on Form 10-K for the year ended December 31, 1990 (File No. 0-16946) and incorporated herein by reference).**\n10.20 Form of Amendment No. 1 to Termination Compensation Agreement, dated January 20, 1995, between the Registrant and corporate\/ executive officers (filed as Exhibit 10.16 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1994 (File No. 0-16946) and incorporated herein by reference).**\n10.21 * Form of Amendment No. 2 to Termination Compensation Agreement, dated February 14, 1996, between the Registrant and corporate\/ executive officers.**\n10.22 Form of Indemnification Agreement between Registrant and its directors and corporate\/executive officers (filed as Exhibit 10(i) to Registrant's Annual Report on Form 10-K for the year ended December 31, 1989 (File No. 0-16946) and incorporated herein by reference).\n10.23 * Form of Severance Agreement, dated February 14, 1996, between the Registrant and corporate\/executive officers.**\n10.24 Services Agreement, dated January 1, 1993, among Registrant and LabOne, Inc., relating to services and other matters among the parties (filed as Exhibit 10.17 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1993 (File No. 0-16946) and incorporated herein by reference).\n10.25 1985 Stock Option Plan of Response Oncology, Inc., as amended (filed as Exhibit 10(q) to Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 (File No. 0-16946) and incorporated herein by reference).**\n10.26 1990 Non-Qualified Stock Option Plan of Response Oncology, Inc., as amended through December 31, 1992 (filed as Exhibit 10(r) to Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 (File No. 0-16946) and incorporated herein by reference).**\n10.27 * Amendment No. 2 to 1990 Non-Qualified Stock Option Plan of Response Oncology, Inc., effective April 1995.**\n10.28 Employment Agreement between Response Technologies, Inc. and William H. West, MD, dated January 1, 1992 (filed as Exhibit 10(s) to Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 (File No. 0-16946) and incorporated herein by reference).**\n10.29 * Employment Agreement effective July 1, 1995 between Response Oncology, Inc. and Joseph T. Clark, an executive officer of Registrant.**\n10.30 Long-Term Incentive Plan of LabOne, Inc., approved May 16, 1991 with amendments adopted May 21, 1993 and November 9, 1993 (filed as Exhibit 10.21 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1993 (File No. 0-16946) and incorporated herein by reference).**\n10.31 * Amendment to LabOne's Long Term Incentive Plan, effective February 10, 1995.**\n10.32 LabOne's Stock Plan for non-employee directors (filed as Exhibit 10.23 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1994 (File No. 0-16946) and incorporated herein by reference). ***\n10.33 * LabOne's Annual Incentive Plan.**\n10.34 Employment Agreement between LabOne, Inc. and Bert H. Hood, dated August 5, 1993 and amended November 9, 1993 (filed as Exhibit 10.22 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1993 (File No. 0-16946) and incorporated herein by reference).**\n10.35 Amendment to Employment Agreement between LabOne, Inc. and Bert H. Hood, dated December 31, 1994 (filed as Exhibit 10.27 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1994 (File No. 0-16946) and incorporated herein by reference).**\n10.36 Promissory Note Agreement between LabOne, Inc. and Bert H. Hood dated September 7, 1994 (filed as Exhibit 10.2 to Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1994 (File No. 0-16946) and incorporated herein by reference).\n10.37 * Promissory Note Agreement between LabOne, Inc. and Bert H. Hood dated September 7, 1995.\n11 Statement regarding computation of per share earnings - see Note l of Notes to Consolidated Financial Statements, \"Earnings Per Share.\"\n13 Annual Report to Shareholders for the year ended December 31, 1995 - To be furnished.\n21 Subsidiaries of Registrant (reference is made to Item 1 hereof).\n23 * Consents of KPMG Peat Marwick LLP with respect to Forms S-8.\n27 Financial Data Schedule - as filed electronically by the Registrant in conjunction with this 1995 Form 10-K.\n99 Proxy Statement for Annual Shareholders meeting to be held May 8, 1996 - To be furnished.\n* These documents may be obtained by stockholders of Registrant upon written request to: Seafield Capital Corporation, P.0. Box 410949, Kansas City, Missouri 64141.\n** Management Compensatory Plan\n*** Non-Management Director Compensatory Plan\n(d) Not Applicable.\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.\nSEAFIELD CAPITAL CORPORATION By: \/s\/ W. Thomas Grant II ----------------------------- W. Thomas Grant II Title: Chairman, Chief Executive Officer and Director Date: March 15, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons who serve Registrant in the capacities and on the dates indicated.\nBy: \/s\/ P. Anthony Jacobs By: \/s\/ James R. Seward ----------------------------- ----------------------------- P. Anthony Jacobs James R. Seward Title: President, Chief Title: Executive Vice President, Operating Officer Chief Financial Officer and Director and Director Date: March 15, 1996 Date: March 15, 1996\nBy: \/s\/ Steven K. Fitzwater By: \/s\/ W. D. Grant ----------------------------- ----------------------------- Steven K. Fitzwater W. D. Grant Title: Vice President, Chief Title: Director Accounting Officer and Secretary Date: March 15, 1996 Date: March 15, 1996\nBy: \/s\/ Lan C. Bentsen By: \/s\/ John C. Gamble ----------------------------- ----------------------------- Lan C. Bentsen John C. Gamble Title: Director Title: Director Date: March 15, 1996 Date: March 15, 1996\nBy: \/s\/ Michael E. Herman By: \/s\/ David W. Kemper ----------------------------- ----------------------------- Michael E. Herman David W. Kemper Title: Director Title: Director Date: March 15, 1996 Date: March 15, 1996\nBy: \/s\/ John H. Robinson, Jr. By: \/s\/ Dennis R. Stephen ----------------------------- ----------------------------- John H. Robinson, Jr. Dennis R. Stephen Title: Director Title: Director Date: March 15, 1996 Date: March 15, 1996\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Stockholders Seafield Capital Corporation:\nWe have audited the consolidated financial statements of Seafield Capital Corporation and subsidiaries as listed in Item 14(a)(1). In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedules as listed in Item 14(a)(2). These consolidated financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits and the report of other auditors provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Seafield Capital Corporation and subsidiaries at December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1995, 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\nKansas City, Missouri February 1, 1996\nSEAFIELD CAPITAL CORPORATION AND SUBSIDIARIES Consolidated Balance Sheets - -------------------------------------------------------------------------- December 31, 1995 1994 - -------------------------------------------------------------------------- (In thousands) ASSETS Current assets: Cash and cash equivalents $ 7,581 8,626 Short-term investments 75,632 67,631 Accounts and notes receivable 23,565 32,871 Current income tax receivable 4,457 2,311 Deferred income taxes 1,540 1,766 Other current assets 8,850 10,813 --------------------- Total current assets 121,625 124,018 Property, plant and equipment 21,604 24,981 Investments: Securities 5,647 6,725 Oil and gas 4,247 5,998 Intangible assets 19,477 29,318 Deferred income taxes 6,999 1,715 Other assets 1,158 2,621 Net assets of discontinued real estate operations 42,215 50,011 --------------------- $ 222,972 245,387 ===================== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 6,370 7,475 Notes payable -- 2,823 Other current liabilities 5,859 9,513 --------------------- Total current liabilities 12,229 19,811 Notes payable -- 8 Other liabilities 2,653 3,439 --------------------- Total liabilities 14,882 23,258 --------------------- Minority interests 21,006 21,196 --------------------- Stockholders' equity: Preferred stock of $1 par value. Authorized 3,000,000 shares; none issued -- -- Common stock of $1 par value. Authorized 24,000,000 shares; issued 7,500,000 shares 7,500 7,500 Paid-in capital 1,747 1,002 Equity adjustment from foreign currency translation (447) (561) Retained earnings 208,098 223,169 --------------------- 216,898 231,110 Less cost of 1,038,939 shares of treasury stock (1994-1,121,739 shares) 29,814 30,177 --------------------- Total stockholders' equity 187,084 200,933 --------------------- Commitments and contingencies --------------------- $ 222,972 245,387 =====================\nSee accompanying notes to consolidated financial statements.\nSEAFIELD CAPITAL CORPORATION AND SUBSIDIARIES Consolidated Statements of Operations - -------------------------------------------------------------------------- Year Ended December 31, 1995 1994 1993 - -------------------------------------------------------------------------- (In thousands except per share amounts) REVENUES Healthcare services $ 56,410 45,134 40,882 Insurance services 55,862 67,199 74,803 Other 7,272 11,945 14,182 ---------------------------------- Total revenues 119,544 124,278 129,867\nCOSTS AND EXPENSES Healthcare services 52,838 45,073 37,203 Insurance services 23,598 30,951 33,728 Other 6,357 11,780 14,882 Selling, general and administrative 42,300 40,767 36,923 ---------------------------------- Earnings (loss) from operations (5,549) (4,293) 7,131 Investment income - net 4,401 2,889 10,197 Other income (loss) (4,688) 67 (2,388) ---------------------------------- Earnings (loss) before income taxes (5,836) (1,337) 14,940 ---------------------------------- Taxes on income (benefits): Current (1,429) 2,486 9,373 Deferred (5,134) (1,806) (2,382) ---------------------------------- Total (6,563) 680 6,991 ---------------------------------- Earnings (loss) before minority interests 727 (2,017) 7,949 Minority interests 1,475 (145) 2,331 ---------------------------------- Earnings (loss) from continuing operations (748) (1,872) 5,618 Loss from discontinued real estate operations (6,600) (2,904) -- ---------------------------------- NET EARNINGS (LOSS) $ (7,348) (4,776) 5,618 ==================================\nPer share of common stock: Earnings (loss) from continuing operations $ (.12) (.29) .82 Loss from discontinued real estate operations (1.02) (.46) -- ---------------------------------- NET EARNINGS (LOSS) $ (1.14) (.75) .82 ==================================\nSee accompanying notes to consolidated financial statements.\nSEAFIELD CAPITAL CORPORATION AND SUBSIDIARIES Consolidated Statements of Stockholders' Equity - -------------------------------------------------------------------------- Year Ended December 31, 1995 1994 1993 - -------------------------------------------------------------------------- (In thousands) Common stock: Balance, beginning of year $ 7,500 7,500 8,804 Retirement of stock -- -- (1,304) ---------------------------------- Balance, end of year 7,500 7,500 7,500 ---------------------------------- Paid-in capital: Balance, beginning of year 1,002 1,007 644 Exercise of stock options 745 (5) 363 ---------------------------------- Balance, end of year 1,747 1,002 1,007 ---------------------------------- Foreign currency translation: Balance, beginning of year (561) (350) (438) Net change during year 114 (211) 88 ---------------------------------- Balance, end of year (447) (561) (350) ---------------------------------- Retained earnings: Balance, beginning of year 223,169 235,583 275,944 Net earnings (loss) (7,348) (4,776) 5,618 Dividends declared* (7,723) (7,638) (8,059) Retirement of stock -- -- (37,920) ---------------------------------- Balance, end of year 208,098 223,169 235,583 ---------------------------------- Less treasury stock: Balance, beginning of year 30,177 18,070 56,948 Net issuance pursuant to stock option plans (1995-82,800; 1994-27,366; 1993-27,080) (363) (845) 346 Shares purchased (1994-382,350) -- 12,952 -- Shares retired (1993-1,304,420) -- -- (39,224) ---------------------------------- Balance, end of year 29,814 30,177 18,070 ---------------------------------- STOCKHOLDERS' EQUITY $ 187,084 200,933 225,670 ==================================\n*Dividends per share amounted to $1.20 in 1995, 1994 and 1993.\nSee accompanying notes to consolidated financial statements.\nSEAFIELD CAPITAL CORPORATION AND SUBSIDIARIES Consolidated Statements of Cash Flows - --------------------------------------------------------------------------- Year Ended December 31, 1995 1994 1993 - --------------------------------------------------------------------------- (In thousands) OPERATING ACTIVITIES Earnings (loss) from continuing operations $ (748) (1,872) 5,618 Adjustments to reconcile earnings (loss) from continuing operations to net cash provided (used) by continuing operations: Depreciation and amortization 12,210 15,099 19,621 Earnings applicable to minority interests 1,475 (145) 2,331 Change in trading portfolio, net (11,766) 2,019 -- Change in accounts receivable 2,902 1,856 (7,912) Change in accounts payable (10) 1,643 1,250 Income taxes and other, net (4,974) (2,126) (1,959) ----------------------------- Net cash provided (used) \tby continuing operations (911) 16,474 18,949 ----------------------------- INVESTING ACTIVITIES Sales of investments available for sale 83 -- -- Purchases of investments held to maturity (65,569) (79,502) -- Maturities of investments held to maturity 69,459 90,602 -- Purchases of investments -- -- (17,604) Sales or maturities of investments -- -- 20,599 Short-term investments -- -- (8,763) Proceeds of securitization 1,500 4,000 19,000 Additions to property, plant and equipment, net (4,370) (5,445) (5,689) Oil and gas investments (391) (914) (55) Net increase in notes receivable (2,507) (6,456) (2,213) Purchase of stock in consolidated subsidiaries -- (722) (2,365) Proceeds from sale of subsidiaries, net 12,054 -- -- Net cash provided (used) by discontinued real estate operations 1,196 (2,023) 10,520 Other, net (1,995) (812) (691) ----------------------------- Net cash provided (used) by investing activities 9,460 (1,272) 12,739 ----------------------------- FINANCING ACTIVITIES Payments under line of credit agreements, net (2,831) (1,725) (6,891) Proceeds from long-term debt -- 59 168 Payment of principal on long-term debt -- (98) (3,843) Payment of capital lease (169) (367) -- Dividends paid (7,723) (7,638) (8,059) Purchase of treasury stock -- (12,952) -- Issuance of common stock 1,108 840 17 ----------------------------- Net cash used by financing activities (9,615) (21,881) (18,608) ----------------------------- Effect of foreign currency translation 21 (186) 165 ----------------------------- Net increase (decrease) in cash and cash equivalents (1,045) (6,865) 13,245 Cash and cash equivalents at beginning of year 8,626 15,491 2,246 ----------------------------- Cash and cash equivalents at end of year $ 7,581 8,626 15,491 ============================= Supplemental disclosures of cash flow information: Cash paid (received) during the year for: Interest $ 140 273 539 ============================= Income taxes, net $ (1,693) 1,965 5,726 =============================\nSee accompanying notes to consolidated financial statements.\nSEAFIELD CAPITAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1995, 1994 and 1993\nNOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION The accompanying consolidated financial statements include the accounts of Seafield Capital Corporation (Seafield or the Company) and all majority- owned subsidiaries and joint ventures. Investments with ownerships of 20% to 50% are accounted for by the equity method.\nTwo publicly-traded subsidiaries are included in the consolidated financial statements of Seafield. LabOne, Inc. (LabOne) was formerly Home Office Reference Laboratory, Inc. and is 82% owned. Response Oncology, Inc. (Response) was formerly Response Technologies, Inc. and is 56% owned.\nAll significant intercompany transactions have been eliminated in consolidation. Certain 1994 and 1993 amounts have been reclassified for comparative purposes with no effect on net earnings.\nIn 1992, Seafield's board of directors approved a plan for the discontinuance of real estate operations. During 1995's fourth quarter, Seafield recorded an additional valuation allowance of $6.6 million. The increased allowance reflects values based on recent sales transactions of undeveloped land parcels and sales activity at the residential project in New Mexico. In 1994, an after-tax loss of $2.9 million was recorded for a sales contract signed in January 1995. See Note 13 for additional information on discontinued real estate operations.\nUSE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS 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.\nCASH AND CASH EQUIVALENTS Cash and cash equivalents include demand deposits in banks and overnight investments that are stated at cost which approximates market value.\nINVESTMENT SECURITIES Investment securities consist of certificates of deposit, equity securities, debt securities and debt obligations of the United States government and state and political subdivisions. Short-term investments are securities with maturities of less than one year.\nThe classification of debt and equity securities as trading, available for sale or held to maturity is made at the time of purchase. Trading securities are stated at fair value and unrealized holding gains and losses are included in income. Securities which are classified as available for sale are stated at market value. Securities which the Company has the intent and ability to hold to maturity are stated at cost.\nThe Company calculates the fair value of financial instruments using appropriate market information and valuation methodologies. The additional fair value information is included in the notes to the financial statements when it is different than the stated value of those financial instruments. When the fair value approximates the stated value, no additional disclosure is made.\nPROPERTY, PLANT AND EQUIPMENT Property, plant and equipment is recorded at cost with depreciation provided over the useful lives. Upon sale or retirement, the costs and related accumulated depreciation are eliminated from the accounts. Any resulting gains or losses are included in the determination of net earnings. See Note 4 for additional information on depreciation.\nOIL AND GAS INVESTMENTS The Company's oil and gas investments are accounted for using the full cost method. All costs incurred in acquisition and development are capitalized. Depletion is computed on the units of production method based on all proved reserves. All general operating costs are expensed as incurred.\nINTANGIBLE ASSETS The patent process utilized in coating the plates on which blood and urine testing is performed is recorded at its acquisition cost and is being amortized on a straight-line basis over its remaining life (184 months at date of acquisition).\nGoodwill is recorded at acquisition as the excess of cost over fair value of net assets acquired and is being amortized on a straight-line basis over appropriate periods up to twenty years.\nIMPAIRMENT OF LONG-LIVED ASSETS When facts and circumstances indicate potential impairment, the Company evaluates the recoverability of carrying values of long-lived assets using estimates of undiscounted future cash flows over remaining asset lives. When impairment is indicated, any impairment loss is measured by the excess of carrying values over fair values.\nDISPOSITIONS The Company sold its 80.1% owned insurance premium finance subsidiary, Agency Premium Resource, Inc., during the second quarter of 1995. The sale generated an after-tax gain of $1.5 million.\nThe Company completed an asset sale by its 79% owned real estate, personal property and sales and use tax consulting subsidiary, Tenenbaum and Associates, Inc., during the second quarter of 1995. This subsidiary then distributed its assets to shareholders and filed for dissolution. The effect of the sale, distribution and dissolution was an after-tax gain of $500,000.\nThe Company sold its 80% owned underwriting and policy administration services subsidiary, International Underwriting Services, Inc., during the third quarter of 1995. The sale generated an after-tax gain of $1 million.\nThe Company's 74% owned radiopharmaceuticals subsidiary, Pyramid Diagnostic Services, Inc. (Pyramid), entered voluntary bankruptcy in the fourth quarter of 1995 as a result of an adverse judgment in a lawsuit. The Company fully reserved its investment in this subsidiary and recorded an after-tax loss of $1.2 million. The Company expects the Pyramid bankruptcy to be finalized in 1996 with no further financial consequences to the Company.\nFEDERAL INCOME TAXES Statement of Financial Accounting Standards No. 109 \"Accounting for Income Taxes\" required a change from the deferred method of accounting for income taxes of APB Opinion 11 to the asset and liability method of accounting for income taxes. Under the asset and liability method of Statement 109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under Statement 109, the effect on deferred tax assets and liabilities of a change in tax rates was recognized in income in the period that includes the enactment date.\nOTHER LIABILITIES The components of \"Other Liabilities\" on the Consolidated Balance Sheets are as follows:\nDecember 31, 1995 December 31, 1994 Current Noncurrent Current Noncurrent ----------------------------------------- (In thousands) Accrued payroll and benefits $ 2,230 1,514 2,191 1,622 Accrued commissions and consulting fees 1,135 41 2,552 184 Other accrued expenses 1,982 -- 3,454 -- Other liabilities 512 1,098 1,316 1,633 ---------------------------------------- $ 5,859 2,653 9,513 3,439 ========================================\nOTHER INCOME\/(LOSS) The components of \"Other Income\/(Loss)\" on the Consolidated Statements of Operations are as follows:\nYear ended December 31, 1995 1994 1993 - --------------------------------------------------------------------------- (In thousands) Gain\/(loss) on dispositions of subsidiaries $ (1,068) -- -- Provision for subsidiary bankruptcy (3,382) -- -- Provision for litigation costs -- -- (1,500) Other (238) 67 (888) --------------------------- $ (4,688) 67 (2,388) ===========================\nRECENTLY ISSUED ACCOUNTING STANDARDS Statement of Financial Accounting Standards No. 114 \"Accounting by Creditors for Impairment of a Loan\" and No. 118 \"Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures\" have been implemented for the year ending December 31, 1995. The adoption of these standards has had no significant impact on the Company's financial position or results of operations.\nStatement of Financial Accounting Standards No. 121 \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of\" has been implemented for the year ending December 31, 1995. The adoption of this standard has had no significant impact on the Company's financial position or results of operations.\nStatement of Financial Accounting Standards No. 123 \"Accounting for Stock- Based Compensation\" is required to be implemented for fiscal years beginning after December 15, 1995. The Company does not plan to adopt an optional accounting treatment based on the estimated fair value of employee stock options allowed by Statement No. 123. However, presentation of pro forma disclosures of net earnings and earnings per share as if the optional accounting method had been utilized will be required.\nEARNINGS PER SHARE Earnings per share of common stock are based on the weighted average number of shares of common stock outstanding and the common share equivalents of dilutive stock options, where applicable: 1995 - 6,454,068, 1994 - 6,374,952, and 1993 - 6,847,559.\nNOTE 2 - BENEFIT PLANS\nEffective January 1, 1991, Seafield and certain subsidiaries established a savings plan qualifying under Section 401(k) of the Internal Revenue Code and a money purchase pension plan. All salaried employees who have worked 500 hours within the first six months of employment are eligible to participate in the plans. After the first 12-month period, eligibility is measured on a plan-year basis.\nParticipants in the 401(k) plan may contribute 2% to 10% of annual compensation. Seafield and the participating subsidiaries contribute for each participant an amount equal to 50% of the participant's contribution. A participant is immediately fully vested with respect to the participant's contributions. A participant is 100% vested with respect to the companies' contributions after five years of service. Both the participants' and the companies' contributions are invested by the trustees of the plan at the direction of the participants in any one or more of six investment funds, one of which is a Seafield Stock Fund. The matching contributions made by Seafield and the participating subsidiaries amounted to $109,000 for 1995, $91,000 for 1994 and $87,000 for 1993.\nThe money purchase pension plan is a defined contribution plan under which Seafield and the participating subsidiaries contribute a percentage of a participant's annual compensation. The companies contribute an amount equal to 7% of base compensation up to the maximum social security wage base ($61,200 in 1995, $60,600 in 1994 and $57,600 in 1993) and 12.7% of earnings in excess of this amount up to an annual limit ($150,000 in 1995 and 1994 and $235,840 in 1993). Participants become 100% vested after five years of service, normal retirement at age 65, or in the event of disability or death while employed by the companies. Contributions to this plan by Seafield and the participating subsidiaries were $143,000 for 1995, $202,000 for 1994 and $225,000 for 1993.\nSeafield has a stock purchase plan which is open to all non-employee directors of the Company and employees of the Company and participating subsidiaries who are designated by the chairman of the board. The directors may contribute an amount equal to all or part of their directors' compensation. The designated employees may contribute the lesser of 10% of their salary or $30,000. The Company matches each participant's contribution at a rate of 50%. Seafield common stock is purchased on the open market each month and each participant receives as many shares as the participant's contribution, plus the Company's matching contribution, will purchase. No employees are presently designated to participate. The matching contributions made by Seafield amounted to $39,000, $40,000 and $44,000 for the years ended December 31, 1995, 1994 and 1993, respectively.\nLabOne, Response and certain other subsidiaries maintain profit sharing plans qualifying under Section 401(k) of the Internal Revenue Code. LabOne also has a defined contribution plan. These subsidiaries contributed $1,774,000, $1,666,000 and $1,702,000 to the plans for the years ended December 31, 1995, 1994 and 1993, respectively.\nNOTE 3 - COMMITMENTS AND CONTINGENCIES\nSeafield received a notice during 1992 of proposed adjustments from the Internal Revenue Service (IRS) with respect to 1986-87 federal income taxes. Later, the IRS determined to include 1988-90 as a part of its review. In May 1995, the IRS issued a revised notice of proposed adjustments to 1986-87 taxes in response to Seafield's protest filed in 1992. This revised notice reduced the previously proposed tax of approximately $17 million to $13.5 million. In June 1995, the IRS issued proposed adjustments to 1988-1989 federal income taxes. Additional proposed taxes for these years are $182,000. Also, during 1995 the IRS issued tentative proposed federal income tax adjustments for the 1990 year totaling approximately $16 million. In early 1996, the IRS reduced the $16 million tentatively proposed tax adjustments for the 1990 year to approximately $7 million. The IRS has used these proposed increases in federal income taxes to deny Seafield a 1990 claim for refund of $7.6 million. Resolution of these matters is not expected during 1996. Seafield believes that it has meritorious defenses to many of the substantive issues raised by the IRS, and adequate accruals for income tax liabilities.\nIn 1986, a lawsuit was initiated in the Circuit Court of Jackson County, Missouri by Seafield's former insurance subsidiary (i.e., Business Men's Assurance Company of America) against Skidmore, Owings & Merrill (\"SOM\") which is an architectural and engineering firm, and a construction firm to recover costs incurred to remove and replace the facade on the former home office building. Because the removal and replacement costs had been incurred prior to the sale of the insurance subsidiary, Seafield negotiated with the buyer for an assignment of the cause of action from the insurance subsidiary. Thus, any recovery will be for the benefit of Seafield and all costs incurred in connection with the litigation will be paid by Seafield. Any ultimate recovery will be recognized as income when received and would be subject to income taxes. In September 1993, the Missouri Court of Appeals reversed a $5.7 million judgment granted in 1992 in favor of Seafield; the Court of Appeals remanded the case to the trial court for a jury trial limited to the question of whether or not the applicable statute of limitations barred the claim. The Appeals Court also set aside $1.7 million of the judgment originally granted in 1992. A new trial is expected in the second quarter of 1996. The only remaining defendant is SOM; settlement arrangements with other defendants have resulted in payments to plaintiff which have offset legal fees and costs to date of approximately $400,000. None of the prior or future legal fees or costs are recoverable from the remaining defendant, even if the judgment in plaintiff's favor is ultimately upheld. Future legal fees and costs can not reliably be estimated.\nIn 1988, a lawsuit was initiated in the United States District Court for the District of New Mexico against Seafield's former insurance subsidiary by Lyon Development Company and Jeanne Lyon, d\/b\/a Lyon and Associates Realty, its former partners in the Quail Run real estate project in Santa Fe, New Mexico. The plaintiffs alleged that the project partnership agreement was improperly terminated, thus denying them an ongoing interest in the project, and the loss of their exclusive real estate brokerage arrangement. The plaintiffs were seeking approximately $11 million in actual damages and unspecified punitive damages based upon alleged breaches of contract and fiduciary duty and economic compulsion. After a trial in July 1994, the jury returned a verdict absolving Seafield of any liability. Subsequent to the trial, the judge awarded Seafield approximately $250,000 in connection with marketing expenses which the plaintiffs were to have repaid, and approximately $64,000 in legal costs, with interest until paid. Total legal fees and costs incurred by Seafield and its former insurance subsidiary have aggregated approximately $3.6 million. In February 1996, the United States Court of Appeals for the Tenth Circuit affirmed the jury's verdict in Seafield's favor, reversed the trial judge's award for marketing expenses, and affirmed the trial judge's award of legal costs. A bond posted by one of the plaintiffs\/counter defendants secures payment of the legal costs awarded by the trial judge and affirmed by the Court of Appeals. Because the Quail Run project was retained by Seafield in connection with the sale of its former insurance subsidiary, Seafield defended the lawsuit under an indemnification arrangement with the purchaser of the former insurance subsidiary; all costs incurred and any judgments rendered in favor of the plaintiff have been and will be for the account of Seafield.\nIn the opinion of management, after consultation with legal counsel and based upon current available information, none of these lawsuits is expected to have a material adverse impact on the consolidated financial position or results of operations of Seafield.\nNOTE 4 - PROPERTY, PLANT AND EQUIPMENT AND ACCOUNTS AND NOTES RECEIVABLE\nA summary of property, plant and equipment is as follows: Rate of December 31, Depreciation 1995 1994 ------------------------------------ (In thousands) Property, plant and equipment 5% - 33% $ 65,681 67,930 Less accumulated depreciation 44,077 42,949 ----------------- $ 21,604 24,981 =================\nA summary of accounts and notes receivable is as follows: December 31, 1995 1994 ----------------- (In thousands) Accounts receivable $ 26,146 37,228 Notes receivable 1,083 1,578 Allowance for doubtful accounts (3,314) (4,637) ----------------- 23,915 34,169 Less current portion 23,565 32,871 ----------------- $ 350 1,298 =================\nInterest rates on notes receivable were 5% to 9% in 1995 and 1994. Included in notes receivable is a loan to an officer of a subsidiary aggregating $500,000 at December 31, 1995. The note, with an interest rate of 6.74%, is due in 1996.\nNOTE 5 - SECURITIZATION OF RECEIVABLES\nIn July 1993, a subsidiary of Seafield entered into an extendable two-year agreement whereby it can sell undivided interests in a designated pool of accounts receivable on an ongoing basis. The maximum allowable amount of receivables to be sold was increased by amendment in August 1994 from $22 million to $30 million, subject to voluntary reduction by the seller to a minimum of $12 million. As collections reduce accounts receivable in the pool, the purchaser permits the subsidiary to apply such collections to additional purchases up to the maximum. The subsidiary had securitized receivables of $23 million at December 31, 1994. The net cash proceeds were reported as an investing activity in the accompanying Consolidated Statements of Cash Flows. The securitized receivables were reflected as a reduction of accounts receivable in the accompanying Consolidated Balance Sheet at December 31, 1994.\nThe subsidiary did not record a gain or loss on the sales as the costs of receivables sold approximated the proceeds. Receivables of $2.8 million at December 31, 1994 were subordinated to undivided interests sold in the event of defaults or delinquencies with respect to the underlying receivables. A default reserve is required for the greater of 12% of the accounts receivable sold or an amount set forth by a formula based on preceding months' default ratios.\nThe subsidiary was sold in May 1995.\nNOTE 6 - SEGMENT DATA\nThe following table shows segment information from continuing operations:\nYear ended December 31, 1995 1994 1993 - -------------------------------------------------------------------------- (In thousands) REVENUES: Healthcare services $ 56,410 45,134 40,882 Insurance services 55,862 67,199 74,803 Other 7,272 11,945 14,182 ---------------------------------- Total revenues $ 119,544 124,278 129,867 ================================== OPERATING EARNINGS (LOSS): Healthcare services $ (3,687) (5,272) 158 Insurance services 7,179 8,966 15,441 Other (3,858) (1,041) (3,145) Corporate investment and other income 1,522 1,594 8,470 Corporate expense (6,868) (5,284) (5,738) Interest expense (124) (300) (246) ---------------------------------- Earnings (loss) before income taxes and minority interests (5,836) (1,337) 14,940 Income taxes 6,563 (680) (6,991) Minority interests (1,475) 145 (2,331) ---------------------------------- Earnings (loss) from continuing operations $ (748) (1,872) 5,618 ==================================\nIDENTIFIABLE ASSETS: Healthcare services $ 39,035 35,683 41,067 Insurance services 74,817 99,301 101,945 Net assets of discontinued operations 42,215 50,011 52,596 Other 66,905 60,392 77,962 ---------------------------------- Total identifiable assets $ 222,972 245,387 273,570 ==================================\nOperating earnings (loss) are revenues less expenses other than corporate and interest expense, net of intersegment transactions. Depreciation and amortization amounts for 1995, 1994 and 1993 were $8,590,000, $11,836,000 and $16,474,000, respectively. Goodwill amortization for 1995, 1994 and 1993 was $3,620,000, $3,263,000 and $3,147,000, respectively. In January 1994, approximately $13 million of the $78 million other identifiable assets was used to purchase 382,350 shares of Seafield common stock from an institutional shareholder in a single transaction. Capital expenditures and depreciation and amortization expense for the significant segments are as follows:\n1995 1994 1993 ---------------------------------- (In thousands) Healthcare services: Capital expenditures $ 3,032 3,194 3,606 ================================== Depreciation and amortization $ 3,381 2,761 2,014 ================================== Insurance services: Capital expenditures $ 1,437 2,030 1,877 ================================== Depreciation and amortization $ 3,326 6,547 9,255 ==================================\nNOTE 7 - INCENTIVE STOCK OPTION PLAN\nSeafield has three Stock Option Plans which provide for Qualified and Nonqualified Stock Options, Stock Appreciation Rights (SAR's) and restricted stock awards to key employees and directors. The plans entitle the grantee to purchase shares at prices ranging from 75% to 110% of the fair market value at date of grant during terms up to ten years. All options have been awarded at 100% of fair market value. SAR's may be issued in tandem with stock options and entitle the holder to elect to receive the appreciated value in cash. Restricted stock awards were rights to receive or retain shares in payment of compensation earned or to be earned. During 1995, restricted stock awards of 60,604 shares became vested and were issued. As of December 31, 1995, there were no restricted stock awards outstanding. The following presents a summary of stock options activity for the three years ended December 31, 1995:\nNumber of Option Shares Price - -------------------------------------------------------------------------- Outstanding December 31, 1992 753,713 $ 21.500 - 43.250 Granted 33,500 32.000 - 34.875 Exercised 107,617 21.500 - 31.000 Terminated or forfeited 46,335 21.500 - 43.250 ----------------------------------- Outstanding December 31, 1993 633,261 21.500 - 34.875 Exercised 56,998 28.000 - 31.000 Terminated or forfeited 1,000 31.000 - 31.000 ----------------------------------- Outstanding December 31, 1994 575,263 21.500 - 34.875 Exercised 392,263 21.500 - 31.000 ----------------------------------- Outstanding December 31, 1995 183,000 $ 21.500 - 34.875 ===================================\nOptions for 173,665 shares were exercisable at December 31, 1995 and 130,000 shares were available to be awarded. The difference between the per share exercise price and the cost per share of the treasury stock issued for stock options exercised increased paid-in capital by $745,000 in 1995 and decreased paid in capital by $5,000 in 1994. Additionally, Seafield maintains a Stock Purchase Plan under which each participant's contribution is matched at a rate of 50%. Seafield common stock is purchased on the open market each month. Of the 100,000 shares registered under this plan, 66,345 shares were eligible for issuance at December 31, 1995.\nNOTE 8 - LEASE COMMITMENTS\nSeafield and subsidiaries lease office space, equipment, land and buildings under various, noncancelable leases that expire over the next several years. Rental expense for these leases during 1995, 1994 and 1993 amounted to $3,302,000, $3,868,000 and $3,038,000, respectively.\nFuture minimum lease payments under these agreements as of December 31, 1995 are as follows:\nYear Amount ------------------------- (In thousands) 1996 $ 2,724 1997 2,098 1998 1,338 1999 898 2000 599 Thereafter 1,092\nNOTE 9 - INVESTMENT SECURITIES\nA summary of investment securities information relating to quoted market values and holding gains and losses at December 31, 1995 and 1994 is in the following table.\nAmount at Which Amortized Market Shown in Cost Value Balance Holding Holding Sheet Gains Losses - --------------------------------------------------------------------------- (In thousands) December 31, 1995 - -----------------\nAvailable for Sale - ------------------ Common stock $ 4 4 4 -- -- Preferred stock 3,515 3,515 3,515 -- -- -------------------------------------------------------- $ 3,519 3,519 3,519 -- -- ========================================================\nHeld to Maturity - ---------------- Obligations of states and political subdivisions $ 6,848 6,840 6,848 3 (11) Canadian government notes 3,955 3,955 3,955 -- -- Certificate of deposit 362 362 362 -- -- Notes receivable 183 183 183 -- -- -------------------------------------------------------- $ 11,348 11,340 11,348 3 (11) ========================================================\nDecember 31, 1994 - -----------------\nAvailable for Sale - ------------------ Common stock $ 56 88 56 32 -- Preferred stock 3,515 3,515 3,515 -- -- -------------------------------------------------------- $ 3,571 3,603 3,571 32 -- ========================================================\nHeld to Maturity - ---------------- U.S. treasury securities $ 3,031 3,069 3,031 38 -- Obligations of states and political subdivisions 7,888 7,916 7,888 35 (7) Canadian government notes 3,326 3,326 3,326 -- -- Certificate of deposit 100 100 100 -- -- Notes receivable 326 326 326 -- -- -------------------------------------------------------- $ 14,671 14,737 14,671 73 (7) ========================================================\nAt December 31, 1995, debt securities will mature as follows:\nWithin Between 1 1 Year and 5 Years -------------------------- (In thousands) Available for sale $ -- 3,515 ========================== Held to Maturity 10,480 506 $ ==========================\nThe proceeds from sales of available for sale securities and the gross realized gains and losses on those sales are in the following table. Cost is determined by specific identification for computing realized gains and losses.\nYear ended December 31, 1995 1994 1993 - --------------------------------------------------------------------------- (In thousands) Proceeds $ 83 -- -- ================================== Gross realized gains $ 34 -- -- ================================== Gross realized losses (3) -- -- $ ==================================\nTrading securities primarily include United States treasury securities, common stock, money market funds and obligations of states and political subdivisions and totaled $65 million and $54 million at December 31, 1995 and 1994, respectively. The changes in net unrealized holding gains and losses on trading securities that have been included in earnings are losses of $485,000 and $2.2 million for the years ended December 31, 1995 and 1994, respectively, and a gain of $463,000 for the year ended December 31, 1993.\nSeafield has investments in two majority-owned entities that are publicly- traded. At December 31, 1995, based on the market prices of publicly traded shares of these two subsidiaries, pretax unrealized gains of approximately $130 million ($20.11 per share) on these investments were not reflected in either Seafield's book value or stockholders' equity.\nNOTE 10 - INCOME TAXES\nSeafield and those subsidiaries that are eligible file a consolidated U.S. federal income tax return. Prior to consolidation in Seafield's federal income tax return, various subsidiaries generated taxable losses of approximately $6.5 million. These net operating loss carryforwards are usable only against future taxable income of the corporation that generated the losses. Upon the disposition of the stock, in 1992, of the former employee benefits consulting services subsidiary, $4.1 million of net operating loss carryforwards were reattributed to Seafield. In 1994 and 1993, Seafield utilized approximately $1.1 million and $1.6 million of these reattributed losses, thereby reducing income tax expense by $389,000 and $534,000, respectively. The remainder of these net operating loss carryforwards will begin to expire in the year 2006.\nDuring 1995, Seafield generated approximately $6.6 million in current capital losses that exceeded capital gains. These losses are carried forward through the year 2000. Also, deferred capital losses of $5.7 million were generated on the write-off of Seafield's radiopharmaceutical subsidiary. Deferred income tax assets have been generated by these losses. Future realization of these tax assets or any existing deductible temporary differences or carryforwards ultimately depends on the existence of sufficient taxable income of the appropriate character within the carryover period. When it becomes more likely than not that a deferred tax asset will not be realized, a valuation allowance is accrued against that deferred tax asset.\nDuring 1995 and 1993, Response utilized approximately $1,710,000 and $1,374,000 of available federal net operating loss carryforwards resulting in tax benefits of $667,000 and $522,000, respectively. Response is not included in Seafield's consolidated federal income tax return. Response has remaining federal net operating loss carryforwards of approximately $4.9 million that are limited by the Internal Revenue Code and are available to offset only $475,000 of taxable income per year. These limited federal net operating losses are available annually until 2005. Response also has approximately $1,345,000 of federal net operating loss carryforwards which are not limited as to their utilization. These begin to expire in 2005.\nThe components of the provision (benefit) for income taxes on income from continuing operations are as follows:\nYear Ended December 31, 1995 1994 1993 - -------------------------------------------------------------------------- (In thousands) Current: Federal $ (1,785) 1,244 6,638 State 186 473 1,424 Foreign 170 769 1,311 ---------------------------------- (1,429) 2,486 9,373 ---------------------------------- Deferred: Federal (4,203) (1,674) (1,867) State (1,025) 73 (426) Foreign 94 (205) (89) ---------------------------------- (5,134) (1,806) (2,382) ---------------------------------- $ (6,563) 680 6,991 ==================================\nEarnings (loss) before income taxes: Domestic $ (6,410) (2,440) 12,281 Foreign 574 1,103 2,659 ---------------------------------- $ (5,836) (1,337) 14,940 ==================================\nThe reconciliation of income tax attributable to continuing operations computed at federal statutory tax rates to income tax expense is as follows:\nYear Ended December 31, 1995 1994 1993 - -------------------------------------------------------------------------- (In thousands) Computed expected tax expense(benefit) $ (1,984) (454) 5,079 State income taxes, net of federal benefit (564) 348 806 Goodwill amortization 1,214 1,087 1,070 Tax exempt interest and dividends (152) (302) (201) Tax benefits not available for subsidiary losses 261 1,063 156 Losses on sale of subsidiaries (4,239) -- -- Deferred tax on unremitted earnings of foreign subsidiaries 175 -- -- Other, net (456) (799) 530 Utilization of federal net operating loss (902) (389) (768) Foreign tax in excess of U.S. rate 84 126 319 ---------------------------------- Actual income tax expense (benefit) $ (6,563) 680 6,991 ==================================\nEffective rate 112% (51%) 47%\nThe significant components of deferred income tax assets and liabilities are as follows:\nDecember 31, 1995 1994 1993 - -------------------------------------------------------------------------- (In thousands) Current deferred income tax assets (liabilities): Valuation allowance on stock investments $ 269 661 255 Allowance on accounts receivable 703 1,008 994 Excess book expense accruals 718 877 629 Excess book accrued legal fees -- -- 572 Excess book partnership expenses -- -- 57 Other (22) 35 (164) Federal net operating loss carryforwards 151 43 -- State net operating loss carryforwards 923 8 80 ---------------------------------- Gross current deferred income tax assets 2,742 2,632 2,423 Current valuation allowance (1,202) (866) (802) ---------------------------------- Net current deferred income tax assets 1,540 1,766 1,621 ----------------------------------\nNon-current deferred income tax assets (liabilities): Valuation allowances on investments 2,151 19 19 Excess book (tax) expense accruals 392 321 326 Excess book (tax) accrued legal fees -- -- 27 Excess book (tax)partnership expenses 123 244 (37) Excess book (tax) oil and gas expenses 842 449 210 Excess book (tax) depreciation and amortization 1,048 900 (51) Alternative minimum tax credit 233 188 127 Other (150) (90) (1,216) Capital loss carryforwards 2,888 -- -- Federal net operating loss carryforwards 2,360 4,102 3,868 State net operating loss carryforwards 602 1,304 1,062 ---------------------------------- Gross non-current deferred income tax assets 10,489 7,437 4,335 Valuation allowance for non-current deferred income tax assets (3,490) (5,722) (5,058) ---------------------------------- Net non-current deferred income tax assets (liabilities) 6,999 1,715 (723) ---------------------------------- Net deferred income tax assets (liabilities) $ 8,539 3,481 898 ==================================\nThe valuation allowance as of January 1, 1993 was approximately $6,330,000. The valuation allowance decreased during 1995 by approximately $1,896,000, increased by $728,000 during 1994 and decreased by $470,000 during 1993.\nNOTE 11 - INTANGIBLE ASSETS\nThe cost and accumulated amortization of intangible assets are as follows:\nDecember 31, 1995 1994 - --------------------------------------------------------------------------- (In thousands) Goodwill - excess of cost over fair value of net assets acquired $ 29,804 43,571 Less accumulated amortization 11,774 16,297 -------------------- 18,030 27,274 -------------------- Laboratory patent, antibodies, antigens, and nicotine screens 8,000 11,845 Less accumulated amortization 6,739 10,062 -------------------- 1,261 1,783 --------------------\nOther intangible assets 252 1,300 Less accumulated amortization 66 1,039 -------------------- 186 261 -------------------- Intangible assets, net of accumulated amortization $ 19,477 29,318 ====================\nAny excess of the cost over the fair value of the net assets purchased is being amortized on a straight line basis over 5 to 20 years. The laboratory patent process is being amortized over 184 months from date of acquisition while antibodies, antigens, and nicotine screens are being amortized over their estimated remaining useful lives.\nNOTE 12 - NOTES PAYABLE\nNotes payable are as follows:\nDecember 31, 1995 1994 - --------------------------------------------------------------------------- Maturities Maturities Maturities Maturities Due Within Due After Due Within Due After One Year One Year One Year One Year ---------------------------------------------- (In thousands) Prime line of credit, secured by accounts receivable of $1,964,000 -- -- 2,475 -- Prime + 1 1\/2% line of credit secured by accounts receivable of $1,241,000 -- -- 268 -- Other -- -- 80 8 --------------------------------------------- $ -- -- 2,823 8 =============================================\nLine of credit agreements totaled $7.5 million at December 31, 1995 and expire in 1996. Available borrowings under these agreements amounted to $7,500,000. Affiliates' debt at December 31, 1995 totaled $493,000 which arose under lines of credit. The Consolidated Statements of Operations include interest expense totaling $124,000, $309,000, and $527,000 in 1995, 1994 and 1993, respectively. The weighted average interest rates on borrowings outstanding for 1995 and 1994 were 8.82% and 6.57%, respectively.\nNOTE 13 - DISCONTINUED OPERATIONS\nOperations of Discontinued Real Estate Segment\nIn 1992, Seafield's board of directors approved a plan to discontinue real estate operations. As a result of this decision, a $6 million after-tax loss provision for estimated write-downs and costs through final disposition was included in the discontinued real estate's 1992 loss. Additional after-tax losses of $2.9 million and $6.6 million were recorded in 1994 and 1995, respectively. The 1994 loss was recorded for a sales contract signed in January 1995. The 1995 increase in the valuation allowance reflects values based on recent sales transactions of undeveloped land parcels and sales activity at the residential project in New Mexico. The remaining real estate assets will be sold as soon as practicable.\nA summary of discontinued real estate operations follows:\nYear Ended December 31, 1995 1994 1993 - -------------------------------------------------------------------------- (In thousands)\nRevenues $ 11,912 11,991 18,320 =================================== Loss $ (10,000) (4,400) -- Income tax benefits (3,400) (1,496) -- ----------------------------------- Net loss $ (6,600) (2,904) -- ===================================\nNet Assets of Discontinued Real Estate Segment\nA summary of the net assets of the discontinued real estate operations follows:\nDecember 31, 1995 1994 - -------------------------------------------------------------------------- (In thousands) Assets Current assets $ 281 956 Real estate 35,021 38,584 Other non-current assets 8,979 13,555 -------------------- Total assets 44,281 53,095 -------------------\nLiabilities Current liabilities 777 209 Non-current liabilities 1,289 2,875 -------------------- Total liabilities 2,066 3,084 -------------------- Net Assets $ 42,215 50,011 ====================\nAt December 31, 1995, real estate debt totaled $7.6 million, of which $6.3 million was recourse debt.\nNOTE 14 - QUARTERLY FINANCIAL DATA (UNAUDITED)\nSummarized 1995 quarterly financial data is as follows:\nMar. 31, Jun. 30, Sep. 30, Dec. 31, Quarter Ended 1995 1995 1995 1995 - --------------------------------------------------------------------------- (In thousands except per share amounts)\nRevenues $ 33,428 32,764 28,226 25,126 ========================================\nEarnings (loss) from continuing operations $ (567) 1,643 (1,591) (233) Loss from discontinued real estate operations -- -- -- (6,600) ---------------------------------------- Net earnings (loss) $ (567) 1,643 (1,591) (6,833) ========================================\nPer share: Earnings (loss) from continuing operations $ (.09) .26 (.25) (.04) Loss from discontinued real estate operations -- -- -- (1.02) ---------------------------------------- Net earnings (loss) $ (.09) .26 (.25) (1.06) ========================================\nDividends paid per share $ .30 .30 .30 .30 ======================================== Stock prices: High $ 38 3\/4 40 5\/8 38 37 1\/2 Low $ 32 1\/8 34 33 33 1\/4\nSummarized 1994 quarterly financial data is as follows:\nMar. 31, Jun. 30, Sep. 30, Dec. 31, Quarter Ended 1994 1994 1994 1994 - --------------------------------------------------------------------------- (In thousands except per share amounts)\nRevenues $ 29,550 30,934 31,557 32,237 ========================================\nEarnings (loss) from continuing operations $ 648 47 (1,745) (822) Loss from discontinued real estate operations -- -- -- (2,904) ---------------------------------------- Net earnings (loss) $ 648 47 (1,745) (3,726) ========================================\nPer share: Earnings (loss) from continuing operations $ .10 .01 (.27) (.12) Loss from discontinued real estate operations -- -- -- (.46) ---------------------------------------- Net earnings (loss) $ .10 .01 (.27) (.58) ========================================\nDividends paid per share $ .30 .30 .30 .30 ======================================== Stock prices: High $ 41 1\/4 40 1\/2 38 1\/4 37 1\/4 Low $ 33 1\/2 38 1\/2 35 1\/2 30 3\/4\nSee Note 13 of Notes to Consolidated Financial Statements for a description of discontinued operations which affected the results of operations for the quarters shown above. Quarterly earnings per share amounts may not add to the annual earnings per share amounts due to the effect of common stock equivalents and the timing of treasury stock purchases and net earnings.\nSEAFIELD CAPITAL CORPORATION AND SUBSIDIARIES Schedule II Valuation and Qualifying Accounts and Reserves\n- --------------------------------------------------------------------------- Additions ----------------- Charged Charged Balance at to Costs to Other Balance at Beginning and Accounts- End of Description of Year Expenses Describe Deductions* Year - --------------------------------------------------------------------------- (In thousands) Year ended December 31, 1995 Accounts and notes receivable - allowance for doubtful accounts $ 4,637 2,935 -- 4,258 3,314\nYear ended December 31, 1994 Accounts and notes receivable - allowance for doubtful accounts 4,589 2,671 -- 2,623 4,637\nYear ended December 31, 1993 Accounts and notes receivable - allowance for doubtful accounts 2,385 3,068 -- 864 4,589\n* Uncollectible accounts written-off\nSEAFIELD CAPITAL CORPORATION AND SUBSIDIARIES Schedule III Real Estate and Accumulated Depreciation December 31, 1995 (Page 1 of 2)\nCosts Capitalized Gross Amount Initial Cost Subsequent At Which Carried to Company to Acquisition at December 31, 1995 ----------------- ----------------- ---------------------- Buildings & Buildings & Improve- Improve- Carrying Improve- Description Land ments ments Costs Land ments Total - ------------------------------- ----------------- ---------------------- (In thousands) Land Investments\/ Developments: Houston, TX $ 6,158 49 1,014 1,553 4,321 -- 4,321 Tulsa, OK 754 -- -- 754 -- 754 Ft Worth, TX 11,501 -- 91 -- 7,720 -- 7,720 Ft Worth, TX 3,886 -- -- -- 3,886 -- 3,886 Ft Worth, TX 2,770 -- -- 42 2,812 -- 2,812 Ft Worth, TX 4,633 -- -- -- 4,633 -- 4,633 Ft Worth, TX 1,000 -- -- -- 665 -- 665 Olathe, KS 3,292 -- 46 -- 2,484 -- 2,484\nParking: Reno, NV -- 5,277 19 -- -- 5,296 5,296\nResidential: Juno Beach, FL 8,400 -- 24,343 2,246 223 3,783 4,006 Juno Beach, FL 5,340 -- 8,626 443 1,105 2,580 3,685 Santa Fe, NM 4,576 -- 65,122 17,054 1,369 27,711 29,080 -------------------------------------------------------------- $ 52,310 5,326 99,261 21,338 29,972 39,370 69,342 ==================================================\nReserves (33,028) ------- Net real estate before depreciation 36,314 Accumulated depreciation (1,293) ------- Net real estate $ 35,021 =======\nSEAFIELD CAPITAL CORPORATION AND SUBSIDIARIES Schedule III Real Estate and Accumulated Depreciation December 31, 1995 (Page 2 of 2)\nDate Accum. Tax Constr. Date Depr. Description Reserves Depr. Basis Began Acquired Life - --------------------------------------------------------------------------- (In thousands) Land Investments\/ Developments Houston, TX 890 -- 4,615 -- 1974 -- Tulsa, OK 579 -- 754 -- 1980 -- Ft Worth, TX 5,404 -- 7,495 -- 1986 -- Ft Worth, TX 3,487 -- 3,886 -- 1986 -- Ft Worth, TX 2,642 -- 1,932 -- 1984 -- Ft Worth, TX 4,327 -- 2,203 -- 1989 -- Ft Worth, TX 629 -- 665 -- 1986 -- Olathe, KS -- -- 2,681 -- 1991 --\nParking: Reno, NV 1,500 1,293 4,572 -- 1989 20 yrs\nResidential: Juno Beach, FL 4,100 -- 1,043 1985 1983 -- Juno Beach, FL -- -- 4,297 1989 1983 -- Santa Fe, NM 9,470 -- 23,044 1987 1985 -- ------------------------ 33,028 1,293 57,187 =========================\nSEAFIELD CAPITAL CORPORATION AND SUBSIDIARIES Schedule III Real Estate and Accumulated Depreciation Reconciliation Between Years\nA) Reconciliations of total real estate carrying value for the three years ended December 31, 1995 are as follows:\n1995 1994 1993 - --------------------------------------------------------------------------- (In thousands) Balance at beginning of year $ 39,665 38,921 46,346\nAdditions during year: Improvements 16,539 11,689 7,014 Consolidate joint venture -- 3,292 -- ---------------------------------- 56,204 53,902 53,360\nDeductions during year: Value of real estate sold 9,890 9,837 14,439 Provision for loss on sale of real estate 10,000 4,400 -- ---------------------------------- 19,890 14,237 14,439 ---------------------------------- Balance at end of year $ 36,314 39,665 38,921 ==================================\nB) Reconciliations of accumulated depreciation for the three years ended December 31, 1995 are as follows:\n1995 1994 1993 - --------------------------------------------------------------------------- (In thousands) Balance at beginning of year $ 1,081 868 655\nAdditions during year - depreciation 212 213 213 ---------------------------------- 1,293 1,081 868\nDeductions during year - accumulated depreciation of real estate sold -- -- -- ---------------------------------- Balance at end of year $ 1,293 1,081 868 ==================================","section_15":""}
{"filename":"356858_1995.txt","cik":"356858","year":"1995","section_1":"ITEM 1: BUSINESS\nFirst Banking Center, Inc.\nFirst Banking Center, Inc. (the Corporation) is a multi-bank holding company incorporated as a business corporation under the laws of the State of Wisconsin on August 24, 1981. In April, 1982, the Corporation became the sole owner of First Bank and Trust Company, Burlington, Wisconsin, a Wisconsin state banking corporation. On September 1, 1984, the Corporation acquired 100% of the capital stock of the Bank of Albany, Albany, Wisconsin, a Wisconsin state banking corporation.\nOn January 1, 1985, the name of the Corporation was changed from the First Community Bank Group, Inc. to the First Banking Center, Inc., and the name of the subsidiary companies were changed to First Banking Center - Burlington and First Banking Center - Albany. respectively.\nThe Corporation's primary business activity is the ownership and control of these banks. The Corporation also provides administrative and operational services for the banks.\nFirst Banking Center - Burlington\nThe Bank was organized in 1920 and is a full service commercial bank located in the City of Burlington, Wisconsin. The Bank has branch offices located in Burlington, Kenosha, Lake Geneva, Lyons, Union Grove, Walworth, Wind Lake, and Whitewater, Wisconsin. The bank offers a wide range of services which includes: Loans, Personal Banking, Trust and Investment Services, and Insurance and Annuity Products.\nLending The lending area provides a wide variety of credit services to commercial and individual consumers. Consumer lending consists primarily of residential mortgages, installment loans, home equity loans, and student loans. Commercial lending consists of commercial property financing, equipment and inventory financing, and real estate development, as well as the financing of agricultural production, farm equipment, and farmland. Commercial lending usually involves a greater degree of credit risk than consumer lending. This increased risk requires higher collateral value to loan amount than may be necessary on some consumer loans. The collateral value required on a commercial loan is determined by the degree of risk associated with that particular loan.\nPersonal Banking This area provides a wide variety of services to customers such as savings plans, certificates of deposit, checking accounts, individual retirement accounts, securities services, discount brokerage, and other specialized services.\nTrust and Investments The Trust Department provides a full range of services to individuals, corporations and charitable organizations. It provides such specific services as investment advisory, custodial, executor, trustee and employee benefit plans.\nInsurance and Annuity Products This area provides a complete line of life insurance as well as long-term health care, fixed and variable rate annuities, and mutual funds.\nFirst Banking Center - Albany\nThe Bank was organized in 1892 and is a full service commercial bank located in the Village of Albany, Green County, Wisconsin. The bank is located approximately 65 miles west of Burlington. The bank has a branch office located in Monroe, Wisconsin, which was established in December of 1992. The bank offers credit services primarily to business and individual customers. Credit services offered include lines of credit, term loans, automobile financing, personal loans, and residential and commercial mortgages. The bank's retail services include checking accounts, savings plans, certificates of deposit, individual retirement accounts, and other specialized services.\nCOMPETITION\nThe financial services industry is highly competitive. The subsidiary banks compete with other commercial banks and with other financial institutions including savings and loan associations, finance companies, mortgage banking companies, insurance companies, brokerage firms, and credit unions.\nSUPERVISION AND REGULATION\nThe Company is a bank holding company subject to the supervision of the Board of Governors of the Federal Reserve System under the Bank Holding Company Act of 1956, as amended. As a bank holding company, the Company is required to file an annual report and such additional information with the Board of Governors as the Board of Governors may require pursuant to the Act. The Board of Governors may also make examinations of the Company and its subsidiaries.\nThe Bank Holding Company Act requires every bank holding company to obtain the prior approval of the Board of Governors before it may acquire substantially all the assets of any bank, or ownership or control of any voting shares of any bank if, after such acquisitions, it would own or control, directly or indirectly, more than 5% of the voting shares of such bank. Under existing federal and state laws, the Board of Governors may approve the acquisition by the Company of the voting shares of, or substantially all the assets of, any bank located in states specified in the Wisconsin Interstate Banking Bill which became effective January 1, 1987.\nIn addition, a bank holding company is generally prohibited from itself engaging in, or acquiring direct or indirect control of voting shares of any company engaged in non-banking activities. One of the principal exceptions to this prohibition is for activities found by the Board of Governors, by order or regulation to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. Some of the activities that the Board of Governors has determined by regulation to be closely related to banking are making or servicing loans, full payout property leasing, investment advisory services, acting as a fiduciary, providing data processing services and promoting community welfare projects.\nSubsidiary banks of a bank holding company are subject to certain restrictions imposed by the Federal Reserve Act on any extensions of credit to the bank holding company or any of its subsidiaries, on investments in the stock or other securities thereof, and on the taking of such stock or securities as collateral for loans to any borrower. Further, under the Bank Holding Company Act and regulations of the Board of Governors, a bank holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property or furnishing of services.\nThe Company is also subject to the Securities Exchange Act of 1934 and has reporting obligation to the Securities and Exchange Commission.\nThe business of banking is highly regulated and there are various requirements and restrictions in the laws of the United States and the State of Wisconsin affecting the Company's subsidiary banks and their operations, including the requirement to maintain reserves against deposits, restrictions on the nature and amount of loans which may be made by the banks and restrictions relating to investment, branching and other activities of the banks.\nThe Company is supervised and examined by the Federal Reserve Board. The Company's subsidiary banks, as state chartered institutions, are subject to the supervision of, and are regularly examined by, Wisconsin state authorities. Banks are also members of the Federal Deposit Insurance Corporation and as such are subject to regulation and examination by that agency.\nThe Company, under Federal Reserve Board policy, is expected to act as a source of financial strength to each subsidiary bank and to commit resources to support each of the subsidiaries.\nGOVERNMENTAL POLICIES\nThe earnings of the Company's subsidiary banks as lenders and depositors of money are affected by legislative changes and by the policies of the various regulatory authorities including the State of Wisconsin, the United States Government, foreign governments and international agencies. The effect of this regulation upon the future business and earnings of the Company cannot be predicted. Such policies include, among others, statutory maximum lending rates, domestic monetary policies of the Board of Governors of the Federal Reserve System, United States fiscal policies and international currency regulations and monetary policies. Governmental and Reserve Board policies have had a significant effect on the operating results of commercial banks in the past and are expected to do so int the future. Management is not able to anticipate and evaluate the future impact of such policies and practices on the growth and profitability of the Company or its subsidiary banks.\nMATERIAL DEPOSIT AND LOANS\nNo single borrower accounted for a material portion for a material portion of the loans in the subsidiary banks.\nNo single depositor accounted for a material portion of deposits in the subsidiary banks.\nEMPLOYEES\nThe Company and its staff share a commitment to equal opportunity. All personnel decisions are made without regard to race, color, religion, sex, age, national origin, handicap or veteran status. At March 15, 1996, the Company and its subsidiaries had 158 full and part-time employees.\nMISCELLANEOUS\nThe business of the Company is not seasonal. To the best of management's knowledge, there is not anticipated material effect upon the Company's capital expenditures, earnings, and competitive position by reason of any laws regulating or protecting the environment. The Company has no material patents, trademarks, licenses, franchises or concessions. No material amounts have been spent on research activities and no employees are engaged full time in research activities.\nNOTE: Subsections of Item I, to which no response has been made are inapplicable to the business of the Company.\nFIRST BANKING CENTER, INC.\nBurlington, Wisconsin\nSELECTED FINANCIAL DATA\nThe Company, through the operations of its Banks, offers a wide range of financial services. The following financial data provides a detailed review of the Company's business activities.\nThe following information shows: the company's average assets, liabilities and stockholder's equity; the interest earned and average yield on interest- earning assets; the interest paid and average rate on interest-bearing liabilities; and the maturity schedules for investment and specifies loans; for the years ended December 31, 1995, 1994, and 1993. Also, where applicable, information is presented for December 31, 1992 and 1991.\nSection I\nSchedule A\nFIRST BANKING CENTER, INC.\nDISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS' EQUITY\nAverage Balance Sheet\n(000's Omitted)\n1995 1994 1993 Cash and due from banks $ 8,648 6,637 9,733 Fed. funds sold and securities purchased under agreement to resell 5,191 1,534 3,839 Interest bearing deposits in other banks 3,180 4,431 8,955\nInvestment securities: U.S. Treasury agency and other 48,073 42,873 26,629 States and political subdivisions 8,829 10,1921 3,013 Unrealized Gain\/(Loss) on Securities (672) (395)\nLoans: Real estate mortgages 68,019 63,394 57,699 Consumer - net 12,183 12,007 8,712 Commercial and other 82,742 71,578 63,688 Total 162,944 146,979 130,099 Less allowance for loan losses 2,200 1,989 1,860\nNet loans 160,744 144,990 128,239\nOther assets 9,709 7,598 6,651\nTotal assets $ 243,702 217,860 197,059\nInterest bearing deposits: NOW accounts $ 18,705 16,619 13,774 Savings deposits 26,163 26,850 22,696 Money Market deposit accounts 34,849 37,569 34,892 Time deposits 85,454 72,817 72,204 Total interest bearing deposits 165,171 153,855 143,566\nDemand deposits 26,563 23,945 20,061\nTotal deposits 191,734 177,800 163,627 Short-term borrowings 766 1,418 680 Sec. sold under agreements to repurchase 17,112 10,017 6,614 Other liabilities 2,443 1,566 1,951 Long-Term Borrowings 9,186 6,745 5,125\nTotal liabilities 221,241 197,546 177,997\nEquity capital 22,461 20,314 19,062\nTotal liabilities and capital $ 243,702 217,860 197,059\nSECTION I Schedule B\nSECTION I\nSchedule C\nFIRST BANKING CENTER, INC.\nTwo Year Summary of Rate and Volume Variances\n(000's Omitted)\n$ AMOUNT VOLUME RATE (a) OF CHANGE VARIANCE VARIANCE\nIncrease (decrease) for 1995: Time deposits in banks $ 3 (49) 52 Investment (taxable) (b) 540 291 249 Investments (nontaxable) (b) (c) (123) (117) (6) Funds sold 253 131 122 Loans (d) 2,849 1,330 1,519 Total interest income 3,522 1,586 1,936\nNOW accounts 78 55 23 Savings deposits (22) (20) (2) Money Market deposit accounts 160 (89) 249 Other time deposits 1,456 581 875 Short-term borrowings (3) (23) 20 Long-term Borrowings 510 295 215 Securities sold under Agreement to Repurchase 152 127 25 Total interest expense 2,331 926 1,405\nNet change for 1995 $ 1,191 660 531\nIncrease (decrease) for 1994: Time deposits in banks $ (164) (175) 11 Investment (taxable) 800 976 (176) Investments (nontaxable) (294) (253) (41) Funds sold (58) (68) 10 Loans 629 1,518 (889) Total interest income 913 1,998 (1,085)\nNOW accounts 38 83 (45) Savings deposits 57 135 (78) Money Market deposit accounts (27) 96 (123) Other time deposits (141) 30 (171) Short-term borrowings 36 17 19 Long-term Borrowings 87 84 3 Securities sold under Agreement to Repurchase 127 149 (22) Total interest expense 177 594 (417)\nNet change for 1994 $ 736 1,403 (666)\n(a) The application of the rate\/volume variance has been allocated in full to the rate variance. (b) Portions of investments both taxable and nontaxable have been presented on a state taxable equivalent basis assuming a 7.9% tax rate. (c) The interest and average yield for nontaxable securities are presented on a federal taxable equivalent basis assuming a 34% tax rate. (d) Loans placed on nonaccrual status have been included in average balances used to determine average rates.\nSECTION II\nSchedule A\nFIRST BANKING CENTER, INC.\nBook Value of Investment Portfolio\n(000's Omitted)\nAvailable for Sale: U.S. Treasury and other U.S. Gov't. Agencies and Corps. $ 25,762 Other 4,330\nHeld to Maturity: U.S. Treasury and other U.S. Gov't Agencies and Corporations 17,284 Obligs. of states and pol. subs. 11,377 Other 1,244\nTotal $ 59,997\n1995 (b) 1993 (b)\nU.S. Treasury and other U.S. Gov't Agencies and Corporations $ 37,797 35,250 Obligs. of states and pol. subs. 8,914 13,551 Other 5,076 5,887\nTotal $ 51,787 54,688\n(a) The aggregate book value of securities from any single issuer does not exceed ten percent of stockholder's equity; except for, securities issued by the U.S. Government and U.S. Government agencies and corporations.\n(b) Prior to January 1, 1994 and the implementation of FASB115, all securities were classified as securities held for investment.\nSECTION II Schedule B\nSECTION III\nSchedule A\nFIRST BANKING CENTER, INC.\nLoan Summarization\n(000's Omitted)\nDecember 31, 1995 1994 1993 1992 1991 Commercial $ 27,659 27,713 24,908 16,887 35,877 Agricultural production 5,810 6,163 7,593 9,376 7,235 Real Estate: Construction 20,652 14,437 13,213 10,463 6,149 Commercial 37,005 33,027 23,663 25,805 3,466 Agriculture 733 1,014 1,646 2,229 3,658 Residential 67,729 66,004 56,548 47,726 44,079 Municipal 3,806 2,341 2,815 2,682 2,052 Consumer 6,961 7,074 7,201 10,843 10,876 TOTAL $ 170,355 157,773 137,587 126,011 113,392\nSECTION III\nSchedule B\nSECTION III\nSchedule C FIRST BANKING CENTER, INC.\nSummary of Nonperforming Loans\n(000's Omitted)\nDECEMBER 31,\n1995 1994 1993 1992 1991\nNonaccrual Loans $ 1,501 778 1,754 551 444 Past Due 90 days + (1) 2 ---- ------ ---- ---- Restructured Loans (2) ------ ---- ------ ---- ----\nNotes:\n(1) Loans are placed in nonaccrual status when contractually past due 90 days or more.\n(2) There were no restructured loans for each of the presented years.\n(3) Interest which would have been recorded had the loans been on the accrual basis, would have amounted to $25,000 in 1995, $12,000 in 1994, $95,000 in 1993, $11,000 in 1992, and $18,000 in 1991. Interest income on these loans, which is recorded only when received, amounted to $7,000 in 1995, $4,000 in 1994, $2,000 in 1993, $11,000 in 1992, and $12,000 in 1991.\n(4) Each of the loans which are contractually past due 90 days or more as to principal or interest payments are reviewed by management and reported to the Loan Committee of the Board of Directors of each Bank. These loans are then placed on a nonaccrual basis.\n(5) As of December 31, 1995, management, to the best of its knowledge, is not aware of any significant loans, group of loans or segments of the loan portfolio not included above, where there are serious doubts as to the ability of the borrowers to comply with the present loan payment terms.\nSECTION IV\nSchedule A\nFIRST BANKING CENTER, INC.\nAnalysis of The Allowance for Loan Losses\n(000's Omitted)\n1995 1994 1993 1992 1991 Beginning loan loss reserve $ 2,095 1,886 1,714 1,393 1,147\nCharge-offs: Commercial 22 4 167 58 0 Agricultural prod 0 1 5 0 67 Real Estate: Construction 0 0 114 0 0 Commercial 0 0 190 0 0 Agriculture 0 0 0 0 0 Other Mortgages 214 198 29 0 0 Installment - consumer 55 102 99 50 154\nRecoveries: Commercial 19 68 6 16 0 Agricultural prod 0 3 10 0 11 Real Estate: Construction 0 113 2 0 0 Commercial 0 0 0 0 0 Agriculture 0 0 17 0 0 Other Mortgages 2 13 2 2 4 Installment - consumer 41 47 29 33 36\nNet Charge-offs 231 61 538 57 170\nAdditions charged to operations (1) 470 270 710 378 416\nBalance at end of period $ 2,336 2,095 1,886 1,714 1,393\nRatio of net charge-offs during the period to ave. loans outstanding during the period 0.14% 0.04% 0.42% 0.05% 0.16%\nNote: (1) For each year ending December 31, the determination of the additions to loan loss reserve charged to operating expenses was based on an evaluation of the loan portfolio, current domestic economic conditions, past loan losses and other factors.\nSECTION IV\nSchedule B\nFIRST BANKING CENTER, INC.\nThe allowance for loan losses is based on an evaluation of risk in the loan portfolio, current domestic economic conditions, past loan losses and other factors. The majority of risk in the loan portfolio lies in commercial loans, which include commercial real estate, agricultural production, and construction loans. The Company has allocated $1.3 million or 56% of the allowance to these loans. These loans comprise about 56% of the loan portfolio. Residential mortgages carry a small element of risk and comprise about 40% of the loan portfolio. One hundred seventy thousand dollars of the allowance or about 7% has been allocated to residential morgages. Consumer loans comprise about 4% of the loan portfolio and $90 thousand or about 4% of the allowance is allocated to consumer loans. The company has allocted $25 thousand dollars of the allowance to unfunded loan commitments which total approximately $24 million dollars. The balance of the allowance or $741 thousand is unallocated.\nSECTION V\nSchedule A\nFIRST BANKING CENTER, INC.\nThree Year Summary of Average Deposits\n(000's Omitted)\nRate Rate Rate 1995 Paid 1994 Paid 1993 Paid Deposit in domestic bank offices: Non-interest bear. demand $ 26,563 23,945 20,061 Interest-bearing demand 18,705 2.77% 16,619 2.65% 13,774 2.93% Money Market demand 34,849 3.99% 37,569 3.29% 34,892 3.60% Savings deposits 26,163 2.95% 26,850 2.95% 22,696 3.24% Time Deposits 85,454 5.63% 72,817 4.60% 72,204 4.84%\nTotal Deposits $ 191,734 3.90% 177,800 3.27% 163,627 3.60%\nSECTION V\nSchedule B\nFIRST BANKING CENTER, INC.\nMaturity Schedule for Time Deposits of $100,00 or More\n(000's Omitted)\nFor Year Ending December 31, 1995: Over Over Over 3 Mos. 3 Mos. 6 Mos. 12 Mos.\nCertificates of Deposit $ 1,453 2,940 4,205 821 Other Time Deposits 0 108 0 107\nTOTAL $ 1,453 3,048 4,205 928\nSECTION VI\nFIRST BANKING CENTER, INC.\nThree Year Summary of Return on Equity and Assets\n1995 1994 1993\nReturn on average assets 1.15% 1.09% 1.11%\nReturn on average equity 12.48% 11.64% 11.44%\nDividend payout ratios on common stock 20.94% 22.36% 22.17%\nAverage equity to average assets 9.22% 9.32% 9.67%\nSECTION VII\nFIRST BANKING CENTER, INC.\nShort-term Borrowings\n(000's Omitted)\nSecurities sold under agreements to repurchase (1)\nEnd of Year: 1995 1994 1993 Balance $ 20,225 13,755 9,588 Weighted Ave. Rate 5.48% 4.18% 3.75%\nFor the Year: Maximum Amount Outstanding $ 20,225 13,755 9,588 Average Amount Outstanding $ 17,112 10,017 6,614 Weighted Average Rate 5.39% 4.16% 4.38%\n(1) Securities sold under repurchase agreements are borrowed on a short-term basis by the subsidiary banks at prevailing rates for these funds. The approximate average maturity for these borrowings is 3.6 months, 3.7 months, and 4 months for the years 1995, 1994, and 1993 respectively.\nITEM 2:","section_1A":"","section_1B":"","section_2":"ITEM 2: PROPERTIES\nThe Company owns no properties; it currently occupies space in the building that houses the Lake Geneva branch. Since January 1, 1995 the company has been making rent payments to First Banking Center - Burlington for the space that it occupies and the equipment it uses.\nBurlington\nThe Bank owns banking facilities in Burlington, Lyons, Wind Lake, Kenosha and Lake Geneva. A portion of the building in Lake Geneva is owned by a partnership of which the Bank is a 50% owner. The bank leases space for its bookkeeping and loan operations departments in the portion of the building owned by the partnership. Each of the banks offices is well maintained and adequately meets the needs of the bank. The bank leases office space in Walworth, Union Grove, and Whitewater.\nAlbany\nThe bank owns banking offices in Albany and Monroe. Both structures are well maintained and adequately meet the needs of the bank.\nITEM 3:","section_3":"ITEM 3: LEGAL PROCEEDING\nNeither the Corporation nor it subsidiaries is a party, nor is any of their property, subject to any material existing or pending legal proceedings other than ordinary routine litigation incidental to its business. No officer, director, affiliate of the Corporation, or any of their associates is a party to any material proceedings adverse to the Corporation or its subsidiaries.\nITEM 4:","section_4":"ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo items were submitted during the fourth quarter of the fiscal year covered by this report to a vote of the security holders through the solicitation of proxies or otherwise.\nPART II\nITEM 5:","section_5":"ITEM 5: MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nMarket price of common stock and related matters are presented on page 10 of the Annual Report to Shareholders for the year ended December 31, 1995 and are incorporated herein by reference.\n(a) There were 792 holders of record of the Company's $1.00 par value common stock on March 1, 1996.\nITEM 6:","section_6":"ITEM 6: SELECTED FINANCIAL DATA\nSelected financial data is presented in the Annual Report Shareholders for the year ended December 31, 1995 and 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 is presented in the Annual Report to Shareholders for the year ended December 31, 1995 and is incorporated herein by reference.\nITEM 8:","section_7A":"","section_8":"ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA\nThe following consolidated financial statements of the Registrant and its subsidiaries included in the Annual Report to Shareholders for the year ended December 31, 1995 are incorporated herein by reference:\nReport of Independent Certified Public Accountants Consolidated Balance Sheets December 31, 1995 and 1994 Consolidated Statements of Income Years ended December 31, 1995, 1994, and 1993 Consolidated Statements of Changes in Components of Stockholder's Equity Years ended December 31, 1995, 1994 and 1993 Consolidated Statements of Cash Flows Years ended December 31, 1995, 1994, and 1993 Notes to Consolidated Financial Statements\nITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA\nThe Company had no disagreement with the accountants regarding any information presented.\nPART III\nITEM 10:","section_9":"","section_9A":"","section_9B":"","section_10":"ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information called for herein is presented in the proxy statement to be furnished in connection with the solicitation of proxies on behalf of the Board of Directors of the Registrant for use at its Annual Meeting to be held on Tuesday, April 16, 1996, is incorporated herein by reference.\nITEM 11:","section_11":"ITEM 11: EXECUTIVE COMPENSATION\nThe information called for herein is presented in the proxy statement to be furnished in connection with the solicitation of proxies on behalf of the Board of Directors of the Registrant for use at its Annual Meeting to be held on Tuesday, April 16, 1996, is incorporated herein by reference.\nITEM 12:","section_12":"ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information called for herein is presented in the proxy statement to be furnished in connection with the solicitation of proxies on behalf of the Board of Directors of the Registrant for use at its Annual Meeting to be held on Tuesday, April 16, 1996, is incorporated herein by reference.\nITEM 13:","section_13":"ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\n(a) Transactions with management and other None\n(b) Certain business relationships None\n(c) Indebtedness of management This information is presented in Note E of the Annual Report to Shareholders, and is incorporated herein by reference.\n(d) Transactions with promoters None\nPART IV\nITEM 14:","section_14":"ITEM 14: EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS AND FORM 8-K\n(a) (1) Financial Statements (see ITEM 8 for listing).\n(2) Financial Statement Schedules (all required schedules not applicable).\n(3) Exhibits\n(3.1) Articles of Incorporation have been submitted with previous 10-K reports.\n(13) 1995 Annual Report to Shareholders\n(22) Notice of Annual Meeting and Proxy Statement.\n(b) Reports on Form 8-K None\n(c) Financial Statements and Financial Statement Schedules required to be filed as part of this report are included in Note T of the Annual Report To Shareholders.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the 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 BANKING CENTER, INC. Registrant\nDate: March 25, 1995 By ROMAN BORKOVEC Roman Borkovec 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.*\nROMAN BORKOVEC JAMES SCHUSTER Roman Borkovec James Schuster Chief Executive Officer Principal Accounting Officer\nMELVIN WENDT RICHARD MCKINNEY Melvin Wendt, Director Richard McKinney, Director\nJOHN SMITH JOHN ERNSTER John Smith, Director John Ernster, Director\nDAVID BOILINI DEAN HOULBERG David Boilini, Director Dean Houlberg, Director\n*Each of the above signatures is affixed as of March 25, 1996.\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.\n(a) Annual Report to shareholders\n(b) All proxy material in connection with the 1995 Annual Shareholders Meeting. Above items will be furnished to shareholders subsequent to this filing.","section_15":""}
{"filename":"792723_1995.txt","cik":"792723","year":"1995","section_1":"ITEM 1. BUSINESS\nOctel Communications Corporation (Octel or the Company) is a world leader in voice processing technology, with a market share estimated by Dataquest to be approximately 23%. Octel's voice processing technology integrates with both telephone and data networks. The Company's broad array of products and services allows users to communicate more effectively by making it simple to deliver and exchange information over world-wide communications networks. Over 29 million Octel mailboxes have been deployed in over 40 countries. The Company sells and supports hardware and software and is a major provider of voice messaging services in both the public and private sectors. The Company's products and services enable people to send voice and fax messages to each other and to have their telephones and fax calls answered by a voice mail system. Octel's 18,000 customers include many small and medium-sized businesses, large international corporations (including over 70% of the Fortune 50), universities, governments, major telephone companies and many major cellular providers worldwide.\nThe Company was reincorporated in Delaware in December 1989 as the successor to a California corporation and a related corporation and research and development limited partnership first formed in 1982.\nINTRODUCTION\nOver the past few years, the communications environment has broadened substantially. The demand for communications has created many different options such as voice messaging, telephone answering, telecommunications, fax, paging, overnight couriers, radio systems, postal delivery systems and the Internet for both business and personal use. Because of information's great importance, communication tools are more pervasive and important in people's lives than ever before. The Company's customers use voice messaging technology to meet a number of objectives, including increased efficiency, improved customer service, enhanced business competitiveness, increased operating flexibility and greater employee productivity. Voice messaging allows the user to be accessible 24 hours a day. With fax processing capabilites, subscribers can efficiently receive, store, retrieve and redirect fax documents using any touch-tone phone.\nVoice messaging has a number of advantages over electronic mail (e-mail) and other communication mediums. Voice messaging:\n- - TAKES ADVANTAGE OF THE ACCESSABILITY OF THE TELEPHONE TO SEND AND RECEIVE MESSAGES. Users can send or listen to voice messages from nearly any telephone at any time. E-mail requires that users have access to a computer. Computer access while traveling or at home can be inconvenient or not readily available.\n- - IS SIMPLE, FAST AND CONVENIENT. Speech is one of our most basic skills. Voice messaging allows users to take advantage of this skill and to convey emotions, humor, subtlety and nuance in a message-characteristics that are much more difficult to duplicate in a written format. Furthermore, voice messages are quick and easy to create and send.\n- - DOESN'T REQUIRE A \"REAL-TIME\" SCHEDULE. With messaging, one party sends a message when it is convenient for them; the receiving party (or group) listens to the message and responds at their convenience. There is no need to arrange for a time that is mutually convenient for all parties, and so communications need not be deferred until everyone is available. This ability is especially useful when traveling or messaging across time zones.\n- - IS IDEALLY SUITED FOR MESSAGING TO GROUPS. In the developed parts of the world, nearly everyone has a telephone. In developing regions, many people are gaining access to phone lines through wireless services. As a result, a single voice message can be distributed to a broad audience.\n- - USES FIXED LINE AND WIRELESS TELEPHONE NETWORKS TO SEND AND RECEIVE MESSAGES. These networks are generally more pervasive and reliable than data communications networks such as the Internet, on-line services and in-house networks.\nVoice messaging is increasingly available to small businesses and homes via telephone and cellular providers. Despite these advances, it is still difficult to connect incompatible systems internally and externally and to interconnect global sites. The Company believes this has been a barrier to effective messaging. Over the past three years, the Company has endeavored to develop a network that would allow seamless voice messaging among disparate systems and ultimately allow messaging to anyone with a telephone number and networking capability. With the introduction of OcteLink services in July 1995, the barrier to effective messaging is being overcome. Using OcteLink provides ubiquitous message exchange regardless of the voice processing system used or its location.\nCORPORATE STRATEGY\nBroad Product Line\nAfter becoming a publicly traded company in 1988, Octel pursued a strategy of both vertical and horizontal integration. Having developed the broadest range of voice processing systems in the industry, Octel acquired several companies which expanded the range of its product and service offerings. In 1992, the Company merged with the PC Products Division (OPCPD, formerly Compass), a software developer and marketer of personal computer (PC) based voice processing systems. In 1992, the Company also acquired Octel Network Services (ONS, formerly Tigon), from Ameritech, a Regional Bell Operating Company (RBOC) based in Chicago, Illinois. ONS specializes in the outsourcing and management of voice messaging systems.\nIn March 1994, the Company merged with VMX, Inc. (VMX), a designer, manufacturer and marketer of integrated voice mail systems and software products. The VMX product lines were integrated with Octel's product line in early fiscal 1996. As part of the merger, the Company also acquired VMX's subsidiary, Rhetorex, a designer and manufacturer of voice processing components for PCs including board-level hardware and operating system software.\nThe Company has also acquired certain intellectual and personal property from other companies such as its fiscal 1992 acquisition of a provider of interactive voice response technology in Israel and its fiscal 1995 acquisition of certain assets of a French software company which provides voice processing solutions for the Voice Information Services (VIS) marketplace.\nThe key strengths of Octel's broad product and service offerings are its:\n- - LARGE INSTALLED BASE\/GLOBAL PRESENCE: With over 45,000 systems installed at more than 18,000 customers in over 40 countries, Octel has a large installed base from which it may derive future revenues in the form of upgrade options, replacement products and new technology enhancements.\n- - BROAD PRODUCT LINE: Octel's solutions meet the needs of emerging companies, small- to medium-sized businesses with satellite offices and branch offices, and multinational corporations with large branch offices and subsidiaries worldwide. Recently, the Company consolidated its Octel and VMX products into a single product family called the Octel Overture Message Server family. These products are scalable, designed for multi-application environments and support the most widely deployed messaging software in the world. In addition to the Overture product family, the Company also designs and sells the Sierra system, which is a multi-application voice information processing system specifically designed to meet the special needs of telephone companies and other VIS customers.\n- - COMPATIBILITY WITH PUBLIC BRANCH EXCHANGE (PBX) SYSTEMS: Octel's voice messaging systems work with nearly every brand of PBX system in the world.\n- - UPGRADEABILITY: Octel's voice messaging solutions enable businesses of all sizes to protect their technology investments and to expand and grow as their needs change. For example, customers who invested in Octel's original Aspen system eleven years ago can migrate to one of the new Octel Overture Message Servers without losing some important resources - their voice mail database information, applications, software features, voice recordings and messages. Furthermore, Octel's Capacity On Demand (COD) software allows customers to enable additional message storage hours, system mailboxes and fax capabilities on an as-needed basis.\n- - ENTERPRISE-WIDE NETWORKING: As corporations move toward distributed, enterprise-wide information systems, networking capabilities become even more crucial. Via OctelNet, the Company's networking software application, Octel customers on Octel systems at different locations can exchange messages. Via \"digital networking,\" customers can use their existing Local Area Network (LAN) and Wide Area Network (WAN) infrastructure to transfer voice messages between users. This serves to improve speed and voice quality while leveraging existing technology investments to reduce costs. In the future, it is anticipated that the integration of voice on the information superhighway will allow voice and fax messages to be accessed, manipulated and transferred just like any other digital data by devices of all types - from desktop computers to personal digital assistants. The Company's Digital Networking, announced in March 1995, represents a key component of Octel's vision to bring voice processing to enterprise networks worldwide. Octel is continuing to enhance its product lines and plans to introduce digital networking on all product platforms in the next few years.\n- - OCTEL NETWORK SERVICES: ONS is the largest voice messaging outsourcing organization in the world. It performs millions of messaging transactions for approximately 900,000 end users from more than 600 customers on a daily basis. An increasing number of the Company's GBS and VIS customers are recognizing the benefits of outsourcing the management of their voice mail networks. ONS provides complete voice mail network management, disaster recovery, voice processing services, operations management, systems administration and project management.\n- - STRONG DISTRIBUTION PARTNERS: Octel has a strong distribution network to reach corporations, governments and institutions through a combination of direct sales, independent distributors and original equipment manufacturers (OEMs) in the United States and international markets.\n- - COMPLETE SOLUTION: The Company competes in two major markets: Global Business Solutions (GBS) for corporations, institutions and governments and VIS for service providers. Furthermore, Octel provides software, hardware, outsourcing and customer services and support to customers in both GBS and VIS markets giving the Company a broad infrastructure to support customers' voice messaging needs globally.\nOctel's Messaging Strategy\nIn July 1995, Octel introduced OcteLink, a revolutionary new form of global voice message exchange. Octel's ultimate goal is to link all voice messaging systems and services together over the telephone network so that anyone, anywhere with access to a telephone and networking capability - regardless of protocol, system size or geographic location - will be able to send a voice message to anyone else.\nOctel has developed a two-pronged approach to address this global messaging strategy:\n- - First, Octel is developing \"unified messaging\" products for voice, fax and e-mail messaging. Unified messaging essentially unites voice, fax and e-mail messaging together in a client\/server architecture using standard PC and LAN technology. This integration brings together several discrete technologies into a single mailbox that provides user access from a telephone or a PC. In May 1995, Octel announced the first component of its unified messaging technology. Octel's first implementation of unified messaging will be available on Microsoft Exchange, a LAN-based, enterprise-wide messaging architecture.\n- - Second, Octel's goal is to expand the messaging network beyond traditional user boundaries. Octel has developed OcteLink - the world's first \"messaging post office\" that allows the interconnection of virtually any voice mail system, regardless of protocol, system size or geographic location. OcteLink's global message\nexchange is intended to make it easier to send or receive voice mail, fax and, in the future, e-mail messages. This global messaging network is designed to link commercial, residential and institutional customers worldwide.\nStrategic Business Units\nOctel has historically focused on two principal customer markets: Global Business Solutions (formerly Customer Premise Equipment) and Voice Information Services. At the same time, the Company continued to broaden its product line to address these markets. Accordingly, in fiscal 1995, the Company's management was reorganized to center on three Strategic Business Units which are focused on serving the specific needs of the respective markets:\nGlobal Business Solutions (GBS). GBS markets include small to large corporations, institutions and government agencies worldwide. Octel's GBS group provides a wide range of voice messaging hardware, software and services to a number of these customers. Product sales to the corporate market include proprietary systems designed to meet the communications needs of mid-sized to large-sized domestic and international corporations, PC-based voice messaging systems for small businesses from OPCPD and components to Value Added Resellers (VARs) and OEMs from the Company's Rhetorex subsidiary.\nVoice Information Services (VIS). Octel's VIS group provides a wide range of voice processing hardware, software and services to voice information service providers such as RBOCs, independent telephone companies, wireless communications companies and service bureaus around the world. The VIS group also pursues opportunities in the international market for \"virtual telephone\" applications. Such applications use the voice mailbox as a substitute for simultaneous communication in those countries in which basic telephone service is difficult or costly to obtain.\nBoth the GBS and VIS business units provide services to customers including maintenance, spares and support, educational and consulting services. Maintenance, spares and support operates a 24-hour Customer Services Center in San Jose, California focused on providing domestic GBS customers the highest \"system availability\" utilizing the latest call center technology and training. Educational Services offers both classroom-based and computer-based training programs in the United States and Europe that allow customers to leverage their investments in the Company's products. Consulting Services offers fee-based services to design and develop sophisticated call processing business solutions for both GBS and VIS customers.\nServices. This strategic business unit is comprised of ONS and OcteLink and sells to customers in both the GBS and the VIS markets. The Company's ONS division is a leading provider of voice information processing services and private network management to organizations wishing to outsource their voice processing needs. ONS operates its own independent voice processing network that spans the United States and provides international links to Canada, Europe, Japan and Australia. OcteLink is a global message exchange intended to make it easier to send or receive voice mail, fax and, in the future, e-mail messages. This global messaging network is designed to link commercial, residential and institutional customers worldwide.\nCUSTOMER BASE\nBy the end of fiscal 1995, Octel had an installed base of over 45,000 systems in more than 40 countries, representing a total of over 29 million mailboxes. No single customer accounted for more than 10% of the Company's total net revenues for fiscal 1995, 1994 or 1993.\nThe Company's GBS customers account for over 9 million mailboxes worldwide. Corporate customers include over 35 companies in the Fortune 50 group, including Amoco, General Electric, Hewlett-Packard and Prudential Insurance.\nThe Company's VIS customers are comprised of 130 service providers in 25 countries, including six of the seven RBOCs and all major Canadian telephone companies. In Europe, Octel is strong in providing voice processing services to Europe's Global System for Mobile Communications (GSM) cellular network and its\nemerging business and residential markets. VIS customers include AT&T Wireless (formerly McCaw Cellular), Cambridge Cable, Leicester Cable, Mannesmann Mobilfunk (Germany), New Zealand Telecom, Piltel (Philippines), Radiolinja (Finland), Telcel (Mexico), Telecom Italia (formerly SIP), U.S. West and Vodacom (South Africa). Octel has more than 20 million mailboxes deployed with over 15 million subscribers in the VIS market.\nPRODUCTS\nOctel's broad product family ranges from two-port systems for as few as 20 subscribers to 432-port systems for up to 120,000 subscribers in certain VIS applications.\nGBS Products\nOctel recently consolidated all Octel and VMX products into a single product family with increased functionality and COD software via the introduction of the Octel Overture family of message servers. These message servers consolidate eleven different products into a family of five servers and three software products designed to provide customers with better price\/performance, greater flexibility for system expansion, enhanced management tools and Octel's 24-hour-per-day, seven-day-per-week service and support. The new Octel Overture product line offers common features, one of two caller interfaces for those calling into an Octel system, a common pricing arrangement and a common networking scheme via the OctelNet protocols and the new OcteLink global messaging networks.\nThe GBS offering currently includes the Octel Overture PC, Overture 200, Overture 250, Overture 300 and Overture 350. Overture products feature one of the following user interfaces: Octel Overture PC offers the Performer interface; Octel Overture 200 and 300 products offer the Serenade interface; Octel Overture 250 and 350 products offer the Aria interface.\n- - OCTEL OVERTURE PC (formerly Call Performer Plus) is a PC-based system designed for small branch offices and remote sites.\n- - OCTEL OVERTURE 200 (formerly the VMX 200) is a mid-level system designed for small-to-medium-sized offices and branch sites.\n- - OCTEL OVERTURE 250 (new product announced in July 1995 which replaces Branch, Aspen and Maxum) is a mid-level system designed for medium-sized businesses or large branch offices in the U.S., Canada and the United Kingdom.\n- - OCTEL OVERTURE 300 (formerly the VMX 300) is a mid- to high-end system designed for larger companies or institutions worldwide.\n- - OCTEL OVERTURE 350 (formerly the Aspen XC1000) is a high-end system designed for Fortune 500 companies in the United States and Canada.\n- - SOFTWARE SETS: Overture software products are now called Aria (replaces Aspen); Serenade (replaces D.I.A.L.) and Performer.\nSystem models and specifications include the following:\n- ------------------ (1) The number of users actually supported will depend upon the specific customer application.\nAs Octel focuses on high value software applications, the Company will be shifting the value of its GBS product offerings from hardware to software. An example of this software focus is COD, a feature that provides lower entry costs and greater scalability. With it, users can easily and cost-effectively expand the capacity of their message servers as their needs change.\nOctel has developed integrations which permit its systems to be compatible with, and to communicate directly with, virtually all major brands of PBX telephone systems, central office switches and cellular telephone switches. Integration enables the customer's voice information processing systems to exchange data with telephone switches from different manufacturers. Integration is necessary to permit several important voice processing features. It allows the caller to reach a subscriber's mailbox directly without dialing the subscriber's extension or mailbox number and allows message notification at the subscriber's telephone.\nVIS Products\nOctel's high-capacity Sierra platform is designed to meet the special needs of RBOC and independent telephone companies and other VIS providers by supporting multiple voice processing applications from within a single platform. Sierra is designed to be expandable to suit market growth and be capable of handling a very large number of subscribers. Sierra is also designed to meet Bellcore's Network Equipment Building Systems (NEBS) standards. When configured into a three-unit cluster, the Sierra currently supports up to 120,000 subscribers, 432 ports and 2,016 message storage hours.\nClient\/Server Architecture for Integrated Messaging. In order to make its VIS product line more complete, Octel intends to expand the benefits, performance and capabilities of its Sierra platform with a next-generation client\/server architecture, scheduled for first-phase release in fiscal 1996. This first phase release is intended to allow VIS service providers to build voice messaging \"networks\" that support millions of messaging subscribers on a single platform.\nUnlike closed architectures that inhibit the integration of new technologies into networks, Octel's open architecture will be designed to provide for flexible, integrated service creation for adding multiple new technologies or network platforms. It will offer faster and less expensive service creation for large subscriber bases, enabling service providers to create customized applications more easily for various countries or communities of interest.\nThe architecture will consist of a UNIX\/RISC-based application that serves as a dedicated service creation environment, a new back-end database server for running the new application and a specialized Sierra Media Server that will store and process voice and fax messages. All of the stand-alone elements are based on object-oriented technology - thereby providing developers with an easy to use point-and-click graphical environment that makes application development far easier. Octel's new client\/server architecture will offer:\n- - an open, flexible service creation environment - - scalable integrated services - - seamless, transparent network offerings - - high-performance client\/server database\nThe Company believes that the timely introduction and market acceptance of its next-generation client\/server architecture is a key factor in determining the Company's success in the VIS market, and the Company is focusing significant resources and talent on developing and bringing products using this architecture to market. However, there can be no assurance that introduction of products using this architecture will not be delayed, allowing competitors to gain a market share advantage, or that such products will be successful in the marketplace.\nServices\nONS. ONS is the largest voice messaging outsourcing organization in the world. ONS operates its own independent voice processing network that spans the United States and provides international links to Canada, Europe, Japan and Australia. ONS performs millions of messaging transactions for approximately 900,000 end users from more than 600 customers on a daily basis. An increasing number of the Company's GBS and VIS customers are recognizing the benefits of outsourcing the management of their voice mail networks. Some of the reasons companies are outsourcing include the customer's desire to focus on its core business, manage risk, control costs, improve overall quality, provide a guaranteed service level or to respond to a lack of internal resources. ONS provides complete voice mail network management, disaster recovery, voice processing services, operations management, systems administration and project management.\nOcteLink. In July 1995, Octel Services introduced OcteLink, the world's first network that interconnects virtually any voice messaging system with networking capability, regardless of protocol, system size or geographic location. OcteLink makes possible a global network and an administrative, service and support infrastructure that enables customers to link their voice processing and other messaging systems to Octel's network easily. Messages are sent to an OcteLink hub or \"messaging post office\" that processes and forwards the message to the appropriate recipient. The OcteLink hubs are connected via high-speed, digital data links designed for high-quality, rapid transport of messages. These post office hubs connect voice processing and other messaging systems, sort traffic and efficiently direct each message to its destination. The hub acts as a multimedia gateway - accepting voice, fax and, in the future, e-mail with delivery based on the recipient's terminal of choice: telephone (hard-wired or cellular), PC, personal digital assistant (PDA), laptop or fax machine.\nLike the Internet, OcteLink is based upon a strong existing infrastructure. In Octel's case, the network foundation is its private telecommunications network service: ONS, the world's largest voice mail service and outsourcing organization.\nOcteLink currently supports OctelNet, Octel analog and Audio Messaging Interchange Specifications (AMIS) messaging. Support for the Internet as a delivery network and additional voice mail and communications protocols is planned for the future. Octel will also make its protocols available to other vendors under licensing arrangements so that messages can be transmitted more easily.\nAlthough the Company believes OcteLink is a viable global messaging network, there is currently no reliable data regarding the demand for such services in multiple customer segments. Furthermore, there is no assurance that demand for a global messaging network will not be slow to materialize or that potential competitors will not successfully introduce alternative solutions to OcteLink that achieve better market acceptance.\nSALES, CUSTOMER SUPPORT AND WARRANTIES\nThe Company sells and supports its voice processing systems through direct sales, independent distributors, VARs and OEM providers. This strategy reduces Octel's dependence on any single sales channel and is designed to improve market coverage and customer satisfaction for the Company's products. Direct sales operations in the United States are conducted from approximately 40 field offices and international direct sales operations are conducted from 11\noffices. The Company's domestic GBS sales force is structured into four geographic areas, with each group responsible for sales - distributor, direct, and national account - within its area. A separate sales force is focused on opportunities in the domestic VIS market. Sales outside the United States are structured into three geographic territories - Canada, Europe and Intercontinental, which includes Asia-Pacific and Latin America.\nThe Company believes that its network of distributors, VARs and OEM providers represents an important part of its overall sales strategy and that the loss of, or changes in the relationship with, or performance by, one or more of these sales channels could have an adverse effect on the Company's revenues and operating results. Distributors purchase products at discounts and, accordingly, the Company's operating margins can vary depending upon the mix between distributor and direct sales in any particular operating period. The Company anticipates that this mix will fluctuate in future operating periods.\nThe Company offers a leasing alternative to its customers through its leasing division, Octel Capital. Customers who wish to lease the Company's products may do so using financing options available through the Company's sales organization.\nSales outside the United States were approximately 25%, 24% and 24% of net revenues for fiscal 1995, 1994 and 1993, respectively. In fiscal 1995 and 1994, the majority of international sales were made in the United Kingdom and Canada. In fiscal 1993, the Company had substantial sales in Italy and the United Kingdom, as well as in Canada. In fiscal 1994, the Company formed wholly owned subsidiaries in Japan and Hong Kong to sell to customers in Japan and other Asia-Pacific countries. In addition, in December 1993, the Company and Alcatel Austria AG signed a joint product development and distribution agreement, pursuant to which Alcatel distributes and supports the Company's voice information processing products outside the United States and Canada.\nThe Company's Customer Services Organization includes field engineers, customer support specialists and applications consultants who together provide installation and implementation assistance to end-user customers and distributors. This organization also administers technical software courses, system maintenance courses and customer support courses.\nThe Company provides a warranty for parts and labor on its products which is generally for 12 months from date of shipment (or, if the Company installs the product, generally for 12 months from the date of installation). The Company maintains and services its products on a contractual basis after the initial product warranty has expired. Warranty and post-warranty service is provided directly to customers from Octel's district sales offices and through distributors, supplemented by major Octel support centers in California, the United Kingdom and Ontario, Canada. The Company maintains inventories of spare parts at a number of locations in the United States and internationally, including all Octel facilities and distributor locations, in order to provide prompt service. The Company operates a telephone support center 24 hours per day in San Jose, California to respond to requests for problem definition and resolution.\nONS provides network management solutions throughout the United States to large corporate customers and selected foreign locations of its domestic customers, federal, state and local governments and not-for-profit organizations. Customers may choose to outsource their voice processing requirements completely through ONS rather than buy or lease equipment. ONS also provides services to Ameritech, the RBOC in the midwestern section of the United States. Through international marketing partners, ONS provides access from Australia, Europe and Japan to its voice processing network. ONS also provides complete voice processing services on a private-label basis for resale by VIS providers.\nBACKLOG\nThe Company's backlog at June 30, 1995 was $74.4 million compared to $72.2 million at June 30, 1994. The Company measures its backlog as confirmed orders for equipment, maintenance contracts and Octel Network Services for the next six months. An increasing portion of the backlog is from the services business, which is more predictable and reduces dependence from quarter to quarter on systems business. Because of the possibility of customer changes in delivery schedules or cancellation of orders, the Company's backlog as of any particular date may\nnot be indicative of actual revenues for any future period. The Company believes that its backlog on a quarterly basis will not generally be large enough to assure that its revenue targets for a particular quarter will be met. Furthermore, a large percentage of any quarter's shipments are booked in the last month of the quarter. Consequently, quarterly revenues and operating results will depend on the volume and timing of new orders received during a quarter, which are difficult to forecast. This is particularly true in the VIS marketplace, where sales orders are generally larger. Fourth quarter revenues are typically enhanced by sales incentives provided to employees and promotion programs for customers, while first quarter sales are traditionally not as strong. This seasonal pattern is likely to continue.\nCOMPETITION\nThe voice information processing industry is highly competitive and the Company believes that competition from new and existing competitors will continue to intensify. The Company competes with different companies in the different customer markets it serves and the principal competitive factors vary depending on the customer market. The Company believes that competition to date for the sale of voice information processing systems in its principal customer markets has been based on product features, system performance, product quality and reliability, price, service and post-sales support, and marketing and distribution capabilities. The Company believes that it competes favorably with respect to these competitive factors.\nGlobal Business Solutions\nIn the corporate and institutional markets, Octel competes primarily with two types of companies: PBX manufacturers including AT&T, Northern Telecom Limited and Siemens Rolm Communications, Inc.; and independent voice processing manufacturers, such as Centigram Communications Corporation, as well as PC-based system suppliers, including Active Voice Corporation and Applied Voice Technology, Inc. (AVT).\nThe PBX manufacturers sell voice processing products that integrate principally with their own PBXs. These companies have considerably greater financial, technical, marketing and sales resources than the Company, and may have a competitive advantage when customers are purchasing a voice processing system at the same time they are purchasing a new PBX. They also benefit from the large installed base of their own brands of PBXs. PBX manufacturers have intensified their competitiveness by focusing on low prices, providing single source procurement and by selling voice processing equipment as a PBX peripheral device with limited, core voice processing functionality such as telephone answering and voice mail. The Company believes that its competitive strengths compared to these PBX manufacturers are its multi-application voice processing systems, the broad set of features incorporated into the Company's products, including its multiple technology applications such as fax processing, a more friendly user interface, the ability to integrate with the PBXs of multiple manufacturers and networking. The Company also believes that development and delivery of customer applications will increase in importance as a competitive factor as customers demand not only core voice processing functionality, such as telephone answering and voice messaging, but also IVR, fax, audiotex and integration with computer networks.\nThe independent voice processing manufacturers (including Centigram, AVT and Active Voice) also offer multiple integrations with PBXs. The Company believes that its competitive strengths compared to these companies are its large installed base, strong support organization, broad set of features, strong financial condition and substantial cumulative investment in research and development. The Company also believes that its direct and distributor channels of distribution allow it to compete favorably with companies with only one channel of distribution. Furthermore, the Company believes that its application generators and application development specialists represent an opportunity to provide applications tailored to meet the needs of vertical and horizontal markets as well as providing unique solutions for individual customers.\nIndirect competitors may be able to compete more directly with the Company in selling to larger corporate customers and VIS providers by increasing system capacities and adding new system capabilities and applications. To the extent the Company markets additional applications that enable interaction with host computers, suppliers of such other systems as interactive voice response systems will become more direct competitors.\nThe Company expects that new or enhanced products will be offered by its principal existing competitors and new competitors, including large domestic and international telecommunications and computer companies. The Company also expects that computer software vendors such as Novell, Inc., Lotus Development Corporation (a subsidiary of IBM) and Microsoft Corporation will continue to develop enhanced messaging and networking software with voice and data information processing applications.\nA large number of voice processing companies compete primarily in the market for smaller capacity systems (fewer than 16 ports) that are typically sold to smaller customers or to small offices of larger companies; however, some of these companies also use success in the smaller capacity systems market to penetrate the large capacity systems market. Some of these competitors primarily emphasize their automated attendant and call processing capabilities, while others focus on voice messaging applications. In addition, a number of companies produce personal computer add-on cards and software primarily aimed at specialized applications or small user groups. The primary competitors for the Company's PC products include other PC-based system suppliers including Active Voice and AVT. Certain PBX manufacturers, including AT&T and Northern Telecom, also offer competitive products to small businesses which are generally tailored to a specific brand of PBX. The market for smaller capacity systems is characterized by intense competition on price and sales coverage. The Company believes that as smaller businesses become more familiar with voice processing and its benefits, enhanced feature content will become increasingly important for small capacity systems. The Company believes that its PC-based products compete favorably against products from other PC-based vendors and PBX manufacturers because of their feature set and the Company's extensive dealer network.\nCompetitors in the international corporate and institutional market segment vary by country and include both United States and foreign companies. In the past, international competition was less significant as markets outside of North America were less developed and competitors were in the early stages of developing their business strategies. As the international markets have developed, competition from traditional competitors as well as local start-up companies has increased. These competitors are primarily in the market for smaller capacity systems, which present competitive risks similar to those discussed above. Octel believes that factors in its favor in international markets are the broad set of features in its existing products, including its multiple technology applications, its large installed base of multinational companies and its strong financial condition. The Company's international competitive position also benefits from the distribution alliances that the Company has established with nearly 20 organizations, including Alcatel NV, a division of Alcatel Alsthom, Bull S.A., Telefon AB LM Ericsson, Hitachi, Italtel, J.S. Telecom, Mercury Communications, a subsidiary of the Cable & Wireless Group, and Siemens AG.\nVoice Information Services\nIn the VIS market, Octel currently competes with Boston Technology, Centigram, Comverse, Digital Sound, Ericsson, Glenayre, Tecnomen and Unisys. Octel anticipates that this list of competitors will continue to change and evolve and that other competitors, potentially including the RBOCs, may enter the market in the future.\nOther telecommunications and computer companies, including some large companies that currently supply network and corporate infrastructure equipment to the RBOCs and some companies with greater financial and technical resources than the Company, are expected to enter the VIS market. In addition, although currently barred from such activities by governmental regulations stemming from the breakup of AT&T in 1984, the RBOCs may be allowed to manufacture their own voice processing equipment at some time in the future. The Company believes that specific product requirements are becoming clearer as the RBOCs and other telephone companies are gaining more experience with VIS. The Company continues to develop enhancements to its Sierra product to address what the Company believes are the emerging requirements of the telephone companies and other service providers. However, there can be no assurance that product requirements will not change as this market develops or that other companies will not be faster or more successful in bringing comparable products to market.\nThe Company believes that the key competitive factors in the VIS market are likely to depend on the method of implementing voice information services used by the specific VIS provider. In this market, the Company believes it benefits from its greater experience in providing voice processing systems, its installed base and the reliability, capacity and broad feature functionality of its products. In addition, against certain competitors, the Company competes favorably on the basis of its strong financial condition and its limited reliance on any single customer for its viability.\nCompetition in the international VIS market has primarily come from those companies based in and currently competing in the United States. As in the international GBS market, the primary competitors in international VIS markets may change as the market for voice information services develops and additional vendors are attracted. The Company believes that its strengths in the domestic VIS market will be valuable to the Company in international VIS markets.\nCurrent competitors or new market entrants in both the GBS and VIS markets may introduce and commercially deliver new products with features and expanded capabilities that could adversely affect the competitive position of the Company's systems in some or all of its markets. In order to maintain its competitive position, the Company must continue to develop and market new products successfully and enhance its existing products, and there is no assurance that the Company will be able to do so. Increased competitive pressures could result in intensified price competition in the Company's markets, which would adversely affect the Company's net revenues and net income.\nONS\nONS competes both with other voice processing service providers and with equipment manufacturers. Other services suppliers include independent companies such as VoiceCom and VoiceTel. ONS also competes with equipment manufacturers if the customer is uncertain whether to outsource its voice processing through a service provider such as ONS or purchase equipment from a manufacturer. In situations where a customer's capital budget is constrained or resources to manage systems are not present, ONS' service solutions become attractive as compared to equipment purchases. The Company believes that ONS competes favorably in the outsourcing market because of its proven experience in the business of providing outsourcing services as Tigon Corporation, years of network development and management and Octel's strong consolidated financial position.\nMANUFACTURING\nThe Company's manufacturing operations consist primarily of final assembly and extensive test and quality control of materials, components, subassemblies and systems. Most of the Company's high-end hardware and software product designs are proprietary, except for some peripheral products. Low-end products, such as PC products, are designed with a more open architecture. The Company currently manufactures its products in San Jose, California.\nThe Company presently uses third parties to perform printed circuit board assembly and sheet metal fabrication. Although the Company generally uses standard parts and components for its products, certain components, including power supplies, disk drives and certain semiconductors, are presently available only from a single source or from limited sources. The Company, to date, has been able to obtain adequate supplies of these components in a timely manner from existing sources or, when necessary, from alternative sources of supply. There can be no assurance, however, that such supplies will be available in the future or, if such supplies are available, that they will be available at reasonable prices. The inability to develop such alternative sources if and as required in the future, or to obtain sufficient sole or limited source components as required, would adversely affect the Company's total net revenues and net income.\nRESEARCH AND DEVELOPMENT\nThe Company believes that the continued timely development of new products and enhancements to its existing products is essential to maintaining the Company's market position, and this effort requires a high level of expenditures by the Company for research and development. The Company has continued to improve the features, capabilities, capacity and price\/performance of its product line while maintaining compatibility with its customers' existing installations. The Company is currently involved in the development of new products and enhancements to its existing products to increase performance, reliability and manufacturability. The Company must continue to retain skilled research and development personnel, particularly software and hardware engineers who are generally in short supply. The Company, from time to time, has purchased and anticipates that it will continue to purchase technology from third parties.\nThe Company releases performance enhancements and new features for its products on an ongoing basis. As the functionality of the Company's systems increases, the complexity of the software will also increase. Although the Company performs rigorous testing prior to releasing its product designs, products as complex as the Company's often contain undetected errors or \"bugs\" when first released, and these errors are discovered only after the product has been used by many different customers and in varying applications. Because of the importance the Company places on product reliability, the Company has from time to time temporarily delayed product shipments to complete \"debugging\" efforts. In addition, the Company has been required, in a few instances and primarily for VIS customers, to write custom software and to make design modifications to satisfy customer application requirements. Identifying and correcting errors and making required design modifications typically is expensive and time-consuming and the Company expects such modifications to increase in complexity with the increasing sophistication of the Company's products. Despite extensive testing, there can be no assurance that errors will not cause delays in product introductions and shipments, require design modifications or impair customer satisfaction, which could adversely affect operating results.\nDuring fiscal 1995, 1994 and 1993, the Company spent $74.6 million, $58.3 million and $44.4 million, respectively, on research and development. The Company expects to continue to increase expenditures on research and development in fiscal 1996 in absolute terms and these expenses could increase as a percentage of total net revenues. During fiscal 1995, 1994 and 1993, the Company entered into development contracts with certain customers whereby the Company performed development work on applications software using customer funds. During fiscal 1995, $1.0 million ($0.8 million in fiscal 1994 and $0.3 million in fiscal 1993) was recognized as revenue and $1.0 million ($0.8 million in fiscal 1994 and $0.3 million in fiscal 1993) was charged to cost of sales for projects completed. No internal software development costs have been capitalized to date under the provisions of Statement of Financial Accounting Standards No. 86, \"Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed.\" Prior to the merger of Octel and VMX, VMX had capitalized certain software development costs and incurred annual amortization expense. In March 1994, in connection with the VMX merger, the Company incurred a one-time pre-tax charge to cost of sales of $1.1 million to write off certain capitalized software development costs to conform accounting practices.\nGOVERNMENT REGULATION\nVoice messaging services and telecommunications equipment manufacturing are regulated almost exclusively at the federal level, if at all. Other than routine equipment registration for devices attached to the public switched telephone network, the Company is not subject to federal telecommunications regulations. State regulatory authorities have sought to regulate some aspects of intrastate telephone answering and voice messaging services offered by telephone companies and may seek in the future to regulate such services offered by independent service providers such as the Company. At present, however, the Company is not subject to such state regulation.\nThe activities of the RBOCs are subject to ongoing oversight by the United States District Court for the District of Columbia under the terms of the 1984 consent decree governing the breakup of AT&T. The consent decree imposed certain \"line of business\" restrictions which, among other things, prevent the RBOCs from offering voice messaging services that originate in one Local Access and Transport Area (LATA) and terminate in another LATA without prior approval of the District Court. The consent decree also prohibits the RBOCs from manufacturing telecommunications equipment. The RBOCs are allowed to provide customer premise equipment (CPE) and to acquire both CPE and telecommunications equipment for their own use. The RBOCs may only offer voice messaging and related services using equipment purchased or leased from unaffiliated companies such as Octel. In offering voice messaging and other \"enhanced\" services within LATAs, the RBOCs are also subject to various regulatory requirements of the Federal Communications Commission adopted to ensure nondiscriminatory access to RBOC customers and deter cross-subsidization by the RBOCs.\nThese restrictions on the RBOCs may change in the near future because of legislation pending in the United States Congress. As of August 1995, two separate bills had passed both the House and the Senate, H.R. 1555 and S. 652, respectively. The legislation would supersede the consent decree and permit the RBOCs to manufacture telecommunications equipment and to provide inter-exchange services after complying with requirements to open their telephone networks and markets to competition. It would also allow the RBOCs to collaborate or enter royalty\nagreements with telecommunications equipment manufacturers such as the Company upon satisfaction of statutory requirements. While the legislation, in some form, is expected to become law, its passage is by no means certain.\nPATENTS, COPYRIGHTS, TRADEMARKS AND TECHNOLOGY LICENSES\nThe Company relies on a combination of patent, copyright, trade secret and trademark law, licensing and technical measures to protect its intellectual property. There can be no assurance that the Company's efforts to protect its intellectual property will be successful.\nThe Company holds 31 United States patents and has 13 patent applications pending in the United States. The Company's issued patents expire on dates ranging from 2002 to 2010. The Company also has patent applications pending in many foreign countries. There can be no assurance that the Company will be able to protect its technology or that competitors will not be able to develop similar technology independently. No assurance can be given that patents will be issued from any applications filed by the Company or that, if patents are issued, the claims allowed will be sufficiently broad to protect the Company's technology. In addition, no assurance can be given that any patents issued to the Company will not be challenged, invalidated or circumvented or that the rights granted thereunder will provide competitive advantages to the Company. In spite of the possible strength of the Company's existing and future patents, the Company believes that patents are of less significance in its industry than such factors as innovation, technological expertise and distribution strength.\nThe Company licenses technology from Northern Telecom, Mitel Corporation and ROLM to facilitate integration of Octel's products with those manufacturers' PBXs. The Northern Telecom license is perpetual, the Mitel license expires in 1998 and the ROLM license expires in 2004. Royalty payments on these licenses are not material.\nA number of companies, including competitors of the Company, hold patents in the same general area as the technology used by the Company. The Company has from time to time been notified and may be notified in the future that its products may be infringing certain patents and other intellectual property rights of others.\nIn April 1992, the Company filed suit, in United States District Court in Northern California, against Theis Research, Inc. (\"Theis\") for declaratory judgment that the Company's products do not infringe three patents of Theis and that those patents are invalid. In November 1992, Theis filed a counterclaim against the Company alleging infringement of seven of Theis' patents. Subsequently, Theis dismissed with prejudice the claims as to all but four of the patents. During the first quarter of fiscal 1995, the Company engaged in a jury trial regarding infringement of the three remaining patents and the defense of patent invalidity. In October 1994, the jury returned a verdict finding, among other things, that Octel was correct in its claim that the three patents at issue were invalid. Post-trial motions are pending and, if no settlement between the parties is reached, it is anticipated that Theis will appeal the verdict.\nIn January 1994, Gilbarco, Inc. (\"Gilbarco\") filed suit in the U.S. District Court for the District of Colorado against the Company and one of the Company's telephone company customers, U.S. West, alleging infringement of a Gilbarco patent and seeking unspecified damages. The Company filed an answer to the complaint denying any infringement of the patent and raising several affirmative defenses, including an assertion that the patent is invalid and unenforceable. In September 1994, the claims asserted against the Company were transferred to the U.S. District Court for the Northern District of California and those claims asserted against U.S. West were stayed and administratively closed pending the outcome of the California action. Fact discovery in the case has been completed, expert discovery is scheduled for completion in December 1995 and a trial date has been set for March 19, 1996. The Company is currently planning to file one or more motions before the trial which could dispose of some or all of the claims asserted against it.\nThe Company believes, based upon information currently available, including consultations with patent counsel, that the Company is not infringing any valid patents of Theis or Gilbarco. The Company will vigorously defend the patent infringement claims and any related claims for compensatory damages. While litigation is inherently uncertain, the Company believes that the ultimate resolution of these matters will not have a material adverse effect on the Company's financial position.\nThe Company is currently evaluating several additional claims of third parties. Based in part on industry practice and in part on discussions with certain of such third parties, the Company believes that in most cases any necessary licenses or rights could be obtained on commercially reasonable terms. However, no assurance can be given that future licenses will be obtained on acceptable terms, that costly litigation will not occur or that the Company will receive a favorable decision in any litigation that may ensue. The failure to obtain necessary licenses or other rights, or litigation arising out of such claims, could have a material adverse affect on the Company's operations.\nOctel, Octel Communications, the Octel logo, OctelNet, Aspen, Branch, Call Performer Plus, D.I.A.L., Maxum, Sierra, Tigon and VMX are registered trademarks of the Company. Aria, Digital Networking, OcteLink, Octel Overture Message Server, Overture, Octel Overture PC, Octel Overture 200, Octel Overture 250, Octel Overture 300, Octel Overture 350 and Serenade are trademarks of the Company. All other product names are trademarks which belong to their respective owners.\nEMPLOYEES\nThe Company's success depends in part upon the continued contribution of its officers and key personnel, many of whom would be difficult to replace. If certain of these people were to leave the Company, the Company's operating results could be adversely affected. At June 30, 1995, the Company employed approximately 2,700 people on a full-time basis. During fiscal 1996 the Company intends to hire additional personnel, especially in the international arena. Many of the Company's employees are highly skilled, and the Company's continued growth and success will depend in part upon its ability to attract and retain such employees, who are in great demand, and on the ability of the Company's officers and key employees to manage successfully the growth of the Company through use of appropriate management information systems and controls. The Company has never had a work stoppage, no 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 currently conducts all headquarter operations, except manufacturing and customer support, in a newly constructed, five building, 375,000 square foot campus and an adjacent 44,000 square foot leased building in Milpitas, California. Manufacturing and customer support operations are conducted in two leased buildings in San Jose, California totaling 170,000 square feet. These three leases expire at various dates ranging from 1997 to 1999. The Company is nearing completion of the integration of the VMX customer support facilities in San Jose. Integration of VMX's Dallas, Texas manufacturing facilities is expected to be completed during the first quarter of fiscal 1996. Movement of these operations to San Jose began in June 1995. Previously existing leases have either been terminated or subleases are being pursued. The Company also leases over 40 sales and customer support offices throughout the United States totaling 272,000 square feet. These leases expire at various dates through 2000. The aggregate monthly rental expense for leased property in the United States, excluding OPCPD, ONS and Rhetorex, is approximately $479,000, of which approximately 44% was for facilities near the Milpitas campus.\nOPCPD conducts all activities from a 35,000 square foot leased building in Sarasota, Florida with a monthly rental expense of $42,000. The OPCPD lease expires in 2005. ONS' principal offices are located in five buildings in Dallas, Texas and consist of approximately 108,000 square feet under leases which expire in 1997 and 1998. ONS also leases an additional 53,000 square feet of space for 24 operations centers and sales offices throughout the United States. The aggregate monthly rental expense for all of ONS' facilities is approximately $170,000, of which approximately 52% is for facilities at or near the Dallas offices. Rhetorex conducts all activities from a 16,000 square foot leased building in Campbell, California with a monthly rental expense of $16,000. This lease expires in 1997.\nThe Company leases six offices in Canada totaling 17,000 square feet at a monthly rental expense of approximately $22,000. The Company also leases 37,000 square feet in four cities in the United Kingdom at an aggregate monthly rental expense of $104,000. Octel also has two offices in France totaling 15,000 square feet with a monthly rental expense of approximately $32,000. Additionally, the Company leases four offices in Germany, Israel, Japan and Hong Kong for total monthly rental expense of approximately $48,000. These leases expire at various dates and the Company expects to be able to renew or replace such leases at the end of their terms on a commercially reasonable basis.\nOn July 6, 1995, the Company entered into a one-year operating lease for a parcel of undeveloped land adjacent to its Milpitas, California campus on which additional offices may be constructed over the next three years. Monthly rent expense varies based upon the London interbank offering rate (LIBOR). See Note 14 to the consolidated financial statements.\nThe Company expects that it may require additional sales and customer support locations during fiscal 1996 and believes that suitable space will be available as needed on commercially reasonable terms.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nSee \"Patents, Copyrights, Trademarks and Technology Licenses\" in Item 1 above.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThere were no matters submitted to a vote of security holders during the fourth quarter of fiscal 1995.\nEXECUTIVE OFFICERS OF OCTEL COMMUNICATIONS CORPORATION\nThe executive officers of the Company and their respective ages as of July 31, 1995 are as follows:\nMr. Cohn, a founder of the Company, served as its President and Chief Executive Officer from the Company's inception in 1982 until October 1990, and then resumed those positions in November 1993. Mr. Cohn has served as a director from the Company's inception and, in June 1990, the Board of Directors appointed Mr. Cohn Chairman of the Board. Prior to founding the Company, he was employed by Acurex Corporation, a manufacturer of microprocessor-based measurement and control systems, from 1979 to 1982. From 1976 to 1979, he was employed by McKinsey & Co., Inc., a management consulting company. Mr. Cohn holds a B.S. in Mathematics and Computer Science from the University of Florida and an M.B.A. from Stanford University. Mr. Cohn is also a director of Global Village Communication, Inc., a manufacturer of communications hardware and software for personal computers.\nMr. West serves as Vice Chairman for the Company. He joined the Company in September 1986 as Executive Vice President and was responsible for sales and customer service. From 1979 to September 1986, Mr. West was employed by ROLM, serving for three years during this period as President of an operating subsidiary of ROLM and then as General Manager of its National Sales Division. Mr. West attended Southern Illinois University.\nMr. Ladd joined the Company in March 1994 as Executive Vice President following the Company's merger with VMX, Inc. and, as Chief Technology Officer, is responsible for research and development. At VMX, Mr. Ladd served as Executive Vice President and a director from July 1988 until March 1994. Prior to joining VMX, Mr. Ladd served as President and Executive Vice President of OPCOM, a manufacturer of call processing systems that was merged into\na wholly owned subsidiary of VMX in July 1988. Mr. Ladd holds a B.A. in Engineering Physics from the University of California-Berkeley and an M.A. in Mathematics from the Stevens Institute of Technology.\nMr. Campodonico joined the Company in July 1987 as its Director of Manufacturing and is now Senior Vice President, Operations. He is responsible for manufacturing, information systems and corporate quality. Prior to joining the Company, he was employed by ROLM, serving for two years as Vice President of Operations. Mr. Campodonico holds a B.S. in Business Administration and an M.B.A. from San Francisco State University.\nMr. Levine joined the Company in December 1994 as Vice President and General Manager of Octel Services. Mr. Levine was subsequently named Senior Vice President and General Manager of Octel Services. Prior to joining Octel, Mr. Levine served as President and CEO of CFT Systems and as Products and Services Vice President of AT&T's General Business Systems Division. Mr. Levine has also held executive marketing positions with General Electric and Procter & Gamble. Mr. Levine graduated from Trinity College with a major in Economics and received his M.B.A. from Northwestern University.\nMr. Mattiuz joined the Company in March 1994 in connection with the VMX merger. He is currently Senior Vice President of worldwide field operations. Prior to joining Octel, Mr. Mattiuz held executive positions with VMX, Inc., Conveyant Systems, Inc., CXC Corporation and Northern Telecom. Mr. Mattiuz holds a B.S. degree in electrical engineering from the University of Ottawa, Canada and has completed numerous management development programs from Harvard, Columbia and Harbridge House.\nMs. Norton joined the Company in February 1988 as a Group Product Manager in Customer Premise Equipment (now GBS) Marketing and was subsequently promoted to Director of CPE Marketing, Vice President of Marketing, to Vice President and General Manager of VIS and Senior Vice President and General Manager, VIS, the position she now holds. She holds a B.A. in Economics from the University of Arizona and an M.B.A. from the University of Connecticut.\nMs. Snell joined the Company in August 1994 and now serves as Senior Vice President and General Manager, GBS, where she is responsible for products and services to corporations, institutions and government. Prior to joining the Company, Ms. Snell was President and Chief Executive Officer of Aristacom International, Inc. from August 1993 to April 1994 and prior to that was co-founder and Senior Vice President, Worldwide Operations for Aspect Telecommunications Corporation for eight years. Ms. Snell holds a B.S. in Business from the University of North Carolina.\nMr. Daley joined the Company in August 1988 as its General Counsel, was elected Vice President in September 1989 and became Secretary of the Company in October 1990. He is responsible for internal legal matters, legal compliance and supervision of outside law firms employed by the Company. Prior to joining the Company, Mr. Daley was an associate and then a partner in the law firm of Wilson, Sonsini, Goodrich & Rosati from September 1985 to September 1988, and an associate with the law firm of Brobeck, Phleger & Harrison from September 1980 to September 1985. Mr. Daley holds a B.S. in History and a J.D. from Stanford University.\nMr. Simpson joined the Company in conjunction with the October 1992 acquisition of Tigon Corporation (now ONS). Mr. Simpson now serves as President of ONS. Previously, Mr. Simpson served eighteen months as Vice President of Finance and Administration for Tigon. Before joining Tigon, he was Controller for Ameritech Development Corporation in Chicago, Illinois. Mr. Simpson holds an M.B.A. and a B.S. in Accounting from Northern Illinois University and is a Certified Public Accountant.\nMr. Viera joined the Company in February 1989 as Director of Organizational Planning and was subsequently promoted to Director of Compensation, Director of Human Resources and Vice President, Human Resources, the position he now holds. He holds a B.S. in Business Administration from Golden Gate University and an M.S. in Counseling Psychology from California State University, Hayward and is a certified Senior Human Resources Professional by the International Human Resources Professional Society.\nThe Company is currently recruiting for a Chief Financial Officer.\nAll officers serve at the discretion of the Board of Directors. There are no family relationships between directors or executive officers of the Company.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nOctel Communications Corporation Common Stock is traded on the over-the-counter market and is quoted on The Nasdaq National Market under the symbol OCTL. As of June 30, 1995, there were approximately 3,194 stockholders of record. The following table sets forth for the periods indicated the high and low closing prices for Octel's Common Stock as reported by The Nasdaq National Market.\nThe Company has not paid cash dividends on its Common Stock to date and does not plan to pay cash dividends to its stockholders in the foreseeable future.\nThe Company believes factors such as quarter-to-quarter variances in financial results and announcements of new products and new orders by the Company or its competitors could cause the market price of the Company's Common Stock to fluctuate substantially. In addition, the stock prices for many high technology companies typically experience extreme price fluctuations, which often are not related to changes in the operating performance of the specific companies. Broad market fluctuations as well as general economic conditions, such as a recessionary period or high interest rates, may adversely affect the market price of the Company's Common Stock. Both the Company's Common Stock and the stock market generally are at or near historic highs and there can be no assurance that such valuations will continue or increase.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\n- -------------------------- (1) Includes non-recurring charges for the write-off of in-process research and development of $4.7 million ($3.2 million net of taxes) and integration costs of $2.8 million ($1.9 million net of taxes).\n(2) Includes total non-recurring charges for the VMX merger and integration costs of $24.1 million ($18.8 million net of taxes).\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nBASIS OF PRESENTATION\nEffective March 31, 1994, Octel consummated a business combination with VMX which was accounted for as a pooling of interests. VMX provides integrated messaging and call processing systems, software and services that combine voice, data and image for business communications worldwide. To effect the combination, approximately 5.4 million shares of Octel's Common Stock were issued in exchange for all of the outstanding Common Stock of VMX. The net assets of VMX amounted to approximately $45.1 million at March 31, 1994. The financial information presented herein has been restated to include the accounts and operations of VMX for all periods.\nRESULTS OF OPERATIONS - ANNUAL\nNet Revenues\nThe Company derives revenues from the sale of systems, license fees and performance of services. Systems revenues consist of equipment, upgrades and expansions sold to corporations and other institutions, as well as telephone and cellular companies. Services revenues consist of a range of voice processing and network management services provided by ONS, particularly to customers in the residential market through an RBOC and voice services market, service contracts, applications development products, the sale of spares, licenses and hardware repair and maintenance.\nThe growth in total net revenues since fiscal 1993 resulted from increases in the volume of services revenues generated by ONS, spares and maintenance and the sale of systems to new and existing customers and the sale of upgrades and expansions. Total domestic net revenues for fiscal 1995 were $353.6 million compared to $308.8 million in fiscal 1994, an increase of 15%. International net revenues totaled $119.0 million for fiscal 1995 compared to $97.4 million in fiscal 1994, an increase of 22%. Domestic and international net revenues for fiscal 1993 were $257.8 million and $80.7 million, respectively. International sales were primarily to customers in Europe and Canada and, to a lesser extent, New Zealand, Japan, Hong Kong and China.\nTotal GBS net revenues grew by 11% compared to fiscal 1994. Domestic net revenue growth was 12% and international revenues grew 6%. The increases are due to greater sales of high-end systems offset by fewer low-end systems sales compared to fiscal 1994. During fiscal 1995, international GBS sales were generally made through the Company's direct sales force and distributors, principally in the United Kingdom and Canada. The GBS market continues to be dependent upon the following: purchases by existing customers of expansions and upgrades to support expanding corporate voice messaging networks; purchases of new, integrated applications such as fax processing by large organizations; sales to small business or branch offices of large companies of less expensive voice messaging equipment; and purchases by large organizations that have already adopted competitive voice processing technology switching to the Company's products.\nTotal VIS net revenues grew by 2% compared to fiscal 1994. Domestic net revenue decreased 4% whereas international revenues grew 9%. In the United States, the Company continues to sell to customers who provide telephone answering services, which is experiencing slower growth than other VIS markets. Furthermore, the Company experienced a decline in VIS market share from fiscal 1994 to fiscal 1995. The Company continues to believe that the residential and cellular voice messaging markets are large market opportunities. The Company and its VIS customers, including the cellular companies, are working jointly to develop programs to address these markets, however, there can be no assurance that future declines in market share will not occur. International VIS sales were primarily made through the Company's direct sales force. The Company's operations in the United Kingdom made a significant contribution to international revenues as a result of new opportunities which were realized during the year, however, this increase was offset by a decrease in Canada's VIS revenues which were adversely affected by a capital spending freeze at one of Canada's largest VIS providers. International VIS net systems revenues decreased slightly in fiscal 1994 as compared to fiscal 1993 due principally to large systems sales in Italy in fiscal 1993 which were not repeated in fiscal 1994.\nNet services and license revenues increased as a result of growth in ONS revenues of 58% compared to fiscal 1994 that resulted from increased services provided to one of the RBOCs which provides residential services and from other new accounts added during the year. Higher spares and hardware maintenance revenues due to the increased installed base also contributed to the overall increase in net service revenues. In recent years, services and license revenues have experienced significant growth in absolute dollars and as a percentage of net revenues. There can be no assurance that such growth will be sustained or continue.\nSystems sales orders from VIS customers are generally larger than GBS sales and VIS customers do not follow consistent buying patterns; therefore, net revenue volume and mix in future periods could be affected by the extent and timing of new orders from VIS customers. In addition, the Company continues to monitor trends in the general economy that have previously imposed budgetary constraints and, therefore, adversely affected the ordering process of customers. The Company cannot predict how future domestic and international economic trends may affect sales orders. The Company may establish additional subsidiaries or joint ventures in the future in those countries where it believes significant sales opportunities exist. Extensive effort is required in the local government approval processes before the Company's new products or modifications to existing products can be sold and installed in each country. This work was completed in several countries during fiscal 1995. Local government approvals for other selected countries are in process.\nCost of Systems and Services\nTotal cost of sales as a percentage of total net revenues increased from fiscal 1994 to fiscal 1995 due to the continued growth of services and license revenues, which have a higher cost structure than systems sales, and to an increase in the cost of systems. The increase as a percentage of total net revenues from fiscal 1993 to fiscal 1994 was primarily due to non-recurring costs incurred to conform VMX's accounting practices to the Company's. This negative effect was partially offset by the effects of revenue transactions for which costs were previously expensed due to uncertainty of revenue recognition and a favorable mix in the configuration of high-end products.\nThe increase in cost of systems as a percentage of total systems revenues from fiscal 1994 to fiscal 1995 was due primarily to product mix changes. The increase from fiscal 1993 to fiscal 1994 was due primarily to non-recurring costs of $2.2 million incurred to conform VMX's accounting practices to the Company's.\nThe decrease in cost of services as a percentage of total services and license revenues since fiscal 1993 is primarily attributable to the increase in ONS revenues, which have a lower cost structure as a percentage of services and license revenues than hardware repair and maintenance.\nDuring fiscal 1995, 1994 and 1993, the Company used sales promotions and pricing programs, including price reductions and discounts, to stimulate demand for the Company's products. If the Company is required to respond to economic or competitive pressures through similar programs in the future, cost of systems and services could increase as a percentage of total net revenues.\nResearch and Development\nThe increase in research and development expenses in absolute dollars and as a percentage of total net revenues is due to the Company's increased spending on the development of new products, projects to meet customer commitments, the adaptation of existing products and technology for international markets, and the continued commitment to enhancements to existing products. Fiscal 1995 expenses also reflect research and development expenses incurred by the development facility acquired by the Company in August 1994. Additionally, the Company incurred a one-time charge of approximately $1.2 million during fiscal 1995 related to a cancelled contract for software development.\nDuring fiscal 1995, 1994 and 1993, the Company entered into development contracts with certain customers whereby the Company performed development work on applications software using customer funds. During fiscal 1995, $1.0 million ($0.8 million in fiscal 1994 and $0.3 million in fiscal 1993) was recognized as revenue and $1.0 million ($0.8 million in fiscal 1994 and $0.3 million in fiscal 1993) was charged to cost of sales for projects completed. No internal software development costs have been capitalized to date under the provisions of Statement of Financial Accounting Standards No. 86, \"Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed.\" See Note 2 to consolidated financial statements.\nThe Company expects to continue to increase expenditures on research and development in fiscal 1996 in absolute terms and these expenses could increase as a percentage of total net revenues.\nSelling, General and Administrative\nThe increases in selling, general and administrative expenses resulted primarily from payroll related expenses for employees hired to support the growth of the Company's worldwide operations. The increases in fiscal 1995 were partially offset by a reduction in legal expenses related to ongoing patent litigation incurred during fiscal 1994, the absence of costs related to the departure of the prior CEO which were incurred during fiscal 1994 and reduced occupancy costs due to the consolidation of certain office facilities in fiscal 1995. Selling, general and administrative expenses declined as a percentage of total net revenues due to the factors discussed above and the Company's continued monitoring of expenses and employment of cost control measures. Since fiscal 1994, the Company has continued to redeploy resources to support the faster growing business segments, including the hiring of employees to support new\ninternational subsidiaries and international sales opportunities. Since the merger with VMX, the Company has analyzed organizational and operational synergies that can be achieved and began to realize the benefits from those synergies in fiscal 1995. The Company believes that additional selling, general and administrative expenses will be required to maintain its competitive position, including expanded international sales activities, and expects that these expenses will increase in absolute terms and could increase as a percentage of total net revenues. Additionally, the Company is currently involved in patent litigation that may cause an increase in legal expenses in the future. See \"Business - Patents, Copyrights, Trademarks and Technology Licenses.\"\nNon-recurring Charge for Acquired In-process Research and Development\nIn August 1994, the Company purchased certain intellectual property and fixed assets from another company for $5.1 million. Of the total purchase price, $4.7 million was allocated to in-process research and development and $0.4 million was allocated to property and equipment. The in-process research and development was expensed in the first quarter of fiscal 1995.\nIntegration Costs\nIn connection with the VMX merger in fiscal 1994, the Company recorded $18.3 million for integration costs related to the consolidation of facilities and personnel. In fiscal 1995, an additional $2.8 million of integration costs were incurred which related primarily to literature design for name change and other modifications to literature for the merged Company and the consolidation of processes and computer systems of the merged Company.\nInterest and Other Income (Expense), Net\nInterest and other income (expense), net for fiscal 1995 increased $4.4 million from fiscal 1994 and for fiscal 1994 decreased $5.8 million from fiscal 1993. These changes were due primarily to merger related expenses of $3.6 million incurred in fiscal 1994. Since fiscal 1993, the Company has realized lower interest income due to lower interest rates and lower average cash and cash equivalent and short-term investment balances and had smaller realized gains on sales of short-term investments. During fiscal 1995, there were net foreign exchange gains of $0.8 million compared to losses of $0.4 million in fiscal 1994 and gains of $0.2 million in fiscal 1993. Other expenses in fiscal 1994 included one-time costs related to the merger with VMX for which no such expenses were incurred in fiscal 1995. Other expenses in fiscal 1993 included one-time costs associated with the acquisition of one of the Company's subsidiaries. Other expenses in each fiscal year included costs of the Company's foreign exchange hedging program and fees paid to the Company's investment advisors. The Company continues to utilize its hedging program to mitigate the foreign exchange financial exposure of foreign currency transactions.\nIncome Taxes\nThe effective tax rate for fiscal 1995 was 32% compared to 22% in fiscal 1994 and 28% in fiscal 1993. The lower effective tax rate in fiscal 1994 was attributable to a combination of factors. First, various tax assets of VMX that had been fully reserved were recognized as a tax benefit. Additionally, the retroactive reinstatement of the U.S. research and development credit for the fiscal year ended June 30, 1993 had a favorable impact on the effective tax rate in fiscal 1994.\nDuring the third quarter of fiscal 1993, but effective July 1, 1992, the Company changed its method of accounting for income taxes to the liability method required by Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes.\" Prior to this date the Company used the deferred method of accounting for income taxes under APB No. 11. As permitted by SFAS No. 109, no financial statements for periods prior to July 1, 1992 were restated. Results for the first quarter of fiscal 1993 were previously restated to include a charge of $115,000, representing the cumulative effect, as of July 1, 1992, of this change in accounting for income taxes. Other immaterial adjustments (netting to $115,000) were made to the tax provision in the first quarter of fiscal 1993 to reflect the change to SFAS No. 109. No adjustments to the second quarter results of fiscal 1993 were necessary. See Note 13 to the Consolidated Financial Statements.\nDividends\nThe Company has not paid cash dividends on its Common Stock to date and does not plan to pay cash dividends to its stockholders in the foreseeable future. The Company presently intends to retain any earnings to finance its business and to repurchase shares of its Common Stock under a program approved by the Board of Directors. See \"Liquidity and Capital Resources.\"\nRESULTS OF OPERATIONS - QUARTERLY\nThe following table presents unaudited quarterly operating results and certain items as a percentage of total net revenues for the Company's four quarters in fiscal 1995. The Company believes that all necessary adjustments, consisting only of normal recurring adjustments, have been included in the amounts stated below to present fairly the selected quarterly information. This information should be read in conjunction with the consolidated financial statements included elsewhere herein. The operating results for any quarter are not necessarily indicative of results for any subsequent period.\nPercentage amounts may not total due to rounding.\nLower total net revenues in the first quarter compared to the prior and subsequent quarters are due primarily to a historically slow summer both domestically and internationally. The increase in fourth quarter net revenues compared to prior quarters resulted from special promotions for existing and new products introduced during the third quarter of fiscal 1995.\nCost of systems, as a percentage of total net revenues, increased throughout the year primarily as a result of higher systems costs related to changes in product mix, whereas cost of services as a percentage of total net revenues remained relatively flat throughout the year.\nOperating margin for the first quarter was affected by the lower revenues discussed above combined with the non-recurring charge for acquired in-process research and development. Excluding the non-recurring charge, operating margin for the first quarter would have been 9 percent. Third quarter operating margin was affected by higher integration costs as the Company continues to finalize the consolidation of VMX operations. Fourth quarter operating margin was affected by higher revenue, a favorable product mix and significant efforts to reduce expense growth.\nThe quarterly effective tax rates reflect the provision required for the annual rate of 32%.\nThe Company believes that its backlog on a quarterly basis will not generally be large enough to assure that its revenue targets for a particular quarter will be met. Furthermore, a large percentage of any quarter's shipments have historically been booked in the last month of the quarter. Consequently, quarterly revenues and operating results will depend on the volume and timing of new orders received during a quarter, which is difficult to forecast. This is particularly true in the VIS market, where sales orders are generally larger. The Company offers products with base system list prices from approximately $11,000 to over $1,250,000 depending on customer configurations and requirements, and generally has a higher gross margin on its fully configured products. The Company provides discounts to distributors and generally has a higher gross margin on direct sales. In addition, the Company's services and license revenues generally have lower gross margins than systems gross margins. As a result, the Company's revenues and gross margins will be affected by the product, service and channel mix and timing of orders it receives. In addition, because the Company recognizes revenues on sales to distributors and customers which have previously installed the Company's product at the time of shipment and on certain direct sales to end users at the time of installation, quarterly revenues can also fluctuate depending on the customer installation schedules for direct sales at the end of a quarter. Installation on direct sales typically occurs within five weeks of shipment. The Company has not experienced any significant returns by customers of any of its products.\nFourth quarter total net revenues are typically enhanced by sales incentives to employees and promotional programs for customers; as a result, first quarter sales are typically less than fourth quarter sales. The Company anticipates that this trend will continue in the first quarter of fiscal 1996.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company's cash and equivalents and short-term investments decreased to $52.6 million at June 30, 1995 from $86.4 million at June 30, 1994 and $100.4 million at June 30, 1993. Cash flows from operations resulted in net cash provided of $46.8 million in fiscal 1995, $49.4 million in fiscal 1994 and $39.8 million in fiscal 1993. In fiscal 1995, cash from operations resulted primarily from net income of $31.1 million, which included $30.7 million of non-cash expenses for depreciation and amortization, offset by an increase in accounts receivable of $24.0 million. The increase in accounts receivable is due primarily to an increase in fourth quarter total net revenues of $19.0 million compared to the same quarter of fiscal 1994.\nThe primary uses of cash during fiscal 1995 were investment in property, plant and equipment of $56.9 million ($58.6 million and $30.8 million in fiscal 1994 and 1993, respectively) and the repurchase of Common Stock for approximately $28.4 million ($5.8 million and $13.1 million in fiscal 1994 and 1993, respectively) under the Company's stock repurchase program, both of which aim to increase return to investors as compared to the return which would be earned by investing the cash and generating interest at the low rates available during fiscal 1995.\nAs of June 30, 1995, the Company had invested $48.7 million in the purchase of land and the development of the Company's new corporate offices on that land. The Company now occupies those facilities. Effective July 6, 1995, the Company entered into a one-year operating lease agreement to lease undeveloped land on which additional offices may be constructed adjacent to the existing corporate offices over the next three years under a similar leasing arrangement. Under the terms of the operating lease, the Company is contingently liable under a 97% first-loss clause for up to $9.9 million at July 6, 1996. See Note 14 to the consolidated financial statements. The Company also expects to purchase additional equipment and make certain leasehold improvements during fiscal 1996; however, spending levels are not expected to be at the levels they were in fiscal 1995 and 1994 because of the completion of the new corporate offices. The Company anticipates that its property and equipment investments will eventually result in greater efficiencies and increased flexibility for the Company.\nIn connection with the VMX merger, the Company recorded integration costs of $18.3 million in fiscal 1994. In addition to the integration costs recorded in fiscal 1994, the Company incurred additional merger-related integration costs during fiscal 1995 of $2.8 million, which have been charged to operations. The charges were recorded based on decisions made by management to consolidate certain facilities and personnel. As of June 30, 1995, the balance of expected future cash expenditures was approximately $4.6 million and was recorded in \"Accrued and Other Liabilities.\" The majority of this amount will be spent during the first quarter of fiscal 1996 as consolidation of the Company's manufacturing facilities is completed. Remaining integration charges are expected to be immaterial. The integration charges are the primary reason for the decrease in working capital from fiscal 1993 to fiscal 1994.\nIn July 1994, the Company's Board of Directors approved the repurchase of up to 3.5 million shares of its Common Stock over a period of approximately two years. During fiscal 1995, the Company repurchased approximately 1.3 million shares of its Common Stock at an average per share price of $22. The Company expects to continue to repurchase its Common Stock under this program if warranted by market conditions.\nIn August 1994, the Company purchased certain intellectual and personal property from another company for $5.1 million. Of the total purchase price, $4.7 million was allocated to in-process research and development and $0.4 million was allocated to property and equipment. The in-process research and development was expensed during the first quarter of fiscal 1995. The full amount of the purchase price was paid during fiscal 1995.\nThe Company anticipates that cash flows from operations, existing cash and equivalents balance, short-term investment balance and its existing $30 million bank revolving line of credit will be adequate to meet the Company's cash requirements through the end of fiscal 1996.\nFACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS\nThe Company believes that in the future its results of operations could be affected by factors such as market acceptance of new products and upgrades, growth in the worldwide voice processing market, competition, expansion of services by its VIS customers, the outcome of litigation and changes in general economic conditions in any of the countries in which the Company does business.\nThe Company believes that the successful introduction of new and enhanced products and services will be essential for it to maintain or improve its competitive position. In July 1995, the Company introduced OcteLink - a global \"messaging post office\" that could eventually allow the interconnection of virtually any voice messaging system with networking capability, regardless of protocol, system size or geographic location. Revenues from OcteLink are expected to commence during the latter part of the second quarter of fiscal 1996 but are not expected to be material for the fiscal year and the Company expects to incur additional research and development expenditures to launch OcteLink. Although the Company believes OcteLink is a viable global messaging network, there is currently no reliable data regarding the demand for such services in multiple customer segments. Furthermore, there is no assurance that demand for a global messaging network will not be slow to materialize or that potential competitors will not successfully introduce alternative solutions to OcteLink that achieve better market acceptance. Additionally, the Company introduced the Overture Family of message servers in July 1995. The Overture 250 is a new product which is a mid-level system designed for medium-sized businesses and large branch offices. Although the Company anticipates a favorable reception of the Overture 250 into the marketplace, there can be no assurance that it will be successful in generating additional sales. Furthermore, the Company is developing \"unified messaging\" products for voice, fax and electronic mail messaging. Unified messaging essentially unites voice, fax and e-mail together in a client\/server architecture that uses standard PC and LAN technology. This integration brings together several discrete technologies into a single mailbox that provides user access from a telephone or a PC. In May 1995, Octel announced the first component of its unified messaging technology that will be available on Microsoft Exchange, a LAN-based, enterprise-wide messaging architecture. Current expectations are for revenue to commence in fiscal 1997; however, there can be no assurance that the product introduction will be successful in the marketplace or that it will not be delayed, thereby reducing future expected revenues or resulting in additional expenses to bring the product to market.\nThe timely introduction and market acceptance of the Company's next-generation client\/server architecture for its Sierra platform is a key factor in determining the Company's success in the VIS market, and the Company is focusing\nsignificant resources and talent on developing and bringing products using this architecture to market. The new architecture is scheduled for first-phase release in fiscal 1996, however, there can be no assurance that introduction of products using this architecture will not be delayed, allowing competitors to gain a market share advantage, or that such products will be successful in the marketplace, thereby resulting in additional expenses to bring the product to market or reducing future expected revenues.\nThe integration of certain operations as a result of the VMX merger continues to require the dedication of management resources which may temporarily distract attention from the day-to-day business of the Company. The Company has executed a plan to reduce expenses by eliminating duplicate facilities - particularly sales offices - employees and other expenses. These efforts are expected to continue through the first quarter of fiscal 1996 as the consolidation of the Company's manufacturing and support facilities is completed. There can be no assurance that Octel will be able to reduce expenses in this fashion, that there will not be high costs associated with such activities, that such reductions will not result in a decrease in revenues or that there will not be other material adverse effects of such activities. Although it believes there are opportunities to gain from synergies resulting from the VMX merger, the Company cannot determine the ultimate effect that the continued integration of Octel and VMX will have on revenues, earnings or the Common Stock price.\nDuring the latter half of fiscal 1995, the Company adopted a new, capacity-based pricing approach for its largest GBS system, the XC-1000. This pricing approach was also adopted for other Overture system sales beginning in fiscal 1996. This approach allows customers to purchase systems with only part of the equipment's capacity enabled and then have additional capacity enabled in the future upon payment of additional fees. While the Company believes that this approach will make it more competitive, there can be no assurance that this approach will be successful in winning additional sales or will not defer revenue that might have otherwise been earned earlier. Difficulties in implementing this approach, delays or adverse results due to renegotiation of sales and distribution agreements to accommodate capacity-based pricing, deferral of revenue or the failure to generate additional sales could have an adverse effect on the Company's results of operations.\nDue to the factors noted above and elsewhere in management's discussion and analysis of financial condition and results of operations, the Company's future earnings and Common Stock price may be subject to significant volatility, particularly on a quarterly basis. Past financial performance should not be considered a reliable indicator of future performance and investors should not use historical trends to anticipate results or trends in future periods. Any shortfall in revenue or earnings from the levels anticipated by securities analysts could have an immediate and significant effect on the trading price of the Company's Common Stock in any given period. Additionally, the Company may not learn of such shortfalls until late in a fiscal quarter, which could result in an even more immediate and adverse effect on the trading price of the Company's Common Stock. Both the Company's Common Stock and the stock market generally are at or near historic highs and there can be no assurance that such valuations will continue or increase. Finally, the Company participates in a highly dynamic industry which often results in volatility of the Company's Common Stock price.\nThe Company has been and may in the future continue to be required to litigate enforcement of its intellectual property or commercial rights or to defend itself in litigation arising out of claims by third parties. Such litigation, even if the Company is ultimately victorious, can be extremely expensive and may have a material adverse effect on the Company's results of operations in any particular period. Litigation may also occupy management resources that would otherwise be available to address other aspects of the Company's business. See \"Business - Patents, Copyrights, Trademarks and Technology Licenses.\"\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nINDEX TO CONSOLIDATED FINANCIAL STATEMENT\nSchedules not listed above have been omitted because the information required to be set forth therein is not applicable.\nCONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA)\nASSETS\nSee notes to consolidated financial statements.\nCONSOLIDATED STATEMENTS OF INCOME (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\nSee notes to consolidated financial statements.\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (IN THOUSANDS, EXCEPT SHARE DATA)\nSee notes to consolidated financial statements.\nCONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)\nSee notes to consolidated financial statements\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. ORGANIZATION AND BASIS OF PRESENTATION\nThe Company designs, manufactures and markets voice information processing systems. The Company also provides voice processing and networking services. The consolidated financial statements include the Company and its wholly owned subsidiaries. Intercompany balances and transactions are eliminated in consolidation. Certain prior years' costs previously reported as selling, general and administrative have been reclassified to cost of services to conform to the fiscal 1995 presentation.\n2. SIGNIFICANT ACCOUNTING POLICIES\nCash equivalents\nCash equivalents consist of all highly liquid debt instruments purchased with a maturity of three months or less.\nShort-term investments\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\"). The Company adopted the provisions of SFAS 115 for investments held as of June 30, 1994. Under the provisions of SFAS 115, the Company has classified its investments in certain debt securities as \"available-for-sale.\" Such investments are recorded at fair value, with unrealized gains and losses reported as a separate component of stockholders' equity. Interest income is recorded using an effective interest rate, with the associated premium or discount amortized to \"Interest and other income (expense), net.\" The cost of securities sold is based upon the specific identification method. In accordance with the provisions of SFAS 115, prior period financial statements have not been restated to reflect the change in accounting principle. The cumulative effect as of June 30, 1994 of adopting SFAS 115 was to decrease stockholders' equity by $0.5 million to reflect the net unrealized loss on investments classified as \"available-for-sale\" and previously recorded at cost. See Note 3.\nForeign currency translation\nThe Company's foreign subsidiaries operate using local functional currencies, except for Israel, which uses the U.S. Dollar as its functional currency. Accordingly, assets and liabilities denominated in foreign currencies are translated at the exchange rate on the balance sheet date. Revenues, costs and expenses are translated at average rates of exchange prevailing during the year. Translation adjustments resulting from this process are accumulated as a separate component of stockholders' equity. Realized and unrealized gains and losses on foreign currency transactions and hedge contracts are included in interest and other income (expense), net.\nFinancial instruments and risk concentration\nThe forward hedge contracts discussed above require the Company to exchange currencies at rates agreed upon at the inception of the contracts. Although the gross amounts are used to express the volume of these transactions, the amounts potentially subject to credit risk are limited to the difference between the counterparty's obligation and the obligation of the Company. The contracts do not subject the Company to significant market risk from exchange rate movements because the contracts offset foreign currency balances and transactions being hedged. The Company maintains policies for entering into foreign exchange contracts and investments.\nFinancial instruments which potentially subject the Company to concentrations of credit risk are primarily cash equivalents, short-term investments, accounts receivable and financial instruments used in hedging activities. The Company's cash equivalents and short-term investments are primarily in U.S. government obligations and municipal notes and bonds that have maturities ranging from 1995 through 2003. The Company believes no significant concentration of credit risk exists with respect to these financial instruments. Balances due from international\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\ncustomers account for 32 percent of the total accounts receivable at June 30, 1995 (35 percent at June 30, 1994). Additionally, distributors and VIS customers comprise 13 percent and 38 percent of total accounts receivable, respectively (18 percent and 40 percent in 1994, respectively). Generally, the Company requires no collateral from customers. The Company believes that any credit risks are substantially mitigated by the Company's credit evaluation process.\nFair value of financial instruments\nFor certain of the Company's financial instruments, including cash and equivalents, short-term investments, accounts receivable, accounts payable and accrued expenses, the carrying amounts approximate fair value due to their short maturities. Consequently, such instruments are not included in the following table. The following table provides information regarding the estimated fair values of off balance sheet financial instruments determined based on quoted market prices of comparable instruments (in thousands):\nInventories\nInventories are stated at the lower of cost (first-in, first-out) or market.\nDevelopment costs\nDevelopment costs incurred in the research and development of new software products and enhancements to existing software products are expensed as incurred until technological feasibility has been established. After technological feasibility is established, any additional costs would be capitalized in accordance with Statement of Financial Accounting Standards No. 86, \"Accounting for the Costs of Computer Software to Be Sold, Leased or Otherwise Marketed.\" The Company has not capitalized any software development costs, as the Company's current process for developing this software is essentially completed concurrently with the establishment of technological feasibility. In connection with the VMX merger, certain costs formerly capitalized by VMX were written off to conform accounting practices during fiscal 1994.\nIn fiscal 1995, 1994 and 1993, the Company entered into contracts for funded software development projects. These contracts are contractual services as defined by Statement of Financial Accounting Standards No. 68, \"Research and Development Arrangements.\" The Company defers development costs and revenue for these projects and such deferred costs are expensed to cost of sales when the related revenue is recognized. The Company maintains all rights related to the funded projects. During fiscal 1995, the Company incurred a one-time charge of approximately $1.2 million related to a cancelled contract for software development. As of June 30, 1995, all current projects are expected to be completed substantially in accordance with the related contract.\nAs of June 30, 1995, $0.5 million of costs related to these contracts were deferred ($2.9 million and $1.9 million at June 30, 1994 and 1993, respectively). Prepayments recorded as a liability were $0.2 million at June 30, 1995 ($1.0 million and $0.1 million were recorded at June 30, 1994 and 1993, respectively). In fiscal year 1995, $1.0 million was expensed to cost of sales and $1.0 million recognized as revenue for contracts ($0.8 million was expensed to cost of sales and recognized as revenue in 1994 and $0.3 million was expensed to cost of sales and recognized as revenue in 1993).\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nAcquired in-process research and development\nIn August 1994, the Company purchased certain intellectual and personal property from another company for $5.1 million. Of the total purchase price, $4.7 million was allocated to in-process research and development and $0.4 million was allocated to property and equipment. The in-process research and development was expensed in the first quarter of fiscal 1995.\nProperty, plant and equipment\nProperty, plant and equipment are stated at cost. Depreciation is computed using the straight-line method over the following estimated useful lives:\nIntangible assets\nGoodwill represents the excess of acquisition cost, including reserves for certain acquisition-related expenses, over the fair value of the net assets acquired and was being amortized on a straight-line basis over ten years. Goodwill of $1.7 million was included in the balance sheet caption \"Deposits and other assets\" as of June 30, 1994. During fiscal 1995, the balance in Goodwill was eliminated in connection with the reversal of remaining acquisition reserves that were no longer required.\nThe Company has acquired various technology licenses and enters into other agreements requiring pre-payments. The cost of the licenses and other agreements is amortized from the date that the related product is commercially available over periods based on anticipated future revenue streams from the related products not exceeding 36 months. As of June 30, 1995 and 1994, $2.5 million and $3.3 million, respectively, were included in the balance sheet caption \"Deposits and other assets\" for such assets.\nRevenue recognition\nRevenue is recognized upon shipment to distributors and upon installation for end users. Revenue is also recognized upon shipment to end users for orders from businesses which have previously installed the Company's products, and upon shipment of upgrades and expansions to larger capacity systems.\nRevenues on service contracts are primarily recognized ratably over the contract period.\nReturns and allowances\nThe Company does not generally reserve for returns because, historically, the Company has not experienced any significant returns of any of its products by customers.\nWarranty costs\nThe Company warrants its products for one year after delivery to the purchaser or after Company performed installation. Provision for estimated warranty costs is recorded at the time of sale.\nIncome taxes\nEffective July 1, 1992, the Company adopted SFAS No. 109, \"Accounting for Income Taxes.\" Under SFAS No. 109, the liability method is used in accounting for income taxes. Under this method, deferred tax assets and\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nliabilities 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.\nAs permitted by SFAS No. 109, the Company elected to record the cumulative effect of adopting this pronouncement as a change in accounting principle as of July 1, 1992, the result of which was a reduction in fiscal 1993 net income of $0.1 million. This charge represents the writedown of net deferred tax assets and liabilities from the tax rates in effect when they arose to current statutory tax rates.\nNet income per common and equivalent share\nPrimary and fully diluted net income per common and equivalent share are computed based upon the weighted average number of common and equivalent shares from stock options and put warrants (using the treasury stock method) and shares subscribed under the Employee Stock Purchase Plan.\n3. INVESTMENTS\nAt June 30, 1995, all cash equivalents and short-term investments were considered available-for-sale securities and consisted of the following (in thousands):\nAt June 30, 1994, all cash equivalents and short-term investments were considered available-for-sale securities and consisted of the following (in thousands):\nAt June 30, 1995 and 1994, these securities were classified on the balance sheet as follows (in thousands):\nThe cost and estimated fair value of available-for-sale debt securities as of June 30, 1995, by contractual maturity, consisted of the following (in thousands):\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nFor the year ended June 30, 1995, the Company had $212.3 million in proceeds from sales of available-for-sale investments, $0.3 million of gross realized gains and $0.4 million of gross realized losses on those sales.\n4. BUSINESS COMBINATIONS -- POOLING OF INTERESTS METHOD\nVMX, Inc.\nOn March 31, 1994, Octel Acquisition Corporation, a wholly owned subsidiary of Octel, was merged with and into VMX, Inc. (VMX), with VMX being the surviving corporation and a wholly owned subsidiary of Octel. In the transaction, approximately 5.4 million shares of Octel's common stock were issued in exchange for all of the outstanding common stock of VMX. The merger was accounted for as a pooling of interests, and accordingly, the accompanying financial statements have been restated to include the accounts and operations of VMX for all periods prior to the merger. Effective in the quarter ended March 31, 1994, VMX recorded $2.2 million in charges to operations to conform certain changes in estimates and accounting policies to those of Octel.\nVMX provided integrated messaging and call processing systems, software and services that combined voice, data and image for business communications, worldwide.\nSeparate results of the combining entities for the periods prior to the merger were as follows (in thousands):\nIn connection with the merger, approximately $3.6 million of merger expenses were incurred and charged to interest and other income (expense), net during the third quarter of fiscal 1994. These non-recurring expenses included investment banking fees of $2.6 million, legal and accounting fees of $0.6 million and other miscellaneous expenses of $0.4 million.\nAlso in connection with the merger, the Company recorded integration costs in the third quarter of fiscal 1994 of $18.3 million related to costs associated with consolidating facilities and personnel. Included in such integration costs were building lease termination fees and moving costs in connection with redundant facilities, employee severance,\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nrelocation expenses, and the write-off of leasehold improvements and assets impaired as a direct result of the merger. The balance in these reserves of $4.6 million at June 30, 1995 is included in \"Accrued and other liabilities\" on the balance sheet. Additional expenses of $2.8 million were incurred in fiscal 1995, relating primarily to literature design for name change and other modifications to literature for the merged company and the consolidation of processes and computer systems of the merged company.\nRhetorex, Inc.\nIn March 1993, the Company issued the equivalent of 346,218 shares of its Common Stock in exchange for all of the outstanding capital stock of Rhetorex, Inc. (Rhetorex), which has been accounted for as a pooling of interests. In addition the Company assumed Rhetorex stock options which represented options to purchase 3,779 shares of the Company's Common Stock subsequent to the transaction. Rhetorex designs and manufactures high performance voice processing components and software for personal computers.\nCompass Technology, Inc.\nEffective August 12, 1992, the Company consummated a business combination with Compass Technology, Inc. (now Octel PC Products Division (OPCPD)) which was accounted for as a pooling of interests. OPCPD develops and markets voice processing applications software for PC-based systems. To effect the combination, approximately 460,000 shares of common stock were issued in exchange for substantially all equity securities of OPCPD. The net assets of OPCPD amounted to $0.5 million at June 30, 1992.\n5. BUSINESS COMBINATION -- PURCHASE METHOD\nOn October 21, 1992, the Company acquired Tigon Corporation (now Octel Network Services (ONS)) from Ameritech. ONS is a provider of voice processing and networking services primarily in the United States. The purchase price of $12 million was paid in cash. The acquisition was accounted for as a purchase and the results of ONS' operations were combined with those of the Company from the date of acquisition. Goodwill of $7.5 million, representing the excess of acquisition cost, including reserves for certain acquisition related expenses, over the $10.3 million estimated fair value of the net assets acquired, was recorded at the date of acquisition, prior to the adoption of SFAS No. 109. As discussed in Note 13 below, the assets and liabilities assumed in the acquisition of ONS were remeasured in connection with the adoption of SFAS No. 109 by the Company. The gross balance of goodwill at June 30, 1994 was $ 2.1 million, which reflects the change for the SFAS No. 109 remeasurement and the final purchase price allocation adjustment of $1.3 million made prior to the end of the one year anniversary date of the acquisition. Goodwill amortization expense for fiscal 1995, 1994 and 1993 was $0.2 million, $0.3 million and $0.1 million respectively. During fiscal 1995, the balance in Goodwill was eliminated in connection with the reversal of remaining acquisition reserves that were no longer required.\n6. INVENTORIES\nInventories consist of (in thousands):\n7. PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment consist of (in thousands):\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n8. ACCRUED AND OTHER LIABILITIES\nAccrued and other liabilities consist of (in thousands):\nOther liabilities primarily consist of property and sales taxes, amounts due to direct customers and other liabilities.\n9. LINE OF CREDIT AND LETTERS OF CREDIT\nEffective June 1994, the Company obtained a $30 million bank revolving line of credit which also allows the Company to obtain standby letters of credit. Borrowings under the line are unsecured and bear interest at either an adjusted LIBOR rate plus one and one-quarter percent or the greater of the Bank's base rate or the Federal Funds Effective Rate plus one-half of one percent, at the Company's discretion upon borrowing the funds. Borrowings under the line are subject to certain financial covenants and restrictions on indebtedness, equity distributions, financial guarantees, business combinations and other related items. The Company was in compliance with these covenants and had no borrowings under this line as of June 30, 1995. The line expires in June 1996.\nAt June 30, 1995, the Company had $1.8 million of stand-by letters of credit outstanding. The letters of credit are primarily to guarantee payments for inventory purchases and facility lease payments. The majority of the Letters of Credit are denominated in Japanese Yen, U.S. Dollars and French Francs and expire on various dates through July 1, 1998.\n10. STOCKHOLDERS' EQUITY\nIn July 1990, the Company's Board of Directors approved a common shares rights agreement and declared a dividend distribution, payable to stockholders of record on August 15, 1990, of one Common Stock purchase right for each outstanding share of its Common Stock. Initially, each right entitles the stockholder to buy one newly issued share of the Company's Common Stock at an exercise price of $80. The rights become exercisable (unless postponed by\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\naction of the disinterested directors) on the earlier of: (1) ten days following a public announcement that a person or group has acquired, or obtained the right to acquire, beneficial ownership of 21% or more of the outstanding Common Stock or (2) ten days following the commencement or announcement of a tender offer or exchange offer, the consummation of which would result in the beneficial ownership by a person or group of 21% or more of the Company's outstanding Common Stock.\nIf the Company is acquired in a merger or other business combination transaction without approval by the Company's Board of Directors, each right not held by the acquiring person would entitle its holder to purchase $160 worth of the common stock of the acquiring company for $80. If any person or group acquires 21% or more of the Company's Common Stock without approval by the Company's Board of Directors, each right not held by the acquiring person would entitle its holder to purchase $160 worth of the Company's Common Stock for $80.\nThe rights are redeemable at the Company's option for $0.01 per right. Additionally, the exercise price, number of rights and number of common shares that may be acquired are subject to adjustment from time to time to prevent dilution. The rights expire on July 31, 2000. At June 30, 1995 substantially all shares of Common Stock are subject to this agreement.\nCommon Stock\nDuring fiscal 1992, a stock repurchase program was approved by the Board of Directors whereby the Company may repurchase such shares of its Common Stock on the open market as may reasonably be required for exercises under the 1985 Incentive Stock Option Plan and issuances under the 1987 Employee Stock Purchase Plan. In July 1994, the Company's Board of Directors approved the repurchase of up to 3.5 million shares of its Common Stock over a period of approximately two years. During fiscal 1995, 1994 and 1993, the Company repurchased 1,305,600 shares, 232,000 shares, and 603,951 shares, respectively. Average prices paid during these periods (exclusive of any put warrant proceeds) were $22 per share, $25 per share and $22 per share, respectively. As of June 30, 1995, approximately 1.8 million of the repurchased shares have been reissued under employee stock plans with the balance expected to be reissued under such plans in fiscal 1996.\nDuring fiscal 1993 and 1995, in connection with its stock repurchase program, the Company sold put warrants in a series of private placements, with the intention of reducing the cost of the stock repurchase program. The put warrants entitle the holder to sell one share of common stock to the Company for each warrant held, at a specified price, if the holder exercises the warrant. The activity for fiscal 1995, 1994 and 1993 is summarized as follows:\nIn November 1994, the Company increased the number of shares of Common Stock reserved for issuance under its 1987 Employee Stock Purchase Plan from 1,250,000 to 1,650,000. Eligible employees may authorize payroll\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\ndeductions of up to 10% of their compensation to purchase shares at the lower of 85% of the fair market value of the Common Stock as of the date of grant (first day of an offering period, or for newly hired employees, the date their participation begins) or the last day of the six-month offering period. In fiscal 1995, 369,000 shares were purchased at an average price of $16.17 (327,000 in fiscal 1994 at an average price of $15.98 and 252,000 in fiscal 1993 at an average price of $16.04).\nDuring fiscal 1994, the Company increased the number of shares of Common Stock reserved for issuance under its 1985 Incentive Stock Plan from 6,300,000 to 9,600,000. In November 1994, the Company increased shares of Common Stock reserved for issuance under the Directors' Stock Option Plan from 200,000 to 350,000. Under the plans, stock options may be granted to employees, consultants and directors to purchase Common Stock at not less than fair market value at the date of grant. Options become exercisable as determined by the Board of Directors, generally over five years. However, options granted after June 1, 1994 become exercisable over four years. Options granted before November 1988 expire ten years from date of grant, while those granted after that date expire five and one-half years from date of grant, or within six months after becoming fully exercisable, whichever is sooner. At June 30, 1995, a total of 957,541 shares were available for future grants under the plans.\nIn June 1994, the Board of Directors approved a repricing of stock options for certain employees, excluding senior management and officers. The employees had the option of either maintaining their existing options or cancelling any options with exercise prices greater than $17.25 and receiving new options representing 90% of the options being cancelled. The new options' vesting commencement date was reset to June 22, 1994 and the new options will vest at the rate of 25% each year over four years. The options expire five and one-half years from the grant date. The vested options may only be exercised when the fair market value of the Company's Common Stock equals or exceeds the original option exercise price; however, after five years and three months from June 22, 1994, the options may be exercised regardless of the fair market value of the Company's Common Stock for up to three months. Options for up to 1,574,717 shares were qualified for the repricing. Under this repricing, options for approximately 1,253,000 shares were cancelled and options for approximately 1,120,000 shares were granted. Fiscal 1994 activity has been adjusted in the table below to reflect the repricing.\nInformation regarding outstanding stock options is as follows:\nAt June 30, 1995, options to purchase 2,195,647 shares were exercisable.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nAt June 30, 1995, the Company has reserved shares of Common Stock for issuance as follows:\nDuring fiscal 1995, certain employees exercised stock options in exchange for notes. Notes receivable from the sale of stock bear interest at variable rates ranging from 6.62% to 7.43% and are due at various dates through 1998. The notes are secured, in part, by the stock issued upon exercise of the stock options.\nIn October 1990, the Board of Directors authorized a restricted stock purchase of 60,000 shares for $.001 per share by an individual who was an officer of the Company. Deferred compensation, representing the difference between $.001 per share and the fair market value of the shares at the date of issuance, was amortized over the three-year vesting period. In fiscal 1994 and 1993, $55,000 and $216,000, of deferred compensation was amortized, respectively.\n11. RELATED PARTY TRANSACTIONS\nDuring fiscal 1995, 1994 and 1993, the Company had sales of approximately $26.0 million, $28.4 million and $23.6 million, respectively, to companies in which a member of the Company's Board of Directors is also an officer and to a company that owned approximately 3.8 percent, 6.5 percent and 9.0 percent of the Company's Common Stock at June 30, 1995, 1994 and 1993, respectively. Amounts due from these companies at June 30, 1995 and 1994 were $6.3 million and $2.2 million, respectively.\n12. INTEREST AND OTHER INCOME (EXPENSE), NET\nInterest and other income (expense), net consists of (in thousands):\nCash payments for interest were $0.2 million, $0.3 million and $0.1 million in fiscal 1995, 1994 and 1993, respectively.\n13. INCOME TAXES\nEffective July 1, 1992, the Company adopted SFAS No. 109. As permitted by SFAS No. 109, the Company elected to record the cumulative effect of adopting this pronouncement as a change in accounting principle as of July 1, 1992, the result of which was a reduction in fiscal 1993 net income of $0.1 million.\nIn accordance with the provisions of SFAS No. 109, the assets acquired and liabilities assumed in the purchase of ONS in October 1992 were remeasured. The result of applying SFAS No. 109 to the purchase of ONS was to recognize deferred tax assets and deferred tax liabilities for the future tax consequences of the deductible and taxable temporary differences between the assigned fair values of the assets and liabilities and the tax bases. In addition, a deferred tax asset has been recognized for the tax benefit of ONS' net operating loss carryforwards existing at the date of acquisition. A valuation allowance was recognized to reduce the deferred tax asset to the amount more likely than not to be realized. Goodwill, originally recorded, was reduced by $6.8 million to the difference between the purchase\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nprice and the values assigned to identifiable assets and liabilities, including deferred tax assets (net of valuation allowance) and deferred tax liabilities. In fiscal 1994, the final purchase price allocation adjustment was made (see Note 5) which had the effect of increasing deferred tax assets by approximately $0.9 million.\nAs of June 30, 1995, the Company had net operating loss carryforwards of $11.8 million, resulting from the acquisition of ONS, that expire beginning in fiscal 1997 and ending in fiscal 2001. As mentioned above, a valuation allowance of $3.6 million has been recognized to offset the deferred tax assets related to those carryforwards by the tax effect of the amount of the net operating loss carryforwards which are not likely to be utilized. If realized, the tax benefit for those reserved items will be applied as a reduction of income tax expense.\nThe major components of the Company's deferred tax assets and liabilities are as follows (in thousands):\nAt June 30, 1995 and 1994, a net current deferred tax asset of $6.7 million and $7.5 million, respectively, has been included in the balance sheet caption \"Prepaid expenses and other,\" and a net long-term deferred tax asset of $7.9 million and $8.1 million, respectively, has been included in the balance sheet caption \"Deposits and other assets.\"\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nIncome before income taxes and cumulative effect of accounting change includes the following components:\nThe provision for income taxes, attributable to income before income taxes and cumulative effect of accounting change, consists of:\nThe reconciliation of the statutory federal income tax rate to the effective tax rate is as follows:\nCash payments for income taxes were $5.7 million, $5.8 million and $13.1 million in fiscal 1995, 1994 and 1993, respectively.\n14. LEASES\nManufacturing and administrative facilities are leased under operating leases through 2005 with certain renewal options. At June 30, 1995, future minimum annual payments under operating leases are as follows (in thousands):\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nRent expense was $9.8 million, $12.3 million, and $11.2 million in fiscal 1995, 1994 and 1993, respectively.\nOn July 6, 1995, the Company entered into a one year operating lease for a parcel of undeveloped land adjacent to its current campus on which additional offices may be constructed over the next three years. This lease provides for monthly payments which vary based on the London interbank offering rate (LIBOR) and requires the Company to maintain certain financial covenants similar to its credit facilities. Future minimum lease payments under this lease are not included in the above table. In addition, this lease provides the Company with the option at the end of the lease of either acquiring the property at its original cost or arranging for the property to be acquired. The Company is contingently liable to the lessor under a 97% first-loss clause for up to $9.9 million at July 6, 1996.\n15. EXPORT SALES\nExport revenues to nonaffiliated customers primarily in Europe and Canada, and to a lesser extent in New Zealand, Japan, Hong Kong and China, aggregated $119.0 million in fiscal 1995. Export revenues were $97.4 million and $80.7 million in fiscal 1994 and 1993, respectively.\n16. LITIGATION\nTheis Research, Inc.\nIn April 1992, the Company filed suit, in California, against Theis Research, Inc. (\"Theis\") for declaratory judgment that the Company's products do not infringe three patents of Theis and that those patents are invalid. In November 1992, Theis filed a counterclaim against the Company alleging infringement of seven of Theis' patents. Subsequently, Theis dismissed with prejudice the claims as to all but four of the patents. During the first quarter of fiscal 1995, the Company engaged in a jury trial regarding infringement of the three remaining patents and the defense of patent invalidity. In October 1994, the jury returned a verdict finding, among other things, that Octel was correct in its claim that the three patents at issue were invalid. Post-trial motions are pending and, if no settlement between the parties is reached, it is anticipated that Theis will appeal the verdict.\nGilbarco, Inc.\nIn January 1994, Gilbarco, Inc. (\"Gilbarco\") filed suit in the U.S. District Court for the District of Colorado against the Company and one of the Company's telephone company customers, U.S. West, alleging infringement of a Gilbarco patent and seeking unspecified damages. The Company filed an answer to the complaint denying any infringement of the patent and raising several affirmative defenses, including an assertion that the patent is invalid and unenforceable. In September 1994, the claims asserted against the Company were transferred to the U.S. District Court for the Northern District of California and those claims asserted against U.S. West were stayed and administratively closed pending the outcome of the California action. Fact discovery in the case has been completed, expert discovery is scheduled for completion in December 1995 and a trial date has been set for March 19, 1996. The Company is currently planning to file one or more motions before the trial which could dispose of some or all of the claims asserted against it.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nThe Company believes, based upon information currently available, including consultations with patent counsel, that the Company is not infringing any valid patents of Theis or Gilbarco. The Company will vigorously defend the patent infringement claims and any related claims for compensatory damages. Legal expenses related to ongoing patent litigation were approximately $0.9 million in fiscal 1995. While litigation is inherently uncertain, the Company believes that the ultimate resolution of these matters will not have a material adverse effect on the Company's financial position.\n17. QUARTERLY RESULTS (unaudited)\nThe following table presents unaudited quarterly operating results for each of the Company's eight fiscal quarters in the period ended June 30, 1995.\n- --------------- (1) Includes total non-recurring charges during the first quarter for in-process research and development and integration costs of $5.0 million ($3.4 million net of taxes) and integration costs in each of the subsequent quarters of $0.8 million, $1.3 million and $0.6 million, respectively ($0.5 million, $0.9 million and $0.4 million net of taxes, respectively).\n(2) Certain fiscal 1994 costs previously reported as selling, general and administrative expenses have been reclassified to cost of services to conform to the fiscal 1995 presentation.\n(3) Includes total non-recurring charges for the VMX merger and integration costs of $24.1 million ($18.8 million net of taxes).\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Stockholders Octel Communications Corporation\nWe have audited the accompanying consolidated balance sheets of Octel Communications Corporation and subsidiaries as of June 30, 1995 and 1994, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended June 30, 1995. In connection with our audits of the consolidated financial statements, we have also audited the financial statement schedule as listed in the accompanying Index at Item 8. These consolidated financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Octel Communications Corporation and its subsidiaries as of June 30, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 1995 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\/ KPMG PEAT MARWICK LLP\nPalo Alto, California July 25, 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\nThe information regarding directors of the Company required by this Item is incorporated by reference to the Proxy Statement for the Company's Annual Meeting of Stockholders, tentatively scheduled to be held on November 16, 1995, under the heading \"Election of Directors -- Nominees.\"\nThe information regarding executive officers required by this Item is incorporated by reference to the section in Part I hereof entitled \"Executive Officers of Octel Communications Corporation.\"\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by this Item is incorporated by reference to the Proxy Statement for the Company's Annual Meeting of Stockholders, tentatively scheduled to be held on November 16, 1995, under the heading \"Executive Compensation.\"\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required by this Item is incorporated by reference to the Proxy Statement for the Company's Annual Meeting of Stockholders, tentatively scheduled to be held on November 16, 1995, under the heading \"Security Ownership of Management.\"\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by this Item is incorporated by reference to the Proxy Statement for the Company's Annual Meeting of Stockholders, tentatively scheduled to be held on November 16, 1995, under the heading \"Certain Transactions.\"\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) 1. CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE\nSee Index to Consolidated Financial Statements at Item 8 on page 30 of this report.\n2. EXHIBITS\n* Designates management contracts or compensatory plans, contracts or arrangements required to be filed as exhibits pursuant to Item 14(c) of Form 10-K.\n(1) Incorporated by reference to the exhibit filed with the Company's Form 8-B filed with the Securities and Exchange Commission on February 12, 1990.\n(2) Incorporated by reference to the exhibit filed with the Company's Registration Statement on Form S-1 (No. 33-19777), as amended, which became effective February 26, 1988.\n(3) Incorporated by reference to the exhibit filed with the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1990.\n(4) Incorporated by reference to the exhibit filed with the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1991.\n(5) Incorporated by reference to the exhibit filed with the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1992.\n(6) Incorporated by reference to the exhibit filed with the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1994.\n(7) Incorporated by reference to the exhibit filed with the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1994.\n(b) REPORTS ON FORM 8-K\nNo reports on Form 8-K were filed during fiscal 1995.\n(c) EXHIBITS\nSee Item 14(a) above.\n(d) FINANCIAL STATEMENT SCHEDULE\nSee Item 14(a) above.\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.\nOCTEL COMMUNICATIONS CORPORATION\nDated: September 28, 1995 By: \/s\/ ROBERT COHN ------------------------------------- Robert Cohn, Chairman of the Board, President and Chief Executive Officer\nPOWER OF ATTORNEY\nKNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Robert Cohn and Derek S. Daley, jointly and severally, his attorneys-in-fact, each with the power of substitution, for the undersigned in any and all capacities, to sign any amendments to this Report on Form 10-K, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact, or any substitute 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 in the capacities and on the dates indicated.\nOCTEL COMMUNICATIONS CORPORATION\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS\nINDEX TO EXHIBITS\n* Designates management contracts or compensatory plans, contracts or arrangements required to be filed as exhibits pursuant to Item 14(c) of Form 10-K.\n(1) Incorporated by reference to the exhibit filed with the Company's Form 8-B filed with the Securities and Exchange Commission on February 12, 1990.\n(2) Incorporated by reference to the exhibit filed with the Company Registration Statement on Form S-1 (No.33-197777), as amended, which became effective February 26, 1988.\n(3) Incorporated by reference to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1990.\n(4) Incorporated by reference to the exhibit filed with the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1991.\n(5) Incorporated by reference to the exhibit filed with the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1992.\n(6) Incorporated by reference to the exhibit filed with the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1994.\n(7) Incorporated by reference to the exhibit filed with the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1994.","section_15":""}
{"filename":"899652_1995.txt","cik":"899652","year":"1995","section_1":"ITEM 1. BUSINESS\nCinergy, CG&E, PSI, and ULH&P\nOrganization\nCinergy, a Delaware corporation, is a registered holding company under the PUHCA. Cinergy was created in the October 1994 merger of Resources and CG&E. The business combination was accounted for as a pooling of interests. Following the merger, Cinergy became the parent holding company of PSI, CG&E, Investments, and Services.\nCinergy's two utility subsidiaries, CG&E and PSI, account for substantially all of Cinergy's total operating revenues and Cinergy's total assets.\nCinergy, CG&E, and ULH&P\nCG&E\nCG&E, an Ohio corporation, is a combination electric and gas public utility company with four wholly-owned utility subsidiaries, ULH&P, Miami Power Corporation (Miami), The West Harrison Gas and Electric Company (West Harrison), and Lawrenceburg. In addition, CG&E has two wholly-owned non- utility subsidiaries, KO Transmission and Tri-State Improvement Company (Tri- State).\nCG&E and its utility subsidiaries are engaged in the production, transmission, distribution, and sale of electric energy and\/or the sale and transportation of natural gas in the southwestern portion of Ohio and adjacent areas in Kentucky and Indiana. The area served with electricity, gas, or both covers approximately 3,000 square miles, has an estimated population of 1.8 million people, and includes the cities of Cincinnati and Middletown in Ohio, Covington and Newport in Kentucky, and Lawrenceburg in Indiana.\nKO Transmission, a Kentucky corporation, will be used to acquire an interest in an interstate natural gas pipeline to which CG&E is entitled as a result of a settlement with the Columbia Gas Transmission Corp. KO Transmission will be engaged in the transportation of natural gas in interstate commerce between Kentucky and Ohio.\nTri-State, an Ohio corporation, is devoted to acquiring and holding property in Ohio, Kentucky, and Indiana for substations, electric and gas rights of way, office space, and other uses in CG&E's and its subsidiaries' utility operations.\nULH&P\nULH&P is engaged in the transmission, distribution, and sale of electric energy and\/or the sale and transportation of natural gas in northern Kentucky. The area served with electricity, gas, or both covers approximately 500 square miles, has an estimated population of 292,000 people, and includes the cities of Covington and Newport in Kentucky.\nCinergy and PSI\nPSI\nPSI, 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 two 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 PSI 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 2.1 million customers. PSI Energy Argentina owns a small equity interest in this project and provides operating and consulting services.\nSouth Construction Company, Inc. (South Construction), a wholly-owned subsidiary of PSI 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 PSI's business (such as undeveloped real estate of PSI abutting a PSI office building) or which has some defect in title which is unacceptable to PSI. Most of the real estate to which South Construction acquires title relates to PSI's utility business.\nCinergy\nInvestments\nInvestments, a Delaware corporation, is a non-utility subholding company that was formed to operate Cinergy's non-utility businesses and interests. Investments holds the following active non-utility subsidiaries and interests, which are more fully described below: Power International, formerly Enertech, its direct subsidiary, Bruwabel, and its indirect subsidiaries, Power International s.r.o. and Power Development s.r.o.; Cinergy Resources, Inc. (Cinergy Resources), formerly CG&E Resource Marketing, Inc.; CGE ECK, Inc. (CGE ECK) and its interest in ECK s.r.o.; PSI Recycling, Inc. (Recycling); PESCO; Wholesale Power; PSI Argentina, Inc. (PSI Argentina) and its subsidiary, Costanera; Cinergy Technology, Inc. (Technology), formerly PSI Environmental Corp.; and Cinergy Cooling Corp. (CoolCo).\nEnertech was incorporated in Ohio in 1992 as a vehicle for CG&E to offer utility management consulting services and to pursue investment opportunities in energy-related areas, including DSM services, consulting, energy and fuel brokering, engineering services, construction and\/or operation of generation, cogeneration, independent power production facilities, and project development. In July 1994, Enertech acquired Bruwabel and its subsidiaries for the purpose of pursuing design, engineering, and development work involving energy privatization projects, primarily in the Czech Republic. Subsequently, Enertech changed its name to Power International. While an office in the Czech Republic is still being maintained, activities in the Czech Republic and elsewhere have been reduced. Currently, Investments is exploring opportunities to sell Bruwabel and its subsidiaries and their assets, including the Vytopna Kromeriz Heating Plant which was acquired by Power Development s.r.o. in 1995. (See Note 13(d) of the \"Notes to Financial Statements\" in \"Item 8. Financial Statements and Supplementary Data\".) Cinergy Resources, a Delaware corporation, was formed to hold CG&E's interest in U.S. Energy Partners, a gas marketing partnership that was dissolved effective September 1, 1995. Upon dissolution, Cinergy Resources took its portion of the partnership assets to continue in the gas marketing business. Cinergy Resources will compete with traditional, regulated local distribution companies by offering \"merchant service\" (i.e., acquiring natural gas for resale to end-use customers) and will broker gas to industrial and large commercial customers.\nCGE ECK, a Delaware corporation, was formed to hold an investment in ECK s.r.o., a Czech limited liability company which owns and operates a generating facility in the Czech Republic. At present, CGE ECK holds an approximate 3% interest in ECK s.r.o. and intends to dispose of that interest.\nRecycling is an Indiana corporation which recycles metal from CG&E and paper, metal, and other materials from PSI, its largest single supplier, and other sources. Investments is actively pursuing the sale of Recycling.\nPESCO was incorporated in Indiana to sell equipment and parts from a PSI generating plant which was canceled, the Marble Hill Nuclear Project. PESCO also purchased equipment for resale, brokered equipment, and sold equipment on consignment for others. In late 1995 and early 1996, PESCO sold its remaining assets and is in the process of discontinuing operations.\nWholesale Power, an Indiana corporation, was formed to engage in the business of brokering power, emission allowances, electricity futures, and related products and services and to provide consulting services in the wholesale power-related markets. In addition, Wholesale Power was formed to create, market, and maintain the services of an \"electronic bulletin board\" for the bulk power market. The use of the electronic bulletin board was limited in 1995 and is being phased out in 1996.\nPSI Argentina was formed as an Indiana corporation to, among other things, own foreign generating facilities. In 1995, Costanera, a wholly-owned subsidiary of PSI Argentina, sold its equity interest in its only investment, the 1,260- mw Costanera power plant in Buenos Aires, Argentina. Costanera had obtained its interest in the plant as a member of a multi-national consortium which has controlling ownership of the plant.\nTechnology, an Indiana corporation, was created to manage Cinergy's existing non-regulated, technology-related investments, assess the market potential for non-regulated product and service development opportunities, and form key alliances for non-regulated product development.\nCoolCo, incorporated in Ohio in February 1996, was formed to engage in the district cooling business. The City of Cincinnati awarded a non-exclusive franchise that will permit CoolCo to construct, install, maintain, and operate a chilled water system in the downtown business district of Cincinnati, Ohio. Construction of such system is expected to begin in the first half of 1996.\nCinergy, CG&E, PSI, and ULH&P\nServices\nServices, a Delaware corporation, is the service company for the Cinergy system, providing member companies with a variety of administrative, management, and support services.\nCinergy, CG&E, PSI, and ULH&P\nCustomer, Sales, and Revenue Data\nThe number of customers served at year-end and the percent of operating revenues derived from the sale of electricity and the sale and transportation of natural gas for each registrant for 1995 are as follows:\nOperating Customers Revenues Registrant Electric Gas Electric Gas\nCinergy and subsidiaries 1,369,043 439,427 85% 13% CG&E and subsidiaries 719,227 439,427 77% 22% PSI 649,816 N\/A 98% N\/A ULH&P 113,874 73,680 72% 27%\nCinergy's utilities' service territory spans 86 counties in Ohio, Indiana, and Kentucky and includes approximately 840 cities, towns, unincorporated communities, and adjacent rural areas, including municipal utilities and rural electric cooperatives.\nThe service territory of CG&E and its utility subsidiaries, including ULH&P, is heavily populated and characterized by a stable residential customer base and a diverse mix of industrial customers. CG&E's and its utility subsidiaries' service territory spans 19 counties in Ohio, Indiana, and Kentucky (of which ULH&P serves six counties in Kentucky) and includes approximately 130 (44 for ULH&P) cities, towns, unincorporated communities, and adjacent rural areas, including municipal utilities and rural electric cooperatives. The area served by PSI is a residential, agricultural, and widely diversified industrial territory. PSI'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 operating revenues for PSI, 5% of electric or gas operating revenues for CG&E and its utility subsidiaries, or 10% of electric or gas operating revenues for ULH&P. Sales of electricity and gas sales and transportation are affected by seasonal weather patterns, and, therefore, operating revenues and associated operating expenses are not distributed evenly during the year.\nCinergy, CG&E, and ULH&P\nFinancial Information by Business Segment\nFor financial information by business segment, see Note 16 of the \"Notes to Financial Statements\" in \"Item 8. Financial Statements and Supplementary Data\". For a discussion of the potential divestiture of CG&E's, including ULH&P's, gas operations, see Note 13(f) of the \"Notes to Financial Statements\" in \"Item 8. Financial Statements and Supplementary Data\".\nRegulation\nCinergy, CG&E, PSI, and ULH&P\nCinergy, its utility subsidiaries, and certain of its non-utility subsidiaries are subject to regulation by the 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. In addition, the PUHCA generally limits registered holding companies to a single \"integrated\" public utility system, which the SEC traditionally has interpreted to prohibit a registered holding company, with limited exceptions, from owning both gas and electric properties. (Refer to the information appearing under the captions \"Repeal of the PUHCA\" in the \"Competitive Pressures\" section and \"Potential Divestiture of Gas Operations\" in the \"Regulatory Matters\" section in \"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\".)\nCG&E, ULH&P, Miami, and PSI are each subject to regulation by the 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. In addition, services by KO Transmission will be rendered in accordance with terms and conditions and at rates contained in a gas tariff filed with the FERC. Transportation of gas between CG&E and ULH&P is subject to regulation by the FERC under the Natural Gas Act.\nCinergy, CG&E, and ULH&P\nCG&E, as a public utility under the laws of Ohio, is also subject to regulation by the PUCO as to retail electric and gas rates, services, accounts, depreciation, issuance of securities, acquisitions and sales of certain utility properties, and in other respects as provided by Ohio law. Rates within municipalities in Ohio are subject to original regulation by the municipalities. The Ohio Power Siting Board, a division of the PUCO, has jurisdiction in Ohio over the location, construction, and initial operation of new electric generating facilities and certain electric and gas transmission lines presently utilized by CG&E. As to retail rates and other matters, ULH&P is regulated by the KPSC, and West Harrison and Lawrenceburg are regulated by the IURC.\nCinergy and PSI\nPSI, as a public utility under the laws of Indiana, is also regulated by the 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.\nCinergy, CG&E, PSI, and ULH&P\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\nCinergy, CG&E, PSI, and ULH&P\nCG&E, PSI, and 27 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. (Refer to the information appearing under the caption \"Cinergy's Response to the Changing Competitive Environment\" in the \"Competitive Pressures\" section of \"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\" for a discussion of Cinergy's involvement in a coalition for operation of a regional transmission system.)\nIn addition to the intercompany tie between CG&E's and PSI's electric systems, Cinergy's electric system, which is operated by Services, is interconnected with the electric systems of Indiana Michigan Power Company, Columbus and Southern Ohio Electric Company, Ohio Power Company (all doing business as AEP), Central Illinois Public Service Company, East Kentucky, Hoosier Energy Rural Electric Cooperative, Inc., Indianapolis Power and Light Company, Kentucky Utilities Company, Louisville Gas & Electric Company (LG&E), NIPSCO, Southern Indiana Gas and Electric Company, The Dayton Power and Light Company, Ohio Valley Electric Corporation, and Tennessee Valley Authority.\nCinergy, CG&E, and PSI\nCG&E and East Kentucky have an agreement for the interchange of electric power, subject to availability, during certain times of the year through March 2000. Under the agreement, CG&E, a summer peaking company, has the right to obtain up to 150 mw of electricity through March 31, 1997, and up to 50 mw from April 1, 1997, through March 31, 2000, from East Kentucky during the months of June, July, and August. East Kentucky, a winter peaking company, has the right to receive up to 150 mw through March 31, 1997, and up to 50 mw from April 1, 1997, through March 31, 2000, from CG&E in December, January, and February. In addition, PSI has a power supply relationship with WVPA and IMPA through power coordination agreements. WVPA and IMPA are also parties with PSI to a joint transmission and local facilities agreement.\nCinergy, CG&E, and ULH&P\nULH&P does not own or operate any electric generating facilities. Its requirements for electric energy are purchased from CG&E at rates regulated by the FERC.\nFuel Supply\nCinergy\nCinergy purchases approximately 23 million tons of coal annually for use by CG&E and PSI, which historically would rank Cinergy as the sixth largest utility coal purchaser in the United States.\nCinergy, CG&E, and PSI\nA major portion of the coal required by CG&E and PSI 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. 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, Indiana, and Pennsylvania for PSI and Ohio, Kentucky, West Virginia, and Pennsylvania for CG&E. CG&E and PSI monitor alternative sources to assure a continuing availability of economical fuel supplies. The companies intend to maintain the practice of purchasing a portion of their coal requirements on the spot market and will continue to investigate the least cost coal options in connection with their compliance with the CAAA (see the information appearing under the caption \"Environmental Issues\" in \"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\").\nThe companies believe they will be able to obtain sufficient coal to meet future generating requirements. However, both CG&E and PSI are unable to predict the extent to which coal availability and price may ultimately be affected by future environmental requirements. Presently, CG&E and PSI expect 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.\nCinergy, CG&E, and ULH&P\nGas Supply\nOrder 636 restructured the operations of gas pipelines and the supply portfolios of gas distribution companies. As gas pipelines unbundled their historic service of supply aggregation, gas distribution companies are entering into term (one year or more) contracts directly with producers and marketers, diminishing the once prominent spot market (see the information appearing under the caption \"Order 636\" in the \"Competitive Pressures\" section of \"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\").\nCG&E and its utility subsidiaries, including ULH&P, now obtain the majority of their natural gas supply (91%) from firm supply agreements, with remaining volumes purchased in the spot market. These firm contracts feature dual levels of gas supply: base load for continuous supply for CG&E's and its utility subsidiaries' core requirements, and \"swing\" load, which is gas available on a daily basis to accommodate changes in demand. While a premium is paid for the swing load, the use of industry indices to price firm gas volumes on a monthly basis ensures that the price CG&E and its utility subsidiaries pay remains economically competitive.\nGas is transported on interstate pipelines either directly to CG&E's and its subsidiaries' distribution systems, or it is injected into pipeline storage facilities for withdrawal and delivery in the future. Most of CG&E's and its utility subsidiaries' gas supplies are sourced from the Gulf of Mexico coastal area. CG&E and its subsidiaries have also obtained limited supply sourced from the Appalachian region and the mid-continent (Arkansas - Oklahoma) basin, and from methane gas recovered from an Ohio landfill. Over the long term, natural gas is expected to retain its competitiveness with alternative fuels; however, the costs of discovery and development of new sources of supply,, among other things, will influence prices.\nCinergy, CG&E, PSI, and ULH&P\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\".\nCinergy, CG&E, PSI, and ULH&P\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\".\nCinergy, CG&E, and PSI\nEnvironmental Matters\nEnvironmental compliance construction expenditures for 1996 for Cinergy and its subsidiaries are forecasted to be as follows:\nRegistrant Expenditures (in thousands)\nCG&E and subsidiaries $309 PSI 51 Cinergy and subsidiaries $360\nIn addition, refer to the information appearing under the caption \"Environmental Issues\" in \"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\".\nEmployees\nCinergy\nThe number of employees of Cinergy and its subsidiaries at December 31, 1995, was 8,602, of whom 4,859 belonged to bargaining units. These bargaining unit employees were represented by labor agreements between CG&E and its subsidiaries, including ULH&P, or PSI and the applicable union organization. Of Cinergy's total employees, 3,236 employees were represented by the IBEW, 466 were represented by the USWA, and 1,157 were represented by the IUU. (For additional information, See Note 13(g) of the \"Notes to Financial Statements\" in \"Item 8. Financial Statements and Supplementary Data\".)\nEmployees assigned to Services at December 31, 1995, totaled 2,739, of whom 922 belonged to bargaining units. These bargaining unit employees were represented by the labor agreements previously discussed. Of Services' total employees, 455 were represented by the IUU and 467 were represented by the IBEW (158 were represented by the agreement with PSI and 309 were represented by the agreement with CG&E).\nCinergy and CG&E\nThe number of employees of CG&E and its subsidiaries at December 31, 1995, was 3,056, of whom CG&E employed 2,759, ULH&P employed 284, and Lawrenceburg employed 13.\nCG&E and its subsidiaries have collective bargaining agreements with several union organizations. Of CG&E's and its subsidiaries' total employees 702 employees were represented by the IUU, 466 were represented by the USWA, and 1,214 were represented by the IBEW. The current contract between CG&E and the IUU will expire in March 1998. CG&E and its subsidiaries have a three-year contract with the USWA expiring May 15, 1997. The IBEW contract expires April 1, 1997.\nCinergy and PSI\nThe number of employees of PSI at December 31, 1995, was 2,807, of whom 1,555 were represented by the IBEW.\nPSI's collective bargaining agreement with the IBEW will expire at the end of April 1996.\nCinergy and ULH&P\nThe number of employees of ULH&P at December 31, 1995, was 284, of whom 228 belonged to bargaining units. These bargaining unit employees were represented by the same labor agreements between CG&E and the applicable union organization. Of ULH&P's total employees, 58 employees were represented by the IBEW, 104 were represented by the USWA, and 66 were represented by the IUU.\nThe current contract between ULH&P and the IUU will expire in March 1998. ULH&P has three-year agreements with the USWA and IBEW that will expire May 15, 1997, and April 1, 1997, respectively.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nCinergy, CG&E, PSI, and ULH&P\nSubstantially all utility plant is subject to the lien of each applicable company's first mortgage bond indenture.\nIn addition to the information discussed herein, refer to Note 14 of the \"Notes to Financial Statements\" in \"Item 8. Financial Statements and Supplementary Data\".\nCinergy, CG&E, and PSI\nAt December 31, 1995, the Cinergy utility subsidiaries owned electric generating plants, or portions thereof in the case of jointly owned plants, with net capabilities (winter ratings) as shown in the following table:\nCinergy and CG&E\nCG&E\nCG&E's 1995 peak load, which occurred on August 14 and was exclusive of off- system transactions, was 4,509 mw. For the period 1996 through 2005, peak load and kwh sales are each forecasted to have annual growth rates of 2%. These forecasts reflect CG&E's load growth, alternative fuel choices, population growth, and housing starts. These forecasts exclude an assessment of DSM, non-firm power transactions, and any potential off-system, long-term firm power sales.\nAs of December 31, 1995, CG&E's transmission system consisted of 388 circuit miles of 345,000 volt line, 605 circuit miles of 138,000 volt line, 512 circuit miles of 69,000 volt line, and 117 circuit miles of lesser volt line, all within the states of Ohio and Kentucky. In addition, as of December 31, 1995, CG&E's distribution system consisted of 14,556 circuit miles, all within the state of Ohio. As of the same date, CG&E's transmission substations had a combined capacity of 14,845,000 kilovolt-amperes, and the distribution substations had a combined capacity of 5,964,000 kilovolt-amperes. A portion of CG&E's total transmission system is jointly owned, primarily in connection with its jointly owned electric generating units.\nDuring 1995, almost all of the electricity generated by units owned by CG&E or in which it has an ownership interest was produced by coal-fired generating units. Those units generate most of the electric requirements of CG&E and its utility subsidiaries.\nCG&E owns two propane\/air peakshaving plants. Associated with these plants are two underground caverns, one with a seven million gallon capacity and one with an eight million gallon capacity. Both plants and storage caverns are located in Ohio and used primarily to augment CG&E's supply of natural gas during periods of peak demand and emergencies. CG&E also owns natural gas distribution systems consisting of 5,506 miles of mains and service lines in southwestern Ohio.\nCinergy and PSI\nPSI\nPSI's 1995 peak load, which occurred on August 14 and was exclusive of off- system transactions, was 5,274 mw. For the period 1996 through 2005, peak load and kwh sales are each forecasted to have annual growth rates of 2%. These forecasts reflect PSI's load growth, alternative fuel choices, population growth, and housing starts. These forecasts exclude an assessment of DSM, non-firm power transactions, and any potential off-system, long-term firm power sales.\nAs of December 31, 1995, PSI's transmission system consisted of 719 circuit miles of 345,000 volt line, 656 circuit miles of 230,000 volt line, 1,595 circuit miles of 138,000 volt line, and 2,427 circuit miles of 69,000 volt line, all within the state of Indiana. In addition, as of December 31, 1995, PSI's distribution system consisted of 19,264 circuit miles, all within the state of Indiana. As of the same date, PSI's transmission substations had a combined capacity of 21,608,000 kilovolt-amperes, and the distribution substations had a combined capacity of 6,142,000 kilovolt-amperes.\nDuring 1995, almost all of PSI's kwh production was obtained from coal-fired and hydroelectric generation. Cinergy, CG&E, and ULH&P\nULH&P\nAs of December 31, 1995, ULH&P owned 104 circuit miles of 69,000 volt electric transmission line, an electric distribution system consisting of 2,504 circuit miles, and a gas distribution system consisting of 1,230 miles of mains and service lines in northern Kentucky. ULH&P also owns a propane\/air peakshaving plant, a seven million gallon capacity underground cavern for the storage of liquid propane, and related liquid propane feeder lines, located in northern Kentucky and adjacent to one of the gas lines that transports natural gas to CG&E. The propane\/air plant and cavern are used primarily to augment CG&E's and ULH&P's supply of natural gas during periods of peak demand and emergencies.\nCinergy and CG&E\nOther Utility Subsidiaries\nAs of December 31, 1995, Lawrenceburg owned a gas distribution system consisting of 171 miles of mains and service lines in Indiana adjacent to the western part of CG&E's service area. Lawrenceburg is connected with and sells gas at wholesale to the city of Aurora, Indiana, and is also connected within Indiana with the lines of Texas Gas Transmission Corporation and Texas Eastern Transmission Corporation.\nAs of December 31, 1995, West Harrison owned a small electric distribution system consisting of 10 circuit miles in Indiana adjacent to CG&E's service area. As of the same date, Miami owned 40 miles of 138,000 volt transmission line connecting the lines of LG&E with those of CG&E.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nCinergy, CG&E, and PSI\nPower International Litigation\nSee Note 13(d) of the \"Notes to Financial Statements\" in \"Item 8. Financial Statements and Supplementary Data\".\nCinergy, CG&E, and PSI\nMerger Litigation\nIn August 1995, AEP filed a petition in the United States Court of Appeals for the District of Columbia Circuit for review of the FERC's Merger Order. AEP has objected to the Merger Order alleging that the post-merger operations of Cinergy would require the use of AEP's transmission facilities on a continuous basis without compensation. AEP contends that the FERC, in issuing the Merger Order, did not adequately evaluate the impact on AEP or whether the need to use AEP's transmission facilities would interfere with Cinergy achieving merger benefits. In addition, AEP claims that the FERC failed to evaluate the extent to which the merged facilities' operations would be consistent with the integrated public utility concept of the PUHCA. CG&E and PSI have intervened in this action and have filed a Motion to Dismiss. At this time, Cinergy, CG&E, and PSI cannot predict the outcome of the appeal.\nCinergy, CG&E, and PSI\nShareholder Litigation\nIn March 1993, in conjunction with a proposed tender offer for Resources, IPALCO filed suit in the United States District Court for the Southern District of Indiana, Indianapolis Division (District Court), against Resources, Cinergy, PSI, CG&E, and James E. Rogers (at that time Mr. Rogers was an officer and director of Resources and PSI). In addition, in the weeks following, suits with claims similar to those of IPALCO were filed by purported shareholders of Resources. IPALCO's claim was subsequently dismissed in November 1993, and in November 1995, the District Court dismissed the shareholders' claims in accordance with the terms of a settlement agreement entered into by the parties.\nULH&P\nULH&P has no material pending legal proceedings.\nCinergy, CG&E, PSI, and ULH&P\nIn addition to the above litigation, see Notes 2, 13(b), 13(c), 13(e), and 13(f) of the \"Notes to 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\nCinergy, CG&E, and PSI\nNone.\nULH&P\nOmitted pursuant to instruction J(2)(c).\nEXECUTIVE OFFICERS OF THE REGISTRANTS (at February 29, 1996)\nAge at Dec. 31, Name 1995 Office & Date Elected or in Job\nCinergy, CG&E, and PSI\nJackson H. Randolph 65 Chairman of Cinergy, CG&E, and PSI - 1995 Chairman and Chief Executive Officer of Cinergy, CG&E, and PSI - 1994 Chairman, President, and Chief Executive Officer of CG&E - 1993 President and Chief Executive Officer of CG&E - 1986\nJames E. Rogers 48 Vice Chairman, President, and Chief Executive Officer of Cinergy - 1995 Vice Chairman and Chief Executive Officer of CG&E and PSI - 1995 Vice Chairman, President, and Chief Operating Officer of Cinergy - 1994 Vice Chairman and Chief Operating Officer of CG&E and PSI - 1994 Chairman and Chief Executive Officer of Resources - 1993 Chairman, President, and Chief Executive Officer of PSI - 1990\nTerry E. Bruck 50 Group Vice President, Transmission and Distribution of Cinergy, CG&E, and PSI - 1995 Group Vice President, Wholesale Power and Transmission Operations of CG&E and PSI - 1995 Group Vice President, Wholesale Power and Transmission Operations of Cinergy - 1994 Vice President, Electric Operations of CG&E - 1988\nCheryl M. Foley 48 Vice President, General Counsel, and Secretary of CG&E - 1995 Vice President, General Counsel, and Secretary of Cinergy - 1994 Vice President, General Counsel, and Secretary of PSI and Resources - 1991 Vice President and General Counsel of Resources - 1990\nJ. Wayne Leonard 45 Group Vice President and Chief Financial Officer of CG&E and PSI - 1995 Group Vice President and Chief Financial Officer of Cinergy - 1994 Senior Vice President and Chief Financial Officer of PSI and Resources - 1992 Vice President and Chief Financial Officer of PSI and Resources - 1989\nStephen G. Salay 58 Group Vice President, Power Operations of CG&E and PSI - 1995 Group Vice President, Power Operations of Cinergy - 1994 Vice President, Electric Production and Fuel Supply of CG&E - 1988\nWilliam L. Sheafer 52 Treasurer of Cinergy and PSI - 1994 Treasurer of CG&E - 1987\nGeorge H. Stinson 50 Vice President, Corporate Services of Cinergy, CG&E, and PSI - 1995 Vice President of Cinergy - 1995 President of CG&E - 1994 Vice President, Gas Operations of CG&E - 1991 Manager, Gas Operations of CG&E - 1990\nLarry E. Thomas 50 Group Vice President and Chief Transformation Officer of Cinergy, CG&E, and PSI - 1995 Group Vice President, Reengineering and Operations Services of CG&E and PSI - 1995 Group Vice President, Reengineering and Operations Services of Cinergy - 1994 Senior Vice President and Chief Operations Officer of PSI - 1992 Senior Vice President and Chief Operating Officer, Customer Operations of PSI - 1990\nCharles J. Winger 50 Comptroller of CG&E - 1995 Comptroller of Cinergy - 1994 Comptroller of Resources - 1988 Comptroller of PSI - 1984\nCinergy and CG&E\nWilliam J. Grealis 1\/ 50 President of CG&E - 1995 Vice President of Cinergy - 1995 President, Gas Business Unit of CG&E - 1995 President of Investments - 1995 Partner - Akin, Gump, Strauss, Hauer & Feld 2\/ - 1978\nCinergy and PSI\nJohn M. Mutz 3\/ 60 Vice President of Cinergy - 1995 President of PSI - 1994 President of Resources - 1993 President - Lilly Endowment, Inc. 2\/ - 1989\nULH&P\nOmitted pursuant to instruction J(2)(c).\nCinergy, CG&E, and PSI\nNone of the officers are related in any manner. Executive officers of Cinergy 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 Investments, Mr. Grealis was a partner in the Washington, D.C. law firm of Akin, Gump, Strauss, Hauer & Feld. In addition, prior to the merger, Mr. Grealis was President of PSI Investments, Inc. on an interim basis beginning in 1992.\n2\/ Non-affiliate of Cinergy.\n3\/ 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.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nCinergy, CG&E, PSI, and ULH&P\nCinergy's common stock is listed on the New York Stock Exchange and has unlisted trading privileges on the Boston, Chicago, Cincinnati, Pacific, and Philadelphia exchanges. As of February 5, 1996, Cinergy's most recent dividend record date, there were 80,550 common shareholders of record. Trading of CG&E's and Resources' common stock ended at the close of the market October 24, 1994. Trading of Cinergy's common stock began upon the opening of the market October 25, 1994. The following table shows the high and low sales prices per share, if applicable, and the dividends on common stock declared by CG&E, Resources, PSI, ULH&P, and Cinergy for the past two years:\nMarket Price (a) Dividends Declared High Low (per share) (in thousands) CG&E 4th Quarter $23 3\/8 $21 7\/8 $ .3272 (b) $15 267 (c) 3rd Quarter 23 1\/4 20 7\/8 .43 2nd Quarter 23 7\/8 21 .43 1st Quarter 27 3\/4 23 5\/8 .43\nResources 4th Quarter 23 1\/2 22 .1805 (b) 3rd Quarter 23 1\/8 20 3\/4 .31 2nd Quarter 23 1\/8 19 5\/8 .31 1st Quarter 26 5\/8 22 3\/4 .31\nPSI 4th Quarter 10 376 (c) 3rd Quarter 16 174 (c) 2nd Quarter 16 622 (c) 1st Quarter 15 970 (c)\nULH&P 4th Quarter 6.00\nCinergy 4th Quarter 24 20 3\/4 .1028 (b)\nCG&E 4th Quarter 56 600 (c) 3rd Quarter 55 400 (c) 2nd Quarter 55 900 (c) 1st Quarter 51 650 (c)\nULH&P 4th Quarter 6.00\nCinergy 4th Quarter 31 1\/8 27 3\/4 .43 3rd Quarter 27 7\/8 25 1\/4 .43 2nd Quarter 27 24 5\/8 .43 1st Quarter 25 1\/4 23 3\/8 .43\n(a) Market price for PSI and ULH&P for 1994 and for CG&E, PSI, and ULH&P for 1995 is not applicable.\n(b) The prorated fourth quarter dividends for CG&E and Resources were determined by multiplying that portion of each company's regular quarterly dividend by a fraction equal to the number of days from their last respective common dividend payment dates (August 15, 1994, for CG&E; September 1, 1994, for Resources) to and including the closing date of the merger, divided by the number of days in the quarterly period for each respective company (92 for CG&E; 91 for Resources). These respective prorated dividends were in addition to, but paid separately from, the fourth quarter dividend on Cinergy common stock, which was determined by prorating Cinergy's 43-cents per share quarterly dividend for the remainder of the quarter ending November 15, 1994.\n(c) All of PSI's 1994 dividends were paid to Resources. CG&E's 1994 fourth quarter dividend of $15,276,000 and all of CG&E's 1995 dividends were paid to Cinergy.\nSee Notes 3(b) and 4(c) of the \"Notes to Financial Statements\" in \"Item 8. Financial Statements and Supplementary Data\" for a brief description of common dividend restrictions.\nAll CG&E and PSI common stock is held by Cinergy and all ULH&P common stock is held by CG&E; therefore, there is no public trading market for their common stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nCinergy\n1995 1994 1993 1992 1991 (in millions, except per share amounts)\nOperating revenues (1) $3 031 $2 898 $2 843 $2 613 $2 640 Net income (1) 347 191 63 271 202 Common stock Earnings per share (1) 2.22 1.30 .43 1.91 1.46 Dividends declared per share 1.72 1.50 1.46 1.39 1.33\nTotal assets (2) 8 220 8 150 7 804 7 133 6 681 Cumulative preferred stock of subsidiaries subject to mandatory redemption (3) 160 210 210 210 192 Long-term debt (4) 2 531 2 715 2 645 2 547 2 376 Long-term debt due within one year 202 60 - 46 115\nCG&E 1995 1994 1993 1992 1991 (in millions)\nOperating revenues (1) $1 848 $1 788 $1 752 $1 553 $1 518 Net income (loss)(1) 236 158 (9) 202 207\nTotal assets (2) 5 177 5 182 5 144 4 802 4 584 Cumulative preferred stock subject to mandatory redemption (3) 160 210 210 210 167 Long-term debt (4) 1 703 1 838 1 829 1 810 1 734 Long-term debt due within one year 152 - - 7 25\nPSI 1995 1994 1993 1992 1991 (in millions)\nOperating revenues (1) $1 248 $1 114 $1 092 $1 066 $1 120 Net income (1) 146 82 125 107 30\nTotal assets (2) 3 076 2 945 2 645 2 300 2 093 Cumulative preferred stock subject to mandatory redemption (3) - - - - 26 Long-term debt (4) 828 878 816 737 642 Long-term debt due within one year 50 60 - 40 90\nCinergy, CG&E, and PSI\n(1) See Notes 1, 2, and 16 of the \"Notes to Financial Statements\" in \"Item 8. Financial Statements and Supplementary Data\".\n(2) See Notes 1(d) and 7 of the \"Notes to Financial Statements\" in \"Item 8. Financial Statements and Supplementary Data\".\n(3) Includes $39.5 million, $36.5 million, and $3 million in 1991 for Cinergy, CG&E, and PSI, respectively, to be redeemed within one year. Also, see Note 4 of the \"Notes to Financial Statements\" in \"Item 8. Financial Statements and Supplementary Data\".\n(4) See Note 5 of the \"Notes to Financial Statements\" in \"Item 8. Financial Statements and Supplementary Data\".\nIn addition, see \"Item 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nCinergy, CG&E, PSI, and ULH&P\nTHE COMPANIES\nCinergy is a registered holding company under the PUHCA. Cinergy was created in the October 1994 merger of Resources and CG&E. The business combination was accounted for as a pooling of interests. Following the merger, Cinergy became the parent holding company of PSI, previously Resources' utility subsidiary, CG&E, Investments, and Services.\nFINANCIAL CONDITION\nCOMPETITIVE PRESSURES\nElectric Utility Industry\nCinergy, CG&E, PSI, and ULH&P\nIntroduction The primary factor influencing the future profitability of Cinergy is the changing competitive environment for energy services, including the impact of emerging technologies, and the related commoditization of electric power markets. Changes in the industry include increased competition in wholesale power markets and ongoing pressure for \"customer choice\" by large industrial customers and, ultimately, by all retail customers.\nPressures for Customer Choice Extending choice to end-user customers, also referred to as retail wheeling, would allow customers within a particular utility's service territory to \"unbundle\" their purchase decisions. Customers would be able to buy power as a commodity directly from another source and buy distribution service over the power lines of the local utility for delivery. The regulatory and legislative reform to facilitate this result is primarily driven by: (1) large industrial energy users; (2) the emergence of new suppliers in the competitive markets; and (3) increasing evidence from other regulated industries that wherever effective competition is feasible, it can yield lower costs and a wider range of customer options and services than traditional cost-of-service regulation. Industrial customers are intensifying their efforts to change the regulatory process so that they may access the lower-cost power necessary to remain competitive in the global marketplace. The current restrictions on access to low-cost power are exacerbated by traditional cost-of-service regulation which has produced average industrial rates to customers that vary substantially across the United States (from less than 3 cents per kwh to approximately 10 cents per kwh).\nWhile customer efforts at industry reform have resulted in some success, the emergence of new competitors to the local franchise utility has become an equally effective force for change. This new competition was facilitated by the Energy Policy Act of 1992 (Energy Act), which granted the FERC authority to order wholesale transmission access. New competitors include power marketers, power brokers, and local franchise utilities that now sell power in regional or national markets. To date, the FERC has granted approximately 150 power marketers the ability to sell at market-based rates and accepted several utilities' general sales tariffs that allow for sales anywhere in the United States. Cinergy's non-firm power sales tariff was accepted by the FERC in December 1995, and an affiliated power marketer of Cinergy was given authorization to begin transacting business in September 1995. Additionally, utilities are using merger and acquisition strategies to achieve expanded scale and scope to support a regional or national market strategy. For example, since the beginning of 1995, there were seven mergers involving major investor-owned utilities announced in the industry, representing nearly $28 billion of combined market value.\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 (to which they have title) 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.\nDespite increased activity by utilities and new competitors to respond to the demands of industrial customers for greater choice and lower prices, the pace of legislative and regulatory restructuring appears to have slowed somewhat in 1995. Many states continue to examine the complex technical and economic issues restructuring presents. Among other things, states are considering the trade-offs between achieving long-run economic efficiency and potential short- term wealth transfers between customers and shareholders (see further discussion below) or among customers, as well as the potential impact (if any) of restructuring on other socially desirable objectives like clean air or energy efficiency.\nThe most difficult issue polarizing the debate on the future competitive framework of the industry is the transition from the old order to the new and who will bear the costs of historical utility investments or past commitments incurred under cost-of-service regulation. If the generation component of the industry's business was immediately brought to market and priced at competitive wholesale prices, it is likely that many utilities would currently be unable to recover a large percentage of their fixed costs. Other costs such as investments in energy efficiency (DSM investments) could also become \"stranded\" (i.e., unrecoverable at competitive market prices) in this scenario. The financial impact on the industry of alternative scenarios for a transition to market prices is highly dependent upon: (1) the speed of the transition; (2) the clearing price for electricity in a fully competitive market; and (3) customer behavior (e.g., loyalty) when afforded potentially lower-cost alternatives.\nBecause of the complex nature of electric power flows, the variety of state- by-state regulations, and the potential inability or unwillingness to shut down high-cost plants (e.g., nuclear) in a fully competitive market, great uncertainty exists as to the time frame required for the future price of electricity in a commodity market to rise to long-run marginal cost (e.g., full cost of new resources) and, importantly, how close to short-term marginal cost (e.g., fuel and variable operating expenses) prices may fall in the interim. For example, depending upon the scenario, Moody's has quantified the stranded investment issue for the industry at between $50 billion and $300 billion (with the most likely result approximately $135 billion), while S&P has estimated a total exposure of between $10 billion and $26 billion (6% and 16%, respectively) of total industry annual revenues. The Oak Ridge National Laboratory has quantified the industry financial impact at $6 billion for every 1 mill (tenth of a cent) change in market price.\nThe position that all prudent past investments and commitments must be honored has received support from regulators at the FERC and in the state of California, both of which have provided for the recovery of utility stranded investments (see further discussion of each of these proposals herein), although that position varies from state to state. For example, a recent survey of 90 state utility commissioners from 40 states concluded that approximately 50% agreed with allowing recovery of stranded costs at the state level, while 26% disagreed with recovery, and the remaining 24% were uncertain.\nCinergy's Response to the Changing Competitive Environment Cinergy supports increased competition in the electric utility industry. Cinergy believes that competition would benefit electric customers and the economy as a whole. At the same time, Cinergy possesses competitive advantages (e.g., low-cost generation) that could work to the benefit of its shareholders in a competitive environment. However, these advantages could be substantially eroded by restrictive regulations that lag the development of a competitive market and limit the Company's ability to preempt the competition in responding to customer needs. As such, Cinergy has chosen to take a leadership role in state and Federal debates on industry reform.\nHowever, Cinergy believes there are two substantial impediments to realizing the potential efficiencies of competition in the generation segment of the business: (1) resolving the issue of stranded costs associated with past utility commitments and (2) recognizing states' rights, concerns, and authority in regulating a product that flows in interstate commerce. While Cinergy is among the lowest-cost producers nationwide and has been recognized by both Moody's and S&P as having little exposure to stranded investment, Cinergy nevertheless recognizes the legitimacy of the industry's equity argument for recovery of at least some of the costs associated with past commitments and the importance of resolving this issue in the interest of moving the debate to more important issues like how to achieve the potential economic efficiencies that competition offers and what regulatory and structural reforms are necessary to achieve those results. Cinergy remains concerned that even low-cost producers, under certain scenarios, could face difficult if not ruinous competition in an excess capacity market that was created at least in part by past government policies. Cinergy has approximately $1 billion of regulatory assets (past costs incurred for which regulators have promised recovery in the future) that could be at risk, at least in part, in some scenarios. At the same time, Cinergy believes that full recovery of the industry's potential stranded investment is unrealistic to expect in a market where certain customers can bypass stranded cost mechanisms (e.g., self-generation), is politically infeasible, and is neither necessarily equitable nor efficient.\nAdditionally, Cinergy believes that efficient competition cannot be achieved if neighboring states reach substantially different conclusions concerning items such as the transition rules, the timetables for implementation, universal service to customers, and reliability standards. Such state-by- state disparity would provide inequitable advantages to some competitors while unduly harming others' ability to compete in the marketplace. While Cinergy believes that satisfactory results cannot be achieved without a broad national consensus for the long-term goal and a time frame for getting there, Cinergy does not believe a total preemption of states' rights on this issue is either politically feasible or necessary.\nCinergy intends to pursue aggressively a national solution that will recognize the legitimacy of certain claims to past costs (within some level of cost and demonstrated prudence) and provide a required framework for states to align their regulations and policies within a specified time frame. The framework would require a consistent transition to full competition for generation in all markets, thus minimizing the current fragmentation resulting from the initiatives of multiple regulators and regulations.\nAs further evidence of its leadership in the restructuring of the electric utility industry, in February 1996, Cinergy and several other midwestern utilities announced the formation of a coalition to create and develop a multi-state transmission region operated by an independent system operator (ISO). The coalition, which Cinergy believes is likely to expand in membership, is proposing a midwest ISO which would ensure non-discriminating open transmission access, develop a regional transmission tariff, and ensure system reliability. Cinergy believes the formation of ISOs will be a major step toward facilitating competition in the electric utility industry and potentially more mergers among utilities (i.e., reduced market power concerns).\nFor an electric utility to be successful in this competitive environment, it is critical that regulatory reform in all segments of the business keeps pace with the competitive realities facing electric utilities and their customers in not only generation, but also transmission, distribution, and energy services activities. Strict adherence to traditional, cost-based rate-of- return regulation will both significantly disadvantage a utility's ability to compete successfully to supply customer needs and result in a failure to realize the potential economic efficiencies from restructuring. For example, performance-based regulation (e.g., price caps) would result in better economic incentives to control costs and likely add substantial flexibility for the franchise utility in the transition to a fully competitive environment.\nLegislation allowing significant flexibility was passed (Senate Bill 637) in Indiana in 1995. The Company intends to pursue similar flexibility in all markets where it conducts business.\nFederal Developments\nMega-NOPR The Energy Act granted the FERC the authority to order wholesale transmission access. Acting on that authority, in March 1995, the FERC took a substantial step toward assuring increased competition in the electric industry by issuing the mega-NOPR.\nCinergy was the first utility in the country to file its comments endorsing the mega-NOPR, reaffirming its support for the FERC's authority to order utilities owning transmission systems to provide access to other entities at rates and terms comparable to those provided to affiliated companies. As proposed, the FERC's mega-NOPR would, among other things, provide for mandatory filing of open access\/comparability transmission tariffs, provide for functional unbundling of all services, require utilities to use the filed tariffs for their own bulk power transactions, establish an electronic bulletin board for transmission availability and pricing information, and establish a contract-based approach to recovering any potential stranded costs as a result of customer choice at the wholesale level. A final order is expected to be issued during the first half of 1996.\nRepeal of the PUHCA After a year-long review of its continuing regulation of public utility holding companies under the PUHCA, in June 1995, the SEC endorsed recommendations for reform of the PUHCA. The recommendations call for repeal and, pending repeal, significant administrative reform of the 60- year-old statute. While the report offers three alternative approaches to repeal and legislative reform, the SEC's preferred option is repeal coupled with a transition period of one year or longer and a transfer of certain consumer-protection provisions of the PUHCA to the FERC.\nThe report further recommends that, pending consideration of legislative options, the SEC take prompt administrative action, by rulemaking and on a case-by-case basis, to modernize and simplify regulation under the PUHCA, with particular reference to financing transactions, diversification into non- utility businesses, utility mergers and acquisitions, and the PUHCA's \"integration\" standards. In the latter regard, the report recommends a changed interpretation of the PUHCA to permit registered holding companies to own combination electric and gas utility companies, provided the affected states agree. Subsequent to the issuance of the report, the SEC adopted rule changes exempting various types of financing transactions by utility and non- utility subsidiaries of registered holding companies. The SEC also proposed a rule that would exempt investments by registered systems in specified \"energy- related companies\", subject to certain conditions.\nIn October 1995, a bill was introduced in the United States Senate providing for the repeal of the PUHCA. The bill is pending before Congress. In addition, various members of Congress have indicated their support for industry restructuring. One view that has been publicly stated in Congress is that the repeal of the PUHCA and the orderly transition to open competition should be considered comprehensively rather than piecemeal. Hearings have been initiated in Congress for a comprehensive review of the electric utility industry and the role Congress should play in fostering competition. Cinergy supports the repeal of the PUHCA, either as part of comprehensive reform of the electric utility industry or as separate legislation.\nCinergy, CG&E, PSI, and ULH&P\nState Developments During 1995, 40 states initiated or took part in formal or informal processes, held hearings, and\/or passed legislation addressing retail wheeling, restructuring, competition, alternative regulation, or closely related issues concerning electric utility industry restructuring.\nCinergy and CG&E\nOhio The PUCO has been actively examining issues raised by continuing competitive pressures. The Chairman of the PUCO has publicly stated his desire to make progress toward enhancing competition in Ohio, but with the objective of doing it right and not necessarily first. In late 1994, the PUCO formed an electric competition roundtable that meets on an informal basis to address competition, restructuring, performance-based regulation, and related issues, with a stated mission of \"promoting increased competitive options for Ohio businesses that do not unduly harm the interests of utility company shareholders or ratepayers\". In 1995, the roundtable participants submitted principles for a customer choice pilot program for interruptible buy-through service. The PUCO issued the proposed guidelines for comments in late 1995 and issued final guidelines in February 1996.\nAdditionally, two recent actions of the PUCO provide support for maintaining the financial integrity of the utilities in the state. In October 1995, the PUCO approved a stipulated rate plan which could improve the competitive position of a major utility in the state by the end of a 10-year moratorium period, including provisions for accelerating depreciation and amortization of the utility's nuclear plants and regulatory assets, respectively. In November 1995, the PUCO staff recommended a rate increase for another \"at risk\" utility that is conditioned upon the increase being utilized to achieve a significant reduction in the utility's uneconomic generating assets.\nFinally, a retail wheeling bill was introduced in the Ohio legislature that would, if passed, require utilities to develop retail wheeling plans by January 1, 1998, and provide flexibility to propose alternatives to traditional cost-of-service ratemaking methodologies. The bill is expected to be considered during the 1996 legislative session.\nCinergy, CG&E, and PSI\nIndiana The IURC has taken several steps to investigate the desirability of retail competition in the state. A legislative regulatory flexibility committee was established by Senate Bill 637. Senate Bill 637 also allows the IURC to approve utility alternative regulation proposals upon a showing that, among other things, traditional regulation in a particular service sector is no longer needed.\nAdditionally, the IURC has sponsored informal competition forums that are designed to develop a better understanding of issues related to expanding the competitive market on both the wholesale and retail levels. While various parties have participated in this process, the Citizens Action Coalition of Indiana, Inc. (CAC)(a non-profit organization representing customers) has called for electric utilities to make a new \"covenant\" with customers. The CAC outlines eight principles intended to balance various economic and environmental interests at stake in the debate. Among other things, the covenant would include a voluntary pledge by utilities that: customers' bills will not increase; the environment will not be polluted; universal service will be provided; construction of new power plants will be avoided; and customers will not be harmed by utility self-dealing.\nCinergy, CG&E, and ULH&P\nKentucky There has been considerably less activity and interest in industry restructuring in Kentucky. This situation is generally attributed to the fact that Kentucky is one of the lowest-cost states in the country for electric service. While large volume customers have circulated a draft of a retail wheeling bill, Cinergy does not believe such legislation, if introduced, would receive much attention in 1996.\nCinergy, CG&E, PSI, and ULH&P\nOther States In addition to the states in which Cinergy operates, significant developments in other states have occurred during 1995. Not surprisingly, the higher-cost regions of the country have been most interested in facilitating the more rapid development of a competitive market for electric utilities. For example, in December 1995, California regulators adopted a hybrid plan for restructuring the state's electric services industry. The plan will simultaneously create an ISO, a wholesale power exchange, and direct access (customer choice) phased in over five years beginning on January 1, 1998. The plan further provides for a non-bypassable competitive transition charge on all retail customers to ensure utilities the opportunity for full recovery of their stranded investments by 2005. Several aspects of the plan require enabling legislation to be passed in California prior to restructuring. The plan contemplates the continuation of state regulation over the transmission and distribution segments of the industry.\nIn the northeastern United States, Massachusetts, Connecticut, New Hampshire, and Rhode Island have all recently issued guidelines or principles for industry restructuring, authorized restructuring studies, or created retail wheeling pilot programs. In particular, the restructuring principles issued in August 1995 by the Massachusetts state commission provide for the largest utilities in the state to file negotiated restructuring plans in February 1996 to provide for a transition to full competition, including provisions for functional unbundling and retail wheeling. A major utility in the region has already filed a plan that provides for customer choice, transition to a competitive market, restructuring, lower prices to customers in the interim, and the recovery for shareholders of all stranded costs.\nAt the same time, the traditionally low-cost Midwest has also been exploring how competition can efficiently and effectively be implemented for the benefit of customers. In Wisconsin, a revised proposal by a state commissioner focuses on some of the social issues and economic trade-offs involved in restructuring the industry. The plan has established the year 2000 as a target date for implementation of restructuring in that state, modifying the previously adopted \"building block\" approach. The proposal would create an ISO for the transmission system, while the distribution system would continue to be subject to commission jurisdiction. Other provisions of the proposal include a request for utilities to file plans for establishing functional separation of the generation, transmission, and distribution business units, commission certification of new market entrants, continuation of the winter moratorium on disconnections, a permanent commitment to low-income and universal service programs, priority generation service for Wisconsin customers, and the transfer of the risk of decisions on power generation from customers to shareholders.\nThe state of Michigan has proposed a thorough review of existing state laws and the comprehensive changes to those laws that would be required to facilitate competition in the electric utility industry. Additionally, Michigan has also mandated retail wheeling experiments for two of the large utility companies in the state, scheduled to begin at the time of each respective utility's next capacity solicitation. In Illinois, the legislature has passed a resolution establishing a joint legislative committee to study and recommend policy changes regarding competition. At least two of Illinois' investor-owned utilities have recently filed two proposed retail wheeling pilot programs with the state commission.\nCinergy, CG&E, PSI, and ULH&P\nCinergy's Future - Others' Views The major credit rating agencies continue to recognize the risk of the imminent restructuring of the electric utility industry. In August 1995, Moody's issued a report entitled \"Stranded Costs Will Threaten Credit Quality of U.S. Electrics\", wherein Moody's notes its belief that a substantial amount of fixed costs approved for recovery under the traditional regulatory regime is likely to be stranded. In November 1995, S&P issued its report, \"Direct Access Threatens Electric Utility Revenues\", in which S&P estimated the potential loss of annual revenues in the industry. However, Cinergy has received praise and some measure of optimism for its position in a more competitive environment. As part of the November 1995 upgrade of Cinergy's operating subsidiaries' debt and preferred stock, Moody's expressed its opinion that Cinergy \"will have no exposure to stranded costs\" and that \"Cinergy is expected to be a formidable competitor because of its low production costs\". All such models used to predict potential exposure to stranded costs are extremely sensitive to the assumed future market clearing price. In its July 1995 upgrade of Cinergy's operating subsidiaries' debt and preferred stock, S&P commented that \"the business position evaluation of all the Cinergy operating units is now high average\" reflecting \"low electric production costs, efficient coal-fired equipment, relatively low rates, a well positioned gas operation, the absence of nuclear challenges, a healthy service territory, and a balanced capital structure\".\nCertain sell-side equity analysts continue to rank Cinergy highly as a utility possessing a strong competitive profile and aggressive and innovative management, with some considering Cinergy to be well positioned to outperform the market in the competitive arena. Cinergy believes the opinions of these rating agencies and equity analysts further support its position that its competitive strategy and agenda will be successful.\nCinergy, CG&E, and ULH&P\nGas Utility Industry\nOrder 636 In 1992, the FERC issued Order 636 which restructured operations between interstate gas pipelines and their customers for gas sales and transportation services. Order 636 mandated changes to the way CG&E and its utility subsidiaries purchase gas supplies and contract for transportation and storage services, resulting in increased risks in meeting the gas demands of their customers.\nCG&E and its utility subsidiaries have responded to the supply risks and opportunities of Order 636 by introducing innovations to their supply strategy. These innovations include: contracting with major producers and marketers for firm gas supply agreements with flexible, extremely market sensitive pricing, marketing short-term unused pipeline capacity and storage gas to other companies throughout the country through use of electronic bulletin boards, and restructuring their allotment of interstate pipeline capacity among delivering pipelines.\nOrder 636 also allowed pipelines to recover transition costs they incurred in complying with the order from customers, including CG&E and its utility subsidiaries. In July 1994, the PUCO issued an order approving a stipulation between CG&E and its residential and industrial customer groups providing for recovery of these pipeline transition costs. CG&E is presently recovering its Order 636 transition costs pursuant to a PUCO-approved tariff. CG&E and its utility subsidiaries, including ULH&P, recover such costs through their gas cost recovery mechanisms.\nCustomer Choice In a January 1996 gas filing in Ohio (see additional discussion in Note 2(b) of the \"Notes to 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 Cinergy Corp., The Cincinnati Gas & Electric Company, PSI Energy, Inc., and The Union Light, Heat and Power Company:\nWe have audited the financial statements of Cinergy Corp. (a Delaware Corporation), The Cincinnati Gas & Electric Company (an Ohio Corporation), PSI Energy, Inc. (an Indiana Corporation), and The Union Light, Heat and Power Company (a Kentucky Corporation), as of December 31, 1995 and 1994, and for each of the three years in the period ended December 31, 1995, as listed in the index on page 46. These financial statements and the schedules referred to below are the responsibility of 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 Cinergy Corp., The Cincinnati Gas & Electric Company, PSI Energy, Inc., and The Union Light, Heat and Power Company as of December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995, 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 supplemental financial statement schedules listed in the index on page 47 pursuant to 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 financial statement schedules have been subjected to the auditing procedures applied in our audits of the basic financial statements and, in our opinion, are fairly stated in all material respects in relation to the basic financial statements taken as a whole.\nArthur Andersen LLP Cincinnati, Ohio, January 25, 1996\nRESULTS OF OPERATIONS - CINERGY\nKwh Sales\nCinergy's total kwh sales in 1995, as compared to 1994, increased 4.1%, reflecting increased sales to all retail customer classes. Contributing significantly to this increase were higher residential and commercial sales due to warmer weather during the 1995 summer cooling season and colder weather during the fourth quarter of 1995. Additionally, increased sales to industrial customers, reflecting growth in the primary metals and chemicals sectors, contributed to the increased kwh sales level. These increases were offset, in part, by a decline in non-firm power sales for resale.\nTotal kwh sales increased 2.8% in 1994, as compared to 1993, due in large part to non-firm power sales for resale, reflecting third party, short-term power sales to other utilities through PSI's system and direct power sales by PSI to other utilities. This increase was partially offset by CG&E's reduced power sales to other utilities in 1994. Also significantly contributing to the total kwh sales levels were increased sales to industrial customers. This increase reflected growth in the primary metals and transportation equipment sectors. Commercial sales increased due, in part, to new customers. A decrease in residential sales resulted from the milder weather experienced during the third and fourth quarters of 1994.\nA return to more normal weather contributed to the 5.3% increase in total kwh sales in 1993, as compared to 1992. In addition, growth in the primary metals and transportation equipment sectors resulted in increased industrial sales. Partially offsetting these increases was a reduction in non-firm power sales for resale, which reflected a significant decrease in third party, short-term power sales to other utilities through PSI's system.\nYear-to-year changes in kwh sales for each major class of customers are shown below:\nIncrease (Decrease) from Prior Year\n1995 1994 1993_ Retail Residential 5.8 % (1.7)% 10.3 % Commercial 4.3 1.9 6.3 Industrial 4.6 4.6 4.2\nTotal retail 4.9 1.6 6.9\nSales for resale Firm power obligations 1.7 2.5 2.6 Non-firm power transactions (1.3) 14.4 (5.3)\nTotal sales for resale (.4) 10.5 (2.8)\nTotal sales 4.1 2.8 5.3\nCinergy currently forecasts a 2% annual compound growth rate in kwh sales over the 1996 through 2005 period. This forecast does not reflect the effects of DSM programs and excludes non-firm power sales for resale and any potential new off-system, long-term firm power sales.\nMcf Sales and Transportation\nTotal gas sales and transportation volumes increased 8.6% in 1995, as compared to 1994. Increased sales to residential customers, resulting from colder weather during the fourth quarter of 1995 and an increase in the number of customers, contributed to higher retail sales. Additionally, increases in commercial and industrial transportation volumes, which resulted from customers electing to purchase gas directly from suppliers, more than offset declines in industrial and commercial sales. The increased transportation volumes mainly reflect industrial demand for gas transportation services in the primary metals, food products, and paper products sectors.\nThe milder weather experienced in 1994 contributed to a decrease in residential and commercial gas sales volumes and led to the decrease in total Mcf sales and transportation of 1.2% in 1994, as compared to 1993. An increase in gas transportation volumes to industrial customers, mainly in the primary metals sector, partially offset this decrease.\nThe increase in retail Mcf sales of 5.4% in 1993, when compared to 1992, was primarily attributable to higher residential and commercial sales volumes as a result of the return to more normal weather during the 1993 heating season and the addition of a number of customers to CG&E's gas system during the year. Gas transportation volumes for 1993 increased largely as a result of additional industrial demand for gas transportation services in the primary metals sector. The increase in Mcf transported more than offset the decrease in Mcf sold to industrial customers.\nYear-to-year changes in Mcf sales for each major class of customers and Mcf transportation volumes are shown below:\nIncrease (Decrease) from Prior Year\n1995 1994 1993_\nRetail Residential 10.5 % (10.2)% 9.5 % Commercial (2.0) (1.5) 1.1 Industrial (26.6) (9.9) (.8)\nTotal retail 1.5 (6.7) 5.4\nGas transported 24.4 13.9 12.7\nTotal gas sold and transported 8.6 (1.2) 7.2\nOperating Revenues\nELECTRIC OPERATING REVENUES\nHigher retail kwh sales, PSI's electric rate increases which became effective in February 1995 and March 1995, and a full year's effect of CG&E's electric rate increase which became effective in May 1994, significantly contributed to the $165 million (6.7%) increase in electric operating revenues for 1995, when compared to 1994.\nElectric operating revenues increased $82 million (3.4%) in 1994, as compared to 1993, as a result of CG&E's electric rate increases which became effective in May 1993, August 1993, and May 1994, PSI's increased kwh sales, and the effects of PSI's $31 million refund to retail customers accrued in June 1993 as a result of the settlement of the IURC's April 1990 Order.\nElectric operating revenues increased $155 million (7.0%) in 1993 primarily as a result of greater kwh sales and electric rate increases granted to CG&E in 1993 and 1992. These increases were partially offset by the refund resulting from the settlement of the April 1990 Order.\nAn analysis of electric operating revenues for the past three years is shown below:\n1995 1994 1993_ (in millions)\nPrevious year's electric operating revenues $2 456 $2 374 $2 219 Increase (Decrease) due to change in: Price per kwh Retail 54 32 12 Sales for resale Firm power obligations (1) 1 (1) Non-firm power transactions 4 - 10 Total change in price per kwh 57 33 21\nKwh sales Retail 109 34 138 Sales for resale Firm power obligations 1 2 2 Non-firm power transactions (1) 14 (5) Total change in kwh sales 109 50 135\nOther (1) (1) (1)\nCurrent year's electric operating revenues $2 621 $2 456 $2 374\nGAS OPERATING REVENUES\nThe increasing trend of industrial customers purchasing gas directly from producers and utilizing CG&E facilities to transport the gas (see the \"Mcf Sales and Transportation\" section) continues to put downward pressure on gas operating revenues. When Cinergy sells gas, the sales price reflects the cost of gas purchased by Cinergy to support the sale plus the costs to deliver the gas. When gas is transported, Cinergy does not incur any purchased gas costs but delivers gas the customer has purchased from other sources. Since providing transportation services does not necessitate recovery of gas purchased costs, the revenue per Mcf transported is less than the revenue per Mcf sold. As a result, a higher relative volume of gas transported to gas sold translates into lower gas operating revenues.\nIn 1995, gas operating revenues declined $32 million (7.1%), as compared to 1994, as a result of the aforementioned trend toward increased transportation services and the operation of fuel adjustment clauses reflecting a lower average cost of gas purchased.\nGas operating revenues decreased $27 million (5.7%) in 1994, as compared to 1993, due to the operation of fuel adjustment clauses which reflected a lower average cost of gas purchased during the latter part of 1994 and a reduction in total volumes sold and transported.\nIn 1993, gas operating revenues increased $75 million (19.1%) as a result of rate increases granted in 1993, higher volumes of gas sold, and the operation of fuel adjustment clauses reflecting an increase in the average cost of gas purchased.\nOperating Expenses\nFUEL\nFuel Used in Electric Production Electric fuel costs, Cinergy's largest operating expense, remained relatively constant in 1995, showing less than a 1% increase when compared to 1994.\nAn analysis of these fuel costs for the past three years is shown below:\n1995 1994 1993 (in millions)\nPrevious year's fuel expense $713 $733 $707 Increase (Decrease) due to change in: Price of fuel (25) (39) (2) Kwh generation 29 19 28\nCurrent year's fuel expense $717 $713 $733\nGas Purchased In 1995, gas purchased expense decreased $42 million (16.9%), as compared to 1994, reflecting a decline in the average cost per Mcf of gas purchased of 17.2%.\nA reduction in the average cost per Mcf of gas purchased (5.1%) and lower volumes purchased (6.8%) contributed to the decline in gas purchased expense of $33 million (11.6%) in 1994, as compared to 1993.\nGas purchased expense increased $53 million (23.0%) in 1993 as a result of an increase in the average cost per Mcf of gas purchased of 17.5% and an increase in volumes purchased of 4.7%.\nPURCHASED AND EXCHANGED POWER\nPurchased and exchanged power increased $13 million (35.6%) in 1994, as compared to 1993, reflecting an increase in third party, short-term power sales to other utilities through PSI's system and increased purchases of other non-firm power by PSI primarily to serve its own load.\nIn 1993, PSI increased its purchases of non-firm power primarily to serve its own load, which resulted in an increase in purchased and exchanged power costs of $16 million (78.0%).\nOTHER OPERATION\nIn 1995, other operation expenses decreased $29 million (5.2%), as compared to 1994. Charges of $62 million in 1994 for Merger Costs and other expenditures which cannot be recovered from customers under the merger savings sharing mechanisms authorized by regulators significantly contributed to the decrease. In addition, emphasis on achieving merger savings and other cost reductions led to lower operating costs for 1995. These decreases were partially offset by the recognition of postretirement benefit costs on an accrual basis, an increase in the ongoing level of DSM expenses, and the amortization of deferred postretirement benefit costs, deferred Merger Costs, and deferred DSM costs, all of which are being recovered in revenues pursuant to the February 1995 Order.\nOther operation expenses increased $107 million (23.4%) in 1994, as compared to 1993, due to a number of factors including the previously discussed charges of $62 million, fuel litigation expenses of $8 million incurred by PSI, and increased electric production and distribution expenses.\nMAINTENANCE\nMaintenance costs decreased $19 million (9.3%) in 1995, as compared to 1994, primarily due to improved scheduling of routine maintenance on electric generating units. Lower maintenance costs on gas and electric distribution facilities also contributed to this decrease.\nIncreased maintenance on a number of PSI's generating stations and the initial costs of PSI's new distribution line clearing program resulted in increased maintenance expenses of $8 million (4.2%) in 1994.\nDEPRECIATION\nIn 1995, depreciation expense decreased $15 million (5.0%), when compared to 1994, due in large part to the adoption of lower depreciation rates for PSI effective in March 1995. This decrease was partially offset by the effect of additions to utility plant.\nDepreciation expense increased $16 million (5.6%) in 1994, as compared to 1993, primarily as a result of additions to electric utility plant.\nDepreciation expense increased $21 million (8.1%) in 1993 primarily due to a full year's effect of the first five units of Woodsdale which were placed in commercial operation in 1992, the sixth unit which was placed in commercial operation in 1993, and other additions to electric utility plant.\nPOST-IN-SERVICE DEFERRED OPERATING EXPENSES - NET\nPost-in-service deferred operating expenses - net reflect various deferrals of depreciation, operation and maintenance expenses (exclusive of fuel costs), and property taxes on certain generating units and other utility plant from the in-service date until the related plant is reflected in retail rates, net of amortization of these deferrals as they are recovered through retail rates. (See Note 1(h) of the \"Notes to Financial Statements\" in \"Item 8. Financial Statements and Supplementary Data\".)\nPHASE-IN DEFERRED DEPRECIATION AND RETURN AND AMORTIZATION OF PHASE-IN DEFERRALS\nPhase-in deferred depreciation, phase-in deferred return, and amortization of phase-in deferrals reflect the PUCO-ordered phase-in plan for Zimmer. (See Note 1(f) of the \"Notes to Financial Statements\" in \"Item 8. Financial Statements and Supplementary Data\".)\nTAXES OTHER THAN INCOME TAXES\nTaxes other than income taxes increased $12 million (4.9%) in 1995, $15 million (6.5%) in 1994, and $13 million (5.8%) in 1993, primarily due to increased property taxes resulting from a greater investment in taxable property (including Zimmer and Woodsdale) and higher property tax rates.\nOther Income and Expenses - Net\nPOST-IN-SERVICE CARRYING COSTS\nPost-in-service carrying costs reflect the deferral of carrying costs on certain generating units and other utility plant from the in-service date until the related plant is reflected in retail rates. (See Note 1(h) of the \"Notes to Financial Statements\" in \"Item 8. Financial Statements and Supplementary Data\".)\nREDUCTION OF LOSS RELATED TO THE JUNE 1987 ORDER\nThe December 1993 Order resolved open issues related to the June 1987 Order which addressed the effect on PSI of the 1987 reduction in the Federal income tax rate. The December 1993 Order provided for PSI to refund $119 million to its retail customers, which was a reduction of $20 million from the loss previously recognized.\nWRITE-OFF OF A PORTION OF ZIMMER\nIn the May 1992 Order authorizing the rate phase-in plan for Zimmer, the PUCO disallowed from rates approximately $230 million of Zimmer costs. Upon appeal, the Supreme Court of Ohio upheld the PUCO's decision, and CG&E wrote off Zimmer costs of approximately $223 million, net of taxes, in November 1993.\nOTHER - NET\nOther - net increased $32 million in 1995, as compared to 1994, due in part to $4 million of interest on an income tax refund related to prior years, a $10 million gain on the sale of Cinergy's investment in an Argentine utility, and charges of $17 million in 1994 for merger-related and other expenditures which cannot be recovered from customers.\nIn 1994, other - net increased $12 million, as compared to 1993, primarily as a result of the write-off during 1993 of $22 million related to the defense against the IPALCO hostile takeover attempt. The increase was offset, in part, by the charges in 1994 of $17 million previously discussed.\nThe decrease in other - net of $38 million in 1993, as compared to 1992, was primarily the result of the previously discussed write-off of IPALCO defense costs in 1993.\nRESULTS OF OPERATIONS - CG&E\nKwh Sales\nKwh sales for 1995 increased 15.3% over 1994, reflecting increased sales to all customer classes. Significantly contributing to this increase were higher non-firm power sales for resale primarily due to increased sales to PSI, as a result of the coordination of CG&E's and PSI's electric dispatch systems. Higher residential and commercial sales resulted primarily from warmer weather during the 1995 summer cooling season and colder weather during the fourth quarter of 1995. Additionally, increased sales to industrial customers were mainly attributable to growth in the primary metals and chemicals sectors.\nCG&E's total kwh sales in 1994, as compared to 1993, decreased 1.2%, due in large part to reduced power sales to other utilities in 1994 and decreased residential sales resulting from milder weather experienced during the third and fourth quarters of 1994. This decrease was partially offset by increased kwh sales to industrial customers reflecting growth in the primary metals and machinery sectors.\nA return to more normal weather contributed to the 5.3% increase in total kwh sales in 1993, as compared to 1992. In addition, growth in the primary metals, transportation equipment, and chemicals sectors resulted in increased industrial sales.\nYear-to-year changes in kwh sales for each major class of customers are shown below:\nIncrease (Decrease) from Prior Year\n1995 1994 1993 Retail Residential 3.8% (2.0)% 8.6 % Commercial 3.4 2.3 5.4 Industrial 3.9 4.3 2.4\nTotal retail 3.8 1.1 5.8\nSales for resale Firm power obligations 6.3 1.7 6.1 Non-firm power transactions 211.8 (29.3) (.4)\nTotal sales for resale 172.6 (24.9) 1.1\nTotal sales 15.3 (1.2) 5.3\nCG&E currently forecasts a 2% annual compound growth rate in kwh sales over the 1996 through 2005 period. This forecast does not reflect the effects of DSM programs and excludes non-firm power sales for resale and any potential new off-system, long-term firm power sales.\nMcf Sales and Transportation\nTotal gas sales and transportation volumes increased 8.6% in 1995, as compared to 1994. Increased sales to residential customers, resulting from colder weather during the fourth quarter of 1995 and an increase in the number of customers, contributed to higher retail sales. Additionally, increases in commercial and industrial transportation volumes, which resulted from customers electing to purchase gas directly from suppliers, more than offset declines in industrial and commercial sales. The increased transportation volumes mainly reflect industrial demand for gas transportation services in the primary metals, food products, and paper products sectors.\nThe milder weather experienced in 1994 contributed to a decrease in residential and commercial gas sales volumes and led to the decrease in total Mcf sales and transportation of 1.2% in 1994, as compared to 1993. An increase in gas transportation volumes to industrial customers, mainly in the primary metals sector, partially offset this decrease.\nThe increase in retail Mcf sales of 5.4% in 1993, when compared to 1992, was primarily attributable to higher residential and commercial sales volumes as a result of the return to more normal weather during the 1993 heating season and the addition of a number of customers to CG&E's gas system during the year. Gas transportation volumes for 1993 increased largely as a result of additional industrial demand for gas transportation services in the primary metals sector. The increase in Mcf transported more than offset the decrease in Mcf sold to industrial customers.\nYear-to-year changes in Mcf sales for each major class of customers and Mcf transportation volumes are shown below:\nIncrease (Decrease) from Prior Year\n1995 1994 1993\nRetail Residential 10.5 % (10.2)% 9.5 % Commercial (2.0) (1.5) 1.1 Industrial (26.6) (9.9) (.8)\nTotal retail 1.5 (6.7) 5.4\nGas transported 24.4 13.9 12.7\nTotal gas sold and transported 8.6 (1.2) 7.2\nOperating Revenues\nELECTRIC OPERATING REVENUES\nElectric operating revenues increased $91 million (6.8%) in 1995, as compared to 1994. This increase reflects the higher kwh sales, as previously discussed and a full year's effect of CG&E's electric rate increase which became effective in May 1994. This increase was partially offset by the operation of fuel adjustment clauses reflecting a lower average cost of fuel used in electric production.\nCG&E's electric rate increases which became effective in May 1993, August 1993, and May 1994 substantially contributed to the increase in electric operating revenues of $64 million (4.9%) in 1994, as compared to 1993.\nElectric operating revenues increased $123 million (10.6%) in 1993 primarily as a result of greater kwh sales and electric rate increases granted to CG&E in 1993 and 1992.\nAn analysis of electric operating revenues for the past three years is shown below:\n1995 1994 1993 (in millions) Previous year's electric operating revenues $1 346 $1 282 $1 159 Increase (Decrease) due to change in: Price per kwh Retail (10) 55 49 Sales for resale Firm power obligations 1 - - Non-firm power transactions (9) 3 5 Total change in price per kwh (18) 58 54\nKwh sales Retail 49 14 66 Sales for resale Firm power obligations 1 - 1 Non-firm power transactions 60 (9) 1 Total change in kwh sales 110 5 68\nOther (1) 1 1 Current year's electric operating revenues $1 437 $1 346 $1 282\nGAS OPERATING REVENUES\nThe increasing trend of industrial customers purchasing gas directly from producers and utilizing CG&E facilities to transport the gas (see the \"Mcf Sales and Transportation\" section) continues to put downward pressure on gas operating revenues. When Cinergy sells gas, the sales price reflects the cost of gas purchased by Cinergy to support the sale plus the costs to deliver the gas. When gas is transported, Cinergy does not incur any purchased gas costs but delivers gas the customer has purchased from other sources. Since providing transportation services does not necessitate recovery of gas purchased costs, the revenue per Mcf transported is less than the revenue per Mcf sold. As a result, a higher relative volume of gas transported to gas sold translates into lower gas operating revenues.\nIn 1995, gas operating revenues declined $32 million (7.1%), as compared to 1994, as a result of the aforementioned trend toward increased transportation services and the operation of fuel adjustment clauses reflecting a lower average cost of gas purchased.\nGas operating revenues decreased $27 million (5.7%)in 1994, as compared to 1993, due to the operation of fuel adjustment clauses which reflected a lower average cost of gas purchased during the latter part of 1994 and a reduction in total volumes sold and transported.\nIn 1993, gas operating revenues increased $75 million (19.1%) as a result of rate increases granted in 1993, higher volumes of gas sold, and the operation of fuel adjustment clauses reflecting an increase in the average cost of gas purchased.\nOperating Expenses\nFUEL\nFuel Used in Electric Production Electric fuel costs remained relatively constant in 1995, showing less than a 1% increase when compared to 1994.\nAn analysis of these fuel costs for the past three years is shown below:\n1995 1994 1993 (in millions)\nPrevious year's fuel expense $325 $333 $321 Increase (Decrease) due to change in: Price of fuel (20) (9) (8) Kwh generation 22 1 20\nCurrent year's fuel expense $327 $325 $333\nGas Purchased In 1995, gas purchased expense decreased $42 million (16.9%), as compared to 1994, reflecting a decline in the average cost per Mcf of gas purchased of 17.2%.\nA reduction in the average cost per Mcf of gas purchased (5.1%) and lower volumes purchased (6.8%) contributed to the decline in gas purchased expense of $33 million (11.6%) in 1994, as compared to 1993.\nGas purchased expense increased $53 million (23.0%) in 1993 as a result of an increase in the average cost per Mcf of gas purchased of 17.5% and an increase in volumes purchased of 4.7%.\nPURCHASED AND EXCHANGED POWER\nPurchased and exchanged power costs increased $36 million in 1995, as compared to 1994, reflecting increased purchases from PSI resulting from the coordination of PSI's and CG&E's electric dispatch systems. These increases were partially offset by a decline in third party, short-term power sales to other utilities.\nOTHER OPERATION\nIn 1995, other operation expenses decreased $44 million (13.1%), as compared to 1994. Charges of $52 million in 1994 for Merger Costs and other expenditures which cannot be recovered from customers under the merger savings sharing mechanism authorized by the PUCO, significantly contributed to the decrease. In addition, emphasis on achieving merger savings and other cost reductions led to lower operating costs for 1995. The decrease was partially offset by the write-off of obsolete inventory in December 1995.\nOther operation expenses increased $79 million (30.5%) in 1994, as compared to 1993, due to a number of factors including the previously discussed charges of $52 million and increased electric production and distribution expenses.\nThe $15 million (6.1%) increase in other operation expense in 1993 was due to a number of factors, including wage increases, the adoption of two accounting standards involving postemployment and postretirement benefits, and increases in gas production expenses.\nMAINTENANCE\nThe decrease in maintenance expense of $12 million (11.3%) in 1995, as compared to 1994, was primarily attributable to improved scheduling of routine maintenance on electric generating units. Lower maintenance costs on gas and electric distribution facilities also contributed to the decline.\nDEPRECIATION\nDepreciation expense increased $11 million (7.8%) in 1993 primarily due to a full year's effect of the first five units of Woodsdale which were placed in commercial operation in 1992 and the sixth unit which was placed in commercial operation in 1993.\nPOST-IN-SERVICE DEFERRED OPERATING EXPENSES - NET\nPost-in-service deferred operating expenses - net reflect various deferrals of depreciation, operation and maintenance expenses (exclusive of fuel costs), and property taxes on certain generating units and other utility plant from the in-service date until the related plant is reflected in retail rates, net of amortization of these deferrals as they are recovered through retail rates. (See Note 1(h) of the \"Notes to Financial Statements\" in \"Item 8. Financial Statements and Supplementary Data\".)\nPHASE-IN DEFERRED DEPRECIATION AND RETURN AND AMORTIZATION OF PHASE-IN DEFERRALS\nPhase-in deferred depreciation, phase-in deferred return, and amortization of phase-in deferrals reflect the PUCO-ordered phase-in plan for Zimmer. (See Note 1(f) of the \"Notes to Financial Statements\" in \"Item 8. Financial Statements and Supplementary Data\".)\nTAXES OTHER THAN INCOME TAXES\nTaxes other than income taxes increased $6 million (3.2%) in 1995, $14 million (7.6%) in 1994, and $9 million (5.3%) in 1993, primarily due to increased property taxes resulting from a greater investment in taxable property (including Zimmer and Woodsdale) and higher property tax rates.\nOther Income and Expenses - Net\nPOST-IN-SERVICE CARRYING COSTS\nPost-in-service carrying costs reflect the deferral of carrying costs on certain generating units from the in-service date until the related plant is reflected in retail rates. (See Note 1(h) of the \"Notes to Financial Statements\" in \"Item 8. Financial Statements and Supplementary Data\".)\nWRITE-OFF OF A PORTION OF ZIMMER\nIn the May 1992 Order authorizing the rate phase-in plan for Zimmer, the PUCO disallowed from rates approximately $230 million of Zimmer costs. Upon appeal, the Supreme Court of Ohio upheld the PUCO's decision, and CG&E wrote off Zimmer costs of approximately $223 million, net of taxes, in November 1993.\nOTHER - NET\nThe increase in other - net of $11 million in 1995, as compared to 1994, is due in part to $4 million of interest on an income tax refund related to prior years and charges of $12 million in 1994 for merger-related and other expenditures which cannot be recovered from customers.\nPREFERRED DIVIDEND REQUIREMENT\nCG&E's preferred dividend requirement decreased $5 million (21.0%) for 1995, as compared to 1994. The decrease was attributable to the early redemption of 400,000 shares of $100 par value, 9.28% Series Cumulative Preferred Stock in April 1994, along with the early redemption of 400,000 and 500,000 shares of $100 par value Cumulative Preferred Stock, 7.44% Series and 9.15% Series, respectively, on July 1, 1995.\nRESULTS OF OPERATIONS - PSI\nKwh Sales\nKwh sales in 1995, as compared to 1994, increased 6.3%, reflecting increased sales to all customer classes. Contributing significantly to this increase were higher residential and commercial sales due to warmer weather during the 1995 summer cooling season, colder weather during the fourth quarter of 1995, and an increase in the number of residential and commercial customers. Increased sales to industrial customers, reflecting growth in the primary metals, chemicals, and food products sectors, also contributed to the increased kwh sales level. This increase also reflects higher non-firm power sales for resale resulting from an increase in sales to CG&E reflecting the coordination of PSI's and CG&E's electric dispatch systems.\nTotal kwh sales increased 6.3% in 1994, as compared to 1993, due in large part to non-firm power sales for resale, reflecting third party, short-term power sales to other utilities through PSI's system and direct power sales by PSI to other utilities. Also contributing to the total kwh sales levels were increased sales to industrial customers. This increase reflected growth in the primary metals and transportation equipment sectors. A decrease in residential sales resulted from the milder weather experienced during the third and fourth quarters of 1994.\nNew customers and a return to more normal weather contributed to the 3.6% increase in total kwh sales in 1993, as compared to 1992. In addition, growth in the primary metals, transportation equipment, precision instruments, and photographic and optical goods sectors resulted in increased industrial sales. Partially offsetting these increases was a reduction in non-firm power sales for resale, which reflected a significant decrease in sales associated with third party, short-term power sales to other utilities through PSI's system.\nYear-to-year changes in kwh sales for each major class of customers are shown below:\nIncrease (Decrease) from Prior Year\n1995 1994 1993 Retail Residential 7.9% (1.4)% 12.2 % Commercial 5.2 1.4 7.2 Industrial 5.1 4.9 5.5\nTotal retail 6.0 2.0 8.0\nSales for resale Firm power obligations 1.1 2.6 2.2 Non-firm power transactions 10.2 33.5 (15.4)\nTotal sales for resale 7.4 22.4 (9.8)\nTotal sales 6.3 6.3 3.6\nPSI currently forecasts a 2% annual compound growth rate in kwh sales over the 1996 through 2005 period. This forecast does not reflect the effects of DSM programs and excludes non-firm power sales for resale and any potential new off-system, long-term firm power sales. Operating Revenues\nHigher kwh sales and electric rate increases which became effective in February 1995 and March 1995 significantly contributed to the $134 million (12.1%) increase in operating revenues for 1995, when compared to 1994.\nOperating revenues increased $22 million (1.9%) in 1994, as compared to 1993, as a result of increased kwh sales, the effects of a $31 million refund to retail customers accrued in June 1993 as a result of the settlement of the April 1990 Order, and increased fuel costs. Partially offsetting these increases were the 1.5% retail rate reduction resulting from the IURC's December 1993 Order and the return of approximately $11 million (an increase of $9 million when compared to 1993) to customers in connection with certain provisions of Indiana law which limit the level of retail operating income as determined in quarterly fuel adjustment clause proceedings.\nIn 1993, operating revenues increased $26 million (2.5%), as compared to 1992, reflecting increased kwh sales which were offset, in part, by the refund resulting from the settlement of the April 1990 Order.\nAn analysis of operating revenues for the past three years is shown below:\n1995 1994 1993 (in millions)\nPrevious year's operating revenues $1 114 $1 092 $1 066 Increase (Decrease) due to change in: Price per kwh Retail 68 (23) (38) Sales for resale Firm power obligations (1) 2 (1) Non-firm power transactions 1 - 7 Total change in price per kwh 68 (21) (32)\nKwh sales Retail 55 18 71 Sales for resale Firm power obligations 1 2 2 Non-firm power transactions 9 23 (12) Total change in kwh sales 65 43 61\nOther 1 - (3)\nCurrent year's operating revenues $1 248 $1 114 $1 092\nOperating Expenses\nFUEL\nFuel costs, PSI's largest operating expense, remained relatively constant in 1995, showing less than a 1% increase when compared to 1994.\nAn analysis of these fuel costs for the past three years is shown below:\n1995 1994 1993 (in millions)\nPrevious year's fuel expense $387 $400 $386 Increase (Decrease) due to change in: Price of fuel (5) (30) 5 Kwh generation 7 17 9\nCurrent year's fuel expense $389 $387 $400\nPURCHASED AND EXCHANGED POWER\nPurchased and exchanged power costs increased $22 million (54.3%) in 1995, as compared to 1994, reflecting increased purchases from CG&E as a result of the coordination of PSI's and CG&E's electric dispatch systems. These increases were partially offset by a decline in third party, short-term power sales to other utilities.\nPurchased and exchanged power increased $17 million (70.6%) in 1994, as compared to 1993, reflecting an increase in third party, short-term power sales to other utilities through PSI's system and increased purchases of other non-firm power by PSI primarily to serve its own load.\nIn 1993, PSI increased its purchases of non-firm power primarily to serve its own load, which resulted in an increase in purchased and exchanged power costs of $11 million (76.8%), as compared to 1992.\nOTHER OPERATION\nIn 1995, other operation expenses increased $15 million (7.2%), as compared to 1994. This increase was due to a number of factors, including the recognition of postretirement benefit costs on an accrual basis, an increase in the ongoing level of DSM expenses, and the amortization of deferred postretirement benefit costs, deferred Merger Costs, and deferred DSM costs, all of which are being recovered in revenues pursuant to the February 1995 Order. These increases were partially offset by charges of $10 million in 1994 for severance benefits to former officers of PSI which cannot be recovered from customers under the merger savings sharing mechanisms authorized by the IURC. In addition, emphasis on achieving merger savings and other cost reductions also partially offset the increase in other operation expenses.\nOther operation expenses increased $26 million (14.2%) in 1994, as compared to 1993, due to a number of factors including the previously discussed charges of $10 million and fuel litigation expenses of $8 million.\nMAINTENANCE\nMaintenance costs decreased $7 million (7.1%) in 1995, as compared to 1994, primarily due to improved scheduling of routine maintenance on generating units and lower maintenance costs on transmission and distribution facilities.\nMaintenance on a number of PSI's generating stations and the initial costs of a new distribution line clearing program resulted in increased maintenance expenses of $10 million (12.1%) in 1994.\nDEPRECIATION\nIn 1995, depreciation expense decreased $17 million (12.3%), when compared to 1994, due in large part to the adoption of lower depreciation rates effective in March 1995. This decrease was partially offset by the effect of additions to utility plant.\nAdditions to electric utility plant led to increases in depreciation expense of $11 million (8.6%), and $10 million (8.3%) in 1994 and 1993, respectively.\nPOST-IN-SERVICE DEFERRED OPERATING EXPENSES - NET\nPost-in-service deferred operating expenses - net reflect the deferral of depreciation on certain major projects, primarily environmental in nature, from the in-service date until the related projects are reflected in retail rates, net of amortization of these deferrals as they are recovered. (See Note 1(h) of the \"Notes to Financial Statements\" in \"Item 8. Financial Statements and Supplementary Data\".)\nTAXES OTHER THAN INCOME TAXES\nTaxes other than income taxes increased $6 million (11.9%) in 1995, as compared to 1994, primarily due to increased property taxes resulting from a greater investment in taxable property.\nOther Income and Expenses - Net\nALLOWANCE FOR EQUITY FUNDS USED DURING CONSTRUCTION\nIn 1995, allowance for equity funds used during construction decreased $4 million (95.9%), as compared to 1994, primarily due to a decrease in the average balance of CWIP.\nA decrease of $7 million (62.1%) in allowance for equity funds used during construction in 1994, as compared to 1993, was due to an increase in borrowings of short-term debt which resulted in a decrease in the equity rate.\nThe equity component of AFUDC increased in 1993, as compared to 1992, primarily as a result of increased construction.\nPOST-IN-SERVICE CARRYING COSTS\nPost-in-service carrying costs reflect the deferral of carrying costs on certain major projects, primarily environmental in nature, from the in-service date until the related projects are reflected in retail rates. (See Note 1(h) of the \"Notes to Financial Statements\" in \"Item 8. Financial Statements and Supplementary Data\".)\nREDUCTION OF LOSS RELATED TO THE JUNE 1987 ORDER\nThe December 1993 Order resolved open issues related to the June 1987 Order which addressed the effect on PSI of the 1987 reduction in the Federal income tax rate. The December 1993 Order provided for PSI to refund $119 million to its retail customers, which was a reduction of $20 million from the loss previously recognized.\nInterest\nALLOWANCE FOR BORROWED FUNDS USED DURING CONSTRUCTION\nAllowance for borrowed funds used during construction decreased $5 million (55.0%) in 1995, as compared to 1994, primarily as a result of a decrease in the average balance of CWIP which was partially offset by an increase in the debt component of the AFUDC rate.\nThe Union Light, Heat and Power Company\nRESULTS OF OPERATIONS - ULH&P\nKwh Sales\nULH&P's total kwh sales in 1995, as compared to 1994, increased 7.2% reflecting increased sales to all customer classes. The increase in residential and commercial kwh sales was due to warmer weather during the 1995 summer cooling season and colder weather during the fourth quarter of 1995 and an increase in the average number of customers. The increased industrial sales primarily reflect growth in the primary metals sector.\nTotal kwh sales increased 2.8% in 1994, as compared to 1993, primarily due to increased retail sales to commercial and industrial customers. Industrial sales reflected a higher level of economic activity, including growth in the primary metals, industrial machinery, food products, and rubber and plastic products sectors. The increase in commercial sales was due, in part, to new customers. A decrease in residential sales resulted from the milder weather experienced during the third and fourth quarters of 1994.\nA return to more normal weather contributed to the 5.8% increase in total kwh sales in 1993, as compared to 1992. In addition, growth in the food products, industrial machinery, transportation equipment, and fabricated metal products sectors resulted in increased industrial sales.\nYear-to-year changes in kwh sales for each major class of customers are shown below:\nIncrease (Decrease) from Prior Year\n1995 1994 1993 Retail Residential 10.0% (4.6)% 6.6% Commercial 5.6 6.0 5.8 Industrial 5.2 7.2 4.4\nTotal retail 7.2 2.8 5.9\nFirm power sales for resale 7.4 5.1 4.7\nTotal sales 7.2 2.8 5.8\nULH&P currently forecasts a 2% annual compound growth rate in kwh sales over the 1996 through 2005 period. This forecast does not reflect the effects of DSM programs and excludes any potential new off-system, long-term firm power sales.\nMcf Sales and Transportation\nMcf gas sales and transportation volumes increased 8.6% for 1995, as compared to 1994. The colder weather during the fourth quarter of 1995 primarily attributed to the increase in residential and commercial sales. These increases were partially offset by a decline in industrial sales resulting from customers electing to purchase directly from suppliers, creating additional demand for transportation services provided by ULH&P. The increased transportation volumes mainly reflect industrial demand for gas transportation services in the paper products sector. The milder weather experienced in 1994 contributed to a decrease in residential gas sales volumes and led to the decrease in total Mcf sales and transportation of 4.3%, as compared to 1993. The increase in gas transportation more than offset the decrease in industrial sales volumes and was attributable to additional demand for gas transportation services by industrial customers mainly in the primary metals, paper products, and food products sectors.\nThe increase in Mcf sales and transportation of 5.8% in 1993, when compared to 1992, was attributable to higher sales to retail customers. This increase was primarily attributable to higher sales to residential customers caused by the return to more normal weather during the 1993 heating season and the addition of a number of customers to ULH&P's gas system during the year. Gas transportation volumes for 1993 decreased largely as a result of lower industrial demand for gas transportation services in the paper products sector. However, the decrease in Mcf transported was more than offset by the increase in Mcf sold to industrial customers.\nYear-to-year changes in Mcf sales for each major class of customers and Mcf transportation volumes are shown below:\nIncrease (Decrease) from Prior Year\n1995 1994 1993\nRetail Residential 9.5 % (11.2)% 8.2 % Commercial 3.8 4.1 4.1 Industrial (8.4) (9.2) 23.9\nTotal retail 6.0 (6.6) 8.3\nGas transported 24.3 12.9 (10.5)\nTotal gas sold and transported 8.6 (4.3) 5.8\nOperating Revenues\nELECTRIC OPERATING REVENUES\nElectric operating revenues increased $9.6 million (5.4%) in 1995, and $1.9 million (1.1%) in 1994. These increases reflect higher kwh sales, as previously discussed. In 1993, electric operating revenues increased $16.0 million (10.0%) due to an increase in kwh sales and the full effect of a rate increase that became effective in May 1992.\nAn analysis of electric operating revenues for the past three years is shown below:\n1995 1994 1993 (in thousands) Previous year's electric operating revenues $177 564 $175 712 $159 690 Increase (Decrease) due to change in: Price per kwh Retail (3 934) (3 095) 6 355 Firm power sales for resale 24 170 82 Total change in price per kwh (3 910) (2 925) 6 437\nKwh sales Retail 13 363 4 761 9 196 Firm power sales for resale 157 92 78 Total change in kwh sales 13 520 4 853 9 274\nOther 6 (76) 311 Current year's electric operating revenues $187 180 $177 564 $175 712\nGAS OPERATING REVENUES\nThe increasing trend of industrial customers purchasing gas directly from producers and utilizing ULH&P facilities to transport the gas (see the \"Mcf Sales and Transportation\" section) continues to put downward pressure on gas operating revenues. When ULH&P sells gas, the sales price reflects the cost of gas purchased by ULH&P to support the sale plus the costs to deliver the gas. When gas is transported, ULH&P does not incur any purchased gas costs but delivers gas the customer has purchased from other sources. Since providing transportation services does not necessitate recovery of gas purchased costs, the revenue per Mcf transported is less than the revenue per Mcf sold. As a result, a higher relative volume of gas transported to gas sold translates into lower gas operating revenues.\nGas operating revenues declined $1.7 million (2.3%) in 1995, as compared to 1994 as a result of the aforementioned trend toward increased transportation services and the operation of fuel adjustment clauses reflecting a lower average cost of gas purchased.\nIn 1994, gas operating revenues decreased $3.8 million (5.0%), as compared to 1993, primarily as a result of a decline in total volumes sold and transported of 4.3%. This decrease was partially offset by the effect of a gas rate increase which became effective in mid-1993.\nGas operating revenues increased $13.1 million (21.0%) in 1993 due to the operation of the fuel adjustment clause reflecting an increase in the cost of gas purchased, the mid-1993 rate increase, and a 5.8% increase in total volumes sold and transported.\nOperating Expenses\nELECTRICITY PURCHASED FROM PARENT COMPANY FOR RESALE\nElectricity purchased increased $7.4 million (5.5%) in 1995 due to an 8.1% increase in volumes purchased. In 1993, electricity purchased increased $7.1 million (5.6%) due to a 6.3% increase in volumes purchased.\nGAS PURCHASED\nIn 1995, gas purchased expense decreased $3.8 million (9.3%) from 1994 primarily due to a 13.7% decrease in the average cost per Mcf of gas purchased. Gas purchased expense in 1994 decreased $2.9 million (6.6%) due to a 5.2% decrease in volumes purchased. In 1993, gas purchased expense increased $8.0 million (22.5%) due to an 11.8% increase in the average cost per Mcf of gas purchased and to a 9.5% increase in volumes purchased.\nOTHER OPERATION\nIn 1995, other operation expense decreased $1.6 million (4.9%), as compared to 1994, due, in part, to decreased gas and electric distribution expenses and decreased gas production expenses. In 1994, other operation expense increased $1.9 million (6.2%), as compared to 1993, due primarily to increased gas and electric distribution expenses and increased wages and benefits. Other operation expense decreased $1.2 million (3.8%) in 1993 due to a number of factors including reduced electric and gas distribution expenses and cost control efforts.\nMAINTENANCE\nMaintenance expense decreased $.9 million (16.3%) in 1995 and $.8 million (12.7%) in 1994 primarily as a result of reduced maintenance costs on gas and electric distribution facilities.\nDEPRECIATION\nDepreciation expense increased $.8 million (7.5%) in 1995, as compared to 1994, primarily due to additions to electric and gas plant in service. Increases in 1994 and 1993 of $.8 million (8.5%) and $1.5 million (18.0%), respectively, were due to increases in depreciable plant in service and the adoption of higher depreciation rates on gas and common plant in accordance with a KPSC rate order issued in 1993.\nNOTES TO FINANCIAL STATEMENTS\n1. Summary of Significant Accounting Policies\nCinergy, CG&E, PSI, and ULH&P\n(a) Consolidation Policy Cinergy, a Delaware corporation, was created in the October 1994 merger of Resources and CG&E. Cinergy's subsidiaries are CG&E, PSI, Investments, and Services. The accompanying Financial Statements include the accounts of Cinergy and its subsidiaries after elimination of significant intercompany transactions and balances.\nAt merger consummation, 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 CG&E, its utility subsidiaries (including ULH&P), and PSI were not affected by the merger. The merger was accounted for as a pooling of interests, and the Financial Statements, along with the related notes, are presented as if the merger was consummated as of the beginning of the earliest period presented.\nResources' and CG&E's consolidated operating revenues and net income for the nine months ended September 30, 1994, and the year ended December 31, 1993, were as follows:\nResources CG&E Eliminations(i) Cinergy (in millions)\nNine months ended September 30, 1994 (unaudited) Operating revenues $ 849(ii) $1 363 $ (7) $2 205 Net income 60 146 - 206\nYear ended December 31, 1993 Operating revenues 1 102(ii) 1 752 (10) 2 844 Net income (loss) 97 (34)(iii) - 63\n(i) Eliminations of intercompany power sales. (ii) Reflects reclassifications from previously reported amounts to conform to the 1995 presentation. (iii) Reflects write-off of a portion of Zimmer ($223 million, net of taxes).\nCinergy, CG&E, PSI, and ULH&P\n(b) Nature of Operations Cinergy is a registered holding company under the PUHCA. CG&E, an Ohio combination electric and gas utility, and its four wholly-owned utility subsidiaries (including ULH&P, a Kentucky combination electric and gas utility) are primarily engaged in the production, transmission, distribution, and sale of electric energy and\/or the sale and transportation of natural gas in the southwestern portion of Ohio and adjacent areas in Kentucky and Indiana. PSI, an Indiana electric utility and previously Resources' utility subsidiary, is engaged in the production, transmission, distribution, and sale of electric energy in north central, central, and southern Indiana. Investments, a Delaware corporation, is a non- utility subholding company that was formed to operate Cinergy's non-utility businesses and interests. Services, a Delaware corporation, is the service company for the Cinergy system, providing member companies with a variety of administrative, management, and support services. The majority of Cinergy's operating revenues are derived from the sale of electricity and the sale and transportation of natural gas.\nCinergy, CG&E, PSI, and ULH&P\n(c) Management's Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities. Estimates are also required with respect to the 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. (See Note 13.)\nCinergy, CG&E, PSI, and ULH&P\n(d) Regulation Cinergy, its utility subsidiaries, and certain of its non- utility subsidiaries are subject to regulation by the SEC under the PUHCA. Cinergy's utility subsidiaries are also subject to regulation by the FERC and the state utility commissions of Ohio, Kentucky, and Indiana. The accounting policies of Cinergy's utility subsidiaries conform to the accounting requirements and ratemaking practices of these regulatory authorities and to generally accepted accounting principles, including the provisions of Statement 71.\nUnder the provisions of Statement 71, regulatory assets represent probable future revenue associated with deferred costs to be recovered from customers through the ratemaking process. The following regulatory assets of PSI and CG&E and its utility subsidiaries are reflected in the Balance Sheets as of December 31:\n1995 1994 PSI CG&E 1\/ Cinergy PSI CG&E 1\/ Cinergy (in millions)\nAmounts due from customers - income taxes $ 27 $397 $ 424 $ 27 $382 $ 409 Post-in-service carrying costs and deferred operating expenses 39 148 187 30 155 185 Phase-in deferred return and depreciation - 100 100 - 101 101 Deferred DSM costs 110 19 129 94 10 104 Deferred merger costs 42 15 57 38 12 50 Unamortized costs of reacquiring debt 34 40 74 37 33 70 Postretirement benefit costs 21 4 25 21 4 25 1992 workforce reduction costs - 8 8 - 17 17 Other 13 29 42 9 35 44\nTotal $286 $760 $1 046 $256 $749 $1 005\n1\/ Includes $7 million and $5 million related to ULH&P at December 31, 1995 and 1994, respectively.\nPSI has previously received regulatory orders authorizing the recovery of $149 million of its total regulatory assets at December 31, 1995, and is currently requesting recovery of an additional $119 million. CG&E has previously received regulatory orders authorizing the recovery of $701 million (including $3 million for ULH&P) of its total regulatory assets at December 31, 1995, and is currently requesting recovery of an additional $11 million. Both PSI and CG&E (including ULH&P) will request recovery of additional amounts in future rate proceedings in each applicable jurisdiction. (See Note 2.)\nSee Note 1(e), (f), (g), (h), (i), (j), and (k) for additional information regarding amounts due from customers - income taxes, phase-in deferred return and depreciation, deferred DSM costs, post-in-service carrying costs and deferred operating expenses, deferred merger costs, costs of reacquiring debt, and 1992 workforce reduction costs, respectively. For additional information regarding postretirement benefit costs, see Note 11.\nCertain criteria must be met in order to continue to apply the provisions of Statement 71, including regulated rates designed to recover the specific utility's costs. Failure to satisfy the criteria in Statement 71 would eliminate the basis for reporting regulatory assets. Although Cinergy's utility subsidiaries' current regulatory orders and regulatory environment fully support the continued recognition of their 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 Cinergy's utility subsidiaries discontinuing application of Statement 71 for all or part of their business. Such an event would require the write-off of the portion of any regulatory asset for which sufficient regulatory assurance of future recovery no longer exists. No evidence currently exists that would support a write-off of any portion of Cinergy's utility subsidiaries' regulatory assets.\nIn March 1995, the FASB issued Statement 121, which is effective in January 1996 for Cinergy and its utility subsidiaries. Statement 121, which addresses the identification and measurement of asset impairments for all enterprises, will be particularly relevant for electric utilities as a result of the potential for deregulation of the generation segment of the business. Statement 121 requires recognition of impairment losses on long-lived assets when book values exceed expected future cash flows. Based on the regulatory environment in which Cinergy currently operates, compliance with the provisions of Statement 121 is not expected to have an adverse effect on its financial condition or results of operations. However, this conclusion may change in the future as competitive pressures and potential restructuring influence the electric utility industry.\nCinergy and its utility subsidiaries intend to continue their pursuit of competitive strategies that mitigate the potential impact of these issues on the financial condition of the companies (see the \"Competitive Pressures\" section of \"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\").\nCinergy, CG&E, PSI, and ULH&P\n(e) 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 PSI, CG&E, and its utility subsidiaries. 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. The future revenues associated with these amounts are reflected in the accompanying Financial Statements as a regulatory asset based on the probable recovery through customers' rates in future periods. Conversely, to the extent deferred income taxes recovered in rates exceed amounts payable in future periods, such amounts are reflected in the accompanying Financial Statements as \"Income taxes refundable through rates\" on the basis of their probable repayment in future years.\nCinergy and CG&E\n(f) Phase-in Deferred Return and Depreciation In the first three years of a rate phase-in plan for Zimmer included in the May 1992 Order by the PUCO, rates charged to customers did not fully recover depreciation expense and return on investment. In accordance with the provisions of the May 1992 Order, this deficiency has been deferred on the Consolidated Balance Sheets and is being recovered over a seven-year period beginning in May 1995.\nCinergy, CG&E, PSI, and ULH&P\n(g) DSM In February 1995, the IURC issued the February 1995 Order approving a rate settlement agreement among PSI and certain intervenors which authorized the recovery of DSM expenditures deferred through July 1993 ($35 million), together with carrying costs. In addition, base rates include recovery of $23 million of DSM expenditures on an annual basis. Under the February 1995 Order, current deferral of DSM expenditures is 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 is reduced by such difference. In its current retail rate proceeding, PSI has requested recovery of DSM expenditures deferred between July 1993 and August 1995, together with carrying costs, and an increase in the ongoing annual expense level from $23 million to $39 million (see Note 2(a)). DSM expenditures subsequent to August 1995 in excess of the annual ongoing level in base rates are being deferred, with carrying costs, for recovery in a subsequent rate proceeding.\nIn the August 1993 Order, CG&E was authorized to recover approximately $5 million annually of costs associated with DSM programs for residential customers. In 1995, the PUCO authorized the deferral, with carrying costs, of the expenditures associated with a number of approved DSM programs to the extent such expenditures are in excess of the $5 million already being recovered. CG&E is also requesting PUCO approval to defer the costs of additional DSM programs. Additionally, the KPSC has authorized recovery of costs related to various DSM programs of ULH&P.\nCinergy, CG&E, and PSI\n(h) Post-in-service Carrying Costs and Deferred Operating Expenses CG&E received various orders from the PUCO which permitted the deferral of carrying costs and non-fuel operating expenses (including depreciation) for Zimmer and Woodsdale. Effective with the dates of the PUCO's orders reflecting the units in customer rates, the deferrals of post-in-service carrying costs are being recovered over the lives of the applicable units and the deferred non-fuel operating expenses are being recovered over a 10-year period.\nPSI received authority from the IURC for the accrual of the debt component of carrying costs (to the extent not recovered currently in retail rates) and the deferral of depreciation expense on certain major projects, primarily environmental in nature, including the Clean Coal Project and a scrubber at Gibson. These deferrals are either being recovered currently over the remaining lives of the related assets in accordance with the February 1995 Order, have been requested for recovery in PSI's current retail rate proceeding, or will be requested for recovery in a subsequent PSI retail rate proceeding.\nCinergy, CG&E, PSI, and ULH&P\n(i) Merger Costs CG&E and its utility subsidiaries are deferring the non- PUCO electric jurisdictional portion of Merger Costs for future recovery in customer rates, including $6 million requested for recovery in CG&E's current gas rate proceeding. In accordance with the February 1995 Order, PSI is deferring Merger Costs it incurs through October 31, 1996, and is recovering the deferrals over a 10-year period as an offset against merger savings. In 1994, CG&E and PSI completed voluntary workforce reduction programs. As a result of the programs, the Cinergy subsidiaries incurred a combined pre-tax cost of approximately $28.8 million ($17.4 million for CG&E and its subsidiaries($1.8 million for ULH&P), including $15.6 million of additional pension costs further discussed in Note 10, and $11.4 million for PSI). In the third quarter of 1994, CG&E expensed $11 million representing the PUCO electric jurisdictional portion of these costs. The remaining $6.4 million of costs have been deferred as costs to achieve merger savings. The cost of PSI's voluntary workforce reduction program was deferred as a cost to achieve merger savings.\nCinergy, CG&E, PSI, and ULH&P\n(j) Debt Discount, Premium, and Issuance Expenses and Costs of Reacquiring Debt Debt discount, premium, and issuance expenses on outstanding long-term debt of Cinergy's utility subsidiaries are amortized over the lives of the respective issues.\nIn accordance with established ratemaking practices, Cinergy's utility subsidiaries have deferred costs (principally call premiums) from the reacquisition of long-term debt and are amortizing such amounts over periods ranging from one to 25 years (three to 17 years for PSI, one to 25 years for CG&E and its subsidiaries, and 24 years for ULH&P).\nCinergy, CG&E, and ULH&P\n(k) 1992 Workforce Reduction Costs In 1992, CG&E and its subsidiaries incurred $30.4 million (of which approximately $3 million related to ULH&P) in connection with a workforce reduction program. In accordance with the August 1993 Order, CG&E is recovering the majority of these costs through rates over a three-year period. ULH&P is recovering the gas portion of these costs through rates over a 10-year period.\nCinergy, CG&E, PSI, and ULH&P\n(l) Utility Plant Utility plant is stated at the original cost of construction, which includes AFUDC and a proportionate share of overhead costs. Construction overhead costs include salaries, payroll taxes, fringe benefits, and other expenses.\nSubstantially all utility plant is subject to the lien of each applicable company's first mortgage bond indenture.\nCinergy, CG&E, PSI, and ULH&P\n(m) AFUDC Cinergy's utility subsidiaries capitalize 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\". AFUDC accrual rates were as follows, and are compounded semi- annually:\n1995 1994 1993 Cinergy Average 7.9% 6.9% 9.2% CG&E and utility subsidiaries Average 8.8 9.1 8.3 ULH&P Average 7.0 5.9 8.8 PSI 7.0 6.4 9.5\nCinergy, CG&E, PSI, and ULH&P\n(n) Depreciation and Maintenance Provisions for depreciation are determined by using the straight-line method applied to the cost of depreciable plant in service. The rates are based on periodic studies of the estimated service lives and net cost of removal of the properties. The depreciation rates for utility plant during each of the following three years were:\n1995 1994 1993_\nPSI 3.1% 3.8% 3.8% CG&E and its utility subsidiaries Electric 2.9 2.9 2.9 Gas 2.8 2.8 2.7 Common 3.4 3.4 3.3 ULH&P Electric 3.3 3.3 3.4 Gas 3.1 3.1 2.9 Common 5.1 5.1 4.1\nIn accordance with the February 1995 Order, revised depreciation rates for PSI were implemented in March 1995. This change resulted in a decrease in annual depreciation expense of approximately $30 million.\nIn a July 1993 rate order, the KPSC authorized changes in depreciation accrual rates on ULH&P's gas and common plant. The changes resulted in an increase in depreciation expense of approximately $.5 million for 1993.\nFor Cinergy's utility subsidiaries, maintenance 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.\nCinergy, CG&E, PSI, and ULH&P\n(o) Operating Revenues and Fuel Costs Cinergy's utility subsidiaries recognize revenues for electric and gas service rendered during the month, which include revenues for sales unbilled at the end of each month. The costs of electricity and gas purchased and the cost of fuel used in electric production are expensed as recovered through revenues, and any portion of these costs recoverable or refundable in future periods is deferred in the accompanying Balance Sheets. In accordance with the settlement agreement approved in the February 1995 Order and the Indiana statute in effect at the time of the settlement agreement, PSI's recovery of fuel costs is subject to a determination that such recovery will not result in PSI earning a return in excess of that allowed in the February 1995 Order. Cinergy, CG&E, and ULH&P\n(p) Order 636 In 1992, the FERC issued Order 636 which restructured operations between interstate gas pipelines and their customers for gas sales and transportation services. Order 636 also allowed pipelines to recover transition costs they incurred in complying with the order from customers, including CG&E and its utility subsidiaries. In July 1994, the PUCO issued an order approving a stipulation between CG&E and its residential and industrial customer groups providing for recovery of these pipeline transition costs. CG&E presently is recovering its Order 636 transition costs pursuant to a PUCO-approved tariff. CG&E's utility subsidiaries, including ULH&P, recover such costs through their gas cost recovery mechanisms. These costs are deferred as incurred by CG&E and its utility subsidiaries and amortized as recovered from customers.\nCinergy, CG&E, PSI, and ULH&P\n(q) Statements of Cash Flows All temporary cash investments with maturities of three months or less, when acquired, are reported as cash equivalents. Cinergy and its subsidiaries had no material non-cash investing or financing transactions during the years 1993 through 1995.\nCinergy, CG&E, PSI, and ULH&P\n(r) Reclassification Certain amounts in the 1993 and 1994 Financial Statements have been reclassified to conform to the 1995 presentation.\n2. Rates\nCinergy and PSI\n(a) PSI's Current Retail Rate Proceeding PSI currently has pending before the IURC a retail rate increase request of 11.1% ($111.2 million annually). Major components of the increase include the costs of the Clean Coal Project, increased DSM costs, the costs of a scrubber at Gibson, and other investments in utility plant. Both the Clean Coal Project and the scrubber at Gibson were previously approved by the IURC. The request also reflects a return on common equity of 11.9%, before the 100 basis points additional common equity return allowed as a merger savings sharing mechanism in the February 1995 Order, with an 8.6% overall rate of return on net original cost rate base. The UCC filed testimony with the IURC recommending a 4.7% ($47.3 million annually) retail rate increase. The primary differences between PSI's request and the UCC's proposal are the requested return on common equity and DSM costs. The UCC recommended the requested increase in DSM costs be excluded from this proceeding and addressed in a separate currently pending proceeding specifically established to review PSI's current and proposed DSM programs. An order in the rate proceeding is anticipated by the end of the second quarter of 1996. Cinergy cannot predict what action the IURC may take with respect to this proposed rate increase. (See Note 17 for an event subsequent to the date of the auditor's report.)\nCinergy and CG&E\n(b) CG&E's Current Gas Rate Proceeding In January 1996, CG&E filed a request with the PUCO supporting a gas rate increase of 7.8% ($26.7 million annually). The increase, anticipated to be effective in November 1996, is being requested, in part, to recover capital investments made since CG&E's last gas rate increase in 1993. The proposed rate design includes a pilot program that would allow 8,000 to 12,000 residential customers to choose their natural gas supplier with CG&E providing transportation services to the customers' premises. Settlement discussions with gas customer representatives, which began in July 1995, are ongoing. Cinergy cannot predict the outcome of the settlement discussions nor what actions the PUCO may take with respect to the proposed rate increase.\n3. Common Stock\n(a) Changes in Common Stock Outstanding\nCinergy\nThe following table reflects the shares of Cinergy common stock reserved for issuance at December 31, 1995, and issued in 1995, 1994, and 1993, for the Company's stock-based plans, including previous plans of Resources and CG&E. Shares issued prior to merger consummation have been adjusted for Resources' merger conversion ratio of 1.023.\nShares Reserved at Shares Issued Dec. 31, 1995 1995 1994 1993\n401(k) Savings Plans 6 469 373 1 222 379 1 458 631 1 152 096\nDividend Reinvestment and Stock Purchase Plan 1 798 486 935 711 1 127 881 944 168\nDirectors' Deferred Compensation Plan 200 000 - 77 61 266\nPerformance Shares Plan* 771 793 28 207 27 116 28 447\nEmployee Stock Purchase and Savings Plan 1 932 384 1 010 140 039 244\nStock Option Plan 4 596 003 403 997 25 575 139 026\n*A long-term incentive compensation plan for certain participants designated by the Compensation Committee of Cinergy's Board of Directors.\nIn addition to the issuances of common stock previously discussed, Resources issued 1,118,671 shares of common stock in 1993 to the trustee of its two Master Trust Agreements as required as a result of the announcement of the merger. Prior to consummation of the merger in October 1994, Resources issued an additional 16,518 shares to the trustee and distributed 98,400 shares (reflected in the above table as shares issued in 1994) to participants of certain benefit plans. As a result of the merger consummation, in December 1994, Cinergy retired the remaining 1,036,789 shares held by the trustee.\nIn December 1994, Cinergy publicly issued 7,089,000 shares of common stock under a shelf registration statement for the sale of up to eight million shares. In addition, upon consummation of the merger, Cinergy awarded five shares of common stock to all non-officer employees for additional issuances under this shelf registration statement of 43,605 shares and 10 shares in 1994 and 1995, respectively. During 1995, Cinergy retired 119,211 shares of common stock, primarily representing shares tendered as payment for the exercise of previously granted stock options.\nCG&E\nCG&E issued 1,601,003 shares of common stock in 1994 (prior to the merger), and 1,673,058 shares in 1993, for its stock-based compensation and dividend reinvestment plans. After merger consummation, the common stock issued to CG&E's 401(k) Savings Plans is Cinergy common stock rather than CG&E common stock, and CG&E's Dividend Reinvestment and Stock Purchase Plan was merged into and replaced by Cinergy's Dividend Reinvestment and Stock Purchase Plan.\nULH&P\nAll of ULH&P's common stock is held by CG&E.\nCinergy, CG&E, and PSI\n(b) Dividend Restrictions Cinergy owns all of the common stock of CG&E and PSI. The ability of Cinergy to pay dividends to holders of Cinergy common stock is dependent on the ability of CG&E and PSI to pay common dividends to Cinergy. CG&E and PSI cannot purchase or otherwise acquire for value or pay dividends on their common stock if dividends are in arrears on their preferred stock or if they are in arrears in the redemption of preferred stock pursuant to mandatory redemption requirements. The amount of common stock dividends that each company can pay also may be limited by certain capitalization and earnings requirements. Currently, these requirements do not impact the ability of either company to pay dividends on common stock.\nCinergy\n(c) Stock Option Plan The Stock Option Plan, which succeeded a similar plan of Resources, is designed to align executive compensation with shareholder interests. Under the Stock Option Plan, incentive and non-qualified stock options and stock appreciation rights may be granted to key employees, officers, and outside directors. Common stock granted under the Stock Option Plan may not exceed five million shares. Options are granted at the fair market value of the shares on the date of grant, except that non-qualified stock options were granted to two executive officers under Resources' stock option plan at an option price equal to 91% of the fair market value of the shares at the date of grant. Options vest over five years and have a purchase term of up to 10 years. All options granted prior to November 1993, but not previously vested, became vested upon approval of the merger by Resources' shareholders. No incentive stock options may be granted under the plan after October 24, 2004.\nThe Stock Option Plan activity for 1993, 1994, and 1995, adjusted for Resources' merger conversion ratio of 1.023, is summarized as follows:\nRange of Shares Subject Option Prices to Option Per Share\nBalance at December 31, 1992 1 186 554 $12.26 to 17.35 Options Exercised (139 026) 12.26 to 16.56\nBalance at December 31, 1993 1 047 528 $12.50 to 17.35 Options Granted 1 387 500 22.88 Options Exercised (25 575) 13.14 to 16.56\nBalance at December 31, 1994 2 409 453 $12.50 to 22.88 Options Granted 1 672 500 24.31 to 28.81 Options Exercised _(403 997) 12.50 to 17.35\nBalance at December 31, 1995 3 677 956 $12.50 to 28.81\nShares Reserved for Future Grants At December 31, 1993 1 368 263 At December 31, 1994 2 590 547 At December 31, 1995 918 047\nIn addition, 45,000 options were granted to various employees in January 1996, at an option price of $31.56 per share.\nNo stock appreciation rights have been granted under this plan. The total options exercisable at December 31, 1995, 1994, and 1993, were 895,456, 1,021,953, and 1,047,528, respectively.\n4. Preferred Stock of Subsidiaries\nCinergy, CG&E, and PSI\nCinergy, CG&E, and PSI\n(b) Changes in Cumulative Preferred Stock Outstanding Changes in cumulative preferred stock outstanding during 1995, 1994, and 1993, were as follows:\nShares Issued Par (Retired) Value (in thousands) Not subject to mandatory redemption Par value $100 per share CG&E 7.44 % Series (400 000) $(40 000) PSI 3 1\/2% Series (329) (32) Subject to mandatory redemption Par value $100 per share CG&E 9.15 % Series (500 000) (50 000)\nNot subject to mandatory redemption Par value $100 per share CG&E 9.28 % Series (400 000) (40 000) PSI 3 1\/2% Series (598) (60)\nNot subject to mandatory redemption Par value $25 per share PSI 7.44 % Series 4 000 000 100 000 Par value $100 per share PSI 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\nCinergy and CG&E\n(c) Cumulative Preferred Stock with Mandatory Redemption In each of 1998, 1999, and 2000, CG&E is required to redeem $4 million of its 7 3\/8% Series Cumulative Preferred Stock, which is subject to mandatory redemption each August 1, beginning in 1998, in an amount sufficient to retire 40,000 shares, at a price of $100 per share, plus accrued dividends. In addition, CG&E, at its option, may redeem up to a like amount of shares in any given year, at a price of $100 per share. CG&E may satisfy this sinking fund requirement, in whole or in part, by crediting shares acquired during the year. To the extent CG&E does not satisfy the sinking fund obligation in any year, such obligation must be satisfied in the succeeding year or years. CG&E may not purchase or otherwise acquire for value or pay dividends on its common stock if it is in arrears in the redemption of preferred stock pursuant to the mandatory sinking fund requirements.\nCinergy, CG&E, PSI, and ULH&P 5. Long-term Debt\nCinergy, CG&E, PSI, and ULH&P\n(b) Mandatory Redemption and Other Requirements Long-term debt maturities for the next five years are as follows:\nCinergy and CG&E and Subsidiaries Subsidiaries PSI ULH&P (in millions)\n1996 $ 50 $ - $ 50 $ - 1997 140 130 10 - 1998 36 - 36 - 1999 187 180 7 20 2000 31 - 31 - $444 $310 $134 $20\nIn January 1996, CG&E retired $5 million principal amount of its 10.20% first mortgage bonds (due December 1, 2020). Additionally, CG&E redeemed in February 1996, the remaining $131.5 million principal amount of these bonds at a price of 100% through the M&R Fund provision of its first mortgage bond indenture. ULH&P also redeemed, in February 1996, $9 million principal amount of its 10 1\/4% first mortgage bonds (due November 15, 2020) at a price of 107.20% and the remaining $6 million principal amount of such bonds at a price of 100% through its M&R Fund provision. The first mortgage bonds retired in January and February 1996 by CG&E and ULH&P have been classified as \"Long-term debt due within one year\" in the appropriate Balance Sheets. M&R Fund provisions contained in CG&E's, PSI's, and ULH&P's first mortgage bond indentures require cash payments, bond retirements, or pledges of unfunded property additions each year based on a formularized amount related to the net revenues of the respective company.\n6. Notes Payable\nCinergy, CG&E, PSI, and ULH&P\nCinergy's subsidiaries had regulatory authority to borrow up to $838 million ($438 million for CG&E and its subsidiaries, including $35 million for ULH&P, and $400 million for PSI) as of December 31, 1995. In connection with this authority, Committed Lines have been established which permit borrowings of up to $322 million ($106 million for CG&E and its subsidiaries, including $30 million for ULH&P, and $215 million for PSI), of which $182 million ($106 million for CG&E and its subsidiaries, including $30 million for ULH&P, and $74 million for PSI) remained unused at December 31, 1995. CG&E and PSI also issue commercial paper from time to time. All outstanding commercial paper is supported by Committed Lines of the respective company. Additionally, pursuant to this authority, Uncommitted Lines are arranged with various banks. 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 lines are maintained by compensating balances or commitment fees. Commitment fees for the Committed Lines were immaterial during the 1993 through 1995 period.\nTo better manage cash and working capital requirements, Cinergy's utility subsidiaries, including CG&E, PSI, and ULH&P, participate in a money pooling arrangement. Under the money pool, participants with surplus short-term funds, whether from internal sources, bank loans, or commercial paper sales, provide short-term loans to other system companies at rates that approximate the costs of the funds in the money pool. The SEC's approval, pursuant to the PUHCA, of the money pool extends through May 31, 1997.\nIn addition, Cinergy has a $100 million credit facility which expires in September 1997 and was unused at December 31, 1995. The facility may be increased to a maximum of $300 million, and the Company has an annual option of extending the term of the facility by one year. This credit facility will be used for general corporate purposes and funding non-utility business ventures.\nThe weighted average interest rates on short-term borrowings outstanding at December 31, 1995 and 1994, were as follows:\n1995 1994_ Cinergy and subsidiaries 5.97% 6.11% CG&E and subsidiaries - 6.14 PSI 5.97 6.11 ULH&P - 6.14\n7. Sale of Accounts Receivable\nCinergy, CG&E, PSI, and ULH&P\nIn January 1996, CG&E, PSI, and ULH&P entered into an agreement to sell, on a revolving basis, undivided percentage interests in certain of their accounts receivable up to an aggregate maximum of $350 million. PSI had a similar agreement, which expired in January 1996, to sell up to $90 million of its accounts receivable. Accounts receivable on the Consolidated Balance Sheets of Cinergy and PSI are net of a $90 million and $87 million interest sold under the prior PSI agreement at December 31, 1995 and 1994, respectively.\n8. Leases\nCinergy, CG&E, PSI, and ULH&P\nCinergy and its subsidiaries have entered into operating lease agreements covering various facilities and properties, including office space and computer, communications, and transportation equipment. Total rental payments on operating leases for each of the past three years were as follows:\n1995 1994 1993 (in millions) Cinergy and subsidiaries $36 $36 $35 CG&E and subsidiaries 22 22 22 PSI 14 14 13 ULH&P 5 5 4\nFuture minimum lease payments required under operating leases with remaining, non-cancelable lease terms in excess of one year as of December 31, 1995, are as follows:\nCinergy and CG&E and Subsidiaries Subsidiaries PSI ULH&P* (in millions, ULH&P in thousands)\n1996 $28 $13 $12 $35 1997 22 10 9 24 1998 14 5 6 12 1999 7 4 3 - 2000 5 2 1 - After 2000 20 17 3 - $96 $51 $34 $71\n* Excludes amounts applicable to CG&E's non-cancelable leases allocated to ULH&P. Cinergy, CG&E, PSI, and ULH&P\n9. Fair Values of Financial Instruments\nThe estimated fair values of Cinergy's and its subsidiaries' financial instruments were as follows (this information does not purport to be a valuation of the companies as a whole):\nDecember 31 December 31 1995 1994 Carrying Fair Carrying Fair Amount Value Amount Value_ (in millions; ULH&P in thousands) Financial Instruments\nCinergy and Subsidiaries First mortgage bonds and other long-term debt (includes amounts due within one year) $ 2 733 $ 2 837 $ 2 776 $ 2 718 Cumulative preferred stock of subsidiary - subject to mandatory redemption 160 163 210 221\nCG&E and Subsidiaries First mortgage bonds and other long-term debt (includes amounts due within one year) $ 1 855 $ 1 912 $ 1 838 $ 1 806 Cumulative preferred stock - subject to mandatory redemption 160 163 210 221\nPSI First mortgage bonds and other long-term debt (includes amounts due within one year) $ 878 $ 925 $ 938 $ 912\nULH&P First mortgage bonds and other long-term debt (includes amounts due within one year) $69 377 $72 804 $89 238 $91 361\nThe following methods and assumptions were used to estimate the fair values of each major class of financial instruments:\nCash and temporary cash investments, restricted deposits, and notes payable Due to the short period to maturity, the carrying amounts reflected on the Balance Sheets approximate fair values.\nFirst mortgage bonds and other long-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 (NYSE), on the present value of future cash flows. The discount rates used approximate the incremental borrowing costs for similar instruments.\nCumulative preferred stock - subject to mandatory redemption The aggregate fair value of preferred stock subject to mandatory redemption was based on the latest closing prices quoted on the NYSE for each series or, if no trades occurred during the period, on the present value of future cash flows using discount rates that approximate the incremental borrowing costs for similar instruments.\n10. Pension Plans\nCinergy, CG&E, PSI, and ULH&P\nThe defined benefit pension plans of Cinergy's subsidiaries cover 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 or benefit amount.\nThe funding policies of the operating subsidiaries are to contribute annually to the plans an amount which is not less than the minimum amount required by the Employee Retirement Income Security Act of 1974 and not more than the maximum amount deductible for income tax purposes. Contributions applicable to the 1995, 1994, and 1993 plan years for Cinergy's subsidiaries were $15.4 million, $3.5 million, and $11.3 million, respectively. Of these amounts, CG&E and its subsidiaries contributed $6.8 million and $3.1 million for the 1995 and 1993 plan years, respectively. There were no contributions made for the 1994 plan year by CG&E and its subsidiaries. PSI's contributions were $8.6 million, $3.5 million, and $8.2 million for the 1995, 1994, and 1993 plan years, respectively. The plans' assets consist of investments in equity and fixed income securities.\nCinergy\nCinergy's pension cost for 1995, 1994, and 1993 included the following components: 1995 1994 1993 (in millions)\nBenefits earned during the period $ 18.5 $ 19.4 $ 16.9 Interest accrued on projected benefit obligations 61.4 54.9 53.9 Actual (return) loss on plans' assets (119.3) 8.0 (69.9) Net amortization and deferral 61.1 (66.3) 15.4\nNet periodic pension cost $ 21.7 $ 16.0 $ 16.3\nCG&E and ULH&P\nCG&E's and its subsidiaries' (including ULH&P's) pension cost for 1995, 1994, and 1993 included the following components: 1995 1994 1993 (in millions)\nBenefits earned during the period $ 9.8 $ 10.7 $ 9.2 Interest accrued on projected benefit obligations 38.8 35.1 34.5 Actual (return) loss on plans' assets (71.9) 5.6 (31.4) Net amortization and deferral 35.5 (43.2) (4.7)\nNet periodic pension cost $ 12.2 $ 8.2 $ 7.6\nPSI\nPSI's pension cost for 1995, 1994, and 1993 included the following components:\n1995 1994 1993 (in millions)\nBenefits earned during the period $ 8.7 $ 8.7 $ 7.7 Interest accrued on projected benefit obligation 22.6 19.8 19.4 Actual (return) loss on plan assets (47.4) 2.4 (38.5) Net amortization and deferral 25.6 (23.1) 20.1\nNet periodic pension cost $ 9.5 $ 7.8 $ 8.7\nCinergy, CG&E, and ULH&P\nDuring 1994, CG&E and its subsidiaries (including ULH&P) recognized an additional $15.6 million of accrued pension cost in accordance with Statement of Financial Accounting Standards No. 88, Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits. This amount represents the costs associated with additional benefits extended in connection with a voluntary workforce reduction program (see Note 1(i)).\nCinergy, CG&E, PSI, and ULH&P 1995 1994 1993 Actuarial Assumptions: For determination of projected benefit obligations Discount rate 7.50% 8.50% 7.50% Rate of increase in future compensation PSI 4.50 5.50 4.50-5.00 CG&E and subsidiaries 4.50 5.50 5.00\nFor determination of pension cost Rate of return on plans' assets PSI 9.00 9.00 9.00 CG&E and subsidiaries 9.50 9.50 9.50\nCinergy\nThe following table reconciles the plans' funded status with amounts recorded in the Consolidated Financial Statements. Under the provisions of Statement 87, certain assets and obligations of the plans are deferred and recognized in the Consolidated Financial Statements in subsequent periods.\nThe following table reconciles the plans' funded status with amounts recorded in the Consolidated Financial Statements of CG&E. Under the provisions of Statement 87, certain assets and obligations of the plans are deferred and recognized in the Financial Statements in subsequent periods.\nPSI\nThe following table reconciles the plan's funded status with amounts recorded in the Consolidated Financial Statements. Under the provisions of Statement 87, certain assets and obligations of the plan are deferred and recognized in the Consolidated Financial Statements in subsequent periods.\n1995 1994 (in millions) Actuarial present value of benefits Vested benefits $(238.6) $(197.5) Non-vested benefits (9.6) (8.0)\nAccumulated benefit obligation (248.2) (205.5)\nEffect of future compensation increases (65.5) (67.3)\nProjected benefit obligation (313.7) (272.8)\nPlan's assets at fair value 291.3 256.3\nProjected benefit obligation in excess of plan's assets (22.4) (16.5)\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 (5.0) (5.7)\nUnrecognized net loss resulting from experience different from that assumed and effects of changes in assumptions 4.8 5.7\nPrior service cost not yet recognized in net periodic pension cost 15.7 17.2\nPrepaid (Accrued) pension cost at December 31 $ (6.9) $ .7\n11. Other Postretirement Benefits\nCinergy, CG&E, PSI, and ULH&P\nCinergy's subsidiaries provide certain health care and life insurance benefits to retired employees and their eligible dependents. The health care benefits include medical coverage and prescription drugs. Additionally, PSI provides dental benefits. PSI employees must meet minimum age and service requirements to be eligible for these postretirement benefits. All retirees of CG&E and its subsidiaries are eligible to receive health care benefits, while life insurance is provided to retirees who participated in the plans and earned the right to postretirement life insurance benefits prior to January 1, 1991. The health care and dental benefits provided are subject to certain limitations, such as deductibles and co-payments. Neither CG&E and its subsidiaries nor PSI currently pre-fund their obligations for these postretirement benefits; however, PSI, in connection with the settlement which resulted in the February 1995 Order, agreed to begin pre-funding.\nPostretirement benefit cost for 1995, 1994, and 1993 included the following components:\nCinergy\nHealth Life Care Insurance Total (in millions) Benefits earned during the period $ 4.4 $ .1 $ 4.5 Interest accrued on APBO 15.6 2.2 17.8 Amortization of transition obligations 8.1 .3 8.4\nNet periodic postretirement benefit cost $28.1 $2.6 $30.7\nBenefits earned during the period $ 5.2 $ .2 $ 5.4 Interest accrued on APBO 13.8 2.2 16.0 Net amortization and deferral .1 - .1 Amortization of transition obligations 8.1 .3 8.4\nNet periodic postretirement benefit cost $27.2 $2.7 $29.9\nBenefits earned during the period $ 4.3 $ .2 $ 4.5 Interest accrued on APBO 13.4 2.1 15.5 Amortization of transition obligations 8.1 .3 8.4\nNet periodic postretirement benefit cost $25.8 $2.6 $28.4\nCG&E and ULH&P\nHealth Life Care Insurance Total (in millions) Benefits earned during the period $ .4 $ .1 $ .5 Interest accrued on APBO 4.5 2.0 6.5 Amortization of transition obligation 2.6 .4 3.0\nNet periodic postretirement benefit cost $7.5 $2.5 $10.0\nBenefits earned during the period $ .9 $ .1 $ 1.0 Interest accrued on APBO 3.9 2.0 5.9 Amortization of transition obligation 2.6 .4 3.0\nNet periodic postretirement benefit cost $7.4 $2.5 $ 9.9\nBenefits earned during the period $1.0 $ .1 $ 1.1 Interest accrued on APBO 4.2 2.0 6.2 Amortization of transition obligation 2.6 .4 3.0\nNet periodic postretirement benefit cost $7.8 $2.5 $10.3 PSI\nHealth Life Care Insurance Total (in millions) Benefits earned during the period $ 4.0 $ - $ 4.0 Interest accrued on APBO 11.1 .2 11.3 Amortization of transition obligation 5.5 (.1) 5.4\nNet periodic postretirement benefit cost $20.6 $ .1 $20.7\nBenefits earned during the period $ 4.3 $ .1 $ 4.4 Interest accrued on APBO 9.9 .2 10.1 Net amortization and deferral .1 - .1 Amortization of transition obligation 5.5 (.1) 5.4\nNet periodic postretirement benefit cost $19.8 $ .2 $20.0\nBenefits earned during the period $ 3.3 $ .1 $ 3.4 Interest accrued on APBO 9.2 .1 9.3 Amortization of transition obligation 5.5 (.1) 5.4\nNet periodic postretirement benefit cost $18.0 $ .1 $18.1 Cinergy, CG&E, PSI, and ULH&P\nThe following tables reconcile the APBO of the health care and life insurance plans with amounts recorded in the Financial Statements. Under the provisions of Statement of Financial Accounting Standards No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions (Statement 106), certain obligations of the plans are deferred and recognized in the Financial Statements in subsequent periods.\nCinergy Health Life Care Insurance Total_ (in millions) Actuarial present value of benefits Fully eligible active plan participants $ (11.7) $ (1.1) $ (12.8) Other active plan participants (112.0) (2.7) (114.7) Retirees and beneficiaries (99.2) (26.4) (125.6) Projected APBO (222.9) (30.2) (253.1) Unamortized transition obligations 137.1 .7 137.8 Unrecognized prior service cost (.3) - (.3) Unrecognized net loss resulting from experience different from that assumed and effects of changes in assumptions 26.1 .5 26.6 Accrued postretirement benefit obligations at December 31, 1995 $ (60.0) $(29.0) $ (89.0)\nActuarial present value of benefits Fully eligible active plan participants $ (11.4) $ (.9) $ (12.3) Other active plan participants (84.3) (2.3) (86.6) Retirees and beneficiaries (92.0) (23.5) (115.5) Projected APBO (187.7) (26.7) (214.4) Unamortized transition obligations 145.2 1.0 146.2 Unrecognized net (gain) loss resulting from experience different from that assumed and effects of changes in assumptions 2.2 (2.6) (.4) Accrued postretirement benefit obligations at December 31, 1994 $ (40.3) $(28.3) $ (68.6)\nIncreasing the health care cost trend rate by one percentage point in each year would increase the APBO by approximately $37 million and $27 million for 1995 and 1994, respectively, and the aggregate of the service and interest cost components of the postretirement benefit cost for each of 1995, 1994, and 1993 by approximately $3.4 million, $3.7 million, and $3.4 million, respectively.\nCG&E and ULH&P\nHealth Life Care Insurance Total_ (in millions) Actuarial present value of benefits Fully eligible active plan participants $ (2.7) $ (.9) $ (3.6) Other active plan participants (32.0) (2.0) (34.0) Retirees and beneficiaries (30.5) (24.5) (55.0) Projected APBO (65.2) (27.4) (92.6) Unamortized transition obligation 43.4 2.9 46.3 Unrecognized net loss resulting from experience different from that assumed and effects of changes in assumptions 4.4 .1 4.5 Accrued postretirement benefit obligation at December 31, 1995 $ (17.4) $(24.4) $ (41.8)\nActuarial present value of benefits Fully eligible active plan participants $ (2.2) $ (.8) $ (3.0) Other active plan participants (26.3) (1.8) (28.1) Retirees and beneficiaries (25.2) (21.7) (46.9) Projected APBO (53.7) (24.3) (78.0) Unamortized transition obligation 46.1 3.3 49.4 Unrecognized net (gain) resulting from experience different from that assumed and effects of changes in assumptions (5.2) (2.7) (7.9) Accrued postretirement benefit obligation at December 31, 1994 $ (12.8) $(23.7) $ (36.5)\nIncreasing the health care cost trend rate by one percentage point in each year would increase the APBO by approximately $12.7 million and $10.0 million for 1995 and 1994, respectively, and the aggregate of the service and interest cost components of the postretirement benefit cost for 1995 by approximately $1.0 million and each of 1994 and 1993 by approximately $1.2 million.\nPSI\nHealth Life Care Insurance Total_ (in millions) Actuarial present value of benefits Fully eligible active plan participants $ (9.0) $ (.2) $ (9.2) Other active plan participants (80.0) (.7) (80.7) Retirees and beneficiaries (68.7) (1.9) (70.6) Projected APBO (157.7) (2.8) (160.5) Unamortized transition obligation 93.7 (2.2) 91.5 Unrecognized prior service cost (.3) - (.3) Unrecognized net loss resulting from experience different from that assumed and effects of changes in assumptions 21.7 .4 22.1 Accrued postretirement benefit obligation at December 31, 1995 $ (42.6) $ (4.6) $ (47.2)\nActuarial present value of benefits Fully eligible active plan participants $ (9.2) $ (.1) $ (9.3) Other active plan participants (58.0) (.5) (58.5) Retirees and beneficiaries (66.8) (1.8) (68.6) Projected APBO (134.0) (2.4) (136.4) Unamortized transition obligation 99.1 (2.3) 96.8 Unrecognized net loss resulting from experience different from that assumed and effects of changes in assumptions 7.4 .1 7.5 Accrued postretirement benefit obligation at December 31, 1994 $ (27.5) $ (4.6) $ (32.1)\nIncreasing the health care cost trend rate by one percentage point in each year would increase the APBO by approximately $24 million and $17 million for 1995 and 1994, respectively, and the aggregate of the service and interest cost components of the postretirement benefit cost for each of 1995, 1994, and 1993 by approximately $2.4 million, $2.5 million, and $2 million, respectively.\nCinergy, CG&E, PSI, and ULH&P\nThe following assumptions were used to determine the APBO:\n1995 1994 1993 Discount rate 7.50% 8.50% 7.50%\nHealth care cost trend rate, gradually declining to 5% CG&E and subsidiaries 8.00-11.00% 9.00-12.00% 10.00-13.00% PSI 8.00-10.00 8.00-12.00 8.00-12.00\nYear ultimate trend rates achieved CG&E and subsidiaries 2002 2002 2002 PSI 2007 2007 2007\nCinergy, CG&E, and ULH&P\nThe majority of CG&E's and its subsidiaries' postretirement benefit costs are subject to PUCO jurisdiction. The PUCO has authorized CG&E to recover these costs on an accrual basis. Prior to the recovery of these health care costs in customers' rates on an accrual basis, the PUCO authorized CG&E to defer for future recovery the difference between postretirement benefit costs determined in accordance with the provisions of Statement 106 and the costs determined in accordance with CG&E's previous accounting practice. CG&E's deferrals totaled $4 million as of December 31, 1995. CG&E is requesting authorization for recovery of the gas portion of these costs in its current gas rate proceeding. CG&E will request authorization to begin recovering the electric portion of these costs in its next retail rate proceeding.\nCinergy and PSI\nIn accordance with the February 1995 Order, PSI is recovering the cost of postretirement benefits other than pensions on an accrual basis. 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 PSI's previous accounting practice was deferred for future recovery. PSI's deferrals totaled $21 million as of December 31, 1995. Commencing in February 1995, approximately $6 million of costs deferred for the period January 1, 1993, through July 31, 1993, are being recovered over a five-year period. Recovery over a five-year period of the remaining deferrals is being requested in PSI's current retail rate proceeding.\n12. Income Taxes\nCinergy, CG&E, PSI, and ULH&P\nCinergy and its subsidiaries comply with 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.\nThe significant components of each registrant's net deferred income tax liability at December 31, 1995, and 1994, are as follows:\nCinergy\n1995 1994 (in millions)\nDeferred Income Tax Liabilities Utility plant $ 981.8 $ 947.8 Unamortized costs of reacquiring debt 28.8 26.1 Deferred operating expenses and carrying costs 86.6 87.8 Amounts due from customers - income taxes 143.4 112.1 Deferred DSM costs 47.3 39.8 Other 36.4 47.2 Total deferred income tax liabilities 1 324.3 1 260.8\nDeferred Income Tax Assets Unamortized investment tax credits 67.5 70.8 Litigation settlement 29.8 29.8 Deferred fuel costs 13.0 13.1 Accrued pension and other benefit costs 41.1 33.7 Other 52.0 42.3 Total deferred income tax assets 203.4 189.7\nNet Deferred Income Tax Liability $1 120.9 $1 071.1\nCG&E\n1995 1994 (in millions)\nDeferred Income Tax Liabilities Utility plant $663.8 $639.8 Unamortized costs of reacquiring debt 14.2 10.3 Deferred operating expenses and carrying costs 76.2 76.4 Amounts due from customers - income taxes 139.8 108.5 Deferred DSM costs 5.6 2.6 Other 25.5 37.1 Total deferred income tax liabilities 925.1 874.7\nDeferred Income Tax Assets Unamortized investment tax credits 46.1 47.9 Deferred fuel costs 8.1 10.0 Accrued pension and other benefit costs 28.7 27.6 Other 46.8 42.1 Total deferred income tax assets 129.7 127.6\nNet Deferred Income Tax Liability $795.4 $747.1\nPSI\n1995 1994_ (in millions)\nDeferred Income Tax Liabilities Electric utility plant $315.7 $308.0 Unamortized costs of reacquiring debt 14.6 15.8 Deferred operating expenses and accrued carrying costs 12.5 11.4 Deferred DSM costs 41.7 37.2 Other 13.0 13.7 Total deferred income tax liabilities 397.5 386.1\nDeferred Income Tax Assets Unamortized investment tax credits 21.4 22.9 Litigation settlement 29.8 29.8 Accrued pension and other benefit costs 13.4 6.1 Other 1.0 2.6 Total deferred income tax assets 65.6 61.4\nNet Deferred Income Tax Liability $331.9 $324.7\nULH&P\n1995 1994 (in thousands)\nDeferred Income Tax Liabilities Utility plant $32 104 $30 637 Other 3 852 3 740 Total deferred income tax liabilities 35 956 34 377\nDeferred Income Tax Assets Unamortized investment tax credits 2 060 2 175 Amounts due to customers - income taxes 1 904 1 810 Deferred fuel costs 1 857 1 773 Accrued pension and other benefit costs 2 365 2 179 Other 4 042 3 214 Total deferred income tax assets 12 228 11 151\nNet Deferred Income Tax Liability $23 728 $23 226 Cinergy, CG&E, PSI, and ULH&P\nA summary of Federal and state income taxes charged (credited) to income and the allocation of such amounts is as follows:\nCinergy 1995 1994 1993 (in millions)\nCurrent Income Taxes Federal $175.3 $104.1 $ 49.1 State 10.4 6.5 1.3 Total current income taxes 185.7 110.6 50.4\nDeferred Income Taxes Federal Depreciation and other utility plant- related items 53.8 62.2 58.4 Loss related to the June 1987 Order - (5.2) 45.9 Property taxes - (13.3) (9.3) DSM costs 12.0 14.5 11.7 Write-off of a portion of Zimmer - - (11.0) Pension and other benefit costs (20.8) (12.5) (4.2) Deferred operating expenses and carrying costs (1.6) (1.6) 4.7 Other items - net (6.6) (5.4) 3.2 Total deferred Federal income taxes 36.8 38.7 99.4\nState 1.7 2.7 7.5 Total deferred income taxes 38.5 41.4 106.9\nInvestment Tax Credits - Net (10.1) (10.4) (10.3)\nTotal Income Taxes $214.1 $141.6 $147.0\nAllocated to: Operating income $219.4 $152.2 $172.6 Other income and expenses - net (5.3) (10.6) (25.6) $214.1 $141.6 $147.0\nCG&E\n1995 1994 1993 (in millions)\nCurrent Income Taxes Federal $102.4 $ 82.3 $ 61.8 State 2.5 1.5 2.0 Total current income taxes 104.9 83.8 63.8\nDeferred Income Taxes Federal Depreciation and other utility plant- related items 33.9 42.9 48.4 Property taxes - (11.3) (11.3) Unrecovered gas costs - net 3.8 (6.8) .7 Pension and other benefit costs (10.7) (8.4) (5.5) Write-off of a portion of Zimmer - - (11.0) Deferred fuel costs - net (1.3) 5.3 (4.2) Deferred operating expenses and carrying costs (1.6) (1.6) 4.7 DSM costs 3.6 1.9 1.2 Other items - net 4.4 (2.8) 6.3 Total deferred Federal income taxes 32.1 19.2 29.3\nState .8 .6 .5\nTotal deferred income taxes 32.9 19.8 29.8\nInvestment Tax Credits - Net (6.0) (6.1) (6.1)\nTotal Income Taxes $131.8 $ 97.5 $ 87.5\nAllocated to: Operating income $136.4 $104.1 $109.0 Other income and expenses - net (4.6) (6.6) (21.5) $131.8 $ 97.5 $ 87.5 PSI\n1995 1994 1993 (in millions)\nCurrent Income Taxes Federal $71.4 $22.0 $ .6 State 7.5 5.5 .4 Total current income taxes 78.9 27.5 1.0\nDeferred Income Taxes Federal Depreciation and other electric utility plant-related items 19.9 19.2 9.6 Loss related to the June 1987 Order - (5.2) 45.9 Property taxes - (2.0) 2.0 DSM costs 8.4 12.6 10.6 Pension and other benefit costs (10.1) (1.8) - Deferred fuel costs - net (6.0) .7 (1.8) Other items - net (4.0) 2.8 (.9) Total deferred Federal income taxes 8.2 26.3 65.4\nState 1.1 2.2 7.0 Total deferred income taxes 9.3 28.5 72.4\nInvestment Tax Credits - Net (4.1) (4.3) (4.2)\nTotal Income Taxes $84.1 $51.7 $69.2\nAllocated to: Operating income $85.0 $50.4 $64.9 Other income and expenses - net (.9) 1.3 4.3 $84.1 $51.7 $69.2 ULH&P 1995 1994 1993 (in thousands)\nCurrent Income Taxes Federal $5 955 $2 746 $3 580 State 1 324 498 1 126 Total current income taxes 7 279 3 244 4 706\nDeferred Income Taxes Federal Depreciation and other utility plant- related items 1 382 1 727 1 664 Unrecovered gas costs - net (277) (741) 575 Pension and other benefit costs (381) (349) (329) Deferred fuel costs - net (257) 764 (685) Unamortized costs of reacquiring debt 808 - - Other items - net (556) 280 (147) Total deferred Federal income taxes 719 1 681 1 078\nState Depreciation and other utility plant- related items 390 656 431 Other items - net (172) (8) (222) Total deferred state income taxes 218 648 209\nTotal deferred income taxes 937 2 329 1 287\nInvestment Tax Credits - Net (285) (287) (288)\nTotal Income Taxes $7 931 $5 286 $5 705\nAllocated to: Operating income $7 887 $5 342 $5 751 Other income and expenses - net 44 (56) (46) $7 931 $5 286 $5 705\nCinergy, CG&E, PSI, and ULH&P\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 Statements of Income for each registrant as follows:\nCinergy 1995 1994 1993 (in millions)\nStatutory Federal income tax provision $191.2 $109.8 $ 68.1 Increases (Reductions) in taxes resulting from: Amortization of investment tax credits (10.1) (10.4) (10.0) Depreciation and other utility plant- related differences 9.0 13.5 13.1 Preferred dividend requirements of subsidiaries 10.8 12.4 13.3 AFUDC equity (.6) (2.2) (5.0) Phase-in deferred return (.6) (3.1) (7.2) Write-off of a portion of Zimmer - - 69.4 Other - net 2.3 12.4 (3.5) Federal income tax expense $202.0 $132.4 $138.2\nCG&E\nStatutory Federal income tax provision $121.4 $81.0 $17.9 Increases (Reductions) in taxes resulting from: Amortization of investment tax credits (6.0) (6.1) (5.8) Depreciation and other utility plant- related differences 9.0 8.2 6.9 Preferred dividends 6.2 7.8 8.8 AFUDC equity (.6) (.7) (1.1) Phase-in deferred return (.6) (3.1) (7.2) Write-off of a portion of Zimmer - - 69.4 Other - net (.9) 8.3 (3.9) Federal income tax expense $128.5 $95.4 $85.0\nPSI 1995 1994 1993 (in millions)\nStatutory Federal income tax provision $77.5 $44.2 $65.3 Increases (Reductions) in taxes resulting from: Amortization of investment tax credits (4.1) (4.3) (4.2) Depreciation and other electric utility plant-related differences - 1.8 4.1 AFUDC equity - (1.5) (3.9) Other - net 2.1 3.8 .5 Federal income tax expense $75.5 $44.0 $61.8\nULH&P 1995 1994 1993 (in thousands)\nStatutory Federal income tax provision $6 496 $4 385 $4 798 Increases (Reductions) in taxes resulting from: Amortization of investment tax credits (285) (287) (288) Depreciation and other utility plant- related differences 219 138 108 AFUDC equity (25) (27) (104) Other - net (16) (69) (144) Federal income tax expense $6 389 $4 140 $4 370\n13. Commitments and Contingencies\n(a) Construction and Other Expenditures\nCinergy, CG&E, PSI, and ULH&P\nCinergy and its subsidiaries will have commitments in connection with their forecasted construction programs. Aggregate expenditures for Cinergy's construction program for the 1996 through 2000 period are currently forecasted to be $2.1 billion. Of these projected expenditures, approximately $1.1 billion relates to CG&E, including $102 million for ULH&P, and $1.0 billion relates to PSI.\nCinergy and PSI\nIn November 1995, a 25-year contractual agreement between PSI and Destec Energy, Inc. (Destec) for the provision of coal gasification services began upon commercial operation of the Clean Coal Project. The agreement requires PSI to pay Destec a base monthly fee including certain monthly operating expenses. Over the next five years (1996 through 2000), the fixed component of the base monthly fee is expected to total $63 million, and the variable expenses are estimated at $105 million in nominal dollars. PSI's currently pending retail rate increase request includes recovery of the operating costs, including gasification services, associated with the Clean Coal Project. PSI received authorization in the February 1995 Order to defer for future recovery the costs incurred prior to the order in its current retail rate proceeding.\n(b) MGP Sites\nCinergy, CG&E, PSI, and ULH&P\n(i) General Prior to the 1950s, gas was produced at MGP sites through a process that involved the heating of coal and\/or oil. The gas produced from this process was sold for residential, commercial, and industrial uses.\nCinergy and PSI\n(ii) PSI Coal tar residues, related hydrocarbons, and various metals associated with MGP sites have been found at former MGP sites in Indiana, including, but not limited to, Shelbyville and Lafayette, two sites previously owned by PSI. PSI has identified at least 21 MGP sites which it previously owned, including 19 it sold in 1945 to IGC, including the Shelbyville and Lafayette sites. IGC has informed PSI of the basis for its claim that PSI, as a PRP under the CERCLA, should contribute to IGC's response costs related to investigating and remediating contamination at MGP sites which PSI sold to IGC.\nThe Shelbyville site has been the subject of an investigation and cleanup enforcement action by the IDEM against IGC and PSI. Without admitting liability, PSI and IGC have conducted an investigation and remedial activities at the Shelbyville site. PSI and IGC are sharing the costs of the Shelbyville site, and based upon environmental investigations and remediation completed to date, PSI believes that any further required investigation and remediation for this site will not have a material adverse effect on its financial condition or results of operations.\nIn 1992, the IDEM issued an order to IGC, naming IGC as a PRP as defined in the 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 that site.\nDuring 1995, PSI received notification from NIPSCO alleging PSI is a PRP under the CERCLA with respect to contamination associated with MGP sites previously owned and\/or operated by both PSI and NIPSCO (or their predecessors). The notification included seven sites, five of which PSI acquired from NIPSCO and subsequently sold to IGC.\nPSI has placed its insurance carriers on notice of IGC's and NIPSCO's claims.\nIGC and PSI have entered into discussions regarding IGC's claim; however, with the exception of the Shelbyville site, PSI has not assumed any responsibility to reimburse IGC or NIPSCO for their costs of investigating and remediating MGP sites. It is premature, at this time, to predict the nature, extent, and ultimate costs of, or PSI's responsibility for, environmental investigations and remediations at MGP sites owned or previously owned by PSI. Information available to PSI regarding the current status of investigation and\/or remediation at the sites identified in IGC's claim indicates PSI's potential exposure to probable and reasonably estimable liabilities associated with these MGP sites would not be material to its financial condition or results of operations. However, further investigation and remediation activities at these sites and the additional sites identified in NIPSCO's claim may indicate that the potential liability for MGP sites could be material.\nIn May 1995, the IURC denied IGC's request for recovery of costs incurred in complying with Federal, state, and local environmental regulations related to MGP sites in which IGC has an interest, including sites acquired from PSI. IGC has appealed this decision, which IGC contends is contrary to decisions made by other state utility commissions with respect to this issue. In August 1995, the IURC granted PSI's motion to establish a sub-docket to PSI's pending retail rate proceeding to consider its request for rate recovery of any MGP site-related costs it may incur. PSI is unable to predict the extent to which it will be able to recover through rates any MGP costs ultimately incurred.\nCinergy, CG&E, and ULH&P\n(iii) CG&E and its Utility Subsidiaries Lawrenceburg also has an MGP site. In May 1995, Lawrenceburg and the IDEM reached an agreement to include the Lawrenceburg MGP site in the IDEM's voluntary cleanup program. Lawrenceburg is currently implementing a remediation plan, and total cleanup costs are not expected to exceed amounts previously accrued of $400,000.\nCG&E and its utility subsidiaries are aware of other potential sites where MGP activities may have occurred at some time in the past. None of these sites is known to present a risk to the environment. Except for the Lawrenceburg site, neither CG&E nor its utility subsidiaries have undertaken responsibility for investigating other potential MGP sites.\nCinergy and CG&E\n(c) United Scrap Lead Site The EPA alleges that CG&E is a PRP under the CERCLA liable for cleanup of the United Scrap Lead site in Troy, Ohio. CG&E was one of approximately 200 companies so named. CG&E believes it is not a PRP and should not be responsible for cleanup of the site. Under the CERCLA, CG&E could be jointly and severally liable for costs incurred in cleaning up the site, estimated by the EPA to be $27 million, of which CG&E estimates its portion to be immaterial to its financial condition or results of operations.\nCinergy, CG&E, and PSI\n(d) Power International Litigation On October 25, 1995, a suit was filed in the Federal District Court for the Southern District of Ohio by three former employees of Power International, a subsidiary of Investments, naming as defendants Power International, Cinergy, Investments, CG&E, PSI, James E. Rogers, and William J. Grealis. (Mr. Rogers and\/or Mr. Grealis are officers and\/or directors of the foregoing companies.) The lawsuit, which stems from the termination of employment of the three former employees, alleges that they entered into employment contracts with Power International based on the opportunity to participate in potential profits from future investments in energy projects in central and eastern Europe. The suit alleges causes of action based upon, among other theories, breach of contract related to the events surrounding the termination of their employment and fraud and misrepresentation related to the level of financial support for future projects. The suit alleges compensatory damages of $154 million based upon assumed future success of potential future investments and punitive damages of three times that amount. All defendants intend to defend vigorously against the charges based upon meritorious defenses. Cinergy, CG&E, and PSI are currently unable to predict the outcome of this litigation. Cinergy and PSI\n(e) WVPA Litigation In 1984, WVPA discontinued payments to PSI for its 17% share of Marble Hill, a nuclear project jointly owned by PSI and WVPA which was canceled by PSI in 1984, and filed suit against PSI 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 PSI 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 PSI and the other defendants.\nIn 1985, PSI and WVPA entered into an agreement under which PSI 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, PSI 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:\nPSI, on behalf of itself and its officers, will pay $80 million on behalf of WVPA to RUS and the CFC. The $80 million obligation, net of insurance proceeds, other credits, and applicable income tax effects, was charged to income in 1988 and 1989.\nWVPA will transfer its 17% ownership interest in the site to PSI, and PSI will assume responsibility for all future costs associated with the site, excluding WVPA's 17% share of future salvage program expenses. Additionally, RUS and the CFC will receive the balance in the salvage escrow account and 17% of future salvage proceeds, net of related salvage program expenses.\nPSI 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 PSI'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 PSI, on behalf of itself and its officers, to RUS and the 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, PSI must do so within 60 days. The settlement provides that in the event PSI is party to a merger or acquisition, PSI 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, PSI will record a $90 million regulatory asset. Concurrently, a $90 million obligation to RUS and the 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 the 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, and on December 28, 1995, the Seventh Circuit Court of Appeals affirmed the decision of the Indiana District Court. PSI cannot predict whether RUS will appeal this decision to the U.S. Supreme Court, and if appealed, the outcome of such 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, 1997, either party may terminate the settlement agreement. (See Note 17 for an event subsequent to the date of the auditor's report.)\nCinergy, CG&E, and ULH&P\n(f) Potential Divestiture of Gas Operations Under the PUHCA, the divestiture of CG&E's, including ULH&P's, gas operations may be required. In its order approving the merger, the SEC reserved judgment over Cinergy's ownership of the gas operations for a period of three years. However, in June 1995, the SEC endorsed recommendations for reform\/repeal of the PUHCA, including allowing registered holding companies to own combination electric and gas utility companies, provided the affected states agree. In addition, legislation providing for the repeal of the PUHCA is currently pending before Congress.\nRegardless of the outcome of the proposals to reform\/repeal the PUHCA, Cinergy believes it has a justifiable basis for retention of its gas operations and will continue its pursuit of SEC approval. If divestiture is ultimately required, the SEC has historically allowed companies sufficient time to accomplish divestitures in a manner that protects shareholder value. See Note 16 for financial information by business segment.\nCinergy, CG&E, PSI, and ULH&P\n(g) 1996 Voluntary Workforce Reduction Program In January 1996, Cinergy announced a voluntary workforce reduction program which provides enhanced retirement and\/or severance benefits to eligible employees. There are 840 employees who meet certain age and service requirements and are potentially eligible for enhanced retirement benefits under this program. Eligible employees who do not meet age and service requirements would receive severance benefits upon resignation from their employment. Program costs will not be known until after the participation election period ends on May 15, 1996. Cinergy intends to classify these costs as costs to achieve merger savings which, consistent with the merger savings sharing mechanisms previously approved by regulators, will result in the portion of these costs allocable to Ohio electric jurisdictional customers (approximately 38%) being charged to earnings in the second quarter of 1996, and the remaining costs allocable to other jurisdictions being deferred for future recovery through rates as an offset against merger savings. (See Note 1(i).) A significant portion of these benefits will be eligible for funding from qualified retirement plan assets.\nCinergy, CG&E, and PSI\n14. Jointly Owned Plant\nPSI is a joint owner of Gibson Unit 5 with WVPA and IMPA. Additionally, PSI 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 PSI. CG&E, Columbus Southern Power Company, and The Dayton Power and Light Company have constructed electric generating units and related transmission facilities on varying common ownership bases. The Consolidated Statements of Income reflect PSI's and CG&E's portions of all operating costs associated with the commonly owned facilities.\nPSI's and CG&E's investments in jointly owned plant are as follows:\n15. Quarterly Financial Data (unaudited)\nCinergy\nNet Earnings Operating Operating Income (Loss) Quarter Ended Revenues Income (Loss) Per Share (in millions, except per share amounts)\nMarch 31 $ 809 $161 $102 $ .65 June 30 668 120 60 .39 September 30 768 168 109 .69 December 31 786 133 76 .49 Total $3 031 $582 $347 $2.22\nMarch 31 $ 851 $155 $ 99 $ .68 June 30 662 106 49 .33 September 30 692 118(a) 58 (a) .40 (a) December 31 693 61(a) (15)(a) (.11)(a) Total $2 898 $440 $191 $1.30\n(a) In 1994, Cinergy recognized charges to earnings of approximately $79 million ($56 million, net of taxes) or 38 cents per share primarily for certain merger-related and other expenditures which cannot be recovered from customers under the merger savings sharing mechanisms authorized by regulators. Of these charges, approximately $46 million, net of taxes (31 cents per share), was recognized in the fourth quarter, and approximately $8 million, net of taxes (5 cents per share), was recognized in the third quarter. The charges include the PUCO electric jurisdictional portion of Merger Costs incurred through December 31, 1994, previously capitalized information systems development costs, and severance benefits to former officers of CG&E and PSI. Of the total $79 million charge, $62 million is reflected in \"Operating Expenses - Other operation\" and $17 million is reflected in \"Other Income and Expenses - Net\".\nCG&E\nNet Operating Operating Income Quarter Ended Revenues Income (Loss) (in millions)\nMarch 31 $ 525 $109 $ 77 June 30 393 71 40 September 30 435 98 69 December 31 495 82 50 Total $1 848 $360 $236\nMarch 31 $ 563 $106 $ 76 June 30 391 70 39 September 30 409 81 (a) 48 (a) December 31 425 34 (a) (5)(a) Total $1 788 $291 $158\n(a) In 1994, CG&E recognized charges to earnings of approximately $64 million ($46 million, net of taxes) primarily for certain merger-related and other expenditures which cannot be recovered from customers under the merger savings sharing mechanism authorized by the PUCO. Of these charges, approximately $39 million, net of taxes, was recognized in the fourth quarter and approximately $7 million, net of taxes, was recognized in the third quarter. The charges include the PUCO electric jurisdictional portion of Merger Costs incurred through December 31, 1994, previously capitalized information systems development costs, and severance benefits to former officers of CG&E. Of the total $64 million charge, $52 million is reflected in \"Operating Expenses - Other operation\" and $12 million is reflected in \"Other Income and Expenses - Net\".\nPSI\nNet Operating Operating Income Quarter Ended Revenues Income (Loss) (in millions)\nMarch 31 $ 299 $ 53 $ 33 June 30 290 49 29 September 30 343 70 50 December 31 316 55 34 Total $1 248 $227 $146\nMarch 31 $ 288 $ 48 $ 35 June 30 272 37 19 September 30 284 38 20 December 31 270 29 (a) 8 (a) Total $1 114 $152 $ 82\n(a) In the fourth quarter of 1994, PSI recognized a charge to earnings of approximately $10 million ($6 million, net of taxes) for severance benefits to former officers of PSI which cannot be recovered from customers under the merger savings sharing mechanism authorized by the IURC. The total $10 million charge is reflected in \"Operating Expenses - Other operation\".\n16. Financial Information by Business Segment\nCinergy Operating Operating Operating Income Provision for Construction Year Ended Revenues Income Taxes Depreciation Expenditures (in millions) Electric $2 620 $543 $207 $258 $286 Gas 411 39 12 22 36 Total $3 031 $582 $219 $280 $322\nElectric $2 456 $412 $144 $274 $432 Gas 442 28 8 20 42 Total $2 898 $440 $152 $294 $474\nElectric $2 374 $450 $166 $261 $517 Gas 469 33 7 18 45 Total $2 843 $483 $173 $279 $562\nDecember 31 1995 1994 1993_ (in millions) Property, Plant, and Equipment - net Electric $5 719 $5 680 $5 519 Gas 532 519 504 6 251 6 199 6 023 Other Corporate Assets 1 969 1 951 1 781 Total Assets $8 220 $8 150 $7 804\nFor a discussion of the potential divestiture of CG&E's, including ULH&P's, gas operations, see Note 13(f).\nCG&E Operating Operating Operating Income Provision for Construction Year Ended Revenues Income Taxes Depreciation Expenditures (in millions) Electric $1 437 $321 $124 $137 $101 Gas 411 39 12 22 36 Total $1 848 $360 $136 $159 $137\nElectric $1 346 $263 $ 96 $137 $138 Gas 442 28 8 20 42 Total $1 788 $291 $104 $157 $180\nElectric $1 283 $287 $102 $134 $157 Gas 469 33 7 18 45 Total $1 752 $320 $109 $152 $202 CG&E Continued\nDecember 31 1995 1994 1993_ (in millions) Property, Plant, and Equipment - net Electric $3 244 $3 277 $3 282 Gas 532 519 504 3 776 3 796 3 786 Other Corporate Assets 1 401 1 386 1 358 Total Assets $5 177 $5 182 $5 144\nFor a discussion of the potential divestiture of CG&E's, including ULH&P's, gas operations, see Note 13(f).\nULH&P\nOperating Operating Operating Income Provision for Construction Year Ended Revenues Income Taxes Depreciation Expenditures (in thousands) Electric $187 180 $11 425 $4 500 $ 6 679 $10 909 Gas 70 288 8 405 3 387 4 759 8 063 Total $257 468 $19 830 $7 887 $11 438 $18 972\nElectric $177 564 $ 9 736 $3 007 $ 6 213 $12 127 Gas 71 971 6 654 2 335 4 431 8 277 Total $249 535 $16 390 $5 342 $10 644 $20 404\nElectric $175 712 $ 9 821 $3 078 $ 5 798 $16 291 Gas 75 744 8 115 2 673 4 015 8 133 Total $251 456 $17 936 $5 751 $ 9 813 $24 424\nDecember 31 1995 1994 1993 (in thousands)\nProperty, Plant, and Equipment - net Electric $138 482 $134 508 $130 054 Gas 104 749 102 340 98 445 243 231 236 848 228 499 Other Corporate Assets 56 566 50 280 57 546 Total Assets $299 797 $287 128 $286 045\nFor a discussion of the potential divestiture of ULH&P's gas operations, see Note 13(f).\n17. Subsequent Events (unaudited)\n(a) PSI's Current Retail Rate Proceeding In connection with the filing of its proposed retail rate order with the IURC in March 1996, PSI reduced its requested retail rate increase to 10.3% ($102.9 million annually) from 11.2% ($111.2 million annually). (See Note 2(a).)\n(b) WVPA Litigation RUS has requested a rehearing by the Seventh Circuit Court of Appeals. PSI cannot predict the disposition of the rehearing request or whether RUS will appeal an unfavorable decision to the U.S. Supreme Court, and in the event of such an appeal, the outcome of such appeal. (See Note 13(e).)\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nCinergy, CG&E, PSI, and ULH&P\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANTS\nBoard of Directors\nCinergy\nReference is made to Cinergy's 1996 Proxy Statement with respect to identification of directors and their current principal occupations.\nCG&E\nThe directors of CG&E at February 29, 1996, included:\nJackson H. Randolph Mr. Randolph, age 65, is Chairman of CG&E. He has served as a director of CG&E since 1983, and his current term as director expires April 25, 1996.\nJames E. Rogers Mr. Rogers, age 48, is Vice Chairman and Chief Executive Officer of CG&E. He has served as a director of CG&E since October 24, 1994, and his current term as director expires April 25, 1996.\nWilliam J. Grealis Mr. Grealis, age 50, is President of CG&E. He has served as a director of CG&E since September 1, 1995, and his current term expires April 25, 1996.\nPSI\nReference is made to PSI's 1996 Information Statement with respect to identification of directors and their current principal occupations.\nULH&P\nOmitted pursuant to Instruction J(2)(c).\nExecutive Officers\nCinergy, CG&E, and PSI\nThe information included in Part I of this report on pages 21 through 23 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.\nULH&P\nOmitted pursuant to Instruction J(2)(c).\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nCinergy\nReference is made to Cinergy's 1996 Proxy Statement with respect to executive compensation.\nCG&E\nBoard Compensation Committee Report on Executive Compensation\nThe executive compensation program of Cinergy and its subsidiaries is administered by the Compensation Committee of Cinergy's Board of Directors (the \"Committee\"). The Committee establishes the compensation philosophy and the compensation of the chief executive officer and all other executive officers of Cinergy and its subsidiaries. The Committee also recommends and administers compensation plans for all executive officers and key employees. The Committee is composed of Messrs. Van P. Smith (Chairman), Michael G. Browning, George C. Juilfs, and John J. Schiff, Jr., each of whom is an independent, non-employee director (of Cinergy), and an \"outside director\" (of Cinergy) within the meaning of Section 162(m) of the Internal Revenue Code of 1986, as amended (the \"Code\").\nCompensation Philosophy\nThe Committee reported in Cinergy's 1995 proxy statement that although its executive compensation philosophy was developing, it expressed an intent to emphasize incentive compensation, both short-term and long-term, in order to tie the interests of the executive officers and Cinergy's shareholders. At that time, the Committee anticipated that base salary, annual cash incentives, and long-term incentives would play an integral part in Cinergy's executive compensation program.\nWith assistance from an independent compensation and benefits consulting firm which conducted a study of existing executive compensation program structures, the Committee has formulated an integrated executive compensation philosophy which includes base salary, and annual and long-term incentives. The consulting firm has also advised as to the retention, modification or replacement of certain existing compensation and benefits plans and as to plan design generally.\nCinergy and its subsidiaries seek to provide a total compensation program that will attract, retain, and motivate the high quality employees needed to provide superior service to its customers and to maximize returns to its shareholders. Base salaries for the executive group will be targeted at the median of comparably sized utility companies based on kilowatt hours sold. Because of the low-cost position of Cinergy and its subsidiaries, kilowatt hours sold is considered to be a better size measure than revenues for constructing a comparator group. Base salary levels will be reviewed annually. Salary increases will be based on such factors as corporate financial results, each individual's performance, and the executive's role and skills. The executive compensation program seeks to link executive and shareholder interests through cash-based and equity-based incentive plans, in order to reward corporate and individual performance and balance short-term and long-term considerations. Thus, annual and long-term incentive plans will be structured to provide opportunities that are competitive with general industry companies.\nThis philosophy will result in a compensation mix for the chief executive officer and senior officers, including executive officers, consisting of annual incentive and long-term incentives that will account for at least 50% of the employee's total compensation.\nDuring 1995, the Committee adopted a charter which supports Cinergy's executive compensation philosophy and the Committee's role in designing and implementing that philosophy. Pursuant to the charter, the Committee:\n- - reviews and determines the annual base salaries, annual incentives, and long-term incentives of the executive officers of Cinergy and its subsidiaries, and develops an appropriate balance between short-term and long- term incentives while focusing on long-term shareholder interests; and\n- - reviews the operation of the executive compensation programs; establishes and periodically reviews policies for the administration of these programs; and takes steps, if appropriate, to modify such programs and to design and implement new executive compensation programs.\nConsistent with its charter and its executive compensation philosophy, the Committee has reviewed Cinergy's existing short-term and long-term incentive plans and has concluded that it would be in the best interests of Cinergy and its shareholders to modify the Annual Incentive Plan and to adopt a new long- term incentive compensation plan.\nUnder the proposed amendment to the Annual Incentive Plan, the maximum award opportunity for \"covered employees\", as that term is defined in Code Section 162(m), would be one million dollars. Currently, the maximum award is 75% of annual base salary. Expressing the maximum possible award for covered employees in this manner is consistent with regulations issued by the Internal Revenue Service (the \"IRS\") in December, 1995.\nThe proposed 1996 Long-Term Incentive Compensation Plan would allow Cinergy flexibility to design long-term incentive compensation programs which will help achieve its goals. The adoption of this plan is subject to approval by Cinergy's shareholders. The 1996 Long-Term Incentive Compensation Plan is intended, in part, to replace Cinergy's Performance Shares Plan.\nAnnual Incentive Plan\nFor 1995, executive officers were eligible for incentives under Cinergy's Annual Incentive Plan. Approximately 400 key employees participated in the plan in 1995 and were granted cash awards to the extent that certain pre- determined corporate and individual goals were attained during that year. Graduated standards for achievement were developed to encourage each employee's contribution. The potential awards ranged from 2.5% to 55% of the annual salary of the participant (including deferred compensation), depending upon the achievement levels and the participant's position. The Committee reviewed and approved both the plan goals at the beginning of the year and the achievements at the end of the year.\nFor 1995, the Annual Incentive Plan used a combination of corporate and individual goals. Achievement of corporate goals and achievement of individual goals each accounted for 50% of the total possible award. The portion of the payout in March, 1996, attributable to the corporate goals was based on 1995 achievement in two areas: (1) earnings per share; and (2) non- fuel operation and maintenance merger savings. The earnings per share goal accounted for 37.5% and the merger savings goal constituted 12.5% of the total possible award. The achievement level for each of the corporate goals was at the maximum award level for 1995.\nIn 1995, incentive awards for each executive officer reflected individual achievement as well as Cinergy's attainment of its corporate goals. Individual performance goals for each executive varied from executive to executive; however, all related to the achievement of Cinergy's overall strategic vision of becoming a premier general energy services company.\nFor each executive officer, the Committee assessed the extent to which each person contributed toward the accomplishment of Cinergy's vision in 1995. Although its determinations were subjective, the Committee believed that its assessment accurately measured the performance of each executive officer. Based upon the extraordinary efforts of the executive officers in 1995, the Committee determined that a maximum award was payable to each.\nFor 1996, Cinergy's Annual Incentive Plan will again use a combination of corporate and individual goals. The corporate goal will account for 50% of the total possible award and achievement of individual goals will account for the remaining 50%. The corporate goal for 1996 will be based on earnings per share. For 1996, approximately 400 key employees will participate in the plan. The potential awards will range from 2.5% to 90% of the participant's annual salary, depending upon the achievement levels and the participant's position.\nOther Compensation Decisions\nThe Committee, at its discretion, can award other forms of compensation in recognition of outstanding service to Cinergy or any of its subsidiaries. Consistent with that philosophy, the Committee approved in 1995 special performance awards for Messrs. Leonard and Thomas and Ms. Foley for exemplary performance associated with consummation of the corporate reorganization resulting in the formation of Cinergy (as set forth in footnotes to the Summary Compensation Table).\nLong-Term Incentive Plan and Stock Option Plan\nCinergy's Performance Shares Plan (the \"Performance Shares Plan\") is a long- term incentive plan developed to reward officers and other key employees for contributing to long-term success by achieving corporate and individual goals approved by the Committee. The executive officers named in the compensation tables participate in this plan, and the same corporate and individual goals used in Cinergy's Annual Incentive Plan are applicable to this plan. The potential award opportunities are established in the same manner as the Annual Incentive Plan, with the minimum award opportunities ranging from 13.33% to 36.66% of annual salary for the full performance cycle. Performance cycles consist of overlapping four year periods. Because the former Resources' performance shares plan was merged into the Performance Shares Plan effective as of October 24, 1994, the then existing Resources performance cycles of 1992-1995 and 1994-1997 became performance cycles under the Performance Shares Plan. Awards earned under the 1992-1995 performance cycle by executive officers are paid in two installments: one-half of the award was paid in February, 1996, and the remaining portion will be paid in February, 1997. The dollar value of the awards to Messrs. Rogers, Leonard, and Thomas and Ms. Foley, paid in February 1995 and earned under the 1990-1993 performance cycle, are set forth in the Summary Compensation Table. The next overlapping four year performance cycle under the Performance Shares Plan began January 1, 1996 and will end December 31, 1999. As mentioned previously, the 1996 Long-Term Incentive Compensation Plan is intended, in part, to replace the Performance Shares Plan; the details of the transition have yet to be determined.\nCinergy's executive officers and other key employees are also eligible for grants under Cinergy's Stock Option Plan in amounts determined to be appropriate by the Committee. The plan is designed to align executive compensation with shareholder interests. Both non-qualified and incentive stock options have been granted under the plan. Options vest at the rate of 20% per year over a five-year period from the date of grant and may be exercised over a 10-year term.\nChief Executive Officer\nMr. Randolph's 1995 base salary was determined pursuant to an employment agreement with Cinergy dated December 11, 1992, as amended and restated effective October 24, 1994 (see Employment Agreements and Severance Arrangements discussed further herein). For 1995, Mr. Randolph also earned incentive compensation under the Annual Incentive Plan in the amount of $321,750, of which 50% was based on achievement of corporate goals and 50% was based upon the Committee's determination of his achievement of individual goals.\nMr. Rogers' 1995 base salary was determined pursuant to an employment agreement with Cinergy dated December 11, 1992, as amended and restated effective July 2, 1993 (see Employment Agreements and Severance Arrangements discussed further herein). For 1995, Mr. Rogers also earned incentive compensation under the Annual Incentive Plan in the amount of $321,750, of which 50% was based on achievement of corporate goals and 50% was based upon the Committee's determination of his achievement of individual goals.\nGiving consideration to the accomplishments of 1995 leading to a total return to Cinergy shareholders of 39.1% and an increase in earnings per share of 17%, the latter adjusted for the effects of weather and non-recurring items, sufficient goals were met to obtain the maximum award available. Other goals pertaining to budgeting, reengineering, development of a comprehensive human resource strategy, enhancement of top management team effectiveness, and elevation of Cinergy's impact in community involvement were also met. The relative importance in meeting these goals was equal in the determination of awards.\nSummary\nThe Committee has established its executive compensation philosophy which emphasizes incentive compensation, both short-term and long-term, in order to tie the interests of the executive officers and shareholders. Base salary, annual cash incentives, and long-term incentives are an integral part of executive compensation. The Committee has determined that the Annual Incentive Plan should be modified to increase the maximum amount which can be awarded under that plan to \"covered employees\" under Code Section 162(m), and that the proposed 1996 Long-Term Incentive Compensation Plan is needed to provide flexibility in designing competitive long-term incentive programs in order to attract and retain qualified and highly motivated executive employees in the future.\nThe 1993 Omnibus Budget Reconciliation Act (\"OBRA\") became law in August, 1993, for compensation earned in 1994 and later. Under the law, income tax deductions of publicly traded companies may be limited to the extent total compensation for certain executive officers exceeds one million dollars in any one year. Under OBRA, the deduction limit does not apply to payments which qualify as \"performance based\" or compensation which is payable under a written contract that was in effect before February 17, 1993. The Committee has reviewed the final regulations issued by the IRS and will continue to review the application of these rules to future compensation; however, the Committee intends to compensate executives on performance achieved, both corporate and individual. Summary Compensation Table\nThe following table sets forth the compensation of Messrs. Rogers and Randolph, each of whom served as chief executive officer at different periods during 1995, and each of the additional four most highly compensated executive officers (these six executive officers sometimes hereinafter collectively referred to as the \"named executive officers\") for services to Cinergy and its subsidiaries, including CG&E, during the calendar years ended December 31, 1995, 1994, and 1993. (The data presented includes, for Mr. Randolph compensation from CG&E, and for the remaining named executive officers compensation from PSI, for the periods prior to October 24, 1994.)\nOption\/SAR Grants Table\nThe following table sets forth information concerning options to purchase Cinergy common stock granted to Mr. Grealis, the only named executive officer granted such options during 1995.\nAggregated Option\/SAR Exercises and Year-End Option\/SAR Value Table\nThe following table sets forth information concerning stock options exercised by the named executive officers during 1995, including the values realized for such options exercised, which represent the positive spread between the respective exercise prices and market prices on dates of exercises, and the numbers of shares for which options were held as of December 31, 1995, including the values for \"in-the-money\" options, which represent the positive spread between the respective exercise prices of outstanding stock options and the market price of the shares of Cinergy common stock as of December 31, 1995, which was $30.625 per share.\nLong-Term Incentive Plan Awards Table\nThe following table sets forth the potential payouts of an award contingently granted under the Performance Shares Plan to Mr. Grealis, the only named executive officer granted such award during 1995.\nPension Benefits\nThe primary pension benefits payable at retirement to each of the named executive officers are provided pursuant to the terms of either CG&E's non- contributory management pension plan (the \"CG&E Pension Plan\") or PSI's non- contributory pension plan (the \"PSI Pension Plan\"). Mr. Randolph is covered under the terms of the CG&E Pension Plan. Messrs. Rogers, Grealis, Leonard, and Thomas and Ms. Foley are covered under the terms of the PSI Pension Plan.\nUnder the terms of the CG&E Pension Plan, the retirement income payable to a pensioner is 1.3% of final average pay plus 0.35% of final average pay in excess of covered compensation, times the number of years of credited service through 30 years, plus 0.1% of final average pay times the number of years of credited service over 30 years. Final average pay is the average annual salary, based on July 1 pay rates, during the employee's five consecutive calendar years producing the highest such average within the last ten calendar years immediately preceding retirement. The IRS annually establishes a dollar limit, indexed to inflation, of the amount of pay permitted for consideration under the terms of the plan, which for 1995 was $150,000. Covered compensation is the average social security taxable wage base over a 35-year period. The accrued annual benefit payable to Mr. Randolph upon his retirement under the terms of the plan is $106,211 based upon IRS limits and credited service of 37 years.\nCinergy and Mr. Randolph have entered into an Amended and Restated Supplemental Executive Retirement Income Agreement which in effect freezes as of December 31, 1994, the accrual of benefits payable to Mr. Randolph under CG&E's Supplemental Executive Retirement Plan upon his retirement, death, or disability. Under the amended agreement, the annual supplemental retirement benefit of $511,654 shall be paid to Mr. Randolph or his beneficiary in monthly installments of $42,638 for 180 months beginning December 1, 2000.\nThe PSI Pension Plan covers all of its employees who meet certain minimum age and service requirements. Compensation utilized to determine benefits under the PSI Pension Plan includes substantially all salaries and annual incentive compensation, including deferred compensation for Mr. Rogers. PSI Pension Plan benefits are determined under a final average pay formula with consideration of years of service to a maximum of 30, age at retirement and the applicable average social security wage base. PSI also maintains an Excess Benefit Plan which is designed to restore pension benefits to those individuals whose benefits under the PSI Pension Plan would otherwise exceed the limits imposed by the Code. Each of the named executive officers, with the exception of Mr. Randolph, participates in the Excess Benefit Plan.\nThe following pension plan table illustrates the estimated annual benefits payable as a straight-life annuity under both plans to participants who retire at age 62. Such benefits are not subject to any deduction for social security or other offset amounts.\nYears of Service Compensation 5 10 15 20 25 30 $ 300,000 $23,190 $ 46,380 $ 69,575 $ 92,765 $115,955 $139,145 400,000 31,190 62,380 93,575 124,765 155,955 187,145 500,000 39,190 78,380 117,575 156,765 195,955 235,145 600,000 47,190 94,380 141,575 188,765 235,955 283,145 700,000 55,190 110,380 165,575 220,765 275,955 331,145 800,000 63,190 126,380 189,575 252,765 315,955 379,145 900,000 71,190 142,380 213,575 284,765 355,955 427,145 1,000,000 79,190 158,380 237,575 316,765 395,955 475,145 1,100,000 87,190 174,380 261,575 348,765 435,955 523,145\nThe estimated credited years of service at age 62 for each of the named executive officers covered under the terms of the PSI Pension Plan are as follows: Mr. Rogers, 20.22 years; Mr. Grealis, 11.69 years; Mr. Leonard, 30 years; Mr. Thomas, 30 years; and Ms. Foley, 19.22 years.\nMessrs. Rogers and Grealis and Ms. Foley also participate in the PSI Supplemental Retirement Plan, which is designed to provide coverage to employees, previously designated by the board of directors of PSI, who will not otherwise qualify for full retirement benefits under the PSI Pension Plan. The benefit provided by the PSI Supplemental Retirement Plan will be an amount equal to that which a covered employee with maximum permitted years of participation (30 years) would have received under the PSI Pension Plan, reduced by the actual benefit provided by the PSI Pension Plan and the Excess Benefit Plan, and further reduced by benefits the covered employee will be eligible to receive from retirement plans from previous self-employment and from previous employers. The estimated annual benefit payable at age 62 under the PSI Supplemental Retirement Plan is $192,158 for Mr. Rogers, $3,230 for Mr. Grealis, and $54,624 for Ms. Foley.\nCinergy has an Executive Supplemental Life Insurance Program, which provides key management personnel, including the named executive officers, with additional life insurance coverage during employment, and post-retirement deferred compensation. At the later of age 55 or retirement, the participant's life insurance coverage under the program will be canceled. At that time, the participant will receive the total amount of coverage in the form of deferred compensation payable in ten equal annual installments. The annual benefit payable, at the later of age 55 or retirement, to each of the named executive officers is $15,000 per year over ten years.\nEmployment Agreements and Severance Arrangements\nCinergy entered into individual employment agreements with Mr. Randolph and Mr. Rogers (each sometimes hereinafter individually referred to as the \"Executive\") effective as of October 24, 1994.\nPursuant to his employment agreement, Mr. Randolph served as Chairman and Chief Executive Officer of Cinergy until November 30, 1995, at which time he relinquished the position of Chief Executive Officer; he will continue to serve as Chairman of the Board of Cinergy until November 30, 2000. Mr. Rogers served as Vice Chairman, President and Chief Operating Officer of Cinergy until November 30, 1995, and thereafter has served as Vice Chairman, President and Chief Executive Officer of Cinergy. Mr. Rogers' agreement is for a term of three years; however, as amended in December 1995, on each annual anniversary date it will be automatically extended for an additional year, unless either Cinergy or Mr. Rogers gives timely notice otherwise.\nDuring the terms of their agreements, Messrs. Randolph and Rogers will receive minimum annual base salaries of $465,000 and $422,722, respectively. Each will also be paid an annual incentive award of up to a maximum of no less than 55% of his annual salary pursuant to Cinergy's Annual Incentive Plan, and will be eligible to participate in all other incentive, stock option, performance award, savings, retirement and welfare plans applicable generally to Cinergy employees and executives.\nIf the Executive's employment terminates as a result of death, his beneficiary will receive a lump sum cash amount equal to the sum of (a) the Executive's annual base salary through the termination date to the extent not previously paid, (b) a pro rata portion of the benefit under Cinergy's Annual Incentive Plan calculated based upon the termination date, and (c) any compensation previously deferred but not yet paid to the Executive (with accrued interest or earnings thereon) and any unpaid accrued vacation pay. In addition to these accrued amounts, if Cinergy terminates the Executive's employment without \"cause\" or the Executive terminates his employment for \"good reason\" (as each is defined in the employment agreements), Cinergy will pay to the Executive (a) a lump sum cash amount equal to the present value of his annual base salary and benefit under Cinergy's Annual Incentive Plan payable through the end of the term of employment, at the rate and applying the same goals and factors in effect at the time of notice of such termination, (b) the value of all benefits to which the Executive would have been entitled had he remained in employment until the end of the term of employment under Cinergy's Performance Shares Plan and Executive Supplemental Life Insurance Program, (c) the value of all deferred compensation and all executive life insurance benefits whether or not then vested or payable, and (d) medical and welfare benefits for the Executive and his family through the end of the term of employment. If the Executive's employment is terminated by Cinergy for cause or by the Executive without good reason, the Executive will receive unpaid annual base salary accrued through the termination date and any accrued deferred compensation.\nMr. Randolph has a severance agreement with Cinergy which provides that if, within three years after October 24, 1994, he terminates his employment for good cause or his employment is terminated by Cinergy other than for disability or cause, Cinergy will pay him a cash amount equal to 300% of his annualized compensation for the most recent five years ending before October 24, 1994, less $1,000, plus a cash \"gross-up\" payment equal to the federal excise tax due on such amount, if any.\nCinergy and Mr. Grealis entered into an employment agreement which commenced on January 16, 1995, and shall continue until June 30, 2000; provided, however, commencing on January 1, 1999, and each January 1, 1999, and each January 1 thereafter, the term of the employment agreement may be extended for one additional year upon mutual agreement. Pursuant to the terms of his agreement, Mr. Grealis initially served as President of Investments and President of CG&E's Gas Operations. However, Mr. Grealis may be further assigned such other responsible executive capacity or capacities as the boards of directors of Cinergy or Services or Cinergy's chief executive officer may from time to time determine. Effective September 1, 1995, Mr. Grealis was named to the position of President of CG&E in addition to retaining the position of President of Investments. During the term of his agreement, Mr. Grealis will receive a minimum annualized base salary of $288,000, will be eligible to participate in all other incentive, stock option, performance award, savings, retirement and welfare benefit plans applicable generally to Cinergy employees and executives, and will receive other fringe benefits. In connection with his retirement, the employment agreement provides that Mr. Grealis will receive an annual benefit of no less than $283,000 payable as a straight-life annuity at age 62.\nCinergy entered into individual employment agreements with Messrs. Leonard and Thomas and Ms. Foley, which shall continue until December 31, 1997; provided, however, effective January 1, 1996, and each January 1 thereafter, the term of each such employment agreement may be extended for one additional year upon mutual agreement. Pursuant to the terms of their respective agreements, Mr. Leonard has served as Group Vice President and Chief Financial Officer of Cinergy and its subsidiaries, Mr. Thomas initially served as Group Vice President, Reengineering and Operation Services of Cinergy and its subsidiaries, and Ms. Foley has served as Vice President, General Counsel and Secretary of Cinergy and its subsidiaries. However, each such officer may be further assigned such other responsible executive capacity or capacities as the boards of directors of Cinergy or Services or Cinergy's chief executive officer may from time to time determine. Effective September 1, 1995, Mr. Thomas was named to the position of Group Vice President and Chief Transformation Officer. During the term of their agreements, Messrs. Leonard and Thomas and Ms. Foley will receive minimum annual base salaries of $250,000, $240,000, and $230,000, respectively, and each will be eligible to participate in all other incentive, stock option, performance award, savings, retirement and welfare benefit plans applicable generally to Cinergy employees and executives, and will receive other fringe benefits.\nIf the employment of Messrs. Grealis, Leonard, or Thomas or Ms. Foley (each sometimes hereinafter individually referred to as the \"officer\") is terminated as a result of death, for cause, or by the officer without good reason, the officer or the officer's beneficiary will be paid a lump sum cash amount equal to (a) the officer's unpaid annual base salary through the termination date, (b) a pro rata portion of the officer's award under Cinergy's Annual Incentive Plan, (c) the officer's vested accrued benefits under Cinergy's Performance Shares Plan, and (d) any unpaid deferred compensation (including accrued interest or earnings) and unpaid accrued vacation pay. If, instead, the officer's employment is terminated prior to a change in control (as defined) without cause or by the officer for good reason, the officer will be paid (a) a lump sum cash amount equal to the present value of the officer's annual base salary and target annual incentive award payable through the end of the term of the agreement, at the rate and applying the same goals and factors in effect at the time of notice of such termination, (b) the present value of all benefits to which the officer would have been entitled had the officer remained in employment until the end of the term of the agreement under Cinergy's Performance Shares Plan and Executive Supplemental Life Insurance Program, (c) the value of all deferred compensation and all executive life insurance benefits whether or not vested or payable, and (d) continued medical and welfare benefits through the end of the term of the agreement.\nIf the employment of any such officer (as defined above) is terminated after a change in control, the officer will be paid a lump sum cash payment equal to the greater of (i) three times (two times in the case of Mr. Grealis) the sum of the officer's annual base salary immediately prior to the date of the officer's termination of employment or, if higher, the date of the change in control, plus all incentive compensation or bonus plan amounts in effect prior to the date of the officer's termination of employment or, if higher, prior to the change in control, and (ii) the present value of all annual base salary, bonuses and incentive compensation and retirement benefits that would otherwise be due under the agreement plus deferred compensation and executive life insurance benefits. In addition, the officer will be provided life, disability, accident and health insurance benefits for thirty-six months (twenty-four months in the case of Mr. Grealis), reduced to the extent comparable benefits are received, without cost, by the officer.\nDeferred Compensation Agreements\nMr. Randolph and CG&E, and Mr. Rogers and Resources, entered into deferred compensation agreements effective as of January 1, 1992 (the \"Deferred Compensation Agreements\"), pursuant to which each such officer is credited with a $50,000 base salary increase in the form of deferred compensation. Such amount is deferred annually, in the case of both Mr. Randolph and Mr. Rogers, for a five-year period beginning January 1, 1992, and ending December 31, 1996, and in the case of Mr. Rogers, for an additional five-year period beginning January 1, 1997 and ending December 31, 2001. The Deferred Compensation Agreements were assumed by Cinergy effective as of October 24, 1994.\nIn general, Mr. Randolph's Deferred Compensation Agreement provides that if his employment terminates for any reason, other than death or disability, prior to January 1, 1997, he will receive the total amount of his deferred income plus interest. If Mr. Randolph's employment terminates on or after January 1, 1997, he will receive an annual cash benefit of $179,000 payable for a 15-year period beginning January 2001. Proportional benefits are payable to Mr. Randolph in the event his employment is terminated for death or disability prior to January 1, 1997.\nIn general, Mr. Rogers' Deferred Compensation Agreement provides that if his employment terminates for any reason, other than death, prior to January 1, 1997, he will receive a lump sum cash payment equal to the total amount deferred for the first five-year period described above plus interest. If Mr. Rogers' employment terminates for any reason, other than death, on or after January 1, 1997, he will receive an annual cash benefit over a 15-year period beginning the first January following termination of his employment, but in no event earlier than January 2003 nor later than January 2010. The annual cash benefit amount payable for such 15-year period ranges from $179,000 per year if payment begins in January 2003, to $554,400 per year if payment commences in January 2010. Comparable amounts are payable to Mr. Rogers in the event his employment is terminated for disability prior to January 1, 1997, or if Mr. Rogers dies (i) prior to January 1, 1997, while employed or disabled, or (ii) on or after January 1, 1997, but before commencement of payment of the 15-year payments described above; provided, however, if Mr. Rogers becomes disabled prior to the completion of the first award period, the amounts paid will be proportionately reduced based on the ratio of the amount deferred to the date of disability to the total amount that would have been deferred to the end of the first award period. In addition, if Mr. Rogers' employment terminates for any reason, other than death or disability, on or after January 1, 1997, but before January 1, 2002, he will receive a lump sum cash payment equal to the total amount deferred during the second five-year period described above plus interest. Additionally, if Mr. Rogers' employment terminates for any reason, other than death or disability, on or after January 1, 2002, he will receive an additional annual benefit for a 15-year period beginning the first January following termination of his employment, but in no event earlier than January 2008 nor later than January 2010. The annual cash benefit amount payable for such period ranges from $179,000 per year if payment begins in January 2008, to $247,000 per year if payment begins in January 2010. Provided that Mr. Rogers is employed on January 1, 1997, comparable amounts are payable to Mr. Rogers in the event his employment is terminated for disability prior to January 1, 2002, or if Mr. Rogers dies (i) prior to January 1, 2002, while employed or disabled, or (ii) on or after January 1, 2002, but before commencement of payment of benefits; provided, however, if Mr. Rogers becomes disabled prior to the completion of the second award period, his payments will be proportionately reduced in the same manner as described above for disability during the first award period.\nCompensation Committee Interlocks and Insider Participation\nMr. Schiff, Chairman of the Board of Cincinnati Financial Corporation, serves on the Compensation Committee of the board of directors of Cinergy, and Mr. Randolph, Chairman of the Board of Cinergy and its subsidiaries, including CG&E, serves on the board of directors of Cincinnati Financial Corporation.\nPerformance Graph\nThe following line graph compares the cumulative total shareholder return of the common stock of CG&E with the cumulative total returns during the same time period of the S&P Electric Utilities Index and the S&P 500 Stock Index. The graph tracks performance from January 1, 1991, through October 24, 1994, the final trading date of CG&E's common stock. The graph assumes a $100 investment on January 1, 1991, and reinvestment of all dividends.\n[OMITTED IS A LINE GRAPH ILLUSTRATING THE FOLLOWING DATA]\n1\/1\/91 1\/1\/92 1\/1\/93 1\/1\/94 10\/24\/94\nCG&E Common Stock $100 $145 $144 $169 $149\nS&P Electric Utilities Index $100 $130 $138 $155 $128\nS&P 500 Stock Index $100 $130 $140 $155 $156 Directors' Compensation\nDirectors who are not employees (the \"non-employee directors\") receive an annual retainer fee of $8,000 plus a fee of $1,000 for each CG&E board of directors' meeting attended; however, any non-employee director of CG&E who also serves as a non-employee director of Cinergy or any of its affiliates shall neither receive such annual retainer fee, nor any compensation for attendance at any CG&E board meeting that is held concurrently or consecutively with a meeting of the board of directors of Cinergy. Directors who are also employees of Cinergy or any of its subsidiaries (Messrs. Randolph, Rogers, and Grealis) will receive no remuneration for their services as directors.\nUnder Cinergy's Directors' Deferred Compensation Plan, each non-employee director of Cinergy or any of its subsidiaries may defer fees and have them accrued either in cash or in units representing shares of Cinergy common stock. If deferred in such units, the stock will be distributed to the director at the time of retirement from the appropriate board. Amounts deferred in cash will be paid at the same time.\nUnder Cinergy's Retirement Plan for Directors, non-employee directors with five or more years of service will receive annual retirement compensation in an amount equal to the annual CG&E board retainer fee in effect at the time of termination of service as a director, plus the product of the fee paid for attendance at a CG&E board meeting multiplied by five. Retirement compensation is paid for as many years as the director served on the CG&E board. This plan covers non-employee directors serving on the boards of directors of Cinergy, Services, CG&E, or PSI. Prior service by non-employee directors of CG&E, PSI, or Resources is credited under this plan.\nPSI\nReference is made to PSI's 1996 Information Statement with respect to executive compensation.\nULH&P\nOmitted pursuant to Instruction J(2)(c).\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nCinergy\nReference is made to Cinergy's 1996 Proxy Statement with respect to security ownership of certain beneficial owners and security ownership of management.\nCG&E\nCinergy owns all the outstanding shares of common stock of CG&E. The only two holders of record known by management of CG&E to be the beneficial owners of more than 5% of the class of CG&E's cumulative preferred stock as of December 31, 1995 are set forth in the following table.\nName and Address Amount and Nature Percent of Beneficial Owner of Beneficial Ownership of Class\nU. S. Leasing International, Inc. 282,500 shares 14.13% 733 Front Street San Francisco, CA 94111\nHousehold Finance Corporation 105,000 shares 5.25% 2700 Sanders Road Prospect Heights, IL 60070\nCG&E's directors and executive officers did not beneficially own any shares of any series of the class of CG&E's cumulative preferred stock as of December 31, 1995. The beneficial ownership of Cinergy's common stock held by each director and named executive officer as of December 31, 1995 is set forth in the following table.\nAmount and Nature Name of Beneficial Owner(1) of Beneficial Ownership (2)\nCheryl M. Foley 71,592 shares William J. Grealis 300 shares J. Wayne Leonard 74,060 shares Jackson H. Randolph 75,658 shares James E. Rogers 252,582 shares Larry E. Thomas 75,640 shares\nAll directors and executive 666,772 shares (2) officers as a group (representing 0.42% of the class)\n(1) No individual listed beneficially owned more than 0.16% of the outstanding shares of Cinergy common stock. (2) Includes shares which there is a right to acquire within 60 days pursuant to the exercise of stock options in the following amounts: Ms. Foley - 57,397; Mr. Leonard - 57,611; Mr. Randolph - 50,000; Mr. Rogers - - 189,403; Mr. Thomas - 51,107; and all directors and executive officers as a group - 491,093. PSI\nReference is made to PSI's 1996 Information Statement with respect to security ownership of certain beneficial owners and security ownership of management.\nULH&P\nOmitted pursuant to Instruction J(2)(c).\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nCinergy, CG&E, and PSI\nNone.\nULH&P\nOmitted pursuant to Instruction J(2)(c).\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) Financial Statements and Schedules.\nCinergy, CG&E, PSI, and ULH&P\nRefer to the page captioned \"Index to Financial Statements and Financial Statement Schedules\", pages 46 and 47 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.\nCinergy, CG&E, PSI, and ULH&P\nNone\n(c) Exhibits.\nCopies of the documents listed below which are identified with an asterisk (*) have heretofore been filed with the SEC and are incorporated herein by reference and made a part hereof. Exhibits not so identified are filed herewith.\nExhibit Designation Nature of Exhibit\nCinergy\n3-a *Certificate of Incorporation of Cinergy. (Exhibit to Cinergy's 1993 Form 10-K in File No. 1-11377.)\n3-b *By-laws of Cinergy as amended January 25, 1996. (Exhibit to Cinergy's Form U-1 Declaration filed February 23, 1996, in File No. 70- 8807.)\nCG&E\n3-c *Amended Articles of Incorporation of CG&E effective January 24, 1994. (Exhibit to CG&E's 1993 Form 10-K in File No. 1-1232.)\n3-d *Regulations of CG&E as amended, adopted June 16, 1995. (Exhibit to CG&E's Form 8-A dated July 24, 1995.)\nPSI\n3-e *Amended Articles of Consolidation of PSI, as amended to April 20, 1995. (Exhibit to PSI's June 30, 1995, Form 10-Q in File No. 1-3543.)\n3-f By-laws of PSI, as amended January 25, 1996.\nULH&P\n3-g *Restated Articles of Incorporation made effective May 7, 1976. (Exhibit to ULH&P's Form 8-K, May 1976.)\n3-h *By-laws of ULH&P as amended, adopted by shareholders June 16, 1995. (Exhibit to ULH&P's June 30, 1995, Form 10-Q in File No. 2- 7793.)\nCinergy and PSI\n4-a *Original Indenture (First Mortgage Bonds) dated September 1, 1939, between PSI 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 PSI and The First National Bank of Chicago dated January 1, 1972. (Exhibit to File No. 2- 42545.)\n4-c *Twenty-third Supplemental Indenture between PSI and The First National Bank of Chicago dated January 1, 1977. (Exhibit to File No. 2- 57828.)\n4-d *Twenty-fifth Supplemental Indenture between PSI and The First National Bank of Chicago dated September 1, 1978. (Exhibit to File No. 2- 62543.)\n4-e *Twenty-seventh Supplemental Indenture between PSI and The First National Bank of Chicago dated March 1, 1979. (Exhibit to File No. 2- 63753.)\n4-f *Thirty-fifth Supplemental Indenture between PSI and The First National Bank of Chicago dated March 30, 1984. (Exhibit to PSI's 1984 Form 10-K in File No. 1-3543.)\n4-g *Thirty-ninth Supplemental Indenture between PSI and The First National Bank of Chicago dated March 15, 1987. (Exhibit to PSI's 1987 Form 10-K in File No. 1-3543.)\n4-h *Forty-first Supplemental Indenture between PSI and The First National Bank of Chicago dated June 15, 1988. (Exhibit to PSI's 1988 Form 10-K in File No. 1-3543.)\n4-i *Forty-second Supplemental Indenture between PSI and The First National Bank of Chicago dated August 1, 1988. (Exhibit to PSI's 1988 Form 10-K in File No. 1-3543.)\n4-j *Forty-fourth Supplemental Indenture between PSI and The First National Bank of Chicago dated March 15, 1990. (Exhibit to PSI's 1990 Form 10-K in File No. 1-3543.)\n4-k *Forty-fifth Supplemental Indenture between PSI and The First National Bank of Chicago dated March 15, 1990. (Exhibit to PSI's 1990 Form 10-K in File No. 1-3543.)\n4-l *Forty-sixth Supplemental Indenture between PSI and The First National Bank of Chicago dated June 1, 1990. (Exhibit to PSI's 1991 Form 10-K in File No. 1-3543.)\n4-m *Forty-seventh Supplemental Indenture between PSI and The First National Bank of Chicago dated July 15, 1991. (Exhibit to PSI's 1991 Form 10-K in File No. 1-3543.)\n4-n *Forty-eighth Supplemental Indenture between PSI and The First National Bank of Chicago dated July 15, 1992. (Exhibit to PSI's 1992 Form 10-K in File No. 1-3543.)\n4-o *Forty-ninth Supplemental Indenture between PSI and The First National Bank of Chicago dated February 15, 1993. (Exhibit to PSI's 1992 Form 10-K in File No. 1-3543.)\n4-p *Fiftieth Supplemental Indenture between PSI and The First National Bank of Chicago dated February 15, 1993. (Exhibit to PSI's 1992 Form 10-K in File No. 1-3543.)\n4-q *Fifty-first Supplemental Indenture between PSI and The First National Bank of Chicago dated February 1, 1994. (Exhibit to PSI's 1993 Form 10-K in File No. 1-3543.)\n4-r *Indenture (Secured Medium-term Notes, Series A), dated July 15, 1991, between PSI and The First National Bank of Chicago, as Trustee. (Exhibit to PSI's Form 10-K\/A, Amendment No. 2, dated July 15, 1993, in File No. 1-3543.)\n4-s *Indenture (Secured Medium-term Notes, Series B), dated July 15, 1992, between PSI and The First National Bank of Chicago, as Trustee. (Exhibit to PSI's Form 10-K\/A, Amendment No. 2, dated July 15, 1993, in File No. 1-3543.)\nCinergy and CG&E\n4-t *Original Indenture (First Mortgage Bonds) between CG&E and The Bank of New York (as Trustee) dated as of August 1, 1936. (Exhibit to CG&E's Registration Statement No. 2-2374.)\n4-u *Tenth Supplemental Indenture between CG&E and The Bank of New York dated as of July 1, 1967. (Exhibit to CG&E's Registration Statement No. 2- 26549.)\n4-v *Eleventh Supplemental Indenture between CG&E and The Bank of New York dated as of May 1, 1969. (Exhibit to CG&E's Registration Statement No. 2-32063.)\n4-w *Thirteenth Supplemental Indenture between CG&E and The Bank of New York dated as of November 1, 1971. (Exhibit to CG&E's Registration Statement No. 2-41974.)\n4-x *Fourteenth Supplemental Indenture between CG&E and The Bank of New York dated as of November 2, 1972. (Exhibit to CG&E's Registration Statement No. 2-60961.)\n4-y *Fifteenth Supplemental Indenture between CG&E and The Bank of New York dated as of August 1, 1973. (Exhibit to CG&E's Registration Statement No. 2-60961.)\n4-z *Thirty-second Supplemental Indenture between CG&E and The Bank of New York dated as of December 15, 1991. (Exhibit to CG&E's Registration Statement No. 33-45115.)\n4-aa *Thirty-third Supplemental Indenture between CG&E and The Bank of New York dated as of September 1, 1992. (Exhibit to CG&E's Registration Statement No. 33-53578.)\n4-bb *Thirty-fourth Supplemental Indenture between CG&E and The Bank of New York dated as of October 1, 1993. (Exhibit to CG&E's September 30, 1993, Form 10-Q in File No. 1-1232.)\n4-cc *Thirty-fifth Supplemental Indenture between CG&E and The Bank of New York dated as of January 1, 1994. (Exhibit to CG&E's Registration Statement No. 33-52335.)\n4-dd *Thirty-sixth Supplemental Indenture between CG&E and The Bank of New York dated as of February 15, 1994. (Exhibit to CG&E's Registration Statement No. 33-52335.)\n4-ee *Loan Agreement between CG&E and County of Boone, Kentucky dated as of February 1, 1985. (Exhibit to CG&E's 1984 Form 10-K in File No. 1- 1232.)\n4-ff *Loan Agreement between CG&E and State of Ohio Air Quality Development Authority dated as of December 1, 1985. (Exhibit to CG&E's 1985 Form 10-K in File No. 1-1232.)\n4-gg *Loan Agreement between CG&E and State of Ohio Air Quality Development Authority dated as of December 1, 1985. (Exhibit to CG&E's 1985 Form 10-K in File No. 1-1232.)\n4-hh *Repayment Agreement between CG&E and The Dayton Power and Light Company dated as of December 23, 1992. (Exhibit to CG&E's 1992 Form 10-K in File No. 1-1232.)\n4-ii *Loan Agreement between CG&E and State of Ohio Water Development Authority dated as of January 1, 1994. (Exhibit to CG&E's 1993 Form 10-K in File No. 1-1232.)\n4-jj *Loan Agreement between CG&E and State of Ohio Air Quality Development Authority dated as of January 1, 1994. (Exhibit to CG&E's 1993 Form 10-K in File No. 1-1232.)\n4-kk *Loan Agreement between CG&E and County of Boone, Kentucky dated as of January 1, 1994. (Exhibit to CG&E's 1993 Form 10-K in File No. 1-1232.)\n4-ll *Original Indenture (Unsecured Debt Securities) between CG&E and The Fifth Third Bank dated as of May 15, 1995. (Exhibit to CG&E's Form 8-A dated July 24, 1995, in File No. 1-1232.)\n4-mm *First Supplemental Indenture between CG&E and The Fifth Third Bank dated as of June 1, 1995. (Exhibit to CG&E's June 30, 1995, Form 10-Q in File No. 1-1232.)\n4-nn *Second Supplemental Indenture between CG&E and The Fifth Third Bank dated as of June 30, 1995. (Exhibit to CG&E's Form 8-A dated July 24, 1995, in File No. 1-1232.)\n4-oo *Loan Agreement between CG&E and the State of Ohio Air Quality Development Authority dated as of September 13, 1995. (Exhibit to CG&E's September 30, 1995, Form 10-Q in File No. 1-1232.)\n4-pp *Loan Agreement between CG&E and the State of Ohio Air Quality Development Authority dated as of September 13, 1995. (Exhibit to CG&E's September 30, 1995, Form 10-Q in File No. 1-1232.)\nCinergy, CG&E, and ULH&P\n4-qq *Original Indenture (First Mortgage Bonds) between ULH&P and The Bank of New York dated as of February 1, 1949. (Exhibit to ULH&P's Registration Statement No. 2-7793.)\n4-rr *Fifth Supplemental Indenture between ULH&P and The Bank of New York dated as of January 1, 1967. (Exhibit to CG&E's Registration Statement No. 2-60961.)\n4-ss *Seventh Supplemental Indenture between ULH&P and The Bank of New York dated as of October 1, 1973. (Exhibit to CG&E's Registration Statement No. 2-60961.)\n4-tt *Eighth Supplemental Indenture between ULH&P and The Bank of New York dated as of December 1, 1978. (Exhibit to CG&E's Registration Statement No. 2-63591.)\n4-uu *Thirteenth Supplemental Indenture between ULH&P and The Bank of New York dated as of August 1, 1992. (Exhibit to ULH&P's 1992 Form 10-K in File No. 2-7793.)\n4-vv *Original Indenture (Unsecured Debt Securities) between ULH&P and the Fifth Third Bank dated as of July 1, 1995. (Exhibit to ULH&P's June 30, 1995, Form 10-Q in File No. 2-7793)\n4-ww *First Supplemental Indenture between ULH&P and The Fifth Third Bank dated as of July 15, (Exhibit to ULH&P's June 30, 1995, Form 10-Q in File No. 2-7793.)\nCinergy, CG&E, and PSI\n10-a *+Amended and Restated Employment Agreement dated October 24, 1994, among CG&E, Cinergy Corp. (an Ohio corporation), Cinergy (a Delaware corporation), PSI Resources, Inc., PSI, and Jackson H. Randolph. (Exhibit to Cinergy's 1994 Form 10-K in File No. 1-11377.)\n10-b *+Amended and Restated Employment Agreement dated July 2, 1993, among PSI Resources, Inc., PSI, 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-c +First Amendment to Amended and Restated Employment Agreement dated December 12, 1995, retroactively effective to October 24, 1994, amended and restated July 2, 1993, among Cinergy, Services, CG&E, PSI, and James E. Rogers.\n10-d *+Employment Agreement dated January 1, 1995, among Cinergy, CG&E, Services, Inc., Investments, PSI, and William J. Grealis. (Exhibit to Cinergy's 1994 Form 10-K in File No. 1-11377.)\n10-e Employment Agreement dated October 24, 1994, among Cinergy, Services, CG&E, PSI, and Larry E. Thomas.\n10-f First Amendment to Employment Agreement dated October 24, 1994, among Cinergy, Services, CG&E, PSI, and Larry E. Thomas.\n10-g Employment Agreement dated October 24, 1994, among Cinergy, Services, CG&E, PSI, and J. Wayne Leonard.\n10-h First Amendment to Employment Agreement dated October 24, 1994, among Cinergy, Services, CG&E, PSI, and J. Wayne Leonard.\n10-i Employment Agreement dated October 24, 1994, among Cinergy, Services, CG&E, PSI, and Cheryl M. Foley.\n10-j First Amendment to Employment Agreement dated October 24, 1994, among Cinergy, Services, CG&E, PSI, and Cheryl M. Foley.\nCinergy and PSI\n10-k First Amendment to the PSI Union Employees' 401(k) Savings Plan, dated December 31, 1995.\n10-l First Amendment to the PSI Employees' 401(k) Savings Plan, dated December 31, 1995.\n10-m *+Employment Agreement dated October 4, 1993, among Cinergy, PSI, and John M. Mutz. (Exhibit to PSI Resources, Inc.'s September 30, 1993, Form 10-Q, File No. 1-9941.)\n10-n *+Deferred Compensation Agreement, effective as of January 1, 1992, between Cinergy and James E. Rogers, Jr. (Exhibit to PSI's Form 10-K\/A in File No. 1-3543, Amendment No. 1, dated April 29, 1993.)\n10-o *+Split Dollar Life Insurance Agreement, effective as of January 1, 1992, between Cinergy and James E. Rogers, Jr. (Exhibit to PSI's Form 10- K\/A in File No. 1-3543, Amendment No. 1, dated April 29, 1993.)\n10-p *+First Amendment to Split Dollar Life Insurance Agreement between Cinergy and James E. Rogers, Jr. dated December 11, 1992. (Exhibit to PSI's Form 10-K\/A in File No. 1-3543, Amendment No. 1, dated April 29, 1993.)\n10-q *+PSI Supplemental Retirement Plan amended and restated December 16, 1992, retroactively effective January 1, 1989. (Exhibit to PSI's 1992 Form 10-K in File No. 1-3543.)\n10-r *+PSI Excess Benefit Plan, formerly named the Supplemental Pension Plan, amended and restated December 16, 1992, retroactively effective January 1, 1989. (Exhibit to PSI's 1992 Form 10-K in File No. 1-3543.)\nCinergy and CG&E\n10-s *CG&E Deferred Compensation and Investment Plan, as amended, effective January 1, 1989. (Exhibit to Cinergy's Form S-8, filed August 30, 1994.)\n10-t *CG&E Savings Incentive Plan, as amended, effective January 1, 1989. (Exhibit to Cinergy's Form S-8, filed August 30, 1994.)\n10-u *+Deferred Compensation Agreement between Jackson H. Randolph and Cinergy dated January 1, 1992. (Exhibit to CG&E's 1992 Form 10-K in File No. 1-1232.)\n10-v *+Supplemental Executive Retirement Income Plan between CG&E and certain executive officers. (Exhibit to CG&E's 1988 Form 10-K in File No. 1-1232.)\n10-w *+Amendment to Supplemental Executive Retirement Income Plan between CG&E and certain executive officers. (Exhibit to CG&E's 1992 Form 10-K in File No 1-1232.)\n10-x +Amended and Restated Supplemental Retirement Income Plan between CG&E and Jackson H. Randolph.\n10-y *+Amendment to Executive Severance Agreement between CG&E and certain executive officers. (Exhibit to CG&E's 1992 Form 10-K in File No. 1-1232.)\n10-z *+Executive Severance Agreement between CG&E and certain executive officers. (Exhibit to CG&E's 1989 Form 10-K in File No. 1-1232.)\nCinergy\n10-aa *+Cinergy Stock Option Plan, adopted October 18, 1994, effective October 24, 1994. (Exhibit to Cinergy's Form S-8, filed October 19, 1994.)\n10-bb *+Cinergy Performance Shares Plan, adopted October 18, 1994, effective October 24, 1994. (Exhibit to Cinergy's Form S-8, filed October 19, 1994.)\n10-cc *+Cinergy Annual Incentive Plan, adopted October 18, 1994, effective October 24, 1994. (Exhibit to Cinergy's 1994 Form 10-K in File No. 1-11377.)\n10-dd *Cinergy Employee Stock Purchase and Savings Plan, adopted October 18, 1994, effective October 24, 1994. (Exhibit to Cinergy's Form S-8, filed October 19, 1994.)\n10-ee *Amendment to Cinergy Employee Stock Purchase and Savings Plan, adopted January 25, 1995, retroactively effective January 1, 1995. (Exhibit to Cinergy's 1994 Form 10-K in File No. 1-11377.)\n10-ff *+Cinergy Directors' Deferred Compensation Plan, adopted October 18, 1994, effective October 24, 1994. (Exhibit to Cinergy's Form S-8, filed October 19, 1994.)\n10-gg *+Cinergy Retirement Plan for Directors, adopted October 18, 1994, effective October 24, 1994. (Exhibit to Cinergy's 1994 Form 10-K in File No. 1-11377.)\n10-hh *+Cinergy Executive Supplemental Life Insurance Program adopted October 18, 1994, effective October 24, 1994, consisting of Defined Benefit Deferred Compensation Agreement, Executive Supplemental Life Insurance Program Split Dollar Agreement I, and Executive Supplemental Life Insurance Program Split Dollar Agreement II. (Exhibit to Cinergy's 1994 Form 10-K in File No. 1-11377.)\n10-ii *+Split Dollar Insurance Agreement, effective as of May 1, 1993, between Cinergy and Jackson H. Randolph. (Exhibit to Cinergy's 1994 Form 10-K in File No. 1-11377.)\nCinergy and PSI\n10-jj *PSI Union Employees' 401(k) Savings Plan, amended and restated October 24, 1994, effective January 1, 1992. (Exhibit to Cinergy's Form S-8, filed October 18, 1994.)\n10-kk *PSI Employees' 401(k) Savings Plan, amended and restated October 24, 1994, effective January 1, 1992. (Exhibit to Cinergy's Form S-8, filed October 18, 1994.)\nCinergy\n21 Subsidiaries of Cinergy\nCinergy, CG&E, PSI, and ULH&P\n23 Consent of Independent Public Accountants.\n24 Power of Attorney.\n27 Financial Data Schedules (included in electronic submission only).\nCinergy\n99-a 1995 Form 11-K Annual Report of Cinergy Directors' Deferred Compensation Plan.\n99-b 1995 Form 11-K Annual Report of Cinergy Employee Stock Purchase and Savings Plan. (To be filed by amendment.)\n____________ + Management contract, compensation plan or arrangement required to be filed as an exhibit pursuant to Item 14(c) of Form 10-K.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Cinergy Corp., The Cincinnati Gas & Electric Company, PSI Energy, Inc., and The Union Light, Heat and Power Company have each duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nCINERGY CORP. THE CINCINNATI GAS & ELECTRIC COMPANY PSI ENERGY, INC. THE UNION LIGHT, HEAT AND POWER COMPANY Registrants\nDated: March 27, 1996\nBy James E. Rogers Vice 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 Cinergy, CG&E, PSI, and ULH&P Jackson H. Randolph Chairman\nCinergy Neil A. Armstrong Director Clement L. Buenger Director Phillip R. Cox Director Kenneth M. Duberstein Director George C. Juilfs Director Melvin Perelman, Ph.D. Director Thomas E. Petry Director John J. Schiff, Jr. Director Phillip R. Sharp Director Dudley S. Taft Director Oliver W. Waddell Director\nCinergy and PSI James K. Baker Director Michael G. Browning Director John A. Hillenbrand II Director Van P. Smith Director\nCG&E and ULH&P William J. Grealis President and Director\nPSI John M. Mutz President and Director\nULH&P Terry E. Bruck Group Vice President and Director Cheryl M. Foley Vice President, General Counsel, Secretary, and Director Stephen G. Salay Director\nCinergy, CG&E, PSI, and ULH&P\nJames E. Rogers Vice Chairman, Chief March 27, 1996 Attorney-in-fact for all Executive Officer, and Director the foregoing persons President of Cinergy (Principal Executive Officer)\nJ. Wayne Leonard Group Vice President and March 27, 1996 Chief Financial Officer Director of ULH&P (Principal Financial Officer)\nCharles J. Winger Comptroller March 27, 1996 (Principal Accounting Officer)","section_15":""}
{"filename":"84278_1995.txt","cik":"84278","year":"1995","section_1":"ITEM 1. BUSINESS\n(a) General Development of Business.\nDuring the fiscal year ended October 31, 1995, the Registrant continued for the most part to operate its business as it has the past four years by manufacturing merchant steel bar products, fabricating open-web steel joists and concrete reinforcing steel, and extracting scrap steel and other materials from junked automobiles. In December 1988, however, the Registrant's rebar subsidiary, RESCO Steel Products Corporation, purchased the assets of another rebar fabricating facility located in Salem, Virginia at a cost of $775,000, doubling its production capacity. Due to adverse economic conditions, and in order to initiate cost saving measures, in November 1990, the two rebar facilities were consolidated into one plant, now operating out of the newer location. Roanoke Technical Treatment & Services, Inc., a Roanoke, Virginia subsidiary, was formed in 1990 to license a process for the treatment of electric arc furnace dust. The subsidiary is awaiting various approvals and permits and is uncertain as to a specific time for start-up. In March 1991, the Registrant closed its merchant steel bar rolling mill located in Salem, Virginia due to a decline in order rates. The products manufactured at the Salem plant were produced at the Roanoke plant, which is considerably more efficient. During fiscal year 1994, the Registrant's auto shredding subsidiary, Shredded Products Corporation, completed construction of its new modern facility in Rocky Mount, Virginia, and in November 1994 began operations at the new locality, at a total investment in excess of $8,000,000 for plant and equipment. The new facility, with its own landfill, is providing considerable savings in waste disposal costs. In addition, cost savings and better metal recoveries are being achieved through the use of the more technologically advanced equipment. The other subsidiaries of the Registrant, John W. Hancock, Jr., Inc. and Socar, Inc., have had no material changes in operations or in the mode of conducting their business for the past five years. John W. Hancock, Jr. founded both the Hancock joist subsidiary and its parent, Roanoke Electric Steel Corporation, and served on the Registrant's Board of Directors as Chairman of the Executive Committee until his death in March 1994.\nPART I (con'd.)\nThe Registrant currently anticipates no material changes in operations during the next fiscal year unless there are unforeseen changes in market conditions and profitability.\n(b) Financial Information about Industry Segments.\nThe Registrant's business consists of one industry segment or line of business, which is the extracting of scrap metal from discarded automobiles and the manufacturing, fabricating and marketing of merchant steel bar products, reinforcing bars, open-web steel joists and billets. The industry segment consists of three classes of products - merchant steel products, fabricated bar joists and reinforcing bars and billets.\nFINANCIAL INFORMATION RELATING TO INDUSTRY SEGMENTS AND CLASSES OF PRODUCTS OR SERVICES\n1995 1994 1993 Sales to Unaffiliated Customers:\nMerchant Steel $103,531,770 $96,782,588 $75,531,009\nBar Joists & Rebar $110,370,872 $78,854,207 $56,503,380\nBillets $46,065,882 $40,172,433 $35,259,989\n$259,968,524 $215,809,228 $167,294,378\nNet Earnings from Operations $20,228,902 $8,766,435 $4,750,106\nIdentifiable Assets $157,774,658 $140,473,510 $130,620,435\n(c) Narrative Description of Business.\n(1) (i) The Registrant manufactures merchant steel products consisting of Angles, Plain Rounds, Flats, Channels and Reinforcing Bars of various sizes and lengths. The principal markets for the Registrant's products are steel fabricators and steel service centers. The products are distributed directly to customers from orders solicited by a paid sales staff of the Registrant.\nPART I (con'd.)\nThe Registrant's subsidiary, Shredded Products Corporation, is involved in the extraction of scrap iron and steel and other metals from junked automobiles and other waste materials. Almost all of the ferrous material is used by the Parent as raw materials. The non-ferrous metals are sold to unrelated purchasers.\nTwo other subsidiaries, John W. Hancock, Jr., Inc. and Socar, Inc., are engaged in the manufacturing of long- and short-span steel joists. Joists are open-web steel horizontal supports for floors and roofs, used primarily in the construction of commercial and industrial buildings such as shopping centers, factories, warehouses, hospitals, schools, office buildings, nursing homes, and the like. Joists are cheaper and lighter than structural steel or reinforced concrete. The joists are distributed by these subsidiaries to their customers from orders solicited by manufacturer's representatives and pursuant to successful bids placed directly by the companies.\nThe Registrant's subsidiary, RESCO Steel Products Corporation, fabricates concrete reinforcing steel by cutting and bending rebars to contractors' specifications. The rebars are distributed to contractors from orders solicited by a paid sales staff and pursuant to successful bids placed directly by the subsidiary.\n(ii) The Registrant has not recently introduced a new product or begun to do business in a new industry segment that will require the investment of a material amount of assets or that otherwise is material.\n(iii) The Registrant's main raw material, scrap steel, is supplied for the most part by scrap dealers within a 200 mile radius of the mill. It is purchased through the David J. Joseph Company who are scrap brokers. The Shredded Products subsidiary supplies 9,000 to 13,000 tons of scrap per month. Although scrap is generally available to the Registrant, the price of scrap steel is highly responsive to changes in demand, including demand in foreign countries as well as in the United States. The ability to maintain satisfactory profit margins in times when scrap is relatively high priced is dependent upon the levels of steel prices, which are determined by market forces. Alloys and other materials needed for the melting process are provided by various domestic and foreign companies.\nPART I (con'd.)\nShredded Products Corporation often experiences difficulty in purchasing scrap automobiles at a satisfactory level. Competition from an increasing number of shredding operations and reluctance by dealers to sell scrap automobiles due to market conditions are the main causes. High offering prices generally increase the supply; however, the increased cost to produce sometimes is very competitive with the price of similar scrap that can be purchased on the outside.\nSubstantially all of John W. Hancock, Jr., Inc.'s steel components are purchased from the Parent, which is located conveniently nearby and, therefore such components are generally available to the Company as needed.\nRESCO Steel Products Corporation purchases most of its steel components from suppliers within its market area, determined mainly by freight cost. Such components would be generally available to the Company, since the Parent could produce and supply this raw material, as needed.\nSocar, Inc. receives most of its raw steel material from the Parent and other nearby suppliers, the determinant usually being freight cost. The availability of raw materials is not of major concern to the Company, since the Parent could supply most of its needs.\n(iv) The Registrant currently holds no patents, trade marks, licenses, franchises or concessions that are material to its business operations.\n(v) The business of the Registrant is not seasonal.\n(vi) The Registrant does not offer extended payment terms to its customers nor is it normally required to carry significant amounts of inventory to meet rapid delivery requirements of customers; although, at times market conditions have required the stockpiling of popular bar products for rapid delivery. Working capital practices generally remain constant during the course of business except when the Registrant determines it to be advantageous to stockpile raw materials due to price considerations.\n(vii) During fiscal year 1995, sales (tons) by the Registrant to John W. Hancock, Jr., Inc., Socar, Inc. and RESCO Steel Products Corporation, wholly-owned subsidiaries, were approximately 10%, 8% and less than 1% of the\nPART I (con'd.)\nRegistrant's total sales (tons), respectively. The largest nonaffiliated customer purchased approximately 26% of total sales (tons) ---15% of total sales (dollars). Alternative marketing and production arrangements were available to the Registrant, so that the loss of this nonaffiliate would not have had a materially adverse effect on the Registrant and its subsidiaries taken as a whole.\n(viii) The Registrant is of the opinion that the amount of its backlog is not generally material to an understanding of the business. All backlog is shipped within the current fiscal year.\n(ix) None of the business of the Registrant is subject to renegotiation of profits or termination of contracts or subcontracts at the election of the Government.\n(x) The Registrant competes with steel-producing mills of similar size operative within its market region and also larger mills producing similar products. The market region in which the Registrant sells its products consists of the majority of states east of the Mississippi River. Price, including transportation cost, is the major determinant in securing business. Economic recession began to intensify competition during 1990, as selling prices dropped due to a softening in demand. This trend continued through most of 1991 with sharp declines in selling prices due to poor demand and excess inventories and capacity at most mills, although by year-end prices rose slightly. In comparison to the 1991 recession lows, order rates in 1992 showed some improvement while selling prices remained flat. In 1993, market conditions and demand improved significantly, while industry-wide selling prices increased to offset higher raw material costs. Demand in 1994 was fueled by continued improvement in business conditions and economic growth, with higher raw material costs again forcing selling prices upward, although some of the increased selling prices were demand driven. Even though market conditions and backlogs remained strong for much of 1995, shipments were flat due to customers' inventory reductions, while improved selling prices were attributable to higher raw material costs and rising demand, although by year-end prices fell slightly.\nPART I (con'd.)\nThe joist business is highly competitive. Due to similarity of product, relatively small price differences are often determinative in placing business. Ability to meet the customer's time requirements for delivery also is important in securing business. Competing successfully becomes more difficult with the distance to point of delivery due to transportation costs. In 1990, selling prices and order rates declined as a result of a weakened construction industry, causing increased competition. The severely depressed activity in the construction industry, due to overbuilding, again in 1991 resulted in drastic declines in selling prices and demand. In spite of depressed conditions, 1992 brought improved shipments due mainly to successful job bidding; however, in order to book a higher percentage of quotations, selling prices consequently suffered. Again in 1993, successful job bidding resulted in improved shipment levels, while higher raw material costs pushed selling prices upward, even though the construction industry remained depressed and highly competitive. In 1994, an easing of competitive conditions within the construction industry led to increased shipment levels, while selling prices were again forced upward by higher raw material costs. Reduced competition and increased activity in 1995 again led to higher shipment levels within the construction industry, as demand and increased raw material costs forced selling prices higher.\nBillets are semi-finished products used by the Registrant in its rolling mill process to manufacture various merchant bar products. With the addition of new casting equipment in recent years, the Registrant has anticipated a growing billet market of nonaffiliated customers who further fabricate the billets for various end uses. Competition within the industry caused a drop in selling prices in 1990, with demand slowing. In 1991, selling prices trended further downward, while order rates fell due to the sagging economy. Billet sales improved significantly in 1992 as a result of increased domestic demand and entry into the much more competitive export markets, although selling prices still continued to slump. Again in 1993, increased export business and improved domestic demand resulted in significantly higher billet shipments. Selling prices also rose in reaction to higher scrap steel costs. Shipments of billets declined slightly in 1994 due to a lack of export shipments, although domestic shipments improved significantly. While the export markets\nPART I (con'd.)\nwere much more competitive, domestic demand improved dramatically. Higher billet prices were also driven by higher scrap steel costs, but the increased domestic billet shipments, which bring a higher price, also contributed. Improved market conditions and increased domestic demand resulted in improved 1995 billet shipments, as export markets remained highly competitive. Higher scrap steel costs and improved product mix together caused billet selling prices to climb.\n(xi) During the last three fiscal years, the Registrant was not involved in any material research and development activities.\n(xii) The United States Environmental Protection Agency (EPA) has notified the Registrant and the County of Roanoke (County) of their potential liability and responsibility for costs of response to materials at a County-owned landfill site and adjacent streams near Salem, Virginia. The Registrant has entered into a cost-sharing agreement with the County for response action (cleanup) at the landfill site and the streams. Pursuant to a Consent Decree to which EPA, the County and the Registrant were parties, the County completed a remedial action at the landfill in 1995. Under a separate consent order with EPA, the Registrant is performing a removal action at the streams, which includes removal, treatment and on-site placement of materials and affected sediment and soil. That work is approximately 30% performed, and completion is expected in approximately one year. The Registrant has not received notification of other claims associated with the landfill or streams. The Registrant does not anticipate significant future potential liability for response costs associated with the landfill, and while the cost of future response activities or any future claims associated with the streams is difficult to project, management believes such costs would not have a materially adverse effect on the consolidated financial position, results of operations and competitive position of the Registrant. See Note 7, \"Commitments and Contingent Liabilities\", in Notes to Consolidated Financial Statements contained in the Registrant's 1995 Annual Report to Stockholders, filed as an Exhibit to this Form 10-K.\nPART I (con'd.)\nThe Registrant currently disposes of the furnace dust through a contract with an approved waste disposal firm. The Registrant believes it is in substantial compliance with applicable federal, state and local regulations. However, future changes in regulations may require expenditures which could adversely affect earnings in subsequent years. The Registrant has constructed over the years pollution control equipment at an aggregate cost of over $7,700,000. Annual operating expenses and depreciation of all pollution control equipment and waste disposal costs are in excess of $4,300,000 in the aggregate. The Registrant is expected to spend approximately $1,000,000 to $2,000,000 for additional pollution control and waste disposal equipment and facilities during subsequent fiscal years. Adoption of the Clean Air Act Amendments of 1990 is not anticipated to have a materially adverse effect on the Registrant's operations, capital resources or liquidity, nor should any incremental increase in capital expenditures occur due to the Act.\n(xiii) At October 31, 1995, the Registrant employed 499 persons at its Roanoke plant, with no employment at its Salem division, idle since mid-1991. The Registrant's subsidiaries, John W. Hancock, Jr., Inc., Socar, Inc., Shredded Products Corporation and RESCO Steel Products Corporation employed 259, 259, 47 and 44 persons, respectively.\n(d) Financial Information about Foreign and Domestic Operations and Export Sales.\nWhen the Registrant's billet production exceeds its required needs, this semi-finished product is offered for sale. During past years, a portion of the excess billets has been sold to brokers who represent foreign purchasers. During 1993, export (billet) sales to China and Mexico amounted to $4,485,565 and $620,028, respectively, slightly below break-even margins. There were no foreign sales of excess billets or other products during fiscal years 1994 and 1995. The information required by this paragraph by geographical area, as to foreign and domestic operations, is not provided since it is identical to the table in paragraph (b) with all information pertaining to the United States.\nPART I (con'd.)\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Registrant owns 68 acres situated in the City of Roanoke, Virginia, which comprises its main plant, of which 25 acres are used to provide 334,000 square feet of manufacturing space with an annual billet capacity of approximately 600,000 tons. A 30 acre site is owned in Salem, Virginia, of which 10 acres were used to provide 51,355 square feet of manufacturing space, until March 1991, when the plant was idled. The Registrant acquired in 1991 a 447 acre tract of land in Franklin County, Virginia, 100 acres of which was transferred to Shredded Products Corporation in a move of shredding operations from its Montvale location. Part of this new Shredded Products property is being used as an approved industrial landfill. The remaining 337 acres of this land, 47 acres of which was sold in 1995, will be marketed as an industrial park for Franklin County.\nShredded Products Corporation operates in both Montvale and Rocky Mount, Virginia. The Montvale plant is situated on a 75 acre site owned by the Registrant, approximately 20 acres of which are regularly used in its scrap processing operation, with an annual production capacity of approximately 18,000 tons. The new Rocky Mount facility is located on a 100 acre site owned by Shredded Products Corporation, partially consisting of a 25 acre industrial landfill used for the disposal of its auto fluff, and another 25 acres of which are regularly used in its shredding operation, with an annual production capacity of approximately 150,000 tons.\nJohn W. Hancock, Jr., Inc. is located in Roanoke County near Salem, Virginia. The plant is situated on a 37 acre site owned by Hancock, Inc., 17 acres of which are regularly used in its operations. Buildings on the site contain 131,614 square feet of floor space.\nSocar, Inc. and its subsidiaries are located in Florence, South Carolina, and in Continental and Bucyrus, Ohio. The Florence facility is located on a 28 acre site owned by Socar, Inc., 16 acres of which are regularly used in its operations. Buildings on the site contain 93,359 square feet of floor space. The plant located on a 31 acre site\nPART I (con'd.)\nin Continental, Ohio, owned by Socar, Inc., has 81,172 square feet of floor space in manufacturing buildings, situated on 8 acres regularly used in its operations. There is an idle facility in Bucyrus, Ohio, owned by Socar, Inc. (leased to an unaffiliated manufacturer), and located on a 17 acre site, 7 acres of which contain 118,228 square feet of building floor space.\nRESCO Steel Products Corporation operates from a building containing 43,340 square feet of floor space, located in Salem, Virginia, on a 7 acre site owned by RESCO.\nThe various buildings are of modern design, well-maintained, and suitable and adequate for the requirements of the business.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nA County of Roanoke (County) landfill site, where the Registrant disposed of furnace dust from 1969 until 1976, was placed on the National Priorities List as a Superfund site in 1989. The United States Environmental Protection Agency (EPA) has notified the Registrant and the County of their potential liability and responsibility for costs of response at the landfill site and adjacent streams. The Registrant has entered into a cost-sharing agreement with the County for response action (cleanup) at the landfill site and sharing of contribution received from other potentially responsible parties, if any. Under EPA oversight, the County completed remediation action there in 1995. The Registrant's costs associated with that work were reflected in past financial statements or in the accompanying financial statements. Under a consent order and EPA oversight, the Registrant, is implementing a removal action (cleanup) of the streams. While the cost of future response activities or any future claims associated with the streams is difficult to project, management believes such costs would not have a materially adverse effect on the consolidated financial position, results of operations and competitive position of the Registrant. See Note 7, \"Commitments and Contingent Liabilities\", in Notes to Consolidated Financial Statements contained in the Registrant's 1995 Annual Report to Stockholders, filed as an Exhibit to this Form 10-K.\nPART I (con'd.)\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 the fiscal year covered.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nPursuant to General Instruction G(3) of Form 10-K, the following list is included as an unnumbered Item in Part I of this report in lieu of being included in the Proxy Statement for the Annual Meeting of Shareholders to be held on February 20, 1996.\nThe names, ages and positions of all of the executive officers of the Registrant as of October 31, 1995 are listed below with their business experience with the Registrant for the past five years. Officers are elected annually by the Board of Directors at the first meeting of directors following the annual meeting of shareholders. There are no family relationships among these officers, nor any agreement or understanding between any officer and any other person pursuant to which the officer was selected.\nThomas J. Crawford, 40, has served as Secretary of the Registrant since January 1985 and as Assistant Vice President since January 1993; prior thereto, he had served as Manager of Inside Sales since 1984 and as a Sales Representative since 1977. He has 18 years of service with the Registrant.\nDonald R. Higgins, 50, has served as Vice President - Sales of the Registrant since January 1986; prior thereto, he had served as General Sales Manager since 1984 and Assistant Sales Manager since 1978. He has 30 years of service with the Registrant.\nJohn E. Morris, 54, has served as Vice President - Finance of the Registrant since October 1988 and as Assistant Treasurer since 1985; prior thereto, he had served as Controller since 1971. He has 24 years of service with the Registrant.\nPART I (con'd.)\nWilliam L. Neal, 68, has served as President of John W. Hancock, Jr., Inc. (wholly-owned subsidiary of the Registrant) since October 1984 and as Director of the Registrant since January 1989; prior thereto, he had served as Executive Vice President since December 1972. He has 40 years of service with Hancock, Inc.\nDonald G. Smith, 60, has served as Chairman of the Board of the Registrant since February 1989, as Chief Executive Officer since November 1986, as President and Treasurer since January 1985 and as Director of the Registrant since April 1984; prior thereto, he had served as Vice President - - Administration since September 1980 and as Secretary since January 1967. He has 38 years of service with the Registrant.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe specified information required by this item is incorporated by reference to the information under the heading \"Stock Activity\" in the 1995 Annual Report to Stockholders.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe specified information required by this item is incorporated by reference to the information under the heading \"Selected Financial Data\" in the 1995 Annual Report to Stockholders.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe specified information required by this item is incorporated by reference to the information under the heading \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" in the 1995 Annual Report to Stockholders.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe specified information required by this item is incorporated by reference to the information under the headings \"Independent Auditors' Report\", \"Consolidated Financial Statements\" and \"Notes to Consolidated Financial Statements\" in the 1995 Annual Report to Stockholders.\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 specified information required by this item is incorporated by reference to the information under the heading \"Information Concerning Directors and Nominees\" in the Proxy Statement dated December 22, 1995, as filed with the Commission, or is included under the heading \"Executive Officers of the Registrant\" in Part I of this 10-K filing. The disclosure required by Item 405 of Regulation S-K is not applicable.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe specified information required by this item is incorporated by reference to the information under the headings \"Executive Compensation\", \"Compensation and Stock Option Committee Report on Executive Compensation\", \"Compensation Committee Interlocks and Insider Participation\", \"Performance Graph\" and \"Board of Directors and Committees - -- Director Compensation\" in the Proxy Statement dated December 22, 1995, as filed with the Commission.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe specified information required by this item is incorporated by reference to the information under the headings \"Security Ownership of Certain Beneficial Owners\" and \"Security Ownership of Management\" in the Proxy Statement dated December 22, 1995, as filed with the Commission.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe specified information required by this item is incorporated by reference to the information under the heading \"Compensation Committee Interlocks and Insider Participation\" in the Proxy Statement dated December 22, 1995, as filed with the Commission.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) The following documents are filed as a part of this report:\n(1) The following financial statements are filed as part of the 1995 Annual Report to Stockholders which is incorporated by reference:\n(a) Consolidated Balance Sheets (b) Consolidated Statements of Stockholders' Equity (c) Consolidated Statements of Earnings (d) Consolidated Statements of Cash Flows (e) Notes to Consolidated Financial Statements (f) Independent Auditors' Report\nIndividual financial statements of the Registrant are not being filed because the Registrant is primarily an operating company and its subsidiaries do not have minority equity interests and\/or long-term indebtedness (including current portions) to any person outside the consolidated group (excluding long-term indebtedness which is collateralized by the Registrant by guarantee, pledge, assignment or otherwise), in amounts which together exceed 5 percent of the total consolidated assets.\n. PART IV (con'd.)\n(2) Pursuant to Regulation S-K the following Exhibit Index is added immediately preceding the exhibits filed as part of the subject Form 10-K:\nEXHIBIT INDEX EXHIBIT NO. EXHIBIT PAGE\n(3) (a) Articles of Incorporation 20 Incorporated by Reference\n(b) By-Laws, as amended 21\n(4) Instruments Defining the Rights of Security Holders 22\n(10) * (a) Executive Officer Incentive Arrangement 23 Incorporated by Reference\n* (b) Roanoke Electric Steel Corporation Employees'Stock Option Plan 23 Incorporated by Reference\n(13) 1995 Annual Report to Stockholders 24\n(21) Subsidiaries of the Registrant 25\n(23) Consent of Independent Auditors 26\n(27) Financial Data Schedule 27\n(b) Reports on Form 8-K.\nThere were no reports on Form 8-K filed by the Registrant during the last quarter of the fiscal period covered by the Annual Report.\n* Management contract, or compensatory plan or agreement, required to be filed as an Exhibit to this Form 10-K pursuant to Item 14 (c).\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nROANOKE ELECTRIC STEEL CORPORATION Registrant\nBy: Donald G. Smith Donald G. Smith, Chairman, President, Treasurer and Chief Executive Officer (Principal Executive Officer, Principal Financial Officer and Director)\nDate: January 25, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, 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 and Title Date\nDonald G. Smith January 25, 1996 Donald G. Smith, Chairman, President, Treasurer and Chief Executive Officer (Principal Executive Officer, Principal Financial Officer and Director)\nJohn E. Morris January 25, 1996 John E. Morris, Vice President - Finance and Assistant Treasurer (Principal Accounting Officer)\nGeorge B. Cartledge, Jr. January 25, 1996 George B. Cartledge, Jr. Director\nPaul E. Torgersen January 25, 1996 Paul E. Torgersen Director\nWilliam L. Neal January 25, 1996 William L. Neal Director\nThomas L. Robertson January 25, 1996 Thomas L. Robertson Director\nGordon C. Willis January 25, 1996 Gordon C. Willis Director\nEXHIBIT NO. 3 (a)\nARTICLES OF INCORPORATION\nIncorporated by reference to the previously filed Form 10-K for October 31, 1990 on file in the Commission office.\nEXHIBIT NO. 3 (b)\nBY-LAWS, AS AMENDED\nEXHIBIT NO. 4\nINSTRUMENTS DEFINING THE RIGHTS OF SECURITY HOLDERS\nPursuant to Item 601(b) (4) (iii) of Regulation S-K, the Registrant hereby undertakes to furnish to the Commission, upon request, copies of the instruments defining the rights of holders of the long-term debt of Roanoke Electric Steel Corporation and its subsidiaries described in its 1995 Annual Report to Stockholders and Form 10-K.\nEXHIBIT NO. 10\n* (a)\nEXECUTIVE OFFICER INCENTIVE ARRANGEMENT\nIncorporated by reference to the previously filed Form 10-K for October 31, 1993 on file in the Commission office.\n* (b)\nROANOKE ELECTRIC STEEL CORPORATION EMPLOYEES' STOCK OPTION PLAN\nIncorporated by reference to the previously filed Form 10-K for October 31, 1992 on file in the Commission office.\n* Management contract, or compensatory plan or agreement, required to be filed as an Exhibit to this Form 10-K pursuant to Item 14 (c).\nEXHIBIT NO. 13\n1995 ANNUAL REPORT TO STOCKHOLDERS\nEXHIBIT NO. 21\nSUBSIDIARIES OF THE REGISTRANT\nRegistrant: Roanoke Electric Steel Corporation\nOrganized Under Subsidiary of Registrant Jurisdiction of\nShredded Products Corporation Virginia John W. Hancock, Jr., Inc. Virginia Socar, Incorporated South Carolina RESCO Steel Products Corporation Virginia Roanoke Technical Treatment and Services, Inc. Virginia\nEXHIBIT NO. 23\nDELOITTE & TOUCHE LLP Suite 1401 Telephone: (910) 721-2300 500 West Fifth Street Facsimile: (910) 721-2301 P.O. Box 20129 Winston-Salem, North Carolina 27120-0129\nCONSENT OF INDEPENDENT AUDITORS\nRoanoke Electric Steel Corporation:\nWe hereby consent to the incorporation by reference in Registration Statement Nos. 33-27359 and 33-35243 on Form S-8 of our report dated November 17, 1995, appearing in and incorporated by reference in this Annual Report on Form 10-K of Roanoke Electric Steel Corporation for the year ended October 31, 1995.\nDeloitte & Touche LLP\nWinston-Salem, North Carolina January 25, 1996\nDeloitte Touche Tohmatsu International\nEXHIBIT NO. 27\nFINANCIAL DATA SCHEDULE","section_15":""}
{"filename":"759253_1995.txt","cik":"759253","year":"1995","section_1":"Item 1. Business.\nGeneral.\nWinthrop Financial Associates, A Limited Partnership (\"WFA\") was organized as a Maryland limited partnership under the Maryland Revised Uniform Limited Partnership Act on December 4, 1984. WFA is a real estate investment and management firm, primarily engaged, through entities which it controls, in the acquisition and operation of real estate for its own account and in the business of providing property management, asset management and investor services to affiliated investment partnerships and unaffiliated owners of developed real estate.\nThe general partner of WFA is Linnaeus Associates Limited Partnership, a Maryland limited partnership (\"Linnaeus\"). See \"Change in Control\" below.\nAt the time of its formation, WFA's principal business and revenue source was its real estate syndication operation. This operation was the mechanism by which WFA increased the portfolio of real estate assets under its control and management. By the end of 1993, WFA decided to discontinue financing its investment activities through the syndication process. WFA continues to provide asset management, investor services and, in many instances, property management services to investment partnerships previously syndicated by WFA, or currently controlled by WFA or its affiliates.\nThe company's business is presently focused on strategic investment acquisitions of improved real estate for its own account and the growth of its asset and property management-related service operations.\nChange In Control\nPrior to December 22, 1994, Mr. Arthur J. Halleran, Jr. was the sole general partner of Linnaeus. On December 22, 1994, the general partnership interest in Linnaeus was transferred to W.L. Realty, L.P. (\"W.L. Realty\") pursuant to an Investment Agreement entered into among Nomura Asset Capital Corporation (\"NACC\"), a Delaware corporation, Mr. Halleran and certain other individuals who comprised the senior management of WFA. NACC is a wholly-owned subsidiary of Nomura America Holding Inc., a Delaware corporation, which is a wholly-owned subsidiary of Nomura Securities Company, Ltd., a Japanese corporation with worldwide investment banking, securities and commodities operations. W.L. Realty was a then newly-organized Delaware limited partnership, the general partner of which was A.I. Realty Company, LLC, a then newly-organized New York limited liability company (\"Realtyco\"). The equity securities of Realtyco were held by certain employees of NACC. The limited partners of W.L. Realty at the time of its formation were NACC, Mr. Halleran and five other individuals who comprised the senior management of WFA.\nOn July 18, 1995 Londonderry Acquisition II Limited Partnership (\"Londonderry II\"), a Delaware limited partnership and affiliate of Apollo Real Estate Advisors, L.P. (\"Apollo\"), a Delaware limited partnership, executed a purchase agreement, dated as of July 14, 1995 (\"Purchase Agreement\"), by and among Londonderry II, NACC, Realtyco, Partnership Acquisition Trust I, a Delaware business trust (\"PATI\"), and Property Acquisition Trust I, a Delaware business trust (\"PAT\").\nPursuant to the Purchase Agreement, Londonderry II purchased (i) NACC's sixty four percent (64%) limited partnership interest in W.L. Realty, (ii) Realtyco's one percent (1%) general partnership interest in W.L. Realty, (iii) all of NACC's right, title and interest in and to, and the indebtedness evidenced by, that certain acquisition loan agreement (the \"WLR Acquisition Loan Agreement\"), dated as of December 22, 1994, with W.L. Realty, as borrower, pursuant to which NACC made loans to W.L. Realty to finance W.L. Realty's acquisition of general and limited partnership interests in Linnaeus Associates Limited Partnership, a Maryland limited partnership (\"Linnaeus\"), (iv) all of NACC's right, title and interest to, and the indebtedness evidenced by, that certain acquisition loan agreement dated as of January 31, 1995, with Aquarius Acquisition, L.P., a Delaware limited partnership (the \"Aquarius Partnership\"), as borrower, pursuant to which NACC made loans to the Aquarius Partnership to finance the Aquarius Partnership's acquisition of limited partnership interests in Springhill Lake Investors Limited Partnership, a Maryland limited partnership (\"Springhill Lake\"), pursuant to a tender offer and certain private acquisition transactions, (v) all of NACC's right, title and interests pursuant to the agreement (the \"Investment Agreement\"), dated as of December 3, 1994, by and among NACC, Linnaeus, Mr. Arthur J. Halleran, Mr. Jonathan W. Wexler and the other signatories thereto (collectively, the \"Management Group\"), (vi) the one percent (1%) general partnership interest in the Aquarius Partnership, and (vii) a seventy four percent (74%) limited partnership interest in the Aquarius Partnership.\nAs a result of the foregoing acquisitions, Londonderry II is the sole general partner of W.L. Realty which is the sole general partner of Linnaeus, and which in turn is the sole general partner of WFA. As a result of the foregoing, Londonderry II acquired control of WFA from NACC.\nLondonderry II consummated the transactions set forth above for a total consideration of $32 million, of which $10 million was provided by Apollo. In addition, Londonderry II issued NACC a $22 million non-recourse purchase money note due 1998 (the \"Purchase Money Note\"), as set forth in a loan agreement, dated as of July 14, 1995, by and between NACC and Londonderry II.\nInitial security for the Purchase Money Note includes (i) the W.L. Realty partnership interest acquired by Londonderry II, (ii) the Aquarius partnership interests in Springhill Lake, (iii) the partnership interests in WFA of Londonderry Acquisition Limited Partnership, a Delaware limited partnership which is an affiliate of Londonderry II and Apollo (\"Londonderry I\"), (iv) the W.L. Realty partnership interest in Linnaeus, and (v) Londonderry II's title and interest in and to, and the indebtedness evidenced by, the WLR Acquisition Loan Agreement.\nIn addition to the foregoing, Apollo, Londonderry I, WFA and the Management Group executed an agreement, dated as of July 14, 1995 (the \"Management Agreement\"), which effected (i) the sale to WFA of the equity interests held by the members of the Management Group in W.L. Realty and certain of its affiliates, (ii) the release of the Management Group by Londonderry I, Apollo and WFA from all claims other than those arising out of the Management Agreement, (iii) the release of Londonderry I, Apollo and WFA by the Management Group from all claims other than those arising out of the Management Agreement and (iv) certain matters with respect to the employment of the Management Group, as set forth below.\nIn connection with the Management Groups' sale of their equity interests in W.L. Realty and certain of its affiliates, Messrs. Halleran and Wexler resigned all of their positions as officers, employees and directors of WFA and its affiliates. In connection therewith, pursuant to their respective employment agreements WFA paid an aggregate of $2,318,537 in severance to Messrs. Halleran and Wexler. Messrs. Halleran and Wexler also reaffirmed the survival of their non-competition and non-solicitation covenants with WFA. Also, pursuant to the Management Agreement, certain members of WFA's continuing management received bonuses from WFA to continue in their current employ with WFA. Such members of WFA's management have covenanted as to the continuing survival of their employment agreements with WFA. See \"Item 11, Executive Compensation\".\nAs a result of these transactions and subsequent purchases of limited partnership assignee units, Apollo and its affiliates beneficially own the entire general partner ownership interest in WFA, representing a 13.01% of ownership interest in WFA, and a limited partnership interest in WFA, representing approximately a 82.25% ownership interest. See \"Item 12, Security Ownership of Certain Beneficial Owners and Management.\"\nDescription of Business.\n(a) Investment Acquisitions.\nDuring 1993, 1994 and 1995 WFA and its affiliates acquired the fee interest in 35 apartment properties. As of December 31, 1995, WFA and its affiliates owned a total of 35 apartment properties with a total of 8,176 apartment units. Rental income derived from WFA's wholly-owned real estate represents approximately 66% of the company's total revenue for 1995. WFA has no current intention to syndicate its wholly-owned apartment properties and is presently holding these properties for investment purposes. Significant property acquisitions and financing activities completed in 1995, 1994 and 1993 are summarized below.\nSpringhill Lake Limited Partnership (\"Springhill Lake\"). On February 1, 1995, Aquarius Acquisition, L.P., a Delaware limited partnership, the general partner of which is Londonderry II and the limited partner of which is WFA (\"Aquarius\"), offered to purchase outstanding limited partner interests (\"Springhill Units\") in Springhill Lake. Springhill Lake was organized in 1984 to invest in ten operating partnerships formed to own and operate a garden apartment complex containing 2,899 apartment units located in Greenbelt, Maryland (the \"Project\"). On March 21, 1995, Aquarius' offer to purchase Springhill Units for cash consideration of $36,400 concluded. Aquarius purchased 216.65 Springhill Units (approximately 33.4% of the total Springhill Units outstanding). Subsequently, a number of limited partners in Springhill Lake requested that Aquarius purchase their units for the price specified in the tender offer. As of March 1, 1996, Aquarius owns a total of 234.65 Springhill Units (approximately 36.16% of the total Springhill Units outstanding).\nThe tender offer was commenced shortly following the mailing on January 19, 1995 of a consent solicitation to the limited partners of Springhill Lake by Greenbelt Residential Limited Partnership (\"Greenbelt\"), an affiliate of Theodore N. Lerner (\"Lerner\"). Lerner negotiated the purchase of Springhill Lake's 90% interest in the Project in the mid 1980's and holds a 10% limited partnership interest in each of the ten operating partnerships. An affiliate of Lerner (\"Lerner Management\") had performed property management services at the Project for the 10 years prior to May 1995. In October 1994 Springhill Lake notified Lerner Management of its intention to terminate the property management contract with Lerner Management. Greenbelt thereafter made an offer to purchase the Project and approximately six weeks later began soliciting the consent of a majority in interest of the limited partners of Springhill Lake to a dissolution of Springhill Lake, with the stated goal of forcing a sale of the Project. The termination of Lerner Management as property manager, the engagement of Winthrop Management as the new property manager and the tender offer have given rise to a series of lawsuits. See, \"Item 3, Legal Proceedings.\" Effective May 1, 1995, Winthrop Management executed a property management agreement and assumed responsibility for on-site management of the Project.\nWinthrop-Austin Holdings, LP (\"Winthrop-Austin\"). Winthrop-Austin, a Delaware limited partnership, was formed in 1995 for the purpose of acquiring in April 1995 the fee interest in a 329 unit garden style apartment complex located in Austin, Texas known as \"The Hills\" and \"The Hills West\". Fifteen Winthrop Properties, Inc. is the sole general partner of Winthrop-Austin and WFA as the sole limited partner of Winthrop-Austin. Winthrop-Austin acquired The Hills for a total purchase price of $11,050,000 (approximately $33,587 per apartment unit) of which $1,000,000 was provided in seller financing and $8,470,000 was provided through a mortgage loan from NACC. See \"Item 13, Certain Relationships and Related Party Transactions.\" At the time of acquisition, Winthrop Management assumed property management and asset management functions.\nSouthwestern Properties. In July 1993 two wholly-owned subsidiaries of WFA acquired a general partnership interest and approximately 11% of the total equity interest in a portfolio of 25 apartment properties (containing 6,287 units) located primarily in Texas and Arizona (the \"Southwestern Properties\"). WFA paid approximately $5.2 million (excluding brokerage fees) for these interests and the management rights associated with these properties. In January 1994, WFA acquired the balance of the general partnership interest and control of the partnerships owning these properties, together with a 30% equity interest held by affiliates of an investment banking firm which had arranged debt financing for the properties, for approximately $3.9 million. On May 31, 1994, WFA acquired the balance of the equity interests held by the seller and its affiliates for approximately $10.4 million.\nAs part of the transaction in which WFA acquired its general partnership interest in the Southwestern Properties, the partnerships owning these properties incurred an aggregate of $106.3 million of non-recourse mortgage financing. The loans are generally payable, interest only at 9% per annum until July 2000. A senior portion of the debt, in the approximate amount of $93 million, matures in July 2000. A junior portion of the debt, in the approximate amount of $13.3 million, matures in July 2018, but the annual rate of interest payable on the principal balance and accrued interest after July 2000 is 11%.\nIn July 1995, WFA contributed to Winthrop Southwest Holdings Limited Partnership (\"WSWH\"), a newly-formed partnership, all of its right, title and interest in and to the Southwestern Properties and NACC contributed to WSWH a $17,800,000 note receivable from WFA and First Winthrop Corporation. Pursuant to the terms of WSWH's partnership agreement, NACC is entitled to receive the first $17,800,000 in distributions from such partnership together with a priority return of LIBOR plus 6.5% on such contribution. The $17,800,000 note was the note made in connection with the settlement of a litigation involving First Winthrop Corporation. See \"Item 3, Legal Proceedings - Fred Rosen et al v. First Winthrop Corporation et al.\"\nWinthrop Florida Apartments Limited Partnership (\"Winthrop Florida\"). Winthrop Florida is a Maryland limited partnership which owns nine apartment complexes (the \"Winthrop Florida Properties\") consisting of 1,560 units in the aggregate. The general partner of Winthrop Florida is Fourteen Winthrop Properties, Inc.(\"14 Winthrop\") and WFA is the limited partner. The properties owned by Winthrop Florida are all managed by Winthrop Management.\nOf the nine properties, two garden style apartment complexes containing 486 units were acquired in 1994. These properties are located in Jacksonville, Florida and San Antonio, Texas. The aggregate acquisition price for these properties was $15.1 million (averaging approximately $31,100 per apartment unit) which was originally funded from advances from WFA's cash resources, advances under WFA's credit facilities and the assumption of $9.4 million of mortgage debt. The average age of these properties is 8 years.\nIn connection with the refinancing of the Winthrop Florida Properties described below:\n(i) Sandcastles Associates Limited Partnership (\"Sandcastles\"), a limited partnership, the general partner of which was 14 Winthrop and the limited partner of which was WFA, transferred its interest in its 138 unit garden style apartment complex located in Houston, Texas which it had acquired in 1994. Sandcastles acquisition price for this property was $5.2 million (approximately $37,700 per apartment unit) which was originally funded from advances from WFA's cash resources, advances under WFA's credit facilities and the assumption of $3.9 million of mortgage debt. The age of the property is 8 years; and\n(ii) Winthrop Multi-Family Limited Partnership transferred its interest in six properties containing 936 units in the aggregate. Of the six properties, two are located in Houston, Texas, and one property is located in each of Morrow, Georgia, Greensboro, North Carolina, Bedford, Texas and Austin, Texas. These properties were encumbered by $15,000,000 of first mortgage debt.\nIn July, 1995, Winthrop Florida obtained a loan from a third party lender in order to refinance the existing mortgages on all of the Winthrop Florida Properties. The principal amount of the mortgage loan was $42,000,000. It bears interest at LIBOR plus 3%, with an overall interest rate cap of 10.19%, and matures on June 30, 1998.\nSee \"Item 13, Certain Relationships & Related Party Transactions,\" for additional information on investment acquisitions made by WFA.\n(b) Service Business.\nApproximately 27% of WFA's revenue in 1995 was derived from its property management-related service operations. WFA, through its subsidiary partnerships, performs on-site property management, leasing, asset management, insurance brokerage and certain tenant-related services (collectively, the \"Service Business\"). During 1995 and the first quarter of 1996, management determined to outsource certain services which it had historically performed such as building security and cleaning services. The Service Business provides management and related services to many of the investment partnerships organized or controlled by WFA. Most of the revenue earned by WFA's Service Business is derived from contractual relationships with investment partnerships organized by WFA.\nWFA's Service Business is conducted primarily through Winthrop Management, a general partnership consisting of wholly-owned corporate subsidiaries of WFA. The Service Business is organized functionally into three principal divisions which are described below.\nApartment Division. The Apartment Division of Winthrop Management is responsible for property management (as well as acquisitions) with respect to the portion of WFA's portfolio comprised of multifamily apartment properties. This division also provides strategic direction, performance evaluation and advisory services to certain investment partnerships organized or controlled by WFA which own apartment properties. This division employs a total of approximately 912 people, which total includes acquisitions officers, national property management staff (including accounting functions), regional property management staff and on-site management personnel. The division maintains its headquarters in Boston and maintains regional offices at property locations throughout the United States. As of January 1, 1996, the division managed a total of approximately 30,287 apartment units, making WFA the 19th largest apartment manager in the U.S., based on a ranking compiled by the National Multi-Housing Council as of January 1, 1996. All but one of the apartment properties under management at December 31, 1995 were owned either by investment partnerships organized by WFA or by partnerships in which a subsidiary of WFA has acquired control through purchase of the general partnership interest.\nIn addition to the new management assignments described in \"Item 1, Description of Business-Investment Acquisitions,\" dDuring the second quarter of 1995 the Apartment Division assumed management of an apartment complex owned by a third party consisting of 643 units.\nCommercial Division. During 1995 the Commercial Division provided property management, leasing, consulting and tenant services to commercial office, retail and industrial facilities owned by both Winthrop-syndicated partnerships and unaffiliated third parties. Revenues for 1995 earned under contracts with non-affiliates represented approximately 23.8% of the total revenues earned for 1995 from the operations of the Commercial Division. The decline in revenues derived from non-affiliates compared to prior years is principally attributable to the termination in August 1995 of Winthrop Management's management and leasing assignment at One Federal Street, a 1.1 million square foot office tower located in Boston, Massachusetts.\nFollowing the loss of One Federal assignment, WFA evaluated the staffing requirements and profitability of its remaining third party management and advisory service assignments and its tenant services business. As a result of this evaluation, WFA made the decision to downsize its Commercial Division and to terminate the remainder of its existing third party assignments. In the first quarter of 1996, WFA outsourced to third party operators all of its tenant service functions, including construction services and building cleaning and security. In addition, in connection with the sale by the holder of the debt encumbering the properties owned by Nineteen New York Properties Limited Partnership, an affiliate of WFA, WFA and its affiliates no longer provide property management or leasing services for these properties.\nUntil December 1995, the Commercial Division also provided advisory services to Pioneer Winthrop Real Estate Investment Fund (the \"Fund\"), an open-ended mutual fund which is a member of the Pioneer Group of Funds. The Fund was organized in 1993 to invest in securities of real estate investment trusts and other real estate-related companies. A registered Investment Advisor, which is wholly-owned by WFA, had been engaged to provide advisory services to the Fund's manager, including evaluating and selecting securities of real estate investment trusts and other real estate-related companies for the Fund.\nAs a result of the placement of a number of services previously performed by the Commercial Division with third parties, the number of employees employed by the Commercial Division has been reduced from approximately 414 people in 1994 to 97 people at April 1, 1996. The Commercial Division employees are located either in the Boston headquarters office or at the individual properties.\nAs of March 1, 1996, Winthrop Management continues to provide management, consulting, leasing, construction and supervisory services to three office towers, five industrial properties and one mixed-use property, consisting principally of retail shops. The division currently manages and\/or leases approximately 3.4 million square feet of commercial space, all of which is owned by investment partnerships organized or controlled, directly or indirectly, by WFA, of which 2,726,000 square feet consists of office space, 546,000 square feet consists of industrial space and 143,000 square feet consists of retail shops.\nRevenue from the operations of the Commercial Division represented 3.7% of WFA's annual revenue for 1995. As a result of the significant changes made in the Commercial Division during 1995 and the first quarter of 1996, it is expected that the percentage of WFA's total revenue earned from the activities of the Commercial Division will be substantially less in 1996. Similarly, the expenses attributable to the Commercial Division are expected to be substantially reduced.\nAsset Management Division. This division provides strategic direction, performance evaluation and advisory services principally to 226 existing investment partnerships sponsored by WFA and its affiliates. The division also handles relations and communications with investor limited partners in these partnerships. These investors consist of approximately 40,000 individuals and fiduciaries.\nHotel Division. In July 1994, WFA sold its hotel management operations to an unaffiliated party for $1.5 million. WFA and its affiliates, however, retain their ownership interests in the related hotel properties. See \"Item 7, Management's Discussion and Analysis of Results of Operations and Financial Condition.\"\nEmployees. As of March 1, 1996, WFA and its affiliates employed approximately 1,050 individuals down from 1,245 at March 21, 1995, with approximately 1,010 employed in the investment acquisition and Service Business and approximately 40 employed in corporate administration and support functions.\nCompetition. The performance of WFA's wholly-owned apartment properties is impacted by a number of competitive factors, including (i) the relative age and quality of WFA's properties in comparison to other apartment properties in the same market, (ii) rental concessions offered at properties of similar quality in similar locations in response to fluctuations in consumer demand, and (iii) and the types and quality of amenities and services provided by properties in the markets in which WFA's properties are located.\nCompetition for property management-related service contracts tends to be dominated by regionally-based firms. WFA possesses industry knowledge, relationships and operating efficiencies that come from being a large, well-established organization. Because the company's operational activities are conducted through a network of regional and local operating offices, WFA has first-hand knowledge about the various economic, governmental and other important factors affecting its markets.\nBoth the Commercial Division and, the Apartment Division provide services primarily to properties which are either wholly-owned by, or controlled by, WFA and its affiliates and is therefore not at significant risk of losing property management-related business to competitors.\nEnvironmental Regulations. Under various Federal and state environmental laws and regulations, a current or previous owner or operator of real estate may be required to investigate and clean up certain hazardous or toxic substances or petroleum product releases at a property, and may be held liable to a governmental entity or to third parties for property damage and for investigation and cleanup costs incurred by such parties in connection with contamination. The owner or operator of a site may be liable under common law to third parties for damages and injuries resulting from environmental contamination emanating from the site. Management is not currently aware of any environmental liabilities which are expected to have a material adverse effect on WFA's operations or financial condition.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nWFA currently rents its principal executive offices consisting of (i) approximately 31,450 square feet in Boston, Massachusetts, and (ii) approximately 4,800 square feet in Jericho, New York of which approximately 3,000 square feet is subleased to non-affiliated third parties.\nIn addition to the apartment properties referenced above under the subheading \"Investment Acquisitions,\" WFA and its affiliates also own (i) certain retail properties containing 17,240 square feet and other real estate assets on the island of Nantucket, Massachusetts, and (ii) six parcels of land subject to long-term ground leases to investment partnerships organized by WFA.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nWFA, its affiliates and subsidiaries are parties to routine litigation arising in the ordinary course of business, in respect of which any liability is expected to be covered by liability insurance. In addition, WFA, certain of it affiliates and subsidiaries, and various former and current officers of WFA are or were defendants in the following legal proceedings:\nFred Rosen, et al v. First Winthrop Corporation, et al., filed in December, 1988 in the State District Court of Harris County, Texas. The plaintiffs were investor limited partners in One Houston Associates Limited Partnership (\"One Houston\"), a real estate investment partnership organized in 1982. One Houston owned an office building in Houston occupied by a single tenant under a net lease. The tenant became insolvent in 1988, necessitating a renegotiation of the lease and the mortgage indebtedness encumbering the property. Ultimately, in 1992, the tenant's operations were taken over by the FDIC, which rejected the lease, triggering a filing for relief under Federal bankruptcy law by One Houston. A foreclosure sale occurred on March 30, 1994.\nThe case was tried to a jury and, on February 2, 1995, the jury returned a verdict for the plaintiffs against First Winthrop and found damages of at least $30 million. On March 3, 1995, WFA and First Winthrop entered into a memorandum of agreement with the plaintiffs in which WFA and First Winthrop agreed to settle the case by paying One Houston the sum of $17 million on or before June 1, 1995. Notice of the settlement was sent out to limited partners of One Houston and the settlement was approved by the court several weeks later at a hearing held on May 12, 1995.\nIn order to finance the settlement amount, First Winthrop obtained an unsecured loan from NACC in the amount of $17,700,000. This loan was subsequently increased to $17,800,000 and contributed by NACC to a newly-formed partnership, the partners of which are NACC and WFA. See \"Item 1, Business - Description of Business, Investment Acquisitions, Southwestern Properties.\"\nGray, et al v. First Winthrop Corporation, et al. (No. C-90-2600- JPV), filed on September 10, 1990 in the U.S. District Court, Northern District of California. This suit was brought by a class of limited partners in 353 San Francisco Associates Limited Partnership (\"353\"), a real estate investment partnership organized in 1984. 353 owned an office building in San Francisco which was foreclosed upon by the first mortgage lender in April 1990. The plaintiffs allege violations of common law and securities law fraud in the conduct of the original offering of investment interests and seek rescission of their investment, totaling $28 million.\nIn September, 1994, summary judgment was entered against the plaintiffs and in favor of First Winthrop on all claims asserted by the plaintiffs. The plaintiffs appealed to the United States Court of Appeals for the Ninth Circuit and oral arguments were heard on January 6, 1996. First Winthrop expects that summary judgment will be affirmed.\nM&R Limited Partnership v. Winthrop Financial Associates, et al. (Case No. 94-02575), filed on March 4, 1994 in Circuit Court of the 17th Judicial Circuit, Broward County, State of Florida. The plaintiff is a limited partner in Sixty Six Associates Limited Partnership (\"Sixty-Six LP\"). Sixty-Six LP was organized in 1987 to invest in two operating partnerships formed to own and operate the Pier 66 Resort and Marina in Fort Lauderdale, Florida. In March 1993, the operating partnerships filed for bankruptcy and, pursuant to a pre-negotiated plan, the operating partnerships sold the resort to an unaffiliated party. The plaintiff has asserted individual claims, derivative claims and class claims (brought on behalf of an unidentified class of similarly situated limited partners), alleging violations of Florida state securities laws, breach of fiduciary duties, fraud and negligence associated with the offering of limited partnership interests in the Partnership. The complaint sought unspecified damages, but asserted that damages exceeded $66 million. In December 1995, the court approved a Stipulation of Settlement and, after notice to the class members and a final hearing, the court, on March 4, 1996, entered a final order which dismissed with prejudice all class claims, all derivative claims and the action in its entirety as against WFA. Pursuant to the terms of the settlement, WFA and certain of its affiliates paid $675,000 in consideration of the settlement. Twelve class members opted out of the settlement and are not bound by the settlement.\nAlbert Friedman, individually and as a representative of a class of similarly situated persons v. Linnaeus Associates Limited Partnership, et al. (Case No. 94-CH-11524), filed in December, 1994, in Circuit Court of Cook County, State of Illinois. The plaintiff is a limited partner in WFA and seeks to represent a class comprised of Preferred Unitholders of WFA. The plaintiff asserts various claims against Linnaeus, NACC and members of WFA's senior management, including breaches of fiduciary duties in entering into the December 22, 1994 transactions resulting in the transfer of the general partnership interest in Linnaeus. Plaintiff seeks damages in an unspecified amount. Linnaeus and certain of the individual defendants have filed a special appearance with the Court for the purpose of contesting personal jurisdiction.\nOn March 20, 1996, a Stipulation of Settlement was entered into pursuant to which Londonderry Acquisition Corp., Inc. or its affiliate (\"Londonderry Corp.\"), an affiliate of WFA, will undertake to liquidate the investments of the class members by effecting a merger pursuant to which the Preferred Unitholders of WFA will have the right to receive cash consideration per Preferred Unit equal to an amount determined by Londonderry Corp., but which must be opined on by a nationally recognized, independent investment banking firm as fair from a financial point of view. In no event will the price per Preferred Unit be less than $10.50. Preferred Unitholders will retain their rights to receive, in lieu of the merger price, an amount determined pursuant to such limited partner's appraisal rights under Maryland law. In exchange, Preferred Unitholders who do not request exclusion from the class will completely and finally release their claims against the defendants in this action and their right to bring derivative action on behalf and in the right of WFA. If Preferred Unitholders holding a certain percentage of units request exclusion from the settlement, Londonderry Corp. has the right to declare the stipulation null and void. A hearing for final approval of the Stipulation of Settlement is scheduled for May 23, 1996. If the settlement is approved, Preferred Unitholders interest in WFA will be liquidated pursuant to the merger transaction and affiliates of Apollo will own 100% of the total partnership interests in WFA.\nTheodore N. Lerner v. Three Winthrop Properties, Inc., (Case No. DKC-3601) (the \"Lerner Action\").\nMitchel R. Montgomery, et al. v. Three Winthrop Properties, Inc. (Case No. 132222-V) (the \"Montgomery Action\")\nLER 8 v. Three Winthrop Properties, Inc., et al. (Case No. DKC-95- 555) (the \"LER 8 Action\").\nIn connection with the tender offer made by Aquarius for units of limited partnership interest in Springhill Lake and the termination of Lerner Management and the appointment of Winthrop Management as the property manager at the Springhill Lake property, a number of lawsuits were commenced against Three Winthrop Properties, Inc., the managing general partner of Springhill Lake, NACC and certain affiliated parties. These lawsuits, to the extent they involve damage claims against WFA, its subsidiaries and affiliates, are described below:\nThe Lerner Action was filed on December 27, 1994, in United States District Court for the District of Maryland, Southern District. The plaintiff (\"Lerner\") is a limited partner in the Springhill Operating Partnerships. The claims against Three Winthrop are for an accounting and breach of fiduciary duty. The plaintiff contends that Three Winthrop as managing general partner of the general partner of the Springhill Operating Partnerships has failed to make certain distributions to which he claims an entitlement. Plaintiff has not specified a particular monetary amount which he seeks, but does claim that more than $50,000 is involved. Three Winthrop acknowledges that the plaintiff is entitled to approximately $200,000 in distributions for the 1994 calendar year, but has denied that he is owed any other amount. Discovery is ongoing and it is not possible to predict the likely outcome of the litigation at this time.\nThe Montgomery Action was filed on February 7, 1995, in Circuit Court of Montgomery County, Maryland. The plaintiffs are two limited partners in Springhill Lake and the limited partner in the Springhill Operating Partnerships (Lerner). Plaintiffs allege that Three Winthrop has breached its fiduciary duty by attempting to discharge the current property management agent for the Project and replace it with an affiliate of Three Winthrop. Plaintiffs seek equitable relief and damages in an unspecified amount. During the pendency of the Montgomery Action, one of the plaintiffs sold his interest in Springhill Lake and ceased to be a plaintiff. On January 22, 1996, the court granted the defendant's motion for partial summary judgment on all individual claims as well as the claims of another of the plaintiffs. The only remaining claim is therefore the claim of plaintiff Lerner on behalf of the operating partnerships.\nThe LER 8 Action was filed in U.S. District Court for the District of Maryland, Southern District, on February 27, 1995. A limited partner filed this lawsuit on its own behalf and derivatively on behalf of Springhill Lake, alleging that Three Winthrop is in violation of Rule 13E-3 promulgated under the Securities Exchange Act of 1934 and that Three Winthrop has breached its fiduciary duty to limited partners. LER 8 also moved to preliminarily enjoin the tender offer commenced by Aquarius. Plaintiff has not articulated a claim for any damages. On February 27, 1995, Greenbelt Residential Limited Partnership (\"Greenbelt\"), an affiliate of Lerner, filed a motion to intervene as a plaintiff in the above action. On March 7, 1995, the court held a hearing on a motion to preliminarily enjoin the tender offer of Aquarius. Counsel for LER 8 and Greenbelt appeared and argued in support of the preliminary injunction. At the conclusion of the hearing, the court denied the motion for preliminary injunction, as well as an application for a temporary restraining order pursuant to an amended complaint filed the day of the hearing. The Court based its decision on the grounds that no irreparable injury would be suffered by limited partners of Springhill Lake if Aquarius' offer to purchase limited partner interests were allowed to proceed.\nThree Winthrop believes that the aforementioned claims against Three Winthrop are without merit and intends to defend vigorously against these allegations.\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 1995.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.\nWFA has, to date, issued 15,284,243 units of limited partnership interest. WFA Nominee Co., Inc., a subsidiary of WFA, legally owns all units of limited partnership interest in WFA and has assigned substantially all of such limited partnership interests to Linnaeus and to those purchasers of assignee units of limited partnership interest who acquired such units in a public offering pursuant to a 1985 registration statement. Such units were assigned on the basis of one unit of limited partnership interest per assignee unit of limited partnership interest (the \"Assignee Units\"). All of the ownership attributes of limited partnership interests were also granted to holders of Assignee Units (\"Unitholders\").\nIn September 1986, WFA's Partnership Agreement was amended by a majority vote of Unitholders of WFA. The amendment had the effect of: (i) granting to Unitholders, exclusive of Linnaeus, (the \"Preferred Unitholders\") a preferred distribution from all available operating cash flow equal to 6% per annum cumulative simple return on the Preferred Unitholders' original investment, reduced from time to time by any capital distributions, (ii) granting to all Preferred Unitholders a preferred distribution from all capital distributions of an amount equal to the greater of their original investment or fair market value, and (iii) granting WFA the right to redeem at any time all Assignee Units held by Preferred Unitholders (the \"Preferred Units\").\nThere is generally no established public trading market for the Preferred Units. Trading in the Preferred Units is sporadic and occurs solely through private transactions. As of December 31, 1995, there were 1,424 Preferred Unitholders holding 2,712,814 Preferred Units. See \"Item 3, Legal Proceedings - Albert Friedman, individually and as a representative of a class of similarly situated persons v. Linnaeus Associates Limited Partnership, et al\" for a description of the proposed settlement of this action which will cause the liquidation of the Preferred Unitholders' interest in WFA.\nOn November 9, 1994, Londonderry Acquisition Limited Partnership, an entity controlled by Apollo Real Estate Advisors, L.P., made a tender offer for 100% of the Preferred Units for a purchase price of $10.00 per Preferred Unit. The tender offer concluded on December 14, 1994 and Londonderry submitted to WFA transfer instruments for approximately 1,109,000 of such Preferred Units representing 40.9% of the total Preferred Units. All Assignee Units, other than the Preferred Units, are held by Linnaeus. See \"Item 12, Security Ownership of Certain Beneficial Owners and Management.\"\nWFA's Certificate and Agreement of Limited Partnership, as amended to the date hereof (the \"Partnership Agreement\"), provides that cash distributions may be paid at any time and from time to time in the sole and absolute discretion of Linnaeus. The amount of each distribution will be determined by Linnaeus in its sole discretion. There are no legal or contractual restrictions on WFA's present or future ability to make cash distributions.\nAs a result of the losses for the years ended December 31, 1995, 1994 and 1993, WFA did not have positive operating cash flow as defined for this period. There were no distributions paid to Unitholders, including Linnaeus, for 1995, 1994, or 1993. Under the terms of the Partnership Agreement, the Preferred Unitholders are entitled to a 6% per annum cumulative non-compounded priority distribution from all operating cash flow. At December 31, 1995, this unpaid accumulated preference amounted to $20,346,000 or $7.50 per Unit.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nThe tables on the following pages sets forth selected financial data for WFA and its consolidated subsidiaries and is qualified in its entirety by, and should be read in conjunction with, the Consolidated Financial Statements and Notes and Exhibits thereto included herein as an Exhibit.\nBalance Sheet Data:\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Results of Operations and Financial Condition.\nThe following discussion should be read in conjunction with the financial information contained in Item 6 above and Item 8","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nINDEX TO FINANCIAL STATEMENTS AND SCHEDULES\nFinancial Statements\nReport of Independent Public Accountants\nConsolidated Balance Sheets as of December 31, 1995 and 1994\nConsolidated Statements of Operations for the years ended December 31, 1995, 1994 and 1993\nConsolidated Statements of Cash Flows for the years ended December 31, 1995, 1994 and 1993\nConsolidated Statements of Partners' Capital for the years ended December 31, 1995, 1994 and 1993\nNotes to Consolidated Financial Statements\nFinancial Statement Schedules\nSchedule II - Valuation and Qualifying Accounts Schedule III - Real Estate Owned\nWINTHROP FINANCIAL ASSOCIATES, A LIMITED PARTNERSHIP\nFINANCIAL STATEMENTS AS OF DECEMBER 31, 1995 AND 1994 TOGETHER WITH AUDITORS' REPORT\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo Winthrop Financial Associates, A Limited Partnership:\nWe have audited the accompanying consolidated balance sheets of Winthrop Financial Associates, A Limited Partnership (a Maryland limited partnership) and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations, partners' capital and cash flows for each of the three years in the period ended December 31, 1995. These consolidated financial statements and the schedules referred to below are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these consolidated financial statements and schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Winthrop Financial Associates, A Limited Partnership, and subsidiaries as of December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995, 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. Schedules II and III are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic consolidated financial statements. These schedules have been subjected to the auditing procedures applied in the audits of the basic consolidated financial statements and, in our opinion, fairly state, in all material respects, the financial data required to be set forth therein, in relation to the basic consolidated financial statements taken as a whole.\nARTHUR ANDERSEN LLP\nBoston, Massachusetts March 29, 1996\nWINTHROP FINANCIAL ASSOCIATES A LIMITED PARTNERSHIP\nCONSOLIDATED BALANCE SHEETS\n(AMOUNTS IN THOUSANDS)\nThe accompanying notes are an integral part of these consolidated financial statements.\nWINTHROP FINANCIAL ASSOCIATES A LIMITED PARTNERSHIP\nThe accompanying notes are an integral part of these consolidated financial statements.\nWINTHROP FINANCIAL ASSOCIATES A LIMITED PARTNERSHIP\nThe accompanying notes are an integral part of these consolidated financial statements.\nWINTHROP FINANCIAL ASSOCIATES A LIMITED PARTNERSHIP\nSUPPLEMENTAL DISCLOSURE OF NONCASH ACTIVITIES: On January 13, 1994, a subsidiary of WFA acquired the controlling interest in partnerships that wholly own certain real estate properties. The assets and liabilities acquired consisted primarily of real estate assets of approximately $105 million and related mortgage notes payable of approximately $106 million, as well as several operating assets and liabilities.\nIn conjunction with the Company's 1994 purchase of a real estate asset, a note in the amount of $604,000 was assumed by the Company. The principal balance was paid in full during 1995.\nIn April 1995, the Company purchased, from an unaffiliated party, an apartment complex (the Hills Apartments) in Austin, Texas. In conjunction therewith, the Company obtained $1,000,000 in seller financing and a mortgage loan from a related party of $8,470,000.\nIn July 1995, Nomura Asset Capital Corp. (NACC) contributed $17.7 million of notes payable by the Company in exchange for a preferred equity interest (see Note 2).\nIn October 1995, $2,108,000 in debt of a wholly owned property was forgiven in exchange for real estate of approximately the same amount.\nDuring 1995, the Company obtained debt from an affiliate and purchased $8,000,000 of units in a limited partnership which had been previously syndicated by the Company.\nThe accompanying notes are an integral part of these consolidated financial statements.\nWINTHROP FINANCIAL ASSOCIATES A LIMITED PARTNERSHIP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1995\n(1) ORGANIZATION\nWinthrop Financial Associates, A Limited Partnership (WFA), is organized under the Revised Uniform Limited Partnership Act of the State of Maryland. The primary operating companies in the WFA consolidated group (the Company) are First Winthrop Corporation (First Winthrop) and Winthrop Management. Also included in the financial statements are the assets, liabilities and operating results of 35 majority-owned real estate properties. (See Note 8 for discussion of discontinuance of the operations of Winthrop Securities.)\nThe general partner of WFA is Linnaeus Associates Limited Partnership (Linnaeus), a Maryland limited partnership. Prior to December 22, 1994, Mr. Arthur J. Halleran, Jr., was the sole general partner of Linnaeus. On December 22, 1994, pursuant to an Investment Agreement (the Investment Agreement) entered into among Nomura Asset Capital Corporation (NACC), a Delaware corporation, Mr. Halleran and certain other individuals who comprised the senior management of WFA, the general partnership interest in Linnaeus was transferred to W.L. Realty, L.P. (W.L. Realty). NACC is a subsidiary of Nomura America Holding Inc., a Delaware corporation, which is a wholly owned subsidiary of Nomura Securities Company, Ltd., a Japanese corporation with worldwide investment banking, securities and commodities operations. W.L. Realty is a Delaware limited partnership, the general partner of which was A.I. Realty Company, LLC (Realtyco), a New York limited liability company, prior to July 14, 1995.\nOn July 18, 1995, Londonderry Acquisition II Limited Partnership (Londonderry II), a Delaware limited partnership and affiliate of Apollo Real Estate Advisors, L.P. (Apollo), a Delaware limited partnership, executed a purchase agreement, dated as of July 14, 1995 (Purchase Agreement), by and among Londonderry II, NACC, Realtyco, Partnership Acquisition Trust I (PATI), a Delaware business trust, and Property Acquisition Trust I (PAT), a Delaware business trust. Pursuant to the Purchase Agreement, Londonderry II purchased NACC's and Realtyco's interests in W.L. Realty, and as a result, Londonderry II is the sole general partner of W.L. Realty which is the sole general partner of Linnaeus, and which in turn is the sole general partner of WFA.\nIn addition to the foregoing, Apollo and its affiliates, WFA and certain executives of WFA (the Management Investors) executed an agreement whereby the Management Investors sold to WFA their respective equity interests in W.L. Realty, and certain executives resigned. The Company has recorded the purchase of the interests in W.L. Realty as a treasury stock transaction and, thus, has reduced equity by the purchase price ($4,244,000). In addition, the Company has recorded a provision for Nonrecurring Organizational Costs in 1995 in the amount of $5,689,000 related to the settlement of certain employment contracts and other transaction-related costs (see Note 6 for further discussion).\nWINTHROP FINANCIAL ASSOCIATES A LIMITED PARTNERSHIP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1995\n(Continued)\n(1) ORGANIZATION (Continued)\nThe Partnership Agreement of the Company provides that interests of Public Unitholders are redeemable by the Company at the option of the General Partner and that Unitholders are entitled to a 6% cumulative noncompounded preferred priority return payable from cash flow (as defined in the Partnership Agreement) on the Public Unitholders' original investment, reduced from time to time by any capital distributions, and priority allocation from all nonoperating distributions.\nThe Company made no distributions to its Partners during 1995, 1994 or 1993. The cumulative unpaid preferred priority is $20,346,000, or $7.50 per unit, at December 31, 1995.\nOn March 4, 1995, an Information Statement was mailed to the Public Unitholders by the General Partner in connection with a proposed amendment (the Amendment) to WFA's Partnership Agreement. The Amendment modified the previous prohibition against the General Partner entering into certain agreements, contracts or arrangements on behalf of WFA with the General Partner, partners of the General Partner or an affiliate of the General Partner. Under the Amendment, the General Partner is authorized to enter into transactions with affiliates provided that the transactions are of the nature contemplated under the Investment Agreement or the General Partner reasonably believes that the transaction is on terms no less favorable to WFA than those which could be obtained from an unaffiliated third party. The Amendment was filed April 4, 1995, and was operative, by its terms, as of December 22, 1994.\nSee Note 13, for discussion of a proposed settlement related to interests of the Public Unitholders.\n(2) FINANCIAL CONDITION\nIn 1988, the investor limited partners of One Houston Associates Limited Partnership (One Houston), an investment program organized by the Company, brought suit against WFA, First Winthrop, Linnaeus-Hawthorne Associates (the general partner of One Houston), Arthur J. Halleran, Jr., Jonathan W. Wexler, George J. Carter, David C. Hewitt, John V. McMannon, Jr., and John M. Nelson, IV (each general partners of Linnaeus-Hawthorne Associates). The case was tried to a jury, and on February 2, 1995, the jury returned a verdict for the plaintiffs against First Winthrop Corporation and found damages of at least $30 million.\nOn March 3, 1995, WFA and First Winthrop entered into a memorandum of agreement with the plaintiffs in which WFA and First Winthrop agreed to settle the case by paying One Houston the sum of $17 million.\n(2) FINANCIAL CONDITION (Continued)\nA trial court hearing announcing the terms of the proposed settlement was held on March 13, 1995. At the hearing, the parties filed a conditional agreed judgment for $20 million, plus postjudgment interest and costs, which was to only become effective if First Winthrop defaulted on its undertaking to fund the settlement payment of $17 million by June 1, 1995. The Company funded this settlement with interim financing provided by NACC and, upon payment, was released from any prior or future claims related to this lawsuit.\nIn July 1995, the Company contributed certain assets and liabilities to a newly formed partnership owned by the Company (WSWH), and NACC contributed its $17,800,000 note receivable (the interim financing provided by NACC to the Company in order to settle the legal matter discussed above) to WSWH in exchange for preferred equity which provides NACC with certain preferences of cash flow from WSWH.\nNACC's equity in WSWH has been recorded in the accompanying financial statements as a Minority Interest Liability. In addition, NACC receives a return on its equity, as defined, of LIBOR plus 6.5%. Such amounts have been recorded as Minority Interest Expense in the accompanying consolidated statements of operations.\nGiven the above transactions, as well as the financing arrangement with General Electric Capital Corp. entered into July 1995 (see Note 9), management believes the Company has sufficient working capital which, when combined with cash flow from operations, will permit the Company to continue its current operations for the foreseeable future.\n(3) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBasis of Consolidation\nThe accompanying consolidated financial statements reflect the accounts of WFA and its controlled subsidiaries (the Company). All significant intercompany accounts and transactions have been eliminated in consolidation.\nLoans Receivable\nThe Company has made loans to certain investment programs it has organized in order to provide the investment programs with working capital to fund operations and other cash requirements. Such loans are generally to be repaid from future operating cash flow of the programs.\n(3) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)\nLand, Buildings, Furniture, Fixtures and Equipment and Depreciation\nLand and buildings, furniture, fixtures and equipment are carried at cost. Expenditures for replacements are capitalized; repairs and maintenance are charged to operations, as incurred.\nThe Company provides for depreciation of buildings and furniture, fixtures and equipment on the straight-line method using the assets' estimated useful lives, ranging from 5 to 27.5 years.\nEquity Interests in and Advances to Investment Programs\nAs of December 31, 1995, the Company had sponsored a total of 266 publicly and privately placed investment programs organized to own various types of real estate projects, federally insured mortgages or agricultural enterprises.\nThe Company acts as a general or limited partner in the majority of investment programs that it has organized. The Company accounts for its interests in investment programs in which it exercises significant influence on the equity method. The Company accounts for all of its other interests in investment programs on the cost method.\nThe Company has made both interest and noninterest-bearing advances to certain investment programs, generally for operating purposes, debt negotiation requirements or to satisfy partnership agreements. Such advances are to be repaid from future sales of assets or equity interests.\nLong-term Fees Receivable\nLong-term fees receivable consist primarily of the long-term portion of fees due from 10 investment programs in fixed annual or semiannual installments which began in 1995.\nDeferred Costs\nDeferred costs consist of expenses incurred in connection with the acquisition of management contracts, properties and financings. These costs are amortized over their estimated useful lives. Amortization related to these costs was $1,888,000, $1,687,000 and $765,000 for the years ended December 31, 1995, 1994 and 1993, respectively (see Note 5 for further discussion).\n(3) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)\nMinority Interest\nMinority interest included in the accompanying balance sheet represents NACC's preferred equity in WSWH of $17,800,000 as increased by LIBOR plus 6.5% per annum, and reduced by any payments.\nProperty Acquisition and Related Fee Income\nFor accounting purposes, the Company's property acquisition and related fee income includes acquisition fees and certain interest guarantee fees, which are considered to be components of the Company's fees for providing financial services to the investment programs organized by the Company.\nThe primary source of the Company's revenues in this category was comprised of fees associated with the structuring of net lease arrangements and the institutional placement of debt and equity associated with such transactions.\nLeasing Commissions\nThe Company earns leasing commissions from certain of the properties it manages for brokering or co-brokering leases for space therein. Leasing commissions fluctuate in any given period depending on market conditions in the geographical areas where the Company operates and the amount of space available to rent at the properties. Historically, a substantial portion of the leasing commission revenue has been earned from one investment partnership sponsored by the Company. As discussed further in Note 4, the Company will no longer provide lease brokerage services to this partnership.\nTenant Service Revenue\nThe Company earns tenant service revenue for providing commercial cleaning, building security, construction management and other related services to properties and to the tenants of properties it manages. The fees are paid out of the properties' operating cash flow or directly by the tenants and are recognized by the Company in the period the services are performed. The Company has ceased providing such services in 1996.\n(3) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)\nManagement Fees\nThe Company earns management fees from most of the investment programs it has organized, as well as from third parties. The Company provides general property management, asset management, consulting and administrative services for these investment programs and third parties.\nInterest Income\nInterest income is generated on the Company's cash equivalents and long-term receivables.\nRental Revenue\nThe Company earns rental revenue from the various commercial and residential properties it owns. The leases are generally for a term of one year and are accounted for as operating leases in accordance with Statement of Financial Accounting Standards (SFAS) No. 13, Accounting for Leases.\nIncome Taxes\nTaxes with respect to the portion of the net income or loss of the Company attributable to its corporate subsidiaries are reflected in the consolidated financial statements of the Company. The balance of the net income or net loss is reflected on the tax returns of the partners of WFA. The Company adopted SFAS No. 109, Accounting for Income Taxes, in the first quarter of 1993. The adoption did not have a material impact on reported results of operations.\nAllocation of Income (Loss) to Partners\nAllocations of income (loss) among the Partners for financial statement and tax reporting purposes are made in accordance with WFA's Partnership Agreement, assuming the continuing operations of the Partnership. Thus, the related Partners' capital accounts do not represent amounts that would be received upon liquidation of the Partnership.\n(3) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)\nConsolidated Statements of Cash Flows\nFor purposes of the consolidated statements of cash flows, cash equivalents are defined by the Company as investments consisting of certificates of deposit, money market funds, commercial paper and other instruments with original maturities of less than 90 days. The Company made interest and income tax payments (receipts) during the three years in the period ended December 31 as follows:\nInterest Taxes (Amounts in thousands) Year Ended 1993 $ 2,202 $ (4,710) 1994 13,870 412 1995 14,818 83\nFinancial Instruments\nSFAS No. 105, Disclosure of Information about Financial Instruments, requires disclosure of the off-balance-sheet credit risk and concentrations of credit risk associated with financial instruments. The Company satisfies the disclosure requirements related to its financial instruments with off-balance-sheet credit risk in Note 12. The Company's receivables are predominantly from real estate investment programs organized by the Company, and as such, the Company's receivables may be exposed to the inherent risks associated with the ownership and operation of real estate (see Note 4). The viability of certain investment programs is contingent on receipt of rents from one major national retail chain. The Company has no other significant concentration of credit risk.\nReclassification\nCertain reclassifications have been made to the prior years' financial statements to conform to the 1995 presentation.\nUse of Estimates\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\n(3) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)\nImpairment of Long-Lived Assets\nIn March 1995, the Financial Accounting Standards Board issued SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets To Be Disposed Of, which requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amount. SFAS No. 121 also addresses the accounting for long-lived assets and identifiable intangibles that are expected to be disposed of. The Company intends to adopt SFAS No. 121 in the first quarter of 1996, as required. Management does not expect that the effects of SFAS No. 121 will have a material impact on its financial position.\nFair Value of Financial Instruments\nSFAS No. 107, Disclosures About the Fair Value of Financial Instruments, which was adopted by the Company effective January 1, 1995, requires that the Company disclose estimates of the fair value of all classes of financial instruments.\nThe carrying amounts reported on the consolidated balance sheets for cash, receivables, other current assets, accounts payable, accrued expenses and current notes payable approximate fair value, due to the short-term nature of these investments. All long-term receivables are recorded net, at realizable value, which management believes approximates fair value at December 31, 1995. Based on current market conditions, management believes that the carrying value of its debt approximates fair value at December 31, 1995.\n(4) 1626 NEW YORK ASSOCIATES LIMITED PARTNERSHIP\n1626 New York Associates Limited Partnership (1626) is an investment program sponsored by the Company in 1984 which owns a portfolio of office buildings in New York City. 1626 had defaulted on certain receivables payable to the Company, and in 1991, the Company wrote down the receivables from 1626, which totaled $29,000,000. 1626's only source of funds to pay the Company's receivables was the net proceeds from the future distributable cash flow, sales or refinancing of the investment program's properties.\n(4) 1626 NEW YORK ASSOCIATES LIMITED PARTNERSHIP (Continued)\nDuring 1991 and 1992, Nineteen New York Properties Limited Partnership (19NY), a subsidiary of 1626, defaulted on certain of its mortgage loans. During the third quarter of 1992 through the first quarter of 1993, the Company, 19NY and 19NY's lenders executed agreements to restructure certain of the lenders' mortgage notes. Pursuant to the restructuring agreements, the terms of the mortgages were modified to include a reduction in the original principal due from 19NY, extensions of maturity dates and reduction in the pay rates.\nThe agreements required the Company to provide, in September 1992, to 19NY, a $10,800,000 loan and, in January 1993, a $1,500,000 loan, both of which accrued interest at prime plus .75%. Collection of these loans and accrued interest was payable from proceeds available to 19NY from future distributable cash flow, property sales and refinancings. During 1993, 1994 and 1995, the Company advanced additional funds and deferred certain fees payable to the Company by 1626. This enabled 1626 to pay certain interest and fees and comply with the loan restructuring in 1992, and 1993. On February 28, 1996, an affiliate of Apollo purchased the 19NY lenders' mortgage notes and, WFA and certain of its affiliates entered into an agreement with 1626, 19NY and the Apollo affiliate (the Agreement).\nIn conjunction with the Agreement, WFA and its affiliates contributed approximately $36.6 million of receivables to 19NY (which included deferred syndication, property management and tenant service fees; such amounts had been previously reserved, for financial reporting purposes). In addition, WFA sold its remaining $10 million note to an affiliate of Apollo in exchange for $6 million in cash, which management believes represented the fair value of the note. This amount was greater than the net carrying value of the Company's assets related to 1626 and 19NY included in the accompanying balance sheet at December 31, 1995. Subsequent to execution of the Agreement, the Company will not hold receivables or other assets related to 1626 or 19NY.\nIn addition, the Agreement provided for a change in the property manager of the 19NY properties and thus, beginning in 1996, the Company will no longer provide property management services, including leasing brokerage services, to 19NY.\n(4) 1626 NEW YORK ASSOCIATES LIMITED PARTNERSHIP (Continued)\nAs a result of a legal case settlement in 1994, the Company forgave $10 million plus interest accrued from December 1, 1992 through August 2, 1994. For financial reporting purposes, this amount was previously reserved. The Company also subordinated the collection of an additional $10 million (sold in 1996 to an Apollo affiliate), plus interest accrued thereon since December 1, 1992 until the Limited Partners of 1626 receive a distribution equal to a stated amount.\n(5) NONRECURRING ORGANIZATIONAL COSTS\nDuring the first quarter of 1993, the Company began to explore the desirability of converting WFA to a publicly traded real estate investment trust. By June 1993, the Company had retained an investment banker and decided that such a conversion was both desirable and feasible. The Company developed a plan (the REIT Plan) to implement a series of transactions expected to culminate in an initial public offering of common stock in a newly formed real estate investment trust.\nIn the first half of 1994, the Company's confidence in the feasibility of the REIT Plan declined, and during the third quarter of 1994, the Company concluded that WFA should primarily direct its efforts to finding private capital, and that WFA should postpone the REIT Plan. In accordance with this decision, WFA's financial statements reflect a pretax provision of $6,643,000 to write off costs related to the REIT Plan.\nSee the Company's November 2, 1994 filing on Form 14D-9 for further information concerning Management's capital-raising activities.\nIn conjunction with the organizational restructurings, certain departments were eliminated and employees were severed, resulting in severance costs of $519,500 for the year ended December 31, 1995.\nWFA with certain affiliates and The Alternative Group Limited Partnership (TAG), Beal Investment Group, Inc., Beal Companies, Steven R. Bodi, Bruce A. Beal, Robert L. Beal and George L. McGoldrick, Jr. agreed on December 28, 1995 to settle all existing disputes between them. Each of the disputes arose out of a consent solicitation initiated by TAG to unseat WFA or its affiliates as the general partner of an investment limited partnership. TAG was not successful in any of those solicitations, and the parties agreed to resolve their disputes arising in connection with the solicitations. The Company has included the proxy solicitation, legal and settlement costs related to these disputes as a component of its 1995 Nonrecurring Organizational Costs.\n(5) NONRECURRING ORGANIZATIONAL COSTS (Continued)\nSee Note 6 for a discussion of the additional 1995 provision related to Nonrecurring Organizational Costs.\n(6) CONFLICTS OF INTEREST AND TRANSACTIONS WITH RELATED PARTIES\nOn December 22, 1994, all the general partnership interests and substantially all of the limited partnership interests in the General Partner were transferred to W.L. Realty pursuant to the Investment Agreement dated as of December 3, 1994. The general partner of W.L. Realty prior to July 14, 1995 was Realtyco which held a 1% interest in W.L. Realty. The partners of W.L. Realty prior to July 14, 1995 in addition to Realtyco, were (i) NACC, which held a 64% limited partnership interest and (ii) each of the following individuals (who held limited partnership interests in the specified percentages): Arthur J. Halleran, Jr. (17.5%), Jonathan W. Wexler (4.45%), Jeffrey Furber (4.14%), Stephen G. Kasnet (3.81%), F.X. Jacoby (2.55%) and Richard J. McCready (2.55%) (collectively referred to as the Management Investors). Under the limited partnership agreement of W.L. Realty, NACC and Realtyco had the right, at the election of either of them, to purchase at any time all (but not less than all) of the limited partnership interests held by the Management Investors for a price equal to the greater of (i) the fair market value of such interests, as determined by specified appraisal procedures, or (ii) $8,000,000, if the purchase occurred on or before December 22, 1995, $6,500,000, if the purchase occurred after December 22, 1995 but on or before December 22, 1996, and $4,000,000, if the purchase occurred after December 22, 1996 but on or before December 22, 1999 (there was no minimum purchase price thereafter). As further discussed in Note 1, pursuant to the Purchase Agreement, Londonderry II purchased NACC's and Realtyco's interest in W.L. Realty. In addition, the Management Investors sold to the Company their respective equity interests in W.L. Realty, and certain Management Investors resigned. The acquisition of the Management Investors' equity interests was recorded as a reduction in equity, classified as Investment in W.L.\nRealty Limited Partnership.\nIn connection with the December 22, 1994 transaction, the Management Investors entered into employment contracts with WFA, guaranteeing employment for terms ranging from three to five years, commencing on January 1, 1995. Two of the executives had five-year contracts guaranteeing base salaries of $250,000, with guaranteed annual bonuses of $150,000 and $450,000 for each year. In conjunction with the July 18, 1995 transaction described in Note 1 (the transfer of the G.P. interest from NACC to Londonderry II), the Chairman and the Vice Chairman resigned and $2,318,537 was paid to these executives in settlement of their employment contracts. Each of the other four executives executed a three-year contract, with guaranteed annual salaries of $250,000, $250,000, $190,000 and $180,000, respectively. One of these four executives has a guaranteed annual bonus of $250,000 for each year. During 1995, two of the remaining four executives resigned, and therefore, the Company is no longer obligated under the respective employment contracts.\n(6) CONFLICTS OF INTEREST AND TRANSACTIONS WITH RELATED PARTIES (Continued)\nIn addition, also in conjunction with the July 18, 1995 transaction described in Note 1, payments were made to obtain releases from certain liabilities from the Chairman and Vice Chairman and bonuses were paid to the remaining Management Investors to induce them to continue their employment with the Company. Such payments amounted to $3,371,360. The payments related to settlement of certain employment agreements, the release of certain liabilities, and bonuses to certain members of management to continue their employment with the Company have been recorded as Nonrecurring Organizational Costs in the accompanying Statement of Operations in the amount of $5,689,897, for the year ended December 31, 1995.\nAs a result of its general partnership interest and its ownership of 12,571,429 units, the General Partner is entitled to allocations of WFA's profits, losses and cash distributions as specified in WFA's Partnership Agreement.\nThe previous General Partner and certain of the previous partners of W.L. Realty were officers, directors or employees of WFA or First Winthrop and received compensation in connection with such employment.\nPartnerships composed of various combinations of current and former officers of WFA have retained an equity interest in some of the investment programs organized by the Company prior to the formation of WFA. Certain current and former employees own equity interests in some of the investment programs organized by the Company.\nIn December 1994 and in January 1995, WFA purchased from various current and former officers of the Company an 89.47% interest in Clarendon Land Company, Inc., an 82.61% interest in Marlboro Land Company, Inc., and a 63.63% interest in Linnaeus San Francisco Associates, Limited Partnership. Marlboro Land Company, Inc. and Clarendon Land Company, Inc. own residual interests in the land underlying properties owned by certain of the Company's previous syndications. Linnaeus-San Francisco owns a small, freestanding retail store. The Company paid an aggregate of $935,926 to acquire these interests. The Company believed it to be the fair market value of such interests.\nDuring 1995, the Company made advances of $234,000 to certain affiliates of Apollo. Such amounts bear interest at prime plus 1% and are due on demand..\nIn April 1995, the Company purchased, from an unaffiliated party, an apartment complex for approximately $11.3 million (the Hills Apartments) in Austin, Texas. In conjunction therewith, the Company obtained $1,000,000 in seller financing and obtained a mortgage loan from a related party of $8,470,000.\n(6) CONFLICTS OF INTEREST AND TRANSACTIONS WITH RELATED PARTIES (Continued)\nDuring 1995, the Company obtained debt from Londonderry II and purchased $8,000,000 of units in a limited partnership which had been previously syndicated by the Company. These units and the related debt were subsequently transferred from the Company to Londonderry II and, therefore, are not included in the financial statements of the Company at December 31, 1995.\nSee Notes 2 and 4 for additional discussion of related party transactions.\n(7) ACCOUNTING FOR EQUITY INTERESTS IN INVESTMENT PROGRAMS AND UNCONSOLIDATED SUBSIDIARY\nThe Company accounts for its interests in investment programs in which it exercises significant influence using the equity method. Upon completion of the offering of limited partnership interests, the Company's remaining interest in the investment programs is generally less than 5%. The following is an unaudited, combined summary of financial data for these investment programs (including Winthrop California Investors, L.P., as discussed below):\n(7) ACCOUNTING FOR EQUITY INTERESTS IN INVESTMENT PROGRAMS AND UNCONSOLIDATED SUBSIDIARY (Continued)\n(a) Thirteen investment programs own interests in 58 partnerships or joint ventures that own and operate commercial properties or residential housing developments.\nThe Company typically held a substantial equity interest in the investment programs it organized during the investment programs' syndication period. The Company accounted for its interest in these investment programs, during the syndication period, on the same basis as the basis used on final admission of investor limited partners.\nIn May 1986, the Company acquired, through a wholly owned partnership (consolidated with the Company through 1990), 1,000 units (Units) of limited partnership interest in Winthrop California Investors, L.P. (WCI), an investment program organized by the Company, for an aggregate cost of $54,000,000 funded with $29,500,000 of working capital provided by the Company and a $24,500,000 loan. The loan is nonrecourse except to such Units (and cash held in escrow as described below) and bears interest until December 31, 1998 at 10.75% per annum. During this period, interest only is payable on the loan in annual amounts equal to the cash flow received in respect to the Units, subject to specified minimum and maximum interest payments. Interest not paid currently will be added to principal and accrue interest at 10.75% per annum.\n(7) ACCOUNTING FOR EQUITY INTERESTS IN INVESTMENT PROGRAMS AND UNCONSOLIDATED SUBSIDIARY (Continued)\nThe outstanding balance of this loan at December 31, 1995 is $52,282,000, including unpaid interest that has been added to principal. The lender has the option to acquire, on December 31, 1998, a 45% interest in the WCI Units at a price equal to the lesser of (a) all accrued and unpaid interest on the loan or (b) 45% of the fair market value of the Units subject to the loan (excluding accrued and unpaid interests). The Company has received a capital distribution of $3,373,000 in connection with its investment in the Units. In accordance with the original terms of the loan, these funds will remain in escrow until the lender's option to acquire an interest in the Units is exercised or expires.\nAs of April 1991, the Company had stopped making the annual interest payments and has since determined that it does not intend to invest or commit significant further resources to maintain ownership of the WCI Units. As a result, the Company, for financial reporting purposes, has deconsolidated this wholly owned partnership and reflected the net carrying value at December 31, 1995 and 1994 (which is accounted for on the cost method beginning October 1, 1991) as an offset against equity interests in and advances to investment programs, net, in the accompanying consolidated balance sheets.\nThe following are the condensed balance sheets and statements of operations and cash flows of this wholly owned partnership (amounts in thousands):\n(7) ACCOUNTING FOR EQUITY INTERESTS IN INVESTMENT PROGRAMS AND UNCONSOLIDATED SUBSIDIARY (Continued)\nThe wholly owned partnership accounts for its investment in the WCI units on the equity method. Therefore, the significant loss recorded in 1995 is directly attributable to the significant loss recorded by WCI, primarily as a result of a provision to write down its real estate to net realizable value. Since the wholly owned partnership owns limited partner Units, it has not written its investment below zero.\n(8) DISCONTINUED OPERATIONS\nIn the fourth quarter of 1993, the Company decided to discontinue its investment-sales related operations and to terminate the business operations of Winthrop Securities, the Company's securities brokerage subsidiary. This decision completed the Company's decision to terminate all fee-based activity related to raising investment capital.\nAccordingly, this business segment was presented as a discontinued operation in 1993. The estimated loss on the disposal was $1,403,000 net of tax benefit of $424,000, consisting of a provision for severance, losses through disposal, etc.\nSummary operating results of the discontinued operation for the year ended December 31, 1993 are as follows:\nRevenues $ 1,868 Expenses 4,816 ------------- Loss before tax (2,948)\nTax benefit 742 Loss from discontinued operations (2,206)\nLoss on disposition (1,403) ------------- Net loss from discontinued operations $ (3,609) ==========\n(9) NOTES PAYABLE\nThe Company's notes payable for 1995 and 1994 are summarized as follows:\nPrincipal payments are due as follows:\n1996 $ 2,059 1997 724 1998 49,559 1999 2,060 2000 96,332 Thereafter 26,846 ------------\n$ 177,580\n(9) NOTES PAYABLE (Continued)\nThe Company is currently in default on a mortgage payable of $1,161,000, secured solely by specific assets of the Company. The Company is currently negotiating with the lender of the note. The Company does not expect a material adverse or significant impact on the Company's results of operations or financial position, as a result of the current default.\nAs of December 31, 1995, substantially all of the Company's real estate assets had been pledged as collateral for various notes payable.\nWinthrop Florida Apartments, L.P. (Winthrop Florida), a wholly owned entity of the Company, entered into an interest rate protection agreement with Morgan Guaranty Trust Company of New York (MGT) in July 1995. The agreement expires on July 1, 1998. Under the agreement, Winthrop Florida paid MGT a transaction fee of $302,400 in exchange for an interest rate cap of 10.19%, with a floating rate option on the notional principal amount of $33,600,000. The original note rate was LIBOR plus three percent. In the event of nonperformance by the counterparty, Winthrop Florida would be exposed to interest rate risk if LIBOR plus three percent rate were to exceed the cap rate. As of December 31, 1995, LIBOR plus three percent did not exceed the cap rate. Winthrop Florida recorded $50,400 of amortization expense during 1995 related to the interest rate protection agreement.\n(10) INCOME TAXES\nEffective the beginning of fiscal 1993, the Company adopted SFAS No. 109, Accounting for Income Taxes. Taxes in respect of the portion of the net income or loss of the Company attributable to its corporate subsidiaries is reflected in the statements of the Company. The balance of the net income or loss is reflected on the tax returns of the partners of WFA. SFAS No. 109 requires recognition of deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statements and tax returns. Under this method, deferred tax liabilities and assets are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse.\nThe components of the net deferred tax liability as of December 31, 1995 and 1994 are as follows:\n(10) INCOME TAXES (Continued)\nThe Company's deferred tax assets are expected to be realized through the reversal of the deferred tax liabilities.\nSignificant items making up the deferred tax liabilities and deferred tax assets as of December 31, 1995 and 1994 are as follows:\nAs of January 1, 1996, the Company has net operating loss carryforwards which are available to offset future taxable income. These carryforwards, which are expected to be fully utilized, expire in the year 2010.\nWFA's taxable income (loss) differs from its net loss for financial statement purposes due primarily to differences in the recognition of WFA's share of First Winthrop's and certain investment programs' results of operations for financial statement and tax reporting purposes.\n(10) INCOME TAXES (Continued)\nWFA's taxable income is estimated as follows:\nFirst Winthrop's total provision (credit) for income taxes differs from that which would have been calculated using the statutory federal income tax rate, due primarily to the net effect of the provision (credit) for state income taxes. Deferred income taxes result from temporary differences in the recognition of revenues and expenses for tax and financial reporting purposes, primarily related to the excess, in respect of various investment programs, of tax losses over losses reported for financial statement purposes.\n(10) INCOME TAXES (Continued)\nSignificant components of the provision (credit) for income taxes from continuing operations are as follows:\n(11) PENSION AND PROFIT-SHARING PLANS\nThe Company has two contributory 401(k) plans (the Plans) covering most of its employees meeting certain age and service criteria. The first plan is for office employees and the second is for field employees. Under both Plans, participants may make pretax contributions of up to 15% of their salary. Under the office employees' plan, the Company will match employee contributions up to 3.5% of the employees' salary. The Company's contribution may be reduced as a result of forfeiture of unvested account balances by terminated employees. The employee contributions will be 100% vested, and the Company's matching contributions to the Plan, as well as all prior account balances, will vest 50% upon completion of three years of services and 100% upon completion of four years of service.\nThe Company recognized expenses relating to the Plans of $98,000, $599,000 and $290,000 for the years ended December 31, 1995, 1994 and 1993, respectively. The Company currently funds amount accrued under the Plans.\nThe Company does not provide any other postretirement benefits in addition to the benefits discussed above.\n(12) COMMITMENTS AND CONTINGENCIES\n(a) Guarantees of Syndicated Investment Programs' Obligations\nAs of December 31, 1995, the Company has agreed to fund up to $3,179,000 of potential operating deficits that may be incurred by three investment programs. In general, the Company will not be liable under these commitments until the investment programs' reserves to fund operating deficits are exhausted.\nAs of December 31, 1995, the Company has guaranteed $45,700,000 of seven investment programs' mortgage financing. The Company's liability is for only the most senior portion of the mortgages, and in none of the cases is this guaranteed portion more than 50% of the mortgage financing. The Company will only be liable under these guarantees to the extent that the potential sale or refinancing of properties held by the investment programs do not provide sufficient funds to satisfy the guaranteed portions of the investment programs' obligations. In addition, the Company has guaranteed $10,000,000 of one investment program's mortgage financing in the event of environmental liability or fraud.\nThe Company has guaranteed a minimum return to the limited partners of one investment program organized by the Company. In another investment program organized by the Company, a partnership is required to purchase those units tendered by the investor limited partners, including a cumulative 10% annually compounded return on the basic capital contribution, less any cash flow previously distributed (the net amount so calculated being referred to as the Put Payment). If the partnership does not have sufficient funds to make all required Put Payments, then the general partner, a subsidiary of First Winthrop, shall contribute to the partnership, as an additional capital contribution, such funds as are required to allow the partnership to complete the Put Payments.\nLiabilities related to the above commmmitments as of December 31, 1995 and December 31, 1994 are reflected in accrued expenses ($823,000 and $600,000, respectively) and other long-term liabilities ($1,274,000 and $3,070,000, respectively). Management believes that these amounts are adequate to cover the Company's exposure on these guarantees.\n(12) COMMITMENTS AND CONTINGENCIES (Continued)\n(b) Leases\nSubsidiaries of the Company are leasing real properties on a completely net basis under lease agreements (the Master Leases) from two investment programs organized by the Company. The subsidiaries are, in turn, leasing the real properties on a completely net basis under separate lease agreements (the Subleases) to unaffiliated corporate tenants. The Master Leases have primary terms of 30 years while the Subleases have primary terms of 25 years, both having several five-year renewal options. The Company expects that the corporate tenants will exercise their first five-year renewal options under the Subleases. Lease payments due to the subsidiaries during the primary and renewal periods of the Subleases are adequate to meet their obligations under corresponding periods of the Master Leases.\nThe following is a summary of the average payments due during the primary terms of the Master and Subleases, which are accounted for as operating leases:\nMaster Years Leases Subleases (Amounts in Thousands)\n1996-2008 $ 10,587 $ 10,656 2009-2013 3,895 -\nThe Company's liability under the Master Leases is limited to $2,000,000 with respect to any one investment program, subject to an overall $5,000,000 limitation.\nThe Company leases office space and office equipment. The Company incurred rental expense of approximately $1,993,000, $1,933,000 and $2,658,000 for the years ended December 31, 1995, 1994 and 1993, respectively.\nThe following is a summary of the Company's approximate minimum rental commitments under the noncancelable portion of long-term operating leases (in thousands):\nYear Ended December 31,\n1996 $ 1,830 1997 1,487 1998 308 1999 140 2000 140 Thereafter 350\n(12) COMMITMENTS AND CONTINGENCIES (Continued)\n(c) Litigation\nAs a result of actions brought by investors, the Company is a party to litigation involving certain investment programs it has organized. Each of these programs has experienced financial difficulties due to market conditions. In general, the actions brought against the Company allege that the Company, as general partner or sponsor, acted improperly in the organization, syndication or operation of the investment programs. In each pending case, the Company believes that the allegations are without merit and intends to vigorously defend itself. The Company does not expect that the outcome of any of these suits or any other suits will have a material adverse effect on its financial condition or results of operations.\nDuring 1995, the Company settled lawsuits initiated by the limited partners of Sixty-Six Associates Limited Partnership, Park Towne Place Associates Limited Partnership, and Parsippany Commerce Associates Limited Partnership for an aggregate amount of $1,216,000. These amounts had been previously reserved for by the Company, and thus, the settlements had no impact on the Company's 1995 results of operations.\nAs discussed in Note 2, as a result of a legal case settlement, First Winthrop paid One Houston the sum of $17 million.\nIn addition, as discussed in Note 4, as a result of a legal case settlement, the Company forgave $10 million plus accrued interest owed by an investment program.\n(d) Letters of Credit\nIn conjunction with WFA's acquisition of the Hills Apartments, WFA executed two letters of credit, $100,000 and $900,000, respectively, to collateralize notes retained by the seller, Carwin, Ltd. These letters of credit have initial terms ending January 3, 1997, and August 1, 1996, respectively.\n(e) Employment Arrangements\nOn January 15, 1996, the Company entered into an employment agreement with its newly hired Chief Executive Officer. Under the terms of this three-year agreement, the Chief Executive Officer will receive an annual salary of $360,000 per year, subject to increase based upon the U.S. Consumer Price Index, and a bonus, based upon the improved financial performance or\n(12) COMMITMENTS AND CONTINGENCIES (Continued)\n(e) Employment Arrangements (Continued)\ncondition of the Company or its direct or indirect subsidiaries. In addition, the Chief Executive Officer is entitled to a monthly car allowance, as well as participation in all employee health and benefit plans. This employment agreement will terminate immediately upon the employee's death, disability, or for cause. Upon the termination of the Chief Executive Officer's employment agreement for any reason other than cause, the Company will continue to be obligated to make payments in accordance with the agreement for the remainder of the term, unless termination is a result of the officer's death or disability, in which case the amount to be paid will the lesser of one year's salary, or the salary due over the remaining term of the agreement.\nSee Note 6 for discussion of additional employment contracts.\n(13) SUBSEQUENT EVENTS\nOn December 22, 1994, a class action suit was brought against WFA, Linnaeus Associates Limited Partnership (Linnaeus), a Maryland limited partnership and sole general partner of WFA, former and current members of WFA's senior management (collectively, the WFA Defendants) and Nomura Asset Capital Corporation, by those individuals who owned units of limited partnership interest in WFA known as preferred units (Preferred Unitholders and Class Members). The suit alleges in the first amended complaint, filed February 28, 1995, that, among other things, the WFA Defendants breached their fiduciary duties by improperly selling their interest in Linnaeus to NACC, while failing to obtain a similar buyout opportunity for the Preferred Unitholders.\nOn March 8, 1996, a second amended complaint was filed which contained the class claims asserted in the previous complaint and, in addition, that the defendants breached the twelfth amendment to the Partnership Agreement by failing to make a capital distribution as a result of the Investment Agreement and by failing to effect a redemption of the Preferred Units.\n(13) SUBSEQUENT EVENTS (Continued)\nA Stipulation for Settlement, dated as of March 20, 1996 (the Stipulation), provides that Londonderry Acquisition Corp., Inc. or its affiliate (Londonderry), an affiliate of Apollo, will undertake to liquidate the investment of Class Members by effecting a merger (the Merger Transaction) pursuant to Maryland law which will provide Class Members (regardless whether such Class Members opt out of the Class) with the right to receive cash consideration per Preferred Unit in an amount to be opined by a nationally recognized, independent investment banking firm as fair from a financial point of view, but in no event less than ten dollars and fifty cents ($10.50) per Preferred Unit (the Offered Price). Class Members will retain their rights under Maryland law to pursue an appraisal of the value of their units and receive an amount determined pursuant to their appraisal rights under Maryland law (the Appraised Price).\nLondonderry has indicated that it is willing to purchase the Preferred Units at the offered price only if the proposed settlement, pursuant to the Stipulation, is approved and the class action is dismissed with prejudice. If the proposed settlement is not approved, Londonderry may not make an offer to liquidate the Class Members' investment in WFA. The final approval hearing will be held May 23, 1996 in Chicago, Illinois. If a significant number of Class Members opt out of the proposed settlement, Londonderry and Linnaeus have the right to declare the Stipulation null and void.\nWINTHROP FINANCIAL ASSOCIATES (A Limited Partnership)\nSCHEDULE II VALUATION AND QUALIFYING ACCOUNTS DECEMBER 31, 1995\n(1) Uncollectible accounts written off. (2) Payments. (3) These amounts represented deferred revenue.\nWINTHROP FINANCIAL ASSOCIATES\n10-K SCHEDULE III SCHEDULE 3-A DECEMBER 31, 1995\nWINTHROP FINANCIAL ASSOCIATES\n10-K SCHEDULE III DECEMBER 31, 1995\nWINTHROP FINANCIAL ASSOCIATES\n10-K SCHEDULE III DECEMBER 31, 1995\nItem 9.","section_9":"Item 9. Changes in and 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) and (b) Identification of Directors and Executive Officers. WFA is a limited partnership, the ultimate corporate general partner of which is Londonderry Acquisition Corp. II, Inc. (\"Londonderry Acquisition\"). Pursuant to the Partnership Agreement of WFA, the control of WFA is vested in its general partner and the executive officers of WFA appointed by its general partner. As of March 1, 1996, the names of the directors of Londonderry Acquisition and executive officers of WFA and the position held by each of them, are as follows:\nPosition Held with WFA or Served as an Name Londonderry Acquisition Officer Since\nMichael Weiner Director 7-95\nW. Edward Scheetz Director 7-95\nMichael L. Ashner Chief Executive Officer 1-96\nRichard J. McCready President and Chief Operating Officer 7-95\nJeffrey Furber Executive Vice President 1-96 and Clerk\nAnthony R. Page Chief Financial Officer 8-95 Vice President and Treasurer\nPeter Braverman Senior Vice President 1-96\nEach director of Londonderry Acquisition and officer of WFA will hold office until the next annual meeting of the stockholders of Londonderry Acquisition and until his successor is elected and qualified.\n(c) Identification of Certain Significant Employees. None.\n(d) Family Relationships. None.\nBusiness Experience.\nMichael Weiner, age 43, has been an officer of Apollo Advisors, L.P. since 1992, which, together with an affiliate thereof, serves as the managing general partner of Apollo Investment Fund, L.P., AIF II, L.P. and Apollo Investment Fund III, L.P., private securities investment funds, and of Lion Advisors, L.P. which serves as financial advisor to and with respect to and representative for certain institutional investors with respect to securities investments. In addition, Mr. Weiner has been an officer of Apollo Real Estate Advisors, L.P. (\"Apollo\"), the managing general partner of Apollo Real Estate Investment Fund, L.P., a private real estate investment fund since 1993. Prior to joining Apollo, Mr. Weiner was a partner of the national law firm of Morgan, Lewis & Bockius. Mr. Weiner is a director of Applause, Inc., Capital Apartment Properties, Inc., a multi-family residential real estate investment trust, Continental Graphics Holdings, Inc., The Florsheim Shoe Company, Inc. and Furniture Brands International, Inc.\nW. Edward Scheetz, age 31, has been a principal of Apollo directing its real estate investment activities since May 1993. Mr. Scheetz is also a director of Roland International, Inc., Capital Apartment Properties, Inc., and Crocker Realty Trust, Inc. Prior to May 1993, Mr. Scheetz was a principal of Trammel Crow Ventures, a national real estate investment firm.\nMichael L. Ashner, age 44, has been the Chief Executive Officer of WFA since January 15, 1996. From June 1994 until January 1996, Mr. Ashner was a Director, President and Co-chairman of National Property Investors, Inc., a real estate investment company (\"NPI\"). Mr. Ashner was also a Director and executive officer of NPI Property Management Corporation (\"NPI Management\") from April 1984 until January 1996. In addition, since 1981 Mr. Ashner has been President of Exeter Capital Corporation, a firm which has organized and administered real estate limited partnerships.\nRichard J. McCready, age 37, is the President and Chief Operating Officer of WFA and its subsidiaries. Mr. McCready previously served as a Managing Director, Vice President and Clerk of WFA and a Director, Vice President and Clerk of the Managing General Partner and all other subsidiaries of WFA. Mr. McCready joined the Winthrop organization in 1990.\nJeffrey Furber, age 36, has been the Executive Vice President of WFA and the President of Winthrop Management since January 1996. Mr. Furber served as a Managing Director of WFA from January 1991 to December 1995 and as a Vice President from June 1984 until December 1990.\nAnthony R. Page, age 32, has been the Chief Financial Officer for WFA since August 1995. From July, 1994 to August 1995, Mr. Page was a Vice President with Victor Capital Group, L.P. and from 1990 to July 1994, Mr. Page was a Managing Director with Principal Venture Group. Victor Capital and Principal Venture are investment banks emphasizing on real estate securities, mergers and acquisitions.\nPeter Braverman, age 44, has been a Senior Vice President of WFA since January 1996. From June 1995 until January 1996, Mr. Braverman was a Vice President of NPI and NPI Management. From June 1991 until March 1994, Mr. Braverman was President of the Braverman Group, a firm specializing in management consulting for the real estate and construction industries. From 1988 to 1991, Mr. Braverman was a Vice President and Assistant Secretary of Fischbach Corporation, a publicly traded, international real estate and construction firm.\nOther than Mr. Weiner, each of the above individuals are also directors or executive officers of a general partner (or general partner of a general partner) of the following limited partnerships which either have a class of securities registered pursuant to Section 12(g) of the Securities and Exchange Act of 1934, or are subject to the reporting requirements of Section 15(d) of such Act: Winthrop Partners 79 Limited Partnership; Winthrop Partners 80 Limited Partnership; Winthrop Partners 81 Limited Partnership; Winthrop Residential Associates I, A Limited Partnership; Winthrop Residential Associates II, A Limited Partnership; Winthrop Residential Associates III, A Limited Partnership; 1626 New York Associates Limited Partnership; 1999 Broadway Associates Limited Partnership; Indian River Citrus Investors Limited Partnership; Nantucket Island Associates Limited Partnership; One Financial Place Limited Partnership; Presidential Associates I Limited Partnership; Riverside Park Associates Limited Partnership; Sixty- Six Associates Limited Partnership; Springhill Lake Investors Limited Partnership; Twelve AMH Associates Limited Partnership; Winthrop California Investors Limited Partnership; Winthrop Interim Partners I, A Limited Partnership; Winthrop Growth Investors I Limited Partnership; Southeastern Income Properties Limited Partnership; Southeastern Income Properties II Limited Partnership; Winthrop Miami Associates Limited Partnership; and Winthrop Apartment Investors Limited Partnership.\nItem 11.","section_11":"Item 11. Executive Compensation.\nThe following table sets forth the total annual compensation paid or accrued by WFA to or for the account of the Chairman of WFA and each of the four other highest compensated executive officers of WFA for services in all capacities to WFA and its subsidiaries during the year ended December 31, 1995.\nAnnual Compensation Name and All Other Principal Position Year Salary Bonus Compensation(2)\nArthur J. Halleran(1) 1995 $135,400 $ 50,000 $4,657,705(3) Chairman 1994 250,000 50,000 8,771 1993 250,000 -- 8,816\nJonathan W. Wexler(1) 1995 $135,400 $ 50,000 $3,189,763(3) Vice Chairman 1994 250,000 50,000 8,771 1993 250,000 -- 8,750\nJeffrey D. Furber 1995 $250,000 $250,000 $ 801,607(3) Executive Vice 1994 250,000 250,000 7,743 President 1993 180,000 70,000 35,207(4)\nRichard J. McCready 1995 $224,375 $ 50,000 $494,298 (3) Chief Operating 1994 175,000 -- 4,813 Officer 1993 160,000 60,000 3,850\nFrancis X. Jacoby(1) 1995 $136,500 $ 65,000 484,479(3) 1994 160,000 50,000 5,616 1993 160,000 85,000 4,900\n(1) For the period from January 1, 1995 to July 14, 1995, at which time Messrs. Halleran and Wexler ceased being employed by WFA. For period the January 1, 1995 to September 18, 1995, at which time Jacoby ceased being employed by WFA.\n(2) \"All Other Compensation\" represents matching contributions made by First Winthrop during the period covered on behalf of each of the listed individuals pursuant to the Company's 401(k) plan.\n(3) Due to the transfer of control of Linnaeus to Apollo, Messrs. Halleran, Wexler, Furber, McCready and Jacoby received from an affiliate of WFA's general partner (i) as payment for such individuals interest in W.L. Realty, (ii) in the case of Messrs. McCready and Furber, an inducement to remain with WFA and (iii) in the case of Messrs. Halleran, Wexler and Jacoby, as payment for certain restrictive covenants and amounts due under their employment contracts, $4,651,122, $3,183,180, $792,836, $488,341 and $478,341, respectively.\n(4) Includes $26,814 of relocation expenses and $1,383 of tax equalization payments made in connection with Mr. Furber's assignment to WFA's Hong Kong office.\nDefined Benefit or Actuarial Plan Disclosure. The Company has two contributory 401(k) plans (the Plans) covering most of its employees meeting certain age and service criteria. The first plan is for office employees and the second is for field employees. Under both Plans, participants may make pretax contributions of up to 15% of their salary. Under the office employees' plan, the Company will match employee contributions up to 3.5% of the employees' salary. The Company's contribution may be reduced as a result of forfeiture of unvested account balances by terminated employees. The employee contributions will be 100% vested, and the Company's matching contributions to the Plan as well as all prior account balances, will vest 50% upon completion of three years of services and 100% upon completion of four years of service.\nEmployment Contracts and Termination of Employment and Change-in- Control Arrangements. In connection with the December 22, 1994 transaction described in \"Item 12, Security Ownership of Certain Beneficial Owners and Management - Changes in Control,\" the following named executive officers of WFA and two other senior executives of WFA entered into employment contracts with WFA dated December 22, 1994 guaranteeing employment for terms ranging from three years to five years commencing on January 1, 1995. Arthur J. Halleran, Jr. and Jonathan W. Wexler entered into five year employment contracts with WFA which extend through December 31, 1999. These agreements were subsequently terminated upon the acquisition of control of WFA by Londonderry II. Jeffrey D. Furber and Richard McCready are employed pursuant to employment agreements which provide for a term of three years extending through December 31, 1997. Pursuant to his employment agreement, Mr. Furber will be paid a base salary of $250,000 per annum and a minimum guaranteed annual bonus payment of $250,000 for each of the calendar years 1995, 1996 and 1997. Pursuant to Mr. McCready's employment agreement, Mr. McCready will be paid a base salary of $190,000 per annum and is entitled to an annual discretionary bonus. Mr. McCready's employment contract was amended in July 1995, when he was appointed Chief Operating Officer of WFA, to increase his salary to $265,000 annually.\nEffective January 15, 1996, Mr. Michael Ashner entered into an employment agreement with WFA pursuant to which Mr. Ashner will serve as WFA's Chief Executive Officer. Pursuant to the terms of the employment agreement which has a term of three years, Mr. Ashner is entitled to receive an annual salary of $360,000 per annum, subject to increase based on the U.S. Consumer Price Index and a bonus which is based upon the improved financial performance or condition of WFA or its direct or indirect subsidiaries. Upon the termination of Mr. Ashner's employment for any reason other than cause, WFA will continue to be obligated to make payments to Mr. Ashner in accordance with the agreement for the remainder of the term, unless such termination is a result of his death or disability, in which case the amount due to Mr. Ashner will be the lesser of one year or the remaining term.\nCompensation Committee Interlocks and Insider Participation in Compensation Decisions. Compensation for all executive officers of WFA during 1995 was determined in accordance with their respective employment agreements or pursuant to agreements entered into in connection with the acquisition of control of WFA by Londonderry II.\nNo executive officer of either WFA or its subsidiaries served on the board of directors or any other committee establishing compensation for executive entities or entities which are not affiliated with WFA.\nPerformance Graph\nPursuant to Rule 304(d) of Regulation S-T, the following table summarizes the information which would otherwise be presented in the performance graph required by Regulation 402(l) of Regulation S-K. WFA, however, believes that the presentation of this information is not informative because WFA's partnership units are not traded on an exchange or NASDAQ market whereas the other groups presented consist of securities traded on an exchange or NASDAQ market. WFA partnership units are traded solely through private transactions and, because WFA is a partnership, certain tax laws limit the number of units that can be exchanged during any twelve month period. As a result, the volume of trades and ability to purchase and sell WFA's units on the secondary market is significantly lower than those of the other groups presented.\nNAREIT Equity Year WFA S&P 500 REIT Index\n1\/1\/91 $111.00 $127.61 $ 89.57 1\/1\/92 69.32 166.40 148.04 1\/1\/93 53.96 178.18 169.66 1\/1\/94 52.52 188.32 203.00 1\/1\/95 32.96 190.74 209.43 1\/1\/96 13.57 257.89 250.85\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nThe following table sets forth information as of March 1, 1996 regarding ownership of WFA's voting securities by each person who is known by WFA to own beneficially more than 5% of the voting securities of the Company. The WFA Partnership Agreement provides that all Assignee Units, including Preferred Units, vote as a single class.\nName and Address Amount and Nature Percent of of Beneficial Owner of Beneficial Interest all Assignee Units\nLinnaeus Associates 12,571,429 Assignee Units 82.25% Limited Partnership One International Place Boston, MA 02110\nLondonderry Acquisition 1,149,236 Preferred Units 7.52% Limited Partnership 2 Manhattanville Road Purchase, NY 10577\nChanges in Control. In connection with its acquisition of control of Linnaeus, Londonderry II issued NACC a $22 million non-recourse purchase money note due 1998 (the \"Purchase Money Note\"), as set forth in a loan agreement, dated as of July 14, 1995, by and between NACC and Londonderry II. Initial security for the Purchase Money Note includes (i) the WLR partnership interest acquired by Londonderry II, (ii) the Aquarius partnership interests in Springhill Lake, (iii) the Londonderry I partnership interests in WFA, (iv) the WLR partnership interest in Linnaeus, and (v) the Londonderry's title and interest in and to, and the indebtedness evidenced by, the WLR Acquisition Loan Agreement. Accordingly, if Londonderry II does not satisfy its obligations under the Purchase Money Note, NACC would have the right to foreclose upon Londonderry I's and Londonderry II's interests in WFA and WLR respectively.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Party Transactions.\nSee \"Item 11, Executive Compensation\" for information relating to payments made to current and former executive officers in connection with the acquisition of control of WFA by Londonderry II.\nAs a result of its general partnership interest and its ownership of 12,571,429 assignee units, Linnaeus is entitled to allocations of WFA's profits, losses and cash distributions as specified in WFA's partnership agreement.\nAs a result of its ownership of 1,149,236 Preferred Units, Londonderry I is entitled to allocations of WFA's profits, losses and cash distributions as specified in WFA's partnership agreement.\nIn December 1994 and in January 1995, WFA purchased from various current and former officers of WFA and its affiliates an 89.47% interest in Clarendon Land Company, Inc. (\"Clarendon\"), an 82.61 interest in Marlboro Land Company, Inc. (\"Marlboro\") and a 63.63% interest in Linnaeus San Francisco Associates, Limited Partnership (\"Linnaeus-San Francisco\"). Clarendon and Marlboro own residual interests in the land underlying properties owned by certain of WFA's previous syndications. Linnaeus-San Francisco owns a small, freestanding retail store. WFA paid an aggregate of $935,926 to acquire these interests which it believed to the fair market value of such interests.\nDuring 1995, WFA and its affiliates advanced $234,000 to affiliates of Apollo. These amounts bear interest at the prime rate plus 1% and are due on demand.\nIn February 1996, the Company contributed approximately $36.6 million of receivables to 19NY in connection with a loan restructuring transaction pursuant to which an affiliate of Apollo acquired the existing debt on certain of 19NY's properties. The remaining $10 million of receivables owed by 19NY and 1626 New York Associates Limited Partnership, a general partner of 19NY, were evidenced by a promissory note which the Company sold to an affiliate of Apollo for $6,000,000, which management believes represented the fair value of the note.\nPrior to transferring its interest in Linnaeus to Londonderry II, NACC provided financing to WFA and its affiliates as follows:\nIn March 1995, WFA contributed to Winthrop Southwest Holdings Limited Partnership (\"WSWH\"), a newly-formed partnership, all of its right, title and interest in and to the Southwestern Properties and NACC contributed to WSWH a $17,800,000 note receivable from WFA and First Winthrop Corporation. Pursuant to the terms of WSWH's partnership agreement, NACC is entitled to receive the first $17,800,000 in distributions from such partnership together with a priority return of LIBOR plus 6.5% on such contribution. The $17,800,000 note was the note made in connection with the settlement of a litigation involving First Winthrop Corporation.\nAquarius Tender Offer. The funds necessary for the consummation of the tender offer for Springhill Lake Units by Aquarius, an entity in which affiliates of NACC then collectively owned a 75% ownership interest (as general and limited partners) and WFA then owned a 25% limited partnership interest, were obtained through a 10-year credit facility (the \"Facility\") provided to Aquarius by NACC. This loan was subsequently acquired by an affiliate of Apollo in July 1995. All cash flow distributions received by Aquarius from Springhill Lake will be applied to the interest due on the Facility (which bears interest at a variable rate equal to 3% above the 30-day London interbank offer rate, reset monthly) and any unpaid interest will be accrued. Upon sale of the Project or sale of the Springhill Units owned by Aquarius, the Facility and all accrued interest will be repaid from proceeds received by Aquarius.\nAcquisition of \"The Hills\" and \"The Hills West\" Apartment Properties. In connection with its acquisition of The Hills and The Hills West in Austin, TX (collectively, \"The Hills\"), Winthrop- Austin obtained a mortgage loan from NACC in the amount of $8,470,000. The loan bears interest at a fixed rate of 10.04%; is being amortized over a 25 year schedule with payments of interest and principal due monthly for seven years. A balloon payment of the remaining balance will be due on May 1, 2002. NACC had previously acquired the existing mortgage on the Project from the prior lender which loan was in the principal amount of $9,945,974 (the \"Prior Loan\"). At closing of the purchase of the Hills, the Prior Loan was satisfied. Also in connection with this transaction, WFA paid NACC (i) a financing fee in the amount of $198,920, which was refunded in the form of a credit against closing costs payable by Winthrop-Austin at the time of the closing on the purchase of the existing mortgage debt from NACC and (ii) a loan commitment fee in connection with the new mortgage financing equal to 1.5% of the principal amount of the new mortgage debt (totaling $127,050), as well as reimbursements for legal fees and certain other costs.\nRiverside Acquisition Tender Offer. During 1995, the Company obtained debt from Londonderry II, and purchased $8,000,000 of units in a limited partnership which had been previously syndicated by the Company. These units and the related debt were subsequently transferred from the Company to Londonderry II, and therefore, are not included in the financial statements of the Company at December 31, 1995.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.\n(a) The following documents are filed as part of this Report:\n1. Financial Statements - See Index to Financial Statements in Item 8.\n2. Financial Statement Schedules - See Index to Financial Statement Schedule filed pursuant to Item 14(a) (2) in \"Item 8, Financial Statements and Supplementary Data.\" Financial statement schedules not included in Item 8 have been omitted because of the absence of conditions under which they are required or because the information is included elsewhere in the financial statements.\n3. The exhibits listed in the accompanying Index to Exhibits are filed as part of this Report.\n(b) Reports on Form 8-K: No reports on Form 8-K were filed during the last quarter 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.\nWINTHROP FINANCIAL ASSOCIATES, A LIMITED PARTNERSHIP\nBy: \/s\/ Michael L. Ashner Michael Ashner Chief Executive Officer\nDate: April 12, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, 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\/Name Title Date\n\/s\/ W. Edward Scheetz Director April 12, 1996 W. Edward Scheetz\n\/s\/ Michael Weiner Director April 12, 1996 Michael Weiner\n\/s\/ Anthony R. Page Chief Financial April 12, 1996 Anthony R. Page Officer\nEXHIBIT INDEX\nExhibit\n3A Agreement and Certificate of Limited Partnership (a) of Winthrop Financial Associates, A Limited Partnership (\"WFA\") and Amendments One through Twelve thereto\n3B Amendments Thirteen and Fourteen to the WFA (b) Partnership Agreement\n3C Amendment Fifteen to the WFA Partnership Agreement (c)\n3D Articles of Incorporation and By-Laws of WFA (a) Nominee Co., Inc.\n10A Agreement to Acquire Partnership Interests, dated (d) as of January 31, 1994, by and among Eleven Winthrop Properties, Inc. and 25 limited partnerships identified on Exhibit A to the Agreement\n10B Certificate of Limited Partnership of W.L. (c) Realty, L.P. dated as of December 21, 1995\n10C Agreement of Limited Partnership of W.L. (c) Realty, L.P. dated as of December 22, 1994\n10D Acquisition Loan Agreement between Nomura and W.L. Realty dated December 22, 1994 (a)\n10E Non-Recourse Note dated as of December 22, (c) 1994 by and between W.L. Realty, L.P., as Borrower, and Nomura Asset Capital Corporation, as Lender\n10F Partnership Interest Pledge and Security (c) Agreement between W.L. Realty, L.P., as Pledgor, and Nomura Asset Capital Corporation, as Pledgee, dated December 22, 1994\n10G Employment Agreement between Richard J. McCready, (c) and WFA, dated as of December, 1994\n10H Employment Agreement between Jeffrey D. Furber and (c) WFA, dated as of December, 1994\n10I Employment Agreement between Michael Ashner and WFA, dated as of February 21, 1996\n10J Letter Amendment dated August 11, 1995 to Employement Agreement between Richard J. McCready and WFA, dated as of December, 1994\n- -----------\n(a) Incorporated by reference WFA's Registration Statement on Form S-11 filed with the Commission on March 13, 1985 (the \"Registration Statement\")\n(b) Incorporated by reference to WFA's Form 10-K for its fiscal year ended December 31, 1991.\n(c) Incorporated by reference to WFA's Form 10-K for its fiscal year ended December 31, 1994.\n(d) Incorporated by reference to WFA's current report on Form 8- K filed with the Commission on April 11, 1994.\nExhibit 10I\nEMPLOYMENT AGREEMENT\nAGREEMENT made and entered into as of the 21st day of February, 1996, by and between WINTHROP FINANCIAL ASSOCIATES, A LIMITED PARTNERSHIP, a Maryland limited partnership with its principal place of business at One International Place, Boston, Massachusetts 02110 (the \"Company\") and Michael L. Ashner, an individual residing at 17 Buttonwood Drive, Dix Hills, New York 11746 (the \"Executive\").\nW I T N E S S E T H:\nWHEREAS, the Company desires to retain the services of the Executive, and the Executive is willing to provide such services to the Company, all upon the terms and conditions set forth herein.\nNOW, THEREFORE, for and in consideration of the foregoing premises and the mutual agreements set forth below, the Company and the Executive hereby agree as follows:\n1. Employment. The Company shall employ the Executive, and the Executive shall serve the Company, upon the terms and conditions hereinafter set forth.\n2. Term. Subject to the terms and conditions hereinafter set forth, the term of the Executive's employment hereunder (the \"Term\") shall commence on January 15, 1996 (the \"Effective Date\"), and shall continue until the third anniversary of the Effective Date, unless sooner terminated as hereinafter provided.\n3. Duties and Extent of Services.\n(a) During the Term, the Executive shall serve as the Chief Executive Officer and President of the Company and as the Chairman, Chief Executive Officer and President of each direct and indirect subsidiary of the Company. Subject to the supervision and direction of Linnaeus Associates Limited Partnership, the general partner of the Company or its successor (the \"General Partner\"), and subject to paragraphs (b) and (c) of this Section 3, the Executive's duties under this Agreement shall consist of generally overseeing all the operations of the Company and each of the Company's direct and indirect subsidiaries, including, without limitation, the hiring and firing of officers and employees, the establishment and modification of compensation payable to officers and employees, the incurrence of non-recourse indebtedness, the location of executive offices and other offices and the selection of legal counsel, accountants and other advisors, together with such other reasonable duties as may be assigned to him from time to time by the General Partner which are consistent with the positions set forth in the first sentence of this Section 3(a). The Executive will perform his duties under this Agreement faithfully and to the best of his ability. The Executive shall devote substantially all of his business time to his employment under this Agreement, provided, that, the Company expressly acknowledges that the Executive will devote a reasonable amount of his business time to the supervision and management of assets which the Executive owns or controls prior to the date of this Agreement and to the business activities described in Section 7.\n(b) Notwithstanding the provisions of paragraph (a) of this Section 3, the Executive shall not retain the services of any legal counsel, independent accountants or other advisors without the consent of the General Partner.\n(c) Notwithstanding the provisions of paragraph (a) of this Section 3, the Executive shall perform his duties on behalf of the Company in full compliance with the Company's Agreement and Amended Certificate of Limited Partnership dated as of December 4, 1984, as amended and restated through February 13, 1995, as amended.\n(d) The Executive shall report to the Board of Directors of the general partner of Londonderry Acquisition Corporation II, Inc. (or any successor corporation in control of the General Partner) not less frequently than once each calendar quarter during the Term regarding the operations of the Company and its Affiliates.\n(e) The Executive hereby represents and warrants to the Company that the execution and delivery of this Agreement by the Executive and the performance of its terms shall not violate or contravene any other agreement to which the Executive is a party or by which he is bound.\n(f) The Executive shall perform his services hereunder from the Company's offices in Nassau County, New York, provided, however, Executive shall spend up to 80 business days per year during the Term at the Company's offices in Boston, Massachusetts.\n4. Base Salary. Commencing on the Effective Date, the Company shall pay the Executive during the Term a salary at the rate of $360,000 per annum, which shall be payable in accordance with the Company's payroll practices as in effect from time to time with respect to senior executives, but not less often than monthly. The annual base salary of the Executive shall be increased on each anniversary date of the Term in an amount equal of the product of the prior year's base salary and the U.S. Consumer Price Index (as determined by the United States Department of Commerce) increase for the 12 month period that most closely corresponds to the prior year of the Term. (The annual salary of the Executive as in effect from time to time is herein referred to as his \"Base Salary\".)\n5. Bonus. The Company shall pay to the Executive, in addition to the Base Salary, an annual bonus payment (\"Bonus\"), the amount of which shall be based upon improved financial performance of, improved financial condition of, and\/or realization of asset values of, the Company or its direct and indirect subsidiaries, as reasonably determined by the General Partner in good faith. The Company agrees to cause the General Partner to commence discussions with the Executive regarding the amount of the Bonus no later than 30 days prior to each anniversary date of this Agreement.\n6. Other Compensation.\n(a) The Company shall pay or reimburse the Executive for all reasonable travel or other expenses incurred by the Executive in connection with the performance of his duties and obligations under the Agreement, in accordance with the Company's normal policies from time to time in effect for senior executive employees.\n(b) The Executive shall be entitled to participate in all employee group hospitalization, health, dental care, life insurance, pension, savings and thrift plans or programs, and to receive all benefits, perquisites and emoluments for which senior executive employees of the Company are eligible under any such plan or program, now or hereafter established by the Company and maintained by the Company and\/or its direct or indirect subsidiaries for salaried employees, to the extent permissible under the general provisions of such plans or programs.\n(c) During the Term, the Executive shall be entitled to vacation at the rate of 25 vacation days per annum. Except as otherwise permitted by the General Partner, any unused vacation days in any year may not be carried over to subsequent years, and the Executive shall receive no additional compensation for any unused vacation days.\n(d) The Company shall provide the Executive with a monthly allowance in connection with his purchase or lease of an automobile in the amount of $1,500 plus costs of gasoline and insurance.\n7. Participation Opportunities in Tender Offers. (a) For the purposes of this Section 7, the following terms have the respective meanings specified or referred to below:\n(i) \"Affiliate\" means with respect to any Person, any other Person directly or indirectly controlling, controlled by or under common control with such Person. For purposes of this definition \"control\" (including with correlative meanings, the terms \"controlling\", \"controlled by\" or \"under common control with\") as applied to any Person means the possession, directly or indirectly, of the power to direct or cause the direction of the management and powers of that Person, whether through the ownership of voting securities or by contract or otherwise.\n(ii) \"Apollo\" means Apollo Real Estate Advisors, L.P., a Delaware limited partnership.\n(iii) \"Associate\" shall have the meaning set forth in Rule 12b-2 promulgated under the Securities Exchange Act of 1934, as amended.\n(iv) A Person shall be deemed to \"Beneficially Own\" (and to be the \"Beneficial Owner\" and have \"Beneficial Ownership\" of) any security if (a) such Person \"beneficially owns\" such security within the meaning of Rule 13d-3 promulgated under the Securities Exchange Act of 1934, as amended or (b) such Person has any direct or indirect economic interest in such security.\n(v) \"Invested Capital\" means with respect to any Person the amount of cash and other amounts contributed from time to time to the capital of any other Person.\n(vi) \"Person\" means any individual, corporation, partnership, joint venture, estate, trust, cooperative, syndicate, consortium, coalition, committee, firm or other enterprise, association, organization or other entity.\n(vii) \"Real Estate Business\" means (A) the acquisition of any securities (including general or limited partnership interests) in, (B) the management of general partnership interests in, (C) the management of assets for, and\/or (D) the provision of investor services for, any public and\/or private general or limited partnerships, real estate companies or real estate investment trusts whose primary business is the ownership, management and\/or operation of real property interests and related assets.\n(viii) \"Tender Offer\" means an offer or proposal to acquire ownership by means of an offer pursuant to Regulation 14D promulgated under the Securities Exchange Act of 1934 of the equity or debt securities of any Person.\n(b) Except as set forth in Section 7(f), if during the Term Apollo or any controlled Affiliate of Apollo (an \"Apollo Initiating Person\") makes or proposes to make a Tender Offer for equity or debt securities issued by any private or publicly-held limited partnership that derives substantially all of its revenues from the Real Estate Business which is not an Affiliate of Apollo, the Company shall cause the Apollo Initiating Person to offer to the Executive in a written notice (the \"Apollo Tender Offer Notice\") the opportunity to invest directly or indirectly in the Person through which the Tender Offer is proposed to be made (the \"Tendering Entity\"). The Executive will be granted the option to acquire a direct or indirect ownership interest (which may be a so-called \"phantom\" interest) in the Tendering Entity or in another Person which has Beneficial Ownership in the Tendering Entity (as determined by the Apollo Initiating Person) that gives the Executive the right to acquire direct or indirect Beneficial Ownership in the Tendering Entity in an amount equal to up to 12% of the Apollo Initiating Person's ownership interest in the Tendering Entity, at the time such Tender Offer is initially made, on substantially similar terms as the Apollo Initiating Person's investment in the Tendering Entity. The Apollo Tender Offer Notice shall specify, in reasonable detail, the nature and scope of the proposed Tender Offer and any other material terms thereof. The Executive will have ten (10) days following the receipt of the Apollo Tender Offer Notice to exercise the option provided for in this Section 7(b) by giving written notice of such exercise to the Apollo Initiating Person. If the proposed Tender Offer is made on terms and conditions materially more onerous than those set forth in the Apollo Tender Offer Notice, the Executive shall have the right to revoke any prior acceptance of the offer set forth in the Apollo Tender Offer Notice and shall have a new 10 day period in which to elect to participate in such Tender Offer on such revised terms.\n(c) Except as set forth in Section 7(f), if during the Term an Apollo Initiating Person makes or proposes to make a Tender Offer for equity or debt securities issued by any private or publicly-held limited partnership that derives substantially all its revenues from the Real Estate Business which, at the time of such offer, is an Affiliate of Apollo, the Company shall cause the Apollo Initiating Person to offer to the Executive in an Apollo Tender Offer Notice the opportunity to invest directly or indirectly in the Tendering Entity. The Executive will be granted the option to acquire a direct or indirect ownership (which may be a so-called \"phantom\" interest) interest in the Tendering Entity or in another Person which has Beneficial Ownership in the Tendering Entity (as determined by the Apollo Initiating Person) that gives the Executive the right to acquire direct or indirect Beneficial Ownership in the Tendering Entity in an amount equal to up to 6% of the Apollo Initiating Person's ownership interest in the Tendering Entity, at the time such Tender Offer is initially made, on substantially similar terms as the Apollo Initiating Person's investment in the Tendering Entity. The Apollo Tender Offer Notice shall specify, in reasonable detail, the nature and scope of the proposed Tender and any other material terms thereof. The Executive will have ten (10) days following the receipt of the Apollo Tender Offer Notice to exercise the option provided for in this Section 7(c) by giving written notice of such exercise to the Apollo Initiating Person. If the proposed Tender Offer is made on terms and conditions materially more onerous than those set forth in the Apollo Tender Offer Notice, the Executive shall have the right to revoke any prior acceptance of the offer set forth in the Apollo Tender Offer Notice and shall have a new 10 day period in which to elect to participate in such Tender Offer on such revised terms. If the Executive exercises the option set forth in this Section 7(c), makes an investment in the Tendering Entity on the accepted terms and is responsible for implementing or supervising the implementation of such Tender Offer, the Executive shall receive, at no cost to the Executive, an additional ownership interest (which may be a so-called \"phantom\" interest) in the Tendering Entity or in another Person which has Beneficial Ownership in the Tendering Entity (as determined by the Apollo Initiating Person) that gives the Executive the right to receive, directly or indirectly, 6% (or, if the percentage interest initially acquired by the Executive in connection with such Tender Offer shall be less than 6%, such lesser percentage) of the Apollo Initiating Person's profits, losses and distributions from the Tendering Entity subordinated to the receipt by the Apollo Initiating Person of distributions of cash or other assets (valued at fair market value) in an amount equal to its Invested Capital plus a cumulative compounded return equal to 12% per annum on its unreturned Invested Capital.\n(d) If during the Term the Executive, any Associate of Executive or any controlled Affiliate of the Executive (an \"Executive Initiating Person\") makes or proposes to make a Tender Offer for equity or debt securities issued by any private or publicly-held limited partnership engaged in the Real Estate Business, the Executive Initiating Person shall offer to Apollo in a written notice (the \"Executive Tender Offer Notice\") the opportunity to invest in the Tendering Entity, and Apollo (or its designee) will have the option to acquire an ownership interest in the Tendering Entity in an amount not more than 7.33 times greater than the collective ownership interest of the Executive Initiating Persons ownership interest in the Tendering Entity (it being understood that Apollo (or its designee) therefore shall have the right to acquire up to 88% of all ownership interests in the Tendering Entity), at the time such Tender Offer is initially made, on substantially similar terms as the Executive Initiating Person's investment in the Tendering Entity. The Executive Tender Offer Notice shall specify, in reasonable detail, the nature and scope of the proposed Tender Offer and any other material terms thereof. Apollo will have ten (10) days following the receipt of the Executive Tender Offer Notice to exercise the option provided for in this Section 7(d) by giving written notice of such exercise to the Executive Initiating Person. If the proposed Tender Offer is made on terms and conditions materially more onerous than those set forth in the Executive Tender Offer Notice, Apollo shall have the right to revoke any prior acceptance of the offer set forth in the Executive Tender Offer Notice and shall have a new 10 day period in which to elect to participate in such Tender Offer on such revised terms. If Apollo (or its designee) exercises the option set forth in this Section 7(d) and makes an investment directly or indirectly in the Tendering Entity on the accepted terms, the Executive Initiating Person shall receive, at no cost to the Executive Initiating Person, an additional ownership interest in the Tendering Entity or in another Person which has Beneficial Ownership in the Tendering Entity (as determined by Apollo) that gives the Executive Initiating Person the right to receive, directly or indirectly, 12% (or, if the percentage interest initially acquired by the Executive in connection with such Tender Offer shall be less than 12%, such lesser percentage) of Apollo's or its designee's profits, losses and distributions from the Tendering Entity subordinated to the receipt by Apollo or its designee of distributions of cash or other assets (valued at fair market value) in an amount equal to its Invested Capital plus a cumulative compounded return equal to 12% per annum on its unreturned Invested Capital.\n(e) If the Executive elects to acquire ownership interests in any Tendering Entity, the Executive, subject to any restrictions that may be imposed by third parties participating in the Tender Offer or restrictions imposed, based on the advice of counsel, that are necessary in order to permit the Tendering Entity to be taxed as a partnership for federal income tax purposes, shall have the right to convey, assign, sell or transfer all, or any portion, of his right to acquire such ownership interests to any other Person who is at the time of such transfer a full time employee of the Company; provided, that, (A) the Executive (i) retains the exclusive voting power with respect to all such ownership interests or (ii) receives an irrevocable proxy from each transferee of any such ownership interest giving the Executive the right to vote such ownership interests on any matter to be voted upon by holders of such ownership interests, and (B) the Executive remains liable for all his obligations to the Tendering Entity.\n(f) The obligations of the Company set forth in this Section 7 shall not apply to the Tender Offers listed in Schedule 1.\n8. Termination.\n(a) The Executive's employment under the Agreement will terminate:\n(i) by the Company immediately upon the death of the Executive;\n(ii) by the Company or the Executive in the event the Executive is totally disabled (total disability meaning a disability which substantially prevents the Executive from performing his duties under this Agreement for more than 90 consecutive days);\n(iii) by the Executive for good reason which shall exist upon the occurrence of either of the following, provided, that the Executive delivers notice to the Company that he intends to terminate this Agreement for good reason and the Executive allows the Company 30 days to correct the particular act giving rise to such good reason termination, including as part of such corrective action reimbursing the Executive for any loss, cost, liability or expense incurred by the Executive as a result of the particular action or inaction giving rise to such good reason termination: (x) there is a change in the Executive's duties or responsibilities under this Agreement which would in form or substance constitute a diminution in the Executive's duties or responsibilities or (y) a material breach by the Company of any provision of this Agreement;\n(iv) by the Company for \"Cause\" (as defined below);\n(v) by the Executive voluntarily for any reason other than good reason or total disability; or\n(vi) by the Company for any reason other than death, total disability or Cause.\n(b) Within 15 days after any termination of the Executive's employment hereunder during the Term by the Executive for good reason or by the Company for any reason other than death, total disability or Cause, the Executive may elect to receive (A) either (x) the Executive's Base Salary at the rate then in effect for the remainder of the Term as if the Executive had continued employment through the end of the Term or (y) a lump sum payment representing the discounted present value (computed using an 8% per annum discount rate) of the Executive's Base Salary at the rate then in effect that would have been payable from the date of such termination through the third anniversary of the date his employment commenced under this Agreement had such employment not terminated and (B) a lump sum payment equal to the pro rata portion (based on the number of days the Executive was employed during the applicable period) of the Bonus which the Executive would have earned during the year in which the termination of employment occurred. The Executive shall be deemed to have made the election contemplated by clause (A)(y) in the event that Executive shall fail to make the election contemplated by the preceding sentence within such 15 day period. If an election of the type contemplated by clause (A)(y) is made, then the Company shall make the payment contemplated by such clause within 5 days following the end of such 15 day period. In addition, the Executive shall (I) continue to be entitled to any benefits which he may be entitled to as a former employee under the terms of all applicable benefit plans or programs and (II) continue to be entitled to the rights set forth in Section 7 (provided, that, Apollo shall also continue to be entitled to the rights set forth in Section 7) until the third anniversary of the Effective Date.\n(c) Upon any termination of the Executive's employment hereunder by the Company for Cause or by the Executive voluntarily other than for good reason or as a result of total disability, the Company shall, within ten (10) days of such termination, pay to the Executive any accrued but unpaid Base Salary.\n(d) For the purposes of paragraph (a) of this Section 8, \"Cause\" shall mean (i) the Executive is convicted of, pleads guilty to, or confesses to any felony or any act of fraud, misappropriation or embezzlement under state or federal law; (ii) any action by the Executive involving willful malfeasance or willful misconduct in connection with the performance of his duties and obligations under this Agreement; (iii) the Executive engages in a fraudulent act to the material damage or prejudice of the Company or any Affiliate of the Company or in conduct or activities materially damaging to the property, business or reputation of the Company or any Affiliate of the Company; or (iv) failure by the Executive to comply in any material respect with the terms of this Agreement or any written policies or directives of the General Partner consistent with the terms of this Agreement. In each case, the existence of Cause must be confirmed by the General Partner on behalf of the Company prior to any termination therefor in a notice to the Executive that the Company intends to terminate the Executive's employment for Cause, specifying in reasonable detail the act or acts constituting Cause. The Company cannot terminate the Executive for Cause unless the Company delivers the foregoing notice and allows the Executive 30 days to correct the particular act or failure to act, including as part of such corrective action reimbursing the Company for any loss, cost, liability or expense incurred by the Company as a result of the particular act or failure to act.\n(e) In the event this Agreement is terminated as a result of the death or total disability of Executive, the Company within 10 days of such termination shall make a payment equal to the Executive's then applicable Base Salary for the period equal to the lesser of (i) one year and (ii) the period of time from the date of termination through the third anniversary of the Effective Date to the Executive or the Executive's beneficiaries, estate or other legal representatives entitled to receive the benefits of this Agreement.\n(f) In the event of any termination of this Agreement, the Executive shall be under no obligation to seek other employment, and there shall be no offset against amounts due the Executive under this Agreement on account of any remuneration attributable to any subsequent employment that he may obtain.\n9. Noncompete; Non-Solicitation.\n(a) Except as provided in the last sentence of Section 3(a) and in Section 7, the Executive agrees that to the extent permitted by law he shall not, during his employment with the Company and, if the Executive's employment hereunder is voluntarily terminated by the Executive or terminated by the Company for Cause, for a period of two (2) years thereafter, commencing on the date of termination of such employment, directly or indirectly, own, manage, operate, join or control, or participate in the ownership, management, operation or control of, or be a director or employee of, or a consultant to, or authorize the use of his name by, or be connected in any manner with, any business, firm or corporation, anywhere in the United States of America, which at the time or at any time during such two year period is involved in business activities directly competitive with the business operations of the Company (or any subsidiaries as the same now exist or may be established from time to time) on the date of the termination of such employment.\n(b) The provisions of this Section 9 shall not apply to investments by the Executive in shares of stock traded on a national securities exchange or on the national over-the-counter market which shall constitute less than three percent (3%) of the outstanding shares of any class of such stock.\n(c) The Executive agrees that he shall not, during the Executive's employment with the Company and, if the Executive's employment hereunder is voluntarily terminated by the Executive or terminated by the Company for Cause, for a period of two (2) years thereafter, commencing on the date of termination of such employment, directly or indirectly, induce or attempt to influence any present or future employee of the Company or any subsidiary of the Company to leave its employ except Peter Braverman and the Executive's executive secretary at the time of such termination.\n10. Confidential Information. The Executive shall not at any time publish, disseminate, distribute, disclose, sell, assign, transfer, commercially exploit, or otherwise make use of any business and financial information, and other information relating to the businesses, methods or tactics of the Company except (a) as reasonably believed by the Executive to be authorized by the General Partner or as required for the due and proper performance of his duties and obligations under this Agreement, and (b) for any information which (i) is generally available to the public, (ii) is lawfully obtained by the Executive from a source other than the Company or (iii) is required to be disclosed by judicial or administrative process or by applicable law. Upon any termination, the Executive agrees that the Executive shall not retain any non-public information of the Company or its direct and indirect subsidiaries.\n11. Remedies. The Executive acknowledges that the services to be rendered by him hereunder are of a special, unique and extraordinary character, and that a breach by the Executive of the provisions of Sections 9 or 10 will cause the Company irreparable injury and damage. If any court holds that the whole or any part of the provisions of Sections 9 or 10 is unenforceable by reason of the extent or duration thereof, or otherwise, then the court or arbitrator making such determination shall have the right to reduce such extent, duration or other provisions thereof, and in its reduced form the provisions of Sections 9 or 10 shall be enforceable in the manner contemplated hereby. In the event of the Executive's breach of the provisions of Sections 9 or 10, the Company shall be entitled to injunctive relief against the Executive in addition to such other rights as the Company may have under this Agreement at law or in equity.\n12. Indemnification.\n(a) Subject to the limitations set forth in the Partnership Agreement and applicable law, the Company will indemnify or reimburse the Executive against any losses, claims, damages or liabilities and pay on his behalf all Expenses (as defined below) incurred by the Executive in any Proceeding (as defined below). This indemnification and reimbursement shall not apply if it is determined by a court of competent jurisdiction in a Proceeding that any losses, claims, damages or liabilities arose primarily out of the willful misconduct or bad faith of the Executive.\n(b) The term \"Proceeding\" shall include any threatened, pending or completed action, suit or proceeding, or any inquiry or investigation, whether brought in the name of the Company or otherwise and whether of a civil, criminal, administrative or investigative nature, in which the Executive was or is a party or is threatened to be made a party by reason of the fact that the Executive is or was a director, officer, employee, agent or fiduciary of the Company or of any direct or indirect subsidiary of the Company or by reason of the fact that he is or was serving at the request of the Company or any direct or indirect subsidiary of the Company as a director, officer, employee, trustee, fiduciary or agent of another corporation, partnership, joint venture, employee benefit plan, trust or other enterprise, whether or not he is serving in such capacity at the time any liability or expense is incurred for which indemnification or reimbursement can be provided under this Agreement.\n(c) The term \"Expenses\" shall include, without limitation thereto, expenses (including, without limitation, reasonable attorneys' fees and expenses) of investigations, judicial or administrative proceedings or appeals by or on behalf of the Executive and any Expenses of establishing a right to indemnification or reimbursement under this Agreement.\n(d) The Expenses incurred by the Executive in any Proceeding shall be paid by the Company as incurred and in advance of the final disposition of the Proceeding at the written request of the Executive. The Executive hereby agrees and undertakes to repay such amounts if it shall ultimately be decided in a proceeding that he is not entitled to be indemnified by the Company pursuant to this Agreement.\n(e) The provisions of this Section 11 shall survive the expiration or termination, for any reason, of this Agreement and shall be separately enforceable and shall be nonrecourse to the General Partner.\n13. Legal Expenses. The Company shall pay all of the Executive's reasonable attorneys' fees and expenses in connection with the preparation and negotiation of this Agreement, which fees and expenses shall not exceed $25,000.\n14. Prior Agreement; Amendments. This Agreement contains the entire understanding between the parties hereto with respect to the subject matter hereof and supersedes any prior employment agreement between the Company and any predecessor of the Company and the Executive. This Agreement may not be changed orally, but only by an instrument in writing signed by the party against whom enforcement of any waiver, change, modification, extension or discharge is sought.\n15. Assignability and Binding Effect. This Agreement shall inure to the benefit of and shall be binding upon the Company and its successors and permitted assigns and the Executive and his heirs, executors, legal representatives, successors and permitted assigns. However, neither party may assign, transfer, pledge, encumber, hypothecate or otherwise dispose of this Agreement or any of its or his rights hereunder without the prior written consent of the other party and any such attempted assignment, transfer, pledge, encumbrance, hypothecation or other disposition without such consent shall be null and void and without effect. Notwithstanding the foregoing, the Company shall be entitled to assign this Agreement, without the prior written consent of the Executive, in connection with the merger or consolidation of the Company with another person or the sale of all or substantially all of the assets and business of the Company to another person; provided, however, that the Company shall cause such other person to assume the Company's obligations thereunder. Upon such consolidation, merger or transfer of assets and assumption, the term \"the Company\" as used herein shall mean such other person and this Agreement shall continue in full force and effect.\n16. Headings. The paragraph headings contained herein are included solely for convenience of reference and shall not control or affect the meaning or interpretation of any of the provisions of this Agreement.\n17. Notices. Any notices or other communications hereunder by either party shall be in writing and shall be deemed to have been duly given upon delivery, if delivered personally to the other party, or five (5) business days after deposit in a United States Postal Service Depository, if sent by registered or certified mail, postage prepaid, return receipt requested, to the other party at his or its address set forth at the beginning of this Agreement or at such other address as such other party may designate in conformity with the foregoing.\n18. Governing Law. This Agreement shall be governed by, and construed and enforced in accordance with, the laws of New York applicable to contracts made and to be performed therein, without giving effect to the principles thereof relating to the conflict of laws.\nIN WITNESS WHEREOF, intending to be legally bound, the parties hereto have duly executed this Agreement the day and year first above written.\nWINTHROP FINANCIAL ASSOCIATES, A LIMITED PARTNERSHIP\nBy: Linnaeus Associates Limited Partnership, its general partner\nBy: W. L. Realty L.P., its general partner\nBy: Londonderry Acquisition II Limited Partnership, its general partner\nBy: LDY-GP Partners II, L.P., its general partner\nBy: Londonderry Acquisition Corporation II, Inc., its general partner\nBy: --------------------------------- Name: Title:\n--------------------------------- Michael L. Ashner\nSchedule 1\n1. Limited partnership interests or assignee units of limited partnership interests in the Company, Apollo or Apollo Real Estate Investment Fund.\n2. CAPREIT interests and tender offers by CAPREIT for interests in the CAPREIT Realty Investor Tax Exempt Funds.\n3.Limited partnership interests in Growth Hotel Investors, a California limited partnership.\n4. Limited partnership interests in Growth Hotel Investors II, a California limited partnership.\n5. At such time, if ever, that Insignia Financial Group, Inc. (\"Insignia\") shall become an Affiliate of the Company or Apollo, the Executive and the Company in good faith, with the consent of Insignia, shall renegotiate whether or not the obligations of the Company and the Executive set forth in Section 7 shall apply to Tender Offers for Affiliates of Insignia.\nExhibit 10J\nW. Edward Scheetz August 11, 1995 Apollo Real Estate Advisors, L.P. 1301 Avenue of the Americas - 38th Floor New York, New York 10019\nDear Ed:\nFollowing up on a discussion we had several weeks ago, I am writing to confirm our agreement that, in connection with my assuming the role of Chief Operating Officer at Winthrop, my annual salary will be increased from $190,000 to $265,000. This will serve as an amendment to the salary figure set forth in my Employment Agreement dated as of December 22, 1994 with WFA\nVery truly yours,\nRichard J. McCready\nAcknowledged and agreed to effective as of July 15, 1995:\n- -------------------------- W. Edward Scheetz, as Authorized Officer of Londonderry Acquisition Corporation II, Inc.","section_15":""}
{"filename":"25373_1995.txt","cik":"25373","year":"1995","section_1":"ITEM 1. BUSINESS\nCracker Barrel Old Country Store, Inc. (the \"Company\" or \"Cracker Barrel\") was incorporated in October 1969 under the laws of the State of Tennessee. The Company owns and operates 229 full service \"country store\" restaurants which are located in the southeast, midwest, mid-atlantic and southwest United States along interstate highways, including 6 stores located at \"tourist destinations\". These family restaurants serve breakfast, lunch and dinner between the hours of 6:00 a.m. and 10:00 p.m. (11:00 p.m. on Fridays and Saturdays) and feature home style country cooking prepared on the premises from the Company's own recipes using quality ingredients and emphasizing authenticity. Menu items are moderately priced and include country ham, chicken, fish, barbecue pork ribs, roast beef, beans, turnip greens, vegetable plates, salads, sandwiches, pancakes, eggs, bacon, sausage and grits. The restaurants do not serve alcoholic beverages. The stores are constructed in a rustic, country store design and feature a separate gift shop area offering a wide variety of items specializing in hand-blown glassware, cast iron cookware, toys and wood crafts as well as various old fashioned candies, jellies and other foods. The Company considers its store operations to constitute an integrated, single line of business.\nThe Company owns and operates three Cracker Barrel Old Country Store Corner Markets (the \"Corner Market\") which are located on major thoroughfares in the Middle Tennessee area. The Corner Markets serve lunch and dinner between the hours of 10:30 a.m. and 9:00 p.m. and feature home style country cooking prepared on the premises from the Company's own recipes using quality ingredients. The menu in these stores is a down-scaled version of the menu offered in the traditional Cracker Barrel Old Country Store and include meatloaf, chicken and dumplings, roast beef, and grilled chicken tenderloin as daily entrees as well as an assortment of freshly prepared vegetables. The Corner Markets do not serve alcoholic beverages. The stores are constructed in an old fashioned market design, are free-standing and incorporate a drive-through\/pick-up window. Two of the Corner Market properties are ground leases and the third Corner Market property is owned by the Company. The stores feature a hot food display case, along with refrigerated display cases for desserts and chilled food items such as sandwiches, salads, and drinks and a limited selection of food-related merchandise. The Corner Markets have indoor seating for approximately 50 people and outdoor seating for approximately 20 people. The Company is encouraged by initial volumes and will continue to monitor the progress of this concept before reaching a decision on future expansion plans.\nOperations\nStore Format: The format of each of Cracker Barrel's traditional stores consists of a rustic, country store style building. All stores are free standing buildings with adequate parking facilities and standard landscaping. Store interiors are subdivided into a dining area consisting of approximately 26% of the total interior store space, a gift shop area consisting of approximately 21% of such space, with the balance primarily consisting of kitchen and storage areas. All stores have wood-burning fireplaces and are decorated with antique-style furnishings and other authentic items of the past similar to those used and sold in original old country stores. The kitchen areas contain modern food preparation and storage equipment allowing for extensive flexibility in menu variation and development.\nProducts: Cracker Barrel's restaurants offer rural American cooking featuring the Company's own recipes. In keeping with the Company's emphasis on authenticity and quality, Cracker Barrel's traditional restaurants prepare menu selections on the premises. The Company's traditional restaurants offer breakfast, lunch and dinner from a moderately-priced menu. Most items may be ordered at any time throughout the day. Breakfast items include juices, eggs, pancakes, bacon, country ham, sausage, grits, and a variety of biscuit specialties, with prices for a breakfast meal ranging from $2.59 to $7.49. Lunch and dinner items include country ham, chicken, fish, steak, barbecue pork ribs, roast beef, beans, turnip greens, vegetable plates, salads, sandwiches, homemade soups and specialty items such as beef stew with muffins. Lunches and dinners range in price from $2.99 to $13.99. The Company from time to time increases its prices and increased its menu prices approximately 3% in February 1995.\nThe gift shops, which are decorated with antique signs, primitive tools and other memorabilia in a turn-of-the-century atmosphere, offer a wide variety of items consisting primarily of hand-blown glassware, cast iron cookware, old-fashioned crockery, handcrafted figurines, classic children's toys and various other gift items, as well as various candies, preserves, smoked sausage, syrups and other foodstuffs. Many of the candy items, smoked bacon, jellies and jams along with other high quality products are sold under the Cracker Barrel Old Country Store brand name.\nProduct Merchandising: Cracker Barrel maintains a quality control department which also develops new and improved menu items in response to shifts in customer preferences and changes in supply of ingredients used in the Company's menu items. Company merchandising specialists are involved on a continuing basis in selecting and positioning of merchandise in the gift shop areas. Management believes that the Company has adequate flexibility to meet future shifts in consumer preference on a timely basis.\nStore Management: Store management typically consists of a general manager, four associate managers and a gift shop manager who are responsible for approximately 93 employees on two shifts. The relative complexity of operating a Cracker Barrel Old Country Store requires an effective management team at the individual store level. As a motivation to store managers to improve sales and operational efficiency, Cracker Barrel has a bonus plan designed to provide store management with an opportunity to share in the pre-tax profits of their store. To assure that individual stores are operated at a high level of quality, the Company emphasizes the selection and training of store managers and has a level of District Management to assist individual store managers.\nThe store management recruiting and training program begins with an evaluation and screening program. In addition to multiple interviews and background and experience verification, the Company conducts testing which it believes is important in selecting those applicants best suited to manage store operations. Those candidates who successfully pass this screening process are then required to complete a 10-week training program conducted at the Company's Lebanon, Tennessee facility. This program allows new managers the opportunity to become familiar with the Company's operations, management objectives, controls and evaluation criteria before assuming management responsibility.\nPurchasing and Distribution: Cracker Barrel negotiates directly with food vendors as to price and other material terms of most food purchases. The Company purchases the majority of its food products and restaurant supplies on a cost-plus basis through a distributor headquartered in Nashville, Tennessee with custom distribution centers in Lebanon, Tennessee and Gainesville, Florida. The distributor is responsible for placing food orders and warehousing and delivering food products to the Company's stores. This distributor is not affiliated with the Company. Certain perishable food items are purchased locally by the Company's stores.\nThe majority of gift shop items are purchased directly by Cracker Barrel, warehoused at its Lebanon warehouse and shipped to the stores.\nThe single food category accounting for the largest share (approximately 16%) of the Company's food purchasing expense is pork. The single food item within the pork category accounting for the largest share (approximately 4%) of the Company's food purchasing expense is country ham. The Company presently purchases its pork food items through twelve vendors and its country ham through two vendors. Should any pork items from these vendors become unavailable for any reason, management is of the opinion that these food items could be obtained in sufficient quantities from other sources at competitive prices.\nQuality, Cost and Inventory Controls: Costs are monitored by management to determine if any material variances in food cost or operating expenses have occurred. The Company's computer system is used to analyze store operating information by providing management reports for continual monitoring of sales mix and detailed operational cost data. This system is also used in the development of budget analyses and planning.\nMarketing: New store locations generally are not advertised in the media until several weeks after they have been opened in order to give the staff time to adjust to local customer habits and traffic volume. To effectively reach consumers in the primary trade area for each Cracker Barrel store and also interstate travelers and tourists, outdoor advertising is the primary advertising media utilized, accounting for approximately 54% of advertising expenditures. Advertising costs are approximately 2% of annual sales.\nSeasonal Aspects: Historically the profits of the Company have been lower in the second fiscal quarter than in the first and third fiscal quarters and highest in the fourth fiscal quarter. Management attributes these variations primarily to the decrease in interstate tourist traffic during the winter months and the increase in interstate tourist traffic during the summer months.\nWorking Capital: Since substantially all sales in the restaurant industry are for cash, the Company, like most other restaurant companies, is able and may from time to time operate with a negative working capital. Inventories are generally financed from normal trade credit aided by rapid turnover of the restaurant inventory.\nExpansion\nThe Company's primary customer is the interstate traveler. Therefore, the Company's major emphasis in the opening of new stores will continue to be locating stores at interstate highway locations. In addition, specific major tourist destinations will be targeted as potential locations for new units.\nThe Company opened thirty-six new stores in fiscal 1995. Three of the stores are located on: Interstate 35 in Lewisville, Texas, Eagan, Minnesota and Fort Worth, Texas; three are located on Interstate 94 in Woodbury, Minnesota, Stevensville, Michigan and Port Huron, Michigan; three are located on Interstate 75 in Monroe, Michigan, Port Charlotte, Florida and Saginaw, Michigan; two are located on Interstate 10 in Pensacola, Florida and West Houston, Texas; two are located on Interstate 20 in Arlington, Texas and Shreveport, Louisiana; two are located on Interstate 25 in Northglenn, Colorado and Colorado Springs, Colorado; two are located on Interstate 65 in Shepherdsville, Kentucky and Madison, Alabama; two are located on Interstate 70 in Troy, Illinois and Independence, Missouri; two are located on Interstate 95 in Mechanicsville, Virginia and West Palm Beach, Florida, and one each on Interstate 4 in Lakeland, Florida, Interstate 24 in Chattanooga, Tennessee , Interstate 34 in San Antonio, Texas, Interstate 40 in Amarillo, Texas, Interstate 45 in League City, Texas, Interstate 64 in Evansville, Indiana, Interstate 71 in Mansfield, Ohio, Interstate 74 in Morton, Illinois, Interstate 77 in North Canton, Ohio, Interstate 80 in Joliet, Illinois, Interstate 83 in York, Pennsylvania, Interstate 85 in Opelika, Alabama, Interstate 88 in Naperville, Illinois, Interstate 90 in Madison, Wisconsin and Interstate 96 in Lansing, Michigan.\nThe Company plans to open forty-three new stores by the end of fiscal 1996. Eleven of the stores are already open; two are on Interstate 95 in Ashland, Virginia and Stuart, Florida, and there is one each on Highway 360 in Arlington, Texas, Interstate 25 in Albuquerque, New Mexico, Interstate 35 in Olathe, Kansas, Interstate 40 in Clemmons, North Carolina, Interstate 65 in Edinburgh, Indiana, Interstate 66 in Manassas, Virginia, Interstate 72 in Decatur, Illinois, Interstate 85 in Concord, North Carolina and Interstate 90 in Rockford, Illinois.\nPrior to committing to a new location, the Company performs extensive reviews of various available sites, gathering approximate cost, demographic and traffic data. The Company utilizes in-house engineers to consult on architectural plans, to develop engineering plans and to oversee new construction. The Company is currently engaged in the process of seeking and selecting new sites, negotiating purchase or lease terms and developing chosen sites.\nIt is the Company's preference to own its restaurant properties. The Company presently owns 212 of its 229 traditional restaurant properties. The other 17 properties are either ground leases or ground and building leases. Currently, average cost for a new store is approximately $650,000 for land and $1,850,000 for site work, building and equipment. The current store size is approximately 10,000 square feet with 178 seats in the restaurant.\nEmployees\nAs of July 28, 1995, Cracker Barrel employed 26,299 people, of whom 133 were in advisory and supervisory capacities, 1,374 were in store management positions and 13 were officers of the Company. Most of the restaurant personnel are employed on a full-time basis. The Company has an incentive plan for its hourly employees which is intended to lower turnover and to increase productivity by providing a defined career path through testing and ranking of employees. The Company's employees are not represented by any union, and management considers its employee relations to be good.\nCompetition\nThe restaurant business is highly competitive and is often affected by changes in the taste and eating habits of the public, local and national economic conditions affecting spending habits, and population and traffic patterns. The principal basis of competition in the industry is the quality and price of the food products offered. Site selection, quality and speed of service, advertising and the attractiveness of facilities are also important.\nThere are a large number of restaurants catering to the public, including several franchised operations in the family segment of the restaurant industry, which are substantially larger and have greater financial and marketing resources than those of the Company and which compete directly and indirectly in all areas in which the Company operates.\nTrademarks\nThe Company owns certain registered copyrights, patents and trademarks relating to the names \"Cracker Barrel Old Country Store\" and \"Cracker Barrel Old Country Store's Corner Market,\" as well as their logos, menus, designs of buildings, and other aspects of operations. The Company believes that the use of these names have some value in maintaining the atmosphere and public acceptance of its mode of operations.\nResearch and Development\nWhile research and development are important to the Company, these expenditures have not been material.\nCompliance With Environmental Protection Requirements\nCompliance with federal, state and local provisions which have been enacted or adopted regulating the discharge of materials into the environment should have no material effect upon capital expenditures, earnings, or the competitive position of the Company.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's present corporate headquarters and warehouse facilities are situated on approximately 120 acres of land owned by the Company in Lebanon, Tennessee.\nThe Company utilizes approximately 190,000 square feet of office space and 270,000 square feet of warehouse facilities. The management feels that the current amount of office space is sufficient to meet the Company's needs through the end of the fiscal 1997. As the number of stores increases, the need for more warehouse space will also increase. Because of this, the Company plans to expand the gift shop distribution center by approximately 120,000 square feet in fiscal 1996.\nIn addition to the corporate facilities, the Company owns or leases the following properties:\nSee \"Business-Operations\" and \"Business-Expansion\" for additional information on the Company's stores.\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\nNot applicable.\nPursuant to Instruction 3 to Item 401(b) of Regulation S-K and General Instruction G(3) to Form 10-K, the following information is included in Part I of this Form 10-K.\nExecutive Officers of the Registrant ____________________________________\nThe following table sets forth certain information concerning the executive officers of the Company as of October 2, 1995:\nThe following background material is provided for those executive officers who have been employed by the Registrant for less than five years:\nPrior to his employment with the Company in August, 1995, Mr. Magruder was Vice-Chairman of Darden Restaurants, Inc. from December 1994 to August 1995. Mr. Magruder had been employed by General Mills for 23 years, serving in various capacities within their restaurant division. Previously, Mr. Magruder was Executive Vice President of General Mills Restaurants and President of the Olive Garden from 1987 to 1994.\nPrior to his employment with the Company in January 1995, Mr. Fisher was Executive Vice President of Marketing with Baker's Square since 1993. Mr. Fisher was Vice President of Marketing with Shakey's Pizza, Inc. from 1989 to 1993.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nSince the initial public offering of the Company's common stock in November 1981, the Company's common stock has been traded on The Nasdaq Stock Market (National Market) with the symbol CBRL. There were 17,158 shareholders of record as of October 2, 1995.\nThe following table indicates the high and low sales prices of the Company's common stock as reported on The Nasdaq Stock Market (National Market) during the periods indicated.\nIn September 1983 the Board of Directors of the Company initiated a policy of declaring dividends on a quarterly basis. Prior to such date the Board followed a policy of declaring annual dividends during the first fiscal quarter. Quarterly dividends of $.005 per share were paid during all four quarters of fiscal 1994 and 1995. The Company foresees paying comparable cash dividends per share in the future.\nThe covenants relating to the 9.53% Senior Notes in the original amount of $30,000,000 restrict the payment of cash dividends and the purchase of treasury stock. Retained earnings not restricted under the covenants were approximately $271,000,000 at July 28, 1995.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe table \"Selected Financial Data\" on page 17 of the Company's Annual Report to Shareholders for the year ended July 28, 1995 (the \"1995 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 following portions of the 1995 Annual Report are incorporated herein by reference:\nManagement's Discussion and Analysis of Financial Condition and Results of Operations on pages 18 and 19.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe following portions of the 1995 Annual Report are incorporated herein by reference:\nFinancial Statements and Independent Auditors' Report on pages 20 through 31.\nQuarterly Financial Data (Unaudited) on page 30.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information required by this item with respect to directors of the Company is incorporated herein by reference to the section entitled \"Election of Directors\" in the Company's definitive proxy statement for its 1995 Annual Meeting of Shareholders (the \"1995 Proxy Statement\"). The information required by this item with respect to executive officers of the Company is set forth in Part I of this Form 10-K.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by this item is incorporated herein by reference to the section entitled \"Executive Compensation\" in the Company'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 to the section entitled \"Security Ownership of Management\" in the Company'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 to the section entitled \"Transactions with Management\" in the Company's 1995 Proxy Statement.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS AND REPORTS ON FORM 8-K\nA. List of documents filed as part of this report:\n1. The following Financial Statements and the Report of Deloitte & Touche LLP on pages 20 through 31 of the 1995 Annual Report are incorporated herein by reference:\nIndependent Auditors' Report dated September 6, 1995\nBalance Sheets as of July 28, 1995 and July 29, 1994\nStatements of Income for each of the three fiscal years ended July 28, 1995, July 29, 1994 and July 30, 1993\nStatements of Changes in Stockholders' Equity for each of the three fiscal years ended July 28, 1995, July 29, 1994 and July 30, 1993\nStatements of Cash Flows for each of the three fiscal years ended July 28, 1995, July 29, 1994 and July 30, 1993\nNotes to Financial Statements\n2. The exhibits listed in the accompanying Index to Exhibits on pages 14 & 15 are filed as part of this annual report.\nB. Reports on Form 8-K:\nThere were no reports filed on Form 8-K during the fourth quarter of the fiscal year ended July 28, 1995.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Cracker Barrel Old Country Store, Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nCRACKER BARREL OLD COUNTRY STORE, INC.\nDate: October 23, 1995\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 Company and in the capacities and on the dates indicated.\nINDEX TO EXHIBITS\nExhibit _______","section_15":""}
{"filename":"3982_1995.txt","cik":"3982","year":"1995","section_1":"ITEM 1. BUSINESS.\n(a) Development of the Business\nGENERAL\nAllis-Chalmers Corporation (\"Allis-Chalmers\" or the \"Company\") was incorporated in 1913 under Delaware law. The Company sold its major operating businesses in 1988 in accordance with its First Amended and Restated Joint Plan of Reorganization (Plan of Reorganization) under Chapter 11 of the United States Bankruptcy Code. The Plan of Reorganization was confirmed by the Bankruptcy Court on October 31, 1988 after acceptance by creditors and shareholders and was consummated on December 2, 1988. See Item 3. LEGAL PROCEEDINGS for a discussion of such proceedings.\nThe Company has its principal executive office in West Allis, Wisconsin and it maintains three wholly-owned subsidiaries. One subsidiary, Houston Dynamic Service, Inc., operates a machine repair business in Houston, Texas; the other two subsidiaries, KILnGAS R&D, Inc. and U.S. Fluidcarbon Inc., are inactive.\nOn September 22, 1994, the Company sold its B.R.B. Industries division. B.R.B. Industries, which was acquired by the Company on December 20, 1989 in a purchase of assets, is a Hoboken, New Jersey manufacturer of molded fabric products serving the apparel and lingerie markets and the home sewing and notions industries.\n(b) Financial Information About Industry Segments\nThe Company operates in a single industry segment -- the repair and service of mechanical rotating equipment for the industrial, utility and governmental aftermarkets.\n(c) Narrative Description of Business\nThe principal business activities of the Company are as follows:\nMACHINE REPAIR\nSales of the machine repair business operated by Houston Dynamic Service, Inc. (HDS), a wholly-owned subsidiary of the Company, were $3,190,000 in 1995, $3,580,000 in 1994 and $3,298,000 in 1993. The decrease in sales from 1994 was primarily the result of a weakened market for machinery repair and services.\nHDS services and repairs various types of mechanical equipment, including compressors (centrifugal, rotary, axial and reciprocating), pumps, turbines, engines, heat exchangers, centrifuges, rollers, gears, valves, blowers, kilns, crushers and mills. Services provided include\nemergency repair, disassembly, inspection, repair testing, parts duplication, machining, balancing, metalizing, milling, grinding, boring, welding, modification, reassembly, field machining, maintenance, alignment, field service, installation, startup and training.\nHDS employed 30 people on December 31, 1995. It operates out of a facility in Houston, Texas which was purchased by HDS in 1990. The facility includes repair shop and office space.\nHDS serves various industrial customers, including those in the petrochemical, chemical, refinery, utility, waste and waste treatment, minerals processing, power generation, pulp and paper and irrigation industries.\nOTHER DATA\nCompetition in the Company's machine repair business consists of nine major original equipment manufacturers (OEM) and numerous smaller independent competitors. Many of these competitors have special strengths in certain product areas because of customer preferences for OEM suppliers or because specialized patented technologies are offered. The principal methods of competition are price, quality, delivery, customer service and warranty.\nThe principal raw materials and purchased components used in the machine repair business are alloy and stainless steels, castings and forgings, aluminum, copper, gears and other basic materials. Alternative sources of supply exist or could be developed for all of these raw materials and components. This business is highly labor intensive.\nSome of the Company's products, processes and systems are covered by patents owned by or licensed to the Company. No particular product, process or system is dependent on a single fundamental patent, the loss of which would jeopardize the Company's businesses. The Company licenses the use of a number of its trademarks, from which it receives income.\nIn 1995, the Company recorded sales to one customer which accounted for 10% or more of total sales -- Amoco Chemical generated 26% of 1995 sales, 19% of 1994 sales and 22% of 1993 sales. In 1994 the Company, had two customers which accounted for 10% or more of total sales. Amoco Chemical (detailed above) and Chevron Corporation generated 15% of 1994 sales. In 1993 sales of 10% or more of the total sales were made to two customers -- Amoco Chemical (detailed above) and Siemens Corporation at 11% of 1993 sales.\nExpenditures relating to compliance with federal, state and local environmental protection laws are not expected to have a material effect on the Company's capital expenditures, results of operations, financial condition or competitive position. The Company is not aware of any present statutory requirements concerning environmental quality that would necessitate capital outlays which would materially affect the Company. In conjunction with consummation of the Plan of Reorganization, the Company settled all known environmental claims asserted by the United States Environmental Protection Agency (EPA) as well as claims asserted by certain state agencies. However, the EPA and eight third parties have claimed that Allis-Chalmers is liable for cleanup costs associated with certain hazardous waste disposal sites in which products\nmanufactured and sold by Allis-Chalmers before consummation of the Plan of Reorganization were ultimately disposed of by others. Since Allis- Chalmers manufactured and sold the products disposed of in these sites before consummation of the Plan of Reorganization, Allis-Chalmers has taken the position that all cleanup costs or other liabilities related to these sites were discharged in the bankruptcy. See Item 3. LEGAL PROCEEDINGS.\nThe Company's employment was 34, 41 and 136 at December 31, 1995, 1994 and 1993 respectively.\nFor more detailed information, the 1995 Consolidated Financial Statements, Notes to Consolidated Financial Statements and Management's Discussion and Analysis should be read in their entirety.\n(d) Financial Information About Foreign and Domestic Operations and Export Sales\nThe Company has no foreign operations or significant export sales.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company's principal operating facility is a repair shop and office building in Houston, Texas which is owned by HDS. Allis-Chalmers leases its administrative offices in West Allis, Wisconsin on a short-term basis. The facilities are considered adequate and suitable for the Company's principal business.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nREORGANIZATION PROCEEDINGS UNDER CHAPTER 11 OF THE UNITED STATES BANKRUPTCY CODE\nOn June 29, 1987 Allis-Chalmers and 17 of its domestic subsidiaries filed separate voluntary petitions for reorganization under Chapter 11 of the United States Bankruptcy Code. The Plan of Reorganization was confirmed by the Bankruptcy Court on October 31, 1988 after acceptance by creditors and shareholders, and the Plan of Reorganization was consummated on December 2, 1988.\nAt confirmation, the Bankruptcy Court approved the establishment of the A- C Reorganization Trust as the primary vehicle for distributions under the Plan of Reorganization, two trust funds to service health care and life insurance programs for retired employees and a trust fund to process and liquidate future product liability claims. Cash of approximately $400 million and other assets with a net book value of $38 million were distributed to creditors or transferred to the trusts, and the trusts assumed responsibility for substantially all remaining cash distributions to be made to holders of claims and interests pursuant to the Plan of Reorganization. The Company was thereby discharged of all debts that arose before confirmation of the Plan of Reorganization,\nand all of its capital stock was canceled and made eligible for exchange for shares of the reorganized Company.\nThe Company does not administer any of the aforementioned trusts and retains no responsibility for the assets transferred to or distributions to be made by such trusts pursuant to the Plan of Reorganization.\nFor a description of restrictions on the transfer of the common stock of the reorganized Company (Common Stock), see Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nENVIRONMENTAL PROCEEDINGS\nAs part of the Plan of Reorganization the Company made a cash payment of $4.5 million to the EPA in settlement of the EPA's claims for cleanup costs at all sites where the Company was alleged to have disposed of hazardous waste. The EPA settlement included both past and future cleanup costs at these sites and released the Company of liability for claims of contribution or indemnity which may be asserted by other potentially responsible parties against Allis-Chalmers in connection with these specific sites.\nIn addition to the EPA settlement, the Company negotiated settlements of various environmental claims which had been asserted by certain state environmental protection agencies. These settlements, totaling approximately $200,000, were approved by the Bankruptcy Court.\nSince consummation of the Plan of Reorganization on December 2, 1988, a number of parties, including the EPA, have asserted that the Company is responsible for the cleanup of hazardous waste sites. These assertions have been made only with respect to the Company's prebankruptcy activities. No claims have been asserted against the Company involving its postbankruptcy operations.\nBefore the settlement with the EPA in the bankruptcy proceedings, an attempt was made by the parties to identify all possible hazardous waste disposal sites and to settle all liabilities relating to those sites. Notwithstanding the breadth of the settlement, various EPA regional offices have continued to assert cleanup claims against Allis-Chalmers with respect to six sites. Apparently, not all offices of the EPA are aware of the settlement agreement, since at least two of these claims involve sites with respect to which the EPA specifically agreed not to sue.\nEight other parties have asserted that the Company is responsible for environmental cleanup costs or associated EPA fines in connection with seven additional sites. In each instance the Company activities complained of occurred prior to the Company's bankruptcy proceedings and the third parties did not file proofs of claim in the bankruptcy proceedings. The filing of such proofs of claim is required by the Bankruptcy Code to effect a claim against a Chapter 11 debtor. A bankruptcy discharge defense has been asserted by the Company in each instance. Although the law in this area is still somewhat unsettled, three Federal Courts of Appeal have held that a debtor can be discharged of environmental cleanup liabilities related to its prebankruptcy activities. The Company believes it will prevail in its position that its liability to the EPA and third parties for prebankruptcy environmental cleanup costs has been fully discharged. In one particular site, the EPA's Region III has concurred with the Company's position that claims for environmental cleanup were discharged pursuant to the bankruptcy. While each site is unique with different circumstances, the Company has notified other Regional Offices of the EPA of this determination associated with the Region III site. The Company has not received responses from the other Regional offices.\nThe EPA and certain state agencies also continue to request information in connection with various waste disposal sites in which products manufactured by Allis-Chalmers before consummation of the Plan of Reorganization were ultimately disposed of by other parties. Although the Company has been discharged of liabilities with respect to hazardous waste sites, it is under a continuing obligation to provide information with respect to its products to federal and state agencies. The A-C Reorganization Trust, under its mandate to provide Plan of Reorganization implementation services to the Company, has responded to these informational requests because prebankruptcy activities are involved.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNot applicable. PART II\nThe information required by Items 5, 6, 7 and 8 of Part II is incorporated by reference to the Company's 1995 Annual Report to Shareholders as follows:\nItem 5.","section_5":"Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS - page 4 of 1995 Annual Report to Shareholders.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA - page 5 of 1995 Annual Report to Shareholders.\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - pages 6 through 11 of 1995 Annual Report to Shareholders.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - pages 12 through 28 of 1995 Annual Report to Shareholders.\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.\n(a) Identification of Directors\nThe following individuals were elected as directors of the Company at the meeting of shareholders on October 25, 1989 (or have been appointed to fill vacancies caused by the resignation of two such directors) to serve until the next meeting of shareholders.\nJohn R. Collins, age 68, a director since December 1988. Mr. Collins retired in 1989 after serving since 1985 as Administrative Assistant to the Secretary-Treasurer of International Union, United Automobile, Aerospace & Agricultural Implement Workers of America -- UAW.\nJohn T. Grigsby, Jr., age 55, a director since December 1988. Mr. Grigsby has been a Vice Chairman of the Board of the Company since May 1989, an Executive Vice President since October 1989 and Chief Financial Officer since January 1996, having previously served since December 1988 as the Company's Chairman and Chief Executive Officer. Prior to that time and since July 1987, Mr. Grigsby was employed by the Company as Managing Director, Restructure Project. Mr. Grigsby also serves as the A-C Reorganization Trustee, as President of Thomson McKinnon Securities, Inc. during winddown and liquidation of its affairs and President and Chief Executive Officer of Nationwise Automotive, Inc., an automotive replacement parts retailer. He has been a director of 1st Southern Bank of Boca Raton, Florida since September 1987 and First Florida Industries, Inc. since July 1985.\nH. Sean Mathis, age 49, a director since December 1988. Mr. Mathis was elected as Chairman and Chief Executive Officer of the Company on January 16, 1996 and prior thereto, Mr. Mathis served as a Vice President of the Company since July, 1989. Mr. Mathis acted as the Federal Court Appointed Trustee for International Wire News Service Liquidation Corp., formerly United Press International (UPI) from August 1992 to May 1994. From November 1991 to July 1992, he served as Vice Chairman and a Director of UPI (then a news syndication service). Mr. Mathis was President and Chief Operating Officer of Ameriscribe Corporation, New York from May 1990 to October 1993 and is currently President and a Director of Gulfstream Capital Partners, Inc. From 1993 to 1995 Mr. Mathis was President and a Director of RCL Capital Corporation. He is also a Director of USTrails Inc. and Allied Digital Technologies Corp.\nClaude D. Montgomery, age 43, a director since December 1988. Since June 1993 Mr. Montgomery has been a director and shareholder in Marcus Montgomery P.C., a law firm, formerly known as Marcus Montgomery Wolfson P.C. Mr. Montgomery was a director and shareholder in Varet, Marcus & Fink P.C., formerly known as Milgrim, Thomajan & Lee P.C., attorneys, New York August 1989 through June 1993. Mr. Montgomery was a founding partner of Myerson & Kuhn, attorneys, New York, from January 1988 to July 1989. Prior to that time and since 1984, he was a founding partner of Booth, Marcus &\nPierce, attorneys, New York.\nRobert E. Nederlander, age 62, a director since May 1989. Mr. Nederlander was elected by the Board of Directors on November 16, 1993 to serve as a Vice Chairman of the Board, having previously served as Chairman of the Board and Chief Executive Officer of the Company since May 1989. He is also President and director of Nederlander Organization, Inc., New York, an owner and operator of one of the world's largest chains of theaters since November 1981; President of Nederlander Television and Film Productions, Inc. since October 1985; Partner in New York Yankees Baseball Club since 1973 and Managing General Partner from September 13, 1990 through December 31, 1991; director and Chairman of the Board of Riddell Sports, Inc. since April 1988; Chairman of the Board of MEGO Corporation, since January 1988; and a director of HFS Incorporated since 1995.\nJohn E. Sundman, age 69, a director since December 1988. Mr. Sundman retired in December 1991 as Vice President of Corcap, Inc., Hartford, Connecticut, a position which he held since July 1988, when Corcap was spun off by Lydall, Inc., Manchester, Connecticut. Prior to that time and since April 1978, he was Vice President, Chief Financial Officer and a director of Lydall, Inc. He remains a director of Corcap, Inc.\nAllan R. Tessler, age 59, a director since September 1992. Mr. Tessler served as Chairman of the Board and Chief Executive Officer of the Company from November 1993 until January 1996. Mr. Tessler is Chairman of the Board and Chief Executive Officer of International Financial Group, Inc. since 1987; and Co-Chief Executive Officer of Data Broadcasting Corporation since June 1992. Mr. Tessler is also Chairman of the Board of Great Dane Holdings, Inc., Enhance Financial Services Group, Inc. and Jackpot Enterprises, Inc. and director of The Limited, Inc.\nLeonard Toboroff, age 62, a director since May 1989. Mr. Toboroff has been a Vice Chairman of the Board and an Executive Vice President of the Company since May 1989; a director and Vice Chairman of Riddell Sports, Inc. from April 1988 to the present; a practicing attorney continuously since 1961 to the present; a director since August 1987 and former Chairman and Chief Executive Officer from December 1987 to May 1988 of Ameriscribe Corporation; and formerly a director, Chairman and Chief Executive Officer from May 1982 through June 1982 and Vice Chairman June 1982 through September 1988 of American Bakeries Company. Mr. Toboroff is also a director of Banner Aerospace, Inc. and Saratoga Beverage, Inc.\n(b) Identification of Executive Officers\nName, Age as of March 1, 1996, and Position Business Experience H. Sean Mathis, 49, See Item 10, subsection (a) above. Chairman of the Board and Chief Executive Officer Leonard Toboroff, 62, See Item 10, subsection (a) above. Vice Chairman of the Board and Executive Vice President\nJohn T. Grigsby, Jr., 55, See Item 10, subsection (a) above. Vice Chairman of the Board, Executive Vice President and Chief Financial Officer\nRobert E. Nederlander, 62, See Item 10, subsection (a) above. Vice Chairman of the Board\nJeffrey I. Lehman, 46, Mr. Lehman commenced his Treasurer employment with Allis-Chalmers and was elected to his current position in February, 1996. Since 1991, Mr. Lehman has been employed by the A-C Reorganization Trust and Thomson McKinnon Securities during winddown and liquidation of their affairs. He has also provided financial consultation since 1985.\n(c) Identification of Certain Significant Employees\nNone\n(d) Family Relationships\nNone\n(e) Business Experience\nSee this Item 10, subsections (a) and (b) above.\n(f) Involvement in Certain Legal Proceedings\nNone\n(g) Promoters and Control Persons\nNot applicable ITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nEXECUTIVE COMPENSATION\nThe following table sets forth certain information concerning compensation paid to or earned by the Company's only executive officer who earned more than $100,000 during the fiscal year ended December 31, 1995. Allan R. Tessler, Chairman of the Board and Chief Executive Officer received no compensation during 1995. Mr. Tessler resigned from these positions on January 16, 1996.\nSummary Compensation Table\nAnnual Compensation Other Name and Principal Position Salary Bonus Compensation\nRobert M. Qualls Vice President and 1995 $160,546* $ - $ - Chief Financial Officer, Treasurer 1994 $114,048 $ - $ - and Secretary 1993 $113,541 $ - $ -\n*Mr. Qualls resigned as Vice President and Chief Financial Officer, Treasurer and Secretary effective November 1, 1995 and received severance pay equal to six months salary in accordance with Company employee benefit programs. Pursuant to the Plan of Reorganization, the Company was reimbursed for severance paid to Mr. Qualls.\nLONG-TERM STOCK INCENTIVE PLAN\nThe Company's Long-Term Stock Incentive Plan (1989), adopted by the shareholders at the 1989 shareholders meeting, provides for grants to officers and key employees of stock options, stock appreciation rights, performance shares, restricted stock, restricted stock units and other stock-based awards. The maximum number of shares which may be granted with respect to stock-based awards is 50,000. Options to purchase shares may be granted at prices equal to not less than the fair market value at the date of grant, except that options to purchase up to 13,333 shares may be granted at a price which is not less than the fair market value on October 25, 1989, the date on which the Stock Incentive Plan was approved by shareholders. Options are exercisable within a period not to exceed 10 years from date of grant. Stock appreciation rights allow the holder to receive the difference between the exercise price and the fair market value of the stock at the date of exercise in cash or shares of common stock. No stock options or stock appreciation rights have been granted to date. RETIREMENT PLAN\nThe Allis-Chalmers Consolidated Pension Plan covers 5 active employees at the beginning of 1996. The Retirement Plan is a tax qualified defined benefit pension plan whose participants include Mr. Qualls. Effective March 31, 1987 the Retirement Plan was capped and frozen, without further increase in benefits provided by the Company after that date.\nThe approximate annual retirement benefits which will commence to Mr. Qualls upon attaining age 65 will be $5,900. The amount is before any adjustment for a surviving spouse's pension and is not subject to Social Security offset or other deductions.\nSAVINGS PLAN\nThe Company's Savings Plan was initiated in 1968. The Savings Plan permits the Company to contribute in its discretion cash or stock to participants' accounts. However, on June 1, 1985 the Company discontinued contributions to the Savings Plan. Employees may terminate voluntary participation in certain portions of the Savings Plan and withdraw their voluntary contributions at any time. However, there are restrictions on withdrawals of the Company matching contributions.\nUpon retirement, death or other termination of employment, employee account balances generally may be withdrawn in lump sum or in installments. Withdrawal of contributions is also permitted for defined hardships.\nDuring 1995 contributions by Company participants to the Savings Plan under Section 401(k) of the Internal Revenue Code totaled $59,400. At December 31, 1995 there were a total of 290 participants in the Savings Plan, of whom 17 were active employees of the Company.\nCOMPENSATION OF DIRECTORS\nSince December 1, 1990, the annual retainer for services as a director (previously $13,500 per year) has been suspended, the attendance fee for each Board meeting attended was reduced from $425 to $100 and the attendance fee for each Committee meeting was suspended.\nTERMINATION OF EMPLOYMENT AND CHANGE OF CONTROL ARRANGEMENT\nRobert M. Qualls, Vice President and Chief Financial Officer, Treasurer and Secretary resigned from the Company effective November 1, 1995.\nAllan R. Tessler, a current director, resigned as Chairman of the Board and Chief Executive Officer effective January 16, 1996.\nH. Sean Mathis became Chairman of the Board and Chief Executive Officer, effective January 16, 1996, in addition to his position as Director.\nJohn T. Grigsby, Jr. became Chief Financial Officer, effective January 16, 1996 in addition to being Vice Chairman, Executive Vice President and a Director.\nJeffrey I. Lehman became Treasurer, effective February 16, 1996.\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 lists the beneficial ownership with respect to all persons known to the Company to be the beneficial owner of more than 5% of the Company's Common Stock as of March 1, 1996.\nAmount and Nature Percent of Name and Address of Ownership Class\nAL-CH Company, L.P., 810 Seventh Avenue, New York, NY 10019 (includes shares held by Messrs. Nederlander and Toboroff as described below) 407,251(1) 40.6%\nWells Fargo Bank, P.O. Box 60347, Los Angeles, CA 90060, Trustee under that certain Amended and Restated Retiree Health Trust Agreement for UAW Retired Employees of Allis-Chalmers Corporation 136,406 13.6%\nFirstar Trust Company, 777 East Wisconsin Avenue, Milwaukee, WI 53202, Trustee under that certain Amended and\nRestated Retiree Health Trust Agreement for Non-UAW Retired Employees of Allis-Chalmers Corporation 101,977 10.2%\n(1) Messrs. Nederlander and Toboroff are beneficial owners of and have shared voting power and shared dispositive power over the 407,251 shares of common stock held by AL-CH Company, L.P., a Delaware limited partnership, of which the general partners are Q.E.N., Inc., a Michigan corporation controlled by Mr. Nederlander, and Lenny Corp., a Delaware corporation controlled by Mr. Toboroff. Mr. Allan R. Tessler is a limited partner in AL-CH Company, L.P. (b) Security Ownership of Management\nThe following table sets forth the number of shares of common stock of the Company beneficially owned as of March 1, 1996 by directors, the executive officers named in the Summary Compensation Table and all directors and executive officers as a group. Except as otherwise noted in the footnotes, the persons listed have sole voting and investment power over the shares beneficially owned.\nAmount and Nature Percent of Name of Ownership Class\nJohn R. Collins 0 * John T. Grigsby, Jr. 9,535 1.0% H. Sean Mathis 0 * Claude D. Montgomery 533 (1) * Robert E. Nederlander 407,251 (2) 40.6% (2) John E. Sundman 3,333 * Allan R. Tessler 0 * Leonard Toboroff 407,251 (2) 40.6% (2) All directors and officers as a group (including the above) 420,652 41.9%\n*less than 1%\n(1) Shares are owned beneficially by Mr. Montgomery's spouse as to which he disclaims beneficial ownership.\n(2) Messrs. Nederlander and Toboroff are beneficial owners of and have shared voting power and shared dispositive power over the 407,251 shares of common stock held by AL-CH Company, L.P., a Delaware limited partnership, of which the general partners are Q.E.N., Inc., a Michigan corporation controlled by Mr. Nederlander, and Lenny Corp., a Delaware corporation controlled by Mr. Toboroff. Mr. Allan R. Tessler is a limited partner in AL-CH Company, L.P.\n(c) Changes in Control\nNone\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\n(a) Transactions with Management and Others\nNone\n(b) Certain Business Relationships\nNone\n(c) Indebtedness of Management\nNone\n(d) Transactions with Promoters\nNot applicable PART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. Page (a) The Selected Financial Data, Management's Discussion and Analysis and the Company's financial statements, together with the report thereon of Price Waterhouse LLP, appearing on pages 5 through 28 of the Company's 1995 Annual Report to Shareholders, are incorporated by reference in this Form 10-K Annual Report. With the exception of the aforementioned information, the 1995 Annual Report to Shareholders is not deemed to be filed as part of this report. The schedule to the financial statements listed below should be read in conjunction with the financial statements in such 1995 Annual Report to Shareholders. Financial statement schedules not included in this Form 10-K Annual Report have been omitted because they are not applicable or the required information is shown in the financial statements or notes thereto.\nAllis-Chalmers Corporation and Consolidated Subsidiaries - Schedule to Financial Statements:\nVIII. Valuation and Qualifying Accounts. 19\nReport of Independent Accountants on Financial Statement Schedule. 20\n(b) Reports on Form 8-K. There were no reports on Form 8-K filed by the Company during the fourth quarter of 1995.\n(c) Exhibits:\n2.1. First Amended Disclosure Statement pursuant to Section 1125 of the Bankruptcy Code, which includes the First Amended and Restated Joint Plan of Reorganization dated September 14, 1988 (incorporated by reference to the Company's Report on Form 8-K dated December 1, 1988).\n3.1. Amended and Restated Certificate of Incorporation of Allis-Chalmers Corporation (incorporated by reference to the Company's Report on Form 8-A dated August 12, 1992).\n3.2. By-laws of Allis-Chalmers Corporation (incorporated by reference to the Company's Report on Form 8-A dated August 12, 1992).\n10.1. Amended and Restated Retiree Health Trust Agreement between Allis-Chalmers Corporation and Wells Fargo Bank (incorporated by reference to Exhibit C-1 of the First Amended and Restated Joint Plan of Reorganization dated September 14, 1988 included in the Company's Report on Form 8-K dated December 1, 1988).\n10.2. Amended and Restated Retiree Health Trust Agreement between Allis-Chalmers Corporation and Firstar Trust Company (incorporated by reference to Exhibit C-2 of the First Amended and Restated Joint Plan of Reorganization dated September 14, 1988 included in the Company's Report on Form 8-K dated December 1, 1988).\n10.3. Reorganization Trust Agreement between Allis- Chalmers Corporation and John T. Grigsby, Jr., Trustee (incorporated by reference to Exhibit D of the First Amended and Restated Joint Plan of Reorganization dated September 14, 1988 included in the Company's Report on Form 8-K dated December 1, 1988).\n10.4. Product Liability Trust Agreement between Allis- Chalmers Corporation and Bruce W. Strausberg, Trustee (incorporated by reference to Exhibit E of the First Amended and Restated Joint Plan of Reorganization dated September 14, 1988 included in the Company's Report on Form 8-K dated December 1, 1988).\n10.5.* Allis-Chalmers Corporation Long-Term Stock Incentive Plan (1989) (incorporated by reference to the Company's Report on Form 10-Q for the three months ended September 30, 1989).\n10.6. Subscription and Shareholder Agreement between Allis-Chalmers Corporation and AL-CH Company, L.P. dated May 18, 1989 (incorporated by reference to the Company's Report on Form 8-K dated May 24, 1989).\n10.7. Commercial Installment Loan Agreement by and between Allis-Chalmers Corporation and Marine Midland Bank, N.A., dated as of December 20, 1989 (incorporated by reference to the Company's Report on Form 8-K dated December 20, 1989).\n10.8.* Employment Agreement between Allis-Chalmers Corporation and John T. Grigsby, Jr. (incorporated by reference to the Company's Report on Form 10-Q for the three months ended September 30, 1989). 10.9. Asset Purchase Agreement by and between Allis-Chalmers Corporation, B.R.B. Industries, Inc., Jack Ehrenhaus and Fredric Allen dated as of November 7, 1989 (incorporated by reference to the Company's Report on Form 8-K dated December 20, 1989).\n10.10.* Allis-Chalmers Savings Plan (incorporated by reference to the Company's Report on Form 10-K for the year ended December 31, 1988).\n10.11.* Allis-Chalmers Consolidated Pension Plan (incorporated by reference to the Company's Report on Form 10-K for the year ended December 31, 1988).\n10.12. Asset Purchase Agreement by and between Allis- Chalmers Corporation and BRB Industries Corp. dated as of August 4, 1994, and amended by and among Allis-Chalmers Corporation, BRB Industries Corp. and Power Manufacturing, Inc. as of September 22, 1994 (incorporated by reference to the Company's Report on Form 8-K dated September 22, 1994.\n13.1. 1995 Annual Report to Shareholders of Allis- Chalmers Corporation (only those portions of such Annual Report that are incorporated by reference in this Report on Form 10-K are deemed filed herewith).\n21.1. Subsidiaries of Allis-Chalmers Corporation.\n27.1. Financial Data Schedule.\n* A management contract or compensatory plan or arrangement.\nALLIS-CHALMERS CORPORATION AND CONSOLIDATED SUBSIDIARIES\nSCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS\nFOR THE YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995\n(thousands)\nBalance at Balance Year Ended Beginning at Close December 31, 1993 of Period Additions Deductions of Period\nDoubtful receivables $ 367 $ 130 $ 248(a) $ 249\nPlant rearrangement $ 68 $ 0 $ 0 $ 68 Restructure costs 161 0 113 48 ------- ------- ------ ------- $ 229 $ 0 $ 113 $ 116 ======= ======= ====== =======\nBalance at Balance Year Ended Beginning at Close December 31, 1994 of Period Additions Deductions of Period\nDoubtful receivables $ 249 $ 73 $ 3 $ 319\nPlant rearrangement $ 68 $ 0 $ 0 $ 68 Restructure costs 48 0 48 0 ------- ------- ------ ------- $ 116 $ 0 $ 48 $ 68 ======= ======= ====== =======\nBalance at Balance Year Ended Beginning at Close December 31, 1995 of Period Additions Deductions of Period\nDoubtful receivables $ 319 $ 0 $ 13 $ 306\nPlant rearrangement $ 68 $ 0 $ 0 $ 68 Restructure costs 0 0 0 0 ------- ------- ------ ------- $ 68 $ 0 $ 0 $ 68 ======= ======= ====== =======\n(a) Includes writeoff of uncollectible receivables, less recoveries.\nREPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE\nTo the Board of Directors of Allis-Chalmers Corporation\nOur audits of the consolidated financial statements referred to in our report dated February 27, 1996 appearing on page 12 of the 1995 Annual Report to Shareholders of Allis-Chalmers 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 Schedule listed in Item 14(a) of this Form 10-K. In our opinion, this Financial Statement Schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.\nPrice Waterhouse LLP\nMilwaukee, Wisconsin February 27, 1996\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.\nAllis-Chalmers Corporation\n\/s\/John T. Grigsby, Jr. John T. Grigsby, Jr. Vice Chairman, Executive Vice President and Chief Financial Officer Date: March 15, 1996\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, this report has been signed on March 15, 1996 by the following persons on behalf of the registrant and in the capacities indicated.\n\/s\/H. Sean Mathis \/s\/Robert E. Nederlander H. Sean Mathis Robert E. Nederlander, Director Chairman of the Board, Chief Executive Officer and Director\n\/s\/ John R. Collins \/s\/John E. Sundman John R. Collins, Director John E. Sundman, Director\n\/s\/John T. Grigsby, Jr. \/s\/Allan R. Tessler John T. Grigsby, Jr. Director Allan R. Tessler, Director\n\/s\/Claude D. Montgomery \/s\/Leonard Toboroff Claude D. Montgomery, Director Leonard Toboroff, Director\nEXHIBIT INDEX\nExhibit No. Description\n13.1 1995 Annual Report to Shareholders of Allis-Chalmers Corporation (only those portions of such Annual Report that are incorporated by reference in this Report on Form 10-K are deemed filed herewith)\n21.1 Subsidiaries of Allis-Chalmers Corporation\n27.1 Financial Data Schedule","section_15":""}
{"filename":"62348_1995.txt","cik":"62348","year":"1995","section_1":"Item 1. Business\nHSBC Americas, Inc. (the Company), formerly Marine Midland Banks, Inc., is a New York State based bank holding company registered under the Bank Holding Company Act of 1956, as amended. At December 31, 1995, the Company, together with its subsidiaries, had assets of $20.5 billion and employed approximately 8,300 full and part time employees.\nAll of the Company's common stock is owned by HSBC Holdings B.V., an indirect wholly owned subsidiary of HSBC Holdings plc (HSBC). HSBC, the ultimate parent company of The Hongkong and Shanghai Banking Corporation Limited (HongkongBank) and Midland Bank plc, is an international banking and financial services organization with major commercial and investment banking franchises operating under long established names in Asia, Europe, North America and the Middle East. Principal executive offices of HSBC are located in London. HSBC, with assets of $352 billion at December 31, 1995, is one of the world's largest banking groups.\nThe Company's principal subsidiary, Marine Midland Bank (the Bank), which had assets of $20.3 billion and deposits of $16.6 billion at December 31, 1995, is supervised and routinely examined by the Superintendent of Banks of the State of New York and the Board of Governors of the Federal Reserve System.\nThe Bank is a regional bank with a distinctive geographic franchise encompassing the entire State of New York. Selected banking products are offered on a national basis. The Bank is engaged in a general commercial banking business, offering a full range of banking products and services to corporations, institutions, governments and individuals. Through its affiliation with HSBC, the Bank offers its customers access to global markets and services. In turn, the Bank plays a role in the delivery and processing of other HSBC products.\nThe Bank is subject to banking laws and regulations which, among other things, require that reserves be maintained against deposits and currently limit the establishment of branch banking offices in the U.S. outside its home state. The Company is also prohibited, with certain exceptions, from engaging, directly or indirectly, in activities which are not closely related to banking. In addition, the Federal Reserve Act restricts certain transactions between banks and their nonbank affiliates.\nThe FDIC Improvement Act of 1991 (FDICIA) set standards for: addressing the safety and soundness of the deposit insurance system, supervision of domestic and foreign depository institutions, accounting, prompt regulatory action and federal deposit insurance. Pursuant to FDICIA, a well capitalized institution must have a Tier 1 risk-based capital ratio of at least 6%, a total risk-based capital ratio of at least 10%, a leverage ratio of at least 5% and not be subject to a capital directive order. The leverage ratio measures Tier 1 capital against total non-risk weighted assets. The Bank's ratios at December 31, 1995 exceeded the ratios required for the well capitalized category. Revisions to the risk-based capital guidelines regarding interest rate risk have been proposed. As proposed, these guidelines would not materially affect the Company's risk-based capital ratios.\nPART I Continued\nItem 1. Business Continued\nIn connection with establishing standards to assure the safety and soundness of financial institutions as required by FDICIA, the Federal Reserve Board issued guidelines on operations and management and compensation. The Federal Reserve Board has proposed standards for asset quality and earnings. The Company does not expect the guidelines and proposed regulations to have a material effect on its operations.\nThe Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (IBBEA) authorized interstate acquisitions of banks and bank holding companies without geographic limitation beginning in 1995. In addition, beginning in 1997, a bank may merge with a bank in another state as long as neither of the states opt out of interstate branching. Also, IBBEA protects key provisions of state law, establishes a mechanism for de novo interstate branching, and includes provisions relating to interstate branching by foreign banks.\nThe Company and its subsidiaries face competition in all the markets they serve. Other commercial banks, thrift institutions, consumer finance companies, mortgage bankers, insurance companies and investment banking firms are traditional competitors. Many of these institutions are not subject to the same laws and regulations imposed on the Company and its subsidiaries.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe principal executive offices of the Company and the Bank are located in Buffalo, New York, in a building under a long-term lease. The Bank has more than 300 other banking offices in New York State located in approximately 47 counties. More than half of these offices are located in buildings owned by the Bank and the remaining are located in leased quarters. In addition, there are branch offices and locations for other activities occupied under various types of ownership and leaseholds in 9 states other than New York, none of which is materially important to the respective activities. For information relating to lease commitments, see Note 17 to the Financial Statements.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe Company and its subsidiaries are defendants in a number of legal proceedings arising out of, and incidental to, their businesses. Management of the Company, based on its review with counsel of the development of these matters to date, is of the opinion that the ultimate resolution of these pending proceedings will not have a material adverse effect on the business or financial position of the Company.\nPART I Continued\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nReference is made to Item 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters\nSince all common stock of the Company is owned by HSBC Holdings B.V., shares of the Company's common stock are not listed or traded on a securities exchange.\nItem 7.","section_6":"","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nThe Company reported net income for 1995 of $291.7 million compared with $17.2 million in 1994 and a loss of $70.9 million in 1993 after the cumulative effect of an accounting change which increased income for 1993 by $40 million.\nThe Company's reported results are consolidated with Concord Leasing, Inc. (Concord). Concord, which provides equipment financing through secured loan and finance lease transactions, had assets of $1.5 billion at December 31, 1994. Concord was merged with the Company on January 1, 1995 through the contribution of Concord's outstanding common stock held by HSBC Holdings, B.V. to the Company. The merger transaction was accounted for as a transfer of assets between companies under common control, with the assets and liabilities of Concord combined with those of the Company at their historical carrying values. The Company's consolidated financial statements reflect a restatement of all prior periods to include the accounts and results of operations of Concord as though the merger transaction occurred as of the beginning of the earliest period presented.\nA detailed review comparing 1995 operations with 1994 and 1993 follows. It should be read in conjunction with the consolidated financial statements of the Company which begin on page 33.\nE A R N I N G S P E R F O R M A N C E R E V I E W\nNet Interest Income\nNet interest income is the total interest income on earning assets less the interest expense on deposits and borrowed funds. In the discussion that follows, interest income and rates are presented and analyzed on a taxable equivalent basis, i.e., an amount equivalent to tax-exempt benefits is included in both interest income and applicable income taxes.\nNet interest income of $879.8 million in 1995 improved from $769.9 million in 1994 due to a number of factors, including an increase in the volume of\naccruing commercial and consumer loans, a higher prime rate and lower nonaccruing loans. The following table presents net interest income components on a taxable equivalent basis, using marginal tax rates of 35%, and quantifies the changes in the components according to \"volume and rate\".\nThe changes in interest income and interest expense due to both rate and volume have been allocated in proportion to the absolute amounts of the change in each.\nAverage Balances and Interest Rates\nAverage balances and interest rates earned or paid for the past three years are reported on pages 8 and 9. Interest rates earned on assets generally rose faster than interest rates paid on interest bearing liabilities resulting in increased net yields on average earning assets to 5.06% in 1995 from 4.57% in 1994.\nYields on commercial loans increased from 7.32% in 1994 to 8.79% in 1995 as a result of several factors. Outstanding loans to middle sized and smaller sized businesses increased where rates are generally higher than larger commercial customers. The prime rate on which loan rates are generally based averaged 8.83% in 1995 compared with 7.63% in 1994. The level of nonaccruing loans decreased from $855 million at year-end 1994 to $381 million at year-end 1995.\nAverage residential mortgages increased to $2,898 million in 1995 from $2,654 million in 1994 and $2,092 million in 1993. In addition, the yield on these loans increased from 6.36% in 1994 to 7.47% in 1995 as a result of higher interest rates. Other consumer loans include credit card receivables and installment loans such as automobile loans. Average credit card receivables increased to $1,720 million in 1995 from $1,516 million in 1994.\nDomestic time deposits, including NOW accounts, and consumer, commercial and public savings and other time deposits averaged $10.1 billion during 1995, compared with $9.2 billion in 1994. Average effective rates on these types of deposits were 3.88% in 1995, compared with 3.03% in 1994. This increase is reflective of a higher interest rate environment in 1995 in comparison to 1994.\nNontrading Income\nNontrading income was $298.3 million or $5.6 million lower than 1994. The increase in nontrading income between 1994 and 1993 relates primarily to mortgage servicing income (expense) which had been negatively impacted by accelerated mortgage prepayments due to the high volume of mortgage refinancings occurring within the industry during 1993 and 1992. Mortgage servicing rights amortization and write downs were $259.4 million in 1993 compared with $16.5 million in 1994 and $17.4 million in 1995. The carrying value of mortgage servicing rights at December 31, 1995 was $37 million compared with an estimated market value of $65 million.\nTrading Revenues\nTrading revenue includes securities trading gains and losses, commissions earned from distributing municipal obligations, and foreign exchange fees from transactions with corporate clients and correspondent banks. It does not include interest income from these activities (included as a component of net interest income), which is usually substantial. The following is an analysis of the average balance outstanding, interest income (on a taxable equivalent basis) and trading revenue related to trading assets. This analysis excludes foreign exchange revenue which is separately disclosed in the table relating to other operating income.\nIn 1994, the Company lowered its risk positions as a result of instability in the money markets driven by volatile interest rates. As interest rates stabilized in 1995, the Company increased its trading portfolio during the fourth quarter of 1995 to $617 million at year-end 1995 compared with $404 million at year-end 1994.\nSecurities Transactions\nSecurities transactions during 1995 resulted in net gains of $12.3 million compared with net gains of $7.9 million in 1994 and $6.5 million in 1993. The gains realized relate to equity investments classified as available for sale, primarily highly leveraged partnership interests.\nPersonnel Expense\nPersonnel expense was $354.2 million in 1995 compared with $363.8 million in 1994 and $372.7 million in 1993. Average staffing levels have declined during the three year period from 8,943 in 1993 to 8,301 in 1995. During 1994, the Company offered a voluntary retirement program. The charge for this program was included in other expenses.\nOther Operating Expenses\nOther operating expenses excluding personnel, have been reduced through operating efficiency programs as well as decreases in costs associated with problem credits. ORE and owned asset expenses were credits of $3.9 million in 1995 compared with expenses of $20.9 million in 1994 and expenses of $87.5 million in 1993. The years 1994 and 1993 include $10.5 million and $80.5 million, respectively, of revaluation adjustments related to ORE and owned assets. During 1995, these revaluations are considered in the level of provision provided for ORE and owned assets.\nIn mid-1995, the Federal Deposit Insurance Corporation (FDIC) lowered the insurance premium rate the Bank is assessed on deposits resulting in a $14.4 million expense reduction from 1994.\nMarketing and other expenses in 1995 continued to include amounts associated with a multi-faceted image campaign which included a statewide advertising campaign and, in 1994, the adoption of a new logo.\nIn 1994, other expenses include $29.8 million as provision to cover the costs of an early retirement program. Other expenses in 1993 included a charge of $25.0 million relating to the planned disposition of excess space as a result of continuing centralization of operations.\nProvision for Loan Losses\nProvision for loan losses was $167.0 million in 1995 compared with $150.6 million in 1994 and $85.3 million in 1993. Upon merger of Concord into the Company, management adopted an aggressive strategy of accelerating the timing of disposal of a troubled aircraft portfolio. This strategy resulted in an increased provision in 1995. Nonaccruing loans were 56% less at December 31, 1995 than one year ago. An analysis of the loan loss allowance and the provision for loan losses begins on page 28.\nIncome Taxes\nEffective January 1, 1993, the Company prospectively adopted Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (FAS 109), and reported the cumulative effect of the change at January 1, 1993 (a benefit of $40 million) separately in the consolidated statement of income for 1993. The recognition of the $40 million net deferred tax asset was based on the Company's forecast that it would generate taxable income of at least $118 million during 1993 and thus realize the benefit of a portion of its net reported operating loss carryforwards, which totaled approximately $300 million at January 1, 1993. The net operating loss carryforwards resulted from substantial loan losses in 1991 and 1990.\nAs of December 31, 1994, recognition of the $40 million deferred tax asset was based on the forecast that net temporary deductible differences of approximately $114 million will reverse during the years 1995 through 1997 and thus, be available for carryback to offset the Company's 1994 taxable income. For the years ended December 31, 1993, 1994 and 1995 the Company generated taxable income at a rate that was well in excess of that required to support the $40 million asset.\nAs of December 31, 1995, the Company had net deferred tax assets of $88.2 million, $73.5 million of which relates to a Federal net operating loss carryforward resulting from the merger of Concord into the Company. The recognition of the Federal net operating loss carryforward in 1995 was based on the Company's forecast that it would generate taxable income of at least $210.0 million during 1996 and thus realize the benefit of the net operating loss carryforward. Also as of December 31, 1995, recognition of the remaining $14.7 million of net deferred tax assets was based on a forecast that net temporary differences in excess of $42 million will reverse during the years 1996 through 1998 and, thus, be available for carryback to offset the Company's 1995 taxable income.\nB A L A N C E S H E E T R E V I E W\nAsset-Liability Management\nThe principal objectives of asset-liability management are to ensure adequate liquidity and to manage exposure to interest rate risk. Liquidity management requires maintaining funds to meet customers' borrowing and deposit withdrawal requirements as well as funding anticipated growth. Interest rate exposure management seeks to control both near term and longer term interest rate risk in order to provide a more stable base of net interest income.\nThe Bank, as both a large retail and commercial bank with a well established franchise in New York State with access to domestic and international money markets, has a wide range of available techniques for implementing asset-liability management decisions. The asset-liability management process is designed to take advantage of the Company's strengths in managing diversified financial businesses. Overall balance sheet strategy is centralized under the Asset and Liability Management Policy Committee, comprised of senior officers. Authority and responsibility for implementation of the Committee's broad strategy is controlled under a framework of defined trading and balance sheet position limits.\nThe Company maintains a strong liquidity position. The size and stability of its New York State deposit base are complemented by its maintenance of a surplus borrowing capacity in the money markets, including the ability to issue additional commercial paper and access unused lines of credit of $100 million at December 31, 1995. Wholesale liabilities increased to $4,205 million at December 31, 1995 from $3,175 million a year ago primarily as a result of increased money market activities. Deposits at December 31, 1995 were 111.1% of loans compared with 106.7% at December 31, 1994.\nThe Company is subject to interest rate risk associated with the repricing characteristics of its balance sheet assets and liabilities. Specifically, as interest rates change, interest earning assets reprice at intervals that do not correspond to the maturities or repricing patterns of interest bearing liabilities. This mismatch between assets and liabilities in repricing sensitivity results in shifts in net interest income as interest rates move.\nTo help manage the risks associated with the effects of changes in interest rates, and to optimize net interest income within the ranges of interest rate risk that the Company's management considers acceptable, the Company maintains a portfolio of off-balance sheet financial instruments. Consisting principally of interest rate swaps and forward rate agreements, these derivative instruments mitigate interest rate risk by altering the repricing characteristics of certain on-balance sheet assets.\nThe Company employs a combination of risk assessment techniques, principally gap analysis and dynamic simulation modeling, to analyze the sensitivity of its earnings to changes in interest rates. These risk assessment techniques are comprehensive, in that they include all on-balance sheet and off-balance sheet items. In dynamic simulation modeling, reaction to a range of positive and negative interest rate movements is projected with consideration given to known activities and to the behavioral patterns of individual assets and liabilities in the corresponding rate environments. As a financial institution, patterns of certain asset and liability movements can\nbe reasonably estimated based upon available historical data. Gap analysis assumes static conditions in that the effect of interest rate changes is calculated with consideration basically given to only known, as opposed to projected, maturity and repricing patterns.\nManagement has primarily utilized interest rate swaps and forward rate agreements to alter the repricing characteristics of balance sheet assets, thereby decreasing the Company's overall sensitivity to changes in interest rates.\nIn addition to utilizing derivative positions to manage overall repricing risk, the Company also utilizes these instruments to manage basis risk associated with the potential divergence of market interest rate indices. Specifically, the variable component of the majority of the Company's overall interest rate risk management derivatives are based upon the London Interbank Offered Rate (LIBOR). Given that the majority of rate sensitive loan assets are prime based, consistent with risk management philosophy, the Company enters into certain interest rate swaps whereby the LIBOR and prime interest streams are exchanged. Derivative financial instruments are also utilized to a lesser extent to manage the risk associated with the cash flows generated by certain specific balance sheet positions. A further discussion of derivative activities can be found in Note 19 to the Financial Statements.\nThe following table shows the repricing structure of assets and liabilities as of December 31, 1995, with each maturity interval referring to the earliest repricing opportunity for each asset and liability, that is, the earlier of its actual maturity or its expected rate reset date. The resulting \"gaps\" indicate the sensitivity of earnings with respect to the direction, magnitude and timing of changes in market interest rates.\nData shown is as of one day, and one day figures can be distorted by temporary swings in assets or liabilities.\nThe table provides approximate maturities of outstanding loans at year-end 1995. Maturities of outstanding loans are generally extended with the same credit approval process required of new credits. The table also shows the breakdown of the maturities which are at fixed or adjustable rates. Loans are considered to be rate sensitive, i.e., have floating or adjustable interest rates, when rates change within 100 days of fluctuations in key money market rates; otherwise, the loans are treated as fixed or predetermined interest rate obligations.\nSecurities Portfolios\nEffective January 1, 1994, the Company prospectively adopted Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities (FAS 115), which specifies the accounting and reporting for all investments in debt securities and for investments in equity securities that have readily determinable fair values. Under FAS 115, debt securities that the Company has the ability and intent to hold to maturity are reported at amortized cost. Securities acquired 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. All other securities are classified as available for sale and carried at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of shareholders' equity.\nIn November 1995, the Financial Accounting Standards Board issued a Special Report, \"A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities\" which provided a one-time opportunity for companies to reassess the appropriateness of the designations of all securities held upon the initial application of the Special Report. The Company reassessed the classifications of its securities held and, during December 1995 transferred securities with an amortized cost of $2,491 million and a fair value of $2,535 million from held to maturity to available for sale. The resulting redesignations were accounted for at fair value resulting in a net unrealized gain, net of tax of $29.4 million recorded in shareholders' equity.\nThe following table reflects the distribution of maturities of the available for sale portfolio at year-end 1995 together with the approximate taxable equivalent yield of the portfolio. The yields shown are calculated by dividing annual interest income, including the accretion of discounts and the amortization of premiums, by the fair value of securities outstanding at December 31, 1995. Yields on tax-exempt obligations have been computed on a taxable equivalent basis using applicable statutory tax rates. The table excludes securities with total fair value of $79 million, including $43 million in Federal Reserve Bank stock, without fixed maturities which had a weighted average yield of 4.35%.\nThe maturity distribution of U.S. Government agency obligations and other securities which include asset backed securities, primarily mortgages, are based on the contractual due date of the final payment. These securities have an anticipated cash flow that includes contractual principal payments and prepayments. Based on the anticipated cash flows, the total maturity distributions for the portfolio would be $672 million, $1,628 million, $189 million and $46 million for within one year, after one but within five years, after five years but within ten years and after ten years, respectively.\nDomestic Office Deposits\nCertificates of deposit of $100,000 or more issued by domestic offices which totaled $1,239 million at December 31, 1995, mature as follows: under 3 months, $971 million; 3 to 6 months, $123 million; 6 to 12 months, $83 million; and over 12 months, $62 million.\nAll other short-term borrowings include $746 million and $1 billion at year ends 1995 and 1994, respectively, from HSBC. See Notes 1 and 14 to the Financial Statements.\nCapital Resources\nTotal shareholders' equity at year-end 1995 was $1,665 million, compared with $1,500 million at year-end 1994. The equity base was increased by $291.7 million from net income and $29.4 million from net unrealized gains on securities available for sale, and reduced by $150 million for common shareholder dividends paid to HSBC Holdings B.V. and $5.9 million for preferred shareholder dividends. The ratio of shareholders' equity to total year-end assets increased to 8.12% at December 31, 1995 from 8.02% at December 31, 1994.\nCapital Adequacy\nThe Federal Reserve Board has Risk-Based Capital Guidelines for assessing the capital adequacy of U.S. banking organizations. The guidelines place balance sheet assets into four categories of risk weights, primarily based on the relative credit risk of the counterparty. Some off-balance sheet items such as letters of credit and loan commitments are taken into account by applying different categories of \"credit conversion factors\" to arrive at credit-equivalent amounts, which are then weighted in the same manner as balance sheet assets involving similar counterparties. For off-balance sheet items relating to interest rate and foreign exchange rate contracts, the credit-equivalent amounts are arrived at by estimating both the current exposure, mark to market value and the potential exposure over the remaining life of each contract. The credit-equivalent amount is similarly assigned to the risk weight category appropriate to the counterparty.\nThe guidelines include the concept of Tier 1 capital and total capital. Tier 1 capital is essentially common equity, excluding net unrealized gain (loss) on securities available for sale and goodwill, plus certain types of perpetual preferred stock. Total capital includes Tier 1 capital and other forms of capital such as the allowance for loan losses, subject to limitations, and subordinated debt. The guidelines establish a minimum standard risk-based target ratio of 8%, of which at least 4% must be in the form of Tier 1 capital.\nThe capital adequacy guidelines establish a limit on the amount of certain deferred tax assets that may be included in (that is, not deducted from) Tier 1 capital for risk-based and leverage capital purposes. The deferred tax asset recognized by the Company under FAS 109 meets the criteria for capital recognition and has been included in the calculation of the Company's capital ratios.\nUnder these guidelines, the Company's total risk adjusted assets and off-balance sheet items at December 31, 1995 was approximately $15.0 billion. Tier 1 capital was $1.6 billion and total capital was $2.4 billion resulting in risk adjusted capital ratios of 10.71% at the Tier 1 level and 16.21% at the total capital level. These ratios compared with 10.93% at the Tier 1 level and 17.25% at the total capital level at December 31, 1994.\nBanking industry regulators also have guidelines that set forth the leverage ratios to be applied to banking organizations in conjunction with the risk-based capital framework. Under these guidelines, strong banking\norganizations are required to maintain a minimum leverage ratio of Tier 1 capital to quarterly average total assets of 3%. At December 31, 1995, the Company had a 8.32% leverage ratio compared with 8.16% at December 31, 1994.\nThe regulatory agencies established five capital categories applicable to banks: well capitalized, adequately capitalized, undercapitalized, signifi- cantly undercapitalized and critically undercapitalized. A well capitalized institution must have a Tier 1 capital ratio of at least 6%, a total risk- based capital ratio of at least 10%, a leverage ratio of at least 5% and not be subject to a capital directive order. The Bank's ratios at December 31, 1995 exceeded the ratios required for the well capitalized category.\nFrom time to time, the bank regulators propose amendments to or issue interpretations of risk-based capital guidelines. The Federal Reserve Board has proposed amendments to the guidelines regarding interest rate risk. As proposed, this amendment would not materially affect the Company's risk-based capital.\nCredit Management\nThe credit policy function is centralized under the control of the Chief Credit Officer. The structure is designed to emphasize credit decision accountability, optimize credit quality, facilitate improvement in credit policies and procedures and encourage consistency in the approach to, and management of, the credit process throughout the Company as it relates to both on- and off-balance sheet activities.\nThe Credit Policy Committee, comprised of senior line and credit managers, is responsible for the design and management of the credit function. The Committee is charged with the responsibility for monitoring and making changes, where appropriate, to written credit policies.\nIn addition to active supervision and evaluation by lending officers, periodic reviews of the loan portfolio are made by internal auditors, independent auditors, the Board of Directors' Examining Committee and regulatory agency examiners. These reviews cover selected borrowers' current financial position, past and prospective earnings and cash flow, and realizable value of collateral and guarantees. These reviews also serve as an early identification of problem credits.\nProblem Loan Management\nBorrowers who experience difficulties in meeting the contractual payment terms of their loans receive special attention. Depending on circumstances, decisions may be made to cease accruing interest on such loans or to record interest at a reduced rate.\nThe Company complies with regulatory requirements which mandate that interest not be accrued on commercial loans with principal or interest past due for a period of ninety days unless the loan is both adequately secured and in process of collection. In addition, commercial loans are designated as nonaccruing when, in the opinion of management, reasonable doubt exists with respect to collectibility of all interest and principal based on certain factors, including adequacy of collateral.\nInterest that has been recorded but unpaid on loans placed on nonaccruing status is generally reversed and reduces current income at the time loans are so categorized. Interest income on these loans may be recognized to the extent of cash payments received. In those instances where there is doubt as to collectibility of principal, any cash interest payments received are applied as principal reductions. Loans are not reclassified as accruing until interest and principal payments are brought current and future payments are reasonably assured.\nIn certain situations where the borrower is experiencing temporary cash flow problems, and after careful examination by management, the interest rate and payment terms may be adjusted from the original contractual agreement. When this occurs and the revised terms at the time of renegotiation are less than the Company would be willing to accept for a new loan with comparable risk, the loan is separately identified as restructured.\nNonaccruing loans at December 31, 1995 totaled $381 million or 2.76% of total loans, compared with $855 million or 6.62% of total loans, a year ago. The reduced level of nonaccruing loans resulted from aggressive management of problem credits as well as improvement in the domestic economy. The merger of Concord into the Company resulted in an increased level of nonaccruing loans prior to 1995, primarily aircraft. During 1995 an aggressive strategy of accelerating the timing of gaining title to and disposing of these assets was adopted. As a result, provision for loan losses totaling $113 million was recorded in the first quarter of 1995 to reflect the change in strategy. The majority of the decline in nonaccruing loans at December 31, 1995 compared\nwith December 31, 1994 occurred in this portfolio. The large provision in the second quarter of 1994 was made to recognize deterioration in the used aircraft market.\nNonaccruing loans that have been restructured but remain in nonaccruing status amounted to $70 million, $11 million and $20 million at December 31, 1995, 1994 and 1993, respectively.\nOf the nonaccruing loans at December 31, 1995 over 46% are less than 30 days past due as to cash payment of principal and interest. Cash payments received on loans on nonaccruing status during 1995, or since loans were placed on nonaccruing status, whichever was later, totaled $52 million, $21 million of which was applied as interest income and $31 million as reduction of loan principal.\nIncluded in accruing loans contractually past due 90 days or more were consumer installment loans as follows: 1995, $36 million; 1994, $20 million; 1993, $24 million and residential real estate mortgages past due 90 days or more as follows: 1995, $15 million; 1994, $18 million; 1993, $12 million. When consumer loans cease to be accruing, rather than categorizing such loans as nonaccruing, they are generally charged off according to an established delinquency schedule.\nThe Company adopted Statement of Financial Accounting Standards No. 114, Accounting by Creditors for Impairment of a Loan (FAS 114), as amended by Statement of Financial Accounting Standards No. 118, Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures (FAS 118) effective January 1, 1995. FAS 114 provides guidance in defining and measuring loan impairment. 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. Impaired loans so identified are valued at the present value of expected future cash flows, discounted at the loan's original 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. The adoption of this statement did not result in any significant change in the Company's allowance for loan losses.\nThe Company identified impaired loans as defined by FAS 114 totaling $322 million at December 31, 1995 of which $117 million had a specific loan loss allowance of $61 million. No interest income was recognized on impaired loans during 1995.\nOther Problem Assets\nIn situations where loans are secured by real estate or other assets and the borrower cannot continue to meet its obligations, the property can be acquired through foreclosure. When property is so acquired, the lower of cost or fair market value (including cost to dispose) is reported on the balance sheet as other real estate and other owned assets. Any part of the loan exceeding the value of the property at the time of transfer is charged against the loan loss allowance. Subsequent decreases in fair value are included in other operating expense.\nForeign Country Outstandings and Risk\nOutstandings which are shown by category of borrower in the following table include loans, interest bearing deposits and other assets. Loans are distributed primarily on the basis of the location of the head office or residence of the borrower or, in the case of certain guaranteed loans, the guarantor. Interest bearing deposits with banks and their branches are grouped by the location of the head office of the foreign bank. Investments and acceptances are distributed on the basis of the location of the borrower. There were no loans to government and official institutions for the countries listed.\n* The table excludes bonds issued by the United Mexican States and the Republic of Venezuela which are collateralized by zero-coupon U.S. Treasury securities with a face value equal to that of the underlying bonds. They are known as \"Brady bonds.\" The fair value of such collateral for the $188 million of 6.25% Mexican bonds due 2019 was approximately $29 million, $27 million and $25 million at year ends 1995, 1994 and 1993, respectively. Interest payments are partially secured by cash equivalent instruments for an 18 month period. The fair value of such collateral for the $166 million book value, $177 million face value of 6.75% Venezuelan bonds due 2020 was approximately $26 million, $24 million and $22 million at year ends 1995, 1994 and 1993, respectively. Interest payments are partially secured by cash equivalent instruments for a 14 month period. These bonds had an aggregate fair value of $229 million at December 31, 1995.\nAllowance for Loan Loss and Charge Offs\nAt year-end 1995, the allowance was $477.5 million, or 3.46% of total loans, compared with $495.4 million, or 3.84% of total loans, a year ago. The ratio of the allowance to nonaccruing loans was 125.49% at December 31, 1995 compared with 57.92% a year earlier. The Company's nonaccruing loans were reduced to $381 million at December 31, 1995 from $855 million at December 31, 1994.\nThe allowance for loan losses is an allowance for possible credit related losses. The allowance is increased as provisions for loan losses are charged to current operating income. The allowance is reduced as charge offs are recorded. Recoveries are added to the allowance. In determining the amount of provisions for loan losses, management considers a number of factors.\nThese include judgments covering possible losses on loans, loan evaluations and examination classifications and expected performance of various categories of loans within an anticipated range of economic conditions. This is an ongoing process. Charge offs of commercial loans reflect management's judgment with respect to the ultimate collectibility of all or part of a loan. Charge offs of consumer loans occur according to an established delinquency schedule. Recoveries on loans previously charged off are added to the allowance.\nThe loan loss allowance is considered by management to be a general allowance available to cover loan losses within the entire portfolio. The classifications within the table below are based on management's current assessment of the loss potential associated with specific loans and elements of the portfolio. Allocation is especially problematical because of the difficulties inherent in predicting and evaluating the impact of economic events on fully performing loans, work-outs and previously charged off loans. Amounts allocated to consumer installment loans represent estimates of charge offs based on formulas appropriate to the type of loan. Management cautions that the loan loss allowance allocation does not necessarily represent the total amount which may be available for actual future losses in any one or more of the categories. Management is of the opinion that the loan loss allowance as of December 31, 1995 is adequate as a general allowance.\nThe provisions of FAS 114 are described briefly on page 26. As a result of this statement, effective January 1, 1995, allowances are established against impaired loans equal to the difference between the recorded investment in the asset and the present value of the cash flows to be received or the fair value of the collateral, if the loan is collateral dependent. This statement does not address the overall adequacy of the allowance for loan losses. The allowance for loan losses did not change as a result of adopting FAS 114.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nPage\nReport of Management 31\nReport of Independent Auditors 32\nHSBC Americas, Inc.: Consolidated Balance Sheet 33 Consolidated Statement of Income 34 Consolidated Statement of Changes in Shareholders' Equity 35 Consolidated Statement of Cash Flows 36\nMarine Midland Bank: Consolidated Balance Sheet 37\nSummary of Significant Accounting Policies 38\nNotes to Financial Statements 42\nR E P O R T O F M A N A G E M E N T\nManagement of HSBC Americas, Inc., is responsible for the integrity of the financial information presented in this annual report. Management has prepared the financial statements in conformity with generally accepted accounting principles. In preparing the financial statements, management makes judgments and estimates of the expected effect of events that are accounted for or disclosed.\nThe Company's systems of internal accounting control are designed to provide reasonable assurance that assets are safeguarded against loss from unauthorized acquisition, use or disposition and that the financial records are reliable for preparing financial statements. The selection and training of qualified personnel and the establishment and communication of accounting and administrative policies and procedures are elements of these control systems. Management believes that the system of internal control, which is subject to close scrutiny by management and by internal auditors, supports the integrity and reliability of the financial statements.\nThe Board of Directors meets regularly with management, internal auditors and the independent auditors to discuss internal control, internal auditing and financial reporting matters, and also the scope of the annual audit and interim reviews. Both the internal auditors and the independent auditors have direct access to the Board of Directors.\nR E P O R T O F I N D E P E N D E N T A U D I T O R S\nThe Board of Directors and Shareholders of HSBC Americas, Inc.\nWe have audited the accompanying consolidated balance sheets of HSBC Americas, Inc. (formerly Marine Midland Banks, Inc.) and subsidiaries as of December 31, 1995 and 1994, 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, 1995, and the accompanying consolidated balance sheets of Marine Midland Bank and subsidiaries as of December 31, 1995, and 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 HSBC Americas, Inc. and subsidiaries as of December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the years in the three year period ended December 31, 1995, and the financial position of Marine Midland Bank and subsidiaries as of December 31, 1995 and 1994, in conformity with generally accepted accounting principles.\nAs discussed in the Summary of Significant Accounting Policies, the Company adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes\" and SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" in 1993, the provisions of SFAS No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" in 1994, and 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\" in 1995.\n\/s\/ KPMG PEAT MARWICK LLP\nBuffalo, New York January 26, 1996\nS U M M A R Y O F S I G N I F I C A N T A C C O U N T I N G P O L I C I E S\nHSBC Americas, Inc. (the Company), formerly Marine Midland Banks, Inc., is a New York State based bank holding company. All of the common stock of the Company is owned by HSBC Holdings B.V., an indirect wholly owned subsidiary of HSBC Holdings plc (HSBC).\nThe accounting and reporting policies of the Company and its subsidiaries, including its principal subsidiary, Marine Midland Bank (the Bank), conform to generally accepted accounting principles and to predominant practice within the banking industry. The preparation of financial statements in conformity with generally accepted accounting principles requires the use of estimates and assumptions relating principally to unsettled transactions and events as of the balance sheet date of the financial statements. Accordingly, upon settlement, actual results may differ from estimated amounts. Prior years' financial statements have been reclassified to conform with the current financial statement presentation.\nThe following is a description of the more significant policies and practices.\nPrinciples of Consolidation\nThe financial statements of the Company and the Bank are consolidated with those of their respective wholly owned subsidiaries. All material intercompany transactions and balances have been eliminated.\nInvestments in companies in which the percentage of ownership is at least 20%, but not more than 50%, are accounted for under the equity method and are included in other assets in the consolidated balance sheet.\nSecurities\nEffective January 1, 1994, the Company adopted Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities (FAS 115), which specifies the prospective accounting and reporting for all investments in debt securities and for investments in equity securities that have readily determinable fair values. Under FAS 115, debt securities that the Company has the ability and intent to hold to maturity are reported at cost, adjusted for amortization of premiums and accretion of discounts. Securities acquired principally for the purpose of selling them in the near term are classified as trading assets and reported at fair value, with unrealized gains and losses included in earnings. All other securities are classified as available for sale and carried at fair value, with unrealized gains and losses, net of related income taxes, excluded from earnings and reported as a separate component of shareholders' equity.\nRealized gains and losses on sales of securities are computed on a specific identified cost basis and are reported within other income in the consolidated statement of income. Adjustments of trading assets to fair value and gains and losses on the sale of such securities are recorded in trading revenues.\nPrior to the adoption of FAS 115, securities available for sale were reported at the lower of aggregate cost or market value with any valuation adjustments reflected in income.\nLoans\nLoans are stated at their principal amount outstanding, net of unearned income and the net of unamortized nonrefundable fees and related direct loan origination costs. Loans held for sale are carried at the lower of aggregate cost or market value. Interest income is recorded based on methods that result in level rates of return over the terms of the loans. Loans include lease financing transactions representing the aggregate of lease receivables plus estimated residual values net of unearned income. Unearned income is amortized over the lease terms by methods producing a constant rate of return on net lease assets.\nCommercial loans are categorized as nonaccruing when, in the opinion of management, reasonable doubt exists with respect to collectibility of interest or principal based on certain factors including period of time past due (principally ninety days) and adequacy of collateral. At the time a loan is classified as nonaccruing, any accrued interest recorded on the loan is generally reversed and charged against income. Interest income on these loans is recognized only to the extent of cash received. In those instances where there is doubt as to collectibility of principal, any interest payments received are applied to principal. Loans are not reclassified as accruing until interest and principal payments are brought current and future payments are reasonably assured. Consumer loans, including residential mortgages, are charged off against the allowance for loan losses according to an established delinquency schedule.\nEffective January 1, 1995, the Company adopted Statement of Financial Accounting Standards No. 114, Accounting by Creditors for Impairment of a Loan (FAS 114), as amended by Statement of Financial Accounting Standards No. 118, Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures (FAS 118). FAS 114 considers a loan 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. Impaired loans are valued at the present value of expected future cash flows, discounted at the loan's original 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.\nRestructured loans are loans for which the original contractual terms have been modified to provide for terms that are less than the Company would be willing to accept for new loans with comparable risk because of a deterioration in the borrowers' financial condition. Interest on these loans is accrued at the renegotiated rates.\nLoan Fees\nNonrefundable fees and related direct costs associated with the origination or purchase of loans are deferred and netted against outstanding loan balances. The amortization of net deferred fees and costs are recognized in interest income, generally by the interest method, based on the contractual terms of the loans. Nonrefundable fees related to lending activities other than direct loan origination are recognized as other income over the period the related service is provided. This includes fees associated with the issuance of loan commitments where the likelihood of the commitment being exercised is considered remote. In the event of the exercise of the commitment, the\nremaining unamortized fee is recognized in interest income over the loan term using the interest method. Other credit-related fees, such as standby letter of credit fees, loan syndication and agency fees and annual credit card fees are recognized as other operating income over the period the related service is performed.\nAllowance for Loan Losses\nThe allowance for loan losses is an allowance for possible credit related losses. Additions to the allowance are made by provisions charged to current operating income. The determination of the balance of the allowance is based on many factors including credit evaluation of the loan portfolio, current economic conditions, and past loan loss experience. The allowance for loan losses includes a general component which, in management's judgment, is adequate to provide for unidentified losses in the loan portfolio.\nOther Real Estate and Other Owned Assets\nIn situations where loans are secured by real estate or other property and the borrower cannot continue to meet its obligations, the property can be acquired through foreclosure. Such properties are recorded at the lower of cost or fair value (including costs to dispose of the property) on the acquisition dates. Any part of the loan exceeding the fair value of the property at the time of transfer is charged against the loan loss allowance. Subsequent decreases in fair value and net operating results on the property are included in other operating expenses.\nMortgage Servicing Rights\nMortgage servicing rights (MSRs) include purchased mortgage servicing rights (PMSRs) and excess mortgage servicing rights (EMSRs). PMSRs represent the cost of rights acquired in a purchase of mortgage loans where a definitive plan for the sale of loans exists when the transaction was initiated or the cost to acquire the rights to service a pool of mortgages that have previously been sold. EMSRs are recognized when mortgage loans are sold with servicing retained and the net servicing fee rate exceeds the normal servicing fee. The selling price of the loans is adjusted for such excess.\nMSRs are amortized over the expected life of the loans serviced, including expected prepayments, using a method that approximates the level yield method. The carrying value of the MSRs is periodically evaluated in relation to estimated future net servicing revenue. Write downs of MSRs are recognized when unexpected prepayments are experienced or anticipated, so that estimated future net servicing income exceeds the carrying amount. The evaluation of future net servicing income is based on a discounted and disaggregated (individual portfolio) methodology.\nIncome Taxes\nEffective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (FAS 109). FAS 109 requires an asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, as well as the estimated future tax consequences attributable to net operating loss and tax credit carryforwards. A valuation allowance is established to reduce deferred tax assets to the amounts expected to be realized.\nThe Company and its subsidiaries file a consolidated federal income tax return. Taxes of each subsidiary of the Company are generally determined on the basis of filing separate returns.\nDerivative Financial Instruments\nDerivative financial instruments, principally interest rate swaps and forward rate agreements are utilized by the Company to manage risk pursuant to an overall asset-liability management strategy. To the extent that these risk management positions are linked to assets-liabilities that are valued on an historical cost basis, accrual or deferral based accounting is applied. As such, risk management positions are not marked to current market value, rather cash flows and\/or gains and losses realized are accrued and\/or amortized as an adjustment to net interest income, or to the income or expense generated by the corresponding specific asset-liability position.\nDerivative financial instruments specifically linked to and utilized to offset the risk associated with securities classified as available for sale, are accounted for on the same basis as the underlying securities. The mark to market value of the derivatives are included with the fair value of the related instruments and as such become a component of the unrealized gains (losses) recorded in the shareholders' equity adjustment account.\nTrading positions in derivative financial instruments utilized to offset risk associated with cash trading instruments and foreign exchange trading activity are accounted for on a mark to market (fair value) basis consistent with the accounting applied to the related activity. The mark to market adjustment, which is recorded through the use of a valuation reserve and may include an interest receivable\/payable component, along with any related gains or losses realized upon liquidation of a derivative trading position, is recorded as a component of trading revenues (loss).\nDerivative financial instruments entered into to facilitate the needs of customers are immediately matched off by taking corresponding and offsetting positions with other counterparties. The Company considers this activity to be a fee generating service offered to certain select customers and does not maintain unmatched positions within this portfolio. With the exception of a small spread between the pay and receive rates, representing compensation for facilitating the transaction, the periodic accrual amounts effectively offset each other. If a position becomes unmatched for any reason, it is immediately accounted for on a mark to market basis.\nN O T E S T O F I N A N C I A L S T A T E M E N T S\nNote 1. Significant Acquisitions\nOn January 1, 1995 Concord Leasing, Inc. (Concord), an indirect wholly owned subsidiary of HSBC, was merged with the Company. Concord's outstanding stock was contributed to the Company. Concord provides equipment financing through secured loan and finance lease transactions. Assets of Concord totaled $1.5 billion at December 31, 1994.\nThe merger transaction was accounted for as a transfer of assets between companies under common control, with the assets and liabilities of Concord combined with those of the Company at their historical carrying values. The Company's accompanying consolidated financial statements reflect a restatement of prior periods to include the accounts and results of operations of Concord as though the merger transaction occurred as of the beginning of the earliest period presented. Previously reported information was as follows:\nOn January 1, 1996 Oleifera Investments, Ltd., (OIL), an indirect wholly owned subsidiary of HSBC, was transferred to the Company. OIL's outstanding stock was contributed to the Company. Assets of OIL totaling $183 million at December 31, 1995 consisted primarily of commercial loans and other real estate. The merger transaction was accounted for as a transfer of assets between companies under common control similar to the accounting followed by the Concord merger.\nThe following unaudited pro forma data summarizes the combined results of operations of the Company and OIL.\nThe Company has reached an agreement to acquire the East River Savings Bank branch network and deposits, and selected commercial, residential and consumer loans for $93 million. The agreement calls for the Company to acquire all 11 branches, and $1.1 billion in assets and to assume $1.2 billion in deposits. The purchase transaction is subject to regulatory approvals and is expected to be consummated in the second quarter of 1996.\nNote 2. Cash and Due from Banks\nThe Bank is required to maintain noninterest bearing balances at Federal Reserve Banks as part of its membership requirements in the Federal Reserve System. These balances averaged $214,338,000 in 1995 and $203,669,000 in 1994.\nNote 3. Trading Assets\nNote 4. Securities\nOn October 1, 1993, the Company transferred its entire available for sale portfolio having a market value of $881,354,000 to trading assets. As a result of the transfer, the adoption of Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities (FAS 115), on January 1, 1994 had no effect on the Company's financial statements.\nIn November 1995, the Financial Accounting Standards Board issued a Special Report, \"A Guide to the Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities\" which provided a one-time opportunity for companies to reassess the appropriateness of the classifications of securities under FAS 115. The Company reassessed the classifications of its securities held and during December 1995 transferred securities from held to maturity with an amortized cost of $2,491,402,000 and a fair value of $2,535,262,000 to available for sale. The redesignations were accounted for at fair value resulting in an unrealized gain net of taxes of $29,390,000 recorded in shareholders' equity. The one-time reassessment does\nnot call into question management's ability and intent to hold securities to maturity in the future. The amortized cost and fair value of securities follows.\nAt December 31, 1994, with regard to securities held to maturity, the Company had gross unrealized gains of $29,000, $267,000 and $722,000 and gross unrealized losses of $27,750,000, $32,210,000 and $1,046,000 related to U.S. Treasury, U.S. Government agency and other debt securities, respectively.\nProceeds from the sale of securities available for sale during 1995 were $20,732,000 resulting in gross realized gains of $16,680,000 and gross realized losses of $4,340,000 compared with proceeds of $16,136,000 and gross realized gains of $8,935,000 and gross realized losses of $1,029,000 in 1994. The net gains realized related to equity investments classified as available for sale during 1995 and 1994. During 1993, proceeds from the sale of securities totaled $1,875,322,000 resulting in gross gains and losses of $2,900,000 and $7,300,000 respectively. Substantially all interest income on securities is taxable.\nThe carrying and fair values of debt securities available for sale at December 31, 1995, by contractual maturity are shown in the following table. Expected maturities will differ from contractual maturities because borrowers may have the right to prepay obligations with or without prepayment penalties. The amounts reflected in the table exclude $77,212,000 amortized cost, ($78,568,000 fair value) of equity securities available for sale that do not have fixed maturities.\nNote 5. Loans\nLoans are presented net of unearned income of $196,399,000 and $253,980,000 at December 31, 1995 and 1994, respectively. A distribution of the loan portfolio follows. International loans include \"Brady bonds\" issued by the United Mexican States and the Republic of Venezuela in the refinancing of their debt obligations. These bonds had an aggregate carrying value of $353,334,000 (face value $365,600,000) and an aggregate fair value of $228,679,000, $185,907,000 and $284,729,000 at year ends 1995, 1994 and 1993, respectively. The Company's intent is to hold these instruments until maturity. The bonds are fully secured as to principal by zero-coupon U.S. Treasury securities with face value equal to that of the underlying bonds.\nResidential mortgages include $121,586,000 and $21,350,000 of residential mortgages held for sale at December 31, 1995 and 1994, respectively. Other consumer loans include $397,250,000 and $406,009,000 of higher education loans also held for sale at December 31, 1995 and 1994, respectively.\nAt December 31, 1995 and 1994, the Company's nonaccruing loans were $380,524,000 and $855,409,000, respectively. At December 31, 1995 and 1994, the Company had commitments to lend additional funds of $10,379,000 and $9,869,000, respectively, to borrowers whose loans are classified as nonaccruing. A significant portion of these commitments include clauses that provide for cancellation in the event of a material adverse change in the financial position of the borrower.\nAs a result of adopting the provisions of FAS 114, insubstance foreclosed real estate (ISORE) and insubstance foreclosed other assets are now classified as nonaccruing loans. ISORE totaling $67,000,000 and insubstance foreclosed other assets totaling $3,200,000 at December 31, 1994 have been reclassified to loans in the consolidated balance sheet to reflect consistent presentation.\nThe Company identified impaired loans as defined by FAS 114 totaling $321,919,000 at December 31, 1995, of which $116,661,000 had specific loan loss allowance of $61,159,000. All impaired loans are classified as nonaccruing. The average recorded investment in such impaired loans during 1995 was $415,691,000. No interest income was recognized on impaired loans during 1995.\nThe Company has loans outstanding to certain nonemployee directors and to certain entities in which a director is a general partner or has a 10% or more ownership. The loans were made in the ordinary course of business on substantially the same terms, including interest rates and collateral, as those prevailing at the same time for comparable transactions with other persons and do not involve more than normal risk of collectibility or present other unfavorable features. The aggregate amount of such loans does not exceed 5% of shareholders' equity at December 31, 1995 and 1994.\nNote 6. Allowance for Loan Losses\nNote 5 provides information on impaired loans as defined by FAS 114 and the related specific loan loss allowance. The allowance did not change as a result of adopting FAS 114 and FAS 118.\nNote 7. Mortgage Servicing Rights\nThe Company services mortgages for others. The unpaid balances of these loans were $6.5 billion, $6.9 billion and $7.3 billion at December 31, 1995, 1994, and 1993, respectively.\nThe MSRs at December 31, 1995 were estimated to have a market value of $65 million. The carrying value of MSRs is periodically evaluated in relation to the estimated future net servicing revenue. The evaluation of estimated future net servicing revenue is based on a discounted and disaggregated methodology incorporating prepayment speeds based on the published security dealer estimates and other assumptions. At December 31, 1995, the carrying value of both PMSRs and EMSRs was below the estimated future net servicing revenue. Amortization and writedowns related to MSRs was $17 million, $16 million and $259 million for the years 1995, 1994 and 1993, respectively.\nThe Company is required to adopt Statement of Financial Accounting Standards No. 122, Accounting for Mortgage Servicing Rights (FAS 122), effective January 1, 1996. FAS 122 requires that a mortgage banking enterprise recognize as separate assets the rights to service mortgage loans for others, however those servicing rights are acquired. FAS 122 also introduces the concept of evaluating impairment in servicing rights based on fair value. The Company does not expect that the adoption of FAS 122 will have a material effect on its financial position or results of operation.\nNote 8. Short-Term Borrowings\nAt December 31, 1995, the Company had unused lines of credit with HSBC aggregating $100,000,000. These lines of credit do not require compensating balance arrangements and commitment fees are not significant. Outstanding domestic commercial paper borrowings were $276,590,000 and $226,152,000 at December 31, 1995 and 1994, respectively.\nNote 9. Income Taxes\nEffective January 1, 1993, the Company prospectively adopted Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (FAS 109). Total income tax expense (benefit) for the years ended December 31, 1995, 1994 and 1993 was allocated as follows including the deferred Federal income tax benefit of $40,000,000 reflected as the cumulative effect at January 1, 1993, of the change in accounting for income taxes.\nThe following table is an analysis of the difference between effective rates based on the total income tax provision attributable to income from operations and the statutory U.S. Federal income tax rate.\nDuring 1995, gross deferred tax assets declined by $45,605,000 and deferred tax liabilities increased by $11,999,000. These changes were offset by a decrease of $105,779,000 in the valuation allowance, resulting in an increase of $48,175,000 in the net deferred tax asset. The recognition of the $88,175,000 net deferred tax asset at December 31, 1995 was based principally on the forecast that taxable income in 1996 would be sufficient to fully utilize the Federal net operating loss carryforward.\nNote 10. Long-Term Debt\nDebt issued by Marine Midland Bank or its subsidiaries excludes a floating rate note payable to the Company of $100,000,000 due 2000.\nInterest rates on floating rate notes are determined periodically by formulas based on certain money market rates or, in certain instances, by minimum interest rates as specified in the agreements governing the respective issues. Interest rates on the floating notes in effect at December 31, 1995 are shown in parentheses.\nAt maturity, the floating rate subordinated capital notes due 1999 and the 8 5\/8% subordinated capital notes due 1997 will be exchanged by the Company for capital securities of the Company, or at the Company's option, the principal amount may be paid from funds designated by the Board of Governors of the Federal Reserve System as available for the retirement or redemption of the notes.\nThe floating rate subordinated capital notes due 1996 issued by the Bank are to be purchased by the Company at maturity for consideration consisting of (i) cash equal to any net proceeds of the sale of capital securities, (ii) capital securities of the Company having a market value equal to the principal amount of the notes, or (iii) a combination thereof.\nScheduled maturities for the debt, excluding obligations under capital leases, over the next five years are as follows: 1996, $125,052,000; 1997, $125,057,000; 1998, $63,000; 1999, $100,069,000; and 2000, $200,011,000. Maturities for obligations under capital leases are reported in Note 17, Commitments and Contingent Liabilities.\nNote 11. Preferred Stock\nThe $5.50 cumulative preferred stock has a stated value and a liquidation value of $100 per share and is redeemable at the election of the Company at $100 per share.\nThe adjustable rate cumulative preferred stock has a liquidation preference of $50 per share. The dividend rate is determined quarterly and is based on a formula which considers certain short- and long-term interest rates. The dividend rate per annum for any dividend period will not be less than 6% nor greater than 12%. This stock is redeemable at the option of the Company at $50 per share.\nNote 12. Common Stock\nAll of the common stock of the Company is owned by HSBC Holdings B.V. Common shares authorized and issued are 1,100 and 1,001, respectively, with a par value of $5.00.\nNote 13. Retained Earnings\nBank dividends are a major source of funds for payment by the Company of shareholder dividends and along with interest earned on investments, cover the Company's operating expenses which consist primarily of interest on outstanding debt. The approval of the Federal Reserve Board is required if the total of all dividends declared by the Bank in any year would exceed the net profits for that year, combined with the retained profits for the two preceding years. Under a separate restriction, payment of dividends are prohibited in amounts greater than undivided profits then on hand, after deducting actual losses and bad debts. Bad debts are debts due and unpaid for a period of six months unless well secured and in the process of collection. These rules currently restrict the Bank from paying dividends to the Company as of December 31, 1995.\nRestrictions on the Company's ability to pay common dividends are contained in its Certificate of Incorporation. Under the covenant, the aggregate amount of all common dividends, distributions and payments declared or made after December 31, 1963 cannot exceed an amount computed under a formula set forth in the certificate. As of December 31, 1995, the amount available under the formula exceeded such payments since December 31, 1963 by $1.5 billion.\nNote 14. Transactions with Principal Shareholder\nThe Company's common stock is owned by HSBC Holdings B.V., an indirect wholly owned subsidiary of HSBC.\nIn the normal course of business, the Company conducts transactions with HSBC, including its 25% or more owned subsidiaries (HSBC Group). These transactions occur at prevailing market rates and terms and, include deposits taken and placed, short-term borrowings and interest rate contracts.\nAt December 31, 1995 and 1994 assets of $537,382,000 and $358,732,000, respectively, and liabilities of $1,796,463,000 and $1,731,223,000, respectively, related to such transactions with the HSBC Group were included in the Company's balance sheet. In anticipation of the merger transaction\ndescribed in Note 1, HSBC transferred $1 billion to the Company in December 1994. These funds were used by Concord to extinguish its debt payable to nonaffiliated parties prior to January 1, 1995. Borrowings from HSBC, included in other short-term borrowings on the balance sheet, were $745,500,000 at December 31, 1995.\nInterest rate forward and futures contracts and interest rate swap contracts entered into with the HSBC Group are used primarily as an asset and liability management tool to manage interest rate risk. At December 31, 1995 and 1994 the notional value of these contracts with members of the HSBC Group were $17,302,744,000 and $15,216,960,000, respectively.\nLegal restrictions on extensions of credit by the Bank to the HSBC Group require that such extensions be secured by eligible collateral. At December 31, 1995 and 1994, outstanding extensions of credit secured by eligible collateral were $362,406,000 and $99,428,000, respectively.\nNote 15. Employee Benefit Plans\nThe Company, the Bank and certain other subsidiaries maintain a noncontributory pension plan covering substantially all of their employees. Certain other HSBC subsidiaries participate in this plan. Benefits under the plan are based on age, years of service and employee's compensation during the last five years of employment. The following table sets forth the plan's funded status.\nAccrued pension cost at December 31, 1995 and December 31, 1994, includes $460,000 and $545,000, respectively, and net pension expense includes $905,000 for 1995 and $696,000 for 1994 and 1993 recognized in the financial statements of other HSBC subsidiaries.\nThe Company maintains unfunded noncontributory health and life insurance coverage for all employees who retired from the Company and were eligible for immediate pension benefits from the Company's retirement plan. Employees retiring after January 1, 1993 will absorb a portion of the cost of these benefits. Employees hired after this same date are not eligible for these benefits. A premium cap has been established for the Company's share of retiree medical costs.\nFor measurement purposes, the health care cost trend rate was assumed initially decreasing 1% per year to increases of 7% per year in the year 2002. The health care cost trend rate assumption has an effect on the amounts\nreported. For example, increasing the assumed health care cost trend rates by 1% point in each year would increase the accumulated postretirement benefit obligation as of December 31, 1995 by $1,124,000 and the aggregate of the interest cost and service cost components of the net periodic cost by $104,000. The amortization of the initial liability of $66,064,000 over 20 years beginning January 1, 1993 is reflected in the amortization of unrecognized transition obligation. The initial liability represented an accumulated postretirement benefit obligation of $43,987,000 for current retirees and $22,077,000 for active employees based on a weighted-average discount rate of 8.25%.\nDuring 1994, the Company reflected the expense impact of a voluntary retirement program. Based on Statement of Financial Accounting Standards No. 88, Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination of Benefits, the Company recorded $19,950,000 for specific termination benefits relating to pension payments in operating expenses. The Company also recorded an additional $393,000 expense relating to retiree health and life insurance as a result of this program.\nEffective in 1994, the Company adopted Statement of Financial Accounting Standards No. 112, Employers' Accounting for Postemployment Benefits (FAS 112) which requires recognition of the cost of benefits provided to former or inactive employees after employment but before retirement on an accrual basis, rather than expensing such costs when paid. Since the Company was substantially in compliance with the provisions of FAS 112, the adoption of this statement had an immaterial impact on 1994 earnings.\nNote 16. International Operations\nInternational activities are defined as those conducted with non-U.S. domiciled customers. In the following table, international loans are distributed geographically primarily on the basis of the location of the head office or residence of the borrowers or, in the case of certain guaranteed loans, the guarantors. Interest bearing deposits with banks and their branches are grouped by the location of the head office of the foreign bank. Investments and acceptances are distributed on the basis of the location of the issuers or borrowers. The following tables summarize the Company's international activities.\nTotal international assets averaged $1,555,000,000, $1,729,000,000 and $1,924,000,000, or 8.4%, 9.6% and 10.4% of total average assets, during 1995, 1994 and 1993, respectively. Total international liabilities averaged $1,433,000,000, $1,597,000,000 and $1,800,000,000, or 8.4%, 9.6% and 10.5% of total average liabilities, during 1995, 1994 and 1993, respectively.\nInterest and fee related income on international assets is distributed geographically on the same basis as the related asset. Other international operating income is distributed to the geographic area where the service or operation is performed. Included in consolidated other income are foreign currency exchange gains of $3,845,000, $3,625,000 and $7,282,000 for 1995, 1994 and 1993, respectively.\nIn order to arrive at income before taxes and change in accounting by geographic areas, various allocations, some of which are subjective by necessity, have been made. In addition to estimating a provision for loan losses, allocations of indirect expenses and administrative overhead are made among areas to best reflect services provided and a charge or credit is made at market rates for use of funds after consideration has been given for the use of capital. Taxes are estimated for international operations and are allocated geographically in proportion to income before taxes.\nNote 17. Commitments and Contingent Liabilities\nAt December 31, 1995 securities, loans and other assets carried in the consolidated balance sheets at $1,198,480,000 were pledged as collateral for borrowings, to secure governmental and trust deposits and for other purposes.\nThe Company and its subsidiaries are obligated under a number of noncancellable leases for premises and equipment. Certain leases contain renewal options and escalation clauses. Minimum future rental commitments on leases in effect at December 3l, l995 were:\nOperating expenses include rental expense, net of sublease rentals, of $36,608,000, $33,832,000 and $42,301,000 in 1995, 1994 and 1993, respectively.\nThe Company and its subsidiaries are defendants in a number of legal proceedings arising out of, and incidental to, their businesses. Management of the Company, based on its review with counsel of the development of these matters to date, is of the opinion that the ultimate resolution of these pending proceedings will not have a material adverse effect on the business or financial position of the Company.\nNote 18. Financial Instruments With Off-Balance Sheet Risk\nThe Company is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers, to reduce its own exposure to fluctuations in interest rates and to realize profits. The contract or notional amount of those instruments expresses the extent of involvement the Company has in particular classes of financial instruments. These financial instruments involve, to varying degrees, elements of credit and market risk in excess of the amount recognized in the consolidated balance sheet. Credit risk represents the possibility of loss resulting from the failure of another party to perform in accordance with the terms of a contract. The Company uses the same credit policies in making commitments and conditional obligations as it does for balance sheet instruments.\nMarket risk represents the exposure to future loss resulting from the decrease in value of an on- or off-balance sheet financial instrument caused by changes in interest rates. Market risk is a function of the type of financial instrument involved, transaction volume, tenor and terms of the agreement and\nthe overall interest rate environment. The Company controls market risk by managing the mix of the aggregate financial instrument portfolio and by entering into offsetting positions.\nFor commitments to extend credit, standby letters of credit and guarantees, the Company's exposure to credit loss in the event of non-performance by the counterparty to the financial instrument, is represented by the contractual amount of those instruments. Management does not anticipate any material losses as a result of these transactions.\nFor those financial instruments whose contractual or notional amount does not represent the amount exposed to credit loss, risk at any point in time represents the cost, on a present value basis, of replacing these existing transactions at current interest and exchange rates. Based on this measurement, $118,293,000 was at risk at December 31, 1995. See Note 19 for further discussion of activities in derivative financial instruments. The Company controls the credit risk associated with off-balance sheet derivative financial instruments established for each counterparty through the normal credit approval process. The Company generally does not require collateral or other security to support these financial instruments.\nStandby letters of credit and guarantees have been reduced by $56,567,000 and $44,966,000 at December 31, 1995 and 1994, respectively, which represent the amounts participated to other institutions. Maturities of guarantees for certain debt obligations of borrowers range from 1996 to 2015. Fees received are generally recognized as revenue over the life of the guarantee.\nForeign exchange contracts represent the gross amount of contracts to purchase and sell foreign currencies, and do not consider the extent to which offsets may exist.\nNote 19. Derivative Financial Instruments\nAs principally an end-user of off-balance sheet financial instruments, the Company uses various derivative products to manage its overall interest rate risk by reducing the risk associated with changes in the income stream of certain on-balance sheet assets. The Company also maintains various derivatives in its trading and available for sale securities portfolio to offset risk associated with changes in market value of the related assets, and to satisfy the foreign currency requirements of customers.\nThe derivative instrument portfolios are actively managed in response to changes in overall and specific balance sheet positions, cash requirements, expectations of future interest rates, market environments and business strategies. Associated credit risk is controlled through the establishment and monitoring of approved limits in derivative positions. Credit risk is also mitigated by the fact that almost all derivative contracts are executed with members of the HSBC group, and such contracts are subject to enforceable master netting agreements.\nRisk management activities - Through the normal course of operations, the Company is subject to the risk of interest rate fluctuations to the extent that interest earning assets and interest bearing liabilities mature or reprice at different times or by differing amounts. The Company's risk management activities are designed to optimize net interest income within ranges of interest rate risk that management considers acceptable. Currently, the Company conducts its risk management activities within the context of an asset-sensitive balance sheet position. This asset-sensitive position, while improving net interest margin when interest rates rise and assets are repricing to higher rates in advance of liabilities, negatively impacts margin when interest rates are falling. At December 31, 1995, interest rate swaps included pay variable\/receive fixed positions of $6,122,000,000, pay fixed\/receive variable positions of $5,699,000,000 and pay variable\/receive variable positions of $870,000,000.\nThe Company uses interest rate swaps and forward rate agreements in its risk management activities which are linked as hedges of various on-balance sheet assets. As net interest margins decrease as a result of decreases in interest rates, cash flows from the derivative contracts will increase to replace a portion of the lost margins. Conversely, as net interest margins improve as interest rates rise, amounts due under the derivative contracts increase to dampen the positive effect of rate increases.\nInterest rate risk is measured through a combination of various simulation modeling techniques and repricing analyses.\nAt December 31, 1995, derivative contracts with a notional value of $9,410,000,000 and unrecognized fair value loss of $2,847,000 were being effectively utilized to hedge interest rate risk associated with certain residential mortgage assets. In addition, $6,531,000,000 in notional value contracts, with an unrecognized loss of $2,613,000 were being utilized to hedge interest rate risk associated with certain commercial loan assets. The Company also has $155,750,000 in notional value contracts with an unrecognized fair value gain of $857,000 being utilized to hedge risk associated with mortgage servicing rights. Further $135,818,000 in notional value contracts with an unrecognized fair value gain of $17,000 were entered into to facilitate the needs of certain customers and $525,300,000 in notional value of derivative contracts with a fair value loss of $6,066,000 are specifically linked to securities reported as available for sale.\nFor those assets reported on an historical cost basis, risk management positions are not marked to current market value, rather, cash flows and\/or gains and losses realized are accrued and\/or amortized as an adjustment to the interest income generated by the corresponding specific asset position.\nFor investment securities reported as available for sale, the mark to market of the related derivative contacts are considered a component of the fair value of the securities they are linked to for purposes of determining the adjustment to shareholders' equity that results pursuant to the valuation of these instruments.\nTrading activities - The Company deploys excess liquidity by maintaining active trading positions in a variety of highly-liquid debt instruments including U.S. Government obligations, non-high risk mortgage and asset-backed and other securities for the purpose of generating income. The trading portfolio is managed to realize profits from short-term price movements associated with holding high credit quality securities and associated off- balance sheet derivative instruments.\nThe majority of derivative instruments held in the trading portfolio are utilized to hedge market and interest rate risk associated with the on-balance sheet cash instruments they are linked to. That is, changes in value of cash instruments are effectively offset by changes in value of the related derivative to the extent the on-balance sheet positions are hedged. The Company had no speculative derivative positions at December 31, 1995.\nThe Company's derivative trading positions, which are currently limited to interest rate swaps, exchange traded forwards, futures and open foreign\nexchange contracts, are subject to interest rate risk, maturity and credit exposure limits. Stop loss limits have been imposed on all trading positions, including derivatives, to mitigate exposure to price movements.\nDerivative trading positions are marked to market with gains and losses recorded as a component of net trading revenues. Generally, as individual trading assets are sold, the corresponding derivative positions are liquidated and gains and losses realized.\nForeign exchange trading activities - The Company maintains open positions in various foreign exchange contracts, principally to accommodate customer demands for specific currencies. Foreign currencies are purchased and sold on a spot basis, with settlement occurring within a two day period. Addition- ally, certain forward purchase and sale agreements are entered into in order to match customer requests with settlement requirements associated with foreign markets. The Company also maintains a limited number of open positions.\nApproximately 75% of the contracts outstanding are denominated in major currencies. All open foreign exchange contracts are marked to market on a daily basis with gains and losses recorded as a component of net trading revenues.\nRelating to certain contracts, the Company records unrealized gains as assets and unrealized losses as liabilities on the balance sheet. Offsetting of unrealized gains and losses is recognized for multiple contracts executed with the same counterparty if a valid right and intent to set off exists. The majority of the Company's arrangements are subject to legally enforceable master netting agreements with affiliated companies which provide for the right of set off.\nNote 20. Concentrations of Credit Risk\nThe Company enters into a variety of transactions in the normal course of business that involve both on- and off-balance sheet credit risk. Principal among these activities is lending to various commercial, institutional, governmental and individual customers. Although the Company actively participates in lending activity throughout the United States and on a limited basis abroad, credit risk is concentrated in the Northeastern United States. The ability of individual borrowers to repay is linked to the economic stability of the regions from where the loans originate, as well as the creditworthiness of the borrower. With emphasis on the Western, Central and Metropolitan regions of New York State, the Company maintains a diversified portfolio of loan assets.\nIn general, the Company controls the varying degrees of credit risk involved in on- and off-balance sheet transactions through specific credit policies. These policies and procedures provide for a strict approval, monitoring and reporting process.\nIt is the Company's policy to require collateral in support of on- and off-balance sheet transactions, when it is deemed appropriate. Varying degrees and types of collateral are secured dependent upon management's credit evaluation.\nNote 21. Fair Value of Financial Instruments\nThe following disclosures represent the Company's best estimate of the fair value of on- and off-balance sheet financial instruments, determined on a basis consistent with the requirements as outlined in Financial Accounting Standards No. 107, Disclosures About Fair Value of Financial Instruments (FAS 107). To the extent possible, these values have been determined by reference to current market quotations. In those instances where market quotes are not available, fair values have been estimated by management based upon quoted prices for financial instruments with similar characteristics or on reasonable valuation techniques such as present value analyses using appropriate discount rates and adjustments for associated credit risk. The Company has employed\nthe following methods and assumptions to estimate the fair value of each class of financial instrument for which it is practicable to do so.\nFinancial instruments with carrying value equal to fair value - The carrying value of certain financial assets including cash and due from banks, interest bearing deposits with banks, federal funds sold and securities purchased under resale agreements, accrued interest receivable, and customers' acceptance liability and certain financial liabilities including short-term borrowings, interest, taxes and other liabilities and acceptances outstanding, as a result of their short-term nature, carrying value is considered to be equal to fair value.\nSecurities and trading assets - For securities, fair value has been based upon current market quotations, where available. If quoted market prices are not available, fair value has been estimated based upon the quoted price of similar instruments.\nLoans - The fair value of the performing loan portfolio has been determined principally based upon a discounted analysis of the anticipated cash flows, adjusted for expected credit losses. The loans have been grouped to the extent possible, into homogeneous pools, segregated by maturity and the weighted average maturity and average coupon rate of the loans within each pool calculated. Depending upon the type of loan involved, maturity assumptions have been based on either contractual or expected maturity.\nPursuant to the valuation methodology, credit risk has been factored into the present value analysis of cash flows associated with each loan type, by allocating the allowance for credit losses. The allocated portion of the allowance, adjusted by a present value factor based upon the timing of expected losses, has been deducted from the gross cash flows prior to performing the present value calculation.\nAs a result of the allocation of the allowance to adjust the anticipated cash flows for credit risk, a published interest rate that equates as closely as possible to a \"risk-free\" or \"low-risk\" loan has been selected for the purpose of discounting the commercial loan portfolio, adjusted for a liquidity factor where appropriate.\nConsumer loans have been discounted at the estimated rate of return an investor would demand for the product, without regard to credit risk. This rate has been formulated based upon reference to current market rates. The fair value of the residential mortgage portfolio has been determined by reference to quoted market prices for loans with similar characteristics and maturities.\nThe portion of the allowance attributable to nonperforming loans has been deducted from carrying value to arrive at an estimate of fair value for nonperforming loans.\nIntangible assets - The Company has elected not to specifically disclose the fair value of certain intangible assets. In addition, the Company has not estimated the fair value of unrecorded intangible assets associated with its own portfolio of core deposits and credit card receivables. The fair value of the Company's intangibles is believed to be significant.\nDeposits - The fair value of demand, savings and certain money market deposits is equal to the amount payable on demand at the reporting date. For other types of deposits with fixed maturities, fair value has been estimated based upon interest rates currently being offered on deposits with similar characteristics and maturities.\nLong-term debt - Fair value has been estimated based upon interest rates currently available to the Company for borrowings with similar characteristics and maturities.\nThe following, which is provided for disclosure purposes only, provides a comparison of the carrying value and fair value of the Company's on-balance sheet financial instruments. Fair values have been determined on a basis consistent with the requirements of FAS 107 and do not necessarily represent the amount that would be realized upon their liquidation.\nThe above table excludes $155,750,000 notional value interest rate floors with a fair value of $857,000 associated with mortgage servicing rights and $135,818,000 of notional value customer facilitation interest rate swaps with a fair value of $17,000 which are outside of the scope required in this footnote.\nThe amounts reported for 1995 include the carrying value and fair value of derivatives used for asset-liability management activities. Derivatives associated with loans are hedging interest rate risk on certain variable rate commercial loans and fixed rate residential mortgage assets. The fair value of the related derivatives hedging the market value of securities available for sale is included in determining the net unrealized gain on securities reported as a separate component of shareholders' equity.\nIn 1994, the Company did not disclose the linkage between on-balance sheet assets carried at historical cost and the related derivative contracts even though these contracts were effectively hedging the associated interest rate risk. The carrying value of derivatives used for asset-liability management was included in other assets and other liabilities.\nThe fair value of derivative financial instruments is disclosed in Note 19, Derivative Financial Instruments.\nThe notional amount of off-balance sheet commitments to extend credit, standby letters of credit and financial guarantees, is considered equal to fair value. Due to the uncertainty involved in attempting to assess the likelihood and timing of a commitment being drawn upon, coupled with lack of an established market and the wide diversity of fee structures, the Company does not believe it is meaningful to provide an estimate of fair value that differs from the notional value of the commitment. Further detail with respect to off-balance sheet financial instruments is provided in Note 18, Financial Instruments With Off-Balance Sheet Risk.\nThe Bank is subject to legal restrictions on certain transactions with its nonbank affiliates in addition to the restrictions on the payment of dividends by the Bank to the Company (see Note 13). Restricted net assets of consolidated subsidiaries were $1,645,364,000 at December 31, 1995.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nThere were no disagreements on accounting and financial disclosure matters between the Company and its independent accountants during 1995.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nDirectors Set forth below is certain biographical information relating to the members of the Company's Board of Directors. Each director is elected annually. The information includes principal occupation, age, the year first elected a director of the Company, and other directorships. There are no family relationships among the directors.\nJohn R. H. Bond, age 54, Group Chief Executive Officer of HSBC since 1993. Formerly President and Chief Executive Officer of the Company and the Bank since 1991. Previously Executive Director Banking, HongkongBank from 1990 to 1991 and Executive Director Americas from 1988 to 1990. Mr. Bond is Chairman of Hongkong Bank of Canada and a director of HSBC, Hang Seng Bank Limited, HongkongBank, Midland Bank plc, British Steel plc, the London Stock Exchange, Saudi British Bank, Eurorail CTRL Limited and VISA International. Elected in 1987.\nJames H. Cleave, age 53, President and Chief Executive Officer of the Company and the Bank since 1992. Formerly Executive Director from June 1992 through December 1992. Previously Director, President and Chief Executive Officer of Hongkong Bank of Canada since 1987. Mr. Cleave is also a director of Hongkong Bank of Canada, HSBC Markets, Inc., HSBC Holdings B.V., and Wells Fargo HSBC Trade Bank, N.A., and he is a member of the Executive Committee of HSBC. Elected in 1991.\nWilliam R. P. Dalton, age 52, President and Chief Executive Officer of Hongkong Bank of Canada since 1992 and a director since 1987. Appointed Chief Operating Officer Hongkong Bank of Canada in 1987. Joined the HSBC Group in 1980 as an officer of Wardley Canada Limited, which converted to the Hongkong Bank of Canada in 1981. Elected January 1, 1996.\nNorthrup R. Knox, age 67, Chairman of the Company and the Bank since 1988. Formerly President, Niagara Frontier Hockey Corporation, professional hockey team. Mr. Knox is a director of HSBC. He is President and a director of The Seymour H. Knox Foundation, Inc. and Vice President of The Buffalo Fine Arts Academy. Elected in 1973.\nSir William Purves, age 64, Chairman, HSBC. Formerly Chairman and Chief Executive Officer, HSBC, from 1990 to 1992. Formerly, Chairman and Chief Executive Officer, Deputy Chairman, Executive Director Banking and General Manager International, HongkongBank. Sir Purves is Chairman of The British Bank of the Middle East and Midland Bank plc. He is a director of HongkongBank, The \"Shell\" Transport and Trading Company, plc. and The East Asiatic Company Ltd. Elected in 1984.\nDirectors' Compensation\nDirectors who are employees of the Company, HSBC or other group affiliates do not receive any compensation for their services as Company directors. As nonexecutive Chairman of the Company and the Bank, Mr. Knox, the only nonemployee director of the Company, receives an annual fee of $50,000 in lieu of the current nonemployee $20,000 annual retainer and attendance fees. The Company has standard arrangements pursuant to which a nonemployee director may defer all or part of their fees.\nThe Directors' Retirement Plan covers nonemployee directors of the Company, except those serving as directors at the request of HSBC. Mr. Knox is currently the only director participating in this Plan. Upon retirement from the Board, Mr. Knox will receive benefit payments for a period of ten years. Mr. Knox's annual benefit will be 100 percent of the annual retainer for nonemployee directors that is in effect at the last Board meeting attended. The retirement benefit for Mr. Knox is fully vested and will be paid out over the ten year period to his beneficiary in the event of death before benefit payments commence, and for the balance of the period if death occurs after retirement. The Plan is unfunded and payment will be made out of the general funds of the Company or the Bank.\nJames H. Cleave joined the Bank and the Company as Executive Director in 1992. Mr. Cleave had been Director, President and CEO of Hongkong Bank of Canada since 1987 and a director of the Company since 1991.\nColin Bamford joined the Company as Senior Executive Vice President in November 1995. Mr. Bamford had been Chief Executive Officer, HongkongBank Japan since 1990.\nKerry B. Alberti joined the Bank and the Company as Senior Executive Vice President, Investment Services in 1993. Mr. Alberti had been Managing Director, Midland Financial Services, Midland Bank plc and an employee of Midland Bank since 1988.\nK. Stewart Armstrong joined the Bank and the Company as Executive Vice President and Group Audit Executive, USA in 1994. Mr. Armstrong had been Vice President and Chief Auditor of Hongkong Bank of Canada since 1988.\nGerald A. Ronning joined the Bank and the Company as Executive Vice President & Controller in 1991. Mr. Ronning had been Senior Vice President, Chief Financial Officer and Corporate Controller, Goldome.\nAll other executive officers have served the Company or the Bank in executive capacities for more than five years. There are no family relationships among the above officers.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe following table sets forth information as to the compensation earned through December 31, 1995 by James H. Cleave, President and Chief Executive Officer and by the four most highly compensated officers of the Company and the Bank. Three executive officers have been seconded to the Bank by HSBC, which pays their salary and other benefits pursuant to arrangements applicable to international HSBC officers. The three officers are: I.M. Burnett, Chief Operating Officer; John A.D. Hamilton, Executive Vice President, Information Technology; and Eric W. Gill, Executive Vice President and Regional President, Central Region. The Bank reimbursed HSBC for the salary and certain benefits paid to these officers and that reimbursement amounted to $1,731,730.\nOther Annual Compensation for Mr. Cleave includes $109,917, $115,802 and $125,492 for 1995, 1994 and 1993, respectively, received for housing allowance together with miscellaneous other benefit payments. Other Annual Compensation for the other named executives includes health and insurance benefits.\nAmounts reported as All Other Compensation for 1995 include the Company's contributions to its 401(K) plan and a four percent credit on salary deferred under the Company's deferred salary plan. Since deferred salary is not eligible for the company matching contributions under the 401(K) plan, salary deferrals are increased by four percent, which is the maximum matching contribution available under the 401(K) plan. HSBC secondees to the Company do not participate in these benefit plans. Reimbursed moving expenses are included in All Other Compensation for Mr. Alberti in 1993 and for Mr. Davidson in 1994 and 1993.\nHSBC has granted options on HSBC common stock to the named executives. Options were granted on March 7, 1995, exercisable beginning March 7, 1998 and expiring March 7, 2005.\nThe following table shows the estimated annual retirement benefit payable upon normal retirement on a straight life annuity basis to participating employees, including officers, in the compensation and years of service classifications indicated under the Company's retirement plans which cover most officers and employees on a non-contributory basis. The amounts shown are before application of social security reductions. Years of service credited for benefit purposes is limited to 30 years in the aggregate.\nThe Pension Plan is a non-contributory defined benefit pension plan under which the Bank and other participating subsidiaries of the Company make contributions in actuarially determined amounts. Compensation covered by the Pension Plan includes regular basic earnings (including salary reduction contributions to the 401(K) plan) and general staff bonuses, but not other incentive awards, bonuses, special payments or deferred salary. The Company maintains supplemental benefit plans which provide for the difference between the benefits actually payable under the Pension Plan and those that would have been payable if certain other awards, special payments and deferred salaries were taken into account and if compensation in excess of the limitations set by the Internal Revenue Code could be counted. Payments under these plans are unfunded and will be made out of the general funds of the Bank or other participating subsidiaries. The calculation of retirement benefits is based on the highest five-consecutive year compensation.\nMembers of the Senior Management Committee of the Bank receive two times their normal credited service for each year and fraction thereof served as a committee member in determining pension and severance benefits to a maximum of 30 years of credited service in total. This additional service accrual is unfunded and payments will be made from the general funds of the Bank or other subsidiaries. As of December 31, 1995, the individuals listed in the Summary Compensation Table have total years of credited service in determining benefits payable under the plans as follows: Mr. Cleave, 7.2; Mr. Butcher, 13.7; Mr. Alberti, 10.0; Mr. Davidson, 4.8; and Mr. Toohey, 14.5. HSBC secondees to the Company do not participate in the retirement plans.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nPrincipal Holder of Securities The Company is 100 percent owned by HSBC Holdings B.V. HSBC Holdings B.V. is an indirect wholly owned subsidiary of HSBC Holdings plc.\nMessrs. Purves, Bond and Knox are directors of HSBC. Messrs. Purves and Bond are officers of HSBC.\nNone of the directors or executive officers owned any of the Company's common or preferred stock at December 31, 1995.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nDirectors and officers of the Company, members of their immediate families and HSBC and its affiliates were customers of, and had transactions with, the Company, the Bank and other subsidiaries of the Company in the ordinary course of business during 1995. Similar transactions in the ordinary course of business may be expected to take place in the future.\nAll loans to executive officers and directors and members of their immediate families and to HSBC and its affiliates 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.\nPART I V\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\nA\n1. and 2. Financial Statements and Schedules The following financial statements and schedules of the Company and its subsidiaries are included in Item 8: Report of Independent Auditors HSBC Americas, Inc.: Consolidated Balance Sheet Consolidated Statement of Income Consolidated Statement of Changes in Shareholders' Equity Consolidated Statement of Cash Flows Marine Midland Bank: Consolidated Balance Sheet Summary of Significant Accounting Policies Notes to Financial Statements\n3. Exhibits 3 a Registrant's Restated Certificate of Incorporation and Amendments Thereto b Registrant's By-Laws, as Amended to Date 4 Instruments Defining the Rights of Security Holders, Including Indentures Registrant has previously filed with the Commission as Exhibits to various registration statements all Indentures and other Instruments Defining the Rights of Security Holders 22 Subsidiaries of the Registrant The Company's only significant subsidiary, as defined, is Marine Midland Bank, a state bank organized under the laws of New York State.\nB\nReports on Form 8-K A Current Report on Form 8-K dated October 2, 1995, was filed with the Securities and Exchange Commission on October 2, 1995, reporting that the Company had changed its name from Marine Midland Banks, Inc. to HSBC Americas, Inc.\nS I G N A T U R E S\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nHSBC Americas, Inc. Registrant\n\/s\/ Philip S. Toohey Philip S. Toohey Legal Advisor, Americas and Secretary\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed on February 29, 1996 by the following persons on behalf of the Registrant and in the capacities indicated:\n\/s\/ Robert M. Butcher Robert M. Butcher Executive Vice President & Chief Financial Officer (Principal Financial Officer)\n\/s\/ Gerald A. Ronning Gerald A. Ronning Executive Vice President & Controller (Principal Accounting Officer)\nNorthrup R. Knox* Chairman of the Board James H. Cleave* Director, President & Chief Executive Officer John R. H. Bond* Director William R. P. Dalton* Director William Purves* Director\n* \/s\/ Philip S. Toohey Philip S. Toohey Attorney-in-fact\nRESTATED CERTIFICATE OF INCORPORATION\nOF\nHSBC AMERICAS, INC.\nHSBC Americas, Inc. a corporation organized and existing under the laws of the State of Delaware (the \"Corporation\"), hereby certifies as follows:\n1. The name of the Corporation is HSBC Americas, Inc. HSBC Americas, Inc. was originally incorporated under the name of Marine Midland Corporation, and the original Certificate of Incorporation of the Corporation was filed with the Secretary of State of the State of Delaware on September 23, 1929.\n2. Pursuant to Sections 242 and 245 of the General Corporation Law of the State of Delaware, this Restated Certificate of Incorporation restates and integrates and also further amends the provisions of the Certificate of Incorporation of this Corporation, and has been duly adopted in accordance with Sections 228, 242, and 245 of the General Corporation Law of the State of Delaware pursuant to a written consent adopted by the sole holder of all outstanding shares of common stock, par value $5.00 per share, of the Corporation.\n3. The text of the Restated Certificate of Incorporation as heretofore amended or supplemented is hereby restated and further amended to read in its entirety as follows:\nFirst: The name of this corporation is HSBC Americas, Inc.\nSecond: Its registered office in the State of Delaware is located at 32 Loockerman Square, Suite L-100, Dover, Kent County, Delaware. The name and address of its registered agent is The Prentice-Hall Corporation System, Inc., 32 Loockerman Square, Suite L-100, Dover, Kent County, Delaware 19901.\nThird: The nature of the business and the objects and purposes proposed to be transacted, promoted and carried on, are to do any or all of the things herein mentioned as fully and to the same extent as natural persons might or could do in any part of the world as set forth below. (Wherever used in this Article Third, the expression \"evidence of indebtedness\" or \"evidences of indebtedness\" shall mean and include, without limiting its generality, any and all bonds, debentures, notes, coupons, mortgages, commercial paper and\/or any other instruments evidencing indebtedness, however created, issued or granted and whether fully paid or subject to further payments; and the expression \"certificate of interest,\" or \"certificates of interest\" shall mean and include, without limiting its generality, any and all certificates or shares of stock, scrip, interim receipts, participation certificates, voting trust certificates, subscription warrants, option warrants and\/or any other instruments evidencing interest in share capital or other property, however created, issued or granted and whether fully paid or subject to further payments.)\n(1) To acquire by purchase, subscription, contract or otherwise, hold for investment or otherwise, own, sell, exchange, mortgage, pledge or otherwise dispose of, and generally deal in and with evidences of indebtedness and\/or certificates of interest issued or created in any and all parts of the world by banks, trust companies, financial institutions of every kind and description, corporations, associations, partnerships, firms, trustees, syndicates, individuals, governments, states, municipalities or other political or governmental divisions or subdivisions, or by any combinations, organizations or entities whatsoever, irrespective of their form or the name by which they may be described, and to issue in exchange therefor or in payment thereof, in any manner permitted by law, its own evidences of indebtedness and\/or certificates of interest, or to make payment therefor by any other lawful means of payment whatsoever; and to exercise any and all of said powers, either on its own account, or with or as agent for other persons, firms, corporations or organizations.\n(2) To receive, collect and dispose of interest, dividends and income upon, of and from any evidence of indebtedness or certificate of interest and any other property held or owned by it, and to exercise any and all rights, powers and privileges of individual ownership or interest in respect of any and all such evidences of indebtedness or certificates of interest, including the right to vote thereon for any and all purposes.\n(3) To endorse or guarantee the payment of principal and\/or interest or dividends upon, and to guarantee the performance of sinking fund or other obligations of, any evidences of indebtedness or certificates of interest, and to guarantee the performance of any of the contracts or other undertakings in which the corporation may otherwise be or become interested, of any corporation, association, partnership, firm, trustee, syndicate, individual, government, state, municipality or other political or governmental division or subdivision, domestic or foreign, in so far as may be permitted by law to a corporation of this character. (4) To enter into, make, perform and carry out or cancel and rescind contracts relating to or underwritings of evidences of indebtedness or certificates of interest, of any corporation, association, partnership, firm, trustee, syndicate, individual, government, state, municipality or other political or governmental division or subdivision, domestic or foreign, or of any combination, organization, or entity, domestic or foreign, and to act as manager of any underwriting or purchasing or selling syndicate.\n(5) To lend money, whether or not secured by mortgages or other liens on real estate or personal property, and to negotiate and make, either as principal or broker or agent, contracts or other agreements in connection therewith.\n(6) To borrow money with or without security, to make, accept, endorse, guarantee, execute and issue evidences of indebtedness and to secure the same by a mortgage, pledge, deed of trust, other lien or otherwise, upon all or any part of the property of the corporation, wherever situated.\n(7) To act as agent or representative of individuals, firms and corporations, and as such to develop and extend the business interests of individuals, firms and corporations.\n(8) To purchase, hold, sell and transfer the shares of its own capital stock, provided it shall not use its funds or property for the purchase of its own shares of capital stock when such use would cause any impairment of its capital, and provided that shares of its own capital stock belonging to it shall not be voted upon, directly or indirectly, but nothing in this subdivision shall be construed as limiting the exercise of the rights given by Section 243 of the General Corporation Law of the State of Delaware.\n(9) To take, lease, purchase or otherwise acquire and to own, use, hold, sell, convey, lease, exchange, mortgage, improve, develop, cultivate and otherwise handle, deal in and dispose of real estate, real property and any interest or right therein.\n(10) To purchase, manufacture, acquire, hold, own, mortgage, pledge, lease, sell, assign and transfer, and to invest, trade, deal in and with goods, wares, merchandise, patents, trade-marks, rights, privileges, franchises, grants and property of every kind and description; to carry on any of the above businesses or any other business connected therewith, wherever the same may be permitted by law, and to the same extent as the laws of this State will permit and as fully and with all the powers that the laws of this State confer upon corporations and organizations under the General Corporation Law of the State of Delaware.\n(11) To acquire and take over as a going concern and\/or carry on the business of any person, firm, association or corporation engaged in any business which this corporation is authorized to carry on.\n(12) To render service, assistance, counsel and advice to any person, firm, association or corporation in the conduct of his or its business.\n(13) To do all and everything necessary, suitable and proper for the accomplishment of any of the purposes or the attainment of any of the objects or the furtherance of any of the powers hereinbefore set forth, either as principal or agent, either alone or associated with other corporations or with firms or individuals, and either directly or indirectly through one or more subsidiary company or companies organized or utilized for the purpose, and to do any other act or acts, thing or things, incidental or pertaining to or growing out of, or connected with the aforesaid business, or powers, or any parts thereof, provided the same be not inconsistent with the law under which this corporation is organized.\n(14) The business or purpose of the corporation is from time to time to do any one or more acts and things herein set forth; and it may conduct such business in all its branches or any part thereof either within or outside the State of Delaware, and in other states and territories and dependencies of the United States and in foreign countries.\nThe foregoing enumeration of specific powers shall not be deemed to limit or restrict in any manner the general powers of the corporation and the enjoyment and exercise thereof as conferred by the laws of the State of Delaware upon corporations formed under the General Corporation Law of said State, and the doing of any or all the things hereinbefore set forth to the same extent as natural persons might or could do; but this corporation shall not, by any implication or construction, be deemed to possess the power of issuing bills, notes, or other evidences of debt for circulation as money, or the power of carrying on the business of receiving deposits of money, or the business of buying gold and silver bullion or foreign coins.\nFourth: The total number of shares of all classes of stock which the Corporation shall have authority to issue is ten million, fifty thousand, two hundred, fifty-eight (10,050,258) shares of which forty-nine thousand, one hundred, fifty-eight (49,158) shares without par value are to be of a class designated Cumulative Preferred Stock, ten million (10,000,000) shares of the par value of $1.00 each are to be designated Preferred Stock and one thousand, one hundred (1,100) of the par value of $5.00 each are to be of a class designated Common Stock.\nThe designations and the voting powers, preferences, and relative, participating, optional and other special rights of the Cumulative Preferred Stock and the Common Stock, and the qualifications, limitations and restrictions thereof, are as follows:\n1. Issue of Cumulative Preferred Stock in Series. The Cumulative Preferred Stock shall be issued from time to time in series as hereinafter provided. All shares of Cumulative Preferred Stock, regardless of series, shall be of equal rank with each other and shall be identical with each other in all respects except as provided in this Article Fourth; and the shares of Cumulative Preferred Stock of any one series shall be identical with each other in all respects except as to the dates from and after which dividends thereon shall be cumulative.\n2. $5.50 Convertible Preferred Stock. There is hereby established a first series of Cumulative Preferred Stock, which shall consist (and shall not be increased to a number in excess) of 24,579 shares. Such first series shall have the designation, voting powers, preferences and rights, and the qualifications, limitations and restrictions thereof, which are set forth in this Article Fourth in respect of the Cumulative Preferred Stock of all series and in addition, the following:\n(a) The designation of such first series of Cumulative Preferred Stock shall be \"$5.50 Convertible Preferred Stock\" (hereinafter called the $5.50 Preferred Stock).\n(b) The dividend rate for the $5.50 Preferred Stock shall be $5.50 per share per annum, and the date from and after which dividends on each share of the $5.50 Preferred Stock shall be cumulative is the date of issue of the $5.50 Preferred Stock.\n(c) The $5.50 Preferred Stock may not be redeemed prior to the fifth anniversary of the date of issue thereof. On and after such anniversary the $5.50 Preferred Stock shall be redeemable at the option of the corporation at the following respective redemption prices per share during the year commencing on the indicated anniversary of the above-mentioned date of issue:\nRedemption Redemption Price Per Price Per Anniversary Share Anniversary Share Fifth . . . . .$105.00 Tenth . . . .$102.50 Sixth . . . . . 104.50 Eleventh . . 102.00 Seventh . . . . 104.00 Twelfth . . . 101.50 Eighth . . . . 103.50 Thirteenth . 101.00 Ninth . . . . . 103.00 Fourteenth . 100.50\nand thereafter at the redemption price of $100.00 per share, plus, in each case, an amount equal to all accrued and unpaid dividends thereon to the date fixed for redemption.\n(d) In the event of any liquidation, dissolution or winding up of the affairs of the corporation, the holders of the $5.50 Preferred Stock then outstanding shall be entitled to receive out of the assets of the corporation, before any distribution or payment shall be made to the holders of any junior stock, (i) if such liquidation, dissolution or winding up shall be voluntary, (A) prior to the second anniversary of the date of issue of the $5.50 Preferred Stock, $111.00 per share or (B) thereafter and prior to the fifth anniversary of the date of issue of the $5.50 Preferred Stock, $105.00 per share or (C) on or after such fifth anniversary, an amount equal to the redemption price set forth in paragraph (c) of this subdivision 2 then in effect, and (ii) if such liquidation, dissolution or winding up shall be involuntary, the amount of $100.00 per share, plus, in each case, an amount equal to all accrued and unpaid dividends thereon to the date fixed for payment of such distributive amounts.\n(e) So long as any shares of the $5.50 Preferred Stock shall be outstanding, the corporation shall not, without the consent, given in writing or by resolution adopted at a meeting duly called for that purpose, of the holders of record of at least a majority of that number of shares of the $5.50 Preferred Stock then outstanding, reduce its capital in respect of the $5.50 Preferred Stock below an amount equal to $100 times the number of shares of the $5.50 Preferred Stock then outstanding.\n3. Provisions Applicable to all Series of Cumulative Preferred Stock. The voting powers, preferences and rights, and the qualifications, limitations and restrictions thereof, applicable to the Cumulative Preferred Stock of all series, are as follows:\n(a) Dividends on Cumulative Preferred Stock. The holders of the Cumulative Preferred Stock of each series shall be entitled to receive, in preference to the holders of any junior stock, when and as declared by the Board of Directors, but only out of net profits or net assets of the corporation legally available for the payment of dividends, cumulative cash dividends at the annual rate for such series fixed in this Article FOURTH, and no more, payable on the first days of January, April, July, and October in each year (such days being herein called \"dividend payment dates\" and the quarterly periods ending on such days being herein called \"dividend periods\"), to stockholders of record on the respective dates, which shall be the same dates for all series, fixed for the purpose by the Board of Directors in advance of payment of each particular dividend. The holders of shares of the Cumulative Preferred Stock shall not be entitled to receive any dividends thereon other than the dividends referred to in this paragraph (a).\nNo dividends shall be paid upon, or declared or set apart for, any share of Cumulative Preferred Stock of any series for any dividend period unless at the same time a like proportionate dividend for the same dividend period, ratably in proportion to the respective annual dividend rates fixed therefor, shall be paid upon, or declared and set apart for, all shares of Cumulative Preferred Stock of all series then issued and outstanding and entitled to receive such dividend.\n(b) Dividends on Junior Stock. So long as any shares of the Cumulative Preferred Stock shall be outstanding, the corporation will not declare or pay any dividend on any junior stock (other than dividends payable solely in junior stock) or make any other distribution of any sort, either directly or indirectly, in respect of any junior stock or make any payment on account of the purchase, redemption or other acquisition of any junior stock, unless, at the date of such declaration in the case of a dividend or at the date of such distribution or other payment\n(i) all cumulative dividends on the then outstanding shares of Cumulative Preferred Stock for all past dividend periods shall have been paid or declared and a sum sufficient for the payment thereof set apart; and\n(ii) after giving effect, as if paid, to the proposed dividend, distribution or payment, the aggregate amount of all such dividends, distributions and payments declared or made after December 31, 1963 does not exceed the sum of\n(A) Consolidated Net Operating Income from December 31, 1963 to such date of declaration, distribution or payment,\n(B) the net proceeds to the corporation, valued where other than cash by the Board of Directors, from the issuance or sale after June 30, 1964 of any shares of junior stock and of any convertible securities (other than junior stock) which have been converted into junior stock, and\n(C) $17,000,000. Subject to the foregoing provisions of this paragraph (b), such dividends (payable in cash, stock or otherwise) as may be determined by the Board of Directors may be declared and paid on any junior stock from time to time out of the net profits or net assets of the corporation legally available therefor, and the Cumulative Preferred Stock shall not be entitled to participate in any such dividends.\n(c) Redemption of Cumulative Preferred Stock. Subject to the provisions of paragraph (d) of this subdivision 3, the corporation at its option (expressed by resolution of the Board of Directors) may (except as provided in subdivision 2 in respect of the $5.50 Preferred Stock) redeem the outstanding shares of Cumulative Preferred Stock, or of any series thereof, at any time in whole, or from time to time in part, upon notice duly given as hereinafter specified, at the applicable redemption price or prices for such shares fixed in subdivision 2 of this Article Fourth, plus, in each case, an amount equal to all accrued and unpaid dividends thereon to the date fixed for redemption. Notice of every such redemption of Cumulative Preferred Stock, in form approved by the Board of Directors, shall be given by mailing such notice not less than thirty nor more than sixty days prior to the date fixed for such redemption to each holder of record of shares so to be redeemed at his address as the same shall appear on the books of the corporation. In case of redemption of a part only of the Cumulative Preferred Stock of any series at the time outstanding, the redemption may be either pro rata or by lot, as determined by the Board of Directors. Subject to the foregoing, the Board of Directors shall have full power and authority to prescribe the manner in which the drawings by lot or the pro rata redemption shall be conducted and the terms and conditions upon which the Cumulative Preferred Stock shall be redeemed from time to time.\nIf any such notice of redemption shall have been duly given, then, from and after the date fixed in such notice as the redemption date (unless default be made by the corporation in providing funds for the payment of the redemption price, and accrued and unpaid dividends to the date fixed for redemption), notwithstanding that any certificate for shares so called for redemption shall not have been surrendered for cancellation, all shares so called for redemption shall no longer be deemed outstanding on and after such redemption date, and the right to receive dividends thereon and all other rights with respect to such shares shall forthwith on such redemption date cease and terminate, except only the right of the holders thereof to receive the amount payable on redemption thereof, without interest.\nIf any such notice of redemption shall have been duly given or if the corporation shall have given to the bank or trust company hereinafter referred to irrevocable written authorization promptly to give or complete such notice, and if on or before the redemption date specified therein the funds necessary for such redemption shall have been deposited by the corporation with a bank or trust company designated in such notice, doing business in the Borough of Manhattan, the City of New York, State of New York, and having a capital, surplus and undivided profits aggregating at least $5,000,000 according to its last published statement of condition, in trust for the pro rata benefit of the holders of the shares so called for redemption, then, notwithstanding that any certificate for shares so called for redemption shall not have been surrendered for cancellation, from and after the time of such deposit all shares so called for redemption shall no longer be deemed outstanding and all rights with respect to such shares shall forthwith cease and terminate, except only the right of the holders thereof to receive from such bank or trust company at any time after the time of such deposit the funds so deposited, without interest, and the right to exercise, before the date fixed for redemption, all privileges of conversion or exchange, if any, not theretofore expired. Any interest accrued on such funds shall be paid to the corporation from time to time. Any funds so deposited and unclaimed at the end of six years from such redemption date shall be repaid to the corporation, after which the holders of the shares so called for redemption shall look only to the corporation for payment thereof; provided that any funds so deposited which shall not be required for redemption because of the exercise of any privilege of conversion or exchange subsequent to the date of deposit shall be repaid to the corporation forthwith.\nNone of the shares of Cumulative Preferred Stock of any series redeemed pursuant to the foregoing provisions or converted into or exchanged for other shares of the corporation or purchased or otherwise acquired by the corporation shall be reissued, and the corporation may from time to time take such appropriate corporate action as may be necessary to eliminate such shares from its authorized capital stock.\n(d) Limitation of Right to Redeem or Purchase Cumulative Preferred Stock. If and so long as all cumulative dividends on the outstanding shares of Cumulative Preferred Stock of all series for all past dividend periods shall not have been paid or declared and a sum sufficient for the payment thereof set apart, the corporation shall not redeem less than all of the Cumulative Preferred Stock at the time outstanding, and neither the corporation nor any subsidiary shall purchase or otherwise acquire for value any of the Cumulative Preferred Stock at the time outstanding unless such purchase or other acquisition shall be pursuant to tenders called for on at least twenty days' previous notice by mail to all the holders of record of the Cumulative Preferred Stock at their respective addresses as the same shall appear on the books of the corporation, and the shares so purchased or otherwise acquired shall be those tendered at the lowest prices pursuant to such call for tenders; provided, however, that if some, but less than all, of the shares tendered at a particular price are to be purchased or otherwise acquired pursuant to such call for tenders, the number of shares to be purchased or acquired from each holder who has tendered shares at such price shall be in the proportion which the number of shares he has tendered at such price bears to the total number of shares tendered at such price.\n(e) Voting Rights. Except as otherwise provided by law and as otherwise provided in this Article Fourth, and subject to the provisions of the by-laws of the corporation, as from time to time amended, with respect to the closing of the transfer books and the fixing of a record date for the determination of stockholders entitled to vote, the holders of the Common Stock shall exclusively possess voting power for the election of directors and for all other purposes, and the holders of the Cumulative Preferred Stock shall have no voting power and shall not be entitled to any notice of any meeting of stockholders; provided, however, that if at the time of the giving of notice of any annual meeting of stockholders for the election of directors a default in preferred dividends, as hereinafter defined, shall exist, the holders of the Cumulative Preferred Stock, voting separately as a class and without regard to series, shall have the right at such annual meeting to elect two members of the Board of Directors but shall not be entitled to vote in the election of any of the other directors of the corporation, and the holders of the Common Stock, voting separately as a class, shall be entitled to elect the remaining members of the Board of Directors but shall not be entitled to vote in the election of the two directors of the corporation so to be elected by the holders of the Cumulative Preferred Stock. Any director elected by the holders of the Cumulative Preferred Stock, voting as a class as aforesaid, together with each director elected to fill a vacancy in the office of a Preferred Director as hereinafter provided (hereinafter called a \"Preferred Director\"), shall continue to serve as such director until the next annual meeting of stockholders and until his successor shall be elected and qualified, notwithstanding that prior to the end of such term a default in preferred dividends shall cease to exist. Any Preferred Director may be removed with or without cause by, and shall not be removed except by, the vote of the holders of the Cumulative Preferred Stock, voting separately as a class without regard to series, at a meeting of stockholders or at a meeting of the holders of shares of Cumulative Preferred Stock called for the purpose. So long as a default in preferred dividends shall exist (i) any vacancy in the office of a Preferred Director may, except as provided in the following clause (ii), be filled for the unexpired term by the remaining Preferred Director or, if there shall at the time be no Preferred Director in office, by the remaining members of the Board of Directors, and (ii) in the case of the removal of any Preferred Director, the vacancy may be filled for the unexpired term by the vote of the holders of the Cumulative Preferred Stock, voting separately as a class without regard to series, at the same meeting at which such removal shall be voted or at any subsequent meeting. So long as there is a Preferred Director in office (i) if there shall be an executive or similar committee of the Board of Directors, at least one Preferred Director shall be a member of such committee, (ii) notice of each special meeting of the Board of Directors shall be given to each Preferred Director not less than three days by mail or one day by telegraph or telephone prior to the meeting, and (iii) notice of each special meeting of the executive or similar committee of the Board of Directors, if any, shall be given to each Preferred Director who is a member thereof not less than three days by mail or one day by telegraph or telephone prior to the meeting. Preferred Directors need not be stockholders. For the purposes of this paragraph (e), a default in preferred dividends shall be deemed to have occurred whenever at the time of giving of notice of any annual meeting of stockholders for the election of directors the amount of accrued and unpaid dividends upon any shares of any series of the Cumulative Preferred Stock shall be equivalent to four quarterly dividends or more, and, having so occurred, such default in preferred dividends shall be deemed to exist thereafter until, but only until, all cumulative dividends on all shares of Cumulative Preferred Stock then outstanding, of each and every series, for all past dividend periods shall have been paid or declared and set apart for payment. Nothing herein contained shall be deemed to prevent an amendment of the by-laws of the corporation, in the manner therein provided, which shall increase the number of directors of the corporation so as to provide additional places on the Board of Directors for either one or both of the two directors so to be elected by the holders of the Cumulative Preferred Stock, or so as to increase the number of directors to be elected by the holders of the Common Stock, or to prevent any other change in the number of the directors of the corporation.\nSo long as a default in preferred dividends shall exist (i) the presence in person or by proxy of the holders of twenty- five percent of the outstanding shares of the Cumulative Preferred Stock, considered as a class without regard to series, shall be (except as provided above in respect of the filling of a vacancy caused by the removal of a Preferred Director) required to constitute a quorum of such class at any meeting of stockholders or at any meeting of the holders of shares of Cumulative Preferred Stock called for the purpose of electing a Preferred Director or Preferred Directors; provided, however, that a majority of the holders of the Cumulative Preferred Stock who are present in person or represented by proxy at any such meeting at which there shall be no quorum of such class shall have power to adjourn the meeting from time to time, without notice other than announcement at the meeting, solely for the purpose of electing a Preferred Director or Preferred Directors at an adjourned session of such meeting at which there shall be a quorum of such class; and (ii) the presence in person or by proxy of the holders of a majority (or such lesser number as may at the time be specified in the by-laws of the corporation) of the outstanding shares of Common Stock shall be required to constitute a quorum of such class at any meeting of stockholders at which the holders of the Common Stock, voting as a class aforesaid, shall be entitled to vote for the election of directors of the corporation. No delay or failure by the holders of the Cumulative Preferred Stock to elect a Preferred Director shall invalidate the election of the members of the Board of Directors elected by the holders of the Common Stock. Holders of Cumulative Preferred Stock shall be entitled to notice of each meeting of stockholders at which they shall have the right to elect a Preferred Director, such notice to be mailed to such holders at least 10 days prior to such meeting.\nEach stockholder entitled to vote at any particular time in accordance with the provisions of this Article Fourth shall have one vote for each share of stock held of record by him and at the time entitled to voting power.\n(f) Restrictions on Certain Capital Changes. So long as any shares of the Cumulative Preferred Stock of any series shall be outstanding, the corporation shall not, without the consent, given in writing or by resolution adopted at a meeting duly called for that purpose, of the holders of record of at least two-thirds of the number of shares of the Cumulative Preferred Stock of all series then outstanding, considered as a class without regard to series,\n(i) create or issue any shares of any new class of stock ranking prior to the Cumulative Preferred Stock or alter or change the designations or the voting powers, preferences or rights, or the qualifications, limitations or restrictions thereof, of the Cumulative Preferred Stock or of any series thereof; provided, however, that any such alteration or change of the designations or of the voting powers, preferences or rights, or the qualifications, limitations or restrictions thereof, of any particular series of the Cumulative Preferred Stock which does not affect the holders of the Cumulative Preferred Stock of any other series may be effected with the consent, given as aforesaid, of the holders of record of at least two-thirds of the number of shares of the particular series of Cumulative Preferred Stock affected by such alteration or change; and provided, further, that nothing in this clause (i) shall require the vote or consent of the holders of the Cumulative Preferred Stock for or in respect of the creation or increase in the authorized number of shares of any junior stock or any stock (other than the Cumulative Preferred Stock) ranking on a parity with the Cumulative Preferred Stock; or\n(ii) create or issue any shares of any new class of stock ranking on a parity with the Cumulative Preferred Stock, unless, after giving effect to the issue of such shares, (A) the sum of (1) the aggregate par value (or stated value in the case of shares without par value) of all outstanding shares of stock of the corporation, (2) the aggregate amount of the surplus (whether capital, earned or other) and the contingency or other surplus reserves of the corporation, all as determined in accordance with generally accepted accounting principles applicable to banks and bank holding companies, and (3) the sum of the combined reserves for possible loan losses and other valuation reserves of the constituent banks, as determined in accordance with generally accepted accounting principles applicable to banks, will be at least 250% of the aggregate par value (or stated value in the case of shares without par value) of all shares of the Cumulative Preferred Stock and all shares of stock of the corporation of every other class ranking prior to or on a parity with the Cumulative Preferred Stock, and (B) the Consolidated Net Operating Income earned during the three calendar years immediately preceding such issue shall have averaged at least four times the annual dividend requirements on all shares of Cumulative Preferred Stock and all shares of stock of the corporation of every other class ranking prior to or on a parity with the Cumulative Preferred Stock which will be outstanding.\n(g) Rights on Liquidation. In the event of any liquidation, dissolution or winding up of the affairs of the corporation, the holders of the Cumulative Preferred Stock of each series shall be entitled to receive out of the assets of the corporation, before any distribution or payment shall be made to the holders of any junior stock, the amount per share specified in this Article FOURTH with respect thereto, and the holders of the junior stock shall be entitled, to the exclusion of the holders of the Cumulative Preferred Stock of any and all series, to share ratably in all the remaining assets of the corporation in accordance with their respective rights. If upon any liquidation, dissolution or winding up of the affairs of the corporation the assets available for distribution shall be insufficient to pay the holders of all outstanding shares of Cumulative Preferred Stock the full amounts to which they respectively shall be entitled, the holders of shares of Cumulative Preferred Stock of all series shall share ratably in any distribution of assets in accordance with the sums which would be payable on such distribution if all sums payable were paid in full. Neither the consolidation or merger of the corporation with or into any other corporation, nor any sale, lease or conveyance of all or any part of the property or business of the corporation, shall be deemed to be a liquidation, dissolution or winding up of the affairs of the corporation within the meaning of this paragraph (g).\n(h) Preemptive Rights. No holder of Cumulative Preferred Stock of any series shall be entitled as such, as a matter of right, to subscribe for or purchase any part of any new or additional issue of stock of any class whatsoever, or of obligations or other securities convertible into, or exchangeable for, any stock of any class whatsoever, whether now or hereafter authorized and whether issued for cash or other consideration or by way of dividend.\n4. Definitions. For all purposes of this Article Fourth:\nThe term \"accrued and unpaid dividends\" when used with reference to any share of any series of the Cumulative Preferred Stock shall mean (whether or not in any dividend period there shall have been net profit or net assets of the corporation legally available for the payment of dividends) an amount computed at the annual dividend rate for the shares of such series from the date on which dividends on such share become cumulative to and including the date to which such dividends are to be accrued, less the aggregate amount of all dividends theretofore paid on such share; but no interest shall be payable upon any arrearages.\nThe term \"Board of Directors\" shall mean the Board of Directors of the corporation.\nThe term \"Consolidated Net Operating Income\" shall mean the consolidated net operating income of the corporation, the constituent banks and such subsidiaries the accounts of which are in fact consolidated with those of the corporation in its annual report to stockholders, all as determined from time to time in accordance with generally accepted accounting principles applicable to banks and bank holding companies.\nThe term \"constituent banks\" shall mean all commercial banks and trust companies, whether organized under Federal or State law, at least a majority of the shares of voting stock of which shall at the time be owned, directly or indirectly, by the corporation or by one or more subsidiaries or by the corporation and one or more subsidiaries.\nThe term \"junior stock\", when used with reference to the Cumulative Preferred Stock, shall mean the Common Stock and any other stock of the corporation, now or hereafter authorized, over which the Cumulative Preferred Stock has preference or priority either in the payment of dividends or in the distribution of assets upon any liquidation, dissolution or winding up of the affairs of the corporation.\nThe term \"stock ranking on a parity with the Cumulative Preferred Stock\" shall mean any stock of the corporation, now or hereafter authorized, which has preference on a parity with the Cumulative Preferred Stock either in the payment of dividends or in the distribution of assets upon any liquidation, dissolution or winding up of the affairs of the corporation.\nThe term \"stock ranking prior to the Cumulative Preferred Stock\" shall mean any stock of the corporation, now or hereafter authorized, which has preference over the Cumulative Preferred Stock either in the payment of dividends or in the distribution of assets upon any liquidation, dissolution or winding up of the affairs of the corporation.\nThe term \"subsidiary\" shall mean any corporation, association or business trust at least a majority of the shares of the voting stock of which shall at the time be owned, directly or indirectly, by the corporation or by one or more subsidiaries or by the corporation and one or more subsidiaries.\nThe term \"voting stock\", as applied to the stock (or the equivalent thereof, in the case of corporations incorporated outside the continental limits of the United States of America) of any corporation, shall mean stock (or such equivalent) of any class or classes, however designated, having ordinary voting power for the election of a majority of the directors of such corporation, other than stock (or such equivalent) having such power only by reason of the happening of a contingency.\n5. Class Voting. Except as otherwise required by law or by the provisions of the Certificate of Incorporation, the vote of the holders of all or any portion of any class of stock, as a class, shall not be required for any action whatsoever to be taken or authorized by the stockholders of the corporation, including any amendment of the Certificate of Incorporation.\n6. Preferred Stock. The Preferred Stock may be issued from time to time in one or more series and with such designation for each such series as shall be stated and expressed in the resolution or resolutions providing for the issue of each such series adopted by the Board of Directors. The Board of Directors in any such resolution or resolutions is expressly authorized to state and express for each such series:\n(i) the voting powers, if any, of the holders of stock of such series;\n(ii) the rate per annum and the times at and conditions upon which the holders of stock of such series shall be entitled to receive dividends, and whether such dividends shall be cumulative or non- cumulative and if cumulative the terms upon which such dividends shall be cumulative;\n(iii) the price or prices and the time or times at and the manner in which the stock of such series shall be redeemable;\n(iv) the terms, if any, upon which shares of stock of such series shall be convertible into, or exchangeable for, shares of stock of any other class or classes or of any other series of the same or any other class or classes; including the price or prices or the rate or rates of conversion or exchange and the terms of adjustment, if any;\n(v) the rights to which the holders of the shares of stock of such series shall be entitled upon any voluntary or involuntary liquidation, dissolution or winding up of the corporation, provided, however, that in no event shall they be entitled to receive upon any such liquidation, dissolution or winding up more than $120 per share, plus in respect of each such share a sum computed at the annual dividend rate for such series from and after the date on which dividends on such shares become cumulative to and including the date fixed for such payment, less the aggregate of dividends theretofore paid thereon; and\n(vi) any other designations, preferences and relative, participating, optional or other special rights, and qualifications, limitations or restrictions thereof so far as they are not inconsistent with the provisions of the certificate of incorporation, as amended, and to the full extent now or hereafter permitted by the laws of Delaware, provided, however, that in no event shall any series of Preferred Stock rank prior to the Cumulative Preferred Stock.\n7. Adjustable Rate Cumulative Preferred Stock, Series A. Pursuant to authority conferred by this Article Fourth on the Board of Directors of the corporation, the Board of Directors, pursuant to a Certificate of Designations filed in the Office of the Secretary of State of the State of Delaware on March 7, 1983, established a series of Preferred Stock of the corporation (\"Preferred Stock\") to consist of 2,000,000 shares. Such series has the voting powers, designation, preferences and relative, participating, optional or other special rights, and the qualifications, limitations or restrictions, in addition to those set forth in this Article Fourth in respect of the Preferred Stock of all series as follows:\n(a) Designation. The designation of this series of Preferred Stock shall be \"Adjustable Rate Cumulative Preferred Stock, Series A\" (hereinafter called this \"Series\") and the number of shares constituting this Series is Two Million (2,000,000). The number of authorized shares of this Series may be reduced by further resolution duly adopted by the Board of Directors of the corporation and by the filing of a certificate pursuant to the provisions of the General Corporation Law of the State of Delaware stating that such reduction has been so authorized, but the number of authorized shares of this Series shall not be increased.\n(b) Dividend Rate.\n(1) Dividend rates on the shares of this Series shall be: (i) for the periods (the \"Initial Dividend Periods\") (A) from the date of their original issue to and including March 31, 1983, (B) from April 1, 1983 to and including June 30, 1983, and (C) from July 1, 1983 to and including September 30, 1983, at a rate per annum of 10% on the liquidation preference thereof, and (ii) for each quarterly dividend period (hereinafter referred to as a \"Quarterly Dividend Period\"; and any Initial Dividend Period or any Quarterly Dividend Period being hereinafter individually referred to as a \"Dividend Period\" and collectively referred to as \"Dividend Periods\") thereafter, which quarterly dividend periods shall commence on January 1, April 1, July 1 and October 1 in each year and shall end on and include the day next preceding the first day of the next Quarterly Dividend Period, at a rate per annum on the liquidation preference thereof equal to the Applicable Rate (as defined in paragraph (2) of this Section (b)) in respect of such Quarterly Dividend Period. Such dividends shall be cumulative from the date of original issue of such shares and shall be payable, when and as declared by the Board of Directors or by a committee of said Board duly authorized by said Board to declare such dividends, on January 1, April 1, July 1, and October 1 of each year, commencing April 1, 1983. Each such dividend shall be paid to the holders of record of shares of this Series as they appear on the stock register of the corporation on such record date, not exceeding 30 days preceding the payment date thereof, as shall be fixed by the Board of Directors of the corporation or by a committee of said Board of Directors duly authorized to fix such date. Dividends on account of arrears for any past Dividend Periods may be declared and paid at any time, without reference to any regular dividend payment date, to holders of record on such date, not exceeding 30 days preceding the payment date thereof, as may be fixed by the Board of Directors of the corporation or by a committee of said Board of Directors duly authorized to fix such date.\n(2) Except as provided below in this paragraph, the \"Applicable Rate\" for any Quarterly Dividend Period shall be (a) 2% less than (b) the highest of the Treasury Bill Rate, the Ten Year Constant Maturity Rate and the Twenty Year Constant Maturity Rate (each as hereinafter defined) for such Dividend Period. In the event that the corporation determines in good faith that for any reason\n(i) any one of the Treasury Bill Rate, the Ten Year Constant Maturity Rate and the Twenty Year Constant Maturity Rate cannot be determined for any Quarterly Dividend Period, then the Applicable Rate for such Dividend Period shall be 2% less than the higher of whichever two of such Rates can be so determined;\n(ii) only one of the Treasury Bill Rate, the Ten Year Constant Maturity Rate and the Twenty Year Constant Maturity Rate can be determined for any Quarterly Dividend Period, then the Applicable Rate for such Dividend Period shall be 2% less than whichever such Rate can be so determined; or\n(iii) None of the Treasury Bill Rate, the Ten Year Constant Maturity Rate and the Twenty Year Constant Maturity Rate can be determined for any Quarterly Dividend Period, then the Applicable Rate in effect for the preceding Dividend Period shall be continued for such Dividend Period.\nAnything herein to the contrary notwithstanding, the Applicable Rate for any Quarterly Dividend Period shall in no event be less than 6% per annum or greater than 12% per annum.\n(3) Except as provided below in this paragraph, the \"Treasury Bill Rate\" for each Quarterly Dividend Period shall be the arithmetic average of the two most recent weekly per annum market discount rates (or the one weekly per annum market discount rate, if only one such rate shall be published during the relevant Calendar Period (as defined below)) for three-month U.S. Treasury bills, as published weekly by the Federal Reserve Board during the Calendar Period immediately prior to the last ten calendar days of March, June, September or December, as the case may be, prior to the Quarterly Dividend Period for which the dividend rate on this Series is being determined. In the event that the Federal Reserve Board does not publish such a weekly per annum market discount rate during such Calendar Period, then the Treasury Bill Rate for such Dividend Period shall be the arithmetic average of the two most recent weekly per annum market discount rates (or the one weekly per annum market discount rate, if only one such rate shall be published during the relevant Calendar Period) for three- month U.S. Treasury bills, as published weekly during such Calendar Period by any Federal Reserve Bank or by any U.S. Government department or agency selected by the corporation. In the event that a per annum market discount rate for three-month U.S. Treasury bills shall not be published by the Federal Reserve Board or by any Federal Reserve Bank or by any U.S. Government department or agency during such Calendar Period, then the Treasury Bill Rate for such Dividend Period shall be the arithmetic average of the two most recent weekly per annum market discount rates (or the one weekly per annum market discount rate, if only one such rate shall be published during the relevant Calendar Period as provided below) for all of the U.S. Treasury bills then having maturities of not less than 80 nor more than 100 days, as published during such Calendar Period by the Federal Reserve Board or, if the Federal Reserve Board shall not publish such rates, by any Federal Reserve Bank or by any U.S. Government department or agency selected by the corporation. In the event that the corporation determines in good faith that for any reason no such U.S. Treasury bill rates are published as provided above during such Calendar Period, then the Treasury Bill Rate for such Dividend Period shall be the arithmetic average of the per annum market discount rates based upon the closing bids during such Calendar Period for each of the issues of marketable noninterest bearing U.S. Treasury securities with a maturity of not less than 80 nor more than 100 days from the date of each such quotation, as chosen and quoted daily for each business day in New York City (or less frequently if daily quotations shall not be generally available) to the corporation by at least three recognized dealers in U.S. Government securities selected by the corporation. In the event that the corporation determines in good faith that for any reason the corporation cannot determine the Treasury Bill Rate for any Quarterly Dividend Period as provided above in this paragraph, the Treasury Bill Rate for such Dividend Period shall be the arithmetic average of the per annum market discount rates based upon the closing bids during such Calendar Period for each of the issues of marketable interest-bearing U.S. Treasury securities with a maturity of not less than 80 nor more than 100 days, as chosen and quoted daily for each business day in New York City (or less frequently if daily quotations shall not be generally available) to the corporation by at least three recognized dealers in U.S. Government securities selected by the corporation.\n(4) Except as provided below in this paragraph, the \"Ten Year Constant Maturity Rate\" for each Quarterly Dividend Period shall be the arithmetic average of the two most recent weekly per annum Ten Year Average Yields (or the one weekly per annum Ten Year Average Yield, if only one such Yield shall be published during the relevant Calendar Period as provided below), as published weekly by the Federal Reserve Board during the Calendar Period immediately prior to the last ten calendar days of March, June, September or December, as the case may be, prior to the Quarterly Dividend Period for which the dividend rate on this Series is being determined. In the event that the Federal Reserve Board does not publish such a weekly per annum Ten Year Average Yield during such Calendar Period, then the Ten Year Constant Maturity Rate for such Dividend Period shall be the arithmetic average of the two most recent weekly per annum Ten Year Average Yields (or the one weekly per annum Ten Year Average Yield, if only one such Yield shall be published during the relevant Calendar Period as provided below), as published weekly during such Calendar Period by any Federal Reserve Bank or by any U.S. Government department or agency selected by the corporation. In the event that a per annum Ten Year Average Yield shall not be published by the Federal Reserve Board or by any Federal Reserve Bank or by any U.S. Government department or agency during such Calendar Period, then the Ten Year Constant Maturity Rate for such Dividend Period shall be the arithmetic average of the two most recent weekly per annum average yields to maturity (or the one weekly average yield to maturity, if only one such yield shall be published during the relevant Calendar Period as provided below) for all of the actively traded marketable U.S. Treasury fixed interest rate securities (other than Special Securities) then having maturities of not less than eight nor more than twelve years, as published during such Calendar Period by the Federal Reserve Board or, if the Federal Reserve Board shall not publish such yields, by any Federal Reserve Bank or by any U.S. Government department or agency selected by the corporation. In the event that the corporation determines in good faith that for any reason the corporation cannot determine the Ten Year Constant Maturity Rate for any Quarterly Dividend Period as provided above in this paragraph, then the Ten Year Constant Maturity Rate for such Dividend Period shall be the arithmetic average of the per annum average yields to maturity based upon the closing bids during such Calendar Period for each of the issues of actively traded marketable U.S. Treasury fixed interest rate securities (other than Special Securities) with a final maturity date not less than eight nor more than twelve years from the date of each such quotation, as chosen and quoted daily for each business day in New York City (or less frequently if daily quotations shall not be generally available) to the corporation by at least three recognized dealers in U.S. Government securities selected by the corporation.\n(5) Except as provided below in this paragraph, the \"Twenty Year Constant Maturity Rate\" for each Quarterly Dividend Period shall be the arithmetic average of the two most recent weekly per annum Twenty Year Average Yields (or the one weekly per annum Twenty Year Average Yield, if only one such Yield shall be published during the relevant Calendar Period as provided below), as published weekly by the Federal Reserve Board during the Calendar Period immediately prior to the last ten calendar days of March, June, September or December, as the case may be, prior to the Quarterly Dividend Period for which the dividend rate on this Series is being determined. In the event that the Federal Reserve Board does not publish such a weekly per annum Twenty Year Average Yield during such Calendar Period, then the Twenty Year Constant Maturity Rate for such Dividend Period shall be the arithmetic average of the two most recent weekly per annum Twenty Year Average Yields (or the one weekly per annum Twenty Year Average Yield, if only one such Yield shall be published during the relevant Calendar Period as provided below), as published weekly during such Calendar Period by any Federal Reserve Bank or by any U.S. Government department or agency selected by the corporation. In the event that a per annum Twenty Year Average Yield shall not be published by the Federal Reserve Board or by any Federal Reserve Bank or by any U.S. Government department or agency during such Calendar Period, then the Twenty Year Constant Maturity Rate for such Dividend Period shall be the arithmetic average of the two most recent weekly per annum average yields to maturity (or the one weekly average yield to maturity, if only one such yield shall be published during the relevant Calendar Period as provided below) for all of the actively traded marketable U.S. Treasury fixed interest rate securities (other than Special Securities) then having maturities of not less than eighteen nor more than twenty-two years, as published during such Calendar Period by the Federal Reserve Board or, if the Federal Reserve Board shall not publish such yields, by any Federal Reserve Bank or by any U.S. Government department or agency selected by the corporation. In the event that the corporation determines in good faith that for any reason the corporation cannot determine the Twenty Year Constant Maturity Rate for any Quarterly Dividend Period as provided above in this paragraph, then the Twenty Year Constant Maturity Rate for such Dividend Period shall be the arithmetic average of the per annum average yields to maturity based upon the closing bids during such Calendar Period for each of the issues of actively traded marketable U.S. Treasury fixed interest rate securities (other than Special Securities) with a final maturity date not less than eighteen nor more than twenty-two years from the date of each such quotation, as chosen and quoted daily for each business day in New York City (or less frequently if daily quotations shall not be generally available) to the corporation by at least three recognized dealers in U.S. Government securities selected by the corporation.\n(6) The Treasury Bill Rate, the Ten Year Constant Maturity Rate and the Twenty Year Constant Maturity Rate shall each be rounded to the nearest five one-hundredths of a percentage point.\n(7) The Applicable Rate with respect to each Quarterly Dividend Period will be calculated as promptly as practicable by the corporation according to the appropriate method described herein. The corporation will cause each Applicable Rate to be published in a newspaper of general circulation in New York City prior to the commencement of the Quarterly Dividend Period to which it applies and will cause notice of such Applicable Rate to be enclosed with the dividend payment checks next mailed to the holders of shares of this Series.\n(8) For purposes of this Section (b), the term\n(i) \"Calendar Period\" shall mean 14 calendar days;\n(ii) \"Special Securities\" shall mean securities which can, at the option of the holder, be surrendered at face value in payment of any Federal estate tax or which provide tax benefits to the holder and are priced to reflect such tax benefits or which were originally issued at a deep or substantial discount;\n(iii) \"Ten Year Average Yield\" shall mean the average yield to maturity for actively traded marketable U.S. Treasury fixed interest rate securities (adjusted to constant maturities of ten years); and\n(iv) \"Twenty Year Average Yield\" shall mean the average yield to maturity for actively traded marketable U.S. Treasury fixed interest rate securities (adjusted to constant maturities of 20 years).\n(9) So long as any shares of this Series are outstanding, the corporation shall not (a) declare or pay or set apart for payment any dividend or other distribution (other than dividends or distributions payable in shares of stock of the corporation ranking junior to this Series as to dividends and upon liquidation) for any period upon any stock of the corporation ranking on a parity with, or any stock of the corporation ranking junior to, this Series as to dividends or upon liquidation or (b) redeem, purchase or otherwise acquire for any consideration any stock of the corporation ranking on a parity with, or any stock of the corporation ranking junior to, this Series as to dividends or upon liquidation, unless, in either case, all dividends payable to holders of shares of this Series and of any stock of the corporation ranking on a parity therewith as to dividends for its current dividend period and all past dividend periods have been paid, are contemporaneously being paid or have been declared and a sum sufficient for the payment thereof set aside for such payment, except that notwithstanding clause (a) above the corporation may pay dividends on the shares of this Series and shares of stock of the corporation ranking on a parity therewith as to dividends ratably in accordance with the sums which would be payable on such shares if all dividends, including accumulations, if any, were declared and paid in full. Holders of shares of this Series shall not be entitled to any dividends, whether payable in cash, property or stock, in excess of full cumulative dividends, as herein provided, on this Series. No interest, or sum of money in lieu of interest, shall be payable in respect of any dividend payment or payments on this Series which may be in arrears.\n(10) Dividends payable on this Series for each full Quarterly Dividend Period shall be computed by analyzing the Applicable Rate and dividing by four. Dividends payable on this Series for any period less than a full Dividend Period shall be computed on the basis of a 360-day year of 30-day months and the actual number of days elapsed in the period for which payable.\n(c) Redemption.\n(1) The shares of this Series shall not be redeemable prior to April 1, 1988. On and after April 1, 1988, the corporation, at its option, may redeem shares of this Series, as a whole or in part, at any time or from time to time, at a redemption price (i) in the case of any redemption on a redemption date occurring on or after April 1, 1988, and prior to April 1, 1993, of $51.50 per share and (ii) in the case of any redemption on a redemption date occurring on or after April 1, 1993, of $50 per share, plus, in each case, accrued and unpaid dividends thereon to the date fixed for redemption.\n(2) In the event that fewer than all the outstanding shares of this Series are to be redeemed, the number of shares to be redeemed shall be determined by the Board of Directors and the shares to be redeemed shall be determined by lot or pro rata as may be determined by the Board of Directors or by any other method as may be determined by the Board of Directors in its sole discretion to be equitable.\n(3) In the event the corporation shall redeem shares of this Series, notice of such redemption shall be given by first class mail, postage prepaid, mailed not less than 30 nor more than 60 days prior to the redemption date, to each holder of record of the shares to be redeemed, at such holder's address as the same appears on the stock register of the corporation. Each such notice shall state: (i) the redemption date; (ii) the number of shares of this Series to be redeemed and, if fewer than all the shares held by such holder are to be redeemed, the number of such shares to be redeemed from such holder; (iii) the redemption price; (iv) the place or places where certificates for such shares are to be surrendered for payment of the redemption price; and (v) that dividends on the shares to be redeemed will cease to accrue on such redemption date.\n(4) Notice having been mailed as aforesaid, from and after the redemption date (unless default shall be made by the corporation in providing money for the payment of the redemption price) dividends on the shares of this Series so called for redemption shall cease to accrue, and said shares shall no longer be deemed to be outstanding, and all rights of the holders thereof as stockholders of the corporation (except the right to receive from the corporation the redemption price) shall cease. Upon surrender in accordance with said notice of the certificates for any shares so redeemed (properly endorsed or assigned for transfer, if the Board of Directors of the corporation shall so require and the notice shall so state), such shares shall be redeemed by the corporation at the redemption price aforesaid. In case fewer than all the shares represented by any such certificate are redeemed, a new certificate shall be issued representing the unredeemed shares without cost to the holder thereof.\n(5) Any shares of this Series which shall at any time have been redeemed shall, after such redemption, have the status of authorized but unissued shares of Preferred Stock, without designation as to series until such shares are once more designated as part of a particular series by the Board of Directors.\n(6) Notwithstanding the foregoing provisions of this Section (c), if any dividends on this Series are in arrears, no shares of Preferred Stock shall be redeemed, and the corporation shall not purchase or otherwise acquire any shares of this Series; provided, however, that the foregoing shall not prevent the purchase or acquisition of shares of this Series pursuant to a purchase or exchange offer made on the same terms to all holders of Preferred Stock and any other shares of stock of the Company ranking on a parity therewith as to dividends.\n(d) Conversion or Exchange. The holders of shares of this Series shall not have any rights herein to convert such shares into or exchange such shares for shares of any other class or classes or of any other series of any class or classes of capital stock of the corporation.\n(e) Voting. The shares of this Series shall not have any voting powers either general or special, except as expressly required by applicable law and except that\n(1) The consent of the holders of at least 66-2\/3% of all of the shares of this Series at the time outstanding, given in person or by proxy, either in writing or by a vote at a meeting called for the purpose at which the holders of shares of this Series shall vote together as a separate class, shall be necessary for authorizing, effecting or validating the amendment, alteration or repeal of any of the provisions of the Certificate of Incorporation or of any certificate amendatory thereof or supplemental thereto (including any Certificate of Designation and Terms or any similar document relating to any series of Preferred Stock) so as to materially adversely affect the powers, preferences, privileges or rights of this Series;\n(2) The consent of the holders of at least 66-2\/3% of all of the shares of this Series and all other series of Preferred Stock ranking on a parity with shares of this Series, either as to dividends or upon liquidation, at the time outstanding, given in person or by proxy, either in writing or by a vote at a meeting called for the purpose at which the holders of shares of this Series and such other series of Preferred Stock shall vote together as a single class without regard to series, shall be necessary for authorizing, effecting or validating the creation, authorization, increase in the authorized amount of or issue of any shares of any class or series of stock of the corporation ranking prior to the shares of this Series as to dividends or upon liquidation, or the reclassification of any authorized stock of the corporation into any such prior shares, or the creation, authorization or issue of any obligation or security convertible into or evidencing the right to purchase any such prior shares;\n(3) The consent of the holders of at least a majority of all of the shares of this Series and all other series of Preferred Stock ranking on a parity with this Series, either as to dividends or upon liquidation, at the time outstanding, given in person or by proxy, either in writing or by a vote at a meeting called for the purpose at which the holders of shares of this Series and such other series of Preferred Stock shall vote together as a single class without regard to series, shall be necessary for authorizing, effecting or validating the sale, lease or conveyance of all or substantially all the property or business of the corporation or the merger or consolidation of the corporation into or with any other corporation; provided, however, that no such vote or consent of the holders of shares of this Series and such other series of Preferred Stock, voting as a class without regard to series, shall be required for the merger or consolidation of another corporation into or with the corporation if none of the preferences, rights, powers or privileges of this Series or such other series of Preferred Stock or the holders thereof will be adversely affected thereby and there shall not be authorized or outstanding after such merger or consolidation any class of stock or other securities (except such stock or securities of the corporation as may have been authorized or outstanding immediately preceding such merger or consolidation) ranking prior to the shares of this Series and such other series of Preferred Stock as to dividends or upon liquidation; and provided further, however, that there shall not be authorized or outstanding after such merger or consolidation more than 10,000,000 shares of Preferred Stock or any class of stock or other securities (except such stock or securities of the corporation as may have been authorized or outstanding immediately preceding such merger or consolidation) ranking on a parity with the shares of this Series as to dividends or upon liquidation, in which case the vote specified by this paragraph (3) shall be required;\n(4) If at the time of any annual meeting of stockholders for the election of directors a default in preference dividends on the Preferred Stock shall exist, the number of directors constituting the Board of Directors of the corporation shall be increased by two, and the holders of the Preferred Stock of all series (whether or not the holders of such series of Preferred Stock would be entitled to vote for the election of directors if such default in preference dividends did not exist), shall have the right at such meeting, voting together as a single class without regard to series, to the exclusion of the holders of Common Stock, to elect two directors of the corporation to fill such newly created directorships. Such right shall continue until there are no dividends in arrears upon the Preferred Stock. Each director elected by the holders of shares of Preferred Stock (herein called a \"Preferred Director\"), shall continue to serve as such director for the full term for which he shall have been elected, notwithstanding that prior to the end of such term a default in preference dividends shall cease to exist. Any Preferred Director may be removed by, and shall not be removed except by, the vote of the holders of record of the outstanding shares of Preferred Stock, voting together as a single class without regard to series, at a meeting of the stockholders, or of the holders of shares of Preferred Stock, called for the purpose. So long as a default in any preference dividends on the Preferred Stock shall exist (A) any vacancy in the office of a Preferred Director may be filled (except as provided in the following clause (B)) by an instrument in writing signed by the remaining Preferred Director and filed with the corporation and (B) in the case of the removal of any Preferred Director, the vacancy may be filled by the vote of the holders of the outstanding shares of Preferred Stock, voting together as a single class without regard to series, at the same meeting at which such removal shall be voted. Each director appointed as aforesaid by the remaining Preferred Director shall be deemed, for all purposes hereof, to be a Preferred Director. Whenever the term of office of the Preferred Directors shall end and a default in preference dividends shall no longer exist, the number of directors constituting the Board of Directors of the corporation shall be reduced by two. For the purposes hereof, a \"default in preference dividends\" on the Preferred Stock shall be deemed to have occurred whenever the amount of accrued dividends upon any series of the Preferred Stock shall be equivalent to six full quarter-yearly dividends or more, and, having so occurred, such default shall be deemed to exist thereafter until, but only until, all accrued dividends on all shares of Preferred Stock of each and every series then outstanding shall have been paid to the end of the last preceding Quarterly Dividend Period;\n(f) Liquidation Rights.\n(1) Upon the dissolution, voluntary or involuntary liquidation or winding up of the corporation, the holders of the shares of this Series shall be entitled to receive out of the assets of the corporation, before any payment or distribution shall be made on the Common Stock or on any other class of stock of the corporation ranking junior to the Preferred Stock upon liquidation, the amount of $50 per share, plus a sum equal to all dividends (whether or not earned or declared) on such shares accrued and unpaid thereon to the date of final distribution.\n(2) For the purposes of this Section (f), a voluntary or involuntary liquidation, dissolution or winding up of the corporation shall include neither the consolidation or merger of the corporation with or into any other corporation, nor any sale, lease or conveyance of all or any part of the property or business of the corporation.\n(3) After the payment to the holders of the shares of this Series of the full preferential amounts provided for in this Section (f), the holders of this Series as such shall have no right or claim to any of the remaining assets of the corporation.\n(4) In the event the assets of the corporation available for distribution to the holders of shares of this Series upon any dissolution, liquidation or winding up of the corporation, whether voluntary or involuntary, shall be insufficient to pay in full all amounts to which such holders are entitled pursuant to paragraph (1) of this Section (f), no such distribution shall be made on account of any shares of stock of the corporation ranking on a parity with the shares of this Series upon such dissolution, liquidation or winding up unless proportionate distributive amounts shall be paid on account of the shares of this Series, ratably, in proportion to the full distributable amounts for which holders of all such parity shares are respectively entitled upon such dissolution, liquidation or winding up.\n(5) Upon the dissolution, liquidation or winding up of the corporation, the holders of shares of this Series then outstanding shall be entitled to be paid out of the assets of the corporation available for distribution to its stockholders all amounts to which such holders are entitled pursuant to paragraph (1) of this Section (f) before any payment shall be made to the holders of any class of capital stock of the corporation ranking junior upon liquidation to this Series.\n(g) For purposes of this Series, any stock of any class or classes of the corporation shall be deemed to rank:\n(1) prior to the shares of this Series, either as to dividends or upon liquidation, if the holders of such class or classes shall be entitled to the receipt of dividends or of amounts distributable upon dissolution, liquidation or winding up of the corporation, as the case may be, in preference or priority to the holders of shares of this Series;\n(2) on a parity with shares of this Series, either as to dividends or upon liquidation, whether or not the dividend rates, dividend payment dates or redemption or liquidation prices per share or sinking fund provisions, if any, be different from those of this Series, if the holders of such stock shall be entitled to the receipt of dividends or of amounts distributable upon dissolution, liquidation or winding up of the corporation, as the case may be, in proportion to their respective dividend rates or liquidation prices, without preference or priority, one over the other, as between the holders of such stock and the holders of shares of this Series; and\n(3) junior to shares of this Series, either as to dividends or upon liquidation, if such class shall be Common Stock or if the holders of shares of this Series shall be entitled to receipt of dividends or of amounts distributable upon dissolution, liquidation or winding up of the corporation, as the case may be, in preference or priority to the holders of shares of such class or classes.\n(4) The Series shall rank on a parity as to dividends and upon liquidation with the Cumulative Preferred Stock of the corporation.\nFifth: The minimum amount of capital with which the corporation will commence business is One Thousand Dollars ($1,000.00).\nSixth: This corporation is to have perpetual existence.\nSeventh: The private property of the stockholders shall not be subject to payment of corporate debts to any extent whatsoever.\nEighth: No holder of shares of stock of the corporation of any class, now or hereafter authorized, shall have any preemptive right to subscribe for, purchase or receive any shares of stock of the corporation of any class, now or hereafter authorized, or any options or warrants for such shares, or any rights to subscribe to or purchase such shares, or any securities convertible into or exchangeable for such shares, which may at any time be issued, sold or offered for sale by the corporation.\nNinth: Subject to the provisions of law and in furtherance and not in limitation of the powers conferred by law, the Board of Directors of the corporation is hereby empowered by resolution or resolutions:\n1. To provide for the issuance from time to time of its shares of stock of any class, whether now or hereafter authorized, and securities convertible into shares of its stock of any class, and\/or securities whether now or hereafter authorized carrying a privilege to subscribe for or receive shares of its stock of any class, for such considerations and upon such terms and conditions as the Board of Directors may fix from time to time.\n2. To determine that only a part of the consideration which shall be received by the corporation in excess of the par value of its shares of capital stock or any thereof, which it shall issue from time to time, shall be capital.\n3. Without the consent of the stockholders of any class, to authorize the issuance and sale from time to time of evidences of indebtedness (as defined in Article Third hereof) of the corporation for such considerations as it may deem advisable, to provide that such evidences of indebtedness be issued in such series, in such denomination or denominations, and with such interest rate or rates, redemption price or prices, and maturing at such time or times and otherwise varying as it may determine; and likewise without such consent to mortgage, pledge and\/or hypothecate all or any part of the corporation's property, real, personal or mixed (except its corporate franchises), and its rents, revenues and income, whether now owned or hereafter acquired, and to authorize the execution, delivery, filing and recording of all mortgages, deeds of trust or other indentures, in such form as shall be determined by it, to secure the payment of all or any of such evidences of indebtedness, the principal and interest thereof, the premium, if any, thereon, and any and all amounts or sums payable in respect thereof or in connection therewith.\n4. To make, alter, amend, change, add to or repeal the by-laws of this corporation, without any action on the part of the stockholders.\n5. By resolution passed by a majority of the whole board, to designate two or more of its number to constitute an executive committee, which committee, so far as is provided in said resolution or in the by-laws of this corporation, shall have and may exercise the powers of the Board of Directors in the management of the business and affairs of this corporation, and have power to authorize the seal of this corporation to be affixed to all papers which may require it.\n6. When and as authorized by the affirmative vote of the holders of a majority of the stock issued and outstanding having voting power given at a stockholders' meeting duly called for that purpose, or when authorized by the written consent of the holders of a majority of the voting stock issued and outstanding, to sell, lease or exchange all of the property and assets of the corporation, including its good will and its corporate franchises, upon such terms and conditions and for such consideration, which may be in whole or in part evidences of indebtedness and\/or certificates of interest (as defined in Article Third hereof), as its Board of Directors shall deem expedient and for the best interests of the corporation.\n7. From time to time, to determine whether and to what extent and at what times and places and under what conditions and regulations the accounts and books of this corporation (other than the stock ledger) or any of them shall be open to the inspection of stockholders; and no stockholder shall have any right of inspecting any account, book or document of this corporation, except as conferred by statute, unless authorized by resolution of stockholders or directors.\n8. To set apart out of any of the funds or assets of this corporation, available for dividends, a reserve or reserves for any proper purpose, and to abolish any such reserve or reserves. Against any such reserve or reserves and\/or surplus so established, there may be charged losses at any time incurred by this corporation, also dividends or other distribution upon stock. Such reserve or reserves and\/or surplus may be reduced from time to time by the Board of Directors by transfer from such reserve or reserves and\/or surplus to capital account.\n9. At any time or from time to time to create and issue (without any action by the stockholders of the corporation), whether or not in connection with the issue and sale of any shares of stock or other securities of the corporation, rights or options entitling the holders thereof to purchase from the corporation shares of its capital stock, such rights or options to be evidenced by or in such instrument or instruments as shall be approved by the Board of Directors. The terms upon which, the time or times, which may be limited or unlimited in duration, at or within which, and the price or prices at which any such shares may be purchased from the corporation upon the exercise of any such right or option shall be such as shall be fixed and stated in a resolution or resolutions adopted by the Board of Directors providing for the creation and issue of such rights or options, and set forth or incorporated by reference in the instrument or instruments evidencing such rights or options.\nTenth: The number of Directors which shall constitute the whole Board shall be such from time to time as shall be fixed by the by-laws, but in no case shall the Board be less than three (3). In case of any increase in the number of Directors, such additional Directors shall be chosen by the Directors or stockholders at the time entitled to vote, as may be prescribed in the by-laws of this corporation. Directors need not be stockholders. This corporation may in its by-laws confer powers upon its directors in addition to those conferred in this certificate of incorporation and in addition to the powers and authorities expressly conferred upon them by statute.\nEleventh: The corporation shall be entitled to treat the person in whose name any share is registered as the owner thereof for all purposes, and shall not be bound to recognize any equitable or other claim to or interest in such share on the part of any other person, whether or not the corporation shall have notice thereof, save as expressly provided by the laws of the State of Delaware.\nTwelfth: Both stockholders and directors shall have power, if the by-laws so provide, to hold their meetings and to have one or more offices within or without the State of Delaware and to keep the books of this corporation (subject to the provisions of the General Corporation Law of said State) outside the State of Delaware, at such places as may be from time to time designated by the Board of Directors.\nThirteenth: All the powers of this corporation in so far as the same may be lawfully vested by this certificate of incorporation in the Board of Directors, are hereby conferred upon the Board of Directors of this corporation, provided, however, that by resolution of the Board of Directors adopted either by a quorum disinterested in the subject matter of the resolution or interested therein, as the case may be, any matter concerning the management of the corporation or its affairs may be referred to the stockholders of the corporation for decision and in such cases such matters may be authorized by vote adopted by the majority of a quorum of the stockholders entitled to vote at a meeting thereof duly held. Fourteenth: A Director of the corporation shall not in the absence of fraud be disqualified by his office from dealing or contracting with the corporation either as a vendor, purchaser or otherwise, nor in the absence of fraud shall any transaction or contract of the corporation be void or voidable or affected by reason of the fact that any director, or any firm of which any director is a member, or any corporation or association of which any director is an officer, director or stockholder, is in any way interested in such transaction or contract; provided that at the meeting of the Board of Directors or of a committee thereof having authority in the premises, authorizing or confirming said contract or transaction, the existence of an interest of such director, firm, corporation or association is disclosed or made known (or shall have been disclosed and spread upon the records at a previous meeting at which a quorum was present) and there shall be present a quorum of the Board of Directors or of the directors constituting such committee, and such contract or transaction shall be approved by a majority of such quorum, which majority shall consist of directors not so interested or connected. Nor shall any director be liable to account to the corporation for any profit realized by him from or through any such transaction or contract of the corporation ratified or approved as aforesaid, by reason of the fact that he or any firm of which he is a member, or any corporation or association of which he is an officer, director or stockholder, was interested in such transaction or contract. Anything herein contained to the contrary notwithstanding, all or any of the Directors of the corporation, in connection with the organization of this corporation and the issuance of its stock for cash and\/or properties, may vote to approve and authorize Plans and Agreements for the acquisition by this corporation, through the issuance of its own stock in exchange therefor, of stock in banks and\/or trust companies of which said Directors, or any of them, may be stockholders, directors, or officers, and to approve and authorize an underwriting agreement or agreements for the sale of stock of this corporation, in which they or any of them may be interested, with the same force and effect as though not so interested. Directors so interested may be counted when present at meetings of the Board of Directors or of such committee for the purpose of determining the existence of a quorum. Any contract, transaction or act of the corporation or of the Board of Directors or of any committee thereof (whether or not approved or ratified as hereinabove provided) which shall be ratified by a majority in interest of a quorum of the stockholders entitled to vote at any annual meeting or any special meeting called for such purpose or approved in writing by a majority in interest of the stockholders entitled to vote without a meeting, shall be as valid and as binding as though ratified by every stockholder of the corporation.\nFifteenth: To the fullest extent that the General Corporation Law of the State of Delaware, as the same exists or may hereafter be amended, permits, elimination or limitation of the liability of directors, no director of the corporation shall be liable to the corporation or its shareholders for monetary damages for breach of his fiduciary duty as a director. Any repeal or modification of this Article by the shareholders of the corporation shall be prospective only and shall not adversely affect any limitation on the personal liability of a director of the corporation for acts or omissions occurring prior to the effective date of such repeal or modification.\nSixteenth: This corporation reserves the right to amend, alter, change or repeal any provision contained in this certificate of incorporation in the manner now or hereafter prescribed by statute, and all rights conferred on officers, directors and stockholders herein are granted subject to this reservation.\nIN WITNESS WHEREOF, said HSBC Americas, Inc., has caused this certificate to be signed by James H. Cleave, its President, and attested by Philip S. Toohey, its secretary this 17th day of August, 1995.\nHSBC AMERICAS, INC.\nBy \/s\/ James H. Cleave President (SEAL)\nATTEST:\nBy \/s\/ Philip S. Toohey Secretary\nIDwt 218307.01\n(Restated as amended as of February 29, 1996)\nBY-LAWS\nof\nHSBC AMERICAS, INC.\nARTICLE I\nSHAREHOLDERS' MEETINGS\nSection 1.1 Annual Meeting. The Annual Meeting of the shareholders for the election of directors and the transaction of such other business as may properly come before the meeting, shall be held in April each year at the Office of the Corporation, One Marine Midland Center, City of Buffalo, State of New York, or at such other place and at such time and on such day as may be designated from time to time by the Board of Directors.\nSection 1.2 Special Meeting. Except as otherwise specifically provided by statute, special meetings of the shareholders may be called for any purpose at any time by the Board, the Chairman of the Board, the President, the Chief Executive Officer or the Secretary. Business transacted at all special meetings of shareholders shall be confined to the purposes stated in the Notice of Meeting.\nSection 1.3 Quorum. The holders of a majority of the stock issued and outstanding, and entitled to vote thereat, present in person or represented by proxy, shall constitute a quorum at all meetings of shareholders unless otherwise provided by law.\nSection 1.4 Voting. At any meeting of the shareholders each shareholder may vote in person or by proxy duly authorized in writing. Each shareholder shall at every meeting of shareholders be entitled to one vote for each share of stock held by such shareholder. A majority of the votes cast shall decide every question or matter submitted to the shareholders at any meeting, unless otherwise provided by law or by the Certificate of Incorporation.\nAny action required to be taken at an annual or special meeting of shareholders may be taken without a meeting by written consent setting forth the action and signed by the holders of outstanding shares having not less than the minimum number of shares necessary to authorize or to take such action at a meeting at which all shares entitled to vote thereon were present and voted.\nSection 1.5 Notice of Meeting. Written notice of each meeting of shareholders stating the place, date, and hour of the meeting, and, in the case of a special meeting, the purpose or purposes for which the meeting is called, shall be delivered personally or shall be mailed postage prepaid to each shareholder entitled to vote at such meeting, directed to the shareholder at his address as it appears on the records of the Corporation, not less than ten days before the date of the meeting.\nARTICLE II\nDIRECTORS\nSection 2.1 Board of Directors. The Board of Directors (hereinafter referred to as the \"Board\"), shall have the power to manage and administer the business and affairs of the Corporation, and, except as expressly limited by law, all corporate powers of the Corporation shall be vested in an may be exercised by said Board unless such powers are required by statute, by the Certificate of Incorporation, or by these By-laws to be done by the shareholders.\nSection 2.2 Number and Term. The Board shall consist of not less than three nor more than twenty-five directors, the exact number within such minimum and maximum limits to be fixed and determined from time to time by resolution of a majority of the full Board or by resolution of the shareholders at any meeting of shareholders. Unless sooner removed or disqualified, each director shall hold office until the next annual meeting of the shareholders and until his successor has been elected and qualified.\nSection 2.3 Organization Meeting. At its first meeting after each annual meeting of shareholders, the Board shall choose a Chairman of the Board, a President and a Chief Executive Officer from its own members and otherwise organize the new Board and appoint officers of the Corporation for the succeeding year.\nSection 2.4 Chairman of the Board. The Chairman of the Board shall preside at all meetings of the Board and of shareholders and perform such duties as shall be assigned to him from time to time by the Board. Except as may be otherwise provided by the By-Laws or the Board, he shall be a member ex officio of all committees authorized by these By-Laws or the Board. He shall be kept informed by the executive officers about the affairs of the Corporation.\nSection 2.5 Regular Meetings. The Regular Meetings of the Board shall be held at such time and place as designated by the Board. No notice of a Regular Meeting shall be required if the meeting is held according to a Schedule of Regular Meetings approved by the Board.\nSection 2.6 Special Meetings. Special meetings of the Board may be called by the Chairman of the Board, the President, the Chief Executive Officer or the Secretary or at the written request of any three or more directors. Each member of the Board shall be given notice stating the time and place of each such special meeting by telegram, telephone, or similar electronic means, or in person, at lease one day prior to such meeting, or by mail at least three days prior.\nSection 2.7 Quorum. Three directors shall constitute a quorum at any meeting, except when otherwise provided by law. If a quorum is not present at any meeting, the directors present may adjourn the meeting, and the meeting may be held, as adjourned, without further notice provided that a quorum is then present. The act of a majority of the directors present at any meeting at which there is a quorum, shall be the act the Board, unless otherwise specifically provided by statute, by the Certificate of Incorporation, or by these By-laws.\nSection 2.8 Vacancies. When any vacancy occurs among the directors, the remaining members of the Board may appoint a director to fill each such vacancy at any regular meeting of the Board, or at a special meeting called for that purpose. Any director so appointed shall hold office until the next annual meeting or the shareholders and until his successor has been elected and qualified, unless sooner displaced.\nSection 2.9 Removal of Directors. Any director may be removed either with or without cause, at any time, by a vote of the holders of a majority of the shares of the Corporation at any meeting of shareholders called for that purpose. A director may be removed for cause by a vote of a majority of the full Board.\nSection 2.10 Compensation of Directors. The Board shall fix the amounts to be paid directors for their services as directors and for their attendance at the meetings of the Board or of committees or otherwise. No director who receives a salary from the Corporation shall receive any fee for attending meetings of the Board or of any of its committees.\nSection 2.11 Action of the Board. Except as otherwise provided by law, corporate action to be taken by the Board shall mean such action at a meeting of the Board. Any action required or permitted to be taken by the Board or any committee of the Board may be taken without a meeting if all members of the Board or the committee consent in writing to a resolution authorizing the action. The resolution and the written consents thereto shall be filed with the minutes of the proceedings of the Board or committee. Any one or more members of the Board or any committee may participate in a meeting of the Board or committee 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.\nSection 2.12 Waiver of Notice. Notice of the Meeting need not be given to any director who submits a signed Waiver of Notice whether before or after the meeting, or who attends the meeting without protesting, prior thereto or at its commencement, a lack of such notice.\nARTICLE III\nCOMMITTEES OF THE BOARD\nSection 3.1 Committees. The Board, by a resolution or resolutions adopted by a majority of the members of the whole Board, may appoint an Executive Committee, an Audit Committee, and any other committees as it may deem appropriate. Each committee shall have and may exercise any and all powers as are conferred or authorized by the resolution appointing it. A majority of each committee may determine its action and may fix the time and place of its meetings, unless provided otherwise by the Board. The Board shall have the power at any time to fill vacancies in, to change the size of membership of, and to discharge any committee.\nARTICLE IV\nOFFICERS\nSection 4.1 President. The Board shall appoint one of its members to be President. In the absence of the Chairman of the Board, the President shall preside at all meetings of the Board and of shareholders. Except as may be otherwise provided by the By-Laws or the Board, he shall be a member ex officio of all committees authorized by these By-Laws or the Board. The President shall have general executive powers, shall participate actively in all major policy decisions and shall have and may exercise any and all other powers and duties pertaining by law, regulation, or practice, to the Office of President, or imposed by these By-Laws. The President shall also have and may exercise such further powers and duties as from time to time may be conferred, or assigned by the Board or the Chief Executive Officer.\nSection 4.2 Chief Executive Officer. The Board shall appoint one of its members to be Chief Executive Officer of the Corporation. The Chairman of the Board or the President may at the same time be appointed Chief Executive Officer. The Chief Executive Officer shall exercise general supervision over the policies and business affairs of the Corporation and the carrying out of the policies adopted or approved by the Board. Except as otherwise provided by these By-Laws, he shall have power to determine the duties to be performed by the officers appointed as provided in Section 4.5 of these By-Laws, and to employ and discharge officers and employees. Except as otherwise provided by the By-Laws or the Board, he shall be a member ex officio of all committees authorized by these By-Laws or created by the Board. In the absence of the Chairman of the Board and the President, he shall preside at all meetings of the Board and of shareholders.\nSection 4.3 Executive and Other Senior Officers. The Board shall by resolution determine from time to time those officers whose appointment shall require approval by the Board or a committee of the Board. Each such officer shall have such powers and duties as may be assigned by the Board, a committee of the Board, the President or the Chief Executive Officer.\nSection 4.4 Secretary. The Board shall appoint a Secretary who shall be the Secretary of the Board and of the Corporation and shall keep accurate minutes of all the meetings of shareholders and of the Board. The Secretary shall attend to the giving of all notices required to be given by these By- Laws; shall be custodian of the corporate seal, records, documents, and papers of the Corporation; shall provide for the keeping of proper records of all transactions of the Corporation; shall have and may exercise any and all other powers and duties pertaining by law, regulation or practice, to the Office of Secretary, or imposed by these By-Laws; and shall also perform such other duties as may be assigned from time to time by the Board, the President or the Chief Executive Officer.\nSection 4.5 Other Officers. The President or the Chief Executive Officer or his designee may appoint all officers whose appointment does not require approval by the Board or a committee of the Board, and assign to them such titles, as from time to time may appear to be required or desirable to transact the business of the Corporation. Each such officer shall have such powers and duties as may be assigned by the Board, the President or the Chief Executive Officer.\nSection 4.6 Tenure of Office. The Chairman of the Board, the President and the Chief Executive Officer shall hold office for the current year for which the Board was elected, unless they shall resign, become disqualified, or be removed. All other officers shall hold office until their successors have been appointed and qualify unless they shall resign, become disqualified or be removed. The Board shall have the power to remove the Chairman of the Board, the President and the Chief Executive Officer. The Board or the Chief Executive Officer or his designee shall have the power to remove all other officers and employees. Any vacancy occurring in the offices of Chairman of the Board, President or Chief Executive Officer shall be filled promptly by the Board.\nSection 4.7 Compensation. The Board shall by resolution determine from time to time the officers whose compensation will require approval by the Board or a committee of the Board. The Chief Executive Officer shall fix the compensation of all officers and employees whose compensation does not require approval by the Board.\nARTICLE V\nSTOCK AND STOCK CERTIFICATES\nSection 5.1 Transfers. Shares of stock shall be transferable on the books of the Corporation only by the person named in the certificate or by an attorney, lawfully constituted in writing, and upon surrender of the certificate therefor. Every person becoming a shareholder by such transfer shall, in proportion to his shares, succeed to all rights of the prior holder of such shares.\nSection 5.2 Stock Certificates. The certificates of stock of the Corporation shall be numbered and shall be entered in the books of the Corporation as they are issued. They shall exhibit the holder's name and number of shares and shall be signed by the Chairman of the Board, the President, the Chief Executive Officer, a Vice President or any other officer appointed by the Board for this purpose, and the Secretary or an Assistant Secretary.\nARTICLE VI\nCORPORATE SEAL\nSection 6.1 Corporate Seal. The Chairman of the Board, the President the Chief Executive Officer, the Secretary, any Assistant Secretary, Vice President, Assistant Vice President, or other officer thereunto designated by the Board or the Chief Executive Officer or his designee, shall have authority to affix the corporate seal to any document requiring such seal, and to attest the same. Such seal shall be substantially in the following form:\n(impression ) ( of ) ( Seal )\nARTICLE VII\nMISCELLANEOUS PROVISIONS\nSection 7.1 Fiscal Year. The Fiscal Year of the Corporation shall be the calendar year.\nSection 7.2 Execution of Instruments. All agreements, indentures, mortgages, deeds, conveyances, transfers, certificates, declarations, receipts, discharges, releases, satisfactions, settlements, petitions, schedules, accounts, affidavits, bonds, undertakings, proxies and other instruments or documents may be signed, executed, acknowledged, verified, delivered or accepted on behalf of the Corporation by the Chairman of the Board, or the President, or the Chief Executive Officer, or the Secretary, or any Vice President, or any other officer or employee designated by the Board or the Chief Executive Officer of his designee. Any such instruments may also be executed, acknowledged, verified, delivered or accepted in behalf of the Corporation in such other manner and by such other officers as the Board may from time to time direct. The provisions of this Section 7.2 are supplementary to any other provisions of these By- Laws. Each of the foregoing authorizations shall be at the pleasure of the Board, and each such authorization by the Chief Executive Officer or his designee also shall be at the pleasure of the Chief Executive Officer.\nSection 7.3 Records. The By-Laws and the proceedings of all meeting of the shareholders, the Board, and standing committees of the Board, shall be recorded in appropriate minute books provided for the purpose. The minutes of each meeting shall be signed by the Secretary or other officer appointed to act as Secretary of the meeting.\nSection 7.4 Emergency Operations. In the event of war or warlike damage or disaster of sufficient severity to prevent the conduct and management of the affairs, business, and property of the Corporation by its directors and officers as contemplated by these By-Laws, any two or more available members of the then incumbent Board shall constitute a quorum for the full conduct and management of the affairs, business, and property of the Corporation. This By-Law shall be subject to implementation by resolutions of the Board passed from time to time for that purpose, and any provisions of these By-Laws (other than this Section) and any resolutions which are contrary to the provisions of this Section or to the provisions of any such implementary resolutions shall be suspended until it shall be determined by any interim Board acting under this Section that it shall be to the advantage of the Corporation to resume the conduct and management of its affairs, business, and property under all of the other provisions of these By-Laws.\nSection 7.5 (a) Right to Indemnification. Each person who was or is made a party or is threatened to be made a party to or is otherwise involved in any action, suit or proceeding, whether civil, criminal, administrative or investigative, by reason of the fact that he is or was a director or officer of the Corporation or, while a director or officer of the Corporation is or was serving at the request of the Corporation as a director, officer, employee or agent of another corporation or of a partnership, joint venture, trust or other enterprise, including service with respect to an employee benefit plan (an \"Indemnitee\"), whether the basis of such proceeding is alleged action in an official capacity as a director, officer, employee or agent or in any other capacity while serving as a director or officer, shall be indemnified and held harmless by the Corporation to the fullest extent authorized by the Delaware General Corporation Law, as the same exists or may hereafter be amended, against all expense, liability and loss (including attorneys' fees, judgments, fines, ERISA excise taxes or penalties and amounts paid in settlement) reasonably incurred or suffered by such Indemnitee in connection therewith and such indemnification shall continue as to an Indemnitee who has ceased to be a director or officer and shall inure to the benefit of the Indemnitee's heirs, executors and administrators; provided, however, that, except as provided in Section 7.5(b) hereof with respect to proceedings to enforce rights to indemnification, the Corporation shall indemnify any such Indemnitee in connection with a proceeding (or party thereof) initiated by such Indemnitee only if such proceeding (or part thereof) was authorized by the Board. The right to indemnification conferred in this Section 7.5 shall be a contract right and shall include the right to be paid by the Corporation the expenses incurred in defending any such proceeding in advance of its final disposition; provided, however, that, if the Delaware General Corporation Law so requires, an advancement of expenses incurred by an Indemnitee shall be made only upon delivery to the Corporation of an undertaking, by or on behalf of such Indemnitee, to repay all amounts so advanced if it shall ultimately be determined by final judicial decision from which there is no further right to appeal that such Indemnitee is not entitled to be indemnified for such expenses under this Section or otherwise.\n(b) Right of Indemnitee to Bring Suit. If a claim under paragraph (a) of this Section 7.5 is not paid in full by the Corporation within sixty days after a written claim has been received by the Corporation, except in the case of a claim for an advancement of expenses, in which case the applicable period shall be twenty days, the Indemnitee may at any time thereafter bring suit against the Corporation to recover the unpaid amount of the claim. If successful in whole or in part in any such suit, or in a suit brought by the Corporation to recover an advancement of expenses pursuant to the terms of such Indemnittee's undertaking the Indemnitee shall be entitled to be paid the expense of prosecuting or defending such suit. In any suit brought by the Indemnitee to enforce a right to indemnification hereunder it shall be a defense that, and in any suit by the Corporation to recover an advancement of expenses pursuant to the terms of an undertaking the Corporation shall be entitled to recover such expenses upon a final adjudication that, the Indemnitee has not met the applicable standard of conduct set forth in the Delaware General Corporation Law. Neither the failure of the Corporation to have made a determination prior to the commencement of such suit that indemnification of the Indemnitee is proper in the circumstances because the Indemnitee has met the applicable standard of conduct set forth in the Delaware General Corporation Law, nor an actual determination by the Corporation that the Indemnitee has not met such applicable standard of conduct, shall create a presumption that the Indemnitee has not met the applicable standard of conduct or, in the case of such a suit brought by the Indemnitee, be a defense to such suit. In any suit brought by the Indemnitee to enforce a right to indemnification or to an advancement of expenses hereunder, or by the Corporation to recover an advancement of expenses pursuant to the terms of an undertaking by the Indemnitee, the Corporation shall have the burden of proving that the Indemnitee is not entitled to be indemnified, or to such advancement of expenses, under this Section 7.5 or otherwise.\n(c) Non-Exclusivity of Rights. The rights to indemnification and to the advancement of expenses conferred in this Section 7.5 shall not be exclusive of any other right which any person may have or hereafter acquire under any statute, the Corporation's Certificate of Incorporation, By-Law, agreement, vote of shareholders or disinterested directors or otherwise.\n(d) Indemnification of Employees and Agents of the Corporation. The Corporation may, to the extent authorized from time to time by the Board, grant rights to indemnification, and to the advancement of expenses to any employee or agent of the Corporation to the fullest extent of the provisions of this Section 7.5 with respect to the indemnification and advancement of expenses of directors and officers of the Corporation.\n(e) Insurance. The Corporation may maintain insurance, at its expense, to protect itself and any director, officer, employee or agent of the Corporation or another corporation, partnership, joint venture, trust or other enterprise against any expense, liability or loss, whether or not the Corporation would have the power to indemnify such person against such expense, liability or loss under the Delaware General Corporation Law, as the same exists or may hereafter be amended.\nSection 7.6 Amendments. The By-Laws may be added to, amended, altered or repealed at any regular meeting of the Board, by a vote of a majority of the total number of the directors, or at any meeting of shareholders, duly called and held, by a majority of the stock represented at such meeting.\nI, Gea Tung, CERTIFY that: (1) I am the duly constituted Assistant Secretary of HSBC Americas, Inc. and as such officer have access to its official records; (2) the foregoing By-Laws are the By-Laws of said Corporation, and all of them are now lawfully in force and effect.\nIN TESTIMONY WHEREOF, I have hereunto affixed my official signature and the seal of the said Corporation, in the city of Buffalo, New York, on this 22nd day of March, 1996.\n\/s\/ Gea Tung\ndl\/HAIBYLAW.mis","section_15":""}
{"filename":"32379_1995.txt","cik":"32379","year":"1995","section_1":"ITEM 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 1995.\nSERVICE AREA AND CUSTOMERS\nAt December 31, 1995 Elizabethtown and Mount Holly furnished water service on a retail basis to general customers and to industrial customers served through 195,375 meters in 54 municipalities in the counties of Union, Middlesex, Somerset, Mercer, Hunterdon, Ocean, Morris and Burlington in the central part of New Jersey. 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, 1995 are as follows:\nGeneral customers 62.2% Sales to other systems 17.3% Larger industrial customers 7.3% Fire protection service\/miscellaneous 13.2%\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 1995, Elizabethtown's pumpage averaged 132.5 million gallons per day (MGD) and Mount Holly's pumpage averaged 3.6 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 1995, surface water sources supplied approximately 88% of Elizabethtown's supply with wells supplying the remaining 12%. 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) 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. The NJWSA has available and, as needed to meet system demand, Elizabethtown purchases, water over and above the Company's 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 3.6 MGD in 1995 was supplied from wells. To ensure an adequate supply of quality water\nfrom 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. Mount Holly has a 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 the water and pump it into the Mount Holly system. This is referred to as the Mansfield Project. The project is currently estimated to cost $16.5 million excluding an Allowance for Funds Used During Construction (AFUDC). Construction is expected to begin after issuance of the final water allocation diversion permit and is expected to be completed in 1997. The land for the supply and treatment facilities has been purchased and wells have been drilled and can produce the required supply. Mount Holly has filed for rate relief relating to the Mansfield Project.\nOn October 5, 1995, the New Jersey Department of Environmental Protection (NJDEP) granted Mount Holly a water allocation diversion permit for four wells that are to be the water supply for the Mansfield Project. On October 20, 1995, New Jersey-American Water Company requested, and was subsequently granted, an adjudicatory hearing on the permit. The Company and Mount Holly believe that the permit in question will be upheld but cannot predict the outcome of the objection. In the event that the objection is successful and the permit is rescinded Mount Holly would utilize the alternative plan of purchasing water from New Jersey-American Water Company.\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, in all material respects, 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. 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\nand 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 88% in 1995. 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 $83.0 million, excluding AFUDC of $7.2 million, on the Plant as of December 31, 1995. The project is proceeding on schedule, the construction contract remains on budget and the project is expected to be completed during the third quarter of 1996.\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. 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 also provides for a potential rate setting mechanism for the Plant during the construction period that has never been required to be triggered.\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 set 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 projects including corrosion inhibitor facilities for Elizabethtown will be completed later in 1996. Elizabethtown has requested that the costs of compliance be recovered in rates in the Company's pending rate proceeding.\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\nthe 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 is replacing existing chlorine gas disinfection facilities with liquid sodium hypochlorite to improve community and employee safety and will install corrosion inhibitor facilities in conformance with the LCR.\nTRANSMISSION AND DISTRIBUTION\nAs of December 31, 1995, Elizabethtown Water Company's transmission and distribution system included 2,869 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 $1.0 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, 1995, 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, 1995 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 and initiates plans to construct pumping, transmission and storage facilities as needed.\nENERGY SUPPLY\nElizabethtown pumps most of its water with electric power purchased from two major electric utilities. The Company is replacing certain electric pumps with natural gas fired pumps to reduce energy costs. 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\nduring 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 residuals 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 had disposed of this material in landfills. As a result of revised regulations governing landfills, Elizabethtown has been reusing this material on site and is presently removing some material off-site for beneficial reuse. Due to limited on-site storage capacity, Elizabethtown is investigating alternatives to dry the by-product for beneficial reuse.\nDuring the late 1980's, Elizabethtown withdrew a well field from service because of increased groundwater contamination and more stringent water quality regulations. 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 necessary 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 has been able to construct all plant facilities and obtain all diversion authorizations necessary to maintain customer service. Mount Holly has also been able to construct all facilities and obtain all diversion authorizations with the exception of the pending objection to the diversion permit for the Mansfield Project as discussed above.\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, 1995, the Corporation had a total of 398 full-time employees, of which 210 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, 1996 and will expire on January 31, 1999.\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 New Jersey Board of Public Utilities (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.\nElizabethtown\nOn November 20, 1995, Elizabethtown filed with the BPU for an increase in rates of $31.6 million, or 29.6%. The largest portion of the request, $22.9 million, is needed to cover the cost to finance and operate the Plant. The remainder of the rate increase, $8.7 million, is needed to cover the cost to finance additional construction projects and to cover increases in operating expenses since rates were last established in February 1995. A decision by the BPU is expected in the summer of 1996. In light of the approval by the BPU of the 1993 Plant Stipulation and Elizabethtown's experience in obtaining base rate relief, Elizabethtown expects the BPU to grant timely and adequate rate relief, 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 pre-tax interest coverage ratio has remained above the 2.0 times trigger level and therefore, the surcharge has not been required. The 1993 Plant Stipulation also provides that the rate of return on common shareholder'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 shareholder's equity established in the Company's most recent base\nrate case. The authorized rate of return on common shareholder's equity is currently 11.5%.\nIn January 1995, the BPU approved a stipulation (1995 Stipulation) for Elizabethtown for a rate increase of $5.3 million 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 1994 current service cost portion of the obligation accrued under Statement of Financial Accounting Standards No. 106, \"Employer's Accounting for Postretirement Benefits Other Than Pensions,\" provided this amount is funded by the Company. Elizabethtown funded $.3 million in 1995 which represents the 1994 current service cost allowed in the 1995 Stipulation. The rate increase covered the cost to finance $62.0 million of construction projects since rates were last established in March 1993. These projects include treatment, transmission and storage facilities needed to ensure that Elizabethtown continues to meet federal and state regulations water quality and service. The increase also offset increased costs for power, labor and benefits, primarily medical. The 1995 Stipulations also provides for an increase in annual depreciation expense of approximately $.5 million. The 1995 Stipulation also required Elizabethtown to maintain a monthly average percentage of common equity to total capitalization of at least 45.1% for the 12 months ended January 31, 1996. The Company has met this requirement.\nMount Holly\nOn June 26, 1995, Mount Holly petitioned the BPU for an increase in rates, to take place in two phases. In the first phase rates would be increased by $.9 million and in the second phase by $2.8 million. The first phase is necessary to cover costs that were not reflected in rates last increased in October 1986. The second phase would cover the cost of the Mansfield Project as discussed above.\nOn January 24, 1996, the BPU approved a stipulation (Mount Holly Stipulation) for an increase in rates of $.6 million effective as of that date. The Mount Holly Stipulation has, effectively, concluded the first phase of the rate proceeding. Mount Holly is continuing with the adjudicatory process with respect to the second phase of the petition. While management believes that the water supply, treatment and transmission project planned for Mount Holly is the most cost-effective response to the state legislation affecting the area, management cannot predict the ultimate outcome of the rate proceeding at this time.\nFor information regarding additional rate matters see Note 8 to the Notes to Consolidated Financial Statements contained in Appendix I.\nREAL ESTATE MATTERS\nProperties and E'town currently own several parcels of land aggregating approximately 740 acres located in central New Jersey\nhaving an original acquisition cost of approximately $8 million. A portion 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.\nProperties has entered into an agreement to sell a parcel of land to a developer. The agreement requires the buyer to obtain all approvals required by governmental agencies in order to develop the property. Properties may cancel the agreement if the closing does not occur by December 31, 1996. Other events have been established during this period, at which time either the buyer or Properties may cancel the agreement if certain criteria, generally relating to the development potential of the property, are not met.\nExecutive Officers of the Corporation and Elizabethtown\nName Age Positions Held\nRobert W. Kean, Jr. 73 Chairman and Chief Executive Officer of the Corporation since 1985 and Elizabethtown since 1973.\nHenry S. Patterson, II 73 President of the Corporation since March 1985 and Properties since July 1987.\nThomas J. Cawley 65 Vice Chairman of Elizabethtown since January 1996 and 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 40 Chief Financial Officer of the Corporation since August 1989 and Treasurer of the Corporation since November 1990. President of Elizabethtown since January 1996 and Executive Vice President of Elizabethtown from May 1994 to December 1995. He served as Senior Vice President of Elizabethtown from April 1993 to May 1994, Chief Financial Officer of Elizabethtown from November 1990 to December 1995 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 51 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 46 Secretary of the Corporation, Properties and Elizabethtown since December 1990 and Vice President and General Counsel of Elizabethtown since August 1988. Previously, Assistant Secretary and General Attorney of Elizabethtown since May 1983.\nNorbert Wagner 60 Senior Vice President-Operations of Elizabethtown since May 1992. Vice President-Operations since March 1987, Chief Engineer since October 1978.\nEdward F. Cash 60 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 previously reported, several lawsuits had been filed against Elizabethtown and other parties in connection with a fire that occurred in a storage facility in 1989 resulting in damage to property stored at that facility. This matter was settled in 1995 resulting in a payment by Elizabethtown of approximately $.1 million. A provision for this estimated liability was previously recorded.\nIn the opinion of management, other litigation in which the Corporation or its subsidiaries is involved is in the ordinary course of business and will not have a material adverse effect on the consolidated financial condition of the Corporation.\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\n________________________________ E'town Corporation\n__________________\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), presently constitute the major portion of E'town Corporation's (E'town or Corporation) assets and earnings. Mount Holly contributed 3% of Elizabethtown Water Company's consolidated operating revenues for 1995. 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, 1995 and 1994, and the results of operations for the years ended December 31, 1995, 1994 and 1993 for Elizabethtown Water Company.\nLIQUIDITY AND CAPITAL RESOURCES Capital Expenditures Program\nCapital expenditures were $73.8 million during 1995. Capital expenditures for the three-year period ending December 31, 1998, are estimated to be $148.9 million, of which $128.4 million is for Elizabethtown and $20.5 million for Mount Holly. A major portion of the capital outlays will occur in the first nine months of the three-year period as Elizabethtown completes its new water treatment plant. After this project is completed in late 1996, the capital outlays for Elizabethtown are expected to return to levels experienced in the early 1990s. Mount Holly expects to incur significant capital expenditures in 1997 as it constructs new water supply, treatment and transmission facilities as discussed below.\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 (mgd) and has been designed to permit expansion to 200 mgd, 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 groundwater contamination. Expansion of the Plant's production capacity beyond 40 mgd is not expected to occur in the foreseeable future. Elizabethtown's construction program also includes additional mains\nand 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 estimated cost of the Plant is approximately $100 million, excluding an Allowance for Funds Used During Construction (AFUDC). The Company has expended $83.0 million, excluding AFUDC of $7.2 million on the Plant, as of December 31, 1995. The project is proceeding on schedule, the construction contract remains on budget and the project is expected to be completed during the third quarter of 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 the Company's estimate regarding the Plant's cost, at that time $87 million and construction period are reasonable. In April 1994, Elizabethtow-n notified all parties to the 1993 Plant Stipulation that the estimated cost of the Plant had increased.\nThe 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 pre-tax interest coverage has remained above the 2.0 times trigger level and therefore, the surcharge has not been required. The 1993 Plant Stipulation also provides that the rate of return on common shareholder'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 shareholder's equity established in Elizabethtown's most recent base rate case. The authorized rate of return on Elizabethtown's common shareholder's equity is currently 11.5%. Elizabethtown has filed for a rate increase to reflect the financing and operating costs of the Plant which is expected to take effect when the Plant is completed later this year (see Economic Outlook).\nMount Holly\nTo ensure an adequate supply of quality water from an aquifer serving parts of southern New Jersey, state legislation requires 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 approval from the New Jersey Department of Environmental Protection (NJDEP) for its 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 the water and pump it into the Mount Holly system. This is referred to as the Mansfield Project. The project is currently estimated to cost $16.5 million, excluding AFUDC, and is expected to be completed in 1997. The land for the supply and treatment facilities has been purchased and wells have been drilled and can produce the required supply. Mount Holly has filed for rate relief relating to the Mansfield Project (see Economic Outlook).\nOn October 5, 1995, the NJDEP granted Mount Holly a water allocation diversion permit for four wells that are to be the water supply for the Mansfield Project. On October 20, 1995, New Jersey-American Water Company requested, and was subsequently granted, an adjudicatory hearing on the permit. The Company and Mount Holly believe that the permit in question will be upheld but cannot predict the outcome of the objection. In the event that the objection is successful and the permit is rescinded, Mount Holly would utilize the alternative plan of purchasing water from New Jersey-American Water Company.\nCAPITAL RESOURCES\nDuring 1995, Elizabethtown, including Mount Holly, financed 8.4% 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), tax exempt bonds issued through the New Jersey Economic Development Authority (NJEDA) and short-term borrowings under a revolving credit agreement discussed below.\nFor the three-year period ending December 31, 1998, Elizabethtown, including Mount Holly, estimates 34% of its capital expenditures will be financed with internally generated funds (after payment of common stock dividends). The balance will be financed with a combination of capital contributions from the proceeds from the sale of E'town common stock, long-term debentures, proceeds of tax-exempt NJEDA bonds, short-term borrowings under the revolving credit agreement and other short-term financing. -The NJEDA has granted preliminary approval for the financing of almost all of Elizabethtown's and Mount Holly'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 & Poor's, respectively.\nIn June 1995, E'town issued 660,000 shares of common stock for net proceeds of $16.9 million which were used to fund an equity contribution to Elizabethtown. The equity contribution has been used to repay short-term debt that had been issued under Elizabethtown's revolving credit agreement to partially fund the Company's capital program, the predominant portion of which relates to the construction of the Plant. During 1995, 248,846 shares of common stock were issued for proceeds of $6.4 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.\nIn December 1995, Elizabethtown issued $40.0 million of 5.60% tax-exempt Debentures through the NJEDA. The proceeds of the issue\nwere used to repay amounts outstanding under Elizabethtown's revolving credit agreement.\nDuring 1995, Elizabethtown obtained a portion of funds required for its capital program through borrowings under its revolving credit agreement (Agreement) with an agent bank and five additional banks. The Agreement provides up to $60.0 million in revolving short-term financing, which together with internal funds, other short-term financing, proceeds of future issuances 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 1998. The Agreement allows Elizabethtown to borrow, repay and reborrow up to $60.0 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 percentage 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, 1995, the percentage o-f Elizabethtown's common and preferred equi-ty to total capitalization, calculated in accordance with the Agreement, was 47%. For the 12 months ended December 31, 1995, Elizabethtown's pre-tax interest coverage ratio, calculated in accordance with the Agreement, was 3.12 to 1. At December 31, 1995, Elizabethtown had borrowings outstanding of $27.0 million under the Agreement at interest rates from 5.75% to 6.00%, at a weighted average rate of 5.94%.\n1994 and 1993\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 had been used to partially fund Elizabethtown's construction program, the predominant portion of which related to the Plant. During 1994, 273,159 shares of common stock were issued for proceeds of $7.1 million under E'town's DRP. The proceeds were used to make capital contributions to Elizabethtown to partially fund its capital program.\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.\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 to fund working capital requirements.\nDuring 1993, 200,878 shares of common stock were issued for proceeds of $6.0 million under E'town's DRP. Such proceeds were used to fund equity contributions to Elizabethtown, primarily for Elizabethtown's capital expenditures.\nIn November 1993, Elizabethtown issued $50.0 million of 7 1\/4% Debentures due November 1, 2028. The proceeds of the issue were used to redeem $30.0 million of the Company's 8 5\/8% Debentures due 2007 and $20.0 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.\nRESULTS OF OPERATIONS\nEarnings Applicable to Common Stock for 1995 were $16.5 million as compared to $13.4 million for 1994. The combined effect of a $5.3 million rate increase in February 1995 (discussed below), increases in AFUDC in 1995 and a non-recurring charge in 1994 all contributed to the increase between 1994 and 1995.\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, the combined effect of a non-recurring charge in 1994, and increases in operating and depreciation expenses since March 1993, when rates were last increased, all contributed to the decrease between 1993 and 1994.\nOperating Revenues increased $6.4 million or 6.2% in 1995. Of this increase, $4.6 million relates to the rate increase, discussed below, effective February 1995. Increased consumption by retail customers and an increase in the number of customers increased revenues by $1.4 million. Revenues from industrial customers resulting from consumption increased $.2 million while revenues from other water systems resulting from consumption decreased $.2 million. Revenues from fire service customers increased $.4 million.\nOperating Revenues increased $2.0 million or 2.0% in 1994. Of this increase, $1.2 million relates to a rate increase discussed below, effective March 1993. Sales to retail customers related to consumption 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 related to consumption increased by $.6 million and $.7 million, respecti-vely. Due to normal growth within the service territory, fire service revenues increased by $.4 million.\nOperation Expenses increased $2.4 million or 5.9% in 1995. The increase is due, primarily, to increased costs for labor, benefits and the cost of purchased water calculated in accordance with a Purchased Water Adjustment Clause (PWAC) (see Note 8 to the Notes to Consolidated Financial Statements.) Benefit costs increased due to increases in the actuarially calculated pension expense and the cost of postemployment benefits, a portion of which is being expensed in\n1995 as it is recognized in rates pursuant to the 1995 Stipulation effective February 1995 (see Economic Outlook).\nOperation Expenses increased $2.2 million or 5.7% in 1994. The increase is due, primarily, to increased costs for labor, benefits, miscellaneous expenses and the unit cost of raw water purchased from the New Jersey Water Supply Authority (NJWSA), which is reflected in the PWAC, 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.\nMaintenance Expenses decreased $.8 million or 12.4% in 1995. The decrease is due, primarily, to the absence in 1995 of the unusually harsh winter weather that occurred in 1994. Also, the results of preventive maintenance programs have contributed to an overall decrease in maintenance expenses.\nMaintenance Expenses increased $.9 million or 15.9% in 1994 due, primarily, 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.\nDepreciation Expense increased $.9 million or 12.1% in 1995 and $.6 million or 7.9% in 1994 due, primarily, to additional depreciable plant being placed in service during those periods. Also, an increase in authorized depreciation rates as a result of the 1995 Stipulation, effective February 1995, accounted for $.4 million of the increase.\nRevenue Taxes increased $.8 million or 6.6% in 1995 and $.2 million or 2.0% in 1994, due to additional taxes on the higher revenues discussed above.\nReal Estate, Payroll and Other Taxes increased $.1 million or 2.0% and $.2 million or 8.1% in 1995 and 1994, respectively, due to increased payroll taxes resulting from labor cost increases.\nFederal Income Taxes increased $.8 million or 11.5% in 1995 and decreased $.5 million or 6.3% in 1994 due to changes in the components of taxable income discussed herein. In addition, in 1995 Elizabethtown received tax refunds related to the years 1984 and 1985 of $.1 million.\nOther Income increased $1.7 million in 1995 due, primarily, to an increase in the equity component of AFUDC of $1.8 million and a non-recurring litigation settlement of $.9 million in 1994 as discussed below. These increases were offset by the federal income taxes associated with the various components.\nOther Income decreased 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.) In addition, increases in the equity component of AFUDC of $.7 million resulted from increased construction expenditures, primarily related to the Plant. Other increases of $.3 million resulted from\nmiscellaneous items. Federal income taxes, as a result of all of the above, decreased less than $.1 million.\nTotal Interest Charges increased $.7 million or 6.8% in 1995 due, primarily, to an increase in interest expense of $2.1 million on increased borrowings under Elizabethtown's revolving credit agreement to finance the Company's ongoing capital program, the largest component of which is the Plant. This amount was offset by an increase in the debt component of AFUDC of $1.6 million, also primarily related to the construction of the Plant. In addition, in 1995 Elizabethtown received interest on tax refunds related to 1984 and 1985 of $.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.\nPreferred Stock Dividends decreased less than $.1 million due to savings from the refinancing of the $8.75 series preferred stock with $5.90 series preferred stock in March 1994.\nECONOMIC OUTLOOK\nEarnings for Elizabethtown and Mount Holly for the next several years will be determined primarily by Elizabethtown's and Mount Holly's ability to obtain adequate and timely rate relief in connection with their additions to utility plant.\nElizabethtown and Subsidiary\nOver the last several years, governmental water quality and service regulations have required Elizabethtown and Mount Holly to make significant investments in water supply, water treatment, transmission and storage facilities, including the Plant and the Mansfield Project, to augment existing facilities. This capital program is requiring regular external financing and rate relief. Currently, Elizabethtown and Mount Holly believe they are in compliance with all water quality standards in all material respects.\nIn November 1995, Elizabethtown filed for a $31.6 million or 29.6% rate increase primarily to cover the financing and operating costs of the Plant. While Mount Holly received a $.6 million or 19.9% rate increase effective January 1996, deliberations regarding the portion of the rate case related to the Mansfield Project, in which Mount Holly is requesting an additional 84.2% rate increase, are ongoing and awaiting the award of the final water diversion permit. Accordingly, the timing and amount of rate increases obtained by Elizabethtown and Mount Holly, in response to the pending rate requests, will be a major factor affecting earnings in 1996 and beyond. 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 levels experienced in the early 1990's. As a result, the need for external\nfinancing and rate relief should become less frequent. Therefore, more so than in recent years, management's ongoing efforts to grow unit sales and control operating cost will benefit the customer by reducing the frequency of rate increases and will benefit shareholders by positively affecting earnings.\nOn November 20, 1995, Elizabethtown filed a petition with the BPU for an increase in rates of $31.6 million, or 29.6%. The largest portion of the request, $22.9 million, is needed to cover the costs to finance and operate the Plant. The remainder of the rate increase, $8.7 million, is needed to cover the cost to finance additional construction projects and to cover increases in operating expenses since rates were last established in February 1995. A decision by the BPU is expected in the summer of 1996. In light of the approval by the BPU of the 1993 Plant Stipulation and Elizabethtown's experience in obtaining base rate relief, Elizabethtown expects the BPU to grant timely and adequate rate relief, but cannot predict the ultimate outcome of any rate proceeding.\nIn January 1995, the BPU approved a stipulation (1995 Stipulation) for Elizabethtown for a rate increase of $5.3 million 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 1994 current service cost portion of the obligation accrued under Statement of Financial Accounting Standards No. 106, \"Employer's Accounting for Postretirement Benefits Other Than Pensions,\" provided this amount is funded by the Company. Elizabethtown funded $.3 million in 1995, which represents the 1994 current service cost allowed in the 1995 Stipulation. The rate increase is covering the cost to finance $62.0 million of construction projects since rates were last established in March 1993. These projects include treatment, transmission and storage facilities needed to ensure that Elizabethtown continues to meet federal and state regulations on water quality and service. The increase is also offsetting increased costs for power, labor and benefits, primarily medical. The 1995 Stipulation also provides for an increase in depreciation rates resulting in an increase in annual depreciation expense of approximately $.5 million. The 1995 Stipulation also required Elizabethtown to maintain a monthly average percentage of common equity to total capitalization of at least 45.1% for the 12 months ended January 31, 1996. The Company has met this requirement.\nOn June 26, 1995, Mount Holly petitioned the BPU for an increase in rates, to take place in two phases. In the first phase rates would be increased by $.9 million and in the second phase by $2.8 million. The first phase is necessary to cover costs that were not reflected in rates last increased in October 1986. The second phase would cover the cost of the Mansfield Project as discussed above. The project is currently estimated to cost $16.5 million. Construction is expected to begin upon final issuance of the water allocation diversion permit from the NJDEP, and the project is expected to be completed in 1997.\nOn January 24, 1996, the BPU approved a stipulation (Mount Holly Stipulation) for an increase in rates of $.6 million effective as of that date. The Mount Holly Stipulation has, effectively, concluded the first phase of the rate proceeding. Mount Holly is continuing with the adjudicatory process with respect to the second phase of the petition. While management believes that the water supply, treatment and transmission project planned for Mount Holly is the most cost-effective response to the state legislation affecting the area, management cannot predict the ultimate outcome of the rate proceeding at this time.\nNew Accounting Pronouncement\nSee Note 2 of the Notes to Consolidated Financial Statements for a discussion of a new accounting standard that will become effective in 1996.\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 19 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 1996 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 1996 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 1996 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 1996 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, 1995, 1994 and 1993.\nConsolidated Balance Sheets as of December 31, 1995 and 1994.\nStatements of Consolidated Capitalization as of December 31, 1995 and 1994.\nStatement of Consolidated Shareholder's Equity for the years ended December 31, 1995, 1994 and 1993.\nStatements of Consolidated Cash Flows for the years ended December 31, 1995, 1994 and 1993.\nNotes to Consolidated Financial Statements.\nE'town Corporation\nA portion of the 1995 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 19 of Appendix I.\nE'town and Elizabethtown Water Company\nThe Independent Auditors' Reports for E'town and Elizabethtown Water Company appear on page 28 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, 1995, 1994 and 1993.\nSupplemental Schedule of Property, Plant and Equipment at December 31, 1995 and 1994.\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, 1996 E'TOWN CORPORATION\nBy: \/s\/ Robert W. Kean, Jr.\n_________________________ 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, 1996.\nChairman, Chief Executive Officer and Director \/s\/ Robert W. Kean, Jr.\n_________________________\nPresident and Director \/s\/ Henry S. Patterson, II\n_________________________\nVice President and Director \/s\/ Anne Evans Estabrook\n_________________________\nChief Financial Officer, Treasurer and Director \/s\/ Andrew M. Chapman\n_________________________ (Principal Financial & Accounting Officer)\nDirector \/s\/ Brendan T. Byrne\n_________________________\nDirector \/s\/ Thomas J. Cawley\n_________________________\nDirector \/s\/ John Kean\n_________________________\nDirector \/s\/ Robert W. Kean III\n_________________________\nDirector \/s\/ Arthur P. Morgan\n_________________________\nDirector \/s\/ Barry T. Parker\n_________________________\nDirector \/s\/ Hugo M. Pfaltz, Jr.\n_________________________\nDirector \/s\/ Chester A. Ring III\n_________________________\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.\nMarch 29, 1996 ELIZABETHTOWN WATER COMPAY\nBy: \/s\/ Robert W. Kean, Jr.\n__________________________ 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, 1996.\nChairman, Chief Executive Officer and Director \/s\/ Robert W. Kean, Jr.\n__________________________\nVice Chairman and Director \/s\/ Thomas J. Cawley\n__________________________\nPresident and Director \/s\/ Andrew M. Chapman\n__________________________\nVice President - Finance & Treasurer \/s\/ Gail P. Brady\n__________________________ (Principal Financial Officer)\nController \/s\/ Dennis W. Doll\n__________________________ (Principal Accounting Officer)\nDirector \/s\/ Brendan T. Byrne\n__________________________\nDirector \/s\/ Anne Evans Estabrook\n__________________________\nDirector \/s\/ John Kean\n__________________________\nDirector \/s\/ Robert W. Kean III\n__________________________\nDirector \/s\/ Arthur P. Morgan\n__________________________\nDirector \/s\/ Barry T. Parker\n__________________________\nDirector \/s\/ Henry S. Patterson, II\n__________________________\nDirector \/s\/ Hugo M. Pfaltz, Jr.\n__________________________\nDirector \/s\/ Chester A. Ring III\n__________________________\nINDEPENDENT AUDITORS' REPORT\nE'TOWN CORPORATION:\nWe have audited the consolidated financial statements of E'town Corporation and its subsidiaries as of December 31, 1995 and 1994, and for each of the three years in the period ended December 31, 1995, and have issued our report thereon dated February 15, 1996; such consolidated financial statements and report are included in your 1995 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\nFebruary 15, 1996 Parsippany, New Jersey\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, 1995 $463,000 $600,648 (A) $531,648 $532,000\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\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, 1995 AND 1994\n1995 1994\n_________ _________ ELIZABETHTOWN WATER COMPANY:\n____________________________ UTILITY PLANT IN SERVICE: Intangible Plant $ 250,766 $ 250,766 Source of Supply Plant 10,073,447 9,739,125 Pumping Plant 44,838,866 43,658,801 Water Treatment Plant 53,070,107 46,008,913 Transmission & Distribution Plant 378,216,166 354,703,279 General Plant 15,373,329 14,068,349 Leasehold Improvements 117,186 110,954 Acquisition Adjustments 632,388 632,388\n____________ ____________ Utility Plant in Service 502,572,255 469,172,575 Construction Work in Progress 100,212,636 55,739,951\n____________ ____________ Total Utility Plant 602,784,891 524,912,526\nNON-UTILITY PROPERTY - net 83,178 85,690\n____________ ____________ TOTAL $602,868,069 $524,998,216\n____________ ____________\n____________ ____________ E'TOWN CORPORATION:\n___________________ UTILITY PLANT (as above) $602,784,891 $524,912,526\nNON-UTILITY PROPERTY - net 12,151,496 12,061,574\n____________ ____________ TOTAL $614,936,387 $536,974,100\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)]\n3(b) - By-Laws of E'town Corp. [Form 10-K for the year 1994, Exhibit 3(b)]\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)]\n10(b) - Savings and Investment Plan - 401(k) [Form 10-K for the year 1994, Exhibit 10(b)]\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]\nExhibit No. Description\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, 1995, Exhibit 10]\n*11 - Statement Regarding Computation of Per Share Earnings\n*13 - Portion of the 1995 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, 1994, Exhibit 3(a)]\n3(b) - By-Laws of Elizabethtown Water Company\n4(a) - Indenture dated as of November 1, 1994 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, 1994, 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, 1993, 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)]\n*4(h) - Indenture dated as of December 1, 1995 from Elizabethtown Water Company to The Bank of New York, Trustee, relating to the 5.60% Debentures due 2025\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, 1993, 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)]\n10(i) - Supplemental Executive Retirement Plan of Elizabethtown Water Company [Form 10-Q for the year ended September 30, 1995, Exhibit 10] Exhibit No. Description\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, 1995, 1994 AND 1993 AND INDEPENDENT AUDITORS' REPORT\nAPPENDIX I\nELIZABETHTOWN WATER COMPANY AND SUBSIDIARY\n__________________________________________\n______________________________________________________________________\nINDEPENDENT AUDITORS' REPORT\nSTATEMENTS OF CONSOLIDATED INCOME FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nCONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 1995 AND 1994\nSTATEMENTS OF CONSOLIDATED CAPITALIZATION AS OF DECEMBER 31, 1995 AND 1994\nSTATEMENTS OF CONSOLIDATED SHAREHOLDER'S EQUITY FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSTATEMENTS OF CONSOLIDATED CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\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, 1995 and 1994, 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, 1995. 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, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995 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\nFebruary 15, 1996 Parsippany, New Jersey\nElizabethtown Water Company and Subsidiary APPENDIX I\nStatements of Consolidated Income\nYear Ended December 31,\n________________________________________ 1995 1994 1993\n_____________ _____________ ____________\nOperating Revenues $108,398,105 $102,032,505 $99,996,120\n____________ ____________ ____________\nOperating Expenses: Operation 43,132,400 40,722,980 38,529,149 Maintenance 5,805,511 6,623,772 5,716,157 Depreciation 8,808,169 7,860,180 7,285,309 Revenue taxes 13,591,212 12,748,161 12,501,804 Real estate, payroll and other taxes 2,771,716 2,717,067 2,513,891 Federal income taxes (Note 3) 8,002,292 7,176,396 7,658,770\n____________ ____________ ___________ Total operating expenses 82,111,300 77,848,556 74,205,080\n____________ ____________ ___________\nOperating Income 26,286,805 24,183,949 25,791,040\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) 2,976,290 1,178,133 445,339 Federal income taxes (Note 3) (1,159,218) (237,599) (258,024) Other-net 335,763 432,922 169,474\n____________ ____________ ___________ Total other income 2,152,835 441,253 479,189\n____________ ____________ ___________\nTotal Operating and Other Income 28,439,640 24,625,202 26,270,229\n____________ ____________ ___________\nInterest Charges: Interest on long-term debt 10,892,129 10,774,008 11,527,301 Other interest expense-net 2,343,903 175,507 77,921 Capitalized interest (Note 2) (2,445,093) (867,101) (391,895) Amortization of debt discount-net 323,557 319,646 224,383\n____________ ____________ ___________ Total interest charges 11,114,496 10,402,060 11,437,710\n____________ ____________ ___________\nIncome Before Preferred Stock Dividends 17,325,144 14,223,142 14,832,519 Preferred Stock Dividends 813,000 854,047 1,050,000\n____________ ____________ ___________\nEarnings Applicable to Common Stock $ 16,512,144 $ 13,369,095 $13,782,519\n____________ ____________ ___________\n____________ ____________ ___________\nSee Notes to Consolidated Financial Statements.\nElizabethtown Water Company and Subsidiary APPENDIX I\nConsolidated Balance Sheets\nDecember 31,\n___________________________ Assets 1995 1994\n____________ ____________\nUtility Plant-at Original Cost: Utility plant in service $502,572,255 $469,172,575 Construction work in progress 100,212,636 55,739,951\n____________ ____________ Total utility plant 602,784,891 524,912,526 Less accumulated depreciation and amortization 94,926,413 87,456,550\n____________ ____________ Utility plant-net 507,858,478 437,455,976\n____________ ____________\nNon-utility Property 83,178 85,690\n____________ ____________\nCurrent Assets: Cash and cash equivalents 3,796,757 1,485,115 Customer and other accounts receivable (less reserve: 1995, $532,000; 1994, $463,000) 16,943,725 12,350,802 Unbilled revenues 7,443,656 7,161,483 Materials and supplies-at average cost 1,912,015 1,724,969 Prepaid insurance, taxes, other 1,874,338 1,410,401 Prepaid federal income taxes 1,344,630\n____________ ____________ Total current assets 31,970,491 25,477,400\n____________ ____________\nDeferred Charges (Note 7): Prepaid pension expense (Note 10) 580,534 926,142 Waste residual management 970,182 546,490 Unamortized debt and preferred stock expenses 9,384,609 8,902,271 Taxes recoverable through future rates (Note 3) 26,427,627 26,339,057 Postretirement benefit expense (Note 10) 2,900,569 2,077,051 Purchased water under recovery - net 37,316 314,128 Other unamortized expenses 594,875 723,709\n____________ ____________ Total deferred charges 40,895,712 39,828,848\n____________ ____________ Total $580,807,859 $502,847,914\n____________ ____________\n____________ ____________\nSee Notes to Consolidated Financial Statements.\nElizabethtown Water Company and Subsidiary APPENDIX I\nConsolidated Balance Sheets\nDecember 31,\n____________________________ Capitalization and Liabilities 1995 1994\n____________ ____________\nCapitalization (Notes 4 and 5): Common shareholder's equity $176,684,773 $151,624,255 Cumulative preferred stock 12,000,000 12,000,000 Long-term debt-net 181,922,528 141,908,430\n____________ ____________ Total capitalization 370,607,301 305,532,685\n____________ ____________\nCurrent Liabilities: Notes payable-banks (Note 5) 27,000,000 23,000,000 Long-term debt-current portion (Note 4) 30,000 42,000 Accounts payable and other liabilities 16,723,904 18,165,522 Customers' deposits 305,349 278,895 Municipal and state taxes accrued 13,661,620 12,831,524 Federal income taxes accrued 533,286 Interest accrued 2,937,637 2,828,464 Preferred stock dividends accrued 59,000 59,000\n____________ ____________ Total current liabilities 61,250,796 57,205,405\n____________ ____________\nDeferred Credits: Customer advances for construction 45,460,749 45,554,476 Federal income taxes (Note 3) 64,886,448 60,109,244 Unamortized investment tax credits 8,448,811 8,650,537 Accumulated postretirement benefits (Note 10) 2,900,569 2,077,051\n____________ ____________ Total deferred credits 121,696,577 116,391,308\n____________ ____________\nContributions in Aid of Construction 27,253,185 23,718,516\n____________ ____________\nCommitments and Contingent Liabilities (Note 9)\n____________ ____________ Total $580,807,859 $502,847,914\n____________ ____________\n____________ ____________\nSee Notes to Consolidated Financial Statements.\nElizabethtown Water Company and Subsidiary APPENDIX I\nStatements of Consolidated Capitalization\nDecember 31,\n____________________________ 1995 1994\n____________ ____________\nCommon Shareholder's Equity (Notes 4 and 5): Common stock without par value, authorized, 10,000,000 shares; issued 1995 and 1994, 1,974,902 shares $ 15,740,602 $ 15,740,602 Paid-in capital 112,157,348 88,868,632 Capital stock expense (484,702) (484,702) Retained earnings 49,271,525 47,499,723\n____________ ____________ Total common shareholder's equity 176,684,773 151,624,255\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 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 5.60% Debentures, due 2025 40,000,000 7 1\/4% Debentures, due 2028 50,000,000 50,000,000\nThe Mount Holly Water Company: Notes Payable (due serially through 2000) 117,500 144,300\n____________ ____________ Total long-term debt 183,117,500 143,144,300 Unamortized discount-net (1,194,972) (1,235,870)\n____________ ____________ Total long-term debt-net 181,922,528 141,908,430\n____________ ____________ Total capitalization $370,607,301 $305,532,685\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_______________________________________ 1995 1994 1993\n____________ ___________ ___________\nCommon Stock: $ 15,740,602 $ 15,740,602 $ 15,740,602\n____________ ____________ ____________\nPaid-in Capital: Balance at Beginning of Year 88,868,632 63,522,594 43,713,297 Capital contributed by parent company 23,288,716 25,346,038 19,809,297\n____________ ____________ ____________ Balance at End of Year 112,157,348 88,868,632 63,522,594\n____________ ____________ ____________\nCapital Stock Expense: (484,702) (484,702) (484,702)\n____________ ____________ ____________\nRetained Earnings: Balance at Beginning of Year 47,499,723 46,986,485 44,054,327 Income Before Preferred Stock Dividends 17,325,144 14,223,142 14,832,519 Dividends on Common Stock (14,740,342) (12,855,857) (10,850,361) Preferred Stock Dividends (813,000) (854,047) (1,050,000)\n____________ ____________ ____________ Balance at End of Year 49,271,525 47,499,723 46,986,485\n____________ ____________ ____________\nTotal Common Shareholder's Equity $176,684,773 $151,624,255 $125,764,979\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_____________________________________ 1995 1994 1993\n___________ ___________ ___________ Cash Provided by Operating Activities: Income Before Preferred Stock Dividends $ 17,325,144 $ 14,223,142 $ 14,832,519 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 8,808,169 7,860,180 7,285,309 Gain on sale of land (122,400) Decrease (increase) in deferred charges 327,562 (169,459) 260,600 Deferred income taxes and investment tax credits-net 4,486,908 4,256,534 3,332,558 Allowance for debt and equity funds used during construction (AFUDC) (5,421,383) (2,045,234) (837,234) Other operating activities-net (61,590) (130,902) (449,792) Change in current assets and liabilities excluding cash, short-term investments and current portion of debt: Customer and other accounts receivable (4,592,923) (462,817) (840,485) Unbilled revenues (282,173) 86,839 (688,601) Accounts payable and other liabilities (1,415,164) 8,517,848 669,078 Accrued\/prepaid interest and taxes 2,353,248 (1,464,787) 232,741 Other (187,046) (101,266) (6,870)\n____________ ____________ ____________ Net cash provided by operating activities 21,340,752 30,570,078 23,667,423\n____________ ____________ ____________ Cash Provided by Financing Activities: Decrease in funds held by Trustee for construction expenditures 382,306 8,519,877 Proceeds from issuance of debentures 40,000,000 50,000,000 Proceeds from issuance of preferred stock 12,000,000 Redemption of preferred stock (12,000,000) Debt and preferred stock issuance costs (482,338) (876,594) (3,139,571) Capital contributed by parent company 23,288,716 25,346,038 19,809,297 Repayment of long-term debt (38,800) (42,000) (50,042,000) Contributions and advances for construction-net 3,440,942 3,453,604 1,909,905 Net increase (decrease) in notes payable-banks 4,000,000 23,000,000 (5,500,000) Dividends paid on common and preferred stock (15,448,342) (13,631,154) (11,900,361)\n____________ ____________ ____________ Net cash provided by financing activities 54,760,178 37,632,200 9,657,147\n____________ ____________ ____________ Cash Used for Investing Activities: Utility plant expenditures (excluding AFUDC) (73,789,288) (69,980,619) (32,501,865) Proceeds from sale of land 131,000\n____________ ____________ ____________ Net cash used for investing activities (73,789,288) (69,980,619) (32,370,865)\n____________ ____________ ____________ Net Increase (Decrease) in Cash and Cash Equivalents 2,311,642 (1,778,341) 953,705 Cash and Cash Equivalents at Beginning of Year 1,485,115 3,263,456 2,309,751\n____________ ____________ ____________ Cash and Cash Equivalents at End of Year$ 3,796,757 $ 1,485,115 $ 3,263,456\n____________ ____________ ____________\n____________ ____________ ____________ Supplemental Disclosures of Cash Flow Information: Cash paid during the year for: Interest (net of amount capitalized) $ 7,833,355 $ 9,952,838 $ 11,837,347 Income taxes 4,158,093 6,771,254 5,881,008 Preferred stock dividends $ 708,000 $ 805,475 $ 1,050,000\nSee Notes to Consolidated Financial Statements.\nELIZABETHTOWN WATER COMPANY AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. ORGANIZATION Elizabethtown Water Company (Elizabethtown or Company) and its wholly owned subsidiary, The Mount Holly Water Company (Mount Holly), 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 Basis of Presentation The 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).\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.\nUtility Plant and Depreciation Income 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 1.83% for 1995, 1.75% for 1994 and 1.74% for 1993. The 1995 rate case (see Note 8) allowed an increase in depreciation rates effective February 1, 1995.\nAllowance for Funds Used During Construction Elizabethtown and Mount Holly capitalize, 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, a non-cash credit on the Statements of Consolidated Income, 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. AFUDC totaled $5,421,383, $2,045,234 and $837,234 for 1995, 1994 and 1993, respectively (see Note 8).\nRevenues Revenues 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 Elizabethtown Water Company files a consolidated federal tax return with E'town. 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 Customer 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, under the terms of individual main extension agreements, are no longer subject to refund.\nCash Equivalents Elizabethtown Water Company considers all highly liquid debt instruments purchased with maturities of three months or less to be cash equivalents.\nNew Accounting Pronouncement In March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed of,\" which is effective in 1996. The statement requires that long-lived assets be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The resultant impairment, if any, would be measured based on the fair value of the asset. The Company believes that the adoption of SFAS 121 will not have any effect on the Company's results of operations or financial position.\nReclassification Certain prior year amounts have been reclassified to conform to the current year's presentation.\n3. FEDERAL INCOME TAXES The computation of federal income taxes and the reconciliation of the tax provision computed at the federal statutory rate (35%) with the amount reported in the Statements of Consolidated Income follow: 1995 1994 1993 ------------------------- (Thousands of Dollars)\nTax expense at statutory rate $9,270 $7,573 $7,962 Items for which deferred taxes are not provided: Capitalized interest (2) (2) Difference between book and tax depreciation 133 92 81 Investment tax credits (204) (209) (208) Other (37) (40) 84 ----------------------- Provision for federal income taxes $9,162 $7,414 $7,917 ======================= The provision for federal income taxes is composed of the following: Current $6,409 $5,087 $5,926 Tax collected on main extensions (1,734) (1,931) (1,341) Deferred: Tax depreciation 3,492 3,366 3,222 Capitalized interest 800 384 72 Main cleaning and lining 405 396 323 Other (8) 314 (91) Investment tax credits-net (202) (202) (194) ----------------------- Total provision $9,162 $7,414 $7,917 =======================\nEffective January 1, 1993, the Company adopted SFAS 109, \"Accounting for Income Taxes.\" SFAS 109 established accounting rules that changed 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 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%.\nThe tax effect of significant temporary differences representing deferred income tax assets and liabilities as of December 31, 1995 and 1994 is as follows:\n1995 1994 --------------------- (Thousands of Dollars)\nWater utility plant-net $(56,956) $(53,517) Taxes recoverable through future rates (9,250) (9,219) Investment tax credit 2,957 3,028 Prepaid pension expense (203) (324) Capitalized interest (1,308) (508) Other assets 654 557 Other liabilities (780) (126) ------------------- Net deferred income tax liabilities $(64,886) $(60,109) ===================\nIn 1995 Elizabethtown received tax refunds and interest related to the years 1984 and 1985 that contributed to an increase in net income of $206,948.\n4. CAPITALIZATION In June 1995, E'town issued 660,000 shares of common stock for net proceeds of $16,863,860. The gross proceeds of $17,737,500 were used to fund equity contributions to Elizabethtown totalling $16,900,000. These equity contributions have been used to repay short-term debt that had been issued under Elizabethtown's revolving credit agreement (see below) to partially fund the Company's capital program, the predominant portion of which relates to the construction of the Canal Road Water Treatment Plant (Plant) (see Note 9).\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 had been used to partially fund Elizabethtown's construction program, the predominant portion of which related to the Plant.\nE'town routinely makes equity contributions to Elizabethtown which represent the proceeds of common stock issued under E'town's Dividend Reinvestment and Stock Purchase Plan (DRP). E'town contributed $6,388,716 and $7,146,038 in 1995 and 1994, respectively, to Elizabethtown from the proceeds of DRP issuances.\nCumulative Preferred Stock In 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.\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 Elizabethtown'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\ncommon stock, all of which is held by E'town. At December 31, 1995, $7,753,084 of Elizabethtown's retained earnings were restricted under the most restrictive indenture provision. Therefore, $35,241,659 of E'town's consolidated retained earnings were unrestricted.\nIn December 1995, Elizabethtown issued $40,000,000 of 5.60% tax-exempt debentures through the New Jersey Economic Development Authority (NJEDA). The proceeds of the issue were used to repay amounts outstanding under a revolving credit agreement (see Note 5).\n5. LINES OF CREDIT In 1994, Elizabethtown executed a committed revolving credit agreement (Agreement) with an agent bank and five additional banks that replaced the Company's uncommitted lines of credit. The Agreement provides up to $60,000,000 in revolving short-term financing, which together with internal funds, other short-term financing, 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 $148,905,000 through 1998. At December 31, 1995, Elizabethtown had outstanding borrowings of $27,000,000 under the Agreement at interest rates from 5.75% to 6.00%, at a weighted average rate of 5.94%.\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 a percentage 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, 1995, the percentage of Elizabethtown's common and preferred equity to total capitalization, as calculated in accordance with the Agreement, was 47%. For the 12 months ended December 31, 1995, Elizabethtown's pre-tax interest coverage ratio, calculated in accordance with the Agreement, was 3.12 to 1.\nElizabethtown has $17,000,000 of uncommitted lines of credit with several banks in addition to the lines under the Agreement.\nInformation relating to bank borrowings for 1995, 1994 and 1993 is as follows: 1995 1994 1993 ------------------------------- (Thousands of Dollars)\nMaximum amount outstanding.......... $60,000 $23,000 $7,000 Average monthly amount outstanding.. $39,636 $ 2,958 $2,062 Average interest rate at year end... 5.9% 6.1% (A) Compensating balances at year end... $ 0 $ 0 $ 195 Weighted average interest rate based on average daily balances.......... 6.2% 5.7% 3.8%\n(A) No outstanding bank borrowings at year end.\n6. FINANCIAL INSTRUMENTS The carrying amounts and the estimated fair values, as of December 31, 1995 and 1994, of financial instruments issued or held by the Company, are as follows: 1995 1994 ------------------------ (Thousands of Dollars) Cumulative preferred stock (1): Carrying amount $ 12,000 $ 12,000 Estimated fair value 11,940 10,860 Long-term debt (1): Carrying amount $181,923 $141,908 Estimated fair value 189,664 129,355\n(1) Estimated fair values are based upon quoted market prices for these or similar securities.\n7. REGULATORY ASSETS AND LIABILITIES Certain costs incurred by Elizabethtown and Mount Holly which have been deferred have been recognized as regulatory assets and are being amortized over various periods as set forth below:\n1995 1994 ----------------------- (Thousands of Dollars)\nWaste residual management $ 970 $ 546 Unamortized debt and preferred stock expense 9,385 8,902 Taxes recoverable through future rates (Note 3) 26,428 26,339 Postretirement benefit expense (Note 10) 2,901 2,077 Purchased water under recovery-net (Note 8) 37 314 ------------------- Total $39,721 $38,178 ===================\nWaste Residual Management The costs of disposing of the waste generated by Elizabethtown's and Mount Holly's water treatment plants are being amortized over three-year periods for ratemaking and financial statement purposes. No return is being earned on these deferred balances.\nUnamortized Debt and Preferred Stock Expenses Costs 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 and financial statement 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 and financial statement purposes.\nThere were no regulatory liabilities at December 31, 1995 or 1994.\n8. REGULATORY MATTERS Rates Elizabethtown On November 20, 1995, Elizabethtown filed a petition with the BPU for an increase in rates of $31,634,500 or 29.6%. The largest portion of the request, $22,925,227, is to cover the cost to finance and operate the Plant (see Note 9). The remainder of the rate request, $8,709,273\nis needed to cover the cost to finance additional construction projects and to cover increases in operating expenses since rates were last established in February 1995. A decision by the BPU is expected in the summer of 1996. In light of the approval by the BPU of the 1993 Plant Stipulation (discussed below) and Elizabethtown's experience in obtaining base rate relief, Elizabethtown expects the BPU to grant timely and adequate rate relief, but cannot predict the ultimate outcome of any rate proceeding.\nIn February 1996, Elizabethtown filed a petition with the BPU for a decrease in rates of $390,318 under a Purchased Water Adjustment Clause (PWAC). This procedure, established by BPU rules, allows Elizabethtown to reflect in rates a change in the cost of water purchased from the New Jersey Water Supply Authority (NJWSA) without a complete rate case. The purpose of this request is to reflect in rates the expected decrease in the rate for water purchased by Elizabethtown from the NJWSA effective July 1, 1996.\nIn August 1993, the 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 that the Plant is necessary and that the Company's estimates regarding the Plant's cost ($87,000,000 at that time) and construction period are reasonable (see Note 9). 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 the Company 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 1993 Plant Stipulation also provides that the rate of return on common shareholder'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 shareholder's equity established in the Company's most recent base rate case. The authorized rate of return on common shareholder's equity is currently 11.5%.\nIn January 1995, the BPU approved a stipulation (1995 Stipulation) for Elizabethtown 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 is covering the cost to finance $62,000,000 of construction projects that were not reflected in the rates established in March 1993. These projects include treatment, transmission and storage facilities needed to ensure that Elizabethtown continues to meet federal and state regulations on water quality and service. The increase is also offsetting increased 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 $469,000. The 1995 Stipulation also required Elizabethtown to maintain a percentage of common equity to total capitalization of at least 45.1% for the 12 months ended January 31, 1996. The Company has met this requirement.\nOn July 7, 1995, the BPU approved a Stipulation for a decrease in rates under a PWAC. The Stipulation resulted in a decrease in rates\nfor the PWAC, effective July 13, 1995 of $348,527. This Stipulation reflects the decrease in rates for water purchased from the NJWSA.\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, reflecting the increase in rates for water purchased from the NJWSA.\nMount Holly On June 26, 1995, Mount Holly petitioned the BPU for an increase in rates, to take place in two phases. In the first phase rates would be increased by $851,171 and in the second phase by $2,794,002. The first phase is necessary to cover costs that were not reflected in rates last increased in October 1986. The second phase would cover the cost of a new water supply, treatment and transmission system necessary to obtain water outside a designated portion of an aquifer currently used by Mount Holly and to treat and pump the water into the Mount Holly distribution system. Management believes this project is the most cost-effective alternative available to Mount Holly to comply with recent state legislation which restricts the amount of water that can be withdrawn from an aquifer in certain areas of southern New Jersey. The project is currently estimated to cost $16,500,000. The land for the supply and treatment facilities has been purchased and wells have been drilled and can produce the required supply. On October 5, 1995, the New Jersey Department of Environmental Protection granted Mount Holly a water allocation diversion permit for four wells that are to be the water supply for the Mansfield Project. On October 20, 1995, New Jersey-American Water Company requested, and was subsequently granted, an adjudicatory hearing on the permit. The Company and Mount Holly believe that the permit in question will be upheld, but cannot predict the outcome of the objection. In the event that the objection is successful and the permit is rescinded, Mount Holly would utilize the alternative plan of purchasing water from New Jersey-American Water Company.\nOn January 24, 1996, the BPU approved a stipulation (Mount Holly Stipulation) for an increase in rates of $550,000, effective as of that date. The Mount Holly Stipulation has, effectively, concluded the first phase of the rate proceeding. Mount Holly is continuing with the process with respect to the second phase of the petition. While management believes that the water supply, treatment and transmission system planned for Mount Holly is the most cost-effective response to the state legislation affecting the area, we cannot predict the ultimate outcome of the rate proceeding at this time.\nMain Extension Refunds Previous disclosures have detailed events surrounding several lawsuits filed by developers with respect to the BPU's suggested refund formula for particular main extension agreements. The BPU's formula suggests refunds of 2 1\/2 times annual revenues for each metered connection for water service. The plaintiffs had received refunds in accordance with this suggested formula. The initial petitions by the developers and the related litigation have been ongoing since 1984 with numerous BPU decisions, Appellate Division decisions and a New Jersey Supreme Court decision.\nIn June 1995, the New Jersey Supreme Court once again reviewed these matters and declined to hear the final appeal of the developers.\nEffectively, the BPU's suggested refund formula has been reaffirmed and therefore no refunds in excess of the 2 1\/2 times revenues formula are required by the Company. Based upon the New Jersey Supreme Court's decision, the plaintiffs have withdrawn their suits.\n9. COMMITMENTS Elizabethtown 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, 1996, the annual cost under the contract will be $7,861,486. The total cost of water purchased from the NJWSA, including additional water purchased on an as-needed basis, was $9,344,792, $8,987,472 and $8,819,212 for 1995, 1994 and 1993, 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, ---------------------- (Thousands of Dollars)\n1996 $ 909 1997 859 1998 12 1999 -0- 2000 -0- ------ Total $1,780 ======\nRent expense totaled $820,481, $829,562 and $789,636 for 1995, 1994 and 1993, respectively.\nCapital expenditures through 1998 are estimated to be $148,905,000 for Elizabethtown's and Mount Holly's utility plant.\nCanal Road Water Treatment Plant In 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 project is being completed on schedule and the construction contract is on budget. The Company has expended $82,952,434, excluding AFUDC of $7,167,396, on the Plant as of December 31, 1995. Construction is expected to be completed in the third quarter of 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.\nThe components of the net pension costs (credits) are as follows:\n1995 1994 1993 ------------------------- (Thousands of Dollars) Service cost--benefits earned during the year .. $ 915 $1,052 $ 899 Interest cost on projected benefit obligation .. 2,156 1,946 1,973 Return on Plan assets .......................... (7,587) 939 (1,409) Net amortization and deferral .................. 4,862 (3,860) (1,658) ------------------------- Net pension costs (credits) .................... $ 346 $ 77 $ (195) =========================\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:\n1995 1994 ---------------------- (Thousands of Dollars)\nMarket value of Plan assets $36,957 $30,810 Actuarial present value of Plan benefits: ---------------- Vested benefits 25,986 20,776 Non-vested benefits 101 157 ---------------- Accumulated benefit obligation 26,087 20,933 Projected increases in compensation levels 7,877 5,642 ---------------- Projected benefit obligation 33,964 26,575 Excess of Plan assets over projected benefit ---------------- obligation 2,993 4,235 Unrecognized net gain (620) (1,337) Unrecognized prior service cost 363 451 Unrecognized transition asset (2,156) (2,423) ---------------- Prepaid pension expense $ 580 $ 926 ================\nThe assumed rates used in determining the actuarial present value of the projected benefit obligations were as follows: 1995 1994 1993 ------------------------ Discount rate 7.00% 8.00% 7.00% Compensation increase 5.50% 5.50% 5.50% Rate of return on Plan assets 9.00% 8.50% 8.50%\nThe Company provides certain health care and life insurance benefits for substantially all of its retired employees. As a result of a contract negotiated in February 1996 with the Company's bargaining unit, all union and non-union employees retiring after January 1, 1997 will pay 25% of future increases in the premiums the Company pays for postretirement medical benefits.\nEffective January 1, 1993, the Company adopted SFAS 106. Under SFAS 106, the costs 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, was $7,214,736 as of January 1, 1993. The transition obligation is being amortized over 20 years. The following table details the postretirement benefit obligation at December 31:\n1995 1994 ---------------------- (Thousands of Dollars)\nRetirees $2,404 $2,457 Fully eligible plan participants 6,263 5,080 ----------------- Accumulated postretirement benefit obligation 8,667 7,537 Plan assets at fair value (320) 0 Unrecognized net gain 685 1,033 Unrecognized transition obligation (6,131) (6,493) ----------------- Accrued postretirement benefit obligation $2,901 $2,077 =================\nThe assumed health care cost trend rate used in measuring the accumulated postretirement benefit obligation as of December 31, 1995, and for 1995, was 12%. This rate decreases linearly each successive year until it reaches 5% in 2005, after which the rate remains constant. The assumed rates used in determining the actuarial present value of the projected benefit obligations were as follows: 1995 1994 1993 ------------------------- Discount rate 7.00% 8.00% 7.00%\nA 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, 1995, and net postretirement service and interest cost by approximately $1,260,000 and $250,000, respectively.\nBased upon the independent actuarial study referred to above, the annual postretirement cost calculated under SFAS 106 is as follows:\n1995 1994 1993 ---------------------------- (Thousands of Dollars) Service cost - benefits earned during the year $ 474 $ 369 $ 249 Interest cost on accumulated postretirement benefit obligation 579 592 602 Amortization of transition obligation 360 361 361 --------------------------------- Total 1,413 1,322 1,212 Deferred amount for regulated companies pending recovery (824) (1,072) (1,005) --------------------------------- Net postretirement benefit expense $ 589 $ 250 $ 207 =================================\nThe rate increases allowed by the 1995 Stipulation and the Mount Holly Stipulation include as an allowable expense the pay-as-you-go portion of postretirement benefits as well as the current service cost, and require that the current service cost be funded. Elizabethtown funded $318,222 in 1995. These stipulations allow Elizabethtown and Mount Holly to defer the amount accrued in excess of these amounts for consideration in future rate cases. 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, 1995, the amount that has been deferred is $2,900,569.\nRecovery of Elizabethtown's deferred postretirement costs has been requested in Elizabethtown's recent rate case. Management believes that Elizabethtown\nand Mount Holly will recover the deferred postretirement costs in future rates.\n11. LEGAL MATTERS\nAs reported in 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.\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 applied a portion of the settlement against an insurance reserve. The effect on 1994 earnings was $932,203 or $605,932 net of federal income taxes. The Company is seeking recovery from its insurance carriers.\nAs previously reported, several lawsuits had been filed against Elizabethtown and other parties in connection with a fire that occurred in a storage facility in 1989 resulting in damage to property stored at that facility. This matter has been settled in 1995 resulting in a payment by Elizabethtown of $114,250. A provision for this estimated liability was previously recorded.\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 with are billed on a monthly basis. Elizabethtown is billed for financial services by E'town.\nThe total of all intercompany billings was $469,548, $426,944 and $278,191 for 1995, 1994 and 1993, respectively. In addition, various expenditures are made to vendors which are common to the entities. Each entity absorbs its proportionate share of these costs.\n13 QUARTERLY FINANCIAL DATA (Unaudited)\nA summary of financial data for each quarter of 1995 and 1994 follows:\nIncome Before Earnings Operating Operating Preferred Applicable Quarter Revenues Income Stock Dividends to Common Stock ------------------------------------------------------------------------ (Thousands of Dollars Except Per Share Amounts)\n1st $25,174 $ 5,906 $ 3,653 $3,449 2nd 27,101 6,542 4,377 4,174 3rd 30,451 8,085 5,720 5,517 4th 25,672 5,754 3,575 3,372 ----------------------------------------------------- Total $108,398 $26,287 $17,325 $16,512 ===================================================== 1st $ 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 =====================================================\nWater utility revenues are subject to a seasonal fluctuation due to normal increased consumption during the third quarter of each year.","section_15":""}
{"filename":"806549_1995.txt","cik":"806549","year":"1995","section_1":"Item 1. - BUSINESS\nGeneral\nLamcor Incorporated, formerly Laminations Incorporated was formed in July, 1983 as the successor company to Film Converting Services, Inc. The name was changed in September, 1986 to Lamcor Incorporated.\nThere are two basic processes that take place in the plant of the company. First the roll of plastic film is laminated with another roll of film to give it strength. The other is to apply a heat seal coating to the basic material to act as a sealant, and is called a coated roll. This resulting roll is either used in the next process, or sold to others as is. The laminated rolls are sold to the meat industry, to other food packagers, and as a generic product. The coated rolls are sold to snack food makers, to specialty food manufacturers, and as a generic product. The product sales mix is about 10% laminated rolls, 20% coated rolls, and 70% pouches, and are sold to wide variety of customers. The company has been able in the past to keep the employees employed full time as a result, since it can sell this basic laminated roll to any number of customers.\nThe other process takes the laminated roll of plastic film, folds it over, and makes a pouch. This machine seals the pouch on three sides, cuts it to the desired length, and is able to make the folded over roll wide enough to make two pouches at the same time. These are sold in standard sizes, and some to customers specifications.\nThe pouch that comes from this process is then used for packaging products. The customer takes the pouch, inserts the product, removes the air from the pouch, and seals the fourth side. This removal of air causes the plastic pouch to collapse around the product and the result is the package found in most stores. Some processors do this by machine, but most pack the product in the pouch by hand. The FDA has set standards for this type of plastic film pouch for food products. The company meets these standards. The FDA standards are met by the suppliers of the basic material; the company relies on these written representations and its own testing to ensure that the FDA standards are met.\nThe company has machinery that will enable it to custom make pouches for various customers in different thicknesses and sizes.\nThe advent of microwave cooking has brought new demands to the requirements for plastic packaging of food. Microwave cooking requires that the food be packaged in plastic that will also be used in cooking not just in the storage of the food. The cooking of the food has brought more stringent requirements from the FDA for plastic packaging. The company complies with the FDA requirements, and so far has been able to fully comply. Along with the more stringent requirements has come a vastly expanded market.\nThe convenience of microwave cooking is a market that has barely been tapped at this time. The company feels that the market for microwave cooking will greatly expand in the next few years, and the company wants to be in position to exploit its portion of that market; the plastic packaging of the convenience foods. The pouch that the company makes is in many ways the ideal vehicle to package the microwave foods, and, in fact, the company has several customers that use its pouch at this time in microwave foods, such as entrees and snack foods. About 30% of the production of the products of the company at this time is used for microwave foods.\nMajor Customers\nReference is made to Note 9 to the financial statements with regard to customers from which the company derived more than 10% of its sales.\nPatents and Trademarks\nThe Company has no patents on any of its products, however there is a patent pending on a vacuum seal for its plastic bags.\nEmployees\nAs of September 30, 1995, the Company had 38 full time employees, of which nine are in management and twenty nine are in production.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. - PROPERTY\nFacilities\nThe Company purchased its manufacturing and office facilities for $340,000 in March, 1991. The Company expanded the plant in 1994, adding an additional 9,500 square feet to bring the size of the plant to 23,000 square feet, at a cost of $210,000. The sales offices were moved from leased space in Edina, Minnesota to expanded space at the plant. The Company added an additional 1,200 square feet at a cost of $100,000 for the new offices.\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\nThe Company's common stock has been actively traded principally in the Minneapolis over-the-counter market since March 1, 1987. As of September 30, 1995, the following brokerage firms were making a market in the Company's common stock: R.J. Steichen & Co. Corp., Van Clemons Co.\nThe following table sets forth for the periods indicated the range of high and low closing bid quotations per share as reported by the local over-the-counter market. These quotations represent inter-dealer prices, without retail markups, markdowns or commissions and may not necessarily represent actual transactions.\nPrice Per Share High Low\nFiscal year 1995 First Quarter (October 1, 1994 through December 31, 1994) $ 3.50 $ 3.00\nSecond Quarter (January 1, 1995 through March 31, 1995) $ 2.50 $ 1.75\nThird Quarter (April 1, 1995 through June 30, 1995) $ 3.37 $ 3.00\nFourth Quarter (July 1, 1995 through September 30, 1995) $ 3.75 $ 3.00\nOn September 30, 1995 the high closing bid and low asked prices of the Company's common stock were $3.00 and $3.75 per share, respectively. On September 30, 1995 there were 183 holders of record.\nItem 6.","section_6":"Item 6. - SELECTED FINANCIAL DATA\nItem 7.","section_7":"Item 7. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nProfitability was achieved for a sixth consecutive year. Net income was double that of 1994, and was aided, in part, by stability in raw material markets. Management feels that this will be a continuing trend with only moderate increases in fixed costs.\nNet sales for 1995 were $7,158,636, up from $4,817,411 in 1994, $3,682,870 in 1993. This reflected an increase of 49% in one year and almost double in the last 4 years. Net income was $358,795, compared to $176,918 in 1994, an increase of 103%. Per share income was $.22 per share, as opposed to $.12 in 1994. All income was from operations.\nCost of goods sold for 1995 was $5,194,981, compared to $3,542,411 in 1994 and $2,762,358 in 1993. Gross profit was $1,963,655 in 1995 compared to $1,275,000 in 1994 and $920,512 in 1993. Selling and administrative expense for 1995, 1994 and 1993 were $1,244,694, $936,587 and $693,781 respectively. During the course of the year financing was procured to provide capital for building expansion and for new machinery for production. Assets increased from $3,527,547 in 1994 to $4,164,080 in 1995. Long term debt increased from $837,761 in 1994 to $1,277,799, primarily due to building expansion and capital lease obligation.\nCapital expenditures this year included the delivery of a new P.D.I. pouch machine capable of making large recloseable pouches. Full utilization was only recent, and there are orders employing its capabilities.\nTen new offices were completed in the second quarter of 1995. For the past several years the Company has maintained a sales office in Edina, Minnesota, and the lease term ended in 1995. Management determined that the sales operations would be enhanced by a move to the manufacturing headquarters in LeSuer. This put all operations under one roof, at a lower cost, and enhanced communications between sales and production\nThe company funded $15,200 in 1994 and $18,000 in 1995 to the 401(k) plan. Nearly all of the employees contributed to the plan, and management feels that it adds stability to the work force.\nThe company is planning another major expansion to the plant to double its size for manufacturing and warehouse space and to purchase a six color impression printing press in 1996. All printing of the plastic bags has been done by others to this time. The increased volume of sales, and the added space with the new addition to the plant will enable the company to do the printing in its own facility. Management feels that the printing will enable the company to control the timing of the printing, its quality, and enhance profits.\nInflation has not had a significant effect on the company, and the company has budgeted 1996 based on moderate economic growth. The only significant variable has been the volatile price of the film purchased as a raw material.\nItem 8.","section_7A":"","section_8":"Item 8. - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe financial statements are attached following Item 14.\nItem 9.","section_9":"Item 9. - DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNone.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nThe executive officers and directors of the Company, with a brief description, are as follows:\nName Age Position\nLeo Lund 64 Chairman of the Board\nToby Jensen 43 President\nDavid Stewart 55 Director\nSue Jones 41 Director\nChristopher Elliott 38 Director\nThe directors of the company are elected annually by the shareholders for a term of one year or until their successors are elected and qualified. The officers serve at the pleasure of the Board of Directors.\nLEO LUND, Chairman of the Board and Secretary, age 64. Mr. Lund is an accountant, and was a partner in the firm of Lund & Associates, P.A. from 1955 to 1992, which provided accounting services. Mr. Lund sold his interest in the accounting firm in 1992, and is now semi retired. He serves as a board member of several corporations, which are not registered corporations. Mr. Lund devotes less than 5% of his time to the company.\nTOBY JENSEN, President, age 43. Mr. Jensen has a degree from the University of Minnesota, and has been in management and sales with 2 flexible packaging companies for the past 17 years. He has been the President of the Company since 1988.\nDAVID STEWART, Director, age 55. Mr. Stewart is the President of Paragon Enterprises, Inc. a real estate development company.\nSUE JONES, Director, age 41. Ms Jones was the Vice President and General Manager of Strout Plastics, Inc., for 13 years until 1994. She is now an independent sales representative in the flexible packaging industry.\nCHRISTOPHER ELLIOTT, Director, age 38. Mr. Elliott is an attorney and has practiced with the firm Christoffel, Elliott and Albrecht since 1989.\nItem 11.","section_11":"Item 11. - EXECUTIVE COMPENSATION.\nThe following table sets forth the cash compensation for services rendered in all capacities to the company during the company's fiscal year ended September 30, 1995, as paid by the company to each executive officer whose cash compensation exceeded $60,000 and to all executive officers as a group:\nName Capacity Cash Compensation\nToby Jensen President $ 93,799\nAll executive officers as a group $121,499\nItem 12.","section_12":"Item 12. - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThere are presently 1,341,542 shares of the company's common shares outstanding. The following table sets forth the information as to the ownership of each person who, as of the date of this report, owns of record, or is known by the company to own beneficially, more than five percent of the company's common stock, and the officers and directors of the company.\nNumber Of Percent Of Name of Beneficial Owner Shares Shares\nLeo Lund 145,075 10.8%\nTanana, Inc. 122,300 9.1%\nKathy Young 103,230 7.6%\nChristopher Elliott 156,000 11.6%\nToby Jensen 45,000 3.3%\nSue Jones 5,000 0.3%\nDavid Stewart 11,300 0.8%\nAll executive officers and directors as a group (5 individuals) 362,375 27.0%\nDoes not take into account any unexecuted warrants or options.\nItem 13.","section_13":"Item 13. - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nSee notes 6, 8, 9 & 11 to Financial Statement.\nPART IV\nItem 14.","section_14":"Item 14. - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(a) Attached are the Financial Statements and Independent Auditor's Report on Examination of Financial Statements for the year ended September 30, 1994, 1993 and 1992.\n(b) Attached are the following Financial Statement Schedules and Auditors Report on Schedules,\nIndependent Auditors Report on Schedules Schedule V - Property, Plant and Equipment Schedule VI - Accumulated Depreciation, Depletion, and Amortization of Property, Plant and Equipment Schedule IX - Short-term borrowings\nAll other schedules are omitted because they are not required or not applicable or the information is shown in the consolidated financial statements or notes thereto.\n(c) No report was filed on Form 8-K.\n(d) There are no 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.\nDated December 22,1995\nLAMCOR, INC.\nby____________________________ Leo W. Lund\nLAMCOR, INCORPORATED\nFINANCIAL REPORT\nSEPTEMBER 30, 1995, 1994 AND 1993\nINDEPENDENT AUDITOR'S REPORT\nBoard of Directors and Shareholders Lamcor, Incorporated LeSueur, Minnesota\nWe have audited the accompanying balance sheets of Lamcor, Incorporated as of September 30, 1995 and 1994, and the related statements of income, changes in stockholders' equity and cash flows for each of the three years in the period ended September 30, 1995. 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 Lamcor, Incorporated as of September 30, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended September 30, 1995, in conformity with generally accepted accounting principles.\n\/s\/ HOUSE, NEZERKA & FROELICH, P.A.\nNovember 20, 1995\nSee Notes to Financial Statements.\nSee Notes to Financial Statements.\nSee Notes to Financial Statements.\nSee Notes to Financial Statements.\nLAMCOR, INCORPORATED\nNOTES TO FINANCIAL STATEMENTS Years Ended September 30, 1995, 1994 and 1993\nNote 1. Nature of Business and Significant Accounting Policies:\nNature of business:\nThe Company is engaged in the business of laminating plastic and manufacturing of plastic pouches used in the food and medical industries with sales throughout the United States.\nA summary of the Company's significant accounting policies follows:\nInventories:\nInventories are stated at the lower of cost (using standard costs for work in progress and finished goods) or market, computed on a basis which approximates the first-in, first-out (FIFO) method.\nProperty, equipment and improvements:\nProperty, equipment and improvements are stated at cost. For financial reporting purposes, depreciation is computed using the straight-line method over the following estimated useful lives:\nYears Building and improvements 3-40 Manufacturing equipment 5-15 Office equipment and other 3-5\nDepreciation on property, equipment and improvements was $175,715, $124,805 and $103,556 for the years ended September 30, 1995, 1994 and 1993, respectively.\nFor income tax reporting purposes, other lives and methods are used; deferred income taxes are provided for these differences.\nIncome taxes:\nEffective October 1, 1993, the Company began accounting for income taxes in accordance with SFAS No. 109, \"Accounting for Income Taxes\" (see Note 10). Deferred tax assets and liabilities are recognized for the future consequences attributable to temporary differences between the financial statement carrying amounts of assets and liabilities and their respective tax bases.\nEarnings per share:\nEarnings per share has been determined by dividing net income by the weighted average common shares outstanding during each period plus the effect of common shares contingently issuable, primarily from stock options as computed using the modified treasury stock method.\nEstimates and assumptions:\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses during the reporting period. Actual results could differ from those estimates.\nNote 2. Inventories:\nThe components of inventory are as follows:\n1995 1994 -------- -------- Raw materials $246,576 $ 480,394 Work in progress 416,504 355,094 Finished goods 323,358 229,199 -------- -------- $986,438 $1,064,687 ======== ========\nNote 3. Other Assets:\n1995 1994 -------- -------- Building lease deposit $ -- $ 844 Equipment deposits 277 291,673 Refinancing costs, less accumulated amortization 1995 $928; 1994 $464 2,381 2,845 Land deposit 1,500 -- -------- -------- $ 4,158 $295,362 ======== ========\nNote 4. Bank Line of Credit:\nThe Company has two revolving lines of credit with a bank in the maximum amount of $300,000 and $90,000 which expire September 26, 1998 and October 10, 1995, respectively. Interest is payable at 1.5% over the bank's reference rate which was 8.75% at September 30, 1995. The notes are payable on demand and are collateralized by receivables, inventory and equipment.\nNote 5. Long-Term Debt:\nMaturities for the next five years on long-term debt outstanding at September 30, 1995 are as follows:\nYear Ending September 30 1996 $ 97,000 1997 94,883 1998 102,389 1999 103,781 2000 169,057 After 381,983 -------- $949,093\nNote 6. Leases:\nOn August 11, 1994, the Company entered into a capital lease agreement with a financing company to acquire $489,920 of equipment. The financing company advanced the manufacturer $157,030 for which the Company was directly obligated as of September 30, 1994. Payments totaling $332,890 were made by the financing company during the 1995 year. The lease began on May 1, 1995 and calls for 84 monthly payments of $8,147 including interest at 10.33%.\nOn January 17, 1995, the Company entered into a capital lease agreement to purchase a truck for $18,884. The lease requires 48 monthly payments of $400 including interest at 9.75%.\nThe Company also entered into a capital lease agreement to purchase a computer for $4,304 which began on April 30, 1995 and requires 36 monthly payments of $130.\nThe following is a schedule by year of the future minimum lease payments due under capital leases together with the present value of the net minimum lease payments:\nYear Ended September 30: 1996 $104,125 1997 104,125 1998 103,345 1999 99,360 2000 97,763 After 2000 154,791 -------- Total minimum lease payments 663,509 Less amount representing interest 180,700 -------- Present value of minimum lease payments 482,809 Less current obligation under capital lease 57,103 -------- Non-current obligation under capital lease $425,706 ========\nCost and accumulated amortization of leased assets are as follows:\n1995 1994 -------------- ---------- Cost $ 513,108 $ - Accumulated amortization 23,290 - -------------- ---------- $ 489,818 $ - ============== ==========\nAmortization of assets under capital leases is included in depreciation expense and was $23,290 for the year ended September 30, 1995.\nThe Company rented space for a Minneapolis sales office under an operating lease which commenced June 1, 1990 and expired May 31, 1995. Rent expense under all operating leases was $16,488, $14,810 and $12,962 for the years ended September 30, 1995, 1994 and 1993, respectively.\nNote 7. Stock Options:\nThe Company has reserved shares of common stock for issuance to key employees and stockholders under incentive stock option and purchase plans. Options are exercisable on a graduated scale and\/or expire based on the individual terms of the option agreements. The options are exercisable at prices ranging from $ .50 to $2.00 per share. Other pertinent information related to the plan is as follows:\nThe options exercised during the years ended September 30, 1995, 1994 and 1993 were at an average price of $.81, $.66 and $1.25 per share, respectively.\nNote 8. Notes Receivable Arising From the Sale of Common Stock:\nIssued shares are being held by the Company as collateral for the above notes pending payment of the amounts due.\nNote 9. Major Customers:\nThe Company derived more than 10% of its net sales from the following unaffiliated customers and had receivable balances from those customers in the amounts of:\n* The net sales to customers A and B were less than 10% of the total net sales for the period indicated.\nNote 10. Income Taxes:\nEffective October 1, 1993, the Company adopted SFAS No. 109, \"Accounting for Income Taxes.\" The adoption of Statement 109 changes the Company's method of accounting for income taxes from the deferred method to a liability method. Under the deferred method, the Company recorded the tax effects of timing differences between financial reporting and taxable income. As explained in Note 1, the liability method requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the reported amounts of assets and liabilities and their tax bases. The cumulative effect relating to the adoption of Statement No. 109 was not significant.\nThe income tax components are as follows:\nNet deferred tax liabilities consist of the following:\nDifferences between income tax expense and the amount computed by applying the statutory federal income tax rates to earnings before income taxes are as follows:\nNote 11. Other Accrued Expenses:\nOther accrued expenses consist of the following:\nNote 12. Profit Sharing Plan:\nDuring the year ended September 30, 1993, the Company implemented a profit sharing plan under Section 401(k) of the Internal Revenue Code for all eligible employees. The Plan provides that Company contributions are at the discretion of the Board of Directors. In addition, participants may elect to enter into salary reduction agreements with the Company for a portion of their compensation. Company contributions for the years ended September 30, 1995, 1994 and 1993 were $18,000, $15,300 and $0, respectively.\nINDEPENDENT AUDITOR'S REPORT ON SCHEDULES\nBoard of Directors and Shareholders Lamcor, Incorporated LeSueur, Minnesota\nOur audits of the financial statements of Lamcor, Incorporated included schedules V, VI and IX contained herein, for the years ended September 30, 1995, 1994 and 1993.\nIn our opinion, such schedules present fairly the information required to be set forth therein in conformity with generally accepted accounting principles.\nHOUSE, NEZERKA & FROELICH, P.A.\nBloomington, Minnesota November 20, 1995\nDepreciation and amortization of building, equipment and improvements are provided on the straight-line method over the following estimated useful lives of the assets:\nYears Building and improvements 3-40 Manufacturing equipment 5-15 Office equipment and other 3-5\nLAMCOR, INCORPORATED\nSCHEDULE VI - ACCUMULATED DEPRECIATION, DEPLETION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT\nLAMCOR, INCORPORATED\nSCHEDULE IX - SHORT-TERM BORROWINGS\n(1) Note payable to bank under a revolving line of credit borrowing arrangement which expires September 26, 1998. Collateralized by receivables, inventory and equipment.\n(2) Note payable to bank under a revolving line of credit borrowing arrangement which expires October 10, 1995. Collateralized by receivables, inventory and equipment.\n(3) Note payable to bank under a revolving line of credit borrowing arrangement which expires November 3, 1994. Collateralized by receivables, inventory and equipment.\n(4) Note payable to bank dated September 28, 1993 under a revolving line of credit borrowing arrangement which expires December 28, 1998. Collateralized by receivables, inventory and equipment.\n(5) Total of daily outstanding principal balances divided by days in the year.\n(6) Actual interest divided by the average amount outstanding.","section_15":""}
{"filename":"808377_1995.txt","cik":"808377","year":"1995","section_1":"ITEM 1. BUSINESS --------\nDevelopment and Description of Business - ---------------------------------------\nThe information required by Part I, Item 1 is contained in (1) Part II, Item 6, Selected Financial Data; (2) Part II, Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations and (3) Part IV, Item 14 in Notes 1, 2, 3 and 4 of the notes to financial statements, which are incorporated herein by reference.\nEmployees - ---------\nThe Company has no employees. Services are performed by the General Partner and agents retained by it.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES ----------\nThe following is a description of the hotels and the leasehold interests owned by the Partnership as of December 31, 1995:\nI-1\nPART I ------\nOn July 19, 1995, the Partnership sold the Days Inn Kankakee to American Indus Hotels, Inc., an unaffiliated entity. See Part II, Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations and the notes to the financial statements for additional information pertaining to the sale.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS -----------------\nThere are no material pending legal proceedings to which the Partnership is a party.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ---------------------------------------------------\nNo matters were submitted to a vote of security holders during the fourth quarter of 1995.\nI-2\nPART II -------\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S PARTNERSHIP INTERESTS AND ----------------------------------------------------- RELATED PARTNERSHIP MATTERS ---------------------------\n(a), (b) and (c)\nThe information required in these sections is part of the Selected Financial Data included in Part II, Item 6, which is incorporated herein by reference.\nII-1\nPART II -------\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA -----------------------\n(1) Certain amounts in the 1993, 1992 and 1991 selected financial data have been reclassified to conform to the 1995 presentation.\nMarket Data - -----------\nThe Partnership's Beneficial Assignee Certificates (BACs) of limited partnership interests were sold through a public offering managed by CRICO Securities Corporation and certain participating broker-dealers. As of February 28, 1996, there were approximately 1,700 registered holders of BACs in the Partnership. The Partnership BACs are not publicly traded on any registered stock exchange but can be traded on an informal secondary market. The Partnership has been informed by Equity Resource Fund XVIII (Fund XVIII), a Massachusetts limited partnership, that Fund XVIII initiated a tender offer on February 16, 1996, to purchase up to 30,000 BACs on a \"first-come, first-buy\" basis, at a price of $8 per BAC. Fund XVIII has stated that it made the offer for the express purpose of holding the BACs as a long-term investment. The purchase offer of $8 per BAC was determined solely at the discretion of Fund XVIII and does not necessarily represent the fair market value of each BAC. The General Partner takes no position as to recommending or not recommending this\nII-2\nPART II -------\nITEM 6. SELECTED FINANCIAL DATA - Continued -----------------------\noffer to BAC Holders. The offer is expected to expire on March 16, 1996. As of February 16, 1996, Fund XVIII and\/or its affiliates held a 1.1% limited partner interest in the Partnership. If Fund XVIII is successful in acquiring 30,000 BACs, it would hold an additional 3.5% limited partner interest in the Partnership, bringing the total ownership percentage of Fund XVIII and\/or its affiliates to 4.6%. There is no assurance that Fund XVIII will acquire any or all of the 30,000 BACs as a result of this solicitation to BAC Holders. As of February 28, 1996, the Partnership was not aware of any BACs having been purchased by Fund XVIII as a result of this solicitation. Other than the Fund XVIII solicitation, it is not anticipated that there will be any other market for resale of BACs. As a result, an investor may be unable to sell or otherwise dispose of his or her interest in the Partnership.\nCash available for distribution, as defined in the Partnership Agreement, is intended to be distributed on a quarterly basis within sixty days after the end of each calendar quarter. The Partnership paid or accrued distributions of $2,033,028 and $1,690,915 to BAC Holders during 1995 and 1994, respectively. See Part II, Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, for additional information regarding the distributions during the years ended December 31, 1995 and 1994 and for a discussion of factors which may affect future distribution levels.\nII-3\nPART II -------\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL ------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS -----------------------------------\nGeneral -------\nCRI Hotel Income Partners, L.P. (the Partnership) is a limited partnership which was formed under the Delaware Revised Uniform Limited Partnership Act as of September 23, 1986 and will continue until December 31, 2016, unless dissolved earlier in accordance with the Partnership Agreement. The Partnership was formed for the purpose of investing in hotels that were acquired from Days Inns of America, Inc. (Days Inns). The Partnership's primary objective continues to be cash flow growth and capital appreciation. However, the attainment of this objective is principally dependent on the hotels' operations. The hotels are operated by Buckhead Hotel Management Company, Inc. (Buckhead), formerly known as Days Inns Management Company, Inc., under the nationally recognized franchise name of Days Inns.\nThe Registration Statement of the Partnership was declared effective by the Securities and Exchange Commission (SEC) on April 17, 1987, and subsequently, a Prospectus of the same date was printed. The Partnership registered a total of 6,000,000 Beneficial Assignee Certificates (BACs), at $25 per BAC, with the SEC. BACs represent beneficial assignments of limited partnership interests which were held by CRICO Hotel Fund, Inc. (CRICO Hotel Fund). BACs were to be offered in series, with Series A having a minimum of 196,000 BACs, or $4,900,000, and a maximum amount of 2,344,000 BACs, or $58,600,000. The Partnership terminated the Series A offering on March 31, 1988 with 868,662 BACs, or gross proceeds of $21,716,550, and does not intend to offer another series.\nThe General Partner of the Partnership is CRICO Hotel Associates I, L.P. (CRICO Associates), a Delaware limited partnership, the general partner of which is C.R.I., Inc. (CRI), a Delaware corporation. The General Partner has complete authority in the overall management and control of the Partnership. The Assignor Limited Partner of the Partnership is CRICO Hotel Fund.\nThe number of BACs sold generated sufficient proceeds to purchase the following hotels and leasehold interest:\nHotels Date of Purchase Amount of Purchase - -------------------- ---------------- ------------------ Clearwater Days Inn 4\/01\/88 $3,750,000 Days Inn Kankakee (A) 11\/01\/87 $2,250,000 Minneapolis Days Inn 11\/01\/87 $4,800,000 Plymouth Days Inn 12\/30\/87 $4,000,000 Roseville Days Inn 3\/01\/88 $4,200,000\nLeasehold interest Date of Purchase Amount of Purchase - -------------------- ---------------- ------------------ Scottsdale Days Inn (B) 7\/01\/88 $2,000,000\n(A) The Kankakee hotel was sold on July 19, 1995, as discussed below.\n(B) Included in the purchase of the Scottsdale leasehold interest was $618,000 allocated to furniture, fixtures and equipment.\nII-4\nPART II -------\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL ------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS - Continued -----------------------------------\nFinancial Condition\/Liquidity -----------------------------\nThe Partnership expects that the hotels in the aggregate will generate sufficient cash flow to achieve a positive cash flow after operating expenses. During 1996, certain hotels are expected to retain aggregate additional replacement reserves of approximately $138,000 for the purpose of funding the purchase of electronic door locks. The installation of these electronic door locks is required by the American Automobile Association (AAA) as a condition of the hotels being listed in AAA travel books. Other than the purchase of electronic door locks and the periodic replacement of fixed assets, which are also funded from the replacement reserves, there are no material commitments for capital expenditures.\nDue to the expiration of all remaining cash flow guarantees in 1993, the Partnership's liquidity and future results of operations are primarily dependent upon the performance of the underlying hotels. Hotel operations may be materially affected by changing market conditions and by seasonality caused by variables such as vacations, holidays and climate. The Partnership closely monitors its cash flow position in an effort to ensure that sufficient cash is available for operating requirements and distributions to BAC Holders. The Partnership's net cash provided by operating activities for 1995 and 1994 was adequate to support operating, investing and financing requirements and declared distributions to BAC Holders and the General Partners. Cash and cash equivalents decreased in 1994 principally due to deposits to the Partnership's working capital reserves. The Partnership estimates that existing cash and cash equivalents along with future cash flows from the hotels' operations, in the aggregate, will be sufficient to pay operating expenses and short term commitments, fund replacement reserves, and make distributions to BAC Holders. Short-term liabilities of $1,506,245 increased slightly from 1994. This resulted principally from an increase in declared distributions payable as a result of improved operations in 1995. In addition, accrued expenses at four hotels increased in 1995 as compared to 1994. These increases were offset by a decrease in hotel trade payables at five hotels, as well as a decrease in building lease payable resulting from the timing of lease payments made by one hotel.\nOn October 20, 1994, a contract for the sale of the Kankakee hotel was signed. The sale was completed on July 19, 1995. Accordingly, the assets of this hotel were classified as an asset held for sale on the balance sheet as of December 31, 1994. The sale price of the property of $1.2 million generated sufficient proceeds to the Partnership to retire the purchase money note obligation of the Partnership with respect to such property. The sale resulted in a net financial statement loss and a net tax loss in 1995 of approximately $7,000, and $607,000, respectively. Reserves for loss on the sale of the Kankakee hotel of $400,000 and $200,000 were recognized for financial statement purposes in 1994 and 1993, respectively. The sale of the Kankakee hotel is not expected to have a negative effect on the future net income or cash flow of the Partnership.\nOn February 21, 1995 and May 10, 1995, the Partnership advanced $35,000 and $42,000, respectively, from the working capital reserves to the Kankakee hotel to fund the hotel's short-term working capital needs. These advances were repaid and the working capital reserves were replenished on July 19, 1995 from\nII-5\nPART II -------\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL ------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS - Continued -----------------------------------\nsale proceeds of the Kankakee hotel, as discussed above. Additionally, 1994 advances of $62,055 were repaid from sale proceeds and were included in cash distributions from operating activities in the third quarter of 1995.\nWorking Capital Reserve - -----------------------\nThe working capital reserve of $225,000 and $150,000 as of December 31, 1995 and 1994, respectively, represents funds held in reserve, initially established in an amount of not less than 1% of Series A gross offering proceeds, which are maintained as working capital for the Partnership. The working capital reserves may be increased or reduced by the General Partner as it deems appropriate. The General Partner increased the working capital reserves by $75,000 and $100,000 during 1995 and 1994, respectively. Advances to the Kankakee hotel from working capital reserves during 1995 and 1994 were repaid to working capital reserves in 1995, as discussed above.\nStatement of Financial Accounting Standards No. 107, \"Disclosures About Fair Value of Financial Instruments\" (SFAS 107), requires the disclosure of fair value information about financial instruments for which it is practicable to estimate that value. The Partnership implemented SFAS 107 in 1995 and has determined that the carrying amount of its working capital reserves approximate fair value.\nGuaranteed Return on Hotels - ---------------------------\nThe Partnership entered into an agreement with Days Inns, Days Inns Corporation and Buckhead (collectively the Guarantors) whereby the Guarantors guaranteed a return on four hotels equal to 10.5% per year of the combined purchase price of the hotels for the first three consecutive twelve-month periods after the acquisition of each hotel. The guarantee period for the Minneapolis, Kankakee and Plymouth Days Inns expired in 1990, and the Roseville Days Inn guarantee expired in 1991. The Clearwater Days Inn 10.5% guarantee (for five consecutive twelve-month periods) expired March 31, 1993. The Scottsdale Days Inn 14% guarantee (for five consecutive twelve-month periods) expired June 30, 1993.\nDuring 1993, the remaining cash flow guarantees expired. The guarantee periods were on a fiscal year basis as compared to the guarantee payments which were paid quarterly on a calendar year basis. As a result of this timing difference, at the expiration of the guarantee period for the Clearwater and Scottsdale Days Inns, certain guarantee payments received by the Partnership were returned to the Guarantors and classified as recoveries on the statement of operations in 1993. Also included in recoveries on the statement of operations for 1993 are adjustments arising from a change in accounting estimate related to the timing differences between hotel operations and cash flows recorded by the Partnership.\nOn September 27, 1991, the Guarantors filed in the Bankruptcy Court for the District of Delaware a voluntary petition for reorganization (the Bankruptcy) pursuant to the provisions of Chapter 11 of the Federal Bankruptcy Code. The Partnership filed a proof of claim with the Bankruptcy Court. The Guarantors filed their plan for reorganization (the Plan), and the Plan was confirmed by\nII-6\nPART II -------\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL ------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS - Continued -----------------------------------\nthe Bankruptcy Court in 1992. As of December 31, 1993, $23,798 of the $145,549 remaining cash flow guarantee payment for the third quarter of 1991 and 2,345 shares of Buckhead America Corp. common stock had been received by the Partnership. On February 10, 1994, the Partnership received $3,589 and 261 shares of Buckhead America Corp. common stock. In 1995, the Partnership received $12,339 and 229 shares of Buckhead America Corp. common stock as a distribution from its beneficial interest in a trust (the Trust) established to receive proceeds from certain Buckhead litigation if such litigation is successful. The total recovery of cash flow guarantee payments to the Partnership aggregated $53,950 as of December 31, 1995, based on cash received and the market value of the common stock at the date of receipt. The common stock, which has a carrying value of $14,224 as of December 31, 1995, is included in receivables, reserve for replacements and other assets on the balance sheets. Based on the quoted market price of these instruments, the Partnership estimates that the fair value of the common stock approximates $18,000 as of December 31, 1995. The cash, shares of common stock and the beneficial interest in the Trust constitute full settlement of the Partnership's claim. There is no assurance that further distributions will be received as a result of the Partnership's beneficial interest in the Trust.\nPurchase Money Notes - --------------------\nIn addition to the capital provided by the sale of BACs, the Partnership received Zero Coupon Purchase Money Note (the Notes) financing from Days Inns for the acquisition of the hotels. The Notes are nonrecourse notes collateralized by the various properties. Each Note provides for a ten year maturity from the date of acquisition with an accrual of interest at 9% per annum, compounded on a monthly basis. Principal and accrued interest, which will equal 47.4% of the original purchase price of the hotel, is due to BancBoston Mortgage Corporation upon maturity of each Note. The Notes may be prepaid at the initial note balance plus accrued interest at any time without premium or penalty. The Kankakee note payable of $434,925 plus accrued interest of $440,746 was retired on July 19, 1995 in connection with the sale of the hotel, as discussed below. The Managing General Partner is currently investigating refinancing options for the remaining notes. There is no assurance that a refinancing or refinancings will be completed.\nThe balances of the Notes, including accrued interest, due upon maturity are as follows:\nII-7\nPART II -------\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL ------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS - Continued -----------------------------------\nSFAS 107 requires the disclosure of fair value information about financial instruments for which it is practicable to estimate that value. The Partnership has determined that it is not practicable to estimate the fair value of the Notes due to the lack of an active market for this type of financial instrument, as well as the excessive costs associated with an independent appraisal of the Notes.\nDistributions - -------------\nThe following distributions were paid or accrued to BAC Holders of record during 1995, 1994 and 1993:\nII-8\nPART II -------\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL ------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS - Continued -----------------------------------\n* Includes the distribution of net cash proceeds from the sale of the Kankakee hotel of $52,478 (approximately $0.06 per BAC), which is net of payment of outstanding Kankakee real estate taxes, retirement of the related note payable and repayment of Partnership advances.\nThe General Partner expects the distribution for the quarter ended March 31, 1996 to range from approximately $0.52 to $0.60 per BAC. The General Partner expects the distribution for the year ending December 31, 1996 to range from approximately $2.15 to $2.35 per BAC. Due to the expiration of the remaining cash flow guarantees during 1993, distributions are dependent on the net cash flow produced from hotel operations, net of Partnership expenses. The cash flow from certain hotels may be materially affected by changing market conditions and by seasonality. Also, cash flow from certain hotels in 1996 is expected to be reduced due to additions to replacement reserves in the first quarter of 1996 to fund the purchase of electronic door locks, as previously discussed.\nResults of Operations ---------------------\n1995 versus 1994 - ----------------\nThe Partnership's net income, which consists principally of revenues from hotel operations, increased in 1995 from 1994 primarily due to an 8% decrease in total hotel operating costs and expenses for 1995 as compared to 1994. Operating costs and expenses decreased 4% as a result of the reserve for loss on sale of the Kankakee hotel recognized in 1994, and decreased another 4% as a result of decreased operations and the eventual sale of the Kankakee hotel. Operating costs and expenses of the remaining hotels did not change significantly in 1995 from 1994. Partially offsetting the increase in net income was a .7% decrease in room revenue. Room revenue decreased 5% as a result of the sale of the Kankakee hotel in the third quarter of 1995, as discussed above. This decrease in room revenue was partially offset by a 4%\nII-9\nPART II -------\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL ------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS - Continued -----------------------------------\nincrease in room revenue from the remaining hotels, primarily due to an increase in average room rates at all hotels.\n1994 versus 1993 - ----------------\nThe Partnership's net income increased in 1994 from 1993. Room revenue increased approximately 11% in 1994 from 1993 primarily due to an increase in average occupancy at five of the six hotels, as well as an increase in average room rates at all six hotels. Contributing to the increase in net income was the return in 1993 of previously received guarantee payments due to the timing of guarantee payments, as discussed above. Also contributing to the increase in net income was a decrease in depreciation and amortization expense in 1994 from 1993, principally due to certain assets becoming fully amortized in the first quarter of 1994. An increase in telephone revenue relating to the increase in hotel occupancies also contributed to the increase in net income. Partially offsetting the increase in net income was an additional reserve for loss on the anticipated sale of the Kankakee hotel recorded in 1994, as discussed above. Also partially offsetting the increase in net income was an increase in room expenses relating to the increases in hotel occupancy, as well as an increase in management fees due to the payment of incentive management fees on two hotels in accordance with the amended management agreements, as discussed below. The hotel operations are further described in \"Hotels' Results of Operations.\"\nHotels' Results of Operations -----------------------------\nThe hotels' results of operations are affected by changing market conditions and by seasonality caused by variables such as vacations, holidays and climate. Based on the hotels' operating budgets, the following months should provide the highest gross operating income and net cash flow:\nHotel Location Peak Months ------------------ --------------------- Clearwater, FL October through April Minneapolis, MN May through October Plymouth, MN June through October Roseville, MN May through October Scottsdale, AZ January through May\nThe Statements of Operations include operating results for each of the hotels as outlined below. Gross Operating Income represents total revenue less departmental expenses. Net Cash Flow represents cash flow after operating expenses and before replacement reserves and guarantee payments. The operating results and average occupancy for the hotels for the years ended December 31, 1995, 1994 and 1993 are as follows:\nII-10\nPART II -------\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL ------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS - Continued -----------------------------------\nII-11\nPART II -------\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL ------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS - Continued -----------------------------------\n(1) The 1995 operating results presented for the Kankakee hotel are through July 19, 1995, the date of sale.\n(2) The sub-totals and totals for average occupancy are based on a weighted average taking into consideration the number of rooms at each location.\nOn January 1, 1993, the management agreements between the Partnership and Buckhead, pertaining to Buckhead's management of each of the hotels, were amended to extend the existing term of each agreement for an additional two to five years and increase the base management fee from 2.5% to 3.5% of gross revenue. The amendments for the Clearwater Days Inn and the Scottsdale Days Inn included a modification to the method of calculating the incentive management fee. Incentive management fees of $78,408, $64,328 and $22,830 were earned or paid in 1995, 1994 and 1993, respectively. These agreements were amended as part of the bankruptcy process. The Partnership accepted these modifications to the management agreements in lieu of having the agreements terminated by Buckhead in its Chapter 11 Bankruptcy case (filed in 1991). Had the Partnership contracted another management agent, costs (which would have included franchise fees currently not payable because of Buckhead's management of the hotels) were expected to exceed the increase in management fees.\n1995 versus 1994 - ----------------\nGross operating income and net cash flow for the Clearwater hotel increased in 1995 from 1994 primarily due to an increase in average room rates, as well as management's implementation of cost-control strategies. The hotel lost a major client in the fourth quarter of 1995 when the client relocated its training facilities out of the Clearwater area. This client accounted for approximately 11% of total room revenue for the Clearwater hotel in 1995. Gross operating income and net cash flow for the Minneapolis hotel increased in 1995 from 1994 primarily due to an increase in room rates resulting from management's marketing\nII-12\nPART II -------\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL ------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS - Continued -----------------------------------\nprograms. Gross operating income and net cash flow for the Plymouth hotel increased in 1995 from 1994 primarily due to an increase in room rates resulting from increased group volume. Gross operating income and net cash flow for the Roseville hotel increased in 1995 from 1994 primarily due to an increase in occupancy and average room rates resulting from increased room demand in the Roseville area. Gross operating income for the Scottsdale hotel did not change significantly in 1995 from 1994 as a decrease in occupancy was offset by an increase in average room rates. Net cash flow for the Scottsdale hotel increased in 1995 from 1994 as a result of increased cost control efforts in 1995. The Kankakee hotel was sold on July 19, 1995, as previously discussed. From January 1, 1995 to the date of sale, gross operating income and net cash flow for the Kankakee hotel decreased from the same period in 1994 primarily due to the re-opening of a nearby competitor, as well as the opening of a new competitor in 1994.\n1994 versus 1993 - ----------------\nGross operating income and net cash flow for the Clearwater hotel did not change significantly in 1994 from 1993 despite an overall decline in Florida tourism. Gross operating income and net cash flow for the Minneapolis hotel increased in 1994 from 1993 primarily due to an increase in occupancy and room rates resulting from management's marketing programs and increased room demand in the Minneapolis area. Gross operating income and net cash flow for the Plymouth hotel increased in 1994 from 1993 primarily due to an increase in occupancy and room rates resulting from increased room demand in the Plymouth area. Gross operating income and net cash flow for the Roseville hotel increased in 1994 from 1993 primarily due to an increase in occupancy resulting from increased room demand in the Roseville area and an increase in room rates resulting from management's strategy to displace lower rated volume business with higher rated segments. Gross operating income and net cash flow for the Scottsdale hotel increased in 1994 from 1993 primarily due to an increase in room rates and occupancy resulting from increased room demand in the Scottsdale area combined with new corporate accounts secured in 1994. Gross operating income and net cash flow for the Kankakee hotel increased in 1994 from 1993 primarily due to an increase in occupancy and room rates resulting from the temporary closing of a major competitor and a decrease in operating expenses resulting from a reduction in hotel staff and other cost-saving measures.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA -------------------------------------------\nThe information required by this item is contained in Part IV.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ------------------------------------------------ ACCOUNTING AND FINANCIAL DISCLOSURES ------------------------------------\nNone.\nII-13\nPART III --------\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT --------------------------------------------------\n(a), (b) and (c) The Partnership has no directors, executive officers or significant employees of its own. (a), (b), (c) and (e) The names, ages and business experience of the directors and executive officers of C.R.I., Inc. (CRI), the Managing General Partner of the Partnership, are as follows:\nWilliam B. Dockser, 59, has been the Chairman of the Board of CRI and a Director since 1974. Prior to forming CRI, he served as President of Kaufman and Broad Asset Management, Inc., an affiliate of Kaufman and Broad, Inc., which managed a number of publicly held limited partnerships created to invest in low and moderate income multifamily apartment complexes. For a period of 2-1\/2 years prior to joining Kaufman and Broad, he served in various positions at HUD, culminating in the post of Deputy FHA Commissioner and Deputy Assistant Secretary for Housing Production and Mortgage Credit, where he was responsible for all federally insured housing production programs. Before coming to Washington, Mr. Dockser was a practicing attorney in Boston and also was a special Assistant Attorney General for the Commonwealth of Massachusetts. He holds a Bachelor of Laws degree from Yale University Law School and a Bachelor of Arts degree, cum laude, from Harvard University. He is also Chairman of the Board of CRIIMI MAE Inc., CRIIMI, Inc. and CRI Liquidating REIT, Inc.\nH. William Willoughby, 49, President, Secretary and a Director of CRI since January 1990 and Senior Executive Vice President, Secretary and a Director of CRI from 1974 to 1989. He is principally responsible for the financial management of CRI and its associated partnerships. Prior to joining CRI in 1974, he was Vice President of Shelter Corporation of America and a number of its subsidiaries dealing principally with real estate development and equity financing. Before joining Shelter Corporation, he was a senior tax accountant with Arthur Andersen & Company. He holds a Juris Doctorate degree, a Master of Business Administration degree and a Bachelor of Science degree in Business Administration from the University of South Dakota. He is also a Director and executive officer of CRIIMI MAE Inc., CRIIMI, Inc. and CRI Liquidating REIT, Inc.\nRichard J. Palmer, 44, Senior Vice President-Chief Financial Officer. Prior to joining CRI in 1983 as Director of Tax Policy, he was a Tax Manager at Grant Thornton (formerly Alexander Grant & Company). He also served in the Tax and Audit Departments of Peat, Marwick, Main and Company (formerly Peat, Marwick, Mitchell and Company) prior to his seven years at Grant Thornton. He holds a Bachelor of Business Administration degree from the Florida Atlantic University and is also a Certified Public Accountant.\nRonald W. Thompson, 49, Group Executive Vice President-Hotel Asset Management. Prior to joining CRI in 1985, he was employed at the Hyatt Organization where he most recently served as the General Manager of the Hyatt Regency in Flint, Michigan. During his nine year tenure with Hyatt, Mr. Thompson held senior management positions with the Hyatt Regency in Dearborn, Michigan, the Hyatt in Richmond, Virginia, the Hyatt in Winston-Salem, North Carolina and the Hyatt Regency in Atlanta, Georgia. Before joining Hyatt, Mr. Thompson worked in London, England for the English Tourist Board as well as holding management positions in Europe, Australia, and New Zealand in the hotel industry. Mr. Thompson received his education in England where he received a business degree in Hotel Administration from Winston College.\nIII-1\nPART III --------\nITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - Continued --------------------------------------------------\nSusan R. Campbell, 37, Senior Vice President-CRI Realty Services. Prior to joining CRI in March 1985, she was employed by the B. F. Saul Advisory Company. She holds a Bachelor of Science degree in business from the University of Maryland.\nMelissa Cecil Lackey, 39, Senior Vice President and General Counsel. Prior to joining CRI in 1990, she was associated with the firms of Zuckerman, Spaeder, Goldstein, Taylor & Kolker in Washington, D.C. and Hirsch & Westheimer in Houston, Texas. She holds a Juris Doctorate from the University of Virginia School of Law and a Bachelor of Arts degree from the College of William & Mary.\n(d) There is no family relationship between any of the foregoing directors and executive officers.\n(f) Involvement in certain legal proceedings.\nNone.\n(g) Promoters and control persons.\nNot applicable.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION ----------------------\nThe information required by Item 11 is incorporated herein by reference to Note 6 of the notes to the financial statements contained in Part IV, Item 14.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND --------------------------------------------------- MANAGEMENT ----------\n(a) Security ownership of certain beneficial owners.\nNo person or \"group\", as that term is used in Section 13(d)(3) of the Securities Exchange Act of 1934, is known by the Partnership to be the beneficial owner of more than 5% of the issued and outstanding BACs at February 28, 1996.\n(b) Security ownership of management.\nThe following table sets forth certain information concerning all BACs beneficially owned, as of February 28, 1996, by each director and by all directors and officers as a group of the managing general partner of the Partnership's General Partner. The voting and investment powers for the BACs listed are held solely by the named beneficial owner.\nIII-2\nPART III --------\nITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND --------------------------------------------------- MANAGEMENT - Continued ----------\n(c) Changes in control.\nThere exists no arrangement known to the Partnership, the operation of which may, at a subsequent date, result in a change in control of the Partnership. There is a provision in the Limited Partnership Agreement which allows, under certain circumstances, the ability to change control.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ----------------------------------------------\n(a) Transactions with management and others.\nThe Partnership has no directors or officers. In addition, the Partnership has had no transactions with individual officers or directors of the managing general partner of the General Partner of the Partnership other than any indirect interest such officers and directors may have in the amounts paid to the General Partner or its affiliates by virtue of either their partnership interest in the managing general partner of the General Partner or their stock ownership in CRI, respectively. Item 11 of this report, which contains a discussion of the fees and other compensation paid or accrued by the Partnership to the General Partner or its affiliates, is incorporated herein by reference.\n(b) Certain business relationships.\nThe Partnership's response to Item 13(a) is incorporated herein by reference. In addition, the Partnership has no business relationship with entities of which the managing general partner of the General Partner of the Partnership are officers, directors or equity owners other than as set forth in the Partnership's response to Item 13(a).\n(c) Indebtedness of management.\nNone.\n(d) Transactions with promoters.\nNot applicable.\nIII-3\nPART IV -------\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON ------------------------------------------------------- FORM 8-K --------\n(a) 1. Financial Statements Page -------------------- ----\nReport of Independent Certified Public Accountants IV-5\nBalance Sheets as of December 31, 1995 and 1994 IV-6\nStatements of Operations for the years ended December 31, 1995, 1994 and 1993 IV-8\nStatements of Changes in Partners' Capital (Deficit) for the years ended December 31, 1995, 1994 and 1993 IV-9\nStatements of Cash Flows for the years ended December 31, 1995, 1994 and 1993 IV-10\nNotes to Financial Statements IV-11\n(a) 2. Financial Statement Schedules -----------------------------\nReport of Independent Certified Public Accountants on Financial Statement Schedules IV-22\nSchedule III - Real Estate and Accumulated Depreciation IV-23\nThe remaining schedules are omitted because the required information is included in the financial statements and notes thereto or they are not applicable or not required.\n(a) 3. Exhibits (listed according to the number assigned in the table in Item 601 of Regulation S-K)\nExhibit 1 - Underwriting Agreement\na. Forms of Sales Agency Agreement, incorporated by reference to the Registration Statement on Form S-1 filed on December 24, 1986. b. Forms of Selected Dealer Agreements, incorporated by reference to the Registration Statement on Form S-1 filed on December 24, 1986.\nIV-1\nPART IV -------\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON ------------------------------------------------------- FORM 8-K - Continued --------\nExhibit 3 - Articles of Incorporation and Bylaws\na. Certificate of Limited Partnership dated as of September 23, 1986 of CRI Hotel Income Partners, L.P. (formerly named CRI Hotel Income Fund, L.P.), incorporated by reference to the Registration Statement on Form S-1 filed on December 24, 1986.\n1. Amendment dated as of March 12, 1987. 2. Amendment dated as of April 17, 1987.\nExhibit 10 - Material Contracts\na. Sale\/Purchase Agreement, dated as of October 9, 1986, by and between Days Inns of America, Inc. (DIA), Days Inns Corp. (DIC), Days Inns Management Company, Inc. (DIMC), and CRI Hotel Income Fund, L.P., and six modifications thereof, incorporated by reference to the Registration Statement on Form S-1 filed on December 24, 1986. b. Form of Management Agreement by and between DIMC and CRI Hotel Income Fund, L.P., incorporated by reference to the Registration Statement on Form S-1 filed on December 24, 1986. c. Forms of Cash Flow Guarantee Agreement (Interim and Permanent) by and between DIC, DIA, DIMC and CRI Hotel Income Fund, L.P., incorporated by reference to the Registration Statement on Form S-1 filed on December 24, 1986. d. Form of Bond Escrow Agreement by and between DIA, CRI Hotel Income Fund, L.P. and Escrow Agent, incorporated by reference to the Registration Statement on Form S-1 filed on December 24, 1986. e. Form of Escrow Agreement between Registrant and Escrow Agent, incorporated by reference to the Registration Statement on Form S-1 filed on December 24, 1986. f. Form of Beneficial Assignee Certificate, incorporated by reference to the Registration Statement on Form S-1 filed on December 24, 1986. g. Forms of Amendment to Hotel Management Agreement by and between CRI Hotel Income Partners, L.P. and Buckhead Hotel Management Company, Inc. incorporated by reference to the 1994 Annual Report of Form 10-K filed on March 15, 1995.\nExhibit 27 - Financial Data Schedule\n(b) Reports on Form 8-K -------------------\nNo reports on Form 8-K were filed during the quarter ended December 31, 1995.\nIV-2\nPART IV -------\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON ------------------------------------------------------- FORM 8-K - Continued --------\n(c) Exhibits --------\nThis list of Exhibits required by Item 601 of Regulation S-K is included in Item (a)(3) above.\n(d) Financial Statement Schedules -----------------------------\nSee Item a (2), above.\nIV-3\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.\nCRI Hotel Income Partners, L.P.\nBy: CRICO Hotel Associates I, L.P., General Partner\nBy: C.R.I., Inc., General Partner\nMarch 5, 1996 \/s\/ William B. Dockser - -------------- ------------------------------------ DATE William B. Dockser, Director Chairman of the Board, Treasurer and Principal Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:\nMarch 5, 1996 \/s\/ H. William Willoughby - -------------- ------------------------------------ DATE H. William Willoughby Director, President and Secretary\nMarch 5, 1996 \/s\/ Richard J. Palmer - -------------- ------------------------------------ DATE Richard J. Palmer Senior Vice President, Finance Chief Financial Officer Principal Financial and Principal Accounting Officer\nIV-4\nReport of Independent Certified Public Accountants --------------------------------------------------\nTo the Partners CRI Hotel Income Partners, L.P.\nWe have audited the accompanying balance sheets of CRI Hotel Income Partners, L.P. as of December 31, 1995 and 1994, and the related statements of operations, changes in partners' capital (deficit), and cash flows for the years ended December 31, 1995, 1994 and 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 CRI Hotel Income Partners, L.P. as of December 31, 1995 and 1994 and the results of its operations, changes in partners' capital (deficit) and cash flows for the years ended December 31, 1995, 1994 and 1993, in conformity with generally accepted accounting principles.\nGrant Thornton LLP\nVienna, VA February 28, 1996\nIV-5\nCRI HOTEL INCOME PARTNERS, L.P.\nBALANCE SHEETS\nASSETS\nThe accompanying notes are an integral part of these financial statements.\nIV-6\nCRI HOTEL INCOME PARTNERS, L.P.\nBALANCE SHEETS\nLIABILITIES AND PARTNERS' CAPITAL (DEFICIT)\nThe accompanying notes are an integral part of these financial statements.\nIV-7\nCRI HOTEL INCOME PARTNERS, L.P.\nSTATEMENTS OF OPERATIONS\nThe accompanying notes are an integral part of these financial statements.\nIV-8\nCRI HOTEL INCOME PARTNERS, L.P.\nSTATEMENTS OF CHANGES IN PARTNERS' CAPITAL (DEFICIT)\nFor the years ended December 31, 1995, 1994 and 1993\nThe accompanying notes are an integral part of these financial statements.\nIV-9\nCRI HOTEL INCOME PARTNERS, L.P.\nSTATEMENTS OF CASH FLOWS\nThe accompanying notes are an integral part of these financial statements.\nIV-10\nCRI HOTEL INCOME PARTNERS, L.P.\nNOTES TO FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\na. Organization and offering -------------------------\nCRI Hotel Income Partners, L.P. (the Partnership) is a limited partnership which was formed under the Delaware Revised Uniform Limited Partnership Act as of September 23, 1986 and will continue until December 31, 2016, unless dissolved earlier in accordance with the Partnership Agreement. The Partnership was formed for the purpose of investing in hotels that were acquired from Days Inns of America, Inc. (Days Inns). The Partnership's primary objective continues to be cash flow growth and capital appreciation. However, the attainment of this objective is principally dependent on the hotels' operations. The hotels are operated by Buckhead Hotel Management Company, Inc. (Buckhead), formerly known as Days Inns Management Company, Inc., under the nationally recognized franchise name of Days Inns.\nThe Registration Statement of the Partnership was declared effective by the Securities and Exchange Commission (SEC) on April 17, 1987, and subsequently, a Prospectus of the same date was printed. The Partnership registered a total of 6,000,000 Beneficial Assignee Certificates (BACs), at $25 per BAC, with the SEC. BACs represent beneficial assignments of limited partnership interests which were held by CRICO Hotel Fund, Inc. (CRICO Hotel Fund). BACs were to be offered in series, with Series A having a minimum of 196,000 BACs, or $4,900,000, and a maximum amount of 2,344,000 BACs, or $58,600,000. The Partnership terminated the Series A offering on March 31, 1988 with 868,662 BACs, or gross proceeds of $21,716,550, and does not intend to offer another series.\nThe General Partner of the Partnership is CRICO Hotel Associates I, L.P. (CRICO Associates), a Delaware limited partnership, the general partner of which is C.R.I., Inc. (CRI), a Delaware corporation. The General Partner has complete authority in the overall management and control of the Partnership. The Assignor Limited Partner of the Partnership is CRICO Hotel Fund.\nCumulative offering costs in the amount of $2,580,132, consisting of legal and filing fees and certain travel, communication and other expenses, were recorded as a reduction of partners' capital when incurred and are not amortized for financial statement or income tax purposes.\nb. Method of Accounting --------------------\nThe financial statements of the Partnership have been prepared on the accrual basis of accounting in accordance with generally accepted accounting principles.\nIV-11\nCRI HOTEL INCOME PARTNERS, L.P.\nNOTES TO FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued\nc. Use of estimates ----------------\nIn preparing financial statements in conformity with generally accepted accounting principles, the Partnership is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses during the reporting period. Actual results could differ from those estimates.\nd. Fair value of financial instruments -----------------------------------\nStatement of Financial Accounting Standards No. 107, \"Disclosures About Fair Value of Financial Instruments\" (SFAS 107), requires the disclosure of fair value information about financial instruments for which it is practicable to estimate that value. The Partnership implemented SFAS 107 in 1995.\ne. Cash and cash equivalents -------------------------\nCash and cash equivalents consist of all time and demand deposits, repurchase agreements and commercial paper with original maturities of three months or less. The Partnership has determined that the carrying amount of its cash and cash equivalents approximate fair value.\nf. Working capital reserve -----------------------\nThe working capital reserve of $225,000 and $150,000 as of December 31, 1995 and 1994, respectively, represents funds held in reserve, initially established in an amount of not less than 1% of Series A gross offering proceeds, which are maintained as working capital for the Partnership. The working capital reserves may be increased or reduced by the General Partner as it deems appropriate. The General Partner increased the working capital reserves by $75,000 and $100,000 during 1995 and 1994, respectively. Advances to the Kankakee hotel from working capital reserves during 1995 and 1994 were repaid to working capital reserves in 1995, as discussed below. The Partnership has determined that the carrying amount of its working capital reserves approximate fair value.\ng. Reserve for replacements ------------------------\nPursuant to the terms of the Management Agreement, the hotels retain 3% of gross hotel revenues for a reserve for replacement of fixed assets.\nIV-12\nCRI HOTEL INCOME PARTNERS, L.P.\nNOTES TO FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued\nh. Depreciation and amortization -----------------------------\nDepreciation is based on the estimated useful lives of depreciable assets using the straight-line method. The estimated lives used in determining depreciation are as follows:\nType of Asset Estimated Life --------------------------------- ----------------- Building and site improvements 30 years Furniture, fixtures and equipment 5-10 years Leasehold improvements 5 years, 7 months\nAmortization of property purchase costs and acquisition fees is provided for over a 30-year period on a straight-line basis.\ni. Income taxes ------------\nFor federal and state income tax purposes, each partner reports on his or her personal income tax return his or her share of the Partnership's income or loss as determined for tax purposes. Accordingly, no provision has been made for income taxes in these financial statements.\nj. Statements of Cash Flows ------------------------\nThe statements of cash flows are intended to reflect only cash receipt and cash disbursement activity; therefore, the statements do not reflect investing and financing activity affecting recognized assets or liabilities which was not a result of cash receipts or payments. This non-cash activity principally consists of distributions payable of $549,562 and $452,059 at December 31, 1995 and 1994, respectively. Other than the pay-off of the Kankakee purchase money note principal and accrued interest of $434,925 and $440,746, respectively, in connection with the sale of the hotel in 1995, as discussed below, the Partnership did not pay interest on long-term debt during 1995, 1994 or 1993, pursuant to the terms of the debt agreements.\nk. Assets held for sale --------------------\nOn October 20, 1994, a contract for the sale of the Kankakee hotel was signed. The sale was completed on July 19, 1995. Accordingly, the assets of this hotel were classified as an asset held for sale on the balance sheet as of December 31, 1994. Assets held for sale are not recorded in excess of estimated net realizable value. Reserves for loss on the sale of the Kankakee hotel of $400,000 and $200,000 were recognized for financial statement purposes in 1994 and 1993, respectively, to reduce the asset to its estimated net realizable basis.\nIV-13\nCRI HOTEL INCOME PARTNERS, L.P.\nNOTES TO FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued\nl. Implementation of accounting standards --------------------------------------\nIn March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121 \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of\". This statement addresses how entities should measure impairment on long-lived assets. This statement is effective for fiscal years beginning after December 15, 1995 and will be implemented by the Partnership in 1996. The adoption of SFAS 121 is not expected to have a material effect on the Partnership's financial statements.\nm. Reclassifications -----------------\nCertain amounts in the 1993 financial statements have been reclassified to conform to the 1995 presentation.\n2. HOTELS AND LEASEHOLD INTEREST OWNED BY THE PARTNERSHIP\nThe number of BACs sold generated sufficient proceeds to purchase the following hotels and leasehold interest:\nHotels Date of Purchase Amount of Purchase - -------------------- ---------------- ------------------ Clearwater Days Inn 4\/01\/88 $3,750,000 Days Inn Kankakee (A) 11\/01\/87 $2,250,000 Minneapolis Days Inn 11\/01\/87 $4,800,000 Plymouth Days Inn 12\/30\/87 $4,000,000 Roseville Days Inn 3\/01\/88 $4,200,000\nLeasehold interest Date of Purchase Amount of Purchase - -------------------- ---------------- ------------------ Scottsdale Days Inn (B) 7\/01\/88 $2,000,000\n(A) The Kankakee hotel was sold on July 19, 1995, as discussed below.\n(B) Included in the purchase of the Scottsdale leasehold interest was $618,000 allocated to furniture, fixtures and equipment.\nOn October 20, 1994, a contract for the sale of the Kankakee hotel was signed. The sale was completed on July 19, 1995. Accordingly, the assets of this hotel were classified as an asset held for sale on the balance sheet as of December 31, 1994. The sale price of the property of $1.2 million generated sufficient proceeds to the Partnership to retire the purchase money note obligation of the Partnership with respect to such property. The sale resulted in a net financial statement loss and a net tax loss in 1995 of approximately $7,000, and $607,000, respectively. Reserves for loss on the sale of the Kankakee hotel of $400,000 and $200,000 were recognized for financial statement purposes in 1994 and 1993, respectively. The sale of the Kankakee hotel is not expected to have a negative effect on the future net income or cash flow of the Partnership.\nOn February 21, 1995 and May 10, 1995, the Partnership advanced $35,000 and $42,000, respectively, from the working capital reserves to the Kankakee hotel to fund the hotel's short-term working capital needs. These advances were\nIV-14\nCRI HOTEL INCOME PARTNERS, L.P.\nNOTES TO FINANCIAL STATEMENTS\n2. HOTELS AND LEASEHOLD INTEREST OWNED BY THE PARTNERSHIP - Continued\nrepaid and the working capital reserves were replenished on July 19, 1995 from sale proceeds of the Kankakee hotel, as discussed above. Additionally, 1994 advances of $62,055 were repaid from sale proceeds and are included in cash distributions from operating activities in the third quarter of 1995.\n3. NOTES PAYABLE\nIn addition to the capital provided by the sale of BACs, the Partnership received Zero Coupon Purchase Money Note (the Notes) financing from Days Inns for the acquisition of the hotels. The Notes are nonrecourse notes collateralized by the various properties. Each Note provides for a ten year maturity from the date of acquisition with an accrual of interest at 9% per annum, compounded on a monthly basis. Principal and accrued interest, which will equal 47.4% of the original purchase price of the hotel, is due to BancBoston Mortgage Corporation upon maturity of each Note. The Notes may be prepaid at the initial note balance plus accrued interest at any time without premium or penalty. The Kankakee note payable of $434,925 plus accrued interest of $440,746 was retired on July 19, 1995 in connection with the sale of the hotel, as discussed below. The Managing General Partner is currently investigating refinancing options for the remaining notes. There is no assurance that a refinancing or refinancings will be completed.\nAs of December 31, 1995 and 1994, the Notes, including accrued interest, consist of the following:\nIV-15\nCRI HOTEL INCOME PARTNERS, L.P.\nNOTES TO FINANCIAL STATEMENTS\n3. NOTES PAYABLE - Continued\n(A) The Kankakee note payable of $434,925 plus accrued interest of $440,746 was retired July 19, 1995 in connection with the sale of the hotel, as discussed above.\nCumulative accrued interest on the Notes was $3,367,199 and $3,192,786 at December 31, 1995 and 1994, respectively. Interest expense during 1995, 1994 and 1993 was $615,159, $588,797 and $538,300, respectively.\nThe balances of the Notes, including accrued interest, due upon maturity are as follows:\nSFAS 107 requires the disclosure of fair value information about financial instruments for which it is practicable to estimate that value. The Partnership has determined that it is not practicable to estimate the fair value of the Notes due to the lack of an active market for this type of financial instrument, as well as the excessive costs associated with an independent appraisal of the Notes.\nIV-16\nCRI HOTEL INCOME PARTNERS, L.P.\nNOTES TO FINANCIAL STATEMENTS\n4. COMMITMENTS\na. Cash flow guarantee -------------------\nThe Partnership entered into an agreement with Days Inns of America, Inc., Days Inns Corporation and Buckhead (collectively the Guarantors) whereby the Guarantors guaranteed a return on four hotels equal to 10.5% per year of the combined purchase price of the hotels for the first three consecutive twelve-month periods after the acquisition of each hotel. The guarantee period for the Minneapolis, Kankakee and Plymouth Days Inns expired in 1990, and the Roseville Days Inn guarantee expired in 1991. The Clearwater Days Inn 10.5% guarantee (for five consecutive twelve-month periods) expired March 31, 1993. The Scottsdale Days Inn 14% guarantee (for five consecutive twelve-month periods) expired June 30, 1993.\nDuring 1993, the remaining cash flow guarantees expired. The guarantee periods were on a fiscal year basis as compared to the guarantee payments which were paid quarterly on a calendar year basis. As a result of this timing difference, at the expiration of the guarantee period for the Clearwater and Scottsdale Days Inns, certain guarantee payments received by the Partnership were returned to the Guarantors and classified as recoveries on the statement of operations in 1993. Also included in recoveries on the statement of operations for 1993 are adjustments arising from a change in accounting estimate related to the timing differences between hotel operations and cash flows recorded by the Partnership.\nOn September 27, 1991, the Guarantors filed in the Bankruptcy Court for the District of Delaware a voluntary petition for reorganization (the Bankruptcy) pursuant to the provisions of Chapter 11 of the Federal Bankruptcy Code. The Partnership filed a proof of claim with the Bankruptcy Court. The Guarantors filed their plan for reorganization (the Plan), and the Plan was confirmed by the Bankruptcy Court in 1992. As of December 31, 1993, $23,798 of the $145,549 remaining cash flow guarantee payment for the third quarter of 1991 and 2,345 shares of Buckhead America Corp. common stock had been received by the Partnership. On February 10, 1994, the Partnership received $3,589 and 261 shares of Buckhead America Corp. common stock. In 1995, the Partnership received $12,339 and 229 shares of Buckhead America Corp. common stock as a distribution from its beneficial interest in a trust (the Trust) established to receive proceeds from certain Buckhead litigation if such litigation is successful. The total recovery of cash flow guarantee payments to the Partnership aggregated $53,950 as of December 31, 1995, based on cash received and the market value of the common stock at the date of receipt. The common stock, which has a carrying value of $14,224 as of December 31, 1995, is included in receivables, reserve for replacements and other assets on the balance sheets. Based on the quoted market price of these instruments, the Partnership estimates that the fair value of the common stock approximates $18,000 as of December 31, 1995. The cash, shares of common stock and the beneficial interest in the Trust constitute full settlement of the Partnership's claim. There is no assurance that further distributions will be received as a result of the Partnership's beneficial interest in the Trust.\nb. Hotel operations management agreements --------------------------------------\nThe Partnership entered into management agreements with Buckhead in connection with operations of the hotels. Each agreement was for an initial\nIV-17\nCRI HOTEL INCOME PARTNERS, L.P.\nNOTES TO FINANCIAL STATEMENTS\n4. COMMITMENTS - Continued\nterm of ten years, with a five-year renewal option. The agreements called for a base management fee of 2.5% of gross revenue from operations, a marketing fee of 1.5% of net room revenues, and a reservation fee of 2.3% of gross revenues from rental of hotel guest rooms. The agreements also called for incentive management fees generally equal to 25% of net cash flow available after payment of a preferred cash flow return to the Partnership equal to 11% of the aggregate purchase price for Series A hotels owned by the Partnership.\nOn January 1, 1993, the management agreements between the Partnership and Buckhead, pertaining to Buckhead's management of each of the hotels, were amended to extend the existing term of each agreement for an additional two to five years and increase the base management fee from 2.5% to 3.5% of gross revenue. The amendments for the Clearwater Days Inn and the Scottsdale Days Inn included a modification to the method of calculating the incentive management fee. Incentive management fees of $78,408, $64,328 and $22,830 were earned or paid in 1995, 1994 and 1993, respectively. These agreements were amended as part of the bankruptcy process. The Partnership accepted these modifications to the management agreements in lieu of having the agreements terminated by Buckhead in the Bankruptcy. Had the Partnership contracted another management agent, costs (which would have included franchise fees currently not payable because of Buckhead's management of the hotels) were expected to exceed the increase in management fees.\nc. Operating lease agreements --------------------------\nThe Partnership assumed an existing lease agreement from Days Inns in connection with the acquisition of the leasehold interest in the Scottsdale Days Inn. The assumption transfers the rights to operate the property on the lease's existing terms over the remaining life of the lease. Effective January 1, 1994, the lease was renewed for an additional 5-year period. The lease may be renewed at the option of the lessee for two additional 5-year periods. Annual Lease payments are equal to the greater of $140,450 or 22% of total room revenue and 2.5% of food and beverage revenue. Minimum lease payments of $11,704 are payable monthly with a quarterly analysis of the actual amount due.\nThe Partnership also assumed various leases entered into by Days Inns of America for equipment used by the operating hotels. These leases expire through 1997. Minimum lease payments under the leases, including the two renewal periods for the Scottsdale facility lease, are as follows:\n1996 $ 176,793 1997 170,344 1998 168,626 1999 168,626 2000 158,568 Thereafter 1,182,419 ---------- $2,025,376 ==========\nIV-18\nCRI HOTEL INCOME PARTNERS, L.P.\nNOTES TO FINANCIAL STATEMENTS\n4. COMMITMENTS - Continued\nTotal rental expense under the leases was $735,084, $710,848 and $753,336 for the years ended December 31, 1995, 1994 and 1993, respectively.\nd. Ground lease agreement ----------------------\nThe Partnership entered into a ground lease with Vicorp Restaurants, Inc. (Vicorp) effective January 1991, pursuant to which the Partnership is leasing a portion of the Minneapolis Days Inn property to Vicorp, which is operating a restaurant (Baker's Square) on the property. Gross rental income pursuant to the lease agreement, which is included in Rental and Other Revenue on the accompanying statements of operations, was $48,770, $47,121 and $45,527 during 1995, 1994 and 1993, respectively.\n5. PARTNERS' CAPITAL\nThe Partnership's Series A profits and losses and distributions are allocated 98% to the BAC Holders and 2% to the General Partner. Upon reaching a non-cumulative, annual preferred cash flow return of 12%, the Partnership's Series A profits and losses and distributions will be allocated 85% to the BAC Holders and 15% to the General Partner. To date, the annual preferred cash flow return has not been achieved. Cash available for distribution, as defined in the Partnership Agreement, is intended to be distributed on a quarterly basis within sixty days after the end of each calendar quarter.\nThe following distributions were paid or accrued to BAC Holders of record during 1995, 1994 and 1993:\nIV-19\nCRI HOTEL INCOME PARTNERS, L.P.\nNOTES TO FINANCIAL STATEMENTS\n5. PARTNERS' CAPITAL - Continued\n* Includes the distribution of net cash proceeds from the sale of the Kankakee hotel of $52,478 (approximately $0.06 per BAC), which is net of payment of outstanding Kankakee real estate taxes, retirement of the related note payable and repayment of Partnership advances.\nThe General Partner expects the distribution for the quarter ended March 31, 1996 to range from approximately $0.52 to $0.60 per BAC. The General Partner expects the distribution for the year ending December 31, 1996 to range from approximately $2.15 to $2.35 per BAC. Due to the expiration of the remaining cash flow guarantees during 1993, distributions are dependent on the net cash flow produced from hotel operations, net of Partnership expenses. The cash flow from certain hotels may be materially affected by changing market conditions and by seasonality. Also, cash flow from certain hotels in 1996 is expected to be reduced due to additions to replacement reserves during the first quarter of 1996 in the aggregate amount of approximately $138,000. Replacement reserves from these hotels are expected to be used for the purpose of installing electronic door locks in all the rooms. The installation of these door locks, which is expected to be completed in 1996, is required by the American Automobile Association (AAA) as a condition of the hotels being listed in AAA travel books.\n6. RELATED-PARTY TRANSACTIONS\nIn accordance with the Partnership Agreement, the Partnership paid the General Partner a fee for services in connection with the review, selection, evaluation, negotiation and acquisition of the hotels. The fee amounted to $1,142,516, which was equal to 4.5% of Total Capitalization (Gross Offering Proceeds plus all receipts of the Partnership arising from mortgage loans). The acquisition fees were capitalized and are being amortized over a thirty-year period using the straight-line method. Acquisition fees and accumulated amortization of acquisition fees of $122,412 and $29,460, respectively, relating to the Kankakee hotel were written off in connection with the sale of the hotel in 1995, as discussed above.\nThe Partnership reimbursed the General Partner or its affiliates for costs incurred on behalf of the Partnership for real estate appraisals and market studies, engineering studies, legal consultation and accounting fees, as well as\nIV-20\nCRI HOTEL INCOME PARTNERS, L.P.\nNOTES TO FINANCIAL STATEMENTS\n6. RELATED-PARTY TRANSACTIONS - Continued\ntravel and communication expenses related to the acquisition of the hotels. These costs, amounting to $233,474, have been capitalized as property purchase costs and are being amortized over a thirty-year period using the straight-line method. Property purchase costs and accumulated amortization of property purchase costs of $51,207 and $12,160, respectively, relating to the Kankakee hotel were written off in connection with the sale of the hotel in 1995, as discussed above.\nThe Partnership, in accordance with the terms of the Partnership Agreement, is obligated to reimburse the General Partner or its affiliates for their direct expenses in managing the Partnership. The Partnership paid or accrued $52,226, $62,973 and $40,383, for the years ended December 31, 1995, 1994 and 1993, respectively, to the General Partner or its affiliates as direct reimbursement of expenses incurred on behalf of the Partnership. Such reimbursements are included in general and administrative expense on the statements of operations.\nThe annual amount of the base asset management fee earned by the General Partner and\/or its affiliates is equal to 0.50% of the weighted average balance of the adjusted partnership investment during the period, as defined in the Partnership Agreement. During 1995, the adjusted partnership investment decreased from $21,000,000 to $18,750,000 as a result of the sale of the Kankakee hotel on July 19, 1995, as discussed above. Based on the weighted average balance of the adjusted partnership investment during 1995, the Partnership paid or accrued a base asset management fee of $99,956 for the year ended December 31, 1995. During each of the years ended December 31, 1994 and 1993, the Partnership paid or accrued a base asset management fee of $105,000.\n7. RECONCILIATION OF NET INCOME (LOSS) PER FINANCIAL STATEMENTS TO NET INCOME (LOSS) PER TAX RETURN\nThe following is a reconciliation of net income (loss) per the financial statements to net income (loss) per the tax return for the years ended December 31, 1995, 1994 and 1993:\nIV-21\nCRI HOTEL INCOME PARTNERS, L.P.\nNOTES TO FINANCIAL STATEMENTS\n7. RECONCILIATION OF NET INCOME (LOSS) PER FINANCIAL STATEMENTS TO NET INCOME (LOSS) PER TAX RETURN - Continued\nIV-22\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS -------------------------------------------------- ON FINANCIAL STATEMENT SCHEDULES --------------------------------\nPartners CRI Hotel Income Partners, L.P.\nWe have also audited Schedule III of CRI Hotel Income Partners, L.P. as of December 31, 1995. In our opinion, this schedule presents fairly, in all material respects, the information required to be set forth therein.\nGrant Thornton, LLP\nVienna, VA February 28, 1996\nIV-23\nCRI HOTEL INCOME PARTNERS, L.P.\nSCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION\nDECEMBER 31, 1995\nIV-24\nCRI HOTEL INCOME PARTNERS, L.P.\nSCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION\nDECEMBER 31, 1995\nIV-25\nCRI HOTEL INCOME PARTNERS, L.P.\nSCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION - Continued\nDECEMBER 31, 1995\n(A) Secured by Zero Coupon Purchase Money Notes.\n(B) Originally constructed in 1970, closed for full renovation in 1986, and reopened in 1987.\n(C) The aggregate cost of land for federal income tax purposes is $1,574,490 and the aggregate cost of buildings and site improvements for federal income tax purposes is $14,494,968. The total of the above mentioned items is $16,069,458.\n(D) Excludes the Days Inn Kankakee hotel, which was sold on July 19, 1995.\nIV-26\nEXHIBIT INDEX -------------\nExhibit Method of Filing - ------- -----------------------------\n27 Financial Data Schedule Filed herewith electronically\nIV-27","section_15":""}
{"filename":"816956_1995.txt","cik":"816956","year":"1995","section_1":"Item 1: Business\nGeneral\nCONMED Corporation (\"CONMED\" or the \"Company\") was incorporated on February 10, 1970 in the State of New York. The Company is a leading provider of advanced electrosurgical systems and ECG electrodes and accessories. The Company also manufactures and markets a line of instruments for use in MIS procedures, as well as products used for IV therapy. Eighty-five percent of the Company's revenues are derived from the sale of single-use, disposable products. The Company's products are used in a variety of clinical settings, such as operating rooms, physicians' offices and critical care areas of hospitals.\nThe Company is divided into three divisions: Electrosurgical Systems, Patient Care and Minimally-Invasive Surgery. Each division has its own dedicated salesforce. Through its Electrosurgical Systems Division, the Company develops, manufactures and markets a comprehensive range of electrosurgical generators, argon beam coagulation systems, electrosurgical ground pads and electrosurgical pencils. The Company's Patient Care Division develops, manufactures and markets a broad line of ECG electrodes (adult, infant, premie, stress test and diaphoretic), ECG cables and lead wires, IV stabilization dressings and IV fluid drip rate gravity controllers. As disclosed below, the Company's Patient Care Division will enter the wound care market with the NDM acquisition. The Company's Minimally-Invasive Surgery Division develops, manufactures and markets a line of minimally-invasive surgical (\"MIS\") products, including an electronic trocar system, suction-irrigation instruments, scissors and electrosurgical probes with suction\/irrigation capability.\nThe Company has used strategic business acquisitions to increase its market share in certain product lines, broaden its product offerings and realize economies of scale. In July 1993, the Company acquired the business and certain assets of Medtronic Andover Medical, Inc., a manufacturer of ECG monitoring and diagnostic electrodes and ECG cables and lead wires, for a cash purchase price of approximately $21.8 million plus the assumption of approximately $1.2 million of liabilities. In November 1994, the Company purchased the assets associated with a product line involving the manufacture and sale of ECG electrodes from Becton Dickinson Vascular Access, Inc. for approximately $2.0 million. These acquisitions expanded the ECG product offerings of the Company and have given the Company the additional market share necessary to become a leading supplier of ECG disposables to the domestic ECG disposables industry.\nIn March 1995, the Company acquired Birtcher Medical Systems, Inc. (\"Birtcher\") for approximately 1.6 million shares of common stock in a transaction valued at approximately $21.2 million. With the Birtcher acquisition, the Company added the argon beam coagulation technology to its existing lines of electrosurgical products and strengthened the Company's position as a leading supplier of electrosurgical systems to the medical industry. In May 1995, the Company acquired the business and certain assets and liabilities of The Master Medical Corporation (\"Master Medical\") for a cash purchase price of approximately $9.5 million plus the assumption of net liabilities totaling approximately $0.5 million. The Master Medical acquisition added a line of single-use IV fluid drip rate gravity controllers to the Company's product line. The completed acquisitions, together with internal growth, resulted in net sales growth of approximately 135% over the past three years.\nIn October 1995, the Company signed an asset purchase agreement whereby the Company will acquire substantially all the business and certain assets of New Dimensions in Medicine, Inc. (\"NDM\") for a cash purchase price of approximately $32.0 million plus the assumption of net liabilities of approximately $5.1 million. Through the NDM acquisition, which closed on February 23, 1996, the Company has acquired the business of NDM relating to the design, manufacture and marketing of a broad line of ECG electrode products, disposable electrosurgical products and a broad line of various Hydrogel wound care products.\nIndustry\nThe health care industry is undergoing significant and rapid change. Health care delivery costs have increased dramatically in recent years as compared to the overall rate of inflation. The growing influence of managed care has resulted in increasing pressure on participants in the health care industry to contain costs. Accordingly, health care providers have been purchasing medical devices which improve productivity and contain costs.\nHealth care providers continue to utilize low-cost, disposable medical devices, such as electrosurgical pencils and ground pads, ECG electrodes and other patient care products. Disposable devices improve health care professional productivity and, unlike reusable products, do not require costly, labor-intensive sterilization or reassembling. The risks of transmission of infectious diseases, such as AIDS, hepatitis and tuberculosis, and related concerns about occupational safety of health care professionals have also contributed to an increased demand for disposable, single-use products. In addition, the combination of medical cost containment pressures and patient-driven demands have resulted in greater use of minimally-invasive procedures as an alternative to traditional open surgery. MIS procedures reduce patient hospitalization and therapy, thereby reducing the cost to patients and health insurers.\nAccording to the American Hospital Association and the American College of Surgeons, in 1993 more than 23 million surgical procedures were performed in the over 5,300 general hospitals in the United States, with another approximately three million procedures being performed in the approximately 1,800 free standing ambulatory surgery centers. The Company believes that a majority of these operations involved electrosurgery. The American Hospital Association data also show that of the hospitals in the United States, there are approximately 96,000 intensive care beds, including neonatal, pediatric, cardiac and medical\/surgical intensive care. The Company believes that a majority of these beds are equipped for ECG monitoring. In addition, the Company believes that demographic trends, such as the aging of the U.S. population, also should have a favorable effect on the demand for the Company's disposable medical products, since older people generally require more medical care and undergo more surgical procedures.\nIn response to increased competitive pressures in the health care industry, manufacturers of medical devices have been improving efficiency and productivity and consolidating. The Company believes that consolidations in the industry have increased primarily as a result of health care cost containment pressures. Consolidations can reduce costs from synergies in manufacturing, corporate overhead and research and development. The Company regards these developments as presenting opportunities for medical device companies seeking to increase sales in core product lines and expand into new product lines through acquisitions.\nElectrosurgical Systems Division\nThe Company's electrosurgical products consist of electrosurgical pencils, electrosurgical ground pads and electrosurgical generators. The Company also distributes a wide range of accessories used with electrosurgical generators such as forceps, adapters and cables. Most accessories of other electrosurgical companies are compatible with the Company's generators, including specialty accessories used in urologic surgery. During 1993, 1994 and 1995, net sales attributable to the Electrosurgical Systems Division represented 43%, 54% and 53%, respectively, of the Company's net sales.\nElectrosurgery\nElectrosurgery is the technique of using a high-frequency electric current which, when applied to tissue through special instruments, can be used to cut tissue, coagulate, or cut and coagulate simultaneously. An electrosurgical system consists of a generator, an active electrode in the form of a pencil or other instrument which the surgeon uses to apply the current from the generator to the target tissue and a ground pad to safely return the current to the generator. Electrosurgery is routinely used in most forms of surgery, including dermatologic and thoracic, orthopedic, urologic, neurosurgical, gynecological, laparoscopic and other endoscopic procedures.\nArgon Beam Coagulation (\"ABC\") is a special method of electrosurgery, which allows a faster and more complete coagulation of many tissues as compared to conventional electrosurgery. Unlike conventional electrosurgery, the current travels in a beam of ionized argon gas, allowing the current to be dispersed onto the bleeding tissue without the instrument touching the tissue. Clinicians have reported notable benefits of ABC in certain clinical situations including open-heart surgery, liver, spleen and trauma surgery and various other applications.\nElectrosurgery Products\nElectrosurgical Pencils. The Company manufactures and markets electrosurgical pencils, which are used by surgeons to introduce the electrosurgical current to the target tissue. The pencils can be either foot-controlled or hand-controlled; the majority of pencils sold by the Company are hand-controlled. The Company manufactures primarily disposable electrosurgical pencils, but also offers reusable pencils. In addition, the Company sells a line of disposable blades used with electrosurgical pencils for specific surgical applications, including cutting, coagulating and the resection of diseased tissue.\nElectrosurgical Ground Pads. The Company manufactures and markets disposable ground pads in adult, pediatric and infant sizes as well as a ground pad specifically designed for prematurely born or low birth-weight infants (premies), the PREMIE Ground Pad. The Company believes that its PREMIE Ground Pad is the only disposable ground pad specifically made and marketed for these special patients. The Company also manufactures and markets ground pads specifically designed for use with its Aspen Return Monitor alarm system (A.R.M.), as well as alarm systems of competitive generators. Most of the Company's ground pads are made with its proprietary conductive adhesive polymer.\nElectrosurgical Generators. The Company offers both conventional electrosurgical generators and the ABC(R), which combines conventional electrosurgical cutting and coagulation capabilities with the Company's patented argon gas electrocoagulation technology. Most models include a safety alarm, the A.R.M., which monitors the contact of the ground pad to the patient's skin surface. Should the ground pad lose contact with the patient's skin, or a rise in electrical resistance occur, the monitor will disable the electrosurgical current until the problem is identified and corrected. Systems such as this provide an increased level of safety to the patient.\nThe Company's line of conventional electrosurgical generators features the EXCALIBUR(R) PLUS, which incorporates the A.R.M. and offers full-function capabilities for both monopolar and bipolar applications, including general surgery as well as thoracic, urologic, laparoscopic and neurosurgical procedures. In addition to the EXCALIBUR(R) PLUS, the conventional generators marketed by the Company include the SABRE(R) 2400, a full-feature generator suitable for routine use in most surgical procedures, and the SABRE(R) 180, a low-power generator for surgical procedures in a physician's office or clinic setting.\nHyfrecator Plus(R) is a low-power electrosurgical generator specifically designed for the physician's office based procedures, including dermatology, plastic surgery, dental and oral surgery and otolaryngology. The Hyfrecator Plus(R) is the latest model of Hyfrecator(R) generator that has been marketed to physicians for over 50 years, and was acquired in the Birtcher acquisition. The Company markets a line of accessories for the Hyfrecator Plus(R).\nArgon Beam Coagulation System. The Company's ABC(R) products include specialized electrosurgical generators, specialized disposable handpieces and ground pads. The Company's proprietary ABC(R) devices provide non-contact argon gas electrocoagulation and conventional electrosurgical cutting and coagulation capabilities. The models 6000 and 6400 ABC(R) generators offer automatic gas-flow control as the power settings are increased or decreased, and a full-function electrosurgical generator with integrated argon beam coagulation capability. The Company's Beamer ABC(R) module is a gas cart which is used in conjunction with an existing electrosurgical generator and is a lower cost alternative to the fully featured ABC(R) system. The Beamer ABC(R) units work in conjunction with the hospital's present electrosurgery unit.\nPatient Care Division\nThe Company's patient care products consist of ECG monitoring electrodes, intravenous flow controllers and catheter stabilization dressings, wound care products and other miscellaneous products. During 1993, 1994 and 1995, net sales attributable to the Patient Care Division represented 55%, 44% and 44%, respectively, of the Company's net sales.\nECG Monitoring\nECGs. An ECG is a representation of the electrical activity that stimulates the contraction of the heart muscle. This electrical activity can be detected by disposable electrodes which consist of a conductive element, a conductive gel for contact to the skin and an adhesive backing material that keeps the electrode adhered to the patient's skin for the required period of ECG monitoring. ECG monitoring is used to diagnose irregularities in heart function.\nDisposable ECG electrodes are placed on the patient's skin in various patterns around the heart using 3, 5 or 10 electrodes per patient, depending upon the specific type of monitoring technique. The electrodes provide a direct contact to the skin surface by which the electrical activity of the heart can be sensed and relayed to a special ECG monitor by way of its lead wire and cable connections. ECG electrodes are used in the operating room and critical care areas of hospitals and for diagnostic tests, including exercise stress testing and ambulatory monitoring. Many ambulances and paramedic units have the capability to monitor the ECG in emergency situations outside of the hospital.\nECG Monitoring Products. The Company has developed and markets ECG electrodes for various patients and applications, including prematurely born infants, diaphoretic patients, stress test monitoring, ambulatory monitoring and special ECG electrodes for use in surgery. The strength of the product line lies in specific design features that provide those characteristics required to accurately detect the electrical signal and to remain in contact with the patient's skin for extended periods of time. Several special monitoring situations require electrodes that will not show a visible image under x-ray. This will allow the patient to undergo special diagnostic or therapeutic procedures with the use of x-ray and still have continuous monitoring of the ECG. The Company has developed special electrodes for this purpose.\nThe Company also manufactures and markets ECG monitoring cables, lead wire products and accessories. ECG cables and lead wires are products designed to transmit ECG signals from the heart (converted into electrical signals by an electrode) to an ECG monitor or recorder. Lead wires connected directly to the electrodes are plugged into the patient end of the cable. Cables are designed to accept from three to fifteen lead wires depending on the level of monitoring required. The Company also manufactures and markets disposable defibrillation pads for use in cardio defibrillation.\nIntravenous Therapy\nIVs. A large percentage of patients admitted to hospitals will undergo some type of IV therapy where medical fluids or blood are introduced into the patient's bloodstream. As part of the nursing care to the patient, the catheter or needle must be stabilized onto the skin to prevent movement of the catheter, as well as be covered with a dressing to keep the entry site free from bacterial contamination. The volume and speed of fluids administered to the patient in surgery or medical units must be controlled for proper infusion of the fluids. Typically, the flow of these intravenous fluids is controlled either by an electronic pump or gravity controller or by a manually operated clamping mechanism.\nIntravenous Therapy Products -- VENI-GARD(R) Catheter Stabilization Dressing. VENI-GARD(R) is a disposable, sterile product designed to hold and secure an IV needle or catheter in place. VENI-GARD(R) provides a protective, sterile barrier over the entry site by incorporating a transparent, semi-permeable membrane to allow an unobstructed view of the entry site with a patented foam border to provide stabilization of the catheter. This membrane also allows the evaporation of moisture vapor but is impermeable to outside fluids. The VENI-GARD(R) product line also includes specialized products for various applications in specialty segments of the IV therapy market including those used in conjunction with Total Parenteral Nutrition (intravenous feeding) and cardiovascular catheters, as well as NeoDerm(R) for use in stabilizing epidural catheters.\nDisposable IV Fluid Drip Rate Gravity Controllers. With the Master Medical acquisition, the Company acquired Master Medical's line of disposable IV fluid drip rate gravity controllers. These disposable devices are a cost-effective alternative to electronic controllers or pumps. These devices are available as add-on extension sets which are attached to the primary IV tubing or as part of the full tubing set connecting the main IV bag to the patient's IV catheter.\nWound Care Management\nWound Care. Wounds to the skin are referred to as acute, such as surgical incisions and burns, or chronic, which are slow-healing conditions such as chronic venous ulcers, pressure ulcers, diabetic ulcers and wounds from various skin diseases. Traditionally, most open wounds have been treated with \"dry\" dressings such as gauze or covered with various ointments. A recent trend has been the use of occlusive dressings made from polymers called hydrocolloids and hydrogels. These occlusive dressings keep the wound \"moist\" or hydrated in order to promote healing. Wound care dressings are sold to hospitals as well as to alternate care sites such as nursing homes and skilled nursing facilities.\nWound Care Products. As part of the NDM acquisition, the Company expanded into the wound care market. NDM has developed a proprietary hydrogel technology, which is currently manufactured and marketed under the name ClearSite(R). It is a transparent wound dressing that consists of hydrogel and a flexible, continuous polyurethane film covering. Because ClearSite(R) is transparent, the health care provider is able to monitor the course of healing without removing the wound dressing. ClearSite(R) absorbs wound exudate and, as the gel begins to saturate, moisture vapor transpires into the atmosphere. ClearSite(R) is able to absorb 2 1\/2 times its weight in wound exudate and maintain its structural integrity and wound healing capabilities for up to seven days.\nIn 1994, NDM introduced its island dressing form of ClearSite(R). The island dressing has a clear, breathable, pliable, adhesive polyurethane film border. The Company also markets a wound care product called Hydrogauze(R), which is a gauze-like material that has been impregnated with dehydrated ClearSite(R) that hydrates upon contact with wound exudate. Hydrogauze(R) combines the look and feel of gauze bandages with the wound healing advantages of ClearSite(R) hydrogel.\nMinimally-Invasive Surgery Division\nBuilding on its expertise in electrosurgery, in 1991 the Company began marketing its line of MIS products, consisting of electronic trocars and multifunctional instruments. In 1993, 1994 and 1995, net sales attributable to the Minimally-Invasive Surgery Division represented 2%, 2% and 3%, respectively, of the Company's net sales.\nMinimally-Invasive Surgery\nMIS, or surgery performed without a major incision, results in less trauma for the patient and produces important cost savings as a result of reduced hospitalization and therapy. Laparoscopic surgery is an MIS procedure performed on organs in the abdominal cavity such as the gallbladder, appendix and female reproductive organs. During a laparoscopic procedure, devices called \"trocars\" are used to puncture the abdominal wall and then removed, leaving in place a trocar cannula. The trocar cannula provides access into the abdomen for the camera systems and surgical instruments. The recent trend toward minimally invasive surgery has led to the development of additional applications for laparoscopic surgery that can utilize electrosurgery systems.\nElectrosurgical Products for Laparoscopic Surgery\nTroGARD(R), a proprietary electronically controlled trocar system for laparoscopic surgery, incorporates a blunt-tipped version of a trocar (ordinarily a sharp pointed surgical instrument that punctures the abdominal wall) and an Electronic Trocar Monitor (\"ETM\") for making the puncture through the body wall. The TroGARD(R) cuts through the body wall with electrosurgical current rather than the sharp, pointed tips of conventional trocars. The ETM automatically and immediately deactivates the electrosurgical generator when the monitor senses that the trocar has entered the abdominal cavity. Simultaneously, it sounds an audible alarm for the surgeon upon entry into the abdominal cavity.\nThe Company also markets the UNIVERSAL S\/I (suction\/irrigation) and UNIVERSAL-PLUS laparoscopic instruments, specialized suction\/irrigation electrosurgical instrument systems for use in laparoscopic surgery, which consist of a disposable handle and valve\/control assembly with a system of interchangeable, single-use, disposable cannulae and instrument tips. The UNIVERSAL-PLUS offers the surgeon a choice of hand-control or foot-control of electrosurgery with suction\/irrigation controls conveniently located on the handle of the instrument. The UNIVERSAL S\/I laparoscopic instrument system provides high flow suction\/irrigation, without electrosurgical capability, to fit the preferences of a wide range of surgeons and laparoscopic techniques. The Company also markets electrosurgical pencils, suction\/irrigation accessories, laparoscopic scissors, active electrodes, insufflation needles and ABC(R) handpieces for use in laparoscopic surgery.\nMarketing\nThe principal markets for the Company's products are the approximately 5,300 general hospitals and approximately 1,800 surgery centers in the United States. Certain of the Company's products are sold to others in the medical industry for private labeling. The total domestic sales and marketing force consists of approximately 100 persons. The Company's salespeople have been with the Company an average of five years.\nThe Company has located its salespeople (territory managers) in key metropolitan areas. They are supervised and supported by district managers and regional managers. Home office sales and marketing management provide the overall direction for the sales of the Company's products. The sales force is required to work closely with distributors where applicable and to maintain close relationships with end-users. Domestically, the Company's products are sold through approximately 20 national and regional hospital distributors, 150 to 250 local distributors, and directly to hospitals.\nThe Company's domestic salesforce is structured into three groups, Electrosurgical Systems, Patient Care and MIS. The Electrosurgical Systems salesforce is responsible for selling the Company's electrosurgical products which are typically used during surgical procedures. The Patient Care salesforce is responsible for selling the Company's products which are typically used by various patient care areas of a hospital. The primary patient care products are ECG electrodes and the IV therapy products. The MIS salesforce is responsible for selling the Company's laparoscopic products.\nThe Company's international sales efforts are conducted by five international marketing managers. International sales accounted for 15.5% of the Company's sales during 1995. Among the top foreign markets for the Company are Japan, Germany, Canada, China and Korea. International sales grew in 1994 in all regions and sales growth continued in 1995, with the strongest sales gains in China and the Far East.\nThe Company focuses on keeping its salespeople highly trained and educated in the applications for its products. The Company's salespeople call on key departments such as the surgery, intensive care, cardiac care and neonatal intensive care units and the emergency room. Therefore, it is essential that the sales force has the ability to train doctors and nursing staff on the techniques needed to take full advantage of the Company's products. A key element in the sale of any Company product is the initial and ongoing inservice training required of the end-user. The hiring criteria of the Company's salespeople include requiring them to have a background in the sale of medical devices. The field sales force is trained in the technical aspects of the Company's products and their uses, and provides hospital personnel and surgeons with information relating to the technical features and benefits of the Company's products.\nResearch and Development Activities\nThe Company's research and development department consists of approximately 35 employees. The Company's research and development programs are focused on the development of new products, as well as the enhancement of existing products through the updating of technology and design. Product development efforts include product extensions and improvements, electrosurgical applications in MIS procedures and other single use medical products. During the three years 1993, 1994 and 1995, the Company spent approximately $2,222,000, $2,352,000 and $2,832,000, respectively, for research and development.\nThe Company has approximately 146 U.S. patents and numerous corresponding foreign patents on its products expiring at various dates from 1996 through 2013 and has additional patents pending. Due to technological change, the Company does not solely rely on its patents, but believes that development of new products and improvement of existing ones is and will be generally more important than patent protection in maintaining its competitive position.\nNew Products\nAt the American College of Surgeons meeting in October 1995, the Company introduced four new products. The EXCALIBUR(R) PLUS\/PC (Power Control) is the most recent generation of the Company's EXCALIBUR(R) generator and incorporates a unique feature not previously seen in electrosurgical generators. The EXCALIBUR(R) PLUS\/PC has been designed with a special software program that allows the surgeon to use any standard hand-controlled pencil or instrument to directly increase or decrease the power settings of the generator. The Company believes this is the first technology of its kind applied to electrosurgery and has applied for patent protection. The Company began marketing EXCALIBUR(R) PLUS\/PC in January 1996.\nThe Company has extended its line of electrosurgical instruments for laparoscopic surgery with its SELECT ONE(R) Monopolar Laparoscopic Scissors. The laparoscopic scissors are single-use and disposable. The Company released this product in early November 1995.\nThe third product introduced at the College of Surgeons meeting was the disposable smoke evacuation pencil. This electrosurgical pencil has specially designed channels to remove the smoke plume, generated by the cutting and coagulation of tissue, from the surgical field. This feature addresses the concerns of health care givers toward certain potential health hazards from prolonged exposure to possible contaminants carried by the smoke plume generated by the use of electrosurgery and lasers. The Company began the marketing of this product in January 1996.\nThe BEAMER PLUS ABC(R) module is an updated design of the Company's current stand-alone ABC(R) module, the BEAMER(R). The BEAMER PLUS adds increased flow capabilities and flow control for use in laparoscopic surgery. The BEAMER PLUS is a more economical unit for providing argon beam coagulation capability to most electrosurgical generators. The Company began marketing the BEAMER PLUS in January 1996.\nManufacturing and Supply Arrangements\nThe Company manufactures or assembles most of its products at its own facilities. The Company's vertically integrated manufacturing process allows it to (i) obtain cost efficiencies by purchasing raw materials for its disposable products in bulk and converting those materials into the parts and pieces used in final assembly and (ii) react quickly to changes in demand for the Company's products. The Company believes that its manufacturing capabilities are significant in terms of cost control, quality control and security of proprietary processes. The Company uses various manual, semi-automated and automated equipment for fabrication and assembly of its products and is continuing to further automate its facilities to remain competitive.\nThe Company believes its production and inventory practices are generally reflective of conditions in the industry. The Company's products are not generally made to order or to individual customer specifications. Accordingly, the Company schedules production and stocks inventory on the basis of experience and its knowledge of customer order patterns, and its judgment as to anticipated demand. Since customer orders must generally be filled promptly for immediate shipment, backlog is not significant to an understanding of the Company's business.\nIn connection with the NDM acquisition, the Company agreed to assume all of NDM's obligations under NDM's distribution agreement with Baxter Healthcare Corporation (\"Baxter\"). Under the distribution agreement, which Baxter has assigned to the Company, Baxter has the non-exclusive right to sell and distribute NDM's critical care products and patient care products throughout the United States. The agreement is effective until December 31, 1996 and is subject to renewal, unless terminated by either party. Baxter is the largest distributor of NDM's products, accounting for approximately 95% of NDM's sales to U.S. hospitals.\nCompetition\nThe market for the Company's products is competitive. The Company faces competition from other manufacturers and from suppliers of products employing other technologies. Competitive pricing pressures or the introduction of new products by the Company's competitors could have an adverse effect on the Company's revenues and profitability. In addition, the Company operates in an industry that engages in extensive research efforts. Some of the companies with which the Company now competes or may compete in the future have or may have more extensive research, marketing and manufacturing capabilities and significantly greater technical and personnel resources than the Company, and may be better positioned to continue to improve their technology in order to compete in an evolving industry. The major competitors of the Company include ValleyLab (a division of Pfizer), 3M Corporation, Johnson & Johnson and U.S. Surgical Corporation.\nThe Company believes that product design, development and improvement, customer acceptance, marketing strategy, customer service and price are critical elements to compete in the industry. Demand for and use of the Company's electrosurgical equipment may fluctuate as a result of changes in surgeon preferences, the introduction of new electrosurgery products or new features to existing products, the introduction of alternative surgical technology and advances in surgical procedures and discoveries or developments in the health care industry. In addition, the growing trend toward managed care has increased cost-containment efforts of hospital purchasing departments. There can be no assurances that demand for the Company's products will not be adversely affected by such fluctuations and trends.\nGovernment Regulation\nAll the Company's products are classified as medical devices subject to regulation by the FDA. The Company's new products require FDA clearance under a procedure known as 510(k) premarketing notification. A 510(k) premarketing notification clearance indicates FDA agreement with an applicant's determination that the product for which clearance has been sought is substantially equivalent to another medical device that was on the market prior to 1976 or that has received 510(k) premarketing notification clearance. Some products have been continuously produced, marketed and sold since May 1976 and require no 510(k) premarketing clearance. The Company's products are all either Class I or Class II products with the FDA, meaning that the Company's products must meet certain FDA standards and are subject to the 510(k) premarketing notification clearance discussed above, but are not required to be approved by the FDA. FDA clearance is subject to continual review, and later discovery of previously unknown problems may result in restrictions on a product's marketing or withdrawal of the product from the market.\nThe Company markets its products in a number of foreign markets. Requirements pertaining to its products vary widely from country to country, ranging from simple product registrations to detailed submissions such as those required by the FDA. The Company's European Community sales are subject to government regulations known as the \"CE\" mark certification. The Company's electronic devices (electrosurgical generators, Hyfrecators(R) and ABC(R) units) have received a \"CE\" mark certification. The Company believes that its products currently meet all applicable standards for the countries in which they are marketed.\nAs a manufacturer of medical devices, the Company's manufacturing processes and facilities are subject to periodic on-site inspections and continuing review by the FDA to insure compliance with \"Good Manufacturing Practices.\" Many of the Company's products are subject to industry-set standards. Industry standards relating to the Company's products are generally formulated by committees of the Association for the Advancement of Medical Instrumentation. The Company believes that its products presently meet applicable standards.\nThe Company is subject to product recall. In March 1993, the Company voluntarily recalled certain lots of its TechSwitch electrosurgical pencils due to a production matter which caused a small percentage of the pencils in the affected lots to function in an inconsistent manner. The production matter was resolved and did not have a material effect on the Company's financial condition.\nAny change in existing federal, state or foreign laws or regulations, or in the interpretation or enforcement thereof, or the promulgation or any additional laws or regulations could have an adverse effect on the Company's financial condition or results of operations.\nEmployees\nAs of December 29, 1995 the Company had 876 full-time employees, of whom 631 were in manufacturing, 35 were in research and development, and the balance were in sales, marketing, executive and administrative positions. None of the Company's employees is represented by a union, and the Company considers its employee relations to be excellent. The Company has never experienced any strikes or work stoppages.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company operates in Utica, New York from an owned facility of approximately 130,000 square feet and in Rome, New York from a leased facility of approximately 120,000 square feet. Additionally, the Aspen subsidiary operates from an owned facility of approximately 65,000 square feet of space in Englewood, Colorado; the Birtcher subsidiary leases a 15,000 square foot warehouse and distribution center in El Paso, Texas pursuant to a lease that expires in May 1997 and a 25,000 square foot manufacturing facility in Juarez, Mexico pursuant to a lease that expires in June 1998; and the NDM business is operated from an owned facility of approximately 100,000 square feet in Dayton, Ohio. The Company believes its facilities are adequate in terms of space and suitability for its needs over the next several years.\nItem 3.","section_3":"Item 3. Legal Proceedings\nFrom time to time the Company is a defendant in certain lawsuits alleging product liability or other claims incurred in the ordinary course of business. These claims are generally covered by various insurance policies, subject to certain deductible amounts and maximum policy limits.\nThe Company's Birtcher subsidiary is voluntarily participating in an environmental investigation at its former facility in El Monte, California. The former facility is located in the El Monte Operable Unit of the San Gabriel Valley Superfund Site. The Environmental Protection Agency has not named Birtcher as a Potentially Responsible Party in this matter. In connection with its accounting for the Birtcher acquisition, the Company has established what it believes is an appropriate reserve for this matter. Such reserve is the subject of an adjustment in the purchase accounting for the Birtcher acquisition. The Company does not expect that the resolution of the environmental investigation will have a material adverse effect on the Company's financial condition and results of operations.\nThe Company's ABC(R) technology is protected by patents in the United States, Canada, United Kingdom, Germany and Japan. Three separate companies have filed challenges to the validity of the United Kingdom, German and Japanese patents. The Company is vigorously defending the validity of these patents in those jurisdictions.\nManufacturers of medical products may face exposure to significant product liability claims. To date, the Company has not experienced any material product liability claims, but any such claims arising in the future could have a material adverse effect on the Company's business or results of operations. The Company currently maintains commercial product liability insurance of $10,000,000 per incident and $10,000,000 in the aggregate annually, which the Company, based on its experience, believes is adequate. This coverage is on a claims-made basis. There can be no assurance that claims will not exceed insurance coverage or that such insurance will be available in the future at a reasonable cost to 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 ended December 29, 1995.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters\nThe Company's Common Stock, par value $.01 per share, is traded on the Nasdaq National Market System (symbol - CNMD). At December 29, 1995, there were 1,365 owners of record of the Company's Common Stock.\nThe following table show the high-low last sales prices for the years ended December 30, 1994 and December 29 1995, as reported by the Nasdaq National Market. The sales prices have been adjusted to give retroactive effect to the three-for-two stock splits in the form of stock dividends paid on December 27, 1994 and November 30, 1995.\n---- Period High Low - ------ ------ ------ First Quarter $ 6.89 $ 4.44 Second Quarter 6.44 5.11 Third Quarter 8.44 5.56 Fourth Quarter 13.67 8.00\n---- Period High Low - ------ ------ ------ First Quarter $15.17 $11.17 Second Quarter 16.67 9.67 Third Quarter 23.33 15.67 Fourth Quarter 25.00 20.25\nThe Company did not pay cash dividends on its Common Stock during 1994 and 1995. The Board of Directors presently intends to retain future earnings to finance the development of the Company's business and does not presently intend to declare cash dividends. Should this policy change, the declaration of dividends will be determined by the Board in light of conditions then existing, including the Company's financial requirements and condition and provisions affecting the declaration and payment of dividends contained in debt agreements.\nItem 6.","section_6":"Item 6. Selected Financial Data\n(1) Includes the results of (i) CONMED Andover Medical from July 12, 1993; (ii) Birtcher from March 14, 1995; and Master Medical from May 22, 1995, in each such case from the date of acquisition.\n(2) Includes litigation charge of $5,000 relating to a patent infringement case involving CONMED's line of coated electrosurgical accessory blades and a product restructure charge of $675 for the write-off of obsolete inventory, net of related tax benefit of $1,930.\n(3) Share and per share information have been adjusted to give retroactive effect to the three-for-two stock splits the form of stock dividends paid to shareholders on December 27, 1994 and November 30, 1995.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nThe following discussion and analysis provides information which management believes is relevant to an assessment and understanding of the Company's consolidated results of operations and financial condition. The discussion should be read in conjunction with the consolidated financial statements and notes thereto.\nResults of Operations\nThe following table presents, as a percent of net sales, certain categories included in the Company's consolidated statements of income for the periods indicated:\nYears Ended December 29, 1995 and December 30, 1994\nThe Company had net sales of $99,558,000 for 1995 as compared to $71,064,000 in 1994, an increase of $28,494,000 or 40.1%. The increase was substantially a result of the effects of the Birtcher and Master Medical acquisitions.\nThe Company's gross margin percentage was 47.4% in 1995 as compared to 45.4% in 1994. This increase was primarily a result of manufacturing efficiencies and economies of scale realized through the Birtcher and Master Medical acquisitions. On a quarterly basis, gross margin percentage for the first quarter of 1995 was 45.7% and approximated 47.8% for each of the remaining three quarters of 1995.\nSelling and administrative expense increased to $25,570,000 during 1995 compared to $20,979,000 in 1994, an increase of $4,591,000 or 21.9%, due primarily to the effects of the Birtcher and Master Medical acquisitions. However, as a percentage of net sales, selling and administrative expense declined to 25.7% in 1995 as compared to 29.5% in 1994, due to the economies of scale resulting from the acquisitions of Birtcher and Medical Medical.\nResearch and development expense increased 20.4% to $2,832,000 in 1995 as compared to $2,352,000 in 1994. Research and development expenditures for 1995 reflect increased activities relative to integration and further development of Birtcher products, as well as the continued emphasis on the development of surgical products for MIS procedures.\nThe Company incurred $1,991,000 in interest expense in 1995 compared to $628,000 in 1994. This increase reflects the incremental debt incurred as a result of the Birtcher and Master Medical acquisition.\nThe Company's effective tax rate for 1995 was 35.2% as compared to 34.8% in 1994.\nYears Ended December 30, 1994 and December 31, 1993\nNet sales in 1994 increased to $71,064,000 compared to $53,641,000 in 1993, an increase of 32.5%. Approximately 75% of the total increase was a function of the Andover Medical acquisition that occurred on July 12, 1993. Net sales of CONMED Andover Medical's products are included with the Company's consolidated sales for all of 1994 but for only one-half of 1993. The remainder of the increase was a result of increased volumes of product sold.\nThe gross margin percentage increased to 45.4% in 1994 compared to 43.7% in 1993. This increase in gross margin is a result of increasing economies of scale and manufacturing efficiencies. During 1994, the Company consolidated its ECG wire and plastic molding operations in one location, and this reduced manufacturing expense as a percentage of net sales.\nSelling and administrative expense increased 20.6% to $20,979,000 from $17,402,000 as a result of increased sales activity. However, as a percentage of net sales, selling and administrative expense declined to 29.5% in 1994 compared to 32.4% in 1993. This improvement in selling and administrative expense as compared to net sales was a result of economies of scale resulting from the increased level of net sales and cost improvement programs including consolidation of customer service and realignment of sales territories after the Andover Medical acquisition.\nDuring 1993, the Company recorded a pre-tax charge of $5,700,000 for litigation and product restructure costs. No such costs were incurred in 1994.\nResearch and development expense increased 5.9% in 1994 compared to 1993. The Company continues to conduct research activities in all of its product lines, with a particular emphasis on surgical products for MIS procedures.\nNet interest expense increased to $628,000 in 1994 from $214,000 in 1993. The increase was primarily a result of the Andover Medical acquisition indebtedness being outstanding for an entire year in 1994 and only approximately one-half year in 1993. Further, 1993 had higher interest income amounts than 1994 as the Company had higher invested cash balances in the first half of 1993 prior to the Andover Medical acquisition.\nThe Company's effective tax rate in 1994 was 34.8% reflecting the federal statutory rate of 34%, the effect of state income taxes and the tax benefit of a foreign sales corporation.\nLiquidity and Capital Resources\nCash flow from operations was $5,059,000 for 1995 as compared to $8,260,000 provided from operations in 1994. Operating cash flows for 1995 were aided by higher net income as compared to 1994. Additionally, depreciation and amortization in 1995 increased due to the effects of the Birtcher and Master Medical acquisitions. Cash flows from operations in 1995 were negatively impacted by increases in accounts receivable and inventories, and the timing of payments for income taxes. The increases in accounts receivable and inventories relate primarily to working capital requirements associated with the Birtcher and Master Medical acquisitions. Additionally, payment of the patent litigation award also adversely impacted 1995 operating cash flows.\nCash flows from operations were $8,260,000 for 1994 compared to $5,673,000 for 1993. Operating cash flows in 1994 were impacted by higher net income as well as increased depreciation expense and amortization caused by the Andover Medical acquisition. Additionally, accruals for payroll and withholding increased $1,327,000, causing a positive addition to operating cash flows for 1994. Accounts receivable increases of $1,684,000 and inventory increases of $619,000 partially offset increases in cash flow from operations in 1994, and are due to increased working capital requirements of the Company's expanded business.\nNet cash used by investing activities was $14,695,000 in 1995 compared to $4,190,000 in 1994. The Master Medical acquisition utilized $9,500,000 of cash. Additions to property, plant and equipment for 1995 totaled $5,195,000. Included in this amount was the purchase of land and a building for the relocation of CONMED Andover Medical to Rome, New York, for $1,200,000 for manufacturing purposes.\nThe Company purchased $2,190,000 of new plant and equipment, and invested $2,000,000 to purchase an ECG product line from Becton Dickinson Vascular Access Inc. during 1994, resulting in a net use of cash for investing activities. Financing activities resulted in a net use of cash as the Company repaid $2,530,000 in long-term debt during 1994.\nCash flows provided by financing activities were $7,560,000 for 1995. The Company refinanced its existing bank debt and received $26,590,000 in additional proceeds. Payments on debt and other obligations included $4,371,000 on the Company's debt, $5,846,000 to Birtcher's bank to liquidate debt assumed in connection with the Birtcher acquisition and $12,141,000 to liquidate other Birtcher liabilities assumed in connection with the acquisition.\nPrior to the equity offering discussed below, the Company's credit facility consisted of a $65,000,000 secured term loan and secured revolving line of credit of $15,000,000. As of December 29, 1995, an aggregate of $32,340,000 was outstanding under this facility. In connection with the NDM acquisition on February 23, 1996, the Company borrowed $32,660,000 bringing aggregate borrowings under the credit facility to $65,000,000. In March 1996, the Company consummated an equity offering of common stock and used the proceeds to eliminate the indebtedness of the Company. Upon the closing of this equity offering, the Company's credit facility was amended to consist of a $60,000,000 secured revolving line of credit. This revolving line of credit terminates in March 2001 and carries an interest rate of 0.5% - 1.25% over LIBOR depending on defined cash flow performance ratios. As of March 20, 1996, the Company had no borrowings under this facility.\nManagement believes that cash generated from operations, its current cash resources and funds available under its banking agreement will provide sufficient liquidity to ensure continued working capital for operations and funding of capital expenditures.\nInflation\nManagement does not believe that inflation has had or is likely to have any significant impact on the Company's operations.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe Company's 1995 Financial Statements, together with the report thereon of Price Waterhouse LLP dated January 29, 1996, included elsewhere herein. See Item 14 for a list of Financial Statements and Financial Statement Schedules.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures\nThe Company and Price Waterhouse LLP have had no disagreements which would be required to be reported under this Item 9.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nInformation with respect to the Directors and Executive Officers of the Company is incorporated herein by reference to the sections captioned \"Proposal One: Election of Directors\" and \"Directors and Executive Officers\" in CONMED Corporation's definitive Proxy Statement to be mailed on or about April 12, 1996 for the annual meeting of shareholders to be held on May 21, 1996.\nItem 11.","section_11":"Item 11. Executive Compensation\nInformation with respect to Executive Compensation is incorporated herein by reference to the sections captioned \"Compensation of Executive Officers\", \"Stock Option Plans\", and \"Pension Plans\" in CONMED Corporation's definitive Proxy Statement to be mailed on or about April 12, 1996 for the annual meeting of shareholders to be held on May 21, 1996.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nInformation with respect to Security Ownership of Certain Beneficial Owners and Management is incorporated herein by reference to the section captioned \"Security Ownership of Certain Beneficial Owners and Management\" in CONMED Corporation's definitive Proxy Statement to be mailed on or about April 12, 1996 for the annual meeting of shareholders to be held on May 21, 1996.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nInformation regarding certain relationships and related transactions is incorporated herein by reference to the section captioned \"Certain Relationships and Related Transactions\" in CONMED Corporation's definitive Proxy Statement to be mailed on or about April 12, 1996 for the annual meeting of shareholders to be held on May 21, 1996.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\nIndex to Financial Statements:\n(a)(1) List of Financial Statements Form 10-K Page\nReport of Independent Accountants\nConsolidated Balance Sheets at December 30, 1994 and December 29, 1995\nConsolidated Statements of Income for the years ended December 31, 1993, December 30, 1994, and December 29, 1995\nConsolidated Statements of Shareholders' Equity for each of the years ended December 31, 1993, December 30, 1994, and December 29, 1995\nConsolidated Statements of Cash Flows for each of the years ended December 31, 1993, December 30, 1994, and December 29, 1995\nNotes to Consolidated Financial Statements\n(2) List of Financial Statement Schedules\nValuation and Qualifying Accounts (Schedule VIII)\nAll other schedules have been omitted because they are not applicable, or the required information is shown in the financial statements or notes thereto.\n(3) List of Exhibits\nThe exhibits listed on the accompanying Exhibit Index on pages 20-21 below are filed as part of this Form 10-K.\n(b) Reports on Form 8-K\n(1) On October 20, 1995, the Company filed a report on Form 8-K regarding a press release issued in connection with the anticipated acquisition of a business.\n(2) On December 21, 1995 and February 16, 1996, the Company filed reports on Form 8-K which included the historic financial statements of a business being acquired.\n(3) On February 16, 1996 (as amended on February 26, 1996), the Company filed a report on Form 8-K which included the consolidated financial statements of the Company for the three years ended December 29, 1995 and the Company's amended credit agreements.\n(4) On March 8, 1996, the Company filed a report on Form 8-K which included pro forma financial information for a business acquired.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the 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 below.\nCONMED CORPORATION\nMarch 28, 1996\nBy: \/s\/ EUGENE R. CORASANTI -------------------------- Eugene R. Corasanti (Chairman of the Board, Chief Executive Officer and President)\nPursuant to the requirements of the Securities Act of 1934, this report has been signed below by the following persons on behalf of the registrants and in the capacities and on the dates indicated.\nList of Exhibits\nExhibit No. Description of Instrument\n3.1 - Amended and Restated By-Laws, as adopted by the Board of Directors on December 26, 1990 -- incorporated herein by reference to the exhibit in the Company's Current Report on Form 8-K, dated March 7, 1991 (File No. 0-16093).\n3.2 - 1992 Amendment to Certificate of Incorporation and Restated Certificate of Incorporation of CONMED Corporation -- incorporated herein by reference to the exhibit in the Company's Annual Report on Form 10-K for the year ended December 25, 1992.\n4.1 - See Exhibit 3.1.\n4.2 - See Exhibit 3.2.\n4.3 - Warrant to Purchase Common Stock, dated August 31, 1989, issued by the Company to Zimmer, Inc. covering 300,000 shares of Common Stock -- incorporated herein by reference to Exhibit 4.6 of the Company's Registration Statement on Form S-2 (File No. 33-40455).\n4.4 - Credit Agreement-Term Loan Facility dated as of December 29, 1995 among CONMED Corporation, the Banks signatory thereto, and The Chase Manhattan Bank, N.A., as agent - incorporated herein by reference to Exhibit 99.1 of the Company's current report on Form 8-K filed February 16, 1996.\n4.5 - Credit Agreement-Revolving Credit Facility dated as of December 29, 1995 among CONMED Corporation, the Banks signatory thereto, and The Chase Manhattan Bank, N.A., as agent - incorporated herein by reference to Exhibit 99.2 of the Company's current report on Form 8-K filed February 16, 1996.\n10.1 - Asset Purchase Agreement dated June 10, 1993 among Medtronic Andover Medical, Inc. and Medtronic, Inc. and CONMED Acq. Inc. and CONMED Corporation -- incorporated herein by reference to Exhibit 2 to Form 8-K dated June 11, 1993.\n10.2 - Employment Agreement between the Company and Eugene R. Corasanti, dated October 17, 1991, and Amendment thereto dated March 6, 1992 -- incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended December 27, 1991.\n10.3 - Amended and Restated Employee Stock Option Plan (including form of Stock Option Agreement)--incorporated herein by reference to the exhibit in the Company's Annual Report on Form 10- K for the year ended December 25, 1992.\n10.4 - (a) Eugene R. Corasanti disability income plans with Northwestern Mutual Life Insurance Company, dated January 14, 1980 and March 7, 1981 -- policy specification sheets -- incorporated herein by reference to Exhibit 10.9(a) of the Company's Registration Statement on Form S-2 (File No. 33-40455).\n(b) William W. Abraham disability income plan with Northwestern Mutual Life Insurance Company, dated March 24, 1981 -- policy specification sheet -- incorporated herein by reference to Exhibit 10.9(b) of the Company's Registration Statement on Form S-2 (File No. 33-40455).\n(c) Eugene R. Corasanti life insurance plan with Northwestern Mutual Life Insurance Company, dated October 6, 1979 -- policy specification sheet -- incorporated herein by reference to Exhibit 10.9(c) of the Company's Registration Statement on Form S-2 (File No. 33-40455).\n(d) Eugene R. Corasanti life insurance plans with Northwestern Mutual Life Insurance Company dated August 25, 1991 -- Statements of Policy Cost and Benefit Information, Benefits and Premiums, Assignment of Life Insurance Policy as Collateral -- incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended December 27, 1991.\n10.5 - 1992 Stock Option Plan (including form of Stock Option Agreement). -- incorporated herein by reference to the exhibit in the Company's Annual Report on Form 10-K for the year ended December 25, 1992.\n10.6 - Plan and Agreement of Merger dated as of December 5, 1994 among the Company, CONMED Acquisition Corporation and Birtcher Medical Systems, Inc. - incorporated herein by reference to appendix A of the Company's registration statement on S-4 (File No. 33-87746)\n10.7 - Asset Purchase Agreement by and between New Dimensions In Medicine, Inc. and CONMED Corporation dated as of the 18th day of October 1995 - incorporated herein by reference to New Dimensions In Medicine, Inc's. (Commission File No. 1-09156) Report on Form 8-K dated October 18, 1995.\n10.8 - Non-Exclusive Distribution Agreement effective as of January 1, 1995 between New Dimensions In Medicine, Inc. (NDM) and Baxter Healthcare Corporation, as assigned by NDM to CONMED Corporation on February 23, 1996.\n11 - Statement regarding computation of per share earnings.\n21 - Subsidiaries of the registrant.\n23 - Consent of Independent Accountants.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholders of CONMED Corporation\nIn our opinion, the consolidated financial statements listed in the index appearing under Item 14(a)(1) and (2) on page 18 of the Annual Report on Form 10-K present fairly, in all material respects, the financial position of CONMED Corporation and its subsidiaries at December 29, 1995 and December 30, 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 29, 1995, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.\nPRICE WATERHOUSE LLP\nSyracuse, New York January 29, 1996\nCONMED CORPORATION CONSOLIDATED BALANCE SHEETS (In thousands except share amounts)\nCONMED CORPORATION CONSOLIDATED BALANCE SHEETS -- Continued (In thousands except share amounts)\nSee notes to consolidated financial statements.\nCONMED CORPORATION CONSOLIDATED STATEMENTS OF INCOME (In thousands except per share amounts)\nSee notes to consolidated financial statements.\nCONMED CORPORATION CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY\nFor the Years Ended December 31, 1993, December 30, 1994 and December 29, 1995 (In thousands)\nSee notes to consolidated financial statements.\nCONMED CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)\nCONMED CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS - Continued (In thousands)\nSee notes to consolidated financial statements.\nCONMED CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1 - OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES\nOrganization and operations\nThe consolidated financial statements include the accounts of CONMED Corporation and its subsidiaries (the Company). All intercompany transactions have been eliminated. The Company is primarily engaged in the development, manufacturing and marketing of disposable medical products and related devices for various medical applications.\nStatement of cash flows\nThe Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents.\nFiscal year end\nThe Company's fiscal year ends on the last Friday in December.\nInventories\nThe inventories are stated at the lower of cost or market, cost being determined on the first-in, first-out basis.\nProperty, plant and equipment\nProperty, plant and equipment are stated at cost and depreciated using the straight-line method over the estimated useful lives of the related assets, which range from four to forty years. Expenditures for repairs and maintenance are charged to expense as incurred. When assets are retired or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts and any resultant gain or loss is recognized.\nPatents and Trademarks\nPatents and trademarks are amortized over their expected useful lives of 3 to 17 years. Accumulated amortization of patents and trademarks was $504,000 and $867,000 at December 30, 1994 and December 29, 1995, respectively.\nGoodwill\nGoodwill is amortized over periods ranging from 13 to 40 years. Accumulated amortization of goodwill amounted to $894,000 and $2,171,000 at December 30, 1994 and December 29, 1995, respectively.\nCovenant not to compete\nCovenant not to compete is amortized over a 5 year period. Accumulated amortization related to this asset amounted to $2,750,000 and $3,047,000 at December 30, 1994 and December 29, 1995, respectively.\nEarnings per common and common equivalent share\nEarnings per common and common equivalent share was computed by dividing net income (loss) by the weighted average number of shares of common stock and common stock equivalents outstanding during the year.\nUse of estimates\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the 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.\nReclassifications\nCertain amounts previously reported have been reclassified to conform to current year classifications.\nNOTE 2 - INVENTORIES\nThe components of inventory are as follows (in thousands):\nNOTE 3 - PROPERTY, PLANT AND EQUIPMENT\nDetails of property, plant and equipment are as follows (in thousands):\nRental expense on operating leases was approximately $392,000, $441,000, and $445,000 for the years ended December 1993, 1994, and 1995, respectively. The aggregate future minimum lease commitments for operating leases at December 29, 1995 amounted to approximately $233,000 and $31,000 payable in 1996 and 1997, respectively.\nNOTE 4 - LONG-TERM DEBT\nLong-term debt consists of the following (in thousands):\nThe Company's credit facility consists of a $30,000,000 term loan and a $10,000,000 revolving line of credit. The existing term loan is payable in quarterly installments of $1,500,000 at an interest rate of 1.625% over LIBOR (7.60% at December 29, 1995). The existing revolving line of credit expires on April 1, 1998 and carries an interest rate of 1.50% over LIBOR (7.47% at December 29, 1995). The credit facility, which is secured by substantially all of the assets of the Company, contains minimum requirements for working capital, cash flow and net worth. The Company has met these requirements.\nIn anticipation of the proposed acquisition of NDM (Note 10), the Company has obtained a commitment from existing lenders to increase its aggregate credit facility to $80,000,000. Under terms of this commitment which will become effective upon consummation of the NDM acquisition, the Company will have a term loan of $65,000,000 and an available revolving line of credit of $15,000,000. The term loan will be payable in quarterly installments over five years while the revolving credit facility will initially be outstanding for a period of three years. Under this commitment, the Company will have interest rate options equal to a base rate (the higher of prime or a federal funds rate) or 1.25% over LIBOR.\nTotal interest costs in 1993 and 1994 were $306,000 and $628,000, respectively, all of which was expensed. Interest cost during 1995 was $2,119,000 of which $73,000 was capitalized as interest during construction.\nNOTE 5 - LEASES AND OTHER LONG-TERM LIABILITIES\nUpon the Company's acquisition of Birtcher (Note 10), use of certain manufacturing and administrative facilities previously occupied by Birtcher was discontinued. A liability of approximately $4,407,000 was established in connection with Birtcher purchase accounting representing the aggregate future rental payments net of committed sublease income at the date of acquisition.\nFuture minimum rental commitments, net of sublease income, for such leases at December 29, 1995 are as follows (in thousands):\nPrior to its acquisition by the Company, Birtcher voluntarily began participation in an environmental investigation at a former facility located in El Monte, California. The former facility is located in the El Monte Operable Unit of the San Gabriel Valley Superfund Site. The Environmental Protection Agency has not named Birtcher as a Potentially Responsible Party in this matter. Based on estimates prepared by the Company's environmental consultants, the Company established a liability for site clean-up of $1,500,000 in connection with purchase accounting for Birtcher.\nNOTE 6 - FEDERAL AND STATE INCOME TAXES\nThe provision for income taxes consists of the following (in thousands):\nA reconciliation between income taxes computed at the statutory federal rate and the provision for income taxes follows:\nThe tax effects of the significant temporary differences which comprise the deferred tax assets and liabilities are as follows (in thousands):\nBirtcher net operating losses are subject to certain limitations and expire over the period 2008 to 2010. Management has established a valuation allowance of $5,417,000 to reflect the uncertainty of realizing the benefit of certain of these carryforwards. Utilization of Birtcher operating loss carryforwards in excess of the net amount recorded at December 29, 1995 of $667,000 will serve to decrease Goodwill associated with the Birtcher acquisition.\nNOTE 7 - SHAREHOLDERS' EQUITY\nOn November 22, 1994 and October 31, 1995, the Board of Directors of the Company declared three-for-two splits of the Company's common stock to be effected in the form of stock dividends. Such dividends were payable on December 27, 1994 and November 30, 1995 to shareholders of record on December 8, 1994 and November 13, 1995, respectively. Accordingly, common stock, retained earnings, earnings (loss) per share, the number of shares outstanding, the weighted average number of shares and equivalents outstanding and stock option data have been restated to retroactively reflect the split.\nOn December 22, 1995, the Company filed a Registration Statement with the Securities and Exchange Commission in anticipation of a public offering of 2,800,000 shares of the Company's common stock. Proceeds of this offering, which is expected to occur in the first quarter of 1996, will be used to repay outstanding debt under the Company's credit facility (Note 4).\nIn 1983, the shareholders authorized 500,000 shares of preferred stock, par value $.01 per share, which may be issued in one or more series by the Board of Directors without further action by the shareholders. As of December 29, 1995, no preferred stock had been issued.\nThe Company has reserved shares of common stock for issuance to employees and directors under three Stock Option Plans (the \"Plans\"). As of December 29, 1995, a total of 1,682,470 of these options had been granted at $.89 to $25.00 per share. The option price on all outstanding options is equal to the estimated fair market value of the stock at the date of grant. Stock options are non-transferable other than on death and are exercisable one year from date of grant but for not more than ten years from date of grant. As of December 29, 1995, 1,263,000 stock options were exercisable.\nThe following is a summary of incentive stock option activity under the Plans (in thousands except per share amounts):\nThrough the Company's 1989 acquisition of Aspen Laboratories, Inc., Bristol-Myers Squibb Company received a warrant dated as of August 31, 1989 to purchase at $4.29 per share 698,470 shares of the Company's common stock subject to adjustment for certain stock transactions. The warrant is currently exercisable and expires on August 31, 2000.\nIn connection with the acquisition of Birtcher (Note 10), Birtcher incentive stock options outstanding as of the acquisition were exchanged for options to purchase common stock of CONMED Corporation. Such options were exercisable for a period of six months from the date of the acquisition. Proceeds resulting from the exercise of options of 100,000 shares for $797,000 have been recorded as an increase to common stock and paid-in capital.\nIn October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123 (SFAS 123), \"Accounting for Stock-Based Compensation\". SFAS 123 defines a fair value based method of accounting for an employee stock option. Under the fair value based method, compensation cost is measured at the grant date based on the fair value of the award and is recognized over the service period. A company may elect to adopt SFAS 123 or elect to continue accounting for its stock option or similar equity awards using the intrinsic method, where compensation cost is measured at the date of grant based on the excess of the market value of the underlying stock over the exercise price. If a company elects not to adopt the fair value method defined by SFAS 123, then it must provide pro forma disclosure of net income and earnings per share, as if the fair value based method had been applied. SFAS No. 123 is effective for transactions entered into for fiscal years that begin after December 15, 1995. It is currently anticipated that the Company will continue to account for stock-based compensation plans under the intrinsic method and therefore, SFAS 123 will have no effect on the Company's consolidated financial position or results of operations.\nNOTE 8 - EXPORT SALES AND MAJOR CUSTOMERS\nSales outside of the United States accounted for approximately 12.8% of the Company's total sales in 1993, 13.6% in 1994 and 15.5% in 1995. The Company's products are provided to medical professionals and facilities directly and through medical supply distributors. Sales to one distributor totaled 12.3% of the Company's sales in 1995 and 10.7% of 1994 sales. Sales to another distributor totaled 10.0% of the Company's sales in 1994.\nNOTE 9 - PENSION PLANS\nThe Company maintains defined benefit plans covering substantially all employees. The Company makes annual contributions to the plans equal to the maximum deduction allowed for federal income tax purposes.\nNet pension cost for 1993, 1994, and 1995 included the following components (in thousands):\nThe following tables set forth the plans' funded status and amounts recognized in the Company's Consolidated Balance Sheet at December 30, 1994, and December 29, 1995 (in thousands):\nFor actuarial calculation purposes, the weighted average discount rate was 7.0% in 1993, 1994 and 1995. The expected long term rate of return was 8.0% in 1993, 1994 and 1995. The rate of increase in future compensation levels was 4.0% in 1993, 1994 and 1995. Common stock of the Company included in plan assets, at fair value, was approximately $462,000 at December 30, 1994 and $459,000 at December 29, 1995.\nNOTE 10 - BUSINESS ACQUISITIONS\nIn July 1993 the Company acquired certain assets and the business of Medtronic Andover Medical, Inc., a manufacturer of cardiac monitoring disposable products, from Medtronic, Inc. in a purchase transaction for approximately $21,800,000 in cash. Accordingly, the results of operations of the acquired business are included in the consolidated results of the Company from the date of acquisition. The transaction was accounted for using the purchase method of accounting. Goodwill is being amortized on a straight-line basis over a 40 year period while a covenant not to compete and other intangible assets related to the acquisition are being amortized on a straight-line basis over periods ranging from five to eight years.\nIn November 1994, the Company acquired a specialty ECG monitoring product line from Becton Dickinson Vascular Access Company in a purchase transaction amounting to $2,000,000 in cash. The product line's operations have been included with the Company's financial results since the acquisition date. Goodwill is being amortized on a straight-line basis over a 40 year period and a covenant not to compete is amortized over a five year period.\nOn March 14, 1995, the Company acquired Birtcher Medical Systems, Inc. (\"Birtcher\") through an exchange of the Company's common stock for all of the outstanding common and preferred stock of Birtcher. In connection with this transaction, the Company issued 1,590,000 shares of common stock valued at $17,750,000 and assumed approximately $3,500,000 of net liabilities. Accordingly, the results of operations of the acquired business are included in the consolidated results of the Company from the date of acquisition. The acquisition was accounted for using the purchase method of accounting. Goodwill associated with the acquisition is being amortized on a straight-line basis over a 40 year period.\nOn May 22, 1995, the Company acquired the business and certain assets of the Master Medical Corporation (\"Master Medical\") for a cash purchase price of approximately $9,500,000 and assumption of $500,000 of liabilities. Accordingly, the results of operations of the acquired business are included in the consolidated results of the Company from the date of acquisition. The acquisition was accounted for using the purchase method of accounting. Goodwill associated with the acquisition is being amortized on a straight-line basis over a 15 year period.\nOn an unaudited pro forma basis, assuming the Birtcher and Master Medical acquisitions had occurred as of the beginning of the periods presented, the consolidated results of the Company would have been as follows (in thousands, except per share amounts):\nIn October 1995, the Company signed an asset purchase agreement whereby the Company will acquire substantially all the business and certain assets of New Dimensions in Medicine, Inc. (\"NDM\") for a cash purchase price of approximately $32.0 million plus the assumption of net liabilities of approximately $5.1 million. Through this acquisition, which is expected to close in the first quarter of 1996 and which is subject to the approval of the shareholders of NDM, the Company will acquire the business of NDM relating to the design, manufacture and marketing of a broad line of ECG electrode products, disposable electrosurgical products and various Hydrogel wound care products.\nOn an unaudited pro forma basis, assuming the Birtcher, Master Medical and NDM acquisitions had occurred as of the beginning of the periods presented, the consolidated results of the Company would have been as follows (in thousands, except per share amounts):\nThe unaudited pro forma financial information presented above gives effect to purchase accounting adjustments which have resulted or are expected to result from the acquisitions, and in the case of the NDM acquisition to the elimination of certain overhead costs which are not expected to be incurred by the combined entity. This pro forma information is not necessarily indicative of the results that would actually have been obtained had the companies been combined for the periods presented.\nNOTE 11 - LEGAL MATTERS AND PRODUCT RESTRUCTURE\nOn October 13, 1993, a jury in a U.S. District Court trial in Salt Lake City, Utah found that the Company's line of coated electrosurgical accessory blades infringed a patent held by a competitor. Subsequently, the District Court trial Judge fixed the damage award at $2,100,000 and issued an injunction prohibiting CONMED from selling the affected products. During 1993, the Company recorded a $5,000,000 charge related to this infringement, which included the court awarded damages, legal fees and writedown of related inventory. The $2,100,000 damage award was paid in 1995 after the award was affirmed.\nAdditionally, during 1993 management determined that approximately $675,000 of inventory, primarily in the electrosurgical pencil product line, had become obsolete due to product modifications. Accordingly, these obsolete items were charged to product restructure expense.\nFrom time to time, the Company has been named as a defendant in certain lawsuits alleging product liability or other claims incurred in the ordinary course of business. These claims are generally covered by various insurance policies, subject to deductible amounts and maximum policy limits. Ultimate liability with respect to these contingencies, if any, is not considered to be material to the consolidated financial statements of the Company.\nNOTE 12 - SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)\nSelected quarterly financial data for the years ended December 30, 1994 and December 29, 1995 are follows (in thousands, except per share amounts):","section_15":""}
{"filename":"355019_1995.txt","cik":"355019","year":"1995","section_1":"Item 1. Business.\nGeneral\nFONAR Corporation (the \"Company\" or \"FONAR\") is a Delaware corporation which was incorporated on July 17, 1978. The Company's address is 110 Marcus Drive, Melville, New York 11747 and its telephone number is (516) 694-2929.\nFONAR is the originator of the iron-core non-superconductive and permanent magnet technology and is engaged in the business of designing, developing, manufacturing, marketing and servicing magnetic resonance imaging (\"MRI\" or \"MR\") scanners which utilize that technology for the detection and diagnosis of human disease. FONAR's iron frame technology made FONAR the originator of \"open\" MRI scanners. FONAR introduced the first \"open\" MRI in 1980 and maintained its \"open\" design ever since.\nThe Company's principal products are its new \"Quad\" series of MRI scanners. On October 5, 1993, the Company unveiled the \"Quad 12000TM\" MR scanner, which utilizes a 6000 gauss iron core electromagnet and is accessible from four sides. The Quad 12000 was the first \"open\" MR scanner above low field (above 600 gauss). Shortly thereafter, on March 1, 1994, FONAR unveiled the \"Quad 7000TM,\" which is similar in design to the Quad 12000 but utilizes a smaller 3,500 gauss electromagnet.\nFONAR received FDA approval to market the Quad 7000 in April, 1995 and presently is awaiting FDA approval for the Quad 12000.\nIn 1990 the Company introduced the Ultimate 7000TM scanner, which was its principal product prior to the introduction of the Quad scanners. The QuadTM and Ultimate TM scanners are revolutionary new MR scanning products representing the culmination of years of total company wide effort to design and construct the \"Ultimate MR\" scanner product line. These products replaced the Company's traditional principal products, the Beta 3000TM scanner (which utilizes a permanent magnet) and the Beta 3000MTM scanner (which utilizes an iron core electromagnet). All of the Company's scanners create cross-sectional images of the human body.\nRecent Developments and Overview.\nThe \"Quad\" scanners are unique MR scanners in that four sides are open, thus allowing access to the scanning area from four vantage points. Equipped with up to four beds, the user is able to prep one or more \"on deck\" patients while another patient is being scanned, thereby increasing throughput and reducing scan prices. The starshaped open design of the Quad will also make possible a host of new applications, particularly MRI mammography and MRI directed surgery (Interventional MRI).\nWith the Quad's multi-bed patient handling system, many more short scan procedures such as those used in breast imaging can be done in a day, allowing the price of MRI mammography to drop without reducing the scanner's revenue-generating capacity. At the same time, there is not the painful compression of the breast characteristic of X-ray mammography.\nMRI directed surgery (laproscopic surgical procedures) is made possible by the Quad's ability to supply images to a monitor positioned next to the patient, enabling a surgeon to view in process surgical procedure from an unlimited number of vantage points.\nThe vertical patient space in the Quad has been increased by nearly 50%, which is important not only for comfort, but diagnostically, by permitting the utilization of the Company's software for the taking of \"moving scans.\" Those \"moving scans\" or \"CINE,\" enable the physician to observe the scanned body part (e.g., knee, neck and elbow) in motion. The Quad enables a full range of motion studies that cannot be completely performed in the claustrophobic cylindrical tubes of today's superconductive magnets.\nThe Quad 7000, utilizing a 3500 gauss iron core electro magnet, is envisioned by the Company as an economical solution to the rising cost of medicine. Priced at $650,000, the Company expects the Quad 7000 to be a success in the market, not only with first time buyers but with users who must now replace their obsolete MRI equipment.\nThe Quad 12000 scanner will utilize a 6000 gauss (.6 Tesla field strength) iron core electromagnet. The greater field strength of the 6000 gauss magnet, when enhanced by the electronics already utilized by the Company's scanners, produces images of a quality and clarity competitive with high field superconductive magnets. The Quad 12000 scanner magnet is the highest field \"open MRI\" in the industry.\nAs a result of these new products and other research and development, the Company is positioning itself to dramatically in crease sales and improve its competitive position in the marketplace.\nIn tandem with new product and software developments, the Company has been strengthening and continues to strengthen its legal position for the purpose of protecting its proprietary technology as well as other interests. The Company does not intend to permit its competitors and would-be competitors to capitalize, to the detriment of the Company, on its inventions and exhaustive research and development efforts, as the Company believes has happened in the past.\nOn September 2, 1992, the Company filed a patent infringement suit against Hitachi Ltd., General Electric Company and others in the United States District Court for the Eastern District. In April, 1995, the Company reached a settlement with Hitachi Ltd. and related defendants. In May, 1995, the jury rendered a verdict in FONAR's favor against General Electric Company. In October, 1995, the Court awarded FONAR judgment of $62 million, plus interest and issued an injunction (stayed pending appeal) enjoining General Electric from future violations of Fonar's Multi-Angle Oblique (MAO)TM patent.\nFollowing its favorable jury verdict against General Electric Company, FONAR filed patent infringement suits against Siemens Medical Systems, Inc., Siemens, AG, Philips Electronics, NV, Philips Medical Systems, Inc. and Philips Electronics North America Corporation. The patents sought to be enforced against both defendants include the Multi-Angle Oblique improvement patent (U.S. Patent No. 4,871,966 entitled \"Apparatus and Method for Multiple Angle Oblique Magnetic Resonance Imaging\").\nThe Company is optimistic about sales of its new scanner products. At September 1, 1995, the Company's backlog of unfilled orders had increased to $4.0 million as compared to $1.5 million at September 1, 1994. To further promote product recognition and sales, FONAR will attend the RSNA (Radiological Society of North America) trade show in November 1995 to exhibit its new products. The RSNA is the leading trade show in the MRI industry. Approximately 25,000 radiologists, who are among the principal groups to whom the Company directs its marketing efforts, are expected to attend to view MRI industry's most current product developments.\nThe Company is actively seeking to promote foreign sales, thus enhancing America's competitive position as well as its own. Since commencing its current foreign sales program, the Company has sold scanners in Korea, Mexico and Poland. Based on numerous indications of interest, meetings, sales trips abroad and negotia tions, the Company is cautiously optimistic that foreign sales will produce significant revenues in fiscal 1996 and\/or 1997, depending on timing of orders and completion of projects.\nThe Company believes there are and will be significant market opportunities abroad, particularly in Asia and Eastern Europe.\nProducts Offered\nBoth the \"Quad\" and \"Ultimate\" scanners are entirely new products. The Quad 12000 and Quad 7000 utilize 6000 gauss and 3500 gauss iron core electromagnets respectively, and the Ultimate 7000 utilizes a 3500 gauss electromagnet. In addition to the patient comfort, increased throughput and new applications (such as MRI directed surgery and MRI mammography) made possible by the Quad scanners' open design, the Quad 7000 is designed to maximize image quality through an optimal combination of signal-to-noise (S\/N) and contrast-to-noise (C\/N) ratios. The technical improvements realized in the Quad's design over its predecessors also include increased image-processing speed and diagnostic flexibility.\nThe principal difference between the Quad 7000 and other open MRI scanners is in field strength. Other open MRIs operate at significantly lower magnetic field strengths and, therefore, are unable to produce the amount of MRI image-producing signal necessary to make high-quality MRI images (measured by signal-to-noise ratios, S\/N). The Quad 7000 operates at 3500 gauss, over five times as powerful as some of the others.\nMaximal S\/N is achieved when the direction of the magnetic field and the direction of the receiving coil axis are perpendicular to one another, as is the case with the Quad scanners. The orientation of the magnetic field is vertical and when combined with any one of Fonar's array of solenoidal (wrap-around) surface coils, the Quad 7000 produces as much S\/N as a supercon MRI at twice the field strength. So that prospective buyers can make an accurate comparison, the number 7000 is used to describe the S\/N equivalency of the Quad 7000 to 7000-gauss superconductive machines.\nSeveral technological advances have been engineered into the Quad 7000 for extra improvements in S\/N, including: new high-S\/N Organ SpecificTM receiver coils; new ceramic magnet poles that provide advanced eddy-current control; new advanced front-end electronics featuring high-speed, wide-dynamic-range analog-to-digital conversion and a miniaturized ultra-low-noise pre-amplifier; high-speed automatic tuning, bandwidth-optimized pulse sequences, multi-bandwidth sequences, and off-center FOV imaging capability.\nIn addition to the signal-to-noise ratio, however, the factor that must be considered when it comes to image quality is contrast, the quality that enables reading physicians to clearly distinguish adjacent, and sometimes minute, anatomical structures. This quality is measured by contrast-to-noise ratios (C\/N). Unlike S\/N, which increases with increasing field strength, relaxometry studies have shown that C\/N peaks in the mid-field range and actually falls off precipitously at higher field strengths. At 3500 gauss, the Quad 7000 operates squarely in the mid-field range and, therefore, enjoys the winning combination of abundant S\/N and C\/N, making its images second to none.\nThe Quad 7000's state-of-the-art electronics package features five computer processors performing parallel processing. Its incomparable speed is demonstrated by its ability to scan and reconstruct images simultaneously and its ability to reconstruct a 256x256 image in 0.7 seconds, the fastest of any MRI scanner on the market.\nThe Quad 7000 provides various features allowing for versatile diagnostic capability. For example, SMARTTM scanning allows for same-scan customization of up to 63 slices, each slice with its own thickness, resolution, angle and position. This is an extremely valuable feature for scanning parts of the body that include small-structure sub-regions requiring finer slice parameters. There's also Evolving ImagesTM, Multi-Angle Oblique (MAO)TM imaging, and oblique imaging.\nBecause of the openness of the Quad 7000 and FONAR's coil development and CINE, Quad 7000 users can plan on adding the works-in-progress CINE-FLEXTM option to their scanners. CINE-FLEXTM is a set of specialized coils and matching fixtures that enable full-range CINEs of the knee, shoulder, C-spine, L-spine and TMJ - an impossibility with supercon MRIs.\nThe Quad 7000 console includes a mouse-driven, multi-window interface for easy operation and a 19-inch, 1280x1280-pixel, 20-up, high-resolution image monitor with features such as electronic magnifying glass and real-time, continuous zoom and pan.\nThe Quad MR scanner is a top-down new design in computer architecture and high speed image processing that incorporate the latest state-of-the-art chip technology. The time to construct an image, for example, has been reduced from 12 seconds per image to 0.7 seconds.\nThe Beta 3000 initiated the Company's product line and resulted in over 150 worldwide FONAR installations to date. The effort to achieve the Quad and the Ultimate product line represented a company-wide aspiration to seize the opportunity to incorporate into the Company's product line all of the desirable features FONAR had learned since it opened the industry in 1980. The facility of these features have been achieved in FONAR's \"Quad\" and \"Ultimate\" MR machines.\nMarkets and Marketing\nThe principal markets for the \"Quad\" and \"Ultimate\" scanners are hospitals and private scanning centers, the same as for the Beta 3000 and Beta 3000M. In particular, the Company regards its existing customers as potential purchasers of its new products. The Company has conducted its marketing in the United States through its own sales network and internationally through selected distributors. Direct domestic marketing is accomplished through field solicitation of potential users by Company personnel. The Company intends to make greater use of independent sales representatives and distributors working on a commission basis.\nIn addition, the Company plans to attend the trade show held by the Radiological Society of North America (\"RSNA\") in Chicago in November 1995, where it will exhibit its new products. The RSNA trade show is held annually and is attended by most manufacturers of MRI scanners. Attendance in 1995 is expected to reach nearly 60,000, including 25,000 radiologists. Radiologists are among the principal groups to whom the Company directs its marketing.\nThe Company plans to direct its marketing efforts to meeting the increasing demand for low price MRI. To date, the increased pressure for lower scanning prices has come largely from preferred provider organizations, health maintenance organizations and other private sector group plans and stricter insurance requirements, but government mandated health care reform is also under consideration.\nTo meet this demand, the Company has set a base price of $650,000 for the Quad 7000 scanner. In addition to reducing the health care provider's equipment cost, the Quad 7000 scanner's improved image processing speed and extra-bed(s) option (allowing patients to be prepped while another patent is being scanned) would enable the provider to increase patient volume and further reduce per scan costs.\nThe reduced per scan costs will enable the Company to promote the Quad 7000 for short scan procedures such as MRI mammograms. MRI mammograms have the advantage over traditional x-rays of involving no radiation, and an MRI breast scan can be taken in most cases through ordinary street clothes without any painful compression.\nThe Company also will also seek to introduce new MRI applications for the Quad scanners such as MRI-directed surgery and head-to-toe MRI preventive screening.\nSee \"Note 9 to Notes to Consolidated Financial Statements\" for the percentage of foreign sales as in relation to the Company's total revenues.\nService and Upgrades\nThe Company regards its customer base of over 100 scanners installed or in the process of being installed as a major asset. It has been and will continue to be a significant source of income, independent of direct sales.\nIncome is generated from the installed base in two principal areas namely, service and upgrades. Service and maintenance revenues from the Company's installed base were approximately $7.7 million in fiscal 1994 and $6.6 million in fiscal 1995. The decrease in fiscal 1995 is principally the result of the retirement of old scanners.\nSubstantial upgrades income, which is new to the medical instrument industry, originates in the exceptional versatility and productivity of the MRI technology. New medical uses for the technology are constantly being discovered. Dramatic new features can often be added to the scanner by the implementation of little more than versatile new software packages. Such enhancements are attractive to the end users because they extend the useful life of the equipment and enable the user to avoid obsolescence and the expense of having to purchase new equipment.\nMRI Scanning Centers\nThe Company's subsidiary, Advanced Medical Diagnostics Corporation (\"AMD\") was formed to organize and supervise, as the general partner, limited partnerships which have established diagnostic centers to operate MRI scanners.\nSince its inception, AMD has formed four limited partnerships either as the managing general partner or as co-general partner. The partnerships to date have not generated significant distributions to AMD.\nAMD's interests in these four limited partnerships were sold to related parties during the 1994 fiscal year. (See Certain Relationships and Related Transactions.) No new AMD sponsored partnerships have been formed since 1986 and none are presently contemplated. Earlier changes in the Internal Revenue Code and recent regulations concerning self-referrals (see \"Government Regulations\") have worked against the utilization of syndicated limited partnerships as a vehicle for financing and operating MRI centers.\nResearch and Development\nDuring the fiscal year ended June 30, 1995, the Company incurred expenditures of $3,508,101 ($151,981 of which was capitalized) on research and development, as compared to $3,604,785 ($687,551 of which was capitalized) and $3,119,898 ($938,926 of which was capitalized) incurred during the fiscal years ended June 30, 1994 and June 30, 1993, respectively.\nResearch and development activities have focused, in large part, on the development and enhancement of the Company's \"Quad\" MR scanners and on the continued enhancement of the Ultimate and Beta 3000 and Beta 3000M products. The \"Quad\" and \"Ultimate\" scanners involved significant software and hardware development as the new products represented entirely new hardware design and architecture requiring a complete new operating software system. Most recently, the Company's research activity has centered on developing a multitude of new features for the Quad series scanners made possible by the Quad's high speed processing power.\nBacklog\nThe Company's backlog of unfilled orders at September 1, 1995 increased to approximately $ 4.0 million, as compared to $1.5 million at September 1, 1994. Of these amounts, approximately $2.4 million and $925,000 had been paid to the Company as customer advances as at September 1, 1995 and September 1, 1994, respectively. It is expected that the existing backlog of orders will be filled within the current fiscal year. The Company's contracts generally provide that if a customer cancels an order, the customer's initial down payment for the MRI scanner is nonrefundable.\nPatents and Licenses\nThere are currently numerous foreign and domestic patents in effect which relate to the technology and components of the MRI scanners, some of which are registered in the name of the Company and others which are registered in the name of Dr. Raymond V. Damadian, the President and principal stockholder of the Company. The Company believes that these patents, which expire at various times from 1999 to 2009, and the know-how it developed, are material to its business.\nDr. Damadian has granted an exclusive world-wide license to the Company to make, use and sell apparatus covered by certain domestic and foreign patents relating to his MRI technology. The license continues until the expiration of the last patent included within the licensed patent rights, but is terminable earlier, at the option of Dr. Damadian, if he is removed from his position as Chairman of the Board or President of the Company without his consent, or if any stockholder or group of stockholders acting in concert becomes the beneficial owner of Company securities having voting power equal to or greater than the voting power of the securities held directly by him, his executors, administrators, successors or heirs. The agreement can also be terminated by Dr. Damadian upon the commission of an act of bankruptcy by the Company. If Dr. Damadian is unable to serve the Company by reason of his death or disability, the license agreement will remain in effect.\nOne of the patents, issued in the name of Dr. Damadian and covered by said license, is United States patent No. 3,789,832, Apparatus and Method for Detecting Cancer in Tissue (the \"1974 Patent\"). The development of the Beta 3000 was based upon the 1974 Patent, and Management believes that the 1974 Patent was the first of its kind to utilize MR to scan the human body and to detect cancer. The 1974 Patent was extended beyond its original 17-year term and expired in February, 1992.\nThe Company has significantly enhanced its patent position within the industry and now possesses a substantial patent portfolio which provides the Company, under the aegis of United States patent law, \"the exclusive right to make, use and sell\" many of the scanner features which FONAR pioneered and which are now incorporated in most MRI scanners sold by the industry. The patents further enhance Dr. Damadian's pioneer patent (the 1974 Patent), that initiated the MRI industry and provided the original invention of MRI scanning.\nThe Company has entered into a cross- licensing agreement (utilizing other than FONAR's MRI technology) with another entity to use prior art developed for nuclear magnetic resonance technology and has entered into a license to utilize the MRI technology covered by the existing patent portfolio of a patent holding company.\nEnforcement Litigation\nOn September 2, 1992, the Company commenced legal action to enforce its patent rights, filing suit against Hitachi Ltd., General Electric Company and others in the United States District Court for the Eastern District of New York. Prior to trial in April 1995, FONAR settled with Hitachi. On May 26, 1995 the jury rendered a verdict against General Electric Company awarding FONAR $110,575,000 for infringement of its multi-angle oblique patent (Apparatus and Method for Multiple Angle Oblique MRI, 10\/3\/89, U.S. Patent No. 4,871,966) and Dr. Damadian's pioneer cancer detection patent (Apparatus and Method for Detecting Cancer in Tissue, 2\/5\/74, U.S. Patent No. 3,789,832). On October 6, 1995, the Court announced its decisions on the parties' respective post-trial motions, awarding FONAR $62 million and an injunction (stayed pending appeal) on the multi-angle oblique patent (U.S. Patent No. 4,871,966). Although finding that the cancer detection patent was valid (U.S. Patent No. 3,789,832), the Court overturned the jury's determination that General Electric Company's MRI scanners infringed the patent. Both the Company and General Electric Company plan to appeal. The Company is represented by Robins, Kaplan, Miller and Ciresi, the Minneapolis based national law firm that represented Honeywell in its lawsuit against Minolta for infringement of Honeywell's autofocus patents.\nFollowing the rendering of the jury's verdict in favor of FONAR against General Electric Company, the Company, represented by Robins, Kaplan, Miller and Ciresi, filed suits against Siemens Medical Systems, Inc., Philips Electronics North America Corporation and related parties for infringement of FONAR's multi-angle oblique patent, Dr. Damadian's pioneer cancer detection patent and, in the case of Siemens Medical Systems, Inc., two additional MRI improvement patents.\nThe Company believes that it has achieved a significant milestone in protecting and enforcing its proprietary rights in its lawsuit against General Electric Company, and having pioneered the establishment and development of the medical MRI scanning industry, the Company intends to take the steps necessary to enforce its rights and protect its proprietary technology against other infringers as well. (See \"Litigation.\")\nCompetition\nMRI Scanners\nA majority of the MRI scanners in use in hospitals and outpatient facilities and at mobile sites in the United States are based on superconductive magnet technology while the balance are based on non-superconductive magnet technology. FONAR's non-superconductive MRI scanners are competing principally with superconductive scanners.\nFONAR believes that its MRI scanners have significant advantages as compared to the superconductive scanners. These advantages include:\n1. There is no fringe magnetic field. Super conductive scanners require a more expensive shielded room than is required for the non-superconductive scanners. The shielded room required for the non-superconductive scanners is intended to prevent interference from external radio frequencies.\n2. Do not require costly coolants (liquid nitrogen and liquid helium) or highly complex technology to handle them.\n3. Are more open, quiet and in the case of the Quad scanners allow for faster throughput of patients.\n4. Require smaller space to install.\n5. Annual operating costs are lower.\n6. The set-up and disconnect time for a Mobile Scanner is shorter than for a mobile superconductive scanner.\n7. Can scan the trauma victim, the cardiac arrest patient, the respirator-supported patient, and premature and newborn babies. This is not possible with superconductive scanners because their magnetic field interferes with conventional life-support equipment.\nFONAR faces competition within the MRI industry from such firms as General Electric Company; Picker International, which is a Division of General Electric Company PLC, of England; Elscint Ltd; Philips N.V.; Toshiba Corporation, Hitachi Corporation, Shimadzu Corporation and Siemens A.G. Most competitors have marketing and financial resources more substantial than those available to the Company and have in the past, and may in the future, heavily discount the sales price of their scanners.\nOther Imaging Modalities\nFONAR's MRI scanners also compete with other diagnostic imaging systems, all of which are based upon the ability of energy waves to penetrate human tissue and to be detected by either photographic film or electronic devices for presentation of an image on a television monitor. Three different kinds of energy waves - x-ray, gamma and sound - are used in medical imaging techniques which compete with MRI medical scanning, the first two of which involve exposing the patient to potentially harmful radiation.\nX-rays are the most common energy source used in imaging the body and are employed in three imaging modalities:\n1. Conventional x-ray systems, the oldest method of imaging, are typically used to image bones and teeth. The image resolution of adjacent structures that have high contrast, such as bone adjacent to soft tissue, is excellent, while the discrimination between soft tissue organs is poor because of the nearly equivalent penetration of x-rays.\n2. Computerized Tomography (\"CT\") systems couple computers to x-ray instruments to produce cross-sectional images of particular large organs or areas of the body. The CT scanner addresses the need for images, not available by conventional radiography, that display anatomic relationships spatially. However, CT images are generally limited to the transverse plane and cannot readily be obtained in the two other planes (sagittal and coronal). Improved picture resolution is available at the expense of increased exposure to x-rays from multiple projections. Furthermore, the pictures obtained by this method are computer reconstructions of a series of projections and, once diseased tissue has been detected, CT scanning cannot be focused for more detailed pictorial analysis or obtain a chemical analysis.\n3. Digital radiography systems add computer image processing capability to conventional x-ray systems. Digital radiography can be used in a number of diagnostic procedures which provide continuous imaging of a particular area with enhanced image quality and reduced patient exposure to radiation.\nNuclear medicine systems, which are based upon the detection of gamma radiation generated by radioactive pharmaceuticals introduced into the body, are used to provide information concerning soft tissue and internal body organs and particularly to examine organ function over time.\nUltrasound systems emit, detect and process high frequency sound waves reflected from organ boundaries and tissue interfaces to generate images of soft tissue and internal body organs. These systems have comprised one of the most rapidly growing modalities during recent years due to an increasing number of procedures for established applications, as well as the expansion of ultrasound into new applications. Although the images are substantially less detailed than those obtainable with x-ray methods, ultrasound is generally considered harmless and therefore has found particular use in imaging the pregnant uterus.\nX-ray machines, ultrasound machines, digital radiography systems and nuclear medicine compete with the MRI scanners by offering significantly lower price and space requirements. However, FONAR believes that the quality of the images produced by its MRI scanners is generally superior to the quality of the images produced by those other methodologies.\nFONAR believes that the introduction of its Quad 7000 scanner will enable MRI users to compete on the basis of cost, as well as quality, with those methodologies, thereby expending the range of economically feasible MRI applications and demand for FONAR's products. In addition, only MRI scanners and ultrasound systems do not produce harmful ionizing radiation.\nGovernment Regulation\nUnder the Medical Device Amendments of 1976 to the Federal Food, Drug and Cosmetic Act, all medical devices are classified by the Food and Drug Administration (the \"FDA\") into one of three classes. A Class I device is subject only to certain controls, such as labeling requirements and manufacturing practices; a Class II device must comply with certain performance standards established by the FDA; and a Class III device must obtain pre-market approval from the FDA prior to commercial marketing. The Company received approval to market its Beta 3000 and Beta 3000M scanners as Class III devices on September 26, 1984. On July 28, 1988, the Magnetic Resonance Diagnostic Device which includes MR Imaging and MR Spectroscopy was reclassified by the FDA to Class II status. On June 25, 1992, the Company received FDA approval to market the Ultimate Magnetic Resonance Imaging Scanner as a Class II device, and on April 10, 1995, the Company received FDA approval to market its latest product, the Quad 7000, as a Class II device. The Company presently is awaiting FDA approval to market the Quad 12000.\nThe FDA has authority to conduct detailed inspections of manufacturing plants, to establish \"good manufacturing practices\" which must be followed in the manufacture of medical devices, to require periodic reporting of product defects and to prohibit the exportation of medical devices that do not comply with the law.\nEffective November 22, 1985, the Department of Health and Human Services authorized reimbursement of MRI scans under the Federal Medicare program. In addition, most private insurance companies have authorized reimbursement for MRI scans.\nProposed and enacted legislation at the State and Federal levels has restricted referrals by physicians to medical and diagnostic centers in which they or their family members have an interest. In addition, regulations have been adopted by the Secretary of Health and Human Services which provide limited \"safe harbors\" under the Medicare Anti-Kickback Statute. These safe harbors describe payments and transactions which are permitted between an entity receiving reimbursement under the Medicare program and those having an interest in or dealings with the entity. Although the Company cannot predict the overall effect of the adoption of these regulations on the medical equipment industry, the use and continuation of limited partnerships (where investors may be referring physicians) to own and operate MRI scanners could be greatly diminished.\nEmployees\nAs of September 1, 1995, the Company employed 165 persons on a full-time basis. Of such employees, 10 were engaged in marketing and sales, 26 in research and development, 47 in manufacturing, 47 in customer support services, and 35 in administration.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company leases approximately 93,240 square feet of office and plant space at its principal office in Melville, New York and at one other location in Farmingdale, New York at a current aggregate rental rate of approximately $671,000, excluding utilities, taxes and other related expenses. The terms of the various leases extend through 1997. Management believes that these premises are adequate for its current needs.\nItem 3.","section_3":"Item 3. Legal Proceedings\nOn September 2, 1992, the Company filed an action against General Electric Company, (\"General Electric\"), Hitachi Ltd. (\"Hitachi\") and other defendants for patent infringement in the United States District Court for the Eastern District of New York seeking injunctive relief and damages. (FONAR Corporation and Dr. Raymond V. Damadian v. Hitachi Ltd. et. al. Civil Action No. 92-4196). The defendants contested the Company's claims, and Hitachi counterclaimed, alleging infringement by the Company of two of its patents. In April, 1995, prior to the commencement of trial FONAR and Hitachi settled. On May 26, 1995, the jury rendered a verdict against General Electric Company awarding FONAR $110,575,000 for infringement of two of its patents: United States Patent Number 3,789,832 entitled \"Apparatus and Method for Detecting Cancer in Tissue\" and United States Patent Number 4,871,966 entitled \"Apparatus and Method for Multiple Angle Oblique Magnetic Resonance Imaging.\" Subsequent to the verdict General Electric made motions to the Court to enter judgment as a matter of law in its favor and against FONAR with respect to both patents notwithstanding the jury's verdict. FONAR made a motion to the Court for an injunction restraining General Electric Company from using the multi-angle oblique imaging technology covered by U.S. Patent No. 4,871,966. On October 6, 1995 the Court announced its decision. In its decision, the Court awarded FONAR $62 million in damages against General Electric for direct infringement of U.S. Patent No. 4,871,966 (Multiple Angle Oblique Magnetic Resonance Imaging) and granted an injunction against General Electric prohibiting future violations of the patent. The injunction was stayed pending appeal, however, subject to the posting of a bond. With respect to U.S. Patent No. 3,789,832 (Cancer Detection Patent), the judge agreed with the jury's finding that the patent was valid, but disagreed with the jury finding of infringement and determined that General Electric's MRI scanners did not infringe the patent. The Court also rejected the jury's finding that General Electric had induced others to infringe U.S. Patent No. 4,871,966. General Electric is expected to appeal the portion of the judgment upholding the jury's award of damages to FONAR for direct infringement of U.S. Patent No. 4,871,966 and the issuance of the injunction. FONAR intends to appeal the portion of the judgment overturning the jury's findings of infringement on U.S. Patent No. 3,789,832 and contributory infringement in respect of U.S. Patent No. 4,871,966.\nOn June 16, 1995, the Company filed an action against Siemens Medical Systems, Inc., Phillip Electronics North America Corporation, Philips Electronics, N.V. and other defendants for patent infringement in the United States District Court for the Eastern District of New York. FONAR is seeking injunctive relief and damages (FONAR Corporation and Dr. Raymond V. Damadian V. Siemens Medical Systems, Inc. et al. Civil Action No. CV 95-2469 (LJW). In its suit, FONAR has alleged that four of its patents were infringed, including U.S. Patent Nos. 3,789,832 (Apparatus and Method for Detecting Cancer in Tissue) and 4,871,966 (Apparatus and Method for Multiple Angle Oblique Magnetic Resonance Imaging).\nPreviously, in May 1995, Siemens Medical Systems, Inc. had filed a complaint against FONAR in the United States District Court for the District of Delaware seeking a declaratory judgment that the four patents were invalid and unenforceable, as well as an adjudication that Siemens was not infringing the four patents. On June 14, 1995, Siemens Medical Systems, Inc. amended the Complaint to add Siemens AG as a plaintiff, to add Raymond V. Damadian, M.D. MR Scanning Centers Management Company as a defendant and to include a claim against FONAR for infringement of one of Siemens' MRI patents (Siemens Medical Systems, Inc. and Siemens AG, v. FONAR Corporation and Raymond V. Damadian, M.D. MR Scanning Centers Management Company, Civil Action No. 95-261.\nThereafter, on June 30, 1995, Philips Electronics North America Corporation and Philips Electronics, N.V. filed a complaint against FONAR in the United States District Court for the District of Delaware seeking a declaratory judgment that FONAR's U.S. Patents Nos. 3,789,832 and 4,871,966 are invalid, unenforceable and not infringed (Philips Electronics North America Corporation and Philips Electronics, N.V. v. FONAR Corporation, Case No. 95-431).\nMotions have been made by the Siemens affiliates and Philips affiliates to transfer the action commenced by FONAR in District Court for the Eastern District of New York to the Delaware District Court and FONAR has moved to transfer the actions commenced against it in the Delaware District Court to the Eastern District of New York. The respective parties are expected to vigorously contest the claims against them.\nSeparately, U.S. Philips Corporation, an affiliate of Philips Electronics North America Corporation and Philips Electronics, N.V., commenced an action in the United States Court for the District of Delaware alleging infringement by FONAR of two of its patents. FONAR has answered the complaint denying plaintiff's claims of infringement and will vigorously contest the case. The case is in discovery.\nOn March 4, 1987, Philip B. Kivitz, M.D. and Rad-Sonic Diagnostic Medical Clinics, Inc., filed a complaint against AMD, FONAR, Raymond V. Damadian and others in the San Francisco County Superior Court (Case Action No. 870407) seeking $10,000,000 in compensatory damages and $10,000,000 in punitive damages. In January 1993, the case went to trial and the jury returned a verdict of $880,000 against AMD and $120,000 against FONAR. On June 17, 1993, the Court granted FONAR's and AMD's motion for judgment notwithstanding the verdict, thereby vacating the entire award against both FONAR and AMD. The plaintiffs appealed the Court's granting of judgment notwithstanding the verdict. On February 27, 1995, the appellate court affirmed the lower court's judgment notwithstanding the verdict as to FONAR, but reversed the judgment as to AMD. As a result, the trial court's determination that the plaintiffs could not recover against FONAR was upheld, but the jury verdict against AMD was reinstated. AMD filed a petition for review with the California Supreme Court. AMD's petition was denied on May 17, 1995.\nOn April 3, 1990, Summit, Rovins and Feldesman commenced an action in the Supreme Court of the State of New York, County of New York against the Company and its President, Raymond V. Damadian. The complaint alleges unpaid fees for legal services and disbursements in the amount of $664,371.65. The Company is contesting the plaintiff's claims as excessive and improper charges for legal services, and has asserted various defenses and a counterclaim of $100,000 for a refund of fees. The plaintiff made a motion for summary judgment which was granted as to the existence of liability but denied as to the amount. Dr. Damadian's cross-motion to dismiss the action against him per sonally was granted. Both parties appealed the court's decisions. On March 9, 1995, the appellate court reversed the granting of summary judgment against FONAR. The appellate court also upheld the dismissal of the action against Dr. Damadian personally. The case is in discovery.\nOn June 18, 1990, Medical Equipment Fund II, Limited Partnership commenced an action against the Company and others in the Supreme Court of the State of New York, New York County. The complaint alleged that one of the Company's former lenders borrowed monies from the plaintiff for the express purpose of financing the construction of one of the Company's scanning systems, and that the defendants, with the Company's lender, conspired to divert the application of the loan proceeds to other projects. The complaint sought compensatory damages of $1,758,000 and punitive damages of $10,000,000. The defendants had had no dealings with the plaintiff and had no knowledge of any of the alleged arrangements between the plaintiff and the lender. Consequently, the defendants regarded the claim as meritless and contested the claim vigorously. Finding that even the plaintiff's evidence did not make a valid case against the defendants, the Court dismissed the complaint following plaintiff's presentation of its case and entered judgment in the Company's favor dismissing the complaint.\nIn January, 1991, Myheal Technologies and a former employee commenced an action against the Company in the United States District Court for the Eastern District of New York (Index No. 91 CIV 0204). The amount claimed was $5,000,000 in compensatory damages and $5,000,000 in punitive damages. The claim arose out of an alleged breach of an agreement between the Company and a former research and development employee of the Company. A jury verdict rendered in December, 1993 against the Company for $1,150,000 was set aside, and a second trial was ordered and held. On March 24, 1995 the jury rendered a verdict in favor of Myheal Technologies in the amount of $250,000. On April 21, 1995, the Company made a motion requesting judgment as a matter of law dismissing the plaintiffs' claim or in the alternative a new trial or reduction of damages. The Company's motion was denied and judgment was entered against the Company in August, 1995. The Company is appealing the District Court's decision.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nThe Company's annual meeting of shareholders was held on April 3, 1995. At the meeting, the stockholders reelected the sitting Board of Directors, Raymond V. Damadian, Claudette Chan, Robert Janoff and Herbert Maisel. The stockholders also approved a recapitalization proposal, the creation of a new class of preferred stock to be issued to holders of the Company's Common Stock as a stock dividend, a stock bonus plan and two stock option plans, and the selection of Tabb, Conigliaro & McGann, P.C. as the Company's auditors for fiscal 1995.\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 in the over-the-counter market under the National Association of Securities Dealers Automated Quotation System (\"NASDAQ\") symbol FONR. The following table sets forth the high and low bid and asked prices reported in NASDAQ System for the periods shown. The prices represent quotations between dealers and do not include certain mark-ups, mark-downs or commissions, and do not necessarily represent actual transactions.\nFiscal Quarter\nBid Ask High Low High Low\nJuly - September 1993 3.28 1.13 3.38 1.16 October - December 1993 3.53 1.81 3.59 1.84 January - March 1994 2.63 1.59 2.66 1.66 April - June 1994 1.72 1.22 2.00 1.25 July - September 1994 1.91 1.22 2.00 1.25 October - December 1994 2.50 1.28 2.53 1.31 January - March 1995 2.50 1.53 2.53 1.63 April - June 1995 4.50 2.38 4.56 2.41 July - September 1995 3.84 2.56 4.00 2.63\nOn September 15, 1995, the Company had approximately 4,828 and 19 stockholders of record of the Company's Common Stock and Class B Common Stock, respectively.\nThe Company has paid no dividends to date. The Company anticipates, however, based on the results of its lawsuit against General Electric Company and Hitachi Ltd., paying dividends on monies it receives from the enforcement of its patents in that case. Except for these dividends, it is expected that the Company will continue to retain earnings to finance the development and expansion of its business.\nItem 7. Management's Discussion and Analysis of Financial Conditions and Results of Operations.\nResults of Operations.\nFiscal 1995 Compared to Fiscal 1994\nIn fiscal 1995 the Company experienced a loss of $1,762,971 on gross revenues of $14.1 million, while in fiscal 1994 a loss of $334,574 was reported on gross revenues of $15.4 million.\nContributing to the Company's net loss of $1,762,971 were the recognition in the fourth quarter of unfavorable judgments in excess of $1.5 million in the aggregate. The most significant of these actions were the $880,000 judgment against Fonar's subsidiary AMD in the Kivitz et ano v. AMD et al. action (approximately $1.1 million with accrued interest) and, notwithstanding that Fonar is appealing the court's decision, the $250,000 judgment rendered against the Company in Myheal Technologies et ano. v. Fonar (approximately $369,000 with accrued interest). (See \"Litigation\"). Also significantly contributing to the Company's net loss for the year were the continuing losses of its Israeli subsidiary, Medical SNI (formerly Vonar Ltd.). These losses were in the amount of $867,100 for fiscal 1995 and $558,892 for fiscal 1994 (after giving effect to the minority interest).\nThe Company continues to benefit as a result of programs that the Company set in motion in fiscal 1989; namely strict cost containment initiatives and the redirecting of corporate business into other profitable enterprises within the MRI industry. As a result of these programs, the percentage of the Company's revenue derived from sources other than scanner sales (customer service and upgrades) was approximately 48% for fiscal 1995 as compared to 33% for fiscal 1990. The Company believes, however, that this trend may have peaked in fiscal 1991 and 1992 when the percentage was approximately 61%. The trend has reversed in part because of the retirement of old scanners. Management expects that this trend may be reversed further as a result of the introduction into the market of its new Quad scanner products following the Company's receipt of FDA approval for the Quad 7000 in the fourth quarter of fiscal 1995. Customer service and upgrades, however, are and will continue to be priorities for the Company.\nLower revenues experienced in fiscal 1995, as in fiscal 1994, were the principal reason for the operating losses experienced in both fiscal years ($6.4 million in fiscal 1995 and $2.5 in fiscal 1994). Lower revenues reflected strong competition and a continued weak domestic demand for MRI scanners in a marketplace eager to see new products that would address both the heightened cost pressures on MRI and the patient demand for non-claustrophobic scanners.\nHaving received FDA approval for its Quad 7000 scanner in April 1995 and anticipating FDA approval for its Quad 12000 scanner in the near future, the Company believes it is in a position to aggressively seek new sales. At .6 Tesla field strength, FONAR's Quad 12000 magnet is the highest field \"open MRI\" in the industry, offering non-claustrophobic MRI together with high-field image quality for the first time. The Quad 12000 magnet has three times the field strength of General Electric Company's recently introduced \"open MRI\" scanner which has a field strength of .2 Tesla.\nFONAR is uniquely positioned to take advantage of the rapidly expanding \"open MRI\" market which FONAR pioneered and which a host of multi-national corporations acknowledged when all introduced \"open MRI\" products at the industry's annual trade show, RSNA (Radiological Society of North America), in November 1994. Consequently, the Company will be attending the RSNA show in November 1995, where it will exhibit its new products. The RSNA is one of the largest medical meetings in the world with total attendance expected to reach 60,000, including 25,000 radiologists, who are among the principal groups to whom the Company will direct its marketing efforts.\nAs at September 1, 1995, the Company's backlog of unfilled orders was approximately $4.0 million, as compared to $1.5 million at September 1, 1994.\nThe Company also believes that efforts to reduce infringement of its intellectual property rights by competitors have begun to produce material benefits, as reflected in the $62 million judgment rendered in its favor against General Electric Company. During the 1995 fiscal year the Company commenced similar patent infringement suits against other major competitors (See \"Litigation\").\nLower service and repair fees in fiscal 1995, as in fiscal 1994 (approximately $6.6 million in fiscal 1995 as compared to approximately $7.7 million in fiscal 1994) indirectly resulted from reduced sales, as well as from competition, as older scanners were retired without offsetting new scanners to maintain or increase the Company's customer base.\nOverall, expenses increased from approximately $10.0 million in fiscal 1994 to $11.5 million in fiscal 1995. General and administrative expenses decreased from approximately $5.8 million in fiscal 1994 to approximately $5.3 million in fiscal 1995, but research and development expenses increased from approximately $2.8 million in fiscal 1994 to $3.4 million in fiscal 1995 (exclusive of the portion of such expenses capitalized), and selling and marketing expenses increased from approximately $1.3 million in fiscal 1994 to $1.5 million in fiscal 1995. The greatest part of the overall increase in expenses resulted from an increase in the compensatory element of stock issuances from $193,527 in fiscal 1994 to $1,363,194 in fiscal 1995. This increase resulted mostly from non-recurring bonuses granted to a large number of employees. The Company notes that maintaining or increasing expenses are necessary for the Company to realize its objective to develop and market new scanner products.\nIn fiscal 1992 the Company began laying the ground work for increased scanner sales, in foreign countries as well as domestically. The Company has continued these efforts through fiscal 1995, and based on sales to date, further indications of interest, meetings, sales trips abroad and negotiations, the Company is cautiously optimistic that foreign sales will produce significant revenues in fiscal 1996 and\/or 1997 depending on the timing of orders and completion of projects. Having received FDA approval for its Quad 7000 Scanner, the Company also anticipates increased demand for its new Quad MR scanner products.\nThe Company maintains an installed base of over 100 scanners which generates revenue in two principal areas: namely on-going service and equipment upgrades.\nThe exceptional versatility and productivity of MRI tech nology creates the impetus for new uses. As a result, dramatic new features are developed and sold to the Company's customer base thereby extending the useful life of their equipment, avoiding obsolescence and minimizing capital expenditures. Upgrades consist of hardware, software and pulse sequences designed to maximize throughput while maintaining image quality and patient comfort. This income resource is considered to be a major asset of the company.\nAs a result of its upgrade program, the Company derived approximately $1.7 million in upgrades income in fiscal 1992, $1.3 million in 1993, $61,000 in 1994 and $338,000 in 1995. Significant research and development of new programs have been undertaken, which emphasize the development of new features for the Company's scanner upgrade program. More specifically, products derived from the Company's new scanners are expected to generate substantial upgrade revenue in fiscal 1996 as customers upgrade their existing scanners to take advantage of the improved image quality and high speed image processing capabilities.\nThe Company is optimistic that its new Quad 12000 and Quad 7000 scanners will significantly improve the Company's competitive position. The Quad scanners are highly competitive and totally new high field non-claustrophobic scanners not previously available in the MRI market. The Company expects vigorous sales from these new products.\nContinuing its tradition as the originator of MRI the Company remained committed to maintaining its position as the leading innovator of the industry through aggressive investing in research and development. In fiscal 1995 the Company continued its investment in the development of its new MRI scanners together with software and upgrades, with an investment of $3,508,101 in R&D ($151,981 of which was capitalized) as compared to $3,604,785 in R&D ($687,551 of which was capitalized in fiscal 1994. The R&D expenditure was approximately 25% of revenues in 1995 and 23% of revenues in 1994.\nFiscal 1994 Compared to Fiscal 1993\nIn fiscal 1994 a loss of $334,574 was experienced on gross revenues of $15.4 million, while in fiscal 1993 earnings of $238,283 were reported on gross revenues of $16.8 million.\nThe percentage of the Company's revenue derived from sources other than scanner sales (customer service, fee-for-service, upgrades and scanning center management) was approximately 51% for fiscal 1994, 60% for fiscal 1993, 61% for fiscal 1992 and 1991 and 33% for fiscal 1990.\nSignificantly, the net loss of $699,568 ($558,892 after giving effect to the minority interest) suffered by the Company's Israeli subsidiary, Medical SNI (formerly Vonar Ltd.), in fiscal 1994, as compared to Medical SNI's net income of $45,212 in fiscal 1993, contributed to the consolidated net loss in fiscal 1994 for the Company and its subsidiaries. The expenses incurred by Medical SNI in fiscal 1994 included a non-recurring $188,655 in connection with a public offering which was canceled.\nLower revenues experienced in fiscal 1994, as in fiscal 1993, were the principal reason for the operating losses experienced in both fiscal years ($2.5 million in fiscal 1994 and $2.0 in fiscal 1993). Lower revenues reflected strong competition and a continued weak domestic demand for MRI scanners. The Company strongly believes, however, that some of its competitors are unfairly competing by infringing the Company's patents, copyrights and other intellectual property rights. Consequently, the Company commenced legal action against its most significant competitors (see \"Litigation).\nLower service and repair fees in fiscal 1994 (approximately $7.7 million in fiscal 1994 as compared to approximately $8.3 million in fiscal 1993) indirectly resulted from reduced sales, as well as from competition, as older scanners were retired without offsetting new scanners to maintain or increase the Company's customer base.\nOverall, expenses increased from approximately $9.2 million in fiscal 1993 to $10 million in fiscal 1994. Small decreases from fiscal 1993 to fiscal 1994 in selling and marketing expenses ($1,325,393 to $1,282,328) and increases in research and development expenses ($2,180,892 to $2,803,221, exclusive of the portion of such expenses capitalized) were not indicative of any trends but were within the scope of normal variation. Notwithstanding the Company's cost containment policies, general and administrative expenses increased from $5,409,965 in fiscal 1993 to $5,765,598 in fiscal 1994 (approximately 6.5%). The Company does not believe the increases in general and administrative expenses from fiscal 1993 to fiscal 1994 were indicative of any material trend but were the result of the specific circumstances encountered by the Company in the fiscal periods. The Company notes that maintaining or increasing expenses are necessary for the Company to realize its objective to develop and market new scanner products.\nOffsetting reduced revenues from operations, the Company recognized a significant nonrecurring gain of approximately $1.27 million on the sale to related parties of its interests in four limited partnerships (see Item 13, Certain Relationships and Related Transactions and Note 3 to Financial Statements). Nevertheless, the smaller amount of gain recognized from this transaction as compared to the nonrecurring gain recognized in fiscal 1993 ($3.3 million) on the sale of certain joint venture and limited partnership interests to related parties, was insufficient to offset the Company's operating loss and resulted in a loss for fiscal 1994.\nContinuing its tradition as the originator of MRI, in fiscal 1994 the Company continued its investment in the development of its new MRI scanners together with software and upgrades, with an investment of $3,604,785 in R&D ($687,551 of which was capitalized) as compared to $3,119,898 ($938,926 of which was capitalized) in fiscal 1993. The R&D expenditure in 1994 was 23% of revenues and in 1993 was 18.6% of revenues.\nLiquidity and Capital Resources\nAt June 30, 1995, the Company's liquidity and capital resources position had changed from June 30, 1994 as follows:\n___________ June 30 _____________ 1995 1994 Change Working Capital (deficiency) (5,077,477) (7,748,904) 2,671,427\nThe improvement in the Company's working capital position resulted primarily from a decrease in current liabilities (from $17.8 million in fiscal 1994 to $14.6 million in fiscal 1995). The decrease in current liabilities as well as the decrease in the Company's long-term debt and capital lease obligations ($1.46 million in fiscal 1994 as compared to $528,543 million in fiscal 1995) is attributable to the Company continuing to pay down its debt obligations and in part to the assumption of a portion of the Company's obligations to a secured lender by a related party in connection with the exercise of a purchase option under a scanner lease covering the encumbered scanner. (See Certain Relationship and Related Transactions.)\nThe Company offers its products for sale or lease to cus tomers. Cash flows from leasing transactions are derived under the terms of the underlying agreements. Over the long term, the Company expects enhanced cash flows and increased revenues from such transactions while in the short term, such transactions impair cash flow. In order to mitigate the short term effect on cash flow, the Company previously had borrowed money secured by the leases and the underlying equipment. Such debt comprises substantially all of the remaining long-term debt in the accompanying financial statements.\nDuring the fiscal years from 1990 through 1995 the Company restructured various long-term loans and notes. The significant changes included extended maturity dates, and the addition of unpaid interest to the note and loan balances.\nSince June, 1989 a principal objective of the Company has been to reduce and ultimately eliminate its debt. Since the inception of the plan interest bearing debt was reduced from $23.1 million in fiscal 1989 to $18.5 million in fiscal 1990. From June 30, 1990 to June 30, 1991 interest bearing debt was reduced by $3.3 million to $15.2 million. Through June 30, 1992 interest bearing debt was reduced by an additional $3.1 million to $12.1 million and through June 30, 1993 interest bearing debt was further reduced by $2.3 million to $9.8 million. Through June 30, 1994 interest bearing debt was reduced by an additional $3.8 million to approximately $6.0 million and through June 30, 1995 interest bearing debt was reduced by an additional $2.1 million to $3.9 million.\nAs of June 30, 1995, the Company had no unused credit facilities with banks or financial institutions.\nCapital expenditures for 1995 and 1994 approximate $1.8 million and $1.9 million, respectively, and substantially consisted of capitalized computer software costs in connection with the development of scanner products, patent costs and copyright costs and production equipment.\nThe Company's business plan, initiated during September 1989, addressed its financial objectives. The plan is based to a substantial extent, on the successful implementation of several new programs designed to position the Company for long-term growth and expansion. The plan has, as its objective, the enhancement and stabilization of revenue streams through the generation of additional income from its installed base of over 100 scanners and leasing programs. In addition, the Company instituted strict cost containment programs. While continuing to focus on new sources of income, the Company, with its new \"Quad\" scanners, expects to re-emphasize MRI scanner sales.\nSuch cost containment programs primarily focused on the restructuring of employee staffing levels and manufacturing facilities to bring them into line with current requirements. These programs have resulted in significant reductions in expenses since fiscal 1989. The cost containment programs will be continued.\nThe Company's plan calls for a continuing emphasis on providing its customers with enhanced equipment service and maintenance capabilities and delivering state-of-the-art, innovative and high quality equipment upgrades at competitive prices. Fees for on-going service and maintenance from the Company's installed base of scanners were $8.3 million for the year ended June 30, 1993, $7.7 for the year ended June 30, 1994 and $6.6 for the year ended June 30, 1995. The Company will continue to aggressively develop and market upgrades and enhancements for previously installed scanners.\nThe Company's working capital deficiency as of June 30, 1995 approximates $5.1 million, down from $7.7 million as of June 30, 1994. The Company expects to reduce this deficiency further by June 30, 1996. This is to be accomplished by internally generated cash from operating profits and the refinancing and\/or restructuring of maturity terms of certain loans now classified as short term obligations. The Company also will pursue equity financing alternatives.\nThe Company believes that the above mentioned financing arrangements and programs will provide the cash flows needed to achieve the sales, service and production levels necessary to support its operations. In addition, the Company is exploring other more permanent financing alternatives which may become available during fiscal 1996 as the success of the previously described programs accelerates.\nItem 8.\nFINANCIAL STATEMENTS AND SUPPLEMENTARY DATA FONAR CORPORATION AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES\nPage No. ------------ INDEPENDENT AUDITORS' REPORT\nCONSOLIDATED BALANCE SHEETS to At June 30, 1995 AND 1994\nCONSOLIDATED STATEMENTS OF OPERATIONS ; For the Three Years Ended June 30, 1995, 1994 and 1993\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY to For the Three Years Ended June 30, 1995, 1994 and 1993\nCONSOLIDATED STATEMENTS OF CASH FLOWS to For the Three Years Ended June 30, 1995, 1994 and 1993\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS to\nSUPPLEMENTARY SCHEDULES:\nINDEPENDENT AUDITORS' REPORT ON SCHEDULES S-1\nSCHEDULE II - Amounts Receivable from Related Parties and Underwriters, Promoters and Employees Other than Related Parties S-2 For the Years Ended June 30, 1995, 1994 and 1993 SCHEDULE VIII - Valuation and Qualifying Accounts For the Three Years Ended S-3 June 30, 1995, 1994 and 1993\nSELECTED FINANCIAL DATA (*)\nFor the Five Years Ended June 30, 1995 (*) Included in Part II, 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.\nDirectors serve from the date of their election until the next annual meeting of stockholders and until their successors are elected and qualify. Officers serve at the discretion of the Board of Directors.\nThe officers and directors of the Company are set forth below:\nRaymond V. Damadian, M.D. 59 President, Chairman of the Board and a Director\nLuciano B. Bonanni 40 Executive Vice President\nTimothy R. Damadian 31 Vice President of Operations\nDavid B. Terry 48 Secretary and Treasurer\nClaudette J.V. Chan 58 Director\nRobert J. Janoff 68 Director\nHerbert Maisel 51 Director\nRaymond V. Damadian, M.D. has been the Chairman of the Board and President of FONAR since its inception. Dr. Damadian was employed the State University of New York, Downstate Medical Center, New York, as an Associate Professor of Biophysics from 1967 until September 1979. Dr. Damadian received an M.D. degree in 1960 from Albert Einstein College of Medicine, New York, and a B.S. degree in mathematics from the University of Wisconsin in 1956. In addition, Dr. Damadian conducted post-graduate work at Harvard University, where he studied extensively in the fields of physics, mathematics and electronics. Dr. Damadian is the author of numerous articles and books on the nuclear magnetic resonance effect in human tissue, which is the theoretical basis for the FONAR MRI scanners. Dr. Damadian is a 1988 recipient of the National Medal of Technology and in 1989 was inducted into the National Hall of Fame, for his contributions in conceiving and developing the application of magnetic resonance technology to medical applications including whole body scanning and diagnostic imaging.\nLuciano B. Bonanni has been a Vice President of FONAR since 1981. Mr. Bonanni was an Electrical Engineer with the Aviation Systems Group of Cardion Electronics (a subsidiary of General Signal Corp.) for approximately two years before joining FONAR in April 1979. He received his bachelor of science degree in electrical engineering from Manhattan College in 1977.\nTimothy R. Damadian has been a Vice President of FONAR since July 1992. He has been employed by FONAR since 1981, initially on a part-time basis. Mr. Damadian served as a field service technician for FONAR, after graduating from Suburban Technical School in 1982, where he studied digital computer technology. Mr. Damadian became Director of Manufacturing in October 1989 and was promoted to Vice President of Operations in July 1992. Timothy Damadian is the son of Raymond V. Damadian and nephew of David Terry and Claudette Chan.\nDavid B. Terry is the Secretary and Treasurer of the Company. Mr. Terry has been serving as Secretary and Treasurer since May 1990, and previously served as Secretary from July 1978 through June 1987 and as Treasurer from August 1981 through June 1987. From July 1978 through June 1987, he was also a Director of the Company. Between July 1987 and January 1990, Mr. Terry was a co-owner and actively engaged in the business of Carman-Terry Realty, a real estate brokerage firm. In January 1990, Mr. Terry resumed his employment with the Company. Mr. Terry is the brother-in-law of Raymond V. Damadian and uncle of Timothy R. Damadian.\nClaudette J.V. Chan has been a Director of FONAR since October 1987. Mrs. Chan has been employed since 1992 by Raymond V. Damadian, M.D. MR Scanning Centers Management Company as \"site inspector,\" in which capacity she is responsible for supervising and implementing standard procedures and policies for MRI scanning centers. From 1989 to 1994 Mrs. Chan was employed by St. Matthew's and St. Timothy's Neighborhood Center, Inc., as the director of volunteers in the \"Meals on Wheels\" program, a program which cares for the elderly. In approximately 1983, Mrs. Chan formed the Claudette Penot Collection, a retail mail-order business specializing in women's apparel and gifts, of which she was the President until she stopped operating the business in approximately 1989. Mrs. Chan practiced and taught in the field of nursing until 1973, when her son was born. She received a bachelor of science degree in nursing from Cornell University in 1960. Mrs. Chan is the sister of Raymond V. Damadian and aunt of Timothy R. Damadian.\nRobert J. Janoff has been a Director of FONAR since February, 1989. Mr. Janoff has been a self-employed New York State licensed private investigator for more than thirty-five years and has been a Senior Adjustor in Empire Insurance Group for more than 10 years. Mr. Janoff also served, from June 1985 to June 1991, as President of Action Data Management Strategies, Ltd., a supplier of computer programs for use by insurance companies.\nHerbert Maisel has been a Director of FONAR since February, 1989. Mr. Maisel has been the manager of Melville MRI, P.C., an MRI scanning center located in Melville, New York, since January, 1992, and of Damadian MRI in Garden City, P.C., an MRI scanning center located in Garden City, New York since April, 1995. Mr. Maisel was also manager of Damadian MRI in Islandia, P.C. from December, 1993 to March, 1995. Prior to that time Mr. Maisel had been the President and owner of Bagel World, Inc., a bagel bakery, from March 1984 to January 1992. Prior thereto, Mr. Maisel served as a supervisor of a commercial printing plant.\nItem 11.","section_11":"Item 11. Executive Compensation.\nWith the exception of the Chief Executive Officer, the compensation of the Company's executive officers is based on a combination of salary and bonuses based on performance. The Chief Executive Officer's compensation consists only of a salary which has remained constant for more than the past three fiscal years. The Board of Directors does not have a compensation committee. Dr. Raymond V. Damadian, President, Chief Executive Officer and Chairman of the Board, is the only executive officer who is a member of the Board of Directors. Dr. Damadian participates in the determination of executive compensation for the Company's officers.\nThere is set forth in the following Summary Compensation Table the compensation provided by the Company during fiscal 1995 to its Chief Executive Officer and executive officer whose salary and bonus were equal to at least $100,000, and there is set forth in the following Option Grant Table and Option Exercise Table the stock options granted and exercised by those individuals during fiscal 1995.\nEmployee Compensation Plans\nThe Company's 1984 Incentive Stock Option Plan, adopted as of August 24, 1984, permitted the issuance of stock options covering an aggregate of 312,500 shares of Common Stock to employees of the Company. The options had an exercise price equal to the fair market value of the underlying stock on the date the option was granted, were nontransferrable, were exercisable for a period not exceeding ten years and expired upon the voluntary termination of employment. The 1984 Incentive Stock Option Plan terminated on August 23, 1994. As of June 30, 1995 no options were available for future grant under the plan.\nThe Company's 1986 Nonstatutory Stock Option Plan, adopted on January 17, 1986, permitted the issuance of stock options covering an aggregate of 1,250,000 shares of Common Stock. The options may be issued at such price and upon such terms and conditions as are determined by the Company. The 1986 Nonstatutory Stock Option plan will terminate on January 16, 1996. As of June 30, 1995, no options were available for future grant under the plan.\nThe Company's 1986 Incentive Stock Option Plan, adopted on January 17, 1986, is intended to qualify as an incentive stock option plan under Section 422A of the Internal Revenue Code of 1954, as amended. The 1986 Incentive Stock Option Plan permits the issuance of stock options covering an aggregate of 1,250,000 shares of Common Stock. The options have an exercise price equal to the fair market value of the underlying stock on the date the option is granted, are nontransferrable, are exercisable for a period not exceeding ten years and expire upon the voluntary termination of employment. The 1986 Incentive Stock Option Plan will terminate on January 16, 1996. As of June 30, 1995, options to purchase 157,302 shares of Common Stock were available for future grant under the plan.\nThe Company's 1993 Incentive Stock Option Plan, adopted on March 26, 1993, is intended to qualify as an incentive stock option plan under Section 422A of the Internal Revenue Code of 1954, as amended. The 1993 Incentive Stock Option Plan permits the issuance of stock options covering an aggregate of 1,500,000 shares of Common Stock. The options have an exercise price equal to the fair market value of the underlying stock on the date the option is granted, are nontransferrable, are exercisable for a period not exceeding ten years and expire upon the voluntary termination of employment. The 1993 Stock Option Plan will terminate on March 25, 2003. As of June 30, 1995, options to purchase 1,112,000 shares of Common Stock were available for future grant under the plan.\nThe 1994 Stock Bonus Plan, adopted on December 1, 1993, permits the Company to issue an aggregate of 5,000,000 shares of Common Stock as a bonus or compensation. The Company selects the persons to whom bonus stock will be issued, the number of shares awarded and such other terms and conditions as it deems advisable. The 1994 Stock Bonus Plan will terminate on November 30, 2003. As of June 30, 1995, 524,745 shares of Common Stock were available for future grant.\nThe Company's 1995 Nonstatutory Stock Option Plan, adopted on April 1, 1995, permits the issuance of stock options covering a aggregate of 5,000,000 shares of Common Stock. The options may be issued at such price and upon such terms and conditions as are determined by the Company. The 1995 Nonstatutory Stock Option Plan will terminate on March 31, 2005. As of June 30, 1995, options to purchase 5,000,000 shares of Common Stock were available for future grant.\nThe Company's 1995 Stock Bonus Plan, adopted on April 1, 1995, permits the Company to issue an aggregate of 5,000,000 shares of Common Stock as a bonus or compensation. The Company selects the persons to whom bonus stock will be issued, the number of shares awarded and such other terms and conditions as it deems advisable. The 1995 Stock Bonus Plan will terminate on March 31, 2005. As of June 30, 1995, 4,641,000 shares of Common Stock were available for future grant.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nThe following table sets forth the number and percentage of shares of the Company's securities held by each director, by each person known by the Company to own in excess of five percent of the Company's voting securities and by all officers and directors as a group as of September 15, 1995.\nName and Address of Shares Percent Beneficial Owner (1) Beneficially Owned of Class\nRaymond V. Damadian, M.D. c\/o FONAR Corporation Melville, New York Director, President CEO, 5% + Stockholder Common Stock 2,366,637.5 6.06% Class B Stock 3,187,058 99.80%\nClaudette Chan Director Common Stock 4,000 *\nRobert J. Janoff 25,000 * Director Common Stock (2) * Herbert Maisel 100 Director Common Stock (3)\nLuciano Bonanni 160,661 * Executive Vice President\nAll Officers and Directors as a Group (7 persons) (2)(3)(4) Common Stock 2,625,398.5 6.72% Class B Stock 3,187,058 99.80% ___________________________ * Less than one percent\n1. Address provided for each beneficial owner owning more than five percent of the voting securities of the Company.\n2. Includes presently exercisable options to purchase 15,000 shares of the Company's Common Stock.\n3. Includes 50 shares of the Company's Common Stock which are held in the name of Mr. Maisel as trustee for his minor daughter and 50 shares of the Company's Common Stock which are held by Mr. Maisel's wife.\n4. Includes options to purchase 4,000 shares of the Company's Common Stock held by an officer.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nOn April 7, 1989, at a time when the Company lacked both the financing and working capital to establish its own centers, Donna Damadian, the wife of Raymond V. Damadian, M.D., Chairman of the Company, purchased from FONAR a scanner for a purchase price of $1,508,000 (the price paid by FONAR's customers for like equipment). $1.2 million was paid in cash, providing a much needed cash infusion for the Company, and the balance was paid over time with interest pursuant to a promissory note of even date. The scanner is being leased to Macon Magnetic Resonance Imaging, P.C. (\"Macon Center\"), a Georgia professional corporation wholly-owned by, and of which Dr. Damadian is, the President.\nSince May, 1990, Raymond V. Damadian M.D., MR Scanning Centers Management Company, a Delaware corporation of which Raymond V. Damadian is the sole shareholder, director and President (\"RVDC\"), has been party to a standard service agreement with the Company for the servicing of the scanner at the Macon Center. The current annual price is $123,760, which is the standard price charged to the Company's other customers for like equipment. The term of the current one-year service agreement runs from April, 1995 to April, 1996. The current annual price was also in effect during the prior year from April, 1994 to April, 1995.\nBy agreement dated June 27, 1990, Tallahassee Magnetic Resonance Imaging, P.A., a Florida corporation of which Raymond V. Damadian is the sole shareholder, director and President (\"TMRI\"), agreed to support the Company's financial obligations to one of its secured lenders by agreeing to be the lessee of one of its mobile scanners for a period of five years, subject to the superior rights of the Company's secured lender. Effective June 30, 1991, the lease arrangements were restructured to provide for a five year term, commencing June 30, 1991, and the monthly payment was fixed at $43,217, eliminating the previous per scan fee (with a minimum monthly payment of $43,200). In addition, since service and maintenance for the scanner is not included under the new lease, TMRI has been party to a standard service agreement with the Company for the scanner since June 30, 1991. The annual price is currently $120,000, and the term of the current one-year service agreement runs from June 30, 1995 to June 29, 1996. The current annual price was also in effect during the prior year from June 30, 1994 to June 29, 1995.\nIn addition, in fiscal years 1990 and 1992, RVDC leased four MRI scanners previously leased by the Company to unrelated parties, where the original lessees had defaulted or were unwilling to continue to perform. RVDC thereby preserved the leases for the Company and rescued the Company from defaulting with the lender. The following is a description of these transactions.\nBy agreement dated April 1, 1990, RVDC agreed to assume the financial and other obligations of the original lessee under a lease for a mobile scanner dated June 29, 1988, on the same terms and conditions as the original lessee. Effective June 30, 1991, the lease arrangements were restructured to provide for a five year term, commencing June 30, 1991 and the monthly payment was fixed at $35,167, eliminating the previous per scan fee (with a minimum monthly payment of $40,000). In addition, since service and maintenance for the scanner was not included under the terms of the new lease, RVDC obtained a standard service agreement with the Company for the scanner, the price for which was $122,256 for the period from June 30, 1993 to June 29, 1994. RVDC in turn provided the use of the scanner to Albany Magnetic Imaging Center, P.C., a Georgia professional corporation of which Raymond V. Damadian is the sole stockholder, director and President (\"Albany Center\"). Effective December 1, 1993, RVDC assigned its purchase option under the lease to the Albany Center, and the Albany Center concurrently exercised the option and purchased the scanner from the Company for a purchase price of $1,128,844. Of the purchase price, $574,077 was paid by the assumption and payment of the Company's indebtedness to the lender secured by the scanner. Such indebtedness to the lender was retired pursuant to a new equipment finance lease between the lender and the Albany Center, guaranteed by the Company, providing for 18 monthly payments of $35,000 each. Following payment of the lease, the remaining $554,767 of the purchase price due to the Company is required to be paid pursuant to a promissory note, with interest at 10% per annum, over an 18 month term (17 payments of $35,000 each and one final payment of $2,454.08). Effective December 1, 1993, the Albany Center also assumed RVDC's service agreement for the scanner for the balance of the contract year, and upon expiration of the agreement entered into a new service agreement with the Company for the period from June 30, 1994 to June 29, 1995 at a price of $122,256. The term of the current one-year service contract runs from June 30, 1995 to June 29, 1996 at the same price.\nPursuant to an agreement dated March 7, 1990, RVDC agreed to assume the financial and other obligations of the original lessee under a lease for a mobile scanner dated December 13, 1988, on the same terms and conditions as the original lessee. Effective June 30, 1991, the lease arrangements were restructured to provide for a five year term commencing June 30, 1991, and the monthly payment was fixed at $42,387, eliminating the previous per scan fee (with a minimum monthly payment of $52,000). In addition, since service and maintenance for the scanner is not included under the terms of the new lease, RVDC has been party to a standard service agreement with the Company for the scanner since June 30, 1991. The annual price is currently $105,000, which was reduced from $120,000 in the previous year to bring the price into line with the Company's standard pricing for like equipment. The term of the current one-year service agreement runs from June 30, 1995 to June 29, 1996. RVDC in turn has provided the use of the scanner to Central Island MRI, P.C., a New York professional corporation of which Raymond V. Damadian is the sole shareholder, director and President (\"Staten Island Center\").\nBy agreement dated March 7, 1990, RVDC agreed to assume the financial and other obligations of the original lessee under a lease for a mobile scanner dated August 16, 1988, on the same terms and conditions as the original lessee. Effective June 30, 1991, the lease arrangements were restructured to provide for a five year term, commencing June 30, 1991 and the monthly payment was fixed at $31,373, eliminating the previous per scan fee (with a minimum monthly payment of $41,500.) In addition, since service and maintenance for the scanner was not included under the terms of the new lease, RVDC obtained a standard service agreement with the Company for the scanner, the price for which was $120,000 for the period from June 30, 1993 to June 29, 1994. RVDC in turn provided the use of the scanner to Deerfield Magnetic Resonance Imaging P.A., a Florida professional association, of which Raymond V. Damadian is the sole shareholder, director and President (\"Deerfield Center\"). In July 1994, the lease between FONAR and RVDC was terminated, and the Deerfield Center concurrently purchased the scanner from the Company by assuming the Company's indebtedness to the lender secured by the scanner in the amount of $508,180.07. This amount is to be paid pursuant to a note, guaranteed by the Company, with interest at 10% per annum, providing for 17 monthly payments of $30,519.81 each and a final payment of the remaining principal balance plus unpaid interest. In connection with assuming the debt to the lender, the Deerfield Center assumed the remaining outstanding lease obligation of RVDC to the Company respecting the scanner in the amount of $454,005.11. This amount is to be paid pursuant to a promissory note, bearing interest at the rate of 10% per annum, in 17 monthly installments (16 installments of $30,000 each and one installment of $7,274.79) commencing January 1, 1996, following the final scheduled payment by the Deerfield Center of the obligation to the lender. The Deerfield Center also entered into a service agreement with the Company for the period from June 30, 1994 to June 29, 1995 at a price of $120,000. The term of the current one-year service contract runs from June 30, 1995 to June 29, 1996 at the same price.\nDuring fiscal 1992, RVDC agreed to assume the financial and other obligations of the original lessee under a lease for a mobile scanner dated June 30, 1989 and restructured the terms to provide for a monthly payment of $24,421.44 commencing April 1, 1992 and extended the term of the lease seven years from that date. In addition, RVDC entered into a standard service contract with the Company for the Scanner, the price for which was $105,105.60 for the period from May 6, 1993 to May 5, 1994. RVDC in turn provided the use of the scanner to Daytona Beach Magnetic Resonance Imaging, P.A., a Florida professional association of which Raymond V. Damadian is the sole shareholder, director and President (\"Daytona Beach Center\"). Effective December 1, 1993, RVDC assigned its purchase option under the lease to the Daytona Beach Center, and the Daytona Beach Center exercised the option and purchased the scanner from the Company for a purchase price of $1,416,717. Of the purchase price, $328,044 was paid by the assumption and payment of the Company's indebtedness to the lender secured by the scanner. Such indebtedness to the lender was retired pursuant to a new equipment finance lease between the lender and the Daytona Beach Center, guaranteed by the Company, providing for 18 monthly payments of $20,000 each. The remaining $1,088,673 of the purchase price due to the Company is required to be paid pursuant to a promissory note, with interest at 10% per annum, over a 45 month term commencing July 1, 1994 as follows: eleven installments of $15,000 each, thirty-three installments of $35,000 each and one installment of $19,097.26. Effective December 1, 1993, the Daytona Beach Center also assumed RVDC's service agreement with the Company for the scanner for the balance of the contract year, and upon its expiration, entered into a new service agreement with the Company for the period from May 6, 1994 to May 5, 1995 at a price of $105,105.60. The term of the current one-year service agreement runs from May 6, 1995 to May 5, 1996 at the same price.\nRVDC supported the Company's business by leasing two and agreeing to purchase four MRI scanners from the Company in fiscal 1992.\nBy agreement dated September 30, 1991, RVDC agreed to lease one of the Company's mobile scanners for a term of five years at a monthly lease payment of $36,119.98 commencing January 1, 1992. RVDC also maintained a service agreement with the Company on the scanner, the price for which was $125,000 for the period from December 15, 1992 to December 14, 1993. RVDC in turn provided the use of the scanner to Melville MRI, P.C., a New York professional corporation of which Raymond V. Damadian is the sole shareholder, director and President (\"Melville Center\").\nEffective June 30, 1994, RVDC assigned its purchase option under the lease to the Melville Center, and the Melville Center concurrently exercised the option and purchased the scanner from the Company for a purchase price of $1,011,431.12. Of the purchase price, $900,000 is to be paid by the assumption and payment of the Company's indebtedness to the lender secured by the scanner pursuant to a note bearing interest at 14% per annum and providing for 60 monthly payments of $20,700 each. The remaining $111,431.12 of the purchase price is to be paid concurrently with the payments to the lender pursuant to a note, with interest at 10% per annum, providing for 60 monthly payment of $2,367.58 each. In addition the Melville Center assumed RVDC's current service contract with the Company for the scanner, the fee for which was $125,000 for the period from December 15, 1993 to December 14, 1994. The term of the current one-year service agreement runs form December 15, 1994 to December 14, 1995 at the same price.\nPursuant to an agreement dated December 31, 1991, RVDC agreed to lease one of the Company's scanners for a monthly lease payment of $18,081.92 for a period of seven years commencing April 1, 1992. RVDC in turn provided the use of the scanner to Damadian MRI at Astoria, P.C. (the \"Astoria Center\"), a New York professional corporation of which Raymond V. Damadian is the sole shareholder, director and President. Effective November 13, 1993, the lease between the Company and RVDC was terminated, and the scanner was leased directly by the Company to the Astoria Center pursuant to a new lease providing for 84 monthly payments of $16,978.43 each commencing February 1, 1994. In addition, the Astoria Center is party to a service agreement with the Company for the scanner, the fee for which is $105,000 for the period from October 27, 1995 to October 26, 1996.\nRVDC agreed to purchase four MRI scanners from the Company pursuant to sales agreements dated April 29, 1992, May 26, 1992, June 3, 1992 and June 18, 1992, for sites in Bayside (Queens County), Islandia (Suffolk County), Elmhurst (Queens County) and Forest Hills (Queens County), New York. Each of the four sales agreements provided for a purchase price of $1,000,000 payable in installments as follows: (1) 10% down payment within 30 days of execution, (2) 10% within 30 days of delivery of the magnet and shielded room and (3) 80% in 84 monthly installments of $12,468.97 each (inclusive of interest at 8% per annum) pursuant to a promissory note to be executed by RVDC upon acceptance of the scanner.\nEffective November 13, 1993, the sales agreement for the scanner to be utilized in Islandia, New York was terminated, and the Company instead leased the scanner to Damadian MRI at Islandia, P.C. (the \"Islandia Center\"), a New York professional corporation of which Raymond V. Damadian is the sole shareholder, director and President. The lease provides for monthly payments of $15,586.21 for a term of 84 months commencing February 1, 1994. In addition, the Islandia Center is party to a service agreement with the Company for the scanner, the fee for which is $105,000 for the period from December 6, 1994 to December 5, 1995.\nThe scanner purchased by RVDC for Bayside (Queens County), New York, is being provided to Bayside MRI, P.C. (the \"Bayside Center\"), a New York professional corporation of which Raymond V. Damadian is the sole stockholder, director and President, and the scanner purchased by RVDC for Elmhurst (Queens County), New York, is being provided to Elmhurst MRI, P.C. (the \"Elmhurst Center\"), a New York professional corporation of which Raymond V. Damadian is the sole stockholder, director and President. RVDC is party to a service agreement with the Company for the scanner being provided to the Bayside Center for the period January 11, 1995 to January 10, 1996 at a price of $105,000. The current annual price was also in effect during the prior year from January 11, 1994 to January 10, 1995.\nIn fiscal 1993, RVDC and its affiliates supported the Company and its objectives by leasing one MRI scanner, purchasing one MRI scanner and purchasing the Company's interest in three MRI scanning centers.\nPursuant to an agreement dated December 31, 1992, RVDC agreed to lease from the Company a mobile scanner, which is in turn being leased to a third party in Bethesda, Maryland. The term of the lease is for 84 months and the monthly lease payment of $15,586.21 (commencing January 1, 1993) is based on a principal amount of $1,000,000 amortized over 84 months with an interest rate of 8% per annum. The lease includes an option to RVDC to purchase the scanner. RVDC is party to a standard service agreement with the Company for the scanner, the annual rate for which was $120,000 for the period from June 22, 1994 to June 21, 1995 and is $120,000 for the period from June 22, 1995 to June 21, 1996.\nPursuant to an agreement dated March 31, 1993, RVDC agreed to purchase the Company's general partnership interest (approximately 92% of the partnership) in a partnership owning and operating an MRI scanning center in Bensonhurst (Brooklyn), New York (\"the \"Bensonhurst Center\"). The purchase price of $923,000 is payable in 84 equal monthly installments of $14,386.07 each commencing May 1, 1993, which amount includes principal and interest at the rate of 8% per annum amortized over the term. The partnership is also party to a standard service agreement with the Company. The current annual rate is $105,000 for the one year service contract from May 18, 1995 to May 17, 1996. The current annual price was also in effect during the prior year from May 18, 1994 to May 17, 1995.\nPursuant to a sales agreement dated June 30, 1993 RVDC agreed to purchase an MRI scanner from the Company which RVDC is planning to utilize at a site located in Coral Gables, Florida (the \"Coral Gables Center\"). The sales agreement provides for a purchase price of $1,000,000 payable in installments as follows: (1) 10% down payment within 30 days of execution, (2) 10% within 30 days of delivery of the magnet and shielded room, and (3) 80% in 84 monthly installments of $12,468.97 each (inclusive of interest at 8% per annum) pursuant to a promissory note to be executed by RVDC upon acceptance of the Scanner.\nPursuant to an agreement dated April 6, 1993, First Coast Magnetic Resonance Imaging, P.A., (\"First Coast\") a professional association of which Dr. Damadian is the stockholder, director and President, purchased the Company's partnership\/joint venture interests in two MRI scanning centers in Florida (one in Jacksonville and one in Fort Meyers) for a purchase price of $3,200,000. The agreement provided for payment of the purchase price as follows: $200,000 no later than June 30, 1993 and the balance in (a) 36 equal monthly installments of principal and interest (8% per annum) in the amount of $46,758.64 each and (b) one final 37th installment of principal in the amount of $1,915,323.60. The centers are parties to service agreements with the Company with prices as follows: Jacksonville: $105,416 for each of the periods from February 15, 1994 to February 14, 1995 and May 18, 1995 to May 17, 1996; Fort Myers $100,000 for the period from August 10, 1994 to August 9, 1995 and $65,000 for each of the periods from July 19, 1995 to July 18, 1996 and July 19, 1996 to July 18, 1997.\nIn fiscal 1994, RVDC and its affiliates supported the Company and its objectives by purchasing five MRI scanners and purchasing the interests of a subsidiary of the Company in four limited partnerships.\nPursuant to a sales agreement dated February 3, 1994 and amended April 1, 1994, RVDC agreed to purchase an MRI scanner from the Company which RVDC is planning to utilize at a site located in Manhattan, New York (the \"West Side Center\"). The sales agreement provides for a purchase price of $800,000 payable in installments as follows: (1) $100,000 down payment within 30 days of execution, and (2) $700,000 in 84 monthly installments, commencing January 1, 1995, of $11,346.73 each (inclusive of interest at 8% per annum) pursuant to a promissory note.\nPursuant to a sales agreement dated March 31, 1994, RVDC agreed to purchase an MRI scanner from the Company which RVDC is planning to utilize at a site located in Israel (the \"Israel Center\"). The sales agreement provides for a purchase price of $1,000,000 payable in 84 monthly installments, commencing January 1, 1995, of $16,209.66 each (inclusive of interest at 8% per annum) pursuant to a promissory note.\nPursuant to a sales agreement dated April 1, 1994, RVDC agreed to purchase an MRI scanner from the Company which RVDC is planning to utilize at a site located in Cape Coral, Florida (the \"Cape Coral Center\"). The sales agreement provides for a purchase price of $1,000,000 payable in installments as follows: (1) $100,000 down payment within 30 days of execution, and (2) $900,000 in 84 monthly installments of $14,027.59 each (inclusive of interest at 8% per annum) pursuant to a promissory note to be executed by RVDC upon acceptance of the scanner.\nPursuant to a sales agreement dated May 18, 1994, RVDC agreed to purchase an MRI scanner from the Company which RVDC is planning to utilize at a site located in Orlando, Florida (the \"Orlando Center\"). The sales agreement provides for a purchase price of $1,000,000 payable in installments as follows: (1) $100,000 within 30 days of execution, and (2) $900,000 in 84 monthly installments of $14,027.59 each (inclusive of interest at 8% per annum) pursuant to a promissory note to be executed by RVDC upon acceptance of the scanner.\nPursuant to an agreement dated March 31, 1994, the Company sold an MRI scanner to Ellwood City MRI Center Limited Partnership, a Pennsylvania limited partnership of which RVDC is the general partner. The sales agreement provided for a purchase price of $400,000, the first $200,000 of which was paid subsequent to the fiscal year end and the second $200,000 of which will be paid by the transfer of RVDC's distributions until the sum of $200,000 is reached. The partnership is utilizing the scanner to set up an MRI scanning center in Ellwood City, Pennsylvania.\nPursuant to an agreement dated September 30, 1993, Advanced Medical Diagnostics Corporation (\"AMD\"), a subsidiary of FONAR, sold its interests in a partnership operating an MRI scanning center in Southfield Michigan to RVDC for $600,000. The purchase price is payable with interest at 10% per annum, over a period of 48 months commencing October 1, 1993 as follows: $2,000 per month for the first year, $8,333.33 per month for the second year, $16,666.67 per month for the third year and $20,909.91 for the fourth and fifth years. The partnership is party to a service agreement for the scanner at a current annual fee of $144,000, for the period January 29, 1995 to January 28, 1996. For the prior year, from January 29, 1994 to January 28, 1995, the fee also was $144,000.\nPursuant to an agreement dated September 30, 1993, AMD sold its interests in a partnership operating an MRI scanning center in Melbourne, Florida to Melbourne Magnetic Resonance Imaging, P.A. (the \"Melbourne Center\"), for a purchase price of $150,000. The purchase price is payable, with interest at 10% per annum, over a period of fifteen months commencing September 1, 1995 as follows: $13,500 per month for the first fourteen months and $1,185.60 for the fifteenth month. The Melbourne Center is a Florida professional corporation of which Raymond V. Damadian is the sole stockholder, director and President. The partnership has been party to a service agreement for the scanner at an annual fee of $108,200 for the periods from May 19, 1994 to May 18, 1995 and May 19, 1995 to May 18, 1996.\nPursuant to an agreement dated September 30, 1993, AMD sold to Dade County MRI, P.A. (the \"Dade County Center\") its interests in a partnership which had formerly operated an MRI scanning center in Miami, Florida, but is now inactive. The purchase price of $100,000 is payable, with interest at 10% per annum, in sixty (60) equal consecutive monthly installments of principal and interest (including interest accrued from September 30, 1993), commencing 90 days after the scanner is placed in service. The Dade County Center is a Florida professional association of which Raymond V. Damadian is the sole stockholder, director and President.\nPursuant to an agreement dated December 31, 1993, AMD sold its interests in a partnership operating an MRI scanning center in San Francisco to RVDC. The purchase price of $265,000 is payable, with interest at 10% per annum, at the rate of $9,405.88 per month over a period of 36 months commencing January 1, 1995. The partnership has been party to a service agreement with the Company for the scanner at an annual fee of $110,384 for the periods from March 20, 1995 to March 19, 1996 and March 20, 1994 to March 19, 1995.\nPursuant to an agreement dated December 31, 1993, AMD sold its interest in a joint venture operating an MRI scanning center in Philadelphia, Pennsylvania to Liberty MRI, P.C. (the \"Liberty Center\"). The purchase price of $400,000 is payable, with interest at 10% per annum, at a rate of $9,348.70 per month over a period of 60 months commencing January 1, 1995. The Liberty Center is a Pennsylvania professional corporation of which Raymond V. Damadian is the sole stockholder, director and President. The Liberty Center has been party to a service agreement with the Company for the scanner at an annual fee of $102,700 for the period from November 2, 1994 to November 1, 1995 and from November 2, 1993 to November 1, 1994.\nWest Palm Beach MRI, P.A. (the \"West Palm Beach Center\"), a Florida professional association of which Raymond V. Damadian is the sole stockholder, director and President, has been party to a service agreement with the Company for its scanner at an annual fee of $105,000 for the periods from March 1, 1994 to February 28, 1995 and March 1, 1995 to February 28, 1996.\nIn fiscal 1995, RVDC supported the Company and its objectives by purchasing seven MRI scanners.\nPursuant to a sales agreement dated July 12, 1994, RVDC agreed to purchase an MRI scanner from the Company which RVDC is planning to utilize at a site located in Ft. Lauderdale, Florida (the \"Ft. Lauderdale Center\"). The sales agreement provides for a purchase price of $800,000 payable in installments as follows: (1) $80,000 down payment within 30 days of execution and (2) $720,000 in 84 monthly installments of $11,222.07 each (inclusive of interest at 8% per annum) pursuant to a promissory note to be executed by RVDC upon acceptance of the scanner.\nPursuant to a sales agreement dated July 12, 1994, RVDC agreed to purchase an MRI scanner from the Company which RVDC is planning to utilize at a site located in Leeds, England (the \"Leeds Center\"). The sales agreement provides for a purchase price of $800,000 payable in installments as follows: (1) $80,000 down payment within 30 days of execution and (2) $720,000 in 84 monthly installments of $11,222.07 each (inclusive of interest at 8% per annum) pursuant to a promissory note to be executed by RVDC upon acceptance of the scanner.\nPursuant to a sales agreement dated October 1, 1994, RVDC agreed to purchase an MRI scanner from the Company which RVDC is planning to utilize at a site located in St. Petersburg, Florida (the \"St. Petersburg Center\"). The sales agreement provides for a purchase price of $800,000 payable in installments as follows: (1) $80,000 down payment within 30 days of execution and (2) $720,000 in 84 monthly installments of $11,222.07 each (inclusive of interest at 8% per annum) pursuant to a promissory note to be executed by RVDC upon acceptance of the scanner.\nPursuant to a sales agreement dated October 4, 1994, RVDC agreed to purchase an MRI scanner from the Company which RVDC is planning to utilize at a site located in Boca Raton, Florida (the \"Boca Raton Center\"). The sales agreement provides for a purchase price of $800,000 payable in installments as follows: (1) $80,000 down payment within 30 days of execution and (2) $720,000 in 84 monthly installments of $11,222.07 each (inclusive of interest at 8% per annum) pursuant to a promissory note to be executed by RVDC upon acceptance of the scanner.\nPursuant to a sales agreement dated November 25, 1994, RVDC agreed to purchase an MRI scanner from the Company which RVDC is planning to utilize at a site located in Birmingham, England (the \"Birmingham Center\"). The sales agreement provides for a purchase price of $800,000 payable in installments as follows: (1) $80,000 down payment within 30 days of execution and (2) $720,000 in 84 monthly installments of $11,222.07 each (inclusive of interest at 8% per annum) pursuant to a promissory note to be executed by RVDC upon acceptance of the scanner.\nPursuant to a sales agreement dated January 4, 1995, RVDC agreed to purchase an MRI scanner from the Company which RVDC is planning to utilize at a site located in Sarasota, Florida (the \"Sarasota Center\"). The sales agreement provides for a purchase price of $800,000 payable in installments as follows: (1) $80,000 down payment within 30 days of execution and (2) $720,000 in 84 monthly installments of $11,222.07 each (inclusive of interest at 8% per annum) pursuant to a promissory note to be executed by RVDC upon acceptance of the scanner.\nPursuant to a sales agreement dated January 16, 1995, RVDC agreed to purchase an MRI scanner from the Company which RVDC is planning to utilize at a site located in Largo, Florida (the \"Largo II Center\"). The sales agreement provides for a purchase price of $800,000 payable in installments as follows: (1) $80,000 down payment within 30 days of execution and (2) $720,000 in 84 monthly installments of $11,222.07 each (inclusive of interest at 8% per annum) pursuant to a promissory note to be executed by RVDC upon acceptance of the scanner.\nIn addition, pursuant to an agreement dated April 1, 1995, RVDC assigned its right to purchase an MRI scanner from a third party for $85,000 and FONAR assumed the obligations of RVDC under the agreement. RVDC also sold FONAR an MRI machine for $23,000 pursuant to an agreement dated April 1, 1995.\nFor the year ended June 30, 1995 total receipts by the Company from RVDC and its affiliates were $4,013,100, as compared to receipts of $4,913,968 in fiscal 1994 and receipts in fiscal 1993 of $2,665,000.\nRVDC executed and delivered to the Company a promissory note, dated June 30, 1992 in the principal amount of $4,284,692 with interest thereon at the rate of 10% per annum, payable in quarterly installments of interest only during the first year and thereafter, amortized over a five-year period. The note represented the indebtedness of RVDC to the Company incurred during fiscal 1992 for lease payments, service contract fees, management fees and reimbursable expenses and incorporated and superseded the outstanding balance of the note to the Company from RVDC dated June 30, 1991 in the principal amount of $1,996,100 (which was amortized over five years with interest at 10%). The note is guaranteed by the Macon Center, Albany Center, Staten Island Center, Deerfield Center, Daytona Beach Center and Melville Center and is secured by certain assets of RVDC and the guarantors. These security interests are in certain cases subordinate to the security interests of unrelated lenders.\nTMRI executed and delivered to the Company a promissory note dated June 30, 1992 in the principal amount of $803,272, with interest thereon at the rate of 10% per annum, payable in quarterly installments of interest only during the first year and thereafter, amortized over a five year period. The note represents the indebtedness of TMRI to the Company during fiscal 1992 for lease payments, service contract fees and reimbursable expenses and incorporates and supersedes the outstanding balance of the note to the Company from TMRI dated June 30, 1991 in the principal amount of $169,200 (which was amortized over five years with interest at 10%).\nPursuant to an agreement dated March 3, 1994, Network MRI, Inc. (\"Network\") engaged the Company to disassemble, transport and reinstall an MRI scanner purchased by Network from a third party. Luciano Bonanni, the Executive Vice President of the Company, is the President, director and shareholder of Network. The agreement provides for a price of $120,000 payable as follows: (1) $5,000 upon the giving of notice by Network to commence the deinstallation, (2) $15,000 upon the completion of the installation of the magnet and shielded room and (3) $100,000 in 36 monthly installments of $3,133.64 each (inclusive of interest at 8% per annum) pursuant to a note executed upon completion of the reinstallation.\nPursuant to an agreement dated June 20, 1994, MRI Enterprises, Inc. (\"Enterprises\"), a New York corporation of which Luciano Bonanni is the stockholder, director and President, engaged the Company to disassemble, transport and reinstall an MRI scanner purchased by Enterprises from a third party. The agreement provided for a price of $120,000 payable as follows: (1) $5,000 upon the giving of notice by Enterprises to commence the deinstallation, (2) $15,000 upon the completion of the installation of the magnet and shielded room and (3) $100,000 with interest at 8% per annum pursuant to a note executed upon completion of the reinstallation.\nIn addition, as of June 30, 1995, Enterprises assumed the liability of a third party to FONAR which had defaulted in its obligation to pay for service for an MRI scanner being provided by Enterprises to the third party. The liability, in the amount of $50,604.00 was assumed by Enterprises in exchange for FONAR assigning the account receivable to Enterprises. The liability is payable by Enterprises to FONAR amortized over a period of thirty-six months with interest at 8% per annum commencing on January 1, 1996.\nEnterprises was indebted to the Company as at June 30, 1995, in the amount of $204,539 pursuant to a promissory note due January 15, 1995 in the original principal amount of $324,235 with interest at the rate of 10% per annum. The original principal amount of this note represents the liability of a third party to the Company for service and other items which was assumed by Enterprises in connection with Enterprises' acquisition of an MRI scanner and assumption of said party's finance lease covering the scanner.\nThe aggregate indebtedness of Enterprises and Network to the Company as at June 30, 1995 was $432,339.00.\nPursuant to an agreement dated August 3, 1993 MRI Specialties, Inc. (\"Specialties\") engaged the Company to deinstall, transport and reinstall an MRI scanner purchased from a third party. Timothy Damadian, a Vice President of the Company, is the stockholder, director and President of Specialities. The agreement provides for a price of $120,000 payable in 36 monthly installments of $3,760.36 each (inclusive of interest at 8% per annum) pursuant to a note executed and delivered by Specialties upon the completion of the reinstallation. The scanner is owned by Canarsie MRI Associates (\"Canarsie\"), a joint venture partnership of which Specialties is an owner, and Canarsie is party to a service agreement for the scanner with the Company at an annual fee of $70,000 for the period September 1, 1994 through August 31, 1995 and $73,500 for the period September 1, 1995 through August 31, 1996. The annual fee for the following two annual periods will not exceed $77,000 and $80,500, respectively.\nThe aggregate indebtedness of Specialties and Canarsie to the Company as at June 30, 1995 was $142,925.00.\n(Remainder of page intentionally left blank)\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.\na) Financial Statements and Schedules\nThe following consolidated financial statements are included in Part II, Item 8.\nReport of Independent Certified Public Accountants.\nConsolidated Balance Sheets as at June 30, 1995 and 1994.\nConsolidated Statements of Operations for the Three Years Ended June 30, 1995, 1994 and 1993.\nConsolidated Statements of Stockholders' Equity for the Three Years Ended June 30, 1995, 1994 and 1993.\nConsolidated Statements of Cash Flows for the Three Years Ended June 30, 1995, 1994 and 1993.\nNotes to Consolidated Financial Statements.\nThe following consolidated financial statement schedules are included in Item 14 (d).\nSupplementary Schedules\nReport of Independent Certified Public Accountants on Schedules.\nInformation required by other schedules called for under Regulation S-X is either not applicable or is included in the consolidated financial statements or notes thereto.\nb) Reports on Form 8-K\nNone.\nc) Exhibits\n3.1 Certificate of Incorporation, as amended, of the Company incorporated herein by reference to Exhibit 3.1 to the Registrant's registration statement on Form S-1, Commission File No. 33-13365.\n3.2 Article Fourth of the Certificate of Incorporation, as amended, of the Company incorporated by reference to Exhibit 4.1 to the Registrant's registration statement on Form S-8, Commission File No. 33-62099.\n3.3 By-Laws, as amended, of the Company incorporated herein by reference to Exhibit 3.2 to the Registrant's registration statement on Form S-1, Commission File No. 33-13365.\n4.1 Specimen Common Stock Certificate incorporated herein by reference to Exhibit 4.1 to the Registrant's registration statement on Form S-1, Commission File No. 33-13365.\n4.2 Specimen Class B Common Stock Certificate incorporated herein by reference to Exhibit 4.2 to the Registrant's registration statement on Form S-1, Commission File No. 33-13365.\n10.1 License Agreement between FONAR and Raymond V. Damadian incorporated herein by reference to Exhibit 10 (e) to Form 10-K for the fiscal year ended June 30, 1983, Commission File No. 0-10248.\n10.2 1983 Nonstatutory Stock Option Plan incorporated herein by reference to Exhibit 10 (a) to Form 10-K for the fiscal year ended June 30, 1983, Commission File No. 0-10248, and amendments thereto dated as of March 7, 1984 and dated August 22, 1984, incorporated herein by referenced to Exhibit 28 (a) to Form 10-K for the year ended June 30, 1984, Commission File No. 0-10248.\n10.3 1984 Incentive Stock Option Plan incorporated herein by reference to Exhibit 28 (c) to Form 10-K for the year ended June 30, 1984, Commission File No. 0-10248.\n10.4 1986 Nonstatutory Stock Option Plan incorporated herein by reference to Exhibit 10.7 to Form 10-K for the fiscal year ended June 30, 1986, Commission File No. 0-10248.\n10.5 1986 Stock Bonus Plan incorporated herein by reference to Exhibit 10.8 to Form 10-K for the fiscal year ended June 30, 1986, Commission File No. 0-10248.\n10.6 1986 Incentive Stock Option Plan incorporated herein by reference to Exhibit 10.9 to Form 10-K for the fiscal year ended June 30, 1986, Commission File No. 0-10248.\n10.7 Lease Agreement, dated as of August 18, 1987, between FONAR and Reckson Associates incorporated herein by reference to Exhibit 10.26 to Form 10-K for the fiscal year ended June 30, 1987, Commission File No. 0-10248.\n10.8 1993 Incentive Stock Option Plan incorporated herein by reference to Exhibit 28.1 to the Registrant's registration statement on Form S-8, Commission File No. 33-60154.\n10.9 1993 Non-Statutory Stock Option Plan incorporated herein by reference to Exhibit 28.2 to the Registrant's registration statement on Form S-8, Commission File No. 33-60154.\n10.10 1993 Stock Bonus Plan incorporated herein by reference to Exhibit 28.3 to the Registrant's registration statement on Form S-8, Commission File No. 33-60154.\n10.11 1994 Non-Statutory Stock Option Plan incorporated herein by reference to Exhibit 28.1 to the Registrant's registration statement on Form S-8, Commission File No. 33-81638.\n10.12 1994 Stock Bonus Plan incorporated herein by reference to Exhibit 28.2 to the Registrant's registration statement on Form S-8, Commission File No. 33-81638.\n10.13 1995 Non-Statutory Stock Option Plan incorporated herein by reference to Exhibit 28.1 to the Registrant's registration statement on Form S-8, Commission File No. 33-62099.\n10.14 1995 Stock Bonus Plan incorporated herein by reference to Exhibit 28.2 to the Registrant's registration statement on Form S-8, Commission File No. 33-62099.\n11. Statement Re Computation Of Per Share Earnings. See Exhibits.\n22.1 Subsidiaries of the Registrant. Incorporated herein by reference to Exhibit 22.1 Form 10-K for the fiscal year ended June 30, 1989, Commission File No. 0-10248.\nd) Financial Statement Schedules\n[See pages S-1 through S-3]\nINDEPENDENT AUDITORS' REPORT ON SCHEDULES\nTo the Board of Directors FONAR Corporation and Subsidiaries\nIn connection with our audit of the consolidated financial statements of FONAR Corporation and Subsidiaries as at June 30, 1995 and 1994, and for the years in the three-year period ended June 30, 1995, we have also audited the supplemental schedules listed in the accompanying index to consolidated financial statements and schedules. Our audit was made for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. These schedules 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 otherwise a required part of the basic consolidated financial statements. The supplemental 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.\nTABB, CONIGLIARO & McGANN, P.C.\nNew York, New York November 3, 1995 S-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.\nFONAR CORPORATION\nDated: November 7, 1995\nBy: \/s\/ Raymond Damadian Raymond V. Damadian, President\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nSignature Title Date\n\/s\/ Raymond Damadian Chairman of the November 7, 1995 Raymond V. Damadian Board of Directors, President and a Director (Principal Executive Officer)\n\/s\/ Claudette J.V. Chan Director November 7, 1995 Claudette J.V. Chan\n\/s\/ Robert J. Janoff Director November 7, 1995 Robert J. Janoff\n\/s\/ Herbert Maisel Director November 7, 1995 Herbert Maisel","section_15":""}
{"filename":"752692_1995.txt","cik":"752692","year":"1995","section_1":"ITEM 1. BUSINESS --------\nGENERAL -------\nMiltope Group Inc. (the \"Company\"), a Delaware corporation incorporated in March 1984, is the parent company of Miltope Corporation, an Alabama corporation (\"Miltope\"), and Miltope Business Products, Inc., a New York corporation (\"MBP\"). Miltope was originally incorporated as a New York corporation in 1975 to acquire the assets and business of the Military Equipment Division of Potter Instrument Company, Inc. and until June 1984 was a wholly owned subsidiary of Stonebrook Group Inc. (formerly Stenbeck Reassurance Co. Inc.) (\"SGI\"). In June 1984, all of the outstanding stock of the Company was issued to SGI in exchange for all of the outstanding stock of Miltope. SGI is a privately held corporation which, since 1975, has supported the formation and funding of companies engaged in the development and manufacture of electronic hardware for defense and communications applications and in communications services. In January 1985, shareholders of the Company (including SGI) sold 700,000 shares of the Company's Common Stock in an initial public offering. In November 1985, the Company sold an additional 1,000,000 shares of its Common Stock to the public. As of December 30, 1994, Miltope merged with and into a newly formed Alabama corporation, which succeeded to all of the New York corporation's assets and liabilities. On January 1, 1995, Innova International Corporation, a Delaware corporation (\"IIC\"), acquired 62.8% of the outstanding shares of Common Stock of the Company pursuant to certain share exchange transactions with SGI, which at such time was a holder of approximately 55.6% of the outstanding shares of common stock of the Company, and Stuvik AB, a Swedish corporation and, at such time, a holder of approximately 7.2% of the outstanding shares of Company common stock. IIC provides, through its operating subsidiaries, integrated network products and services. IIC is a subsidiary of Great Universal American Industries Inc. (formerly American Satellite Network, Inc.), a Delaware corporation which is engaged in network integration services and the provision of satellite television programming.\nMiltope is engaged in the design, development, manufacture and testing of computers and computer peripheral equipment for military, rugged and other specialized applications requiring reliable operations in severe land, sea and airborne environments for both military and commercial customers. Miltope's product lines include a broad range of computer printers, disk memory products, magnetic tape drives, hand held terminals, transportable microcomputers and electronically erasable programmable read only memory (\"EEPROM\") together with subsystems incorporating these products. Miltope believes that it is the largest independent producer (\"non-OEM\"; not an original equipment manufacturer) of such militarized and ruggedized computer and peripheral equipment in the United States. In addition, Miltope provides a complete line of ruggedized Hewlett Packard Company computers and related equipment and has introduced a new product family consisting of ruggedized portable and hand held computers.\nMBP, incorporated in May 1984, develops, manufactures and markets commercial computer printers and document processing products.\nOn January 1, 1996, the Company consolidated the operations of MBP and Miltope Corporation. The Company's two industry segments will be maintained through product line accountability.\nIn September 1994, the Company relocated its headquarters from Melville, New York to Montgomery, Alabama.\nOn January 12, 1995, the Company completed a $6,100,000 industrial revenue bond offering by the Alabama State Industrial Development Authority (\"SIDA\"), the proceeds of which were used to improve, equip and furnish the new Montgomery facility and to pay the $3,375,000 principal amount of bank indebtedness which was used in part in the acquisition of such facility.\nSEGMENT INFORMATION -------------------\nThe Company's business is divided into two industry segments, consisting of the manufacture of militarized and rugged equipment primarily for military applications conducted by the \"Military\/Rugged\" segment, and the manufacture and distribution of commercial products conducted by the \"Commercial\" segment (formerly MBP). Financial information regarding the Company's industry segments is included in Note 12 to the Notes to Consolidated Financial Statements located in Item 8 of this Form 10-K.\nDESCRIPTION OF BUSINESS -----------------------\nMILITARY\/RUGGED GENERAL -----------------------\nThe military\/rugged segment is engaged in the design, development, manufacture and testing of computer and computer peripheral equipment for military, rugged and other specialized applications requiring reliable operations in severe land, sea and airborne environments for both military and commercial customers. Military\/rugged product lines include a broad range of computer printers, disk memory products, magnetic tape drives, hand held terminals, transportable microcomputers and EEPROM solid state memories, together with subsystems incorporating these products. The Company believes that it is the largest independent producer (non-OEM) of such militarized and ruggedized computers and peripheral equipment in the United States. In 1988, the Company introduced a complete line of ruggedized Hewlett Packard Company computers and related peripherals. The equipment is being used for the United States Army's Tactical Command and Control System\/Common Hardware Software Program (\"ATCCS\/CHS\") under a contract awarded to the Company in August 1988, as well as to other customers for related applications. During 1995, the Company introduced a new product family consisting of ruggedized portable and hand held computers to be used for both military and commercial applications. These new products are reconfigurable for specific applications and employ commercial \"off the shelf\" technology.\nSubstantially all of the military\/rugged segment sales consist of militarized and ruggedized products. \"Militarized\" equipment is designed and built, with respect to each component and the whole, to conform to stringent United States Department of Defense (\"DOD\") specifications developed for severe land, sea and airborne operating environments. These specifications define equipment operating parameters including atmosphere, temperature and humidity conditions, permitted levels of shock and vibration, susceptibility to electromagnetic interference and detection and hardening for nuclear survivability. \"Ruggedized\" equipment is designed and manufactured to less demanding specifications and may include commercially available devices which are suitably modified for these applications.\nProduction of equipment conforming to these DOD specifications has required the development over the years by the Company of proprietary electronic and electro-mechanical designs and engineering techniques and specialized manufacturing and testing methods. By these means, the Company has developed a broad range of proprietary components which meet these specifications and are otherwise unavailable in the commercial market. To support its engineering, manufacturing and testing activities, the Company has extensive manufacturing equipment, clean rooms and reliability and environmental testing facilities as well as a multi-function computer aided design and manufacturing (\"CAD\/CAM\") system and an electro-magnetic interference (\"EMI\") test lab.\nMilitary\/rugged products are sold for use in a broad range of military programs for the United States Air Force, Army, Navy and Marine Corps, for NATO, for the British, Canadian, French, German, Israeli, Italian, Spanish and Norwegian armed forces and for the armed forces of other countries. Miltope's militarized and ruggedized computers and peripheral products are compatible with most standard military computers and are sold to the DOD and many prime DOD systems contractors and integrators, including Boeing Co., EDS, E-Systems, Inc., Northrop Grumman Corporation, GTE Corp., ITT Federal Services Corporation, Litton Data Systems, Lockheed Martin, Marconi Radar Control Systems Limited, McDonnell Douglas Corp., Motorola Inc., Rockwell International, Loral Federal Systems, Teledyne Controls, Thompson CSF, CAE Inc., ITT Defense Systems, TRW, Inc., and Westinghouse Electric.\nMiltope believes that it has captured a major portion of the market for militarized printers, magnetic tape systems and disk memory products. In addition, Miltope is recognized as a leading supplier of rugged computers and related equipment. A key element of Miltope's strategy has been to develop and deliver a broad range of high reliability peripheral components and systems on a cost effective and timely basis. The breadth of Miltope's product offerings enables system integrators to avoid the risks normally encountered when procuring peripherals from multiple suppliers and to achieve significant price advantages. Miltope's ability to meet the diverse requirements of its customers has resulted in substantial recurring business. Also, as defense budgets have been reduced, an emphasis on commercially adaptable electronics and the requirement for smaller, less expensive and more portable systems has occurred. Miltope believes its new product family of ruggedized, reconfigurable portable and handheld computing devices will serve this growing market niche well.\nMiltope has been performing under a nine year DOD contract which runs until August 1997 in connection with the ATCCS\/CHS Program. The purpose of the ATCCS\/CHS Program is to integrate most of the aspects of land combat through the common automation of mission command and control areas. To date, Miltope has been issued firm orders valued at approximately $281,000,000 under this contract. In addition, the Company has received orders for ATCCS\/CHS equipment for other defense contractors and foreign governments.\nCOMMERCIAL - GENERAL --------------------\nThe commercial segment (formerly MBP) develops, manufactures and markets commercial products primarily for transportation markets. Its primary products are airborne cockpit printers, and printers for airline tickets and boarding passes. These products are based on direct thermal and thermal transfer technology. This segment's business represented approximately 15% of the Company's 1995 revenues, approximately 12% of the Company's 1994 revenues and approximately 8% of the Company's 1993 revenues.\nIn January 1993, MBP completed the purchase of the assets of Mag-Tek Inc.'s (\"Mag-Tek\") Airline Products Group. Included in this purchase was the Automatic Ticket and Boarding Pass (ATB) Encoded\/Printer. This product is designed to meet the future needs of the international air transport industry's passenger handling and ticketing systems, adding to this segments current line of ticket printers.\nSALES AND SIGNIFICANT CUSTOMERS -------------------------------\nSales in 1995 attributable to the military industry segment were approximately as follows: 64% from large DOD programs (each accounting for 2% or more of annual sales), 9% from smaller programs and sales of standard items in Miltope's catalogue, 23% from sales to foreign governments and defense contractors and 4% from spare parts sales. Sales to any one large DOD program have varied substantially from year to year due to product cycles and DOD requirements.\nIn 1995, sales to the DOD accounted for 63% of net sales of the Company. Sales to Marconi Radar Control Systems Limited accounted for 13% of net sales. No other customer accounted for more than 10% of net sales.\nThe Company has experienced large fluctuations from year to year in the percentage of sales represented by particular customers due to product cycles and customer requirements. The Company believes its customers and the industry are moving to shorter lead times due to compressed technology cycles and changes in procurement strategies.\nSales in 1995 attributable to the commercial industry segment amounted to approximately 15% of the Company's total net sales.\nGOVERNMENT CONTRACTS --------------------\nMiltope's business is subject to various statutes, regulations and provisions governing defense contracts including the Truth in Negotiations Act, which provides for the examination by the U.S. government of cost records to determine whether accurate pricing information was disclosed in connection with government contracts.\nContracts with the U.S. government as well as with U.S. government prime contractors are typically at a fixed price with a delivery cycle of 6 to 18 months, with contracts under a particular program being subject to further funding and negotiation. Miltope's defense contracts contain customary provisions permitting termination at any time at the convenience of the customer and providing for payment for work-in-progress should the contract be canceled.\nBACKLOG -------\nBacklog for both the military and commercial industry segments at December 31, 1995 was $17,200,000, a 65.9% decrease from the $50,400,000 backlog at December 31, 1994. The Company believes a significant part of this decrease was due to its customers and the industry moving to shorter lead times in order to avoid technological obsolescence.\nBacklog includes only orders covered by signed contracts with customers and only current, funded portions of multi-year programs. The Company believes that substantially all of the backlog will be recognized as revenue by December 31, 1996. The Company also believes that a substantial part of new business captured in 1996 will be recognized as revenue in the same year due to shorter lead times.\nBacklog for the commercial industry segment was approximately 26% of the total backlog at December 31, 1995 and approximately 12% of the total backlog at December 1994.\nCOMPETITION -----------\nBoth of the Company's industry segments face intense competition in markets for certain of their products. Competition comes from independent producers as well as prime contractors. Some of these competitors have greater resources than the Company. Competition is based on such factors as price, technological capability, quality, reliability and timely delivery.\nThe Company's competitive position in the military\/rugged industry segment has been based upon the experience of its technical personnel in their respective specialized fields of computer and peripheral product design; its broad range of products; its ability to design and manufacture its products to meet customers' specifications; its specialized manufacturing and testing facilities; its long association with many of its customers and its managerial and marketing expertise in dealing with prime contractors and the DOD. The Company believes that once a particular supplier's computer and\/or peripheral products have been selected for incorporation in a military program, further competition by other vendors during the life cycle of that program is limited.\nENGINEERING, RESEARCH AND DEVELOPMENT -------------------------------------\nThe Company believes that success within the industry depends in large part upon its ability to develop and apply new technology to modify, enhance and expand its existing line of proprietary products. The funding of these activities is primarily internal through Company sponsored research and development. Product development activities are generally the result of the need to respond to the anticipated requirements of future programs, the introduction of new technology which can be used to enhance product performance and direct requests by customers and the DOD. In certain cases the Company has licensed technology from commercial manufacturers for subsequent militarization and ruggedization. Management believes that a budget of approximately 4% to 7% of net sales for engineering, research and development expenditures should adequately support the growth of the Company's business.\nEngineering, research and development expenditures in 1993, 1994 and 1995 were approximately $5,400,000, $4,300,000 and $3,900,000, respectively.\nCurrently, Miltope's funded research efforts for its military\/rugged segment include projects to enhance its disk drive, printer, computer workstation and portable\/hand held computer products. The commercial segment's research and development costs have been incurred to enhance its airline ticket printers and airborne cockpit printers for the commercial market.\nEMPLOYEES ---------\nAt December 31, 1995, the Company employed 319 full-time personnel. None of the Company's employees are represented by a labor union and the Company has experienced no work stoppages. The Company believes that relations with its employees are excellent.\nEXPORT SALES ------------\nThe Company recorded foreign sales in its military\/rugged industry segment of approximately $6,800,000, $11,160,000 and $12,846,000 in 1993, 1994 and 1995, respectively. The Company recorded foreign sales in its commercial industry segment in 1993, 1994 and 1995 of approximately $1,200,000, $940,000 and $257,000, respectively. Neither of the Company's industry segments is dependent upon the Company's foreign sales.\nSOURCE OF SUPPLY ----------------\nThe Company utilized multiple suppliers for most materials and components. In order to minimize the risk of delay in delivering finished systems, components are sometimes procured according to the projected need for such components under annual purchasing agreements.\nMISCELLANEOUS -------------\nNeither of the Company's two industry segments is subject to seasonal business fluctuations.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES ----------\nThe Company owns a 90,000 square foot building located on 25 acres in Hope Hull (Montgomery), Alabama.\nIn addition, the Company owns a 60,000 square foot assembly and test facility in Troy, Alabama and a 25,000 square foot clean room, assembly and test facility in Springfield, Vermont.\nThe Company also leases various sales offices in the United States and England.\nThe Company owns substantially all of the machinery and equipment used in these facilities. The Company believes that these facilities are well maintained and are adequate to meet its needs in the foreseeable future.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS -----------------\nNone.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ---------------------------------------------------\nDuring the fourth quarter of the fiscal year covered by this Report, 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 REGISTRANT'S COMMON STOCK AND RELATED ------------------------------------------------ SHAREHOLDER MATTERS -------------------\nMARKET INFORMATION ------------------\nThe Company's Common Stock has been traded in the over-the-counter market under the NASDAQ symbol \"MILT\" since its initial public offering on January 23, 1985 and has been trading on the NASDAQ National Market since June 4, 1985. The high and low closing sale prices for the Common Stock in the over-the-counter market reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions. The quarterly high and low selling prices (the last daily sale price) of the Common Stock since January 1, 1994 have been:\nCALENDAR YEAR 1994 HIGH LOW ------------------ --- ---- First Quarter................ $ 5-1\/8 $ 3-7\/8 Second Quarter .............. 3-7\/8 2-1\/4 Third Quarter................ 4-3\/8 2-1\/2 Fourth Quarter .............. 5-1\/8 3-3\/8\nCALENDAR YEAR 1995 ------------------ First Quarter.............. $ 4-7\/8 $ 3-1\/2 Second Quarter ............ 4-3\/8 2-3\/4 Third Quarter ............ 3-7\/8 3 Fourth Quarter ............ 3-7\/8 2-1\/2\nHOLDERS OF COMMON STOCK -----------------------\nAs of March 20, 1996, there were approximately 1,240 shareholders of record and beneficial owners of the Company's Common Stock.\nDIVIDED POLICY -------------\nNo dividends were paid in 1994 or 1995. The Company does not presently anticipate paying cash dividends on its Common Stock. However, the Board of Directors of the Company will review this policy from time to time in light of its earnings, capital requirements and financial condition and other relevant factors, including applicable debt agreement limitations.\nOn December 12, 1995, the Company received waivers from its lending bank of certain financial covenant violations existing at September 30, 1995 and amendments of such covenants for future periods through December 31, 1996. The amendments prohibit payment of dividends as long as waivers are required of certain financial covenants. Thereafter, the Company's bank loan agreement permits the Company to pay annual dividends of up to 50% of the prior year's net income.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA -----------------------\nThe following is a summary of selected consolidated financial data of the Company for the five years ended December 31, 1995 which should be read in conjunction with the consolidated financial statements of the Company and the notes thereto:\n(ALL AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)\nYEAR ENDED DECEMBER 31, ------------------------------------------------- 1991 1992 1993 1994 1995\nIncome Statement Data: ----------------------\nNet sales............ $103,078 $114,401 $84,320 $75,569 $65,708 Gross profit 25,104 28,392 21,232 5,680 13,372 Income (loss) before income taxes....... 4,992 6,610 (1,381) (18,885) (984) Net income (loss).... 3,397 4,187 (856) (15,460) (984) Net income (loss) per share.............. .58 .71 (.15) (2.65) (.17) Cash dividends per share......... - - - - - Average shares outstanding........ 5,863 5,857 5,825 5,834 5,853\nBalance Sheet Data: ------------------- Working capital....... $34,996 $35,769 $31,460 $19,398 $18,896 Total assets.......... 62,129 58,859 62,587 53,162 41,440 Long-term debt........ 14,642 11,231 7,872 17,551 16,953 Stockholders' equity.. 28,820 32,863 32,033 17,230 15,913\nThe Company changed its method of accounting for certain inventories to the actual-cost-incurred method from the last-in, first-out (LIFO) cost method. The results of operations for the years ended December 31, 1991 through December 31, 1993 have been adjusted to reflect this change.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL ------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS -----------------------------------\nBUSINESS ENVIRONMENT --------------------\nThe Company's primary business segment provides specialized computers and related peripheral equipment to the United States and foreign military defense departments. Equipment in this segment takes two primary forms. The first of these is fully militarized products, usually designed especially for a particular mission area with demanding environmental and quality requirements. The second of these is rugged products, usually based on a commercial baseline product, but adapted by the Company to meet environmental and quality specifications that exceed the requirements for commercial products.\nThis entire segment has been impacted in recent years by reduced government spending and defense appropriations. The militarized product area has been especially subject to defense budget cuts. The military continues to reduce funding for the development and limited production quantities of highly customized systems and products. The long design cycle for these programs creates an intangible cost in the form of rapid technological obsolescence. Some military programs that would have sought militarized equipment some years ago have modified the requirements to reflect a need for rugged or commercial products. This trend has tended to benefit sales of the Company's rugged product line. Even in the rugged product area, however, defense cuts have taken a toll. Competition in this area has become more keen in recent years, as many government contractors pursue fewer military programs.\nThrough its commercial segment, the Company designs, develops and markets airline ticketing and boarding pass printers and baggage tag printers for airline transportation and travel related industries. Through this segment, the Company also designs, develops and markets airborne cockpit printers. Sales in this commercial segment increased by 12.0% in 1995 reflecting the trend within the travel related industries toward new magnetic encoding technology, ATB 2, as endorsed by the International Air Transportation Association. Implementation of this technology involves replacement of document printers at airports and major travel agencies throughout the world.\nThe Company has continued its strategy to downsize and reallocate its resources to accommodate as well as take advantage of this changing market environment. Specifically, the Company has taken the following actions:\n1. The Company has streamlined its product development cycle by implementing rapid prototyping capabilities.\n2. The Company continues its development of a broad offering of low cost, rugged, commercial based products that are customized to meet specific needs for both DOD and commercial markets.\n3. The Company continues its commitment and focus on commercial market opportunities.\n4. The Company consolidated the operations of Miltope Corporation and MBP to eliminate redundancies and reduce costs.\nThese actions have positioned the Company to go forward with a substantially reduced cost base and to compete more aggressively in its core businesses.\nRESULTS OF OPERATIONS ---------------------\nThe Company reported income from operations of $377,000 compared to a loss from operations of $17.6 million (including a relocation and restructuring charge in the amount of $9.1 million and special charges totaling $10 million) in 1994 and a loss from operations of $233,000 in 1993. The net loss per common share was $.17 compared to a net loss of $2.65 per share in 1994 and a net loss of $.15 per share in 1993.\nIn 1994, the Company changed its method of accounting for certain inventories to the actual-cost-incurred method from the last-in, first-out (LIFO) cost method. The results of operations for the year ended December 31, 1993 has been adjusted to reflect this change.\nIn 1994, the Company made the decision to restructure and relocate the Company resulting in special charges which significantly impacted 1994 operating results. The Company incurred a pre-tax charge of $9.1 million to cover costs associated with severance and related human resource programs, employee relocation, the transfer of assets and the operational impact due to the transition. The transition was completed during 1995. Additional special charges in the amount of $10 million were recorded in 1994 to reflect inventory obsolescence and other costs related to discontinued product lines, end of life contract costs and additional costs on long-term contracts. The special charges were principally non-cash in nature and included $4.9 million applicable to discontinued products and inventory obsolescence, $2.2 million related to end of life contracts and $2.9 million for additional costs on long-term contracts.\nSales for 1995 totaled $65.7 million, a decrease of $9.9 million, or 13.1%, from 1994. This change was attributable to a reduction in military sales of $10.9 million partially offset by an increase in commercial sales in the amount of $1.0 million. Sales in 1994 totaled $75.6 million, a decrease of $8.8 million, or 10.4% from 1993. A substantial portion of the sales decline was attributable to difficulties in effecting the relocation.\nExclusive of special charges in 1994, gross profit as a percent of sales declined from 20.7% in 1994 to 20.4% in 1995. This decline was the result of a change in mix in products and the different margins associated with the commercial and ruggedized lines.\nSelling, general and administrative expenses, as a percentage of sales, totaled 16.4% in 1993, 13.0% in 1994 and 13.9% in 1995. The increase in 1995 was principally due to an emphasis on increased marketing and business development efforts and severance costs related to a reorganization which took place in the second quarter of 1995. The decrease in 1994 was principally due to cost benefits of the relocation and reduced sales related expenses and professional fees.\nEngineering, research and development expenses, as a percentage of sales, totaled 6.4% in 1993, 5.7% in 1994 and 5.9% in 1995. The increase in 1995 was driven primarily by product development of the company's new family of portable and hand held computers. The primary cause of the decrease in 1994 was related to the cost benefits of the relocation.\nDuring 1993, the Company exercised an option to purchase its main operating facility in Melville, New York for $5.0 million. Prior to December 31, 1993, the Company recognized a non-recurring charge of approximately $2.2 million representing the excess of the carrying value of the building and related improvements over the estimated selling price less cost to dispose which in turn was sold in 1994.\nLIQUIDITY AND CAPITAL RESOURCES -------------------------------\nWorking capital at December 31, 1995 totaled $18.9 million, a decrease of $502 thousand from December 31, 1994. Accounts receivable and inventory declined by $7.2 million reflecting the Company's lower sales volume. A term loan from the bank was used by the Company to purchase and renovate its new corporate headquarters in 1994 in anticipation of receiving industrial revenue bond financing. The decrease in accounts payable is due to the payment of same with the proceeds of the industrial revenue bond. The decrease in accrued expenses reflects the payment of the Company's relocation charges that remained outstanding as at December 31, 1994 and the Company's lower sales volume.\nThe Company entered into a revolving credit facility in July 1994 for an amount not to exceed $15 million. In February 1995, the credit facility was amended to an amount not to exceed $19 million. In November 1995 the credit facility was amended again to an amount not to exceed $15 million and it was extended for an additional one-year period expiring May 31, 1997, subject to extension for additional one-year periods. As of December 31, 1995, the Company had approximately $4.7 million available under such facility. In August 1994, the Company sold its principal operating facility in Melville, New York for $6.1 million. Net proceeds of the sale were used to pay down the revolving credit facility.\nCash provided by (used in) operating activities was $5.7 million in 1993, $(2.0 million)in 1994 and $(295 thousand) in 1995. The decrease of cash used in operating activities in 1995 compared to 1994 is primarily a result of decreases in accounts receivable and inventories and collection of an income tax receivable partially offset by the payment in 1995 of accounts payable that were used in 1994 to fund the purchase of a new headquarters facility and related costs prior to receiving industrial revenue bond financing, and the payment in 1995 of remaining relocation charges accrued in 1994.\nIn April 1994, the Company purchased a new headquarters facility and related capital equipment located in Montgomery, Alabama. The purchase was financed through a bank term loan and the proceeds of the offering of taxable revenue bonds (the \"Bonds\") by the Alabama State Industrial Development Authority which was completed January 12, 1995 (the \"SIDA Offering\"). Repayment of the Bonds is secured by an irrevocable letter of credit issued by First Alabama Bank in an amount up to $6.2 million which in turn is secured by a mortgage on the Montgomery and Troy, Alabama facilities and a security interest in the equipment located at such facilities.\nAs a result of the net operating losses, the Company was unable to remain in compliance with financial covenants contained in the revolving credit agreement. On December 12, 1995, an amendment to the agreement was executed, which principally provided additional flexibility with respect to certain future covenants and waived technical violations of those covenants which existed at September 30, 1995.\nThe Company has a net operating loss carry forward for Federal income tax purposes of approximately $10.3 million and $1.2 million which will expire in 2009 and 2010, respectively, if not utilized. No benefit has been recognized within the 1995 consolidated financial statements for the related net deferred tax asset which could be recognized in future periods if the probability of realization increases.\nThe Company believes that its working capital and capital requirement needs for its current lines of business and new product development will be met by its cash flow from operations and existing bank loan arrangements.\nEFFECTS OF INFLATION --------------------\nInflation has not had a significant impact on the Company's results of operations.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA -------------------------------------------\nSee Table of Contents to Consolidated Financial Statements on Page.\nITEM 9.","section_9":"ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE ----------------------------------------------------\nDuring the twenty-four months prior to the date of the financial statements contained herein, no Form 8-K reporting a change of accountants has been filed which included a reported disagreement on any matter of accounting principles or practices or financial statement disclosure.\nPART III --------\nThe information called for by Part III (Items 10, 11, 12 and 13) of this Report is hereby incorporated by reference from the Company's definitive Proxy Statement to be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934 in connection with the election of directors at the 1996 Annual Meeting of Stockholders of the Company, which definitive Proxy Statement will be filed with the Securities and Exchange Commission not later than 120 days after the end of the Company's fiscal year ended December 31, 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) The following documents are filed as part of Page this Report ----\n1. Consolidated Financial Statements:\nTable of Contents to Consolidated Financial Statements\nIndependent Auditors' Report\nConsolidated Balance Sheets as of December 31, 1994 and 1995\nConsolidated Statements of Operations for the Years Ended December 31, 1993, 1994 and 1995\nConsolidated Statements of Stockholders' Equity for the Years Ended December 31, 1993, 1994 and 1995\nConsolidated Statements of Cash Flows for the Years Ended December 31, 1993, 1994 and 1995\nNotes to Consolidated Financial Statements for the Years Ended December 31, 1993, 1994 and 1995\n2. All schedules are omitted because they are not applicable or the required information is shown in the consolidated financial statements or notes thereto.\n3. Exhibits 16\nEXHIBIT PAGE NUMBER DESCRIPTION OF EXHIBIT NUMBER ----- ---------------------- ------\n3(a) Certificate of Incorporation of the Registrant, as amended to date [Incorporated by reference to Exhibit 3(a) to the Registrant's Registration Statement on Form S-1 filed with the Commission on September 6, 1984 (Registration No. 2-93134)]\n3(b) By-laws of the Registrant, as currently in effect [Incorporated by reference to Exhibit 3(b) to the Registrant's Form 10-K filed with the Commission on March 31, 1987 (File No. 0-13433)].\n3(c) Specimen share certificate for the Common Stock of the Registrant [Incorporated by reference to Exhibit 4(b) to Amendment No. 1 to the Registrant's Registration Statement on Form S-1 filed with the Commission on January 8, 1985 (Registration No. 2-93134)].\n10(a)(A) 1985 Key Employee Stock Option Plan adopted by the Board of Directors of the Registrant on July 1, 1985 [Incorporated by reference to Exhibit 10(a) to the Registrant's Registration Statement on Form S-1 filed with the Commission on October 22, 1985 (Registration No. 33-1042)].\n10(a)(B) Form of 1985 Key Employee Stock Option Agreement, dated as of July 1, 1985, between the Registrant and certain key employees of the Registrant [Incorporated by reference to Exhibit 10(b) to the Registrant's Registration Statement on Form S-1 filed with the Commission on October 22, 1985 (Registration No. 33-1042)].\n10(b)(A) Incentive Stock Option Plan adopted by the Board of Directors of the Registrant on June 1, 1984 and approved by Stonebrook Group Inc. (formerly Stenbeck Reassurance Co. Inc.) on June 1, 1984, as amended by the Board of Directors of the Registrant on May 6, 1985 [Incorporated by reference to Exhibit 10(c) to the Registrant's Registration Statement on form S-1 filed with the Commission on October 22, 1985 (Registration No. 33-1042)].\n10(b)(B) Form of Incentive Stock Option Agreement, dated as of June 1, 1984, between the Registrant and certain key employees of the Registrant [Incorporated by reference to Exhibit 10(e) to the Registrant's Registration Statement on Form S-1 filed with the Commission on October 22, 1985 (Registration No. 33-1042)].\n10(c)(A) Management Stock Option Plan adopted by the Board of Directors of the Registrant on June 1, 1984 and approved by Stonebrook Group Inc. on June 1, 1984, as amended by the Board of Directors of the Registrant on May 6, 1985 [Incorporated by reference to Exhibit 10(f) to the Registrant's Registration Statement on Form S-1 filed with the Commission on October 22, 1985 (Registration No. 33-1042)].\n10(c)(B) Form of Management Stock Option Agreement, dated as of June 1, 1984, between the Registrant and certain management employees of the Registrant [Incorporated by reference to Exhibit 10(d) to the Registrant's Registration Statement on Form S-1 filed with the Commission on September 6, 1984 (Registration No. 2-93134)].\n10(d) Miltope Corporation Cash Bonus Plan, as amended, effective January 1, 1984 [Incorporated by reference to Exhibit 10(e) to the Registrant's Registration Statement on Form S-1 filed with the Commission on September 6 , 1984 (Registration No. 2-93134)].\n10(e)(A) Miltope Corporation Pay Conversion Plan (as amended 1984) [Incorporated by reference to Exhibit 10(i)(A) to the Registrant's Form 10-K filed with the Commission on March 31, 1987 (File No. 0-13433)].\n10(e)(B) Amendment No. 1, dated as of January 1, 1984, to the Miltope Corporation Pay Conversion Plan [Incorporated by reference to Exhibit 10(i)(B) to the Registrant's Form 10-K filed with the Commission on March 31, 1987 (File No. 0-13433)].\n10(e)(C) Amendment No. 2, dated as of January 1, 1987, to the Miltope Corporation Pay Conversion Plan [Incorporated by reference to Exhibit 10(h)(C) to the Registrant's Form 10-K filed with the Commission on March 31, 1989 (File No. 0-13433)].\n10(f)(A) 1995 Stock Option and Performance Award Plan adopted by the Board of Directors of the Registrant on April 11, 1995 and approved by the stockholders of the Registrant on June 5, 1995 [Incorporated by reference to Exhibit 4(a)(1) to the Registrant's Registration Statement on Form S-8 filed with the Commission on December 21, 1995 (File No. 33-65233)].\n10(f)(B) Form of Non-Qualified Stock Option Agreement under the 1995 Stock Option and Performance Award Plan [Incorportated by reference to Exhibit 4(a)(2) to the Registrant's Registration Statement on Form S-8 filed with the Commission on December 21, 1995 (File No. 33-65233)].\n10(f)(C) Form of Incentive Stock Option Agreement under the 1995 Stock Option and Performance Award Plan [Incorporated by reference to Exhibit 4(a)(3) to the Registrant's Registration Statement on Form S-8 filed with the Commission on December 21, 1995 (File No. 33-65233)].\n10(g) Lease, dated February 9, 1987, between McConnel Marina Properties and Miltope Corporation [Incorporated by reference to Exhibit 10(k)(B) to the Registrant's Form 10-K filed with the Commission on March 31, 1989 (File No. 0-13433)].\n10(h)(A) Real Estate Sales Contract, dated July 18, 1984, between the City of Troy, Alabama and Miltope Corporation [Incorporated by reference to Exhibit 10(o) to the Registrant's Registration Statement on Form S-1 filed with the Commission on September 6, 1984 (Registration No. 2-93134)].\n10(h)(B) Lease Agreement, dated November 1, 1985, between the Industrial Development Board of the City of Troy, Alabama and Miltope Corporation [Incorporated by reference to Exhibit 10(s)(B) to the Registrant's Form 10-K filed with the Commission on March 31, 1986 (File No. 0-13433)].\n10(i) Agreement of Sale, dated July 15, 1994, between Miltope Corporation and Marc Beige, with respect to the sale of 1770 Walt Whitman Road, Melville, New York [Incorporated by reference to Exhibit 10(l) to the Registrant's Form 10-K filed with the Commission on March 31, 1995 (File No. 0-13433)].\n10(j) Agreement of Lease, dated as of August 10, 1994, between Melville Associates, L.P. and Miltope Corporation [Incorporated by reference to Exhibit 10(m) to the Registrant's Form 10-K filed with the Commission on March 31, 1995 (File No. 0-13433)].\n10(k) Purchase and Sale Agreement, dated April 19, 1994, between Collier Management Group, Inc. and Miltope Corporation, with respect to 500 Richardson Road South, Hope Hull, Alabama [Incorporated by reference to Exhibit 10(n) to the Registrant's Form 10-K filed with the Commission on March 31, 1995 (File No. 0-13433)].\n10(l)(A)(1) Loan Agreement, dated July 27, 1994, among First Alabama Bank, as lender, and Miltope Corporation and Miltope Business Products, Inc., as borrowers [Incorporated by reference to Exhibit 10(o)(A)(1) to the Registrant's Form 10-K filed with the Commission on March 31, 1995 (File No. 0-13433)].\n10(l)(A)(2) Amendment to Loan Agreement, dated as of October 3, 1994, among First Alabama Bank, Miltope Corporation and Miltope Business Products, Inc. [Incorporated by reference to Exhibit 10(o)(A)(2) to the Registrant's Form 10-K filed with the Commission on March 31, 1995 (File No. 0-13433)].\n10(l)(A)(3) Amendment to Loan Agreement and Related Documents, dated February 3, 1995, among First Alabama Bank, Miltope Corporation and Miltope Business Products, Inc. [Incorporated by reference to Exhibit 10(o)(A)(3) to the Registrant's Form 10-K filed with the Commission on March 31, 1995 (File No. 0-13433)].\n10(l)(B) Guaranty Agreement, dated July 27, 1994, by the Registrant to First Alabama Bank [Incorporated by reference to Exhibit 10(o)(B) to the Registrant's Form 10-K filed with the Commission on March 31, 1995 (File No. 0-13433)].\n10(l)(C) Security Agreement, dated July 27, 1994, among Miltope Corporation, Miltope Business Products, Inc. and First Alabama Bank [Incorporated by reference to Exhibit 10(o)(C) to the Registrant's Form 10-K filed with the Commission on March 31, 1995 (File No. 0-13433)].\n10(m)(A) Term Loan Agreement, dated October 13, 1994, between First Alabama Bank, as lender, and Miltope Corporation, as borrower [Incorporated by reference to Exhibit 10(p)(A) to the Registrant's Form 10-K filed with the Commission on March 31, 1995 (File No. 0-13433)].\n10(m)(B) Real Estate Mortgage and Security Agreement, dated October 13, 1994, by Miltope Corporation in favor of First Alabama Bank [Incorporated by reference to Exhibit 10(p)(B) to the Registrant's Form 10-K filed with the Commission on March 31, 1995 (File No. 0-13433)].\n10(n)(A) Loan Agreement, dated January 1, 1995, between the State Industrial Development Authority and Miltope Corporation [Incorporated by reference to Exhibit 10(q)(A) to the Registrant's Form 10-K filed with the Commission on March 31, 1995 (File No. 0-13433)].\n10(n)(B) Credit Agreement, dated January 1, 1995, between Miltope Corporation and First Alabama Bank [Incorporated by reference to Exhibit 10(q)(B) to the Registrant's Form 10-K filed with the Commission on March 31, 1995 (File No. 0-13433)].\n10(n)(C) Guaranty Agreement, dated January 1, 1995, by the Registrant to First Alabama Bank [Incorporated by reference to Exhibit 10(o)(C) to the Registrant's Form 10-K filed with the Commission on March 31, 1995 (File No. 0-13433)].\n10(n)(D) Bond Purchase Agreement, dated January 11, 1995, among Miltope Corporation, the State Industrial Development Authority and Merchant Capital, L.L.C. [Incorporated by reference to Exhibit 10(q)(D) to the Registrant's Form 10-K filed with the Commission on March 31, 1995 (File No. 0-13433)].\n10(n)(E) Remarketing Agreement, dated January 1, 1995, among Miltope Corporation, the State Industrial Development Authority and Merchant Capital, L.L.C. [Incorporated by reference to Exhibit 10(q)(E) to the Registrant's Form 10-K filed with the Commission on March 31, 1995 (File No. 0-13433)].\n10(n)(F) Real Estate Mortgage and Security Agreement, dated as of January 1, 1995, from Miltope Corporation in favor of First Alabama Bank [Incorporated by reference to Exhibit 10(q)(F) to the Registrant's Form 10-K filed with the Commission on March 31, 1995 (File No. 0-13433)].\n10(o) License Agreement, dated as of December 31, 1983, between Stonebrook Group Inc. and Miltope Corporation [Incorporated by reference to Exhibit 10(w) to the Registrant's Registration Statement on Form S-1 filed with the Commission on September 6, 1984 (Registration No. 2-93134)].\n10(p) Letter Agreement, dated December 31, 1983, among Miltope Corporation, Stonebrook Group Inc. and Millidyne Inc. [Incorporated by reference to Exhibit 10(x) to the Registrant's Registration Statement on Form S-1 filed with the Commission on September 6, 1984 (Registration No. 2-93134)].\n10(q)(A) Stock Option Agreement, dated as of August 14, 1986, between the Registrant and Jon L. Boyes [Incorporated by reference to Exhibit 10(v) to the Registrant's Form 10-K filed with the Commission on March 31, 1987 (File No. 0-13433)].\n10(q)(B) Stock Option Agreement, dated as of September 7, 1988, between the Registrant and Jon L. Boyes [Incorporated by reference to Exhibit 10(t)(B) to the Registrant's Form 10-K filed with the Commission on March 31, 1989 (File No. 0-13433)].\n10(q)(C) Stock Option Agreement, dated as of March 30, 1990, between the Registrant and Jon L. Boyes [Incorporated by reference to Exhibit 10(r)(C) to the Registrant's Form 10-K filed with the Commission on March 27, 1991 (File No. 0-13433)].\n10(q)(D) Stock Option Agreement, dated as of June 14, 1990, between the Registrant and Jon L. Boyes [Incorporated by reference to Exhibit 10(r)(D) to the Registrant's Form 10-K filed with the Commission on March 27, 1991 (File No. 0-13443)].\n10(q)(E) Stock Option Agreement, dated as of June 13, 1991, between the Registrant and Jon L. Boyes [Incorporated by reference to Exhibit 10(p)(E) to the Registrant's Form 10-K filed with the Commission on March 27, 1992 (File No. 0-13433)].\n10(q)(F) Stock Option Agreement, dated as of June 8, 1992, between the Registrant and Jon L. Boyes [Incorporated by reference to Exhibit 10(p)(F) to the Registrant's Form 10-K filed with the Commission on March 25, 1993 (File No. 0-13433)].\n10(q)(G) Stock Option Agreement, dated as of June 25, 1993, between the Registrant and Jon L. Boyes. [Incorporated by reference to Exhibit 10(p)(G) to the Registrant's Form 10-K filed with the Commission on March 31, 1994 (File No. 0-13433)].\n10(q)(H) Stock Option Agreement, dated as of June 3, 1994, between the Registrant and Jon L. Boyes [Incorporated by reference to Exhibit 10(t)(H) to the Registrant's Form 10-K filed with the Commission on March 31, 1995 (File No. 0-13433)].\n10(r)(A) Stock Option Agreement, dated as of June 25, 1993, between the Registrant and William L. Dickinson. [Incorporated by reference to Exhibit 10(q) to the Registrant's Form 10-K filed with the Commission on March 31, 1994 (File No. 0-13433)].\n10(r)(B) Stock Option Agreement, dated as of June 3, 1994 between the Registrant and William L. Dickinson [Incorporated by reference to Exhibit 10(u)(B) to the Registrant's Form 10-K filed with the Commission on March 31, 1995 (File No. 0-13433)].\n*10(r)(C) Stock Option Agreement, dated as of June 5, 1995 between the Registrant and William L. Dickinson.\n10(s)(A) Stock Option Agreement, dated as of September 7, 1988, between the Registrant and Alvin E. Nashman [Incorporated by reference to Exhibit 10(t)(D) to the Registrant's Form 10-K filed with the Commission on March 31, 1989 (File No. 0-13433)].\n10(s)(B) Stock Option Agreement, dated as of March 30, 1990, between the Registrant and Alvin E. Nashman [Incorporated by reference to Exhibit 10(t)(B) to the Registrant's Form 10-K filed with the Commission on March 27, 1991 (File No. 0-13433)].\n10(s)(C) Stock Option Agreement, dated as of June 14, 1990, between the Registrant and Alvin E. Nashman [Incorporated by reference to Exhibit 10(t)(B) to the Registrant's Form 10-K filed with the Commission on March 27, 1991 (File No. 0-13433)].\n10(s)(D) Stock Option Agreement, dated as of June 13, 1991, between the Registrant and Alvin E. Nashman [Incorporated by reference to Exhibit 10(r)(D) to the Registrant's Form 10-K filed with the Commission on March 27, 1992 (File No. 0-13433)].\n10(s)(E) Stock Option Agreement, dated as of June 8, 1992, between the Registrant and Alvin E. Nashman [Incorporated by reference to Exhibit 10(r)(E) to the Registrant's Form 10-K filed with the Commission on March 25, 1993 (File No. 0-13433)].\n10(s)(F) Stock Option Agreement, dated as of June 25, 1993, between the Registrant and Alvin E. Nashman. [Incorporated by reference to Exhibit 10(r)(F) to the Registrant's Form 10-K filed with the Commission on March 31, 1994 (File No. 0-13443)].\n10(s)(G) Stock Option Agreement, dated as of June 3, 1994, between the Registrant and Alvin E. Nashman [Incorporated by reference to Exhibit 10(w)(G) to the Registrant's Form 10-K filed with the Commission on March 31, 1995 (File No. 0-13433)].\n*10(s)(H) Stock Option Agreement, dated as of June 5, 1995, between the Registrant and Alvin E. Nashman.\n*10(t) Stock Option Agreement, dated as of August 7, 1995, between the Registrant and George K. Webster.\n*10(u) Stock Option Agreement, dated as of November 8, 1995, between the Registrant and James E. Matthews.\n10(v) Representative Agreement, dated as of October 1, 1994, between Miltope Corporation and Pandolfi Group, Inc. [Incorporated by reference to Exhibit 10(x) to the Registrant's Form 10-K filed with the Commission on March 31, 1995 (File No. 0-13433)].\n*10(w) Settlement and Release Agreement, dated November 1, 1995, by and among the Registrant, Miltope Corporation, Miltope Business Products, Inc., Pandolfi Group, Inc. and Richard Pandolfi.\n10(x)(A) Asset Purchase Agreement, dated as of December 23, 1992, between Miltope Business Products, Inc. and Mag-Tek, Inc. [Incorporated by reference to Exhibit 10(x)(A) to the Registrant's Form 10-K filed with the Commission on March 25, 1993 (File No. 0-13433)].\n10(x)(B) Guaranty of the Registrant, dated as of December 23, 1992, pursuant to Asset Purchase Agreement, dated as of December 23, 1992, between Miltope Business Products, Inc. and Mag-Tek, Inc. [Incorporated by reference to Exhibit 10(x)(B) to the Registrant's Form 10-K filed with the Commission on March 25, 1993 (File No. 0-13433)].\n10(x)(C) Supply Agreement, dated as of January 5, 1993, between Miltope Business Products, Inc. and Mag-Tek, Inc. [Incorporated by reference to Exhibit 10(x)(C) to the Registrant's Form 10-K filed with the Commission on March 25, 1993 (File No. 0-13433)].\n10(x)(D) Escrow Agreement, dated as of January 5, 1993, among Miltope Business Products, Inc., Mag-Tek, Inc. and First Interstate Bank of California, as Escrow Agent [Incorporated by reference to Exhibit 10(x)(D) to the Registrant's Form 10-K filed with the Commission on March 25, 1993 (File No. 0-13433)].\n10(x)(E) Marketing Agreement, dated as of January 5, 1993, between Miltope Business Products, Inc. and Mag-Tek, Inc. [Incorporated by reference to Exhibit 10(x)(E) to the Registrant's Form 10-K filed with the Commission on March 25, 1993 (File No. 0-13433)].\n10(x)(F) Noncompetition Agreement, dated as of January 5, 1993, between Miltope Business Products, Inc. and Mag-Tek, Inc. [Incorporated by reference to Exhibit 10(x)(F) to the Registrant's Form 10-K filed with the Commission on March 25, 1993 (File No. 0-13433)].\n*10(y) Employment Agreement, dated November 8, 1995, between the Registrant and James E. Matthews.\n18 Letter re change in accounting principle, dated May 13, 1994 [Incorporated by reference to Exhibit 18 to the Registrant's Form 10-Q filed with the Commission on May 16, 1994 (File No. 0-13433)].\n*21 Subsidiaries of the Registrant.\n*23 Independent Auditors' Consent, dated March 20, 1996, to the incorporation by reference in Registration Statements No. 2-97977, No. 33-8245, No. 33-78744 and No. 33-65233 on Form S-8 and No. 33-33752 on Form S-3 of their report dated March 20, 1996 appearing in this Annual Report on Form 10-K for the year ended December 31, 1995.\n*27 Financial Data Schedule\n----------------- *Filed herewith\nMILTOPE GROUP INC. AND SUBSIDIARIES -----------------------------------\nCONSOLIDATED FINANCIAL STATEMENTS PREPARED FOR FILING AS PART OF THE ANNUAL REPORT (FORM 10-K) TO THE SECURITIES AND EXCHANGE COMMISSION FOR THE YEAR ENDED DECEMBER 31, 1995\nMILTOPE GROUP INC. AND SUBSIDIARIES -----------------------------------\nTABLE OF CONTENTS TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------------------\nPAGE ----\nIndependent Auditors' Report\nConsolidated Balance Sheets as of December 31, 1994 and 1995\nConsolidated Statements of Operations for the Years Ended December 31, 1993, 1994 and 1995\nConsolidated Statements of Stockholders' Equity for the Years Ended December 31, 1993, 1994 and 1995\nConsolidated Statements of Cash Flows for the Years Ended December 31, 1993, 1994 and 1995\nNotes to Consolidated Financial Statements for the Years Ended December 31, 1993, 1994 and 1995\nAll supplemental schedules are omitted because they are not applicable or the required information is shown in the consolidated financial statements or notes thereto.\nINDEPENDENT AUDITORS' REPORT ----------------------------\nTo the Stockholders and Board of Directors of Miltope Group Inc.:\nWe have audited the accompanying consolidated balance sheets of Miltope Group Inc. and its subsidiaries as of December 31, 1994 and 1995, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1995. 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 1995, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles.\nAs further discussed in Note 2, during 1994 the Company changed its method of accounting for certain inventories. The accompanying consolidated financial statements for the year ended December 31, 1993 have been retroactively adjusted for this change.\n\/s\/ Deloitte & Touche LLP\nBirmingham, Alabama March 20, 1996\nMILTOPE GROUP INC. AND SUBSIDIARIES -----------------------------------\nCONSOLIDATED BALANCE SHEETS DECEMBER 31, 1994 AND 1995 --------------------------------------------------------------------------\nASSETS NOTES 1994 1995 ------ ----- ---- ----\nCURRENT ASSETS: Cash $ 811,000 $ 301,000 Accounts receivable 3,7 14,623,000 10,417,000 Inventories 4,7 19,414,000 16,432,000 Income tax receivable 2,524,000 - Advances and other 328,000 256,000 ----------- ----------- Total current assets 37,700,000 27,406,000 ----------- -----------\nPROPERTY AND EQUIPMENT - at cost: 1,7 Machinery and equipment 7,847,000 7,467,000 Furniture and fixtures 1,438,000 1,467,000 Land, buildings and improvements 7,105,000 7,108,000 ----------- ----------- Total property and equipment 16,390,000 16,042,000 Less accumulated depreciation 4,400,000 5,313,000 ----------- ----------- Property and equipment - net 11,990,000 10,729,000 ----------- ----------- OTHER ASSETS 1,6,7 3,472,000 3,305,000 ----------- ----------- TOTAL $53,162,000 $41,440,000 =========== ===========\nLIABILITIES AND STOCKHOLDERS' EQUITY ------------------------------------\nCURRENT LIABILITIES: Accounts payable $13,950,000 $ 5,956,000 Accrued expenses 3,815,000 1,958,000 Current maturities of long-term debt 7 230,000 528,000 Deferred income taxes 1,8 307,000 68,000 ----------- ----------- Total current liabilities 18,302,000 8,510,000 LONG-TERM DEBT 7 17,551,000 16,953,000 DEFERRED INCOME TAXES 1,8 79,000 64,000 ----------- ----------- TOTAL LIABILITIES 35,932,000 25,527,000 ----------- -----------\nCOMMITMENTS AND CONTINGENCIES 11\nSTOCKHOLDERS' EQUITY: 1,7,10 Common stock - $.01 par value; 20,000,000 shares authorized; 5,834,148 and 5,867,148 shares outstanding at December 31, 1994 and 1995, respectively 68,000 68,000 Capital-in-excess of par value 20,154,000 20,253,000 Retained earnings 10,597,000 9,613,000 Net unrealized appreciation on investment available for sale, net of deferred income tax liability of $386,000 and $132,000 at December 31, 1994 and 1995, respectively 1,6 657,000 225,000 ----------- ----------- 31,476,000 30,159,000 Less treasury stock 14,246,000 14,246,000 ----------- ----------- Total stockholders' equity 17,230,000 15,913,000 ----------- ----------- TOTAL $53,162,000 $41,440,000 =========== ===========\nSee notes to consolidated financial statements.\nMILTOPE GROUP INC. AND SUBSIDIARIES -----------------------------------\nCONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995 -------------------------------------------------------------------------\nNOTES 1993 1994 1995 ----- ---- ---- ----\nNET SALES 1,12 $ 84,320,000 $ 75,569,000 $ 65,708,000 ------------- ------------- -------------\nCOSTS AND EXPENSES: Cost of sales, as adjusted 2,4 63,088,000 69,889,000 52,336,000 Selling, general and administrative 13,861,000 9,834,000 9,135,000 Engineering, research and development 1 5,406,000 4,314,000 3,860,000 Excess of asset carrying value over net realizable value 5 2,198,000 - - Relocation and restructuring charge 14 - 9,100,000 - ------------- ------------- -------------\nTotal 84,553,000 93,137,000 65,331,000 ------------- ------------- -------------\nINCOME (LOSS) FROM OPERATIONS (233,000) (17,568,000) 377,000\nINTEREST EXPENSE - net 1,148,000 1,317,000 1,361,000 ------------- ------------ -------------\nLOSS BEFORE INCOME TAXES (1,381,000) (18,885,000) (984,000)\nINCOME TAX BENEFIT 1,8 (525,000) (3,425,000) - ------------- ------------ -------------\nNET LOSS $ (856,000) $ (15,460,000) $ (984,000) ============= ============= =============\nNET LOSS PER COMMON SHARE 1 $ (.15) $ (2.65) $ (.17) ============= ============= =============\nSee notes to consolidated financial statements.\nMILTOPE GROUP INC. AND SUBSIDIARIES -----------------------------------\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995 ------------------------------------------------------------------------\nCommon Stock -------------- Capital-in Par Excess of Retained Shares Value Par Value Earnings ------ ----- --------- --------\nBalance, January 1, 1993 6,762,487 $68,000 $20,125,000 $26,913,000\nExercise of stock options 11,250 - 29,000 -\nNet Loss - - - (856,000) --------- ------- ----------- -----------\nBalance, December 31, 1993 6,773,737 68,000 20,154,000 26,057,000\nChange in unrealized appreciation on investment available for sale - - - -\nNet loss - - - (15,460,000) --------- ------- ----------- -----------\nBalance, December 31, 1994 6,773,737 68,000 20,154,000 10,597,000\nExercise of stock options 33,000 - 99,000 -\nChange in unrealized appreciation on investment available for sale - - - -\nNet loss - - - (984,000) --------- ------- ----------- -----------\nBalance, December 31, 1995 6,806,737 $68,000 $20,253,000 $9,613,000 ========== ======= =========== ==========\nNet Unrealized Appreciation Treasury Stock on Investment -------------- Available for Sale Shares Cost ------------- ------ ----\nBalance, January 1, 1993 939,589 $14,246,000\nExercise of stock options - -\nNet loss - - ---------- ------- -----------\nBalance, December 31, 1994 939,589 14,246,000\nChange in unrealized appreciation on investment available for sale $ 657,000 - -\nNet loss - - - ---------- ------- -----------\nBalance, December 31, 1994 657,000 939,589 14,246,000\nExercise of stock options - - -\nChange in unrealized appreciation on investment available for sale (432,000) - -\nNet loss - - - ---------- ------- -----------\nBalance, December 31, 1995 $ 225,000 939,589 $14,246,000 ========== ======= ===========\nSee notes to consolidated financial statements.\nMILTOPE GROUP INC. AND SUBSIDIARIES -----------------------------------\nCONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995 ------------------------------------------------------------------------\n1993 1994 1995 ---- ---- ----\nCASH FLOWS FROM OPERATING ACTIVITIES: Net loss $ (856,000) $(15,460,000) $ (984,000) Adjustments to reconcile net loss to cash provided by (used in) operating activities: Provision for doubtful accounts receivable - 90,000 100,000 Provision for (recovery of) slow-moving and obsolete inventories (268,000) 2,160,000 883,000 Depreciation and amortization 1,190,000 1,572,000 1,701,000 (Gain) loss on disposi- tion of property and equipment 127,000 (133,000) 420,000 Deferred income taxes (736,000) (1,137,000) - Excess of asset carrying value over net realizable value 2,198,000 - - Gain on sale of investment available for sale - (472,000) (678,000) Write-down of property, equipment and inventory - - 168,000 Change in operating assets and liabilities: Accounts receivable 1,875,000 3,739,000 4,106,000 Inventories 1,560,000 6,038,000 2,282,000 Income tax receivable (968,000) (1,237,000) 2,524,000 Advances and other 14,000 (74,000) 72,000 Other assets 228,000 (920,000) (782,000) Deferred costs - - (256,000) Accounts payable and accrued expenses 1,290,000 3,879,000 (9,851,000) ------------ ----------- ------------- Cash (used in) pro- vided by operating activities 5,654,000 (1,955,000) (295,000) ------------ ----------- -------------\nCASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment (6,591,000) (6,054,000) (716,000) Proceeds from sale of property and equipment 24,000 5,662,000 22,000 Proceeds from sale of investment available for sale - 473,000 680,000 Payment for acquisition of business (2,000,000) - - ------------ ----------- ------------- Cash (used in) pro- vided by investing activities (8,567,000) 81,000 (14,000) ------------ ----------- -------------\nCASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from (payments of) revolving credit loan - net 3,200,000 2,482,000 (3,003,000) Payments of other long-term debt (111,000) (231,000) (22,000) Payments of short-term debt - - (3,375,000) Borrowing of long-term debt - - 6,100,000 Exercise of stock options 29,000 - 99,000 ------------ ----------- ------------- Cash (used in) pro- vided by financing activities 3,118,000 2,251,000 (201,000) ------------ ----------- -------------\nNET INCREASE (DECREASE) IN CASH 205,000 377,000 (510,000) CASH, BEGINNING OF YEAR 229,000 434,000 811,000 ------------ ----------- ------------- CASH, END OF YEAR $ 434,000 $ 811,000 $ 301,000 ============ =========== ============= SUPPLEMENTAL DISCLOSURE: Payments made (received) for: Income taxes $ 1,277,000 $ (1,131,000) $ (2,802,000) ============ =========== ============= Interest $ 1,025,000 $ 1,079,000 $ 1,596,000 ============ =========== =============\nSee notes to consolidated financial statements.\nMILTOPE GROUP INC. AND SUBSIDIARIES -----------------------------------\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995 --------------------------------------------------------------------------\n1. SUMMARY OF SIGNIFICANT ACCOUNTING AND FINANCIAL REPORTING POLICIES ---------------------------------\nPRINCIPLES OF CONSOLIDATION - The consolidated financial statements --------------------------- include the accounts of Miltope Group Inc. (the \"Company\") and its wholly-owned subsidiaries, Miltope Corporation (\"Miltope\"), Miltope Business Products, Inc. (\"MBP\") and Miltope's wholly-owned subsidiary, International Miltope, Ltd., a Foreign Sales Corporation (\"FSC\"). All material intercompany transactions have been eliminated.\nNATURE OF OPERATIONS - The Company through its two industry segments, -------------------- military\/rugged and commercial (MBP), is engaged in the development of computers and peripheral equipment for rugged and other specialized applications for military and commercial customers, domestic and international. On January 1, 1996, the Company consolidated the operations of Miltope and MBP.\nACCOUNTING ESTIMATES - The Company's consolidated financial statements -------------------- are prepared in conformity with generally accepted accounting principles which require 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 consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nFAIR VALUE OF FINANCIAL INSTRUMENTS - The carrying value of the ------------------------------------ Company's accounts receivable, accounts payable and accrued expenses approximates fair value because of the short-term maturity of those instruments. Additional information regarding the fair value of other financial instruments is disclosed in Notes 6 and 7.\nINVESTMENT AVAILABLE FOR SALE - During 1994, the Company adopted the ----------------------------- provisions of Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" (\"SFAS 115\"). SFAS 115 requires a positive intent and ability to hold debt securities to maturity as a precondition for reporting those securities at amortized cost. Securities not meeting the condition are considered either available for sale or trading, as defined, and reported at fair value. The investment owned by the Company is considered available for sale. Gains and losses on the disposition of the investment available for sale are computed under the specific identification method. Unrealized gains and losses, net of tax, related to the investment available for sale are reported as a separate component of stockholders' equity. The Company did not hold any trading investments or securities deemed to be held to maturity throughout 1994 or 1995. Restrictions on the Company's ability to sell this investment were resolved during 1994, thus there would be no effect on stockholders' equity had the Company adopted SFAS 115 at December 31, 1993.\nDEPRECIATION AND AMORTIZATION - Depreciation of machinery, equipment, ----------------------------- furniture and fixtures is computed on the straight-line method over the estimated useful lives of the related assets ranging from 3 to 10 years. Depreciation of buildings and improvements is computed on the straight-line method over an estimated useful life of 30 years. Amortization of leasehold improvements is computed on the straight- line method over the lesser of the estimated useful life of the improvement or the remaining term of the lease.\nINTANGIBLE ASSETS - Intangible assets include a noncompete agreement ----------------- and purchased technology with an aggregate carrying value of $900,000 and $695,000 at December 31, 1994 and 1995, respectively, which are being amortized over a six to seven-year period on a straight-line basis. The accumulated amortization as of December 31, 1994 and 1995 is $313,000 and $605,000, respectively. The Company periodically reviews intangible assets to assess recoverability, and impairments would be recognized in operating results if a permanent diminution were to occur.\nPROGRESS BILLINGS - In accordance with the terms of certain sales ----------------- contracts, a portion of the costs incurred as of the end of specified periods may be billed to the applicable customers even though the contracted units have not been delivered. In accordance with trade practice, such progress payments are not recorded as revenue until the related units are shipped. The amounts of paid progress billings for which the related units have not been shipped are applied against the carrying value of inventories held for the contracts (see Note 4).\nREVENUE RECOGNITION - Sales and related cost of sales are generally ------------------- recognized under the unit-of-delivery method of accounting. A significant multi-year contract is accounted for under the percentage- of-completion method of accounting. Income is recognized under the percentage-of-completion method using the cost-to-cost method after considering management's estimates of costs to complete utilizing all available information. Sales under cost reimbursable type contracts are recorded as work is performed. Provisions for estimated losses on contracts in progress are recorded in the period in which the loss is determined. Revisions in profit estimates are reflected in the period in which the facts that require revision are known. Amounts representing contract change orders or claims are included in sales only when they can be reasonably estimated and realization is probable.\nENGINEERING, RESEARCH AND DEVELOPMENT - Engineering, research and ------------------------------------- development expenditures not made in connection with sales contracts are charged to expense as incurred.\nINCOME TAXES - On January 1, 1993, 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 consolidated 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. The impact on the Company's 1993 consolidated financial statements of the adoption of SFAS 109 was not material.\nNET LOSS PER COMMON SHARE - Net loss per common share is based on the ------------------------- weighted average number of shares outstanding during the year. The dilutive effect of outstanding common stock options was not included in the loss per share computations. The weighted average number of shares used in computing net loss per common share was 5,825,000 in 1993, 5,834,000 in 1994 and 5,853,000 in 1995.\nRECLASSIFICATIONS - Certain prior years amounts have been reclassified ----------------- to conform with the 1995 presentation.\nACCOUNTING STANDARDS - Yet to be Adopted In October 1995, the -------------------- Financial Accounting Standards Board (\"FASB\") issued SFAS No. 123, Accounting for Stock-Based Compensation, which requires adoption of the disclosure provisions no later than fiscal years beginning after December 15, 1995 and adoption of the recognition and measurement provisions for nonemployee transactions entered into after December 15, 1995. The new standard defines a fair value method of accounting for stock options and other equity instruments. Under the fair value method, compensation cost is measured at the grant date based on the fair value of the award and is recognized over the service period, which is usually the vesting period.\nPursuant to the new standard, companies are encouraged, but are not required, to adopt the fair value method of accounting for employee stock-based transactions. Companies are also permitted to continue to account for such transactions under Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, (\"APB No 25\") but would be required to disclose in a note to the financial statements pro forma net income and earnings per share as if the company had applied the new method of accounting.\nThe accounting requirements of the new method are effective for all employee awards granted after the beginning of the fiscal year of adoption. The Company has determined that it will continue to account for employee stock-based transactions under APB No. 25 and will not elect to change to the fair value method. Adoption of the disclosure provisions of this statement in 1996 will result in only increased disclosures regarding pro forma net income and earnings per share as if the Company had applied the new method of accounting.\nThe FASB has also issued SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of. This statement establishes accounting standards for the impairment of long-lived assets, certain identifiable intangibles, and goodwill related to those assets to be held and used, and for long-lived assets and certain identifiable intangibles to be disposed of. This statement is effective for fiscal years beginning after December 15, 1995 and management believes its impact would be immaterial to the Company's consolidated financial statements if adopted currently.\n2. CHANGE IN ACCOUNTING PRINCIPLE ------------------------------\nOn January 1, 1994, the Company changed its method of accounting for certain inventories to the actual-cost-incurred method from the last- in, first-out (\"LIFO\") cost method. The Company adopted the LIFO method during 1975 at a time when the cost of materials, labor and overhead were increasing annually at dramatic rates. However, since that time, the prices for materials have declined and created an annual reduction of such costs while labor and overhead have increased substantially. This has created an inconsistent effect among the Company's cost components and, as a result, LIFO does not properly reflect the aggregate cost of inventories. The change to the actual-cost-incurred method was made to avoid distortions in financial reporting and to achieve what management believes will be a better reflection of operating results and greater comparability from period to period. In addition, the change will eliminate the additional record keeping and computational effort required in using the LIFO method.\nThe Company has retroactively adjusted its consolidated financial statements for this change. The effect of the accounting change decreased net income and net income per share as previously reported for the year ended December 31, 1993 by $986,000 and $.17, respectively.\n3. ACCOUNTS RECEIVABLE -------------------\nAccounts receivable consists of the following:\n1994 1995 ---- ----\nAmounts receivable from the United States Government $ 3,359,000 $ 2,775,000 Unbilled receivables on contracts in progress 3,223,000 1,655,000 Amounts receivable from other customers 8,291,000 6,388,000 Allowance for doubtful accounts (250,000) (401,000) ------------ ------------ Total $ 14,623,000 $ 10,417,000 ============ ============\nUnbilled receivables relate principally to certain long-term contracts accounted for on the percentage-of-completion basis. Receivables on the contracts are billed upon shipment of deliverables to the customers.\n4. INVENTORIES -----------\nInventories consist of the following:\n1994 1995 ---- ----\nPurchased parts and subassemblies $ 3,268,000 $ 2,766,000 Work-in-process 13,769,000 13,581,000 Inventoried costs relating to long- term contracts and programs, net of amounts attributed to revenues recognized to date 2,687,000 85,000 ------------ ------------ 19,724,000 16,432,000 Less progress billings received 310,000 - ------------ ------------ Total $ 19,414,000 $ 16,432,000 ============ ============\nWork-in-process inventories include materials purchased for specific contracts. Inventories include an allowance for slow-moving and obsolete items of $1,240,000, $2,000,000 and $2,700,000 at December 31, 1993, 1994, and 1995, respectively. The Company wrote-off $379,000, $1,400,000 and $183,000 of slow-moving and obsolete inventory during 1993, 1994 and 1995, respectively.\nCost has been determined on the first-in, first-out basis for Miltope and MBP. Inventory relating to a significant long-term government contract is accounted for based on the estimated average cost of all items included in the contract.\n5. ASSET AVAILABLE FOR SALE ------------------------\nDuring 1993, the Company exercised an option to purchase its manufacturing and administrative facility in Melville, New York for $5.0 million. During the fourth quarter of 1993, the Company decided to sell the building. As a result, at December 31, 1993, the Company recognized a charge of approximately $2.2 million representing the excess of the carrying value of the building and related improvements over the estimated selling price (less costs to dispose). At December 31, 1993, the Company classified the net realizable value of the asset and related improvements as a current asset since they intended to consummate the sale during 1994. Such sale occurred during 1994.\n6. OTHER ASSETS ------------\nIn January 1993, the Company acquired certain assets of Mag-Tek, Inc., a manufacturer of commercial airline products, for aggregate consideration, including related acquisition costs, of approximately $3.5 million. The consideration consisted of $2.0 million in cash, aggregate discounted minimum royalties of approximately $1.1 million (see Note 7) and $400,000 in related acquisition costs. The acquisition has been accounted for as a purchase.\nThe Company has an investment available for sale, with an original cost of $5,000, in M-Systems Flash Disk Pioneers, Ltd. (\"M-Systems\"), a company based in Israel. The Company is a major customer of M- Systems. The Company currently owns 92,014 shares of M-Systems stock at December 31, 1995. The fair market value of the Company's investment in M-Systems stock on December 31, 1995 is $357,000 and is included in other assets and as a separate component of stockholders' equity (net of deferred income taxes) on the accompanying consolidated balance sheet. During 1994 and 1995, the Company sold 111,500 and 160,850 shares of stock, respectively. The Company has provided notice to M-Systems of its intent to exercise its option to purchase an additional 153,242 shares of M-Systems stock at a price of $231,000. No value has been ascribed to the option at December 31, 1995.\nThe Company made loans to a related entity of which the chairman of such entity is a member of the Company's board of directors and, through other shareholdings, is affiliated with the majority shareholder of the Company. The loans bear interest at .75 percent above the prime lending rate (such prime lending rate being 8.5 percent and 8.75 percent at December 31, 1994 and 1995, respectively). The maximum amount loaned during the years ended December 31, 1994 and 1995 was $500,000. At December 31, 1994 and 1995, this loan of $500,000 is reflected within other assets on the accompanying consolidated balance sheets since collection is not anticipated to occur during the next fiscal year.\n7. LONG-TERM DEBT --------------\nLong-term debt consists of the following:\n1994 1995 ---- ----\nRevolving credit loan $ 13,307,000 $ 10,304,000 Term loan 3,375,000 Present value of minimum royalty payments 1,099,000 1,077,000 1995 Industrial Development Authority Revenue Bond - 6,100,000 ------------ ------------ Total 17,781,000 17,481,000 Less current maturities 230,000 528,000 ------------ ------------\nTotal $ 17,551,000 $ 16,953,000 ============ ============\nA $15,000,000 revolving credit agreement bears interest at the bank's reference rate plus .25% (8.75% and 9.0% at December 31, 1994 and 1995, respectively) and is scheduled to mature on May 31, 1997, at which time the outstanding amount would be converted into a term loan payable in twelve equal quarterly installments. However, at the request of the Company, the bank may extend the revolving credit agreement for successive one year periods based upon a review of the previous year-end audited consolidated financial statements. The Company's accounts receivable, contract rights and inventories are pledged as collateral to the agreement.\nThe term loan from the bank was used by the Company to purchase and renovate its new corporate headquarters in 1994. The interest rate on this loan at December 31, 1994 was 8.75%. In January 1995, the Company repaid the term loan with a portion of the proceeds of $6,100,000 of the 1995 Industrial Development Authority Revenue Bonds (the \"Bonds\"). Principal payments under the agreement with the Industrial Development Authority begin in December 1996. Repayment of the Bonds is secured by an irrevocable letter of credit issued by an Alabama bank in an amount up to $6.2 million which in turn is secured by a mortgage on the Montgomery and Troy, Alabama facilities and a security interest in the equipment located at such facilities. Property and equipment with a carrying value of $8,205,000 and $7,744,000 at December 31, 1994 and 1995, respectively, are pledged as collateral. The agreement with the Industrial Development Authority bears interest at a variable market rate which ranged from 5.77% to 6.33% during 1995, and was 5.87% at December 31, 1995.\nThe credit agreements referenced above include various provisions requiring the maintenance of certain financial ratios and limitations on (i) transactions with affiliates, (ii) other debt and guarantees, (iii) investment in, and advances to, other entities, and (iv) payment of dividends. On December 12, 1995, the Company received waivers from the bank of certain financial covenant violations existing at September 30, 1995 and amendments of such covenants for future periods through December 31, 1996. There were no financial covenant violations as of December 31, 1995. The amendments prohibit payment of dividends as long as waivers are required of certain financial covenants. Thereafter, the Company's bank loan agreement permits the Company to pay annual dividends of up to 50% of the prior year's net income.\nIn connection with an acquisition (see Note 6), the Company agreed to pay annual minimum royalty payments of $200,000, $400,000, $500,000 and $600,000, which began in October, 1995. The Company recorded this obligation based on the present value of those payments using a 15% discount rate.\nThe aggregate maturities of long-term debt subsequent to December 31, 1995 are as follows:\nYear Ending December 31, ------------------------\n1996 $ 528,000 1997 2,403,000 1998 4,008,000 1999 3,745,000 2000 2,057,000 Thereafter 4,740,000 -----------\nTotal $17,481,000 ===========\nIt is not practicable to estimate the fair value of the minimum royalty payments because quoted market prices do not exist for similar type instruments. The fair value of other long-term debt approximated the carrying value as of December 31, 1995.\n8. INCOME TAXES ------------\nThe provision (benefit) for income taxes consists of the following:\n1993 1994 1995 ---- ---- ---- Current: Federal $ 87,000 $(2,450,000) $ - State 124,000 162,000 - Deferred (736,000) (1,137,000) - --------- ----------- -------------\nTotal $(525,000) $(3,425,000) $ - ========== =========== =============\nThe deferred tax assets and liabilities at December 31, 1994 and 1995 are comprised of the following:\n----------------------------------- DEFERRED DEFERRED TAX Current: TAX ASSETS LIABILITIES ---------- ----------- Inventory - $ (574,000) Non-deductible accruals $ 846,000 - ---------- -----------\nTotal current 846,000 (574,000) Valuation allowance (579,000) - ---------- ----------- Net current 267,000 (574,000) ---------- -----------\nLong-term: Reserves 228,000 - Net operating loss carryforward 3,499,000 - Alternative minimum tax credit carryforward 163,000 - Accelerated depreciation - (922,000) Unrealized appreciation on investment available for sale - (386,000) ----------- ------------\nTotal long-term 3,890,000 (1,308,000) Valuation allowance (2,661,000) - ----------- ------------ Net long-term 1,229,000 (1,308,000) ----------- ------------\nNet $1,496,000 $ (1,882,000) =========== =============\n-----------------------------------\nCurrent: TOTAL ---------- Inventory $ (574,000) Non-deductible accruals 846,000 ----------\nTotal current 272,000 Valuation allowance (579,000) ---------- Net current (307,000) ----------\nLong-term: Reserves 228,000 Net operating loss carryforward 3,499,000 Alternative minimum tax credit carryforward 163,000 Accelerated depreciation (922,000) Unrealized appreciation on investment available for sale (386,000) -----------\nTotal long-term 2,582,000 Valuation allowance (2,661,000) ----------- Net long-term (79,000) -----------\nNet $ (386,000) ===========\n----------------------------------- DEFERRED DEFERRED TAX Current: TAX ASSETS LIABILITIES ---------- ----------- Inventory $ (114,000) Non-deductible accruals $ 205,000 - ---------- -----------\nTotal current 205,000 (114,000) Valuation allowance (159,000) - ---------- ----------- Net current 46,000 (114,000) ---------- -----------\nLong-term: Reserves 297,000 - Net operating loss carryforward 3,962,000 - Alternative minimum tax credit carryforward 163,000 - Accelerated depreciation - (932,000) Unrealized appreciation on investment available for sale - (132,000) ----------- ------------\nTotal long-term 4,422,000 (1,064,000) Valuation allowance (3,422,000) - ----------- ------------ Net long-term 1,000,000 (1,064,000) ----------- ------------\nNet $1,046,000 $ (1,178,000) =========== =============\n-----------------------------------\nCurrent: TOTAL ---------- Inventory $ (114,000) Non-deductible accruals 205,000 ----------\nTotal current 91,000 Valuation allowance (159,000) ---------- Net current (68,000) ----------\nLong-term: Reserves 297,000 Net operating loss carryforward 3,962,000 Alternative minimum tax credit carryforward 163,000 Accelerated depreciation (932,000) Unrealized appreciation on investment available for sale (132,000) -----------\nTotal long-term 3,358,000 Valuation allowance (3,422,000) ----------- Net long-term (64,000) -----------\nNet $ (132,000) ===========\nAt December 31, 1994 and 1995, a valuation allowance of $3,240,000 and $3,581,000 has been established against the net deferred income tax assets. Such valuation allowance can be adjusted in future periods as the probability of realization of the net deferred income tax assets increases.\nThe Company has a net operating loss carryforward for Federal income tax purposes of approximately $10,300,000 and $1,200,000, which will expire in 2009 and 2010, respectively, if not utilized.\nThe Company's benefit for income taxes differs from the amount computed using the Federal statutory tax rate as a result of the following items:\n1993 1994 1995 ---- ---- ----\nAmount at Federal statutory rate $ (469,000) $(6,421,000) $(335,000) Increases (reductions) due to: State taxes - net of Federal income tax benefit 116,000 132,000 (34,000) Exempt FSC income (20,000) - - Reversal of excess amounts provided in prior years (163,000) - - Change in state tax rates - (283,000) - Valuation allowance provided 3,240,000 341,000 Other 11,000 (93,000) 28,000 --------- ----------- ---------- Total $(525,000) $(3,425,000) $ - ========= ========== ==========\n9. EMPLOYEE BENEFIT PLANS ----------------------\nCASH BONUS PLAN - The Company has a bonus plan which provides for --------------- employee participation in earnings. All permanent, full-time employees (excluding certain executives) are eligible. The bonus plan provides for quarterly contributions of up to 8 percent of a defined base. All eligible employees participate in the bonus plan based upon respective salary levels and years of service. The Company's bonus provision for the years ended December 31, 1993 and 1994 was $442,000, and $185,000, respectively. The Company did not award a bonus for 1995.\nSAVINGS PLAN - The Company has a profit-sharing retirement plan ------------ (the \"Plan\") which covers substantially all employees. Company contributions are discretionary and are determined annually based on profits. The Plan allows for an employee pay conversion feature whereby each eligible employee may contribute from 4 to 15 percent of their total pay. The Company's provision pursuant to the Plan amounted to $262,000 and $270,000 in 1993 and 1994, respectively. The Company made no contributions for 1995.\nPERFORMANCE BASED BONUS PLAN The Company has a bonus plan that ---------------------------- provides for additional compensation to certain executive officers. The bonus is payable upon the attainment of certain financial targets that are approved by the Board of Directors, and is calculated as a specified percentage of the officer's current base salary. The Company's bonus provision for 1993 was $20,000. No bonus provision was made for 1994 or 1995.\n10. STOCK OPTIONS -------------\nThe Company has an Incentive Stock Option Plan (\"ISO\"), a Management Stock Option Plan (\"MSO\") and a Key Employee Stock Option Plan (\"KSO\"). The ISO, MSO and KSO Plans expired in 1994 and 1995. In addition, on April 11, 1995, the Company adopted the 1995 Stock Option and Performance Award Plan (\"SOPA\") which was approved by the Company's stockholders on June 5, 1995. Under the ISO, MSO, KSO and SOPA plans, 376,780, 187,700, 150,000 and 500,000 shares of common stock, respectively, were reserved for issuance under options to be granted for periods not to exceed ten years at an exercise price not less than the fair market value of the shares at the date of grant. Such options are exercisable at a cumulative rate of 25 percent in each of the first four years subsequent to the applicable grant. Options for 126,515 shares, 112,390 shares and 185,585 shares were exercisable at December 31, 1993, 1994 and 1995, respectively.\nIn addition, certain of the Company's outside directors have been granted options to purchase shares of common stock at exercise prices of 85 percent of the fair market value of such shares at date of grant. Such options are exercisable at any time during the term of ten years as long as the recipient is a director or within one year after termination of service. Options were exercisable for 68,247 shares, 85,164 shares and 155,085 shares at December 31, 1993, 1994 and 1995, respectively.\nAdditional information regarding stock options granted pursuant to the stock option plans is as follows:\nOptions For Shares Option Price ----------- ------------ OUTSTANDING - December 31, 1992 395,601 $2.55 to $16.79 Granted 108,896 $3.72 to $5.50 Canceled (133,735) $3.00 to $16.00 Exercised (11,250) $2.63 ------------------------------------------------------------------------- OUTSTANDING - December 31, 1993 359,512 $2.55 to $16.79 Granted 41,917 $2.66 to $3.63 Canceled (103,125) $5.50 to $15.38 ------------------------------------------------------------------------- OUTSTANDING - December 31, 1994 298,304 $2.55 to $16.79 Granted 150,278 $2.66 to $3.75 Canceled (168,497) $3.63 to $15.38 ------------------------------------------------------------------------- OUTSTANDING - December 31, 1995 280,085 $2.66 to $16.79 =======\nIn addition, options to purchase 33,000 shares were exercised during 1995 at an exercise price of $3.00 per share. These options were originally granted independently of the aforementioned stock option plans. There are no other options granted independently of the aforementioned stock option plans.\n11. COMMITMENTS AND CONTINGENCIES -----------------------------\nThe Company is obligated under several noncancelable operating leases covering office facilities and equipment. Minimum rental payments under all noncancelable leases, exclusive of renewal options, are as follows:\nYEAR ENDING DECEMBER 31, -----------------------\n1996 $ 222,000 1997 166,000 1998 84,000 1999 68,000 2000 29,000 Thereafter 2,547,000 --------- Total $3,116,000 =========\nAggregate rental expense under noncancelable operating leases amounted to $1,371,000, $749,000 and $688,000 in 1993, 1994 and 1995, respectively.\nIn relation to a significant contract which was terminated in October 1992, the Company has an equitable adjustment claim of $2.4 million, which is part of its prime contractor's claim against its customer, and has submitted a termination settlement proposal which is presently in negotiation. In 1994, $800,000 of the equitable adjustment claim was recognized as revenue.\n12. SEGMENT INFORMATION ------------------- The Company operates in two industry segments. Information about the Company's industry segments is as follows:\nMILITARY\/RUGGED COMMERCIAL --------------- ---------- ----\nSales to unaffiliated customers $ 77,672,000 $ 6,648,000 Intersegment sales 5,981,000 3,000 ------------ -----------\nNet sales $ 83,653,000 $ 6,651,000 ============ ===========\nIncome (loss) from operations $ 2,165,000 $(2,337,000) ============ =========== Interest expense - net Loss before income taxes\nIdentifiable assets $ 53,601,000 $ 9,136,000 ============ ===========\nCapital expenditures $ 5,959,000 $ 632,000 ============ ===========\nDepreciation and amortization $ 952,000 $ 238,000 ============ ===========\nMILITARY\/RUGGED COMMERCIAL --------------- ---------- ----\nSales to unaffiliated customers $ 66,882,000 $ 8,687,000 Intersegment sales 8,976,000 38,000 ------------ -----------\nNet sales $ 75,858,000 $ 8,725,000 ============ ===========\nLoss from operations $(13,287,000) $(4,546,000) ============ =========== Interest expense - net Loss before income taxes\nIdentifiable assets $ 46,201,000 $ 6,846,000 ============ ===========\nCapital expenditures $ 5,972,000 $ 82,000 ============ ===========\nDepreciation and amortization $ 896,000 $ 676,000 ============ ===========\nMILITARY\/RUGGED COMMERCIAL --------------- ---------- ----\nSales to unaffiliated customers $ 55,974,000 $ 9,733,000 Intersegment sales 9,247,000 46,000 ------------ -----------\nNet sales $ 65,221,000 $ 9,779,000 ============ ===========\nIncome (loss) from operations $ 3,164,000 $(2,557,000) ============ =========== Interest expense - net\nLoss before income taxes\nIdentifiable assets $ 35,905,000 $ 5,845,000 ============ ===========\nCapital expenditures $ 563,000 $ 153,000 ============ ===========\nDepreciation and amortization $ 1,024,000 $ 677,000 ============ ===========\nELIMINATIONS CONSOLIDATED ------------ ------------ ----\nSales to unaffiliated customers $ 84,320,000 Intersegment sales $(5,984,000) ----------- ------------\nNet sales $(5,984,000) $ 84,320,000 =========== ============\nIncome (loss) from operations $ (61,000) $ (233,000) =========== Interest expense - net 1,148,000 ------------ Loss before income taxes $ (1,381,000) ============\nIdentifiable assets $ (150,000) $ 62,587,000 =========== ============\nCapital expenditures $ 6,591,000\n============ Depreciation and amortization $ 1,190,000 ============\nELIMINATIONS CONSOLIDATED ------------ ------------ ----\nSales to unaffiliated customers $ 75,569,000 Intersegment sales $(9,014,000) ----------- ------------\nNet sales $(9,014,000) $ 75,569,000 =========== ============\nLoss from operations $ 265,000 $(17,568,000) =========== Interest expense - net 1,317,000 ------------ Loss before income taxes $(18,885,000) ============\nIdentifiable assets $ 115,000 $ 53,162,000 =========== ============\nCapital expenditures $ 6,054,000 ============\nDepreciation and amortization $ 1,572,000 ============\nELIMINATIONS CONSOLIDATED ------------ ------------ ----\nSales to unaffiliated customers $ 65,708,000 Intersegment sales $(9,293,000) ----------- ------------\nNet sales $(9,292,000) $ 65,708,000 =========== ============\nIncome (loss) from operations $ (230,000) $ 377,000 =========== Interest expense - net 1,361,000 ------------ Loss before income taxes $ (984,000) ============\nIdentifiable assets $ 115,000 $ 41,635,000 =========== ============\nCapital expenditures $ 716,000 ============\nDepreciation and amortization $ 1,701,000 ============\nIn 1993, 1994 and 1995, foreign sales accounted for 9 percent, 17 percent and 23 percent, respectively, of the military\/rugged segment net sales and 18 percent, 11 percent and 3 percent, respectively, of the commercial segment net sales.\nDuring 1993, 1994 and 1995, the United States Government accounted for 62 percent, 57 percent and 63 percent of consolidated net sales of the Company, respectively.\n13. UNAUDITED QUARTERLY FINANCIAL DATA ----------------------------------\nSummarized unaudited quarterly financial data for the years ended December 31, 1994 and December 31, 1995 is as follows:\nTHIRTEEN WEEKS ENDED -------------------------------- MARCH 31, 1994 JULY 2, 1994 -------------- ------------\nNet Sales $20,089,000 $18,803,000 =========== ===========\nGross Profit $ 5,046,000 $ 4,913,000 =========== ===========\nNet Income (loss) $(5,144,000) $ 795,000 =========== ===========\nNet Income (loss) Per Common Share $(.88) $.14 ===== ====\nTHIRTEEN WEEKS ENDED -------------------------------- OCTOBER 2, 1994 DECEMBER 31, 1994 --------------- -----------------\nNet Sales $21,085,000 $ 15,592,000 =========== ============\nGross Profit $ 4,848,000 $ (9,127,000) =========== ============\nNet Income (loss) $ 960,000 $(12,101,000) =========== ============\nNet Income (loss) Per Common Share $.16 $(2.07) ==== ======\nTHIRTEEN WEEKS ENDED -------------------------------- MARCH 31, 1995 JULY 1, 1995 -------------- ------------ Net Sales $16,199,000 $21,063,000 =========== ===========\nGross Profit $ 2,546,000 $ 4,662,000 =========== ===========\nNet Income (loss) $(1,332,000) $ 193,000 =========== ===========\nNet Income (loss) Per Common Share $(.23) $.03 ===== ====\nTHIRTEEN WEEKS ENDED ----------------------------------- OCTOBER 1, 1995 DECEMBER 31, 1995 --------------- -----------------\nNet Sales $18,226,000 $ 10,220,000 =========== ============\nGross Profit $ 3,611,000 $ 2,553,000 =========== ============\nNet Income (loss) $ 618,000 $ (463,000) =========== ============\nNet Income (loss) Per Common Share $.11 $(.08) ==== =====\n14. RELOCATION AND RESTRUCTURING ----------------------------\nIn 1994, the Company relocated and restructured substantially all of the manufacturing, engineering and administrative functions located in Melville, New York to Alabama and Vermont. A pre-tax charge of $9.1 million was recorded during fiscal 1994 to cover the costs associated with the relocation and restructuring, which include the following:\nSeverance and related human resource programs $1,080,000 Employee relocation 3,151,000 Transfer of assets to Alabama and Vermont 2,326,000 Production inefficiencies 2,543,000 ----------- Total $9,100,000 ==========\nAt December 31, 1994, $1.3 million of this charge, representing certain relocation related costs, is included in accrued expenses on the accompanying consolidated balance sheet and was paid during 1995. At December 31, 1995, there is substantially no remaining liability on the accompanying consolidated balance sheet, as the relocation is complete.\n15. RELATED PARTY TRANSACTION ------------------------- Effective January 1, 1995, Innova International Corporation acquired 62.8%, subject to adjustment in certain circumstances, of the out- standing common stock of the Company pursuant to certain share ex- change transactions with Stonebrook Group, Inc. and Stuvik AB.\nSIGNATURES ----------\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.\nMILTOPE GROUP INC. March 27, 1996 \/s\/ George K. Webster ------------------------------------- George K. Webster 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.\nMarch 27, 1996 \/s\/ George K. Webster ------------------------------------ George K. Webster President and Chief Executive Officer (Principal Executive Officer)\nMarch 27, 1996 \/s\/ James E. Matthews ------------------------------------ James E. Matthews Vice President, Finance (Principal Accounting and Financial Officer)\nMarch , 1996 ------------------------------------ J. Shelby Bryan Director\nMarch 27, 1996 \/s\/ Alvin E. Nashman ------------------------------------ Alvin E. Nashman Director\nMarch 27, 1996 \/s\/ Jan H. Stenback ------------------------------------ Jan H. Stenbeck Director\nMarch 27, 1996 \/s\/ William Mustard ------------------------------------ William Mustard Director\nMarch 27, 1996 \/s\/ John Cusik ------------------------------------ John Cusick Director\nMarch 27, 1996 \/s\/ Franklin Miller ------------------------------------ Franklin Miller Director\nMarch 27, 1996 \/s\/ William L. Dickinson ------------------------------------ William L. Dickinson Director\nEXHIBIT INDEX\nExhibit Number Description of Exhibit ------ ----------------------\n10(r)(C) Stock Option Agreement, dated as of June 5, 1995 between the Registrant and William L. Dickinson.\n10(s)(H) Stock Option Agreement, dated as of June 5, 1995, between the Registrant and Alvin E. Nashman.\n10(t) Stock Option Agreement, dated as of August 7, 1995, between the Registrant and George K. Webster.\n10(u) Stock Option Agreement, dated as of November 8, 1995, between the Registrant and James E. Matthews.\n10(w) Settlement and Release Agreement, dated November 1, 1995, by and among the Registrant, Miltope Corporation, Miltope Business Products, Inc., Pandolfi Group, Inc. and Richard Pandolfi.\n10(y) Employment Agreement, dated November 8, 1995, between the Registrant and James E. Matthews.\n21 Subsidiaries of the Registrant.\n23 Independent Auditors' Consent, dated March 20, 1996, to the incorporation by reference in Registration Statements No. 2- 97977, No. 33-8245, No. 33-78744 and No. 33-65233 on Form S-8 and No. 33-33752 on Form S-3 of their report dated March 20, 1996 appearing in this Annual Report on Form 10-K for the year ended December 31, 1995.\n27 Financial Data Schedule","section_15":""}
{"filename":"47307_1995.txt","cik":"47307","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL DEVELOPMENT OF BUSINESS\nHickok Incorporated was organized in 1915 as an Ohio corporation, and first offered its securities to the public in 1959. Except as otherwise stated, the terms \"Company\" or \"Hickok\" as used herein mean Hickok Incorporated and its subsidiary. Previously inactive subsidiaries were dissolved during fiscal 1993.\nIn February 1995 the shareholders approved a change in the Company's name to Hickok Incorporated from The Hickok Electrical Instrument Company, which was not representative of the Company's current products and markets and may have conveyed an inaccurate image of the Company to customers, prospects and investors. For those reasons the name change was made.\nThe Company is primarily involved in providing products and services to original equipment manufacturers within the transportation industry. The major market served is automotive. Other markets with which the Company is involved include aircraft, locomotive and marine markets.\nRegarding the products the Company supplies to the transportation industry, the Company for many years has developed and produced precision indicating instruments for aircraft, locomotive and general industrial applications. In recent years the Company has adapted this expertise to become a leader in the development of electronic diagnostic equipment for the automotive market. Production of diagnostic test equipment is now one of the Company's largest product classes.\nIn fiscal 1994 the Company added a new product for the automotive market as part of a strategic program to expand both its customer base and its product line using its existing expertise. In February, 1994 the Company acquired the fastening systems business from Allen-Bradley Company, Inc. The new business provides computerized equipment to control tools that tighten threaded fasteners in an automotive assembly plant to provide high quality threading applications. General Motors is the major customer for fastening systems products. The fastening systems business was fully integrated into Hickok's operations by June, 1994. This product has become a major part of\nthe Company's total business.\nIn addition to its products, the Company also provides various services to the transportation industry generally and to the automotive market in particular. These services have become a very important component of the Company's business and were developed because of the Company's close working relationship with Ford Motor Company in the development of diagnostic tools to service engines and other electronic systems in Ford automobiles. The Company develops software for its own diagnostic tools used by Ford and assists in supporting the overall Ford diagnostic system. This support is primarily in the areas of software specifications and technical writing for the engine, body chassis and electrical systems. In addition, the Company supports the development of data bases used to track information generated from Ford's diagnostic system. Finally, the Company provides telephone hotline information to assist technicians who diagnose Ford vehicles in the dealership.\nThe Company also provides technical training to automotive technicians and engineers relating to the use of diagnostic equipment on automobiles and to the various components themselves. This training is provided both in the Company's classroom facility and at customer sites and was implemented largely as a result of the Company's involvement with Ford Motor Company.\nFinally, in the service area, the Company is using its in-house expertise to provide publishing services to its automotive customers. Documents such as training manuals, sales and product brochures and other items are designed and produced. This service was first offered three years ago and its growth has been modest to date.\nThe Company's operations are currently concentrated in the United States. Sales are primarily to domestic customers although the Company also makes sales to international customers on a world-wide basis. Because its international presence is growing, the Company has established international representation in the sales and service area in fiscal 1995.\nDESCRIPTION OF BUSINESS\nPRODUCTS\nThe Company operates in one major industry segment: instrumentation and controls products for the transportation industry.\nThe Company designs, manufactures and markets instruments used to diagnose problems and to support the servicing of automotive electronic systems. These products are sold primarily to original equipment manufacturers but also to the aftermarket using jobbers and wholesalers. The Company has increased its marketing efforts in order to expand the aftermarket business. Currently the aftermarket accounts for less than 5% of automotive diagnostic tool sales.\nAs a result of the acquisition of the fastening systems business in February, 1994, the Company designs and manufactures instrumentation used to monitor and control pneumatic and electric tools that tighten threaded fasteners so as to provide high quality threading applications. The\nequipment is sold to original equipment manufacturers in the automotive market.\nThe Company develops software and designs systems that are used to develop diagnostic strategies involving automotive electronic systems. The Company also provides automotive service and engineering technicians with training in servicing electronic systems. Leased facilities in Lincoln Park, Michigan are the headquarters for the training activities. Publishing services provided to automotive customers are also performed in Lincoln Park.\nIn addition, the Company specializes in the development, manufacture and marketing of precision indicating instruments used in aircraft, locomotives and other original equipment applications. Within the aircraft market, the Company sells its instruments primarily to manufacturers of business and pleasure aircraft.\nRevenue by class of product\/service is shown in the table below.\nNew Products\/Services\nA major new development in fiscal 1995 was the growth of the fastening systems product which was added by way of acquisition in mid-fiscal 1994. The acquisition was a strategic move to diversify both the customer base and the product line using existing engineering and manufacturing expertise. Fastening systems accounted for $10,968,000 in revenue in fiscal 1995 due to the sale of several large networked systems to General Motors Corporation. However, a larger portion of the market for fastening controls is based on the use of independent single tool controls. Hickok began developing a new line of controls for this market in fiscal 1995 and expects to introduce its single tool control product called ProSpec 1000 in mid-fiscal 1996.\nThere were several new market and product developments in fiscal 1995 within the diagnostic instrument area. The New Generation STAR tool (NGS) was introduced for the first time to Ford dealers in Australia, South America and South Africa. In fiscal 1996 the NGS unit is expected to be introduced to several countries in Europe, Asia and the Far East. A new product, the End-of- Line (EOL) unit was installed at a Ford and Mazda assembly plant in Mexico and Michigan respectively. The EOL unit performs the final test of an automobile's various electronic systems as the vehicle exits the assembly line. A similar unit is being developed for at least one other vehicle manufacturer. Another new product under development is an electrical vehicle controller to be used by an OEM currently involved in building several thousand electric vehicles for fleet use. These controllers are expected to be available in fiscal 1996. Finally, a secondary ignition analyzer for large, non-automotive internal combustion engine users was\nintroduced in late fiscal 1995. Orders for the Watchdog 2000 Secondary Ignition Monitor are expected in fiscal 1996. A smaller, portable version will be developed in fiscal 1996 for use as a periodic maintenance tool for similar though smaller engines.\nDevelopment of the analog\/digital indicator for the aircraft market continued in fiscal 1995 and orders for the product are expected in early fiscal 1996. Acceptance of this product in the industry should allow for significant market expansion of the indicator product class. Another new indicator under development is the solid state indicator which uses an electronic liquid crystal device to display data. The product's long life and light weight make it attractive. This product should be available in about a year.\nNew product developments in fiscal 1994 included the addition to the NGS unit of communication capability with the electronic systems contained in General Motors vehicles. In addition, direct GM capability was added to the Transmission Tester. This was done to enhance these products in the aftermarket. Other product enhancements include developing anti-lock brake and traction control cables to allow for diagnosis of those systems and adding printer capability to the Fuel Injection Regular System Tester (FIRST). Preliminary development continued on diagnostic tools for use on electric vehicles and initial development began on secondary ignition analyzer for large non-automotive, internal combustion engine users.\nNew product development efforts during fiscal 1993 included establishment of the Advanced Training Group whose focus is on training of engineering personnel on Ford Electronic Engine Controls (EEC) Systems and on Ford's Service Bay Diagnostic System. The Advanced Training Group operates out of a leased 20,000 sq. ft. facility in Lincoln Park, Michigan. In May 1993 Hickok Creative Services was established, offering a technical publications capability to automotive customers. It had no revenue in fiscal 1993. Continuing development on the Company's New Generation STAR (NGS) resulted in the issuance of two additional software upgrades for Ford vehicles and several cable adapters. In addition, as part of the original plans for NGS, all units were updated by installation of circuitry enabling the unit to communicate with the newly mandated On-Board Diagnostics (OBD) II communications link to all manufacturers' engine control computers. A tester for automatic diagnosis of both distributor and distributorless ignition systems, which was partially developed in fiscal 1992, was completed in fiscal 1993 and sold to Ford dealerships.\nSOURCES AND AVAILABILITY OF RAW MATERIALS\nRaw materials essential to the business are acquired primarily from a large number of U. S. manufacturers within the electronic components industry. Materials include transistors, integrated circuits, resistors, capacitors, switches, potentiometers and fabricated metal or plastic parts. In general, the required materials are available, if ordered with sufficient lead times, from multiple sources at current prices.\nIMPORTANCE OF PATENTS, LICENSES, FRANCHISES, TRADEMARKS AND CONCESSIONS\nThe Company presently owns certain patents and patent applications which relate to certain of its products. It does not consider that any one patent or group of patents is material to the conduct of its business as a whole and believes that its position in the industry is dependent upon its present level of engineering skill, research, production techniques and service rather than upon its ownership of patents. The Company does not have any material licenses, trademarks, franchises or concessions.\nSEASONALITY\nThe Company does not believe there is any significant seasonality to its business, except to the extent that shipments of certain products are dependent upon customer release dates. The Company's operating results often fluctuate widely from quarter to quarter. The primary reason for such quarterly fluctuations is the effect of the Company's automotive diagnostic test equipment business, since orders for such equipment frequently are relatively large and subject to customer release. In recent years, the fourth quarter of each fiscal year has accounted for a large portion of the Company's net sales. However, the Company does not believe that the importance of the fourth quarter is due to seasonal factors, but instead to the timing of customer release of orders.\nPRACTICES RELATIVE TO WORKING CAPITAL ITEMS\nThe nature of the Company's business requires it to maintain sufficient levels of inventory to meet rapid delivery requirements of customers. The Company provides its customers with payment terms prevalent in the industry.\nDEPENDENCE UPON SINGLE OR FEW CUSTOMERS\nDuring the fiscal year ended September 30, 1995, sales to Ford and General Motors Corporation accounted for approximately 50% and 37% respectively of the consolidated sales of the Company. This compares with 64% and 12% respectively during the prior fiscal year. The Company has no long-term contractual relationships with either Ford or General Motors, and the loss of business from either one without a corresponding increase in business from new or existing customers would have a material adverse effect on the Company.\nBACKLOG\nAt September 30, 1995, the unshipped customer order backlog totaled $4,337,000 in contrast to $9,385,000 at September 30, 1994 and $4,271,000 at September 30, 1993. The decrease in fiscal 1995 relative to fiscal 1994 is largely due to orders for fastening systems products. This business was acquired in mid-fiscal 1994 and an extraordinarily large order for $5.5 million was booked late in the year. At the end of fiscal 1995 backlog for fastening products was $1.1 million, a more typical backlog level for this product class.\nGOVERNMENT CONTRACT RENEGOTIATION\nNo major portion of the business is open to renegotiation of profits or termination of contracts or subcontracts at the election of the Government.\nCOMPETITIVE CONDITIONS\nThe Company is engaged in a highly competitive industry and faces competition from domestic and international firms. Several of the companies with which the Company competes have greater financial resources and larger sales organizations than the Company. Competition with respect to the Company's diagnostic tool business arises from the existence of a number of other significant manufacturers in the field, such as SPX Corporation, Hewlett-Packard and Vetronix which dominate the total available market in terms of total sales. With regard to fastening systems products, competition comes from both companies that make the equipment to control fastening tools and from the tool makers themselves. Specific names include Beta Tech, Atlas Copco, and Stanley. Hickok is a major supplier in the high end market consisting of multi-spindle fastening system control systems. The instrumentation industry is composed primarily of companies which specialize in the production of particular items as opposed to a full line of instruments. The Company believes that its competitive position in this field should be gauged in the area of smaller specialized products, an area in which the Company has operated since 1915 and in which the Company has established itself competitively by offering high-quality, high-performance products in comparison to high-volume, mass-produced items.\nRESEARCH AND DEVELOPMENT ACTIVITIES\nThe Company expensed when incurred product research and development costs of $3,550,450 in 1995, $2,145,073 in 1994 and $2,018,892 in 1993. These expenditures included engineering product support, support for development of diagnostic system manuals and research and development for fastening systems products.\nCOMPLIANCE WITH ENVIRONMENTAL PROVISIONS\nThe Company's capital expenditures, earnings and competitive position are not materially affected by compliance with federal, state and local environmental provisions which have been enacted or adopted to regulate the distribution of materials into the environment.\nNUMBER OF PERSONS EMPLOYED\nTotal employment by the Company at September 30, 1995 was 354 employees. None of the employees are represented by a union. The Company considers its relations with its employees to be good.\nFINANCIAL INFORMATION CONCERNING FOREIGN AND DOMESTIC OPERATIONS AND EXPORT SALES\nDuring the fiscal year ended September 30, 1995, all manufacturing, research and development and administrative operations were conducted in the United States. Revenues derived from export sales approximated $887,000 in\n1995, $538,000 in 1994, and $586,000 in 1993. Shipments to Canada make up the majority of export sales.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nDuring fiscal 1995, the Company had facilities in the United States as shown below:\nOwned or Location Feet Description Leased - -------- ------ ----------- --------\nCleveland, 37,000 Two-story brick construction; Owned Ohio used for corporate administra- tive headquarters, marketing and product development with limited manufacturing.\nGreenwood, 63,000 One-story modern concrete Leased, with Mississippi block construction; used annual renewal for manufacturing instru- options extending ments, test equipment, and through 2061. fastening systems products.\nLincoln Park, 20,000 One-story modern concrete Leased, with a Michigan block construction. used renewal option for training and publishing. extending through 1999.\nManagement believes that the Mississippi and Michigan facilities are adequate to provide for current and anticipated business. In fiscal 1996 the Company plans for modest expansion of the Cleveland facility to improve operating efficiencies. This expansion was anticipated to occur in fiscal 1995 but zoning changes delayed the project for almost a year.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is not a party to any material legal proceedings.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNot Applicable.\nITEM 10. EXECUTIVE OFFICERS OF THE REGISTRANT*\nThe following is a list of the executive officers of the Company as of September 30, 1995. The executive officers are elected each year and serve at the pleasure of the Board of Directors. Mr. Bauman was elected Chairman by the Board of Directors in July 1993. He has been President since 1991. For at least five years prior to 1991 he held the office of Vice President. Mr. Nowakowski was elected Vice President, Finance and Chief Financial Officer by the Board of Directors in December, 1993. He joined the Company in July, 1993 and, for at least five years prior to 1993, was a Vice President with Huntington National Bank in Cleveland, Ohio.\nOffice Officer Age ------ ------- ---\nChairman, President and Robert L. Bauman 55 Chief Executive Officer\nVice President, Finance Eugene T. Nowakowski 52 and Chief Financial Officer\n* The description of Executive Officers called for in this Item is included pursuant to Instruction 3 to Section (b) of Item 401 of Regulation S-K.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\na) MARKET INFORMATION\nThe Registrant's Class A Common Shares are traded in the over-the- counter market (NASDAQ Symbol: HICKA). There is no market for the Registrant's Class B Common Shares. The following table sets forth the range of high and low bid prices for the Registrant's Class A Common Shares for the periods indicated, which prices reflect inter-dealer prices without retail mark-up, mark-down or commissions and may not represent actual transactions:\nBID PRICES FOR THE YEARS ENDED:\nSource of quotations: NASDAQ. Data adjusted for a 2 for 1 stock split in April, 1995.\nb) HOLDERS\nAs of December 14, 1995, there were approximately 630 holders of record of the Company's outstanding Class A Common Shares and approximately 5 holders of record of the Company's outstanding Class B Common Shares.\nc) DIVIDENDS\nOn July 10, 1995 the Company paid a special dividend of $.10 per share to the holders of its Class A and Class B Common Shares. On January 25, 1995 the Company paid a special dividend of $.175 per share to the holders of its Class A and Class B Common Shares. On January 25, 1994 the Company paid a special dividend of $.15 per share to the holders of its Class\nA and Class B Common Shares. On December 6, 1995, the Company declared a special dividend of $.10 per share payable on January 25, 1996 to the holders of record of its Class A and Class B Common Shares on January 3, 1996. The declaration and payment of future dividends is restricted, under certain circumstances, by the provisions of the Company's bank loan agreement. Such restriction is not expected to materially limit the Company's ability to pay dividends in the future, if declared.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nNote: Share data adjusted for a 2 for 1 stock split in April 1995.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nINTRODUCTION\nFor many years Hickok has had a long established reputation as a leader in the development and manufacture of high technology precision indicating instruments for aircraft, locomotive and general industrial applications. For example, aircraft cockpit instruments represent important products for the Company. Over the years, Hickok has also been recognized as an authority in the design and implementation of electronics circuitry. In addition, the Company has considerable experience in technical training and vocational education, developing training courses and manuals for instruction of technical skills.\nIn recent years these areas of expertise have combined to make the Company one of the leaders in automotive electronics diagnostic technology. Hickok designs and manufactures diagnostic tools which enable automotive service technicians to identify problems in the rapidly increasing number of electronics systems in automobiles. Hickok develops instructional programs and trains automotive technicians and engineers in the use of electronic diagnostic tools and systems. The Company now has three operating units based in the Detroit, Michigan area. One unit, housed in a Ford Motor Company facility in Allen Park, develops diagnostic strategies and provides other services for Ford. The other two groups are housed in Lincoln Park in a facility leased by Hickok and provide training and technical publication services.\nIn February, 1994 the Company added a new product for the automotive market by acquiring the fastening systems business from Allen-Bradley Company, Inc. This was part of a strategic program to expand both the Company's customer base and its product line using existing expertise. The new business provides computerized equipment to control tools that tighten threaded fasteners in an automotive assembly plant to provide high quality threading applications. The fastening systems business was fully integrated into Hickok's operations by June, 1994 and made a positive contribution to the Company's operations in the last two fiscal years. This product class has become a major part of the Company's total business.\nThe timing of order releases in the Company's automotive diagnostic test equipment business often creates wide fluctuations in the Company's operating results, particularly on a quarter-to-quarter basis. The same situation applies to the Company's newly acquired fastening systems products. Orders for such equipment frequently are relatively large and subject to customer release. The result can be substantial variations in quarterly sales and earnings. For example, fiscal 1995 fourth quarter net income of $529,082, or $.44 per share, represented 29.5% of the year's total net income. More dramatic results occurred in fiscal 1994 when fourth quarter net income of $813,819, or $.68 per share, represented 52.3% of the year's total net income. The Company's contracts are subject to customer release, and although historically the fourth quarter has accounted for a larger portion of sales and net income, there can be no assurance that the Company's customers will continue to authorize release of contracts during the fourth quarter of future fiscal years. The Company is not aware of any seasonal factors which lead to its customers' release of orders.\nShort-term earnings also can be affected by increases in expenditures for product development, which has become increasingly significant in the Company's operations.\nThe Company's order backlog as of September 30, 1995 totaled $4,337,000 as compared to $9,385,000 as of September 30, 1994 and $4,271,000 as of September 30, 1993. The decrease in fiscal 1995 relative to fiscal 1994 is largely due to orders for fastening systems products. This business was acquired in mid-fiscal 1994 and an extraordinarily large order for $5.5 million was booked late in the year. At the end of fiscal 1995 backlog for fastening products was $1.1 million which is a more typical backlog level for this product class.\nRESULTS OF OPERATIONS\nSales for the fiscal year ended September 30, 1995 rose to $29,384,191, an increase of approximately 31% from fiscal 1994 sales. This increase in sales is almost totally volume-driven and is attributable to significantly higher sales of fastening systems products. Sales of fastening systems products increased $8,316,000 which more than offset both a 5% volume decrease in product sales other than fastening product and an 11% decrease in service sales, almost all of which was volume related.\nSales for the fiscal year ended September 30, 1994 of $22,491,278 were up approximately 8% from fiscal 1993 sales. The increase between fiscal 1994 and fiscal 1993 was primarily due to the addition of the fastening systems business which offset modest volume decreases in automotive diagnostic equipment and price-related decreases in service sales.\nThe high level of fastening systems sales realized in fiscal 1995 will not continue in fiscal 1996 due to lower backlog at the end of fiscal 1995. Even though sales of automotive diagnostic equipment have experienced a slight decline the past three years, continuing development of existing and new products and the opening of new international markets provide opportunities for reversing that trend in fiscal 1996. For example, sales of approximately 4,000 NGS units to Mazda dealers outside of North America, previously expected to occur in late fiscal 1995, are now planned for early in fiscal 1996. In addition, approximately 1,000 NGS units are expected to be sold in fiscal 1996 to Ford dealers throughout the world, exclusive of Europe. Initial sales occurred in fiscal 1995 to Ford dealers in South America, Australia and South Africa. The sales decrease of precision indicating instruments, both aircraft and locomotive, experienced in fiscal 1995 is expected to reverse itself in fiscal 1996 due to stabilizing existing volume, introduction of new products and selective price increases.\nCost of products sold during fiscal 1995 amounted to $13,975,800 or 60.0% of net product sales. For fiscal 1994 the cost of products sold amounted to $9,050,256 or approximately 58.0% of net product sales and for fiscal 1993 the cost of products sold amounted to $7,400,468 or approximately 57.6% of net product sales. The increase in cost of products sold as a percentage of net product sales between fiscal 1995 and fiscal 1994 was due to higher costs of fastening product sales relative to other product sales. The slight increase in the percentage of cost of products sold relative to product sales between fiscal 1994 and fiscal 1993 was due to product mix.\nCost of services sold during fiscal 1995 amounted to $4,909,962 or 80.6% of net service sales. In fiscal 1994 the figure was $5,148,767 or 74.8% and in fiscal 1993 the figure was $5,503,973 or 68.6%. The increase in cost of services sold as a percentage of net service sales between fiscal 1995 and fiscal 1994 was caused primarily by the inability to reduce costs of services sold to the same extent as service sales volume decreased. The increase in cost of services sold as a percentage of net service sales between fiscal 1994 and fiscal 1993 resulted primarily from a significant amount of large quantity contracts involving significant price competition.\nThe percentage of cost of both products sold and services sold relative to net sales in fiscal 1996 is expected to stabilize at the figures experienced in fiscal 1995 based on cost control measures already implemented and on projected product mix.\nFiscal 1995 net income amounted to $1,794,230, or $1.50 per share, an increase of $237,927, or 15.3% from fiscal 1994 net income of $1,556,303, or $1.31 per share. The increase in net income was due primarily to an increase in sales and, to a lesser extent, to a reduction in the effective tax rate compared to the prior year. Fiscal 1994 net income increased by $32,017 or 2.1% over fiscal 1993 net income of $1,524,286, or $1.27 per share, due to an increase in sales and cost control measures.\nDuring fiscal 1995 new product development expenditures amounted to $3,550,450 which represented a 66% increase over fiscal 1994 expenditures of $2,145,073. Approximately 60% of the increase was attributable to engineering and development of existing fastening systems products. The balance was spent on final development of the secondary ignition analyzer, ongoing development of existing automotive products and development of next generation technologies relative to automotive product. It is anticipated that the amount spent on product development in fiscal 1995 will remain at that level in fiscal 1996. Product development expenditures in fiscal 1994 of $2,145,073 were slightly higher than the $2,018,892 spent in fiscal 1993 due to the addition of the fastening systems business.\nMarketing and administrative expense amounted to $4,189,263, or approximately 14.3% of net sales in fiscal 1995; $3,656,136, or approximately 16.3% of net sales in fiscal 1994; $3,510,279, or approximately 16.8% of net sales in fiscal 1993. Expenditures in fiscal 1995 represented a 14.6% increase from fiscal 1994, as compared with a 4.2% increase in fiscal 1994 over the prior fiscal year. The absolute increase in the amount of marketing and administrative expenses between 1995 and 1994 was entirely related to the higher sales in the fastening systems product class. The absolute increase between fiscal 1994 and 1993 was due to the addition of the fastening systems business in the second quarter of fiscal 1994.\nIn fiscal 1995 income taxes were $976,000 and represented an effective tax rate of 35.2%. Fiscal 1994 income taxes were $1,018,000 and represented an effective tax rate of 39.5%. The decrease in the effective tax rate in fiscal 1995 was caused by research and development tax credits related to higher new product development expenditures during the year. In fiscal 1993 income taxes were $910,000 and represented an effective tax rate of 37.4%. The increase in the effective tax rate in fiscal 1994 related to differences in the recognition of revenue and expense for tax and financial reporting purposes. It is anticipated that the effective tax rate in fiscal\n1996 will be about two percentage points higher than fiscal 1995 due to lower available research and development tax credits.\nInterest charges were $134,713 in fiscal 1995, compared with $26,116 in fiscal 1994 and $65,494 in fiscal 1993. The increase in interest charges in fiscal 1995 compared to fiscal 1994 was caused primarily by higher borrowing by the Company under its revolving line of credit to finance increased working capital levels resulting from a 31% increase in sales. The decrease in interest charges in fiscal 1994 compared to fiscal 1993 resulted primarily from decreased borrowing by the Company under its revolving line of credit to finance working capital levels.\nFiscal 1995 and 1994 results include other income of $146,227 and $109,373 respectively coming primarily from rental income of excess space at the Company's Lincoln Park, Michigan location. Fiscal 1995 other income also includes approximately $60,000 of purchased discounts. Fiscal 1993 results include a gain of $57,390 resulting from proceeds from insurance policies held on the life of Robert L. Purcell, the former Chairman.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company's business requires relatively large inventories of both work-in-process and finished goods in order to met anticipated delivery schedules. At the end of fiscal 1995 inventory was up $3,076,790 over the prior year in anticipation of significant orders for automotive product in the first quarter of fiscal 1996. This increase had a temporary negative impact on liquidity relative to the prior year since additional short-term borrowing was required to finance 75% of the increase. The Company believes the impact on liquidity is temporary; however, even though liquidity declined compared with last year it remains strong. Furthermore, the Company believes that internal funds and a $5,000,000 revolving line of credit provide sufficient liquidity to meet ongoing working capital requirements.\nCurrent assets of $14,194,925 at September 30, 1995 were 2.3 times current liabilities and the total of cash and receivables was 1.1 times current liabilities. These ratios compare to 3.0 and 1.9 respectively at the end of fiscal 1994. Total current assets increased $3,779,437 from the previous year- end primarily as a result of the above-mentioned $3,076,790 increase in inventory. Total current liabilities increased $2,651,060 from the previous year due primarily to an increase in short-term financing which was used to finance the inventory increase.\nWorking capital at September 30, 1995 was $8,119,589 as compared to $6,991,212 a year earlier. The increase between the two years was due to retention of earnings and the proceeds were used to finance the increase in inventory.\nInternally generated funds in fiscal 1995 were a negative $646,322 and were not adequate to fund the Company's primary non-operating cash requirement consisting of capital expenditures which amounted to $943,605. The primary reason for the negative cash flow from operations was a $3,076,790 increase in inventory. The shortfall was made up by a $2,280,000 increase in short-term borrowing. The Company does not anticipate the need to increase inventory in fiscal 1996 to the same extent as occurred in fiscal 1995 and therefore expects internally generated funds in fiscal 1996 to be\nadequate to fund approximately $1,100,000 of capital expenditures in fiscal 1996. Included in the $1,100,000 is approximately $450,000 to be spent on the expansion of the Company's Cleveland, Ohio administrative headquarters to accommodate further growth. The balance will be spent to upgrade engineering and laboratory equipment. In fiscal 1994 and fiscal 1993 internally generated funds paid for capital expenditures.\nIn January, 1995 the Company amended an existing credit agreement with its financial lender. The agreement continues to provide for interest at the prime commercial rate and is unsecured. This agreement was amended to provide for a revolving credit facility of $5,000,000. At September 30, 1995, the Company had an outstanding balance of $3,510,000 under this loan facility. The revolving credit facility is subject to annual review by the Company's financial lender. Although no determination has been made to seek renewal of the credit agreement, the Company believes that, given its current financial condition, renewal at the existing amount may be obtained on acceptable terms.\nIn August, 1988 the Company entered into a Section 303 Stock Redemption Agreement (the \"Stock Redemption Agreement\") with Robert D. Hickok. The Stock Redemption Agreement provided that, upon Mr. Hickok's death, his estate will have the right to require the Company to purchase from the estate Class A shares and Class B shares having a value equal to the estate, inheritance, legacy and succession taxes (including any interest collected as part of such taxes) imposed because of the death of Mr. Hickok, plus the amount of funeral and administrative expenses allowable as deductions to the estate of Mr. Hickok under Section 2053 of the Internal Revenue Code. The Stock Redemption Agreement provided that the per share price payable by the company for the shares purchased from Mr. Hickok's estate will be the then market value of such shares. The Estate of Robert D. Hickok sold to the Company 16,107 Class B shares on January 11, 1993 and 4,560 Class B shares on March 31, 1995. No future redemption requests are anticipated from the Estate.\nIMPACT OF INFLATION\nIn recent years, inflation has had a minimal effect on the Company because of low rates of inflation and the Company's policy prohibiting the acceptance of long-term fixed rate contracts without provisions permitting adjustment for inflation.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe following pages contain the Financial Statements and Supplementary Data as specified for Item 8 of Part II of Annual Report on Form 10-K.\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 required by this Item 10 as to the Directors of the Company is incorporated herein by reference to the information set forth under the caption \"Information Concerning Nominees for Directors\" in the Company's definitive Proxy Statement for the Annual Meeting of Shareholders to be held on February 21, 1996, since such Proxy Statement will be filed with the Securities and Exchange Commission not later than 120 days after the end of the Company's fiscal year pursuant to Regulation 14A. Information required by this Item 10 as to the Executive Officers of the Company is included in Part I of this Annual Report on Form 10-K.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by this Item 11 is incorporated by reference to the information set forth under the caption \"Executive Compensation\" in the Company's definitive Proxy Statement for the Annual Meeting of Shareholders to be held on February 21, 1996, since such Proxy Statement will be filed with the Securities and Exchange Commission not later than 120 days after the end of the Company's fiscal year pursuant to Regulation 14A.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required by this Item 12 is incorporated by reference to the information set forth under the captions \"Principal Shareholders\" and \"Share Ownership of Directors and Officers\" in the Company's definitive Proxy Statement for the Annual Meeting of Shareholders to be held on February 21, 1996, since such Proxy Statement will be filed with the Securities and Exchange Commission not later than 120 days after the end of the Company's fiscal year pursuant to Regulation 14A.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by this Item 13 is incorporated by reference to the information set forth under the caption \"Transactions with Management\" in the Company's definitive Proxy Statement for the Annual Meeting of Shareholders to be held on February 21, 1996, since such Proxy Statement will be filed with the Securities and Exchange Commission not later than 120 days after the end of the Company's fiscal year pursuant to Regulation 14A.\nPART III\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON REPORT 8-K\n(a) (1) FINANCIAL STATEMENTS\nThe following Consolidated Financial Statements of the Registrant and its subsidiaries are included in Part II, Item 8:\nPage ----\nReport of Independent Auditors Consolidated Balance Sheet - As of September 30, 1995 and 1994 Consolidated Statement of Income - Years Ended September 30, 1995, 1994 and 1993 Consolidated Statement of Stockholders' Equity - Years Ended September 30, 1995, 1994 and 1993 Consolidated Statement of Cash Flows - Years Ended September 30, 1995, 1994 and 1993 Notes to the Consolidated Financial Statements\n(a) (2) FINANCIAL STATEMENT SCHEDULES\nThe following Consolidated Financial Statement Schedules of the Registrant and its subsidiaries are included in Item 14 hereof.\nSequential Page --------------- Report of Independent Auditors as to Schedules 33 Schedule VIII-Valuation and Qualifying Accounts 34 Schedule IX-Short-term Borrowings 35\nAll other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted.\n(a) (3) EXHIBITS\nReference is made to the Exhibit Index set forth herein.\n(b) There were no reports filed on Form 8-K during the quarter ended September 30, 1995.\n- --------------------------------------------------------------------------------\nINDEPENDENT AUDITORS' REPORT\nSHAREHOLDERS AND BOARD OF DIRECTORS HICKOK INCORPORATED CLEVELAND, OHIO\nWe have audited the accompanying consolidated balance sheets of HICKOK INCORPORATED as of September 30, 1995 and 1994, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended September 30, 1995. 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 that the financial statements are free from material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Hickok Incorporated as of September 30, 1995 and 1994, and the consolidated results of their operations and their cash flows for each of the three years in the period ended September 30, 1995 in conformity with generally accepted accounting principles.\nMEADEN & MOORE, INC. CERTIFIED PUBLIC ACCOUNTANTS NOVEMBER 17, 1995 CLEVELAND, OHIO\n- -------------------------------------------------------------------------------\n- --------------------------------------------------------------------------------\nCONSOLIDATED BALANCE SHEET KICKOK INCORPORATED SEPTEMBER 30\nASSETS\nSee notes to consolidated financial statements\n- --------------------------------------------------------------------------------\n- -------------------------------------------------------------------------------\nLIABILITIES AND STOCKHOLDERS EQUITY\nSee notes to consolidated financial statements\n- --------------------------------------------------------------------------------\nCONSOLIDATED STATEMENT OF INCOME HICKOK INCORPORATED FOR THE YEARS ENDED SEPTEMBER 30\n- --------------------------------------------------------------------------------\nSee notes to consolidated financial statements\n- --------------------------------------------------------------------------------\n- --------------------------------------------------------------------------------\nCONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY HICKOK INCORPORATED FOR THE YEARS ENDED SEPTEMBER 30, 1995, 1994 AND 1993\nSee notes to consolidated financial statements\n- --------------------------------------------------------------------------------\nCONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY HICKOK INCORPORATED FOR THE YEARS ENDED SEPTEMBER 30, 1995, 1994 AND 1993\nSee notes to consolidated financial statements - --------------------------------------------------------------------------------\n- --------------------------------------------------------------------------------\nCONSOLIDATED STATEMENT OF CASH FLOWS HICKOK INCORPORATED FOR THE YEARS ENDED SEPTEMBER 30\nSee notes to consolidated financial statements\n- --------------------------------------------------------------------------------\n- --------------------------------------------------------------------------------\nSee notes to consolidated financial statements\n- --------------------------------------------------------------------------------\n- --------------------------------------------------------------------------------\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS HICKOK INCORPORATED SEPTEMBER 30, 1995, 1994 AND 1993\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nCONSOLIDATION AND LINE OF BUSINESS: The Board of Directors recommended and on February 23, 1995 the shareholders approved the change of the name of the Company to Hickok Incorporated.\nThe consolidated financial statements include the accounts of Hickok Incorporated and its wholly-owned domestic subsidiary (\"Company\"). Significant intercompany transactions and balances have been eliminated in the financial statements. Previously inactive subsidiaries were dissolved during 1993.\nThe Company operates in one major industry segment. The Company develops and manufactures measuring, indicating, instrumentation and controls products, fastening systems and related engineering services for the transportation industry. As an extension of the sales of automotive electronic test equipment, the Company also provides technical training programs for its automotive technician customers in the proper use of the equipment. Sales in the Company's principal product classes, as a percent of consolidated sales, are as follows:\nPRODUCT CLASSES 1995 1994 1993 --------------- -------------------------- Automotive Test Equipment 35.7% 48.1% 52.7% Diagnostic\/Training 19.6 29.2 36.9 Fastening Systems 37.3 11.8 - Other Product Classes 7.4 10.9 10.4 -------------------------- Total 100.0% 100.0% 100.0% -------------------------- --------------------------\nThe Company extends normal credit terms to its customers. Customers in the automotive industry (primarily original equipment manufacturers) comprise approximately 91% of outstanding receivables at September 30, 1995, (84% in 1994). Sales to individual customers in excess of 10% of total sales approximated $14,600,000 and $10,900,000 (1995), $14,500,000 and $2,700,000 (1994) and $16,500,000 (1993).\nREVENUE RECOGNITION: The Company records sales as manufactured items are shipped to customers. Revenue from development contracts is recognized as earned under terms of the contracts. The Company warrants certain products against defects for periods ranging from 12 to 36 months. Charges against income for warranty expense and sales returns and allowances were immaterial during each of the three years in the period ending September 30, 1995.\nPRODUCT DEVELOPMENT: Research and product development costs, which include engineering production support for development of diagnostic systems, are expensed as incurred. Research and development performed for customers represents no more than 1% of sales in each year; the arrangements do not include a repayment obligation by the Company.\nINVENTORIES: Inventories are valued at the lower of cost (first-in, first-out) or market and consist of:\n- --------------------------------------------------------------------------------\n- --------------------------------------------------------------------------------\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nPROPERTY, PLANT AND EQUIPMENT: Property, plant and equipment are carried at cost. Maintenance and repair costs are expensed as incurred. Additions and betterments are capitalized.\nThe depreciation policy of the Company is generally as follows:\nClass Method Rate ------------------------------------------------------------- Buildings Straight-line 2-1\/2 to 4% Machinery and equipment Straight-line 8 to 33-1\/3% Tools and dies Straight-line 33-1\/3%\nDepreciation amounted to $575,213 (1995), $504,011 (1994) and $402,056 (1993).\nINCOME TAXES: Effective October 1, 1993, the Company adopted the provisions of Financial Accounting Standards Board Statement No. 109, \"Accounting for Income Taxes.\" The cumulative effect of the adoption was immaterial and is included in the 1994 deferred income tax provision. Prior to 1994, the Company accounted for deferred income taxes under the provisions of Financial Accounting Standards Board Statement No. 96.\nINCOME PER COMMON SHARE: Income per common share information is computed on the weighted average number of shares outstanding during each period. All per share amounts on the consolidated income statement have been retroactively adjusted to reflect the 100% share dividend. For the years presented, stock options have an immaterial dilutive effect.\nCASH EQUIVALENTS: 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.\nRECLASSIFICATIONS: Certain prior year amounts have been reclassified to conform with current year presentation.\n2. SHORT-TERM FINANCING The Company has an unsecured credit agreement with maximum available borrowings of $5,000,000 with interest at the prime rate. The agreement includes covenants with which the Company has complied. The weighted average interest rate on short-term financing was 8.84% (7.00%, 1994).\n3. LEASES The Company leases a facility and certain equipment under operating leases expiring through September 1996 with a three-year renewal option on the facility. A portion of the facility has been sub-leased through September 1996.\nThe Company's future minimum commitments under operating leases are as follows:\nRental expense under these commitments was $266,106 (1995), $230,297 (1994) and $142,827 (1993).\nA facility held under a capital lease has a net book value of $50,000 at September 30, 1995. Future minimum lease payments which extend through 2061 are immaterial.\n- --------------------------------------------------------------------------------\n- --------------------------------------------------------------------------------\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\n4. CAPITAL STOCK, TREASURY STOCK, CONTRIBUTED CAPITAL AND STOCK OPTIONS On February 23, 1995, the number of authorized shares of Class A and Class B common stock was increased to 3,750,000 from 1,000,000 and 1,000,000 from 295,980, respectively. On April 10, 1995, the Company distributed to stockholders of record on March 10, 1995, a 2-for-1 stock split in the form of a 100% share dividend of Class A and Class B common stock. One share of Class A common stock was issued for each share of Class A outstanding and one share of Class B common stock was issued for each share of Class B outstanding.\nAll per share amounts on the consolidated income statement have been retroactively adjusted for the stock dividend. Additionally, an amount equal to the $1.00 par value of the combined Class A and Class B common stock ($598,455) has been transferred from retained earnings to common stock ($368,742 to Class A common stock and $229,713 to Class B common stock).\nThe Company's Key Employees Stock Option Plan and the 1995 Key Employees Stock Option Plan (collectively the \"Employee Plans\") provide the authority to the Compensation Committee of the Board of Directors to grant options to Key Employees to purchase up to 120,000 Class A shares. The options are exercisable for up to 10 years. Incentive stock options are available at an exercise price of not less than market price on the date the option is granted. However, options available to an individual owning more than 10% of the Company's Class A shares at the time of grant must be made at a price of not less than 110% of the market price. Nonqualified stock options may be issued at such exercise price and on such other terms and conditions as the Compensation Committee may determine. No options may be granted at a price less than $2.925. Non-cash compensation expense related to stock option plans was $29,448 (1995), $3,091 (1994), and $2,300 (1993). All options granted under the Employee Plans are exercisable at September 30, 1995.\nOn February 23, 1995, the Board of Directors adopted the 1995 Outside Directors Stock Option Plan (the \"Directors Plan\"), subject to future approval by the Company's shareholders. The Directors Plan provides for the automatic grant of options to purchase up to 30,000 shares of Class A common stock to members of the Board of Directors who are not employees of the Company, at the fair market value on the date of grant. All options granted under the Directors Plan become exercisable on February 23, 1998.\nA summary of stock option activity is as follows:\n- --------------------------------------------------------------------------------\n- --------------------------------------------------------------------------------\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nUnissued shares of Class A common stock (506,666 and 246,513 shares in 1995 and 1994, respectively) are reserved for the share-for-share conversion rights of the Class B common stock and stock options under the Employee Plans and the Directors Plan. The Class A shares have one vote per share and the Class B shares have three votes per share, except under certain circumstances such as voting on voluntary liquidation, sale of substantially all the assets, etc. Dividends up to $.10 per year, noncumulative, must be paid on Class A shares before any dividends are paid on Class B shares.\nThe Company purchased 16,107 shares of Class B common stock for Treasury for approximately $365,000 from the Estate of Robert D. Hickok (the \"Estate\") in January 1993 pursuant to a Section 303 Stock Redemption Agreement (the \"Agreement\"). The Agreement required the Company to purchase a sufficient number of Class B common stock from the Estate, proceeds of which to be used by the Estate for payment of taxes and expenses in connection with probating the Estate. During 1994, the Company classified approximately $235,000 as redeemable stock to allow for future possible redemption pursuant to the Agreement. The Company purchased an additional 4,560 shares of Class B common stock from the Estate on March 31, 1995 for approximately $78,000, completing the obligation. The Company has reclassified the remaining shares of Class B common stock (approximately $157,000) previously listed as Redeemable Common Stock. Excess of market value over par value of redeemable shares has been added to contributed capital.\n5. INCOME TAXES A reconciliation of the provision for income taxes to the statutory Federal income tax rate is as follows:\nChanges in deferred income taxes which relate to temporary differences in the recognition of revenue and expenses for tax and financial reporting purposes are as follows:\n- --------------------------------------------------------------------------------\n- --------------------------------------------------------------------------------\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nDeferred tax assets (liabilities) consist of the following:\nDeferred tax asset balances are included in \"prepaid and deferred expenses\".\n6. EMPLOYEE BENEFIT PLANS The Company has a formula based profit sharing bonus plan for officers and key employees. The bonus is distributed by the Compensation Committee of the Board of Directors after considering such factors as salary, length of service and merit. The maximum individual distribution is 50% of the distributee's salary. For fiscal years ended September 30, 1995, 1994 and 1993, approximately $456,000, $447,200 and $444,800, respectively, were expensed.\nDuring 1994, the Company started a 401(K) Savings and Retirement Plan covering all full-time employees. Company contributions to the plan, including matching of employee contributions, are at the Company's discretion. Contributions to the plan were approximately $27,300 in 1995 and $26,000 in 1994. The Company does not provide any other post retirement benefits to its employees.\nDuring 1995, the Company established a deferred compensation plan for selected management and highly compensated employees to make tax deferred contributions in the form of a salary reduction instead of or in addition to contributions made by them under the 401(K) Savings and Retirement Plan.\n7. ACQUISITION On February 4, 1994, the Company purchased certain assets of Allen-Bradley Company, Inc.'s Fastening Systems Line for $730,675 which has been accounted for under the purchase method of accounting. The purchase consisted of inventory ($461,092), machinery and equipment ($239,974), goodwill ($180,000) and assumption of liabilities ($150,391). Goodwill will be amortized over 15 years. Operations of the Fastening Systems Line have been included in the statement of income from the date of acquisition. The pro forma effects of the Fastening Systems Line on prior years operations are not determinable.\n- --------------------------------------------------------------------------------\nThe following pages contain the Consolidated Financial Statement Schedules as specified for Item 14(a)(2) of Part IV of Form 10-K.\nREPORT OF INDEPENDENT AUDITORS AS TO CONSOLIDATED SCHEDULES\nTo the Shareholders and Board of Directors Hickok Incorporated Cleveland, Ohio\nWe have audited the consolidated financial statements of HICKOK INCORPORATED (the \"Company\") as of September 30, 1995 and 1994, and for each of the three years in the period ended September 30, 1995, and have issued our report thereon dated November 17, 1995; such consolidated financial statements and report are included in Part II, Item 8 of this Form 10-K. Our audits also included the consolidated financial statement schedules (\"schedules\") of the Company listed in Item 14 (a)(2). These schedules are the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such 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.\nMEADEN & MOORE, INC. Certified Public Accountants\nDecember 18, 1995 Cleveland, Ohio\nHICKOK INCORPORATED\nSCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS\n(1) Classified as bad debt expense. (2) Recoveries on accounts charged off in prior years. (3) Accounts charged off during year as uncollectible. (4) Reserve classified as an offset to a certificate of deposit of $142,995 in current assets which collateralized a related bank guaranteed letter of credit. The certificate was cashed in during fiscal 1993. (5) Inventory charged off during the year as obsolete.\nHICKOK INCORPORATED\nSCHEDULE IX - SHORT-TERM BORROWINGS\n(1) Note payable to bank represents borrowings under a line-of-credit which has no termination date but is reviewed annually for renewal.\n(2) The average amount outstanding during the period was computed by dividing the total of daily outstanding principal balances by 365.\n(3) The weighted average interest rate during the period was computed by dividing the actual interest by the average short-term debt outstanding.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized at Cleveland, Ohio this 20th day of December, 1995.\nTHE HICKOK ELECTRICAL INSTRUMENT COMPANY\nBy:\/s\/ Robert L. Bauman ------------------------------------- Robert L. Bauman, 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 indicated and on the 20th day of December, 1995:\nSignature: Title - ---------- -----\n\/s\/ Robert L. Bauman Chairman, President and Chief Executive - ------------------------------ Officer (Principal Executive Officer) Robert L. Bauman\n\/s\/ Eugene T. Nowakowski Chief Financial Officer - ------------------------------ (Principal Financial and Accounting Eugene T. Nowakowski Officer)\n\/s\/ Thomas H. Barton Director - ------------------------------ Thomas H. Barton\n\/s\/ Harry J. Fallon Director - ------------------------------ Harry J. Fallon\n\/s\/ T. Harold Hudson Director - ------------------------------ T. Harold Hudson\n\/s\/ George S. Lockwood, Jr. Director - ------------------------------ George S. Lockwood, Jr.\n\/s\/ Michael L. Miller Director - ------------------------------ Michael L. Miller\n\/s\/ Janet H. Slade Director - ------------------------------ Janet H. Slade\nEXHIBIT INDEX\nExhibit No.: Document - ------------ ------------\n3(a) Articles of Incorporation and Code of Regulations\n3(b) Amendment to Articles of Incorporation\n10(a) Form of Section 303 Stock Redemption Agreement by and between the Company and Robert D. Hickok (incorporated herein by reference to the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 1988)\n10(b) Loan Agreement dated as of May 20, 1991+wy and between the Company and Huntington National Bank. (Incorporated herein by reference to the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 1991.)\n10(c) First Amendment to Credit and Security Agreement, dated as of February 28, 1992, by and between the Company and Huntington National Bank. (Incorporated herein by reference to the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 1992).\n10(d) Second Amendment to Credit and Security Agreement, dated as of February 28, 1993, by and between the Company and Huntington National Bank. (Incorporated herein by reference to the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 1993.)\n10(e) Third Amendment to Credit and Security Agreement, dated as of February 28, 1994 by and between the Company and The Huntington National Bank. (Incorporated herein by reference to the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 1994.)\n10(f) Fourth Amendment to Credit and Security Agreement, dated as of January 13, 1995, by and between the Company and Huntington National Bank.\n11 Computation of Net Income Per Common Share\nE-1\n22 Subsidiaries of the Registrant (Incorporated herein by reference to the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 1993.)\n23 Consent of Independent Auditors.\n27 Financial Data Schedule\nE-2","section_15":""}
{"filename":"70333_1995.txt","cik":"70333","year":"1995","section_1":"Item 1. Business\nNational Micronetics, Inc. (The \"Company\") was originally incorporated in 1969 in New York and reincorporated in Delaware in 1982. The Company historically has operated exclusively in the magnetic recording head industry.\nIn reliance primarily upon assembly facilities owned and operated by its parent companies, sales revenue attributable to its parent companies and debt financing supplied or guaranteed by its parent companies or its affiliated companies since May 10, 1991, the Company is principally an integrated manufacturer of magnetic recording heads primarily for computer disk drives. The Company is currently primarily performing pilot projects concerning ferrite bars, cores and recording head assemblies.\nThe Company is considering the sale of other products. Some, such as electrical light fixture ballasts, would be outside its previous markets. Some would depend upon other manufacturers and vendors for assembly work.\nRecording Head Products\nGeneral. Most computer applications require more data than can be stored in the central processing unit's memory. As new applications are developed for the use of computers and rapid access to data, peripheral data storage devices are essential adjuncts to computer systems. Disk drives are the most important peripheral data storage devices for computers because they provide immediate random access to the stored data.\nA recording head is the central mechanism by which information is transferred between the computer's central processing unit and its disk storage. The Company's recording heads consist of a magnetically active ferrite core comprised of magnetic poles, conductive windings and an aerodynamic support structure, all of which are mounted on a movable arm to enable positioning of the recording head to record or retrieve data.\nIn order to record information onto a disk, the recording head is used to convert electrical impulses from a computer into a magnetic field on the surface of the disk. Conversely, to read information from the disk, the recording head interacts with the magnetic field on the surface of the disk to create electrical impulses. The recording heads are positioned in close proximity to the surface (as close as 5 millionths of an inch above the disk surface). The recording head must meet extremely precise electrical and mechanical tolerances in order to maintain position close to the rotating surface and transfer data at high speeds.\nThe development of disk storage technology has been directed toward increasing the density of stored data and reducing access time without equivalent increases in price. This trend has created a demand for more precise magnetic recording heads.\nIn some cases the Company assists its customers in the design of the recording head to achieve the specifications stipulated for a particular application.\nThe Company is positioned to supply the market with recording heads assembled to various levels of completion. This enables the Company to complement a variety of customer production methods. Certain manufacturing and assembly operations are performed by Newmax Co., Ltd. (\"Newmax\") in Korea. See footnote 10 to the consolidated financial statements on pages 42 and 43 for a discussion of related party transactions.\nSales and Customers\nThe Company's computer products are sold to original equipment manufacturers. Because product life cycles for computer products are relatively short, sales in one period are not necessarily indicative of future sales. At any given time, the Company is likely to be dependent on sales of specific products to specific customers. Please refer to note 9 to the consolidated financial statements on page 42 for an analysis of export sales, which comprise over 90% of net sales.\nThe past sales and customers of the Company may not be indicative of its future sales and customers, since the Company has sold most of its assembly line production equipment for manufacturing ferrite cores and slider assemblies and is contemplating selling different products in new markets. The Company has begun soliciting orders for electronic light ballasts on a limited basis.\nIn fiscal 1995, one customer, Tae Il Media Co., Ltd. (\"Tae Il\")\/Newmax, accounted for 86% of net sales on a consolidated basis. See footnote 9 on page 42 for a discussion of major customers and footnote 10 to the consolidated financial statements on pages 42 and 43 for a discussion of related party transactions.\nBacklog\nA comparison of backlog at fiscal year-end is shown below:\nJune 24, 1995 June 25, 1994 (in thousands) $1,300 $1,273\nBacklog (primarily Tae Il\/Newmax orders at June 24, 1995) includes only those orders for which a delivery schedule has been specified by the customer, although such orders may be subject to cancellation or modification by the customer without significant penalty. Sales fluctuations are not seasonal and often are not anticipated. Approximately $226,000 of the orders that existed at June 24, 1995 have been cancelled by the customers and cancellation charges are currently being negotiated.\nCompetition\nNewmax, Tae Il and their related entities (see Item 10, under the caption Relationships and Beneficial Interests) are larger and better capitalized than the Company, which has become almost entirely dependent upon them for working capital, assembly facilities, personnel, sales revenue and for bank loan financing. Physical proximity to customers does not significantly affect competition due to low shipping costs for this small and light product. Competition from both recording head and ferrite core suppliers is principally in the areas of price, quality and product performance.\nIn addition to changes within the disk storage market, other types of computer memory technologies may become competitive with current disk drive applications.\nThe Company has not yet ascertained the other markets in which it will compete.\nResearch, Development and Engineering\nDuring fiscal years 1995 and 1994 the Company spent approximately $259,000 and $481,000 respectively, in connection with continuing engineering and product development. Research and engineering efforts are currently being directed toward the enhancement of its floppy disk drive and tape drive recording head products. For the past four years there has been substantial direct support of manufacturing operations and current product lines. Significant effort has been expended during fiscal 1995 and 1994 in developing advanced recording head technologies including Metal-In-Gap (\"MIG\") heads which incorporate a high magnetization metal alloy adjacent to the recording gap and which were brought to market in production quantities in 1992. Double MIG heads were shipped in production quantities early in fiscal 1994. No double MIG heads have been shipped since the end of fiscal 1994 due to significant changes in the needs of the customers.\nThe Company is currently performing technical and market research on products that could be sold by the Company. Many of these products are outside the Company's previous markets and many would be manufactured for the Company by contractors or vendors.\nEmployees\nAt June 24, 1995 the Company actively employed approximately 53 persons.\nEnvironmental Compliance\nThe material effects that 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 upon the future capital expenditures or earnings of the Company are described in Item 3, Legal Proceedings.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company's corporate offices are located at 71 Smith Avenue, Kingston, New York, 12401. The Company's operations are conducted from 83,000 square feet of facilities located in Kingston, New York, owned by the Company, and mortgaged by an institutional lender. The loan from the institutional lender has been in default since June 30, 1995. In addition to the above, the Company sold a 5,400 square foot building on September 7, 1995 and vacant buildings totalling 42,000 squate feet remain available for sale.\nThe Company believes that its facilities and the equipment located therein are in good working condition and are adequate and sufficient for the current conduct of its business. The Company has sold or disposed of idle and obsolete equipment and could not return to the production volumes of previous years without significant changes in operations or use of subcontractors. The Company is dependent upon its parent companies for contract production assembly facilities. See note 2 to the consolidated financial statements on page 37 for a discussion of efforts to overcome under utilization of facilities.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe Company is not a party to any material legal proceedings, except that the Company has been notified it is one of many potentially responsible parties (\"PRP's\") for an Environmental Protection Agency (\"EPA\") Superfund site. A \"PRP\" may be jointly and severally liable for clean-up of a superfund site, except to the extent of any settlement agreement with the Environmental Protection Agency.\nThe site is known as the Solvents Recovery Service of New England Superfund site and is located on Lazy Lane in Southington, Connecticut. The Company was notified by the EPA on June 12, 1992 that it was considered to be a PRP under the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA) with respect to the above referenced site. The EPA has identified in excess of 1,600 PRP's for this site.\nThe EPA has indicated they have incurred costs in excess of $3.35 million but have not as yet completed a remedial action plan. The EPA is not prepared at this time to estimate the cost of remedial action.\nThe Company is currently unable to predict the outcome of this matter as the actual cost of remedial action has not been determined and the method of allocation of liability among parties who may ultimately be found liable remains uncertain. The Company believes, however, that it is unlikely that any liability it may incur would have a significant effect on its financial statements.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nThe last annual meeting of stockholders of the Company was held on March 20, 1991. Since that date, no actions have been taken by written consent of stockholders and no meetings of stockholders have been held. PART II\nItem 5.","section_5":"Item 5. Market for Company's Common Stock and Related Stockholder Matters (a). Price Range of Common Stock\nThere is no established public trading market for the common stock of the Company. The Company's Common Stock is traded on the OTC Bulletin Board and pink sheets. There has been no quoted bid price for the Company's Common Stock since December 27, 1994. The following table sets forth for the periods indicated the bid prices of the Company's Common Stock as reported by market makers. Over-the-counter market quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.\nFiscal Year High Low\nFirst Quarter $ .02 $ .001 Second Quarter .02 .001 Third Quarter N\/A N\/A Fourth Quarter N\/A N\/A First Quarter .01 .001 Second Quarter .03 .001 Third Quarter .015 .001 Fourth Quarter .02 .001\n(b). Approximate Number of Equity Security Holders\nThe approximate number of holders of record of the Company's common stock as of August 31, 1995 was 2,500.\n(c). Dividends\nThe Company has not paid any cash dividends on its Common Stock. Due in part to the working capital deficit of $10,806,000 and the stockholders' deficit of $7,059,000 as of June 24, 1995, the Company does not anticipate paying dividends for the foreseeable future.\nItem 6.","section_6":"Item 6. Selected Financial Data\nSelected Consolidated Statement of Operations Data (in thousands, except per share amounts)\nYear Ended In June 1995 1994 1993 1992 1991\nNet sales $ 3,822 $ 7,227 $12,664 $ 7,397 $15,088 Cost of products sold 3,849 7,777 15,287 10,222 18,628 Gross profit (loss) (27) (550) (2,623) (2,825) (3,540) Research, development and engineering expense 259 481 887 1,141 2,673 Selling and administration expense 712 816 849 169 2,719 Earnings (loss) before income taxes (1,599) (2,699) (5,083) (5,079) (9,725) Earnings (loss) (1,599) (2,699) (5,083) (5,079) (9,725) Earnings (loss) per common and common equivalent share $ (.07) $ (.12) $ (.23) $ (.25) $ (.63) Weighted average shares Outstanding 22,313 22,313 22,313 20,726 15,475 Cash dividends 0 0 0 0 0\nSelected Consolidated Balance Sheet Data (in thousands)\nYear Ended in June\n1995 1994 1993 1992 1991 Working capital (deficit) $(10,806) $(11,267) $(12,846) $(4,783) $(6,461) Total assets 5,400 5,449 6,819 12,772 12,688 Long-term debt and lease obligations, including current portion 4,626 4,494 5,408 6,618 3,051 Stockholders' equity (deficit) ( 7,059) (6,514) (6,986) (2,469) 1,391\nThe reasons for the significant decline in net sales, the significant decline in cost of products sold, the significant operating losses and decline in assets are discussed at Item 7, Management's Discussion and Analysis of Financial Condition, and Results of Operations.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nFiscal 1991 began with the expectation that new orders and production of MIG recording heads in significant volumes was only weeks away. Numerous delays were encountered throughout the fiscal year. These delays included unanticipated technical development problems, delays in obtaining acceptable production yields and customer changes in design and schedules due to the newness of the technology.\nThroughout 1991, the emphasis was placed upon development of MIG technology. Research and development spending for fiscal 1991 was $2,673,000 compared to $2,175,000 for the prior year. This increased effort on development took place even though sales declined dramatically because of its importance to the survival of the Company.\nThe Company booked some orders with negative profit margins to keep skilled technicians and to be prepared to increase volumes of MIG products when the time was right. These orders were completed and production staff decreased when MIG orders did not materialize on schedule.\nOverhead costs were reduced whenever possible throughout fiscal 1991. The California sales office was closed and many administrative functions in Kingston were consolidated by laying-off employees. The Singapore sales office was closed effective June 29, 1991.\nFiscal 1992 began with the lay-off of 40 non-production employees. The Philippine assembly operation of the Company's independent contractor was closed during August to reduce costs. Total employment was at or about 100 for six months. The remaining 40 production employees were utilized primarily for engineering experiments to improve the production process. Net sales for the first six months of fiscal 1992 were a very disappointing $1,390,000. Every effort was made to reduce overhead spending, but it was impossible to attempt to break even at this low a sales volume.\nDuring the third quarter of fiscal 1992, the Company began to see signs of improvement. The Company rehired 100 production employees during the quarter to work on orders for metal-in-gap products. Work-in-progress increased significantly as the Company prepared for fourth quarter deliveries.\nNet sales for the fourth quarter of fiscal 1992 were $4,615,000. The backlog exceeded $7 million at May 4, 1992 and $5 million at June 27, 1992. The fourth quarter and full year results benefited by the recording of the value of Maxtor Corporation common stock received from Maxtor as a result of the Miniscribe bankruptcy. The stock was recorded as a recovery within general and administrative expenses of $883,000. At year-end the stock was reduced to market value of $689,000 by a charge to other expense of $194,000.\nThe Company sold its Maxtor stock for $1,089,000 in late August and early September 1992 pursuant to a registration statement filed by Maxtor. The gain on the sale of $400,000 was recorded in other income during the first quarter of fiscal 1993. The improved sales trend established during fiscal 1992 continued through the first half of fiscal 1993. Sales began to decline during the third quarter of fiscal 1993 as the demand for MIG products with a single sputtered surface declined. The Company continued to sell significant quantities of established products as it intensified efforts to develop a double MIG product. The Company qualified a double MIG product with one customer. The Company continued efforts to qualify double MIG products with additional customers.\nFiscal 1994 began with increasing volume of double MIG slider sales as well as an increase in sales of floppy recording head bars. The sale of MIG products dropped significantly after December 1993 and stopped by the end of February 1994. Sales of floppy recording head bars increased significantly beginning in February 1994 and remained the majority of sales recorded for the rest of fiscal year. The Company continued efforts to obtain orders for double MIG products throughout fiscal 1994. The dramatic changes in disk drive design and ready availability of thin-film recording heads combined to make a very difficult market for selling double MIG products.\nFiscal 1995 saw a continuation of the trend established during the second half of fiscal 1994. There was a significant lay-off in September 1994 as the demand for finished floppy recording head bars dropped dramatically. At this time, the Company began shipping unfinished floppy disc recording head bars which were less labor intensive and had a higher profit margin. The lower selling price resulting from a lower labor and overhead content of the product being sold resulted in a significant reduction in sales for Fiscal 1995. There was some improvement in sales to unrelated parties of ferrite based products made to customers' specifications.\nCurrent levels of production are low by historic standards for the Company. The Company recognizes it must significantly increase production to absorb the engineering and other overhead of its products. Further increases in production are dependent upon receiving larger orders from current customers and cooperation of parent companies or independent contractors. Due to the \"customer specific\" nature of the Company's products and qualification procedures, these increases require time and patience to materialize.\nInflation\nPrices in the peripheral data storage market do not ordinarily increase to offset the effects of inflation. The Company anticipates that inflationary effects on its costs will be largely offset through productivity increases. The Company has curtailed production of certain products due to the inability to obtain price increases and reduce costs.\nLiquidity and Capital Resources\nThe Company entered into an agreement with a lending institution on May 10, 1991. On April 30, 1992 this loan was converted from a $4,000,000 one year renewable loan to a loan with a fixed repayment plan with the last semi-annual installment due September 30, 1994. The balance remaining unpaid on this loan is $2,841,000 as of June 24, 1995 and June 25, 1994. On December 23, 1994 the lending institution agreed to a modification of repayment terms resulting in quarterly payments due from September 30, 1996 through June 30, 1997. Collateral provided by a Newmax affiliate (guarantor) included a letter of credit issued by a Korean Bank. The current letter of credit for $3,050,000 expires November 16, 1995 and must be replaced at that time. The Company expects the letter of credit to be renewed by Newmax upon maturity. The Company entered into a $3,000,000 term loan agreement with the same lending institution on November 5, 1991. On December 23, 1994 the lending institution agreed to a modification of repayment terms resulting in quarterly payments due from June 30, 1995 through June 30, 1996. The balance remaining unpaid on this loan is $1,645,000 as of June 24, 1995 and June 25, 1994. This term loan and the May 1991 revolving credit loan are secured by substantially all the assets of the Company, including a $7,000,000 first mortgage on the facilities of the Company in Kingston, New York. The term loan has been guaranteed by the related parties Newmax, Co., Ltd., Tae Il Media Co., Ltd. and Mr. K.H. Chung. The term loan requires principal payments of $1,316,000 in fiscal 1996.\nThe Company had no material commitments for capital expenditures as of June 24, 1995. Depreciation has exceeded capital expenditures by approximately $1,000,000 per year for the last three years. Anticipated repayments of long-term debt and lease obligations for fiscal 1996 will be $1,358,000 compared to the scheduled repayments of $3,073,000 for fiscal 1995 of which only $8,000 were made. The repayment terms with the primary lending institution have been modified to decrease the payments originally scheduled for fiscal 1995 and increase payments that will be required for fiscal 1997. The Company did not make the $329,000 payment due on June 30, 1995 due to its limited cash resources and thereby defaulted on the lending agreements. An additional $329,000 payment is due by September 30, 1995 and most likely will not be made. A revised payment schedule is being discussed with the primary lending institution, but no agreement has been reached as to terms. The primary lending institution has not initiated any legal action against the Company.\nThe Company is hopeful that funds generated by operations and received from Newmax will be adequate to fund production, new product development, debt service and other operational needs. Although there is no firm commitment, affiliated parties and parents are expected to advance funds on a short-term as needed basis to offset operational cash shortfalls. Management believes that the combination of reduction in overhead spending, continued cooperation of parent companies and their affiliates, cooperation of the institutional lender and development of new distribution markets for non-manufactured products will enable the Company to remain viable for the next twelve months.\nSee note 2 to the Company's consolidated financial statements included herein (page 37) for a further discussion of liquidity and management's action plan.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe information called for by item 8 is set forth on pages 28 to 43 and listed on page 28 of this report.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone. PART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nShares Owned Position with As a Percentage Name, age and Company or Director Of Outstanding Committee Membership Principal Occupation Since Shares\nDr. Yoon H. Choo,......Chairman, President, 1990 - 57 Chief Executive Officer, Secretary and Treasurer\nDr. Heehwan Lee,.......Vice President and 1990 (2) - 45 Chief Operations Officer\nMr. K.H. Chung,........President, Tae Il Media 1990 (1) (2) - 50 Co., Ltd. Ansan City & Seoul, Korea\nAll directors and officers as a group (3 persons).... (1) (3) -\n(1) See the caption Relationships and Beneficial Interests for shares of capital stock of the parents of the Company owned by Mr. K.H. Chung.\n(2) Not listed are shares owned by Newmax Co., Ltd. as explained in detail in Item 12, Security Ownership of Certain Beneficial Owners and Management. Mr. K.H. Chung and Dr. Heehwan Lee expressly disclaim that either of them is at the present time the beneficial owner of any shares of common stock of the Company for the purpose of Section 13(d) or 13(g) of the Securities Exchange Act of 1934, as amended, or that either of them is at the present time able to exercise a controlling influence over the Company.\n(3) Not listed are shares owned by Newmax as explained in detail in Item 12, Security Ownership of Certain Beneficial Owners and Management.\nBusiness Experience of Directors\nDr. Yoon H. Choo was elected Chairman of the Board in January 1991. He was elected President, Chief Executive Officer, Secretary and Treasurer on February 11, 1991. He has been a director of the Company since December 1990. He has been President of Tae Il USA, Inc. since 1984, and Gigamax Corporation since 1989. Tae Il USA, Inc. and Gigamax Corporation are affiliates of the Company and are engaged in businesses which are similar to that of the Company. He previously had more than seven years experience with Digital Equipment Corporation.\nDr. Heehwan Lee has been a director since December 1990. He was elected Vice President and Chief Operations Officer on March 1, 1992. He has been Vice President of Tae Il Media Co., Ltd. since August 1986. He had been Vice President of Newmax from August 1990 until March 29, 1994. Newmax and Media are parents and affiliates of the Company and are engaged in businesses which are similar to that of the Company. From July 1975 to July 1986 he was a Senior Researcher with the Korean Agency for Defense Development.\nMr. K.H. Chung has been a director since December 1990. He has been President of Tae Il Media Co., Ltd. since October 1983. He had been president of Tae Il Magnetics Co., Ltd., from July 1987 until March 29, 1994. He had been president of Newmax Co., Ltd. from August 1990 until March 29, 1994. Newmax, Tae Il Media and Tae Il Magnetics are parents and affiliates of the Company and are engaged in businesses which are similar to that of the Company. He previously had more than seventeen years experience with Hanil Textile Co., Ltd. as Chief of the Corporate Planning Board.\nRelationships and Beneficial Interests\nNewmax designated Mr. K.H. Chung, Dr. Yoon H. Choo and Dr. Heehwan Lee as nominees pursuant to its right to designate a majority of the directors to be nominated pursuant to the Stock Purchase Agreement dated November 30, 1990 between Newmax and the Company.\nNewmax owns 47.1 percent of the common stock of the Company. Pursuant to the Stock Purchase Agreement dated November 30, 1990 between the Company and Newmax, Newmax may agree to purchase additional shares of common stock of the Company from time to time in an amount which will enable Newmax to own more than 50 percent of the issued and outstanding shares of common stock of the Company. This provision directly inures to the benefit of Newmax and may be deemed indirectly to inure to the benefit of Tae Il Media Co., Ltd. (\"Media\"), Tae Il Magnetics Co., Ltd, (\"Magnetics\"), Mr. K.H. Chung, Dr. Heehwan Lee, and Mr. Yoon K. Choo. This provision does not extend to other holders of the common stock of the Company.\nUntil March 29, 1994, Mr. K.H. Chung was the representative director and the president of Newmax and Dr. Heehwan Lee was a director and vice president of Newmax. Media and Magnetics combined own 31 percent of the common stock of Newmax.\nMr. K. H. Chung owns 5 percent of the common Stock of Media and is a representative director and the president of Media and Dr. Heehwan Lee a director and vice president of Media. Mr. Yoon K. Choo is a director and the chairman of the board of directors of Media. Media owns 25 percent of the capital stock of Dae Bang Venture Capital Co., Ltd., which owns 7.1 percent of the common stock of the Company. Media owns 14 percent of the capital stock of Newmax.\nMr. K.H. Chung owns 6 percent of the common stock of Magnetics. Until March 29, 1994, Mr. K.H. Chung was the representative director and the president of Magnetics. Magnetics owns 17 percent of the capital stock of Newmax.\nDr. Yoon H. Choo is the brother of Mr. Yoon K. Choo and Mr. K.H. Chung and Dr. Heehwan Lee are sons-in-law of Mr. Yoon K. Choo.\nMr. Yoon K. Choo is an associate of Mr. K.H. Chung, Dr. Heehwan Lee and Dr. Yoon H. Choo, who are directors of the Company. Newmax and Media also are associates of Mr. K.H. Chung and Dr. Heehwan Lee. Magnetics was an associate of Mr. K.H. Chung and Dr. Heehwan Lee until March 29, 1994.\nNewmax, Media, Magnetics, Mr. Yoon K. Choo, Mr. K.H. Chung and Dr. Heehwan Lee also have a substantial direct interest in the transactions described below.\nThe Stock Purchase Agreement dated November 30, 1990 between Newmax and the Company states that they mutually shall provide technical assistance and patent licenses to one another under the terms of the technical assistance agreement to be agreed upon by them, subject to appropriate government approval.\nTransactions with Management and Others\nNewmax, Media, Magnetics, or their affiliates have made payments to the Company or its subsidiaries for property or services. In particular, the Company sold to Newmax in fiscal 1995, 1994 and 1993 equipment comprising machining assembly lines and other excess equipment in exhange for cash in an amount equal to fair market value, as determined by an independent appraisal in 1991 and by subsequent determinations by employees of the Company, ($1,281,000, $610,000, and $691,000 in fiscal 1995, 1994 and 1993, respectively), of that equipment. Furthermore, the Company or its subsidiaries have made payments to Newmax, Media, Magnetics or their affiliates for property or services in amounts material to the Company. Nearly $5 million has been borrowed by the Company at 8 percent interest from Gigamax Corporation and Tae Il U.S.A., Inc., both of which are controlled by Dr. Yoon H. Choo, President of the Company. See note 10 to the Company's consolidated financial statements included herein (page 42) for a further discussion of related party transactions.\nSee also Item 7, Liquidity and Capital Resources, for a discussion of loans obtained by the Company with the assistance of guarantees provided by Newmax and other related parties. See note 5 to the Company's consolidated financial statements included herein (page 38) for a further discussion of short-term debt and related party assistance and note 6 (page 39) for a further discussion of long-term debt and related party assistance.\nBoard and Committee Meetings\nThe Board of directors has a standing Audit Committee, but does not have a Nominating Committee or Compensation Committee.\nThe functions of the Audit Committee include recommending the appointment of independent auditors, reviewing with the independent auditors the results of the annual audit, reviewing the independence of the auditors, determining the appropriateness of fees for audit and non-audit services provided by independent auditors and reviewing transactions between the Company and associates of the directors or officers of the Company.\nDuring fiscal 1995 and 1994 there were no meetings of the Board of Directors, and no meetings of the Audit Committee. The Independent Public Accountants attended no meetings.\nItem 11.","section_11":"Item 11. Executive Compensation\nSummary Compensation Table\nThe compensation of the chief executive officer of the Company for services rendered to the Company and its subsidiaries is set forth below:\nName and Principal Position Year Annual Salary\nDr. Yoon H. Choo, 1995 $ 80,000 Chairman, President and Chief 1994 $ 80,000 Executive Officer 1993 $ 80,000\nThere are no other officers whose total annual salary and bonus exceeds $100,000.\nBoard Interlocks and Insider Participation\nDr. Yoon H. Choo and Dr. Heehwan Lee served as officers of the Company and as members of the Board of Directors for fiscal 1995 and as such, were entitled to participate in deliberations of Board of Directors concerning executive officer compensation.\nDr. Yoon H. Choo is a director and president of Gigamax Corporation and of Tae Il USA, Inc., which are affiliates of the Company.\nDr. Heehwan Lee was a director and vice president of Newmax until March 29, 1994 and is a director and vice president of Media, both of which are parents of the Company.\nMr. K.H. Chung also served as a member of the Board of Directors of the Company for fiscal 1995 and, as such, was entitled to participate in deliberations of the Board of Directors concerning executive officer compensation. He is the president and a representative director of Media, which is a parent of the Company. Until March 29, 1994 he was the president and representative director of Magnetics and of Newmax, which are parents of the Company. He owns 5 percent of the capital stock of Media and 6 percent of the capital stock of Magnetics.\nSee Transactions with Management and Others on page 14. Also see Relationships and Beneficial Interests on pages 12-13 with respect to the ownerhip by Media and Magnetics of 31 percent of the outstanding shares of capital stock of Newmax and the ownership of Newmax of 47.1 percent of the outstanding shares of common stock of the Company, as well as the ownership by Media of 25 percent of the capital stock of Dae Bang Venture Capital Co., Ltd., which owns 7.1 percent of the outstanding shares of capital stock of the Company.\nDr. Yoon H. Choo has a direct material interest in the loans provided by Gigamax Corporation and by Tae Il USA, Inc. to the Company, as described in notes 5 and 10 to the consolidated financial statements on pages 38 and 43 because of his control over those two companies.\nDr. Heehwan Lee may be deemed to have a material indirect interest in the transactions between the Company and each of Newmax and Media and in the credit enhancements provided by Newmax and Media to the Company, as described in notes 5, 6, and 10 to the consolidated financial statements on pages 38, 39 and 42-43, because of his official relationships with Media and because the father-in-law of Dr. Heehwan Lee, Mr. Yoon K. Choo, is a director and chairman of the Board of directors of Media.\nMr. K.H. Chung has a direct material interest in the credit enhancement which he personally provides to the Company and may be deemed to have an indirect material interest in the transactions between the Company and each of Newmax and Media and in the credit enhancements provided by Newmax and Media to the Company as described in notes 5, 6, and 10 to the consolidated financial statements on pages 38, 39, and 42-43.\nMr. K.H. Chung, who is director of the Company, a representative director and president of Media, a 5 percent stockholder of Media, a 6 percent stockholder of Magnetics, has a direct material interest in the credit enhancement which he personally provides to the Company and may be deemed to have an indirect material interest in the transactions between the Company and each of Media and Newmax, and in the credit enhancements provided by Newmax and Media to the Company, as described in notes 5, 6 and 10 to the consolidated financial statements on pages 38, 39 and 42-43. Newmax owed the Company $63,000 and the Company owed Media $640,000 as of June 24, 1995.\nDr Heehwan Lee, who is a director and the vice president and chief operations officer of the Company, the vice president of Media and the son-in-law of Mr. Yoon K. Choo, may be deemed to have a material indirect interest in the transactions between the Company and each of Media and Newmax, and in credit enhancements provided by Newmax and Media to the Company, as described in notes 5, 6, and 10 to the consolidated financial statements on pages 38, 39, and 42-43. Newmax owed the Company $63,000 and the Company owed Media $640,000 as of June 24, 1995.\nDr. Yoon H. Choo, who is a director, the chairman, the president, the treasurer, and the secretary of the Company, a director and the president of Gigamax Corporation and a director and the president of Tae Il USA, Inc., has a direct material interest in the loans provided by Gigamax Corporation and by Tae Il USA, Inc., to the Company, as described in notes 5 and 10 to the consolidated financial statements on pages 38 and 43. The Company owed Gigamax $4,896,000, in principal and $1,268,000 of net accrued expenses (primarily interest), as of June 24, 1995.\nCompensation of Directors\nThe annual fee for directors who are not employees of the Company is $8,000. All of the outside directors earn $1,000 for each Board meeting or Committee meeting attended, except that if a Committee meets on the same day as the full Board, Committee members earn only $500 for the Committee meeting. Telephonic meetings are compensated at fifty percent of the rates noted above. Fees earned but unpaid to current and former Board members are $173,000 at June 24, 1995. Board members are eligible to receive stock options. See Board Interlocks and Insider Participation above.\nEmployment Contract\nThe Company entered into a Compensation Agreement with Yoon H. Choo on April 17, 1991 for a one year period. Based upon the terms of the agreement, it automatically renews for another year on its anniversary date. The agreement requires periodic salary payments totaling $150,000 per year. Effective November 18, 1991, the salary was renegotiated down to $80,000 per year due to continuing losses of the Company. The agreement provides for payment of one year's salary in the event of contract non-renewal or termination of employment. In the event of a change in control, then a change in title or responsibilities is contractually defined as a termination of employment.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nSecurity Ownership of Certain Beneficial Owners\nThe following table presents information as to the persons who have reported or are otherwise known to the Company to be the beneficial owners of more than 5% of the outstanding Common Stock of the Company as of September 4, 1995. Amount and Nature of Percent Name and Address of Beneficial Owner Beneficial Ownership of Class\nNewmax Co., Ltd. .............................10,500,000 47.1% 27-15 Song Jeong-Dong Direct owner (1) Cheongju, Chungbuk sole voting and 360-290, Korea investment powers\nGwang Jai Koh ................................10,500,000 47.1% Jung Kyun Bae Indirect owner (2) Hong Kyu Shin shared voting Jeong Soo Choi power, shared 456-1 Moknae-Dong investment power Ansan, Kyunggi-Do 425-100, Korea\nDae Bang Venture Capital Co., Ltd. ...........1,575,000 7.1% 1-181 Chagin-Dong Direct owner Iri-si, Jullabuk-do sole voting and Korea investment powers\nS.Y. Choi ....................................1,575,000 7.1% Y.S. Kim Indirect owner (2) K.O. Oh shared voting KWTC Building, Suite 4202 power, shared Samsung-dong investment power Kangnam-gu Seoul, Korea\n(1) See the caption Relationships and Beneficial Interests in Item 10, Directors and Executive Officers of the Registrant.\n(2) The persons who are deemed to be indirect owners possessing shared voting power and shared investment power expressly disclaim that any of them is at the present time the beneficial owner of any shares of common stock of the Company for the purposes of Section 13(d) or 13(g) of the Securities Exchange Act of 1934, as amended, or that any one of them is at the present time able to exercise a controlling influence over the Company.\nSecurity Ownership of Management\nIdentification of and certain information concerning executive officers and directors of the Company is set forth in part III, Item 10 under the heading \"Directors and Executive Officers of the Registrant\".\nThe directors and the executive officers of the Company are not beneficial owners of any equity securities of the Company. The following table presents information as to those directors' and executive officers' beneficial ownership of equity securities in the parents of the Company.\nTitle Name of Amount and Nature Percent of Beneficial of Beneficial of Class Owner Ownership Class\nCapital Stock Kang Hoan Chung 213,218 4.9% of Tae Il Direct owner (2) Media Co., Ltd. (1) Sole voting power Sole investment power\nCapital Stock Kang Hoan Chung 37,396 6.2% of Tae Il Direct owner (2) Magnetics Co., Ltd. (1) Sole voting power Sole investment power\nCapital Stock Kang Hoan Chung 935,595 31.0% of Newmax Indirect owner (2) Co., Ltd. (1) Shared voting power Shared investment power\nCapital Stock Heehwan Lee 410,006 13.6% of Newmax Indirect owner (2) Co., Ltd. (1) Shared voting power Shared investment power\nCapital Stock Directors and 935,595 31.0% of Newmax Executive Indirect owners (2) Co., Ltd. Officers as a Shared voting power Group Shared investment power\n(1) See the caption Relationships and Beneficial Interests in Item 10, Directors and Executive Officers of the Registrant.\n(2) The person who is the direct owner possessing sole voting and sole investment power and the persons who are deemed to be indirect owners possessing shared voting power and shared investment power, expressly disclaim that either of them is at the present time the beneficial owner of any shares of the common stock of the Company for purposes of Section 13(d) or 13(g) of the Securities Exchange Act of 1934, as amended, or that either one of them is at the present time able to exercise a controlling influence over the Company. Item 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nIdentification of and certain information concerning executive officers and directors of the Company is set forth in Part III, Item 10 under the heading \"Directors and Executive Officers of the Registrant\" and under the heading \"Transactions with Management and Others\" and in Part III, Item 11 under the heading \"Board Interlocks and Insider Participation\".\nIdentification of certain information concerning security holders who are known to the Company to own of record or beneficially more than 5% of its outstanding shares of common stock and members of the immediate families of those persons and of executive officers and directors of the Company are set forth in Part I, Item 1, Business, under the headings \"Recording Head Products\", \"Sales and Customers\", \"Backlog\", in Part II, Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, under the Headings, \"Liquidity and Capital Resources\", Item 8, Financial Statements and Supplementary Data, notes 2,5,6,9, and 10, Part III, Item 10, Directors and Executive Officers of the Registrant, under the headings, \"Relationships and Beneficial Interests\", \"Transactions with Management and Others\", and Item 11, Executive Compensation, under the heading \"Board Interlocks and Insider Participation\".\nPART IV Item 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\n(a) 1. Financial Statements\nConsolidated Financial Statements, Notes to Consolidated Financial Statements and the Report of Independent Certified Public Accountants are incorporated in Part II of this report (see index on page 28).\n2. Financial Statement Schedules\nIncluded In Part IV of this report:\nPage # Accountants' Report on Supplementary Information 44\nSchedule II- Valuation and Qualifying Accounts 45\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.\nSeparate financial statements and supplemental schedules of the Company are omitted since the Company is primarily an operating company and its subsidiaries, included in the consolidated financial statements being filed, do not have a minority equity interest or indebtedness to any person other than the Company in an amount which exceeds five percent of the total assets as shown by the consolidated financial statements as filed herein.\n3. Exhibits 3.1 Certificate of Incorporation of the Company dated October 15, 1981.\n3.2 Amendment to Certificate of Incorporation of the Company dated March 2, 1982 (Incorporated by reference to Exhibit 3.2 to Registration Statement of the Company, Registration No. 2-77035).\n3.3 Amendment to the Certificate of Incorporation of the Company dated November 30, 1983.\n3.4 Amendment to the Certificate of Incorporation of the Company dated December 27, 1984 (Incorporated by reference to Exhibit 3.4 to the annual report on Form 10-K for the year ended June 29, 1985, Commission File Number 0-7207).\n3.5 Amendment to the Certificate of Incorporation of the Company dated December 26, 1986 (Incorporated by reference to Exhibit 3.5 to the annual report on Form 10-K for the year ended June 27, 1987, Commission File Number 0-7207).\n3.6 Amendment to the Certificate of Incorporation of the Company dated April 1, 1991 (Incorporated by reference to Exhibit 3.6 to the annual report on Form 10-K for the year ended June 29, 1991, Commission File Number 0-7207).\n3.7 By-Laws of the Company as amended on December 17, 1990 (Incorporated by reference to Exhibit 3.7 to the annual report on form 10-K for the year ended June 29, 1991, Commission File Number 0-7207).\n4.1 Revolving Credit Agreement dated May 10, 1991 between the Company and Shinhan Bank New York Branch (Incorporated by reference to Exhibit (4)(b) to the Report on Form 8-K dated May 10, 1991, Commission File Number 0-7207).\n4.2 Promissory Note dated May 10, 1991 in the maximum principal amount of $4,000,000 payable by the Company to Shinhan Bank New York Branch (Incorporated by reference to Exhibit (4) (c) to the Report on Form 8-K dated May 10, 1991, Commission File Number 0-7207).\n4.3 Term Loan Agreement between the Company and Shinhan Bank New York Branch dated November 5, 1991 (Incorporated by reference to Exhibit 4.1 to the quarterly report on Form 10Q for the quarter ended September 28, 1991, Commission File Number 0-7207).\n4.4 Promissory Note dated November 5, 1991 in the principal amount of $3,000,000 payable by the Company to Shinhan Bank New York Branch (Incorporated by reference to Exhibit 4.2 to the quarterly report on Form 10Q for the quarter ended September 28, 1991, Commission File Number 0-7207).\n4.5 General Loan and Security Agreement between the Company and Shinhan Bank New York Branch dated November 5, 1991 (Incorporated by reference to Exhibit 4.3 to the quarterly report on Form 10Q for the quarter ended September 28, 1991, Commission File Number 0-7207).\n4.6 Mortgage between the Company and Shinhan Bank New York Branch dated November 5, 1991 (Incorporated by reference to Exhibit 4.4 to the quarterly report on Form 10Q for the quarter ended September 28, 1991, Commission File Number 0- 7207).\n4.7 Revised repayment schedule between the Company and Shinhan Bank New York Branch dated December 23, 1994.\n4.8 Promissory Note dated May 31, 1995 in the maximum principal amount of $142,916 payable by the Company to Hartford Fire Insurance Company.\n10.1 1987 Stock Incentive Program, as amended in 1989 (Incorporated by reference to Appendix A to the Company's Proxy Statement dated September 22, 1989 for Annual Meeting of Stockholders to be held on November 2, 1989, Commission File Number 0- 7207).\n10.2 Warrant which is Exhibit B to the Second Restated Credit Agreement between the Company and Wells Fargo Bank, N.A. dated June 30, 1986 (Incorporated by reference to Exhibit 10.5 to the annual report on form 10-K for the year ended June 28, 1986, Commission File Number 0-7207).\n10.3 Warrant issued pursuant to a letter agreement between the Company and Arnhold and S. Bleichroeder, Inc. dated January 5, 1990 (Incorporated by reference to Exhibit 10.16 to the annual report on Form 10-K for the year ended June 30, 1990, Commission File Number 0-7207).\n10.4 Compensation agreement between the Company and Yoon H. Choo dated April 17, 1991 (Incorporated by reference to Exhibit 10.15 to the annual report on Form 10-K for the year ended June 29, 1991, Commission File Number 0-7207).\n10.5 Letter dated December 26, 1990 from the Company to Wells Fargo Bank, N.A. in respect of the Warrant dated July 23, 1986 (Incorporated by reference to Exhibit 10.16 to the annual report on Form 10-K for the year ended June 29, 1991, Commission File Number 0-7207).\n10.6 Letter dated December 26, 1990 from the Company to Arnhold and S. Bleichroeder, Inc. in respect of the Warrant dated January 5, 1990 (Incorporated by reference to Exhibit 10.17 to the annual report on Form 10-K for the year ended June 29, 1991, Commission File Number 0-7207).\n10.7 Letter Agreement dated January 5, 1990 between Arnhold and S. Bleichroeder, Inc. and the Company (Incorporated by reference to Exhibit (c)(1)(i) to the Form 8-K dated December 27, 1990 and filed January 3, 1991 by the Company, Commission File Number 0-7207).\n10.8 Stock Purchase Agreement dated as of November 30, 1990 between Newmax Co. Ltd. and the Company.\n21. Subsidiaries of the Company (Incorporated by reference to Exhibit 22 to the annual report on Form 10-K for the year ended June 30, 1990, Commission File Number 0-7207).\n23. Consent of KPMG Peat Marwick LLP to incorporation by reference of its report on Financial Statements in Registration Statements on Form S-8 Registration Nos. 2-81098, 2-81456, 2-89221, 2-96120, 2-96139, 33-14778 and 33-33567.\n27. Financial Data Schedule (For electronic filing purposes only).\nCopies of Exhibits listed above may be obtained for a nominal fee by writing to the Company's Investor Relations Department at 71 Smith Avenue, Kingston, New York 12401.\n(b) Reports on Form 8-K\nNone\n(c) Executive Compensation Plans and Arrangements\nName or Type Location of Plan Document Exhibit\nStock Incentive Program Proxy Statement Appendix A as amended in 1989 dated September 22, 1989 for Annual Meeting of Stock- holders on November 2, 1989, Commission File Number 0-7207.\nCompensation Agreement Annual Report on 10.15 dated April 17, 1991 Form 10-K for the between the Company year ended June 29, and Yoon H. Choo 1991, Commission File Number 0-7207.\n(This Page Intentionally Left Blank)\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nNATIONAL MICRONETICS, INC.\nBy DR. YOON H. CHOO Dr. Yoon H. Choo President and Chief Executive Officer\nDated: September 18, 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 18th day of September, 1995.\nSignature Title\nDR. YOON H. CHOO Chairman of the Board of Directors, (Dr. Yoon H. Choo) President, Chief Executive Officer, Treasurer and Secretary (Principal Executive, Financial and Accounting Officer).\nDR. HEEHWAN LEE Director, Vice President and Chief (Dr. Heehwan Lee) Operations Officer\nDirector (Mr. K.H. Chung)\nNATIONAL MICRONETICS, INC. AND SUBSIDIARIES\nPages\nIndependent Auditors' Report 29\nConsolidated Balance Sheets as of June 24, 1995 and June 25, 1994 30-31\nConsolidated Statements of Operations for the years ended June 24, 1995, June 25, 1994 and June 26, 1993 32\nConsolidated Statements of Changes in Stockholders' Equity for the years ended June 24, 1995, June 25, 1994 and June 26, 1993 33\nConsolidated Statements of Cash Flows for the years ended June 24, 1995, June 25, 1994 and June 26, 1993 34-35\nNotes to Consolidated Financial Statements 36-43\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Stockholders National Micronetics, Inc.:\nWe have audited the accompanying consolidated balance sheets of National Micronetics, Inc. and subsidiaries as of June 24, 1995 and June 25, 1994, and the related consolidated statements of operations, changes in stockholders' equity (deficit), and cash flows for each of the years in the three-year period ended June 24, 1995. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to report on these consolidated financial statements based on the results of our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant 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.\nThe accompanying consolidated financial statements have been prepared assuming that National Micronetics, Inc. and subsidiaries will continue as a going concern. The Company has suffered recurring losses from operations and has net capital deficiencies. As a result of these recurring losses, the Company has experienced a significant deterioration in liquidity. The Company has received funding for operations from its parent and affiliates in the current and prior years; however, the Company has no guarantee that this funding will continue. These circumstances raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are described in note 2. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.\nBecause of the effects on the consolidated financial statements of such adjustments, if any, as might have been required had the outcome of the uncertainty discussed in the preceding paragraph been known, we are unable to, and do not express, an opinion on the accompanying consolidated financial statements as of June 24, 1995 and June 25, 1994 and for each of the years in the three-year period ended June 24, 1995.\nKPMG PEAT MARWICK LLP Albany, New York August 30, 1995\nNATIONAL MICRONETICS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS\nJune 24, 1995 and June 25, 1994 (in thousands)\nASSETS\n1995 1994 Current assets (note 6): Cash and cash equivalents $ 538 $ 172 Trade receivables 125 49 Inventories (note 3) 814 371 Prepaid and other current assets 78 104\nTotal current assets 1,555 696\nProperty, plant and equipment, at cost (notes 4 and 6) 17,173 20,928 Less accumulated depreciation and amortization (13,328) (16,192)\nNet property, plant and equipment 3,845 4,736\nOther assets - 17 $ 5,400 $ 5,449\nSee accompanying notes to consolidated financial statements.\n(continued)\nNATIONAL MICRONETICS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS - Continued\nJune 24, 1995 and June 25, 1994\n(in thousands, except common share amounts)\nLIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)\n1995 1994\nCurrent liabilities: Current portion of long-term debt and lease obligations (note 6) $ 1,358 $ 3,073 Long-term debt classified as current (note 6) 3,170 1,421 Short-term debt (note 5) 4,896 4,896 Accounts payable 675 1,192 Accrued salaries and related expenses 212 463 Other accrued expenses 205 204 Due to related parties, net (note 10) 1,845 714\nTotal current liabilities 12,361 11,963\nLong term debt and lease obligations, less current portion (note 6) 98 - Total liabilities 12,459 11,963\nStockholders' equity (deficit) (note 7): Common stock ($.10 par value; authorized - 40,000,000 shares; issued 22,312,524) 2,231 2,231 Additional paid-in capital 58,343 57,289 Accumulated deficit (67,633) (66,034)\nTotal stockholders' deficit (7,059) (6,514)\nCommitments and contingencies (notes 2,4 and 11) $ 5,400 $ 5,449\nSee accompanying notes to consolidated financial statements.\nNATIONAL MICRONETICS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS\nYears ended June 24, 1995, June 25, 1994, and June 26, 1993\n(in thousands, except per share amounts)\n1995 1994 1993\nNet sales $ 3,822 $ 7,227 $12,664 Cost and expenses: Cost of products sold 3,849 7,777 15,287 Research, development and engineering 259 481 887 Selling and administration 712 816 849 4,820 9,074 17,023\nLoss from operations ( 998) (1,847) (4,359)\nOther expense (income): Interest expense 911 869 956 Interest income ( 3) ( 1) ( 4) Other (income) expense, net (307) ( 16) (228) 601 852 724\nLoss before income taxes (1,599) (2,699) (5,083)\nIncome taxes (note 8) - - -\nNet loss $(1,599) $(2,699) $(5,083) Loss per common and common equivalent share (note 1) $( .07) $( .12) $( .23)\nSee accompanying notes to consolidated financial statements.\nNATIONAL MICRONETICS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGE IN STOCKHOLDERS' EQUITY (DEFICIT)\nYears ended June 24, 1995, June 25, 1994 and June 26, 1993\n(in thousands, except common share amounts)\nAdditional Common Stock (note 7) Paid-In Accumulated Shares Par Value Capital (Deficit)\nBalance June 26, 1992 22,312,524 $ 2,231 $ 53,552 $ (58,252)\nNet loss -- 1993 - - - ( 5,083) Sale of assets to a related party (note 10) - - 566 -\nBalance June 26, 1993 22,312,524 2,231 54,118 (63,335)\nNet loss -- 1994 - - - (2,699)\nSale of assets to a related party (note 10) - - 3,171 - Balance June 25, 1994 22,312,524 2,231 57,289 (66,034)\nNet loss -- 1995 - - - ( 1,599)\nSale of assets to a related party (note 10) - - 1,054 - 22,312,524 $ 2,231 $ 58,343 $(67,633)\nSee accompanying notes to consolidated financial statements.\nNATIONAL MICRONETICS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS\nYears ended June 24, 1995, June 25, 1994 and June 26, 1993 (in thousands)\n1995 1994 1993 Cash flows from operating activities: Net loss $(1,599) $(2,699) $(5,083) Adjustments to reconcile net loss to net cash used by operating activities: Depreciation and amortization 723 992 1,104 Provision for losses on receivables - (28) (87) Retirements of property and equipment 168 70 169 Changes in operating assets and liabilities: Decrease (Increase) in trade receivables (76) 31 3,092 Decrease (Increase) in inventories (443) 110 866 Decrease (Increase) in other current assets 26 257 573 Decrease (Increase) in other assets 17 53 52 Increase (Decrease) in accounts payable and accrued expenses ( 767) (1,241) (1,633) Increase (Decrease) in due to related parties, net 1,131 (428) 247 Net cash used by operating activities ( 820) (2,883) ( 700) Cash flows from investing activities: Additions to property and equipment - - ( 90) Cash flows from financing activities: Sale of assets to a related party 1,054 3,171 566 Proceeds of long-term debt 143 - - Repayments on long-term debt and capitalized lease obligations ( 11) ( 914) (1,210) Proceeds of short-term debt - 741 1,160 Net cash provided by financing activities 1,186 2,998 516 Net increase (decrease) in cash and cash equivalents 366 115 (274) Cash and cash equivalents at beginning of year 172 57 331\nCash and cash equivalents at end of year $ 538 $ 172 $ 57\nSee accompanying notes to consolidated financial statements. (Continued)\nNATIONAL MICRONETICS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED\nYears ended June 24, 1995, June 25, 1994 and June 26, 1993\n1995 1994 1993\nSupplemental cash flow disclosures: Interest paid $422 $442 $635\nSee accompanying notes to consolidated financial statements.\nNATIONAL MICRONETICS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nJune 24, 1995, June 25, 1994 and June 26, 1993\n(1) Summary of Significant Accounting Policies\nOn December 24, 1990, Newmax Co., Ltd. (\"Newmax\") acquired a controlling interest (50.9%) in the Company through the purchase of common stock. Newmax, a Korean corporation, and its affiliate Tae Il Media Co., Ltd. (\"Tae Il\") operate businesses with product lines similar to that of the Company. The percentage ownership declined to 47.1% at June 27, 1992 due to other equity transactions of the Company. The Company has purchased components from and sold products and equipment to Newmax and its affiliates.\n(a) Principles of Consolidation The consolidated financial statements include National Micronetics, Inc. and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.\n(b) Consolidated Statements of Cash Flows For purpose of the statements of cash flows, the Company considers all highly liquid debt instruments with original maturities of three months or less to be cash equivalents.\n(c) Inventories Inventories are stated at the lower of cost or market. Cost is determined on a first-in, first-out basis.\n(d) Property, Plant and Equipment Depreciation and amortization for financial reporting purposes are provided by the straight-line method. Depreciation for tax purposes is on an accelerated method. Leasehold improvements are amortized either over the estimated useful lives of the improvements or the lease term (including option periods expected to be utilized) whichever is less.\n(e) Income Taxes In 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 of deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.\nNATIONAL MICRONETICS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued\n(1) Summary of Significant Accounting Policies, Continued\nEffective June 27, 1993, the Company adopted Statement 109. Based upon the calculation, there was no cumulative effect of that change in the method of accounting for income taxes required to be reported in the consolidated statement of operations.\n(f) Loss per share Loss per common share is computed by dividing net loss by the weighted average number of common and common equivalent shares outstanding during the respective periods. The weighted average number of common and common equivalent shares were 22,312,524 for fiscal years 1995, 1994 and 1993.\n(g) Fiscal year The Company's fiscal year ends on the last Saturday in June. Fiscal years ended June 24, 1995, June 25, 1994 and June 26, 1993 were all comprised of 52 weeks.\n(2) Liquidity and Management's Action Plan\nThe Company continues to experience negative cash flow from operations. Several factors have had a negative impact on liquidity including product development costs, qualification of products at customers, and under utilization of facilities.\nThe Company is aggressively seeking new orders with existing and new customers. During this rebuilding process, the Company will continue to need significant amounts of operating cash. The Company did not make the $329,000 payment due on June 30, 1995 to its primary lending institution due to its limited cash resources. An additional $329,000 payment is due by September 30, 1995. A revised payment schedule is being discussed with the primary lending institution but no agreement has been reached as to terms. Since December 1990, the Company has received direct and indirect support from its parent company to fund operational needs. Although there is no formal commitment for continuing support, Newmax has made no indication that this support will cease. The Company will continue to make every effort to become self sufficient and profitable.\nThe Company is hopeful that funds generated by operations and received from Newmax will be adequate to fund debt service and other operational needs. Although there is no firm commitment, related parties are expected to advance funds on a short-term as needed basis to offset operational cash shortfalls. Management believes that the combination of reduction in overhead spending and development of distribution markets for non-manufactured products will enable the Company to remain viable for the next twelve months.\nNATIONAL MICRONETICS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued\n(3) Inventories June 24, 1995 June 25, 1994\nFinished goods $ 667 $ 69 Work in process 61 52 Raw materials and supplies 86 250 $ 814 $ 371 Finished goods includes $639,000 of electronic light ballasts purchased from Tae Il for resale to distributors and lighting fixture manufacturers. The Company has the right of return for all of the ballast inventory if any remains unsold after one calendar year.\n(4) Property, Plant and Equipment June 24, June 25, Classification Life 1995 1994 (in thousands) Land - $ 267 $ 267 Buildings and improvements 20 years 7,869 7,875 Machinery and Equipment 3-8 years 8,791 12,368 Leasehold improvements and fixtures 3-10 years 246 418 $17,173 $20,928\nThe Company conducts certain of its operations using equipment under operating leases which expire at various intervals over the next three years. Total rental expense was $22,000, $16,000, and $28,000 for fiscal 1995, 1994, and 1993, respectively.\nThe total minimum rental commitments at June 24, 1995 under noncancellable operating leases are approximately $18,000.\n(5) Short-Term Debt\nA revolving credit agreement was established in April 1991 for $4,000,000 with a lending institution not previously used by the Company. This credit line was renewed on November 16, 1994 and has been collateralized by a Newmax affiliate. Collateral provided by the Newmax affiliate included a letter of credit issued by a Korean bank, which has been renewed until November 16, 1995. The Company expects the letter of credit to be renewed upon maturity. Interest on the revolving credit agreement is payable at prime plus 1% (10% at June 24, 1995; 8.25% at June 25, 1994). In addition to the above, the Company borrowed funds from affiliates Gigamax Corporation and Tae Il USA, Inc. from time to time during fiscal 1995, 1994 and 1993. These loans were unsecured at an 8% interest rate. At June 24, 1995 and June 25, 1994 the balance of these loans were $4,896,000. The average amount of short-term debt outstanding and weighted average interest for the year were $4,896,000 at 8% in fiscal 1995, $4,699,000 at 8% in fiscal 1994, and $3,785,000 at 8% in fiscal 1993. The maximum short-term debt outstanding was $4,896,000, $5,011,000 and $4,155,000 in fiscal 1995, 1994 and 1993, respectively. NATIONAL MICRONETICS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued\n(6) Long-Term Debt and Lease Obligations A summary of long-term debt and obligations under capitalized leases follows:\nAnnual Interest Rate at Balance at June 24, 1995 June 24, 1995 June 25, 1994 (in thousands)\nTerm loan 10% $ 1,645 $ 1,645 Converted revolving loan 9% 2,841 2,841 Capital leases-property, plant and equipment 13-14% 0 8 Debt settlement agreement 4% 140 - Total long-term debt 4,626 4,494\nLess: Current portion 1,358 3,073 Long-term debt classified as current 3,170 1,421\n$ 98 $ 0\nThe Company entered into a $3,000,000 term loan agreement with a lending institution on November 5, 1991. This loan, which based upon a December 23, 1994 revision matures on June 30, 1996, is secured by substantially all the assets of the Company which do not secure other debts. As a condition of this loan, the Company granted a $7,000,000 mortgage to the lending institution which serves as collateral for this loan as well as for a revolving credit agreement executed with the same lending institution in May 1991. Payments are scheduled quarterly through June 30, 1996. The term loan has been guaranteed by the related parties Newmax Co., Ltd., Tae Il Media Co., Ltd. and their President, Mr. K.H. Chung. The term loan agreement requires principal payments of $1,316,000 in fiscal 1996. The amended revolving credit agreement requires no payment until September 1996 and then four quarterly payments to pay the loan in full by June 30, 1997. The repayment terms have been modified to decrease the payments originally scheduled for both loans and extend payment terms through June 1997.\nThe Company did not make the $329,000 payment due June 30, 1995 to its primary lending institution due to its limited cash resources. A revised payment schedule is being discussed but no agreement has been reached as to terms. The long-term portion of the related debt has been reclassified as current due to the unresolved default on payment terms.\nLong-term debt maturities, base upon contractual terms, are as follows: Year Amount 1996 $1,358 1997 2,503 1998 757 1999 8 NATIONAL MICRONETICS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued\n(7) Common Stock and Employee Benefits\nOn June 24, 1992, Dae Bang Venture Capital Co., Ltd. purchased 1,575,000 shares of common stock at $.40 per share for a total of $630,000. The proceeds were recorded as an increase in stockholder's equity.\nOn December 27, 1990, Newmax purchased 10,500,000 shares of common stock at $.40 per share for a total of $4,200,000. The proceeds, net of expenses of $371,000 were recorded as an increase in stockholders' equity.\nThe Company issued a warrant in connection with a lending agreement which provided for the issuance of 1,131,165 shares of common stock at $3.00 per share exercisable to June 30, 1996. This exercise price was reduced to $.40 during fiscal 1991 upon the issuance of common stock to Newmax, in accordance with the original warrant. The warrant also includes a right of first refusal to buy a proportionate amount of stock which may be issued by the Company.\nUnder the terms of the Company's stock option plans, options outstanding at June 24, 1995 for the purchase of 50,700 shares of common stock have been issued to key employees. Options issued under the plans generally become exercisable over a period of from six months to five years from the date of grant at a price per share not less than the fair market value on the date of the grant. Amounts received upon exercise of options in excess of par value of shares sold are credited to additional paid-in capital.\nAs of June 24, 1995 and June 25, 1994 there were no outstanding restricted stock awards for shares issued under the Company's stock award plans.\nUnder the Stock Incentive Program 1,525,000 shares of Common Stock were authorized for the grant of options and the issuance of awards, of which 1,122,797 are available for future grants at June 24, 1995.\nOptions Outstanding Number of Shares Option Price Per Share June 27, 1992 163,700 $ .22 - $2.50 Cancelled (31,000) .22 - 1.00 June 26, 1993 132,700 .22 - 2.50 Cancelled (18,500) .22 - 2.13 June 25, 1994 114,200 .22 - 2.50 Cancelled (63,500) .22 - 1.13 June 24, 1995 50,700 $ .22 - $2.50\nOptions Exercisable: June 24, 1995 50,700 $ .22 - $2.50\nNATIONAL MICRONETICS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued\n(7) Common Stock and Employee Benefits, Continued\nThe Company's profit sharing plan covers all employees with six months employment with the Company at the beginning of each plan year, the Company's fiscal year. Contributions to the plan by the Company are made with its common shares. The annual contribution is determined under a formula which considers each participant's compensation for the plan year and the fair market value of the Company's common shares on the last trading day of the Company's fiscal year. The plan was amended effective June 28, 1987 to allow for Company matching contributions as specified by Internal Revenue Code Section 401(k). This matching contribution is based upon employee contributions to the Company's 401(k) retirement savings plan.\nThere was no contribution for fiscal 1993 through 1995. The plans as amended are intended to comply with the Internal Revenue Code and the Employee Retirement Income Security Act of 1974 and are administered by trustees appointed by the Board of Directors.\n(8) Income taxes\nNo income tax expense or benefit was recognized for fiscal 1995, 1994 and 1993 due to losses incurred and the inability to utilize these losses for income tax purposes. At June 24, 1995, the Company has net operating loss carryforwards of approximately $19,000,000 which will expire in years ending June 2006 through June 2010.\nCarryforwards from prior years have been limited due to the change in control of the Company which took place on December 24, 1990. Loss carryforwards available from years prior to the change in control, which are included above, are approximately $1,300,000.\nDeferred tax liabilities (assets) are comprised of the following at June 24, 1995:\nDepreciation $ 893,000\nNet operating loss carryforwards (4,710,000)\nInventory reserves (511,000)\nOther (16,000)\n(5,237,000)\nDeferred tax valuation allowance 4,344,000\nDeferred taxes, net $ 0\nNATIONAL MICRONETICS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued\n(9) Export Sales - Major Customers\nThe Company's operations consist entirely of the manufacture of recording heads. The principal products manufactured and sold are ferrite materials, recording head cores, and recording head assemblies. A recording head assembly is a significant component of a computer disk or tape memory.\nNet sales of the United States operations includes export sales as follows:\nAsia (in thousands) 1993 $12,383 1994 $ 7,021 1995 $ 3,587\nThe amount and percent of sales to those customers comprising 10 percent or more of total sales are shown below.\nComputer Products ($ in thousands) 1995 1994 1993 Major Customer 1 $ 3,302 - 86% $ 6,888 - 95% $ 3,740 - 30% Major Customer 2 - - - - $ 5,838 - 46% Major Customer 3 - - - - $ 2,550 - 20%\n(10) Related Party Transactions\nDuring fiscal 1995, 1994 and 1993, the Company sold equipment to Newmax for $1,281,000, $918,000 and $691,000 respectively. The gain on the sale of $1,054,000, $837,000 and $566,000,respectively, was recorded as additional paid-in capital and was not recognized in the consolidated statement of operations.\nInventory was sold to Newmax during fiscal 1994 and 1993 totalling $2,124,000 and $210,000, whereby Newmax retained the right to return the goods. These transactions were not recorded as sales due to the high probability that the goods would be returned. Effective June 25, 1994 Newmax waived the right of return on $2,334,000 of merchandise previously purchased. This amount has been recorded as an increase to additional paid-in-capital and not in the statement of operations due to the related party nature of the transactions. Net sales for fiscal 1995, 1994 and 1993 included sales of goods totalling $3,287,000, $5,825,000 and $2,539,000 respectively, to Newmax of products made to specification of Newmax's customer. These products required significant additional value added before sale to the ultimate customer. During fiscal 1994 and 1993, the Company has purchased approximately $187,000 and $6,562,000 respectively, of other goods from Newmax in the ordinary course of business.\n(continued) NATIONAL MICRONETICS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued\n(10) Related Party Transactions, Continued\nNewmax owed the Company $63,000 and the Company owed Newmax $49,000,respectively, at June 24, 1995 and June 25, 1994 which is included in the consolidated balance sheets under due to related parties, net.\nThe Company also sold products to Tae Il Media Co., Ltd. (\"Tae Il\") totalling approximately $ 15,000, $1,063,000 and $1,200,000 in fiscal 1995, 1994 and 1993, respectively. Tae Il sold the Company approximately $650,000 of electrical light fixture ballasts during Fiscal 1995. The Company owed Tae Il $640,000 at June 24, 1995. Tae Il owed the Company $ 10,000 at June 25, 1994. These balances have been included in the consolidated balance sheets under due to related parties, net.\nNewmax has provided quarantees via a letter of credit to assist in obtaining a $4 million revolving credit agreement. Gigamax has made short-term loans averaging $4,896,000 and $4,669,000 for fiscal 1995 and 1994 respectively. Both of these are also discussed in note (5). Included in due to related parties at June 24, 1995 and June 25, 1994 is $1,268,000 and $655,000 respectively due to Gigamax and Tae Il USA, Inc. for interest on short-term borrowings and other charges.\nAlthough negotiated in good faith, the impact of the above transactions on the financial statements may be significantly different than had the transactions been negotiated with unrelated parties.\n(11) Contingent Liabilities\nIn the ordinary course of business there are various legal proceedings pending against the Company. After consultation with outside counsel, management considers that the aggregate exposure, if any, arising from such litigation would not have a significant effect on the Company's financial condition. In addition, the Company has been identified as one of many potentially responsible parties for an Environmental Protection Agency Superfund site. Based upon the information available, management considers that the exposure arising from this action would not have a significant effect on the Company's consolidated financial statements.\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Stockholders National Micronetics, Inc.:\nUnder date of August 30, 1995, we reported on the consolidated balance sheets of National Micronetics, Inc. and subsidiaries as of June 24, 1995 and June 25, 1994, and the related consolidated statements of operations, changes in stockholders' equity (deficit) and cash flows for each of the years in the three-year period ended June 24, 1995. In connection with our audits of the aforementioned consolidated financial statements, we also have audited the related financial statement schedule as listed in the accompanying index. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to report on this financial statement schedule based on the results of our audits.\nThe accompanying financial statement schedule has been prepared assuming that National Micronetics, Inc. and subsidiaries will continue as a going concern. The Company has suffered recurring losses from operations and has net capital deficiencies. As a result of these recurring losses, the Company has experienced a significant deterioration in liquidity. The Company has received funding for operations from its parent and affiliates in the current and prior years; however, the Company has no guarantee that this funding will continue. These circumstances raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are described in note 2 to the consolidated financial statements. The financial statement schedule does not include any adjustments that might result from the outcome of this uncertainty.\nBecause of the effects on the financial statement schedule of such adjustments, if any, as might have been required had the outcome of the uncertainty discussed in the preceding paragraph been known, we are unable to, and do not express, an opinion on the accompanying financial statement schedule for the years ended June 24, 1995, June 25, 1994 and June 26, 1993.\nKPMG PEAT MARWICK LLP\nAlbany, New York August 30, 1995\nSchedule II\nNATIONAL MICRONETICS, INC. AND SUBSIDIARIES Valuation and Qualifying Accounts\nYears ended June 1995, 1994 and 1993 (in thousands)\nAccounts Balance at Charged to Written-off Balance beginning costs and as uncollectable, at end Description of period expenses net of recoveries of period\nYear ended June 1995:\nAllowance for doubtful accounts receivable $ 0 $ - $ - $ 0\nYear ended June 1994:\nAllowance for doubtful accounts receivable $ 33 $ (28) $ 5 $ 0\nYear ended June 1993:\nAllowance for doubtful accounts receivable $ 120 $ (87) $ - $ 33\nExhibits Filed Electronically\nPage\n3.1 Certificate of Incorporation of the Company dated 47 October 15, 1981.\n3.3 Amendment to the Certificate of Incorporation of the Company dated November 30, 1983. 49\n4.7 Revised repayment schedule between the Company and Shinhan Bank New York Branch dated December 23, 1994. 52\n4.8 Promissory Note by the Company payable to Hartford Fire Insurance Company dated May 31, 1995. 54\n10.8 Stock Purchase Agreement dated as of November 30, 1990 between Newmax Co., Ltd. and the Company. 57\n23 Consent of KPMG Peat Marwick LLP to incorporation by reference of its report on Financial Statements in Registration Statements on Form S-8 Registration Nos. 2-81098, 2-81456, 2-89221, 2-96120, 2-96139, 33-14778 and 33-33567. 73\n27 Financial Data Schedule (For electronic filing purposes only). 74\nExhibit 3.1\nCERTIFICATE OF INCORPORATION\nOF\nNATIONAL MICRONETICS, INC.\n* * * * *\n1. The name of the corporation is\nNATIONAL MICRONETICS, INC.\n2. The address of its registered office in the State of Delaware is No. 100 West Tenth Street, in the City of Wilmington, County of New Castle. The name of its registered agent at such address is The Corporation Trust Company.\n3. The nature of the business or purposes to be conducted or promoted is to engage in any lawful act or activity for which corporations may be organized under the General Corporation Law of Delaware.\n4. The total number of shares of stock which the corporation shall have authority to issue is four million (4,000,000) and the par value of each of such shares is Ten Cents ($.10), amounting in the aggregate to Four Hundred Thousand Dollars ($400,000.00).\n5. The name and mailing address of each incorporator is as follows:\nNAME MAILING ADDRESS\nK. L. Husfelt 100 West Tenth Street Wilmington, Delaware 19801\nB. A. Schuman 100 West Tenth Street Wilmington, Delaware 19801\nE. L. Kinsler 100 West Tenth Street Wilmington, Delaware 19801\n6. The corporation is to have perpetual existence.\n7. In furtherance and not in limitation of the powers conferred by statute, the board of directors is expressly authorized to make, alter or repeal the by-laws of the corporation.\nExhibit 3.1 Cont'd\n8. Elections of directors need not be by written ballot unless the by-laws of the corporation shall so provide.\nMeetings of stockholders may be held within or without the State of Delaware, as the by-laws may provide. The books of the corporation may be kept (subject to any provision contained in the statutes) outside the State of Delaware at such place or places as may be designated from time to time by the board of directors or in the by-laws of the corporation.\n9. The corporation reserves the right to amend, alter, change or repeal any provision contained in this certificate of incorporation, in the manner now or hereafter prescribed by statute, and all rights conferred upon stockholders herein are granted subject to this reservation.\nWE, THE UNDERSIGNED, being each of the incorporators herinbefore named, for the purpose of forming a corporation pursuant to the General Corporation Law of the State of Delaware, do make this certificate, hereby declaring and certifying that this is our act and deed and the facts herein stated are true, and accordingly have hereunto set our hands this 15th day of October, 1981.\nK. L. Husfelt K. L. Husfelt\nB. A. Schuman B. A. Schuman\nE. L. Kinsler E. L. Kinsler\nExhibit 3.3\nCERTIFICATE OF AMENDMENT\nOF\nCERTIFICATE OF INCORPORATION\nOF\nNATIONAL MICRONETICS, INC.\n* * * * *\nNATIONAL MICRONETICS, INC., a corporation organized and\nexisting under and by virtue of the General Corporation Law of the State of\nDelaware, DOES HEREBY CERTIFY:\nFIRST: That at a meeting of the Board of Directors of\nNational Micronetics, Inc., a resolution was duly adopted setting forth a\nproposed Amendment to the Certificate of Incorporation of said Corporation\ndeclaring said Amendment to be advisable and calling a meeting of the\nstockholders of said Corporation for consideration thereof. The resolution\nsetting forth the proposed amendment is as follows:\nRESOLVED, that the Certificate of Incorporation of this corporation be amended by changing paragraph 4 thereof so that, as amended, said paragraph shall be read as follows:\n\"4. This corporation is authorized to issue one class of shares to be designated Common Shares. The total number of shares of Common Shares this corporation shall have authority to issue is twelve million six hundred thousand (12,600,000).\n\"The Common shares may be issued from time to time in one or more series. The first series of Common Shares shall consist of 12,000,000 shares, par value Ten Cents ($0.10) per share, and shall be designated `Common Stock'. Upon amendment of this Certificate of Incorporation to read as herein set forth, each of the Company's currently outstanding shares of stock becomes a share of the series of Common Shares designated Common Stock. All other series of Common Shares shall collectively consist of 600,000 shares, par value One Cent ($0.01) per share and shall be designated, as a group `Junior Common Stock'. Exhibit 3.3 Cont'd\n\"The Board of Directors is authorized from time to time to determine or alter the rights, preferences, privileges, and restrictions to be granted or imposed upon any wholly unissued-series of Junior Common Stock, and to fix and issue the number of shares constituting any such series and the designation thereof; provided, however, that each such series shall provide that (1) if such series is convertible into Common Stock, each share of such series shall be convertible into no more than one share of Common Stock; (2) no dividend shall be declared on any share of such series unless there shall at the same time be declared a dividend equal to or greater in amount on each share of Common Stock then outstanding; (3) the holders of Common Stock shall be entitled to receive per share distributions on liquidations not less than the amounts per share to be received by holders of any share of such series; and (4) no share of such series shall have voting rights greater than an outstanding share of Common Stock; and provided further that, in connection with clauses (1), (2), (3) and (4) above, provision may be made for appropriate adjustments upon any stock split, reverse split, stock dividend or other subdivision, combination or distribution affecting the Common Stock or the Junior Common Stock. Within the limits and restrictions, if any, stated in any resolution of the Board of Directors originally fixing the number of shares constituting any such series, the Board of Directors is authorized to increase or decrease (but not below the number of shares of such series then outstanding) the number of shares of any series subsequent to the issue of such series. In case the number of shares of any series shall be so decreased, the shares constituting such series shall resume the status which they had prior to the adoption of the resolution originally fixing the number of shares of such series.\"\nSECOND: That thereafter, pursuant to resolution of its Board\nof Directors, a meeting of the stockholders of said Corporation was duly\ncalled and held, upon notice and in accordance with Section 222 of the\nGeneral Corporation Law of the State of Delaware, at which meeting the\nnecessary number of shares as required by statute were voted in favor of the\nsaid Amendment.\nExhibit 3.3 Cont'd\nTHIRD: That said Amendment was duly adopted in accordance\nwith the provisions of Section 242 of the General Corporation Law of the\nState of Delaware.\nIN WITNESS WHEREOF, said NATIONAL MICRONETICS, INC. has caused\nthe Certificate to be signed by Ned W. Buoymaster, Chairman of the Board of\nDirectors, and attested by Patrick A. Rivelli, its Secretary, this 30th day\nof November, 1983.\nNATIONAL MICRONETICS, INC.\n(CORPORATE SEAL) By: NED W. BUOYMASTER Chairman of the Board of Directors\nATTEST:\nPatrick A. Rivelli Secretary\nExhibit 4.7\nNational Micronetics, Inc. 71 Smith Avenue Kingston, New York 12401\nDecember 23, 1994\nMr. J. C. Lee Shinhan Bank New York Branch 800 Third Avenue New York, NY 10022\nDear J. C. Lee:\nThe purpose of this letter is to formally request revisions of repayment schedules for loans outstanding to your bank.\nAttached to this letter is a revised loan payment schedule addressing both the Revolving Credit and Term Loan balances.\nPlease sign and return a copy of this letter as your acknowledgement of acceptance of the revised payment schedule.\nVery truly yours,\nHEEHWAN LEE Dr. Heehwan Lee Vice President and Chief Operations Officer\nACCEPTED AND APPROVED\nJ. C. LEE December 23, 1994 J. C. Lee Date Shinhan Bank New York Branch\nHL\/LBH1 Attachment NATIONAL MICRONETICS, INC. 71 Smith Avenue Kingston, New York 12401\nNATIONAL MICRONETICS, INC.\nLoan Payment Schedule - Shinhan Bank\nDate Term Loan Revolving Credit\nJune 30, 1995 329,000 - 0 -\nSeptember 30, 1995 329,000 - 0 -\nDecember 31, 1995 329,000 - 0 -\nMarch 31, 1996 329,000 - 0 -\nJune 30, 1996 329,000 - 0 -\nSeptember 30, 1996 - 0 - 710,000\nDecember 31, 1996 - 0 - 710,000\nMarch 31, 1997 - 0 - 710,000\nJune 30, 1997 - 0 - 711,000\n$1,645,000 $2,481,000\nHL\/LBH2\nExhibit 4.8\nPROMISSORY NOTE\nPrincipal Amount: $142,916.00 New York, New York May 31, 1995\nFOR VALUE RECEIVED, the Undersigned, NATIONAL MICRONETICS, INC., having its principal place of business at 71 Smith Avenue, Kingston, New York 12401 (hereinafter referred to as \"Maker\"), promises to pay to the order of HARTFORD FIRE INSURANCE COMPANY, at One Waterside Crossing, Hartford, Connecticut, 06095 attention: Mr. Robert Fournier (hereinafter referred to as \"Holder\"), or at such other place as Holder may designate from time to time in writing, the principal sum of One Hundred Forty Two Thousand Nine Hundred Sixteen ($142916.00) Dollars, (the \"Principal Sum\"), together with interest at a rate of four (4%) percent per annum upon the terms and conditions set forth herein.\nPayment Terms\nAll amounts owing under this Note, if not sooner paid, shall be due and payable as follows: a) In forty (40) equal monthly installments of principal and interest of $3,900.00 due on the first day of June, 1995 and on the first day of each month thereafter and continuing monthly until the entire balance of said principal sum if any, with accrued interest shall be due and payable.\nAll amounts owing under this Note and interest thereon shall be payable in legal tender of the United States of America. Any and all payments received by Holder hereunder shall be applied first to interest and then to principal. The unpaid principal or interest balance of this Note may be prepaid in whole or in part, at the election of the Maker at any time or from time to time without premium. Such prepayments shall be applied in inverse order of priority, first to accrued and unpaid interest and then to principal.\nDefault Interest\nAll past due principal and, if permitted by applicable law, all past due interest, shall bear interest at the highest rate permitted by applicable law, or if no such maximum rate is established by applicable law, then at the rate of eighteen (18%) percent per annum. During the existence of any default hereunder or under any instrument securing or evidencing the loan hereunder, the entire unpaid balance or principal shall bear interest at the highest rate permitted by applicable law, or if no such maximum rate is established by applicable law, then at a rate of eighteen (18%) percent per annum.\nExhibit 4.8 Cont'd Security\nTo secure the payment of this Note, Maker is simultaneously executing a Confession of Judgement for the principal amount of this Note. The Confession of Judgement shall be held in escrow pursuant to a separate Escrow Agreement which is being executed simultaneously herewith.\nSetoff\nIn the event of any and all future retrospective adjustments, result in a credit due maker by holder, then maker shall, after receipt of its retrospective adjustment, have the right to offset the credit against its obligations hereunder. Such offset shall be applied to the last payments of principal due hereunder in inverse order of priority.\nDefault\nUpon the occurrence of an Event of Default, as hereinafter defined, all sums due hereunder shall, at Holder's option, Immediately become due and payable. As used herein, the term \"Event of Default\" shall mean:\na) Any failure of Maker to pay any amounts due hereunder or under the Note, which failure is not cured by Maker within ten (10) days;\nb) Any failure of Maker to perform any covenants, agreements or provisions of a Stipulation of Settlement being executed simultaneously herewith or the Note;\nc) If Maker becomes insolvent or is unable to pay debts as they mature or makes an assignment for the benefit of creditors or liquidating agent is appointed, or if any of said parties make a bulk sale or transfer of thier assets or issue a notice of intended bulk sale or transfer;\nd) If any proceeding in bankruptcy or any suit, proceeding, petition or action under any provision of the Bankruptcy Code for reorganization, liquidation or dissolution shall be commenced by or against the Maker;\ne) If a receiver of the Maker, or any of its property be appointed in any jurisdiction at law or in equity;\nf) If a judgement shall be recovered or order of attachment or injunction shall be issued against any of the property of the maker;\ng) If there is an appointment of a receiver, liquidator, assignee, custodian, trustee or other similar official for all or any substantial part of the property of the Maker, extending on the date of such appointment; and\nh) A default in the payment of any other indebtedness due or to become due the Holder or a default in the performance of any other obligation to the Holder hereof by the Maker. The failure to exercise any such option or any other right hereunder, or any delay in such exercise, shall not waive the right to exercise such option or any other right at a later time so long as such Event of Default remains uncured, and shall not waive the right to exercise such option or other right upon the occurence of any other Event of Default.\nMaximum Interest Rate\nNotwithstanding the foregoing, it is not intended hereby to charge interest at a rate in excess of the maximum rate of interest to be charged to the Maker under applicable law but if, notwithstanding, by virtue of the payment of interest; Holder would be entitled to receive an amount which exceeds the said maximum rate of interest, then and in such event, the payment shall be reduced to an amount which, together with the interest due hereunder, would not exceed such maximum rate.\nWaiver\nMaker and each and every endorser of this Note and each other person who may become liable for all or any part of the obligation evidenced hereby do hereby waive demand, presentment for payment, protest, notice of protest, and notice of non-payment of this Note.\nApplicable Law\nThis Note shall be governed by and construed in accordance with the laws of the State of New York. This Note shall bind Maker's heirs, executors, administrators, successors and assigns and all endorsers hereto, and shall inure to the benefit of Holder and its successors and assigns. This Note may not be changed or terminated orally, but only by written agreement signed by the party against whom enforcement of any such change or termination is sought.\nInvalidity\nIn the event that any one or more of the provisions of this Note shall for any reason be held to be invalid, illegal or unenforceable, in whole or in part, or in any respect, or in the event that any one or more of the provisions of this Note shall operate, or would prospectively operate, to invalidate this Note, then, and in any such event, such provision or provisions only shall be deemed to be null and void and of no force or effect and shall not affect any other provision of this Note, and the remaining provisions of this Note shall remain operative and in full force and effect, shall be valid, legal and enforceable, and shall in no way be affected, prejudiced or disturbed thereby.\nMAKER:\nNATIONAL MICRONETICS, INC.\nBy: HEEHWAN LEE HEEHWAN LEE, VICE PRESIDENT Exhibit 10.8\nSTOCK PURCHASE AGREEMENT\nExhibit 10.8 Cont'd\nArticle Page\n1. Purpose .................................................. 1 2. Reorganization of NMI ..................................... 2 3. Subscription for Shares ................................... 2 4. Transfer of Shares ........................................ 5 5. Preemptive Right .......................................... 6 7. Board of Directors ........................................ 6 8. Basic Corporate and Operating Policies .................... 6 9. Accounts and Auditing ..................................... 7 10. Technical Assistance ...................................... 8 11. Term ...................................................... 8 12. Termination ............................................... 8 13. Consequences of Termination ............................... 9 14. Non Waiver \/ Other Remedies ............................... 9 15. Unenforceable Terms ....................................... 10 16. Force Majeure ............................................. 10 17. Disclaimer of Agency ...................................... 10 18. Arbitration ............................................... 10 19. Assignability ............................................. 11 20. Expenses .................................................. 11 21. Implementation of the Agreement ........................... 11 22. Enforcement Costs ......................................... 10 23. Notice .................................................... 12 24. Language .................................................. 13 25. Governing Law ............................................. 13 26. Effective Date ............................................ 13 27. Entire Agreement .......................................... 13 Exhibit 3.1(a) ........................................... 15 Exhibit 3.3(d) ........................................... 16\nExhibit 10.8 Cont'd\nSTOCK PURCHASE AGREEMENT\nTHIS AGREEMENT made the 30th day of November, 1990, by and between NEWMAX Co., Ltd., a company organized and existing under the laws of the Republic of Korea with its registered head office at 27-15 Songjeong-dong, Cheong-joo, Chungbuk, 360-290, Korea (hereinafter referred to as \"NEWMAX\") and National Micronetics, Inc., a company organized and existing under the laws of the State of Delaware with its principal office at 71 Smith Avenue, Kingston, NY 12401, U.S.A. (hereinafter referred to as \"NMI\").\nWITNESSETH:\nWHEREAS, NEWMAX manufactures and sells, inter alia, electro magnetic recording head products and parts and components thereof;\nWHEREAS, NMI manufactures ferrite cores as well as final recording head assemblies (\"the Products\"); and\nWHEREAS, NEWMAX wishes to purchase new shares of capital stock of NMI and NMI is willing to issue and sell the shares to NEWMAX for its operations of manufacturing, sales and development activities in Foreign Country.\nNOW, THEREFORE, the parties hereby agree as follows:\nARTICLE 1. Purpose\nThe purpose of NMI will be to;\na) engage in the manufacture, marketing, promotion, sale, export and distribution of ferrite core and electro magnetic recording head products;\nb) engage in any and all acts, things, businesses and activities which are related, incidental or conductive directly or indirectly to the attainment of the foregoing objects\nPg. 1 of Stock Purchase Agreement Exhibit 10.8 Cont'd\nARTICLE 2. Reorganization of NMI\n2.1 Promptly upon receipt of all necessary Foreign Country and Korean government approvals and validations for this Agreement and the investment contemplated herein by NEWMAX, including, without limitation approvals under relevant laws of Foreign Country, all in form and substance acceptable to all parties (hereinafter referred to as the \"Government Approvals\"), NMI shall endeavor its best to expand and to improve its operations of manufacturing and selling the products in the Foreign Country. The name of NMI shall be \"National Micronetics, Inc.\" in English, which is the language of the Foreign Country.\n2.2 NMI shall take all actions necessary to ensure that NMI's Certificate of Incorporation and By-Laws are amended, if necessary to carry out this Agreement, promptly upon receipt of the Government Approvals.\nARTICLE 3. Subscription for Shares\n3.1 (a) Subject to the terms and conditions of this Agreement, pursuant to the authority conferred by the relevant resolutions of NMI's Board of Directors (which are in the form attached hereto as Exhibit 3.1 (a), and upon receipt of payment of the subscription price as set forth in this Paragraph 3.1, NMI shall take such steps as are necessary, on or after the Closing Dates (as hereinafter defined), to issue to NEWMAX, and NEWMAX shall acquire from NMI ten million five hundred thousand (10,500,000) shares of common stock, par value $0.10 per share of NMI (the \"New Shares\") in exchange for a subscription price of four million two hundred thousand U.S. dollars (U.S. $4,200,000), payable on or immediately after the Closing Dates.\n(b) During a period of approximately twenty years, NMI has issued 10,121,561 shares of common stock par value $0.10 per share, and those shares are owned by thousands of stockholders.\n3.2 The Closing and issuance of all or a portion of the New Shares as provided in Paragraph 3.1 shall take place at the offices of Blum, Gersen & Stream; 270 Madison Avenue, New York, New York 10016, the United States of America, on or before January 2, 1991 and on the dates designated by NEWMAX (the \"Closing Dates\").\n(a) NEWMAX shall give NMI three (3) day's written notice of said Closing Dates.\n(b) NMI's Board of Directors on September 27, 1990 already has adopted appropriate resolutions, which are attached as Exhibit 3.1(a) hereto, to permit NMI to issue the New Shares.\nPg. 2 of Stock Purchase Agreement Exhibit 10.8 Cont'd\n(c) No person has any preemptive rights in the New Shares so that NEWMAX may acquire the full number of shares referred to in Paragraph 3.1(a).\n3.3 NMI hereby represents and warrants to NEWMAX as follows:\n(a) NMI is a corporation duly organized, validly existing and in good standing under and by virtue of the laws of the State of Delaware in the Foreign Country, with corporate power and all necessary licenses and permits to own its properties and to conduct its business as now conducted and as contemplated by its Certificate of Incorporation currently in force.\n(b) The authorized capital of NMI consists of twenty-five million (25,000,000) common shares having a par value of U.S. $0.10 per share. NMI has no other class of capital shares authorized, outstanding, or issued. NMI has issued capital stock consisting of 10,121,561 shares of common stock.\n(c) After the issuance of the New Shares as contemplated by this Agreement, the capital stock of NMI will be owned as follows:\nPercentage of Stockholders Number of Shares Shares Issued\nNEWMAX 10,500,000 51% Foreign Shareholders 10,121,561 49%\nTOTAL 20,621,561 100%\n(d) All of the issued and outstanding shares of NMI stock are validly issued, fully paid and non-assessable. The New Shares shall, upon issuance and payment therefor, be validly issued, fully paid and non-assessable. There are no outstanding subscription, options, warrants, calls, commitments or agreements to which NMI is bound, which relate to the issuance or sale by it of any shares of NMI stock nor any securities convertible into any shares of any class, except for the issuance of shares of NMI stock contemplated by this Agreement and the issuance of shares of NMI stock as more fully described in Exhibit 3.3(d) in the following amounts for the following purposes:\nPurpose Number of Shares\nWarrant dated June 30, 1986 1,131,165 Warrant dated January 5, 1990 150,000 1987 Stock Incentive Program 1,525,000 Profit Sharing Plan Discretionary\nPg. 3 of Stock Purchase Agreement Exhibit 10.8 Cont'd\n(e) No consent of any other party and no consent, License, approval or authorization of any governmental body is required in connection with the execution, delivery, validity or enforceability of this Agreement, except for the Government Approvals, and subject to the receipt of the Government Approvals, the execution, delivery and performance of this Agreement and the businesses and activities contemplated by NMI will not conflict with, be in violation of, or constitute a default under NMI's Certificate of Incorporation, any provision of any agreement, judgement, statute, government approval, rule or regulation applicable to NMI or result in a default under any mortgage, lien, encumbrance or charge upon the assets or property of NMI. This Agreement constitutes the valid and legally binding agreement of NMI, enforceable in accordance with its terms, subject to laws of general application relating to bankruptcy, insolvency and the relief of debtors and rules of law governing specific performance. Injunctive relief or other equitable remedies.\n(f) NMI has delivered to NEWMAX financial statements of NMI for the fiscal year ended on June 30, 1990, which were prepared in accordance with generally accepted accounting principles of the Foreign Country and were audited in accordance with generally accepted auditing practices in the Foreign country by KPMG Peat Marwick, independent public accountants, who disclaimed any opinion about them, and assuming that NMI remains as a going concern, such financial statements fairly present the financial condition of NMI as of such date and the results of its operations for the year then ended.\n(g) Since the end of its fiscal year ended on June 30, 1990, NMI has not suffered any material adverse change in its financial condition, assets, liabilities or business.\n(h) There are no legal actions pending or threatened against NMI, or any order, decree or other action of the government of the Foreign Country, that might adversely affect this transaction or the present or future business activities of NMI.\n3.4 At the three Closings to be held on the three Closing Dates, as a condition precedent to the obligation of NEWMAX to purchase the New Shares;\n(a) NMI and NEWMAX shall each be satisfied (1) that the Government Approvals have been obtained in acceptable form and substance and (11) that all representations and warranties of the other party made in this Agreement are true and accurate.\n(b) NEWMAX shall be satisfied that all necessary corporate actions for the issuance of the New Shares have been taken by NMI as required by this Agreement.\nPg. 4 of Stock Purchase Agreement Exhibit 10.8 Cont'd\n3.5 The purchase by NEWMAX of the New Shares from NMI shall take place as follows:\n(a) At the first Closing, NMI shall issue and shall deliver to NEWMAX or its designee a stock certificate for two million five hundred thousand (2,500,000) shares of common stock of NMI, registered in the name of NEWMAX, and NEWMAX shall cause its bank to wire good United States funds in the amount of one million dollars ($1,000,000) to the bank account designated by NMI.\n(b) At the second Closing, NMI shall issue and shall deliver to NEWMAX or its designee a stock certificate for two million five hundred-thousand (2,500,000) shares of common stock of NMI, registered in the name of NEWMAX, and NEWMAX shall cause its bank to wire good United States funds in the amount of one million dollars ($1,000,000) to the bank account designated by NMI.\n(c) At the third Closing, NMI shall issue and shall deliver to NEWMAX or its designee a stock certificate for five million five hundred thousand (5,500,000) shares of common stock of NMI, registered in the name of NEWMAX, and NEWMAX shall cause its bank to wire good United States funds in the amount of two million two hundred thousand dollars ($2,200,000) to the bank escrow account designated by Blum, Gersen & Stream, as escrow agent for NEWMAX and NMI.\n3.6 All shares issued by NMI to NEWMAX shall be common shares with full voting rights, registered in the name of NEWMAX and evidenced by share certificates bearing an endorsement as follows:\n\"The shares represented by this certificate have not been registered under the Securities Act of 1933, as amended. This certificate may not be transferred except in compliance with the terms of an agreement between the issuer and Newmax Co., Ltd., dated November 30th, 1990, a copy of which is on file at the office of the issuer.\"\nArticle 4. Transfer of shares\nNEWMAX shall not pledge, sell, transfer, or otherwise encumber or dispose of all or any of its shares in NMI without the prior written consent of NMI, unless those shares shall be registered pursuant to applicable securities laws or exempt from registration in the opinion of counsel for NMI, provided that NEWMAX may transfer its shares in NMI, subject to the restrictions in Paragraph 3.6 and in this Article 4, to any third party which controls NEWMAX, is controlled by NEWMAX or is under common control with NEWMAX (an \"affiliate\" of NEWMAX), without such consent of NMI. For this purpose \"control\" shall mean the direct or indirect ownership of more than fifty (50%) percent of the voting stock of a corporate entity.\nPg. 5 of Stock Purchase Agreement Exhibit 10.8 Cont'd Article 5. Preemptive Right No shareholders of NMI shall have preemptive rights and the certificate of incorporation of NMI shall not be amended to grant preemptive rights to shareholders.\nArticle 6. Meetings and Resolutions of Shareholders\n6.1 The Board of Directors of NMI shall decide the time and place for convening all meetings of the shareholders of NMI except where the General Corporation Law of the State of Delaware provides otherwise.\n6.2 All meetings of shareholders of NMI shall be conducted in English, which is the language of the Foreign Country, and all minutes of the meeting of shareholders of NMI shall be prepared in English.\n6.3 All actions and resolutions of the shareholders of NMI shall be adopted by the affirmative vote of a majority of the shares represented at the meeting where more than one-half of the total number of issued and outstanding shares of NMI are represented unless otherwise required by this Agreement or the laws of the State of Delaware in the Foreign Country.\nArticle 7. Board of Directors\n7.1 The Board of Directors of NMI shall increase the number of directors comprising the entire board of directors of NMI from five persons to seven persons and shall nominate five individuals designated by NEWMAX for election as directors.\n7.2 The Board of Directors of NMI shall elect from among its members president of NMI and shall appoint such other officers as it considers necessary and appropriate to operate NMI.\n7.3 The Board of Directors of NMI shall amend the By-Laws of NMI to provide that special meetings of the Board of Directors may be called at the request of the President when he deems the same to be necessary or advisable, or shall be called by the President when any two directors so request.\n7.4 At all meetings of the Board of Directors of NMI, a majority of the directors shall constitute a quorum for the transaction of business and the act of a majority of the directors present at any meeting at which there is a quorum shall be act of the Board of directors, except as may be otherwise specifically provided by statue or by the certificate of incorporation of NMI.\nArticle 8. Basic Corporate and Operating Policies The parties are in agreement on the following corporate and operating policies. The parties agree to make their best efforts to effectuate such policies during the continuance of this Agreement:\nPg. 6 of Stock Purchase Agreement Exhibit 10.8 Cont'd\n8.1 NEWMAX or its designees may agree to purchase additional shares of common stock of NMI from time to time so that NEWMAX or its designees will continue to own more than 50% of the entire issued capital of NMI.\n8.2 The general policies of NMI regarding the salaries, bonuses and other emoluments of directors, officers and employees of NMI shall be reviewed annually by NEWMAX in consultation with the directors of NMI and general practice current in the foreign Country shall be taken into consideration. Directors who are not officers of NMI will not receive any remuneration unless otherwise agreed upon by the directors of NMI. Compensation and severance pay of directors who are officers of NMI shall be determined in accordance with regulations adopted by a majority of the disinterested directors of NMI.\n8.3 The annual financial statements of NMI will be subject to annual audit by the independent public accountant of NMI selected by mutual agreement of the directors who are nominated by NEWMAX and the directors who are nominated by NEWMAX in accordance with the recommendations of the Audit Committee of the Board of Directors of NMI, subject to the approval of the shareholders of NMI at the Annual Meeting, such audit to be completed within sixty (60) days of the end of the fiscal year. NMI will issue to the shareholders on a semi-annual basis and within forty-five (45) days of the end of the relevant month, financial statements, all of which shall be submitted in English at the expense of NMI.\nArticle 9. Accounts and Auditing\n9.1 The books and records of NMI shall be maintained in accordance with generally accepted accounting principles of the Foreign country and NEWMAX's administrative guidance and requirements under the supervision of the Audit Committee of the Board of Directors of NMI and shall accurately reflect the financial position of NMI and the results of operations of NMI. Such records and supporting documents shall be available for inspection by the directors or by their designee at all reasonable times. NEWMAX may request an audit of such records by an independent public accountant of its selection, other than the independent public accounting firm usee by NMI for its annual audit, at the expense of NEWMAX.\n9.2 The parties hereto agree to cause the books and records of NMI to be audited at the end of each fiscal year during the term of this Agreement by an independent public accounting firm of NMI (\"Annual Audit\"). Such firm of accountants shall yearly perform an audit on the financial statements in accordance with generally accepted audited standards and shall provide the parties with a financial report in English in accordance with generally accepted accounting principles of the Foreign country. Copies of the financial statements prepared in connection with such Annual Audits shall be provided to NEWMAX at the expense of NMI.\nPg. 7 of Stock Purchase Agreement Exhibit 10.8 Cont'd\nSuch Annual Audits shall be final and binding upon the parties as to the revenue, costs, fees, expenses, losses and profits of NMI, absent manifest error or fraud.\nArticle 10. Technical Assistance\n10.1 The parties shall mutually provide technical assistance and patent licenses to the other party under the terms of a technical assistance agreement to be agreed to by the parties, subject to appropriate governmental approval.\nArticle 11. Term\nThis agreement shall continue in effect as long as NEWMAX holds at least twenty (20%) percent of the outstanding shares in NMI unless earlier terminated pursuant to Article 12 herein below.\nArticle 12. Termination\nNotwithstanding the foregoing, this Agreement may be terminated forthwith upon the sending of notice in writing upon the occurrence of one or more of the following events:\na) by either party, if this Agreement has not been approved by the relevant authorities in form and substance acceptable to such party within three(3) months from the date this Agreement is signed by both parties;\nb) by the other party, if either party shall commit a breach of any of its obligations under this Agreement which it shall fail to remedy within ten(10) days from written notice being given requiring that breach to be remedied;\nc) by the other party, if either party shall be or become incapable for a period of twenty-one (21) days of performing any of its obligations under this Agreement because of any event covered by Article 16 hereof about force majeure;\nd) by the other party, if either party or its creditors or any other eligible party shall file for that party's dissolution, liquidation, bankruptcy, reorganization or compulsory composition or if that party has entered into dissolution, liquidation, bankruptcy, reorganization or compulsory composition or that party is unable to pay any debts as they become due, has explicitly or implicitly suspended payment of any debts as they become due or has liabilities which exceed its assets, or if the creditors of that party have taken over its management or if the relevant financial institutions have suspended that party's revolving credit privileges or if any material or significant part of that party's undertaking, property or assets shall be expropriated or confiscated by action of any government;\nPg. 8 of Stock Purchase Agreement Exhibit 10.8 Cont'd e) by NEWMAX, if any agreements entered into for the purpose of implementing this Agreement, are terminated for any reason other than NEWMAX breach;\nf) by NEWMAX, if its common share equity in NMI after all three Closings falls below forty-five (45%) percent of the issued and outstanding common stock of NMI for reasons other than NEWMAX's voluntary sale or transfer of the New Shares;\ng) by NEWMAX, if any of the warranties or representations made by NMI to NEWMAX pursuant to Article 3 of this Agreement are found to be false or misleading, or if any of the covenants made therein for the benefit of NEWMAX are not complied with.\nArticle 13. Consequences of Termination\n13.1 Termination of this Agreement shall be without prejudice to the accrued rights and liabilities of the parties at the date of termination, unless waived in writing by the mutual agreement of the parties.\n13.2 After a termination of this Agreement, NEWMAX shall have the option to have its name or names and\/or its trademarks or other distinctive designations removed from the name of and from use by NMI. If NEWMAX opts to have its name so removed, NMI shall take all step necessary to remove the name, trademark or trade name of or any reference to NEWMAX, or the language of the Foreign Country equivalent of NEWMAX's name, as appropriate. After a termination of this Agreement, NMI agrees that, upon NEWMAX's request, NMI shall immediately return to NEWMAX the proprietary information which is covered by any of NEWMAX'S technical know-how, patents or other industrial property rights and reproductions or copies thereof or other written documents relating thereto and retain no reproductions or copies.\nArticle 14. Non-Waiver \/ Other Remedies\n14.1 Failure of either party hereto to insist upon the strict and punctual performance of any provision hereof shall not constitute waiver of, or estoppel against asserting the right to require such performance, nor should a waiver or estoppel in one case constitute a waiver or estoppel with respect to a later breach whether of similar nature or otherwise.\n14.2 Nothing in this Agreement shall prevent a party from enforcing its rights by such remedies as may be available in lieu of termination.\nPg. 9 of Stock Purchase Agreement Exhibit 10.8 Cont'd\nArticle 15. Unenforceable Terms\nIn the event any term or provision of this Agreement shall for any reason be invalid, illegal or unenforceable in any respect such invalidity, illegality or unenforceability shall not affect any other term or provision of this Agreement and this Agreement shall be interpreted and construed as if such term or provision, to the extent unenforceable, had never been contained in this Agreement.\nArticle 16. Force Majeure\n16.1 The failure or delay of either party hereto to perform any obligation under this Agreement solely by reason of acts of God, acts of government (except as otherwise enumerated herein), riot, wars, strikes, lockouts, accidents in transportation or other causes beyond its control shall not be deemed to be a breach of this Agreement; provided, however, that the party so prevented from complying herewith shall continue to take all actions within its power to comply as fully as possible herewith.\n16.2 Except where the nature of the event shall prevent it from doing so, the party suffering such force majeure shall notify the other party in writing within five (5) days after the occurrence of such force majeure and shall in every instance, to the extent it is capable of doing so, use its best efforts to remove or remedy such cause with all reasonable dispatch.\nArticle 17. Disclaimer of Agency\nThis Agreement shall not be deemed to constitute either party hereto the agent of the other party hereto.\nArticle 18. Arbitration\nAll disputes, controversies, or differences which may arise between the parties, out of or in relation to or in connection with this Agreement, or for the breach hereof, shall be finally settled by arbitration before three (3) arbitrators under the Rules of the Commercial Arbitration and Conciliation of the International Chamber of Commerce in New York, New York or in Seoul, Korea, as the party against which the initial claim will have been asserted may elect. NMI and NEWMAX shall each be entitled to nominate one arbitrator and the arbitrators selected by NMI and NEWMAX shall mutually agree upon the selection of the third arbitrator. The arbitration proceeding shall be conducted in English. The results of such arbitration shall be conclusive and binding upon the parties, and shall be enforceable in any court having jurisdiction over the party against whom the award was rendered.\nPg. 10 of Stock Purchase Agreement Exhibit 10.8 Cont'd\nArticle 19. Assignability\nThis Agreement and each and every covenant, term and condition hereof shall be binding upon and inure to the benefit of the parties hereto and their respective successors and assignees, but neither this Agreement nor any rights or obligations hereunder shall be assignable directly or indirectly by either party hereto without the prior written consent of the other party except for an assignment by NEWMAX to its affiliate as described in Article 4 hereinabove.\nArticle 20. Expenses\nEach party shall bear its own attorney fees and other expenses incurred to obtain approval of this Agreement and shall hold the other party harmless for any such charges.\nArticle 21. Implementation of the Agreement\n21.1 Each party undertakes to carry out this Agreement in good faith and to respect the spirit as well as the letter of its provisions.\n21.2 NEWMAX agrees that neither NEWMAX nor its parent companies, subsidiaries or affiliated companies shall undertake any activities, whether pursuant to a joint venture arrangement, technical assistance or otherwise which shall be detrimental to the purpose of this Agreement as set forth in Article 1 hereof.\n21.3 The parties agree to enter into and execute any and all such further agreements, documents and the like as may be necessary or beneficial to carry our the purposes of this Agreement.\nArticle 22 Enforcement Costs\nEach party hereto agrees to pay and discharge all reasonable costs, attorney fees and expenses (including, but not limited to the costs of litigation or arbitration) that are incurred by the other party hereto in enforcing the terms of this Agreement; provided that such other party shall prevail in such proceedings.\nPg. 11 of Stock Purchase Agreement Exhibit 10.8 Cont'd\nArticle 23. Notice\n23.1 Any notice required or permitted to be given hereunder shall be in writing and may be given by personal service, registered airmail, or by telefacsimile, cable or telex if confirmed on the same day in writing by registered airmail, with postage fully prepaid, to the following addresses:\nTo NEWMAX at: Newmax Co., Ltd. 333-18, Yang Jae-Dong Seocho-Ku, Seoul, Korea 137-130 Attention: Mr. K. H. Chung, President Telex No: TIMKO K26997 Answerback: Telefacsimile: 011-822-572-4979 Cable Address:\nTo NMI at: National Micronetics, Inc. 71 Smith Avenue Kingston, New York 12401 USA Attention: Mr. Robert C. Ristagno Telex No: Answerback: Telefacsimile: 001-1-914-338-0377\nAND\nBlum, Gersen & Stream 270 Madison Avenue 7th Floor New York, NY 10016 USA Attention: Daniel Gersen, Esq. Telefacsimile: 001-1-212-686-2040\n23.2 Any notice so given shall be deemed to be received if by letter: (a) upon receipt or fourteen (14) days after posting, whichever is less, for airmail sent between Korea and the Foreign Country or any other country, or (b) upon receipt or seven (7) days after posting, whichever is less, for mail sent within Korea, the Foreign country or any other country: or if by telefacsimile, telex or cable: forty-eight (48) hours (during business days in the locale of the addressee) after dispatch.\n23.3 To prove services of notice, it shall be sufficient to prove that a letter, telefacsimile, telex or cable containing the notice was properly addressed and properly dispatched or posted.\nPg. 12 of Stock Purchase Agreement Exhibit 10.8 Cont'd\nArticle 24. Language\nThis Agreement is written in English and executed in at least two(2) counterparts, each of which shall be deemed an original. The English language text of this Agreement shall prevail over any translation thereof.\nArticle 25. Governing Law\nThis Agreement shall be interpreted in accordance with and governed by the substantive laws of the State of New York.\nArticle 26. Effective Date\nThis Agreement shall come into effect upon the date both parties hereto have added their signatures or names and seals to the same or different counterparts hereof.\nArticle 27. Entire Agreement\n27.1 This Agreement supersedes all previous representations, understandings or agreements, oral or written, between the parties with respect to the subject matter hereof, and together with the exhibits hereto and the agreements and documents contemplated hereby contain the entire understanding of the parties as to the terms and conditions of their relationship.\n27.2 Terms included herein may not be contradicted by evidence of any prior oral or written agreement or of a contemporaneous oral or written agreement.\n27.3 No changes, alterations or modifications hereto shall be effective unless in writing and signed by authorized representatives of both parties hereto and if required, upon approval by the competent authorities of each party.\n27.4 Headings of Articles in this Agreement are for convenience only and do not substantively affect the terms of this Agreement.\nIN WITNESS WHEREOF the authorized representatives of the parties hereto have set their hands or their names and seals, the day and year first above written.\nPg. 13 of Stock Purchase Agreement Exhibit 10.8 Cont'd\nNEWMAX CO., LTD.\nBY K. H. CHUNG Name: K. H. Chung Title: President\nNATIONAL MICRONETICS, INC.\nBY ROBERT C. RISTAGNO Name: Robert C. Ristagno Title: President\nPg. 14 of Stock Purchase Agreement Exhibit 23\nConsent of Independent Auditors'\nThe Board of Directors National Micronetics, Inc.:\nWe consent to incorporation by reference in the Registration Statement Nos. 2-81098, 2-81456, 2-89221, 2-96120, 2-96139, 33-14778 and 33-33567 on Forms S-8 of National Micronetics, Inc. of our report dated August 30, 1995, relating to the consolidated balance sheets as of June 24, 1995 and June 25, 1994, and the consolidated statements of operations, changes in stockholders' equity and cash flows and related schedule for each of the years in the three-year period ended June 24, 1995 which report appears in the June 24, 1995 annual report on Form 10-K of National Micronetics, Inc.\nOur report dated August 30, 1995 contains an explanatory paragraph that states that the Company's recurring losses from operations, its net capital deficiencies, the deterioration in liquidity and other matters raise substantial doubt about the Company's ability to continue as a going concern.\nBecause of the effects on the consolidated financial statements of such adjustments, if any, as might have been required had the outcome of the uncertainty discussed in the preceding paragraph been known, we were unable to, and did not express, an opinion on the consolidated financial statements and schedule as of June 24, 1995 and June 25, 1994 and for each of the years in the three-year period ended June 24, 1995.\nKPMG PEAT MARWICK LLP\nAlbany, New York September 18, 1995","section_15":""}
{"filename":"771983_1995.txt","cik":"771983","year":"1995","section_1":"ITEM 1. BUSINESS\nThe registrant, First Capital Income Properties, Ltd. - Series XI (the \"Partnership\"), is a limited partnership organized in 1985 under the Uniform Limited Partnership Act of the State of Illinois. The Partnership sold $57,621,000 in Limited Partnership Assignee Units (the \"Units\") to the public from September 1985 to March 1987 pursuant to a Registration Statement on Form S-11 filed with the Securities and Exchange Commission (Registration Statement No. 2-98749). Capitalized terms used in this report have the same meaning as those terms have in the Partnership's Registration Statement.\nThe business of the Partnership is to invest primarily in existing commercial income-producing real estate, such as shopping centers, warehouses and office buildings, and, to a lesser extent, in other types of commercial income- producing real estate. From May 1986 to September 1989, the Partnership: 1) made one real property investment; 2) purchased 50% interests in four joint ventures which were each formed with Affiliated partnerships for the purpose of acquiring a 100% interest in certain real property; 3) purchased 50% interests in four separate joint ventures which were each formed with Affiliated partnerships for the purpose of acquiring a preferred majority interest in certain real property and 4) purchased a 70% preferred majority undivided interest in a joint venture with an unaffiliated third party that was formed for the purpose of acquiring certain real property. All of these joint ventures, prior to dissolution, are operated under the common control of First Capital Financial Corporation (the \"General Partner\"). As of December 31, 1995 the Partnership, with its respective joint venture partner, has dissolved one joint venture with a 50% interest in real property and three joint ventures with 50% preferred majority interests in real property as a result of the sales of the real properties. In addition, the Partnership sold one 50% joint venture interest with an Affiliated partnership to that Affiliated partnership.\nProperty management services for certain of the Partnership's real estate investments are provided by independent real estate management companies for fees calculated as a percentage of gross rents received from the properties. In addition, Affiliates of the General Partner provide property management and supervisory services for fees calculated as a percentage of gross rents received from each of the Partnership's properties.\nThe real estate business is highly competitive. The results of operations of the Partnership will depend upon the availability of suitable tenants, real estate market conditions and general economic conditions which may impact the success of these tenants. Properties owned by the Partnership frequently compete for tenants with similar properties owned by others.\nAs of March 1, 1996, there were 34 employees at the Partnership's properties for on-site property maintenance and administration.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES (a)(b)\nAs of December 31, 1995, the Partnership owned directly or through a joint venture, the following five properties, which were owned in fee simple and were encumbered by mortgages. For complete details of the material terms of the encumbrances, refer to Note 5 of the Notes to Financial Statements.\n(a) For a discussion of significant operating results and major capital expenditures planned for the Partnership's properties refer to Item 7.\n(b) For federal income tax purposes, the Partnership depreciates the portion of the acquisition costs of its properties allocable to real property (exclusive of land), and all improvements thereafter, over useful lives ranging from 19 years to 40 years, utilizing either the Accelerated Cost Recovery System (\"ACRS\") or straight-line method. The Partnership's portion of real estate taxes for Marquette Mall and Office Building (\"Marquette\"), Regency Park Shopping Center (\"Regency Park\"), Sentry Park West Office Campus (\"Sentry West\"), Burlington Office Center I, II and III (\"Burlington\") and Prentice Plaza was $377,500, $130,500, $123,400, $436,500 and $217,200, respectively, for the year ended December 31, 1995. In the opinion of the General Partner, the Partnership's properties are adequately insured and serviced by all necessary utilities.\n(c) Represents the total number of tenants as well as the number of tenants, in parenthesis, that individually occupy more than 10% of the net leasable square footage of the property.\n(d) The Partnership owns a 50% joint venture interest in this property.\n(e) The Partnership owns a 50% interest in a joint venture which owns a preferred majority interest in the joint venture which owns the property.\n(f) The Partnership owns a 70% undivided interest in the joint venture which owns this property.\nITEM 2. PROPERTIES - Continued - ------- ----------------------\nThe following table presents each of the Partnership's properties' occupancy rates as of December 31 for each of the last five years:\nThe amounts in the following table represent each of the Partnership's properties' average annual rental rate per square foot for each of the last five years ended December 31 and were computed by dividing each property's base rental revenues by its average occupied square footage:\nITEM 2. PROPERTIES - Continued - ------- ----------------------\nThe following table summarizes the principal provisions of the leases for each of the tenants which occupy ten percent or more of the rentable square footage at each of the Partnership's properties, except Sentry West which has no such tenants:\n(a) The Partnership's share of per annum base rents for each of the tenants listed above for each of the years between 1996 and the final twelve months for each of the above leases is no lesser or greater than the amounts listed in the above table.\n(b) This tenant does not physically occupy any space at this property but continues to pay rent under the terms of its lease.\nITEM 2. PROPERTIES - Continued - ------- ----------------------\n(c) Tenant has one three-year renewal option and one additional five- year renewal option.\n(d) During the first quarter of 1996, this tenant exercised one of its five-year renewal options. The effects of this exercise are included in the table above.\nThe amounts in the following table represent the Partnership's portion of leases in the year of expiration (assuming no lease renewals) (a) through the year ended December 31, 2005.\n(a) This table does not include the effects of the exercised renewal option at Burlington, previously discussed.\n(b) Represents the Partnership's portion of base rents to be collected each year on expiring leases.\n(c) Represents the Partnership's portion of base rents to be collected each year on expiring leases as a percentage of the Partnership's portion of the total base rents to be collected on leases in effect as of December 31, 1995.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS - ------- -----------------\n(a & b) The Partnership and its properties were not a party to, nor the subject of, any material pending legal proceedings, nor were any such proceedings terminated during the quarter ended December 31, 1995. Ordinary routine litigation incidental to the business which is not deemed material was maintained during the quarter ended December 31, 1995.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - ------- ---------------------------------------------------\n(a, b, c & d) None.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S EQUITY AND RELATED SECURITY HOLDER MATTERS - ------- ----------------------------------------------------------------------\nThere has not been, nor is there expected to be, a public market for Units.\nAs of March 1, 1996, there were 5,278 Holders of Units.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA - ------- -----------------------\nITEM 6. SELECTED FINANCIAL DATA - Continued - ------- -----------------------------------\nThe following table includes a reconciliation of Cash Flow (as defined in the Partnership Agreement) to cash flow provided by operating activities as determined by generally accepted accounting principles (\"GAAP\"):\n(a) Cash Flow is defined in the Partnership Agreement as Partnership revenues earned from operations (excluding tenant deposits and proceeds from the sale, disposition or financing of any Partnership properties or the refinancing of any Partnership indebtedness), minus all expenses incurred (including Operating Expenses, payments of principal (other than balloon payments of principal out of Offering proceeds) and interest on any Partnership indebtedness, and any reserves of revenues from operations deemed reasonably necessary by the General Partner), except depreciation and amortization expenses and capital expenditures and lease acquisition expenditures.\nThe above selected financial data should be read in conjunction with the financial statements and the related notes appearing on pages A-1 through A-8 in this report and the supplemental schedule on pages A-9 and A-10.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The ordinary business of the Partnership is expected to pass through its life cycle in three phases: (i) the Offering of Units and Investment in Properties; (ii) the operation of properties and (iii) the sale or other disposition of properties.\nThe Partnership commenced the Offering of Units on September 12, 1985 and began operations on December 3, 1985 after reaching the required minimum subscription level. On March 31, 1987, the Offering was Terminated upon the sale of 57,621 Units. From May 1986 to September 1989, the Partnership: 1) made one real property investment; 2) purchased 50% interests in four joint ventures which were each formed with Affiliated partnerships for the purpose of acquiring a 100% interest in certain real property; 3) purchased 50% interests in four separate joint ventures which were each formed with Affiliated partnerships for the purpose of acquiring a preferred majority interest in certain real property and 4) purchased a 70% preferred majority undivided interest in a joint venture with an unaffiliated third party that was formed for the purpose of acquiring certain real property.\nOne of the Partnership's objectives is to dispose of its properties when market conditions allow for the achievement of the maximum possible sales price. In 1993 the Partnership, in addition to being in the operation of properties phase, entered the disposition phase of its life cycle. During the disposition phase of the Partnership's life cycle, comparisons of operating results are complicated due to the timing and effect of property sales and dispositions. Partnership operating results are generally expected to decline as real property interests are sold or disposed of since the Partnership no longer receives income generated from such real property interests. As of December 31, 1995 the Partnership, with its respective joint venture partner, has dissolved one joint venture with a 50% interest in real property and three joint ventures with 50% preferred majority interests in real property as a result of the sales of the real properties. In addition, the Partnership sold one 50% joint venture interest with an Affiliated partnership to that Affiliated partnership.\nThe past year was disappointing for most retailers throughout the country. Gross margins and consequently profits were negatively impacted as retailers attempted to turn inventories. The prospects for expansion in 1996 are also minimal, if nonexistent. The poor sales performance of retailers has resulted in less demand for store space, further retailer consolidations and an increased number of bankruptcies. Factors utilized by prospective property purchasers such as higher capitalization and discount rates resulted in lower prices than previously seen in years. In addition, downward pressure on rent, upward pressure on tenant improvement costs and larger reserves for capital expenditures also negatively affected the pricing of retail assets. Marquette Mall and Office Building (\"Marquette\") and Regency Park Shopping Center (\"Regency Park\"), which accounted for 50% of the Partnership's rental revenues for the year ended December 31, 1995, have also experienced other issues which have affected their estimated fair market values. While operations at Marquette have remained stable, its estimated fair market value has been plagued by the national issues affecting retail operations. Capital and tenant improvement costs have been substantial. Recent efforts to sell Marquette at a price approximating its carrying value have been unsuccessful. With respect to Regency Park, the vacancy of an anchor tenant's space for a significant period of time has had a negative impact on the property's appeal to existing and prospective tenants. While the tenant has continued to pay rent pursuant to its lease, the Partnership has experienced difficulty leasing the specialty retail space which surrounds this area of the property. The General Partner has been negotiating with two merchants to each sublet a portion of the vacant space and currently anticipates that each of these stores will be open for business by the third quarter of 1996. While there can be no assurances that either of these two merchants will sublease space at Regency Park, if negotiations are completed and they do take occupancy, then the lease-up of the vacant specialty space may improve.\nThe Partnership's three office buildings accounted for the remaining 50% of the Partnership's gross rental revenues for the year ended December 31, 1995. Several factors have had an effect on operating performance and market values of certain office buildings. While occupancy rates have generally continued to gradually improve, the age of the Partnership's office buildings and increased competition from newer buildings with higher vacancy has caused rental rates to either decline or remain relatively stable in most instances.\nThe General Partner has historically reviewed significant factors regarding the properties, such as those mentioned above, to determine that the properties are carried at lower of cost or market, and where appropriate, has made value impairment adjustments. These factors include, but are not limited to: 1) recent and\/or budgeted operating performance; 2) research of market conditions; 3) economic trends affecting major tenants; 4) economic factors related to the region where the properties are located and 5) when available, recent property appraisals. As a result of the current year review, the Partnership has recorded provisions for value impairment totaling $5,600,000 for the year ended December 31, 1995. Of this amount, $5,100,000 relates to the Partnership's two retail properties and $500,000 relates to one of the Partnership's office buildings. For more details related to these provisions, see Note 10 of Notes to Financial Statements. The General Partner will continue to evaluate real estate market conditions affecting each of the Partnership's properties, in its efforts to maximize the realization of proceeds on their eventual disposition. The recording of the provisions for value impairment does not impact cash flows as defined by generally accepted accounting principles or Cash Flow (as defined in the Partnership Agreement).\nOPERATIONS The table below is a recap of certain operating results of each of the Partnership's properties for the years ended December 31, 1995, 1994 and 1993. The discussion following the table should be read in conjunction with the Financial Statements and Notes thereto appearing in this report.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED)\n(a) Excludes certain income and expense items which are either not directly related to individual property operating results such as interest income, interest expense on the Partnership's Front-End Fees loan and general and administrative expenses or are related to properties disposed of by the Partnership prior to the periods under comparison. (b) Property net (loss) income excludes (losses) from provisions for value impairment which were included in the Statements of Income and Expenses for the years ended December 31, 1995, 1994 and 1993 (see Note 10 of Notes to Financial Statements for additional information). (c) The joint venture which owns Regency Park in which the Partnership has a 50% interest, sold a parcel of land at Regency Park on March 1, 1993. The property net (loss) excludes the (loss) of $(41,600) from the sale of the parcel of land, which was included in the Statement of Income and Expenses for the year ended December 31, 1993 (see Note 9 of Notes to Financial Statements for additional information). (d) The joint ventures which owned Park Central Office Park I, II and III (\"Park Central\"), in which the Partnership had a 50% interest, sold Park Central on June 29, 1994. The property net income excludes the (loss) of $(104,100) from the sale of the property, which was included in the Statement of Income and Expenses for the year ended December 31, 1994 (see Note 9 of Notes to Financial Statements for additional information). (e) The joint venture which owned Sentry Park East Office Campus (\"Sentry East\"), in which the Partnership had a 50% interest, sold one of five office buildings situated in this office campus on July 1, 1993, a second building was sold on October 14, 1993 and a third building was sold on April 22, 1994. The property net (losses) exclude the (losses) from the sales of these buildings which were previously reported by the Partnership as a provision for value impairment which was included in the Statement of Income and Expenses for the year ended December 31, 1992. In addition, on December 29, 1994, the joint venture sold the remaining two office buildings situated in this office campus. The property net (loss) excludes the gain of $292,500 on the sale of these two buildings which was included in the Statement of Income and Expenses for the year ended December 31, 1994 (see Note 9 of Notes to Financial Statements for additional information).\nCOMPARISON OF THE YEAR ENDED DECEMBER 31, 1995 TO THE YEAR ENDED DECEMBER 31, Net (loss) for the Partnership decreased $3,027,100 from $(10,580,500) for the year ended December 31, 1994 to $(7,553,400) for the year ended December 31, 1995. The effects of the sales of certain Partnership properties during 1994 and provisions for value impairment recognized in 1994 and 1995 had a significant impact on the comparison of net (loss) for the year ended December 31, 1995 as compared to 1994. As previously described, the Partnership recorded provisions for value impairment of $5,600,000 during 1995. During 1994, the Partnership recorded provisions for value impairment of $10,000,000 and sold the three remaining office buildings at Sentry East as well as Park Central. Properties sold during 1994 accounted for net income (including operating results and the net gain on sales of properties) of $160,700. For further information, see the table above and the notes thereto as well as Notes 9 and 10 of Notes to Financial Statements.\nExcluding the effects on net income of the properties sold and provisions for value impairment, net (loss) for the year ended December 31, 1995 decreased $78,300 when compared to the year ended December 31, 1994. The decrease in net (loss) was primarily due to improved operating results totaling $325,500 at Regency Park, Marquette, Sentry Park West Office Campus (\"Sentry West\") and Prentice Plaza as well as lower general and administrative expenses of $36,400 primarily due to lower fees for professional and data processing services. Partially offsetting the decrease in net (loss) was lower operating results of $165,500 at Burlington Office Center I, II and III (\"Burlington\") and an increase of $102,600 in interest expense on the Partnership's Front-End Fees loan due to an increase in the variable interest rate and an increase in printing and mailing costs.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED)\nFor purposes of the following comparative discussion, the operating results of Park Central and Sentry East have been excluded.\nRental revenues increased $130,900, or 1%, for the year ended December 31, 1995 when compared to the year ended December 31, 1994. The increase was primarily due to: 1) increases in the average occupancy rate at Sentry West, Regency Park and Prentice Plaza; 2) an increase of $79,600 in percentage rental income at Marquette resulting from higher tenant sales which determine the amount of percentage rents to be paid to the Partnership; 3) an increase in tenant expense reimbursements of $57,800 at Regency Park as a result of the increase in the average occupancy rate as well as the receipt in 1995 of reimbursements related to 1994 and 4) an increase in tenant expense reimbursements of $14,000 at Sentry West primarily as a result of the increase in the average occupancy rate. Partially offsetting the 1995 increase in rental revenues was: 1) lower rental revenues at Burlington due to a decrease in the average occupancy rate primarily as a result of a major tenant exercising a cancellation clause in its lease and downsizing its leasable square footage from 19,700 square feet to 2,500 square feet, a decrease of 10% of the total leasable square footage of the property; 2) the receipt of lease termination fees in 1994 from two tenants at Marquette totaling $137,600; 3) lower tenant expense reimbursements totaling $48,800 as a result of a refund to tenants in 1995 of previously billed 1994 expense reimbursements at Marquette and Prentice Plaza as well as additional 1993 expense reimbursements received in 1994 at Marquette and 4) lower percentage rental income of $29,500 at Regency Park.\nDepreciation and amortization expense decreased $188,100 for the years under comparison. The decrease was primarily due to the reduction in expense as a result of the provisions for value impairment recorded for several Partnership properties for the year ended December 31, 1994. In addition, the periodic depreciation and amortization expense for certain assets for which the depreciable and amortizable lives expired during 1995 exceeded the periodic depreciation and amortization expense for depreciable and amortizable assets placed in service during 1995.\nReal estate tax expense decreased $82,900 for the year ended December 31, 1995 when compared to 1994. The decrease was primarily due to a decrease of $64,500 at Marquette as a result of an overestimate of the 1994 tax liability paid in 1995 as well as a decrease in the 1995 projected liability payable in 1996 and a lower expense of $43,300 at Burlington as a result of the Partnership's successful protest in 1993 which resulted in reduced billings in subsequent periods. Partially offsetting the decrease was an increase in real estate tax expense of $23,500 at Prentice Plaza as a result of an increase in the assessed valuation of the property for real estate tax purposes.\nInsurance expense decreased $34,400 for the year ended December 31, 1995 when compared to 1994. The decrease was primarily due to lower group rates on the Partnership's combined insurance coverage as a result of a minimal amount of claims made over the past several years.\nInterest expense on the Partnership's mortgage loans increased $256,100 for the year ended December 31, 1995 when compared to the year ended December 31, 1994. The increase was primarily due to increases in the principal balance and variable interest rate on the junior mortgage loan collateralized by Marquette as well as an increase in the variable interest rate on the mortgage loan collateralized by Sentry West.\nProperty operating expense increased $42,300 for the year ended December 31, 1995 when compared to the year ended December 31, 1994. The increase was primarily due to: 1) increases at Prentice Plaza, Sentry West and Regency Park as a result of the increases in rental revenues which is a factor in determining the amount of property management and leasing fees; 2) an increase in advertising and promotional fees, security costs and training and development costs at Marquette; 3) an increase in professional service fees at Prentice Plaza, Burlington, Sentry West and Regency Park and 4) increased utility costs at Sentry West. Partially offsetting the increase in property operating expense was: 1) lower utility costs at Burlington and Marquette; 2) lower professional service fees as well as management and leasing fees at Marquette and 3) lower advertising and promotional fees at Regency Park.\nCOMPARISON OF THE YEAR ENDED DECEMBER 31, 1994 TO THE YEAR ENDED DECEMBER 31, Net (loss) for the Partnership increased $207,000 from $(10,373,500) for the year ended December 31, 1993 to $(10,580,500) for the year ended December 31, 1994. The effects of sales and disposition of certain Partnership properties as well as provisions for value impairment recognized in 1994 and 1993 had significant impact on the comparison of net (loss) for the year ended December 31, 1994 when compared to 1993. As described above, the Partnership reported provisions for value impairment of $10,000,000 during 1994 and sold the three remaining office buildings at Sentry East as well as Park Central. During 1993, the Partnership reported provisions for value impairment of $8,300,000, sold two office buildings at Sentry East and sold a parcel of land at Regency Park. As described above, properties sold during 1994 accounted for net income (including operating results and the net gain on sales of properties) of $160,700. Properties sold during 1993 accounted for a net (loss) (including operating results and the net (loss) on the sale of property) of $(255,700). For further information, see the table above and the notes thereto as well as Notes 9 and 10 of Notes to Financial Statements.\nExcluding the effects on net (loss) of the properties sold and provisions for value impairment, net (loss) for the year ended December 31, 1994 increased $211,800 when compared to the year ended December 31, 1993. The increase in net (loss) was primarily due to: 1) decreased operating results totaling $499,200 at Marquette and Burlington; 2) an increase in interest expense of $87,700 on the Partnership's Front-End Fees loan due to an increase in the variable interest rate and 3) a decrease in interest income of $28,400 primarily resulting from a decrease in the funds available for short-term investments. Partially offsetting the increase in net (loss) was: 1) improved operating results totaling $169,500 at Prentice Plaza, Sentry West and Regency Park; 2) the payment in 1993 of $87,700 in loan extension fees on a one-year extension of the junior mortgage loan collateralized by Marquette and 3) lower general and administrative expenses of $44,800 primarily due to a decrease in printing and mailing expenses, professional service fees and Indiana state sales taxes being assessed to the Partnership in 1993 for the tax years 1989, 1990 and 1992.\nFor purposes of the following comparative discussion, the operating results of Park Central and Sentry East have been excluded.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED) Rental revenues decreased $77,700, or 1%, for the year ended December 31, 1994 when compared to the year ended December 31, 1993. The decrease was primarily due to: 1) decreases in the average occupancy rate at Burlington and Marquette; 2) a decrease of $200,400 in percentage rental income at Marquette resulting from lower tenant sales which determine the amount of percentage rents to be paid to the Partnership and 3) a one-time lease buyout fee received in 1993 at Sentry West for $35,000. Partially offsetting the decrease in rental revenues was: 1) increases in the average occupancy rate at Sentry West and Prentice Plaza; 2) the receipt of lease termination fees in 1994 from two tenants at Marquette totaling $137,600 and one tenant at Prentice Plaza of $27,300 and 3) an increase of $45,100 in percentage rental income at Regency Park.\nInterest expense on the Partnership's mortgage loans increased $126,100 for the year ended December 31, 1994 when compared to the year ended December 31, 1993. The increase was primarily due to an increase in the variable interest rates on the mortgage loans collateralized by Marquette and Sentry West.\nProperty operating expense increased $36,400 for the year ended December 31, 1994 when compared to the year ended December 31, 1993. The increase was primarily due to: 1) increases in professional service fees at Marquette, Sentry West and Prentice Plaza; 2) increases in utility costs at Burlington, Sentry West and Regency Park and 3) higher advertising and promotional costs at Regency Park. Partially offsetting the increase in property operating expense was decreases in: 1) advertising and promotional costs at Marquette; 2) professional service fees at Burlington; 3) utility costs at Marquette; 4) security costs at Prentice Plaza and 5) property management and leasing fees at Burlington.\nReal estate tax expense increased $34,900 for the year ended December 31, 1994 when compared to 1993. The primary factor which contributed to this increase was an increase of $42,400 at Burlington as a result of the receipt of a refund of $67,700 in 1993 for the tax years 1991 and 1992 as well as a reduced billing for the 1993 tax year which was the result of the General Partner's protest. Partially offsetting the increase in real estate tax expense was a decrease of $14,200 at Marquette in 1994 due to an overestimate of the 1993 tax liability.\nRepairs and maintenance expense increased $24,000 for the year ended December 31, 1994 when compared to the year ended December 31, 1993. Each property's contribution to this net increase in repairs and maintenance was that: 1) Prentice Plaza increased $15,500 primarily due to an increase in janitorial expenses resulting from a higher average occupancy rate; 2) Regency Park increased $13,500 primarily due to the repairs, maintenance and restriping of the parking lot in 1994; 3) Marquette increased $9,100 due to higher snow removal and HVAC repairs and maintenance costs, partially offset by a decrease in the expenditures made in order to enhance the inside appearance of the building; 4) Burlington decreased $8,200 due to lower personnel costs, partially offset by higher expenditures in order to enhance the appearance of the building and 5) Sentry West decreased $5,900 due to decreases in expenditures to enhance the appearance of the building and for the repairs and maintenance of the HVAC system, partially offset by an increase in the cost of snow removal.\nDepreciation and amortization expense decreased $61,000 for the years under comparison due to the fact that the periodic depreciation and amortization expense for certain assets for which the depreciable and amortizable lives expired during 1994 exceeded the periodic depreciation and amortization expense for depreciable and amortizable assets placed in service during 1994.\nInsurance expense decreased $9,800 for the year ended December 31, 1994 when compared to the prior year. The decrease was primarily due to lower group rates on the Partnership's combined insurance coverage as a result of a minimal amount of claims made over the past several years.\nTo increase and\/or maintain occupancy levels at the Partnership's properties, the General Partner, through its Affiliated asset and property management groups, continues to take the following actions: 1) implementation of marketing programs, including hiring of third-party leasing agents or providing on-site leasing personnel, advertising, direct mail campaigns and development of building brochures; 2) early renewal of existing tenant leases and addressing any expansion needs these tenants may have; 3) promotion of local broker events and networking with local brokers; 4) networking with national level retailers; 5) cold-calling other businesses and tenants in the market area; and 6) providing rental concessions or competitively pricing rental rates depending on market conditions.\nThe rate of inflation has remained relatively stable during the years under comparison and has had a minimal impact on the operating results of the Partnership. The nature of various tenant lease clauses protects the Partnership, to some extent, from increases in the rate of inflation. Certain of the lease clauses provide for the following: (1) annual rent increases based on the Consumer Price Index or graduated rental increases; (2) percentage rentals at shopping centers, for which the Partnership receives as additional rent a percentage of a tenant's sales over predetermined breakeven amounts and (3) total or partial tenant reimbursement of property operating expenses (e.g., common area maintenance, real estate taxes, etc.).\nLIQUIDITY AND CAPITAL RESOURCES Cash Flow (as defined in the Partnership Agreement) is generally not equal to Partnership net (loss) or cash flows as defined by GAAP, since certain items are treated differently under the Partnership Agreement than under GAAP. The General Partner believes that to facilitate a clear understanding of the Partnership's operations, an analysis of Cash Flow (as defined in the Partnership Agreement) should be examined in conjunction with an analysis of net income or cash flows as defined by GAAP. The table in Item 6. Selected Financial Data includes a reconciliation of Cash Flow (as defined in the Partnership Agreement) to cash flow provided by operating activities as defined by GAAP. Such amounts are not indicative of actual distributions to Partners and should not necessarily be considered as an alternative to the results disclosed in the Statements of Income and Expenses and Statements of Cash Flows.\nThe decrease in Cash Flow (as defined in the Partnership Agreement) of $260,600 for the year ended December 31, 1995 when compared to the year ended December 31, 1994 was primarily due to the change in net (loss) previously discussed, exclusive of the decrease in depreciation and\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED) amortization expense, the (loss) from provisions for value impairment and the net gain on the sales of properties, components of which have been previously discussed, as well as to an increase in scheduled principal payments made on the Partnership's regularly scheduled amortizing mortgage loans.\nThe decrease of $281,000 in the Partnership's cash position for the year ended December 31, 1995 was primarily the result of payments for capital and tenant improvements and leasing costs, principal payments on mortgage loans payable and the payment of loan extension fees exceeding the proceeds received on the junior mortgage loan collateralized by Marquette, the proceeds received on the refinancing of the mortgage loan collateralized by Prentice Plaza, the net cash provided by operating activities as well as the releases of the restricted certificate of deposit for Regency Park and the restricted escrow deposit for Marquette. The liquid assets of the Partnership as of December 31, 1995 were comprised of undistributed Refinancing Proceeds held for working capital purposes.\nNet cash provided by operating activities decreased $516,000 for the year ended December 31, 1995 when compared to the year ended December 31, 1994. This decrease was primarily due to decreases in the net cash provided by operating activities at Marquette, Burlington and Regency Park as well as the increase in interest expense on the Partnership's Front-End Fees loan. The decrease was partially offset by an increase in the net cash provided by operating activities at Sentry West and Prentice Plaza as well as the absence of the net cash used for operating activities at Park Central and Sentry East.\nNet cash (used for) provided by investing activities changed by $(4,620,000) for the year ended December 31, 1995 when compared to the year ended December 31, 1994. This change was primarily due to the sale proceeds received on the sales of Park Central and Sentry East in 1994 and an increase in 1995 in the cash used for capital and tenant improvements and leasing costs partially offset by the releasing of the restricted certificate of deposit for Regency Park and the restricted escrow deposit for Marquette. The Partnership maintains working capital reserves to pay for capital expenditures such as building and tenant improvements and leasing costs. During the year ended December 31, 1995, the Partnership spent $1,335,100 for building and tenant improvements and leasing costs and has budgeted to spend approximately $1,130,000 during the year ending December 31, 1996. Included in the amount spent by the Partnership in 1995 is $600,000 which was funded by proceeds received on the junior mortgage loan collateralized by Marquette and related to the refurbishment and modernization of one of the major department stores at Marquette. Included in the 1996 budgeted amount are capital and tenant improvements and leasing costs of approximately: 1) $650,000 for Marquette; 2) $340,000 for Burlington; 3) $90,000 for Prentice Plaza and 4) $50,000 for Regency Park. As of December 31, 1995 the Partnership has accrued $600,000 as a liability which also relates to the refurbishment and modernization of the major department store at Marquette, of which half was paid in February 1996 and is included in the 1996 budgeted amount for Marquette, with the remaining $300,000 payable in February 1997. The General Partner believes these improvements and leasing costs are necessary in order to increase and\/or maintain occupancy levels in very competitive markets, maximize rental rates charged to new and renewing tenants and to prepare the remaining properties for eventual disposition.\nNet cash provided by (used for) financing activities changed by $4,694,500 for the year ended December 31, 1995 when compared to the year ended December 31, 1994. Factors which impacted this change were: 1) the payoff in 1994 of the mortgage loan collateralized by Park Central I and II from the sale proceeds of Park Central; 2) $1,000,000 in proceeds, net of loan fees, received in 1995 on the junior mortgage loan collateralized by Marquette and 3) $750,000 in proceeds, net of loan fees, received on the new mortgage loan collateralized by Prentice Plaza. The change was partially offset by: 1) the net receipt of $165,600 in 1994 of additional proceeds on the mortgage loan collateralized by Sentry West; 2) a net partial principal paydown of $324,400 in 1995 on the mortgage loan collateralized by Sentry West and 3) an increase in the amount of scheduled principal payments made in 1995 on the Partnership's mortgage loans.\nOn December 29, 1994 the joint venture which owns Sentry West, in which the Partnership has a 50% interest with an Affiliated partnership, executed an agreement (the \"Modification\") with the existing lender of this loan, which originally matured on September 30, 1994, to modify and amend this loan. Significant terms of the Modification in proportion to the Partnership's 50% interest included: 1) a reduction in the loan commitment from $5,250,000 to $5,157,800, of which $45,800 was held back for tenant improvements; 2) a change in the variable interest rate to 30-day LIBOR plus 212.50 basis points (unless unavailable in which case the variable interest rate will be the lender's prime rate plus 0.75%); 3) an extension of the maturity date until September 30, 1996; 4) monthly interest only payments until September 30, 1995; thereafter, monthly interest plus principal payments of $25,000 on the first day of each quarter starting October 1, 1995 plus quarterly cash flow principal payments in an amount equal to the adjusted net operating income of the property as defined in the Modification; 5) a restriction that no distributions be made to Partners of the Partnership or Affiliated partnership until the loan is fully repaid and 6) that the loan is guaranteed by the Partnership and the Affiliated partnership. In addition, the joint venture paid $93,200 in extension and administrative fees, of which $46,600 will be amortized by the Partnership over the period of the extension.\nIn March 1996, the Partnership entered into a contract to sell Sentry West. If the sale is not consummated by September 30, 1996, the loan's maturity date, the General Partner will pursue an extension or refinancing of the loan. There can be no assurance that a sale, extension or refinancing will be completed by September 30, 1996.\nOn December 20, 1995, the joint venture which owns Prentice Plaza, in which the Partnership has a 50% interest with an Affiliated partnership, executed a non- recourse promissory note in the amount of $9,750,000, collateralized by a mortgage on and an assignment of leases and rents of the property. The Partnership's share of the note amount was $4,875,000. The existing loan was repaid in full with the proceeds from the note. Significant terms of the promissory note, which matures in December 2000, in proportion to the Partnership's 50% interest, include a monthly interest payment in which the joint venture may choose between either a variable interest rate of 30-day LIBOR plus 175 basis points or the prime rate of the lender plus 125 basis points as well as monthly principal payments of $3,070 starting on\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED) February 1, 1996 and increasing to $3,343, $3,638, $3,960 and $4,305 on January 1 of each subsequent year from 1997 through 2000, respectively.\nOn March 29, 1996, the Partnership executed an amendment of the agreement dated December 29, 1994 which modified and amended the junior mortgage loan collateralized by Marquette. Terms of the amendment included: 1) a reduction in the loan commitment amount from $9,770,000 to $9,350,000; 2) a change from quarterly principal amortization payments of $125,000 on the first day of each quarter beginning January 1, 1996 and increasing to $150,000 on July 1, 1996 to monthly principal amortization payments of $30,000; 3) a reduction in the variable interest rate from 30-day LIBOR plus 300 basis points to 30-day LIBOR plus 250 basis points; 4) an assignment to the lender of the net sale proceeds on the sale of Sentry West (see Note 11 of Notes to Financial Statements) to reduce the outstanding principal balance on the junior mortgage loan and 5) an option to extend the maturity date of the loan to September 30, 1998 for a .5% extension fee, with a change in the interest rate to 30-day LIBOR plus 275 basis points and an increase in the monthly principal amortization payments to $50,000. The March 1996 amendment is retroactive to January 1, 1996. Significant terms of the agreement dated December 29, 1994 included: 1) an extension of the maturity date until September 30, 1997; 2) a restriction that no distributions be made to Partners of the Partnership until the loan is fully repaid and 3) the loan is fully recourse to the Partnership. In addition, the Partnership paid $100,800 in extension and administrative fees which will be amortized over the period of the extension.\nThe joint venture which owns Regency Park, in which the Partnership has a 50% interest with Affiliated partnerships, is in default under the terms of the mortgage loan which matured on January 1, 1996. The General Partner is negotiating with the mortgage lender to extend the maturity of the mortgage loan. If consummated, the agreement for such extension of the loan may include a change in interest rate, modified payment terms and other provisions that do not exist in the matured loan. Since January 1, 1996, the Partnership has continued to make payments to the lender, based on the terms of the matured loan. There can be no assurance that the Partnership and mortgage lender will consummate an extension of this loan. In addition, the General Partner has initiated efforts to market Regency Park for sale.\nPursuant to a modification of the Partnership's Front-End Fees loan agreement, the Partnership has the option to defer payment of interest on this loan, for a 72-month period beginning January 1, 1993. All deferred amounts (including accrued interest thereon) shall be due and payable on January 1, 1999, and shall not be subordinated to repayment to the Limited Partners. Beginning with the interest payment due on January 1, 1996, the Partnership has elected to defer payment of interest.\nThe recourse junior mortgage loan collateralized by Marquette and the mortgage loan collateralized by Burlington mature in 1997, exclusive of the Marquette option mentioned above. The Partnership's ability to satisfy these maturities is dependent upon the successful sale or refinancing of these properties prior to their respective loan maturity dates.\nAs of December 31, 1995, 58 of the 222 tenants at the Partnership's properties have leases totaling 184,305 square feet that expire during 1997. Total base rental revenues budgeted to be collected from these 58 tenants for the year ending December 31, 1996 are $1,954,500. Of this amount, $562,900 relates to two tenants at Burlington. Notwithstanding the market rental rates that may be in effect at the time these leases mature, the Partnership faces a significant amount of uncertainty with respect to the occupancy at its properties in 1997 and possibly beyond. The General Partner and its Affiliated management companies intend to address the possible renewal of these leases well in advance of their scheduled maturities in an attempt to maintain occupancy levels and rental revenues of the Partnership's portfolio.\nThe Partnership has significant financial obligations during the year ending December 31, 1996. As disclosed in Note 5 of Notes to Financial Statements, terms of the mortgage loans collateralized by certain of the Partnership's properties have substantial principal payment requirements. Two of the loans, collateralized by Sentry West and Regency Park, whose December 31, 1995 principal balances totaled $12,654,700, mature in 1996. As described above, in March 1996, the Partnership entered into an agreement to sell Sentry West and is in negotiations with the lender for an extension of the maturity date for the defaulted Regency Park loan. In addition, the Partnership anticipates incurring substantial capital, tenant improvement and leasing costs during 1996. Net cash provided by operating activities may not be sufficient to meet the above debt service and capital expenditure requirements for the year ending December 31, 1996. As a result of these issues, together with the need to have sufficient working capital to potentially retenant properties with leases expiring in 1997 and any restrictions that currently exist or may result from any refinancings, loan extensions or modifications, the General Partner believes that it is in the best interest of the Partnership to retain all cash available. Accordingly, distributions to Partners continue to be suspended. For the year ended December 31, 1995, Cash Flow (Deficit) (as defined in the Partnership Agreement) of $(241,700) was withdrawn from prior periods' retained Cash Flow. The General Partner continues to review other sources of cash available to the Partnership, which includes the sale or refinancing of the Partnership's properties. No assurance can be given as to the timing or successful completion of any future transactions. The General Partner currently believes that the amount of the Partnership's existing cash reserves, combined with any additional net proceeds to be received from sales or refinancings of any properties, as well as the option to defer payments of interest on the Front-End Fees Loan (see Note 3 of Notes to Financial Statements) are sufficient to cover planned expenditures for 1996. Since there can be no assurance that the sale or refinancing of Sentry West will occur prior to the maturity of its loan or that the Partnership will successfully complete any other transactions, including the extension of the mortgage loan collateralized by Regency Park, the Partnership may have inadequate liquidity to meet its mortgage loan obligations which could result in the foreclosure of either property. The General Partner believes that such events would not affect the Partnership's ability to continue business operations.\nBased upon the current estimated value of its assets, net of its outstanding liabilities, together with its expected operating results and capital expenditure requirements, the General Partner believes that the Partnership's cumulative distributions to its Limited Partners from inception through the termination of the Partnership will be substantially less than such Limited Partners' original Capital Investment.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED) there can be no assurance that the sale or refinancing of Sentry West will occur prior to the maturity of its loan or that the Partnership will successfully complete any other transactions, including the extension of the mortgage loan collateralized by Regency Park, the Partnership may have inadequate liquidity to meet its mortgage loan obligations which could result in the foreclosure of either property. The General Partner believes that such events would not affect the Partnership's ability to continue business operations.\nBased upon the current estimated value of its assets, net of its outstanding liabilities, together with its expected operating results and capital expenditure requirements, the General Partner believes that the Partnership's cumulative distributions to its Limited Partners from inception through the termination of the Partnership will be substantially less than such Limited Partners' original Capital Investment.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - ------- -------------------------------------------\nThe response to this item is submitted as a separate section of this report. See page A-1 \"Index of Financial Statements, Schedule and Exhibits.\"\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 Partnership has no directors. First Capital Financial Corporation (\"FCFC\") is the General Partner. The Directors of FCFC, as of March 29, 1996, are shown in the table below. Directors serve for one year or until their successors are elected. The next annual meeting of FCFC will be held in June 1996.\nName Office ---- ------ Samuel Zell........................................ Chairman of the Board Douglas Crocker II................................. Director Sheli Z. Rosenberg................................. Director Sanford Shkolnik................................... Director\nSamuel Zell, 54, has been a Director of the General Partner since 1983 (Chairman of the Board since December 1985) and is Chairman of the Board of Great American Management and Investment, Inc. (\"Great American\"). Mr. Zell is also Chairman of the Board of Equity Financial and Management Company (\"EFMC\") and Equity Group Investments, Inc.(\"EGI\"), and is a trustee and beneficiary of a general partner of Equity Holdings Limited, an Illinois Limited Partnership, a privately owned investment partnership. He is also Chairman of the Board of Directors of Anixter International Inc., Falcon Building Products, Inc. and American Classic Voyages Co. He is Chairman of the Board of Trustees of Equity Residential Properties Trust. He is a director of Quality Food Centers, Inc. and Sealy Corporation. He is Chairman of the Board of Directors and Chief Executive Officer of Capsure Holdings Corp. and Manufactured Home Communities, Inc. and Co-Chairman of the Board of Revco D.S., Inc. Mr. Zell was President of Madison Management Group, Inc. (\"Madison\") prior to October 4, 1991. Madison filed for protection under the Federal bankruptcy laws on November 8, 1991.\nDouglas Crocker II, 55, has been President and Chief Executive Officer since December 1992 and a Director since January 1993 of the General Partner. Mr. Crocker has been an Executive Vice President of EFMC since November 1992. Mr. Crocker has been President, Chief Executive Officer and trustee of Equity Residential Properties Trust since March 31, 1993. He was President of Republic Savings Bank, F.S.B. (\"Republic\") from 1989 to June 1992 at which time the Resolution Trust Company took control of Republic. Mr. Crocker is a member of the Board of Directors of Horizon Group, Inc.\nSheli Z. Rosenberg, 54, was President and Chief Executive Officer of the General Partner from December 1990 to December 1992 and has been a Director of the General Partner since September 1983; was Executive Vice President and General Counsel for EFMC from October 1980 to November 1994; has been President and Chief Executive Officer of EFMC and EGI since November 1994; has been a Director of Great American since June 1984 and is a Director of various subsidiaries of Great American. She is also a Director of Anixter International Inc., Capsure Holdings Corp., American Classic Voyages Co., Falcon Building Products, Inc., Jacor Communications, Inc., Revco D.S., Inc., Sealy Corporation and CFI Industries, Inc. She was Chairman of the Board from January 1994 to September 1994; Co-Chairman of the Board from September 1994 until March 1995 of CFI Industries, Inc. She is also a trustee of Equity Residential Properties Trust. Ms. Rosenberg is a Principal of Rosenberg & Liebentritt, P.C., counsel to the Partnership, the General Partner and certain of their Affiliates. Ms. Rosenberg was Vice President of Madison prior to October 4, 1991. Madison filed for protection under the Federal bankruptcy\nITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - Continued - -------- --------------------------------------------------------------\n(a) DIRECTORS - (continued) -----------------------\nlaws on November 8, 1991. She has been Vice President of First Capital Benefit Administrators, Inc. (\"Benefit Administrators\") since July 22, 1987. Benefit Administrators filed for protection under the Federal bankruptcy laws on January 3, 1995.\nSanford Shkolnik, 57, has been a Director of the General Partner since December 1985. Mr. Shkolnik has been Executive Vice President of EFMC since 1976. He is Chairman of the Board and Chief Executive Officer of SC Management, Inc., which is general partner of Equity Properties and Development Limited Partnership, a nationally ranked shopping center management company.\n(b,c & e) EXECUTIVE OFFICERS ------------------\nThe Partnership does not have any executive officers. The executive officers of the General Partner as of March 29, 1996 are shown in the table. All officers are elected to serve for one year or until their successors are elected and qualified.\nName Office ---- ------ Douglas Crocker II................. President and Chief Executive Officer Arthur A. Greenberg................ Senior Vice President Norman M. Field.................... Vice President - Finance and Treasurer\nPRESIDENT AND CEO - See Table of Directors above.\nArthur A. Greenberg, 55, has been Senior Vice President of the General Partner since August 1986. Mr. Greenberg was Executive Vice President and Chief Financial Officer of Great American from December 1986 to March 1995. Mr. Greenberg also is an Executive Vice President of EFMC since 1971, and President of Greenberg & Pociask, Ltd. He is Senior Vice President since 1989 and Treasurer since 1990 of Capsure Holdings Corp. Mr. Greenberg is a Director of American Classic Voyages Co. and Chairman of the Board of Firstate Financial A Savings Bank. Mr. Greenberg was Vice President of Madison prior to October 4, 1991. Madison filed for protection under the Federal bankruptcy laws on November 8, 1991.\nNorman M. Field, 47, has been Vice President of Finance and Treasurer of the General Partner since February 1984, and also served as Vice President and Treasurer of Great American from July 1983 until March 1995. Mr. Field has been Treasurer of Benefit Administrators since July 22, 1987. He also served as Vice President of Madison until October 4, 1991. He was Chief Financial Officer of Equality Specialties, Inc. (\"Equality\"), a subsidiary of Great American, from August 1994 to April 1995. Equality was sold in April 1995.\n(d) FAMILY RELATIONSHIPS --------------------\nThere are no family relationships among any of the foregoing directors and officers.\n(f) INVOLVEMENT IN CERTAIN LEGAL PROCEEDINGS ----------------------------------------\nWith the exception of the bankruptcy matters disclosed under Items 10 (a), (b), (c) and (e), there are no involvements in certain legal proceedings among any of the foregoing directors and officers.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION - -------- ----------------------\n(a,b,c & d) As stated in Item 10, the Partnership has no officers or directors. Neither the General Partner, nor any director or officer of the General Partner, received any direct remuneration from the Partnership during the year ended December 31, 1995. However, the General Partner and its Affiliates do compensate its directors and officers. For additional information see Item 13 (a) Certain Relationships and Related Transactions.\n(e) None.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - -------- --------------------------------------------------------------\n(a) As of March 1, 1996, no person owned of record or was known by the Partnership to own beneficially more than 5% of the Partnership's 57,621 Units then outstanding.\n(b) The Partnership has no directors or executive officers. As of March 1, 1996, the executive officers and directors of the General Partner, as a group, did not own any Units.\n(c) None.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - -------- ----------------------------------------------\n(a) Affiliates of the General Partner, provide leasing, property management and supervisory services to the Partnership. Compensation to the General Partner, its Affiliates and all other parties for property management services may not exceed the lesser of the compensation customarily charged in arm's-length transactions in the same geographic area and for a comparable property or 6% of the gross receipts from the property being managed where the General Partner or Affiliate provides leasing, re-leasing and leasing related services, or 3% of gross receipts where the General Partner or Affiliate does not perform leasing, re-leasing and leasing related services and, in that event, may pay an unaffiliated party for leasing services to the Partnership in an amount not to exceed the compensation customarily charged in arm's-length transactions by persons rendering similar services as an ongoing public entity in the same geographic location for a comparable property. During the year ended December 31, 1995, these Affiliates were entitled to leasing fees and property management and supervisory fees of $509,800. In addition, other Affiliates of the General Partner were entitled to fees and compensation of $149,400 for insurance, personnel and other services. As of December 31, 1995, $53,500 of the these fees and reimbursements due to Affiliates were unpaid. Services provided by Affiliates are on terms which are fair, reasonable and no less favorable to the Partnership than reasonably could be obtained from unaffiliated persons.\nFor the year ended December 31, 1995 an Affiliate of the General Partner was entitled to interest on the Partnership's Front-End Fees loan in the amount of $673,000. In accordance with the Partnership Agreement, neither the General Partner nor its Affiliates shall lend money to the Partnership with interest rates and other finance charges and fees in excess of the lesser of the amounts that are charged by unrelated lending institutions on comparable loans for the same purpose in the same locality or 2% above the prime rate of interest charged by Chemical Bank. As of December 31, 1995, $56,900 of interest was due to Affiliates.\nPursuant to a modification of the Partnership's Front-End Fees loan agreement, the Partnership has the option to defer payment of interest on this loan, for a 72-month period beginning January 1, 1993. All deferred amounts (including accrued interest thereon) shall be due and payable on\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - Continued - -------- ----------------------------------------------------------\nJanuary 1, 1999, and shall not be subordinated to repayment to the Limited Partners. Beginning with the interest payment due on January 1, 1996, the Partnership has elected to defer payment of interest.\nIn accordance with the Partnership Agreement, Net Profits and Net Losses (exclusive of Net Profits and Net Losses from the sale, disposition or provision for value impairment of Partnership properties) shall be allocated 1% to the General Partner and 99% to the Limited Partners. Net Profits from the sale or disposition of a Partnership property are allocated: first, prior to giving effect to any distributions of Sale or Refinancing Proceeds from the transaction, to the General Partner and Limited Partners with negative balances in their Capital Accounts, pro rata in proportion to such respective negative balances, to the extent of the total of such negative balances; second, to each Limited Partner in an amount, if any, necessary to make the positive balance in its Capital Account equal to the Sale or Refinancing Proceeds to be distributed to such Limited Partner with respect to the sale or disposition of such property; third, to the General Partner in an amount, if any, necessary to make the positive balance in its Capital Account equal to the Sale or Refinancing Proceeds to be distributed to the General Partner with respect to the sale or disposition of such property; and fourth, the balance, if any, 25% to the General Partner and 75% to the Limited Partners. Net Losses from the sale, disposition or provision for value impairment of Partnership properties are allocated: first, after giving effect to any distributions of Sale or Refinancing Proceeds from the transaction, to the General Partner and Limited Partners with positive balances in their Capital Accounts, pro rata in proportion to such respective positive balances, to the extent of the total amount of such positive balances; and second, the balance, if any, 1% to the General Partner and 99% to the Limited Partners. Notwithstanding anything to the contrary, there shall be allocated to the General Partner not less than 1% of all items of Partnership income, gain, loss, deduction and credit during the existence of the Partnership. For the year ended December 31, 1995, the General Partner was allocated a Net (Loss) of $(2,223,200), which included a (loss) from provisions for value impairment of $(2,203,700) as a result of precluding the Limited Partners' capital accounts from being reduced to an amount less than zero.\nANTEC Corporation (\"ANTEC\"), which is in the business of designing, engineering, manufacturing and distributing cable television products, and approximately 30% owned by Anixter International Inc. (formerly known as Itel Corporation), an Affiliate of the General Partner, is obligated to the Partnership under a lease of office space at Prentice Plaza. During the year ended December 31, 1995, ANTEC paid $378,100 in rent. The Partnership owns a 50% joint venture interest in these rents. The per square foot rent paid by ANTEC is comparable to those paid by other tenants at Prentice Plaza.\n(b) Rosenberg & Liebentritt, P.C. (\"Rosenberg\"), serves as legal counsel to the Partnership, the General Partner and certain of their Affiliates. Sheli Z. Rosenberg, President and Chief Executive Officer of the General Partner from December 1990 to December 1992 and a director of the General Partner since December 1983, is a Principal of Rosenberg. For the year ended December 31, 1995, Rosenberg was entitled to $100,100 for legal fees from the Partnership. As of December 31, 1995, $4,300 was due to Rosenberg. Compensation for these services are on terms which are fair, reasonable and no less favorable to the Partnership than reasonably could be obtained from unaffiliated persons.\n(c) No management person is indebted to the Partnership.\n(d) None.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K - -------- ----------------------------------------------------------------\n(a,c & d) See Index of Financial Statements, Schedule and Exhibits on page A-1 of Form 10-K.\n(b) Reports on Form 8-K:\nThere were no reports filed on Form 8-K for the quarter ended December 31, 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.\nFIRST CAPITAL INCOME PROPERTIES, LTD. - SERIES XI\nBY: FIRST CAPITAL FINANCIAL CORPORATION GENERAL PARTNER\nDated: March 29, 1996 By: \/s\/ DOUGLAS CROCKER II -------------------- --------------------------------------------- DOUGLAS CROCKER II President and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\n\/s\/ SAMUEL ZELL March 29, 1996 Chairman of the Board and - ----------------------- -------------- Director of the General Partner SAMUEL ZELL\n\/s\/ DOUGLAS CROCKER II March 29, 1996 President, Chief Executive - ----------------------- -------------- Officer and Director of the DOUGLAS CROCKER II General Partner\n\/s\/ SHELI Z. ROSENBERG March 29, 1996 Director of the General Partner - ----------------------- -------------- SHELI Z. ROSENBERG\n\/s\/ SANFORD SHKOLNIK March 29, 1996 Director of the General Partner - ----------------------- -------------- SANFORD SHKOLNIK\n\/s\/ NORMAN M. FIELD March 29, 1996 Vice President - Finance and - ----------------------- -------------- Treasurer NORMAN M. FIELD\nINDEX OF FINANCIAL STATEMENTS, SCHEDULE AND EXHIBITS\nFINANCIAL STATEMENTS FILED AS PART OF THIS REPORT\nAll other schedules have been omitted as inapplicable, or for the reason that the required information is shown in the financial statements or notes thereto.\nEXHIBITS FILED AS PART OF THIS REPORT\nEXHIBITS (3 & 4) First Amended and Restated Certificate and Agreement of Limited Partnership as set forth on pages A-1 through A-34 of the Partnership's definitive Prospectus dated September 12, 1985; Registration Statement No. 2-98749, filed pursuant to Rule 424(b), is incorporated herein by reference.\nEXHIBIT (10) Material Contracts\n(a) Lease agreements for tenants that individually occupy more than 10% of the net leasable square footage of the Partnership's most significant properties, filed as an exhibit to the Partnership's Report on Form 10-K dated December 31, 1993, are incorporated herein by reference.\nEXHIBIT (13) Annual Report to Security Holders\nThe 1994 Annual Report to Limited Partners is being sent under separate cover, not as a filed document and not via EDGAR, for the information of the Commission.\nEXHIBIT (27) Financial Data Schedule\nA-1\nREPORT OF INDEPENDENT AUDITORS\nPartners First Capital Income Properties, Ltd. - Series XI Chicago, Illinois\nWe have audited the accompanying balance sheets of First Capital Income Properties, Ltd. - Series XI as of December 31, 1995 and 1994, and the related statements of income and expenses, partners' capital (deficit) and cash flows for each of the three years in the period ended December 31, 1995, and the schedule listed in the accompanying index. These financial statements and schedule are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of First Capital Income Properties, Ltd. - Series XI at December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.\nErnst & Young LLP\nChicago, Illinois March 1, 1996, except for Notes 5(c) and 11, as to which the date is March 29, 1996\nA-2\nBALANCE SHEETS December 31, 1995 and 1994 (All dollars rounded to nearest 00s)\nSTATEMENTS OF PARTNERS' CAPITAL (DEFICIT) For the years ended December 31, 1995, 1994 and 1993 (All dollars rounded to nearest 00s)\nThe accompanying notes are an integral part of the financial statements. A-3\nSTATEMENTS OF INCOME AND EXPENSES For the years ended December 31, 1995, 1994 and 1993 (All dollars rounded to nearest 00s except per Unit amounts)\nSTATEMENTS OF CASH FLOWS For the years ended December 31, 1995, 1994 and 1993 (All dollars rounded to nearest 00s)\nThe accompanying notes are an integral part of the financial statements. A-4\nNOTES TO FINANCIAL STATEMENTS 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:\nDEFINITION OF SPECIAL TERMS: Capitalized terms used in this report have the same meaning as those terms have in the Partnership's Registration Statement filed with the Securities and Exchange Commission on Form S-11. Definitions of these terms are contained in Article III of the First Amended and Restated Certificate and Agreement of Limited Partnership, which is included in the Registration Statement and incorporated herein by reference.\nORGANIZATION: The Partnership was formed on May 24, 1985, by the filing of a Certificate and Agreement of Limited Partnership with the Recorder of Deeds of Cook County, Illinois, and commenced the Offering of Units on September 12, 1985. The Certificate and Agreement, as amended and restated, authorized the sale to the public of 50,000 Units (with the General Partner's option to increase to 100,000 Units) and not less than 1,400 Units pursuant to the Prospectus. On December 3, 1985, the required minimum subscription level was reached and the Partnership's operations commenced. The General Partner exercised its option to increase the Offering to 100,000 Units and the Partnership Agreement was subsequently amended to extend the Offering until March 31, 1987, through which date 57,621 Units had been sold. The Partnership was formed to invest primarily in existing, improved, income-producing commercial real estate.\nThe Partnership Agreement provides that the Partnership will be dissolved on or before December 31, 2015. The Limited Partners, by a majority vote, may dissolve the Partnership at any time.\nACCOUNTING POLICIES: The financial statements have been prepared in accordance with generally accepted accounting principles. Under this method of accounting, revenues are recorded when earned and expenses are recorded when incurred.\nPreparation of the Partnership's 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.\nThe financial statements include the Partnership's 50% interest in three joint ventures with Affiliated partnerships. Two of these joint ventures were formed for the purpose of each acquiring a 100% interest in certain real property and one of these joint ventures was formed for the purpose of acquiring a preferred majority interest in certain real property. These joint ventures are operated under the common control of the General Partner. In addition, the 1993 and 1994 financial statements included the Partnership's 50% interest in four joint ventures with Affiliated partnerships, one of which was formed for the purpose of acquiring a 100% interest in certain real property and three of which were formed for the purpose of each acquiring a preferred majority interest in certain real property. These joint ventures were operated under the common control of the General Partner prior to the sales of the properties. Accordingly, the Partnership's pro rata share of the ventures' revenues, expenses, assets, liabilities and capital is included in the financial statements.\nThe financial statements also include the Partnership's 70% undivided interest in a joint venture with an unaffiliated third party (the \"Venture Partner\"). The joint venture owns a 100% interest in the Burlington Office Center I, II and III (\"Burlington\"). This joint venture is operated under the control of the General Partner. The Partnership has included 100% of the venture's revenues, expenses, assets, liabilities and capital in the financial statements. Cash flow from operations (as defined in the general partnership agreement) is distributed first, in the amount necessary to provide the Partnership with a cumulative non-compounded return on its net invested capital balance from the joint venture equal to 8.75% per annum, increasing 0.25% each year, up to a maximum of 11% per annum (the return for 1995 is 10.5%); second, to the Venture Partner in the amount necessary to provide a noncumulative non-compounded return on its net invested capital balance from the joint venture equal to the percentage return allocable to the Partnership for that year and third, the remaining balance, if any, is distributed 70% to the Partnership and 30% to the Venture Partner. For the years ended December 31, 1993, 1994 and 1995, 100% of Cash Flow was allocated to the Partnership. In addition, net operating profits (as defined in the general partnership agreement) are allocated first, to the Partnership until the cumulative amount allocated equals the cumulative distributions from the joint venture; second, to the Venture Partner until the cumulative amount allocated equals its cumulative distributions from the joint venture, and the balance, if any, 70% to the Partnership and 30% to the Venture Partner. Net operating losses (as defined in the general partnership agreement) are allocated 70% to the Partnership and 30% to the Venture Partner. Sale losses (as defined in the general partnership agreement) (including provisions for value impairment) are allocated first, to the Venture Partner, to the extent that its capital account balance of the joint venture is positive; second, to the Partnership, to the extent that its capital account balance of the joint venture is positive; and third, the balance, if any, 50% to the Partnership and 50% to the Venture Partner. For the year ended December 31, 1995, the Partnership was allocated 100% of net operating (losses) (as defined in the general partnership agreement) as a result of the Venture Partner's capital account being reduced to zero in 1994. For the year ended December 31, 1994, the Partnership was allocated net operating (losses) of $(19,500) and a (loss) from provision for value impairment of $(1,720,100). For the year ended December 31, 1993, the Partnership was allocated 100% of net operating profits.\nThe Partnership is not liable for federal income taxes as the Partners recognize their proportionate share of the Partnership income or loss in their individual tax returns; therefore, no provision for income taxes is made in the financial statements of the Partnership. In addition, it is not practicable for the Partnership to determine the aggregate tax bases of the individual Partners; therefore, the disclosure of the differences between the tax bases and the reported assets and liabilities of the Partnership would not be meaningful.\nCommercial rental properties are recorded at cost, net of any provisions for value impairment, and depreciated (exclusive of amounts allocated to land) on the straight-line method over their estimated useful lives. Lease acquisition fees are recorded at cost and amortized over the life of the lease. Repair and maintenance costs are expensed as incurred; expenditures for improvements are capitalized and depreciated over the estimated life of the improvements.\nThe General Partner periodically reviews significant factors regarding the properties to determine that the properties are carried at the lower of cost or fair market value. These factors include, but are not limited to, the General Partner's experience in the real estate industry, an evaluation of recent operating performance against expected results, economic trends or factors affecting major tenants or the regions in which the properties are located, and where available, information included in recent appraisals of properties.\nBased on this analysis, where it is anticipated that the carrying value of an investment property will not be recovered, the General Partner has deemed it appropriate to reduce the basis of the properties for financial reporting purposes to fair market value. Such fair market value is the General Partner's best estimate of the amounts expected to be realized were such properties sold as of the Balance Sheet date, based upon current information available. The ultimate realization may differ from these amounts. Provisions, where applicable, are reflected in the accompanying Statements of Income and Expenses in the year such evaluations have been made. For additional information, see Note 10.\nLoan acquisition costs are amortized over the term of the note issued under mortgage loans made in connection with the acquisitions or refinancing of Partnership's properties. When a property is disposed or refinanced, the related loan acquisition costs and accumulated amortization are removed from the respective accounts and any unamortized balance is expensed.\nProperty sales or dispositions are recorded when title transfers and sufficient consideration has been received by the Partnership. Upon disposition, the related costs and accumulated depreciation and amortization are removed from the respective accounts. Any gain or loss on sale or disposition is recognized in accordance with generally accepted accounting principles.\nCash equivalents are considered all highly liquid investments with an original maturity of three months or less when purchased.\nProceeds received under the Front-End Fees loan payable to an Affiliate are reflected as a liability of the Partnership. Repayment of this loan is subordinated to the prior receipt by Limited Partners of Sale or Refinancing proceeds equal to 100% of their Original Capital Contribution. While Partners' Capital has been reduced for the amount of Front-End Fees incurred, the effect of this subordination is that Partners' Capital will not be utilized for the payment of such loan.\nA-5\nThe Partnership's financial statements include financial instruments, including receivables, trade liabilities and mortgage debt. The Partnership considers the disclosure of the fair value of its mortgage debt to be impracticable due to the general illiquid nature of the real estate financing market and an inability to obtain comparable financing on certain properties due to declines in market value. The fair value of all other financial instruments, including cash and cash equivalents, was not materially different from their carrying value at December 31, 1995 and 1994.\nCertain reclassifications have been made to the previously reported 1993 and 1994 statements in order to provide comparability with the 1995 statements. These reclassifications have no effect on net (loss) or Partners' capital (deficit).\n2. RELATED PARTY TRANSACTIONS:\nIn accordance with the Partnership Agreement, Net Profits and Net Losses (exclusive of Net Profits and Net Losses from the sale, disposition or provision for value impairment of Partnership properties) shall be allocated 1% to the General Partner and 99% to the Limited Partners. Net Profits from the sale or disposition of a Partnership property are allocated: first, prior to giving effect to any distributions of Sale or Refinancing Proceeds from the transaction, to the General Partner and Limited Partners with negative balances in their Capital Accounts, pro rata in proportion to such respective negative balances, to the extent of the total of such negative balances; second, to each Limited Partner in an amount, if any, necessary to make the positive balance in its Capital Account equal to the Sale or Refinancing Proceeds to be distributed to such Limited Partner with respect to the sale or disposition of such property; third, to the General Partner in an amount, if any, necessary to make the positive balance in its Capital Account equal to the Sale or Refinancing Proceeds to be distributed to the General Partner with respect to the sale or disposition of such property; and fourth, the balance, if any, 25% to the General Partner and 75% to the Limited Partners. Net Losses from the sale, disposition or provision for value impairment of Partnership properties are allocated: first, after giving effect to any distributions of Sale or Refinancing Proceeds from the transaction, to the General Partner and Limited Partners with positive balances in their Capital Accounts, pro rata in proportion to such respective positive balances, to the extent of the total amount of such positive balances; and second, the balance, if any, 1% to the General Partner and 99% to the Limited Partners. Notwithstanding anything to the contrary, there shall be allocated to the General Partner not less than 1% of all items of Partnership income, gain, loss, deduction and credit during the existence of the Partnership. For the year ended December 31, 1995, the General Partner was allocated a Net (Loss) of $(2,223,200), which included a (loss) from provisions for value impairment of $(2,203,700) as a result of precluding the Limited Partners' capital accounts from being reduced to an amount less than zero. For the year ended December 31, 1994, the General Partner was allocated a Net (Loss) of $(105,800), which included a Net Profit from the sale of a Partnership property of $2,900, a Net (Loss) from the sale of Partnership properties of $(1,000) and (loss) from provisions for value impairment of $(87,200). For the year ended December 31, 1993, the General Partner was allocated a Net (Loss) of $(103,700), which included a Net (Loss) from the sale of a land parcel of $(400) and (loss) from provisions for value impairment of $(83,000).\nFees and reimbursements paid and payable by the Partnership to Affiliates were as follows:\nANTEC Corporation (\"ANTEC\"), which is in the business of designing, engineering, manufacturing and distributing cable television products, and approximately 30% owned by Anixter International Inc. (formerly known as Itel Corporation), an Affiliate of the General Partner, is obligated to the Partnership under a lease of office space at Prentice Plaza. During the years ended December 31, 1995, 1994 and 1993, ANTEC paid $378,100, $388,100 (which excludes $186,400 in reimbursements from ANTEC for tenant improvements) and $193,100 (which was paid under a lease that was amended to increase its office space from 15,335 square feet as of January 1, 1993 and to 28,007 square feet as of January 1, 1994), respectively, in rent. The Partnership owns a 50% joint venture interest in these rents. The per square foot rent paid by ANTEC is comparable to those paid by other tenants at Prentice Plaza.\nOn-site property management for certain of the Partnership's properties is provided by independent real estate management companies for fees calculated as a percentage of gross rents received by the properties. In addition, Affiliates of the General Partner provide on-site property management and supervisory services for fees based upon various percentage rates of gross rents for the properties. These fees range from 1% to 6% based upon the terms of the individual management agreements.\n3. FRONT-END FEES LOAN PAYABLE TO AFFILIATE:\nThe Partnership originally borrowed from an Affiliate of the General Partner an amount needed for the payment of securities sales commissions, Offering and Organizational Expenses and other Front-End Fees, other than Acquisition Fees. Repayment of the principal amount of the Front-End Fees loan is subordinated to repayment to the Limited Partners of 100% of their Original Capital Contribution from Sale or Refinancing Proceeds (as defined in the Partnership Agreement). Interest on the outstanding balance of this loan is due and payable monthly at a rate no greater than the cost of funds obtained by the Affiliate from unaffiliated lenders.\nAs of December 31, 1995, the Partnership had drawn $8,295,200 under the Front- End Fees loan agreement. The interest rate paid on the Front-End Fees loan is subject to change in accordance with the loan agreement. The weighted average interest rate for the year ended December 31, 1995 was 8.11%. As of December 31, 1995, the interest rate was 7.9688%.\nPursuant to a modification of this loan agreement, the Partnership has the option to defer payment of interest on this loan, for a 72-month period beginning January 1, 1993. All deferred amounts (including accrued interest thereon) shall be due and payable on January 1, 1999, and shall not be subordinated to repayment to the Limited Partners, as discussed above. Beginning with the interest payment due on January 1, 1996, the Partnership has elected to defer payment of interest.\n4. RESTRICTED CERTIFICATE OF DEPOSIT AND ESCROW DEPOSITS:\nOn June 24, 1994, the joint venture which owns Regency Park Shopping Center (\"Regency Park\"), in which the Partnership has a 50% interest, invested $150,000 in a restricted certificate of deposit which collateralized a letter of credit for a construction allowance to a major new tenant which occupies 40,150 leasable square feet at Regency Park. This amount, of which the Partnership's share was $75,000, was reimbursed to the new tenant in 1995 upon compliance with the lease section pertaining to this construction allowance. The letter of credit was cancelled and the certificate of deposit was released to the Partnership in May 1995.\nRestricted escrow deposits at December 31, 1995 and 1994 included $159,400, of which the Partnership's share was 50%, being held by the mortgage holder of Regency Park in a non-interest bearing escrow account as collateral for its mortgage loan (see Note 5 for additional information).\nRestricted escrow deposits at December 31, 1994 included $32,600, which represented an amount being held by the lender of the junior mortgage loan collateralized by Marquette Mall and Office Building (\"Marquette\"). The amount in escrow was to be funded to the Partnership for certain tenant improvements at Marquette provided that the Partnership matches these funds dollar for dollar. This escrow was released to the Partnership in February 1995.\nA-6\n5. MORTGAGE LOANS PAYABLE: Mortgage loans payable at December 31, 1995 and 1994 consisted of the following loans which are non-recourse unless otherwise noted:\n(a) Represents level monthly principal and interest payments, paid in arrears, except where otherwise noted. (b) This repayment may require either sale or refinancing of the respective property. (c) On March 29, 1996, the General Partner executed an amendment of the agreement dated December 29, 1994 which modified and amended the junior mortgage loan. Terms of the amendment included: 1) a reduction in the loan commitment amount from $9,770,000 to $9,350,000; 2) a change from quarterly principal amortization payments of $125,000 on the first day of each quarter beginning January 1, 1996 and increasing to $150,000 on July 1, 1996 to monthly principal amortization payments of $30,000; 3) a reduction in the variable interest rate from 30-day LIBOR plus 300 basis points to 30-day LIBOR plus 250 basis points; 4) an assignment to the lender of a portion of the net sale proceeds received by the Partnership from the joint venture which owns Sentry Park West Office Campus (\"Sentry West\"), in which the Partnership has a 50% interest, on the sale of Sentry West (see Note 11) to reduce the outstanding principal balance on the junior mortgage loan and 5) an option to extend the maturity date of the loan to September 30, 1998 for a .5% extension fee, with a change in the interest rate to 30-day LIBOR plus 275 basis points and an increase in the monthly principal amortization payments to $50,000. The March 29, 1996 amendment is retroactive to January 1, 1996. Significant terms of the agreement dated December 29, 1994 included: 1) an extension of the maturity date until September 30, 1997; 2) a restriction that no distributions be made to Partners of the Partnership until the loan is fully repaid and 3) the loan is fully recourse to the Partnership. In addition, the Partnership paid $100,800 in extension and administrative fees which will be amortized over the period of the extension. (d) This interest rate represents an average for the year ended December 31, 1995. Interest rates are subject to change in accordance with the provisions of the loan agreements. As of December 31, 1995, the interest rates on Marquette, Sentry West and Prentice Plaza mortgage loans were 9.00%, 8.50% and 8.625%, respectively. (e) This property is owned through a joint venture. Amounts represent the Partnership's share of the liability and are not the total amount by which the property is encumbered. (f) On December 29, 1994 the joint venture which owns Sentry West, in which the Partnership has a 50% interest with an Affiliated partnership, executed an agreement (the \"Modification\") with the existing lender of this loan, which originally matured on September 30, 1994, to modify and amend this loan. Significant terms of the Modification in proportion to the Partnership's 50% interest included: 1) a reduction in the loan commitment from $5,250,000 to $5,157,800, of which $45,800 was held back for tenant improvements; 2) a change in the variable interest rate to 30- day LIBOR plus 212.50 basis points (unless unavailable in which case the variable interest rate will be the lender's prime rate plus 0.75%); 3) an extension of the maturity date until September 30, 1996; 4) monthly interest only payments until September 30, 1995; thereafter, monthly interest plus principal payments of $25,000 on the first day of each quarter starting October 1, 1995 plus quarterly cash flow principal payments in an amount equal to the adjusted net operating income of the property as defined in the Modification; 5) a restriction that no distributions be made to Partners of the Partnership or Affiliated partnership until the loan is fully repaid and 6) that the loan is guaranteed by the Partnership and Affiliated partnership. In addition, the joint venture paid $93,200 in extension and administrative fees, of which $46,600 will be amortized by the Partnership over the period of the extension. Incorporated in the Modification are the terms of a 1993 letter agreement whereby the joint venture obtained consent from the lender to terminate the lease agreement with a tenant at Sentry West in order that this tenant may purchase and occupy one of the five buildings at Sentry Park East Office Campus (\"Sentry East\"). Pursuant to this letter agreement, the joint venture was obligated to pay the lender 50% of the excess net sale proceeds over $1,300,000 from the sales of the remaining four buildings at Sentry East for principal paydowns. During 1993 and 1994, the remaining four buildings at Sentry East were sold (see Note 9) and the joint venture paid the lender $184,300 and $598,700, of which the Partnership's share was $92,100 and $299,400, respectively, in May 1994 and January 1995, respectively, from the net proceeds received from the sales of the last three buildings. In addition, in July 1994, the joint venture drew an additional $615,400 as a reimbursement for tenant improvements at one of the buildings in the office campus, in accordance with the loan Modification. The Partnership's share of this draw was $307,700. (g) The joint venture which owns Regency Park, in which the Partnership has a 50% interest with Affiliated partnerships, is in default under the terms of the mortgage loan which matured on January 1, 1996. The General Partner is negotiating with the mortgage lender to extend the maturity of the mortgage loan. If consummated, the agreement for such extension of the loan may include a change in interest rate, modified payment terms and other provisions that do not exist in the matured loan. Since January 1, 1996, the Partnership has continued to make payments to the lender, based on the terms of the matured loan. There can be no assurance that the Partnership and mortgage lender will consummate an extension of this loan. (h) On December 20, 1995, the joint venture which owns Prentice Plaza, in which the Partnership has a 50% interest with an Affiliated partnership, executed a non-recourse promissory note in the amount of $9,750,000, collateralized by a mortgage on and an assignment of leases and rents of the property. The Partnership's share of the note amount was $4,875,000. The existing loan was repaid in full with the proceeds from the note. Significant terms of the promissory note, which matures in December 2000, in proportion to the Partnership's 50% interest, include a monthly interest payment in which the joint venture may choose between either a variable interest rate of 30-day LIBOR plus 175 basis points or the prime rate of the lender plus 125 basis points as well as monthly principal payments of $3,070 starting on February 1, 1996 and increasing to $3,343, $3,638, $3,960 and $4,305 on January 1 of each subsequent year from 1997 through 2000, respectively. Principal amortization of mortgage loans payable for each of the next five years and thereafter as of December 31, 1995 was as follows:\nThe amounts scheduled above do not include amounts equal to the adjusted net operating income of Sentry West, as defined in the loan agreement, which must be paid periodically under the terms of the mortgage loan and amounts which are available but unfunded to the Partnership under certain mortgage loans.\n6. FUTURE MINIMUM RENTALS: The Partnership's share of future minimum rental income due on noncancelable leases as of December 31, 1995 was as follows:\nA-7\nThe Partnership is subject to the usual business risks associated with the collection of the above-scheduled rentals. In addition to the amounts scheduled above, the Partnership expects to receive rental revenue from (i) operating expense and real estate tax reimbursements, (ii) parking income and (iii) percentage rents. Percentage rents earned for the years ended December 31, 1995, 1994 and 1993 were $239,500, $189,500 and $344,800, respectively.\n7. INCOME TAX:\nThe Partnership utilizes the accrual basis of accounting for both income tax reporting and financial statement purposes. Financial statement results will differ from income tax results due to the use of differing depreciation lives and methods, the recognition of rents received in advance as taxable income and the Partnership's provisions for value impairment. The net effect of these accounting differences for the year ended December 31, 1995 was that the (loss) for tax reporting purposes was less than the net (loss) for financial statement purposes by $5,640,900. The aggregate cost of commercial rental properties for federal income tax purposes at December 31, 1995 was $67,781,200.\n8. DISTRIBUTIONS:\nCommencing with the quarter ended September 30, 1990, cash distributions to Limited Partners were suspended and no further distributions will be made until such time as the Partnership's cash position is increased to a level that is expected to be sufficient to meet all of the anticipated capital expenditures, debt repayments, including the loan agreements restricting distributions (see Note 5), and other working capital requirements during the next several years.\n9. PROPERTY SALES:\nOn April 22, 1994, the joint venture which owned Sentry East, located in Blue Bell, Pennsylvania, in which the Partnership had a 50% interest, sold one of the remaining three office buildings situated in this office campus for a sale price of $1,198,500. The joint venture incurred selling expenses of $95,600. The joint venture received net Sale Proceeds of $1,102,900, of which the Partnership's share was $551,500. The (loss) reported by the Partnership for financial statement purposes was $(280,700) and was previously recorded as part of the provisions for value impairment in 1992. For tax reporting purposes, the Partnership reported a total (loss) of $(334,200) in 1994 in connection with this sale.\nOn June 29, 1994, the joint ventures which owned Park Central Office Park I, II and III (\"Park Central\"), located in Greenville, South Carolina, in which the Partnership had 50% interests, sold Park Central for a sale price of $7,250,000. The outstanding indebtedness on Park Central I and II of $7,000,000 was satisfied at closing. The joint ventures incurred selling expenses of $143,700. The joint ventures received net Sale Proceeds of $106,300, of which the Partnership's share was $53,200. The (loss) reported by the Partnership for financial statement purposes was $(4,654,100) of which a total of $(4,550,000) was previously recorded as part of the provisions for value impairment in 1992 and 1993. For tax reporting purposes, the Partnership reported a total (loss) of $(5,049,500) in 1994 in connection with this sale.\nOn December 29, 1994, the joint venture which owned Sentry East sold the remaining two office buildings situated in this office campus for a sale price of $1,286,300. The joint venture incurred selling expenses of $99,900. The joint venture received net Sale Proceeds of $1,186,400, of which the Partnership's share was $593,200. The gain reported by the Partnership for financial statement purposes was $292,500 which represented a partial recovery of the (loss) from provisions for value impairment recorded in 1992. For tax reporting purposes, the Partnership reported a total (loss) of $(559,500) in 1994 in connection with this sale.\nIn addition, pursuant to an agreement between the joint venture which owns Sentry West, in which the Partnership has a 50% interest, and the mortgage holder of the loan collateralized by Sentry West, the Partnership was obligated to pay the mortgage holder $92,100 and $299,400, respectively, from the net proceeds received from the 1994 sales at Sentry East (see Note 5 for details of this agreement).\nOn January 22, 1993, the Partnership sold its 50% interest in the joint venture which owns Citrus Center (formerly known as Firstate Tower). The sale, effective January 1, 1993, was pursuant to the terms of an assignment agreement by and among the Partnership, an Affiliate of the Partnership and a corporation wholly owned by this Affiliate. Net cash proceeds received by the Partnership were $3,081,400, which represented 50% of the appraised value of Citrus Center, as determined by an independent appraiser, less 50% of the outstanding principal balance under the loan collateralized by Citrus Center ($4,868,600) and legal expenses. The (loss) for financial statement purposes was $(5,778,000) and was previously recorded as part of the provisions for value impairment in 1992. For tax reporting purposes, the Partnership reported a (loss) in 1993 of $(4,227,900).\nOn March 1, 1993, a joint venture in which the Partnership holds a 50% interest, sold a parcel of land at Regency Park, located in Jacksonville, Florida. The Partnership's portion of the sale price was $157,500 and selling expenses of $4,100 were incurred. The Partnership received net proceeds from this sale of $153,400, of which $79,700 was deposited in a non-interest bearing escrow held by the mortgage holder of the loan collateralized by Regency Park. For financial statement and tax reporting purposes, the Partnership reported a (loss) of $(41,600) as a result of this transaction.\nOn July 1, 1993, the joint venture which owned Sentry East sold the first of the five office buildings situated in this office campus, for a total sale price of $675,000. The net sale proceeds of $613,800 plus additional funds provided by the Partnership and its Affiliated joint venture partner were used to repay the balance of the mortgage loan collateralized by the entire office campus. The Partnership utilized additional funds of $670,100 in connection with this loan repayment. The Partnership incurred a (loss) on this sale of $(124,500) for financial statement purposes which was previously recorded as part of the provisions for value impairment in 1992. For tax reporting purposes, the Partnership reported a (loss) in 1993 of $(131,000) on this sale.\nOn October 14, 1993, the joint venture which owned Sentry East sold the second of five office buildings situated in this office campus for a total sale price of $625,000. Selling expenses incurred were $51,900, including $7,900 in legal expenses payable to an Affiliate. The Partnership's share of the net proceeds from this sale was $290,500. The Partnership incurred a (loss) on this sale of $(189,100) for financial statement purposes which was previously recorded as part of the provisions for value impairment in 1992. For tax reporting purposes, the Partnership reported a (loss) in 1993 of $(196,300) on this sale.\nAll of the above sales were all-cash transactions, with no further involvement on the part of the Partnership.\n10. PROVISIONS FOR VALUE IMPAIRMENT:\nDue to the depressed economic environment in the retail industry, regional factors affecting the Partnership's retail and office properties and other matters relating specifically to certain of the Partnership's properties, there is uncertainty as to the Partnership's ability to recover the net carrying value of certain of its properties during the remaining estimated holding periods. Accordingly, it was deemed appropriate to reduce the bases of such properties in the Partnership's financial statements during the years ended December 31, 1995, 1994 and 1993. The provisions for value impairment were considered non-cash events for the purposes of the Statements of Cash Flows and were not utilized in the determination of Cash Flow (as defined in the Partnership Agreement). The following is a summary of the provisions for value impairment reported by the Partnership for the years ended December 31, 1995, 1994 and 1993:\nThe provisions for value impairment were material fourth quarter adjustments pursuant to Accounting Principles Board Opinion No. 28, \"Interim Financial Reporting\". No other material adjustments were made in the fourth quarters.\nBeginning on January 1, 1996 the Partnership will adopt Financial Accounting Standards Board Statement No. 121 \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of\" (the \"Standard\"). The Standard established guidance for determining if the value of defined assets are impaired, and if so, how impairment losses should be measured and reported in the financial statements. The Standard is effective for fiscal years beginning after December 15, 1995. The General Partner believes that, based on the current circumstances, the adoption on January 1, 1996 of the Standard will not materially affect the Partnership's financial position or results of operations.\n11. SUBSEQUENT EVENT:\nOn March 25, 1996, the joint venture which owns Sentry West in which the Partnership has a 50% interest with an Affiliated partnership, entered into an agreement to sell Sentry West, located in Blue Bell, Pennsylvania. The closing of this transaction, expected to take place in the second quarter of 1996, is subject to the satisfaction of certain conditions and contingencies and, accordingly, may or may not be consummated. The proceeds from this sale, net of the repayment of the mortgage loan collateralized by this property, will be utilized to reduce the outstanding principal balance on the junior mortgage loan collateralized by Marquette (see Note 5 for additional information).\nA-8\nFIRST CAPITAL INCOME PROPERTIES, LTD. - SERIES XI\nSCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION AS OF DECEMBER 31, 1995\nSee accompanying notes on the following page.\nA-9\nFIRST CAPITAL INCOME PROPERTIES, LTD. - SERIES XI\nNOTES TO SCHEDULE III\nNote 1. Consists of legal fees, appraisal fees, title costs and other related professional fees. Note 2. The following is a reconciliation of activity in columns E and F:\nNote 3. The aggregate cost for federal income tax purposes as of December 31, 1995 was $67,781,200. Note 4. Includes provisions for value impairment. See Note 10 of Notes to Financial Statements for additional information. Note 5. Estimated useful life in years for building. Note 6. Estimated useful life in years for improvements. Note 7. Land was reduced by $195,000 due to the sale of an out-parcel of land in 1993. Note 8. Burlington Office Center I was completed in 1983, Burlington Office Center II was completed in 1985 and Burlington Office Center III was completed in 1989. Burlington Office Center I and II were purchased in September 1988 and Burlington Office Center III was purchased in September 1989.\nA-10","section_15":""}
{"filename":"355313_1995.txt","cik":"355313","year":"1995","section_1":"Item 1 - BUSINESS\nNational Gas & Oil Company (the Company) was organized under the laws of the State of Ohio on March 24, 1981, as a holding company. The Company derives substantially all of its revenues and earnings from the operating results of its subsidiaries.\nThe Company's subsidiaries are engaged in two principal businesses: gas sales and transportation, and oil and gas production and marketing. National Gas & Oil Corporation (National Gas) is a public utility engaged directly in the purchase, storage, distribution, sale and transportation of natural gas in a 12 county area in East Central and Southeastern Ohio. NGO Development Corporation (NGO Development) operates as an oil and gas production and development company within the Appalachian area. As of January 1, 1995 Coshocton Energy Corporation (Coshocton Energy) was merged with it's parent, NGO Development. Producers Gas Sales, Inc. (Producers Gas) is a service company for the marketing of natural gas directly to end-use customers.\nTotal annual revenues during the periods 1993 through 1995 are set forth as follows: 1995 1994 1993 ---- ---- ---- Gas Sales & Transportation (1) Industrial and Off-system ............. $ 2,324,188 $ 8,369,981 $ 6,271,697 Residential .............. 13,736,465 15,111,291 13,035,406 Commercial ............... 5,302,480 5,894,331 5,066,273 Transportation ........... 6,124,990 5,146,050 4,241,745 ----------- ----------- ----------- Subtotal ............... 27,488,123 34,521,653 28,615,121 Oil & Gas Sales (2) ............ 20,630,712 27,201,139 18,067,652 ----------- ----------- ----------- Total Operating Revenues ....... $48,118,835 $61,722,792 $46,682,773 =========== =========== ===========\nIncome from continuing operations before provision for federal income taxes during the periods 1993 through 1995 are set forth below:\n1995 1994 1993 ---- ---- ----\nGas Sales & Transportation(1) .. $4,498,225 $4,235,949 $2,922,721 Oil & Gas Sales (2) ............ 792,409 1,162,595 452,534 ---------- ---------- ---------- Total .......................... $5,290,634 $5,398,544 $3,375,255 ========== ========== ========== _________________ (1) Includes National Gas and Producers Gas. (2) Includes NGO Development.\nGas throughput for the periods 1993 through 1995 is set forth on Page 15.\nGAS SALES AND TRANSPORTATION\nThe Company's gas sales and transportation segment is comprised of National Gas, a public utility, and Producers Gas, a gas marketing company which sells gas to customers both on and off National Gas' pipeline system. Producers Gas aggregates supply to be delivered to end use customers by National Gas or other local distribution companies.\nIn 1995, approximately 69 percent of National Gas' throughput within its service territory was to industrial customers to which National Gas is providing sales or transportation service. These industrial customers are engaged primarily in the manufacture of ceramic products, steel and aluminum products and fiberglass, and use gas primarily for industrial processing purposes.\nTransportation represents service provided to industrial customers whereby National Gas transports gas and does not purchase and resell the gas. In contrast, gas sales consist of gas purchased by National Gas and resold to residential, commercial and certain industrial customers.\nTransportation service rates are based on separate agreements signed by each customer and are derived from the cost of providing the transportation service. Industrial sales rates are based on separate large and small gas service contracts signed with each customer.\nThe sale and transportation of natural gas continued to be a competitive business in 1995, and is expected to remain competitive in the future. The factors affecting the level of competition include the continuation of ample gas supply, regulatory policies, and price competition between sellers and marketers of natural gas as well as between the use of natural gas and other sources of energy. Specifically, many of the industrial customers have alternate fuel capability.\nIn addition to its industrial sales and transportation services, National Gas supplies gas to approximately 24,500 residential and commercial customers in the Ohio cities of Newark, Heath, Caldwell, Buckeye Lake and Zanesville and in the surrounding area, including various small communities in Perry, Licking, Muskingum, Noble, Belmont, Washington and Meigs Counties. Gas sold to these residential and commercial customers is primarily used for heating purposes and is directly affected by the seasonal nature of this type of service.\nThe base rates charged to residential and commercial customers by National Gas are based on local rate ordinances negotiated and signed with the Ohio cities or villages of Batesville, Buckeye Lake, Caldwell, Crooksville, Dexter City, Glenford, Granville, Gratiot, Hanover, Heath, Hebron, Macksburg, Newark, Philo, Roseville, Zanesville, Racine, Rutland and Syracuse, and\ninclude rates to their contiguous areas and rural areas in Fairfield, Licking, Muskingum, Perry, Noble, Belmont, Washington and Meigs Counties. The cost of gas charged to these customers is based upon the gas cost recovery (GCR) mechanism administered by the Public Utilities Commission of Ohio (PUCO).\nColumbia Gas of Ohio (Columbia), a large distribution company headquartered in Columbus, Ohio, also sells gas in Newark, Caldwell and Zanesville. National Gas and Columbia have residential and commercial customers in contiguous areas in and around Newark and Caldwell, but neither, with few exceptions, has a distribution system in an area served by the other. A majority of the industrial customers could be served by either National Gas or Columbia, or both.\nNational Gas and Columbia are in competition with each other and the same electric company, The Ohio Power Company, for heating, air conditioning and other domestic and commercial uses. In the State of Ohio there are no exclusive franchises granted to natural gas distribution companies. National Gas relies upon its ability to react quickly to customer's needs, and has the added benefit of local storage fields which serve to enhance the Company's competitive position. Columbia has no storage of its own, however, it can contract for this service. Additionally, the Company's access to local Ohio production through an extensive gathering system provides gas supply and marketing flexibility. Columbia has similar access. National Gas has a history of providing reliable service to the customers in its service area.\nNational Gas has contracted for pipeline capacity with Texas Eastern Transmission Corporation (Texas Eastern), Tennessee Gas Pipeline Company (Tennessee), Columbia Gas Transmission Corporation (Columbia Transmission) and CNG Transmission Corporation (CNG) to transport a substantial portion of its gas at rates which are subject to the jurisdiction of the Federal Energy Regulatory Commission (FERC). During 1993, all of National Gas' interstate pipeline suppliers began the restructuring of their operations to comply with FERC Order 636, which dictated the unbundling of gas supply and transportation services provided by the interstate pipelines.\nAs a part of the restructuring to comply with FERC Order 636, the FERC has authorized the recovery of prudently incurred transition costs by the interstate pipeline companies. As of December 31, 1995, National Gas has paid approximately $1,444,000 to its interstate pipeline suppliers for transition costs. Approximately $1,357,000 remains to be paid over the next eight years and, accordingly, has been accrued at December 31, 1995. National Gas has\nreceived authorization from the PUCO to recover 79 percent of those transition costs from its rate-regulated customers through the GCR mechanism and 21 percent from its transportation customers via a transition cost surcharge. The majority of transition costs which have been paid and allocated to the rate-regulated customers have been collected while collections from the transportation customers began in 1995.\nA summary of the contracts between National Gas and its interstate suppliers follows:\nMaximum Rate Contract Termination Daily Quantity Supplier Schedule Date Date Dth ____________________________________________________________________________\nTexas Eastern FT-1 11\/10\/95 10\/31\/12 15,275 Texas Eastern SS-I 11\/01\/89 10\/31\/99 3,380 CNG SS-II 04\/12\/90 04\/15\/00 2,500 Tennessee FT-G 09\/01\/85 11\/01\/00 1,479 Columbia Trans. GTS 11\/01\/88 11\/01\/00 3,830\nDuring 1995, National Gas transported 50 percent of its total gas purchased for resale or transportation from the four interstate pipeline companies detailed above. National Gas acquired the remaining 50 percent of its supply requirements from independent Ohio producers. During 1994 and 1995, purchases of Ohio gas began to increase due to increased development of the Rose Run formation by Ohio producers.\nAdditionally, National Gas utilizes its gas storage fields and contract storage to satisfy peak on-system loads during the heating season and markets excess storage capacity to off-system customers. Consequently, excess gas is purchased during the summer months, when prices may be lower, and utilized during the winter months. During 1995, approximately 1,910,000 Mcf were injected into underground storage and approximately 2,300,000 Mcf were withdrawn.\nIn 1995, National Gas connected approximately 700 new residential and commercial customers. In addition, National Gas continued to expand the local Ohio gas gathering system in an effort to assure an adequate supply of gas for all of its current and prospective customers.\nCapital expenditures for National Gas during 1995 were approximately $4,490,000 which included normal system expansion and replacement, the construction of a pipeline to transport gas to American Electric Power Company's electric generating plant in Conesville, Ohio, storage field enhancements and the construction of a natural gas processing facility. Capital expenditures in 1996 are expected to be approximately $4,200,000 to support existing operations and the replacement of selected current facilities and lines.\nNational Gas is subject to the jurisdiction of the PUCO with respect to certain rates, accounts, service, issuance of securities, safety and certain other matters. In the event of certain declared national or state emergencies, National Gas' gas supplies may also be subject to further regulation by federal and state agencies and officials.\nAlthough there were no sales to individual customers in excess of 10 percent of operating revenues during the period 1993 through 1995, one customer comprised 14 percent of total system throughput in 1995. However, National Gas is dependent upon several industrial customers for a significant portion of its throughput. Approximately 25 percent of the total throughput results from serving five major industrial customers which operate in different industries. This customer concentration has remained relatively constant since 1991. Competition for these end users is intense with other natural gas utilities, fuel oil, propane, and electric utilities.\nAs reflected in the quarterly information in the notes to the consolidated financial statements, operating revenues and net income of National Gas are seasonal in nature. While the industrial throughput is relatively constant, the gas sold to residential and commercial customers for heating purposes reflects variations in weather conditions.\nOIL AND GAS SALES\nThe oil and gas sales segment is comprised of NGO Development, an oil and gas exploration, production, development and marketing company operating in the Appalachian Basin. NGO Development maintains working interest ownerships ranging from 100 percent to 5 percent in 618 producing wells. The oil and gas produced from these wells is sold to crude oil and natural gas purchasers in the Appalachian Basin, as well as to end-use customers. Oil and gas production is relatively constant throughout the year. Associated revenues and net income fluctuate based upon changes in oil and gas prices. NGO Development is in competition with many other Appalachian Basin exploration, production and development companies for new oil and gas reserves and undeveloped acreage.\nIn addition to oil and gas exploration and production, NGO Development is active in marketing gas it produces and gas it purchases from third parties. This marketing activity expanded in 1993 and 1994, but was slightly lower in 1995 due to increased competition in this business segment. NGO Development is in competition with many other gas producing and marketing companies, as well as local distribution companies, for new customers.\nIn 1995, the oil and gas sales segment scaled down its capital expenditures due to market conditions to $372,000 covering the purchase, development and\/or completion of various interests in oil and gas wells and for additions to its gas gathering facilities.\nIn 1996 NGO Development expects to incur capital expenditures for oil and gas operations totaling approximately $725,000.\n******************************************************************************** At December 31, 1995, the Company's operating subsidiaries had 130 full-time active employees.\nFor financial information regarding industry segments, see Note 9 of the notes to consolidated financial statements. ********************************************************************************\nEXECUTIVE OFFICERS OF REGISTRANT\nBirth Family Office Held as of Name Date Age Relationship December 31,1995 ________________________________________________________________________________\nWilliam H.Sullivan,Jr. 10\/21\/38 57 None Chairman of the Board\nPatrick J. McGonagle 07\/08\/54 41 None President and Chief Executive Officer\nLawrence P. Haren 08\/03\/54 41 None Executive Vice President, Treasurer and Chief Financial Officer\nJohn B. Denison 02\/14\/40 55 None Vice President and Secretary\nAll of the executive officers listed were elected to their respective offices in the Company on May 18, 1995. All executive officers hold similar positions with National Gas, NGO Development and Producers Gas.\nWilliam H. Sullivan was elected as Chairman of the Board on May 18, 1995, after having served as a Director of the Company since 1978. Patrick J. McGonagle was elected to the position of President and Chief Executive Officer on February 19, 1993. Previously, Mr. McGonagle held the position of Vice President and General Counsel since May 19, 1988. Lawrence P. Haren was elected to the position of Executive Vice President, Treasurer and Chief Financial Officer on February 19, 1993. Previously, Mr. Haren held the position of Vice President, Treasurer and Chief Financial Officer since January 1, 1988. Mr. Haren's employment with the Company ceased on March 7, 1996. John B. Denison, a 24-year employee, was elected to the position of Vice President and Secretary on May 18, 1978.\nItem 2","section_1A":"","section_1B":"","section_2":"Item 2 - PROPERTIES\nNational Gas owns and operates a system consisting of approximately 1,347 miles of distribution, transmission and gathering mains, ranging in size from one inch to 16 inches in diameter. The mains are located on easements or private rights-of-way. In addition, the Company owns and operates seven gathering compressor stations and one distribution (main line boost) compressor station consisting of 2,242 brake horsepower. Five of these compressor stations are situated on lands totaling 19.77 acres owned by National Gas.\nComplementing the above pipeline and compressor station facilities, National Gas also owns and operates three underground natural gas storage fields. These fields have a combined estimated reservoir capacity of 5,300,000 Mcf, and consist of 44 wells and six compressors, totaling 2,650 brake horsepower. The majority of the subsurface rights are held by lease with 955.39 acres held in fee.\nNational Gas owns workhouses, garages, offices, shops and various metering and regulating buildings in its operating area. These facilities are located on 35.42 acres and are owned in fee. The corporate headquarters are located in a 20,000 square foot building which is owned by the Company and is located in Newark, Ohio. In addition, the Company owns a warehouse, office, and meter shop buildings in Zanesville, Ohio, which are leased to an unrelated third party.\nThe Company's investment in its natural gas system is considered suitable to do all things necessary to bring gas to the consumer. National Gas, as is typical in the industry, provides for an ongoing maintenance and replacement program.\nThe oil and gas properties consist of 618 gross and 336 net producing wells as of December 31, 1995. Nearly all wells are combination wells producing both oil and gas. Additionally, NGO Development has leasehold acreage at December 31, 1995, as follows:\nGross Net -------- -------- Developed acreage ................. 64,993 52,897 Undeveloped acreage ............... 53,902 45,727\nThe following table summarizes the average selling prices for oil and gas, the average production cost per equivalent Mcf (one barrel of oil equals six Mcf), and the average daily oil and gas production for the period 1993 through 1995:\n1995 1994 1993 ---- ---- ---- Average sales price per Mcf ........... $ 2.96 $ 3.34 $ 3.03 Average sales price per barrel ........ $16.66 $15.81 $17.10 Average production cost per equivalent Mcf .......... $ 0.31 $ 0.45 $ 0.57 Average daily production of gas (Mcf) ............... 2,902 3,023 3,046 Average daily production of oil (barrels) ........... 110 130 94\nIn 1995, 1994 and 1993, NGO Development participated in the drilling of 6, 12 and 7 exploratory wells which were completed and 4, 7 and 5 dry holes, respectively. Also, NGO Development participated in the drilling of eight developmental wells which were completed in 1995. As of December 31, 1995 there were three exploratory wells and two developmental wells in the process of being drilled or completed.\nItem 3","section_3":"Item 3 - LEGAL PROCEEDINGS\nThe Company and its subsidiaries are not parties at this time to any legal proceedings which are expected to have a material effect on the consolidated financial position, results of operations or liquidity of the Company.\nItem 4","section_4":"Item 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\nPART II\nItem 5","section_5":"Item 5 - MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Registrant's $1.00 par value common shares are traded on the American Stock Exchange (Symbol NLG). The sales prices traded on the American Stock Exchange are stated below:\nSale Prices 1995 High Low - ------------------------------------- ------ ------ First Quarter ............................... 12 1\/2 10 1\/2 Second Quarter ............................. 12 - 9 7\/8 Third Quarter .............................. 11 7\/8 10 - October 1 through November 22 .............. 11 1\/8 10 1\/2 November 23 through December 31 after 3% stock dividend .................. 10 1\/4 9 1\/2\nSale Prices 1994 High Low - ------------------------------------- ------ ------ First Quarter .............................. 18 7\/8 16 1\/2 Second Quarter ............................ 18 5\/8 15 5\/8 Third Quarter ............................. 17 3\/4 14 1\/4 October 1 through December 19 ............. 17 1\/2 15 1\/8 December 20 through December 31 after three-for-two stock split ......... 12 1\/2 10 1\/4\nAt February 28, 1996, there were 1,642 equity shareholders of record of the Company's $1.00 par value common shares. Of the total shares outstanding, approximately 106,800, or 1.56 percent, were held by the Company's employee benefit plans. Dividends in the amount of $.09 per share were paid quarterly for all of 1994 and in the amount of $.06 per share per quarter in 1995 after the stock split. A three-for-two stock split was issued in December 1994, and a three percent stock dividend was issued in December 1995.\nDividend policy is established by the Company's Board of Directors. The Board's decision takes into consideration covenants included in loan agreements, results of operations and retained earnings of the Company. Presently, there are no restrictions on the payment of dividends, as the Company is not in default under the terms of its long-term bank loans.\nItem 6","section_6":"Item 6 - SELECTED FINANCIAL DATA (In Thousands, Except for Per Share Data)\n1995 1994 1993 1992 1991 - -------------------------------------------------------------------------------- Total operating revenues ............... $48,119 $61,723 $46,683 $ 38,298 $ 30,624\nIncome from continuing operations ............. $ 3,230 $ 3,489 $ 2,072 $ 2,612 $ 2,134\nDiscontinued operations ............. $ -- $ -- $ -- $ (364) $ (15)\nCumulative effect of accounting changes ................ $ -- $ -- $ -- $ (235) --\nNet income ............... $ 3,230 $ 3,489 $ 2,072 $ 2,013 $ 2,119\nIncome from continuing operations - per share (1) .................... $ 0.47 $ 0.51 $ 0.30 $ 0.38 $ 0.31\nDiscontinued operations - per share (1) .................... $ -- $ -- $ -- $ (0.05) $ --\nCumulative effect of accounting changes - per share (1) .......... $ -- $ -- $ -- $ (0.04) --\nNet income per share (1) .................... $ 0.47 $ 0.51 $ 0.30 $ 0.29 $ 0.31\nTotal assets ............. $79,430 $80,620 $77,897 $ 69,195 $ 66,189\nLong-term obligations ............ $11,079 $12,956 $ 9,002 $ 6,905 $ 7,438\nCash divi- dends per share (1) .............. $ 0.23 $ 0.23 $ 0.22 $ 0.22 $ 0.22\n(1) Based upon the average number of shares outstanding of 6,860,589 in 1995 and 1994, 6,834,881 in 1992, 6,834,668 for 1991. These shares were adjusted for the three percent stock dividend in December 1995.\nItem 7","section_7":"Item 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\nConsolidated Results\nOperating revenues have been separated into revenues generated from the sale and transportation of natural gas by National Gas and Producers Gas and the sale of oil and gas purchased and produced by NGO Development. Other income includes the revenues of the holding company, National Gas & Oil Company and other income from all subsidiaries.\nConsolidated revenue of $48,119,000 in 1995 decreased 22 percent from 1994 consolidated revenue and consolidated revenue of $61,723,000 in 1994 increased 32 percent from 1993 consolidated revenue. The decrease in revenue in 1995 is primarily attributed to lower gas volumes sold and declining gas prices. The increase in 1994 revenue over 1993 is primarily due to off-system gas marketing activity.\nPurchase gas expense decreased from 1995 to 1994 and increased from 1994 to 1993 as a result of changes in gas sales activities. Interest expense has increased each year since 1993 as a result of additional borrowings to maintain working capital requirements and upgrade storage facilities for National Gas, to finance the acquisition of NGO Development and its capital construction programs and to finance the construction of the pipeline to the American Electric Power Company's electric generating plant.\nNet income amounted to $3,230,000 in 1995, a decrease of $259,000 from 1994. The seven percent decrease was attributable to the oil and gas sales segment. In 1994, net income was up $1,418,000, or 68 percent, from 1993 because of increased income in all business segments.\nNet income per common share in 1995 was $.47, as compared to net income per common share in 1994 of $.51, and in 1993 of $.30. All per share amounts have been restated to reflect the three percent stock dividend in December 1995.\nFinancial Information by Business Segment\nThe following tables compare operating revenues, operating income before federal income taxes and gas throughput for the last three years.\nOperating Revenues 1995 1994 1993 - ------------------ ---- ---- ----\nGas Sales & Transportation: Industrial & Off-System ......... $ 2,324,188 $ 8,369,981 $ 6,271,697 Residential ..................... 13,736,465 15,111,291 13,035,406 Commercial ...................... 5,302,480 5,894,331 5,066,273 Transportation .................. 6,124,990 5,146,050 4,241,745\nSubtotal ....................... 27,488,123 34,521,653 28,615,121 Oil & Gas Sales ................... 20,630,712 27,201,139 18,067,652 ----------- ----------- -----------\nTotal Operating Revenues .......... $48,118,835 $61,722,792 $46,682,773 =========== =========== ===========\nOperating Income Before Federal Income Taxes\n1995 1994 1993 ---- ---- ----\nGas Sales & Transportation ........ $ 4,498,225 $ 4,235,949 $ 2,922,721 Oil & Gas Sales ................... 792,409 1,162,595 452,534 ----------- ----------- ----------- Total Operating Income Before Federal Income Taxes ............ $ 5,290,634 $ 5,398,544 $ 3,375,255 =========== =========== ===========\nGas Throughput (Mcf) 1995 1994 1993 ---- ---- ---- Gas Sales: Industrial ...................... 76,025 76,470 104,346 Residential ..................... 1,984,301 2,016,487 1,926,279 Commercial ...................... 845,353 866,696 827,704 Off-System ...................... 1,237,315 2,889,748 3,371,665 ----------- ----------- ----------- Subtotal ...................... 4,142,994 5,849,401 6,229,994 Transportation .................... 5,552,184 6,807,571 6,447,650 Oil & gas sales ................... 9,489,180 10,626,768 5,535,765\nTotal ............................. 19,184,358 23,283,740 18,213,409 =========== =========== ===========\nGas Sales and Transportation\nOperating revenues associated with this segment of the business decreased 20 percent in 1995, primarily as a result of a decrease in the volumes sold to each customer class which was only partially offset by rate increases to each customer class. Changes in the level of over or under recovery of gas costs and customer conservation contributed to the reduction in residential and commercial operating revenues in 1995. The increase in 1994 revenues from 1993 resulted primarily from an increase in the volumes sold. A portion of the Company's gas throughput is effected by weather. Annual degree days which\nmeasure the effect of weather were 6,742, 6,477, and 6,472 for 1995, 1994 and 1993, respectively. The thirty year average is 6,162.\nOperating income before federal income taxes of the gas sales and transportation segment increased $262,000 in 1995 after increasing $1,313,000 in 1994. The increase in 1995 is primarily attributed to increased margins earned on the residential\/ commercial and transportation customer classes, while the increase in 1994 was attributed to volume and margin increases. The change in gross margin for each on-system customer class of National Gas during 1995 was affected by volume and price as follows:\nVolume Price Total --------- ----------- ---------- Industrial $ (133) $ (3,252) $ (3,385) Residential\/ Commercial (143,923) 732,986 589,063 Transportation (722,269) 1,188,321 466,052\nIn order to protect transportation margins, the Company utilizes a hedging program whereby gas futures contracts are purchased to hedge against rising prices of gas which is allocated to fixed price transportation customers. The Company has reduced the risk it faced in a market of rising gas prices.\nDuring the third quarter of 1993, the Company analyzed the need for base rate increases and decided to apply for rate increases with the cities and villages in National Gas' operating area to cover anticipated increases in operating expenses. Rate increases over a three-year period were successfully negotiated with all municipalities served by National Gas. The initial rate increases were effective December 1, 1993 with subsequent increases effective in 1994 and 1995. Industrial, transportation and off-system rates are subject to competitive pressures. There were no unusual changes in operating or maintenance expenditures during the three-year period.\nGas sales to industrial customers remained relatively flat in 1995 after decreasing by 28,000 Mcf in 1994. In 1995 and 1994, off-system throughput by the gas sales and transportation segment declined. Residential and commercial throughput decreased approximately two percent in 1995 after increasing approximately five percent in 1994. Transportation throughput decreased by 18 percent in 1995 after increasing six percent in 1994. The 1995 decrease in off-system and transportation throughput was caused by a decline in the number of customers.\nThe decrease in purchased gas expense of 41 percent in 1995 is primarily the result of decreased sales volume and a decrease in the cost of gas. The increase in purchased gas expense of 16 percent in 1994 resulted primarily from an increase in sales volume.\nThe Company utilizes its resources to take advantage of the seasonal nature of natural gas pricing. Spot market purchasing is accomplished when possible, and the Company's storage facilities are utilized not only to satisfy peak demand, but to facilitate the seasonal nature of spot market purchasing.\nOil and Gas Sales\nOperating revenues from the oil and gas sales segment in 1995 decreased to $20,631,000 due to the decreased gas marketing activity of NGO Development and lower gas prices. Revenues in 1994 increased significantly over 1993 because of increased gas marketing activity. Gas marketing contributed approximately 66 percent of the total revenue for this business segment in 1995.\nNGO Development's gas marketing activity generally consists of selling gas to off-system customers in a highly competitive environment. Unit margins on these off-system sales are relatively low when compared to unit margins on sales to on- system customers in the Gas Sales and Transportation segment.\nOperating income before federal income taxes from the oil and gas sales segment in 1995 amounted to $586,000, a decrease of $577,000 from income in 1994 of $1,163,000. Income in 1994 represented a $710,000 increase from 1993 income. The decrease in income in 1995 is primarily the result of decreased gas and oil production and lower gas prices, while the increase in 1994 is the result of increased oil production and gas marketing activity. Gas marketing activity contributed approximately 44 percent of the total income for this business segment in 1995.\nGeneral\nThe Company's depreciation, depletion and amortization expenses have increased over the three-year period primarily as a result of the increased level of capital invested. The provision for depreciation of utility property, plant and equipment, excluding transportation and construction equipment, is based on a composite rate of 3.12 percent. Depletion expense for the oil and gas sales segment remained relatively flat over the three-year period.\nReal estate and personal property taxes for the gas sales and transportation segment increased in 1995 because of increases in utility property and in property tax rates. Gross receipts tax applicable to public utilities is based on revenues, and accordingly, such taxes decreased in 1995. Overall, taxes other than income taxes increased $180,000 and $328,000 in 1995 and 1994, respectively.\nFederal Income Taxes\nThe change in federal income tax expense in the three-year period directly reflects the changes in income for the consolidated companies.\nCAPITAL RESOURCES AND LIQUIDITY\nCapital Resources\nThe primary sources and uses of cash during the last three years are summarized in the following condensed cash flow statement:\nSources and (Uses) of Cash ($000)\n1995 1994 1993 ---- ---- ----\nProvided by Operating Activities ........... $ 9,319 $ 7,167 $ 1,025 Capital Expenditures, net of salvage ....... (4,958) (8,398) (5,419) Net Proceeds from long-term debt ........... (1,877) 3,950 2,117 Net Borrowings under short-term bank loans ............................... (1,700) (400) 1,250 Common Dividends ........................... (1,606) (1,603) (1,535) Net Increase (Decrease) in Cash & Cash Equivalents ................ $ (822) $ 716 $(2,562) ======= ======= =======\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. In 1993, working capital changes had a substantial negative impact on cash provided by operating activities. Cash was utilized to purchase gas futures contracts and more cash was tied up in accounts receivable at year end reflecting the increase in revenues. Additionally, a substantial amount of purchased gas expense was deferred until it is included in rates and recovered from customers.\nThe Company expects that internally generated cash and cash reserves will continue to be sufficient to satisfy approximately 90 percent of the operating, normal capital expenditure and dividend requirements of the Company's existing operations in the near future. The remaining requirements will be satisfied by seasonal short-term borrowings or other forms of long- term debt.\nCapital Expenditures\nCapital expenditures by business segment for each of the three years are presented in the following table: ($000)\n1995 1994 1993 ---- ---- ----\nGas Sales & Transportation ............. $4,490 $6,082 $3,056 Oil & Gas Sales ........................ 372 2,509 2,488 ------ ------ ------ $4,862 $8,591 $5,544 ====== ====== ======\nIn 1995, the gas sales and transportation segment accounted for 92 percent of the total capital expenditures. The funds were expended primarily for expansion and upgrading of existing pipeline systems and completion of a new pipeline commenced in 1994 to provide gas service to an electric generating facility. The oil and gas sales segment accounted for eight percent of total capital expenditures which were primarily used for the purchase, development and\/or completion of various interests in oil and gas wells and for additions to the production company's gas gathering facilities.\nApproximately $1 million and $2.5 million of the total capital expenditures in 1995 and 1994, respectively, were used for construction of a pipeline to the electric generating facility. Approximately $1 million of the total capital expenditures in 1993 were used for the acquisition of existing oil and gas producing properties and pipelines.\nThe Company estimates that normal capital expenditures in 1996 will be approximately $4.9 million. The construction program is continually evaluated and actual expenditures may be more or less.\nThe Company continually assesses various alternatives for expanding its business, including the acquisition of other business entities.\nFinancing and Liquidity\nIn March 1994, National Gas issued $6 million of Senior Unsecured Notes in a private placement to a qualified investor. Part of the proceeds were used to fund capital projects in 1994 and 1995 with the balance to be used to fund future capital projects contemplated for 1996. The notes bear a fixed interest rate of 6.63 percent and have a maturity of 15 years and an average life of nine years. The notes carry a 100 percent guaranty by the Company.\nIn February 1993, the Company, and all of its subsidiaries except National Gas, entered into a $3 million revolving line of credit for a term of three years. During 1995, the Company extended the term of this instrument for an additional year. The committed credit line is unsecured and may be utilized by any of the subsidiaries, except National Gas. During 1995, NGO Development had a maximum of $1.45 million outstanding against this credit line and $450,000 remained outstanding as of December 31, 1995.\nIn September, 1992, the Company entered into a 15-year mortgage note to finance construction of additional office facilities to replace leased facilities and to remodel existing facilities. The mortgage is secured by the Company's Granville Road property. The maximum amount drawn on the note during 1993 was $700,000, and $619,000 remained outstanding as of December 31, 1995.\nIn October 1991, the Company entered into a $8.5 million bank loan in conjunction with the acquisition of NGO Development. This loan was originally scheduled to mature in October 1996. During 1995, the Company extended the term of this loan for an additional five years. The loan requires monthly principal payments of $70,833 with the final installment due in October 2001. As of December 31, 1995, $4,888,000 remained outstanding on this note.\nAs of December 31, 1995, the Company and its subsidiaries had short-term lines of credit with various banks aggregating in excess of $6 million, the upper limit on short-term borrowing imposed by the Board of Directors. The terms of each borrowing under the lines of credit are negotiated at the time the funds are requested. During 1995, the Company utilized these credit lines and as of December 31, 1995, a short-term draw of $1,350,000 remained outstanding.\nThe Company is not aware of any material events or uncertainties which would materially limit or restrict its ability to secure additional funds from external sources in either the debt or equity markets.\nThe Company is engaged in certain natural gas futures contracts as a means of hedging a portion of the market risk associated with fluctuations in the market price of natural gas. As of December 31, 1995, the Company and its subsidiaries had $783,000 invested in 307 open contracts with a contracted value of $5,608,000. The fair market value of these investments at December 31, 1995, was $6,297,000. Gains or losses on these investments are offset by increases or decreases in gas cost thereby reducing the market risk of fluctuating gas prices.\nDividends\nThe Company paid total cash dividends of $1,606,000, $1,603,000 and $1,535,000 in 1995, 1994 and 1993 respectively. Additionally, the Company issued a 3 percent stock dividend in 1995, three-for-two stock split in 1994 and a 5 percent stock dividend in 1993. Presently, there are no restrictions on the payment of dividends, as the Company is not in default of the terms in its long-term loans. Dividend policy is established by the Company's Board of Directors. The Board's decision takes into consideration results of operations and retained earnings of the Company. There are currently no restrictions on the present ability to pay such dividends.\nEffects of Inflation\nThe $8.5 million bank loan entered into in October 1991 and the $3 million revolver entered into in February 1993, accrue interest at a fluctuating rate equal to either the bank's prime rate or to the London Interbank Offered Rate (LIBOR). Because of the fluctuating rate, the Company is exposed to increases in interest expense should rates increase due to inflation. This same interest expense risk is present with the $700,000 mortgage note which accrues interest at the prime rate.\nAlthough the rate of inflation has been relatively low over the past few years, and thus has benefitted both the Company and its customers, the Company's operations remain sensitive to increases in the rate of inflation because of the capital-intensive and regulated nature of its major operating segments.\nItem 8","section_7A":"","section_8":"Item 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nINDEX TO FINANCIAL STATEMENTS PAGE\nManagement's Statement of Responsibility for Financial Reporting and Accounting .................................... 26\nReport of Independent Accountants ....................................... 27\nConsolidated Statement of Income for each of the Three Years in the period ended December 31, 1995 ..................... 28\nConsolidated Balance Sheet at December 31, 1995 and 1994 ............................................................ 29-30\nConsolidated Statement of Cash Flows for each of the three years in the period ended December 31, 1995 ..................... 31\nConsolidated Statement of Common Shareholders' Equity for each of the three years in the period ended December 31, 1995 ..................................................... 32\nNotes to Consolidated Financial Statements ............................ 33-51\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\nThere have been no disagreements of the nature described in Item 304 of Regulation S-K with the Company's independent accountants on accounting principles or financial statements.\nPART III\nThe information called for by PART III is incorporated by reference from the Registrant's definitive proxy statement relating to the Company's annual meeting of shareholders to be held May 23, 1996 (the \"definitive proxy statement\"), which involves the election of directors, to be filed pursuant to Regulation 14A not later than 120 days after the close of the fiscal year ended December 31, 1995. 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_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) Financial Statements\nConsolidated Statement of Income for each of the Three Years in the period ended December 31, 1995\nConsolidated Balance Sheet at December 31, 1995 and 1994\nConsolidated Statement of Cash Flows for each of the Three Years in the period ended December 31, 1995\nConsolidated Statement of Common Shareholders' Equity for each of the Three Years in the period ended December 31, 1995\nNotes to Consolidated Financial Statements\n(3) Exhibits\nExhibit Number Description - -------------------------------------------------------------------\n2 Stock Purchase Agreement dated September 12, 1991 by and between National Gas & Oil Company and Stone Container Corporation.\n3(a) Articles of Incorporation of National Gas & Oil Company\n3(b) Code of Regulations of National Gas & Oil Company\n10(a)* National Gas & Oil Company Salary Deferral Plan\n10(b)* Amended and Restated National Gas & Oil Company Compensation Plan for Outside Directors\n10(c)* Summary of Salary Administration Plan\n21 Subsidiaries of the Registrant\n24 Powers of Attorney of Directors\n27 Financial Data Schedule\n99(a) Credit Agreement dated October 1, 1991 by and among National Gas & Oil Company, Stone Resource and Energy Corporation and BancOhio National Bank.\n______________ * Management contract or compensatory plan or arrangement.\n(b) Reports on Form 8-K. No reports on Form 8-K have been filed during the last quarter of the period covered by this report.\n__________________________________\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the 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 GAS & OIL COMPANY (Registrant)\nDate March 27, 1996 By: \/s\/ John B. Denison -------------- -------------------------------- John B. Denison, Vice President, Secretary and Acting Principal Financial Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nDate March 27, 1996 By: \/s\/ William H. Sullivan, Jr. -------------- ----------------------------------- William H. Sullivan, Jr. Chairman of the Board and Director*\nDate March 27, 1996 By: \/s\/ Patrick J. McGonagle -------------- ----------------------------------- Patrick J. McGonagle, President and Chief Executive Officer\nDate March 27, 1996 By: \/s\/ John B. Denison -------------- ----------------------------------- John B. Denison, Vice President and Secretary and Acting Principal Financial Officer\nDate March 27, 1996 By: \/s\/ Alan A. Baker -------------- ------------------------ Alan A. Baker, Director*\nDate March 27, 1996 By: James H. Cameron -------------- --------------------------- James H. Cameron, Director*\nDate March 27, 1996 By: \/s\/ David C. Easley -------------- ------------------------- David C. Easley, Director*\nDate March 27, 1996 By: \/s\/ Edwin L. Heminger -------------- --------------------------- Edwin L. Heminger, Director*\nDate March 27, 1996 By: \/s\/ Richard O. Johnson -------------- ----------------------------- Richard O. Johnson, Director*\nDate March 27, 1996 By: \/s\/ M. Howard Petricoff -------------- ------------------------------ M. Howard Petricoff, Director*\nDate March 27, 1996 By: \/s\/ Graham R. Robb -------------- ------------------------- Graham R. Robb, Director*\n______________________ * Executed pursuant to Power of Attorney attached to this report by John B. Denison, Vice President and Secretary.\n\/s\/ John B. Denison ----------------------------------- John B. Denison, Vice President and Secretary\nMANAGEMENT'S STATEMENT OF RESPONSIBILITY FOR FINANCIAL REPORTING AND ACCOUNTING\nThe management of the Company is responsible for the preparation and integrity of the consolidated financial statements and all other financial information included in this Annual Report. The financial statements were prepared in conformity with generally accepted accounting principles consistently applied, and they necessarily include amounts which are based on estimates and judgments made with due consideration to materiality. The statements are not misstated due to material fraud or error.\nManagement maintains a system of internal accounting controls which it believes provides reasonable assurance that Company policies and procedures are complied with, assets are safeguarded, and transactions are executed in accordance with appropriate corporate authorization and recorded in a manner which permits management to meet its responsibility for the preparation of financial statements. The Company's system of controls includes the communication and enforcement of written policies and procedures.\nThe Audit Committee of the Board of Directors, comprised of three non-employee Directors, meets periodically, and as necessary, with management and Price Waterhouse LLP to review audit plans and the Company's accounting, financial reporting and internal control practices and procedures. Price Waterhouse LLP has full and free access to all levels of management. Management has made available to Price Waterhouse LLP all the Company's financial records and related data, as well as the minutes of shareholders' and directors' meetings. Furthermore, management believes that all representations made to Price Waterhouse LLP during its audit were valid and appropriate.\nPatrick J. McGonagle President and Chief Executive Officer\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholders of National Gas & Oil Company:\nIn our opinion, the accompanying consolidated financial statements listed in the index appearing under Item 8 on Page 22 present fairly, in all material respects, the financial position of National Gas & Oil Company and its subsidiaries at December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.\nPRICE WATERHOUSE LLP\nCleveland, Ohio February 15, 1996\nNATIONAL GAS & OIL COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENT OF INCOME\nFor the years ended December 31, 1995 1994 1993 OPERATING REVENUES: Gas sales ....................... $21,363,133 $29,375,603 $24,373,376 Transportation .................. 6,124,990 5,146,050 4,241,745 Oil and gas sales ............... 20,630,712 27,201,139 18,067,652 ----------- ----------- ----------- TOTAL OPERATING REVENUES .......... 48,118,835 61,722,792 46,682,773 ----------- ----------- -----------\nOPERATING EXPENSES: Purchased gas - gas sales ....... 11,590,683 19,732,082 17,019,953 Purchased gas - oil and gas sales ..................... 15,521,065 21,524,667 12,043,012 Operation and maintenance ....... 9,045,033 8,684,010 8,501,325 Depreciation, depletion and amortization .................. 3,437,538 3,318,064 3,225,037 Taxes other than income ......... 3,303,802 3,124,163 2,796,101 ----------- ----------- ----------- TOTAL OPERATING EXPENSES .......... 42,898,121 56,382,986 43,585,428 ----------- ----------- -----------\nOPERATING INCOME .................. 5,220,714 5,339,806 3,097,345 ----------- ----------- -----------\nOther income ...................... 186,753 376,771 343,124 Interest expense .................. 981,197 887,947 555,111 Federal income taxes .............. 1,195,900 1,339,189 813,722 ----------- ----------- -----------\nNET INCOME ........................ $ 3,230,370 $ 3,489,441 $ 2,071,636 =========== =========== ===========\nNet income per share .............. $ 0.47 $ 0.51 $ 0.30 =========== =========== =========== Average number of shares outstanding .............. 6,860,589 6,860,589 6,860,589 =========== =========== ===========\nCash dividends per share .......... $ 0.23 $ 0.23 $ 0.22 =========== =========== ===========\nThe per share amounts and the average number of shares outstanding have been restated to reflect the three percent stock dividend issued in December 1995.\nThe accompanying notes are an integral part of these statements.\nNATIONAL GAS & OIL COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET ASSETS December 31, 1995 1994 ---------------------------- PROPERTY, PLANT AND EQUIPMENT: Gas utility properties ..................... $62,444,717 $58,155,708 Less-Accumulated depreciation .............. 22,199,392 20,637,405 ----------- ----------- 40,245,325 37,518,303 Oil and gas properties, successful efforts ....................... 21,218,605 21,543,577 Less-Accumulated depreciation, depletion and amortization ............... 7,304,416 6,414,352 ----------- ----------- 13,914,189 15,129,225\nOther, net ................................. 5,492,265 5,748,532 ----------- -----------\nTotal property, plant and equipment .......... 59,651,779 58,396,060\nCURRENT ASSETS: Cash and cash equivalents .................. 448,250 1,271,186 Short-term investments ..................... 782,788 1,842,848 Accounts receivable, less allowance for doubtful accounts of $199,455 and $139,222, respectively ............... 10,285,798 9,770,469 Gas in underground storage ................. 2,321,552 3,333,358 Materials and supplies, at average cost ............................. 980,787 1,004,369 Prepaid taxes .............................. 2,896,527 2,533,423 Other ...................................... 504,340 636,329 ----------- -----------\nTotal current assets ......................... 18,220,042 20,391,982 ----------- -----------\nOTHER ASSETS:\nRecoverable transition costs ............... 818,059 930,320 Other ...................................... 740,422 901,178 ----------- -----------\nTotal other assets ........................... 1,558,481 1,831,498 ----------- -----------\nTOTAL ASSETS ................................. $79,430,302 $80,619,540 =========== ===========\nThe accompanying notes are an integral part of these statements.\nNATIONAL GAS & OIL COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET CAPITALIZATION AND LIABILITIES\nDecember 31, 1995 1994 ----------- -------- CAPITALIZATION: Shareholders' equity-- Common stock, $1 par value, authorized 14,000,000 shares, issued 7,018,512 and 6,819,400 shares, respectively ................. $ 7,018,512 $ 6,819,400 Paid in capital ........................ 31,353,831 29,498,107 Retained earnings ...................... 3,848,185 4,278,964 Treasury stock, 157,923 shares, at cost ............................. (1,550,509) (1,550,509) ------------ ------------\nTotal shareholders' equity ............... 40,670,019 39,045,962\nLong-term debt ........................... 11,079,442 12,955,973 ------------ ------------\nTotal capitalization ....................... 51,749,461 52,001,935 ------------ ------------\nCURRENT LIABILITIES: Current maturities of long-term debt ..... 877,264 877,695 Short-term bank loans .................... 1,350,000 3,050,000 Accounts payable ......................... 5,491,004 4,498,197 Accrued income and other taxes ........... 3,990,295 3,988,887 Refundable gas costs ..................... 1,348,047 1,401,811 Other .................................... 1,947,816 1,662,503 ------------ ------------\nTotal current liabilities .................. 15,004,426 15,479,093 ------------ ------------\nDEFERRED CREDITS AND OTHER LIABILITIES: Federal income taxes ..................... 8,112,490 8,521,800 Investment tax credits ................... 1,084,188 1,182,072 Accrued transition costs ................. 1,035,895 1,177,621 Health care and other .................... 2,443,842 2,257,019\nTotal deferred credits and other liabilities ........................ 12,676,415 13,138,512 ------------ ------------\nTOTAL CAPITALIZATION AND LIABILITIES ....... $ 79,430,302 $ 80,619,540 ============ ============\nThe accompanying notes are an integral part of these statements.\nNATIONAL GAS & OIL COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS\nFor the years ended December 31, CASH FLOWS FROM OPERATING 1995 1994 1993 ACTIVITIES: ----------- ------------ ----------- Net income ...................... $ 3,230,370 $ 3,489,441 $ 2,071,636 Reconciliation of net income to net cash provided by operating activities: Depreciation, depletion and amortization ......... 3,682,364 3,455,254 3,388,408 Deferred income taxes ...... 39,772 (579,264) 354,974 Other, net ................. 61,824 (157,117) (9,831)\nChange in assets and liabilities: Short-term investments ........ 1,060,060 (610,762) (1,232,086) Accounts receivable ........... (575,562) 3,108,559 (4,592,692) Gas in underground storage .... 1,011,806 (1,686,408) 93,272 Materials and supplies ........ 23,582 (76,684) 39,702 Deferred gas cost ............. 362,900 2,557,298 (2,537,611) Accounts payable .............. 992,807 (4,210,477) 2,782,901 Prepaid and accrued taxes ..... (407,920) 1,482,497 (335,469) Other, net .................... (163,428) 394,656 1,002,106 ----------- ----------- ----------- NET CASH PROVIDED BY OPERATING ACTIVITIES ............ 9,318,575 7,166,993 1,025,310 ----------- ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures ............ (4,862,201) (8,590,657) (5,543,582) Net (salvage) proceeds from retirements .............. (96,035) 192,951 124,683 ----------- ----------- ----------- NET CASH USED IN INVESTING ACTIVITIES ...................... (4,958,236) (8,397,706) (5,418,899) ----------- ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from long-term debt .... -- 6,000,000 2,920,505 Payments of long-term debt ...... (1,876,962) (2,049,720) (804,112) Net borrowings under short-term bank loans ......... (1,700,000) (400,000) 1,250,000 Dividends paid .................. (1,606,313) (1,603,142) (1,534,770) NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES ............ (5,183,275) 1,947,138 1,831,623 ----------- ----------- ----------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS .... (822,936) 716,425 (2,561,966)\nCASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR ............... 1,271,186 554,761 3,116,727 ----------- ----------- ----------- CASH AND CASH EQUIVALENTS AT END OF YEAR ..................... $ 448,250 $ 1,271,186 $ 554,761 =========== =========== ===========\nThe accompanying notes are an integral part of these statements.\nNATIONAL GAS & OIL COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENT OF COMMON SHAREHOLDERS' EQUITY\nCommon Stock $1 Paid in Retained Treasury Par Value Capital Earnings Stock\nBALANCE DECEMBER 31, 1992 4,388,417 28,666,479 5,118,410 (1,550,509) Net income ....... -- -- 2,071,636 -- Cash dividends on common stock ... -- -- (1,534,770) -- 5% stock dividend 210,763 3,051,848 (3,262,611) -- ---------- ------------ ----------- -----------\nBALANCE DECEMBER 31, 1993 4,599,180 31,718,327 2,392,665 (1,550,509) Net income ....... -- -- 3,489,441 -- Cash dividends on common stock ... -- -- (1,603,142) -- Three-for-two stock split .... 2,220,220 (2,220,220) -- -- ---------- ------------ ----------- -----------\nBALANCE DECEMBER 31, 1994 6,819,400 29,498,107 4,278,964 (1,550,509) Net income ....... -- -- 3,230,370 -- Cash dividends on common stock ... -- -- (1,606,313) -- 3% stock dividend 199,112 1,855,724 (2,054,836) -- ---------- ------------ ----------- -----------\nBALANCE DECEMBER 31, 1995 $7,018,512 $ 31,353,831 $ 3,848,185 $(1,550,509) ========== ============ =========== ===========\nThe accompanying notes are an integral part of these statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBusiness Description\nNational Gas & Oil Company (the Company) was organized under the laws of the State of Ohio on March 24, 1981 as a holding company. The Company derives substantially all of its revenues and earnings from the operating results of its subsidiaries.\nThe Company's subsidiaries are engaged in two principal businesses: gas sales and transportation, and oil and gas production and development. National Gas & Oil Corporation (National Gas) is a public utility engaged directly in the purchase, storage, distribution, sale and transportation of natural gas in a 12 county area in East Central and Southeastern Ohio. NGO Development Corporation (NGO Development) is an oil and gas production and marketing company. National Production Corporation (National Production), formerly a wholly-owned oil and gas production subsidiary of the Company, was merged into NGO Development as of July 1, 1993. Coshocton Energy Corporation (Coshocton Energy), formerly a wholly-owned oil and gas production subsidiary of NGO Development, was merged into NGO Development as of January 1, 1995. Producers Gas Sales, Inc. (Producers Gas) is a service company for the marketing of natural gas directly to end- use customers.\nApproximately 69 percent of the Company's natural gas throughput within its service territory is to industrial end users. Competition for these end users is intense with other natural gas utilities, fuel oil, propane and electric utilities. One customer comprises 14 percent of total system throughput. Approximately 26 percent of the total throughput results from serving five major industrial customers which operate in different industries.\nPrinciples of Consolidation\nThe accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. National Gas maintains its accounting records in conformity with the Uniform System of Accounts as prescribed by the Federal Energy Regulatory Commission (FERC) and adopted by the Public Utilities Commission of Ohio (PUCO).\nAll intercompany transactions have been eliminated, except for profits on sales of natural gas. These sales were made at prices that were at least as favorable as with those that could have been obtained from independent parties.\nThe preparation of the consolidated 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.\nCertain reclassifications have been made for comparative purposes.\nGas Utility Property, Plant and Equipment\nGas utility property, plant and equipment is stated at original cost, including overheads of payroll related costs, administrative and general expenses. The Company follows the policy of capitalizing major renewals and betterments. Maintenance and repairs are charged to expense as incurred. Upon retirement the cost, together with the cost of removal less salvage, is charged to accumulated depreciation.\nOil and Gas Properties\nOil and gas properties are accounted for using the successful-efforts method. Costs of acquiring nonproducing acreage, costs of drilling successful exploration wells and development costs are capitalized. Annual lease rentals and exploration costs, including geologic and geophysical costs and exploratory dry-hole costs, are expensed as incurred. Oil and gas properties and other property, plant and equipment are stated at cost. Upon abandonment of a property, the cost less salvage value of the property net of plugging is charged to accumulated depletion.\nDepreciation and Depletion\nThe provision for depreciation of gas utility property, plant and equipment, excluding transportation and construction equipment, described below, is based on a composite rate of 3.12 percent. Depreciation of transportation and construction equipment is provided using the straight-line method on estimated service lives of 3 to 10 years.\nDepletion and depreciation of proved oil and gas properties are computed using the unit-of-production method based upon proved reserves. Depreciation of other property, plant and equipment is provided using the straight-line method based on estimated service lives of 3 to 15 years.\nShort Term Investments\nThe Company purchases gas futures contracts in order to hedge against rising gas prices for fixed price sales contracts. Accordingly, the realized and unrealized gains and losses are deferred until the physical gas sale is made, at which time gains and losses are recorded as a component of gas cost.\nThe Company had the following gas futures positions on the New York Mercantile Exchange (NYMEX) at December 31, 1995 and 1994. Fair market value is based upon the NYMEX closing price.\nDecember 31, 1995 1994 ----------- ----------- Open contracts 307 308 Natural gas purchases hedged .......... 3.07 MMBtu 3.08 MMBtu Deposits with brokers ....... $ 782,788 $1,842,848 Contracted value ............ $5,607,980 $5,998,620 Fair market value ........... $6,297,310 $5,349,530\nCash and Cash Equivalents\nThe Company considers cash, time deposits and all other highly liquid investments with an original maturity of three months or less to be cash equivalents.\nSupplemental disclosures of cash flow information is as follows:\nCash paid for: 1995 1994 1993 ---- ---- ----\nIncome taxes ......... $ 1,750,000 $ 1,200,000 $ 650,000 Interest ............. $ 991,760 $ 747,736 $ 429,735\nGas in Underground Storage\nGas in underground storage includes gas stored by National Gas and Producers Gas. Gas stored by National Gas is valued at cost using the last-in, first-out method (LIFO). If the first-in, first-out (FIFO) method had been used, gas in underground storage would have been $3,508,000, and $4,954,000 higher than reported at December 31, 1995 and 1994, respectively. Gas stored by Producers Gas as of December 31, 1995 and 1994, of $339,049, $1,503,140, respectively, is valued using the average cost method.\nRevenues and Purchased Gas\nNational Gas records unbilled revenues for gas delivered but not yet billed. As of December 31, 1995 and 1994, National Gas had unbilled revenues of $1,645,147 and $1,296,841, respectively, included in accounts receivable.\nNational Gas has provisions in sales contracts and tariffs to include a Gas Cost Recovery (GCR) mechanism whereby any over or under recovery of purchased gas cost is reflected in the computation of future billings to customers. Amounts collected through the GCR mechanism are subject to annual review by the PUCO.\nRevenues from the sale of oil and gas produced are generally recognized upon the passage of title, net of royalties and net profit interests.\nNew Accounting Pronouncement\nIn March 1995, the Financial Accounting Standards Board (FASB) issued SFAS No. 121, \"Accounting for the Impairment of Long- Lived Assets and for Long-Lived Assets to be Disposed Of\" (SFAS 121). The statement establishes accounting standards for the impairment of long-lived assets, certain identifiable intangibles and goodwill related to those assets to be held and used and for long-lived assets and certain identifiable intangibles to be disposed of. The Company intends to adopt SFAS 121 on January 1, 1996. The adoption will not have any impact on the Company's financial position or results of operations.\nNOTE 2 - GAS SUPPLY\nNational Gas has contracted for pipeline capacity with Texas Eastern Transmission Corporation (Texas Eastern), Tennessee Gas Pipeline Company (Tennessee), Columbia Gas Transmission Corporation (Columbia Transmission) and CNG Transmission Corporation (CNG) to transport a substantial portion of its gas at rates which are subject to the jurisdiction of the FERC. In 1993, all of National Gas' interstate pipeline suppliers began the restructuring of their operations to comply with FERC Order 636, which dictated the unbundling of gas supply and transportation services provided by the interstate pipelines.\nAs a part of the restructuring to comply with FERC Order 636, the FERC has authorized the recovery of prudently incurred transition costs by the interstate pipeline companies. As of December 31, 1995, National Gas has paid $1,444,166 to its interstate pipeline suppliers for transition costs and $1,356,568 remains to be paid over the next eight years and, accordingly, has been accrued at December 31, 1995. National Gas has received authorization\nfrom the PUCO to recover 79 percent of these transition costs from its rate-regulated customers through the GCR mechanism and 21 percent from its transportation customers via a transition cost surcharge.\nA summary of the contracts between National Gas and its interstate suppliers in the post-636 environment follows.\nMaximum Rate Contract Termination Daily Quantity Supplier Schedule Date Date Dth - ---------------------------------------------------------------------------- Texas Eastern FT-1 11\/10\/95 10\/31\/12 15,275 Texas Eastern SS-I 11\/01\/89 10\/31\/99 3,380 CNG SS-II 04\/12\/90 04\/15\/00 2,500 Tennessee FT-G 09\/01\/85 11\/01\/00 1,479 Columbia Trans. GTS 11\/01\/88 11\/01\/00 3,830\nDuring 1995, National Gas transported 50 percent of its total gas purchased for resale or transportation from the four interstate pipeline companies detailed above. National Gas acquired the remaining 50 percent of its supply requirements from independent Ohio producers.\nNOTE 3 - REGULATORY MATTERS\nThe Company has incurred various costs and received various credits which have been reflected as regulatory assets and liabilities on the Company's consolidated balance sheet. Accounting for such costs and credits as regulatory assets and liabilities is in accordance with SFAS 71, \"Accounting for the Effect of Certain Types of Regulation\" (SFAS 71). This statement sets forth the application of generally accepted accounting principles for those companies whose rates are established by or are subject to approval by an independent third-party regulator. Under SFAS 71, companies defer costs and credits on the balance sheet as regulatory assets and liabilities when probable that those costs and credits will be allowed in the ratemaking process in a period different from the period in which they would have been reflected in income by an unregulated company. These deferred regulatory assets and liabilities are then flowed through the income statement in the period in which the same amounts are reflected in rates. The Company has recorded the following regulatory assets and liabilities:\nDecember 31, 1995 1994 ---------- -------- Regulatory Assets:\nRecoverable future taxes ................... $ 216,686 $ 243,770 Postretirement benefit costs ............... 180,982 203,602 Order 636 transition costs ................. 1,071,390 1,297,392 ----------- ----------\nTotal Regulatory Assets .................... 1,469,058 1,744,764 ----------- ----------\nRegulatory Liabilities:\nAmounts payable to customers ............... 1,348,047 1,404,811 Taxes refundable to customers .............. 282,899 307,031 ----------- ----------\nTotal Regulatory Liabilities ............... 1,630,946 1,711,842 ----------- ----------\nNet Regulatory Assets (Liabilities) ............................ $ (161,888) $ 32,922 =========== ==========\nNOTE 4 - FEDERAL INCOME TAXES\nThe Company follows the liability method of accounting for income taxes which calculates deferred income taxes at the statutory rate applicable for future years based upon temporary differences between book and tax bases of existing assets and liabilities.\nFederal income tax expense was computed as follows:\n1995 1994 1993 ---------- --------- ------ Tax at statutory rates applied to pre-tax book income ......................... $ 1,504,932 $ 1,641,734 $ 981,022 Increase (decrease) in tax caused by -- Depreciation, depletion and basis differences ....... (266,642) (230,212) (104,015) Investment credit amortization ............... (80,528) (81,103) (79,954) Other (net) .................. 38,138 8,770 16,669 ----------- ----------- ---------\nFederal income tax expense .................... $ 1,195,900 $ 1,339,189 $ 813,722 =========== =========== ========= Effective income tax rate ........ 27.0% 27.7% 28.2% =========== =========== =========\n1995 1994 1993 ---------- ---------- -------\nTaxes currently payable .......... $ 1,357,711 $ 2,067,818 $ 380,404 Deferred provision: Intangible drilling costs\/depletion ............... (456,714) (260,308) (337,017) Deferred gas cost .............. (136,658) (1,012,886) 460,788 Property timing differences .... 494,889 519,177 440,295 Property tax ................... -- (170,000) (170,000) Note receivable write-off ...... -- -- 187,718 Alternative minimum tax credit carryforward .......... -- 158,717 (158,717) Deferred compensation .......... (8,157) 2,535 1,911 Other, net ..................... (55,171) 34,136 8,340\nFederal income tax expense ....... $ 1,195,900 $ 1,339,189 $ 813,722 =========== =========== =========\nTemporary differences which give rise to deferred tax assets and liabilities are as follows: December 31, 1995 1994\nPercentage depletion ................... $ 132,135 $ 132,135 Vacation accrual ....................... 72,773 70,125 Inventory capitalization ............... 43,564 36,764 Reserve for accounts and notes receivable ................. 67,815 47,336 Postretirement benefits other than pension ................... 635,574 580,494 Investment tax credit .................. 464,810 506,288 Deferred gas ........................... 354,874 278,533 Other .................................. 151,681 140,716 ----------- ----------- 1,923,226 1,792,391 Valuation allowance .................... (155,351) (155,351) ----------- -----------\nTotal deferred tax assets ........................... 1,767,875 1,637,040 ----------- -----------\nPrepaid taxes .......................... (308,218) (281,664) Property ............................... (9,123,854) (9,503,338) Other .................................. (117,237) (128,701) ----------- -----------\nTotal deferred tax liabilities ...................... (9,549,309) (9,913,703) ----------- -----------\nNet deferred taxes ..................... $(7,781,434) $(8,276,663) =========== ===========\nThe Tax Reform Act of 1986 repealed investment tax credits for all property placed in service after December 31, 1985. Prior to 1986, investment tax credits were deferred and are presently being amortized over the lives of the applicable property additions.\nNOTE 5 - RETIREMENT INCOME PLAN AND POSTRETIREMENT HEALTH CARE BENEFITS\nThe Company has a trusteed, non-contributory retirement income plan (the Plan) which covers all full-time employees of the affiliated companies between the ages of 21 and 65 with more than one year of service. Retirement income is based on accumulated benefits throughout an employee's eligible years of service calculated as a portion of the employee's annual compensation. The Company's Board of Directors determines annual funding levels based upon the funded status of the Plan.\nIn September 1994, the Plan purchased annuities for all retirees and all former employees who were vested in the Plan. The purchase of these annuities was treated as a partial plan settlement which resulted in a pre-tax gain of $123,702. The purchase of the annuities was made with Plan assets and resulted in a decrease in the projected benefit obligation of $1,766,276.\nThe funded status of the retirement plan and the amount recognized in the Company's Consolidated Balance Sheet were as follows:\nSeptember 30, 1995 1994 Plan assets at fair value ------ ------ (principally unallocated insurance contracts) ....................... $ 2,459,153 $ 2,356,649 ----------- ----------- Actuarial present value of benefit obligations: Vested benefits .......................... 1,490,265 1,254,515 Nonvested benefits ....................... 42,175 24,172 ----------- ----------- Accumulated benefit obligation ............... 1,532,440 1,278,687 Additional amounts related to projected salary increases ................. 998,040 809,745 ----------- ----------- Total projected benefit obligation ........... 2,530,480 2,088,432 ----------- -----------\nPlan assets in excess (deficit) of projected benefit obligation ............ (71,327) 268,217\nAmounts necessary to reconcile excess (deficit) assets to prepaid pension cost included in the Consolidated Balance Sheet: Unamortized net asset .................... (299,107) (322,115) Unrecognized prior service cost .......... 317,792 349,760 Unrecognized net loss (gain) ............. 87,196 (188,182) Prepaid pension cost included in other assets ............................ $ 34,554 $ 107,680 =========== ===========\nNet pension cost for the Retirement Plan includes the following:\n1995 1994 1993 ----------------------------------------------- Benefits earned during the year (service cost) .................. $ 171,730 $ 209,894 $ 260,109 Interest accrued on projected benefit obligation .............. 170,648 275,337 261,677 Actual return on plan assets ...... (236,144) (318,080) (387,779) Net amortization and deferral ..... 8,960 (106,765) (31,786)\nNet periodic pension cost ......... $ 115,194 $ 60,386 $ 102,221 ========= ========= =========\nThe Company's assumptions used during the years 1995, 1994 and 1993 in determining net periodic pension cost and pension liability are as follows: 1995 1994 1993 ------ ------ ----- Discount rate ............... 7.50% 8.00% 7.00% Return on plan assets ....... 10.00% 10.00% 10.00% Estimated increase in future compensation ....... 5.00% 5.00% 6.00%\nIn 1995, the Company changed its discount rate assumption from 8.0 percent to 7.5 percent. This resulted in an increase in the projected benefit obligation of $285,170. An increase in the discount rate assumption and the decrease of the estimated increase in future compensation in 1994 resulted in decreases to the projected benefit obligation of $449,696 and $126,979, respectively.\nIn addition to the Retirement Income Plan, the Company provides health care benefits to all eligible active employees and to all retired employees. These benefits are provided through a partially self-funded and partially insured program to which employees contribute a percentage of the cost.\nThe Company follows Statement of Financial Accounting Standard No. 106 \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (SFAS No. 106). SFAS No. 106 requires the accrual method of accounting for postretirement health care benefits based on actuarial determined costs to be recognized over the service life of the employees.\nIn late 1993, National Gas negotiated new base rates with the municipalities that it serves. The rates in effect during 1995 include recovery of a portion of the accumulated postretirement benefit obligation (APBO) over a 10 year period. At December 31, 1995 approximately $181,000 remained to be collected.\nThe components of net periodic postretirement benefit expense were as follows: 1995 1994 ---------- -------\nService cost ......................... $ 49,051 $ 61,421 Interest cost on accumulated post- retirement benefit obligation ......................... 157,407 145,532 ----------- ----------- Net periodic post- retirement benefit expense ............................ 206,458 206,953 Deferral of benefits earned to be col- lected in future rates .............................. 22,620 22,620 ----------- ----------- Net periodic post- retirement benefit expense ............................ $ 229,078 $ 229,573 =========== ===========\nThe amount recognized in the Company's Consolidated Balance Sheet was as follows: September 30, 1995 1994 ----------- -----------\nRetirees ............................. $ 1,314,102 $ 1,242,859 Active employees ..................... 883,795 774,712 ----------- ----------- Accumulated post- retirement health care benefits ...................... 2,197,897 2,017,571 Unrecognized net loss ................ (148,622) (122,852)\nAccrued postretirement health care benefits ............... $ 2,049,275 $ 1,894,719 =========== ===========\nThe Company's assumptions used during the years 1995, 1994 and 1993 in determining net periodic postretirement benefit expense and the liability for postretirement health care benefits are as follows:\n1995 1994 1993 ---- ---- ----\nDiscount rate 7.50% 8.00% 7.00%\nHealth care Trend rate 10.00% 11.00% 12.25% gradually gradually gradually decreasing decreasing decreasing to 5.0% in to 5.0% in to 5.5% in 2001 2001 2004\nAs of September 30, 1995, the discount rate was changed from 8.0 percent to 7.5 percent, which resulted in an increase in the liability for postretirement benefits of $142,965.\nAs of September 30, 1994, the discount rate was changed from 7.0 percent to 8.0 percent and the health care trend rate was changed to gradually decrease from 11.0 percent in 1995 to 5.0 percent in 2001 and thereafter. These changes resulted in decreases in the liability for postretirement health care benefits of $270,300 and $143,500, respectively. Additionally, changes in the medical claims cost by retiree and retirement age assumptions resulted in a net increase in the liability for postretirement health care benefits of $305,200 as of September 30, 1994.\nIf the health care trend rate would increase by one percent in each year, the accumulated benefit obligation would increase by approximately $352,000 at September 30, 1995 and net periodic postretirement benefit expense in 1996 would increase by approximately $42,000.\nNOTE 6 - LONG-TERM DEBT\nThe long-term debt outstanding was as follows:\nDecember 31, 1995 1994 1993 ------------ ------------ ----------- Senior notes, 6.63% interest rate, due 2009 ............. $ 6,000,000 $ 6,000,000 $ --\nPromissory note, variable interest rate, due 2001 ................... 4,887,500 5,737,500 6,658,333\nMortgage note, variable interest rate, due 2008 ................... 619,206 646,168 675,055\nRevolving note, variable interest rate, due 1997 ................... 450,000 1,450,000 2,550,000 ------------ ------------ -----------\nTotal debt ................... 11,956,706 13,833,668 9,883,388 Less-current maturities ...... (877,264) (877,695) (881,041) ------------ ------------ -----------\nLong-term debt ............... $ 11,079,442 $ 12,955,973 $ 9,002,347 ============ ============ ===========\nOn March 15, 1994, National Gas issued $6 million of Senior Unsecured Notes (Senior Notes) to an accredited investor. The proceeds of the Notes have been utilized to construct a pipeline and related facilities to transport gas\nto an Ohio electric generating plant ($3.5 million) and to complete upgrades on National Gas' indigenous storage fields and other various projects ($2.5 million). The notes bear a fixed interest rate of 6.63 percent with interest payments due semi-annually. Annual principal payments of $461,539 commence on March 16, 1997 with the final payment due March 15, 2009. The notes carry a 100 percent guarantee of the Company.\nIn conjunction with the acquisition of NGO Development on October 1, 1991, the Company entered into an $8,500,000 promissory note. The terms of the note require monthly principal installments of $70,833 plus accrued interest with the final installment to be due on October 1, 2001 in an amount equal to the unpaid principal. The variable interest rate on the note at December 31, 1995 was 7.01 percent which represented the London Interbank Offer Rate (LIBOR) plus 1.25 percent per annum as of November 6, 1995 when the Company entered into a six month contracted rate. The note agreement allows the Company to choose either the prime rate or LIBOR plus 1.25 percent for contracted periods. The note is secured by the oil and gas properties of NGO Development and is guaranteed by the Company. Additionally, the Company is required to maintain certain working capital, debt to equity and cash flow ratios. If the Company should default on any of the financial covenants or other terms of the agreement, the Company becomes subject to certain dividend restrictions.\nIn September 1992, the Company entered into a mortgage note to finance the construction of new office facilities. The note has a 15-year amortization period, accrues interest at the prime rate, and monthly payments commenced on March 15, 1993. As of December 31, 1995, the prime rate was 8.50 percent. The mortgage is secured by the Company's Granville Road property.\nIn February 1993, the Company, and all of its subsidiaries except National Gas, entered into a $3 million revolving line of credit for a term of three years. During 1995, the Company extended the term of this instrument for an additional year. The committed credit line is unsecured and may be utilized by any of the subsidiaries, except National Gas. As of December 31, 1995, NGO Development Corporation had borrowed $450,000 at an interest rate of 6.875 percent.\nAnnual maturities of long-term debt are as follows:\n1996 ................. $ 877,264 1997 ................. 1,791,213 1998 ................. 1,343,836 1999 ................. 1,346,691 2000 ................. 1,349,798 Thereafter ................. 5,247,904\nTOTAL ................ $11,956,706 ===========\nBased on the borrowing rates currently available to the Company for loans with similar terms and maturities, the fair value of the Senior Notes is approximately $5,840,000. The fair value amount is not intended to reflect principal amounts that the Company will ultimately be required to pay.\nNOTE 7 - NOTES PAYABLE\nThe Company has lines of credit with various banks in excess of $6,000,000, the upper limit on short-term borrowings imposed by Board Resolution. The terms of each borrowing under the lines of credit are negotiated at the time the funds are requested. The Company is not required to maintain any compensating balances.\nAt December 31, 1995, National Gas had two draws totaling $1,350,000 on one of these credit lines for working capital requirements at interest rates of 6.875 percent and 6.863 percent. National Gas expects to repay these notes in 1996.\nNOTE 8 - CAPITAL STOCK\nThe Company has 100,000 shares of authorized and unissued preferred stock with no par value. National Gas has 10,000 shares of authorized and unissued preferred stock, with a par value of $100 per share.\nDuring 1995, the Company increased the authorized number of common shares from 7,000,000 to 14,000,000. The average common shares outstanding and earnings and cash dividends per common share presented on the accompanying income statement include retroactive recognition of 199,112 shares issued in December 1995 as a result of a three percent stock dividend.\nThe Company issued 2,220,220 shares in December 1994 as a result of a three-for-two stock split. The par value of the stock issued as a result of the stock split was transferred from Paid in Capital to Common Stock. Transfers from retained earnings to common stock and paid in capital for common stock dividends are based on estimated fair market value of the common stock and include cash paid in lieu of fractional shares.\nThere are no restrictions on dividends to the Company by the subsidiaries. National Gas may not make advances or loans to the Company for periods longer than one year without approval of the PUCO.\nIn January 1996, the Board of Directors authorized the repurchase of up to 250,000 shares of common stock at a maximum repurchase price of $9.33 per share. As of February 15, 1996, 1000 additional shares had been repurchased as treasury stock at a cost of $9.25 per share.\nIn February 1996, the Company adopted a Shareholder Rights Plan designed to protect shareholders from attempts to acquire control of the Company at an inadequate price. The plan provides for the distribution of one Preferred Stock Purchase Right as a dividend for each outstanding common share. Each right entitles shareholders to buy one five-hundredth of a share of a new series of preferred shares for $34.00. Each one five-hundredth of a preferred share is intended to be the practical economic equivalent of a common share. The rights may be exercised only if a person or group acquires 15 percent or more of the Company's common shares. The Company may redeem the rights at $0.01 (one cent) each at any time before a buyer acquires 15 percent of the Company's common shares, and thereafter under certain circumstances.\nUnder certain circumstances, including the acquisition of 15 percent of the Company's stock, all rights holders except the acquirer may purchase the Company's stock having a value of twice the exercise price of the rights. If the Company is acquired in a merger after the acquisition of 15 percent of its stock, rights holders may purchase the acquirer's shares at a similar discount.\nThe dividend distribution will be payable to shareholders of record on March 1, 1996. The rights expire on March 1, 2006.\nNOTE 9 - FINANCIAL INFORMATION BY BUSINESS SEGMENT\n1995 1994 1993 ----------------------------------------- Revenues: Gas sales ....................... $21,363,133 $29,375,603 $24,373,376 Transportation .................. 6,124,990 5,146,050 4,241,745 ----------- ----------- ----------- Subtotal ...................... 27,488,123 34,521,653 28,615,121 Oil and gas production .......... 20,630,712 27,201,139 18,067,652\nTotal ......................... $48,118,835 $61,722,792 $46,682,773 =========== =========== ===========\nIncome before provision for federal income taxes: Gas sales and transpor- tation ........................ $ 4,498,225 $ 4,235,949 $ 2,922,721 Oil and gas production .......... 792,409 1,162,595 452,534 ----------- ----------- -----------\nTotal ......................... $ 5,290,634 $ 5,398,544 $ 3,375,255 =========== =========== ===========\nDepreciation, depletion and amortization: Gas sales and transpor- tation ........................ $ 1,781,919 $ 1,643,738 $ 1,570,769 Oil and gas production .......... 1,655,619 1,674,326 1,654,268 ----------- ----------- -----------\nTotal ......................... $ 3,437,538 $ 3,318,064 $ 3,225,037 =========== =========== ===========\nCapital expenditures: Gas sales and transpor- tation and other .............. $ 4,489,771 $ 6,081,623 $ 3,055,855 Oil and gas production .......... 372,430 2,509,034 2,487,727 ----------- ----------- -----------\nTotal ......................... $ 4,862,201 $ 8,590,657 $ 5,543,582 =========== =========== =========== Identifiable assets: Gas sales and transpor- tation ........................ $54,968,627 $54,327,226 $51,168,979 Oil and gas production .......... 23,305,124 25,090,920 25,436,422 Non-operating ................... 1,156,551 1,201,394 1,291,767 ----------- ----------- -----------\nTotal ......................... $79,430,302 $80,619,540 $77,897,168 =========== =========== ===========\nNOTE 10 - QUARTERLY INFORMATION (UNAUDITED)\nThe following represents the quarterly results for 1995 and 1994, which are unaudited. The first three quarters of 1995 and all of 1994 earnings per common share amounts have been restated to reflect the three percent stock dividend issued in December 1995.\nIncome (Loss) Before Net Earnings Quarter Operating Federal Income Per Ended Revenues Income Tax (Loss) Share - --------------------------------------------------------------------------------\n03\/31\/95 .......... $18,031,424 $ 3,211,408 $ 2,163,490 $ 0.32 06\/30\/95 .......... 9,404,685 275,736 225,946 0.03 09\/30\/95 .......... 6,848,925 (934,829) (468,606) (0.07) 12\/31\/95 .......... 13,833,801 1,873,955 1,309,540 0.19\n03\/31\/94 .......... $24,711,066 $ 3,030,987 $ 2,041,355 $ 0.30 06\/30\/94 .......... 12,543,002 600,049 436,804 0.06 09\/30\/94 .......... 10,424,906 (182,239) (76,031) (0.01) 12\/31\/94 .......... 14,043,818 1,379,840 1,087,313 0.16\nNOTE 11 - OIL AND GAS INFORMATION\nCapitalized costs relating to oil and gas producing activities and related accumulated depreciation, depletion and amortization, were as follows:\nDecember 31, 1995 1994\nUnproved oil and gas properties .......... $ 757,462 $ 1,050,638 Proved oil and gas properties ............ 20,461,143 20,492,939 ------------ ------------ Total property costs ............... 21,218,605 21,543,577 Accumulated depreciation, depletion and amortization ......... (7,304,416) (6,414,352) ------------ ------------ Net capitalized costs .............. $ 13,914,189 $ 15,129,225 ============ ============\nCosts incurred relating to oil and gas property acquisition and exploration activities were as follows:\n1995 1994 1993 ---- ---- ----\nAcquisition of properties ........ $335,512 $ 797,383 $1,017,502 Exploration costs ................ $794,595 $1,092,115 $ 644,645 Development costs ................ $446,072 $ 486,212 $ 350,070\nThe results of operations of the Company's oil and gas producing activities, which exclude items such as corporate overhead and gas marketing activities were as follows:\n1995 1994 1993 ---- ---- ----\nOperating revenues .......... $3,450,560 $3,716,554 $3,435,136 Production costs ............ 400,710 619,619 750,487 Exploration costs ........... 612,297 555,069 644,645 Depreciation, depletion and amortization .......... 1,292,722 1,325,551 1,316,092 ---------- ---------- ---------- Operating income ............ 1,144,831 1,216,315 723,912 Income tax expense .......... 202,243 286,479 135,004 ---------- ---------- ---------- Net income ................... $ 942,588 $ 929,836 $ 588,908 ========== ========== ========== Reserves (Unaudited)\nThe following tables are estimates of the Company's net interests in quantities of proved reserves of crude oil and natural gas. All reserves are proved developed. The reserve quantities and the related standardized measure of discounted net cash flow are estimates only, and do not purport to reflect realizable fair market values of the Company's reserves. 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, these estimates are expected to change as future information becomes available.\nProved developed reserves are those expected to be recovered through existing wells, equipment, and operation methods.\n(Oil in barrels, natural gas in thousands of cubic feet)\nOil Gas ----------- ----------- Proved developed reserves\nBalance at December 31, 1992 ................ 249,549 10,117,367 Revision of previous estimates ............ (3,875) (976,470) Extensions and discoveries ................ 10,137 526,693 Purchase of proved reserves ............... 42,745 491,876 Production ................................ (35,357) (1,111,835) -------- -----------\nBalance at December 31, 1993 ................ 263,199 9,047,631 Revision of previous estimates ............ 16,569 28,468 Extensions and discoveries ................ 17,129 360,586 Purchase of proved reserves ............... -- 83,144 Production ................................ (47,487) (1,103,483) -------- -----------\nBalance at December 31, 1994 ................ 249,410 8,416,346 Revision of previous estimates ............ (6,361) (750,646) Extensions and discoveries ................ 5,069 200,369 Production ................................ (40,256) (1,059,043) -------- ----------- Balance at December 31, 1995 ................ 207,862 6,807,026 ======== ===========\nStandardized Measure of Discounted Future Net Cash Flows (Unaudited)\nThe standardized measure of discounted future net cash flows is computed by applying year-end prices of oil and gas to the estimates of quantities of proved developed oil and gas reserves and the periods during which they are expected to be produced. Future development and production costs were computed based on year end costs to be incurred in developing and producing the proved reserves. The discount was computed by application of a 10% discount factor. The calculation also assumes the continuation of the existing economic, operating, and contractual conditions at December 31, 1995, 1994 and 1993.\nThe standardized measure of discounted net cash flows relating to proved developed oil and gas reserves are as follows:\n1995 1994 1993 ---- ---- ----\nFuture cash flows ........... $ 21,261,629 $ 26,229,302 $ 27,655,313 Future production costs ..... (7,163,056) (8,090,928) (8,714,573) Future net cash flows before income taxes ....... 14,098,573 18,138,374 18,940,740 Ten percent discount factor ..................... (5,298,071) (6,601,884) (7,717,107) ------------ ------------ ------------ Standardized measure before income taxes ....... 8,800,502 11,536,490 11,223,633 Future income tax expense ................. (1,554,169) (2,623,460) (2,030,325) ------------ ------------ ------------ Standardized measure after income taxes ........ $ 7,246,333 $ 8,913,030 $ 9,193,308 ============ ============ ============\nThe change in the standardized measure of discounted future net cash flows related to the proved oil and gas reserves at December 31, 1995, 1994 and 1993 is as follows.\nDecember 31, 1995 1994 1993 ------ ------ -----\nBeginning of year ........... $ 8,913,030 $ 9,193,308 $ 9,812,036 Sales, net of production costs ......... (3,049,850) (3,096,935) (2,684,649) Net changes in prices and pro- duction costs ........... (31,628) 464,574 (800,172) Net change due to revisions in quantity estimates ...... (785,768) 190,202 (1,067,000) Extensions and discoveries ............. 230,013 412,350 638,789 Purchase of reserves ...... -- 75,301 755,004 Net change in income taxes ................... 1,069,292 (593,135) 617,609 Accretion of discount ..... 891,303 919,331 981,204 Other ..................... 9,941 1,348,034 940,487 ----------- ----------- ----------- End of year ................. $ 7,246,333 $ 8,913,030 $ 9,193,308 =========== =========== ===========\nEXHIBIT INDEX Reference ____________________________________ Exhibit Commission Number Description File No. Exhibit No. _______________________________________________________________________________\n2 Stock Purchase Agreement 1-8223 Incorporated dated September 12, 1991 by reference by and between National from Exhibit Gas & Oil Company and 2 of Form Stone Container 8-K filed on Corporation October 14, 1991.\n3(a) Articles of Incorporation 1-8223 Page 56-63 of National Gas & Oil Company\n3(b) Code of Regulations of 2-72682 Incorporated National Gas & Oil by reference Company from Exhibit 3(b) of Form S-14 filed on June 8, 1981.\n10(a) National Gas & Oil 33-55390 Incorporated Company Salary by reference Deferral Plan from Exhibit 28(b) of Form S-8 filed on December 4, 1992.\n10(b) Amended and Restated 33-55388 Incorporated National Gas & Oil by reference Company Compensation from Exhibit Plan for Outside 28(c) of Directors Form S-8 filed on December 4, 1992.\n10(c) Summary of Salary Page 54 Administration Plan\n21 Subsidiaries of the Registrant Page 55 24 Powers of Attorney of Directors Page 64-72\n27 Financial Data Schedule Page 73\n99(a) Credit Agreement dated 1-8223 Incorporated October 1, 1991 by and by reference among National Gas & from Exhibit Oil Company, Stone 28 of Form Resource and Energy 8-K filed on Corporation and October 14, BancOhio National 1991. Bank.","section_15":""}
{"filename":"46709_1995.txt","cik":"46709","year":"1995","section_1":"Item 1. Business\nGeneral - HELIX TECHNOLOGY CORPORATION (\"the Company\"), a Delaware corporation organized in 1967, is engaged in the development and application of cryogenic and vacuum technology. The Company provides innovative solutions to customer requirements in selected markets worldwide.\nThrough its CTI-Cryogenics (\"CTI\") operations, the Company provides a critical vacuum subsystem used in a broad range of electronic component manufacturing equipment. The principal customers for CTI's vacuum products are involved in the production of semiconductors, optical and magnetic data storage media and advanced information displays. The Cryo-Torr cryogenic vacuum pump product line combines the expertise of CTI in both cryogenics and vacuum technology. (Cryo-Torr is a registered trademark of Helix Technology Corporation.) CTI's On-Board cryogenic vacuum pumping system incorporates built-in microprocessor capabilities to provide on-line performance monitoring and diagnostics. (On-Board is a registered trademark of Helix Technology Corporation.)\nThe Company also applies its technology and manufacturing competence to provide specialized cryogenic refrigeration solutions for both military and commercial customers. Applications for this capability include the cooling of infrared detectors, advanced electronic circuits and superconducting materials.\nThe Company maintains Customer Support Centers strategically located throughout the world to provide replacement parts, overhaul, repair and upgrade services. The Company's unique GUTS rapid response network is designed to assure that users of the Company's products have direct, twenty- four-hour a day access to the resources of the Customer Support Centers. (GUTS is a registered trademark of Helix Technology Corporation.)\nThe Company encounters strong competition in both domestic and foreign markets for its products. Competition comes from smaller firms and from larger firms that have greater total resources than the Company. The absence of statistics makes it impossible to state the Company's precise position in its served markets, although the Company believes it enjoys a world leadership in the market for cryogenic vacuum pumping systems. Customer service, product quality, performance and price are all factors in selling the Company's products.\nNo significant portion of the Company's business is seasonal or cyclical.\nThe Company's business is, generally, not dependent on the availability of raw materials or components from any single source. Certain components, however, may be available from only one or two qualified sources. The Company's policy is to develop alternative sources for components and, where possible, to avoid using scarce raw material in its products.\nThe Company holds many U.S. and foreign patents in the field of vacuum and cryogenics that it believes are significant to its operations. Trademarks are considered important to the Company's business. These trademarks are protected by registration in the United States and other countries in which the Company's products are marketed.\n- 2 -\nPART I\nItem 1. Business (continued)\nThe Company and Ulvac Corporation of Chigasaki, Japan, operate a joint venture, Ulvac Cryogenics, Inc., engaged in the manufacture and sale of cryogenic vacuum pumps in Japan and some Asian countries. The joint venture is 50% owned by each company.\nBacklog - The backlog of orders believed to be firm was approximately $11.5 million on December 31, 1995, compared to $9.6 million at December 31, 1994. Increases in bookings resulted primarily from record orders for the Company's On-Board vacuum pumping systems. The Company expects to recognize revenues from essentially all of the December 31, 1995, backlog during the 1996 calendar year.\nResearch and Development - The Company expended $4,534,000 in 1995 on research and development efforts compared to $4,411,000 and $3,656,000 in 1994 and 1993, respectively. These expenditures reflect development activities relating to product enhancements and new products for commercial applications.\nEmployment - Total employment in the Company at the end of 1995 was 404 compared with 362 and 340 at the end of 1994 and 1993, respectively.\nEnvironmental Affairs - Compliance with federal, state and local provisions relating to environmental quality has not had, and is not expected to have, a material impact upon capital expenditures, earnings or the competitive position of the Company.\nFinancial Information about Industry Segments and Major Customers - The Company's one industry segment is cryogenic and vacuum equipment. Information concerning operations in different geographic areas and major customers is included in Note G of Notes to Consolidated Financial Statements included elsewhere in this report.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company leases and occupies two buildings in Mansfield, Massachusetts, totaling approximately 218,000 square feet. The Company also leases space to house remote customer support facilities. A facility of approximately 11,000 square feet is leased in Santa Clara, California, and a facility of 12,000 square feet is leased in Austin, Texas. A total of approximately 16,000 square feet is leased in Europe to house three customer support centers. The Company believes that its facilities are adequate to support its current levels of production.\nItem 3.","section_3":"Item 3. Legal Proceedings\nIn the normal course of business, the Company is subject to various legal proceedings and claims. The Company believes that the ultimate outcome of these matters will not have a material effect on its financial statements.\n- 3 -\nPART I\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nDuring the quarter ended December 31, 1995, 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 Common Stock and Related Security Holder Matters\nThe Company's common stock is traded on the Over-The-Counter market (NASDAQ symbol HELX). At December 31, 1995, there were 9,776,944 shares of common stock outstanding and approximately 720 common stockholders of record. In October 1994, the Board of Directors authorized a two-for-one common stock split in the form of a 100% stock dividend. The par value remains at $1 per share. Stock prices and all per share data have been retroactively restated to reflect this stock split. At the Company's 1995 Annual Meeting of Stockholders the number of authorized shares of common stock was increased to 30,000,000 shares from 10,000,000 shares.\nCash Dividend Per Common Share and Price Range of Common Stock\nThe cash dividend per common share and price range of Helix's common stock by quarter are:\n1995 First Second Third Fourth Stock Price Quarter Quarter Quarter Quarter\nHigh $22.00 $45.25 $55.75 $47.00 Low $14.75 $20.00 $43.00 $28.00 Cash dividend per share $ .11 $ .11 $ .11 $ .25\n1994 First Second Third Fourth Stock Price Quarter Quarter Quarter Quarter\nHigh $10.13 $12.88 $17.63 $19.00 Low $ 6.75 $ 8.00 $11.25 $13.25 Cash dividend per share $ .06 $ .06 $ .06 $ .11\nThe Board of Directors declared a quarterly cash dividend of $0.25 per common share payable on March 13, 1996, to common stockholders of record at the close of business on February 28, 1996.\n- 4 -\nPART II\nItem 6.","section_6":"Item 6. Selected Financial Data\n(in thousands except per share data)\n1995 1994 1993 1992 1991\nNet sales $123,667 $86,761 $63,863 $50,822 $55,759\nNet income $ 20,985 $10,603 $ 5,021* $ 2,868 $ 3,082\nNet income per share $ 2.10 $ 1.08 $ .53* $ .30 $ .32\nCash dividends per share $ .58 $ .29 $ .2025 $ .19 $ .19\nTotal assets $ 69,074 $45,386 $32,662 $32,373 $29,080\nCapitalized lease obligations $ - $ 36 $ 81 $ 123 $ 161\nWeighted average number of common shares outstanding 10,007 9,849 9,562 9,500 9,488\n* Includes $108,000 ($0.01 per share) cumulative tax benefit from adoption of SFAS No. 109 in 1993.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nResults of Operations - 1995 Compared With 1994\nNet sales for 1995 increased to $123.7 million, an increase of $36.9 million or 43% compared with prior year sales. The growth in revenues resulted primarily from record sales of the Company's cryogenic vacuum products and services used principally by semiconductor manufacturers worldwide.\nTotal gross profit as a percentage of net sales improved 4.4 percentage points compared with the prior year. The increase in gross profit was principally due to a favorable product mix and volume, driven by increased sales of the On-Board cryogenic vacuum pumping system and efficiencies derived from the Company's manufacturing competencies.\nThe Company's investment in research and development increased 3% in 1995. Selling, general and administrative expenses increased 28% and were 16% and 18% of sales in 1995 and 1994, respectively.\nThe increase in Selling, general and administrative expenses is attributable to increases in selling costs.\nInterest income for 1995 was $623 thousand compared with $123 thousand for 1994, reflecting significantly higher cash balances.\n- 5 -\nPART II\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)\nRoyalty and equity income from the Company's joint venture in Japan improved $593 thousand over last year.\nThe Company's provision for income taxes was $12.7 million and $5.8 million in 1995 and 1994, respectively. The difference between the statutory federal tax rate and the Company's effective tax rate of 37.75% and 35.5%, for 1995 and 1994, respectively, is principally due to state and foreign income taxes.\nIn October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard (SFAS No. 123) - Accounting for Stock-Based Compensation. SFAS No. 123 encourages, but does not require, companies to recognize compensation costs for all stock-based compensation arrangements using a fair value method of accounting. The Company has not adopted SFAS No. 123, and has not yet determined the impact of such adoption on its consolidated results of operations. The adoption of SFAS No. 123 will have no cash flow impact on the Company.\nLiquidity and Capital Resources\nNet cash provided by operating activities increased to $24.2 million in 1995. The Company invested $3.1 million, primarily in machinery and equipment. Cash dividends paid to stockholders increased to $5.7 million.\nAt December 31, 1995, the Company had informal bank lines of credit of $12 million.\nThe Company believes anticipated cash flow from operations and funds available under existing credit lines will be adequate to fund operations through 1996 and that it has opportunities to consider further financing options should additional funds be required.\nResults of Operations - 1994 Compared With 1993\nNet sales for 1994 increased to $86.8 million, an increase of $22.9 million or 36% compared with prior year sales. The growth in revenues resulted primarily from record sales of the Company's cryogenic vacuum products and services used principally by semiconductor manufacturers worldwide.\nSales of On-Board vacuum pumping systems accounted for most of the approximately $26.9 million increase in sales to commercial customers. Continued growth in customer service activities also contributed to the growth in revenues.\nSales for military applications decreased approximately $4 million in 1994 as a result of final shipments of Maverick missile coolers under a program completed early in 1994.\n- 6-\nPART II\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)\nTotal gross profit as a percentage of net sales improved 4.8 percentage points compared with prior year. Increased sales of On-Board vacuum products and the completion of the low-margin Maverick missile program are the primary reasons for improved gross profit in 1994.\nThe Company's investment in research and development increased 21% in 1994. Selling, general and administrative expenses increased 27% and were 18% and 19% of sales in 1994 and 1993, respectively.\nThis increase in Selling, general and administrative expense is attributable to increases in selling costs and performance-based executive compensation (Note E).\nRoyalty and equity income from the Company's joint venture in Japan improved over last year.\nThe Company's provision for income taxes was $5.8 million and $2.5 million in 1994 and 1993, respectively. The difference between the statutory federal tax rate and the Company's effective tax rate of 35.5% and 33.6%, for 1994 and 1993, respectively, is due to state and foreign income taxes.\n- 7 -\nPART II\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES COVERED BY THE REPORT OF INDEPENDENT ACCOUNTANTS\nPage(s)\nReport of Independent Accountants 16\nConsolidated Financial Statements of Helix Technology Corporation\nConsolidated Balance Sheets as of December 31, 1995 and 1994 17\nConsolidated Statements of Operations for the Years Ended December 31, 1995, 1994 and 1993 18\nConsolidated Statements of Stockholders' Equity for the Years Ended December 31, 1995, 1994 and 1993 19\nConsolidated Statements of Cash Flows for the Years Ended December 31, 1995, 1994 and 1993 20\nNotes to Consolidated Financial Statements 21-30\nReport of Independent Accountants 31\nQuarterly Results (Unaudited) 32\nFinancial Statement Schedules for the Years Ended December 31, 1995, 1994 and 1993\nII. Valuation and Qualifying Accounts 33\nSchedules other than those listed above have been omitted since they are either inapplicable or not required.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nThe Company did not change accountants or file a Form 8-K reporting a disagreement on an accounting principle, practice or financial statement disclosure during the twenty-four-month period ended December 31, 1995.\n- 8 -\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 herein by reference to the registrant's proxy statement for its 1996 Annual Meeting of Stockholders which will be filed with the SEC in March 1996, pursuant to Regulation 14A.\nItem 11.","section_11":"Item 11. Executive Compensation\nInformation required by this item is incorporated herein by reference to the registrant's proxy statement for its 1996 Annual Meeting of Stockholders which will be filed with the SEC in March 1996, pursuant to Regulation 14A.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nInformation required by this item is incorporated herein by reference to the registrant's proxy statement for its 1996 Annual Meeting of Stockholders which will be filed with the SEC in March 1996, pursuant to Regulation 14A.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nInformation required by this item is incorporated herein by reference to the registrant's proxy statement for its 1996 Annual Meeting of Stockholders which will be filed with the SEC in March 1996, pursuant to Regulation 14A.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\nPage Number(s) or Incorporation by Description Reference to\n(a) Financial Statements, Schedules & Exhibits:\n(1), (2) The Consolidated Financial Statements and required schedules are indexed under Item 8. 8\n(3) Exhibits required by Item 601 of SEC Regulation S-K.(Exhibit numbers refer to exhibit number on Table I).\n3. Articles of Incorporation Exhibit 3 to the Restated articles of incorporation Company's Form 10-Q as amended on May 7, 1987 and for the Quarter May 18, 1988. Ended September 30, 1988.\n- 9 -\nPART IV\nItem 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K (continued)\nPage Number(s) or Incorporation by Description Reference to\nBy-laws Exhibit (3)-3 to the As amended on December 10, 1986 and Company's Form 10-K December 9, 1987. for the Year Ended December 31, 1987.\n4A. Description of Common Stock Exhibit 3 to the Company's Form 10-Q for the Quarter Ended September 30, 1988.\n4B. Description of Preferred Stock Exhibit 3 to the Company's Form 10-Q for the Quarter Ended September 30, 1988.\n10. Material Contracts:\n(1) Indenture of lease dated April 1, 1969, Exhibit 10.1 to a between the First National Bank of Boston, Registration Trustee, as Lessor, and 500 Incorporated Statement on Form (The Company's former name), as Lessee. S-2, Registration No. 2-84880.\n(2) Guarantee by Arthur D. Little, Inc., Exhibit 10.1 to a dated April 1, 1969, of the Indenture of Registration Lease dated April 1, 1969, between the First Statement on Form National Bank of Boston, Trustee, and 500 S-2, Registration Incorporated (the Company's former name). No. 2-84880.\n(3) Basic agreement between the Company and Exhibit 10.13 to Ulvac Corporation dated August 17, 1981. a Registration Statement on Form S-2, Registration No. 2-84880.\n- 10 -\nPART IV\nItem 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K (continued)\nPage Number(s) or Incorporation by Description Reference to\n(4) Lease agreement dated July 24, 1984, Exhibit 10-(14) between WRC Properties, Inc., as Lessor, to the Company's and the Company as Lessee. Form 10-K for the Year Ended December 31, 1984.\n(5) Lease Agreement dated May 23, 1991, Exhibit 10-(14) between Mansfield Corporate Center Limited to the Company's Partnership, as Lessor, and the Company Form 10K for the as Lessee. Year Ended December 31, 1991.\nCompensation Plans, Contracts and Arrangements:\n(6) The Company's 1992 Stock Option Plan Exhibit 6-(14) for Non-Employee Directors. to the Company's Form 10-K for the Year Ended December 31, 1992.\n(7) The Company's 1981 Incentive Stock Exhibit 7-(14) Option Plan as adopted on November 11, to the Company's 1981, and as amended on April 14, 1982, Form 10-K for the February 6, 1985, December 9, 1987, Year Ended February 5, 1988, April 13, 1988, December 31, 1992. February 8, 1989, and February 13, 1992.\n(8) The Company's informal incentive Exhibit 10.9 to a bonus plan. Registration Statement on Form S-2, Registration No. 2-84880.\n(9) Employment agreement dated December 13, Exhibit 9-(14) to 1989, as amended and restated on the Company's February 13, 1992, and re-executed on Form 10-K for the May 28, 1992, between the Company and Year Ended Robert J. Lepofsky. December 31, 1992.\n(10) The Company's Section 125 Plan. Exhibit 18 to Form 8, Amendment No. 1 to 1985 Annual Report on Form 10-K.\n- 11 -\nPART IV\nItem 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K (continued)\nPage Number(s) or Incorporation by Description Reference to\n(11) The Company's Amended and Restated Exhibit 10-(11) Employee Savings Plan dated December 15, to the Company's 1994. Form 10-K for the Year Ended December 31, 1994.\n(12) The Company's Amended and Restated Exhibit 10-(12) Employee's Pension Plan dated December 15, to the Company's 1994. Form 10-K for the Year Ended December 31, 1994.\n(13) The Company's Amended and Restated Exhibit 10-(13) Employees' Personal Account Plan dated to the Company's December 15, 1994. Form 10-K for the Year Ended December 31, 1994.\n(14) The Company's Supplemental Key Exhibit 14-(14) Executive Retirement Plan effective to the Company's February 13, 1992. Form 10-K for the Year Ended December 31, 1992.\n11. Schedule of Computation of Earnings per Share\n21. Subsidiaries of the Registrant\n23. Consent of Independent Accountants\n24. Powers of Attorney\n27. Financial Data Schedule (EDGAR version only)\n- 12 -\nPART IV\nItem 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K (continued)\n(b) The Company was not required to file any reports on Form 8-K during the quarter ended December 31, 1995.\n(c) Exhibits required by Item 601 of Regulation S-K are indexed under (a)(3) above.\n(d) Separate financial statements of: (1) subsidiaries not consolidated and fifty percent or less owned persons; (2) affiliates whose securities are pledged as collateral; and (3) Schedules I, III, and IV are not filed because they are either not applicable or the items do not exceed the various disclosure levels.\n- 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, this 13th day of March, 1996.\nHELIX TECHNOLOGY CORPORATION (Registrant)\nRobert J. Lepofsky (Signature) 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 on this 13th day of March, 1996, in the capacities indicated.\nSignatures Titles\n(i) Principal Executive Officer\nRobert J. Lepofsky President and Chief Executive (Signature) Officer\n(ii) Principal Financial Officer\nStephen D. Allison Vice President and Chief (Signature) Financial Officer\n- 14 -\n(iii) A Majority of the Board of Directors\nR. Schorr Berman* Director\nFrank Gabron* Director and Chairman of the Board\nMilton C. Lauenstein* Director\nRobert J. Lepofsky Director (Signature)\nMarvin G. Schorr* Director\nWickham Skinner* Director\nMark S. Wrighton* Director\n*Robert J. Lepofsky (Signature) Attorney-in-Fact\n- 15 -\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo The Board Of Directors and Stockholders of Helix Technology Corporation:\nWe have audited the accompanying consolidated balance sheets of Helix Technology Corporation as of December 31, 1995 and 1994, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1995. 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 Helix Technology Corporation as of December 31, 1995 and 1994, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\nCOOPERS & LYBRAND L.L.P. (Signature)\nBoston, Massachusetts February 7, 1996\n- 16 -\nHELIX TECHNOLOGY CORPORATION CONSOLIDATED BALANCE SHEETS\nDecember 31, (in thousands) Notes 1995 1994 ASSETS Current: Cash and cash equivalents A $ 21,697 $ 8,050 Receivables - net of allowances of $150 in 1995 and $157 in 1994 17,974 12,219 Inventories A 12,122 9,556 Deferred income taxes A&D 3,039 2,460 Other current assets 556 586 Total Current Assets 55,388 32,871\nProperty, plant and equipment at cost A 25,387 22,750 Less: accumulated depreciation (17,061) (14,913) Net property, plant and equipment 8,326 7,837 Other assets A&F 5,360 4,678 TOTAL ASSETS $ 69,074 $ 45,386\nLIABILITIES AND STOCKHOLDERS' EQUITY Current: Accounts payable $ 6,558 $ 4,896 Payroll and compensation E 3,755 3,305 Retirement costs H 1,359 610 Income taxes A&D 4,756 1,182 Other accrued liabilities 705 450 Total Current Liabilities 17,133 10,443\nDeferred income taxes A&D 388 562 Capitalized lease obligations C - 36 Commitments C - - Stockholders' Equity: Preferred stock, $1 par value; authorized 2,000,000 shares; issued and outstanding: none - - Common stock, $1 par value; authorized 30,000,000 shares; issued and outstanding: 9,776,944 in 1995 and 9,667,642 in 1994 E 9,777 9,668 Capital in excess of par value 3,659 2,157 Currency translation adjustment A&F 1,307 1,043 Retained earnings E 36,810 21,477 Total Stockholders' Equity 51,553 34,345 TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 69,074 $ 45,386\nThe accompanying notes are an integral part of these financial statements.\n- 17 -\nHELIX TECHNOLOGY CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS\nFor the years ended December 31, (in thousands except per share data) Notes 1995 1994 1993\nNet sales $123,667 $86,761 $63,863\nCosts and expenses: Cost of sales 67,740 51,336 40,889 Research and development A 4,534 4,411 3,656 Selling, general and administrative E 19,588 15,327 12,104 91,862 71,074 56,649 Operating income 31,805 15,687 7,214\nInterest expense - - (82) Joint venture income F 1,392 799 365 Other 517 (47) (101) Income before taxes 33,714 16,439 7,396 Income taxes A&D (12,729) (5,836) (2,483) Income before the cumulative effect of a change in accounting principle 20,985 10,603 4,913 Cumulative effect of a change in accounting for income taxes A&D - - 108 Net income $ 20,985 $10,603 $ 5,021\nIncome per common share before the cumulative effect of a change in accounting principle $ 2.10 $ 1.08 $ .52 Cumulative effect of a change in accounting for income taxes A&D - - .01 Net income per common share A&E $ 2.10 $ 1.08 $ .53 Average shares and equivalents A&E 10,007 9,849 9,562\nThe accompanying notes are an integral part of these financial statements.\n- 18 -\nHELIX TECHNOLOGY CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY\nCapital Par in Excess Translation Retained (in thousands) Value of Par Adjustment Earnings Total\nBalance, December 31, 1992 $9,498 $ 1,231 $ 489 $10,567 $21,785\nShares issued for stock options 38 132 - - 170 Shares tendered for exercise of stock options (5) 1 - - (4) Currency translation adjustment - - (1) - (1) Net income - 1993 - - - 5,021 5,021 Cash dividends ($.2025 per share) - - - (1,923) (1,923) Balance, December 31, 1993 9,531 1,364 488 13,665 25,048\nShares issued for stock options 147 666 - - 813 Income tax benefit from exercise of stock options - 203 - - 203 Shares tendered for exercise of stock options (10) (76) - - (86) Currency translation adjustment - - 555 - 555 Net income - 1994 - - - 10,603 10,603 Cash dividends ($.29 per share) - - - (2,791) (2,791) Balance, December 31, 1994 9,668 2,157 1,043 21,477 34,345\nShares issued for stock options 185 2,708 - - 2,893 Income tax benefit from exercise of stock options - 1,273 - - 1,273 Shares tendered for exercise of stock options (76) (2,479) - - (2,555) Currency translation adjustment - - 264 - 264 Net income - 1995 - - - 20,985 20,985 Cash dividends ($.58 per share) - - - (5,652) (5,652) Balance, December 31, 1995 $9,777 $ 3,659 $1,307 $36,810 $51,553\nThe accompanying notes are an integral part of these financial statements.\n- 19 -\nHELIX TECHNOLOGY CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS\nFor the years ended December 31, (in thousands) 1995 1994 1993 Cash flows from operating activities: Net income $20,985 $10,603 $ 5,021 Adjustments to reconcile net income to net cash provided (used) by operating activities: Depreciation and amortization 2,562 2,049 1,777 Decrease in noncurrent deferred income taxes (174) (9) (168) Undistributed earnings of joint venture, other (418) (120) (248) Increase in accrual for performance-based executive compensation 1,938 1,827 541 Net change in other operating assets and liabilities(1) (665) (3,486) 173 Net cash provided by operating activities 24,228 10,864 7,096 Cash flows from investing activities: Capital expenditures (3,051) (2,237) (1,655) Net cash used by investing activities (3,051) (2,237) (1,655) Cash flows from financing activities: Net decrease in short-term debt - - (3,600) Decrease in capital lease obligations (36) (42) (38) Shares tendered for exercise of stock options (2,555) (86) (4) Net cash provided by employee stock plans 713 665 170 Cash dividends paid (5,652) (2,791) (1,923) Net cash used by financing activities (7,530) (2,254) (5,395) Increase in cash and cash equivalents 13,647 6,373 46 Cash and cash equivalents, January 1 8,050 1,677 1,631 Cash and cash equivalents, December 31 $21,697 $ 8,050 $ 1,677 (1) Change in other operating assets and liabilities: (Increase)\/decrease in accounts receivable $(5,755) $(3,131) $ 61 (Increase)\/decrease in inventories (2,566) (1,359) 151 (Increase)\/decrease in other current assets (549) (998) (330) Increase\/(decrease) in accounts payable 1,662 1,473 (761) Increase\/(decrease) in other accrued expenses 6,543 529 1,052 Net change in other operating assets and liabilities $ (665) $(3,486) $ 173 Supplemental disclosures: Interest paid $ - $ - $ 85 Income taxes paid $ 8,217 $ 6,930 $ 1,675 Supplemental disclosure of non-cash activity: In 1995 and 1994, $2,180,000 and $148,000, respectively, were reclassed from accrued executive compensation to equity in connection with issuance of stock options.\nThe accompanying notes are an integral part of these financial statements.\n- 20 -\nHELIX TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nA. Summary of Significant Accounting Policies\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities 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 reclassifications have been made to prior years' consolidated statements of cash flows to conform with the current presentation.\nPrinciples of Consolidation\nThe consolidated financial statements include the accounts of the Company and its subsidiaries after elimination of all intercompany transactions. The investment in and operating results of the Company's 50%-owned joint venture are included on the basis of the equity method of accounting.\nForeign Currency Translation\nAssets and liabilities of operations outside of the United States are translated into U.S. dollars using current exchange rates. Income and expense accounts are translated at the average rates in effect during the year. The effects of foreign currency translation adjustments are included as a component of stockholders' equity. The cumulative translation adjustment for the Company's 50%-owned joint venture is reported net of income taxes. Transaction gains\/losses were not material.\nInventories\n(in thousands) 1995 1994\nFinished goods $ 3,870 $2,404 Work in process 7,340 6,115 Materials and parts 912 1,037 Net inventories $12,122 $9,556\nInventories are stated at the lower of cost or market on a first-in, first- out basis.\nCash Equivalents\nShort-term investments with maturities of three months or less from the date of purchase are classified as cash equivalents.\n- 21 -\nHELIX TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nA. Summary of Significant Accounting Policies (continued)\nRevenue Recognition\nThe Company records revenue on its standard products when units are shipped. Revenues associated with certain government-related contracts are recognized upon shipment based on sales value per unit, and costs are based on estimated average cost per unit over the entire contract. Changes in estimated average unit costs are recognized in the period they become known.\nResearch and Development\nResearch and development costs are expensed as incurred.\nIncome Taxes\nThe Company provides for income taxes based on provisions of Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes,\" adopted at the beginning of 1993. Deferred income taxes result from temporary differences in the recognition of revenues and expenses between financial statements and tax returns. Tax credits are recognized when realized for tax purposes using the \"flow-through\" method of accounting. The Company has not provided for federal income taxes applicable to undistributed earnings of its foreign subsidiaries since these earnings are indefinitely reinvested.\nEarnings Per Share\nNet income per common share is based on the weighted average number of common shares outstanding during each year after giving effect to stock options considered to be dilutive common stock equivalents. Fully diluted net income per common share is not materially different from primary net income per common share.\nProperty, Plant and Equipment\n(in thousands) 1995 1994 Building - capital lease $ 1,847 $ 1,847 Machinery and equipment 19,497 17,236 Leasehold improvements 4,043 3,667 Total $25,387 $22,750\nDepreciation is provided on the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized over the lesser of their useful life or the remaining life of the lease. Estimated useful lives of machinery and equipment range from 3 to 10 years.\n- 22-\nHELIX TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nA. Summary of Significant Accounting Policies (continued)\nProperty, Plant and Equipment (continued)\nMaintenance and repairs are charged to expense as incurred, and betterments are capitalized. A capital lease on the Company's Waltham facility is depreciated on a straight-line method over the life of the lease. Accumulated depreciation of the capital lease was $1,813,000 at December 31, 1995, and $1,745,000 at December 31, 1994.\nNew Accounting Pronouncements\nStatement of Financial Accounting Standards No. 123, \"Accounting for Stock- Based Compensation\" (SFAS 123), will require the Company to either elect expense recognition or the disclosure-only alternative for stock-based employee compensation. SFAS 123 must be adopted in the Company's 1996 financial statements with comparable disclosures for the prior year. The Company has not yet determined whether it will elect the expense recognition or disclosure-only alternative permitted under SFAS 123 and therefore has not yet determined the impact of such adoption on the consolidated results of operations.\nB. Bank Credit Arrangements\nThe Company's informal lines of credit with several banks amounted to $12,000,000 on December 31, 1995 and 1994. At December 31, 1995 and 1994, no borrowings were outstanding.\nC. Lease Obligations and Commitments\nThe Company leases its facilities and certain equipment under long-term operating and capital leases. In 1991, in connection with consolidating its operations in Mansfield, the Company entered into a noncancelable operating lease, which expires December 31, 2006. The lease includes scheduled base rent increases through the term of the lease and renewal options up to fifteen additional years.\nThe Company's Waltham facility, which is under a capital lease, was subleased in 1992. The sublease revenues are expected to cover the remaining obligations of the capital lease, which expires on September 30, 1996. Future minimum lease payments under the noncancelable operating and capital leases are:\n($ thousands) 1996 1997 1998 1999 2000 Later Yrs Total Operating leases 2,701 2,802 2,610 2,415 1,913 13,260 25,701 Capital lease, including interest 37 - - - - - 37\nTotal rental expense under operating leases was $3,028,445 in 1995, $3,030,000 in 1994, and $3,151,000 in 1993.\n- 23 -\nHELIX TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nC. Lease Obligations and Commitments (continued)\nThe Company enters into short-term foreign currency forward contracts with its primary banks to minimize the effect of fluctuations on its foreign currency denominated transactions, principally intercompany trade receivables, with its wholly owned European subsidiaries. Net realized and unrealized gains and losses on these transactions are not material and are recorded in the statements of operations. The Company's outstanding foreign currency forward contracts at December 31, 1995 and 1994, were $3,329,000 and $1,250,000, respectively.\nD. Income Taxes\nThe Company adopted SFAS No. 109 as of January 1, 1993. The cumulative effect of this change in accounting principle increased net income by $108,000 for that year. The provisions for income taxes are as follows:\n(in thousands) 1995 1994 1993 Current tax expense: Federal $ 9,816 $ 5,197 $2,058 State 2,443 1,340 481 Foreign 1,223 555 474 Total current 13,482 7,092 3,013 Deferred tax expense: Federal (710) (942) (411) State (43) (314) (119) Total deferred (753) (1,256) (530) Total provision for taxes $12,729 $ 5,836 $2,483\n- 24 -\nHELIX TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nD. Income Taxes (continued)\nSignificant components of deferred income taxes are as follows: December 31, December 31, (in thousands) 1995 1994 Gross deferred assets: Inventory valuation $ 1,073 $ 904 Compensation 1,806 1,400 Warranties 100 104 Leases 256 163 Other 59 54 Total gross deferred assets $ 3,294 $2,625 Gross deferred liabilities: Depreciation $ (643) $ (727) Total gross deferred liabilities $ (643) $ (727) Net deferred assets $ 2,651 $1,898\nDeferred income taxes on undistributed earnings of the foreign subsidiaries are not material. The Company does not believe that a valuation allowance is required for the net deferred tax assets.\nDomestic income before income taxes was approximately $31,065,000, $14,950,000 and $6,035,000 in 1995, 1994 and 1993, respectively. Foreign income before income taxes for the same years was approximately $2,649,000, $1,489,000, and $1,361,000, respectively.\nTax returns for the years through 1991 have been examined by the Internal Revenue Service.\nThe following table reconciles income tax based on the federal statutory rate to the income tax provision in the Statement of Operations:\n(in thousands) 1995 1994 1993 Federal tax computed at statutory rate of 35% in 1995 and 1994 and 34% in 1993 $11,800 $5,754 $2,515 State income taxes, net of federal tax benefit 1,545 557 212 Foreign sales corporation tax benefit (704) (102) (48) Earnings not subject to U.S. income taxes (287) (140) (17) R&D tax credit (100) (291) (201) Other 475 58 22 Income tax provision $12,729 $5,836 $2,483 Effective tax rate 37.75% 35.5% 33.6%\n- 25 -\nHELIX TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nE. Capital Stock\nOptions for the purchase of shares of the Company's common stock have been granted to officers, directors and key employees under various incentive and nonqualified stock option agreements. The terms of these agreements provide that the options are exercisable over a number of years from the date of grant at not less than the fair market value at the date of grant.\nOptions expire at various dates through the year 2005. At December 31, 1995 and 1994, respectively, 537,776 and 723,126 shares of common stock were reserved for stock options. At December 31, 1995 and 1994, respectively, 185,200 and 179,300 nonqualified and incentive stock options were exercisable. In 1989, the Company entered into an agreement with its President under which options to purchase up to 400,000 shares of the Company's common stock were granted, at a price of $3.375 per share, exercisable over a ten-year period subject to the attainment of certain financial performance targets. Based on 1995 performance, options for the purchase of 40,000 shares will become exercisable on March 1, 1996. Based on 1994 performance, options for the purchase of 40,000 shares became exercisable on March 1, 1995. In addition, based on cumulative performance for the five-year period ending December 31, 1994, 120,000 shares also became exercisable on March 1, 1995. Based on 1993 performance, options for the purchase of 40,000 shares became exercisable on March 1, 1994. In connection with this agreement, compensation expense of $1,938,000 and $1,827,000 was charged to \"Selling, general and administrative expenses\" in 1995 and 1994, respectively.\nNumber of Option Options Outstanding Common Shares Price Range December 31, 1992 739,600 $ 3.38 - $ 6.69\nOptions granted 10,000 $ 5.41 - $ 5.41 Options lapsed (14,000) $ 5.72 - $ 6.25 Options exercised (38,400) $ 3.35 - $ 6.31 December 31, 1993 697,200 $ 3.38 - $ 6.69\nOptions granted 83,000 $ 7.69 - $14.25 Options lapsed (18,000) $ 7.69 - $14.25 Options exercised (146,650) $ 3.38 - $ 7.69 December 31, 1994 615,550 $ 3.38 - $ 9.31\nOptions granted 17,500 $16.75 - $27.88 Options exercised (185,350) $ 3.38 - $ 7.69 December 31, 1995 447,700 $ 3.38 - $27.88\n- 26 -\nHELIX TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nF. Other Assets\nThe Company has a 50\/50 joint venture company, Ulvac Cryogenics, Inc., with an unrelated Japanese manufacturer to produce cryogenic vacuum pumps in Japan.\nCondensed results of operations for the joint venture for the three years ended September 30, 1995, are as follows:\n(in thousands) 1995 1994 1993 Net sales $27,845 $18,697 $14,490 Gross profit $ 7,894 $ 3,946 $ 2,687 Net income\/(loss) $ 1,642 $ 370 $ (68) Fee income, including royalty income and equity income $ 1,392 $ 799 $ 365\nCondensed balance sheet information as of September 30, is as follows:\n(in thousands) 1995 1994 Current assets $18,390 $15,124 Noncurrent assets 5,010 5,118 Total assets $23,400 $20,242 Current liabilities $10,200 $ 8,329 Long-term liabilities 1,300 1,313 Stockholders' equity 11,900 10,600 Total liabilities and stockholders' equity $23,400 $20,242\nThe Company's net investment in the joint venture of approximately $5,302,000 and $4,622,000 at December 31, 1995 and 1994, respectively, is included in \"Other assets.\" The Company's net investment at December 31, 1995 and 1994, reflects a cumulative translation adjustment of $1,202,000 and $1,317,000, respectively (net of income taxes of $648,000 and $678,000, respectively). This currency translation adjustment, which is also shown as a separate component of the stockholders' equity, resulted from translating the balance sheet of the joint venture into U.S. dollars.\n- 27 -\nHELIX TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nG. Segment Information\nLine of Business and Foreign Operations\nThe Company's operations comprise a single line of business; the development, manufacture and sale of cryogenic and vacuum equipment.\nThe consolidated financial statements include the accounts of wholly owned European subsidiaries which operate customer support facilities to sell and service products manufactured in the United States. A summary of domestic and European operations follows:\nCorporate Expenses United and Assets\/ (in thousands) States Europe Eliminations Consolidated Revenues $117,407 $14,400 $(8,140) $123,667 Operating income 34,362 2,806 (5,363) 31,805 Identifiable assets 39,588 9,209 20,277 69,074\nRevenues $ 82,012 $10,582 $(5,833) $ 86,761 Operating income 18,413 1,636 (4,362) 15,687 Identifiable assets 32,036 6,288 7,062 45,386\nRevenues $ 59,756 $ 8,313 $(4,206) $ 63,863 Operating income 8,368 1,436 (2,590) 7,214 Identifiable assets 26,376 5,239 1,047 32,662\nCorporate expenses consist of certain general and administrative expenses not allocable to operations. Corporate assets consist of cash and cash equivalents. Intercompany transactions are at prices which are comparable to unrelated party sales.\nExport Sales and Significant Customers\nThe Company's export sales, principally to customers in the Far East, were $8,330,000 in 1995, $8,888,000 in 1994 and $6,784,000 in 1993.\nIn 1995, the Company's two largest customers represented 30% and 12% of sales. In 1994 and 1993, the Company's largest customer represented 23% and 16% of sales, respectively. Sales to U.S. Government agencies and their contractors were 2%, 7% and 16% in 1995, 1994 and 1993, respectively. In 1993 a single government contractor accounted for 11%.\n- 28 -\nHELIX TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nH. Employee Benefit Plans\nThe Company's retirement and savings plans cover substantially all of the Company's employees who have one year of service. A noncontributory defined benefit pension plan and a defined contribution plan function together as the Company's retirement program.\nIn February 1994, the Company decided that, beginning in 1994, it would discontinue future contributions to the Company's Defined Contribution Plan. The Company will now fund the Pension Plan directly and not by the way of the Defined Contribution Plan.\nThe Company's funding policy is to contribute not less than the minimum required amount in accordance with the Internal Revenue Code and ERISA. The following table sets forth the funded status of the defined benefit pension plan at December 31, 1995 and 1994, in accordance with SFAS No. 87.\n(in thousands) 1995 1994 Accumulated benefit obligation, including nonvested benefit obligations of $28 and $8 in 1995 and 1994, respectively $(4,316) $(3,435) Projected benefit obligation (7,188) (5,086) Plan assets at fair value 6,812 5,810 Plan assets in excess of projected benefit obligations (376) 724 Unrecognized net transition asset (301) (340) Unrecognized prior service cost 68 77 Unrecognized net gain (491) (941) Accrued pension cost recognized on the consolidated balance sheets $(1,100) $ (480)\nThe Company's net pension cost included the following components:\n(in thousands) 1995 1994 1993 Service cost $ 664 $ 691 $ 76 Interest cost 470 391 337 Actual return on plan assets (1,396) (11) (609) Net amortization and deferral 882 (492) 139 Net pension cost of defined benefit plan $ 620 $ 579 $ (57) Net cost of defined contribution plan $ - $ - $ 621\n- 29 -\nHELIX TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nH. Employee Benefit Plans (continued)\nKey assumptions used in computing pension cost for the defined benefit plan were:\n1995 1994 1993 Discount rate for obligations 7.0% 7.75% 7.0% Rate of compensation increase 5.0% 5.5% 5.0% Long-term rate of return on assets 9.0% 9.0% 9.0%\nDefined benefit plan assets include marketable equity securities, corporate and government debt securities and cash.\nThe Company has an Employee Savings Plan, qualified under Section 401(k), that is designed to supplement income to be received from the Company's retirement program. The Company contributes a percentage of the participants' contributions up to a defined maximum amount. The matching contributions expense, net of forfeitures, was $383,000 in 1995, $333,000 in 1994 and $307,000 in 1993.\nIn 1992, the Company adopted a Supplemental Key Executive Retirement Plan which is designed to supplement benefits paid to participants under Company- funded tax-qualified retirement plans. The Company recorded additional retirement costs of $130,000 in 1995 and $119,000 in 1994 in connection with this Plan.\n- 30 -\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Stockholders of Helix Technology Corporation:\nOur report on the consolidated financial statements of Helix Technology Corporation is included on Page 16 of this Form 10-K. In connection with our audits of such financial statements, we have also audited the related financial statement schedule listed in the index on Page 8 of this Form 10-K.\nIn our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information required to be included therein.\nCOOPERS & LYBRAND L. L. P. (Signature)\nBoston, Massachusetts February 7, 1996\n- 31 -\nHELIX TECHNOLOGY CORPORATION\nQUARTERLY RESULTS (UNAUDITED)\nFirst Second Third Fourth (in thousands except per share data) Quarter Quarter Quarter Quarter Net sales $27,154 $29,030 $32,253 $35,230 Gross profit 12,084 12,910 14,508 16,425 Operating income 6,284 7,448 8,428 9,645 Net income 4,336 4,983 5,502 6,164 Primary net income per share $ .43 $ .50 $ .55 $ .62\nNet Sales $18,785 $21,251 $22,355 $24,370 Gross profit 6,776 8,829 9,356 10,464 Operating income 2,640 4,008 4,260 4,779 Net income 1,757 2,621 2,857 3,368 Primary net income per share $ .18 $ .27 $ .29 $ .34","section_15":""}
{"filename":"814249_1995.txt","cik":"814249","year":"1995","section_1":"ITEM 1. BUSINESS\nBUSINESS OVERVIEW\nMicroAge, Inc. (the \"Company\"), was incorporated in the State of Arizona in 1976 and reincorporated in Delaware in 1987. The Company distributes and integrates information technology products and services through, and in partnership with, a network of resellers, including twelve Company-owned resellers (the \"MicroAge Network\" or the \"Network\"). The products and services the Company markets and sells include microcomputer systems; workstations; networking and telecommunications equipment; system solutions, including integration and installation services and various technical services and support; software; and related products and services.\nThe Company currently markets and distributes products for leading manufacturers, such as COMPAQ Computer Corporation (\"COMPAQ\"), Hewlett-Packard Company (\"Hewlett-Packard\"), International Business Machines Corporation (\"IBM\"), Apple Computer, Inc. (\"Apple\"), Toshiba America Information Systems, Inc. (\"Toshiba\"), Digital Equipment Corporation (\"Digital\"), NEC Technologies, Inc. (\"NEC\"), Microsoft Corporation (\"Microsoft\"), Novell, Inc. (\"Novell\"), and Banyan Systems Incorporated (\"Banyan\").\nMicroAge Network resellers are primarily owned and managed by individuals resident in their respective markets and active in the daily operations of their businesses. This owner-managed reseller model eliminates the need for the Company to employ a large field-based sales and service force.\nUnless the context otherwise requires, as used herein, the term the \"Company\" refers to MicroAge, Inc., its predecessors, and subsidiaries. The Company's headquarters is located at 2400 South MicroAge Way, Tempe, Arizona 85282-1896, and its telephone number is (602) 804-2000.\nThis document may contain \"forward-looking statements\" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. See \"Products and Vendors\" and \"Competition\" in this Item and \"Management's Discussion and Analysis of Financial Condition and Results of Operation -- Results of Operations\" and \"Potential Fluctuations in Operating Results\" in Part II, Item 7 of this report for a discussion of important factors that could affect the validity of any such forward-looking statements.\nBUSINESS STRATEGY\nThe Company's dual strategic focus is to pursue profit expansion and revenue growth. The Company's profit expansion strategy focuses on expense control, effective inventory management, the addition and expansion of higher-margin products, and new pricing programs. Revenue growth is driven by sales to new resellers, the Company's large account strategy, and same location sales growth. The Company implements its business strategy through customer-focused business units targeted to specific strategic market segments.\nPROFIT EXPANSION. The Company's focus on profit expansion has caused the Company to implement new systems, policies and procedures designed to result in expense savings in areas such as inventory and accounts receivable management. During the fourth quarter of fiscal year 1995, the Company approved and began to implement actions targeted at reducing the Company's future cost structure and improving its profitability. These actions included, among other things, (i) the sale of the Company's memory distribution business, (ii) outsourcing certain unprofitable operations, and (iii) a reduction in the number of the Company's associates (employees). See \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Results of Operations\" and \"Potential Fluctuations in Operating Results\" in Part II, Item 7 of this report for a discussion of the economic implications of these actions. The Company's addition and expansion of higher-margin products and services is also designed to increase profit margins. See \"Products and Vendors-- Product Strategy.\" The Company's profit expansion goal may be negatively affected by continuing market pricing pressure.\nLARGE ACCOUNT SALES. Over the past several years, the Company has pursued a strategy of marketing products and services directly to large end-user customers in partnership with certain of its Network resellers. Large end-user customers are generally solicited by the Company's large account sales and service force in partnership with qualified Network resellers. Network resellers and large end-user customers may select from a broad array of Company-sponsored sales support programs, including specially-tailored product pricing alternatives; centralized integration services; multi-site direct product shipment; purchase price financing; and multiple location on-site sales, service and support (including central service dispatch and service call tracking).\nThe Company also offers a program to its resellers whereby the Company grants credit and assumes collection and administration responsibilities for large end-user customers. The continuing use of this program will provide increased revenue and profit opportunities for the Company but will continue to increase working capital requirements as accounts receivable for large end-user customers increase. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources\" in Part II, Item 7 of this report.\nTHE MICROAGE NETWORK. Resellers in the MicroAge Network purchase products and services from the Company generally at lower prices than could be obtained independently from vendors. The Company provides distribution and support services to resellers so that the Company and the resellers may realize operating efficiencies and benefit from economies of scale in product purchasing and distribution, financing, and working capital management. These services include multi-vendor aggregation and system integration, technical support, financing options, back-order management, direct shipping to end-user customers, support for electronic commerce, and complete order shipment. Due in part to \"open sourcing\" (see \"Products and Vendors - Open Sourcing\" below) and the expansion of the Company's product offerings to include products that have previously been offered primarily by wholesale distributors (see \"Products and Vendors - Product Strategy\"), sales to value added resellers (\"VARs\") have been one of the Company's fastest growing sales segments.\nThe Company offers all resellers (including VARs) the option of purchasing products on open credit terms of up to 30 days, subject to credit review and approval. If the Company is successful in achieving continued revenue growth, this reseller financing program will place increased demands on the Company's working capital requirements to fund the associated increase in accounts receivable. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources\" in Part II, Item 7 of this report.\nThe Company will continue to pursue Network expansion through the recruitment of established computer resellers that can use and benefit from the products and services offered by the Company. In addition, in order to establish or solidify its presence in strategic markets or in response to competitive pressures, the Company has made, and in the future may make, acquisitions of or investments in additional reseller locations. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources\" in Part II, Item 7 of this report.\nMICROAGE SERVICES\nThe Company provides a broad array of services to its resellers and end-user customers. These services are generally provided on a fee-for-service basis.\nDISTRIBUTION SERVICES. Orders are fulfilled and shipped from distribution centers located in Tempe, Arizona and Cincinnati, Ohio for delivery in one to three business days to a reseller or end-user anywhere in the continental United States. In conjunction with product ordering and shipment, the Company offers various services to end-user customers and resellers, including expedited delivery, vendor direct shipment, deferred shipment, and the following special services:\nBack-order Management. Network resellers may elect to receive notification of the receipt by the Company of products that were not available for shipment within three days of order placement, rather than having the product shipped to them automatically, thereby avoiding costly product returns.\nMulti-site Direct Shipment. Product shipments, including configured system orders, may be specified for delivery directly to multiple end-user customer locations from the Company's distribution centers. This allows resellers to reduce freight expense, product handling costs, and delivery times to end-user customers.\nComplete Order Shipment. Resellers and end-user customers may elect to defer shipment of orders until all products and services specified in the order are fulfilled, thereby eliminating the costs associated with multiple shipments and the storage of inventory.\nQUALITY INTEGRATION CENTER. Technicians at the Company's Quality Integration Center, located in Tempe, Arizona, perform integration services, including systems set-up; local area network integration and testing; board-level enhancement; disk or tape drive installation; device testing; and software loading, including complex operating systems. The Quality Integration Center also direct-ships configured systems to end-user customers, allowing resellers to service these customers more profitably by reducing inventory levels, carrying costs, and freight expense, and by freeing up technical staff.\nFINANCIAL SERVICES. The Company has developed numerous financial services that are designed to improve the ability of qualifying resellers to purchase products from the Company in a cost-effective manner. See \"Business Strategy - Large Account Sales,\" \"Business Strategy - The MicroAge Network,\" and \"Products and Vendors - Vendor Relationships\" for a discussion of some of these financial services. The Company also sponsors payment programs with commercial credit companies to facilitate reseller purchases of products from vendors that do not offer their own payment programs; under these programs, the Company receives payment for product sales within three to five business days and pays the commercial credit company a fee based on a percentage of the products sold.\nTECHNICAL SERVICES. The Company provides resellers and certain end-user customers with various technical services, including telephone hotline support, technical publications, on-line technical services, training programs, product evaluation, and on-site consultation.\nMICROAGE ZDATA. MicroAge ZDATA, a proprietary, electronic ordering and product inquiry system, allows a participating Network reseller to electronically create, modify, send, and verify orders, check inventory on hand at the Company's distribution centers, and review the status of its account with the Company.\nPRODUCT INFORMATION CENTER. The Company provides new product information and existing product compatibility assistance to help end-user customers and resellers evaluate the effectiveness of a potential system solution. These customers and resellers may use this service to improve product knowledge and awareness and to avoid improper integration.\nINFORMATION SERVICES. Through the creation, packaging, and dissemination of information to its vendors, resellers, and end-user customers, the Company centralizes relevant market data for use by its constituencies. The Company can also provide end-user customers with asset tracking services to assist in the administration of large system installations and service. In addition, the Company has been a leader in providing electronic commerce services in conjunction with the Network. These services include electronic data interchange (\"EDI\") support, Internet hosting, and multimedia. Other services include technical information publications, product evaluation and market surveys, marketing periodicals, and product catalogs.\nPRODUCTS AND VENDORS\nPRODUCT STRATEGY. The Company sells a broad selection of products with a predominant focus on the products of major microcomputer and peripheral manufacturers, such as COMPAQ, Hewlett-Packard, and IBM. Sales of these three manufacturers' products represented approximately 56% of the Company's revenue from product sales during fiscal 1995, compared to approximately 60% during fiscal 1994. The Company's agreements with these vendors generally are renewed periodically and permit termination by the vendor without cause, generally upon 30 to 90 days' notice, depending on the vendor. The Company believes that these provisions are standard in the computer reseller industry. In addition, the Company's business is dependent upon price and related terms and product availability provided by its key vendors. Although the Company considers its relationships with COMPAQ, Hewlett-Packard, and IBM to be good, there can be no assurance that these relationships will continue as presently in effect or that changes by one or more of these key vendors in their volume discount schedules or other marketing programs would not adversely affect the Company. Termination or nonrenewal of the Company's agreements with COMPAQ, Hewlett-Packard, or IBM would have a material adverse effect on the Company's business.\nThe Company continually evaluates its product assortment based on technological advances, the market for information technology products, and the Network's requirements related to technological capability, product availability, and marketability. Over the last several years, the Company has expanded its product offerings in response to market conditions and has established relationships with new vendors to distribute, service, and support both high-end, higher-priced workstation products, as well as complementary computer peripheral products and software. These products generally carry higher profit margins than the Company's traditional brand name products and have historically been distributed primarily by wholesale distributors or sold directly to end-users by manufacturers. Sales of these products generally require the extension of credit by the Company, resulting in increased working capital requirements.\nPRODUCT SUPPLY. The computer reseller industry continues to experience product supply shortages and customer order backlogs due to the inability of certain manufacturers to supply certain products. In addition, certain vendors have initiated new channels of distribution that increase competition for the available product supply. There can be no assurance that vendors will be able to maintain an adequate supply of products to fulfill all of the Company's customer orders on a timely basis. Failure to obtain adequate product supplies could have a material adverse effect on the Company's results of operations.\nOPEN SOURCING. In the past, certain of the Company's vendors required resellers to purchase their products and services exclusively from one source. Vendors have generally removed this requirement, resulting in \"open sourcing\" of their products. To date, open sourcing has significantly contributed to the rapid growth of the Company's sales to VARs. However, competitive pricing pressures throughout the industry have intensified; these competitive pressures have been particularly evident in the Company's Network distribution business. While the Company believes that it can effectively compete for sales of those products available under open sourcing, there can be no assurance that open sourcing will not adversely affect the Company's business.\nVENDOR RELATIONSHIPS. Because of its quantity purchasing capabilities, the Company generally obtains volume discounts from its vendors, enabling it to sell products to resellers on more favorable terms than the typical reseller could obtain on its own from such vendors. In general, the Company's agreements have price protection provisions to protect the Company in the event of price reductions by its vendors on eligible products in the Company's inventory and to permit the return of slow-moving and other products for credit (generally at cost minus a restocking fee). Subject to product availability, the Company carries inventory at levels that it believes will enable it to meet the anticipated needs of its resellers and end-user customers and, to a lesser extent, to take advantage of certain vendor discounts and promotions.\nSeveral major vendors sponsor payment programs with commercial credit companies to facilitate product sales to and through the Network. Such programs generally provide Network resellers with payment terms ranging from 30 to 60 days, depending on the vendor. Under these programs, the Company generally receives payment for product sales within three to five business days, thus significantly reducing the Company's working capital requirements and credit exposure. See \"MicroAge Services - Financial Services\" for a discussion of payment programs that the Company sponsors with commercial credit companies to facilitate reseller purchases of products from vendors that do not offer their own payment programs.\nCOMPETITION\nThe computer reseller industry is characterized by intense competition, based primarily on product availability, price, speed of delivery, credit availability, ability to tailor specific solutions to customer needs, quality and breadth of product lines, service and post-sale support, and quality of customer training. In addition, the Company faces competition in the recruitment and retention of resellers for the MicroAge Network. The Company and MicroAge Network locations compete for sales with numerous resellers, including (i) master resellers; (ii) direct resellers; (iii) wholesalers (resellers that do not sell to end-users); (iv) vendors that sell directly to large purchasers; and (v) parties that implement other sales methods, such as direct mail, computer \"superstores,\" and mass merchandisers. See \"Products and Vendors -- Open Sourcing\" for a discussion of the competitive pressures associated with open sourcing.\nEMPLOYEES\nAs of October 29, 1995, the Company employed approximately 2,088 persons, 436 of whom were employed at the twelve Company-owned reseller locations. No employees are represented by labor unions. The Company considers its employee relations to be good.\nGOVERNMENT REGULATION\nThe Company is subject to a substantial number of state laws regulating franchise operations. In general, these laws impose registration and disclosure requirements on franchisors in the offering and sale of franchises. Also, in certain cases, statutes and court-created doctrines apply substantive standards to the relationship between franchisor and franchisee, including restrictions on the Company's ability to terminate or refuse to renew a franchise agreement. The Company is also subject to Federal Trade Commission regulations governing disclosure requirements in the sale of franchises. The Company believes it is in substantial compliance with all such regulations. See Note 2 of the Company's Consolidated Financial Statements in Part II, Item 8 for additional information regarding the Company's franchising activities.\nTRADEMARKS AND SERVICE MARKS\nThe Company holds various trademarks and service marks, including, among others, MicroAge,(R) The Solution Store,(R) The Solution Center,(R) Solutions,(R) MicroSource,(R) MicroAge 2000,(R) The Franchise Program for the 90's and Beyond,(R) and ZDATA.(R) All trademarks and service marks are registered in the United States, and certain trademarks and service marks are registered in various foreign countries. The marks are not otherwise registered with any states; however, the Company also claims common law rights to the marks based on adoption and use. Management believes that the value of the Company's marks is increasing with the development of its business, but that the business of the Company as a whole is not materially dependent on such marks.\nSEASONALITY\nAlthough the Company's financial performance has not exhibited significant seasonality in the past, the Company and the computer industry in general tend to follow a sales pattern with peaks occurring near the end of the calendar year, due primarily to special vendor promotions and year-end business purchases.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe following table sets forth certain information regarding the executive officers of the Company as of December 31, 1995:\n- --------------- * Mr. Kenneth R. Waters was the Company's President at December 31, 1995, but will be leaving the Company effective January 31, 1996 due to a medical condition. Mr. McKeever assumed Mr. Waters' responsibilities after Mr. Waters underwent heart surgery in June 1995.\nJEFFREY D. MCKEEVER has served as Chief Executive Officer since February 1987, and as Chairman of the Board since October 1991. In June 1995, Mr. McKeever also assumed the duties of President of the Company because Mr. Waters went on leave from the Company at that time due to a medical condition. Mr. McKeever co-founded the Company in August 1976 and has served as a director of the Company since October 1976. He also served as President from January 1993 to February 1993 and from February 1987 to October 1991, Chairman of the Board and Secretary from October 1976 to February 1987 and Treasurer from October 1976 to February 1983 and from February 1987 to December 1988.\nALAN P. HALD has served as Vice-Chairman of the Board since October 1991, and as Secretary since February 1987. He co-founded the Company in August 1976 and has served as a director of the Company since October 1976. He also served as President from February 1993 to August 1993 and from October 1976 to February 1987, Chairman of the Board from February 1987 to October 1991 and Treasurer from February 1983 to February 1987.\nJAMES R. DANIEL has served as Senior Vice President and Chief Financial Officer of the Company since January 1993, and as Treasurer of the Company from January 1993 until December 1994, at which time he assumed the additional position of President, Headquarter Services, MCCI. He reassumed the title of Treasurer in September 1995. Prior to joining MicroAge, he served as Chief Financial Officer and Treasurer of Dell Computers from 1991 to 1993. Prior to Dell, he served as Chief Financial Officer and Treasurer for SCI Systems, an electronics contract manufacturer, from 1984 to 1991. Mr. Daniel is a certified public accountant.\nWARREN T. MILLS has served as Senior Vice President - Sales of the Company since December 1994. He served as Vice President - Sales of the Company from October 1989 until December 1994 and as President of MicroAge Solutions, Inc. from September 1988 until December 1994. From April 1987 through September 1988, he owned a franchised MicroAge location in Burlington, Massachusetts.\nROBERT G. O'MALLEY has served as Vice President - Services Marketing of the Company since January 1996 and as President, MicroAge Data Services, MCCI, since May 1995. Prior to joining the Company, he held various positions with IBM Corporation since January 1976, including General Manager, PC Desktop Systems from September 1994 to February 1995; Vice President of Marketing & Brand Management - Americas from February 1994 to September 1994; Managing Director, Asia Pacific PC Operations from January 1992 to January 1994; Vice President, National Distribution Division, from August 1990 to December 1991; and Director, US Finance and Planning, from February 1988 to July 1990.\nJOHN H. ANDREWS has served as Vice President - Logistics of the Company since December 1995 and as President, MicroAge Logistics Services, MCCI, since July 1993. He served as Vice President - Operations from July 1993 to December 1995; Group Vice President, Operations from January 1993 to July 1993; Vice President and Chief Financial Officer from June 1990 to January 1993; and as Treasurer from June 1991 to January 1993. Mr. Andrews joined the Company in 1984 and served as Principal Accounting Officer from December 1988 to June 1990. Mr Andrews is a certified public accountant.\nWESLEY D. RICHARDS has served as Vice President - Development of the Company since December 1994, and as President of MicroAge Channel Services, MCCI, since August 1995. He served as President of MicroAge Enterprises, Inc. from August 1994 to August 1995. Mr. Richards joined the Company in June 1994 as a consultant on special projects. Prior to joining MicroAge, he operated a consulting business, specializing in computer software, from August 1990 to June 1994. Prior to operating the consulting business, Mr. Richards served as Vice President of Sales and Marketing at Ashton-Tate, a software company, from January 1989 to June 1990.\nCHRISTOPHER J. KOZIOL has served as President, MicroAge Infosystems Services, Inc. since October 1995. He served as President, MicroAge Infosystems Services, MCCI, from July 1993 to October 1995 and as Vice President, Sales, MCCI, from January 1992 to July 1993. He joined the Company in September 1985 and served as Director-Regional Support from March 1988 to December 1991.\nJEFFREY M. SWANSON has served as President, MicroAge Solutions, Inc. since December 1994 and served as General Manager of MCSB, Inc., a Company-owned location in Plymouth, Minnesota from October 1991 to November 1994. Prior to joining MicroAge, he served as Executive Vice President of AmeriData Incorporated from 1981 to 1991.\nHARMAN D. CADIS has served as Chief Technical Officer, MCCI since December 1994 and as President, MicroSource Technologies, Inc. since January 1991. He served as President, MicroAge Technologies, MCCI, from July 1993 to April 1995. Mr. Cadis joined the Company in January 1991 when the Company acquired ICT, a wholesale supplier of computer graphics products. Mr. Cadis founded ICT in September 1983 and served as President and Chairman of the Board from October 1984 through January 1991.\nRAYMOND L. STORCK has served as Vice President - Controller of the Company since July 1993, and as Controller and Assistant Treasurer since October 1991. He joined the Company in 1986 and served in positions in accounting, reporting and analysis, including Director of Planning and Analysis from June 1990 to July 1991.\nJEFFREY A. H. FRANKEL has served as Vice President - Legal of the Company and Vice President of MicroAge International, Inc. since July 1993 and as Assistant Secretary of the Company since February 1993. From October 1992 through July 1993, he served as Corporate Counsel and as Managing Director of the International Department. Mr. Frankel joined the Company in September 1986 and served as Associate Corporate Counsel from September 1986 to September 1992.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's executive offices are located in Tempe, Arizona and occupy approximately 135,000 square feet of commercial office space. The Company operates automated distribution and logistics centers in Tempe, Arizona and Cincinnati, Ohio which occupy approximately 300,000 and 304,000 square feet, respectively. The Company also maintains a 124,000 square foot Technical Services Center in Tempe, Arizona, adjacent to a 133,000 square foot Quality Integration Center.\nThe Company also operates twelve Company-owned reseller locations (one each in Tempe, Arizona; Plymouth, Minnesota; Chicago, Illinois; Westminster, Colorado; Burlington, Massachusetts; Wilton, Connecticut; Novi, Michigan; St. Louis, Missouri; Oklahoma City, Oklahoma; Tulsa, Oklahoma; Houston, Texas; and Irving, Texas) which occupy an aggregate of approximately 146,000 square feet.\nAll facilities are leased. The Company believes that its properties and equipment are well-maintained, in good operating condition, and adequate for its present foreseeable needs.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nOn July 14 through July 19, 1994, seven class action complaints were filed in the United States District Court for the District of Arizona against the Company, certain of its officers and directors, and, in three of the lawsuits, one of the underwriters of the Company's June 16, 1994 public offering of common stock. On December 5, 1994, the Court consolidated the seven actions into a single action. On February 16, 1995, plaintiffs filed and served an amended, consolidated complaint against the Company, certain officers and directors of the Company, and three of the underwriters of the Company's June 16, 1994 public offering of common stock (the \"Complaint\"). The Complaint purports to be brought on behalf of a class of purchasers of the Company's common stock during the period April 13, 1994 through July 14, 1994. The Complaint alleges, among other things, that the Company violated federal securities laws by making misleading public statements and omitting material facts regarding the Company's operations and financial results, which the plaintiffs contend to have artificially inflated the price of the Company's common stock during the alleged class period. The Complaint seeks unspecified compensatory damages as well as fees and costs. On April 28, 1995, the Company filed a motion to dismiss the Complaint in its entirety. The motion was heard on July 31, 1995; no decision has yet been issued. Discovery is ongoing. The Company and the individual defendants deny the plaintiffs' allegations of wrongdoing and intend to vigorously defend themselves in these actions. The proceeding is in its early stage, however, and its outcome cannot be predicted with certainty 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 the Company's security holders during the fourth quarter of fiscal 1995.\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 in the over-the-counter market under the symbol MICA and has been quoted on the Nasdaq National Market since July 1, 1987. The following table sets forth the quarterly high and low sale prices for the common stock as reported by the Nasdaq National Market for the two most recent fiscal years:\nAs of December 31, 1995, there were approximately 447 stockholders of record of the common stock. The Company believes that as of such date there were approximately 6,900 beneficial holders of the common stock.\nThe Company has never declared or paid a cash dividend on its common stock and does not presently intend to do so. Future dividend policy will depend upon the Company's earnings, capital requirements, financial condition and other factors deemed relevant by the Board of Directors.\n- ------------- (1) On December 8, 1993, the Company's Board of Directors declared a 3- for-2 stock split effected in the form of a Common Stock dividend that was paid on January 13, 1994. All prices in this table give effect to the stock split.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following selected financial data for the five fiscal year periods ended October 29, 1995 are derived from the Company's Consolidated Financial Statements. The selected financial data should be read in conjunction with the Company's Consolidated Financial Statements and related notes included elsewhere in this report. See also \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nINCOME STATEMENT DATA: (1)\n- ----------- (1) Effective for the Company's 1994 fiscal year, the Company changed its fiscal year end from September 30 to the Sunday nearest October 31 in each calendar year. See Note 3 to the Company's Consolidated Financial Statements in Part II, Item 8.\n(2) The fiscal year ended October 29, 1995 included $9,029,000 of restructuring and other one-time charges. See \"Managements's Discussion and Analysis of Financial Condition and Results of Operations.\"\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 indicated periods, data as percentages of total revenue:\nFISCAL YEAR ENDED OCTOBER 29, 1995 VERSUS FISCAL YEAR ENDED OCTOBER 30, 1994\nTotal Revenue. Total revenue increased $720 million, or 32%, to $2.9 billion for the fiscal year ended October 29, 1995 as compared to the fiscal year ended October 30, 1994. This revenue increase included a $320 million, or 41%, increase in sales to large accounts and a $341 million, or 26%, increase in sales to resellers.\nThese revenue increases were primarily due to sales to resellers added since October 30, 1994, the Company's focus on large account sales, increased demand for the Company's major vendors' products, the Company's addition of new product lines and same location sales growth (including sales to large accounts).\nThe Company experienced quarterly revenue growth rates in excess of 40% (when compared to the same quarters of the prior years) during the fiscal years ended September 30, 1993 and October 30, 1994 as well as for the first two quarters of fiscal 1995. Quarter over quarter revenue growth decreased to 30% and 20% for the last two quarters of fiscal 1995. In fiscal 1996, the Company will emphasize increased profitability rather than revenue growth. See \"Business Strategy\" in Part I, Item 1 for a discussion of the Company's strategic focus.\nGross Profit Percentage. The Company's gross profit percentage was 5.2% for the fiscal year ended October 29, 1995 and for the fiscal year ended October 30, 1994.\nFuture gross profit percentages may be affected by market pressures, the introduction of new Company programs, changes in revenue mix, the Company's utilization of early payment discount opportunities, vendor pricing actions and other competitive and economic factors. See \"Potential Fluctuations in Operating Results\" below for information regarding industry trends that may affect future gross profit percentages.\nOperating Expense Percentage. As a percentage of revenue, operating expenses increased to 4.3% for the fiscal year ended October 29, 1995, from 3.7% for the fiscal year ended October 30, 1994. Operating expenses increased from $83.2 million for fiscal 1994 to $126.4 million for fiscal 1995. The increase was primarily due to increased costs as a result of higher volumes, capacity expansion in both personnel and facilities added in anticipation of revenue growth and increased depreciation as a result of expenditures for automation initiatives and facility expansion.\nRestructuring and Other One-time Charges. During the fourth quarter of fiscal 1995, the Company approved and implemented actions targeted at reducing the Company's future cost structure and improving its profitability. These actions included, among other things, (i) the sale of the Company's memory distribution business, (ii) outsourcing a certain business function and (iii) a reduction in the number of the Company's employees. The Company's consolidated statement of income for fiscal 1995 includes $9.0 million of pretax charges ($5.4 million net of tax benefits, or $0.38 per share) for restructuring and other one-time charges.\nIf the restructuring and other one-time charges are calculated as though all of the actions targeted at reducing expenses and improving profitability had been implemented on the first day of the fourth fiscal quarter, the total of these charges would have been $10.8 million before tax, or $0.45 per share. The Company reported a loss of $0.40 per share for its fourth fiscal quarter of 1995, including restructuring and other one-time charges. Excluding the $10.8 million in charges, the Company's fourth quarter net income would have been $744,000, or $0.05 per share, up slightly from the $662,000, or $0.05 per share reported for the third quarter of fiscal 1995, and net income for the year would have been $6.7 million, or $0.47 per share.\nOther Expenses - Net. Other expenses - net increased to $15.6 million for the fiscal year ended October 29, 1995 from $5.6 million for the fiscal year ended October 30, 1994. The increase is primarily attributable to an increase in net financing costs during the year. These financing costs included expenses from the sale of receivables under an agreement with a commercial lender, costs from flooring subsidies provided to lenders who floor product purchases from the Company's customers and increased interest expense due to higher average borrowings during the fiscal year.\nEffective tax rate. The Company's effective tax rate increased from 39.4% for the fiscal year ended October 30, 1994 to 78.3% for the fiscal year ended October 29, 1995. This increase is a result of the impact of certain state taxes not based on income and non-deductible expenses, such as meals and entertainment and goodwill amortization, on a lower pretax income amount.\nMarketing Development Funds. The Company receives funds from certain vendors which are earned through marketing programs, meeting established purchasing objectives or meeting other objectives determined by the vendor. There can be no assurance that these programs will be continued by the vendors. A substantial reduction in the vendor funds available to the Company would have an adverse effect on the Company's results of operations.\nFISCAL YEAR ENDED OCTOBER 30, 1994 VERSUS FISCAL YEAR ENDED SEPTEMBER 30, 1993\nTotal Revenue. Total revenue increased $711 million, or 47%, to $2.2 billion for the fiscal year ended October 30, 1994 as compared to the fiscal year ended September 30, 1993. This revenue increase included a $264 million, or 46%, increase in sales to large accounts and a $447 million, or 48%, increase in sales to resellers.\nThese revenue increases were primarily due to sales to resellers added since September 30, 1993, same location sales growth (including sales to large accounts), the Company's focus on large account sales, increased demand for the Company's major vendors' products and the Company's addition of new product lines.\nGross Profit Percentage. The Company's gross profit percentage increased to 5.2% for the fiscal year ended October 30, 1994 from 5.1% for the fiscal year ended September 30, 1993.\nDuring the fiscal year, the Company's gross profit percentage decreased from 5.5% for the quarter ended May 1, 1994 to 4.9% for the quarter ended July 31, 1994. The gross profit percentage increased slightly to 5.1% for the quarter ended October 30, 1994. The gross profit percentage decrease between the quarters ended May 1, 1994 and July 31, 1994 was primarily attributable to general market pricing pressure and costs associated with actions taken to reduce inventory levels.\nOperating Expense Percentage. As a percentage of revenue, operating expenses decreased from 3.9% for the fiscal year ended September 30, 1993 to 3.7% for the fiscal year ended October 30, 1994.\nOther Expenses - Net. Other expenses - net increased to $5.6 million for the fiscal year ended October 30, 1994 from $1.2 million for the fiscal year ended September 30, 1993. The increase is primarily attributable to an increase in net financing costs incurred during the year.\nThese financing costs included expenses from the sale of receivables under an agreement with a commercial lender, costs from flooring subsidies provided to lenders who floor product purchases from the Company's customers and increased interest expense due to higher average borrowings during the fiscal year.\nPOTENTIAL FLUCTUATIONS IN OPERATING RESULTS\nThe Company's operating results may vary significantly from quarter to quarter depending on certain factors, including, but not limited to, demand for the Company's information technology products and services, product availability, competitive conditions, and general economic conditions. See \"Products and Vendors\" and \"Competition\" in Part I, Item 1 for additional information regarding certain of these factors. Although the Company attempts to control its expense levels, these levels are based, in part, on anticipated revenues. Therefore, the Company may not be able to control spending in a timely manner to compensate for any unexpected revenue shortfall. As a result, quarterly period-to-period comparisons of the Company's financial results are not necessarily meaningful and should not be relied upon as an indication of future performance.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company has financed its growth and cash needs to date primarily through working capital financing facilities, bank credit lines, common stock offerings and cash generated from operations. The primary uses of cash have been to fund increases in inventory and accounts receivable resulting from increased sales. If the Company is successful in achieving continued revenue growth (see \"Business Strategy - Large Account Sales\" in Part I, Item 1), its working capital requirements will continue to increase.\nDuring the fiscal year ended October 29, 1995, the Company used $6 million of cash for a business purchase. In order to establish or solidify its presence in strategic markets or to respond to competitive pressures, the Company may make acquisitions of, or investments in, reseller locations. These acquisitions or investments may be made utilizing cash, stock or a combination of cash and stock. See \"Competition\" in Part I, Item 1 for information regarding competitive pressures.\nFor the fiscal year ended October 29, 1995, $32 million of cash was provided by operating activities. Net cash provided by operating activities included a decrease in inventory of $9 million, an increase in accounts payable of $51 million, non-cash depreciation, amortization and bad debt charges of $21 million and non-cash restructuring and other one-time charges of $7 million offset by an increase in accounts receivable of $53 million and increases in other assets of $7 million. The number of days sales in ending accounts receivable increased from 20 days at October 30, 1994 to 22 days at October 29, 1995. The Company's annualized inventory turnover rate increased from 8 times at October 30, 1994 to 10 times at October 29, 1995. The number of days cost of sales in ending accounts payable remained constant at 47 days at October 30, 1994 and October 29, 1995. For fiscal year 1995, net cash of $29 million used in investing activities consisted primarily of $23 million for the purchase of property and equipment and $6 million for a business purchase.\nIn August 1995, the Company amended its primary financing agreement (the \"Agreement\") to increase its financing facility from $250 million to $400 million. The Agreement includes two major components: an accounts receivable facility (the \"A\/R Facility\") and an inventory facility (the \"Inventory Facility\"). The Agreement expires in August 1997.\nUnder the A\/R Facility, the Company has the right to sell certain accounts receivable from time to time, on a limited recourse basis, up to an aggregate amount of $250 million sold at any given time. At October 29, 1995, the net amount of sold accounts receivable was $125 million.\nThe Inventory Facility provides for borrowings up to $150 million. Within the Inventory Facility, the Company has a line of credit for the purchase of inventory from selected product suppliers (\"Inventory Line of Credit\") of $50 million and a line of credit for general working capital requirements (\"Supplemental Line of Credit\") of $100 million. Payments for products purchased under the Inventory Line of Credit vary depending upon the product supplier, but generally are due between 45 and 60 days from the date of the advance. No interest or finance charges are payable on the Inventory Line of Credit if payments are made when due. At October 29, 1995, the Company had $3 million outstanding under the Inventory Line of Credit and had no amounts outstanding under the Supplemental Line of Credit.\nOf the $400 million of financing capacity represented by the Agreement, $272 million was unused as of October 29, 1995. Utilization of the unused $272 million is dependent upon the Company's collateral availability at the time the funds would be needed.\nBorrowings under the Agreement are secured by substantially all of the Company's assets, and the Agreement contains certain restrictive covenants, including working capital and tangible net worth requirements, and ratios of debt to tangible net worth and current assets to current liabilities. At October 29, 1995, the Company was in compliance with these covenants.\nThe Company also maintains trade credit arrangements with its vendors and other creditors to finance product purchases. Several major vendors maintain security interests in their products sold to the Company.\nThe unavailability of a significant portion of, or the loss of, the Agreement or trade credit from vendors would have a material adverse effect on the Company.\nINFLATION\nThe Company believes that inflation has generally not had a material impact on its operations or liquidity to date.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe Consolidated Financial Statements of the Company listed in the index appearing under Item 14(a)(1) hereof are filed as part of this Annual Report on Form 10-K and are hereby incorporated by reference in this Item 8. See also \"Index to Financial Statements\" on page hereof.\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 Company's directors is incorporated herein by reference to the information furnished under the captions \"Election Of Directors\" and \"Section 16 Requirements\" in the Company's Proxy Statement relating to its 1996 Annual Meeting of Stockholders (the \"1996 Proxy Statement\").\nInformation regarding executive officers of the Company is included in Part I, Item 1 hereof, furnished under the caption \"Executive Officers of the Registrant.\"\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation regarding executive compensation is incorporated herein by reference to the information furnished under the captions \"Executive Compensation\" (other than the information furnished under the heading \"Report of the Compensation Committee on Executive Compensation\") and \"Other Information Regarding the Board of Directors\" in the 1996 Proxy Statement.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation regarding security ownership of certain beneficial owners and management of the Company is incorporated herein by reference to the information furnished under the captions \"Security Ownership of Management\" and \"Principal Stockholders\" in the 1996 Proxy Statement.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation regarding certain relationships and related transactions is incorporated herein by reference to the information furnished under the caption \"Certain Relationships and Related Transactions\" in the 1996 Proxy Statement.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES, AND REPORTS ON FORM 8-K\n(a) The following documents are filed as part of this Annual Report on Form 10-K:\n(b) Reports filed on Form 8-K during the quarter ended October 29, 1995:\nNone.\n(c) See Item 14(a)(3) above.\n(d) See \"Index to Consolidated Financial Statements\" included under Item 8 to this Annual Report on Form 10-K.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nMICROAGE, INC. (Registrant)\nBy:\/s\/ Jeffrey D. McKeever --------------------------------- Jeffrey D. McKeever 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.\nANNUAL REPORT ON FORM 10-K\nITEM 8, ITEM 14(a) (1) AND (2), (c) AND (d)\n----------------------------------\nCONSOLIDATED FINANCIAL STATEMENTS\nEXHIBITS\n----------------------------------\nYEAR ENDED OCTOBER 29, 1995\nMICROAGE, INC. AND SUBSIDIARIES\nTEMPE, ARIZONA\nMICROAGE, INC.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Stockholders of MicroAge, Inc.\nIn our opinion, the consolidated financial statements listed in the index appearing under Item 14(a)(1) and (2) on page 17 present fairly, in all material respects, the financial position of MicroAge, Inc. and its subsidiaries at October 29, 1995 and October 30, 1994, and the results of their operations and their cash flows for the fiscal years ended October 29, 1995, October 30, 1994 and September 30, 1993, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.\nPRICE WATERHOUSE LLP\nPhoenix, Arizona December 5, 1995\nMICROAGE, INC. CONSOLIDATED BALANCE SHEETS (in thousands, except share data)\nASSETS\nThe accompanying notes are an integral part of these financial statements.\nMICROAGE, INC. CONSOLIDATED STATEMENTS OF INCOME (in thousands, except per share data)\nThe accompanying notes are an integral part of these financial statements.\nMICROAGE, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS Increase (Decrease) in Cash and Cash Equivalents (in thousands)\nSupplemental disclosure to cash flows - See Note 14\nThe accompanying notes are an integral part of these financial statements.\nMICROAGE, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (in thousands, except share data)\nThe accompanying notes are an integral part of these financial statements.\nMICROAGE, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1 - BUSINESS\nMicroAge, Inc. (\"MicroAge\") distributes and integrates information technology products and services through, and in partnership with, a network of resellers, including twelve Company-owned resellers (the \"MicroAge Network\" or the \"Network\"). The products and services the Company markets and sells include microcomputer systems; workstations; networking and telecommunications equipment; system solutions, including integration and installation services and various technical services and support; software and related products and services. Unless the context otherwise requires, references to the \"Company\" include MicroAge, Inc. and its consolidated subsidiaries.\nNOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPrinciples of consolidation\nThe consolidated financial statements of the Company include the accounts of companies more than 50% owned. Investments in affiliates owned 50% or less are accounted for by the equity method. All material intercompany accounts and transactions have been eliminated.\nDisclosures about fair value of financial instruments\nFinancial instruments that are subject to fair value disclosure requirements are carried in the consolidated financial statements at amounts that approximate fair value.\nCash equivalents\nAll highly liquid debt instruments purchased with an original maturity of three months or less are considered to be cash equivalents. The Company did not have any cash equivalents at October 29, 1995 or October 30, 1994.\nCash overdrafts\nUnder the Company's cash management system, checks issued but not presented to banks frequently result in overdraft balances for accounting purposes. Such amounts, aggregating $38.5 million and $21.5 million at October 29, 1995 and October 30, 1994, respectively, are included as a component of accounts payable in the accompanying balance sheets.\nAccounts and notes receivable\nAccounts and notes receivable are comprised of amounts due from financing companies, end-users, and resellers and are net of an allowance for doubtful accounts of $12,255,000 and $6,833,000 at October 29, 1995 and October 30, 1994, respectively.\nInventory\nInventory consisting of resale merchandise is stated at lower of cost (first-in, first-out method) or market. International Business Machines Corporation (\"IBM\") products totaling $54,083,000 and $48,375,000 included in inventory at October 29, 1995 and October 30, 1994, respectively, are subject to a reservation of the title in IBM for the purpose of assuring that such products are sold and delivered only to IBM-authorized personal computer dealers; such reservation does not prohibit the Company from granting security interests to other parties.\nDuring the fiscal year ended October 29, 1995, sales of COMPAQ Computer Corporation, Hewlett-Packard Company and IBM products accounted for approximately 21%, 20% and 15%, respectively, of the Company's revenue from sales of merchandise. The sales of no other individual vendor's products accounted for more than 10% of such revenue during the fiscal year ended October 29, 1995.\nProperty and equipment\nProperty and equipment are recorded at cost and are depreciated on the straight-line method over their estimated useful lives. Equipment under capital lease is recorded at the lower of fair market value or the present value of future lease payments and is amortized on the straight-line method over the estimated useful life or the term of the lease, whichever is less.\nThe following reflects the estimated lives by category of property and equipment:\nExpenditures for maintenance and repairs are charged to operations in the year in which the expense is incurred.\nIntangible assets\nIntangible assets are amortized over their economic lives ranging from three to fifteen years using the straight-line method. The Company periodically reviews goodwill to assess recoverability, and impairments would be recognized in operating results if a permanent reduction in value were to occur. The excess of cost over the fair value of net identifiable assets acquired is classified as goodwill and is included in intangible assets. Intangible assets are net of $4,573,000 and $4,830,000 of accumulated amortization at October 29, 1995 and October 30, 1994, respectively.\nRevenue recognition\nRevenue from product sales is recognized at the time of shipment. Revenue associated with service contracts is initially recorded as deferred income (included in other liabilities) and amortized on the straight-line method over the service period of the contract.\nMarketing development funds\nIn general, vendors provide the Company with various incentive programs. The funds received under these programs are determined based on the Company's purchases and\/or sales of the vendor's product. The funds are earned by the performance of specific marketing programs or upon completion of predetermined objectives dictated by the vendor. Once earned, the funds are applied against product cost or operating expenses.\nIncome taxes\nIn addition to charging income for taxes paid or payable, the provision for income taxes reflects deferred income taxes resulting from changes in temporary differences between the tax bases of assets and liabilities and their reported amounts in the accompanying financial statements.\nIncome per common share\nIncome per common and common equivalent share is computed using the weighted average number of common and dilutive common equivalent shares outstanding during the period. Dilutive common equivalent shares consist of stock options and warrants using the treasury stock method. The weighted average common and common equivalent shares consist of the following:\nFully diluted earnings per share includes the exercise of all outstanding dilutive options and warrants and results in a dilution of less than 3%. The number of common and common equivalent shares used to compute fully diluted earnings per share was 14,342,326 in fiscal 1995, 13,385,091 in fiscal 1994 and 9,345,456 in fiscal 1993.\nFranchising Activities\nMicroAge distributes its products and services through a network of franchised and affiliated resellers and Company-owned locations. In fiscal 1995, 325 franchised resellers were added and 289 were eliminated due to transferring to an affiliate agreement, closing or terminating their agreement, resulting in 789 franchised reseller locations at October 29, 1995. In fiscal 1995, one business was purchased, resulting in an increase of three Company-owned locations. There were twelve Company-owned locations at October 29, 1995. In fiscal 1995, total revenue and total cost of sales from Company-owned locations were $305,265,000 and $273,936,000, respectively.\nPostemployment Benefits\nDuring 1994, the Company adopted Financial Accounting Standards Board Statement No. 112 (\"SFAS 112\"), \"Employers Accounting for Postretirement Benefits.\" SFAS 112 established standards of financial accounting and reporting for the estimated cost of benefits provided by an employer to current and former employees pursuant to the terms of an employer's agreement to provide those benefits. The adoption of this statement did not have a material impact on the Company's operating results.\nReclassifications\nCertain prior year amounts have been reclassified to conform with current year financial statement presentation.\nNOTE 3 - CHANGE IN FISCAL YEAR\nEffective for the 1994 fiscal year, the Company changed its fiscal year end from September 30 to the Sunday nearest October 31 in each calendar year. The consolidated statements of income are presented for the 52 weeks ended October 29, 1995 and October 30, 1994, exclusive of October 1993 results, and the fiscal period ended September 30, 1993. The Company's financial performance has not exhibited significant seasonality in the past; therefore, the results of operations presented for the fiscal 1995 and 1994 periods are comparable to the results for the fiscal 1993 period.\nThe Company's results of operations for the month of October 1993 reflected revenue of $135.1 million, gross profit of $6.1 million, income tax expense of $73,000, net income of $81,000 and net income per common share of $0.01. During the month of October 1993, net cash of $5.0 million, $696,000 and $85,000 was used in operating, investing and financing activities, respectively. Cash decreased from $20.2 million to $14.5 million during October 1993.\nNOTE 4 - PROPERTY AND EQUIPMENT\nNOTE 5 - LEASES\nThe following is a schedule by year of future minimum lease obligations under noncancelable leases together with the present value of the net minimum capital lease obligations as of October 29, 1995:\nNone of the leases contain significant restrictive provisions; however, some of the leases contain renewal options and provisions for payment by the Company of real estate taxes, insurance and maintenance costs. Total rent expense was (in thousands):\nNOTE 6 - FINANCING ARRANGEMENTS\nIn August 1995, the Company amended its financing agreement (the \"Agreement\") to increase its financing facility from $250 million to $400 million. The Agreement includes two major components: an accounts receivable facility (the \"A\/R Facility\") and an inventory facility (the \"Inventory Facility\"). The Agreement expires in August 1997.\nUnder the A\/R Facility, the Company has the right to sell certain accounts receivable from time to time, on a limited recourse basis, up to an aggregate amount of $250 million sold at any given time. At October 29, 1995, the net amount of sold accounts receivable was $125 million.\nThe Inventory Facility provides for borrowings up to $150 million. Within the Inventory Facility, the Company has a line of credit for the purchase of inventory from selected product suppliers (\"Inventory Line of Credit\") of $50 million and a line of credit for general working capital requirements (\"Supplemental Line of Credit\") of $100 million. Payments for products purchased under the Inventory Line of Credit vary depending upon the product supplier, but generally are due between 45 and 60 days from the date of the advance. No interest or finance charges are payable on the Inventory Line of Credit if payments are made when due. At October 29, 1995, the Company had $3 million outstanding under the Inventory Line of Credit (included in the accounts payable in the accompanying Balance Sheet), and no amounts outstanding under the Supplemental Line of Credit.\nBorrowings under the Agreement are secured by substantially all of the Company's assets, and the Agreement contains certain restrictive covenants, including working capital and tangible net worth requirements, and ratios of debt to tangible net worth and current assets to current liabilities. At October 29, 1995, the Company was in compliance with these covenants.\nThe Company also maintains trade credit arrangements with its vendors and other creditors to finance product purchases. Several major vendors maintain security interests in their products sold to the Company.\nNOTE 7 - LONG-TERM OBLIGATIONS\nFollowing are the annual maturities of long-term obligations (in thousands):\nNOTE 8 - STOCKHOLDERS' EQUITY\nStock Split\nOn December 8, 1993, the Company's Board of Directors declared a 3-for-2 stock split effected in the form of a common stock dividend. The dividend was paid on January 13, 1994, to stockholders of record on December 20, 1993, in the amount of 0.5 shares of common stock for each share of common stock held by such stockholders. All data in the accompanying financial statements and related notes have been restated to give effect to the stock split effected in the form of a common stock dividend.\nPublic offering\nOn June 16, 1994, the Company completed a public offering of 2,000,000 shares of common stock. The proceeds from the sale, net of issuance costs, were approximately $39,502,000.\nIncrease in Authorized Common Shares\nIn March 1994, the Company's stockholders approved an increase in the number of authorized common shares, par value $.01 per share, from 20,000,000 shares to 40,000,000 shares.\nWarrants\nDuring fiscal 1985, the Company granted stock purchase warrants for 95,958 shares of common stock at $4.35 per share. During fiscal 1995, 47,979 warrants were exercised, and at October 29, 1995, there were no unexercised warrants. No additional shares may be granted under these warrant agreements.\nEmployee stock option and award plans\nDuring fiscal 1994, the Board of Directors and stockholders of the Company approved the adoption of the MicroAge Inc. Long-Term Incentive Plan (the \"Incentive Plan\") for officers and other key employees of the Company. The Incentive Plan authorizes grants of Incentive Stock Options, Non-Qualified Stock Options (NQSOs), Stock Appreciation Rights, Performance Shares, Restricted Stock, Dividend Equivalents and other Common Stock based awards. The total number of shares of common stock available for awards under the Incentive Plan is 1,800,000.\nThe Company has issued NQSOs under the Incentive Plan at prices representing the fair market value of the Company's common stock on the date of the grant. The NQSOs are granted for terms of five years and become exercisable on a pro-rata basis on each anniversary of the grant over a five-year period as long as the holder remains an employee of the Company. NQSOs under the Incentive Plan were granted in fiscal 1994 to selected employees in exchange for the employee's irrevocable waiver of a specific amount of base salary or bonus otherwise payable by the Company during a specific period. The options will vest in one-third increments beginning on the January 1 which is three years following the January 1 of the calendar year in which the participant elects to waive compensation. Subsequent to the 1995 fiscal year end, the NQSOs granted during 1994 under the Incentive Plan were amended whereby the exercise price was reduced to reflect the fair market value of the Company's common stock at the date of the amendment. No other awards have been made under the Incentive Plan.\nIn addition to the Incentive Plan, stock options are available under four plans for grant to certain officers and employees of the Company at prices representing the fair market value of the Company's common stock on the date of the grant. Options under these plans are granted for terms of five years and become exercisable on a pro-rata basis on each anniversary date of the grant over a five-year period as long as the holder remains an employee of the Company.\nChanges during fiscal 1993, 1994 and 1995 in options outstanding under the employee stock option plans (including the Incentive Plan) were as follows:\nFranchisee stock option plans\nStock options were granted in 1989 and 1990 under two plans to certain franchisees of the Company at prices representing the fair market value of the Company's common stock on the date of grant. As of October 29, 1995, all options granted in 1989 had been exercised or forfeited. Outstanding options granted in 1990 were granted at $6.38 per share.\nOptions under these plans were granted for terms of six years and become exercisable on a pro-rata basis on each anniversary date of the grant over a five-year period as long as the holder remains a franchisee in good standing of the Company. At October 29, 1995, 9,602 options were outstanding under the remaining stock option plan and all options were exercisable.\nDirector stock plans\nDuring fiscal 1989, the Board of Directors and stockholders approved a stock option plan for those Directors who are not officers or employees of the Company or its subsidiaries (the \"Directors' Plan\"). Under the Directors' Plan, on or before December 7, 1998, options to purchase 1,000 shares of common stock will be automatically granted, immediately following each annual meeting of stockholders, to eligible Directors. The option price will be the fair market value of the Company's common stock on the date of the grant. Options granted pursuant to this plan are exercisable, in full, during the period between three months from the date of grant and three years from the date of grant, and terminate on the earlier of the expiration date or six months after the date that an optionee ceases to be a Director of the Company for any reason other than death or permanent disability. The aggregate number of shares of the Company's common stock which may be sold pursuant to the Directors' Plan may not exceed 75,000 shares. As of October 29, 1995, 27,000 options had been granted under this plan at prices ranging from $8.42 to $31.88 per share. There were 12,000 options exercisable as of October 29, 1995. Options to eligible Directors will no longer be granted under the Directors' Plan. Instead, eligible Directors will be granted options under the 1995 Director Plan (see below).\nIn March 1995, the Board of Directors and stockholders approved an incentive plan for those Directors who are not officers or employees of the Company or its subsidiaries (the \"1995 Director Plan\"). Under the 1995 Director Plan, on November 1 of each year, commencing in 1995 and ending in 2004, each eligible Director will automatically be granted (i) 1,000 shares of the Company's common stock subject to certain restrictions and (ii) options to purchase 1,000 shares of the Company's common stock.\nThe aggregate number of shares of the Company's common stock available for awards under the 1995 Director Plan is 80,000.\nRestricted stock plan\nIn accordance with the provisions of a restricted stock plan approved in fiscal 1982, 45,000 shares of common stock were reserved for issuance. At October 29, 1995, 39,938 shares had been awarded under the plan, and 5,062 additional shares may be awarded under the plan.\nPreferred stock purchase rights\nIn February 1989, as amended in November 1994, the Company's Board of Directors adopted a Stockholder Rights Agreement (the \"Rights Plan\") and declared a dividend distribution of one Right for each share of the Company's common stock outstanding as of the close of business on March 7, 1989 and intends to issue one Right for each share of common stock issued between March 7, 1989 and the date of the distribution of the Rights. As amended, the Rights Plan provides that when exercisable, each Right will entitle its holder to purchase from the Company one one-hundredth (.01) of a share of Series C Junior Participating Preferred stock at a price of $19.90. The Company has reserved 500,000 preferred\nshares for issuance upon exercise of the Rights. Generally, the Rights become exercisable on the earlier of the date a person or group of affiliated or associated persons acquires or obtains the rights to acquire securities representing fifteen percent (15%) or more of the common stock of the Company or on the tenth day following the commencement of a tender or exchange offer which would result in the offeror beneficially owning fifteen percent (15%) or more of the Company's common stock without the prior consent of the Company. In the event that an unauthorized person or group of affiliated persons becomes the beneficial owner of fifteen percent (15%) or more of the common stock of the Company, proper provision shall be made so that each holder of a Right will have the right to receive, upon exercise thereof and the payment of the exercise price, that number of shares of common stock having a market value of two times the exercise price of the Right. The Rights will expire on February 23, 1999, unless redeemed earlier by the Company pursuant to authorization by the Board of Directors.\nGenerally, in the event that the Company is involved in a merger or other business combination transaction after the Rights become exercisable, provision shall be made so that each holder of a Right shall have the right to receive, upon the exercise thereof and the payment of the exercise price, that number of shares of common stock of the acquiring company which at the time of such transaction would have a market value of two times the exercise price of the Right.\nAssociate Stock Purchase Plan\nIn March 1995, the Board of Directors and stockholders approved an associate stock purchase plan (the \"Associate Plan\"). The Associate Plan provides a means for the Company's employees to authorize payroll deductions up to 10% of their earnings to be used for the periodic purchase of the Company's common stock. Under the Associate Plan, the Company will initially sell shares to participants at a price equal to the lesser of 85% of the fair market value of the common stock at the beginning of a six month subscription period or 85% of fair market value at the end of the subscription period. The Associate Plan is intended to qualify as an \"employee stock purchase plan\" under Section 423 of the Internal Revenue Code of 1986, as amended. The maximum number of shares that may be purchased under the Associate Plan is 500,000. The initial subscription period began July 1, 1995.\nNOTE 9 - OTHER EXPENSES - NET\nOther expenses - net consists of the following:\nNOTE 10 - INCOME TAXES\nThe provision for income taxes consists of the following:\nThe components of deferred income tax expense (benefit) from operations are as follows:\nNet deferred tax assets, which are recorded as a component of other assets or other current assets, are comprised of the following:\nIn light of the Company's history of profitable operations, management has concluded that it is more likely than not that the Company will ultimately realize the full benefit of its deferred tax assets related to future deductible items. Accordingly, the Company believes that no valuation allowance is required for the deferred tax assets in excess of deferred tax liabilities.\nThe effective tax rate applied to income before income taxes differs from the expected federal statutory rate as follows:\nDuring fiscal 1994, the Company adopted Financial Accounting Standards Board Statement No. 109, \"Accounting for Income Taxes\" (\"SFAS 109\"). SFAS 109 requires an asset and liability approach for financial accounting and reporting of income taxes. Adoption of this statement did not have a material impact on the Company's operating results.\nNOTE 11 - COMMITMENTS\nThe Company has arrangements with major vendors and certain financing companies to develop inventory and accounts receivable financing facilities for certain reseller customers. These arrangements include repurchase agreements that would require the Company to repurchase inventory which might be repossessed from a reseller by the vendor or the financing company. As of October 29, 1995, such repurchases have been insignificant.\nNOTE 12 - EMPLOYEE BENEFIT PLAN\nIn July 1988, a deferred compensation plan (the \"Savings Plan\") became effective for all eligible employees of the Company under the provisions of Section 401(k) of the Internal Revenue Code. Employees are eligible to participate after one year of service and may contribute a percentage of their salary subject to certain limitations. Subject to certain profitability requirements, the Company has historically matched 25% of the employee contribution up to a maximum employee contribution of 6%, as defined in the Savings Plan. Participants are at all times fully vested in their contributions, and the Company contributions, if any, become fully vested to the participant after five years of employment.\nIn April 1989, the Company amended and restated the Savings Plan to include a leveraged Employee Stock Ownership Plan and Trust (the \"ESOT\") for eligible employees. The ESOT used proceeds of loans from the Company to purchase 312,500 shares and 157,827 shares of the Company's common stock for $2,396,000 and $1,105,000 during the years ended September 30, 1990 and 1989, respectively.\nThe Company's stock is held by the ESOT trustee as collateral for the loans from the Company. The Company makes periodic contributions to the ESOT which are used to make loan principal and interest payments. A portion of the common stock is allocated to the accounts of participating employees annually based upon principal and interest payments. The Company, using the shares allocated method, recognized contribution expenses of $675,000, $694,000, and $731,000 during the fiscal years ended October 29, 1995, October 30, 1994 and September 30, 1993, respectively.\nThe loans from the Company to the ESOT are payable in quarterly installments ending March 31,1997. Interest is payable quarterly at rates equal to 85% of prime and prime plus 0.75%. The Company's receivable from the ESOT is recorded as a separate reduction of the Company's stockholders' equity.\nNOTE 13 - NOTE RECEIVABLE - STOCK PURCHASE AGREEMENT\nDuring fiscal 1994, the Company exchanged 72,728 shares of common stock for a $2,000,000 convertible subordinated debenture. The debenture is payable on February 8, 1998, and accrues interest at the rate of 9% per annum, payable on a quarterly basis. The note is secured by the Company's common shares issued in exchange for the note as well as certain other rights.\nNOTE 14 - SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION\nThe Company's non-cash investing and financing activities and cash payments for interest and income taxes were as follows:\nNOTE 15 - LITIGATION\nOn July 14 through July 19, 1994, seven class action complaints were filed in the United States District Court for the District of Arizona against the Company, certain of its officers and directors, and, in three of the lawsuits, one of the underwriters of the Company's June 16, 1994 public offering of common stock. On December 5, 1994, the Court consolidated the seven actions into a single action. On February 16, 1995, plaintiffs filed and served an amended, consolidated complaint against the Company, certain officers and directors of the Company, and three of the underwriters of the Company's June 16, 1994 public offering of common stock (\"the Complaint\"). The Complaint purports to be brought on behalf of a class of purchasers of the Company's common stock during the period April 13, 1994 through July 14, 1994. The Complaint alleges, among other things, that the Company violated federal securities laws by making misleading public statements and omitting material facts regarding the Company's operations and financial results, which the plaintiffs contend to have artificially inflated the price of the Company's common stock during the alleged class period. The Complaint seeks unspecified compensatory damages as well as fees and costs. On April 28, 1995, the Company filed a motion to dismiss the Complaint in its entirety. The motion was heard on July 31, 1995; no decision has yet been issued. Discovery is ongoing. The Company and the individual defendants deny the plaintiffs' allegations of wrongdoing and intend to vigorously defend themselves in these actions. The proceeding is in its early stages, however, and its outcome cannot be predicted with certainty at this time.\nNOTE 16 - RESTRUCTURING AND OTHER ONE-TIME CHARGES\nDuring the fourth fiscal quarter of 1995, the Company approved and implemented actions targeted at reducing expenses and improving profitability. The Company's consolidated statement of income for fiscal 1995 includes $9.0 million of pretax charges ($5.4 million net of tax benefits, or $0.38 per share) for restructuring and other one-time charges, consisting of the following (in thousands):\nAll actions related to the restructuring were implemented as of October 29, 1995, and the liability for restructuring activities at October 29, 1995 was not material.\nNOTE 17 - RECENT ACCOUNTING PRONOUNCEMENTS\nStatement of Financial Accounting Standards No. 121 - Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of. Effective for fiscal years beginning after December 15, 1995, the standard establishes accounting standards for the impairment of long-lived assets, certain identifiable intangibles, and goodwill related to those assets to be held and used and for long-lived assets and certain identifiable intangibles to be disposed of. This Statement requires that long-lived assets and certain identifiable intangibles to be held and used by an entity be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Company does not believe that adoption of this Statement will have a material impact on its financial position or results of operations.\nStatement of Financial Accounting Standards No. 123 - Accounting for Stock-Based Compensation. The accounting requirements are effective for transactions entered into in fiscal years beginning after December 15, 1995. The disclosure requirements are effective for fiscal years beginning after December 31, 1995. Pro forma disclosures required for entities that elect to continue to measure compensation cost using APB Opinion No. 25 must include the effects of all awards granted in fiscal years that begin after December 15, 1994. This Statement establishes financial accounting and reporting standards for stock-based employee compensation plans. This Statement defines the fair value based method of accounting for an employee stock option or similar equity instrument and encourages all entities to adopt that method of accounting for all of their employee stock compensation plans. However, it also allows an entity to continue to measure compensation cost for those plans using the intrinsic value based method of accounting prescribed by APB Opinion No. 25, Accounting for Stock Issued to Employees. The Company has not completed an evaluation of the effect of this Statement.\nStatement of Position 94-6 - Disclosure of Certain Significant Risks and Uncertainties. Effective for fiscal years ending after December 15, 1995, the statement of position provides guidance on financial statement disclosures of risks and uncertainties that could significantly affect the amounts reported in the financial statements in the near term. Such risks and uncertainties can stem from the nature of the Company's operations, from the necessary use of estimates in the preparation of the Company's financial statements, and from significant concentrations in certain aspects of the Company's operations. The Company expects to adopt this statement during fiscal 1996. Management will continue to assess the impact of implementation.\nMicroAge, Inc. Schedule VIII Valuation and Qualifying Accounts and Reserves (in thousands) Years ended October 29, 1995, October 30, 1994 and September 30, 1993\nS-1 EXHIBIT INDEX\n- -------------- (*) Included only in manually signed original\nE - 1\nEXHIBIT INDEX\n- -------------- (*) Included only in manually signed original\nE - 2 EXHIBIT INDEX\n- -------------- (*) Included only in manually signed original\nE - 3 EXHIBIT INDEX\n- -------------- (*) Included only in manually signed original\nE - 4 EXHIBIT INDEX\n- -------------- (*) Included only in manually signed original\nE - 5 EXHIBIT INDEX\n- -------------- (*) Included only in manually signed original\nE - 6 EXHIBIT INDEX\n- -------------- (*) Included only in manually signed original\nE - 7 EXHIBIT INDEX\n- -------------- (*) Included only in manually signed original\nE - 8 EXHIBIT INDEX\n- -------------- (*) Included only in manually signed original\nE - 9 EXHIBIT INDEX\n(1) Management contract for compensatory plan or arrangement required to be filed as an exhibit pursuant to Item 14(c) of Form 10-K.\n- -------------- (*) Included only in manually signed original\nE - 10","section_15":""}
{"filename":"37748_1995.txt","cik":"37748","year":"1995","section_1":"ITEM 1. BUSINESS.\nFluor Corporation (\"Fluor\" or the \"Company\") was incorporated in Delaware in 1978 as a successor in interest to a California corporation of the same name that was originally incorporated in 1924. Its executive offices are located at 3333 Michelson Drive, Irvine, California 92730, telephone number (714) 975- 2000.\nThrough Fluor Daniel, Inc. and other domestic and foreign subsidiaries, the Company provides engineering, procurement, construction, maintenance and other diversified services on a worldwide basis to an extensive range of industrial, commercial, utility, natural resources, energy and governmental clients.\nThe Company maintains investments in coal-related businesses through its ownership of A. T. Massey Coal Company, Inc. (\"Massey\").\nA summary of the Company's operations and activities by business segment and geographic area is set forth below.\nENGINEERING AND CONSTRUCTION\nThe Fluor Daniel group of domestic and foreign companies (\"Fluor Daniel\") provides a full range of engineering, procurement, construction, maintenance and other diversified services to clients in a broad range of industrial and geographic markets on a worldwide basis. The types of services provided by Fluor Daniel, directly or through companies or partnerships jointly owned or affiliations with other companies, include: feasibility studies, conceptual design, detail engineering, procurement, project and construction management, construction, maintenance, plant operations, technical, project finance, quality assurance\/quality control, start-up assistance, site evaluation, licensing, consulting, construction equipment sales and leasing, temporary technical and non-technical staffing and environmental services.\nFluor Constructors International, Inc. (\"Fluor Constructors\") is organized and operated separately from Fluor Daniel. Fluor Constructors provides construction management, construction and maintenance services in the United States and Canada. Fluor Constructors is the Company's union construction arm.\nThe engineering and construction business is conducted under various types of contractual arrangements, including cost reimbursable (plus fixed or percentage fee), all-inclusive rate, unit price, fixed or maximum price and incentive fee contracts. Contracts are either competitively bid and awarded or individually negotiated. While, in terms of dollar amount, the majority of contracts are of the cost reimbursable type, there has been an increase in the volume of cost-reimbursable contracts with incentive-fee arrangements and in the volume of fixed or unit price contracts. In certain instances, the Company has guaranteed facility completion by a scheduled acceptance date and\/or achievement of certain acceptance and performance testing levels. Failure to meet any such schedule or performance requirements could result in additional costs and the amount of such additional costs could exceed project profit margins.\nThe markets served by the business are highly competitive and for the most part require substantial resources, particularly highly skilled and experienced technical personnel. A large number of companies are competing in the markets served by the business. Competition is primarily centered on performance and the ability to provide the engineering, planning, management and project execution skills required to complete complex projects in a safe, timely and cost efficient manner. The engineering and construction business derives its competitive strength from its diversity, reputation for quality, cost-effectiveness, worldwide procurement capability, project management expertise, geographic coverage, ability to meet client requirements by performing construction on either a union or open shop basis, ability to execute projects of varying sizes, strong safety record and lengthy experience with a wide range of services and technologies.\nDesign and engineering services provided by the engineering and construction business involve the continual development of new and improved versions of existing processes, materials or techniques, some of which are patented. However, none of the existing or pending patents held or licensed by the business are considered essential to operations. Generally, the development and improvement of processes, materials and techniques are performed as part of design and engineering services in connection with the projects undertaken for various clients.\nFLUOR DANIEL\nFluor Daniel's operations are organized into geographical, industry and specialized groups responsible for identifying and capitalizing on opportunities in their market segments. Geographical groups include Asia Pacific, the Americas, and Europe, Africa and the Middle East which provide geographic expertise and capability. Industry groups include Process, Industrial, and Power and Government. Specialized groups include Diversified Services and Sales and Marketing. The Sales and Marketing Group includes strategic planning and project finance and provides sales and marketing support and assistance to all of the other groups. The Industry and Diversified Services groups are described in further detail below.\nIndividual operating companies within the groups focus on specific clients, industries and markets. The operating companies rely on a network of globally located engineering offices to provide resources and expertise in support of project execution worldwide.\nWhile the United States will remain an important market for Fluor Daniel's services, increasingly the largest share of opportunities are located outside the United States. Demand for higher living standards is driving strong economic growth in developing economies, particularly in the Asia Pacific and Latin American regions. Expansion of basic industries is increasing fundamental energy requirements and infrastructure needs. Globalization of markets and geopolitical change is also stimulating strategic investments in new production facilities in these emerging markets.\nThe operations of Fluor Daniel are detailed below by industry group:\nProcess\nServices provided by the Process Group support clients through the following operating companies: Petroleum and Petrochemicals; Production and Pipelines; and Chemicals, Plastic and Fibers.\nDuring the fiscal year 1995, the Process Group contract awards included: engineering, procurement and construction management for a single point mooring and submarine pipeline in Korea, a 90 kilometer, contract crude oil import\/export pipeline, tanks, pump stations and a single point mooring buoy in Lithuania, a hydrotreater unit in Canada, an increase in capacity of two hydro desulfurization units and associated pipeline in Venezuela, modifications of a gasoline reformulation refinery in California, a fatty acids plant in the Philippines, a vinyl acetate monomer plant in Singapore, a polymer plant in England, a new film machine at an existing plant in New York and a silanes plant in Germany; engineering, procurement and construction for a cat feed hydrotreater unit in Louisiana, a 354 kilometer pipeline [with laterals] from Mariquita to Cali in Colombia, a hydrogen peroxide plant in Canada, a polypropylene plant expansion in Pennsylvania, a hydrogen peroxide plant in Texas and a chemical plant debottlenecking project in North Carolina; engineering and construction management for China's first fully refrigerated propane terminal and modification of an existing offshore dock in China; engineering and procurement for revamping of two paraxylene units in Alabama, modifications of a petroleum loading marine terminal in Alaska, a propylene splitter unit in Pennsylvania, an upgrade and expansion of a parex unit in Puerto Rico and a polystyrene plant expansion in Louisiana; program management for a nylon tire cord plant in India; construction management for an expansion and renovation of a paint pigments plant in Delaware; engineering for a polyethylene plant in Texas, three geothermal power generation facilities in Indonesia, a metaxylene unit in Texas, a petroleum refinery expansion in Abu Dhabi, a receiving terminal, pump stations, meter stations, pipelines and export terminal in Azerbaijan, a revamp and modernization of a natural\ngas plant in Hungary, numerous small capital projects at various locations in the USA, a phosphorus plant in Germany and several small capital projects at various locations in Europe; construction of a chemical processing line conversion and a waste water treatment plant, both in South Carolina; consulting for the evaluation of existing oil pipelines and the review for an early oil export line in Azerbaijan; project management for a 200,000 barrels per day production facility with infrastructure, power generation and an 800 mile pipeline and single point mooring loading terminal in Cameroon and Chad; and inspection services for an existing pipeline from Midland to Houston, Texas and existing pipelines in Oklahoma, Kansas and Missouri.\nOngoing projects include: engineering, procurement and construction management for a hydrochlorofluorocarbon plant in Kentucky, gas injection and underground gas storage in the Netherlands, a refinery in Thailand, a cogeneration project in Kansas, a gas oil hydrotreater in California, a methanol plant in Norway and a flue gas desulfurization, a synthetic oil abatement project in Canada, a polymer expansion facility in Virginia, a polymer plant in Mexico, a polymer plant capacity increase in Mexico, a chemical intermediates plant in Spain, a reformulated gasoline and a clean fuels program, both in California, a refinery upgrade in the Netherlands and a flue gas desulphurization, synthetic oil abatement project in Alberta, Canada; engineering, procurement and construction for a polymer plant in North Carolina, a fluid catalytic cracking unit in Korea; program management and procurement for a petrochemical complex in Kuwait; engineering and procurement for an oil production facility in Gabon, reformer unit revamp in Texas, filter products engineering in Tennessee, an expansion and renovation of a paint pigments plant in Delaware, a reformulated fuels project at a refinery in California and a chlor-alkali\/ethylene expansion of a petrochemical plant in Saudi Arabia; construction and maintenance for evergreen small capital construction services in Tennessee and in South Carolina; evergreen capital construction and maintenance services for various chemical and fiber plants throughout the USA; engineering for a pipeline and pump stations in Alaska, an early production system equipment and an oil field production facility in Colombia, a refinery upgrade and expansion in Kansas, a cat feed hydrotreater in Louisiana, an organic acid plant expansion in Texas, a services alliance in Texas, a Kingston evergreen support in Canada, a debottlenecking project in Indonesia and a polyethylene plant in Singapore; procurement and construction management for a general facilities and utilities of a petrochemical complex in Kuwait; and construction for an oxo alcohol and a chemical plant, both in Louisiana.\nProjects completed in fiscal year 1995 included: engineering, procurement and construction management for a herbacide plant in Louisiana, a pipeline from Argentina to Chile, a polymer plant in Singapore, a plastics stretch project in Indiana and a fibers line plant in Luxembourg; engineering, procurement and construction for a fibers facility in North Carolina; engineering and procurement for an inter-refinery pipeline in Pennsylvania, a sour gas plant and a sweetening and sulfur recovery facility, both in Canada; engineering for pipeline development and oil field expansion in Colombia, a liquid petroleum gas plant expansion in Saudi Arabia and oil terminals in Lithuania; construction of an ethoxylation plant in Texas, a restart of a methanol plant in Texas and a spherilene and ethylene purification facility in Texas; and inspection services for a gas pipeline and facilities in Florida and a refinery aromatics project in Pennsylvania. In addition, seven projects were cancelled during fiscal 1995; a fragrance plant in Georgia, an ethylene debottlenecking project for a refinery in Texas, a fluid catalytic cracking unit revamp in Illinois, a refinery upgrade in the Netherlands, a delayed coker in Venezuela and off-site engineering support for installation of a gas- turbine generator in Great Britain.\nIndustrial\nServices provided by the Industrial Group include a broad range of services provided to support clients through the following operating companies: Mining and Metals; Automotive and General Manufacturing; Pharmaceuticals and Biotechnology; Food and Beverage; Commercial and Institutional Facilities; Electronics; Infrastructure; Telecommunications; Jaakko Poyry\/Fluor Daniel which serves the pulp and paper industry and PACE, the operating company dedicated to serving Fluor Daniel's alliance with Procter & Gamble.\nDuring fiscal year 1995, Industrial sector contract awards included: engineering, procurement and construction for gold mines in Chile and Papau, New Guinea, expansion of a dry conversion process facility in\nNorth Carolina, rebuilding a carpet manufacturing facility in Georgia, a gelcaps facility in North Carolina, a contract manufacturing facility and corporate headquarters in North Carolina, a packaging and distribution center in Florida, expansion of various snack food plants in various locations through the United States, and a paper machine expansion in Georgia; engineering, procurement and construction management for an automotive assembly plant in Argentina, a beltway around Denver, Colorado, a copper and gold mine in Argentina, a metal aperture screen manufacturing facility expansion in New York, a silicon wafer facility in Texas and a utilities upgrade and building expansion in California; engineering and construction management for a hotel renovation in Indonesia, an expansion of a spice manufacturing facility in Australia; construction management for a nickel mine expansion in Indonesia, a train station terminal building in Kyoto, Japan and a sports facility in South Carolina; and engineering for a washing machine plant in China, an iron mine in Australia, a copper smelter and refinery in Indonesia, a paper machine rebuild in Georgia, and a paper machine addition in Wisconsin.\nOngoing projects include: engineering, procurement and construction for a blast furnace coal injection facility in Indiana and an emergency 911 response system for the City of Chicago, Illinois; engineering, procurement and construction management for an iron ore pelletizing processing facility in Brazil, a copper mine expansion in Indonesia, a copper concentrator expansion in Chile, a sodium cromoglycate facility in the United Kingdom, a paper products plant in Korea, two de-inking facilities and a paper recycle facility, all in the United Kingdom, a copper expansion and pipeline project in Chile, apparel distribution centers at various locations throughout the United States, a dextrose expansion project in Illinois and a fine chemicals manufacturing plant in Arkansas; engineering and construction for a corn processing plant in Illinois and several consumer products plants in Ohio; construction for a personal care product plant in Puerto Rico, a paper mill environmental upgrade in Florida and an engine plant expansion in Ohio; construction management for a multi-product personal care facility in the Philippines, a renovation of a turbine facility in South Carolina, prison projects in Texas and California, a tobacco processing plant expansion in North Carolina, and an automotive assembly plant in Alabama; engineering for a shampoo facility in China and a wafer fabrication facility in Utah; maintenance services for automotive facilities in Hungary, Tennessee and Germany; engineering and construction management for a tobacco facility in the Netherlands, an engine removal facility in New Jersey and a vaccine manufacturing plant in North Carolina; condition assessment for facilities at twelve military installations at various locations throughout the United States; an engineering study for an automobile manufacturer to determine the feasibility of disassembling and relocating two North American automobile manufacturing facilities to China; and project management for rail stations for the Federal Transportation Administration in New York City, rail transit for the Los Angeles County Metropolitan Transportation Authority in California, highway construction in Orange County, California, and a court\/detention center in Texas.\nProjects completed in fiscal year 1995 included: engineering, procurement and construction for a gold mine in Chile, a food processing plant in Utah, a personal care manufacturing facility in Ohio and a laundry detergent manufacturing facility in Ohio; engineering, procurement and construction management for a zinc, lead and silver mine in Australia, a silicon wafer manufacturing plant in Taiwan, a paint shop in Kentucky, a chocolate plant in China, a gold heap expansion in Peru, and a copper smelter modernization in Utah; construction management for a laundry detergent facility expansion in China, a chemical plant in Puerto Rico, a disk storage plant in Malaysia, an emergency prison program in Texas and a pilot plant for pharmaceutical manufacturing in New Jersey; engineering and construction management for a laundry detergent facility expansion in China; engineering for three products plant expansions in China and a synthetic growth hormone facility in Puerto Rico; construction for an automobile assembly plant in South Carolina and a pulp mill modernization in Ohio; and project management for a convention center in North Carolina.\nPower and Government\nThe Power and Government Group provides services to clients through the Power Generation, Duke\/Fluor Daniel, and Power Services operating companies which serve public utilities and private power companies throughout the world. The Government Services and FERMCO operating companies serve the United States government.\nDuring the fiscal year 1995, Power and Government Group contract awards included: engineering, procurement, construction management and start up for a 2 x 600 megawatt coal fired power plant in Indonesia; operations and maintenance for a 175 megawatt diesel power plant in Indonesia; maintenance and support for a rebuild of a power plant in Texas; engineering, procurement, and construction management of a 650 megawatt combined cycle facility in Virginia; engineering and construction management for a 1200 megawatt phased combined cycle gas facility in Saudi Arabia; and engineering, procurement and construction of a 48 megawatt combined cycle plant in California, a 160 megawatt cogeneration plant in Indiana, a 240 megawatt combined cycle cogeneration plant in Louisiana and a 75 megawatt bottoming cycle and 69 kilovolt transmission line in Illinois.\nOn-going projects include: engineering, procurement, construction management and start-up assistance for coal switching modifications to a coal-fired facility in Indiana; engineering, procurement, construction and construction management for a waste to energy facility in New York; engineering, procurement and construction management for a fuel cell pilot plant in California; environmental remediation management for the United States Department of Energy (\"DOE\") former uranium processing plant in Ohio (the \"Fernald Project\"); engineering, design and procurement for a 385 megawatt pulverized coal plant in South Carolina; engineering and construction for emission monitoring equipment for various power generation sites of utilities in Arkansas, Louisiana, Mississippi, and Texas; engineering and construction management for various radar and weather stations located throughout the United States for the National Oceanic and Atmospheric Administration; engineering for a laboratory facility upgrade in Illinois, a nuclear utility in Illinois, a DOE waste vitrification plant in Washington, the DOE nuclear waste repository program, the reconfiguration of the DOE nuclear weapons program, the DOE National Engineering Laboratories in Idaho, and a waste handling facility for the DOE, in Washington; operations and maintenance for a new 130 megawatt cogeneration facility in Virginia; management and operation services for the Naval Petroleum and Oil Shale Reserves program for the DOE in Colorado, Utah and Wyoming; maintenance for a 3x1,270 megawatt nuclear plant in Arizona, fossil and gas generation plants in Texas, Georgia, Louisiana, Arkansas, Mississippi, Australia, Florida, and Tennessee, and nuclear plants in South Carolina, Kansas, Missouri, Virginia, Alabama, and Texas.\nProjects completed in fiscal year 1995 included: a maintenance and outage support project at various sites for a southeastern power generator in Tennessee and Kentucky.\nDiversified Services\nThe Diversified Services Group was created in fiscal 1994 to extend the offering of services representing the core competencies of Fluor Daniel. Typically these services have been provided within the boundaries of the traditional engineering and construction project cycle in support of Fluor Daniel. They are now offered on a stand alone basis into new and expanded areas of business outside of Fluor Daniel.\nEstablished businesses in the group which have become more focused on external markets include the following operating companies: Facility & Plant Services, which provides plant maintenance and efficiency services; TRS Staffing Solutions, which provides temporary personnel; American Equipment Company, which sells, leases, and outsources equipment for construction and industrial needs; and Environmental Services, which provides environmental engineering and remediation services. Operating companies focused on creating new businesses by expanding core competencies include Consulting, which uses Fluor Daniel resources to provide solutions to client needs that do not typically fall under traditional engineering and construction services; Fluor Daniel Technologies, which uses Fluor Daniel's extensive technical expertise to evaluate new technologies for investment; and Acquion, a provider of procurement outsourcing services and electronic catalog and ordering services.\nDuring fiscal year 1995, Diversified Services Group new awards included: a large equipment outsourcing contract at a petrochemical plant in Texas; management services for computer manufacturing plants in Arizona, Colorado and California; environmental investigation and evaluation at U.S. military facilities in Hawaii, Guam and Puerto Rico; and site remediation at a plant in Illinois.\nOngoing projects include: maintenance for a tire manufacturing facility in Tennessee, a petrochemical plant in Texas, computer manufacturing plants in Florida, Texas and North Carolina, and a refinery in Mississippi; environmental investigation and remediation plan services for a toxic waste site in New York; environmental investigation, remediation design, and implementation services for a chemical waste site in Ohio; environmental investigation, feasibility studies, and remediation for the United States Army Environmental Center, the United States Army Corps of Engineers, and the United States Environmental Protection Agency; and engineering, procurement and construction management for an environmental remediation program for a toxic waste site in Indiana.\nProjects completed in fiscal year 1995 included: design and installation of a computerized maintenance system for a petroleum company in Indonesia; and training services for pre-start up of an automotive assembly plant in Alabama.\nShortly before the end of the fiscal year, the Company acquired Management Resources Group PLC, a London based permanent and temporary placement services company. In addition, on December 12, 1995, the Company announced plans to acquire a majority stake in Groundwater Technology, Inc. (\"GTI\"), a Massachusetts based environmental remediation company. The acquisition is subject to GTI's shareholders' approval as well as other customary conditions.\nFLUOR CONSTRUCTORS\nFluor Constructors is organized and operated separately from Fluor Daniel. Fluor Constructors provides unionized construction management, construction and maintenance services in the United States and Canada, both independently and as a subcontractor to Fluor Daniel, and global support to all Fluor Daniel industry and regional groups.\nDuring fiscal year 1995, Fluor Constructors awards included: construction and construction management services for a steam turbine project in Indiana, a polypropylene plant expansion in Pennsylvania and a hydrogen peroxide project in Canada.\nOngoing projects include: construction and construction management for a reformulated gasoline project at a refinery in California, a blast furnace coal injection facility in Indiana, a hydrocracker revamp for a refinery in Delaware, a refrigerant production facility in Kentucky and a sulfur dioxide unit in Canada; construction management of a potable water supply system in Nevada, an Emergency 911 response system in Illinois and a waste to energy boiler replacement in New York; and maintenance and outage support at various plant sites for a nuclear power plant in Missouri and for fossil power plants in Louisiana, Mississippi and Arkansas.\nProjects completed in fiscal 1995 included: construction and construction management for expansion of an ethylene glycol plant and a coker shutdown in Canada; construction management for an aromatics project for a refinery and an inter-refinery pipeline, both in Pennsylvania; and maintenance and outage support at various plant sites for a southeastern power generator in Tennessee and Kentucky and at a nuclear power plant in Alabama.\nBACKLOG\nFluor Daniel's operating companies are organized into four major industry groups, Process, Industrial, Power and Government, and Diversified Services.\nThe following table sets forth the consolidated backlog of Fluor's engineering and construction segment at October 31, 1995 and 1994 by business group:\nThe following table sets forth the consolidated backlog of Fluor's engineering and construction segment at October 31, 1995 and 1994 by region:\nThe dollar amount of the backlog is not necessarily indicative of the future earnings of Fluor related to the performance of such work. Although backlog represents only business which is considered to be firm, there can be no assurance that cancellations or scope adjustments will not occur. Due to additional factors outside of Fluor's control, such as changes in project schedules, Fluor cannot predict with certainty the portion of its October 31, 1995, backlog to be performed subsequent to fiscal 1996.\nApproximately $1.3 billion of the Power and Government backlog at October 31, 1995, is attributable to the DOE Fernald Project and subject to government funding on an annual basis, and another $1.2 billion of the Power and Government backlog is attributable to the Paiton private power project. At October 31, 1995, approximately $1.4 billion of the Process Group backlog is attributable to a project with a company affiliated with Union Carbide (the Kuwait Petrochemical Refinery).\nCOAL INVESTMENT\nA. T. Massey Coal Company, Inc., which is headquartered in Richmond, Virginia, and its subsidiaries conduct Massey's coal-related businesses and are collectively referred to herein as the \"Massey Companies.\"\nThe Massey Companies produce, process and sell bituminous, low sulfur coal of steam and metallurgical grades from 17 mining complexes (14 of which include preparation plants) located in West Virginia, Kentucky and Tennessee. At October 31, 1995, two of the mining complexes were still in development and not yet producing coal. A third mining complex is idle.\nOperations at certain of the facilities are conducted in part through the use of independent contract miners. The Massey Companies also purchase and resell coal produced by unrelated companies. Steam coal is used\nprimarily by utilities as fuel for power plants. Metallurgical coal is used primarily to make coke for use in the manufacture of steel.\nFor each of the three years in the period ended October 31, 1995, the Massey Companies' production (expressed in thousands of short tons) of steam coal and metallurgical coal, respectively, was 15,756 and 11,607 for fiscal 1995, 17,120 and 7,333 for fiscal 1994, and 16,048 and 5,163 for fiscal 1993. Sales (expressed in thousands of short tons) of coal produced by the Massey Companies were 27,410 for fiscal year 1995, 23,835 for fiscal 1994 and 21,192 for fiscal 1993.\nA large portion of the steam coal produced by the Massey Companies is sold to domestic utilities under long-term contracts. Metallurgical coal is sold to both foreign and domestic steel producers. Approximately 66% of the Massey Companies' fiscal 1995 coal production was sold under long-term contracts, 60% of which was steam coal and 40% of which was metallurgical coal. Approximately 9% of the coal tonnage sold by the Massey Companies in fiscal 1995 was sold outside of North America.\nMassey is among the five largest marketers of coal in the United States. The coal market is a mature market with many strong competitors. Competition is primarily dependent upon coal price, transportation cost, producer reliability and characteristics of coal available for sale. The management of Massey considers Massey to be generally well-positioned with respect to these factors in comparison to its principal competitors.\nRecently passed acid rain legislation is generally anticipated to benefit prices for low sulfur coal. Massey intends to continue to evaluate and pursue, in appropriate circumstances, the acquisition of additional low sulfur coal reserves.\nThe Coal Industry Retiree Health Benefits Act of 1992 (the \"Act\") provides that certain retired coal miners who were members of the United Mine Workers of America, along with their spouses, are guaranteed health care benefits. The Massey Companies' obligation under the Act is currently estimated to aggregate $46.8 million which will be recognized as expense as payments are assessed. The amount expensed during fiscal 1995 approximated $2.3 million.\nThe management of the Massey Companies estimates that, as of October 31, 1995, the Massey Companies had total recoverable reserves (expressed in thousands of short tons) of 1,499,248; 580,886 of which are assigned recoverable reserves and 918,362 of which are unassigned recoverable reserves; and 1,105,793 of which are proven recoverable reserves and 393,455 of which are probable recoverable reserves.\nThe management of the Massey Companies estimates that approximately 37% of the total reserves listed above consist of reserves that would be considered primarily metallurgical grade coal. They also estimate that approximately 66% of all reserves contain less than 1% sulfur. A portion of the steam coal reserves could be beneficiated to metallurgical grade by coal preparation plants, and substantially all of the metallurgical coal reserves could be sold as high quality steam coal, if market conditions warrant.\n\"Reserves\" means that part of a coal deposit which could be economically and legally extracted or produced at the time of the reserve determination. \"Recoverable reserves\" means coal which is recoverable by the use of existing equipment and methods under federal and state laws now in effect. \"Assigned recoverable reserves\" means reserves which can reasonably be expected to be mined from existing or planned mines and processed in existing or planned plants. \"Unassigned recoverable reserves\" means reserves for which there are no specific plans for mining and which will require for their recovery substantial capital expenditures for mining and processing facilities. \"Proven recoverable reserves\" refers to deposits of coal which are substantiated by adequate information, including that derived from exploration, current and previous mining operations, outcrop data and knowledge of mining conditions. \"Probable recoverable reserves\" refers to deposits of coal which are based on information of a more preliminary or limited extent or character, but which are considered likely.\nOTHER MATTERS\nENVIRONMENTAL, SAFETY AND HEALTH MATTERS\nThe Massey Companies are affected by and comply with federal, state and local laws and regulations relating to environmental protection and plant and mine safety and health, including but not limited to the federal Surface Mining Control and Reclamation Act of 1977; Occupational Safety and Health Act; Mine Safety and Health Act of 1977; Water Pollution Control Act, as amended by the Clean Water Act of 1977; Black Lung Benefits Revenue Act of 1977; and Black Lung Benefits Reform Act of 1977. It is impossible to predict the full impact of future legislative or regulatory developments on such operations, because the standards to be met, as well as the technology and length of time available to meet those standards, continue to develop and change.\nIn fiscal 1995, Fluor expended approximately $8.9 million to comply with environmental, health and safety laws and regulations in connection with its coal investment, none of which were capital expenditures. Fluor anticipates making $8.5 million and $5.3 million in such non-capital expenditures in fiscal 1996 and 1997, respectively. Of these expenditures, $8.1 million, $6.0 million and $2.9 million for fiscal 1995, 1996 and 1997, respectively, are (in the case of fiscal 1995) or are anticipated to be (in the case of fiscal 1996 and 1997) for surface reclamation. Existing reserves are believed to be adequate to cover actual and anticipated surface reclamation expenditures. Other expenditures will be expensed as incurred.\nOther\nIn 1986, the California North Coast Regional Water Quality Control Board for the State of California requested that the Company perform a site investigation of a property in Northern California designated as a hazardous waste site under the California Hazardous Waste Control Act. The Company formerly owned the property. The California Environmental Protection Agency has assumed lead agency status for any required remedial action at the site. The Company signed a Consent Order to perform a remedial investigation\/feasibility study that will determine the extent of contamination for purposes of determining the remedial action required to remedy and\/or remove the contamination.\nThe sale by Fluor of its lead business included St. Joe Minerals Corporation (\"St. Joe\") and its environmental liabilities for several different lead mining, smelting and other lead related environmental sites. As a condition of the St. Joe sale, however, Fluor retained responsibility for certain non-lead related environmental liabilities arising out of St. Joe's former zinc mining and smelting division, but only to the extent that such liabilities are not covered by St. Joe's comprehensive general liability insurance. These liabilities arise out of three zinc facilities located in Bartlesville, Oklahoma, Monaca, Pennsylvania and Balmat, New York (the \" Zinc Facilities\").\nIn 1987, St. Joe sold its zinc mining and smelting division to Zinc Corporation of America (\"ZCA\"). As part of the sale agreement, St. Joe and Fluor agreed to indemnify ZCA for certain environmental liabilities arising from operations conducted at the Zinc Facilities prior to the sale. During fiscal year 1993, ZCA made claims under this indemnity as well as under the Comprehensive Environmental Response, Compensation and Liability Act (\"CERCLA\") against St. Joe for past and future environmental expenditures at the Zinc Facilities. In fiscal year 1994, ZCA filed suit against St. Joe and Fluor, among others, seeking compensation for environmental expenditures at the Zinc Facilities. In fiscal year 1994, Fluor and St. Joe, among others, executed a settlement agreement with ZCA which, among other things, cancels the indemnity previously provided to ZCA and limits environmental expenditures at the Zinc Facilities for which St. Joe would be responsible to no more than approximately $10 million. Expenses incurred and payments made under the settlement agreement would be made over the span of at least five years, if not longer.\nFluor and St. Joe, among others, are currently prosecuting cost recovery actions under CERCLA against other potentially responsible parties for the Bartlesville facility. In addition, St. Joe has initiated legal proceedings against certain of its insurance carriers alleging that the investigative and remediation costs, for which St. Joe is or may be responsible, including costs incurred prior to the sale of St. Joe and costs related to the Zinc Facilities,\nare covered by insurance. A portion of any recoveries received from the insurance carriers would be, pursuant to the St. Joe sale agreement, for the benefit of Fluor. In January 1995, St. Joe executed a settlement agreement with one of its primary insurance carriers that provided coverage for a minor portion of the applicable coverage periods. In May 1995, St. Joe received a favorable ruling from the Orange County Superior Court which ordered St. Joe's other insurer to defend St. Joe in certain environmental sites, including the Zinc Facilities. The insurer has appealed the court's order. St. Joe continues to pursue its other primary insurance carrier for additional payments. Because the insurance, as well as the cost recovery, proceedings remain in the early stages of litigation, no credit or offset (other than for amounts actually received in settlement), has been taken into account by Fluor in establishing its reserves for future environmental costs.\nThe Company believes, based upon present information available to it, that its reserves with respect to future environmental costs are adequate, and that such future costs will not have a material effect on the Company's consolidated financial condition, results of operations or liquidity. However, the imposition of more stringent requirements under environmental laws or regulations, new developments or changes regarding site cleanup costs or the allocation of such costs among potentially responsible parties, or a determination that the Company is potentially responsible for the release of hazardous substances at sites other than those currently identified, could result in additional expenditures, or the provision of additional reserves in expectation of such expenditures.\nNUMBER OF EMPLOYEES\nThe following table sets forth the number of salaried and craft\/hourly employees of Fluor and its subsidiaries engaged in Fluor's business segments as of October 31, 1995:\nOPERATIONS BY BUSINESS SEGMENT AND GEOGRAPHIC AREA\nThe financial information for business segments and geographic areas is included in the Operations by Business Segment and Geographic Area section of the Notes to Consolidated Financial Statements in Fluor's 1995 Annual Report to stockholders, which section is incorporated herein by reference.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nMajor Facilities\nOperations of Fluor and its subsidiaries are conducted in both owned and leased properties. In addition, certain owned or leased properties of Fluor and its subsidiaries are leased or subleased to third party tenants. The following table describes the general character of the major existing facilities, exclusive of mines, coal preparation plants and their adjoining offices:\nCoal Properties\nSee Item 1, Business, of this report for additional information regarding the coal operations and properties of Fluor.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nFluor and its subsidiaries, incident to their business activities, are parties to a number of legal proceedings in various stages of development, including but not limited to those described below. The majority of these proceedings, other than environmental proceedings, involve matters as to which liability, if any, of Fluor or its subsidiaries would be adequately covered by insurance. With respect to litigation outside the scope of applicable insurance coverage and to the extent insured claims may exceed liability limits, it is the opinion of the management of Fluor, based on reports of counsel, that these matters individually and in the aggregate will not have a material adverse effect upon the consolidated financial position or results of operations of Fluor.\nIn July 1987, four lawsuits were filed against R. T. Vanderbilt Company, Inc., Gouverneur Talc Company, Inc., St. Joe and Fluor for personal injury and wrongful death allegedly due to asbestos, talc and silicon exposure in certain New York mines. Subsequent to July 1987, 16 additional lawsuits have been filed. All of these suits (representing a total of 213 plaintiffs) have been filed with the New York Supreme Court, St. Lawrence County, New York. The total damages claimed in these cases, referred to as Bailey, Baker, Beane, et al. v. R. T. Vanderbilt Company, Inc., et al. (the claims have not been consolidated), are $287 million against all defendants. Plaintiffs also seek an unspecified amount of punitive damages against all defendants.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNot applicable.\nEXECUTIVE OFFICERS OF THE REGISTRANT(1)\nLeslie G. McCraw, age 61\nDirector since 1984; Chairman of Executive Committee and member of Governance Committee; Chairman of the Board since 1991; Chief Executive Officer since 1990; formerly Vice Chairman of the Board from 1990; formerly President from 1988; joined the Company in 1975.\nDennis W. Benner, age 54\nVice President and Chief Information Officer since November, 1994; formerly Vice President and General Manager, Information, and Vice President and General Manager, Target Marketing Services, for TRW from 1992 and 1986, respectively.\nCharles J. Bradley, Jr., age 60\nVice President, Human Resources and Administration since 1986; joined the Company in 1958.\nJ. Michal Conaway, age 47\nVice President and Chief Financial Officer since May, 1994; formerly Vice President, Finance, from 1993; formerly Vice President and Chief Financial Officer of National Gypsum Company and its parent, Aancor Holdings, Inc., from 1988.\nJames O. Rollans, age 53\nChief Administrative Officer since May, 1994; Senior Vice President since 1992; formerly Chief Financial Officer from 1992; formerly Vice President, Corporate Communications from 1982; joined the Company in 1982.\nP. Joseph Trimble, age 65\nCorporate Secretary since 1992; Senior Vice President, Law, since 1984; joined the Company in 1972.\nEXECUTIVE OPERATING OFFICERS(1)\nHugh K. Coble, age 61\nDirector since 1984; Vice Chairman since April, 1994; formerly Group President of Fluor Daniel, Inc.(2) from 1986; joined the Company in 1966.\nDennis G. Bernhart, age 50\nGroup President, The Americas, of Fluor Daniel, Inc.(2) since May, 1994; formerly President, Latin America, Middle East and Africa, of that company from 1993; formerly Vice President, Sales, from 1982; joined the Company in 1968.\nDon L. Blankenship, age 45\nChairman of the Board and Chief Executive Officer of A.T. Massey Coal Company, Inc.(3) since January, 1992; formerly President and Chief Operating Officer of that subsidiary from 1990; formerly President of Massey Coal Services, Inc.(4) from 1989; joined Rawl Sales & Processing Co.(5) in 1982.\nAlan L. Boeckmann, age 47\nGroup President, Chemical Processes and Industrial, of Fluor Daniel, Inc.(2) since January, 1996; formerly Vice President of Chemicals, Plastics & Fibers of that company from June, 1994; formerly Vice President and General Manager of that company from 1992; formerly Vice President-Engineering Services, of that company from 1989; joined the Company in 1974.\nRichard D. Carano, age 56\nGroup President, Asia\/Pacific, of Fluor Daniel, Inc.(2) since May, 1994; formerly President, Asia\/Pacific, of that company from 1993; formerly Vice President, Sales, of that company from 1987; joined the Company in 1970.\nE. David Cole, Jr., age 58\nGroup President, Process, of Fluor Daniel, Inc.(2) since May, 1994; formerly Vice President, Petroleum and Petrochemicals, of that company from 1987; joined the Company in 1965.\nCharles R. Cox, age 53\nGroup President, Industrial, of Fluor Daniel, Inc.(2) since May, 1994; formerly President, Operations Centers, of that company from 1989; joined the Company in 1969.\nRichard A. Flinton, age 65\nChairman of the Board of Fluor Constructors International, Inc.(6) since 1989; joined the Company in 1960.\nThomas P. Merrick, age 58\nVice President, Strategic Planning, of Fluor Daniel, Inc.(2) since May, 1994; formerly Vice President, Technology, of that company from 1993; formerly Vice President, Government Sales, of that company from 1989; joined the Company in 1984.\nCharles R. Oliver, Jr., age 52\nGroup President, Sales, Marketing and Strategic Planning of Fluor Daniel, Inc.(2) since May, 1994; formerly President, Business Units, of that company from 1993; formerly President, Hydrocarbon Sector, from 1986; joined the Company in 1970.\nCarel J.C. Smeets, age 56\nGroup President, Europe, Africa and Middle East, of Fluor Daniel, Inc.(2) since May, 1994; formerly Vice President, European Operations, of that company from 1991; formerly Vice President and Managing Director, the Netherlands, from 1985; joined the Company in 1969.\nJames C. Stein, age 52\nGroup President, Diversified Services, of Fluor Daniel, Inc.(2) since May, 1994; formerly President, Business Units, of that company from 1993; formerly President, Industrial Sector, of that company from 1986; joined the Company in 1964.\nRichard M. Teater, age 47\nGroup President, Power and Government, of Fluor Daniel, Inc.(2) since May, 1994; formerly President, Power, of that company from 1993; formerly Vice President, Power Marketing, of that company from 1990; formerly Vice President, Industrial Marketing, of that company from 1988; joined the Company in 1980. - -------- (1) Except where otherwise indicated, all references are to positions held with Fluor.\n(2) Fluor Daniel, Inc. is a wholly owned subsidiary of Fluor which provides design, engineering, procurement, construction management and technical services to a wide range of industrial, commercial, utility, natural resources, energy and governmental clients.\n(3) A. T. Massey Coal Company, Inc. is an indirectly wholly-owned subsidiary of Fluor which, along with its subsidiaries, conducts Fluor's coal-related investment.\n(4) Massey Coal Services, Inc. is a wholly owned subsidiary of A. T. Massey Coal Company, Inc.\n(5) Rawl Sales & Processing Co. is a wholly owned subsidiary of A. T. Massey Coal Company, Inc.\n(6) Fluor Constructors International, Inc., a wholly owned subsidiary of Fluor, provides construction and maintenance services to a variety of clients.\nPART II\nInformation for Items 5, 6 and 7 is contained in Fluor's 1995 Annual Report to stockholders, which information is incorporated herein by reference (and except for these sections, and sections incorporated herein by reference in Items 1 and 8 of this report, Fluor's 1995 Annual Report to stockholders is not to be deemed filed as part of this report):\nInformation for Item 8","section_5":"","section_6":"","section_7":"","section_7A":"","section_8":"","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNot Applicable.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nInformation concerning Fluor's executive officers is included under the caption \"Executive Officers of the Registrant\" following Part I, Item 4. Other information required by this item is included in the Biographical section of the Election of Directors portion of the definitive proxy statement pursuant to Regulation 14A, involving the election of directors, which is incorporated herein by reference and will be filed with the Securities and Exchange Commission (the \"Commission\") not later than 120 days after the close of Fluor's fiscal year ended October 31, 1995.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nFluor maintains certain employee benefit plans and programs in which its executive officers and directors are participants. Copies of these plans and programs are set forth or incorporated by reference as Exhibits 10.1 through 10.19 inclusive to this report. Certain of these plans and programs provide for payment of benefits or for acceleration of vesting of benefits upon the occurrence of a change of control of Fluor as that term is defined in such plans and programs. The amounts payable thereunder would represent an increased cost to be paid by Fluor (and indirectly by its stockholders) in the event of a change in control of Fluor. This increased cost would be a factor to be taken into account by a prospective purchaser in determining whether, and at what price, it would seek control of the Company and whether it would seek the removal of then existing management.\nIf a change of control were to have occurred on October 31, 1995, the additional amounts payable by Fluor, either in cash or in stock, if each of the five most highly compensated executive officers and all executive officers as a group were thereupon involuntarily terminated without cause would be as follows:\n- -------- (1) Value at October 31, 1995 of previously awarded restricted stock which would vest upon change of control. (2) Lump sum entitlement of previously awarded benefits which would vest upon change of control.\nFurther disclosure required by this item is included in the Organization and Compensation Committee Report on Executive Compensation and Executive Compensation and Other Information sections of the definitive proxy statement pursuant to Regulation 14A, involving the election of directors, which is incorporated herein by reference and will be filed not later than 120 days after the close of Fluor's fiscal year ended October 31, 1995.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nInformation required by this item is included in the Stock Ownership section of the Election of Directors portion of the definitive proxy statement pursuant to Regulation 14A, involving the election of directors, which is incorporated herein by reference and will be filed not later than 120 days after the close of Fluor's fiscal year ended October 31, 1995.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nInformation required by this item is included in the Other Matters section of the Election of Directors portion of the definitive proxy statement pursuant to Regulation 14A, involving the election of directors, which is incorporated herein by reference and will be filed not later than 120 days after the close of Fluor's fiscal year ended October 31, 1995.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(b) Reports on Form 8-K:\nNone were filed during the last quarter of the period covered by this report.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nFLUOR CORPORATION\nJ. M. CONAWAY January 26, 1996 By __________________________________ J. M. Conaway, 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.\nManually signed Powers of Attorney authorizing L. N. Fisher, R. M. Bukaty and P. J. Trimble and each of them, to sign the annual report on Form 10-K for the fiscal year ended October 31, 1995 and any amendments thereto as attorneys-in-fact for certain directors and officers of the registrant are included herein as Exhibits 24.1 and 24.2.\nFLUOR CORPORATION\nAND FINANCIAL STATEMENT SCHEDULES\nITEM 14(A)\n1. FINANCIAL STATEMENTS\nThe following financial statements are contained in Fluor's 1995 Annual Report to stockholders:\nConsolidated Balance Sheet at October 31, 1995 and 1994\nConsolidated Statement of Earnings for the years ended October 31, 1995, 1994 and 1993\nConsolidated Statement of Cash Flows for the years ended October 31, 1995, 1994 and 1993\nConsolidated Statement of Shareholders' Equity for the years ended October 31, 1995, 1994 and 1993\nNotes to Consolidated Financial Statements\n2. FINANCIAL STATEMENT SCHEDULES\nAll schedules have been omitted since the required information is not present or not present in amounts sufficient to require submission of the schedule, or because the information required is included in the consolidated financial statements and notes thereto.\nEXHIBIT INDEX","section_15":""}
{"filename":"812192_1995.txt","cik":"812192","year":"1995","section_1":"Item 1. Business.\nGeneral - -------\nATA Research\/ProFutures Diversified Fund, L.P. (the \"Registrant\") is a limited partnership organized on March 10, 1987, under the laws of the State of Delaware. The business of the Registrant is the speculative trading of futures contracts on U.S. and non-U.S. exchanges and option contracts, forward contracts on foreign currencies and other commodity interests. The Registrant commenced its business operation in August, 1987.\nThe Registrant maintains offices at those of its respective co-General Partners. Specifically, the office of ProFutures, Inc. and an office of the Registrant is located at 1310 Highway 620, Suite 200, Austin, Texas 78734; the telephone number is (800) 348-3601. The office of ATA Research, Inc. and the other office of the Registrant is located at 5910 N. Central Expwy, Suite 1520, Dallas, Texas 75206; the telephone number is (214) 891-6200.\nTrading Activity - ----------------\nATA Research, Inc. and ProFutures, Inc. are the General Partners of the Registrant. The General Partners administer the business and affairs of the Registrant (exclusive of its trading operations). Trading decisions are made by independent Commodity Trading Advisors chosen by the General Partners. At December 31, 1995 there are eleven Commodity Trading Advisors: Fundamental Futures, Inc.; Wizard Trading, Inc.; Willowbridge Associates, Inc.; Atlas Capital Management, Inc.; Peter Bruno; Rabar Market Research, Inc.; Traval Currency Management Limited; Prospective Commodities, Inc.; Sheridan Investments, Inc.; Bensen Capital Management, Inc.; MicroQuant Capital Management Corp., (collectively, the \"Advisors\"). All advisory fees are paid by the Registrant. Advisors may be changed from time to time by the General Partners.\nATA Research, Inc. is a Texas corporation whose sole Director and stockholder is Aladin T. Abughazaleh. Organized in 1985 to perform research and consulting services associated with monitoring performance of commodity trading advisors, ATA Research, Inc. now monitors, for its own use and that of its clients, performance data for more than 100 trading advisors. ATA Research, Inc. also acts as General Partner of the Registrant and one other commodity pool and as Trading Manager of other commodity pools. ATA Research, Inc. is registered with the Commodity Futures Trading Commission (CFTC) as a Commodity Pool Operator and Commodity Trading Advisor; it is also a member of the National Futures Association (NFA).\nProFutures, Inc., a Texas corporation, is a guaranteed Introducing Broker of Internationale Nederlanden (U.S.) Derivatives Clearing, Inc. (ING), formerly Quantum Financial Services, Inc. It is also registered with the CFTC as a Commodity Trading Advisor and Commodity Pool Operator and is a member of the NFA. Gary D. Halbert is the Chairman and President and principal stockholder of ProFutures, Inc., which was incorporated and began operation in December, 1984, and specializes in speculative managed futures accounts.\nThe objective of the Registrant is to achieve appreciation of its assets through speculative trading in futures and option contracts, forward contracts on foreign currencies and other commodity interests. It ordinarily maintains open positions for a relatively short period of time. The Registrant's ability to make a profit depends largely on the success of the Advisors in identifying market trends and price movements and buying or selling accordingly.\nThe Registrant's Trading Policies are set forth on Page 133 of Registrant's Prospectus dated August 30, 1993, which is incorporated herein by reference.\nMaterial changes in the Trading Policies described in the Prospectus must be approved by a vote of a majority of the outstanding Units of Limited Partnership Interest. A change in contracts traded, however, will not be deemed to be a material change in the Trading Policies.\nTrading Methods and Advisors - ----------------------------\nFutures traders basically rely on either or both of two types of analysis for their trading decisions, \"technical\" or \"fundamental\". Technical analysis uses the theory that a study of the markets will provide a means of anticipating price changes. Technical analysis generally will include a study of actual daily, weekly and monthly price fluctuations, volume variations and changes in open interest, utilizing charts and\/or computers for analysis of these items. Fundamental analysis, on the other hand, relies on a study and evaluation of external factors which affect the price of a futures contract in order to predict prices. These include political and economic events, weather, supply and demand and changes in interest rates.\nThe respective Advisors' trading strategies attempt to detect trends in price movements for the commodities monitored by them. They normally seek to establish positions and maintain such positions while the particular market moves in favor of the position and to exit the particular market and\/or establish reverse positions when the favorable trend either reverses or does not materialize. These trading strategies are not normally successful if a particular market is moving in an erratic and non-trending manner.\nBecause of the nature of the commodities markets, prices frequently appear to be trending when a particular market is, in fact, without a trend. In addition, the trading strategies may identify a particular market as trending favorably to a position even though actual market performance thereafter is the reverse of the trend identified.\nNone of the Advisors or their respective principals own any Units of the Fund. The Fund's Advisors are independent Commodity Trading Advisors and are not affiliated with the General Partners; however, all are also Advisors to other commodity pools with which the General Partners are currently associated. Each Advisor (except TCM) is registered with the CFTC and is a member in such capacity with the NFA. Because of their confidential nature, proprietary trading records of the Advisors and their respective principals are not available for inspection by the Limited Partners of the Fund.\nThe current Advisors are the following:\nFundamental Futures, Inc. (\"FFI\")\nFFI is an Oregon corporation organized in April 1984 whose principal office is located at 9669 Jourdan Way, Dallas, Texas 75230. FFI has established a branch office located at 8950 Northwest 62nd Street, Johnston, Iowa 50131. The books and records for FFI are kept at the principal office in Dallas. Steve DeCook has been the President and a principal shareholder of FFI since its inception. Malinda Goldsmith has been the Vice President\/ Secretary and a principal shareholder of FFI since its inception.\nSheridan Investments, Inc. (\"SII\")\nSII is an Illinois Corporation. Its offices are located at 190 South LaSalle Street, Suite 2790, Chicago, Illinois 60603, Donald M. Newell is President.\nRabar Market Research, Inc. (\"RMR\")\nRMR's offices are located at 10 Bank Street, Suite 830, White Plains, New York 10606-1933, Paul Rabar is President.\nWizard Trading, Inc. (\"WTI\")\nWTI is an Indiana corporation, the mailing address for which is 201 North Illinois, Suite 2100, Indianapolis, Indiana 46204. Jack Schwager and Louis Lukac are equal shareholders of WTI.\nTraval Currency Management Limited (\"TCM\")\nTCM's offices are located at 4 Elvetham Close, Fleet, Hampshire GU13, 8QU (UK); its President is Paul Barrett.\nWillowbridge Associates Inc. (\"WAI\")\nWAI is a Delaware corporation organized on January 29, 1988. WAI's main business address is 315 Enterprise Drive, Suite 102, Plainsboro, New Jersey 08536. Philip L. Yang is the sole shareholder, Director and President; Michael Y. Gan the Executive Vice President and Theresa C. Morris the Vice President.\nAtlas Capital Management, Inc. (\"ACM\")\nACM is a New Jersey corporation. Its offices are located at 17 Canoe Brook Drive, Princeton, New Jersey 08550. Michael Tepper is the President.\nPeter Bruno (\"BRU\")\nMr. Bruno's offices are located at 1248 14th Street, Santa Monica, California 90404.\nProspective Commodities, Inc. (\"PCI\")\nPCI's offices are located at 101 First Street, Los Altos, California 94022; David W. Cook is the President.\nBensen Capital Management, Inc. (\"BCM\")\nBCM is a Delaware corporation. Its offices are located at 34 Barnes Road West, Stamford, Connecticut 06902; L. Christopher Bensen is President.\nMicroQuant Capital Management Corp. (\"MCM\")\nMCM's offices are located at 93 Richards Avenue, Suite 705, Norwalk, Connecticut 06854. Mr. Dan Hajela is the Managing Director.\nFees, Compensation and Expenses - -------------------------------\nThe General Partners receive monthly management fees paid by the Registrant. ATA Research, Inc. receives 1\/12 of 1% of month-end Net Asset Value (approximately 1% annually). ProFutures, Inc. receives 1\/4 of 1% of month-end Net Asset Value (approximately 3% annually).\nSix of the eleven Trading Advisors receive monthly management fees ranging from .0167 to .1667 of 1% (approximately .2% to 2% annually) of month-end Allocated Net Asset Value (paid quarterly). Each of the eleven Advisors receives a quarterly incentive fee ranging from 20% to 27.5% of Trading Profits (as defined). The quarterly incentive fees are payable only on cumulative profits achieved by each Advisor. For example, if one of the Advisors to the Registrant experiences a loss after an incentive fee payment is made, that Advisor retains such payments but receives no further incentive fees until such Advisor has recovered the loss and then generated subsequent Trading Profits since the last incentive fee was paid such Advisor. An incentive fee may be paid to one Advisor but the Registrant may experience no change or a decline in its Net Asset Value because of the performance of another Advisor. The General Partners may allocate or reallocate the registrant's assets at any time among the current Advisors or any others that may be selected. Upon termination of an Advisor's contract, the Registrant may employ other advisory services whose compensation may be calculated without regard to the losses which may be incurred by the present Advisors. Similarly, the Registrant may renew its relationship with each Advisor on the same or different terms.\nNotional Funding Note: As of December 31, 1995, the Fund has allocated notional funds to Advisors equal to approximately 6.4% of the Fund's cash and\/or other margin - qualified assets. Of course, this percentage may be higher or lower over any given 12 month period. The management fees paid to an Advisor, if any, are a percentage of the nominal account size of the account if an account had been notionally funded. The nominal account size is equal to a specific amount of funds initially allocated to an Advisor which increases by profits and decreases by losses in the account, but not by additions to or withdrawals of actual funds from the account. Some, but not all, Advisors are expected to be allocated notional funds, and not all of the Advisors allocated notional funds are expected to be paid management fees. Further, the amount of cash and\/or other margin-qualified assets in an account managed by an Advisor will vary greatly at various times in the course of the Fund's business, depending on the General Partners general allocation strategy and pertinent margin requirements for the trading strategies undertaken by an Advisor.\nThe Registrant is obligated to pay its periodic operating expenses, consisting substantially of preparation of the limited partners' tax return information, filing and recording charges, legal, printing, accounting and auditing fees plus non-recurring expenses. Those periodic recurring expenses are estimated at approximately 1% of the Registrant's average annual Net Asset Value. Non-recurring expenses, not included within these estimates, include expenses associated with significant litigation including, but not limited to, class action suits, suits involving the indemnification provisions of the Agreement of the Limited Partnership or any other agreement to which the Registrant is a party; by their nature, the dollar amount of non-recurring expenses cannot be estimated.\nAdditional descriptions and definitions are set forth in \"Fees, Compensation and Expenses\" on Pages 38-42 of Registrant's Prospectus dated August 30, 1993, which is incorporated herein by reference.\nBrokerage Arrangements - ----------------------\nRegistrant's brokerage arrangements with ING and The First National Bank of Chicago are set forth in \"Brokerage Arrangements\" on Pages 134-135 of Registrant's Prospectus dated August 30, 1993, which is incorporated herein by reference.\nRegulation - ----------\nThe U.S. futures markets are regulated under the Commodity Exchange Act (CEA), which is administered by the Commodity Futures Trading Commission (CFTC), a federal agency created in 1974. The CFTC licenses and regulates commodity exchanges, commodity brokerage firms (referred to in the industry as \"Futures Commission Merchants\"), Commodity Pool Operators, Commodity Trading Advisors and others. The General Partners are registered by the CFTC as Commodity Pool Operators and each Advisor (except TCM, as a trader of forward currency and option contracts only, it is not required to be registered) registered as a Commodity Trading Advisor.\nFutures professionals such as the General Partners and the Advisors are also regulated by the National Futures Association (NFA), a self-regulatory organization for the futures industry that supervises the dealings between futures professionals and their customers. If the pertinent CFTC registrations or NFA memberships were to lapse, be suspended or be revoked, the General Partners would be unable to act as the Registrant's Commodity Pool Operators, and the respective Advisors as Commodity Trading Advisors, to the Registrant.\nThe CFTC has adopted disclosure, reporting and recordkeeping requirements for Commodity Pool Operators (such as the General Partners) and disclosure and recordkeeping requirements for Commodity Trading Advisors. The reporting rules require pool operators to furnish to the participants in their pools a monthly statement of account, showing the pool's income or loss and change in Net Asset Value and an annual financial report, audited by an independent certified public accountant.\nThe CFTC and the exchanges have pervasive powers over the futures markets, including the emergency power to suspend trading and order trading for liquidation only (i.e., traders may liquidate existing positions but not establish new positions). The exercise of such powers could adversely affect the Fund's trading.\nCompetition - -----------\nThe Registrant may experience increased competition for the same futures or option contracts. The Advisors may recommend similar or identical trades to other accounts which they may manage; thus, the Registrant may be in competition with such accounts for the same or similar positions. Such competition may also increase due to the widespread utilization of computerized trend-based trading methods similar to the methods used by some of the Advisors. This Fund may also compete with other funds organized by the General Partners.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nThe Registrant does not own or lease any real property. The General Partners currently provide all necessary office space at no additional charge to the Registrant.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nThe Registrant is not aware of any material pending legal proceedings to which it is a party or to which any of its assets are subject.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nDuring the fiscal year ended December 31, 1995, no matters were submitted to a vote of the holders of Units of Limited Partnership Interest (\"Units\") through the solicitation of proxies or otherwise.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Securities and Related Security Holder Matters.\nThe Partnership has filed a registration statement with the Securities and Exchange Commission for the sale of up to $38,547,364 in Units of Limited Partnership Interest. Such registration statement became effective as of July 31, 1994. This offering was extended on January 31, 1995 and continued through April 30, 1995. On June 23, 1995, Post-Effective Amendment No. 3 was filed to deregister $20,721,920 of Units of Limited Partnership Interest. As of December 31, 1995, a total of 49,196 Units are outstanding and held by 3,354 Unit holders, including 574 Units of General Partnership interest. During the calendar year 1995 a total of 8,967 Units were redeemed.\nThe General Partners have sole discretion in determining what distributions, if any, the Registrant will make to its Unit holders. The General Partners made no distributions as of December 31, 1995, or as of the date hereof. A Limited Partner may request and receive redemption of units subject to restrictions in the limited partnership agreement.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nFollowing is a summary of certain financial information for the Registrant for the calendar years 1995, 1994, 1993, 1992, 1991, 1990 and 1989.\n----\nRealized Gains $ 4,375,196 Change in Unrealized Gains (Losses) on Open Contracts 1,566,823 Interest Income 5,379,779 Management Fees 5,047,834 Incentive Fees 3,372,496 Net Income (loss) (6,415) General Partner Capital 1,087,286 Limited Partner Capital 92,084,180 Partnership Capital 93,171,466 Net Asset Value per General and Limited Partner Unit at End of Year 1,893.89 Net Income (loss)per Unit* (.12)\n----\nRealized Gains $ 9,310,267 Change in Unrealized Gains (Losses) on Open Contracts (1,807,923) Interest Income 3,955,212 Management Fees 5,046,028 Incentive Fees 3,895,306 Net Income (loss) (651,490) General Partner Capital 1,079,392 Limited Partner Capital 94,082,138 Partnership Capital 95,161,530 Net Asset Value per General and Limited Partner Unit at End of Year 1,880.14 Net Income (loss)per Unit* (12.47)\n----\nRealized Gains $ 2,939,834 Change in Unrealized Gains (Losses) on Open Contracts 4,964,156 Interest Income 2,520,939 Management Fees 4,058,814 Incentive Fees 2,217,831 Net Income (loss) 2,169,428 General Partner Capital 1,078,359 Limited Partner Capital 99,341,520 Partnership Capital 100,419,879 Net Asset Value per General and Limited Partner Unit at End of Year 1,889.57 Net Income (loss)per Unit* 50.65\n----\nRealized Gains $ 4,100,947 Change in Unrealized Gains (Losses) on Open Contracts (99,004) Interest Income 1,419,378 Management Fees 1,977,799 Incentive Fees 903,721 Net Income (loss) 1,646,961 General Partner Capital 533,765 Limited Partner Capital 51,136,749 Partnership Capital 51,670,514 Net Asset Value per General and Limited Partner Unit at End of Year 1,773.56 Net Income (loss)per Unit* 69.73\n- --------------- * based on weighted average units outstanding\n----\nRealized Gains $ 1,462,579 Change in Unrealized Gains (Losses) on Open Contracts 1,394,986 Interest Income 1,206,044 Management Fees 999,451 Incentive Fees 814,700 Net Income (loss) 1,712,247 General Partner Capital 286,900 Limited Partner Capital 26,838,522 Partnership Capital 27,125,422 Net Asset Value per General and Limited Partner Unit at End of Year 1,724.81 Net Income (loss)per Unit* 133.51\n- --------------- * based on weighted average units outstanding\n----\nRealized Gains $ 7,272,563 Change in Unrealized Gains (Losses) on Open Contracts (445,009) Interest Income 1,425,216 Management Fees 848,671 Incentive Fees 1,201,766 Net Income (loss) 5,666,199 General Partner Capital 204,177 Limited Partner Capital 19,793,856 Partnership Capital 19,998,033 Net Asset Value per General and Limited Partner Unit at End of Year 1,602.24 Net Income (loss)per Unit* 447.35\n- --------------- * based on weighted average units outstanding\n----\nRealized Gains $ 1,451,912 Change in Unrealized Gains (Losses) on Open Contracts 769,486 Interest Income 1,433,457 Management Fees 746,144 Incentive Fees 585,953 Net Income (loss) 1,772,687 General Partner Capital 183,476 Limited Partner Capital 15,050,429 Partnership Capital 15,233,905 Net Asset Value per General and Limited Partner Unit at End of Year 1,155.51 Net Income (loss)per Unit* 122.35\n- --------------- * based on weighted average units outstanding\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nThe Fund commenced trading on August 3, 1987. The success of the Fund is dependent on the ability of the Advisors to generate profits through speculative trading sufficient to produce substantial capital appreciation after payment of all fees and expenses. Future results will depend in large part upon the futures markets in general, the performance of the Advisors for the Fund and the amount of redemptions and changes in interest rates. Due to the highly leveraged nature of futures trading, small price movements may result in substantial losses. Because of the nature of these factors and their interaction, it is impossible to predict future operating results.\n(a) Liquidity. From the inception of the Fund on March 7, 1987 to December 31, 1995, substantially all of the Fund's assets have been held in cash or near cash investments, except for the portion used to margin its futures positions and to pay Fund expenses or redemptions requested by Limited Partners. At December 31, 1995 cash and short- term investments in fixed income securities comprised 80% of the Fund's assets and the remaining 20% was on deposit as margin with the Clearing Broker. The Fund earns interest on the amounts on deposit with the Clearing Broker.\nThe Fund's operating expenses are accrued and paid on a monthly basis. Accounts payable and accrued expenses at December 31, 1995, including redemptions, represented only 2.3% of the Fund's assets. The Fund has no fixed assets or long-term debt and expects to have none in the future.\nMost United States exchanges (but generally not foreign exchanges, or banks or broker-dealer firms in the case of foreign currency forward contracts) limit by regulation the amount of fluctuation limits. The daily limits establish the maximum amount the price of a futures contract may vary either up or down from the previous day's settlement price at the end of the trading session. Once the \"daily limit\" has been reached in a particular commodity, no trades may be made at a price beyond the limit. Positions in the commodity can then be taken or liquidated only if traders are willing to effect trades at or within the limit during the period for trading on such day. Because the \"daily limit\" rule only governs price movement for a particular trading day, it does not limit losses. The rule may, in fact, substantially increase losses because it may prevent the liquidation of unfavorable positions. Futures prices have occasionally moved the daily limit for several consecutive trading days, and thereby prevented prompt liquidation of futures positions on one side of the market, subjecting those futures traders involved to substantial losses.\nLiquidity will be of concern to the Fund primarily in that the futures markets in which the Advisors take positions may have periods in which illiquidity makes it impossible or economically undesirable to execute trades which its respective trading strategy would otherwise suggest. Other than in respect of the functioning of the markets in which it trades, liquidity will be of little relevance to the operation of the Fund except insofar as the General Partners are relatively thinly capitalized. Nonetheless, the General Partners believe they have sufficient funding to meet both their capital contribution and net worth requirements based on capital contributions from the respective principals of the General Partners, alternative funding sources, including the stock subscription from the Clearing Broker to ProFutures, Inc. and\/or a co-general partner or successor (or some combination thereof).\n(b) Capital Resources. The Fund's initial offering and sale of Units of Limited Partnership Interest commenced on May 27, 1987 and ended on July 31, 1987 after having sold $6,130,568 of units at the initial offering price of $1,000. The Fund commenced trading August 3, 1987. The Fund continued offering Units through February 29, 1988. Thereafter additional offerings of the Fund's Units of Limited Partnership Interest occurred on April 15, 1988, August 24, 1991, May 14, 1992, November 30, 1992, August 30, 1993 and July 31, 1994. The offering effective July 31, 1994 was extended on January 31, 1995 and continued through April 30, 1995. In June 1995, Post-Effective Amendment No. 3 was filed to deregister the Fund's remaining $20,721,920 of Units of Limited Partnership Interest.\n(c) Results of Operations. Due to the speculative nature of trading commodity interests, the Fund's income or loss from operations may vary widely from period to period. Management cannot predict whether the Fund's future Net Asset Value per Unit will increase or experience a decline. Inflation is not a significant factor in the Fund's operations, except to the extent that inflation may affect future prices.\nThe General Partners have established procedures to actively monitor and minimize the market and credit risk of the Fund. ATA Research, Inc. (ATA), in its capacity as Trading Manager of the Fund, manages market risk through the monitoring of the Fund's advisors and their trading in the various commodity markets. The General Partners seek to minimize credit risk primarily by keeping only minimal amounts of excess cash at the brokers, with excess cash being maintained in custodial or other accounts providing credit protection. Additionally, the General Partners monitor credit risk based on their current knowledge of the brokers' credit worthiness.\nPAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.\nYear Ended December 31, 1995 ----------------------------\n1995 was the ninth year of operations. Net loss for 1995 amounted to $6,415, or $.12 per Unit. At December 31, 1995, partners' capital totalled $93,171,466, a net decrease of $1,990,064 from December 31, 1994. Net Asset Value per Unit at December 31, 1995 amounted to $1,893.89, as compared with $1,880.14 at December 31, 1994, an increase of .7%.\nThe Fund's overall flat performance was the result of early year losses in several markets, including the currency markets which were offset later in the year with significant gains in the agricultural, global bond and energy markets.\nYear Ended December 31, 1994 ----------------------------\nNet loss for the year 1994 amounted to $651,490, or $12.47 per Unit. At December 31, 1994 partners' capital totalled $95,161,530, a net decrease of $5,258,349 from December 31, 1993. Net Asset Value per Unit at December 31, 1994 amounted to $1,880.14, as compared to $1,889.57 at December 31, 1993, a decrease of .5%.\nDuring 1994, the Fund profited from agricultural markets such as wheat, soybeans, cotton and coffee. In addition, the industrial metals were profitable overall. These gains were offset primarily by losses in the currency markets during early 1994.\nYear Ended December 31, 1993 ----------------------------\nNet income for the year 1993 amounted to $2,169,428, or $50.65 per Unit. At December 31, 1993 partners' capital totaled $100,419,879, a net increase of $48,749,365 from December 31, 1992. Net Asset Value per Unit at December 31, 1993 amounted to $1,889.57, as compared with $1,773.56 at December 31, 1992, an increase of 6.5%.\nDuring 1993, the Fund profited from the agricultural markets after the mid west flooding reduced the supply of soybeans and corn. In addition, the foreign interest rate markets and the base metals also contributed to the Fund's performance. These gains were somewhat offset by losses in the currency and stock index futures markets.\n(d) Possible changes. The General Partners reserve the right to terminate current Advisors and\/or engage additional Advisors in the future. Furthermore, the General Partners reserve the right to change any of the Fund's clearing arrangements to accommodate any new Advisors.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nFinancial statements meeting the requirements of Regulation S-X are listed on page of this report. The Supplementary Financial information specified by Item 302 of Regulation S-K is not applicable.\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 is a limited partnership and therefore does not have any directors or officers. The Registrant's General Partners, ATA Research, Inc. and ProFutures, Inc., administer and manage the affairs of the Registrant.\nItem 11.","section_11":"Item 11. Executive Compensation.\nAs discussed above, the Registrant does not have any officers, directors or employees. The General Partners receive monthly management fees which aggregated $3,809,356 for 1995, or approximately 4% of the Registrant's Net Asset Value.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\n(a) As of December 31, 1995, a total of 49,196 Units are issued and outstanding, representing 2 General Partners and 3,352 Limited Partners. The Partnership knows of no one person who owns beneficially more than 5% of the Limited Partners' Units.\n(b) The General Partners and their principals owned 574 General Partnership Units as of December 31, 1995, having an aggregate value of $1,087,286, which is approximately 1.17% of the Net Asset Value of the Registrant.\n(c) Changes in control. None have occurred and none are expected.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nRegistrant's Prospectus dated July 31, 1994, Pages 16-18, which is incorporated herein by reference, contains information concerning the relationships and transactions between the General Partners, the Clearing Broker and the Partnership.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statements, Schedules and Reports on Form 8-K.\n(a)(1) Financial Statements.\nSee index to Financial Statements.\nThe financial statements begin on page.\n(a)(2) Schedules other than Schedules I and VIII are omitted for the reason that all required information is contained in the financial statements included in (a)(1) above or are not applicable.\n(a)(3) Exhibits as required by Item 601 of Regulation S-K.\n*1.1 Form of Selling Agreement between the Registrant and ProFutures Financial Group, Inc. *1.2 Form of Additional Selling Agents Agreement between ProFutures Financial Group, Inc. and certain Additional Selling Agents. *3.1 Agreement of Limited Partnership (attached to the Prospectus as Exhibit A). *3.2 Subscription Agreement and Power of Attorney (attached to the Prospectus as Exhibit B). *3.3 Request for Redemption Form (attached to the Prospectus as Exhibit C). *5.1 Opinion of Counsel as to the legality of the Units. *8.1 Tax Opinion of Counsel *10.2 Form of Brokerage Agreement between the Registrant and Quantum Financial Services, Inc. *10.3(a) Advisory Contract between the Registrant and Colorado Commodities Management Corporation. *10.3(a)(a) Advisory Contract between the Registrant and Prospective Commodities, Inc. *10.3(a)(b) Advisory Contract between the Registrant and Atlas Capital Management, Inc. *10.3(a)(c) Advisory Contract between the Registrant and Bensen Capital Management, Inc. *10.3(a)(d) Advisory Contract between the Registrant and Peter Bruno. *10.3(a)(e) Advisory Contract between the Registrant and MicroQuant Capital Management Corp. *10.3(a)(f) Advisory Contract between the Registrant and Travel Currency Management Limited. *10.3(b) Form of Representations Letter of Colorado Commodities Management Corporation. *10.3(c) Advisory Contract between the Registrant and Fundamental Futures, Inc. *10.3(d) Form of Representations Letter of Fundamental Futures, Inc. *10.3(e) Advisory Contract between the Registrant and FX 500 Ltd. *10.3(f) Advisory Contract between the Registrant and Hawksbill Capital Management. *10.3(g) Advisory Contract between the Registrant and Insight Enterprises, Inc. *10.3(h) Advisory Contract between the Registrant and Luck Trading Company, Inc. *10.3(h)(1) Amendment dated December 3, 1993 to Advisory Contract between the Registrant and Luck Trading Company, Inc. dated March 11, 1992. *10.3(h)(2) Amendment dated February 28, 1995 to Advisory Contract dated March 11, 1992 between the Registrant and Luck Trading Company (BVI), Inc. *10.3(i) Advisory Contract between the Registrant and LaSalle Portfolio Management, Inc. *10.3(j) Form of Representations Letter of LaSalle Portfolio Management, Inc. *10.3(k) Advisory Contract between the Registrant and New Forest Capital Management, Inc. *10.3(l) Advisory Contract between the Registrant and Range Wise, Inc. *10.3(l)(1) Second Amendment dated March 31, 1994 to Advisory Contract between the Registrant and Range Wise, Inc. *10.3(m) Advisory Contract between the Registrant and Red Oak Commodity Advisors, Inc. *10.3(n) Advisory Contract between the Registrant and Trinity Money Management, Inc. *10.3(o) Advisory Contract between the Registrant and Visioneering Research and Development Company. *10.3(p) Form of Representations Letter of Visioneering Research and Development Company. *10.3(q) Advisory Contract between the Registrant and Classic Capital, Inc. *10.3(q)(1) First Amendment dated March 31, 1994 to Advisory Contract between the Registrant and Classic Capital, Inc. *10.3(r) Advisory Contract between the Registrant and Wizard Trading, Inc. *10.3(s) Advisory Contract between the Registrant and Devan Capital Management, Inc. *10.3(t) Advisory Contract between the Registrant and Hawksbill Capital Management. *10.3(u) Advisory Contract between the Registrant and Rowayton Capital Management, Inc. *10.3(v) Advisory Contract between the Registrant and Willowbridge Associates, Inc. *10.3(v)(1) First Amendment dated March 31, 1994 to Advisory Contract between the Registrant and Willowbridge Associates, Inc. *10.3(w) Advisory Contract between the Registrant and Zack Hampton Bacon, III. *10.3(x) Advisory Contract between the Registrant and Niederhoffer Investments, Inc. *10.3(y) Advisory Contract between the Registrant and Rabar Market Research, Inc. *10.3(z) Advisory Contract between the Registrant and Considine Trading Corp. *10.4 Form of Stock Subscription Agreement between Quantum Financial Services, Inc. and ProFutures, Inc. *24.1 Consent of Counsel to the Fund *24.2 Consent of Certified Public Accountants, King, Burns & Company, P.C. *24.3 Consent of Certified Public Accountants, Arthur F. Bell, Jr. & Associates, L.L.C.\n- ----------------------- * The foregoing forms of exhibits were filed in the April 6, 1987 Registration Statement No. 33-13008 and\/or Post-Effective Amendment No. 1 thereto filed March 11, 1988, and\/or the June 5, 1991 Registration Statement No. 33-41073, and\/or Pre-Effective Amendment No. 1 thereto filed August 8, 1991, and\/or Post-Effective Amendment No. 1 thereto filed March 26, 1992; and\/or the October 14, 1992 Registration Statement No. 33-53324, and\/or the November 17, 1992 Pre-effective Amendment No. 1 thereto and\/or the July 2, 1993 Registration Statement No. 33-65596, and\/ or the Pre-Effective Amendment No. 1 thereto filed August 16, 1993, and Supplement dated December 3, 1993, Post-Effective Amendment No. 2 thereto filed June 30, 1994 and Supplement dated January 31, 1995. Post-Effective Amendment No. 3 dated June 23, 1995. Accordingly, such exhibits are incorporated herein by reference and notified herewith.\n(b) Reports on Form 8-K.\nThe Registrant did not file any reports on Form 8-K for the year ended December 31, 1995.\n(c) Exhibits.\nFiled herewith:\nNone\n(d) Financial Statements Schedules.\nNot Applicable or information included in the financial statements.\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.\nATA RESEARCH\/PROFUTURES DIVERSIFIED FUND, L.P. (Registrant)\nBy - -------------------------- ---------------------------------------------- Date Aladin T. Abughazaleh, President ATA Research Inc., General Partner ATA Research\/ProFutures Diversified Fund, L.P.\nBy - -------------------------- ---------------------------------------------- Date Gary D. Halbert, President ProFutures, Inc., General Partner ATA Research\/ProFutures Diversified Fund, L.P.\nATA RESEARCH\/PROFUTURES DIVERSIFIED FUND, L.P.\nReport of Independent Certified Public Accountants\nStatements of Financial Condition to\nStatements of Operations\nStatements of Changes in Partners' Capital (Net Asset Value)\nNotes to Financial Statements to\nSchedule II - Valuation and Qualifying Accounts\nAffirmation of the Commodity Pool Operators\nFINANCIAL STATEMENTS AND REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nATA RESEARCH\/PROFUTURES DIVERSIFIED FUND, L.P.\nDECEMBER 31, 1995 AND 1994\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS --------------------------------------------------\nTo the Partners ATA Research\/ProFutures Diversified Fund, L.P.\nWe have audited the accompanying statements of financial condition of ATA Research\/ProFutures Diversified Fund, L.P. (a Delaware Limited Partnership) as of December 31, 1995 and 1994, and the related statements of operations, changes in partners' capital (net asset value) and the financial statement schedule for each of the three years in the period ended December 31, 1995. These financial statements and the related schedule are the responsibility of the Fund'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 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 ATA Research\/ProFutures Diversified Fund, L.P. as of December 31, 1995 and 1994, and the results of its operations and changes in partners' capital for each of the three years in the period ended December 31, 1995, 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.\nOur audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. The accompanying information in Note H is presented for purposes of additional analysis and is not a required part of the basic financial statements. The accompanying information has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, is fairly stated in all material respects in relation to the basic financial statements taken as a whole.\nKING, BURNS & COMPANY, P. C.\nDallas, Texas January 31, 1996\nATA RESEARCH\/PROFUTURES DIVERSIFIED FUND, L.P. STATEMENTS OF FINANCIAL CONDITION December 31, 1995 and 1994\nASSETS ------\n1995 1994 ----------- ----------- ASSETS Cash and cash equivalents $75,639,538 $62,375,070 ----------- -----------\nEquity in trading accounts on deposit with brokers and dealers Margin deposit 357,247 5,991,005 Net option premiums paid - forward contracts - 4,199,010 Unrealized gain on open forward contracts - 248,843 Interest receivable 1,673 136,621 ----------- ----------- 358,920 10,575,479 ----------- -----------\nEquity in commodity futures trading accounts on deposit with brokers Margin deposit 13,012,372 19,605,342 Interest receivable - broker 86,321 108,282 Net option premiums paid (received) (632,793) 662,280 Unrealized gain on open commodity futures\/options contracts 6,133,288 4,317,622 ----------- ----------- 18,599,188 24,693,526 ----------- -----------\nInterest receivable 754,280 9,214 ----------- -----------\nTOTAL ASSETS $95,351,926 $97,653,289 =========== ===========\n- Continued -\nThe accompanying notes are an integral part of these financial statements.\nATA RESEARCH\/PROFUTURES DIVERSIFIED FUND, L.P. STATEMENTS OF FINANCIAL CONDITION - Continued December 31, 1995 and 1994\nLIABILITIES AND PARTNERS' CAPITAL (NET ASSET VALUE) ---------------------------------------------------\n1995 1994 ----------- -----------\nLIABILITIES Accounts payable $ 16,204 $ 26,602 Commissions and other trading fees on open commodity futures contracts 160,715 164,705 Incentive fees payable 823,973 1,024,388 Management fees payable 510,874 501,722 Redemptions payable 668,694 774,342 ----------- -----------\nTotal liabilities 2,180,460 2,491,759 ----------- -----------\nPARTNERS' CAPITAL (NET ASSET VALUE) General Partners - 574 units outstanding at December 31, 1995 and 1994 1,087,286 1,079,392 Limited Partners - 48,622 and 50,040 units outstanding at December 31, 1995 and 1994, respectively 92,084,180 94,082,138 ----------- -----------\nTotal partners' capital (net asset value) 93,171,466 95,161,530 ----------- -----------\nTOTAL LIABILITIES AND PARTNERS' CAPITAL $95,351,926 $97,653,289 =========== ===========\nThe accompanying notes are an integral part of these financial statements.\nATA RESEARCH\/PROFUTURES DIVERSIFIED FUND, L.P. STATEMENTS OF OPERATIONS Years ended December 31, 1995, 1994 and 1993\n1995 1994 1993 ----------- ----------- -----------\nINCOME Gains (losses) on commodity futures\/options contracts Realized $ 4,558,826 $ 9,313,518 $ 3,083,699 Change in unrealized 1,566,823 (1,807,923) 4,964,156 ----------- ----------- ----------- Income from trading 6,125,649 7,505,595 8,047,855\nForeign exchange losses (183,630) (3,251) (143,865) Interest 5,379,779 3,955,212 2,520,939 ----------- ----------- -----------\nTotal income 11,321,798 11,457,556 10,424,929 ----------- ----------- -----------\nEXPENSES Brokerage commissions and other trading fees 2,423,253 2,673,086 1,550,598 Management fees 5,047,834 5,046,028 4,058,814 Incentive fees 3,372,496 3,895,306 2,217,831 Operating expenses 484,630 494,626 428,258 ----------- ----------- -----------\nTotal expenses 11,328,213 12,109,046 8,255,501 ----------- ----------- -----------\nNET INCOME (LOSS) $ (6,415) $ (651,490) $ 2,169,428 =========== =========== ===========\nNet income (loss) per General and Limited Partner Unit (based on weighted - average number of units outstanding) $ (.12) $ (12.47) $ 50.65 =========== =========== ===========\nNumber of weighted-average units outstanding 52,207 52,245 42,832 =========== =========== ===========\nThe accompanying notes are an integral part of these financial statements.\nATA RESEARCH\/PROFUTURES DIVERSIFIED FUND, L.P. STATEMENTS OF CHANGES IN PARTNERS' CAPITAL (NET ASSET VALUE) Years ended December 31, 1995, 1994 and 1993\nTotal Partners' Capital (Net Asset Value) Number of ---------------------------------------- Units General Limited Total --------- ---------- ------------ ------------\nBalances at January 1, 1993 29,134 $ 533,765 $ 51,136,749 $ 51,670,514\nNet income for the year - 32,024 2,137,404 2,169,428\nAdditions 27,175 515,000 52,418,913 52,933,913\nRedemptions (3,165) - (6,030,174) (6,030,174)\nSyndication costs - (2,430) (321,372) (323,802) ------ ---------- ------------ ------------\nBalances at December 31, 1993 53,144 1,078,359 99,341,520 100,419,879\nNet loss for the year - (4,907) (646,583) (651,490)\nAdditions 5,551 6,000 9,989,188 9,995,188\nRedemptions (8,081) - (14,502,095) (14,502,095)\nSyndication costs - (60) (99,892) (99,952) ------ ---------- ------------ ------------\nBalances at December 31, 1994 50,614 1,079,392 94,082,138 95,161,530\nNet income (loss) for the year - 7,894 (14,309) (6,415)\nAdditions 7,549 - 14,222,901 14,222,901\nRedemptions (8,967) - (16,064,321) (16,064,321)\nSyndication costs - - (142,229) (142,229) ------ ---------- ------------ ------------\nBalances at December 31, 1995 49,196 $1,087,286 $ 92,084,180 $ 93,171,466 ====== ========== ============ ============\nNet asset value per unit at December 31, 1993 $1,889.57 ========= December 31, 1994 $1,880.14 ========= December 31, 1995 $1,893.89 =========\nPercent of increase (decrease) in per unit net asset value 1992 to 1993 6.54% ========= 1993 to 1994 (0.50)% ========= 1994 to 1995 0.73% =========\nThe accompanying notes are an integral part of these financial statements.\nATA RESEARCH\/PROFUTURES DIVERSIFIED FUND, L.P. NOTES TO FINANCIAL STATEMENTS\nNOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\n1. General Description of the Partnership --------------------------------------\nATA Research\/ProFutures Diversified Fund, L.P. (the Partnership or Fund) is a Delaware limited partnership and operates as a commodity investment pool. It is subject to regulations of the Commodity Futures Trading Commission, an independent agency of the United States government which regulates most aspects of the commodity futures industry, rules of the National Futures Association, a self regulatory organization, and the requirements of Commodity Exchange and Futures Commission Merchants (brokers) where the Partnership trades.\n2. Method of Reporting -------------------\nThe Partnership's financial statements are presented in accordance with generally accepted accounting principles. Gains or losses are realized when contracts are liquidated. Net unrealized gains or losses on open contracts (the difference between contract purchase price and market price) at statement date are reported in the statement of financial condition in accordance with Financial Accounting Standards Board Interpretation No. 39. Any change in net unrealized gain or loss from the preceding period is reported in the statement of operations. United States Government securities are priced at cost plus accrued interest, which approximates market value.\nInvestments in futures contracts involve elements of market risk in excess of the amounts reflected in the financial statements. Accordingly, the values reported are subject to the consequences of commodity prices that can fluctuate rapidly over a wide range.\n3. Futures Brokerage Commissions -----------------------------\nThe fee charged by a broker for executing a trade in the commodity account of the Partnership is usually paid on a \"round-turn\" basis, that is, only upon the closing of an open position. In some cases however, the brokerage commissions may be charged \"half-in half-out\". For financial reporting purposes and for calculating the Net Asset Value of the Partnership, commodity brokerage commissions and other trading fees are charged to expense when futures positions are opened. The average \"round- turn\" fee paid during 1995 and 1994 approximated $11.00 and $10.00, respectively.\n4. Income Taxes ------------\nThe Partnership prepares calendar year information income tax returns and reports to each partner the allocable share of the Partnership's ordinary income or loss and commodity trading gains or losses. Commodity futures gains or losses on regulated futures contracts open at year end are recognized for tax purposes as if sold at their market value less commissions.\n5. Cash and Cash Equivalents -------------------------\nCash and cash equivalents includes cash and short-term investments in fixed income securities.\nATA RESEARCH\/PROFUTURES DIVERSIFIED FUND, L.P. NOTES TO FINANCIAL STATEMENTS - Continued\nNOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)\n6. Partner Share Unit Additions ----------------------------\nLimited Partner additions are considered pending during the month of receipt by the Partnership. The purchasers are issued units at the Net Asset Value per unit as of the end of business of the last day in the month in which the subscription is accepted.\n7. Partner Share Unit Redemptions and Distributions ------------------------------------------------\nThe Agreement of Limited Partnership provides that upon satisfying certain conditions, Limited Partners may require the Fund to redeem all or a portion of their Units and receive an amount equal to the Net Asset Value per Unit. Redemptions are permitted at the end of any month, upon fifteen days prior written notice, at the Net Asset Value per Unit as of the last day of the month in which the request was received. The Partnership is not required to make distributions, but may do so at the sole discretion of the General Partners.\n8. Foreign Currency Translation ----------------------------\nThe Partnership's functional currency is the United States (U.S.) dollar; however, the Partnership transacts business in currencies other than the U.S. dollar. Assets and liabilities denominated in currencies other than the U.S. dollar are translated into U.S. dollars at the rates in effect at the date of the statement of financial condition. Income and expense items denominated in currencies other than the U.S. dollar are translated into U.S. dollars at the rates in effect during the period. Gains and losses resulting from the translation to the functional currency are reported in income currently.\nNOTE B - DEPOSITS WITH BROKERS\nThe Partnership deposits funds with various commodity brokers to act as clearing brokers subject to Commodity Futures Trading Commission and various exchange regulations on minimum deposits. Margin requirements are satisfied by the deposits of U.S. Treasury bills and cash with such brokers. The Partnership earns interest income on the funds deposited with brokers.\nNOTE C - GENERAL PARTNERS\nThe General Partners of the Partnership are ATA Research, Inc. and ProFutures, Inc., who conduct and manage the business of the Partnership. The Agreement of Limited Partnership provides that the General Partners will contribute to the Fund an amount in the aggregate equal to at least the lesser of $100,000 or 3% of the aggregate initial contributions of all limited partners, but in no event less than 1% of the aggregate initial capitalization of the Fund. The General Partners will purchase Units of General Partnership Interest to the extent of such capital contribution.\nATA RESEARCH\/PROFUTURES DIVERSIFIED FUND, L.P. NOTES TO FINANCIAL STATEMENTS - Continued\nNOTE C - GENERAL PARTNERS - Continued\nThe General Partners will share Fund profits and losses with the limited partners pro rata to the extent of their investment. Unless they own units exceeding their minimum purchase or net worth requirements, the General Partners may not redeem or transfer their interest so long as they are acting as General Partner(s). At December 31, 1995, 1994 and 1993, the General Partners had contributed cumulatively $926,500, $926,500 and $920,500, respectively, to the Partnership. Including all cumulative pro-rata Fund profits, the General Partners were in compliance with this requirement.\nAlso under the Agreement of Limited Partnership, the General Partners are obliged, for as long as they continue to serve as General Partners of the Fund, to maintain in the aggregate a net worth of not less than (i) the lesser of $250,000 or 15% of the aggregate capital contribution to the Fund and any other partnership for which they act as General Partners capitalized at $2,500,000 or less; and (ii) 10% of the aggregate initial capital contributions to the Fund and any other limited partnership capitalized at more than $2,500,000 for which they act as General Partners. For these purposes, \"net worth\" shall reflect the carrying value of all assets at fair market value and shall exclude capital contributions of the General Partners to the Fund or to any other limited partnership of which they may be General Partners. Net worth will be calculated in accordance with generally accepted accounting principles provided that all current assets shall be based on then current market value and may include any notes receivable, letter of credit or stock subscriptions from the Futures Broker and\/or adequately capitalized affiliate(s) of the General Partners. ProFutures, Inc. has a subscription agreement with Internationale Nederlanden (U.S.) Derivatives Clearing, Inc. (ING), formerly Quantum Financial Services, Inc., the Partnership's primary commodity broker, whereby ING agrees to purchase or subscribe for the number of shares of common stock of ProFutures, Inc. necessary to maintain the General Partner net worth requirements. At December 31, 1995, the amount of stock subscribed to ProFutures, Inc. is $19,000,090.\nA monthly management fee is paid by the Partnership to the General Partners. ATA Research, Inc. receives 1\/12 of 1% of month-end Net Asset Value (approximately 1% annually) and ProFutures, Inc. receives 1\/4 of 1% of month- end Net Asset Value (approximately 3% annually).\nTotal management fees earned by ATA Research, Inc. for the years ended December 31, 1995, 1994 and 1993, were $949,479, $945,105 and $804,529, respectively. Total management fees earned by ProFutures, Inc. for the years ended December 31, 1995, 1994 and 1993, were $2,859,877, $2,846,702 and $2,423,283, respectively.\nNOTE D - TRADING ADVISORS\nThe Partnership has trading management agreements with several trading advisors pursuant to which the Partnership pays selected advisors a quarterly incentive fee based on a percentage of excess cumulative Trading Profits (as defined in the Prospectus) and a management fee based on Allocated Net Assets managed (as defined in the Prospectus).\nATA RESEARCH\/PROFUTURES DIVERSIFIED FUND, L.P. NOTES TO FINANCIAL STATEMENTS - Continued\nNOTE E - OPERATING EXPENSES\nAll operating expenses of the Partnership are billed directly to and paid by the Partnership. The General Partners are not reimbursed for indirect expenses incurred in performing services for the Partnership and other items generally falling within the category of overhead. The General Partners may be reimbursed for the actual costs of legal, accounting and auditing services used for or by the Partnership, as well as printing and filing fees and extraordinary expenses incurred for or by the Partnership.\nNOTE F - REGISTRATION STATEMENT\nOn August 24, 1991, May 14, 1992, November 30, 1992, August 30, 1993 and July 31, 1994 the Partnership filed registration statements with the Securities and Exchange Commission for the sale of the Partnership's Units of Limited Partnership Interest. During the offering periods, units were sold at the previous month end Net Asset Value per Unit plus a 1% administrative charge, from which the Partnership reimburses the General Partners for their actual expenses incurred in connection with the offering. The offering effective July 31, 1994 terminated on April 30, 1995.\nNOTE G - TRADING ACTIVITIES AND RELATED RISKS\nThe Partnership engages in the speculative trading of U.S. and foreign futures contracts, options on U.S. and foreign futures contracts, forward contracts and options on forward contracts (collectively, \"derivatives\"). These derivatives include both financial and non financial contracts held as part of a diversified trading strategy. The Partnership is exposed to both market risk, the risk arising from changes in the market value of the contracts, and credit risk, the risk of failure by another party to perform according to the terms of a contract.\nPurchase and sale of futures and options on futures contracts requires margin deposits with the brokers. Additional deposits may be necessary for any loss on contract value. The Commodity Exchange Act requires a broker to segregate all customer transactions and assets from such broker's proprietary activities. A customer's cash and other property (for example, U.S. Treasury bills) deposited with a broker are considered commingled with all other customer funds subject to the broker's segregation requirements. In the event of a broker's insolvency, recovery may be limited to a pro rata share of segregated funds available. It is possible that the recovered amount could be less than total cash and other property deposited.\nThe Partnership deposits assets with brokers and dealers in securities and other financial institutions in connection with its trading of forward contracts and its cash management activities. In the event of a financial institution's insolvency, recovery of Partnership assets on deposit may be limited to account insurance or other protection afforded such deposits. In the normal course of business, the Partnership does not require collateral from such financial institutions. Since forward contracts and options thereon are traded in unregulated markets between principals, the Partnership also assumes the risk of loss from counterparty nonperformance.\nATA RESEARCH\/PROFUTURES DIVERSIFIED FUND, L.P. NOTES TO FINANCIAL STATEMENTS - Continued\nNOTE G - TRADING ACTIVITIES AND RELATED RISKS - Continued\nFor derivatives, risks arise from changes in the market value of the contracts. Theoretically, the Partnership is exposed to a market risk equal to the value of futures and forward contracts purchased and unlimited liability on such contracts sold short. As both a buyer and seller of options, the Partnership pays or receives a premium at the outset and then bears the risk of unfavorable changes in the price of the contract underlying the option. Written options expose the Partnership to potentially unlimited liability, and purchased options expose the Partnership to a risk of loss limited to the premiums paid.\nThe fair value of derivatives represents unrealized gains and losses on open forward and futures contracts and long and short options at market value. The average fair value of derivatives during 1995 was approximately $4,244,000 and the related year end fair value is approximately $5,500,000.\nNet trading income from derivatives for the years ended December 31, 1995, 1994 and 1993 is reflected in the statement of operations and equals gain from trading less brokerage commissions. Such trading income reflects the net gain arising from the Partnership's speculative trading of futures contracts, options on futures contracts, forward contracts and options on forward contracts.\nOpen contracts generally mature within one year, however, the Partnership intends to close all contracts prior to maturity. At December 31, 1995 and 1994, the notional amount of open contracts is as follows:\n---------------------------- Contracts Contracts to purchase to sell -------------- ------------\nDerivatives (excluding purchased options): Futures contracts and written options thereon: - Agriculture $ 46,000,000 $ 17,600,000 - Currency and currency indices 15,600,000 86,300,000 - Energy 10,000,000 1,500,000 - Equity indices 26,700,000 4,500,000 - Interest rates 810,500,000 84,300,000 - Metals 85,100,000 91,100,000 - Other 1,000,000 3,600,000 Forward contracts and written options thereon: - Currency 6,000,000 6,000,000\nPurchased options on: Futures contracts: - Agriculture 3,700,000 200,000 - Currency and currency indices - - - Interest rates - 11,600,000 - Metals 4,300,000 - Forward contracts: - Currency - - -------------- ------------ $1,008,900,000 $306,700,000 ============== ============\n---------------------------- Contracts Contracts to purchase to sell ------------ --------------\nDerivatives (excluding purchased options): Futures contracts and written options thereon: - Agriculture $113,400,000 $ 76,300,000 - Currency and currency indices 201,700,000 75,300,000 - Energy 2,300,000 4,100,000 - Equity indices 16,400,000 20,000,000 - Interest rates 73,000,000 406,500,000 - Metals 62,200,000 52,300,000 - Other - - Forward contracts and written options thereon: - Currency 215,300,000 198,600,000\nPurchased options on: Futures contracts: - Agriculture 16,900,000 16,900,000 - Currency and currency indices - 33,800,000 - Interest rates 9,000,000 - - Metals - 16,000,000 Forward contracts: - Currency 104,600,000 105,700,000 ------------ -------------- $814,800,000 $1,005,500,000 ============ ==============\nATA RESEARCH\/PROFUTURES DIVERSIFIED FUND, L.P. NOTES TO FINANCIAL STATEMENTS - Continued\nNOTE G - TRADING ACTIVITIES AND RELATED RISKS - Continued\nThe above amounts do not represent the Partnership's risk of loss due to market and credit risk, but rather represent the Partnership's extent of involvement in derivatives at the date of the statement of financial condition.\nThe General Partners have established procedures to actively monitor and minimize market and credit risk. The Limited Partners bear the risk of loss only to the extent of the market value of their respective investments and, in certain specific circumstances, distributions and redemptions received.\nNOTE H - ACCOMPANYING INFORMATION - NET ASSET VALUE OF COMMODITY POOL AND PARTICIPATION UNITS\nA five year comparative table of the Partnership's Net Asset Value, number of units outstanding and Net Asset Value per unit follows:\nDecember 31, -------------------------- 1995 1994 ----------- -----------\nTotal Net Asset Value $93,171,466 $95,161,530 =========== ===========\nNumber of participation units 49,196 50,614 =========== ===========\nNet Asset Value per unit $ 1,893.89 $ 1,880.14 =========== ===========\nDecember 31, -------------------------- 1993 1992 ----------- -----------\nTotal Net Asset Value $100,419,879 $51,670,514 ============ ===========\nNumber of participation units 53,144 29,134 ============ ===========\nNet Asset Value per unit $ 1,889.57 $ 1,773.56 ============ ===========\nDecember 31, ------------- -----------\nTotal Net Asset Value $27,125,422 ===========\nNumber of participation units 15,727 ===========\nNet Asset Value per unit $ 1,724.81 ===========\nATA RESEARCH\/PROFUTURES DIVERSIFIED FUND, L.P. SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS Years ended December 31, 1995, 1994 and 1994\n(A) (B) (C1) (C2) Additions Balance ---------------------- at the Charged beginning to Charged of the costs and to income Description period expenses accounts - --------------------- ----------- -------- ----------\nDecember 31, 1995 - ----------------- Unrealized gain (loss) on open commodity futures\/ options contracts $4,317,622 $ - $1,815,666 ========== ======== ==========\nUnrealized gain on open forward contracts $ 248,843 $ - $ - ========== ======== ==========\nDecember 31, 1994 - ----------------- Unrealized gain (loss) on open commodity futures\/ options contracts $6,374,388 $ - $ - ========== ======== ==========\nUnrealized gain on open forward contracts $ - $ - $ 248,843 ========== ======== ==========\nDecember 31, 1993 - ----------------- Unrealized gain (loss) on open commodity futures\/ options contracts $1,410,232 $ - $4,964,156 ========== ======== ==========\nUnrealized gain on open forward contracts $ - $ - $ - ========== ======== ==========\n(A) (D) (E) Deductions ---------- Balance Charged at the to income end Description accounts period - --------------------- ---------- ----------\nDecember 31, 1995 - ----------------- Unrealized gain (loss) on open commodity futures\/ options contracts $ - $6,133,288 ========== ==========\nUnrealized gain on open forward contracts $ 248,843 $ - ========== ==========\nDecember 31, 1994 - ----------------- Unrealized gain (loss) on open commodity futures\/ options contracts $2,056,766 $4,317,622 ========== ==========\nUnrealized gain on open forward contracts $ - $ 248,843 ========== ==========\nDecember 31, 1993 - ----------------- Unrealized gain (loss) on open commodity futures\/ options contracts $ - $6,374,388 ========== ==========\nUnrealized gain on open forward contracts $ - $ - ========== ==========\nATA RESEARCH\/PROFUTURES DIVERSIFIED FUND, L.P. AFFIRMATION OF THE COMMODITY POOL OPERATORS\nTo the Partners ATA Research\/ProFutures Diversified Fund, L.P.\nThe information contained in the accompanying financial statements is accurate and complete to the best of my knowledge and belief.\n- ------------------------ ---------------------------------- Date Aladin T. Abughazaleh, President ATA Research, Inc. Co-Commodity Pool Operator\n- ------------------------ ---------------------------------- Date Gary D. Halbert, President ProFutures, Inc. Co-Commodity Pool Operator","section_15":""}
{"filename":"768384_1995.txt","cik":"768384","year":"1995","section_1":"ITEM 1. BUSINESS\nIntroduction\nBen & Jerry's Homemade, Inc. (Ben & Jerry's or the \"Company\") is a leading manufacturer of super premium ice cream, frozen yogurt and sorbet in unique and regular flavors. The Company also manufactures ice cream novelty products, including Peace Pops. The Company uses natural ingredients in its products and believes that its gourmet-quality, \"down home\", made in Vermont image is a key element of its marketing strategy.\nThe Company's products are currently distributed throughout the United States primarily through independent distributors. However, the Company's marketing resources are concentrated on certain target markets including New England, New York, the Mid- Atlantic region, Florida, Texas, the West Coast and selected other major markets, including the metropolitan Chicago and Denver areas. In 1995, approximately 79% of the sales of the Company's packaged pints were attributable to these target markets. The Company's products are also available in the United Kingdom.\nThe Company currently markets 34 flavors in packaged pints, for sale primarily in supermarkets, grocery stores, convenience stores and other retail food outlets and over 50 flavors of its ice cream and frozen yogurt in bulk, primarily to restaurants and Ben & Jerry's franchised \"scoop shops.\"\nHistory and Philosophy of the Company\nThe Company began active operations in May 1978, when Ben Cohen, now the Company's Chairperson, and Jerry Greenfield, now the Company's Vice Chairperson, opened a retail store in a renovated gas station in Burlington, Vermont. The store featured homemade ice cream made in an antique rock salt ice cream freezer. That ice cream parlor continues to make its own ice cream in the same freezer in a larger location in Burlington.\nThe Company believes that, despite its growth, it has maintained a reputation for producing gourmet-quality, natural ice cream and for sponsoring or creating light-hearted promotions that foster an image as an independent socially conscious Vermont company.\nThe Board of Directors of the Company has formalized its basic business philosophy by adopting a three part \"mission statement\" for Ben & Jerry's. The statement includes a \"product mission,\" to \"make, distribute and sell the finest quality all- natural ice cream\"; an \"economic mission,\" to \"operate the Company on a sound financial basis...increasing value for our shareholders and creating career opportunities and financial rewards for our employees\"; and a \"social mission,\" to \"operate the Company...[to] improve the quality of life of our employees and a broad community: local, national and international.\" Since 1988 the Company's Annual Report to Stockholders has contained a \"social audit\" on the Company's performance during the year.\nThe Company contributed $768,000 to the Ben & Jerry's Foundation, Inc. for grants by the Foundation to charities, and directly to other charitable organizations for the year ended December 30, 1995. Under present Board policy, cash donations to The Ben & Jerry's Foundation and directly to other charitable organizations by the Company, are approximately 7.5% of income before income taxes. The amount of the Company's cash contribution is subject to review by the Board of Directors from time to time in light of the Company's cash needs, its operating results, existing conditions in the industry and other factors deemed relevant by the Board. See \"The Ben & Jerry's Foundation.\"\nBen & Jerry's maintains a special tie to the Vermont community in which it had its origins. The Company donates product to public events and community celebrations in the Vermont area. In 1994, the Company created a Community Action Team at each of the Company's five sites in Vermont. Each Community Action Team receives a portion of the 7.5% of pre-tax profits directed for philanthropy to make cash contributions to various organizations in Vermont. Each county in Vermont is covered by a Ben & Jerry's Community Action Team. Also, the Company, acting as agent, transfers funds to charitable organizations throughout Vermont derived from the sale of \"factory seconds\" to participating Vermont retail grocers.\nBen & Jerry's has also taken actions intended to strengthen the Company's ability to remain an independent, Vermont-based company. Ben & Jerry's believes these actions are in the best interests of the Company, its stockholders, its employees and the Vermont community. See \"Anti-Takeover Effects of Class B Common Stock and Preferred Stock\".\nIn 1991 the Company decided to pay not less than a certain minimum price for its dairy ingredients, other than yogurt cultures, to bring the price up to an amount based upon the average price for dairy products in certain prior periods. This commitment is part of an effort to foster the supply of Vermont dairy products and thereby also seek to maintain the long-term viability of the Company's source of supply of its principal dairy ingredients, against the marketplace background of a continuing trend of decreasing family dairy farms in Vermont. In early 1994 the Company's agreement with the St. Albans Cooperative Creamery was amended to include, as a condition for payment of the premium, an assurance from the St. Albans Cooperative Creamery that the milk and cream purchased by the Company will not come from cows that have been treated with rBST, a synthetic growth hormone approved by the FDA. The Company's premium policy has some adverse impact on its gross margin.\nIn 1992, the Company became a signatory to the CERES Principals adopted by the Community for Environmentally Responsible Economies. The CERES Principles establish an environmental ethic with criteria by which investors and others can assess the environmental performance of companies. Ben & Jerry's is also a founding member of Businesses for Social Responsibility, Inc. (\"BSR\"), an organization in Washington, DC which promotes a concept of business profitability that includes environmental responsibility and social equity. Ben & Jerry's is also a member of the Vermont Business for Social Responsibility.\nThe Super Premium Ice Cream, Frozen Yogurt and Sorbet Market\nThe packaged ice cream industry includes economy, regular, premium and super premium products. Super premium ice cream is generally characterized by a greater richness and density than other kinds of ice cream.\nThis higher quality ice cream generally costs more than other kinds and is usually marketed by emphasizing quality, flavor selection, texture and brand image. Other types of ice cream are largely marketed on the basis of price.\nSuper premium ice cream and super premium frozen yogurt and, more recently, super premium sorbet have become an important part of the frozen dessert industry. In response to the demand for lower fat, lower cholesterol products, the Company introduced its own super premium low fat frozen yogurt in 1992, and four non-fat frozen yogurt flavors in 1995. In February 1996, the Company commenced its introduction of six fat-free and cholesterol-free sorbet flavors.\nThe Company believes, based on information provided by Information Resources, Inc., a software and marketing information services company (\"IRI\"), that total annual U.S. sales in supermarkets at retail prices (defined as grocery stores with annual revenues of at least $2 million) of super premium ice cream, frozen yogurt, ice milk and sorbet were in excess of $443 million in 1995, compared with about $415 million in 1994, although unit volume declined about 1%. The IRI information also indicates that the super premium category, excluding sorbet, declined in volume about 6.6% from 1994. This was caused by a decline in sales of ice cream, combined with flat sales of low-fat frozen yogurt, partially offset by growth in non-fat product categories. In 1995 Ben & Jerry's increased its domestic market share of the super premium ice cream and frozen yogurt categories combined, as surveyed by IRI, although its domestic share of the super premium category overall declined, as Ben & Jerry's did not introduce its sorbet until 1996. All of the information in this paragraph is taken from IRI data.\nBen & Jerry's Super Premium Ice Cream, Frozen Yogurt and Sorbet\nBen & Jerry's super premium ice cream is a high butterfat ice cream, with approximately 15% fat (excluding add-ins) and approximately 20% air content. Ben & Jerry's low fat frozen yogurt is a high quality frozen yogurt with approximately 2% fat (excluding add-ins) and approximately 20% air content. Of the Company's seven frozen yogurt flavors, two flavors are labeled low fat, a third flavor is not labeled low fat because it contains add-ins which increase the total fat content over the 3% fat level required by FDA labeling guidelines. The remaining four flavors in Ben & Jerry's frozen yogurt line are labeled non-fat. Ben & Jerry's non-fat frozen yogurt is a high quality frozen yogurt with approximately 0% fat and approximately 40% air content. The fat content of these products is derived mostly from the butterfat in cream but also from egg yolks (except for frozen yogurt). Ben & Jerry's frozen sorbet is a non-fat sorbet with approximately 20% air content. The sorbet line is manufactured with Vermont Pure(TM) Spring Water and conventionally and organically grown fruit. Pure cane sugar, beet sugar and corn syrup are the only sweeteners used. Ben & Jerry's frozen desserts contain no artificial ingredients or preservatives, although one of the candies used in two of Ben & Jerry's flavors does contain artificial flavoring. All other flavorings used by the Company include premium quality, unpreserved extracts and fruits, nuts, chocolates, liqueurs, cookies and candies. The dairy products in Ben & Jerry's frozen desserts are readily available from dairy cooperatives in Vermont. The various flavorings are readily available from multiple suppliers throughout the country.\nA number of Ben & Jerry's flavors are original creations of the Company, including Cherry Garcia(R), Doonesberry(R) (introduced in 1996), Chunky Monkey(R), Rainforest Crunch, White Russian(TM), Chubby Hubby(R), Chocolate Fudge Brownie and Chocolate Chip Cookie Dough, which has become the Company's most popular flavor.\nBen & Jerry's license agreements include a license from the estate of Jerry Garcia formerly of the Grateful Dead rock group with respect to the Company's Cherry Garcia flavor; political cartoonist Garry Trudeau with respect to the Company's Doonesberry flavor of the new sorbet line of products; Wavy Gravy for the flavor Wavy Gravy; and The Kahlua Company for use of Kahlua(R) as flavoring in White Russian ice cream.\nThe mix used by the Company in the production of Ben & Jerry's ice cream follows the original formula developed by Ben Cohen and Jerry Greenfield and consists of fresh cream, cane or beet sugar, non-fat milk solids, egg yolks and natural stabilizers. All of the Company's plants include mix batching facilities that enable Ben & Jerry's to manufacture its own ice cream mix for use at its plants. The automated mix batching equipment, together with a quality control lab, enhances the Company's ability to maintain consistent quality production. The Company purchases its dairy ingredients, except yogurt cultures, from the St. Albans Cooperative Creamery. The Company purchases cultured pasteurized milk mix from another Vermont dairy cooperative which is used for manufacture of its frozen yogurt products. The Company also purchases Vermont Pure(TM) Spring Water which is used to manufacture the Company's new sorbet products. The Company has designed and modified special machinery to insert large chunks of cookies and candies into its ice cream and frozen yogurt.\nThe Company also makes ice cream novelty products, including stick pops, which Ben & Jerry's markets as Peace Pops(TM), and Brownie Bars commencing March, 1996.\nManufacturing\nThe Company currently has a projected maximum manufacturing capacity at its own facilities of approximately 17.3 million gallons per year of packaged pints and 3.5 million gallons of bulk product contingent upon product mix and excluding novelty lines.\nThe Company manufactures Ben & Jerry's super premium ice cream and frozen yogurt pints at its Waterbury, Vermont plant. The Company generally operates its Waterbury plant 2 shifts a day, six days a week. The Company manufactured approximately 4.6 million gallons at this facility in 1995.\nThe Company's Springfield, Vermont plant is used for the production of ice cream novelties, bulk ice cream and frozen yogurt, and packaged pints and quarts. The plant produced approximately 1.1 million dozen novelties, 2.3 million gallons of bulk ice cream and frozen yogurt, packaged pints and quarts. In 1995, the Company generally operated the Springfield plant five to six days per week, either with one or two production shifts depending on the season.\nFrom June 1992 to September 1995, the Company operated an interim pint manufacturing line in St. Albans, Vermont in space provided by the St. Albans Cooperative Creamery, from which the Company purchases all of its dairy ingredients except yogurt cultures. Production on this line was approximately 2.3 million gallons of packaged pints in 1995. This line was phased out in September 1995 as production at the Company's new St. Albans, Vermont facility increased.\nIn October 1992, the Company started construction of a new manufacturing plant in St. Albans, Vermont at a total cost now estimated at $40.1 million, net of an asset write-down of $6.8 million in 1994. In March 1995, the new plant started manufacturing ice cream on one line using a temporary nitrogen tunnel hardening system. A second line began operation in December 1995. The Company expects the rate of actual production per minute at the new plant to increase during 1996. In 1995, the plant produced 2.2 million gallons of packaged pints. Based upon the current product mix, and with the two lines that became operational in 1995, the new plant is designed to provide a maximum projected capacity of approximately 12 million gallons of packaged pints per year. With the addition of a third manufacturing line at the plant, the maximum projected capacity of this plant would be approximately 17 million gallons of packaged pints per year contingent upon product mix. Currently the St. Albans plant is producing both ice cream and sorbet in packaged pints.\nIn order to meet demand for its pints from 1989 to 1995, the Company had a manufacturing and warehouse agreement with Edy's Grand Ice Cream (\"Edy's\"), a subsidiary of Dreyer's Grand Ice Cream, Inc. (\"Dreyer's\"). Under this agreement, Edy's manufactured certain pint ice cream flavors at its plant in Fort Wayne, Indiana with specifications and quality control provided by Ben & Jerry's and using Vermont dairy products. This agreement expired in September 1995. Approximately 1.9 million gallons, or about 16% of the packaged pints manufactured in 1995, were manufactured under this arrangement, down from approximately 40% in 1994.\nMarkets and Customers\nThe Company markets packaged pints, quarts and novelty products primarily through supermarkets, grocery stores, convenience stores and other retail food outlets. The Company markets ice cream, frozen yogurt and sorbet in 2 1\/2-gallon bulk containers primarily through franchised (and Company-owned) Ben & Jerry's \"scoop shops\" and through restaurants.\nBen & Jerry's products are distributed primarily through Dreyer's and independent regional ice cream distributors. With some exceptions, only one distributor is appointed for each territory for supermarkets. In some areas, sub-distributors are used. Company trucks also distribute some of the products that are sold in Vermont and upstate New York.\nBen & Jerry's has a distribution agreement with Dreyer's under which Dreyer's acts as the master distributor (with exclusivity, in general, for sales to supermarkets and similar accounts) of Ben & Jerry's products in most of the Company's markets outside of New England, upstate New York, Pennsylvania and Texas. Dreyer's markets its own premium ice cream under both the Dreyer's and Edy's brand names as well as certain frozen dessert products of other companies. Dreyer's does not produce or market any other super premium ice cream, or frozen yogurt, (other than novelties), and in the event that Dreyer's were to distribute another super premium ice cream, or frozen yogurt in any part of its territory, Dreyer's would lose the exclusivity granted to it as a Ben & Jerry's distributor under the agreement. The agreement also contains certain additional provisions specific to the greater metropolitan New York market, including special limitations on the ability of either party to terminate the agreement with respect to the New York market. In early 1994, the agreement was amended to provide for the Company to perform the subdistribution of Ben & Jerry's products to convenience stores and \"mom and pops\" in the New York City area. In October 1995, exclusive distribution rights for the New York City area were transferred back to Dreyer's. Net sales to Dreyer's (including sales where the Company acted as a subdistributor in the New York City area) accounted for approximately 44% and 49% of the Company's net sales for 1995 and 1994, respectively.\nIn the event that Dreyer's were to terminate the agreement without cause, the agreement provides for a twelve month notice period (subject to reduction by the Company) and specified minimum purchase requirements by Dreyer's during the notice period. In addition, the agreement provides for termination by Ben & Jerry's without cause upon twelve months' notice and for termination by Ben & Jerry's or Dreyer's on short notice for cause. The agreement also contains certain provisions for termination by one party (at its election) upon a change in control (as defined) of the other, in which event the terminated party experiencing the change in control has a minimum purchase or sale obligation, as the case may be, for a specified additional period and also must make a $20 million termination payment to the other party. In addition, the agreement states that in the event that Dreyer's, directly or indirectly introduces, acquires, or distributes in the United States another super premium product (as defined), the Company may terminate the agreement and Dreyer's must make a $20 million termination payment to the Company. The common stock of Dreyer's is publicly traded. In April 1994, Nestle USA, Inc. (a U.S. subsidiary of a large international conglomerate) acquired a significant minority equity position in Dreyer's. (See also \"Competition\")\nThe relationship between the Company and Dreyer's commenced in 1987, and the distribution agreement has been amended several times since then. The Company and Dreyer's regularly engage in discussions regarding ways to improve their long-term relationship to their mutual benefit, and it is contemplated that the parties may revise and restate the distribution agreement. Any changes which are then or thereafter adopted may have certain beneficial or adverse consequences, the effects of which cannot be foreseen by the Company.\nWhile the Company believes that its relationships with Dreyer's and its other distributors generally have been satisfactory and that these relationships have been instrumental in the Company's growth, the Company has at times experienced difficulties in maintaining these relationships. Available distribution alternatives are limited. Accordingly, there can be no assurance that such difficulties, which may be related to actions by the Company's competitors or by one or more of the distributors themselves (or their controlling persons), will not have a material adverse effect on the Company's business. Loss of one or more of the Company's principal distributors or termination of one or more of the related distribution agreements could have a material adverse effect on the Company's business.\nMarketing\nBen & Jerry's marketing strategy is characterized by its focus on innovative, non-traditional methods of promotion. The Company emphasizes the high quality, natural ingredients in its products, and the \"down home Vermont\" image of its products in its packaging, sales materials and promotional campaigns. Significant prominence has been given to Ben Cohen and Jerry Greenfield, the founders of the Company, as \"two real guys\" still actively involved in the Company. Pictures of Ben and Jerry appear on packaging, and they make personal appearances on TV, radio and at select marketing events.\nAs the Company has become a significant force in super premium ice cream and frozen yogurt, its marketing emphasis has shifted from portraying itself as the small \"underdog\" firm to a Company-wide focus on community involvement and its status as a socially responsible business. In the past, the Company has focused its marketing efforts on communicating newsworthy, company-wide unique business approaches that tend to generate unpaid newspaper, magazine, radio and TV news coverage.\nDuring 1995, the Company created and produced a Ben & Jerry's \"One World, One Heart\" Festival in Vermont. The Company also sponsored the Ben & Jerry's Newport Folk Festival in Newport, Rhode Island. These events, attended by nearly 50,000 people in outdoor public areas generated lots of goodwill, ice cream sampling and social activism, while building customer loyalty and support for the Company's products in the future.\nBen & Jerry's continues to conduct guided tours of its facility in Waterbury, Vermont. In 1995, approximately 250,000 people visited the plant, making it (the Company believes) the single most popular tourist attraction in the State.\nFranchise shops are an integral part of the Company's marketing efforts and work on the local level contributes to the Company's three part mission. A franchise is required to spend at least 4% of its gross sales on community\/self directed marketing, sampling, advertising and participation in certain Ben & Jerry's selected promotions.\nThe Company is introducing its new line of six innovative sorbet flavors made with all natural ingredients and Vermont Pure(TM) Spring Water by offering consumers 1 million free samples during March and April 1996. Samples will be offered at all franchised scoop shops and given away during sampling sessions scheduled in target markets throughout the country.\nFranchise Program\nAs of December 30, 1995, there were 132 franchised Ben & Jerry's \"scoop shops\", as compared with 123 stores open at December 31, 1994, including in each case satellite shops. The franchised \"scoop shops\" are located in New England, New York, the mid-Atlantic region, Georgia, Florida, Ohio, Indiana, Illinois, California and Canada.\nDuring 1995, the Company opened 8 additional franchised \"scoop shops\" under single store, satellite and area franchise agreements discussed below and added one \"Partnershop.\" Ben & Jerry's has changed its policy limiting the development of individual franchise store openings and is actively pursuing locations in selected markets around the country.\nThe Company's domestic franchise agreements with respect to individual stores are for a ten-year term with an option to the franchisee to renew for a second ten-year term. The agreements grant the franchisee an exclusive area for bulk ice cream, frozen yogurt, and sorbet with certain exceptions and require the franchisee to purchase from the appropriate local distributor Ben & Jerry's ice cream, frozen yogurt, sorbet and certain other products, principally baked goods and hot fudge sauce. Franchisees pay an initial franchise fee, currently $25,000 per store, and each franchisee is required to make the advertising payments described above. The franchise agreements with stores sponsored by charitable organizations, often referred to as Partnershops, provide for waivers of certain financial provisions.\nIn addition, the Company has entered into a few exclusive area franchise agreements. Under these agreements, the franchisee agrees to pay a specified negotiated franchise fee in installments and to open a certain number of stores in a particular territory according to a specified schedule. The franchisee is given exclusive franchise rights in the territory, subject to conditions specified in the agreements. Under its current area franchise agreements, franchisees have agreed to open an aggregate of 55 stores, primarily in California, 27 of which had been opened as of December 30, 1995 in accordance with amended build-out schedules. The Company's Canadian subsidiary also has seven franchised Ben & Jerry's \"scoop shops\" including satellite shops in Canada.\nInternational\nThe Company regularly investigates the possibilities of entering new markets and intends to enter additional foreign markets, particularly in Europe and the Pacific Rim. In March 1994, the Company started shipping its products to smaller specialty stores in the United Kingdom. Ben & Jerry's ice cream products are now distributed nationally in the United Kingdom, and are available in parts of Ireland and at one \"hyper-market\" chain in France.\nIn 1990, the Company entered into a joint venture agreement with certain individuals in the former Soviet Union to establish a Ben & Jerry's manufacturing facility and franchised \"scoop shops\" in the Russian state of Karelia. The Company's goal is to provide a model of a small scale private enterprise in the former Soviet Union and to foster international cooperation and global understanding. The joint venture is currently operating three scoop shops in Karelia.\nIn 1992, the Company repurchased the Canadian rights to Ben & Jerry's products which it had previously licensed in 1987. In 1987, the Company granted an exclusive license to manufacture and sell Ben & Jerry's ice cream in Israel.\nCompetition\nThe super premium ice cream, frozen yogurt and sorbet business is highly competitive. The Company's principal competitor is The Haagen-Dazs Company, Inc. Other significant competitors are Dannon, Columbo, and Healthy Choice. Haagen-Dazs, an industry leader in the super premium ice cream market, is owned by The Pillsbury Company, which in turn is owned by Grand Metropolitan PLC, a British food and liquor conglomerate. Grand Metropolitan is a large, diversified company with resources significantly greater than the Company's, and Haagen-Dazs has a significant share of the markets which the Company has entered in recent years and has already been marketing a sorbet line. Haagen-Dazs has also entered substantially more foreign markets than the Company (including certain markets in Europe and the Pacific Rim). Haagen-Dazs and certain other competitors also market flavors using pieces of cookies and candies as ingredients.\nIn the ice cream novelty segment, the Company competes with several well-known brands, including Haagen-Dazs and Dove Bars, manufactured by a division of Mars, Inc. Both of these other brands have achieved far larger shares of the novelty market than the Company.\nDuring 1995, the Company noted that the premium category again experienced increased promotional activity driven by the national competition between Dreyer's Grand Ice Cream, Inc. and Breyer's Ice Cream (owned by Unilever, a large international food company). In accordance with Dreyer's strategic five year plan to accelerate the sales of their branded premium products Dreyer's has increased its consumer marketing efforts and continued expansion of its distribution system into additional U.S. markets.\nThere are a number of other super premium brands, including some significant regional ice cream companies and some new entries. Increased competition and the increased consumer demand for new lower fat, lower cholesterol products like low fat or nonfat frozen yogurt, low fat ice cream and sorbet, combined with limited shelf space within supermarkets, may have, in general, made market entry harder and has already forced some brands out of some markets. The ability to introduce innovative new flavors and low fat offerings on a periodic basis is also a significant competitive factor. The Company expects strong competition to continue, including price\/promotional competition, competition for adequate distribution and limited shelf space within the frozen dessert category in supermarkets and other food retail outlets.\nSeasonality\nThe ice cream, frozen yogurt and frozen dessert industry generally experiences the highest volume during the spring and summer months and the lowest volume in the winter months.\nRegulation\nThe Company is subject to regulation by various governmental agencies, including the United States Food and Drug Administration and the Vermont Department of Agriculture. It must also obtain licenses from the states where Ben & Jerry's products are sold. The criteria for labeling low-fat\/low-cholesterol and other health-oriented foods was revised, and in some respects made more stringent, by the FDA. The Company, like other companies in the food industry, made changes in its labeling in response to these regulations and is in compliance. The Company cannot predict the impact of possible further changes that it may be required to make in response to legislation, rules or inquiries made from time to time by any governmental agencies. FDA regulations may, in certain instances, affect the ability of the Company, as well as others in the frozen desserts industry, to develop and market new products. Nevertheless, the Company does not believe these legislative and administrative rules and regulations will have a significant impact on its operations.\nIn connection with the operation of all its plants, the Company must comply with the Vermont environmental laws and regulations relating to air quality, waste management, and other related land use matters. The Company maintains wastewater discharge permits for all of its manufacturing locations. The Waterbury plant and the new St. Albans plant pretreat production effluent prior to discharge to the municipal treatment facility. The Company believes that it is in compliance with all of the required operational permits relating to environmental regulations.\nThe Company believes that it is in compliance in all material respects with the other regulatory requirements applicable to its operations and that continuing expenditures for compliance with environmental or other regulatory requirements will not materially affect its results.\nTrademarks\nThe name Ben & Jerry's(R) and the proprietary flavor names: Cherry Garcia(R); Chunky Monkey(R); Chubby Hubby(R); Dastardly Mash(R); and Vermont's Finest(TM) are all registered trademarks of the Company. Cherry Garcia(R) and Doonesberry(R) are licensed to the Company, as are certain other flavor names. Some of the Company's other trademarks include: White Russian(TM); New York Super Fudge Chunk(TM); and Peace Pops(TM).\nEmployees\nAt December 30, 1995, Ben & Jerry's employed 703 people including full time, part time and temporary employees. This represents a 14.7% increase from the 613 people employed by the Company at December 31, 1994.\nThe Ben & Jerry's Foundation\nIn 1985, Ben Cohen, Chairperson of the Board, contributed a portion of the equity of the Company which he then owned to The Ben & Jerry's Foundation, Inc., a charitable organization under Section 501(c)(3) of the Internal Revenue Code, in order to enable the Foundation to sell such equity and invest the net proceeds (approximately $598,000) in income-producing securities to generate funds for future charitable grants. Until March 1994, the Foundation was the recipient of the bulk of the Company's cash charitable contributions and provided the principal means for carrying out the Company's cash charitable giving policy. In March 1994, the Board of Directors revised the process to make philanthropic giving more meaningful for, and connected to, the employees of the Company. Employees serving in Community Action Teams now provide the principal means for carrying out the Company's cash charitable giving policy in the State of Vermont. The Foundation, with input from its employee-led grant making committee, provides the principal means for carrying out the Company's cash charitable giving policy across the nation. The Foundation continues to target its grants to local groups concerned with the welfare of children and their families, and other grass roots social change organizations.\nIn October 1985, pursuant to stockholder authorization, the Company sold to the Foundation all of the 900 authorized shares of Preferred Stock for $10 per share. The Preferred Stock gives the Foundation a special class voting right to act with respect to certain mergers and other Business Combinations (as defined in the Company's charter). The sale of Preferred Stock was designed to perpetuate the relationship between the Foundation and the Company and to assist the Company in its determination to remain an independent business headquartered in Vermont.\nAnti-Takeover Effects of Class B Common Stock and Preferred Stock\nThe holders of Class A Common Stock are entitled to one vote for each share held on all matters voted on by stockholders, including the election of directors. The holders of Class B Common Stock are entitled to ten votes for each share held in the election of directors and on all other matters. The Class B Common Stock is generally nontransferable, and there is no trading market for the Class B Common Stock. The Class B Common Stock is freely convertible into Class A Common Stock on a share-for-share basis and transferable thereafter.\nThe Company has been advised that Mr. Ben Cohen (Chairperson and a director of the Company), Mr. Jerry Greenfield (Vice Chairperson and a director of the Company), Mr. Fred Lager (a director and consultant to the Company) and Mr. Jeff Furman (a director and consultant to the Company) (collectively, the \"Principal Stockholders\") presently intend to retain substantial numbers of shares of Class B Common Stock. As a result of conversions by \"public\" stockholders of Class B Common Stock, in order to enable their sales of such securities, the Class B Common Stock is now held disproportionately by Company insiders, including the above-named four directors who are Principal Stockholders. See \"Security Ownership of Certain Beneficial Owners and Management.\" As of March 8, 1996, these four principal individual stockholders held shares representing 48.0% of the aggregate voting power in elections of directors and various other matters but only 20.0% of the aggregate common equity outstanding, permitting them, as a practical matter, generally to decide elections of directors and various other questions submitted to a vote of the Company's stockholders even though they might sell substantial portions of their Class A Common Stock.\nThe Board of Directors, without further stockholder approval, may authorize the issuance of additional shares of Class B Common Stock in the future and sell shares of Class B Common Stock held in the Company's treasury; however, issuance or sale of additional shares of Class B Common Stock, while not permitted under a rule of the NASDAQ-NMS until 1995, is still subject to approval under limited circumstances by the NASDAQ-NMS.\nIn 1985, the Company sold 900 shares of Preferred Stock at a price of $10 per share to The Ben & Jerry's Foundation, Inc. (the \"Foundation\"). While the Foundation is a charitable entity legally separate from the Company, it may be deemed to be an affiliate of the Company because two of the three current directors of the Foundation are Messrs. Greenfield and Furman. The Preferred Stock gives the Foundation a special class voting right to act with respect to certain Business Combinations (as defined in the Company's charter). The sale of the Preferred Stock to the Foundation effectively limits the voting rights that holders of the Class A Common Stock and Class B Common Stock, the owners of virtually all of the equity in the Company, would otherwise have with respect to Business Combinations (as defined). This may have the effect of limiting such common stockholders' participation in certain transactions such as mergers, other Business Combinations (as defined) and tender offers, whether or not such transactions might be favored by such common stockholders.\nThe Class B Common Stock and the Preferred Stock may be deemed to be \"anti-takeover\" devices in that the Board of Directors believes the existence of these securities will make it difficult for a third party to acquire control of the Company on terms opposed by the holders of the Class B Common Stock, including primarily the Principal Stockholders, and the Foundation or for incumbent management and the Board of Directors to be removed. See also \"Risk Factors\" in Item 7 of this Report.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nBen & Jerry's owns a 42.5 acre site in Waterbury, Vermont on which it operates a 46,000 square-foot plant producing ice cream and frozen yogurt in packaged pints. The Company also owns a 48,000 square-foot production facility in Springfield, Vermont. The Springfield plant is used for the production of ice cream novelties, bulk ice cream and frozen yogurt and at times packaged pints and quarts.\nThe Company's property, plant and equipment at its production facilities in Waterbury and Springfield are subject to various liens securing a portion of the Company's long-term debt.\nIn 1991, the Company entered into a twenty-five year lease with an option to purchase 17.1 acres of land in Rockingham, Vermont on which the Company constructed, and operates, a 45,000 square-foot central distribution facility.\nIn 1992, the Company entered into a five-year lease\/purchase agreement for a 42-acre parcel of land in St. Albans, Vermont, the site of the Company's 82,000 square-foot new plant. In February 1996, the Company entered into a ten year lease agreement for approximately 50,000 square-feet of office and light manufacturing space in South Burlington, Vermont where the Company's executive offices and administrative departments are now located, following the 1996 move from its Waterbury headquarters.\nThe Company also leases space for its retail ice cream parlors in Burlington and Montpelier, Vermont and 12,000 square feet of storage space in Waterbury, Vermont. The Company owns two single-family houses, both situated on land adjacent to its manufacturing facility it Waterbury, used for a day-care center, employee training and other purposes.\nThe Company believes that all of its facilities are well maintained and in good repair.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nOn December 14, 1995, the Company was served with a class action complaint filed in federal court in Burlington, Vermont. The complaint, captioned Henry G. Jakobe, Jr. v. Ben & Jerry's Inc., et al., United States District Court (D. Vermont) Case No. 1-95-CV-373, was filed by a Ben & Jerry's shareholder on behalf of himself and purportedly on behalf of all other Ben & Jerry's shareholders who purchased the common stock of the Company during the period from March 25, 1994 through December 19, 1994. Plaintiff alleges that the Company violated the federal securities laws by making, in 1994, untrue statements of material facts and omitting to state material facts primarily concerning the Company's construction and start-up of its new manufacturing facility in St. Albans, Vermont. Also named as defendants in the Complaint are certain present and former officers and directors of the Company, Ben Cohen, Chairperson of the Board; Jerry Greenfield, Vice Chairperson of the Board; Frances Rathke, Chief Financial Officer; and Charles Lacy, former President. Plaintiff is seeking an unspecified amount of monetary damages.\nWhile this action is in its preliminary stages management believes, based on an initial review, the allegations made in the lawsuit are without merit and the Company intends to defend the lawsuit vigorously.\nThe Company is subject to certain additional litigation and claims in the ordinary course of business which management believes are not material to the Company's business.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS\nNo matters were submitted to a vote of security holders of the Company during the fourth quarter of 1995.\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 traded on the NASDAQ National Market System under the symbol BJICA. The following table sets forth for the period January 1, 1994 through March 8, 1996 the high and low closing sales prices of the Company's Class A Common Stock for the periods indicated.\nHigh Low ---- ---\n- ---- First Quarter...................... $20 $14 3\/4 Second Quarter..................... 18 1\/2 14 Third Quarter...................... 16 3\/4 13 Fourth Quarter..................... 14 9 1\/2\n- ---- First Quarter...................... $14 $ 9 5\/8 Second Quarter..................... 15 1\/2 11 3\/4 Third Quarter...................... 20 13 5\/8 Fourth Quarter..................... 19 14 1\/2\n- ---- First Quarter (through March 8).... $17 1\/4 $13 1\/2\nThe Class B Common Stock is generally non-transferable, and there is no trading market for the Class B Common Stock. The Class B Common Stock is freely convertible into Class A Common Stock on a share-for-share basis, and transferable thereafter.\nThe Company has never declared a cash dividend on its Class A Common Stock or the Class B Common Stock and the current policy of its Board of Directors is to retain earnings for expansion and development of the Company's business. Accordingly, the Board of Directors does not anticipate declaring any cash dividends on the Class A or Class B Common Stock in the foreseeable future. See \"Description of Capital Stock-Dividends.\"\nAs of March 8, 1996 there were 11,168 holders of record of the Company's Class A Common Stock and 2,508 holders of record of the Company's Class B Common Stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following table contains selected financial information for the Company's fiscal years 1991 through 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 shows certain items as a percentage of net sales which are included in the Company's Statement of Operations and the percentage increase (decrease) of such items as compared to the indicated prior period.\nPercentage of Net Sales Year Ended 12\/30\/95 12\/31\/94 12\/25\/93 -------- -------- -------- Net sales ................ 100.0% 100.0% 100.0% Cost of sales ............ 70.2 73.8 71.4 ---- ---- ---- Gross profit ............. 29.8 26.2 28.6 Selling, general and administrative expense ............. 23.4 24.4 20.2 Asset write-down ......... (4.6)\nOther income (expenses) .......... (0.4) 0.2 0.2 ----- --- --- Income(loss)before income taxes ........ 6.0 (2.6) 8.6 Income taxes(benefit) .... 2.2 (1.3) 3.5 --- ----- --- Net income(loss) ......... 3.8% (1.3)% 5.1% === ===== ===\nSales\nNet sales in the fourth quarter of 1995 increased 5% from the fourth quarter of 1994, and net sales in 1995 overall increased 4.4% to $155 million from $149 million in 1994. Pint volume decreased 1.5% compared to 1994. The Company believes this decrease in pint volume is consistent with the recent performance in the super premium category overall, excluding sorbet which the Company did not introduce until 1996. This volume decrease was offset by a 3.7% price increase of pints sold to distributors that went into effect in March 1995. Net sales of both novelties and 21\/2 gallon bulk containers product categories had modest increases in 1995.\nPint sales represented approximately 85% of total net sales in 1995, 1994 and 1993. Net sales of 2 1\/2 gallon bulk containers represented approximately 7% of total net sales in 1995 and 1994, and 8% in 1993. Net sales of novelties accounted for approximately 6% of total net sales in 1995 and 5% in 1994 and 1993. Net sales from the Company's retail stores represented 2% of total net sales in 1995, 3% in 1994 and 2% in 1993.\nNet sales in 1994 overall increased 6.0% to $149 million from $140 million in 1993. This was primarily the result of a 7% increase in net sales of packaged pints. The increase in pint sales was primarily due to sales of the Company's new \"Smooth, No Chunks\" line which was introduced nationally during the months of March through May 1994. Sales of the Company's reformulated and repackaged Peace Pops resulted in an increase in Peace Pop sales. However this was offset by the absence of sales of the Brownie Bar which the Company discontinued manufacturing in May 1993, resulting in a approximately the same level of net sales of novelties overall in 1994 as in 1993.\nCost of Sales\nCost of sales in 1995 decreased approximately $.6 million or 0.6% over the same period in 1994 and overall gross profit as a percentage of net sales increased from 26.2% in 1994 to 29.8% in 1995. The higher gross profit as a percentage of sales in 1995 is due to the price increase effective in March 1995 combined with improved inventory management and production efficiencies, as compared with 1994. In addition, the improved gross margin reflects less product manufactured for the Company by Edy's Grand Ice Cream, a subsidiary of Dreyer's Grand Ice Cream, resulting from the transfer of production to the Company's new manufacturing facility in St. Albans, Vermont. During 1995 approximately 16% of the packaged pints manufactured by the Company were produced by Edy's, compared to 40% in 1994.\nCost of sales in 1994 increased approximately $9.6 million, or 9.5% over the same period in 1993 and overall gross profit as a percentage of net sales decreased from 28.6% in 1993 to 26.2% in 1994. Overall gross profit in 1994 was impacted by inventory management problems and production inefficiencies, as well as 1994 start-up costs associated with certain flavors of the new \"Smooth, No Chunks\" ice cream line in packaged pints. The significant increase in the number and complexity of some of the pint flavors being produced requires a higher level of production planning, purchasing, inventory management and operational systems than were then in place in the Company.\nDuring 1994 the lower gross profit as a percentage of sales also reflected higher manufacturing costs due to more product being produced for the Company by Edy's, with approximately 40% of the packaged pints manufactured by the Company produced by Edy's in 1994 as compared to 37% in 1993.\nSelling, General and Administrative Expenses\nSelling, general and administrative expenses increased 0.3% to $36.4 million in 1995 from $36.3 million in 1994 but decreased as a percentage of net sales to 23.4% in 1995 from 24.4% in 1994. This increase in dollar spending primarily reflects strengthening of the Company's infrastructure in order to prepare for increased growth, offset by the lower level of marketing and sales spending compared to 1994, when the launch of the new \"Smooth, No Chunks\" line occurred.\nSelling, general and administrative expenses had increased 28% to $36.3 million in 1994 from $28.3 million in 1993 and increased as a percentage of net sales to 24.4% in 1994 from 20.2% in 1993. This increase was due principally to increased marketing and selling expenses, including higher than anticipated coupon redemption expenses, associated with promoting the then new \"Smooth, No Chunks\" line as well as the Company's taking over the distribution arrangements to the smaller classes of trade in the New York market and one-time costs associated with changes in distribution arrangements in the United Kingdom.\nAsset Write-Down\n1994 results included a pretax charge of $6.8 million, representing a write-down of certain assets of the Company's new St. Albans, Vermont plant, including a portion of the previously incurred capitalized interest and project management costs. The impact of this charge on both the 1994 fourth quarter and full year 1994 results was $4.1 million or $0.57 per share. Following substantial delays with the implementation and completion of certain automated handling processes and refrigeration hardening equipment of the new plant and after receipt of a report from an outside engineering firm experienced in the refrigerated food industry, the Company decided to replace certain of the software and equipment installed at the new plant. The Company began manufacturing at the new St. Albans plant in March 1995, utilizing a temporary set-up on one production line. The two currently planned manufacturing lines were fully operational in December 1995 and it is expected that the rate of production on these lines will be increased in 1996.\nOther Income(Expense)\nInterest income increased $0.6 million during 1995 compared to 1994. This increase was primarily due to higher interest rates on investments. Interest expense increased $1.2 million in 1995 compared to 1994. This increase was due primarily to the capitalization of interest in the prior year as part of the cost of the new plant in St. Albans, Vermont as compared with capitalization of only a small amount of interest in 1995 before the plant became operational.\nInterest income increased $0.3 million during 1994 compared to 1993 reflecting interest earned on investments. Interest expense increased $0.2 million reflecting the issuance of the $30 million Series A and B Notes bearing interest at a weighted average rate of 5.84%. Interest expense was reduced during 1994 by capitalization of interest as part of the cost of the new plant.\nIncome Taxes\nThe Company's effective income tax rate increased from (50.3%) in 1994 to 36.8% in 1995 primarily reflecting the profit in 1995, as compared to the loss in 1994, combined with lower income tax credits and tax-exempt interest income in 1995 as compared to 1994. In 1993, the Company's effective income tax rate was 40.2% reflecting lower income tax credits and tax-exempt interest income. Management expects 1996's effective income tax rate to increase to approximately 38%.\nNet Income\nAs a result of the foregoing, net income increased $7.8 million to $5.9 million in 1995 compared to a net loss of $1.9 million in 1994, and net income of $7.2 million in 1993. Net income (loss) as a percentage of net sales was 3.8% in 1995, (1.3%) in 1994 and 5.1% in 1993.\nSeasonality\nThe Company typically experiences more demand for its products during the summer than during the winter.\nInflation\nInflation has not had a material effect on the Company's business to date. Management believes that the effects of inflation and changing prices were successfully managed in 1995, with both margins and earnings being protected through a combination of pricing adjustments, cost control programs and productivity gains.\nLiquidity and Capital Resources\nThe Company's working capital at December 30, 1995 was approximately $51.0 million as compared to $37.5 million at December 31, 1994. This $13.5 million increase was primarily due to increases of $14.6 million in cash and cash equivalents.\nNet cash provided by operations in 1995 was approximately $15.9 million. Approximately $7.5 million was used for net additions to property, plant and equipment, primarily for the new plant in St. Albans, Vermont that began production in 1995. At December 30, 1995 cash and cash equivalents were $35.4 million.\nInventories have decreased slightly since the end of December 1994 from $13.5 million to $12.6 million at December 30, 1995. Accounts receivable has increased $1.8 million since December 31, 1994 from $9.9 million to $11.7 million at December 30, 1995. This increase is due to increased sales for the month of December, 1995 as compared with December, 1994 as well as increased international sales which have a longer collection cycle than domestic sales.\nDuring the second quarter of 1989, the Company entered into a manufacturing and warehouse agreement with Edy's Grand Ice Cream, a subsidiary of Dreyer's Grand Ice Cream, Inc., to manufacture product at Edy's plant in Fort Wayne, Indiana in accordance with specifications and quality control provided by the Company and using dairy products from Vermont. This agreement expired in September 1995. This agreement assisted the Company in meeting its demand prior to and during the construction period of the Company's new plant in St. Albans, Vermont. Because per unit manufacturing costs were higher under this agreement than at the Company's plants, this agreement had an adverse impact on the Company's gross profit as a percentage of net sales throughout its term.\nIn October 1992, the Company began construction of a new third plant in St. Albans, Vermont. At December 30, 1995, the Company has spent approximately $38.2 million to date, net of the 1994 $6.8 million write-down of certain assets, on building and equipping the new plant ($6.2 million in 1995 of which $1.2 million was transferred from the temporary facility at the St. Albans Cooperative) and anticipates additional capital costs for the St. Albans plant of approximately $1.9 million in 1996. The cost of building and equipping the new plant, net of the 1994 $6.8 million write-down of certain assets is currently estimated to be approximately $40.1 million.\nIn addition to the $6.2 million construction expenditures for the new plant, other capital expenditures in 1995 totaled $2.5 million. These projects included equipment upgrades at the Waterbury and Springfield plants.\nIn addition to $1.9 million of capital expenditures to complete the new plant at St. Albans, the Company anticipates other capital expenditures in 1996 of approximately $10.6 million. Substantially all of these additional projected capital expenditures relate to equipment upgrades in Waterbury and Springfield, leasehold improvements at the Company's headquarter offices in South Burlington, Vermont, and computer related expenditures, with a small proportion for equipment enhancements at the St. Albans plant.\nThe Company's long-term debt includes $30 million aggregate principal amount of Senior Notes issued in 1993 and 1994, which are held in cash equivalents pending their use in the business.\nOn December 29, 1995, the Company extended two line of credit agreements, for an aggregate of $20 million, with The First National Bank of Boston and Key Bank of Vermont. These are unsecured agreements providing for borrowings from time to time, expiring September 29, 1998 and December 29, 1998, respectively. The agreements specify interest at either the banks' Base Rate or the Eurodollar rate plus a maximum of 1.25%. As of March 28, 1996 there have been no borrowings under these line of credit.\nManagement believes that internally generated funds, cash currently on hand, investments held in cash equivalents (pending their use in the business), and equipment lease financing and\/or borrowings under the Company's two unsecured bank lines of credit will be adequate to meet anticipated operating and capital requirements.\nForward-Looking Statements\nThis section, as well as other portions of this document, includes certain forward-looking statements about the Company's business and new products, sales and expenses, effective tax rate and operating and capital requirements. In addition, forward-looking statements may be included in various other Company documents to be issued in the future and in various oral statements by Company representatives to security analysts and investors from time to time. Any such statements are subject to risks that could cause the actual results or needs to vary materially. These risks are discussed below in \"Risk Factors\" in this document.\nRisk Factors\nDependence on Independent Ice Cream Distributors. The Company is dependent on maintaining satisfactory relationships with independent ice cream distributors that now generally act as the Company's exclusive or master distributor in their assigned territories. While the Company believes its relationships with Dreyer's and its other distributors generally have been satisfactory and have been instrumental in the Company's growth, the Company has at times experienced difficulty in maintaining such relationships. Available distribution alternatives are limited. Accordingly, there can be no assurance that difficulties in maintaining relationships with distributors, which may be related to actions by the Company's competitors or by one or more of the Company's distributors themselves (or their controlling persons), will not have a material adverse effect on the Company's business. The loss of one or more of the Company's principal distributors or termination of one or more of the related distribution agreements could have a material adverse effect on the Company's business. See \"Business - Markets and Customers.\"\nGrowth in sales and earnings. In 1995, net sales of the Company increased 4.4% to $155 million from $149 million in 1994. Pint volume decreased 1.5% compared to 1994. The Company believes this decrease is consistent with the recent performance in the super premium category overall excluding sorbet, which contributed more growth than the total increase in the super premium category from 1994 to 1995. Given these overall domestic super premium industry trends, the successful introduction of innovative flavors on a periodic basis has become increasingly important to any sales growth by the Company. Accordingly, the future degree of market acceptance of the Company's sorbet line, which is being introduced February through May 1996, and which will be accompanied by a significant increase in promotional expenditures is likely to have an important impact on the Company's 1996 and future financial results. See \"Management's Discussion and Analysis of Financial Conditions and Results of Operations.\"\nCompetitive Environment. The super premium frozen dessert market is highly competitive with the distinctions between the super premium category, and the \"adjoining\" premium category less marked than in the past and with the domestic super premium frozen dessert category showing a recent decline in industry sales, except for sorbet. And, as noted above, the ability to successfully introduce innovative flavors on a periodic basis that are accepted by the marketplace is a significant competitive factor. In addition, the Company's principal competitors are large, diversified companies with resources significantly greater than the Company's. The Company expects strong competition to continue, including competition for adequate distribution and competition for the limited shelf space for the frozen dessert category in supermarkets and other retail food outlets. See \"Business-Competition\" and \"Business-The Super Premium Frozen Dessert Market.\"\nReliance on a limited number of Key Personnel. The success of the Company is significantly dependent on the services of Robert Holland, Jr., the Chief Executive Officer and a limited number of executive managers working under Mr. Holland, as well as certain continued services of Ben Cohen, the Chairperson of the Board and co-founder of the Company; and Jerry Greenfield, Vice Chairperson and co-founder of the Company. Loss of the services of any of these persons could have a material adverse effect on the Company's business. See \"Directors and Executive Officers of the Company.\"\nThe Company's Social Mission. The Company's basic business philosophy is embodied in a three-part \"mission statement,\" which includes a \"social mission\" to \"operate the Company...[to] improve the quality of life of our employees and a broad community: local, national and international.\" The Company believes that implementation of its social mission, which is integrated into the Company's business, has been beneficial to the Company's overall financial performance. However, it is possible that at some future date the amount of the Company's energies and resources devoted to its social mission could have a material adverse financial effect on the Company's business. See \"Business-History and Philosophy of the Company\" and \"Business-Marketing.\"\nControl of the Company. The Company has two classes of common stock - the Class A Common Stock, entitled to one vote per share, and the Class B Common Stock, entitled, except to the extent otherwise provided by law, to ten votes per share. Ben Cohen, Jerry Greenfield, Fred Lager and Jeffrey Furman (collectively, the \"Principal Stockholders\") hold shares representing 48.0% of the aggregate voting power in elections for directors, permitting them as a practical matter to elect all members of the Board of Directors and thereby effectively control the business, policies and management of the Company. Because of their significant holdings of Class B Common Stock, the Principal Stockholders may continue to exercise this control even if they were to sell substantial portions of their Class A Common Stock. See \"Security Ownership of Certain Beneficial Owners and Management.\"\nIn addition, the Company has issued all of the Class A Preferred Stock to the Foundation. All current directors of the Foundation are directors and or employees of the Company. The Preferred Stock gives the Foundation a special class voting right to act with respect to certain Business Combinations (as defined in the Company's charter) and effectively limits the voting rights that holders of the Class A Common Stock and Class B Common Stock, the owners of virtually all of the equity in the Company, would otherwise have with respect to such Business Combinations. See \"Business- The Ben & Jerry's Foundation.\"\nWhile the Board of Directors believes that the Class B Common Stock and the Preferred Stock are important elements in keeping Ben & Jerry's an independent Vermont-based business, the Class B Common Stock and the Preferred Stock may be deemed to be \"anti-takeover\" devices (and thus may be deemed to have the potential for adverse consequences on the business) in that the Board of Directors believes the existence of these securities will make it difficult for a third party to acquire control of the Company on terms opposed by the holders of the Class B Common Stock, including primarily the Principal Stockholders, or The Foundation, or for incumbent management and the Board of Directors to be removed.\nInternational. The Company's principal competitors have substantial market shares in various countries outside the United States, principally Europe and Japan. The Company has limited international sales to date, but is investigating the possibility of international expansion. However, there can be no assurance that the Company will be successful in entering, on a long-term profitable basis, such international markets as it selects.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe response to this Item is in Item 14(a) 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 COMPANY\nDirectors and Executive Officers\nThe directors and executive officers of the Company are as follows:\nName Age Office - ---- --- ------ Ben Cohen............ 44 Chairperson and Director Robert Holland Jr.... 55 President, Chief Executive Officer and Director Jerry Greenfield..... 44 Vice Chairperson and Director Elizabeth Bankowski.. 48 Director and Director of Social Mission Merritt C. Chandler.. 79 Director Jeffrey Furman....... 52 Director Fred Lager........... 41 Director\nFrederick A. Miller.. 49 Director Henry Morgan......... 70 Director Frances Rathke....... 35 Chief Financial Officer, Treasurer and Secretary Bruce Bowman......... 43 Senior Director of Operations Jerry Welsh.......... 50 Consultant and Acting Director of Marketing and Sales\nAll directors hold office until the 1996 annual meeting of stockholders of the Company and until their successors are elected and qualified. The Board of Directors has an Audit Committee on which Messrs. Morgan, Chandler and Lager (Chairperson) serve and a Compensation Committee on which Messrs. Morgan (Chairperson), Chandler, Furman and Miller serve. Officers serve until their successors are elected and qualified.\nBen Cohen, a founder of the Company, has served as Chairperson of the Board of Directors since February 1989. From January 1, 1991 through January 29, 1995 he was the Chief Executive Officer of the Company. Mr. Cohen has been a director of the Company since 1977. Mr. Cohen is a director of Community Products, Inc., a manufacturer of Rain Forest Crunch candy, Blue Fish Clothing, Inc., and Social Venture Network.\nRobert Holland Jr. has served as President and Chief Executive Officer since January 1995. Mr. Holland has served as a director of the Company since March 1995. Prior to this Mr. Holland served as Chairperson and Chief Executive Officer of ROHKER-J, a consulting firm for Fortune 500 companies since 1991. Mr. Holland served as Chairperson and Chief Executive Officer of Gilreath Manufacturing, Inc. from March 1990 until 1991. From 1968 until 1991 Mr. Holland also served as an associate and then partner of McKinsey & Company, Inc. where he managed projects for global concerns involving operational, strategic and marketing issues. Mr. Holland is Chairperson of the Board of Trustees at Spelman College, a trustee of Atlanta University Center and Mutual of New York and is a member of the Board of Directors of Frontier Corporation, TrueMark Manufacturing Company and the Harlem Junior Tennis Program.\nJerry Greenfield, a founder of the Company, has served as director and Vice Chairperson of the Board of Directors since 1990.\nElizabeth Bankowski has served as Director of Social Mission Development since December 1991. Ms. Bankowski has been a director of the Company since 1990.\nMerritt C. Chandler has served as a director of the Company since 1987. Mr. Chandler has been Business Manager of the Addison, Vermont Central Supervisory Union, a group of school districts, since 1985. Mr. Chandler serves as a member of the Compensation Committee of the Board of Directors and as a member of the Audit Committee of the Board of Directors.\nJeffrey Furman has been a consultant to the Company since March 1991. Prior to that Mr. Furman was an Officer of the Company. He has served as a director of the Company since 1982. Mr. Furman serves as a member of the Compensation Committee of the Board of Directors.\nFred Lager is currently a consultant to the Company. Prior to this Mr. Lager served as President and Chief Executive Officer of the Company from February 1989 until 1991. Mr. Lager has served as a director of the Company since 1982. He currently serves as Chairperson of the Audit Committee of the Board of Directors. Mr. Lager is a director of Working Assets Funding Service and Whole Foods Market, Inc., the largest chain of natural food supermarkets in the country.\nFrederick A. Miller has served as a director of the Company since 1992. Since 1985, he has been President of the Kaleel Jamison Consulting Group, Inc., a strategic cultural change and management consulting firm. Mr. Miller serves as a member of the Compensation Committee of the Board of Directors.\nHenry Morgan has served as a director of the Company since 1987. Mr. Morgan serves as Chairperson of the Compensation Committee and as a member of the Audit Committee of the Board of Directors. He is President and sole director of Symbolics, Inc., a corporation which has filed for protection under Chapter 11 of the United State Bankruptcy Code. He is also a director of Cambridge Bancorporation.\nFrances Rathke has served as Chief Financial Officer and Chief Accounting Officer of the Company since April, 1990 and Secretary and Treasurer effective January 1, 1991. Prior to this, Ms. Rathke was Controller of the Company.\nJerry Welsh is a consultant for the Company with responsibility for Sales and Marketing since October 1995. Jerry Welsh is President of Welsh Marketing Associates, Inc. which he formed in 1988. Prior to this, Mr. Welsh was Senior Executive Vice President for The E. F. Hutton Group, Inc.\nBruce Bowman has served as Senior Director of Operations since August 1995. Prior to this, Mr. Bowman was Senior Vice President of Operations at Tom's Foods, Inc., a food manufacturing company from April 1991 until August 1995.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nSummary Compensation Table\nThe following table sets forth the cash compensation paid by the Company in Fiscal Years 1993 - 1995 as well as certain other compensation paid, awarded or accrued for those years to the Company's Chief Executive Officer (Ben Cohen was CEO prior to Robert Holland's election in January 1995) and the Company's other executive officers at the end of the 1995 fiscal year whose total salary and bonuses for 1995 exceeded $100,000:\nDirectors who are not employees or full-time consultants of the Company receive $9,000 per year plus expenses. On December 17, 1992, two non-employee directors, Mr. Chandler and Mr. Morgan, each received awards of 1,000 shares of the Company's Class A Common Stock under the 1992 Non-Employee Directors' Restricted Stock Plan. The shares had a market value on the date of grant of $28.50 per share.\nThe Company has also adopted the 1995 Non-Employee Directors Plan for Stock in lieu of Directors Cash Retainer under which directors may elect to be paid annually, in lieu of the cash retainer for Board services, shares of common stock having a fair market value (as of the date of payment) equal to the amount of such annual retainer. This plan was not implemented with respect to the year 1995.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following table sets forth certain information as of March 8, 1996 with respect to the beneficial ownership of the outstanding shares of Class A Common Stock, Class B Common Stock and Preferred Stock by (i) all persons owning of record, or beneficially to the knowledge of the Company, more than five percent of the outstanding shares of Class A Common Stock, Class B Common Stock or Preferred Stock, (ii) each director and executive officer of the Company individually, (iii) all directors and officers of the Company as a group and (iv) The Ben & Jerry's Foundation, Inc. The mailing address of each of the persons shown and of the Foundation is c\/o the Company, 115 Kimball Avenue, South Burlington, Vermont 05403.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nMr. Greenfield, Vice Chairperson, is also a director and President of the Foundation. Mr. Furman is a director of the Foundation.\nDuring the year ended December 30, 1995, the Company purchased Rain Forest Crunch cashew-brazilnut buttercrunch candy to be included in Ben & Jerry's Rain Forest Crunch flavor ice cream for an aggregate purchase price of approximately $1,500,000 from Community Products, Inc., a company of which Messrs. Cohen and Furman are the principal stockholders and of which Mr. Cohen is also president. Mr. Lager was a director until January 1994. The candy was purchased from Community Products, Inc. at competitive prices and on standard terms and conditions. Although the Company expects to purchase additional quantities of candy from Community Products, Inc., termination of Ben & Jerry's relationship with this supplier would not have a material effect on the Company's business.\nSubsequent to year-end 1990, Messrs. Lager and Furman retired as employees of the Company and as President (and Chief Executive Officer) and Secretary, respectively. Messrs. Lager and Furman first provided services to the Company in 1982 and 1978, respectively, and have been instrumental, along with the co-founders of the Company, in its emergence as a leading super premium ice cream business and a socially responsible Vermont company. The Board has approved the following employment termination arrangements for Messrs. Lager and Furman, each of whom remains a director of the Company and a consultant to the Company.\nUnder the terms of the Employment Agreement dated January 1, 1984 between the Company and Mr. Lager, Mr. Lager is entitled, in consideration of his covenant not to compete for the period of two years after termination of employment, to severance compensation during that two year period at his annual base salary level in effect on the date of termination of employment ($100,000 per year). The Employment Agreement was amended (i) to extend the termination date from December 31, 1989 to February 2, 1991, (ii) to provide that the Company pay for family health insurance coverage under the Company's regular employee health insurance plan for a twelve year period after termination, (iii) to transfer to Mr. Lager a $1 million life insurance policy presently held by the Company on Mr. Lager's life and to provide for continued payment by the Company of the premiums due on the life insurance policy (currently $11,745 per year) until the date when the policy becomes \"self-funding\", which is estimated to be December 31, 2002, and (iv) to extend the non-compete provisions for an additional three years (without any additional payment) beyond the two-year post-employment non-competition period provided for in the original Employment Agreement.\nUnder the terms of a Consulting Agreement dated as of January 17, 1991 (the \"Original Consulting Agreement\"), Mr. Lager agrees to furnish management consulting services to the Company upon the Company's request (up to approximately 40 hours per month, at the Company's request, subject to holidays and vacations) for a five- year period, commencing February 3, 1991, with compensation being paid at the rate of $75,000 for the first year, and with $5,000 annual increases for each of the following four years. Under the Agreement Mr. Lager has agreed not to compete with the Company during the term of and for a period of two years following the expiration of the Agreement.\nMr. Lager's Original Consulting Agreement was amended in 1994 and 1995 to reflect additional consulting services during the period the Company was searching for a new Chief Executive Officer and while Mr. Lager was Acting Director of Manufacturing. Mr. Lager furnished full-time management consulting services and was compensated at the rate of $3,300 per week plus reasonable out-of-pocket expenses for the period July 1, 1994 through December 31, 1994. For the period January 1, 1995 through August 31, 1995, Mr. Lager was compensated at the rate of $4,615 per week in addition to payments at the rate due under the Original Consulting Agreement, plus reasonable out-of-pocket expenses. Commencing September 1995, Mr. Lager is providing only part-time consulting services called for under the Original Consulting Agreement at the rate provided therein, which is now $8,333 per month, plus reasonable out-of-pocket expenses. In 1994 and 1995, Mr. Lager was paid $147,217 and $235,902. The term of his Original Consulting Agreement, as extended by the 1994-1995 amendment, is July 31, 1996.\nUnder the terms of a Severance and Non-Competition Agreement dated as of December 31, 1990, Mr. Furman was entitled to two-year severance\/non-competition payments similar to those paid to Mr. Lager. Under the terms of the Agreement, Mr. Furman was entitled, as severance and in consideration of his covenant not to compete for a period of five years after termination of employment, to compensation payable for the first two years after termination on March 2, 1991 at the annual rate of $60,000. The Severance and Non-Competition Agreement also provides for the Company to pay for family health insurance coverage under the Company's regular employee health insurance plan for an eight-year period after termination. In 1995, Mr. Furman was paid $51,938 for consulting services in connection with his work on behalf of the Company as the Chair of the CEO Search Committee and consultant for certain projects including the Russian joint venture, franchise partnershops and alternative supplier arrangements.\nMr. Holland was hired January 30, 1995 as President and Chief Executive Officer and replaced Mr. Lacy as a Director in March 1995. Under Mr. Holland's Employment Agreement which has a term of four years, Mr. Holland is entitled to a base salary of $250,000 per year, subject to increase from time to time by the Board of Directors, and an annual incentive award payable in cash or vested shares of Class A Common Stock as determined by the Compensation Committee of the Board of Directors in an amount up to but not exceeding $125,000, with all or such portion thereof to be earned on a sliding scale based upon the extent to which the Committee determines that Mr. Holland has met in each fiscal year the objectives previously established for that year by the Compensation Committee. For 1995, the Incentive Award Objectives were financial objectives and for years 1996 and beyond the Objectives will be financial and non-financial in nature (i.e. Internal Culture and External Social Responsibility, etc.). Under the Company's 1985 Stock Option Plan, Mr. Holland received non- incentive stock options to purchase 180,000 shares of Class A Common Stock of the Company at an exercise price of $10 13\/16 per share equal to the fair market value at the date of grant. The options have a term of eight years and become exercisable at the rate of 20,000 shares a year for the first four years, and thereafter at the rate of 25,000 a year so long as Mr. Holland is an employee of the Company under this Agreement, provided that, in lieu of said \"regular\" annual vesting of options during the fifth through eighth years, options for 25,000 shares which are at the time the latest options to become \"regularly\" exercisable by the passage of time become exercisable, by acceleration, upon the Committee's determination by March 15th of each year, commencing March 15, 1996, that Mr. Holland has met the Non-Financial Option Objectives previously established for that fiscal year by the Committee. As of March 28, 1996 no options had been accelerated. The agreement provides for termination of employment by the Company for cause (as defined) and also provides for termination by the Company other than for cause or by Mr. Holland for good reason (as defined), in each of which events Mr. Holland is entitled to receive for the remaining period of the four year term his base salary and an amount equal to the average Incentive Award that was earned prior to termination under the Agreement times the period remaining and all options which could have become exercisable upon \"regular\" annual vesting prior to the end of the four year term shall be accelerated and become vested upon such termination. The Agreement also provides that during the term and for two years thereafter Mr. Holland will not compete with the Company.\nMr. Cohen, Chairperson and a director, has an employment agreement which has been extended for a term ending April 30, 1997. The agreement provided for a base salary, which may be increased by the Board (the Board has currently fixed such base salary at $150,000), and he is entitled to an incentive bonus at the discretion of the Board. The agreement also provides for certain medical benefits and a covenant not to compete during the term of the agreement and for a two year period thereafter, in consideration of payment by the Company (except as otherwise provided in the agreement) of the then-current base salary during the two-year period.\nMr. Greenfield, Vice Chairperson, a director and also a director and President of Ben & Jerry's Foundation, has an employment agreement which has been extended for a term ending April 30, 1997. The agreement provides for a base salary, which may be increased by the Board (the Board h as currently fixed such base salary at $150,000), and he is entitled to an incentive bonus at the discretion of the Board. The agreement also provides for certain medical benefits and a covenant not to compete during the term of the agreement and for a two-year period thereafter, in consideration of payment by the Company (except as otherwise provided in the agreement) of the then-current base salary during the two-year period.\nMr. Bowman, Senior Director of Operations, has an employment agreement dated August 21, 1995, which has a term of three years, expiring August 20, 1998. The agreement provides for an annual base salary, which may be increased by the Board (the Board has currently fixed such base salary at $160,000), and he is entitled to an incentive bonus, not exceeding 35% of his base salary (payable in cash and shares of Class A Common Stock under the Company's Restricted Stock Plan), as determined by the Chief Executive Officer, subject to approval of the Compensation Committee. The amount of the award for the 1995 short year was $40,000. The agreement also provides for stock options on 25,000 shares of Class A Common Stock which were granted in August, 1995, vesting over a period of six years, commencing January 1, 1997. The agreement also provides for medical, life insurance, 401(k)plan and other employee benefits, a covenant not to compete during the term of the agreement and for a two-year period thereafter, and for one year's continuation of then-current base salary and annual incentive award at the rates in effect on the date of termination of his employment by the Company without cause.\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, AND FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON FORM 8-K\n(a) List of financial statements and financial statement schedule:\nForm 10-K Page No. --------\n(1) The following consolidated financial statements are included in Item 8:\nConsolidated Balance Sheets as of December 30, 1995 and December 31, 1994\nConsolidated Statements of Operations for the years ended December 30, 1995, December 31, 1994, and December 25,1993\nConsolidated Statements of Stockholders' Equity for the years ended December 30, 1995, December 31, 1994 and December 25, 1993\nConsolidated Statements of Cash Flows for the years ended December 30, 1995, December 31, 1994 and December 25, 1993\nNotes to Consolidated Financial Statements to\n(2) The following financial statement schedule is included in Item 14 (d)\nSCHEDULE II - Valuation and Qualifying Accounts\nAll other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted.\n(3) The 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 Exchange Act of 1934 and are referred to and incorporated herein by reference to such filings.\nExhibit No. - -----------\n3.1 Articles of Association, as amended, of the Company (filed with the Securities and Commission as Exhibit 3.1 and 3.1.1 to the Company's Registration Statement on Form-1 (File No. 33-284) and incorporated herein by reference).\n3.1.1 Amendment to Articles of Association on June 27, 1987 (filed as Exhibit 1 to the Company's Quarterly Report on Form 10-Q for the period ended June 30, 1987 and incorporated herein by reference).\n3.1.2 Amendment to Articles of Association on September 7, 1993 (filed as Exhibit 1 to the Company's Quarterly Report on Form 10-Q for the period ended June 26, 1993 and incorporated herein by reference).\n3.1.3 Amendment to Articles of Association on August 4, 1995 (filed as Exhibit 3.1.3 to the Company's Quarterly Report on Form 10-Q for the period ended July 1, 1995 and incorporated herein by reference).\n3.2 By-laws as amended through November 10, 1995 (filed as Exhibit 3.2.2 to the Company's Report on Form 10-Q for the period ended September 30, 1995 and incorporated herein by reference).\n3.2.1 Section 2 of Article 5 of the By-laws as amended on January 18, 1996 (filed herewith).\n4.1 See Exhibit 3.1.\n4.2 See Exhibit 3.2\n4.3 Mortgage and Security Agreement among the State of Vermont, the Company and the Howard Bank, N.A. (filed as Exhibit 4.1 to the Company's Registration Statement on Form S-1 (file no. 33-284) and incorporated herein by reference).\n4.4 Guaranty by the Company accepted by the Howard Bank, N.A., Trustee, and Marine Midland Bank, N.A., as amended (filed as Exhibits 4.2 and 4.2.1 to the Company's Registration Statement on Form S-1 (file no. 33-284) and incorporated herein by reference), as amended November 20, 1987 (filed as Exhibit 4.4 to the Company's Registration Statement on Form S-1 (file no. 33-17516) and incorporated by reference), as amended January 31 and March 10, 1989 (filed as Exhibit 4.4 to the Company's Annual Report on Form 10-K for the year ended December 31, 1988 and incorporated herein by reference).\n4.4.1 Amendment to item 4.4 dated July 28, 1992 (filed an Exhibit to the Company's Registration Statement on Form S-3 (file no. 33-51550) and incorporated herein by reference).\n4.5 Loan Agreement and Amendment between the Village of Waterbury, Vermont and the Company (filed as Exhibit 4.4 to the Company's Registration Statement on Form S-1(file no. 33-284) and incorporated herein by reference).\n4.6 Second Mortgage and Security Agreement dated December 11, 1984 between the Company and the Village of Waterbury, Vermont (filed as Exhibit 4.5 to the Company's Registration Statement on Form S-1 (file no. 33-284)and incorporated herein by reference).\n4.7 Grant Agreement between the Secretary of Housing and Urban Development and the Village of Waterbury, Vermont dated September 15, 1984 (filed as Exhibit 4.6 to the Company's Registration Statement on Form S-1 (file no. 33-284) and incorporated herein by reference).\n4.8 Form of Class A Common Stock Certificate (filed as Exhibit 4.8 to the Company's Registration Statement on Form S-1 (file no. 33-17516) and incorporated herein by reference).\n4.9 Form of Class B Common Stock Certificate (filed as Exhibit 4.9 to the Company's Registration Statement on Form S-1 (file no. 33-17516) and incorporated herein by reference).\n4.10 Omitted.\n4.11 Senior Note Agreement dated as of October 13, 1993 between Ben & Jerry's Homemade, Inc. and The Travelers Insurance Company and Principal Mutual Life Insurance Company (filed as Exhibit 1 to the Company's Quarterly Report on Form 10-Q for the period ended September 25, 1993 and incorporated herein by reference).\nThe registrant agrees to furnish a copy to the Commission upon request of any other instrument with respect to long-term debt (not filed as an exhibit), none of which relates to securities exceeding 10% of the total assets of the registrants.\n10.1 Employment Agreement between Bennett R. Cohen and the Company (filed as Exhibit 10.1 to the Company's Registration Statement on Form S-1 (file no. 33-284) and incorporated herein by reference).\n10.1.1 Amendment to Employment Agreement dated as of March 27,1991 (filed as Exhibit 10.1 to the Company's Registration Statement on Form S-1 (file no. 33-284) and incorporated herein by reference).\n10.1.2 Amendment to Employment Agreement dated as of May 1, 1995 (filed herewith).\n10.2 Employment Agreement between Fred Lager and the Company(filed as Exhibit 10.2 to the Company's Registration Statement on Form S-1 (file no. 33-284) and incorporated herein by reference).\n10.2.1 Amendment to Employment Agreement dated as of December 31, 1990 (filed as Exhibit 10.2.1 to the Company's Annual Report on Form 10-K for the year ended December 29, 1990 and incorporated herein by reference).\n10.2.2 Consulting Agreement between Fred Lager and the Company dated as of January 17, 1991 (filed as Exhibit 10.2.2 to the Company's Annual Report on Form 10-K for the year ended December 18, 1991 and incorporated herein by reference).\n10.2.3 Amendment to Consulting Agreement between Fred Lager and the Company dated as of July 1, 1994 (filed as Exhibit 10.2.3 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994 and incorporated herein by reference).\n10.2.4 Amendment to Consulting Agreement between Fred Lager and the Company dated as of January 1, 1995 (filed as Exhibit 10.2.4 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994 and incorporated herein by reference).\n10.3 Employment Agreement between Charles Lacy and the Company dated August 18, 1994 (filed as Exhibit 10.3 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994 and incorporated herein by reference).\n10.4 Employment Agreement dated May 1, 1995 between Jerry Greenfield and the Company (filed herewith).\n10.5 Settlement Agreement dated March 20, 1985 between the Company and Haagen-Dazs, Inc. (filed as Exhibit 10.8 to the Company's Registration Statement on Form S-1 (file no. 33-284) and incorporated herein by reference).\n10.6 Omitted.\n10.7 License Agreement between the Company and L.S. Heath & Sons, Inc. (filed as Exhibit 10.12 to the Company's Annual Report on Form 10-K for the year ended December 31, 1986 and incorporated herein by reference).\n10.8 Distribution Agreement between the Company and Dreyer's Grand Ice Cream, Inc. dated January 6, 1987 (filed as Exhibit 10.13 to the Company's Annual Report on Form 10-K For the year ended December 31, 1986 and incorporated herein by reference), as amended as of January 20, 1989 (filed as Exhibit 10.14 to the Company's Annual Report on Form 10-K for the year ended December 31, 1988 and incorporated herein by reference).\n10.8.1 Amendment to Item 10.8 dated August 31, 1992 (filed as Exhibit 28.1 to the Company's Registration Statement on Form S-3 (file no. 33-51550) and incorporated here-in by reference).\n10.8.2 Amendment to Item 10.8 dated April 18, 1994 filed as Exhibit 2 to the Company's Quarterly Report on Form 10-Q dated March 26, 1994 and incorporated here-in by reference).\n10.8.3 Subdistribution Agreement between the Company and Dreyer's Grand Ice Cream, Inc. dated February 7, 1994 (filed as Exhibit 1 to the Company's Quarterly Report on Form 10-Q dated March 26, 1994 and incorporated here-in by reference.)\n10.8.4 Amendment to Item 10.8.3 dated October 27, 1995 (filed herewith).\n10.9 License Agreement between the Company and Jerry Garcia and Grateful Dead Productions, Inc. dated July 26, 1987(filed as Exhibit 10.15 to the Company's Registration Statement on Form S-1 (file no. 33-17516) and incorporated herein by reference).\n10.10 Omitted.\n10.11 Area Franchise Agreement between the Company and Ben & Jerry's of Indiana Inc. dated November 18, 1987 (filed as Exhibit 10.20 to the Company's Registration Statement on Form S-1 (file no. 33-17516) and incorporated herein by reference).\n10.12 Omitted.\n10.13 Franchise Agreement between the Company and Ben & Jerry's of California, Inc. dated June 13, 1988 (filed as Exhibit 10.21 to the Company's Annual Report on Form 10-K for the year ended December 31, 1988 and incorporated herein by reference).\n10.13.1 Amendment to 10.13 effective December 17, 1990 (filed as Exhibit 10.13.1 to the Company's Annual Report on Form 10-K for the year ended December 25, 1993 and incorporated herein by reference).\n10.13.2 Amendment to 10.13 dated as of March 20, 1992 (filed as Exhibit 10.13.2 to the Company's Annual Report on Form 10-K for the year ended December 25, 1993 and incorporated herein by reference).\n10.14 Area Franchise Amended and Restated Agreement between the Company and Ben & Jerry's West Coast, Inc. dated March 27, 1992 (filed as Exhibit 10.13.2 on Form 10-K for the year ended December 25, 1993 and incorporated herein by reference).\n10.15 Franchise Agreement between the Company and BJ O\/R, a California limited partnership, dated June 9, 1993 (filed as Exhibit 2 to the Company's Quarterly Report on Form 10-Q for the period ended June 26, 1993 and incorporated herein by reference).\n10.16 Omitted.\n10.17 Lease between the Company and Stedeley Partnership dated November 30, 1988 (filed as Exhibit 10.25 to the Company's Annual Report on Form 10-K for the year ended December 31, 1988 and incorporated herein by reference).\n10.18 Manufacturing and Warehouse Agreement between the Company and Edy's Grand Ice Cream, a subsidiary of Dreyer's Grand Ice Cream, Inc. dated April 5, 1989 (filed as Exhibit 10.18 to the Company's Annual Report on Form 10-K for the year ended December 30, 1989 and incorporated herein by reference).\n10.18.1 Amendment to Item 10.18 dated September 18, 1992 (filed as Exhibit 10.18.1 to the Company's Annual Report on Form 10-K for the year ended December 25, 1993 and incorporated herein by reference).\n10.18.2 Amendment to Item 10.18 dated November 12, 1992(filed as Exhibit 10.18.2 to the Company's Annual Report on Form 10-K for the year ended December 25, 1993 and incorporated herein by reference).\n10.18.3 Amendment to Item 10.18 dated September 2, 1994 (filed as Exhibit 1 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 24, 1994 and incorporated herein by reference).\n10.19 1986 Restricted Stock Plan (filed as Exhibit 10.19 to the Company's Annual Report on Form 10-K for the year ended December 30, 1989 and incorporated herein by reference).\n10.20 1986 Employee Stock Purchase Plan (filed as Exhibit 4 to the Company's Registration Statements on Form S-8 (file nos. 33-9420 and 33-17594) and incorporated herein by reference).\n10.20.1 Amendment to Employee Stock Purchase Plan dated on August 4, 1995 (filed as Exhibit 10.20.1 on Form 10-Q for the period ended July 1, 1995 and incorporated herein by reference).\n10.21 1985 Stock Option Plan (filed as Exhibit 10.21 to the Company's Annual Report on Form 10-K for the year ended December 30, 1989 and incorporated herein by reference).\n10.21.1 1994 Amendment to 1985 Stock Option Plan (filed as Exhibit 10.21.1 to the Company's Annual Report on Form 10-K for the year ended December 30, 1994 and incorporated herein by reference).\n10.22 Ben & Jerry's Homemade, Inc. Employees' Retirement Plan as amended (filed as Exhibit 10.22 to the Company's Annual Report on Form 10-K for the year ended December 30, 1989 and incorporated herein by reference).\n10.22.1 Amendment to Item 10.22 dated January 1, 1990 (filed as Exhibit 10.22.1 to the Company's Report on Form 10-K for the year ended December 29, 1991 and incorporated herein by reference).\n10.22.2 Amendment to Item 10.22 dated June 28, 1990 (filed as Exhibit 10.22.2 to the Company's Report on Form 10-K for the year ended December 25, 1993 and incorporated herein by reference).\n10.22.3 Amendment to Item 10.22 dated January 1, 1991 (filed as Exhibit 10.22.3 to the Company's Report on Form 10-K for the year ended December 25, 1993 and incorporated herein by reference).\n10.23 1991 Restricted Stock Plan (filed as Exhibit 10.23 to the Company's Report on Form 10-K for the year ended December 25, 1993 and incorporated herein by reference).\n10.24 Severance\/Non-Competition Agreement dated as of December 31, 1990 between Jeffrey Furman and the Company (filed as Exhibit 10.24 to the Company's Report on Form 10-K for the year ended December 25, 1993 and incorporated herein by reference).\n10.25 Omitted.\n10.26 Directors and Officers Liability Insurance Policy, dated February 24, 1995 (filed as Exhibit 10.26 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994 and incorporated herein by reference).\n10.26.1 Directors and Officers Liability Insurance Policy, Binder dated February 24, 1996 (filed herewith)\n10.27 1992 Non-employee Directors' Restricted Stock Plan (filed as Exhibit 10.27 to the Company's Annual Report on Form 10-K for the year ended December 25, 1993 and incorporated herein by reference).\n10.28 Employment Agreement between Robert Holland Jr. and the Company dated January 30, 1995, (filed as Exhibit 10.28 to the Company's Report on Form 10-K for the year ended December 31, 1994 and incorporated herein by reference).\n10.29 1995 Equity Incentive Plan (filed as Exhibit 10.29 to the Company's Quarterly Report on Form 10-Q for the period ended July 1, 1995 and incorporated herein by reference).\n10.30 Non-Employee Director's Plan For Stock In Lieu of Directors' Cash Retainer Dated August 4, 1995 (filed as Exhibit 10.30 to Form 10-Q quarter ended July 1, 1995 and incorporated herein by reference).\n10.31 Employment Agreement dated August 21, 1995 between the Company and Bruce Bowman (filed herewith).\n10.32 Lease dated February 1, 1996 between the Company and Technology Park Associates, Inc. (filed herewith).\n11.0 Statement Re: Computation of Per Share Earnings (filed herewith).\n21.1 Subsidiaries of the registrant as of December 30, 1995 (filed herewith).\n23.1 Consent of Ernst & Young LLP (filed herewith).\n(b) No Current Reports on Form 8-K were filed during the fourth quarter of 1995.\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.\nBEN & JERRY'S HOMEMADE, INC.\nDated: March 28, 1996 By: __________________________ \/s\/Robert Holland Jr. President and CEO\nPursuant 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 date indicated.\nMarch 28, 1996 ____________________________________ \/s\/Elizabeth Bankowski Director, Director of Social Mission Development\nMarch 28, 1996 ____________________________________ \/s\/Merritt C. Chandler Director\nMarch 28, 1996 ____________________________________ \/s\/Bennett R. Cohen Director and Chairperson\nMarch 28, 1996 ____________________________________ \/s\/Jeffrey Furman Director\nMarch 28, 1996 ____________________________________ \/s\/Jerry Greenfield Director and Vice Chairperson\nMarch 28, 1996 ____________________________________ \/s\/Robert Holland Jr. Director, President and Principal Executive Officer\nMarch 28, 1996 ____________________________________ \/s\/Fred E. Lager Director\nMarch 28, 1996 ____________________________________ \/s\/Frederick A. Miller Director\nMarch 28, 1996 ____________________________________ \/s\/Henry Morgan Director\nMarch 28, 1996 ____________________________________ \/s\/Frances Rathke Principal Financial Officer and Principal Accounting Officer\nANNUAL REPORT ON FORM 10-K\nITEM 8, ITEM 14(a)(1) and (2),(c)and(d)\nLIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE\nCERTAIN EXHIBITS\nFINANCIAL STATEMENT SCHEDULE\nYEAR ENDED DECEMBER 30, 1995\nBEN & JERRY'S HOMEMADE INC.\nSOUTH BURLINGTON, VERMONT\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE\nReport of Independent Auditors.............................................F-1\nConsolidated Balance Sheets as of December 30, 1995 and December 31, 1994..............................................................F-2\nConsolidated Statements of Operations for the years ended December 30, 1995, December 31, 1994, and December 25, 1993..................................................................F-3\nConsolidated Statements of Stockholders' Equity for the years ended December 30, 1995, December 31, 1994, and December 25, 1993............................................................... .F-4\nConsolidated Statements of Cash Flows for the years ended December 30, 1995, December 31, 1994, and December 25, 1993..................................................................F-5\nNotes to Consolidated Financial Statements.........................F-6 to\nFinancial Schedule:\nSCHEDULE II - Valuation and Qualifying Accounts... ......................F-17\nReport of Ernst & Young LLP, Independent Auditors\nThe Board of Directors and Stockholders Ben & Jerry's Homemade, Inc.\nWe have audited the accompanying consolidated balance sheets of Ben & Jerry's Homemade, Inc. as of December 30, 1995 and December 31, 1994, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 30, 1995. 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 Ben & Jerry's Homemade, Inc. at December 30, 1995 and December 31, 1994 and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 30, 1995 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 26, 1996\nBen & Jerry's Homemade, Inc.\nConsolidated Statements of Operations (In thousands except per share data)\nSee accompanying notes.\nBen & Jerry's Homemade, Inc.\nConsolidated Statements of Stockholders' Equity (In thousands except share data)\nSee accompanying notes.\nBen & Jerry's Homemade, Inc.\nConsolidated Statements of Cash Flows (In thousands)\nSee accompanying notes.\nBen & Jerry's Homemade, Inc.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SIGNIFICANT ACCOUNTING POLICIES\nBusiness Ben & Jerry's Homemade, Inc. (the Company) makes and sells super premium ice cream and other frozen dessert products through distributors and directly to retail outlets, including Company-owned and franchised ice cream parlors.\nPrinciples of Consolidation The consolidated financial statements include the accounts of the Company and all its wholly-owned subsidiaries. Intercompany accounts and transactions have been eliminated.\nUse of Estimates The preparation of the financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.\nFiscal Year The Company's fiscal year is a fifty-two or fifty-three week period ending on the last Saturday in December. 1995 was fifty-two weeks, 1994 was fifty-three weeks and 1993 was fifty-two weeks. The effect of the additional week on 1994's results of operations was not material.\nInventories Inventories are stated at the lower of cost or market. Cost is determined by the first-in, first-out method.\nCash Equivalents Cash equivalents represent highly liquid investments with maturities of three months or less at date of purchase.\nInvestments Management determines the appropriate classification of debt securities at the time of purchase and reevaluates such designation as of each balance sheet date. Marketable 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 shareholders' equity. The amortized cost of debt securities in this category is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization is included in interest income. Realized gains and losses and declines in value judged to be other-than-temporary on available-for-sale securities are included in income. The cost of securities sold is based on the specific identification method. Interest and dividends on securities classified as available-for-sale are included in investment income.\nConcentration of Credit Risk Financial instruments, which potentially subject the Company to significant concentration of credit risk, consist of cash, investments and trade accounts receivable. The Company places its investments in highly rated financial institutions around the country, obligations of the United States Government and investment grade short-term instruments. No more than 20% of the total investment portfolio shall be in any one issuer or guarantor other than United States Government instruments which limits the amount of credit exposure. The Company sells its products primarily to well established frozen dessert distribution companies throughout the United States and the United Kingdom. The Company performs ongoing credit evaluations of its customers and maintains reserves for potential credit losses. Historically, the Company has not experienced significant losses related to investments or trade receivables.\nBen & Jerry's Homemade, Inc.\nNotes to Consolidated Financial Statements (continued) Dollars in tables in thousands except share data\nProperty, Plant and Equipment Property, plant and equipment are carried at cost. Depreciation, including amortization of leasehold improvements, is computed using the straight-line method over the estimated useful lives of the related assets. Amortization of assets under capital leases is computed on the straight-line method over the lease term and is included in depreciation expense.\nTranslation of Foreign Currencies Assets and liabilities of the Company's foreign operations are translated into United States dollars at exchange rates in effect on the balance sheet date. Income and expense items are translated at average exchange rates prevailing during the year. Translation adjustments are accumulated as a separate component of stockholders' equity. Transaction gains or losses are recognized as other income or expense in the period incurred. Transaction gains or losses have been immaterial for all periods presented.\nRevenue Recognition The Company recognizes revenue and the related costs when product is shipped. The Company recognizes franchise fees as income for individual stores when services required by the franchise agreement have been substantially performed and the store opens for business. Franchise fees relating to area franchise agreements are recognized in proportion to the number of stores for which the required services have been substantially performed. Franchise fees recognized as income were approximately $166,000, $82,000 and $103,000 in 1995, 1994 and 1993, respectively. These amounts have been included in net sales.\nAdvertising Advertising costs are expensed as incurred. Advertising expense ( excluding cooperative advertising with distribution companies) amounted to approximately $ 4.3 million , $5.0 million, and $1.6 million for the years ended December 30, 1995, December 31, 1994 and December 25, 1993.\nIncome Taxes The Company accounts for income taxes under the liability method in accordance with Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (SFAS 109). Under the liability method, deferred tax liabilities and assets are recognized for the tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities.\nStock Based Compensation The Company grants stock options for a fixed number of shares with an exercise price equal to the fair value of the shares at the date of the grant. The Company accounts for stock option grants in accordance with APB Opinion No. 25, \"Accounting for Stock Issued to Employees\" and intends to continue to do so. Accordingly, no compensation expense for stock option grants is recognized.\nEarnings Per Share Primary earnings per common share is computed based on the weighted average number of shares of Class A and Class B Common Stock outstanding during the period, and for incremental shares assumed issued for dilutive common stock equivalents. Fully diluted earnings per share did not differ materially from primary earnings per share.\nImpact of Recently Issued Accounting Standards In March 1995, the FASB issued Statement No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of\" which requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amount. Statement 121 also addresses the accounting for long-lived assets that are expected to be disposed of. The Company will adopt Statement 121 in the first quarter of 1996 and, based on current circumstances, does not believe the effect of the adoption will be material.\nBen & Jerry's Homemade, Inc.\nNotes to Consolidated Financial Statements (continued) Dollars in tables in thousands except share data\n2. INVENTORIES\n1995 1994 ---- ----\nIce cream and ingredients $ 11,480 $ 12,395 Paper goods 674 486 Food, beverages, and gift items 462 582 ------------------ ----------------- $ 12,616 $ 13,463 ================== =================\nThe Company purchases certain ingredients (approximately $1,500,000 annually) from a company owned by the Company's Chairperson and a member of the Board of Directors.\n3. PROPERTY, PLANT AND EQUIPMENT\nEstimated Useful Lives\/ 1995 1994 Lease Term ---- ---- ----------\nLand and improvements ............... $ 3,575 $ 2,456 15-25 years Land under capital lease ............ 866 866 Buildings ........................... 35,644 13,234 25 years Equipment and furniture ............. 41,324 26,771 3-20 years Equipment under capital lease ....... 934 934 5 years Leasehold improvements .............. 1,277 2,002 3-10 years Construction in progress ............ 740 32,269 --- ------ 84,360 78,532 Less accumulated depreciation ....... 24,760 20,551 ------ ------ $59,600 $57,981 ======= =======\nAccumulated depreciation at December 30, 1995 and December 31, 1994, included accumulated amortization of $902,000 and $874,000 respectively, related to assets under capital lease.\nBen & Jerry's Homemade, Inc.\nNotes to Consolidated Financial Statements (continued) Dollars in tables in thousands except share data\n4. CASH AND INVESTMENTS\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.\" As required under the Statement, the Company adopted the provisions of the new standards as of the beginning of 1994. In accordance with the Statement, prior period financial statements have not been restated to reflect the change in accounting principle. The cumulative effect of adopting Statement 115 did not have a material effect on the Company's financial statements.\nThe Company's cash and investments in debt securities available-for-sale are carried at fair value, which approximates cost, as summarized below:\n1995 1994 ------- -------\nMunicipal bonds .......................................... $16,507 $ 9,003\nU.S. corporate securities ................................ 14,139 10,000 ------- ------- Total debt securities available-for-sale ........ 30,646 19,003\nCash, cash equivalents and money market accounts ......... 5,760 9,775 ------- ------- Total cash, cash equivalents and investments .... $36,406 $28,778 ======= =======\nAll debt securities at December 30, 1995 have maturities of less than twelve months. Certain debt securities have been classified as long-term to reflect their intended use to finance capital projects.\nInvestments in debt securities mature at par in thirty to forty-five day intervals, at which time the stated interest rates are reset at the then market rate. Gross purchases and maturities aggregated $94,500,000 and $83,525,000 in 1995, and $81,400,000 and $91,960,000 respectively in 1994.\n5. ACCOUNTS PAYABLE AND ACCRUED EXPENSES\n1995 1994 ------- ------- Trade accounts payable ........................... $ 7,283 $ 5,075 Accrued expenses ................................. 6,071 2,627 Accrued construction costs ....................... 51 2,975 Accrued payroll and related costs ................ 1,749 1,607 Accrued promotional costs ........................ 1,313 1,580 Other ............................................ 125 51 ------- ------- $16,592 $13,915 ======= =======\nBen & Jerry's Homemade, Inc.\nNotes to Consolidated Financial Statements (continued) Dollars in tables in thousands except share data\n6. LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS\nProperty, plant and equipment having a net book value of approximately $18,872,000 at December 30, 1995 is pledged as collateral for certain long-term debt.\nLong-term debt and capital lease obligations at December 30, 1995 maturing in each of the next five years and thereafter are as follows:\nCapital lease Long-term obligations debt ----------- ----\n1996 $ 114 $ 382 1997 581 343 1998 15 5,411 1999 15 5,295 2000 15 5,229 Thereafter 245 14,994 --- ------\nTotal minimum payments 985 31,654 Less amounts representing interest 214 --- ------ Present value of minimum payments $ 771 $ 31,654 ========= =========\nInterest of approximately $497,000, $1,288,000 and $295,000 was capitalized in 1995, 1994 and 1993, respectively, as part of the acquisition cost of property, plant and equipment. Interest paid, including interest capitalized, amounted to $2,023,000, $1,755,000 and $239,000 for 1995, 1994 and 1993, respectively.\nThe Company has available two $10,000,000 unsecured working capital line of credit agreements with two banks. Interest on borrowings under the agreements is set at the banks' Base Rate or at the Eurodollar Rate plus a maximum of up to 1.25%. The agreements expire December 29, 1998 and September 29, 1998, respectively, and any outstanding borrowings are due at that time. No amounts were borrowed under these or any prior bank agreements during 1995, 1994, and 1993.\nCertain of the debt agreements contain certain restrictive covenants requiring maintenance of minimum levels of working\nBen & Jerry's Homemade, Inc.\nNotes to Consolidated Financial Statements (continued) Dollars in tables in thousands except share data\ncapital, net worth and debt to capitalization ratios. As of December 30, 1995 the Company was in compliance with the provisions of these agreements. Under the most restrictive of these covenants requiring maintenance of a minimum consolidated tangible net worth of $55 million, approximately $23,000,000 of retained earnings at December 30, 1995 was available for payment of dividends.\n7. INCOME TAXES\nThe provision (benefit) for income taxes consists of the following:\n1995 1994 1993 ---- ---- ---- Federal: Current $ 873 $ (314) $ 4,086 Deferred 1,695 (1,263) (211) ----- ------ ---- 2,568 (1,577) 3,875\nState: Current 418 (15) 1,022 Deferred 471 (301) (53) --- ---- --- 889 (316) 969 --- ---- --- $ 3,457 $ (1,893) $ 4,844 ======= ======== =======\nIncome taxes computed at the federal statutory rate differ from amounts provided as follows:\n1995 1994 1993 ---- ---- ---- Tax at statutory rate .................. 34.0% (34.0)% 35.0% State tax, less federal tax effect ..... 4.5 (5.6) 5.3 Income tax credits ..................... (2.9) (6.7) Municipal bond interest ................ (1.1) (5.0) (1.8) Other, net ............................. 2.3 1.0 1.7 --- --- --- Provision (benefit) for income taxes ... 36.8% (50.3)% 40.2% ==== ===== ====\nDeferred income taxes reflect the net 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 are attributable to the following:\n1995 1994 ------ ------ Deferred tax assets: Accrued liabilities ......................... $1,514 $2,057 Inventories ................................. 1,106 703 Accounts receivable ......................... 386 254\nOther ....................................... 695 245 ------ ------ Total deferred tax assets ................... 3,701 3,259 ------ ------\nDeferred tax liabilities: Depreciation ................................ 3,628 1,003 Other ....................................... 17 ------ ------ Total deferred tax liabilities .............. 3,628 1,020 ------ ------\nNet deferred tax assets ..................... $ 73 2,239 ====== ======\nIncome taxes paid amounted to $1,918,000, $2,111,000 and $4,477,000 during 1995, 1994 and 1993, respectively.\nBen & Jerry's Homemade, Inc.\nNotes to Consolidated Financial Statements (continued) Dollars in tables in thousands except share data\n8. THE BEN & JERRY'S FOUNDATION, INC.\nIn October 1985, the Company issued Class A Preferred Stock to The Ben & Jerry's Foundation, Inc. (the Foundation), a non-profit corporation qualified under section 501(c)(3) of the Internal Revenue Code. The primary purpose of the Foundation is to be a principal recipient of cash contributions from the Company which are then donated to various community organizations and other charitable institutions. Amounts expensed for contributions to the Foundation and directly to other charitable organizations, at the rate of approximately 7.5% of income before income taxes amounted to approximately $768,000, and $977,000 for 1995 and 1993 respectively. In 1994 there were no amounts expensed for contributions to the foundation.\nThe Preferred Stock is entitled to vote as a separate class in certain business combinations, such that approval of two-thirds of the class is required for such business combinations. Two directors, including one of the founders of the Company, are members of the Board of Directors of the Foundation.\n9. STOCK PLANS\nThe Company maintains an Employee Stock Purchase Plan which authorizes the issuance of up to 300,000 shares of common stock. All employees with six months of continuous service are eligible to participate in this plan. Participants in the plan are entitled to purchase Class A Common Stock during specified semi-annual periods through the accumulation of payroll, at the lower of 85% of market value of the stock at the beginning or end of the offering period. At December 30, 1995, 96,664 shares had been issued under the plan and 203,336 shares were available for future issuance.\nThe Company maintains two Stock Option Plans:\nThe 1985 Option Plan provides for the grant of incentive and non-incentive stock options to employees or consultants. The 1985 Option Plan provides that options granted are exercisable at the market value on the date of grant. On March 31, 1994 stock options were granted under the Plan to approximately 500 employees across all levels of the Company. Additional options were granted under the Plan during 1995. While the Company may grant options which may become excercisable at different times or within different periods, the Company has generally granted options to employees of which 50% vest at two years from the date of grant and 100% vest within four years. At December 30, 1995, no shares of Class A Common Stock were available under the 1985 Option Plan for additional grants as the plan had expired.\nA summary of the 1985 Option Plan activity is as follows:\nNumber of Option Price Options Per Share ------- ----------------------------\nOutstanding at December 25, 1993 ....... 0 $ 0.00 - $ 0.00 Granted ............................ 177,927 16.75 - 16.75 Exercised .......................... 0 0.00 - 0.00 Forfeited .......................... (15,619) 16.75 - 16.75 ------- --------------------------- Outstanding at December 31, 1994 ....... 162,308 16.75 - 16.75 Granted ............................ 215,000 10.63 - 14.00 Exercised .......................... 0 0.00 - 0.00 Forfeited .......................... (19,871) 16.75 - 16.75 ------- --------------------------- Outstanding at December 30, 1995 ....... 357,437 $ 10.63 - $ 16.75 =======\nOptions vested at December 30, 1995 .... 25,000 $ 10.63 - $ 10.81\nBen & Jerry's Homemade, Inc.\nNotes to Consolidated Financial Statements (continued) Dollars in tables in thousands except share data\nThe 1995 Equity Incentive Plan provides for the grant to employees and consultants of incentive and non-incentive stock options , stock appreciation rights, restricted stock, unrestricted stock awards, deferred stock awards, cash or stock performance awards, loans or supplemental grants, or combinations thereof. At December 30, 1995, 475,000 shares of Class A Common Stock were available under the 1995 Equity Incentive Plan for additional grants.\nA summary of the 1995 Equity Incentive Plan activity is as follows:\nNumber of Option Price Options Per Share -------- -------------------------\nOutstanding at December 31, 1994 ....... 0 $ 0.00 - $ 0.00 Granted ............................ 25,000 19.00 - 19.00 Exercised .......................... 0 0.00 - 0.00 Forfeited .......................... 0 0.00 - 0.00 ------ ------------------------- Outstanding at December 30, 1995 ....... 25,000 $ 19.00 - $ 19.00\nOptions vested at December 30, 1995 .... 0 $ 0.00 - $ 0.00 ------\nThe Company has three restricted stock plans (the 1986,1991, and 1992 Plans) which provide that employees, consultants, or non-employee directors, on becoming eligible, may be awarded shares of Class A Common Stock by the Compensation Committee of the Board of Directors. Shares issued under the plans become vested over periods of up to five years. The Company has also adopted the 1995 Plan, which provides that non-employee directors can elect to receive stock in lieu of a Director's cash retainer. These shares are vested immediately. At December 30, 1995, a total of 71,000 shares had been awarded under these plans, of which 57,955 were fully vested and 13,045 had been forfeited. 33,000 shares were available for future awards. No further shares may be awarded under the 1986 or 1991 Plans. Restricted shares may also be issued under the 1995 Equity Incentive Plan . Unearned compensation on unvested shares is recorded as of the award date and is amortized over the vesting period.\nAs of December 30, 1995, a total of 711,336 shares are reserved for future grant under all of the Company's stock plans.\n10. EMPLOYEE BENEFIT PLANS\nThe Company maintains profit sharing and savings plans for all eligible employees. Contributions to the profit sharing plan are allocated among all current full-time and regular part-time employees (other than the co-founders, CEO and the Senior Director of Operations) based upon length of service with the Company. The profit sharing plan is informal and discretionary. The savings plan is maintained in accordance with the provisions of Section 401(k) of the Internal Revenue Code and allows all employees with at least twelve months of service to make annual tax-deferred voluntary contributions up to fifteen percent of their salary. The Company may match the contribution up to two percent of the employee's gross annual salary.\nTotal contributions by the Company to the profit sharing and savings plans were approximately $769,000, $508,000 and $894,000 for 1995, 1994 and 1993, respectively.\n11. COMMON STOCK\nIn June 1987, the Company's shareholders adopted an amendment to the Company's Articles of Association that authorized 3,000,000 shares of a new Class B Common Stock and redesignated the Company's existing Common Stock as Class A Common Stock. The Class B Common Stock has 10 votes per share on all matters, is generally non-transferable and is convertible into Class A Common Stock on a one-for-one basis.\nBen & Jerry's Homemade, Inc.\nNotes to Consolidated Financial Statements (continued) Dollars in tables in thousands except share data\n12. WRITE-DOWN OF ASSETS IN 1994\nIn 1994, following substantial delays with the implementation and completion of certain automated handling processes and refrigeration hardening equipment of the Company's St. Albans, Vermont plant and after receipt of a report from an outside engineering firm experienced in the refrigerated food industry, the Company decided to replace certain of the software and equipment installed at the new plant. The loss from the write-down of the related assets (including a portion of the previously incurred capitalized interest and project management costs), recorded in the Company's fourth quarter, amounted to $6,779,000 (approximately $4.1 million after tax or $0.57 per share). Of this amount, $3,804,000 was offset against the balance in construction in progress while $2,975,000 was accrued for additional anticipated costs, which were paid during 1995.\n13. LEGAL MATTERS\nOn December 14, 1995, the Company was served with a class action complaint filed in federal court in Burlington, Vermont. The complaint, captioned Henry G. Jakobe, Jr. v. Ben & Jerry's Inc., et al., , was filed by a Ben & Jerry's shareholder on behalf of himself and purportedly on behalf of all other Ben & Jerry's shareholders who purchased the common stock of the Company during the period from March 25, 1994 through December 19, 1994. Plaintiff alleges that the Company violated the federal securities laws by making, in 1994, untrue statements of material facts and omitting to state material facts primarily concerning the Company's construction and start-up of its new manufacturing facility in St. Albans, Vermont. Also named as defendants in the Complaint are certain present and former officers and directors of the Company, Ben Cohen, Chairperson of the Board; Jerry Greenfield, Vice Chairperson of the Board; Frances Rathke, Chief Financial Officer; and Charles Lacy, former President. Plaintiff is seeking an unspecified amount of monetary damages.\nWhile this action is in its preliminary stages management believes, based on an initial review, the allegations made in the lawsuit are without merit and the Company intends to defend the lawsuit vigorously.\nBen & Jerry's Homemade, Inc.\nNotes to Consolidated Financial Statements (continued) Dollars in tables in thousands except share data\n14. COMMITMENTS\nThe Company leases certain property and equipment under operating leases. Minimum payments for operating leases having initial or remaining noncancellable terms in excess of one year are as follows:\n1996 $ 454 1997 316 1998 206 1999 131 2000 37\nRent expense for operating leases amounted to approximately $662,000, $516,000 and $425,000 in 1995, 1994 and 1993, respectively.\n15. SIGNIFICANT CUSTOMERS\nThe Company's most significant customer, Dreyer's Grand Ice Cream, Inc., accounted for 44%, 49%, or 54% of net sales in 1995, 1994 and 1993 respectively.\n16. FAIR VALUE OF FINANCIAL INSTRUMENTS\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 its fair value.\nInvestments: The fair values for marketable securities are based on quoted market prices.\nLong- and short-term debt: The fair values of the Company's long-term debt are estimated using discounted cash flow analyses, based on the Company's current incremental borrowing rates for similar types of borrowing arrangements.\nThe carrying amounts and fair values of the Company's financial instruments are as follows:\n1995 1994 ------------------- --------------------- Carrying Fair Carrying Fair Amount Value Amount Value ------ ----- ------ -----\nCash and cash equivalents $ 35,406 35,406 20,778 20,778 Investments 1,000 1,000 8,000 8,000 Long-term debt (32,425) (29,815) (32,972) (29,917)\nBen & Jerry's Homemade, Inc.\nNotes to Consolidated Financial Statements (continued) Dollars in tables in thousands except share data\n17. SELECTED QUARTERLY FINANCIAL INFORMATION (UNAUDITED)\nBEN & JERRY'S HOMEMADE, INC.\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS\nYears ended December 30, 1995, December 31, 1994, and December 25, 1993","section_15":""}
{"filename":"784014_1995.txt","cik":"784014","year":"1995","section_1":"ITEM 1. BUSINESS\nDevelopment and Description of Business - --------------------------------------- Information concerning the business of American Insured Mortgage Investors L.P.-Series 86 (the Partnership) is contained in Part II, Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations and in Notes 1 and 4 of the notes to the financial statements of the Partnership (filed in response to Item 8 hereof), which is incorporated herein by reference. Also see Schedule IV-Mortgage Loans on Real Estate, for the table of the Insured Mortgages (as defined below), invested in by the Partnership as of December 31, 1995.\nEmployees - --------- The Partnership has no employees. The business of the Partnership is managed by CRIIMI, Inc. (the General Partner), while its portfolio of mortgages is managed by AIM Acquisition Partners, L.P. (the Advisor) pursuant to an advisory agreement (the Advisory Agreement). CRIIMI, Inc. is a wholly owned subsidiary of CRIIMI MAE Inc. (CRIIMI MAE).\nEffective September 6, 1991, CRIIMI, Inc. (the General Partner) succeeded the former general partners to become the sole general partner of the Partnership. CRIIMI, Inc. is a wholly owned subsidiary of CRIIMI MAE Inc. (CRIIMI MAE). From inception through June 30, 1995, CRIIMI MAE was managed by an adviser whose general partner is C.R.I., Inc. (CRI). However, effective June 30, 1995, CRIIMI MAE became a self-managed and self-administered real estate investment trust (REIT) and, as a result, the adviser no longer advises CRIIMI MAE. In addition, the General Partner acquired the shares of the company which acted as the assignor limited partner in the Partnership. The interest of the former associate general partner (0.1%) was purchased by the Partnership on September 6, 1991, pursuant to the terms of the Partnership Agreement.\nAlso on September 6, 1991, AIM Acquisition Partners, L.P., (the Advisor) succeeded Integrated Funding, Inc. (IFI) as the advisor to the Partnership. AIM Acquisition Corporation (AIM Acquisition) is the general partner of the Advisor, and the limited partners include, but are not limited to, AIM Acquisition, The Goldman Sachs Group, L.P., Broad, Inc., and CRIIMI MAE.\nPursuant to the terms of certain amendments to the Partnership Agreement as discussed below, the General Partner is required to receive the consent of the Advisor prior to taking certain significant actions which affect the management and policies of the Partnership.\nEffective September 6, 1991 and through June 30, 1995, a sub-advisory agreement (the Sub-advisory Agreement) existed whereby CRI\/AIM Management, Inc., an affiliate of CRI, managed the Partnership's portfolio. On June 30, 1995, in connection with a merger transaction approved by CRIIMI MAE's shareholders, an affiliate of CRIIMI MAE acquired the Sub-advisory Agreement, and, as a result, CRIIMI MAE Services Limited Partnership acts as the sub-advisor to the Partnership effective June 30, 1995.\nCompetition - ----------- In disposing of Insured Mortgages, the Partnership competes with private investors, mortgage banking companies, mortgage brokers, state and local government agencies, lending institutions, trust funds, pension funds, and other entities, some with similar objectives to those of the Partnership and some of which are or may be affiliates of the Partnership, its General Partner, the Advisor or their respective affiliates. Some of these entities may have substantially greater capital resources and experience in disposing of Insured Mortgages than the Partnership.\nPART I\nITEM 1. BUSINESS - Continued\nCRIIMI MAE and its affiliates also may serve as general partners, sponsors or managers of real estate limited partnerships, REITs or other entities in the future. The Partnership may attempt to dispose of mortgages at or about the same time that one or more of the other AIM Partnerships and\/or other entities sponsored or managed by CRIIMI MAE, including CRI Liquidating REIT Inc., are attempting to dispose of mortgages. As a result of market conditions that could limit dispositions, CRIIMI MAE Services Limited Partnership and its affiliates could be faced with conflicts of interest in determining which mortgages would be disposed of. Both CRIIMI MAE Services Limited Partnership and CRIIMI, Inc., however, are subject to their fiduciary duties in evaluating the appropriate action to be taken when faced with such conflicts.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nAlthough the Partnership does not own the underlying real estate, the mortgages underlying the Partnership's mortgage investments are non-recourse first liens on the respective multifamily residential developments or retirement homes.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nReference is made to Note 4 of the notes to the financial statements on pages 41 through 46.\nPART I\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matters were submitted to the security holders to be voted on during the fourth quarter of 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S SECURITIES AND RELATED SECURITY HOLDER MATTERS\nPrincipal Market and Market Price for Units - ------------------------------------------- Effective January 1, 1994 the United States Congress repealed portions of the Federal tax code which have had an adverse impact on tax-exempt investors in \"publicly-traded partnerships.\" This tax code change cleared away the major impediment standing in the way of listing the Partnership's Depositary Units of Limited Partnership Interest (Units) for trading on a national stock exchange. In an effort to allow pension funds and other tax-exempt organizations to invest in publicly-traded partnerships, the Revenue Reconciliation Act of 1993 repealed the rule that automatically treated income from publicly-traded partnerships as gross income that is derived from an unrelated trade or business. As a result, investments in publicly-traded partnerships such as the Partnership are now treated the same as investments in other partnerships for purposes of the unrelated business taxable income rules. The General Partner listed the Partnership's Units for trading on the American Stock Exchange (AMEX) on January 18, 1994 in order to provide investment liquidity as contemplated in the Partnership's original prospectus. The Units are traded under the symbol \"AIJ.\"\nThe high and low bid prices for the Units as reported on AMEX for each quarterly period in 1995 and 1994 were as follows:\nQuarter Ended High Low ------------------- ------- -------\nMarch 31, $12 1\/4 $11 3\/8\nJune 30, 12 7\/8 11 3\/4\nSeptember 30, 13 1\/4 12 5\/8\nDecember 31, 13 3\/8 12 3\/4\nPeriod Ended High Low ------------------- ------- ------- January 18 through March 31, $14 $12 1\/4 April 1 through June 30, 12 5\/8 12 1\/8 July 1 through September 30, 12 3\/4 12 October 1 through December 31, 12 11 1\/8\nPART II\nITEM 5. MARKET FOR REGISTRANT'S SECURITIES AND RELATED SECURITY HOLDER MATTERS - Continued\nPrior to listing the Partnership's Units for trading on AMEX, the Units were only tradable through an informal market called the \"secondary market\".\nDistribution Information - ------------------------ Distributions per Unit, payable out of the cash flow of the Partnership, during 1995 and 1994 were as follows:\nDistributions for the Amount of Distribution Quarter Ended Per Unit --------------------- ----------------------\nMarch 31, 1995 $ 0.26(1) June 30, 1995 0.34(1)(2) September 30, 1995 0.31(1) December 31, 1995 0.33(1) -------- $ 1.24 ========\nMarch 31, 1994 $ 0.41 (3)(4) June 30, 1994 0.29 (4) September 30, 1994 0.30 (4) December 31, 1994 0.34 (4) -------- $ 1.34 ========\n(1) This amount includes $0.03 per Unit representing previously undistributed accrued interest receivable from St. Charles Place - Phase II and The Villas.\n(2) This amount includes $0.08 per Unit representing previously undistributed accrued interest receivable from Carmen Drive Estates (The Forest), Woodland Hills Apartments, and Woodbine at Lakewood Apartments.\n(3) This amount includes approximately $0.18 per Unit representing previously undistributed accrued interest received from the disposition of the mortgage on One East Delaware.\n(4) This amount includes approximately $0.01, $0.04, $0.03 and $0.03 per Unit representing previously undistributed accrued interest received from St. Charles Place-Phase II and The Villas for the quarters ended March 31, 1994, June 30, 1994, September 30, 1994 and December 31, 1994, respectively.\nApproximate Number of Unitholders Title of Class as of December 31, 1995 - --------------------------- ------------------------------- Depositary Units of Limited Partnership Interest 13,400\nPART II\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA (Dollars in thousands, except per Unit amounts)\nThe selected statements of operations data presented above for the years ended December 31, 1995, 1994 and 1993, and the balance sheet data as of December 31, 1995 and 1994, are derived from and are qualified by reference to the Partnership's financial statements which have been included elsewhere in this Form 10-K. The statements of operations data for the years ended December 31, 1992 and 1991 and the balance sheet data as of December 31, 1993, 1992 and 1991 are derived from audited financial statements not included in this Form 10- K. This data should be read in conjunction with the financial statements and the notes thereto.\nPART II\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nGeneral - -------\nAmerican Insured Mortgage Investors L.P. - Series 86 (the Partnership) was formed under the Uniform Limited Partnership Act of the state of Delaware on October 31, 1985. During the period from May 2, 1986 (the initial closing date of the Partnership's public offering) through June 6, 1987 (the termination date of the offering), the Partnership, pursuant to its public offerings of Units, raised a total of $191,523,300 in gross proceeds. In addition, the initial limited partner contributed $2,500 to the capital of the Partnership and received 125 units of limited partnership interest in exchange therefor.\nFrom inception through September 6, 1991, AIM Capital Management Corp. served as managing general partner (with a partnership interest of 4.8%), IRI Properties Capital Corp. served as corporate general partner (with a partnership interest of 0.1%) and Second Group Partners, an affiliate of the former general partners, served as the associate general partner (with a partnership interest of 0.1%). All of the foregoing general partners are sometimes collectively referred to as former general partners.\nAt a special meeting of the limited partners and Unitholders, as defined in the Partnership Agreement, of the Partnership held on September 4, 1991, a majority of these interests approved, among other items, the assignment of the general partner interests and the shares of the company which acts as the assignor limited partner in the Partnership.\nEffective September 6, 1991, CRIIMI, Inc. (the General Partner) succeeded the former general partners to become the sole general partner of the Partnership. In addition, the General Partner acquired the shares of the company which acted as the assignor limited partner in the Partnership. The interest of the former associate general partner (0.1%) was purchased by the Partnership on September 6, 1991, pursuant to the terms of the Partnership Agreement. CRIIMI, Inc. is a wholly owned subsidiary of CRIIMI MAE Inc. (CRIIMI MAE). From inception through June 30, 1995, CRIIMI MAE was managed by an adviser whose general partner is C.R.I., Inc. (CRI). However, effective June 30, 1995, CRIIMI MAE became a self-managed and self-administered real estate investment trust (REIT) and, as a result, the adviser no longer advises CRIIMI MAE.\nAlso on September 6, 1991, AIM Acquisition Partners, L.P., (the Advisor) succeeded Integrated Funding, Inc. (IFI) as the advisor to the Partnership. AIM Acquisition Corporation (AIM Acquisition) is the general partner of the Advisor, and the limited partners include, but are not limited to, AIM Acquisition, The Goldman Sachs Group, L.P., Broad, Inc., and CRIIMI MAE. Pursuant to the terms of certain amendments to the Partnership Agreement, as discussed below, the General Partner is required to receive the consent of the Advisor prior to taking certain significant actions which affect the management and policies of the Partnership.\nEffective September 6, 1991 and through June 30, 1995, a sub-advisory agreement (the Sub-advisory Agreement) existed whereby CRI\/AIM Management, Inc., an affiliate of CRI, managed the Partnership's portfolio. On June 30, 1995, in connection with a merger transaction approved by CRIIMI MAE's shareholders, an affiliate of CRIIMI MAE acquired the Sub-advisory Agreement, and, as a result, CRIIMI MAE Services Limited Partnership acts as the sub-advisor to the Partnership effective June 30, 1995.\nPART II\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued\nPrior to the expiration of the Partnership's reinvestment period on December 31, 1994, the Partnership was engaged in the business of originating mortgage loans (Originated Insured Mortgages) and acquiring mortgage loans (Acquired Insured Mortgages and, together with Originated Insured Mortgages, referred to herein as Insured Mortgages). After the expiration of the reinvestment period, the Partnership is required (subject to the conditions set forth in the Partnership Agreement) to distribute such proceeds to its Unitholders. The Partnership Agreement states that the Partnership will terminate on December 31, 2020, unless previously terminated under the provisions of the Partnership Agreement.\nAs of December 31, 1995, the Partnership had invested in 27 Insured Mortgages, with an aggregate amortized cost of approximately $166 million, a face value of approximately $163 million and a fair value of approximately $162 million, as discussed below.\nResults of Operations - ---------------------\n1995 versus 1994 - ----------------\nNet earnings decreased for 1995 as compared to 1994 primarily as a result of the gain recognized on the disposition of the Insured Mortgage on One East Delaware in January 1994. Also contributing to the decrease in net earnings was a decrease in interest and other income, as discussed below. Partially offsetting these decreases was an increase in mortgage investment income, as discussed below.\nMortgage investment income increased for 1995 as compared to 1994 due to increases in total invested assets throughout 1994, the full benefit which was realized in 1995. The increase in total invested assets is attributable to the reinvestment of net proceeds from the disposition of the Insured Mortgages on One East Delaware and Victoria Pointe Apartments-Phase II, which were received in December 1993 and January 1994 and reinvested during the first three quarters of 1994.\nInterest and other income decreased for 1995 as compared to 1994 primarily due to the short-term investment of net disposition proceeds in early 1994 prior to reinvestment in Acquired Insured Mortgages, as previously discussed.\nAsset management fees increased for 1995 as compared to 1994 as a result of the increase in total invested assets.\nGeneral and administrative expenses increased for 1995 as compared to 1994 primarily due to an increase in legal and professional fees related to litigation involving the transfer of mortgage servicing rights, as discussed in Note 4 to the financial statements. Partially offsetting this increase was a decrease in payroll and payroll-related expenses, as a result of the stabilization of the mortgage portfolio during 1994. Also offsetting this increase was a decrease in fees related to the initial listing of the Partnership's units on the American Stock Exchange.\nInterest expense to affiliate decreased for 1995 as compared to 1994 as a result of the paydown of the note payable to the Partnership's affiliate, American Insured Mortgage Investors-L.P. Series 85 (AIM 85) during 1994, partially offset by the execution of a note payable to AIM 88. The note payable to AIM 88 is in the approximate amount of $479,000, at an annual interest rate\nPART II\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued\nof 7.25%, as compared to the note payable to AIM 85 of approximately $1.7 million at an annual interest rate of 8%.\n1994 versus 1993 - ----------------\nNet earnings increased for 1994 as compared to 1993 primarily due to the gain recognized from the disposition of the Insured Mortgage on One East Delaware in January 1994. Also contributing to this increase was an increase in interest and other income as discussed below. Partially offsetting these increases was a decrease in mortgage investment income, as described below.\nMortgage investment income decreased for 1994 as compared to 1993. This decrease was primarily due to the disposition of the mortgages on One East Delaware and Victoria Pointe Apartments, the proceeds of which were not reinvested until the first three quarters of 1994. Also contributing to the decrease in mortgage investment income was a reduction in mortgage interest rates on Acquired Insured Mortgages purchased during 1994 as compared to the mortgage interest rates on those Insured Mortgages which were disposed of in late 1993 and early 1994.\nInterest and other income increased for 1994 as compared to 1993 primarily due to the short-term investment of net disposition proceeds prior to reinvestment in Acquired Insured Mortgages, as previously discussed.\nAsset management fees decreased for 1994 as compared to 1993 primarily due to the decrease in total invested assets, as discussed above.\nGeneral and administrative expenses increased for 1994 as compared to 1993. This increase was due primarily to an increase in payroll and payroll-related expenses incurred in connection with the mortgage dispositions, mortgage acquisitions, and mortgages with performance problems, as described below, and due to the payment in 1994 of a one-time fee in connection with the listing of the Partnership's units on AMEX. Also contributing to the increase in general and administrative expenses was an amendment to the expense reimbursement agreement between the AIM Partnerships and IFI, effective April 1, 1994. The effect of this amendment was to reduce the expense reimbursement the Partnership receives from IFI to reflect the reduction in the Partnership's coinsured loans since the execution of the original reimbursement agreement in 1992. This reimbursement is presented as a reduction of general and administrative expenses on the accompanying statements of operations for the years ended December 31, 1995, 1994 and 1993. The decrease in the expense reimbursement is offset by a decrease in interest expense to affiliate, as discussed below.\nInterest expense to affiliate decreased for 1994 as compared to 1993, as a result of the paydown of the note payable to AIM 85 during the second quarter of 1994, offset by the execution of a note payable to AIM 88. The note payable to AIM 88 is in the approximate amount of $479,000, at an annual interest rate of 7.25%, as compared to the note payable to AIM 85 of approximately $1.7 million at an annual interest rate of 8%. The reduction in the principal amount of the notes reflects the reduction in the Partnership's coinsured loans since the initial capitalization of IFI in 1991.\nInvestment in Insured Mortgages - -------------------------------\nThe Partnership's investment in Insured Mortgages is comprised of participation certificates evidencing a 100% undivided beneficial interest in\nPART II\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued\ngovernment insured multifamily mortgages issued or sold pursuant to programs of the Federal Housing Administration (FHA) (FHA-Insured Certificates), mortgage- backed securities guaranteed by the Government National Mortgage Association (GNMA) (GNMA Mortgage-Backed Securities) and FHA-insured mortgage loans (FHA- Insured Loans). The mortgages underlying the FHA-Insured Certificates, GNMA Mortgage-Backed Securities, and FHA-Insured Loans are non-recourse first liens on multifamily residential developments or retirement homes.\nThe following is a discussion of the Partnership's mortgage investments, along with the risks related to each type of investment:\nA. Fully Insured Originated Insured Mortgages and Acquired Insured Mortgages ---------------------------------------------- The Partnership's investment in fully insured Originated Insured Mortgages consisted of seven and eight FHA-Insured Loans, as of December 31, 1995 and 1994, respectively. As of December 31, 1995, these investments had an aggregate amortized cost of $62,595,492, an aggregate face value of $60,306,932, and an aggregate fair value of $62,183,025. As of December 31, 1994, these investments had an aggregate amortized cost of $69,162,106, an aggregate face value of $66,602,806, and an aggregate fair value of $63,422,100.\nThe Partnership's investment in fully insured Acquired Insured Mortgages consisted of 10 GNMA Mortgage-Backed Securities, 2 FHA-Insured Certificates and 1 FHA-Insured Loan as of December 31, 1995 and 1994. As of December 31, 1995, these investments had an aggregate amortized cost of $42,122,606, an aggregate face value of $42,066,176, and an aggregate fair value of $42,479,072. As of December 31, 1994, these investments had an aggregate amortized cost of $42,473,748, an aggregate face value of $42,415,356 and an aggregate fair value of $37,875,856. As of March 1, 1996, all of the Partnership's fully insured mortgage investments are current with respect to the payment of principal and interest.\nIn December, 1995, the Partnership received net proceeds of $6,169,529 from the prepayment of the mortgage on Lakewood Villas, a fully insured FHA-Insured Loan, and recognized a gain of $5,208, as shown on the accompanying statement of operations for the year ended December 31, 1995. The net proceeds are expected to be distributed May 1, 1996.\nIn addition to base interest payments from fully insured Originated Insured Mortgages, the Partnership is entitled to additional interest based on a percentage of the net cash flow from the underlying development and of the net proceeds from the refinancing, sale or other disposition of the underlying development (referred to as Participations). During the years ended December 31, 1995, 1994 and 1993, the Partnership received additional interest of $73,357, $33,431 and $62,843, respectively, from the fully insured Participations. These amounts are included in mortgage investment income on the accompanying statements of operations.\nIn the case of fully insured Originated Insured Mortgages and Acquired Insured Mortgages, the Partnership's maximum exposure for purposes of determining loan losses would generally be approximately 1% of the unpaid principal balance of the Originated Insured Mortgage or Acquired Insured Mortgage (an assignment fee charged by FHA) at the date of a default, plus the unamortized balance of acquisition fees and closing costs paid in connection with the acquisition of the Insured Mortgage and the loss of approximately 30-days accrued interest.\nCoinsured Mortgages ------------------- Under the HUD coinsurance program, both HUD and the coinsurance lender are responsible for paying a portion of the insurance benefits if a mortgagor defaults and the sale of the development collateralizing the\nPART II\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued\nmortgage produces insufficient net proceeds to repay the mortgage obligation. In such case, the coinsurance lender will be liable to the Partnership for the first part of such loss in an amount up to 5% of the outstanding principal balance of the mortgage as of the date foreclosure proceedings are instituted or the deed is acquired in lieu of foreclosure. For any loss greater than 5% of the outstanding principal balance, the responsibility for paying the insurance benefits will be borne on a pro-rata basis, 85% by HUD and 15% by the coinsurance lender.\nWhile the Partnership is due payment of all amounts owed under the mortgage, the coinsurance lender is responsible for the timely payment of principal and interest to the Partnership. The coinsurance lender is prohibited from entering into any workout arrangement with the borrower without the Partnership's consent and must file a claim for coinsurance benefits with HUD, upon default, if the Partnership so directs. As an ongoing HUD-approved coinsurance lender, and under the terms of the participation documents, the coinsurance lender is required to satisfy certain minimum net worth requirements as set forth by HUD. However, it is possible that the coinsurance lender's potential liability for loss on these developments, and others, could exceed its HUD-required minimum net worth. In such case, the Partnership would bear the risk of loss if the coinsurance lenders were unable to meet their coinsurance obligations. In addition, HUD's obligation for the payment of its share of the loss could be diminished under certain conditions, such as the lender not adequately pursuing regulatory violations of the borrower or the failure to comply with other terms of the mortgage. However, the General Partner is not aware of any conditions or actions that would result in HUD diminishing its insurance coverage.\nAs of December 31, 1995 and 1994, the former managing general partner, on behalf of the Partnership, had invested in seven FHA-Insured Certificates secured by coinsured mortgages. As of December 31, 1995, two of the seven FHA-Insured Certificates secured by coinsured mortgages are coinsured by an unaffiliated third party coinsurance lender under the HUD coinsurance program. The following is a discussion of actual and potential performance problems with respect to the Partnership's coinsured mortgage investments.\n1. Coinsured by third party ------------------------ The Originated Insured Mortgages on The Villas and St. Charles Place - Phase II are coinsured by Patrician. As of December 31, 1995 and December 31, 1994, the Partnership's investment in the mortgage on The Villas had an amortized cost of $15,635,379 and $15,732,782, respectively, a face value of $15,869,089 and $15,966,491, respectively, and a fair value of $15,173,465 and $14,012,209, respectively. As of March 1, 1996, the mortgagor has made payments of principal and interest due on the original mortgage through July 1995, and has made payments of principal and interest due under a modification agreement through August 1993. Patrician is litigating the case in bankruptcy court while negotiating a modification agreement with the borrower.\nThe Partnership's investment in the mortgage on St. Charles Place - Phase II had an amortized cost equal to its face value of $3,068,173 and $3,082,440, as of December 31, 1995 and 1994, respectively. As of December 31, 1995 and 1994, this mortgage had a fair value of $2,933,205 and $2,703,780, respectively. These amounts represent the\nPART II\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued\nPartnership's approximate 45% ownership interest in the mortgage. The remaining 55% ownership interest is held by American Insured Mortgage Investors L.P. - Series 88 (AIM 88), an affiliate of the Partnership. As of March 1, 1996, the mortgagor has made payments of principal and interest due on the mortgage through May 1995 to the Partnership. Patrician is litigating the case in bankruptcy court while negotiating a modification agreement with the borrower.\nThe General Partner intends to continue to oversee the Partnership's interests in these mortgages to ensure that Patrician meets its coinsurance obligations. The General Partner's assessment of the realizability of The Villas and St. Charles Place-Phase II mortgages is based on the most recent information available, and to the extent these conditions change or additional information becomes available, then the General Partner's assessment may change. However, the General Partner does not believe that there would be a material adverse impact on the Partnership's financial condition or its results of operations should Patrician be unable to comply with its full coinsurance obligation.\n2. Coinsured by affiliate ---------------------- As of December 31, 1995 and 1994, the Partnership held investments in five and two FHA-Insured Certificates secured by coinsured mortgages, respectively, where the coinsurance lender is IFI, an affiliate of the Partnership. Two of these mortgage investments were originated by the former managing general partner. As structured by the former managing general partner, with respect to these mortgages, the Partnership bears the risk of loss upon default for IFI's portion of the coinsurance loss.\nThe Originated Insured Mortgages on Carmen Drive Estates (The Forest), Woodbine at Lakewood Apartments and Woodland Hills Apartments were previously coinsured by M-West Mortgage Corporation (M-West), a third party coinsurance lender. During the fourth quarter of 1994, the Partnership was informed that M-West was liquidating its assets and intended to assign the mortgage servicing rights related to these mortgages to another coinsurance lender, Whitehall Funding, Inc. (Whitehall). The Partnership successfully contested this transfer and obtained a court order mandating the transfer of the mortgage servicing rights related to these three coinsured loans to IFI. This transfer was completed during the second quarter of 1995. The Partnership bears the risk of loss upon default for IFI's portion of the coinsurance loss. As of December 31, 1995, receivables and other assets, as shown on the accompanying balance sheet, includes approximately $70,000 due from M-West with respect to these loans. As of March 1, 1996, claims for damages against M-West and Whitehall are still pending.\nAs of March 1, 1996, these five IFI coinsured mortgages, as shown in the table below, were current with respect to the payment of principal and interest, except for the mortgage on Spring Lake Village, for which the Mortgagor has made payments of principal and interest through July 1995. In February 1996, this mortgage was modified a second time to reduce the interest rate to 6% through December 1996, increasing to 6.75% for 1997 and 7.0% for all subsequent years. The General Partner does not anticipate that this modification will have a material adverse impact on the Partnership's financial statements.\nPART II\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued\nThe General Partner believes there is adequate collateral value underlying these coinsured mortgages. Accordingly, no loan losses were recognized on these mortgages during the years ended December 31, 1995 and 1994, except as described below in connection with a mortgage modification during the year ended December 31, 1994. As of December 31, 1995 and 1994, these five investments had an aggregate fair value of $39,670,264 and $36,466,663, respectively.\nPART II\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued\nIn connection with the FHA-Insured Certificates secured by coinsured mortgages, the Partnership has sought, in addition to base interest payments, additional interest (commonly termed Participations) based on a percentage of the net cash flow from the development and the net proceeds from the refinancing, sale or other disposition of the underlying development. All of the FHA-Insured Certificates secured by coinsured mortgages contain such Participations. During the years ended December 31, 1995, 1994 and 1993, the Partnership received additional interest of $76,431, $7,628 and $50,979, respectively, from the coinsured Participations. These amounts are included in mortgage investment income on the accompanying statements of operations.\nb. Asset Held for Sale Under Coinsurance Program\nAs of December 31, 1993, the former managing general partner, on behalf of the Partnership, had invested in one coinsured mortgage, One East Delaware, which was accounted for as an asset held for sale under coinsurance program (AHFS). In January 1994, the Partnership received net proceeds of $33,233,501 from the prepayment of this mortgage and recognized a gain of $1,129,973, as shown on the accompanying statement of operations for the year ended December 31, 1994. The Partnership reinvested the net disposition proceeds in fully insured Acquired Insured Mortgages during 1994.\nLiquidity and Capital Resources - ------------------------------- The Partnership's operating cash receipts, derived from payments of principal and interest on Insured Mortgages, plus cash receipts from interest on short-term investments, were sufficient during 1995 to meet operating requirements.\nThe basis for paying distributions to Unitholders is net proceeds from mortgage dispositions and cash flow from operations, which includes regular interest income and principal from Insured Mortgages. Although Insured\nPART II\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued\nMortgages yield a fixed monthly mortgage payment once purchased, the cash distributions paid to the Unitholders will vary during each quarter due to (1) the fluctuating yields in the short-term money market where the monthly mortgage payments received are temporarily invested prior to the payment of quarterly distributions, (2) the reduction in the asset base and monthly mortgage payments due to monthly mortgage payments received or mortgage dispositions, (3) variations in the cash flow attributable to the delinquency or default of Insured Mortgages and professional fees and foreclosure costs incurred in connection with those Insured Mortgages and (4) variations in the Partnership's operating expenses.\nIf necessary, the Partnership has the right to establish reserves either from the Net Proceeds of the Offering or from Cash Flow (as defined in the Partnership Agreement). However, the Partnership generally intends to distribute substantially all of its Cash Flow from operations. If any reserves are deemed to be necessary by the Partnership, they will be invested in short-term, interest-bearing investments.\nThe Partnership anticipates that reserves generally would only be necessary in the event the Partnership elected to foreclose on an Originated Insured Mortgage insured by FHA and take over the operations of the underlying development. In such case, there may be a need for additional capital. Since foreclosure proceedings can be expensive and time-consuming, the Partnership expects that it will generally assign the fully insured Originated Insured Mortgages to HUD for insurance proceeds rather than initiate foreclosure. In the case of an Originated Insured Mortgage insured under the HUD coinsurance program, the likelihood of foreclosure (and the potential need for reserves) exists since these coinsured mortgages generally cannot be assigned to HUD and the coinsurance lender would be required to acquire title to the property and hold the property for 12 months or until an earlier sale in order to realize the benefit of HUD insurance. The determination of whether to assign the mortgage to HUD or institute foreclosure procedures or whether to set aside any reserves will be made on a case-by-case basis by the General Partner, the Advisor and the sub-advisor to the Partnership. As of December 31, 1995 and 1994, the Partnership had not set aside any reserves.\nCash flow - 1995 versus 1994 - ---------------------------- Net cash provided by operating activities decreased for 1995 as compared to 1994. This decrease was primarily due to a reduction in receivables and other assets during 1994 as a result of the receipt in January 1994 of the remaining net disposition proceeds related to the disposition of the mortgage on Victoria Pointe Apartments - Phase II and receipt of accrued interest related to the mortgage on One East Delaware.\nNet cash provided by investing activities increased for 1995 as compared to 1994, primarily due to the investment in 1994 of approximately $39.7 million in Insured Mortgages, which was partially offset by the receipt in 1994 of net disposition proceeds of approximately $33.2 million from the disposition of the Insured Mortgage on One East Delaware. No Insured Mortgages were acquired during 1995. Also contributing to the increase in net cash provided by investing activities, was the receipt in 1995 of net proceeds of approximately $6.2 million related to the prepayment of the mortgage on Lakewood Villas during 1995.\nNet cash used in financing activities decreased for 1995 as compared to 1994. This decrease was primarily due to the 1994 distribution of accrued, but\nPART II\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued\npreviously undistributed, interest from the disposition of the mortgage on One East Delaware.\nCash flow - 1994 versus 1993 - ---------------------------- Net cash provided by operating activities increased for 1994 as compared to 1993. This increase was primarily due to the receipt in January 1994 of the remaining net disposition proceeds related to the December 1993 disposition of the insured mortgage on Victoria Pointe Apartments-Phase II and receipt of accrued interest related to the One East Delaware disposition. Also contributing to the increase in 1994 were non-recurring payments made in 1993 on certain loans accounted for as AHFS loans and an increase in interest and other income and a decrease in asset management fees, as previously discussed. These increases were partially offset by a decrease in mortgage investment income and an increase in general and administrative expenses, as discussed above.\nNet cash used in investing activities increased for 1994 as compared to 1993 due to the 1994 investment of approximately $39.7 million in Acquired Insured Mortgages, which was partially offset by the receipt of net disposition proceeds of approximately $33.2 million from the disposition of the Insured Mortgage on One East Delaware.\nNet cash used in financing activities increased for the year ended December 31, 1994 as compared to 1993 as a result of an increase in distributions paid to Unitholders. This increase was primarily due to the 1994 distribution of proceeds from the disposition of the Insured Mortgage on One East Delaware.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe information required by this item is contained on pages 29 through 56.\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),(b),(c),(e)\nThe Partnership has no officers or directors. The affairs of the Partnership are managed by the General Partner, which is wholly owned by CRIIMI MAE, a company whose shares are listed on the New York Stock Exchange. Prior to June 30, 1995, CRIIMI MAE was managed by an adviser whose general partner was CRI. However, effective June 30, 1995, CRIIMI MAE became a self-managed and self-administered REIT and, as a result, the adviser no longer advises CRIIMI MAE.\nEffective September 6, 1991, the General Partner succeeded the former general partners to become the sole general partner of the Partnership. CRIIMI, Inc. purchased the interests of the former managing general partner and the former corporate general partner pursuant to the terms of the Partnership Agreement. In addition, the General Partner acquired the shares of the company which acts as the assignor limited partner in the Partnership. The interest of the former associate general partner (0.1%) was purchased by the Partnership on September 6, 1991, pursuant to the terms of the Partnership Agreement.\nAlso, on September 6, 1991, the Advisor succeeded IFI as the advisor of the Partnership. AIM Acquisition is the general partner of the Advisor and the limited partners include, but are not limited to, AIM Acquisition, The Goldman Sachs Group, L.P, Broad, Inc. and CRIIMI MAE. Pursuant to the terms of certain amendments to the Partnership Agreement, as discussed below, the General Partner is required to receive the consent of the Advisor prior to taking certain significant actions which affect the management and policies of the Partnership.\nEffective September 6, 1991, and through June 30, 1995, a sub-advisory agreement (the Sub-advisory Agreement) existed whereby CRI\/AIM Management, Inc., an affiliate of CRI, managed the Partnership's portfolio. In connection with the transaction in which CRIIMI MAE became a self-managed and self-administered REIT, an affiliate of CRIIMI MAE acquired the Sub-advisory Agreement. As a consequence of this transaction, effective June 30, 1995, CRIIMI MAE Services Limited Partnership, an affiliate of CRIIMI MAE, manages the Partnership's portfolio.\nThe General Partner is also the general partner of AIM 84, AIM 85 and AIM 88, limited partnerships with investment objectives similar to those of the Partnership.\n(d) There is no family relationship between any of the officers and directors of the General Partner.\n(f) Involvement in certain legal proceedings.\nNone.\n(g) Promoters and control persons.\nNot applicable.\n(h) Based solely on its review of Forms 3 and 4 and amendments thereto furnished to the Partnership, and written representations from certain reporting persons that no Form 5s were required for those persons, the Partnership believes that all reporting persons have filed on a timely basis Forms 3, 4 and 5 as required in the fiscal year ended December 31, 1995.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by Item 11 is incorporated herein by reference to Note 7 of the notes to the financial statements of the Partnership.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nAs of December 31, 1995, no person was known by the Partnership to be the beneficial owner of more than five percent (5%) of the outstanding Units of the Partnership.\nAs of December 31, 1995, neither the officers and directors, as a group, of the General Partner nor any individual director of the General Partner, are known to own more than 1% of the outstanding Units of the Partnership.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\n(a) Transactions with management and others.\nNote 7 of the notes to the Partnership's financial statements which contains a discussion of the amounts, fees and other compensation paid or accrued by the Partnership to the directors and executive officers of the General Partner and their affiliates, is incorporated herein by reference.\n(b) Certain business relationships.\nOther than as set forth in Item 11 of this report which is incorporated herein by reference, the Partnership has no business relationship with entities of which the former general partners or the current General Partner of the Partnership are officers, directors or equity owners.\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)(1) Financial Statements:\nPage Description Number - ----------- --------------\nBalance Sheets as of December 31, 1995 and 1994 27 Statements of Operations for the years ended December 31, 1995, 1994 and 1993 28\nStatements of Changes in Partners' Equity for the years ended December 31, 1995, 1994 and 1993 29\nStatements of Cash Flows for the years ended December 31, 1995, 1994 and 1993 30\nNotes to Financial Statements 31\n(a)(2) Financial Statement Schedules:\nIV - Mortgage Loans on Real Estate\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(a)(3) Exhibits:\n3. Amended and Restated Certificate of Limited Partnership is incorporated by reference to Exhibit 4(a) to Amendment No. 1 to the Partnership's Registration Statement on Form S-11 (No. 33-1735) dated March 6, 1986 (such Registration Statement, as amended, is referred to herein as the \"Amended Registration Statement\").\n4. Second Amended and Restated Agreement of Limited Partnership is incorporated by reference in Exhibit 3 to the Amended Registration Statement.\n4.(a) Material Amendments to the Second Amended and Restated Agreement of Limited Partnership are incorporated by reference to Exhibit 4(a) to the Annual Report on Form 10-K for the year ended December 31, 1987.\n4.(b) Amendment to the Second Amended and Restated Agreement of Limited Partnership of the Partnership dated February 12, 1990, incorporated by reference to Exhibit 4(b) to the Partnership's Annual Report on Form 10-K for the year ended December 31, 1989.\n10.(a) Escrow Agreement is incorporated by reference to Exhibit 10(a) to the Amended Registration Statement.\n10.(b) Origination and Acquisition Services Agreement is incorporated by reference to Exhibit 10(b) to the Amended Registration Statement.\nPART IV\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K - Continued\n10.(c) Management Services Agreement is incorporated by reference to Exhibit 10(c) to the Amended Registration Statement.\n10.(d) Disposition Services Agreement is incorporated by reference to Exhibit 10(d) to the Amended Registration Statement.\n10.(e) Agreement among the former managing general partner, the former associate general partner and Integrated Resources, Inc. is incorporated by reference to Exhibit 10(e) to the Amended Registration Statement.\n10.(f) Reinvestment Plan is incorporated by reference to the Prospectus contained in the Amended Registration Statement.\n10.(g) Mortgagor-Participant Agreement regarding the One East Delaware Originated Insured Mortgage is incorporated by reference to Exhibit 10(g) to the Annual Report on Form 10-K for the year ended December 31, 1987.\n10.(h) Mortgage, Assignment of Rents and Security Agreements regarding One East Delaware Originated Insured Mortgage is incorporated by reference to Exhibit 10(h) to the Annual Report on Form 10-K for the year ended December 31, 1987.\n10.(i) Pages A-1 - A-5 of the Partnership Agreement of Registrant, incorporated by reference to Exhibit 28 to the Partnership's Annual Report on Form 10-K for the year ended December 31, 1990.\n10.(j) Purchase Agreement among AIM Acquisition, the former managing general partner, the former corporate general partner, IFI and Integrated dated as of December 13, 1990, as amended January 9, 1991, incorporated by reference to Exhibit 28(a) to the Partnership's Annual Report on Form 10- K for the year ended December 31, 1990.\n10.(k) Purchase Agreement among CRIIMI, Inc., AIM Acquisition, the former managing general partner, the former corporate general partner, IFI and Integrated dated as of December 13, 1990 and executed as of March 1, 1991, incorporated by reference to Exhibit 28(b) to the Partnership's Annual Report on Form 10-K for the year ended December 31, 1990.\n10.(l) Amendment to Partnership Agreement dated September 4, 1991, incorporated by reference to Exhibit 28(c), to the Partnership's Annual Report on Form 10-K for the year ended December 31, 1991.\n10.(m) Non-negotiable promissory note to American Insured Investors - Series 85, L.P. in the amount of $1,737,722 dated December 31, 1991, incorporated by reference to Exhibit 28(d) to the Partnership's Annual Report on Form 10-K for the year ended December 31, 1991.\n10.(n) Sub-Management Agreement by and between AIM Acquisition and CRI\/AIM Management, Inc., dated as of March 1, 1991, incorporated by reference to Exhibit 28(e) to the\nPART IV\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K - Continued\nPartnership's Annual Report on Form 10-K for the year ended December 31, 1992.\n10.(o) Expense Reimbursement Agreement by Integrated Funding Inc. and the AIM Funds, effective December 31, 1992, incorporated by reference to Exhibit 28(f) to the Partnership's Quarterly Report on Form 10-Q for the quarter ended June 30, 1993.\n10.(p) Non-negotiable promissory note to American Insured Mortgage Investors L.P. - Series 88 in the amount of $478,612.00 dated April 1, 1994, incorporated by reference to Exhibit 10(p) to the Partnership's Annual Report on Form 10-K for the year ended December 31, 1994.\n10.(q) Amendment to Reimbursement Agreement by Integrated Funding, Inc. and the AIM Funds, effective April 1, 1994, incorporated by reference to Exhibit 10(q) to the Partnership's Annual Report on Form 10-K for the year ended December 31, 1994.\n27. Financial Data Schedule (filed herewith).\n(b) Reports on Form 8-K filed during the last quarter of the fiscal year: None.\nAll other items are not applicable.\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.\nAMERICAN INSURED MORTGAGE INVESTORS L.P. - SERIES 86 (Registrant)\nBy: CRIIMI, Inc. General Partner\nMarch 27, 1996 \/s\/ William B. Dockser - --------------------------- ------------------------- DATE William B. Dockser Chairman of the Board and Principal Executive Officer\nMarch 27, 1996 \/s\/ H. William Willoughby - --------------------------- ------------------------- DATE H. William Willoughby President and Director\nMarch 27, 1996 \/s\/ Cynthia O. Azzara - --------------------------- ------------------------- DATE Cynthia O. Azzara Principal Financial and Accounting Officer\nMarch 27, 1996 \/s\/ Garrett G. Carlson, Sr. - --------------------------- -------------------------- DATE Garrett G. Carlson, Sr. Director\nMarch 27, 1996 \/s\/ Larry H. Dale - --------------------------- ------------------------- DATE Larry H. Dale Director\nMarch 27, 1996 \/s\/ G. Richard Dunnells - --------------------------- ------------------------- DATE G. Richard Dunnells Director\nMarch 27, 1996 \/s\/ Robert F. Tardio - --------------------------- ------------------------- DATE Robert F. Tardio Director\nAMERICAN INSURED MORTGAGE INVESTORS L.P. - SERIES 86\nFinancial Statements as of December 31, 1995 and 1994\nand for the Years Ended December 31, 1995, 1994 and 1993\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Partners of American Insured Mortgage Investors L.P. - Series 86:\nWe have audited the accompanying balance sheets of American Insured Mortgage Investors L.P. - Series 86 (the Partnership) as of December 31, 1995 and 1994, and the related statements of operations, changes in partners' equity and cash flows for the years ended December 31, 1995, 1994 and 1993. These 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 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 the Partnership as of December 31, 1995 and 1994, and the results of its operations and its cash flows for the years ended December 31, 1995, 1994 and 1993, in conformity with generally accepted accounting principles.\nAs explained in Note 2 of the notes to financial statements, effective January 1, 1994, the Partnership changed its method of accounting for its investment in insured mortgages.\nOur audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. Schedule IV-Mortgage Loans on Real Estate as of December 31, 1995 is presented for purposes of complying with the Securities and Exchange Commission's rules and regulations and is not a required part of the basic financial statements. The information in this schedule has been subjected to the auditing procedures applied in our audits of the basic financial statements and, in our opinion, is fairly stated in all material respects in relation to the basic financial statements taken as a whole.\nArthur Andersen LLP\nWashington, D.C. March 22, 1996\nAMERICAN INSURED MORTGAGE INVESTORS L.P. - SERIES 86\nBALANCE SHEETS\nAMERICAN INSURED MORTGAGE INVESTORS L.P. - SERIES 86\nSTATEMENTS OF OPERATIONS\nAMERICAN INSURED MORTGAGE INVESTORS L.P. - SERIES 86 STATEMENTS OF CHANGES IN PARTNERS' EQUITY\nFor the years ended December 31, 1995, 1994 and 1993\nAMERICAN INSURED MORTGAGE INVESTORS L.P. - SERIES 86\nSTATEMENTS OF CASH FLOWS\nAMERICAN INSURED MORTGAGE INVESTORS L.P. - SERIES 86\nNOTES TO FINANCIAL STATEMENTS\n1. ORGANIZATION\nAmerican Insured Mortgage Investors L.P. - Series 86 (the Partnership) was formed under the Uniform Limited Partnership Act of the state of Delaware on October 31, 1985.\nFrom inception through September 6, 1991, AIM Capital Management Corp. served as the managing general partner (with a partnership interest of 4.8%), IRI Properties Capital Corp. served as corporate general partner (with a partnership interest of 0.1%) and Second Group Partners, an affiliate of the former general partners, served as the associate general partner (with a partnership interest of 0.1%). All of the foregoing general partners are sometimes collectively referred to as former general partners.\nAt a special meeting of the limited partners and Unitholders of the Partnership held on September 4, 1991, a majority of these interests approved, among other items, assignment of the general partner interests and the shares of the company which acts as the assignor limited partner in the Partnership.\nEffective September 6, 1991, CRIIMI, Inc. (the General Partner) succeeded the former general partners to become the sole general partner of the Partnership. CRIIMI, Inc. is a wholly owned subsidiary of CRIIMI MAE Inc. (CRIIMI MAE). From inception through June 30, 1995, CRIIMI MAE was managed by an adviser whose general partner is C.R.I., Inc. (CRI). However, effective June 30, 1995, CRIIMI MAE became a self-managed and self-administered real estate investment trust (REIT) and, as a result, the adviser no longer advises CRIIMI MAE. In addition, the General Partner acquired the shares of the company which acted as the assignor limited partner in the Partnership. The interest of the former associate general partner (0.1%) was purchased by the Partnership on September 6, 1991, pursuant to the terms of the Partnership Agreement.\nAlso on September 6, 1991, AIM Acquisition Partners, L.P., (the Advisor) succeeded Integrated Funding, Inc. (IFI) as the advisor to the Partnership. AIM Acquisition Corporation (AIM Acquisition) is the general partner of the Advisor, and the limited partners include, but are not limited to, AIM Acquisition, The Goldman Sachs Group, L.P., Broad, Inc., and CRIIMI MAE.\nPursuant to the terms of certain amendments to the Partnership Agreement as discussed below, the General Partner is required to receive the consent of the Advisor prior to taking certain significant actions which affect the management and policies of the Partnership.\nEffective September 6, 1991 and through June 30, 1995, a sub-advisory agreement (the Sub-advisory Agreement) existed whereby CRI\/AIM Management, Inc., an affiliate of CRI, managed the Partnership's portfolio.\nUntil the change in the Partnership's investment policy, as discussed below, and through December 31, 1994, (the expiration of the Partnership's reinvestment period) the Partnership was in the business of originating mortgage loans (Originated Insured Mortgages) and acquiring mortgage loans (Acquired Insured Mortgages, and together with Originated Insured Mortgages, referred to herein as Insured Mortgages). After the expiration of the reinvestment period, the Partnership is required (subject to the conditions set forth in the Partnership Agreement) to distribute such proceeds to its Unitholders. The Partnership Agreement states that the Partnership will terminate on December 31, 2020, unless previously terminated under the provisions of the Partnership Agreement. As of December 31, 1995, the Partnership had invested in either Originated Insured Mortgages which are insured or guaranteed, in whole or in part, by the Federal Housing Administration (FHA) or Acquired Insured Mortgages which are fully insured (as more fully described below).\nAMERICAN INSURED MORTGAGE INVESTORS L.P. - SERIES 86\nNOTES TO FINANCIAL STATEMENTS\n1. ORGANIZATION - Continued\nEffective September 19, 1991, the General Partner changed, at the Advisor's recommendation, the investment policies of the Partnership to invest only in Acquired Insured Mortgages which are fully insured or guaranteed by the Federal National Mortgage Association, the Government National Mortgage Association (GNMA), FHA or the Federal Home Loan Mortgage Corporation.\nEffective January 1, 1994, the United States Congress repealed portions of the Federal tax code which have had an adverse impact on tax-exempt investors in \"publicly-traded partnerships.\" This tax code change cleared away the major impediment standing in the way of listing the Partnership's Depositary Units of Limited Partnership Interest (Units) for trading on a national stock exchange. In an effort to allow pension funds and other tax-exempt organizations to invest in publicly-traded partnerships, the Revenue Reconciliation Act of 1993 repealed the rule that automatically treated income from publicly-traded partnerships as gross income that is derived from an unrelated trade or business. As a result, investments in publicly-traded partnerships such as the Partnership are now treated the same as investments in other partnerships for purposes of the unrelated business taxable income rules. The General Partner listed the Partnership's Units for trading on the American Stock Exchange on January 18, 1994, in order to provide investment liquidity as contemplated in the Partnership's original prospectus. The Units are traded under the symbol \"AIJ.\"\nAMERICAN INSURED MORTGAGE INVESTORS L.P. - SERIES 86\nNOTES TO FINANCIAL STATEMENTS\n2. SIGNIFICANT ACCOUNTING POLICIES\nMethod of Accounting -------------------- The Partnership's financial statements are prepared on the accrual basis of accounting 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 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.\nInvestment in Insured Mortgages ------------------------------- The Partnership's investment in Insured Mortgages is comprised of participation certificates evidencing a 100% undivided beneficial interest in government insured multifamily mortgages issued or sold pursuant to FHA programs (FHA-Insured Certificates), mortgage-backed securities guaranteed by GNMA (GNMA Mortgage-Backed Securities) and FHA-insured mortgage loans (FHA-Insured Loans). The mortgages underlying the FHA-Insured Certificates, GNMA Mortgage-Backed Securities, and FHA-Insured Loans are non-recourse first liens on multifamily residential developments or retirement homes.\nPayments of principal and interest on FHA-Insured Certificates and FHA-Insured Loans are insured by the United States Department of Housing and Urban Development (HUD) pursuant to Title 2 of the National Housing Act. Payments of principal and interest on GNMA Mortgage-Backed Securities are guaranteed by GNMA pursuant to Title 3 of the National Housing Act.\nPrior to January 1, 1994, the Partnership accounted for its investment in Insured Mortgages at amortized cost in accordance with Statement of Financial Accounting Standards No. 65 \"Accounting for Certain Mortgage Banking Activities\" (SFAS 65) since it had the ability and intent to hold these assets for the foreseeable future. The difference between the cost and the unpaid principal balance, at the time of purchase, is carried as a discount or premium and amortized over the remaining contractual life of the mortgage using the effective interest method. The effective interest method provides a constant yield of income over the term of the mortgage. Mortgage investment income is comprised of amortization of the discount plus the stated mortgage interest payments received or accrued, less amortization of the premium.\nIn May 1993, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 115 \"Accounting for Certain Investments in Debt and Equity Securities\" (SFAS 115), effective for fiscal years beginning after December 15, 1993. The Partnership adopted this statement as of January 1, 1994. This statement requires that investments in debt and equity securities be classified into one of the following investment categories based upon the circumstances under which such securities might be sold: Held to Maturity, Available for Sale, and Trading. Generally, certain debt securities for which an enterprise has both the ability and intent to hold to maturity, should be accounted for using the amortized cost method and all other securities must be recorded at their fair values.\nAMERICAN INSURED MORTGAGE INVESTORS L.P. - SERIES 86\nNOTES TO FINANCIAL STATEMENTS\n2. SIGNIFICANT ACCOUNTING POLICIES - Continued\nAs of December 31, 1995, the weighted average remaining term of the Partnership's investments in GNMA Mortgage-Backed Securities and FHA- Insured Certificates is approximately 28 years. However, the Partnership Agreement states that the Partnership will terminate in approximately 25 years, on December 31, 2020, unless previously terminated under the provisions of the Partnership Agreement. As the Partnership is anticipated to terminate prior to the weighted average remaining term of its investments in GNMA Mortgage-Backed Securities and FHA-Insured Certificates, the Partnership does not have the ability, at this time, to hold these investments to maturity. Consequently, the General Partner believes that the Partnership's investments in GNMA Mortgage-Backed Securities and FHA-Insured Certificates should be included in the Available for Sale category. Although the Partnership's investments in GNMA Mortgage-Backed Securities and FHA-Insured Certificates are classified as Available for Sale for financial statement purposes, the General Partner does not intend to voluntarily sell these assets other than those which may be sold as a result of a default or those which are eligible to be put to FHA at the expiration of 20 years from the date of the final endorsement.\nIn connection with this classification, as of December 31, 1995, the Partnership's investments in GNMA Mortgage-Backed Securities and FHA- Insured Certificates are recorded at fair value, with the unrealized losses on these assets reported as a separate component of partners' equity. Subsequent increases or decreases in the fair value of GNMA Mortgage-Backed Securities and FHA-Insured Certificates, classified as Available for Sale, will be included as a separate component of partners' equity. Realized gains and losses on GNMA Mortgage-Backed Securities and FHA-Insured Certificates, classified as Available for Sale, will continue to be reported in earnings. The amortized cost of the GNMA Mortgage-Backed Securities and FHA-Insured Certificates in this category is adjusted for amortization of discounts and premiums to maturity. Such amortization is included in mortgage investment income.\nGains from dispositions of mortgage investments are recognized upon the receipt of cash or HUD debentures.\nLosses on dispositions of mortgage investments are recognized when it becomes probable that a mortgage will be disposed of and that the disposition will result in a loss. In the case of Insured Mortgages fully insured by HUD, the Partnership's maximum exposure for purposes of determining the loan losses would generally be an assignment fee charged by HUD representing approximately 1% of the unpaid principal balance of the Insured Mortgage at the date of default, plus the unamortized balance of acquisition fees and closing costs paid in connection with the acquisition of the Insured Mortgage and the loss of approximately 30-days accrued interest (see discussion below for losses on mortgages accounted for as AHFS, as defined below).\nCash and Cash Equivalents ------------------------- Cash and cash equivalents consist of time and demand deposits and commercial paper with original maturities of three months or less.\nAMERICAN INSURED MORTGAGE INVESTORS L.P. - SERIES 86\nNOTES TO FINANCIAL STATEMENTS\n2. SIGNIFICANT ACCOUNTING POLICIES - Continued\nReclassification ---------------- Certain amounts in the financial statements for the years ended December 31, 1994 and 1993 have been reclassified to conform with the 1995 presentation.\nIncome Taxes ------------ No provision has been made for Federal, state or local income taxes in the accompanying statements of operations since they are the personal responsibility of the Unitholders.\n3. FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe following estimated fair values of the Partnership's financial instruments are presented in accordance with generally accepted accounting principles which define 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. These estimated fair values, however, do not represent the liquidation value or the market value of the Partnership.\nAMERICAN INSURED MORTGAGE INVESTORS L.P. - SERIES 86\nNOTES TO FINANCIAL STATEMENTS\n3. FAIR VALUE OF FINANCIAL INSTRUMENTS - Continued\nThe following methods and assumptions were used to estimate the fair value of each class of financial instrument:\nInvestment in FHA-Insured Certificates, GNMA Mortgage-Backed Securities and FHA-Insured Loans -------------------------------------------------------- The fair value of the fully insured FHA-Insured Certificates, GNMA Mortgage-Backed Securities and FHA-Insured Loans is based on quoted market prices. In order to determine the fair value of the coinsured FHA-Insured Certificates, the Partnership valued the coinsured FHA-Insured Certificates as though they were fully insured (in the same manner fully insured FHA- Insured Certificates were valued). From this amount, the Partnership deducted a discount factor from the face value of the loan. This discount factor is based on the Partnership's historical analysis of the difference in fair value between coinsured FHA-Insured Certificates and fully insured FHA-Insured Certificates.\nCash and cash equivalents and accrued interest receivable --------------------------------------------------------- The carrying amount approximates fair value because of the short maturity of these instruments.\nAMERICAN INSURED MORTGAGE INVESTORS L.P. - SERIES 86\nNOTES TO FINANCIAL STATEMENTS\n4. INVESTMENT IN INSURED MORTGAGES\nThe following is a discussion of the Partnership's insured mortgage investments, along with the risks related to each type of investment:\nA. Fully Insured Originated Insured Mortgages and Acquired Insured Mortgages ---------------------------------------------- The Partnership's investment in fully insured Originated Insured Mortgages consisted of seven and eight FHA-Insured Loans, as of December 31, 1995 and 1994, respectively. As of December 31, 1995, these investments had an aggregate amortized cost of $62,595,492, an aggregate face value of $60,306,932, and an aggregate fair value of $62,183,025. As of December 31, 1994, these investments had an aggregate amortized cost of $69,162,106, an aggregate face value of $66,602,806, and an aggregate fair value of $63,422,100.\nThe Partnership's investment in fully insured Acquired Insured Mortgages consisted of 10 GNMA Mortgage-Backed Securities, 2 FHA-Insured Certificates and 1 FHA-Insured Loan, as of December 31, 1995 and 1994. As of December 31, 1995, these investments had an aggregate amortized cost of $42,122,606, an aggregate face value of $42,066,176, and an aggregate fair value of $42,479,072. As of December 31, 1994, these investments had an aggregate amortized cost of $42,473,748, an aggregate face value of $42,415,356 and an aggregate fair value of $37,875,856. As of March 1, 1996 all of the Partnership's fully insured mortgage investments are current with respect to the payment of principal and interest.\nIn December, 1995, the Partnership received net proceeds of $6,169,529 from the prepayment of the mortgage on Lakewood Villas, a fully insured FHA-Insured Loan, and recognized a gain of $5,208, as shown on the accompanying statement of operations for the year ended December 31, 1995. The net proceeds are expected to be distributed May 1, 1996.\nIn addition to base interest payments from fully insured Originated Insured Mortgages, the Partnership is entitled to additional interest based on a percentage of the net cash flow from the underlying development and of the net proceeds from the refinancing, sale or other disposition of the underlying development (referred to as Participations). During the years ended December 31, 1995, 1994 and 1993, the Partnership received additional interest of $73,357, $33,431 and $62,843, respectively, from the fully insured Participations. These amounts are included in mortgage investment income on the accompanying statements of operations.\nCoinsured Mortgages ------------------- Under the HUD coinsurance program, both HUD and the coinsurance lender are responsible for paying a portion of the insurance benefits if a mortgagor defaults and the sale of the development collateralizing the mortgage produces insufficient net proceeds to repay the mortgage obligation. In such case, the coinsurance lender will be liable to the Partnership for the first part of such loss in an amount up to 5% of the outstanding principal balance of the mortgage as of the date foreclosure proceedings are instituted or the deed is acquired in lieu of foreclosure. For any loss greater than 5% of the outstanding principal balance, the responsibility for paying the insurance benefits will be borne on a pro-rata basis, 85% by HUD and 15% by the coinsurance lender.\nAMERICAN INSURED MORTGAGE INVESTORS L.P. - SERIES 86\nNOTES TO FINANCIAL STATEMENTS\n4. INVESTMENT IN INSURED MORTGAGES - Continued\nWhile the Partnership is due payment of all amounts owed under the mortgage, the coinsurance lender is responsible for the timely payment of principal and interest to the Partnership. The coinsurance lender is prohibited from entering into any workout arrangement with the borrower without the Partnership's consent and must file a claim for coinsurance benefits with HUD, upon default, if the Partnership so directs. As an ongoing HUD-approved coinsurance lender, and under the terms of the participation documents, the coinsurance lender is required to satisfy certain minimum net worth requirements as set forth by HUD. However, it is possible that the coinsurance lender's potential liability for loss on these developments, and others, could exceed its HUD-required minimum net worth. In such case, the Partnership would bear the risk of loss if the coinsurance lenders were unable to meet their coinsurance obligations. In addition, HUD's obligation for the payment of its share of the loss could be diminished under certain conditions, such as the lender not adequately pursuing regulatory violations of the borrower or the failure to comply with other terms of the mortgage. However, the General Partner is not aware of any conditions or actions that would result in HUD diminishing its insurance coverage.\nAs of December 31, 1995 and 1994, the former managing general partner, on behalf of the Partnership, had invested in seven FHA-Insured Certificates secured by coinsured mortgages. As of December 31, 1995, two of the seven FHA-Insured Certificates secured by coinsured mortgages are coinsured by an unaffiliated third party coinsurance lender, The Patrician Mortgage Company (Patrician), under the HUD coinsurance program. The two coinsured mortgages which are coinsured by Patrician were delinquent with respect to the payment of principal and interest. The following is a discussion of actual and potential performance problems with respect to the Partnership's coinsured mortgage investments.\n1. Coinsured by third party ------------------------ The Originated Insured Mortgages on The Villas and St. Charles Place - Phase II are coinsured by Patrician. As of December 31, 1995 and 1994, the Partnership's investment in the mortgage on The Villas had an amortized cost of $15,635,379 and $15,732,782, respectively, a face value of $15,869,089 and $15,966,491, respectively, and a fair value of $15,173,465 and $14,012,209, respectively. As of March 1, 1996, the mortgagor has made payments of principal and interest due on the original mortgage through July 1995, and has made payments of principal and interest due under a modification agreement through August 1993. Patrician is litigating the case in bankruptcy court while negotiating a modification agreement with the borrower.\nThe Partnership's investment in the mortgage on St. Charles Place - Phase II had an amortized cost equal to its face value of $3,068,173 and $3,082,440, as of December 31, 1995 and 1994, respectively. As of December 31, 1995 and 1994, this mortgage had a fair value of $2,933,205 and $2,703,780, respectively. These amounts represent the Partnership's approximate 45% ownership interest in the mortgage. The remaining 55% ownership interest is held by American Insured Mortgage Investors L.P. - Series 88 (AIM 88), an affiliate of the Partnership. As of March 1, 1996, the mortgagor has made payments of principal and interest due on the mortgage through May 1995 to the Partnership. Patrician is litigating the case in bankruptcy court while negotiating a modification agreement with the borrower.\nAMERICAN INSURED MORTGAGE INVESTORS L.P. - SERIES 86\nNOTES TO FINANCIAL STATEMENTS\n4. INVESTMENT IN INSURED MORTGAGES - Continued\nThe General Partner intends to continue to oversee the Partnership's interest in these mortgages to ensure that Patrician meets its coinsurance obligations. The General Partner's assessment of the realizability of The Villas and St. Charles Place-Phase II mortgages is based on the most recent information available, and to the extent these conditions change or additional information becomes available, then the General Partners' assessment may change. However, the General Partner does not believe that there would be a material adverse impact on the Partnership's financial condition or its results of operations should Patrician be unable to comply with its full coinsurance obligation.\n2. Coinsured by affiliate ---------------------- As of December 31, 1995 and 1994, the Partnership held investments in five and two FHA-Insured Certificates secured by coinsured mortgages, respectively, where the coinsurance lender is Integrated Funding, Inc. (IFI), an affiliate of the Partnership. Two of these mortgage investments were originated by the former managing general partner. As structured by the former managing general partner, with respect to these mortgages, the Partnership bears the risk of loss upon default for IFI's portion of the coinsurance loss.\nThe Originated Insured Mortgages on Carmen Drive Estates (The Forest), Woodbine at Lakewood Apartments and Woodland Hills Apartments were previously coinsured by M-West Mortgage Corporation (M-West), a third party coinsurance lender. During the fourth quarter of 1994, the Partnership was informed that M-West was liquidating its assets and intended to assign the mortgage servicing rights related to these mortgages to another coinsurance lender, Whitehall Funding, Inc. (Whitehall). The Partnership successfully contested this transfer and obtained a court order mandating the transfer of the mortgage servicing rights related to these three coinsured loans to IFI. This transfer was completed during the second quarter of 1995. The Partnership bears the risk of loss upon default for IFI's portion of the coinsurance loss. As of December 31, 1995, receivables and other assets, as shown on the accompanying balance sheet, includes approximately $70,000 due from M-West with respect to these loans. As of March 1, 1996, claims for damages against M-West and Whitehall are still pending.\nAs of March 1, 1996, these five IFI coinsured mortgages, as shown in the table below, were current with respect to the payment of principal and interest, except for the mortgage on Spring Lake Village, for which the Mortgagor has made payments of principal and interest through July 1995. In February 1996, this mortgage was modified a\nAMERICAN INSURED MORTGAGE INVESTORS L.P. - SERIES 86\nNOTES TO FINANCIAL STATEMENTS\n4. INVESTMENT IN INSURED MORTGAGES - Continued\nsecond time to reduce the interest rate to 6% through December 1996, increasing to 6.75% for 1997 and 7.0% for all subsequent years. The General Partner does not anticipate that this modification will have a material adverse impact on the Partnership's financial statements.\nThe General Partner believes there is adequate collateral value underlying these coinsured mortgages. Accordingly, no loan losses were recognized on these mortgages during the years ended December 31, 1995 and 1994, except as described below in connection with a mortgage modification during the year ended December 31, 1994. As of December 31, 1995 and December 31, 1994, these five investments had an aggregate fair value of $39,670,264 and $36,466,663, respectively.\nAMERICAN INSURED MORTGAGE INVESTORS L.P. - SERIES 86\nNOTES TO FINANCIAL STATEMENTS\n4. INVESTMENT IN INSURED MORTGAGES - Continued\nAMERICAN INSURED MORTGAGE INVESTORS L.P. - SERIES 86\nNOTES TO FINANCIAL STATEMENTS\n4. INVESTMENT IN INSURED MORTGAGES - Continued\nIn connection with the FHA-Insured Certificates secured by coinsured mortgages, the Partnership has sought, in addition to base interest payments, additional interest (commonly termed Participations) based on a percentage of the net cash flow from the development and the net proceeds from the refinancing, sale or other disposition of the underlying development. All of the FHA-Insured Certificates secured by coinsured mortgages contain such Participations. During the years ended December 31, 1995, 1994 and 1993, the Partnership received additional interest of $76,431, $7,628 and $50,979, respectively, from the coinsured Participations. These amounts, if any, are included in mortgage investment income on the accompanying statements of operations.\nb. Asset Held for Sale Under Coinsurance Program\nAs of December 31, 1993, the former managing general partner, on behalf of the Partnership, had invested in one coinsured mortgage, One East Delaware, which was accounted for as an asset held for sale under coinsurance program (AHFS). In January 1994, the Partnership received net proceeds of $33,233,501 from the prepayment of this mortgage and recognized a gain of $1,129,973, as shown on the accompanying statement of operations for the year ended December 31, 1994. The Partnership reinvested the net disposition proceeds in fully insured Acquired Insured Mortgages during 1994.\n5. DISTRIBUTIONS TO UNITHOLDERS\nThe distributions paid or accrued to Unitholders on a per Unit basis for the years ended December 31, 1995, 1994 and 1993 are as follows:\n1995 1994 1993 ------ ------ ------\nQuarter ended March 31, $ 0.26(1) $ 0.41(3)(4) $ 0.23 Quarter ended June 30, 0.34(1)(2) 0.29(4) 0.21 Quarter ended September 30, 0.31(1) 0.30(4) 0.29(5) Quarter ended December 31, 0.33(1) 0.34(4) 0.28(6) ------ ------ ------ $ 1.24 $ 1.34 $ 1.01 ====== ====== ======\n(1) This amount includes $0.03 per Unit representing previously undistributed accrued interest receivable from St. Charles Place - Phase II and The Villas.\n(2) This amount includes $0.08 per Unit representing previously undistributed accrued interest receivable from Carmen Drive Estates (The Forest), Woodland Hills Apartments, and Woodbine at Lakewood Apartments.\n(3) This amount includes approximately $0.18 per Unit representing previously undistributed accrued interest received from the disposition of the mortgage on One East Delaware.\n(4) This amount includes approximately $0.01, $0.04, $0.03 and $0.03 per Unit representing previously undistributed accrued interest received from St. Charles Place-Phase II and The Villas for the quarters ending March 31,\nAMERICAN INSURED MORTGAGE INVESTORS L.P. - SERIES 86\nNOTES TO FINANCIAL STATEMENTS\n5. DISTRIBUTIONS TO UNITHOLDERS - Continued\n1994, June 30, 1994, September 30, 1994 and December 31, 1994, respectively.\n(5) In September 1993, the Partnership received $591,872 (approximately $0.06 per Unit) from the mortgage on Victoria Pointe Apartments-Phase II, representing mortgage interest from October 1991 through June 1992, and a partial payment for July 1992. The Partnership distributed approximately $0.03 per Unit of this previously undistributed interest and reserved approximately $0.03 per Unit for the continued funding of coinsurance expenses. The Partnership distributed the remaining interest of approximately $0.03 per Unit to Unitholders as part of the fourth quarter distribution, as discussed below.\n(6) This includes a special distribution of approximately $0.10 per Unit comprised of (i) $0.03 per Unit of previously undistributed accrued interest from the mortgage on Victoria Pointe Apartments-Phase II which was reserved as part of the third quarter distribution, as described above, and (ii) $0.07 per Unit representing previously undistributed accrued interest received in December 1993 resulting from the disposition of the mortgage on Victoria Pointe Apartments-Phase II.\nThe basis for paying distributions to Unitholders is net proceeds from mortgage dispositions and cash flow from operations, which includes regular interest income and principal from Insured Mortgages. Although Insured Mortgages yield a fixed monthly mortgage payment once purchased, the cash distributions paid to the Unitholders will vary during each quarter due to (1) the fluctuating yields in the short-term money market where the monthly mortgage payments received are temporarily invested prior to the payment of quarterly distributions, (2) the reduction in the asset base and monthly mortgage payments due to monthly mortgage payments received or mortgage dispositions, (3) variations in the cash flow attributable to the delinquency or default of Insured Mortgages and professional fees and foreclosure costs incurred in connection with those Insured Mortgages and (4) variations in the Partnership's operating expenses.\n6. INVESTMENT IN AFFILIATE AND NOTE PAYABLE TO AFFILIATE\nEffective December 31, 1991, American Insured Mortgage Investors-Series 85, L.P. (AIM 85), an affiliated entity, transferred a GNMA Mortgage-Backed Security (the GNMA security) in the amount of approximately $4.7 million to IFI in order to capitalize IFI with sufficient net worth under HUD regulations. The Partnership and its affiliate, AIM 88, each issued a demand note payable to AIM 85 and recorded an investment in IFI through an affiliate (AIM Mortgage, Inc.) at an amount proportionate to each entity's coinsured mortgages for which IFI was the mortgagee of record as of December 31, 1991. AIM Mortgage, Inc. is jointly owned by AIM 85, AIM 88 and the Partnership. The Partnership accounts for its investment in IFI under the equity method of accounting. Interest expense on the note payable was based on an interest rate of 8% per annum.\nIn 1992, IFI entered into an expense reimbursement agreement with the Partnership, AIM 85 and AIM 88 (collectively, the AIM Funds) whereby IFI reimburses the AIM Funds for general and administrative expenses incurred on behalf of IFI. The expense reimbursement is allocated to the AIM Funds based on an amount proportionate to each entity's coinsured mortgage investments. The expense reimbursement, along with the Partnership's equity interest in IFI's net income or loss, substantially equals the Partnership's interest expense on the note payable.\nAMERICAN INSURED MORTGAGE INVESTORS L.P. - SERIES 86\nNOTES TO FINANCIAL STATEMENTS\n6. INVESTMENT IN AFFILIATE AND NOTE PAYABLE TO AFFILIATE - Continued\nIn April 1994, IFI received net proceeds of approximately $4.7 million from the prepayment of the GNMA security, which IFI distributed to the AIM Funds. On June 30, 1994, the Partnership repaid its note payable to AIM 85.\nAs a result of this distribution, in April 1994, AIM 88 transferred a GNMA Mortgage-Backed Security in the amount of approximately $2.0 million to IFI in order to recapitalize IFI with sufficient net worth under HUD regulations. The Partnership and AIM 85 each issued a demand note payable to AIM 88 and recorded an investment in IFI through AIM Mortgage, Inc., in proportion to each entity's coinsured mortgages for which IFI was the mortgagee of record as of April 1, 1994. Interest expense on the note payable to AIM 88 is based on an annual interest rate of 7.25%\nIn connection with these transactions, the expense reimbursement agreement was amended as of April 1, 1994 to adjust the allocation of the expense reimbursement to the AIM Funds to an amount proportionate to each entity's coinsured mortgage investments as of April 1, 1994. The expense reimbursement, as amended, along with the Partnership's equity interest in IFI's net income or loss, substantially equals the Partnership's interest expense on the note payable.\n7. TRANSACTIONS WITH RELATED PARTIES\nIn addition to the related party transactions described above in Note 6, the General Partner, and certain affiliated entities, during the years ended December 31, 1995, 1994 and 1993, earned or received compensation or payments for services from the Partnership as follows:\nAMERICAN INSURED MORTGAGE INVESTORS L.P. - SERIES 86\nNOTES TO FINANCIAL STATEMENTS\n7. TRANSACTIONS WITH RELATED PARTIES - Continued\n8. PARTNERS' EQUITY\nDepositary Units representing economic rights in limited partnership interests (Units) were issued at a stated value of $20. A total of 9,576,165 Units were issued for an aggregate capital contribution of $191,523,300. In addition, the initial limited partner contributed $2,500 to the capital of the Partnership and received 125 Units in exchange therefor and the former general partners contributed a total of $1,000 to the Partnership.\nAMERICAN INSURED MORTGAGE INVESTORS L.P. - SERIES 86\nNOTES TO FINANCIAL STATEMENTS\n9. SUMMARY OF QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)\nThe following is a summary of unaudited quarterly results of operations for the years ended December 31, 1995, 1994 and 1993:\nAMERICAN INSURED MORTGAGE INVESTORS L.P. - SERIES 86\nNOTES TO SCHEDULE IV - MORTGAGE LOANS ON REAL ESTATE\nDECEMBER 31, 1995\n(1) Under the Section 221 program of the National Housing Act of 1937, as amended, a mortgagee has the right to assign a mortgage (put) to FHA at the expiration of 20 years from the date of final endorsement if the Insured Mortgage is not in default at such time. Any insured mortgagee electing to assign an FHA-insured mortgage to FHA will receive in exchange HUD debentures having a total face value equal to the then outstanding principal balance of the FHA-insured mortgage plus accrued interest to the date of assignment. These HUD debentures will mature 10 years from the date of assignment and will bear interest at the \"going Federal rate\" at such date. This assignment procedure is applicable to a mortgage which had a firm or conditional FHA commitment for insurance on or before November 30, 1983 and, in the case of insured mortgages sold in a GNMA auction, was sold in an auction prior to February 1984. Certain of the Partnership's mortgages may have the right of assignment under this program. Certain mortgages that do not qualify under this program possess a special assignment option, in certain mortgage documents, which allows the Partnership, anytime after this date, to require payment of the unpaid principal balance of the mortgages. At such time, the borrowers must make payment to the Partnership or the Partnership may cancel the FHA insurance and institute foreclosure proceedings.\n(2) Inclusive of closing costs and acquisition fees.\n(3) Prepayment of these insured mortgages would be based upon the unpaid principal balance at the time of prepayment.\n(4) This represents the base interest rate during the permanent phase of this insured mortgage loan. Additional interest (referred to as Participations) measured as a percentage of the net cash flow from the development and of the net proceeds from sale, refinancing or other disposition of the underlying development (as defined in the participation agreements), will also be due. During the years ended December 31, 1995, 1994 and 1993, the Partnership received additional interest of $149,788, $41,059 and $113,822, respectively, from the Participations.\n(5) In addition, the servicer or the sub-servicer of the Insured Mortgage, primarily unaffiliated third parties, is entitled to receive compensation for certain services rendered.\n(6) These Insured Mortgages are insured under the HUD coinsurance program, as previously discussed. The HUD-approved coinsurance lender for these mortgages is The Patrician Mortgage Company.\nAMERICAN INSURED MORTGAGE INVESTORS L.P. - SERIES 86\nNOTES TO SCHEDULE IV - MORTGAGE LOANS ON REAL ESTATE\nDECEMBER 31, 1995\n(7) These mortgages are insured under the HUD coinsurance program, as previously discussed. Integrated Funding, Inc. is the HUD-approved coinsurance lender, and the Partnership bears the risk of any principal loss, as previously discussed.\n(8) This amount represents the Partnership's 45% interest in this Insured Mortgage. The remaining 55% interest was acquired by AIM 88.\n(9) A reconciliation of the carrying value of the Insured Mortgages and Assets Held for Sale Under Coinsurance Program, for the years ended December 31, 1995 and 1994, is as follows:\n1995 1994 ------------ ------------ Beginning balance $160,265,067 $167,145,316\nInvestment in Acquired Insured Mortgages -- 39,730,658\nPrincipal receipts on Insured Mortgages (1,121,467) (1,019,821)\nLoan losses -- (115,301)\nGain on mortgage disposition 5,208 1,129,973\nDisposition of mortgage and AHFS (6,169,529) (33,233,501)\nUunrealized losses on investment in Insured Mortgages 9,431,165 (13,372,257)\nUnrealized gains on investment in Insured Mortgages 406,534 -- ------------ ------------ Ending balance $162,816,978 $160,265,067 ============ ============\n(10) The mortgages underlying the Partnership's investment in FHA-Insured Certificates, GNMA Mortgage-Backed Securities, and FHA-Insured Loans are non-recourse first liens on multifamily residential developments or retirement homes.\nAMERICAN INSURED MORTGAGE INVESTORS L.P. - SERIES 86\nNOTES TO SCHEDULE IV - MORTGAGE LOANS ON REAL ESTATE\nDECEMBER 31, 1995\n(11) Principal and interest are payable at level amounts over the life of the Insured Mortgages.\n(12) Represents principal amount subject to delinquent principal or interest. See Note 4 to the financial statements.\n(13) Annual payment reflects required principal and interest payments for 1995 as per the modification agreement.\n(14) As of December 31, 1995 and 1994, the tax basis of the Insured Mortgages was approximately $167.2 million and $174.3 million, respectively.","section_15":""}
{"filename":"34903_1995.txt","cik":"34903","year":"1995","section_1":"Item 1. Business ------- --------\nFederal Realty Investment Trust is an owner, operator and redeveloper of retail properties. Founded in 1962 as a District of Columbia business trust of unlimited duration, the Trust is a self-administered equity real estate investment trust. The Trust consolidates the financial statements of one wholly owned subsidiary, eight partnerships and a joint venture. At December 31, 1995 the Trust owned 70 retail properties and one apartment complex.\nThe Trust operates in a manner intended to enable it to qualify as a real estate investment trust (REIT) under Sections 856- 860 of the Internal Revenue Code. Under those sections, a REIT which distributes at least 95% of its real estate investment trust taxable income to its shareholders each year and which meets certain other conditions will not be taxed on that portion of its taxable income which is distributed to its shareholders. Therefore, no provision for Federal income taxes is required.\nAn important part of the Trust's strategy is to acquire older, well- located properties in prime, densely populated and affluent areas and to enhance their operating performance through a program of renovation, expansion, reconfiguration and retenanting. The Trust's traditional focus has been on community and neighborhood shopping centers that are anchored by supermarkets, drug stores or high volume, value oriented retailers that provide consumer necessities. Late in 1994 the Trust expanded this strategy to include retail buildings and shopping centers in prime established main street shopping areas. The Trust continually evaluates its properties for renovation, retenanting and expansion opportunities. Similarly, the Trust regularly reviews its portfolio and from time to time considers selling certain of its properties.\nThe Trust's portfolio of properties has increased from 44 as of January 1, 1991 to 71 at December 31, 1995. During this five year period the Trust acquired 31 retail properties for approximately $305.3 million. Six of the acquisitions were in the Chicago, Illinois area and three were in the Boston, Massachusetts area, both of which are markets the Trust entered during the past five years. During this same period four shopping centers were sold. Also during this period the Trust spent over $145 million to renovate, expand, improve and retenant its properties. One of the retail properties acquired during the last five years was acquired by means of capital and ground leases, one was acquired for common shares of the Trust as well as the assumption of a mortgage and the remainder were acquired primarily for cash. This growth was financed through borrowing and equity offerings, since each year the Trust has distributed all or the majority of its cash provided by operating activities to its shareholders.\nThe Trust's 70 retail properties, consisting of 55 shopping centers and 15 main street retail buildings, are located in 13\nstates and the District of Columbia, primarily along the East Coast between the Boston metropolitan area and Richmond, Virginia. Nineteen of the shopping centers are located in the Washington, D.C. metropolitan area; ten are in Pennsylvania, primarily in the Philadelphia area; nine are in New Jersey; five are in Illinois; three are in Virginia; two are in Massachusetts; and there is one in each of the following states, Connecticut, Georgia, Louisiana, Michigan, New York, North Carolina and Tennessee. No single property accounts for over 10% of the Trust's revenues.\nThe Trust has over 1,700 tenants, ranging from sole proprietors to major national retailers; no one tenant or corporate group of tenants accounts for 5% or more of revenue. The Trust's leases with these tenants are classified as operating leases and typically are structured to include minimum rents, percentage rents based on tenants' sales volumes and reimbursement of certain operating expenses and real estate taxes.\nThe Trust intends to continue its strategy of acquiring older, well- located shopping centers and retail buildings and then enhancing their revenue potential through a program of renovation, retenanting and remerchandising. The Trust is also studying sites which are suitable for the development of new shopping centers. During the years ended December 31, 1995, 1994 and 1993, retail properties have contributed 96%, 95% and 94%, respectively of the Trust's total revenue.\nThe Trust is currently limited to investing east of the Mississippi River; to change this limitation requires Trustee approval. Investments are not required to be based on specific allocation by type of property. The extent to which the Trust might mortgage or otherwise finance investments varies with the investment involved and the economic climate.\nThe success of the Trust depends upon, among other factors, the trends of the economy, including interest rates, construction costs, retailing trends, income tax laws, increases or decreases in operating expenses, governmental regulations, population trends, zoning laws, legislation and the ability of the Trust to keep its properties leased at profitable levels. The Trust competes for tenants with other real estate owners and the Trust's properties account for only a small fraction of the retail space available for lease. The Trust competes for investment opportunities and debt and equity capital with individuals, partnerships, corporations, financial institutions, life insurance companies, pension funds, trust funds and other real estate investment trusts.\nInvestments in real property create a potential for environmental liability on the part of the current and previous owners of, or any mortgage lender on, such real property. If hazardous substances are discovered on or emanating from any property, the owner or operator of the property may be held liable for costs and liabilities relating to such hazardous substances. The Trust's current policy is to obtain an environmental study on each property it seeks to acquire. On recent acquisitions, any substances identified prior to closing\nwhich present an immediate environmental hazard have been or are in the process of remediation. Costs related to the abatement of asbestos which increase the value of Trust properties are capitalized. Other costs are expensed. In 1995 approximately $1.0 million, of which $796,000 was capitalized abatement costs, was spent on environmental matters. The Trust has budgeted approximately $2.0 million for 1996 for environmental matters, a majority of which is projected for asbestos abatement. (See Note 6 of Notes to Consolidated Financial Statements.)\nCurrent Developments --------------------\nIn 1995 the Trust purchased 20 retail properties. Finley Square Shopping Center in suburban Chicago, Illinois was purchased for approximately $18.8 million in cash; Bristol Shopping Center in Bristol, Connecticut was purchased for $19.6 million, by assuming a $11.3 million mortgage and by issuing common shares valued at $7.3 million with the balance in cash; Park & Shop Center in Washington, D.C. was purchased for $11.2 million in cash; and Shirlington Shopping Center in Arlington, Virginia was purchased for $23.5 million in cash. Retail building acquisitions during 1995 were as follows: seven buildings in West Hartford, Connecticut for $15.3 million; two buildings in Greenwich,Connecticut for $14.9 million; one building in Westport, Connecticut for $5.7 million; one building in Brookline, Massachusetts for $3.8 million; one building in Westfield, New Jersey for $2.2 million; two buildings in Evanston, Illinois for $3.6 million; and a building contiguous to Bethesda Row in Bethesda, Maryland for $2.0 million. In addition, the Trust purchased a building abutting Flourtown Shopping Center, one of its existing centers, for $3.1 million.\nThe Trust continued its strategy of renovating, expanding and retenanting its centers in 1995, spending approximately $33.8 million. These improvements included an additional $3.8 million on the redevelopment of Congressional Plaza in Rockville, Maryland, $5.5 million to complete the redevelopment and retenanting of Gaithersburg Square in Gaithersburg, Maryland and $5.8 million for the renovation of Brick Plaza in Brick, New Jersey.\nThe Trust funded its 1995 acquisitions, capital improvement projects and major debt repayment requirements primarily through three issues of senior notes, totalling $165.0 million. The notes bear interest at rates ranging from 6.625% to 8.875% and mature from 2000 to 2005.\nAt December 31, 1995 the Trust had 195 full-time employees.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nRetail Properties - ----------------- The following table sets forth information concerning each retail property in which the Trust owns an equity interest or has a leasehold interest as of December 31, 1995. Except as otherwise noted, retail properties are 100% owned in fee by the Trust.\n(1) Overall occupancy is expressed as a percentage of rentable square feet and includes square feet covered by leases for stores not yet opened. Economic occupancy is expressed as a percentage of rentable square feet, but only includes leases currently generating rental income.\n(2) The Trust has a leasehold interest in this property.\n(3) The Trust owns a 99.9% partnership interest in this center.\n(4) The Trust owns a 49% equity interest in this center.\n(5) The Trust owns this property subject to a ground lease.\n(6) The Trust has a 1% general partnership interest and manages the partnership. A 99% interest was sold to a limited partner.\nApartments - ----------\nThe following table sets forth information concerning the Trust's apartment development as of December 31, 1995 which is 100% owned by the Trust in fee. This development is not subject to rent control.\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\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder ------ ------------------------------------------------------------- Matters. -------\nThe number of holders of record for Federal Realty's common shares of beneficial interest at December 31, 1995 was 5,342.\nFor the years ended December 31, 1995 and 1994, $.43 and $.75, respectively, of dividends paid represented a return of capital.\nDividends declared per quarter during the last two fiscal years were as follows:\nThe Trust's common shares of beneficial interest are listed on the New York Stock Exchange.\nItem 6.","section_6":"Item 6. Selected Financial Data. -----------------------\nIn thousands, except per share data\n(1) Determined in accordance with Financial Accounting Standards Board Statement No. 95.\n(2) Defined as income before depreciation and amortization of real estate assets and before extraordinary items and significant nonrecurring events less gains on sale of real estate. Funds from operations differs from net cash provided by operating activities primarily because funds from operations does not include changes in operating assets and liabilities. Funds from operations is a supplemental measure of performance that does not replace net income as a measure of performance or net cash provided by operating activities as a measure of liquidity.\nManagement's Discussion and Analysis of Financial Condition and Results of Operations\nLiquidity and Capital Resources -------------------------------\nFederal Realty meets its liquidity requirements through net cash provided by operating activities, long term borrowing through debt offerings and mortgages, medium and short term borrowing under revolving credit facilities, and equity offerings. Because all or a significant portion of the Trust's net cash provided by operating activities is distributed to shareholders, capital outlays for property acquisitions, renovation projects and debt repayments require funding from borrowing or equity offerings.\nNet cash provided by operating activities increased from $35.2 million in 1993 to $45.2 million in 1994 to $65.1 million in 1995. The major source of the $10.0 million increase from 1993 to 1994 was an increase in net income of $2.3 million and an increase of $4.4 million in depreciation and amortization. The $19.9 million increase from 1994 to 1995 resulted primarily from a $2.6 million increase in net income, a $5.1 million increase in depreciation and amortization and a $12.9 million increase in cash provided by changes in operating assets and liabilities. Dividends paid in cash were $38.1 million in 1993, $44.0 million in 1994 and $47.9 million in 1995.\nIn 1995 net cash provided by operating activities was comprised primarily of $23.1 million in net income increased by $34.9 million of depreciation and amortization and $6.1 million of cash provided by changes in operating assets and liabilities. In 1994 net cash provided by operating activities was primarily comprised of $20.5 million in net income increased by $29.8 million in depreciation and amortization and decreased by cash used for operating assets and liabilities of $6.8 million. In 1993 net cash provided by operating activities was comprised primarily of $18.1 million in net income increased by $25.4 million of depreciation and amortization and decreased by $6.4 million of cash used for operating assets and liabilities.\nDuring the period 1993 through 1995, the Trust spent over $370 million to acquire properties and to improve its properties. These expenditures were primarily funded from the proceeds of various debt and equity transactions.\nIn 1995 the Trust purchased 19 retail properties. The Trust also purchased a building abutting Flourtown Shopping Center, one of its existing centers, for $3.1 million. The 302,000 square foot Finley Square Shopping Center in suburban Chicago, Illinois was purchased on April 27, 1995 for approximately $18.8 million in cash; the 284,000 square foot Bristol Shopping Center in Bristol, Connecticut was purchased on September 22, 1995 for $19.6 million, by assuming a $11.3 million mortgage and by issuing common shares valued at $7.3 million with the balance in cash; the 47,000 square foot Park & Shop Center in Washington, D.C. was purchased on December 1, 1995 for $11.2 million in cash; and on December 21, 1995 the 349,000 square foot Shirlington Shopping Center in Arlington, Virginia was purchased for $23.5 million in cash. The\nretail building acquisitions during 1995 were as follows: seven buildings in West Hartford, Connecticut for $15.3 million; two buildings in Greenwich, Connecticut for $14.9 million; one building in Westport, Connecticut for $5.7 million; one building in Brookline, Massachusetts for $3.8 million; one building in Westfield, New Jersey for $2.2 million; two buildings in Evanston, Illinois for $3.6 million; and a building contiguous to Bethesda Row in Bethesda, Maryland for $2.0 million.\nDuring 1995 $33.8 million was expended on improvements to Trust properties. These improvements included $3.8 million on the redevelopment of Congressional Plaza in Rockville, Maryland, $5.5 million to complete the redevelopment and retenanting of Gaithersburg Square in Gaithersburg, Maryland and $5.8 million for the renovation of Brick Plaza in Brick, New Jersey.\nDuring 1994 the Trust purchased four shopping centers and one retail building, Idylwood Plaza in Falls Church, Virginia, North Lake Commons in Lake Zurich, Illinois, Garden Market Shopping Center in Western Springs, Illinois, Queen Anne Plaza in Norwell, Massachusetts and the Ship's Building in Westport, Connecticut. In addition, the Trust purchased a 3.9 acre parcel of land, on which there is a supermarket, which adjoins its Bala Cynwyd Shopping Center. These properties were acquired for a total cash investment of $48.3 million and a $1.1 million note.\nDuring 1994, $42.3 million was expended on improvements to Trust properties. These improvements included $15.5 million on the renovation and expansion of Congressional Plaza in Rockville, Maryland, $4.1 million to complete the redevelopment of Ellisburg Circle Shopping Center in Cherry Hill, New Jersey, and $3.9 million to begin the redevelopment and retenanting of Gaithersburg Square Shopping Center in Gaithersburg, Maryland.\nIn 1993 the Trust spent $101.8 million to acquire six shopping centers (Gaithersburg Square and Quince Orchard Shopping Centers in Gaithersburg, Maryland, Pan Am Shopping Center in Fairfax, Virginia, Crossroads Shopping Center in Highland Park, Illinois, Bala Cynwyd Shopping Center in suburban Philadelphia, Pennsylvania, and Dedham Plaza in Dedham, Massachusetts), $6.2 million in connection with the long term lease of Bethesda Row in Bethesda, Maryland, and $34.3 million in improvements to its properties.\nThese acquisitions and improvements, as well as debt repayment requirements, were funded through a variety of equity and debt issues. During 1995 the Trust issued $165 million of senior notes: $100.0 million at 8 7\/8% interest in January netting proceeds of approximately $98.9 million; $25.0 million at 8% interest in April, netting approximately $24.9 million; and $40.0 million at 6 5\/8% interest in December, netting approximately $39.6 million. In January 1995 the Trust repaid a $22.5 million mortgage which had been borrowed in 1994 and a $1.1 million note issued in connection with the purchase of Queen Anne Plaza in 1994.\nIn order to protect itself against the risk that the general level of interest rates for senior notes would rise before the senior notes were priced in January 1995, the Trust entered into two interest rate hedge agreements in December 1994 on a total principal\namount of $75.0 million. The cost of the agreements, which terminated on January 20, 1995, was $21,000, which is being amortized into interest expense over the life of the notes.\nIn January 1995 in connection with the issuance of the $100.0 million of senior notes, the Trust executed a five year interest rate swap on $25.0 million, whereby the Trust swappped fixed interest payment obligations of 8.1% for a floating rate interest payment of three month LIBOR (London Interbank Offered Rate). The floating rate during the first quarter of 1995 was 6.2%. In May 1995 the swap was terminated and the Trust sold the swap for $1.5 million, which is being amortized as a deduction to interest expense over the remaining term.\nIn April 1994 the Trust raised net proceeds of $61.3 million from a public offering of 2.5 million common shares of beneficial interest (\"shares\"). In a concurrent offering of 840,000 shares to an institutional investor, the Trust raised net proceeds of $21.7 million. In April 1994 the Trust redeemed $39.8 million principal amount of its 5 1\/4% convertible subordinated debentures due 2002 at a price equal to 120% of their principal amount or $47.8 million. In November 1994 the Trust spent $4.2 million to exercise the option to purchase the land at Northeast Shopping Center, $3.4 million of which had been recorded as a capital lease obligation.\nIn April 1993, 2.8 million shares were issued in a public offering, netting proceeds of $72.8 million. In December 1993 another 220,000 shares were issued for $5.4 million in a private placement in connection with the long term lease of Bethesda Row. The Trust called its 8 3\/4% convertible subordinated debentures and its 8.65% Senior Notes for redemption in 1993. The Trust redeemed $173,000 principal amount of the 8 3\/4% debentures at a price of $1017.50 per debenture on March 15; the balance of the debentures that had been outstanding or $2.2 million were converted into shares. The senior notes were redeemed on May 14, at a price of $1010 for a total redemption price of $50.5 million. In October 1993 the Trust issued $75.0 million of 5 1\/4% convertible subordinated debentures, realizing cash proceeds of approximately $73.0 million. The debentures, which mature in 2003, are convertible into shares at $36 per share.\nAt December 31, 1995 and 1994 the Trust had $130 million of unsecured medium term revolving credit facilities with four banks. The facilities require fees and have covenants requiring a minimum shareholders' equity and a maximum ratio of debt to net worth. The Trust uses these facilities to fund acquisitions and other cash requirements until conditions are favorable for issuing equity or long term debt. At December 31, 1995 there was $40.1 million drawn under these facilities; the maximum amount borrowed under these facilities during 1995 was $66.8 million. Amounts advanced under these facilities bear interest at LIBOR plus 75 - 100 basis points; the weighted average interest rate on borrowings during 1995 was 6.9%. At December 31, 1994 there was $54.7 million drawn under these facilities, which was the maximum drawn during 1994. The weighted average interest rate on borrowings during 1994 was 5.6%.\nAt December 1993 the Trust had $70.0 million of unsecured medium term revolving credit facilities with three banks. The\nmaximum drawn under these facilities in 1993 was $64.1 million and at December 31, 1993, there was $24.4 million outstanding. The weighted average interest rate on borrowing during 1993 was 4.2%.\nThe Trust has budgeted $48.0 million for capital improvements to its properties in 1996. These improvements include: (1) $12.0 million at Congressional Plaza whose renovation has been expanded to include the construction of an additional 30,000 square feet of space; (2) $6.7 million to renovate and expand a portion of Bethesda Row; (3) $5.6 million to retenant and renovate a portion of Troy Shopping Center; and (4) $2.1 million to complete the retenanting of Brick Plaza.\nThe Trust's long term debt has varying maturity dates and in a number of instances includes balloon payments or other contractual provisions that could require significant repayments during a particular period. The next significant maturity is approximately $53.5 million of mortgage obligations which are due in 1998.\nThe Trust intends to continue to acquire existing retail properties, both shopping centers and main street retail buildings. In addition, the Trust is searching for site acquisitions in its core markets to permit the Trust to build new shopping centers.\nThe Trust will need additional capital in order to fund these acquisitions, expansions and refinancings. Sources of this funding may be proceeds from the sale of existing properties, additional debt and additional equity. The timing and choice between additional debt or equity will depend upon many factors, including the market price for the Trust's shares, interest rates and the ratio of debt to net worth. The Trust believes that it will be able to raise this capital as needed, based on its past success in so doing.\nContingencies -------------\nThe State of New Jersey Division of Taxation assessed the Trust $364,000 in taxes, penalty and interest for the years 1985 through 1990, since the State disallowed the dividends paid deduction in computing New Jersey taxable income. The Trust protested this assessment since the Trust believed that it was entitled to the deduction. The case was dismissed in December 1995 in favor of the Trust.\nAs previously reported, certain of the Trust's shopping centers have some environmental contamination. The North Carolina Department of the Environment, Health and Natural Resources (\"DEHNR\") issued a Notice of Violation (\"NOV\") against a former dry cleaner tenant at Eastgate Shopping Center in Chapel Hill, North Carolina concerning a spill at the shopping center. As owner of the shopping center, the Trust was named in and received a copy of the NOV. Estimates to remediate the spill range from $300,000 to $500,000. The Trust has entered into an agreement with two previous owners of the shopping center to share the costs to assess and remediate. In 1993 the Trust recorded a liability of $120,000 as its estimated share of the cleanup costs.\nIn 1992 contaminants at levels in excess of New Jersey cleanup standards were identified at a shopping center in New Jersey. The Trust has retained an environmental consultant to investigate the contamination. The Trust is also evaluating whether it has insurance coverage for this matter. At this time, the Trust has not determined what the range of remediation costs might be, but does not believe that the costs will have a material effect upon the Trust's financial condition. The Trust has also identified chlorinated solvent contamination at another property. The contamination appears to be linked to the current and\/or previous dry cleaner. The Trust intends to look to the responsible parties for any remediation effort. Evaluation of this situation is preliminary and it is impossible, at this time, to estimate the range of remediation costs, if any.\nOn September 22, 1995 the Trust purchased the Bristol Shopping Center in Bristol, Connecticut. Pursuant to an agreement executed at closing, the Trust agreed to perform all remedial measures necessary to obtain a final letter of compliance from the Connecticut Commissioner of Environmental Protection with respect to certain identified soil and ground water contamination associated with a former dry cleaning operation. The seller established an escrow account at closing of $187,500 to cover such remedial measures and has indemnified the Trust in connection with the identified contamination.\nThe Trust reserved $2.25 million at closing in 1993 for environmental issues principally associated with Gaithersburg Square Shopping Center. Pursuant to an indemnity agreement entered into with the seller at closing, the Trust agreed to take certain actions with respect to identified chlorinated solvent contamination. The seller indemnified the Trust for certain third party claims and government requirements related to contamination at adjacent properties. During the third quarter of 1995 the reserve was reduced by $269,000 with a corresponding reduction in the basis of land at one shopping center since the environmental issue there was resolved.\nPursuant to the provisions of the respective partnership agreements, in the event of the exercise of put options by the other partners, the Trust would be required to purchase the 99% limited partnership interest at Loehmann's Plaza at its then fair market value and a 22.5% interest at Congressional Plaza at its then fair market value.\nResults of Operations ---------------------\nNet income and funds from operations have been affected by the Trust's recent acquisition and financing activities. The Trust has historically reported its funds from operations in addition to its net income and net cash provided by operating activities. Funds from operations is a supplemental measure of real estate companies' operating performance which excludes historical cost depreciation, since real estate values have historically risen and fallen with market conditions rather than over time. Funds from operations was historically defined as income before depreciation and amortization and extraordinary items less gains on sale of real estate. The National Association of Real Estate Investment Trusts (NAREIT)\nissued a white paper during 1995, which has amended the definition as follows: income before depreciation and amortization of real estate assets and before extraordinary items and significant non-recurring events less gains on sale of real estate. The Trust is complying with this new definition and has consequently restated funds from operations for prior periods. Funds from operations does not replace net income as a measure of performance or net cash provided by operating activities as a measure of liquidity. Rather, funds from operations has been adopted by real estate investment trusts to provide a consistent measure of operating performance in the industry.\nThe reconciliation of net income to funds from operations is as follows:\nThe Trust's retail leases generally provide for minimum rents, with periodic increases. Most retail tenants pay a majority of on-site operating expenses. Many leases also contain a percentage rent clause which calls for additional rents based on tenant sales, so that at a given sales volume, if prices increase, so does rental income. These features in the Trust leases reduce the Trust's exposure to higher costs caused by inflation, although inflation has not been significant in recent years.\nRental income, which consists of minimum rent, percentage rent, and cost recoveries, increased 20.9% from $105.9 million in 1993 to $128.1 million in 1994 and 11.5% in 1995 to $142.8 million. If centers acquired and sold in 1993, 1994 and 1995 are excluded, rental income increased 6.1% from 1993 to 1994 and 3.6% from 1994 to 1995.\nMinimum rents increased 19.4% in 1994 to $99.9 million from $83.6 million in 1993 and 14% in 1995 to $113.9 million. If centers acquired and sold in 1993, 1994 and 1995 are excluded, minimum rents increased 4.3% from 1993 to 1994 and 6.2% from 1994 to 1995. Thirty-four percent of the increase in minimum rent in 1995 was from Congressional Plaza whose occupancy has increased since its redevelopment was substantially completed in late 1994.\nCost reimbursements consist of tenant reimbursements of real estate taxes (real estate tax recovery) and common area maintenance expenses (CAM recovery). After removing the effect of properties purchased and sold during the past three years, real estate tax recovery has remained fairly constant, with the largest fluctuation\nbeing at Congressional Plaza. Recovery was down in 1994 from 1993 as the center was vacated for renovation and recovery was up in 1995 compared to 1994 as the center was leased following the renovation. CAM recovery on the portfolio, adjusted to remove the effect of properties purchased in 1993, 1994 and 1995, was $8.4 million in 1993, $11.7 million in 1994 and $10.0 million in 1995. These fluctuations correspond to fluctuations in CAM expenses, primarily snow removal, landscaping and security which were up in 1994 as compared to 1993, but which decreased in 1995.\nOther property income includes items which tend to fluctuate from period to period, such as utility reimbursements, telephone income, merchant association dues, lease termination fees, late fees and temporary tenant income. The increases from 1993 to 1995 were due in part to the acquisition of new properties and in part to the fluctuating nature of the income. Major increases in 1995 over 1994 resulted from lease termination fees, an unexpected recovery from a bankrupt tenant, merchant association dues and a commission on telephone services.\nRental expenses went from $26.5 million in 1993 to $35.8 million in 1994 to $35.1 million in 1995, which represents 23.8% of property income (rental income plus other property income) in 1993, 26.8% in 1994 and 23.3% in 1995. The components of rental expense with the greatest percentage increase in 1994 were repairs and maintenance and ground rent. Snow removal expense, a component of repairs and maintenance, increased from $910,000 in 1993 to over $2.4 million in 1994 because of new properties and because of increased expense on the core portfolio resulting from the harsh weather conditions during 1994. Ground rent increased $2.1 million in 1994 over 1993 because of the acquisition of Bethesda Row on December 31, 1993, a large part of which is ground leased. In 1995 the greatest percentage changes were decreases in repairs and maintenance and in maintenance and security payroll costs. Snow removal expense decreased to $1.3 million despite the acquisition of new properties and there has been a decrease in payroll costs as the Trust has taken measures to control these costs. If rental expenses are adjusted to remove the effect of properties purchased in 1993, 1994 and 1995, rental expenses ranged from $24.9 million in 1993 to $27.2 million in 1994 to $24.5 million in 1995. Real estate taxes have ranged from 9.3% of rental income in 1993 to 9.0% in 1994 to 9.6% in 1995. The decline in 1994 was primarily due to Congressional Plaza, which received a refund of prior year taxes in 1994.\nDepreciation and amortization expenses have increased because of the recent acquisitions and also because of the depreciation on recent tenant work and property improvements.\nInterest income has remained relatively constant in each of the past three years. The Trust's major sources of interest income are on its mortgage notes receivable, its notes to officers, and its available cash balances. Included in interest income in 1995 is the effect of the sale in December 1995 of the Trust's investment in Olympia and York Senior First Mortgage Notes and other real estate investment trusts, both of which were written down to market in prior years.\nInterest expense increased to $39.3 million in 1995 from $31.5 million in 1994, primarily due to interest on the three issues of senior notes in 1995. Interest expense was relatively constant in 1994 and 1993, $31.5 million and $31.6 million, respectively. Decreases in interest expense in 1994 from the repayment of several mortgages, an issue of senior notes and an issue of convertible subordinated debentures was offset by increases due to an issuance of convertible subordinated debentures, the interest portion of the capital lease at Bethesda Row and increased usage of the revolving credit facilities. The ratio of earnings to fixed charges was 1.55x, 1.61X and 1.5X in 1995, 1994 and 1993, respectively. The ratio of funds from operations to fixed charges was 2.35x, 2.52x, and 2.27x in 1995, 1994 and 1993, respectively.\nWhile administrative expenses are increasing as the Trust grows and as it seeks acquisition and development opportunities, administrative expenses as a percentage of total income have remained relatively constant, at 4.7%, 4.8% and 4.1%, in 1995, 1994 and 1993, respectively. The major components of the increase in 1995 over 1994 were in payroll and in costs related to a business combination that the Trust decided not to pursue. The major component of the increase in 1994 over 1993 was an increase in costs connected with the review and analysis of potential property acquisitions which were not purchased.\nOther charges consisted of three nonrecurring items in 1994, a $758,000 write off of a mortgage note receivable and accrued interest thereon, an unrealized loss of $449,000 on an investment in common shares of another real estate investment trust and a $152,000 recovery of a legal settlement paid in 1987. During 1995 the Trust sold its investments in common shares of other real estate investment trusts.\nInvestors' share of operations represents the minority interest in Congressional Plaza, Loehmann's Plaza and North City Plaza. In 1995 minority net losses at Loehmann's and North City exceeded the minority net income at Congressional Plaza.\nIncome before loss on sale of real estate and extraordinary item increased from $16.1 million in 1993 to $20.5 million in 1994 to $23.7 million in 1995, reflecting increased revenues from the Trust's acquisitions and from improved operating results of the core portfolio.\nLoss or gain on the sale of real estate is dependent on the extent and timing of sales. The Trust regularly reviews its portfolio and does from time to time sell properties. In 1995 the Trust sold North City Plaza for $1.8 million resulting in a loss on sale of $545,000.\nIn 1993 the Trust had a net gain of $2.0 million on the early extinguishment of debt, resulting from a gain on the extinguishment of one mortgage offset by losses on the redemption of an issue of senior notes, an issue of convertible subordinated debentures and two other mortgages.\nAs a result of the foregoing items, net income rose from $18.1 million in 1993 to $20.5 million in 1994 to $23.1 million in 1995.\nThe Trust intends to continue to acquire properties in 1996. If successful in so doing, these acquisitions should contribute to growth in rental income and expenses and, thereby, net income. The growth of the core portfolio, however, is, in part, dependent on controlling expenses, some of which are beyond the complete control of the Trust, such as snow removal, and trends in the retailing environment. Recently there have been a number of retailer bankruptcies and others are anticipated. These bankruptcies and a further weakening of the retail environment could adversely impact the Trust, by increasing vacancies and by decreasing rents. In past weak retail and real estate environments, the Trust has been able to replace weak and bankrupt tenants with stronger tenants; management believes that the quality of the Trust's properties will continue to generate demand for its retail space.\nImpact of New Accounting Standards ----------------------------------\nIn October 1995 the Financial Accounting Standards Board (FASB) issued FASB 123, \"Accounting for Stock-Based Compensation\". This standard will be effective for 1996 financial statements and requires that stock based compensation be accounted for on the fair value method described in FASB 123, or on the intrinsic value based method of APB 25, whereby if options are priced at fair market value or above on the date of grant, there is no compensation expense of the options to the Trust. If APB 25 is used, proforma net income and earnings per share must be disclosed as if the fair value based method had been applied. The Trust intends to continue accounting for its employee stock option plan under APB 25 and therefore the only effect on the Trust's financial statements will be the proforma disclosure.\nItem 8. Financial Statements and Supplementary Data. ---------------------------------------------------\nIncluded in Item 14.\nItem 9. Disagreements on Accounting and Financial Disclosure. ------------------------------------------------------------\nNone.\nPart III --------\nItem 10. Directors and Executive Officers of the Registrant. ---------------------------------------------------\nExecutive Officers of the Registrant ------------------------------------\nSteven J. Guttman has been the Trust's President and Chief Executive Officer since April 1980. Mr. Guttman has been associated with the Trust since 1972, became Chief Operating Officer in 1975 and became a Managing Trustee in 1979.\nRon D. Kaplan joined the Trust in November 1992 as Vice President-Capital Markets. Mr. Kaplan was formerly a Vice President of Salomon Brothers Inc where he was responsible for capital raising and financial advisory services for public and private real estate companies. While at Salomon Brothers which he joined in 1987, he participated in two of the Trust's debt offerings.\nCatherine R. Mack came to the Trust in January 1985 as General Counsel and became a Vice President in February 1986. Before joining the Trust, Ms. Mack was an Assistant United States Attorney for the District of Columbia and, prior to that, an attorney with Fried, Frank, Harris, Shriver and Jacobson in Washington, D.C. where she represented several local real estate entities. She has practiced law since 1974.\nMary Jane Morrow joined the Trust in January 1987 as Vice President-Finance and Treasurer. Before joining Federal Realty, Ms.\nMorrow was a Partner with Grant Thornton LLP, the Trust's independent accountants. She was with Grant Thornton LLP for over 10 years and has extensive experience in real estate and accounting.\nHal A. Vasvari joined Federal Realty Management, Inc., the Trust's former managing agent, in August 1985 as Executive Vice President. In January 1989, Mr. Vasvari became Executive Vice President-Management of the Trust. In December 1994, Mr. Vasvari was appointed Chief Operating Officer. Prior to August 1985, he was director of leasing for Kravco Co., a developer of shopping malls and shopping centers.\nCecily A. Ward joined the Trust in April 1987 as Controller. Prior to joining the Trust, Ms. Ward, a certified public accountant, was with Grant Thornton LLP, the Trust's independent accountants.\nRobert S. Wennett joined the Trust's acquisitions department in April 1986. Prior to joining the Trust, Mr. Wennett was an associate with Chemical Realty Corporation in New York where he was involved in real estate financing for corporate clients.\nThe schedule identifying Trustees under the caption \"Election of Trustees\" of the 1996 Proxy Statement is incorporated herein by reference thereto.\nItem 11. Executive Compensation. -------- -----------------------\nThe sections entitled \"Summary Compensation Table\" and \"Aggregated Option Exercises in 1995 and December 31, 1995 Option Values\" of the 1996 Proxy Statement are incorporated herein by reference thereto.\nItem 12. Security Ownership of Certain Beneficial Owners and Management. -------- ---------------------------------------------------------------\nThe section entitled \"Ownership of Shares by Trustees and Officers\" of the 1996 Proxy Statement is incorporated herein by reference thereto.\nItem 13. Certain Relationships and Related Transactions. -------- -----------------------------------------------\nThe section entitled \"Certain Transactions\" of the 1996 Proxy Statement is incorporated herein by reference thereto.\nPart IV -------\nItem 14. Exhibits, Financial Statement Page No. -------- ----------------------------- -------- Schedules, and Reports on ------------------------- Form 8-K --------\n(a) 1. Financial Statements --------------------\nReport of Independent Certified Public Accountants\nConsolidated Balance Sheets- December 31, 1995 and 1994\nConsolidated Statements of Operations - years ended December 31, 1995, 1994 and 1993\nConsolidated Statements of Shareholders' Equity - years ended December 31, 1995, 1994 and 1993\nConsolidated Statements of Cash Flows - years ended December 31, 1995, 1994 and 1993\nNotes to Consolidated Financial Statements (Including Selected Quarterly Data) -\n(a) 2. Financial Statement Schedules -----------------------------\nSchedule III - Summary of Real Estate and Accumulated Depreciation.............F21 -\nSchedule IV - Mortgage Loans on Real Estate ..................................F25 -\nReport of Independent Certified Public Accountants...........................\n(a) 3. Exhibits --------\n(3) (i) The Trust's Third Amended and Restated Declaration of Trust dated May 24, 1984, filed with the Commission on July 5, 1984 as Exhibit 4 to the Trust's Registration Statement on Form S-2 (file No. 2-92057) is incorporated herein by reference thereto.\n(ii) Bylaws of the Trust, filed with the Commission as an exhibit to the Trust's Current Report on Form 8-K dated February 20, 1985, as most recently amended and filed with the Commission as an exhibit to the Trust's Current Report on Form 8-K dated November 30, 1994, is incorporated herein by reference thereto.\n(4) (i) Specimen Share of Beneficial Interest, filed with the Commission on November 23, 1982 as Exhibit 4 to the Trust's Registration Statement on Form S-2 (file No. 2-80524), is incorporated herein by reference thereto.\n(ii) Indenture dated March 15, 1985, relating to the Trust's 8 3\/4% Convertible Subordinated Debentures Due 2010, filed with the Commission on March 1, 1985 as Exhibit 4 (a) (2) to the Trust's Registration Statement on Form S-2 (File No. 2-96136) is incorporated herein by reference thereto.\n(iii) Indenture dated April 1, 1986, relating to the Trust's 8.65% Senior Notes due 1996, filed with the commission on March 27, 1986 as exhibit 4 (a) 1 to the Trust's Registration Statement on Form S-3, (File No. 33-3934) is incorporated herein by reference thereto.\n(iv) The 5 1\/4% Convertible Subordinated Debenture due 2002 as described in Amendment No. 1 to Form S-3 (File No. 33-15264), filed with the Commission on August 4, 1987 is incorporated herein by reference thereto.\n(v) Shareholder Rights Plan, dated April 13, 1989, filed with the Commission as an exhibit to the Trust's Current Report on Form 8-K, dated April 13, 1989, is incorporated herein by reference thereto.\n(vi) Indenture dated December 13, 1993, related to the Trust's 8 7\/8% Senior Notes due January 15, 2000, the Trust's 8% Notes due April 21, 2002 and the Trust's 6 5\/8% Notes due 2005, filed with the commission on December 13, 1993 as exhibit 4 (a) to the Trust's Registration Statement on Form S-3, (File No. 33-51029) is incorporated herein by reference thereto.\n( 9) Voting Trust Agreement..................................*\n(10) (i) Consultancy Agreement with Samuel J. Gorlitz, as amended, filed with the Commission as Exhibit 10 (v) to the Trust's Annual Report on Form 10-K for the year ended\nDecember 31, 1983, is incorporated herein by reference thereto.\n(ii) The Trust's 1983 Stock Option Plan adopted May 12, 1983, filed with the Commission as Exhibit 10 (vi) to the Trust's Annual Report on Form 10-K for the year ended December 31, 1983, is incorporated herein by reference.\n(iii) Deferred Compensation Agreement with Steven J. Guttman dated December 13, 1978, filed with the Commission as Exhibit 10 (iv) to the Trust's Annual Report on Form 10-K for the year ended December 31, 1980 is incorporated herein by reference thereto.\nThe following documents, filed with the Commission as portions of Exhibit 10 to the Trust's Annual Report on Form 10-K for the year ended December 31, 1985, are incorporated herein by reference thereto.\n(iv) The Trust's 1985 Non-Qualified Stock Option Plan, adopted on September 13, 1985\nThe following documents, filed with the Commission as portions of Exhibit 10, to the Trust's Annual Report on Form 10-K for the year ended December 31, 1980, have been modified as noted below, and are incorporated herein by reference thereto.\n(v) Consultancy Agreement with Daniel M. Lyons dated February 22, 1980, as amended (modified as of December l, 1983, to provide for an annual cost of living increase, not to exceed 10%).\nThe following documents filed as portions of Exhibit 10 to the Trust's Annual Report on Form 10-K for the year ended December 31, 1988 are incorporated herein by reference thereto:\n(vi) The 1988 Share Bonus Plan.\n(vii) Amendment No. 3 to Consultancy Agreement with Samuel J. Gorlitz.\nThe following documents filed with the Commission as portions of Item 6 to the Trust's Quarterly Report on Form 10-Q for the quarter ended March 31, 1989 are incorporated herein by reference thereto;\n(viii) Executive Agreement between the Trust and Steven J. Guttman, dated April 13, 1989.\n(ix) Executive Agreement between the Trust and Catherine R. Mack, dated April 13, 1989.\n(x) Executive Agreement between the Trust and Mary Jane Morrow, dated April 13, 1989.\n(xi) Executive Agreement between the Trust and Hal A. Vasvari, dated April 13, 1989.\n(xii) Employment Agreement between the Trust and Steven J. Guttman, dated April 13, 1989.\n(xiii) Employment Agreement between the Trust and Catherine R. Mack, dated April 13, 1989.\n(xiv) Executive Agreement between the Trust and Robert S. Wennett, dated April 13 ,1989, modified January 1, 1990, filed with the Commission as a portion of Exhibit 10 to the Trust's Annual Report on Form 10-K for the year ended December 31, 1989 is incorporated herein by reference thereto.\n(xv) The 1991 Share Purchase Plan, dated January 31, 1991, filed with the Commission as a portion of Exhibit 10 to the Trust's Annual Report on Form 10-K for the year ended December 31, 1990 is incorporated herein by reference thereto.\n(xvi) Employment Agreement between the Trust and Robert S. Wennett, dated January 1, 1992, filed with the Commission as an exhibit to the Trust's Annual Report on Form 10-K for the year ended December 31, 1991 is incorporated herein by reference thereto.\n(xvii) Amendment No. 4 to Consultancy Agreement with Samuel J. Gorlitz, filed with the Commission as an exhibit to the Trust's Annual Report on Form 10-K for the year ended December 31, 1992 is incorporated herein by reference thereto.\n(xviii) Employment and Relocation Agreement between the Trust and Ron D. Kaplan, dated September 30, 1992, filed as an exhibit to the Trust's Annual Report on Form 10-K for the year ended December 31, 1992 is incorporated herein by reference thereto.\n(xix) Amendment dated October 1, 1992, to Voting Trust Agreement dated as of March 3, 1989 by and between I. Wolford Berman and Dennis L. Berman filed as an exhibit to the Trust's Annual Report on Form 10-K for the year ended December 31, 1992 is incorporated herein by reference thereto.\n(xx) 1993 Long-Term Incentive Plan and Certified Resolution Re: Amendment to 1993 Long-Term Incentive Plan, filed with the Commission as portions of Item 6 to the Trust's Quarterly Report on Form 10-Q for the quarter ended June 30, 1993, are incorporated herein by reference thereto.\nThe following documents, filed with the Commission as portions of Item 6 to the Trust's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993 are incorporated herein by reference thereto:\n(xxi) Revolving Credit Agreement dated as of September 1, 1993 among Federal Realty Investment Trust and Corestates Bank.\n(xxii) Credit Agreement dated as of August 25, 1993 between Federal Realty Investment Trust and First Union National Bank of Virginia.\n(xxiii) Revolving Credit Agreement dated as of June 22, 1993 between Federal Realty Investment Trust and Signet Bank\/Maryland.\n(xxiv) Consulting Agreement between Misner Development and Federal Realty Investment Trust.\n(xxv) Fiscal Agency Agreement dated as of October 28, 1993 between Federal Realty Investment Trust and Citibank, N.A.\n(xxvi) Credit Agreement dated as of February 11, 1994 between Federal Realty Investment Trust and Mellon Bank as filed as an exhibit to the Trust's Annual Report on Form 10-K for the year ended December 31, 1993 is incorporated herein by reference thereto.\n(xxvii) Other Share Award and Purchase Note between Federal Realty Investment Trust and Ron D. Kaplan, dated January 1, 1994, filed with the Commission as a portion of Item 6 to the Trust's Quarterly Report on Form 10-Q for the quarter ended March 31, 1994 is incorporated herein by reference thereto.\n(xxviii) Amended and Restated 1983 Stock Option Plan of Federal Realty Investment Trust and 1985 Non-Qualified Stock Option Plan of Federal Realty Investment Trust, filed with the Commission on August 17, 1994 on Form S-8, (File No. 33-55111) is incorporated herein by reference thereto.\nThe following documents, filed with the Commission as portions of Exhibit 10 to the Trust's Annual Report on Form 10-K for the year ended December 31, 1994, are incorporated herein by reference thereto.\n(xxix) Form of Severance Agreement between Federal Realty Investment Trust and Certain of its Officers dated December 31, 1994.\n(xxx) Credit Agreement dated as of September 30, 1994 between Federal Realty Investment Trust and First Union National Bank of Virginia.\n(xxxi) Second Amendment to Revolving Credit Agreement dated as of September 30, 1994 between Federal Realty Investment Trust and Corestates Bank.\n(xxxii) First Amendment to Credit Agreement dated September 30, 1994 between Federal Realty Investment Trust and Mellon Bank.\n(xxxiii) First Amendment to Revolving Credit Agreement dated September 30, 1994 between Federal Realty Investment Trust and Signet Bank\/Maryland.\n(xxxiv) Exclusive Brokerage Agreement between Street Retail Inc. and Westport Advisors Corporation filed as an exhibit to the Trust's Quarterly Report on Form 10-Q for quarter ended March 31, 1995 is incorporated herein by reference thereto.\nThe following documents, filed with the Commission as portions of Item 6 to the Trust's Quarterly Report on Form 10-Q for the quarter ended September 30, 1995 are incorporated herein by reference thereto:\n(xxxv) Non-Exclusive Brokerage Agreement between Federal Realty Investment Trust and Westport Advisors Corporation and Jack Alan Guttman dated August 20, 1995.\n(xxxvi) Exclusive Brokerage Agreement between Street Retail, Inc. and Westport Advisors Corporation and Jack Alan Guttman dated August 20, 1995.\n(11) Statement regarding computation of per share earnings.........................................*\n(12) Statements regarding computation of ratios.......*\n(13) Annual Report to Shareholders, Form 10Q or quarterly report to shareholders.....................................*\n(18) Letter regarding change in accounting principles.......................................*\n(19) Report furnished to security holders.............*\n(21) Subsidiaries of the registrant.................... (xxxvii) Articles of Incorporation of Street Retail, Inc. filed with the Commission as a portion of Exhibit 21 to the Trust's Annual Report on Form 10-K for the year ended December 31, 1994 is incorporated herein by reference thereto.\n(xxxviii) By-Laws of Street Retail, Inc. filed with the Commission as a portion of Exhibit 21 to the Trust's Annual Report on Form 10-K for the year ended December 31 1994 is incorporated herein by reference thereto.\n(22) Published report regarding matters submitted to vote of security holders.........................*\n(23) Consent of Grant Thornton LLP....................\n(24) Power of attorney................................*\n(27) Financial Data Schedule..........................+\n(99) Additional exhibits..............................*\n(b) Reports on Form 8-K Filed during the Last Quarter -------------------------------------------------\nA Form 8-K, dated November 17, 1995, was filed in response to Item 7.","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":"314733_1995.txt","cik":"314733","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIn September 1994, the Company and certain holders and purchasers of certain of the Company's bonds (the \"PPM Group\") went to trial as a result of litigation initiated by the PPM Group in response to the Marriott International Distribution. In October 1994, the judge declared a mistrial based on the inability of the jury to reach a verdict. In January 1995, the judge granted the Company's motion for judgment in its favor on the PPM Group's claims as a matter of law. An appeal was filed by the PPM Group in February 1995, and the appeal was argued in February 1996. In March 1996, the Company settled the litigation for a payment of $1.25 million. The settlement leaves in place the trial court's judgment in favor of the Company on all of the PPM Group's claims. The settlement did not have a material effect on the Company's financial condition and results of operations.\nThe Company and its subsidiaries are involved in litigation incidental to their businesses. Management believes that such litigation is not significant and will not have a material adverse effect on the Company's financial condition and 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 COMPANY'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nThe common stock is listed on the New York Stock Exchange, the Chicago Stock Exchange, the Pacific Stock Exchange and the Philadelphia Stock Exchange and is traded under the symbol \"HMT.\" The following table sets forth, for the fiscal periods indicated, the high and low sales prices per share of the common stock as reported on the New York Stock Exchange Composite Tape and the cash dividends paid per share of common stock. The Special Dividend of HM Services was completed on December 29, 1995 and provided Company shareholders with one share of common stock of HM Services for every five shares of Host Marriott common stock. Therefore, due to the Special Dividend, stock prices are not indicative of the Company's current stock price or dividend policies except for the first quarter of 1996. The Company currently intends to retain future earnings, if any, for use in its business and does not anticipate paying regular cash dividends on the common stock. As of December 29, 1995, there were approximately 57,032 holders of record of common stock.\n- -------- (1) Prior to the Special Dividend. (2) Subsequent to the Special Dividend.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following table presents certain selected historical financial data of the Company which has been derived from the Company's audited Consolidated Financial Statements for the five most recent fiscal years ended December 29, 1995. The financial data for fiscal years 1991 and 1992 and the income statement data for fiscal year 1993 do not reflect the Marriott International Distribution and related transactions and, accordingly, the table presents data for the Company that include amounts attributable to Marriott International. As a result of the Marriott International Distribution and related transactions, the assets, liabilities and businesses of the Company have changed substantially.\n- -------- (1) Operating results for 1995 include a $10 million pre-tax charge to write down the carrying value of five limited service properties to their net realizable value and a $60 million pre-tax charge to write down an undeveloped land parcel to its estimated sales value. In 1995, the Company recognized a $20 million extraordinary loss, net of taxes, on the extinguishment of debt. (2) In 1994, the Company recognized a $6 million extraordinary loss, net of taxes, on the required redemption of senior notes. In 1993, the Company recognized a $4 million extraordinary loss, net of taxes, on the completion of an exchange offer for its then outstanding bonds. (3) Operating results for 1993 include the operations of Marriott International only through the Marriott International Distribution date of October 8, 1993. These operations had a net pre-tax effect on income of $211 million for the year ended December 31, 1993 and are recorded as \"Profit from operations distributed to Marriott International\" on the Company's consolidated statements of operations and are, therefore, not included in sales, operating profit before corporate expenses and interest, interest expense and interest income for the same period. The net pre-tax effect of these operations is, however, included in income before income taxes, extraordinary item and cumulative effect of changes in accounting principles and in net income for the same periods. Statement of Financial Accounting Standard (\"SFAS\") No. 109, \"Accounting for Income Taxes,\" was adopted in the first quarter of 1993. In the second quarter of 1993, the Company changed its accounting method for assets held for sale. During 1993, the Company recorded a $34 million credit to reflect the adoption of SFAS No. 109 and a $32 million charge, net of taxes, to reflect the change in its accounting method for assets held for sale. (4) Operating results in 1993 and 1992 included pre-tax expenses related to the Marriott International Distribution totaling $13 million and $21 million, respectively. (5) Fiscal year 1991 includes 53 weeks. (6) The Company recorded a loss from discontinued operations, net of taxes, as a result of the Special Dividend of $61 million in 1995, $6 million in 1994, and $4 million in 1993, and income from discontinued operations, net of taxes, of $10 million in 1992 and $12 million in 1991. The 1995 loss from discontinued operations includes a pre-tax charge of $47 million for the adoption of SFAS No. 121, \"Accounting For the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of,\" a pre-tax $15 million restructuring charge and an extraordinary loss of $10 million, net of taxes, on the extinguishment of debt. (7) Earnings per common share is computed on a fully diluted basis by dividing net income available for common stock by the weighted average number of outstanding common and common equivalent shares, plus other potentially dilutive securities. Common equivalent shares and other potentially dilutive securities have been excluded from the weighted average number of outstanding common shares for 1995 and 1994, as they are antidilutive. (8) Includes convertible subordinated debt of $20 million at December 31, 1993, $228 million at January 1, 1993 and $210 million at January 3, 1992.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION\nRESULTS OF OPERATIONS\nThe following discussion and analysis addresses the results of operations of the Company for 1995 and 1994 on a historical basis and 1993 on a pro forma basis. On October 8, 1993, Marriott Corporation (as the Company was formerly known) made a special dividend consisting of the distribution (the \"Marriott International Distribution\") to holders of outstanding shares of common stock, on a share-for-share basis, of all outstanding shares of its wholly-owned subsidiary, Marriott International, which at the time of the Marriott International Distribution held all of the assets relating to the lodging and senior living services management, timeshare resort development and operation, food service and facilities management and other contract services businesses (the \"Management Business\") formerly conducted by the Company. Marriott International now conducts the Management Business as a separate publicly traded company.\nManagement believes that a discussion of the Company's historical results of operations for 1993 is not relevant because the significant changes as a result of the Marriott International Distribution and related transactions make the 1994 and 1993 historical results of operations not comparable and that it is more meaningful and relevant in understanding the present and ongoing Company operations to compare the Company's historical 1994 operating results to the pro forma operating results for 1993 reflecting the Marriott International Distribution and related transactions (\"Distribution Pro Forma\"). Accordingly, the Company's Distribution Pro Forma consolidated statement of operations for fiscal 1993 is presented below. This Distribution Pro Forma condensed consolidated statement of operations was prepared as if the Marriott International Distribution and related transactions and the implementation of the various related agreements entered into with Marriott International, including the lodging management agreements and senior living community leases, occurred at the beginning of the period and include only the operations of the businesses retained by the Company, and exclude, among other items, certain nonrecurring costs totaling $13 million relating to the Marriott International Distribution, accounting changes, extraordinary losses and discontinued operations related to the Special Dividend. See Notes 3, 6, 8, 9, 11, 15 and 16 to the Consolidated Financial Statements included elsewhere herein for discussion of the Marriott International Distribution, and the related transactions and agreements.\nThe following Distribution Pro Forma consolidated statement of operations for 1993 and management's discussion and analysis related thereto are presented in the format that the Company adopted as of January 1, 1994. The historical and Distribution Pro Forma consolidated statements of operations and related analysis should be read in conjunction with the Company's Consolidated Financial Statements and Notes thereto included elsewhere herein. The Distribution Pro Forma consolidated statement of operations does not purport to be indicative of results which may occur in the future or what the results of operations and financial position of the Company would have been had such transactions occurred as of the dates indicated. The Distribution Pro Forma consolidated statement of operations only reflects the consummation of the Marriott International Distribution.\n- -------- (1)Significant adjustments to the 1993 historical financial statements for the Distribution Pro Forma data include: . the reduction of hotel revenues by $354 million to equal house profit, which the Company treats as revenue from owned hotels subsequent to the Marriott International Distribution, with a matching decrease in operating costs and expenses. See Note 3 to the Consolidated Financial Statements included elsewhere herein; . the reduction of operating profit by $14 million to reflect management fees paid to Marriott International under the lodging management agreements; . the reduction of property level revenues of $67 million to equal rental income of $23 million and the reduction of operating expenses of $46 million for senior living communities owned by the Company and leased to Marriott International. See Note 3 to the Consolidated Financial Statements included elsewhere herein; . the elimination of the pre-tax profit from operations distributed to Marriott International of $211 million;\n. the elimination of certain nonrecurring charges of $13 million directly related to the Marriott International Distribution; and . the net decrease to interest expense of $12 million primarily related to the assumption by Marriott International of 90% of the Liquid Yield Option Notes (\"LYONs\") issued by Marriott Corporation, partially offset by the increase in interest expense as a result of a debt exchange offer in 1993. See Note 9 to the Consolidated Financial Statements included elsewhere herein.\nSummary historical and Marriott International Distribution Pro Forma data are presented below (in millions):\n(2) SFAS No. 109 \"Accounting for Income Taxes\" was adopted in the first quarter of 1993. In the second quarter of 1993, the Company changed its accounting method for assets held for sale. The Company recorded a $34 million credit to reflect the adoption of SFAS No. 109 and a $32 million charge, net of taxes, to reflect the change in its accounting method for assets held for sale in 1993. See the Notes to the Consolidated Financial Statements included elsewhere herein. (3) In 1995, the Company recognized a $20 million extraordinary loss, net of taxes, on the extinguishment of debt. The Company recognized a $6 million extraordinary loss, net of taxes, on the required redemption of senior notes in 1994. The Company recognized a $4 million extraordinary loss, net of taxes, on the completion of a debt exchange offer in 1993. See Notes 3 and 8 to the Consolidated Financial Statements included elsewhere herein. (4) The Company's loss from discontinued operations, net of taxes, as a result of the Special Dividend was $61 million in 1995, $6 million in 1994 and $4 million in 1993. The 1995 loss from discontinued operations includes a pre-tax charge of $47 million for the adoption of SFAS No. 121, \"Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of\", a pre-tax $15 million restructuring charge and an extraordinary loss of $10 million, net of taxes, on the extinguishment of debt. See the Consolidated Financial Statements included elsewhere herein. (5) The 1993 pro forma weighted average shares are based on weighted average common shares of the Company adjusted to reflect (i) the conversion of the Company's preferred stock into 10.6 million shares of Common Stock prior to the Marriott International Distribution, and (ii) the issuance by the Company of 1.8 million shares of its Common Stock, prior to the Marriott International Distribution, in connection with the refinancing of certain of its senior debt.\nSubsequent to the Marriott International Distribution, revenues primarily represent house profit from the Company's hotel properties, net gains (losses) on real estate transactions, equity in the earnings of affiliates and lease rentals from the Company's senior living communities (1994 and 1993). House profit reflects the net revenues flowing to the Company as property owner and represents hotel sales less property-level expenses (excluding depreciation, management fees, real and personal property taxes, ground and equipment rent, insurance and certain other costs which are classified as operating costs and expenses). The operating costs and expenses of the senior living communities consist of depreciation and amortization, while other operating costs and expenses include idle land carrying costs and certain other costs.\nFor the periods discussed herein, the Company's properties have experienced substantial increases in room revenues generated per available room (\"REVPAR\"). REVPAR is a commonly used indicator of market performance for hotels which represents the combination of the average daily room rate charged and the average occupancy achieved. REVPAR does not include food and beverage or other ancillary revenues generated by the property. The REVPAR increase primarily represents strong percentage increases in room rates, while occupancies have generally increased slightly or remained flat. Increases in room rates have generally been achieved by the managers through shifting occupancies away from discounted group business to higher-rated group and transient business. This has been made possible by increased travel due to improved economic conditions and by the favorable supply\/demand characteristics existing in the lodging industry today, particularly in the full-service segment. The Company expects this supply\/demand imbalance, particularly in the full-service segment, to continue, which should result in improved REVPAR and operating profits at its hotel properties in the near term. However, there can be no assurance that REVPAR will continue to increase in the future.\nNine of the Company's properties were converted to the Marriott brand name following their acquisition by the Company. The conversion of these properties to the Marriott brand is intended to increase occupancy and room rates as a result of Marriott International's nationwide marketing and reservation systems and Honored Guest Awards Program, as well as customer recognition of the Marriott brand name. In connection with the conversion of four of the nine conversion properties, the Company employed, or will employ, additional capital to upgrade these properties to the Company's and the new manager's standards. The invested capital with respect to these properties is primarily used for the improvement of common areas as well as upgrading soft and hard goods (i.e., carpets, drapes, paint, furniture and additional amenities). The conversion process typically causes periods of disruption to these properties as selected rooms and common areas are temporarily taken out of service. Due to these disruptive periods, the time necessary for integration into the nationwide Marriott system and the Company's realization of the anticipated effect of these improvements, the operating results for 1995 do not reflect the full impact of conversion for these four properties. The Company expects to begin to realize the benefits of conversion improvements within six to 12 months of their completion. For three of the four conversion properties, the Company expects to realize the benefits during 1996. For the fourth conversion property, significant conversion improvement efforts will be completed during 1996 and the Company expects to begin to realize the benefits therefrom in 1997. The operating performance of the five properties which did not require significant renovation have begun to reflect the benefits of conversion subsequent to their conversion to the Marriott brand name.\nThe Company's hotel operating costs and expenses are, to a great extent, fixed. Therefore, the Company derives substantial operating leverage from increases in revenue. This operating leverage is somewhat diluted, however, by the impact of base management fees which are calculated as a percentage of sales, variable lease payments and incentive management fees tied to operating performance above certain established levels. Successful 1994 and 1995 full- service hotel performance resulted in certain of the Company's properties reaching levels which allowed the manager to share in the growth of profits in the form of higher management fees. The Company views this as a positive development because it helps to strengthen the alignment of the managers' interest with the Company's. The Company expects that this trend will continue in 1996 as the hotel industry continues to strengthen.\nThe Consolidated Financial Statements of the Company have been restated to reflect the results of the Operating Group as discontinued operations for all periods discussed below.\n1995 COMPARED TO 1994\nRevenues. Revenues primarily represent house profit from the Company's hotel properties, net gains (losses) on real estate transactions, equity in earnings of affiliates and lease rentals for the Company's senior living communities (in 1994). Revenues increased $104 million, or 27%, to $484 million in 1995. The Company's revenue and operating profit from continuing operations were impacted by:\n.improved lodging results (see discussion below); .the net addition of 28 full-service hotel properties during 1994 and 1995; .the 1995 sale and leaseback of 37 of the Company's Courtyard properties; . the $60 million pre-tax charge in 1995 to write down the carrying value of one undeveloped land parcel to its estimated sales value; . the $10 million pre-tax charge in 1995 to write down the carrying value of certain Courtyard and Residence Inn properties held for sale to their net sales values; .the 1994 sale of the Company's senior living communities; .the 1994 and 1995 sales of the Company's Fairfield Inns; and . the 1994 reduction in general liability and workers' compensation self- insurance program reserves related to the Company's continuing operations of $4 million.\nHotel revenues increased $136 million, or 40%, to $474 million in 1995, as all three of the Company's lodging concepts reported growth in REVPAR. The hotels added by the Company in 1994 and 1995 provided $134 million of revenue in 1995. Excluding the impact of the addition of full-service properties, the sales of the Fairfield Inns, and the sale and leaseback of 37 Courtyards, comparable hotel revenues increased $28 million, or 11%, in 1995 over 1994.\nRevenue for nearly all of the Company's full-service hotels, resorts and suites for 1995 was improved or comparable to the results for 1994. Increases in REVPAR of 7% for comparable units led to improved results. On a comparable basis for the Company's full-service properties, average room rates increased 9%, while average occupancy decreased over one percentage point.\nThe Company's moderate-price Courtyard properties reported nearly an 8% increase in REVPAR due to a 7% increase in average room rates and a small increase in occupancy.\nThe Company's extended-stay Residence Inns reported an 8% increase in REVPAR due to an increase in average room rates of 7%, combined with a one percentage point increase in average occupancy. Due to the high occupancy of these properties, the Company expects future increases in REVPAR, if any, to result from room rate increases, rather than occupancy increases. However, there can be no assurance that REVPAR will continue to increase in the future.\nIn the third quarter of 1994, the Company sold 26 of its 30 Fairfield Inns for $114 million and in the second quarter of 1995, the Company sold its four remaining Fairfield Inns to the same buyer for net cash proceeds of $6 million. Revenues and operating profit in 1995 for the four remaining Fairfield Inns prior to their disposition were comparable to 1994.\nThe net loss on property transactions for 1995 includes the pre-tax charge of $10 million to write down the carrying value of five individual Courtyard and Residence Inn properties held for sale to their estimated net sales values, partially offset by the deferred gain amortization related to the 1994 and 1993 sales of the Company's remaining limited partner interests in the Residence Inn USA partnership.\nOperating Costs and Expenses. Operating costs and expenses principally consist of depreciation, management fees, real and personal property taxes, ground and equipment rent, insurance and certain other costs. The Company's operating costs and expenses increased $142 million to $370 million for 1995 primarily\nrepresenting increased hotel operating costs, partially offset by the impact on operating costs from the 1994 sale of the senior living communities. Hotel operating costs increased $83 million to $281 million for 1995 primarily due to the net addition of 28 full-service properties during 1994 and 1995 and increased management fees and rentals tied to improved property results, net of the impact of the sales of certain limited-service properties discussed above. As a percentage of hotel revenues, hotel operating costs and expenses remained unchanged at 59% of revenues in both 1995 and 1994. During the fourth quarter of 1995, the Company determined that a 174-acre undeveloped land site will no longer be developed into an office project over an extended time period as previously planned but, instead, the Company decided to market the site for near-term sale. As a result of this change in strategy, a pre-tax charge of $60 million was recorded to reduce the asset to its estimated sales value.\nOperating Profit. As a result of the changes in revenues and operating costs and expenses discussed above, the Company's operating profit decreased $38 million, or 25%, to $114 million in 1995. Hotel operating profit increased $53 million, or 38%, to $193 million, or 41% of revenues, for 1995 from $140 million, or 41% of revenues, for 1994. The hotels added by the Company in 1994 and 1995 provided $65 million of operating profit for 1995. Excluding the impact of the non-comparable items discussed earlier, hotel operating profit increased $29 million, or 31%, over 1994. Several hotels, including the New York Marriott Marquis, Santa Clara Marriott and the Newport Beach Marriott posted significant improvements in operating profit.\nCorporate Expenses. Corporate expenses increased $5 million to $36 million in 1995 primarily due to an increase in the number of employees and overall higher corporate administrative and travel costs associated with higher revenues. As a percentage of revenues, corporate expenses decreased to 7% of revenues in 1995 from 8% in 1994.\nInterest Expense. Interest expense increased by 8% to $178 million in 1995 primarily due to the additional debt incurred in connection with the 1994 and 1995 full-service hotel acquisitions, increased interest rates on the Company's variable rate debt, and the decreased benefit from the Company's interest rate swap agreements, which was partially offset by the net impact of the 1994 and 1995 redemptions of senior notes of Host Marriott Hospitality, Inc. (\"Hospitality Notes\") and the line of credit with Marriott International.\nContinuing Operations. The loss from continuing operations for 1995 increased $49 million to $62 million principally due to the changes in operating profit discussed above and the increase in corporate expenses and interest expense.\nDiscontinued Operations. The loss from discontinued operations for 1995 of $61 million principally was due to a $10 million extraordinary loss on the redemption and defeasance of certain debt in 1995, a charge of approximately $47 million before taxes for the adoption of SFAS No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of,\" a $15 million pre-tax charge for the restructuring of HM Services' business processes and $9 million of expenses related to the Special Dividend.\nThe Company wrote down 15 individual operating units in connection with the adoption of SFAS No. 121 and the change in accounting to assessment of impairment on an individual operating unit basis. Approximately 73% of the write-down related to two operating units, the Florida Turnpike (approximately $25 million) and the Orlando Airport (approximately $9 million). The Company has written off all of the assets related to these two operating units due to projected future negative cash flows at such operating units. While the Company has been aware that these two operating units have been incurring negative cash flows since the late 1980s (including negative cash flows totaling approximately $2.4 million in 1995), the effects on the Company of such negative cash flows for any period have been offset by positive cash flows from other operating units comprising the Operating Group's airport and tollroad business lines. As of December 29, 1995, the total projected net cash flow deficit for the remaining terms of the leases of the 15 operating units written down was approximately $45 million. As a result of the consummation of the Special Dividend on December 29, 1995, the business operations of the Company no longer include the Operating Group and, therefore, the projected future negative cash flows form these operating units will have no affect on the Company's future financial condition or results of operations.\nExtraordinary Item. In connection with the redemption and defeasance of certain of the Company's debt in 1995, the Company recognized an extraordinary loss of $30 million ($20 million after taxes), primarily representing premiums paid on the redemption of Hospitality Notes of $13 million and the write-off of deferred financing fees and discounts on the Hospitality Notes and the Revolver (as defined herein).\nNet Loss. The Company's net loss for 1995 increased $118 million to $143 million. The net loss for 1995 was $.90 per share, compared to $.17 per share for 1994.\nHISTORICAL 1994 COMPARED TO PRO FORMA 1993\nRevenues. Revenues from continuing operations rose $119 million, or 46%, to $380 million for 1994 from $261 million on a pro forma basis for 1993. The Company's revenue and operating profit from continuing operations were impacted by:\n. improved lodging results (see discussion below);\n. the addition of 18 full-service hotel properties during 1994;\n. the consolidation of the partnership owning the New York Marriott Marquis on December 31, 1993;\n. the 1994 sale of the Company's senior living communities;\n. the 1994 sale of 26 of the Company's Fairfield Inns;\n. the 1994 reduction in general liability and workers' compensation self- insurance program reserves related to the Company's continuing operations of $4 million;\n. the 1993 $11 million charge to write down the carrying value of certain Fairfield Inn properties held for sale to their net realizable value;\n. the 1993 sale of 11 Residence Inns; and\n. the 1993 $10 million gain on the sale of the Company's interest in a hotel partnership.\nHotel revenues increased $89 million, or 36%, to $338 million for 1994, as all of the Company's lodging concepts reported growth in REVPAR for comparable units. The hotels added by the Company in 1994 provided $27 million of revenue. Excluding the impact of the addition of full-service properties, the sales of the Fairfield Inns and Residence Inns and consolidation of the New York Marriott Marquis, comparable hotel revenues increased $31 million, or 15%, in 1994 over pro forma 1993.\nRevenue for the Company's full-service hotels, resorts, and suites was improved or comparable to 1993 results with the exception of the Miami Airport Marriott Hotel which achieved very high occupancy levels in early 1993 resulting from Hurricane Andrew in 1992. The Company's full-service hotels posted a 7% increase in REVPAR for comparable units. Average occupancy increased over one percentage point for comparable units, while average room rates increased 5%.\nThe Company's moderate-priced Courtyard properties reported significant increases in revenues in 1994 due to REVPAR increases. REVPAR of the Company's Courtyard properties increased 8%, due to a 7% increase in average room rates and almost a one percentage point increase in average occupancy.\nThe Company's extended-stay Residence Inns also reported significant increases in revenues in 1994 due to REVPAR increases. REVPAR of the Company's Residence Inns increased 8% for comparable units due primarily to an increase in average room rates of 7%, combined with a one percentage point increase in average occupancy.\nOn August 5, 1994, the Company sold 26 of its Fairfield Inns to an unrelated party for net proceeds of approximately $114 million. Prior to their sale, year-to-date revenues and operating profit were comparable to the prior year. Year-to-date revenues and operating profit for the four remaining Fairfield Inns were comparable to the 1993 pro forma amounts.\nSenior living communities' revenues consist of rentals earned under the lease agreements with Marriott International. During the first quarter of 1994, the Company executed an agreement to sell all of its senior living communities to an unrelated party for approximately $320 million, which approximated the communities' carrying value. The sale of the communities was completed during the second and third quarters of 1994. Prior to their sales, year-to-date revenues and operating profit for senior living communities were comparable to 1993.\nThe net gains (losses) on property transactions for 1994 principally included amortization of the deferred gain on the 1993 sale of Residence Inns, and for 1993 principally included the Fairfield Inn net realizable value write-down and the gain on the 1993 sale of the Company's interest in the partnership owning the Boston Copley Marriott Hotel.\nEquity in earnings (losses) of affiliates was break even for 1994, compared to $27 million of losses recorded in 1993. The significant decrease is attributable to the consolidation of the partnership owning the New York Marriott Marquis on December 31, 1993.\nOperating costs and expenses. Operating costs and expenses increased $47 million to $228 million in 1994. Hotel operating costs increased $43 million to $198 million in 1994. As a percentage of hotel revenues, hotel operating costs and expenses represented 59% of revenues in 1994 and 62% of revenues in 1993. Due to favorable claims experience for the general liability and workers' compensation self-insurance programs, the Company reduced its related actuarially estimated reserves by $4 million in 1994, which is reflected as a reduction in the Company's other operating costs and expenses.\nOperating Profit. As a result of the changes in revenues and operating costs and expenses discussed above, the Company's operating profit increased $72 million, or 90%, to $152 million in 1994. Hotel operating profit increased $46 million, or 49%, to $140 million, or 41% of hotel revenues for 1994 from $94 million or 38% of hotel revenues for 1993 on a pro forma basis. The hotels added by the Company in 1994 provided $13 million of operating profit for 1994. Excluding the impact of the noncomparable items discussed earlier, hotel operating profit increased $24 million, or 32%, over pro forma 1993 levels.\nCorporate expenses. Corporate expenses increased $8 million to $31 million for 1994 primarily due to higher employee restricted stock award expenses and administrative costs. Corporate expenses decreased to 8% of revenues in 1994 from 9% of revenues in 1993.\nInterest expense. Interest expense increased by 9% to $165 million for 1994 due to the consolidation of the partnership owning the New York Marriott Marquis and the impact of rising interest rates on the Company's floating rate debt and interest rate swap agreements, partially offset by the impact of bond redemptions in the second half of 1994.\nContinuing Operations. The loss from continuing operations for 1994 decreased $47 million to $13 million principally due to the strong performance of the Company's lodging properties as discussed above.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company funds its capital requirements with a combination of operating cash flow, debt and equity financing, and proceeds from sales of selected properties and other assets. The Company utilizes these sources of capital to acquire new properties, fund capital additions and improvements, and make principal payments on debt.\nCapital Transactions. On December 20, 1995, HMC Acquisition Properties, Inc. (\"Acquisitions\"), an indirect wholly-owned subsidiary of the Company, issued $350 million of 9% senior notes (the \"Acquisitions Notes\") to several initial purchasers (the \"December 1995 Debt Offering\"). Acquisitions owns 15 of the Company's 90 full-service hotel properties. The Acquisitions Notes were issued at par and have a final maturity of December 2007. The net proceeds totaled $340 million and were utilized to repay in full the outstanding\nborrowings of $210 million under Acquisitions' $230 million revolving credit facility (the \"Revolver\"), which was then terminated, to acquire one full- service property for $29 million in December 1995 and another full-service property for $25 million in the first quarter of 1996, and to finance future acquisitions of full-service hotel properties with the remaining $76 million of proceeds. The Acquisitions Notes are guaranteed by Acquisitions' subsidiary. The indenture governing the Acquisitions Notes contains covenants that, among other things, limit the ability of Acquisitions and its subsidiary to incur additional indebtedness and issue preferred stock, pay dividends or make other distributions, repurchase capital stock or subordinated indebtedness, create certain liens, enter into certain transactions with affiliates, sell certain assets, issue or sell stock of Acquisitions' subsidiary, and enter into certain mergers and consolidations. In addition, under certain circumstances, Acquisitions will be required to offer to purchase the Acquisitions Notes at par value with the proceeds of certain asset sales. Acquisitions will not be required to make principal payments on the Acquisitions Notes until maturity, except in the event of certain changes in control. Distributions by Acquisitions to the Company are available through the payment of dividends only to the extent that the cumulative amount of such dividends from December 20, 1995 does not exceed $15 million plus an amount equal to the excess of Acquisitions' EBITDA over 200% of Acquisitions' interest expense, as defined in the indenture, plus the amount of capital contributions to Acquisitions subsequent to December 20, 1995. Acquisitions has the ability to enter into a revolving credit facility of up to $25 million, which would be available for Acquisitions' working capital, and other general corporate purposes, and to incur other indebtedness as specified in the indenture.\nOn May 25, 1995, two wholly-owned subsidiaries of Host Marriott Hospitality, Inc. (\"Hospitality\"), a wholly-owned subsidiary of the Company, issued an aggregate of $1 billion of 9.5% senior secured notes in two concurrent offerings. HMH Properties, Inc. (\"Properties\"), the owner of 57 of the Company's 90 lodging properties, and Host Marriott Travel Plazas, Inc. (\"HMTP\"), the operator\/manager of HM Services' food, beverage and merchandise concessions business, issued $600 million and $400 million, respectively, of senior notes secured by the stock of certain of their respective subsidiaries. The bonds were issued at par and have a final maturity of May 2005. The net proceeds of approximately $971 million were used to defease, and subsequently redeem, all of Hospitality's remaining bonds (the \"Hospitality Notes\") and to repay borrowings under the line of credit with Marriott International. The Properties Notes are secured by a pledge of the stock of certain of Properties' subsidiaries and are guaranteed, jointly and severally, by certain of Properties' subsidiaries. The indenture governing the Properties Notes contains covenants that, among other things, limit the ability of Properties and its subsidiaries to incur additional indebtedness and issue preferred stock, pay dividends or make other distributions, repurchase capital stock or subordinated indebtedness, create certain liens, enter into certain transactions with affiliates, sell certain assets, issue or sell stock of Properties' subsidiaries, and enter into certain mergers and consolidations. Distributions of Properties' equity are restricted but will be available for the payment of dividends to the extent that the cumulative amount of such dividends from May 25, 1995 does not exceed $25 million plus an amount equal to the excess of Properties' EBITDA over 200% of Properties' interest expense, as defined in the indenture, plus the amount of capital contributions to Properties subsequent to May 25, 1995. Properties has the ability to enter into a revolving credit facility of up to $35 million, which would be available for Properties' working capital and other general corporate purposes, and to incur other indebtedness as specified in the indenture. The HMTP senior notes were included in the HM Services Special Dividend.\nUnder the indentures for the Acquisitions Notes and the Properties Notes, proceeds from the sale of assets within the subsidiary issuing the notes may be used for the acquisition of new properties subject to certain limitations.\nDuring 1995, the Company replaced its $630 million line of credit with a new line of credit with Marriott International (the \"New Line of Credit\") pursuant to which the Company has the right to borrow up to $225 million to fund (i) obligations under certain guarantees made by the Company, (ii) payments of principal on specified recourse debt of the Company and its subsidiaries, (iii) payment of interest on amounts borrowed under the New Line of Credit and on specified recourse debt of the Company and its subsidiaries, (iv) working capital, and (v) other items approved in advance by Marriott International. Borrowings under the New Line of Credit bear interest at LIBOR plus 3% (4% when the outstanding balance exceeds $112.5 million) and mature in June\n1998. Any such borrowings are guaranteed by, or secured by the pledge of the stock of, certain subsidiaries of the Company. An annual commitment fee of 5\/8% is charged on the unused portion of the New Line of Credit. There was $22 million outstanding under the New Line of Credit at December 29, 1995. The New Line of Credit imposes certain restrictions on the ability of the Company and certain of its subsidiaries to incur additional debt, create liens or mortgages on their properties (other than various types of liens arising in the ordinary course of business), extend new guarantees (other than replacement guarantees), pay dividends, and repurchase their common stock. When no advances are outstanding under the New Line of Credit and the Company and certain of its subsidiaries have adequately reserved for debt maturities over a 6-month term, such restricted payments as would otherwise be prohibited are permitted in the amount by which aggregate EBITDA of the Company and certain of its subsidiaries (as defined in the New Line of Credit) and the proceeds of specified stock issuances exceed 170% of the aggregate of certain specified charges.\nIn January 1994, the Company raised $230 million of net proceeds from the sale of 20.1 million shares of common stock. Additionally, the Company obtained the Revolver for up to $230 million with a group of commercial banks for the acquisition of full-service hotels. The common stock and Revolver proceeds were utilized to fund the acquisition of full-service hotel properties. As discussed above, the Revolver was repaid in full, and terminated, with certain proceeds from the December 1995 Debt Offering.\nThere are no plans to pay regular cash dividends on the Company's common stock in the near future, and the Company is prohibited from paying dividends while amounts are outstanding under its New Line of Credit with Marriott International.\nAsset Dispositions. The Company historically has and may, from time to time in the future, consider opportunities to sell certain of its real estate properties if price targets can be achieved. During the first and third quarters of 1995, 37 of the Company's Courtyard properties were sold to and leased back from the REIT for approximately $330 million. The Company received net proceeds from the two transactions of approximately $297 million and will receive approximately $33 million upon expiration of the leases. A deferred gain of $14 million on the sale\/leaseback transactions will be amortized over the initial term of the leases. In February 1996, the Company entered into an agreement with the REIT to sell and lease back 16 of the Company's remaining Courtyard properties for approximately $176 million and 18 of the Company's Residence Inn properties for approximately $172 million (10% of the sale amount of both transactions would be deferred). The transactions are expected to close in the first and second quarters of 1996. In 1995, the Company also sold its four remaining Fairfield Inns for net cash proceeds of approximately $6 million, which approximated their carrying value, and the Springfield Radisson Hotel for net cash proceeds of approximately $3 million, which approximated its carrying value. During the second and third quarters of 1994, the Company sold 14 senior living communities to an unrelated party for approximately $320 million, which approximated the communities' carrying value. Additionally, during the third quarter of 1994, the Company sold 26 of its Fairfield Inns to an unrelated party. The net proceeds from the sale of the hotels was approximately $114 million, which exceeded the carrying value of the hotels by approximately $12 million, and such excess has been deferred. Approximately $27 million of the Fairfield Inn proceeds was payable in the form of a note from the purchaser. The Company also sold 28 undeveloped land parcels during 1994 and 1995 for proceeds of approximately $33 million.\nIn cases where the Company has made a decision to dispose of particular properties, the Company assesses impairment of each individual property to be sold on the basis of expected sales price less estimated costs of disposal. Otherwise, the Company assesses impairment of its real estate properties based on whether it is probable that undiscounted future cash flows from such properties will be less than their net book value. If a property is impaired, its basis is adjusted to its fair market value. In the second quarter of 1995, the Company made a determination that its owned Courtyard and Residence Inn properties were held for sale. While management expects to sell these properties as part of one or more portfolios and has currently signed an agreement to do so, the Company recorded a $10 million charge to write down the carrying value of five individual Courtyard and Residence Inn properties to their estimated net sales values. The Company also recorded an $11 million charge in the fourth quarter of 1993 to write down 15 individual Fairfield Inn properties to their net realizable value, although the overall sales transaction generated a net gain.\nCapital Acquisitions, Additions and Improvements. The Company seeks to grow primarily through opportunistic acquisitions of full-service hotels. The Company believes that the full-service segment of the market offers opportunities to acquire assets at attractive multiples of cash flow and at discounts to replacement value, including under-performing hotels which can be improved under new management. During 1995, the Company acquired nine hotels totaling approximately 3,900 rooms in separate transactions for approximately $390 million ($141 million of which was financed through first mortgage financing on four of the hotels). Four of the nine acquisitions, totaling $223 million, were completed in the fourth quarter of 1995. During 1994, the Company acquired 15 full-service hotels totaling approximately 6,100 rooms (including one 199-room hotel subsequently sold in 1995) for approximately $440 million. The Company also provided 100% financing totaling approximately $35 million to an affiliated partnership, in which the Company owns the sole general partner interest, for the acquisition of two full-service hotels (totaling another 684 rooms) by the partnership. Additionally, the Company acquired a controlling interest in one 662-room, full-service hotel through an equity investment of $16 million and debt financing of $36 million (the debt was subsequently sold in 1995). The Company considers all of these properties as owned hotels for accounting purposes.\nDuring the first quarter of 1996, the Company acquired one full-service hotel (374 rooms) for $25 million, controlling interests in three additional properties (2,269 rooms) for approximately $66 million and an 83% interest in the mortgage loans secured by a 250-room full-service property for $18 million. See \" \"Business and Properties--1996 Acquisitions.\" The Company has also entered into agreements to purchase two full-service properties (608 rooms) for approximately $51 million and a controlling interest in one full- service property (400 rooms) for approximately $18 million. The Company is continually engaged in discussions with respect to other potential acquisition properties.\nUnder the terms of its management agreements, the Company is generally required to spend approximately 5% of gross hotel sales to cover the capital needs of the properties, including major guest room and common area renovations which occur every five to six years. The Company anticipates spending approximately $75 million to $80 million annually on the renovation and refurbishment of the Company's existing lodging properties.\nThe Company completed the construction of the 1,200-room Philadelphia Marriott Hotel, which opened on January 27, 1995. The construction costs of this hotel were funded 60% through a loan from Marriott International ($109 million outstanding at December 29, 1995). Construction of a second hotel in Philadelphia, the 419-room Philadelphia Airport Marriott Hotel (the \"Airport Hotel\"), also was completed and opened on November 1, 1995. The Airport Hotel was financed principally with $40 million of proceeds from an industrial development bond financing. The Company also is constructing a 300-room Residence Inn in Arlington, Virginia, scheduled for completion in early 1996. Capital expenditures for these three hotels totaled $64 million in 1995, $104 million in 1994 and $60 million in 1993. The Company anticipates spending approximately $7 million in 1996 to complete construction of the Pentagon City Residence Inn in Arlington, Virginia.\nDebt Payments. At December 29, 1995, the parent company is obligated on approximately $262 million of recourse debt (which has been classified as \"debt carrying a parent company guarantee of repayment\"), including $22 million outstanding under the New Line of Credit. Required amortization of these obligations is generally limited to $172 million over the next five years.\nThe remainder of the Company's debt, approximately $1,916 million at December 29, 1995, is secured by specific hotel properties or has recourse limited to certain subsidiaries of the Company, and has been classified as \"debt not carrying a parent company guarantee.\" Payments on a large portion of this debt generally come from the specific cash flows generated by the assets securing the debt. Maturities over the next five years total $375 million, a substantial portion ($302 million) of which represents the maturity of the mortgage on the New York Marriott Marquis in 1998.\nThe Company repaid certain indebtedness (with a principal balance of $87 million) upon its maturity on May 24, 1995 with a draw on its line of credit with Marriott International. Additionally, and pursuant to the\nthen-existing indenture, senior notes issued by Hospitality were required to be repaid to the extent of 50% to 75% of net proceeds from certain asset sales (at par) and 100% of net refinancing proceeds (generally at 103% of the principal amount). Based on net proceeds from qualifying asset sales for the first quarter of 1995, the Company redeemed $100 million of Hospitality bonds in the second quarter of 1995.\nThe Company currently is party to eight interest rate exchange agreements with an aggregate notional amount of $545 million. These agreements are with Citibank, N.A., New York, Salomon Brothers and the Industrial Bank of Japan Trust Company (the \"Contracting Parties\"). Under certain of these agreements aggregating $400 million, the Company pays interest based on the specified floating rates of three- and six-month LIBOR (average rate of 5.6% at December 29, 1995) and collects interest at fixed rates (average rate of 7.1% at December 29, 1995) through May 1997. Under the remaining agreements aggregating $145 million, the Company collects interest based on specified floating interest rates of one month LIBOR (rate of 6.1% at December 29, 1995) and pays interest at fixed rates (average rate of 6.4% at December 29, 1995). These agreements expire in 1996 through 1998. The Company realized a net reduction of interest expense of $5 million in 1995, $11 million in 1994 and $21 million in 1993 related to interest rate exchange agreements. The Company monitors the creditworthiness of the Contracting Parties by evaluating credit exposure and referring to the ratings of widely accepted credit rating services. The Standard and Poors' long-term debt ratings for the contracting parties are all BBB+ or better. The Company is exposed to credit loss in the event of non-performance by the Contracting Parties; however, the Company does not anticipate non-performance by the Contracting Parties.\nCash Flows. The Company's cash flow from operations in 1995, 1994 and 1993 totaled $110 million, $75 million and $335 million, respectively.\nThe Company's cash from investing activities from continuing operations in 1995, 1994 and 1993 totaled $156 million, $135 million and $201 million, respectively. Cash from investing activities primarily consists of net proceeds from the sales of certain assets, offset by the acquisition of hotel and other real estate assets and other capital expenditures previously discussed.\nThe Company's cash from financing activities from continuing operations was $204 million for 1995 and $24 million in 1994, while cash used in financing activities was $389 million for 1993. The Company's cash from financing activities from continuing operations primarily consists of the proceeds from equity and debt offerings, borrowings under the line of credit with Marriott International and the Revolver, mortgage financing on certain acquired hotels, offset by redemptions and payments on senior notes, the line of credit with Marriott International, the Revolver and other scheduled principal payments.\nLodging Properties Formerly Held For Sale. Prior to the Marriott International Distribution, the Company developed and sold lodging properties to syndicated limited partnerships, while continuing to operate the properties under long-term agreements. Those agreements provided the Company with specified percentages of sales and operating profits as compensation for operating the properties for the owners.\nMost lodging properties developed by the Company since the early 1980s were reported as assets held for sale prior to 1992. The Company used this classification because the sale of newly developed lodging properties, subject to long-term operating agreements, was the principal method of financing the Company's lodging property development during this period. Sales of such properties also enabled the Company to transfer the risk of real estate ownership. Most of these properties were in the Company's Courtyard, Fairfield Inn and Residence Inn brands, and were sold in large groups with a balanced geographical mix of properties of the same brand.\nIn April 1992, as a result of continuing unfavorable conditions in the real estate markets, the Company decided it was no longer appropriate to view such sales of lodging properties as a primary means of long-term financing. Accordingly, the Company discontinued classification of these properties as assets held for sale.\nDuring the period the Company classified lodging properties as assets held for sale, it determined the net realizable value of such assets on a property- by-property basis in the case of full-service hotels, resorts and suites,\nand on an aggregate basis, by brand, in the case of its limited service (i.e., Courtyard, Fairfield Inn and Residence Inn) lodging properties. On this basis, the carrying value of these properties was not in excess of their net realizable value based on estimated selling prices, although, as a result of deteriorating market conditions, certain individual properties within a limited service brand had carrying values in excess of their estimated selling prices. In certain cases, these unrealized losses related to properties constructed during 1990 and 1991 where total development and construction costs exceeded net realizable value. Following the reclassification of these properties, the Company assesses impairment of its owned real estate properties based on whether it is probable that undiscounted future cash flows from such properties will be less than their net book value.\nBeginning in the second fiscal quarter of 1993, under a new accounting policy adopted by the Company, net realizable value of assets held for sale is determined on a property-by-property basis as to all lodging properties, whereas formerly such determination was made on an aggregate basis by hotel brand as to Courtyard properties, Fairfield Inns and Residence Inns. The after-tax cumulative effect of this change on years prior to 1993 of $32 million was recorded in the quarter ended June 18, 1993. The reduction in the annual depreciation charge as a result of this change did not have a material effect on 1993 results of operations.\nPartnership Activities. The Company serves as general partner or the managing general partner of numerous limited partnerships which own 261 hotels as of December 29, 1995, managed by Marriott International. Debt of the hotel limited partnerships is typically secured by first mortgages on the properties and is generally nonrecourse to the partnership and the partners. However, the Company has committed to advance amounts to these affiliated limited partnerships, if necessary, to cover certain future debt service requirements. Such commitments were limited, in the aggregate, to $173 million at December 29, 1995. Subsequent to year-end, such maximum commitment was reduced to $128 million. Net fundings under these guarantees amounted to $8 million in 1995 and $2 million for 1994.\nLeases. The Company leases certain property and equipment under noncancelable operating leases, including the long-term ground leases for certain hotels, generally with multiple renewal options. The leases related to the 37 Courtyard properties sold during 1995 contain provisions for the payment of contingent rentals based on a percentage of sales in excess of stipulated amounts. The Company remains contingently liable on certain leases related to divested non-lodging properties. Management considers the likelihood of any substantial funding related to these divested properties' leases to be remote.\nInflation. The Company's lodging properties are impacted by inflation through its effect on increasing costs and on the managers' ability to increase room rates. Unlike other real estate, hotels have the ability to change room rates on a daily basis, so the impact of higher inflation generally can be passed on to customers.\nA substantial portion of the Company's debt bears interest at fixed rates. This debt structure largely mitigates the impact of changes in the rate of inflation on future interest costs. However, the Company currently is exposed to variable interest rates through four interest rate exchange agreements with an aggregate notional amount of $400 million. These agreements are with Citibank, N.A., New York and Salomon Brothers. Under these agreements, the Company pays interest based on the specified floating rates of three- and six- month LIBOR (average rate of 5.6% at December 29, 1995) and collects interest at fixed rates (average rate of 7.1% at December 29, 1995) through May 1997. In addition, outstanding borrowings under the New Line of Credit ($22 million as of December 29, 1995) and the mortgage on the Philadelphia Marriott Hotel ($109 million at December 29, 1995) bear interest based on variable rates. Accordingly, the amount of the Company's interest expense under the interest rate swap agreements and the floating rate debt for a particular year will be affected by changes in short-term interest rates.\nAccounting Standards. In the first quarter of 1995, the Company adopted SFAS No. 114, \"Accounting by Creditors for Impairment of a Loan.\" Adoption of SFAS No. 114 did not have a material effect on the Company's consolidated financial statements.\nEffective September 9, 1995, the Company adopted SFAS No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of.\" The adoption of SFAS No. 121 did not have any effect on the Company's continuing operations. See the discussion below for a discussion of the impact of the adoption of SFAS No. 121 on discontinued operations.\nSFAS No. 121 requires that an impairment loss be recognized when the carrying amount of an asset exceeds the sum of the undiscounted estimated future cash flows associated with the asset. Under SFAS No. 121, the Company reviewed the impairment of its assets employed in its operating group business lines (airport, toll plaza and sports and entertainment) on an individual operating unit basis. For each individual operating unit determined to be impaired, an impairment loss equal to the difference between the carrying value and the fair market value of the unit's assets was recognized. Fair market value was estimated to be the present value of expected future cash flows of the individual operating unit, as determined by management, after considering such factors as future air travel and toll-pay vehicle data and inflation. As a result of the adoption of SFAS No. 121, the Company recognized a non-cash, pre-tax charge against earnings during the fourth quarter 1995 of $47 million, which has been reflected in discontinued operations.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe following financial information is included on the pages indicated:\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo Host Marriott Corporation:\nWe have audited the accompanying consolidated balance sheets of Host Marriott Corporation (formerly Marriott Corporation) and subsidiaries as of December 29, 1995 and December 30, 1994, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three fiscal years in the period ended December 29, 1995. 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 an audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Host Marriott Corporation and subsidiaries as of December 29, 1995 and December 30, 1994, and the results of their operations and their cash flows for each of the three fiscal years in the period ended December 29, 1995 in conformity with generally accepted accounting principles.\nAs discussed in Notes 1 and 2 to the consolidated financial statements, in 1995 the Company changed its method of accounting for the impairment of long- lived assets. As discussed in Notes 4 and 6 to the consolidated financial statements, in 1993 the Company changed its methods of accounting for assets held for sale and 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 at Item 14(a)(2) are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic financial statements. These schedules have been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\nArthur Andersen LLP\nWashington, D.C. February 26, 1996\nHOST MARRIOTT CORPORATION AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\nDECEMBER 29, 1995 AND DECEMBER 30, 1994 (IN MILLIONS)\nSee Notes to Consolidated Financial Statements.\nHOST MARRIOTT CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF OPERATIONS\nFISCAL YEARS ENDED DECEMBER 29, 1995, DECEMBER 30, 1994 AND DECEMBER 31, 1993 (IN MILLIONS, EXCEPT PER COMMON SHARE AMOUNTS)\nSee Notes to Consolidated Financial Statements.\nHOST MARRIOTT CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY\nFISCAL YEARS ENDED DECEMBER 29, 1995, DECEMBER 30, 1994 AND DECEMBER 31, 1993\nSee Notes to Consolidated Financial Statements.\nHOST MARRIOTT CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nFISCAL YEARS ENDED DECEMBER 29, 1995, DECEMBER 30, 1994 AND DECEMBER 31, 1993\nSee Notes to Consolidated Financial Statements.\nHOST MARRIOTT CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nDescription of Business\nAs of December 29, 1995, Host Marriott Corporation (the \"Company,\" formerly Marriott Corporation) owned 90 lodging properties generally located throughout the United States and operated under Marriott brand names and managed by Marriott International. The Company also holds minority interests in various partnerships that own 261 additional properties operated by Marriott International. The Company's properties span several market segments, including full-service (hotels, resorts and suites), moderate-price (Courtyard by Marriott) and extended-stay (Residence Inn).\nOn December 29, 1995, the Company distributed to its shareholders through a special tax-free dividend (the \"Special Dividend\") its food, beverage, and merchandise concessions business at airports, on tollroads, and at stadiums, arenas and other attractions (the \"Operating Group\"). See Note 2 for a discussion of the Special Dividend. The consolidated financial statements have been restated to reflect the Operating Group as discontinued operations.\nThe structure of the Company was substantially altered on October 8, 1993 (the \"Marriott International Distribution Date\") when the Company distributed the stock of a wholly-owned subsidiary, Marriott International, Inc. (\"Marriott International\") in a special dividend (the \"Marriott International Distribution\"). See Note 3 for a description of the Marriott International Distribution and related transactions.\nPrinciples of Consolidation\nThe consolidated financial statements include the accounts of the Company and its subsidiaries and controlled affiliates. Investments in 50% or less owned affiliates over which the Company has the ability to exercise significant influence are accounted for using the equity method. All material intercompany transactions and balances have been eliminated.\nThe Company's financial statements include the results of operations and cash flows of Marriott International through the Marriott International Distribution Date. Marriott International's results of operations through the Marriott International Distribution Date included in the accompanying consolidated financial statements consist of the following:\nFiscal Year\nThe Company's fiscal year ends on the Friday nearest to December 31.\nRevenues and Expenses\nSubsequent to the Marriott International Distribution, revenues include house profit from the Company's owned hotel properties because the Company has delegated substantially all of the operating decisions related to the generation of hotel house profit from its hotels to the manager. Revenues subsequent to the Marriott\nHOST MARRIOTT CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nInternational Distribution also include net gains (losses) on real estate transactions, equity in the earnings of affiliates and lease rentals from the Company's senior living communities. House profit reflects the net revenues flowing to the Company as property owner and represents hotel operating results, less property-level expenses, excluding depreciation, management fees, real and personal property taxes, ground and equipment rent, insurance and certain other costs, which are classified as operating costs and expenses.\nIn 1993, revenues related to Marriott International are included in profits from operations distributed to Marriott International in the accompanying statement of operations.\nPrior to the Marriott International Distribution, the Company operated 388 hotels under long-term management agreements whereby payments to owners were based primarily on hotel profits. Working capital and operating results of managed hotels operated with the Company's employees were consolidated because the operating responsibilities associated with such hotels were substantially the same as those for owned and leased hotels.\nEarnings (Loss) Per Common Share\nEarnings (loss) per common share are computed on a fully diluted basis by dividing net income (loss) available for common stock by the weighted average number of outstanding common and common equivalent shares, plus other potentially dilutive securities, aggregating 158.3 million in 1995, 151.5 million in 1994 and 121.3 million in 1993. Common equivalent shares and other potentially dilutive securities have been excluded from the weighted average number of outstanding shares for 1995 and 1994 as they are anti-dilutive.\nInternational Operations\nThe consolidated statements of operations include the following amounts related to non-U.S. subsidiaries and affiliates; revenues of $258 million in 1993 (including $223 million related to Marriott International) and income before income taxes of $26 million in 1993. International sales and income before income taxes, subsequent to the Marriott International Distribution, were not material.\nProperty and Equipment\nProperty and equipment is recorded at cost, including interest, rent and real estate taxes incurred during development and construction. Replacements and improvements are capitalized.\nDepreciation is computed using the straight-line method over the estimated useful lives of the assets, generally 40 years for buildings and three to 10 years for furniture and equipment. Leasehold improvements are amortized over the shorter of the lease term or the useful lives of the related buildings.\nGains on sales of properties are recognized at the time of sale or deferred to the extent required by generally accepted accounting principles. Deferred gains are recognized as income in subsequent periods as conditions requiring deferral are satisfied or expire without further cost to the Company.\nIn cases where management is holding for sale particular lodging properties, the Company assesses impairment based on whether the net realizable value (estimated sales price less costs of disposal) of each individual property to be sold is less than the net book value. A lodging property is considered to be held for sale when the Company has made the decision to dispose of the property. Otherwise, the Company assesses impairment of its real estate properties based on whether it is probable that undiscounted future cash flows from each individual property will be less than its net book value. If a property is impaired, its basis is adjusted to its fair market value.\nHOST MARRIOTT CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nPre-Opening Costs\nCosts of an operating nature incurred prior to opening of lodging properties are deferred and amortized over three years for hotels opened prior to September 8, 1995 and one year for hotels opened after September 8, 1995. Such costs, which are included in other assets, amounted to $7 million and $6 million, net of accumulated amortization, at December 29, 1995 and December 30, 1994, respectively.\nCash and Cash Equivalents\nThe Company considers all highly liquid investments with a maturity of three months or less at date of purchase to be cash equivalents.\nUse of Estimates in the Preparation of Financial Statements\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nSelf-Insurance Programs\nPrior to the Marriott International Distribution Date, the Company was self- insured for certain levels of general liability, workers' compensation and employee medical coverage. Estimated costs of these self-insurance programs were accrued at present values of projected settlements for known and anticipated claims. The Company discontinued its self-insurance programs for claims arising subsequent to the Marriott International Distribution Date.\nInterest Rate Swap Agreements\nThe Company has entered into interest rate swap agreements to diversify certain of its debt to a variable rate or fixed rate basis. The interest rate differential to be paid or received on interest rate swap agreements is accrued as interest rates change and is recognized as an adjustment to interest expense.\nNew Statements of Financial Accounting Standards\nThe Company adopted Statements of Financial Accounting Standards (\"SFAS\") No. 112, \"Employers' Accounting for Postemployment Benefits,\" and SFAS No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" during 1994 and SFAS No. 114, \"Accounting by Creditors for Impairment of a Loan,\" during 1995. Adoption of these statements did not have a material effect on the Company's consolidated financial statements.\nDuring 1995, the Company adopted SFAS No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of.\" The adoption of SFAS No. 121 did not have any effect on the Company's continuing operations. See Note 2 for a discussion of the adoption of SFAS No. 121 on discontinued operations. The Company is also required to adopt SFAS No. 123, \"Accounting for Stock-Based Compensation,\" no later than its fiscal year ending January 3, 1997. Adoption of SFAS No. 123 will not have any material effect on the Company's consolidated financial statements.\nHOST MARRIOTT CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\n2. HM SERVICES SPECIAL DIVIDEND\nOn December 29, 1995, the Company distributed to its shareholders through the Special Dividend all of the outstanding shares of common stock of HM Services, formerly a wholly-owned subsidiary of the Company, which, as of the date of the Special Dividend, owned and operated food, beverage and merchandise concessions at airports, on tollroads and at stadiums and arenas and other tourist attractions (the \"Operating Group\"). The Special Dividend provided Company shareholders with one share of common stock of HM Services for every five shares of Company common stock held by such shareholders on the record date of December 22, 1995. The Company recorded approximately $9 million of expenses related to the consummation of the Special Dividend in 1995. Revenues for the Company's discontinued operations totaled $1,158 million in 1995, $1,121 million in 1994 and $1,067 million in 1993. The provision for loss on disposal includes the operating loss from discontinued operations from August 9, 1995 (measurement date) through December 29, 1995 of $44 million, net of taxes, and estimated expenses related to the Special Dividend of $9 million.\nEffective September 9, 1995, the Company adopted SFAS No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of.\" SFAS No. 121 requires that an impairment loss be recognized when the carrying amount of an asset exceeds the sum of the undiscounted estimated future cash flows associated with the asset. Under SFAS No. 121, the Company reviewed the impairment of its assets employed in its Operating Group business lines (airport, toll plaza and sports and entertainment) on an individual operating unit location basis. For each individual operating unit determined to be impaired, an impairment loss equal to the difference between the carrying value and the fair value of the unit's assets was recognized. Fair value was estimated to be the present value of expected future cash flows of the individual operating unit, as determined by management, after considering such factors as future air travel and toll-pay vehicle data and inflation. As a result of the adoption of SFAS No. 121, the Company recognized a non-cash, pre-tax charge during the fourth quarter of $47 million. Such charge has been reflected in discontinued operations for fiscal year 1995.\nPrior to September 9, 1995, the Company determined the impairment of concession unit assets on a business line basis, not by individual operating unit, which was consistent with the manner in which the Operating Group has managed its business. Using the business line basis, if the net carrying costs exceeded the estimated future undiscounted cash flows from a business line, such excess costs would be charged to expense.\nFor purposes of governing certain of the ongoing relationships between the Company and HM Services after the Special Dividend and to provide for an orderly transition, the Company and HM Services entered into various agreements including a Distribution Agreement, an Employee Benefits Allocation Agreement, a Tax Sharing Agreement and a Transitional Services Agreement. Effective as of December 29, 1995, these agreements provide, among other things, for the division between the Company and HM Services of certain assets and liabilities, including but not limited to liabilities related to employee stock and other benefit plans and the establishment of certain obligations for HM Services to issue shares upon exercise of warrants (see Note 10) and to issue shares or pay cash to the Company upon exercise of stock options held by certain former employees of the Company (see Note 11).\n3. MARRIOTT INTERNATIONAL DISTRIBUTION\nOn October 8, 1993 (the \"Marriott International Distribution Date\"), Marriott Corporation distributed, through a special tax-free dividend (the \"Marriott International Distribution\"), to holders of Marriott Corporation's common stock (on a share-for-share basis), approximately 116.4 million outstanding shares of common stock of an existing wholly-owned subsidiary, Marriott International, resulting in the division of Marriott Corporation's operations into two separate companies. The distributed operations included the former\nHOST MARRIOTT CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nMarriott Corporation's lodging management, franchising and resort timesharing operations, senior living service operations, and the institutional food service and facilities management business. The Company retained the former Marriott Corporation's airport and tollroad food, beverage and merchandise concessions operations, as well as most of its real estate properties. Effective at the Marriott International Distribution Date, Marriott Corporation changed its name to Host Marriott Corporation. Subsequent to the Company's announcement in late 1992 of the planned Marriott International Distribution, the Company recorded a reserve of $21 million, representing management's best estimate, at that time, of the anticipated costs to complete the Marriott International Distribution. During 1993, the Company recognized an additional $13 million of charges based on management's revised estimate of the ultimate cost of completing the Marriott International Distribution. The costs include $30 million payable to attorneys, investment bankers, consultants and financial institutions, and $4 million in employee compensation awards. Substantially all of the unpaid costs at December 31, 1993 were paid during 1994. The other notes to the financial statements discuss further the agreements and events relating to the Marriott International Distribution.\nIn connection with the Marriott International Distribution, the Company completed an exchange offer (\"Exchange Offer\") pursuant to which holders of senior notes in an aggregate principal amount of approximately $1.2 billion (\"Old Notes\") exchanged such Old Notes for a combination of (i) cash, (ii) common stock and (iii) Hospitality Notes (\"Hospitality Notes\") issued by an indirect wholly-owned subsidiary of the Company, Host Marriott Hospitality, Inc. (\"Hospitality\"). The Hospitality Notes were redeemed in 1995 (see Note 8). The Exchange Offer was treated as an extinguishment of debt and, accordingly, the Company recognized an extraordinary loss of $4 million, net of taxes of $3 million, in 1993.\nThe following condensed unaudited pro forma income statement data for continuing operations for the Company is presented as if the Marriott International Distribution and Exchange Offer had occurred at the beginning of fiscal year 1993. This pro forma data has been presented for informational purposes only. It does not purport to be indicative of the results which may occur in the future.\n4. PROPERTY AND EQUIPMENT\nProperty and equipment consists of the following:\nInterest cost capitalized in connection with the Company's development and construction activities totaled $5 million in 1995 and $10 million in 1994 and 1993.\nHOST MARRIOTT CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nFollowing discussions with the Staff of the Securities and Exchange Commission, the Company agreed in the second quarter of 1993 to change its method of determining net realizable value of assets reported as held for sale. The Company previously determined net realizable value of such assets on a property-by-property basis in the case of full-service hotels, resorts and suites, and on an aggregate basis, by hotel brand, in the case of Courtyard hotels, Fairfield Inns and Residence Inns. Beginning in the second fiscal quarter of 1993 and thereafter, under the Company's new accounting policy, net realizable value of all assets held for sale is determined on a property-by- property basis. The after-tax cumulative effect of this change on periods prior to the second quarter of 1993 of $32 million is reflected as a cumulative effect of a change in accounting for assets held for sale in the accompanying consolidated statement of operations for the fiscal year ended December 31, 1993. The reduction in the annual depreciation charge as a result of this change did not have a material effect on results of operations. There was no pro forma effect of this change on the results of operations for 1993.\nIn cases where the Company has made a decision to dispose of particular properties, the Company assesses impairment of each individual property to be sold on the basis of expected sales price less estimated costs of disposal. Otherwise, the Company assesses impairment of its real estate properties based on whether the estimated undiscounted future cash flows from such properties will be less than their net book value. In the second quarter of 1995, the Company made a determination that its owned Courtyard and Residence Inn properties were held for sale. While management expects to sell these properties as part of one or more portfolios, the Company recorded a $10 million charge to write down the carrying value of five individual Courtyard and Residence Inn properties to their estimated net realizable values. The Company's Courtyard and Residence Inn properties held for sale have a net book value of $302 million at December 29, 1995.\nDuring the fourth quarter of 1993, the Company engaged in formal negotiations to sell the majority of its Fairfield Inns and executed a letter of intent in January 1994. In the fourth quarter of 1993, the Company considered these hotels as held for sale and recorded a pre-tax charge to earnings of $11 million to write-down the carrying value of 15 such properties to their individual estimated net realizable value.\nThe Company owns a 174-acre parcel of undeveloped land in Germantown, Maryland, zoned for commercial office building development. The site was originally purchased in the 1980s for a proposed new corporate headquarters. Due to Company downsizing, plans for a new corporate headquarters were dropped. The Company subsequently planned to develop the site into an office project over an extended time period to recover its investment, however, the continuing weakness of the real estate market in Montgomery County, Maryland, has negatively impacted this development plan. In the fourth quarter of 1995, management instituted a program to liquidate certain non-income producing assets and to reinvest the proceeds in the acquisition of full service hotels. As part of this program, management determined that the site will no longer be developed and instead has decided to attempt to sell the property. Accordingly, the Company recorded a pre-tax charge of $60 million in the fourth quarter of 1995 to reduce the asset to its estimated sales value.\n5. INVESTMENTS IN AND RECEIVABLES FROM AFFILIATES\nInvestments in and receivables from affiliates consist of the following:\nHOST MARRIOTT CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nHotel properties owned by affiliates generally were acquired from the Company in connection with limited partnership offerings. The Company or one of its subsidiaries typically serve as a general partner of each partnership and the hotels are operated under long-term agreements by Marriott International.\nAt December 31, 1993, the Company owned a 50% interest in Times Square Marquis Hotel, L.P. (\"Times Square\"), formerly Times Square Hotel Company, the owner of the New York Marriott Marquis, and held security interests in an additional 39% of the partnership interests as collateral for loans made to certain partners. The partners were in default on the loans and the Company, for accounting purposes, realized an in-substance foreclosure of their partnership interests. In the first quarter of 1994, the Company foreclosed on a 29% partnership interest and completed the transfer of an additional 7% partnership interest in Times Square in full satisfaction of the loans. As a result, the Company holds an 86% partnership interest in Times Square at December 29, 1995. In 1993, the Company began reporting substantially all the losses of Times Square and on December 31, 1993 began consolidating Times Square.\nIn December 1993, the Company sold its 15% interest in the partnership owning the Boston Copley Marriott Hotel for $10.4 million.\nIn 1993, the Company sold portions of its equity interests in Residence Inns USA partnership for $31 million. These sales reduced the Company's ownership by the fourth quarter of 1993 to 16.6% and allowed the Company to be released from certain debt guarantee obligations. Accordingly, the Company deconsolidated the partnership at December 31, 1993. In 1994, the Company sold an additional portion of its equity interests in the partnership for $7 million. A gain on the sale transactions totaling $14 million has been deferred and is being amortized through 1996.\nIn the fourth quarter of 1993, a Company-owned addition to a hotel owned by a partnership in which the Company is a general partner was taken through foreclosure by the hotel's lender. The Company's investment in the addition was written off at that time.\nReceivables from affiliates are reported net of reserves of $210 million at December 29, 1995 and $200 million at December 30, 1994. Receivables from affiliates at December 29, 1995 includes a $145 million mortgage note at 9% which amortizes through 2003, and net debt service and other advances totaling $7 million which are generally secured by subordinated liens on the properties. The Company has committed to advance additional amounts to affiliates, if necessary, to cover certain debt service requirements. Such commitments are limited, in the aggregate, to an additional $173 million at December 29, 1995. Subsequent to year-end, such commitments were reduced to $128 million. Net amounts funded under these commitments totaled $8 million in 1995, $2 million in 1994 and $14 million in 1993.\nThe Company's pre-tax income from affiliates includes the following:\nHOST MARRIOTT CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nCombined summarized balance sheet information for the Company's affiliates follows:\nCombined summarized operating results reported by these affiliates follow:\n6. INCOME TAXES\nThe Company adopted SFAS No. 109, \"Accounting for Income Taxes\", during the first quarter of 1993. Prior to such adoption, the Company deferred the past tax effects of timing differences between amounts recorded for financial reporting purposes and taxable income. SFAS No. 109 requires the recognition of deferred tax assets and liabilities equal to the expected future tax consequences of temporary differences.\nThe $34 million cumulative credit resulting from this change in accounting principle has been reflected as a cumulative effect of a change in accounting for income taxes in the consolidated statements of operations for 1993.\nTotal deferred tax assets and liabilities at December 29, 1995 and December 30, 1994 were as follows:\nHOST MARRIOTT CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nThe valuation allowance required under SFAS No. 109 primarily represents net operating loss carryforwards (\"NOLs\") the benefits of which were not previously recorded, but which have been recorded under SFAS No. 109 as deferred tax assets with an offsetting valuation allowance. Any subsequent reduction in the valuation allowance related to the NOLs will be recorded as a reduction of income tax expense. There was no change in the valuation allowance during 1995 and 1994.\nThe tax effect of each type of temporary difference and carryforward that gives rise to a significant portion of deferred tax assets and liabilities as of December 29, 1995 and December 30, 1994 follows:\nThe provision (benefit) for income taxes consists of:\nAt December 29, 1995, the Company has net operating loss carryforwards of $12 million which expire through 2001. Additionally, the Company has approximately $26 million of alternative minimum tax credit carryforwards which do not expire.\nDuring 1995, the Company settled with the Internal Revenue Service (\"IRS\") substantially all remaining issues through the 1990 tax year, except for one issue which the Company expects to resolve with no material impact on the consolidated financial statements. The Company anticipates net payments to the IRS in 1996 of approximately $45 million related to these settlements. Certain adjustments totaling approximately $11 million in 1995 have been made to the tax provision related to those settlements.\nHOST MARRIOTT CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nA reconciliation of the statutory Federal tax rate to the Company's effective income tax rate follows:\nAs part of the Marriott International Distribution, the Company and Marriott International entered into a tax-sharing agreement which reflects each party's rights and obligations with respect to deficiencies and refunds, if any, of Federal, state or other taxes relating to the businesses of the Company, Marriott International and HM Services prior to the Marriott International Distribution and the Special Dividend. The majority of the 1994 adjustment to the Marriott International Distribution of stock of Marriott International related to deferred income taxes.\nCash paid for income taxes, net of refunds received, was $22 million in 1995, $13 million in 1994, and $63 million in 1993.\n7. LEASES\nFuture minimum annual rental commitments for all non-cancelable leases related to continuing operations are as follows:\nThe Company leases certain property and equipment under non-cancelable operating leases. As discussed in Note 13, the Company sold and leased back 37 of its Courtyard properties. The leases, which are accounted for as operating leases and are included above, have initial terms expiring through 2006 and are renewable at the option of the Company. Subsequent to year-end, the initial term of the leases was extended through 2012. Minimum rent payments are $33 million annually and additional rent based upon sales levels are payable to the owner under the terms of the leases. Leases also include long- term ground leases for certain hotels, generally with multiple renewal options. Certain leases contain provision for the payment of contingent rentals based on a percentage of sales in excess of stipulated amounts.\nHOST MARRIOTT CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nCertain of the leases included above relate to facilities used in the former restaurant business. Most leases contain one or more renewal options, generally for five or 10-year periods. Future rentals on leases have not been reduced by aggregate minimum sublease rentals of $116 million payable to the Company under non-cancelable subleases.\nThe Company remains contingently liable at December 29, 1995 on certain leases relating to divested non-lodging properties. Such contingent liabilities aggregated $142 million at December 29, 1995. However, management considers the likelihood of any substantial funding related to these leases to be remote.\nRent expense related to continuing operations consists of:\n8. DEBT\nDebt related to continuing operations consists of the following:\nThe Company repaid certain indebtedness (with a principal balance of $87 million) upon its maturity on May 24, 1995 with a draw on its line of credit with Marriott International. Additionally, and pursuant to the then-existing senior note indenture, senior notes (\"Hospitality Notes\") issued by Host Marriott Hospitality, Inc. (\"Hospitality\"), a wholly-owned subsidiary of the Company, were required to be repaid to the extent of 50% to 75% of net proceeds from certain asset sales (at par) and 100% of net refinancing proceeds (generally at 103% of the principal amount). Based on net proceeds from qualifying asset sales for the first quarter of 1995, the Company redeemed $100 million of Hospitality Notes in the second quarter of 1995. The Company also redeemed $292 million of Hospitality Notes in 1994 from the net proceeds from qualifying assets sales. In connection with the 1994 redemptions, the Company recognized an extraordinary loss of $6 million, net of taxes of $3 million, in 1994.\nHOST MARRIOTT CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nIn May 1995, two wholly-owned subsidiaries of Hospitality issued an aggregate of $1 billion of 9.5% senior secured notes in two concurrent offerings to several initial purchasers. HMH Properties, Inc. (\"Properties\"), the owner of 57 of the Company's 90 lodging properties at December 29, 1995, and Host Marriott Travel Plazas, Inc. (\"HMTP\"), the operator\/manager of HM Services' food, beverage and merchandise concessions business, issued $600 million (the \"Properties Notes\") and $400 million (\"HMTP Notes\"), respectively, of senior notes secured by the stock of certain of their respective subsidiaries. The bonds were issued at par and have a final maturity of May 2005. The net proceeds were used to defease, and subsequently redeem, all of Hospitality's Notes and to repay borrowings under the line of credit with Marriott International. In connection with the redemptions and defeasance, the Company recognized an extraordinary loss in 1995 of $17 million, net of taxes, related to continuing operations, primarily representing premiums paid on the redemptions and the write-off of deferred financing fees and discounts on the Hospitality Notes. The Properties Notes are secured by a pledge of the stock of certain of Properties' subsidiaries and are guaranteed, jointly and severally, by certain of Properties' subsidiaries. The indenture governing the Properties Notes contains covenants that, among other things, limit the ability of Properties and its subsidiaries to incur additional indebtedness and issue preferred stock, pay dividends or make other distributions, repurchase capital stock or subordinated indebtedness, create certain liens, enter into certain transactions with affiliates, sell certain assets, issue or sell stock of Properties' subsidiaries, and enter into certain mergers and consolidations. The net assets of Properties at December 29, 1995 were approximately $380 million, substantially all of which were restricted. The HMTP Notes were included in the Special Dividend to HM Services.\nIn December 1995, HMC Acquisition Properties, Inc. (\"Acquisitions\"), an indirect, wholly-owned subsidiary of the Company, issued $350 million of 9% senior notes (the \"Acquisitions Notes\") to several initial purchasers. The Acquisitions Notes were issued at par and have a final maturity of December 2007. A portion of the net proceeds were utilized to repay in full the outstanding borrowings under the $230 million revolving line of credit (the \"Acquisition Revolver\"), which was then terminated. In connection with the termination of the Acquisition Revolver, the Company recognized an extraordinary loss in 1995 of $3 million, net of taxes of $1 million, representing the write-off of deferred financing fees on the Acquisition Revolver. The Acquisitions Notes are guaranteed by Acquisitions' subsidiary. The indenture governing the Acquisitions Notes contains covenants that, among other things, limit the ability of Acquisitions and its subsidiary to incur additional indebtedness and issue preferred stock, pay dividends or make other distributions, repurchase capital stock or subordinated indebtedness, create certain liens, enter into certain transactions with affiliates, sell certain assets, issue or sell stock of Acquisitions' subsidiary, and enter into certain mergers and consolidations. In addition, under certain circumstances, Acquisitions will be required to offer to purchase the Acquisitions Notes at par value with the proceeds of certain asset sales. The net assets of Acquisitions at December 29, 1995 were approximately $225 million, substantially all of which were restricted.\nDuring 1995, the Company replaced its $630 million line of credit with a new line of credit with Marriott International (the \"New Line of Credit\") pursuant to which the Company has the right to borrow up to $225 million for certain permitted uses. Borrowings under the New Line of Credit bear interest at LIBOR plus 3% (4% when the outstanding balance exceeds $112.5 million) and mature in June 1998. Any such borrowings are guaranteed by, or secured by the pledge of the stock of, certain subsidiaries of the Company. An annual commitment fee of 5\/8% is charged on the unused portion of the New Line of Credit. The New Line of Credit imposes certain restrictions on the ability of the Company and certain of its subsidiaries to incur additional debt, create liens or mortgages on their properties (other than various types of liens arising in the ordinary course of business), extend new guarantees (other than replacement guarantees), pay dividends, and repurchase their common stock.\nIn conjunction with the construction of the Philadelphia Marriott, the Company obtained first mortgage financing from Marriott International for 60% of the construction and development costs of the hotel. As of\nHOST MARRIOTT CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDecember 29, 1995, the outstanding loan balance was $109 million. The loan bears interest at LIBOR plus 3% (8.7% at December 29, 1995) for the period ending two years after construction. For the following 10 years, the loan bears interest at 10% per annum with an additional 2% per annum deferred.\nAt December 29, 1995, the Company was party to interest rate exchange agreements with three financial institutions (the contracting parties) with an aggregate notional amount of $545 million. Under certain of these agreements aggregating $400 million, the Company collects interest at fixed rates (average rate of 7.1% at December 29, 1995) and pays interest based on specified floating interest rates (average rate of 5.6% at December 29, 1995) through May 1997. Under the remaining agreements aggregating $145 million, the Company collects interest based on specified floating interest rates of one month LIBOR (rate of 6.1% at December 29, 1995) and pays interest at fixed rates (average rate of 6.4% at December 29, 1995). These agreements expire in 1996 through 1998. The Company monitors the creditworthiness of its contracting parties by evaluating credit exposure and referring to the ratings of widely accepted credit rating services. The Standard and Poors' long-term debt ratings for the contracting parties are all BBB+ or better. The Company is exposed to credit loss in the event of non-performance by the contracting parties to the interest rate swap agreements; however, the Company does not anticipate non-performance by the contracting parties.\nAggregate debt maturities at December 29, 1995, excluding capital lease obligations, are:\nCash paid for interest for continuing operations, net of amounts capitalized, was $177 million in 1995, $157 million in 1994 and $174 million in 1993. Deferred financing costs, which are included in other assets, amounted to $37 million and $31 million at December 29, 1995 and December 30, 1994, respectively.\n9. CONVERTIBLE SUBORDINATED DEBT\nIn June 1991, the Company issued $675 million (principal amount at maturity) of zero coupon convertible subordinated debt in the form of Liquid Yield Option Notes (\"LYONs\") due 2006. Pursuant to the Marriott International Distribution, Marriott International assumed 90% and the Company retained 10% of the debt obligations evidenced by the LYONs. The LYONs were convertible into 13.277 shares each of the Company's and Marriott International's common stock for each $1,000 principal amount of LYONs. On December 13, 1993, the Company initiated a call of the LYONs redeemable on January 25, 1994. Substantially all of the LYONs' holders elected to convert their LYONs into common stock prior to the redemption. Such conversions represented 8.3 million shares of the Company's common stock issued in 1993 and .7 million shares issued in 1994.\n10. SHAREHOLDERS' EQUITY\nThree hundred million shares of common stock, with a par value of $1 per share, are authorized, of which 159.7 million and 153.6 million were issued and outstanding as of December 29, 1995 and December 30, 1994,\nHOST MARRIOTT CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nrespectively. One million shares of no par value preferred stock are authorized. During 1995, substantially all outstanding shares of such preferred stock were converted into approximately five million shares of common stock. The remaining outstanding shares of preferred stock which were not converted were defeased prior to December 29, 1995 and are no longer outstanding. Additional paid-in capital at December 29, 1995 includes obligations for deferred compensation of $9 million.\nOn January 27, 1994, the Company completed the issuance of 20.1 million shares of common stock for net proceeds of $230 million. In connection with the class action settlement discussed in Note 17, the Company issued warrants to purchase up to 7.7 million shares of the Company's common stock in 1994. The warrants are exercisable for five years from the Marriott International Distribution Date, at $8.00 per share during the first three years and $10.00 per share during the last two years. As of December 29, 1995, there were approximately 7.5 million warrants outstanding.\nIn February 1989, the Board of Directors adopted a shareholder rights plan under which a dividend of one preferred stock purchase right was distributed for each outstanding share of the Company's common stock to shareholders of record on February 20, 1989. Each right entitles the holder to buy 1\/1,000th of a share of a newly issued series of junior participating preferred stock of the Company at an exercise price of $150 per share. The rights will be exercisable 10 days after a person or group acquires beneficial ownership of 20% or more of the Company's common stock, or begins a tender or Exchange Offer for 30% or more of the Company's common stock. Shares owned by a person or group on February 3, 1989 and held continuously thereafter are exempt for purposes of determining beneficial ownership under the rights plan. The rights are non-voting and will expire on February 2, 1999, unless exercised or previously redeemed by the Company for $.01 each. If the Company is involved in a merger or certain other business combinations not approved by the Board of Directors, each right entitles its holder, other than the acquiring person or group, to purchase common stock of either the Company or the acquirer having a value of twice the exercise price of the right.\n11. EMPLOYEE STOCK PLANS\nTotal shares of common stock reserved and available for issuance under employee stock plans at December 29, 1995 are:\nUnder the comprehensive stock plan (the \"Comprehensive plan\"), the Company may award to participating employees (i) options to purchase the Company's common stock, (ii) deferred shares of the Company's common stock and (iii) restricted shares of the Company's common stock. In addition, the Company has an employee stock purchase plan (the \"stock purchase plan\"). The principal terms and conditions of the two plans are summarized below.\nEmployee stock options may be granted to officers and key employees with an exercise price not less than the fair market value of the common stock on the date of grant. Options granted before May 11, 1990 expire 10 years after the date of grant and nonqualified options granted on or after May 11, 1990 expire up to 15 years after the date of grant. Most options vest ratably over each of the first four years following the date of the grant. In connection with the Marriott International Distribution, the Company issued an equivalent number of Marriott International options and adjusted the exercise prices of its options then outstanding based on the relative trading prices of shares of the common stock of the two companies.\nHOST MARRIOTT CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nIn connection with the Special Dividend, the then outstanding options held by current and former employees of the Company were redenominated in both Company and HM Services stock and the exercise prices of the options were adjusted based on the relative trading prices of shares of the common stock of the two companies. For all options held by certain current and former employees of Marriott International, the number and exercise price of the options were adjusted based on the trading prices of shares of the Company's common stock immediately before and after the Special Dividend. Therefore, the options outstanding reflect these revised exercise prices. Pursuant to the Distribution Agreement between the Company and HM Services, the Company has the right to receive up to 1.4 million shares of HM Services' common stock or cash subsequent to exercise of the options held by the certain former and current employees of Marriott International. As of December 29, 1995, the Company valued this right at approximately $7 million, which is included in other assets. Option activity is summarized as follows:\nDeferred stock incentive plan shares granted to officers and key employees after 1990 generally vest over 10 years in annual installments commencing one year after the date of grant. Certain employees may elect to defer payments until termination or retirement. Deferred stock incentive plan shares granted in 1990 and prior years generally vest in annual installments commencing one year after the date of grant and continuing until retirement. Employees also could elect to forfeit one-fourth of their deferred stock incentive plan award in exchange for accelerated vesting over a 10-year period. The Company accrues compensation expense for the fair market value of the shares on the date of grant, less estimated forfeitures. In 1995, 1994 and 1993, 158,000, 159,000, and 489,000 shares were granted, respectively, under this plan.\nIn 1993, 3,537,000 restricted stock plan shares under the comprehensive plan were issued to officers and key executives and will be distributed over the next three to ten years in annual installments based on continued employment and the attainment of certain performance criteria. The Company recognizes compensation expense over the restriction period equal to the fair market value of the shares on the date of issuance adjusted for forfeitures, and where appropriate, the level of attainment of performance criteria and fluctuations in the fair market value of the stock. Subsequent to year-end, 2,133,000 shares of additional restricted shares were granted to certain key employees under terms and conditions similar to the 1993 grants. The Company recorded compensation expense of $5 million, $6 million and $400,000 in 1995, 1994 and 1993, respectively, related to these awards.\nHOST MARRIOTT CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nUnder the terms of the stock purchase plan, eligible employees may purchase common stock through payroll deductions at the lower of market value at the beginning or end of the plan year.\n12. PROFIT SHARING AND POSTEMPLOYMENT BENEFIT PLANS\nThe Company contributes to profit sharing and other defined contribution plans for the benefit of employees meeting certain eligibility requirements and electing participation in the plans. The amount to be matched by the Company is determined annually by the Board of Directors, and totaled $17 million for 1993. The Company contributions were not significant in 1994 and 1995.\nThe Company provides medical benefits to a limited number of retired employees meeting restrictive eligibility requirements. The Company adopted SFAS No. 112, \"Employers' Accounting for Postemployment Benefits\" during 1994. Adoption of SFAS No. 112 did not have a material effect on the accompanying financial statements.\n13. ACQUISITIONS AND DISPOSITIONS\nIn 1995, the Company acquired nine full service hotels totaling approximately 3,900 rooms in separate transactions for approximately $390 million. In 1994, the Company acquired 15 full service hotels (approximately 6,000 rooms) in several transactions for approximately $440 million. The Company also provided 100% financing totaling approximately $35 million to an affiliated partnership, in which the Company owns the sole general partner interest, for the acquisition of two full-service hotels (totaling another 684 rooms). Additionally, the Company acquired a controlling interest in one 662- room, full-service hotel through an equity investment of $16 million and debt financing of $36 million (the debt was subsequently sold in 1995). The Company accounts for all of these properties as owned hotels for accounting purposes.\nDuring the first and third quarters of 1995, 37 of the Company's Courtyard properties were sold and leased back from a real estate investment trust (the \"REIT\") for approximately $330 million. The Company received net proceeds from the two transactions of approximately $297 million and will receive approximately $33 million upon expiration of the leases. A deferred gain of $14 million on the sale\/leaseback transactions will be amortized over the initial term of the leases.\nIn February 1996, the Company entered into an agreement with the REIT to sell and lease back 16 of its Courtyard properties and 18 of its Residence Inn properties for $349 million (10% of which would be deferred). This transaction is expected to close in the first and second quarters of 1996. Transactions to acquire, or purchase controlling interests in, five additional full-service hotels have been consummated or are expected to close in early 1996.\nIn the third quarter of 1994, the Company completed the sale of 26 of its Fairfield Inns to an unrelated third party. The net proceeds from the sale of such hotels were approximately $114 million, which exceeded the carrying value of the hotels by approximately $12 million. Approximately $27 million of the proceeds was payable in the form of a note from the purchaser. The gain on the sale of these hotels has been deferred. During 1994, the Company sold its 14 senior living communities to an unrelated party for $320 million, which approximated the communities' carrying value.\nHOST MARRIOTT CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nThe Company's summarized, unaudited consolidated pro forma results of operations, assuming the above transactions (excluding the New York Vista Hotel acquisition), and the refinancings and new debt activity discussed in Note 8 occurred on January 1, 1994, are as follows (in millions, except per share amounts):\n14. FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe fair values of certain financial assets and liabilities and other financial instruments related to continuing operations are shown below.\nReceivables from affiliates, notes and other financial assets are valued based on the expected future cash flows discounted at risk-adjusted rates. Valuations for secured debt are determined based on the expected future payments discounted at risk-adjusted rates. The fair values of the New Line of Credit and other notes are estimated to be equal to their carrying value. Senior Notes are valued based on quoted market prices.\nThe Company is contingently liable under various guarantees of obligations of certain affiliates (affiliate debt service commitments) with a maximum commitment of $173 million at December 29, 1995 and $236 million at December 30, 1994. Subsequent to year-end, such maximum commitment was reduced to $128 million. A fair value is assigned to commitments with expected future fundings. The fair value of the commitments represents the net expected future payments discounted at risk-adjusted rates. Such payments are accrued on an undiscounted basis.\nThe fair value of interest rate swap agreements is based on the estimated amount the Company would receive to terminate the swap agreements. The aggregate notional amount of the agreements was $545 million at December 29, 1995 and $500 million at December 30, 1994.\n15. RELATIONSHIP WITH MARRIOTT INTERNATIONAL\nThe Company and Marriott International have entered into agreements which provide, among other things, that (i) most of the Company's lodging properties will be managed by Marriott International under agreements with initial terms of 15 to 20 years and which are subject to renewal at the option of Marriott International for up to an additional 16 to 30 years (see Note 16); (ii) the Company leased its owned senior living communities to\nHOST MARRIOTT CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nMarriott International prior to their disposal (see Note 13); (iii) Marriott International guarantees the Company's performance in connection with certain loans and other obligations; (iv) the Company can borrow up to $225 million for certain permitted uses under the New Line of Credit (see Note 8); (v) the Company has borrowed $109 million of first mortgage financing for construction of the Philadelphia Marriott Hotel (see Note 8); (vi) Marriott International provided the Company with $70 million of mortgage financing in 1995 for the acquisition of three full-service properties by the Company at an average interest rate of 8.5%; (vii) three of the Company's full-service properties are operated under franchise agreements with Marriott International with terms of 10 to 30 years; and (viii) Marriott International provides certain administrative services under transitional services agreements.\nIn 1995, 1994 and 1993, the Company paid to Marriott International $67 million, $41 million and $5 million, respectively, in lodging management fees; $21 million, $23 million and $5 million, respectively, in interest and commitment fees under the lines of credit with Marriott International, the Philadelphia Marriott Hotel mortgage and mortgages for three additional full- service properties; $12 million, $11 million and $3 million, respectively, under the various transitional service agreements; and earned $14 million and $5 million under the senior living community leases during 1994 and 1993. The Company also paid Marriott International $1 million of franchise fees in 1995.\nAdditionally, Marriott International has the right to purchase up to 20% of the voting stock of the Company if certain events involving a change in control of the Company occur.\nIn 1995, the Company also acquired a full-service property from a partnership in which Marriott International owned a 50% interest.\n16. MANAGEMENT AGREEMENTS\nThe Company is party to management agreements (the \"Agreements\") which provide for Marriott International to manage most of the Company's hotels generally for an initial term of 15 to 20 years with renewal terms at the option of Marriott International of up to an additional 16 to 30 years. The Agreements generally provide for payment of base management fees equal to one- and-one-half to four percent of sales and incentive management fees generally equal to 40% to 50% of Operating Profit (as defined in the Agreements) over a priority return (as defined) to the Company, with total incentive management fees not to exceed 20% of cumulative Operating Profit. For certain full- service hotels acquired after September 8, 1995, the incentive management fee is equal to 20% of Operating Profits. In the event of early termination of the Agreements, Marriott International will receive additional fees based on the unexpired term and expected future base and incentive management fees. The Company has the option to terminate certain management agreements if specified performance thresholds are not satisfied. No Agreement with respect to a single lodging facility is cross-collateralized or cross-defaulted to any other Agreement and a single Agreement may be cancelled under certain conditions, although such cancellation will not trigger the cancellation of any other Agreement.\nThe limited-service properties are subject to the terms of a \"Consolidation Agreement\" pursuant to which (i) certain fees payable under the management agreement with respect to a particular lodging property will be determined on a consolidated basis with certain fees payable under the Agreements for all lodging properties of the same type, and (ii) until December 31, 2000, certain base fees payable under the management agreement with respect to a particular lodging property will be waived in return for payment upon the sale or certain financings of such properties. After any lodging property is sold or financed, the Consolidation Agreement will no longer be applicable to such property. The Agreements with respect to the Company's full-service hotels are not subject to the Consolidation Agreement and the management fees payable to Marriott International under a single Agreement are calculated solely with respect to the lodging facility managed thereunder.\nHOST MARRIOTT CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nPursuant to the terms of the Agreements, Marriott International is required to furnish the hotels with certain services (\"Chain Services\") which are generally provided on a central or regional basis to all hotels in the Marriott International hotel system. Chain Services include central training, advertising and promotion, a national reservation system, computerized payroll and accounting services, and such additional services as needed which may be more efficiently performed on a centralized basis. Costs and expenses incurred in providing such services are allocated among all domestic hotels managed, owned or leased by Marriott International or its subsidiaries. In addition, the full-service hotels also participate in Marriott's Honored Guest Awards Program and the Courtyard hotels in the Courtyard Club. The costs of these programs are charged to all hotels in the respective hotel system.\nThe Company is obligated to provide the manager with sufficient funds to cover the cost of (a) certain non-routine repairs and maintenance to the hotels which are normally capitalized; and (b) replacements and renewals to the hotels' property and improvements. Under certain circumstances, the Company will be required to establish escrow accounts for such purposes under terms outlined in the Agreements.\nAt December 29, 1995 and December 30, 1994, $65 million and $52 million, respectively, have been advanced to the hotel managers for working capital and are included in \"Due From Hotel Managers\" in the accompanying balance sheet.\n17. LITIGATION\nIn March 1993, the Company reached agreement in principle (the \"Class Action Settlement\") with certain holders and recent purchasers of the Company's Old Notes, who had either instituted or threatened litigation in response to the Marriott International Distribution. In August 1993, the United States District Court approved the Class Action Settlement. In connection with this settlement, the Company issued warrants in 1994 to purchase up to 7.7 million shares of Host Marriott common stock (see Note 10).\nA group of bondholders (the \"PPM Group\"), purported to have at one time owned approximately $120 million of Senior Notes, and another group purporting to hold approximately $7.5 million of Senior Notes, opted out of the Class Action Settlement. The PPM Group alleged that laws had been violated in connection with the sale by the Company of certain series of its Senior Notes and debentures and claimed damages of approximately $30 million. The group purporting to hold $7.5 million of Senior Notes settled with the Company in April 1994. Under the terms of the settlement, the Company repurchased the Senior Notes at their par value in the second quarter of 1994.\nIn September 1994, the Company settled with certain members of the PPM Group whose claims represented about 40% of the PPM Group's aggregate claims. The claims of the remainder of the PPM Group went to trial in September 1994, and in October 1994, the judge declared a mistrial based on the inability of the jury to reach a verdict. In January 1995, the judge granted the Company's motion for judgment in its favor on the PPM Group's claims as a matter of law. An appeal was filed by the PPM Group in February 1995. The appeal was argued in February 1996. In early 1996, the Company reached an agreement to settle all claims relating to this litigation for an immaterial amount.\nThe Company is from time to time the subject of, or involved in, judicial proceedings. Management believes that any liability or loss resulting from such matters will not have a material adverse effect on the financial position or results of operations of the Company.\nHOST MARRIOTT CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\n18. HOTEL OPERATIONS\nAs discussed in Note 1, subsequent to the Marriott International Distribution, hotel revenues reflect house profit from the Company's hotel properties. House profit reflects the net revenues flowing to the Company as property owner and represents all gross hotel operating revenues, less all gross property-level expenses, excluding depreciation, management fees, real and personal property taxes, ground and equipment rent, insurance and certain other costs, which are classified as operating costs and expenses. Prior to the Marriott International Distribution, hotel revenues included room sales and food and beverage sales at hotel properties. Accordingly, the following table presents the details of the Company's house profit for 1995, 1994 and 1993. In 1993, the Company's hotel revenues presented in the accompanying Statement of Operations represent the Company's post-Marriott International Distribution house profit (revenues) for 1993 plus the pre-Marriott International Distribution gross hotel sales for 1993.\n19. QUARTERLY FINANCIAL DATA (UNAUDITED)\nHOST MARRIOTT CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nThe first three quarters consist of 12 weeks each, and the fourth quarter includes 16 weeks.\nThe quarterly financial data has been restated to reflect the results of the Operating Group as discontinued operations.\nSecond quarter 1995 results include a $10 million pre-tax charge to write down the carrying value of five individual Courtyard and Residence Inn properties to their net realizable values (see Note 4). Fourth quarter 1995 results include a $60 million pre-tax charge to write down an undeveloped land parcel to its estimated sales value (see Note 4). The fourth quarter 1995 net loss includes a pre-tax charge of $47 million for the adoption of SFAS No. 121 (see Note 1) and a pre-tax $15 million restructuring charge, both of which were related to HM Services and have been included in discontinued operations in the accompanying 1995 statement of operations. Second and fourth quarter 1995 results include extraordinary after-tax losses of $17 million and $3 million, respectively, on the extinguishment of debt (see Note 8).\nThird and fourth quarter 1994 results each include extraordinary after-tax losses of $3 million on the extinguishment of debt. In the second quarter of 1994, the Company reduced its general liability and workers' compensation insurance reserves by $4 million due to favorable claims experience.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nThe information called for by Items 10--13 is incorporated by reference from the Host Marriott Corporation 1996 Annual Meeting of the Shareholders--Notice and Proxy Statement--(to be filed pursuant to Regulation 14A not later than 120 days after the close of fiscal year).\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\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) LIST OF DOCUMENTS FILED AS PART OF THIS REPORT\n(1) FINANCIAL STATEMENTS\nAll financial statements of the registrant as set forth under Item 8 of this Report on Form 10-K.\n(2) FINANCIAL STATEMENT SCHEDULES\nThe following financial information is filed herewith on the pages indicated.\nFinancial Schedules:\nAll 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\n- -------- #Agreement filed is illustrative of numerous other agreements to which the Company is a party.\n(b) REPORTS ON FORM 8-K\n. September 28, 1995--Report of the announcement that Robert E. Parsons has been named Executive Vice President and Chief Financial Officer, replacing Matthew J. Hart, and Scott A. LaPorta has been named Senior Vice President and Treasurer.\n. November 3, 1995--Report of the announcement that the Company acquired the Toronto Eaton Centre Marriott.\n. November 6, 1995--Amendment to Current Report on Form 8-K dated August 22, 1995 by filing financial statements of the Dallas\/Fort Worth Airport Hotel and pro forma financial information of the Company.\n. December 22, 1995--Report of the announcement that the Company acquired the New York Vista Hotel.\n. December 29, 1995--Report of the announcement that (i) the Company completed the Special Dividend of its Operating Group to its shareholders; (ii) the Company adopted SFAS 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of\"; (iii) Host Marriott Services Corporation recorded a restructuring charge in the fourth quarter of 1995; and (iv) the Company filed financial statements to reflect Host Marriott Services Corporation as discontinued operations.\n. January 11, 1996--Report of the announcement that the Company (i) has reached agreements to acquire controlling interests in the San Diego Marriott Hotel and Marina, two hotels in Mexico City and the Pittsburgh Hyatt, and to purchase the Delta Meadowvale Hotel and Conference Centre in Toronto, Canada; (ii) has recorded a charge in the fourth quarter of 1995 to reduce an undeveloped land site to its estimated sale value; (iii) filed a registration statement with the Securities and Exchange Commission for the public offering of 25 million shares of the Company's common stock; and (iv) has filed pro forma financial information of the Company.\n. January 17, 1996--Amendment to Current Report on Form 8-K dated November 3, 1995 and December 22, 1995 by filing financial statements of the Toronto Eaton Centre Marriott and the New York Vista Hotel.\n. February 28, 1996--Report of the announcement that the Company filed amendment no. 1 to a registration statement with the Securities and Exchange Commission for the public offering of 25 million shares of the Company's common stock. The Company filed the amended registration statement as an exhibit.\n. March 7, 1996--Amendment to Current Report on Form 8-K\/A dated January 17, 1996 by filing updated financial statements of the New York Vista.\n(d) OTHER INFORMATION\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, IN THE CITY OF BETHESDA, STATE OF MARYLAND, ON MARCH 28, 1996.\nHost Marriot Corporation\n\/s\/ Robert E. Parsons, Jr. By __________________________________ Robert E. Parsons, Jr. Executive Vice President and Chief Financial 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.\nSCHEDULE 1 PAGE 1 OF 5\nHOST MARRIOTT CORPORATION\nCONDENSED FINANCIAL INFORMATION OF REGISTRANT\nCONDENSED BALANCE SHEETS\n- -------- The Notes to Consolidated Financial Statements of Host Marriott Corporation and Subsidiaries are an integral part of these statements.\nSee Accompanying Notes to Condensed Financial Information.\nS-1\nSCHEDULE I PAGE 2 OF 5\nHOST MARRIOTT CORPORATION\nCONDENSED FINANCIAL INFORMATION OF REGISTRANT\nCONDENSED STATEMENTS OF OPERATIONS\nFISCAL YEARS ENDED DECEMBER 29, 1995, DECEMBER 30, 1994 AND DECEMBER 31, 1993\n- -------- The Notes to Consolidated Financial Statements of Host Marriott Corporation and Subsidiaries are an integral part of these statements.\nSee Accompanying Notes to Condensed Financial Information.\nS-2\nSCHEDULE I PAGE 3 OF 5\nHOST MARRIOTT CORPORATION\nCONDENSED FINANCIAL INFORMATION OF REGISTRANT\nCONDENSED STATEMENTS OF CASH FLOWS\nFISCAL YEARS ENDED DECEMBER 29, 1995, DECEMBER 30, 1994 AND DECEMBER 31, 1993\n- -------- The Notes to Consolidated Financial Statements of Host Marriott Corporation and Subsidiaries are an integral part of these statements.\nSee Accompanying Notes to Condensed Financial Information.\nS-3\nSCHEDULE I PAGE 4 OF 5\nHOST MARRIOTT CORPORATION\nCONDENSED FINANCIAL INFORMATION OF REGISTRANT\nNOTES TO CONDENSED FINANCIAL INFORMATION\nA) The accompanying condensed financial information of Host Marriott Corporation (the \"Parent Company\") present the financial position, results of operations and cash flows of the Parent Company with the investment in, and operations of, consolidated subsidiaries with restricted net assets on the equity method of accounting.\nIn May 1995, HMH Properties, Inc. (\"Properties\"), an indirect, wholly- owned subsidiary of the Parent Company, issued $600 million of 9.5% senior notes at par value with a final maturity of May 2005 (the \"Properties Notes\"). The Properties Notes are secured by a pledge of the stock of certain of their respective subsidiaries and are guaranteed, jointly and severally, by all of Properties' subsidiaries. The indenture governing the Properties Notes contains covenants that, among other things, limit the ability of Properties and its subsidiaries to incur additional indebtedness and issue preferred stock, pay dividends or make other distributions, repurchase capital stock or subordinated indebtedness, create liens, enter into certain transactions with affiliates, sell certain assets, issue or sell stock of Properties subsidiaries and enter into certain mergers and consolidations. The net assets of Properties at December 29, 1995 were approximately $380 million, substantially all of which were restricted.\nIn December 1995, HMC Acquisition Properties, Inc. (\"Acquisitions\"), an indirect, wholly-owned subsidiary of the Parent Company, issued $350 million of 9% senior notes (the \"Acquisition Notes\") at par value with a final maturity of December 2007. The Acquisition Notes are guaranteed by Acquisitions' subsidiary. The indenture governing the Acquisition Notes contains covenants that, among other things, limit the ability of Acquisitions and its subsidiary to incur additional indebtedness and issue preferred stock, pay dividends or make other distributions, repurchase capital stock or subordinated indebtedness, create liens, enter into certain transactions with affiliates, sell certain assets, issue or sell stock of Acquisitions' subsidiary and enter into certain mergers and consolidations. The net assets of Acquisitions at December 29, 1995 were approximately $225 million, substantially all of which were restricted.\nOn October 8, 1993 (the \"Marriott International Distribution Date\"), the Parent Company distributed, through a special tax-free dividend (the \"Marriott International Distribution\") to holders of its common stock (on a share-for-share basis) all outstanding shares of common stock of an existing wholly-owned subsidiary, Marriott International, Inc. (\"Marriott International\"). In connection with the Marriott International Distribution, the Parent Company completed an exchange offer (\"Exchange Offer\") pursuant to which holders of senior notes in an aggregate principal amount of approximately $1.2 billion (\"Old Notes\") exchanged such Old Notes for a combination of (i) cash, (ii) common stock and (iii) new senior notes (\"Hospitality Notes\") issued by Host Marriott Hospitality, Inc. (\"Hospitality\"), a wholly-owned subsidiary of HMH Holdings, Inc. (\"Holdings\"), which is a wholly-owned subsidiary of the Parent Company. The Hospitality Notes were redeemed in the second quarter of 1995 partially with the net proceeds from the Properties Notes. The indenture governing the Hospitality Notes contained covenants that, among other things, limited the ability of Hospitality and its subsidiaries to incur additional indebtedness, pay dividends or make other distributions, create liens, enter into certain transactions with affiliates, sell certain assets and limit the activities of Holdings. Substantially all of Hospitality's net assets were restricted. Holdings' primary asset was the capital stock of Hospitality and was the borrower of a $630 million line of credit with Marriott International which was terminated during 1995. During 1995, Holdings was liquidated and merged upstream into Host Marriott.\nS-4\nSCHEDULE I PAGE 5 OF 5\nHOST MARRIOTT CORPORATION\nCONDENSED FINANCIAL INFORMATION OF REGISTRANT\nNOTES TO CONDENSED FINANCIAL STATEMENTS--(CONTINUED)\nProperties, Acquisitions and Holdings are restricted subsidiaries of the Parent Company (the \"Restricted Subsidiaries\") and are accounted for under the equity method of accounting on the accompanying condensed financial information of the Parent Company.\nB) Under the terms of the Exchange Offer, the Parent Company secured the Old Series I Notes with a principal balance of $87 million equally and ratably with the Hospitality Notes issued in the Exchange Offer. The Old Series I Notes were repaid upon its maturity in May 1995. Investment in and advances to restricted subsidiaries include $87 million at December 30, 1994, which were pushed down to Hospitality prior to its repayment.\nIn fiscal year 1993, for the period from the beginning of the year through October 8, 1993, Hospitality's financial statements reflect the pushed-down effects of 100% of that portion of the Old Notes that would have been replaced with the Hospitality Notes had the Company received tenders for 100% of the aggregate amount of Old Notes that were subject to the Exchange Offer.\nInterest expense related to the pushed-down debt discussed above of $4 million in 1995, $8 million in 1994 and $63 million in 1993 is included in interest expense in the accompanying condensed statements of income.\nC) In 1995, Properties paid $36 million of cash dividends to the Parent Company as permitted under its indenture agreement. There were no cash dividends paid to the Parent Company in 1994 and 1993.\nD)Aggregate debt maturities at December 29, 1995, excluding capital lease obligations, are (in millions):\nE) The accompanying statements of income reflect the equity in earnings of Restricted Subsidiaries, including Hospitality, after elimination of interest expense (see Note B) and before income taxes. The Restricted Subsidiaries are included in the consolidated income tax returns of Host Marriott Corporation.\nF) As more fully described in Note 2 to the Company's consolidated financial statements, the Company completed a special dividend to shareholders on December 29, 1995 of its operating group (\"Operating Group\") which comprised its food, beverage and merchandise concessions business. The accompanying condensed financial information has been restated to reflect the Operating Group as discontinued operations.\nS-5\nSCHEDULE III PAGE 1 OF 2\nHOST MARRIOTT CORPORATION AND SUBSIDIARIES\nREAL ESTATE AND ACCUMULATED DEPRECIATION\nDECEMBER 29, 1995 (IN MILLIONS)\nS-6\nSCHEDULE III PAGE 2 OF 2\nHOST MARRIOTT CORPORATION AND SUBSIDIARIES\nREAL ESTATE AND ACCUMULATED DEPRECIATION\nDECEMBER 29, 1995 (IN MILLIONS)\nNOTES:\n(A) The change in total cost of properties for the fiscal years ended December 29, 1995 and December 30, 1994 is as follows:\n(C) The aggregate cost of properties for Federal income tax purposes is approximately $3,075 million at December 29, 1995.\n(D)The total cost of properties excludes construction-in-progress properties.\nS-7\nPRO FORMA CONDENSED CONSOLIDATED FINANCIAL DATA\nThe unaudited Pro Forma Condensed Consolidated Statement of Operations of the Company reflect the following transactions for the fiscal year ended December 29, 1995, as if such transactions had been completed at the beginning of the year:\n.1996 acquisition of a controlling interest in the San Diego Marriott Hotel and Marina .1996 acquisition of the Toronto Delta Meadowvale .1996 acquisition of an 83% interest in the mortgage loans secured by the Newport Beach Marriott Suites .Consummation of the Pending Acquisitions .Consummation of the Pending Dispositions .1995 acquisition of eight full-service hotel properties (see discussion below) .1995 sale\/leaseback of 37 Courtyard properties .1995 sale of the Company's remaining four Fairfield Inns .May 1995 Debt Offering .December 1995 Debt Offering\nThe unaudited Pro Forma Condensed Consolidated Balance Sheet of the Company reflects the first quarter 1996 acquisition of a controlling interest in the San Diego Marriott Hotel and Marina, the first quarter 1996 acquisition of the Toronto Delta Meadowvale, the first quarter 1996 purchase of an 83% interest in the mortgage loans secured by the Newport Beach Marriott Suites, the consummation of the Pending Acquisitions and the Pending Dispositions, as if such transactions had been completed on December 29, 1995.\nDuring the first quarter of 1996, the Company acquired the Toronto Delta Meadowvale, a controlling interest in the San Diego Marriott Hotel and Marina and an 83% interest in the mortgage loans secured by the Newport Beach Marriott Suites. In February 1996, the Company entered into an agreement with the REIT to sell and lease back 16 Courtyard properties and 18 Residence Inns, the Pending Dispositions.\nThe Company has also entered into agreements to purchase two full-service hotel properties and a controlling interest in one full-service hotel property. These transactions comprise the Pending Acquisitions.\nDuring 1995, the Company acquired nine full-service hotel properties. The accompanying Unaudited Pro Forma Condensed Consolidated Statement of Operations does not reflect any pro forma adjustments related to the New York Vista Hotel (renamed the Marriott World Trade Center) due to the suspension of hotel operations and the renovation of the hotel as a result of extensive damage from an explosion on February 26, 1993. Because the hotel did not resume full operations until mid-1995, the historical operations of the hotel during the periods presented are not meaningful.\nDuring 1995, 37 of the Courtyard properties were sold to and leased back from the REIT, and the Company sold its four remaining Fairfield Inns.\nHMH Properties, Inc. (\"HMH Properties\"), an indirect wholly-owned subsidiary of the Company, issued $600 million of debt (the \"Properties Notes\") in May 1995 (the \"May 1995 Debt Offering\"). The Properties Notes were issued at par and carry a 9.5% interest rate with a final maturity of May 2005. The net proceeds to the Company were used to defease, and subsequently redeem, bonds which carried a weighted average interest rate of 10.4%, and to pay down a portion of the line of credit with Marriott International. Additionally, the Company replaced its $630 million line of credit with Marriott International with the New Line of Credit.\nIn December 1995, HMC Acquisition Properties, Inc. (\"Acquisitions\"), an indirect, wholly-owned subsidiary of the Company, issued $350 million of 9% senior notes (the \"Acquisitions Notes\") to several initial purchasers (the \"December 1995 Debt Offering\"). The Acquisitions Notes were issued at par and have a final maturity of December 2007. The proceeds were utilized to repay in full the $210 million of outstanding borrowings under, and terminate, Acquisitions' $230 million revolving credit facility (the \"Revolver\"), to acquire one full-service hotel in the fourth quarter of 1995, the Toronto Delta Meadowvale in the first quarter of 1996 and to finance future acquisitions of full-service hotel properties, including one of the Pending Acquisitions.\nS-8\nDuring 1995, the Company sold the 199-room Springfield Radisson Hotel which was acquired as part of a portfolio of lodging properties by the Company in 1994. No adjustment has been reflected in the accompanying Pro Forma Condensed Consolidated Statement of Operations due to the immateriality of the operating results for this property.\nThe \"Historical\" column in the accompanying Pro Forma Condensed Consolidated Statement of Operations excludes the results of the Operating Group, which are considered discontinued operations.\nThe Pro Forma Condensed Consolidated Financial Data of the Company are unaudited and presented for informational purposes only and may not reflect the Company's future results of operations and financial position or what the results of operations and financial position of the Company would have been had such transactions occurred as of the dates indicated. The unaudited Pro Forma Condensed Consolidated Financial Data and Notes thereto should be read in conjunction with the Company's Consolidated Financial Statements and Notes thereto and \"Management's Discussion and Analysis of Results of Operations and Financial Condition\" included elsewhere herein.\nS-9\nHOST MARRIOTT CORPORATION\nUNAUDITED PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET\n(IN MILLIONS)\nSee Notes to Unaudited Pro Forma Condensed Consolidated Financial Data.\nS-10\nHOST MARRIOTT CORPORATION\nUNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS\n(IN MILLIONS, EXCEPT PER SHARE AMOUNTS)\nSee Notes to Unaudited Pro Forma Condensed Consolidated Financial Data.\nS-11\nNOTES TO UNAUDITED PRO FORMA CONDENSED CONSOLIDATED\nFINANCIAL DATA\nA. Represents the adjustment to record the 1996 acquisition of the San Diego Marriott Hotel and Marina, the Toronto Delta Meadowvale and an 83% interest in the mortgage loans secured by the Newport Beach Marriott Suites as follows:\n. Record property and equipment of $245 million . Record the purchase of a mortgage loan securing one full-service property for $18 million . Record the mortgage debt of $206 million for one full-service property . Record the use of cash of $54 million for the acquisition cost . Record the elimination of the prior investment of $12 million in a partnership . Record the property improvement and debt service escrow funds of $9 million for one full-service property\nB. Represents the adjustment to record the Pending Acquisitions as follows:\n. Record property and equipment of $69 million . Record the use of cash of $68 million for the acquisition cost . Record the minority interest of $1 million for the partner of the joint venture acquiring one full- service property\nC. Represents the adjustment to record the Pending Dispositions as follows:\n. Reduce property and equipment by the net book value of assets sold of $302 million . Record the net cash proceeds of $308 million . Record the deferred proceeds of $35 million . Record the deferred gain of $41 million\nD. Represents the adjustment to eliminate the revenues and the operating costs for the 1995 sale of the four remaining Fairfield Inns.\nE. Represents the adjustment to reflect the incremental increase in revenue, operating costs and secured debt interest expense for the 1995 addition of eight full-service properties, as if they were added at the beginning of the fiscal year. On February 26, 1993, an explosion caused damage to the structure and interior of the New York Vista Hotel, as well as the adjoining World Trade Center complex. As a result of the damage, all hotel operations were suspended and the hotel underwent extensive renovation. Because the hotel did not resume full operations until mid-1995, the historical operations of the hotel during the periods presented are not meaningful and the accompanying Unaudited Pro Forma Condensed Consolidated Statement of Operations does not reflect any adjustments related to the hotel.\nF. Represents the adjustment to record the revenue and operating costs for the Pending Acquisitions, including depreciation expense reflecting the Company's basis in the assets and the incremental management fees as a result of the new management agreements that will be entered into in conjunction with the transactions.\nG. Represents the adjustment to record the revenue, operating costs, secured debt interest expense and interest income for the first quarter 1996 acquisition of the Toronto Delta Meadowvale, the acquisition of a controlling interest in the San Diego Marriott Hotel and Marina, and the purchase of an 83% interest in the mortgage loans secured by the Newport Beach Marriott Suites.\nH. Represents the net adjustment to eliminate the depreciation expense and record the incremental lease expense for the 1995 sale\/leaseback of the 37 Courtyard properties.\nI. Represents the net adjustment to eliminate depreciation expense and record the incremental lease expense for the Pending Dispositions.\nS-12\nNOTES TO UNAUDITED PRO FORMA CONDENSED CONSOLIDATED--(CONTINUED)\nFINANCIAL DATA\nJ. Represents the adjustment to reduce interest expense for the redemption of senior notes of Host Marriott Hospitality, Inc. (the \"Hospitality Notes\") with the net sales proceeds from the 26 Fairfield Inns, 14 senior living communities and 21 Courtyard properties.\nK. Represents the adjustment to reduce interest expense to reflect the decrease in interest rates as a result of the issuance of the Properties Notes and the decrease in commitment fees as a result of the New Line of Credit. Extraordinary losses of approximately $17 million, after taxes, related to the 1995 redemption of certain of the Hospitality Notes are not reflected in the accompanying Unaudited Pro Forma Condensed Consolidated Statement of Operations.\nL. Represents the adjustment to interest expense to eliminate the interest expense and related amortization of deferred financing fees for the Revolver, and to record the interest expense and related amortization of deferred financing fees as a result of the issuance of the Acquisitions Notes.\nM. Represents the income tax impact of pro forma adjustments at statutory rates.\nS-13","section_15":""}
{"filename":"31364_1995.txt","cik":"31364","year":"1995","section_1":"Item 1. Business General\nEckerd Corporation (the \"Company\" or \"Eckerd\") operates the Eckerd Drug store chain, which is one of the largest drug store chains in the United States. At January 28, 1995, the Eckerd Drug store chain consisted of 1,735 stores in 13 states located primarily in the Sunbelt, including 553 stores in Florida and 490 stores in Texas. Over its 42-year history, the Eckerd Drug store chain has built a strong market position in areas where demographic characteristics are favorable to drug store growth. The Company's stores are concentrated in 10 of the 12 metropolitan statistical areas with the largest percentage growth in population from 1980 to 1990, and, according to industry sources, the Company ranks first or second in terms of drug store sales in 12 of the 14 major metropolitan markets in which it operates. The primary focus of Eckerd Drug stores is the sale of prescription and over-the-counter drugs, which, during fiscal 1994, generated approximately 61% of the Company's drug store sales. Another significant focus of Eckerd Drug stores is photofinishing. The Company offers overnight photofinishing services in all Eckerd Drug stores and operates Eckerd Express Photo centers, which are one-hour photofinishing mini-labs. Eckerd Express Photo centers were located in 481 Eckerd Drug stores at January 28, 1995.\nThe Company was formed in 1985 by Merrill Lynch Capital Partners, Inc. (\"Merrill Lynch Capital Partners\"), an affiliate of Merrill Lynch & Co., Inc. (\"ML & Co.\"), for the purpose of acquiring the former Jack Eckerd Corporation (\"Old Eckerd\"), in April 1986 (the \"Acquisition\"). Merrill Lynch Capital Partners formed EDS Holdings Inc. (\"EDS\") and its wholly owned subsidiary, Eckerd Holdings II, Inc. (\"EH II\"), to acquire certain additional drug stores in July 1990. On August 12, 1993, the Company completed an initial public offering (the \"IPO\") in which it issued and sold 5,175,000 shares of Common Stock for $14.00 per share. In connection with the consummation of the IPO, the holders of EDS common stock exchanged their shares for shares of Common Stock. Immediately thereafter, EDS was merged into Eckerd with EH II becoming a wholly owned subsidiary of Eckerd. All references in this Form 10-K405 to the \"Company\" for periods prior to such acquisition mean the Company, EDS and their respective subsidiaries. In connection with the IPO the Company also amended its Restated Certificate of Incorporation to effect, among other things, (i) the reclassification of its Class A common stock and Class B common stock into Common Stock at certain specified rates, (ii) a 2-for-3 reverse stock split (the \"Stock Split\"), (iii) the adoption of certain provisions such as a classified board of directors and the prohibition of stockholder action by written consent, which could make non-negotiated acquisitions of the Company more difficult and (iv) the change of the Company's name from \"Jack Eckerd Corporation\" to \"Eckerd Corporation.\" None of the Company's stockholders sold any shares of Common Stock in the IPO. On May 2, 1994, the company completed an underwritten secondary offering of 3,199,056 shares of Common Stock for $19.00 per share. The secondary offering only included shares of Common Stock owned by the Merrill Lynch Investors and certain institutional investors. Stockholders of the Company include (i) certain partnerships affiliated with Merrill Lynch Capital Partners and, (ii) certain other affiliates of ML & Co. ((i) and (ii), collectively, the \"Merrill Lynch Investors\") who beneficially owned 38.3% of the Common Stock of the Company as of March 31, 1995.\nThe Drug Store Industry\nPrescription and over-the-counter medications have traditionally been sold by independent drug stores as well as conventional drug store chains, such as Eckerd Drug stores, and purchased by consumers with cash or credit cards. The drug store industry has recently undergone significant changes as a result of the following important trends: (i) the increase in third-party payments for prescription drugs, (ii) the consolidation within the drug store industry, (iii) the aging of the United States population and (iv) the increase in competition from non-traditional retailers of prescription and over-the-counter drugs.\nDuring the last several years, a growing percentage of prescription drug volume throughout the industry has been accounted for by sales to customers who are covered by third-party payment programs (\"third-party sales\"). In a typical third-party sale, the drug store has a contract with a third-party payor, such as an insurance company, HMO, PPO, other managed care provider, government agency or private employer, which agrees to pay for part or all of the customer's eligible prescription purchases. Although these third-party sales contracts often provide a high volume of prescription sales, such sales typically generate lower gross margins than non third-party sales due principally to the highly competitive nature of this business and recent efforts by third-party payors to contain costs. Larger drug store chains, such as Eckerd Drug stores, are better able to service the growing third-party segment than independent drug stores and smaller chains as a result of the larger chains' more sophisticated technology systems, larger number of stores and greater penetration within their markets.\nAs a result of the economies of scale from which larger drug store chains benefit as well as the third-party payment trend, the number of independent drug stores and smaller drug store chains has decreased as many of such retailers have been acquired by larger drug store chains. This trend is expected to continue because larger chains are better positioned to handle the increased third-party sales, purchase inventory on more advantageous terms and achieve other economies of scale with respect to their marketing, advertising, distribution and other expenditures. The Company believes that the number of independent drug stores and smaller drug store chains remaining in operation may provide significant acquisition opportunities for larger drug store chains, such as the Company. Strong demographic trends have also contributed to changes in the drug store industry, as the group of persons over age 50 is the fastest growing segment of the United States population. This trend has had, and is expected to continue to have, a marked effect on the pharmacy business in the United States because consumer prescription and over-the-counter drug usage generally increases with age. The Company's markets have large concentrations of, and are continuing to experience significant growth in, the number of persons over age 65.\nIn 1994, drug store chains and independent drug stores represented approximately 37% and 31%, respectively, of all pharmacy sales in the United States. In response to a number of factors, including the aging of the United States population, mass merchants (including discounters and deep discounters), supermarkets, combination food and drug stores, mail order distributors, hospitals, HMO's and other managed care providers have entered the pharmacy industry. Supermarkets, including combination food and drug stores, and mass merchants each represented approximately 11% of all pharmacy sales in the United States in 1994. Although the Company currently faces increased competition from these retailers, industry studies show that consumers in the over 65 age group tend to make purchases at traditional drug stores, such as Eckerd Drug stores, and maintain strong store loyalty.\nEckerd Drug Stores\nIn 1992, the Company celebrated the 40th anniversary of the opening of the first Eckerd Drug store. The Company has grown to its present size and developed its leading position in the industry through both internal expansion and acquisitions. As of January 28, 1995, the Company operated the number of Eckerd Drug stores and Eckerd Express Photo centers indicated below in each of the following states:\nDrug Stores Eckerd With Eckerd Drug Express Photo Stores Centers\nFlorida 553 225 Texas 490 132 North Carolina 192 45 Georgia 164 44 Louisiana 110 17 South Carolina 82 13 Tennessee 35 1 New Jersey 27 1 Mississippi 26 - Oklahoma 26 - Alabama 18 3 Delaware 11 - Maryland 1 -\nTotal 1,735 481 Over the past five years, the Company has implemented several initiatives designed to increase the size, and improve the quality and operating performance, of the Company's store base. Among such initiatives are the opening and acquisition of new stores, the closure or divestiture of underperforming stores and an extensive remodeling program. Since 1986, 500 Eckerd Drug stores have been opened or acquired within the Company's existing markets, more than 300 underperforming stores have been closed or divested, and substantially all of the Company's remaining stores have been remodeled. In addition, the Company opened more than 450 Express Photo centers. The Company has also increased the degree to which merchandise is tailored to specific markets, instituted a chainwide shrinkage reduction program and made a significant investment in its management information systems. As a result of, among other things, these actions, aggregate sales have increased from $2.73 billion in fiscal 1987 to $4.55 billion in fiscal 1994.\nThe following table summarizes the number of Eckerd Drug stores operated by the Company and the sales on an aggregate and per store basis for the last five years.\n(1) Includes 96 stores acquired by, and managed on behalf of, EH II (two of which were closed in fiscal year 1991). Excludes 127 stores acquired by EH II that were liquidated or sold. (2) Includes 14 Eckerd Drug stores closed as a result of the acquisition of drug stores by EH II. (3) Excludes relocations.\nThe Company intends to continue to expand its business through both internal expansion and acquisitions of smaller drug store chains and independent drug stores. Although the Company currently plans to expand Eckerd Drug stores within the Company's existing markets, the Company also considers strategic acquisitions in other markets. The Company opened or acquired 55 drug stores, including relocations, in fiscal 1994 and has a goal of opening (including relocations) 90 drug stores in fiscal 1995 and 100 drug stores per year in fiscal 1996 through 1999. In addition to such openings and acquisitions, the Company expects to sell or close a small number of drug stores per year in fiscal 1995 and thereafter through 1999, which would be intended to improve the quality of the Company's store base. In the fourth quarter of fiscal 1994, the Company decided to accelerate the closing of approximately 90 geographically dispersed, under-performing stores over the next twelve to eighteen months, and established a $49.0 million reserve for future store closings. These closings are in addition to the small number of stores the Company closes in the normal course of business. The cash costs associated with opening a drug store are estimated to be approximately $490,000, which includes initial inventory costs of approximately $260,000. The Company intends to use cash flow from operations to finance the cash costs of this growth, although borrowings may also be available to finance such growth. See \"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources.\"\nIn determining the areas in which to open or acquire drug stores, the Company evaluates a number of demographic considerations, including the size, growth pattern and per capita income of the population, as well as the competitive environment and the accessibility of a proposed site to the customer and to the Company'swarehouse and distribution facilities. The Company also continually reviews these factors and the performance of individual stores in determining whether to close or relocate certain stores.\nProducts and Services Pharmacy\nThe primary focus of Eckerd Drug stores is the sale of prescription and over-the-counter drugs. During fiscal 1994, Eckerd Drug Stores filled more than 89 million prescriptions, and sales of prescription and over-the-counter drugs generated approximately 61% of the Company's drug store sales. During the period from fiscal 1990 to fiscal 1994, the dollar volume of sales of prescription drugs by the Company increased 62.8%.\nThe Company seeks to position pharmacists as health-care professionals who build relationships with their customers. Over the years, marketing and advertising campaigns have been focused on reinforcing the professionalism of the Company's pharmacists and positioning them as a key factor to high quality pharmacy service. The Company has also instituted several health-related programs such as health screenings, education and outreach programs, and customer relationship programs. The Company provides to prescription drug customers, the \"Rx Advisor,\" a personalized easy-to-read publication, for each new prescription, which advises the customer of the specific dosages, drug interactions and side effects of his or her new prescription medicine.\nEckerd Drug store pharmacy departments are modern, clean and clearly identified by attractive signs. The pharmacy areas in many of the Company's newer and remodeled stores provide a consultation area and a waiting area with comfortable seating, informational brochures and free blood pressure testing. The pharmacy areas are designed to be conducive to customer service and counseling by the pharmacists.\nThe Company has devoted substantial resources to marketing to third party payors, such as insurance companies, health maintenance organizations, preferred provider organizations and other managed care providers and government agencies. In addition, the Company's computer systems provide on-line adjudication which permits the Company and the third-party payor to determine electronically, at the time of sale, eligibility of the customer, coverage of the prescription and pricing and co-payment requirement, if any, and automatically bills the respective plan. On-line adjudication reduces losses from rejected claims and eliminates a portion of the Company's paperwork for billing and collection of receivables and costs associated therewith. During the past five years, the Company has reduced the average number of days that receivables from third-party sales were outstanding from 48 days in fiscal 1990 to 22 days in fiscal 1994 (or more than 50%) while increasing sales by 187% during the same period. Third-party prescription sales accounted for approximately 64.6%, 58.0%, 49.6%, 43.1% and 36.0% of the Company's prescription sales in fiscal 1994, fiscal 1993, fiscal 1992, fiscal 1991 and fiscal 1990, respectively.\nNonpharmacy Merchandise In addition to prescription and over-the-counter drugs, Eckerd Drug stores sell a wide variety of nonpharmacy merchandise, including health and beauty aids, greeting cards and numerous other convenience products. Eckerd-brand products, which are attractively priced and provide higher margins than similar national brand products, represent a growing segment of products offered by Eckerd Drug stores.\nHealth. Eckerd Drug stores offer a broad assortment of popular national brands as well as private label over-the-counter drugs and other products related to dental care, foot care, vitamins and nutritional supplements, feminine hygiene, family planning and baby care. Eckerd Drug stores provide a helpful environment in which consumers can obtain product information from professional pharmacists, knowledgeable sales associates and store managers or from literature available throughout the store.\nBeauty. Eckerd Drug stores offer an assortment of popular brand name cosmetics, fragrances and other beauty products. Management believes that Eckerd Drug stores provide the customer with a convenient format in which to purchase the lines of beauty products offered in its stores. Skin care products are an increasingly important component of the beauty category due to the aging population and growing concern about the effects of the environment on the skin. The Company has recently completed an expansion which devoted more shelf space to this product category.\nGreeting Cards. The greeting card department in Eckerd Drug stores offers a wide selection of contemporary and traditional cards, gift wrap, bows and novelties. The Company believes that the locations of its stores together with the wide selection offered by Eckerd Drug stores enable customers to satisfy their card and gift needs more conveniently than at traditional card stores. The Company has increased the space devoted to its greeting card department because of the profitability of such merchandise and because the Company believes that the demand for such merchandise will increase traffic in its stores.\nConvenience Products. This merchandise category consists of an assortment of items, including candy, food, tobacco products, books and magazines, household products, seasonal merchandise and toys. These items are carefully positioned to provide optimum convenience to the customer with easy access in the front part of the store. The Company also seeks to serve its customers' needs by specifically tailoring items in this category to meet the needs of its customers in specific store locations. This strategy includes the introduction and further expansion of the food mart section offering convenience food items such as staple grocery shelf items, staple and chilled beverages, snack foods and specialty items in approximately 550 locations. The Company plans to add food mart sections to an additional 400 stores in fiscal 1995. For example, souvenirs and select summer products are offered in beach and tourist locations while convenience food is stressed in urban areas and malls.\nPhotofinishing\nAnother significant focus of Eckerd Drug stores is photofinishing. The Company offers overnight photofinishing services in all Eckerd Drug stores and operates Eckerd Express Photo centers, which are one-hour photo processing mini-labs. Eckerd Express Photo centers were located in 481 Eckerd Drug stores at January 28, 1995.\nThe Company is among the top three vertically integrated retail photofinishers in the United States, and the Company believes that it is the leading source of photofinishing in all of the major markets in which it operates. The Company processed over 28 million rolls of film in fiscal 1994 in its own photo labs and has several well known branded processing programs, including System 2(R) (two prints for the price of one), Ultralab 35(R) (larger size, higher quality prints) and Express Print 60 (one-hour processing). The Company believes that its branded processing programs, which emphasize quality and service, have helped position the Company as a leader in photofinishing. The Company currently intends to continue to expand its one-hour photofinishing business, with a goal of adding approximately 270 new Express Photo centers by 1999. The Company's photo departments also offer camera and photo accessories, small electronics, batteries and audio and video tapes. The entire photo department, including photofinishing, represented approximately 9.2% of the Company's total drug store sales in fiscal 1994.\nStore Operations\nEckerd Drug stores are located and designed to maximize customer service and convenience and are situated in areas of high customer traffic, typically in neighborhood shopping centers with strong supermarket co-tenants or in strategically located free-standing stores. Eckerd Drug stores are designed to facilitate customer movement and feature well-stocked shelves, clearly identified aisles and well-lit interiors to maximize product visibility. Pharmacy departments are generally located near the back of the store to maximize customer exposure to the store. The stores are equipped with modern fixtures and equipment and most of them range in size from 8,200 to 10,800 square feet. About 85% of the floor space is selling area, with the remainder used for storeroom and office space.\nTo enhance productivity per square foot and maintain consistent merchandising, the Company utilizes centrally prepared formats for the display and stocking of products in the Company's stores, while continuing to allow some flexibility to store managers to modify the merchandise assortment based upon the Company's program of tailoring merchandise offerings to the markets in which the stores operate.\nThe typical Eckerd Drug store is open every day of the year except Christmas, with store hours geared to the needs of the specific markets. A select number of strategically located stores stay open until midnight or 24 hours a day.\nEckerd Drug stores are currently grouped under six operating regions located in or near Orlando and Deerfield Beach, Florida; Atlanta, Georgia; Charlotte, North Carolina; and Dallas and Houston, Texas. Each operating region is headed by a vice president who supervises the various districts comprising the region. Within each district, there are managers who are responsible for the drug stores in their districts and regularly visit their stores to assure quality of service and merchandising. District pharmacy managers supervise the pharmacy operations and district Express Photo managers supervise the Express Photo operations in the drug stores. Each drug store is individually supervised by a manager who receives training in the Company's merchandise offerings, customer service and management strategy.\nThe Company has implemented various initiatives designed to reduce shrinkage expense. These initiatives include training and awareness programs, tailored audit programs for district managers, hiring of internal auditors and loss prevention specialists, and computerized exception reporting for, among other things, customer refunds, voids and cash overages and shortages from daily register check-outs. Purchasing and Distribution\nMerchandising and buying are generally, as are all supplier payments, centralized at Company headquarters to assure consistency of marketing approach and efficiency in supplier relations. The Company has implemented an enhanced electronic buying system to improve inventory management and gross profit by enabling the Company to take better advantage of quantity discounts and forward buying opportunities, which the Company believes will lower the average cost of inventory. Additionally, it is anticipated that this buying system and its improved forecasting ability will improve service levels to the stores and will reduce average inventory required in the Company's distribution centers.\nApproximately 85% of store merchandise is purchased centrally and distributed, principally by Company-operated trucks, through the Company's five centrally located distribution facilities located in or near Orlando, Florida; Atlanta, Georgia; Charlotte, North Carolina; and Dallas and Houston, Texas. The remainder of store merchandise is distributed directly to the stores, some of which is purchased at the store level.\nAdvertising and Marketing\nA combination of newspaper advertising and TV and radio spot commercials is carried on throughout the year to promote sales. During the fiscal year ended January 28, 1995, these net advertising expenses totaled approximately 0.5% of Company sales. The Company's concentration of stores within its markets enables it to achieve economies of scale in its advertising and marketing expenditures and also enables the Company to negotiate favorable rates for advertising time and print production. From the time of the Acquisition through fiscal 1994, the Company reduced its net advertising expense as a percentage of sales by more than 70%. In addition, the Company has derived additional cost savings through a rationalization of its advertising expenditures. Certain advertising expenditures related to the Company's overall corporate image have been reduced in favor of advertising efforts such as newspaper circulars. This change in advertising strategy has resulted in increased financial support from the Company's vendors and a more direct impact on sales. The Company believes that its current level of advertising expenditures is appropriate to support its existing marketing strategies.\nThe Company's communications and marketing programs are based upon an ongoing commitment to consumer research. Through regular telephone surveys in all major markets, exit interviews in its stores, and studies of various consumer groups, the Company is able to monitor changes in customer attitudes and shopping habits and adjust its marketing strategies accordingly.\nInformation and Technology The Company intends to continue to invest in information systems to improve customer service, reduce operating costs, provide information needed to support management decisions and enhance the Company's competitive position with third-party payors. The Company's Comp-U-Care System, installed in each pharmacy location, provides support for the pharmacy and assists pharmacists in their prescription processing activities, which in turn enhances the pharmacy's ability to service customers. The system's transfer of information between headquarters and each of the in-store pharmacy terminals allows central monitoring of prescription sales activity by store and item, centralized billing of third-party sales and daily updates to the stores' data files. The Comp-U-Care System performs on-line adjudication of customer and claim eligibility and reimbursement for the majority of the third-party payment plans in which the Company participates. On-line adjudication reduces losses from rejected claims and eliminates a portion of the Company's paperwork for billing and collection of receivables and costs associated therewith. The Company believes that such systems are essential to service the increasing volume of third-party sales.\nThe Company is currently developing its advanced Comp-U-Care 2000 System, which is scheduled to be introduced in Eckerd Drug stores in fiscal 1995. The Comp-U-Care 2000 System will improve speed and productivity in the pharmacy; decrease customer wait time; enhance functionality, including expanded drug utilization reviews; and will ultimately in fiscal 1996 permit the transfer of information directly from one drug store to another enabling customers to fill and refill prescriptions at any Eckerd Drug store.\nDuring fiscal 1994 the Company installed a satellite communications network, enhanced the point-of-sale (\"POS\") system and upgraded the merchandise buying system.\nThe Company currently has POS product scanning equipment in approximately 530 stores and expects to expand scanning to approximately 590 additional stores by the end of fiscal 1995. The Company has been expanding scanning to its higher volume stores and the over 1,100 stores installed by the end of fiscal 1995 will represent approximately 75% of front-end sales. Scanning systems will provide more and better merchant and store level information to facilitate inventory management, automatic re-ordering, product sales and gross profit analysis and inventory shrinkage control. The Company believes that broader use of scanning throughout the chain will improve customer service by decreasing customer check-out time and improving adherence to advertised sale or promotional prices.\nThe Company is expanding its use of electronic data interchange (\"EDI\") systems with certain of its major suppliers. EDI allows for the paperless ordering of products with immediate confirmation from the vendor on price, delivery terms and amount of goods ordered. The Company is also experimenting with automatic replenishment buying in connection with its warehouse and distribution systems, which includes the computer generation of purchase orders for certain vendors. These systems should also allow the Company to reduce lead time on orders and improve cash flow by reducing the amount of inventory required to be kept on hand. EDI will be expanded as the Company expands its scanning system.\nThe Company is also developing or purchasing software with applications in the human resources area to improve personnel scheduling; to expand the merchandise and store information data base systems to enable the Company to more efficiently manage its business; and to start the initial roll out of the warehouse management system to provide improved control and management of inventory and personnel.\nIn 1993, the Company and Integrated Systems Solutions Corporation (\"ISSC\"), a wholly-owned subsidiary of IBM, entered into a Systems Operations Service Agreement pursuant to which the Company and ISSC are developing a state of the art information systems operation to include pharmacy and POS systems for the Company's drug stores. Under the Company's supervision, ISSC manages the entire information systems operation and is responsible for providing technology services to the Company. The Systems Operations Services Agreement has a 10-year term, and the total payments to be made by the Company thereunder are currently expected to be between $400.0 million and $440.0 million over such term, depending on optional services utilized. The Company believes that this arrangement has and will continue to enable the Company to further improve customer service, replace the Company's existing systems, reduce operating costs and capital expenditures for hardware, obtain information needed to support management decisions on an improved basis and increase the Company's focus on its core business.\nCompetition\nThe Company's retail drug stores operate in a highly competitive industry. The Company's drug stores compete primarily on the basis of customer service, convenience of location and store design, price and product mix and selection.\nIn addition to traditional competition from independent drug stores and other drug store chains, the Company faces competition from mass merchants (including discounters and deep discounters), supermarkets, combination food and drug stores, mail order distributors, hospitals and HMOs. These other formats have experienced significant growth in their market share of the prescription and over-the-counter drug business.\nThe Company's Express Photo centers compete with a variety of photo processors including other mini-labs, retail stores and photo specialty stores. The Company's Express Photo business competes primarily on the basis of quality of processing, quality and speed of service and value.\nRegulation\nAll of the Company's pharmacists and stores are required to be licensed by the appropriate state boards of pharmacy. The Company's drug stores and distribution centers are also registered with the Federal Drug Enforcement Administration. Most of the stores sell beer and wine and are subject to various state and local liquor licensing requirements. By virtue of these license and registration requirements, the Company is obligated to observe certain rules and regulations, and a violation of such rules and regulations could result in a suspension or revocation of a license or registration.\nThe Company has a number of third-party payor contracts pursuant to which the Company is a provider of prescription drugs. \"Freedom of choice\" state statutes, pursuant to which all pharmacies would be entitled to be a provider under such a contract, have been enacted in certain states, including Alabama, Georgia, New Jersey, North Carolina, Louisiana, Tennessee and Texas, and may be enacted in others. Although such statutes may adversely affect certain of the Company's third-party contracts, they may also provide the Company with opportunities regarding additional third-party contracts.\nThe Clinton Administration has stated that health care reform is one of its priorities. A health care reform plan by President Clinton as well as a number of competing health care reform proposals were introduced in Congress, and some may be introduced again this year. The Company cannot predict whether any federal health care reform legislation will eventually be passed and, if so, the impact on the Company's financial position or results of operations.\nIn 1993, the State of Florida enacted health care legislation that is applicable to state employees, small businesses with fewer than 50 employees and Medicaid recipients. Such legislation, which began to be implemented in 1994, created 11 health care purchasing cooperatives, which accepted bids from groups of health care providers (which include certain of the Company's managed health care clients) to provide goods and services to the cooperatives members. The Company expects to provide prescription drugs to the cooperatives members through its existing managed health care clients. However, the Company is unable to predict whether its efforts will be successful or whether the Florida legislation will have an adverse impact on the Company's financial position or results of operations.\nOther Operations On March 31, 1994, the company closed on the sale of its Vision Group retail optical operations which was sold effective January 30, 1994 for an amount in cash and notes approximately equal to the book value of the related assets. In fiscal 1993, Vision Group sales were approximately $61 million and earnings before interest and taxes were approximately $3 million.\nOn November 15, 1994, the company closed on the sale of its Insta-Care Pharmacy Services (Insta-Care) institutional pharmacy services operations for a total consideration of $112 million in cash. The net proceeds after certain closing adjustments was approximately $94 million. In fiscal 1994, Insta-Care sales were approximately $89 million and earnings before interest and income taxes were approximately $3 million. The Company recognized a gain on the sale of Insta-Care of $49.5 million, net of income taxes of $4.6 million.\nEmployees As of January 28, 1995, the Company had approximately 42,700 employees, of which 22,200 were full-time employees. The Company believes that overall employee relations are good. None of the Company's employees are represented by unions.\nPatents, Trademarks and Tradenames\nNo patent, trademark, license, franchise or concession is considered to be of material importance to the business of the Company other than the trade names under which the Company operates its retail businesses, including the Eckerd name. The Company also holds servicemarks for its photofinishing products, private label products and information systems.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company conducts substantially all of its retail businesses from stores located in leased premises. Substantially all of these leases will expire within the next twenty-five years. In the normal course of business, however, it is expected that leases will be renewed or replaced by leases on other properties. Most of the Company's store leases provide for a fixed minimum rental together with a percentage rental based on sales.\nThe material office and distribution center properties owned or leased by the Company at January 28, 1995 are as follows:\nOwned or Location Square Feet Leased Largo, Florida 488,000 Owned(1) Charlotte, North Carolina 587,000 Owned Garland, Texas 270,000 Owned Conroe, Texas 345,000 Owned Orlando, Florida 321,000 Owned(2) Orlando, Florida 587,000 Leased(2) Newnan, Georgia 244,000 Owned(3) Hammond, Louisiana 185,000 Owned(3)(4)\n(1) Includes the Company headquarters. (2) In January, 1993 the Company assumed a lease for an office and distribution facility of approximately 587,000 square feet (lease expires 2005). The Company's existing Orlando facilities and the Largo distribution center facility were consolidated into the new facility during 1993. One of the owned Orlando facilities was sold in May 1994, and the other owned facility is under contract to be sold. (3) Construction was financed pursuant to revenue bond issues. Because these properties are currently leased subject to nominal purchase options with development authorities which the Company anticipates it will exercise, they are listed as owned by the Company. (4) The Company closed the Hammond distribution center and subleased the former Hammond, Louisiana office and distribution center.\nThe Company considers that all property owned or leased is well maintained and in good condition.\nItem 3.","section_3":"Item 3. Legal Proceedings\nIn the ordinary course of its business, the Company and its subsidiaries are parties to various legal actions which the Company believes are routine in nature and incidental to the operation of the business of the Company and its subsidiaries. The Company believes that the outcome of the proceedings to which the Company and its subsidiaries currently are parties will not have a material adverse effect upon its operations or financial condition.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNo matters were submitted to a vote of security holders during the last quarter of the fiscal year ended January 28, 1995.\nExecutive Officers of the Registrant\nThe name, age and office of the executive officers of the Company as of year end January 28, 1995 and certain information relating to their business experience are set forth below:\nName Age Position Stewart Turley 60 Director, Chairman of the Board and Chief Executive Officer Francis A. Newman 46 Director, President and Chief Operating Officer Kenneth L. Flynn 50 Senior Vice President\/Store Operations Edward W. Kelly 49 Senior Vice President\/Merchandising Robert L. Myers 49 Senior Vice President\/Pharmacy James M. Santo 53 Senior Vice President\/Administration and Secretary Samuel G. Wright 44 Senior Vice President and Chief Financial Officer Robert D. Boos 55 Vice President Martin W. Gladysz 42 Vice President\/Treasurer Robert E. Lewis 34 Vice President\/General Counsel and Assistant Secretary\nMr. Turley is Chairman of the Board and Chief Executive Officer of the Company, positions he has held since 1986. He served as President of the Company from 1986 until July 1993. He joined Old Eckerd in 1966 and has served as Senior Vice President (1971-1974) and President and Chief Executive Officer (1984-1985) prior to being elected to Chairman of the Board, President and Chief Executive Officer. He is also a director of Barnett Banks, Inc., Sprint Corporation and Springs Industries, Inc.\nMr. Newman is President, Chief Operating Officer and a director of the Company, positions he has held since July 1993. Prior to joining the Company, Mr. Newman served as President, Chief Executive Officer and a director of F&M Distributors, Inc. (\"F&M\"), a drug store chain, since 1986. F&M filed bankruptcy under Chapter 11 of the United States Bankruptcy Code in December 1994. Prior to joining F&M, he was the Executive Vice President of Household Merchandising, a retail firm, from 1984 to 1985 and the Senior Vice President of Merchandising for F.W. Woolworth, a retail firm, from 1980 to 1984. Mr. Newman is also a director of FabriCenters of America, a retail firm.\nMr. Flynn was appointed Senior Vice President\/Store Operations of the Company in December 1994. Prior to joining the Company, Mr. Flynn was Executive Vice President with the Thrifty\/Payless drug chain in Portland, Oregon. Prior to joining Thrifty\/Payless in August 1993, Mr. Flynn was employed by Lucky Stores, Inc. for over 30 years most recently as Senior Vice President\/Store Operations.\nMr. Kelly was appointed Senior Vice President\/Merchandising of the Company in February 1993. Prior thereto he served as Vice President of Merchandising of Eckerd Drug Company, formerly Old Eckerd's principal subsidiary (\"Eckerd Drug Company\") and now the Company's principal division, for more than the past five years.\nMr. Myers was appointed Senior Vice President\/Pharmacy of the Company in February 1993. Prior thereto he was a Vice President of the Company, a position he held for more than the past five years. In addition, Mr. Myers has served as Vice President of Pharmacy Services of Eckerd Drug Company for more than the past five years.\nMr. Santo was appointed Senior Vice President\/Administration of the Company in February 1993. Prior thereto he was Vice President\/Legal Affairs of the Company, a position he held for more than the past five years. In addition, Mr. Santo was appointed Secretary of the Company effective January 1, 1992.\nMr. Wright was appointed Senior Vice President and Chief Financial Officer of the Company in February 1995. Prior thereto Mr. Wright was appointed Senior Vice President\/Finance in February 1993 and was also Vice President and Controller of the Company, from September 1988 until February 1993. Mr. Wright became a Vice President of the Company in June 1986. In addition, Mr. Wright has served as Vice President of Finance of Eckerd Drug Company since May 1985.\nMr. Boos was appointed Vice President of the Company in April 1991. In addition, Mr. Boos has been Vice President of Real Estate and Development of Eckerd Drug Company since August 1985. Mr. Boos joined Eckerd Drug Company in 1982.\nMr. Gladysz was appointed Vice President\/Treasurer of the Company in May 1994. Prior to joining the Company, Mr. Gladysz was Executive Vice President\/Treasurer for Fortune Bancorp, a Florida banking organization, a position he held for more than the past five years.\nMr. Lewis was appointed Vice President\/General Counsel and Assistant Secretary of the Company in August 1994. Prior to joining the Company, Mr. Lewis was a shareholder in the law firm of Shackleford, Farrior, Stallings & Evans, P.A. in Tampa, Florida, from January 1992 to August 1994 and was an associate at that firm for more than five years prior thereto.\nOfficers are elected for a one-year term by the Board of Directors at its annual meeting. There is no family relationship between any of the aforementioned officers or directors of the Company.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters\nThe Company's common stock is listed on the New York Stock Exchange (Symbol: ECK) and started trading on August 6, 1993. The approximate number of shareholders of record on March 31, 1995 was 937. Fiscal 1994 Quarter Ended Market Price Per Share Information 4\/30\/94 7\/30\/94 10\/29\/9 1\/28\/95 High 24.00 25.25 31.50 32.00 Low 18.50 18.125 23.25 25.375\nFiscal 1993 Market Price Quarter Ended Per Share Information 10\/30\/93 1\/29\/94 High 18.00 20.75 Low 12.75 13.75\nThe Company is subject to restrictive covenants under its Credit Agreement and the 9 1\/4% Senior Subordinated Notes which restrict the payment of dividends. The Company has not paid or declared any dividends on its common stock.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe selected financial information required by this item is included in the Company's 1994 annual report to stockholders on page 9 under the heading \"Five Year Financial Operating Summary\". Such information is incorporated herein by reference. The ratio of earnings to fixed charges was 1.7X and 1.0X in fiscal 1994 and 1991, respectively. In fiscal 1993, 1992 and 1990 earnings were inadequate to cover fixed charges, and the Company had a deficiency in earnings to fixed charges of $2,941,000, $4,123,000 and $35,982,000 in fiscal years 1993, 1992 and 1990, respectively.\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 1994 annual report to stockholders on pages 10 through 14 under the heading \"Management's Discussion and Analysis of Results of Operations and Financial Condition\". Such information is incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe following consolidated financial statements as of January 28, 1995 and January 29, 1994 and for each of the years in the three year period ended January 28, 1995 included in the Company's 1994 annual report to stockholders on pages 15 through 27 are incorporated herein by reference:\nConsolidated Statements of Operations Consolidated Balance Sheets Consolidated Statements of Stockholders' Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements\nInformation on selected quarterly financial data also required by this item is included in the Company's 1994 annual report to stockholders on page 30 under the heading \"Quarterly Information (Unaudited)\". Such information is incorporated herein by reference.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNot applicable.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nInformation required by this item regarding the directors of the Company is included in the Company's definitive proxy statement dated April 24, 1995 for the 1995 annual meeting of stockholders on pages 2 through 4 under the headings \"Nominees For Election of Directors In Class II With Terms Expiring in 1998\"; \"Directors in Class III With Terms Expiring in 1996\" and \"Directors in Class I with Terms Expiring in 1997\". Such information is incorporated herein by reference. Information required by this item regarding executive officers of the Company is contained in Part I of this Form 10-K405 under the item entitled \"Executive Officers of the Registrant\".\nItem 11.","section_11":"Item 11. Executive Compensation\nInformation regarding management remuneration is included in the Company's definitive proxy statement dated April 24, 1995 for the 1995 annual meeting of stockholders on pages 1 and 2, and 8 through 14 under the headings \"Nomination and Election of Directors\" and \"Executive Compensation\". Such information 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 of management is included in the Company's definitive proxy statement dated April 24, 1995 for the 1995 annual meeting of stockholders on pages 5 through 7 under the heading \"Security Ownership Of Certain Persons\". Such information is incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nInformation regarding certain relationships and related transactions is included in the Company's definitive proxy statement dated April 24, 1995 for the 1995 annual meeting of stockholders on pages 13 and 17 under the headings \"Executive Compensation - Compensation Committee Interlocks and Insider Participation\" and \"Certain Transactions\". 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\nListed below are all financial statements, notes, schedules, and exhibits filed as part of this Form 10-K405 annual report:\n(a) Financial statements and Schedules\n1. The following financial statements and schedules of the Company together with the Report of Independent Certified Public Accountants dated March 20, 1995 in this Form 10-K405 are filed herewith:\nEckerd Corporation and Subsidiaries\nFinancial Statements: Independent Auditors' Report Consolidated Balance Sheets as of January 28, 1995 and January 29, 1994 Consolidated Statements of Operations for the Years Ended January 28, 1995, January 29, 1994 and January 30, 1993 Consolidated Statements of Stockholders' Equity for the Years Ended January 28, 1995, January 29, 1994 and January 30, Consolidated Statements of Cash Flows for the Years Ended January 28, 1995, January 29, 1994 and January 30, 1993 Notes to Consolidated Financial Statements Schedules: II - Reserves Independent Auditor's Report\nAll other schedules for the Company are omitted as the required information is inapplicable or the information is presented in the respective consolidated financial statements or related notes.\nAlso filed in this Form 10-K405 is the consent of KPMG Peat Marwick LLP to the incorporation by reference of their auditors' report dated March 20, 1995, relating to the consolidated financial statements appearing in the Form 10-K405, into Registration Statement Numbers 33-49977 and 33-50755 on Form S-8 and Registration Statement Numbers 33-10721, 33-50223, and 33-56261 on Form S-3.\n2. Exhibits:\nExhibits previously filed or filed by incorporation by reference:\n3.1(i) Restated Certificate of Incorporation of Eckerd Corporation (the \"Company\") (incorporated by reference to Exhibit 3.1(i) to the Registration Statement on Form S-3 of the Company (No. 33-50223)).\n3.2(ii) Amended and Restated By-laws of the Company (incorporated by reference to Exhibit 3.2(ii) to the Registration Statement on Form S-3 of the Company (No. 33-50223)).\n4.1 Form of certificate for the Company's Common Stock, par value $.01 per share (incorporated by reference to Exhibit 4.1 to the Registration Statement on Form S-2 of the Company (No. 33-64906)).\n4.2 Indenture dated as of May 1, 1986 by and between the Company and Mellon Bank, N.A. as trustee, relating to the 11 1\/8% Subordinated Debentures due 2001 (incorporated by reference to the Registration Statement on Form S-1 of Eckerd Holdings Inc. (No. 33-4576)). (On February 6, 1991, Mellon Bank, N.A. was succeeded by Security Pacific National Trust Company, as trustee.)\n4.3 Indenture dated as of November 1, 1993 between the Company and State Street Bank and Trust Company of Connecticut, National Association, as Trustee relating to the Company's 91\/4% Senior Subordinated Notes Due 2004 (incorporated by reference to Exhibit 4.02 to the Current Report on Form 8-K dated October 26, 1993 of the Company (File No. 1-4844)).\n4.4 Form of 9 1\/4% Senior Subordinated Notes Due 2004 of the Company (incorporated by reference to Exhibit 4.01 to the Current Report on Form 8-K dated October 26, 1993 of the Company (File No. 1-4844)).\n10.1 Merrill Lynch Common Stock Purchase Agreement dated as of April 1, 1986 by and among the Company and the Merrill Lynch Investors (incorporated by reference to the Registration Statement on Form S-4 of Eckerd Holdings Inc. (No. 33-4497)).\n10.2 Commercial Paper Placement Agency Agreement dated July 17, 1989 between the Company and Merrill Lynch Money Markets, Inc. (incorporated by reference to Exhibit 10.15 of Form 10-K of the Company for the period ended February 3, 1990).\n10.3 Registration Rights Agreement dated as of April 30, 1986 by and among the Company, the Merrill Lynch Investors, Morgan Capital Corporation and the other bank affiliates listed therein, the institutional and corporate investors listed therein and certain members of management of the Company (incorporated by reference to Exhibit 10.19 to the Registration Statement on Form S-2 of the Company (No. 33-64906)).\n10.4 First Amendment to Registration Rights Agreement among the Company, EDS Holdings Inc., the Merrill Lynch Investors, the Bank Affiliates, the Institutional Investors and the Management Investors (incorporated by reference to Exhibit 10.20 to Amendment No. 1 to the Registration Statement on Form S-2 of the Company (No. 33-64906)). 10.5 First Employees Management Stock Option Plan (incorporated by reference to the Registration Statement on Form S-8 of the Company (No. 33-30761)).\n10.6 Employment Agreement dated as of April 30, 1986, between the Company and Stewart Turley (incorporated by reference to Exhibit 10.23 to the Registration Statement on FormS-2 of the Company (No. 33-64906)).\n10.7 Employment Agreement dated as of April 30, 1986, between the Company and John W. Boyle (incorporated by reference to Exhibit 10.25 to the Registration Statement on Form S-2 of the Company (No. 33-64906)).\n10.8 Employment Agreement dated June 9, 1993, between the Company and Francis A. Newman (incorporated by reference to Exhibit 10.27 to the Registration Statement on Form S-2 of the Company (No. 33-64906)).\n10.9 Master Lease Agreement I dated as of May 18, 1993 between the Company and Imaging Financial Services d\/b\/a EKCC (\"IFS\") (incorporated by reference to Exhibit 10.28 to Amendment No. 1 to the Registration Statement on Form S-2 of the Company (No. 33-64906)).\n10.10 Master Lease Agreement II dated as of June 15, 1993 between the Company and IFS (incorporated by reference to Exhibit 10.29 to Amendment No. 1 to the Registration Statement on Form S-2 of the Company (No. 33-64906)).\n10.11 Systems Operations Service Agreement dated as of July 14, 1993 between the Company and Integrated Systems Solutions Corporation (incorporated by reference to Exhibit 10.30 to Amendment No. 1 to the Registration Statement on Form S-2 of the Company (No. 33-64906)).\n10.12 Letter dated March 16, 1993 between IFS and the Company relating to IFS Sale and Leaseback (incorporated by reference to Exhibit 10.31 to Amendment No. 2 of the Registration Statement on Form S-2 of the Company (No. 33-64906)).\n10.13 1993 Stock Option and Incentive Plan of the Company (incorporated by reference to Exhibit 99.1 to the Registration Statement on Form S-8 of the Company (No. 33-49977)).\n10.14 Employment Agreement dated October 1, 1988 between the Company and James M. Santo (incorporated by reference to Exhibit 10.38 to Form 10-K for the year ended January 29, 1994 of the Company (File No. 1-4844)).\n10.15 Employment Agreement dated October 1, 1988 between the Company and Robert L. Myers (incorporated by reference to Exhibit 10.38 to Form 10K\/A for the year ended January 29, 1994 of the Company (File No. 1-4844)).\n10.16 Credit Agreement dated as of June 14, 1993, as amended and restated as of August 3, 1994 (the \"Credit Agreement\"), among the Company, the lenders named therein, Chemical Bank and NationsBank of Florida, N.A. as managing agents and swingline lenders, and Chemical Bank, as administrative agent and NationsBank of Florida, N.A. as documentation agent (incorporated by reference to Exhibit 10.1 to form 10-Q of the Company for twenty-six weeks ended July 30, 1994).\n12.1 Statement regarding computation of ratio of earnings to fixed charges of the Company (incorporated by reference to Exhibit 12.1 to the Registration Statement on Form S-3 of the Company (No. 33-50223)).\nExhibits filed herewith:\n10.17 Employment Agreement dated October 1, 1988 between the Company and Samuel G. Wright.\n10.18 Receivables Purchase Agreement dated as of January 26, 1995 between the Company and Three Rivers Funding Corporation.\n10.19 First Amendment to Receivables Purchase Agreement dated as of March 31, 1995 between the Company and Three Rivers Funding Corporation.\n10.20 Registration Rights Agreement dated as of December 31, 1994 by and among the Company and the Eckerd Corporation Profit Sharing Plan.\n10.21 Guarantee Agreement dated as of June 14, 1993 as amended and restated as of August 3, 1994 (the \"Guarantee Agreement\") among the subsidiaries of the Company listed therein and Chemical Bank, as collateral agent.\n10.22 Indemnity, Subrogation and Contribution Agreement dated as of June 14, 1993 as amended and restated as of August 3, 1994 (the \"Indemnity, Subrogation and Contribution Agreement\"), among the Company, each subsidiary of the Company listed therein and Chemical Bank, as collateral agent. 10.23 Pledge Agreement dated as of June 14, 1993 as amended and restated as of August 3, 1994 among the Company, each subsidiary of the Registrant listed therein and Chemical Bank, as collateral agent.\n10.24 Security Agreement dated as of June 14, 1993 as amended and restated as of August 3, 1994 among the Company, each subsidiary of the Company listed therein and Chemical Bank, as collateral agent.\n10.25 Trademark Security Agreement dated as of June 14, 1993 as amended and restated as of August 3, 1994 among the Company, each subsidiary of the Company listed therein and Chemical Bank, as collateral agent.\n10.26 Revolving Note dated as of August 3, 1994 made by the Company in favor of Chemical Bank issued pursuant to the Credit Agreement.\n10.27 Term Note dated as of August 3, 1994 made by the Company in favor of Chemical Bank issued pursuant to the Credit Agreement.\n10.28 Swingline Note dated as of August 3, 1994 made by the Company in favor of Chemical Bank issued pursuant to the Credit Agreement.\n10.29 Deed of Trust, Security Agreement and Assignment of Leases and Rents dated as of June 14, 1993, as amended and restated as of August 3, 1994, by the Company in favor of Kenneth Plifka, as trustee, for the benefit of Chemical Bank, as collateral agent, relating to certain real property located in Dallas County, Texas.\n10.30 Deed of Trust, Security Agreement and Assignment of Leases and Rents dated as of June 14, 1993, as amended and restated as of August 3, 1994, by the Company in favor of Kenneth Plifka, as trustee, for the benefit of Chemical Bank, as collateral agent, relating to certain real property located in Montgomery County, Texas.\n10.31 Amendment, Consent and Waiver dated as of October 31, 1994 to the Credit Agreement, the Guarantee Agreement, the Indemnity, Subrogation and Contribution Agreement.\n10.32 Amended and Restated Mortgage, Security Agreement and Assignment of Leases and Rents dated as of August 3, 1994, as mortgagor and Chemical Bank, as mortgagee.\n12.2 Statement regarding computation of ratio of earnings to fixed charges of the Company.\n13 The following sections of the 1994 annual report to stockholders of the Company incorporated by reference and included in Parts II and IV of this Form 10-K405:\nFive Year Financial Operating Summary. Management's Discussion and Analysis of Results of Operations and Financial Condition. Consolidated Financial Statements and Independent Auditor's Report. Quarterly Information.\n21.1 Subsidiaries of the Company.\n23.1 Consent of Independent Certified Public Accountants.\n27 Financial data schedules.\n(b) Reports on Form 8-K\nThe Company did not file any reports on Form 8-K during the thirteen weeks ended January 28, 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 Form 10-K405 report to be signed on its behalf by the undersigned, thereunto duly authorized.\nApril 27, 1995 ECKERD CORPORATION\nBy:\/s\/ Samuel G. Wright Samuel G. Wright Senior Vice President Chief Financial and Accounting Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on the date indicated.\nSignature Titles Date\n\/s\/Stewart Turley Stewart Turley Chairman of the Board April 27, 1995 and Chief Executive Officer\n\/s\/Francis A. Newman Francis A. Newman President, Chief April 27, 1995 Operating Officer and Director\n\/s\/John W. Boyle John W. Boyle Director April 27, 1995\n\/s\/James T. Doluisio James T. Doluisio Director April 27, 1995\n\/s\/Donald F. Dunn Donald F. Dunn Director April 27, 1995\n\/s\/Albert J. Fitzgibbons, III Albert J. Fitzgibbons, III Director April 27, 1995\n\/s\/Lewis W. Lehr Lewis W. Lehr Director April 27, 1995\n\/s.Alexis P. Michas Alexis P. Michas Director April 27, 1995\n\/s\/Rupinder S. Sidhu Rupinder S. Sidhu Director April 27, 1995\nIndependent Auditor's Report\nThe Board of Directors Eckerd Corporation and Subsidiaries:\nUnder date of March 20, 1995, we reported on the consolidated balance sheets of Eckerd Corporation and subsidiaries as of January 28, 1995 and January 29, 1994, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the years in the three-year period ended January 28, 1995, which are incorporated by reference in the Form 10-K405. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related consolidated financial statement schedule in the Form 10-K405. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement schedule based on our audits.\nIn our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.\nAs discussed in note 9 to the consolidated financial statements, the Company changed its accounting policy in the current year related to the timing of the recognition of closed store obligations.\nKPMG PEAT MARWICK LLP\nTampa, Florida March 20, 1995\nSchedule II\nNotes: (a) This reserve is deducted from receivables in the balance sheets.\nExhibit Index Eckerd Corporation Form 10-K405 for the Fiscal Year Ended January 28, 1995 Exhibit Page Number Description of Exhibit Number\n3.1(i) Restated Certificate of Incorporation of Eckerd * Corporation (the \"Company\") (incorporated by reference to Exhibit 3.1(i) to the Registration Statement on Form S-3 of the Company (No. 33-50223)). 3.2(ii) Amended and Restated By-laws of the Company * (incorporated by reference to Exhibit 3.2(ii) to the Registration Statement on Form S-3 of the Company (No. 33-50223)).\n4.1 Form of certificate for the Company's Common * Stock, par value $.01 per share (incorporated by reference to Exhibit 4.1 to the Registration Statement on Form S-2 of the Company (No. 33- 64906)).\n4.2 Indenture dated as of May 1, 1986 by and between * the Company and Mellon Bank, N.A. as trustee, relating to the 11 1\/8% Subordinated Debentures due 2001 (incorporated by reference to the Registration Statement on Form S-1 of Eckerd Holdings Inc. (No. 33-4576)). (On February 6, 1991, Mellon Bank, N.A. was succeeded by Security Pacific National Trust Company, as trustee.)\n4.3 Indenture dated as of November 1, 1993 between * the Company and State Street Bank and Trust Company of Connecticut, National Association, as Trustee relating to the Company's 9 1\/4% Senior Subordinated Notes Due 2004 (incorporated by reference to Exhibit 4.02 to the Current Report on Form 8-K dated October 26, 1993 of the Company (File No. 1-4844)). 4.4 Form of 9 1\/4% Senior Subordinated Notes Due * 2004 of the Company (incorporated by reference to Exhibit 4.01 to the Current Report of Form 8-K dated October 26, 1993 of the Company (File No. 1-4844)).\n10.1 Merrill Lynch Common Stock Purchase Agreement * dated as of April 1, 1986 by and among the Company and the Merrill Lynch Investors (incorporated by reference to the Registration Statement on Form S-4 of Eckerd Holdings Inc. (No. 33-4497)).\n10.2 Commercial Paper Placement Agency Agreement dated * July 17, 1989 between the Company and Merrill Lynch Money Markets, Inc. (incorporated by reference to Exhibit 10.15 of Form 10-K of the Company for the period ended February 3, 1990).\n10.3 Registration Rights Agreement dated as of * April 30, 1986 by and among the Company, the Merrill Lynch Investors, Morgan Capital Corporation and the other bank affiliates listed therein, the institutional and corporate investors listed therein and certain members of management of the Company (incorporated by reference to Exhibit 10.19 to the Registration Statement on Form S-2 of the Company (No. 33-64906)).\n10.4 First Amendment to Registration Rights Agreement * among the Company, EDS Holdings Inc., the Merrill Lynch Investors, the Bank Affiliates, the Institutional Investors and the Management Investors (incorporated by reference to Exhibit 10.20 to Amendment No. 1 to the Registration Statement on Form S-2 of the Company (No. 33- 64906)).\n10.5 First Employees Management Stock Option Plan * (incorporated by reference to the Registration Statement on Form S-8 of the Company (No. 33-30761)).\n10.6 Employment Agreement dated as of April 30, 1986, * between the Company and Stewart Turley (incorporated by reference to Exhibit 10.23 to the Registration Statement on Form S-2 of the Company (No. 33-64906)).\n10.7 Employment Agreement dated as of April 30, 1986, * between the Company and John W. Boyle (incorporated by reference to Exhibit 10.25 to the Registration Statement on Form S-2 of the Company (No. 33-64906)).\n10.8 Employment Agreement dated June 9, 1993, between * the Company and Francis A. Newman (incorporated by reference to Exhibit 10.27 to the Registration Statement on Form S-2 of the Company (No. 33- 64906)).\n10.9 Master Lease Agreement I dated as of May 18, 1993 * between the Company and Imaging Financial Services d\/b\/a EKCC (\"IFS\") (incorporated by reference to Exhibit 10.28 to Amendment No. 1 to the Registration Statement on Form S-2 of the Company (No. 33-64906)).\n10.10 Master Lease Agreement II dated as of June 15, * 1993 between the Company and IFS (incorporated by reference to Exhibit 10.29 to Amendment No. 1 to the Registration Statement on Form S-2 of the Company (No. 33-64906)).\n10.11 Systems Operations Service Agreement dated as of * July 14, 1993 between the Company and Integrated Systems Solutions Corporation (incorporated by reference to Exhibit 10.30 to Amendment No. 1 to the Registration Statement on Form S-2 of the Company (No. 33-64906)).\n10.12 Letter dated March 16, 1993 between IFS and the * Company relating to IFS Sale and Leaseback (incorporated by reference to Exhibit 10.31 to Amendment No. 2 of the Registration Statement on Form S-2 of the Company (No. 33-64906)).\n10.13 1993 Stock Option and Incentive Plan of the * Company (incorporated by reference to Exhibit 99.1 to the Registration Statement on Form S-8 of the Company (No. 33-49977)).\n10.14 Employment Agreement dated October 1, 1988 * between the Company and James M. Santo (incorporated by reference to Exhibit 10.38 to Form 10-K for the year ended January 29, 1994 of the Company (File No. 1-4844)).\n10.15 Employment Agreement dated October 1, 1988 * between the Company and Robert L. Myers (incorporated by reference to Exhibit 10.38 to Form 10K\/A for the year ended January 29, 1994 of the Company (File No. 1-4844)).\n10.16 Credit Agreement dated as of June 14, 1993, as * amended, and restated as of August 3, 1994 (the \"Credit Agreement\"), among the Company, the lenders named therein, Chemical Bank and NationsBank of Florida, N.A. as managing agents and swingline lenders, and Chemical Bank, as administrative agent and NationsBank of Florida, N.A. as documentation agent (incorporated by reference to Exhibit 10.1 to form 10-Q of the Company for twenty-six weeks ended July 30, 1994).\n10.17 Employment Agreement dated October 1, 1988 between the Company and Samuel G. Wright.\n10.18 Receivables Purchase Agreement dated as of January 26, 1995 between the Company and Three Rivers Funding Corporation. 10.19 First Amendment to Receivables Purchase Agreement dated as of March 31, 1995 between the Company and Three Rivers Funding Corporation.\n10.20 Registration Rights Agreement dated as of December 31, 1994 by and among the Company and the Eckerd Corporation Profit Sharing Plan.\n10.21 Guarantee Agreement dated as of June 14, 1993 as amended and restated as of August 3, 1994 (the \"Guarantee Agreement\") among the subsidiaries of the Company listed therein and Chemical Bank, as collateral agent. 10.22 Indemnity, Subrogation and Contribution Agreement dated as of June 14, 1993 as amended and restated as of August 3, 1994 (the \"Indemnity, Subrogation and Contribution Agreement\"), among the Company, each subsidiary of the Company listed therein and Chemical Bank, as collateral agent.\n10.23 Pledge Agreement dated as of June 14, 1993 as amended and restated as of August 3, 1994 among the Company, each subsidiary of the Company listed therein and Chemical Bank, as collateral agent.\n10.24 Security Agreement dated as of June 14, 1993 as amended and restated as of August 3, 1994 among the Company, each subsidiary of the Company listed therein and Chemical Bank, as collateral agent.\n10.25 Trademark Security Agreement dated as of June 14, 1993 as amended and restated as of August 3, 1994 among the Company, each subsidiary of the Company listed therein and Chemical Bank, as collateral agent.\n10.26 Revolving Note dated as of August 3, 1994 made by the Company in favor of Chemical Bank issued pursuant to the Credit Agreement.\n10.27 Term Note dated as of August 3, 1994 made by the Company in favor of Chemical Bank issued pursuant to the Credit Agreement.\n10.28 Swingline Note dated as of August 3, 1994 made by the Company in favor of Chemical Bank issued pursuant to the Credit Agreement.\n10.29 Deed of Trust, Security Agreement and Assignment of Leases and Rents dated as of June 14, 1993, as amended and restated as of August 3, 1994, by the Company in favor of Kenneth Plifka, as trustee, for the benefit of Chemical Bank, as collateral agent, relating to certain real property located in Dallas County, Texas.\n10.30 Deed of Trust, Security Agreement and Assignment of Leases and Rents dated as of June 14, 1993, as amended and restated as of August 3, 1994, by the Company in favor of Kenneth Plifka, as trustee, for the benefit of Chemical Bank, as collateral agent, relating to certain real property located in Montgomery County, Texas.\n10.31 Amendment, Consent and Waiver dated as of October 31, 1994 to the Credit Agreement, the Guarantee Agreement, the Indemnity, Subrogation and Contribution Agreement.\n10.32 Amended and Restated Mortgage, Security Agreement and Assignment of Leases and Rents dated as of August 3, 1994, as mortgagor and Chemical Bank, as mortgagee.\n12.1 Statement regarding computation of ratio earnings to * fixed charges of the Company (incorporated by reference to Exhibit 12.1 to the Registration Statement on Form S-3 of the Company (No. 33-50223)).\n12.2 Statement regarding computation of ratio of earnings to fixed charges of the Company.\n13 The following sections of the 1994 annual report to stockholders of the Company incorporated by reference and included in Parts II and IV of this Form 10-K405:\nFive Year Financial Operating Summary. Management's Discussion and Analysis of Results of Operations and Financial Condition. Consolidated Financial Statements and Independent Auditor's Report. Quarterly Information.\n21.1 Subsidiaries of the Company.\n23.1 Consent of Independent Certified Public Accountants.\n27 Financial data schedules.\n* Filed by incorporation by reference.","section_15":""}
{"filename":"814702_1995.txt","cik":"814702","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"Item 3. Legal Proceedings\nNone.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\n\t None.\nPart II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Stockholder \t Matters\na) There is no established trading market for the certificates \t representing ownership of the beneficial interest in the Trust.\nb) As of March 29, 1996 there were three holders of certificates \t representing ownership of the beneficial interest in the Trust.\nItem 8.","section_6":"","section_7":"","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\n\t See attached audited financial statements.\nItem 9.","section_9":"Item 9. Disagreements on Accounting and Financial Disclosure\n\t None.\nPart III\nItem 13.","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"Item 13. Certain Relationships and Related Transactions\n\t None.\nPart IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports \t on Form 8-K\na) The following documents are filed as part of this report:\n1. Financial Statements \t Report of Independent Public Accountants \t Statements of Assets and Liabilities as of \t December 31, 1995 and 1994 \t Statements of Income and Expenses, for the Years Ended \t December 31, 1995, 1994 and 1993 \t Statements of Cash Flows, for the Years Ended \t December 31, 1995, 1994 and 1993 \t Notes to Financial Statements\n2. Financial Statement Schedules are omitted because they are \t inapplicable.\n3. Exhibits\n\t Exhibit \t Number Description of Exhibit\n\t 4.1 Form of Trust Agreement, including the \t\t\t form of Rural Electric Cooperative \t\t\t Grantor Trust Certificate \t\t\t (incorporated by reference to Form 10- \t\t\t K for the fiscal year ended December \t\t\t 31, 1987).\n\t 10.1 Loan Agreement (incorporated by \t\t\t reference to Exhibit 10.1 to \t\t\t Registration Statement on Form S-1 \t\t\t [No. 33-14490]).\n\t 10.2 Loan Guarantee and Servicing Agreement \t\t\t (incorporated by reference to Exhibit \t\t\t 10.2 to Registration Statement on Form \t\t\t S-1 [No. 33-14490]).\nb) Form 8-K dated October 2, 1995. \t Semi-annual Report to Certificateholders dated September 30, 1995.\nSupplemental information to be furnished with reports filed pursuant to Section 15(d) of the Act by Registrants which have not registered securities pursuant to Section 12 of the Act.\nNo annual report, proxy statement, form of proxy or other proxy soliciting material has been sent to Certificateholders, and the Registrant does not presently contemplate sending any such material subsequent to the filing of this report.\n\tPursuant to the requirements of Section 13 or 15(d) of the Securities \tAct of 1934, the Registrant has duly caused this report to be signed \ton its behalf by the undersigned, thereunto duly authorized, in the \tCounty of Fairfax, Commonwealth of Virginia on the 29 day of March, \t1996.\n\t RURAL ELECTRIC COOPERATIVE GRANTOR TRUST (SOYLAND) 1987 A-4\n\t By: NATIONAL RURAL UTILITIES COOPERATIVE \t\t FINANCE CORPORATION as Servicer\n\t By: \/s\/ Sheldon C. Petersen \t\t Sheldon C. Petersen, Governor and \t\t\t Chief Executive Officer\n\t\t RURAL ELECTRIC COOPERATIVE GRANTOR \t\t\t TRUST (SOYLAND) 1987-A4\n\t FINANCIAL STATEMENTS AS OF DECEMBER 31, 1995, 1994 AND 1993 \t\t\tTOGETHER WITH AUDITORS' REPORT\n\t\t Report of Independent Public Accountants\nTo the Trustee of Rural Electric Cooperative Grantor Trust (Soyland) 1987-A4, and\nTo the Board of Directors of National Rural Utilities Cooperative Finance Corporation\nWe have audited the accompanying statements of assets and liabilities of Rural Electric Cooperative Grantor Trust (Soyland) 1987-A4 as of December 31, 1995 and 1994, and the related statements of income and expenses and cash flows for each of the three years in the period ended December 31, 1995. 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 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 Rural Electric Cooperative Grantor Trust (Soyland) 1987-A4 as of December 31, 1995 and 1994, the results of and its operations and its cash flows for the years ended December 31, 1995, 1994 and 1993, in conformity with generally accepted accounting principles.\nMarch 11, 1996 \/s\/ Arthur Andersen LLP Washington, D. C.\n\t RURAL ELECTRIC COOPERATIVE GRANTOR TRUST (SOYLAND) 1987-A4\n\t\t\tSTATEMENTS OF ASSETS AND LIABILITIES\n\t\t\t AS OF DECEMBER 31, 1995 AND 1994\n\t\t\t\t\t\t 1995 1994\nA S S E T S\nInterest Receivable $ 1,361,416 $ 1,361,416\nNote Receivable 50,000,000 50,000,000\nTotal Assets $51,361,416 $51,361,416\nL I A B I L I T I E S\nInterest Payable - Grantor Trust $ 1,350,083 $ 1,350,083 Certificates\nServicer Fees Payable 11,333 11,333\nRural Electric Cooperative Grantor Trust Certificates 50,000,000 50,000,000\nTotal Liabilities $51,361,416 $51,361,416\n\t RURAL ELECTRIC COOPERATIVE GRANTOR TRUST (SOYLAND) 1987-A4\n\t\t NOTES TO FINANCIAL STATEMENTS\n\t\t DECEMBER 31, 1995, 1994 AND 1993\n1. ORGANIZATION AND OPERATIONS\nRural Electric Cooperative Grantor Trust (Soyland) 1987-A4 (the \"Trust\") was formed under a Trust Agreement dated March 19, 1987 among National Rural Utilities Cooperative Finance Corporation (\"CFC\"), Soyland Power Cooperative, Inc. (the \"Cooperative\") and The First National Bank of Chicago (the \"Trustee\"). On that date, CFC made a loan to the Cooperative which issued a note (the \"Note\"), evidencing the borrowing, to the Trust. The Trust issued to CFC Rural Electric Cooperative Grantor Trust (Soyland) 9.53% Certificates Due 2006 (the \"Certificates\") in the amount of $50,000,000. The Certificates are solely the obligations of the Trust and are not insured or guaranteed by CFC, the Cooperative, the Trustee, the Rural Utilities Service (\"RUS\") of the United States Depart- ment of Agriculture (\"USDA\") nor any other governmental agency. Each Certificate represents an undivided fractional interest in the Trust. CFC is the depositor of the Trust and acts as Servicer of the Note. CFC filed, on behalf of the Trust, a Registration Statement on Form S-1 (Registration No. 33-14490) which became effective on July 15, 1987, and CFC resold the Certificates thereunder.\nThe assets of the Trust consist primarily of the Note which is guaranteed (the \"Guarantee\") as to timely payment of principal and interest by the United States of America, acting through the Administrator of RUS. The amounts of principal and interest payments on the Note held by the Trust are sufficient to cover the scheduled principal and interest payments on the Certificates issued by the Trust and the scheduled amounts of servicer fees. The General Counsel of the USDA has issued an opinion that the Guarantee is supported by the full faith and credit of the United States of America.\nDebt service and servicer fee payments on the Note are made to the Trustee semi-annually (March 19 and September 19) by the Cooperative. The Trustee deposits all such receipts in the Trust account. The Trustee is authorized by the Trust Agreement to invest all funds in the Trust account at the direction of CFC in certain eligible investments that mature no later than the business day next preceding the day (March 30 and September 30) such amounts are to be distributed to the Certificateholders and the Servicer. The interest earned on the investments is distributed to the Cooperative. Any funds that are not so invested must be held by the Trustee in the Trust account. The Trustee may not reinvest any returns of principal or investment earnings on eligible investments and the Trustee may not sell any eligible investment prior to its maturity except, at the direction of CFC, to preserve the value of the corpus of the Trust.\nOn or before five business days after each date on which payments are made on the Certificates, the Trustee is obligated to supply the holders of such Certificates a report provided by the Servicer, which includes certain pertinent information as to how the payment is to be allocated to principal, interest, servicer fees and premium, if any, as well as the principal balance outstanding after such payment.\nThe fiscal year of the Trust is the calendar year. Within the prescribed period of time for tax reporting purposes, after the end of each calendar year during the term of the Trust Agreement, the Trustee is obligated to prepare and mail to each Certificateholder of record for the Trust, at any time during such year, a report setting forth the information as is reasonably necessary for the preparation of such Certificateholder's Federal income tax return.\nPayments of principal on the Certificates are scheduled to be repaid over a period of five years, beginning in 2002. The principal payment in 2002 is scheduled to be $7,900,000.The Certificates are not subject to re- demption prior to March 20, 1997. Thereafter, such Certificates are subject to optional redemption, in whole and without premium, upon redemption or purchase of the related Note. The Trust Agreement will terminate after payment in full has been made on the Certificates issued thereunder. \t\n2. TAX STATUS OF THE TRUST\nMilbank, Tweed, Hadley & McCloy, counsel to CFC, has advised CFC with respect to the Trust that, in its opinion, (i) the Trust will not be classified as an association taxable as a corporation, but will be classified as a grantor trust and (ii) each Certificateholder will be treated for Federal income tax purposes as the owner of an undivided fractional interest in each of the assets held by the Trust.\nIt is expected that the Trust will not have any liability for Federal or state income taxes for the current or future years.\n3. INTEREST AND SERVICER FEE ACCOUNTING\nThe Trust records interest income as it is earned and accrues interest expense and servicer fees as they are incurred. Servicer fees represent eight basis points of the outstanding principal balance of the Certifi- cates and the Note.\n4. FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe following disclosure of the estimated fair value of financial instru- ments is made in accordance with FASB Statement 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 December 31, 1995, along with other valuation methodologies which are summarized below. Below is a summary of significant methodologies used in estimating fair value amounts and a schedule of fair values at December 31, 1995.\nThe carrying amounts reported for Interest Receivable, Interest Payable - Grantor Trust Certificates, and Servicer Fees Payable approximate fair values due to the short term maturity of these instruments.\nNote Receivable\nFair value 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.\nRural Electric Cooperative Grantor Trust Certificates\nThe fair value of the Certificate is estimated using quoted market prices for similar notes over the same remaining maturities.\nThe carrying and estimated fair values of the Trust's financial instruments as of December 31, 1995, are as follows:\n\t\t\t\t\t Carrying Fair \t\t\t\t\t Value Value\nAssets: Interest Receivable 1,361,416 1,361,416 Note Receivable 50,000,000 71,746,993\nLiabilities: Interest Payable - Grantor Trust Certificates 1,350,083 1,350,083 Servicer Fees Payable 11,333 11,333 Rural Electric Cooperative Grantor Trust Certificates 50,000,000 71,766,234\n\t RURAL ELECTRIC COOPERATIVE GRANTOR TRUST (SOYLAND) 1987 A-4\n\t\t\t Exhibit Index\nExhibit Number Description of Exhibit\n4.1 Form of Trust Agreement, including the form of Rural Electric \t Cooperative Grantor Trust Certificate (incorporated by reference \t to Form 10-K for the fiscal year ended December 31, 1987).\n10.1 Loan Agreement (incorporated by reference to Exhibit 10.1 to \t Registration Statement on Form S-1 [No. 33-14490]).\n10.2 Loan Guarantee and Servicing Agreement (incorporated by reference \t to Exhibit 10.2 to Registration Statement on Form S-1 [No. 33-14490]).","section_15":""}
{"filename":"276400_1995.txt","cik":"276400","year":"1995","section_1":"Item 1. Business\nGENERAL\nThe Company is an Ohio insurance holding company engaged primarily in the underwriting of specialized and niche insurance products and related services through its wholly-owned insurance subsidiary, Ohio Indemnity Company (\"Subsidiary\" or \"Ohio Indemnity\"). Ohio Indemnity is licensed to transact business in 44 states and the District of Columbia and on a surplus lines basis in Texas. During 1993, BCIS Services, Inc. (\"BCIS Services\") was incorporated in Ohio as a wholly-owned subsidiary of the Company. BCIS Services is a non-risk bearing provider of workers' compensation administration and cost control services to employers who self-insure workers' compensation coverage.\nPRODUCTS\nMost of the Company's net premiums written and premiums earned are derived from three distinct lines of specialized and niche insurance products and related services:\nUltimate Loss Insurance. Ultimate Loss Insurance, a form of physical damage blanket single interest insurance, is sold to lending institutions, such as banks, savings and loan associations, credit unions, automobile dealers and finance companies. Ultimate Loss Insurance insures such institutions against damage to pledged collateral in cases where the collateral is not otherwise insured. The standard policy covers physical damage to the collateral, not to exceed the lesser of the collateral's fair market value or the outstanding loan balance. This blanket single interest policy is generally written to cover the lending institution's complete portfolio of collateralized personal property loans, which consist primarily of automobile loans. The Company offers supplemental coverages, at additional premium cost, for losses due to unintentional errors in lien filings and conversion, confiscation and skip risks. Conversion risk coverage protects the lender from unauthorized and wrongful taking of the lender's collateral. Skip risk coverage protects the lender when a delinquent debtor disappears with the loan collateral.\nSince its inception in 1956, the Company has gradually expanded coverage of the program from traditional lenders such as banks, savings and loans and credit unions to nontraditional lenders, such as automobile dealers and finance companies. During 1995, the Company provided Ultimate Loss Insurance coverage to approximately 400 lending institutions. Ultimate Loss Insurance was written in 28 states and represented 39.0% and 15.1% of the Company's premiums written and 34.5% and 30.2% of the Company's premiums earned, respectively, in 1995 and 1994.\nThe premiums charged for Ultimate Loss Insurance reflect claims experience, loan volumes and general market conditions.\nHistorically, the Company has had a low cancellation rate among customers of Ultimate Loss Insurance, averaging less than 10.0% of customers per year over the last three years. As of July 31, 1994, there were changes in the policies of two significant lending institution customers in the Ultimate Loss Insurance program. The first lending institution's policy was canceled and the second lending institution's policy was restructured to eliminate continuation coverage.\nBonded Service Program. Bonded Service is a program in which the Company participates by bonding specific unemployment insurance servicing commitments by a cost containment service firm. The unemployment compensation laws of each state generally permit not-for-profit organizations, school districts and political subdivisions to opt out of the state sponsored unemployment compensation insurance system and, instead, elect to reimburse the state for unemployment compensation claims paid by the state on their behalf. Although the reimbursing employer can usually realize certain cost advantages through this reimbursement method, it also assumes the risk of unexpected, unbudgeted unemployment claims. The Bonded Service program provides the risk mechanism to limit the impact of such unexpected claims costs. The cost containment service firm operates under a service contract with the reimbursing employer by which the cost containment service firm assures that the employer will satisfy his obligations to the state as a\nreimburser. From the Bonded Service fees charged by the cost containment service firm, an aggregate loss fund account is maintained from which losses in excess of expected charges are paid up to the bond limit. The Company controls the Bonded Service participation process.\nThe Company has participated in the Bonded Service program since 1989. In 1992, the Company agreed to write a similar type bond covering groups of smaller not-for-profit entities which could realize the cost benefits of being reimbursers but could not do so on a stand-alone basis. As of December 31, 1995, the Company services five (5) such groups. The Bonded Service program represented 23.4% of the Company's premiums written and 16.6% of the Company's premiums earned in 1995 versus 7.5% and 10.4% respectively in 1994. The Bonded Service program has participants in 23 states.\nThe cost containment service firm's charge to the participating employer is based primarily upon historical claims experience, general economic conditions and other factors specific to the employer. The bond premium paid to the Company is calculated as a percentage of that charge. Subscribers to the Bonded Service program enroll for a term ranging from one to two years and the Company's surety bond extends for the duration of the term. The Bonded Service program fees applicable to any renewal term are adjusted based upon the subscriber's historical claims experience, the subscriber's announced business plans with respect to significant planned changes in employment, stability of the subscriber's source of funding and general economic conditions. Since 1989, annual renewals have averaged 95%.\nSome states require that reimbursing employers post a bond as security for the performance of their reimbursing obligations. On limited occasions, the Company has provided this mandated bond on behalf of employers enrolled in the Bonded Service program for which it assesses a separate premium charge. The Company's obligations under such bonds may not, in every case, cease upon termination of an employer's participation in the Bonded Service program. The financial statements include reserves for losses on such programs for benefits paid. Such reserves were $500,000 and $345,000 at December 31, 1994 and 1995, respectively.\nAutomobile Physical Damage Insurance. Automobile Physical Damage Insurance is designed for the nonstandard automobile insurance market, consisting mostly of inexperienced drivers, drivers with poor driving records or claims experience, or drivers who otherwise do not qualify for the standard market. These drivers are normally charged higher premium rates than drivers considered to be standard or preferred risks. The Company marketed its Automobile Physical Damage Insurance through a general agent who in turn marketed the program through over 600 independent brokers located throughout California. The Company offered Automobile Physical Damage Insurance from June 1992 to August 1995 to California residents and from January 1993 to October 1994 to Arizona residents. The Company does not currently offer Automobile Physical Damage Insurance in any jurisdiction. To control its loss exposure, the Company ceded 50% of the premiums written to, and recovered 50% of the paid loss and loss adjustment expense from, Swiss Reinsurance America Corporation (formerly known as North American Reinsurance Corporation). The Automobile Physical Damage Insurance represented 37.6% of the Company's premiums written and 48.1% of the Company's premiums earned in 1995 versus 77.3% and 58.1%, respectively, in 1994.\nThe Company's Automobile Physical Damage Insurance does not provide bodily injury or property damage liability, medical coverage or uninsured motorist insurance. The rates for Automobile Physical Damage Insurance in California were based on the applicant's driving record and experience, deductible selected, year of insured automobile and value and annual driving mileage. The Company did not insure certain makes and models of automobiles, such as vehicles valued at more than $40,000 and exotic, antique or high performance vehicles.\nThe Company's California Automobile Physical Damage Insurance policy, in addition to other exclusions, did not cover loss to any driver or vehicle unless named in the policy (or any endorsement thereto). California law limits the exclusions that can be made in an Automobile Physical Damage Insurance policy and the use of certain underwriting criteria, which limits are incorporated in the premium determination factors applicable to the California policies. Generally, the Company managed its risk exposure by imposing permitted premium surcharges on drivers with poor driving records\nand excluding from coverage other risks such as automobiles with a value in excess of $40,000.\nOn April 30, 1995, the Company canceled its managing general agent contract for the sales of Automobile Physical Damage Insurance in California. On May 1, 1995, the reinsurance agreement applicable to the Automobile Physical Damage written through its managing general agent was canceled. Reinsurance will remain in force for all policies written by its managing general agent. In addition, on May 1, 1995, the Company assumed marketing and underwriting responsibilities and engaged an independent claims agent to handle subsequent settlements. On July 28, 1995, Ohio Indemnity entered into an agreement with the California Department of Insurance to discontinue sales and renewals of private passenger personal lines in automobile physical damage insurance in California for a maximum period of three years. See Discontinued Products.\nIn Arizona, the rates for Automobile Physical Damage Insurance were determined by the applicant's age, marital status and residence, in addition to the other premium determination factors of driving record, deductible selected, and value and year of insured automobile. The Company did not insure certain makes and models of automobiles, such as vehicles valued at more than $30,000 and exotic, antique or high performance vehicles. The Arizona policy, in addition to other exclusions, did not pay for losses to any automobile not named in the policy (or endorsement thereto) or incurred by any driver under age 25 or members of a household not named in the policy. In October 1994, the Company discontinued sales of Automobile Physical Damage Insurance in Arizona.\nBCIS Services, Inc. BCIS Services is a third party administrator (TPA) specializing in managing workers' compensation obligations assumed by employers who self-insure this coverage. The contract defines specific servicing responsibilities for which the client pays agreed upon fees during the duration of such contract which normally covers one to three years. BCIS Services was formed in February 1993 and began marketing its programs in July 1993. BCIS Services does not engage in the business of underwriting or insuring risks of loss.\nBCIS Services assists the client in controlling factors that impact containment of workplace disability costs from risk control to coordinated managed care. BCIS Services is postured to provide independent claims administration involving other casualty insurance exposures on a multi-state basis. Independent resources are engaged to provide specialized control functions as circumstances dictate. During 1995, the Company provided cost control services to three employers in California which generated revenues of $533,354 in 1995.\nBCIS Services operated in California only during 1993, 1994 and 1995. There can be no assurance that this operation will be commercially successful or profitable.\n(THIS SPACE INTENTIONALLY LEFT BLANK)\nSummary. The following table sets forth the Company's net premiums written and premiums earned by line of business and the percent of total net premiums written and premiums earned, respectively, such line of business represents for the years indicated.\nBUSINESS STRATEGY\nThe Company's business strategy is to maximize underwriting profits through the identification and exploitation of niche markets and products. The Company's primary focus is on increasing net earnings rather than gross written premiums. The Company's business strategy emphasizes the development and marketing of specialized and niche insurance products and related services where the policies written generally do not include \"long-tail\" liability coverages (insurance coverages with relatively long loss payment exposure), allow for frequent underwriting review, and are characterized by relatively short loss recognition and settlement periods. The Company pursues a conservative investment strategy by investing principally in investment-grade fixed income securities and avoiding real estate investments.\nThe Company concentrates on underwriting specialized lines of business where it can utilize its underwriting and claims management expertise to generate underwriting profits superior to property\/casualty industry results. To achieve these goals:\n- - The Company offers specialized insurance coverages with relatively short loss payment patterns (\"short tail\" insurance coverages). The risk characteristics of short tail insurance coverages allow the Company to exercise more control over its underwriting and claims administration.\n- - Management maintains strict risk selection and underwriting discipline by accepting only those risks which it believes will generate underwriting profits, even when market conditions foster extreme pricing competition.\n- - The Company emphasizes responsive and consistent service to its customers, general agents and independent brokers regardless of market or competitive pressures. The Company's high service standards insure that customers are provided with quick responses to policy application, timely policy issuance, rapid claims administration and quality service.\n- - The Company maintains tight control over underwriting expenses by marketing products which do not require extensive claims investigation and administration, by selling directly to its customers, where appropriate, and by forging strong relationships with selected agents which have assumed many of the marketing and administrative responsibilities for the Company's products. In the case of the Bonded Service program in which the Company participates, the cost containment service firm performs most of the marketing and administrative responsibilities.\n- - The Company manages its loss exposure through the selective use of reinsurance, generally in connection with the introduction of new products.\nBUSINESS EXPANSION AND PRODUCT DEVELOPMENT\nThe Company continually searches for new specialty insurance product opportunities and engages in the test-marketing of certain products. The Company's experience has been to promptly discontinue any product which it believes will not achieve expected underwriting profits or will hamper its ability to underwrite other more profitable products.\nCOMPETITION\nWith respect to Ultimate Loss Insurance, the Company competes with \"forced-placement\" insurance and other providers of physical damage blanket single interest insurance. Forced-placement coverage is an alternative to physical damage blanket single interest insurance in that the provider arranges with a lending institution to insure, without the borrower's consent, uninsured or underinsured collateral pledged by the borrower to the lender. The Company believes its Ultimate Loss Insurance is a superior product to forced-placement insurance. Under forced-placement insurance, an individual policy is written for the lending institution's customer without the customer's consent and the premiums are paid directly by the customer through an increase in the customer's outstanding loan balance. The propriety of forced-placement coverage has recently been challenged in a number of class action suits against providers of forced-placement insurance.\nCompetition for the Bonded Service program is provided indirectly by insurers who have designed coverages for reimbursing employers with loss limitation features similar in concept to the Bonded Service program. The Company believes that the Bonded Service program has cost savings and other features which enable the program to compete effectively against providers of loss limitation coverages. The cost containment service firm, on whom the Company relies for growth in bond fees, competes with other cost containment service firm's for cost containment service contracts with not-for-profit organizations, some of which may require loss limitation coverages.\nWith respect to the Automobile Physical Damage Insurance sold by the Company in California, the Company competed against approximately eleven admitted insurers, three of which have an A.M. Best Company (\"Best\") rating of A (Excellent) or better, and an indeterminate number of nonadmitted insurers. In Arizona, the Company competed against approximately six admitted insurers, three of which have a Best rating of A (Excellent) or better, and an indeterminate number of nonadmitted insurers.\nConcerning BCIS Services, competition includes any brokers, agents, insurance companies or consultants which provide administrative services to their clients. The major competitors are TPA's, most of which operate on a regional basis. There are approximately 51 TPA's in California that specialize in serving employers who self-insure workers' compensation.\nThere can be no assurance that the Company will not face additional competition in its markets from new or existing competitors.\nCLAIMS MANAGEMENT AND ADMINISTRATION\nIn accordance with its emphasis on underwriting profitability, the Company is actively and directly involved in claims management. The Company, either directly or through independent adjusters, investigates reported incidents promptly, monitors developments in the claims process, and generally services agents and insureds throughout the claims process. The Company relies on its experienced management staff to effectively manage\nthe processing and administration of claims. Wherever possible, the Company exercises such salvage and subrogation rights as may be provided by applicable law or contract.\nUNDERWRITING\nManagement believes that the Company's specialized insurance products can be profitably underwritten based on the Company's knowledge of its specific target markets, its ability to select, underwrite and price risks, and its ability to mitigate loss exposures through superior claims administration. The Company continually monitors its underwriting approach and makes modifications as appropriate to accommodate changing market conditions. The Company provides its agents with, and requires strict adherence to, underwriting guidelines with respect to its insurance products. The Company works closely with its cost containment service firm in underwriting individual applications under the Bonded Service program.\nRESERVES\nThe Company is directly liable for loss and loss adjustment expense payments under the terms of insurance policies that it writes. The Company operates under insurance laws and regulations that require the Company to maintain reserves for the payment of losses and loss adjustment expenses with respect to both reported and incurred but not reported (\"IBNR\") claims under insurance policies issued by the Company. Historically, the Company has had a short lag time between the occurrence of a loss and the reporting of a loss because of the nature of the coverages it provides and the fact that the Company's policies limit the amount of time that a policyholder can delay in reporting a loss following its occurrence. The Company reflects its liability for the ultimate payment of all incurred losses and loss adjustment expenses by establishing loss and loss adjustment expense reserves, which are balance sheet liabilities representing estimates of future amounts needed to pay claims and related expenses with respect to insured events that have occurred.\nWhen a claim involving a probable loss is reported, the Company establishes a reserve for the estimated amount of the Company's ultimate loss and loss adjustment expense payments (\"case reserves\"). The estimate reflects a judgment based on established reserving practices and the experience and knowledge of the Company's management regarding the nature and value of the claim as well as the estimated expenses of settling the claim, including legal and other fees, and general expenses of administering the claims adjustment process. Management also establishes reserves on an aggregate basis to provide for IBNR losses as well as future developments on losses reported to the Company. Case and IBNR reserves for Automobile Physical Damage Insurance were determined by management with the assistance of the Company's consulting actuary and by reference to California and Arizona industry experiences. The amount of the Company's incurred losses in a given period is determined by adding losses and loss adjustment expenses paid during the period to case loss and loss adjustment expense reserves and IBNR reserves (collectively, \"loss reserves\") at the end of the period, then subtracting loss reserves existing at the beginning of the period.\nAs part of the reserving process, historical data is reviewed and consideration is given to the anticipated effect of various factors, including known and anticipated legal developments, changes in social attitudes, inflation and economic conditions. Reserve amounts are necessarily based on management's estimates, and as other data becomes available and is reviewed, these estimates and judgments are revised, resulting in increases or decreases to existing reserves. To verify the adequacy of its reserves, the Company engages an independent consulting actuary to perform annual ultimate loss reserve analyses.\nThe following table sets forth a reconciliation of beginning and ending reserves for unpaid losses and loss adjustment expenses for the years indicated.\nAs a result of changes in estimates of insured events in prior years, the provision for unpaid losses and loss adjustment expenses increased by $247,000 in 1995 because of higher-than-anticipated losses and related legal expenses in connection with a discontinued product, and increased by $529,000 in 1994 because of higher-than-anticipated losses from the Automobile Insurance business. The provision for unpaid losses and loss adjustment expenses decreased by $1,421,000 in 1993 because of lower-than-anticipated losses from the Surety and Ultimate Loss Insurance business. See Part II Item 7. Discontinued Products.\nREINSURANCE\nTo limit its insurance underwriting exposure on Automobile Physical Damage Insurance, the Company entered into a reinsurance agreement with Swiss Reinsurance America Corporation (formerly known as North American Reinsurance Corporation) in 1992. Under the reinsurance agreement applicable to Automobile Physical Damage insurance policies, 50% of the premiums written are ceded to, and 50% of the paid losses and loss adjustment expenses are recovered from, Swiss Reinsurance America Corporation. During 1995, the Company ceded $8,550,443 of premiums written to, and recovered $528,726 in reserves for unpaid losses and loss adjustment expenses from, Swiss Reinsurance America Corporation.\nOn April 30, 1995, the Company canceled its managing general agent contract for the sales of Automobile Physical Damage Insurance in California. On May 1, 1995, the reinsurance agreement applicable to the Automobile Physical Damage written through its managing general agent was canceled. Reinsurance will remain in force for all policies written by its managing general agent.\nThe ceding of liability to a reinsurer does not legally discharge the ceding insurer from its primary liability for the full amount of the policies on which it obtains reinsurance, and the ceding insurer will be required to pay the entire loss if the\nassuming reinsurer fails to meet its obligations under the reinsurance agreement.\nIn selecting Swiss Reinsurance America Corporation, the Company considered several factors, the most important of which was the financial stability of the reinsurer. Swiss Reinsurance America Corporation has a Best rating of A (Excellent). In an effort to minimize its exposure to the insolvency of its reinsurer, the Company carefully monitors the financial condition of Swiss Reinsurance America Corporation. The Company expects to collect the reinsurance recoverables due it from Swiss Reinsurance America Corporation.\nThe Company regularly assesses its reinsurance needs and from time to time seeks to improve the terms of its reinsurance arrangements as market conditions permit. Such improvements may involve increases in retentions, commutations, modifications in premium rates, changes in reinsurers and other matters.\nThe Company does not carry catastrophe reinsurance coverages. Catastrophe reinsurance applies where specific events produce losses. The Company does not believe that its catastrophe exposure is substantial enough to justify the need for, or the cost of, catastrophe reinsurance.\nOPERATING DATA\nThe following ratios are frequently used in evaluating operating performance in the insurance industry.\n(1)Source: Best's Aggregates & Averages, Property\/Casualty (1994 edition). The 1995 ratios as calculated by Best on a statutory accounting practices (\"SAP\") basis are not yet available. The Company's mix of business is significantly different than the aggregate property\/casualty industry. Best does not currently provide specialty line ratio information that would permit peer group comparison to the Company's specialty lines, however, specialty lines generally have lower combined ratios than the industry as a whole.\n(2)Combined ratios as presented do not include the effects of policyholder dividends.\nCombined Ratios. The statutory combined ratio, which reflects underwriting results but not investment income, is a traditional measure of underwriting performance of a property\/casualty insurer. The Subsidiary's combined ratios were significantly below the property\/casualty industry's average for the years indicated, although there can be no assurance that this trend will continue.\nLoss and Expense Ratios. Management has pursued a strategy of establishing the Subsidiary as a low-cost provider of specialized and niche insurance products while maintaining a commitment to provide superior service to both agents and insureds. This has been accomplished primarily through management's strong control over expenses. Management believes that significant competitive advantages exist in soft market conditions as a result of this strategy of cost control because the Subsidiary is able\nto lower premiums while remaining profitable.\nDuring the past five years, the Subsidiary experienced some increases in its expense ratio because expenses associated with the introduction of new product lines, primarily the Automobile Physical Damage and the Bonded Service programs, initially exceeded the rate of premium growth associated with these products. The Subsidiary's loss ratio decreased during the 1992 and 1993 because the growth in net premiums written significantly exceeded the incremental growth in losses and loss adjustment expenses. During 1992, the Company commenced writing Automobile Physical Damage Insurance (see - \"Business-Products\"). This product experienced a higher loss ratio than the Company's other products. Thus, as the percentage of business in the Automobile Physical Damage Insurance product increased, the Company's loss ratio increased. Management believes the discontinuance of the Automobile Physical Damage program should improve the loss ratio over the long-term, however, there can be no assurance that this will occur.\nPremium to Surplus Ratios. The following table shows, for the periods indicated, the Subsidiary's ratio of net premiums written to statutory surplus.\n(1)Source: Best's Aggregates & Averages, Property\/Casualty (1994 edition). The 1995 ratio as calculated by Best on a SAP basis is not yet available.\nWhile there is no statutory requirement that establishes a permissible net premiums written to surplus ratio, guidelines established by the National Association of Insurance Commissioners (\"NAIC\") provide that this ratio should be no greater than 3 to 1. The Subsidiary maintains a net premiums written to surplus ratio lower than the NAIC guidelines. The Company has the ability to significantly increase net premiums written given its existing surplus and still be in compliance with NAIC guidelines.\nINVESTMENTS\nThe Company's investments consist of those investments permitted by Ohio insurance laws. The Company's overall investment policy is determined by the Company's Board of Directors and is reviewed periodically. The Company focuses on maintaining a conservatively managed investment-grade portfolio. The Company does not have any investments in real estate.\n(THIS SPACE INTENTIONALLY LEFT BLANK)\nThe table below shows the classifications of the Company's investments at December 31, 1995.\n(1) The Company obtains year end fair value information primarily from NAIC's Annual Securities Valuation Manual. Market values are also obtained on a monthly basis from financial market data systems and broker quotes.\n(2) Carrying values for available for sale fixed maturities are at fair value, carrying value for held to maturity fixed maturities, including bonds and preferred stocks with mandatory redemption features, are at amortized cost and carrying values for available for sale equity securities, including common stocks and preferred stocks without mandatory redemption features are at fair value.\n(3) Percentages are based on carrying value.\nThe Company concentrates its investments in obligations of states, municipalities and political subdivisions. Most of the interest income from these investments is exempt from federal income tax. The interest rates on these securities are normally lower than rates on comparable taxable securities but the securities may have equivalent or higher yields on an after-tax basis. As the Company's fixed income securities mature, there can be no assurance that the Company will be able to reinvest in securities with comparable yields.\nThe Company's fixed income securities portfolio principally consists of intermediate-term securities. The Company has the ability and intent to hold these securities to maturity or put date. As of December 31, 1995, the average maturity date of the Company's fixed income securities was 4.7 years. The maturity distribution of the Company's fixed income securities and short-term investments as of December 31, 1995 is set forth below. The Company also maintains a portion of its investments in short-term instruments in order to pay claims on the Company's policies without being obligated to liquidate intermediate-term and long-term investments.\n(1) Amounts are amortized cost.\nThe following table describes the Company's income earned and the yields on investments for each of the years ended December 31:\n- ------------- (1) Calculated on the mean of total investments as of the first day of each calendar month. Investment income does not include net realized gain (loss) on investments or provision for income taxes or unallocated investment expenses.\nThe table below contains additional information concerning the investment ratings of the Company's investment portfolio at December 31, 1995:\n- --------------- (1) The ratings set forth above are based on the ratings, if any, assigned by Moody's Investors Service, Inc. (\"Moody's\") and Standard & Poor's Corporation (\"S&P\"). If Moody's or S&P ratings were unavailable, the equivalent ratings supplied by NAIC were used where available.\n(2) Carrying values for available for sale fixed maturities are at fair value, carrying value for held to maturity fixed maturities, including bonds and preferred stocks with mandatory redemption features, are at amortized cost and carrying values for available for sale equity securities, including common stocks and preferred stocks without mandatory redemption features are at fair value.\nREGULATION\nInsurance Company Regulation\nThe Subsidiary, as an Ohio property\/casualty insurance company, is subject to the primary regulatory supervision of the Ohio Department of Insurance. In addition, the Subsidiary is subject to regulation in each jurisdiction in which it is licensed to write insurance. In general, such regulation is designed to protect the interests of insurance policyholders rather than the Company or the Company's shareholders.\nSuch regulation relates to, among other matters: licensing of insurers and their agents; authorized lines of business; capital and surplus requirements and general standards of solvency; financial reports; reserve requirements; underwriting limitations; investment criteria; transactions with affiliates; dividend limitations; changes in control and a variety of other financial and nonfinancial matters.\nThe principal source of cash available to the Company is dividends from the Subsidiary. The Company is subject to the Ohio Insurance Holding Company System Regulatory Act, as amended, which requires that a 10-day notice of the proposed payment of any dividends or other distributions by the Subsidiary be given to the Ohio Superintendent of Insurance. If such dividends or distributions, together with any other dividends or distributions made within the preceding twelve months, exceed the greater of: (i) 10% of the Subsidiary's statutory surplus as of the immediately preceding December 31st, or (ii) the net income of the Subsidiary for the immediately preceding calendar year, a 30-day notice of such proposed dividend or distribution is required to be given to the Superintendent and the Superintendent may disapprove such dividend or distribution within the 10-day period following receipt of such notice.\nMost states have insurance laws requiring that rate schedules and other information be filed with the state's regulatory authority, either directly or through a rating organization with which the insurer is affiliated. The regulatory authority may disapprove a rate filing if it finds that the rates are inadequate, excessive or unfairly discriminatory. Rates vary by class of business, hazard assumed and size of risk, and are not necessarily uniform for all insurers. Many states have recently adopted laws which limit the ability of insurance companies to effect rate increases. To date, such limitations have had a limited impact on the Company, and the Company has no knowledge of any such limitations that may affect its future results of operations, although there can be no assurance that such limitations will not adversely affect the Company's results of operations in the future.\nAll insurance companies must file annual statements in states where they are authorized to do business and are subject to regular and special examinations by the regulatory agencies of those states. On August 9, 1994, the Ohio Department of Insurance issued its triennial examination report on Ohio Indemnity for the three-year period ended December 31, 1993. The examiners reported that the financial statements set forth in the report reflected the financial condition of Ohio Indemnity. Management is not aware of any recommendations by regulatory authorities which, if implemented, would have, or are reasonably likely to have, a material effect on the Company's liquidity, capital resources or results of operations. The next triennial review of the Company will be conducted by the Ohio Superintendent of Insurance in 1997 for the three-year period ending December 31, 1996.\nNumerous states routinely require deposits of assets by insurance companies to protect policyholders. As of December 31, 1995, securities with a market value of approximately $3,560,089 had been deposited by the Company with eleven state insurance departments. Such deposits must consist of securities which comply with standards established by the particular state's insurance department. The deposits, typically required by a state's insurance department on admission to do insurance business in such state, may be increased periodically as mandated by applicable statutory or regulatory requirements.\nInsurance Holding Company System Regulation\nThe Company is subject to certain provisions of the Ohio Insurance Holding Company System Regulatory Act, as amended, which governs any direct or indirect change in control of the Company and certain affiliated-party transactions involving the Company or its assets. No person may acquire, directly or indirectly, 10% or more of the outstanding voting securities of the Subsidiary, unless the Ohio Superintendent of Insurance has approved such acquisition. The determination of whether to approve any such acquisition is based on a variety of factors, including an evaluation of the acquirer's financial condition, the competence of its management and whether competition in Ohio would be reduced. In addition, certain material transactions involving the Company and the Subsidiary must be disclosed to the Ohio Superintendent of Insurance not less than 30 days prior to the effective date of the transaction. Such transaction can be disapproved by the Superintendent within such 30-day period if it does not meet certain standards. Transactions requiring such approval include, but are not limited to: sales, purchases or exchanges of assets; loans and extensions of credit; and investments not in compliance with statutory guidelines. The Subsidiary is also required to file periodic and updated statements reflecting the current status of its holding company system, the existence of any related-party transactions and certain financial information relating to any person who directly or indirectly controls (presumed to exist with 10% voting control) the Subsidiary. The Company believes that it is in compliance with the Ohio Insurance Holding Company System Regulatory Act and the regulations promulgated thereunder.\nThe National Association of Insurance Commissioners\nAll states have adopted the financial reporting form of NAIC, which is typically referred to as the NAIC \"annual statement,\" and most states, including Ohio, generally defer to NAIC with respect to statutory accounting practices and procedures. In this regard, NAIC has a substantial degree of practical influence and is able to accomplish certain quasi-legislative initiatives through amendments to the NAIC annual statement and applicable statutory accounting practices and procedures. For example, in recent years, NAIC has required all insurance companies to have an annual statutory financial audit and actuarial certification as to loss reserves by including such requirements in the annual statement instructions.\nDuring 1993, the NAIC adopted a Risk Based Capital (RBC) test applicable to property and casualty insurers as of December 31, 1994. The RBC calculation serves as a benchmark of insurance enterprises' solvency by state insurance regulators by establishing statutory surplus targets which will require certain Company level or regulatory level actions. Based on the Company's analysis, it appears that the Company's total adjusted capital is in excess of all required action levels and that no corrective action will be necessary. These Risk Based Capital provisions have not yet been enacted into the Ohio Revised Code.\nPENDING LEGISLATION\nThe insurance industry is under continuous review by both state and federal legislatures. From time to time various regulatory and legislative changes have been proposed in the insurance industry which could have an effect on insurers and reinsurers. Among the proposals that have in the past been, or are at present being, considered are the possible introduction of federal regulation in addition to, or in lieu of, the current system of state regulation of insurers, and other possible restrictions on insurance transactions with unlicensed insurers. The Company is unable to predict whether any of these proposals will be adopted, the form in which any such proposals would be adopted or the impact, if any, such adoption would have on the Company.\nEMPLOYEES\nAs of February 16, 1996, the Company employed 24 full-time employees. The Company is not a party to any collective bargaining agreement and is not aware of any efforts to unionize its employees.\nSERVICE MARKS\nThe Company has developed common law rights in its service mark, ULTIMATE LOSS INSURANCE, which is registered in the State of Ohio. The Company has federally registered its trademark, BI BANCINSURANCE CORPORATION(R) (stylized letters).\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company leases all of its office space, which as of February 16, 1996, totalled approximately 9,900 square feet. The home office in Columbus, Ohio aggregates approximately 7,000 square feet. The lease provides for a monthly gross rental of $7,817. The leased space is shared with Westford Group, Inc., an affiliate of the Company through a common officer and principal shareholder. Rental expense is allocated in accordance with space utilization. BCIS Services' office in Los Angeles, California occupies approximately 2,900 square feet. The lease provides for a monthly gross rental of $4,182.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe Company is routinely a party to litigation incidental to its business, as well as to other nonmaterial litigation. Management believes that no individual item of litigation, or group of similar items of litigation, including the matters referred to below, is likely to result in judgments that will have a material adverse effect on the financial condition or results of operations of the Company.\nOn November 2, 1994 the James L. Miniter Agency, Inc. (\"Agent\") filed a lawsuit against Ohio Indemnity alleging that Ohio Indemnity interfered with Agent's broker relationship with a policyholder. The Agent's complaint also alleged that Ohio Indemnity violated Massachusetts Unfair Trade Practices Act which provides for the trebling of damages in\nsome select circumstances. The case is presently pending in the United States District Court for the District of Massachusetts. On February 16, 1995 the Agent made a demand for $5 million (its purported compensatory damages trebled), an amount Ohio Indemnity believes to be unsupported by the facts or law involved in this matter. On June 2, 1995 Ohio Indemnity filed a motion for summary judgement seeking to have Agent's lawsuit dismissed. That motion is presently pending. Should Ohio Indemnity's motion not be granted, Ohio Indemnity is confident that it will nonetheless prevail in this action.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNot applicable.\n(THIS SPACE INTENTIONALLY LEFT BLANK)\nPART II\nItem 5.","section_5":"Item 5. Market for the Company's Common Stock and Related Security Holders Matters\n(a) Market Information\nBancinsurance Corporation's common stock trades on the Nasdaq National Market since March 1993 under the symbol \"BCIS.\" Prior to that, the Company's common stock was listed on the Nasdaq Small Cap Issues since September 1990. The following table sets forth, for the periods indicated, the high and low sale prices for the Company in the over-the-counter market as reported by the National Quotation Bureau, Inc. The prices shown represent quotation between dealers, without adjustment for retail markups, markdowns or commissions, and may not represent actual transactions. On February 16, 1996, the last reported sale price of the Company's common stock was $2 7\/8.\n(b) Holders\nThe number of holders of record of the Company's common stock as of February 16, 1996 was 1,062.\n(c) Dividends\nNo cash dividends were declared or paid on the Company's outstanding common stock in the two most recent fiscal years. The Company intends to retain earnings to finance the growth of its business and the business of Ohio Indemnity and BCIS Services and, therefore, does not anticipate paying any cash dividends to holders of its common stock. Any determination to pay dividends in the future will be at the discretion of the Company's Board of Directors and will be dependent upon the Company's results of operations, financial condition, legal and regulatory restrictions, and other factors deemed relevant at the time. Reference is made to Note 9 to the Notes to Consolidated Financial Statements for a description of the restrictions on payment of dividends to the Company from the Subsidiary.\n(THIS SPACE INTENTIONALLY LEFT BLANK)\nItem 6.","section_6":"Item 6. Selected Consolidated Financial Data\nSelected Income Statement Data:\nSelected Balance Sheet Data:\n(1) Earnings per share have been computed by dividing net income by the weighted average number of common shares outstanding during the year, including convertible preferred stock and stock options, which are included as common stock equivalents.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nOVERVIEW\nThe Company's principal sources of revenue are premiums paid by insureds for insurance policies issued by the Company. The premiums written become premiums earned for financial statement purposes as the premium is earned incrementally over the term of each insurance policy and after deducting the amount of premium ceded to reinsurers pursuant to reinsurance treaties or agreements. The Company's principal costs are losses and loss adjustment expenses. The principal factor in determining the level of the Company's profit is the difference between these premiums earned and losses and loss adjustment expenses incurred.\nLoss and loss adjustment expense reserves are estimates of what an insurer expects to pay on behalf of claimants. The Company is required to maintain reserves for payment of estimated losses and loss adjustment expenses for both reported claims and IBNR claims. The ultimate liability incurred by the Company may be different from current reserve estimates.\nLoss and loss adjustment expense reserves for IBNR claims are estimated based on many variables including historical and statistical information, inflation, legal developments, economic conditions, general trends in claim severity and frequency and other factors that could affect the adequacy of loss reserves. The Company reviews case and IBNR reserves monthly and makes appropriate adjustments.\nAs of July 28, 1995, Ohio Indemnity Company, a wholly owned subsidiary of the Company (\"Ohio Indemnity\"), entered into an agreement with the California Department of Insurance to discontinue sales and renewals of private passenger personal lines in automobile physical damage insurance in California. See \"DISCONTINUED PRODUCTS.\"\nSUMMARY RESULTS\nThe following table sets forth period to period changes in selected financial data:\nThe combined ratio, which is the sum of the loss ratio and expense ratio, determined in accordance with statutory accounting practices, is the traditional measure of underwriting experience for insurance companies. The following table reflects the loss, expense and combined ratios of the Subsidiary on both a statutory and GAAP basis for each of the years ended December 31:\nInvestments of the Subsidiary's assets are restricted to certain investments permitted by Ohio insurance laws. The Company's overall investment policy is determined by the Company's Board of Directors and is reviewed periodically. The Company principally invests in investment-grade obligations of states, municipalities and political subdivisions because the majority of the interest income from such investments is tax-exempt and such investments have generally resulted in favorable net yields. The Company has the ability and intent to hold its held to maturity fixed income securities to maturity or put date, and as a result carries its held to maturity fixed income securities at amortized cost for GAAP purposes. As the Company's fixed income securities mature, there can be no assurance that the Company will be able to reinvest in securities with comparable yields.\nRESULTS OF OPERATIONS\nYEAR ENDED DECEMBER 31, 1995 AS COMPARED TO YEAR ENDED DECEMBER 31, 1994\nPremiums Written; Premiums Earned. Premiums written decreased 60.6% from $35,629,799 in 1994 to $14,038,845 in 1995, while premiums earned decreased 22.5% from $25,535,824 in 1994 to $19,783,307 in 1995. Premiums decreased primarily due to the initial restructuring of the California Automobile Physical Damage Program in May 1995 and later discontinuance of sales and renewals on July 28, 1995. It is anticipated that premium will predominantly be earned through June 1996 as the policies expire. Management anticipates the discontinuance of the Automobile Physical Damage Program will result in a positive impact on underwriting results although there has been and will continue to be a material reduction in premiums associated with its discontinuance. Nonetheless, there can be no assurance that the discontinuance will not have a material adverse effect on the Company's operating results. See \"DISCONTINUED PRODUCTS.\"\nAutomobile Physical Damage Insurance accounted for $5,272,700 of premiums written and $9,507,516 of premiums earned in 1995, compared with $27,537,712 and $14,835,119 in 1994, a decrease of 80.9% and 35.9% respectively. The Company began commercially marketing the product in California in June 1992 and in Arizona in January 1993. In October 1994, the Company discontinued sales of Automobile Physical Damage insurance in Arizona. On April 30, 1995, the Company canceled its managing general agent contract for the sales of Automobile Physical Damage Insurance in California. On May 1, 1995, the reinsurance agreement applicable to the Automobile Physical Damage written through its managing general agent was canceled. Reinsurance will remain in force for all policies written by its managing general agent. In addition, on May 1, 1995, the Company assumed marketing and underwriting responsibilities and engaged an independent claims agent to handle subsequent settlements. As of December 31, 1995, there were $278,122 in premiums written under the restructured program. On July 28, 1995, Ohio Indemnity Company entered into an agreement with the California Department of Insurance to discontinue sales and renewals of private passenger personal lines in automobile physical damage insurance in California. See \"DISCONTINUED PRODUCTS.\" Premiums earned decreased less significantly than premiums written as a result of reductions in unearned premium resulting from the run-off and reductions in premiums written.\nPremiums written for Ultimate Loss Insurance remained relatively constant from $5,378,178 in 1994 to $5,479,857 in 1995. Premiums earned for Ultimate Loss Insurance decreased 11.7% from $7,717,291 in 1994 to $6,817,904 in 1995. The increase in premiums written during 1995 was the result of reductions in return premium and the decrease in net premiums earned related to reductions in unearned premium associated with the canceled policy and the elimination of continuation coverage on a second policy. See Note 14 to the Notes to Consolidated Financial Statements.\nPremiums written for the Bonded Service program increased 22.8% from $2,675,532 in 1994 to $3,285,708 in 1995, while premiums earned from the Bonded Service program increased 23.6% from $2,664,525 in 1994 to $3,293,325 in 1995. The increases in net premiums written and premiums earned on the Bonded Service program were primarily attributable to the addition in 1995 of one multi-employer group created by the cost containment service firm to service small not-for-profit organizations. As of December 31, 1995, the Company services five such groups.\nNet Investment Income. Net investment income decreased 9.4% from $1,560,625 in 1994 to $1,413,493 in 1995 primarily as a result of a smaller investment portfolio attributable to the Company's premium reduction relating to the discontinued Automobile Physical Damage program, offset in part by a higher return on investments in 1995 due to the prevailing interest rate environment. During 1995, the Company's investment\nstategy was primarily tax driven in order to utilize potentially expiring capital loss carryforwards and to shelter current year realized gains that were primarily market driven. In addition, unallocated investment expenses decreased, primarily attributable to a reduction in bond amortization of 80.4% from $142,365 in 1994 to $27,857 in 1995. The average yield on the investment portfolio was 5.6% in 1994 and 5.8% in 1995.\nClaims Administration. Claims administration income generated by BCIS Services accounted for $521,171 of the increase in revenues for 1994 and $533,354 in 1995. The wholly-owned subsidiary commenced business operations in California during the third quarter of 1993.\nOther Income. Other income increased from $58,938 in 1994 to $80,190 in 1995. The increase in other income was primarily due to earnings in 1995 of $24,400 attributed to fee income earned and $24,522 in recoveries. A portion of the fees charged to participants in the Bonded Service program by the cost containment service firm are used to establish an aggregate loss fund to cover potential losses. If losses reserved do not ultimately develop, a portion of the reserve fund is earned by the Company. Reserve years 1994, 1993 and 1992, though not fully developed at December 31, 1995 are expected to yield redundant reserves due to lower-than-anticipated losses. The Company expects other income to vary from year to year depending on claims experience of the Bonded Service program.\nLosses and Loss Adjustment Expenses, Net of Reinsurance Recoveries. Losses and loss adjustment expenses totaled $15,564,508, or 61.0% of premiums earned in 1994 versus $12,760,094, or 64.5% of premiums earned in 1995. Losses and loss adjustment expenses, as a percentage of premiums earned, increased for the same period because net premiums earned increased at a lower percentage rate than the percentage rate increase in losses and loss adjustment expenses. This result reflected higher loss and loss adjustment expense experience, reductions in premium volume and marginal increases in premium rates.\nThe absolute decrease in losses and loss adjustment expenses was primarily attributable to initial claims from the Automobile Physical Damage Insurance business in 1994 which totaled $11,111,284 compared with $8,614,845 in 1995. This decrease of 22.5%, was primarily due to the discontinuance of the Automobile Physical Damage program in 1995. The losses and loss adjustment expenses for Ultimate Loss Insurance decreased 14.6% from $4,083,264 in 1994 to $3,485,742 in 1995 due to decreases in loss and loss adjustment expenses connected with two significant lending institutions. See Note 14 to the Notes to Consolidated Financial Statements. Losses and loss adjustment expenses for the Bonded Service program decreased from $316,701 in 1994 to $176,684 in 1995 due to a decrease in reserves.\nOperating Expense. Operating expense consists of commission expense, other insurance operating expense, amortization of deferred policy acquisition costs and general and administrative expenses. Operating expense decreased 22.7% from $9,051,956 in 1994 to $6,997,969 in 1995. The decrease in operating expense was primarily attributable to a 8.7% decrease in 1995 in non-deferred commission expense and a 67.0% decrease in policy fees paid to the general agent in connection with administration of Automobile Physical Damage Insurance. Policy fees decreased from $2,483,795 in 1994 to $819,325 in 1995 due to discontinance of the program. Legal expenses increased from $320,800 in 1994 to $590,083 in 1995 as a result of legal work related to a Contract Dispute. See Note 19 to the Notes to Consolidated Financial Statements and Part I, Item 3. Legal Proceedings. Operating expense also decreased as a result of reductions in bond amortization expense, consulting and audit expenses. Amortization of deferred policy acquisition costs decreased 30.0% from $768,059 in 1994 to $538,017 in 1995 due to discontinuance of the Automobile Physical Damage Program. Insurance Department licenses and fees expense decreased 45.5% from $241,550 in 1994 to $131,639 in 1995 primarily due to securing additional states authority to accommodate the expansion of the Surety program during 1994. Additionally, BCIS Services incurred operating expenses of $565,910 in 1995 compared with $667,646 of operating expenses during 1994.\nInterest Expense. Interest expense increased 11.5% from $407,696 in 1994 to $454,497 in 1995. This increase was due to higher borrowing levels on the Company's revolving credit line and increases in the prime rate.\nFederal Income Taxes. The difference between Federal income taxes, $335,403 in 1994 and $176,698 in 1995, provided at the Company's effective tax rate, 12.6% in 1994 and 11.1% in 1995, and the 34% Federal statutory rate was primarily due to lower pre-tax income primarily due to a higher unearned premiums deduction and the recognition of\nhigher losses and loss adjustment expenses in 1995. See Note 6 to the Notes to Consolidated Financial Statements.\nStatutory Combined Ratios. The change in the statutory combined ratio from 95.7% in 1994 to 113.3% in 1995 was attributable to a decrease in premiums written primarily associated with the discontinued sales of automobile physical damage insurance together with higher loss and loss adjustment expense experience. See Losses and Loss Adjustment Expenses, Net of Reinsurance Recoveries.\nYEAR ENDED DECEMBER 31, 1994 AS COMPARED TO YEAR ENDED DECEMBER 31, 1993\nPremiums Written; Premiums Earned. Premiums written decreased 3.4% from $36,884,096 in 1993 to $35,629,799 in 1994, while premiums earned increased 29.0% from $19,787,858 in 1993 to $25,535,824 in 1994.\nAutomobile Physical Damage Insurance accounted for $27,537,712 of premiums written and $14,835,119 of premiums earned in 1994, compared with $26,249,514 and $10,925,091 in 1993, an increase of 4.9% and 35.8% respectively. The Company began commercially marketing Automobile Physical Damage Insurance in California in June 1992 and in Arizona from January 1993 to October 1994.\nPremiums written for Ultimate Loss Insurance decreased 39.0% from $8,809,547 in 1993 to $5,378 178 in 1994. Premiums earned for Ultimate Loss Insurance increased 5.9% from $7,289,015 in 1993 to $7,717,291 in 1994. Premiums written decreased primarily from the cancellation of a significant policy and the recognition of a return premium attributable to the elimination of continuation coverage on a second significant policy. Premiums earned increased as a result of reductions in unearned premium resulting from the canceled policy and the elimination of continuation coverage on the second policy. See Note 15 to the Notes to Consolidated Financial Statements. A discontinued product accounted for (0.3%) of premiums written and 0.1% of premiums earned for 1993.\nPremiums written for the Bonded Service program increased 100.2% from $1,336,473 in 1993 to $2,675,532 in 1994, while premiums earned from the Bonded Service program increased 100.4% from $1,329,361 in 1993 to $2,664,525 in 1994. The increases in net premiums written and premiums earned on the Bonded Service program were primarily attributable to the addition in 1994 of two multi-employer groups created by the TPA to service small not-for-profit organizations. As of December 31, 1994, the Company services four such groups.\nNet Investment Income. Net investment income increased 24.6% from $1,252,922 in 1993 to $1,560,625 in 1994 primarily as a result of higher interest earned on short-term investments and dividends earned on equity securities resulting from growth in invested assets during 1993. In addition, unallocated investment expenses decreased, primarily attributable to a reduction in bond amortization of 37.1% from $226,359 in 1993 to $142,365 in 1994. The average yield on the investment portfolio was 6.1% in 1993 and 5.6% in 1994.\nClaims Administration. Claims administration income generated by BCIS Services accounted for $154,523 of the increase in revenues for 1993 and $521,171 in 1994. The wholly-owned subsidiary commenced business operations in California during the third quarter of 1993.\nOther Income. Other income decreased from $471,562 in 1993 to $58,938 in 1994. The decrease in other income was primarily due to earnings in 1993 of $396,612 attributed to the release of redundant reserves from the aggregate loss fund established in connection with the Bonded Service program. A portion of the fees charged to participants in the Bonded Service program by the TPA is used to establish an aggregate loss fund to cover potential losses. If losses reserved do not ultimately develop, a portion of the reserve fund is earned by the Company. Reserve year 1993, though not fully developed at December 31, 1994 is not expected to yield redundant reserves due to higher-than-anticipated losses. The Company expects other income to vary from year to year depending on claims experience of the Bonded Service program.\nLosses and Loss Adjustment Expenses, Net of Reinsurance Recoveries. Losses and loss adjustment expenses totaled $10,918,649, or 55.2% of premiums earned in 1993 versus $15,564,508, or 61.0% of premiums earned in 1994. Losses and loss adjustment expenses, as a percentage of premiums earned, increased for the same period because premiums earned increased at a lower percentage rate than the percentage rate increase in losses\nand loss adjustment expenses. This result reflected higher loss and loss adjustment expense experience, smaller increases in premium volume and marginal increases in premium rates.\nThe absolute increase in losses and loss adjustment expenses was primarily attributable to initial claims from the Automobile Physical Damage Insurance business written in 1994 which totaled $11,111,284 compared with $7,179,975 in 1993. This increase of 54.8%, was due to higher loss and loss adjustment expense experience in 1994, in part due to the 1994 California earthquake. The losses and loss adjustment expenses for Ultimate Loss Insurance rose 5.1% from $3,884,133 in 1993 to $4,083,264 in 1994 due to higher-than-anticipated loss and loss adjustment expenses related to a discontinued product and increases in loss and loss adjustment expense payments connected with two significant lending institutions. See Note 15 to the Notes to Consolidated Financial Statements. Losses and loss adjustment expenses for the Bonded Service program increased from $(204,363) in 1993 to $316,701 in 1994 due to an increase in reserves.\nOperating Expense. Operating expense consists of commission expense, other insurance operating expense, amortization of deferred policy acquisition costs and general and administrative expenses. Operating expense increased 24.1% from $7,295,811 in 1993 to $9,051,956 in 1994. The increase in operating expense was primarily attributable to a 61.4% increase in 1994 in non-deferred commission expense and a 8.7% increase in policy fees paid to the general agent in connection with administration of Automobile Physical Damage Insurance. Policy fees increased from $2,285,575 in 1993 to $2,483,795 in 1994 due to expansion of the program. Legal expenses decreased from $666,084 in 1993 to $320,800 in 1994 as a result of a reduction in legal work related to a discontinued product. See Note 19 to the Notes to Consolidated Financial Statements and Part I, Item 3. Legal Proceedings. Operating expense also increased as a result of recognition of amortized deferred policy acquisition costs that increased from $535,233 in 1993 to $768,059 in 1994 due to the expansion of the Surety and the Automobile Physical Damage programs. Insurance Department licenses and fees expense increased 63.5% from $147,719 in 1993 to $241,550 in 1994 in part due to securing additional states authority to accommodate the expansion of the Surety program. Additionally, BCIS Services incurred operating expenses of $667,646 in 1994 compared with $455,761 in start-up costs during 1993.\nInterest Expense. Interest expense increased 93.8% from $210,401 in 1993 to $407,696 in 1994. This increase, despite lower interest rates, was due to higher borrowing levels on the Company's revolving credit line and increases in the prime rate.\nFederal Income Taxes. The difference between Federal income taxes, $580,379 in 1993 and $335,403 in 1994, provided at the Company's effective tax rate, 20.5% in 1993 and 12.6% in 1994, and the 34% Federal statutory rate was primarily due to a significant portion of pre-tax income representing dividends received and tax-exempt interest deductions, and in 1994 the adjustment resulting from a restructuring of the policy coverage and the policy cancellation with two significant customers in the Ultimate Loss Insurance program. See Note 6 to the Notes to Consolidated Financial Statements.\nStatutory Combined Ratios. The change in the statutory combined ratio from 80.6% in 1993 to 95.7% in 1994 was attributable to higher general and administrative expenses and higher loss and loss adjustment expense experience, together with marginal increases in premium rates.\nYEAR ENDED DECEMBER 31, 1993 AS COMPARED TO YEAR ENDED DECEMBER 31, 1992\nPremiums Written; Premiums Earned. Premiums written increased 79.0% from $20,608,288 in 1992 to $36,884,096 in 1993, while premiums earned increased 85.7% from $10,657,111 in 1992 to $19,787,858 in 1993.\nAutomobile Physical Damage Insurance accounted for $26,249,514 of premiums written and $10,925,091 of premiums earned in 1993. These amounts represent 97.1% and 94.0%, respectively, of the increase in 1993 in premiums written and premiums earned. The Company began commercially marketing Automobile Physical Damage Insurance in California in June 1992 and in Arizona in January 1993.\nPremiums written for Ultimate Loss Insurance rose 3.1% from $8,543,129 in 1992 to $8,809,547 in 1993. Premiums earned for Ultimate Loss Insurance increased 2.3% from $7,125,358 in 1992 to $7,289,015 in 1993. The marginal increases in net premiums written and premiums earned on Ultimate Loss Insurance were primarily due to the expansion of loan portfolios of existing policyholders. A discontinued product\naccounted for (0.3%) of premiums written and 0.1% of premiums earned for 1993.\nPremiums written for the Bonded Service program increased 29.6% from $1,031,336 in 1992 to $1,336,473 in 1993, while premiums earned from the Bonded Service program increased 30.1% from $1,022,178 in 1992 to $1,329,361 in 1993. The increases in net premiums written and premiums earned on the Bonded Service program were primarily attributable to growth in the program comprising two multi-employer groups created by the TPA to service small not-for-profit organizations.\nNet Investment Income. Net investment income increased 60.3% from $781,659 in 1992 to $1,252,922 in 1993 as a result of growth in cash and invested assets generated by increases in premiums written. Cash and invested assets increased 46.2% from $20,759,612 in 1992 to $30,347,836 in 1993. The average yield on the investment portfolio was 6.1% in 1992 and 6.1% in 1993.\nClaims Administration. Claims administration income generated by BCIS Services accounted for $154,523 of the increase in revenues for 1993. The wholly-owned subsidiary commenced business operations in California during the third quarter of 1993.\nOther Income. Other income increased from $459,499 in 1992 to $471,562 in 1993. The increase in other income was primarily due to earnings of $396,612 attributed to the release of redundant reserves from the aggregate loss fund established in connection with the Bonded Service program. A portion of the fees charged to participants in the Bonded Service program by the TPA is used to establish an aggregate loss fund to cover potential losses. If losses reserved do not ultimately develop, a portion of the reserve fund is earned by the Company. The Company expects other income to vary from year to year depending on claims experience of the Bonded Service program.\nLosses and Loss Adjustment Expenses, Net of Reinsurance Recoveries. Losses and loss adjustment expenses totaled $5,063,855, or 47.5% of premiums earned in 1992 versus $10,918,649, or 55.2% of premiums earned in 1993. Losses and loss adjustment expenses, as a percentage of premiums earned, increased for the same period because premiums earned increased at a lower percentage rate than the percentage rate increase in losses and loss adjustment expenses. This result reflected higher loss and loss adjustment expense experience, smaller increases in premium volume and marginal increases in premium rates.\nThe absolute increase in losses and loss adjustment expenses was primarily attributable to initial claims from the Automobile Physical Damage Insurance business written in 1993 which totaled $6,931,248. The losses and loss adjustment expenses for Ultimate Loss Insurance rose 26.0% from $3,300,219 in 1992 to $4,157,401 in 1993. Losses and loss adjustment expenses for the Bonded Service program decreased from $380,969 in 1992 to ($232,993) in 1993 due to decrease in reserves.\nOperating Expense. Operating expense consists of commission expense, other insurance operating expense, amortization of deferred policy acquisition costs and general and administrative expenses. Operating expense increased 95.3% from $3,734,776 in 1992 to $7,295,811 in 1993. The increase in operating expense was primarily attributable to a 101.6% increase in 1993 in other insurance operating expense. Policy fees paid to the general agent in connection with administration of Automobile Physical Damage Insurance policies increased from $931,100 in 1992 to $2,285,575 in 1993 due to expansion of the program. Legal expenses increased from $62,561 in 1992 to $666,084 in 1993 as a result of legal matters. Management believes the foregoing legal proceedings will not have a material effect on the Company's financial condition or results of operations and that the related reserve for potential losses and legal proceedings are adequate. See Note 19 to the Notes to Consolidated Financial Statements and Part I, Item 3. Legal Proceedings. Operating expense also increased as a result of recognition of amortized deferred policy acquisition costs that increased from $118,130 in 1992 to $535,233 in 1993 due to the expansion of the Automobile Physical Damage program. Other insurance operating expenses also increased by $455,761 for start-up costs related to the commencement of business by BCIS Services, Inc. during 1993 and non-deferred commission expenses increased from $1,295,625 in 1992 to $1,956,733 in 1993 resulting from increased policies written on the Company's product lines.\nInterest Expense. Interest expense increased 3.2% from $203,941 in 1992 to $210,401 in 1993. This increase, despite lower interest rates, was due to higher borrowing levels on the Company's revolving credit line.\nRegistration Expenses. On March 17, 1993, Bancinsurance Corporation filed a registration statement with the SEC in connection with the proposed sale of additional shares of common stock. Later the offering was withdrawn and registration expenses of $415,390 were charged to operations during 1993.\nFederal Income Taxes. The Company adopted SFAS 109, \"Accounting for Income Taxes,\" as of January 1, 1993, and the cumulative effect of this change as reported in the Consolidated Statement of Income was to increase income by $48,587. Prior years' financial statements have not been restated. The difference between Federal income taxes, $580,379 in 1993 and $758,167 in 1992, provided at the Company's effective tax rate, 20.5% in 1993 and 26.2% in 1992, and the 34% Federal statutory rate was primarily due to a significant portion of pre-tax income representing dividends received and tax-exempt interest deductions, and in 1993 the adjustment of prior year tax resulting from adoption of SFAS 109 (see Note 6 of notes to Consolidated Financial Statements).\nStatutory Combined Ratios. The change in the statutory combined ratio from 67.7% in 1992 to 80.6% in 1993 was attributable to higher loss and loss adjustment experience and marginal increases in premium rates, together with higher general and administrative expenses.\nDISCONTINUED PRODUCTS\nIn October 1994, the Company discontinued sales of Automobile Physical Damage insurance in Arizona which accounted for 2.2% of premiums written and 1.9% of premiums earned in 1994. The Company's managing General Agent withdrew from Arizona and discontinued sales. On April 30, 1995, the Company canceled its managing general agent contract for the sales of Automobile Physical Damage Insurance in California. On May 1, 1995, the reinsurance agreement applicable to the Automobile Physical Damage written through its managing general agent was canceled. Reinsurance will remain in force for all policies written by its managing general agent. In addition, on May 1, 1995 the Company assumed marketing and underwriting responsibilities and engaged an independent claims agent to handle subsequent settlements. On July 28, 1995, Ohio Indemnity entered into an agreement with the California Department of Insurance to discontinue sales and renewals of private passenger personal lines in automobile physical damage insurance in California for a maximum period of three years. It is anticipated that premium will predominantly be earned through June 1996 as the policies expire. The Automobile Physical Damage Insurance program represented 37.6% of the Company's premiums written and 48.1% of the Company's premiums earned for 1995 versus 77.3% and 58.1%, and 71.2% and 55.2%, respectively, for 1994 and 1993. See \"RESULTS OF OPERATIONS.\"\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company is an insurance holding company whose principal asset is the stock of Ohio Indemnity. The Company is, and will continue to be, dependent on dividends from the Subsidiary to meet its liquidity requirements, including debt service obligations. The Company has a $10 million credit facility to fund working capital requirements. Based on statutory limitations, the maximum amount of dividends that the Company would be able to receive in 1996 from the Subsidiary, absent regulatory consent, is $2,660,432. See Note 9 to the Notes to Consolidated Financial Statements.\nThe Subsidiary derives its funds principally from net premiums written, reinsurance recoveries, investment income and contributions of capital from the Company. See \"Business - Reinsurance.\" The principal use of these funds is for payment of losses and loss adjustment expenses, commissions, operating expenses and income taxes. Net cash provided by (used in) operating activities equalled $7,585,553, ($1,713,691) and ($4,907,977) for the years ended December 31, 1993, 1994, and 1995, respectively. Net cash provided by (used in) financing activities was $1,831,757, $459,063 and ($415,026) for the years ended December 31, 1993, 1994, and 1995, respectively. Net cash provided by (used in) investing activities of the Company was ($7,972,659), ($815,304) and $6,234,041 for the years ended December 31, 1993, 1994, and 1995, respectively.\nBCIS Services derives its funds principally from claims administration fees which are sufficient to meet its operating obligations.\nThe Company maintains a level of cash and liquid short-term investments which it believes will be adequate to meet anticipated payment obligations without being required to liquidate intermediate-term and long-term investments through the end of 1996. Due to the nature of the risks the Company insures, losses and loss adjustment expenses emanating from its policies are characterized by relatively short settlement periods and quick development of ultimate losses compared to claims emanating from other types of insurance products. Therefore, the Company believes that it can estimate its cash needs to meet its loss and expense payment obligations through the end of 1996.\nThe Company's investments at December 31, 1995 consisted primarily of investment-grade fixed income securities. Cash and short-term investments at December 31, 1995 amounted to $6,583,900, or 27.6% of total cash and invested assets. The fair values of the Company's held to maturity fixed income securities are subject to market fluctuations but are carried on the balance sheet at amortized cost because the Company has the ability and intent to hold held to maturity fixed income securities to maturity or put date. Available for sale fixed income securities are reported at fair value with unrealized gains or losses, net of applicable deferred taxes, reflected in shareholders' equity. The Company earned net investment income of $1,252,922, $1,560,625 and $1,413,493 for the years ended December 31, 1993, 1994 and 1995, respectively.\nAs of December 31, 1995, 84.3% of the Company's total assets consisted of investment-grade fixed income securities, equity securities, short-term investments, other corporate securities and cash. The Company's total shareholders' equity increased from $9,909,742 in 1993 to $11,838,424 in 1994 to $13,710,410 in 1995 representing a 38.4% increase over the three-year period. The increase in total shareholders' equity has strengthened the Company's capital position.\nAs of December 31, 1995, the Company had a $10.0 million revolving line of credit with an outstanding balance of $5,616,132. The credit facility has a maturity date of May 1, 1999 and bears interest at the bank's prime rate (8.5% per annum at December 31, 1995).\nAll material capital commitments and financial obligations of the Company are reflected in the Company's financial statements, except the Company's risk on surety bonds and state mandated performance bonds, written in connection with the Bonded Service program. The financial statements include reserves for losses on such programs for any claims filed and for an estimate of incurred but not reported losses. Such reserves were $500,000 and $345,000 at December 31, 1994 and 1995, respectively.\nUnder applicable insurance statutes and regulations, the Subsidiary is required to maintain prescribed amounts of capital and surplus as well as statutory deposits with the appropriate insurance authorities. The Subsidiary is in compliance with all applicable statutory capital and surplus requirements. The Subsidiary's investments consist only of permitted investments under Ohio insurance laws.\nNAIC guidelines recommend that a property\/casualty insurer's ratio of annual statutory net premiums written to statutory surplus be no greater than 3 to 1. At December 31, 1995, the ratio of combined annual statutory net premiums written by the Subsidiary to its combined statutory surplus was approximately 0.68 to 1.\nFACTORS TO CONSIDER FORWARD LOOKING\nManagement has undertaken several initiatives in 1995 which should favorably impact performance in 1996, although there can be no assurance that this will occur. The discontinuance of the Automobile Physical Damage Program in California should allow the Company to improve its profit potential.\nThe discontinuance of the Automobile Physical Damage Program in California should result in a positive impact on underwriting results although there has been and will continue to be a material reduction in premiums associated with its discontinuance. Additionally, the restructured business should allow for better concentration on established products and opportunities intended to improve the Company's performance over the long-term. Nonetheless, there can be no assurance that the discontinuance will not have a material adverse effect on the Company's results of operations.\nThe Company expects to continue expanding its direct sale force, which should allow the Company to increase its market penetration. These activities will be directed toward\nselected market niches where management believes the Company will be able to provide customers with additional services.\nINFLATION\nAlthough the cumulative effects of inflation on premium growth cannot be fully determined, increases in the retail price of automobiles have generally resulted in increased amounts being financed which constitutes one of the bases for determining premiums on Ultimate Loss Insurance. Despite relatively low inflation during 1995, the Company has experienced no material adverse consequences with respect to its growth in premiums.\nTRENDS\nManagement does not know of any trends, events or uncertainties that will have, or that are reasonably likely to have, a material effect on the Company's liquidity, capital resources or results of operations.\nThe Company's results of operations have varied from quarter to quarter principally because of fluctuations in underwriting results. The Company's experience indicates that more loans for automobile purchases are financed during summer months due to seasonal consumer buying habits. The Company expects that such quarterly fluctuations may lessen as a result of the discontinuance of the California Automobile Physical Damage Program, although there can be no assurance that this will occur. See Note 15 to the Notes to Consolidated Financial Statements.\nINSURANCE REGULATORY MATTERS\nOn August 9, 1994, the Ohio Department of Insurance issued its triennial examination report on Ohio Indemnity as of December 31, 1993. The examiners reported that the financial statements set forth in the report reflected the financial condition of Ohio Indemnity. Management is not aware of any recommendations by regulatory authorities which would have, or are reasonably likely to have, a material effect on the Company's liquidity, capital resources or results of operations.\nThe NAIC has developed a risk-based capital measurement formula to be applied to all property\/casualty insurance companies. This formula calculates a minimum required statutory net worth, based on the underwriting, investment, credit, loss reserve and other business risks inherent in an individual company's operations. Under the current formula, any insurance company which does not meet threshold risk-based capital measurement standards could be forced to reduce the scope of its operations and ultimately could become subject to statutory receivership proceedings. Based on the Company's analysis, it appears that the Company's total adjusted capital is in excess of all required action levels and that no corrective action will be necessary. The Risk Based Capital provisions have not yet been enacted into the Ohio Revised Code.\nRESERVES\nThe amount of incurred losses and loss adjustment expenses is dependent upon a number of factors, including claims frequency and severity, and the nature and types of losses incurred and the number of policies written. These factors may fluctuate from year to year and do not necessarily bear any relationship to the amount of premiums written or earned.\nAs claims are incurred, provisions are made for unpaid losses and loss adjustment expenses by accumulating case reserve estimates for claims reported prior to the close of the accounting period and by estimating IBNR claims based upon past experience modified for current trends. Notwithstanding the variability inherent in such estimates, management believes that the provisions made for unpaid losses and loss adjustment expenses are adequate to meet claims obligations of the Company. Such estimates are reviewed monthly by management and annually by an independent consulting actuary and, as adjustments thereto become necessary, such adjustments are reflected in the Company's results of operations. The Company's independent consulting actuary has opined that loss and loss adjustment expense reserve levels, as of December 31, 1995, were reasonable.\nRECENT ACCOUNTING AND LEGISLATIVE CHANGES\nDuring 1993, the National Association of Insurance Commissioners adopted a Risk Based Capital (RBC) test applicable to property and casualty insurers as of December 31, 1994. The RBC calculation serves as a benchmark of insurance enterprises' solvency by state insurance regulators by establishing statutory surplus targets which will require certain Company level or regulatory level actions. Based on the Company's analysis, it appears that the Company's total adjusted capital is in excess of all required action levels and that no corrective action will be necessary. The Risk Based Capital provisions have not yet been enacted into the Ohio Revised Code.\nIn October 1995, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 123, \"Accounting for Stock-Based Compensation,\" which defines a fair value based method of accounting for employee stock options and similar equity instruments. Hwoever, SFAS No. 123 also allows an entity to continue to account for these plans according to Accounting Principals Board Opinion No. 25 (APB 25), provided pro forma disclosures of net income and earnings per share are made as if the fair value based method of accounting defined by SFAS No. 123 had been applied. The Company expects to continue to measure compensation cost related to employee stock purchase options using APB 25 and will provide pro forma disclosures as required. This statement is effective for the year ended December 31, 1996.\n(THIS SPACE INTENTIONALLY LEFT BLANK)\nItem 8.","section_7A":"","section_8":"Item 8. Consolidated Financial Statements and Supplementary Data\nIndex to Consolidated Financial Statements\nIncluded in Part II of this report:\nIndependent Auditors' Reports\nConsolidated Balance Sheets as of December 31, 1995 and 1994\nConsolidated Statements of Income for the years ended December 31, 1995, 1994 and 1993\nConsolidated Statements of Shareholders' Equity for the years ended December 31, 1995, 1994 and 1993\nConsolidated Statements of Cash Flows for the years ended December 31, 1995, 1994 and 1993\nNotes to Consolidated Financial Statements\nIndex to Financial Statement Schedules\nIncluded in Part IV of this report:\nSchedule I -- Summary of investments - other than investments in related parties\nSchedule II -- Condensed financial information of Bancinsurance Corporation (Parent Company Only)\n(THIS SPACE INTENTIONALLY LEFT BLANK)\nREPORT OF INDEPENDENT ACCOUNTANTS\nThe Board of Directors and Shareholders Bancinsurance Corporation:\nWe have audited the consolidated balance sheets of Bancinsurance Corporation and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of income, shareholders' equity, cash flows, and the financial statement schedules for each of the years in the three-year period ended December 31, 1995, as listed in Item 8 of this Form 10-K. These consolidated financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as 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 Bancinsurance Corporation and subsidiaries as of December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1995, 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 consolidated financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.\nAs discussed in Note 1(d) to the consolidated financial statements, effective January 1, 1994, the Company adopted the provisions of Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\".\n\/s\/ Coopers & Lybrand L.L.P. ------------------------ Columbus, Ohio February 23, 1996\nBANCINSURANCE CORPORATION AND SUBSIDIARIES\nConsolidated Balance Sheets\nDecember 31, 1995 and 1994\n(Continued)\nBANCINSURANCE CORPORATION AND SUBSIDIARIES\nConsolidated Balance Sheets, Continued\nSee accompanying notes to consolidated financial statements.\nBANCINSURANCE CORPORATION AND SUBSIDIARIES\nConsolidated Statements of Income\nYears Ended December 31, 1995, 1994, and 1993\nSee accompanying notes to consolidated financial statements.\nBANCINSURANCE CORPORATION AND SUBSIDIARIES\nConsolidated Statements of Shareholders' Equity\nYears Ended December 31, 1995, 1994, and 1993\nSee accompanying notes to consolidated financial statements.\nBANCINSURANCE CORPORATION AND SUBSIDIARIES\nConsolidated Statements of Cash Flows\nYears Ended December 31, 1995, 1994, and 1993\n(Continued)\nBANCINSURANCE CORPORATION AND SUBSIDIARIES\nConsolidated Statements of Cash Flows, Continued\nSee accompanying notes to consolidated financial statements.\nBANCINSURANCE CORPORATION AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\nDecember 31, 1995, 1994, and 1993\n(1) Summary of Significant Accounting Policies\n(a) Organization\nBancinsurance Corporation (the Company) was incorporated in the state of Ohio in 1970. The Company is primarily engaged, through its wholly-owned subsidiary, Ohio Indemnity, in the underwriting of specialized property and casualty insurance. Ohio Indemnity is licensed in forty-four states and the District of Columbia and licensed for surplus lines in Texas. As such, Ohio Indemnity is subject to the regulations of the Department of Insurance of the State of Ohio (the Department) and the regulations of each state in which it operates. During 1993, BCIS Services, Inc. was incorporated as a wholly-owned subsidiary of the Company. BCIS Services provides workers' compensation professional administration and cost control services to employers who self-insure this obligation. No single customer of the Company accounts for a predominant share of consolidated revenue, except for one customer in the Ultimate Loss Insurance program and one customer in the Surety program. See Note 14.\n(b) Basis of Financial Statement Presentation\nThe accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles (GAAP) (which vary in certain respects from reporting practices prescribed or permitted by the Department). Prescribed statutory accounting practices include a variety of publications of the National Association of Insurance Commissioners (NAIC), as well as state laws, regulations, and general administrative rules. Permitted statutory accounting practices encompass all accounting practices not so prescribed. Statutory accounting practices differ from GAAP in that: (1) assets must be included in the statutory statements at \"admitted asset value\" and \"nonadmitted assets\" must be excluded through a charge against surplus; (2) policy acquisition costs are charged against income as incurred rather than being deferred and amortized over the terms of the related policies; (3) ceded reinsurance balances payable are reflected as a reduction of premiums in the course of collection rather than as a liability; (4) adjustments reflecting the revaluation of stocks are carried to the surplus account as unrealized investment gains or losses, without providing for Federal income taxes; and (5) the fixed maturities are carried at amortized cost instead of market value with no unrealized gain or loss reflected in surplus. The effects of these differences on stockholder's equity and net income are shown in Note 10.\nThe Company received written approval from the Department to record Unearned Premium reserves in the amount of $1,654,848 at December 31, 1995 for the premium applicable to the unexpired portion of certain ultimate loss insurance policies, whereby coverage was extended to include runoff and to record Contract Funds On Deposit for the portion of funds allocated toward the payment of benefits collected pursuant to a bond insuring the payment of certain reimbursable unemployment compensation benefits on behalf of enrolled employers.\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\n(c) Consolidation Policy\nThe accompanying financial statements include the accounts of the Company and\nBANCINSURANCE CORPORATION AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\nits wholly-owned subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation.\n(d) Investments\nEffective January 1, 1994, the Company adopted SFAS No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" and has reported the cumulative effect of this accounting change, represented by the unrealized gain for available for sale securities of $1,016,646, net of the related deferred income taxes of $345,660 as an increase in shareholders' equity. Investments in fixed maturities held as available for sale are carried at fair value. The net unrealized holding gain or loss, net of applicable deferred taxes, is shown as a separate component of stockholders' equity, and is not included in the determination of net earnings. Prior to the adoption of SFAS No. 115, fixed maturities were reported at cost adjusted for the amortization of premium or discount and other than temporary market value declines. Investments in held to maturity fixed maturities, which include bonds and preferred stocks with mandatory redemption features, where the Company has the ability and intent to hold to maturity or put date, are carried at amortized cost. As permitted by the Financial Accounting Standards Board's Special Report entitled \"A Guide to Implementation of Statement 115 an Accounting for Certain Investments in Debt and Equity Securities\", the Company reassessed the appropriateness of its classifications of all securities held. As a result, the Company transferred additional securities from its held to maturity portfolio to available for sale.\nAvailable for sale equity securities, which include common stocks and preferred stocks without mandatory redemption features, are reported at fair value with unrealized gains or losses, net of applicable deferred taxes, reflected in shareholders' equity. Short-term investments are reflected at cost which approximates fair value.\nRealized gains and losses on disposal of investments are determined by the specific identification method and are included in investment income. The carrying value of investments is revised and the amount of revision is charged to net realized losses on investments when management determines that a decline in the value of an investment is other than temporary.\n(e) Excess of Investment Over Net Assets of Subsidiary\nAs allowed by generally accepted accounting principles, the excess of investment over net assets of Ohio Indemnity acquired is not being amortized as the acquisition took place on April 22, 1970, and there is no permanent diminution in value of such excess.\n(f) Recognition of Premium Revenues and Related Expenses\nInsurance premiums are recorded as revenue over the period of risk assumed. For the Company's \"Ultimate Loss Insurance\" products, a form of physical damage blanket single interest insurance sold to lending institutions, premiums are earned in relation to the level of exposure assumed. For the surety and auto physical damage products, premiums are earned pro rata. The portion of premiums written applicable to the unexpired portion of insurance contracts is recorded in the balance sheet as unearned premiums.\n(g) Acquisition costs\nDuring 1992, the Company started writing a new line of business and began capitalizing and amortizing certain policy acquisition costs incurred at policy issuance. Such costs are deferred and amortized over the term of the policy to the extent that these deferred costs can be recovered from future profits, including anticipated investment income related to the line of\nBANCINSURANCE CORPORATION AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\nbusiness. Certain other lines of business have acquisition costs that have not been deferred due to the uncertainty surrounding ultimate profit margins.\n(h) Reserve for Unpaid Losses and Loss Adjustment Expenses\nReserve for unpaid losses and loss adjustment expenses includes case basis estimates of reported losses and estimates of losses incurred but not reported based upon past experience. The reserve also includes an estimate of the loss adjustment expenses to be incurred in the settlement of items provided for in the reserve for unpaid losses. These reserves are reported net of amounts recoverable from salvage and subrogation. Management believes the reserve for unpaid losses and loss adjustment expenses is adequate. Amounts recoverable from the reinsurer are estimated in a manner consistent with the reserve for unpaid losses and loss adjustment expenses and are recorded as a reinsurance receivable.\n(i) Reinsurance\nThe Company's reinsurance transactions are primarily attributable to premiums written in its automobile physical damage business, for which the Company seeks to reduce its loss exposure. The Company records its reinsurance transactions in accordance with the provisions of SFAS No. 113, \"Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts.\"\n(j) Contract Funds on Deposit\nThe Company has an agreement with a cost containment service firm involving a program designed to control the unemployment compensation costs of certain non-profit employers. Pursuant to this agreement, a bond has been issued insuring the payment of certain reimbursable unemployment compensation benefits on behalf of the employers enrolled in this program. Certain monies allocated toward the payment of these benefits are held by the Company. The Company and cost containment service firm share any redundancy resulting from the development of the claims to be paid from the contract funds held on deposit. The Company recognized $396,612 in redundant reserves which are included in other income in 1993. No redundant reserves were recognized in 1995 or 1994.\n(k) Return Premiums Payable\nReturn premiums payable are computed based upon a comparison of reported losses to expected losses with certain insured companies. If actual losses reported are less than expected losses, a return of premium is due to the insured.\n(l) Depreciation and Amortization\nFurniture and fixtures are stated at cost and depreciated using the straight-line method over a five year useful life. Leasehold improvements are amortized over the remaining office lease term. Maintenance, repairs and minor renewals are charged directly to expense as incurred. When furniture and fixtures are sold or otherwise disposed of, the related cost and accumulated depreciation are removed from the accounts and the resulting gains or losses are included in the accompanying statements of income.\n(m) Earnings Per Share\nEarnings per share have been computed by dividing net income less requirements for preferred dividends by the weighted average number of common shares outstanding during the year, including outstanding convertible preferred stock and stock options, which are included as common stock equivalents.\nBANCINSURANCE CORPORATION AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\n(n) Federal Income Taxes\nBancinsurance Corporation files a consolidated federal income tax return with its subsidiaries. Effective January 1, 1993, the Company adopted the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS 109\"). Accordingly, deferred tax liabilities and assets have been recognized for the expected future tax consequences of events that have been included in the financial statements or tax returns. Deferred income taxes are recognized at prevailing income tax rates 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.\n(o) Disclosures about Fair Value of Financial Instruments\nThe following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that fair value:\nCash, short-term investments and securities purchased under agreements to resell:\nFor these short-term investments, the carrying amounts are reasonable estimates of fair value.\nFixed maturities and equity securities:\nFair values are based upon quoted market prices or dealer quotes for comparable securities.\nNote payable to bank:\nRates currently available to the Company for debt with similar terms and remaining maturities are used to estimate fair value of existing debt. The carrying amount is a reasonable estimate of fair value.\n(THIS SPACE INTENTIONALLY LEFT BLANK)\nBANCINSURANCE CORPORATION AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\n(2) Investments\nThe amortized cost and estimated fair values of investments in held to maturity and available for sale securities were as follows:\nBANCINSURANCE CORPORATION AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\nThe amortized cost and estimated fair value of investments in held to maturity and available for sale securities at December 31, 1995 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.\nGross investment income, including net realized gains and losses, is summarized below:\nAllfixed maturity investments were income producing for the years ended December 31, 1995, 1994 and 1993.\nPre-tax net realized gains (losses) on investments were as follows for each of the years ended December 31:\nFrom time to time, the Company purchases securities under agreements to resell the same securities (repurchase agreements). The amounts advanced under these agreements represent short-term loans. The fair value of the securities underlying the agreements approximates the carrying value.\nAt December 31, 1995, investments having a par value of $3,420,000 were on deposit with various state insurance departments to meet their respective regulatory requirements.\nBANCINSURANCE CORPORATION AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\n(3) Deferred Policy Acquisition Costs\nChanges in deferred policy acquisition costs at December 31 are summarized as follows:\n(4) Note Payable to Bank\nAs of December 31, 1995, the Company had a $10,000,000 revolving line of credit with a maturity date of May 1, 1999 and an outstanding balance of $5,616,132. The revolving credit agreement bears interest payable quarterly, at the bank's prime rate (8.5% per annum at December 31, 1995). Under the terms of the revolving line of credit agreement, the Company has provided the lending bank a collateral assignment of a $100,000 face value life insurance policy on the life of the President. The policy cash value at December 31, 1995, was $22,148.\n(5) Leases and Shared Expenses\nOhio Indemnity leases its office facility and an automobile. The office facilities are shared with other affiliated entities and rental and bookkeeping expenses are allocated among them. This operating lease expires in 2000. BCIS Services leases its office facility under an operating lease that expires in 1996.\nConsolidated rental expenses under operating leases were $73,750 in each of the years 1995, 1994 and 1993, respectively.\nThe future minimum lease payments required under these operating leases, as of December 31, 1995 follows:\nBANCINSURANCE CORPORATION AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\n(6) Federal Income Taxes\nDeferred income taxes for 1995 and 1994 reflect the impact of \"temporary differences\" between amounts of assets and liabilities for financial reporting purposes and such amounts as measured on an income tax basis. Temporary differences which give rise to the net deferred tax asset at December 31 are as follows:\nNet deferred tax assets and federal income tax expense in future years can be significantly affected by changes in enacted tax rates or by unexpected adverse events that would impact management's conclusions as to the ultimate realizability of deferred tax assets. The Company has not recorded a valuation allowance, as the deferred tax assets are presently considered to be realizable based on expected reversal of the temporary differences.\nThe provision for federal income taxes at December 31, consists of the following:\nThe difference between income taxes provided at the Company's effective tax rate and the 34% federal statutory rate at December 31, is as follows:\nBANCINSURANCE CORPORATION AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\n(7) Profit Sharing Plan\nThe Company has a profit sharing plan for all employees with six months of service. Contributions are determined annually by the Board of Directors. Contributions to the plan were $44,745, and $42,684 in 1994 and 1993, respectively. There was no contribution to the plan in 1995. See Note 20.\n(8) Stock Option Plan\nThe Company has incentive stock option plans for all employees of the Company and its subsidiaries. Non-employee directors are also eligible to receive stock options under the plans. Activity in these plans were as follows:\nThe Company has a 1984 Stock Option Plan for all employees of the Company and its subsidiaries. All options were granted before May 17, 1994 for a term of not more than ten years. The options for 155,000 shares outstanding at December 31, 1995 expire at various dates from 1996 through 2004 and range in option price per share from $.625 to $6.00.\nThe 1994 Stock Option Plan (the \"Plan\") provides for the grant of options to purchase up to an aggregate of 500,000 shares, 100,000 shares for any one individual, of the common stock of the Company. Certain key employees, officers, and directors of, and consultants and advisors to, the Company and its subsidiaries are eligible to participate in the Plan. The Plan is administered by the Stock Option Committee which will determine to whom and when options will be granted along with the terms and conditions of the options. The options for 44,500 shares outstanding at December 31, 1995 expire at dates from 2004 to 2005 and range in option price per share from $2.50 to $6.75.\n(THIS SPACE INTENTIONALLY LEFT BLANK)\nBANCINSURANCE CORPORATION AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\n(9) Dividend Restrictions\nUnder Ohio law, insurance companies may only pay dividends to shareholders from shareholders' equity determined in accordance with statutory accounting practices. Further, Ohio law limits dividends to shareholders, without prior approval of the Department, to the greater of the prior year's statutory net income or 10% of statutory shareholders' equity. As of December 31, 1995, dividends from Ohio Indemnity in 1996 are limited to $2,660,432 without prior approval of the Department.\n(10) Statutory Shareholders' Equity and Net Income\nAs of December 31, 1995, Ohio Indemnity's statutory surplus and net income determined in accordance with accounting practices prescribed or permitted by the Department differed from shareholders' equity and net income determined in accordance with GAAP by the following:\nAs of December 31, 1994, Ohio Indemnity's statutory surplus differed from GAAP shareholders' equity by an amount of $4,287 in nonadmitted assets, $397,029 for deferred acquisition costs, $710,322 in deferred taxes and ($162,989) in unrealized loss on available for sale fixed maturities. Statutory net income for the year ended December 31, 1994 differed from GAAP net income by $15,980 for deferred acquisition costs, ($212,979) in deferred taxes and $175,000 in restatement for anticipated salvage and subrogation.\n(THIS SPACE INTENTIONALLY LEFT BLANK)\nBANCINSURANCE CORPORATION AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\n(11) Reserve for Unpaid Losses and Loss Adjustment Expenses\nActivity in the reserve for unpaid losses and loss adjustment expenses is summarized as follows.\nAs a result of changes in estimates of insured events in prior years, the provision for unpaid losses and loss adjustment expenses increased by $247,000 in 1995 because of higher-than-anticipated losses and related legal expenses in connection with a discontinued product, and increased by $529,000 in 1994 because of higher- than-anticipated losses from the Automobile Insurance business. The provision for unpaid losses and loss adjustment expenses decreased by $1,421,000 in 1993 because of lower-than-anticipated losses from the Surety and Ultimate Loss Insurance business.\n(12) Reinsurance\nThe Company maintains quota share reinsurance agreements, by which Ohio Indemnity cedes a portion of its insurance to a reinsurer. These arrangements limit the net claim liability potential arising from specific policies. These reinsurance agreements do not relieve the Company from its obligations to policyholders. Consequently, failure of the reinsurer to honor its obligations could result in losses to the Company. The Company currently recovers 50% of the paid losses and loss adjustment expense applicable to Automobile Physical Damage insurance policies.\nAs of December 31, ceded reinsurance reduced commission expense incurred by $121,972, $3,137,726 and $3,732,890 in 1995, 1994 and 1993, respectively.\n(13) Related Parties\nIncluded in other assets at December 31, 1995 is a $15,000 loan to an officer\/director of the Company. Interest only is payable in monthly installments at the rate of two points above prime through April 10, 1996. In addition, a $19,000 loan to an officer of Ohio Indemnity is included in other assets at December 31, 1995 and 1994. Interest only is payable in quarterly installments at the rate of two points above prime through December 1996. The carrying amounts of these loans are reasonable estimates of fair value.\nBANCINSURANCE CORPORATION AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\nDuring 1994, the Company entered into a Split Dollar Insurance Agreement with a bank, as trustee, for the benefit of an officer\/shareholder and his spouse. The bank has acquired a second-to-die policy on the lives of the insureds, in the aggregate face amount of $2,700,000. At December 31, 1995, the Company had loaned the trustee $143,744 under this agreement for payment of insurance premiums. Amounts loaned by the Company to the trustee are to be repaid, in full, without interest from any of the following sources; cash surrender value of the underlying insurance contracts, death benefits and\/or the sale of 15,000 shares of the Company's common stock contributed by the officer\/shareholder to the Trust.\n(14) Concentrations\nA single customer in the Ultimate Loss Insurance program represented $2,343,398, $2,425,234 and $1,515,200 of the Company's net premiums earned in 1995, 1994 and 1993, respectively.\nA single customer in the Surety program represented $1,074,126, $1,059,839 and $794,039 of the Company's net premiums earned in 1995, 1994 and 1993, respectively.\n(15) Quarterly Results of Operations (Unaudited)\nThe Company's results of operations have varied, and in the future may vary from quarter to quarter principally because of fluctuations in underwriting results. Consequently, quarterly results are not necessarily indicative of full year results, nor are they comparable to the results of other quarters. The following table sets forth certain unaudited quarterly consolidated financial and operating data:\nBANCINSURANCE CORPORATION AND SUBSIDIARIES\nNotes to Consolidated Financial Statements, Continued\n(16) Regulatory Standard\nDuring 1993, the National Association of Insurance Commissioners adopted a Risk Based Capital (RBC) test applicable to property and casualty insurers as of December 31, 1994. The RBC calculation serves as a benchmark of insurance enterprises' solvency by state insurance regulators by establishing statutory surplus targets which will require certain Company level or regulatory level actions. Based on the Company's analysis, it appears that the Company's total adjusted capital is in excess of all required action levels and that no corrective action will be necessary. The Risk Based Capital provisions have not yet been enacted into the Ohio Revised Code.\n(17) Registration Expenses\nOn March 17, 1993, Bancinsurance Corporation filed a registration statement with the SEC in connection with the proposed sale of additional shares of common stock. Later the offering was withdrawn and registration expenses of $415,390 were charged to operations during 1993.\n(18) Common Share Repurchase Program\nOn November 13, 1995 the Board of Directors adopted a common share repurchase program. The program allows the Company to repurchase, from time to time, up to a total of 100,000 of its common shares. The program will expire on December 31, 1997. As of December 31, 1995, the Company repurchased 60,400 shares at an average price per share of $2.70 under this program. Repurchases have been and will continue to be funded by cash flows from operations.\n(19) Litigation\nThe Company is routinely a party to litigation incidental to its business, as well as to other nonmaterial litigation. Management believes that no individual item of litigation, or group of similar items of litigation, including the matters referred to below, is likely to result in judgments that will have a material adverse effect on the financial condition or results of operations of the Company.\nOn November 2, 1994 the James L. Miniter Agency, Inc. (\"Agent\") filed a lawsuit against Ohio Indemnity alleging that Ohio Indemnity interfered with Agent's broker relationship with a policyholder. The Agent's complaint also alleged that Ohio Indemnity violated Massachusetts Unfair Trade Practices Act which provides for the trebling of damages in some select circumstances. The case is presently pending in the United States District Court for the District of Massachusetts. On February 16, 1995 the Agent made a demand for $5 million (its purported compensatory damages trebled), an amount Ohio Indemnity believes to be unsupported by the facts or law involved in this matter. On June 2, 1995 Ohio Indemnity filed a motion for summary judgement seeking to have Agent's lawsuit dismissed. That motion is presently pending. Should Ohio Indemnity's motion not be granted, Ohio Indemnity is confident that it will nonetheless prevail in this action.\n(20) Subsequent Events\nOn January 1, 1996, the Company implemented the Ohio Indemnity Company Employee 401(K) and Profit Sharing Plan (the \"401(K) Plan\"). The 401(K) Plan is available to full-time employees who meet the 401(K) Plan's eligibility requirements. Under the 401(K) Plan, the Company matches 50% of the qualified employee's contribution up to 6%. Concurrent with this implementation, the Company merged the Profit Sharing Plan, Note 7, into the Company's 401(K) Plan.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Company\nSi Sokol has been Chairman of the Board of Directors of the Company since 1970 and President since December 1980, and is also Chairman of the Board and President of Ohio Indemnity and President of BCIS Services, Inc. Mr. Sokol is also President and a Director of Westford Group, Inc., which is a holding company currently involved in the preparation of codes and publishing of municipal ordinances, and which has its common stock registered pursuant to Section 12 of the Securities Exchange Act of 1934. Mr. Sokol is a Director of Fifth Third Bank of Columbus, Ohio and has previously served on the boards of a number of corporations including several national banks and a federally chartered savings and loan association located in the State of Ohio. Mr. Sokol is Saul Sokol's brother and John Sokol's father.\nDaniel D. Harkins is a private investor. He also serves as a Director of Ohio Indemnity. Prior to 1987, Mr. Harkins was the owner and president of Ace Beverage Distributing Company. From 1973 to 1978, he served as General Sales Manager and International Sales Manager for several divisions of Ashland Chemical Co., and from 1978 to 1980, he served as a consultant for A. T. Kearney Inc., a management consulting firm.\nItem 10. Directors and Executive Officers of the Company (continued)\nSaul Sokol, brother of Si Sokol, is the owner of Sokol Insurance Agency. He is a chartered life underwriter (CLU) and a chartered property\/casualty insurance underwriter (CPCU). He is the past president of the Columbus Life Underwriter's Association and the Columbus Chapter of Chartered Property\/Casualty Underwriters. Mr. Sokol is a member of several local, state and national insurance associations. In addition, he has published a book for consumers dealing with insurance. Mr. Sokol also serves as a Director of Ohio Indemnity.\nMilton O. Lustnauer is a private investor. He also serves as a Director of Ohio Indemnity. Mr. Lustnauer was co-founder of BBF, Inc., a restaurant chain, and served as Executive Vice President of that corporation from 1961 to 1969 when it was acquired by Borden Inc. Following the acquisition, he became President of BBF, Inc., a position he held from 1969 to 1973. He previously served as director of numerous corporations, including two banks.\nJames R. Davis joined the Company in 1989 as the Administrator of Ohio Indemnity's Bonded Service program and was elected a Vice President of the Company in 1992. He also serves as a Director of Ohio Indemnity and Westford Group, Inc. and as Vice President of BCIS Services. From 1986 to 1989, Mr. Davis served as an independent consultant to third party administrators of self-insured workers' compensation programs. He acted as President and Director of James R. Davis & Associates, Inc., a corporation providing cost management services, from 1980 to 1986, which he sold in 1985. He was President of Gates, McDonald & Company, a corporation providing cost management services from 1971 to 1979.\nJohn Sokol, son of Si Sokol, became a Director of Bancinsurance Corporation and Ohio Indemnity Company in 1990. In addition, he has been Vice President of Bancinsurance Corporation and Ohio Indemnity since 1993. He also has served as Director of Westford Group, Inc. since 1990. He acted as Treasury Officer, Capital Markets, at The Chemical Banking Corp. of New York, formerly Manufacturers Hanover, from January 1992 to June 1993. From August 1989 to January 1992, he was an Associate, Corporate Banking at Manufacturers Hanover, now The Chemical Banking Corp., of New York. In May 1989, he received a Masters of Business Administration Degree from Vanderbilt University. From 1985 to 1987, he was a Client Services Manager with Financial Guaranty Insurance Company.\nSally J. Cress has served as the Secretary, Treasurer and principal accounting officer of the Company and Ohio Indemnity since March 1985. She also serves as Director of Ohio Indemnity and as Secretary and Treasurer of BCIS Services and Westford Group, Inc. Mrs. Cress is a Certified Public Accountant.\nThere are no arrangements or understandings between any of the officers and directors of the Company and other persons relating to their selections as officers and directors.\nAll Directors serve a term of one year or until their successors are elected and qualified. The officers are elected annually and serve at the discretion of the Board of Directors.\nIn October 1982, the Board of Directors of the Company established an Executive Committee. The Executive Committee has authority to take any action, other than filling vacancies on the Board of Directors or on any committee of the Board of Directors, that the Board of Directors may from time to time delegate to the Executive Committee. Messrs. Si Sokol, Harkins and Lustnauer currently serve as members of the Executive Committee.\nIn August 1989, the Board of Directors of the Company established an Investment Committee. The Investment Committee has the authority to review the Company's investment results and make recommendations on the Company's investments and investment strategies. Messrs. Si Sokol, Saul Sokol and Lustnauer currently serve as members of the Investment Committee.\nItem 10. Directors and Executive Officers of the Company (continued)\nIn November 1992, the Company established an Audit Committee. The Audit Committee recommends the annual appointment of the Company's auditors, with whom the Audit Committee reviews the scope of the audit and nonaudit assignments and related fees, the accounting principles used by the Company in financial reporting, internal financial auditing procedures and the adequacy of the Company's internal control procedures. Messrs. John S. Sokol, Harkins and Lustnauer currently serve as members of the Audit Committee.\nIn June 1994, the Company established a Stock Option Committee to administer the 1994 Stock Option Plan. The Committee consists solely of directors who are not, and have never been, employees of, or paid consultants or advisors to, the Company. The Committee is authorized to determine to whom and at what time options may be granted. The Committee determines the number of shares subject to option, the duration of the option, the per share exercise price, the rate and manner of exercise, and whether the option is intended to be a Nonqualified Option or an Incentive Option. Messrs. Harkins and Lustnauer currently serve as members of the Stock Option Committee.\nSection 16(a) of the Securities Exchange Act of 1934 requires the Company's officers and directors, and greater than 10% shareholders, to file reports of ownership and changes in ownership of the Company's securities with the Securities and Exchange Commission (SEC). Copies of the reports are required by SEC regulation to be furnished to the Registrar. Based on its review of such reports and written representations from reporting persons, the Company believes that, during fiscal 1995, all filing requirements were complied with.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe following table sets forth the compensation paid by the Corporation and its principal subsidiaries to the Corporation's Chief Executive Officer and the executive officers whose salary and bonus exceeded $100,000 for the fiscal years ended December 31, 1995, 1994 and 1993, respectively.\nSUMMARY COMPENSATION TABLE\n(1) Represents, for each named executive, the amount of the Corporation's contributions to the Ohio Indemnity Company Employee Profit Sharing Plan, effective January 1, 1986, as to which Messrs. Sokol and Davis are 100% vested as of December 31, 1995. There was no contribution to the plan in 1995. Additionally, Mr. Davis is entitled to annual reimbursement for automobile expenses of $5,400 per annum, and, for Mr. Sokol, costs associated with the term portion of a split dollar life insurance policy, which premium equaled $699 and $595 for 1995 and 1994, respectively.\nItem 11. Executive Compensation (continued)\n(2) The aggregate annual premium of Mr. Sokol's split dollar life insurance policy is comprised of a term and a whole life portion, of which the whole life portion is treated as an interest-free loan. The premium for the whole life portion of Mr. Sokol's split dollar life insurance policy equaled $71,020 and $71,430 for 1995 and 1994, respectively, and has not been included in the Summary Compensation Table. The aggregate annual premiums associated with the split dollar life insurance policy are to be repaid, in full, upon the second-to-die of Mr. and Mrs. Sokol. See Item 13 and Note 13 to the Notes to Consolidated Financial Statements.\nThe following table sets forth certain information regarding stock options granted to the executive officers named in the Summary Compensation Table during the Corporation's 1995 fiscal year and the exercise price and expiration date of the options granted to such executive officers.\nOPTION GRANTS IN LAST FISCAL YEAR\n- ------------- (1) The option price is the fair market value of the Company's common stock on the date of grant, determined in accordance with the 1994 Stock Option Plan (i.e., the closing sales price per share on the NASDAQ National Market on that date).\n(2) The dollar amounts in these columns are the product of (a) the difference between (1) the product of $2.50 (the per share market price on the date of grant) and the sum of 1 plus the assumed rate of appreciation (5% and 10%) compounded over the term of the option (ten years) and (2) $2.50 (the per share exercise price) and (b) the number of shares underlying the grant at the end of fiscal 1995.\n(3) The appreciation rates stated are arbitrarily assumed, and may or may not reflect actual appreciation in the stock price over the life of the option. Regardless of any theoretical value which may be placed on a stock option, no increase in its value will occur without an increase in the value of the underlying shares. Whether such an increase will be realized will depend not only on the efforts of the recipient of the option, but also on the conditions in the Company's industry and market area, competition, and general and local economic conditions, over which the optionee may have little or no control.\n(4) This option was granted December 21, 1995 and will vest 20% every year over a five year period.\nItem 11. Executive Compensation (continued)\nThe following table sets forth certain information regarding stock options exercised by the executive officers named in the Summary Compensation Table during the Corporation's 1995 fiscal year and the year-end values of unexercised options held by such executive officers.\nAGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES\n- ------------ (1) Represents the difference between the per share fair market value on the date of exercise and the per option exercise price, multiplied by the number of shares to which the exercise relates.\n(2) Represents the total gain which would be realized if all in-the-money options held at year end were exercised, determined by multiplying the number of shares underlying the options by the difference between the per share option exercise price and the per share fair market value at year end. An option is in-the-money if the fair market value of the underlying shares exceeds the exercise price of the option.\nCompensation of Directors:\nOhio Indemnity paid each non-employee director $400 per meeting attended in 1995 plus a $1,000 retainer. Employee directors did not receive additional compensation for serving as directors. Non-employee members of the Audit Committee received $200 per meeting attended in 1995.\nCompensation Pursuant to Plans:\nIncentive Stock Option Plan\nThe Company has a 1984 Stock Option Plan (the \"1984 Plan\"), to encourage stock ownership by employees of the Company and its subsidiaries, and other individuals who are not employees, such as directors, consultants and advisors, by granting them stock options. Options were authorized under the 1984 Plan for a maximum of 600,000 common shares. The 1984 Plan is administered by the Board of Directors who determined the persons who were granted options and the number of shares granted under each option. All options were required to be granted on or before May 17, 1994 and were required to be for a term of not more than ten years. Options for all 600,000 shares authorized under the 1984 Plan were granted.\nThe option price was not less than the fair market value of the shares for which the option was granted on the date on which it was granted. Upon the exercise of an option, the share must be paid for in full, either in case or by delivery of shares having a fair market value equal to the shares being purchased. At December 31, 1995, seven persons held stock options under the 1984 Plan.\nItem 11. Executive Compensation (continued)\nThe Company adopted the 1994 Stock Option Plan (the \"1994 Plan\") at the June 14, 1994 Annual Meeting of Shareholders that provides for the grant of options to purchase up to an aggregate of 500,000 shares, 100,000 shares for any one individual, of the common stock of the Company. Certain key employees, officers, and directors of, and consultants and advisors, to the Company an its subsidiaries are eligible to participate in the 1994 Plan. The 1994 Plan is administered by the Stock Option Committee which will determine to whom and when options will be granted along with the terms and conditions of the options. At December 31, 1995, eight persons held options under the 1994 Plan.\nThe table below sets forth information as of December 31, 1995 regarding the number of shares of common stock of the Company subject to option, the per share exercise price for such shares and the expiration date of such options.\nDuring 1995, options for 38,500 shares were granted. As of December 31, 1995, options for 445,000 shares have been exercised or canceled in connection with the 1984 Stock Option Plan.\nIn October 1995, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 123, \"Accounting for Stock-Based Compensation,\" which defines a fair value based method of accounting for employee stock options and similar equity instruments. Hwoever, SFAS No. 123 also allows an entity to continue to account for these plans according to Accounting Principals Board Opinion No. 25 (APB 25), provided pro forma disclosures of net income and earnings per share are made as if the fair value based method of accounting defined by SFAS No. 123 had been applied. The Company expects to continue to measure compensation cost related to employee stock purchase options using APB 25 and will provide pro forma disclosures as required. This statement is effective for the year ended December 31, 1996.\nProfit Sharing Plan\nThe Ohio Indemnity Company Employee Profit Sharing Plan, effective January 1, 1986, allows all eligible employees of the Company to share in the profits of the Company. An employee is eligible to participate in the Profit Sharing Plan as of January 1st of the year following the later of the completion of six months of service or the attainment of age 21. The Company contribution to the Profit Sharing Plan is determined by resolution of the Board of Directors of the Company. The contribution allocated to each participant is based upon the ratio that the total eligible compensation bears to the total eligible compensation of all participants. Twenty percent of each eligible employee's account balance vests after two years of service, and an additional 20% of each eligible employee's account balance vests for each additional year of service for the next four years. Contributions to the Profit Sharing Plan are invested in annuity or life insurance contracts for eligible employees. There was no accrued contribution to the Profit Sharing Plan for the fiscal year ended December 31, 1995.\nOn January 1, 1996, the Company implemented the Ohio Indemnity Company Employee 401(K) and Profit Sharing Plan (the \"401(K) Plan\"). The 401(K) Plan is available to full-time employees who meet the 401(K) Plan's eligibility requirements. Under the 401(K) Plan, the Company matches 50% of the qualified employee's contribution up to 6%. Concurrent with this implementation, the Company merged the Profit Sharing Plan into the Company's 401(K) Plan.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThe following table sets forth: (i) the name and address of each person known by the Company to be the beneficial owner of more than 5% of the Company's voting securities and the name of each director and each officer named in the Summary Compensation Table of the Company; and (ii) the number and percent of the Company's common shares beneficially owned by each such person and by all directors and the officers named in the Summary Compensation Table of the Company as a group as of December 31, 1995:\n(1) Except as otherwise noted, none of the named individuals shares with another person either voting or investment power as to the shares reported.\n(2) Calculated on the basis of the number of outstanding shares plus the number of shares a person has the right to acquire within 60 days of December 31, 1995.\n(3) Includes 2,252,780 common shares owned by Barbara K. Sokol, of which 634,620 shares are owned by her as trustee for her children including 211,540 as trustee for John Sokol, her son, and 654,120 common shares owned by Si Sokol, her husband. Included in both Mr. and Mrs. Sokol's shares are 15,000 indirectly owned shares that were contributed, 7,500 from each, to the Si and Barbara K. Sokol Irrevocable Trust (Fifth Third Bank as Trustee) in connection with a split-dollar insurance policy on the life of Mr. and Mrs. Sokol, for the benefit of their three children, including 5,000 as pledged through a collateral agreement for John Sokol, over which John Sokol shares no investment control over the Trust. The rules of the Securities and Exchange Commission require that Mr. and Mrs. Sokol's shares be aggregated for purposes of this disclosure; however, Mr. and Mrs. Sokol each disclaim any beneficial ownership of the other's shares.\nItem 12. Security Ownership of Certain Beneficial Owners and Management (continued)\n(4) Includes 30,000, 4,000, 4,000, 25,000 and 4,000 common shares each for Messrs. John Sokol, Harkins, Lustnauer, Davis and Saul Sokol and 117,000 common shares for all directors and officers of the Company as a group which may be purchased pursuant to stock options exercisable within 60 days of December 31, 1995.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nIn May 1994, the Company entered into a Split Dollar Insurance Agreement (\"Agreement\") with the Fifth-Third Bank of Columbus as Trustee (\"Trustee\") for the benefit of Si Sokol, the Company's Chief Executive Officer, and his spouse, Barbara K. Sokol (the \"Insureds\"). Pursuant to the Agreement, the Trustee has acquired a second-to-die policy on the lives of the Insureds, in the aggregate face amount of $2,700,000. The aggregate annual premium is comprised of a term and a whole life portion, of which the whole life portion is treated as an interest-free loan with the insurance policy assigned to the Company as collateral to secure the Company's interest in the policy. The term and whole life portion of the split dollar life insurance policy equaled $699 and $71,020, respectively, for 1995. All premiums paid by the Company in connection with the split dollar life insurance policy are to be repaid, in full, without interest, upon the death of the second-to-die of the Insureds. In addition, Mr. and Mrs. Sokol have contributed 15,000 shares of the Company's Common Stock to the Si and Barbara K. Sokol Irrevocable Trust dated May 6, 1994 (the \"Trust\"), and the Trust has pledged such shares to secure the Trustee's rights under the Agreement.\nSee Item 2, Properties.\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\n(a) Exhibits\n3(a) Amended Articles of Incorporation (reference is made to Exhibit 3(a) of Form 10-K for the fiscal year ended December 31, 1984 (file number 0-8738), which is incorporated herein by reference).\n3(b) Amended Code of Regulations (reference is made to Exhibit 3(b) of Form 10-K for the fiscal year ended December 31, 1984 (file number 0- 8738), which is incorporated herein by reference).\n10(a) Amended Tax Allocation Agreement (reference is made to Exhibit 10(d) of Form 10-K for the fiscal year ended December 31, 1983 (file number 0-8738), which is incorporated herein by reference).\n10(b) Private Passenger Automobile Physical Damage Quota Share Reinsurance Agreement between Ohio Indemnity Company and North American Reinsurance Corporation (reference is made to Exhibit 10(d) of Form 10-K\/A for the fiscal year ended December 31, 1992 (file number 0- 8738), which is incorporated herein by reference).\n10(c) Amended and Restated Unemployment Compensation Administration Agreement Between Ohio Indemnity Company and The Gibbens Co., Inc. (The Company has requested that portions of this Exhibit be given confidential treatment.) (reference is made to Exhibit 10(e) of Form 10-K\/A for the fiscal year ended December 31, 1992 (file number 0- 8738), which is incorporated herein by reference).\nItem 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K (continued)\nThe following are management contracts and compensatory plans and arrangements in which directors or executive officers participate:\n10(d) Employee Profit Sharing Plan (reference is made to Exhibit 10(a) of Form 10-K for the fiscal year ended December 31, 1986 (file number 0- 8738), which is incorporated herein by reference).\n10(e) 1984 Stock Option Plan (reference is made to Exhibit 10(d) of Form 10-K for the fiscal year ended December 31, 1984 (file number 0- 8738), which is incorporated herein by reference).\n10(f) 1994 Stock Option Plan - (reference is made to Exhibit 10(f) of Form 10-Q for the fiscal quarter ended June 30, 1994 (file number 0-8738), which is incorporated herein by reference).\n21 Subsidiaries of the Company, as of December 31, 1995.\n23 Consents of independent accountants to incorporation of their opinions by reference in Registration Statement on Form S-8.\n27 Financial Data Schedule.\n(b) Financial Statement Schedules\nIncluded in Part IV of this report:\nSchedule I -- Summary of investments - other than investments in related parties Schedule II -- Condensed financial information of Bancinsurance Corporation (Parent Company Only)\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.\n(c) Reports on Form 8-K\nNo reports on Form 8-K were filed by the Company during the quarter ended December 31, 1995.\n(THIS SPACE INTENTIONALLY LEFT BLANK)\nBANCINSURANCE CORPORATION AND SUBSIDIARY\nSchedule I - SUMMARY OF INVESTMENTS - OTHER THAN INVESTMENT IN RELATED PARTIES\n(1) Original cost of equity securities, adjusted for any permanent write downs, and, as to fixed maturities, original cost reduced by repayments, write downs and adjusted for amortization of premiums or accrual of discounts.\nBANCINSURANCE CORPORATION AND SUBSIDIARIES\nSchedule II - CONDENSED FINANCIAL INFORMATION OF BANCINSURANCE CORPORATION (PARENT COMPANY ONLY)\nCONDENSED BALANCE SHEETS\nDecember 31, 1995 and 1994\nBANCINSURANCE CORPORATION AND SUBSIDIARIES\nSchedule II - CONDENSED FINANCIAL INFORMATION OF BANCINSURANCE CORPORATION (PARENT COMPANY ONLY)\nCONDENSED STATEMENTS OF INCOME\nYears Ended December 31, 1995, 1994, and 1993\nBANCINSURANCE CORPORATION AND SUBSIDIARIES\nSchedule II - CONDENSED FINANCIAL INFORMATION OF BANCINSURANCE CORPORATION (PARENT COMPANY ONLY)\nCONDENSED STATEMENTS OF CASH FLOWS\nYears Ended December 31, 1995, 1994, and 1993\n(Continued)\nBANCINSURANCE CORPORATION AND SUBSIDIARIES\nSchedule II - CONDENSED FINANCIAL INFORMATION OF BANCINSURANCE CORPORATION (PARENT COMPANY ONLY), Continued\nCONDENSED STATEMENTS OF CASH FLOWS, Continued\nSignatures\nPursuant to the requirements 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.\nBancinsurance Corporation (Company)\nBy Si Sokol --------------- Si Sokol Chairman of Board of Directors, 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, which include the Chief Executive Officer, the Chief Financial Officer and a majority of the Board of Directors, on behalf of the Registrant and in the capacities and on the dates indicated:\n3\/15\/96 Si Sokol 3\/15\/96 Sally Cress - --------- -------------------------- --------- -------------------------- DATE Si Sokol DATE Sally Cress Chairman of Board of Treasurer, Secretary Directors, President and Chief Financial Officer Chief Executive Officer and Chief Accounting Officer\n3\/15\/96 Daniel D. Harkins 3\/15\/96 Milton O. Lustnauer - --------- -------------------------- --------- -------------------------- DATE Daniel D. Harkins DATE Milton O. Lustnauer Director Director\n3\/15\/96 Saul Sokol 3\/15\/96 James R. Davis - --------- -------------------------- --------- -------------------------- DATE Saul Sokol DATE James R. Davis Director Director\n3\/15\/96 John S. Sokol - --------- -------------------------- DATE John S. Sokol Director\nINDEX OF EXHIBITS\nThe following is the Index of Exhibits required by Item 601 of Regulation S-K.\nExhibit No. Description Page No. - ----------- ----------- --------\n3(a) Amended Articles of Incorporation (reference is made to Exhibit 3(a) of Form 10-K for the fiscal year ended December 31, 1984 (file number 0-8738), which is incorporated herein by reference).\n3(b) Amended Code of Regulations (reference is made to Exhibit 3(b) of Form 10-K for the fiscal year ended December 31, 1984 (file number 0-8738), which is incorporated herein by reference).\n10(a) Amended Tax Allocation Agreement (reference is made to Exhibit 10(d) of Form 10-K for the fiscal year ended December 31, 1983 (file number 0-8738), which is incorporated herein by reference).\n10(b) Private Passenger Automobile Physical Damage Quota Share Reinsurance Agreement between Ohio Indemnity Company and North American Reinsurance Corporation (reference is made to Exhibit 10(d) of Form 10-K\/A for the fiscal year ended December 31, 1992 (file number 0-8738), which is incorporated herein by reference).\n10(c) Amended and Restated Unemployment Compensation Administration Agreement between Ohio Indemnity Company and The Gibbens Co., Inc. (The Company has requested that portions of this Exhibit be given confidential treatment.) (references is made to Exhibit 10(e) of Form 10-K\/A for the fiscal year ended December 31, 1992 (file number 0-8738), which is incorporated herein by reference).\nThe following are management contracts and compensatory plans and arrangements in which directors or executive officers participate:\n10(d) Employee Profit Sharing Plan (reference is made to Exhibit 10(a) of Form 10-K for the fiscal year ended December 31, 1986 (file number 0-8738), which is incorporated herein by reference).\n10(e) 1984 Stock Option Plan (reference is made to exhibit 10(d) of From 10-K for the fiscal year ended December 31, 1984 (file number 0-8738), which is incorporated herein by reference).\n10(f) 1994 Stock Option Plan - (reference is made to Exhibit 10(f) of Form 10-Q for the fiscal quarter ended June 30, 1994 (file number 0-8738), which is incorporated herein by reference).\n21 Subsidiaries of the Company, as of December 31, 1995. 66\n23 Consent of independent accountants to incorporation of their opinion by reference in Registration Statement on Form S-8. 67\n27 Financial Data Schedule. 68","section_15":""}
{"filename":"740553_1995.txt","cik":"740553","year":"1995","section_1":"Item 1. Business - ----------------\nBalcor Equity Properties-XVIII 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 $52,811,000 from sales of Limited Partnership Interests. The Registrant's operations consist exclusively of investment in and operation of income-producing real property, and all financial information included in this report relates to this industry segment.\nThe Registrant utilized the net offering proceeds to acquire four real property investments and a minority joint venture interest in one additional property. The property in which the Registrant held a minority joint venture interest was sold in December 1994 and the Registrant sold 101 Marietta Tower in February 1996. The Registrant owns the remaining properties described under \"Properties\" (Item 2). The Partnership Agreement generally provides that the proceeds of any sale or refinancing of the Registrant's properties will not be reinvested in new acquisitions.\nOverall, the investment real estate market saw gradual improvement over the last year. This improvement has taken place in an environment of generally low interest rates and little or no new supply, parameters which may not exist in the next few years. Demand for real estate space, while projected to improve in line with the overall economy, is also vulnerable to external forces. The major challenges facing the real estate industry today include increased international competition, corporate restructurings, new computer and communications technologies, an aging population and potential revisions of the tax code. In addition, the increased flow of capital to real estate through new vehicles such as commercial mortgage-backed securities and REITs could spur new construction at unsupportable levels, as well as impact existing property values.\nOperationally, existing apartment properties continued to register occupancy percentages in the 90s, with average rents rising at an annual rate of between 3 and 4 percent. Apartments are still considered one of the top real estate asset classes in terms of performance. However, some markets are experiencing new construction of rental units which, if unrestrained, could impact the performance of existing properties. Most of the new construction is aimed at the two segments of the rental market which are growing the fastest: low-income households and upper-income households who prefer to rent rather than own. Of all the major asset classes, apartments typically display the least volatility in terms of property values.\nThe General Partner had previously advised Limited Partners that its strategy was to sell the Registrant's remaining properties over the next two to three year period. The General Partner also stated that the timing of the liquidation could be lengthened or shortened due to changes in market conditions, economic factors, interest rates and unforeseen events. The General Partner now believes that the market for multifamily housing properties has become increasingly favorable to sellers of these properties. If current market conditions for sales remain favorable, the liquidation of the Registrant's properties may be accelerated.\nThe Registrant received notice of unsolicited offers for the purchase of limited partnership interests (\"tender offers\") in August and November 1995. The tender offers were made by Equity Resource Fund-XVII (\"Equity Resources\"). Equity Resources stated that their primary motive in making the offers was to make a profit from the purchase of the interests. Equity Resources acquired 2.38% of the total interests outstanding in the Registrant pursuant to the tender offers. The Registrant incurred administrative costs in responding to the tender offers and may incur additional costs if additional tender offers are made in the future. The General Partner cannot predict with any certainty what the impact of these tender offers or any future tender offers will have on the operations of the Registrant.\nThe Registrant sold 101 Marietta Tower in February 1996. See Other Information below, Item 7. Liquidity and Capital Resources and Note 10 of Notes to Financial Statements 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 Equity Partners-XVIII, the General Partner of the Registrant, and its affiliates perform services for the Registrant. The Registrant currently has no employees engaged in its operations.\nOther Information - -----------------\n101 Marietta Tower - -------------------\nIn 1984, the Registrant acquired the 101 Marietta Tower office complex and a leasehold interest in 200 parking spaces in the parking garage across the street (together, the \"Property\") utilizing $20,595,745 of offering proceeds. The Property was purchased subject to a first mortgage loan in the amount of $20,000,000.\nOn December 19, 1995, the Registrant contracted to sell the Property for a sale price of $29,500,000 to an unaffiliated party, Lennar Partners, Inc., a Florida corporation (\"Lennar\"). The sale price was subsequently reduced to $26,000,000. Lennar assigned its rights as purchaser under the contract and on February 12, 1996, the Property was acquired by Leisure Colony Management Corp., a Florida corporation which is an affiliate of Lennar (the \"Purchaser\"). The Purchaser acquired the Property subject to the first mortgage loan which had an outstanding principal balance of approximately $17,350,000 at closing.\nFrom the proceeds of the sale, the Registrant paid a brokerage commission of $260,000 to an affiliate of the company which provides property management services at the Property (the \"Broker\"). An affiliate of the Broker is also a principal of the Purchaser. The Registrant also paid closing and other sale costs of approximately $206,000 and received the remaining sale proceeds of $8,184,000. In addition, the contract provided that in the event the purchaser receives certain payments in the future from the principal tenant of the Property relating to reimbursements for certain operating expenses, the Registrant was entitled to receive 25% of these payments. This percentage has been increased to 75% by the parties. The General Partner was reimbursed by the Registrant for its actual expenses incurred in connection with the sale.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties - ------------------\nThe Registrant owns the three properties described below:\nLocation Description of Property - -------- -----------------------\nSan Antonio, Texas Canyon Point Apartments: a 214-unit apartment complex located on approximately 9 acres.\nGreenville, South Carolina Mallard Cove Apartments (formerly Hidden Lakes): a 211-unit apartment complex located on approximately 15 acres.\nGrand Blanc, Michigan Knollwood Village Apartments: a 648-unit apartment complex located on approximately 55 acres.\nEach of the above properties is held subject to various mortgages and other forms of financing.\nIn the opinion of the General Partner, the Registrant has provided adequate insurance coverage for its real estate investment properties.\nSee Notes to Financial Statements for other information regarding real property investments.\nItem 3.","section_3":"Item 3. Legal Proceedings - -------------------------\nProposed class action - ---------------------\nOn February 29, 1996, a proposed class action complaint was filed, Raymond Masri vs. Lehman Brothers, Inc., et al., Case No. 96\/103727 (Supreme Court of the State of New York, County of New York). The Registrant, additional limited partnerships which were sponsored by The Balcor Company, three limited partnerships sponsored by the predecessor of Lehman Brothers, Inc. (together with the Registrant and the affiliated partnerships, the \"Defendant Partnerships\"), Lehman Brothers, Inc. and Smith Barney Holdings, Inc. are defendants. The complaint alleges, among other things, common law fraud and deceit, negligent misrepresentation and breach of fiduciary duty relating to the disclosure of information in the offering of limited partnership interests in the Defendant Partnerships. The complaint seeks judgment for compensatory damages equal to the amount invested in the Defendant Partnerships by the proposed class plus interest accrued thereon; general damages for injuries arising from the defendants' actions; recovery from the defendants of all profits received by them as a result of their actions relating to the Defendant Partnerships; exemplary damages; attorneys' fees and other costs.\nThe defendants intend to vigorously contest this action. No class has been certified as of this date. Management of each of the defendants believes they have meritorious defenses to contest the claims. It is not determinable at this time whether or not an unfavorable decision in this action would have a material adverse impact on the Registrant.\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 1995.\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 Item 7. Liquidity and Capital Resources, below.\nAs of December 31, 1995, the number of record holders of Limited Partnership Interests of the Registrant was 5,179.\nItem 6.","section_6":"Item 6. Selected Financial Data - -------------------------------\nYear ended December 31, ----------------------------------------------------------- 1995 1994 1993 1992 1991 ------------ ---------- ---------- ---------- -----------\nTotal income $16,743,567 $16,740,793 $15,328,981 $13,535,576 $13,015,657 Provision for in- vestment property writedown 1,016,987 None None None None Net income (loss) 1,240,270 885,014 (8,829) (1,754,481) (1,776,892) Net income (loss) per Limited Partner- ship Interest 23.25 16.59 (.16) (32.89) (33.31) Total assets 58,114,553 58,914,891 58,492,849 58,875,919 61,394,682 Mortgage notes payable 39,475,209 40,078,625 39,289,424 39,415,967 39,861,120 Distributions per Limited Partner- ship Interest(A) 20.00 20.00 None None None\n(A) No distributions of original capital were made in any of the last five years.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results - ------------------------------------------------------------------------------- of Operations - -------------\nOperations - ----------\nSummary of Operations - ---------------------\nImproved operations at 101 Marietta Tower office complex and Knollwood Village Apartments resulted in an increase in net income for Balcor Equity Properties-XVIII A Real Estate Limited Partnership (the \"Partnership\") for 1995 as compared to 1994. This increase was offset by a provision recognized in connection with the sale of the 101 Marietta Tower office complex. In 1994, the Partnership recognized its share of the gain on the sale of Belmere Apartments, in which it held a minority joint venture interest, which partially offset this increase, and also resulted in net income for 1994 as compared to a slight net loss during 1993. Further discussion of the Partnership's operations is summarized below.\n1995 Compared to 1994 - ---------------------\nDue to higher average cash balances and interest rates, interest income on short-term investments increased during 1995 as compared to 1994.\nBelmere Apartments, in which the Partnership held a minority joint venture interest, was sold during 1994. As a result of the gain recognized in connection with the sale, the Partnership recognized income from participation in joint venture with an affiliate in 1994.\nA lower property assessment at the 101 Marietta Tower office complex retroactive to the 1993 tax year, reduced real estate tax expense and resulted in a refund of 1993 real estate taxes which was received and recognized as other income in 1995.\nThe refinancing of the Knollwood Village Apartments mortgage note payable in 1994 required the payment of deferred expenses which are being amortized over the term of the mortgage note payable. As a result, amortization expense increased for 1995 as compared to 1994.\nDue to lower tenant-related repairs and maintenance expenses and leasing costs at the 101 Marietta Tower office complex in 1995 and the exterior painting of the Canyon Point and Knollwood Village apartment complexes completed in 1994, property operating expense decreased in 1995 as compared to 1994.\nThe lower property assessment at the 101 Marietta Tower office complex and a lower tax rate at the Knollwood Village Apartments resulted in a decrease in real estate taxes during 1995 as compared to 1994.\nA recalculation of the recoverable expenses as required by the terms of the General Service Administration (\"GSA\") lease at the 101 Marietta Tower office complex was made in late 1993. Additional income related to this recalculation was received in 1994, resulting in additional management fees. This caused a decrease in property management fees during 1995 as compared to 1994.\nDue to lower portfolio management fees, administrative expenses decreased during 1995 as compared to 1994.\nThe 101 Marietta Tower office complex was sold in February 1996. At December 31, 1995, for financial statement purposes, the property was written down to an amount equal to the February 1996 net sales proceeds received and the Partnership recognized a provision for investment property writedown of $1,016,987. See Note 10 of Notes to Financial Statements for additional information.\n1994 Compared to 1993 - ---------------------\nHigher rental and\/or occupancy rates at all of the Partnership's properties resulted in an increase in rental income and property management fees for 1994 as compared to 1993.\nAs required by the terms of the General Service Administration (\"GSA\") lease at the 101 Marietta Tower office complex, a recalculation of the recoverable operating and real estate tax expenses was made in late 1993. This recalculation and subsequent collection of 1993 and 1994 reimbursements resulted in an increase in service income and property management fees during 1994 when compared to 1993.\nDue to higher cash balances and interest rates, interest income on short-term investments increased during 1994 as compared to 1993.\nAs a result of the gain recognized in connection with the sale of Belmere Apartments, the Partnership recognized income from participation in joint venture with an affiliate in 1994 compared to a loss in 1993.\nAs a result of a prepayment penalty on the previous first mortgage loan, which was recorded as interest expense, and a higher mortgage loan balance associated with the Knollwood Village Apartments refinancing in June 1994, interest expense on mortgage notes payable increased for 1994 as compared to 1993. This increase was partially offset by the 1993 refinancing of the Canyon Point Apartments' mortgage note at a lower interest rate.\nThe loan refinancings in 1993 related to Mallard Cove and Canyon Point apartment complexes and in 1994 related to Knollwood Village Apartments required the payment of certain expenses which are deferred and amortized over the terms of the mortgage notes payable. As a result, amortization expense increased for 1994 as compared to 1993.\nAs a result of higher insurance and janitorial expenses at the 101 Marietta Tower office complex and higher insurance expense at the Canyon Point, Mallard Cove and Knollwood Village apartment complexes, property operating expense increased for 1994 as compared to 1993.\nA lower property assessment at the 101 Marietta Tower office complex and a decrease in tax rates at the Knollwood Village Apartments caused real estate tax expense to decrease for 1994 as compared to 1993.\nDue to higher portfolio management and accounting fees which were partially offset by decreases in other professional and consulting fees, administrative expenses increased slightly for 1994 as compared to 1993.\nLiquidity and Capital Resources - -------------------------------\nThe cash position of the Partnership increased as of December 31, 1995 as compared to December 31, 1994 primarily due to improved operations at the Partnership's properties. The Partnership's cash provided by operating activities included the cash flow from operations of the Partnership's properties and interest income received on short-term investments, which was partially offset by administrative costs. The cash provided by investing activities consisted of the final distribution received from the joint venture which owned Belmere Apartments and represents the Partnership's share of sales proceeds and fourth quarter 1994 property operations. The net cash used in financing activities consisted of capital improvement escrow activity, principal payments on mortgage notes payable and distributions to Limited Partners.\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. 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. All four of the Partnership's properties have underlying debt. During 1995 and 1994, all four of the Partnership's properties generated positive cash flow. Belmere Apartments, in which the Partnership held a minority joint venture interest, was sold in December 1994 and was generating a marginal cash flow deficit during 1994 prior to its sale. As of December 31, 1995, the occupancy rates of the Partnership's residential properties ranged from 95% to 98%, while the occupancy rate at the 101 Marietta Tower office complex was 99%.\nWhile the cash flow of certain of the Partnership's properties has improved, the General Partner continues to pursue actions aimed at improving property operating performance and to seek rent increases where market conditions allow.\nThe General Partner had previously advised Limited Partners that its strategy was to sell the Partnership's remaining properties over the next two to three year period. The General Partner also stated that the timing of the liquidation could be lengthened or shortened due to changes in market conditions, economic factors, interest rates and unforeseen events. The General Partner now believes that the market for multifamily housing properties has become increasingly favorable to sellers of these properties. If current market conditions for sales remain favorable, the liquidation of the Partnership's properties may be accelerated.\nThe 101 Marietta Tower office complex, which represented 50% of the Partnership's original portfolio, was sold in February 1996 for $26,000,000. The purchaser of the 101 Marietta Tower office complex acquired the property subject to the existing $17,353,151 first mortgage loan. There will be a special distribution consisting of the proceeds from the 101 Marietta Tower office complex sale plus any excess cash reserves above an amount necessary to protect against unforeseen events in the second quarter of 1996.\nIn January 1991, quarterly distributions to Limited Partners were suspended due to the March 1991 maturity of the Canyon Point mortgage note payable and the pending December 1992 expiration of the GSA lease at 101 Marietta Tower office complex. With the resolution of these issues, along with the refinancing of the Mallard Cove mortgage note payable, the Partnership resumed quarterly distribution to Limited Partners in January 1994. The Partnership made four distributions of Net Cash Receipts totaling $20.00 per Interest in 1995 and 1994, respectively. See Statement of Partners' Capital for additional information.\nIn January 1996, the Partnership paid $264,055 ($5.00 per Interest) representing the quarterly distribution to Limited Partners for the fourth quarter of 1995. The level of this distribution is consistent with that of the prior quarter. Assuming property operations meet current projections, the Partnership anticipates making regular quarterly distributions from the Partnership's continuing property operations and from any cash reserves above an amount necessary to protect against unforeseen events. Including the January 1996 distribution, Limited Partners have received distributions of Net Cash Receipts totaling $120.50 and Net Cash Proceeds totaling $14.50 per $1,000 Interest, as well as certain tax benefits. In light of results to date and current market conditions, there can be no assurance that investors will recover all of their original investment.\nIn December 1994, the joint venture in which the Partnership owned a 25.6% interest sold the Belmere Apartments for a sale price of $8,500,000. From the sale proceeds, the joint venture repaid the first mortgage loan and other costs and received approximately $1,755,000. In February 1995, the Partnership received a distribution of $482,229 which represents its share of sales proceeds and fourth quarter property operations. This amount was included in accounts receivable in the financial statements at December 31, 1994.\nIn February 1996, the Partnership sold 101 Marietta Tower office complex for a sales price of $26,000,000. The purchaser acquired the property subject to the existing $17,353,151 first mortgage loan and the Partnership received the remaining proceeds of $8,181,086. See Note 10 of Notes to Financial Statements and Item 1. Business - Other Information for additional information.\nEach of the Partnership's properties is owned through the use of third-party mortgage loan financing and, therefore, the Partnership is subject to the financial obligations required by such loans. As a result of the General Partner's efforts to modify and refinance these loans, the Partnership has no third party financing which matures prior to 1998.\nIn 1995, the Financial Accounting Standards Board issued Statement No. 121 \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of\" which established accounting standards for impairment of long-lived assets and long-lived assets to be disposed of. This statement has been adopted by the Partnership as of January 1, 1995, and did not have a material impact on the financial position or results of operations of the Partnership.\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 Financial Statements and 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, 1995 December 31, 1994 ----------------------- ------------------------- Financial Tax Financial Tax Statements Returns Statements Returns ---------- --------- ---------- ---------\nTotal assets $58,114,553 $54,224,324 $58,914,891 $54,244,538 Partners' capital (deficit): General Partner (221,590) (219,628) (233,993) (237,302) Limited Partners 16,881,697 13,719,433 16,710,050 13,025,947 Net income (loss): General Partner 12,403 17,674 8,850 24,359 Limited Partners 1,227,867 1,749,706 876,164 760,804 Per Limited Part- nership Interest 23.25 33.13 16.59 14.41\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and - ----------------------------------------------------------------------- Financial Disclosure - --------------------\nOn September 14, 1995 the Registrant approved the engagement of Coopers & Lybrand L.L.P. as its independent auditors for the fiscal year ending December 31, 1995 to replace the firm of Ernst & Young LLP, who were dismissed as auditors of the Registrant effective September 14, 1995. The General Partner of the Registrant approved the change in auditors.\nThe reports of Ernst & Young LLP on the Registrant's financial statements for the past two fiscal years did not contain an adverse opinion or a disclaimer of opinion and were not qualified or modified as to uncertainty, audit scope, or accounting principles.\nIn connection with the audits of the Registrant's financial statements for each of the two fiscal years ended December 31, 1994, and in the subsequent interim period, there were not disagreements with Ernst & Young LLP on any matters of accounting principles or practices, financial statement disclosure, or auditing scope and procedures which, if not resolved to the satisfaction of Ernst & Young LLP would have caused Ernst & Young LLP to make reference to the matter in their report.\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 Equity Partners-XVIII, 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 Senior Vice President Alexander J. Darragh Senior Vice President Josette V. Goldberg Senior Vice President Alan G. Lieberman Senior Vice President, Chief Brian D. Parker Financial Officer, Treasurer and Assistant Secretary Senior Vice President John K. Powell, Jr.\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. He is also Senior Vice President of American Express Company and is responsible for its real estate operations worldwide. 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.\nAlexander J. Darragh (February 1955) joined Balcor in September 1988 and is responsible for due diligence analysis and real estate advisory services for Balcor and American Express Company. He also has supervisory responsibility for Balcor's environmental matters. Mr. Darragh received masters' degrees in Urban Geography from Queen's University and in Urban Planning from Northwestern University.\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 MIS functions. 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 Balcor's property sales and capital markets functions. Mr. Lieberman is a Certified Public Accountant.\nBrian D. Parker (June 1951) joined Balcor in March 1986 and, as Chief Financial Officer and Chief Accounting Officer, is responsible for Balcor's financial, legal and treasury functions. He is a Director of The Balcor Company. 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 portfolio and asset management matters relating to Balcor's partnerships. Mr. Powell also has supervisory responsibility for Balcor's risk management and investor services functions. He received a Master of Planning degree from the University of Virginia. Mr. Powell 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.\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 1995.\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 Balcor Equity Partners-XVIII, 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 8 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 Equity Partners-XVIII 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 100 Interests Less than 1%\nRelatives and affiliates of the officers and partners of the General Partner do not own any additional 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 8 of Notes to Financial Statements for additional information relating to transactions with affiliates.\nSee Note 3 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 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. 2 to the Registrant's Registration Statement on Form S-11 dated September 17, 1984 (Registration No. 2-89380) is hereby incorporated herein by reference.\n(4) Form of Subscription Agreement, previously filed as Exhibit 4.1 to Amendment No. 1 to Registrant's Registration Statement on Form S-11 dated May 15, 1984 (Registration No. 2-89380), 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. 0-13357) are incorporated herein by reference.\n(10) Material Contracts\n(a) Agreement of Sale and attachment thereto relating to the sale of the 101 Marietta Tower office building previously filed as Exhibit (2) to the Registrant's Report on Form 8-K dated December 19, 1995 (Commission File No. 0-13357) is incorporated herein by reference.\n(b) Reinstatement of, and First Amendment To, Agreement of Sale relating to the sale of the 101 Marietta Tower office building is attached hereto.\n(16) Letter from Ernst & Young LLP dated September 19, 1995 regarding the change in the Registrant's certifying accountant previously filed as Exhibit 16 to the Registrant's Report on Form 8-K\/A dated October 27, 1995 (Commission File No. 0-13357) is incorporated herein by reference.\n(27) Financial Data Schedule of the Registrant for 1995 is attached hereto.\n(b) Reports on Form 8-K:\n(i) A Current Report of Form 8-K\/A dated October 27, 1995, amending the Current Report on Form 8-K dated September 19, 1995 reporting a change in the Registrant's certifying public accountant, was filed (Commission File No. 0-13357).\n(ii) A Current Report on Form 8-K dated December 19, 1995 (Commission File No. 0-13357) was filed relating to the contract for the sale of the 101 Marietta Tower office building.\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 EQUITY PROPERTIES-XVIII A REAL ESTATE LIMITED PARTNERSHIP\nBy: \/s\/Brian D. Parker ----------------------------------- Brian D. Parker Senior Vice President, and Chief Financial Officer (Principal Accounting and Financial Officer) of Balcor Equity Partners-XVIII, the General Partner\nDate: March 28, 1996 -----------------------\nPursuant to the requirements of the Securities Exchange Act of 1934, 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 Equity Partners-XVIII, the General \/s\/Thomas E. Meador Partner March 28, 1996 - ---------------------- ------------- Thomas E. Meador\nSenior Vice President, and Chief Financial Officer (Principal Accounting Officer and Financial Officer) of Balcor Equity Partners-XVIII, the \/s\/Brian D. Parker General Partner March 28, 1996 - ---------------------- ------------- Brian D. Parker\nINDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE\nReport of Independent Accountants\nReport of Independent Auditors\nFinancial Statements:\nBalance Sheets, December 31, 1995 and 1994\nStatements of Partners' Capital, for the years ended December 31, 1995, 1994 and 1993\nStatements of Income and Expenses, for the years ended December 31, 1995, 1994 and 1993\nStatements of Cash Flows, for the years ended December 31, 1995, 1994 and 1993\nNotes to Financial Statements\nFinancial Statement Schedule:\nIII - Real Estate and Accumulated Depreciation, as of December 31, 1995\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 Equity Properties-XVIII A Real Estate Limited Partnership:\nWe have audited the accompanying balance sheet and financial statement schedule of Balcor Equity Properties-XVIII A Real Estate Limited Partnership (An Illinois Limited Partnership) as of December 31, 1995 and the related statements of partners' capital, income and expenses and cash flows for the year then ended. 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 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 Balcor Equity Properties-XVIII A Real Estate Limited Partnership (An Illinois Limited Partnership) at December 31, 1995, and the results of its operations and its cash flows for the year then ended 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 23, 1996\nREPORT OF INDEPENDENT AUDITORS\nTo the Partners of Balcor Equity Properties-XVIII: A Real Estate Limited Partnership:\nWe have audited the accompanying balance sheet of Balcor Equity Properties-XVIII A Real Estate Limited Partnership (An Illinois Limited Partnership) as of December 31, 1994 and the related statements of partners' capital, income and expenses and cash flows for each of the two 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. We did not audit the financial statements of Balcor Equity Properties - XIV, an affiliate, which is the majority joint venturer of the partnership which owned the Belmere Apartments. The Partnership's share of the operating income (loss) of this joint venture included in the accompanying 1994 and 1993 statements of income and expenses was approximately $755,000 (principally due to the gain on sale of the property owned) and ($77,000), respectively. The financial statements of Balcor Equity Properties - XIV were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to the amounts included for the aforementioned investment in joint venture, 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, based on our audits and the report of other auditors, the financial statements referred to above present fairly, in all material respects, the financial position of Balcor Equity Properties-XVIII A Real Estate Limited Partnership at December 31, 1994 and the results of its operations and its cash flows for each of the two years in the period ended December 31, 1994, in conformity with generally accepted accounting principles.\nERNST & YOUNG LLP\nChicago, Illinois March 1, 1995\nBALCOR EQUITY PROPERTIES-XVIII A REAL ESTATE LIMITED PARTNERSHIP (An Illinois Limited Partnership)\nBALANCE SHEETS December 31, 1995 and 1994\nASSETS\n1995 1994 -------------- -------------- Cash and cash equivalents $ 10,008,666 $ 6,190,971 Escrow deposits 1,694,388 2,082,249 Accounts and accrued interest receivable 809,538 1,101,624 Prepaid expenses 178,688 58,398 Deferred expenses, net of accumulated amortization of $233,092 in 1995 and $148,659 in 1994 476,297 560,730 -------------- -------------- 13,167,577 9,993,972 -------------- -------------- Investment in real estate: Land 10,331,853 10,514,910 Buildings and improvements 69,865,669 70,699,599 -------------- -------------- 80,197,522 81,214,509 Less accumulated depreciation 35,250,546 32,293,590 -------------- -------------- Investment in real estate, net of accumulated depreciation 44,946,976 48,920,919 -------------- -------------- $ 58,114,553 $ 58,914,891 ============== ==============\nLIABILITIES AND PARTNERS' CAPITAL\nAccounts payable $ 204,221 $ 225,336 Due to affiliates 33,430 67,045 Accrued liabilities, principaly interest and real estate taxes 1,539,679 1,853,632 Security deposits 201,907 214,196 Mortgage notes payable 39,475,209 40,078,625 -------------- -------------- Total liabilities 41,454,446 42,438,834 -------------- -------------- Limited Partners' capital (52,811 Interests issued and outstanding) 16,881,697 16,710,050 General Partner's deficit (221,590) (233,993) -------------- -------------- Total partners' capital 16,660,107 16,476,057 -------------- -------------- $ 58,114,553 $ 58,914,891 ============== ==============\nThe accompanying notes are an integral part of the financial statements.\nBALCOR EQUITY PROPERTIES-XVIII A REAL ESTATE LIMITED PARTNERSHIP (An Illinois Limited Partnership)\nSTATEMENTS OF PARTNERS' CAPITAL for the years ended December 31, 1995, 1994 and 1993\nPartners' Capital (Deficit) Accounts -------------- ----------------------------- General Limited Total Partner Partners -------------- -------------- -------------- Balance at December 31, 1992 $ 16,656,092 $ (242,754) $ 16,898,846\nNet loss for the year ended December 31, 1993 (8,829) (89) (8,740) -------------- -------------- -------------- Balance at December 31, 1993 16,647,263 (242,843) 16,890,106\nCash distributions to Limited Partners (A) (1,056,220) (1,056,220)\nNet income for the year ended December 31, 1994 885,014 8,850 876,164 -------------- -------------- -------------- Balance at December 31, 1994 16,476,057 (233,993) 16,710,050\nCash distributions to Limited Partners (A) (1,056,220) (1,056,220)\nNet income for the year ended December 31, 1995 1,240,270 12,403 1,227,867 -------------- -------------- -------------- Balance at December 31, 1995 $ 16,660,107 $ (221,590) $ 16,881,697 ============== ============== ==============\n(A) Summary of cash distributions per Interest:\n1995 1994 1993 -------------- -------------- --------------\nFirst Quarter $ 5.00 $ 5.00 None Second Quarter 5.00 5.00 None Third Quarter 5.00 5.00 None Fourth Quarter 5.00 5.00 None\nThe accompanying notes are an integral part of the financial statements.\nBALCOR EQUITY PROPERTIES-XVIII A REAL ESTATE LIMITED PARTNERSHIP (An Illinois Limited Partnership)\nSTATEMENTS OF INCOME AND EXPENSES for the years ended December 31, 1995, 1994 and 1993\n1995 1994 1993 -------------- -------------- -------------- Income: Rental $ 12,939,827 $ 12,672,200 $ 12,334,913 Service 3,103,906 3,090,448 2,894,136 Interest on short-term investments 472,679 223,412 99,932 Participation in income of joint venture with an affiliate 754,733 Other income 227,155 -------------- -------------- -------------- Total income 16,743,567 16,740,793 15,328,981 -------------- -------------- -------------- Expenses: Interest on mortgage notes payable 3,647,305 3,785,223 3,586,643 Depreciation 2,956,956 2,935,846 3,040,277 Amortization of deferred expenses 84,433 67,939 28,958 Property operating 5,438,275 6,270,831 5,837,673 Real estate taxes 1,157,793 1,400,303 1,597,631 Property management fees 800,165 930,617 730,637 Administrative 401,383 465,020 439,444 Participation in loss of joint venture with an affiliate 76,547 Provision for investment property writedown 1,016,987 -------------- -------------- -------------- Total expenses 15,503,297 15,855,779 15,337,810 -------------- -------------- -------------- Net income (loss) $ 1,240,270 $ 885,014 $ (8,829) ============== ============== ============== Net income (loss) allocated to General Partner $ 12,403 $ 8,850 $ (89) ============== ============== ============== Net income (loss) allocated to Limited Partners $ 1,227,867 $ 876,164 $ (8,740) ============== ============== ============== Net income (loss) per Limited Partnership Interest (52,811 issued and outstanding) $ 23.25 $ 16.59 $ (0.16) ============== ============== ==============\nThe accompanying notes are an integral part of the financial statements.\nBALCOR EQUITY PROPERTIES-XVIII A REAL ESTATE LIMITED PARTNERSHIP (An Illinois Limited Partnership)\nSTATEMENTS OF CASH FLOWS for the years ended December 31, 1995, 1994 and 1993\n1995 1994 1993 -------------- -------------- -------------- Operating activities: Net income (loss) $ 1,240,270 $ 885,014 $ (8,829) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Provision for investment property writedown 1,016,987 Participation in (income) loss of joint venture with with an affiliate (754,733) 76,547 Depreciation 2,956,956 2,935,846 3,040,277 Amortization of deferred expenses 84,433 67,939 28,958 Collection (accrual) of recoverable expenses 1,509,618 (1,509,618) Net change in: Escrow deposits (87,700) (141,768) (908,628) Accounts and accrued interest receivable (190,143) (103,281) 100,938 Prepaid expenses (120,290) 96,810 230,298 Accounts payable (21,115) 65,145 (199,282) Due to affiliates (33,615) (9,012) 4,187 Accrued liabilities (313,953) 35,732 (104,708) Security deposits (12,289) 6,314 675 -------------- -------------- -------------- Net cash provided by operating activities 4,519,541 4,593,624 750,815 -------------- -------------- -------------- Investing activities: Capital contributions to joint venture with an affiliate (21,628) (25,117) Distribution from joint venture with an affiliate 482,229 Improvements to properties (333,283) (127,696) -------------- -------------- -------------- Net cash provided by (used in) investing activities 482,229 (354,911) (152,813) -------------- -------------- --------------\nFinancing activities: Distributions to Limited Partners (1,056,220) (1,056,220) Repayment of mortgage notes payable (11,700,000) (9,001,276) Proceeds from refinancing of mortgage note payable 13,000,000 9,300,000 Payment of deferred expenses (329,872) (269,517) Release of capital improvement escrow 668,946 172,331 Funding of capital improvement escrow (193,385) (903,512) Principal payments on mortgage notes payable (603,416) (510,799) (425,267) -------------- -------------- -------------- Net cash used in financing activities (1,184,075) (1,328,072) (396,060) -------------- -------------- -------------- Net change in cash and cash equivalents 3,817,695 2,910,641 201,942 Cash and cash equivalents at beginning of year 6,190,971 3,280,330 3,078,388 -------------- -------------- -------------- Cash and cash equivalents at end of year $ 10,008,666 $ 6,190,971 $ 3,280,330 ============== ============== ==============\nThe accompanying notes are an integral part of the financial statements.\nBALCOR EQUITY PROPERTIES-XVIII A REAL ESTATE LIMITED PARTNERSHIP (An Illinois Limited Partnership)\nNOTES TO FINANCIAL STATEMENTS\n1. Nature of the Partnership's Business:\nBalcor Equity Properties-XVIII A Real Estate Limited Partnership (the \"Partnership\") is engaged principally in the operation of residential and commercial real estate located in various markets within the United States.\n2. Accounting Policies:\n(a) The preparation of the financial statements in conformity with generally accepted accounting principles requires the General Partner 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 vary from those estimates.\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 ----- Buildings and improvements 18-30 Furniture and fixtures 5\nMaintenance and repairs are charged to expense when incurred. Expenditures for improvements are charged to the related asset account.\n(c) Effective January 1, 1995 the Partnership adopted Statement of Financial Accounting Standards, No. 121 (SFAS 121), \"Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of\". Under SFAS 121, the Partnership records its investments in real estate at the lower of cost or fair value, and periodically assesses, but not less than on an annual basis, possible impairment to the value of its properties. The General Partner estimates the fair value of its properties by dividing the property's expected net operating income by a risk adjusted rate of return which considers economic and demographic conditions in the market. In the event the General Partner determines an impairment in value has occurred, and the carrying amount of the real estate asset will not be recovered, a provision is recorded to reduce the carrying basis of the property to its estimated fair value. The General Partner considers the method referred to above to result in a reasonable measurement of a property's fair value, unless other factors affecting the property's value indicate otherwise.\n(d) Deferred expenses consist of refinancing fees which are amortized over the terms of the respective agreements.\n(e) The Financial Accounting Standard Board's Statement No. 107, \"Disclosures About Fair Value of Financial Instruments\", requires disclosure of fair value information about financial instruments for which it is practicable to estimate that value. Since quoted market prices are not available for the Partnership's financial instruments, fair values have been based on estimates using present value techniques. These techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, may not be realized in immediate settlement of the instrument. Statement No. 107 does not apply to all balance sheet items and excludes certain financial instruments and all non-financial instruments such as real estate and investment in joint ventures from its disclosure requirements.\n(f) Cash and cash equivalents include all highly liquid investments with an original maturity of three months or less. Cash equivalents primarily are held or invested with one issuer of commercial paper.\n(g) Revenue is recognized on an accrual basis in accordance with generally accepted accounting principles. Income from operating leases with significant abatements and\/or scheduled rent increases is recognized on a straight line basis over the respective lease term. Service income includes reimbursements from operating costs such as real estate taxes, maintenance and insurance and is recognized as revenue in the period the applicable costs are incurred.\n(h) The Partnership is not liable for Federal income taxes and each partner recognizes his proportionate share of the Partnership loss or income in his tax return; therefore, no provision for income taxes is made in the financial statements of the Partnership.\n(j) A reclassification has been made to the previously reported 1994 and 1993 financial statements to conform with the classification used in 1995. This reclassification has not changed the 1994 and 1993 results.\n3. Partnership Agreement:\nThe Partnership was organized in January 1984. The Partnership Agreement provides for Balcor Equity Partners-XVIII to be the General Partner and for the admission of Limited Partners through the sale of up to 100,000 Limited Partnership Interests at $1,000 per Interest, 52,811 of which were sold on or prior to July 31, 1985, the termination date of the offering.\nAll profits and losses of the Partnership are allocated 99% to the capital accounts of the Limited Partners and 1% to the capital account of the General Partner.\nWhen and as cash distributions are made, 100% of the Net Cash Receipts will be distributed to holders of Interests. The General Partner will not receive any portion of Net Cash Receipts; however, there will be accrued for the benefit of the General Partner an amount equal to 1% of Net Cash Receipts distributed to holders of Interests, which will be paid only out of Net Cash Proceeds as a part of the General Partner's distributive share on sale or refinancing of properties.\nWhen the Partnership sells or refinances its properties, the Net Cash Proceeds resulting therefrom which are available for distribution will be distributed only to holders of Limited Partnership Interests until such time as they have received an amount equal to their Original Capital plus a 6% per annum non-compounded return. The remaining Net Cash Proceeds available for distribution will be distributed 85% to holders of Limited Partnership Interests and 15% to the General Partner, provided that the General Partner's distributive share shall be further subordinated to the prior receipt by Limited Partners of a Preferential Cumulative Distribution of their Original Capital in the amount of 100% for Interests purchased prior to January 1, 1985 and 80% for Interests purchased thereafter.\n4. Mortgage Notes Payable:\nMortgage notes payable at December 31, 1995 and 1994 consisted of the following:\nCarrying Carrying Current Final Property Amount of Amount of Inter- Matur- Periodic Estimated Pledged as Notes at Notes at est ity Payment Balloon Collateral 12\/31\/95 12\/31\/94 Rate Date Terms Payment - -------------- ---------- ---------- ------ ------ ------- ---------- Apartment Complexes: Canyon Point $ 5,149,774$ 5,193,774 8.59% 1998 $ 40,703 $ 5,022,000 Mallard Cove 3,976,029 4,007,623 9.01 2000 32,616 3,797,000 Knollwood Village (A) 12,878,068 12,961,273 9.55 2004 109,786 11,737,000\nOffice Building: 101 Marietta Tower (B) 17,471,338 17,915,955 10.00 2001 554,971 13,899,000 ----------- ----------- $39,475,209 $40,078,625 =========== ===========\n(A) In June 1994, this loan was refinanced. The interest rate increased from 9.00% to 9.55%, the maturity date was extended from December 1994 to July 2004 and the monthly payments increased from $87,750 to $109,786. A portion of the proceeds from the new $13,000,000 first mortgage loan were used to repay the existing first mortgage loan of $11,700,000.\n(B) In February 1996, the property collateralizing this loan was sold subject to the loan. See Note 10 for additional information.\nDuring 1995, 1994 and 1993 the Partnership incurred interest expense on mortgage notes payable of $3,647,305, $3,785,223 and $3,586,643 and paid interest expense of $3,804,468, $3,968,746 and $3,949,717, respectively.\nThe Partnership's loans described above require current monthly payments of principal and interest, except for the 101 Marietta Tower loan which requires quarterly payments of principal and interest.\nReal estate with an aggregate carrying value of $80,197,522 at December 31, 1995 was pledged as collateral for repayment of the mortgage notes.\nMaturities of the above mortgage notes payable during each of the next five years are approximately as follows:\n1996 $ 174,000 1997 191,000 1998 5,202,000 1999 167,000 2000 3,939,000\nThe maturities listed above do not include the 101 Marietta Tower loan. In February, 1996 the property collateralizing this loan was sold subject to the loan.\n5. Management Agreements:\nAs of December 31, 1995, all of the properties owned by the Partnership are under management agreements with a third-party management company. These management agreements provide for annual fees of 5% of gross operating receipts for the residential properties and 3% to 6% of gross operating receipts for 101 Marietta Tower.\n6. Investment in Joint Venture with an Affiliate:\nThe Partnership owned a 25.6% joint venture interest in Belmere Apartments and accounted for it under the equity method. In December 1994, the joint venture sold the property for a sales price of $8,500,000. From the sales proceeds, the joint venture repaid the first mortgage loan and other selling costs and received approximately $1,755,000. In February 1995, the Partnership received a distribution of $482,229 which represented its share of sales proceeds and fourth quarter 1994 property operations. This amount was included in accounts receivable in the financial statements at December 31,1994. The Partnership's share of the gain on the sale is $949,032 and is included in \"Participation in income of joint venture with an affiliate\" in 1994 and is partially offset by the Partnership's share of operating losses through the sale date. During 1994 and 1993, the Partnership made capital contributions of $21,628 and $25,117, respectively to the joint venture.\n7. 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 income for 1995 in the financial statements is $489,877 more than the tax income of the Partnership for the same period.\n8. Transactions with Affiliates:\nFees and expenses paid and payable by the Partnership to affiliates are:\nYear Ended Year Ended Year Ended 12\/31\/95 12\/31\/94 12\/31\/93 -------------- -------------- -------------- Paid Payable Paid Payable Paid Payable ------ ------- ------ ------- ------ -------\nProperty management fees None None $842,028 None $732,228 $58,502 Reimbursement of expenses to the General Partner, at cost: Accounting $46,607 $4,326 61,056 22,549 46,147 3,819 Data processing 12,337 525 30,712 5,868 20,772 4,578 Investor communica- tions 6,127 None 18,801 5,524 18,181 1,505 Legal 24,805 3,699 12,405 6,419 12,347 1,022 Portfolio management 90,767 14,122 93,124 9,612 66,900 5,626 Other 10,317 1,502 12,405 17,073 12,142 1,005 Property sales 10,741 9,256 None None None None\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 however; the General Partner is reimbursed for program expenses. The Partnership paid premiums to the deductible insurance program of $97,729, $118,333 and $80,847 for 1995, 1994 and 1993, respectively.\nAllegiance Realty Group, Inc., an affiliate of the General Partner, managed all of the Partnership's properties until the affiliate was sold to a third party in November 1994.\n9. Fair Value of Financial Instruments:\nThe carrying amounts and fair values of the Partnership's financial instruments at December 31, 1995 are as follows:\nThe carrying value of cash and cash equivalents, accounts and accrued interest receivable and accounts payable approximates fair value.\nBased on borrowing rates available to the Partnership at the end of 1995 for mortgage loans with similar terms and maturities, the fair value of the mortgage notes payable approximates the carrying value.\n10. Subsequent Events:\n(a) In January 1996, the Partnership paid a distribution of $264,055 ($5.00 per Interest) to Limited Partners relating to the fourth quarter of 1995.\n(b) In February 1996, the Partnership sold 101 Marietta Tower office complex in an all cash sale for $26,000,000. The purchaser of the 101 Marietta Tower office complex acquired the property subject to the existing $17,353,151 first mortgage loan and the Partnership paid $465,743 consisting of a brokerage commission and other closing costs. The basis of the property was $26,551,244 at December 31, 1995. As a result of the sale the property was written down to an amount equal to the February 1996 net sales proceeds received and the Partnership recognized a $1,016,987 provision for investment property writedown in 1995.\nThe Partnership received rental income at 101 Marietta Tower office complex from the leasing of office space under operating leases. During 1996, prior to the sale, the Partnership received $593,900 of rental income related to operating leases.\nApproximately 83% of the space at 101 Marietta Tower office complex was leased to General Service Administration (\"GSA\") and 50%, 47% and 48% of the Partnership's total rental and service income recognized during 1995, 1994 and 1993, respectively, related to GSA.\n(c) On February 29, 1996, a proposed class action complaint was filed, Raymond Masri vs. Lehman Brothers, Inc., et al., Case No. 96\/103727 (Supreme Court of the State of New York, County of New York). The Partnership, additional limited partnerships which were sponsored by The Balcor Company, three limited partnerships sponsored by the predecessor of Lehman Brothers, Inc. (together with the Partnership and the affiliated partnerships, the \"Defendant Partnerships\"), Lehman Brothers, Inc. and Smith Barney Holdings, Inc. are defendants. The complaint alleges, among other things, common law fraud and deceit, negligent misrepresentation and breach of fiduciary duty relating to the disclosure of information in the offering of limited partnership interests in the Defendant Partnerships. The complaint seeks judgment for compensatory damages equal to the amount invested in the Defendant Partnerships by the proposed class plus interest accrued thereon; general damages for injuries arising from the defendants' actions; recovery from the defendants of all profits received by them as a result of their actions relating to the Defendant Partnerships; exemplary damages; attorneys' fees and other costs.\nThe defendants intend to vigorously contest this action. No class has been certified as of this date. Management of each of the defendants believes they have meritorious defenses to contest the claims. It is not determinable at this time whether or not an unfavorable decision in this action would have a material adverse impact on the Partnership.\nBALCOR EQUITY PROPERTIES-XVIII A REAL ESTATE LIMITED PARTNERSHIP (An Illinois Limited Partnership)\nBALCOR EQUITY PROPERTIES-XVIII A REAL ESTATE LIMITED PARTNERSHIP (An Illinois Limited Partnership)\nBALCOR EQUITY PROPERTIES-XVIII A REAL ESTATE LIMITED PARTNERSHIP (An Illinois Limited Partnership)\nNOTES TO SCHEDULE III\n(a) See description of Mortgage Notes Payable in Note 4 of Notes to Financial Statements.\n(b) This property was sold in February 1996.\n(c) Consists of legal fees, appraisal fees, title costs and other related professional fees.\n(d) Guaranteed income earned on properties under the terms of certain management and guarantee agreements was recorded by the Partnership as a reduction of the basis of the property to which the guaranteed income related.\n(e) Represents a reduction of basis due to a permanent impairment of the asset value (See Note 10)\n(f) The aggregate cost of land for Federal income tax purposes is $10,537,326 and the aggregate cost of buildings and improvements for Federal income tax purposes is $71,381,388. The total of these is $81,918,714.\n(g)Reconciliation of Real Estate --------------------------------\n1995 1994 1993 ---------- ---------- ---------- Balance at beginning of year $81,214,509 $80,881,226 $80,753,530 Additions during the year: Improvements 333,283 127,696 Reductions during the year: Impairments 1,016,987 ----------- ----------- ----------- Balance at end of year $80,197,522 $81,214,509 $80,881,226 ============ =========== ===========\nReconciliation of Accumulated Depreciation -------------------------------------------\n1995 1994 1993 ----------- ----------- ----------- Balance at beginning of year $32,293,590 $29,357,744 $26,317,467 Depreciation expense for the year 2,956,956 2,935,846 3,040,277 ------------ ----------- ----------- Balance at end of year $35,250,546 $32,293,590 $29,357,744 ============ =========== ===========\n(h) Depreciation expense is computed based upon the following estimated useful lives:\nYears ----- Buildings and improvements 18-30 Furniture and fixtures 5\n(i) This apartment complex was completed in three phases from 1970 through 1973.","section_15":""}
{"filename":"715577_1995.txt","cik":"715577","year":"1995","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 semiconductor components used in the processing of electronic signals. The Company's products are used primarily in medical and analytical instrumentation, process control systems, laboratory instrumentation, manufacturing automation, automatic test equipment, digital audio equipment, communications, imaging, computer peripherals and multimedia. 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 reincorporated in Delaware in 1983. The Company's management and technical team has many years of experience in the design, manufacture and world-wide marketing of high performance analog and mixed signal semiconductor components and in solving customer problems in the markets served. This document contains forward looking statements which are subject to the risk factors set forth at the end of \"Item I: Business\".\nTHE INDUSTRY Integrated circuits may be divided into three categories: analog, digital and mixed signal. Digital circuits, which include memory devices and microprocessors, use many repetitive circuit elements that can each represent the two values (\"1\" and \"0\") required by the binary number system that serves as a basis for most computation. Analog circuits, on the other hand, are capable of representing infinite numbers of values with an output signal based on a continously varying input signal. These input signals typically represent \"real world\" phenomena such as temperature, pressure, position, light, sound and speed. Mixed signal circuits are circuits that employ both analog and digital signal processing techniques. Analog and mixed signal circuits are used in most electronic systems, with major markets for such circuits including computing, telecommunications and data communications, test and measurement, medical instrumentation, industrial process control, manufacturing automation, digital audio and automotive electronics. Typical analog circuits include signal amplifiers, instrumentation amplifiers, current transmitters, regulators, analog multipliers and isolation amplifiers. Typical mixed signal circuits include analog-to-digital and digital- to-analog converters. Recently, the rapid growth of the high speed and wireless communications, multimedia and portable computing, and digital audio markets have created important new growth opportunities for high performance analog and mixed signal products. Industry sources estimate that analog and mixed signal circuits accounted for 14% of the $128 billion market for semiconductors in 1995.\nThe market for, and design and production of, analog circuits differs from that of digital circuits in several important ways. In general, the market for analog circuits is more diverse than for digital circuits, with each application requiring different operating specifications for resolution, processing linearity, speed, power and amplitude capability. As a result, analog circuit markets generally have relatively smaller volume requirements per device. The markets for analog circuits are generally fragmented, and competition within those markets tends to depend less upon price and more upon performance, functionality, quality and reliability. Analog circuits designed for specified applications are often characterized by longer life cycles and more stable pricing compared to typical digital circuits. Computer-aided design and engineering tools, which have proliferated and enhanced the design effort for digital integrated circuits, are less effective for analog devices. Accordingly, analog circuit design has traditionally been highly dependent on the skills and experience of individual design engineers. Also, in contrast to digital circuits, the performance of analog circuits is more dependent on circuit design, circuit layout and the matching of circuit elements than on advanced capabilities in submicron manufacturing processes. Consequently, the production of high performance analog circuits typically requires less capital investment than the production of highly integrated digital circuits. Because analog circuits are found in most electronic systems, the growth in the use of digital systems across a broad range of applications has in turn fueled a growth in the demand for analog integrated circuits.\nPRODUCTS The Company operates predominantly 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 1995 1994 Analog Integrated Circuits 42.4% 43.3 % 42.5 % Data Conversion Integrated Circuits 42.4% 37.8 % 40.6 % Power Conversion Products 9.5% 10.3 % 5.6 % Other 5.7% 8.6 % 11.3 %\nDemand 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 high 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 and productivity in industry. Since the early seventies, the availability of low cost digital microprocessors and later digital signal processing, in cost-effective single chip form, has enabled an acceleration of the trend toward digitization of systems. This has led to increased use of computers as 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 microcontrols, and digital signal processors (DSP's) 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 relatively weak and contaminated with a large amount of electrical noise. The Company's signal processing components are used to strengthen, filter, transmit and otherwise condition the signal. The resulting signal, still in analog form, must be converted into a digital signal before it can be processed by a computer. 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 proprietary high precision, 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 complete 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 the 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 a customer's sole source for that particular component.\nANALOG INTEGRATED CIRCUITS Analog linear 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, instrumentation 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 communications equipment.\nOPERATIONAL AMPLIFIERS. Operational amplifiers are used to detect and amplify weak (low level) analog signals and are an integral part of most measurement and control systems. The operational amplifier is the fundamental\nbuilding block in analog systems design. In addition to amplification, it can perform mathematical 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 communications systems, robotics vision systems and magnetic resonance and computer-aided tomography (CAT) body scanning systems.\nOTHER AMPLIFIERS. The Company manufactures a number of other amplifiers, including instrumentation amplifiers, programmable gain amplifiers and isolation amplifiers. These products perform a variety of functions related to the amplification 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 the switching of high voltage equipment. These amplifiers are used in many diverse applications 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 effectively 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.\nISOLATION PRODUCTS. The Company's Isolation Product Division, which is operated by Burr-Brown's wholly- owned Scottish subsidiary, focuses on the design, development, manufacturing, and marketing of isolation amplifiers, isolated analog digital converters, bus transceivers and DC-to-DC converters. These products provide galvanic isolation of input and output signals and thereby achieve reduced circuit noise interference and prevent harm to people or equipment due to high voltage transients or current leakage. The product line utilizes optical, transformer and capacitive techniques to produce linear transfer functions between input and output. In certain products, isolated digital couplers are used in lieu of opto-couplers in the galvanic isolation of data signals. The isolation products are used in industrial process control, communication and in medical instrumentation.\nDATA CONVERSION PRODUCTS The Company's Data Conversion Products Division focuses on the design, manufacturing and marketing of integrated circuit devices used to convert analog signals to digital form (\"A\/D converters\") or to convert digital signals to analog form (\"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 mixed signal components revenue is derived from moderate speed, high resolution and high accuracy converters. These general purpose converters are used primarily in manufacturing process control instrumentation, electronic test instrumentation, automatic test systems and communications 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.\nHIGH SPEED CONVERSION PRODUCTS. In the early 1980's, the Company began developing high speed, high resolution A\/D and D\/A converters at speeds substantially greater than general purpose products. These products utilize a unique combination of technologies and design expertise to achieve state-of- the-art performance. High 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, the high speed, high resolution data converter products have limited competition.\nDIGITAL AUDIO PRODUCTS DIVISION (BURR-BROWN JAPAN). The Company's Digital Audio Products Division, which is operated by the Company's wholly-owned Japanese subsidiary, focuses on the design, manufacturing and marketing of high precision, single chip, digital-to- analog converters and analog-to-digital converters for the digital audio market. The Company believes that Burr-Brown was the first company to introduce such a product into this marketplace and is currently one of the largest merchant market suppliers of such devices worldwide. This product, a pulse-code-modulated (\"PCM\") conversion device, plays an essential role in digital audio systems, such as compact disc (\"CD\") players, that use laser technology to achieve improved audio reproduction performance. The Company's component converts the digital signals for each stereo channel into analog form. Several generations of products of this type have been developed and introduced for use in digital audio systems. Involvement in the CD market also helped the Company's early entry into the digital audio tape (\"DAT\") and multimedia markets. The Company believes that the technology developed for its digital audio D\/A converter products enables the Company to develop products for other markets. Burr- Brown's PCM converters have now been designed into musical instruments, computer games, automobile sound systems, CD-ROMs for multimedia applications and set top box tuners for cable and satellite TV.\nSYSTEM PRODUCTS INTELLIGENT INSTRUMENTATION INC. Intelligent Instrumentation Inc. (III), a majority owned subsidiary, designs, manufactures and markets a broad line of data acquisition products, including plug-in boards, portable data acquisition systems, microterminals and supporting software for IBM- compatible PCs, as well as signal conditioning accessories for such systems. These products are applied worldwide for a wide range of industrial and scientific applications such as inventory control, package tracking, image pattern recognition and electro-medical systems. A key part of the data acquisition product line is the Visual DesignerTM software, a graphical development environment which enables users to design applications by connecting functional blocks, called icons, in a flow diagram. III also offers integrated data collection systems that not only collect data, but format and deliver that data to a customer's information system in real time. Representative customers include Mercedes Benz, Siemens, Nikon Koden, Novellus Systems and Xerox.\nPOWER CONVERTIBLES CORPORATION. Power Convertibles Corporation (PCC), a majority-owned affiliate of Burr- Brown, manufactures DC-to-DC converters and battery chargers used in cellular telephone applications. In 1995, PCC was responsible for about 9.5% of Burr- Brown revenues and approximately 3% of Burr-Brown profits. In 1996, Burr-Brown Corporation sold its interest in PCC in order to focus resources on the primary business of analog and mixed signal integrated circuits.\nRESEARCH & 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 dependent upon the ability to produce chips with very 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, comparatively costly capital investment in wafer fabrication facilities.\nAnalog circuits, on the other hand, require the ability to accurately match 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 that which is required for digital circuit processing.\nDesigners of analog circuits must take into account complex interrelationships between the manufacturing process, the circuit elements, the packaging process and the customer's application, 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.\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\nused 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 $25.7 million in 1995, $21.9 million in 1994 and $19.8 million in 1993 for product and process development. This represents an expenditure of approximately 9.6 percent, 11.3 percent and 11.7 percent of revenue in 1995, 1994 and 1993, respectively. (See \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" in the Company's Annual Report to Shareholders, incorporated by reference to Item 7 of this report.)\nPATENTS AND LICENSES The Company owns 118 United States patents expiring from 1996 to 2015, and has applications for 16 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.\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. Approximately 35% of 1995 worldwide revenue was realized through third party distribution.\nIn approximately 45 countries and the less significant domestic markets where the Company does not have a direct sales force, independent sales representatives 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 25,000 customers. The largest customer, a domestic distributor, accounted for approximately 9 percent of sales in 1995. 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 stage. Accordingly, the Company is often a customer's sole source for a particular component. Over 40 percent of the revenue in 1995 for analog and data conversion integrated circuits was for products introduced within the preceding five years. Representative major customers of the Company include Elsag Bailey, Hewlett-Packard, Matsushita Electric, Northern Telecom, Siemens, Sony, Toshiba, Mitsubishi, Alcatel, Nokia, Advantest, NEC, Fujitsu, Ericsson and Hughes Network Systems Inc..\nSales outside the United States accounted for approximately 64 percent of total revenues in 1995, 62 percent of total revenues in 1994 and 64 percent of total revenue in 1993. (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 headquarters in Tucson, Arizona.\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.\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 twelve 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 backlog as of December 31, 1995, 1994 and 1993, was approximately $62.3 million, $45.5 million and $31.4 million, respectively.\nCOMPETITION Burr-Brown estimates that it is among the top four manufacturers of high performance amplifiers and data conversion integrated circuits. The Company's major competitor in the high performance analog integrated circuits market is Analog Devices Inc., believed to be the largest supplier of these devices. Other competitors include Linear Technology Corporation and Maxim Integrated Products Inc.. With respect to a small number of products, the Company also competes with National Semiconductor Corporation, Harris Corporation, Motorola Inc., Texas Instruments Inc., Cirrus Logic Inc., Signal Processing Technologies, Datel Inc., Sipex Corporation and Unitrode Corporation.\nThe Company is not aware of any significant competition from foreign companies providing analog integrated circuits, personal computer instrumentation products 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, and multimedia systems, including Analog Devices Inc., Cirrus Logic Inc., Asahi Kasei Micro, Sony Electronics Inc., Hitachi America Limited, Matsushita Electric Corporation of America, Mitsubishi Corporation 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 reliability, 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 competitive 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 components. 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 products.\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. The Company can utilize its in- house process technology, purchase wafer processing 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.\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 resistors that enable the Company to manufacture high precision, cost effective products.\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 DAC's and ADC's, and a very high frequency bipolar process used for products such as video amplifiers.\nThe 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 Philippines. 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 operation 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 has developed and implemented a Quality Program focused on customer satisfaction. The program includes annual Satisfaction Reviews with customers to assess improvement priorities. The Quality Program also includes Quality System Certification (ISO9001), a comprehensive Product\/Process Reliability Monitoring Program, and extensive Qualification Program for new products and processes. The Company has a reputation for high quality and highly reliable products as evidenced by the highest satisfaction rating reported by our customers for these factors.\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 and 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. The 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. In Japan, the Company's Atsugi Technical Center, near Tokyo, performs product development, final product testing and quality and reliability testing for the PCM product line for sale in Japan and export to other markets.\nThe principal 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 possible shortage problems.\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 operating performance. The Company eliminated the use of ozone-depleting chemicals in the manufacturing process December 1, 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 the EPA. The cost for the implementation required in 1995 was approximately $106,000.\nHUMAN RESOURCES At December 31, 1995, the Company employed 1,839 people worldwide, including 1,164 people in manufacturing and assembly, 255 people in research and development, 210 in sales and marketing and 210 in management and administration. (These numbers include 431 employees of Power Convertibles Corporation which was sold in the first quarter of 1996.) 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 manufacturers, 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.\nRISK FACTORS The Company's quarterly and annual operating results are affected by a variety of factors that could materially and adversely affect net revenue, gross profit and profitability, including the volume and timing of orders, changes in product mix, market acceptance of the Company's and its customers' products, competitive pricing pressures, fluctuations in foreign currency exchange rates, the timing of new product introductions and fluctuations in manufacturing yields. Historically, average selling prices in the semiconductor industry have decreased over the life of particular products. If the Company is unable to introduce new products with higher average selling prices or is unable to reduce manufacturing costs to offset decreases in the prices of its existing products, the Company's operating results will be adversely affected. In addition, the Company is limited in its ability to reduce costs quickly in response to any revenue shortfalls.\nThe fabrication of integrated circuits is a highly complex and precise process. Manufacturing yields can be impacted by a variety of factors, many of which are outside the Company's control. A large portion of the Company's manufacturing costs are relatively fixed and consequently, the number of shippable die per wafer for a given product is critical to the Company's results of operations. To the extent the Company does not achieve acceptable manufacturing yields or experiences product shipment delays, its financial condition, cash flows and results of operations would be materially and adversely affected. To meet anticipated future demand and to utilize a broader range of fabrication processes, the Company intends to increase its manufacturing capacity. However, given the complexity and expense of designing and constructing a significant expansion of a semiconductor fabrication plant, during the construction of the additions, the Company's manufacturing yields could be materially and adversely impacted.\nThe Company desires to continue to expand its operations outside of the United States and to enter additional international markets, which will require significant management attention and financial resources and subject the Company further to the risks of operating internationally. These risks include unexpected changes in regulatory requirements, delays resulting from difficulty in obtaining export licenses for certain technology, tariffs and other barriers and restrictions, and the burdens of complying with a variety of foreign laws. The Company is also subject to general geopolitical risks in connection with its international operations, such as political and economic instability and changes in diplomatic and trade relationships. In addition, because most of the Company's international sales are denominated in foreign currencies, gains and losses on the conversion to U.S. dollars of accounts receivable and accounts payable arising from international operations may contribute to fluctuations in the Company's operating results.\nThe Company's success depends upon its ability to develop new analog and mixed signal products for existing and new markets, to introduce such products in a timely manner and to have such products gain market acceptance. The development of new products is highly complex, and from time to time the Company has experienced delays in developing and introducing new products. Successful product development and introduction depends on a number of factors, including proper new product definition, timely completion of design and testing of new products, achievement of acceptable manufacturing yields, and market acceptance of the Company's and its customers' products. Moreover, successful product design and development is dependent on the Company's ability to attract, retain and motivate qualified analog design engineers, of which there is a limited number. There can be no assurance that the Company will be able to meet these challenges or adjust to changing market conditions as quickly and cost-effectively as necessary to compete successfully. Due to the complexity and variety of products manufactured by the Company, the limited number of analog circuit designers and the limited effectiveness of computer- aided design systems in the design of analog circuits, there can be no assurance that the Company will be able to successfully develop and introduce new products on a timely basis. Although the Company seeks to design products that have the potential to become broadly accepted for high volume applications, there can be no\nassurance that any products introduced by the Company will achieve such market success. The Company's failure to develop and introduce new products successfully could materially and adversely affect its business and operating results. The Company has targeted new markets in which it has relatively little experience, including the market niches for wireless applications for the communications industry, power management applications for the computing industry, and CD-ROM and PC sound applications for the digital audio industry. There can be no assurance that the Company's products will adequately meet the requirements of such new markets, or that the Company's products will achieve market acceptance.\nThe semiconductor industry is intensely competitive and is characterized by price erosion, rapid technological change, product obsolescence and heightened international competition in many markets. Many of the Company's competitors have substantially greater financial, technical, marketing, distribution and other resources, broader product lines and longer standing relationships with customers than the Company. In the event of a downturn in the market for analog circuits, companies that have broader product lines and longer standing customer relationships may be in a stronger competitive position than the Company. Competitors with greater financial resources or broader product lines also may have more resources than the Company to engage in sustained price reductions in the Company's primary markets to gain market share.\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 approximately 88,800 square feet in Tucson. Approximately 28,000 square feet of this leased space is on short term contracts of two years or less. The major single building lease is for 61,000 square feet and will expire in March 1997. The aggregate current gross rental for all Tucson properties is approximately $552,000 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 building 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 on this facility which expires in 2001.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThese four proceedings are the only litigation matters other than ordinary pending litigation:\na. Mary H. Yslava, et.al. v. Hughes Aircraft Company, CIV91-525-TUC-JMR, U.S. District Court filed on September 20, 1991.\nb. Joe Ann Lanier, et.al. v. Hughes Aircraft Company, CIV92-564-TUC-JMR, U.S. District Court filed on March 7, 1994.\nc. Arellano v. Hughes Aircraft Company, CIV94-718- TUC-ROS, U.S. District Court filed on January 9, 1995.\nThe Company, upon stipulation and court order dated September 23, 1995, was dismissed from these three cases.\nd. Cordova v. Hughes Aircraft Company, 294158, Superior Court, State of Arizona, Pima County filed on January 13, 1992, is as follows: The plaintiffs are charging that they and their respective properties are damaged from the release of contaminants including Trichloroethylene (TCE) into the ground waters 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.\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, 1995.\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 1995 Annual Report to Stockholders on page 24, 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 1995 Annual Report to Stockholders on page 28, 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 24, 25, 26 and 27 of the 1995 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 1995 Annual Report to Stockholders on pages 12 through 23, which is included as Exhibit 13 to this report and is incorporated herein by reference.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None 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\" on pages 4 and 5 in the Registrant's Proxy Statement for the 1996 Annual Meeting of Stockholders is incorporated herein by reference.\nEXECUTIVE OFFICERS OF THE REGISTRANT At December 31, 1995, there were 3 individuals designated as executive officers by the Board of Directors. The following sets forth certain information with regard to the only executive officer of Burr-Brown who is not a Director:\nJOHN L. CARTER (age 61) joined the Company in August 1993 as Executive Vice President, responsible for Components Operations and was then appointed Chief Financial Officer in July 1994. Prior to that, Mr. Carter served as a consultant 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 manufacturing and general management positions, including General Manager of Tucson IBM operations.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION The information, with respect to Executive Compensation, appearing under the caption \"Executive Compensation and Other Information\" on pages 7 through 10 of the Registrant's Proxy Statement for the 1996 Annual Meeting of Stockholders 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 Stockholders\" on pages 2 and 3 of the Registrant's Proxy Statement for the 1996 Annual Meeting of Stockholders is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS None\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 1995 Annual Report to Stockholders: PAGES OF 1995 ANNUAL REPORT TO STOCKHOLDERS INCORPORATED BY REFERENCE\nReport of Ernst & Young LLP, Independent Auditors Consolidated Statements of Income for the years ended December 31, 1995, 1994 and 1993\nConsolidated Statements of Changes in Stockholders' Equity for the years ended December 31, 1995, 1994 and 1993\nConsolidated Balance Sheets at December 31, 1995, 1994 and 1993\nConsolidated Statements of Cash Flows for the years ended December 31, 1995, 1994 and 1993\nNotes to Consolidated Financial Statements 16-22\na(2) Financial Statement Schedules for the years ended: FORM 10-K December 31, 1995, 1994 and 1993: PAGE\nSchedule II - Valuation and Qualifying Accounts All other schedules are omitted because they are not applicable or the required information is shown in the consolidated financial statements.\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. Amendment to Restated Certificate of Incorporation dated September 20, 1995, filed herein.\n3.2 Restated By-laws of the Registrant dated October 21, 1994, incorporated by reference to Exhibit 3.2 of the Registrants 10-K filing for the period ended December 31, 1994.\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 Harris Trust (assigned by 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, 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 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 Registrant's 10-K filing for the period ended December 31, 1989. Amended July 23, 1993, to name John L. Carter as Co-trustee. Incorporated by reference to Exhibit 10.4 of the Registrant's 10-K filing for the period ended December 31, 1993. Amendment to Stock Bonus Plan dated 1995, filed herein.\n10.3 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.\n10.4 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.\n10.5 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.\n10.6 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.\n10.7 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.\n10.8 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.\n10.9 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. Incorporated by reference to Exhibit 10.17 of the Registrant's 10-K filing for the period ended December 31, 1994. Amendment to Employee Retirement Plan dated January 1, 1995, filed herein.\n10.10 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.\n10.11 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.\n10.12 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.\n10.13 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.\n10.14 Master Equipment Lease Agreement dated June 20, 1990, between General Electric Capital Corporation, formerly known as Ellco Leasing Corporation, 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. Incorporated by reference to Exhibit 10.27 of the Registrant's 10-K filing for the period ended December 31, 1994.\n10.15 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.\n10.16 Burr-Brown Corporation's amended Stock Incentive Plan dated February 11, 1994, which replaces the Stock Incentive Plan dated February 11, 1993. Incorporated by reference to Exhibit 10.29 of the Registrant's 10-K filing for the period ended December 31, 1994.\n10.17 Future Investment Trust Plan dated July 23, 1993, replaces 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. Incorporated by reference to Exhibit 10.30 of the Registrant's 10-K filing for the period ended December 31, 1994. Amendments to Future Investment Trust dated January 1, 1995, and July 1, 1995, filed herein.\n10.18 Cash Profit Sharing Plan dated April 21, 1995, filed herein.\n10.19 Loan Agreement dated January 31, 1996, 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, 1995, 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 of Form 8-K have been filed during the fourth quarter of 1995.\nSIGNATURES Pursuant 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 20, 1996 Syrus P. Madavi President and Chief Executive Officer\nPOWER OF ATTORNEY KNOW 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 the 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 substitute 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 Registrant and in the capacities and on the dates indicated.\nNAME TITLE DATE\nSYRUS P. MADAVI President and Chief March 20, 1996 Syrus P. Madavi Executive Officer\nJOHN L. CARTER Executive Vice President March 20, 1996 John L. Carter and Chief Financial Officer (Principal Financial and Accounting Officer)\nTHOMAS R. BROWN, JR. Chairman of the Board March 20, 1996 Thomas R. Brown, Jr.\nTHOMAS J. TROUP Vice Chairman of the Board March 20, 1996 Thomas J. Troup\nFRANCIS J. AGUILAR Director March 20, 1996 Francis J. Aguilar\nJOHN ANDEREGG, JR. Director March 20, 1996 John Anderegg, Jr.\nMARCELO A. GUMUCIO Director March 20, 1996 Marcelo A. Gumucio\nBOB JENKINS Director March 20, 1996 Bob Jenkins\nJAMES A. RIGGS Director March 20, 1996 James A. Riggs\nEXHIBIT 21\nBURR-BROWN CORPORATION AND SUBSIDIARIES\nJURISDICTION NAME OF CORPORATION OF INCORPORATION\n1. Burr-Brown International Holding Corporation Delaware\n2. Burr-Brown Limited Scotland\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 (fka Analog Microsystems, Inc.) Arizona\n14. PCC de Mexico, S.A. de C.V. Mexico\n15. Power Convertibles Ireland, Ltd. 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 Sales Corporation Barbados","section_15":""}
{"filename":"93389_1995.txt","cik":"93389","year":"1995","section_1":"ITEM 1. BUSINESS - -----------------\n(a) General Development of Business -------------------------------\nRegistrant manufactures replacement parts for the automotive industry. Product groups include automotive ignition systems, wires and cables, fuel system parts, climate control systems and brake systems parts, and distributes a general service line of automotive related items.\nIn February 1995, the Company acquired, for approximately $3,900,000, the assets and certain liabilities of Pik-A-Nut Corporation. Located in Huntington, Indiana, Pik-A-Nut distributes a complete line of general fasteners, brass fittings, expansion plugs and clamps primarily to the automotive aftermarket. This acquisition expands the capability of the Company's Champ Service Line Division to supply a full line of service products to the automotive aftermarket. The acquisition increased consolidated net sales by approximately $3,800,000 in 1995 and had an immaterial effect on consolidated net earnings for the same period.\nIn June 1995, the Company acquired, for approximately $4,000,000, the assets and certain liabilities of Automotive Dryers, Inc. and Air Parts, Inc. Automotive Dryers, Inc. manufactures and distributes receiver filter dryers and accumulators for mobile air conditioning systems. Air Parts, Inc. is a distributor of parts for mobile air conditioning systems. Located in Cumming, Georgia, these acquisitions expand the manufacturing and distribution capabilities of the Company's Four Seasons Climate Control Division. These acquisitions increased consolidated net sales by $3,400,000 in 1995 and had an immaterial effect on consolidated net earnings for the same period.\nIn November 1995, the Company entered into a joint venture in China through its Hong Kong subsidiary. The joint venture will produce ignition modules for use in Chinese original equipment applications. The Company owns 40% of the joint venture and will provide the joint venture with technical and engineering support. The total projected investment of all parties in the joint venture is estimated at $5,000,000.\nIn February 1996, the Company acquired substantially all of the assets and certain liabilities of Federal Parts Corporation for approximately $13,400,000, plus contingent payments based on performance. Located in Dallas, Texas, Federal Parts assembles and distributes ignition wire sets and battery cables primarily to traditional aftermarket customers in North America. This acquisition will expand the Standard Division's presence in the ignition wire business.\nReplacement Parts Market The size of the replacement parts market ------------------------ depends, in part, upon the average age and number of cars on the road and the number of miles driven per year. According to the Motor Vehicle Manufacturers Association and United States government sources, all three of the above factors increased from 1990 through 1995 and this trend is projected to continue during the balance of the 1990's.\n- 3 -\n(b) Financial Information about Industry Segments ---------------------------------------------\nDistribution of Sales The table below shows the registrant's sales --------------------- by product groups. [CAPTION]\nThe business of the registrant is not dependent on any single customer. In the year ended December 31, 1995, the registrant's five largest customers accounted for approximately 29.3% of sales, or approximately $194,000,000.\nIgnition Parts Replacement parts for automotive ignition and -------------- emission control systems account for about 35% of the registrant's revenues. These parts include distributor caps and rotors, electronic ignition control modules, voltage regulators, coils, switches and sensors. The registrant is a basic manufacturer of many of the ignition parts it markets. These products cover a wide range of applications, from 30-year old vehicles to current models, both domestic and import, including passenger car, truck, farm, off-road and marine applications.\nLike most automotive aftermarket suppliers, the registrant began by offering ignition parts which were equal in quality to O.E. (original equipment parts installed on new vehicles). Soon afterward, the registrant pioneered the concept of offering an alternate higher level of quality, significantly better than O.E. and priced proportionately higher. This has now evolved to a \"good-better-best\" concept, and a lower priced line has been made available under the registrant's Tru-Tech brand.\n- 4 -\nNearly all new vehicles are factory-equipped with computer-controlled engine management systems to control ignition, emission control and fuel injection. The on-board computer monitors inputs from many types of sensors located throughout the vehicle, and controls a myriad of valves, switches and motors. The registrant is a leader in the manufacture and sale of these engine management component parts, including remanufactured automotive computers.\nElectronic control modules and electronic voltage regulators comprise a significant and growing portion of registrant's total ignition sales. The registrant is one of the few aftermarket companies that manufactures these parts, and the only independent aftermarket supplier to manufacture the complex electronic control modules for distributorless ignition systems. The registrant's electronic production is divided between highly-automated operations, which are performed in Long Island City, NY, and assembly operations, which are performed in assembly plants in Hong Kong and Puerto Rico. The joint venture entered into in November 1995 in China will produce ignition modules for use in Chinese original equipment applications.\nThe registrant's sales of such parts as sensors, valves and solenoids have increased steadily as auto manufacturers equip their cars with more complex engine management systems. New government emission laws including the 1990 Federal Clean Air Act are expected to increase automotive repair activity creating an increase in parts sales. Although there is much controversy over how quickly these new procedures will be implemented, it is no doubt going to have a positive impact on sales of the registrant's products. The registrant is a basic manufacturer of throttle position sensors, air pump check valves, coolant temperature sensors, air charge temperature sensors, EGR valves, idle air control valves and MAP sensors.\nThe joint venture entered into in 1992 with Blue Streak Electronics, Inc., a rebuilder of engine management computers and MAF sensors, has positioned the registrant as a key supplier in the fast growing remanufactured electronics market. In 1994, the registrant vastly increased its offering of remanufactured computers, and instituted a program to offer slower-moving items by overnight shipment from its factory. This has enabled the registrant's customers to expand their coverage without increasing inventory investment. In 1995, Blue Streak Electronics, Inc. opened a research and development center in Haifa, Israel. A joint venture with Intermotor Limited, initiated at the beginning of 1996, will supply rebuilt engine computers for Europe.\nThe Registrant has begun the manufacture of MAP\/Barometric Pressure sensors - electronic devices which measure air pressure and convert it to computer inputs. These products have previously been available only from OE suppliers. Using an integrated electronic pressure module developed by Motorola, the Standard design offers advantages in reduced component count, higher yield, and greater reliability. The joint Standard\/Motorola effort reduced the design-to-market cycle by many months, while raising quality and lowering costs.\nBrake System Products As of August 31, 1986, the registrant --------------------- acquired the EIS Brake Parts Division from Parker-Hannifin Corporation. In the aftermarket, brake parts represent the single largest product group in a warehouse distributor's inventory.\nThe division manufactures a full line of brake replacement parts and also markets many special tools and fluids used by mechanics who perform brake service. EIS has a long- established reputation in the industry for quality products and engineering excellence.\n- 5 -\nEIS brake products account for approximately 25% of the registrant's revenues, making it the second largest revenues source for the registrant. We anticipate that EIS's growth will be enhanced in 1996 and the future as a result of the increased wear on friction products resulting from front wheel drives and other vehicle design dynamics. The Company's growth should also be enhanced by the continued vertical integration of its manufacturing capabilities, emphasis on new market channels such as OE Service and Undercar, and continued expansion of product line offerings.\nIn 1994, a joint venture with Autoline Industries was begun to manufacture loaded calipers (disc brake calipers pre-assembled with disc pads and hardware). This plant, located in California, is in full operation and sales are growing. In 1995 the Company established a factory in Canada to manufacture brake friction materials. This operation gave us a toehold in the rapidly growing friction business, and is expected to reduce costs significantly in 1996 and after.\nThe brake rebuilding factory in Rural Retreat, VA was closed at the end of 1995, and its operations consolidated into the Manila, AR operation, with savings in overhead costs and no disruption of customer service.\nIn 1995 the manufacture of wheel cylinders and brake hoses at the Berlin plant was converted to CNC machining centers, with quick-change tooling. These essential low-volume parts can now be made economically in smaller batches, with consequent reductions of inventories. Just-in-time manufacturing cells have recently been implemented in the manufacture of clutch master and slave cylinders, also aimed at reducing in-process inventories and improving turnaround time. A new pack-to-order system, including an automated carousel picking system, was completed in 1995. The Company can now replace multiple branded inventories with lesser inventories of unpackaged products.\nWires and Cables Wire and cable parts account for about 7% of the ---------------- registrant's revenues. These products include ignition (spark plug) wires, battery cables and a wide range of electrical wire, terminals, connectors and tools for servicing an automobile's electrical system.\nA major part of this product line is the sale of ignition wire sets. The registrant has historically offered a premium brand of ignition wires and battery cables, which capitalize on the market's awareness of the importance of quality. With the growing customer interest in lower-priced products, the registrant introduced a second line of wire and cable products in 1989. This line has steadily expanded to include import coverage, and in 1995 was offered under the registrant's Tru-Tech brand name. The acquisition of Federal Parts Corporation in February 1996, the leading supplier of economy wire sets in the industry, will further expand the Registrant's presence in the ignition wire business.\nFuel System Parts Fuel system parts account for about 6% of the ----------------- registrant's revenues. The registrant manufactures and markets over 2,000 parts for the maintenance and repair of automotive fuel systems. These include parts for carburetors, mechanical and electric fuel pumps, and fuel injection systems.\nFor several decades, the registrant's most important fuel system product was the carburetor rebuilding kit. Sales of these kits have been declining in recent years, since nearly all new cars are equipped with electronic fuel injection systems. However, the registrant's sales of fuel injection parts have steadily increased, and this segment of the business is expected to continue to grow.\n- 6 -\nIn 1988 the registrant began manufacturing mechanical fuel pumps, and added the manufacture of electric fuel pumps in 1994. Electric pumps are replacing the traditional mechanical units at O.E. levels, since they are more easily integrated into an electronic fuel injection system. Electric pumps are expected to become the dominant technology, and the fuel pump is now seen as an integral part of the engine management system.\nClimate Control Systems The registrant manufactures and ----------------------- markets a line of replacement parts for automotive climate control systems (air conditioning and heating), primarily under the brand name Four Seasons. However, in recent years Four Seasons has offered private label packaging to its larger accounts which are experiencing significant growth. Revenues from Four Seasons account for approximately 20% of the registrant's total sales.\nIn 1995 Four Seasons continued its double-digit annual sales growth and is now one of the industry's largest marketers of automotive climate control products. To further strengthen its position as an industry leader, in 1995 the division completed two acquisitions and initiated a number of start-up operations.\nAir Parts, a packager\/distributor of promotionally-priced air conditioning parts, was acquired in June 1995. In a related move, the Company acquired Automotive Dryers, a manufacturer and distributor of steel receiver dryers and accumulators. The Air Parts and Automotive Dryers operations will remain in their Cumming, GA facilities.\nIn early 1995, Unimotor, Ltd. was established in Ontario, Canada to manufacture small, difficult-to-source, motors to augment Four Seasons' motor coverage. Additionally, a heat exchange manufacturing plant was started in Dallas to produce aluminum evaporators and related products.\nMid-1996 will see the opening of Four Seasons Europe (FSE), a European distribution center, in Strasbourg, France. Working through regional distributors, FSE will provide overnight availability of Four Seasons' product line to Europe.\nFour Seasons has expanded its use of first computerized (CNC) machining centers to manufacture internal components for use in the compressor remanufacturing process. The Company has developed expertise in machining components and has expanded its manufacturing capabilities. These capabilities have permitted the Company to recently initiate production of completely new air conditioning system compressors - a first by an aftermarket company.\nChamp Service Line Products In 1995, Champ accounted for --------------------------- approximately 7% of the registrant's total sales. The division markets over 9,000 different automotive-related items, ranging from mirrors, window cranks and antennas to cleaning and polishing materials, specialty tools and maintenance supplies.\nChamp purchases products from a wide range of manufacturers and packages them under the Champ and Big A private brand label, enabling its customers to conveniently order items in many separate product groups from a single source. Champ's marketing program offers its customers ordering efficiency, marketing support and effective shipping that are considered key benefits by the registrant's customers.\nIn February 1995, the Company acquired the assets and certain liabilities of Pik-A-Nut Corporation, a reseller of a complete line of general fasteners, brass fittings, expansion plugs and clamps primarily to the automotive aftermarket in both retail and bulk packaging. This acquisition expands the capability of Champ to supply a full line of service products to the automotive aftermarket. - 7 - The sales and service work formerly done by Champ's sales force was turned over to a network of independent sales agents at the close of 1995. We believe this will result in both reduced costs and better service to our customers.\n(c) Narrative Description of Business ---------------------------------\nSales and Distribution The registrant sells its products ---------------------- the United States and Canada under its proprietary brand names and private labels to approximately 1,600 warehouse distributors, who distribute to approximately 27,000 jobber outlets. The jobbers sell the registrant's products primarily to professional mechanics, and secondarily to consumers who perform their own automobile repairs. The registrant has a direct field sales force of approximately 460 persons.\nThe registrant generates demand for its products by directing the major portion of its sales effort to its customers' customers (i.e. jobbers and professional mechanics). In 1995 the registrant conducted approximately 5,200 instructional clinics, which teach mechanics how to diagnose and repair complex new electronic ignition systems, automotive brake systems and climate control systems. The registrant also publishes and sells service manuals and video\/cassettes and provides a free technical information bulletin service to registered mechanics. In addition, our Standard Plus Club, a professional service dealer network comprising approximately 13,000 members, offers technical and business development support and has a technical service telephone hotline.\nThe registrant continued expansion into the retail market by selling its products to large retail chains. The registrant expects continued growth in the retail market in future years.\nProduction and Engineering The registrant engineers, tools and -------------------------- manufactures many of the components for its products, except for certain commonly available small parts in climate control, brake and fuel system products and all of the Champ Service Line. The Company also performs its own plastic and rubber molding operations, extensive screw machining and stamping operations, automated electronics assembly and a wide variety of other processes.\nThe registrant has engineering departments staffed by 100 persons, approximately 64% of whom are graduate engineers. The departments perform product research and development and quality control and, wherever practical, design machinery for automation of the registrant's factories.\nAs new models of automobiles, trucks, tractors, buses and other equipment are introduced, the registrant engineers and manufactures replacement parts for them. The registrant employs and trains tool and die makers needed in its manufacturing operations.\nCompetition Although the registrant is a leading independent ----------- manufacturer of automotive replacement parts and supplies, it faces substantial competition in all markets that it serves. A number of major manufacturers of replacement parts and supplies are divisions of companies having greater financial resources than those of the registrant. In addition, automobile manufacturers supply virtually every replacement part sold by the registrant.\nThe competitive factors affecting the registrant's products are primarily product quality, customer service and price. The registrant's business requires that it maintain inventory levels sufficient for the rapid delivery requirements of customers. Management believes that it is able to compete effectively and that its trademarks and trade names are well known and command respect in the industry and the marketplace.\n- 8 -\nBacklog Backlog is maintained at minimal levels by the ------- registrant. The registrant primarily fills orders, as received, from inventory and manufactures to maintain inventory levels.\nSupplies The principal raw materials purchased by the -------- registrant consist of brass, electronic components, fabricated copper (primarily in the form of magnet wire and insulated cable), ignition wire, stainless steel coils and rods, aluminum coils and rods, lead, rubber molding compound, thermo-set and thermo plastic molding powders, cast iron castings and friction lining materials. All of these materials are purchased in the open market and are available from a number of prime suppliers.\nInsurance The registrant maintains basic liability coverage --------- (general, product and automobile) of $1 million and umbrella liability coverage of $50 million. Historically, the registrant has not experienced casualty losses in any year in excess of its coverage. Management has no reason to expect this experience to change, but can offer no assurances that liability losses in the future will not exceed the registrant's coverage.\nEmployees The registrant has approximately 3,470 employees --------- in the United States, Canada, Puerto Rico, Israel and Hong Kong. Of these, approximately 1,600 are production employees. Long Island City, New York production employees are covered by a collective bargaining agreement with the United Auto Workers, which expires on October 1, 1998. Edwardsville, Kansas production employees are covered by a United Auto Workers contract that expires April 2, 1997. Berlin, Connecticut employees were covered by a collective bargaining agreement with the United Auto Workers, which expired on June 1, 1995. These employees have been working since June 1, 1995 without a collective bargaining agreement. The registrant believes that its facilities are in favorable labor markets with ready access to adequate numbers of skilled and unskilled workers. In the opinion of management, employee relations have been good. There have been no significant strikes or work stoppages in the last five years.\n(d) Financial Information About Export Sales ----------------------------------------\nThe registrant sells its general line of products primarily through Canada, Latin America, Europe and the Middle East. The table below shows the registrant's export sales for the last three years:\n(U.S. Dollars in thousands)\nYears Ended December 31, 1995 1994 1993 - ------------------------ ---- ---- ----\nCanada $38,876 $38,109 $32,341 All Others 11,768 12,341 12,746 ------- ------- ------- Total $50,644 $50,450 $45,087 ------- ------- ------- ------- ------- ------- - 9 -\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES - -------------------\nThe registrant maintains its executive offices and a manufacturing plant at 37-18 Northern Boulevard, Long Island City, NY.\nThe table below describes the registrant's major (a) manufacturing and packaging properties and (b) warehousing properties. (For information with respect to rentals, see note 16 of Notes to Consolidated Financial Statements on page.).\n(a) Manufacturing Properties ------------------------\nApproximate Products Number of (See Key Location Square Feet Owned or Leased Employees On Page 11) - -------- ----------- --------------- ---------- -----------\nLong Island City, 318,000 Owned (1) (2) (5) 526 A, B, I New York Edwardsville, 150,000 Owned 177 C Kansas Puerto Rico 114,000 Leased (expires in 1997) 233 A, B, H, I Puerto Rico 24,100 Leased (expires in 2004) 48 B Hong Kong 22,500 Leased (expires in 1997) 91 I Grapevine, Texas 180,000 Owned (2) (3) 397 E Middletown, CT 161,700 Owned (7) -0- Berlin, CT 165,000 Owned (1) 183 H Manila, AR 119,300 Owned 214 F Manila, AR 100,000 Owned (2) (8) 19 F Rural Retreat, VA 72,300 Leased (expires in 2003) (9) 32 F West Bend, WI 110,600 Owned (4) -0- Ontario, CA 107,600 Leased (expires in 2003) 42 F Mississauga, Canada 94,600 Leased (expires in 2004) 29 F St. Thomas, Canada 40,000 Owned 42 E Cumming, GA 32,000 Leased (expires in 2000) (11) 35 E Dallas, Texas 28,400 Leased (expires in 1998) (13) 3 E Herzliya, Israel 1,800 Leased (expires in 1996) (14) 2 I\n-Continued-\nSee Notes on page 12\n- 10 -\n(b) Warehousing Properties ----------------------\nApproximate Number of Location Square Feet Owned or Leased Employees Products - -------- ----------- --------------- ---------- -----------\nDisputanta, VA 411,000 Owned 249 A, B, D, I Edwardsville, 205,000 Owned (1) 165 C, D Kansas Reno, Nevada 67,000 Owned 18 A, B, C, E, I Coppell, Texas 168,000 Owned (1) 132 E Berlin, CT 66,000 Owned 153 H Manila, AR 150,000 Owned (2) (6) 54 F, G Mississauga, Canada 96,800 Leased (expires in 1996)(15) 44 A, B, C, D, E, F, H, I Calgary, Canada 33,500 Leased (expires in 1998) 11 A, B, C, D, E, F, G, H, I Ontario, CA 142,600 Leased (expires in 2003) 26 A, B, C, E, F, G, H, I Grand Prairie, Texas 51,200 Leased (expires in 1996) 5 E Huntington, Indiana 60,000 Leased (expires in 2000) 64 D Dallas, Texas 57,300 Leased (expires in 2002)(10) -0- C Cumming, GA 30,000 Leased (expires in 2000)(12) 16 E\nProduct Key: A) Ignition - ------------ B) Fuel System Parts C) Wire & Cable D) Champ Service Line E) Climate Control System Parts F) Friction - Brake Shoes & Pads G) Drums & Rotors H) Hydraulic Brake System Components I) Electronic Ignition\nSee Notes on page 12\n- 11 - NOTES TO PROPERTY SCHEDULE: - ---------------------------\n(1) Includes executive or division offices.\n(2) While owned by the registrant for accounting purposes, these properties were actually sold to local industrial development authorities and leased to the registrant under the terms of Industrial Revenue Bond (\"IRB\") financing agreements. Under those agreements, title to these properties passes to the registrant at maturity for little or no consideration. The rental payments made by the registrant equal the principal and interest due under each IRB.\n(3) Financed with a bond issue in 1980 for $2,670,000 fully paid off in 1993 and a bond issue in 1984 for $2,000,000 maturing through 1999.\n(4) As of January 1, 1987, the registrant vacated this facility. It is now being leased by the registrant to a third party. This facility is presently being offered for sale.\n(5) This property was purchased on January 5, 1988.\n(6) Financed with a bond issue in 1989 for $2,500,000 maturing through 1999.\n(7) Part of this facility is now being leased by the registrant to a third party. This facility is presently being offered for sale.\n(8) Financed with a bond issue in 1990 for $1,800,000 maturing through 2000.\n(9) Under terms of the lease, the registrant has an option to purchase the property for $350,000 by 12\/31\/97 or $200,000 by 12\/31\/2002. As of January 15, 1996, the registrant vacated this facility. It is presently being offered for sale.\n(10) This lease agreement was entered into in February 1996 in connection with the acquisition of the assets of Federal Parts, Corporation.\n(11) This lease agreement was entered into in June 1995 in connection with the acquisition of the assets of Automotive Dryers, Inc.\n(12) This lease agreement was entered into in June 1995 in connection with the acquisition of the assets of Air Parts, Inc.\n(13) Heat exchange plant opened in 1995 to produce aluminum evaporators and related products.\n(14) This facility is engaged in research and development activities.\n(15) A new 10 year lease agreement, signed in 1995, will take effect in July 1996. The Registrant will occupy 128,400 square feet of the same facility under the new lease agreement. - 12 -\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS - ------------------------------\nCurrently, there are no legal proceedings which management deems would have a material economic impact on the Company.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - ----------------------------------------------------------------\nNone\nPART II -------\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND - ----------------------------------------------------------- RELATED STOCKHOLDER MATTERS ---------------------------\nThe Company's stock is listed on the New York Stock Exchange. The number of Shareholders of record of Common Stock on February 29, 1996 was approximately 925 including brokers who hold approximately 7,215,255 shares in street name. The quarterly market price and dividend information is presented in the following chart.\nPrice Range of Common Stock and Dividends\nThe Company's Common Stock is traded on the New York Stock Exchange under the symbol SMP. The following table shows the high and low sale prices on the composite tape of, and the dividend paid per share on, the Common Stock during the periods indicated.\n1995 Quarter High Low Dividend 1994 Quarter High Low Dividend - -------------------------------------------------------------------------------- 1st $20.50 $18.75 $.08 1st $26.88 $16.00 $.08\n2nd 20.63 18.88 .08 2nd 18.38 14.75 .08\n3rd 20.63 18.75 .08 3rd 19.75 17.38 .08\n4th 19.13 14.50 .08 4th 19.75 16.88 .08 - --------------------------------------------------------------------------------\nThe Board of Directors will consider the payment of future dividends on the basis of earnings, capital requirements and the financial condition of the Company. The Company's loan agreements limit dividends and distributions by the Company. As of December 31, 1995, approximately $16,195,000 of retained earnings was available under those agreements for payment of cash dividends and purchase of capital stock.\n- 13 -\nPART II (CONT'D) -----------------\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA - -------------------------------------- [CAPTION]\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL - ---------------------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS -----------------------------------\nLiquidity and Capital Resources - In 1995, cash provided by operations amounted to $801,000. This compares unfavorably to 1994 and 1993 when cash provided by operations was $21,104,000 and $22,065,000, respectively. Net earnings of $16,132,000 in 1995 were offset by an increase in inventories of $17,749,000. Cash used in investing activities in 1995 was $26,985,000 primarily due to capital expenditues and payments for 1995 acquisitions. For the three years ended December 31, 1995, capital expenditures totaled $16,651,000, $12,509,000 and $12,212,000, respectively. Cash provided by financing activities in 1995 of $34,201,000 was primarily due to $53 million in new long-term financing primarily offset by repayment of debt and dividend payments. In 1996, required long-term debt payments will be approximately $14,262,000.\nIn January 1996, the Company secured an additional $20,000,000 in long-term financing. In all three years in the three year period ended December 31, 1995, dividends paid were approximately $4,200,000. Overall, during 1995 stockholders' equity increased $15,311,000 to $210,400,000.\n- 14 - PART II (CONT'D) ----------------- Total debt (current and non-current) increased $36,613,000. This was mainly due to an increase in inventories, capital expenditures and payments for acquisitions. The Company is continuing to aggressively pursue ways to reduce inventories. Significant efforts are focusing on pack-to-order systems and improved requirements forecasting systems. Pack-to-order systems retain parts in a bulk state until an order is received for a specific brand of product.\nThe Company expects capital expenditures for 1996, excluding acquisitions, to be approximately $17,000,000 primarily for new machinery and equipment. At December 31, 1995, the Company had unused lines of credit aggregating approximately $105,000,000 which will be used as a source of funding working capital requirements, capital expenditures and new acquisitions. The Company anticipates that its present sources of funds will continue to be adequate to meet its needs.\nAs part of an ongoing operating strategy, the Company is reviewing potential acquisition candidates in related automotive component businesses. If such acquisitions are made, additional sources of capital could be required. It presently is anticipated that any such acquisition could be funded by presently available lines of credit. In February 1996 Federal Parts was acquired for approximately $13,400,000, plus contingent payments based on performance.\nComparison of 1995 to 1994 -\nNet sales increased $22,675,000 or 3.5% from the comparable period in 1994 primarily due to a significant sales increase at the Climate Control Systems Division and sales resulting from 1995 acquisitions.\nCost of goods sold increased $28,374,000 from $415,687,000 to $444,061,000. Gross margins, as a percentage of net sales, decreased from 35.1% to 33.1%. The decrease reflects the Company's continued expansion into lower margin business and an increase in customer returns and rebates.\nSelling, general and administrative expenses increased by 4.6% or $8,270,000, and as a percentage of net sales, increased from 27.9% to 28.2%. The expense increase was primarily a result of costs related to a reorganization of the company's sales force, costs to acquire new customers, costs to support new acquisitions and higher variable distribution expenses due to increased sales, partially offset by lower bad debt expenses.\nOther income (expense), net increased $1,193,000 primarily due to an increase in income from Blue Streak Electronics, Inc. and a higher rate of return on investments in 1995, partially offset by an increase in the loss on sale of accounts receivable.\nInterest expense increased by $2,330,000 due to higher average borrowings.\nTaxes based on earnings decreased $7,573,000 due to both lower earnings and a lower effective tax rate of 20.5% in 1995, as compared to 33.1% in 1994. The lower effective tax rate in 1995 was primarily due to the higher relative earnings of the Company's Puerto Rican and Hong Kong subsidiaries, which have lower tax rates than the U.S. statutory rate.\n- 15 - PART II (CONT'D) ----------------- Comparison of 1994 to 1993 -\nNet sales increased $57,959,000 or 9.9%. Sales increases were evident in all divisions with the largest percentage increases at the Climate Control Division and the Canadian Division. The increase in sales was predominantly due to volume increases.\nCost of goods sold increased $42,099,000 from $373,588,000 to $415,687,000. Gross margins, as a percentage of net sales, decreased from 35.9% to 35.1%. The decrease reflects the price reductions implemented early in the first quarter to respond to competitive actions. It also reflects the continuing shift of sales mix to lower margin market segments.\nSelling, general and administrative expenses increased by 5.7% or $9,693,000, but as a percentage of net sales, decreased from 29% to 27.9%. The expense increase was primarily due to increased new customer acquisition costs in the first half of 1994 and higher variable distribution expenses due to increased sales, partially offset by cost reduction programs.\nRestructuring charges of $2,781,000 were incurred in 1993 primarily due to the consolidation of the EIS Brake Parts operation within Connecticut and the rationalization of the Company's manufacturing operations involving the relocation of several product lines.\nOther income (expense), net decreased $412,000 primarily due to an increase in the loss on sale of accounts receivables and a lower rate of return on investments in 1994, partially offset by an increase in income from Blue Streak Electronics, Inc.\nTaxes based on earnings increased by $3,525,000 due to increased earnings and a higher effective tax rate. The higher effective tax rate in 1994 was primarily due to a lower relative benefit from earnings of the Company's Puerto Rico and Hong Kong subsidiaries, which have lower tax rates than the U.S. statutory rate.\nCumulative effect of changes in accounting for postretirement benefits and income taxes, net is the result of the Company adopting, as of January 1, 1993 two changes in accounting principles, Statement of Financial Accounting Standards (SFAS) No. 106 - \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" and SFAS No. 109 - \"Accounting for Income Taxes\". The after-tax charge for SFAS No. 106 of $6,135,000 (after an income tax benefit of $4,090,000), combined with the tax benefit for SFAS No. 109 of $5,045,000 reduced net earnings by $1,090,000.\n- 16 - PART II (CONT'D) ----------------- Impact of Inflation - Although inflation is not a significant issue, the Company's management believes it will be able to continue to minimize any adverse effect of inflation on earnings. This will be achieved principally by cost reduction programs and, where competitive situations permit, selling price increases.\nFuture Results of Operations - The Company is continuing to face competitive pressures. In order to sell at competitive prices while maintaining profit margins, the Company is continuing to focus on overhead and cost reduction. This is being done through acquisitions, start-ups and joint ventures. In 1995, the Company achieved more than $10 million in annual savings.\nThe Company is continuing to broaden its customer base both geographically and to new customers, including original equipment vehicle manufacturers. The Company has initiated joint ventures in China, Great Britain and Israel and will soon be distributing Four Seasons products throughout Europe from a distribution facility in France.\nThe Company will continue to pursue improved inventory management. The multiplicity of brands the Company offers has been a major factor in the dramatic increase in inventories during the past several years. This is being addressed with pack-to-order systems in significant locations and improved requirements forecasting systems. Pack-to-order is already in place at several major locations.\nRecently Issued Accounting Standards - The Company has not adopted Statement of Financial Accounting Standards No. 121, \"Accounting For The Impairment Of Long-lived Assets And For Long-lived Assets To Be Disposed Of\" (SFAS 121). SFAS 121 is effective for fiscal years beginning after December 15, 1995. The Company believes that the adoption of this accounting standard will not have a material effect on the Company's consolidated financial statements.\nThe FASB issued Statement No. 123, \"Accounting for Stock-Based Compensation,\" which becomes effective for transactions entered into after December 15, 1995. The Company, as permitted by Statement No. 123, has not adopted the provisions of this statement when accounting for stock-based compensation and the Company believes any disclosure requirements in connection with such statement will not have a material effect on the consolidated financial statements.\n- 17 -\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - ----------------------------------------------------------\nINDEPENDENT AUDITORS' REPORT - ----------------------------\nThe Board of Directors and Stockholders Standard Motor Products, Inc.:\nWe have audited the consolidated balance sheets of Standard Motor Products, Inc. and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of earnings, changes in stockholders' equity, and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as 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 Standard Motor Products, Inc. and subsidiaries as of December 31, 1995 and 1994, and the results of their operations and their cash flows for the years then ended in conformity with generally accepted accounting principles.\nKPMG Peat Marwick LLP\nNew York, New York February 24, 1996\n- -\nINDEPENDENT AUDITORS' REPORT\nTo The Board of Directors and Stockholders Standard Motor Products, Inc.\nWe have audited the consolidated statements of earnings, changes in stockholders' equity and cash flows of Standard Motor Products, Inc. and subsidiaries for the year ended December 31, 1993. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated results of operations and cash flows of Standard Motor Products, Inc. and subsidiaries for the year ended December 31, 1993 in conformity with generally accepted accounting principles.\nDavid Berdon & Co. LLP Certified Public Accountants\nNew York, New York February 25, 1994\n- -\n[CAPTION]\nSee accompanying notes to consolidated financial statements.\n- - [CAPTION]\nSee accompanying notes to consolidated financial statements. - - [CAPTION]\nSee accompanying notes to consolidated financial statements. - - [CAPTION]\nSee accompanying notes to consolidated financial statements. - -\nStandard Motor Products, Inc. and Subsidiaries Notes to Consolidated Financial Statements\n1. Summary of Significant Accounting Policies\nPrinciples of Consolidation\nThe Company is engaged in the manufacture and sale of automotive replacement parts.\nThe consolidated financial statements include the accounts of the Company and its subsidiaries, all of which are wholly owned. As more fully described in Note 2, the Company's investments in unconsolidated affiliates are accounted for on the equity method. All significant intercompany items have been eliminated.\nUse of Estimates\nIn conformity with generally accepted accounting principles, management of the Company has made a number of estimates and assumptions relating to the reporting of assets, liabilities, revenues and expenses, and the disclosure of contingent assets and liabilities to prepare these consolidated financial\nstatements. Actual results could differ from those estimates.\nReclassifications\nWhere appropriate, certain amounts in 1993 and 1994 have been reclassified to conform with the 1995 presentation.\nCash and Cash Equivalents\nThe Company considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents.\nMarketable Securities\nAt December 31, 1995, held-to-maturity securities amounted to approximately $13,290,000 and trading securities amounted to approximately $582,000.\nHeld-to-maturity securities consist primarily of U.S. Treasury Bills and\ncorporate debt securities which are reported at unamortized cost which approximates fair value. As of December 31, 1995, $6,090,000 of the held-to-maturity securities mature within one year and $7,200,000 mature within five to ten years.\nThe first-in, first-out method is used in computing realized gains or losses.\nInventories\nInventories are stated at the lower of cost (determined by means of the first-in, first-out method) or market.\nProperty, Plant and Equipment\nThese assets are recorded at cost and are depreciated using the straight-line method of depreciation over the estimated useful lives as follows: Estimated Life -------------- Buildings 30 to 33 1\/2 years Building and land improvements 10 to 20 years or life of building Machinery and equipment 7 to 12 years Tools, dies and auxiliary equipment 3 to 8 years Furniture and fixtures 3 to 12 years Leasehold improvements 10 years or life of lease\nRevenue Recognition\nThe Company recognizes revenues from product sales upon shipment to the customers. Appropriate provisions are made for product returns.\nNet Earnings Per Common and Common Equivalent Share\nNet earnings per common and common equivalent share are calculated using the daily weighted average number of common shares outstanding during each year and if material, the net additional number of shares which would be issuable upon the exercise of stock options, assuming that the Company used the proceeds received to purchase additional shares at market value. Shares held by the ESOP are considered outstanding and are included in the calculation to determine earnings per share.\nIncome Taxes\nDeferred income taxes result from temporary differences in methods of recording certain revenues and expenses for financial reporting and income tax purposes (see Note 14).\nCustomer Acquisition Costs\nCosts associated with the acquisition of new customer accounts are deferred and amortized over a twelve-month period.\nForeign Currency Translation\nAssets and liabilities are translated into U.S. dollars at year end exchange rates and revenues and expenses are translated at average exchange rates during the year. The resulting translation adjustments are recorded in a separate component of stockholders' equity.\nConcentrations of Credit Risk\nFinancial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash investments and accounts receivable. The Company places its cash investments with high quality financial institutions and limits the amount of credit exposure to any one institution. With respect to accounts receivable, such receivables are primarily from warehouse distributors in the automotive aftermarket industry located in the United States. The Company performs ongoing credit evaluations of its customers' financial conditions and does require collateral or other security to support customer receivables where appropriate. Members of one marketing group represent the Company's largest group of customers and accounted for 15% of consolidated net sales for the years ended December 31, 1995 and December 31, 1994. No individual member of this marketing group accounted for more than 10% of net sales for the years ended December 31, 1995 and December 31, 1994. The Company's five largest individual customers, including the members of this marketing group, accounted for 29% and 27% of net sales in 1995 and 1994, respectively.\n- -\n2. Acquisitions\nIn April 1993, the Company acquired, for approximately $9,000,000, substantially all of the general service line inventory and certain other related assets of APS, Inc., a national distributor of automotive parts, along with a ten-year agreement to supply this product line to APS, Inc. on an exclusive basis. This acquisition has been accounted for as a purchase. The acquisition increased consolidated net sales by approximately $15,500,000 in 1995, $16,300,000 in 1994 and $10,900,000 in 1993.\nDuring 1994 the Company made two additional investments. The investments had no significant effect on the Company's financial position or results of operations.\nIn February 1995, the Company acquired, for approximately $3,900,000, the assets and certain liabilities of Pik-A-Nut Corporation. Located in Huntington, Indiana, Pik-A-Nut Corporation distributes a complete line of general fasteners, brass fittings, expansion plugs and clamps primarily to the automotive aftermarket. This acquisition has been accounted for as a purchase. The acquisition increased consolidated net sales by approximately $3,800,000 in 1995 and had an immaterial effect on consolidated net earnings for the same period.\nIn June 1995, the Company acquired, for approximately $4,000,000, the assets and certain liabilities of Automotive Dryers, Inc. and Air Parts, Inc. Automotive Dryers, Inc., located in Cumming, Georgia, manufactures and distributes receiver filter dryers and accumulators for mobile air conditioning systems. Air Parts, Inc., also situated in Cumming, Georgia, is a distributor of parts for mobile air conditioning systems. This acquisition has been accounted for as a purchase. The acquisition increased consolidated net sales by approximately $3,400,000 in 1995 and had an immaterial effect on consolidated net earnings for the same period.\nIn November 1995, the Company entered into a joint venture in China. The joint venture will produce ignition modules for use in Chinese original equipment applications. The Company acquired 40% ownership in the joint venture and the investment is accounted for under the equity method. The accompanying consolidated Financial Statements include the investment at December 31, 1995 of $1,160,000 in \"Other assets\". The joint venture had an immaterial effect on consolidated net earnings in 1995.\nSubsequent to year end 1995, the Company acquired substantially all of the assets and certain liabilities of Federal Parts Corporation for approximately $13,400,000 plus contingent payments based on performance. Located in Dallas, Texas, Federal Parts assembles and distributes ignition wire sets and battery cables.\n3. Sale of Accounts Receivable\nOn December 20, 1993, the Company entered into a new three-year agreement whereby it can sell up to a $25,000,000 undivided interest in a designated pool of certain eligible accounts receivable. At December 31, 1995 and 1994, net receivables amounting to $25,000,000 had been sold under these agreements. As collections reduce previously sold undivided fractional interest, new receivables are customarily sold up to the $25,000,000 level. At the expiration of the agreement, the Company and the purchaser share a proportionate risk of loss based on the ratio of the purchaser's interest to the eligible pool of accounts receivable (see Note 13).\n4. Inventories (In thousands)\nDecember 31, -------------------------------- 1995 1994 ----------------------------------------------------------------------------- Inventories consist of: Finished goods .................... $ 125,839 $ 114,021 Work in process .................. 12,597 19,336 Raw materials ..................... 67,843 52,498 ----------------------------------------------------------------------------- Total inventories .................. $ 206,279 $ 185,855 -----------------------------------------------------------------------------\n5. Property, Plant and Equipment (In thousands)\nDecember 31, -------------------------------- 1995 1994 ----------------------------------------------------------------------------- Property, plant and equipment consist of the following: Land, buildings and improvements ...... $ 70,159 $ 67,819 Machinery and equipment ............... 76,263 65,146 Tools, dies and auxiliary equipment ... 7,766 7,244 Furniture and fixtures ................ 17,339 15,025 Leasehold improvements ................ 5,486 4,641 Construction in progress .............. 7,527 7,481 ----------------------------------------------------------------------------- 184,540 167,356 Less, accumulated depreciation and amortization .................... 75,003 63,230 ----------------------------------------------------------------------------- Total property, plant and equipment, net ...................... $ 109,537 $ 104,126 -----------------------------------------------------------------------------\n6. Other Assets (In thousands)\nDecember 31, -------------------------------- 1995 1994 ----------------------------------------------------------------------------- Other assets consist of the following: Deferred new customer acquisition costs.. $ 13,596 $ 12,233 Marketable securities .................. 7,200 4,800 Unamortized customer supply agreements .. 5,638 6,908 Equity in joint ventures ............... 3,995 2,196 Goodwill ............................... 3,561 -- Pension assets ......................... 476 632 Other .................................. 2,688 2,579 ----------------------------------------------------------------------------- Total other assets $ 37,154 $ 29,348 -----------------------------------------------------------------------------\nIncluded in Other is a preferred stock investment in a customer of the Company. Net sales to such customer amounted to $53,499,000 and $51,935,000 in 1995 and 1994, respectively.\n- -\n7. Notes Payable - Banks\nThe maximum amount of short-term bank borrowings outstanding at any month-end was $91,000,000 in 1995 and $38,500,000 in 1994, and averaged $61,483,000 and $27,268,000, respectively. The weighted average short-term interest rate was 6.47% for 1995 and 4.77% for 1994. At December 31, 1995, the Company had unused lines of credit aggregating approximately $105,000,000.\n8. Long-Term Debt (In thousands)\nDecember 31, -------------------------------- 1995 1994 ----------------------------------------------------------------------------- Long-term debt consists of: 7.85% senior note payable .............. $ 65,000 $ 65,000 6.81% senior note payable .............. 53,000 -- 9.75%-10.50% senior note payable ........ 2,000 4,000 9.47% senior note payable .............. 30,000 30,000 6.01% senior note payable .............. -- 15,000 Credit Agreement ....................... 5,034 6,714 7.50%-10.50% purchase obligations ...... 7,113 8,200 Floating rate purchase obligation ...... 780 950 9.50% mortgage payable ................. -- 50 ----------------------------------------------------------------------------- 162,927 129,914 Less current portion ................... 14,262 19,987 ----------------------------------------------------------------------------- Total noncurrent portion of long-term debt $ 148,665 $ 109,927 -----------------------------------------------------------------------------\nUnder the terms of the $65,000,000 senior note agreement, the Company is required to repay the loan in seven equal annual installments beginning in 1996.\nThe $53,000,000 is part of a $73,000,000 note agreement. An additional $20,000,000 was received in January 1996. Under the terms of the $73,000,000 senior note agreement, the Company is required to repay the loan in seven equal annual installments beginning in 2000.\nUnder the terms of the $2,000,000 senior note agreement, the Company is required to repay the remaining loan in one installment in 1996.\nUnder the terms of the $30,000,000 senior note agreement, the Company is required to repay the loan in seven varying annual installments beginning in 1998. Subject to certain restrictions, the Company may make prepayments without premium beginning in 1998.\nThe $15,000,000 senior note agreement was fully paid off in 1995.\nThe Credit Agreement matures in varying annual installments through 1998 and bears interest at the lower of 91% of prime rate, or 91% of the London Interbank Offering Rate (\"LIBOR\") plus 1.092%. The Company also entered into an interest rate swap agreement to reduce the impact of changes in interest rates on its Credit Agreement. The swap agreement modifies the interest rate on the Credit Agreement, adjusted favorably or unfavorably for the spread between 77.52% of the 3-month reserve unadjusted \"LIBOR\" and 7.69%. The proceeds of such note were loaned to the Company's Employee Stock Ownership Plan (ESOP) to purchase 1,000,000 shares of the Company's common stock to be distributed in accordance with the terms of the ESOP established in 1989 (see Note 11).\nThe 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 purchase obligations, due under agreements with municipalities, mature in annual installments through 2003, and are secured by properties having a net book value of approximately $20,528,000 at December 31, 1995.\nThe floating rate purchase obligation matures in annual installments through 1999, bears interest at sixty-five percent of prime, and is secured by property having a net book value of approximately $1,821,000 at December 31, 1995.\nThe mortgage payable was fully paid off in 1995.\nMaturities of long-term debt during the five years ending December 31, 2000 are $14,262,000, $12,312,000, $16,601,000, $14,982,000 and $22,019,000 respectively. Including the additional $20,000,000 received in January 1996, $24,876,000 of long-term debt matures in 2000.\nCertain loan agreements require the maintenance of a specified amount of working capital and limit, among other items, investments, leases, indebtedness and distributions for the payment of dividends and the acquisition of capital stock. At December 31, 1995, the Company had unrestricted retained earnings of $16,195,000.\n9. Stockholders' Equity\nThe Company has authority to issue 500,000 shares of preferred stock, $20 par value, and the Board of Directors is vested with the authority to establish and designate series of preferred, to fix the number of shares therein and the variations in relative rights as between series. On December 18, 1995, the Board of Directors established a new series of preferred shares designated as Series A Participating Preferred Stock. The number of shares constituting the Series A Preferred Stock are 30,000. The Series A Preferred Stock is designed to participate in dividends, ranks senior to the Company's common stock as to dividends and liquidation rights and has voting rights. Each share of the Series A Preferred Stock shall entitle the holder to one thousand votes on all matters submitted to a vote of the stockholders of the Company. No such shares were outstanding at December 31, 1995.\nOn January 17, 1996, the Board of Directors adopted a Shareholder Rights Plan (Plan). Under the Plan, the Board declared a dividend of one Preferred Share Purchase Right (Right) for each outstanding common share of the Company. The dividend is payable on March 1, 1996 to the shareholders of record as of February 15, 1996. The Rights are attached to and automatically trade with the outstanding shares of the Company's common stock.\n- -\nThe Rights will become exercisable only in the event that any person or group of affiliated persons becomes a holder of 20% or more of the Company's outstanding common shares, or commences a tender or exchange offer which, if consummated, would result in that person or group of affiliated persons owning at least 20% of the Company's outstanding common shares. Once the rights become exercisable they entitle all other shareholders to purchase, by payment of an $80.00 exercise price, one one-thousandth of a share of Series A Participating Preferred Stock, subject to adjustment, with a value of twice the exercise price. In addition, at any time after a 20% position is acquired and prior to the acquisition of a 50% position, the Board of Directors may require, in whole or in part, each outstanding Right (other than Rights held by the acquiring person or group of affiliated persons) to be exchanged for one share of common stock or one one-thousandth of a share of Series A Preferred Stock. The Rights may be redeemed at a price of $0.001 per Right at any time prior to their expiration on February 28, 2006.\nOn April 20, 1994, the Company announced that the Board of Directors has authorized the repurchase by the Company of up to 200,000 shares of its common stock to be used to meet present and future requirements of its stock option program. As of December 31, 1995, 90,300 shares were repurchased at a cost of $1,480,000.\n10.Stock Options\nUnder the Company's stock option plans, while the holder is an employee of the Company, the options are exercisable in whole or in part anytime during the five years following the date of grant for options granted prior to 1994. For options granted in 1994, while the holder is an employee of the Company, the options are exercisable in whole or in part anytime during the five years following the date of vesting.\nOn May 26, 1994, the shareholders approved an increase of 400,000 shares for issuance under the Company's 1994 Omnibus Stock Option Plan. At December 31, 1995, 431,000 shares of authorized but unissued common stock were reserved for issuance under the Company's stock option plans, of which 281,000 shares were subject to outstanding options.\nThe changes in outstanding options are as follows: 1995 1994 1993 ----------------------------------------------------------------------------- Outstanding at beginning.. 288,000 82,300 437,700 Granted................... -- 250,000 32,000 Exercised (1995 - $12.75 to $16.39, 1994 and 1993 - $10.13 to $16.88)......... (7,000) (35,950) (378,650) Terminated and expired.... -- (8,350) (8,750) ----------------------------------------------------------------------------- Outstanding at end........ 281,000 288,000 82,300 ----------------------------------------------------------------------------- Vested at end............. 93,500 38,000 82,300 ----------------------------------------------------------------------------- Aggregate option price.... $4,648,925 $4,756,375 $1,337,688 -----------------------------------------------------------------------------\nAt a price range per share of:\n1995 1994 1993 ----------------------------------------------------------------------------- Beginning $12.75 to $18.56 $10.13 to $18.56 $10.13 to $16.88 End $12.75 to $18.56 $12.75 to $18.56 $10.13 to $18.56 -----------------------------------------------------------------------------\n11.Employee Benefit Plans\nThe Company has a defined benefit pension plan covering substantially all of the unionized employees of the EIS Brake Parts Division. The benefits are based on years of service. The Company's funding policy is to contribute annually the maximum amount that can be deducted for federal income tax purposes. Contributions are intended to provide not only for benefits attributed to service to date but also for those expected to be earned in the future.\n(In thousands) December 31, ------------------------------ 1995 1994 1993 ----------------------------------------------------------------------------- Net periodic pension cost for 1995, 1994 and 1993 includes the following components: Service cost - benefits earned during the period ..................... $235 $250 $248 Interest cost on projected benefit obligation ............................ 634 631 613 Actual return on plan assets .......... (1,760) (88) (960) Net amortization and deferral ......... 1,185 (521) 391 ----------------------------------------------------------------------------- Net periodic pension cost ............. $294 $272 $292 -----------------------------------------------------------------------------\n- -\nThe following table sets forth the plans funded status at December 31, 1995 and 1994: (In thousands) December 31, ------------------------------ 1995 1994 ----------------------------------------------------------------------------- Actuarial present value of benefit obligations: Accumulated benefit obligation, including vested benefits of $(9,710) and $(9,706) in 1995 and 1994, respectively ............... $(10,317) $(10,322) ----------------------------------------------------------------------------- Projected benefit obligation for service rendered to date .................. $(10,317) $(10,322) Plan assets at fair value (primarily debt securities, commercial mortgages and listed stocks) ........................ 9,814 8,486 ----------------------------------------------------------------------------- Plan assets (less than) projected benefit obligation ........................ (503) (1,836) Unrecognized prior service cost ........... 416 460 Unrecognized net loss ..................... 27 1,343 Unrecognized net obligation being recognized over 15 years .................. 145 172 Adjustment required to recognize minimum liability ......................... (588) (1,975) ----------------------------------------------------------------------------- Accrued pension cost included in accrued expenses .......................... $(503) $(1,836) ----------------------------------------------------------------------------- Assumptions used in accounting for the pension plan are as follows: 1995 1994 1993 ----------------------------------------------------------------------------- Discount rates ............................ 6.5% 6.5% 6.5% Expected long-term rate of return on assets ................................. 8.0% 8.0% 8.0% ----------------------------------------------------------------------------- In addition, the Company participates in several multiemployer plans which provide defined benefits to substantially all unionized workers. The Multiemployer Pension Plan Amendments Act of 1980 imposes certain liabilities upon employers associated with multiemployer plans. The Company has not received information from the plans' administrators to determine its share, if any, of unfunded vested benefits.\nThe Company and certain of its subsidiaries also maintain various defined contribution plans, which include profit sharing, providing retirement benefits for other eligible employees.\nThe provisions for retirement expense in connection with the plans are as follows: Defined Multi- Contribution employer Plans and Other Plans ----------------------------------------------------------------------------- Year-end December 31, 1995 $366,000 $3,091,000 1994 379,000 5,033,000 1993 358,000 4,760,000 -----------------------------------------------------------------------------\nIn January 1989, the Company established an Employee Stock Ownership Plan and Trust for employees who are not covered by a collective bargaining agreement. The ESOP authorized the Trust to purchase up to 1,000,000 shares of the Company's common stock in the open market. In 1989, the Company entered into an agreement with a bank authorizing the Company to borrow up to $18,000,000 in connection with the ESOP. Under this agreement, the Company borrowed $16,729,000, payable in annual installments through 1998 (see Note 8), which was loaned on the same terms to the ESOP for the purchase of common stock. During 1989, the ESOP made open market purchases of 1,000,000 shares at an average cost of $16.78 per share. Future company contributions plus dividends earned will be used to service the debt.\nDuring 1995, 1994 and 1993, 97,100, 96,800 and 100,700 shares were allocated to the employees, leaving 301,700 unallocated shares in the ESOP trust at December 31, 1995.\nContributions to the ESOP are based on a predetermined formula which is primarily tied into dividends earned by the ESOP and loan repayments. The provision for expense in connection with the ESOP was approximately $1,334,000 in 1995, $1,321,000 in 1994 and $1,380,000 in 1993. The expense was calculated by subtracting dividend and interest income earned by the ESOP, which amounted to approximately $289,000, $296,000 and $305,000 for the years ended December 31, 1995, 1994 and 1993, respectively, from the principal repayment on the outstanding bank loan. Interest costs amounted to approximately $515,000, $645,000 and $772,000 for the years ended December 31, 1995, 1994 and 1993, respectively.\nAt December 31, 1995 and 1994, indebtedness of the ESOP to the Company in the amounts of $5,025,000 and $6,705,000, respectively, is shown as deductions from stockholders' equity in the consolidated balance sheets. Dividends paid on ESOP shares are recorded as reductions in retained earnings in the consolidated balance sheets.\nIn August 1994 the Company established an unfunded Supplemental Executive Retirement Plan for key employees of the Company. Under the plan, employees may elect to defer a portion of their compensation and, in addition, the Company may at its discretion make contributions to the plan on behalf of the employees. Such contributions were not significant in 1995 and 1994.\n12.Postretirement Benefits\nThe Company provides certain medical and dental care benefits to eligible retired employees. Approximately 1,800 employees and 200 retirees are eligible under this plan. Salaried employees become eligible for retiree health care benefits after reaching age 65 if they retire at age 65 or older with at least 15 years of continuous service. EIS Brake Parts unionized employees become eligible after reaching age 65 if they retire at age 65 or older with at least 10 years of continuous service. Other unionized employees are covered under union health care plans.\n- -\nGenerally, the health care plans pay a stated percentage of most health care expenses reduced for any deductible and payments made by government programs and other group coverage. The costs of providing most of these benefits has been shared with retirees since 1991. Retiree annual contributions will increase proportionally if the Companys health care payments increase.\nEffective January 1, 1993 the Company adopted Statement of Financial Accounting Standards (SFAS) No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" SFAS No. 106 requires that the expected cost of these postretirement benefits be charged to expense during the years that the employees render services. SFAS No. 106 was adopted using the immediate recognition transition option; the accumulated postretirement benefit obligation of $10,225,000, and related deferred tax benefit of $4,090,000 (net of $6,135,000), has been included in \"cumulative effect of changes in accounting for postretirement benefits and income taxes, net\" in the 1993 consolidated statement of earnings. This new accounting method has no effect on the Company's cash outlays for retiree benefits. The Company's current policy is to fund the cost of the health care plans on a pay-as-you-go basis.\nThe components of the net periodic benefit cost, excluding the cumulative effect of this accounting change, for the years ended December 31, 1995 and 1994 are as follows:\n(In thousands) 1995 1994 ----------------------------------------------------------------------------- Service cost................................. $ 592 $ 701 Interest cost ............................... 1,147 960 Net amortization and deferral ............... 30 -- ----------------------------------------------------------------------------- $1,769 $1,661 -----------------------------------------------------------------------------\nThe following table sets forth the amounts included in the accompanying consolidated balance sheets at December 31, 1995 and 1994: (In thousands) 1995 1994 ----------------------------------------------------------------------------- Accumulated Postretirement Benefit Obligation (APBO):\nRetirees ........................................... $ 7,398 $ 4,012 Fully eligible active participants ................. 888 1,011 Other active participants .......................... 9,731 7,779 ----------------------------------------------------------------------------- 18,017 12,802 Less unrecognized net loss ......................... 3,948 -- ----------------------------------------------------------------------------- Accrued postretirement benefit costs recognized in the balance sheet $14,069 $12,802 ----------------------------------------------------------------------------- For measuring the expected postretirement benefit obligation, a health care cost trend rate of 11 and 13 percent was assumed for 1995 and 1994, respectively. The rate was assumed to gradually decrease to 5 percent in 2002 and remain at that level thereafter. The weighted-average discount rate used in determining the APBO was 7 and 8 percent at December 31, 1995 and 1994.\nThe health care cost trend rate has a significant effect on the APBO and net periodic benefit cost. A 1 percent increase in the trend rate for health care costs would increase the APBO by $2,718,000 and service and interest costs by $292,000.\n13.Other Income (Expense), Net\n(In thousands) December 31, ------------------------------ 1995 1994 1993 -----------------------------------------------------------------------------\nOther income (expense), net consists of: Interest and dividend income ...... $2,066 $1,724 $1,648 (Loss) on sale of accounts receivable (Note 3) ............... (1,516) (1,107) (660) Income from joint ventures ........ 1,700 828 352 Other - net ....................... 179 (209) 308 ----------------------------------------------------------------------------- Total other income (expense), net $2,429 $1,236 $1,648 -----------------------------------------------------------------------------\n14.Taxes Based on Earnings\nEffective January 1, 1993 the Company adopted Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes\". Under SFAS No. 109, deferred tax balances are stated at tax rates expected to be in effect when taxes are actually paid or recovered. The cumulative catch-up adjustment resulted in a deferred tax benefit of $5,045,000, which has been included in the consolidated statements of earnings as \"cumulative effect of changes in accounting for postretirement benefits and income taxes, net.\"\nReconciliations between the U.S. federal income tax rate and the Company's effective income tax rate as a percentage of earnings before income taxes and cumulative effect of changes in accounting principles follow:\n----------------------------------------------------------------------------- 1995 1994 1993 ----------------------------------------------------------------------------- U.S. federal income tax rate ....... 35.0% 35.0% 35.0% Increase (decrease) in tax rate resulting from: State and local income taxes, net of federal income tax benefit ..... 1.4 5.2 5.5 (Tax-exempt income)\/ non-deductible items - net ........ 0.1 0.1 0.2 Benefits of income subject to taxes at lower than the U.S. federal rate (15.9) (8.6) (9.7) Other ............................. (0.1) 1.4 (0.4) ----------------------------------------------------------------------------- Effective tax rate .................. 20.5% 33.1% 30.6% -----------------------------------------------------------------------------\n- -\nThe following is a summary of the components of the net deferred tax assets and liabilities recognized in the accompanying consolidated balance sheets:\n(In thousands) December 31, ------------------------- 1995 1994 ----------------------------------------------------------------------------- Deferred tax assets: Inventories ......................... $13,223 $12,161 Allowance for customer returns ...... 4,943 6,075 Postretirement benefits ............. 5,639 4,827\nAllowance for doubtful accounts ..... 1,209 1,287 Accrued salaries and benefits ....... 2,123 1,315 Other ............................... 2,689 1,704 -----------------------------------------------------------------------------\nTotal ............................... $29,826 $27,369 ----------------------------------------------------------------------------- Deferred tax liabilities: Depreciation ........................ $ 9,217 $ 8,847 Promotional costs ................... 2,272 1,820 Other ............................... 1,420 1,454 ----------------------------------------------------------------------------- Total ............................... 12,909 12,121 ----------------------------------------------------------------------------- Net deferred tax assets ............. $16,917 $15,248 -----------------------------------------------------------------------------\nBased upon the level of historical taxable income and projections for future taxable income over the periods which the deferred tax assets are deductible, the Company believes that it is more likely than not that the results of future operations will generate sufficient taxable income to realize the net deferred tax assets.\nThe Company has not provided for federal income taxes on the undistributed income of its foreign subsidiaries because of the availability of foreign tax credits and\/or the Company's intention to permanently reinvest such undistributed income. Cumulative undistributed earnings of foreign subsidiaries on which no United States income tax has been provided were $13,140,000 at the end of 1995, $12,502,000 at the end of 1994 and $10,011,000 at the end of 1993.\nEarnings of a subsidiary operating in Puerto Rico, amounting to approximately $11,278,000 (1994 - $9,482,000; 1993 - $7,285,000), which are not subject to United States income taxes, are partially exempt from Puerto Rican income taxes under a tax exemption grant expiring on December 31, 2002. The tax benefits of the exemption, reduced by a minimum tollgate tax instituted in 1993, amounted to $.29 per share in 1995 (1994 - $.24; 1993 - $.19).\nForeign income taxes amounted to approximately $689,000, $1,097,000 and $838,000 for 1995, 1994 and 1993, respectively.\n15.Fair Value of Financial Instruments\nThe following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:\nCash and cash equivalents\nThe carrying amount approximates fair value because of the short maturity of those instruments.\nMarketable securities\nThe fair values of investments are estimated based on quoted market prices for these or similar instruments.\nLong-term debt\nThe fair value of the Company's long-term debt is estimated based on the current rates offered to the Company for debt of the same remaining maturities.\nInterest rate swap agreements\nThe fair value of interest rate swaps (used for hedging purposes) is the estimated amount that the Company would receive or pay to terminate the swap agreements at the reporting dates, taking into account current interest rates.\nThe estimated fair values of the Company's financial instruments are as follows:\n(In thousands) Carrying Fair December 31, 1995 Amount Value ----------------------------------------------------------------------------- Cash and cash equivalents ........... $ 10,856 $ 10,856 Marketable securities ............... 13,872 13,879 Long-term debt ...................... (162,927) (169,485) Off-Balance Sheet financial instruments: Interest rate swaps: In a net payable position ....... -- (263) -----------------------------------------------------------------------------\n(In thousands) Carrying Fair December 31, 1994 Amount Value ----------------------------------------------------------------------------- Cash and cash equivalents ........... $ 2,796 $ 2,796 Marketable securities ............... 10,818 10,811 Long-term debt ...................... (129,914) (127,077) Off-Balance Sheet financial instruments: Interest rate swaps: In a net payable position ....... -- (482) -----------------------------------------------------------------------------\n- -\n16.Commitments and Contingencies Total rent expense for the three years ended December 31, 1995 was as follows:\n(In thousands) Real Total Estate Other ----------------------------------------------------------------------------- 1995 ........................... $5,839 $2,720 $3,119\n1994 ........................... 5,345 2,223 3,122 1993 .......................... 5,544 2,320 3,224\nAt December 31, 1995, the Company is obligated to make minimum rental payments (exclusive of real estate taxes and certain other charges) through 2004, under operating leases for real estate, as follows: (In thousands) 1996 ..................... $ 2,772\n1997 ..................... 2,305\n1998 ..................... 1,924 1999 ..................... 1,818 2000 ..................... 1,616 Thereafter ............... 5,387 ----------------------------------------------------------------------------- $15,822 -----------------------------------------------------------------------------\nAt December 31, 1995, the Company had letters of credit outstanding aggregating approximately $1,513,000. The contract amount of the letters of credit is a reasonable estimate of their value as the value for each is fixed over the life of the commitment.\nThe Company is involved in various litigation matters arising in the ordinary course of business. Although the final outcome of these matters cannot be determined, it is management's opinion that the final resolution of these matters will not have a material effect on the Company's financial position and results of operations.\n17.Restructuring Charges\nDuring 1993, the Company recorded a $2,781,000 provision for restructuring charges. Included in the restructuring plan are charges for the expected costs of facility consolidations, asset retirements, employee separations, relocations and related costs. Restructuring plans started in 1993 were completed by the end of 1994.\n18.Quarterly Financial Data (Unaudited)\nNet Gross Net Per Sales Profit Earnings Share ----------------------------------------------------------------------------- (In thousands, except per share amounts) ----------------------------------------------------------------------------- 1995 Quarter: First $159,720 $ 54,199 $ 3,894 $ .30 Second 184,040 60,768 8,301 .63 Third 178,251 54,598 3,127 .24 Fourth 141,474 49,859 810 .06 ----------------------------------------------------------------------------- Total $663,485 $219,424 $16,132 $1.23 -----------------------------------------------------------------------------\n1994 Quarter: First $147,126 $ 50,226 $ 2,745 $ .21 Second 187,645 63,989 8,216 .62 Third 168,291 58,825 7,730 .59 Fourth 137,748 52,083 4,974 .38 ----------------------------------------------------------------------------- Total $640,810 $225,123 $23,665 $1.80 -----------------------------------------------------------------------------\nThe fourth quarter of 1995 reflects an improved gross profit percentage, compared to the prior 1995 quarters, primarily due to favorable year-end inventory adjustments of approximately $3,000,000 ($1,800,000 net of income taxes). Conversely, the fourth quarter of 1995 was negatively impacted by a $1,800,000 ($1,080,000 net of income taxes) reserve for expenses related to a reorganization of the Company's sales force.\nThe fourth quarter of 1994 results reflect physical inventory adjustments which had the effect of increasing fourth quarter operating income by approximately $3,245,000 ($1,947,000 net of income taxes).\n- -\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Stockholders Standard Motor Products, Inc.:\nUnder date of February 24, 1996, we reported on the consolidated balance sheets of Standard Motor Products, Inc. and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of earnings, changes in stockholders' equity, and cash flows for the years then ended, as contained in the annual report on Form 10-K for the year 1995. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related consolidated financial statement schedule as listed in the accompanying index. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement schedule based on our audits.\nIn our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.\nKPMG Peat Marwick LLP\nNew York, New York February 24, 1996\n- 18 -\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Stockholders Standard Motor Products, Inc.:\nIn connection with our audit of the consolidated statements of earnings, changes in stockholders' equity and cash flows of Standard Motor Products, Inc. and subsidiaries for the year ended December 31, 1993, we have also audited the financial statement schedule listed in the accompanying index at Item 14(a) (2) for the year ending December 31, 1993. Our audit of the financial statements were made for the purpose of forming an opinion on those statements taken as a whole. The financial statement schedule is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This financial statement schedule has been subjected to the auditing procedures applied in our 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.\nDavid Berdon & Co. LLP Certified Public Accountants\nNew York, New York February 25, 1994\n- 19 -\nITEM 9.","section_9":"ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. - -------------------------------------------------------------- None.\nPART III --------\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - --------------------------------------------------------------\nInformation relating to Directors and Executive Officers is set forth in the 1996 Annual Proxy Statement.\nITEM 11.","section_11":"ITEM 11. MANAGEMENT REMUNERATION AND TRANSACTIONS. - -----------------------------------------------------\nInformation relating to Management Remuneration and Transactions is set forth in the 1996 Annual Proxy Statement.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS - ----------------------------------------------------------- AND MANAGEMENT --------------\nInformation relating to Security Ownership of Certain Beneficial Owners and Management is set forth in the 1996 Annual Proxy Statement.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - ----------------------------------------------------------\nInformation relating to Certain Relationships and Related Transactions is set forth under \"Certain Transactions\" in the 1996 Annual Proxy Statement.\n- 20 -\nPART IV -------\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON - ------------------------------------------------------------------- FORM 8-K. ---------\n14.(a) Document List -------------\n(a)(1) Among the responses to this Item 14(a) are the following financial statements.\nIndependent Auditor's Report\nFinancial Statements:\nConsolidated Balance Sheets - December 31, 1995 and 1994\nConsolidated Statements of Earnings - Years Ended December 31, 1995, 1994 and 1993\nConsolidated Statements of Changes in Stockholders' Equity - Years Ended December 31, 1995, 1994 and 1993\nConsolidated Statements of Cash Flows - Years Ended December 31, 1995, 1994 and 1993\nNotes to Consolidated Financial Statements\n(a)(2) The following financial schedule for the years 1995, 1994 and 1993 is submitted herewith:\nSchedule Page -------- ----\nII. Valuation and Qualifying Accounts 27\nSelected Quarterly Financial Data, for the Years Ended December 31, 1995 and 1994, are included herein by reference to Part II, Item 8.\nAll other schedules are omitted because they are not required, not applicable or the information is included in the financial statements or notes thereto.\n- 21 - (a)(3) Exhibits required by Item 601 of Securities and Exchange Commission Regulations S-K.\n(A) The following such Exhibits are filed as a separate section of this report.\n(3) By-Laws filed as an Exhibit of Registrant's annual report on Form 10-K for the year ended December 31, 1986 is incorporated herein by reference.\nRestated Certificate of Incorporation, dated July 31, 1990, filed as an Exhibit of Registrant's Annual Report on Form 10-K for the year ended December 31, 1990 is incorporated herein by reference.\n(10) Note Purchase Agreement of January 15, 1987 between the Registrant and the Travelers Insurance Company, the Great-West Life Assurance Company, the Franklin Life Insurance Company, the Franklin United Life Insurance Company, and the Woodmen Accident and Life Company filed as an Exhibit of Registrant's Annual Report on Form 10-K for the year ended December 31, 1986 is incorporated herein by reference.\nLetter Agreement of January 25, 1989 amending the Note Agreement between the Registrant and the Travelers Insurance Company, the Great-West Life Assurance Company, the Franklin Life Insurance Company, the Franklin United Life Insurance Company, and the Woodmen Accident and Life Company dated January 15, 1987 filed as an Exhibit of Registrant's Annual Report on Form 10-K for the year ended December 31, 1987 filed as an Exhibit of Registrant's Annual Report on Form 10-K for the year ended December 31, 1989 is incorporated herein by reference.\nCredit Agreement dated March 10, 1989 between the Registrant and Chemical Bank filed as an Exhibit of Registrant's Annual Report on Form 10-K for the year ended December 31, 1989 is incorporated herein by reference.\n- 22 -\nNote Purchase Agreement dated October 15, 1989 between the Registrant and the American United Life Insurance Company, the General American Life Insurance Company, the Jefferson-Pilot Life Insurance Company, the Ohio National Life Insurance Company, the Crown Insurance Company, the Great-West Life Assurance Company, the Guarantee Mutual Life Company, the Security Mutual Life Insurance Company of Lincoln, Nebraska, and the Woodmen Accident and Life Company filed as an Exhibit of Registrant's Annual Report on Form 10-K for the year ended December 31, 1989 is incorporated herein by reference.\nLetter Agreement of January 15, 1990 amending the Note Agreement between the Registrant and the Travelers Insurance Company dated January 15, 1987 filed as an Exhibit of Registrant's Annual Report on Form 10-K for the year ended December 31, 1990 is incorporated herein by reference.\nLetter Agreement of July 20, 1990 amending the Credit Agreement between the Registrant and Chemical Bank dated March 10, 1989 filed as an Exhibit of Registrant's Annual Report on Form 10-K for the year ended December 31, 1990 is incorporated herein by reference.\nLetter Agreement of September 30, 1990 amending the Note Agreement between the Registrant and the Travelers Insurance Company, the Great-West Life Assurance Company, the Franklin Life Insurance Company, the Franklin United Life Insurance Company, and the Woodmen Accident and Life Company dated January 15, 1987 filed as an Exhibit of Registrant's Annual Report on Form 10-K for the year ended December 31, 1991 is incorporated herein by reference.\nLetter Agreement of March 4, 1991 amending the Credit Agreement between the Registrant and Chemical Bank dated March 10, 1989 filed as an Exhibit of Registrant's Annual Report on Form 10-K for the year ended December 31, 1991 is incorporated herein by reference.\n- 23 -\nLetter Agreement of December 20, 1991 amending the Credit Agreement between the Registrant and Chemical Bank dated March 10, 1989 filed as an Exhibit of Registrant's Annual Report on Form 10-K for the year ended December 31, 1991 is incorporated herein by reference.\nLetter Agreement of February 28, 1992 amending the Note Agreement between the Registrant and the Travelers Insurance Company, the Great-West Life Assurance Company, the Franklin Life Insurance Company, the Franklin United Life Insurance Company and the Woodmen Accident and Life Company dated January 15, 1987 filed as an Exhibit of Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 is incorporated herein by reference.\nLetter Agreement of July 22, 1992 amending the Note Agreement between the Registrant and the Travelers Insurance Company, the Great-West Life Assurance Company, the Franklin Life Insurance Company, the Franklin United Life Insurance Company, and the Woodmen Accident and Life Company dated January 15, 1987 filed as an Exhibit of Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 is incorporated herein by reference.\nLetter Agreement dated October 30, 1992 amending the Credit Agreement between the Registrant and Chemical Bank, assigned to NBD Bank, N.A. with amendment dated December 20, 1991, dated March 10, 1989 filed as an Exhibit of Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 is incorporated herein by reference.\nNote Agreement of November 15, 1992 between the Registrant and Kemper Investors Life Insurance Company, Federal Kemper Life Assurance Company, Lumbermens Mutual Casualty Company, Fidelity Life Association, American Motorists Insurance Company, American Manufacturers Mutual Insurance Company, Allstate Life Insurance Company, Teachers Insurance & Annuity Association of America, and Phoenix Home Life Mutual Insurance Company filed as an Exhibit of Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 is incorporated herein by reference. - 24 - Letter Agreement dated December 27, 1993 amending the Credit Agreement between the Registrant and Chemical Bank, assigned to NBD Bank, N.A. with amendment dated December 20, 1991, dated March 10, 1989 filed as an Exhibit of Registrant's Annual Report on Form 10-K for the year ended December 31, 1993 is incorporated herein by reference.\nEmployee Stock Ownership Plan and Trust dated January 1, 1989 filed as an Exhibit of Registrant's Annual Report on Form 10-K for the year ended December 31, 1989 is incorporated herein by reference.\nSupplemental Executive Retirement Plan dated August 15, 1994 filed as an Exhibit of Registrant's Annual Report on Form 10K for the year ended December 31, 1994 is incorporated herein by reference.\n1994 Omnibus Stock Option Plan of Standard Motor Products, Inc. is incorporated by reference to Exhibit 4.1 of the Company's Registration Statement on Form S-8 (33-58655).\nNote Purchase Agreement dated December 1, 1995 between the Registrant and Metropolitan Life Insurance Company, the Travelers Insurance Company, Connecticut General Life Insurance Company, CIGNA Property and Casualty Insurance Company, Life Insurance Company of North America and American United Life Insurance Company is included as Exhibit 10.\n(21) List of Subsidiaries of Standard Motor Products, Inc. is included on Page 28.\n(23.1) Consent of Independent Auditors KPMG Peat Marwick LLP, is included on Page 29.\n(23.2) Consent of Independent Auditors David Berdon & Co. LLP, is included on Page 30.\n(27) Financial Data Schedule is included on Page 31.\n14(b) Reports on Form 8-K -------------------\nNo reports on Form 8-K were required to be filed for the three months ended December 31, 1995.\n- 25 - 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.\nSTANDARD MOTOR PRODUCTS, INC. (Registrant)\nLawrence I. Sills -------------------------------------------- Lawrence I. Sills, President, Director, Chief Operating Officer\nMichael J. Bailey -------------------------------------------- Michael J. Bailey, Vice President Finance, Chief Financial Officer\nJames J. Burke -------------------------------------------- James J. Burke, Corporate Controller\nDated: New York, New York March 27, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, 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 27, 1996 Lawrence I. Sills - -------------- -------------------------------------------- (Dated) Lawrence I. Sills, President, Director, Chief Operating Officer\nMarch 27, 1996 Bernard Fife - -------------- -------------------------------------------- (Dated) Bernard Fife Co-Chairman, Director\nMarch 27, 1996 Nathaniel L. Sills - -------------- -------------------------------------------- (Dated) Nathaniel L. Sills Co-Chairman, Director\nMarch 27, 1996 Arthur D. Davis - -------------- -------------------------------------------- (Dated) Arthur D. Davis, Director\nMarch 27, 1996 Marilyn F. Cragin - -------------- -------------------------------------------- (Dated) Marilyn F. Cragin, Director\nMarch 27, 1996 Arthur S. Sills - -------------- -------------------------------------------- (Dated) Arthur S. Sills, Director\n- 26 - [CAPTION]\n- 27 -\nEXHIBIT 21 ----------\nSUBSIDIARIES OF THE REGISTRANT ------------------------------\nAS OF FEBRUARY 29, 1996\nPercent State or of Voting Country of Securities Name Incorporation Owned - ---- ------------- ----------\nBlue Streak-Hygrade Motor Products, Ltd. Canada 100 Marathon Auto Parts and Products, Inc. New York 100 Motortronics, Inc. New York 100 Reno Standard Incorporated Nevada 100 Stanric, Inc. Delaware 100 Mardevco Credit Corp. (1) New York 100 Standard Motor Products (Hong Kong) Limited Hong Kong 100 Industrial & Automotive Associates, Inc. California 100 Unimotor, Ltd. Canada 100 EIS Brake Manufacturing, Ltd. Canada 100 Standard Motor Electronics, Ltd. Israel 100\nAll of the subsidiaries are included in the consolidated financial statements.\n(1) Wholly owned subsidiary of Stanric, Inc.\n- 28 -\nExhibit 23.1 ------------\nIndependent Auditors' Consent -----------------------------\nTo the Board of Directors and Stockholders Standard Motor Products, Inc.:\nWe consent to incorporation by reference in the Registration Statement (No. 33-58655) on Form S-8 of Standard Motor Products, Inc. of our reports dated February 24, 1996, relating to the consolidated balance sheets of Standard Motor Products, Inc. and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of earnings, changes in stockholders' equity, and cash flows and related schedule for the years then ended, which reports appear in the December 31, 1995 annual report on Form 10-K of Standard Motor Products, Inc.\nKPMG Peat Marwick LLP\nNew York, New York March 28, 1996\n- 29 -\nExhibit 23.2 ------------\nIndependent Auditors' Consent -----------------------------\nTo the Board of Directors and Stockholders Standard Motor Products, Inc.\nWe consent to the incorporation by reference in the Registration Statement (No. 33-58655) of Standard Motor Products, Inc. on Form S-8 of our report dated February 25, 1994, related to the consolidated statements of earnings, changes in stockholders' equity and cash flows, and schedule included in Part II, Item 3 (1) of the 1994 Omnibus Stock Option Plan of Standard Motor Products, Inc.\nDavid Berdon & Co. LLP Certified Public Accountants\nNew York, New York March 28, 1996\n- 30 -\nExhibit 10 ----------\nSTANDARD MOTOR PRODUCTS, INC.\nNote Purchase Agreement\nDated as of December 1, 1995\n$73,000,000 Principal Amount 6.81% Senior Notes Due February 25, 2006\nPage\n1. DESCRIPTION OF NOTES AND COMMITMENT . . . . . . . . . . . 1 1.1 Description of Notes . . . . . . . . . . . . . . . . 1 1.2 Closings.. . . . . . . . . . . . . . . . . . . . . . 1\n2. PREPAYMENT OF NOTES . . . . . . . . . . . . . . . . . . . 2 2.1 Scheduled Prepayments. . . . . . . . . . . . . . . . 2 2.2 Other Prepayments. . . . . . . . . . . . . . . . . . 3 2.3 Notice of Prepayments. . . . . . . . . . . . . . . . 4 2.4 Surrender of Notes on Prepayment or Exchange . . . . 4 2.5 Direct Payment and Deemed Date of Receipt. . . . . . 5 2.6 Allocation of Payments . . . . . . . . . . . . . . . 5 2.7 Payments Due on Saturdays, Sundays and Holidays. . . 5\n3. REPRESENTATIONS . . . . . . . . . . . . . . . . . . . . . 5 3.1 Representations of the Company . . . . . . . . . . . 5 3.2 Representations of the Purchasers. . . . . . . . . . 12\n4. CLOSING CONDITIONS. . . . . . . . . . . . . . . . . . . . 13 4.1 Representations and Warranties . . . . . . . . . . . 14 4.2 Legal Opinions . . . . . . . . . . . . . . . . . . . 14 4.3 Events of Default. . . . . . . . . . . . . . . . . . 14 4.4 Payment of Fees and Expenses . . . . . . . . . . . . 14 4.5 Sale of Notes at Closings. . . . . . . . . . . . . . 14 4.6 Legality of Investment . . . . . . . . . . . . . . . 14 4.7 Private Placement Number . . . . . . . . . . . . . . 15 4.8 Consent of NBD, N.A. . . . . . . . . . . . . . . . . 15 4.9 Proceedings and Documents. . . . . . . . . . . . . . 15\n5. INTERPRETATION OF AGREEMENT . . . . . . . . . . . . . . . 15 5.1 Certain Terms Defined. . . . . . . . . . . . . . . . 15 5.2 Accounting Principles. . . . . . . . . . . . . . . . 25 5.3 Direct or Indirect Actions . . . . . . . . . . . . . 25\n6. AFFIRMATIVE COVENANTS . . . . . . . . . . . . . . . . . . 25 6.1 Corporate Existence. . . . . . . . . . . . . . . . . 25 6.2 Insurance. . . . . . . . . . . . . . . . . . . . . . 26 6.3 Taxes, Claims for Labor and Materials. . . . . . . . 26 6.4 Maintenance of Properties. . . . . . . . . . . . . . 26 6.5 Maintenance of Records . . . . . . . . . . . . . . . 26 6.6 Financial Information and Reports. . . . . . . . . . 26 6.7 Inspection of Properties and Records . . . . . . . . 29 6.8 Pension Plans. . . . . . . . . . . . . . . . . . . . 30 6.9 Compliance with Laws . . . . . . . . . . . . . . . . 30 6.10 Acquisition of Notes . . . . . . . . . . . . . . . . 31 6.11 Private Offering.. . . . . . . . . . . . . . . . . . 31 6.12 Private Placement Number . . . . . . . . . . . . . . 31\n7. NEGATIVE COVENANTS. . . . . . . . . . . . . . . . . . . . 31 7.1 Consolidated Net Worth . . . . . . . . . . . . . . . 31 7.2 Indebtedness . . . . . . . . . . . . . . . . . . . . 31 7.3 Subsidiary Indebtedness. . . . . . . . . . . . . . . 32 7.4 Fixed Charge Ratio . . . . . . . . . . . . . . . . . 32 7.5 Liens. . . . . . . . . . . . . . . . . . . . . . . . 32 7.6 Restricted Payments. . . . . . . . . . . . . . . . . 34 7.7 Merger or Consolidation. . . . . . . . . . . . . . . 34 7.8 Sale of Assets; Sale of Receivables. . . . . . . . . 35 7.9 Disposition of Stock of Subsidiaries . . . . . . . . 35 7.10 Permitted Investments. . . . . . . . . . . . . . . . 35 7.11 Transactions with Affiliates . . . . . . . . . . . . 36 7.12 Nature of Business . . . . . . . . . . . . . . . . . 36 7.13 Guaranties . . . . . . . . . . . . . . . . . . . . . 36\n8. EVENTS OF DEFAULT AND REMEDIES THEREFOR . . . . . . . . . 36 8.1 Nature of Events . . . . . . . . . . . . . . . . . . 36 8.2 Default Remedies.. . . . . . . . . . . . . . . . . . 37 8.3 Annulment of Acceleration of Notes . . . . . . . . . 38 8.4 Other Remedies . . . . . . . . . . . . . . . . . . . 39 8.5 Conduct No Waiver; Collection Expenses . . . . . . . 39 8.6 Remedies Cumulative. . . . . . . . . . . . . . . . . 39 8.7 Notice of Default. . . . . . . . . . . . . . . . . . 39\n9. AMENDMENTS, WAIVERS AND CONSENTS. . . . . . . . . . . . . 40 9.1 Matters Subject to Modification. . . . . . . . . . . 40 9.2 Solicitation of Holders of Notes . . . . . . . . . . 40 9.3 Binding Effect . . . . . . . . . . . . . . . . . . . 40\n10. FORM OF NOTES, REGISTRATION, TRANSFER, EXCHANGE AND REPLACEMENT . . . . . . . . . . . . . . . . . . . . . . . 41 10.1 Form of Notes. . . . . . . . . . . . . . . . . . . . 41 10.2 Note Register. . . . . . . . . . . . . . . . . . . . 41 10.3 Issuance of New Notes Upon Exchange or Transfer. . . 41 10.4 Replacement of Notes . . . . . . . . . . . . . . . . 41\n11. MISCELLANEOUS . . . . . . . . . . . . . . . . . . . . . . 42 11.1 Expenses . . . . . . . . . . . . . . . . . . . . . . 42 11.2 Notices. . . . . . . . . . . . . . . . . . . . . . . 42 11.3 Reproduction of Documents. . . . . . . . . . . . . . 42 11.4 Successors and Assigns . . . . . . . . . . . . . . . 43 11.5 Law Governing. . . . . . . . . . . . . . . . . . . . 43 11.6 Headings, Independent Construction . . . . . . . . . 43 11.7 Counterparts . . . . . . . . . . . . . . . . . . . . 43 11.8 Reliance on and Survival of Provisions . . . . . . . 43 11.9 Integration and Severability . . . . . . . . . . . . 43\nAnnex 1 -- Information as to Purchasers Annex 2 -- Payment Instructions at Closing Annex 3 -- Information as to the Company Annex 4 -- Notice Information as to Make-Whole Amount Exhibit A -- Form of 6.81% Senior Note Due February 25, 2006 Exhibit B1-- Form of Opinion of Counsel to the Company Exhibit B2-- Form of Opinion of Counsel to the Purchasers Exhibit C -- Form of Officer's Certificate of the Company Exhibit D -- Form of Secretary's Certificate of the Company\nSTANDARD MOTOR PRODUCTS, INC.\nNOTE PURCHASE AGREEMENT\nDated as of December 1, 1995\nSeparately addressed to each of the Purchasers named on Annex 1\nLadies and Gentlemen:\nSTANDARD MOTOR PRODUCTS, INC., a New York corporation (the \"Company\"), agrees with you as follows:\n1. DESCRIPTION OF NOTES AND COMMITMENT\n1.1 Description of Notes.\nThe Company has authorized the issuance and sale of $73,000,000 aggregate principal amount of its Senior Notes (the \"Notes\"). The Notes shall be dated the date of issuance and shall bear interest (computed on the basis of a 360-day year comprised of twelve 30-day months) from such date payable semi-annually in arrears on February 25 and August 25 of each year, commencing February 25, 1996, and at maturity at the rate of 6.81% per annum. Interest shall accrue on any overdue principal (including any overdue optional or required prepayment), on any overdue Make-Whole Amount, and (to the extent legally enforceable) on any overdue installment of interest on the Notes at a rate per annum equal to the greater of 8.81% or 2% over the prime rate of Chemical Bank (or its successors) from time to time in effect. The Notes shall be expressed to mature on February 25, 2006 and shall be substantially in the form attached hereto as Exhibit A. The term \"Notes\" as used herein shall include each Note delivered pursuant to this Agreement or another Note Purchase Agreement, and each Note delivered in substitution or exchange therefor, and, where applicable, shall include the singular numbers as well as the plural. Any reference to you in this Agreement shall in all instances be deemed to include any nominee of yours or any separate account or other person on whose behalf you are purchasing Notes.\n1.2 Closings.\n(a) The Company hereby agrees to sell to you and you hereby agree to purchase from the Company, in accordance with the provisions hereof, the aggregate principal amount of Notes set forth below your name on Annex 1 at one hundred percent (100%) of the principal amount thereof.\n(b) The initial closing (the \"Initial Closing\") of the Company's sale of the Notes will be held on December 15, 1995 (the \"Initial Closing Date\") at 9:00 a.m., local time, at the office of Hebb & Gitlin, P.C., 1 State Street, Hartford, Connecticut. At the Initial Closing, the Company will deliver to you the Notes, if any, to be purchased by you on the Initial Closing Date (as set forth below your name on Annex 1), in the denominations indicated on Annex 1, in the aggregate principal amount of your purchase on said date, dated the Initial Closing Date and payable to you or payable as indicated on Annex 1, against payment by federal funds wire transfer in immediately available funds of the purchase price thereof, as directed by the Company on Annex 2, which shall be an account at a bank located in the United States of America.\n(c) The second closing (the \"Second Closing\") of the Company's sale of Notes will be held on January 4, 1996 (the \"Second Closing Date\") at 9:00 a.m., local time, at the office of Hebb & Gitlin, P.C., 1 State Street, Hartford, Connecticut. At the Second Closing, the Company will deliver to you the Notes, if any, to be purchased by you on the Second Closing Date (as set forth below your name on Annex 1), in the denominations indicated on Annex 1, in the aggregate principal amount of your purchase on said date, dated the Second Closing Date and payable to you or payable as indicated on Annex 1, against payment by federal funds wire transfer in immediately available funds of the purchase price thereof, as directed by the Company on Annex 2, which shall be an account at a bank located in the United States of America.\n(d) If on the Initial Closing Date or the Second Closing Date the Company shall fail to tender to you the Notes to be purchased by you on such date, you shall be relieved of all remaining obligations under this Agreement. Nothing in the preceding sentence shall relieve the Company of any liability occasioned by such failure to deliver the Notes.\n(e) Contemporaneously with the execution and delivery hereof, the Company is entering into a separate Note Purchase Agreement identical (except for the name and signature of the purchaser) hereto (each, a \"Note Purchase Agreement\") with each other purchaser listed on Annex 1 hereto, providing for the sale to each such other purchaser of Notes in the aggregate principal amount set forth below its name on such Annex. The sales of the Notes to you and to each such other purchaser are to be separate sales.\n2. PREPAYMENT OF NOTES\n2.1 Scheduled Prepayments.\nIn addition to payment of all outstanding principal of the Notes at maturity, the Company shall prepay and there shall become due and payable $10,428,571 principal amount of the Notes on February 25, 2000 and each February 25 thereafter to and including February 25, 2005. Each such prepayment shall be at 100% of the principal amount prepaid, together with interest accrued thereon to the date of prepayment. Each such prepayment, and the payment of all outstanding principal of the Notes at maturity, shall be allocated pursuant to Section 2.6.\n2.2 Other Prepayments.\n(a) Optional Prepayments. Upon notice as provided in Section 2.3, the Company may prepay the Notes, in whole or in part, at any time, in an amount not less than $1,000,000, an integral multiple of $100,000 in excess thereof or such lesser amount as shall constitute payment in full of the Notes. Each such prepayment shall be at a price of 100% of the principal amount to be prepaid, plus interest accrued thereon to the date of prepayment, plus the Make-Whole Amount. Each such prepayment shall be allocated pursuant to Section 2.6.\n(b) Mandatory Prepayment Upon Change of Control. Promptly following the day on which the Company first learns of a proposed Change of Control, the Company shall give notice thereof to the holders of the Notes, which notice shall include the estimated date (if known) on which such Change of Control may occur. In the event of a Change of Control, the Company shall immediately and in any event not later than 5 calendar days after such date, give written notice to each holder of a Note of the Change of Control, accompanied by a certificate of an authorized officer of the Company specifying the nature of the Change of Control. Such notice shall (i) contain the written, irrevocable offer of the Company to prepay, on a date specified in such notice which shall be not less than 30 or more than 45 calendar days after the effective date of such Change of Control, the entire principal amount of the Notes held by each holder at a price equal to 100% thereof, plus interest accrued thereon to the date of prepayment, (ii) state that notice of acceptance of the Company's offer to prepay under this Section 2.2(b) must be delivered to the Company not later than 10 calendar days prior to the date fixed for prepayment, and (iii) contain the information specified in clause (v) of the first sentence of Section 2.3. Upon receipt by the Company of a notice of acceptance from any holder, but subject to the following sentence, the aggregate principal amount of Notes held by such holder plus the interest accrued thereon shall become due and payable on the day specified in the Company's notice. Not earlier than 7 calendar days prior to the date fixed for prepayment, the Company shall give written notice to each holder of those holders who have given notices of acceptance of the Company's offer and the principal amount of Notes held by each, and thereafter any holder may change its response to the Company's offer by written notice to such effect delivered to the Company not less than 3 Business Days prior to the date fixed for prepayment. The failure of a holder to timely respond to the Company pursuant to the previous two sentences shall be deemed a rejection of such offer to prepay, or a rejection of such ability to change its response, as the case may be.\n(c) Mandatory Prepayment Upon Non-Occurrence of Second Closing. In the event that the consummation of the sale of the entire Twenty Million Dollars ($20,000,000) principal amount of the Notes to be sold at the Second Closing fails to occur on or before the Second Closing Date pursuant to this Agreement, the Company shall, promptly upon first learning of such failure, give notice thereof to the holders of the Notes. Such notice shall (i) contain the written, irrevocable offer of the Company to prepay, on a date specified in such notice which shall be not less than 10 or more than 30 calendar days after the Second Closing Date, the entire principal amount of the Notes held by each holder at a price equal to 100% thereof, plus interest accrued thereon to the date of prepayment, (ii) state that notice of acceptance of the Company's offer to prepay under this Section 2.2(c) must be delivered to the Company not later than 10 calendar days prior to the date fixed for prepayment, and (iii) contain the information specified in clause (v) of the first sentence of Section 2.3. Upon receipt by the Company of a notice of acceptance from any holder, but subject to the following sentence, the aggregate principal amount of Notes held by such holder plus the interest accrued thereon shall become due and payable on the day specified in the Company's notice. Not earlier than 7 calendar days prior to the date fixed for prepayment, the Company shall give written notice to each holder of those holders who have given notices of acceptance of the Company's offer and the principal amount of Notes held by each, and thereafter any holder may change its response to the Company's offer by written notice to such effect delivered to the Company not less than 3 Business Days prior to the date fixed for prepayment. The failure of a holder to timely respond to the Company pursuant to the previous two sentences shall be deemed a rejection of such offer to prepay, or a rejection of such ability to change its response, as the case may be.\n(d) Any prepayment of less than all of the Notes outstanding pursuant to Section 2.2(a), 2.2(b) or 2.2(c) shall be applied to reduce, pro rata, the prepayments and payment at maturity required by Section 2.1.\n(e) Except as provided in Section 2.1 and this Section 2.2, the Notes shall not be prepayable in whole or in part.\n2.3 Notice of Prepayments.\nThe Company shall give notice of any optional prepayment of the Notes pursuant to Section 2.2(a) to each holder of the Notes not less than 30 calendar days nor more than 60 calendar days before the date fixed for prepayment, specifying (i) such prepayment date, (ii) the principal amount of the holder's Notes to be prepaid on such date, (iii) the Determination Date for calculating the Make-Whole Amount, (iv) the Company's calculation of an estimated Make-Whole Amount, if any, due in connection with such prepayment, showing in detail the method of calculation of such Make-Whole Amount and (v) the accrued interest applicable to the prepayment. Notice of prepayment having been so given, the aggregate principal amount of the Notes specified in such notice, together with the Make-Whole Amount, if any, and accrued interest thereon shall become due and payable on the prepayment date.\n2.4 Surrender of Notes on Prepayment or Exchange.\nUpon any partial prepayment of a Note pursuant to this Section 2 or partial exchange of a Note pursuant to Section 10.3, such Note may, at the option of the holder thereof, (i) be surrendered to the Company pursuant to Section 10.3 in exchange for a new Note or Notes equal to the principal amount remaining unpaid on the surrendered Note, or (ii) be made available to the Company, at the Company's principal office, for notation thereon of the portion of the principal so prepaid or exchanged. In case the entire principal amount of any Note is prepaid or exchanged, such Note shall be surrendered to the Company for cancellation and shall not be reissued, and no Note shall be issued in lieu of such Note.\n2.5 Direct Payment and Deemed Date of Receipt.\nNotwithstanding any other provision contained in the Notes or this Agreement, the Company will pay all sums becoming due on each Note held by you or any subsequent Institutional Holder by federal funds wire transfer of immediately available funds to such account as you or such subsequent Institutional Holder have designated in Annex 1, or as you or such subsequent Institutional Holder may otherwise designate by notice to the Company, in each case without presentment and without notations being made thereon, except that any such Note so paid or prepaid in full shall be surrendered to the Company for cancellation following such payment. Any wire transfer shall identify such payment in the manner set forth in Annex 1 and shall identify the payment as principal, Make-Whole Amount, if any, and\/or interest. You and any subsequent Institutional Holder of a Note to which this Section 2.5 applies agree that, before selling or otherwise transferring any such Note, you or it will make a notation on such Note or an attachment thereto of the aggregate amount of all payments of principal theretofore made and of the date to which interest has been paid and, upon written request of the Company, will provide a copy of such notations to the Company; provided that the failure to make such notations, or any error in making such notations, shall not affect the obligations of the Company under this Agreement or the Notes. Any payment made pursuant to this Section 2.5 shall be deemed received on the payment date only if received before 11:00 a.m., Eastern time. Payments received after 11:00 a.m., Eastern time, shall be deemed received on the next succeeding Business Day.\n2.6 Allocation of Payments.\nIn the case of a prepayment pursuant to Section 2.1 or Section 2.2(a), if less than the entire principal amount of all of the Notes outstanding is to be paid, the Company will prorate the aggregate principal amount to be prepaid among the outstanding Notes in proportion to the unpaid principal amounts thereof.\n2.7 Payments Due on Saturdays, Sundays and Holidays.\nIn any case where the date of any required prepayment of the Notes or any interest payment date on the Notes or the date fixed for any other payment of any Note or exchange of any Note is not a Business Day, then such payment, prepayment or exchange need not be made on such date but may be made on the next succeeding Business Day, with the same force and effect as if made on the due date, except that interest shall be payable to the actual date of payment.\n3. REPRESENTATIONS\n3.1 Representations of the Company.\nAs an inducement to, and as part of the consideration for, your purchase of the Notes pursuant to this Agreement, the Company represents and warrants to you as follows:\n(a) Corporate Organization and Authority. The Company is a solvent corporation duly organized, validly existing and in good standing under the laws of the State of New York, has all requisite corporate power and authority to own and operate its properties, to carry on its business as now conducted and as presently proposed to be conducted, to enter into and perform this Agreement and to issue and sell the Notes as contemplated by this Agreement.\n(b) Qualification to Do Business. The Company is duly qualified or licensed and in good standing as a foreign corporation authorized to do business in each jurisdiction where the nature of the business transacted by it or the character of its properties owned or leased makes such qualification or licensing necessary, except for jurisdictions, individually or in the aggregate, where the failure to be so licensed or qualified could not have a Material Adverse Effect.\n(c) Subsidiaries and Affiliates. The Company has no Subsidiaries or Affiliates other than those listed on Part 3.1(c) of Annex 3. Part 3.1(c) of Annex 3 correctly sets forth the jurisdiction of incorporation and the percentage of the outstanding Voting Stock or equivalent interest of each Subsidiary which is owned, of record or beneficially, by the Company and\/or one or more Subsidiaries. Each Subsidiary has been duly organized and is validly existing and in good standing under the laws of its jurisdiction of incorporation and is duly licensed or qualified and in good standing as a foreign corporation in each other jurisdiction where the nature of the business transacted by it or the character of its properties owned or leased makes such qualification or licensing necessary, except for jurisdictions, individually or in the aggregate, where the failure to be so licensed or qualified could not have a Material Adverse Effect. Each Subsidiary has all necessary corporate and other power and authority to own and operate its properties and to carry on its business as now conducted and as presently proposed to be conducted. The Company and each Subsidiary has good and marketable title to all of the shares it purports to own of the capital stock or equivalent interest of each Subsidiary, free and clear in each case of any Lien, except as otherwise disclosed in Part 3.1(c) of Annex 3, and all such shares have been duly issued and are fully paid and nonassessable. Part 3.1(c) of Annex 3 correctly sets forth the name of each of the Affiliates and the nature of the affiliation of such Affiliates.\n(d) Financial Statements. The consolidated balance sheets of the Company and its Subsidiaries as of December 31, 1990, 1991, 1992, 1993 and 1994, and the related consolidated statements of earnings, changes in stockholders' equity and cash flows for the years ended on such dates, accompanied by the reports and unqualified opinions of David Berdon & Co., for 1990, 1991, 1992 and 1993, and KPMG Peat Marwick LLP for 1994, copies of which have heretofore been delivered to you, were prepared in accordance with generally accepted accounting principles consistently applied throughout the periods involved (except as otherwise noted therein) and present fairly the consolidated financial condition of the Company and its Subsidiaries on such dates and their consolidated results of operations and cash flows for the years then ended. The unaudited consolidated balance sheet of the Company and its Subsidiaries as of September 30, 1995 and the related unaudited consolidated statements of earnings and cash flows for the nine months ended September 30, 1995, copies of which have heretofore been delivered to you, were prepared in accordance with generally accepted accounting principles and present fairly (subject to normal year end adjustments) the consolidated financial condition of the Company and its Subsidiaries as of such date and the consolidated results of their operations and changes in their cash flows for the period then ended.\n(e) No Contingent Liabilities or Adverse Changes. Neither the Company nor any of its Subsidiaries has any contingent liabilities which, individually or in the aggregate, have a Material Adverse Effect, other than as indicated in the most recent audited and unaudited financial statements described in the foregoing paragraph (d) of this Section 3.1, and, since December 31, 1994, there have been no changes in the condition, financial or otherwise, of the Company and its Subsidiaries except for changes occurring in the ordinary course of business which have not, individually or in the aggregate, had a Material Adverse Effect.\n(f) No Pending Litigation or Proceedings. There are no actions, suits or proceedings pending or threatened against or affecting the Company or any of its Subsidiaries at law or in equity or before or by any federal, state, municipal or other governmental department, commission, board, bureau, agency or instrumentality, domestic or foreign, which could have a Material Adverse Effect.\n(g) Compliance with Law.\n(i) Neither the Company nor any of its Subsidiaries is in default, and the execution, delivery and performance by the Company of this Agreement and the Notes will not result in a default (x) with respect to any order, writ, injunction or decree of any court to which it is a named party or (y) under any law, rule, regulation, ordinance or order relating to its or their respective businesses, the sanctions and penalties resulting from which defaults described in clauses (x) and (y) could have a Material Adverse Effect.\n(ii) Neither the Company nor any of its Subsidiaries is, and the execution, delivery and performance by the Company of this Agreement and the Notes will not cause the Company to be, (x) defined as a \"designated national\" within the meaning of the Foreign Assets Control Regulations, 31 C.F.R. Chapter V or (y) in violation of any federal statute or presidential executive order, or any rules or regulations of any department, agency or administrative body promulgated under any such statute or order, concerning trade or other relations with any foreign country or any citizen or national thereof.\n(h) Pension Plans.\n(i) Disclosure. Part 3.1(h) of Annex 3 sets forth all ERISA Affiliates and all \"employee benefit plans\" maintained by the Company (or any \"affiliate\" thereof) or in respect of which the Notes could constitute an \"employer security\" (\"employee benefit plan\" has the meaning specified in section 3 of ERISA, \"affiliate\" has the meaning specified in Section 407(d) of ERISA and Section V of the Department of Labor Prohibited Transaction Exemption 95-60 (60 FR 35925, July 12, 1995) and \"employer security\" has the meaning specified in section 407(d) of ERISA).\n(ii) Prohibited Transactions. The execution and delivery of this Agreement and the issuance and sale of the Notes hereunder will not involve any transaction that is subject to the prohibitions of section 406 of ERISA or in connection with which a tax could be imposed pursuant to section 4975(c)(1)(A) through section 4975(D), inclusive, of the IRC. The representation by the Company in the immediately preceding sentence is made in reliance upon the representations in Section 3.2(b) as to the source of funds used by you.\n(iii)Accumulated Funding Deficiency. No accumulated funding deficiency (as defined in section 302 of ERISA and section 412 of the IRC), whether or not waived, exists with respect to any Pension Plan.\n(iv) Unfunded Benefit Liabilities. Except as disclosed in the financial statements referred to in Section 3.1(d), there is no \"amount of unfunded benefit liabilities,\" as defined in section 4001(a)(18) of ERISA, under any Pension Plan.\n(v) Material Adverse Liabilities. No liability to the PBGC has been incurred by the Company or any of the ERISA Affiliates with respect to any Pension Plan that, individually or in the aggregate, has or could reasonably be expected to have a Material Adverse Effect.\n(vi) Compliance with ERISA. The Company and the ERISA Affiliates and each Pension Plan are in compliance with ERISA, except for such failures to comply that in the aggregate for all such failures could not reasonably be expected to have a Material Adverse Effect.\n(vii)Multiemployer Plans. Except as disclosed on Part 3.1(h) of Annex 3, neither the Company nor any ERISA Affiliate contribute to, maintain, or have any liability or obligation in respect of, a Multiemployer Plan.\n(viii)Multiemployer Withdrawal Liabilities. Neither the Company nor any ERISA Affiliate has incurred or currently expects to incur any withdrawal liability under Title IV of ERISA with respect to any Multiemployer Plan. There have been no \"reportable events\" (as such term is defined in section 4043 of ERISA) with respect to any Multiemployer Plan that could result in the termination of such Multiemployer Plan and give rise to a liability of the Company or any ERISA Affiliate in respect thereof that, individually or in the aggregate, has or could reasonably be expected to have a Material Adverse Effect.\n(ix) Foreign Pension Plan. All contributions required to be made by the Company under relevant law to each Foreign Pension Plan have been made.\n(i) Title to Properties. Except as disclosed on the most recent audited consolidated balance sheet described in the foregoing paragraph (d) of this Section 3.1, the Company and each Subsidiary has (i) good and marketable title in fee simple or its equivalent under applicable law to all the real property owned by it and (ii) good and marketable title to all of the other property reflected in such balance sheet or subsequently acquired by the Company or any Subsidiary (except as sold or otherwise disposed of in the ordinary course of business), in each case free from all Liens or defects in title except Liens permitted by Section 7.5.\n(j) Leases. The Company and each Subsidiary enjoys peaceful and undisturbed possession under all leases under which the Company or such Subsidiary is a lessee or is operating, except for leases which, if terminated, would not, individually or in the aggregate, have a Material Adverse Effect.\n(k) Franchises, Patents, Trademarks and Other Rights. The Company and each Subsidiary has all franchises, permits, licenses and other authority necessary to carry on its business as now being conducted, and is not in default under any of such franchises, permits, licenses or other authorities, except for such defaults that, individually or in the aggregate, do not or could not reasonably be expected to have a Material Adverse Effect. The Company and each Subsidiary owns or possesses all patents, trademarks, service marks, trade names, copyrights, licenses and rights with respect to the foregoing necessary for the present conduct of its business without any known conflict with the rights of others that, individually or in the aggregate, has or could reasonably be expected to have a Material Adverse Effect.\n(l) Authorization. This Agreement and the Notes have been duly authorized on the part of the Company, and the Agreement does, and the Notes when issued will, constitute the legal, valid and binding obligations of the Company, enforceable in accordance with their terms, except to the extent that enforcement of the Notes may be limited by applicable bankruptcy, insolvency, reorganization, moratorium or similar laws of general application relating to or affecting the enforcement of the rights of creditors or by equitable principles, regardless of whether enforcement is sought in equity or at law. The sale of the Notes and compliance by the Company with all of the provisions of this Agreement and of the Notes (i) are within the corporate powers of the Company, (ii) have been duly authorized by proper corporate action, (iii) are legal and will not violate any provisions of any law or regulation or order of any court, governmental authority or agency and (iv) will not result in any breach of any of the provisions of, or constitute a default under, or result in the creation of any Lien on any property of the Company or any Subsidiary under the provisions of, any charter document, by-law, loan agreement or other agreement or instrument to which the Company or any Subsidiary is a party or by which any of them or their property may be bound.\n(m) No Defaults. No event has occurred and no condition exists which, upon the issuance of the Notes, would constitute a Default or an Event of Default under this Agreement. Neither the Company nor any Subsidiary is in default under any charter document or by-law. Neither the Company nor any Subsidiary is in default under any loan agreement or other material agreement or material instrument to which it is a party or by which it or its property may be bound, except for such defaults that, individually or in the aggregate, do not or could not reasonably be expected to have a Material Adverse Effect.\n(n) Governmental Consent. Neither the nature of the Company or any of its Subsidiaries, their respective businesses or properties, nor any relationship between the Company or any of its Subsidiaries and any other Person, nor any circumstances in connection with the offer, issuance, sale or delivery of the Notes is such as to require a consent, approval or authorization of, or withholding of objection on the part of, or filing, registration or qualification with, any governmental authority on the part of the Company in connection with the execution and delivery of this Agreement or the offer, issuance, sale or delivery of the Notes.\n(o) Taxes. All income tax returns and all other material tax returns required to be filed by the Company or any Subsidiary in any jurisdiction have been filed, and all taxes, assessments, fees and other governmental charges upon the Company or any Subsidiary, or upon any of their respective properties, income or franchises, which are due and payable, have been paid timely or within appropriate extension periods or contested in good faith by appropriate proceedings and (in the case of any such contests) the collection thereof has been stayed by the applicable governmental authority during the period of the contest. The Company does not know of any proposed additional tax assessment against it or any Subsidiary for which adequate provision has not been made on its books. The statute of limitations with respect to federal income tax liability of the Company and its Subsidiaries has expired for all taxable years up to and including the taxable year ended December 31, 1991, and no material controversy in respect of additional taxes due since such date is pending or, to the Company's knowledge, threatened. To the best knowledge of the Company, the provisions for taxes on the books of the Company and each Subsidiary are adequate for all open years and for the current fiscal period.\n(p) Status under Certain Statutes. Neither the Company nor any Subsidiary is: (i) a \"public utility company\" or a \"holding company,\" or an \"affiliate\" or a \"subsidiary company\" of a \"holding company,\" or an \"affiliate\" of such a \"subsidiary company,\" as such terms are defined in the Public Utility Holding Company Act of 1935, as amended or (ii) a \"public utility\" as defined in the Federal Power Act, as amended, or (iii) an \"investment company\" or an \"affiliated person\" thereof or an \"affiliated person\" of any such \"affiliated person\", as such terms are defined in the Investment Company Act of 1940, as amended.\n(q) Private Offering. Neither the Company nor PaineWebber Incorporated (the only Persons authorized or employed by the Company as agent, broker, dealer or otherwise in connection with the offering of the Notes or any similar security of the Company) has offered any of the Notes or any similar security of the Company for sale to, or solicited offers to buy any thereof from, or otherwise approached or negotiated with respect thereto with, any prospective purchaser, other than 55 institutional investors, including the Purchasers, each of whom was offered all or a portion of the Notes at private sale for investment. Neither the Company nor anyone acting on its authorization will offer the Notes or any part thereof or any similar security for issuance or sale to, or solicit any offer to acquire any of the same from, anyone so as to require registration for the issuance or sale of the Notes under the provisions of Section 5 of the Securities Act.\n(r) Effect of Other Instruments. Except for the NBD Credit Agreement, neither the Company nor any Subsidiary is bound by any agreement or instrument or subject to any charter or other corporate restriction which (i) in any way restricts the Company's ability to enter into this Agreement or to issue and sell the Notes or to perform its obligations under this Agreement and the Notes, (ii) in any way restricts any Subsidiary's ability to pay dividends or make advances to the Company or (iii) could have a Material Adverse Effect.\n(s) Use of Proceeds. The Company will apply the net proceeds from the sale of the Notes to the repayment of Current Debt and for general corporate purposes. None of the transactions contemplated in this Agreement (including, without limitation thereof, the use of the proceeds from the sale of the Notes) will violate or result in a violation of Section 7 of the Exchange Act, or any regulations issued pursuant thereto, including, without limitation, Regulations G, T, U and X of the Board of Governors of the Federal Reserve System (12 C.F.R., Chapter II). No part of the proceeds from the sale of the Notes hereunder will be used, directly or indirectly, for the purpose of buying or carrying any margin stock within the meaning of Regulation G of the Board of Governors of the Federal Reserve System (12 CFR 207), or for the purpose of buying or carrying or trading in any securities under such circumstances as to involve the Company in a violation of Regulation X of said Board (12 CFR 224) or to involve any broker or dealer in a violation of Regulation T of said Board (12 CFR 220). Margin stock does not constitute more than ten percent (10%) of the Consolidated Total Assets and the Company does not have any present intention that margin stock will constitute more than ten percent (10%) of the Consolidated Total Assets. As used in this Section, the terms \"margin stock\" and \"purpose of buying or carrying\" shall have the meanings assigned to them in said Regulation G.\n(t) Condition of Property. All of the facilities of the Company and its Subsidiaries are in sound operating condition and repair, except for facilities being repaired in the ordinary course of business or facilities which, individually or in the aggregate, are not material to the Company and its Subsidiaries taken as a whole.\n(u) Books and Records. The Company and each of its Subsidiaries (i) maintain books, records and accounts in reasonable detail which accurately and fairly reflect their respective transactions and business affairs in all material respects, and (ii) maintain a system of internal accounting controls sufficient to provide reasonable assurances that transactions are executed in accordance with management's general or specific authorization and to permit preparation of financial statements in accordance with generally accepted accounting principles.\n(v) Environmental Compliance. The Company and each Subsidiary (including their operations and the condition at or in their Facilities) comply in all material respects with all Environmental Laws, except for instances of alleged noncompliance which the Company or such Subsidiary is contesting in good faith and which, individually or in the aggregate, if determined adversely to the Company or such Subsidiary, will not have a Material Adverse Effect; the Company and each Subsidiary has obtained all permits under Environmental Laws necessary to their respective operations, all such permits are in good standing, and the Company and each Subsidiary is in compliance with all material terms and conditions of such permits. Neither the Company nor any of its Subsidiaries has any liability (contingent or otherwise) in connection with any Release of any Hazardous Material or the existence of any Hazardous Material on, under or about any Facility that could give rise to an Environmental Claim that will have a Material Adverse Effect.\n(w) Full Disclosure. Neither the Private Placement Memorandum (together with all exhibits and annexes thereto, the \"Placement Memorandum\"), prepared in October, 1995, a copy of which previously has been delivered to you, the financial statements referred to in paragraph (d) of this Section 3.1, nor this Agreement, nor any other written statement or document furnished by the Company to you in connection with the negotiation of the sale of the Notes, taken together, contain any untrue statement of a material fact or omit a material fact necessary to make the statements contained therein or herein not misleading in light of the circumstances under which they were made. There is no fact (exclusive of general economic, political or social conditions or trends) particular to the Company and known by the Company that the Company has not disclosed to you in writing and that has had a Material Adverse Effect or, so far as the Company can now foresee, will have a Material Adverse Effect.\n(x) Nature of Business. The Placement Memorandum correctly describes in all material respects the general nature of the business and principal properties of the Company and the Subsidiaries.\n(y) Indebtedness. The Placement Memorandum and the financial statements referred to in Section 3.1(d) correctly and accurately describe the outstanding Indebtedness of the Company and the Subsidiaries as of the dates thereof. Part 3.1(y) of Annex 3 provides the following information with respect to the Indebtedness of the Company and the Subsidiaries: amount by class or type of Indebtedness, amount which is long-term, amount which is short-term, and amount secured and the nature of the collateral therefor. No event or condition exists with respect to any Indebtedness of the Company or any Subsidiary that would permit (or with notice or lapse of time would permit) a Person to cause such Indebtedness to become due and payable before its stated maturity or its regularly scheduled dates of payment.\n3.2 Representations of the Purchasers.\n(a) Purchase for Investment. You represent, and in entering into this Agreement the Company understands, that you are acquiring the Notes for your own account and not with a view to any distribution thereof, provided that the disposition of your property shall at all times be and remain within your control. You acknowledge that the Notes have not been registered under the Securities Act and you understand that the Notes must be held indefinitely unless they are subsequently registered under the Securities Act or an exemption from such registration is available. You have been advised that the Company does not contemplate registering, and is not legally required to register, the Notes under the Securities Act.\n(b) ERISA. You represent, with respect to the funds with which you are acquiring the Notes, that all of such funds are from or are attributable to one or more of the following:\nPAX General Account -- your general account assets or from assets of one or more segments of such general account, and that, solely for purposes of determining whether such acquisition is a \"prohibited transaction\" (as provided for in section 406 of ERISA or section 4975 of the IRC) and in reliance on the representations of the Company set forth in Section 3.1(h) and the related disclosure of \"employee benefit plans\" set forth in Part 3.1(h) of Annex 3, all requirements for an exemption under Department of Labor Prohibited Transaction Exemption 95- 60 (60 FR 35925, July 12, 1995) in respect of such \"employee benefit plans\" have been satisfied;\n(ii) Separate Account -- a \"separate account\" (as defined in section 3 of ERISA):\n(A) 10% Pooled Separate Account -- in respect of which all requirements for an exemption under Department of Labor Prohibited Transaction Class Exemption 90-1 are met with respect to the use of such funds to purchase the Notes;\n(B) Identified Plan Assets -- that is comprised of employee benefit plans identified by you in writing and with respect to which the Company hereby warrants and represents that, as of the Closing Date, neither the Company nor any ERISA Affiliate is a \"party in interest\" (as defined in section 3 of ERISA) or a \"disqualified person\" (as defined in section 4975 of the IRC) with respect to any plan so identified; or\n(C) Guaranteed Separate Account -- that is maintained solely in connection with fixed contractual obligations of an insurance company, under which any amounts payable, or credited, to any employee benefit plan having an interest in such account and to any participant or beneficiary of such plan (including an annuitant) are not affected in any manner by the investment performance of the separate account (as provided by 29 C.F.R. 2510.3-101(h)(1)(iii));\n(iii)Qualified Professional Asset Manager -- an \"investment fund\" managed by a \"qualified professional asset manager\" (as such terms are defined in Part V of Department of Labor Prohibited Transaction Class Exemption 84-14) and all the requirements for an exemption under such Exemption are met with respect to the use of funds to purchase the Notes;\n(iv) Excluded Plan -- an employee benefit plan that is excluded from the provisions of section 406 of ERISA by virtue of section 4(b) of ERISA; or\n(v) Exempt Funds -- a separate investment account that is not subject to ERISA and no funds of which come from assets of an \"employee benefit plan\" or a \"plan\" or any other entity that is deemed to hold assets of an \"employee benefit plan\" or a \"plan\" (\"employee benefit plan\" is defined in section 3 of ERISA, and \"plan\" is defined in section 4975(e)(1) of the IRC).\n4. CLOSING CONDITIONS\nYour obligation to purchase Notes on any Closing Date shall be subject to the performance by the Company of its agreements hereunder which are to be performed at or prior to the time of delivery of such Notes, and to satisfaction of the following conditions on or before such Closing Date:\n4.1 Representations and Warranties.\nThe representations and warranties of the Company contained in this Agreement or otherwise made in writing in connection herewith shall be true and correct on and as of such Closing Date, and the Company shall have delivered to you a certificate to such effect dated such Closing Date and executed by the president or the chief financial officer of the Company.\n4.2 Legal Opinions.\nYou shall have received from Hebb & Gitlin, P.C., your special counsel in this transaction, and from Kelley Drye & Warren, special counsel for the Company, their respective legal opinions, dated such Closing Date, in form and substance satisfactory to you and covering the matters set forth in the attached Exhibits B and C.\n4.3 Events of Default.\nNo Default or Event of Default shall exist, and the Company shall have delivered to you a certificate to such effect dated such Closing Date and executed by the president or the chief financial officer of the Company.\n4.4 Payment of Fees and Expenses.\nThe Company shall have paid all fees, expenses, costs and charges, including the fees and expenses of Hebb & Gitlin, P.C., your special counsel, incurred by you through such Closing Date and incident to the proceedings in connection with, and transactions contemplated by, this Agreement and the Notes.\n4.5 Sale of Notes at Closings.\n(a) Initial Closing. With respect to the Initial Closing, the Company shall have entered into a separate Note Purchase Agreement with each Purchaser, and each Purchaser shall be prepared to accept delivery of and make payment for the Notes to be purchased by it on the Initial Closing Date, as set forth on Annex 1 hereto.\n(b) Second Closing. With respect to the Second Closing, the Company shall have consummated the sale of the entire $53,000,000 principal amount of the Notes to be sold on the Initial Closing Date pursuant to this Agreement, and each Purchaser shall be prepared to accept delivery of and make payment for the Notes to be purchased by it on the Second Closing Date, as set forth on Annex 1 hereto.\n4.6 Legality of Investment.\nYour acquisition of the Notes shall constitute a legal investment as of such Closing Date under the laws and regulations of each jurisdiction to which you may be subject (without resort to any \"basket\" or \"leeway\" provision which permits the making of an investment without restrictions as to the character of the particular investment being made), and such acquisition shall not subject you to any penalty or other onerous condition in or pursuant to any such law or regulation; and you shall have received such certificates or other evidence as you may reasonably request to establish compliance with this condition.\n4.7 Private Placement Number.\nA private placement number with respect to the Notes shall have been issued by Standard & Poor's Corporation.\n4.8 Consent of NBD, N.A.\nNBD, N.A., as assignee of Chemical Bank under the Credit Agreement (the \"NBD Credit Agreement\") dated as of March 10, 1989 among the Company, as borrower, certain of its subsidiaries, as guarantors, and Chemical Bank, as lender, as such Credit Agreement has been amended, restated or supplemented from time to time prior to the date hereof, shall have granted its consent in writing to the issuance of the Notes.\n4.9 Proceedings and Documents.\nAll proceedings taken in connection with the transactions contemplated by this Agreement, and all documents necessary to the consummation of such transactions shall be satisfactory in form and substance to you and your special counsel, and you and your special counsel shall have received copies (executed or certified as may be appropriate) of all legal documents or proceedings which you and they may reasonably request.\n5. INTERPRETATION OF AGREEMENT\n5.1 Certain Terms Defined.\nThe terms hereinafter set forth when used in this Agreement shall have the following meanings:\nAffiliate - Any Person (other than a Subsidiary, or a Person solely in its capacity as an executive officer or director of the Company or any Subsidiary) (i) which directly or indirectly through one or more intermediaries controls, or is controlled by, or is under common control with, the Company, (ii) which beneficially owns or holds securities representing 5% or more of the combined voting power of the Voting Stock of the Company or any Subsidiary or (iii) of which securities representing 5% or more of the combined voting power of its Voting Stock (or in the case of a Person not a corporation, 5% or more of its equity) is beneficially owned or held by the Company or any Subsidiary. 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.\nAgreement, this - This Note Purchase Agreement, as it may be amended and restated from time to time.\nAverage Daily Balance of Current Debt - With respect to any Clean Down Period shall mean, the sum of the aggregate amounts of Consolidated Current Debt outstanding at the close of each day of such Clean Down Period, divided by 45.\nBusiness Day - Any day, other than Saturday, Sunday or a legal holiday or any other day on which banking institutions in the United States of America, the State of New York or the State of Connecticut generally are authorized by law to close.\nCapitalized Lease - Any lease the obligation for Rentals with respect to which, in accordance with generally accepted accounting principles, would be required to be capitalized on a balance sheet of the lessee or for which the amount of the asset and liability thereunder, as if so capitalized, would be required to be disclosed in a note to such balance sheet.\nChange of Control - The acquisition, through purchase or otherwise, by any \"person\" (as such term is used in Sections 13(d) and 14(d)(2) of the Exchange Act), other than Bernard Fife, Nathaniel Sills and Lawrence Sills, their personal representatives, spouses, children and heirs and trusts created for the exclusive benefit of their families, who is or becomes a \"beneficial owner\" (as such term is defined in Rule 13d-3 under the Exchange Act) of shares of Voting Stock representing more than 50% of the combined voting power of all classes of Voting Stock of the Company.\nClean Down Period - As defined in Section 7.2(b).\nClosing Date - The Initial Closing Date or the Second Closing Date.\nCompany - As defined in the introductory sentence hereof.\nComputing Holder--at any time, means the holder of Notes with the highest aggregate principal amount outstanding determined as of the applicable Determination Date.\nConsolidated Capitalization - The sum of Consolidated Funded Debt and Consolidated Net Worth.\nConsolidated Current Debt - The aggregate amount of Current Debt of the Company and its Subsidiaries determined on a consolidated basis in accordance with generally accepted accounting principles.\nConsolidated Funded Debt - The aggregate amount of Funded Debt of the Company and its Subsidiaries determined on a consolidated basis in accordance with generally accepted accounting principles.\nConsolidated Net Income - For any period, the consolidated net income (or net loss) of the Company and its Subsidiaries determined in accordance with generally accepted accounting principles, but excluding therefrom:\n(i) the net income of any Person (other than a Subsidiary) in which the Company or a Subsidiary has an equity interest, except to the extent that such income has been distributed and received by the Company or a Subsidiary in the form of cash or other property (valued at the fair market value thereof at the time of distribution as determined by the Company's independent public accountants), or the net loss of any Person (other than a Subsidiary) in which the Company or a Subsidiary has an equity interest,\n(ii) the net income or net loss of any Subsidiary for any period prior to the date it becomes a Subsidiary,\n(iii)any gain or loss (net of any tax effect) resulting from the reappraisal, reevaluation or write-up of assets subsequent to the Initial Closing Date,\n(iv) any extraordinary gain or loss (including, without limitation, capital gains or losses in aggregate amounts exceeding One Hundred Thousand Dollars ($100,000) in any one fiscal year, and extraordinary charges or credits),\n(v) proceeds of any life insurance policy,\n(vi) net income of a Subsidiary which for any reason cannot be distributed as a dividend to the Company or any Subsidiary,\n(vii)gain arising from the acquisition of debt securities for a cost less than the principal amount thereof plus accrued interest,\n(viii)any amounts paid or payable in any currency that at the time of determination is not fully convertible into United States dollars,\n(ix) net earnings of any successor or transferee corporation of the Company accrued prior to consummation of the transaction that resulted in such Person being such successor or transferee, and\n(x) any deferred credit (or amortization of a deferred credit) arising from the acquisition by the Company of any Person.\nConsolidated Net Worth - The consolidated stockholders' equity of the Company and its Subsidiaries determined in accordance with generally accepted accounting principles.\nConsolidated Operating Cash Flow - For any period, the sum of (i) Consolidated Net Income for such period, (ii) all provisions for federal, state and other income taxes made by the Company and its Subsidiaries for such period, (iii) Interest Charges for such period and (iv) depreciation and amortization expense for such period.\nConsolidated Total Assets - The total assets of the Company and its Subsidiaries determined on a consolidated basis in accordance with generally accepted accounting principles.\nCurrent Debt - All Indebtedness of the Company and its Subsidiaries which by its terms is payable on demand or matures within one year from the creation thereof, including, at any time, the portion of Funded Debt payable within one year, provided that all Indebtedness outstanding under a revolving credit or similar agreement that obligates the lender or lenders thereunder to extend credit over a period of more than one year shall be treated as Current Debt for all purposes of this Agreement.\nDefault - Any event which, with the lapse of time or the giving of notice, or both, would become an Event of Default.\nDetermination Date - The date of acceleration pursuant to Section 8.2, or the day 3 Business Days before the date fixed for a prepayment pursuant to Section 2.2(a).\nDisposition - As defined in Section 7.8(a).\nEnvironmental Claim - Any notice of violation, claim, demand, abatement order or other order by any Person for any damage, including personal injury (including sickness, disease or death), tangible or intangible property damage, contribution, indemnity, indirect or consequential damages, damage to the environment, nuisance, pollution, contamination or other adverse effects on the environment, or for fines, penalties or restrictions, resulting from or based upon (i) the existence of a Release (whether sudden or non-sudden or accidental or nonaccidental) of, or exposure to, any Hazardous Material in, into or onto the environment at, in, by, from or related to any Facility, (ii) the use, handling, transportation, storage, treatment or disposal of Hazardous Materials in connection with the operation of any Facility, or (iii) the violation, or alleged violation, of any statutes, rules, regulations, ordinances, orders, permits, licenses or authorizations of or from any governmental authority, agency or court relating to environmental matters pertaining to the Facilities.\nEnvironmental Laws - All laws relating to environmental matters, including those relating to (i) fines, orders, injunctions, penalties, damages, contribution, cost recovery compensation, losses or injuries resulting from the Release or threatened Release of Hazardous Materials and to the generation, use, storage, transportation, or disposal of Hazardous Materials, in any manner applicable to the Company or any of its Subsidiaries or any of their respective properties, including, without limitation, the Comprehensive Environmental Response, Compensation, and Liability Act of 1980 (42 U.S.C. 9601 et. seq.), the Hazardous Materials Transportation Act (49 U.S.C. 1801 et. seq.), the Resource Conservation and Recovery Act (42 U.S.C. 6901 et. seq.), the Water Pollution Control Act (33 U.S.C. 1251 et seq.), The Clean Air Act (42 U.S.C. 7401 et. seq., the Toxic Substances Control Act (15 U.S.C. 2601 et. seq.), the Occupational Safety and Health Act of 1970 (29 U.S.C. 651 et. seq.) and the Emergency Planning and Community Right-to-Know Act of 1986 (42 U.S.C. 11001 et. seq.), and (ii) environmental protection, including the National Environmental Policy Act of 1969 (42 U.S.C. 4321 et. seq.), and comparable state laws, each as amended or supplemented, and any similar or analogous local, state and federal statutes and regulations promulgated pursuant thereto, each as in effect as of the date of determination.\nERISA - The Employee Retirement Income Security Act of 1974, as amended from time to time.\nERISA Affiliate -- The Company and all corporations, trades or business (whether or not incorporated) and other Persons that, together with the Company are treated as a single employer under the section 414(b), section 414(c), section 414(m) or section 414(o) of the IRC or Title I or Title IV of ERISA.\nEvent of Default - As defined in Section 8.1.\nExchange Act - The Securities Exchange Act of 1934, as amended, and as it may be further amended from time to time.\nFacility - Any and all real property (including all buildings, fixtures or other improvements located thereon) now or heretofore owned, leased, operated or used (under permit or otherwise) by the Company or any of its Subsidiaries.\nFixed Charges - For any period, the sum of Interest Charges and Rentals of the Company and its Subsidiaries accrued for such period.\nForeign Pension Plan - means any plan, fund or other similar program:\n(a) established or maintained outside of the United States of America by any one or more of the Company or the Subsidiaries primarily for the benefit of the employees (substantially all of whom are aliens not residing in the United States of America) of the Company or such Subsidiaries, which plan, fund or other similar program provides for retirement income for such employees or results in a deferral of income for such employees in contemplation of retirement; and\n(b) not otherwise subject to ERISA.\nFunded Debt - shall mean (i) all Indebtedness of the Company and its Subsidiaries which by its terms matures more than one year from the date of creation thereof, excluding any portion thereof payable within one year and any portion thereof outstanding pursuant to a revolving credit or similar agreement that obligates the lender or lenders thereunder to extend credit over a period of more than one year, and (ii) amounts deemed to be Funded Debt pursuant to Section 7.2(b).\nGuaranties - All obligations (other than endorsements in the ordinary course of business of negotiable instruments for deposit or collection) of a Person guaranteeing or, in effect, guaranteeing any Indebtedness, dividend or other obligation of any other Person in any manner, whether directly or indirectly, including, without limitation, all obligations incurred through an agreement, contingent or otherwise, by such Person: (i) to purchase such Indebtedness or obligation or any property or assets constituting security therefor, (ii) to advance or supply funds (x) for the purchase or payment of such Indebtedness or obligation, (y) to maintain working capital or other balance sheet condition or (z) otherwise to advance or make available funds for the purchase or payment of such Indebtedness or obligation, (iii) 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 against loss in respect thereof, or (iv) otherwise to assure the owner of the Indebtedness or obligation against loss in respect thereof. For the purposes of all computations made under this Agreement, Guaranties in respect of any indebtedness for borrowed money shall be deemed to be Indebtedness equal to the principal amount of such indebtedness for borrowed money which has been guaranteed, and Guaranties in respect of any other obligation or liability or any dividend shall be deemed to be Indebtedness equal to the maximum aggregate amount of such obligation, liability or dividend.\nHazardous Materials - (i) Any chemical, material or substance defined-as or included in the definition of \"hazardous substances,\" \"hazardous wastes,\" \"hazardous materials,\" \"extremely hazardous waste,\" \"restricted hazardous waste,\" or \"toxic substances\" or words of similar import under any Environmental Laws; (ii) any oil, petroleum or petroleum derived substance, any drilling fluids, produced waters and other wastes associated with the exploration, development or production of crude oil, any flammable substances or explosives, any radioactive materials, any hazardous wastes or substances, any toxic wastes or substances or any other materials or pollutants that (x) pose a hazard to any property of the Company or any of its Subsidiaries or to Persons on or about such property or (y) cause such property to be in violation of any Environmental Law; (iii) friable asbestos, urea formaldehyde foam insulation, electrical equipment with contains any oil or dielectric fluid with levels of polychlorinated biphenyls in excess of fifty parts per million; and (iv) any other chemical, material or substance, exposure to which is prohibited, limited or regulated by any governmental authority.\nIndebtedness - of any Person shall mean, all indebtedness, obligations and liabilities for borrowed money which in accordance with generally accepted accounting principles would be included as a liability on a balance sheet of such Person, and shall also mean (i) all indebtedness, obligations and liabilities secured by a Lien on property of such Person whether or not such indebtedness, obligations or liabilities shall have been assumed, (ii) all Guaranties, (iii) any agreement of such Person to pay the purchase price of any product or service where such agreement to pay is not dependent upon whether such product or service is furnished, and (iv) any obligations of such Person under any Capitalized Lease.\nInitial Closing - As defined in Section 1.2(b).\nInitial Closing Date - As defined in Section 1.2(b).\nInstitutional Holder - Any bank, trust company, insurance company, pension fund, mutual fund or other similar financial institution, including, without limiting the foregoing, any \"qualified institutional buyer\" within the meaning of Rule 144A under the Securities Act, which is or becomes a holder of any Note.\nInterest Charges - For any period, all amounts accrued within such period which are properly classified as interest expense in accordance with generally accepted accounting principles.\nInvestments - All investments made, in cash or by delivery of property, directly or indirectly, in any Person or any property, whether by acquisition of shares of capital stock, indebtedness or other obligations or securities or by loan, advance, capital contribution or otherwise; provided, however, that \"Investments\" shall not mean or include investments in property to be used or consumed in the ordinary course of business permitted by Section 7.12.\nIRC - The Internal Revenue Code of 1986, together with all rules and regulations promulgated pursuant thereto (other than proposed rules and regulations that are not yet effective), as amended from time to time.\nLien - Any mortgage, pledge, security interest, encumbrance, lien or charge of any kind, including any agreement to grant any of the foregoing, any conditional sale or other title retention agreement, any lease in the nature thereof, or the filing of or agreement to file any financing statement under the Uniform Commercial Code of any jurisdiction in connection with any of the foregoing.\nMake-Whole Amount - With respect to any prepayment under Section 2.2(a) or any acceleration of Notes shall mean, the excess (calculated as of the Determination Date with respect to such prepayment or acceleration) of (a) the sum of the present values of the then remaining principal and interest payments that would be payable in respect of the aggregate principal amount of such prepayment or acceleration of Notes but for the prepayment or acceleration thereof (exclusive of accrued interest on such Notes to the date of prepayment or acceleration) determined by discounting (semi-annually on the basis of a 360- day year composed of twelve 30-day months) such payments at a rate that is equal to the Reinvestment Yield over (b) the aggregate principal amount of such prepayment or acceleration. If the Reinvestment Yield on any Determination Date is equal to or higher than the interest rate payable on or in respect of such Notes, the Make-Whole Amount shall be zero.\nThe Company shall calculate the Make-Whole Amount in respect of any prepayment under Section 2.2(a), and shall, as soon as practicable (but in any event no later than the Determination Date), deliver a copy of such calculation to each holder of Notes. If for any reason the Computing Holder shall object to such calculation of Make-Whole Amount made by the Company, the Computing Holder shall give the Company written notice of such objection not later than the second Business Day preceding the proposed prepayment, and include within such notice its computation of the Make-Whole Amount; and such Make- Whole Amount (computed by the Computing Holder) shall be binding upon the Company and the holders of the Notes absent manifest error. The Company shall immediately transmit such computation received from the Computing Holder to each other holder of Notes. All communications required to be delivered pursuant to this paragraph shall be sent by telecopier to the number and attention set forth oppose the respective parties on Annex 4 hereto.\nThe holders of the Notes hereby appoint the Computing Holder to effect the calculations referred to in the immediately preceding paragraph, and to deliver the results of the calculations to the Company. If any such holder shall decline to discharge the responsibilities in this paragraph (and each such holder may elect to so decline), the Required Holders shall, at their option, act collectively in discharging such responsibilities, appoint another holder to effect the same or authorize the Company to make such calculations.\nThe Required Holders shall calculate the Make-Whole Amount in respect of any acceleration under Section 8.2(a), and shall deliver a copy of such calculation to the Company not later than the time of such acceleration. Each calculation referred to in this paragraph shall be binding upon the Company absent manifest error.\nEach holder of Notes accelerating Notes under Section 8.2(b) shall calculate the Make-Whole Amount in respect of its acceleration and shall deliver a copy of such calculation to the Company at the time the notice of acceleration is given. Each calculation referred to in this paragraph shall be binding upon the Company absent manifest error.\nAny failure for any reason whatsoever of any Computing Holder, holder of Notes or the Required Holders to deliver a calculation required under this definition to the Company shall not excuse, release or discharge the Company from its payment obligations hereunder and under the Notes, including, without limitation, paying any Make-Whole Amount that may be payable in connection with any prepayment or acceleration of all or some of the Notes. The Company shall cooperate with the holders of Notes in making the calculations required in this definition and in coordinating the distribution of such calculations and the effecting of the payments or prepayments referred to above.\nMaterial Adverse Effect - A material adverse effect on\n(a) the business, operations, assets or financial condition of the Company and the Subsidiaries, in the aggregate,\n(b) the ability of the Company to perform its obligations set forth herein and in the Notes, or\n(c) the validity or enforceability of this Agreement or the Notes.\nMeasuring Period - As defined in Section 7.2(b).\nMultiemployer Plan - means any \"multiemployer plan\" (as defined in section 3(37) of ERISA) in respect of which the Company or any ERISA Affiliate is an \"employer\" (as such term is defined in section 3 of ERISA).\nNBD Credit Agreement - As defined in Section 4.8.\nNote Purchase Agreement - As defined in Section 1.2(e).\nNote Register - As defined in Section 10.2.\nNotes - As defined in Section 1.1.\nPBGC - means the Pension Benefit Guaranty Corporation, and any Person succeeding to the functions of the PBGC.\nPension Plan - means, at any time, any \"employee pension benefit plan\" (as such term is defined in section 3 of ERISA) maintained at such time by the Company or any ERISA Affiliate for employees of the Company or such ERISA Affiliate, excluding any Multiemployer Plan.\nPermitted Investments - (i) Investments in Subsidiaries, including any Investment in a Person which, after giving effect to such Investment, immediately becomes a Subsidiary; (ii) Investments in direct obligations of the U.S. government or obligations of any U.S. government agency backed by the full faith and credit of the U.S. government, in each case having maturities of one year or less from the date of acquisition thereof; (iii) Investments in certificates of deposit or banker's acceptances in each case maturing within one year of the date of issuance issued by commercial banks or trust companies located and organized in the United States of America and having combined capital, surplus and undivided profits aggregating at least $500,000,000, and who has, or whose parent company has, senior, unsecured Indebtedness rated \"A+\" (or the equivalent) or better by Standard & Poor's Corporation or the equivalent by Moody's Investors Service, Inc.; (iv) Investments in commercial paper maturing within 270 days from the date of issuance and rated A-1 or P-1 (or the equivalent) at the date of acquisition by Standard & Poor's Corporation or Moody's Investors Service, Inc.; (v) Investments not exceeding $10,000,000 in the aggregate in receivables arising from the sale of goods and services in the ordinary course of business; and (vi) Investments in addition to those described in clauses (i) through (v) not exceeding Twenty Million Dollars ($20,000,000) in the aggregate.\nPerson - Any individual, corporation, partnership, joint venture, association, joint-stock company, trust, limited liability company, unincorporated organization or government or any governmental authority, agency or political subdivision.\nPlacement Memorandum - As defined in Section 3.1(w).\nPurchasers -- means the Persons listed as purchasers of Notes on Annex 1.\nReinvestment Yield - With respect to any Determination Date, shall mean the sum of (i) 0.50% plus (ii) the yield as set forth on page \"USD\" of the Bloomberg Financial Markets Service (or other on-the-run service acceptable to the Required Holders) at 10:00 A.M. (New York time) on such Determination Date for actively traded U.S. Treasury securities having a maturity equal to the then remaining Weighted Average Life to Maturity of the Notes then being prepaid or paid as of the date of prepayment or payment, rounded to the nearest month. If such yields shall not be reported as of such time or the yields reported as of such time are not ascertainable in accordance with the preceding sentence, then the arithmetic mean of the yields published in the statistical release designated H.15(519) of the Board of Governors of the Federal Reserve System under the caption \"U.S. Government Securities -- Treasury Constant Maturities\" (the \"statistical release\") for the maturity corresponding to the remaining Weighted Average Life to Maturity of the Notes then being prepaid or paid as of the date of such prepayment or payment rounded to the nearest month shall be employed; for purposes of this sentence, the most recent weekly statistical release published prior to the applicable Determination Date shall be used. If no maturity exactly corresponding to such rounded Weighted Average Life to Maturity shall appear, yields for the two most closely corresponding maturities (one of which occurs prior and the other subsequent to such rounded Weighted Average Life to Maturity) shall be calculated pursuant to the foregoing, and the Reinvestment Yield shall be interpolated from such yields on a straight-line basis (rounding, in each of such relevant periods, to the nearest month).\nRelease - Any release, spill, emission, leaking, pumping, pouring, emptying, dumping, injection, escaping, deposit, disposal, discharge, dispersal, leaching or migration into the indoor or outdoor environment (including the abandonment or disposal of any barrel, container or other closed receptacle containing any Hazardous Material), or into or out of any Facility, including the movement of any Hazardous Material through the air, soil, surface water, groundwater or property.\nRentals - As of the date of any determination thereof, all fixed payments (including all payments which the lessee is obligated to make to the lessor on termination of the lease or surrender of the property) payable by the Company or a Subsidiary, as lessee or sublessee under a lease (other than a Capitalized Lease), of real or personal property, having a remaining unexpired term as at such date (including the original term and any term renewals or extensions available at the lessee's sole option) in excess of three (3) years, but exclusive of any amounts required to be paid by the Company or a Subsidiary (whether or not designated as rents or additional rents) on account of maintenance, repairs, insurance, taxes, assessments, amortization and similar charges. Fixed rents under any so-called \"percentage leases\" shall be computed on the basis of the minimum rents, if any, required to be paid by the lessee, regardless of sales volume or gross revenues.\nRequired Holders -- means, at any time, the holders of more than fifty percent (50%) in principal amount of the Notes at the time outstanding (exclusive of Notes then owned by any one or more of the Company, any Subsidiary or any Affiliate), without regard to the series thereof.\nRestricted Payment - shall mean:\n(i) any dividend or other distribution, direct or indirect, on or on account of any shares of capital stock of any class of the Company, except a dividend or distribution payable solely in such shares;\n(ii) any redemption, retirement, purchase or other acquisition, direct or indirect, of any shares of capital stock of any class of the Company or of any warrants, rights or options to purchase or otherwise acquire any such shares, in any manner other than (x) solely in exchange for other such shares or (y) unless such redemption, retirement, purchase or other acquisition shall be made contemporaneously from the net proceeds of a sale of such stock, warrants, rights or options; and\n(iii)any prepayment, payment, purchase or other retirement or acquisition, direct or indirect, by the Company or any Subsidiary of all or part of the principal amount of any item of subordinated debt (except out of the proceeds of a substantially concurrent issuance of other subordinated debt) provided that the provisions of this clause (iii) shall not restrict the taking of any such action which is required pursuant to the terms of the instrument under which such subordinated debt was issued.\nSale and Leaseback - Any arrangement, directly or indirectly, with any Person whereby a seller or a transferor shall sell or otherwise transfer any real or personal property and then or thereafter lease (whether or not by means of a Capitalized Lease), or repurchase under an extended purchase contract, the same or similar property from the purchaser of the transferee of such property.\nSecond Closing - As defined in Section 1.2(c).\nSecond Closing Date - As defined in Section 1.2(c).\nSecurities Act - The Securities Act of 1933, as amended, and as it may be further amended from time to time.\nSubsidiary - A Person (i) the accounts of which are included in the consolidated financial statements of the Company and (ii) of which shares of Voting Stock (or other equity interests) representing more than 50% of the voting power of each outstanding class of Voting Stock (or other equity interests) are owned or controlled, directly or indirectly, by the Company.\nVoting Stock - Capital stock of any class of a corporation having power to vote for the election of members of the board of directors of such corporation, or persons performing similar functions.\nWeighted Average Life to Maturity - As applied to any payment or prepayment of principal of the Notes, at any date, the number of years obtained by dividing (a) the principal amount of the Notes to be paid or prepaid into (b) the sum of the products obtained by multiplying (i) the amount of each then remaining installment or other required payment, including payment at final maturity, that would have been payable in respect of the aggregate principal amount of such payment or prepayment of Notes but for the payment or prepayment thereof, by (ii) the number of years (calculated to the nearest 1\/12th) which would have elapsed between such date and the making of such required payment.\nWholly-Owned - When applied to a Subsidiary, any Subsidiary 100% of the Voting Stock of all classes of which is owned by the Company and\/or its Wholly-Owned Subsidiaries.\nTerms which are defined in other Sections of this Agreement shall have the respective meanings specified therein.\n5.2 Accounting Principles.\nWhere the character or amount of any asset or liability or item of income or expense is required to be determined or any consolidation or other accounting computation is required to be determined or any consolidation or other accounting computation is required to be made for the purposes of this Agreement, the same shall be done in accordance with generally accepted accounting principles as in effect in the United States of America from time to time, except where such principles are inconsistent with the requirements of this Agreement.\n5.3 Direct or Indirect Actions.\nWhere any provision in this Agreement refers to action to be taken by any Person, or which such Person is prohibited from taking, such provision shall be applicable whether the action in question is taken directly or indirectly by such Person.\n6. AFFIRMATIVE COVENANTS\nThe Company agrees that, for so long as any amount remains unpaid on any Note:\n6.1 Corporate Existence.\nThe Company will maintain and preserve, and will cause each Subsidiary to maintain and preserve, its corporate existence and right to carry on its business and maintain, preserve, renew and extend all of its rights, powers, privileges and franchises necessary to the proper conduct of its business; provided, however, that the foregoing shall not prevent any transaction permitted by Section 7.7 or Section 7.8 or the termination of the corporate existence of any Subsidiary if, in the opinion of the board of directors of the Company, such termination is in the best interests of the Company, is not disadvantageous to holders of the Notes and is not otherwise prohibited by this Agreement.\n6.2 Insurance.\nThe Company will, and will cause each Subsidiary to, maintain insurance coverage with financially sound and reputable insurers in such forms and amounts, with such deductibles and against such risks as is required by law or sound business practice and customary for corporations engaged in the same or similar businesses and owning and operating similar properties as the Company and its Subsidiaries. All such insurance shall be carried with insurers in Financial Site Category Class XII or higher that are accorded an A rating or better from A.M. Best Company, Inc.\n6.3 Taxes, Claims for Labor and Materials.\nThe Company will pay and discharge when due, and will cause each Subsidiary to pay and discharge when due, all taxes, assessments and governmental charges or levies imposed upon it or its property or assets, or upon properties leased by it (but only to the extent required to do so by the applicable lease), other than taxes which individually and in the aggregate are not material in amount and the non-payment of which could not have a Material Adverse Effect, and all lawful claims which, if unpaid, might become a Lien upon its property or assets, provided that neither the Company nor any Subsidiary shall be required to pay any such tax, assessment, charge, levy or claim, the payment of which is being contested in good faith and by proper proceedings that will stay the forfeiture or sale of any property and with respect to which adequate reserves are maintained in accordance with generally accepted accounting principles.\n6.4 Maintenance of Properties.\nThe Company will maintain, preserve and keep, and will cause each Subsidiary to maintain, preserve and keep, its properties (whether owned in fee or a leasehold interest) in good repair and working order, ordinary wear and tear excepted, and from time to time will make all necessary repairs, replacements, renewals and additions.\n6.5 Maintenance of Records.\nThe Company will keep, and will cause each Subsidiary to keep, at all times proper books of record and account in which full, true and correct entries will be made of all dealings or transactions of or in relation to the business and affairs of the Company or such Subsidiary, in accordance with generally accepted accounting principles consistently applied throughout the period involved (except for such changes as are disclosed in such financial statements or in the notes thereto and concurred in by the Company's independent certified public accountants), and the Company will, and will cause each Subsidiary to, provide reasonable protection against loss or damage to such books of record and account.\n6.6 Financial Information and Reports.\nThe Company will furnish to the Securities Valuation Office of the National Association of Insurance Commissioners, 195 Broadway, New York, New York 10007, a copy of the financial statements referred to in Sections 6.6(a) and (b) as soon as they are available. The Company will furnish to you and to any other Institutional Holder (in duplicate if you or such other holder so request) the following:\n(a) As soon as available and in any event within 45 days after the end of each of the first three quarterly accounting periods of each fiscal year of the Company, a consolidated balance sheet of the Company and its Subsidiaries as of the end of such period and consolidated statements of earnings and cash flows of the Company and its Subsidiaries for the periods beginning on the first day of such fiscal year and the first day of such quarterly accounting period and ending on the date of such balance sheet, in each case setting forth in comparative form the corresponding consolidated figures for the corresponding periods of the preceding fiscal year, all in reasonable detail, prepared in accordance with generally accepted accounting principles consistently applied throughout the period involved (except for changes disclosed in such financial statements or in the notes thereto and concurred in by the Company's independent certified public accountants) and certified by the chief financial officer or chief accounting officer of the Company (i) outlining the basis of presentation, and (ii) stating that the information presented in such statements presents fairly the financial condition of the Company and its Subsidiaries and the results of operations for the period, subject to customary year-end audit adjustments;\n(b) As soon as available and in any event within 90 days after the last day of each fiscal year a consolidated balance sheet of the Company and its Subsidiaries as of the end of such fiscal year and the related consolidated statements of earnings, changes in stockholders' equity, and cash flows for such fiscal year, in each case setting forth in comparative form figures for the preceding fiscal year, all in reasonable detail, prepared in accordance with generally accepted accounting principles consistently applied throughout the period involved (except for changes disclosed in such financial statements or in the notes thereto and concurred in by the Company's independent certified-public accountants), and accompanied by an unqualified report of KPMG Peat Marwick or another firm of independent public accountants of recognized national standing selected by the Company to the effect that such financial statements have been prepared in conformity with generally accepted accounting principles and present fairly in all material respects the financial condition of the Company and its Subsidiaries and that the examination of such financial statements by such accounting firm has been made in accordance with generally accepted auditing standards;\n(c) Together with the financial statements delivered pursuant to paragraphs (a) and (b) of this Section 6.6, (i) a management's discussion and analysis of the financial condition and results of operations for the periods reported upon by such financial statements, which discussion and analysis shall satisfy the requirements of Item 303 of Securities and Exchange Commission Regulation S-K, and (ii) a certificate of the chief financial officer or chief accounting officer of the Company, (x) to the effect that such officer has re-examined the terms and provisions of this Agreement and that at the date of such certificate, during the periods covered by such financial reports and as of the end of such periods, the Company is not, or was not, in default in the fulfillment of any of the terms, covenants, provisions and conditions of this Agreement and that no Default or Event of Default is occurring or has occurred as of the date of such certificate, during such periods and as of the end of such periods, or if the signer is aware of any Default or Event of Default, such officer shall disclose in such statement the nature thereof, its period of existence and what action if any, the Company has taken or proposes to take with respect thereto and (y) stating whether the Company is in compliance with Sections 7.1 through 7.13 and setting forth, in sufficient detail, the information and computations required to establish whether or not the Company was in compliance with the requirements of Sections 7.1 through 7.13 during the periods covered by the financial reports then being furnished and as of the end of such periods;\n(d) Together with the financial reports delivered pursuant to paragraph (b) of this Section 6.6, a letter of the independent certified public accountants stating that in making the examination necessary for expressing an opinion on such financial statements, nothing came to their attention that caused them to believe that there is in existence or has occurred any Default or Event of Default hereunder (the occurrence of which is ascertainable by accountants in the course of normal audit procedures) or, if such accountants shall have obtained knowledge of any such Default or Event of Default, describing the nature thereof and the length of time it has existed;\n(e) Promptly after the Company obtains knowledge thereof, notice of any litigation or any governmental proceeding pending against the Company or any Subsidiary in which the damages sought exceed $1,000,000, individually or in the aggregate, or which might reasonably be expected, individually or in the aggregate, to have a Material Adverse Effect;\n(f) As soon as available, copies of each financial statement, notice, report and proxy statement which the Company shall furnish to its stockholders; copies of each registration statement and periodic report which the Company may file with the Securities and Exchange Commission, and any similar or successor agency of the federal government administering the Securities Act, the Exchange Act or the Trust Indenture Act of 1939, as amended; without duplication, copies of each report (other than reports relating solely to the issuance of, or transactions by others involving, its securities) relating to the Company or its securities which the Company may file with any securities exchange on which any of the Company's securities may be registered; copies of any orders in any material proceedings to which the Company or any of its Subsidiaries is a party, issued by any governmental agency, federal or state, having jurisdiction over the Company or any of its Subsidiaries; and, except at such times as the Company is a reporting company under Section 13 or 15(d) of the Exchange Act or has complied with the requirements for the exemption from registration under the Exchange Act set forth in Rule 12g-3-2(b), such financial or other information as any holder of the Notes or prospective purchaser of the Notes may reasonably determine is required to permit such holder to comply with the requirements of Rule 144A under the Securities Act in connection with the resale by it of the Notes;\n(g) As soon as available a copy of each other report submitted to the Company or any Subsidiary by independent accountants retained by the Company or any Subsidiary in connection with any interim or special audit made by them of the books of the Company or any Subsidiary;\n(h) As soon as available, a copy of each management letter delivered to the Company or any Subsidiary by its independent accountants and management's response to such letter;\n(i) within fifteen (15) Business Days of becoming aware of the occurrence of any \"reportable event\" (as such term is defined in section 4043 of ERISA) for which notice thereof has not been waived pursuant to regulations of the Department of Labor, or \"prohibited transaction\" (as such term is defined in section 406 of ERISA or section 4975 of the IRC) in connection with any Pension 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, the Department of Labor or the PBGC with respect thereto;\n(j) prompt written notice of and, where applicable, a description of\n(i) any notice from the PBGC in respect of the commencement of any proceedings pursuant to section 4042 of ERISA to terminate any Pension Plan or for the appointment of a trustee to administer any Pension Plan, and any distress termination notice delivered to the PBGC under section 4041 of ERISA in respect of any Pension Plan, and any determination of the PBGC in respect thereof,\n(ii) notice of the placement of any Multiemployer Plan in reorganization status under Title IV of ERISA, any Multiemployer Plan becoming \"insolvent\" (as such term is defined in section 4245 of ERISA) under Title IV of ERISA, or the whole or partial withdrawal of the Company or any ERISA Affiliate from any Multiemployer Plan and the withdrawal liability incurred in connection therewith, or\n(iii)the occurrence of any event, transaction or condition that could result in the incurrence of any material liability of the Company or any ERISA Affiliate or the imposition of a Lien on the property of the Company or any ERISA Affiliate, in either case pursuant to Title I or Title IV of ERISA or pursuant to the penalty or excise tax or security provisions of the IRC;\n(k) Promptly following any change in the composition of the Company's Subsidiaries from that set forth in Part 3.1(c) of Annex 3, as theretofore updated pursuant to this paragraph, an updated list setting forth the information specified in Part 3.1(c) of Annex 3;\n(l) If at any time the Company provides consolidating financial statements to any Person other than an Affiliate, copies of such consolidating financial statements; and\n(m) Such additional information as you or such other Institutional Holder of the Notes may reasonably request concerning the Company and its Subsidiaries.\n6.7 Inspection of Properties and Records.\nThe Company will allow, and will cause each Subsidiary to allow, any representative of you or any other Institutional Holder, so long as you or such other Institutional Holder holds any Note, to visit and inspect any of its properties, to examine its books of record and account and to discuss its affairs, finances and accounts with its officers and its public accountants (and by this provision the Company authorizes such accountants to discuss with you or such Institutional Holder its affairs, finances and accounts), all at such reasonable times and as often as you or such Institutional Holder may reasonably request and, if at the time thereof any Default or Event of Default has occurred and is continuing, at the Company's expense.\n6.8 Pension Plans.\n(a) Compliance. The Company will, and will cause each ERISA Affiliate to, at all times with respect to each Pension Plan, comply with all applicable provisions of ERISA and the IRC, except for such failures to comply that, in the aggregate, could not reasonably be expected to have a Material Adverse Effect.\n(b) Prohibited Actions. The Company will not, and will not permit any ERISA Affiliate to:\n(i) engage in any \"prohibited transaction\" (as such term is defined in section 406 of ERISA or section 4975 of the IRC) or \"reportable event\" (as such term is defined in section 4043 of ERISA) that could result in the imposition of a tax or penalty;\n(ii) incur with respect to any Pension Plan any \"accumulated funding deficiency\" (as such term is defined in section 302 of ERISA), whether or not waived;\n(iii)terminate any Pension Plan in a manner that could result in the imposition of a Lien on the property of the Company or any Subsidiary pursuant to section 4068 of ERISA or the creation of any liability under section 4062 of ERISA;\n(iv) fail to make any payment required by section 515 of ERISA;\n(v) incur any withdrawal liability under Title IV of ERISA with respect to any Multiemployer Plan or any liability as a result of the termination of any Multiemployer Plan; or\n(vi) incur any liability or suffer the existence of any Lien on the property of the Company or any ERISA Affiliate, in either case pursuant to Title I or Title IV of ERISA or pursuant to the penalty or excise tax or security provisions of the IRC,\nif the aggregate amount of the taxes, penalties, funding deficiencies, interest, amounts secured by Liens, and other liabilities in respect of any of the foregoing at any time could reasonably be expected to have a Material Adverse Effect.\n6.9 Compliance with Laws.\n(a) The Company will comply, and will cause each Subsidiary to comply, with all laws, rules and regulations, including Environmental Laws, relating to its or their respective businesses, other than laws, rules and regulations the failure to comply with which or the sanctions and penalties resulting from which, individually or in the aggregate, will not have a Material Adverse Effect; provided, however, that the Company and its Subsidiaries shall not be required to comply with laws, rules and regulations the validity or applicability of which are being contested in good faith and by appropriate proceedings and as to which the Company has established adequate reserves on its books.\n(b) Promptly upon the occurrence thereof, the Company will give you and each other Institutional Holder notice of the institution of any proceedings against, or the receipt of notice of potential liability or responsibility of, the Company or any Subsidiary for violation, or the alleged violation, of any Environmental Law which violation could give rise to a liability in excess of One Million Dollars ($1,000,000).\n6.10 Acquisition of Notes.\nNeither the Company, nor any Subsidiary, nor any Affiliate acting on behalf of the Company or any Subsidiary, directly or indirectly, will repurchase or offer to repurchase any Notes.\n6.11 Private Offering.\nThe Company will not, and will not permit any Subsidiary, any Affiliate acting on behalf of the Company or any Subsidiary, or any other Person acting on behalf of the Company or any Subsidiary to, offer the Notes or any part thereof or any similar securities for issuance or sale to, or solicit any offer to acquire any of the same from, any Person so as to require registration of the issuance or sale of the Notes under the provisions of section 5 of the Securities Act.\n6.12 Private Placement Number.\nThe Company consents to the filing of copies of this Agreement with Standard & Poor's Corporation to obtain a private placement number and with the National Association of Insurance Commissioners.\n7. NEGATIVE COVENANTS\nThe Company agrees that, for so long as any amount remains unpaid on any Note:\n7.1 Consolidated Net Worth.\nThe Company will not permit Consolidated Net Worth to be less than $160,000,000 at any time.\n7.2 Indebtedness.\n(a) Funded Debt. Neither the Company nor any Subsidiary shall incur or in any manner become liable in respect of any Funded Debt except:\n(i) the Notes,\n(ii) Funded Debt existing on December 15, 1995 and listed on Part 7.2(a) of Annex 3,\n(iii)Funded Debt owed to the Company or a Wholly- Owned Subsidiary, and\n(iv) additional Funded Debt, provided that after giving effect thereto and to any concurrent application of the proceeds thereof Consolidated Funded Debt (including amounts deemed to be Funded Debt pursuant to Section 7.2(b)) shall not exceed 60% of Consolidated Capitalization.\n(b) Clean Down of Current Debt. The Company will not at any time have any Consolidated Current Debt outstanding unless, during the period of twelve (12) consecutive months ended on such date (the \"Measuring Period\"), there shall have been a period of at least 45 consecutive days (the \"Clean Down Period\") on each of which there shall have been no Consolidated Current Debt outstanding in excess of the amount of additional Funded Debt that the Company would have been permitted to (but did not) incur on such day under Section 7.2(a). The Company shall be deemed to have incurred, on the first day of the relevant Clean Down Period, Funded Debt in an amount equal to the Average Daily Balance of Current Debt outstanding during such Clean Down Period, and such amount of Funded Debt shall be deemed to be outstanding at such time and to have been outstanding at all times during the Measuring Period.\n7.3 Subsidiary Indebtedness.\nThe Company will not permit any Subsidiary to create, assume, incur or otherwise become liable for, directly or indirectly, any Indebtedness, other than Indebtedness of a Subsidiary to the Company or a Wholly-Owned Subsidiary, unless, after giving effect thereto and to the application of the proceeds thereof, the sum of (i) Indebtedness of Subsidiaries, other than Indebtedness of a Subsidiary to the Company or a Wholly-Owned Subsidiary, and (ii) Indebtedness of the Company and its Subsidiaries secured by Liens permitted by Section 7.5(i), does not exceed 20% of Consolidated Net Worth.\n7.4 Fixed Charge Ratio.\nThe Company will not permit as of the end of any fiscal quarter the ratio of Consolidated Operating Cash Flow for any four of the six immediately preceding fiscal quarters to Fixed Charges for such quarters to be less than 1.75 to 1.00.\n7.5 Liens.\nThe Company will not, and will not permit any Subsidiary to, permit to exist, create, assume or incur, directly or indirectly, any Lien on its properties or assets, whether now owned or hereafter acquired, except:\n(a) Liens existing on property or assets of the Company or any Subsidiary as of the date of this Agreement that are described in Part 7.5 of Annex 3;\n(b) Liens for taxes, assessments or governmental charges not then due and delinquent or the validity of which is being contested in good faith and as to which the Company has established adequate reserves on its books;\n(c) Deposits or pledges in connection with or to secure payment of workers' compensation, unemployment insurance, old-age pensions or other social security, or in connection with the good faith contest of any tax Lien;\n(d) Construction, mechanics', materialmen's or warehousemen's Liens securing obligations not due or, if overdue, being contested in good faith by appropriate proceedings;\n(e) Liens arising in connection with court proceedings, provided the execution of such Liens is effectively stayed, such Liens are being contested in good faith and the Company has established adequate reserves therefor on its books;\n(f) Liens arising in the ordinary course of business and not incurred in connection with the borrowing of money (including encumbrances in the nature of zoning restrictions, easements, rights and restrictions of record on the use of real property and landlord's and lessor's liens) that in the aggregate do not materially interfere with the conduct of the business of the Company and its Subsidiaries taken as a whole or materially impair the value of the property or assets subject thereto;\n(g) Liens securing Indebtedness of a Subsidiary to the Company or to a Wholly-Owned Subsidiary;\n(h) Liens or Capitalized Leases on fixed assets created within twelve (12) months of the date of acquisition or improvement thereof to secure or provide for all or a portion of the purchase price or cost of construction or improvement of such fixed assets, provided that such Liens do not extend to other property of the Company or any Subsidiary, incurrence of the Indebtedness secured by such Liens is otherwise permitted by this Agreement, and the aggregate principal amount of Indebtedness secured by each such Lien does not exceed 100% of the lesser of (i) the cost of the property or such improvements subject thereto or (ii) the fair market value of such property at the time of incurrence; and\n(i) Liens not otherwise permitted by paragraphs (a) through (h) above incurred subsequent to the Closing Date to secure Indebtedness, provided that after giving effect to such Liens and the incurrence of all Indebtedness secured thereby (i) no Default or Event of Default would exist, (ii) the Company would be permitted to incur one dollar of additional Funded Debt in accordance with Section 7.2(a), and (iii) the sum of (x) Indebtedness secured by Liens incurred pursuant to this paragraph (i) plus, (y) without duplication, Indebtedness of Subsidiaries (other than Indebtedness owed to the Company or to a Wholly-Owned Subsidiary), does not at any time exceed 20% of Consolidated Net Worth.\n7.6 Restricted Payments.\nThe Company will not declare or make any Restricted Payment unless, after giving effect thereto, (a) no Default or Event of Default would exist, (b) the Company could incur one dollar of additional Funded Debt in accordance with Section 7.2(a), and (c) the aggregate amount of Restricted Payments made after December 15, 1995 to and including the date of the Restricted Payment in question would not exceed the sum of (i) $40,000,000, plus (ii) 75% of Consolidated Net Income (less 100% of any loss) realized subsequent to December 15, 1995, plus (iii) the net cash proceeds of the issuance or sale of any of the Company's capital stock after December 15, 1995.\n7.7 Merger or Consolidation.\nThe Company will not, and will not permit any Subsidiary to, merge or consolidate with, or sell all or substantially all of its assets to, any Person, except that:\n(a) The Company may merge or consolidate with, or sell all or substantially all of its assets to, any Person or permit any Person to merge into it, provided that immediately after giving effect thereto,\n(i) The Company is the successor corporation or, if the Company is not the successor corporation, the successor corporation is a solvent corporation organized under the laws of a state of the United States of America or the District of Columbia and expressly assumes in writing the Company's obligations under the Notes and this Agreement, and the holders of the Notes shall have received an opinion of legal counsel reasonably acceptable to them that this Agreement and the Notes are legal, valid and binding obligations of the successor corporation, enforceable against the successor corporation in accordance with their terms;\n(ii) There shall exist no Default or Event of Default; and\n(iii)The Company or such successor corporation could incur at least $1.00 of additional Funded Debt in accordance with Section 7.2(a); and\n(b) Any Subsidiary may (i) merge into the Company or a Wholly-Owned Subsidiary or (ii) sell, transfer or lease all or any part of its assets to the Company or to a Wholly-Owned Subsidiary or (iii) merge into any Person which, as a result of such merger, becomes a Wholly-Owned Subsidiary; provided in each such instance that immediately after giving effect thereto there shall exist no Default or Event of Default.\n7.8 Sale of Assets; Sale of Receivables.\n(a) The Company will not, and will not permit any Subsidiary to, sell, lease, transfer or otherwise (including by way of merger) dispose of (collectively a \"Disposition\") any assets (including capital stock of Subsidiaries) in one or a series of transactions (other than in the ordinary course of business or as permitted by Section 7.7) to any Person other than the Company or a Wholly-Owned Subsidiary, if, after giving effect to such Disposition, the aggregate net book value of assets subject to Dispositions during the fiscal year in which such Disposition occurs would exceed 15% of Consolidated Net Worth, determined as of the end of the fiscal quarter immediately preceding such Disposition; provided, that such Disposition shall not be subject to or included in the foregoing limitation and computation if within six months of such Disposition the net proceeds thereof are either (x) reinvested in productive fixed assets of the Company or a Wholly-Owned Subsidiary, or (y) applied to repay Indebtedness.\n(b) Notwithstanding the foregoing Section 7.8(a) the Company and its Subsidiaries may sell, with or without recourse, accounts receivable, provided that the discount on receivables sold with recourse is not more than 20% of the face amount or fair market value of such receivables, whichever is greater, and the net proceeds from the sale of receivables without recourse is not less than 80% of the face amount or fair market value of such receivables, whichever is greater.\n(c) Neither the Company nor any Subsidiary shall act as seller or lessee in any Sale and Leaseback unless, after giving effect thereto and to any concurrent transactions, no Default or Event of Default would exist and the Company would be able to incur one dollar of additional Funded Debt in accordance with Section 7.2(a).\n7.9 Disposition of Stock of Subsidiaries.\nThe Company will not, and will not permit any Subsidiary to, issue, sell or transfer the capital stock of a Subsidiary unless (i) all shares of capital stock of such Subsidiary and all Indebtedness of such Subsidiary owned by the Company and by every other Subsidiary shall simultaneously be sold, transferred or otherwise disposed of, (ii) such Subsidiary does not thereafter own any shares of capital stock or Indebtedness of the Company or another Subsidiary, (iii) such sale would be permitted by Section 7.8(a), and (iv) the board of directors of the Company shall have made a good faith determination that such sale or transfer is in the best interests of the Company.\n7.10 Permitted Investments.\nThe Company will not, and will not permit any Subsidiary to, make any Investment other than a Permitted Investment.\n7.11 Transactions with Affiliates.\nThe Company will not, and will not permit any Subsidiary to, enter into any transaction (including the furnishing of goods or services) with an Affiliate, whether or not in the ordinary course of business, except on terms and conditions no less favorable to the Company or such Subsidiary than would be obtained in a comparable arm's-length transaction with a Person not an Affiliate.\n7.12 Nature of Business.\nThe Company will not, and will not permit any Subsidiary to, engage in any business that is not substantially similar to the type of business carried on during the fiscal year ended December 31, 1994, or is not an activity which is ancillary, incidental or necessary to the ongoing business of the Company or such Subsidiary.\n7.13 Guaranties.\nThe Company will not, and will not permit any Subsidiary to, become or be liable in respect to any guaranty of Indebtedness except Guaranties which are limited in amount to a stated maximum principal amount dollar exposure.\n8. EVENTS OF DEFAULT AND REMEDIES THEREFOR\n8.1 Nature of Events.\nAn \"Event of Default\" shall exist if any one or more of the following occurs and is continuing:\n(a) Any default in the payment of interest when due on any of the Notes and continuance of such default for a period of 5 days;\n(b) Any default in the payment of the principal of any of the Notes or the Make-Whole Amount thereon, if any, at maturity, upon acceleration of maturity or at any date fixed for prepayment;\n(c) Any default (i) in the payment of any principal of, or interest or premium on, any other Indebtedness of the Company or a Subsidiary as and when due and payable (whether by lapse of time, declaration, call for redemption or otherwise) and the continuation of such default beyond the period of grace allowed with respect thereto, or (ii) which results in the acceleration of any Indebtedness of the Company or any Subsidiary; provided that, in each case, the aggregate amount of all obligations in respect of such Indebtedness exceeds at such time One Million Dollars ($1,000,000);\n(d) Any default in the observance of any covenant or agreement contained in any one or more of Sections 7.1 through 7.9, inclusive;\n(e) Any default in the observance or performance of any other covenant or provision of this Agreement which is not remedied within 30 days after the Company obtains knowledge thereof;\n(f) Any representation or warranty made by the Company in this Agreement, or made by the Company in any written statement or certificate furnished by the Company in connection with the issuance and sale of the Notes or furnished by the Company pursuant to this Agreement, proves incorrect in any material respect as of the date of the issuance or making thereof;\n(g) A final, non-appealable judgment or judgments in an aggregate amount in excess of $1,000,000 shall be entered against the Company or any Subsidiary and remain unpaid for a period of 60 days after the Company receives notice thereof;\n(h) (i) A receiver, liquidator, custodian or trustee of the Company or any Subsidiary, or of all or any substantial part of the property of either, shall be appointed by court order and such order remains in effect for more than sixty (60) days; or an order for relief shall be entered with respect to the Company or any Subsidiary, or the Company or any Subsidiary shall be adjudicated a bankrupt or insolvent;\n(ii) all or any substantial part of the property of the Company or any Subsidiary shall be sequestered by court order and such order shall remain in effect for more than sixty (60) days; or\n(iii)a petition shall be filed against the Company or any Subsidiary under any bankruptcy, reorganization, arrangement, insolvency, readjustment of debt, dissolution or liquidation law of any jurisdiction, whether now or hereafter in effect, and shall not be dismissed within sixty (60) days after such filing;\n(i) The Company or any Subsidiary shall file a petition in voluntary bankruptcy or seeking relief under any provision of any bankruptcy, reorganization, arrangement, insolvency, readjustment of debt, dissolution or liquidation law of any jurisdiction, whether now or hereafter in effect, or shall consent to the filing of any petition against it under any such law; or\n(j) The Company or any Subsidiary shall make a general assignment for the benefit of its creditors, or admits in writing its inability, or fails, to pay its debts generally as they become due, or shall consent to the appointment of a receiver, liquidator or trustee of the Company or a Subsidiary or of all or a substantial part of its property.\n8.2 Default Remedies.\n(a) Acceleration on Event of Default.\n(i) If any Event of Default specified in Section 8.1(h) through Section 8.1(j), inclusive, shall exist, all of the Notes at the time outstanding shall automatically become immediately due and payable together with interest accrued thereon at such time, and, to the extent permitted by law, the Make-Whole Amount as of the Determination Date, with respect to the principal amount of the Notes, without presentment, demand, protest or notice of any kind, all of which are hereby expressly waived, and,\n(ii) If any Event of Default other than those specified in Section 8.1(h) through Section 8.1(j), inclusive, shall exist, the Required Holders may exercise any right, power or remedy permitted to such holder or holders by law, and shall have, in particular, without limiting the generality of the foregoing, the right to declare the entire principal of, and all interest accrued on, all the Notes then outstanding to be, and such Notes shall thereupon become, forthwith due and payable, without any presentment, demand, or protest, all of which are hereby expressly waived, to the extent permitted by law, and the Company shall forthwith pay to the holder or holders of all the Notes then outstanding the entire principal of, and interest accrued on, the Notes at such time and, to the extent permitted by law, the Make-Whole Amount as of the Determination Date, with respect to such principal amount of such Notes.\n(b) Acceleration on Payment Default. During the existence of an Event of Default described in Section 8.1(a) and Section 8.1(b), and irrespective of whether any of the Notes then outstanding shall have been declared to be due and payable pursuant to Section 8.2(a)(ii), any holder of Notes who or which shall have not consented to any waiver with respect to such Event of Default may, at his or its option, by notice in writing to the Company, declare the Notes then held by such holder to be, and such Notes shall thereupon become, forthwith due and payable together with all interest accrued thereon, without any presentment, demand, or protest, all of which are hereby expressly waived, to the extent permitted by law, and the Company shall forthwith pay to such holder the entire principal of and interest accrued on such Notes at such time and, to the extent permitted by law, the Make-Whole Amount as of the Determination Date, with respect to such principal amount of such Notes.\n(c) Valuable Rights. The Company acknowledges, and the parties hereto agree, that the right of each holder to maintain its investment in the Notes free from repayment by the Company (except as herein specifically provided for) is a valuable right and that the provision for payment of a Make-Whole Amount by the Company in the event that the Notes are prepaid or are accelerated as a result of an Event of Default, is intended to provide compensation for the deprivation of such right under such circumstances.\n8.3 Annulment of Acceleration of Notes.\nThe provisions of Section 8.2 are subject to the condition that if the principal of, the Make-Whole Amount and accrued interest on the Notes have been declared immediately due and payable by reason of the occurrence of any Event of Default described in Section 8.1(a) through Section 8.1(g), inclusive, the holder or holders of 66-2\/3% in aggregate principal amount of the Notes then outstanding may, by written instrument filed with the Company, rescind and annul such declaration and the consequences thereof, provided that (i) at the time such declaration is annulled and rescinded no judgment or decree has been entered for the payment of any monies due pursuant to the Notes or this Agreement, (ii) all arrears of interest upon all the Notes and all other sums payable under the Notes and under this Agreement (except any principal, Make- Whole Amount or interest on the Notes which has become due and payable solely by reason of such declaration under Section 8.2) shall have been duly paid and (iii) each and every Default or Event of Default shall have been cured or waived; and provided further, that no such rescission and annulment shall extend to or affect any subsequent Default or Event of Default or impair any right consequent thereto.\n8.4 Other Remedies.\nIf any Event of Default shall be continuing, any holder of Notes may enforce its rights by suit in equity, by action at law, or by any other appropriate proceedings, whether for the specific performance (to the extent permitted by law) of any covenant or agreement contained in this Agreement or in the Notes or in aid of the exercise of any power granted in this Agreement, and may enforce the payment of any Note held by such holder and any of its other legal or equitable rights.\n8.5 Conduct No Waiver; Collection Expenses.\nNo course of dealing on the part of any holder of Notes, nor any delay or failure on the part of any holder of Notes to exercise any of its rights, shall operate as a waiver of such rights or otherwise prejudice such holder's rights, power and remedies. If the Company fails to pay, when due, the principal of, the Make-Whole Amount, or the interest on, any Note, or fails to comply with any other provision of this Agreement, the Company will pay to each holder, to the extent permitted by law, on demand, such further amounts as shall be sufficient to cover the cost and expenses, including but not limited to reasonable attorneys' fees, incurred by such holder in collecting any sums due on the Notes or in otherwise enforcing any of its rights.\n8.6 Remedies Cumulative.\nNo right or remedy conferred upon or served to any holder of Notes under this Agreement is intended to be exclusive of any other right or remedy, and every right and remedy shall be cumulative and in addition to every other right or remedy given under this Agreement or now or hereafter existing under any applicable law. Every right and remedy given by this Agreement or by applicable law to any holder of Notes may be exercised from time to time and as often as may be deemed expedient by such holder, as the case may be.\n8.7 Notice of Default.\nWith respect to Defaults, Events of Default or claimed defaults, the Company will give the following notices:\n(a) The Company promptly, but in any event within 5 days after an officer of the Company obtains knowledge, will furnish to each holder of a Note written notice of the occurrence of a Default or an Event of Default. Such notice shall specify the nature of such default, the period of existence thereof and what action the Company has taken or is taking or proposes to take with respect thereto.\n(b) If the holder of any Note or of any other evidence of Indebtedness of the Company or any Subsidiary gives any notice or takes any other action with respect to a claimed default, the Company with forthwith give written notice thereof to each holder of the then outstanding Notes, describing the notice or action and the nature of the claimed default.\n9. AMENDMENTS, WAIVERS AND CONSENTS\n9.1 Matters Subject to Modification.\nAny term, covenant, agreement or condition of this Agreement may, with the consent of the Company, be amended, or compliance therewith 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 Holders; provided, however, that, without the written consent of the holder or holders of all of the Notes then outstanding, no such waiver, modification, alteration or amendment shall be effective which will (i) change the time of payment (including any required prepayment or optional prepayment) of the principal of or the interest on any Note, (ii) reduce the principal amount thereof or the Make-Whole Amount, if any, or change the rate of interest thereon, (iii) change any provision of any instrument affecting the preferences between holders of the Notes or between holders of the Notes and other creditors of the Company, or (iv) change any of the provisions of Section 8.2, Section 8.3 or this Section 9.\nFor the purpose of determining whether holders of the requisite principal amount of Notes have made or concurred in any waiver, consent, approval, notice or other communication under this Agreement, Notes held in the name of, or owned beneficially by, the Company, any Subsidiary or any Affiliate thereof, shall not be deemed outstanding.\n9.2 Solicitation of Holders of Notes.\nThe Company will not solicit, request or negotiate for or with respect to any proposed waiver or amendment of any of the provisions of this Agreement or the Notes unless each holder of the Notes (irrespective of the amount of Notes then owned by it) shall concurrently be informed thereof by the Company and shall be afforded the opportunity of considering the same and shall be supplied by the Company with sufficient information to enable it to make an informed decision with respect thereto. Executed or true and correct copies of any waiver or consent effected pursuant to the provisions of this Section 9 shall be delivered by the Company to each holder of outstanding Notes forthwith following the date on which the same shall have been executed and delivered by the holder or holders of the requisite percentage of outstanding Notes. The Company will not, directly or indirectly, pay or cause to be paid any remuneration, whether by way of supplemental or additional interest, fees or otherwise, to any holder of the Notes as consideration for or as an inducement to the entering into by any holder of the Notes of any waiver or amendment of any of the terms and provisions of this Agreement unless such renumeration is concurrently paid, on the same terms, ratably to each holder of the then outstanding Notes.\n9.3 Binding Effect.\nAny such amendment or waiver shall apply equally to all the holders of the Notes and shall be binding upon them, upon each future holder of any Note 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 or impair any right related thereto.\n10. FORM OF NOTES, REGISTRATION, TRANSFER, EXCHANGE AND REPLACEMENT\n10.1 Form of Notes.\nEach Note initially delivered under this Agreement will be in the form of one fully registered Note in the form attached as Exhibit A. The Notes are issuable only in fully registered form and in denominations of at least $100,000 (or the remaining outstanding balance thereof, if less than $100,000).\n10.2 Note Register.\nThe Company shall cause to be kept at its principal office a register (the \"Note Register\") for the registration and transfer of the Notes. The names and addresses of the holders of Notes, the transfer thereof and the names and address of the transferees of the Notes shall be registered in the Note Register. The Company may deem and treat the Person in whose name a Note is so registered as the holder and owner thereof for all purposes and shall not be affected by any notice to the contrary, until due presentment of such Note for registration of transfer as provided in this Section 10.\n10.3 Issuance of New Notes Upon Exchange or Transfer.\nUpon surrender for exchange or registration of transfer of any Note at the office of the Company designated for notices in accordance with Section 11.2, the Company shall execute and deliver within five (5) Business Days, at its expense, one or more new Notes of any authorized denominations requested by the holder of the surrendered Note, each dated the date to which interest has been paid on the Notes so surrendered (or, if no interest has been paid, the date of such surrendered Note), but in the same aggregate unpaid principal amount as such surrendered Note, and registered in the name of such person or persons as shall be designated in writing by such holder. Every Note surrendered for registration of transfer shall be duly endorsed, or be accompanied by a written instrument of transfer duly executed, by the holder of such Note or by his attorney duly authorized in writing. The Company may condition its issuance of any new Note in connection with a transfer by any Person upon compliance by the transferor with Section 3.2(a), Section 2.5, and payment to the Company of a sum sufficient to cover any stamp tax or other governmental charge imposed in respect of such transfer.\n10.4 Replacement of Notes.\nUpon receipt of evidence satisfactory to the Company of the loss, theft, mutilation or destruction of any Note, and in the case of any such loss, theft or destruction upon delivery of a bond of indemnity in such form and amount as shall be reasonably satisfactory to the Company or in the event of such mutilation upon surrender and cancellation of the Note, the Company, without charge to the holder thereof, will make and deliver within five (5) Business Days a new Note, of like tenor in lieu of such lost, stolen, destroyed or mutilated Note. If any such lost, stolen, or destroyed Note is owned by you or any other Institutional Holder, then the affidavit of an authorized officer of such owner setting forth the fact of such loss, theft or destruction and of its ownership of the Note at the time of such loss, theft or destruction shall be accepted as satisfactory evidence thereof, and no further indemnity shall be required as a condition to the execution and delivery of a new Note, other than a written agreement of such owner (in form reasonably satisfactory to the Company) to indemnify the Company.\n11. MISCELLANEOUS\n11.1 Expenses.\nWhether or not the purchase of Notes herein contemplated shall be consummated, the Company agrees to pay directly all of your reasonable expenses in connection with the preparation, execution and delivery of this Agreement and the transactions contemplated by this Agreement, including, but not limited to, out-of-pocket expenses, filing fees of Standard & Poor's Corporation in connection with obtaining a private placement number, filing fees of the National Association of Insurance Commissioners, charges and disbursements of your special counsel, photocopying and printing costs and charges for shipping the Notes, adequately insured, to you at your home office or at such other address as you may designate, and all similar expenses (including the fees and expenses of your counsel) relating to any amendments, waivers or consents in connection with this Agreement or the Notes, including, but not limited to, any such amendments, waiver or consents resulting from any work-out, renegotiation or restructuring relating to the performance by the Company of its obligations under this Agreement and the Notes. The Company also agrees that it will pay and save you harmless against any and all liability with respect to stamp and other documentary taxes, if any, which may be payable, or which may be determined to be payable in connection with the execution and delivery of this Agreement or the Notes (but not in connection with a transfer of any Notes), whether or not any Notes are then outstanding. The obligations of the Company under this Section 11.1 shall survive the retirement of the Notes.\n11.2 Notices.\nExcept as otherwise expressly provided herein, all communications provided for in this Agreement shall be in writing and delivered or sent by registered or certified mail, return receipt requested, or by overnight courier (i) if to you, to the address set forth below your name in Annex 1, or to such other address as you may in writing designate, (ii) if to any other holder of the Notes, to such address as the holder may designate in writing to the Company, and (iii) if to the Company, to Standard Motor Products, Inc., 37-18 Northern Boulevard, Long Island City, New York 11101, Attention: Treasurer, or to such other address as the Company may in writing designate.\n11.3 Reproduction of Documents.\nThis Agreement and all documents relating hereto, including, without limitation, (i) consents, waivers and modifications which may hereafter be executed, (ii) documents received by you at the closing of the purchase of the Notes (except the Notes themselves), and (iii) financial statements, certificates and other information previously or hereafter furnished to you, may be reproduced by you by any photographic, photostatic, microfilm, micro-card, miniature photographic or other similar process, and you may destroy any original document so reproduced. The Company agrees and stipulates that any such reproduction which is legible shall be admissible in evidence as the original itself in any judicial or administrative proceeding (whether or not the original is in existence and whether or not such reproduction was made by you in the regular course of business) and that any enlargement, facsimile or further reproduction of such reproduction shall likewise be admissible in evidence; provided that nothing herein contained shall preclude the Company from objecting to the admission of any reproduction on the basis that such reproduction is not accurate, has been altered or is otherwise incomplete.\n11.4 Successors and Assigns.\nThis Agreement will inure to the benefit of and be binding upon the parties hereto and their respective successors and assigns.\n11.5 Law Governing.\nThis Agreement shall be governed by and construed and enforced in accordance with the laws of the State of New York.\n11.6 Headings, Independent Construction.\nThe headings of the sections and subsections of this Agreement are inserted for convenience only and do not constitute a part of this Agreement. Each covenant contained herein shall be construed (absent an express contrary provision herein) as being independent of each other covenant contained herein, and compliance with any one covenant shall not (absent such an express contrary provision) be deemed to excuse compliance with one or more other covenants.\n11.7 Counterparts.\nThis Agreement may be executed simultaneously in one or more counterparts, each of which shall be deemed an original, but all such counterparts shall together constitute one and the same instrument, and it shall not be necessary in making proof of this Agreement to produce or account for more than one such counterpart or reproduction thereof permitted by Section 11.3.\n11.8 Reliance on and Survival of Provisions.\nAll covenants, representations and warranties made by the Company herein and in any certificates delivered pursuant to this Agreement, whether or not in connection with a closing, (i) shall be deemed to have been relied upon by you, notwithstanding any investigation heretofore or hereafter made by you or on your behalf and (ii) shall survive the delivery of this Agreement and the Notes.\n11.9 Integration and Severability.\nThis Agreement embodies the entire agreement and understanding between you and the Company, and supersedes all prior agreements and understandings relating to the subject matter hereof. In case any one or more of the provisions contained in this Agreement or in any Note, or application thereof, shall be invalid, illegal or unenforceable in any respect, the validity, legality and enforceability of the remaining provisions contained in this Agreement and in any Note, and any other application thereof, shall not in any way be affected or impaired thereby.\n[Remainder of page intentionally left blank; next page is signature page] IN WITNESS WHEREOF, you and the Company have caused this Agreement to be executed and delivered by a duly authorized officer.\nSTANDARD MOTOR PRODUCTS, INC.\nBy____________________________________ Name: Title:\nAccepted:\nAMERICAN UNITED LIFE INSURANCE COMPANY\nBy KENT R. ADAMS Name: KENT R. ADAMS Title: VICE PRESIDENT\nANNEX 1 INFORMATION AS TO PURCHASER\n- -------------------------------------------------------------------------------- Purchaser Name METROPOLITAN LIFE INSURANCE COMPANY - -------------------------------------------------------------------------------- Name in Which Note is Registered METROPOLITAN LIFE INSURANCE COMPANY - -------------------------------------------------------------------------------- Note Registration Number, R-1; $35,000,000 Principal Amount to be purchased at Initial Closing - -------------------------------------------------------------------------------- Note Registration Number, N\/A Principal Amount to be purchased at Second Closing - -------------------------------------------------------------------------------- Payment on Account of Note\nMethod Federal Funds Wire Transfer\nAccount Information The Chase Manhattan Bank, N.A. 33 East 23rd Street ABA No. 021000021 Account No. 002-2-410591 - -------------------------------------------------------------------------------- Accompanying Information Name of Company: STANDARD MOTOR PRODUCTS, INC. Description of Security: 6.81% Senior Notes due February 25, 2006 Security Number:853666 C@ 2 Due Date and Application (as among principal, premium and interest) of the payment being made: - -------------------------------------------------------------------------------- Address for Notices Related to Metropolitan Life Insurance Company Payments One Madison Avenue New York, NY 10010 Attention: Treasurer\nwith a copy to:\nMetropolitan Life Insurance Company Capital Markets Group 200 Park Avenue 21st Floor New York, NY 10166 Attention: Vice President\nFax: (212) 692-5784 - -------------------------------------------------------------------------------- Purchaser Name METROPOLITAN LIFE INSURANCE COMPANY - -------------------------------------------------------------------------------- Address for All other Notices Metropolitan Life Insurance Company One Madison Avenue New York, NY 10010 Attention: Treasurer\nwith a copy to:\nMetropolitan Life Insurance Company Capital Markets Group 200 Park Avenue 21st Floor New York, NY 10166 Attention: Vice President\nFax: (212) 692-5784 - -------------------------------------------------------------------------------- Instructions re Delivery of NotesRuth R. Gluck, Esq. Metropolitan Life Insurance Company One Madison Avenue New York, NY 10010-3690\nTel: (212) 578-2863 - -------------------------------------------------------------------------------- Signature Block format METROPOLITAN LIFE INSURANCE COMPANY\nBy__________________________ Name: Title:\nBy__________________________ Name: Title: - -------------------------------------------------------------------------------- Tax Identification Number 13-5581829 - -------------------------------------------------------------------------------- Purchaser Name CONNECTICUT GENERAL LIFE INSURANCE COMPANY, on behalf of one or more separate accounts - -------------------------------------------------------------------------------- Name in Which Note is Registered CIG & CO. - -------------------------------------------------------------------------------- Note Registration Number, N\/A Principal Amount to be purchased at Initial Closing - -------------------------------------------------------------------------------- Note Registration Number, R-5; $4,000,000 Principal Amount to be purchased R-6; $3,000,000 at Second Closing - -------------------------------------------------------------------------------- Payment on Account of Note\nMethod Federal Funds Wire Transfer\nAccount Information Chase NYC\/CTR\/ BNF=CIGNA Private Placements\/AC=9009001802 ABA No.: 021000021 - -------------------------------------------------------------------------------- Accompanying Information Name of Company: Standard Motor Products, Inc. Description of Security: 6.81% Senior Notes due February 25, 2006 Security Number:853666 C@ 2 Due Date and Application (as among principal, premium and interest) of the payment being made: - -------------------------------------------------------------------------------- Address for Notices Related to CIG & Co. Payments c\/o CIGNA Investments, Inc. Attention: Securities Processing S-206 900 Cottage Grove Road Hartford, CT 06152-2206\nwith a copy to:\nChase Manhattan Bank, N.A. Private Placement Servicing P.O. Box 1508 Bowling Green Station New York, New York 10081 Attention: CIGNA Private Placements Fax: (212) 552-3107\/1005 - -------------------------------------------------------------------------------- Address for All other Notices CIG & Co. c\/o CIGNA Investments, Inc. Attention: Private Securities Division S-307 900 Cottage Grove Road Hartford, Connecticut 06152-2307 Fax: (203) 726-7203 - -------------------------------------------------------------------------------- Instructions re Delivery of NotesEllen Flynn, Esq. CIGNA Investments, Inc. 900 Cottage Grove Road, (S-215) Hartford, CT 06002\nTel: (203) 726-3884 - -------------------------------------------------------------------------------- Purchaser Name CONNECTICUT GENERAL LIFE INSURANCE COMPANY, on behalf of one or more separate accounts - -------------------------------------------------------------------------------- Signature Block format CONNECTICUT GENERAL LIFE INSURANCE COMPANY, on behalf of one or more separate accounts By CIGNA Investments, Inc.\nBy _____________________________ Name: Title: - -------------------------------------------------------------------------------- Tax Identification Number 13-3574027 - -------------------------------------------------------------------------------- Purchaser Name CONNECTICUT GENERAL LIFE INSURANCE COMPANY - -------------------------------------------------------------------------------- Name in Which Note is Registered CIG & CO. - -------------------------------------------------------------------------------- Note Registration Number, N\/A Principal Amount to be purchased at Initial Closing - -------------------------------------------------------------------------------- Note Registration Number, R-7; $6,000,000 Principal Amount to be purchased at Second Closing - -------------------------------------------------------------------------------- Payment on Account of Note\nMethod Federal Funds Wire Transfer\nAccount Information Chase NYC\/CTR\/ BNF=CIGNA Private Placements\/AC=9009001802 ABA No.: 021000021 - -------------------------------------------------------------------------------- Accompanying Information Name of Company: STANDARD MOTOR PRODUCTS, INC. Description of Security: 6.81% Senior Notes due February 25, 2006 Security Number:853666 C@ 2 Due Date and Application (as among principal, premium and interest) of the payment being made: - -------------------------------------------------------------------------------- Address for Notices Related to CIG & Co. Payments c\/o CIGNA Investments, Inc. Attention: Securities Processing S-206 900 Cottage Grove Road Hartford, CT 06152-2206\nwith a copy to:\nChase Manhattan Bank, N.A. Private Placement Servicing P.O. Box 1508 Bowling Green Station New York, New York 10081 Attention: CIGNA Private Placements Fax: (212) 552-3107\/1005 - -------------------------------------------------------------------------------- Address for All other Notices CIG & Co. c\/o CIGNA Investments, Inc. Attention: Private Securities Division S-307 900 Cottage Grove Road Hartford, Connecticut 06152-2307 Fax: (203) 726-7203 - -------------------------------------------------------------------------------- Instructions re Delivery of NotesEllen Flynn, Esq. CIGNA Investments, Inc. 900 Cottage Grove Road, (S-215) Hartford, CT 06002\nTel: (203) 726-3884 - -------------------------------------------------------------------------------- Purchaser Name CONNECTICUT GENERAL LIFE INSURANCE COMPANY - -------------------------------------------------------------------------------- Signature Block format CONNECTICUT GENERAL LIFE INSURANCE COMPANY By CIGNA Investments, Inc.\nBy _____________________________ Name: Title: - -------------------------------------------------------------------------------- Tax Identification Number 13-3574027 - -------------------------------------------------------------------------------- Purchaser Name CIGNA PROPERTY AND CASUALTY INSURANCE COMPANY - -------------------------------------------------------------------------------- Name in Which Note is Registered CIG & CO. - -------------------------------------------------------------------------------- Note Registration Number, N\/A Principal Amount to be purchased at Initial Closing - -------------------------------------------------------------------------------- Note Registration Number, R-8; $4,000,000 Principal Amount to be purchased at Second Closing - -------------------------------------------------------------------------------- Payment on Account of Note\nMethod Federal Funds Wire Transfer\nAccount Information Chase NYC\/CTR\/ BNF=CIGNA Private Placements\/AC=9009001802 ABA No.: 021000021 - -------------------------------------------------------------------------------- Accompanying Information Name of Company: STANDARD MOTOR PRODUCTS, INC. Description of Security: 6.81% Senior Notes due February 25, 2006 Security Number:853666 C@ 2 Due Date and Application (as among principal, premium and interest) of the payment being made: - -------------------------------------------------------------------------------- Address for Notices Related to CIG & Co. Payments c\/o CIGNA Investments, Inc. Attention: Securities Processing S-206 900 Cottage Grove Road Hartford, CT 06152-2206\nwith a copy to:\nChase Manhattan Bank, N.A. Private Placement Servicing P.O. Box 1508 Bowling Green Station New York, New York 10081 Attention: CIGNA Private Placements Fax: (212) 552-3107\/1005 - -------------------------------------------------------------------------------- Address for All other Notices CIG & Co. c\/o CIGNA Investments, Inc. Attention: Private Securities Division S-307 900 Cottage Grove Road Hartford, Connecticut 06152-2307 Fax: (203) 726-7203 - -------------------------------------------------------------------------------- Instructions re Delivery of NotesEllen Flynn, Esq. CIGNA Investments, Inc. 900 Cottage Grove Road, (S-215) Hartford, CT 06002\nTel: (203) 726-3884 - -------------------------------------------------------------------------------- Purchaser Name CIGNA PROPERTY AND CASUALTY INSURANCE COMPANY - -------------------------------------------------------------------------------- Signature Block format CIGNA PROPERTY AND CASUALTY INSURANCE COMPANY By CIGNA Investments, Inc.\nBy _____________________________ Name: Title: - -------------------------------------------------------------------------------- Tax Identification Number 13-3574027 - -------------------------------------------------------------------------------- Purchaser Name LIFE INSURANCE COMPANY OF NORTH AMERICA - -------------------------------------------------------------------------------- Name in Which Note is Registered CIG & CO. - -------------------------------------------------------------------------------- Note Registration Number, N\/A Principal Amount to be purchased at Initial Closing - -------------------------------------------------------------------------------- Note Registration Number, R-9; $3,000,000 Principal Amount to be purchased at Second Closing - -------------------------------------------------------------------------------- Payment on Account of Note\nMethod Federal Funds Wire Transfer\nAccount Information Chase NYC\/CTR\/ BNF=CIGNA Private Placements\/AC=9009001802 ABA No.: 021000021 - -------------------------------------------------------------------------------- Accompanying Information Name of Company: STANDARD MOTOR PRODUCTS, INC. Description of Security: 6.81% Senior Notes due February 25, 2006 Security Number:853666 C@ 2 Due Date and Application (as among principal, premium and interest) of the payment being made: - -------------------------------------------------------------------------------- Address for Notices Related to CIG & Co. Payments c\/o CIGNA Investments, Inc. Attention: Securities Processing S-206 900 Cottage Grove Road Hartford, CT 06152-2206\nwith a copy to:\nChase Manhattan Bank, N.A. Private Placement Servicing P.O. Box 1508 Bowling Green Station New York, New York 10081 Attention: CIGNA Private Placements Fax: (212) 552-3107\/1005 - -------------------------------------------------------------------------------- Address for All other Notices CIG & Co. c\/o CIGNA Investments, Inc. Attention: Private Securities Division S-307 900 Cottage Grove Road Hartford, Connecticut 06152-2307 Fax: 203-726-7203 - -------------------------------------------------------------------------------- Instructions re Delivery of NotesEllen Flynn, Esq. CIGNA Investments, Inc. 900 Cottage Grove Road, (S-215) Hartford, CT 06002\nTel: (203) 726-3884 - -------------------------------------------------------------------------------- Purchaser Name LIFE INSURANCE COMPANY OF NORTH AMERICA - -------------------------------------------------------------------------------- Signature Block format LIFE INSURANCE COMPANY OF NORTH AMERICA By CIGNA Investments, Inc.\nBy _____________________________ Name: Title: - -------------------------------------------------------------------------------- Tax Identification Number 13-3574027 - -------------------------------------------------------------------------------- Purchaser Name THE TRAVELERS INSURANCE COMPANY - -------------------------------------------------------------------------------- Name in Which Note is Registered TRAL & CO. - -------------------------------------------------------------------------------- Note Registration Number, R-2; $10,000,000 Principal Amount to be purchased at Initial Closing - -------------------------------------------------------------------------------- Note Registration Number, N\/A Principal Amount to be purchased at Second Closing - -------------------------------------------------------------------------------- Payment on Account of Note\nMethod Federal Funds Wire Transfer\nAccount Information The Chase Manhattan Bank, N.A. One Chase Manhattan Plaza New York, NY 10081 ABA No. 021000021 For the account of: The Travelers Insurance Company -- Account No.: 910-2-587434 - -------------------------------------------------------------------------------- Accompanying Information Name of Company: STANDARD MOTOR PRODUCTS, INC. Description of Security: 6.81% Senior Notes due February 25, 2006 Security Number:853666 C@ 2 Due Date and Application (as among principal, premium and interest) of the payment being made: - -------------------------------------------------------------------------------- Address for Notices Related to The Travelers Insurance Company Payments One Tower Square Hartford, CT 06183-2030 Attention: Securities Department -- Cashier - -------------------------------------------------------------------------------- Address for All other Notices The Travelers Insurance Company One Tower Square Hartford, CT 06183-2030 Attention: Securities Department -- Private Placements Fax: (203) 954-3730 - -------------------------------------------------------------------------------- Instructions re Delivery of NotesDaniel B. Kenney, Esq. The Travelers Insurance Company One Tower Square Securities Department (9PB) Hartford, CT 06183-2030\nTel: (203) 277-5254 - -------------------------------------------------------------------------------- Signature Block format THE TRAVELERS INSURANCE COMPANY\nBy___________________________ Name: Title: - -------------------------------------------------------------------------------- Tax Identification Number 06-0566090 - -------------------------------------------------------------------------------- Purchaser Name AMERICAN UNITED LIFE INSURANCE COMPANY - -------------------------------------------------------------------------------- Name in Which Note is Registered American United Life Insurance Company - -------------------------------------------------------------------------------- Note Registration Number, R-3; $4,000,000 Principal Amount to be purchased R-4; $4,000,000 at Initial Closing - -------------------------------------------------------------------------------- Note Registration Number, N\/A Principal Amount to be purchased at Second Closing - -------------------------------------------------------------------------------- Payment on Account of Note\nMethod Federal Funds Wire Transfer\nAccount Information Bank of New York One Wall Street, 3rd Floor New York, NY 10286 Window A\nABA No.: 021000018 Account No.: 186683\/AUL - -------------------------------------------------------------------------------- Accompanying Information Name of Company: STANDARD MOTOR PRODUCTS, INC. Description of Security: 6.81% Senior Notes due February 25, 2006 Security Number:853666 C@ 2 Due Date and Application (as among principal, premium and interest) of the payment being made: - -------------------------------------------------------------------------------- Address for Notices Related to American United Life Insurance Company Payments Law Department Post Office Box 368 Indianapolis, IN 46206 Attn: Rebecca Davis - -------------------------------------------------------------------------------- Address for All other Notices American United Life Insurance Company Law Department Post Office Box 368 Indianapolis, IN 46206 Attn: Rebecca Davis\nFax: (317) 263-1470 - -------------------------------------------------------------------------------- Instructions re Delivery of NotesBank of New York One Wall Street, 3rd Floor New York, NY 10286 Window A Acct# 186682\/AUL ABA# 021000018 - -------------------------------------------------------------------------------- Signature Block format - -------------------------------------------------------------------------------- Tax Identification Number 35-0145825 - --------------------------------------------------------------------------------\nANNEX 2 PAYMENT INSTRUCTIONS AT CLOSINGS\nRe: Standard Motor Products, Inc. -- $73,000,000 6.81% Senior Notes due 2006\nIn accordance with Section 1.2(b) and Section 1.2(c) of the Agreement, the Company directs you to make payment for the Note or Notes being purchased by you by payment by federal funds wire transfer in immediately available funds of the purchase price thereof to:\nChemical Bank New York, NY\nABA No: 021000128\nAccount No:027-022048\nAccount Name: Standard Motor Products, Inc.\nContact person at Bank:\nName: Jon Russell Phone No.:(718) 830-5812 ANNEX 3 PART 3.1 (C) SUBSIDIARIES & AFFILIATES\nPercent State or of Voting Country of Securities Name Incorporation Owned\nBlue Streak-Hygrade Motor Canada 100 (1) Products, Ltd. Marathon Auto Parts & Products, Inc. New York 100 Motortronics, Inc. New York 100 Reno Standard Incorporated Nevada 100 Stanric, Inc. Delaware 100 Mardevco Credit Corp. (2) New York 100 Standard Motor Products (Hong Hong Kong 100 Kong) Limited Industrial & Automotive Associates, California 100 Unimotor, Ltd. Canada 100 EIS Brake Manufacturing, Ltd. Canada 100 Standard Motor Electronics, Ltd. Israel 100\nAll of the subsidiaries are included in the consolidated financial statements.\n(1) Except for directors' qualifying shares. (2) Wholly owned subsidiary of Stanric, Inc.\nAFFILIATES\nPercent State or of Voting Country of Securities Name Incorporation Owned\nEISLINE Manufacturing Co. California 50 (A) Blue Streak Electronics, Inc. Canada 50 (B) Testar, Ltd. Israel 50 (C) Standard Motor Products (Wuhan) Ltd. China 50 (D)\n(A) 50% owned by Autoline, Inc. (B) 50% owned by Aron Regev and Family (C) 50% owned by Aron Regev (D) 39% owned by China Wuhan Changlong High Tech Enterprise Co., Ltd. 15% owned by Dongfeng Auto Works Electrical Factory 6% owned by Hong Kong Baixin Enterprise Ltd.\nAnnex 3 PART 3.1 (h) ERISA Affiliates and \"Employee Benefit Plans,\" Multi-Employer Plans\nMedical Plans: Champ Service Line: Champ Service Line LaHood & Associates; Blue Advantage HMO; Blue Care HMO (U\/N)\nAirParts & ADI: AirParts Health & Welfare, All America (H\/S)\nFour Seasons: Four Seasons Health & Welfare Plan; All America (H\/S)\nCanada: Blue Streak-Hygrade Motor Parts Ltd. (Metropolitan Life Ins.) (N)\nPik-A-Nut: Pik-A-Nut Health & Welfare Plan; Warren Steinborn Associates (H\/S)\nL.I.C.: Standard Motor Products Health & Welfare Plan, SNL Administrators (N)\nReno: Standard Motor Products Health & Welfare Plan, SNL Administrators (N)\nStanric (Puerto Rico): Plan Medico Empleados Stanric Inc.; Cook & Stratton P.P.O. (N)\nEIS: EIS Division Health & Welfare - SNL Administrators, Connecticare, M.D. Health benefits, F.H.P. TakeCare (U\/N)\nHong Kong: Employee Benefit Health Insurance; National Mutual Insurance Co. Ltd. (Support & Management Staff)\n[U=Union] [N=Non-Union] [H=Hourly] [S=Salaried]\nAnnex 3 PART 3.1 (h) ERISA Affile Benefit Plans,\" Multi-Employer Plans\nDental: Champ Service Line: Cigna Dental Ins. (U) Kansas City Life Insurance Co. Dental Benefits (N)\nAirParts & ADI: AirParts Dental Care (U\/N)\nFour Seasons: United Dental Care (H) All America Dental Plan (S)\nCanada: Blue Streak-Hygrade Motor Parts Ltd. (Metropolitan Life Ins.) (N) (Dental Continued)\nPik-A-Nut: Pik-A-Nut Division of S.M.P. Kansas City Life Insurance Dental Plan (H\/S)\nL.I.C.: Standard Motor Products, Inc. Dental Plan, SNL Administrators (N) U.A.W. Welfare Fund, Local 365 (U)\nReno: Standard Motor Products, Inc. Dental Plan, SNL Administrators (N)\nStanric (Puerto Rico): Delta Dental de Puerto Rico (N)\nEIS: EIS Employees Dental - SNL Administrators (N)\n[U=Union] [N=Non-Union] [H=Hourly] [S=Salaried]\nAnnex 3 PART 3.1 (h) ERISA Affiliates ande Benefit Plans,\" Multi-Employer Plans\nLife Insurance: Champ Service Line: Phoenix Home Life Mutual Insurance Co. (U) Kansas City Life Ins. Co. Group Life Benefits (N)\nAirParts & ADI: All America (H\/S)\nFour Seasons: U.S. Life Ins. Co. (H) All America Insurance Co. (S)\nCanada: Blue Streak-Hygrade Motor Products Ltd. (Metropolitan Life Ins.) (N)\nPik-A-Nut: North American Insurance Co., A.D. & D. Cigna Group Ins. (H\/S)\nL.I.C.: Hartford Insurance Co. (U\/N)\nReno: Hartford Insurance Co. (U\/N)\nStanric (Puerto Rico): United of Omaha (N) Security National Life Insurance Co. (Office only()\nEIS: Hartford Insurance Co. (U\/N)\nHong Kong: Employee Benefit Life Insurance; National Mutual Insurance Co. Ltd. (Support & Management Staff)\n[U=Union] [N=Non-Union] [H=Hourly] [S=Salaried]\nAnnex 3 PART 3.1 (h) ERISA Affiliates ande Benefit Plans,\" Multi-Employer Plans\nShort-Term Disability: Champ Service Line: Kansas City Life Ins. Co. Grp. Weekly Disability Insurance Benefits (U\/N)\nCanada: Blue Streak-Hygrade Motor Products Ltd. (Metropolitan Life Ins.) (N)\nPik-A-Nut: Warren Steinbach Associates, T.P.A. North American Ins. Co. (H\/S)\nL.I.C.: Wausau Insurance Company (N)\nReno: Wausau Insurance Company (N)\nStanric (Puerto Rico): Sinot: Seguro de Incapcidad no Ocupacional; National Life Insurance Co. (N)\nEIS: S.N.L. Administrators (U\/N)\nHong Kong: Employee Benefit Life Insurance; National Mutual Insurance Co. Ltd. (Support & Management Staff)\nLong-Term Disability: Champ Service Line: Kansas City Life Insurance Company Group Long-Term Disability Ins. Benefits (N)\nAirParts & A.D.I.: UNUM Ins. Co. (H\/S)\nFour Seasons: UNUM Ins. Co. (H\/S) [U=Union] [N=Non-Union] [H=Hourly] [S=Salaried]\nAnnex 3 PART 3.1 (h) ERISA Affiliates ande Benefit Plans,\" Multi-Employer Plans\nCanada: Blue Streak-Hygrade Motor Products Ltd. (Metropolitan Life Ins) (N)\nPik-A-Nut: Kansas City Life Ins. Group Long-Term Disability (H\/S)\nL.I.C.: Guardian Insurance Co. (N)\nReno: Guardian Insurance Co. (N)\nStanric (Puerto Rico): Guardian Insurance Co. (N)\nEIS: UNUM (N)\nHong Kong: Employee Benefit Life Insurance; National Mutual Insurance Co. Ltd. (Support & Management Staff)\nRetirement: EIS: Cigna Retirement and Investment Service (U)-EIS Union Employees Pension Plan (U)\nHong Kong: Provident Fund Scheme; American International Assurance Co. (Bermuda) Ltd. (AIA) (Support & Management Staff)\n[U=Union] [N=Non-Union] [H=Hourly] [S=Salaried]\nAnnex 3 PART 3.1 (h) ERISA Affiliates ande Benefit Plans,\" Multi-Employer Plans\n\"401K and\/or Profit Sharing: Champ Service Line: Champ Service Line Production Employees 401K Plan (U) S.M.P. Inc. Profit Sharing Capital Accumulation Plan (N)\nAirParts & ADI: S.M.P., Inc. Profit Sharing Capital Accumulation Plan (U\/N)\nFour Seasons: S.M.P., Inc. Profit Sharing Capital Accumulation Plan (H\/S)\nCanada: Deferred Profit Sharing Plan (National Trust) (N)\nPik-A-Nut: S.M.P., Inc. Profit Sharing Capital Accumulation Plan (H\/S)\nL.I.C.: S.M.P., Inc. Profit Sharing Capital Accumulation Plan (N)\nReno: S.M.P., Inc. Profit Sharing Capital Accumulation Plan (N)\nStanric (Puerto Rico): S.M.P., Inc. Profit Sharing Capital Accumulation Plan (N)\nEIS: S.M.P., Inc. Profit Sharing Capital Accumulation Plan (N)\nESOP: Champ Service Line: Employee Stock Ownership Plan and Trust of SMP, Inc. (N)\nAir Parts\/A.D.I.: Employee Stock Ownership Plan and Trust of SMP, Inc. (N)\n[U=Union] [N=Non-Union] [H=Hourly] [S=Salaried]\nAnnex 3 PART 3.1 (h) ERISA Affiliates ande Benefit Plans,\" Multi-Employer Plans\nFour Seasons: Employee Stock Ownership Plan & Trust of SMP, Inc. (H\/S)\nCanada: Deferred Profit Sharing Plan (National Trust) (N)\nPik-A-Nut: Employee Stock Ownership Plan & Trust of SMP, Inc. (H\/S)\nL.I.C.: Employee Stock Ownership Plan & Trust of SMP, Inc. (N)\nReno: Employee Stock Ownership Plan & Trust of SMP, Inc. (N)\nStanric (Puerto Rico): Employee Stock Ownership Plan & Trust of SMP, Inc. (N)\nEIS: Employee Stock Ownership Plan & Trust of SMP, Inc. (N)\nMulti-Employer Plans: L.I.C.: U.A.W. Local 365 Hip\/Welfare Fund\/Major Medical (U) U.A.W. Local 365 Welfare Fund (U) U.A.W. Local 365 Pension Plan (U)\n[U=Union] [N=Non-Union] [H=Hourly] [S=Salaried]\nANNEX 3 PART 3.1(y) INDEBTEDNESS AS AT DECEMBER 15, 1995\nLONG TERM CURRENT AMOUNT NAME TOTAL AMOUNT (FUNDED DEBT)\nIRB'S AND LONG-TERM NOTES\nTEXAS # 2 - IRB 780,000.00 180,000.00 600,000.00 MANILA ARK. BOND # 1 - IRB 1,200,000.00 270,000.00 950,000.00 MANILA ARK. BOND # 2 - IRB 1,060,000.00 180,000.00 880,000.00 LIC - IRB 4,833,334.33 666,667.00 4,166,667.33 NOTES PAY: TRAVELERS # 3 2,000,000.00 2,000,000.00 0.00 NOTES PAY: INSURANCE CO'S 30,000,000.00 0.00 30,000,000.00 NOTES PAY: $65 MILLION 65,000,000.00 9,285,714.00 55,714,286.00 NBD BANK - ESOP 5,033,571.00 1,680,000.00 3,353,571.00\nSUB - TOTAL 109,926,905.33 14,262,381.00 95,664,524.33\nBANK REVOLVING CREDIT (AS AT 12\/13\/95)\nCHEMICAL 14,000,000.00 14,000,000.00 NAT WEST 14,100,000.00 14,100,000.00 BK OF NEW YORK 17,300,000.00 17,300,000.00 NBD BANK 8,900,000.00 8,900,000.00\nSUB - TOTAL 54,300,000.00 54,300,000.00\nTOTAL INDEBTEDNESS 164,226,905.33 68,562,381.00 95,664,524.33\nANNEX 3 PART 7.2(A) EXISTING FUNDED DEBT AS AT DECEMBER 15, 1995\nNAME TOTAL\nTEXAS # 2 - IRB 600,000.00 MANILA ARK. BOND # 1 - IRB 950,000.00 MANILA ARK. BOND # 2 - IRB 880,000.00 LIC - IRB 4,166,667.33 NOTES PAY: INSURANCE CO'S 30,000,000.00 NOTES PAY: $65 MILLION 55,714,286.00 NBD BANK - ESOP 3,353,571.00\nTOTAL FUNDED DEBT 95,664,524.33 ANNEX 3 PART 7.5 EXISTING LIENS\n1. Industrial Revenue Bond - Grand Park Woodall Rogers, N.A., Dallas, Texas dated 8\/1\/84 in the original amount of $2,000,000.\n2. Industrial Revenue Bond - New York City Industrial Development Authority dated January 1, 1988 in the amount of $10,000,000.\n3. Industrial revenue Bond - First National Bank of Lawrence County, Walnut Ridge, Arkansas dated 12\/16\/89 the original amount of $2,500,000.\n4. Industrial revenue Bond - First National Bank of Lawrence County, Walnut Ridge, Arkansas dated 6\/1\/90 the original amount of $1,800,000.\n5. Credit Agreement with Chemical Bank dated 3\/10\/80 for a maximum of $18,000,000 to be used for the acquisition of stock of the Company's ESOP; First Amendment and Waiver Agreement Dated 7\/20\/90; Second Amendment and Waiver Agreement dated 3\/4\/91; Third Amendment assigning the Credit Agreement to NBD Bank, N.A. dated 12\/20\/91; Waiver dated 1\/13\/92; Fourth Amendment dated 10\/30\/92; Waiver dated 12\/8\/92.\n6. Asset Purchase and Sale Agreement with Abacus Funding Co. as Investor and Manufacturers Hanover Agent Bank Services Corporation as Agent dated 7\/10\/90 in the original amount of $25,000,000.\nUNPAID PRINCIPAL BALANCES AS OF DECEMBER 15, 1995\n1. $780,000\n2. $4,833,333\n3. $1,220,000\n4. $1,060,000\n5. $5,033,571\n6. $25,000,000 ANNEX 4 Notice Information as to Make-Whole Amount\nRe: Standard Motor Products, Inc. -- $73,000,000 6.81% Senior Notes due 2006\nIn accordance with the definition of \"Make-Whole Amount\" set forth in Section 5.1 of this Agreement, all communications required to be delivered pursuant to such definition shall be sent by telecopier to the number and attention set forth with the respective parties below:\n(i) if to the Company,\nStandard Motor Products, Inc. Attention: Treasurer FAX: (718) 729-4549\nor at such other telecopier number as the Company shall have furnished in writing to all holders of the Notes at the time outstanding, and\n(ii) if to any of the holders of the Notes,\n(A) if to any of the Purchasers, at the telecopier number set forth on Annex 1, and further including any additional parties referred to on such Annex 1 that are required to receive notices, and\n(B) if to any other holders of Notes, at their respective telecopier numbers set forth in the register for the registration and transfer of Notes maintained pursuant to Section 10.2,\nor to any such party at such other telecopier number as such party may designate by notice duly given in accordance with this Annex 4 to the Company (which other telecopier number shall be entered in such register). EXHIBIT A\nFORM OF NOTE\nSTANDARD MOTOR PRODUCTS, INC.\n6.81% Senior Note Due February 25, 2006\nNo. R-____ PPN:________________ $________ [Closing Date]\nSTANDARD MOTOR PRODUCTS, INC. (the \"Company\"), a New York corporation, for value received, hereby promises to pay to ______ or registered assigns the principal sum of ______ DOLLARS ($______) on February 25, 2006 and to pay interest (computed on the basis of a 360-day year of twelve 30-day months) on the unpaid principal balance thereof from the date of this Note at the rate of six and eighty-one one-hundredths percent (6.81%) per annum, semi-annually on February 25 and August 25 of each year, commencing on the later of February 25, 1996 or the payment date next succeeding the date hereof, until the principal amount hereof shall become due and payable; and to pay on demand interest on any overdue principal (including any overdue prepayment of principal) and Make-Whole Amount, if any, and (to the extent permitted by applicable law) on any overdue installment of interest, at a rate equal to the lesser of (a) the highest rate allowed by applicable law or (b) the greater of (i) eight and eighty- one one-hundredths percent (8.81%), or (ii) two percent (2%) over the rate of interest publicly announced by Chemical Bank from time to time as its prime rate.\nPayments of principal, Make-Whole Amount, if any, and interest shall be made in such coin or currency of the United States of America as at the time of payment is legal tender for the payment of public and private debts to the registered holder hereof at the address shown in the register maintained by the Company for such purpose, in the manner provided in the Note Purchase Agreement (defined below).\nThis Note is one of an issue of Notes of the Company issued in an aggregate principal amount limited to Seventy Three Million Dollars ($73,000,000) pursuant to the Company's separate Note Purchase Agreements, (collectively, the \"Note Purchase Agreement\"), each dated as of December 1, 1995, with the purchasers listed on Annex 1 thereto, and is entitled to the benefits thereof. Capitalized terms used herein and not otherwise defined herein have the meanings specified in the Note Purchase Agreement.\nAs provided in the Note Purchase Agreement, (i) portions of the principal of this Note must be repaid (and will become due and payable) prior to the stated maturity hereof, (ii) all or a portion of the principal of this Note may be repaid at the option of the Company (and will, on the exercise of such option, become due and payable) prior to the stated maturity hereof and a Make-Whole Amount may be due in connection therewith and (iii) all of the principal of this Note (together with any applicable Make-Whole Amount) may, under certain circumstances, be declared due and payable in the manner and with the effect provided in the Note Purchase Agreement.\nThis Note is a registered Note and is transferable only by surrender thereof at the principal office of the Company as specified in the Note Purchase Agreement, duly endorsed or accompanied by a written instrument of transfer duly executed by the registered holder of this Note or such holder's attorney duly authorized in writing.\nTHIS NOTE SHALL BE GOVERNED BY, AND CONSTRUED AND ENFORCED IN ACCORDANCE WITH, THE LAW OF THE STATE OF NEW YORK, EXCLUDING CHOICE-OF-LAW PRINCIPLES OF THE LAW OF SUCH STATE THAT WOULD REQUIRE THE APPLICATION OF THE LAWS OF A JURISDICTION OTHER THAN SUCH STATE.\nSTANDARD MOTOR PRODUCTS, INC.\nBy:\nName:\nTitle: EXHIBIT B1\n[FROM OF OPINION OF COUNSEL TO THE COMPANY]\n[Letterhead of Kelley Drye & Warren]\n[Closing Date]\nTo the Persons Listed on Annex 1 hereto\nRe: Standard Motor Products, Inc. (the \"Company\")\nLadies and Gentlemen:\nReference is made to the separate Note Purchase Agreements, each dated as of December 1, 1995 (collectively, the \"Note Purchase Agreement\"), between the Company and each of the purchasers listed on Annex 1 attached thereto (the \"Purchasers\"), which provide, among other things, for the issuance and sale by the Company of its 6.81% Senior Notes due February 25, 2006, in the aggregate principal amount of Seventy-Three Million Dollars ($73,000,000). The capitalized terms used herein and not defined herein have the meanings specified by the Note Purchase Agreement.\nWe have acted as special counsel to the Company in connection with the transactions contemplated by the Note Purchase Agreement. In acting as such counsel, we have examined:\n(a) the Note Purchase Agreement;\n(b) the Company's 6.81% Senior Notes due February 25, 2006, each dated the date hereof, in the respective forms, principal amounts, and with the registration numbers set forth on Annex 1 to the Note Purchase Agreement (collectively, the \"Notes\");\n(c) the documents executed and delivered by the Company in connection with the transactions contemplated by the Note Purchase Agreement;\n(d) the bylaws and minute books of the Company and a certified copy of the certificate of incorporation of the Company, as in effect on the date hereof;\n(e) a long-form good standing certificate from the state of incorporation of the Company, good standing certificates from the states of incorporation of each Subsidiary, and foreign good standing certificates for each of such corporations from each of the applicable states set forth on Annex 2 hereto;\n(f) letters to Hebb & Gitlin and certain other Persons from PaineWebber Incorporated, describing the manner of the offering of the Notes (the \"Offeree Letter\");\n(g) the opinion of Hebb & Gitlin, special counsel to the Purchasers, dated the date hereof; and\n(h) originals, or copies certified or otherwise identified to our satisfaction, of such other documents, records, instruments and certificates of public officials as we have deemed necessary or appropriate to enable us to render this opinion.\nIn rendering our opinion, we have assumed\n(i) that all signatures (other than signatures of officers of the Company) are genuine,\n(ii) that all documents submitted to us as originals are genuine,\n(iii)that all copies submitted to us conform to the originals,\n(iv) that all natural Persons have legal capacity, and\n(v) as to documents executed by or on behalf of Persons other than the Company,\n(A) that each such Person executing documents had the power to enter into and perform its obligations under such documents, and\n(B) that such documents have been duly authorized, executed and delivered by, and are binding upon and enforceable against, such Persons.\nIn rendering our opinion, we have relied, to the extent we deem necessary and proper, on (I) warranties and representations as to certain factual matters contained in the Note Purchase Agreement, and (II) the Offeree Letter. We have no actual knowledge of any material inaccuracies in any of the facts contained in the documents listed in the foregoing items (I) and (II).\nOur opinion is based upon the laws of the State of New York and United States federal law.\nBased on the foregoing, we are of the following opinions:\n1. Each of the Company and the Subsidiaries is a corporation duly incorporated, validly existing and in good standing under the laws of its state of incorporation and has all requisite corporate power and authority to carry on its business and own its property.\n2. Each of the Company and the Subsidiaries is duly qualified 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, except where the failure to so qualify and be in good standing would not have a material adverse effect on the ability of the Company to perform its obligations under the Note Purchase Agreement and the Notes.\n3. All consents, approvals and authorizations of, and all designations, declarations, filings, registrations, qualifications, or recordations with, governmental authorities required on the part of each of the Company and the Subsidiaries have been obtained in connection with the ownership of its properties and the conduct of its businesses, except where the failure to obtain any such consent, approval or authorization with respect to such ownership and conduct would not have a material adverse effect on the ability of the Company to perform its obligations under the Note Purchase Agreement and the Notes.\nExhibit B1-2\n4. There is no default or existing condition which with the passage of time or notice, or both, would result in a default by the Company or any Subsidiary under any contract, lease or commitment known to us to which any one or more of the Company or any Subsidiary is a party or by which their respective properties may be bound, except where such default would not have a material adverse effect on the ability of the Company to perform its obligations set forth in the Note Purchase Agreement and the Notes.\n5. There is no judgment, order, action, suit, proceeding, inquiry, order or investigation, at law or in equity, before any court or governmental authority, arbitration board or tribunal, pending or threatened against the Company or any one or more of the Subsidiaries, except for any such judgment, order, action, suit, proceeding, inquiry, order or investigation that would not have a material adverse effect on the ability of the Company to perform its obligations under the Note Purchase Agreement and the Notes.\n6. The Company has the requisite corporate power and authority to execute and deliver the Note Purchase Agreement, to issue and sell the Notes, and to perform its obligations set forth in each of the Note Purchase Agreement and the Notes.\n7. Each of the Note Purchase Agreement and the Notes has been duly authorized by all necessary corporate action on the part of the Company (no action on the part of the stockholders of the Company being required in respect thereof), has been executed and delivered by duly authorized officers of the Company, and constitutes a legal, valid and binding obligation of the Company, enforceable against the Company in accordance with its terms.\n8. The execution and delivery of the Note Purchase Agreement and the Notes, and the issue and sale of the Notes, by the Company and the performance by the Company of its obligations thereunder will not conflict with, constitute a violation of, result in a breach of any provision of, constitute a default under, or result in the creation or imposition of any Lien or encumbrance upon any of its property or the property of a Subsidiary pursuant to the certificate of incorporation or bylaws of the Company or such Subsidiary, any applicable statute, rule or regulation to which the Company or any Subsidiary are subject, or to any agreement or instrument to which the Company or such Subsidiary is a party or by which its respective properties may be bound.\n9. All consents, approvals and authorizations of, and all designations, declarations, filings, registrations, qualifications and recordations with, governmental authorities required on the part of the Company have been obtained in connection with the execution and delivery of each of the Note Purchase Agreement and the Notes and the issue and sale of the Notes and the use of the proceeds thereof.\n10. The issuance, sale and delivery of the Notes is not subject to the registration requirements of the Securities Act of 1933, as amended, or the \"Blue Sky\" laws of the State of New York, and the Company is not required to qualify an indenture with respect thereto under the Trust Indenture Act of 1939, as amended.\nExhibit B1-3\n11. Neither the issuance of the Notes nor the intended use of the proceeds of the Notes (as set forth in Section 3.1(s) of the Note Purchase Agreement) will violate Regulations G, T, U or X of the Board of Governors of the Federal Reserve System.\n12. Neither the issuance and sale of the Notes, nor the performance of the Company of its obligations under the Note Purchase Agreement, is subject to regulation under the Investment Company Act of 1940 as amended, the Public Utility Holding Company Act of 1935 as amended, the Interstate Commerce Act as amended or the Federal Power Act as amended.\n13. The Company has good title to all of the shares it purports to own of the capital stock of each Subsidiary, free and clear in each case of any perfected security interest or any other Lien.\nAll opinions herein contained with respect to the enforceability of documents and instruments are qualified to the extent that:\n(a) the availability of equitable remedies, including without limitation, specific enforcement and injunctive relief, is subject to the discretion of the court before which any proceedings therefor may be brought; and\n(b) the enforceability of certain terms provided in the Note Purchase Agreement and the Notes may be limited by applicable bankruptcy, reorganization, arrangement, insolvency, moratorium, fraudulent conveyance or similar laws affecting the enforcement of creditors' rights generally as at the time in effect and common law or statutory requirements with respect to commercial reasonableness.\nWe acknowledge that this opinion is being issued at the request of the Company pursuant to Section 4.2 of the Note Purchase Agreement and we agree that the parties listed on Annex 1 hereto may rely and are relying hereon in connection with the consummation of the transactions contemplated by the Note Purchase Agreement. Hebb & Gitlin may rely on this opinion for the sole purpose of rendering their opinion to be rendered pursuant to Section 4.2 of the Note Purchase Agreement. Subsequent holders of the Notes may rely on this opinion as if it was addressed to them.\nVery truly yours,\nExhibit B1-4\nANNEX 1 Addressees\nMetropolitan Life Insurance Company One Madison Avenue New York, NY 10010\nConnecticut General Life Insurance Company on behalf of one or more separate accounts c\/o CIGNA Investments, Inc. Attention: Private Securities Division S-307 900 Cottage Grove Road Hartford, CT 06152-2307\nConnecticut General Life Insurance Company c\/o CIGNA Investments, Inc. Attention: Private Securities Division S-307 900 Cottage Grove Road Hartford, CT 06152-2307\nCIGNA Property and Casualty Insurance Company c\/o CIGNA Investments, Inc. Attention: Private Securities Division S-307 900 Cottage Grove Road Hartford, CT 06152-2307\nLife Insurance Company of North America c\/o CIGNA Investments, Inc. Attention: Private Securities Division S-307 900 Cottage Grove Road Hartford, CT 06152-2307\nThe Travelers Insurance Company One Tower Square Hartford, CT 06183-2030\nAmerican United Life Insurance Company Law Department Post Office Box 368 Indianapolis, IN 46206\nExhibit B1-5\nANNEX 2 Foreign Good Standing Certificates\nCorporation State\n(To be provided by Company)\nExhibit B1-6 EXHIBIT C\nSTANDARD MOTOR PRODUCTS, INC. CERTIFICATE OF OFFICERS\nWe, ______ and ______, each hereby certify that we are, respectively, the ______, and the ______ of STANDARD MOTOR PRODUCTS, INC., a New York corporation (the \"Company\"), and that, as such, we have access to its corporate records and are familiar wi the matters herein certified, and we are authorized to execute and deliver this Certificat name and on behalf of the Company, and that:\n1. This certificate is being delivered pursuant to Section 4.1 and Section 4.3 of the Company's separate Note Purchase Agreements (collectively, the \"Note Purchase Agreement\"), each dated as of December 1, 1995 with each of the purchasers listed on Annex 1 thereto (collectively, the \"Purchasers\"). The terms used in this Certificate and not defined here the respective meanings specified in the Note Purchase Agreement.\n2. The warranties and representations contained in Section 3.1 of the Note Purchase Agreement are true in all material respects on the date hereof with the same effect as tho made on and as of the date hereof.\n3. The Company has performed and complied with all agreements and conditions contained in the Note Purchase Agreement that are required to be performed or complied with by the Company before or at the date hereof.\n4. No event has occurred and no condition exists which, on the date hereof, would constitute a Default or an Event of Default under the Note Purchase Agreement.\n5. ______, from ______ __, 199_ [date of resolutions to sell Notes] to the date hereof, inclusive, has been and is the duly elected, qualified and acting Secretary of the Company, and the signature appearing on the Certificate of Secretary dated the date hereof delivered to the Purchasers contemporaneously herewith is his genuine signature.\nExhibit C-1\nIN WITNESS WHEREOF, we have executed this Certificate in the name and on behalf of the Company on [Closing Date].\nSTANDARD MOTOR PRODUCTS, INC.\nBy: Name:\nBy: Name:\nExhibit C-2 EXHIBIT D\nSTANDARD MOTOR PRODUCTS, INC. CERTIFICATE OF SECRETARY\nI, ______, hereby certify that I am the duly elected, qualified and acting Secretary of STANDARD MOTOR PRODUCTS, INC., a New York corporation (the \"Company\"), and that, as such, I have access to its corporate records and am familiar with the matters herein certified, and I am authorized to execute and deliver this Certificate in the name and on behalf of the Company, and that:\n1. This certificate is being delivered pursuant to the Company's separate Note Purchase Agreements (collectively, the \"Note Purchase Agreement\"), each dated as of December 1, 1995 with each of the purchasers listed on Annex 1 thereto (collectively, the \"Purchasers\"). The terms used in this Certificate and not defined herein have the respective meanings specified in the Note Purchase Agreement.\n2. Attached hereto as Attachment A is a true and correct copy of resolutions, and the preamble thereto, adopted by the Board of Directors of the Company on ______ __, 1995, and such resolutions and preamble set forth in Attachment A hereto were duly adopted by said Board of Directors and are in full force and effect on and as of the date hereof, not having been amended, altered or repealed, and such resolutions are filed with the records of the Board of Directors.\n3. The documents listed below were executed and delivered by the Company pursuant to and in accordance with the resolutions set forth in Attachment A hereto and said documents as executed are substantially in the form submitted to and approved by the Board of Directors of the Company as aforementioned:\n(a) the Company's Note Purchase Agreement providing for the sale by the Company and the purchase by the Purchasers of the Company's 6.81% Senior Notes due February 25, 2006 (collectively, the \"Notes\"); and\n(b) the Notes.\n4. Attached hereto as Attachment B is a true, correct and complete copy of the bylaws of the Company as in full force and effect on and as of the date hereof, which bylaws were last amended by the Board of Directors of the Company on, and have been in full effect in said form at all times from ______ __, 1995 [date of resolution to sell notes] to the date hereof, inclusive, without modification or amendment in any respect.\n5. Each of the following named persons is and has been a duly elected, qualified and acting officer of the Company holding the office or offices set forth below opposite his or her name from ______ __, 1995 [date of resolution to sell notes] to the date hereof, inclusive:\n[List Only Officers Executing Documents]\nName Office [Chairman of the Board] \/s\/ [President] \/s\/ [Vice President, Finance] \/s\/ [Secretary] \/s\/ [Assistant Secretary] \/s\/ [Treasurer] \/s\/ [Comptroller] \/s\/\n6. The signature appearing opposite the name of each such person set forth above is his or her genuine signature.\n7. Attached hereto as Attachment C is a long-form good standing certificate in respect of the Company from the State of New York which certificate\n(a) lists all corporate documents filed with the Secretary of State of New York on or prior to the date hereof in respect of the Company,\n(b) has attached copies of such documents,\n(c) bears the certification of the Secretary of State of New York and\n(d) is true, correct and complete.\n8. There have been no amendments or supplements to or restatements of the Certificate of Incorporation of the Company since ______ __, 1995 [date preceding date of copy certified by Sec. of State].\nIN WITNESS WHEREOF, I have hereunto set my hand on [Closing Date].\nSTANDARD MOTOR PRODUCTS, INC.\n----------------------------- Secretary\nExhibit D-2\nAttachment A\nBOARD OF DIRECTORS STANDARD MOTOR PRODUCTS, INC. RESOLUTIONS ADOPTED\nWHEREAS, there has been submitted to this Board a draft of the form of Note Purchase Agreement (together with all exhibits and schedules thereto, the \"Note Purchase Agreement\"), to be entered into separately by the Company and each of the purchasers listed on Annex 1 thereto (together with any affiliate of any thereof, the \"Purchasers\") pursuant to which the Purchasers will purchase from the Company the aggregate principal amount of $73,000,000 of the Company's 6.81% Senior Notes due February 25, 2006 (collectively, the \"Notes\");\nWHEREAS, this Board has reviewed in detail and discussed the terms and provisions of the Note Purchase Agreement, including the forms of the Notes specified therein; and\nWHEREAS, on the basis of its review of the Note Purchase Agreement and of the principal terms and provisions of the transactions provided for therein, this Board deems it advisable and in the best interest of the Company that the transactions provided in the Note Purchase Agreement be consummated substantially in accordance with the provisions of the Note Purchase Agreement; and\nWHEREAS, terms used in these preambles and resolutions and not herein defined shall have the respective meanings ascribed to them in the Note Purchase Agreement;\nNOW THEREFORE, BE IT RESOLVED, that the form of, and each of the terms and provisions contained in, the Note Purchase Agreement, are hereby authorized and approved in each and every respect; and each and every transaction effected or to be effected pursuant to and substantially in accordance with the terms of the Note Purchase Agreement, including, but not limited to, each specific transaction that is described, authorized and approved in these resolutions, is hereby authorized and approved in each and every respect;\nRESOLVED, that the Company enter into a Note Purchase Agreement with each of the Purchasers or any affiliate thereof; and that each of the Chairman of the Board, the President, any Vice President, the Treasurer and each other officer of the Company (each an \"Authorized Officer\") is hereby severally authorized to execute and deliver, in the name and on behalf of the Company, the Note Purchase Agreement, each substantially in the form thereof presented to this Board and heretofore approved, with such changes therein as shall be approved by the officer executing and delivering the same, such approval to be evidenced conclusively by such execution and delivery; and\nRESOLVED, that the Company borrow from the Purchasers an aggregate amount of funds as provided in the Note Purchase Agreement, such indebtedness to be evidenced by the Notes, in the amounts and upon the terms and conditions provided for in the Note Purchase Agreement; and that each of the Authorized Officers is hereby severally authorized to execute and deliver the Notes, in the name and on behalf of the Company, substantially in the respective forms thereof presented to this Board and heretofore approved, with such changes therein as shall be approved by the officer or officers executing and delivering the same, such approval to be evidenced conclusively by such execution and delivery; and\nExhibit D-3\nRESOLVED, that this Board hereby authorizes each of the Authorized Officers, severally, to execute and deliver for and on behalf of the Company the certificates required by the Note Purchase Agreement; and\nRESOLVED, that the Authorized Officers and any person or persons designated and authorized so to act by any Authorized Officer are hereby each severally authorized to do and perform or cause to be done and performed, in the name and on behalf of the Company, all other acts, to pay or cause to be paid, on behalf of the Company, all related costs and expenses and to execute and deliver or cause to be executed and delivered such other notices, requests, demands, directions, consents, approvals, orders, applications, agreements, instruments, certificates, undertakings, supplements, amendments, further assurances or other communications of any kind, under the corporate seal of the Company or otherwise and in the name of and on behalf of the Company or otherwise, as he, she or they may deem necessary, advisable or appropriate to effect the intent of the foregoing Resolutions or to comply with the requirements of the instruments approved and authorized by the foregoing Resolutions, including but not limited to the Note Purchase Agreement and the Notes; and\nRESOLVED, that any acts of any Authorized Officer of the Company and of any person or persons designated and authorized to act by any Authorized Officer of the Company, which acts would have been authorized by the foregoing Resolutions except that such acts were taken prior to the adoption of such Resolutions, are hereby severally ratified, confirmed, approved and adopted as the acts of the Company; and\nRESOLVED, that each of the Secretary and each Assistant Secretary of the Company is hereby severally authorized and empowered to certify to the passage of the foregoing Resolutions under the seal of this Company or otherwise.\nExhibit D-4\nAttachment B\nBylaws of the Company\n[TO BE SUPPLIED BY COMPANY]\nExhibit D-5\nAttachment C\nLong Form Good Standing Certificate of the Company\n[TO BE SUPPLIED BY COMPANY]\nExhibit D-6","section_15":""}
{"filename":"74818_1995.txt","cik":"74818","year":"1995","section_1":"Item 1. BUSINESS\nOrbit International Corp. (the \"Company\" or \"Orbit\") operates through three business segments: Electronics, United States Apparel and Canadian Apparel. Through its Orbit Instrument Division and through a wholly-owned subsidiary, Orbit Instrument of California, Inc. (\"Orbit California\"), the Company is engaged in the design, manufacture and sale of customized electronic components. The Company is engaged in the import and manufacture of men's and women's garments in the United States through an operating division known as the East\/West Division (\"East\/West\"). Through its three wholly-owned subsidiaries in Canada, Canada Classique Inc. (\"Classique\"), Winnipeg Leather (1991) Inc. (\"Winnipeg Leather\") and Symax Garment Co. (1993) Ltd. (\"Symax\"), the Company operates its Canadian Apparel Division.\nThe Company's Electronics segment is involved in the manufacture of customized electronics components and subsystems for military and non-military government application.\nIn February 1996, Cabot Court, Inc. (\"Cabot Court\"), a Delaware corporation and wholly-owned subsidiary of the Company, completed the acquisition of certain of the assets, subject to certain liabilities, of Astrosystems, Inc. a Delaware corporation (\"Astrosystems\"), and Behlman Electronics, Inc. (\"Behlman Electronics\"), a New York corporation. Each of Astrosystems and Behlman Electronics manufacture and sell power supplies, AC power sources, frequency converters, UPS and associated analytical equipment and other electronic equipment. The acquisition of each of Astrosystems and Behlman Electronics were partially financed pursuant to a bridge loan from BNY Financial Corporation (\"BNY\"), which loan was secured by a second mortgage on the Company's corporate facility at 80 Cabot Court, Hauppauge, New York. It is anticipated that such bridge loan will be replaced by a term loan and revolving credit facility with BNY, which has not been finalized. However, there is no assurance that such permanent financing will be successfully negotiated. Concurrently with the purchase of Astrosystems and Behlman Electronics, Cabot Court changed its name to Behlman Electronics, Inc.\nEast\/West designs, imports and sells women's active-wear and outer-wear, principally under the East\/West label. East\/West is based in New York City and commenced operations in July 1993 following its acquisition of the operating assets of The Panda Group, Inc. (\"Panda\"). In December 1995, the operations of East End Apparel Group, Ltd. (\"East End\") were merged into East\/West. East End manufacturers and sells women's outer-wear and sportswear principally under the Campton Place label. East End is based in New York City and commenced operations in June 1994.\nClassique manufactures branded and private label men's, women's and children's outer-wear. Classique is based in Winnipeg, Manitoba, Canada, and commenced operations in December 1990 following its acquisition of the operating assets of Rice Sportswear Ltd.\nWinnipeg Leather manufactures and sells women's garments under private labels including Daniel Marcus. Winnipeg Leather is based in Winnipeg, Manitoba, Canada and commenced operations in May 1991 following its acquisition of the operating assets of the Winnipeg Leather division of the Sterling-Stall Group.\nSymax manufactures and sells private label men's outer-wear. Symax, based in Vancouver, British Columbia, Canada, commenced operations in February 1993 following its acquisition of the operating assets of Symax Garment Co. (1989) Ltd.\nIn January 1995, the Company discontinued the manufacture and sale of women's sportswear previously conducted through its wholly-owned subsidiary, Ax Elle Fashions, Inc.\nIn May 1994, USA Classic, Inc. (\"USA Classic\"), an approximately 43% owned subsidiary of the Company, filed a petition under Chapter 11 of the United States Bankruptcy Code.\nThe following sets forth certain selected historical financial information relating to the Company's business segments:\nAdditional financial information relating to the industry segments in which Orbit conducts business is set forth in Footnote M to the consolidated financial statements appearing elsewhere in this report.\nThis Report contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended. Actual results could differ materially from those projected in the forward-looking statements as a result of certain risk factors set forth in this Report.\nELECTRONICS SEGMENT\nORBIT INSTRUMENT DIVISION\nGeneral\nThe Orbit Instrument Division designs, manufactures and sells customized electronic components and subsystems for military, and to a lesser extent, non-military, governmental applications. Products include positional devices (ball trackers, force transducers and joysticks), data entry and display systems (computer controlled action entry panels, rear projection readout panels and manual entry displays), customized keyboards, plasma units and other specialized electronic systems. The Division also sells, on a repeat order basis, previously designed equipment, such as magnetic clutches, gearheads, indicators and differentials for console applications.\nThe Division's products, which in most instances are designed to customer specifications on a firm order basis, are utilized in surveillance aircraft, missiles, torpedoes, nuclear subsystems, naval vessels, guidance control and ground console radar equipment. A substantial portion of the Division's net sales during the Company's fiscal years ended December 31, 1995 and December 31, 1994 were attributable to one customer in the Company's capacity as a defense subcontractor for the United States Government. See \"Substantial Customers\" below.\nThe Division purchases its raw materials and parts in the open market primarily from a variety of local manufacturers, dealers or suppliers.\nProducts\nPositional Devices\nThe Division designs and manufactures ball trackers, joysticks and force transducers which are incorporated into radar and sonar display systems. These devices enable an operator to move a cursor across a screen for tracking missiles, ships, aircraft and other moving targets.\nData Entry, Keyboards and Display Systems\nThe Division manufactures a computer-controlled, action entry panel (\"CCAEP\") which provides a console operator with multiple displays of computer-generated data. The Segment's other data entry and display systems, digital data and manual entry units and panels are used in readout and switch panels located in fire control, sonar control and command communication consoles.\nThe Division also manufactures a family of keyboards designed to military specifications and has added to this product group, keyboards which include backlit and multi-function panels. These new keyboards have been sold for use in ships and aircraft.\nThe Division has designed, and is selling, a low-power, light-weight, minimum-depth display unit providing output similar to cathode ray tube displays by utilizing AC plasma technology, a flat panel display technology. This technology eliminates bulk and space requirement of cathode ray tube displays, and offers improved visual resolution and lower power requirements at environmental extremes. The Division is currently under contract to incorporate the plasma display panels in display consoles for Aegis class ships.\nPositional Readout Devices\nNuclear rod position indicators manufactured by the Division control and measure the depth of rods going into the core of a nuclear reactor energy source. The Division's rear projection readout devices provide operators with multiple sources of film stored display information capable of storing up to 48 messages per unit.\nGraphic Display Terminals\nThe Division's family of graphic display terminals enables the operator to monitor and control a ship's radar and sonar systems and subsystems through the ship's central computer. The terminals are used throughout a ship as adjuncts to larger display consoles. The modular design of these terminals facilitates applications on all size surface ships, submarines and aircraft.\nOperator Control Trays\nThe variety of operator control trays engineered and manufactured by the Division help organize and present an influx of data created by interactive communications systems, making such data more manageable for operator consumption. The tray can be used for patrol and surveillance aircraft, standard shipboard display consoles, shore or mobile-based defense equipment and subsurface sonar displays. The Division's control trays are currently used in both naval service and operator simulators.\nPlasma Flat Panel Technology\nThe Division has designed an intermediate sized display using AC gas discharge plasma technology. This touch sensitive unit allows interactive capability for communication between the operator and the host computer. Applications for this unit include weapons control, ships status, target recognition, air traffic control plus information exchange panels used in conjunction with image processing.\nProposed Products\nSubstantially all of the Division's efforts in the development of new products consist of design and engineering services associated with, and necessary for, the manufacture of new products. The Division generally begins development efforts after its customers have indicated that the proposed new products or improvements are desirable. The following is presently being developed by the Division; however, there can be no assurance that the Division's development efforts will result in any marketable products. The Division does not yet have any firm orders for products described below and there can be no assurance that any sales will be made.\nThe Division is expanding its design and development of AC plasma display panels to include bit mapping and graphics technologies. These next generation panels are intended to be used in aircraft and naval applications. The graphics version of the AC plasma display panel was completed in mid 1995 and the Division received contracts for these units on two separate programs. The Division has also been contracted to deliver a more advanced version of its panel with embedded intercommunication capability.\nThe Division has designed and developed a flat panel technology based communication panel. The Company has received prototype orders for these units for the LHA ship class.\nA flat panel development has been commenced for interactive color liquid crystal and Electroluminescent displays.\nCompetition\nThe Division's competitive position in the electronics industry is, in Management's view, predicated upon the Company's manufacturing techniques, its ability to design and manufacture products which will meet the specific needs of its customers and its long-standing successful relationship with its major customer. There are numerous concerns (many of which are substantially larger than the Company) capable of producing substantially all of the Company's products. However, to the Company's knowledge, none of such competitors produce all of the products that the Division produces.\nSales to one customer, General Motors Hughes Electronics Corporation, accounted for approximately 54% and 66% of the sales of the Division for the fiscal years ended December 31, 1995 and December 31, 1994, respectively. The loss of such customer would have a materially adverse effect on the Division's sales and earnings.\nBEHLMAN ELECTRONICS, INC.\nIn February 1996, the Company, through its wholly-owned subsidiary, Cabot Court, completed the acquisition of certain of the assets, subject to certain liabilities, of Astrosystems and Behlman Electronics. Concurrently with the purchase, Cabot Court changed its name to Behlman Electronics, Inc. (\"Behlman\").\nGeneral\nThe military division of Behlman designs and manufactures power conversion devices and electronic products for measurement and display. The commercial products division produces high quality, distortion free commercial power units and low noise uninterruptable power supplies (UPS).\nSales and Marketing\nProducts of the military division are marketed by Behlman's program managers and other management personnel. Commercial products are sold by Behlman's regional sales managers, manufacturer's representatives and non-exclusive distributors.\nCompetition\nCompetition in these fields depends on such factors as price, product reliability and performance, engineering and production. In particular, due primarily to budgetary restraints and program cutbacks, competition in the Company's government markets has been increasingly severe and price has become the major overriding factor in contract and subcontract awards. To the best of the Company's knowledge, some of its regular competitors are much larger companies with substantially greater capital resources and far larger engineering, administrative, sales and production staffs.\nUS APPAREL SEGMENT\nEAST\/WEST\nGeneral\nIn July 1993 Orbit acquired substantially all of the assets of Panda, a designer, importer and seller of women's active-wear and outer-wear. Orbit operates Panda as a separate division called the East\/West Division. In December 1995, the Company merged the operations of East End into the East\/West Division.\nProducts\nEast\/West designs, imports and sells women's jogging suits and outer-wear under the private label East-West as well as women's sportswear and outer-wear under the Campton Place label. The product collections of East\/West are designed and marketed to focus on quality and value to the consumer. A majority of the Division's products are sold at moderate price points. After the Fall 1995 season, East\/West discontinued marketing men's outer- wear.\nSales and Marketing\nEast\/West markets its various active-wear and outer-wear lines to major department stores and specialty stores throughout the United States and Canada through its direct sales force. Sales of East\/West accounted for approximately 73% of the total net sales of the United States Apparel Segment during the fiscal year ended December 31, 1995.\nUnder the Campton Place label, East\/West sells and distributes its products to retailers throughout the United States and Canada. These collections retail between $59 and $99. East\/West also aggressively promotes private label product development with major chains using its branded line fashion concepts to enhance and enrich store interest for their gross margin advantages. Sales of East End accounted for approximately 26% of the total net sales of the United States Apparel Segment during the fiscal year ended December 31, 1995.\nImporting\nEast\/West imports all of its garments from a large number of independent contract manufacturers located in several countries in the Far East. The Division utilizes four agents in the Far East to place orders with independent contractors and to monitor production. The Division also has placed some production and imported from the Caribbean basin.\nCompetition\nThe apparel industry is highly competitive. The competitors of East\/West include many apparel manufacturers which have greater financial and manufacturing resources than the Division. East\/West believes it can compete successfully in the market place by delivering a product of good quality at an affordable price to the consumer.\nCANADIAN APPAREL SEGMENT\nCLASSIQUE\nGeneral\nIn December 1990, Classique acquired the operating assets, subject to certain liabilities, of Rice Sportswear Ltd. (\"Rice\"), a manufacturer of branded and private label men's and women's outer-wear located in Winnipeg, Manitoba, Canada. Classique is continuing the operations of Rice under the Rice Sportswear name.\nProducts\nRice's products and collections, sold under both proprietary and private labels, are generally designed and marketed for sale at moderate and higher price points through retailers throughout Canada.\nThrough its various domestic and import facilities, it markets and distributes outer-wear collections under the following proprietary labels: Mountaineer, men's and women's winter outer- wear; Hemingway, cloth and leather outer-wear; and Micro Tex, activewear fabric. These lines are an essential part of the Canadian retailing business, bringing value and fashion into an affordable collection with names that are associated with quality and style in over 750 customer accounts in Canada. Rice utilizes various fabrications, colors and insulations to produce specialized products that are identifiable to both retailers and consumers in specific markets.\nRice is seeking to broaden its customer base and enhance its market share by diversifying its product offerings. In particular, Rice is expanding its offerings of more casual products, and less constructed garments, based on its recognition of changing consumer preferences towards such products. Rice also sells boys' and girls' outer-wear.\nDuring 1993, Rice formed a division called Apparel Image Marketing (\"AIM\") which manufactures and sells men's and women's outer-wear utilizing the corporate logo of its customers. During the fiscal year ended December 31, 1995, sales for the AIM division accounted for approximately 31% of the total net sales of the Canadian Apparel Segment.\nSales and Marketing\nRice markets its various mens' and ladies' cloth and leather outer-wear to major department store chains and specialty apparel retail stores throughout Canada through its direct sales force of 8 sales people and through 24 independent sales representatives. Sales of Rice accounted for approximately 68% of the total net sales of the Canadian Apparel Segment during the fiscal year ended December 31, 1995.\nManufacturing\nRice has one domestic manufacturing facility producing in excess of 170,000 units of product annually. These facilities are fully vertical in the manufacturing and assembly process. The facilities cut, sew and completely finish various products.\nRice also imports products from many independent contract manufacturers located in the Far East and Europe. It furnishes its foreign contractors with design and manufacturing specifications for the products it imports. Rice's use of foreign sources varies from season to season based upon cost, quality and other factors determined by Rice's product requirements. Rice believes that having a domestic as well as a foreign basis for its manufacturing allows it to effectively combine price, performance and quality.\nCompetition\nThe apparel industry, in general, and the active-wear segment, in particular, are intensively competitive. The market is composed of both large manufacturers and small independent Companies. Many of the large manufacturers have substantially greater resources than the Company. The Company believes that competition is based upon design, price and customer support.\nWINNIPEG LEATHER\nGeneral\nIn May 1991, the Company, through a wholly-owned subsidiary, acquired the operating assets of the Winnipeg Leather division of the Sterling-Stall Group.\nProducts\nWinnipeg Leather manufactures, sells and markets women's leather, suede and cloth garments under private labels, including Daniel Marcus. Winnipeg Leather's products are sold to major department store chains and specialty apparel retail stores throughout Canada and to several major department stores in the United States.\nSales and Marketing\nSales of Winnipeg Leather accounted for approximately 25% of the total net sales of the Canadian Apparel Segment during the fiscal year ended December 31, 1995. Winnipeg Leather will be broadening its importance as a major resource for outer-wear by taking on the design, manufacturing and marketing aspects of Rice's ladies cloth business.\nWinnipeg Leather has over 200 Customer accounts. A large portion of the business is done by private label developmental programs with regular as well as specialty size chain stores.\nApproximately one-third of Winnipeg Leather's sales are through sportswear items. It manufactures a complete line of sportswear that coordinates with the outer-wear portion of the business.\nSYMAX\nGeneral\nIn February 1993, the Company, through a wholly-owned subsidiary, acquired the operating assets of Symax Garment Co. (1989) Ltd.\nProducts\nSymax manufactures, sells and markets men's outer-wear under private labels. It is a leading manufacturer in British Columbia of uniform jackets, serving some 40 public bodies as well as private clubs, associations and numerous retailers.\nSales\nApproximately 32% of Symax's sales are for uniform jackets delivered to government agencies while the remainder of its sales are made to retailers. Sales for Symax accounted for approximately 7% of the total net sales of the Canadian Apparel Segment during the fiscal year ended December 31, 1995.\nUSA CLASSIC\nIn July 1988 Orbit, through a wholly-owned subsidiary USA Classic, acquired all of the outstanding stock of U.S. Apparel, Inc. In November 1992, USA Classic completed an initial public offering (the \"Offering\") of 3,105,000 shares of its common stock, thereby reducing Orbit's ownership to approximately 43%. USA Classic designed, manufactured and marketed men's, women's and children's active-wear, sportswear and outer-wear until it, and its subsidiaries, filed petitions under Chapter 11 of the United States Bankruptcy Code in 1994. The Company recorded a non cash charge related to such bankruptcy of $13,987,000, which includes its 43% equity interest in USA Classic, subordinated debt owing by USA Classic to the Company of approximately $2,400,000 and approximately $2,500,000 of related costs.\nCERTAIN INFORMATION RELATING TO THE COMPANY\nSubstantial Customers\nGeneral Motors Hughes Electronics Corporation (\"GMHEC\"), Fullerton, California accounted for approximately 11% of the Company's consolidated net sales during its fiscal year ended December 31, 1995. GMHEC, Northrup Grumman and various agencies of the United States government accounted for approximately 54%, 16% and 13% respectively, of net sales of the Electronics Segment for the fiscal year ended December 31, 1995. The loss of GMHEC as a customer would have a materially adverse effect on the Electronic Segment's sales and earnings. In the fiscal year ended December 31, 1995, Sears Canada and Polaris Industries (U.S. and Canada) accounted for approximately 18% and 16% of net sales of the Canadian Apparel Segment. The loss of Sears Canada and Polaris Industries would have a materially adverse effect on the Canadian Apparel Segment.\nSince substantially all of the products which the Electronics Segment manufactures are used in military applications, any substantial reduction in overall military spending by the United States Government could have a materially adverse effect on the Company's sales and earnings.\nBacklog\nAs of December 31, 1995 and December 31, 1994 the Company's consolidated backlog was as follows:\nDecember 31, 1995 December 31, 1994 Electronic* $13,000,000 $18,000,000 Apparel-U.S. Operations 2,000,000 3,000,000 Apparel-Canadian Operations 1,000,000 1,000,000\nTotal $16,000,000 $22,000,000\n* Does not include backlog of Behlman acquired in February 1996.\nA majority of the business of the United States and Canadian Apparel Segments is associated with the sale of outer-wear. The first and second quarters are historically weak periods since its customers do not generally request shipment of merchandise at that time. Consequently, the backlog of these Segments at December 31, 1995 reflect the impending weak selling periods for 1996.\nThe United States Apparel Segment reflects the backlog of East\/West and East End at December 31, 1995 and at December 31, 1994.\nOf the Electronics Segment backlog during the fiscal year ended December 31, 1995, approximately $5,000,000 represents backlog under contracts which will not be shipped during the 1996 fiscal year.\nAdditionally, substantially all of the Electronics Segment's contracts are subject to termination at the convenience of the United States Government.\nSpecial Features of Government Contracts\nOrders under government prime contracts or subcontracts are customarily subject to termination at the convenience of the government, in which event the contractor is normally entitled to reimbursement for allowable costs and for a reasonable allowance for profits, unless the termination of a contract was due to a default on the part of the contractor. No material terminations for the convenience of the government occurred during the fiscal year ended December 31, 1995.\nIn certain instances, the Electronics Segment ships products to its major customers prior to the issuance of final purchase orders. Therefore, certain of the prices may be subject to adjustment when the customer completes its review of all elements of the letter subcontract which is issued to the Company prior to the issuance of the purchase order. While these contracts are material to the Company's business, the Company does not believe that any material price adjustments will be made in these contracts. See Footnote J to the consolidated financial statements appearing elsewhere in this report.\nSubstantially all of the Electronics Segment's revenues are subject to audit under the Vinson-Trammel Act of 1934 and other federal statutes. The Company believes that adjustments to such revenues, if any, will not have a material effect on the Company's financial position.\nResearch and Development\nThe Electronics Segment incurred approximately $420,000 of research and development expenses during the fiscal year ended December 31, 1995, as compared with $381,000 of such expenses during the comparable period of the prior year. The Company did not incur any material research and development costs as defined in FASB Statement No. 2 (October 1974) during these two fiscal years.\nPatents\nThe Company does not own any patents which it believes are of material significance to its operations.\nEmployees\nAs of March 15, 1996, the Company employed 395 persons. Of these, the Apparel Segments employed 276 people, 11 in design functions, 15 in sales, 34 in administration and the balance in production. The Electronics Segment employed 119 people consisting of 23 in engineering and drafting, 8 in sales and marketing, 20 in direct and corporate administration and the balance in production.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nThe Company's plant and executive offices, located at 80 Cabot Court, Hauppauge, New York, consist of 60,000 square feet (of which approximately 50,000 square feet are utilized for manufacturing operations) in a two-story, sprinklered, brick building which was completed in October 1982 and expanded in 1985.\nBehlman is renegotiating a new lease for its premises in Ventura, California consisting of 1700 square feet. The new lease is expected to be for a term of one year at an annual rental of approximately $13,000.\nEast\/West leases approximately 15,000 square feet of showroom and office space at 500 7th Avenue in New York City at an annual rental of $233,605 under a lease which expires in January 2000. East\/West also leases 80,000 square feet of warehouse space at 2400 83rd Street in North Bergen, New Jersey, at an annual rent of $258,000 under a lease which expires January 2000.\nEast End leases approximately 5,000 square feet of showroom and office space at 500 7th Avenue in New York City at an annual rental of $77,625 under a lease which expires in January 2000. The Company is currently seeking a third party to sublet this showroom and office space.\nClassique leases 82,000 square feet of space at 1270 Notre Dame Avenue in Winnipeg, Manitoba, Canada at an annual rent of C$182,000. This lease, which commenced November 30, 1990, expires in November 2000. This space is used for distribution and warehousing, design, production and executive offices. Classique also leases 48,000 square feet at 181 Bannatyne Avenue in Winnipeg for warehousing and distribution.\nClassique has assigned the leases for 20,000 square feet of production space in Steinbach, Manitoba and 20,000 square feet of production space in St. Malo, Manitoba. The Company remains as a secondary guarantor on such leases, which expire in November 2000.\nWinnipeg Leather leases 22,000 square feet at 1270 Notre Dame Avenue in Winnipeg at an annual rental of C$66,000 under a lease which expires in November 2000. The space is used for distribution and warehousing, design, production and executive offices.\nSymax leases 3,500 square feet of office and showroom space at 1654 Franklin Street in Vancouver, British Columbia, Canada at an annual rent of C$65,000 under a lease which expires in January 1997 with no renewal options.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nThere are no material pending legal proceedings against the Company, other than routine litigation incidental to the Company's business, except as described below.\nIn re USA Classic Securities Litigation: In September 1993, a class action (the \"Class Action\") was commenced by an alleged shareholder of USA Classic, against USA Classic and certain of its directors in the United States District Court for the Southern District of New York. The action was commenced on behalf of shareholders, other than the defendants, who acquired their shares from November 20, 1992, the date of the initial Offering, through September 22, 1993, and alleges violations of the Securities Act of 1933 in connection with the Offering as well as violations of Section 1Ob of the Securities Exchange Act of 1934. The plaintiffs are seeking compensatory damages as well as fees and expenses.\nIn February 1994, a First Amended and Consolidated Complaint was filed in the Class Action. The First Amended and Consolidated Complaint added the Company as a defendant and alleged that the Company is a \"controlling person\" of USA Classic and an \"aider and abetter\" of the alleged violations of the securities laws. The Company answered the First Amended and Consolidated Complaint in March 1994. The Class Action has been stayed as against USA Classic as a result of USA Classic's filing of a petition for reorganization under Chapter 11 of the United States Bankruptcy Code.\nIn October 1994, a Second Amended and Consolidated Complaint was filed in the Class Action. The Second Amended and Consolidated Complaint restated the allegations against the Company and added Paine Webber Incorporated and Ladenburg Thalmann & Co. Inc., the lead underwriters in the Offering, as additional defendants. On November 15, 1994, the Company and such underwriters moved to dismiss certain of the allegations in the Second Amended and Consolidated Complaint. While the dismissal motion, if granted, will not dispose of all the claims asserted in the Second Amended and Consolidated Complaint, the Company intends to vigorously defend against any remaining claims. In or about June 1995, the court denied the dismissal motion in its entirety.\nIn March 1995, the plaintiffs' representatives filed a motion for class certification. Since that date, the parties have been conducting depositions and reviewing documents relevant to the class certification issue. The defendants' response to the class certification motion has been adjourned without date pending completion of discovery into that issue. In February 1996, the underwriter defendants moved the court to stay all substantive discovery until the court rules upon the class certification motion. The Company joined in this motion. On March 7, 1996, the court denied the motion to stay substantive discovery. The next deposition is scheduled for April 17, 1996. It is estimated that discovery in this matter will continue throughout 1996. The Company plans to continue to vigorously defend this action.\nSandra Lakritz v. Orbit International Corp.: In July 1995, Sandra Lakritz, a former employee of East\/West commenced an action in Supreme Court, New York County, claiming employment discrimination based upon age and disability. In December 1995, the Company answered the complaint and denied the allegations set forth therein. Simultaneously with its answer, the Company served upon plaintiff's counsel numerous discovery requests. To date, plaintiff has only partially responded to the discovery requests. In February 1996, plaintiffs' counsel filed a request for a preliminary conference. The court has yet to schedule such a conference. The Company intends to vigorously defend this action.\nVenture Garments, Ltd. v. East End Apparel Group, Ltd. and Orbit International Corp.: In December 1995, Venture Garments, Ltd., a supplier of East End commenced an action in Supreme Court, New York County for goods had and received and related equitable relief against both East End and the Company. In February 1996, the Company answered the complaint, asserted counterclaims against Venture and impleaded East End's former president, Gary Jacobs. While the Company contests the allegations set forth in the complaint, in an effort to avoid litigation costs, the Company is engaging in negotiations to resolve the dispute with the plaintiff. Presently, the Company has agreed to adjourn Venture's time to reply to the counterclaim, to provide discovery and Jacobs' time to answer the third-party complaint sine die. Should the settlement negotiations prove to be unsuccessful, the Company intends to vigorously defend this action and prosecute its counterclaims and third-party claims.\nGary Jacobs v. East End Apparel Group, Ltd. and Orbit International Corp.: In December 1995, Gary Jacobs, former president of East End, commenced an action against the Company in connection with his termination. Jacobs' complaint alleges that he was wrongfully terminated in violation of his employment agreement with the Company. The complaint seeks damages in the amount of $2,000,000. In February 1996, the Company answered the complaint and asserted a counterclaim against Jacobs and his personal counsel, for breach of the contract, breach of fiduciary duty, tortious interference of the contract and other related relief seeking damages in the aggregate amount of $30,400,000. In February 1996, Jacob's counsel moved to dismiss the claims asserted against it and against one of its partners. That motion and Jacobs' time to reply to the counterclaims and provide discovery has been adjourned to April 4, 1996. It is possible that the settlement negotiations concerning the Venture v. East End litigation (see above) may resolve this action as well. Should such negotiations prove unsuccessful, the Company intends to vigorously defend Jacobs' claims and to vigorously prosecute the counterclaims set forth in this action.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS\nAn Annual Meeting of Stockholders of the Company was held on December 18, 1995. The holders of 5,886,093 shares of Common Stock of the Company were entitled to vote at the meeting, the holders of 5,524,550 shares of Common Stock, or approximately 93.9% of shares entitled to vote at the meeting, were represented by proxy and the holders of 1,000 shares of Common Stock were present in person. The following actions took place:\n1. The stockholders voted for the election of each of the following persons nominated to serve as a director of the Company until the next annual meeting and until his successor is elected and qualified: Dennis Sunshine by 4,640,270 votes for and 885,280 against, Bruce Reissman by 4,638,730 votes for and 886,820 against, Mitchell Binder by 4,632,730 votes for and 892,820 against, Nathan A. Greenberg by 4,632,330 votes for and 893,220 against, John Molloy by 4,638,530 votes for and 887,020 against and Stanley Morris by 4,638,517 votes for and 887,033 against.\n2. The stockholders approved a proposal to adopt the Company's 1995 Employee Stock Option Plan. The holders of 2,395,267 shares voted for the proposal, the holders of 1,340,129 voted against the proposal and the holders of 19,954 shares abstained from voting.\n3. The stockholders also approved a proposal to adopt the Company's 1995 Stock Option Plan for Non-Employee Directors. The holders of 2,701,153 shares voted for the proposal, the holders of 1,121,007 voted against the proposal and the holders of 41,758 shares abstained from voting.\n4. The stockholders also ratified the appointment of Richard A. Eisner & Company, LLP as the independent accounts for the Company for the year ending December 31, 1995. The holders of 5,316,114 shares voted for the proposal, the holders of 141,407 voted against the proposal and the holders of 68,029 shares abstained from voting.\n5. The stockholders rejected a proposal to amend the Company's Certificate of Incorporation to create a class of 1,000,000 shares of preferred stock which may be issued in one or more series and to authorize the Company's Board of Directors to determine the voting powers, designations, preferences and rights and the qualifications, limitations or restrictions thereof, of each such series. The holders of 2,175,078 shares voted for the proposal, the holders of 1,197,028 shares voted against the proposal and the holders of 35,471 shares abstained from voting.\n6. Finally, the stockholders rejected a stockholder proposal to require that the majority of Company's Board of Directors be non-family members and individuals who do not currently work or consult with the Company, have been employed by the Company or have consulted with the Company in the past. The holders of 1,223,516 shares voted for the proposal, the holders of 2,134,658 shares voted against the proposal and the holders of 49,340 shares abstained from voting.\nPART II\nItem 5.","section_5":"Item 5. MARKET FOR REGISTRANT'S CAPITAL STOCK AND RELATED SECURITY HOLDER MATTERS\nAs of March 25, 1996 the Company had 754 shareholders of record. The Company's stock is traded in the over-the-counter market (Nasdaq symbol ORBT) and is quoted in the Nasdaq Small Cap Market.\nThe quarterly closing prices for the period January 1, 1994 through December 31, 1995, as reported by Nasdaq, were as follows:\nCLOSE High Low 1994: First Quarter 5 3 7\/8 Second Quarter 4 1\/8 3 1\/2 Third Quarter 3 3\/8 2 7\/8 Fourth Quarter 3 3\/8 1 1\/2 1995:\nFirst Quarter 2 1\/2 1 5\/8 Second Quarter 2 1\/8 1 3\/8 Third Quarter 1 5\/8 1 3\/16 Fourth Quarter 1 9\/16 3\/4\nThe Company has not declared any dividends during the aforesaid period.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA\nItem 9.","section_7":"","section_7A":"","section_8":"","section_9":"Item 9. DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThe Company has not had any disagreements with its accountants on accounting or financial disclosure.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nIncorporated by reference to the Company's definitive proxy statement to be filed pursuant to regulation 14A promulgated under the Securities Exchange Act of 1934 in connection with the Company's 1996 Annual Meeting of Stockholders.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION\nIncorporated by reference to the Company's definitive proxy statement to be filed pursuant to regulation 14A promulgated under the Securities Exchange Act of 1934 in connection with the Company's 1996 Annual Meeting of Stockholders.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nIncorporated by reference to the Company's definitive proxy statement to be filed pursuant to regulation 14A promulgated under the Securities Exchange Act of 1934 in connection with the Company's 1996 Annual Meeting of Stockholders.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nIncorporated by reference to the Company's definitive proxy statement to be filed pursuant to regulation 14A promulgated under the Securities Exchange Act of 1934 in connection with the Company's 1996 Annual Meeting of Stockholders.\nPART IV\nItem 14.","section_14":"Item 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES, AND REPORTS ON FORM 8-K\n(a) The following documents are filed as part of this Annual Report on Form 10-K for the fiscal year ended December 31, 1995.\n1. Financial Statements and Schedules:\nThe index to the financial statements and schedules is incorporated by reference to the index to financial statements attached as an exhibit to this Annual Report on Form 10-K.\n2. Exhibits: Exhibit No. Description of Exhibit\n3 (a) Certification of Incorporation, as amended. Incorporated by reference to Exhibit 3(a) to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1991.\n3 (b) By-Laws, as amended. Incorporated by reference to Exhibit 3(b) to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1988.\n4(a) Orbit International Corp. 1995 Employee Stock Option Plan. Incorporated by reference to Annex B to the Company's definitive proxy statement dated November 17, 1995.\n4(b) Orbit International Corp. 1995 Stock Option Plan for Non-Employee Directors. Incorporated by reference to Annex C to the Company's definitive proxy statement dated November 17, 1995.\n10(a) Employment Agreement, dated July 1, 1992 between the Company and Mitchell Binder. Incorporated by reference to Exhibit 10(b) to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1992.\n10(b) Employment Agreement dated July 1, 1992 between the Company and Bruce Reissman. Incorporated by reference to Exhibit 10(c) to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1992.\n10(c) Employment Agreement dated July 1, 1992 between the Company and Dennis Sunshine. Incorporated by reference to Exhibit 10(d) to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1992.\n10(d) Form of Indemnification Agreement between the Company and each of its Directors. Incorporated by reference to Exhibit 10(e) to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1988.\n10(e) Asset Purchase Agreement, dated July 12, 1993, among the Panda Group, Inc., Kenneth Freedman, Frederick Meyers and Registrant. Incorporated by reference to Exhibit 1 to the Company's Current Report on Form 8-K dated July 12, 1993.\n10(f) Asset Purchase Agreement, dated as of January 11, 1996, by and among Astrosystems, Inc., and Behlman electronics, Inc., Orbit International Corp. and Cabot Court, Inc.. Incorporated by reference to the Company's Current Report on Form 8-K dated February 6, 1996.\n10(g) Form of Agreement among Kenneth Freedman, Frederick Meyers, The Panda Group, Inc. and Orbit International Corp. dated March 28, 1996; Form of Amended Promissory Note dated March 28, 1996; and Form of Warrant to Purchase 125,000 shares of Orbit International Corp. Common Stock.\n10(h) Form of Factoring Security and Loan Agreement, dated August 4, 1995 between BNY Financial Corporation - Canada, Canada Classique, Inc., Winnipeg Leather (1991), Inc. and Symax Garment Co. (1993) Ltd.\n21 Subsidiaries of Registrant.\n(b) Reports on Form 8-K:\nNo reports on Form 8-K have been filed during the last quarter of the period covered by this report.\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, thereunder duly authorized.\nORBIT INTERNATIONAL CORP.\nDated: March 29, 1996 By: \/s\/ Dennis Sunshine Dennis Sunshine, 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\/ Dennis Sunshine Dennis Sunshine President, Chief Executive Officer and Director March 29, 1996\n\/s\/ Mitchell Binder Mitchell Binder Vice President- Finance, Chief Financial Officer and Director March 29, 1996\n\/s\/ Bruce Reissman Bruce Reissman Executive Vice President, Chief Operating Officer and Director March 29, 1996\n\/s\/ Harlan Sylvan Harlan Sylvan Treasurer, Secretary and Controller March 29, 1996\n\/s\/ Nathan A. Greenberg Nathan A. Greenberg Director March 29, 1996\n\/s\/ John Molloy John Molloy Director March 29, 1996\n\/s\/ Stanley Morris Stanley Morris Director March 29, 1996\nEXHIBT INDEX\nExhibit No. Description of Exhibit\n3 (a) Certification of Incorporation, as amended. Incorporated by reference to Exhibit 3(a) to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1991.\n3 (b) By-Laws, as amended. Incorporated by reference to Exhibit 3(b) to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1988.\n4(a) Orbit International Corp. 1995 Employee Stock Option Plan. Incorporated by reference to Annex B to the Company's definitive proxy statement dated November 17, 1995.\n4(b) Orbit International Corp. 1995 Stock Option Plan for Non-Employee Directors. Incorporated by reference to Annex C to the Company's definitive proxy statement dated November 17, 1995.\n10(a) Employment Agreement, dated July 1, 1992 between the Company and Mitchell Binder. Incorporated by reference to Exhibit 10(b) to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1992.\n10(b) Employment Agreement dated July 1, 1992 between the Company and Bruce Reissman. Incorporated by reference to Exhibit 10(c) to the Company's Annual Report on Form 10- K for the fiscal year ended June 30, 1992.\n10(c) Employment Agreement dated July 1, 1992 between the Company and Dennis Sunshine. Incorporated by reference to Exhibit 10(d) to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1992.\n10(d) Form of Indemnification Agreement between the Company and each of its Directors. Incorporated by reference to Exhibit 10(e) to the Company's Annual Report on Form 10- K for the fiscal year ended June 30, 1988.\n10(e) Asset Purchase Agreement, dated July 12, 1993, among the Panda Group, Inc., Kenneth Freedman, Frederick Meyers and Registrant. Incorporated by reference to Exhibit 1 to the Company's Current Report on Form 8-K dated July 12, 1993.\n10(f) Asset Purchase Agreement, dated as of January 11, 1996, by and among Astrosystems, Inc., and Behlman electronics, Inc., Orbit International Corp. and Cabot Court, Inc.. Incorporated by reference to the Company's Current Report on Form 8-K dated February 6, 1996.\n10(g) Form of Agreement among Kenneth Freedman, Frederick Meyers, The Panda Group, Inc. and Orbit International Corp. dated March 28, 1996; Form of Amended Promissory Note dated March 28, 1996; and Form of Warrant to Purchase 125,000 shares of Orbit International Corp. Common Stock.\n10(h) Form of Factoring Security and Loan Agreement, dated August 4, 1995 between BNY Financial Corporation - Canada, Canada Classique, Inc., Winnipeg Leather (1991), Inc. and Symax Garment Co. (1993) Ltd.\n21 Subsidiaries of Registrant.","section_15":""}
{"filename":"805080_1995.txt","cik":"805080","year":"1995","section_1":"ITEM 1. BUSINESS\nREGISTRANT AND ITS SUBSIDIARIES\nWest Suburban Bancorp, Inc., an Illinois corporation (the \"Company\"), is a multi-bank holding company registered under the Bank Holding Company Act of 1956, as amended (the \"BHC Act\"), and a thrift holding company registered under the Home Owner's Loan Act, as amended (the \"HOLA\"). The Company's operating subsidiaries consist of: West Suburban Bank, Lombard, Illinois; West Suburban Bank of Downers Grove\/Lombard, Downers Grove, Illinois; West Suburban Bank of Darien, Darien, Illinois; West Suburban Bank of Carol Stream\/Stratford Square, Bloomingdale, Illinois; and West Suburban Bank of Aurora, F.S.B., Aurora, Illinois. West Suburban Bank, West Suburban Bank of Downers Grove\/Lombard, West Suburban Bank of Darien and West Suburban Bank of Carol Stream\/Stratford Square may be referred to collectively as the \"Bank Subsidiaries,\" West Suburban Bank of Aurora, F.S.B. may be referred to as \"WSB Aurora\" and the Bank Subsidiaries and WSB Aurora may be referred to collectively as the \"Subsidiaries.\"\nThe Company was incorporated in 1986 and became the parent bank holding company of the Bank Subsidiaries in 1988. On July 13, 1990, the Company acquired WSB Aurora, a federally-chartered thrift, thereby also becoming a thrift holding company.\nThe Subsidiaries are headquartered in the near western suburbs of Chicago among some of the faster growing areas in Illinois. Due to the nature of the market areas served by the Subsidiaries, the Subsidiaries provide a wide range of financial services to individuals and small and medium sized businesses. The western suburbs of Chicago have a diversified economy, with many new corporate headquarters and numerous small and medium sized industrial and non-industrial businesses providing employment.\nThe Subsidiaries engage in a general full service retail banking business and offer a broad variety of consumer and commercial products and services. The Subsidiaries also offer trust services, safe deposit boxes and extended banking hours, including Sunday hours and 24-hour banking through either a proprietary network of 36 automated teller machines (\"ATMs\") or Tele-Bank 24, a bank-by- phone system. Other consumer related services are available including financial services and a competitively priced VISA card through West Suburban Bank Card Services. During 1995, the Subsidiaries began to offer their customers a debit card called the West Suburban Bank Check Card. The West Suburban Bank Check Card allows customers to make purchases with funds from their checking accounts without writing checks.\nAlthough each Subsidiary operates under the direction of its own board of directors, the Company has standard operating policies regarding asset\/liability management, liquidity management, investment management, lending practices and deposit structure management. The Company has historically centralized certain operations where economies of scale can be achieved.\nThe following table sets forth financial and other information concerning the Subsidiaries as of December 31, 1995:\nSUBSIDIARIES OF WEST SUBURBAN BANCORP, INC. (1) (Dollars in thousands)\n- ----------------\n(1) The data presented in this table is not intended to present the Company's consolidated financial results for 1995. The Company's consolidated financial statements are provided in this Form 10-K in response to Item 14.\n(2) The number of locations reflected for the Bank Subsidiaries includes all facilities at which customers of any Bank Subsidiary can conduct their banking business, and includes a facility which consists solely of a proprietary stand-alone ATM facility.\nCOMPETITION\nThe Company encounters competition in all areas of its business pursuits. It competes for loans, deposits, fiduciary and other services with financial and other institutions located both within and outside of its market area. In order to compete effectively, to develop its market base, to maintain flexibility and to move in pace with changing economic and social conditions, the Company continuously refines and develops its products and services. The principal methods of competition in the financial services industry are price, service and convenience.\nEMPLOYEES\nThe Company employed 646 persons (505 full time equivalent employees) on December 31, 1995. The Company believes that its relations with its employees are good.\nSUPERVISION AND REGULATION\nGeneral\nThe growth and earnings performance of the Company can be affected not only by management decisions and general economic conditions, but also by the policies of various governmental regulatory authorities including, but not limited to, the Board of Governors of the Federal Reserve System (the \"FRB\"), the Federal Deposit Insurance Corporation (the \"FDIC\"), the Illinois Commissioner of Banks and Trust Companies (the \"Commissioner\"), the Office of Thrift Supervision (the \"OTS\"), the Internal Revenue Service, the Illinois Department of Revenue and the Securities and Exchange Commission (the \"SEC\"). Financial institutions and their holding companies are extensively regulated under federal and state law. The effect of such statutes, regulations and policies can be significant, and cannot be predicted with a high degree of certainty.\nFederal and state laws and regulations generally applicable to financial institutions, such as the Company, regulate the scope of business, investments, loans, deposit insurance, reserves against deposits, capital adequacy, the establishment of branches, mergers, consolidations, dividends and other aspects of their operations. The system of supervision and regulation applicable to the Company and the Subsidiaries establishes a comprehensive framework for the operations of the Company and the Subsidiaries and is intended primarily for the protection of the FDIC's deposit insurance funds and the depositors, rather than the shareholders, of financial institutions.\nThe following references to material statutes and regulations affecting the Company and the Subsidiaries are brief summaries thereof and do not purport to be complete, and are qualified in their entirety by reference to such statutes and regulations. Any change in applicable law or regulations may have a material effect on the business of the Company.\nRecent Regulatory Developments\nOn August 8, 1995, the FDIC amended its regulations to change the range of deposit insurance assessments charged to members of the Bank Insurance Fund (the \"BIF\"), such as the Bank Subsidiaries, from the then-prevailing range of .23% to .31% of deposits, to a range of .04% to .31% of deposits. Additionally, because the change in BIF-assessments was applied retroactively to June 1, 1995, BIF- member institutions, including the Bank Subsidiaries, received a refund of the difference between the amount of assessments previously paid at the higher assessment rates for the period from June 30, 1995, and the amount that would have been paid for that period at the new rates. In the case of the Bank Subsidiaries, this refund totaled $495,276. The FDIC did not, however, change the assessment rates charged to members of the Savings Association Insurance Fund (the \"SAIF\"), such as WSB Aurora, and SAIF-insured institutions continue to pay assessments ranging from .23% to .31% of deposits. As a result of the change in the assessment rates charged to BIF-member institutions, WSB Aurora currently pays significantly higher deposit insurance assessments as a member of the SAIF than members of the BIF.\nThe difference between the deposit insurance assessments paid by BIF-member institutions and those paid by SAIF-member institutions will increase further in calendar year 1996. On November 14, 1995, the FDIC reduced the deposit insurance assessments for BIF-member institutions by four basis points. As a result, the range of BIF assessments for the semi-annual assessment period commencing January 1, 1996 will be between 0% and .27% of deposits. BIF-member institutions which qualify for the 0% assessment category will, however, still have to pay the $1,000 minimum semi-annual assessment required by federal statute.\nThe FDIC changed the range for BIF-member deposit insurance assessments to their current levels because the ratio of the insurance reserves of the BIF to total BIF-insured deposits exceeds the statutorily designated reserve ratio of 1.25%. Because the SAIF does not meet this designated reserve ratio, the FDIC is prohibited by federal law from reducing the deposit insurance assessments charged to SAIF-member institutions to the same levels currently charged to BIF- member institutions. Legislative proposals pending before the Congress would recapitalize the SAIF to the designated reserve ratio by imposing a special\nassessment against SAIF-insured institutions, payable in a single installment, sufficient in the aggregate to increase the ratio of the insurance reserves of the SAIF to total SAIF-insured deposits to 1.25%. Based upon the information currently available to the Company with respect to the manner in which any such special assessment would be calculated under the pending legislation, the Company estimates that the imposition of a special assessment under the pending legislation would result in a one-time charge to WSB Aurora of approximately $1.0 million. At such time as the SAIF meets the designated reserve ratio of 1.25%, the assessment rates charged SAIF-member institutions could be reduced to levels consistent with those charged to BIF-member institutions. Legislation has also been introduced in the Congress that would, among other things, require federal thrift institutions to convert to state or national banks and merge the BIF and the SAIF into a single deposit insurance fund administered by the FDIC. At this time, it is not possible to predict whether, or in what form, any such legislation will be adopted or the impact, if any, such legislation if adopted would have on the Company, the Bank Subsidiaries or WSB Aurora.\nThe Company\nGENERAL. The Company, as the controlling shareholder of the Bank Subsidiaries, is a bank holding company. As a bank holding company, the Company is registered with, and is subject to regulation by, the FRB under the BHC Act. In accordance with FRB policy, the Company is expected to act as a source of financial strength to the Bank Subsidiaries and to commit resources to support the Bank Subsidiaries in circumstances where the Company might not do so absent such policy. Under the BHC Act, the Company is subject to periodic examination by the FRB and is required to file periodic reports of its operations and such additional information as the FRB may require.\nBecause the Company's principal place of business is in Illinois, the Company is also subject to the requirements of the Illinois Bank Holding Company Act. Further, due to the Company's ownership of WSB Aurora, a federally chartered savings association, the Company is a savings and loan holding company within the meaning of the HOLA and, as such, is subject to the examination, supervision, reporting and enforcement requirements of the OTS.\nINVESTMENTS AND ACTIVITIES. Under the BHC Act, a bank holding company must obtain FRB approval before: (i) acquiring, directly or indirectly, ownership or control of any voting shares of another bank or bank holding company if, after such acquisition, it would own or control more than 5% of such shares (unless it already owns or controls the majority of such shares); (ii) acquiring all or substantially all of the assets of another bank or bank holding company; or (iii) merging or consolidating with another bank holding company.\nPrior to September 29, 1995, the BHC Act prohibited the FRB from approving any direct or indirect acquisition by a bank holding company of more than 5% of the voting shares, or of all or substantially all of the assets, of a bank located outside of the state in which the operations of the bank to be acquired is located specifically authorized such an acquisition. Pursuant to amendments to the BHC Act which took effect September 29, 1995, the FRB may now allow a bank holding company to acquire banks located in any state of the United States without regard to geographic restrictions or reciprocity requirements imposed by state law, but subject to certain other acceptable conditions, if any, imposed by that state that apply to all holding companies, including, for example, limitations on the aggregate amount of deposits that may be held by a holding company and all of its insured depository institutions.\nThe BHC Act also prohibits, with certain exceptions noted below, the Company from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company which is not a bank and from engaging in any business other than that of banking, managing and controlling banks or furnishing services to banks and their subsidiaries, except that bank holding companies may engage in, and may own shares of companies engaged in, certain businesses found by the FRB to be \"so closely related to banking ... as to be a proper incident thereto.\" Under current regulations of the FRB, the Company and any non-bank subsidiaries are permitted to engage in, among other activities, such banking-related businesses as the operation of a thrift, sales and consumer finance, equipment leasing, the operation of a computer service bureau, including software development, mortgage banking and mortgage brokerage. The BHC Act does not place territorial restrictions on the activities of non-bank subsidiaries of bank holding companies.\nThe HOLA prohibits a savings and loan holding company, such as the Company, directly or indirectly or through any subsidiary, from: acquiring control of, or acquiring by merger or purchase of assets, another savings association or savings and loan holding company without the prior written approval of the OTS; acquiring or retaining, with certain exceptions, more than 5% of the voting shares of a non-subsidiary savings association, a non-subsidiary savings and loan holding company, or a non-subsidiary company engaged in activities other than those permitted by the HOLA; or acquiring or retaining control of a depository institution that is not federally insured.\nFederal law also prohibits the acquisition of \"control\" of a bank or bank holding company, such as the Company, without prior notice to certain federal bank regulators. \"Control\" is defined in certain cases as the acquisition of 10% of the outstanding shares of a bank or bank holding company.\nCAPITAL REQUIREMENTS. The FRB uses capital adequacy guidelines in its examination and regulation of bank holding companies. If capital falls below minimum guideline levels, a bank holding company, among other things, may be denied approval to acquire or establish additional banks or non-bank businesses.\nThe FRB's capital guidelines establish the following minimum regulatory capital requirements for bank holding companies: a risk-based requirement expressed as a percentage of total risk-weighted assets, and a leverage requirement expressed as a percentage of total assets. The risk-based requirement consists of a minimum ratio of total capital to total risk-weighted assets of 8%, of which at least one-half must be Tier 1 capital (which consists principally of shareholders' equity). The leverage requirement consists of a minimum ratio of Tier 1 capital to total assets of 3% for the most highly rated companies, with a minimum requirement of 4% to 5% for all others.\nThe risk-based and leverage standards presently used by the FRB are minimum requirements, and higher capital levels will be required if warranted by the particular circumstances or risk profiles of individual banking organizations. Further, any banking organization experiencing or anticipating significant growth would be expected to maintain capital ratios, including tangible capital positions (I.E., Tier 1 capital less all intangible assets), well above the minimum levels.\nAs of December 31, 1995, the Company had regulatory capital in excess of the FRB's minimum requirements, with a Tier 1 risk-based capital ratio of 11.92%, a total risk-based capital ratio of 12.90% and a leverage ratio of 9.72%.\nDIVIDENDS. The FRB has issued a policy statement on the payment of cash dividends by bank holding companies. In the policy statement, the FRB expressed its view that a bank holding company experiencing earnings weaknesses should not pay cash dividends exceeding its net income or which could only be funded in ways that weakened the bank holding company's financial health, such as by borrowing. Additionally, the FRB possesses enforcement powers over bank holding companies and their non-bank subsidiaries to prevent or remedy actions that represent unsafe or unsound practices or violations of applicable statutes and regulations. Among these powers is the ability to proscribe the payment of dividends by banks and bank holding companies.\nIn addition to the restrictions on dividends imposed by the FRB, the Illinois Business Corporation Act, as amended, prohibits the Company from paying a dividend if, after giving effect to the dividend, the Company would be insolvent or the net assets of the Company would be less than zero or less than the maximum amount then payable to shareholders of the Company who would have preferential distribution rights if the Company were liquidated.\nFEDERAL SECURITIES REGULATION. The Company's common stock is registered with the SEC under the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended (the \"Exchange Act\"). Consequently, the Company is subject to the information, proxy solicitation, insider trading and other restrictions and requirements of the SEC under the Exchange Act.\nThe Subsidiaries\nGENERAL. The Bank Subsidiaries are Illinois-chartered banks, the deposit accounts of which are insured by the BIF of the FDIC. As BIF-insured, Illinois- chartered banks, the Bank Subsidiaries are subject to the examination, supervision, reporting and enforcement requirements of the Commissioner, as the chartering authority for Illinois banks, and the FDIC, as administrator of the BIF.\nWSB Aurora is a federally chartered savings association, the deposits of which are insured by the SAIF of the FDIC. As a SAIF-insured, federally chartered savings association, WSB Aurora is subject to the examination, supervision, reporting and enforcement requirements of the OTS, as the chartering authority for federal savings associations, and the FDIC as administrator of the SAIF. WSB Aurora is also a member of the Federal Home Loan Bank System, which provides a central credit facility primarily for member institutions.\nDEPOSIT INSURANCE. As FDIC-insured institutions, the Bank Subsidiaries and WSB Aurora are required to pay deposit insurance premium assessments to the FDIC. The amount each FDIC-insured institution pays for deposit insurance coverage is determined in accordance with a risk-based assessment system under which all insured depository institutions are placed into one of nine categories and assessed insurance premiums based upon their level of capital and supervisory evaluation. Institutions classified as well-capitalized (as defined by the FDIC) and considered healthy, pay the lowest premium while institutions that are less than adequately capitalized (as defined by the FDIC) and considered of substantial supervisory concern pay the highest premium. For the semi-annual assessment period ended December 31, 1995, BIF assessments ranged from .04% to .31% of deposits, while SAIF assessments ranged from .23% to .31% of deposits. The premiums currently paid by WSB Aurora for membership in the SAIF are substantially higher than the premiums currently paid by the Bank Subsidiaries for membership in the BIF. See \"Recent Regulatory Developments.\" Risk classification of all insured institutions is made by the FDIC for each semi- annual assessment period.\nThe FDIC may terminate the deposit insurance of any insured depository institution if the FDIC determines, after a hearing, that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, order, or any condition imposed in writing by, or written agreement with, the FDIC. The FDIC may also suspend deposit insurance temporarily during the hearing process for a permanent termination of insurance if the institution has no tangible capital. Management of the Company is not aware of any activity or condition that could result in termination of the deposit insurance of any of the Bank Subsidiaries or WSB Aurora.\nCAPITAL REQUIREMENTS. The FDIC has established the following minimum capital standards for state-chartered insured non-member banks, such as the Bank Subsidiaries: a leverage requirement consisting of a minimum ratio of Tier 1 capital to total assets of 3% for the most highly-rated banks with minimum requirements of 4% to 5% for all others and a total risk-based capital requirement consisting of a minimum ratio of total capital to total risk- weighted assets of 8%, at least one-half of which must be Tier 1 capital.\nThe OTS has established the following minimum capital standards for savings associations, such as WSB Aurora: a core capital requirement, consisting of a minimum ratio of core capital (consisting primarily of stockholders' equity) to total assets of 3%; a tangible capital requirement consisting of a minimum ratio of tangible capital (defined as core capital minus all intangible assets other than a specified amount of purchased mortgage servicing rights) to total assets of 1.5%; and a risk-based capital requirement, consisting of a minimum ratio of total capital to total risk-weighted assets of 8%, at least one-half of which must consist of core capital.\nThe capital requirements described above are minimum requirements. Higher capital levels may be required if warranted by the particular circumstances or risk profiles of individual institutions. For example, the regulations of the FDIC and the OTS provide that additional capital may be required to take adequate account of the risks posed by concentrations of credit, nontraditional activities and the institution's ability to manage such risks.\nFurther, a savings association may be required to maintain additional capital to account for its interest rate risk (\"IRR\") exposure. Under OTS regulations, the OTS quantifies each savings association's level of IRR exposure based on data reported by each association, using an OTS model designed to measure the change in the net present value of the association's assets, liabilities and off- balance sheet positions resulting from a hypothetical 200 basis point increase or decrease in interest rates. IRR exposure, as measured by the OTS, is used as the basis for determining whether the association must hold additional risk- based capital to account for IRR.\nSimilarly, on August 2, 1995, the FDIC published amendments to its risk-based capital standards designed to take into account IRR exposure. The amendments provide that a bank's exposure to declines in the economic value of its capital due to changes in interest rates will be among the factors considered by the FDIC in evaluating a bank's capital adequacy. Although the IRR amendments do not establish a system for measuring IRR exposure, concurrently with the adoption of the amendments, the FDIC, together with the FRB and the Office of the Comptroller of the Currency, issued a proposed joint policy statement setting out a framework that would be used to measure the IRR exposure of individual banks. The proposed policy statement would generally require banks to quantify their level of IRR exposure using a measurement system developed by the regulators that weights a bank's assets, liabilities and off-balance sheet positions by risk factors designed to reflect the approximate change in each instrument's value that would result from 200 basis point changes in interest rates. The level of IRR exposure reflected by this measurement system, would then be considered by the agencies in assessing a bank's capital adequacy. Although it is not presently possible to predict whether, or in what form, the proposed policy statement will be adopted, management does not anticipate that the adoption of a policy statement substantially in the form proposed would have a material adverse effect on the ability of the Bank Subsidiaries to maintain compliance with applicable capital requirements.\nDuring the year ended December 31, 1995, none of the Bank Subsidiaries or WSB Aurora was required by the FDIC or the OTS, respectively, to increase its capital to an amount in excess of the minimum regulatory requirement. As of December 31, 1995, each of the Bank Subsidiaries and WSB Aurora exceeded its minimum regulatory capital requirements.\nThe following table sets forth selected regulatory capital ratios of the Bank Subsidiaries at December 31, 1995:\nAt December 31, 1995, WSB Aurora maintained a core capital ratio of 10.77%, a tangible capital ratio of 12.91% and a total risk-based capital ratio of 13.93%.\nFederal law provides the federal banking regulators with broad power to take prompt corrective action to resolve the problems of undercapitalized institutions. The extent of the regulators' powers depends on whether the institution in question is \"well capitalized,\" \"adequately capitalized,\" \"undercapitalized,\" \"significantly undercapitalized\" or \"critically undercapitalized.\" Depending upon the capital category to which an institution is assigned, the regulators' corrective powers include: requiring the submission of a capital restoration plan; placing limits on asset growth and restrictions on activities; requiring the institution to issue additional capital stock (including additional voting stock) or to be acquired; restricting transactions with affiliates; restricting the interest rate the institution may pay on deposits; ordering a new election of directors of the institution; requiring that senior executive officers or directors be dismissed; prohibiting the institution from accepting deposits from correspondent banks; requiring the institution to divest certain\nsubsidiaries; prohibiting the payment of principal or interest on subordinated debt; and ultimately, appointing a receiver for the institution.\nAdditionally, institutions insured by the FDIC may be liable for any loss incurred by, or reasonably expected to be incurred by, the FDIC in connection with the default of commonly controlled FDIC insured depository institutions or any assistance provided by the FDIC to commonly controlled FDIC insured depository institutions in danger of default.\nDIVIDENDS. Under the Illinois Banking Act, Illinois-chartered banks may not pay, without prior regulatory approval, dividends in excess of their adjusted profits.\nOTS regulations impose limitations upon all capital distributions by thrifts, including cash dividends. The rule establishes three tiers of institutions. An institution that exceeds all fully phased-in capital requirements before and after the proposed capital distribution (\"Tier 1 Institution\") could, after prior notice to, but without the approval of, the OTS, make capital distributions during a calendar year of up to the higher of (i) 100% of its net income to date during the calendar year plus the amount that would reduce by one-half its \"surplus capital ratio\" (the excess capital over its fully phased-in capital requirements) at the beginning of the calendar year, or (ii) 75% of its net income over the most recent preceding four quarter period. Any additional capital distributions would require prior regulatory approval. As of December 31, 1995, WSB Aurora was a Tier 1 Institution.\nThe payment of dividends by any financial institution or its holding company is affected by the requirement to maintain adequate capital pursuant to applicable capital adequacy guidelines and regulations. As described above, the Company, the Bank Subsidiaries and WSB Aurora each exceeded its minimum capital requirements under applicable guidelines as of December 31, 1995. As of December 31, 1995, approximately $20.7 million was available to be paid as dividends to the Company by the Bank Subsidiaries and WSB Aurora.\nINSIDER TRANSACTIONS. The Bank Subsidiaries and WSB Aurora are subject to certain restrictions imposed by the Federal Reserve Act on any extensions of credit to the Company and the Subsidiaries, on investments in the stock or other securities of the Company and the Subsidiaries and the acceptance of the stock or other securities of the Company or the Subsidiaries as collateral for loans. Certain limitations and reporting requirements are also placed on extensions of credit by the Bank Subsidiaries and WSB Aurora to their respective directors and officers, to directors and officers of the Company and the Subsidiaries, to principal stockholders of the Company, and to \"related interests\" of such directors, officers and principal stockholders. In addition, such legislation and regulations may affect the terms upon which any person becoming a director or officer of the Company or one of the Subsidiaries or a principal stockholder of the Company may obtain credit from banks with which one of the Bank Subsidiaries or WSB Aurora maintains a correspondent relationship.\nSAFETY AND SOUNDNESS STANDARDS. On July 10, 1995, the federal banking regulators, including the FDIC and the OTS, published final guidelines establishing operational and managerial standards to promote the safety and soundness of federally insured depository institutions. The guidelines, which took effect on August 9, 1995, establish standards for internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, and compensation, fees and benefits. In general, the guidelines prescribe the goals to be achieved in each area, and each institution will be responsible for establishing its own procedures to achieve those goals. If an institution fails to comply with any of the standards set forth in the guidelines, the institution's primary federal regulator may require the institution to submit a plan for achieving and maintaining compliance. The preamble to the guidelines states that the agencies expect to require a compliance plan from any institution whose failure to meet one or more of the standards is of such severity that it could threaten the safe and sound operation of the institution. Failure to submit an acceptable compliance plan, or failure to adhere to a compliance plan that has been accepted by the appropriate regulator, would constitute grounds for further enforcement action. The federal banking agencies have also published for comment proposed asset quality and earnings standards which, if adopted, would be added to the safety and soundness guidelines. This proposal, like the final guidelines, would establish the goals to be achieved with respect to asset quality and earnings,\nand each institution would be responsible for establishing its own procedures to meet such goals.\nBRANCHING AUTHORITY. All banks located in Illinois have traditionally been restricted as to the number and geographic location of branches which they may establish. On June 7, 1994, Governor Edgar signed into law legislation eliminating all branching restrictions. Accordingly, as of that date, the Bank Subsidiaries were allowed to establish branches anywhere in Illinois without regard to the location of other bank main offices or the number of branches previously maintained by the Bank Subsidiaries establishing the branch. Federal savings associations, such as WSB Aurora, have for some time had similar branching rights.\nEffective June 1, 1997 (or earlier if expressly authorized by applicable state law), the Riegle-Neal Interstate Banking and Branch Efficiency Act of 1994 (the \"Riegle-Neal Act\") allows banks to establish interstate branch networks through acquisitions of other banks, subject to certain conditions, including certain limitations on the aggregate amount of deposits that may be held by the surviving bank and all of its insured depository institution affiliates. The establishment of DE NOVO interstate branches or the acquisition of individual branches of a bank in another state (rather than the acquisition of an out-of- state bank in its entirety) is allowed by the Riegle-Neal Act only if specifically authorized by state law. The legislation allows individual states to \"opt-out\" of certain provisions of the Riegle-Neal Act by enacting appropriate legislation prior to June 1, 1997. Illinois has enacted legislation permitting interstate bank mergers beginning on June 1, 1997. Federal savings associations, such as WSB Aurora, currently have nationwide interstate branching authority under the HOLA and OTS regulations.\nSTATE BANK ACTIVITIES. Under federal law, as implemented by final regulations adopted by the FDIC, FDIC insured state banks are prohibited, subject to certain exceptions, from making or retaining equity investments of a type, or in an amount, that are not permissible for a national bank. Federal law, as implemented by FDIC regulations, also prohibits FDIC insured state banks and their subsidiaries, subject to certain exceptions, from engaging as principal in any activity that is not permitted for a national bank or its subsidiary, respectively, unless the bank meets, and continues to meet, its minimum regulatory capital requirements and the FDIC determines the activity would not pose a significant risk to the deposit insurance fund of which the bank is a member. Impermissible investments and activities must be divested or discontinued within certain time-frames set by the FDIC in accordance with federal law. These restrictions have not had, and are not currently expected to have, a material impact on the operations of the Bank Subsidiaries.\nQUALIFIED THRIFT LENDER TEST. Under the HOLA, as implemented by OTS regulations, WSB Aurora is required to satisfy a qualified thrift lender (\"QTL\") test. In order to meet the current QTL test WSB Aurora generally is required to invest at least 65% of its portfolio assets in \"qualified thrift investments,\" as measured on a monthly average basis in nine out of every 12 months. Qualified thrift investments for purposes of the current QTL test consist principally of residential mortgage loans, mortgage-backed securities and other housing and consumer-related investments. The term \"portfolio assets\" is statutorily defined to mean a savings association's total assets less goodwill and other intangible assets, the association's business property and a limited amount of its liquid assets. As of December 31, 1995, WSB Aurora satisfied the QTL test.\nLIQUIDITY REQUIREMENTS. OTS regulations currently require each savings association to maintain, for each calendar month, an average daily balance of liquid assets (including cash, certain time deposits, bankers' acceptances, and specified United States Government, state or federal agency obligations) equal to at least 5% of the average daily balance of its net withdrawable accounts plus short-term borrowings (those repayable in 12 months or less) during the preceding calendar month. This liquidity requirement may be changed from time to time by the OTS to an amount within a range of 4% to 10% of such accounts and borrowings, depending upon economic conditions and the deposit flows of savings associations. OTS regulations also require each savings association to maintain, for each calendar month, an average daily balance of short-term liquid assets (generally liquid assets having maturities of 12 months or less) equal to at least 1% of the average daily balance of its net withdrawable accounts plus short-term borrowings during the preceding calendar month. Penalties may be imposed for failure to meet liquidity ratio requirements. At December 31, 1995, WSB Aurora was in compliance with OTS liquidity requirements, with an overall liquidity ratio of 5.54% and a short-term liquidity ratio of 4.45%.\nEXECUTIVE OFFICERS OF THE COMPANY\nThe names and ages of the executive officers of the Company, along with a brief description of the business experience of each such person, during the past five years, and certain other information is set forth below:\nSTATISTICAL DATA\nThe statistical data required by Securities and Exchange Act of 1934, as amended (the \"1934 Act\") Industry Guide 3, \"Statistical Disclosure By Bank Holding Companies,\" has been incorporated by reference from the Company's 1995 Annual Report to Shareholders (attached as Exhibit 13.1 hereto) or is set forth below. This data should be read in conjunction with the Company's 1995 Consolidated Financial Statements and related notes, and the discussion included in Management's Discussion and Analysis of Financial Condition and Results of Operations as set forth in the Company's 1995 Annual Report to Shareholders. All dollar amounts of the statistical data included below are expressed in thousands.\nInvestment Securities\nThe following table sets forth by category the amortized cost of securities at December 31 (dollars in thousands):\nThe following table sets forth by contractual maturity the amortized cost and weighted average yield (not tax-effected) of investment securities available for sale at December 31, 1995 (dollars in thousands):\nThe following table sets forth, by contractual maturity, the amortized cost and weighted average yield of investment securities held to maturity at December 31, 1995. Yields on tax-exempt securities represent actual coupon yields (dollars in thousands):\nLoan Portfolio\nThe following table sets forth the major loan categories at December 31 (dollars in thousands):\nThe following table sets forth the maturity and interest rate sensitivity of selected loan categories at December 31, 1995 (dollars in thousands):\nNonperforming Loans\nThe following table sets forth the aggregate amount of nonperforming loans and selected ratios at December 31 (dollars in thousands):\nThe Company's normal policy is to discontinue accruing interest on a loan when it becomes 90 days past due or when management believes, after considering economic and business conditions and collection efforts, that the borrower's financial condition is such that collection of principal or interest is doubtful. In some circumstances a loan that is more than 90 days past due can remain on accrual status if it can be established that payment will be received within another 90 days or if it is adequately secured. When a loan has been placed on nonaccrual status, interest that has been earned but not collected is charged back to the appropriate interest income account. When payments are received on nonaccrual loans they are first applied to principal, then to expenses incurred for collection and finally to interest income. The gross amount of interest that would have been recorded if all nonperforming loans had been accruing interest at their original terms was approximately fifty-three thousand dollars for the year ended December 31, 1995 and no interest was recorded in operations for the year ended December 31, 1995.\nAs of December 31, 1995, due to information regarding possible credit problems of borrowers or possible deficits in the cash flow of property given as collateral, management had doubts as to the ability of certain borrowers to comply with the present repayment terms of loans, which are not nonaccrual and not nonperforming, with an aggregate principal amount of $4.9 million. Accordingly, management may be required to categorize some or all of these loans as nonperforming assets in the future.\nAllowance for Loan Losses\nThe allowance for loan losses reduces the level of gross loans outstanding by an estimate of uncollectible loans. When management determines that loans are uncollectible, they are charged-off against the allowance. Periodically, a provision for loan losses is charged against current income. Management attempts to maintain the allowance for loan losses at a level adequate to absorb anticipated loan losses. The amount of the allowance is established based upon past loan loss experience and other factors which, in management's judgment, deserve consideration in estimating loan losses. Other factors considered by management in this regard include growth and composition of the loan portfolio, the relationship of the allowance for loan losses to outstanding loans and economic conditions in the Company's market area. Based on such reviews, management at this time does not anticipate any increase in nonperforming assets that will have a significant effect on its operations because the estimated exposure to losses has already been substantially reflected in its allowance for loan losses. This could, however, change dramatically if a significant decline in the real estate market area served by the Company occurs.\nThe following table sets forth the activity in the allowance for loan losses for the years ended and at December 31 (dollars in thousands):\nThe entire allowance for loan losses is available to absorb losses in any particular category of loans, notwithstanding management's allocation of the allowance. The following table sets forth the allocation of allowance for loan losses and the percentage of loans in each category to total loans at December 31 (dollars in thousands):\nDeposits\nThe following table sets forth by category average daily deposits and rates for the years ended December 31 (dollars in thousands):\nThe following table sets forth by maturity time deposits $100 and over at December 31 (dollars in thousands):\n------- Within Three months $42,605 After 3 months but within 12 months 12,673 After 1 year but within 5 years -- After 5 years 12,785 ------- Total $68,063 ------- -------\nReturn on Equity and Assets and Other Financial Ratios\nThe following table sets forth selected financial ratios at and for the years ended December 31:\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company and the Subsidiaries occupy a total of approximately 219,000 square feet in 32 locations. The Company's principal offices are located in approximately 32,500 square feet of office space at 711 South Meyers Road, Lombard, Illinois. As indicated below, West Suburban Bank also operates the facility located at 711 South Meyers Road, Lombard, Illinois as a branch.\nThe following table sets forth certain information concerning the facilities of the Subsidiaries:\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThere are no material pending legal proceedings to which the Company or the Subsidiaries is a party other than ordinary routine litigation incidental to their respective businesses.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Company's authorized and outstanding equity securities consist of Class A Common Stock, no par value, and Class B Common Stock, no par value. Except as required by law, rights and privileges of the holders of the Class A Common Stock and Class B Common Stock are identical.\nThe Company's per share book value as of the end of each quarter and dividend information for each quarter is set forth in the following table:\nThe Company's common stock is not traded on any national or regional exchange. While there is no established trading market for the Company's common stock, the Company is aware that from time to time limited or infrequent quotations are made with respect to the Company's common stock and that there occurs limited trading in the Company's common stock resulting from private transactions not involving brokers or dealers. Transactions in the Company's common stock have been infrequent. As of March 15, 1996, the Company had 347,015 shares of Class A Common Stock outstanding and approximately 943 shareholders of record, and had 85,480 shares of Class B Common Stock outstanding and approximately 236 shareholders of record. Management is aware of approximately 28 transactions during 1995 involving the sale of approximately 973 shares of Class A Common Stock and approximately 3 transactions during 1995 involving the sale of approximately 108 shares of Class B Common Stock. The average sale price in such transactions was approximately $251.85.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe Company hereby incorporates by reference the information called for by Item 6 of this Form 10-K from the section entitled \"Selected Financial Data\" of the Company's Annual Report to Shareholders for the fiscal year ended December 31, 1995 (attached as Exhibit 13 hereto).\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe Company hereby incorporates by reference the information called for by Item 7 of this Form 10-K from the section entitled \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" of the Company's Annual Report to Shareholders for the fiscal year ended December 31, 1995 (attached as Exhibit 13 hereto).\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe Company hereby incorporates by reference the information called for by Item 8 of this Form 10-K from the Consolidated Financial Statements and from the section entitled \"Selected Quarterly Financial Data\" as set forth in the Company's Annual Report to Shareholders for the fiscal year ended December 31, 1995 (attached as Exhibit 13 hereto).\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL MATTERS\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe Company hereby incorporates by reference the information called for by Item 10 of this Form 10-K regarding directors of the Company from the section entitled \"Election of Directors\" of the Company's 1996 Proxy Statement.\nSection 16(a) of the of 1934 Act requires that the Company's executive officers and directors and persons who own more than 10% of their Company's common stock file reports of ownership and changes in ownership with the Securities and Exchange Commission and with the exchange on which the Company's shares of common stock are traded. Such persons are also required to furnish the Company with copies of all Section 16(a) forms they file. Based solely on the Company's review of the copies of such forms furnished to the Company and, if appropriate, representations made to the Company by any such reporting person concerning whether a Form 5 was required to be filed for the 1995 fiscal year, the Company is not aware that any of its directors and executive officers or 10% shareholders failed to comply with the filing requirements of Section 16(a) during the period commencing January 1, 1995 through December 31, 1995 except that Mr. Howard failed to file his Form 4, reporting August, 1995 transactions, on a timely basis.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe Company hereby incorporates by reference the information called for by Item 11 of this Form 10-K from the section entitled \"Executive Compensation\" of the Company's 1996 Proxy Statement; provided, however, Report of the Board of Directors on Executive Compensation is specifically not incorporated into this Form 10-K.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe Company hereby incorporates by reference the information called for by Item 12 of this Form 10-K from the section entitled \"Security Ownership of Certain Beneficial Owners\" of the Company's 1996 Proxy Statement.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe Company hereby incorporates by reference the information called for by Item 13 of this Form 10-K from the section entitled \"Transactions with Directors, Officers and Associates\" of the Company's 1996 Proxy Statement.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\nITEM (A)1 AND 2. FINANCIAL STATEMENTS\nWEST SUBURBAN BANCORP, INC. AND SUBSIDIARIES LIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nThe following audited Consolidated Financial Statements of the Company and its subsidiaries and related notes and independent auditors' report are incorporated by reference from the Company's Annual Report to Shareholders for the fiscal year ended December 31, 1995 (attached as Exhibit 13 hereto).\nAnnual Report Page No. --------------\nReport of Independent Auditors 5\nConsolidated Balance Sheets - December 31, 1995 and 1994 6\nConsolidated Statements of Income - Years Ended December 31, 1995, 1994 and 1993 7\nConsolidated Statements of Changes in Shareholders' Equity - Years Ended December 31, 1995, 1994 and 1993 8\nConsolidated Statements of Cash Flows - Years Ended December 31, 1995, 1994 and 1993 9\nNotes to Consolidated Financial Statements 11\nThe following Condensed Financial Information-Parent Only is incorporated by reference from Note 16 to the Company's audited Consolidated Financial Statements as set forth in the Company's Annual Report to Shareholders for the fiscal year ended December 31, 1995 (attached as Exhibit 13).\nAnnual Report Page No. --------------\nCondensed Balance Sheets - December 31, 1995 and 1994 21\nCondensed Statements of Income - Years Ended December 31, 1995, 1994 and 1993 21\nCondensed Statements of Cash Flows - Years Ended December 31, 1995, 1994 and 1993 22\nSCHEDULES\nSchedules other than those listed above are omitted for the reason that they are not required or are not applicable or the required information is shown in the financial statements incorporated by reference or notes thereto.\nITEM 14(a)3. EXHIBITS\nThe exhibits required by Item 601 of Regulation S-K are included with this Form 10-K and are listed on the \"Index to Exhibits\" immediately following the signature page.\nITEM 14(b). REPORTS ON FORM 8-K\nNone\n***\nUpon written request to the Chairman of the Board of West Suburban Bancorp, Inc., 711 South Meyers Road, Lombard, Illinois, 60148, copies of the exhibits listed above are available to shareholders of the Company by specifically identifying each exhibit desired in the request. A fee of $.20 per page of exhibit will be charged to shareholders requesting copies of exhibits to cover copying and mailing costs.\nFORM 10-K SIGNATURE PAGE\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nWEST SUBURBAN BANCORP, INC. (Registrant)\nBy \/s\/ John A. Clark ----------------------------- John A. Clark Chief Executive Officer\nDate: March 28, 1996 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on the 28th day of March, 1996.\nSIGNATURE TITLE --------- -----\n\/s\/ Kevin J. Acker 3\/28\/96 Chairman of the Board - ----------------------------- ---------- and Director Kevin J. Acker Date\n\/s\/ John A. Clark 3\/28\/96 Chief Executive - ----------------------------- ---------- Officer and John A. Clark Date Director\n\/s\/ Duane G. Debs 3\/28\/96 Chief Financial - ----------------------------- ---------- Officer and Chief Duane G. Debs Date Accounting Officer\n\/s\/ David Bell 3\/28\/96 Director - ----------------------------- ---------- David Bell Date\n\/s\/ Peggy P. LoCicero 3\/28\/96 Director - ----------------------------- ----------- Peggy P. LoCicero Date\n\/s\/ Charles P. Howard 3\/28\/96 Director - ----------------------------- ----------- Charles P. Howard Date\nThe foregoing includes all of the Board of Directors of the Company.\nINDEX TO EXHIBITS (continued)\nExhibit Sequential Number Description Page No. - ------- ----------- ----------\n3.1 Articles of Incorporation - Incorporated by reference N\/A from Exhibit 3.1 of Form S-1 of the Company dated November 10, 1988, under Registration No. 33-25225\n3.2 Form of Certificate of Amendment to Articles of N\/A Incorporation - Incorporated by reference from Exhibit 3.2 of Form S-1 of the Company dated November 10, 1988, under Registration No. 33-25225\n3.3 Certificate of Amendment to Articles of Incorporation N\/A dated May 10, 1990 - Incorporated by reference from Exhibit 3.3 of the Form 10-K of the Company dated March 28, 1991, Commission File No. 0-17609\n3.4 By-Laws - Incorporated by reference to Exhibit 3.3 of N\/A Form S-1 of the Company dated November 10, 1988, Registration No. 33-25225\n4.1 Specimen of Class A Common Stock certificate Incorporated N\/A by reference from Exhibit 4.1 of the Form 10-K of the Company dated March 28, 1991, Commission File No. 0-17609\n4.2 Specimen of Class B Common Stock certificate - Incorporated N\/A by reference from Exhibit 4.1 of the Form S-1 of the Company dated November 10, 1988, Registration No. 33-25225\n4.3 Articles of Incorporation of the Company (see Exhibits 3.1, N\/A 3.2, 3.3 and 3.4 above)\n4.4 By-Laws of the Company (see Exhibit 3.4 above) N\/A\nINDEX TO EXHIBITS (continued)\nExhibit Sequential Number Description Page No. - ------- ----------- ----------\n10.1 Employment Agreement between one of the N\/A Company's subsidiaries and Ralph Acker, dated December 31, 1985 - Incorporated by reference from Exhibit 10.1 of Form S-1 of the Company dated November 10, 1988, Registration No. 33-25225\n10.2 Employment Agreement between one of the N\/A Company's subsidiaries and John A. Clark, dated May 10, 1989 - Incorporated by reference from Exhibit 10.2 of Form 10-K of the Company dated March 28, 1990, Commission File No. 0-17609\n10.3 Employment Agreement between one of the Company's N\/A subsidiaries and Keith W. Acker, dated November 10, 1989 - Incorporated by reference from Exhibit 10.3 of Form 10-K of the Company dated March 28, 1990, Commission File No. 0-17609\n10.4 Employment Agreement between one of the Company's N\/A subsidiaries and Craig R. Acker, dated May 10, 1989 - Incorporated by reference from Exhibit 10.4 of Form 10-K of the Company dated March 28, 1990, Commission File No. 0-17609\n10.5 Employment Agreement between one of the Company's N\/A subsidiaries and Alana S. Acker, dated May 9, 1989 - Incorporated by reference to Exhibit 10.5 of Form 10-K of the Company dated March 28, 1990, Commission File No. 0-17609\nINDEX TO EXHIBITS (continued)\nExhibit Sequential Number Description Page No. - ------- ----------- ----------\n10.6 Employment Agreement between one of the Company's N\/A subsidiaries and Kevin J. Acker, dated May 9, 1989 - Incorporated by reference from Exhibit 10.6 of Form 10-K of the Company dated March 28, 1990, Commission File No. 0-17609\n10.7 Employment Agreement between one of the Company's N\/A subsidiaries and Gregory Ruffolo, dated May 9, 1989 - Incorporated by reference from Exhibit 10.7 of Form 10-K of the Company dated March 28, 1990, Commission File No. 0-17609\n10.8 Employment Agreement between one of the Company's N\/A subsidiaries and Michael P. Brosnahan, dated May 10, 1989 - Incorporated by reference from Exhibit 10.8 of Form 10-K of the Company dated March 28, 1990, Commission File No. 0-17609\n10.9 Employment Agreement between one of the Company's N\/A subsidiaries and Gregory L. Young, dated November 14, 1990 - Incorporated by reference from Exhibit 10.9 of Form 10-K of the Company dated March 28, 1991, Commission File No. 0-17609\n10.10 Deferred Compensation Agreement between one of the Company's N\/A subsidiaries and John A. Clark, dated November 14, 1990 - Incorporated by reference from Exhibit 10.10 of Form 10-K of the Company dated March 28, 1991, Commission File No. 0-17609\n10.11 Deferred Compensation Agreement between one of the Company's N\/A subsidiaries and Keith W. Acker, dated November 14, 1990 - Incorporated by reference from Exhibit 10.11 of Form 10-K of the Company dated March 28, 1991, Commission File No. 0-17609\nINDEX TO EXHIBITS (continued)\nExhibit Sequential Number Description Page No. - ------- ----------- ----------\n10.12 Deferred Compensation Agreement between one of the Company's N\/A subsidiaries and Craig R. Acker, dated November 14, 1990 - Incorporated by reference from Exhibit 10.12 of Form 10-K of the Company dated March 28, 1991, Commission File No. 0-17609\n10.13 Deferred Compensation Agreement between one of the Company's N\/A subsidiaries and Michael P. Brosnahan, dated November 14, 1990 - Incorporated by reference from Exhibit 10.13 of Form 10-K of the Company dated March 28, 1991, Commission File No. 0-17609\n10.14 Deferred Compensation Agreement between one of the Company's N\/A subsidiaries and Gregory L. Young, dated November 14, 1990 - Incorporated by reference from Exhibit 10.14 of Form 10-K of the Company dated March 28, 1991, Commission File No. 0-17609\n10.15 Deferred Compensation Agreement between one of the Company's N\/A subsidiaries and Alana S. Acker, dated November 13, 1990 - Incorporated by reference from Exhibit 10.15 of Form 10-K of the Company dated March 28, 1991, Commission File No. 0-17609\n10.16 Deferred Compensation Agreement between one of the Company's N\/A subsidiaries and Gregory M. Ruffolo, dated November 13, 1990 - Incorporated by reference from Exhibit 10.16 of Form 10-K of the Company dated March 28, 1991, Commission File No. 0-17609\nINDEX TO EXHIBITS (continued)\nExhibit Sequential Number Description Page No. - ------- ----------- ----------\n10.17 Deferred Compensation Agreement between one of the Company's N\/A subsidiaries and Kevin J. Acker, dated November 13, 1990 - Incorporated by reference from Exhibit 10.17 of Form 10-K of the Company dated March 28, 1991, Commission File No. 0-17609\n10.18 Employment Agreement between one of the Company's subsidiaries N\/A and Stanley C. Celner, Jr., dated December 10, 1991 - Incorporated by reference from Exhibit 10.18 of Form 10-K of the Company dated March 28, 1992, Commission File No. 0-17609\n10.19 Deferred Compensation Agreement between one of the Company's N\/A subsidiaries and Stanley C. Celner, Jr., dated December 10, 1991 - Incorporated by reference from Exhibit 10.19 of Form 10-K of the Company dated March 28, 1992, Commission File No. 0-17609\n10.20 Employment Agreement between one of the Company's subsidiaries N\/A and Duane G. Debs, dated as of March 8, 1993 - Incorporated by reference from Exhibit 10.20 of Form 10-K of the Company dated March 28, 1994, Commission File No. 0-17609\n10.21 Deferred Compensation Agreement between one of the Company's N\/A subsidiaries and Duane G. Debs, dated as of March 8, 1993 - Incorporated by reference from Exhibit 10.21 of Form 10-K of the Company dated March 28, 1994, Commission File No. 0-17609\n10.22 Employment Agreement between one of the Company's subsidiaries N\/A and Jacqueline R. Weigand, dated as of March 8, 1993 - Incorporated by reference from Exhibit 10.22 of Form 10-K of the Company dated March 28, 1994, Commission File No. 0-17609\n10.23 Deferred Compensation Agreement between one of the Company's N\/A subsidiaries and Jacqueline R. Weigand, dated as of March 8, 1993 - Incorporated by reference from Exhibit 10.23 of Form 10-K of the Company dated March 28, 1994, Commission File No. 0-17609\n10.24 Employment Agreement between one of the Company's subsidiaries N\/A and Timothy P. Dineen, dated as of March 8, 1993 - Incorporated by reference from Exhibit 10.24 of Form 10-K of the Company dated March 28, 1994, Commission File No. 0-17609\nINDEX TO EXHIBITS (continued)\nExhibit Sequential Number Description Page No. - ------- ----------- ----------\n10.25 Deferred Compensation Agreement between one of the Company's N\/A subsidiaries and Timothy P. Dineen, dated as of March 8, 1993 - Incorporated by reference from Exhibit 10.25 of Form 10-K of the Company dated March 28, 1994, Commission File No. 0-17609\n10.26 Employment Agreement between one of the Company's subsidiaries N\/A and Pamela N. Greening, dated as of March 8, 1993 - Incorporated by reference from Exhibit 10.26 of Form 10-K of the Company dated March 28, 1994, Commission File No. 0-17609\n10.27 Deferred Compensation Agreement between one of the Company's N\/A subsidiaries and Pamela N. Greening, dated as of March 8, 1993 - Incorporated by reference from Exhibit 10.27 of Form 10-K of the Company dated March 28, 1994, Commission File No. 0-17609\n10.28 Employment Agreement between one of the Company's subsidiaries N\/A and Steven A. Jennrich, dated as of January 12, 1994 - Incorporated by reference from Exhibit 10.28 of Form 10-K of the Company dated March 28, 1995, Commission File No. 0-17609\n10.29 Deferred Compensation Agreement between one of the Company's N\/A subsidiaries and Steven A. Jennrich, dated as of January 12, 1994 - Incorporated by reference from Exhibit 10.29 of Form 10-K of the Company dated March 28, 1995, Commission File No. 0-17609\n10.30 Amended Employment Agreement between one of the Company's N\/A subsidiaries and Jacqueline R. Weigand, dated as of August 9, 1994 - Incorporated by reference from Exhibit 10.30 of Form 10-K of the Company dated March 28, 1995, Commission File No. 0-17609\n10.31 Amended Employment Agreement between one of the Company's N\/A subsidiaries and Timothy P. Dineen, dated as of August 9, 1994 - Incorporated by reference from Exhibit 10.31 of Form 10-K of the Company dated March 28, 1995, Commission File No. 0-17609\n10.32 Employment Agreement between one of the Company's N\/A subsidiaries and George E. Ranstead, dated as of November 9, 1994 - Incorporated by reference from Exhibit 10.32 of Form 10-K of the Company dated March 28, 1995, Commission File No. 0-17609\n10.33 Deferred Compensation Agreement between one Company's N\/A subsidiaries and George E. Ranstead, dated as of November 9, 1994 - Incorporated by reference from Exhibit 10.33 of Form 10-K of the Company dated March 28, 1995, Commission File No. 0-17609\n10.34 Employment Agreement between one of the Company's N\/A subsidiaries and David S. Orr, dated as of November 9, 1994 - Incorporated by reference from Exhibit 10.34 of Form 10-K of the Company dated March 28, 1995, Commission File No. 0-17609\nINDEX TO EXHIBITS (continued)\nExhibit Sequential Number Description Page No. - ------- ----------- ----------\n10.35 Deferred Compensation Agreement between one of the N\/A Company's subsidiaries and David S. Orr, dated as of November 9, 1994 - Incorporated by reference from Exhibit 10.35 of Form 10-K of the Company dated March 28, 1995, Commission File No. 0-17609\n10.36 Employment Agreement Amendment entered into between a 35 Subsidiary of the Company and each of John A. Clark, Kevin J. Acker, Craig R. Acker, Keith W. Acker and Alana S. Acker, each agreement dated as of August 8, 1995.\n10.37 Employment Agreement Amendment entered into between a 41 Subsidiary of the Company and each of Michael P. Brosnahan, Duane G. Debs, Stanley C. Celner, Jr., Timothy P. Dineen, Pamela N. Greening, Steven A. Jennrich, David S. Orr, George Ranstead, Gregory M. Ruffolo, Jacqueline R. Weigand and Gregory L. Young, each agreement dated as of August 8, 1995.\n11 Statement regarding computations of earnings per share 47 for the Registrant\n13 Annual Report to Shareholders of the Company for fiscal 48 year ended December 31, 1995\n21 Subsidiaries of Registrant 88\n27 Financial Data Schedule 89","section_15":""}
{"filename":"28365_1995.txt","cik":"28365","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company's manufacturing, research and general office operations are conducted at its 92,000 square foot facility at 130 Perinton Parkway, Fairport, New York. This plant was financed by an industrial development bond issue and the bond is secured by a lien on the land and building and other assets acquired with the bond proceeds.\nThe Company also leases small amounts of office space for its regional distribution center in Hixson, Tennessee, and Auburn, California.\nInternationally, the Company has leased a 70,000 square foot manufacturing facility in Southeast Asia and has branch offices\/distribution centers located in Australia, France and Hong Kong.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nOn January 26, 1995, the Company reached a settlement with C & K Systems on patent infringement suits commenced in fiscal 1993. The settlement was reached through an exchange of patent rights.\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 Company's fourth quarter ending March 31, 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS.\nThe Company's common stock trades on The Nasdaq Stock Market under the symbol: DETC. The information regarding the price range of the Company's Common Stock presented on page 16 of the Company's 1995 Annual Report to Shareholders (\"Annual Report\") is incorporated herein as Exhibit 1. On June 23, 1995, the closing price, as reported by The Nasdaq Stock Market, was $6.625 per share.\nThe Company has never paid cash dividends on its Common Stock. The Company presently intends to retain all future earnings, if any, for the operation and expansion of its business and does not expect to pay any cash dividends on its Common Stock in the foreseeable future.\nThe Company's industrial development bond issued to finance the Company's Fairport plant limits the amount of dividends the Company may declare or pay in any fiscal year to 50% of its net income for the preceding fiscal year.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nInterim quarterly results for the Company over the past three years were as follows (thousands of dollars, except per share data):\nINCOME Fiscal Year Ending NET GROSS NET PER March 31, SALES MARGIN INCOME SHARE - ------------------ ------ ------ ------ ----- Fourth Quarter $8,075 $3,193 $ 27 -- Third Quarter 9,416 3,759 569 $.20 Second Quarter 8,672 3,362 460 .16 First Quarter 8,173 3,192 458 .16\nFourth Quarter $8,145 $3,069 $402 $.14 Third Quarter 8,300 3,257 437 .15 Second Quarter 8,589 3,272 431 .15 First Quarter 6,321 2,215 5 --\nFourth Quarter $8,265 $3,399 $517 $.18 Third Quarter 7,485 2,796 339 .12 Second Quarter 6,732 2,473 216 .08 First Quarter 6,949 2,728 365 .13\nThe Company's five year summary of operations is included as Exhibit 10 to this 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 is included as Exhibit 2 of this Form 10-K.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nPages 17 through 24 of the Company's Annual Report for the year ended March 31, 1995 contain the information required by Item 8 of Form 10-K. This information is also included as Exhibit 3 of this Form 10-K.\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.\nName and Age Position, Offices Held and Year Appointed Karl H. Kostusiak (56) President (1968)\nDavid B. Lederer (55) Executive Vice President, (1968)\nGeorge E. Behlke (37) Vice President, Engineering (1995)\nR. Wayne Carlton (58) Vice President, National Sales (1993)\nFrank J. Ryan (41) Vice President, Secretary and Treasurer (1982)\nLawrence R. Tracy (48) President, Detection Systems, International, Inc., a subsidiary of Detection Systems, Inc. (1995)\nEach officer is elected to serve until the first meeting of the Board of Directors held after the next annual meeting of shareholders and until his successor is elected and has qualified. There is no family relationship between any of the above officers.\nMessrs. Kostusiak and Lederer have been President and Executive Vice President of the Company since it was formed in 1968. Mr. Ryan has been employed by the Company in various financial positions since 1980 and was promoted to Vice President in 1989. Mr. Carlton has been employed by the Company in various sales positions since 1975 and was promoted to Vice President in 1994. Mr. Tracy was hired in February 1995 as President of the Company s Detection Systems, International, Inc. subsidiary. Mr. Behlke has been employed by the Company in various engineering positions since 1977 and was promoted in May 1995 to Vice President.\nThe Company's Proxy Statement for the 1995 Annual Meeting of Shareholders contains the other information required by Item 10 of Form 10- K. That information is incorporated in this report as Exhibit 5.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe Company's Proxy Statement for the 1995 Annual Meeting of Shareholders contains the information required by Item 11 of Form 10-K. That information is incorporated in this report as Exhibit 5.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe Company has stock purchase agreements with Messrs. Kostusiak and Lederer which could in the future result in a change of control of the registrant. These agreements are included as Exhibit 4 of this Form 10-K.\nThe Company's Proxy Statement for the 1995 Annual Meeting of Shareholders contains the information required by Item 12 of Form 10-K. The Proxy is included in this Form 10-K as Exhibit 5.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nIn the last fiscal year the Company and its subsidiaries contracted with Adair & Stoner, of which Mr. Adair, a Director of the Company, is a partner, for legal services rendered for the Company and its ECI subsidiary. In addition, Mr. McIrvine, another Director of the Company, performed consulting work for the Company during the last fiscal year. Messrs. Adair and McIrvine also serve as members of the compensation and stock option committees of the Board of Directors.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.\n(a)(I) and (2) The financial statements and schedules are included in Exhibit 3 of this Report on Form 10-K. (a)(3) See Exhibit Index attached to this Report on Form 10-K.\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.\nDETECTION SYSTEMS, INC. (Registrant)\nDate: June 27, 1995 By: \/s\/ Karl H. Kostusiak Karl H. Kostusiak 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\nKarl H. Kostusiak President and Director June 27, 1995 Karl H. Kostusiak (Principal Executive Officer)\nFrank J. Ryan Vice President June 27, 1995 Frank J. Ryan Secretary\/Treasurer (Principal Financial Officer and Principal Accounting Officer)\nDonald R. Adair Director David B. Lederer Director\nBy: \/s\/ Karl H. Kostusiak Attorney-in-Fact June 27, 1995 Karl H. Kostusiak\nEXHIBIT INDEX\nItem Exhibits Location\n3 Certificate of Incorporation Incorporated by reference to Exhibits 3(a) of the Company's 1993 Annual Report on Form 10-K\n3 By-Laws as amended Incorporated by reference to Exhibits 3(b) of the Company's 1993 Annual Report on Form 10-K\n4(a) Rights of Holders of common Incorporated by reference to Exhibit 4 stock - 1981 plan of the Company's 1993 Annual Report on Form 10-K\n6 5-year summary of operations Included as Exhibit 11 of this Form 10-K.\n10(a)Non-employee director stock Incorporated by reference to Exhibit option plan (warrant plan) 10(a) of the Company's 1994 Annual Report on Form 10-K\n10(b) Medical reimbursement plan Incorporated by reference to Exhibit 10(b) of the Company's 1994 Annual Report on Form 10-K\n10(c) Employee stock purchase plan Incorporated by reference to Exhibit 10(c) of the Company's 1994 Annual Report on Form 10-K\n10(d) Line of credit agreements Included as Exhibit 6 of this Form 10K\n10(e) Industrial Development Bond Incorporated by reference to Exhibit 10 Purchase Agreement, Bond, of the Company's fiscal 1982 Annual Lease Agreement, Mortgage Report on Form 10-K and Guaranty\n10(f) Deferred Compensation Plan Incorporated by reference to Exhibit 10 of the Company's 1993 Annual Report on Form 10-K\n10(g) 1992 Stock Option Plan Incorporated by reference to Exhibit 10(c) of the Company's 1994 Annual Report on Form 10-K\n10(h) Key employee bonus plan Incorporated by reference to Exhibit 10(h) of the Company's 1994 Annual Report on Form 10-K\n10(i) Executive employment Included as Exhibits 7 and 8 of this contracts Form 10-K\n10(j) License and Mfg. Agreement Incorporated by reference to Exhibit Amendment No. 1 w\/ ECI 10(j) of the Company's 1994 Annual Report on Form 10-K\n10(k) Shareholders Agreements w\/ Incorporated by reference to Exhibit ECI and AMS 10(k) of the Company's 1994 Annual Report on Form 10-K\n11 Statement re: Computation Included as Exhibit 9 of this Form 10-K of Per Share Earnings\n12 Stock Purchase Agreements Included as Exhibit 4 of this Form 10-K\n17 Proxy Statement Included as Exhibit 5 of this Form 10-K\n24 Report of Independent Included as Exhibit 12 of this Form Accountants of Financial 10-K Statement Schedules\n25 Powers of Attorney Included as Exhibit 10 of this Form 10-K\n26 Annual Report to Shareholders Incorporated by reference to paper copies of the Company's Annual Report to Shareholders mailed to the Securities and Exchange Commission and The Nasda Stock Market on June 22, 1995.\nSchedule 8 - Reserves Included as Exhibit 13 of this Form 10-K\nComputation of Net Income Included as Exhibit 9 of this Form 10-K\nEDGAR EXHIBITS\nExhibit 1 Price Range of Common Stock\nExhibit 2 Management Discussion and Analysis\nExhibit 3 Financial and other Reports from 1995 Annual Report --Report of Independent Accountant Consolidated Balance Sheet --Consolidated Statement of Income and Retained Earnings --Consolidated Statement of Cash Flows --Notes to Consolidated Financial Statements\nExhibit 4 Stock Purchase Agreements --Karl H. Kostusiak --David B. Lederer\nExhibit 5 1995 Proxy Statement\nExhibit 6 Credit Agreements --Fleet Bank (previously Norstar Bank) --Chemical Bank\nExhibit 7 Employment Agreements --Karl H. Kostusiak --David B. Lederer\nExhibit 8 Employment Agreement --Lawrence R. Tracy\nExhibit 9 Computation of Per Share Earnings Statement\nExhibit 10 Powers of Attorney --Donald R. Adair --Mortimer B. Fuller III --Edward C. McIrvine\nExhibit 11 5-Year Summary of Operations\nExhibit 12 Report of Independent Accountants of Financial Statement Schedules\nExhibit 13 Schedule 8 Reserves Statement\nExhibit 27 Financial Data Schedule","section_15":""}
{"filename":"354963_1995.txt","cik":"354963","year":"1995","section_1":"ITEM 1. BUSINESS\n(a) General development of business is incorporated by reference -\n1995 Annual Report to Security Holders - Inside Front Cover\n(b) Financial information about industry segments -\nNot Applicable\n(c) Narrative description of business is incorporated by reference -\n1995 Annual Report to Security Holders - Pages 4 - 7\n(d) The registrant does not engage in operations in foreign countries.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe properties of the Company consist of land, structures, plant and equipment required in providing telephone, CATV, wireless communications and related telecommunications services. The Company's main office and corporate headquarters is in Edinburg, VA and a service building is located outside the town limits of Edinburg, VA. Additionally, the Company owns and operates nine local telephone exchanges (switching units) housed in brick\/concrete buildings. One of these is the main attended central office co-located with the main office in Edinburg, Virginia. The unattended central offices and outside plant are located at:\n(a) Basye, VA (b) Bergton, VA (c) Fort Valley, VA (d) Mount Jackson, VA (e) New Market, VA (f) Strasburg, VA (g) Toms Brook, VA (h) Woodstock, VA\nThe Company owns long distance facilities outside of its local franchised area as follows:\n(a) Hagerstown, MD (b) Harrisonburg, VA (c) Martinsburg, WV PART I (Continued)\nITEM 2. PROPERTIES (Continued)\n(d) Stephens City, VA (e) Weyers Cave, VA (f) Winchester, VA\nCATV reception equipment is located at the service building, outside the town limits of Edinburg, Virginia and at Basye, Virginia.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nNone\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matters were submitted to a vote of security holders for the three months ended December 31, 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\n(a) Common stock price ranges are incorporated by reference -\n1995 Annual Report to Security Holders Market Information - Inside Front Cover\n(b) Number of equity security holders are incorporated by reference -\n1995 Annual Report to Security Holders Five-Year Summary of Selected Financial Data - Page 3\n(c) Frequency and amount of cash dividends are incorporated by reference -\n1995 Annual Report to Security Holders Market and Dividend Information - Inside Front Cover\nAdditionally, the terms of a mortgage agreement require the maintenance of defined amounts of the subsidiary's equity and working capital after payment of dividends. Accordingly, approximately $18,309,000 of retained earnings was available for payment of dividends at December 31, 1995.\nFor additional information, see Note 4 in the Consolidated Financial Statements of the 1995 Annual Report to Security Holders, which is incorporated as a part of this report.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nFive-Year Summary of Selected Financial Data is incorporated by reference -\n1995 Annual Report to Security Holders Five-Year Summary of Selected Financial Data - Page 3\nPART II (Continued)\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nResults of operations, liquidity, and capital resources are incorporated by reference -\n1995 Annual Report to Security Holders Management's Discussion and Analysis of Financial Condition and Results of Operations - Pages 8-9\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nConsolidated financial statements included in the 1995 Annual Report to Security Holders are incorporated by reference as identified in Part IV, Item 14, on Pages 6 and 7.\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 concerning directors and executive officers is incorporated by reference -\nProxy Statement, Dated March 22, 1996 - Pages 1 - 5\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation concerning executive compensation is incorporated by reference -\nProxy Statement, Dated March 22, 1996 - Page 5\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\n(a) No person, director or officer owned over 5 percent of the common stock as of March 1, 1996.\n(b) Security ownership by management is incorporated by reference -\nProxy Statement, Dated March 22, 1996 Stock Ownership - Page 4\n(c) Contractual arrangements -\nThe Company knows of no contractual arrangements which may, at a subsequent date, result in change of control of the Company.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThere are no relationships or transactions to disclose other than services provided by Directors which are incorporated by reference - Proxy Statement, Dated March 22, 1996 Directors - Page 2\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\nA. Document List\nThe following documents are filed as part of this Form 10-K. Financial statements are incorporated by reference and are found on the pages noted.\nPage Reference\nAnnual Form 10-K Report 1. Financial Statements\nThe following consolidated financial statements of Shenandoah Telecommunications are included in Part II, Item 8\nAuditor's Report 1995 and 1994 Financial Statements 17\nAuditor's Report 1993 Financial Statements 9\nConsolidated Balance Sheets at December 31, 1995, 1994, and 1993 10 & 11\nConsolidated Statements of Income for the Years Ending December 31, 1995, 1994, and 1993 12\nConsolidated Statement of Retained Earnings Years Ended December 31, 1995, 1994, and 1993 12\nConsolidated Statements of Cash Flow for the Years Ending December 31, 1995, 1994, and 1993 13\nNotes to Consolidated Financial Statements 14-17\nPART IV (Continued)\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (Continued)\nPage Reference\nAnnual Form 10-K Report\n2. Financial Statement Schedules\nAll other schedules are omitted because they are not applicable, or not required, or because the required information is included in the accompanying financial statements or notes thereto.\n3. Exhibits\nExhibit No.\n99. Proxy Statement, prepared by Registrant for 1995 Annual Stockholders Meeting - Filed Herewith\n13. Annual Report to Security Holders - Filed Herewith\n21. List of Subsidiaries - Filed Herewith\nB. Reports on Form 8-K\nReported the signing of a Letter of Intent to acquire the Shenandoah County, Virginia cable television systems of FrontierVision Operating Partners, L.P., of Denver, Colorado. The acquisition is subject to execution of a definitive agreement and approval by the local governing bodies for the transfer of the existing franchises.\nPART IV (Continued)\nSIGNATURES\nPursuant to the requirements of Sections 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nSHENANDOAH TELECOMMUNICATIONS COMPANY\nMarch 29, 1996 By CHRISTOPHER E. FRENCH, PRESIDENT Christopher E. French, President\nPursuant to the requirements of the Securities Exchange Act of 1934, this report signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nPresident & Chief Executive CHRISTOPHER E. FRENCH Officer March 29, 1996 Christopher E. French\nLAURENCE F. PAXTON Principal Financial March 29, 1996 Laurence F. Paxton Accounting Officer\nDICK D. BOWMAN Treasurer & Director March 29, 1996 Dick D. Bowman\nKEN L. BURCH Director March 29, 1996 Ken L. Burch\nPHILIP M. GRABILL, JR. Director March 29, 1996 Philip M. Grabill, Jr.\nHAROLD MORRISON Director March 29, 1996 Harold Morrison\nNOEL M. BORDEN Director March 29, 1996 Noel M. Borden\nJAMES E. ZERKEL II Director March 29, 1996 James E. Zerkel II REPORT OF INDEPENDENT AUDITORS\nTo the Board of Directors and the Stockholders of Shenandoah Telecommunications Company\nWe have audited the accompanying consolidated balance sheets of Shenandoah Telecommunications Company and subsidiaries, as of December 31, 1993, and the related consolidated statements of income, retained earnings, and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as 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 Shenandoah Telecommunications Company and subsidiaries as of December 31, 1993, and the results of their operations and their cash flows for the years then ended in conformity with generally accepted accounting principles.\nS.B. HOOVER & COMPANY, LLP\nHarrisonburg, VA 22801 January 21, 1994\nEXHIBIT 99. PROXY STATEMENT\nSHENANDOAH TELECOMMUNICATIONS COMPANY 124 South Main Street Edinburg, Virginia\nNOTICE OF ANNUAL MEETING OF STOCKHOLDERS TO BE HELD APRIL 16, 1996\nMarch 22, 1996\nTO THE STOCKHOLDERS OF SHENANDOAH TELECOMMUNICATIONS COMPANY:\nThe annual meeting of stockholders of Shenandoah Telecommunications Company will be held in the Social Hall of the Edinburg Fire Department, Stoney Creek Boulevard, Edinburg, Virginia, on Tuesday, April 16, 1996, at 11:00 a.m. for the following purposes:\n1. To elect nine directors to serve for the ensuing year;\n2. To approve the Shenandoah Telecommunications Company Stock Incentive Plan; and\n3. To transact such other business as may properly come before the meeting or any adjournment thereof.\nOnly stockholders of record at the close of business March 20, 1996, will be entitled to vote at the meeting.\nLunch will be provided.\nBy Order of the Board of Directors Harold Morrison, Jr. Secretary\nIMPORTANT\nYOU ARE URGED TO COMPLETE, SIGN, AND RETURN THE ENCLOSED PROXY CARD IN THE SELF-ADDRESSED STAMPED (FOR U. S. MAILING) ENVELOPE PROVIDED AS PROMPTLY AS POSSIBLE, WHETHER OR NOT YOU PLAN TO ATTEND THE MEETING IN PERSON. IF YOU DO ATTEND THE MEETING IN PERSON, YOU MAY THEN WITHDRAW YOUR PROXY AND VOTE YOUR OWN SHARES.\nSEE PROXY STATEMENT ON THE FOLLOWING PAGES PAGE\nPROXY STATEMENT P. O. Box 459 Edinburg, VA 22824 March 22, 1996\nTO THE STOCKHOLDERS OF SHENANDOAH TELECOMMUNICATIONS COMPANY:\nYour proxy in the enclosed form is solicited by the management of the Company for use at the Annual Meeting of Stockholders to be held in the Social Hall of the Edinburg Fire Department, Stoney Creek Boulevard, Edinburg, Virginia, on Tuesday, April 16, 1996, at 11:00 a.m., and any adjournment thereof.\nThe mailing address of the Company's executive offices is P. O. Box 459, Edinburg, Virginia 22824.\nThe Company has 8,000,000 authorized shares of common stock, of which 3,760,760 shares were outstanding on March 20, 1996. This proxy statement and the Company's annual report, including financial statements for 1995, are being mailed on or about March 22, 1996, to approximately 3,270 stockholders of record on March 20, 1996. Only stockholders of record on that date are entitled to vote. Each outstanding share will entitle the holder to one vote at the Annual Meeting. No director, officer, or other party owns as much as five percent of the outstanding shares of the common stock of the Company. The Company intends to solicit proxies by the use of the mail, in person, and by telephone. The cost of soliciting proxies will be paid by the Company.\nExecuted proxies may be revoked at any time prior to exercise. Proxies will be voted as indicated by the stockholders.\nTHE ELECTION OF DIRECTORS\nAt the meeting, nine directors (constituting the entire Board of Directors of the Company) are to be elected for the ensuing year.\nThe proxy holders will vote the proxies received by them (unless contrary instructions are noted on the proxies) for the election as directors of the following nominees, all of whom are now members of and constitute the Company's Board of Directors. If any such nominees should be unavailable, the proxy holders will vote for substitute nominees in their discretion. Stockholders may withhold the authority to vote for the election of directors or one or more of the nominees. Directors will be elected by a plurality of the votes cast. Abstentions and shares held in street name that are not voted in the election of directors will not be included in determining the number of votes cast. PAGE\nTHE ELECTION OF DIRECTORS (Continued)\nWarren B. French, Jr. retired as Chairman and Director December 31, 1995 in accordance with the age requirements of the Bylaws of the Company; and effective January 1, 1996, President Christopher French replaced him as Director. I. Clinton Miller, who resigned as Director February 14, 1996, because of his appointment to the Virginia State Corporation Commission, was replaced effective February 15 by Philip M. Grabill, Jr.\nPAGE\nNominees for Election of Directors\nElected Principal Occupation and Other Name of Director Director Age Directorships for Past Five Years (1) (2) (3)\nNoel M. Borden 1972 59 Pres., H. L. Borden Lumber Co. (a Vice President retail building materials firm); Chairman of Board, 1st National Corp.\nDick D. Bowman 1980 67 Pres., Bowman Bros., Inc. (a farm Treasurer of the Co. equip. dealer); Dir., Shen. Valley Elec. Coop.; Dir., Rockingham Mutual Ins. Co.; Dir., Old Dominion Electric Coop.\nKen L. Burch 1995 51 Farmer\nChristopher E. French 1996 38 Pres., Shen. Telecommunications Co. President & its Subsidiaries; Dir., 1st National Corp.\nPhilip M. Grabill, Jr. 1996 46 Attorney-at-Law\nGrover M. Holler, Jr. 1952 75 Pres., Blue Ridge Homes, Inc. (a real estate developer); Pres., Valley View, Inc.\nHarold Morrison, Jr. 1979 66 Chairman of the Board, Woodstock Secretary of the Co. Garage, Inc. (auto sales & repair firm); Dir., 1st Va. Bank-SV\nZane Neff 1976 67 Retired Manager, Hugh Saum Co., Asst. Secretary Inc. (a hardware and furniture of the Co. store); Director, Crestar Bank\nJames E. Zerkel II 1985 51 Vice Pres., James E. Zerkel, Inc. (a plumbing, heating, gas, & hardware firm) PAGE\n(1) The directors who are not full-time employees of the Company were compensated in 1995 for their services on the Board and one or more of the Boards of the Company's subsidiaries at the rate of $340 per month plus $340 for each Board meeting attended. Additional compensation was paid to the Vice President, Secretary, Assistant Secretary, and Treasurer, for their services in these capacities, in the amounts of $1,240, $2,600, $1,240, and $2,600, respectively.\n(2) Years shown are when first elected to the Board of the Company or the Company's predecessor, Shenandoah Telephone Company. Each nominee has served continuously since the year he joined the Board.\n(3) Each director also serves as a director of one or more of the Company's subsidiaries.\n\/TABLE\nStanding Audit, Nominating, and Compensation Committees of the Board of Directors\n1. Audit Committee - The Finance Committee of the Board of Directors, consisted of the following directors: Dick D. Bowman (Chairman), Grover M. Holler, Jr., and Noel M. Borden. It performed a function similar to that of an Audit Committee. This committee is responsible for the employment of outside auditors and for receiving and reviewing the auditor's report. During 1995 there were three meetings of the Finance Committee. Additional business of the committee was conducted in connection with the regular Board meetings.\n2. Nominating Committee - The Board of Directors does not have a standing Nominating Committee.\n3. Compensation Committee - The Personnel Committee of the Board of Directors, consisted of the following directors: Noel M. Borden (Chairman), Harold Morrison, Jr., and I. Clinton Miller. It performed a function similar to that of a Compensation Committee. This committee is responsible for the wages, salaries, and benefit programs for all employees. During 1995 there were three meetings of this committee.\nAttendance of Board Members at Board and Committee Meetings\nDuring 1995, the Board of Directors held 14 meetings. All of the directors attended at least 75 percent of the aggregate of: (1) the total number of meetings of the Board of Directors; and (2) the total number of meetings held by all committees of the Board on which they served.\nCertain Transactions\nIn 1995, the Company received services from Mr. Morrison's company in the amount of $10,827 and from Mr. Zerkel's company in the amount of $9,390. Management believes that each of the companies provides these services to the Company on terms comparable to those available to the Company from other similar companies. No other director is an officer, director, employee, or owner of a significant supplier or customer of the Company.\nPAGE\nSTOCK OWNERSHIP\nThe following table presents information relating to the beneficial ownership of the Company's outstanding shares of common stock by all directors, the president, and all directors and officers as a group.\nNo. of Shares Name and Address Owned as of 2-1-96 Percent of Class (1) (2) Noel M. Borden 17,456 * Strasburg, VA 22657 Dick D. Bowman 42,744 1.14 Edinburg, VA 22824 Ken L. Burch 45,172 1.20 Quicksburg, VA 22847 Christopher E. French 127,486 3.39 Woodstock, VA 22664 Philip M. Grabill, Jr. 3,840 * Woodstock, VA 22664 Grover M. Holler, Jr. 70,736 1.88 Edinburg, VA 22824 Harold Morrison, Jr. 20,378 * Woodstock, VA 22664 Zane Neff 7,616 * Edinburg, VA 22824 James E. Zerkel II 4,298 * Mt. Jackson, VA 22842 Total shares beneficially owned by 12 directors and officers as a group 341,882 9.09\n(1) Includes shares held by relatives and in certain trust relationships, which may be deemed to be beneficially owned by the nominees under the rules and regulations of the Securities and Exchange Commission; however, the inclusion of such shares does not constitute an admission of beneficial ownership.\n(2) Asterisk indicates less than 1%. PAGE\nA report of beneficial ownership to the S.E.C. for the purchase of 300 shares by Dick D. Bowman, Treasurer, was filed late due to a broker's delay in delivery for transfer. A report of beneficial ownership to the S.E.C. for the purchase of 100 shares for an IRA and 30 shares for a Keogh Plan by Christopher E. French, President, was filed late due to a clerical error.\nSUMMARY COMPENSATION TABLE\nThe following Summary Table is furnished as to the salary and incentive payment paid by the Company and its subsidiaries on an accrual basis during the fiscal years 1993, 1994, and 1995 to, or on behalf of, the chief executive officer and each of the next four most highly compensated executive officers who earn $100,000 or more per year.\nName and Principal Incentive Position Year Salary Payment\nChristopher E. French 1995 $114,684 $ 20,150 President 1994 107,816 14,875 1993 100,904 14,159\n\/TABLE\nRETIREMENT PLAN\nThe Company maintains a noncontributory defined benefit Retirement Plan for its employees. The following table illustrates normal retirement benefits based upon Final Average Compensation and years of credited service. The normal retirement benefit is equal to the sum of:\n(1) 1.14% times Final Average Compensation plus 0.65% times Final Average Compensation in excess of Covered Compensation (average annual compensation with respect to which Social Security benefits would be provided at Social Security retirement age) times years of service (not greater than 30); and\n(2) 0.29% times Final Average Compensation times years of service in excess of 30 years (such excess service not to exceed 15 years).\nEstimated Annual Pension Years of Credited Service Final Average Compensation 15 20 25 30 35 $ 20,000 $ 3,420 $ 4,560 $ 5,700 $ 6,840 $ 7,130 35,000 6,709 8,945 11,181 13,418 13,925 50,000 10,736 14,315 17,894 21,473 22,198 75,000 17,449 23,265 29,081 34,898 35,985 100,000 24,161 32,215 40,269 48,323 49,773 120,000 29,531 39,375 49,219 59,063 60,803\nCovered Compensation for those retiring in 1996 is $27,576. Final Average Compensation equals an employee's average annual compensation for the five consecutive years of credited service for which compensation was the highest. The amounts shown as estimated annual pensions were calculated on a straight-life basis assuming the employee retires in 1996. The Company made contributions totaling $197,200 to the Retirement Plan in 1995. Christopher French has 14 years of credited service under the plan as of January 1, 1996.\nCOMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION\nThe members of the Personnel Committee of the Board of Directors of the Company perform the function of a Compensation Committee. The Committee's approach to compensation of the Company's executive officers, including the chief executive officer, is to award a total compensation package consisting of salary, incentive, and fringe benefit components. The compensation package is designed to provide a level of compensation to enable the Company to attract and retain the executive talent necessary for the long-term success of the organization. PAGE\nThe incentive plan component of the total compensation package provides an incentive to the officers to meet or exceed certain performance objectives. The plan also places a portion of the officers' compensation at risk in the event the Company does not achieve its objectives. The objectives include a component measuring the improvement in the level of service provided to the Company's customers and a component measuring the increase in the Company's net income. In 1995, the Company reached over 123 percent of its combined goals.\nSubmitted by the Company's Personnel Committee: Noel Borden, Chairman, Harold Morrison, Jr., Clinton Miller\nFIVE-YEAR STOCKHOLDER RETURN COMPARISON\nThe Securities and Exchange Commission requires that the Company include in its Proxy Statement a line graph presentation comparing cumulative, five-year stockholder returns on an indexed basis with a performance indicator of the overall stock market and either a nationally recognized industry standard or an index of peer companies selected by the Company. The broad market index used in the graph is the NASDAQ Market Index. The S&P Telephone Index consists of the seven regional Bell Operating Companies and GTE.\nThe Company's stock is not listed on any national exchange nor NASDAQ; therefore, for purposes of the following graph, the value of the Company's stock, including the price at which dividends are assumed to have been reinvested, has been determined based upon the average of the prices of transactions in the Company's stock that were reported to the Company in each fiscal year.\nComparison of Five-Year Cumulative Total Return* among Shenandoah Telecommunications Company, NASDAQ Market Index, and S&P Telephone Index\n1990 1991 1992 1993 1994 1995\nShenandoah Telecommunications 100.00 177.11 186.83 195.65 186.88 201.52\nNASDAQ Market Index 100.00 160.00 186.90 214.50 209.70 296.30\nS&P Telephone Index 100.00 107.54 118.01 136.29 130.66 196.82\nAssumes $100 invested December 31, 1990 in Shenandoah Telecommunications Company stock, NASDAQ Market Index, and S&P Telephone Index\n*Total return assumes reinvestment of dividends\nAPPROVAL OF THE SHENANDOAH TELECOMMUNICATIONS COMPANY STOCK INCENTIVE PLAN\nThe Board proposes that the shareholders approve the Shenandoah Telecommunications Company Stock Incentive Plan (the \"Plan\"), adopted by the Board on January 8, 1996, subject to the approval of the Company's shareholders. The approval of the Plan requires the affirmative vote of the holders of a majority of the shares of Common Stock present or represented by properly executed and delivered proxies at the meeting. Abstentions and Broker Shares voted as to any matter at the meeting will be included in determining the number of votes present or represented at the meeting with respect to determining the vote on the Plan. Broker Shares that are not voted on any matter at the meeting will not be included in determining the number of shares present or represented at the meeting with respect to determining the vote on the Plan.\nThe following paragraphs summarize the principal features of the Plan. This summary is subject, in all respects, to the terms of the Plan. The Company will provide promptly, upon request and without charge, a copy of the full text of the Plan to each person to whom a copy of this proxy statement is delivered. Requests should be directed to: Laurence F. Paxton, Vice President-Finance, Shenandoah Telecommunications Company, P. O. Box 459, Edinburg, Virginia 22824 (Telephone (540) 984-5222).\nSummary of the Plan\nThe Board believes that the Plan will benefit the Company by (i) assisting it in recruiting and retaining employees with ability and initiative, (ii) providing greater incentive for employees of the Company or its affiliates and (iii) associating the interests of employees with those of the Company, its affiliates, and its shareholders through opportunities for increased stock ownership. A maximum of 240,000 shares of Common Stock may be issued under the Plan.\nThe Personnel Committee of the Board (the \"Committee\") will administer the Plan. The Committee may delegate its authority to administer the Plan to one or more officers of the Company. The Committee, however, may not delegate its authority with respect to individuals who are subject to Section 16 of the Securities Exchange Act of 1934 (\"Section 16\"). As used in this summary, the term \"Administrator\" means the Committee and any delegate, as appropriate.\nEach employee of the Company or an affiliate is eligible to participate in the Plan. The Administrator will select the individuals who will participate in the Plan (\"Participants\") but no person may participate in the Plan while he is a member of the Committee. The Administrator may, from time to time, grant stock options, stock appreciation rights (\"SARs\"), or stock awards to Participants.\nOptions granted under the Plan may be incentive stock options (\"ISOs\") or nonqualified stock options. A stock option entitles the Participant to purchase shares of Common Stock from the Company at the option price. The option price will be fixed by the Administrator at the time the option is granted, but the price cannot be less than the shares' Fair Market Value on the date of grant. The option price may be paid in cash, with shares of Common Stock, or with a combination of cash and Common Stock. \"Fair Market Value\" means, on any given date, the fair market value of a share of Common Stock as determined by the Committee using any reasonable method in good faith.\nSARs entitle the Participant to receive with respect to each share of Common Stock encompassed by the exercise of such SAR, an amount determined by the Committee. If the Committee does not make such a determination, the Participant will be entitled to receive the excess of the Fair Market Value of a share of Common Stock on the date of exercise over the initial value of the SAR. The initial value of the SAR is the Fair Market Value of a share of Common Stock on the date of grant. The amount payable upon the exercise of an SAR may be paid in cash, Common Stock, or a combination of the two.\nSARs may be granted in relation to option grants (\"Corresponding SARs\") or independently of option grants. The difference between these two types of SARs is that to exercise a Corresponding SAR, the Participant must surrender unexercised that portion of the stock option to which the Corresponding SAR relates.\nParticipants may also be awarded shares of Common Stock pursuant to a stock award. The Administrator, in its discretion, may prescribe that a Participant's rights in a stock award shall be nontransferable or forfeitable or both unless certain conditions are satisfied. These conditions may include, for example, a requirement that the Participant continue employment with the Company or an affiliate for a specified period or that the Company, an affiliate, or the Participant achieve stated objectives.\nAll awards made under the Plan will be evidenced by written agreements between the Company and the Participant. A maximum of 240,000 shares of Common Stock may be issued under the Plan. The share limitation and the terms of outstanding awards shall be adjusted, as the Committee deems appropriate, in the event of a stock dividend, stock split, combination, reclassification, recapitalization, or other similar events.\nNo option, SAR or stock award may be granted under the Plan after January 7, 2006. The Board may sooner terminate the Plan without further action by shareholders. The Board also may amend the Plan except that no amendment that increases the number of shares of Common Stock that may be issued under the Plan, changes\nthe class of individuals who may be selected to participate in the Plan, or materially increases the benefits that may be provided under the Plan will become effective until it is approved by shareholders.\nNeither the number of individuals who will be selected to participate in the Plan nor the type or size of awards that will be approved by the Administrator can be determined. The Company is also unable to determine the number of individuals who would have participated in the Plan or the type or size of awards that would have been made under the Plan had it been in effect in 1995.\nFederal Income Tax Consequences\nThe Company has been advised by counsel regarding the federal income tax consequences of the Plan. No income is recognized by a Participant at the time an option is granted. If the option is an ISO, no income will be recognized upon the Participant's exercise of the option. Income is recognized by a Participant when he disposes of shares acquired under an ISO. The exercise of a nonqualified stock option generally is a taxable event that requires the Participant to recognize, as ordinary income, the difference between the shares' fair market value and the option price.\nNo income is recognized upon the grant of an SAR. The exercise of an SAR generally is a taxable event. The Participant generally must recognize income equal to any cash that is paid and the fair market value of Common Stock that is received in settlement of an SAR.\nThe Participant will recognize income on account of a stock award on the first day that the shares are either transferable or not subject to a substantial risk of forfeiture. The amount of income recognized by the Participant is equal to the fair market value of the Common Stock received on that date.\nThe employer (either the Company or an affiliate) will be entitled to claim a federal income tax deduction on account of the exercise of a nonqualified option or SAR and the vesting of a stock award. The amount of the deduction is equal to the ordinary income recognized by the Participant. The employer will not be entitled to a federal income tax deduction on account of the grant or the exercise of an ISO. The employer may claim a federal income tax deduction on account of certain dispositions of Common Stock acquired upon the exercise of an ISO.\nTHE BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS A VOTE \"FOR\" APPROVAL OF THE SHENANDOAH TELECOMMUNICATIONS COMPANY INCENTIVE PLAN. PAGE\nEMPLOYMENT OF AUDITORS\nThe Board of Directors, on the recommendation of the Audit Committee, has appointed the firm of McGladrey and Pullen as auditors to make an examination of the accounts of the Company for the 1996 fiscal year. It is not expected that representatives of the firm will be present at the annual meeting.\nPROPOSALS OF SECURITY HOLDERS\nProposals of security holders to be included in management's proxy statement and form of proxy relating to next year's annual meeting must be received at the Company's principal executive offices not later than November 22, 1996.\nOTHER MATTERS\nManagement does not intend to bring before the meeting any matters other than those specifically described above and knows of no matters other than the foregoing to come before the meeting. If any other matters properly come before the meeting, it is the intention of the persons named in the accompanying form of proxy to vote such proxy in accordance with their judgment on such matters, including any matters dealing with the conduct of the meeting.\nFORM 10-K\nThe Company's Annual Report on Form 10-K filed with the Securities and Exchange Commission is available to stockholders, without charge, upon request to Mr. Laurence F. Paxton, Vice President-Finance, Shenandoah Telecommunications Company, P. O. Box 459, Edinburg, VA 22824.\nPAGE\nEXHIBIT 13. ANNUAL REPORT (inside front cover) STOCKHOLDER INFORMATION\nOur Business\nShenandoah Telecommunications Company is a holding company which provides telephone service through its subsidiary, Shenandoah Telephone Company, primarily in Shenandoah County and small service areas in Rockingham, Frederick, and Warren counties, all in Virginia. The Company provides cable television service through its subsidiary, Shenandoah Cable Television Company, at Edinburg and in rural areas in the vicinity of Edinburg, Woodstock, and Bryce Mountain. The Company provides unregulated communications equipment and services through its subsidiary, ShenTel Service Company, which sells and maintains PBXs, key systems, computers, and security systems. The Company finances purchases of telecommunications facilities and equipment through its subsidiary, Shenandoah Valley Leasing Company. Shenandoah Mobile Company furnishes paging, mobile telephone, business radio, and cellular telephone services in the northern Shenandoah Valley. Shenandoah Mobile Company is the managing general partner of a partnership providing cellular services in Virginia RSA 10 covering the northwestern portion of Virginia. The Company resells long distance services through Shenandoah Long Distance Company. Shenandoah Network Company operates and maintains the Company's interstate fiber optic network. Under an agreement with American Personal Communications, Shenandoah Personal Communications Company is building and operating a personal communications network in the four-state region from Chambersburg, Pennsylvania to Harrisonburg, Virginia.\nAnnual Meeting\nThe Board of Directors extends an invitation to all stockholders to attend the Annual Meeting of Stockholders. The meeting will be held Tuesday, April 16, 1996, at 11:00 a.m. in the Social Hall of the Edinburg Fire Department, Stoney Creek Boulevard, Edinburg, Virginia. Notice of the Annual Meeting, Proxy Statement, and Proxy were mailed to each stockholder on or about March 22, 1996.\nForm 10-K\nThe Company's Annual Report on Form 10-K filed with the Securities and Exchange Commission is available to stockholders, without charge, upon request to Mr. Laurence F. Paxton, Vice President - Finance, Shenandoah Telecommunications Company, P. O. Box 459, Edinburg, VA 22824. (Inside front cover bottom)\nMarket and Dividend Information\nThe stock of Shenandoah Telecommunications Company is not listed on any national exchange or NASDAQ, and the Company is not aware of any broker who maintains a position in the Company's stock. It, however, is aware of unconfirmed transactions of the stock which have been handled privately and by brokers and local auctioneers. Some of these prices include commissions and auctioneers' fees. Since some prices are not reported to the Company and family transactions are not applicable, all transactions are not included in the following summary of prices. The shares, prices, and cash dividends for 1994 have been adjusted to reflect a 2-for-1 stock split which was paid to stockholders of record January 23, 1995. The Company has maintained a policy of declaring an annual cash dividend.\n1995 1994 No. No. No. No. Qtr. Trans. Shares High Low Trans. Shares High Low 1st 69 10,123 $25.00 $18.41 59 11,348 $25.00 $20.00 2nd 221 22,860 40.00 19.00 45 9,086 25.00 14.41 3rd 167 13,860 31.00 19.00 112 13,870 25.00 17.50 4th 119 10,885 30.00 19.00 57 6,600 25.00 19.00\nAverage price per share - $21.42 $20.31 Annual cash dividend per share - .42 .375 Special cash dividend per share - .06 -\nCorporate Headquarters Independent Auditors Shenandoah Telecommunications Company McGladrey & Pullen, LLP 124 South Main Street 1051 East Cary Street Edinburg, VA 22824 Richmond, VA 23210\nStockholders' Questions and Stock Transfers - Call (540) 984-5260 Transfer Agent - Common Stock Shenandoah Telecommunications Company P. O. Box 459 Edinburg, VA 22824\nFIVE-YEAR SUMMARY OF SELECTED FINANCIAL DATA\n1995 1994 1993 1992 1991\nOperating Revenues $21,919,150 $20,229,178 $18,329,886 $17,359,114 $15,180,205 Operating Expenses 13,027,468 12,050,713 11,455,136 10,454,448 9,535,090 Income Taxes 3,572,956 2,577,641 2,481,764 2,189,663 1,792,022 Other Income less Other Expenses (1) 456,544 (90,897) (154,454) 188,210 307,259 Interest Expense 685,971 658,908 621,944 667,900 771,285 Gain (loss) on Security Sales or Writedown 1,141,386 - - (220,000) - Consolidated Net Income $ 6,230,685 $ 4,851,019 $ 4,602,619 $ 4,015,313 $ 3,389,067 Consolidated Net Income from Operations (2) $ 5,522,904 $ 4,851,019 $ 4,156,300 $ 4,151,801 $ 3,389,067 Total Assets $59,896,990 $52,464,150 $49,652,064 $44,839,501 $42,206,407 Long-Term Obligations $10,558,953 $ 9,941,209 $ 9,381,813 $ 8,754,524 $ 9,033,561 Stockholder Information Number of Stockholders 3,226 2,979 2,879 2,683 2,519 Shares of Stock (3) 3,760,760 3,760,760 3,760,760 3,760,760 3,760,760 Earnings per Share (3) $ 1.66 $ 1.29 $ 1.22 $ 1.07 $ .90 - Continuing Operations (3) $ 1.47 $ 1.29 $ 1.11 $ 1.10 $ .90 Cash Dividend per Share (3) $ .42 $ .375 $ .30 $ .275 $ .25 Special Cash Dividend per Share (3) $ .06 $ - $ - $ - $ -\n(1) Includes non-operating income less expenses and minority interest in net income of consolidated subsidiaries.\n(2) Excludes gain on sale of investments in Virginia Metrotel and MFS Communications Company in 1995; gain on sale of fiber optic lease asset; write-off of portion of investment in Metrotel Services, Ltd.; share of loss of Virginia Metrotel in 1994 and 1993; and write-down of AvData in 1992.\n(3) The information has been restated to reflect a 2-for-1 split to stockholders of record January 23, 1995. \/TABLE\nPCS STARTED IN RURAL AREAS\nShenandoah Personal Communications Company, the newest subsidiary of Shenandoah Telecommunications, has initiated service for the first rural PCS (Personal Communications Services) system in the United States. PCS is the next generation of wireless telephone and data service. The PCS technology was developed more than a decade ago in order to create a common mobile telephone system for Europe. PCS has been the European standard for wireless communications since 1982. Our involvement with PCS began in 1994 when Shenandoah Personal Communications Company agreed to build the western part of the PCS network for American Personal Communications (APC). APC built the first PCS network in the United States, covering the Washington\/Baltimore metropolitan trading area (MTA). Mirroring the historic first phone call ever placed (from Baltimore to Washington), Vice President Al Gore made the first PCS call from Washington to Baltimore. The Mayor of Baltimore, with whom the Vice President spoke, joked that it was about time Washington returned their call. Based in Bethesda, Maryland, APC is an affiliate of the Sprint Telecommunications Venture, the company that will offer PCS nationwide under the brand name Sprint Spectrum. Shenandoah Personal Communications Company will also be marketing PCS under the Sprint Spectrum name to a potential customer base of 750,000 in rural Virginia, West Virginia, and Maryland.\nPCS uses digital technology to provide high-quality voice communications, alpha-numeric paging, and VoiceMail in one handset, for totally mobile wireless communications. The handsets are also capable of fax and data transmission, so portable computer users will soon have the ability to be \"on- line\" anywhere in the network from their PCS handset without the need for a separate modem. The brain of a PCS handset is a computer chip called a Smart Card. Because a user's serial number does not transmit over the air, where it could potentially be fraudulently intercepted, this technology eliminates unauthorized use of your number.\nShenandoah Personal Communications Company has been extremely busy building our PCS network. In the past year we have built nine towers in the Hagerstown\/Chambersburg area and are on track to extend the service area north and south along the I-81 corridor. As of December 1995, we had coverage in the Greater Hagerstown area (Maryland), north to Greencastle, Pennsylvania, south to Nipetown, West Virginia, and east on I-70 to Myersville, Maryland. We will have continuous coverage from Hagerstown, Maryland to Harrisonburg, Virginia by December 1996. Our PCS network will eventually extend along the I-81 corridor from Rockingham County, Virginia to Franklin County, Pennsylvania. The grand opening of our store in Hagerstown is scheduled for March 1996; however, we have already been open for business, and there is a tremendous amount of excitement about our products and services. With its PCS venture, Shenandoah Telecommunications Company is remaining in the forefront of technology, which is part of our continuing commitment to bring the technologies of the future to our customers today.\nSHENANDOAH CABLE TELEVISION TO ACQUIRE C4 MEDIA CABLE PROPERTIES IN SHENANDOAH COUNTY\nOn February 21, 1996 Shenandoah Cable Television Company signed a letter of intent to acquire the Shenandoah County CATV systems formerly owned by C4 Media Cable. The systems, which were recently acquired by FrontierVision Operating Partners, L.P. of Denver, Colorado, will become part of Shentel's existing CATV system, which presently serves the town of Edinburg, Basye and surrounding areas of Shenandoah County.\nThis acquisition will allow us to offer the residents of Shenandoah County the benefits of local ownership and operation of their CATV services. At the same time it will enable us to continue expanding our broadband network services in order to provide the services needed by our customers, both today and in the future.\nOur Company had previously expressed interest in acquiring the former C4 properties as we felt the acquisition would be in the best long term interests of the residents of Shenandoah County. The recent enactment of the Telecommunications Act of 1996 removes the requirement of approval by the Federal Communications Commission, and now allows the Company to purchase or build CATV facilities within the same areas as it provides local telephone services. Operation of CATV and telephone networks in the same area will allow both services to share common network elements, such as the Company's state of the art fiber optics facilities.\nOwning and operating a combined CATV system will allow us to offer all of our CATV customers a broad selection of video programming, and to supplement the basic services with additional features and functionality in the future. Of particular interest is the potential to use the bandwidth capacity of the CATV network for the delivery of new services such as high speed Internet access, development of a community public access channel, and possible integration with educational efforts such as the Shenandoah County School's Interactive Classroom system. Work will initially be focused on bringing the systems up to the quality standards expected by residents of the area, and then to explore ways to enhance the range of services available to our customers. The acquisition is subject to finalization of a definitive agreement, and approval by the local governing bodies for the transfer of the existing franchises.\nINTERNET SERVICE CONTINUES RAPID GROWTH\nIn September 1994, ShenTel Service Company became the first provider in the Northern Shenandoah Valley to offer local access to the Internet. Local access has now been expanded to include Shenandoah, Rockingham, Frederick, Clarke, Warren, and Page counties. Usage of our Internet service has continued to grow, due in part to our continued investment in providing high-quality service. While the Internet has received much publicity and hype, we have focused on providing the necessary network capacity and overall service quality in order to remain the premier provider of service.\nDuring 1995, ShenTel offered free access to the Internet to all public schools and public libraries in ShenTel's Internet service area. The offer reflects the organization's view that this is a valuable tool for educational purposes and reinforces our commitment and support for the education of our youth. We believe that by making the Internet more readily accessible, all members of our community will be able to broaden their horizons, educational opportunities, and be part of the global information society.\nThe Internet continues to evolve and grow, both in popularity and available services. ShenTel remains committed to providing our customers with state of the art technology to meet and surpass their telecommunications needs.\nDBS SERVICE NOW AVAILABLE FROM SHENTEL\nShenTel Service Company is now offering DIRECTV, an all- digital satellite television service. DIRECTV is a relatively new technology which uses high-powered communications satellites to broadcast digital TV signals to a small receiving dish located at the customer's premises. DIRECTV provides our customers with an additional choice on how they receive their video programming services. The equipment includes an 18\" satellite dish which captures signals from a communications satellite. The signal is then passed on to a VCR-sized digital receiving box that works with a remote control. A wide range of programming choices is available, along with a unique \"video store in the home\" capability which allows customers to order on demand recent box office hits and classic movies.\nShenTel currently markets and services the larger C-band dishes, and our cable operation provides conventional cable television services to a large portion of Shenandoah County. The addition of this product offering allows us to bring the leading edge information and entertainment technology to all of our customers and earn revenues from the sale of equipment and programming.\nPERSONNEL\nThe business growth and expansion of our organization was reflected in the increase in our number of employees. At the end of the year we had 140 full-time equivalent (FTE) employees, as compared to 122 FTE employees at the end of 1994. These additions were primarily due to the start-up of our PCS operations, growth of our Internet business, and the additions to our Accounting Department.\nEmployees hired in 1995 include: Shenandoah Telephone Company - - Teresa Edmonds, Part-time Communications Center Operator; Shelly Bowman, Junior Staff Accountant; Sandra Nelson, Rhonda Rau, and Deborah Smoot, Accounting Clerks; Robin Miller, Facility Clerk; Betty Ayers and Lisa Shillingburg, Service Representatives; Angela Talley, Office Assistant; and Edward Williams, Laborer. ShenTel Service Company Internet Department - Richard Church, Product Manager; Beth Venditti, Sales Assistant; and Donna Miller, Office Assistant. Shenandoah Cellular - Gayle Morris, Sales Manager; William Hunt, Installer-Repairman; and Tamara Weekley and Kelly Clark, Service Representatives. Shenandoah Personal Communications Company (Edinburg office) - David MacDonald, Construction Manager; Leonard Greisz, Project Manager; and Zoe Forrester and Lynda Hoffman, Office Assistants; (Hagerstown office) - William Young, Local Manager; David Dillard, Sales and Marketing Director; and David Mathias and Timothy Klick, Retail Sales Representatives; and (Winchester office) - Brian Brooks, Sales Manager.\nIn addition, the following seven employees received promotions during the year: Steven Heltzel and Chris Herbaugh, Installer- Repairmen; Jeffrey Manning, Field Engineer; Rhonda Rau, Junior Staff Accountant; Curtis Sawyer, Accounting Clerk; Freddie Wellard, Construction Coordinator; and Lorrie Wood, Cellular Sales Representative.\nMany milestone anniversaries were reached in 1995. We recognized the following 17 employees for a total of 250 years of service: 35 years - Ray Hawkins and Lewis Fadely; 30 years - Roger Baker and Larry Richard; 20 years -Kenneth Fadely and William Sibert, Jr.; 15 years - Eugene Miller; 10 years - Richard Keller, Charles MacLeod, and Dwayne Ryman; and 5 years - Susan France, Chris Herbaugh, Dale Jordan, Ronnie Judd, Adora Kipps, David Myers, and Phillip Speicher.\nOur summer internship program was again active during 1995. A total of 19 college students assisted our organization during the summer months and holiday vacations.\nDuring the year our employees supported many charitable organizations, including Shenandoah County Hospice, the local food pantries, Response, and a toy drive in conjunction with the Sheriff's Department. The employees also participated in community and industry events, including telephone book recycling, parades and National Small Independent Telephone Company week.\nOn February 14, 1996, Clinton Miller resigned as a Director of our organization in order to accept his appointment as a Commissioner of the Virginia State Corporation Commission (VSCC). Mr. Miller will fill the unexpired term of Preston Shannon, who retired after 24 years of service. The VSCC oversees the insurance, banking, transportation, telecommunications, and utility industries in the Commonwealth of Virginia. Mr. Miller's appointment came after serving the Shenandoah Valley area for over 23 years as a member of the Virginia House of Delegates.\nOn December 31, 1995, Warren B. French, Jr. retired as Chairman of the Board of Shenandoah Telecommunications Company in accordance with the Company's Bylaws. Mr. French's association with the forerunner companies of Shenandoah Telecommunications has been a long one, beginning in 1954 when he was hired as General Manager of Farmers Mutual Telephone System of Shenandoah County. In addition to other positions, Mr. French became President and Director of Shenandoah Telephone Company in 1973, positions which he held until his retirement as President in 1988, at which time he was appointed as Chairman of the Board of Shenandoah Telecommunications Company. During the past four decades Mr. French has also been active at the state and national levels, holding positions with the National Exchange Carrier Association, the FCC Network Reliability Council, the U. S. Telephone Association, the Virginia Telephone Association, and the Organization for the Protection and Advancement of Small Telephone Companies. Mr. French has had a profound impact on our organization and the telecommunications industry through his vision and leadership. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nShenandoah Telecommunications Company is a diversified telecommunications holding company providing both regulated and unregulated telecommunications services through its eight wholly- owned subsidiaries.\nThe regulated telephone local exchange company is the largest subsidiary, accounting for over 59.0% of revenue and 79.0% of consolidated net income from operations. This industry is in a period of transition from a protected monopoly to a competitive environment as evidenced by the recent passage of the Telecommunications Act of 1996. As a result, Shenandoah Telecommunications has made and plans to continue to make significant investments in the new and emerging technologies. In 1994 the Company began providing Internet access and in December of 1995 became the first in the United States to offer Personal Communications Services in a rural location.\nOther significant services provided are cellular phone, cable television, long distance, and facilities leased to interexchange carriers on a Company owned fiber optic cable network. The Company also sells and leases equipment, mainly related to services provided. The Company also participates in emerging technologies by direct investment in non-affiliated companies.\nRESULTS OF OPERATIONS\nThe Company's largest source of revenue continues to be for access to the Company's local exchange network by interexchange carriers. The volume for these access revenues are measured in minutes of use. The minutes of use during 1995 increased 7.2% compared to an increase of 6.8% in 1994. The revenue increase was not as large as the minutes of use increase, principally due to a change in the mix of interstate and intrastate minutes of use.\nThe decrease in the ShenTel Service revenues category for 1995 compared to 1994, is due to a decrease in retail equipment sales. The decrease equaled $262,603 or 32.0% for 1995 compared to a $405,311 increase in 1994. Offsetting this decrease is an increase in revenues from our Internet Service operation of $149,608. The Company began offering access to the Internet in 1994 and revenues were insignificant in that year.\nThe Mobile revenues are mainly comprised of revenues from wireless communications services. Local cellular service revenues increased $177,761 or 8.9% in 1995 compared to $529,635 or 36.0% in 1994. Outcollect roamer revenues increased $536,772 or 26.1% in 1995 compared to $561,514 or 37.6% in 1994. The increase in local cellular revenues was due to a 27.5% increase in the customer base, compared to an 18.6% increase in 1994. Financing lease revenues are chiefly for leases and rentals of a few large telecommunications systems, small systems sold by Company subsidiaries, and customer premise equipment. One lease for fiber optic facilities between Charlottesville and Richmond which accounted for $143,683 of 1993 revenue, expired at the end of 1993. The lessee exercised the fair market buy-out provision, resulting in a one-time after tax gain of $611,734 in 1993. The remaining lease revenues are derived from smaller leases for equipment such as PBXs and home satellite dishes sold through Company subsidiaries.\nOn September 1, 1994, the cable television company restructured its rates by increasing its rates for basic and premium service and decreasing or eliminating its charges for other services such as rental of converters. This was primarily responsible for the 17.1% increase in cable television revenues compared to the 7.9% increase in 1994.\nThe Company also leases capacity on fiber optic facilities in West Virginia and Maryland to interexchange carriers. The revenue for this activity appears as Network revenues on the income statement. This service experienced a revenue decrease of 9.5% in 1994. The decrease was due to contracts expiring and being renewed at lower rates. New contracts added in late 1994 were primarily responsible for the 1995 increase of 42.6%.\nTotal payroll costs (including capitalized costs) increased 8.9% in 1995 compared to 1994. Total payroll costs in 1994 decreased 2.5% from the previous year. The increase in 1995 is due to an increase in full-time equivalent employees, primarily due to the start-up of the Internet Service and Personal Communications Services operations.\nDepreciation, our largest expense category, increased at a slower rate than the previous year. Over 40% of our additions to Property, Plant, and Equipment during 1995 were placed in service during the fourth quarter, reducing their effect on the increase in depreciation.\nThe expense category with the largest increase in 1995 was Network and Other. The increase in 1995 was due primarily to facilities costs attributed to our Internet Service operation. These costs increased $164,945 or 780.0% due to the rapidly increasing customer base.\nThe increase in Taxes Other Than Income in 1994 was primarily due to a rate increase in the real estate tax for the local jurisdiction in which a majority of our regulated Telephone plant is located.\nThe Non-operating Income Less Expenses category consists mainly of the income or loss from investments made by the Company. The increase reflected on the income statement is due to an increase in the amount of interest bearing investments compared to a year earlier. Investments accounted for by the equity method that are also included in this category, had an increase in income of $359,909 due mainly to the sale of Virginia MetroTel discussed below. The Company recorded a loss of $221,477 on this investment in 1994 compared to none in 1995.\nThe Company, along with other telecommunications providers, founded Virginia Metrotel to construct and operate a fiber optic network in the Richmond, Virginia metropolitan area. The fiber network would provide competitive access to businesses in the area. As a result of a strategic change, it was agreed to sell this business to MFS Communications Company. The Company recognized a gain on the sale in January 1995. The amount of the gain was $872,125. The Company recognized further gains of $269,261 on subsequent sales of MFS stock.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company continued to generate a cash flow from operations that adequately met the Company's need for cash in 1995. Other available sources of liquidity are $4,500,000 in unsecured lines of credit with two local banks. No advances were made from these lines of credit in 1995. The Company has a loan agreement with the Rural Telephone Bank in the amount of $9,240,000. The Company received an advance of $1,047,900 in August of this year. As of December 31, 1995, the Company has received advances in the amount of $4,433,900. Expenditure of these loan funds is limited to capital projects for the regulated local exchange carrier.\nAs discussed above, the Company recently began participating in the new Personal Communications Services (PCS) business. This will require significant investment in new plant and equipment. The Company has budgeted approximately $6,000,000 for PCS-related new plant in 1996, and anticipates additional cash flow requirements for inventory and initial operating losses.\nThe Company has a material contractual commitment for capital expenditures, requiring the build out of our PCS network by certain time periods. The Company's Board of Directors has approved a construction budget of approximately $14,000,000. This budget includes the expenditures for PCS discussed above. The remaining amounts are primarily for telephone central office equipment and fiber optic cable facilities.\nThe Company signed a letter of intent in February 1996 to acquire the Shenandoah County cable television assets of FrontierVision Operating Partners, L.P. The Company expects to finance this planned transaction, as well as the expenditures discussed above, through internally generated cash flows, additional advances from the RTB note, and loans from external sources.\nIndependent Auditor's Report\nThe Board of Directors Shenandoah Telecommunications Company Edinburg, Virginia\nWe have audited the accompanying consolidated balance sheets of Shenandoah Telecommunications Company and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of income, retained earnings, and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. The consolidated financial statements of Shenandoah Telecommunications Company and subsidiaries for the year ended December 31, 1993 were audited by other auditors whose report, dated January 21, 1994, 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 Shenandoah Telecommunications Company and subsidiaries as of December 31, 1995 and 1994, and the results of their operations and their cash flows for the years then ended 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 consolidating information is presented for purposes of additional analysis of the basic consolidated financial statements rather than to present the financial position and results of operations of the individual companies. The consolidating information has been subjected to the auditing procedures applied in the audits of the basic consolidated financial statements and, in our opinion, is fairly stated in all material respects in relation to the basic consolidated financial statements taken as a whole.\nRichmond, Virginia January 26, 1996\nSHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS December 31, 1995, 1994 and 1993\nASSETS 1995 1994 1993 Current Assets Cash and cash equivalents $ 6,106,447 $ 8,574,559 $ 8,304,415 Certificates of deposit 1,242,228 930,911 106,375 Short-term investments (Note 2) - - 969,382 Investment in held-to-maturity securities (Note 2) 2,488,773 950,750 - Accounts receivable 3,068,379 2,880,428 2,284,197 Direct financing leases, current portion (Note 3) 74,350 81,140 63,243 Materials and supplies 1,922,090 1,511,006 1,545,082 Prepaid and other current assets 406,653 236,191 356,678 Total current assets 15,308,920 15,164,985 13,629,372\nInvestments and Other Assets Investment in available-for-sale securities (Note 2) 2,000,077 - - Investment in held-to-maturity securities (Note 2) 2,098,968 499,687 - Other investments (Note 2) 3,412,464 4,615,689 4,463,221 Direct financing leases, long-term portion (Note 3) 250,321 287,584 55,620 7,761,830 5,402,960 4,518,841\nProperty, Plant and Equipment (Note 4) Plant in service 53,316,016 49,102,832 47,290,763 Plant under construction 2,372,750 248,717 476,378 55,688,766 49,351,549 47,767,141\nLess accumulated depreciation 18,862,526 17,455,344 16,263,290 36,826,240 31,896,205 31,503,851 $ 59,896,990 $ 52,464,150 $ 49,652,064 See Notes to Consolidated Financial Statements. SHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS December 31, 1995, 1994 and 1993\nLIABILITIES AND STOCKHOLDERS' EQUITY 1995 1994 1993\nCurrent Liabilities Notes payable, bank (Note 4) $ - $ - $ 875,000 Current maturities of long-term debt (Note 4) 461,927 423,329 329,891 Accounts payable 813,887 307,691 537,884 Advance billings and payments 625,559 526,105 550,413 Customers' deposits 107,509 137,793 147,952 Accrued construction costs 1,097,844 - - Other current liabilities 1,066,225 910,968 907,867 Income taxes payable - 26,618 462,325 Other taxes payable 85,804 53,739 43,294 Total current liabilities 4,258,755 2,386,243 3,854,626 Long-Term Debt, less current maturities (Note 4) 10,097,026 9,517,880 9,051,922 Other Liabilities and Deferred Credits Deferred investment tax credit 367,143 442,844 518,545 Deferred income taxes (Note 5) 3,965,318 3,535,014 3,512,637 Pension and other (Note 6) 438,324 745,935 542,151 4,770,785 4,723,793 4,573,333 Minority Interests 1,499,151 1,219,493 996,176 Stockholders' Equity (Note 4) Common stock, no par value, authorized 8,000,000 shares; issued 3,760,760 shares 4,740,677 4,740,677 4,740,677 Retained earnings 34,301,584 29,876,064 26,435,330 Unrealized gain on available-for-sale securities, net (Note 2) 229,012 - - 39,271,273 34,616,741 31,176,007 $ 59,896,990 $ 52,464,150 $ 49.652.064\nSee Notes to Consolidated Financial Statements. SHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF INCOME Years Ended December 31, 1995, 1994 and 1993\n1995 1994 1993 Operating revenues Telephone revenues: Local service $ 3,072,097 $ 2,868,656 $ 2,665,975 Access service 6,648,495 6,447,067 6,396,425 Toll service 9,581 8,886 11,154 Miscellaneous: Directory 1,119,858 1,024,740 993,053 Facility leases 1,699,709 1,291,390 994,344 Billing and collection 409,983 447,008 440,836 Other miscellaneous 109,910 121,538 101,590 Total telephone revenues 13,069,633 12,209,285 11,603,377 Cable Television revenues 868,310 741,491 686,951 ShenTel Service revenues 1,379,200 1,555,848 1,150,537 Leasing revenues 24,116 19,796 162,577 Shenandoah Long Distance revenues 1,129,554 1,148,705 1,170,713 Mobile revenues 4,952,967 4,206,736 3,172,041 Network revenues 495,370 347,317 383,690 Total operating revenues 21,919,150 20,229,178 18,329,886\nOperating expenses: Cost of products sold 764,264 802,904 579,015 Line costs 543,873 543,887 523,212 Plant specific 1,850,316 1,742,824 1,726,444 Plant nonspecific: Network and other 2,059,255 1,649,329 1,571,935 Depreciation 2,864,521 2,730,938 2,536,920 Customer operations 2,465,316 2,206,931 2,264,622 Corporate operations 1,988,852 1,903,653 1,847,065 Other operating expense 185,133 154,241 135,955 Taxes other than income 305,938 316,006 269,968 $ 13,027,468 $ 12,050,713 $ 11,455,136\n(Continued) SHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (Continued) Years Ended December 31, 1995, 1994 and 1993\n1995 1994 1993\nOperating income $ 8,891,682 $ 8,178,465 $ 6,874,750 Other income (expenses): Nonoperating income, less expenses 991,202 302,420 (84,918) Interest expense (685,971) (658,908) (621,944) Gain on sale of assets 1,141,386 986,031 10,338,299 7,821,977 7,153,919 Income taxes (Note 5) 3,572,956 2,577,641 2,481,764 6,765,343 5,244,336 4,672,155 Minority interests (534,658) (393,317) (69,536) Net income $ 6,230,685 $ 4,851,019 $ 4,602,619\nNet income per share $ 1.66 $ 1.29 $ 1.22\nCash dividends per share $ 0.480 $ 0.375 $ 0.300\nWeighted average shares outstanding 3,760,760 3,760,760 3,760,760\nSee Notes to Consolidated Financial Statements. SHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF RETAINED EARNINGS Years Ended December 31, 1995, 1994 and 1993\n1995 1994 1993\nBalance, beginning $ 29,876,064 $ 26,435,330 $ 22,960,939 Net income 6,230,685 4,851,019 4,602,619 36,106,749 31,286,349 27,563,558 Cash dividends 1,805,165 1,410,285 1,128,228\nBalance, ending $ 34,301,584 $ 29,876,064 $ 26,435,330\nSee Notes to Consolidated Financial Statements. SHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31, 1995, 1994 and 1993\n1995 1994 1993 Cash Flows From Operating Activities Net income $ 6,230,685 $ 4,851,019 $ 4,602,619\nAdjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 2,864,521 2,730,938 2,536,920 Deferred taxes 323,680 (53,324) (518,360) Gain on sale of assets (1,141,386) - (986,031) Investment losses 43,763 207,510 276,205 Minority share of income 279,658 223,317 69,536 Other (4,551) 224,378 253,858 Changes in assets and liabilities: (Increase) decrease in: Accounts receivable (187,951) (596,231) (154,233) Material and supplies (411,084) 34,076 37,269 Increase (decrease) in: Accounts payable 396,307 (209,571) 172,802 Income taxes payable (26,618) (435,707) 176,989 Other prepaids, deferrals and accruals (205,731) 305,220 166,554 Net cash provided by operating activities 8,161,293 7,281,625 6,634,128\n(Continued) SHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS(Continued) Years Ended December 31, 1995, 1994 and 1993\n1995 1994 1993 Cash Flows From Investing Activities Purchases of property and equipment $ (6,697,476) $ (3,356,079) $ (3,762,267) Investment in direct financing leases (39,038) (332,213) (74,733) Payments received on direct financing leases 83,091 82,352 315,323 Sale of lease residual - - 1,892,931 Purchase of certificates of deposit (1,252,016) (930,911) - Maturities of certificates of deposits 940,699 106,375 - Cash flows from securities (Note 2) (2,427,349) (810,461) - Sale of investment securities - - 782,897 Purchase of investment securities - - (2,676,419) Net cash used in investing activities (9,393,089) (5,240,937) (3,522,268)\nCash Flows From Financing Activities Dividends paid $ (1,805,165) $ (1,410,285) $ (1,128,228) Proceeds from notes payable - - 875,000 Payment on notes payable - (875,000) - Proceeds from long-term debt 998,000 893,000 929,000 Principal payments on long-term debt (430,151) (378,259) (348,160) Net cash provided by (used in) financing activities (1,237,316) (1,770,544) 327,612 Net increase (decrease) in cash and cash equivalents (2,468,112) 270,144 3,439,472 Cash and cash equivalents: Beginning 8,574,559 8,304,415 4,864,943 Ending $ 6,106,447 $ 8,574,559 $ 8,304,415\n(Continued) SHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued) Years Ended December 31, 1995, 1994 and 1993\n1995 1994 1993\nSupplemental Disclosures of Cash Flow Information Cash payments for: Interest, net of capitalized interest of $39,070 in 1995 $ 683,313 $ 661,029 $ 623,715 Income taxes $ 3,081,596 $ 3,013,201 $ 2,820,772\nSupplemental Schedule of Noncash Investing and Financing Activities Notes receivable exchanged for investment in stock $ - $ - $ 103,000\nCommon stock received in sale of equity investee $ 1,446,942 $ - $ -\nChange in classification of investments from cost method to available-for-sale (Note 2) $ 1,225,858 $ - $ -\nProceeds of long-term debt for stock in Rural Telephone Bank $ 49,900 $ 44,650 $ 46,450\nSee Notes to Consolidated Financial Statements. \/TABLE\nSHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNote 1. Summary of Accounting Policies\nThe Company operates entirely in the telecommunications industry. The Company is a holding company which, through its subsidiaries, provides telephone service, cable television service, unregulated communications equipment and services, paging, mobile telephone, business radio, and cellular telephone services. In addition, through its subsidiaries, the Company finances purchases of telecommunications facilities and equipment and operates and maintains an interstate fiber optic network. The Company's operations are primarily located in the Northern Shenandoah Valley and the surrounding areas. A summary of the Company's significant accounting policies follows:\nPrinciples of consolidation: The consolidated financial statements include the accounts of all wholly owned subsidiaries and those partnerships where effective control is exercised. All significant intercompany accounts and transactions have been eliminated.\nAccounting estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nCash and cash equivalents: The Company considers all temporary cash investments with a purchased maturity of three months or less to be cash equivalents. The Company places its temporary cash investments with high credit quality financial institutions. At times such investments may be in excess of the FDIC insurance limit.\nSecurities and investments and accounting change: The Company has investments in debt and equity securities, which consist of shares of common and preferred stock and partnerships. Debt securities consist primarily of obligations of the U. S. Government.\nSHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNote 1. Summary of Accounting Policies (Continued)\nThe Company adopted the provisions of FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities, as of January 1, 1994. Statement 115 requires that management determine the appropriate classification of debt and equity securities that have readily determinable fair values. Classification is determined at the date of adoption, and thereafter at the date individual investment securities are acquired. The appropriateness of such classification is reassessed continually. The classification of those securities and the related accounting policies are as follows:\nHeld-to-maturity securities: These consist entirely of debt securities which are obligations of the U. S. Government. The Company has both the intent and ability to hold to maturity regardless of changes in market conditions, liquidity needs or changes in general economic conditions. These securities are valued at amortized cost.\nAvailable-for-sale securities: Securities classified as available for sale are those securities that the Company intends to hold for an indefinite period of time but not necessarily to maturity. Any decision to sell a security classified as available for sale would be based on various factors, including changes in market conditions, liquidity needs and other similar factors. Securities available-for-sale are carried at fair value. Unrealized gains and losses are reportable as increases and decreases in stockholders' equity net of tax. Realized gains and losses, are determined on the basis of the cost of specific securities sold, are included in earnings.\nInvestments carried at cost: These investments are those where the Company does not have significant ownership and for which there is no ready market. Information regarding these and all other investments is reviewed continuously for evidence for impairment in value. No impairment was deemed to have occurred at December 31, 1995.\nEquity method investments: These investments consist of partnership and corporate investments where the Company's ownership is 20% or more, except where such investments meet the requirements for consolidation. Under the equity method, the Company's equity in earnings or losses of these companies is reflected in the earnings.\nSHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNote 1. Summary of Accounting Policies\nPrior to the adoption of Statement 115, the Company stated its debt securities at the lower of amortized cost or fair value. Under both the newly adopted accounting standard and the Company's former accounting practices, premiums and discounts on investments in debt securities are amortized over their contractual lives. The method of amortization results in a constant yield on those securities (the interest method). Interest on debt securities is recognized in income as accrued. Realized gains and losses, including losses from declines in value of specific securities determined by management to be other-than-temporary, are included in income. Realized gains and losses are determined on the basis of specific securities sold.\nMaterials and supplies: New and reusable materials are carried in inventory principally at average original cost. Specific costs are used in the case of large individual items. Nonreusable material is carried at estimated salvage value.\nProperty, plant and equipment: Property, plant and equipment is stated at cost. Accumulated depreciation is charged with the cost of property retired, plus removal cost, less salvage. Depreciation is determined under the remaining life method and straight-line composite rates. Depreciation provisions were approximately 5.7%, 5.7%, and 5.6% of average depreciable assets for the years 1995, 1994 and 1993, respectively.\nPension plan: The Company maintains a noncontributory defined benefit retirement plan covering substantially all employees. Pension benefits are based primarily on the employee's compensation and years of service. The Company's policy is to fund the maximum allowable contribution calculated under federal income tax regulations.\nIncome taxes: Deferred taxes are provided on a liability method whereby deferred tax assets are recognized for deductible temporary differences 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 and liabilities are adjusted for the effect of changes in tax laws and rates on the date of enactment. Investment tax credits have been deferred and are amortized over the estimated life of the related assets.\nSHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNote 1. Summary of Accounting Policies (Continued)\nRevenue recognition: Local, access, toll and cellular revenues are recognized when earned regardless of the period in which they are billed. The Company has a telephone subsidiary which participates in the telephone revenue pooling and settlements process of the National Exchange Carriers Association.\nEarnings per common share: Earnings per common share is computed by dividing net income by the weighted average number of common shares outstanding. All per share amounts have been restated to give effect to stock splits.\nNote 2. Investments\nAs of January 1, 1994, the Company changed its method of accounting for equity securities having readily determinable fair values and all debt securities in accordance with FASB Statement No. 115. As provided by this statement, the 1993 comparative financial statements have not been restated for the change in accounting principle. Investments consist of the following:\nInvestment in held-to-maturity securities:\n1995 1994 1993\nU. S. Treasury securities, current $2,488,773 $ 950,750 $ - U. S. Treasury securities, noncurrent (due within three years) 2,098,968 499,687 - $4,587,741 $1,450,437 $ -\nThe fair market value approximates the carrying value for all held to maturity investments at December 31, 1995 and 1994. At December 31, 1993, investments in debt securities were classified on the accompanying balance sheets as short-term investments and were recorded at amortized cost, which approximates market value.\nSHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNote 2. Investments (Continued)\n1995 1994 1993\nInvestment in available-for-sale securities: Orion Network Systems, Inc., Common (including unrealized gain of $142,263 in 1995) $1,444,855 $ - $ - MFS Communications Company, Inc. (including unrealized gain of $210,750 in 1995) 532,500 - - Comsat Corporation (including unrealized gain of $16,123 in 1995) 22,722 - - Total securities available for sale $2,000,077 $ - $ -\nIn 1995, the Company realized a gain of approximately $269,000 on the sale of available-for-sale securities.\nChanges in the unrealized gain on available-for-sale securities:\nUnrealized gain at January 1, 1995 $ - Unrealized gains during the year 369,136 Unrealized gains at December 31, 1995 369,136 Related deferred tax effect 140,124 Unrealized gain included in stockholders' equity $ 229,012\nSHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNote 2. Investments (Continued)\nCash flows from purchases, sales, and maturities of securities:\n1995 1994 Available-for-sale securities: Sales $ 1,392,354 $ - Purchases (83,335) -\nHeld-to-maturity securities: Maturities 5,466,558 969,384 Purchases (8,603,862) (1,450,439)\nOther investments: Sales 63,751 - Purchases (662,815) (329,406)\nTotal $(2,427,349) $ (810,461)\nSHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNote 2. Investments (Continued)\nOther investments comprised of equity securities which do not have readily determinable fair values consist of the following:\n1995 1994 1993 Cost method: Orion Network Systems, Inc. $ $ 1,552,592 $ 1,352,592 Independent Telecommunications Network, Inc. 773,600 773,600 773,600 AvData Systems, Inc. 149,860 149,860 149,860 Rural Telephone Bank 568,992 519,097 474,442 Other 556,919 368,081 252,550 2,049,371 3,363,230 3,003,044 Equity method: Virginia MetroTel - 633,627 855,104 South Atlantic Venture Fund III L.P. 369,289 - - Virginia Independent Telephone Alliance 206,138 234,888 269,266 Rural Service Area - 6 378,989 368,554 329,207 Other 408,677 15,390 6,600 1,363,093 1,252,459 1,460,177 Total other securities and investments $ 3,412,464 $ 4,615,689 $ 4,463,221\nDuring the year ended December 31, 1995 Onion Network Systems,Inc. became publicly traded and was therefore reclassified from cost method to available-for-sale.\nIn January 1995, Virginia MetroTel was sold in exchange for stock of the acquiring company, MFS Communications Company, Inc. and approximately $59,000 in cash. A gain of approximately $872,000 resulted from the sale.\nSHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNote 3. Direct Financing Leases\nThe Company is the lessor of various telecommunications equipment under direct financing leases. The typical lease agreement is for a period of 2 to 10 years. The payments below are net of unearned lease income as of December 31, 1995.\nMinimum Future Lease Payments Amount\n1996 $ 74,350 1997 70,841 1998 79,667 1999 20,718 2000 14,000 During the remaining term of the leases 65,095 Total minimum future lease payments $ 324,671\nInvestment in direct financing leases consists of the following:\nDecember 31, 1995 1994 1993\nMinimum lease payments receivable $ 482,559 $ 596,407 $ 137,440 Unearned lease income (157,888) (227,683) (18,577) $ 324,671 $ 368,724 $ 118,863\nSHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNote 4. Long-Term Debt and Lines of Credit\nLong-term debt is comprised of notes payable to the Rural Utilities Service (RUS) and the Rural Telephone Bank (RTB) which are secured by assets, with a book value of approximately $36,000,000 and Industrial Development Bonds (IDB) which bear interest at a floating rate based upon the bank's prime rate.\nInterest Rate 1995 1994 1993\nRTB 6.04% - 8% $ 9,765,672 $ 9,004,549 $ 8,300,813 RUS 2% - 5% 716,562 819,945 924,289 IDB 77.7% of prime 76,719 116,715 156,711 10,558,953 9,941,209 9,381,813 Current maturities 461,927 423,329 329,891 Total long-term debt $ 10,097,026 $ 9,5177.880 $ 9,051,922\nThe approximate annual debt maturities for the five years subsequent to December 31, 1995 are as follows:\nYear Amount\n1996 $ 461,927 1997 483,928 1998 474,585 1999 499,013 2000 512,817 Later years 8,126,683 $10,558,953\nThe long-term debt agreements contain restrictions on the payment of dividends and redemption of capital stock. The terms of the agreements require the maintenance of defined amounts of equity and working capital after payment of dividends. Accordingly, approximately $18,309,000 of retained earnings was available for payment of dividends at December 31, 1995. SHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNote 4. Long-Term Debt and Lines of Credit (Continued)\nAs of December 31, 1995, the Company had no borrowings outstanding on other approved lines of credit for $4,500,000.\nLong-term debt carries rates which approximate market rates for similar debt being issued. Therefore the carrying value of long-term debt is not significantly different than fair market value at December 31, 1995.\nNote 5. Income Taxes\nThe Company and its subsidiaries file consolidated tax returns. The provision for income taxes included in the consolidated statements of income consists of the following components: Years Ended December 31, 1995 1994 1993 Current: Federal $ 2,837,187 $ 2,402,840 $ 2,642,516 State 412,089 228,125 356,353 Total 3,249,276 2,630,965 2,998,869 Deferred: Federal 272,529 (72,622) (452,481) State 51,151 19,298 (64,624) Total $ 323,680 $ (53,324) $ (517,105) Provision for income taxes $ 3,572,956 $2,577,641 $2,481,764\nSHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNote 5. Income Taxes (Continued)\nA reconciliation of income taxes determined using the statutory federal income tax rates to actual income taxes provided is as follows:\nYears Ended December 31, 1995 1994 1993 Federal income tax expense at statutory rates $ 3,336,620 $ 2,525,744 $ 2,408,690 State income taxes net of federal tax benefit 305,738 163,299 190,515 Amortization of investment tax credit (75,701) (75,701) (75,701) Other 6,299 (35,701) (41,740) Provision for income taxes $ 3,572,956 $ 2,577,641 $ 2,481,764\nNet deferred tax liabilities consist of the following at December 31, 1995 and 1994: 1995 1994 1993 Deferred tax liabilities: Accelerated depreciation $ 4,106,119 $ 4,019,391 $ 3,877,476 Unrealized gain on securities available for sale 140,124 - - 4,246,243 4,019,391 3,877,476 Deferred tax assets: Accrued compensation costs 92,329 76,413 86,815 Accrued pension costs 105,084 139,432 92,396 Equity investments 83,512 268,532 184,460 Other - - 1,168 280,925 484,377 364,839 Net deferred tax liabilities $ 3,965,318 $ 3,535,014 $ 3,512,637\nSHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNote 6. Pension Plan\nThe Company maintains a noncontributory defined benefit pension plan. The following table presents the plan's funded status and amounts recognized in the Company's consolidated balance sheets.\n1995 1994 1993\nActuarial present value of benefit obligations:\nVested $ 2,645,748 $ 2,263,951 $ 2,091,910 Nonvested 52,826 62,286 63,968 Accumulated benefit obligations $ 2,698,574 $ 2,326,237 $ 2,155,878\nProjected benefit obligation for service rendered to date $ 4,408,161 $ 3,800,239 $ 3,573,241 Plan assets at fair value, common stocks and bonds 4,449,840 3,676,436 3,839,827\nPlan assets in excess (deficient) of projected benefit obligation $ 261,679 $ (123,803) $ 266,586 Unrecognized prior service cost 278,513 299,218 319,923 Unrecognized transition asset at January 1, 1987, being recognized over 17 years (239,234) (267,978) (296,722) Unrecognized net gain (621,588) (276,453) (553,163) Net pension liability $ (320,630) $ (369,016) $ (263,376)\nSHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNote 6. Pension Plan (Continued)\nNet pension cost included the following components:\n1995 1994 1993\nService costs (benefits earned) $ 147,568 $ 143,072 $ 123,592 Interest cost on projected benefit obligation 280,691 263,693 246,235 Actual (return) loss on plan assets (914,207) 46,130 (455,124) Net amortization and deferral 634,762 (347,255) 183,789 Net periodic pension cost $ 148,814 $ 105,640 $ 98,492\nSHENANDOAH TELECOMMUNICATIONS COMPANY AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNote 6. Pension Plan (Continued)\nAssumptions used by the Company in the determination of pension plan information consisted of the following at December 31, 1995, 1994 and 1993:\n1995 1994 1993\nDiscount rate 7.50% 7.50% 7.50% Rate of increase in compensation levels 5.50 5.50 5.50 Expected long-term rate of return on plan assets 7.50 7.50 7.50\nNote 7. Reclassification\nCertain amounts on the 1994 and 1993 financial statements have been reclassified, with no effect on net income, to conform with the classifications adopted in 1995.\nNote 8. Proposed Stock Incentive Plan\nOn January 8, 1996, the Board of Directors adopted a Company Stock Incentive Plan to be proposed for stockholders' approval at the Annual Meeting to be held April 16, 1996. A maximum of 240,000 shares of common stock may be awarded for a period of 10 years under the proposed Plan. Subject to certain restrictions, it is expected that full-time employees of the Company will be eligible to participate in the Plan. \/TABLE\nEXHIBIT 21. LIST OF SUBSIDIARIES\nThe following are all subsidiaries of Shenandoah Telecommunications Company:\n- Shenandoah Telephone Company\n- ShenTel Service Company\n- Shenandoah Cable Television Company\n- Shenandoah Long Distance Company\n- Shenandoah Valley Leasing Company\n- Shenandoah Mobile Company\n- Shenandoah Network Company\n- Shenandoah Personal Communications Company","section_15":""}
{"filename":"40779_1995.txt","cik":"40779","year":"1995","section_1":"ITEM 1. BUSINESS.\nGeneral Public Utilities Corporation (GPU or the Corporation), a Pennsylvania corporation, organized in 1946, is a holding company registered under the Public Utility Holding Company Act of 1935 (1935 Act). GPU does not operate any utility properties directly, but owns all of the outstanding common stock of three electric utilities serving customers in New Jersey - Jersey Central Power & Light Company (JCP&L), incorporated under the laws of New Jersey in 1925, - and in Pennsylvania - Metropolitan Edison Company (Met-Ed), a Pennsylvania corporation incorporated in 1922, and Pennsylvania Electric Company (Penelec), a Pennsylvania corporation incorporated in 1919. The business of these subsidiaries (the Subsidiaries) consists predominantly of the generation, transmission, distribution and sale of electricity. GPU also owns all of the common stock of Energy Initiatives, Inc., EI Power, Inc., and EI Energy, Inc. (collectively, the \"EI Group\"), which develop, own and operate generation, transmission and distribution facilities in the United States and in foreign countries. GPU Service Corporation (GPUSC), a service company; GPU Nuclear Corporation (GPUN), which operates and maintains the nuclear units of the Subsidiaries; and GPU Generation Corporation (Genco), which operates and maintains the fossil-fueled and hydroelectric units of the Subsidiaries, are also wholly owned subsidiaries of GPU. Wholly owned subsidiaries of the Subsidiaries are listed in Exhibit 21. The Subsidiaries own all of the common stock of the Saxton Nuclear Experimental Corporation, which owns a small demonstration nuclear reactor that has been partially decommissioned. All of these companies together with their affiliates are referred to as the \"GPU System.\" The income of GPU consists almost exclusively of earnings on the common stock of the Subsidiaries.\nAs a registered holding company system, the GPU System is subject to regulation by the Securities and Exchange Commission (SEC) under the 1935 Act. Retail rates, conditions of service, issuance of securities and other matters are subject to regulation in the state in which each Subsidiary operates - in New Jersey by the New Jersey Board of Public Utilities (NJBPU) and in Pennsylvania by the Pennsylvania Public Utility Commission (PaPUC). The Nuclear Regulatory Commission (NRC) regulates the construction, ownership and operation of nuclear generating stations. The Subsidiaries are also subject to wholesale rate and other regulation by the Federal Energy Regulatory Commission (FERC) under the Federal Power Act. In addition, certain EI Group foreign subsidiaries are subject to limited rate and other regulation (see REGULATION).\nINDUSTRY DEVELOPMENTS\nThe electric power markets have traditionally been served by integrated regulated monopolies. Over the last few years, however, market forces combined with state and federal actions, have laid the foundation for the development of increased competition in the electric utility industry. The electric utility industry is undergoing a major transition as it proceeds from a traditional rate regulated environment based on cost recovery to some combination of a competitive marketplace and modified regulation. The Public Utility Regulatory Policies Act of 1978 (PURPA) facilitated the entry of competitors into the electric generation business. Since then, more competition has been introduced through various state actions and the Energy Policy Act of 1992 (EPAct).\nThe EPAct has fostered further competition among utility and nonutility generators (NUGs) in the wholesale electric generation market, accelerating the industry restructuring that has been underway since the enactment of PURPA. Among its provisions, the EPAct allows the FERC, subject to certain criteria, to order owners of electric transmission systems to provide third parties with transmission access for wholesale power transactions. Although the legislation did not give the FERC the authority to order retail transmission access, movement toward opening the transmission network to retail customers is currently under consideration in many states, including New Jersey and Pennsylvania.\nThe competitive pressures resulting from the EPAct, coupled with increasing customer demands for lower-priced electricity, are expected to create opportunities to compete for new customers and revenues, as well as increase risk which could lead to the loss of customers and reduction in revenues from existing customers.\nOperating in a competitive environment places new pressures on utility profit margins and credit quality. Utilities with significantly higher cost structures than are supportable in the marketplace will experience reduced earnings as they attempt to meet their customers' demands for lower-priced electricity. Competitive forces continue to influence some retail pricing. In some cases, commercial and industrial customers have indicated their intention to pursue competitively priced electricity from other providers, and in some instances have obtained price concessions from utilities. This prospect of increasing competition in the electric utility industry has already led the major credit rating agencies to apply more stringent guidelines in making credit rating determinations.\nIn response to competitive forces and regulatory changes, the GPU System has from time to time considered, and expects to continue to consider, various strategies designed to enhance its competitive position and to increase its ability to adapt to, and anticipate changes in, its business. These strategies may include business combinations with other companies, internal restructurings involving the complete or partial separation of its wholesale and retail businesses, acquisitions of other businesses (including foreign utility companies), and additions to or dispositions of all or portions of its generation, transmission or distribution businesses. No assurances can be given as to whether any potential transaction of the type described above may actually occur, or as to the ultimate effect thereof on the financial condition or competitive position of the GPU System.\nRegulatory Initiatives\nDuring 1995, there were a number of major federal and state developments in the area of competition within the electric utility industry as outlined below:\n- The FERC ruled that a power purchase agreement between Connecticut Power & Light Co. and a NUG was invalid because the state law mandating the agreement provided for the utility to pay rates in excess of its \"avoided costs,\" contrary to PURPA and the FERC's regulations. In February 1995, the FERC found that the California Public Utilities Commission's (CPUC) capacity procurement program also violated PURPA because, as designed, it resulted in contract rates above the state utilities' avoided costs. The FERC further expressed concerns that the CPUC had based its finding of\ncapacity requirements on stale data. Following these two decisions, other utilities, including the Subsidiaries, sought to have the FERC determine that certain of their NUG power purchase agreements are void on the same or similar grounds. The Subsidiaries have thus far been unsuccessful in these efforts. In addition, the GPU System is, together with other electric utilities, currently engaged in efforts to repeal PURPA.\n- Legislation was introduced in the U.S. Senate that would repeal Section 210 of PURPA. Under that section, certain qualifying NUGs can \"lock-in\" long-term rates that may result in electric utilities being required to purchase power at costs higher than available alternative sources of energy. Similar legislation has been introduced in the House of Representatives. Other legislation has been introduced which would, among other things, repeal the 1935 Act and provide for the restructuring of the electric utility industry.\n- The FERC issued a Notice of Proposed Rulemaking (NOPR) on open access nondiscriminatory transmission services by utilities and a supplemental NOPR on recovery of stranded costs. The new rules, if adopted, would in essence provide open access to the interstate electric transmission network and thereby encourage a fully competitive wholesale electric power market.\nAmong other things, the FERC's proposal would (1) require electric utilities to file nondiscriminatory open access transmission tariffs which would be available to all wholesale sellers and buyers of electricity; (2) require utilities to accept service under these new tariffs for their own wholesale transactions; and (3) permit utilities to recover their legitimate and verifiable \"stranded costs\" incurred when a franchise customer elects to purchase power from another supplier using the utility's transmission system.\nWith respect to stranded costs, the FERC proposed to provide recovery mechanisms where stranded costs result from municipalization or other instances where former retail customers become wholesale customers, as well as for wholesale stranded costs. The FERC stated that it would expect the state regulatory agencies to provide for recovery of stranded costs attributable to retail wheeling or direct access programs, and the FERC would intervene only when such agencies lacked necessary authority.\nIn addition, while it does not provide for \"corporate unbundling,\" which the FERC defines as the disposing of ancillary services or creating separate affiliates to manage transmission services, the proposed rule does call for \"functional unbundling\" of transmission and ancillary services.\n- An SEC Staff report recommended a series of legislative and administrative reforms to the 1935 Act. This included SEC Staff support for repeal of the 1935 Act with a minimum one year transition period, and a transfer of audit, reporting and certain other responsibilities to the FERC while giving state agencies access to holding company books and records. In the interim, the SEC Staff recommended that the SEC adopt a series of administrative reforms that would streamline such things as the\nissuance of securities for routine financings and permit a wide range of energy related diversification activities. The SEC Staff also recommended that the SEC more flexibly interpret the 1935 Act's integrated system requirements by allowing utility acquisitions and specifically, combination electric and gas systems, where the affected state commissions concur.\nIn response to the SEC Staff report, the SEC has adopted certain changes which will streamline routine financings, and has proposed a number of others. GPU and other registered holding companies are seeking to repeal the 1935 Act because they believe it is a significant impediment to a registered holding company's ability to be competitive.\n- The NJBPU issued Phase I of the New Jersey Energy Master Plan (NJEMP) promoting regulatory policy changes intended to move New Jersey's electric and gas utilities into a competitive marketplace. In the Phase I Report, the NJBPU recommended, among other things, (1) rate-flexibility legislation to allow utilities to compete in order to retain and attract customers in a changing regulatory environment; (2) alternative regulation as an interim and possibly a long-term measure to allow market forces to stimulate efficiency, productivity and innovation; (3) consumer protection standards to ensure that captive ratepayers do not subsidize competitive activities and to ensure that all ratepayers benefit from the transition to greater competition; and (4) an integrated resource planning and competitive supply-side procurement process to streamline the regulatory review process, lower costs for all ratepayers, and ensure that New Jersey's environmental and energy conservation goals are met in a competitive marketplace. The Phase I Report also emphasized that regulation must continue to guarantee access to safe, adequate and reliable service at a reasonable cost; protect the public interest; meet environmental and energy efficiency goals; assure system reliability; and protect the financial integrity of utilities which have an obligation to serve the public.\n- The NJBPU initiated Phase II of the NJEMP and established working groups to develop draft proposals and models by March 1996 on (1) competition issues; (2) stranded assets; (3) regional issues such as the environment and emissions standards; and (4) public policy issues, including social programs and conservation. The NJEMP is being developed in three phases, with Phase III expected to be completed by the end of 1996.\n- The PaPUC has initiated an investigation into the role of competition in Pennsylvania's electric utility industry and solicited comments on various issues. Met-Ed and Penelec jointly filed responses suggesting, among other things, that the PaPUC provide for the equitable recovery of stranded investments, enable utilities to offer flexible pricing to customers with competitive alternatives, and address regulatory requirements that impose costs unequally on Pennsylvania utilities as compared with unregulated or out-of-state suppliers. In August 1995, the PaPUC released a staff report in which the staff decided not to recommend retail wheeling at this time. Evidentiary hearings on this matter began in December 1995 and the PaPUC is expected to present recommendations to the Governor and state General Assembly in the spring of 1996.\nGPU System Initiatives\nIn response to the above federal and state regulatory developments, the GPU System has undertaken a number of initiatives during 1995:\n- GPU made investments aggregating approximately $160 million in foreign utility companies and foreign generating facilities through the EI Group (see EI GROUP, in MANAGEMENT'S DISCUSSION AND ANALYSIS).\n- JCP&L and Met-Ed bought out a total of five NUG (JCP&L two NUGs; Met-Ed three NUGs) power purchase contracts aggregating 540 MW (JCP&L 200 MW; Met-Ed 340 MW) of capacity, which is expected to save ratepayers more than $2 billion (JCP&L $0.7 billion; Met-Ed $1.3 billion) based on the projected cost of alternative sources of energy over the terms of these agreements. JCP&L and Met-Ed have agreed to pay the project developers up to a total of $84 million (JCP&L $17 million; Met-Ed $67 million) to cancel the contracts. JCP&L and Met-Ed have deferred the costs of these buyouts and are seeking to recover these costs through their energy adjustment clauses.\n- The FERC accepted for filing, subject to possible rate refunds, the Subsidiaries' proposed open access transmission tariffs. The FERC has ordered that hearings be held on a number of aspects of these tariffs, including whether they are consistent in certain respects with FERC policy on open access and comparability of service. The tariffs provide for both firm and interruptible service on a point-to-point basis. Network service, where requested, will be negotiated on a case by case basis.\n- The Subsidiaries, along with six other electric utility members of the Pennsylvania-New Jersey-Maryland Interconnection (PJM), filed with the FERC a detailed plan to increase competition in the Mid-Atlantic region. This comprehensive plan offers to all generators and wholesale buyers of electricity, a regional energy market and open access to high-voltage transmission lines which will result in greater availability of economic energy for wholesale electricity buyers and sellers. The Subsidiaries believe the plan will satisfy the goals of the FERC's NOPR on open access nondiscriminatory transmission services, and if approved by the FERC, open access transmission tariffs filed with the FERC under this plan would supersede the Subsidiaries' open access transmission tariffs.\nThe sponsoring PJM companies intend to make a comprehensive filing with the FERC consistent with this detailed plan by May 1996, and expect to implement the new structure by year-end 1996. The Subsidiaries have been advised that the Justice Department is reviewing possible antitrust implications of merger activity among PJM members.\n- The Subsidiaries and certain of the PJM companies have proposed the formation of a wholesale market regional power pool managed by an Independent System Operator (ISO). The power pool would function as a spot market, with generators of electricity allowed to sell into the pool and purchasers of electricity allowed to buy from the pool. It would also accommodate contracts between specific buyers and sellers of power. The ISO would be responsible for supporting regional transmission planning and directing the operation of generation and transmission\nfacilities to assure the reliability and integrity of the regional electric grid.\nThe Subsidiaries have also proposed the use of a competitive transition charge (CTC) as an equitable approach to recover stranded costs. The CTC would be applied to all customers who depend on the electric system for delivery of their electric supply. Efforts by utilities to mitigate their stranded commitments could be required as part of the implementation of a CTC. The Subsidiaries also support in their proposals retail customer choice of energy suppliers, products and services.\nWith the expectation that a segment of the industry will continue to be regulated by the states, the proposals advocate the use of performance- based rates to encourage utilities to reduce costs while maintaining service reliability.\nAnd in keeping with the public policy objectives associated with the electric utility industry, such as access to basic service for low income consumers, the proposals endorse the creation of a \"public purpose charge\" that would be collected from all consumers.\nStatement of Financial Accounting Standards No. 71 (FAS 71), \"Accounting for the Effects of Certain Types of Regulation,\" applies to regulated utilities that have the ability to recover their costs through rates established by regulators and charged to customers. If a portion of the GPU System's operations continues to be regulated, FAS 71 accounting may only be applied to that portion. Insofar as the Subsidiaries are concerned, potentially unrecoverable costs will most likely be related to generation investment, purchased power contracts, and \"regulatory assets,\" which are deferred accounting transactions whose value depends on the Subsidiaries' ability to recover such costs from their respective customers in the future. In markets where there is excess capacity (as there currently is in the Mid- Atlantic and surrounding regions which include New Jersey and Pennsylvania) and many available sources of power supply, the market price of electricity is expected to be lower than what would be necessary to support full recovery of the investment in the generating facilities. Another significant exposure in the transition to a competitive market results if the prices of a utility's existing purchased power contracts, consisting primarily of contractual obligations with NUGs, are higher than future market prices (see NONUTILITY AND OTHER POWER PURCHASES). Utilities locked into expensive purchased power arrangements may be forced to value the contracts at market prices and recognize certain losses. The GPU System believes that to the extent that it no longer qualifies for FAS 71 accounting treatment, a material adverse effect on its results of operations and financial position may result from such a valuation. At this time, it is difficult to project the future level of stranded assets or other unrecoverable costs, if any, without knowing what the market price of electricity will be, or to what extent regulators will allow recovery of such costs from customers.\nCorporate Realignment\nIn January 1996, GPU received regulatory approval from the SEC to form Genco to operate and maintain the fossil-fueled and hydroelectric units owned by the Subsidiaries as well as construct any new nonnuclear generation\nfacilities which the Subsidiaries may need in the future. The Subsidiaries had already received necessary regulatory approvals from the PaPUC and NJBPU.\nTHE SUBSIDIARIES\nThe electric generating and transmission facilities of the Subsidiaries are physically interconnected and are operated as a single integrated and coordinated system serving a population of approximately five million in New Jersey and Pennsylvania. For the year 1995, the Subsidiaries' revenues were about equally divided between Pennsylvania customers and New Jersey customers. During 1995, sales to customers by customer class were as follows:\n% Operating Revenues % KWH Sales GPU JCP&L Met-Ed Penelec GPU JCP&L Met-Ed Penelec Residential 42 45 42 36 36 41 35 29 Commercial 35 38 28 33 32 38 27 30 Industrial 21 16 28 27 29 21 36 34 Other* 2 1 2 4 3 - 2 7 100 100 100 100 100 100 100 100\n* Rural electric cooperatives, municipalities, street and highway lighting, and others.\nThe Subsidiaries also make interchange and spot market sales of electricity to other utilities. Reference is made to System Statistics and Company Statistics on pages,,, and, for additional information concerning the GPU System's sales and revenues. Revenues of JCP&L, Met-Ed and Penelec derived from their largest single customers accounted for less than 3%, 2% and 1%, respectively, of their electric operating revenues for the year and their 25 largest customers, in the aggregate, accounted for approximately 9%, 13% and 12%, respectively, of such revenues.\nIn January 1996, one of JCP&L's larger industrial customers, Anchor Glass Company (Anchor), announced that it would be closing its Aberdeen, New Jersey plant during 1996. Anchor accounts for approximately $4 million of JCP&L's annual revenues.\nThe area served by the Subsidiaries extends from the Atlantic Ocean to Lake Erie, is generally comprised of small communities, rural and suburban areas and includes a wide diversity of industrial enterprises, as well as substantial farming areas. JCP&L provides retail service in northern, western and east central New Jersey having an estimated population of approximately 2.5 million. Met-Ed provides retail electric service in all or portions of 14 counties, in the eastern and south central parts of Pennsylvania, having an estimated population of almost one million. Met-Ed also sells electricity at wholesale to four municipalities having an estimated population of over 11,000. Penelec provides retail and wholesale electric service within a territory located in western, northern and south central Pennsylvania extending from the Maryland state line northerly to the New York state line, with a population of about 1.5 million, approximately 24% of which is concentrated in ten cities and twelve boroughs, all with populations over 5,000. Penelec also provides wholesale service to five municipalities in New Jersey, and, as lessee of the property of the Waverly Electric Light & Power\nCompany, also serves a population of about 13,700 in Waverly, New York and vicinity.\nThe Subsidiaries' transmission facilities are physically interconnected with neighboring nonaffiliated utilities in Pennsylvania, New Jersey, Maryland, New York and Ohio. The Subsidiaries are members of PJM and the Mid-Atlantic Area Council, an organization providing coordinated review of the planning by utilities in the PJM area. The interconnection facilities are used for substantial capacity and energy interchange and purchased power transactions as well as emergency assistance.\nTHE EI GROUP\nThe EI Group is engaged in the development, ownership and operation of generation, transmission and distribution facilities in the United States and foreign countries. During 1995, the EI Group expanded its activities in the following areas:\nEI Power acquired from the Bolivian government, for approximately $47 million, a 50% ownership interest in Empresa Guaracachi S.A., a Bolivian electric generating company having an aggregate capacity of 216 MW of gas- fired and oil-fired generation.\nEI Energy, together with the Australian Gas Light Company, acquired Solaris Power (Solaris), an electric distribution company based in Melbourne, Australia, for a total purchase price of approximately $712 million, of which EI Energy's 50% share was $356 million. EI Energy made an equity investment in Solaris of approximately $112 million; the balance of the purchase price was provided through borrowings by Solaris from an Australian bank syndicate. Solaris, which provides electric service to more than 230,000 customers in and around Melbourne, was sold by the Government of Victoria through a competitive bid as part of that state's privatization of the electric industry.\nEI Power, along with its development partners, has completed the financing for the acquisition of a 240 MW gas-fired generating plant in Barranquilla, Colombia and the construction of a new 750 MW gas-fired plant adjacent to the existing plant. Electricity generated by these plants will be sold to Corporacion Electrica de la Costa Atlantica under a 20-year contract. Total project costs, including the acquisition of the existing plant, are approximately $750 million, of which EI Power's equity contribution is expected to be approximately $65 million. The balance of the funds is being provided by a group of lenders, including the Overseas Private Investment Corporation (OPIC) and the U.S. Export-Import Bank (Eximbank) which have agreed to fund an aggregate of $303 million (OPIC $150 million and Eximbank $153 million) of project costs. EI Power has agreed to make additional equity contributions to the project of up to $58 million under certain circumstances. GPU has guaranteed all of EI Power's equity contribution commitments.\nOn March 1, 1996, President Clinton decertified the Republic of Colombia under the Foreign Assistance Act of 1961 for that country's failure to comply with the objectives of the 1988 United Nations anti-narcotics convention. That Act generally governs the terms and conditions under which the United States provides financial aid and support to foreign countries. On March 7, 1996, OPIC funded an additional $21 million of the Barranquilla project costs.\nEximbank has stated that it is seeking to clarify whether the decertification will affect its existing funding commitments to the project.\nLoss of either OPIC or Eximbank financing for the Barranquilla project would adversely affect the cost and schedule for the project and could result in an event of default under the project's financing documents. In that event, unless substitute financing acceptable to the other lenders could be obtained, GPU could be required to immediately fund its equity contribution of up to $123 million to the project.\nAt December 31, 1995, the EI Group had ownership interests in eleven operating combined-cycle cogeneration plants located in the United States (totaling 932 MW of capacity) and five operating generating facilities located in Canada and South America (totaling 480 MW of capacity). The EI Group also has a number of additional projects at various stages of development, including a 300 MW gas-fired project and a 180 MW gas-fired project for which long-term power purchase agreements have been executed with Georgia Power Company and Wisconsin Public Service Company, respectively.\nGPU has obtained SEC approval to finance investments in foreign utility companies and exempt wholesale generators (both domestically and internationally) up to an aggregate amount equal to 50% of GPU's average consolidated retained earnings. At December 31, 1995, GPU has investments, through the EI Group, in exempt wholesale generators and foreign utility companies totaling approximately $300 million. This amount includes investments made by the EI Group totaling $160 million, of which $81 million was contributed by GPU; and GPU guarantee obligations aggregating $140 million. In addition, GPU has investments, through the EI Group, in qualifying cogeneration facilities and project development activities aggregating $124 million. Selected financial data for the EI Group is as follows:\n(In Millions) 1995* 1994 1993\nTotal assets $380 $130 $ 44\nCapitalization: Common equity $209 $118 $ 39 Notes payable 2 - - Long-term debt 104 - - Total $315 $118 $ 39\nPurchase of investments $165 $ 74 $ 16\nNet income\/(loss) $ 9 $ (3) $ (2)\n* Total assets includes approximately $62 million held by a minority owner.\nNUCLEAR FACILITIES\nThe Subsidiaries have made investments in three major nuclear projects -- Three Mile Island Unit 1 (TMI-1) and Oyster Creek, both of which are operating generation facilities, and Three Mile Island Unit 2 (TMI-2), which was damaged during a 1979 accident. At December 31, 1995, the Subsidiaries' net\ninvestment, including nuclear fuel, in TMI-1 was $640 million (JCP&L $166 million; Met-Ed $318 million; Penelec $156 million) and $785 million for Oyster Creek. The Subsidiaries' net investment in TMI-2 at December 31, 1995 was $95 million (JCP&L $85 million; Met-Ed $2 million; Penelec $8 million). JCP&L is collecting revenues for TMI-2 on a basis which provides for the recovery of its remaining investment in the plant by 2008. Met-Ed and Penelec are collecting revenues for TMI-2 from their wholesale customers. TMI-1 and TMI-2 are jointly owned by JCP&L, Met-Ed and Penelec in the percentages of 25%, 50% and 25%, respectively. Oyster Creek is owned by JCP&L.\nCosts associated with the operation, maintenance and retirement of nuclear plants have continued to be significant and less predictable than costs associated with other sources of generation, in large part due to changing regulatory requirements, safety standards, availability of nuclear waste disposal facilities and experience gained in the construction and operation of nuclear facilities. The GPU System may also incur costs and experience reduced output at its nuclear plants because of the prevailing design criteria at the time of construction and the age of the plants' systems and equipment. In addition, for economic or other reasons, operation of these plants for the full term of their now assumed lives cannot be assured. Also, not all risks associated with ownership or operation of nuclear facilities may be adequately insured or insurable. Consequently, the ability of electric utilities to obtain adequate and timely recovery of costs associated with nuclear projects, including replacement power, any unamortized investment at the end of each plant's useful life (whether scheduled or premature), the carrying costs of that investment and retirement costs, is not assured. Management intends, in general, to seek recovery of any such costs through the ratemaking process, but recognizes that recovery is not assured.\nTMI-1\nThe operating license for TMI-1, a 786 MW pressurized water reactor, expires in 2014. TMI-1 completed a 34-day scheduled refueling outage in October 1995, and operated at a capacity factor of 92.8% for the year. Its next refueling outage is scheduled to begin in September 1997.\nOyster Creek\nThe operating license for the Oyster Creek station, a 619 MW boiling water reactor (as rerated in January 1995 from 610 MW), expires in 2009. Oyster Creek operated at a 95.8% capacity factor for 1995. The station's next refueling outage is scheduled to begin in September 1996 and is expected to last approximately 6 to 8 weeks. This outage may be extended an additional 6 to 8 weeks in order to move spent nuclear fuel from the reactor's spent fuel pool to an on-site dry storage facility.\nTMI-2\nThe 1979 TMI-2 accident resulted in significant damage to, and contamination of, the plant and a release of radioactivity to the environment. The cleanup program was completed in 1990, and, after receiving NRC approval, TMI-2 entered into long-term monitored storage in December 1993.\nAs a result of the accident and its aftermath, individual claims for alleged personal injury (including claims for punitive damages), which are material in amount, have been asserted against the Corporation and the\nU.S. District Court for the Middle District of Pennsylvania. Some of the Subsidiaries. Approximately 2,100 of such claims are pending in the claims also seek recovery for injuries from alleged emissions of radioactivity before and after the accident.\nAt the time of the TMI-2 accident, as provided for in the Price-Anderson Act, the Subsidiaries had (a) primary financial protection in the form of insurance policies with groups of insurance companies providing an aggregate of $140 million of primary coverage, (b) secondary financial protection in the form of private liability insurance under an industry retrospective rating plan providing for up to an aggregate of $335 million in premium charges under such plan, and (c) an indemnity agreement with the NRC for up to $85 million, bringing their total primary, secondary and tertiary financial protection up to an aggregate of $560 million. Under the secondary level, the Subsidiaries are subject to a retrospective premium charge of up to $5 million per reactor, or a total of $15 million (JCP&L, $7.5 million; Met-Ed, $5 million; Penelec, $2.5 million).\nThe insurers of TMI-2 had been providing a defense against all TMI-2 accident-related claims against the Corporation and the Subsidiaries and their suppliers (the defendants) under a reservation of rights with respect to any award of punitive damages. However, in March 1994, the defendants in the TMI-2 litigation and the insurers agreed that the insurers would withdraw their reservation of rights, with respect to any award of punitive damages. A trial of ten allegedly representative cases is scheduled to begin in June 1996.\nIn October 1995, the U.S. Court of Appeals for the Third Circuit ruled that the Price-Anderson Act provides coverage under its primary and secondary levels for punitive as well as compensatory damages, but that punitive damages could not be recovered against the Federal Government under the third level of financial protection. In so doing, the Court of Appeals referred to the \"finite fund\" (the $560 million of financial protection under the Price- Anderson Act) to which plaintiffs must resort to get compensatory as well as punitive damages. The Corporation and its Subsidiaries have asked the U.S. Supreme Court to review that portion of the Court of Appeals' decision that punitive damages may be recovered in public liability actions under the Price- Anderson Act. The Corporation and its Subsidiaries do not know whether plaintiffs will appeal any aspect of the Court of Appeals' decision.\nBased upon the Court of Appeals' decision, the Corporation and its Subsidiaries believe that any liability to which they might be subject by reason of the TMI-2 accident will not exceed their financial protection under the Price-Anderson Act.\nIn February 1996, the U.S. Supreme Court denied a petition filed by the Corporation and its Subsidiaries to review a finding by the Court of Appeals that the standard of care owed by the defendants to a plaintiff was determined by the specific level of radiation which was released into the environment, as measured at the site boundary, rather than as measured at the specific site where the plaintiff was located at the time of the accident (as the Corporation and its Subsidiaries proposed). The Court of Appeals had also held that each plaintiff still must demonstrate exposure to radiation released during the TMI-2 accident and that such exposure had resulted in injuries.\nThere can be no assurance as to the outcome of this litigation.\nNUCLEAR PLANT RETIREMENT COSTS\nRetirement costs for nuclear plants include decommissioning the radiological portions of the plants and the cost of removal of nonradiological structures and materials. The disposal of spent nuclear fuel is covered separately by contracts with the U.S. Department of Energy (DOE). See the NUCLEAR FUEL DISPOSAL FEE section of Note 2 to GPU's consolidated financial statements for further information regarding nuclear fuel disposal costs.\nIn 1990, the Subsidiaries submitted a report, in compliance with NRC regulations, setting forth a funding plan (employing the external sinking fund method) for the decommissioning of their nuclear reactors. Under this plan, the Subsidiaries intend to complete the funding for Oyster Creek and TMI-1 by the end of the plants' license terms, 2009 and 2014, respectively. The TMI-2 funding completion date is 2014, consistent with TMI-2's remaining in long- term storage and being decommissioned at the same time as TMI-1. Based on NRC studies, a comparable funding target has been developed which takes into account the accident. Under the NRC regulations, the funding targets (in 1995 dollars) are as follows:\n(Millions) Oyster Creek TMI-1 TMI-2\nJCP&L $189 $ 39 $ 63 Met-Ed - 79 125 Penelec - 39 62 Total $189 $157 $250\nThe NRC continues to study the levels of these funding targets. Management cannot predict the effect that the results of this review will have on the funding targets. The funding targets, while not considered cost estimates, are reference levels designed to assure that licensees demonstrate adequate financial responsibility for decommissioning. While the regulations address activities related to the removal of the radiological portions of the plants, they do not establish residual radioactivity limits nor do they address costs related to the removal of nonradiological structures and materials.\nThe Subsidiaries charge to expense and contribute to external trusts amounts collected from customers for nuclear plant decommissioning and nonradiological costs. In addition, JCP&L has contributed amounts written off for TMI-2 nuclear plant decommissioning in 1990, and Met-Ed and Penelec have contributed amounts written off for TMI-2 nuclear plant decommissioning in 1991, to TMI-2's external trust (see TMI-2 Future Costs). Amounts deposited in external trusts, including the interest earned on these funds, are classified as Nuclear Decommissioning Trusts on the Balance Sheet.\nIn 1995, a consultant to GPUN performed site-specific studies of the TMI site, including both Units 1 and 2, and of Oyster Creek, that considered various decommissioning methods and estimated the cost of decommissioning the radiological portions and the cost of removal of the nonradiological portions of each plant, using the prompt removal\/dismantlement method. GPUN management\nhas reviewed the methodology and assumptions used in the site-specific studies, is in agreement with them, and believes the results are reasonable as follows:\n(Millions) Oyster GPU Creek TMI-1 TMI-2\nRadiological decommissioning $347 $295 $358 Nonradiological cost of removal 33 73 37* Total $380 $368 $395\n* Net of $3 million spent as of December 31, 1995.\n(Millions) Oyster JCP&L Creek TMI-1 TMI-2\nRadiological decommissioning $347 $74 $90 Nonradiological cost of removal 33 18 9* Total $380 $92 $99\n* Net of $750 thousand spent as of December 31, 1995.\n(Millions)\nMet-Ed TMI-1 TMI-2\nRadiological decommissioning $147 $179 Nonradiological cost of removal 37 19* Total $184 $198\n* Net of $1.5 million spent as of December 31, 1995.\n(Millions)\nPenelec TMI-1 TMI-2\nRadiological decommissioning $74 $89 Nonradiological cost of removal 18 9* Total $92 $98\n* Net of $750 thousand spent as of December 31, 1995.\nThe ultimate cost of retiring the GPU System's nuclear facilities may be different from the cost estimates contained in these site-specific studies. Such costs are subject to (a) the escalation of various cost elements (including, but not limited to, general inflation), (b) the further development of regulatory requirements governing decommissioning, (c) the technology available at the time of decommissioning, and (d) the availability of nuclear waste disposal facilities.\nIn February, 1996 the Financial Accounting Standards Board (FASB) issued an Exposure Draft titled \"Accounting for Certain Liabilities Related to Closure or Removal of Long-Lived Assets,\" which includes nuclear plant retirement costs. If the Exposure Draft's current provisions are finalized,\nOyster Creek and TMI-1 future retirement costs will have to be recognized as a liability currently, rather than recorded over the life of the plants (as is currently the practice), with an offsetting asset recorded for amounts collectible through rates. Any amounts not collectible through rates will have to be charged to expense. For TMI-2, a liability has already been recognized since the plant is no longer operating (see TMI-2 Future Costs). Comments on the Exposure Draft are due by May 31, 1996, and a final statement is expected to be effective for fiscal years beginning after December 15, 1996.\nTMI-1 and Oyster Creek\nJCP&L is collecting revenues for decommissioning, which are expected to result in the accumulation of its share of the NRC funding target for each plant. JCP&L is also collecting revenues, based on estimates of $15 million for TMI-1 and $32 million for Oyster Creek adopted in previous rate orders issued by the NJBPU, for its share of the cost of removal of nonradiological structures and materials. The PaPUC previously granted Met-Ed revenues for decommissioning costs of TMI-1 based on its share ($37 million) of the NRC funding target and nonradiological cost of removal estimated in an earlier 1988 site-specific study to be $74 million (in 1995 dollars). The PaPUC also permitted Penelec to increase the collection of revenues for decommissioning costs for TMI-1 to a basis equivalent to that granted Met-Ed. Collections from customers for retirement expenditures are deposited in external trusts. Provision for the future expenditure of these funds has been made in accumulated depreciation, amounting to $73 million (JCP&L $23 million; Met-Ed $36 million; Penelec $14 million) for TMI-1 and $138 million for Oyster Creek at December 31, 1995. TMI-1 and Oyster Creek retirement costs are charged to depreciation expense over the expected service life of each nuclear plant, and amounted to $15 million (JCP&L $3 million; Met-Ed $8 million; Penelec $4 million) and $13 million, respectively, for 1995.\nManagement believes that any TMI-1 and Oyster Creek retirement costs, in excess of those currently recognized for ratemaking purposes, should be recoverable under the current ratemaking process.\nTMI-2 Future Costs\nThe estimated liabilities for TMI-2 Future Costs (reflected as Three Mile Island Unit 2 Future Costs on the Balance Sheet) as of December 31, 1995 are as follows: (millions) GPU JCP&L Met-Ed Penelec\nRadiological Decommissioning $358 $ 90 $179 $ 89 Nonradiological Cost of Removal 37* 9 19 9 Incremental Monitored Storage 18 4 9 5 Total $413 $103 $207 $103\n* Net of $3 million (JCP&L $750 thousand; Met-Ed $1.5 million; Penelec $750 thousand) spent as of December 31, 1995.\nThe liability recorded on the Balance Sheet for radiological decommissioning and nonradiological cost of removal is based on the 1995 site- specific study.\nOffsetting the $413 million liability is $271 million (JCP&L $53 million; Met-Ed $147 million; Penelec $71 million) which is probable of recovery from customers and included in Three Mile Island Unit 2 Deferred Costs on the Balance Sheet, and $143 million (JCP&L $60 million; Met-Ed $57 million; Penelec $26 million) in trust funds for TMI-2 and included in Nuclear Decommissioning Trusts on the Balance Sheet. Of the $271 million still to be recovered from customers, $66 million (JCP&L $17 million; Met-Ed $33 million; Penelec $16 million) represents an increase from 1994 due to the 1995 site- specific study. Earnings on trust fund deposits collected from customers are included in amounts shown on the Balance Sheet under Three Mile Island Unit 2 Deferred Costs. TMI-2 decommissioning costs charged to expense in 1995 amounted to $14 million (JCP&L $3 million; Met-Ed $9 million; Penelec $2 million).\nThe NJBPU has granted JCP&L decommissioning revenues for the remainder of the NRC funding target and allowances for the cost of removal of nonradiological structures and materials. In 1993, the Pennsylvania Office of Consumer Advocate filed a petition for review of a Met-Ed rate order with the Pennsylvania Commonwealth Court seeking to set aside a March 1993 PaPUC rate order which allowed Met-Ed to recover in the future certain TMI-2 retirement costs. In 1994, the Commonwealth Court reversed that rate order and, as a consequence, Met-Ed and Penelec recorded pre-tax charges totalling $128 million and $56 million, respectively. In September 1995, the Pennsylvania Supreme Court reversed the Commonwealth Court decision. Met-Ed and Penelec have therefore reversed the previous write-offs, resulting in the crediting of pre-tax income for $128 million and $56 million, respectively. However, notwithstanding the Supreme Court's decision, Met-Ed and Penelec have determined that the recovery of the incremental monitored storage costs is no longer probable, and have recorded pre-tax charges of $10 million and $4.7 million, respectively, during 1995.\nAt December 31, 1995, the accident-related portion of TMI-2 radiological decommissioning costs is considered to be $63 million (JCP&L $16 million; Met- Ed $32 million; Penelec $15 million), which is the difference between the 1995 TMI-1 and TMI-2 site-specific study estimates of $295 million and $358 million, respectively (JCP&L $74 million and $90 million; Met-Ed $147 million and $179 million; Penelec $74 million and $89 million). In connection with rate case resolutions at the time, JCP&L, Met-Ed and Penelec made contributions to irrevocable external trusts relating to their shares of the accident-related portions of the decommissioning liability. In 1990, JCP&L contributed $15 million and in 1991, Met-Ed and Penelec contributed $40 million and $20 million, respectively, to irrevocable external trusts. These contributions were not recovered from customers and have been expensed. The Subsidiaries will not pursue recovery from customers for any of these amounts contributed in excess of the $63 million accident-related portion referred to above.\nJCP&L intends to seek recovery for any increases in TMI-2 retirement costs, and Met-Ed and Penelec intend to seek recovery for any increases in the nonaccident-related portion of such costs, but recognize that recovery cannot be assured.\nAs a result of TMI-2's entering long-term monitored storage in late 1993, the Subsidiaries are incurring incremental storage costs of approximately $1 million (JCP&L $250 thousand; Met-Ed $500 thousand; Penelec $250 thousand) annually. The Subsidiaries estimate that the remaining storage costs will total $18 million through 2014, the expected retirement date of TMI-1. JCP&L's rates reflect its share of these costs.\nINSURANCE\nThe GPU System has insurance (subject to retentions and deductibles) for its operations and facilities including coverage for property damage, liability to employees and third parties, and loss of use and occupancy (primarily incremental replacement power costs). There is no assurance that the GPU System will maintain all existing insurance coverages. Losses or liabilities that are not completely insured, unless allowed to be recovered through ratemaking, could have a material adverse effect on the financial position of the GPU System.\nThe decontamination liability, premature decommissioning and property damage insurance coverage for the TMI station and for Oyster Creek totals $2.7 billion per site. In accordance with NRC regulations, these insurance policies generally require that proceeds first be used for stabilization of the reactors and then to pay for decontamination and debris removal expenses. Any remaining amounts available under the policies may then be used for repair and restoration costs and decommissioning costs. Consequently, there can be no assurance that in the event of a nuclear incident, property damage insurance proceeds would be available for the repair and restoration of that station.\nThe Price-Anderson Act limits the GPU System's liability to third parties for a nuclear incident at one of its sites to approximately $8.9 billion. Coverage for the first $200 million of such liability is provided by private insurance. The remaining coverage, or secondary financial protection, is provided by retrospective premiums payable by all nuclear reactor owners. Under secondary financial protection, a nuclear incident at any licensed nuclear power reactor in the country, including those owned by the GPU System, could result in assessments of up to $79 million per incident for each of the GPU System's two operating reactors, subject to an annual maximum payment of $10 million per incident per reactor. In addition to the retrospective premiums payable under Price-Anderson, the GPU System is also subject to retrospective premium assessments of up to $69 million (JCP&L $41 million; Met-Ed $19 million; Penelec $9 million) in any one year under insurance policies applicable to nuclear operations and facilities.\nThe GPU System has insurance coverage for incremental replacement power costs resulting from an accident-related outage at its nuclear plants. Coverage commences after the first 21 weeks of the outage and continues for three years beginning at $1.8 million for Oyster Creek and $2.6 million for TMI-1 per week for the first year, decreasing to 80 percent of such amounts for years two and three.\nNONUTILITY AND OTHER POWER PURCHASES\nPursuant to the requirements of PURPA and state regulatory directives, the Subsidiaries have entered into power purchase agreements with NUGs for the purchase of energy and capacity for periods up to 25 years each for JCP&L and Penelec, and 26 years for Met-Ed. The majority of these agreements contain certain contract limitations and subject the NUGs to penalties for nonperformance. While a few of these facilities are dispatchable, most are must-run and generally obligate the Subsidiaries to purchase, at the contract price, the net output up to the contract limits. As of December 31, 1995, facilities covered by these agreements having 1,624 MW (JCP&L 892 MW; Met-Ed 335 MW; Penelec 397 MW) of capacity were in service. Actual payments from 1993 through 1995, and estimated payments from 1996 through 2000 to NUGs, assuming that all facilities which have existing agreements, or which have obtained orders granting them agreements, enter service, are as follows:\nPayments Under NUG Agreements (Millions)\nTotal JCP&L Met-Ed Penelec\n1993 $ 491 $ 292 $ 95 $ 104 1994 528 304 101 123 1995 670 381 131 158 * 1996 696 369 151 176 * 1997 739 400 155 184 * 1998 837 430 210 197 * 1999 931 442 211 278 * 2000 987 463 216 308\n* Estimate\nOf these amounts, payments to the projects which are not in service at December 31, 1995 are estimated as follows:\nPayments Under NUG Agreements Not In Service (Millions)\nTotal JCP&L Met-Ed Penelec\n1997 $ 40 $ 25 $ 15 $ - 1998 123 53 65 5 1999 202 58 68 76 2000 231 62 71 98\nIn the year 2000, NUG agreements, in the aggregate, will provide for the purchase of approximately 2,062 MW (JCP&L 1,002 MW; Met-Ed 485 MW; Penelec 575 MW) of capacity and energy by the GPU System, at varying prices.\nThe emerging competitive generation market has created uncertainty regarding the forecasting of the System's energy supply needs which has caused the Subsidiaries to change their supply strategy to seek shorter-term agreements offering more flexibility. Due to the current availability of excess capacity in the marketplace, the cost of near- to intermediate-term (i.e., one to eight years) energy supply from generation facilities now in\nservice is currently and is expected to continue to be priced below the costs of new supply sources, at least for some time. The projected cost of energy from new generation supply sources has also decreased due to improvements in power plant technologies and reduced forecasted fuel prices. As a result of these developments, the rates under virtually all of the Subsidiaries' NUG agreements are substantially in excess of current and projected prices from alternative sources.\nThe Subsidiaries are seeking to reduce the above market costs of these NUG agreements by (1) attempting to convert must-run agreements to dispatchable agreements; (2) attempting to renegotiate prices of the agreements; (3) offering contract buyouts while seeking to recover the costs through their energy adjustment clauses (see Managing Nonutility Generation, in MANAGEMENT'S DISCUSSION AND ANALYSIS); and (4) initiating proceedings before federal and state agencies, and in the courts, where appropriate. In addition, the Subsidiaries intend to avoid, to the maximum extent practicable, entering into any new NUG agreements that are not needed or not consistent with current market pricing and are supporting legislative efforts to repeal PURPA. These efforts may result in claims against the GPU System for substantial damages. There can, however, be no assurance as to the extent to which the Subsidiaries' efforts will be successful in whole or in part.\nWhile the Subsidiaries thus far have been granted recovery of their NUG costs from customers by the PaPUC and NJBPU, there can be no assurance that the Subsidiaries will continue to be able to recover these costs throughout the term of the related agreements. The GPU System currently estimates that for 1998, when substantially all of these NUG projects are scheduled to be in service, above market payments (benchmarked against the expected cost of electricity produced by a new gas-fired combined-cycle facility) will range from $240 million to $350 million (JCP&L $100 to $150 million; Met-Ed $50 million to $80 million; Penelec $90 million to $120 million). The amount of these estimated above market payments may increase or decrease substantially based upon, among other things, payment escalations in the contract terms, changes in fuel prices and changes in the capital and operating cost of new generating equipment.\nIn 1995, the Subsidiaries entered into a three-year fuel management agreement with New Jersey Natural Energy Corporation, an affiliate of New Jersey Natural Gas Company, to manage the Subsidiaries' natural gas purchases and interstate pipeline capacity. The Subsidiaries' gas-fired facilities, as well as up to approximately 1,100 MW (JCP&L 885 MW; Met-Ed 200 MW; Penelec 15 MW) of NUG capacity, will be pooled and managed under this agreement, allowing the Subsidiaries to reduce their power purchase expenses. The Subsidiaries have conditional or final agreements with four NUGs (JCP&L three NUGs; Met-Ed one NUG), having an aggregate capacity of approximately 430 MW (JCP&L 385 MW; Met-Ed 45 MW), to supply natural gas from the pool.\nIn 1995, Met-Ed and Penelec filed a petition for enforcement and declaratory order with the FERC requesting that the FERC effectively invalidate four contracts (Met-Ed two contracts; Penelec two contracts) with NUGs, aggregating 487 MW (Met-Ed 327 MW; Penelec 160 MW) of capacity, on the grounds that the PaPUC's implementation of PURPA directing Met-Ed and Penelec to enter into these agreements was unlawful. The FERC has denied the petition, and Met-Ed and Penelec have not determined whether they will seek judicial review of the FERC's action. Subsequent to the FERC's decision, Met-Ed bought out the contracts for two of these projects, totaling 327 MW.\nIn 1993, the PaPUC ordered Penelec to enter into long-term contracts to purchase a total of 160 MW from two NUGs commencing in 1997 or later. Penelec's subsequent appeal of the PaPUC order to the Commonwealth Court was denied, but the case was remanded back to the PaPUC to recalculate the avoided costs to be paid for the power. In January 1996, a PaPUC Administrative Law Judge (ALJ) issued a decision recommending a levelized avoided cost which is in excess of current market prices. Penelec and other parties have filed exceptions to the ALJ's decision.\nIn August 1995, the Pennsylvania Supreme Court granted Penelec's petition to review the Commonwealth Court's decision which upheld the PaPUC order requiring Penelec to enter into such power purchase agreements. Briefs have been filed and oral argument was held in January 1996. These matters are pending.\nIn March 1995, the U.S. Court of Appeals denied petitions for rehearing filed by JCP&L, the NJBPU, and the New Jersey Division of Ratepayer Advocate (Ratepayer Advocate), seeking reconsideration of the Court's earlier decision prohibiting the NJBPU from reexamining its order approving the rates payable to Freehold Cogeneration Associates (Freehold) under a long-term power purchase agreement entered into pursuant to PURPA. The U.S. Supreme Court has denied petitions for review filed by JCP&L and the Ratepayer Advocate. JCP&L also petitioned the FERC to invalidate the agreement as unlawful under PURPA. The FERC has denied JCP&L's petition and in February 1996 JCP&L requested the U.S. Court of Appeals to review the FERC's decision. JCP&L is also seeking to invalidate the Freehold power purchase agreement in a separate action pending in New Jersey Superior Court. Freehold has moved to dismiss JCP&L's claim, and the matter is pending. JCP&L believes that over the 20-year term of the agreement, the above market costs of this contract will amount to approximately $1.2 billion over alternative sources of energy.\nIn 1994, MidAtlantic Cogen Inc. requested the PaPUC to order Met-Ed to enter into a long-term agreement to buy 322 MW of capacity and energy from its Fairless Cogeneration Project. The PaPUC subsequently ordered that hearings be held and assigned the matter to an ALJ. Met-Ed moved to dismiss MidAtlantic's petition and, in February 1996, an ALJ issued a recommended decision granting Met-Ed's request. This matter is pending before the PaPUC.\nJCP&L has entered into agreements with other utilities to purchase capacity and energy for various periods through 2004. These agreements will provide for up to 1,085 MW in 1996, declining to 878 MW in 1999 and 696 MW in 2004. Payments pursuant to these agreements are estimated to be $174 million in 1996, $164 million in 1997, $145 million in 1998, $124 million in 1999, and $95 million in 2000. Applications for approval of three of these agreements are pending before the NJBPU. These three agreements provide for the purchase of up to 351 MW in 1996, increasing to 696 MW in 1999, with payments pursuant to these agreements estimated to be $11 million in 1996, $37 million in 1997, $57 million in 1998, $82 million in 1999, and $95 million in 2000.\nIn January 1996, JCP&L issued an all-supply source solicitation for the short-term supply of energy and capacity to meet its minimum forecasted needs from 1999 through 2002 (see New Energy Supplies, in MANAGEMENT'S DISCUSSION AND ANALYSIS).\nRATE PROCEEDINGS\nPennsylvania\nIn January 1996, Met-Ed filed a preliminary Energy Cost Rate (ECR) request with the PaPUC for an annual increase of $23.6 million, representing a 2.9% increase in overall retail customer charges. Met-Ed's request is primarily attributable to an increase in payments under NUG contracts and recovery of $17 million of buy-out costs for canceled NUG projects after giving effect to lower energy costs resulting from an anticipated increase in TMI-1 generation. The ECR change is proposed to go into effect April 1, 1996.\nAlso in January 1996, Penelec filed a preliminary ECR request with the PaPUC for an annual increase of $31.9 million, representing a 3.8% increase in overall retail customer charges. Penelec's request is primarily attributable to an increase in payments under NUG contracts and the per unit cost of coal- fired generation after giving effect to lower energy costs resulting from an anticipated increase in TMI-1 generation. The ECR change is proposed to go into effect April 1, 1996.\nIn September 1995, a Pennsylvania Supreme Court decision overturned a 1994 Commonwealth Court order and restored a 1993 PaPUC rate order allowing Met-Ed to recover certain TMI-2 retirement costs from customers (see NUCLEAR PLANT RETIREMENT COSTS - TMI-2 Future Costs).\nIn 1994, at the request of the PaPUC, the affected Pennsylvania electric utilities have submitted to the PaPUC proposals for the establishment of a nuclear performance standard. The matter is pending before the PaPUC.\nNew Jersey\nIn December 1995, JCP&L filed a petition with the NJBPU requesting a net increase in overall retail customer rates of $36.5 million annually, or an increase of 1.8%, effective March 1, 1996. The proposed increase is primarily related to JCP&L's demand side management programs, levelized energy adjustment clause (LEAC) charges, which include recovery of costs to buy out NUG contracts, and other tariff revisions.\nConcurrent with the its proposed March 1996 LEAC change, JCP&L filed a petition with the NJBPU to implement a Manufactured Gas Plant Remediation Adjustment Clause (RAC) for the recovery of underrecovered Manufactured Gas Plant (MGP) costs. The RAC mechanism, which was approved by the NJBPU in December 1994, provides for the recovery of MGP costs, net of insurance and other recoveries, over rolling seven year periods with interest on any unamortized balance. In its petition, JCP&L proposes to recover $44,000 annually through the RAC.\nIn July 1995, New Jersey adopted energy rate-flexibility legislation that will enable electric utilities to offer rate discounts to certain customers. If certain conditions are met, utilities may be permitted to recover from customers, on a prospective basis following a base rate case, up to 50% of revenue lost as a result of rate discounts. JCP&L has submitted its initial compliance filing which sets forth JCP&L's minimum price for off-tariff rate agreements applicable to commercial and industrial customers. The legislation\nalso provides utilities with the opportunity to propose to the NJBPU alternative ways to set rates. JCP&L expects to file such an alternative rate plan with the NJBPU in 1996.\nJCP&L's two operating nuclear units are subject to the NJBPU's annual nuclear performance standard. Operation of these units at an aggregate annual generating capacity factor below 65% or above 75% would trigger a charge or credit based on replacement energy costs. At current cost levels, the maximum annual effect of the performance standard charge at a 40% capacity factor would be approximately $10 million before tax. While a capacity factor below 40% would generate no specific monetary charge, it would require the issue to be brought before the NJBPU for review. The annual measurement period, which begins in March of each year, coincides with that used for the LEAC.\nThe NJBPU has instituted a generic proceeding to address the appropriate recovery of capacity costs associated with electric utility power purchases from NUG projects. The proceeding was initiated, in part, to respond to contentions of the Ratepayer Advocate that by permitting utilities to recover such costs through the LEAC, an excess or \"double\" recovery may result when combined with the recovery of the utilities' embedded capacity costs through their base rates. In 1994, the NJBPU ruled that the LEAC periods prior to March 1991 were considered closed but subsequent LEAC periods remain open for further investigation. This matter is pending before a NJBPU Administrative Law Judge. JCP&L estimates that the potential refund liability for the LEAC periods from March 1991 through February 1996, the end of the most recent LEAC period, is $55 million. There can be no assurance as to the outcome of this proceeding.\nCAPITAL PROGRAMS\nGeneral\nDuring 1995, gross plant additions were approximately $459 million (JCP&L $232 million; Met-Ed $101 million; Penelec $123 million; GPUSC $3 million) attributable principally to improvements and modifications to existing generation, transmission and distribution facilities, a new generation facility, and clean air requirements. Expenditures for maturing obligations totaled $91 million (JCP&L $47 million; Met-Ed $41 million; GPUSC $3 million) in 1995. In addition, the EI Group made investments in 1995 totaling $165 million, consisting primarily of investments in generation facilities in South America and an electric distribution business in Australia (see THE EI GROUP). The principal categories of the 1996 anticipated Subsidiary construction expenditures, which include anticipated expenditures by GPUSC and an allowance for other funds used during construction, are as follows:\n(In Millions)\nGPU JCP&L Met-Ed Penelec\nGeneration - Nuclear $ 57 $ 41 $11 $ 5 Nonnuclear 82 26 15 41 Total Generation 139 67 26 46 Transmission & Distribution 269 140 60 69 Other 83 49 11 9 Total $491 $256 $97 $124\nThe anticipated increase in construction expenditures during 1996 is principally attributable to expenditures associated with ongoing system development and upgrading JCP&L's communication system. Gross plant additions are expected to be approximately $437 million in 1997 (JCP&L $200 million; Met-Ed $108 million; Penelec $116 million; GPUSC $13 million). The decrease in construction expenditures during 1997 is largely due to the anticipated completion in 1996 of JCP&L's communication system and a new generation facility. During 1996 and 1997, GPU will continue to provide the EI Group with capital contributions and credit support (in amounts which may be substantial) as project investment opportunities arise. In addition, expenditures for maturing obligations are expected to be $131 million for 1996 (JCP&L $36 million; Met-Ed $15 million; Penelec $75 million; GPUSC $3 million; EI Group $2 million) and $158 million for 1997 (JCP&L $86 million; Met-Ed $40 million; Penelec $26 million; GPUSC $3 million; EI Group $3 million).\nGPU and the Subsidiaries estimate that a substantial portion of their anticipated total capital needs in each of 1996 and 1997 will be satisfied through internally generated funds.\nThe Subsidiaries expect to obtain the remainder of these funds principally through the sale, subject to market conditions, of first mortgage bonds (FMBs). The Subsidiaries' FMB indentures and charters include provisions that limit the amount of long-term debt, preferred stock and short- term debt the Subsidiaries may issue (see LIMITATIONS ON ISSUING ADDITIONAL SECURITIES). Present plans call for the Subsidiaries to issue long-term debt during the next three years to, among other things, finance construction activities and fund the redemption of maturing senior securities.\nThe GPU System's gross plant additions exclude nuclear fuel requirements provided under capital leases that amounted to $52 million (JCP&L $19 million; Met-Ed $22 million; Penelec $11 million) in 1995. When consumed, the presently leased material, which amounted to $152 million (JCP&L $88 million; Met-Ed $43 million; Penelec $21 million) at December 31, 1995, is expected to be replaced by additional leased material at a rate of between $40 million and $45 million (JCP&L $20 million - $25 million; Met-Ed $13 million; Penelec $7 million) annually. In the event the replacement nuclear fuel needs cannot be leased, the associated capital requirements would have to be met by other means.\nOver the next five years, assuming the continuation of existing retail electric regulation, each of the Subsidiaries is expected to experience an average growth in sales to customers of about 2% annually, principally due to continued economic growth in the service territories and a slight increase in customers. The Subsidiaries intend to provide for these increased energy needs through a mix of economic supply sources.\nIn response to the increasingly competitive business climate and excess capacity of nearby utilities, the GPU System's supply plan places an emphasis on maintaining flexibility. Supply planning focuses increasingly on short- to intermediate-term commitments, reliance on \"spot\" market purchases, and avoidance of long-term firm commitments. GPU's present strategy includes minimizing the financial exposure associated with new long-term purchase commitments and the construction of new facilities by evaluating these options in terms of an unregulated power market. As part of this strategy, GPU is also evaluating the future financial viability of its generating assets, including possible plant retirements, on an ongoing basis. The GPU System\nwill take necessary actions to avoid adding new capacity which would result in costs that may exceed future market prices. In addition, the Subsidiaries will continue to seek regulatory support to renegotiate or buy out contracts with NUGs where the pricing is in excess of projected prices of alternative sources.\nIn February 1996, JCP&L announced plans to close the 58 MW Werner Unit 4 and 72 MW Gilbert Unit 3 generating plants due to high operating costs. The combined remaining investment in these plants is approximately $15 million at December 31, 1995. JCP&L has not determined whether it will seek recovery of such costs through the ratemaking process.\nConservation and Load Management\nThe NJBPU and PaPUC continue to encourage the development of new conservation and load-management programs. The benefits of some of these programs may not, however, offset program costs and the Subsidiaries are working to mitigate the impacts these programs can have on their competitive position in the marketplace.\nIn New Jersey, JCP&L continues to conduct DSM programs approved in 1992 by the NJBPU. DSM includes utility-sponsored activities designed to improve energy efficiency in customer electricity use and load-management programs that reduce peak demand. These JCP&L programs have resulted in summer peak demand reductions of 79 MW through 1995. In August 1995, JCP&L filed a revised DSM plan for NJBPU approval covering programs for 1996 and 1997. This filing is currently under review by the NJBPU.\nIn a December 1993 order, the PaPUC adopted guidelines for the recovery of DSM costs and directed utilities to implement DSM programs. Met-Ed and Penelec subsequently filed DSM programs that were expected to be approved by the PaPUC in the first quarter of 1995. An industrial intervenor contested the PaPUC's guidelines. In January 1995, the Commonwealth Court reversed the PaPUC order and in February 1996 the Pennsylvania Supreme Court upheld the Commonwealth Court's decision. As a result, the nature and scope of Met-Ed and Penelec's DSM programs is uncertain at this time.\nFINANCING ARRANGEMENTS\nThe Corporation and the Subsidiaries expect to have short-term debt outstanding from time to time throughout 1996. The peak in short-term debt outstanding is expected to occur in the spring, coinciding with normal cash requirements for revenue tax payments.\nThe GPU System has $529 million of credit facilities, which includes a Revolving Credit Agreement (Credit Agreement) with a consortium of banks. The credit facilities generally provide for the payment of a commitment fee on the unborrowed amount of 1\/8 of 1% annually. Borrowings under these credit facilities generally bear interest based on the prime rate or money market rates. Notes issued under the Credit Agreement, which expires November 1, 1999, are limited to $250 million in total borrowings outstanding at any time and are subject to various covenants and acceleration under certain conditions. The Credit Agreement borrowing rates and facility fee are dependent on the long-term debt ratings of the Subsidiaries.\nIn 1995, GPU sold five million shares of common stock. The net proceeds of $157.5 million were used to make cash capital contributions to the Subsidiaries and to repay GPU short-term debt, a portion of which had been incurred to acquire interests in a generating company in Bolivia and the Solaris distribution business in Australia.\nThe Subsidiaries have regulatory authority to issue and sell FMBs, which may be issued as secured medium-term notes, and preferred stock through various periods into 1997. Under existing authorizations, JCP&L, Met-Ed and Penelec may issue these senior securities in aggregate amounts of $225 million, $190 million and $160 million, respectively, of which $100 million for each Subsidiary may consist of preferred stock. The Subsidiaries also have regulatory authority to incur short-term debt, a portion of which may be through the issuance of commercial paper.\nIn 1995, the Subsidiaries issued an aggregate of $338 million (JCP&L $50 million; Met-Ed $89 million; Penelec $199 million) principal amount of FMBs. The proceeds from these issuances were used to refinance $128 million (Met-Ed $29 million; Penelec $99 million) principal amount of higher cost FMBs, to redeem at maturity $59 million (JCP&L $47 million; Met-Ed $12 million) principal amount of FMBs, to moderate short-term debt levels and to fund growth in capitalization. In addition, the EI Group has borrowed $68 million under a credit agreement, the proceeds of which were used primarily to finance the acquisition of Solaris (see THE EI GROUP).\nJCP&L Capital, L.P., a special-purpose partnership in which a subsidiary of JCP&L is the sole general partner, issued $125 million stated value of mandatorily redeemable preferred securities. The proceeds from the issuance were used to reduce JCP&L short-term debt and retire senior securities. Also in 1995, JCP&L repurchased $6 million stated value of cumulative preferred stock. The repurchased shares may be used to satisfy future sinking fund requirements.\nIn March 1996, JCP&L and Penelec expect to redeem approximately $26 million and $25 million principal amount of 6 1\/8% series and 6 1\/4% series FMBs, respectively, using lower cost short-term debt.\nPresent plans call for the Subsidiaries to issue long-term debt during the next three years to finance construction activities, fund the redemption of maturing senior securities, and depending on interest rates, refinance outstanding senior securities. In addition, significant further investments by the EI Group, or otherwise, may require GPU to issue additional debt and\/or new shares of common stock.\nDuring 1995, the Subsidiaries refinanced their nuclear fuel lease agreements with nonaffiliated fuel trusts. The new lease arrangements provide that an aggregate of up to $210 million ($100 million for Oyster Creek and $110 million for TMI-1) of nuclear fuel costs may be outstanding at any one time. It is contemplated that when consumed, portions of the presently leased material will be replaced by additional leased material. The Subsidiaries are responsible for the disposal costs of nuclear fuel leased under these agreements.\nLIMITATIONS ON ISSUING ADDITIONAL SECURITIES\nThe Subsidiaries' FMB indentures and\/or charters contain provisions which limit the total amount of securities evidencing secured indebtedness and\/or unsecured indebtedness which the Subsidiaries may issue, the more restrictive of which are discussed below.\nThe Subsidiaries' FMB indentures require that, for a period of any twelve consecutive months out of the fifteen calendar months immediately preceding the issuance of additional FMBs, net earnings (before income taxes, with other income limited to 5% of operating income before income taxes for JCP&L and Met-Ed and 10% for Penelec) available for interest on FMBs shall have been at least twice the annual interest requirements on all FMBs to be outstanding immediately after such issuance. Moreover, the Subsidiaries' FMB indentures restrict the ratio of the principal amount of FMBs which may be issued to not more than 60% of available bondable value of property additions. In addition, the indentures, in general, permit the Subsidiaries to issue additional FMBs against a like principal amount of previously issued and retired FMBs.\nAt December 31, 1995, the net earnings requirement under the Subsidiaries' FMB indentures, as described above, would have permitted JCP&L, Met-Ed and Penelec to issue $1.3 billion, $537 million and $724 million, respectively, principal amount of additional FMBs at an assumed 8% interest rate. However, the Subsidiaries had bondable value of property additions sufficient to permit JCP&L, Met-Ed and Penelec to only issue approximately $330 million, $383 million and $236 million, respectively, principal amount of additional FMBs. In addition, the Subsidiaries' FMB indentures would have permitted JCP&L, Met-Ed and Penelec to issue approximately $316 million, $46 million and $107 million, respectively, of FMBs against a like principal amount of previously issued and retired FMBs.\nAmong other restrictions, the Subsidiaries' charters provide that without the consent of the holders of two-thirds of the outstanding preferred stock, no additional shares of preferred stock may be issued unless, for a period of any twelve consecutive months out of the fifteen calendar months immediately preceding such issuance, the after-tax net earnings available for the payment of interest on indebtedness shall have been at least one and one-half times the aggregate of (a) the annual interest charges on indebtedness and (b) the annual dividend requirements on all shares of preferred stock to be outstanding immediately after such issuance. At December 31, 1995, these provisions would have permitted JCP&L, Met-Ed and Penelec to issue $1.2 billion, $1.0 billion and $778 million, respectively, stated value of cumulative preferred stock at an assumed 7.5% dividend rate.\nThe Subsidiaries' charters also provide that, without the consent of the holders of a majority of the total voting power of the Subsidiaries' outstanding preferred stock, the Subsidiaries may not issue or assume any securities representing short-term unsecured indebtedness, except to refund certain outstanding unsecured securities issued or assumed by the Subsidiaries or to redeem all outstanding preferred stock, if immediately thereafter the total principal amount of all outstanding unsecured debt securities having an initial maturity of less than ten years (or within 3 years of maturity for JCP&L) would exceed 10% of the aggregate of (a) the total principal amount of all outstanding secured indebtedness issued or assumed by the Subsidiaries and (b) the capital and surplus of the Subsidiaries. At December 31, 1995, these\nrestrictions would have permitted JCP&L, Met-Ed and Penelec to have approximately $288 million, $132 million and $147 million, respectively, of unsecured indebtedness outstanding.\nThe Subsidiaries have obtained authorization from the SEC to incur short- term debt (including indebtedness under the Credit Agreement and commercial paper) up to the Subsidiaries' charter limitations.\nREGULATION\nAs a registered holding company, GPU is subject to regulation by the SEC under the 1935 Act. The GPU System companies are also subject to regulation under the 1935 Act with respect to accounting, the issuance of securities, the acquisition and sale of utility assets, securities or any other interest in any business, the entering into, and performance of, service, sales and construction contracts, and certain other matters. The SEC has determined that the electric facilities of the Subsidiaries constitute a single integrated public utility system under the standards of the 1935 Act. The 1935 Act also limits the extent to which the GPU System may engage in nonutility businesses. Each Subsidiary's retail rates, conditions of service, issuance of securities and other matters are subject to regulation in the state in which such Subsidiary operates - in New Jersey by the NJBPU and in Pennsylvania by the PaPUC. Additionally, Penelec, as lessee, operates the facilities serving the village of Waverly, New York. Penelec's retail rates for New York customers, as well as Penelec's New York operations and property, are subject to regulation by the New York Public Service Commission. Although Penelec does not render electric service in Maryland, the Public Service Commission of Maryland has jurisdiction over the portion of Penelec's property located in that state. Moreover, with respect to wholesale rates, the transmission of electric energy, accounting, the construction and maintenance of hydroelectric projects and certain other matters, the Subsidiaries are subject to regulation by the FERC under the Federal Power Act. The NRC regulates the construction, ownership and operation of nuclear generating stations and other related matters. JCP&L is also subject, in certain respects, to regulation by the PaPUC in connection with its participation in the ownership and operation of certain facilities located in Pennsylvania. (See ELECTRIC GENERATION AND THE ENVIRONMENT - Environmental Matters for additional regulation to which the Subsidiaries are or may be subject.)\nSolaris, EI Energy's electric distribution subsidiary in Australia, is subject to regulation by the Office of the Regulator General. Solaris' network and connection charges are subject to regulatory review every five years, with the next review scheduled for January 1, 2000. In addition, Solaris' franchise license becomes nonexclusive in stages through the year 2001, at which time all customers will be permitted to choose their source of electric supply. Empresa Guaracachi S.A., EI Power's electric generation subsidiary in Bolivia, is subject to regulation under the Electricity Law of 1994. Twice each year, the Superintendency of Electricity recalculates the prices that Empresa Guaracachi S.A. and other electric generators may charge for capacity based upon an estimated cost of constructing a new generating unit. In addition, energy prices are recalculated semi-annually based upon a projected cost of generation, including fuel and nonfuel variable operation and maintenance costs.\nELECTRIC GENERATION AND THE ENVIRONMENT\nFuel\nThe Subsidiaries utilized fuels in the generation of electric energy during 1995 in approximately the following percentages:\nGPU JCP&L Met-Ed Penelec\nCoal 58% 20% 56% 88% Nuclear 38% 71% 41% 13% Gas 3% 7% 2% - Oil 1% 3% - - Other* - (1)% 1% (1)%\n* Represents hydro and pumped storage (which is a net user of electricity).\nApproximately 41% (JCP&L 56%; Met-Ed 40%; Penelec 32%) of the Subsidiaries' total energy requirements in 1995 was supplied by purchases and interchange from other utilities and NUGs. For 1996, the Subsidiaries estimate that their generation of electric energy will be in the following proportions:\nGPU JCP&L Met-Ed Penelec\nCoal 62% 25% 55% 88% Nuclear 34% 66% 41% 12% Gas 3% 10% 2% - Oil 1% 3% - - Other* - (4)% 2% -\n* Represents hydro and pumped storage.\nThe anticipated changes in 1996 fuel utilization percentages are principally attributable to a refueling outage at Oyster Creek scheduled for September 1996. Approximately 41% (JCP&L 60%; Met-Ed 38%; Penelec 27%) of the Subsidiaries' 1996 energy requirements are expected to be supplied by purchases and interchange from other utilities and NUGs.\nFossil: The Subsidiaries have entered into long-term contracts with nonaffiliated mining companies for the purchase of coal for certain generating stations in which they have ownership interests (JCP&L - 16.67% ownership interest in Keystone; Met-Ed - 16.45% ownership interest in Conemaugh; and Penelec - 50% ownership interest in Homer City). The contracts, which expire between 1996 and 2004, require the purchase of either fixed or minimum amounts of coal. The price of the coal under the contracts is based on adjustments of indexed cost components. One of Penelec's contracts for Homer City also includes a provision for the payment of postretirement benefits costs. The Subsidiaries' share of the cost of coal purchased under these agreements is expected to aggregate $115 million (JCP&L $20 million; Met-Ed $18 million; Penelec $77 million) for 1996.\nThe Subsidiaries' coal-fired generating stations now in service are estimated to require an aggregate of 167 million tons (JCP&L 15 million tons; Met-Ed 41 million tons; Penelec 111 million tons) of coal over the next twenty years. Of this total requirement, approximately 10 million tons (JCP&L 3 million tons; Penelec 7 million tons) are expected to be supplied by\nnonaffiliated mine-mouth coal companies with the balance supplied through short- and long-term contracts and spot market purchases.\nAt the present time, adequate supplies of fossil fuels are readily available to the Subsidiaries, but this situation could change rapidly as a result of actions over which they have no control.\nNuclear: Preparation of nuclear fuel for generating station use involves various manufacturing stages for which the GPU System contracts separately. Stage I involves the mining and milling of uranium ores to produce natural uranium concentrates. Stage II provides for the chemical conversion of the natural uranium concentrates into uranium hexafluoride. Stage III involves the process of enrichment to produce enriched uranium hexafluoride from the natural uranium hexafluoride. Stage IV provides for the fabrication of the enriched uranium hexafluoride into nuclear fuel assemblies for use in the reactor core at the nuclear generating station.\nFor TMI-1, under normal operating conditions, there is, with minor planned modifications, sufficient on-site storage capacity to accommodate spent nuclear fuel through the end of its licensed life while maintaining the ability to remove the entire reactor core. As a result of completion of an interim spent fuel dry storage facility in early 1996, Oyster Creek also has sufficient on-site storage capacity to accommodate, under normal operating conditions, its spent nuclear fuel while maintaining the ability to remove the entire reactor core.\nEnvironmental Matters\nThe GPU System is subject to a broad range of federal, state and local environmental and employee health and safety legislation and regulations. In addition, the Subsidiaries are subject to licensing of hydroelectric projects by the FERC and of nuclear power projects by the NRC. Such licensing and other actions by federal agencies with respect to projects of the Subsidiaries are also subject to the National Environmental Policy Act.\nAs a result of existing and proposed legislation and regulations, and ongoing legal proceedings dealing with environmental matters, including but not limited to acid rain, water quality, air quality, global warming, electromagnetic fields, and storage and disposal of hazardous and\/or toxic wastes, the GPU System may be required to incur substantial additional costs to construct new equipment, modify or replace existing and proposed equipment, remediate, decommission or clean up waste disposal and other sites currently or formerly used by it, including formerly owned MGPs and mine refuse piles and generating facilities, and with regard to electromagnetic fields, postpone or cancel the installation of, or replace or modify, utility plant, the costs of which could be material. The consequences of environmental issues, which could cause the postponement or cancellation of either the installation or replacement of utility plant, are unknown. The GPU System believes the costs described above should be recoverable through the ratemaking process but recognizes that recovery cannot be assured.\nWater: The federal Water Pollution Control Act (Clean Water Act) generally requires, with respect to existing steam electric power plants, the application of the best conventional or practicable pollutant control technology available and compliance with state-established water quality\nstandards. Additionally, water quality-based effluent limits (more stringent than \"technology\" limits) may be applied to utility waste water discharges based on receiving stream quality. With respect to future plants, the Clean Water Act requires the application of the \"best available demonstrated control technology, processes, operating methods or other alternatives.\"\nThe U.S. Environmental Protection Agency (EPA) has adopted regulations that establish thermal and other limitations for effluents discharged from both existing and new steam electric generating stations. Standards of performance are developed and enforcement of effluent limitations is accomplished through the issuance by the EPA, or states authorized by the EPA, of discharge permits that specify limitations to be applied. Discharge permits are required for all of the Subsidiaries' steam generating stations. JCP&L's discharge permits have expired, and timely reapplications have been filed as required by regulations. Until new permits are issued, JCP&L's currently expired permits remain in effect. JCP&L has also filed an application with the New Jersey Department of Environmental Protection (NJDEP) for a discharge permit for its Yards Creek pumped storage facility. Discharge permits have been reissued for Met-Ed's Titus and York Haven stations and administratively extended for the Portland station pending action by the Pennsylvania Department of Environmental Protection (PaDEP) on timely reapplication. Penelec has obtained all required discharge permits.\nThe discharge permit received by JCP&L for the Oyster Creek station may, among other things, require the installation of a closed-cycle cooling system, such as a cooling tower, to meet New Jersey state water quality-based thermal effluent limitations. Although construction of such a system is not required in order to meet the EPA's regulations setting effluent limitations for the Oyster Creek station (such regulations would accept the use of the once- through cooling system now in operation at this station), a closed-cycle cooling system may be required in order to comply with the water quality standards imposed by the NJDEP for water quality certification and incorporated in the station's discharge permit. If a cooling tower is required, the capital costs could exceed $150 million. In October 1994, following six years of studies, the NJDEP issued a new Discharge to Surface Water Permit for the Oyster Creek station. The new permit grants JCP&L a variance from the New Jersey Surface Water Quality Standards. The variance allows the continued operation of the existing once-through cooling system without modifications such as cooling towers. The variance is effective through October 1999. The NJDEP could revoke the variance at any time upon failure to comply with the permit conditions.\nThe NJDEP has proposed thermal and other conditions for inclusion in the discharge permits for JCP&L's Gilbert and Sayreville generating stations which, among other things, could require JCP&L to install cooling towers and\/or modify the water intake\/discharge systems at these facilities. JCP&L has objected to these conditions and has requested an adjudicatory hearing with respect thereto. Implementation of these permit conditions has been stayed pending action on JCP&L's hearing request. JCP&L has made filings with the NJDEP that, JCP&L believes, demonstrate compliance with state water quality standards at the Gilbert generating station and justify the issuance of a thermal variance at the Sayreville generating station to permit the continued use of the present once-through cooling system. Based on the NJDEP's review of these demonstrations, substantial modifications may be required at these stations, which may result in material capital expenditures.\nThe Subsidiaries are also subject to environmental and water diversion requirements adopted by the Delaware River Basin Commission and the Susquehanna River Basin Commission as administered by those commissions or the PaDEP and the NJDEP.\nIn 1993, York Haven Power Company, a wholly-owned subsidiary of Met-Ed, entered into an agreement with various agencies to construct a fish passage facility at the York Haven hydroelectric project by the year 2000. The present estimated installed cost of the facility is $8.5 million. Construction is expected to begin in 1998.\nNuclear: Reference is made to NUCLEAR FACILITIES for information regarding the TMI-2 accident, its aftermath and the GPU System's other nuclear facilities.\nNew Jersey and Connecticut have established the Northeast Compact, to construct a low level radioactive waste (radwaste) disposal facility in New Jersey. The estimated cost to license and build the facility is $100 million. GPUN's minimum expected $29.5 million share of the cost for this facility is to be paid annually over a six-year period from 1992 to 1997. In a February 1993 rate order, the NJBPU authorized JCP&L to recover these amounts currently from customers. Through December 1995, $6 million has been paid. The development of the facility is expected to continue after 1997 which will most likely result in additional costs in excess of $29.5 million.\nPennsylvania, Delaware, Maryland and West Virginia have established the Appalachian Compact (which includes eleven nuclear power plants - 9 in Pennsylvania and 2 in Maryland) to construct a facility for the disposal of low level radwaste in those states, including low level radwaste from TMI-1. To date $33 million, of a minimum estimated $88 million, of pre-construction costs has been paid. The eleven plants have so far shared equally in the pre- construction cost, including GPUN which has contributed $3 million. All contributors, including nonutility radwaste producers within the compact that make voluntary contributions, will receive certain credits from surcharges paid by all depositors of waste over a ten-year period. The methodology for the allocation of these credits has yet to be determined. In addition, $50 million of estimated construction costs will be funded by an independent contractor and recovered by the contractor through waste disposal fees collected during the first five years of the facility's operation.\nGPUN is currently shipping low level radwaste to the Barnwell, South Carolina radwaste disposal site. The development of the Northeast Compact disposal facility is expected to continue beyond 1997, the projected completion date. The Appalachian Compact disposal facility is currently scheduled to open in June 1999. Continuing delays in the completion of the disposal facilities will require GPUN to perform an evaluation of its ability to safely store radwaste beyond these dates.\nThe Subsidiaries have provided for future contributions to the Decontamination and Decommissioning Fund (part of the EPAct) for the cleanup of uranium enrichment plants operated by the Federal Government. The GPU System's total liability at December 31, 1995 amounted to $36 million (JCP&L $23 million; Met-Ed $9 million; Penelec $4 million). The Subsidiaries made their initial payment in 1993. The remaining amount recoverable from ratepayers at December 31, 1995 is $39 million (JCP&L $25 million; Met-Ed $9 million; Penelec $5 million).\nAir: The Subsidiaries are subject to certain state environmental regulations of the NJDEP and the PaDEP. The Subsidiaries are also subject to certain federal environmental regulations of the EPA.\nCurrent Pennsylvania environmental regulations prescribe criteria that generally limit the sulfur dioxide content of stack gas emissions from Penelec's generating stations constructed before 1972 and stations constructed after 1971 but before 1978, to 3.7 pounds and 1.2 pounds per million BTU of heat input, respectively. In the case of Met-Ed's facilities, the sulfur dioxide content of stack gas emissions is limited to 2.8 pounds or 3.7 pounds per million BTU of heat input depending on location. On a weighted average basis, the Subsidiaries have been able to obtain coal with a sulfur content meeting these criteria. If, and to the extent that, the Subsidiaries cannot continue to meet such limitations with processed coal, it may be necessary to retrofit operating stations with sulfur dioxide control equipment that may require substantial capital expenditures as well as substantial additional operating costs. Such retrofitting would take approximately five years.\nAs a result of the Clean Air Act, which requires substantial reductions in sulfur dioxide and nitrogen oxide (NOx) emissions by the years 1995 and 2000, it will be necessary for the GPU System to install and operate emission control equipment as well as switch to slightly lower sulfur coal at some of the GPU System's coal-fired plants in order to achieve compliance. To comply with Title IV (the acid rain provisions) of the Clean Air Act, the GPU System expects to spend up to $410 million (JCP&L $42 million; Met-Ed $158 million; Penelec $210 million) for air pollution control equipment by the year 2000, of which approximately $234 million (JCP&L $41 million; Met-Ed $100 million; Penelec $93 million) has been spent as of December 31, 1995. The capital costs of equipment are for the installation of scrubbers, low NOx burner technology, selective noncatalytic reduction and particulate removal upgrades. The capital costs of this equipment and the increased operating costs of the affected stations are expected to be recoverable through the ratemaking process but recovery is not assured. The second of two scrubbers was completed at the Conemaugh station during 1995. This action is part of the GPU System's plans to comply with Clean Air Act sulfur dioxide emission limitations. In its January 1993 rate order, the PaPUC approved Met-Ed's request for $24.5 million of current expenditures to be included in rate base representing certain costs associated with the installation of scrubbers at the Conemaugh station and other environmental compliance projects. The plan for the Portland station is to meet its Phase I compliance obligation through the use of sulfur dioxide emission allowances, including allowances allocated directly to Portland station by the EPA and allowances resulting from the installation of scrubbers at the Conemaugh station. Shawville station will require lower sulfur coal and\/or the purchase of emission allowances to meet its Phase I requirements.\nThe GPU System's current strategy for Phase II compliance under Title IV of the Clean Air Act is to evaluate the installation of scrubbers, the use of fuel switching and allowances at the Keystone station and at the Homer City Unit 3 station. Switching to lower sulfur coal and\/or the purchasing of allowances is currently planned for the Titus, Seward, Portland, Shawville and Warren stations. Homer City Units 1 and 2 will use existing coal cleaning technology. Additional control modifications are not expected to be necessary for compliance with Title IV in Phase II at Conemaugh, Gilbert and Sayreville stations.\nThe GPU System continues to reassess its options for compliance with the Clean Air Act including those that may result from the continued development of the emission trading allowance market. The GPU System's compliance strategy, especially with respect to Phase II, could change as a result of further review, discussions with co-owners of jointly owned stations and changes in federal and state regulatory requirements.\nThe ultimate impact of Title I of the Clean Air Act, which deals with the attainment of ambient air quality standards, is highly uncertain. In particular, this Title has established an ozone transport region that includes 12 northeast states and the District of Columbia identified as the Ozone Transport Region (OTR). Pennsylvania and New Jersey are part of the OTR, and will be required to control NOx emissions to a level that will provide for the attainment of the ozone standard in the Northeast. As an initial step, major sources of NOx were required to implement Reasonably Available Control Technology (RACT) by May 31, 1995. Compliance with the PaDEP's RACT regulations has been achieved through operational modifications and installation of low NOx burners with separate overfire air at the Keystone, Titus, Portland and Conemaugh stations. An extension of time has been obtained to bring Homer City Units 1 and 2 into compliance with the PaDEP's RACT regulations. The NJDEP's RACT regulations establish maximum allowable emission rates for utility boilers based on fuel used and boiler type, and on combustion turbines based on fuel used. Existing units are eligible for emissions averaging upon approval of an averaging plan by the NJDEP. A Memorandum of Understanding (MOU) has been signed by the members of the Ozone Transport Commission (OTC). This calls for inner and outer zones with seasonal NOx emission reductions of 65% and 55%, from 1990 emission levels, respectively, by May 1, 1999. Met-Ed and Penelec will spend an estimated $10 million and $50 million, respectively, to meet the reductions set by the OTC. The MOU also calls for a 75% reduction by May 2003, unless scientific data shows this level of reduction is unnecessary to achieve the Clean Air Act's 2005 National Ambient Air Quality Standard (NAAQS) for ozone. The ultimate impact of Title III of the Clean Air Act, which deals with emissions of hazardous air pollutants, is also highly uncertain. Specifically, the EPA has not completed a Clean Air Act study to determine whether it is appropriate to regulate emissions of hazardous air pollutants from electric utility steam generating units.\nBoth the EPA and the PaDEP are questioning the attainment of NAAQS for sulfur dioxide in the vicinity of the Chestnut Ridge Energy Complex (Homer City, Conemaugh, Keystone and Seward generating stations). The Homer City, Conemaugh and Keystone stations are jointly owned with nonaffiliated utilities. The EPA and the PaDEP have approved the use of a nonguideline air quality model to evaluate the ambient air quality impacts of these generating stations. This nonguideline model is more representative and less conservative than the EPA guideline model and will be used in the development of a compliance strategy for all generating stations in the Chestnut Ridge Energy Complex.\nThe area around the Warren station has been designated as nonattainment for sulfur dioxide. In early 1993, Penelec began a model evaluation study of the area. The PaDEP and the EPA have approved the use of the nonguideline model which is more representative than guideline models. A model evaluation study has also been conducted at Shawville station. The results of this\nstudy, which remain subject to PaDEP approval, show attainment of the NAAQS at the Shawville station with current Pennsylvania sulfur dioxide emission limits.\nThe sulfur dioxide attainment issue has been taken into account as part of the design of the Conemaugh station scrubbers. Met-Ed has initiated ambient air quality modeling studies for its Portland and Titus stations that will take several years to complete. While the results are uncertain, these studies may result in a revised Pennsylvania State Implementation Plan (PaSIP) in order to attain NAAQS for sulfur dioxide. If sulfur dioxide emissions need to be reduced to meet the new PaSIP, Met-Ed will reevaluate its options available for Portland and Titus stations.\nBased on the results of the studies pursuant to compliance with NAAQS, significant sulfur dioxide reductions may be required at one or more of these stations which could result in significant capital and additional operating expenditures.\nCertain other environmental regulations limit the amount of particulate matter emitted into the environment. The Subsidiaries have installed equipment at their coal-fired generating stations and may find it necessary to either upgrade or install additional equipment at certain of their stations to consistently meet particulate emission requirements.\nIn the fall of 1993, the Clinton Administration announced its Climate Change Action Plan intended to reduce greenhouse gas emissions to 1990 levels by the year 2000. The Climate Change Action Plan relies heavily on voluntary action by industry. GPU has joined approximately 150 other electric utility companies by signing an accord that is part of the Department of Energy Climate Challenge Program. The GPU System's program is expected to avoid or reduce the equivalent of 8 million tons of carbon dioxide emissions between 1995 and 2000.\nTitle IV of the Clean Air Act requires Phase I and Phase II affected units to install a continuous emission monitoring system (CEMS) and quality assure the data for sulfur dioxide, nitrogen oxides, opacity and volumetric flow. In addition, Title VIII requires all affected sources to monitor carbon dioxide emissions. Monitoring systems have been installed and certified on JCP&L, Met-Ed and Penelec's Phase I and Phase II affected units as required by EPA, NJDEP and PaDEP regulations.\nThe PaDEP has a CEMS enforcement policy to ensure consistent compliance with air quality regulations under federal and state statutes. The CEMS enforcement policy includes matters such as visible emissions, sulfur dioxide emission standards, nitrogen oxide emissions and a requirement to maintain certified continuous emission monitoring equipment. In addition, this policy provides a mechanism for the payment of certain prescribed amounts to the Pennsylvania Clean Air Fund (Clean Air Fund) for air pollutant emission excesses or monitoring failures. With respect to the operation of Met-Ed and Penelec's generating stations for 1995, it is not anticipated that payments to be made to the Clean Air Fund will be material in amount. The Clean Air Act has also expanded the enforcement options available to the EPA and the states and contains more stringent enforcement provisions and penalties. Moreover, citizen suits can seek civil penalties for violations of this act.\nThe EPA has established Best Available Retrofit Technology (BART) sulfur dioxide emission standards to be used for Penelec's Shawville and Seward stations under the applicable stack height regulations. Dependent upon the Chestnut Ridge Compliance Strategy and the results of the Shawville model evaluation study mentioned above, lower sulfur coal purchases may be necessary for compliance. Discussions with the EPA and the PaDEP regarding this matter are continuing.\nIn 1988, the Environmental Defense Fund (EDF), the New Jersey Conservation Foundation, the Sierra Club and Pennsylvanians for Acid Rain Control requested that the NJDEP and the NJBPU seek to reduce sulfur deposition in New Jersey, either by reducing emissions from both in-state and out-of-state sources, or by requiring that certain electricity imported into New Jersey be generated from facilities meeting minimum emission standards. JCP&L purchases a substantial portion of its net system requirements from out-of-state coal-fired facilities, including the 1,700 MW Keystone station in Pennsylvania in which it owns a 16.67% interest. In addition, coal-fired generating facilities owned by Met-Ed and Penelec supply electric energy to JCP&L and other New Jersey members of PJM. Hearings on the EDF petition were held during 1989 and 1990, and the matter is pending before the NJDEP and the NJBPU.\nIn New Jersey, where the bulk of the GPU System's oil-fired generating capacity is located, NJDEP regulations establish that the maximum sulfur content of No. 6 fuel oil may not exceed .3% for most of JCP&L's generating stations and 1% for the balance. For No. 2 fuel oil, the sulfur content may not exceed .2% for most of JCP&L's generating stations and .3% for the balance.\nIn 1995, the Subsidiaries made capital expenditures of approximately $93 million (JCP&L $36 million; Met-Ed $14 million; Penelec $43 million) in response to environmental considerations and have budgeted approximately $18 million (JCP&L $3 million; Met-Ed $3 million; Penelec $12 million) for this purpose in 1996. The incremental annual operating and maintenance costs for such equipment is expected to be immaterial.\nElectromagnetic Fields: There have been a number of studies regarding the possibility of adverse health effects from electric and power frequency magnetic fields that are found everywhere there is electricity. While some of the studies have indicated some association between exposure to magnetic fields and cancer, other studies have indicated no such association. The studies have not shown any causal relationship between exposure to magnetic fields and cancer, or any other adverse health effects. In 1990, the EPA issued a draft report that identifies magnetic fields as a possible carcinogen, although it acknowledged that there is still scientific uncertainty surrounding these fields and their possible link to adverse health effects. On the other hand, a 1992 White House Office of Science and Technology policy report states that \"there is no convincing evidence in the published literature to support the contention that exposures to extremely low frequency electric and magnetic fields generated by sources such as household appliances, video display terminals, and local power lines are demonstrable health hazards.\" In 1994, results of a large-scale epidemiology study of electric utility workers suggested a statistical relationship between brain cancer and the class of workers who received the highest exposure. These\nfindings conflicted with two earlier large-scale studies that found no such relationship. Additional studies, which may foster a better understanding of the subject, are presently underway.\nCertain parties have alleged that the exposure to electric and magnetic fields associated with the operation of transmission and distribution facilities will produce adverse impacts upon public health and safety and upon property values. Furthermore, regulatory actions under consideration by the NJDEP and bills introduced in the Pennsylvania legislature could, if enacted, establish a framework under which the intensity of the fields produced by electric transmission and distribution lines would be limited or otherwise regulated.\nThe Subsidiaries cannot determine at this time what effect, if any, this matter will have on their respective results of operations and financial position.\nResidual Waste: PaDEP residual waste regulations became effective in July 1992. These regulations impose additional restrictions on operating existing ash disposal sites and for siting future disposal sites and will increase the costs of establishing and operating these facilities. The main objective of these regulations is to prevent degradation of groundwater and to abate any existing degradation.\nThe regulations require, among other things, groundwater assessments of landfills if existing groundwater monitoring indicates the possibility of degradation. The assessments require the installation of additional monitoring wells and the evaluation of one year's data. All of Penelec's active landfills require assessments. If the assessments show degradation of the groundwater, Penelec would be required to develop abatement plans. Penelec and Met-Ed's landfills had preliminary permit modification applications submitted to the PaDEP by July 1994, and complete permit applications must be under evaluation by July 1997. Met-Ed's Portland and Titus landfills have had preliminary assessments proposed which are currently under review by the PaDEP. Additional data will be collected and evaluated to determine if degradation has occurred and if development of abatement plans is necessary. The Titus station ash disposal site was upgraded in 1991 and now meets many of the lined facility requirements. The Portland station ash disposal site will require significant modifications under the new regulations. Various alternatives for upgrading the site are being evaluated, including beneficial uses of coal ash.\nOther compliance requirements at Penelec that may need to be implemented in the future include the lining of currently unlined disposal sites and storage impoundments. Impoundments also will eventually require groundwater monitoring systems and assessments of impact on groundwater. Groundwater abatement may be necessary at locations where pollution problems are identified. The removal of all the residual waste (\"clean closure\") will be done at some impoundments to eliminate the need for future monitoring and abatement requirements. Storage impoundments must have implemented groundwater monitoring plans by 2002, but the PaDEP can require this at any time prior to this date or, at its discretion, defer full compliance beyond 2002 for some storage impoundments. Also being evaluated are the options for beneficial use of ash authorized by the regulations and source reductions.\nPreliminary groundwater assessment plans have also been conducted at Met-Ed's Portland and Titus stations' industrial waste treatment impoundments. New groundwater monitoring wells were installed at the Titus station. The Portland station assessment plan is pending with the PaDEP. Additional data will be collected and evaluated to determine if abatement will be required. The Portland station impoundments were upgraded in 1987 and meet the requirements for lined impoundments. The Titus station impoundments will require significant modifications by 2002.\nThere are also a number of issues still to be resolved regarding certain waivers related to Penelec's existing landfill and storage impoundment compliance requirements. These waivers could significantly reduce the cost of many of Penelec's facility compliance upgrades.\nHazardous\/Toxic Wastes: Under the Toxic Substances Control Act (TSCA), the EPA has adopted certain regulations governing the use, storage, testing, inspection and disposal of electrical equipment that contains polychlorinated biphenyls (PCBs). Such regulations permit the continued use and servicing of certain electrical equipment (including transformers and capacitors) that contain PCBs. The Subsidiaries have met all requirements of the TSCA necessary to allow the continued use of equipment containing PCBs and have taken substantive voluntary actions to reduce the amount of PCB containing electrical equipment in the System.\nPrior to 1953, the Subsidiaries owned and operated MGPs in New Jersey and Pennsylvania. Waste contamination associated with the operation and dismantlement of these MGPs, are or may be present, both on-site and off-site. Claims have been asserted against the Subsidiaries for the cost of investigation and remediation of these sites. The amount of such remediation costs and penalties may be significant and may not be covered by insurance. To date, JCP&L has identified 17 former MGP sites and two off-site properties where waste may have been sent. JCP&L has entered into cost sharing agreements with New Jersey Natural Gas Company and Elizabethtown Gas Company under which JCP&L is responsible for 60% of all costs incurred in connection with the remediation of 12 of these sites. JCP&L has entered into Administrative Consent Orders (ACOs) with the NJDEP for seven of these sites and has entered into Memoranda of Agreement (MOAs) with the NJDEP for eight of these sites. JCP&L anticipates entering into MOAs for the remaining sites. The ACOs specify the agreed upon obligations of both JCP&L and the NJDEP for remediation of the sites. The MOAs afford JCP&L greater flexibility in the schedule for investigation and remediation of sites.\nAs of December 31, 1995, JCP&L has an estimated environmental liability of $29 million recorded on its Balance Sheet relating to these sites. The estimated liability is based upon ongoing site investigations and remediation efforts, including capping the sites and pumping and treatment of ground water. If the periods over which the remediation is currently expected to be performed are lengthened, JCP&L believes that it is reasonably possible that the future costs may range as high as $50 million. Estimates of these costs are subject to significant uncertainties because: JCP&L does not presently own or control most of these sites; the environmental standards have changed in the past and are subject to future change; the accepted technologies are subject to further development; and the related costs for these technologies are uncertain. If JCP&L is required to utilize different remediation methods, the costs could be materially in excess of $50 million.\nIn December 1995, JCP&L filed a petition with the NJBPU to implement, concurrent with the its proposed March 1996 LEAC change, a Manufactured Gas Plant Remediation Adjustment Clause for the recovery of underrecovered MGP costs (see RATE PROCEEDINGS - New Jersey).\nIn 1994, JCP&L filed a complaint with the New Jersey Superior Court against several of its insurance carriers, relating to these MGP sites. JCP&L requested the Court to order the insurance carriers to reimburse JCP&L for all amounts it has paid, or may be required to pay, in connection with the remediation of the sites. Pretrial discovery has begun in this case.\nThe Federal Resource Conservation and Recovery Act of 1976, the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (CERCLA) and the Superfund Amendment and Reauthorization Act of 1986 authorize the EPA to issue an order compelling responsible parties to take cleanup action at any location that is determined to present an imminent and substantial danger to the public or to the environment because of an actual or threatened release of one or more hazardous substances. Pennsylvania and New Jersey have enacted legislation giving similar authority to the PaDEP and the NJDEP, respectively. Because of the nature of the Subsidiaries' business, various by-products and substances are produced and\/or handled that are classified as hazardous under one or more of these statutes. The Subsidiaries generally provide for the treatment, disposal or recycling of such substances through licensed independent contractors, but these statutory provisions also impose potential responsibility for certain cleanup costs on the generators of the wastes. The GPU System companies have been notified by the EPA and state environmental authorities that they are among the potentially responsible parties (PRPs) who may be jointly and severally liable to pay for the costs associated with the investigation and remediation at 11 hazardous and\/or toxic waste sites (including those described below).\nJCP&L MET-ED PENELEC GPUN GPU TOTAL\nPRPs 6 4 2 1 1 11*\n* In some cases, the Subsidiaries are named separately for the same site.\nIn addition, the Subsidiaries have been requested to voluntarily participate in the remediation or supply information to the EPA and state environmental authorities on several other sites for which they have not yet been named as PRPs. The Subsidiaries have also been named in lawsuits requesting damages for hazardous and\/or toxic substances allegedly released into the environment. At December 31, 1995, the Subsidiaries have liabilities recorded on their balance sheets for environmental matters (in addition to the $29 million for JCP&L's MGP sites) totaling $8.2 million (JCP&L $6.6 million; Met-Ed $900 thousand; Penelec $700 thousand).\nJCP&L, Met-Ed and GPUN are among the more than 800 PRPs under CERCLA who may be liable to pay for the cost associated with the investigation and remediation of the Maxey Flats disposal site, located in Fleming County, Kentucky. A negotiated settlement among all parties has been finalized and cleanup efforts have begun. The interim remediation work is estimated to cost $63 million, for which all responsible parties will be jointly and severally liable. The estimated allocation, which is based upon a percentage of the total volume of waste believed shipped to the site, is JCP&L $1.1 million, Met-Ed $400 thousand and GPUN $150 thousand.\nIn 1994, JCP&L received a letter from the EPA notifying it of potential liability for the disposal of PCB liquids and related equipment at the Kansas City, Missouri site of PCB Treatment, Incorporated. JCP&L's cleanup cost obligation is currently estimated to be $1.3 million based upon a percentage allocation of waste delivered by JCP&L to the site. The ultimate costs, however, may range as high as $3.3 million if JCP&L becomes liable for the potential nonpayment of other responsible parties. JCP&L is seeking indemnification from its waste broker.\nIn 1988, JCP&L received a PRP notice from the NJDEP alleging that JCP&L disposed of asbestos at the High Point Sanitary Landfill in Warren County, New Jersey. JCP&L is one of over 20 PRPs at this site. By 1993, JCP&L made payments totaling $131 thousand to the NJDEP for certain remediation investigation and feasibility studies. The extent of JCP&L's obligation for remediation costs, if any, will be subject to the results of additional studies. There can be no assurance as to the outcome of this matter.\nMet-Ed received a PRP notice from the PaDEP asserting that Met-Ed disposed of hazardous waste at the Industrial Solvents & Chemical Company site, a former solvents recycler. This site is being remediated under the Pennsylvania Hazardous Sites Cleanup Act. Met-Ed made immaterial payments in 1995 to the PRP group for the removal of tanks, drums and other materials at the site. A feasibility study to determine the extent of ground water contamination is expected to be completed in 1996. Met-Ed cannot reasonably estimate its remaining liability until the feasibility study results are available and the PaDEP selects a remedy for ground water contamination.\nPenelec has been named as a PRP by the EPA, along with over 1,000 other PRPs, for allegedly disposing of hazardous materials at the Jack's Creek\/Sitken site, a former metals recycling and smelting operation in Mifflin County, Pennsylvania. Penelec joined a PRP group, which is working on the issues presented at the site. The PRP group is also exploring a settlement with the EPA, but Penelec cannot predict the ultimate outcome of the negotiations.\nPursuant to certain federal monitoring requirements, Penelec has reported to the PaDEP that contaminates from coal mine refuse piles were identified in storm water run-off at Penelec's Seward station property. Penelec signed a Consent Order and is negotiating with the PaDEP to determine a schedule for long-term remediation based on possible future operating scenarios, including the installation of fluidized bed combustion technology. If the station is reboilered using this technology, a low cost solution would be to mix the ash from the reboilered station with the existing refuse. Early negotiations with the PaDEP indicate that this approach would be acceptable. If the station is not reboilered using such technology, remediation of the site may be required. Based upon a conceptual engineering report prepared by Penelec, the cost of remediation is estimated to range from $12 million to $25 million. These costs are subject to uncertainties based on the extent of remediation and available technologies. Penelec must notify the PaDEP by December 31, 1996 of its decision.\nThe ultimate cost of remediation of these sites will depend upon changing circumstances as site investigations continue, including (a) the existing technology required for site cleanup, (b) the remedial action plan chosen and (c) the extent of site contamination and the portion attributed to the GPU System companies.\nThe Corporation and its Subsidiaries are unable to estimate the extent of possible remediation and associated costs of additional environmental matters. Management believes the costs described above should be recoverable through the ratemaking process but realizes recovery is not assured.\nFRANCHISES AND CONCESSIONS\nJCP&L operates pursuant to franchises in the territory served by it and has the right to occupy and use the public streets and ways of the state with its poles, wires and equipment upon obtaining the consent in writing of the owners of the soil, and also to occupy the public streets and ways underground with its conduits, cables and equipment, where necessary, for its electric operation. JCP&L has the requisite legal franchise for the operation of its electric business within the State of New Jersey, including in incorporated cities and towns where designations of new streets, public ways, etc., may be obtained upon application to such municipalities. JCP&L holds a FERC license expiring in 2013 authorizing it to operate and maintain the Yards Creek pumped storage hydroelectric station in which JCP&L has a 50% ownership interest.\nMet-Ed and Penelec have the necessary franchise rights to furnish electric service in the various respective municipalities or territories in which each company now supplies such services. These electric franchise rights, which are generally nonexclusive rights, consist generally of (a) charter rights and (b) certificates of public convenience issued by the PaPUC and\/or \"grandfather rights\". Such electric franchise rights are free from unduly burdensome restrictions and unlimited as to time, except in a few relatively minor cases and except as otherwise described below. The secondary franchise granted by the Borough of Boyertown to Met-Ed contains a provision that the Borough shall have the right at any time to purchase the electric system in the Borough at a valuation to be fixed by appraisers. Met-Ed holds a FERC license expiring in 2014 for the continued operation and maintenance of the York Haven hydroelectric project. Penelec holds a license from the FERC, which expires in 2002, for the continued operation and maintenance of the Piney hydroelectric project. In addition, Penelec and the Cleveland Electric Illuminating Company hold a license expiring in 2015 for the Seneca Pumped Storage Hydroelectric station in which Penelec has a 20% undivided interest. For the same station, Penelec and the Cleveland Electric Illuminating Company hold a Limited Power Permit issued by the Pennsylvania Water and Power Resources Board which is unlimited as to time. For purposes of the Homer City station, Penelec and New York State Electric & Gas Corporation hold a Limited Power Permit issued by the Pennsylvania Water and Power Resources Board which expires in 2017, but is renewable by the permittees until they have recovered all capital invested by them in the project. Penelec also holds a Limited Power Permit issued by the Pennsylvania Water and Power Resources Board for its Shawville station which expires in 2003, but is renewable by Penelec until it has recovered all capital invested in the project.\nEMPLOYEE RELATIONS\nAt February 29, 1996, the GPU System had 10,310 full-time employees (JCP&L 3,049; Met-Ed 2,133; Penelec 2,216; all other companies 2,912). The nonsupervisory production and maintenance employees of the Subsidiaries and certain of their nonsupervisory clerical employees are represented for collective bargaining purposes by local unions of the International Brotherhood of Electrical Workers (IBEW) at JCP&L, Met-Ed and Penelec and the Utility Workers Union of America (UWUA) at Penelec.\nPenelec's five-year contracts with the IBEW and UWUA expire on May 14, 1998 and June 30, 1998, respectively. Met-Ed's three-year contract with the IBEW expires on April 30, 1997. JCP&L's two-year contract with the IBEW expires on October 31, 1996.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nGenerating Stations\nAt December 31, 1995, the generating stations of the Subsidiaries had an aggregate effective capability of 6,592,000 net kilowatts (KW), as follows:\nName of Year of Net KW Station Subsidiary Installation (Summer) COAL-FIRED: Homer City(a) Penelec 1969-1977 942,000 Shawville Penelec 1954-1960 597,000 Portland Met-Ed 1958-1962 401,000 Keystone(b) JCP&L 1967-1968 283,000 Conemaugh(c) Met-Ed 1970-1971 280,000 Titus(d) Met-Ed 1951-1953 243,000 Seward Penelec 1950-1957 196,000 Warren Penelec 1948-1949 82,000\nNUCLEAR: TMI-1(e) All 1974 786,000 Oyster Creek(f) JCP&L 1969 619,000\nGAS\/OIL-FIRED: Sayreville JCP&L 1930-1958 229,000 Gilbert(g) JCP&L 1930-1949 72,000 Combustion Turbines(h) All 1960-1989 1,160,000 Werner(i) JCP&L 1953 58,000 Other(j) All 1968-1977 298,000 Hydroelectric(k) Met-Ed\/Penelec 1905-1969 64,000\nPUMPED STORAGE:(l) Yards Creek JCP&L 1965 195,000 Seneca Penelec 1969 87,000 TOTAL 6,592,000\nAggregate Effective Capability by Subsidiary\nNet KW (Summer) (Winter) JCP&L 2,704,000 3,068,000 Met-Ed 1,604,000 1,705,000 Penelec 2,284,000 2,365,000 TOTAL 6,592,000 7,138,000\n(a) Represents Penelec's undivided 50% interest in the station.\n(b) Represents JCP&L's undivided 16.67% interest in the station.\n(c) Represents Met-Ed's undivided 16.45% interest in the station.\n(d) Effective June 19, 1995, the Titus station was rerated from 241,000 KW.\n(e) Jointly owned by JCP&L, Met-Ed and Penelec in percentages of 25%, 50% and 25%, respectively.\n(f) Effective January 17, 1995, the Oyster Creek station was rerated from 610,000 KW.\n(g) Effective November 1, 1995, 45,000 KW of capability were retired. JCP&L announced plans to close this station in 1996.\n(h) JCP&L - 762,000 KW, Met-Ed - 266,000 KW and Penelec 132,000 KW.\n(i) JCP&L announced plans to close this station in 1996.\n(j) Consists of internal combustion and combined-cycle units (JCP&L - 290,000 KW, Met-Ed - 2,000 KW and Penelec - 6,000 KW).\n(k) Consists of Met-Ed's York Haven station (19,000 KW) and Penelec's Piney (27,000 KW) and Deep Creek stations (18,000 KW).\n(l) Represents the Subsidiaries' undivided interests in these stations which are net users rather than net producers of electric energy. Effective June 1, 1995, the Yards Creek station was rerated from 190,000 KW.\nThe Subsidiaries' coal-fired, hydroelectric (other than the Deep Creek station) and pumped storage stations (other than the Yards Creek station) are located in Pennsylvania. The TMI-1 nuclear station is also located in Pennsylvania. The Subsidiaries' gas-fired and oil-fired stations (other than some combustion turbines in Pennsylvania), the Yards Creek pumped storage station and the Oyster Creek nuclear station are located in New Jersey. The Deep Creek hydroelectric station is located in Maryland.\nSubstantially all of the Subsidiaries' properties are subject to the lien of their respective FMB indentures.\nThe peak loads of the GPU System and its Subsidiaries were as follows:\n(In KW) Company Date Peak Load\nGPU Aug. 2, 1995 9,101,000 JCP&L July 9, 1993 4,564,000 Met-Ed Aug. 2, 1995 2,186,000 Penelec Dec. 11, 1995 2,589,000\nEI Group Facilities\nThe EI Group has ownership interests in sixteen natural gas-fired cogeneration and other nonutility power production facilities located in the United States, South America and Canada with an aggregate capability of 1,412,000 KW as follows:\nU.S. Facilities\nName of Year of EI Ownership Facility Location Installation Total KW Interest (KW)\nSelkirk NY 1992\/94 350,000 70,000 Lake* FL 1993 112,000 47,150 Pasco* FL 1993 112,000 56,000 Onondaga* NY 1993 80,000 40,000 Syracuse* NY 1992 80,000 3,500 Marcal* NJ 1989 65,000 32,500 Ada* MI 1991 29,000 290 Camarillo* CA 1988 27,000 13,500 Chino* CA 1987 27,000 13,500 FPB CA 1983 26,000 7,800 Berkeley* CA 1987 24,000 12,000 Total 932,000 296,240\nNon-U.S. Facilities\nTermobarran- quilla* Colombia 1972-83 240,000 72,000 Guaracachi* Bolivia 1975-94 161,000 80,500 Aranjuez* Bolivia 1974-94 40,000 20,000 Karachipampa* Bolivia 1982 15,000 7,500 Brooklyn* Canada 1996 24,000 18,000 Total 480,000 198,000\nTotal capability 1,412,000 494,240\n* The EI Group has operating responsibility for these facilities.\nTransmission and Distribution System\nAt December 31, 1995, the GPU System owned the following: GPU System JCP&L Met-Ed Penelec Total Transmission and Distribution Substations 296 288 468 1,052\nAggregate Installed Transformer Capacity of Substations (in kilovoltamperes - KVA) 20,893,974 11,827,100 15,914,320 48,635,394\nTransmission System:\nLines (In Circuit Miles):\n500 KV 18 188 235 441 345 KV - - 149 149 230 KV 570 383 650 1,603 138 KV - 3 11 14 115 KV 232 361 1,325 1,918 69 KV, 46 KV and 34.5 KV 1,760 472 364 2,596 Total 2,580 1,407 2,734 6,721\nDistribution System:\nLine Transformer Capacity (KVA) 9,618,670 5,654,976 6,213,003 21,486,649\nPole Miles of Overhead Lines 15,649 12,613 22,797 51,059\nTrench Miles of Underground Cable 6,738 1,943 1,834 10,515\nIn addition, Solaris provides service to more than 230,000 customers in and around a 385 square mile area in Melbourne, Australia (see THE EI GROUP under Item 1). Solaris owns a total of 3,629 pole miles of overhead lines.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nReference is made to NUCLEAR FACILITIES - TMI-2, RATE PROCEEDINGS, and ELECTRIC GENERATION AND THE ENVIRONMENT - Environmental Matters under Item 1 and to Note 1 to GPU's consolidated financial statements contained in Item 8 for a description of certain pending legal proceedings involving the GPU System.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNone.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nAll of JCP&L, Met-Ed and Penelec's outstanding common stock is owned by GPU. During 1995, the Subsidiaries paid dividends on their common stock to GPU as follows: JCP&L $140 million, Met-Ed $95 million and Penelec $75 million.\nIn accordance with the Subsidiaries' FMB indentures, as supplemented, the balances of retained earnings at December 31, 1995 that are restricted as to the payment of dividends on their common stock are as follows:\nJCP&L - $1.7 million Met-Ed - $3.4 million Penelec - $10 million\nStock Trading\nGeneral Public Utilities Corporation is listed as GPU on the New York Stock Exchange. On February 1, 1996, there were approximately 46,300 registered holders of GPU common stock.\nDividends\nGPU common stock dividend declaration dates are the first Thursdays of April, June, October and December. Dividend payment dates fall on the last Wednesdays of February, May, August and November. Dividend declarations and quarterly stock price ranges for 1995 and 1994 are set forth below.\nCommon Stock\nDividends Declared Price Ranges* 1995 1994 1995 1994 Quarter High\/Low High\/Low\nApril $.47 $.45 First $30 5\/8 26 1\/4 $30 7\/8 $27 5\/8 June .47 .45 Second 31 28 1\/4 31 5\/8 26 October .47 .45 Third 31 1\/4 28 1\/8 27 1\/2 23 3\/4 December .47 .45 Fourth 34 30 5\/8 26 7\/8 24\n* Based on New York Stock Exchange Composite Transactions as reported in the Wall Street Journal.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nSee pages and for references to each registrant's Selected Financial Data required by this item.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nSee pages and for references to each registrant's Management's Discussion and Analysis of Financial Condition and Results of Operations required by this item.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nSee pages and for references to each registrant's Financial Statements and Quarterly Financial Data (unaudited) required by this item.\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.\nIdentification of Directors\nInformation regarding GPU's directors is incorporated by reference to pages 2 through 4 of GPU's Proxy Statement for the 1996 Annual Meeting of Stockholders. The current directors of JCP&L, Met-Ed and Penelec, their ages, positions held and business experience during the past five years are as follows: Year First Name Age Position Elected JCP&L: J. R. Leva (a) 63 Chairman of the Board 1986 and Chief Executive Officer D. Baldassari (b) 46 President 1982 R. C. Arnold (c) 58 Director 1989 J. G. Graham (d) 57 Vice President and Chief 1986 Financial Officer M. P. Morrell (e) 47 Vice President 1993 G. E. Persson (f) 64 Director 1983 D. W. Myers (g) 51 Vice President and Comptroller 1994 S. C. Van Ness (h) 62 Director 1983 S. B. Wiley (i) 66 Director 1982\nYear First Elected Met-Ed\/Penelec: Met-Ed Penelec J. R. Leva (a) 63 Chairman of the Board 1992 1992 and Chief Executive Officer F. D. Hafer (j) 54 President 1978 1994 J. G. Graham (d) 57 Vice President and 1986 1986 Chief Financial Officer J. F. Furst (k) 49 Vice President 1994 1994 G. R. Repko (l) 50 Vice President 1994 1993 R. S. Zechman (m) 52 Vice President 1994 1994 R. C. Arnold (c) 58 Director 1989 1989\n(a) Mr. Leva is also Chairman, President, Chief Executive Officer and a director of GPUSC; Chairman, Chief Executive Officer and a director of Genco; and Chairman and a director of GPUN, Energy Initiatives, Inc. (EI), EI Power, Inc. (EI Power), and EI Energy, Inc. (EI Energy), all subsidiaries of GPU. Prior to 1992, Mr. Leva served as President of JCP&L since 1986. Mr. Leva is also a director of Utilities Mutual Insurance Company.\n(b) Mr. Baldassari was elected President of JCP&L in 1992. Prior to that, Mr. Baldassari served as Vice President - Materials & Services of JCP&L since 1990. Mr. Baldassari is also a director of GPUSC, GPUN, Genco and First Morris Bank of Morristown, NJ.\n(c) Mr. Arnold has been Executive Vice President-Power Supply of GPUSC since 1990. He is also a director of GPUSC and Genco.\n(d) Mr. Graham was elected Senior Vice President of GPU in 1989. He is also Executive Vice President, Chief Financial Officer and a director of GPUSC; Vice President and Chief Financial Officer of GPUN; and a director of Genco, EI, EI Power and EI Energy. Mr. Graham is also a director of Edisto Resources, Inc., Nuclear Electric Insurance Limited, Nuclear Mutual Limited and Utilities Mutual Insurance Company.\n(e) Mr. Morrell became Vice President - Regulatory and Public Affairs in 1994. Prior to that, Mr. Morrell served as Vice President of GPU since 1989. He is also a director of Utilities Mutual Insurance Company.\n(f) Mrs. Persson serves as liaison (Special Assistant Director) between the N.J. Division of Consumer Affairs and various State Boards. Prior to 1995, she was owner and President of Business Dynamics Associates of Red Bank, NJ. Mrs. Persson is a member of the United States Small Business Administration National Advisory Board, the New Jersey Small Business Advisory Council, the Board of Advisors of Brookdale Community College and the Board of Advisors of Georgian Court College.\n(g) Prior to 1994, Mr. Myers served as Vice President and Treasurer of GPU, GPUSC, JCP&L, Met-Ed and Penelec since 1993. He served as Vice President and Comptroller of GPUN from 1986 to 1993.\n(h) Mr. Van Ness has been affiliated with the law firm of Pico, Mack, Kennedy, Jaffe, Perrella and Yoskin of Trenton, NJ since 1990. He is also a director of The Prudential Insurance Company of America.\n(i) Mr. Wiley has been a partner in the law firm of Wiley, Malehorn and Sirota of Morristown, NJ since 1973. He is also Chairman of First Morris Bank of Morristown, NJ.\n(j) Mr. Hafer became President of Met-Ed and Penelec in 1994. Prior to that, he was President of Met-Ed since 1986. Mr. Hafer is also a director of GPUSC, GPUN, Genco, Meridian Bancorp, Meridian Bank of Reading, PA and Utilities Mutual Insurance Company.\n(k) Mr. Furst was elected Vice President - Rates & Marketing of Met-Ed and Penelec in 1994. Prior to that, he served as Vice President - Customer Services of Penelec since 1984.\n(l) Mr. Repko was elected Vice President - Customer Services and Operations of Met-Ed and Penelec in 1994. Prior to that, he served as Vice President - Division Operations of Penelec from 1986 to 1993.\n(m) Mr. Zechman was elected Vice President-Administration and Finance of Met-Ed and Penelec in 1994. Prior to that, he served as Vice President - Administrative Services of Met-Ed since 1992 and as Vice President - Human Resources of Met-Ed from 1990 to 1992.\nThe directors of the Subsidiaries are elected at their respective annual meetings of stockholders to serve until the next meeting of stockholders and until their respective successors are duly elected and qualified. There are no family relationships among the directors of the Subsidiaries.\nIdentification of Executive Officers\nThe current executive officers of GPU, JCP&L, Met-Ed and Penelec, their ages, positions held and business experience during the past five years are as follows:\nYear First Name Age Position Elected GPU: J. R. Leva (a) 63 Chairman, President and Chief 1992 Executive Officer I. H. Jolles (b) 57 Senior Vice President and General 1990 Counsel J. G. Graham (c) 57 Senior Vice President and Chief 1987 Financial Officer F. A. Donofrio (d) 53 Vice President, Comptroller and 1985 Chief Accounting Officer P. C. Mezey (e) 56 Senior Vice President, GPUSC 1992 T. G. Howson (f) 47 Vice President and Treasurer 1994 M. A. Nalewako (g) 61 Secretary 1988 T. G. Broughton (h) 50 President, GPUN 1996 R. L. Wise (i) 52 President, Genco 1994 F. D. Hafer (j) 54 President, Met-Ed and Penelec 1994 D. Baldassari (k) 46 President, JCP&L 1992 B. L. Levy (l) 40 President and Chief Executive 1991 Officer, EI, EI Power and EI Energy R. C. Arnold (m) 58 Executive Vice President, GPUSC 1990\nJCP&L: J. R. Leva (a) 63 Chairman of the Board and Chief 1992 Executive Officer D. Baldassari (k) 46 President 1992 C. R. Fruehling 60 Vice President - Engineering and 1982 Operations J. G. Graham (c) 57 Vice President and Chief 1987 Financial Officer E. J. McCarthy (n) 57 Vice President - Customer Operations 1982 and Sales M. P. Morrell (o) 47 Vice President - Regulatory 1993 and Public Affairs T. G. Howson (f) 47 Vice President and Treasurer 1994 D. W. Myers (p) 51 Vice President - Operations Support 1994 and Comptroller R. J. Toole (q) 53 Vice President - Generation 1990 J. J. Westervelt (r) 55 Vice President - Human Resources 1982 and Corporate Services R. S. Cohen 53 Secretary and Corporate Counsel 1986\nYear First Elected Name Age Position Met-Ed Penelec Met-Ed\/Penelec: J. R. Leva (a) 63 Chairman of the Board and 1992 1992 Chief Executive Officer F. D. Hafer (j) 54 President 1986 1994 J. G. Graham (c) 57 Vice President and Chief Financial Officer 1987 1987 J. F. Furst (s) 49 Vice President - Rates and 1994 1984 Marketing T. G. Howson (f) 47 Vice President and Treasurer 1994 1994 G. R. Repko (t) 50 Vice President - Customer 1994 1986 Services and Operations R. J. Toole (q) 53 Vice President - Generation 1989 1996 R. S. Zechman (u) 52 Vice President - Administration 1990 1994 and Finance D. L. O'Brien 53 Comptroller 1981 1994 W. A. Boquist II (v) 48 Vice President - Legal Services 1994 1994 C. B. Snyder (w) 50 Vice President - Public Affairs 1994 1994 W. C. Matthews II (x) 43 Secretary 1994 1990\n(a) See Note (a) on page 47.\n(b) Mr. Jolles is also Executive Vice President, General Counsel and a director of GPUSC, General Counsel of GPUN and Genco, and a director of EI, EI Power, EI Energy and Genco.\n(c) See Note (d) on page 48.\n(d) Mr. Donofrio was elected Vice President of GPU in 1989. He is also Senior Vice President - Financial Controls of GPUSC and a director of GPUSC.\n(e) Mr. Mezey was elected Senior Vice President - System Services of GPUSC in 1992 and is a director of EI, EI Power and EI Energy. He previously served as Vice President of GPUSC from January 1991 through March 1992 and President of EI from February 1990 through December 1991.\n(f) Mr. Howson is also Vice President and Treasurer of GPUSC, GPUN and Genco. He served as Vice President - Materials, Services and Regulatory Affairs and a director of JCP&L in 1992. Prior to that, he served as Vice President - Corporate Strategic Planning for GPUSC since 1989.\n(g) Mrs. Nalewako is also Secretary of GPUSC and Genco and Assistant Secretary of GPUN, JCP&L, Met-Ed and Penelec.\n(h) Mr. Broughton previously served as Executive Vice President for GPUN since September 1995. Prior to that, he served as Vice President-TMI of GPUN since 1991. Mr. Broughton is also a director of GPUSC and Genco.\n(i) Mr. Wise is also a director of GPUSC, GPUN, Genco, EI, EI Power and EI Energy. He previously served as President, Fossil Generation-GPUSC since 1994. Prior to that, Mr. Wise served as President and a director of Penelec since December 1986. He is also a director of U.S. Bancorp and U.S. National Bank of Johnstown, PA.\n(j) See Note (j) on page 48.\n(k) See Note (b) on page 47.\n(l) Mr. Levy is also a director of EI, EI Power, EI Energy and Genco. He has served as President, Chief Executive Officer and director of EI since 1991. Prior to that, Mr. Levy served as Vice President - Business Development of EI since 1985.\n(m) See Note (c) on page 47.\n(n) Mr. McCarthy became Vice President - Customer Operations and Sales in 1994. Prior to that, he served as Vice President - Customer Services of JCP&L since 1982.\n(o) See Note (e) on page 48.\n(p) See Note (g) on page 48.\n(q) Mr. Toole was also elected a Vice President and a director of Genco in 1996.\n(r) Mr. Westervelt became Vice President - Human Resources and Corporate Services in 1994. Prior to that, he served as Vice President - Human Resources of JCP&L since 1982.\n(s) See note (k) on page 48.\n(t) See note (l) on page 48.\n(u) See note (m) on page 48.\n(v) Mr. Boquist also served as Corporate Counsel and Secretary of Met-Ed from 1992 to 1994 and Assistant Secretary of Met-Ed from 1988 to 1992.\n(w) Mrs. Snyder also served as Regional Director of Met-Ed from 1991 to 1994. Prior to that, she was Divisional Director of Met-Ed since 1990.\n(x) Mr. Matthews was elected Secretary of Met-Ed and Penelec in 1994. Prior to that, he served as Corporate Counsel and Secretary of Penelec from 1990.\nThe executive officers of the GPU System companies are elected each year by their respective Boards of Directors at the first meeting of the Board held following the annual meeting of stockholders. Executive officers hold office until the next meeting of directors following the annual meeting of stockholders and until their respective successors are duly elected and qualified. There are no family relationships among the executive officers.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe information required by this Item with respect to GPU is incorporated by reference to pages 7 through 17 of GPU's Proxy Statement for the 1996 Annual Meeting of Stockholders. The following table sets forth remuneration paid, as required by this Item, to the most highly compensated executive officers of JCP&L, Met-Ed and Penelec for the year ended December 31, 1995.\nThe managements of Met-Ed and Penelec were combined in a 1994 reorganization. Accordingly, the amounts shown below represent the aggregate remuneration paid to such executive officers by Met-Ed and Penelec during 1995.\n(1) \"Other Annual Compensation\" is composed entirely of the above-market interest accrued on the pre-retirement portion of deferred compensation.\n(2) The restricted units issued in 1995 under the 1990 Stock Plan for Employees of GPU Corporation and Subsidiaries (the \"1990 Stock Plan\") are performance based as shown in the \"Long-Term Incentive Plans - Awards in Last Fiscal Year\" table (the \"LTIP table\"). Dividends are paid or accrued on the aggregate restricted shares\/units awarded under the 1990 Stock Plan and reinvested.\nThe aggregate number and value (based on the stock price per share at December 31, 1995) of nonvested restricted shares\/units include the amounts shown on the LTIP table and at the end of 1995 were:\nAggregate Aggregate Shares\/Units Value JCP&L: D. Baldassari 7,575 $257,550 M. P. Morrell 3,275 $111,350 E. J. McCarthy 2,915 $ 99,110 D. W. Myers 2,990 $101,660 R. S. Cohen 2,750 $ 93,500\nMet-Ed\/Penelec: F. D. Hafer 8,875 $301,750 R. J. Toole 3,100 $105,400 G. R. Repko 3,000 $102,000 R. S. Zechman 2,815 $ 95,710\n(3) Consists of Performance Cash Incentive Awards paid on the 1990 restricted stock awards which have vested under the 1990 Stock Plan. These amounts are designed to compensate recipients of restricted stock\/unit awards for the amount of federal and state income taxes that are payable upon vesting of the restricted stock\/unit awards. Amounts for Mr. Herbein include Performance Cash Incentive Awards of $10,665 on the 1990 restricted stock award, $57,901 on the 1992, 1993 and 1994 restricted stock awards which vested upon retirement and $29,900 paid in cash in lieu of receiving restricted units in 1995.\n(4) As noted above, Mr. Leva is Chairman and Chief Executive Officer of General Public Utilities Corporation and its Subsidiaries. Mr. Leva is compensated by GPUSC for his overall service on behalf of the GPU System and accordingly is not compensated directly by the other subsidiary companies for his services. Information with respect to Mr. Leva's compensation is included on pages 11 through 13 in GPU's 1996 Proxy Statement, which is incorporated herein by reference.\n(5) Consists of employer matching contributions under the Savings Plan ($6,000), matching contributions under the non-qualified deferred compensation plan ($7,480), the benefit of interest-free use of the non- term portion of employer paid premiums for split-dollar life insurance ($5,851) and above-market interest accrued on the retirement portion of deferred compensation ($94).\n(6) Consists of employer matching contributions under the Savings Plan ($6,000), matching contributions under the non-qualified deferred compensation plan ($1,160) and above-market interest accrued on the retirement portion of deferred compensation ($2).\n(7) Consists of employer matching contributions under the Savings Plan ($6,000), matching contributions under the non-qualified deferred compensation plan ($8) and above-market interest accrued on the retirement portion of deferred compensation ($66).\n(8) Consists of employer matching contributions under the Savings Plan ($5,280).\n(9) Consists of employer matching contributions under the Savings Plan ($5,136), matching contributions under the non-qualified deferred compensation plan ($48) and above-market interest accrued on the retirement portion of deferred compensation ($275).\n(10) Consists of employer matching contributions under the Savings Plan ($6,000), matching contributions under the non-qualified deferred compensation plan ($8,280), the benefit of interest-free use of the non- term portion of employer paid premiums for split-dollar life insurance ($8,548) and above-market interest accrued on the retirement portion of deferred compensation ($248).\n(11) Mr. Herbein retired as Vice President - Generation of Penelec effective December 31, 1995.\n(12) Consists of employer matching contributions under the Savings Plan ($4,600), matching contributions under the non-qualified deferred compensation plan ($1,340) and above-market interest accrued on the retirement portion of deferred compensation ($5,241).\n(13) Consists of employer matching contributions under the Savings Plan ($5,740), matching contributions under the non-qualified deferred compensation plan ($944) and above-market interest accrued on the retirement portion of deferred compensation ($278).\n(14) Consists of employer matching contributions under the Savings Plan ($6,000) and above-market interest accrued on the retirement portion of deferred compensation ($66).\n(15) Consists of employer matching contributions under the Savings Plan ($6,000).\nNote: The split-dollar life insurance amounts reported in the \"All Other Compensation\" column are equal to the present value of the interest-free use of the current year employer paid premiums to the projected date the premiums will be refunded to the respective GPU System companies.\n(1) The restricted units issued in 1995 under the 1990 Stock Plan provide for a performance adjustment to the aggregate number of units vesting for the recipient based on the annualized GPU Total Shareholder Return (TSR) percentile ranking against all companies in the Standard & Poor's Electric Utility Index for the period between the award and vesting dates. With a 55th percentile ranking, the performance adjustment would be 100% as reflected in the \"Target\" column. In the event that the percentile ranking is below the 55th percentile, the performance adjustment would be reduced in steps reaching 0% at the 39th percentile as reflected in the \"Threshold\" column. Should the TSR percentile ranking exceed the 59th percentile, then the performance adjustment would be increased in steps reaching 200% at the 90th percentile as reflected in the \"Maximum\" column. The estimated future payouts above are computed based on the number of restricted units awarded for 1995 multiplied by the 1995 year-end market value of $34 per share. Actual payouts under the Plan would be based on the actual number of shares issued and the market value of those shares at the time the restrictions lapse and may be different from those indicated above.\n(2) The $29,900 in cash received by Mr. Herbein in lieu of receiving restricted units in 1995 is included in the Summary Compensation Table under LTIP Payouts.\nProposed Remuneration of Executive Officers\nNone of the named executive officers in the Summary Compensation Table has an employment contract. The compensation of executive officers is determined from time to time by the Personnel & Compensation Committee of the GPU Board of Directors.\nRetirement Plans\nThe GPU System pension plans provide for pension benefits, payable for life after retirement, based upon years of creditable service with the GPU System and the employee's career average compensation as defined below. Under federal law, an employee's pension benefits that may be paid from a qualified trust under a qualified pension plan such as the GPU System plans are subject to certain maximum amounts. The GPU System companies also have adopted non- qualified plans providing that the portion of a participant's pension benefits which, by reason of such limitations or source, cannot be paid from such a qualified trust shall be paid directly on an unfunded basis by the participant's employer.\nThe following table illustrates the amount of aggregate annual pension benefits from funded and unfunded sources resulting from employer contributions to the qualified trust and direct payments payable upon retirement in 1996 (computed on a single life annuity basis) to persons in specified salary and years of service classifications:\n(1) Career Average Compensation is the average annual compensation received from January 1, 1984 to retirement and includes Salary and Bonus. The Career Average Compensation amounts for the following named executive officers differ by more than 10% from the three year average annual compensation set forth in the Summary Compensation Table and are as follows: JCP&L: Messrs. Baldassari - $175,136; Morrell - $128,798; McCarthy - $125,601; Myers - $145,654; Cohen - $111,397 and Met-Ed\/Penelec: Messrs. Hafer - $249,444; Herbein - $140,854; Toole - $127,434; Repko - $127,376; Zechman - $110,388.\n(2) Years of Creditable Service at December 31, 1995: JCP&L: Messrs. Baldassari - 26 years; Morrell - 24 years; McCarthy - 35 years; Myers - 15 years; Cohen - 27 years and Met-Ed\/Penelec: Messrs. Hafer - 33 years; Herbein - 35 years; Toole - 29 years; Repko - 29 years; Zechman - 26 years.\n(3) Based on an assumed retirement at age 65 in 1996. To reduce the above amounts to reflect a retirement benefit assuming a continual annuity to a surviving spouse equal to 50% of the annuity payable at retirement, multiply the above benefits by 90%. The estimated annual benefits are not subject to any reduction for Social Security benefits or other offset amounts.\n(4) Annual retirement benefits under the basic pension per the above table cannot exceed 55% of the average compensation during the highest paid thirty-six calendar months.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe information required by this Item for GPU is incorporated by reference to page 6 of the GPU Proxy Statement for the 1996 Annual Meeting of Stockholders.\nAll of the outstanding shares of JCP&L (15,371,270), Met-Ed (859,500) and Penelec (5,290,596) common stock are owned beneficially and of record by the Company's parent, General Public Utilities Corporation, 100 Interpace Parkway, Parsippany, NJ 07054.\nThe following table sets forth, as of February 1, 1996, the beneficial ownership of equity securities of each of the directors and each of the executive officers named in the Summary Compensation Tables, and of all directors and executive officers of each of the respective GPU System companies as a group. The shares owned by all directors and executive officers as a group constitute less than 1% of the total shares outstanding.\nTitle of Amount and Nature of Name Security Beneficial Ownership (1) JCP&L: J. R. Leva GPU Common Stock 4,376 Shares - Direct GPU Common Stock 100 Shares - Indirect J. G. Graham GPU Common Stock 4,321 Shares - Direct GPU Common Stock 1,180 Shares - Indirect R. C. Arnold GPU Common Stock 2,231 Shares - Direct GPU Common Stock 3,943 Shares - Indirect D. Baldassari GPU Common Stock 1,061 Shares - Direct R. S. Cohen GPU Common Stock 882 Shares - Direct E. J. McCarthy GPU Common Stock 869 Shares - Direct M. P. Morrell GPU Common Stock 1,126 Shares - Direct D. W. Myers GPU Common Stock 1,008 Shares - Direct G. E. Persson GPU Common Stock None S. C. Van Ness GPU Common Stock None S. B. Wiley GPU Common Stock None\nAll Directors and GPU Common Stock 19,831 Shares - Direct Officers as a Group GPU Common Stock 5,223 Shares - Indirect\nMet-Ed\/Penelec: J. R. Leva GPU Common Stock 4,376 Shares - Direct GPU Common Stock 100 Shares - Indirect J. G. Graham GPU Common Stock 4,321 Shares - Direct GPU Common Stock 1,180 Shares - Indirect R. C. Arnold GPU Common Stock 2,231 Shares - Direct GPU Common Stock 3,943 Shares - Indirect J. F. Furst GPU Common Stock 670 Shares - Direct F. D. Hafer GPU Common Stock 4,756 Shares - Direct GPU Common Stock 124 Shares - Indirect G. R. Repko GPU Common Stock 643 Shares - Direct R. J. Toole GPU Common Stock 1,072 Shares - Direct R. S. Zechman GPU Common Stock 947 Shares - Direct\nAll Directors and GPU Common Stock 22,317 Shares - Direct Officers as a Group GPU Common Stock 5,347 Shares - Indirect\n(1) The number of shares owned and the nature of such ownership, not being within the knowledge of the Company, have been furnished by each individual.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. None.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(a) See pages and for references to Financial Statements and Financial Statement Schedules required by this item.\n1. Exhibits:\n3-A Articles of Incorporation of GPU, as amended through March 27, 1990 - Incorporated by reference to Exhibit 3-A, 1989 Annual Report on Form 10-K, SEC File No. 1-6047.\n3-A-1 Articles of Amendment to Articles of Incorporation of GPU dated May 5, 1995 - Incorporated by reference to Exhibit A- 4, Certificate Pursuant to Rule 24, SEC File No. 70-8569.\n3-B By-Laws of GPU, as amended June 7, 1990 - Incorporated by reference to Exhibit 3-A, 1990 Annual Report on Form 10-K, SEC File No. 1-6047.\n3-C Restated Certificate of Incorporation of JCP&L, as amended - Incorporated by reference to Exhibit 3-A, 1990 Annual Report on Form 10-K, SEC File No. 1-3141.\n3-C-1 Certificate of Amendment to Restated Certificate of Incorporation of JCP&L, dated June 19, 1992 - Incorporated by reference to Exhibit A-2(a), Certificate Pursuant to Rule 24, SEC File No. 70-7949.\n3-C-2 Certificate of Amendment to Restated Certificate of Incorporation of JCP&L, dated June 19, 1992 - Incorporated by reference to Exhibit A-2(a)(i), Certificate Pursuant to Rule 24, SEC File No. 70-7949.\n3-D By-Laws of JCP&L, as amended - Incorporated by reference to Exhibit 3-B, 1993 Annual Report on Form 10-K, SEC File No. 1-3141.\n3-E Restated Articles of Incorporation of Met-Ed - Incorporated by reference to Exhibit B-18, 1991 Annual Report of GPU on Form U5S, SEC File No. 30-126.\n3-F By-Laws of Met-Ed dated July 27, 1995, as amended.\n3-G Restated Articles of Incorporation of Penelec as amended through March 10, 1992 - Incorporated by reference to Exhibit 3A, 1991 Annual Report on Form 10-K, SEC File No. 1- 3522.\n3-H By-Laws of Penelec dated July 27, 1995, as amended.\n4-A Indenture of JCP&L, dated March 1, 1946, between JCP&L and United States Trust Company of New York, Successor Trustee, as amended and supplemented by eight supplemental indentures dated December 1, 1948 through June 1, 1960 - Incorporated by reference to JCP&L's Instruments of Indebtedness Nos. 1 to 7, inclusive, and 9 and 10 filed as part of Amendment No. 1 to 1959 Annual Report of GPU on Form U5S, SEC File Nos. 30-126 and 1-3292.\n4-A-1 Ninth Supplemental Indenture of JCP&L, dated November 1, 1962 - Incorporated by reference to Exhibit 2-C, Registration No. 2-20732.\n4-A-2 Tenth Supplemental Indenture of JCP&L, dated October 1, 1963 - Incorporated by reference to Exhibit 2-C, Registration No. 2-21645.\n4-A-3 Eleventh Supplemental Indenture of JCP&L, dated October 1, 1964 - Incorporated by reference to Exhibit 5-A-3, Registration No. 2-59785.\n4-A-4 Twelfth Supplemental Indenture of JCP&L, dated November 1, 1965 - Incorporated by reference to Exhibit 5-A-4, Registration No. 2-59785.\n4-A-5 Thirteenth Supplemental Indenture of JCP&L, dated August 1, 1966 - Incorporated by reference to Exhibit 4-C, Registration No. 2-25124.\n4-A-6 Fourteenth Supplemental Indenture of JCP&L, dated September 1, 1967 - Incorporated by reference to Exhibit 5-A-6, Registration No. 2-59785.\n4-A-7 Fifteenth Supplemental Indenture of JCP&L, dated October 1, 1968 - Incorporated by reference to Exhibit 5-A-7, Registration No. 2-59785.\n4-A-8 Sixteenth Supplemental Indenture of JCP&L, dated October 1, 1969 - Incorporated by reference to Exhibit 5-A-8, Registration No. 2-59785.\n4-A-9 Seventeenth Supplemental Indenture of JCP&L, dated June 1, 1970 - Incorporated by reference to Exhibit 5-A-9, Registration No. 2-59785.\n4-A-10 Eighteenth Supplemental Indenture of JCP&L, dated December 1, 1970 - Incorporated by reference to Exhibit 5-A-10, Registration No. 2-59785.\n4-A-11 Nineteenth Supplemental Indenture of JCP&L, dated February 1, 1971 - Incorporated by reference to Exhibit 5-A-11, Registration No. 2-59785.\n4-A-12 Twentieth Supplemental Indenture of JCP&L, dated November 1, 1971 - Incorporated by reference to Exhibit 5-A-12, Registration No. 2-59875.\n4-A-13 Twenty-first Supplemental Indenture of JCP&L, dated August 1, 1972 - Incorporated by reference to Exhibit 5-A-13, Registration No. 2-59785.\n4-A-14 Twenty-second Supplemental Indenture of JCP&L, dated August 1, 1973 - Incorporated by reference to Exhibit 5-A-14, Registration No. 2-59785.\n4-A-15 Twenty-third Supplemental Indenture of JCP&L, dated October 1, 1973 - Incorporated by reference to Exhibit 5-A-15, Registration No. 2-59785.\n4-A-16 Twenty-fourth Supplemental Indenture of JCP&L, dated December 1, 1973 - Incorporated by reference to Exhibit 5-A- 16, Registration No. 2-59785.\n4-A-17 Twenty-fifth Supplemental Indenture of JCP&L, dated November 1, 1974 - Incorporated by reference to Exhibit 5-A-17, Registration No. 2-59785.\n4-A-18 Twenty-sixth Supplemental Indenture of JCP&L, dated March 1, 1975 - Incorporated by reference to Exhibit 5-A-18, Registration No. 2-59785.\n4-A-19 Twenty-seventh Supplemental Indenture of JCP&L, dated July 1, 1975 - Incorporated by reference to Exhibit 5-A-19, Registration No. 2-59785.\n4-A-20 Twenty-eighth Supplemental Indenture of JCP&L, dated October 1, 1975 - Incorporated by reference to Exhibit 5-A-20, Registration No. 2-59785.\n4-A-21 Twenty-ninth Supplemental Indenture of JCP&L, dated February 1, 1976 - Incorporated by reference to Exhibit 5-A-21, Registration No. 2-59785.\n4-A-22 Supplemental Indenture No. 29A of JCP&L, dated May 31, 1976 - Incorporated by reference to Exhibit 5-A-22, Registration No. 2-59785.\n4-A-23 Thirtieth Supplemental Indenture of JCP&L, dated June 1, 1976 - Incorporated by reference to Exhibit 5-A-23, Registration No. 2-59785.\n4-A-24 Thirty-first Supplemental Indenture of JCP&L, dated May 1, 1977 - Incorporated by reference to Exhibit 5-A-24, Registration No. 2-59785.\n4-A-25 Thirty-second Supplemental Indenture of JCP&L, dated January 20, 1978 - Incorporated by reference to Exhibit 5-A-25, Registration No. 2-60438.\n4-A-26 Thirty-third Supplemental Indenture of JCP&L, dated January 1, 1979 - Incorporated by reference to Exhibit A-20(b), Certificate Pursuant to Rule 24, SEC File No. 70-6242.\n4-A-27 Thirty-fourth Supplemental Indenture of JCP&L, dated June 1, 1979 - Incorporated by reference to Exhibit A-28, Certificate Pursuant to Rule 24, SEC File No. 70-6290.\n4-A-28 Thirty-sixth Supplemental Indenture of JCP&L, dated October 1, 1979 - Incorporated by reference to Exhibit A-30, Certificate Pursuant to Rule 24, SEC File No. 70-6354.\n4-A-29 Thirty-seventh Supplemental Indenture of JCP&L, dated September 1, 1984 - Incorporated by reference to Exhibit A- 1(cc), Certificate Pursuant to Rule 24, SEC File No. 70- 7001.\n4-A-30 Thirty-eighth Supplemental Indenture of JCP&L, dated July 1, 1985 - Incorporated by reference to Exhibit A-1(dd), Certificate Pursuant to Rule 24, SEC File No. 70-7109.\n4-A-31 Thirty-ninth Supplemental Indenture of JCP&L, dated April 1, 1988 - Incorporated by reference to Exhibit A-1(a), Certificate Pursuant to Rule 24, SEC File No. 70-7263.\n4-A-32 Fortieth Supplemental Indenture of JCP&L, dated June 14, 1988 - Incorporated by reference to Exhibit A-1(ff), Certificate Pursuant to Rule 24, SEC File No. 70-7603.\n4-A-33 Forty-first Supplemental Indenture of JCP&L, dated April 1, 1989 - Incorporated by reference to Exhibit A-1(gg), Certificate Pursuant to Rule 24, SEC File No. 70-7603.\n4-A-34 Forty-second Supplemental Indenture of JCP&L, dated July 1, 1989 - Incorporated by reference to Exhibit A-1(hh), Certificate Pursuant to Rule 24, SEC File No. 70-7603.\n4-A-35 Forty-third Supplemental Indenture of JCP&L, dated March 1, 1991 - Incorporated by reference to Exhibit 4-A-35, Registration No. 33-45314.\n4-A-36 Forty-fourth Supplemental Indenture of JCP&L, dated March 1, 1992 - Incorporated by reference to Exhibit 4-A-36, Registration No. 33-49405.\n4-A-37 Forty-fifth Supplemental Indenture of JCP&L, dated October 1, 1992 - Incorporated by reference to Exhibit 4-A-37, Registration No. 33-49405.\n4-A-38 Forty-sixth Supplemental Indenture of JCP&L, dated April 1, 1993 - Incorporated by reference to Exhibit C-15, 1992 Annual Report of GPU on Form U5S, SEC File No. 30-126.\n4-A-39 Forty-seventh Supplemental Indenture of JCP&L, dated April 10, 1993 - Incorporated by reference to Exhibit C-16, 1992 Annual Report of GPU on Form U5S, SEC File No. 30-126.\n4-A-40 Forty-eighth Supplemental Indenture of JCP&L, dated April 15, 1993 - Incorporated by reference to Exhibit C-17, 1992 Annual Report of GPU on Form U5S, SEC File No. 30-126.\n4-A-41 Forty-ninth Supplemental Indenture of JCP&L, dated October 1, 1993 - Incorporated by reference to Exhibit C-18, 1993 Annual Report of GPU on Form U5S, SEC File No. 30-126.\n4-A-42 Fiftieth Supplemental Indenture of JCP&L, dated August 1, 1994 - Incorporated by reference to Exhibit C-19, 1994 Annual Report of GPU on Form U5S, SEC File No. 30-126.\n4-B Indenture of Met-Ed, dated November 1, 1944 with United States Trust Company of New York, Successor Trustee, as amended and supplemented by fourteen supplemental indentures dated February 1, 1947 through June 1, 1957 - Incorporated by reference to Met-Ed's Instruments of Indebtedness Nos. 1 to 14, inclusive and 16, filed as part of Amendment No. 1 to 1959 Annual Report of GPU on Form U5S, SEC File Nos. 30-126 and 1-3292.\n4-B-1 Supplemental Indenture of Met-Ed, dated May 1, 1960 - Incorporated by reference to Exhibit 2-C, Registration No. 2-16192.\n4-B-2 Supplemental Indenture of Met-Ed, dated December 1, 1962 - Incorporated by reference to Exhibit 2-E(1), Registration No. 2-59678.\n4-B-3 Supplemental Indenture of Met-Ed, dated March 20, 1964 - Incorporated by reference to Exhibit 2-E(2), Registration No. 2-59678.\n4-B-4 Supplemental Indenture of Met-Ed, dated July 1, 1965 - Incorporated by reference to Exhibit 2-E(3), Registration No. 2-59678.\n4-B-5 Supplemental Indenture of Met-Ed, dated June 1, 1966 - Incorporated by reference to Exhibit 2-B-4, Registration No. 2-24883.\n4-B-6 Supplemental Indenture of Met-Ed, dated March 22, 1968 - Incorporated by reference to Exhibit 4-C-5, Registration No. 2-29644.\n4-B-7 Supplemental Indenture of Met-Ed, dated September 1, 1968 - Incorporated by reference to Exhibit 2-E(6), Registration No. 2-59678.\n4-B-8 Supplemental Indenture of Met-Ed, dated August 1, 1969 - Incorporated by reference to Exhibit 2-E(7), Registration No. 2-59678.\n4-B-9 Supplemental Indenture of Met-Ed, dated November 1, 1971 - Incorporated by reference to Exhibit 2-E(8), Registration No. 2-59678.\n4-B-10 Supplemental Indenture of Met-Ed, dated May 1, 1972 - Incorporated by reference to Exhibit 2-E(9), Registration No. 2-59678.\n4-B-11 Supplemental Indenture of Met-Ed, dated December 1, 1973 - Incorporated by reference to Exhibit 2-E(10), Registration No. 2-59678.\n4-B-12 Supplemental Indenture of Met-Ed, dated October 30, 1974 - Incorporated by reference to Exhibit 2-E(11), Registration No. 2-59678.\n4-B-13 Supplemental Indenture of Met-Ed, dated October 31, 1974 - Incorporated by reference to Exhibit 2-E(12), Registration No. 2-59678.\n4-B-14 Supplemental Indenture of Met-Ed, dated March 20, 1975 - Incorporated by reference to Exhibit 2-E(13), Registration No. 2-59678.\n4-B-15 Supplemental Indenture of Met-Ed, dated September 25, 1975 - Incorporated by reference to Exhibit 2-E(15), Registration No. 2-59678.\n4-B-16 Supplemental Indenture of Met-Ed, dated January 12, 1976 - Incorporated by reference to Exhibit 2-E(16), Registration No. 2-59678.\n4-B-17 Supplemental Indenture of Met-Ed, dated March 1, 1976 - Incorporated by reference to Exhibit 2-E(17), Registration No. 2-59678.\n4-B-18 Supplemental Indenture of Met-Ed, dated September 28, 1977 - Incorporated by reference to Exhibit 2-E(18), Registration No. 2-62212.\n4-B-19 Supplemental Indenture of Met-Ed, dated January 1, 1978 - Incorporated by reference to Exhibit 2-E(19), Registration No. 2-62212.\n4-B-20 Supplemental Indenture of Met-Ed, dated September 1, 1978 - Incorporated by reference to Exhibit 4-A(19), Registration No. 33-48937.\n4-B-21 Supplemental Indenture of Met-Ed, dated June 1, 1979 - Incorporated by reference to Exhibit 4-A(20), Registration No. 33-48937.\n4-B-22 Supplemental Indenture of Met-Ed, dated January 1, 1980 - Incorporated by reference to Exhibit 4-A(21), Registration No. 33-48937.\n4-B-23 Supplemental Indenture of Met-Ed, dated September 1, 1981 - Incorporated by reference to Exhibit 4-A(22), Registration No. 33-48937.\n4-B-24 Supplemental Indenture of Met-Ed, dated September 10, 1981 - Incorporated by reference to Exhibit 4-A(23), Registration No. 33-48937.\n4-B-25 Supplemental Indenture of Met-Ed, dated December 1, 1982 - Incorporated by reference to Exhibit 4-A(24), Registration No. 33-48937.\n4-B-26 Supplemental Indenture of Met-Ed, dated September 1, 1983 - Incorporated by reference to Exhibit 4-A(25), Registration No. 33-48937.\n4-B-27 Supplemental Indenture of Met-Ed, dated September 1, 1984 - Incorporated by reference to Exhibit 4-A(26), Registration No. 33-48937.\n4-B-28 Supplemental Indenture of Met-Ed, dated March 1, 1985 - Incorporated by reference to Exhibit 4-A(27), Registration No. 33-48937.\n4-B-29 Supplemental Indenture of Met-Ed, dated September 1, 1985 - Incorporated by reference to Exhibit 4-A(28), Registration No. 33-48937.\n4-B-30 Supplemental Indenture of Met-Ed, dated June 1, 1988 - Incorporated by reference to Exhibit 4-A(29), Registration No. 33-48937.\n4-B-31 Supplemental Indenture of Met-Ed, dated April 1, 1990 - Incorporated by reference to Exhibit 4-A(30), Registration No. 33-48937.\n4-B-32 Amendment dated May 22, 1990 to Supplemental Indenture of Met-Ed, dated April 1, 1990 - Incorporated by reference to Exhibit 4-A(31), Registration No. 33-48937.\n4-B-33 Supplemental Indenture of Met-Ed, dated September 1, 1992 - Incorporated by reference to Exhibit 4-A(32)(a), Registration No. 33-48937.\n4-B-34 Supplemental Indenture of Met-Ed, dated December 1, 1993 - Incorporated by reference to Exhibit C-58, 1993 Annual Report of GPU on Form U5S, SEC File No. 30-126.\n4-B-35 Supplemental Indenture of Met-Ed, dated July 15, 1995.\n4-C Mortgage and Deed of Trust of Penelec dated January 1, 1942 between Penelec and United States Trust Company of New York, Successor Trustee, and indentures supplemental thereto dated March 7, 1942 through May 1, 1960 - Incorporated by reference to Penelec's Instruments of Indebtedness Nos. 1- 20, inclusive, filed as a part of Amendment No. 1 to 1959\nAnnual Report of GPU on Form U5S, SEC File Nos. 30-126 and 1-3292.\n4-C-1 Supplemental Indentures to Mortgage and Deed of Trust of Penelec dated May 1, 1961 through December 1, 1977 - Incorporated by reference to Exhibit 2-D(1) to 2-D(19), Registration No. 2-61502.\n4-C-2 Supplemental Indenture of Penelec dated June 1, 1978 - Incorporated by reference to Exhibit 4-A(2), Registration No. 33-49669.\n4-C-3 Supplemental Indenture of Penelec dated June 1, 1979 - Incorporated by reference to Exhibit 4-A(3), Registration No. 33-49669.\n4-C-4 Supplemental Indenture of Penelec dated September 1, 1984 - Incorporated by reference to Exhibit 4-A(4), Registration No. 33-49669.\n4-C-5 Supplemental Indenture of Penelec dated December 1, 1985 - Incorporated by reference to Exhibit 4-A(5), Registration No. 33-49669.\n4-C-6 Supplemental Indenture of Penelec dated December 1, 1986 - Incorporated by reference to Exhibit 4-A(6), Registration No. 33-49669.\n4-C-7 Supplemental Indenture of Penelec dated May 1, 1989 - Incorporated by reference to Exhibit 4-A(7), Registration No. 33-49669.\n4-C-8 Supplemental Indenture of Penelec dated December 1, 1990- Incorporated by reference to Exhibit 4-A(8), Registration No. 33-45312\n4-C-9 Supplemental Indenture of Penelec dated March 1, 1992 - Incorporated by reference to Exhibit 4-A(9), Registration No. 33-45312.\n4-C-10 Supplemental Indenture of Penelec, dated June 1, 1993 - Incorporated by reference to Exhibit C-73, 1993 Annual Report of GPU on Form U5S, SEC File No. 30-126.\n4-C-11 Supplemental Indenture of Penelec, dated November 1, 1995.\n4-D Subordinated Debenture Indenture of JCP&L dated May 1, 1995 - Incorporated by reference to Exhibit A-8(a), Certificate Pursuant to Rule 24, SEC File No. 70-8495.\n4-E Subordinated Debenture Indenture of Met-Ed dated August 1, 1994 - Incorporated by reference to Exhibit A-8(a), Certificate Pursuant to Rule 24, SEC File No. 70-8401.\n4-F Subordinated Debenture Indenture of Penelec dated July 1, 1994 - Incorporated by reference to Exhibit A-8(a), Certificate Pursuant to Rule 24, SEC File No. 70-8403.\n4-G Amended and Restated Limited Partnership Agreement of JCP&L Capital, L.P., dated May 11, 1995 - Incorporated by reference to Exhibit A-5(a), Certificate Pursuant to Rule 24, SEC File No. 70-8495.\n4-H Action Creating Series A Preferred Securities of JCP&L Capital, L.P., dated May 11, 1995 - Incorporated by reference to Exhibit A-6(a), Certificate Pursuant to Rule 24, SEC File No. 70-8495.\n4-I Payment and Guarantee Agreement of JCP&L, dated May 18, 1995 - Incorporated by reference to Exhibit B-1(a), Certificate Pursuant to Rule 24, SEC File No. 70-8495.\n4-J Amended and Restated Limited Partnership Agreement of Met-Ed Capital, L.P., dated August 16, 1994 - Incorporated by reference to Exhibit A-5(a), Certificate Pursuant to Rule 24, SEC File No. 70-8401.\n4-K Action Creating Series A Preferred Securities of Met-Ed Capital, L.P., dated August 16, 1994 - Incorporated by reference to Exhibit A-6(a), Certificate Pursuant to Rule 24, SEC File No. 70-8401.\n4-L Payment and Guarantee Agreement of Met-Ed, dated August 23, 1994 - Incorporated by reference to Exhibit B-1(a), Certificate Pursuant to Rule 24, SEC File No. 70-8401.\n4-M Amended and Restated Limited Partnership Agreement of Penelec Capital, L.P., dated June 27, 1994 - Incorporated by reference to Exhibit A-5(a), Certificate Pursuant to Rule 24, SEC File No. 70-8403.\n4-N Action Creating Series A Preferred Securities of Penelec Capital, L.P., dated June 27, 1994 - Incorporated by reference to Exhibit A-6(a), Certificate Pursuant to Rule 24, SEC File No. 70-8403.\n4-O Payment and Guarantee Agreement of Penelec, dated July 5, 1994 - Incorporated by reference to Exhibit B-1(a), Certificate Pursuant to Rule 24, SEC File No. 70-8403.\n10-A GPU System Companies Deferred Compensation Plan dated June 1, 1995.\n10-B GPU System Companies Master Directors' Benefits Protection Trust dated September 1, 1995.\n10-C GPU System Companies Master Executives' Benefits Protection Trust dated September 1, 1995.\n10-D Employee Incentive Compensation Plan of JCP&L dated April 1, 1995.\n10-E Employee Incentive Compensation Plan of Met-Ed dated April 1, 1995.\n10-F Employee Incentive Compensation Plan of Penelec dated April 1, 1995.\n10-G Incentive Compensation Plan for Elected Officers of JCP&L dated January 1, 1995.\n10-H Incentive Compensation Plan for Elected Officers of Met-Ed dated January 1, 1995.\n10-I Incentive Compensation Plan for Elected Officers of Penelec dated January 1, 1995.\n10-J Deferred Remuneration Plan for Outside Directors of JCP&L dated September 1, 1995.\n10-K JCP&L Supplemental and Excess Benefits Plan dated January 1, 1995.\n10-L Met-Ed Supplemental and Excess Benefits Plan dated January 1, 1995.\n10-M Penelec Supplemental and Excess Benefits Plan dated January 1, 1995.\n10-N Letter agreement dated November 22, 1995 relating to supplemental pension benefits for J.R. Leva.\n10-O Letter agreement dated September 18, 1995 relating to terms of employment and pension benefits for I.H. Jolles.\n10-P Letter agreement dated November 22, 1995 relating to supplemental pension benefits for J.G. Graham.\n10-Q GPU Restricted Stock Plan for Outside Directors - Incorporated by reference to Exhibit 10-A, 1994 Annual Report on Form 10-K, SEC File No. 1-6047.\n10-R Retirement Plan for Outside Directors of GPU - Incorporated by reference to Exhibit 10-B, 1994 Annual Report on Form 10- K, SEC File No. 1-6047.\n10-S Deferred Remuneration Plan for Outside Directors of GPU - Incorporated by reference to Exhibit 10-C, 1994 Annual Report on Form 10-K, SEC File No. 1-6047.\n10-T Amended and Restated Nuclear Material Lease Agreement, dated November 17, 1995, between Oyster Creek Fuel Corp. and JCP&L - Incorporated by reference to Exhibit B-2(a)(i), Certificate Pursuant to Rule 24, SEC File No. 70-7862.\n10-U Amended and Restated Nuclear Material Lease Agreement, dated November 17, 1995, between TMI-1 Fuel Corp. and JCP&L - Incorporated by reference to Exhibit B-2(a)(ii), Certificate Pursuant to Rule 24, SEC File No. 70-7862.\n10-V Letter Agreement, dated November 17, 1995, from JCP&L relating to Oyster Creek Nuclear Material Lease Agreement - Incorporated by reference to Exhibit B-2(b)(i), Certificate Pursuant to Rule 24, SEC File No. 70-7862.\n10-W Letter Agreement, dated November 17, 1995, from JCP&L relating to JCP&L TMI-1 Nuclear Material Lease Agreement - Incorporated by reference to Exhibit B-2(b)(ii), Certificate Pursuant to Rule 24, SEC File No. 70-7862.\n10-X Amended and Restated Trust Agreement, dated November 17, 1995, between United States Trust Company of New York, as Owner Trustee, Lord Fuel Corp., as Trustor and Beneficiary, and JCP&L, Met-Ed and Penelec - Incorporated by reference to Exhibit B-3(i), Certificate Pursuant to Rule 24, SEC File No. 70-7862.\n10-Y Amended and Restated Nuclear Material Lease Agreement, dated November 17, 1995, between TMI-1 Fuel Corp. and Met-Ed - Incorporated by reference to Exhibit B-2(a)(iii), Certificate Pursuant to Rule 24, SEC File No. 70-7862.\n10-Z Letter Agreement, dated November 17, 1995, from Met-Ed relating to Met-Ed TMI-1 Nuclear Material Lease Agreement - Incorporated by reference to Exhibit B-2(b)(i), Certificate Pursuant to Rule 24, SEC File No. 70-7862.\n10-AA Amended and Restated Nuclear Material Lease Agreement, dated November 17, 1995, between TMI-1 Fuel Corp. and Penelec - Incorporated by reference to Exhibit B-2(a)(iv), Certificate Pursuant to Rule 24, SEC File No. 70-7862.\n10-BB Letter Agreement, dated November 17, 1995, from Penelec relating to Penelec Nuclear Material Lease Agreement - Incorporated by reference to Exhibit B-2(b)(i), Certificate Pursuant to Rule 24, SEC File No. 70-7862.\n12 Statements Showing Computation of Ratio of Earnings to Combined Fixed Charges and Preferred Stock Dividends.\nA - JCP&L B - Met-Ed C - Penelec\n21 Subsidiaries of the Registrant\nA - JCP&L B - Met-Ed C - Penelec\n23 Consent of Independent Accountants\nA - GPU B - JCP&L C - Met-Ed D - Penelec\n27 Financial Data Schedule\nA - GPU B - JCP&L C - Met-Ed D - Penelec\n(b) Reports on Form 8-K:\nA - GPU B - JCP&L C - Met-Ed D - Penelec\nFor the month of October 1995, dated October 4, 1995, under Item 5 (Other Events).\nFor the month of October 1995, dated October 20, 1995, under Item 5 (Other Events), as amended by Form 8-K\/A No. 1, dated October 27, 1995.\nA - GPU\nFor the month of December 1995, dated December 13, 1995, under Item 5 (Other Events).\nGENERAL PUBLIC UTILITIES CORPORATION\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nGENERAL PUBLIC UTILITIES CORPORATION\nDated: March 11, 1996 BY: \/s\/ J. R. Leva J. R. Leva, Chairman 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.\nSignature and Title Date\n\/s\/ J. R. Leva March 11, 1996 J. R. Leva, Chairman (Chief Executive Officer) President and Director\n\/s\/ J. G. Graham March 11, 1996 J. G. Graham, Senior Vice President (Chief Financial Officer)\n\/s\/ F. A. Donofrio March 11, 1996 F. A. Donofrio, Vice President and Comptroller (Chief Accounting Officer)\n\/s\/ L. J. Appell, Jr. March 11, 1996 L. J. Appell, Jr., Director\n\/s\/ T. H. Black March 11, 1996 T. H. Black, Director\n\/s\/ H. F. Henderson, Jr. March 11, 1996 H. F. Henderson, Jr., Director\n\/s\/ J. M. Pietruski March 11, 1996 J. M. Pietruski, Director\n\/s\/ C. A. Rein March 11, 1996 C. A. Rein, Director\n\/s\/ P. R. Roedel March 11, 1996 P. R. Roedel, Director\n\/s\/ C. A. H. Trost March 11, 1996 C. A. H. Trost, Director\n\/s\/ P. K. Woolf March 11, 1996 P. K. Woolf, Director\nJERSEY CENTRAL POWER & LIGHT COMPANY\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. The Signature of the undersigned company shall be deemed to relate only to matters having reference to such company and any subsidiaries thereof.\nJERSEY CENTRAL POWER & LIGHT COMPANY\nDated: March 11, 1996 BY: \/s\/ D. Baldassari D. Baldassari, 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 and Title Date\n\/s\/ J. R. Leva March 11, 1996 J. R. Leva, Chairman (Principal Executive Officer) and Director\n\/s\/ D. Baldassari March 11, 1996 D. Baldassari, President (Principal Operating Officer) and Director\n\/s\/ J. G. Graham March 11, 1996 J. G. Graham, Vice President (Principal Financial Officer) and Director\n\/s\/ D. W. Myers March 11, 1996 D. W. Myers, Vice President-Comptroller (Principal Accounting Officer) and Director\n\/s\/ R. C. Arnold March 11, 1996 R. C. Arnold, Director\n\/s\/ M. P. Morrell March 11, 1996 M. P. Morrell, Vice President and Director\n\/s\/ G. E. Persson March 11, 1996 G. E. Persson, Director\n\/s\/ S. C. Van Ness March 11, 1996 S. C. Van Ness, Director\n\/s\/ S. B. Wiley March 11, 1996 S. B. Wiley, Director\nMETROPOLITAN EDISON COMPANY\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. The Signature of the undersigned company shall be deemed to relate only to matters having reference to such company and any subsidiaries thereof.\nMETROPOLITAN EDISON COMPANY\nDated: March 11, 1996 BY: \/s\/ F. D. Hafer F. D. Hafer, 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 and Title Date\n\/s\/ J. R. Leva March 11, 1996 J. R. Leva, Chairman (Principal Executive Officer) and Director\n\/s\/ F. D. Hafer March 11, 1996 F. D. Hafer, President (Principal Operating Officer) and Director\n\/s\/ J. G. Graham March 11, 1996 J. G. Graham, Vice President (Principal Financial Officer) and Director\n\/s\/ D. L. O'Brien March 11, 1996 D. L. O'Brien, Comptroller (Principal Accounting Officer)\n\/s\/ J. F. Furst March 11, 1996 J. F. Furst, Vice President and Director\n\/s\/ G. R. Repko March 11, 1996 G. R. Repko, Vice President and Director\n\/s\/ R. S. Zechman March 11, 1996 R. S. Zechman, Vice President and Director\n\/s\/ R. C. Arnold March 11, 1996 R. C. Arnold, Director\nPENNSYLVANIA ELECTRIC COMPANY\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. The Signature of the undersigned company shall be deemed to relate only to matters having reference to such company and any subsidiaries thereof.\nPENNSYLVANIA ELECTRIC COMPANY\nDated: March 11, 1996 BY: \/s\/ F. D. Hafer F. D. Hafer, 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 and Title Date\n\/s\/ J. R. Leva March 11, 1996 J. R. Leva, Chairman (Principal Executive Officer) and Director\n\/s\/ F. D. Hafer March 11, 1996 F. D. Hafer, President (Principal Operating Officer) and Director\n\/s\/ J. G. Graham March 11, 1996 J. G. Graham, Vice President (Principal Financial Officer) and Director\n\/s\/ D. L. O'Brien March 11, 1996 D. L. O'Brien, Comptroller (Principal Accounting Officer)\n\/s\/ J. F. Furst March 11, 1996 J. F. Furst, Vice President and Director\n\/s\/ G. R. Repko March 11, 1996 G. R. Repko, Vice President and Director\n\/s\/ R. S. Zechman March 11, 1996 R. S. Zechman, Vice President and Director\n\/s\/ R. C. Arnold March 11, 1996 R. C. Arnold, Director\nINDEX TO SUPPLEMENTARY DATA, FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nGENERAL PUBLIC UTILITIES CORPORATION\nSupplementary Data Page System Statistics Selected Financial Data Management's Discussion and Analysis of Financial Condition and Results of Operations Quarterly Financial Data\nFinancial Statements Report of Independent Accountants Statements of Income for the Years Ended December 31, 1995, 1994 and 1993 Balance Sheets as of December 31, 1995 and 1994 Statements of Retained Earnings for the Years Ended December 31, 1995, 1994 and 1993 Statements of Cash Flows for the Years Ended December 31, 1995, 1994 and 1993 Notes to Financial Statements\nFinancial Statement Schedules Schedule II - Valuation and Qualifying Accounts for the Years 1993-1995\nJERSEY CENTRAL POWER & LIGHT COMPANY\nSupplementary Data Page Company Statistics Selected Financial Data Management's Discussion and Analysis of Financial Condition and Results of Operations Quarterly Financial Data\nFinancial Statements Report of Independent Accountants Statements of Income for the Years Ended December 31, 1995, 1994 and 1993 Balance Sheets as of December 31, 1995 and 1994 Statements of Retained Earnings for the Years Ended December 31, 1995, 1994 and 1993 Statement of Capital Stock as of December 31, 1995 Statements of Cash Flows for the Years Ended December 31, 1995, 1994 and 1993 Statement of Long-Term Debt as of December 31, 1995 Notes to Financial Statements\nFinancial Statement Schedules Schedule II - Valuation and Qualifying Accounts for the Years 1993-1995\nINDEX TO SUPPLEMENTARY DATA, FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nMETROPOLITAN EDISON COMPANY Supplementary Data Page Company Statistics Selected Financial Data Management's Discussion and Analysis of Financial Condition and Results of Operations Quarterly Financial Data\nFinancial Statements Report of Independent Accountants Statements of Income for the Years Ended December 31, 1995, 1994 and 1993 Balance Sheets as of December 31, 1995 and 1994 Statements of Retained Earnings for the Years Ended December 31, 1995, 1994 and 1993 Statement of Capital Stock and Preferred Securities as of December 31, 1995 Statements of Cash Flows for the Years Ended December 31, 1995, 1994 and 1993 Statement of Long-Term Debt as of December 31, 1995 Notes to Financial Statements\nFinancial Statement Schedules Schedule II - Valuation and Qualifying Accounts for the Years 1993-1995\nPENNSYLVANIA ELECTRIC COMPANY Supplementary Data Page Company Statistics Selected Financial Data Management's Discussion and Analysis of Financial Condition and Results of Operations Quarterly Financial Data\nFinancial Statements Report of Independent Accountants Statements of Income for the Years Ended December 31, 1995, 1994 and 1993 Balance Sheets as of December 31, 1995 and 1994 Statements of Retained Earnings for the Years Ended December 31, 1995, 1994 and 1993 Statement of Capital Stock and Preferred Securities as of December 31, 1995 Statements of Cash Flows for the Years Ended December 31, 1995, 1994 and 1993 Statement of Long-Term Debt as of December 31, 1995 Notes to Financial Statements\nFinancial Statement Schedules Schedule II - Valuation and Qualifying Accounts for the Years 1993-1995\nSchedules other than those listed above have been omitted since they are not required, are inapplicable or the required information is presented in the Financial Statements or Notes thereto.\nGeneral Public Utilities Corporation and Subsidiary Companies\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS Net income in 1995 was $440.1 million, or $3.79 per share, compared to 1994 net income of $163.7 million, or $1.42 per share. The increase in net income was primarily due to the net effect of several 1995 and 1994 nonrecurring items. GPU's return on average common equity was 16.0% in 1995 compared to 6.3% in 1994.\nExcluding these nonrecurring items, net income for 1995 would have been $343.6 million, or $2.95 per share, compared to 1994 net income of $328.4 million, or $2.85 per share. Return on average common equity for 1995 and 1994, on this basis, would have been 12.7% and 12.1%, respectively. Contributing to this increase were higher new customer sales, partially offset by higher depreciation and financing expenses.\nThe 1995 nonrecurring items consisted of a reversal of $104.9 million (after-tax), or $0.91 per share, of certain future Three Mile Island Unit 2 (TMI-2) retirement costs written off by Metropolitan Edison Company (Met-Ed) and Pennsylvania Electric Company (Penelec) in 1994. The reversal of this write-off resulted from a 1995 Pennsylvania Supreme Court decision that overturned a 1994 Pennsylvania Commonwealth Court order, and restored a 1993 Pennsylvania Public Utility Commission (PaPUC) order allowing Met-Ed to recover such TMI-2 retirement costs from customers. Partially offsetting this increase was a charge to income of $8.4 million (after-tax), or $0.07 per share, for TMI-2 monitored storage costs deemed not probable of recovery through ratemaking.\nThe 1994 nonrecurring items included the above mentioned TMI-2 write-off of $104.9 million (after-tax), or $0.91 per share. Also in 1994, there was a charge to income of $76.1 million (after-tax), or $0.66 per share, for early retirement program costs; a write-off of $10.6 million (after-tax), or $0.09 per share, for certain postretirement benefit (OPEB) costs; and net interest income of $26.9 million (after-tax), or $0.23 per share, resulting from refunds of previously paid federal income taxes related to the tax retirement of TMI-2.\nNet income in 1994 was $163.7 million, or $1.42 per share, compared to net income in 1993 of $295.7 million, or $2.65 per share. The 1994 earnings reduction was attributable to the 1994 nonrecurring items mentioned above. Also, in 1993 there was a write-off of $15.4 million (after-tax), or $0.14 per share, for the cancellation of proposed power supply and transmission facilities agreements between the Subsidiaries and Duquesne Light Company. Excluding these nonrecurring items, net income for 1994 would have been $328.4 million, or $2.85 per share, compared to 1993 net income of $311.1 million, or $2.79 per share.\nEarnings in 1994 were also positively affected by higher sales resulting from an increase in new customers and colder winter weather as compared to the\nGeneral Public Utilities Corporation and Subsidiary Companies\nprevious year, and higher revenues attributable to a February 1993 retail base rate increase at Jersey Central Power & Light Company (JCP&L). These increases were partially offset by increases in other operation and maintenance (O&M) expense.\nOPERATING REVENUES: Operating revenues increased 4.3% to $3.8 billion in 1995 after increasing 1.5% to $3.65 billion in 1994. The components of these changes are as follows:\n(In Millions) 1995 1994\nKilowatt-hour (KWH) revenues (excluding energy portion) $ 14.7 $ 30.6 Rate increases - 20.8 Energy revenues 141.6 (.9) Other revenues (1.2) 2.9 Increase in revenues $155.1 $ 53.4\nKilowatt-hour revenues\nThe increase in KWH revenues was due to an increase in new residential and commercial customer sales, partially offset by lower weather-related sales.\nThe increase in KWH revenues was due primarily to an increase in sales resulting from new customer additions in the residential and commercial sectors, and colder winter weather as compared to the previous year.\n1995 MWH Customer Sales by Service Class\nResidential 36% Commercial 32% Industrial\/Other 32%\nEnergy revenues\n1995 and 1994 Changes in energy revenues do not affect earnings as they reflect corresponding changes in the energy cost rates billed to customers and expensed. Energy revenues in 1995 increased primarily from additional sales to other utilities and higher energy cost rates.\nGeneral Public Utilities Corporation and Subsidiary Companies\nOther revenues\n1995 and 1994 Generally, changes in other revenues do not affect earnings as they are offset by corresponding changes in expense, such as taxes other than income taxes.\nOPERATING EXPENSES: Power purchased and interchanged\n1995 and 1994 Generally, changes in the energy component of power purchased and interchanged (PP&I) expense do not significantly affect earnings since these cost increases are substantially recovered through the Subsidiaries' energy adjustment clauses. However, earnings in 1994 benefitted from lower reserve capacity expense (which is a component of PP&I) resulting from the replacement of expiring utility purchase power contracts at lower rates.\nFuel and Deferral of energy costs, net\n1995 and 1994 Generally, changes in fuel expense and deferral of energy costs do not affect earnings as they are offset by corresponding changes in energy revenues.\nOther operation and maintenance\nThe decrease in other O&M expense was due to a $127 million (pre-tax) charge in 1994 related to the early retirement programs. Partially offsetting this decrease was a 1995 write-off of $14.7 million (pre-tax) for TMI-2 monitored storage costs deemed not probable of recovery through ratemaking.\nThe increase in other O&M expense was due primarily to a $127 million (pre-tax) charge for the early retirement programs. The increase was also due to higher emergency and winter storm repairs and the accrual of additional payroll expense under an expanded employee incentive compensation program designed to tie pay increases more closely to business results and enhance productivity.\nDepreciation and amortization\nThe increase in depreciation and amortization expense was due primarily to additions to plant in service.\nTaxes, other than income taxes\n1995 and 1994 Generally, changes in taxes other than income taxes do not significantly affect earnings as they are substantially recovered in revenues.\nGeneral Public Utilities Corporation and Subsidiary Companies\nOTHER INCOME AND DEDUCTIONS: Other income\/(expense), net\n1995 and 1994 In the third quarter of 1995, Met-Ed and Penelec reversed $183.9 million (pre-tax) of certain future TMI-2 retirement costs written off in 1994. The reversal of this write-off resulted from a 1995 Pennsylvania Supreme Court decision that overturned a 1994 Pennsylvania Commonwealth Court order, and restored a 1993 PaPUC order allowing Met-Ed to recover such costs from customers. The 1995 increase also included higher EI Group income of $14.3 million (pre-tax), which includes an $11.8 million (pre-tax) gain on the sale of securities.\nIn 1994, Penelec expensed $18.6 million (pre-tax) for certain OPEB costs believed not probable of recovery in rates. Of this amount, $14.6 million was written off as a result of a PaPUC order disallowing a nonaffiliated utility to collect such costs, and $4 million was charged to expense for OPEB costs related to employees who participated in the early retirement programs. Also, the Subsidiaries recorded interest income of $59.4 million (pre-tax) resulting from refunds of previously paid federal income taxes related to the tax retirement of TMI-2.\nINTEREST CHARGES AND PREFERRED DIVIDENDS: Other interest\n1995 and 1994 In 1994, the Subsidiaries recognized interest expense related to the tax retirement of TMI-2. The tax retirement of TMI-2 resulted in a $13.8 million (pre-tax) charge to interest expense on additional amounts owed for tax years in which depreciation deductions with respect to TMI-2 had been taken.\nDividends on subsidiary-obligated mandatorily redeemable preferred securities\n1995 and 1994 Through special-purpose partnerships, Met-Ed and Penelec issued in 1994 $100 million and $105 million, respectively, and in May 1995, JCP&L issued $125 million, of mandatorily redeemable preferred securities.\nLIQUIDITY AND CAPITAL RESOURCES Capital Needs:\nThe Subsidiaries' capital needs were $553 million in 1995, consisting of cash construction expenditures of $462 million and amounts for maturing obligations of $91 million. In addition, the EI Group made investments in 1995 totaling $165 million, consisting primarily of investments in generating facilities in South America and an electric distribution business in Australia (see EI GROUP).\nGeneral Public Utilities Corporation and Subsidiary Companies\nDuring 1995, construction expenditures were used primarily to maintain and improve existing generation, transmission and distribution facilities, build a new generation facility, and for various clean air compliance projects. In 1996, construction expenditures for the Subsidiaries are estimated to be $491 million, consisting primarily of $418 million for ongoing system development, $26 million for upgrading JCP&L's communication system, and $15 million for the continued construction of new generation facilities. Expenditures for maturing obligations will total $131 million in 1996, and $158 million in 1997. In the late 1990s, construction expenditures are expected to include substantial amounts for additional clean air requirements and other System needs. Management estimates that approximately three-fourths of the GPU System's 1996 capital needs will be satisfied through internally generated funds.\nCash Construction Expenditures (In millions of dollars) 1991 1992 1993 1994 1995 1996 $467 $460 $496 $586 $462 $491*\n* Estimate\nThe Subsidiaries' capital leases consist primarily of leases for nuclear fuel. Nuclear fuel capital leases at December 31, 1995 totaled $152 million. In 1995, the Subsidiaries refinanced the Oyster Creek and TMI-1 nuclear fuel leases to provide for aggregate borrowings of up to $210 million ($100 million for Oyster Creek and $110 million for TMI-1) outstanding at any one time. These nuclear fuel leases have initial terms of three years expiring in November 1998, and are renewable annually thereafter at the lender's option for a period up to 20 years. When consumed, portions of the presently leased material will be replaced by additional leased material at a rate of between $40 million and $45 million annually. In the event the needed nuclear fuel cannot be leased, the associated capital requirements would have to be met by other means.\nFinancing:\nIn 1995, GPU sold five million shares of common stock. The net proceeds of $157.5 million were used to make cash capital contributions to the Subsidiaries and to repay GPU short-term debt, a portion of which had been incurred to acquire interests in a generating company in Bolivia and a distribution business in Australia.\nThe Subsidiaries have regulatory authority to issue and sell first mortgage bonds (FMBs), which may be issued as secured medium-term notes, and preferred stock through various periods into 1997. Under existing authorizations, JCP&L, Met-Ed and Penelec may issue these senior securities in aggregate amounts of $225 million, $190 million and $160 million, respectively, of which $100 million for each Subsidiary may consist of preferred stock. The Subsidiaries also have regulatory authority to incur short-term debt, a portion of which may be through the issuance of commercial paper.\nGeneral Public Utilities Corporation and Subsidiary Companies\nIn 1995, the Subsidiaries issued an aggregate of $338 million principal amount of FMBs. The proceeds from these issuances were used to refinance $128 million principal amount of higher cost FMBs, to redeem at maturity $59 million principal amount of FMBs, to moderate short-term debt levels and to fund growth in capitalization. In addition, the EI Group has borrowed $68 million under a credit agreement, the proceeds of which were used primarily to finance the acquisition of an electric distribution business in Australia (see EI GROUP). JCP&L Capital L.P., a special-purpose partnership in which a subsidiary of JCP&L is the sole general partner, issued $125 million stated value of mandatorily redeemable preferred securities (carried on the balance sheet as Subsidiary-obligated mandatorily redeemable preferred securities). The proceeds from the issuance were used to reduce JCP&L short-term debt and retire senior securities. Also in 1995, JCP&L repurchased, in the market, $6 million stated value of cumulative preferred stock. The repurchased shares may be used to satisfy future sinking fund requirements.\nThe Subsidiaries' bond indentures and articles of incorporation include provisions that limit the amount of long-term debt, preferred stock and short- term debt the Subsidiaries may issue. The Subsidiaries' interest and preferred dividend coverage ratios are currently in excess of indenture and charter restrictions.\nThe GPU System's cost of capital and ability to obtain external financing are affected by the Subsidiaries' security ratings, which are periodically reviewed by the three major credit rating agencies. The GPU System's senior securities ratings have remained constant since August 1994. The Subsidiaries' FMBs are currently rated at an equivalent of BBB+ or higher by the three major credit rating agencies, while the preferred stock and mandatorily redeemable preferred securities issues have been assigned an equivalent of BBB or higher. In addition, the Subsidiaries' commercial paper is rated as having good to high credit quality.\nIn October 1995, the Standard & Poor's (S&P) rating outlook (which is used to assess the potential direction of an issuer's long-term debt rating over the intermediate to longer-term) for Met-Ed was revised to \"positive\" from \"stable.\" According to S&P, this outlook reflects expectations of modest financial improvement based on gradual economic growth, the successful buyout of some expensive nonutility generation (NUG) contracts, and continued strong nuclear operations. It also reflects the Pennsylvania Supreme Court's reversal of a lower court order that had disallowed recovery of certain future TMI-2 retirement costs. The S&P rating outlook for JCP&L and Penelec remained as \"stable,\" and reflects manageable construction programs, minimal rate relief requirements and expectations of modest strengthening in the service area economies. The S&P business positions assigned to the Subsidiaries remained unchanged throughout the year at \"low average\" to \"average.\" The business position is a financial benchmarking standard for rating the debt of electric utilities to reflect the changing risk profiles resulting primarily from the intensifying competitive pressures in the industry.\nPresent plans call for the Subsidiaries to issue long-term debt during the next three years to finance construction activities, fund the redemption of maturing senior securities, and depending on interest rates, refinance outstanding senior securities. In addition, significant further investments\nGeneral Public Utilities Corporation and Subsidiary Companies\nby the EI Group, or otherwise, may require GPU to issue additional debt and\/or new shares of common stock.\nCapitalization:\nThe GPU System's target capitalization ratios are designed to provide credit quality ratings that permit capital market access at reasonable costs. The targets and actual capitalization ratios are as follows:\nTarget Range 1995 1994 1993 Common equity 46-49% 47% 44% 47% Preferred equity 8-10 9 8 5 Notes payable and long-term debt 46-41 44 48 48 100% 100% 100% 100%\nIn 1995, the quarterly dividend on GPU common stock was increased by 4.4% to an annualized rate of $1.88 per share. GPU's payout rate in 1995 was 63% of earnings (excluding the nonrecurring items). Management will continue to review its dividend policy to determine how to best serve the long-term interests of shareholders.\nEI GROUP The EI Group (Energy Initiatives, EI Power, and EI Energy) is engaged in the development, ownership and operation of generation, transmission and distribution facilities in the United States and foreign countries. GPU has obtained SEC approval to finance investments in foreign utility companies and exempt wholesale generators (both domestically and internationally) up to an aggregate amount equal to 50% of GPU's average consolidated retained earnings. At December 31, 1995, GPU has investments, through the EI Group, in exempt wholesale generators and foreign utility companies totaling approximately $300 million. The $300 million includes investments made by the EI Group totaling $160 million, of which $81 million was contributed by GPU; and GPU guarantee obligations aggregating $140 million. In addition, GPU has investments, through the EI Group, in qualifying cogeneration facilities and project development activities aggregating $124 million. Selected financial data for the EI Group is as follows:\n(In Millions) 1995* 1994 1993 Total assets $380 $130 $ 44\nCapitalization: Common equity $209 $118 $ 39 Notes payable 2 - - Long-term debt 104 - - Total $315 $118 $ 39\nPurchase of investments $165 $ 74 $ 16\nNet income\/(loss) $ 9 $ (3) $ (2)\n* Total assets includes approximately $62 million held by a minority owner.\nGeneral Public Utilities Corporation and Subsidiary Companies\nIn 1995, EI Power acquired from the Bolivian government, for approximately $47 million, a 50% ownership interest in Empresa Guaracachi S.A., a Bolivian electric generating company having an aggregate capacity of 216 MW of gas-fired and oil-fired generation.\nIn 1995, EI Energy, together with the Australian Gas Light Company, acquired Solaris Power (Solaris), an electric distribution company based in Melbourne, Australia, for a total purchase price of approximately $712 million, of which EI Energy's 50% share was $356 million. EI Energy has made an equity investment in Solaris of approximately $112 million; the balance of the purchase price was provided through borrowings by Solaris from an Australian bank syndicate. Solaris, which provides electric service to more than 230,000 customers in and around Melbourne, was sold by the Government of Victoria through a competitive bid as part of that state's privatization of the electric industry.\nIn 1995, EI Power, along with its development partners, completed the financing for the acquisition of a 240 MW gas-fired generating plant in Barranquilla, Colombia and the construction of a new 750 MW gas-fired plant adjacent to the existing plant. Electricity generated by these plants will be sold to Corporacion Electrica de la Costa Atlantica under a 20-year contract. Total project costs, including the acquisition of the existing plant, are approximately $750 million, of which EI Power's equity contribution is expected to be approximately $65 million. EI Power has agreed to make additional equity contributions to the project of up to $58 million under certain circumstances.\nAt December 31, 1995, the EI Group had ownership interests in eleven operating combined-cycle cogeneration plants located in the United States (totaling 932 MW of capacity) and five operating generating facilities located in Canada and South America (totaling 480 MW of capacity). The EI Group also has a number of additional projects at various stages of development, including a 300 MW gas-fired project and a 180 MW gas-fired project for which long-term power purchase agreements have been executed with Georgia Power Company and Wisconsin Public Service Company, respectively.\nManagement expects that the EI Group will be a source of future earnings growth and intends to make additional investments in these types of business activities. The timing and amounts of these investments, however, will depend upon appropriate opportunities.\nThe following remaining sections of MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS are being presented for GPU and for each of the Subsidiaries on a combined basis.\nGeneral Public Utilities Corporation and Subsidiary Companies\nCOMPETITIVE ENVIRONMENT Recent Regulatory Actions:\nThe electric power markets have traditionally been served by integrated regulated monopolies. Over the last few years, however, market forces combined with state and federal actions, have laid the foundation for the development of increased competition in the electric utility industry.\nIn 1995, the Federal Energy Regulatory Commission (FERC) issued a Notice of Proposed Rulemaking (NOPR) on open access nondiscriminatory transmission services by utilities and a supplemental NOPR on recovery of stranded costs. The new rules, if adopted, would in essence provide open access to the interstate electric transmission network and thereby encourage a fully competitive wholesale electric power market.\nAmong other things, the FERC's proposal would (1) require electric utilities to file nondiscriminatory open access transmission tariffs which would be available to all wholesale sellers and buyers of electricity; (2) require utilities to accept service under these new tariffs for their own wholesale transactions; and (3) permit utilities to recover their legitimate and verifiable \"stranded costs\" incurred when a franchise customer elects to purchase power from another supplier using the utility's transmission system.\nIn addition, while the proposed rule does not provide for \"corporate unbundling\", which the FERC defines as the disposing of ancillary services or creating separate affiliates to manage transmission services, it does call for \"functional unbundling\" of transmission and ancillary services.\nWith respect to stranded costs, the FERC proposed to provide recovery mechanisms where stranded costs result from municipalization or other instances where former retail customers become wholesale customers, as well as for wholesale stranded costs. The state regulatory agencies would be expected to provide for recovery of stranded costs attributable to retail wheeling or direct access programs, and the FERC would intervene only when such agencies lacked necessary authority.\nIn September 1995, the FERC accepted for filing, subject to possible rate refunds, the Subsidiaries' proposed open access transmission tariffs. The FERC has ordered that hearings be held on a number of aspects of these tariffs, including whether they are consistent in certain respects with FERC policy on open access and comparability of service. The tariffs provide for both firm and interruptible service on a point-to-point basis. Network service, where requested, will be negotiated on a case by case basis.\nIn November 1995, the Subsidiaries, along with six other electric utility members of the Pennsylvania-New Jersey-Maryland Interconnection (PJM Power Pool), filed with the FERC a detailed plan to increase competition in the Mid- Atlantic region. This comprehensive plan offers to all generators and wholesale buyers of electricity, a regional energy market and open access to high-voltage transmission lines which will result in greater availability of economic energy for wholesale electricity buyers and sellers. The Subsidiaries believe the plan will satisfy the goals of the FERC's NOPR on\nGeneral Public Utilities Corporation and Subsidiary Companies\nopen access nondiscriminatory transmission services, and if approved by the FERC, open access transmission tariffs filed with the FERC under this plan would supersede the Subsidiaries' open access transmission tariffs.\nThe sponsoring PJM companies intend to make a comprehensive filing with the FERC consistent with this detailed plan by May 1996, and expect to implement the new structure by year-end 1996. The Subsidiaries have been advised that the Justice Department is reviewing possible antitrust implications of merger activity among PJM members.\nIn April 1995, legislation was introduced in the U.S. Senate that would repeal Section 210 of the Public Utility Regulatory Policies Act of 1978 (PURPA). Under that section of PURPA, certain qualifying NUGs can \"lock-in\" long-term rates that may result in electric utilities being required to purchase power at costs higher than available alternative sources of energy. Similar legislation has been introduced in the House of Representatives.\nIn October 1995, legislation was introduced in the U.S. Senate that largely reflects a 1995 Securities and Exchange Commission (SEC) Staff report recommending a series of legislative and administrative reforms to the Public Utility Holding Company Act of 1935 (Holding Company Act). The SEC Staff recommended that the SEC support repeal of the Holding Company Act with a minimum one year transition period, and a transfer of audit, reporting and certain other responsibilities to the FERC while giving state agencies access to holding company books and records. In the interim, the SEC Staff recommended that the SEC adopt a series of administrative reforms that would streamline such things as the issuance of securities for routine financings and permit a wide range of energy-related diversification activities. The SEC Staff also recommended that the SEC more flexibly interpret the Holding Company Act's integrated system requirements by allowing utility acquisitions and specifically, combination electric and gas systems, where the affected state commissions concur.\nIn response to the SEC Staff report, the SEC has adopted certain changes which will streamline routine financings, and has proposed a number of others. GPU and other registered holding companies believe that repeal of the Holding Company Act is necessary to remove a significant impediment to a registered holding company's ability to be competitive.\nIn May 1995, the New Jersey Board of Public Utilities (NJBPU) issued Phase I of the New Jersey Energy Master Plan (NJEMP) promoting regulatory policy changes intended to move New Jersey's electric and gas utilities into a competitive marketplace. In the Phase I Report, the NJBPU recommended, among other things, (1) rate-flexibility legislation to allow utilities to compete in order to retain and attract customers in a changing regulatory environment; (2) alternative regulation as an interim and possibly a long-term measure to allow market forces to stimulate efficiency, productivity and innovation; (3) consumer protection standards to ensure that captive ratepayers do not subsidize competitive activities and to ensure that all ratepayers benefit from the transition to greater competition; and (4) an integrated resource planning and competitive supply-side procurement process to streamline the regulatory review process, lower costs for all ratepayers, and ensure that New Jersey's environmental and energy conservation goals are met in a competitive\nGeneral Public Utilities Corporation and Subsidiary Companies\nmarketplace. The Phase I Report also emphasized that regulation must continue to guarantee access to safe, adequate and reliable service at a reasonable cost; protect the public interest; meet environmental and energy efficiency goals; assure system reliability; and protect the financial integrity of utilities which have an obligation to serve the public.\nIn August 1995, the NJBPU initiated Phase II of the NJEMP. Four working groups have been established to develop draft proposals and models by March 1996. The subjects for each of the groups are as follows: (1) competition issues; (2) stranded assets; (3) regional issues such as the environment and emissions standards; and (4) public policy issues, including social programs and conservation. The NJEMP is being developed in three phases, with Phase III expected to be completed by the end of 1996.\nIn July 1995, New Jersey adopted energy rate-flexibility legislation that will enable electric utilities to offer rate discounts to certain customers and allow these customers access to competitive markets. If certain conditions are met, utilities may be permitted to recover from customers 50% of revenue lost as a result of rate discounts. The legislation also provides utilities with the opportunity to propose to the NJBPU alternative ways to set rates. JCP&L has submitted its initial compliance filing which sets forth JCP&L's minimum price for off-tariff rate agreements applicable to commercial and industrial customers.\nIn 1994, the PaPUC initiated an investigation into the role of competition in Pennsylvania's electric utility industry and solicited comments on various issues. Met-Ed and Penelec jointly filed responses suggesting, among other things, that the PaPUC provide for the equitable recovery of stranded investments, enable utilities to offer flexible pricing to customers with competitive alternatives, and address regulatory requirements that impose costs unequally on Pennsylvania utilities as compared with unregulated or out- of-state suppliers. In August 1995, the PaPUC released a Staff report in which the Staff decided not to recommend retail wheeling at this time. Evidentiary hearings on this matter began in December 1995 and the PaPUC is expected to present recommendations in the spring of 1996.\nIn response to these state proceedings, the Subsidiaries have proposed the formation of a wholesale market regional power pool managed by an independent system operator. The power pool would function as a spot market, with generators of electricity allowed to sell into the pool and purchasers of electricity allowed to buy from the pool. It would also accommodate contracts between specific buyers and sellers of power. The power pool operator would be responsible for supporting regional transmission planning and directing the operation of generation and transmission facilities to assure the reliability and integrity of the regional electric grid.\nThe Subsidiaries have also proposed the use of a competitive transition charge (CTC) as an equitable approach to recover stranded costs. The CTC would be applied to all customers who depend on the electric system for delivery of their electric supply. Efforts by utilities to mitigate their\nGeneral Public Utilities Corporation and Subsidiary Companies\nstranded commitments could be required as part of the CTC. The Subsidiaries also support in their proposals retail customer choice for such things as energy supplier, products and services.\nWith the expectation that a segment of the industry will continue to be regulated by the states, the proposals advocate the use of performance-based rates to encourage utilities to reduce costs while maintaining service reliability.\nAnd in keeping with the public policy objectives associated with the electric utility industry, including such things as access to basic service for low income consumers, the proposals endorse the creation of a \"public purpose charge\" that would be collected from all consumers.\nManaging the Transition:\nGPU has identified five strategic objectives to guide the GPU System over the next several years: (1) strengthen and increase the distribution business; (2) maximize existing generation asset values consistent with competitive market economics; (3) internally and externally position GPU for industry deregulation and restructuring; (4) seek earnings growth outside the traditional regulated businesses, including making investments in the EI Group; and (5) develop a culture that will prepare the GPU System for competition.\nOn January 26, 1996, GPU received regulatory approval from the SEC to form a new subsidiary, GPU Generation Corporation (Genco), to operate, maintain and repair the nonnuclear generation facilities owned by the Subsidiaries as well as construct any new nonnuclear generation facilities which the Subsidiaries may need in the future. In 1994, the Subsidiaries received regulatory approval from the PaPUC and NJBPU to enter into an operating agreement with Genco.\nThe Subsidiaries entered into a three-year fuel management agreement with New Jersey Natural Energy Corporation, an affiliate of New Jersey Natural Gas Company, to manage the Subsidiaries' natural gas purchases and interstate pipeline capacity. The Subsidiaries' gas-fired facilities, as well as up to approximately 1,100 MW (JCP&L 885 MW; Met-Ed 200 MW; Penelec 15 MW) of NUG capacity, will be pooled and managed under this agreement, allowing the Subsidiaries to reduce their power purchase expenses. The Subsidiaries have conditional or final agreements with four NUGs (JCP&L three NUGs; Met-Ed one NUG), having an aggregate capacity of approximately 430 MW (JCP&L 385 MW; Met- Ed 45 MW), to supply natural gas from the pool. Also, because the gas pool will help to reduce fuel costs, some of the Subsidiaries' gas-fired generating stations may at times be more economical in the PJM Power Pool's dispatching order. As a result, the Subsidiaries may be able to reduce their dependence upon more expensive purchased power and increase their energy sales to the PJM Power Pool and other utilities.\nIn response to competitive forces and regulatory changes, the GPU System has from time to time considered, and expects to continue to consider, various strategies designed to enhance its competitive position and to increase its ability to adapt to, and anticipate changes in, its business.\nGeneral Public Utilities Corporation and Subsidiary Companies\nThese strategies may include business combinations with other companies, internal restructurings involving the complete or partial separation of its wholesale and retail businesses, acquisitions of other businesses, and additions to or dispositions of all or portions of its generation, transmission or distribution businesses. No assurances can be given as to whether any potential transaction of the type described above may actually occur, or as to the ultimate effect thereof on the financial condition or competitive position of the GPU System.\nNonutility Generation Agreements:\nAs competition in the electric utility industry increases as a result of regulatory actions, and customers are given a choice for their electric supplier, the price of the GPU System's electricity will be critical. GPU is attempting to assess the impact that these and other changes will have on its financial condition and results of operations. For additional information regarding the other changes that may have an adverse effect on the Subsidiaries, see the COMPETITION AND THE CHANGING REGULATORY ENVIRONMENT section of Note 1 to GPU's Consolidated Financial Statements.\nDue to the current availability of excess capacity in the marketplace, the cost of near- to intermediate-term (i.e., one to eight years) energy supply from generation facilities now in service is currently and is expected to continue to be priced below the costs of new supply sources, at least for some time. The projected cost of energy from new generation supply sources has also decreased due to improvements in power plant technologies and reduced forecasted fuel prices. As a result of these developments, the rates under virtually all of the Subsidiaries' NUG agreements are substantially in excess of current and projected prices from alternative sources.\nPursuant to the requirements of PURPA and state regulatory directives, the Subsidiaries have entered into power purchase agreements with NUGs for the purchase of energy and capacity. While the Subsidiaries thus far have been granted recovery of their NUG costs from customers by the PaPUC and NJBPU, there can be no assurance that the Subsidiaries will continue to be able to recover these costs throughout the terms of the related agreements. The GPU System currently estimates that for 1998, when substantially all of these NUG projects are scheduled to be in service, above market payments (benchmarked against the expected cost of electricity produced by a new gas-fired combined- cycle facility) will range from $240 million to $350 million (JCP&L $100 million to $150 million; Met-Ed $50 million to $80 million; Penelec $90 million to $120 million). The amount of these estimated above-market payments may increase or decrease substantially based upon, among other things, payment escalations in the contract terms, changes in fuel prices and changes in the capital and operating cost of new generating equipment.\nThe Subsidiaries intend to avoid, to the maximum extent practicable, entering into any new NUG agreements that are not needed or not consistent with current market pricing and are supporting legislative efforts to repeal PURPA. The Subsidiaries are also attempting to renegotiate, and in some cases buyout, existing high cost long-term NUG agreements (see Managing Nonutility Generation).\nGeneral Public Utilities Corporation and Subsidiary Companies\nTHE GPU SUPPLY PLAN The GPU supply plan is prepared on a GPU System basis. Under existing retail regulation, supply planning in the electric utility industry is directly related to projected growth in the franchise service territory. At this time, management cannot estimate the timing and extent to which retail electric competition will affect the GPU supply plan. As GPU prepares to operate in a competitive environment, its supply plan currently focuses on maintaining the Subsidiaries' existing customer base by offering competitively priced electricity.\nOver the next five years, assuming the continuation of existing retail electric regulation, each of the Subsidiaries is projected to experience an average growth in sales to customers of about 2% annually, principally due to continued economic growth in the service territories and a slight increase in customers. To meet this growth, actual and projected capacity and sources of energy are as follows:\nCapacity 1995 2000 MW % MW % Coal 3,024 29 3,024 27 Nuclear 1,405 13 1,405 13 Gas, Hydro & Oil 2,163 21 2,079 19 Contracted Purchases 3,832 37 3,287 30 Uncommitted Sources - - 1,239 11 Total 10,424 100 11,034 100\nSources of Energy 1995 2000 GWH % GWH % Coal 17,500 34 18,631 35 Nuclear 11,582 23 9,930 19 Gas, Hydro & Oil 1,018 2 1,405 3 Contracted Purchases 16,598 32 17,183 33 Spot Market & Interchange Purchases 4,411 9 5,127 10 Total 51,109 100 52,276 100\nIn response to the increasingly competitive business climate and excess capacity of nearby utilities, the GPU System's supply plan places an emphasis on maintaining flexibility. Supply planning focuses increasingly on short- to intermediate-term commitments, reliance on \"spot\" market purchases, and avoidance of long-term firm commitments. GPU's present strategy includes minimizing the financial exposure associated with new long-term purchase commitments and the construction of new facilities by evaluating these options in terms of an unregulated power market. As part of this strategy, GPU is also evaluating the future financial viability of its generating assets, including possible plant retirements, on an ongoing basis. The GPU System will take necessary actions to avoid adding new capacity which would result in\nGeneral Public Utilities Corporation and Subsidiary Companies\ncosts that may exceed future market prices. In addition, GPU will continue to seek regulatory support to renegotiate or buy out contracts with NUGs where the pricing is in excess of projected market prices.\nNew Energy Supplies:\nThe GPU System's supply plan includes contracted capacity from NUGs, the replacement of expiring utility purchase contracts at lower costs, the construction of new peaking units, the repowering of existing generation facilities, and the continued promotion of economic energy-conservation and load-management programs. The supply plan also includes the addition of approximately 1,239 MW (primarily related to JCP&L) of currently uncommitted capacity. Additional capacity needs are principally related to the expiration of existing commitments rather than new customer load.\nThe Subsidiaries have contracts and anticipated commitments with NUGs under which a total of 1,624 MW (JCP&L 892 MW; Met-Ed 335 MW; Penelec 397 MW) of capacity are currently in service and about an additional 438 MW (JCP&L 110 MW; Met-Ed 150 MW; Penelec 178 MW) are currently scheduled to be in service by 2000.\nIn January 1996, JCP&L issued an all-supply source solicitation for the short-term supply of energy and capacity to meet its minimum forecasted needs through 2002. The solicitation will seek contracts to purchase about 600 MW of capacity beginning in 1999, increasing to approximately 800 MW by 2002. JCP&L plans to meet any energy and capacity needs, over and above its short- term supply minimum forecast, by purchasing energy options which could be exercised as needed. JCP&L will continue to evaluate additional economic purchase opportunities as both demand and supply market conditions evolve and conduct further solicitations to fulfill, if warranted, a significant part of the uncommitted sources identified in GPU's supply plan.\nJCP&L is constructing a 141 MW gas-fired combustion turbine at its Gilbert generating station. This estimated $50 million project, of which $34 million has been spent, is expected to be in-service by mid-1996. An industry trade group representing the NUGs has appealed the issuance of an air permit by the New Jersey Department of Environmental Protection, and the NJBPU's order to the Appellate Division of New Jersey Superior Court. There can be no assurance as to the outcome of this proceeding.\nPenelec has determined that it will not continue funding a proposed $146 million research and development project with the U.S. Department of Energy to repower its 82 MW Warren generating station. In 1995, Penelec wrote off approximately $2 million of costs related to this project.\nManaging Nonutility Generation:\nThe Subsidiaries are seeking to reduce the above market costs of NUG agreements, by (1) attempting to convert must-run agreements to dispatchable agreements; (2) attempting to renegotiate prices of the agreements; (3) offering contract buyouts while seeking to recover the costs through their\nGeneral Public Utilities Corporation and Subsidiary Companies\nenergy adjustment clauses; and (4) initiating proceedings before federal and state agencies, and in the courts, where appropriate. In addition, the Subsidiaries intend to avoid, to the maximum extent practicable, entering into any new NUG agreements that are not needed or not consistent with current market pricing and are supporting legislative efforts to repeal PURPA. These efforts may result in claims against the GPU System for substantial damages. There can, however, be no assurance as to what extent the Subsidiaries' efforts will be successful in whole or in part.\nDuring 1995, JCP&L and Met-Ed bought out a total of five NUG (JCP&L two NUGs; Met-Ed three NUGs) power purchase contracts aggregating 540 MW (JCP&L 200 MW; Met-Ed 340 MW) of capacity, which is expected to save ratepayers more than $2 billion (JCP&L $0.7 billion; Met-Ed $1.3 billion) based on the projected cost of alternative sources of energy over the terms of these agreements. JCP&L and Met-Ed have agreed to pay the project developers up to a total of $84 million (JCP&L $17 million; Met-Ed $67 million) to cancel the contracts. The Subsidiaries have deferred the costs of these buyouts and are seeking to recover these costs through their energy adjustment clauses.\nIn 1995, Met-Ed and Penelec filed a petition for enforcement and declaratory order with the FERC requesting that the FERC effectively invalidate four contracts (Met-Ed two contracts; Penelec two contracts) with NUGs, aggregating 487 MW (Met-Ed 327 MW; Penelec 160 MW) of capacity, on the grounds that the PaPUC's implementation of PURPA directing Met-Ed and Penelec to enter into these agreements was unlawful. The FERC has denied the petition, and Met-Ed and Penelec have not determined whether they will seek judicial review of the FERC's action. Subsequent to the FERC's decision, Met-Ed bought out the contracts for two of these projects, totaling 327 MW.\nIn 1994, Penelec requested the Pennsylvania Supreme Court to review a Commonwealth Court decision upholding a PaPUC order requiring Penelec to purchase a total of 160 MW from two NUGs. The PaPUC had ordered Penelec in 1993 to enter into power purchase agreements with the developers for 80 MW of power each under long-term contracts commencing in 1997 or later. The Commonwealth Court denied Penelec's appeal of the PaPUC order, but remanded the case back to the PaPUC to recalculate the avoided costs to be paid for the power. In May 1995, the PaPUC assigned the matter to an Administrative Law Judge (ALJ) for a recommended decision, and hearings have been scheduled by the ALJ. In August 1995, the Pennsylvania Supreme Court granted Penelec's petition for review of the Commonwealth Court's decision. Briefs have been filed and oral argument was held in January 1996.\nIn March 1995, the U.S. Court of Appeals denied petitions for rehearing filed by JCP&L, the NJBPU, and the New Jersey Division of Ratepayer Advocate, seeking reconsideration of the Court's earlier decision prohibiting the NJBPU from reexamining its order approving the rates payable to Freehold Cogeneration Associates (Freehold) under a long-term power purchase agreement entered into pursuant to PURPA. The U.S. Supreme Court has denied petitions for review filed by JCP&L and the Ratepayer Advocate. JCP&L also petitioned the FERC to invalidate the agreement as unlawful under PURPA. The FERC has denied JCP&L's petition and JCP&L intends to seek judicial review of the FERC's decision. JCP&L is also seeking to invalidate the Freehold power\nGeneral Public Utilities Corporation and Subsidiary Companies\npurchase agreement in a separate action pending in a New Jersey Superior Court. Freehold has moved to dismiss JCP&L's claim, and the matter is pending.\nIn 1994, MidAtlantic Cogen Inc. requested the PaPUC to order Met-Ed to enter into a long-term agreement to buy capacity and energy from its Fairless Cogeneration Project. In 1994, the Pennsylvania Commonwealth Court granted the PaPUC's application to revise its order for the purpose of reevaluating MidAtlantic's right to sell power to Met-Ed. The PaPUC subsequently ordered that hearings be held and assigned the matter to an ALJ. Met-Ed has moved to dismiss MidAtlantic's petition. MidAtlantic has filed a cross-motion for summary judgment. The motions are pending before the PaPUC.\nENVIRONMENTAL ISSUES The federal Clean Air Act Amendments of 1990 (Clean Air Act) require substantial reductions in sulfur dioxide and nitrogen oxide (NOx) emissions by the year 2000. The Subsidiaries' plan includes installing and operating emission control equipment at some of their coal-fired facilities as well as switching to lower sulfur coal at other coal-fired facilities.\nTo comply with the Clean Air Act, the Subsidiaries expect to spend up to $410 million (JCP&L $42 million; Met-Ed $158 million; Penelec $210 million) for air pollution control equipment by the year 2000. During 1994 and 1995, scrubbers were installed at the jointly owned Conemaugh station which are expected to reduce sulfur dioxide emissions by 95%. Met-Ed's share of the total project costs was approximately $57 million. Through December 31, 1995, the Subsidiaries have made capital expenditures of approximately $234 million (JCP&L $41 million; Met-Ed $95 million; Penelec $98 million) (including the Conemaugh scrubbers) to comply with the Clean Air Act requirements.\nIn 1994, the Ozone Transport Commission (OTC), consisting of representatives of 12 northeast states (including New Jersey and Pennsylvania) and the District of Columbia, proposed reductions in NOx emissions it believes necessary to meet ambient air quality standards for ozone and the statutory deadlines set by the Clean Air Act. The Subsidiaries expect that the U.S. Environmental Protection Agency will approve the state implementation plans consistent with the proposal, and that as a result, they will spend an estimated $60 million (Met-Ed $14 million; Penelec $46 million) (included in the Clean Air Act total mentioned above), beginning in 1997, to meet the seasonal reductions agreed upon by the OTC. The OTC has stated that it anticipates that additional NOx reductions will be necessary to meet the Clean Air Act's 2005 National Ambient Air Quality Standards for ozone. However, the specific requirements that will have to be met at that time have not been finalized. The Subsidiaries are unable to determine what additional costs, if any, will be incurred.\nIn developing its least-cost plan to comply with the Clean Air Act, the GPU System will continue to evaluate major capital investments compared to participation in the emission allowance market, and the use of low-sulfur fuel or the retirement of facilities. These and other compliance alternatives may result in the substitution of increased operating expenses for capital costs.\nGeneral Public Utilities Corporation and Subsidiary Companies\nAt this time, costs associated with the capital invested in this pollution control equipment and the increased operating costs of the affected plants are expected to be recoverable through the current ratemaking process, but management recognizes that recovery is not assured.\nFor more information, see the ENVIRONMENTAL MATTERS section of Note 1 to GPU's Consolidated Financial Statements.\nLEGAL MATTERS - TMI-2 ACCIDENT CLAIMS As a result of the TMI-2 accident and its aftermath, individual claims for alleged personal injury (including claims for punitive damages), which are material in amount, have been asserted against GPU and the Subsidiaries. Approximately 2,100 of such claims are pending in the United States District Court for the Middle District of Pennsylvania. Some of the claims also seek recovery for injuries from alleged emissions of radioactivity before and after the accident. For more information, see the TMI-2 section of Note 1 to GPU's Consolidated Financial Statements.\nEFFECTS OF INFLATION Under traditional ratemaking, the GPU System is affected by inflation since the regulatory process results in a time lag during which increased operating expenses are not fully recovered. As competition and deregulation accelerate, there can be no assurance as to the recovery of increased operating expense or utility plant investments. The GPU System is committed to long-term cost control and continues to seek and implement measures to reduce or limit the growth of operating expenses and capital expenditures, including the associated effects of inflation.\nAlthough currently operating in a regulated environment, the GPU System is focusing less on the ratemaking process, and is actively trying to find new ways to increase revenues, improve performance and reduce costs to facilitate the competitive pricing of its products and services.\nGeneral Public Utilities Corporation and Subsidiary Companies\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors General Public Utilities Corporation Parsippany, New Jersey\nWe have audited the consolidated financial statements and financial statement schedule of General Public Utilities Corporation and Subsidiary Companies as listed in the index on page of this Form 10-K. 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.\nWe conducted our audits in accordance with generally accepted auditing standards. These standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of General Public Utilities Corporation and Subsidiary Companies as of December 31, 1995 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, 1995 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 consolidated financial statements taken as a whole, presents fairly, in all material respects, the information required to be included therein.\nCOOPERS & LYBRAND L.L.P.\nNew York, New York January 31, 1996\nGeneral Public Utilities Corporation and Subsidiary Companies\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nGeneral Public Utilities Corporation (the Corporation) is a holding company registered under the Public Utility Holding Company Act of 1935. The Corporation does not directly operate any utility properties, but owns all the outstanding common stock of three electric utilities -- Jersey Central Power & Light Company (JCP&L), Metropolitan Edison Company (Met-Ed) and Pennsylvania Electric Company (Penelec) (the Subsidiaries). The Subsidiaries serve areas of New Jersey and Pennsylvania with a population of approximately five million, with revenues about equally divided between New Jersey and Pennsylvania customers. The Corporation also owns all the common stock of GPU Service Corporation (GPUSC), a service company; GPU Nuclear Corporation (GPUN), which operates and maintains the nuclear units of the Subsidiaries; and Energy Initiatives, Inc., EI Power, Inc. and EI Energy, Inc., (collectively, the \"EI Group\") which develop, own and operate generation, transmission and distribution facilities in the United States and in foreign countries. All of these companies considered together with their subsidiaries are referred to as the \"GPU System.\"\nNote 1, \"Commitments and Contingencies,\" and Note 2, \"Summary of Significant Accounting Policies,\" are being presented on a combined basis; the separate disclosures relating to the Corporation and each of the Subsidiaries have been combined and are presented below. The remaining Notes continue to be presented separately for the Corporation and for each of the Subsidiaries.\n1. COMMITMENTS AND CONTINGENCIES\nNUCLEAR FACILITIES\nThe Subsidiaries have made investments in three major nuclear projects-- Three Mile Island Unit 1 (TMI-1) and Oyster Creek, both of which are operational generating facilities, and Three Mile Island Unit 2 (TMI-2), which was damaged during a 1979 accident. TMI-1 and TMI-2 are jointly owned by JCP&L, Met-Ed and Penelec in the percentages of 25%, 50% and 25%, respectively. Oyster Creek is owned by JCP&L. At December 31, the Subsidiaries' net investment in TMI-1 and Oyster Creek, including nuclear fuel, was as follows:\nNet Investment (Millions) TMI-1 Oyster Creek\nJCP&L $166 $785 Met-Ed 318 - Penelec 156 - Total $640 $785\nGeneral Public Utilities Corporation and Subsidiary Companies\nNet Investment (Millions) TMI-1 Oyster Creek\nJCP&L $162 $817 Met-Ed 311 - Penelec 154 - Total $627 $817\nThe Subsidiaries' net investment in TMI-2 at December 31, 1995 was $95 million (JCP&L, Met-Ed and Penelec's shares are $85 million, $2 million, and $8 million, respectively). The Subsidiaries' net investment in TMI-2 at December 31, 1994 was $103 million (JCP&L, Met-Ed and Penelec's shares are $89 million, $6 million, and $8 million, respectively). JCP&L is collecting revenues for TMI-2 on a basis which provides for the recovery of its remaining investment in the plant by 2008. Met-Ed and Penelec are collecting revenues for TMI-2 related to their wholesale customers.\nCosts associated with the operation, maintenance and retirement of nuclear plants continue to be significant and less predictable than costs associated with other sources of generation, in large part due to changing regulatory requirements, safety standards, availability of nuclear waste disposal facilities and experience gained in the construction and operation of nuclear facilities. The GPU System may also incur costs and experience reduced output at its nuclear plants because of the prevailing design criteria at the time of construction and the age of the plants' systems and equipment. In addition, for economic or other reasons, operation of these plants for the full term of their now-assumed lives cannot be assured. Also, not all risks associated with the ownership or operation of nuclear facilities may be adequately insured or insurable. Consequently, the ability of electric utilities to obtain adequate and timely recovery of costs associated with nuclear projects, including replacement power, any unamortized investment at the end of each plant's useful life (whether scheduled or premature), the carrying costs of that investment and retirement costs, is not assured (see NUCLEAR PLANT RETIREMENT COSTS). Management intends, in general, to seek recovery of such costs through the ratemaking process, but recognizes that recovery is not assured (see COMPETITION AND THE CHANGING REGULATORY ENVIRONMENT).\nTMI-2:\nThe 1979 TMI-2 accident resulted in significant damage to, and contamination of, the plant and a release of radioactivity to the environment. The cleanup program was completed in 1990, and after receiving Nuclear Regulatory Commission (NRC) approval, TMI-2 entered into long-term monitored storage in December 1993.\nAs a result of the accident and its aftermath, individual claims for alleged personal injury (including claims for punitive damages), which are material in amount, have been asserted against the Corporation and the Subsidiaries. Approximately 2,100 of such claims are pending in the United States District Court for the Middle District of Pennsylvania. Some of the claims also seek recovery for injuries from alleged emissions of radioactivity before and after the accident.\nGeneral Public Utilities Corporation and Subsidiary Companies\nAt the time of the TMI-2 accident, as provided for in the Price-Anderson Act, the Subsidiaries had (a) primary financial protection in the form of insurance policies with groups of insurance companies providing an aggregate of $140 million of primary coverage, (b) secondary financial protection in the form of private liability insurance under an industry retrospective rating plan providing for up to an aggregate of $335 million in premium charges under such plan, and (c) an indemnity agreement with the NRC for up to $85 million, bringing their total primary, secondary and tertiary financial protection up to an aggregate of $560 million. Under the secondary level, the Subsidiaries are subject to a retrospective premium charge of up to $5 million per reactor, or a total of $15 million (JCP&L, Met-Ed and Penelec's shares are $7.5 million, $5 million and $2.5 million, respectively).\nThe insurers of TMI-2 had been providing a defense against all TMI-2 accident-related claims against the Corporation and the Subsidiaries and their suppliers (the defendants) under a reservation of rights with respect to any award of punitive damages. However, in March 1994, the defendants in the TMI-2 litigation and the insurers agreed that the insurers would withdraw their reservation of rights with respect to any award of punitive damages. A trial of ten allegedly representative cases is scheduled to begin in June 1996.\nIn October 1995, the U.S. Court of Appeals for the Third Circuit ruled that the Price-Anderson Act provides coverage under its primary and secondary levels for punitive as well as compensatory damages, but that punitive damages could not be recovered against the Federal Government under the third level of financial protection. In so doing, the Court of Appeals referred to the \"finite fund\" (the $560 million of financial protection under the Price- Anderson Act) to which plaintiffs must resort to get compensatory as well as punitive damages. The Corporation and its Subsidiaries have asked the U.S. Supreme Court to review that portion of the Court of Appeals' decision that punitive damages may be recovered in public liability actions under the Price- Anderson Act. The Corporation and its Subsidiaries do not know whether plaintiffs will appeal any aspect of the Court of Appeals' decision.\nBased upon the Court of Appeals' decision, the Corporation and its Subsidiaries believe that any liability to which they might be subject by reason of the TMI-2 accident will not exceed their financial protection under the Price-Anderson Act.\nThe Court of Appeals also found that the standard of care owed by the defendants to a plaintiff was determined by the specific level of radiation which was released into the environment, as measured at the site boundary, rather than as measured at the specific site where the plaintiff was located at the time of the accident (as the Corporation and its Subsidiaries proposed). The Court of Appeals had also held that each plaintiff still must demonstrate exposure to radiation released during the TMI-2 accident and that such exposure had resulted in injuries. The Corporation and its Subsidiaries have requested that the U.S. Supreme Court review this issue. They do not know if whether plaintiffs will do so as well.\nGeneral Public Utilities Corporation and Subsidiary Companies\nThere can be no assurance as to the outcome of this litigation.\nNUCLEAR PLANT RETIREMENT COSTS\nRetirement costs for nuclear plants include decommissioning the radiological portions of the plants and the cost of removal of nonradiological structures and materials. As described in the NUCLEAR FUEL DISPOSAL FEE section of Note 2, the disposal of spent nuclear fuel is covered separately by contracts with the U.S. Department of Energy (DOE).\nIn 1990, the Subsidiaries submitted a report, in compliance with NRC regulations, setting forth a funding plan (employing the external sinking fund method) for the decommissioning of their nuclear reactors. Under this plan, the Subsidiaries intend to complete the funding for Oyster Creek and TMI-1 by the end of the plants' license terms, 2009 and 2014, respectively. The TMI-2 funding completion date is 2014, consistent with TMI-2's remaining in long- term storage and being decommissioned at the same time as TMI-1. Based on NRC studies, a comparable funding target has been developed for TMI-2 which takes the accident into account. Under the NRC regulations, the funding targets (in 1995 dollars) are as follows:\n(Millions) Oyster Creek TMI-1 TMI-2\nJCP&L $189 $ 39 $ 63 Met-Ed - 79 125 Penelec - 39 62 Total $189 $157 $250\nThe NRC continues to study the levels of these funding targets. Management cannot predict the effect that the results of this review will have on the funding targets. The funding targets, while not considered cost estimates, are reference levels designed to assure that licensees demonstrate adequate financial responsibility for decommissioning. While the regulations address activities related to the removal of the radiological portions of the plants, they do not establish residual radioactivity limits nor do they address costs related to the removal of nonradiological structures and materials.\nThe Subsidiaries charge to expense and contribute to external trusts amounts collected from customers for nuclear plant decommissioning and nonradiological costs. In addition, JCP&L has contributed amounts written off for TMI-2 nuclear plant decommissioning in 1990, and Met-Ed and Penelec have contributed amounts written off for TMI-2 nuclear plant decommissioning in 1991, to TMI-2's external trust (see TMI-2 Future Costs). Amounts deposited in external trusts, including the interest earned on these funds, are classified as Nuclear Decommissioning Trusts on the Balance Sheet.\nGeneral Public Utilities Corporation and Subsidiary Companies\nIn 1995, a consultant to GPUN performed site-specific studies of the TMI site, including both Units 1 and 2, and of Oyster Creek, that considered various decommissioning methods and estimated the cost of decommissioning the radiological portions and the cost of removal of the nonradiological portions of each plant, using the prompt removal\/dismantlement method. GPUN management has reviewed the methodology and assumptions used in the site-specific studies, is in agreement with them, and believes the results are reasonable as follows: (Millions) Oyster GPU Creek TMI-1 TMI-2\nRadiological decommissioning $347 $295 $358 Nonradiological cost of removal 33 73 37* Total $380 $368 $395\n* Net of $3 million spent as of December 31, 1995.\n(Millions) Oyster JCP&L Creek TMI-1 TMI-2\nRadiological decommissioning $347 $74 $90 Nonradiological cost of removal 33 18 9* Total $380 $92 $99\n* Net of $.75 million spent as of December 31, 1995.\n(Millions) Met-Ed TMI-1 TMI-2\nRadiological decommissioning $147 $179 Nonradiological cost of removal 37 19* Total $184 $198\n* Net of $1.5 million spent as of December 31, 1995.\n(Millions) Penelec TMI-1 TMI-2\nRadiological decommissioning $74 $89 Nonradiological cost of removal 18 9* Total $92 $98\n* Net of $.75 million spent as of December 31, 1995.\nThe ultimate cost of retiring the GPU System's nuclear facilities may be different from the cost estimates contained in these site-specific studies. Such costs are subject to (a) the escalation of various cost elements (including, but not limited to, general inflation), (b) the further development of regulatory requirements governing decommissioning, (c) the\nGeneral Public Utilities Corporation and Subsidiary Companies\ntechnology available at the time of decommissioning, and (d) the availability of nuclear waste disposal facilities.\nThe Financial Accounting Standards Board (FASB) is reviewing the utility industry's accounting practices for closure and removal of long-lived assets, including nuclear plant retirement costs. If the FASB's tentative conclusions are adopted, Oyster Creek and TMI-1 future retirement costs will have to be recognized as a liability currently, rather than recorded over the life of the plants (as is currently the practice), with an offsetting asset recorded for amounts collectible through rates. Any amounts not collectible through rates will have to be charged to expense. For TMI-2, a liability has already been recognized since the plant is no longer operating (see TMI-2 Future Costs). The FASB is expected to release an Exposure Draft in early 1996, and a final statement is expected to be effective for fiscal years beginning after December 15, 1996.\nTMI-1 and Oyster Creek:\nJCP&L is collecting revenues for decommissioning, which are expected to result in the accumulation of its share of the NRC funding target for each plant. JCP&L is also collecting revenues, based on its share ($3.83 million) of an estimate of $15.3 million for TMI-1 and $31.6 million for Oyster Creek adopted in previous rate orders issued by the New Jersey Board of Public Utilities (NJBPU), for its share of the cost of removal of nonradiological structures and materials. The Pennsylvania Public Utility Commission (PaPUC) previously granted Met-Ed revenues for decommissioning costs of TMI-1 based on its share ($37 million) of the NRC funding target and nonradiological cost of removal estimated in an earlier 1988 site-specific study to be $74 million (in 1995 dollars). The PaPUC also approved a rate change for Penelec which increased the collection of revenues for decommissioning costs for TMI-1 to a basis equivalent to that granted Met-Ed. Collections from customers for retirement expenditures are deposited in external trusts. Provision for the future expenditure of these funds has been made in accumulated depreciation, amounting to $73 million (JCP&L, Met-Ed and Penelec's shares are $23 million, $36 million and $14 million, respectively) for TMI-1 and $138 million for Oyster Creek at December 31, 1995. TMI-1 and Oyster Creek retirement costs are charged to depreciation expense over the expected service life of each nuclear plant, and amounted to $15 million (JCP&L, Met-Ed and Penelec's shares are $3 million, $8 million and $4 million, respectively) and $13 million, respectively, for 1995.\nManagement believes that any TMI-1 and Oyster Creek retirement costs, in excess of those currently recognized for ratemaking purposes, should be recoverable under the current ratemaking process.\nTMI-2 Future Costs:\nThe estimated liabilities for TMI-2 Future Costs (reflected as Three Mile Island Unit 2 Future Costs on the Balance Sheet) as of December 31, are as follows:\nGeneral Public Utilities Corporation and Subsidiary Companies\n(Millions) GPU JCP&L Met-Ed Penelec\nRadiological Decommissioning $358 $ 90 $179 $ 89 Nonradiological Cost of Removal 37* 9 19 9 Incremental Monitored Storage 18 4 9 5 Total $413 $103 $207 $103\n* Net of $3 million (JCP&L, Met-Ed and Penelec's shares are $.75 million, $1.5 million and $.75 million, respectively) spent as of December 31, 1995.\n(Millions) GPU JCP&L Met-Ed Penelec\nRadiological Decommissioning $250 $63 $125 $62 Nonradiological Cost of Removal 72* 18 36 18 Incremental Monitored Storage 19 5 9 5 Total $341 $86 $170 $85\n* Net of $2 million spent (JCP&L, Met-Ed and Penelec's shares are $.5 million, $1 million and $.5 million, respectively) as of December 31, 1994.\nThe 1995 liability recorded on the Balance Sheet for radiological decommissioning and nonradiological cost of removal is based on the 1995 site- specific study. The 1994 liability for radiological decommissioning was based on the NRC funding target, while the 1994 liability for nonradiological cost of removal was based on the 1988 site-specific study for TMI-1 ($74 million).\nOffsetting the $413 million liability is $271 million (JCP&L, Met-Ed and Penelec's shares are $53 million, $147 million and $71 million, respectively) which is probable of recovery from customers and included in Three Mile Island Unit 2 Deferred Costs on the Balance Sheet, and $143 million (JCP&L, Met-Ed and Penelec's shares are $60 million, $57 million and $26 million, respectively) in trust funds for TMI-2 and included in Nuclear Decommissioning Trusts on the Balance Sheet. Of the $271 million still to be recovered from customers, $66 million (JCP&L, Met-Ed and Penelec's shares are $17 million, $33 million and $16 million, respectively) represents an increase from 1994 due to the 1995 site-specific study. Earnings on trust fund deposits collected from customers are included in amounts shown on the Balance Sheet under Three Mile Island Unit 2 Deferred Costs. TMI-2 decommissioning costs charged to expense in 1995 amounted to $14 million (JCP&L, Met-Ed and Penelec's shares are $3 million, $9 million and $2 million, respectively).\nThe NJBPU has granted JCP&L decommissioning revenues for the remainder of the NRC funding target and allowances for the cost of removal of nonradiological structures and materials. In 1993, a PaPUC rate order permitted Met-Ed future recovery of certain TMI-2 retirement costs, based on the NRC funding target, and the cost of removal of nonradiological structures and materials, based on the 1988 site-specific study. The Pennsylvania Office\nGeneral Public Utilities Corporation and Subsidiary Companies\nof Consumer Advocate appealed that order to the Commonwealth Court, which reversed the PaPUC order in 1994. Consequently, Met-Ed recorded pre-tax charges totaling $127.6 million during 1994. Penelec, which is also subject to PaPUC regulation, recorded pre-tax charges of $56.3 million during 1994 for its share of such costs applicable to its retail customers. These charges appear in the Other Income and Deductions section of the 1994 Consolidated Statement of Income and are composed of $121 million (Met-Ed and Penelec's shares are $82.6 million and $38.4 million, respectively) for radiological decommissioning costs, $48.2 million (Met-Ed and Penelec's shares are $35 million and $13.2 million, respectively) for the nonradiological cost of removal and $14.7 million (Met-Ed and Penelec's shares are $10 million and $4.7 million, respectively) for incremental monitored storage costs. In September 1995, the Pennsylvania Supreme Court reversed the Commonwealth Court decision. Met-Ed and Penelec have therefore reversed the previous write-offs, resulting in pre-tax income of $127.6 million and $56.3 million, respectively, being credited to the Other Income and Deductions section of the 1995 Consolidated Statement of Income. However, notwithstanding the Supreme Court's decision, Met-Ed and Penelec have determined that the recovery of the incremental monitored storage costs is no longer probable, and have recorded pre-tax charges to operating income of $10 million and $4.7 million, respectively, during 1995.\nAt December 31, 1995 the accident-related portion of TMI-2 radiological decommissioning costs is considered to be $63 million (JCP&L, Met-Ed and Penelec's shares are $16 million, $32 million and $15 million, respectively), which is the difference between the 1995 TMI-1 and TMI-2 site-specific study estimates of $295 million and $358 million, respectively (JCP&L, Met-Ed and Penelec's shares are $74 million and $90 million, $147 million and $179 million, and $74 million and $89 million, respectively). In connection with rate case resolutions at the time, JCP&L, Met-Ed and Penelec made contributions to irrevocable external trusts relating to their shares of the accident-related portions of the decommissioning liability. In 1990, JCP&L contributed $15 million and in 1991, Met-Ed and Penelec contributed $40 million and $20 million respectively, to irrevocable external trusts. These contributions were not recovered from customers and have been expensed. The Subsidiaries will not pursue recovery from customers for any of these amounts contributed in excess of the $63 million accident-related portion referred to above.\nJCP&L intends to seek recovery for any increases in TMI-2 retirement costs, and Met-Ed and Penelec intend to seek recovery for any increases in the nonaccident-related portion of such costs, but recognize that recovery cannot be assured.\nAs a result of TMI-2's entering long-term monitored storage in late 1993, the Subsidiaries are incurring incremental storage costs of approximately $1 million (JCP&L, Met-Ed and Penelec's shares are $.25 million, $.5 million, and $.25 million, respectively) annually. The Subsidiaries estimate that the remaining storage costs will total $18 million through 2014, the expected retirement date of TMI-1. JCP&L's rates reflect its share of these costs.\nGeneral Public Utilities Corporation and Subsidiary Companies\nINSURANCE\nThe GPU System has insurance (subject to retentions and deductibles) for its operations and facilities including coverage for property damage, liability to employees and third parties, and loss of use and occupancy (primarily incremental replacement power costs). There is no assurance that the GPU System will maintain all existing insurance coverages. Losses or liabilities that are not completely insured, unless allowed to be recovered through ratemaking, could have a material adverse effect on the financial position of the GPU System.\nThe decontamination liability, premature decommissioning and property damage insurance coverage for the TMI station and for Oyster Creek totals $2.7 billion per site. In accordance with NRC regulations, these insurance policies generally require that proceeds first be used for stabilization of the reactors and then to pay for decontamination and debris removal expenses. Any remaining amounts available under the policies may then be used for repair and restoration costs and decommissioning costs. Consequently, there can be no assurance that in the event of a nuclear incident, property damage insurance proceeds would be available for the repair and restoration of that station.\nThe Price-Anderson Act limits the GPU System's liability to third parties for a nuclear incident at one of its sites to approximately $8.9 billion. Coverage for the first $200 million of such liability is provided by private insurance. The remaining coverage, or secondary financial protection, is provided by retrospective premiums payable by all nuclear reactor owners. Under secondary financial protection, a nuclear incident at any licensed nuclear power reactor in the country, including those owned by the GPU System, could result in assessments of up to $79 million per incident for each of the GPU System's two operating reactors, subject to an annual maximum payment of $10 million per incident per reactor. In addition to the retrospective premiums payable under Price-Anderson, the GPU System is also subject to retrospective premium assessments of up to $69 million (JCP&L, Met-Ed and Penelec's shares are $41 million, $19 million and $9 million, respectively) in any one year under insurance policies applicable to nuclear operations and facilities.\nThe GPU System has insurance coverage for incremental replacement power costs resulting from an accident-related outage at its nuclear plants. Coverage commences after the first 21 weeks of the outage and continues for three years beginning at $1.8 million for Oyster Creek and $2.6 million for TMI-1 per week for the first year, decreasing to 80 percent of such amounts for years two and three.\nCOMPETITION AND THE CHANGING REGULATORY ENVIRONMENT\nNonutility Generation Agreements:\nPursuant to the requirements of the federal Public Utility Regulatory Policies Act (PURPA) and state regulatory directives, the Subsidiaries have entered into power purchase agreements with nonutility generators (NUGs) for\nGeneral Public Utilities Corporation and Subsidiary Companies\nthe purchase of energy and capacity for periods up to 25 years for JCP&L, 26 years for Met-Ed, and 25 years for Penelec. The majority of these agreements contain certain contract limitations and subject the NUGs to penalties for nonperformance. While a few of these facilities are dispatchable, most are must-run and generally obligate the Subsidiaries to purchase, at the contract price, the net output up to the contract limits. As of December 31, 1995, facilities covered by these agreements having 1,624 MW (JCP&L, Met-Ed and Penelec's shares are 892 MW, 335 MW and 397 MW, respectively) of capacity were in service. Actual payments from 1993 through 1995, and estimated payments from 1996 through 2000 to NUGs, assuming that all facilities which have existing agreements, or which have obtained orders granting them agreements, enter service, are as follows:\nPayments Under NUG Agreements (Millions)\nTotal JCP&L Met-Ed Penelec\n1993 $ 491 $ 292 $ 95 $ 104 1994 528 304 101 123 1995 670 381 131 158 * 1996 696 369 151 176 * 1997 739 400 155 184 * 1998 837 430 210 197 * 1999 931 442 211 278 * 2000 987 463 216 308\n* Estimate\nOf these amounts, payments to the projects which are not in service at December 31, 1995 are estimated as follows:\nPayments Under NUG Agreements Not In Service (Millions)\nTotal JCP&L Met-Ed Penelec\n1997 $ 40 $ 25 $ 15 $ - 1998 123 53 65 5 1999 202 58 68 76 2000 231 62 71 98\nIn the year 2000 these agreements, in the aggregate, will provide approximately 2,062 MW (JCP&L 1,002 MW, Met-Ed 485 MW and Penelec 575 MW) of capacity and energy to the GPU System, at varying prices.\nThe emerging competitive generation market has created uncertainty regarding the forecasting of the System's energy supply needs which has caused the Subsidiaries to change their supply strategy to seek shorter-term agreements offering more flexibility. Due to the current availability of excess capacity in the marketplace, the cost of near- to intermediate-term (i.e., one to eight years) energy supply from generation facilities now in service is currently and is expected to continue to be priced below the costs\nGeneral Public Utilities Corporation and Subsidiary Companies\nof new supply sources, at least for some time. The projected cost of energy from new generation supply sources has also decreased due to improvements in power plant technologies and reduced forecasted fuel prices. As a result of these developments, the rates under virtually all of the Subsidiaries' NUG agreements are substantially in excess of current and projected prices from alternative sources.\nThe Subsidiaries are seeking to reduce the above market costs of these NUG agreements by (1) attempting to convert must-run agreements to dispatchable agreements; (2) attempting to renegotiate prices of the agreements; (3) offering contract buyouts while seeking to recover the costs through their energy adjustment clauses (see Managing Nonutility Generation, in Management's Discussion and Analysis of Financial Condition and Results of Operations) and (4) initiating proceedings before federal and state agencies, and in the courts, where appropriate. In addition, the Subsidiaries intend to avoid, to the maximum extent practicable, entering into any new NUG agreements that are not needed or not consistent with current market pricing and are supporting legislative efforts to repeal PURPA. These efforts may result in claims against the GPU System for substantial damages. There can, however, be no assurance as to the extent to which the Subsidiaries' efforts will be successful in whole or in part.\nWhile the Subsidiaries thus far have been granted recovery of their NUG costs from customers by the PaPUC and NJBPU, there can be no assurance that the Subsidiaries will continue to be able to recover these costs throughout the term of the related agreements. The GPU System currently estimates that for 1998, when substantially all of these NUG projects are scheduled to be in service, above market payments (benchmarked against the expected cost of electricity produced by a new gas-fired combined cycle facility) will range from $240 million to $350 million (JCP&L $100 to $150 million; Met-Ed $50 million to $80 million; and Penelec $90 million to $120 million). The amount of these estimated above-market payments may increase or decrease substantially based upon, among other things, payment escalations in the contract terms, changes in fuel prices and changes in the capital and operating cost of new generating equipment.\nRegulatory Assets and Liabilities:\nIn accordance with Statement of Financial Accounting Standards No. 71 (FAS 71), \"Accounting for the Effects of Certain Types of Regulation,\" the GPU System's financial statements reflect assets and costs based on current cost- based ratemaking regulation. Continued accounting under FAS 71 requires that the following criteria be met:\na) A utility's rates for regulated services provided to its customers are established by, or are subject to approval by, an independent third-party regulator;\nb) The regulated rates are designed to recover specific costs of providing the regulated services or products; and\nGeneral Public Utilities Corporation and Subsidiary Companies\nc) In view of the demand for the regulated services and the level of competition, direct and indirect, it is reasonable to assume that rates set at levels that will recover a utility's costs can be charged to and collected from customers. This criteria requires consideration of anticipated changes in levels of demand or competition during the recovery period for any capitalized costs.\nA utility's operations can cease to meet those criteria for various reasons, including deregulation, a change in the method of regulation, or a change in the competitive environment for the utility's regulated services. Regardless of the reason, a utility whose operations cease to meet those criteria should discontinue application of FAS 71 and report that discontinuation by eliminating from its Balance Sheet the effects of any actions of regulators that had been recognized as assets and liabilities pursuant to FAS 71, but which would not have been recognized as assets and liabilities by enterprises in general.\nIn accordance with the provisions of FAS 71, the Subsidiaries have deferred certain costs pursuant to actions of the NJBPU, PaPUC and Federal Energy Regulatory Commission (FERC) and are recovering or expect to recover such costs in electric rates charged to customers. Regulatory assets are reflected in the Deferred Debits and Other Assets section of the Consolidated Balance Sheet, and regulatory liabilities are reflected in the Deferred Credits and Other Liabilities section of the Consolidated Balance Sheet. Regulatory assets and liabilities, as reflected in the December 31, 1995 Consolidated Balance Sheet, were as follows:\nGPU (In Thousands) Assets Liabilities Income taxes recoverable\/refundable through future rates $ 527,584 $94,931 TMI-2 deferred costs 368,712 - Unamortized property losses 105,729 - NUG contract termination costs 84,132 - Other postretirement benefits 58,362 - N.J. unit tax 51,518 - Unamortized loss on reacquired debt 50,198 - Load and demand-side management programs 48,071 - DOE enrichment facility decommissioning 38,519 - Manufactured gas plant remediation 29,608 - Nuclear fuel disposal fee 21,946 - N.J. low-level radwaste disposal 21,778 - Storm damage 18,294 - Oyster Creek deferred costs 4,830 - Other 10,427 3,068 Total $1,439,708 $97,999\nGeneral Public Utilities Corporation and Subsidiary Companies\nJCP&L (In Thousands) Assets Liabilities Income taxes recoverable\/refundable through future rates $134,787 $36,343 TMI-2 deferred costs 138,472 - Unamortized property losses 100,176 - NUG contract termination costs 17,482 - Other postretirement benefits 32,390 - N.J. unit tax 51,518 - Unamortized loss on reacquired debt 34,285 - Load and demand side management programs 48,071 - DOE enrichment facility decommissioning 24,503 - Manufactured gas plant remediation 29,608 - Nuclear fuel disposal fee 23,165 - N.J. low-level radwaste disposal 21,778 - Storm damage 18,294 - Oyster Creek deferred costs 4,830 - Other 5,369 1,254 Total $684,728 $37,597\nMet-Ed (In Thousands) Assets Liabilities Income taxes recoverable\/refundable through future rates $178,513 $24,765 TMI-2 deferred costs 149,004 - Unamortized property losses 3,273 - NUG contract termination costs 66,650 - Other postretirement benefits 25,972 - Unamortized loss on reacquired debt 6,945 - DOE enrichment facility decommissioning 9,344 - Nuclear fuel disposal fee (1,025) - Other 1,299 1,696 Total $439,975 $26,461\nPenelec (In Thousands) Assets Liabilities Income taxes recoverable\/refundable through future rates $214,284 $33,823 TMI-2 deferred costs 81,236 - Unamortized property losses 2,280 - Unamortized loss on reacquired debt 8,968 - DOE enrichment facility decommissioning 4,672 - Nuclear fuel disposal fee (194) - Other 3,759 118 Total $315,005 $33,941\nIncome taxes recoverable\/refundable through future rates: Represents amounts deferred due to the implementation of FAS 109, \"Accounting for Income Taxes,\" in 1993.\nGeneral Public Utilities Corporation and Subsidiary Companies\nTMI-2 deferred costs: Represents costs that are recoverable through rates for the Subsidiaries' remaining investment in the plant and fuel core, radiological decommissioning and the cost of removal of nonradiological structures and materials in accordance with the 1995 site-specific study, and JCP&L's share of long-term monitored storage costs. For additional information, see TMI-2 Future Costs.\nUnamortized property losses: Consists mainly of costs associated with JCP&L's Forked River Project, which are included in rates.\nNUG contract termination costs: Represents one-time costs incurred for terminating power purchase contracts with NUGs, for which rate recovery has been granted or is probable (see Managing Nonutility Generation, in Management's Discussion and Analysis of Financial Condition and Results of Operations).\nOther postretirement benefits: Includes costs associated with the adoption of FAS 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" which are deferred in accordance with Emerging Issues Task Force Issue 92-12, \"Accounting for OPEB Costs by Rate-Regulated Enterprises.\"\nN.J. unit tax: JCP&L received NJBPU approval in 1993 to recover, with interest, over a ten-year period on an annuity basis, $71.8 million of Gross Receipts and Franchise Tax not previously recovered from customers.\nUnamortized loss on reacquired debt: Represents premiums and expenses incurred in the early redemption of long-term debt. In accordance with FERC regulations, reacquired debt costs are amortized over the remaining original life of the retired debt.\nLoad and demand-side management (DSM) programs: Consists of load management costs that are currently being recovered, with interest, through JCP&L's retail base rates pursuant to a 1993 NJBPU order, and other DSM program expenditures that are recovered annually. Also includes provisions for lost revenues between base rate cases and performance incentives.\nDOE enrichment facility decommissioning: These costs, representing payments to the DOE over a 15-year period beginning in 1994, are currently being collected through the Subsidiaries' energy adjustment clauses.\nManufactured gas plant remediation: Consists of costs being recovered associated with the investigation and remediation of several gas manufacturing plants. For additional information, see ENVIRONMENTAL MATTERS.\nNuclear fuel disposal fee: Represents amounts recoverable through rates for estimated future disposal costs for spent nuclear fuel at Oyster Creek and TMI-1 in accordance with the Nuclear Waste Policy Act of 1982.\nN.J. low-level radwaste disposal: Represents the accrual of the estimated assessment for the siting of a disposal facility for low-level waste from Oyster Creek, less amortization as allowed in JCP&L's rates.\nGeneral Public Utilities Corporation and Subsidiary Companies\nStorm damage: Relates to incremental noncapital costs associated with various storms in the JCP&L service territory that are not recoverable through insurance. These amounts were deferred based upon past rate recovery precedent. An annual amount for recovery of storm damage expense is included in JCP&L's retail base rates.\nOyster Creek deferred costs: Consists of replacement power and operation and maintenance (O&M) costs deferred in accordance with orders from the NJBPU. JCP&L has been granted recovery of these costs through rates at an annual amount until fully amortized.\nAmounts related to the decommissioning of TMI-1 and Oyster Creek, which are not included in Regulatory Assets on the Balance Sheet, are separately disclosed in NUCLEAR PLANT RETIREMENT COSTS.\nThe Subsidiaries continue to be subject to cost-based ratemaking regulation. However, in the event that either all or a portion of their operations are no longer subject to these provisions, the related regulatory assets, net of regulatory liabilities, would have to be written off. In addition, any above market costs of purchased power commitments would have to be expensed (see Nonutility Generation Agreements), and increased depreciation expense would have to be recorded for any differences created by the use of a regulated depreciation method that is different from that which would have been used under generally accepted accounting principles for enterprises in general. The Corporation is unable to estimate when and to what extent FAS 71 may no longer be applicable.\nENVIRONMENTAL MATTERS\nAs a result of existing and proposed legislation and regulations, and ongoing legal proceedings dealing with environmental matters, including but not limited to acid rain, water quality, air quality, global warming, electromagnetic fields, and storage and disposal of hazardous and\/or toxic wastes, the GPU System may be required to incur substantial additional costs to construct new equipment, modify or replace existing and proposed equipment, remediate, decommission or clean up waste disposal and other sites currently or formerly used by it, including formerly owned manufactured gas plants, mine refuse piles and generating facilities, and with regard to electromagnetic fields, postpone or cancel the installation of, or replace or modify, utility plant, the costs of which could be material.\nTo comply with the federal Clean Air Act Amendments of 1990 (Clean Air Act), the Subsidiaries expect to spend up to $410 million (JCP&L, Met-Ed and Penelec's shares are $42 million, $163 million, and $205 million, respectively) for air pollution control equipment by the year 2000, of which approximately $234 million (JCP&L, Met-Ed and Penelec's shares are $41 million, $100 million, and $93 million, respectively) has already been spent. In developing its least-cost plan to comply with the Clean Air Act, the GPU System will continue to evaluate major capital investments compared to participation in the emission allowance market and the use of low-sulfur fuel or retirement of facilities. In 1994, the Ozone Transport Commission (OTC), consisting of representatives of 12 northeast states (including New Jersey and\nGeneral Public Utilities Corporation and Subsidiary Companies\nPennsylvania) and the District of Columbia, proposed reductions in nitrogen oxide (NOx) emissions it believes necessary to meet ambient air quality standards for ozone and the statutory deadlines set by the Clean Air Act. The Subsidiaries expect that the U.S. Environmental Protection Agency (EPA) will approve state implementation plans consistent with the proposal, and that as a result, they will spend an estimated $60 million (Met-Ed and Penelec's shares are $14 million and $46 million, respectively) (included in the Clean Air Act total), beginning in 1997, to meet the seasonal reductions agreed upon by the OTC. The OTC has stated that it anticipates that additional NOx reductions will be necessary to meet the Clean Air Act's 2005 National Ambient Air Quality Standard for ozone. However, the specific requirements that will have to be met at that time have not been finalized. The Subsidiaries are unable to determine what additional costs, if any, will be incurred.\nThe GPU System companies have been notified by the EPA and state environmental authorities that they are among the potentially responsible parties (PRPs) who may be jointly and severally liable to pay for the costs associated with the investigation and remediation at 11 hazardous and\/or toxic waste sites, broken down by company as follows:\nJCP&L MET-ED PENELEC GPUN GPU TOTAL\nPRPs 6 4 2 1 1 11*\n* In some cases, the Subsidiaries are named separately for the same site.\nIn addition, the Subsidiaries have been requested to voluntarily participate in the remediation or supply information to the EPA and state environmental authorities on several other sites for which they have not yet been named as PRPs. The Subsidiaries have also been named in lawsuits requesting damages for hazardous and\/or toxic substances allegedly released into the environment. The ultimate cost of remediation will depend upon changing circumstances as site investigations continue, including (a) the existing technology required for site cleanup, (b) the remedial action plan chosen and (c) the extent of site contamination and the portion attributed to the GPU System companies.\nJCP&L has entered into agreements with the New Jersey Department of Environmental Protection (NJDEP) for the investigation and remediation of 17 formerly owned manufactured gas plant sites. JCP&L has also entered into various cost-sharing agreements with other utilities for most of the sites. As of December 31, 1995, JCP&L has an estimated environmental liability of $29 million recorded on its Balance Sheet relating to these sites. The estimated liability is based upon ongoing site investigations and remediation efforts, including capping the sites and pumping and treatment of ground water. If the periods over which the remediation is currently expected to be performed are lengthened, JCP&L believes that it is reasonably possible that the future costs may range as high as $50 million. Estimates of these costs are subject to significant uncertainties because: JCP&L does not presently own or control most of these sites; the environmental standards have changed in the past and are subject to future change; the accepted technologies are subject to further development; and the related costs for these technologies are uncertain. If JCP&L is required to utilize different remediation methods, the costs could be materially in excess of $50 million.\nGeneral Public Utilities Corporation and Subsidiary Companies\nIn 1993, the NJBPU approved a mechanism similar to JCP&L's Levelized Energy Adjustment Clause (LEAC) for the recovery of future manufactured gas plant remediation costs when expenditures exceed prior collections. The NJBPU decision also provided for interest on any overrecovery to be credited to customers until the overrecovery is eliminated and for future costs to be amortized over seven years with interest. JCP&L is pursuing reimbursement of the remediation costs from its insurance carriers. In 1994, JCP&L filed a complaint with the Superior Court of New Jersey against several of its insurance carriers, relative to these manufactured gas plant sites. JCP&L requested the Court to order the insurance carriers to reimburse JCP&L for all amounts it has paid, or may be required to pay, in connection with the remediation of the sites. Pretrial discovery has begun in this case.\nThe GPU System companies are unable to estimate the extent of possible remediation and associated costs of additional environmental matters. Also unknown are the consequences of environmental issues, which could cause the postponement or cancellation of either the installation or replacement of utility plant.\nOTHER COMMITMENTS AND CONTINGENCIES\nThe GPU System's construction programs, for which substantial commitments have been incurred and which extend over several years, contemplate expenditures of $491 million (JCP&L, Met-Ed, Penelec and GPUSC's shares are $256 million, $97 million, $124 million and $14 million, respectively) during 1996. As a consequence of reliability, licensing, environmental and other requirements, additions to utility plant may be required relatively late in their expected service lives. If such additions are made, current depreciation allowance methodology may not make adequate provision for the recovery of such investments during their remaining lives. Management intends to seek recovery of such costs through the ratemaking process, but recognizes that recovery is not assured.\nThe Subsidiaries have entered into long-term contracts with nonaffiliated mining companies for the purchase of coal for certain generating stations in which they have ownership interests. The contracts, which expire at various dates between 1996 and 2004, require the purchase of either fixed or minimum amounts of the stations' coal requirements. The price of the coal under the contracts is based on adjustments of indexed cost components. One of Penelec's contracts for the Homer City station also includes a provision for the payment of postretirement benefit costs. The Subsidiaries' share of the cost of coal purchased under these agreements is expected to aggregate $115 million (JCP&L, Met-Ed and Penelec's shares are $20 million, $18 million and $77 million, respectively) for 1996.\nJCP&L has entered into agreements with other utilities to purchase capacity and energy for various periods through 2004. These agreements will provide for up to 1,085 MW in 1996, declining to 878 MW in 1999 and 696 MW in 2004. For the years 1996, 1997, 1998, 1999 and 2000, payments pursuant to these agreements are estimated to be $174 million, $164 million, $145 million, $124 million and $95 million, respectively.\nGeneral Public Utilities Corporation and Subsidiary Companies\nJCP&L is constructing a 141 MW gas-fired combustion turbine at its Gilbert generating station. This estimated $50 million project, of which $34 million has been spent, is expected to be in-service by mid-1996. In 1995, the NJDEP issued an air permit for the facility based, in part, on the NJBPU's 1994 order which found that New Jersey's Electric Facility Need Assessment Act is not applicable and that construction of this facility, without a market test, is consistent with New Jersey energy policies. An industry trade group representing NUGs has appealed the NJDEP's issuance of the air permit and the NJBPU's order to the Appellate Division of the New Jersey Superior Court. There can be no assurance as to the outcome of this proceeding.\nThe NJBPU has instituted a generic proceeding to address the appropriate recovery of capacity costs associated with electric utility power purchases from NUG projects. The proceeding was initiated, in part, to respond to contentions of the Division of the Ratepayer Advocate that by permitting utilities to recover such costs through the LEAC, an excess or \"double\" recovery may result when combined with the recovery of the utilities' embedded capacity costs through their base rates. In 1994, the NJBPU ruled that the LEAC periods prior to March 1991 were considered closed but subsequent LEAC periods remain open for further investigation. This matter is pending before a NJBPU Administrative Law Judge. JCP&L estimates that the potential refund liability for the LEAC periods from March 1991 through February 1996, the end of the current LEAC period, is $55 million. There can be no assurance as to the outcome of this proceeding.\nJCP&L's two operating nuclear units are subject to the NJBPU's annual nuclear performance standard. Operation of these units at an aggregate annual generating capacity factor below 65% or above 75% would trigger a charge or credit based on replacement energy costs. At current cost levels, the maximum annual effect on net income of the performance standard charge at a 40% capacity factor would be approximately $10 million before tax. While a capacity factor below 40% would generate no specific monetary charge, it would require the issue to be brought before the NJBPU for review. The annual measurement period, which begins in March of each year, coincides with that used for the LEAC.\nAs of December 31, 1995, approximately 52% of the GPU System's workforce was represented by unions for collective bargaining purposes. JCP&L employees' collective bargaining agreement is due to expire in 1996, representing 45% of the GPU System's union employees.\nNiagara Mohawk Power Corporation (NIMO) has filed with the New York Public Service Commission a proposed restructuring plan that it claims may be needed to avoid seeking reorganization under Chapter XI of the Bankruptcy Code. Energy Initiatives has ownership interests, with an aggregate book value of approximately $35 million, in three NUG projects which have long-term purchase power agreements with NIMO. In the restructuring plan, NIMO has insisted on renegotiating all of its contracts with NUGs, and has claimed that it has the right to use eminent domain to condemn NUG facilities, if such negotiations are not successful. There can be no assurance as to the outcome of this matter.\nGeneral Public Utilities Corporation and Subsidiary Companies\nNIMO has also initiated actions in federal and state court seeking to invalidate numerous NUG contracts or limit the amount of annual generation produced by the NUG, and is withholding allegedly \"excess\" payments made in respect of \"over generation\" under these contracts, including the contracts for two of Energy Initiatives' projects. NIMO alleges to have overpaid Energy Initiatives approximately $10 million for the years 1993 through 1995. Energy Initiatives has filed motions to dismiss these complaints and is vigorously defending these actions. There can be no assurance as to the outcome of these proceedings.\nAt December 31, 1995, the EI Group had investments totalling $160 million in facilities located in four foreign countries. Although management attempts to mitigate the risk of investing in certain foreign countries by securing political risk insurance, the EI Group faces additional risks inherent to operating in such locations, including foreign currency fluctuations (see EI GROUP, in Management's Discussion and Analysis of Financial Condition and Results of Operations).\nIn March 1995, the FASB issued FAS 121, \"Accounting for the Impairment of Long-Lived Assets,\" which is effective for fiscal years beginning after June 15, 1995. FAS 121 requires that long-lived assets, identifiable intangibles, capital leases and goodwill be reviewed for impairment whenever events occur or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. In addition, FAS 121 requires that regulatory assets meet the recovery criteria of FAS 71, \"Accounting for the Effects of Certain Types of Regulation,\" on an ongoing basis in order to avoid a writedown (see Regulatory Assets and Liabilities).\nThe implementation of FAS 121 by the GPU System in 1995 did not have an impact on results of operations because management believes the carrying amounts of all assets are probable of recovery from customers. However, as the Subsidiaries enter a more competitive environment, some assets could be subject to impairment, thereby necessitating writedowns, which could have a material adverse effect on the GPU System's results of operations and financial condition.\nThe FASB exposure draft relating to closure and removal of long-lived assets (see NUCLEAR PLANT RETIREMENT COSTS), applies to all long-lived assets, including fossil-fueled generating plants. For these assets, a liability will have to be recognized wherever a legal or constructive obligation exists to perform dismantlement or removal activities.\nDuring the normal course of the operation of their businesses, in addition to the matters described above, the GPU System companies are from time to time involved in disputes, claims and, in some cases, as defendants in litigation in which compensatory and punitive damages are sought by the public, customers, contractors, vendors and other suppliers of equipment and services and by employees alleging unlawful employment practices. While management does not expect that the outcome of these matters will have a material effect on the GPU System's financial position or results of operations, there can be no assurance that this will continue to be the case.\nGeneral Public Utilities Corporation and Subsidiary Companies\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and revenues and expenses during the reporting period. Actual results could differ from those estimates.\nSYSTEM OF ACCOUNTS Certain reclassifications of prior years' data have been made to conform with the current presentation. The Subsidiaries' accounting records are maintained in accordance with the Uniform System of Accounts prescribed by the FERC and adopted by the PaPUC and NJBPU.\nCONSOLIDATION The consolidated financial statements include the accounts of all subsidiaries. All significant intercompany transactions and accounts are eliminated in consolidation. The GPU System uses the equity method of accounting for investments in affiliates in which it has the ability to exercise significant influence (generally evidenced by a 20% to 50% ownership interest), and consolidates its wholly-owned subsidiaries, and any affiliates in which it has a controlling financial interest (generally evidenced by a greater than 50% ownership interest). All other investments are accounted for using the cost method.\nCURRENCY TRANSLATION In accordance with Statement of Financial Accounting Standards No. 52 (FAS 52), \"Foreign Currency Translation,\" balance sheet accounts of the GPU System's foreign operations are translated from foreign currencies into U.S. dollars at either year-end rates or historical rates, while income statement accounts are translated at the weighted average exchange rates for the period. The resulting translation adjustments are not material and are included in Retained Earnings. Any gains and losses resulting from foreign currency transactions would be included in net income.\nREVENUES\nThe Subsidiaries recognize electric operating revenues for services rendered (including an estimate of unbilled revenues) to the end of the respective accounting period.\nDEFERRED ENERGY COSTS Energy costs are recognized in the period in which the related energy clause revenues are billed.\nGeneral Public Utilities Corporation and Subsidiary Companies\nUTILITY PLANT It is the policy of the GPU System to record additions to utility plant (material, labor, overhead and an allowance for funds used during construction) at cost. The cost of current repairs and minor replacements is charged to appropriate operating and maintenance expense and clearing accounts, and the cost of renewals is capitalized. The original cost of utility plant retired or otherwise disposed of is charged to accumulated depreciation.\nDEPRECIATION The GPU System provides for depreciation at annual rates determined and revised periodically, on the basis of studies, to be sufficient to depreciate the original cost of depreciable property over estimated remaining service lives, which are generally longer than those employed for tax purposes. The Subsidiaries used depreciation rates which, on an aggregate composite basis, resulted in annual rates as follows:\nGPU JCP&L Met-Ed Penelec\n1995 3.22% 3.64% 3.07% 2.61% 1994 3.16% 3.62% 3.04% 2.49% 1993 3.19% 3.59% 2.91% 2.74%\nALLOWANCE FOR FUNDS USED DURING CONSTRUCTION (AFUDC) The Uniform System of Accounts defines AFUDC as \"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 recorded as a charge to construction work in progress, and the equivalent credits are to interest charges for the pre-tax cost of borrowed funds and to other income for the allowance for other funds. While AFUDC results in an increase in utility plant and represents current earnings, it is realized in cash through depreciation or amortization allowances only when the related plant is recognized in rates. On an aggregate composite basis, the annual rates utilized were as follows:\nGPU JCP&L Met-Ed Penelec\n1995 8.05% 8.04% 8.62% 7.78% 1994 6.45% 5.35% 7.31% 7.19% 1993 6.80% 7.80% 7.48% 4.91%\nAMORTIZATION POLICIES\nAccounting for TMI-2 and Forked River Investments:\nJCP&L is collecting annual revenues for the amortization of TMI-2 of $9.6 million. This level of revenue will be sufficient to recover the remaining investment by 2008. Met-Ed and Penelec have collected all of their\nGeneral Public Utilities Corporation and Subsidiary Companies\nTMI-2 investment attributable to retail customers. At December 31, 1995, $86 million is included in Unamortized Property Losses on the Balance Sheet for JCP&L's Forked River project. JCP&L is collecting annual revenues for the amortization of this project of $11.2 million, which will be sufficient to recover its remaining investment by the year 2006. Because the Subsidiaries have not been provided revenues for a return on the unamortized balances of the damaged TMI-2 facility and the cancelled Forked River project, these investments are being carried at their discounted present values. The related annual accretion, which represents the carrying charges that are accrued as the asset is written up from its discounted value, is recorded in Other Income\/(Expense), Net on the Income Statement.\nNuclear Fuel:\nNuclear fuel is amortized on a unit-of-production basis. Rates are determined and periodically revised to amortize the cost over the useful life.\nThe Subsidiaries have provided for future contributions to the Decontamination and Decommissioning Fund (part of the Energy Policy Act of 1992) for the cleanup of enrichment plants operated by the Federal Government. The total liability at December 31, 1995 amounted to $36 million (JCP&L, Met-Ed and Penelec's shares are $23 million, $9 million and $4 million, respectively) and is primarily reflected in Deferred Credits and Other Liabilities - Other. Utilities with nuclear plants will contribute annually, based on an assessment computed on prior enrichment purchases, over a 15-year period. The Subsidiaries made their initial payment to this fund in 1993, and they are recovering the remaining amounts through their fuel clauses. At December 31, 1995, $39 million (JCP&L, Met-Ed and Penelec's shares are $25 million, $9 million and $5 million, respectively) is recorded on the Balance Sheet in Regulatory Assets - Other.\nNUCLEAR OUTAGE MAINTENANCE COSTS The GPU System accrues incremental nuclear outage maintenance costs anticipated to be incurred during scheduled nuclear plant refueling outages.\nNUCLEAR FUEL DISPOSAL FEE The Subsidiaries are providing for estimated future disposal costs for spent nuclear fuel at Oyster Creek and TMI-1 in accordance with the Nuclear Waste Policy Act of 1982. The Subsidiaries entered into contracts in 1983 with the DOE for the disposal of spent nuclear fuel. The total liability under these contracts, including interest, at December 31, 1995, all of which relates to spent nuclear fuel from nuclear generation through April 1983, amounted to $162 million (JCP&L, Met-Ed and Penelec's shares are $121 million, $27 million and $14 million, respectively), and is reflected in Deferred Credits and Other Liabilities - Other. As the actual liability is substantially in excess of the amount recovered to date from ratepayers, the Subsidiaries have reflected such excess of $22 million (JCP&L, Met-Ed and Penelec's shares are $23 million, ($1) million and ($0.2) million, respectively) at December 31, 1995 in Regulatory Assets - Other. The rates\nGeneral Public Utilities Corporation and Subsidiary Companies\npresently charged to customers provide for the collection of these costs, plus interest, over remaining periods of 11 years for JCP&L and Met-Ed, and two years for Penelec.\nThe Subsidiaries are collecting one mill per kilowatt-hour from their customers for spent nuclear fuel disposal costs resulting from nuclear generation subsequent to April 1983. These amounts are remitted quarterly to the DOE.\nINCOME TAXES The GPU System companies file a consolidated federal income tax return. All participants are jointly and severally liable for the full amount of any tax, including penalties and interest, which may be assessed against the group. Each subsidiary is allocated the tax reduction attributable to GPU expenses, in proportion to the average common stock equity investment of GPU in such subsidiary, during the year. In addition, each subsidiary will receive in current cash payments the benefit of its own net operating loss carrybacks to the extent that the other subsidiaries can utilize such net operating loss carrybacks to offset the tax liability they would otherwise have on a separate return basis (after taking into account any investment tax credits they could utilize on a separate return basis). This method of allocation does not allow any subsidiary to pay more than its separate return liability.\nDeferred income taxes, which result primarily from liberalized depreciation methods, deferred energy costs, decommissioning funds and discounted Forked River and TMI-2 investments, are provided for differences between book and taxable income. Investment tax credits (ITC) are amortized over the estimated service lives of the related facilities.\nEffective January 1, 1993, the GPU System implemented Statement of Financial Accounting Standards No. 109 (FAS 109), \"Accounting for Income Taxes\" which requires the use of the liability method of financial accounting and reporting for income taxes. Under FAS 109, deferred income taxes reflect the impact of temporary differences between the amounts of assets and liabilities recognized for financial reporting purposes and the amounts recognized for tax purposes.\nSTATEMENTS OF CASH FLOWS For the purpose of the consolidated statements of cash flows, temporary investments include all unrestricted liquid assets, such as cash deposits and debt securities, with maturities generally of three months or less.\n3. SHORT-TERM BORROWING ARRANGEMENTS\nAt December 31, 1995 and 1994, the GPU System had $124 million and $347 million of short-term notes outstanding, respectively, of which $60 million in 1994 was commercial paper and the remainder was issued under bank lines of credit (credit facilities). The GPU System's weighted average interest rate\nGeneral Public Utilities Corporation and Subsidiary Companies\non short term borrowings was 5.9% and 6.2% at December 31, 1995 and 1994, respectively.\nThe GPU System has $529 million of credit facilities, which includes a Revolving Credit Agreement (Credit Agreement) with a consortium of banks. The credit facilities generally provide for the payment of a commitment fee on the unborrowed amount of 1\/8 of 1% annually. Borrowings under these credit facilities generally bear interest based on the prime rate or money market rates. Notes issued under the Credit Agreement, which expires November 1, 1999, are limited to $250 million in total borrowings outstanding at any time and subject to various covenants and acceleration under certain conditions. The Credit Agreement borrowing rates and facility fee are dependent on the long-term debt ratings of the Subsidiaries.\n4. LONG-TERM DEBT\nAt December 31, 1995, the GPU System had long-term debt outstanding, as follows:\nInterest Rates\n5.35% to 7% to 9% to Maturities 6.9% 8.85% 9.48% Total (In Thousands) First mortgage bonds: 1996-2005 $ 667,575 $ 514,191 $ 120,000 $1,301,766 2006-2015 177,120 118,500 - 295,620 2016-2025 253,500 645,000 50,000 948,500 Total $1,098,195 $1,277,691 $ 170,000 2,545,886\nAmounts due within one year (115,701) Total 2,430,185\nOther long-term debt (net of $5,545 due within one year) 141,429 Unamortized net discount (3,716) Total $2,567,898\nFor the years 1996, 1997, 1998, 1999 and 2000, the GPU System has long-term debt maturities of $121 million, $148 million, $140 million, $36 million and $126 million, respectively. Substantially all of the utility plant owned by the Subsidiaries is subject to the lien of their respective mortgages.\nGeneral Public Utilities Corporation and Subsidiary Companies\nThe estimated fair value of the GPU System's long-term debt, as of December 31, 1995 and 1994 was as follows:\n(In Thousands) Carrying Fair Amount Value\n1995 $2,567,898 $2,712,102 1994 $2,345,417 $2,142,854\nThe fair value of long-term debt is estimated based on the quoted market prices for the same or similar issues or on the current rates offered to the GPU System for debt of the same remaining maturities and credit qualities.\n5. SUBSIDIARY-OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES\nJCP&L Capital, L.P., Met-Ed Capital, L.P. and Penelec Capital, L.P., are special-purpose partnerships in which a subsidiary of JCP&L, Met-Ed and Penelec, respectively, is the sole general partner. The following issues of mandatorily redeemable preferred securities (Preferred Securities) were outstanding at December 31, 1995:\nIssue Securities Total Company Series Price Outstanding (In Thousands)\nJCP&L Capital 8.56% $25 5,000,000 $125,000 Met-Ed Capital 9.00% $25 4,000,000 100,000 Penelec Capital 8.75% $25 4,200,000 105,000 Total $330,000\nThe fair value of the Preferred Securities based on market price quotations at December 31, 1995 and 1994 is $106 million and $98 million, respectively, for Met-Ed Capital; $110 million and $101 million, respectively, for Penelec Capital; and $131 million for JCP&L Capital at December 31, 1995.\nIn 1995, JCP&L Capital, L.P. issued $125 million of Preferred Securities and in 1994, Met-Ed Capital, L.P. and Penelec Capital, L.P. issued $100 million and $105 million, respectively, of Preferred Securities. The proceeds from the sales of the Preferred Securities were then lent to JCP&L, Met-Ed and Penelec which, in turn, issued their deferrable interest subordinated debentures to the partnerships. JCP&L, Met-Ed and Penelec are taking tax deductions for the interest paid on the subordinated debentures.\nThe Preferred Securities of JCP&L Capital, L.P. mature in 2044, while those of Met-Ed Capital, L.P. and Penelec Capital, L.P. mature in 2043. The Preferred Securities are redeemable at the option of JCP&L beginning in 2000, and at the option of Met-Ed and Penelec beginning in 1999, at 100 percent of their principal amount, or earlier under certain limited circumstances, including the loss of the tax deduction for interest paid on the subordinated debentures. The partnerships' sole assets are the subordinated debentures. JCP&L, Met-Ed and Penelec have fully and unconditionally guaranteed payment of\nGeneral Public Utilities Corporation and Subsidiary Companies\ndistributions, to the extent there is sufficient cash on hand to permit such payments and legally available funds, and payments on liquidation or redemption of their respective partnerships' Preferred Securities. Distributions on the Preferred Securities (and interest on the subordinated debentures) may be deferred for up to 60 months, but JCP&L, Met-Ed and Penelec may not pay dividends or redeem or acquire any of their preferred or common stock until deferred payments on their respective subordinated debentures are paid in full.\n6. CAPITAL STOCK\nCOMMON STOCK The following table presents information relating to the common stock ($2.50 par value) of the Corporation:\n1995 1994\nAuthorized shares 350,000,000 150,000,000 Issued shares 125,783,338 125,783,338 Reacquired shares 5,359,997 10,575,086 Outstanding shares 120,423,341 115,208,252 Restricted units 195,499 107,063\nIn 1995 and 1993, the Corporation sold five million and four million additional shares of common stock, respectively, for net proceeds of $157.5 million and $128.7 million, respectively. The issuances resulted in credits to capital surplus totaling $71.9 million and $60.2 million, in 1995 and 1993 respectively. In 1995, 1994 and 1993, under the Corporation's Dividend Reinvestment Plan, capital surplus was credited $2.7 million, $2.3 million and $2.1 million, respectively, for shares sold. No shares of common stock were reacquired in 1995 or 1994.\nIn 1995 and 1994, pursuant to the 1990 Restricted Stock Plan, the Corporation issued to officers restricted units representing rights to receive shares of common stock, on a one-for-one basis, at the end of the vesting or restriction period. Beginning with units awarded in 1995, the units will be adjusted at the end of the vesting or restriction period based on the Corporation's performance over the restriction period. The shares issuable at the end of the vesting period could range from 0% to 200% of the originally issued units. The restricted units do not affect the issued and outstanding shares of common stock until conversion at the end of the restriction period. However, the restricted units are considered common stock equivalents and therefore are included in average common shares outstanding for the earnings per share computation on the income statement. The restricted units accrue dividends on a quarterly basis. In 1995 and 1994, the Corporation awarded to plan participants 83,600 and 34,595 restricted units, respectively. In 1995 and 1994, the Corporation issued a total of 30,558 and 6,275 shares, respectively, from previously reacquired shares.\nGeneral Public Utilities Corporation and Subsidiary Companies\nPREFERRED STOCK At December 31, 1995, the Subsidiaries had the following issues of cumulative preferred stock outstanding:\nStated Value Shares Stated Value Series per Share Outstanding (In Thousands)\nWith mandatory redemption: 7.52% $100 440,000 $ 44,000 8.48% $100 500,000 50,000 8.65% $100 500,000 50,000 Total 1,440,000 144,000 Securities due within one year (10,000) Total $134,000\nWithout mandatory redemption: 3.70% - 4.70% $100 723,912 $ 72,391 7.88% $100 250,000 25,000 Total 973,912 97,391 Premium 725 Total $ 98,116\nThe fair value of the preferred stock with mandatory redemption, based on market price quotations at December 31, 1995 and 1994, is $146.6 million and $140.1 million, respectively.\nThe 7.52% and 8.65% Series are callable at various prices above their stated values beginning in 2002 and 2000, respectively. The 7.52% Series is to be redeemed ratably over twenty years beginning in 1998. The 8.65% Series is to be redeemed ratably over six years beginning in 2000. The 8.48% Series is not callable and is to be redeemed ratably over five years beginning in 1996. The outstanding shares with mandatory redemption have aggregate redemption requirements of $65 million for the years 1996 through 2000.\nThe outstanding shares of preferred stock without mandatory redemption are callable at various prices above their stated values. At December 31, 1995, the aggregate amount at which these shares could be called by the Subsidiaries was $102 million.\nDuring 1995, JCP&L repurchased in the market 60,000 shares of its 7.52% cumulative preferred stock with mandatory redemption, with a stated value of $6 million. JCP&L's total cost of the redemption was $6.1 million, which resulted in a $.1 million charge to Retained Earnings.\nDuring 1994, Met-Ed and Penelec redeemed their 7.68% (aggregate stated value of $35 million) and 8.36% (aggregate stated value of $25 million) cumulative preferred stock, respectively. Met-Ed's total cost of the redemption was $36 million, which resulted in a $1.2 million charge to Retained Earnings. Penelec's total cost of the redemption was $26 million, resulting in a $1.1 million charge to Retained Earnings.\nGeneral Public Utilities Corporation and Subsidiary Companies\nDuring 1993, the Subsidiaries redeemed preferred stock as follows: JCP&L redeemed all of its outstanding 8.12% Series and 8% Series cumulative preferred stock (aggregate stated value of $50 million) at a total cost of $52.4 million. Met-Ed redeemed all of its outstanding 8.32% Series H, 8.32% Series J, 8.12% Series I and its 8.12% cumulative preferred stock (aggregate stated value of $81 million) at a total cost of $85.3 million. Penelec redeemed all of its outstanding 8.12% Series I cumulative preferred stock (aggregate stated value of $25 million) at a total cost of $26 million. These redemptions resulted in a net $6.9 million charge to Retained Earnings.\nAt December 31, 1995 and 1994, the Subsidiaries were authorized to issue 37,035,000 shares of cumulative preferred stock. If dividends on any of the preferred stock of any of the Subsidiaries are in arrears for four quarters, the holders of preferred stock, voting as a class, are entitled to elect a majority of the board of directors of that Subsidiary until all dividends in arrears have been paid. A Subsidiary may not redeem preferred stock unless dividends on all of that Subsidiary's preferred stock for all past quarterly dividend periods have been paid or declared and set aside for payment.\n7. INCOME TAXES\nEffective January 1, 1993, the GPU System implemented FAS 109, \"Accounting for Income Taxes.\" The cumulative effect of this accounting change on net income was immaterial. As of December 31, 1995 and 1994, the balance sheet reflected $528 million and $562 million, respectively, of income taxes recoverable through future rates (primarily related to liberalized depreciation), and a regulatory liability for income taxes refundable through future rates of $95 million and $106 million, respectively (related to unamortized ITC), substantially due to the recognition of amounts not previously recorded.\nGeneral Public Utilities Corporation and Subsidiary Companies\nA summary of the components of deferred taxes as of December 31, 1995 and 1994 is as follows:\n(In Millions)\nDeferred Tax Assets Deferred Tax Liabilities\n1995 1994 1995 1994 Current: Current: Unbilled revenue $ 23 $ 16 Revenue taxes $ 16 $ 18 Other 4 2 Deferred energy 7 4 Total $ 27 $ 18 Total $ 23 $ 22\nNoncurrent: Noncurrent: Unamortized ITC $ 95 $106 Liberalized Decommissioning 62 131 depreciation: Contribution in aid previously flowed of construction 23 25 through $ 301 $ 333 Other 150 167 future revenue Total $330 $429 requirements 209 229 Subtotal 510 562 Liberalized depreciation 817 767 Forked River 11 54 Other 128 56 Total $1,466 $1,439\nThe reconciliations from net income to book income subject to tax and from the federal statutory rate to combined federal and state effective tax rates are as follows: (In Millions) 1995 1994 1993\nNet income $440 $164 $296 Preferred stock dividends 17 21 29 Income tax expense 265 86 197 Book income subject to tax $722 $271 $522\nFederal statutory rate 35% 35% 35% State tax, net of federal benefit 4 - 4 Other (2) (3) (1) Effective income tax rate 37% 32% 38%\nGeneral Public Utilities Corporation and Subsidiary Companies\nFederal and state income tax expense is comprised of the following:\n(In Millions) 1995 1994 1993 Provisions for taxes currently payable $154 $162 $127\nDeferred income taxes: Liberalized depreciation 31 31 32 New Jersey revenue tax (2) 32 32 Deferral of energy costs 1 12 6 Accretion income 5 11 7 Decommissioning 71 (76) - VERP 24 (51) - Other (8) (21) 5 Deferred income taxes, net 122 (62) 82 Amortization of ITC, net (11) (14) (12) Income tax expense $265 $ 86 $197\nIn 1994, the GPU System and the Internal Revenue Service (IRS) reached an agreement to settle the Corporation's claim for 1986 that TMI-2 has been retired for tax purposes. The Corporation's Subsidiaries have received net refunds totaling $17 million, which have been credited to their customers. Also in 1994, the GPU System received net interest from the IRS totaling $46 million (before income taxes), associated with the refund settlement, which was credited to income. The IRS has completed its examinations of the GPU System's federal income tax returns through 1989. The years 1990 through 1992 are currently being audited.\n8. SUPPLEMENTARY INCOME STATEMENT INFORMATION\nMaintenance expense and other taxes charged to operating expenses consisted of the following:\n(In Millions) 1995 1994 1993\nMaintenance $253 $271 $275 Other taxes: New Jersey unit tax $209 $204 $202 Pennsylvania state gross receipts 74 70 68 Real estate and personal property 23 21 21 Other 43 54 53 Total $349 $349 $344\nGeneral Public Utilities Corporation and Subsidiary Companies\n9. EMPLOYEE BENEFITS\nPension Plans:\nThe GPU System maintains defined benefit pension plans covering substantially all employees. The GPU System's policy is to currently fund net pension costs within the deduction limits permitted by the Internal Revenue Code.\nA summary of the components of net periodic pension cost follows:\n(In Millions) 1995 1994 1993 Service cost-benefits earned during the period $ 30.0 $ 34.8 $ 28.6 Interest cost on projected benefit obligation 109.8 95.4 91.8 Less: Expected return on plan assets (112.9) (104.4) (96.6) Amortization (1.4) (1.4) (2.2) Net periodic pension cost $ 25.5 $ 24.4 $ 21.6\nThe above 1994 amounts do not include a pre-tax charge to earnings of $97 million resulting from the Voluntary Enhanced Retirement Programs (VERP).\nThe actual return on the plans' assets for the years 1995, 1994 and 1993 were gains of $322.0 million, $13.8 million and $145.9 million, respectively.\nThe funded status of the plans and related assumptions at December 31, 1995 and 1994 were as follows: (In Millions) 1995 1994 Accumulated benefit obligation (ABO): Vested benefits $ 1,172.8 $ 1,118.2 Nonvested benefits 133.7 120.5 Total ABO 1,306.5 1,238.7 Effect of future compensation levels 237.7 182.6 Projected benefit obligation (PBO) $ 1,544.2 $ 1,421.3\nPlan assets at fair value $ 1,596.1 $ 1,279.9 PBO (1,544.2) (1,421.3) Plan assets in excess of (less than) PBO 51.9 (141.4) Less: Unrecognized net (gain) loss (64.9) 72.5 Unrecognized prior service cost (credit) 5.2 (0.6) Unrecognized net transition asset (5.8) (6.6) Adjustment required to recognize minimum liability (0.2) (1.2)\nAccrued pension liability $ (13.8) $ (77.3)\nPrincipal actuarial assumptions (%): Annual long-term rate of return on plan assets 8.5 8.5 Discount rate 7.5 8.0 Annual increase in compensation levels 5.5 6.0\nGeneral Public Utilities Corporation and Subsidiary Companies\nIn 1995, changes in assumptions, primarily the decrease in the discount rate assumption from 8% to 7.5%, resulted in a $67 million increase in the PBO as of December 31, 1995. The assets of the plans are held in a Master Trust and generally invested in common stocks and fixed income securities. The unrecognized net loss represents actual experience different from that assumed, which is deferred and not included in the determination of pension cost until it exceeds certain levels. Both the unrecognized prior service cost resulting from retroactive changes in benefits and the unrecognized net transition asset arising out of the adoption of Statement of Financial Accounting Standards No. 87, \"Employers' Accounting for Pensions,\" are being amortized to pension cost over the average remaining service periods for covered employees.\nAt December 31, 1995 and 1994, GPUSC had accumulated pension obligations in excess of amounts accrued; as a result, additional minimum liabilities in the amounts of $.1 million and $.7 million, net of deferred income taxes of $.1 million and $.5 million, respectively, are reflected as reductions in Retained Earnings.\nSavings Plans:\nThe GPU System also maintains savings plans for substantially all employees. These plans provide for employee contributions up to specified limits. The GPU System's savings plans provide for various levels of matching contributions. The matching contributions for the GPU System for 1995, 1994 and 1993 were $13.4 million, $12.7 million and $12.2 million, respectively.\nPostretirement Benefits Other Than Pensions:\nThe GPU System provides certain retiree health care and life insurance benefits for substantially all employees who reach retirement age while working for the GPU System. Health care benefits are administered by various organizations. A portion of the costs are borne by the participants. Effective January 1, 1993, the GPU System adopted Statement of Financial Accounting Standards No. 106 (FAS 106), \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" FAS 106 requires that the estimated cost of these benefits, which are primarily for health care, be accrued during the employee's active working career. The GPU System has elected to amortize the unfunded transition obligation existing at January 1, 1993 over a period of 20 years. The unrecognized net loss represents actual experience different from that assumed, which is deferred and not included in the determination of postretirement benefit cost until it exceeds certain levels. The unrecognized prior service cost resulting from retroactive changes in benefits is being amortized to postretirement benefit cost over the average remaining service periods for covered employees.\nGeneral Public Utilities Corporation and Subsidiary Companies\nA summary of the components of the net periodic postretirement benefit cost for 1995, 1994 and 1993 follows:\n(In Millions) 1995 1994 1993 Service cost-benefits attributed to service during the period $ 13.4 $ 14.6 $ 12.5 Interest cost on the accumulated postretirement benefit obligation 43.4 37.0 34.3 Expected return on plan assets (11.0) (7.0) (3.4) Amortization of transition obligation 17.4 18.1 18.1 Other amortization, net 1.3 2.1 - Net periodic postretirement benefit cost 64.5 64.8 61.5 Less, deferred for future recovery (15.0) (15.8) (27.5) Postretirement benefit cost, net of deferrals $ 49.5 $ 49.0 $ 34.0\nThe above 1994 amounts do not include a pre-tax charge to earnings of $30 million relating to the VERP.\nThe actual return on the plans' assets for the years 1995, 1994 and 1993 was a gain of $27.9 million, $2.3 million and $3.9 million, respectively.\nThe funded status of the plans at December 31, 1995 and 1994, was as follows:\n(In Millions) 1995 1994 Accumulated Postretirement Benefit Obligation: Retirees $ 361.6 $ 291.7 Fully eligible active plan participants 32.4 67.2 Other active plan participants 232.4 197.6 Total accumulated postretirement benefit obligation (APBO) $ 626.4 $ 556.5\nAPBO $(626.4) $(556.5) Plan assets at fair value 191.3 129.0 APBO in excess of plan assets (435.1) (427.5) Less: Unrecognized net loss 65.0 46.9 Unrecognized prior service cost 2.3 2.5 Unrecognized transition obligation 295.9 313.3 Accrued postretirement benefit liability $ (71.9) $ (64.8)\nPrincipal actuarial assumptions (%): Annual long-term rate of return on plan assets 8.5 8.5 Discount rate 7.5 8.0\nThe GPU System intends to continue funding amounts for postretirement benefits with an independent trustee, as deemed appropriate from time to time. The plan assets include equities and fixed income securities.\nGeneral Public Utilities Corporation and Subsidiary Companies\nIn 1995, the decrease in the health-care cost trend rate assumptions resulted in a $51 million decrease in the APBO, which was partially offset by an increase of $42 million in the APBO caused by the decrease in the discount rate assumption from 8% to 7.5%. The accumulated postretirement benefits obligation was determined by application of the terms of the medical and life insurance plans, including the effects of established maximums on covered costs, together with relevant actuarial assumptions and health-care cost trend rates of 12% for those not eligible for Medicare and 9% for those eligible for Medicare, then decreasing gradually to 6% in 2000 and thereafter. These costs also reflect the implementation of a cost cap of 6% for individuals who retire after December 31, 1995 and reach age 65. The effect of a 1% annual increase in these assumed cost trend rates would increase the accumulated postretirement benefit obligation by approximately $65 million as of December 31, 1995 and the aggregate of the service and interest cost components of net periodic postretirement health-care cost by approximately $8 million.\nIn JCP&L's 1993 base rate proceeding, the NJBPU allowed JCP&L to collect $3 million annually of the incremental postretirement benefit costs, charged to expense, recognized as a result of FAS 106. Based on the final order and in accordance with Emerging Issues Task Force (EITF) Issue 92-12, \"Accounting for OPEB Costs by Rate-Regulated Enterprises,\" JCP&L is deferring the amounts above that level. Met-Ed is deferring the incremental postretirement benefit costs, charged to expense, associated with the adoption of FAS 106 and in accordance with EITF Issue 92-12, as authorized by the PaPUC in its 1993 base rate order.\nIn 1994, the Pennsylvania Commonwealth Court reversed a PaPUC order that allowed a nonaffiliated utility, outside a base rate proceeding, to defer certain incremental postretirement benefit costs for future recovery from customers. As a result of the Court's decision, in 1994, Penelec determined that its FAS 106 costs, including costs deferred since January 1993, were not likely to be recovered and charged $18.8 million to expense. In addition, $4 million of Penelec's unrecognized transition obligation resulting from employees who elected to participate in the VERP was also written off in 1994. In 1995, Penelec recorded a charge to income of approximately $9 million, which represents continued amortization of the transition obligation along with current accruals of FAS 106 expense for active employees.\n10. JOINTLY OWNED STATIONS\nEach participant in a jointly owned station finances its portion of the investment and charges its share of operating expenses to the appropriate expense accounts. The Subsidiaries participated with nonaffiliated utilities in the following jointly owned stations at December 31, 1995:\nGeneral Public Utilities Corporation and Subsidiary Companies\nBalance (In Millions) % Accumulated Station Owner Ownership Investment Depreciation\nHomer City Penelec 50 $458.2 $161.6 Conemaugh Met-Ed 16.45 144.3 34.3 Keystone JCP&L 16.67 91.4 21.9 Yards Creek JCP&L 50 28.9 7.4 Seneca Penelec 20 16.4 4.8\n11. LEASES\nThe GPU System's capital leases consist primarily of leases for nuclear fuel. Nuclear fuel capital leases at December 31, 1995 and 1994 totaled $152 million and $148 million, respectively (net of amortization of $189 million and $112 million, respectively). The recording of capital leases has no effect on net income because all leases, for ratemaking purposes, are considered operating leases.\nThe Subsidiaries have nuclear fuel lease agreements with nonaffiliated fuel trusts. In 1995, the Subsidiaries refinanced the Oyster Creek and TMI-1 nuclear fuel leases to provide for aggregate borrowings of up to $210 million ($100 million for Oyster Creek and $110 million for TMI-1) outstanding at any one time. Reductions in nuclear fuel financing costs are expected through the new credit facilities. It is contemplated that when consumed, portions of the presently leased material will be replaced by additional leased material. The Subsidiaries are responsible for the disposal costs of nuclear fuel leased under these agreements. These nuclear fuel leases have initial terms of three years expiring in November 1998, and are renewable annually thereafter at the lender's option for a period up to 20 years. Subject to certain conditions of termination, the Subsidiaries are required to purchase all nuclear fuel then under lease at a price that will allow the lessor to recover its net investment. Lease expense consists of an amount designed to amortize the cost of the nuclear fuel as consumed plus interest costs. For the years ended December 31, 1995, 1994 and 1993, these amounts were $57 million, $50 million and $66 million, respectively.\nJCP&L and Met-Ed have sold and leased back substantially all of their respective ownership interests in the Merrill Creek Reservoir project. The minimum lease payments under these operating leases, which have remaining terms of 37 years, average approximately $3 million annually for each company.\nJersey Central Power & Light Company and Subsidiary Company\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS The Company's earnings in 1995 were $184.6 million, compared to 1994 earnings of $148 million. Contributing to this earnings increase were higher new customer sales, partially offset by lower weather-related sales; and lower other operation and maintenance expenses (O&M) due primarily to a $30.4 million (after-tax) charge in 1994 for early retirement programs. Also in 1994, the Company recognized net interest income of $7.4 million (after-tax) resulting from refunds of previously paid federal income taxes related to the tax retirement of Three Mile Island Unit 2 (TMI-2).\nThe Company's return on average common equity was 13.1% in 1995 compared to 11.2% in 1994.\nEarnings in 1994 were $148 million, compared to 1993 earnings of $141.5 million. This earnings increase was due principally to higher new customer sales, colder winter weather in 1994, and an increase in revenues resulting from a February 1993 retail base rate case. Also contributing to this earnings increase were reduced reserve capacity expense, net interest income of $7.4 million (after-tax) related to the TMI-2 tax refunds, and a performance award for the operation of the Company's nuclear generating stations. Partially offsetting these increases were a charge of $30.4 million (after-tax) related to the 1994 early retirement programs and increased O&M expenses, which included higher emergency and winter storm repairs.\nOPERATING REVENUES: Operating revenues increased 4.3% to $2.04 billion in 1995 after increasing 0.9% to $1.95 billion in 1994. The components of these changes are as follows:\n(In Millions) 1995 1994\nKilowatt-hour (KWH) revenues (excluding energy portion) $ 11.4 $ 21.5 Rate increase - 20.8 Energy revenues 72.3 (31.0) Other revenues (0.2) 5.2 Increase in revenues $ 83.5 $ 16.5\nKilowatt-hour revenues\nThe increase in KWH revenues was due to increases in new residential and commercial customer sales, partially offset by lower weather-related sales.\nJersey Central Power & Light Company and Subsidiary Company\nThe increase in KWH revenues was due to increases in new residential and commercial customer sales, and colder winter weather as compared to the previous year.\n1995 MWH Customer Sales by Service Class\nResidential 41% Commercial 38% Industrial\/Other 21%\nEnergy revenues\n1995 and 1994 Changes in energy revenues do not affect earnings as they reflect corresponding changes in the energy cost rates billed to customers and expensed. Energy revenues in 1995 increased primarily from additional sales to other utilities and higher energy cost rates.\nOther revenues\n1995 and 1994 Generally, changes in other revenues do not affect earnings as they are offset by corresponding changes in expense, such as taxes other than income taxes.\nOPERATING EXPENSES: Power purchased and interchanged\n1995 and 1994 The increase in power purchased and interchanged (PP&I) expense was due largely to higher nonutility generation purchases.\nGenerally, changes in the energy component of PP&I expense do not significantly affect earnings since these cost increases are substantially recovered through the Company's energy adjustment clause. However, 1995 earnings were negatively affected by higher reserve capacity expense (which is a component of PP&I) resulting primarily from a Pennsylvania-New Jersey- Maryland (PJM Power Pool) prior year adjustment and one-time net charges of $3.6 million (pre-tax) from another utility. Earnings in 1994 benefitted from lower reserve capacity expense resulting primarily from the expiration of a power purchase contract with another utility and a reduction in purchases from affiliated companies.\nFuel and Deferral of energy and capacity costs, net\n1995 and 1994 Generally, changes in fuel expense and deferral of energy costs do not affect earnings as they are offset by corresponding changes in energy revenues.\nJersey Central Power & Light Company and Subsidiary Company\nOther operation and maintenance\n1995 and 1994 The decrease in other O&M expense was due primarily to a $46.9 million (pre-tax) charge in 1994 related to the early retirement programs and lower 1995 winter storm repairs.\nThe increase in other O&M expense was primarily attributable to a $46.9 million (pre-tax) charge for the early retirement programs. Also contributing to the increase were higher emergency and winter storm repairs and the accrual of additional payroll expense under an expanded employee incentive compensation program designed to tie pay increases more closely to business results and enhance productivity.\nDepreciation and amortization\nThe increase in depreciation and amortization expense was due to additions to plant in service, partially offset by lower regulatory asset amortizations.\nDepreciation and amortization expense increased due to additions to plant in service and higher regulatory asset amortizations.\nTaxes, other than income taxes\n1995 and 1994 Generally, changes in taxes other than income taxes do not significantly affect earnings as they are substantially recovered in revenues.\nOTHER INCOME AND DEDUCTIONS: Other income, net\n1995 and 1994 In 1994, the Company recorded interest income of $14.7 million (pre-tax) resulting from refunds of previously paid federal income taxes related to the tax retirement of TMI-2. Also in 1994, there was a write-off of $4.2 million (pre-tax) for a cancelled project.\nINTEREST CHARGES AND PREFERRED DIVIDENDS: Other interest\n1995 and 1994 In 1994, the Company recognized interest expense related to the tax retirement of TMI-2. The tax retirement of TMI-2 resulted in a $3.3 million (pre-tax) charge to interest expense on additional amounts owed for tax years in which depreciation deductions with respect to TMI-2 had been taken.\nJersey Central Power & Light Company and Subsidiary Company\nDividends on company-obligated mandatorily redeemable preferred securities\nThrough a special-purpose partnership, the Company issued $125 million stated value of mandatorily redeemable preferred securities.\nLIQUIDITY AND CAPITAL RESOURCES Capital Needs:\nThe Company's capital needs were $265 million in 1995, consisting of cash construction expenditures of $218 million and amounts for maturing obligations of $47 million.\nDuring 1995, construction expenditures were used primarily to maintain and improve existing generation, transmission and distribution facilities, continue with the construction of a new generation facility, and for various clean air compliance projects. In 1996, construction expenditures for the Company are estimated to be $256 million, consisting primarily of $202 million for ongoing system development, $26 million for upgrading the communication system, and $15 million for the continued construction of a new generation facility. Expenditures for maturing obligations will total $36 million in 1996, and $86 million in 1997. Management estimates that approximately three- fourths of the Company's 1996 capital needs will be satisfied through internally generated funds.\nCash Construction Expenditures (In millions of dollars) 1991 1992 1993 1994 1995 1996 $242 $219 $197 $244 $218 $256*\n* Estimate\nThe Company and its affiliates' capital leases consist primarily of leases for nuclear fuel. The Company's share of nuclear fuel capital leases at December 31, 1995 totaled $88 million. In 1995, the Company and its affiliates refinanced the Oyster Creek and TMI-1 nuclear fuel leases to provide for aggregate borrowings of up to $210 million ($100 million for Oyster Creek and $110 million for TMI-1) outstanding at any one time. These nuclear fuel leases have initial terms of three years expiring in November 1998, and are renewable annually thereafter at the lender's option for a period up to 20 years. When consumed, portions of the presently leased material will be replaced by additional leased material at a rate of between $20 million and $25 million annually. In the event the needed nuclear fuel cannot be leased, the associated capital requirements would have to be met by other means.\nFinancing:\nIn 1995, GPU sold five million shares of common stock. The net proceeds of $157.5 million were used to make cash capital contributions to the GPU\nJersey Central Power & Light Company and Subsidiary Company\nSystem, of which the Company's share was $75 million, and to repay GPU short- term debt.\nThe Company has regulatory authority to issue and sell first mortgage bonds (FMBs), which may be issued as secured medium-term notes, and preferred stock through June 1997. Under existing authorizations, the Company may issue these senior securities in the amount of up to $225 million, of which $100 million may consist of preferred stock. The Company also has regulatory authority to incur short-term debt, a portion of which may be through the issuance of commercial paper.\nIn 1995, the Company issued $50 million principal amount of FMBs, the proceeds of which were used to moderate short-term debt levels. JCP&L Capital L.P., a special-purpose partnership in which a subsidiary of the Company is the sole general partner, issued $125 million stated value of mandatorily redeemable preferred securities (carried on the balance sheet as Company- obligated mandatorily redeemable preferred securities). The proceeds from the issuance were used to reduce short-term debt and retire senior securities. Also in 1995, the Company repurchased, in the market, $6 million stated value of cumulative preferred stock. The repurchased shares may be used to satisfy future sinking fund requirements.\nThe Company's FMB indenture and certificate of incorporation include provisions that limit the amount of long-term debt, preferred stock and short- term debt the Company may issue. The Company's interest and preferred dividend coverage ratios are currently in excess of indenture and charter restrictions.\nThe Company's cost of capital and ability to obtain external financing are affected by its security ratings, which are periodically reviewed by the three major credit rating agencies. The Company's senior securities ratings have remained constant since August 1994. The Company's FMBs are currently rated at an equivalent of BBB+ by the three major credit rating agencies, while the preferred stock and mandatorily redeemable preferred securities issues have been assigned an equivalent of BBB. In addition, the Company's commercial paper is rated as having good credit quality.\nThe Standard & Poor's (S&P) rating outlook for the Company has remained at \"stable,\" and reflects a manageable construction program, minimal rate relief requirements and expectations of modest strengthening in the service area economy. The rating outlook is used to assess the potential direction of an issuer's long-term debt rating over the intermediate to longer-term. The S&P business position assigned to the Company has remained unchanged throughout the year at \"low average\". The business position is a financial benchmarking standard for rating the debt of electric utilities to reflect the changing risk profiles resulting primarily from the intensifying competitive pressures in the industry.\nThe Company may issue long-term debt during the next three years to finance construction activities, fund the redemption of maturing senior securities, and depending on interest rates, refinance outstanding senior securities.\nJersey Central Power & Light Company and Subsidiary Company\nCapitalization:\nThe Company's target capitalization ratios are designed to provide credit quality ratings that permit capital market access at reasonable costs. The targets and actual capitalization ratios are as follows:\nTarget Range 1995 1994 1993 Common equity 48-51% 49% 47% 47% Preferred equity 8-10 10 7 7 Notes payable and long-term debt 44-39 41 46 46 100% 100% 100% 100%\nThe following remaining sections of MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS are being presented on a combined basis, and are included in the GPU section of this Form 10-K.\nCOMPETITIVE ENVIRONMENT: See GPU page.\nRecent Regulatory Actions: See GPU page.\nManaging the Transition: See GPU pages.\nNonutility Generation Agreements: See GPU page.\nTHE GPU SUPPLY PLAN: See GPU page.\nNew Energy Supplies: See GPU page.\nManaging Nonutility Generation: See GPU page.\nENVIRONMENTAL ISSUES: See GPU pages.\nLEGAL MATTERS - TMI-2 ACCIDENT CLAIMS: See GPU page.\nEFFECTS OF INFLATION: See GPU page.\nJersey Central Power & Light Company and Subsidiary Company\nQUARTERLY FINANCIAL DATA (Unaudited)\nIn Thousands\nFirst Quarter Second Quarter 1995 1994* 1995 1994**\nOperating revenues $468,034 $486,910 $453,081 $458,897\nOperating income 57,227 71,521 61,834 29,270\nNet income 36,211 53,097 36,796 5,175\nEarnings available for common stock 32,512 49,398 33,210 1,476\nIn Thousands\nThird Quarter Fourth Quarter 1995 1994 1995 1994\nOperating revenues $625,479 $567,827 $489,334 $438,791\nOperating income 119,457 99,304 52,702 54,183\nNet income 95,447 74,573 30,635 29,996\nEarnings available for common stock 91,861 70,875 27,049 26,297\n* Results for the first quarter of 1994 reflect an increase in earnings of $7.4 million (after-tax) resulting from net interest income on refunds of previously paid federal income taxes related to the tax retirement of TMI-2.\n** Results for the second quarter of 1994 reflect a decrease in earnings of $30.4 million (after-tax) for costs related to early retirement programs.\nJersey Central Power & Light Company and Subsidiary Company\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors Jersey Central Power & Light Company Morristown, New Jersey\nWe have audited the consolidated financial statements and financial statement schedule of Jersey Central Power & Light Company and Subsidiary Company as listed in the index 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 financial statement schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. These standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Jersey Central Power & Light Company and Subsidiary Company as of December 31, 1995 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, 1995 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 consolidated financial statements taken as a whole, presents fairly, in all material respects, the information required to be included therein.\nCOOPERS & LYBRAND L.L.P.\nNew York, New York January 31, 1996\nJersey Central Power & Light Company and Subsidiary Company\nCONSOLIDATED STATEMENTS OF INCOME\n(In Thousands) For the Years Ended December 31, 1995 1994 1993\nOperating Revenues $2,035,928 $1,952,425 $1,935,909\nOperating Expenses: Fuel 101,110 94,503 98,683 Power purchased and interchanged: Affiliates 17,950 18,661 23,681 Others 642,858 579,948 578,131 Deferral of energy and capacity costs, net (5,949) (19,448) 28,726 Other operation and maintenance 475,448 526,623 460,128 Depreciation and amortization 194,976 191,042 182,945 Taxes, other than income taxes 226,994 231,070 228,690 Total operating expenses 1,653,387 1,622,399 1,600,984\nOperating Income Before Income Taxes 382,541 330,026 334,925 Income taxes 91,321 75,748 77,995 Operating Income 291,220 254,278 256,930\nOther Income and Deductions: Allowance for other funds used during construction 1,803 893 2,471 Other income, net 14,889 21,995 6,281 Income taxes (5,905) (9,372) (2,847) Total other income and deductions 10,787 13,516 5,905\nIncome Before Interest Charges and Dividends on Preferred Securities 302,007 267,794 262,835\nInterest Charges and Dividends on Preferred Securities: Interest on long-term debt 92,602 93,477 100,246 Other interest 9,709 14,726 6,530 Allowance for borrowed funds used during construction (6,021) (3,250) (2,285) Dividends on company-obligated mandatorily redeemable preferred securities 6,628 - - Total interest charges and dividends on preferred securities 102,918 104,953 104,491\nNet Income 199,089 162,841 158,344 Preferred stock dividends 14,457 14,795 16,810 Earnings Available for Common Stock $ 184,632 $ 148,046 $ 141,534\nThe accompanying notes are an integral part of the consolidated financial statements.\nJersey Central Power & Light Company and Subsidiary Company\nCONSOLIDATED BALANCE SHEETS\n(In Thousands) December 31, 1995 1994\nASSETS Utility Plant: In service, at original cost $4,311,458 $4,119,617 Less, accumulated depreciation 1,669,893 1,499,405 Net utility plant in service 2,641,565 2,620,212 Construction work in progress 157,885 136,884 Other, net 111,023 123,349 Net utility plant 2,910,473 2,880,445\nOther Property and Investments: Nuclear decommissioning trusts 225,200 165,511 Nuclear fuel disposal fund 95,393 82,920 Other, net 7,218 6,906 Total other property and investments 327,811 255,337\nCurrent Assets: Cash and temporary cash investments 922 1,041 Special deposits 7,358 4,608 Accounts receivable: Customers, net 150,002 126,760 Other 21,912 16,936 Unbilled revenues 66,389 59,288 Materials and supplies, at average cost or less: Construction and maintenance 95,949 95,937 Fuel 18,693 18,563 Deferred energy costs 5,290 (148) Deferred income taxes 12,142 10,454 Prepayments 20,869 45,880 Total current assets 399,526 379,319\nDeferred Debits and Other Assets: Regulatory assets: Three Mile Island Unit 2 deferred costs 138,472 138,294 Unamortized property losses 100,176 104,451 Income taxes recoverable through future rates 134,787 132,642 Other 311,293 309,230 Total regulatory assets 684,728 684,617 Deferred income taxes 122,082 122,944 Other 20,359 13,978 Total deferred debits and other assets 827,169 821,539\nTotal Assets $4,464,979 $4,336,640\nThe accompanying notes are an integral part of the consolidated financial statements.\nJersey Central Power & Light Company and Subsidiary Company\nCONSOLIDATED BALANCE SHEETS\n(In Thousands) December 31, 1995 1994\nLIABILITIES AND CAPITAL Capitalization: Common stock $ 153,713 $ 153,713 Capital surplus 510,769 435,715 Retained earnings 816,770 772,240 Total common stockholder's equity 1,481,252 1,361,668 Cumulative preferred stock: With mandatory redemption 134,000 150,000 Without mandatory redemption 37,741 37,741 Company-obligated mandatorily redeemable preferred securities 125,000 - Long-term debt 1,192,945 1,168,444 Total capitalization 2,970,938 2,717,853\nCurrent Liabilities: Securities due within one year 35,710 47,439 Notes payable 800 110,356 Obligations under capital leases 90,329 102,059 Accounts payable: Affiliates 31,885 34,283 Other 111,225 118,369 Taxes accrued 10,516 22,561 Interest accrued 28,718 29,765 Other 75,069 75,159 Total current liabilities 384,252 539,991\nDeferred Credits and Other Liabilities: Deferred income taxes 607,188 598,843 Unamortized investment tax credits 66,874 72,928 Three Mile Island Unit 2 future costs 103,271 85,273 Nuclear Fuel Disposal Fee 121,121 114,374 Regulatory liabilities 37,597 41,732 Other 173,738 165,646 Total deferred credits and other liabilities 1,109,789 1,078,796\nCommitments and Contingencies (Note 1)\nTotal Liabilities and Capital $4,464,979 $4,336,640\nThe accompanying notes are an integral part of the consolidated financial statements.\nJersey Central Power & Light Company and Subsidiary Company\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nJersey Central Power & Light Company (the Company), which was incorporated under the laws of New Jersey in 1925, is a wholly-owned subsidiary of General Public Utilities Corporation (GPU), a holding company registered under the Public Utility Holding Company Act of 1935. The Company's business is the generation, transmission, distribution and sale of electricity. The Company owns all of the common stock of JCP&L Preferred Capital, Inc., which is the sole general partner of JCP&L Capital L.P., a special-purpose partnership. The Company is affiliated with Metropolitan Edison Company (Met-Ed) and Pennsylvania Electric Company (Penelec). The Company, Met-Ed and Penelec are referred to herein as the \"Company and its affiliates.\" The Company is also affiliated with GPU Service Corporation (GPUSC), a service company; GPU Nuclear Corporation (GPUN), which operates and maintains the nuclear units of the Company and its affiliates; and Energy Initiatives, Inc., EI Power, Inc., and EI Energy, Inc. (collectively, the \"EI Group\"), which develop, own and operate generation, transmission and distribution facilities in the United States and in foreign countries. All of the Company's affiliates are wholly-owned subsidiaries of GPU. The Company and its affiliates, as well as GPUSC, GPUN and the EI Group, are referred to herein as the \"GPU System.\"\nNote 1, \"Commitments and Contingencies,\" and Note 2, \"Summary of Significant Accounting Policies,\" are being presented for GPU, the Company and its affiliates on a combined basis and are included in the GPU section of this Form 10-K.\nNote 1 - Commitments and Contingencies: See GPU page.\nNuclear Facilities: See GPU page.\nNuclear Plant Retirement Costs: See GPU page.\nInsurance: See GPU page.\nCompetition and the Changing Regulatory Environment: See GPU page.\nEnvironmental Matters: See GPU page.\nOther Commitments and Contingencies: See GPU page.\nNote 2 - Summary of Significant Accounting Policies: See GPU page.\nJersey Central Power & Light Company and Subsidiary Company\n3. SHORT-TERM BORROWING ARRANGEMENTS\nAt December 31, 1995 and 1994, the Company had $1 million and $110 million of short-term notes outstanding, respectively, of which $33 million in 1994 was commercial paper and the remainder was issued under bank lines of credit (credit facilities). The Company's weighted average interest rate on short term borrowings was 6% and 6.2% at December 31, 1995 and 1994, respectively.\nGPU and the Company and its affiliates have $529 million of credit facilities, which includes a Revolving Credit Agreement (Credit Agreement) with a consortium of banks. The credit facilities generally provide for the payment of a commitment fee on the unborrowed amount of 1\/8 of 1% annually. Borrowings under these credit facilities generally bear interest based on the prime rate or money market rates. Notes issued under the Credit Agreement, which expires November 1, 1999, are limited to $250 million in total borrowings outstanding at any time and subject to various covenants and acceleration under certain conditions. The Credit Agreement borrowing rates and facility fee are dependent on the long-term debt ratings of the Company and its affiliates.\n4. FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe estimated fair values of the Company's financial instruments, as of December 31, 1995 and 1994, are as follows:\n(In Millions) Carrying Fair Amount Value December 31, 1995: Cumulative preferred stock with mandatory redemption $ 134 $ 147 Company-obligated mandatorily redeemable preferred securities 125 131 Long-term debt 1,193 1,261\nDecember 31, 1994: Cumulative preferred stock with mandatory redemption $ 150 $ 140 Long-term debt 1,168 1,051\nThe fair values of the Company's financial instruments are estimated based on the quoted market prices for the same or similar issues or on the current rates offered to the Company for instruments of the same remaining maturities and credit qualities.\n5. INCOME TAXES\nEffective January 1, 1993, the Company implemented FAS 109, \"Accounting for Income Taxes.\" The cumulative effect of this accounting change on net\nJersey Central Power & Light Company and Subsidiary Company\nincome was immaterial. As of December 31, 1995 and 1994, the balance sheet reflected $135 million and $132 million, respectively, of income taxes recoverable through future rates (primarily related to liberalized depreciation), and a regulatory liability for income taxes refundable through future rates of $36 million and $40 million, respectively (related to unamortized ITC), substantially due to the recognition of amounts not previously recorded.\nA summary of the components of deferred taxes as of December 31, 1995 and 1994 is as follows:\n(In Millions)\nDeferred Tax Assets Deferred Tax Liabilities\n1995 1994 1995 1994 Current: Current: Unbilled revenue $ 12 $ 10 Revenue taxes $ 16 $ 18 Deferred energy 3 - Total $ 12 $ 10 Total $ 19 $ 18\nNoncurrent: Noncurrent: Unamortized ITC $ 36 $ 40 Liberalized Decommissioning 26 25 depreciation: Contribution in aid previously flowed of construction 19 20 through $ 77 $ 86 Other 41 38 future revenue Total $122 $123 requirements 42 46 Subtotal 119 132 Liberalized depreciation 393 383 Forked River 11 54 Other 84 29 Total $607 $598\nThe reconciliations from net income to book income subject to tax and from the federal statutory rate to combined federal and state effective tax rates are as follows: (In Millions) 1995 1994 1993\nNet income $199 $163 $158 Income tax expense 97 85 81 Book income subject to tax $296 $248 $239\nFederal statutory rate 35% 35% 35% Other (2) (1) (1) Effective income tax rate 33% 34% 34%\nJersey Central Power & Light Company and Subsidiary Company\nFederal and state income tax expense is comprised of the following:\n(In Millions) 1995 1994 1993 Provisions for taxes currently payable $100 $ 50 $ 42\nDeferred income taxes: Liberalized depreciation 8 13 19 NUG buyout costs 6 - - Gain\/Loss on reacquired debt - 6 9 New Jersey revenue tax (2) 32 32 Deferral of energy costs 1 9 (8) Abandonment loss - Forked River (4) (5) (4) Nuclear outage maintenance costs (6) 6 - Accretion income 5 6 6 Unbilled revenue (2) 2 5 VERP 3 (15) - Other (6) (12) (14) Deferred income taxes, net 3 42 45 Amortization of ITC, net ( 6) ( 7) ( 6) Income tax expense $ 97 $ 85 $ 81\nIn 1994, the GPU System and the Internal Revenue Service (IRS) reached an agreement to settle the claim for 1986 that TMI-2 has been retired for tax purposes. The Company and its affiliates have received net refunds totaling $17 million, of which the Company's share is $4 million, which have been credited to their customers. Also in 1994, the GPU System received net interest from the IRS totaling $46 million, of which the Company's share is $11.5 million (before income taxes), associated with the refund settlement, which was credited to income. The IRS has completed its examinations of the GPU System's federal income tax returns through 1989. The years 1990 through 1992 are currently being audited.\n6. SUPPLEMENTARY INCOME STATEMENT INFORMATION\nMaintenance expense and other taxes charged to operating expenses consisted of the following: (In Millions) 1995 1994 1993\nMaintenance $128 $132 $135 Other taxes: New Jersey unit tax $209 $204 $202 Real estate and personal property 8 7 6 Other 10 20 21 Total $227 $231 $229\nJersey Central Power & Light Company and Subsidiary Company\nFor the years 1995, 1994 and 1993, the cost to the Company of services rendered to it by GPUSC amounted to approximately $43 million, $48 million and $39 million, respectively, of which approximately $35 million, $37 million and $29 million, respectively, was charged to income. For the years 1995, 1994 and 1993, the cost to the Company of services rendered to it by GPUN amounted to approximately $186 million, $268 million and $227 million, respectively of which approximately $148 million, $205 million and $184 million, respectively was charged to income. For the years 1995, 1994 and 1993, the Company purchased $23 million, $22 million and $23 million, respectively, in energy from a cogeneration project in which an affiliate has a 50 percent partnership interest.\n7. EMPLOYEE BENEFITS\nPension Plans:\nThe Company maintains defined benefit pension plans covering substantially all employees. The Company's policy is to currently fund net pension costs within the deduction limits permitted by the Internal Revenue Code.\nA summary of the components of net periodic pension cost follows:\n(In Millions) 1995 1994 1993 Service cost-benefits earned during the period $ 7.3 $ 8.8 $ 8.7 Interest cost on projected benefit obligation 32.9 29.0 29.4 Less: Expected return on plan assets (35.2) (33.3) (32.1) Amortization (0.3) (0.5) (0.4) Net periodic pension cost $ 4.7 $ 4.0 $ 5.6\nThe above 1994 amounts do not include a pre-tax charge to earnings of $38 million resulting from the Voluntary Enhanced Retirement Programs (VERP).\nThe actual return on the plans' assets for the years 1995, 1994 and 1993 were gains of $101.3 million, $4.4 million and $48.0 million, respectively.\nThe funded status of the plans and related assumptions at December 31, 1995 and 1994 were as follows:\nJersey Central Power & Light Company and Subsidiary Company\n(In Millions) 1995 1994 Accumulated benefit obligation (ABO): Vested benefits $ 359.8 $ 335.9 Nonvested benefits 30.4 34.3 Total ABO 390.2 370.2 Effect of future compensation levels 69.9 55.9 Projected benefit obligation (PBO) $ 460.1 $ 426.1\nPlan assets at fair value $ 494.4 $ 403.7 PBO (460.1) (426.1) Plan assets in excess of (less than) PBO 34.3 (22.4) Less: Unrecognized net (gain) loss (32.2) 13.3 Unrecognized prior service cost 2.4 3.5 Unrecognized net transition asset (2.1) (2.5) Prepaid (accrued) pension cost $ 2.4 $ (8.1)\nPrincipal actuarial assumptions (%): Annual long-term rate of return on plan assets 8.5 8.5 Discount rate 7.5 8.0 Annual increase in compensation levels 5.5 6.0\nIn 1995, changes in assumptions, primarily the decrease in the discount rate assumption from 8% to 7.5%, resulted in a $19 million increase in the PBO as of December 31, 1995. The assets of the plans are held in a Master Trust and generally invested in common stocks and fixed income securities. The unrecognized net (gain) loss represents actual experience different from that assumed, which is deferred and not included in the determination of pension cost until it exceeds certain levels. Both the unrecognized prior service cost resulting from retroactive changes in benefits and the unrecognized net transition asset arising out of the adoption of Statement of Financial Accounting Standards No. 87, \"Employers' Accounting for Pensions,\" are being amortized to pension cost over the average remaining service periods for covered employees.\nSavings Plans:\nThe Company also maintains savings plans for substantially all employees. These plans provide for employee contributions up to specified limits. The Company's savings plans provide for various levels of matching contributions. The matching contributions for the Company for 1995, 1994 and 1993 were $3.2 million, $2.4 million and $2.4 million, respectively.\nPostretirement Benefits Other Than Pensions:\nThe Company provides certain retiree health care and life insurance benefits for substantially all employees who reach retirement age while working for the Company. Health care benefits are administered by various organizations. A portion of the costs are borne by the participants.\nJersey Central Power & Light Company and Subsidiary Company\nEffective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 106 (FAS 106), \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" FAS 106 requires that the estimated cost of these benefits, which are primarily for health care, be accrued during the employee's active working career. The Company has elected to amortize the unfunded transition obligation existing at January 1, 1993 over a period of 20 years. The unrecognized net loss represents actual experience different from that assumed, which is deferred and not included in the determination of postretirement benefit cost until it exceeds certain levels. The unrecognized prior service cost resulting from retroactive changes in benefits is being amortized to postretirement benefit cost over the average remaining service periods for covered employees.\nA summary of the components of the net periodic postretirement benefit cost for 1995, 1994 and 1993 follows:\n(In Millions) 1995 1994 1993 Service cost-benefits attributed to service during the period $ 3.0 $ 3.3 $ 3.4 Interest cost on the accumulated postretirement benefit obligation 11.2 9.4 10.4 Expected return on plan assets (2.3) (1.7) (0.7) Amortization of transition obligation 5.0 5.2 5.7 Other amortization, net 0.5 0.4 - Net periodic postretirement benefit cost 17.4 16.6 18.8 Less, deferred for future recovery (4.0) (7.8) (9.6) Postretirement benefit cost, net of deferrals $ 13.4 $ 8.8 $ 9.2\nThe above 1994 amounts do not include a pre-tax charge to earnings of $9 million relating to the VERP. The amount deferred for future recovery does not include $5.0 million of allocated postretirement benefit costs from the Company's affiliates for 1995.\nThe actual return on the plans' assets for the years 1995, 1994 and 1993 was a gain of $5.7 million, $0.6 million and $0.9 million, respectively.\nThe funded status of the plans at December 31, 1995 and 1994, was as follows:\nJersey Central Power & Light Company and Subsidiary Company\n(In Millions) 1995 1994 Accumulated Postretirement Benefit Obligation: Retirees $ 89.2 $ 72.0 Fully eligible active plan participants 18.9 24.7 Other active plan participants 53.4 47.1 Total accumulated postretirement benefit obligation (APBO) $ 161.5 $ 143.8\nAPBO $(161.5) $(143.8) Plan assets at fair value 39.7 26.0 APBO in excess of plan assets (121.8) (117.8) Less: Unrecognized net loss 12.9 7.5 Unrecognized transition obligation 85.3 90.0 Accrued postretirement benefit liability $ (23.6) $ (20.3)\nPrincipal actuarial assumptions (%): Annual long-term rate of return on plan assets 8.5 8.5 Discount rate 7.5 8.0\nThe Company intends to continue funding amounts for postretirement benefits with an independent trustee, as deemed appropriate from time to time. The plan assets include equities and fixed income securities.\nIn 1995, the decrease in the health-care cost trend rate assumptions resulted in a $13 million decrease in the APBO, which was partially offset by an increase of $11 million in the APBO caused by the decrease in the discount rate assumption from 8% to 7.5%. The accumulated postretirement benefits obligation was determined by application of the terms of the medical and life insurance plans, including the effects of established maximums on covered costs, together with relevant actuarial assumptions and health-care cost trend rates of 12% for those not eligible for Medicare and 9% for those eligible for Medicare, then decreasing gradually to 6% in 2000 and thereafter. These costs also reflect the implementation of a cost cap of 6% for individuals who retire after December 31, 1995 and reach age 65. The effect of a 1% annual increase in these assumed cost trend rates would increase the accumulated postretirement benefit obligation by approximately $17 million as of December 31, 1995 and the aggregate of the service and interest cost components of net periodic postretirement health-care cost by approximately $2 million.\nIn the Company's 1993 base rate proceeding, the NJBPU allowed the Company to collect $3 million annually of the incremental postretirement benefit costs, charged to expense, recognized as a result of FAS 106. Based on the final order and in accordance with Emerging Issues Task Force Issue 92-12, \"Accounting for OPEB Costs by Rate-Regulated Enterprises,\" the Company is deferring the amounts above that level.\nJersey Central Power & Light Company and Subsidiary Company\n8. JOINTLY OWNED STATIONS\nEach participant in a jointly owned station finances its portion of the investment and charges its share of operating expenses to the appropriate expense accounts. The Company participated with affiliated and nonaffiliated utilities in the following jointly owned stations at December 31, 1995:\nBalance (In Millions) % Accumulated Station Ownership Investment Depreciation Three Mile Island Unit 1 25 $214.4 $ 70.1 Keystone 16.67 91.4 21.9 Yards Creek 50 28.9 7.4\n9. LEASES\nThe Company's capital leases consist primarily of leases for nuclear fuel. Nuclear fuel capital leases at December 31, 1995 and 1994 totaled $88 million and $99 million, respectively (net of amortization of $127 million and $68 million, respectively). The recording of capital leases has no effect on net income because all leases, for ratemaking purposes, are considered operating leases.\nThe Company and its affiliates have nuclear fuel lease agreements with nonaffiliated fuel trusts. In 1995, the Company and its affiliates refinanced the Oyster Creek and TMI-1 nuclear fuel leases to provide for aggregate borrowings of up to $210 million ($100 million for Oyster Creek and $110 million for TMI-1) outstanding at any one time. Reductions in nuclear fuel financing costs are expected through the new credit facilities. It is contemplated that when consumed, portions of the presently leased material will be replaced by additional leased material. The Company and its affiliates are responsible for the disposal costs of nuclear fuel leased under these agreements. These nuclear fuel leases have initial terms of three years expiring in November 1998, and are renewable annually thereafter at the lender's option for a period up to 20 years. Subject to certain conditions of termination, the Company and its affiliates are required to purchase all nuclear fuel then under lease at a price that will allow the lessor to recover its net investment. Lease expense consists of an amount designed to amortize the cost of the nuclear fuel as consumed plus interest costs. For the years ended December 31, 1995, 1994 and 1993, these amounts were $35 million, $28 million and $34 million, respectively.\nThe Company has sold and leased back substantially all of its ownership interest in the Merrill Creek Reservoir Project. The minimum lease payments under this operating lease, which has a remaining term of 37 years, average approximately $3 million annually.\nMetropolitan Edison Company and Subsidiary Companies\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS The Company's 1995 earnings were $147.6 million, compared to a net loss of $2.2 million for 1994. The increase in earnings was primarily due to the net effect of several 1995 and 1994 nonrecurring items. The Company's return on average common equity was 23.5% in 1995 compared to (0.4)% in 1994.\nExcluding these nonrecurring items, earnings for 1995 would have been $80.5 million, compared to 1994 earnings of $77.7 million. Return on average common equity for 1995 and 1994, on this basis, would have been 13.4% and 11.6%, respectively. Contributing to this increase were higher customer sales and lower operation and maintenance (O&M) expenses, partially offset by higher depreciation and financing expenses.\nThe 1995 nonrecurring items consisted of a reversal of $72.8 million (after-tax) of certain future Three Mile Island Unit 2 (TMI-2) retirement costs written off in 1994. The reversal of this write-off resulted from a 1995 Pennsylvania Supreme Court decision that overturned a 1994 Pennsylvania Commonwealth Court order, and restored a 1993 Pennsylvania Public Utility Commission (PaPUC) order allowing the Company to recover its share of such costs from customers. Partially offsetting this increase was a $5.7 million (after-tax) charge to income for the Company's share of TMI-2 monitored storage costs deemed not probable of recovery through ratemaking.\nThe 1994 nonrecurring items included the above mentioned TMI-2 write-off of $72.8 million (after-tax). Also in 1994, there was a charge to income of $20.1 million (after-tax) for early retirement program costs; and net interest income of $13 million (after-tax) resulting from refunds of previously paid federal income taxes related to the tax retirement of TMI-2.\nIn 1994, the Company had a net loss of $2.2 million, compared to earnings in 1993 of $70.9 million. The 1994 earnings reduction was attributable to the 1994 nonrecurring items mentioned above. Also, in 1993 there was a write-off of $4.8 million (after-tax) for the cancellation of proposed power supply and transmission facilities agreements. Excluding these nonrecurring items, earnings for 1994 would have been $77.7 million, compared to 1993 earnings of $75.7 million.\nOPERATING REVENUES: Operating revenues increased 6.7% to $854.7 million in 1995 after decreasing slightly to $801.3 million in 1994. The components of these changes are as follows:\nMetropolitan Edison Company and Subsidiary Companies\n(In Millions) 1995 1994\nKilowatt-hour (KWH) revenues (excluding energy portion) $ 4.8 $ 0.4 Energy revenues 46.4 (2.2) Other revenues 2.2 1.6 Increase\/(decrease) in revenues $ 53.4 $ (0.2)\nKilowatt-hour revenues\nThe increase in KWH revenues was due to an increase in new residential and commercial customer sales and higher industrial customer usage, partially offset by lower weather-related sales.\nThe increase in KWH revenues was due principally to an increase in customer usage and an increase in new residential customer sales, partially offset by lower sales to other utilities.\n1995 MWH Customer Sales by Service Class\nResidential 35% Commercial 27% Industrial\/Other 38%\nEnergy revenues\n1995 and 1994 Changes in energy revenues do not affect earnings as they reflect corresponding changes in the energy cost rates billed to customers and expensed. Energy revenues in 1995 increased primarily from higher energy cost rates and additional sales to other utilities. The 1994 decrease was due primarily to lower electric sales to other utilities, partially offset by higher sales to customers.\nOther revenues\n1995 and 1994 Generally, changes in other revenues do not affect earnings as they are offset by corresponding changes in expense, such as taxes other than income taxes.\nOPERATING EXPENSES: Power purchased and interchanged\n1995 and 1994 Generally, changes in the energy component of power purchased and interchanged (PP&I) expense do not significantly affect earnings since these cost increases are substantially recovered through the Company's energy adjustment clause. However, 1995 and 1994 earnings benefitted from lower\nMetropolitan Edison Company and Subsidiary Companies\nreserve capacity expense (which is a component of PP&I). Contributing to the 1995 increase in PP&I were higher nonutility generation (NUG) purchases and higher interchange purchases from affiliated companies.\nFuel and Deferral of energy costs, net\n1995 and 1994 Generally, changes in fuel expense and deferral of energy costs do not affect earnings as they are offset by corresponding changes in energy revenues.\nOther operation and maintenance\nThe decrease in other O&M expense was due primarily to a $35.2 million (pre-tax) charge in 1994 related to the early retirement programs. Partially offsetting this decrease was a 1995 write-off of $10 million (pre-tax) for TMI-2 monitored storage costs deemed not probable of recovery through ratemaking.\nThe increase in other O&M expense was due primarily to a $35.2 million (pre-tax) charge for the early retirement programs. The increase was also due to higher emergency and winter storm repairs and the accrual of additional payroll expense under an expanded employee incentive compensation program designed to tie pay increases more closely to business results and enhance productivity.\nDepreciation and amortization\nThe increase in depreciation and amortization expense was due primarily to additions to plant in service and adjustments for TMI-2 decommissioning.\nTaxes, other than income taxes\n1995 and 1994 Generally, changes in taxes other than income taxes do not significantly affect earnings as they are substantially recovered in revenues.\nOTHER INCOME AND DEDUCTIONS: Other income\/(expense), net\n1995 and 1994 In the third quarter of 1995, the Company reversed $127.6 million (pre- tax) of certain future TMI-2 retirement costs written off in 1994. The reversal of this write-off resulted from a 1995 Pennsylvania Supreme Court decision that overturned a 1994 Pennsylvania Commonwealth Court order, and restored a 1993 PaPUC order allowing the Company to recover its share of such costs from customers.\nMetropolitan Edison Company and Subsidiary Companies\nAlso, in 1994 the Company recorded interest income of $29.8 million (pre- tax) resulting from refunds of previously paid federal income taxes related to the tax retirement of TMI-2.\nINTEREST CHARGES AND PREFERRED DIVIDENDS: Other interest\n1995 and 1994 In 1994, the Company recognized interest expense related to the tax retirement of TMI-2. The tax retirement of TMI-2 resulted in a $7 million (pre-tax) charge to interest expense on additional amounts owed for tax years in which depreciation deductions with respect to TMI-2 had been taken.\nDividends on company-obligated mandatorily redeemable preferred securities\n1995 and 1994 In 1994, through a special-purpose partnership, the Company issued $100 million stated value of mandatorily redeemable preferred securities.\nPreferred stock dividends\n1995 and 1994 In 1994 and 1993, the Company redeemed $35 million and $81 million stated value of preferred stock, respectively.\nLIQUIDITY AND CAPITAL RESOURCES Capital Needs:\nThe Company's capital needs were $154 million in 1995, consisting of cash construction expenditures of $113 million and amounts for maturing obligations of $41 million.\nDuring 1995, construction expenditures were used primarily to maintain and improve existing generation, transmission and distribution facilities, and for various clean air compliance projects. In 1996, construction expenditures for the Company are estimated to be $97 million, consisting primarily of ongoing system development. Expenditures for maturing obligations will total $15 million in 1996, and $40 million in 1997. In the late 1990s, construction expenditures are expected to include substantial amounts for additional clean air requirements and other Company needs. Management estimates that a significant portion of the Company's 1996 capital needs will be satisfied through internally generated funds.\nCash Construction Expenditures (In millions of dollars) 1991 1992 1993 1994 1995 1996 $122 $131 $142 $160 $113 $ 97*\n* Estimate\nMetropolitan Edison Company and Subsidiary Companies\nThe Company and its affiliates' capital leases consist primarily of leases for nuclear fuel. The Company's share of the TMI-1 nuclear fuel capital lease at December 31, 1995 was $43 million. In 1995, the Company and its affiliates refinanced the TMI-1 nuclear fuel lease to provide for aggregate borrowings of up to $110 million outstanding at any one time. The nuclear fuel lease has an initial term of three years expiring in November 1998, and is renewable annually thereafter at the lender's option for a period up to 20 years. When consumed, portions of the presently leased material will be replaced by additional leased material at a rate of $13 million annually. In the event the needed nuclear fuel cannot be leased, the associated capital requirements would have to be met by other means.\nFinancing:\nIn 1995, GPU sold five million shares of common stock. The net proceeds of $157.5 million were used to make cash capital contributions to the GPU System, of which the Company's share was $25 million, and to repay GPU short- term debt.\nThe Company has regulatory authority to issue and sell first mortgage bonds (FMBs), which may be issued as secured medium-term notes, and preferred stock through December 1997. Under existing authorizations, the Company may issue these senior securities in the amount of up to $190 million, of which $100 million may consist of preferred stock. The Company also has regulatory authority to incur short-term debt, a portion of which may be through the issuance of commercial paper.\nIn 1995, the Company issued $89 million principal amount of FMBs. The proceeds from these issuances were used to refinance $29 million principal amount of maturing higher cost FMBs, to redeem at maturity $12 million principal amount of FMBs, to moderate short-term debt levels and to fund growth in capitalization.\nThe Company's FMB indenture and articles of incorporation include provisions that limit the amount of long-term debt, preferred stock and short- term debt the Company may issue. The Company's interest and preferred dividend coverage ratios are currently in excess of indenture and charter restrictions.\nThe Company's cost of capital and ability to obtain external financing are affected by its security ratings, which are periodically reviewed by the three major credit rating agencies. The Company's senior securities ratings have remained constant since August 1994. The Company's FMBs are currently rated at an equivalent of BBB+ or higher by the three major credit rating agencies, while the preferred stock and mandatorily redeemable preferred securities issues have been assigned an equivalent of BBB or higher. In addition, the Company's commercial paper is rated as having good to very good credit quality.\nIn October 1995, the Standard & Poor's (S&P) rating outlook (which is used to assess the potential direction of an issuer's long-term debt rating over the intermediate to longer-term) for Met-Ed was revised to \"positive\" from \"stable\". According to S&P, this outlook reflects expectations of modest\nMetropolitan Edison Company and Subsidiary Companies\nfinancial improvement based on gradual economic growth, the successful buyout of some expensive NUG contracts, and continued strong nuclear operations. It also reflects the Pennsylvania Supreme Court's reversal of a lower court order that had disallowed recovery of certain future TMI-2 retirement costs. The S&P business position assigned to the Company remained unchanged throughout the year at \"low average\". The business position is a financial benchmarking standard for rating the debt of electric utilities to reflect the changing risk profiles resulting primarily from the intensifying competitive pressures in the industry.\nPresent plans call for the Company to issue long-term debt during the next three years to finance construction activities, fund the redemption of maturing senior securities, and depending on interest rates, refinance outstanding senior securities.\nCapitalization:\nThe Company's target capitalization ratios are designed to provide credit quality ratings that permit capital market access at reasonable costs. The targets and actual capitalization ratios are as follows:\nTarget Range 1995 1994 1993 Common equity 46-49% 47% 46% 48% Preferred equity 8-10 9 10 5 Notes payable and long-term debt 46-41 44 44 47 100% 100% 100% 100%\nMetropolitan Edison Company and Subsidiary Companies\nThe following remaining sections of MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS are being presented on a combined basis, and are included in the GPU section of this Form 10-K.\nCOMPETITIVE ENVIRONMENT: See GPU page.\nRecent Regulatory Actions: See GPU page.\nManaging the Transition: See GPU page.\nNonutility Generation Agreements: See GPU page.\nTHE GPU SUPPLY PLAN: See GPU page.\nNew Energy Supplies: See GPU page.\nManaging Nonutility Generation: See GPU page.\nENVIRONMENTAL ISSUES: See GPU page.\nLEGAL MATTERS - TMI-2 ACCIDENT CLAIMS: See GPU page.\nEFFECTS OF INFLATION: See GPU page.\nMetropolitan Edison Company and Subsidiary Companies\nQUARTERLY FINANCIAL DATA (Unaudited)\nIn Thousands\nFirst Quarter Second Quarter\n1995 1994* 1995 1994**\nOperating revenues $205,749 213,159 $190,342 $196,674\nOperating income 31,155 39,914 28,335 8,808\nNet income 16,384 37,802 12,617 (75,109)\nEarnings available for common stock 16,148 36,894 12,381 (76,017)\nIn Thousands\nThird Quarter Fourth Quarter\n1995*** 1994 1995 1994\nOperating revenues $241,664 $204,903 $216,919 $186,567\nOperating income 35,121 32,258 37,194 30,516\nNet income 97,391 20,453 22,148 17,585\nEarnings available for common stock 97,155 19,545 21,912 17,349\n* Results for the first quarter of 1994 reflect an increase in earnings of $13.0 million (after-tax) resulting from net interest income on refunds of previously paid federal income taxes related to the tax retirement of TMI-2.\n** Results for the second quarter of 1994 reflect the write-off of $72.8 million (after-tax) of certain future TMI-2 retirement costs; and charges of $20.1 million (after-tax) for costs related to early retirement programs.\n*** Results for the third quarter of 1995 reflect the reversal of $72.8 million (after-tax) of certain future TMI-2 retirement costs written off in the second quarter of 1994. The reversal of this write-off resulted from a 1995 Pennsylvania Supreme Court decision that overturned a 1994 lower court order, and restored a 1993 PaPUC order allowing for the recovery of such costs. Partially offsetting this increase was a charge to income of $5.7 million (after-tax) of TMI-2 monitored storage costs deemed not probable of recovery through ratemaking.\nMetropolitan Edison Company and Subsidiary Companies\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors Metropolitan Edison Company Reading, Pennsylvania\nWe have audited the consolidated financial statements and financial statement schedule of Metropolitan Edison Company and Subsidiary Companies as listed in the index 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 financial statement schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. These standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Metropolitan Edison Company and Subsidiary Companies as of December 31, 1995 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, 1995 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 consolidated financial statements taken as a whole, presents fairly, in all material respects, the information required to be included therein.\nCOOPERS & LYBRAND L.L.P.\nNew York, New York January 31, 1996\nMetropolitan Edison Company and Subsidiary Companies\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nMetropolitan Edison Company (the Company), a Pennsylvania corporation, incorporated in 1922, is a wholly-owned subsidiary of General Public Utilities Corporation (GPU), a holding company registered under the Public Utility Holding Company Act of 1935. The Company's business is the generation, transmission, distribution and sale of electricity. The Company owns all of the common stock of York Haven Power Company, the owner of a small hydroelectric generating station, and Met-Ed Preferred Capital, Inc., which is the sole general partner of Met-Ed Capital, L.P., a special-purpose partnership. The Company is affiliated with Jersey Central Power & Light Company (JCP&L) and Pennsylvania Electric Company (Penelec). The Company, JCP&L and Penelec are referred to herein as the \"Company and its affiliates.\" The Company is also affiliated with GPU Service Corporation (GPUSC), a service company; GPU Nuclear Corporation (GPUN), which operates and maintains the nuclear units of the Company and its affiliates; and Energy Initiatives, Inc., EI Power, Inc., and EI Energy Inc. (collectively, the \"EI Group\"), which develop, own and operate generation, transmission and distribution facilities in the United States and foreign countries. All of the Company's affiliates are wholly-owned subsidiaries of GPU. The Company and its affiliates, as well as GPUSC, GPUN and the EI Group, are referred to herein as the \"GPU System.\"\nNote 1, \"Commitments and Contingencies,\" and Note 2, \"Summary of Significant Accounting Policies,\" are being presented for GPU, the Company and its affiliates on a combined basis and are included in the GPU section of this Form 10-K.\nNote 1 - Commitments and Contingencies: See GPU page.\nNuclear Facilities: See GPU page.\nNuclear Plant Retirement Costs: See GPU page.\nInsurance: See GPU page.\nCompetition and the Changing Regulatory Environment: See GPU page.\nEnvironmental Matters: See GPU page.\nOther Commitments and Contingencies: See GPU page.\nNote 2 - Summary of Significant Accounting Policies: See GPU page.\n3. SHORT-TERM BORROWING ARRANGEMENTS\nAt December 31, 1995, the Company had $22 million of short-term notes outstanding which was issued under bank lines of credit (credit facilities). The Company's weighted average interest rate on short-term borrowings was 5.6% at December 31, 1995. The Company had no short-term notes outstanding at December 31, 1994.\nMetropolitan Edison Company and Subsidiary Companies\nGPU and the Company and its affiliates have $529 million of credit facilities, which includes a Revolving Credit Agreement (Credit Agreement) with a consortium of banks. The credit facilities generally provide for the payment of a commitment fee on the unborrowed amount of 1\/8 of 1% annually. Borrowings under these credit facilities generally bear interest based on the prime rate or money market rates. Notes issued under the Credit Agreement, which expires November 1, 1999, are limited to $250 million in total borrowings outstanding at any time and subject to various covenants and acceleration under certain conditions. The Credit Agreement borrowing rates and facility fee are dependent on the long-term debt ratings of the Company and its affiliates.\n4. FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe estimated fair values of the Company's financial instruments, as of December 31, 1995 and 1994, are as follows:\n(In Millions) Carrying Fair Amount Value December 31, 1995: Company-obligated mandatorily redeemable preferred securities $100 $106 Long-term debt 603 645\nDecember 31, 1994: Company-obligated mandatorily redeemable preferred securities $100 $ 98 Long-term debt 530 485\nThe fair values of the Company's financial instruments are estimated based on the quoted market prices for the same or similar issues or on the current rates offered to the Company for instruments of the same remaining maturities and credit qualities.\n5. INCOME TAXES\nEffective January 1, 1993, the Company implemented FAS 109, \"Accounting for Income Taxes.\" The cumulative effect of this accounting change on net income was immaterial. As of December 31, 1995 and 1994, the balance sheet reflected $179 million and $202 million, respectively, of income taxes recoverable through future rates (primarily related to liberalized depreciation), and a regulatory liability for income taxes refundable through future rates of $25 million and $30 million, respectively (related to unamortized ITC), substantially due to the recognition of amounts not previously recorded.\nA summary of the components of deferred taxes as of December 31, 1995 and 1994 is as follows:\nMetropolitan Edison Company and Subsidiary Companies\n(In Millions)\nDeferred Tax Assets Deferred Tax Liabilities 1995 1994 1995 1994 Noncurrent: Current: Liberalized Unbilled revenue $ 6 $ 3 depreciation: Other 2 2 previously flowed Total $ 8 $ 5 through $100 $116 future revenue Noncurrent: requirements 76 86 Unamortized ITC $25 $ 30 Decommissioning 23 71 Subtotal 176 202 Contribution in aid Liberalized of construction 2 2 depreciation 182 163 Other 41 47 Other 22 7 Total $91 $150 Total $380 $372\nThe reconciliations from net income to book income subject to tax and from the federal statutory rate to combined federal and state effective tax rates are as follows: (In Millions) 1995 1994 1993\nNet income $149 $ 1 $ 78 Income tax expense 92 (9) 47 Book income subject to tax $241 $ (8) $125\nFederal statutory rate 35% 35% 35% State tax, net of federal benefit 6 32 6 Amortization of ITC (1) 22 (2) Other (2) 20 (1) Effective income tax rate 38% 109% 38%\nFederal and state income tax expense is comprised of the following:\n(In Millions) 1995 1994 1993 Provisions for taxes currently payable $23 $ 45 $35\nDeferred income taxes: Liberalized depreciation 10 6 8 Deferral of energy costs - 6 4 Decommissioning 46 (52) - VERP 8 (15) - Unbilled revenue (4) 2 - NUG buyout costs 8 - - Other 3 2 3 Deferred income taxes, net 71 (51) 15 Amortization of ITC, net (2) (3) (3) Income tax expense $92 $ (9) $47\nMetropolitan Edison Company and Subsidiary Companies\nIn 1994, the GPU System and the Internal Revenue Service (IRS) reached an agreement to settle the claim for 1986 that TMI-2 has been retired for tax purposes. The Company and its affiliates have received net refunds totaling $17 million, of which the Company's share is $9 million, which have been credited to their customers. Also in 1994, the GPU System received net interest from the IRS totaling $46 million, of which the Company's share is $23 million (before income taxes), associated with the refund settlement, which was credited to income. The IRS has completed its examinations of the GPU System's federal income tax returns through 1989. The years 1990 through 1992 are currently being audited.\n6. SUPPLEMENTARY INCOME STATEMENT INFORMATION\nMaintenance expense and other taxes charged to operating expenses consisted of the following: (In Millions) 1995 1994 1993 Maintenance $54 $59 $59 Other taxes: Pennsylvania state gross receipts $35 $32 $32 Real estate and personal property 7 6 7 Capital stock 7 7 8 Other 6 7 6 Total $55 $52 $53\nFor the years 1995, 1994 and 1993, the cost to the Company of services rendered to it by GPUSC amounted to approximately $27 million, $27 million and $23 million, respectively, of which approximately $23 million, $22 million and $19 million, respectively, were charged to income. For the years 1995, 1994, and 1993, the cost to the Company of services rendered to it by GPUN amounted to approximately $81 million, $77 million and $88 million, respectively, of which approximately $69 million, $65 million and $74 million, respectively, were charged to income.\n7. EMPLOYEE BENEFITS\nPension Plans:\nThe Company maintains defined benefit pension plans covering substantially all employees. The Company's policy is to currently fund net pension costs within the deduction limits permitted by the Internal Revenue Code.\nA summary of the components of net periodic pension cost follows:\nMetropolitan Edison Company and Subsidiary Companies\n(In Millions) 1995 1994 1993 Service cost-benefits earned during the period $ 4.4 $ 4.7 $ 4.9 Interest cost on projected benefit obligation 20.2 17.7 18.8 Less: Expected return on plan assets (20.3) (19.1) (19.3) Amortization (0.1) (0.3) (0.3) Net periodic pension cost $ 4.2 $ 3.0 $ 4.1\nThe above 1994 amounts do not include a pre-tax charge to earnings of $26 million resulting from the Voluntary Enhanced Retirement Programs (VERP).\nThe actual return on the plans' assets for the years 1995, 1994 and 1993 were gains of $59.4 million, $2.5 million and $29.2 million, respectively.\nThe funded status of the plans and related assumptions at December 31, 1995 and 1994 were as follows:\n(In Millions) 1995 1994 Accumulated benefit obligation (ABO): Vested benefits $ 220.9 $ 212.4 Nonvested benefits 24.0 19.7 Total ABO 244.9 232.1 Effect of future compensation levels 42.4 30.9 Projected benefit obligation (PBO) $ 287.3 $ 263.0\nPlan assets at fair value $ 293.1 $ 234.6 PBO (287.3) (263.0) Plan assets in excess of (less than) PBO 5.8 (28.4) Less: Unrecognized net (gain) loss (7.6) 15.9 Unrecognized prior service cost 3.5 2.3 Unrecognized net transition asset (1.3) (1.4) Prepaid (accrued) pension cost $ 0.4 $ (11.6)\nPrincipal actuarial assumptions (%): Annual long-term rate of return on plan assets 8.5 8.5 Discount rate 7.5 8.0 Annual increase in compensation levels 5.5 6.0\nIn 1995, changes in assumptions, primarily the decrease in the discount rate assumption from 8% to 7.5%, resulted in a $12 million increase in the PBO as of December 31, 1995. The assets of the plans are held in a Master Trust and generally invested in common stocks and fixed income securities. The unrecognized net (gain) loss represents actual experience different from that assumed, which is deferred and not included in the determination of pension cost until it exceeds certain levels. Both the unrecognized prior service cost resulting from retroactive changes in benefits and the unrecognized net transition asset arising out of the adoption of Statement of Financial\nMetropolitan Edison Company and Subsidiary Companies\nAccounting Standards No. 87, \"Employers' Accounting for Pensions,\" are being amortized to pension cost over the average remaining service periods for covered employees.\nSavings Plans:\nThe Company also maintains savings plans for substantially all employees. These plans provide for employee contributions up to specified limits. The Company's savings plans provide for various levels of matching contributions. The matching contributions for the Company for 1995, 1994 and 1993 were $2.7 million, $2.2 million and $1.8 million, respectively.\nPostretirement Benefits Other Than Pensions:\nThe Company provides certain retiree health care and life insurance benefits for substantially all employees who reach retirement age while working for the Company. Health care benefits are administered by various organizations. A portion of the costs are borne by the participants. Effective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 106 (FAS 106), \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" FAS 106 requires that the estimated cost of these benefits, which are primarily for health care, be accrued during the employee's active working career. The Company has elected to amortize the unfunded transition obligation existing at January 1, 1993 over a period of 20 years. The unrecognized net loss represents actual experience different from that assumed, which is deferred and not included in the determination of postretirement benefit cost until it exceeds certain levels. The unrecognized prior service cost resulting from retroactive changes in benefits is being amortized to postretirement benefit cost over the average remaining service periods for covered employees.\nA summary of the components of the net periodic postretirement benefit cost for 1995, 1994 and 1993 follows:\n(In Millions) 1995 1994 1993 Service cost-benefits attributed to service during the period $ 2.0 $ 2.3 $ 2.2 Interest cost on the accumulated postretirement benefit obligation 8.3 7.1 7.4 Expected return on plan assets (1.4) (1.2) (0.7) Amortization of transition obligation 3.4 3.4 3.9 Other amortization, net 0.3 0.5 - Net periodic postretirement benefit cost 12.6 12.1 12.8 Less, deferred for future recovery (5.6) (8.3) (7.8) Postretirement benefit cost, net of deferrals $ 7.0 $ 3.8 $ 5.0\nThe above 1994 amounts do not include a pre-tax charge to earnings of $9 million relating to the VERP. The amount deferred for future recovery does not include $1.8 million of allocated postretirement benefit costs from the Company's affiliates for 1995.\nMetropolitan Edison Company and Subsidiary Companies\nThe actual return on the plans' assets for the years 1995, 1994 and 1993 was a gain of $3.3 million, $0.4 million and $0.7 million, respectively.\nThe funded status of the plans at December 31, 1995 and 1994, was as follows:\n(In Millions) 1995 1994 Accumulated Postretirement Benefit Obligation: Retirees $ 80.2 $ 65.0 Fully eligible active plan participants 3.5 11.3 Other active plan participants 39.2 30.9 Total accumulated postretirement benefit obligation (APBO) $ 122.9 $ 107.2\nAPBO $(122.9) $(107.2) Plan assets at fair value 21.9 14.1 APBO in excess of plan assets (101.0) ( 93.1) Less: Unrecognized net loss 17.7 11.7 Unrecognized transition obligation 57.4 59.6 Accrued postretirement benefit liability $ (25.9) $ (21.8)\nPrincipal actuarial assumptions (%): Annual long-term rate of return on plan assets 8.5 8.5 Discount rate 7.5 8.0\nThe Company intends to continue funding amounts for postretirement benefits with an independent trustee, as deemed appropriate from time to time. The plan assets include equities and fixed income securities.\nIn 1995, the decrease in the health-care cost trend rate assumptions resulted in a $9 million decrease in the APBO, which was partially offset by an increase of $8 million in the APBO caused by the decrease in the discount rate assumption from 8% to 7.5%. The accumulated postretirement benefits obligation was determined by application of the terms of the medical and life insurance plans, including the effects of established maximums on covered costs, together with relevant actuarial assumptions and health-care cost trend rates of 12% for those not eligible for Medicare and 9% for those eligible for Medicare, then decreasing gradually to 6% in 2000 and thereafter. These costs also reflect the implementation of a cost cap of 6% for individuals who retire after December 31, 1995 and reach age 65. The effect of a 1% annual increase in these assumed cost trend rates would increase the accumulated postretirement benefit obligation by approximately $12 million as of December 31, 1995 and the aggregate of the service and interest cost components of net periodic postretirement health-care cost by approximately $1 million.\nThe Company is deferring the incremental postretirement benefit costs, charged to expense, associated with the adoption of FAS 106 and in accordance with Emerging Issues Task Force Issue 92-12, \"Accounting for OPEB Costs by Rate-Regulated Enterprises,\" as authorized by the PaPUC in its 1993 base rate order.\nMetropolitan Edison Company and Subsidiary Companies\n8. JOINTLY OWNED STATIONS\nEach participant in a jointly owned station finances its portion of the investment and charges its share of operating expenses to the appropriate expense accounts. The Company participated with affiliated and nonaffiliated utilities in the following jointly owned stations at December 31, 1995:\nBalance (In Millions) % Accumulated Station Ownership Investment Depreciation\nConemaugh 16.45 $144.3 $ 34.3 Three Mile Island Unit 1 50 425.8 150.5\n9. LEASES\nThe Company's capital leases consist primarily of leases for nuclear fuel. Nuclear fuel capital leases at December 31, 1995 and 1994 totaled $43 million and $33 million, respectively (net of amortization of $41 million and $29 million, respectively). The recording of capital leases has no effect on net income because all leases, for ratemaking purposes, are considered operating leases.\nThe Company and its affiliates have nuclear fuel lease agreements with nonaffiliated fuel trusts. In 1995, the Company and its affiliates refinanced the Oyster Creek and TMI-1 nuclear fuel leases to provide for aggregate borrowings of up to $210 million ($100 million for Oyster Creek and $110 million for TMI-1) outstanding at any one time. Reductions in nuclear fuel financing costs are expected through the new credit facilities. It is contemplated that when consumed, portions of the presently leased material will be replaced by additional leased material. The Company and its affiliates are responsible for the disposal costs of nuclear fuel leased under these agreements. These nuclear fuel leases have initial terms of three years expiring in November 1998, and are renewable annually thereafter at the lender's option for a period up to 20 years. Subject to certain conditions of termination, the Company and its affiliates are required to purchase all nuclear fuel then under lease at a price that will allow the lessor to recover its net investment. Lease expense consists of an amount designed to amortize the cost of the nuclear fuel as consumed plus interest costs. For the years ended December 31, 1995, 1994 and 1993, these amounts were $15 million, $15 million and $25 million, respectively.\nThe Company has sold and leased back substantially all of its ownership interest in the Merrill Creek Reservoir Project. The minimum lease payments under this operating lease, which has a remaining term of 37 years, average approximately $3 million annually.\nPennsylvania Electric Company and Subsidiary Companies\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS The Company's 1995 earnings were $109.5 million, compared to 1994 earnings of $28.9 million. The increase in earnings was primarily due to the net effect of several 1995 and 1994 nonrecurring items. The Company's return on average common equity was 15.8% in 1995 compared to 4.2% in 1994.\nExcluding these nonrecurring items, earnings for 1995 would have been $80.1 million, compared to 1994 earnings of $90.7 million. Return on average common equity for 1995 and 1994, on this basis, would have been 11.8% and 12.5%, respectively. Contributing to this earnings decrease were higher other operation and maintenance (O&M) expenses and increased financing expenses.\nThe 1995 nonrecurring items consisted of a reversal of $32.1 million (after-tax) of certain future Three Mile Island Unit 2 (TMI-2) retirement costs written off in 1994. The reversal of this write-off resulted from a 1995 Pennsylvania Supreme Court decision that overturned a 1994 Pennsylvania Commonwealth Court order, and restored a 1993 Pennsylvania Public Utility Commission (PaPUC) order allowing an affiliate (Met-Ed) to recover its share of such costs from customers. Partially offsetting this increase was a $2.7 million (after-tax) charge to income for the Company's share of TMI-2 monitored storage costs deemed not probable of recovery through ratemaking.\nThe 1994 nonrecurring items included the above mentioned TMI-2 write-off of $32.1 million (after-tax). Also in 1994, there was a charge to income of $25.6 million (after-tax) for early retirement program costs; a write-off of $10.6 million (after-tax) for certain postretirement benefit (OPEB) costs; and net interest income of $6.5 million (after-tax) resulting from refunds of previously paid federal income taxes related to the tax retirement of TMI-2.\nEarnings in 1994 were $28.9 million, compared to earnings in 1993 of $90.7 million. This earnings reduction was attributable to the 1994 nonrecurring items mentioned above and increased other O&M expenses. Also, in 1993 there was a write-off of $4.4 million (after-tax) for the cancellation of proposed power supply and transmission facilities agreements.\nOPERATING REVENUES: Operating revenues increased 3.9% to $981.3 million in 1995 after increasing 4.0% to $944.7 million in 1994. The components of these changes are as follows:\nPennsylvania Electric Company and Subsidiary Companies\n(In Millions) 1995 1994\nKilowatt-hour (KWH) revenues (excluding energy portion) $ 1.7 $ 1.6 Energy revenues 32.3 39.7 Other revenues 2.6 (4.9) Increase in revenues $ 36.6 $ 36.4\nKilowatt-hour revenues\nThe increase in KWH revenues was due to increases in new commercial and residential customer sales.\nThe increase in KWH revenues was due principally to increases in new commercial and wholesale customer sales, and higher usage by wholesale customers. In 1993, the Company successfully negotiated power supply agreements at lower rates with some wholesale customers previously served by the Company's affiliates. This was in response to offers made by other utilities seeking to provide electric service to these customers. These increases were mostly offset by decreased industrial customer usage and decreased capacity sales to affiliated companies.\n1995 MWH Customer Sales by Service Class\nResidential 29% Commercial 30% Industrial 34% Other 7%\nEnergy revenues\n1995 and 1994 Changes in energy revenues do not affect earnings as they reflect corresponding changes in the energy cost rates billed to customers and expensed. Energy revenues in 1995 increased from additional sales to other utilities and higher energy cost rates. The 1994 increase was due primarily to higher energy cost rates and the reclassification in 1993 of certain transmission service revenues.\nOther revenues\n1995 and 1994 Generally, changes in other revenues do not affect earnings as they are offset by corresponding changes in expense, such as taxes other than income taxes.\nPennsylvania Electric Company and Subsidiary Companies\nOPERATING EXPENSES: Power purchased and interchanged\n1995 and 1994 Generally, changes in the energy component of power purchased and interchanged (PP&I) expense do not significantly affect earnings since these cost increases are substantially recovered through the Company's energy adjustment clause. The increase in PP&I expense was due largely to higher nonutility generation purchases.\nFuel and Deferral of energy costs, net\n1995 and 1994 Generally, changes in fuel expense and deferral of energy costs do not affect earnings as they are offset by corresponding changes in energy revenues.\nOther operation and maintenance\nThe decrease in other O&M expense was due to a $44.9 million (pre-tax) charge in 1994 related to the early retirement programs. Partially offsetting this decrease were a 1995 write-off of $4.7 million (pre-tax) for TMI-2 monitored storage costs deemed not probable of recovery through ratemaking and severance payments in 1995 resulting from the management combination of the Company and Met-Ed.\nThe increase in other O&M expense was due primarily to a $44.9 million (pre-tax) charge for the early retirement programs. The increase was also due to higher emergency and winter storm repairs and the accrual of additional payroll expense under an expanded employee incentive compensation program designed to tie pay increases more closely to business results and enhance productivity.\nDepreciation and amortization\nThe increase in depreciation and amortization expense was due primarily to additions to plant in service.\nThe decrease in depreciation and amortization expense was due largely to lower TMI-2 amortization and the recognition in 1993 of TMI-2 nonradiological retirement costs. The lower TMI-2 amortization was attributable to the Company completing, in 1993, its recovery of the TMI-2 investment from retail customers.\nPennsylvania Electric Company and Subsidiary Companies\nTaxes, other than income taxes\n1995 and 1994 Generally, changes in taxes other than income taxes do not significantly affect earnings as they are substantially recovered in revenues.\nOTHER INCOME AND DEDUCTIONS: Other income\/(expense), net\n1995 and 1994 In the third quarter of 1995, the Company reversed $56.3 million (pre- tax) of certain future TMI-2 retirement costs written off in 1994. The reversal of this write-off resulted from a 1995 Pennsylvania Supreme Court decision that overturned a 1994 Pennsylvania Commonwealth Court order, and restored a 1993 PaPUC order allowing Met-Ed to recover its share of such costs from customers.\nIn 1994, the Company expensed $18.6 million (pre-tax) for certain OPEB costs believed not probable of recovery in rates. Of this amount, $14.6 million was written off as a result of a PaPUC order disallowing a nonaffiliated utility to collect such costs, and $4 million was charged to expense for OPEB costs related to employees who participated in the early retirement programs. Also, the Company recorded interest income of $14.9 million (pre-tax) resulting from refunds of previously paid federal income taxes related to the tax retirement of TMI-2.\nINTEREST CHARGES AND PREFERRED DIVIDENDS: Other interest\n1995 and 1994 In 1994, the Company recognized interest expense related to the tax retirement of TMI-2. The tax retirement of TMI-2 resulted in a $3.5 million (pre-tax) charge to interest expense on additional amounts owed for tax years in which depreciation deductions with respect to TMI-2 had been taken. Also contributing to the 1995 increase were higher average short-term debt levels and increased interest rates.\nDividends on company-obligated mandatorily redeemable preferred securities\n1995 and 1994 In 1994, through a special-purpose partnership, the Company issued $105 million stated value of mandatorily redeemable preferred securities.\nPreferred stock dividends\n1995 and 1994 In 1994 and 1993, the Company redeemed in each year $25 million stated value of preferred stock.\nPennsylvania Electric Company and Subsidiary Companies\nLIQUIDITY AND CAPITAL RESOURCES Capital Needs:\nThe Company's capital needs were $131 million in 1995, consisting of cash construction expenditures. During 1995, construction expenditures were used primarily to maintain and improve existing generation, transmission and distribution facilities, and for various clean air compliance projects. In 1996, construction expenditures for the Company are estimated to be $124 million, consisting primarily of $117 million for ongoing system development. Expenditures for maturing obligations will total $75 million in 1996, and $26 million in 1997. In the late 1990s, construction expenditures are expected to include substantial amounts for additional clean air requirements and other Company needs. Management estimates that approximately three-fourths of the Company's 1996 capital needs will be satisfied through internally generated funds.\nCash Construction Expenditures (In millions of dollars) 1991 1992 1993 1994 1995 1996 $101 $111 $150 $174 $131 $124*\n* Estimate\nThe Company and its affiliates' capital leases consist primarily of leases for nuclear fuel. The Company's share of the TMI-1 nuclear fuel capital lease at December 31, 1995 was $21 million. In 1995, the Company and its affiliates refinanced the TMI-1 nuclear fuel lease to provide for aggregate borrowings of up to $110 million outstanding at any one time. The nuclear fuel lease has an initial term of three years expiring in November 1998, and is renewable annually thereafter at the lender's option for a period up to 20 years. When consumed, portions of the presently leased material will be replaced by additional leased material at a rate of $7 million annually. In the event the needed nuclear fuel cannot be leased, the associated capital requirements would have to be met by other means.\nFinancing:\nIn 1995, GPU sold five million shares of common stock. The net proceeds of $157.5 million were used to make cash capital contributions to the GPU System, of which the Company's share was $20 million, and to repay GPU short- term debt.\nThe Company has regulatory authority to issue and sell first mortgage bonds (FMBs), which may be issued as secured medium-term notes, and preferred stock through June 1997. Under existing authorizations, the Company may issue these senior securities in the amount of up to $160 million, of which $100 million may consist of preferred stock. The Company also has regulatory authority to incur short-term debt, a portion of which may be through the issuance of commercial paper.\nIn 1995, the Company issued $199 million principal amount of FMBs. The proceeds from these issuances were used to refinance $99 million principal\nPennsylvania Electric Company and Subsidiary Companies\namount of higher cost FMBs, to moderate short-term debt levels and to fund growth in capitalization.\nThe Company's FMB indenture and articles of incorporation include provisions that limit the amount of long-term debt, preferred stock and short- term debt the Company may issue. The Company's interest and preferred dividend coverage ratios are currently in excess of indenture and charter restrictions.\nThe Company's cost of capital and ability to obtain external financing are affected by its security ratings, which are periodically reviewed by the three major credit rating agencies. The Company's senior securities ratings have remained constant since August 1994. The Company's FMBs are currently rated at an equivalent A- or higher by the three major credit rating agencies, while the preferred stock and mandatorily redeemable preferred securities issues have been assigned an equivalent of BBB+ or higher. In addition, the Company's commercial paper is rated as having good to high credit quality.\nThe Standard & Poor's (S&P) rating outlook for the Company has remained at \"stable\" and reflects a manageable construction program, minimal rate relief requirements and expectations of modest strengthening in the service area economy. The rating outlook is used to assess the potential direction of an issuer's long-term debt rating over the intermediate to longer-term. The S&P business position assigned to the Company remained unchanged throughout the year at \"average\". The business position is a financial benchmarking standard for rating the debt of electric utilities to reflect the changing risk profiles resulting primarily from the intensifying competitive pressures in the industry.\nPresent plans call for the Company to issue long-term debt during the next three years to finance construction activities, fund the redemption of maturing senior securities, and depending on interest rates, refinance outstanding senior securities.\nCapitalization:\nThe Company's target capitalization ratios are designed to provide credit quality ratings that permit capital market access at reasonable costs. The targets and actual capitalization ratios are as follows:\nTarget Range 1995 1994 1993 Common equity 45-48% 45% 43% 48% Preferred equity 8-10 9 9 4 Notes payable and long-term debt 47-42 46 48 48 100% 100% 100% 100%\nPennsylvania Electric Company and Subsidiary Companies\nThe following remaining sections of MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS are being presented on a combined basis, and are included in the GPU section of this Form 10-K.\nCOMPETITIVE ENVIRONMENT: See GPU page.\nRecent Regulatory Actions: See GPU page.\nManaging the Transition: See GPU page.\nNonutility Generation Agreements: See GPU page.\nTHE GPU SUPPLY PLAN See GPU page.\nNew Energy Supplies: See GPU page.\nManaging Nonutility Generation: See GPU page.\nENVIRONMENTAL ISSUES See GPU page.\nLEGAL MATTERS - TMI-2 ACCIDENT CLAIMS See GPU page.\nEFFECTS OF INFLATION See GPU page.\nPennsylvania Electric Company and Subsidiary Companies\nQUARTERLY FINANCIAL DATA (Unaudited)\nIn Thousands\nFirst Quarter Second Quarter\n1995 1994* 1995 1994**\nOperating revenues $253,412 $247,180 $238,451 $227,122\nOperating income 46,110 46,017 37,218 8,749\nNet income 30,566 38,965 20,276 (46,671)\nEarnings available for common stock 30,180 38,057 19,890 (47,580)\nIn Thousands\nThird Quarter Fourth Quarter\n1995*** 1994 1995 1994\nOperating revenues $249,234 $240,267 $240,232 $230,175\nOperating income 30,911 38,238 27,822 33,228\nNet income 50,015 24,351 10,153 15,154\nEarnings available for common stock 49,629 23,617 9,767 14,768\n* Results for the first quarter of 1994 reflect an increase in earnings of $6.5 million (after-tax) resulting from net interest income on refunds of previously paid federal income taxes related to the tax retirement of TMI-2.\n** Results for the second quarter of 1994 reflect the write-off of $32.1 million (after-tax) of certain future TMI-2 retirement costs; charges of $25.6 million (after-tax) for costs related to early retirement programs; and a write-off $10.6 million (after-tax) for postretirement benefit costs believed not probable of recovery in rates.\n*** Results for the third quarter of 1995 reflect the reversal of $32.1 million (after-tax) of certain future TMI-2 retirement costs written off in the second quarter of 1994. The reversal of this write- off resulted from a 1995 Pennsylvania Supreme Court decision that overturned a 1994 lower court order, and restored a 1993 PaPUC order allowing for the recovery of such costs. Partially offsetting this increase was a charge to income of $2.7 million (after-tax) of TMI-2 monitored storage costs deemed not probable of recovery through ratemaking.\nPennsylvania Electric Company and Subsidiary Companies\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors Pennsylvania Electric Company Reading, Pennsylvania\nWe have audited the consolidated financial statements and financial statement schedule of Pennsylvania Electric Company and Subsidiary Companies as listed in the index 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 financial statement schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. These standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Pennsylvania Electric Company and Subsidiary Companies as of December 31, 1995 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, 1995 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 consolidated financial statements taken as a whole, presents fairly, in all material respects, the information required to be included therein.\nCOOPERS & LYBRAND L.L.P.\nNew York, New York January 31, 1996\nPennsylvania Electric Company and Subsidiary Companies\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nPennsylvania Electric Company (the Company), a Pennsylvania corporation incorporated in 1919, is a wholly-owned subsidiary of General Public Utilities Corporation (GPU), a holding company registered under the Public Utility Holding Company Act of 1935. The Company's business is the generation, transmission, distribution and sale of electricity. The Company owns all of the common stock of Penelec Preferred Capital, Inc., which is the sole general partner of Penelec Capital, L.P., a special-purpose partnership. The Company also has two minor wholly-owned subsidiaries. The Company is affiliated with Jersey Central Power & Light Company (JCP&L) and Metropolitan Edison Company (Met-Ed). The Company, JCP&L and Met-Ed are referred to herein as the \"Company and its affiliates.\" The Company is also affiliated with GPU Service Corporation (GPUSC), a service company; GPU Nuclear Corporation (GPUN), which operates and maintains the nuclear units of the Company and its affiliates; and Energy Initiatives, Inc., EI Power, Inc., and EI Energy, Inc. (collectively, the \"EI Group\"), which develop, own and operate generation, transmission and distribution facilities in the United States and foreign countries. All of the Company's affiliates are wholly-owned subsidiaries of GPU. The Company and its affiliates are referred to herein as the \"GPU System.\"\nNote 1, \"Commitments and Contingencies,\" and Note 2, \"Summary of Significant Accounting Policies,\" are being presented for GPU, the Company and its affiliates on a combined basis and are included in the GPU section of this Form 10-K.\nNote 1 - Commitments and Contingencies: See GPU page.\nNuclear Facilities: See GPU page.\nNuclear Plant Retirement Costs: See GPU page.\nInsurance: See GPU page.\nCompetition and the Changing Regulatory Environment: See GPU page.\nEnvironmental Matters: See GPU page.\nOther Commitments and Contingencies: See GPU page.\nNote 2 - Summary of Significant Accounting Policies: See GPU page.\nPennsylvania Electric Company and Subsidiary Companies\n3. SHORT-TERM BORROWING ARRANGEMENTS\nAt December 31, 1995 and 1994, the Company had $27 million and $111 million of short-term notes outstanding, respectively, of which $27 million in 1994 was commerical paper and the remainder was issued under bank lines of credit (credit facilities). The Company's weighted average interest rate on short- term borrowings was 5.9% and 6.2% at December 31, 1995 and 1994, respectively.\nGPU and the Company and its affiliates have $529 million of credit facilities, which includes a Revolving Credit Agreement (Credit Agreement) with a consortium of banks. The credit facilities generally provide for the payment of a commitment fee on the unborrowed amount of 1\/8 of 1% annually. Borrowings under these credit facilities generally bear interest based on the prime rate or money market rates. Notes issued under the Credit Agreement, which expires November 1, 1999, are limited to $250 million in total borrowings outstanding at any time and subject to various covenants and acceleration under certain conditions. The Credit Agreement borrowing rates and facility fee are dependent on the long-term debt ratings of the Company and its affiliates.\n4. FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe estimated fair values of the Company's financial instruments, as of December 31, 1995 and 1994, are as follows:\n(In Millions) Carrying Fair Amount Value December 31, 1995: Company-obligated mandatorily redeemable preferred securities $ 105 $ 110 Long-term debt 642 678\nDecember 31, 1994: Company-obligated mandatorily redeemable preferred securities $ 105 $ 101 Long-term debt 616 577\nThe fair values of the Company's financial instruments are estimated based on the quoted market prices for the same or similar issues or on the current rates offered to the Company for instruments of the same remaining maturities and credit qualities.\n5. INCOME TAXES\nEffective January 1, 1993, the Company implemented FAS 109, \"Accounting for Income Taxes.\" The cumulative effect of this accounting change on net income was immaterial. As of December 31, 1995 and 1994, the balance sheet reflected $214 million and $228 million, respectively, of income taxes recoverable through future rates (primarily related to liberalized depreciation), and a regulatory liability for income taxes refundable through\nPennsylvania Electric Company and Subsidiary Companies\nfuture rates of $34 million and $36 million, respectively (related to unamortized ITC), substantially due to the recognition of amounts not previously recorded.\nA summary of the components of deferred taxes as of December 31, 1995 and 1994 is as follows:\n(In Millions)\nDeferred Tax Assets Deferred Tax Liabilities\n1995 1994 1995 1994 Current: Current: Unbilled revenue $ 5 $ 3 Deferred energy $ 4 $ 4 Total $ 5 $ 3 Total $ 4 $ 4\nNoncurrent: Noncurrent: Unamortized ITC $34 $ 36 Liberalized Decommissioning 13 35 depreciation: Contribution in aid previously flowed of construction 3 3 through $121 $131 Other 29 40 future revenue Total $79 $114 requirements 91 97 Subtotal 212 228 Liberalized depreciation 229 217 Other 21 9 Total $462 $454\nThe reconciliations from net income to book income subject to tax and from the federal statutory rate to combined federal and state effective tax rates are as follows:\n(In Millions) 1995 1994 1993\nNet income $111 $32 $ 96 Income tax expense 70 11 69 Book income subject to tax $181 $43 $165\nFederal statutory rate 35% 35% 35% State tax, net of federal benefit 6 1 7 Other ( 2) (10) - Effective income tax rate 39% 26% 42%\nPennsylvania Electric Company and Subsidiary Companies\nFederal and state income tax expense is comprised of the following:\n(In Millions) 1995 1994 1993 Provisions for taxes currently payable $28 $ 61 $51\nDeferred income taxes: Liberalized depreciation 12 12 8 Deferral of energy costs - (3) 11 Accretion income - 5 - Decommissioning 21 (24) - VERP 13 (21) - Other (1) (15) 3 Deferred income taxes, net 45 (46) 22 Amortization of ITC, net (3) (4) (4) Income tax expense $70 $ 11 $69\nIn 1994, the GPU System and the Internal Revenue Service (IRS) reached an agreement to settle the claim for 1986 that TMI-2 has been retired for tax purposes. The Company and its affiliates have received net refunds totaling $17 million, of which the Company's share is $4 million, which have been credited to their customers. Also in 1994, the GPU System received net interest from the IRS totaling $46 million, of which the Company's share is $11.5 million (before income taxes), associated with the refund settlement, which was credited to income. The IRS has completed its examinations of the GPU System's federal income tax returns through 1989. The years 1990 through 1992 are currently being audited.\n6. SUPPLEMENTARY INCOME STATEMENT INFORMATION\nMaintenance expense and other taxes charged to operating expenses consisted of the following: (In Millions) 1995 1994 1993\nMaintenance $71 $80 $81 Other taxes: Pennsylvania state gross receipts $39 $38 $36 Real estate and personal property 8 8 8 Capital stock 9 9 9 Other 11 11 9 Total $67 $66 $62\nFor the years 1995, 1994 and 1993, the cost to the Company of services rendered to it by GPUSC amounted to approximately $38 million, $40 million and $37 million, respectively, of which approximately $31 million, $31 million and $25 million, respectively, were charged to income. For the years 1995, 1994\nPennsylvania Electric Company and Subsidiary Companies\nand 1993, the cost to the Company of services rendered to it by GPUN amounted to approximately $41 million, $40 million and $46 million, respectively, of which approximately $36 million, $33 million and $38 million, respectively, were charged to income.\n7. EMPLOYEE BENEFITS\nPension Plans:\nThe Company maintains defined benefit pension plans covering substantially all employees. The Company's policy is to currently fund net pension costs within the deduction limits permitted by the Internal Revenue Code.\nA summary of the components of net periodic pension cost follows:\n(In Millions) 1995 1994 1993 Service cost-benefits earned during the period $ 8.9 $ 10.2 $ 8.0 Interest cost on projected benefit obligation 34.9 30.6 29.9 Less: Expected return on plan assets (35.6) (32.4) (30.4) Amortization 0.3 0.5 0.1 Net periodic pension cost $ 8.5 $ 8.9 $ 7.6\nThe above 1994 amounts do not include a pre-tax charge to earnings of $33 million resulting from the Voluntary Enhanced Retirement Programs (VERP).\nThe actual return on the plans' assets for the years 1995, 1994 and 1993 were gains of $100.3 million, $4.2 million and $46.1 million, respectively.\nThe funded status of the plans and related assumptions at December 31, 1995 and 1994 were as follows:\n(In Millions) 1995 1994 Accumulated benefit obligation (ABO): Vested benefits $ 364.4 $ 358.0 Nonvested benefits 44.1 38.6 Total ABO 408.5 396.6 Effect of future compensation levels 73.3 57.0 Projected benefit obligation (PBO) $ 481.8 $ 453.6\nPlan assets at fair value $ 496.8 $ 401.3 PBO (481.8) (453.6) Plan assets in excess of (less than) PBO 15.0 (52.3) Less: Unrecognized net (gain) loss (18.8) 27.3 Unrecognized prior service cost 3.8 1.8 Unrecognized net transition obligation 3.0 3.5 Prepaid (accrued) pension cost $ 3.0 $ (19.7)\nPennsylvania Electric Company and Subsidiary Companies\nPrincipal actuarial assumptions (%): Annual long-term rate of return on plan assets 8.5 8.5 Discount rate 7.5 8.0 Annual increase in compensation levels 5.5 6.0\nIn 1995, changes in assumptions, primarily the decrease in the discount rate assumption from 8% to 7.5%, resulted in a $20 million increase in the PBO as of December 31, 1995. The assets of the plans are held in a Master Trust and generally invested in common stocks and fixed income securities. The unrecognized net (gain) loss represents actual experience different from that assumed, which is deferred and not included in the determination of pension cost until it exceeds certain levels. Both the unrecognized prior service cost resulting from retroactive changes in benefits and the unrecognized net transition obligation arising out of the adoption of Statement of Financial Accounting Standards No. 87, \"Employers' Accounting for Pensions,\" are being amortized to pension cost over the average remaining service periods for covered employees.\nSavings Plans:\nThe Company also maintains savings plans for substantially all employees. These plans provide for employee contributions up to specified limits. The Company's savings plans provide for various levels of matching contributions. The matching contributions for the Company for 1995, 1994 and 1993 were $2.5 million, $3.0 million and $3.0 million, respectively.\nPostretirement Benefits Other Than Pensions:\nThe Company provides certain retiree health care and life insurance benefits for substantially all employees who reach retirement age while working for the Company. Health care benefits are administered by various organizations. A portion of the costs are borne by the participants. Effective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 106 (FAS 106), \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" FAS 106 requires that the estimated cost of these benefits, which are primarily for health care, be accrued during the employee's active working career. The Company has elected to amortize the unfunded transition obligation existing at January 1, 1993 over a period of 20 years. The unrecognized net loss represents actual experience different from that assumed, which is deferred and not included in the determination of postretirement benefit cost until it exceeds certain levels. The unrecognized prior service cost resulting from retroactive changes in benefits is being amortized to postretirement benefit cost over the average remaining service periods for covered employees.\nA summary of the components of the net periodic postretirement benefit cost for 1995, 1994 and 1993 follows:\nPennsylvania Electric Company and Subsidiary Companies\n(In Millions) 1995 1994 1993 Service cost-benefits attributed to service during the period $ 4.3 $ 4.6 $ 3.6 Interest cost on the accumulated postretirement benefit obligation 15.6 13.4 12.2 Expected return on plan assets (4.3) (2.3) (1.2) Amortization of transition obligation 6.2 6.5 6.5 Other amortization, net 0.5 0.8 - Net periodic postretirement benefit cost 22.3 23.0 21.1 Net write-off (deferral) 1.3 9.0 (10.1) Postretirement benefit cost, net of deferrals $ 23.6 $ 32.0 $ 11.0\nThe above 1994 amounts do not include a pre-tax charge to earnings of $12 million relating to the VERP.\nThe actual return on the plans' assets for the years 1995, 1994 and 1993 was a gain of $11.1 million, $0.8 million and $1.3 million, respectively.\nThe funded status of the plans at December 31, 1995 and 1994, was as follows:\n(In Millions) 1995 1994 Accumulated Postretirement Benefit Obligation: Retirees $ 139.7 $ 111.3 Fully eligible active plan participants 6.0 21.4 Other active plan participants 79.6 67.2 Total accumulated postretirement benefit obligation (APBO) $ 225.3 $ 199.9\nAPBO $(225.3) $(199.9) Plan assets at fair value 75.3 53.1 APBO in excess of plan assets (150.0) (146.8) Less: Unrecognized net loss 25.0 15.9 Unrecognized prior service cost 2.3 2.5 Unrecognized transition obligation 106.1 112.4 Accrued postretirement benefit liability $ (16.6) $ (16.0)\nPrincipal actuarial assumptions (%): Annual long-term rate of return on plan assets 8.5 8.5 Discount rate 7.5 8.0\nThe Company intends to continue funding amounts for postretirement benefits with an independent trustee, as deemed appropriate from time to time. The plan assets include equities and fixed income securities.\nIn 1995, the decrease in the health-care cost trend rate assumptions resulted in an $18 million decrease in the APBO, which was partially offset by\nPennsylvania Electric Company and Subsidiary Companies\nan increase of $15 million in the APBO caused by the decrease in the discount rate assumption from 8% to 7.5%. The accumulated postretirement benefits obligation was determined by application of the terms of the medical and life insurance plans, including the effects of established maximums on covered costs, together with relevant actuarial assumptions and health-care cost trend rates of 12% for those not eligible for Medicare and 9% for those eligible for Medicare, then decreasing gradually to 6% in 2000 and thereafter. These costs also reflect the implementation of a cost cap of 6% for individuals who retire after December 31, 1995 and reach age 65. The effect of a 1% annual increase in these assumed cost trend rates would increase the accumulated postretirement benefit obligation by approximately $23 million as of December 31, 1995 and the aggregate of the service and interest cost components of net periodic postretirement health-care cost by approximately $3 million.\nIn 1994, the Pennsylvania Commonwealth Court reversed a PaPUC order that allowed a nonaffiliated utility, outside a base rate proceeding, to defer certain incremental postretirement benefit costs for future recovery from customers. As a result of the Court's decision, in 1994, the Company determined that its FAS 106 costs, including costs deferred since January 1993, were not likely to be recovered and charged $18.8 million to expense. In addition, $4 million of the Company's unrecognized transition obligation resulting from employees who elected to participate in the VERP was also written off in 1994. In 1995, the Company recorded a charge to income of approximately $9 million, which represents continued amortization of the transition obligation along with current accruals of FAS 106 expense for active employees.\n8. JOINTLY OWNED STATIONS\nEach participant in a jointly owned station finances its portion of the investment and charges its share of operating expenses to the appropriate expense accounts. The Company participated with affiliated and nonaffiliated utilities in the following jointly owned stations at December 31, 1995:\nBalance (In Millions) % Accumulated Station Ownership Investment Depreciation\nHomer City 50 $458.2 $161.6 Three Mile Island Unit 1 25 213.3 78.3 Seneca 20 16.4 4.8\n9. LEASES\nThe Company's capital leases consist primarily of leases for nuclear fuel. Nuclear fuel capital leases at December 31, 1995 and 1994 totaled $21 million and $16 million, respectively (net of amortization of $21 million and $15 million, respectively). The recording of capital leases has no effect on net income because all leases, for ratemaking purposes, are considered operating leases.\nPennsylvania Electric Company and Subsidiary Companies\nThe Company and its affiliates have nuclear fuel lease agreements with nonaffiliated fuel trusts. In 1995, the Company and its affiliates refinanced the Oyster Creek and TMI-1 nuclear fuel leases to provide for aggregate borrowings of up to $210 million ($100 million for Oyster Creek and $110 million for TMI-1) outstanding at any one time. Reductions in nuclear fuel financing costs are expected through the new credit facilities. It is contemplated that when consumed, portions of the presently leased material will be replaced by additional leased material. The Company and its affiliates are responsible for the disposal costs of nuclear fuel leased under these agreements. These nuclear fuel leases have initial terms of three years expiring in November 1998, and are renewable annually thereafter at the lender's option for a period up to 20 years. Subject to certain conditions of termination, the Company and its affiliates are required to purchase all nuclear fuel then under lease at a price that will allow the lessor to recover its net investment. Lease expense consists of an amount designed to amortize the cost of the nuclear fuel as consumed plus interest costs. These amounts were $7 million for each of the years ended December 31, 1995, 1994 and 1993.","section_15":""}
{"filename":"78066_1995.txt","cik":"78066","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"Item 3. Legal Proceedings - --------------------------\nI. The Corporation is participating, either directly as a party or as a member of certain trade associations, in several legal challenges to air quality rules or guidance documents issued by EPA. This litigation primarily involves the establishment or amendment of national ambient air quality standards, the requirements for the construction or major modification of major sources of criteria pollutants, Title V operating permits, and the status of fugitive emissions under the Title V and federal hazardous air pollutants programs.\nIn August 1983, EPA proposed regulations (48 Fed. Reg. 38,742) which, if adopted, would have substantially implemented a February 1982 settlement agreement dealing with fugitive emissions, but on October 26, 1984, EPA promulgated final regulations inconsistent with the August 1983 proposal. In December 1984, the Corporation, the American Mining Congress and several mining and energy development companies filed a petition (No. 84-1609) in the U.S. Court of Appeals for the District of Columbia for review of the October 26, 1984, regulations, asserting that the terms of the settlement agreement, to which they were party, had not been carried out. The court stayed the petition pending the outcome of further EPA rulemakings.\nThe further EPA rulemakings were also challenged by the American Mining Congress and others in federal court actions filed in 1989 and 1993. The U.S. Court of Appeals for the District of Columbia Circuit decided two of the appeals in 1995. In National Mining Association v. EPA, 59 F.3d 1351 (D.C. Cir. 1995), the court agreed with EPA that, under the federal hazardous air pollutants program, collocated facilities should be considered as part of the same emitting \"source\" and fugitive emissions must be counted when determining whether a source is a \"major source.\" The court agreed with the industry petitioners that a source could avoid \"major source\" status by using effective air pollution controls, even if the controls are not \"federally enforceable.\"\nIn Chemical Manufacturers Association et al. v. EPA, No. 89-1514, Slip op. (D.C. Cir. 1995), the court agreed with the industry petitioners and vacated and remanded EPA's rules which did not allow facilities to consider air pollution controls when determining whether a permit is needed for new or increased emissions of criteria pollutants, unless the controls were \"federally enforceable.\" In response, EPA has asserted that its rules nevertheless remain in effect and that it may cure the defect in the rules merely by issuing written guidance in the near future. The industry petitioners have requested the court to enforce its original mandate against the agency.\nThe effect of these decisions on the Corporation's facilities will vary on a case-by-case basis. They will have no effect on some facilities; they may cause some facilities to be regulated as \"major sources\" under one or more federal programs; and they may allow some sources to avoid regulation as \"major sources\" by using air pollution controls that are enforceable under federal, state or local laws.\nII. Reference is made to Part I, Items 1 and 2 of this report for information regarding proceedings that pertain to water used by the Corporation's Morenci, Arizona, operations.\nA. The following state water rights adjudication proceedings are pending in Arizona Superior Court:\n1. In re the General Adjudication of All Rights to Use Water in the Little Colorado River System and Source, No. 6417 (Superior Court of Arizona, Apache County).\n(a) Petition was filed by the Corporation on or about February 17, 1978, and process has been served on all potential claimants. Virtually all statements of claimant have been filed.\n(b) The principal parties, in addition to the Corporation, are the State of Arizona, the Navajo Tribe of Indians, the Hopi Indian Tribe, the San Juan Southern Paiute group of Indians and the United States on its own behalf and on behalf of those Indian tribes. In this adjudication and in the adjudications reported in items 2.(a), (b) and (c) below, the United States and the Indian tribes seek to have determined and quantified their rights to use water arising under federal law on the basis that, when the Indian reservations and other federal reservations were established by the United States, water was reserved from appropriation under state law for the use of those reservations.\n(c) This proceeding could affect, among other things, the Corporation's rights to impound water in Show Low Lake and Blue Ridge Reservoir and to transport this water into the Salt River and Verde River watersheds for exchange with the Salt River Valley Water Users' Association. The Corporation has filed statements of claimant for these and other water claims. This litigation is stayed pending the outcome of current settlement negotiations. The Court has not set a final schedule of cases to go to trial, should the litigation resume.\n2. In re the General Adjudication of All Rights to Use Water in the Gila River System and Source, Nos. W-1 (Salt River), W-2 (Verde River), W-3 (Gila River) and W-4 (San Pedro River) (Superior Court of Arizona, Maricopa County). As a result of consolidation proceedings, this action now includes general adjudication proceedings with respect to the following three principal river systems and sources:\n(a) The Gila River System and Source Adjudication:\n(i) Petition was filed by the Corporation on February 17, 1978. Process has been served on water claimants in the upper and lower reaches of the watershed and virtually all statements of claimant have been filed.\n(ii) The principal parties, in addition to the Corporation, are the Gila Valley Irrigation District, the San Carlos Irrigation and Drainage District, the State of Arizona, the San Carlos Apache Tribe, the Gila River Indian Community and the United States on its own behalf and on behalf of the tribe and the community.\n(iii) This proceeding could affect, among other things, the Corporation's claim to the approximately 3,000 acre-feet of water that it diverts annually from Eagle Creek, Chase Creek or the San Francisco River and its claims to percolating groundwater that is pumped from wells located north of its Morenci Branch operations in the Mud Springs and Bee Canyon areas and in the vicinity of the New Cornelia Branch at Ajo. The Corporation has filed statements of claimant with respect to waters that it diverts from these sources.\n(iv) By a letter agreement dated September 7, 1990, the Corporation and the San Carlos Apache Tribe agreed upon principles to settle the water claims of that Tribe. Legislation authorizing that settlement was enacted into law on October 30, 1992. A comprehensive settlement agreement is presently being negotiated. Congress has approved a second one-year extension to that law so that the settlement will become effective if it is approved by the Arizona Superior Court and certain conditions are met by December 31, 1996.\n(b) The Salt River System and Source Adjudication:\n(i) Petition was filed by the Salt River Valley Water Users' Association on or about April 25, 1974. Process has been served, and statements of claimant have been filed by virtually all claimants.\n(ii) Principal parties, in addition to the Corporation, include the petitioner, the State of Arizona and the United States, on its own behalf and on behalf of various Indian tribes and communities including the White Mountain Apache Tribe, the San Carlos Apache Tribe, the Fort McDowell Mohave-Apache Indian Community, the Salt River Pima-Maricopa Indian Community and the Gila River Indian Community.\n(iii) The Corporation has filed a statement of claimant to assert its interest in the water exchange agreement with the Salt River Valley Water Users' Association by virtue of which it diverts from the Black River water claimed by the Association and repays the Association with water impounded in Show Low Lake and Blue Ridge Reservoir on the Little Colorado River Watershed, and to assert its interest in \"water credits\" to which the Corporation is entitled as a result of its construction of the Horseshoe Dam on the Verde River.\n(iv) The Salt River Pima-Maricopa Indian Community, Salt River Valley Water Users' Association, the principal Salt River Valley Cities, the State of Arizona and others have negotiated a settlement as among themselves for the Verde and Salt River system. The settlement has been approved by Congress, the President and the Arizona Superior Court. Under the settlement, the Salt River Pima-Maricopa Indian Community waived all water claims it has against all other water claimants (including the Corporation) in Arizona.\n(v) Active proceedings with respect to other claimants have not yet commenced in this adjudication.\n(c) The Verde River System and Source Adjudication:\n(i) Petition was filed by the Salt River Valley Water Users' Association on or about February 24, 1976, and process has been served. Virtually all statements of claimant have been filed.\n(ii) The principal parties, in addition to the Corporation, are the petitioner, the Fort McDowell Mohave-Apache Indian Community, the Payson Community of Yavapai Apache Indians, the Salt River Pima-Maricopa Indian Community, the Gila River Indian Community, the United States on its own behalf and on behalf of those Indian communities, and the State of Arizona.\n(iii) This proceeding could affect, among other things, the Corporation's Horseshoe Dam \"water credits\" with the Salt River Valley Water Users' Association resulting from its construction of the Horseshoe Dam on the Verde River. (See the Black River water exchange referred to in Paragraph II.A. 2.(b)(iii) above.) The Corporation has filed statements of claimant with respect to Horseshoe Dam and water claims associated with the former operations of the United Verde Branch.\n(iv) The Fort McDowell Mohave-Apache Indian Community, Salt River Valley Water Users' Association, the principal Salt River Valley Cities, the State of Arizona and others have negotiated a settlement as among themselves for the Verde River system. This settlement has been approved by Congress, the President and the Arizona Superior Court. Under this settlement, the Fort McDowell Mohave-Apache Indian Community waived all water claims it has against all other water claimants (including the Corporation) in Arizona.\nB. The following proceedings involving water rights adjudication are pending in the U.S. District Court for the District of Arizona:\n1. On June 29, 1988, the Gila River Indian Community filed a complaint-in-intervention in United States v. Gila Valley Irrigation District, et al., Globe Equity No. 59 (D. Ariz.). The underlying action was initiated by the United States in October 1925 to determine conflicting claims to water rights in certain portions of the Gila River watershed. Although the Corporation was named and served as a defendant in that action, it was dismissed without prejudice as a defendant in March 1935. In June 1935, the Court entered a decree setting forth the water rights of numerous parties, but not those of the Corporation. The Court retained, and still has, jurisdiction of the case. The complaint-in-intervention does not name the Corporation as a defendant; however, it does name the Gila Valley Irrigation District as a defendant. Therefore, the complaint-in-intervention could affect the approximately 3,000 acre-feet of water that the Corporation diverts annually from Eagle Creek, Chase Creek or the San Francisco River pursuant to the agreement between the Corporation and the Gila Valley Irrigation District. In April 1990, the Court entered Findings of Fact and Conclusions of Law on four of the counts in the complaint-in-intervention. Trial on additional issues (primarily issues raised by plaintiff-in-intervention San Carlos Apache Tribe) was conducted in November 1991. In November 1992, after submission of post-trial briefs, the Court entered a judgment on the additional issues. The Corporation believes that neither the Findings of Fact or the Conclusions of Law entered in 1990 nor the judgment entered in 1992 should affect the 3,000 acre-feet of water that the Corporation diverts annually pursuant to the agreement with the Gila Valley Irrigation District. An appeal of the 1992 judgment, however, has been noticed by the Gila Valley Irrigation District and others.\nThe major users on the mainstream of the Gila River (decreed right holders) had engaged in continuing mandatory settlement discussions under the supervision of the Court until those discussions terminated during the summer of 1994. Some remaining issues were tried in November 1994. The Court's rulings entered April 14, 1995, regarding water quality, limitations on industrial uses, the definition of subflow and the plaintiff-in-intervention's right to natural flows from the Gila River, could affect the approximately 3,000 acre-feet of water that the Corporation diverts annually from Eagle Creek, Chase Creek or the San Francisco River pursuant to the agreement between the Corporation and the Gila Valley Irrigation District.\nAdditional issues remain, some of which may go to trial during 1996.\n2. On December 30, 1982, the Gila River Indian Community initiated an action styled Gila River Indian Community v. Gila Valley Irrigation District, et al., No. CIA 82-2185 (D. Ariz.), complaining about allegedly improper uses by approximately 17,000 named defendants of \"water from within the Gila River watershed.\" The Corporation was named as a defendant in the complaint, but it has not yet been served with process. The complaint seeks an injunction restraining future uses of water that interfere with the alleged prior rights of the Gila River Indian Community, as well as compensatory and punitive damages in an unspecified amount.\n3. Prior to December 1982, various Indian tribes filed several suits in the U.S. District Court for the District of Arizona claiming prior and paramount rights to use waters which are presently being used by many water users, including the Corporation, and claiming damages for prior use in derogation of their allegedly paramount rights. These federal proceedings have been stayed pending final adjudication in the state courts.\nIII. Prior to the mid-1960s, a predecessor of Phelps Dodge Industries, Inc. (PDI), a subsidiary of the Corporation, manufactured and sold some cable and wire products that were insulated with material containing asbestos. PDI believes that the use of its products did not result in significant releases of airborne asbestos fibers. PDI and the Corporation are collectively referred to below as PDI.\nSince the late 1980s, PDI has been served with complaints in asbestos-related actions filed on behalf of over 16,350 claimants. In these proceedings, plaintiffs have alleged bodily injury or death caused by purported exposure to asbestos and have claimed damages based on theories of strict liability and negligence. Over 12,500 of those claimants were participants in the Ingalls Shipyard asbestos litigation filed in Pascagoula, Mississippi. Each claimant in that litigation sought from $2 million to $20 million in compensatory and punitive damages from a group of approximately 100 to 150 defendants, which included PDI. During 1993 and 1994, PDI was successful in obtaining dismissal of all claims against it in Mississippi with the exception of one wrongful death claim.\nA total of 197 claims against PDI were dismissed in 1995. During that year, 2,559 new asbestos-related claims were filed against PDI in ten states. As of December 31, 1995, a total of 2,701 asbestos-related claims were pending against PDI in 15 jurisdictions. PDI is vigorously contesting and defending these asbestos-related claims.\nIn December 1995, Phelps Dodge and its insurers executed an agreement embodying a cost sharing arrangement for defense and indemnity costs arising out of the asbestos litigation.\nIV. Claims under CERCLA and related state acts involving the Corporation have been raised with respect to the remediation of 36 waste disposal and other sites. Most are sites where the Corporation has received information requests or other indications that the Corporation may be a Potentially Responsible Party (PRP) under CERCLA. CERCLA is intended to expedite the remediation of hazardous substances without regard to fault. Responsible parties for each site include present and former owners, operators, transporters, and generators of the substances at the site. Liability is strict, joint and several. Because of the ambiguity of the regulations, the difficulty of identifying the responsible parties for any particular site, the complexity of allocating the remediation costs among them, the uncertainty as to the most desirable remediation techniques and amount of remediation costs, and the time period during which such costs may be incurred, the Corporation is unable to reasonably estimate the full cost of compliance with CERCLA or equivalent state statutes.\nWith respect to these 36 sites, based on currently available information, which in many cases is preliminary and incomplete, the Corporation has no reason to believe that its ultimate responsibility for remediation costs will exceed $1.0 million at any site and believes most will be substantially under $0.1 million. While additional costs to the Corporation are reasonably possible, that cost is not expected to exceed $10.0 million.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders - ------------------------------------------------------------\nNo matters were submitted during the fourth quarter of 1995 to a vote of security holders, through the solicitation of proxies or otherwise.\nExecutive Officers of Phelps Dodge Corporation - ----------------------------------------------\nThe executive officers of Phelps Dodge Corporation are elected to serve at the pleasure of its Board of Directors. As of March 1, 1996, the executive officers of Phelps Dodge Corporation were as follows:\nAge at Officer of the Name 3\/1\/96 Position Corporation since ---- ------ -------- -----------------\nDouglas C. Yearley 60 Chairman of the Board, President and Chief Executive Officer 1981\nManuel J. Iraola 47 Senior Vice President 1995\nThomas M. St. Clair 60 Senior Vice President and Chief Financial Officer 1989\nJ. Steven Whisler 41 Senior Vice President 1987\nExcept as stated below, all of the above have been officers of Phelps Dodge Corporation for the past five years.\nMr. Iraola was elected Senior Vice President in January 1995. Prior to his election, Mr. Iraola was President of Phelps Dodge International Corporation, the largest Phelps Dodge Industries' company, a position he held since 1992. Prior to that time, he was Senior Vice President and Chief Financial Officer of Columbian Chemicals Company, acquired by Phelps Dodge in 1986.\nPart II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters - --------------------------------------------------------------------------------\nThe information called for by Item 5 appears in Management's Discussion and Analysis in this report.\nITEM 7.","section_6":"","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS - ---------------------------------------------\nPhelps Dodge reported 1995 consolidated net income of $746.6 million, or $10.65 per common share. This amount compares with 1994 income of $362.7 million, or $5.10 per common share, less non-recurring after-tax charges in the fourth quarter of $91.7 million, or $1.29 per common share, that reduced reported 1994 net income to $271.0 million, or $3.81 per common share. The 1994 non-recurring charges primarily reflected additional provisions for estimated future costs associated with environmental matters and for estimated losses on the disposition of certain operating facilities. Note 2 to the Consolidated Financial Statements contains further information to which reference should be made for a fuller understanding of the 1994 non-recurring charges.\nThe Corporation reported 1993 consolidated net income of $187.9 million, or $2.66 per common share, including after-tax revenues of $26.0 million, or 37 cents per common share, from copper price protection arrangements. Net income in 1993 was adversely affected by the passage of the Omnibus Budget Reconciliation Act of 1993 in the third quarter that retroactively raised the maximum corporate income tax rate from 34 percent to 35 percent effective January 1, 1993. As a result, the Corporation raised its 1993 tax provision by approximately $9.0 million, or 13 cents per common share.\nThe Corporation's consolidated financial results for the last three years are summarized below (in millions except per common share amounts):\n- --------------------------------------------------------------------------------\n1995 1994 1993 ---- ---- ----\nSales and other operating revenues ........ $ 4,185.4 3,289.2 2,595.9 Operating income .......................... $ 1,100.5 400.4 326.5 Net income ................................ $ 746.6 271.0 187.9 Net income per common share ............... $ 10.65 3.81 2.66\n- --------------------------------------------------------------------------------\nA significant factor influencing the Corporation's 1995 results was the improved price of copper, the Corporation's principal product. The New York Commodity Exchange (COMEX) spot price per pound of copper cathode, upon which the Corporation bases its selling price, averaged $1.35 in 1995, compared with $1.07 in 1994 and 85 cents in 1993. The COMEX price averaged $1.17 per pound for the first two months of 1996, and closed at $1.18 on March 7, 1996.\nAny material change in the price the Corporation receives for copper, or in its unit production costs, has a significant effect on the Corporation's results. The Corporation's present share of annual production is approximately 1.4 billion pounds of copper. Accordingly, each 1 cent per pound change in the average annual copper price received by the Corporation, or in average annual unit production costs, causes a variation in annual operating income before taxes of approximately $14 million.\nThe Corporation enters into price protection arrangements from time to time, depending on market circumstances, to ensure a minimum price for a portion of its expected future mine production. With respect to 1995 production, the Corporation had contracts that provided minimum quarterly average London Metal Exchange (LME) prices of 80 cents per pound for approximately 640 million pounds of copper. These contracts expired on December 31, 1995, without payment to Phelps Dodge. In addition, the Corporation had contracts that provided minimum (approximately 95 cents) and maximum (approximately $1.33) LME prices per pound for approximately 650 million pounds of copper. These contracts expired on December 31, 1995, with Phelps Dodge making payments totaling $1.3 million to the financial institutions involved. During 1994, contracts that provided the Corporation with minimum average LME copper prices of 75 cents per pound for about 21 percent of that year's production expired without payment to Phelps Dodge. During 1993, the Corporation received revenues of $39.4 million before taxes ($26.0 million, or 37 cents per common share, after taxes) from similar arrangements.\nWith respect to 1996 production, as of March 7, 1996, the Corporation had entered into contracts with several financial institutions that provide for a combination of minimum and maximum prices based on the quarterly average LME price. These contracts are summarized in the following table:\n- --------------------------------------------------------------------------------\nContracts Providing Contracts Providing Minimum Minimum Prices and Maximum Prices -------------- ------------------ Copper Cathode Copper Price (LME) Cathode Price Pounds ----------------- Pounds (LME) (millions) Minimum Maximum (millions) ----- ---------- ------- ------- ----------\nFirst Quarter ........ $0.95 170 $0.95 $1.47 170 Second Quarter ....... $0.95 90 $0.95 $1.42 170 Third Quarter ........ $0.95 40 $0.90 $1.40 145 Fourth Quarter ....... - $0.95 $1.36 190 ------ ----- 300 675 ====== =====\n- ----------------\nNote: If average quarterly LME prices exceed the maximum prices, Phelps Dodge will be obligated to pay the difference to the financial institutions involved; if average quarterly LME prices fall below the minimum prices, the financial institutions will be obligated to pay Phelps Dodge the difference.\n- -------------------------------------------------------------------------------\nThe Corporation periodically enters into forward exchange contracts to hedge certain recorded transactions denominated in foreign currencies and enters into currency option contracts to hedge certain firm commitments and other anticipated foreign currency transactions. The Corporation does not hold these financial instruments for trading purposes. The objective of the Corporation's foreign currency hedging activities is to protect the Corporation from the risk that the eventual equivalent dollar cash flows resulting from transactions denominated in foreign currencies will be adversely affected by changes in exchange rates. During 1995, recorded and anticipated foreign currency transactions that the Corporation had hedged did not exceed $85 million and totaled $73 million at year end. The Corporation did not have any deferred unrealized gains or losses on its foreign exchange contracts at December 31, 1995, compared with deferred unrealized losses of $0.9 million at December 31, 1994. Notes 1 and 19 to the Consolidated Financial Statements contain further information to which reference should be made for a fuller understanding of the Corporation's policy for hedging foreign currency transactions.\nConsolidated 1995 revenues were $4,185.4 million, compared with $3,289.2 million in 1994. This increase principally resulted from higher average copper prices, increased volumes of copper sold from mine production, and higher prices and sales volumes for carbon black, wheels and rims, and wire and cable products. The increase in consolidated revenues from $2,595.9 million in 1993 to $3,289.2 million in 1994 primarily resulted from higher average copper prices and higher sales volumes of copper (including copper purchased for resale), wheels and rims, wire and cable products (including magnet wire sales from two U.S. plants acquired in early 1994) and carbon black.\nPhelps Dodge's results for 1995, 1994 and 1993 can be meaningfully compared by separate reference to its reporting segments, Phelps Dodge Mining Company and Phelps Dodge Industries. Phelps Dodge Mining Company includes the Corporation's worldwide copper operations from mining through rod production, marketing and sales, other mining operations and investments, and worldwide mineral exploration and development programs. Phelps Dodge Industries includes the Corporation's carbon black operations, its wheel and rim business, and its wire and cable operations.\nWithin each such segment, significant events and transactions have occurred which, as indicated in the separate discussions presented below, are material to an understanding of the particular year's results and to a comparison with results of the other periods. Note 20 to the Consolidated Financial Statements contains further information to which reference should be made for a fuller understanding of the following discussion and analysis. Statistics on reserves and production can be found in Part I, Items 1 and 2 of this report.\nRESULTS OF PHELPS DODGE MINING COMPANY\nPhelps Dodge Mining Company is an international business comprising a group of companies involved in vertically integrated copper operations including mining, concentrating, electrowinning, smelting and refining, rod production, marketing and sales, and related activities. Copper is sold primarily to others as rod, cathode or concentrates, and as rod to the Phelps Dodge Industries segment. In addition, Phelps Dodge Mining Company at times smelts and refines copper and produces copper rod for others on a toll basis. Phelps Dodge Mining Company also produces gold, silver, molybdenum and copper chemicals as by-products, and sulfuric acid from its air quality control facilities. This segment also includes the Corporation's other mining operations and investments (including fluorspar, silver, lead and zinc operations) and its worldwide mineral exploration and development programs.\n- --------------------------------------------------------------------------------\n1995 1994 1993 ---- ---- ---- Copper (from own mines - thousand tons) * Production .............................. 712.7 572.8 547.7 Deliveries .............................. 696.6 560.6 543.9 COMEX average spot copper price per pound - cathodes .................... $ 1.35 1.07 0.85\n(millions of dollars)\nSales and other operating revenues ......... $ 2,488.7 1,820.7 1,320.3 Operating income ........................... $ 896.8 326.4 227.2\n- ----------------\n* The Corporation's worldwide copper production and deliveries shown in the above table exclude the amounts attributable to (i) the 15 percent undivided interest in the Morenci, Arizona, copper mining complex held by Sumitomo Metal Mining Arizona, Inc. (Sumitomo), (ii) the one-third partnership interest in Chino Mines Company in New Mexico held by Heisei Minerals Corporation (Heisei), and (iii) the 20 percent interest in Candelaria held by SMMA Candelaria, Inc., a jointly owned indirect subsidiary of Sumitomo Metal Mining Co., Ltd. and Sumitomo Corporation. Excluded production amounts for 1995, 1994 and 1993 were 65,600 tons, 61,000 tons and 60,500 tons produced at Morenci for the account of Sumitomo and 56,200 tons, 53,200 tons and 53,200 tons produced at Chino for the account of Heisei. Excluded production amounts for 1995 and 1994 at Candelaria for the account of Sumitomo were 33,100 tons and 6,200 tons.\n- --------------------------------------------------------------------------------\nPhelps Dodge Mining Company reported 1995 operating income of $896.8 million. This compares with 1994 operating income of $420.8 million, which was reduced to $326.4 million after reflecting $94.4 million of fourth quarter non-recurring pre-tax charges applicable to its operations, and $227.2 million in 1993. The increase in 1995 operating earnings resulted from higher average copper prices and higher volumes of copper sold from mine production, especially from Candelaria which commenced operation in the 1994 fourth quarter. Unit production costs for 1995 were approximately the same as those in 1994 as certain costs associated with higher copper prices were offset by the favorable effects of higher-than-average ore grades mined at Candelaria and the start up of the Southside solution extraction\/electrowinning (SX\/EW) project at the Morenci mine. The increase in operating earnings in 1994 compared with 1993 also resulted from higher average copper prices and sales volumes of copper sold from mine production.\nThe Candelaria mine is located near Copiapo in the Atacama Desert of northern Chile. Phelps Dodge Mining Company completed construction and commenced operations at Candelaria in October 1994, and achieved full production in 1995. Phelps Dodge owns an 80 percent interest in Candelaria and a jointly owned indirect subsidiary of Sumitomo Metal Mining Co., Ltd. and Sumitomo Corporation, both of Japan, owns a 20 percent interest. The project consists of an open-pit mine, concentrator, port and associated facilities.\nDuring the third quarter of 1995, Phelps Dodge Mining Company completed construction and commenced operations at its $200 million Southside project (the Corporation's share was $170 million with the remainder provided by its co-participant, Sumitomo) at its Morenci mine in southeastern Arizona. This project has increased Phelps Dodge's share of annual electrowon copper production capacity by approximately 130 million pounds. The expansion involved the development of the Southside ore deposit adjacent to the existing open-pit mine at Morenci. The expansion included the construction of an electrowinning tankhouse, the expansion of existing solution extraction plants, the upgrading of infrastructure systems and the addition of mining equipment.\nCopper unit production costs generally have been stable for the three-year period ended December 31, 1995, primarily as a result of high levels of production of low-cost cathode copper at SX\/EW plants in Morenci, Arizona; Tyrone, New Mexico; and Santa Rita, New Mexico; and as a result of the closure of the higher cost concentrator operations at Tyrone in February 1992. In 1995, the Corporation produced a total of 364,200 tons of cathode copper at its SX\/EW facilities, compared with 325,800 tons in 1994 and 308,200 tons in 1993. The SX\/EW method is a cost-effective process of extracting copper from certain types of ores. As used by the Corporation in conjunction with its conventional concentrating, smelting and refining, SX\/EW is a major factor in its continuing efforts to maintain internationally competitive costs.\nConcentrate production at Tyrone, which historically approximated 100,000 tons of copper annually, was indefinitely suspended in February 1992 because the higher grade sulfide copper ore reserves were substantially depleted. However, in order to operate the Burro Chief SX\/EW plant near Tyrone at capacity, the Corporation has undertaken mine-for-leach operations. In early 1992, the Corporation completed a fourth expansion of the SX\/EW plant, increasing its production capacity to 70,000 tons of cathode copper per year. The Corporation expects to operate the plant for the next 10 years or more; however, unless further reserves are identified, production will decline toward the latter part of that period.\nThe Corporation has additional sources of copper that could be placed in production should market circumstances warrant. Permitting and significant capital expenditures would be required, however, to develop such additional production capacity.\nRESULTS OF PHELPS DODGE INDUSTRIES\nPhelps Dodge Industries is a business segment comprising a group of companies that manufacture engineered products principally for the transportation, energy and telecommunications sectors worldwide. Its operations are characterized by products with significant market share, internationally competitive cost and quality, and specialized engineering capabilities. This business segment includes the Corporation's carbon black operations through Columbian Chemicals Company and its subsidiaries (Columbian Chemicals); its wheel and rim operations through Accuride Corporation and its subsidiaries (Accuride); and its wire and cable and specialty conductor operations through Phelps Dodge International Corporation and Phelps Dodge Magnet Wire Company and their subsidiaries and affiliates.\n- --------------------------------------------------------------------------------\n1995 1994 1993 ---- ---- ---- (millions of dollars)\nSales and other operating revenues ..... $ 1,696.7 1,468.5 1,275.6 Operating income ....................... $ 243.3 106.1 129.1\n- --------------------------------------------------------------------------------\nPhelps Dodge Industries reported 1995 operating income of $243.3 million including a pre-tax gain of $26.8 million from the sale of Columbian Chemicals Company's synthetic iron oxide division (MAPICO), compared with 1994 operating income of $150.7 million that was reduced to $106.1 million by $44.6 million of 1994 fourth quarter non-recurring pre-tax charges applicable to its facilities. Operating income in 1993 was $129.1 million. Higher 1995 operating earnings primarily reflected continued excellent results in the carbon black business which saw higher average worldwide prices and higher sales volumes both in the United States and Europe, especially from new operations in Hungary and recently acquired operations in Spain. Increased 1995 operating income also reflected higher prices and sales volumes in the wire and cable businesses and in the wheel and rim business (which experienced a modest decline in sales volumes in the 1995 fourth quarter). Earnings increases in 1994 over 1993 were attributable to the continuing economic recovery in North America, particularly in the automotive sector, as well as improved economic conditions in Europe. This resulted in higher sales volumes of wheels and rims, magnet wire and carbon black.\nColumbian Chemicals' 1995 earnings were higher than in 1994 primarily because of higher sales in both North America, as overall capacity continued to tighten in the industry, and Europe. Margins in North America were favorably affected by high operating rates and improved prices. European sales volumes and prices improved during the course of the year as European economies continued to recover from the recent recession. Columbian Chemicals' 1994 earnings were higher than in 1993 primarily because of higher sales volumes and prices in North America and Europe. The 1994 earnings were offset in part by a non-recurring pre-tax provision of approximately $9.0 million for the closure of its plant in Hamburg, Germany, reflecting that plant's high cost structure and environmental restrictions. This charge was included in the 1994 fourth quarter reserve discussed in Note 2 to the Consolidated Financial Statements.\nIn December 1994, Columbian Chemicals, through its wholly owned subsidiary, Columbian Carbon Spain, S.A., acquired for approximately $25 million the assets of a carbon black plant in Santander, Spain, from Repsol Quimica S.A. The acquisition of this plant increases the presence of Phelps Dodge Industries in the European market and extends the ability of Columbian Chemicals to serve customers in Spain and Portugal.\nIn late 1993, Columbian Chemicals and its joint venture partner, Tiszai Vegyi Kombinat (TVK), began operation through Columbian Tiszai Carbon Ltd. (CTC) of the first carbon black manufacturing plant in Hungary. Located in the northeastern Hungarian city of Tiszaujvaros, CTC has an annual production capacity sufficient to supply the entire Hungarian carbon black market. In excess of 80 percent of CTC's production is exported. Columbian Chemicals holds a 60 percent interest in CTC; TVK, Hungary's largest petrochemical company, holds the remaining 40 percent interest.\nAccuride's 1995 earnings exceeded its 1994 earnings principally as a result of higher sales volumes and prices. North American demand for light, medium and heavy trucks and trailers continued to be strong for most of 1995. Industry build rates for commercial light trucks, heavy trucks and trailers, which were at near-record levels for most of 1994 and 1995, began to decrease in the 1995 fourth quarter. This late-1995 decrease in new and backlogged orders may be an indication of a predicted cyclical softening of this market. The increase in 1994 earnings over those in 1993 resulted from a 16 percent increase in sales volume of wheels, rims and components in response to strong demand.\nHigher 1995 earnings from Phelps Dodge Magnet Wire were primarily the result of an increase in sales volumes and improved margins. In addition to an increase in selling prices, margins also benefited from producing at capacity and the effects of certain cost reduction programs. Earnings in 1994 exceeded 1993 earnings as a result of sales volume increases and improved margins in North America. Demand in the housing, automotive and major home appliance industries allowed the company to operate at capacity throughout 1994. Sales volumes benefited from the acquisition in early 1994 of two U.S. magnet wire facilities.\nIn March 1994, Phelps Dodge Magnet Wire Company acquired for approximately $52.0 million certain assets of a plant that manufactures fine-gauge magnet wire in Laurinburg, North Carolina, from Rea Magnet Wire Company, Inc. (Rea), and certain assets of a magnet wire manufacturing plant in El Paso, Texas, from Texas Magnet Wire Company, an affiliate of Rea and Fujikura International, Inc. The capacity of the Laurinburg and El Paso facilities is expected to increase by 60 percent and 100 percent, respectively, upon completion of plant expansion projects currently under way.\nIn response to demand by Japanese subsidiary companies located in North America, SPD Magnet Wire Company, a joint venture of Phelps Dodge Magnet Wire Company and Sumitomo Electric Industries, Ltd., each owning a 50 percent interest, expanded its plant in Edmonton, Kentucky. The capacity of this facility has increased by 75 percent after new equipment was installed in late 1995.\nIn March 1993, Phelps Dodge Magnet Wire Company expanded its international presence with the acquisition of Elektrodraht Mureck, Phelps Dodge Eldra GmbH. The magnet wire joint venture with Eldra Elektrodraht-Erzeugung GmbH, a leading European magnet wire manufacturer, is located in Mureck, Austria. Phelps Dodge holds a 51 percent interest in the company; Eldra Elektrodraht-Erzeugung GmbH holds the remaining 49 percent.\nThe 1995 earnings of Phelps Dodge International Corporation were higher than those in 1994 primarily as a result of higher sales volumes and prices. Earnings increased despite the continuation of the economic difficulties in Venezuela and the opening of traditionally local Latin American markets to global competition. Sales volumes benefited from the continued growth of the telephone cable and energy cable markets in Thailand while the Venezuelan business benefited from increased demand for energy cable from that country's oil industry. Earnings for the U.S. specialty conductor business also improved in 1995 as manufacturing cost reduction programs and an administrative reorganization began to take effect. Earnings in 1994 were lower than 1993 earnings primarily because of the economic difficulties in Venezuela and economic slowdowns in Mexico and Chile. These conditions resulted in additional costs associated with complying with strict foreign exchange controls instituted in June 1994 by the Venezuelan government, and a pre-tax loss of $7.0 million on the sale of the Corporation's 40 percent interest in its Mexican associate company, CONELEC S.A. de C.V. Earnings in 1994 also reflected a pre-tax provision of $20.0 million for the impairment of value of the Corporation's wholly owned U.S. specialty conductor operations. This charge reflected an unfavorable change in market conditions, particularly in the defense sector, that is now considered permanent. The loss on the sale of CONELEC and the provision for impairment of value of the specialty conductor business are included in the 1994 fourth quarter reserve discussed in Note 2 to the Consolidated Financial Statements. The effect of these charges on earnings was offset in part by higher sales volumes, particularly in Thailand where earnings benefited from strong demand for telephone cables. Earnings in 1993 reflected the integration of a group of Venezuelan wire and cable manufacturing companies acquired in late 1992, and the continued growth of telephone cable, power cable and commercial wire sales in other markets.\nIn 1995, operations outside the United States provided 51 percent of Phelps Dodge Industries' sales, compared with 48 percent in 1994 and 51 percent in 1993. During the year, operations outside the United States contributed 53 percent of the segment's operating income (after excluding from U.S. earnings the $26.8 million pre-tax gain on the sale of Columbian Chemicals Company's MAPICO division), compared with 52 percent in 1994 and 66 percent in 1993.\nOTHER MATTERS RELATING TO THE STATEMENT OF CONSOLIDATED OPERATIONS\nThe Corporation reported net interest expense in 1995 of $62.0 million, compared with $36.6 million in 1994 and $37.0 million in 1993. Increased 1995 net interest expense principally resulted from the cessation of capitalization of interest costs for the Candelaria project in Chile reflecting the substantial completion of construction and development in the 1994 fourth quarter. The 1995 increase also reflected interest expense on second half 1994 borrowings at Candelaria that remain outstanding, and interest expense on increased short-term borrowings at the Corporation's international wire and cable operations to finance working capital requirements. Partially offsetting the 1995 increases were foreign currency exchange gains of $8.1 million reflecting the remeasurement of Venezuelan local currency debt after a major devaluation of the Bolivar. Reported net interest expense remained relatively constant between 1994 and 1993 despite a $49.7 million increase in debt in 1994 and a $158.7 million increase in debt in 1993. This resulted from the capitalization of interest charges (totaling $20.7 million in 1994, compared with $17.5 million in 1993) primarily relating to the construction and development of two major projects -- Candelaria and the carbon black project in Hungary. Capitalization of interest charges for the carbon black plant in Hungary ceased at the end of 1993.\nThe Corporation's 1995 miscellaneous income, net of miscellaneous expense, was $37.2 million, compared with $11.3 million in 1994 and $16.4 million in 1993. The increase in 1995 primarily resulted from higher interest income earned on cash and short-term investments. Miscellaneous income in 1995 also included an increase of $10.1 million in dividends received from the Corporation's 13.9 percent minority interest in Southern Peru Copper Corporation. The decrease in 1994 from 1993 principally reflected losses of $6.3 million from changes in currency exchange rates, especially in countries with highly inflationary economies (particularly Venezuela).\nFor the year ended December 31, 1995, the Corporation recorded a provision for taxes of $322.7 million (an effective rate of approximately 30.0 percent). This compares with a 1994 provision for taxes of $104.7 million (an effective rate of approximately 27.9 percent) and a 1993 provision of $105.9 million (an effective rate of approximately 34.6 percent). The 1995 effective rate was higher than 1994 primarily as a result of a decrease in the tax benefit for percentage depletion. Despite higher average realized copper prices in 1995, the benefit from the Corporation's allowable deduction for percentage depletion decreased from 1994 due to the first full year of operating results at Candelaria which are not subject to percentage depletion. The 1994 effective rate was lower than the 1993 effective rate as a result of an increase in the tax benefit for percentage depletion, resulting in large part from higher average realized copper prices. The 1993 effective rate was adversely affected by the passage of the Omnibus Budget Reconciliation Act of 1993 that retroactively raised the maximum U.S. corporate tax rate from 34 percent to 35 percent effective January 1, 1993. In addition to the effect of the increase in the maximum tax rate on 1993 earnings, the Corporation was required to provide an additional $6.0 million for deferred taxes on temporary differences existing at December 31, 1992. (See Note 6 to the Consolidated Financial Statements for a reconciliation of the Corporation's effective tax rates to statutory rates.)\nThe Corporation's federal income tax returns for the years 1992, 1993 and 1994 are currently under examination. The Corporation has received proposed assessments from the Internal Revenue Service relating to the Corporation's federal income tax liability for the years 1990 and 1991 and will contest those proposals with the appropriate authorities. The Corporation has reached a tentative agreement with the Internal Revenue Service to settle the proposed assessment relating to the Corporation's federal income tax liability for the years 1988 and 1989. Management believes that it has made adequate provision so that the final resolution of the issues involved, including application of those determinations to subsequent open years, will not have a material adverse effect on the consolidated financial condition or results of operations of the Corporation. It is possible, however, that settlement of these issues may have a material effect on the timing and extent of its tax payments.\nUnder current financial accounting standards, any significant year-to-year movement in the rate of interest on long-term, high-quality corporate bonds necessitates a change in the discount rate used to calculate the actuarial present value of the Corporation's accumulated pension and other postretirement benefit obligations. As a result of the 1995 decrease in long-term interest rates, the Corporation decreased its discount rate from 8.5 percent at December 31, 1994, to 7.25 percent at December 31, 1995. The Corporation's estimated pension obligations increased by a net $68 million primarily as a result of this discount rate decrease. The effect of the decreased discount rate on these pension obligations was offset mostly by better-than-expected returns on plan assets. Other estimated postretirement benefit obligations of the Corporation increased by a net $14 million as a result of the discount rate decrease. The effect of the decreased discount rate on this estimated obligation was offset mostly by a 1 percentage point decrease for each year in the assumed annual rate of increase in the per capita cost of covered health care benefits. For a further discussion of these issues, see Notes 15 and 16 to the Consolidated Financial Statements.\nCHANGES IN FINANCIAL CONDITION; CAPITALIZATION\nAt the end of 1995, the Corporation had cash and short-term investments of $608.5 million, compared with $286.9 million at the beginning of the year. The Corporation's operating activities provided $959.0 million of cash during the year which was more than adequate to cover dividend payments on its common stock and its investing activities.\nThe Corporation also used cash provided by operating activities to purchase 2,760,600 of its common shares at a total cost of $163 million, including 2,675,600 shares under a 5 million share buy-back program authorized on March 7, 1995, and 85,000 shares under the superseded program. There were 68,593,300 common shares outstanding on December 31, 1995. On March 6, 1996, the Corporation announced that its current share purchase authorization had been increased from 5 million shares to a total of 10 million shares. Through March 7, 1996, the Corporation purchased a total of 4,424,900 of its common shares under the program, leaving an additional 5,575,100 shares authorized for purchase. The Corporation will continue to make purchases in the open market as circumstances warrant, and will also consider purchasing shares in privately negotiated transactions.\nInvesting activities during 1995 included capital expenditures of $404.9 million, compared with $355.0 million in 1994 and $387.2 million in 1993. The 1995 capital expenditures included $40 million for certain mining properties owned by Azco Mining, Inc. and its subsidiaries, comprising the Sanchez property in southeastern Arizona and a 70 percent interest in the Piedras Verdes property in Mexico. Investing activities in 1995 also included cash proceeds of $45.0 million for the divestiture of Columbian Chemicals Company's synthetic iron oxide facility (MAPICO). The $32.2 million decrease in 1994 capital expenditures from 1993 principally reflected higher 1993 spending on the Candelaria project, substantially completed in October 1994, and the Hungarian carbon black plant, substantially completed in late 1993. These 1994 decreases in spending were offset partially by increased spending on Phelps Dodge Mining Company's Southside expansion at its Morenci mine. Investments in subsidiaries in 1994 included the acquisition of two U.S. magnet wire facilities for approximately $52.0 million and the acquisition of a carbon black plant in Spain for approximately $25.0 million. Investing activities in 1994 also included cash proceeds of $15.0 million from the divestiture of the Corporation's 40 percent interest in its Mexican associate company, CONELEC S.A. de C.V., and $8.0 million from the issuance of shares of the Corporation's majority-owned affiliate in Venezuela.\nThe Corporation expects capital outlays in 1996 to be approximately $300 million for Phelps Dodge Mining Company and approximately $125 million for Phelps Dodge Industries. These capital outlays will be funded from cash reserves and operating cash flow or, if necessary, from other borrowings.\nThe $6.4 million increase in dividend payments on the Corporation's common shares, from $119.2 million in 1994 to $125.6 million in 1995, principally resulted from a 9 percent increase in the dividend rate in the 1994 fourth quarter (from 41.25 cents per common share to 45 cents per common share).\nThe Corporation's total debt was $696.5 million at December 31, 1995 (including $66.6 million of foreign short-term borrowings), compared with $696.9 million at the end of 1994 (including $49.3 million of foreign short-term borrowings). Total debt remained virtually unchanged as short-term borrowings at the Corporation's international wire and cable operations to finance working capital requirements were offset by payments on the Corporation's foreign long-term debt. The ratio of total debt to total capitalization was 20.2 percent at the end of 1995, compared with 23.6 percent at the end of 1994.\nDuring the 1995 second quarter, the Corporation's majority-owned subsidiary, Compania Contractual Minera Candelaria (CCMC), satisfied all operating, financial, construction and legal tests and conditions as set forth in the completion agreement associated with the $290.0 million project financing of its Candelaria mine in Chile. Borrowings under these debt facilities are now non-recourse to Phelps Dodge. Financing agreements for the $290 million debt were executed during 1993. The debt carries a 13-year maturity, and comprises $200 million of floating rate dollar denominated debt, $60 million of fixed rate dollar denominated debt, and $30 million of floating rate debt denominated in Chilean pesos. The agreements provide for a nine and one-half year repayment period, which starts in 1997. As the Corporation consolidates its interest in majority-owned mining joint ventures using the proportional consolidation method, only 80 percent of this debt and related financing charges have been reflected in the Corporation's consolidated financial statements. The Corporation also caused CCMC to enter into an interest rate protection agreement with certain financial institutions to limit the effect of increases in the cost of the $200 million of floating rate debt. Under the terms of the agreement, the project will receive payments from these institutions if the six-month London Interbank Offered Rate (LIBOR) exceeds 9 percent prior to December 31, 2001, and 11 percent during the two subsequent years ending December 31, 2003.\nDuring 1993, the Corporation's 60-percent-owned Hungarian subsidiary, Columbian Tiszai Carbon Ltd., borrowed $33.5 million under facilities from the Overseas Private Investment Corporation (OPIC) and the European Bank for Reconstruction and Development (EBRD) to finance construction of a carbon black manufacturing plant. Both facilities are with recourse to Columbian Chemicals Company until satisfaction of certain completion tests, and non-recourse thereafter.\nDuring 1994, the Corporation issued $81.1 million of tax-exempt, unsecured 5.45 percent obligations due in 2009. The proceeds from the issue were used to retire the Corporation's 5.75 percent to 6.25 percent Series A and B notes due in the years 1994 through 2004.\nIn February 1993, the Corporation sold $90 million of tax-exempt, unsecured 6.50 percent refunding bonds due April 1, 2013. The proceeds from the sale of these bonds were used in April 1993 to repay the Corporation's 7 percent Installment Sale Obligations due in the years 1993 through 2003.\nAn existing revolving credit agreement between the Corporation and several lenders was amended on October 31, 1994. The agreement, as amended, permits borrowings of up to $200 million from time to time until its maturity on October 31, 1999. Interest is payable at a fluctuating rate based on the agent bank's prime rate or a fixed rate, based on the Eurodollar Interbank Offered Rate or at fixed rates offered independently by the several lenders, for maturities of from seven to 360 days. This agreement provides for a facility fee of one-eighth of 1 percent of total commitments. The agreement requires the Corporation to maintain a minimum consolidated tangible net worth of $1.1 billion and limits indebtedness to 40 percent of total consolidated capitalization. There were no borrowings under this agreement at either December 31, 1995, or December 31, 1994.\nThe Corporation had other lines of credit totaling $100.0 million at December 31, 1995, and December 31, 1994. These facilities are subject to agreement as to availability, terms and amount. There were no borrowings outstanding under these lines of credit at either December 31, 1995, or December 31, 1994.\nThe Corporation had $66.6 million in short-term borrowings, all by its international operations, at December 31, 1995, compared with $49.3 million at December 31, 1994. The weighted average interest rate on this debt at December 31, 1995, and December 31, 1994, was 18.5 percent and 14.9 percent, respectively.\nAccuride Canada Inc. has a revolving credit facility that permits borrowings of up to U.S. $25.0 million. Interest on these borrowings is payable at a fluctuating rate based on the agent bank's Base Rate Canada, or a fixed rate based on LIBOR, for maturities of one week to six months. This facility, which is subject to renewal annually, provides for a standby fee of one-eighth of 1 percent of the $25.0 million. There were no borrowings outstanding under this facility at either December 31, 1995, or December 31, 1994.\nThe current portion of the Corporation's long-term debt, scheduled for payment in 1996, is $16.8 million including $13.7 million for its international manufacturing operations, $2.2 million for its mining operations and $0.9 million for other Corporate obligations.\nDuring 1995, increases in current assets (exclusive of cash and short-term investments) together with decreases in current liabilities (exclusive of current debt) resulted in an $84.2 million change in net working capital (exclusive of adjustments for foreign currency exchange rate changes). This change principally resulted from a $55.5 million decrease in accounts payable, a $29.5 million decrease in accrued income taxes, a $15.8 million increase in inventories and an $11.9 million increase in supplies, partially offset by a $36.8 million increase in accrued expenses. The $55.5 million decrease in accounts payable primarily resulted from lower copper concentrate purchase requirements by Phelps Dodge Mining Company's smelter operations and the timing of raw material purchases by the Phelps Dodge Industries businesses. The $29.5 million decrease in accrued income taxes was principally the result of approximately $22 million in additional federal income taxes paid in the first quarter of 1995 with the Corporation's 1994 income tax return. The $15.8 million increase in inventories was attributable to higher inventories of copper at Phelps Dodge Mining Company, partially offset by lower inventories at Accuride. The $11.9 million increase in supplies was the result of increases at Candelaria and Accuride. The $36.8 million increase in accrued expenses primarily resulted from higher accruals for copper conversion and freight charges and accruals for certain costs associated with higher copper prices at Phelps Dodge Mining Company (higher conversion and freight accruals are due to the higher copper inventory balances at the end of 1995), and an increase in the current portion of Corporate-wide pension liabilities due to an increase in expected plan funding in 1996 resulting from certain provisions of the recently enacted General Agreement on Tariffs and Trade (GATT).\nDuring 1994, increases in current assets (exclusive of cash and short-term investments) exceeded increases in current liabilities (exclusive of current debt) by $36.0 million. This change in net working capital (exclusive of adjustments for foreign currency exchange rate changes) principally resulted from a $138.6 million increase in accounts receivable and a $35.4 million increase in inventories, partially offset by a $110.3 million increase in accounts payable and accrued expenses and a $32.2 million increase in accrued income taxes. The $138.6 million increase in accounts receivable was primarily the result of higher copper sales prices and volumes in 1994 and higher sales volumes of carbon black, magnet wire and wheels and rims. The $35.4 million increase in inventories was attributable to higher inventories of copper, silver and gold at Phelps Dodge Mining Company and higher inventories of aluminum and other raw materials at Phelps Dodge Industries, especially in Thailand. The $110.3 million increase in accounts payable and accrued expenses principally resulted from the timing of raw material and equipment purchases. The $32.2 million increase in accrued income taxes primarily resulted from higher pre-tax income in 1994 and a lower year-end balance at December 31, 1993, due to $26.6 million of additional federal income taxes paid during 1993 with the Corporation's amended 1991 income tax return.\nThe Corporation is subject to federal, state and local environmental laws, rules and regulations, including the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (CERCLA or Superfund), as amended by the Superfund Amendments and Reauthorization Act of 1986. Under Superfund, the Environmental Protection Agency (EPA) has identified approximately 35,000 sites throughout the United States for review, ranking and possible inclusion on the National Priorities List (NPL) for possible response. Among the sites identified, EPA has included 13 sites owned by the Corporation. The Corporation believes that most, if not all, of its sites so identified will not qualify for listing on the NPL.\nIn addition, the Corporation may be required to remove hazardous waste or remediate the alleged effects of hazardous substances on the environment associated with past disposal practices at sites not owned by the Corporation. The Corporation has received notice that it is a potentially responsible party from EPA and\/or individual states under CERCLA or a state equivalent and is participating in environmental assessment and remediation activity at 36 sites. For further information about these proceedings, see Item 3. Legal Proceedings, Part IV.\nThe 1990 Amendments to the federal Clean Air Act require EPA to develop and implement many new requirements, and they allow states to establish new programs to implement some of the new requirements, such as the requirements for operating permits under Title V of the 1990 Amendments and hazardous air pollutants under Title III of the 1990 Amendments. Because EPA has not yet adopted or implemented all of the changes required by Congress, the air quality laws will continue to expand and change in coming years as EPA develops new requirements and then implements them or allows the states to implement them. Nevertheless, most states have made or are in the process of making certain required changes to their laws regarding Title V. In response to these new laws, several of the Corporation's subsidiaries already have submitted or are in the process of preparing applications for Title V operating permits. These programs will likely increase the Corporation's regulatory obligations and compliance costs. These costs could include implementation of maximum achievable control technology for any of the Corporation's facilities that is determined to be a major source of federal hazardous air pollutants. Until more of the implementing regulations are adopted, and more experience with the new programs is gained, it is not possible to determine the impact of the new requirements on the Corporation.\nAt December 31, 1995, the Corporation had reserves of $144.1 million for remediation of certain of the sites referred to above and other environmental costs in accordance with its policy to record liabilities for environmental expenditures when it is probable that obligations have been incurred and the costs reasonably can be estimated. The Corporation's estimates of these costs are based upon currently available facts, existing technology, and presently enacted laws and regulations. Where the available information is sufficient to estimate the amount of liability, that estimate has been used; where the information is only sufficient to establish a range of probable liability and no point within the range is more likely than any other, the lower end of the range has been used.\nThe amounts of the Corporation's liabilities for remedial activities are very difficult to estimate due to such factors as the unknown extent of the remedial actions that may be required and, in the case of sites not owned by the Corporation, the unknown extent of the Corporation's probable liability in proportion to the probable liability of other parties. The Corporation has probable environmental liabilities that in its judgment cannot reasonably be estimated, and losses attributable to remediation costs are reasonably possible at other sites. The Corporation cannot now estimate the total additional loss it may incur for such environmental liabilities, but such loss could be substantial.\nThe possibility of recovery of some of the environmental remediation costs from insurance companies or other parties exists; however, the Corporation does not recognize these recoveries in its financial statements until they become probable.\nThe Corporation's operations are subject to myriad environmental laws and regulations in jurisdictions both in the United States and in other countries in which it does business. For further discussion of these laws and regulations, please see \"Environmental and Other Regulatory Matters\" and \"Environmental Matters\" in Part I, Items 1 and 2 of this report. The estimates given in those discussions of the capital expenditures for programs to comply with applicable environmental laws and regulations in 1996 and 1997, and the expenditures for those programs in 1995, are separate from the reserves and estimates described above.\nOn December 23, 1994, Chino Mines Company (CMC), which is two-thirds owned by Phelps Dodge Corporation and is located near Silver City, New Mexico, entered into an Administrative Order on Consent (AOC) with the New Mexico Environment Department that will require CMC to study the environmental impacts and potential health risks associated with portions of the CMC property affected by historical mining operations. Phelps Dodge acquired CMC at the end of 1986. Those studies began in 1995 and, until completed, it will not be possible to determine the nature, extent, cost, and timing of remedial work which will be required under the AOC, although remedial work is expected to be required.\nIn 1993 and 1994, the New Mexico and Arizona legislatures, respectively, passed laws requiring the reclamation of mined lands in those states. The New Mexico Mining Commission adopted rules for the New Mexico program during 1994, and the Corporation's operations began submitting the required permit applications in December 1994. The Arizona State Mine Inspector has been directed to adopt rules implementing the Arizona law by June 30, 1996. These laws and regulations will likely increase the Corporation's regulatory obligations and compliance costs with respect to mine closure and reclamation. At this time, it is not possible to quantify the impact of the new laws and regulations on the Corporation.\nIn 1995, legislation was introduced in both the U.S. House of Representatives and the U.S. Senate to amend the Mining Law of 1872. None of the bills was enacted into law. However, mining law amendments were added to the 1996 budget bill, which is still the subject of negotiation between the Congress and the President. The amendments contained in the budget bill (i) impose a 5 percent net proceeds royalty on minerals extracted from federal lands, (ii) require payment of fair market value for patenting federal lands, (iii) make permanent the existing claim maintenance fee and double the fee in the future, and (iv) require that patented lands used for non-mining purposes revert to the federal government. While the effect of such changes on Phelps Dodge's current operations and other currently owned mineral resources on private lands would be minimal, passage of the amendments would result in additional expenses in the development and operation of new mines on federal lands.\nCAPITAL OUTLAYS\nThe Corporation's capital outlays in each of the past three years are set forth in the following table. These capital outlays are exclusive of capitalized interest and the portions of the expenditures at Morenci, Chino and Candelaria payable by minority interest holders.\n- --------------------------------------------------------------------------------\n1995 1994 1993 ---- ---- ---- (millions of dollars)\nPhelps Dodge Mining Company: Southside project (Morenci mine) ..... $ 112.6 49.6 - Azco acquisition ..................... 40.2 - - Candelaria ........................... 15.1 137.9 189.8 Other ................................ 153.7 111.7 95.6 ------- ------- ------- 321.6 299.2 285.4 Phelps Dodge Industries ................ 82.3 55.1 101.2 Corporate and other .................... 1.0 0.7 0.6 ------- ------- ------- $ 404.9 355.0 387.2 ======= ======= =======\n- --------------------------------------------------------------------------------\nINFLATION\nDuring the last three years, the principal impact of general inflation upon the financial results of the Corporation has been on unit production costs, especially supply costs, at the Corporation's mining and industrial operations. In considering the impact of changing prices on the financial results of the Corporation, it is important to recognize that the selling price of the Corporation's principal product, copper, does not necessarily parallel the rate of inflation or deflation.\nDIVIDENDS AND MARKET PRICE RANGES\nPhelps Dodge's common shares are listed on the New York Stock Exchange, the principal market on which they are traded. At March 6, 1996, there were 11,894 holders of record of the Corporation's common shares. The Corporation paid quarterly dividends of 41.25 cents on each common share throughout 1993 and for the first three quarters of 1994. In the 1994 fourth quarter, the quarterly dividend was increased 9 percent to 45 cents on each common share and has continued at that rate.\nThe table below sets forth the high, low and closing prices per common share (composite quotation) in the periods indicated.\n- --------------------------------------------------------------------------------\nMarket Price Ranges * - ---------------------\nHigh Low Close ---- ---- ---- 1995: - ---- First Quarter .... $ 63.00 51.88 56.88 Second Quarter ... 60.25 52.50 59.00 Third Quarter .... 70.50 58.50 62.75 Fourth Quarter ... 69.50 59.75 62.25\n1994: - ---- First Quarter .... $ 59.50 47.63 52.25 Second Quarter ... 60.88 50.50 57.00 Third Quarter .... 65.00 55.88 62.00 Fourth Quarter ... 64.00 54.38 61.88\n1993: - ---- First Quarter .... $ 55.63 47.75 50.38 Second Quarter ... 50.75 41.50 44.63 Third Quarter .... 49.25 39.13 39.75 Fourth Quarter ... 50.88 40.00 48.75\n- ---------------\n* The market price ranges reflect actual share prices as reported for each day's trading.\n- --------------------------------------------------------------------------------\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - ----------------------------------------------------\nPHELPS DODGE CORPORATION AND CONSOLIDATED SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS\nThe consolidated balance sheet at December 31, 1995 and 1994, and the related consolidated statements of income, of cash flows and of common shareholders' equity for each of the three years in the period ended December 31, 1995, and notes thereto, together with the report thereon of Price Waterhouse LLP dated January 22, 1996, follow. The additional financial data referred to below should be read in conjunction with these financial statements. Schedules not included with these additional financial data have been omitted because they are not applicable or the required information is shown in the financial statements or notes thereto. The individual financial statements of the Corporation have been omitted because the Corporation is primarily an operating company and all subsidiaries included in the consolidated financial statements, in the aggregate, do not have minority equity interests and\/or indebtedness to any person other than the Corporation or its consolidated subsidiaries in amounts which together exceed 5 percent of total consolidated assets at December 31, 1995. Separate financial statements of subsidiaries not consolidated and 50 percent or less owned persons accounted for by the equity method, other than those for which summarized financial information is provided in Note 3 to the Consolidated Financial Statements, have been omitted because, if considered in the aggregate, such subsidiaries and 50 percent or less owned persons would not constitute a significant subsidiary.\nADDITIONAL FINANCIAL DATA\nFinancial statement schedule for the years ended December 31, 1995, 1994 and 1993:\nVIII - Valuation and qualifying accounts and reserves.\nREPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE\nTo the Board of Directors of Phelps Dodge Corporation\nOur audits of the consolidated financial statements referred to in our report dated January 22, 1996 appearing on page 54 of this report also included an audit of the Financial Statement Schedule listed in the foregoing index titled \"Additional Financial Data.\" 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\nPhoenix, Arizona January 22, 1996\nREPORT OF MANAGEMENT\nThe management of Phelps Dodge Corporation is responsible for preparing the consolidated financial statements presented in this annual report and for their integrity and objectivity. The statements have been prepared in accordance with generally accepted accounting principles appropriate in the circumstances, and include amounts that are based on management's best estimates and judgments. Management also has prepared the other information in this annual report and is responsible for its accuracy and consistency with the financial statements.\nManagement maintains a system of internal controls, including internal accounting controls, which in management's opinion provides reasonable assurance that assets are safeguarded and that transactions are properly recorded and executed in accordance with management's authorization. The system includes formal policies and procedures that are communicated to employees with significant roles in the financial reporting process and updated as necessary. The system also includes the careful selection and training of qualified personnel, an organization that provides a segregation of responsibilities and a program of internal audits that independently assesses the effectiveness of internal controls and recommends possible improvements.\nThe Audit Committee, currently consisting of six non-employee directors, meets at least three times a year to review, among other matters, internal control conditions and internal and external audit plans and results. It meets periodically with senior officers, internal auditors and independent accountants to review the adequacy and reliability of the Corporation's accounting, financial reporting and internal controls.\nThe consolidated financial statements have also been audited by Price Waterhouse LLP, our independent accountants, whose appointment was ratified by the shareholders. The Price Waterhouse LLP examination included a study and evaluation of internal accounting controls to establish a basis for reliance thereon in determining the nature, extent and timing of audit tests applied in the examination of the financial statements.\nManagement also recognizes its responsibility for fostering a strong ethical climate so that the Corporation's affairs are conducted according to the highest standards of personal and corporate conduct. This responsibility is characterized and reflected in the Corporation's code of business ethics and policies, which is distributed throughout the Corporation. The code of conduct addresses, among other things, the necessity of ensuring open communication within the Corporation; potential conflicts of interest; compliance with all applicable laws, including those relating to financial disclosure; and the confidentiality of proprietary information. The Corporation maintains a systematic program to assess compliance with these policies.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholders of Phelps Dodge Corporation\nIn our opinion, the accompanying consolidated balance sheet and the related consolidated statements of income, of cash flows and of common shareholders' equity present fairly, in all material respects, the financial position of Phelps Dodge Corporation and its subsidiaries at December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995, 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.\nPRICE WATERHOUSE LLP\nPhoenix, Arizona January 22, 1996\nCONSOLIDATED BALANCE SHEET - -------------------------- (In thousands except per share values) December December 31, 31, 1995 1994 ---- ---- ASSETS Current assets: Cash and short-term investments, at cost ....... $ 608,500 286,900 Accounts receivable, less allowance for doubtful accounts (1995 - $12,000; 1994 - $11,800) .............................. 483,700 489,500 Inventories .................................... 281,500 266,300 Supplies ....................................... 121,400 110,700 Prepaid expenses ............................... 15,500 15,900 Deferred income taxes .......................... 44,600 38,600 --------- --------- Current assets ................................ 1,555,200 1,207,900 Investments and long-term accounts receivable .. 79,000 82,000 Property, plant and equipment, net ............. 2,728,700 2,566,400 Other assets and deferred charges .............. 283,000 277,500 --------- --------- $ 4,645,900 4,133,800 ========= =========\nLIABILITIES Current liabilities: Short-term debt ................................ $ 66,600 49,300 Current portion of long-term debt .............. 16,800 25,300 Accounts payable and accrued expenses .......... 504,800 528,500 Income taxes ................................... 16,800 46,600 --------- --------- Current liabilities ........................... 605,000 649,700 Long-term debt ................................. 613,100 622,300 Deferred income taxes .......................... 358,100 243,600 Other liabilities and deferred credits ......... 318,700 365,300 --------- --------- 1,894,900 1,880,900 --------- --------- COMMITMENTS AND CONTINGENCIES (SEE NOTES 17 AND 18)\nMINORITY INTERESTS IN CONSOLIDATED SUBSIDIARIES .. 73,300 65,300 --------- --------- COMMON SHAREHOLDERS' EQUITY Common shares, par value $6.25; 100,000 shares authorized; 68,593 outstanding (1994 - 70,672) after deducting 6,595 shares (1994 - 4,503) held in treasury ............... 428,700 441,700 Capital in excess of par value .................. - 84,500 Retained earnings ............................... 2,360,100 1,770,300 Cumulative translation adjustments .............. (93,900) (93,800) Other ........................................... (17,200) (15,100) --------- --------- 2,677,700 2,187,600 --------- --------- $ 4,645,900 4,133,800 ========= =========\nSee Notes to Consolidated Financial Statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------ (Dollar amounts in tables stated in thousands except as noted)\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Consolidation. The consolidated financial statements include the accounts of the Corporation and its majority-owned subsidiaries. Interests in mining joint ventures in which the Corporation owns more than 50 percent are reported using the proportional consolidation method. Interests in other majority-owned subsidiaries are reported using the full consolidation method; the consolidated financial statements include 100 percent of the assets and liabilities of these subsidiaries and the ownership interests of minority participants are recorded as \"Minority interests in consolidated subsidiaries.\" All material intercompany balances and transactions are eliminated.\nInvestments in unconsolidated companies owned 20 percent or more are recorded on an equity basis. Investments in companies less than 20 percent owned are carried at cost.\nManagement's Estimates and Assumptions. 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.\nForeign Currency Translation. Except as noted below, the assets and liabilities of foreign subsidiaries are translated at current exchange rates while revenues and expenses are translated at average rates in effect for the period. The related translation gains and losses are included in a separate component of common shareholders' equity. For the translation of the financial statements of certain foreign subsidiaries dealing predominantly in U.S. dollars and for those affiliates operating in highly inflationary economies, assets and liabilities receivable or payable in cash are translated at current exchange rates, and inventories and other non-monetary assets and liabilities are translated at historical rates. Gains and losses resulting from translation of such financial statements are included in operating results, as are gains and losses incurred on foreign currency transactions.\nStatement of Cash Flows. For the purpose of preparing the Consolidated Statement of Cash Flows, the Corporation considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents.\nInventories and Supplies. Inventories and supplies are stated at the lower of cost or market. Cost for substantially all inventories is determined by the last-in, first-out method (LIFO). Cost for substantially all supplies is determined by a moving-average method.\nProperty, Plant and Equipment. Property, plant and equipment are carried at cost. Cost of significant assets includes capitalized interest incurred during the construction and development period. Expenditures for replacements and betterments are capitalized; maintenance and repair expenditures are charged to operations as incurred.\nThe principal depreciation method used for mining, smelting and refining operations is the units of production method. Buildings, machinery and equipment for other operations are depreciated using the straight-line method over estimated lives of five to 40 years, or the estimated life of the operation if shorter. Upon disposal of assets depreciated on a group basis, cost less salvage is charged to accumulated depreciation.\nValues for mining properties represent mainly acquisition costs or pre-1932 engineering valuations. Depletion of mines is computed on the basis of an overall unit rate applied to the pounds of principal products sold from mine production.\nMine exploration costs and development costs to maintain production of operating mines are charged to operations as incurred. Mine development expenditures at new mines and major development expenditures at operating mines that are expected to benefit future production are capitalized and amortized on the units of production method over the estimated commercially recoverable minerals.\nEnvironmental Expenditures. Environmental expenditures are expensed or capitalized depending upon their future economic benefits. Liabilities for such expenditures are recorded when it is probable that obligations have been incurred and the costs reasonably can be estimated. The Corporation's estimates of these costs are based upon currently available facts, existing technology, and presently enacted laws and regulations. Where the available information is sufficient to estimate the amount of liability, that estimate has been used; where the information is only sufficient to establish a range of probable liability and no point within the range is more likely than any other, the lower end of the range has been used. The possibility of recovery of some of these costs from insurance companies or other parties exists; however, the Corporation does not recognize these recoveries in its financial statements until they become probable.\nGoodwill. Included in \"Other assets and deferred charges\" are costs in excess of the net assets of businesses acquired. These amounts are amortized on a straight-line basis over periods of 15 to 40 years. The Corporation evaluates for impairment its long-term assets to be held and used and its identifiable intangible assets when events or changes in economic circumstances indicate the carrying amount of such assets may not be recoverable. Long-term assets to be disposed of are carried at the lower of cost or fair value less the costs of disposal.\nHedging Programs. The Corporation does not acquire, hold or issue derivative financial instruments for trading purposes. Derivative financial instruments are used to manage well-defined commodity price and foreign exchange risks.\nThe Corporation may periodically use various price protection programs to mitigate the risk of adverse price fluctuations on a portion of its copper production. The costs of programs that guarantee a minimum price over a specified period are amortized on a straight-line basis over that period. Gains and losses from programs that effectively establish price ranges for future production are recognized in income during the periods affected. Any net premiums paid for programs that effectively establish price ranges for future production are amortized on a straight-line basis over the period the hedge is designed to protect.\nThe Corporation periodically enters into forward exchange contracts to hedge certain recorded transactions denominated in foreign currencies and enters into currency option contracts to hedge certain firm commitments and other anticipated foreign currency transactions. The objective of the Corporation's foreign currency hedging program is to protect the Corporation from the risk that the eventual equivalent dollar cash flows resulting from transactions denominated in foreign currencies will be adversely affected by changes in exchange rates. Deferred gains and losses on option contracts are recognized in income when the underlying hedged transaction is recognized or when a previously anticipated transaction is no longer expected to occur. Changes in market value of forward exchange contracts and certain option contracts protecting anticipated transactions are recognized in the period incurred.\nThe Corporation may enter into interest rate agreements to limit the effect of increases in the interest rates on any floating rate debt. The costs associated with such agreements are amortized to interest expense over the term of the agreement.\nStock Compensation. The Corporation has elected early adoption of Statement of Financial Accounting Standards (SFAS) No. 123, \"Accounting for Stock-Based Compensation.\" In accordance with the provisions of SFAS No. 123, the Corporation applies APB Opinion 25 and related Interpretations in accounting for its stock option plans and, accordingly, does not recognize compensation cost. Note 14 to the Consolidated Financial Statements contains a summary of the pro forma effects to reported net income and earnings per share for 1995, 1994 and 1993 if the Corporation had elected to recognize compensation cost based on the fair value of the options granted at grant date as prescribed by SFAS No. 123.\nIncome Taxes. In addition to charging income for taxes actually paid or payable, the provision for taxes reflects deferred income taxes resulting from changes in temporary differences between the tax bases of assets and liabilities and their reported amounts in the financial statements. The effect on deferred income taxes of a change in tax rates is recognized in income in the period that includes the enactment date.\nPension Plans. The Corporation has trusteed, non-contributory pension plans covering substantially all of its U.S. employees and in some cases employees of international subsidiaries. The benefits are based on, in the case of certain plans, final average salary and years of service and, in the case of other plans, a fixed amount for each year of service. The Corporation's funding policy provides that payments to the pension trusts shall be at least equal to the minimum funding requirements of the Employee Retirement Income Security Act of 1974 for U.S. plans or, in the case of international subsidiaries, the minimum legal requirements in that particular country. Additional payments may also be provided by the Corporation from time to time.\nPostretirement Benefits Other Than Pensions. The Corporation has several postretirement health care and life insurance benefit plans covering most of its U.S. employees and in some cases employees of international subsidiaries. Postretirement benefits vary among plans and many plans require contributions from employees. The Corporation accounts for these benefits on an accrual basis. The Corporation's funding policy provides that payments shall be at least equal to its cash basis obligation, plus additional amounts that may be approved by the Corporation from time to time.\nPostemployment Benefits. The Corporation has certain postemployment benefit plans covering most of its U.S. employees and in some cases employees of international subsidiaries. The benefit plans may provide severance, disability, supplemental health care, life insurance or other welfare benefits. The Corporation accounts for these benefits on an accrual basis. The Corporation's funding policy provides that payments shall be at least equal to its cash basis obligation, plus additional amounts that may be approved by the Corporation from time to time.\nEarnings per Share. Earnings per share amounts are computed based on the weighted average number of shares actually outstanding during the period plus the shares that would be outstanding assuming the exercise of dilutive stock options, which are considered to be common stock equivalents. The number of equivalent shares that would be issued from the exercise of stock options is computed using the treasury stock method. Note 14 to the Consolidated Financial Statements contains a summary of the pro forma effects to reported earnings per share for 1995, 1994 and 1993 if the Corporation had elected to recognize compensation cost in accordance with SFAS No. 123, \"Accounting for Stock-Based Compensation.\"\nReclassification. For comparative purposes, certain prior year amounts have been reclassified to conform with the current year presentation.\n2. PROVISION FOR ENVIRONMENTAL COSTS AND ASSET DISPOSITIONS During the 1995 first quarter, the Corporation recognized a $26.8 million gain before taxes from the sale of Columbian Chemicals Company's synthetic iron oxide facility in St. Louis, Missouri (MAPICO). This gain increased net income by $16.6 million, or 24 cents per common share, after taxes. MAPICO was peripheral to Columbian's core business.\nIn the 1994 fourth quarter, the Corporation recorded non-recurring pre-tax charges of $140.2 million reflecting additional provisions of $98.7 million before taxes for estimated future costs associated with environmental matters primarily in Phelps Dodge Mining Company and $41.5 million before taxes for estimated losses, primarily in Phelps Dodge Industries, on the disposition of certain operating facilities. These charges reduced net income by $91.7 million, or $1.29 per common share, after taxes.\nThe pre-tax charge of $98.7 million for estimated future costs associated with environmental matters comprised $88.9 million applicable to Phelps Dodge Mining Company, $8.6 million applicable to Phelps Dodge Industries and $1.2 million applicable to Corporate and other. As a result of these 1994 environmental charges and balances remaining from previously provided charges for environmental costs, the Corporation's reserves for such costs totaled $144.1 million and $168.9 million at December 31, 1995, and December 31, 1994, respectively (see Note 1 to the Consolidated Financial Statements for further information concerning the Corporation's policy for recording environmental obligations).\nThe pre-tax charge of $41.5 million associated with the disposition of certain operating facilities included $36.0 million for Phelps Dodge Industries and $5.5 million for Phelps Dodge Mining Company issues. The portion of the charge attributable to Phelps Dodge Industries comprised a provision of $20.0 million for the impairment of value of Hudson International Conductors, a loss of $7.0 million on the sale of the Corporation's 40 percent interest in its Mexican associate company, CONELEC S.A. de C.V., and a provision of $9.0 million for the closure of Columbian Chemicals Company's plant in Hamburg, Germany.\nAlso included in the provision for environmental costs and asset dispositions for the full year 1994 was a second quarter provision for the sale of Phelps Dodge Mining Company's interest in its Santa Gertrudis gold property in Mexico and its Olinghouse gold property in Nevada. The combined net loss on the sale of these interests was $17.5 million before taxes. This charge reduced net income by $11.2 million, or 16 cents per common share, after taxes.\n3. EQUITY EARNINGS AND INVESTMENTS AND LONG-TERM RECEIVABLES Equity earnings (losses) were as follows:\n- --------------------------------------------------------------------------------\n1995 1994 1993 ---- ---- ----\nInternational wire and cable manufacturers .......................... $ 1,000 1,700 3,300 Black Mountain .......................... 4,500 6,000 (600) Santa Gertrudis ......................... - (600) (3,300) Other ................................... 1,000 1,500 600 ------- ------- ------- $ 6,500 8,600 - ======= ======= =======\n- --------------------------------------------------------------------------------\nDividends were received as follows:\n- -------------------------------------------------------------------------------- 1995 1994 1993 ---- ---- ----\nEquity investments: International wire and cable manufacturers ......................... $ 300 1,400 400 Black Mountain ......................... 5,700 2,900 - Other .................................. 100 - - ------- ------- ------- $ 6,100 4,300 400 ======= ======= ======= Cost basis investments: Southern Peru Copper Corporation (13.9%) ................... $ 13,600 3,500 2,900 Other .................................. 300 400 600 ------- ------- ------- $ 13,900 3,900 3,500 ======= ======= =======\n- --------------------------------------------------------------------------------\nInvestments and long-term receivables were as follows: - --------------------------------------------------------------------------------\n1995 1994 1993 ---- ---- ---- Equity basis: International wire and cable manufacturers ........................ $ 18,200 18,500 38,300 Black Mountain ........................ 11,300 12,800 10,200 Santa Gertrudis ....................... - - 3,000 Other ................................. 12,200 11,100 9,300 Cost basis: Southern Peru Copper Corporation (13.9%) ................... 13,200 13,200 13,200 Other ................................. 24,100 26,400 41,400 ------- ------- ------- $ 79,000 82,000 115,400 ======= ======= =======\n- --------------------------------------------------------------------------------\nRetained earnings of the Corporation include undistributed earnings of equity investments of (in millions): 1995 - $59.0; 1994 - $58.6; 1993 - $54.3.\nCondensed financial information for companies in which the Corporation has equity basis investments together with majority-owned foreign subsidiaries previously accounted for on an equity basis is as follows:\n- --------------------------------------------------------------------------------\n1995 1994 1993 ---- ---- ----\nSales ................................ $ 771,200 637,200 637,200 Net income ........................... 42,000 46,000 36,700 - --------------------------------------------------------------------------------\nNet current assets ................... $ 66,600 63,300 44,700 Fixed assets, net .................... 259,100 249,500 292,300 Long-term debt ....................... (40,500) (39,000) (64,900) Other assets, net .................... (3,900) (2,500) 27,500 -------- -------- -------- Net assets ........................... $ 281,300 271,300 299,600 ======== ======== ========\n- --------------------------------------------------------------------------------\n4. INTEREST EXPENSE, NET OF AMOUNT CAPITALIZED The Corporation reported net interest expense in 1995 of $62.0 million, compared with $36.6 million in 1994 and $37.0 million in 1993. Increased 1995 net interest expense principally resulted from the cessation of capitalization of interest costs for the Candelaria project in Chile reflecting the substantial completion of construction and development in the 1994 fourth quarter. Also included in 1995 interest expense were foreign currency exchange gains of $8.1 million reflecting the remeasurement of Venezuelan local currency debt after a major devaluation of the Bolivar.\n5. MISCELLANEOUS INCOME AND EXPENSE, NET Interest income totaled $31.5 million in 1995, principally from the Corporation's short-term investments, compared with $11.0 million and $10.9 million in 1994 and 1993, respectively. Miscellaneous income in 1995 also included pre-tax dividends of $13.6 million on its 13.9 percent minority interest in Southern Peru Copper Corporation, compared with $3.5 million and $2.9 million in 1994 and 1993, respectively. Losses from changes in currency exchange rates, especially in Venezuela and Chile, amounted to $10.2 million in 1995, compared with losses of $6.3 million and $0.1 million in 1994 and 1993, respectively.\n6. INCOME TAXES The Corporation reports its income taxes in accordance with SFAS No. 109, \"Accounting for Income Taxes.\" SFAS No. 109 mandates an asset and liability approach for financial accounting and reporting of income taxes. One of the principal requirements of the standard is that changes in tax rates and laws be reflected in income from operations in the period such changes are enacted. SFAS No. 109 also requires balance sheet classification of deferred income taxes according to the balance sheet classification of the asset or liability to which the temporary difference is related.\nGeographic sources of income before taxes, minority interests and equity in net earnings of affiliated companies for the years ended December 31 were as follows:\n- --------------------------------------------------------------------------------\n1995 1994 1993 ---- ---- ----\nUnited States ................. $ 816,200 298,900 258,200 Foreign ....................... 259,500 76,200 47,700 --------- ------- ------- $ 1,075,700 375,100 305,900 ========= ======= =======\n- --------------------------------------------------------------------------------\nThe provisions for income taxes for the years ended December 31 were as follows:\n- --------------------------------------------------------------------------------\n1995 1994 1993 ---- ---- ---- Currently payable: Federal ................... $ 157,800 94,000 49,900 State ..................... 23,900 14,000 8,400 Foreign ................... 38,100 25,000 18,100 --------- --------- --------- 219,800 133,000 76,400 --------- --------- --------- Deferred: Federal ................... 78,400 (27,100) 24,700 State ..................... 400 (2,500) 2,700 Foreign ................... 24,100 1,300 2,100 --------- --------- --------- 102,900 (28,300) 29,500 --------- --------- --------- $ 322,700 104,700 105,900 ========= ========= =========\n- --------------------------------------------------------------------------------\nA reconciliation of the U.S. statutory tax rate to the Corporation's effective tax rate is as follows:\n- --------------------------------------------------------------------------------\n1995 1994 1993 ---- ---- ----\nStatutory tax rate ................. 35.0 % 35.0 35.0 Depletion .......................... (5.3) (10.6) (4.7) State and local income taxes ....... 1.5 2.0 2.5 Rate increase effect on existing temporary differences ............. - - 2.0 Other items, net ................... (1.2) 1.5 (0.2) ----- ----- ----- Effective tax rate 30.0 % 27.9 34.6 ===== ===== =====\n- --------------------------------------------------------------------------------\nThe Corporation paid federal, state, local and foreign income taxes of approximately $247 million in 1995, compared with approximately $114 million in 1994 and approximately $113 million in 1993. As of December 31, 1995, the Corporation had alternative minimum tax credits of approximately $87 million available for carryforward for federal income tax purposes. These credits can be carried forward indefinitely, but may only be used to the extent the regular tax exceeds the alternative minimum tax. The Corporation also has alternative minimum foreign tax credit carryforwards for federal income tax purposes of approximately $30 million, which begin to expire in 1996.\nThe Corporation's federal income tax returns for the years 1992, 1993 and 1994 are currently under examination. The Corporation has received proposed assessments from the Internal Revenue Service relating to the Corporation's federal income tax liability for the years 1990 and 1991 and will contest those proposals with the appropriate authorities. The Corporation has reached a tentative agreement with the Internal Revenue Service to settle the proposed assessment relating to the Corporation's federal income tax liability for the years 1988 and 1989. Management believes that it has made adequate provision so that the final resolution of the issues involved, including application of those determinations to subsequent open years, will not have a material adverse effect on the consolidated financial condition or results of operations of the Corporation. It is possible, however, that settlement of these issues may have a material effect on the timing and extent of its tax payments.\nDeferred income tax assets and (liabilities) comprised the following at December 31:\n- --------------------------------------------------------------------------------\n1995 1994 ---- ----\nMinimum tax credits .............................. $ 86,700 119,000 Postretirement and postemployment benefits ....... 52,500 49,300 Reserves ......................................... 89,600 85,800 Mining costs ..................................... 33,100 19,800 Other ............................................ 6,400 13,100 --------- --------- Deferred tax assets ............................ 268,300 287,000 --------- --------- Depreciation ..................................... (540,600) (452,000) Mining properties ................................ (9,300) (13,500) Exploration and mine development costs ........... (8,300) (8,800) Pensions ......................................... (25,000) (15,500) Inventories ...................................... 1,400 (2,200) --------- --------- Deferred tax liabilities ....................... (581,800) (492,000) --------- --------- $(313,500) (205,000) ========= =========\n- --------------------------------------------------------------------------------\nIncome taxes have not been provided on the Corporation's share ($398 million) of undistributed earnings of those manufacturing and mining interests abroad over which the Corporation has sufficient influence to control the distribution of such earnings and has determined that such earnings have been reinvested indefinitely. These earnings could become subject to additional tax if they were remitted as dividends, if foreign earnings were loaned to the Corporation or a U.S. affiliate, or if the Corporation should sell its stock in the subsidiaries. It is estimated that repatriation of these foreign earnings would generate additional foreign tax withholding and U.S. tax, net of foreign tax credit, in the amounts of $61 million and $31 million, respectively.\n7. INVENTORIES AND SUPPLIES Inventories at December 31 were as follows (in millions): - --------------------------------------------------------------------------------\n1995 1994 ---- ----\nMetals and other raw materials .................. $ 200.4 176.6 Work in process ................................. 14.6 15.3 Finished manufactured goods ..................... 61.4 69.4 Other ........................................... 5.1 5.0 ------- ------ $ 281.5 266.3 ======= ======\n- --------------------------------------------------------------------------------\nInventories valued by the last-in, first-out method would have been greater if valued at current costs by approximately $115 million and $111 million at December 31, 1995 and 1994, respectively.\nSupplies in the amount of $121.4 million and $110.7 million at December 31, 1995 and 1994, respectively, are stated net of a reserve for obsolescence of $10.5 million and $14.0 million, respectively.\n8. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment at December 31 comprised the following (in millions):\n- --------------------------------------------------------------------------------\n1995 1994 ---- ----\nBuildings, machinery and equipment ................ $ 4,296.2 4,060.9 Mining properties ................................. 173.2 129.1 Capitalized mine development ...................... 284.8 283.9 Land and water rights ............................. 66.6 72.5 -------- ------- 4,820.8 4,546.4 Less accumulated depreciation, depletion and amortization ................................. 2,092.1 1,980.0 -------- ------- $ 2,728.7 2,566.4 ======== =======\nThe net increases in property, plant and equipment of $162.3 million in 1995 and $226.2 million in 1994 are summarized below (in millions):\n- --------------------------------------------------------------------------------\n1995 1994 ---- ----\nBalance at beginning of year ...................... $ 2,566.4 2,340.2 -------- ------- Capital expenditures .............................. 404.9 355.0 Depreciation, depletion and amortization .......... (218.7) (190.2) Property, plant and equipment of acquired companies ........................................ - 69.8 Asset sales, currency translation adjustments and other ........................................ (23.9) (8.4) -------- ------- 162.3 226.2 -------- ------- Balance at end of year ............................ $ 2,728.7 2,566.4 ======== =======\n- --------------------------------------------------------------------------------\n9. OTHER ASSETS AND DEFERRED CHARGES Other assets and deferred charges at December 31 were as follows (in millions):\n- --------------------------------------------------------------------------------\n1995 1994 ---- ----\nGoodwill, less accumulated amortization (1995 - $34.5; 1994 - $30.1) ....................... $ 120.8 125.2 Employee benefit plans .............................. 108.8 95.8 Debt issue costs .................................... 29.2 32.8 Intangible pension asset ............................ 18.0 18.0 Other intangible assets ............................. 4.0 4.1 Other ............................................... 2.2 1.6 ------- ------ $ 283.0 277.5 ======= ======\n- -------------------------------------------------------------------------------- 10. ACCOUNTS PAYABLE AND ACCRUED EXPENSES Accounts payable and accrued expenses at December 31 were as follows (in millions): - --------------------------------------------------------------------------------\n1995 1994 ---- ----\nAccounts payable .................................... $ 247.5 303.5 Employee benefit plans .............................. 55.8 39.5 Insurance and loss reserves ......................... 12.3 11.4 Salaries, wages and other compensation .............. 36.5 30.3 Environmental reserves .............................. 51.1 42.1 Smelting, refining and freight ...................... 25.9 15.1 Other accrued taxes ................................. 17.6 14.6 Shutdown, relocation and restructuring .............. 7.1 11.4 Interest * .......................................... 13.6 12.4 Candelaria development .............................. - 6.8 Returnable containers ............................... 3.3 4.9 Other ............................................... 34.1 36.5 ------ ------ $ 504.8 528.5 ====== ====== - ---------------\n* Interest paid by the Corporation in 1995 was $70.4 million, compared with $58.5 million in 1994 and $54.9 million in 1993.\n- --------------------------------------------------------------------------------\n11. OTHER LIABILITIES AND DEFERRED CREDITS Other liabilities and deferred credits at December 31 were as follows (in millions):\n- --------------------------------------------------------------------------------\n1995 1994 ---- ----\nPostretirement and postemployment benefit plans ......... $ 148.8 139.4 Other employee benefit plans ............................ 39.9 63.9 Environmental reserves .................................. 92.1 124.9 Shutdown, relocation and restructuring .................. 11.2 13.1 Insurance and loss reserves ............................. 20.7 20.9 Other ................................................... 6.0 3.1 ------ ------ $ 318.7 365.3 ====== ======\n- --------------------------------------------------------------------------------\n12. LONG-TERM DEBT AND OTHER FINANCING Long-term debt at December 31 is summarized below (in millions):\n- --------------------------------------------------------------------------------\n1995 1994 ---- ----\n7.75% Notes due 2002 .................................. $ 100.0 100.0 7.96% Notes due 1998-2000 ............................. 50.0 50.0 Air Quality Control Obligations: 5.45% Notes due 2009 ................................. 81.1 81.1 6.50% Installment sale obligations due 2013 .......... 90.0 90.0 Candelaria ............................................ 237.4 235.4 Ojos del Salado ....................................... 8.0 10.4 Columbian Tiszai Carbon Ltd. .......................... 30.0 33.5 Columbian Carbon Spain, S.A ........................... 14.1 13.0 Phelps Dodge International Corporation ................ 13.3 24.3 Other ................................................. 6.0 9.9 ------- ------ Long-term debt before current portion ................. 629.9 647.6 Less current portion .................................. 16.8 25.3 ------- ------ Long-term debt after current portion .................. $ 613.1 622.3 ======= ======\n- --------------------------------------------------------------------------------\nAnnual maturities of debt outstanding at December 31, 1995, are as follows (in millions): 1996 - $16.8; 1997 - $38.5; 1998 - $51.9; 1999 - $56.1; 2000 - $48.7.\nDuring 1994, the Corporation issued $81.1 million of tax-exempt, unsecured 5.45 percent obligations due in 2009. The proceeds from the issue were used to retire the Corporation's 5.75 percent to 6.25 percent Series A and B notes due in the years 1994 through 2004.\nAn existing revolving credit agreement between the Corporation and several lenders was amended on October 31, 1994. The agreement, as amended, permits borrowings of up to $200 million from time to time until its maturity on October 31, 1999. Interest is payable at a fluctuating rate based on the agent bank's prime rate or a fixed rate, based on the Eurodollar Interbank Offered Rate or at fixed rates offered independently by the several lenders, for maturities of from seven to 360 days. This agreement provides for a facility fee of one-eighth of 1 percent of total commitments. The agreement requires the Corporation to maintain a minimum consolidated tangible net worth of $1.1 billion and limits indebtedness to 40 percent of total consolidated capitalization. There were no borrowings under this agreement at either December 31, 1995, or December 31, 1994.\nAccuride Canada Inc. has a revolving credit facility that permits borrowings of up to U.S. $25.0 million. Interest on these borrowings is payable at a fluctuating rate based on the agent bank's Base Rate Canada, or a fixed rate based on the London Interbank Offered Rate (LIBOR), for maturities of one week to six months. This facility, which is subject to renewal annually, provides for a standby fee of one-eighth of 1 percent of the $25.0 million. There were no borrowings outstanding under this facility at either December 31, 1995, or December 31, 1994.\nThe Corporation had other lines of credit totaling $100.0 million at December 31, 1995, and at December 31, 1994. These facilities are subject to agreement as to availability, terms and amount. There were no borrowings outstanding under these lines of credit at either December 31, 1995, or December 31, 1994.\nThe Corporation had $66.6 million in short-term borrowings, all by its international operations, at December 31, 1995, compared with $49.3 million at December 31, 1994. The weighted average interest rate on this debt at December 31, 1995, and December 31, 1994, was 18.5 percent and 14.9 percent, respectively.\nThe Corporation's 80-percent-owned Compania Contractual Minera Candelaria (CCMC) subsidiary borrowed $290 million under its project financing agreements to finance construction of the Candelaria copper project in Chile. Under the proportional consolidation method, the Corporation reflects 80 percent of this amount in its financial statements. These borrowings became non-recourse to the Corporation subsequent to the satisfaction of certain completion tests during the second quarter of 1995. This $290 million of 13-year financing comprises $200 million of floating rate dollar denominated debt (with a rate based on the six-month LIBOR), $60 million of fixed rate dollar denominated debt, and $30 million of floating rate debt denominated in Chilean pesos (with a rate based on the 90-day Tasa Activa Bancaria), with a nine and one-half year repayment period that starts in 1997. The Corporation also caused CCMC to enter into an interest rate protection agreement with certain financial institutions to limit the effect of increases in the cost of the $200 million of floating rate dollar denominated debt. Under the terms of the agreement, the project will receive payments from these institutions if the six-month LIBOR exceeds 9 percent prior to December 31, 2001, and 11 percent during the two subsequent years ending December 31, 2003.\nThe Corporation's 60-percent-owned Hungarian subsidiary, Columbian Tiszai Carbon Ltd., borrowed $33.5 million under facilities from the Overseas Private Investment Corporation (OPIC) and the European Bank for Reconstruction and Development (EBRD) to finance construction of a carbon black manufacturing plant. Both facilities are with recourse to Columbian Chemicals Company until satisfaction of certain completion tests, and non-recourse thereafter. The OPIC facility is a $24.5 million fixed rate dollar borrowing bearing interest rates of between 8.01 percent and 9.15 percent, and the EBRD $9 million loan is a fixed rate dollar borrowing bearing an interest rate of 8.30 percent. The balances due on these borrowings mature in the years 1996 through 2001.\n13. SHAREHOLDERS' EQUITY During 1995, the Corporation purchased 2,760,600 of its common shares at a total cost of $163 million. These purchases included 2,675,600 shares under a new 5 million share buy-back program authorized on March 7, 1995, and 85,000 shares under the superseded program. There were 68,593,300 common shares outstanding on December 31, 1995.\nDuring 1994, the Corporation purchased 76,000 of its common shares under a 4 million common share buy-back program initiated in September 1989 (numbers of shares have been revised to give effect to the two-for-one stock split in May 1992). The Corporation purchased a total of 2,449,000 of its common shares under this program through December 31, 1994. These purchased shares were restored to the treasury.\nThe Corporation has 6,000,000 authorized preferred shares with a par value of $1.00 each; no shares were outstanding at either December 31, 1995, or December 31, 1994.\nIn 1988, the Corporation adopted a Preferred Share Purchase Rights Plan and declared a dividend of one right on each of its common shares. In certain circumstances, if a person or group of persons acquires or tenders for 20 percent or more of the Corporation's outstanding common shares, these rights vest and entitle the holder to certain share purchase rights. Until 10 days after vesting, the rights may be modified or redeemed by the Board of Directors.\n14. STOCK OPTION PLANS; RESTRICTED STOCK Executives and other key employees have been granted options to purchase common shares under stock option plans adopted in 1979, 1987 and 1993. In each case, the option price equals the fair market value of the common shares on the day of the grant and an option's maximum term is ten years. Options granted vest ratably over a three-year period. The options include limited stock appreciation rights under which an optionee has the right, in the event common shares are purchased pursuant to a third party tender offer or in the event a merger or similar transaction in which the Corporation shall not survive as a publicly held corporation is approved by the Corporation's shareholders, to relinquish the option and to receive from the Corporation an amount per share equal to the excess of the price payable for a common share in such offer or transaction over the option price per share.\nThe Corporation has elected early adoption of Statement of Financial Accounting Standards (SFAS) No. 123, \"Accounting for Stock-Based Compensation,\" issued in October 1995. In accordance with the provisions of SFAS No. 123, the Corporation applies APB Opinion 25 and related Interpretations in accounting for its stock option plans and, accordingly, does not recognize compensation cost. If the Corporation had elected to recognize compensation cost based on the fair value of the options granted at grant date as prescribed by SFAS No. 123, net income and earnings per share would have been reduced to the pro forma amounts indicated in the table below (in millions except per share amounts):\n- --------------------------------------------------------------------------------\n1995 1994 1993 ---- ---- ---- Net income - as reported ............... $ 746.6 271.0 187.9 Net income - pro forma ................. 741.6 266.8 184.7\nEarnings per share - as reported ....... 10.65 3.81 2.66 Earnings per share - pro forma ......... 10.60 3.76 2.62\n- --------------------------------------------------------------------------------\nThe fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions:\nExpected dividend yield 3.34% Expected stock price volatility 22.1% Risk-free interest rate 6.00% Expected life of options 3 years\nThe weighted average fair value of options granted during 1995 is $11.04 per share.\nThe 1993 plan provides (and the 1987 plan provided) for \"reload\" option grants to executives and other key employees. If an optionee exercises an option under the 1993 or 1987 plan with already-owned shares of the Corporation, the optionee receives a reload option that restores the option opportunity on a number of common shares equal to the number of shares used to exercise the original option. A reload option has the same terms as the original option except that it has an exercise price per share equal to the fair market value of a common share on the date the reload option is granted and is exercisable six months after the date of grant.\nThe 1993 plan provides (and the 1987 plan provided) for the issuance to executives and other key employees, without any payment by them, of common shares subject to certain restrictions (Restricted Stock). The 1993 plan limits the award of Restricted Stock to 1,000,000 shares.\nUnder a stock option plan adopted in 1989, options to purchase common shares have been granted to directors who have not been employees of the Corporation or its subsidiaries for one year or are not eligible to participate in any plan of the Corporation or its subsidiaries entitling participants to acquire stock, stock options or stock appreciation rights.\nAt December 31, 1995, options for 627,187 shares, 38,643 shares and 826,272 shares were exercisable under the 1987 plan, the 1989 plan and the 1993 plan, respectively, at average prices of $43.46, $39.82 and $52.70 per share. In addition, 225,925 shares of Restricted Stock issued under the 1993 plan were outstanding at December 31, 1995. Also at December 31, 1995, 2,650,259 shares were available for option grants (including 761,258 shares as restricted stock awards) under the 1993 plan (plus an additional 600,999 shares that may be issued as reload options) and 92,403 shares were available for option grants under the 1989 plan. These amounts are subject to future adjustment. No further options may be granted under the 1987 plan.\nChanges during 1993, 1994 and 1995 in options outstanding for the combined plans were as follows:\n- --------------------------------------------------------------------------------\nAverage option Shares price per share ------ ----------------\nOutstanding at December 31, 1992 ................ 1,975,850 $ 36.78 Granted ....................................... 831,896 45.11 Exercised ..................................... (377,203) 28.03 Expired or terminated ......................... (50,982) 41.37 --------- Outstanding at December 31, 1993 ................ 2,379,561 40.88 Granted ....................................... 961,087 58.35 Exercised ..................................... (479,660) 37.32 Expired or terminated ......................... (28,802) 44.34 --------- Outstanding at December 31, 1994 ................ 2,832,186 47.38 Granted ....................................... 953,838 66.37 Exercised ..................................... (635,881) 38.19 Expired or terminated ......................... (110,345) 51.03 --------- Outstanding at December 31, 1995 * .............. 3,039,798 55.13 ========= - ------------\n* Exercise prices for options outstanding at December 31, 1995, range from a minimum of approximately $27 per share to a maximum of approximately $68 per share. The average remaining maximum term of options outstanding is approximately 8 years.\n- --------------------------------------------------------------------------------\nChanges during 1993, 1994 and 1995 in Restricted Stock were as follows:\n- --------------------------------------------------------------------------------\nShares ------\nOutstanding at December 31, 1992 .................................. 79,600 Granted ......................................................... 51,000 Released ........................................................ (30,400) -------- Outstanding at December 31, 1993 .................................. 100,200 Granted ......................................................... 14,226 Terminated ...................................................... (13,000) Released ........................................................ (33,400) -------- Outstanding at December 31, 1994 .................................. 68,026 Granted ......................................................... 186,516 Released ........................................................ (28,617) -------- Outstanding at December 31, 1995 .................................. 225,925 ========\n- --------------------------------------------------------------------------------\n15. PENSION PLANS The Corporation has several non-contributory employee defined benefit pension plans covering substantially all U.S. employees (the U.S. pension plans). Employees covered under the salaried defined benefit pension plans are eligible to participate upon the completion of one year of service, and benefits are based upon final average salary and years of service. Employees covered under the remaining plans are generally eligible to participate at the time of employment, and benefits are generally based on a fixed amount for each year of service. Employees are vested in the plans after five years of service. The Corporation also maintains pension plans for certain employees of international subsidiaries following the legal requirements in those countries.\nIn a number of these plans, the plan assets exceed the accumulated benefit obligations (overfunded plans) and in the remainder of the plans, the accumulated benefit obligations exceed the plan assets (underfunded plans).\nThe status of employee pension benefit plans at December 31 is summarized below (in millions):\n- --------------------------------------------------------------------------------\nOverfunded Underfunded Plans Plans ------------- ------------- 1995 1994 1995 1994 ---- ---- ---- ---- Actuarial present value of projected benefit obligation, based on employment service to date and current salary levels: Vested employees ......................... $ 335 254 194 205 Non-vested employees ..................... 18 14 17 17 ----- ----- ----- ----- Accumulated benefit obligation ........... 353 268 211 222 Additional amounts related to projected salary increases ........................ 39 31 5 7 ----- ----- ----- ----- Total projected benefit obligation ....... 392 299 216 229\nPlan assets at fair value .................. 448 357 178 176 ----- ----- ----- ----- Projected pension benefit obligation in excess of (less than) plan assets ......... (56) (58) 38 53 Unamortized net asset (liability) existing at January 1, 1985 .............. 10 13 (3) (4) Unrecognized prior service cost ............ (14) (15) (15) (13) Unrecognized net loss from actuarial experience ...................... (12) (10) (11) (17) ----- ----- ----- ----- Accrued (prepaid) pension cost ............. $ (72) (70) 9 19 ===== ===== ===== =====\n- --------------------------------------------------------------------------------\nThe Corporation's pension plans were valued between November 1, 1994, and January 1, 1995, and the obligations were projected to, and the assets were valued as of, the end of 1995. Of its 21 U.S. pension plans at December 31, 1995, eight were overfunded while 13 were underfunded. Of the Corporation's 18 U.S. pension plans at December 31, 1994, five were overfunded while 13 were underfunded. The majority of plan assets are invested in a diversified portfolio of stocks, bonds and cash or cash equivalents. A small portion of the plan assets is invested in pooled real estate and other private corporate investment funds.\nThe components of net periodic pension cost were as follows (in millions):\n- --------------------------------------------------------------------------------\n1995 1994 1993 ---- ---- ----\nBenefits earned during the year ................. $ 11.2 12.6 10.8 Interest accrued on projected benefit obligation ..................................... 42.9 40.1 40.8 Return on assets - actual ....................... (119.6) (0.4) (68.0) - unrecognized gain (loss) ..... 66.6 (51.2) 17.5 Net amortization ................................ 1.0 1.2 0.5 ------ ------ ------ Net periodic pension cost for the year ....... $ 2.1 2.3 1.6 ====== ====== ======\n- --------------------------------------------------------------------------------\nAssumptions used to develop the net periodic pension cost included an 8.5 percent discount rate in 1995, compared with discount rates of 7.25 percent and 8.5 percent in 1994 and 1993, respectively. An expected long-term rate of return on assets of 9.5 percent and a rate of increase in compensation levels of 4 percent were used for 1995 and 1994, compared with rates of 10 percent and 5 percent, respectively, for 1993. For the valuation of pension obligations, the discount rate at the end of 1995 was 7.25 percent, decreased from 8.5 percent in 1994 and equivalent to the discount rate at the end of 1993, and the rate of increase in compensation levels was 4 percent, the same as 1994 and 1993.\nThe Corporation recognizes a minimum liability in its financial statements for its underfunded plans. \"Other liabilities and deferred credits\" at December 31, 1995, included $26 million relating to this minimum liability, compared with $40 million at December 31, 1994. This amount was offset by an $18 million intangible asset, a $5 million reduction in \"Common Shareholders' Equity\" and a $3 million deferred tax benefit at December 31, 1995, compared with an $18 million intangible asset, a $13 million reduction in \"Common Shareholders' Equity\" and a $9 million deferred tax benefit at December 31, 1994.\nThe Corporation intends to fund at least the minimum amount required under the Employee Retirement Income Security Act of 1974 for U.S. plans or, in the case of international subsidiaries, the minimum legal requirements in that particular country. The excess of amounts accrued over minimum funding requirements, together with such excess amounts accrued in prior years, have been included in \"Other liabilities and deferred credits.\" The anticipated funding for the current year is included in \"Accounts payable and accrued expenses.\"\n16. POSTRETIREMENT BENEFITS OTHER THAN PENSIONS The Corporation records its obligation for postretirement medical and life insurance benefits in accordance with SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" SFAS No. 106 requires recognition of these benefits on an accrual basis. One of the principal requirements of the method is that the expected cost of providing such postretirement benefits be accrued during the years employees render the necessary service.\nSubstantially all of the Corporation's U.S. employees who retire from active service on or after normal retirement age of 65 are eligible for life insurance benefits. The Corporation also provides postretirement life insurance for employees of international subsidiaries in some cases. Life insurance benefits also are available under certain early retirement programs or pursuant to the terms of certain collective bargaining agreements. The majority of the costs of such benefits were paid out of a previously established fund maintained by an insurance company; however, a portion was paid through an insured contract. Health care insurance benefits also are provided for many employees retiring from active service. The coverage is provided on a non-contributory basis for certain groups of employees and on a contributory basis for other groups. The majority of these benefits are paid by the Corporation.\nThe status of employee postretirement benefit plans at December 31 is summarized below (in millions):\n- --------------------------------------------------------------------------------\n1995 1994 ---- ---- Accumulated Postretirement Benefit Obligation: Retirees .............................................. $ 80 69 Fully eligible active plan participants ............... 10 8 Other active plan participants ........................ 61 56 ----- ----- Total accumulated postretirement benefit obligation ........................................... 151 133\nPlan assets at fair value ............................... 11 11 ----- ----- Accumulated postretirement benefit obligation in excess of plan assets .................................. 140 122 Unrecognized prior service cost ......................... 7 5 Unrecognized net gain (loss) from actuarial experience ............................................. (10) 1 ----- ----- Accrued postretirement benefit cost ..................... $ 137 128 ===== =====\n- --------------------------------------------------------------------------------\nThe components of net periodic postretirement benefit cost were as follows (in millions):\n- --------------------------------------------------------------------------------\n1995 1994 1993 ---- ---- ---- Benefits attributed to service during the year ........................................ $ 4 4 3 Interest cost on accumulated postretirement benefit obligation .............................. 11 10 10 Return on assets - actual ........................ (1) (1) (1) Net amortization ................................. (1) (1) (1) ---- ---- ---- Net periodic postretirement benefit cost for the year .................................... $ 13 12 11 ==== ==== ====\n- --------------------------------------------------------------------------------\nFor 1995 measurement purposes, annual rates of increase in the per capita cost of covered health care benefits were assumed to average 9 percent for 1996 decreasing gradually to 5.3 percent by 2010 and remaining at that level thereafter. For 1994 measurement purposes, annual rates of increase in the per capita cost of covered health care benefits were assumed to average 11 percent for 1995 decreasing gradually to 6.3 percent by 2010 and remaining 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 percentage point in each year would increase the accumulated postretirement benefit obligation as of December 31, 1995, by approximately $14.0 million and the aggregate of the service and interest cost components of net periodic postretirement benefit cost for the year then ended by approximately $1 million.\nThe weighted average discount rate used in determining the accumulated postretirement benefit obligation was 7.25 percent for 1995, compared with 8.5 percent used for 1994. The expected long-term rate of return on plan assets was 8 percent for both years. Assumptions used to develop net periodic postretirement benefit cost included an 8.5 percent discount rate in 1995, increased from 7.25 percent in 1994 and equivalent to the discount rate used in 1993.\n17. COMMITMENTS Rent expense for the years 1995, 1994 and 1993 was (in millions): $18.8, $23.5 and $26.6, respectively. Future minimum lease payments for all noncancelable operating leases having a remaining term in excess of one year totaled $61.3 million at December 31, 1995. These commitments for future periods are as follows (in millions): 1996 - $14.2; 1997 - $11.9; 1998 - $8.6; 1999 - $7.6; 2000 - $5.3; 2001 and thereafter - $13.7.\nThe Corporation enters into price protection arrangements from time to time, depending on market circumstances, to ensure a minimum price for a portion of its expected future mine production. See Note 19 to the Consolidated Financial Statements to which reference should be made for a fuller understanding of these arrangements with respect to expected 1996 production.\n18. CONTINGENCIES The Corporation is from time to time involved in various legal proceedings of a character normally incident to its past and present businesses. Management does not believe that the outcome of these proceedings will have a material adverse effect on the financial condition or results of operations of the Corporation on a consolidated basis.\nThe Corporation is subject to federal, state and local environmental laws, rules and regulations, including the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (CERCLA or Superfund), as amended by the Superfund Amendments and Reauthorization Act of 1986. Under Superfund, the Environmental Protection Agency (EPA) has identified approximately 35,000 sites throughout the United States for review, ranking and possible inclusion on the National Priorities List (NPL) for possible response. Among the sites identified, EPA has included 13 sites owned by the Corporation. The Corporation believes that most, if not all, of its sites so identified will not qualify for listing on the NPL.\nIn addition, the Corporation may be required to remove hazardous waste or remediate the alleged effects of hazardous substances on the environment associated with past disposal practices at sites not owned by the Corporation. The Corporation has received notice that it is a potentially responsible party from EPA and\/or individual states under CERCLA or a state equivalent and is participating in environmental assessment and remediation activity at 36 sites.\nThe amounts of the Corporation's liabilities for remedial activities are very difficult to estimate due to such factors as the unknown extent of the remedial actions that may be required and, in the case of sites not owned by the Corporation, the unknown extent of the Corporation's probable liability in proportion to the probable liability of other parties. The Corporation has probable environmental liabilities that in its judgment cannot reasonably be estimated, and losses attributable to remediation costs are reasonably possible at other sites. The Corporation cannot now estimate the total additional loss it may incur for such environmental liabilities, but such loss could be substantial (see Notes 1 and 2 to the Consolidated Financial Statements for further information concerning the Corporation's environmental obligations).\nIn 1993 and 1994, the New Mexico and Arizona legislatures, respectively, passed laws requiring the reclamation of mined lands in those states. The New Mexico Mining Commission adopted rules for the New Mexico program during 1994, and the Corporation's operations began submitting the required permit applications in December 1994. The Arizona State Mine Inspector has been directed to adopt rules implementing the Arizona law by June 30, 1996. These laws and regulations will likely increase the Corporation's regulatory obligations and compliance costs with respect to mine closure and reclamation. At this time, it is not possible to quantify the impact of the new laws and regulations on the Corporation.\n19. DERIVATIVE FINANCIAL INSTRUMENTS HELD FOR PURPOSES OTHER THAN TRADING AND FAIR VALUE OF FINANCIAL INSTRUMENTS The Corporation does not acquire, hold or issue derivative financial instruments for trading purposes. Derivative financial instruments are used to manage well-defined commodity price, foreign exchange and, to a lesser extent, interest rate risks, that arise out of the Corporation's core business activities. The fair values of the Corporation's derivative financial instruments are based on quoted market prices for similar financial instruments. A summary of derivative financial instruments held by the Corporation is as follows:\nCopper Price Protection Agreements - The Corporation may periodically use various price protection programs to mitigate the risk of adverse price fluctuations on its copper production. With respect to 1995 production, the Corporation had contracts that provided minimum quarterly average London Metal Exchange (LME) prices of 80 cents per pound for approximately 640 million pounds of copper. These contracts expired on December 31, 1995, without payment to Phelps Dodge. In addition, the Corporation had contracts that provided minimum (approximately 95 cents) and maximum (approximately $1.33) LME prices per pound for approximately 650 million pounds of copper. These contracts expired on December 31, 1995, with Phelps Dodge making payments totaling $1.3 million to the financial institutions involved. During 1994, contracts that provided the Corporation with minimum average LME copper prices of 75 cents per pound for about 21 percent of that year's production expired without payment to Phelps Dodge. During 1993, the Corporation received revenues of $39.4 million before taxes ($26.0 million, or 37 cents per common share, after taxes) from similar arrangements.\nWith respect to 1996 production, the Corporation has entered into contracts with several financial institutions that provide for a combination of minimum and maximum prices based on the quarterly average LME price. These contracts are summarized in the following table:\n- ----------------------------------------------------------------------------\nContracts Providing Contracts Providing Minimum Minimum Prices and Maximum Prices -------------- ------------------\nCopper Cathode Copper Price (LME) Cathode Price Pounds ------------------ Pounds (LME) (millions) Minimum Maximum (millions) --- -------- ------- ------- --------\nFirst Quarter ............... $ 0.95 170 $ 0.95 $ 1.47 170 Second Quarter .............. $ 0.95 90 $ 0.95 $ 1.42 170 Third Quarter ............... $ 0.95 40 $ 0.90 $ 1.40 145 Fourth Quarter .............. - $ 0.95 $ 1.36 190 ----- --- 300 675 ===== ===\n- ----------------\nNote: If average quarterly LME prices exceed the maximum prices, Phelps Dodge will be obligated to pay the difference to the financial institutions involved; if average quarterly LME prices fall below the minimum prices, the financial institutions will be obligated to pay Phelps Dodge the difference.\n- --------------------------------------------------------------------------------\nForeign Exchange Contracts - The Corporation periodically enters into forward exchange contracts to hedge certain recorded transactions denominated in foreign currencies and enters into currency option contracts to hedge certain firm commitments and other anticipated foreign currency transactions. The objective of the Corporation's foreign currency hedging activities is to protect the Corporation from the risk that the eventual equivalent dollar cash flows resulting from transactions denominated in foreign currencies will be adversely affected by changes in exchange rates. In hedging a transaction, the Corporation's foreign exchange hedging strategy may, in certain circumstances, involve the use of a number of offsetting currency option contracts to minimize the cost of the underlying hedge. Thus, the notional principal amount, which represents the arithmetic sum of all outstanding foreign currency hedging instruments, is not a measurement of risk to the Corporation from the use of derivative financial instruments. At December 31, 1995, the Corporation had protection in place for approximately $73 million of recorded and anticipated foreign currency transactions through the use of currency option contracts with an aggregate notional principal amount of approximately $80 million. The currency option contracts acquired by the Corporation have maturities of less than one year. The Corporation did not have any deferred unrealized gains or losses on its foreign exchange contracts at December 31, 1995, compared with deferred unrealized losses of $0.9 million at December 31, 1994.\nInterest Rate Protection Agreement - The Corporation has caused its 80-percent-owned Candelaria copper project in Chile to enter into an interest rate protection agreement with certain financial institutions to limit the effect of increases in the interest rate on its $200 million floating rate dollar denominated debt. Under the terms of the agreement, the project will receive payments from these institutions if the six-month London Interbank Offered Rate (LIBOR) exceeds 9 percent prior to December 31, 2001, and 11 percent during the two subsequent years ending December 31, 2003.\nCredit Risk - The Corporation is exposed to credit loss in the event of nonperformance by counterparties to its price protection, foreign exchange and interest rate protection agreements. To minimize the risk of credit loss, the Corporation deals only with highly rated financial institutions and monitors the credit worthiness of these institutions on a continuing basis. The Corporation does not anticipate nonperformance by any of these counterparties.\nThe methods and assumptions used to estimate the fair value of each class of financial instrument for which it is practicable to estimate a value are as follows:\nCash and short-term investments -- the carrying amount is a reasonable estimate of the fair value because of the short maturity of those instruments.\nInvestments and long-term receivables -- the fair values of some investments are estimated based on quoted market prices for those or similar investments. The fair values of other types of instruments are estimated by discounting the future cash flows using the current rates at which similar instruments would be made with similar credit ratings and for the same remaining maturities.\nLong-term debt -- the fair value of substantially all of the Corporation's long-term debt is estimated based on the quoted market prices for the same or similar issues or on the current notes offered to the Corporation for debt of the same remaining maturities.\nStandby letters of credit and financial guarantees -- the fair values of guarantees and letters of credit are based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties at the reporting date. The Corporation has guaranteed the borrowings of certain subsidiaries totaling $59.4 million. There is no market for these guarantees or standby letters of credit and they were issued without explicit cost. Therefore, it is not practicable to establish their fair value.\nThe estimated fair values of the Corporation's financial instruments as of December 31, 1995, were as follows (in millions):\n- --------------------------------------------------------------------------------\nCarrying Fair Amount Value -------- -----\nCash and short-term investments ................ $ 608.5 608.5 Price protection arrangements (copper price guarantees) ..................... 4.7 (0.4) Investments and long-term receivables (including amounts due within one year) for which it is practicable to estimate fair value * .......... 34.7 201.7 Long-term debt (including amounts due within one year) .............................. 629.9 659.3 Interest rate protection agreements ............ 2.5 1.2 Foreign currency exchange contracts ............ 0.6 0.3\n- -----------\n* The Corporation's largest cost basis investment is its minority interest in Southern Peru Copper Corporation (SPCC), which is carried at a book value of $13.2 million. Phelps Dodge's interest in SPCC was reduced from 16.25 percent to 13.9 percent through an exchange offering of SPCC common shares recently completed whereby 14.2 percent of SPCC's equity capital was registered for trading on the New York and Lima Stock Exchanges. Based on the New York Stock Exchange closing market price of those shares as of January 5, 1996 (the first day of trading), the estimated fair value of the Corporation's investment in SPCC is approximately $180 million. Phelps Dodge's ownership interest in SPCC is represented by its share of a class of SPCC common stock which is currently not registered for trading on any public exchange.\n- --------------------------------------------------------------------------------\n20. BUSINESS SEGMENT DATA The Corporation's business consists of two segments, Phelps Dodge Mining Company and Phelps Dodge Industries. The principal activities of each segment are described below, and the accompanying tables present results of operations and other financial information by segment and by significant geographic area.\nPhelps Dodge Mining Company is an international business comprising a group of companies involved in vertically integrated copper operations including mining, concentrating, electrowinning, smelting and refining, rod production, marketing and sales, and related activities. Copper is sold primarily to others as rod, cathode or concentrates, and as rod to the Phelps Dodge Industries segment. In addition, Phelps Dodge Mining Company at times smelts and refines copper and produces copper rod for others on a toll basis, and produces gold, silver, molybdenum and copper chemicals as by-products, and sulfuric acid from its air quality control facilities. This segment also includes the Corporation's other mining operations and investments (including fluorspar, silver, lead and zinc operations) and its worldwide mineral exploration and development programs.\nPhelps Dodge Industries is a business segment comprising a group of companies that manufacture engineered products principally for the transportation, energy and telecommunications sectors worldwide. Its operations are characterized by products with significant market share, internationally competitive cost and quality, and specialized engineering capabilities. This business segment includes the Corporation's carbon black operations through Columbian Chemicals Company and its subsidiaries; its wheel and rim operations through Accuride Corporation and its subsidiaries; and its wire and cable and specialty conductor operations through Phelps Dodge International Corporation and Phelps Dodge Magnet Wire Company and their subsidiaries and affiliates.\nThe Corporation's total 1995 sales included exports of $93.7 million from U.S. operations to unaffiliated foreign customers, compared with $76.2 million in 1994 and $60.3 million in 1993. Intersegment sales reflect the transfer of copper from Phelps Dodge Mining Company to Phelps Dodge Industries at the same prices charged to outside customers.\nThe following tables give a summary of financial data by business segment and geographic area for the years 1993 through 1995. Major unusual items during the three-year period included (i) a 1995 pre-tax gain of $26.8 million included in Phelps Dodge Industries' operating income from the sale by its carbon black operations of a synthetic iron oxide facility, (ii) a 1994 pre-tax charge of $94.4 million to Phelps Dodge Mining Company's operating income for costs associated with environmental matters and asset dispositions, and (iii) a 1994 pre-tax charge of $44.6 million to Phelps Dodge Industries' operating income for costs associated with environmental matters and asset dispositions, including $17.6 million for carbon black facilities and $27.0 million for wire and cable and specialty conductor facilities. (See Note 2 to the Consolidated Financial Statements for a further discussion of these issues.)\nFINANCIAL DATA BY GEOGRAPHIC AREA (In millions)\n- ---------------------------------------------------------------------------\n1995 1994 1993 ---- ---- ----\nSALES AND OTHER OPERATING REVENUES: Unaffiliated customers United States ................... $ 3,072.6 2,485.9 1,918.7 Latin America ................... 537.3 346.7 274.0 Other ........................... 575.5 456.6 403.2 -------- ------- ------- $ 4,185.4 3,289.2 2,595.9 ======== ======= ======= Intergeographic areas United States ................... $ 13.1 19.3 17.1 Latin America ................... 23.7 - - Other ........................... 47.9 54.4 53.6 -------- ------- ------- $ 84.7 73.7 70.7 ======== ======= ======= OPERATING INCOME: United States .................... $ 810.4 337.2 267.7 Latin America .................... 196.8 30.0 17.7 Other ............................ 93.3 33.2 41.1 -------- ------- ------- $ 1,100.5 400.4 326.5 ======== ======= ======= IDENTIFIABLE ASSETS AT DECEMBER 31: United States .................... $ 3,157.1 2,789.0 2,581.2 Latin America .................... 931.3 798.2 653.3 Other ............................ 557.5 546.6 486.4 -------- ------- ------- $ 4,645.9 4,133.8 3,720.9 ======== ======= =======\n- ---------------------------------------------------------------------------\nItem 9.","section_9":"Item 9. Disagreements on Accounting and Financial Disclosure - ---------------------------------------------------------------------------\nNot applicable.\nPart III\nItems 10, 11, 12 and 13. - ------------------------\nThe information called for by Part III (Items 10, 11, 12 and 13) is incorporated herein by reference from the material included under the captions \"Election of Directors,\" \"Beneficial Ownership of Securities,\" \"Executive Compensation\" and \"Other Matters\" in Phelps Dodge Corporation's definitive proxy statement (to be filed pursuant to Regulation 14A) for its Annual Meeting of Shareholders to be held May 1, 1996 (the 1996 Proxy Statement), except that the information regarding executive officers called for by Item 401 of Regulation S-K is included in Part I of this report. The 1996 Proxy Statement is being prepared and will be filed with the Securities and Exchange Commission and furnished to shareholders on or about April 1, 1996.\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.\n2. Financial Statement Schedules.\n3. Exhibits:\n3.1 Restated Certificate of Incorporation of the Corporation, effective June 16, 1987 (incorporated by reference to Exhibit 3.1 to the Corporation's Form 10-Q for the quarter ended June 30, 1987 (SEC File No. 1-82)). Certificate of Amendment of such Restated Certificate of Incorporation, effective August 4, 1988, and Certificate of Amendment of such Restated Certificate of Incorporation, effective August 9, 1988 (incorporated by reference to Exhibits 3.1 and 3.2 to the Corporation's Form 10-Q for the quarter ended September 30, 1988 (SEC File No. 1-82)). Complete composite copy of the Certificate of Incorporation of the Corporation as amended to date (incorporated by reference to Exhibit 3.1 to the Corporation's 1992 Form 10-K (SEC File No. 1-82)).\n3.2 By-Laws of the Corporation, as amended effective September 1, 1994 (incorporated by reference to Exhibit 3.2 to the Corporation's Form 10-Q for the quarter ended September 30, 1994 (SEC File No. 1-82)).\n4.1 Reference is made to Exhibits 3.1 and 3.2 above.\n4.3 Rights Agreement, dated as of July 29, 1988 and Amended and Restated as of December 6, 1989, between the Corporation and Chemical Bank (formerly Manufacturers Hanover Trust Company), which includes the form of Certificate of Amendment setting forth the terms of the Junior Participating Cumulative Preferred Shares, par value $1.00 per share, as Exhibit A, the form of Right Certificate as Exhibit B and the Summary of Rights to Purchase Preferred Shares as Exhibit C (incorporated by reference to Exhibit 1 to the Corporation's Current Report on Form 8-K filed on December 7, 1989 (SEC File No. 1-82)).\nNote: Certain instruments with respect to long-term debt of the Corporation have not been filed as Exhibits to this Report since 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. The Corporation agrees to furnish a copy of each such instrument upon request of the Securities and Exchange Commission.\n10. Management contracts and compensatory plans and agreements.\n10.1 The Corporation's 1987 Stock Option and Restricted Stock Plan (the 1987 Plan), as amended to and including June 3, 1992, and form of Stock Option Agreement and form of Reload Option Agreement, both as modified through June 3, 1992 (incorporated by reference to Exhibit 10.2 of the Corporation's Form 10-Q for the quarter ended June 30, 1992 (SEC File No. 1-82)). Form of Restricted Stock letter under the 1987 Plan (incorporated by reference to Exhibit 10.1 to the Corporation's 1990 10-K (SEC File No. 1-82)) and the amendment thereto dated June 25, 1992 (incorporated by reference to Exhibit 10.2 to the Corporation's 1992 Form 10-K (SEC File No. 1-82)).\n10.2 The Corporation's 1989 Directors Stock Option Plan (the 1989 Directors Plan), as amended to and including June 3, 1992 (incorporated by reference to Exhibit 10.3 to the Corporation's Form 10-Q for the quarter ended June 30, 1992 (SEC File No. 1-82)). Form of Stock Option Agreement under the 1989 Directors Plan (incorporated by reference to the Corporation's Registration Statement on Form S-8 (Reg. No. 33-34363)).\n10.3 The Corporation's 1993 Stock Option and Restricted Stock Plan (the 1993 Plan), as amended through December 1, 1993, and form of Restricted Stock letter under the 1993 Plan (incorporated by reference to Exhibit 10.4 to the Corporation's 1993 Form 10-K (SEC File No. 1-82)). Form of Stock Option Agreement and form of Reload Option Agreement, both as amended through November 2, 1994, under the 1993 Plan (incorporated by reference to Exhibit 10.3 to the Corporation's 1994 Form 10-K (SEC File No. 1-82)).\nNote: Omitted from filing pursuant to the Instruction to Item 601(b) (10) are actual Stock Option Agreements between the Corporation and certain officers, under the 1987 Plan and the 1993 Plan, and certain Directors, under the 1989 Directors Plan, which contain substantially similar provisions to Exhibits 10.1, 10.2 and 10.3 above.\n10.4 Description of the Corporation's Incentive Compensation Plan (incorporated by reference to Exhibit 10.5 to the Corporation's 1993 Form 10-K (SEC File No. 1-82)).\n10.5 Deferred Compensation Plan for the Directors of the Corporation, amended and restated as of July 31, 1992 (incorporated by reference to Exhibit 10 to the Corporation's Form 10-Q for the quarter ended September 30, 1992 (SEC File No. 1-82)).\n10.6 Form of Change-of-Control Agreement between the Corporation and certain executives, including all of the current executive officers to be listed in the summary compensation table to the 1996 Proxy Statement (incorporated by reference to Exhibit 10.7 to the Corporation's 1992 Form 10-K (SEC File No. 1-82)).\n10.7 Form of Severance Agreement between the Corporation and certain executives, including all of the current executive officers to be listed in the summary compensation table to the 1996 Proxy Statement (incorporated by reference to Exhibit 10.11 to the Corporation's 1988 Form 10-K (SEC File No. 1-82)).\n10.8 The Corporation's Retirement Plan for Directors, effective January 1, 1988 (incorporated by reference to Exhibit 10.13 to the Corporation's 1987 Form 10-K (SEC File No. 1-82)).\n10.9 The Corporation's Comprehensive Executive Nonqualified Retirement and Savings Plan (the Nonqualified Plan), as amended November 7, 1990 (incorporated by reference to Exhibit 10.14 to the Corporation's 1990 Form 10-K (SEC File No. 1-82)). Amendment, effective January 1, 1991, to the Nonqualified Plan (incorporated by reference to Exhibit 10.2 to the Corporation's Form 10-Q for the quarter ended June 30, 1991 (SEC File No. 1-82)). Four amendments, one effective as of January 1, 1991, one effective as of November 15, 1993 (both incorporated by reference to Exhibit 10.13 of the Corporation's 1993 Form 10-K (SEC File No. 1-82)), one effective as of September 7, 1994 (incorporated by reference to Exhibit 10.11 of the Corporation's 1994 Form 10-K (SEC File No. 1-82)), and one effective June 7, 1995 (incorporated by reference to Exhibit 10.11 of the Corporation's Form 10-Q for the quarter ended June 30, 1995 (SEC File No. 1-82)).\n10.10 Deferred Compensation Agreement dated January 27, 1988 between Dr. Patrick J. Ryan and the Corporation (incorporated by reference to Exhibit 10.6 to the Corporation's 1987 Form 10-K (SEC File No. 1-82)) and amendment to such agreement dated March 17, 1989 (incorporated by reference to Exhibit 10.7 to the Corporation's 1988 Form 10-K (SEC File No. 1-82)).\n10.11 Retirement Agreement dated as of June 20, 1995, between Dr. Patrick J. Ryan and the Corporation (incorporated by reference to Exhibit 10.13 of the Corporation's Form 10-Q for the quarter ended June 30, 1995 (SEC File No. 1-82)).\n10.12 Consulting Agreement dated as of June 20, 1995, between Dr. Patrick J. Ryan and the Corporation (incorporated by reference to Exhibit 10.14 of the Corporation's Form 10-Q for the quarter ended June 30, 1995 (SEC File No. 1-82)).\n12 Statement re computation of ratios of total debt to total capitalization.\n21 List of Subsidiaries and Investments.\n23 Consent of Price Waterhouse LLP.\n24 Powers of Attorney executed by certain officers and directors who signed this Annual Report on Form 10-K.\nNote: Shareholders may obtain copies of Exhibits by making written request to the Secretary of the Corporation and paying copying costs of 10 cents per page, plus postage.\n(b) Reports on Form 8-K:\nNo current Reports on Form 8-K were filed by the Corporation during the quarter ended December 31, 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.\nPHELPS DODGE CORPORATION ------------------------ (Registrant)\nMarch 20, 1996 By: Thomas M. St. Clair -------------------- Thomas M. St. Clair Senior Vice President and Chief Financial Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nChairman of the Board, President, Chief Executive Officer and Director Douglas C. Yearley (Principal Executive Officer) March 20, 1996 - ------------------- Douglas C. Yearley\nSenior Vice President and Chief Financial Officer Thomas M. St. Clair (Principal Financial Officer) March 20, 1996 - ------------------- Thomas M. St. Clair\nVice President and Controller Thomas M. Foster (Principal Accounting Officer) March 20, 1996 - ------------------- Thomas M. Foster\nEdward L. Addison, Robert N. Burt, Paul W. Douglas, ) William A. Franke, Paul Hazen, Marie L. Knowles, ) March 20, 1996 Robert D. Krebs, Southwood J. Morcott, Gordon R. Parker,) J. Steven Whisler, Directors )\nBy: Thomas M. St. Clair ------------------- Thomas M. St. Clair Attorney-in-fact","section_15":""}
{"filename":"91882_1995.txt","cik":"91882","year":"1995","section_1":"ITEM 1. BUSINESS\nTHE COMPANY\nORGANIZATION\nThe Company, a wholly owned subsidiary of SCANA, is a South Carolina corporation organized in 1924 and has its principal executive office at 1426 Main Street, Columbia, South Carolina 29201, telephone number (803) 748-3000. The Company had 3,721 full-time, permanent employees as of December 31, 1995 as compared to 4,009 full-time, permanent employees as of December 31, 1994.\nSCANA, a South Carolina corporation, was organized in 1984 and is a public utility holding company within the meaning of PUHCA but is presently exempt from registration under such Act. SCANA holds all of the issued and outstanding common stock of the Company. (See Note 1A of Notes to Consolidated Financial Statements.)\nINDUSTRY SEGMENTS\nThe Company is a regulated public utility engaged in the generation, transmission, distribution and sale of electricity and in the purchase and sale, primarily at retail, of natural gas in South Carolina. The Company also renders urban bus service in the metropolitan areas of Columbia and Charleston, South Carolina. The Company's business is subject to seasonal fluctuations. Generally, sales of electricity are higher during the summer and winter months because of air-conditioning and heating requirements, and sales of natural gas are greater in the winter months due to its use for heating requirements.\nThe Company's electric service area extends into 24 counties covering more than 15,000 square miles in the central, southern and southwestern portions of South Carolina. The service area for natural gas encompasses all or part of 30 of the 46 counties in South Carolina and covers more than 20,000 square miles. The total population of the counties representing the Company's combined service area is approximately 2.3 million.\nThe predominant industries in the territories served by the Company include: synthetic fibers; chemicals and allied products; fiberglass and fiberglass products; paper and wood products; metal fabrication; stone, clay and sand mining and processing; and various textile-related products.\nInformation with respect to industry segments for the years ended December 31, 1995, 1994 and 1993 is contained in Note 11 of Notes to Consolidated Financial Statements and all such information is incorporated herein by reference.\nCOMPETITION\nThe electric utility industry has begun a major transition that could lead to expanded market competition and less regulatory protection. Future deregulation of electric wholesale and retail markets will create opportunities to compete for new and existing customers and markets. As a result, profit margins and asset values of some utilities could be adversely affected. The pace of deregulation, the future market price of electricity, and the regulatory actions which may be taken by the PSC in response to the changing environment cannot be predicted. However, the Company is aggressively pursuing actions to position itself strategically for the transformed environment. To enhance its flexibility and responsiveness to change, the Company operates Strategic Business Units. Maintaining a competitive cost structure is of paramount importance in the utility's strategic plan. The Company has undertaken a variety of initiatives, including reductions in operation and maintenance costs and in staffing levels. In January 1996 the PSC approved (as discussed under \"Capital Requirements and Financing\nProgram\") the accelerated recovery of the Company's electric regulatory assets and the shift of depreciation reserves from transmission and distribution assets to nuclear production assets. The Company believes that these actions as well as numerous others that have been and will be taken demonstrate its ability and commitment to succeed in the new operating environment to come.\nRegulated public utilities are allowed to record as assets some costs that would be expensed by other enterprises. If deregulation or other changes in the regulatory environment occur, the Company may no longer be qualified to apply this accounting treatment and may be required to eliminate such regulatory assets from its balance sheet. Such an event could have a material adverse effect on the Company's results of operations in the period the write-off is recorded. The Company reported on its balance sheet at December 31, 1995 approximately $116 million and $4 million of regulatory assets and liabilities, respectively, excluding amounts related to net accumulated deferred income tax assets of approximately $33 million.\nCAPITAL REQUIREMENTS AND FINANCING PROGRAM\nCapital Requirements\nThe cash requirements of the Company arise primarily from its operational needs and its construction program. The ability of the Company to replace existing plant investments, as well as to expand to meet future demand for electricity and gas, will depend upon its ability to attract the necessary capital on reasonable terms.\nThe Company recovers the costs of providing services through rates charged to customers. Rates for regulated services are generally based on historical costs. As customer growth and inflation occur and the Company expands its construction program it is necessary to seek increases in rates. On July 10, 1995, the Company filed an application with the PSC for an increase in retail electric rates. On January 9, 1996 the PSC issued an order granting the Company an increase of 7.34% which will produce additional revenues of approximately $67.5 million annually. The increase will be implemented in two phases. The first phase, an increase in revenues of approximately $59.5 million annually based on a test year, or 6.47%, commenced on January 15, 1996. The second phase will be implemented in January 1997 and will produce additional revenues of approximately $8.0 million annually, or .87% more than current rates. The PSC authorized a return on common equity of 12.0%. The PSC also approved establishment of a Storm Damage Reserve Account capped at $50 million to be collected through rates over a ten-year period. Additionally, the PSC approved accelerated recovery of substantially all (excluding accumulated deferred income taxes) of the Company's electric regulatory assets and the transition obligation for postretirement benefits other than pensions, changing the amortization periods to allow recovery by the end of the year 2000. The Company's request to shift approximately $257 million of depreciation reserves from transmission and distribution assets to nuclear production assets was also approved. The Company's future financial position and results of operations will be affected by its ability to obtain adequate and timely rate and other regulatory relief. (See \"Regulation.\")\nDuring 1996 the Company is expected to meet its capital requirements principally through internally generated funds (approximately 77%, after payment of dividends), the issuance and sale of debt securities and additional equity contributions from SCANA. Short-term liquidity is expected to be provided by issuance of commercial paper. The timing and amount of such sales and the type of securities to be sold will depend upon market conditions and other factors.\nThe Company's estimates of its cash requirements for construction and nuclear fuel expenditures, which are subject to continuing review and adjustment, for 1996 and the four-year period 1997-2000 as now scheduled, are as follows:\nType of Facilities 1997-2000 1996 (Thousands of Dollars) Electric Plant: Generation. . . . . . . . . . . . . . . . $268,987 $ 49,036 Transmission. . . . . . . . . . . . . . . 92,502 17,976 Distribution. . . . . . . . . . . . . . . 319,092 64,227 Other . . . . . . . . . . . . . . . . . . 34,152 13,835 Nuclear Fuel. . . . . . . . . . . . . . . . 86,413 21,147 Gas . . . . . . . . . . . . . . . . . . . . 94,147 16,918 Common. . . . . . . . . . . . . . . . . . . 34,089 34,633 Other . . . . . . . . . . . . . . . . . . . 1,511 553 Total . . . . . . . . . . . . . . $930,893 $218,325\nThe above estimates exclude AFC.\nConstruction\nThe Company's cost estimates for its construction program for the periods 1996 and 1997-2000, shown in the above table, include costs of the projects described below.\nThe Company entered into a contract with Duke\/Fluor Daniel in 1991 to design, engineer and build a 385 MW coal-fired electric generating plant near Cope, South Carolina. Construction of the plant started in November 1992. Commercial operation began in January 1996. The cost of the Cope plant, excluding AFC, is $410.9 million. In addition, the transmission lines for interconnection with the Company's system cost $22.5 million. Approximately $9.8 million of the amounts included in the above table for 1996 relate to the completion of the Cope plant.\nDuring 1995 the Company expended approximately $15.9 million as part of a program to extend the operating lives of certain non-nuclear generating facilities. Additional improvements under the program to be made during 1996 are estimated to cost approximately $19.9 million.\nAdditional Capital Requirements\nIn addition to the Company's capital requirements for 1996 described in \"Capital Requirements\" above, approximately $21.2 million will be required for refunding and retiring outstanding securities and obligations. For the years 1997-2000, the Company has an aggregate of $292.8 million of long-term debt maturing (including approximately $69.2 million for sinking fund requirements, of which $68.7 million may be satisfied by deposit and cancellation of bonds issued upon the basis of property additions or bond retirement credits) and $9.8 million of purchase or sinking fund requirements for preferred stock.\nActual 1996 expenditures may vary from the estimates set forth above due to factors such as inflation, economic conditions, regulation, legislation, rates of load growth, environmental protection standards and the cost and availability of capital.\nFinancing Program\nThe Company's First and Refunding Mortgage Bond Indenture, dated April 1, 1945 (Old Mortgage), contains provisions prohibiting the issuance of additional bonds thereunder (Class A Bonds) unless net earnings (as therein defined) for twelve consecutive months out of the fifteen months prior to the month of issuance are at least twice the annual interest requirements on all Class A Bonds to be outstanding (Bond Ratio). For the year ended December 31, 1995 the Bond Ratio was 3.97. The issuance of additional Class A Bonds also is restricted to an additional principal amount equal to (i) 60% of unfunded net property additions (which unfunded net property additions totaled approximately $162.3 million at December 31, 1995), (ii) retirements of Class A Bonds (which retirement credits totaled $64.8 million at December 31, 1995), (iii) and cash on deposit with the Trustee.\nThe Company has placed a new bond indenture (New Mortgage) dated April 1, 1993 covering substantially all of its electric properties under which its future mortgage-backed debt (New Bonds) will be issued. New Bonds are issued under the New Mortgage on the basis of a like principal amount of Class A Bonds issued under the Old Mortgage which have been deposited with the Trustee of the New Mortgage (of which $185 million were available for such purpose at December 31, 1995), until such time as all presently outstanding Class A Bonds are retired. Thereafter, New Bonds will be issuable on the basis of property additions in a principal amount equal to 70% of the original cost of electric and common plant properties (compared to 60% of value for Class A Bonds under the Old Mortgage), cash deposited with the Trustee, and retirement of New Bonds. New Bonds will be issuable under the New Mortgage only if adjusted net earnings (as therein defined) for twelve consecutive months out of the eighteen months immediately preceding the month of issuance are at least twice the annual interest requirements on all outstanding bonds (including Class A Bonds) and New Bonds to be outstanding (New Bond Ratio). For the year ended December 31, 1995 the New Bond Ratio was 5.31.\nThe following additional financing transaction has occurred since December 31, 1994:\nOn April 12, 1995 the Company issued $100 million of First Mortgage Bonds, 7 5\/8% series due April 1, 2025 to repay short-term borrowings.\nWithout the consent of at least a majority of the total voting power of the Company's preferred stock, the Company may not issue or assume any unsecured indebtedness if, after such issue or assumption, the total principal amount of all such unsecured indebtedness would exceed 10% of the aggregate principal amount of all of the Company's secured indebtedness and capital and surplus; provided, however, that no such consent shall be required to enter into agreements for payment of principal, interest and premium for securities issued for pollution control purposes.\nPursuant to Section 204 of the Federal Power Act, the Company must obtain the FERC authority to issue short-term debt. The FERC has authorized the Company to issue up to $200 million of unsecured promissory notes or commercial paper with maturity dates of twelve months or less, but not later than December 31, 1997.\nThe Company had $165 million authorized and unused lines of credit at December 31, 1995. In addition, Fuel Company has a credit agreement for a maximum of $125 million with the full amount available at December 31, 1995. The credit agreement supports the issuance of short-term commercial paper for the financing of nuclear and fossil fuels and sulfur dioxide emission allowances. Fuel Company commercial paper outstanding at December 31, 1995 was $76.8 million.\nThe Company's Restated Articles of Incorporation prohibit issuance of additional shares of preferred stock without consent of the preferred stockholders unless net earnings (as defined therein) for the twelve consecutive months immediately preceding the month of issuance are at least one and one-half times the aggregate of all interest charges and preferred stock dividend requirements (Preferred Stock Ratio). For the year ended December 31, 1995 the Preferred Stock Ratio was 2.58.\nThe ratios of earnings to fixed charges (SEC Method) were 3.41, 3.46, 3.57, 2.73 and 3.32 for the years ended December 31, 1995, 1994, 1993, 1992 and 1991, respectively.\nThe Company expects that it has or can obtain adequate sources of financing to meet its projected cash requirements for the next twelve months and for the foreseeable future.\nFuel Financing Agreements\nThe Company has assigned to Fuel Company all of its rights and interests in its various contracts relating to the acquisition and ownership of nuclear and fossil fuels. To finance nuclear and fossil fuels and sulfur dioxide emission allowances, Fuel Company issues, from time to time, commercial paper which is supported, up to $125 million, by an irrevocable revolving credit agreement which expires July 31, 1998. Accordingly, the amounts outstanding have been included in long- term debt. This commercial paper and amounts outstanding under the revolving credit agreement, if any, are guaranteed by the Company.\nAt December 31, 1995 commercial paper outstanding was approximately $76.8 million at a weighted average interest rate of 5.76%. (See Notes 1N and 4 of Notes to Consolidated Financial Statements.)\nELECTRIC OPERATIONS\nElectric Sales\nIn 1995 residential sales of electricity accounted for 43% of electric sales revenues; commercial sales 30%; industrial sales 20%; sales for resale 4%; and all other 3%. KWH sales by classification for the years ended December 31, 1995 and 1994 are presented below:\nSales KWH % Classification 1995 1994 Change (thousands)\nResidential 5,726,815 5,311,139 7.83 Commercial 5,078,185 4,848,620 4.73 Industrial 5,210,368 5,161,717 0.94 Sale for resale 1,063,064 1,024,376 3.78 Other 506,806 494,030 2.59 Total Territorial 17,585,238 16,839,882 4.43\nInterchange 195,591 171,046 14.35 Total 17,780,829 17,010,928 4.53\nThe Company furnishes electricity for resale to three municipalities, four investor-owned utilities, two electric cooperatives and one public power authority. Such sales for resale accounted for 4% of total electric sales revenues in 1995.\nDuring 1995 the Company recorded a net increase of 7,943 electric customers, increasing its total customers to 484,381.\nThe electric sales volume increased for the year ended December 31, 1995 compared to the prior year as a result of increased residential and commercial sales due to favorable weather and customer growth. The all-time peak demand of 3,683 MW was set on August 14, 1995.\nOn August 8, 1995 the Company signed an agreement with the DOE to lease the Savannah River Site's (SRS) power and steam generation and transmission facilities. The agreement calls for SRS to purchase all its electrical and a majority of its steam requirements from the Company. The Company will lease (with an option to renew) the power plant for ten years and the electrical transmission lines for 40 years, with an option to refurbish the facilities or build a new system.\nElectric Interconnections\nThe Company purchases all of the electric generation of Williams Station, owned by GENCO, under a Unit Power Sales Agreement which has been approved by the FERC. Williams Station has a generating capacity of 560 MW.\nThe Company's transmission system is part of the interconnected grid extending over a large part of the southern and eastern portions of the nation. The Company, Virginia Power Company, Duke Power Company, Carolina Power & Light Company, Yadkin, Incorporated and PSA are members of the Virginia- Carolinas Reliability Group, one of the several geographic divisions within the Southeastern Electric Reliability Council. This council provides for coordinated planning for reliability among bulk power systems in the Southeast. The Company is also interconnected with Georgia Power Company, Savannah Electric & Power Company, Oglethorpe Power Corporation and Southeastern Power Administration's Clark Hill Project.\nFuel Costs\nThe following table sets forth the average cost of nuclear fuel and coal and the weighted average cost of all fuels (including oil and natural gas) used by the Company and GENCO for the years 1993-1995.\n1995 1994 1993 Nuclear: Per million BTU $ .48 $ .51 $ .47 Coal: Company: Per ton $40.01 $39.92 $39.95 Per million BTU 1.57 1.57 1.55 GENCO: Per ton $42.21 $41.85 $41.64 Per million BTU 1.63 1.63 1.62 Weighted Average Cost of All Fuels: Per million BTU $ 1.26 $ 1.39 $ 1.31\nThe fuel costs shown above exclude the effects of a PSC-approved offsetting of fuel costs through the application of credits carried on the Company's books as a result of a 1980 settlement of certain litigation.\nFuel Supply\nThe following table shows the sources and approximate percentages of total KWH generation (including Williams Station) by each category of fuel for the years 1993-1995 and the estimates for 1996 and 1997.\nPercent of Total KWH Generated Estimated Actual 1997 1996 1995 1994 1993\nCoal 73% 71% 65% 76% 72% Nuclear 24 24 27 17 23 Hydro 3 3 5 6 5 Natural Gas & Oil - 2 3 1 - 100% 100% 100% 100% 100%\nCoal is used at all five of the Company's major fossil fuel- fired plants and GENCO's Williams Station. Unit train deliveries are used at all of these plants. On December 31, 1995 the Company had approximately a 73-day supply of coal in inventory and GENCO had approximately a 49-day supply.\nThe supply of coal is obtained through contracts and purchases on the spot market. Spot market purchases are expected to continue for coal requirements in excess of those provided by the Company's existing contracts. Contracts for the purchase of coal represent 91.5% of estimated requirements for 1996 (approximately 5.3 million tons, including requirements of Williams Station).\nThe supply of contract coal is purchased from seven suppliers located in eastern Kentucky and southwest Virginia. Contract commitments, which expire at various times from 1997- 2003, approximate 4.85 million tons annually. Sulfur restrictions on the contract coal range from .75% to 2%.\nThe Company believes that its operations are in substantial compliance with all existing regulations relating to the discharge of sulfur dioxide. The Company has not been advised by officials of DHEC that any more stringent sulfur content requirements for existing plants are contemplated at the State level. However, the Company will be required to meet the more stringent Federal emissions standards established by the Clean Air Act (see \"Environmental Matters\").\nThe Company has adequate supplies of uranium under contract to manufacture nuclear fuel for Summer Station through 2005. The following table summarizes all contract commitments for the stages of nuclear fuel assemblies:\nCommitment Contractor Regions(1) Term\nUranium Energy Resources of Australia 9-13 1990-1997 Uranium Everest Minerals 9-13 1990-1996 Conversion Sequoyah Fuel Corp. 8-12 1989-1995 Enrichment USEC 12-18 1995-2005 Fabrication Westinghouse 1-21 1982-2009 Reprocessing None\n(1) A region represents approximately one-third to one-half of the nuclear core in the reactor at any one time. Region no. 11 was loaded in 1994 and Region no. 12 will be loaded in 1996.\nThe Company has on-site spent nuclear fuel storage capability until at least 2009 and expects to be able to expand its storage capacity to accommodate the spent fuel output for the life of the plant through rod consolidation, dry cask storage or other technology as it becomes available. In addition, there is sufficient on-site storage capacity over the life of Summer Station to permit storage of the entire reactor core in the event that complete unloading should become desirable or necessary for any reason. (See \"Nuclear Fuel Disposal\" under \"Environmental Matters\" for information regarding the contract with the DOE for disposal of spent fuel.)\nDecommissioning\nDecommissioning of Summer Station is presently projected to commence in the year 2022 when the operating license expires. Based on a 1991 study, the expenditures (on a before-tax basis) related to the Company's share of decommissioning activities are estimated, in 2022 dollars assuming a 4.5% annual rate of inflation, to be $545.3 million including partial reclamation costs. The Company is providing for its share of estimated decommissioning costs of Summer Station over the life of Summer Station. The Company's method of funding decommissioning costs is referred to as COMReP (Cost of Money Reduction Plan). Under this plan, funds collected through rates ($3.2 million in each of 1995 and 1994) are used to purchase insurance policies on the lives of certain Company personnel. Through the purchase of insurance contracts, the Company is able to take advantage of income tax benefits and accrue earnings on the fund on a tax- deferred basis at a rate higher than can be achieved using more traditional funding approaches. Amounts for decommissioning collected through electric rates, insurance proceeds, and interest on proceeds less expenses are transferred by the Company to an external trust fund in compliance with the financial assurance requirements of the NRC. Management intends for the fund, including earnings thereon, to provide for all eventual decommissioning expenditures on an after-tax basis. The trust's sources of decommissioning funds under the COMReP program include investment components of life insurance policy proceeds, return on investment and the cash transfers from the Company described above. The Company records its liability for decommissioning costs in deferred credits.\nGAS OPERATIONS\nGas Sales\nIn 1995 residential sales accounted for 47% of gas sales revenues; commercial sales 32%; industrial sales 21%. Dekatherm sales by classification for the years ended December 31, 1995 and 1994 are presented below:\nSales Dekatherms % Classification 1995 1994 Change\nResidential 12,333,769 11,531,558 7.0 Commercial 10,436,987 9,813,454 6.4 Industrial 13,467,687 10,938,713 23.1 Transportation gas 3,603,314 5,469,728 (34.1) Total 39,841,757 37,753,453 5.5\nDuring 1995 the Company recorded a net increase of 4,909 gas customers, increasing its total customers to 243,342.\nThe Company purchases all of its natural gas from Pipeline Corporation.\nThe demand for gas is affected by conservation, the weather, the price relationship between gas and alternate fuels and other factors.\nThe deregulation of natural gas prices at the wellhead and the changes in the prices of natural gas that have occurred under Federal regulation have resulted in the development of a spot market for natural gas in the producing areas of the country. Pipeline Corporation has been successful in purchasing lower cost natural gas in the spot market and arranging for its transportation to South Carolina.\nOn November 1, 1993 Transco and Southern Natural (Pipeline Corporation's interstate suppliers) began operations under Order No. 636, which deregulated the markets for interstate sales of natural gas by requiring that pipelines provide transportation services that are equal in quality for all gas supplies whether the customer purchases gas from the pipeline or another supplier. The impact of this order on the Company will be primarily through changes affecting its supplier, Pipeline Corporation.\nTo reduce dependence on imported oil, NEPA imposes purchase requirements for the purchase of alternate fuel vehicles on Federal, state, municipal and private fleets. The Company expects these requirements to develop business opportunities for the sale of compressed natural gas as fuel for vehicles, but it cannot predict the magnitude of this new market.\nGas Cost and Supply\nPipeline Corporation purchases natural gas under contracts with producers and marketers on a short-term basis at current price indices and on a long-term basis for reliability assurance at index prices plus a gas inventory charge. The gas is brought to South Carolina through transportation agreements with both Southern Natural and Transco, which expire at various times from 1996 to 2003. The volume of gas which Pipeline Corporation is entitled to transport under these contracts on a firm basis is shown below:\nMaximum Daily Supplier Contract Demand Capacity (MCF)\nSouthern Natural Firm Transportation 184,974 Transco Firm Transportation 29,300 Total 214,274\nUnder a contract with Pipeline Corporation, the Company's maximum daily contract demand is 224,270 dekatherms. The contract allows the Company to receive amounts in excess of this demand based on availability.\nThe average cost per MCF of natural gas purchased from Pipeline Corporation was approximately $3.77 in 1995 compared to $4.29 in 1994.\nTo meet the requirements of the Company and its other high priority natural gas customers during periods of maximum demand, Pipeline Corporation supplements its supplies of natural gas from two LNG plants. The LNG plants are capable of storing the lique- fied equivalent of 1,900,000 MCF of natural gas, of which approximately 1,695,489 MCF were in storage at December 31, 1995. On peak days the LNG plants can regasify up to 150,000 MCF per day. Additionally, Pipeline Corporation had contracted for 6,450,727 MCF of natural gas storage space of which 4,307,796 MCF were in storage on December 31, 1995.\nThe Company believes that supplies under contract and available for spot market purchase are adequate to meet existing customer demands and to accommodate growth.\nCurtailment Plans\nThe FERC has established allocation priorities applicable to firm and interruptible capacities on interstate pipeline companies to their customers which require Southern Natural and Transco to allocate capacity to Pipeline Corporation. The FERC allocation priorities are not applicable to deliveries by the Company to its customers, which are governed by a separate curtailment plan approved by the PSC.\nREGULATION\nGeneral\nThe Company is subject to the jurisdiction of the PSC as to retail electric, gas and transit rates, service, accounting, issuance of securities (other than short-term promissory notes) and other matters. The Company is subject to regulation under the Federal Power Act, administered by the FERC and the DOE, in the transmission of electric energy in interstate commerce and in the sale of electric energy at wholesale for resale, as well as with respect to licensed hydroelectric projects and certain other matters, including accounting and the issuance of short-term promissory notes.\nIn the opinion of the Company, it will be able to meet successfully the challenges of the NEPA without any material adverse impact on its results of operations, financial position or business prospects.\nFederal Energy Regulatory Commission\nThe Company is subject to regulation under the Federal Power Act, administered by the FERC and the DOE, in the transmission of electric energy in interstate commerce and in the sale of electric energy at wholesale for resale, as well as with respect to licensed hydroelectric projects and certain other matters including accounting and the issuance of short-term promissory notes. (See \"Capital Requirements and Financing Program.\")\nThe Company holds licenses under the Federal Water Power Act or the Federal Power Act with respect to all its hydroelectric projects. The expiration dates of the licenses covering the projects are as follows:\nProject Capability (KW) License Expiration Date\nNeal Shoals 5,000 1993 Stevens Creek 9,000 2025 Columbia 10,000 2000 Saluda 206,000 2007 Parr Shoals 14,000 2020 Fairfield Pumped Storage 512,000 2020\nPursuant to the provisions of the Federal Power Act, as amended, applications for new licenses for Neal Shoals and Stevens Creek were filed with the FERC on December 30, 1991. No competing applications were filed. The FERC issued a new 30-year license for the Stevens Creek project on November 22, 1995. The Neal Shoals license application is in the final stage of review. The FERC has issued a Notice of Authorization for Continued Project Operation for Neal Shoals until the FERC acts on the Company's application for a new license.\nAt the termination of a license under the Federal Power Act, the United States government may take over the project covered thereby, or the FERC may extend the license or issue a license to another applicant. If the United States takes over a project or the FERC issues a license to another applicant, the original licensee is entitled to be paid its net investment in the project, not to exceed fair value, plus severance damages.\nThe Company has filed an application with the FERC requesting authorization to sell bulk power at market based rates. The application also included proposed open access transmission tariffs. (See \"National Energy Policy Act of 1992 and FERC Order 636.\")\nNuclear Regulatory Commission\nThe Company is subject to regulation by the NRC with respect to the ownership and operation of Summer Station. The NRC's jurisdiction encompasses broad supervisory and regulatory powers over the construction and operation of nuclear reactors, including matters of health and safety, antitrust considerations and environmental impact. In addition, the Federal Emergency Management Agency is responsible for the review, in conjunction with the NRC, of certain aspects of emergency planning relating to the operation of nuclear plants.\nFor the fourth time in the last five evaluations, Summer Station received a category one rating from the Institute of Nuclear Power Operations (INPO). The category one rating is the highest given by INPO for a nuclear plant's overall operations.\nNational Energy Policy Act of 1992 and FERC Order 636\nThe Company's regulated business operations are likely to be impacted by the NEPA and FERC Order No. 636. NEPA is designed to create a more competitive wholesale power supply market by creating \"exempt wholesale generators\" and by potentially requiring utilities owning transmission facilities to provide transmission access to wholesalers. Order No. 636 is intended to deregulate the markets for interstate sales of natural gas by requiring that pipelines provide transportation services that are equal in quality for all gas suppliers whether the customer purchases gas from the pipeline or another supplier. In the opinion of the Company, it will be able to meet successfully the challenges of these altered business climates and does not anticipate there to be any material adverse impact on the results of its operations, its financial position or its business prospects.\nRATE MATTERS\nThe following table presents a summary of significant rate activity for the years 1991-1995 based on test years:\nREQUESTED GRANTED\nDate of % % of General Rate Application\/ Amount Increase Date of Amount Increase Applications Hearing (Millions) Requested Order (Millions) Granted\nPSC Electric Retail 07\/10\/95 $ 76.7 8.4% 1\/09\/96 $67.5 88% Retail 12\/07\/92 $ 72.0* 11.4% 6\/07\/93 $60.5 84%\nTransit Fares 03\/12\/92 $ 1.7 42.0% 9\/14\/92 $ 1.0 59%\n* As modified to reflect lowering of rate of return the Company was seeking.\nOn July 10, 1995, the Company filed an application with the PSC for an increase in retail electric rates. On January 9, 1996 the PSC issued an order granting the Company an increase of 7.34% which will produce additional revenues of approximately $67.5 million annually. The increase will be implemented in two phases. The first phase, an increase in revenues of approximately $59.5 million annually based on a test year, or 6.47%, commenced on January 15, 1996. The second phase will be implemented in January 1997 and will produce additional revenues of approximately $8.0 million annually, or .87% more than current rates. The PSC authorized a return on common equity of 12.0%. The PSC also approved establishment of a Storm Damage Reserve Account capped at $50 million to be collected through rates over a ten-year period. Additionally, the PSC approved accelerated recovery of substantially all (excluding accumulated deferred income taxes) of the Company's electric regulatory assets and the remaining transition obligation for postretirement benefits other than pensions, changing the amortization periods to allow recovery by the end of the year 2000. The Company's request to shift approximately $257 million of depreciation reserves from transmission and distribution assets to nuclear production assets was also approved.\nOn October 27, 1994 the PSC issued an order approving the Company's request to recover through a billing surcharge to its gas customers the costs of environmental cleanup at the sites of former manufactured gas plants. The billing surcharge, which was effective with the first billing cycle in November 1994 and is subject to annual review, provides for the recovery of approximately $16.2 million representing substantially all actual and projected site assessment and cleanup costs for the Company's gas operations that had previously been deferred. In October 1995, as a result of the ongoing annual review, the PSC approved the continued use of the billing surcharge. The balance remaining to be recovered amounts to approximately $14.5 million.\nOn September 14, 1992 the PSC issued an order granting the Company a $.25 increase in transit fares from $.50 to $.75 in both Columbia and Charleston, South Carolina; however, the PSC also required $.40 fares for low-income customers and denied the Company's request to reduce the number of routes and frequency of service. The new rates were placed into effect on October 5, 1992. The Company has appealed the PSC's order to the Circuit Court. On May 23, 1995 the Circuit Court ordered the case back to the PSC for reconsideration of several issues including the low-income rider program, routing changes, and the $.75 fare. The Supreme Court declined to review an appeal of the Circuit Court decision and dismissed the case. The PSC filed, along with other intervenors, another Petition for Reconsideration, which the Circuit Court denied. Procedural matters in this case are yet to be resolved in the court.\nFuel Cost Recovery Procedures\nThe PSC has established a fuel cost recovery procedure which determines the fuel component in the Company's retail electric base rates semiannually based on projected fuel costs for the ensuing six-month period, adjusted for any overcollection or undercollection from the preceding six-month period. The Company has the right to request a formal proceeding at any time should circumstances dictate such a review.\nIn the April 1995 semiannual review of the fuel cost component of electric rates, the PSC decreased the rate from 14.16 mills per KWH to 13.48 mills per KWH, a monthly decrease of $.68 for an average customer using 1,000 KWH a month. For the October 1995 review the PSC continued the rate of 13.48 mills per KWH.\nThe Company's gas rate schedules and contracts include mechanisms which allow it to recover from its customers changes in the actual cost of gas. The Company's firm gas rates allow for the recovery of a fixed cost of gas, based on projections, as established by the PSC in annual gas cost and gas purchase practice hearings. Any differences between actual and projected gas costs are deferred and included when projecting gas costs during the next annual gas cost recovery hearing.\nIn the October 1995 review the PSC decreased the base cost of gas from 51.058 cents per therm to 43.081 cents per therm which resulted in a monthly decrease of $7.98 (including applicable taxes) based on an average of 100 therms per month on a residential bill during the heating season.\nENVIRONMENTAL MATTERS\nGeneral\nFederal and state authorities have imposed environmental control requirements relating primarily to air emissions, wastewater discharges and solid, toxic and hazardous waste management. Developments in these areas may require that equipment and facilities be modified, supplemented or replaced. The ultimate effect of these regulations and standards upon existing and proposed operations cannot be forecast.\nCapital Expenditures\nIn the years 1993 through 1995, capital expenditures for environmental control amounted to approximately $90.0 million. In addition, approximately $10.4 million, $8.8 million and $7.4 million of environmental control expenditures were made during 1995, 1994 and 1993, respectively, which were included in \"Other operation\" and \"Maintenance\" expenses. It is not possible to estimate all future costs for environmental purposes but forecasts for capitalized expenditures are $10.1 million for 1996 and $138.8 million for the four-year period 1997 through 2000. These expenditures are included in the Company's construction program.\nAir Quality Control\nThe Clean Air Act requires electric utilities to reduce substantially emissions of sulfur dioxide and nitrogen oxide by the year 2000. These requirements are being phased in over two periods. The first phase had a compliance date of January 1, 1995 and the second, January 1, 2000. The Company's facilities did not require modifications to meet the requirements of Phase I. The Company will most likely meet the Phase II requirements through the burning of natural gas and\/or lower sulfur coal in its generating units and the purchase and use of sulfur dioxide emission allowances. Low nitrogen oxide burners are being installed to reduce nitrogen oxide emissions to the levels required by Phase II. Air toxicity regulations for the electric generating industry are likely to be promulgated around the year 2000.\nThe Company filed compliance plans related to Phase II requirements with DHEC by December 31, 1995. The Company currently estimates that air emissions control equipment will require capital expenditures of $113 million over the 1996-2000 period to retrofit existing facilities, with increased operation and maintenance cost of approximately $1 million per year. To meet compliance requirements through the year 2005, the Company anticipates total capital expenditures of approximately $150 million.\nWater Quality Control\nThe Federal Clean Water Act, as amended, provides for the imposition of effluent limitations that require various levels of treatment for each wastewater discharge. Under this Act, compliance with applicable limitations is achieved under a national permit program. Discharge permits have been issued for all and renewed for nearly all of the Company's and GENCO's generating units. Concurrent with renewal of these permits the permitting agency has implemented a more rigorous control program. The Company has been developing compliance plans to meet this program. Amendments to the Clean Water Act proposed in Congress include several provisions which, if passed, could prove costly to the Company. These include limitations to mixing zones and the implementation of technology-based standards.\nSuperfund Act and Environmental Assessment Program\nThe Company has an environmental assessment program to identify and assess current and former operations sites that could require environmental cleanup. As site assessments are initiated, estimates are made of the cost, if any, to investigate and clean up each site. These estimates are refined as additional information becomes available; therefore, actual expenditures could differ significantly from original estimates. Amounts estimated and accrued to date for site assessments and cleanup relate primarily to regulated operations; such amounts are deferred and are being amortized and recovered through rates over a ten-year period for electric operations and an eight-year period for gas operations. Deferred amounts totaled $18.0 million and $20.2 million at December 31, 1995 and 1994, respectively. Estimates include, among other items, the costs estimated to be associated with the matters discussed in the following paragraphs.\nThe Company owns four decommissioned manufactured gas plant sites which contain residues of by-product chemicals. The Company has maintained an active review of the sites to monitor the nature and extent of the residual contamination.\nIn September 1992 the EPA notified the Company, the City of Charleston and the Charleston Housing Authority of their potential liability for the investigation and cleanup of the Calhoun Park Area Site in Charleston, South Carolina. This site originally encompassed approximately eighteen acres and included properties which were the locations for industrial operations, including a wood preserving (creosote) plant and one of the Company's decommissioned manufactured gas plants. The original scope of this investigation has been expanded to approximately 30 acres, including adjacent properties owned by the National Park Service and the City of Charleston, and private properties. The site has not been placed on the National Priority List, but may be added before cleanup is initiated. The PRPs have agreed with the EPA to participate in an innovative approach to site investigation and cleanup called \"Superfund Accelerated Cleanup Model,\" allowing the pre-cleanup site investigations process to be compressed significantly. The PRPs have negotiated an administrative order by consent for the conduct of a Remedial Investigation\/Feasibility Study and a corresponding Scope of Work. Field work began in November 1993. The Company is also working with the City of Charleston to investigate potential contamination from the manufactured gas plant which may have migrated to the city's aquarium site. In 1994 the City of Charleston notified the Company that it considers the Company to be responsible for a $43.5 million increase in costs of the aquarium project attributable to delays resulting from contamination of the Calhoun Park Area Site. The Company believes that it has meritorious defenses against this claim and does not expect its resolution to have a material impact on its financial position or results of operations.\nThe Company has been listed as a PRP and has recorded liabilities, which are not material, for the Macon-Dockery waste disposal site near Rockingham, North Carolina. The Company has participated in de minimis buy-outs for the Aqua-Tech Environmental Inc. site in Greer, South Carolina and a landfill owned by Lexington County in South Carolina. The Company expects to have no further involvement with these two sites.\nThe Arkansas Department of Pollution Control and Ecology has identified the Company as a PRP for clean-up of PCBs at an abandoned transformer rebuilding plant in Little Rock, Arkansas. No formal notice from the Department has been received. The Company believes that its identification as a PRP was in error, and that the resolution of this issue will not have a material effect on the Company's results of operations or financial position.\nSolid Waste Control\nThe South Carolina Solid Waste Policy and Management Act of 1991 directed the DHEC to promulgate regulations for the disposal of industrial solid waste. DHEC has promulgated a proposal regulation, which if adopted as a final regulation in its present form, would significantly increase the Company's costs of construction and operation of existing and future ash management facilities.\nNuclear Fuel Disposal\nThe Nuclear Waste Policy Act of 1982 requires that the United States government make available by 1998 a permanent repository for high-level radioactive waste and spent nuclear fuel and imposes a fee of 1.0 mill per KWH of net nuclear generation after April 7, 1983. Payments, which began in 1983, are subject to change and will extend through the operating life of Summer Station. The Company entered into a contract with the DOE on June 29, 1983, providing for permanent disposal of its spent nuclear fuel by the DOE. The DOE presently estimates that the permanent storage facility will not be available until 2010. The Company has on-site spent fuel storage capability until at least 2009 and expects to be able to expand its storage capacity over the life of Summer Station to accommodate the spent nuclear fuel output for the life of the plant through rod consolidation, dry cask storage or other technology as it becomes available. The Act also imposes on utilities the primary responsibility for storage of their spent nuclear fuel until the repository is available.\nOTHER MATTERS\nWith regard to the Company's insurance coverage for Summer Station, reference is made to Note 10B of Notes to Consolidated Financial Statements.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's bond indentures, securing the First and Refunding Mortgage Bonds and First Mortgage Bonds issued thereunder, constitute direct mortgage liens on substantially all of its property.\nELECTRIC\nThe following table gives information with respect to the Company's electric generating facilities.\nNet Generating Present Year Capability Facility Fuel Capability Location In-Service (KW)(1)\nSteam Urquhart Coal\/Gas Beech Island, SC 1953 250,000 McMeekin Coal\/Gas Irmo, SC 1958 252,000 Canadys Coal\/Gas Canadys, SC 1962 430,000 Wateree Coal Eastover, SC 1970 700,000 Summer (2) Nuclear Parr, SC 1984 594,000 D-Area (3) Coal DOE Savannah River Site, SC 1995 17,000 Cope (4) Coal Cope, SC 1996 385,000\nGas Turbines Burton Gas\/Oil Burton, SC 1961 28,500 Faber Place Gas Charleston, SC 1961 9,500 Hardeeville Oil Hardeeville, SC 1968 14,000 Canadys Gas\/Oil Canadys, SC 1968 14,000 Urquhart Gas\/Oil Beech Island, SC 1969 38,000 Coit Gas\/Oil Columbia, SC 1969 30,000 Parr (5) Gas\/Oil Parr, SC 1970 60,000 Williams (6) Gas\/Oil Goose Creek, SC 1972 49,000 Hagood Gas\/Oil Charleston, SC 1991 95,000\nHydro Neal Shoals Carlisle, SC 1905 5,000 Parr Shoals Parr, SC 1914 14,000 Stevens Creek Martinez, GA 1914 9,000 Columbia Columbia, SC 1927 10,000 Saluda Irmo, SC 1930 206,000\nPumped Storage Fairfield Parr, SC 1978 512,000 Total (7) 3,722,000\n(1) Summer rating. (2) Represents the Company's two-thirds portion of the Summer Station. (3) This plant is operated under lease from the DOE and is dispatched to DOE's Savannah River Site steam needs. \"Net Capacity Rating\" for this plant is expected average hourly output. The lease, which may be extended, expires on October 1, 2005. (4) Plant began commercial operation in January 1996. (5) Two of the four Parr gas turbines are leased and have a net capability of 34,000 KW. This lease expires on June 29, 1996. The Company has agreed to purchase the leased turbines on the lease expiration date. (6) The two gas turbines at Williams are leased and have a net capability of 49,000 KW. This lease expires on June 29, 1997. (7) Excludes Williams Station.\nThe Company owns 429 substations having an aggregate transformer capacity of 19,577,868 KVA. The transmission system consists of 3,090 miles of lines and the distribution system consists of 15,596 pole miles of overhead lines and 3,191 trench miles of underground lines.\nGAS\nNatural Gas\nThe Company's gas system consists of approximately 6,833 miles of three-inch equivalent distribution pipelines and approximately 11,265 miles of distribution mains and related service facilities.\nPropane\nThe Company has propane air peak shaving facilities which can supplement the supply of natural gas by gasifying propane to yield the equivalent of 102,000 MCF per day of natural gas. These facilities can store the equivalent of 430,405 MCF of natural gas.\nTRANSIT\nThe Company owns 98 motor coaches which operate on a route system of 286 miles.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nFor information regarding legal proceedings, see ITEM 1., \"BUSINESS - RATE MATTERS\" and \"BUSINESS - ENVIRONMENTAL MATTERS - Superfund Act and Environmental Assessment Program\" and Note 10 of Notes to Consolidated Financial Statements appearing in Item 8., \"FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\"\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNot Applicable\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS\nAll of the Company's common stock is owned by SCANA and therefore there is no market for such stock. During 1995 and 1994 the Company paid $116.7 million and $115.1 million, respectively, in cash dividends to SCANA.\nThe Restated Articles of Incorporation of the Company and the Indenture underlying its First and Refunding Mortgage Bonds contain provisions that may limit the payment of cash dividends on common stock. In addition, with respect to hydroelectric projects, the Federal Power Act may require the appropriation of a portion of the earnings therefrom. At December 31, 1995 approximately $14.5 million of retained earnings were restricted as to payment of cash dividends on common stock.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nCOMPETITION\nThe electric utility industry has begun a major transition that could lead to expanded market competition and less regulatory protection. Future deregulation of electric wholesale and retail markets will create opportunities to compete for new and existing customers and markets. As a result, profit margins and asset values of some utilities could be adversely affected. The pace of deregulation, future prices of electricity, and the regulatory actions which may be taken by the PSC in response to the changing environment cannot be predicted. However, the Company is aggressively pursuing actions to position itself strategically for the transformed environment. To enhance its flexibility and responsiveness to change, the Company operates Strategic Business Units. Maintaining a competitive cost structure is of paramount importance in the utility's strategic plan. The Company has undertaken a variety of initiatives, including reductions in operation and maintenance costs and in staffing levels. In January 1996 the PSC approved (as discussed under \"Liquidity and Capital Resources\") the accelerated recovery of the Company's electric regulatory assets and the shift of depreciation reserves from transmission and distribution assets to nuclear production assets. The Company believes that these actions as well as numerous others that have been and will be taken demonstrate its ability and commitment to succeed in the new operating environment to come.\nRegulated public utilities are allowed to record as assets some costs that would be expensed by other enterprises. If deregulation or other changes in the regulatory environment occur, the Company may no longer be eligible to apply this accounting treatment and may be required to eliminate such regulatory assets from its balance sheet. Such an event could have a material adverse effect on the Company's results of operations in the period the write-off is recorded. The Company reported approximately $116 million and $4 million of regulatory assets and liabilities, respectively, excluding amounts related to net accumulated deferred income tax assets of approximately $33 million, on its balance sheet at December 31, 1995.\nLIQUIDITY AND CAPITAL RESOURCES\nThe cash requirements of the Company arise primarily from its operational needs and its construction program. The ability of the Company to replace existing plant investment, as well as to expand to meet future demands for electricity and gas, will depend upon its ability to attract the necessary financial capital on reasonable terms. The Company recovers the costs of providing services through rates charged to customers. Rates for regulated services are generally based on historical costs. As customer growth and inflation occur and the Company expands its construction program, it is necessary to seek increases in rates. As a result, the Company's future financial position and results of operations will be affected by its ability to obtain adequate and timely rate and other regulatory relief.\nDue to continuing customer growth, the Company entered into a contract with Duke\/Fluor Daniel in 1991 to design, engineer and build a 385 MW coal-fired electric generating plant near Cope, South Carolina. Construction of the plant started in November 1992. Commercial operation began in January 1996. The estimated cost of the Cope plant, excluding AFC, is $410.9 million. In addition, the transmission lines for interconnection with the Company's system are expected to cost $22.5 million.\nOn July 10, 1995 the Company filed an application with the PSC for an increase in retail electric rates. On January 9, 1996 the PSC issued an order granting the Company an increase of 7.34% which will produce additional revenues of approximately $67.5 million annually. The increase will be implemented in two phases. The first phase, an increase in revenues of approximately $59.5 annually based on a test year, or 6.47%, commenced on January 15, 1996. The second phase will be implemented in January 1997 and will produce additional revenues of approximately $8.0 million annually, or .87% more than current rates. The PSC authorized a return on common equity of 12.0%. The PSC also approved establishment of a Storm Damage Reserve Account capped at $50 million to be collected through rates over a ten-year period. Additionally, the PSC approved accelerated recovery of substantially all of the Company's electric regulatory assets (excluding accumulated deferred income taxes) and the remaining transition obligation for postretirement benefits other than pensions, changing the amortization periods to allow recovery by the end of the year 2000. The Company's request to shift approximately $257 million of depreciation reserves from transmission and distribution assets to nuclear production assets was also approved.\nThe estimated primary cash requirements for 1996, excluding requirements for fuel liabilities and short-term borrowings, (including notes payable to affiliated companies), and the actual primary cash requirements for 1995 are as follows:\n1996 1995 (Thousands of Dollars) Property additions and construction expenditures, net of allowance for funds used during construction $197,179 $250,870 Nuclear fuel expenditures 21,147 21,045 Maturing obligations, redemptions and sinking and purchase fund requirements 21,197 15,812 Total $239,523 $287,727\nApproximately 45% of total cash requirements (after payment of dividends) was provided from internal sources in 1995 as compared to 22% in 1994.\nThe Company's First and Refunding Mortgage Bond Indenture, dated April 1, 1945 (Old Mortgage), contains provisions prohibiting the issuance of additional bonds thereunder (Class A Bonds) unless net earnings (as therein defined) for twelve consecutive months out of the fifteen months prior to the month of issuance are at least twice the annual interest requirements on all Class A Bonds to be outstanding (Bond Ratio). For the year ended December 31, 1995 the Bond Ratio was 3.97. The issuance of additional Class A Bonds also is restricted to an additional principal amount equal to (i) 60% of unfunded net property additions (which unfunded net property additions totaled approximately $162.3 million at December 31, 1995), (ii) retirements of Class A Bonds (which retirement credits totaled $64.8 million at December 31, 1995), (iii) and cash on deposit with the Trustee.\nThe Company has a new indenture (New Mortgage) dated April 1, 1993 covering substantially all of its electric properties under which its future mortgage-backed debt (New Bonds) will be issued. New Bonds are issued under the New Mortgage on the basis of a like principal amount of Class A Bonds issued under the Old Mortgage which have been deposited with the Trustee of the New Mortgage (of which $185 million were available for such purpose as of December 31, 1995), until such time as all presently outstanding Class A Bonds are retired. Thereafter, New Bonds will be issuable on the basis of property additions in a principal amount equal to 70% of the original cost of electric and common plant properties (compared to 60% of value for Class A Bonds under the Old Mortgage), cash deposited with the Trustee, and retirement of New Bonds. New Bonds will be issuable under the New Mortgage only if adjusted net earnings (as therein defined) for twelve consecutive months out of the eighteen months immediately preceding the month of issuance are at least twice the annual interest requirements on all outstanding bonds (including Class A Bonds) and New Bonds to be outstanding (New Bond Ratio). For the year ended December 31, 1995 the New Bond Ratio was 5.31.\nThe following financing transaction has occurred since December 31, 1994:\nOn April 12, 1995 the Company issued $100 million of First Mortgage Bonds, 7 5\/8% series due April 1, 2025 to repay short-term borrowings.\nWithout the consent of at least a majority of the total voting power of the Company's preferred stock, the Company may not issue or assume any unsecured indebtedness if, after such issue or assumption, the total principal amount of all such unsecured indebtedness would exceed 10% of the aggregate principal amount of all of the Company's secured indebtedness and capital and surplus; provided, however, that no such consent shall be required to enter into agreements for payment of principal, interest and premium for securities issued for pollution control purposes.\nPursuant to Section 204 of the Federal Power Act, the Company must obtain the FERC authority to issue short-term indebtedness. The FERC ha authorized the Company to issue up to $200 million of unsecured promissory notes or commercial paper with maturity dates of twelve months or less, but not later than December 31, 1997.\nThe Company had $165 million authorized and unused lines of credit at December 31, 1995. In addition, the Company has a credit agreement for a maximum of $125 million with the full amount available at December 31, 1995. The credit agreement supports the issuance of short-term commercial paper for the financing of nuclear and fossil fuels and sulfur dioxide emission allowances. Fuel Company commercial paper outstanding at December 31, 1995 was $76.8 million.\nThe Company's Restated Articles of Incorporation prohibit issuance of additional shares of preferred stock without consent of the preferred stockholders unless net earnings (as defined therein) for the twelve consecutive months immediately preceding the month of issuance are at least one and one-half times the aggregate of all interest charges and preferred stock dividend requirements (Preferred Stock Ratio). For the year ended December 31, 1995 the Preferred Stock Ratio was 2.58.\nThe Company anticipates that its 1996 cash requirements of $378.9 million will be met through internally generated funds (approximately 77%, after payment of dividends), the sales of additional equity securities, additional equity contributions from SCANA and the incurrence of additional short-term and long- term indebtedness. The timing and amount of such financing will depend upon market conditions and other factors. Actual 1996 expenditures may vary from the estimates set forth above due to factors such as inflation and economic conditions, regulation and legislation, rates of load growth, environmental protection standards and the cost and availability of capital.\nThe Company expects that it has or can obtain adequate sources of financing to meet its projected cash requirements for the next twelve months and for the foreseeable future.\nEnvironmental Matters\nThe Clean Air Act requires electric utilities to reduce substantially emissions of sulfur dioxide and nitrogen oxide by the year 2000. These requirements are being phased in over two periods. The first phase had a compliance date of January 1, 1995 and the second, January 1, 2000. The Company's facilities did not require modifications to meet the requirements of Phase I. The Company will most likely meet the Phase II requirements through the burning of natural gas and\/or lower sulfur coal in its generating units and the purchase and use of sulfur dioxide emission allowances. Low nitrogen oxide burners are being installed to reduce nitrogen oxide emissions to the levels required by Phase II. Air toxicity regulations for the electric generating industry are likely to be promulgated around the year 2000.\nBy December 31, 1995 the Company had filed compliance plans related to Phase II requirements with DHEC. The Company currently estimates that air emissions control equipment will require capital expenditures of $113 million over the 1996-2000 period to retrofit existing facilities, with increased operation and maintenance cost of approximately $1 million per year. To meet compliance requirements through the year 2005, the Company anticipates total capital expenditures of approximately $150 million.\nThe Federal Clean Water Act, as amended, provides for the imposition of effluent limitations that require various levels of treatment for each wastewater discharge. Under this Act, compliance with applicable limitations is achieved under a national permit program. Discharge permits have been issued for all and renewed for nearly all of SCE&G's and GENCO's generating units. Concurrent with renewal of these permits, the permitting agency has implemented more rigorous control programs. The Company has been developing compliance plans for this program. Amendments to the Clean Water Act proposed in Congress include several provisions which, if passed, could prove costly to the Company. These include limitations to mixing zones and the implementation of technology-based standards.\nThe South Carolina Solid Waste Policy and Management Act of 1991 directed DHEC to promulgate regulations for the disposal of industrial solid waste. DHEC has promulgated a proposed regulation which, if adopted as a final regulation in its present form, would significantly increase the Company's and GENCO's costs of construction and operation of existing and future ash management facilities.\nThe Company has an environmental assessment program to identify and assess current and former operations sites that could require environmental cleanup. As site assessments are initiated, estimates are made of the cost, if any, to investigate and clean up each site. These estimates are refined as additional information becomes available; therefore, actual expenditures could differ significantly from original estimates. Amounts estimated and accrued to date for site assessments and cleanup relate primarily to regulated operations; such amounts are deferred and are being amortized and recovered through rates over a ten-year period for electric operations and an eight- year period for gas operations. Deferred amounts totaled $18.0 million and $20.2 million at December 31, 1995 and 1994, respectively. Estimates include, among other items, the costs associated with the matters discussed in the following paragraphs.\nThe Company owns four decommissioned manufactured gas plant sites which contain residues of by-product chemicals. The Company maintains an active review of the sites to monitor the nature and extent of the residual contamination.\nIn September 1992 the EPA notified the Company, the City of Charleston and the Charleston Housing Authority of their potential liability for the investigation and cleanup of the Calhoun Park Area Site in Charleston, South Carolina. This site originally encompassed approximately eighteen acres and included properties which were the locations for industrial operations, including a wood preserving (creosote) plant and one of the Company's decommissioned manufactured gas plants. The original scope of this investigation has been expanded to approximately 30 acres, including adjacent properties owned by the National Park Service and the City of Charleston, and private properties. The site has not been placed on the National Priority List, but may be added before cleanup is initiated. The PRPs have agreed with the EPA to participate in an innovative approach to site investigation and cleanup called \"Superfund Accelerated Cleanup Model,\" allowing the pre-cleanup site investigation process to be compressed significantly. The PRPs have negotiated an administrative order by consent for the conduct of a Remedial Investigation\/Feasibility Study and a corresponding Scope of Work. Field work began in November 1993. The Company is also working with the City of Charleston to investigate potential contamination from the manufactured gas plant which may have migrated to the City's aquarium site. In 1994 the City of Charleston notified the Company that it considers the Company to be responsible for a $43.5 million increase in costs of the aquarium project attributable to delays resulting from contamination of the Calhoun Park Area Site. The Company believes it has meritorious defenses against this claim and does not expect its resolution to have a material impact on its financial position or results of operations.\nRegulatory Matters\nThe Company filed for electric rate relief in 1995 to encompass primarily the remaining costs of completing the Cope Generating Station. As discussed under \"Liquidity and Capital Resources,\" the PSC issued an order on January 9, 1996 increasing electric retail rates.\nThe Company's regulated business operations are likely to be impacted by the NEPA and FERC Order No. 636. NEPA is designed to create a more competitive wholesale power supply market by creating \"exempt wholesale generators\" and by potentially requiring utilities owning transmission facilities to provide transmission access to wholesalers. Order No. 636 is intended to deregulate the markets for interstate sales of natural gas by requiring that pipelines provide transportation services that are equal in quality for all gas suppliers whether the customer purchases gas from the pipeline or another supplier. In the opinion of the Company, it will be able to meet successfully the challenges of these altered business climates and does not anticipate there to be any material adverse impact on the results of its operations, its financial position or its business prospects.\nStatements of Financial Accounting Standards To Be Adopted\nThe Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of.\" The provisions of the Statement, which will be implemented by the Company for the fiscal year beginning January 1, 1996, require the recognition of a loss in the income statement and related disclosures whenever events or changes in circumstances indicate that the carrying amount of a long-lived asset may not be recoverable. The Company does not believe that adoption of the provisions of the Statement will have a material impact on its results of operations or financial position.\nThe Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, \"Accounting for Stock- Based Compensation,\" which will be implemented by the Company on January 1, 1996. The Company does not believe that adoption of the provisions of the Statement will have a material impact on its results of operations or financial position.\nRESULTS OF OPERATIONS\nNet Income\nNet income and the percent increase (decrease) from the previous year for the years 1995, 1994 and 1993 were as follows:\n1995 1994 1993\nNet income $169,185 $152,043 $145,968 Percent increase (decrease) in net income 11.27% 4.16% 42.9%\n1995 Net income increased for the year primarily due to increases in electric and gas margins and lower operating and maintenance expenses which more than offset increases in fixed costs.\n1994 Net income increased for the year primarily due to an increase in the electric margin which more than offset increases in operating expenses.\nThe Company's financial statements include an allowance for funds used during construction (AFC). AFC is a utility accounting practice whereby a portion of the cost of both equity and borrowed funds used to finance construction (which is shown on the balance sheet as construction work in progress) is capitalized. An equity portion of AFC is included in nonoperating income and a debt portion of AFC is included in interest charges (credits) as noncash items, both which have the effect of increasing reported net income. AFC represented approximately 7.9 % of income before income taxes in 1995, 6.3% in 1994 and 5.6% in 1993.\nElectric Operations\nElectric sales margins for 1995, 1994 and 1993 were as follows:\n1995 1994 1993 (Millions of Dollars)\nElectric revenues $1,006.6 $974.3 $940.2 (Provision) for rate refunds - 1.2 0.3 Net Electric operating revenues 1,006.6 975.5 940.5 Less: Fuel used in electric generation 177.6 176.6 164.2 Purchased power 98.2 112.9 111.1 Margin $ 730.8 $686.0 $665.2\n1995 The electric sales margin increased over the prior year primarily as a result of the combined impact of warmer weather in the third quarter of 1995, colder weather in the fourth quarter of 1995 and the base rate increase received by the Company in mid-1994. These factors more than offset the negative impact of milder weather experienced during the first half of 1995. An increase of 7,943 electric customers to 484,381 total customers contributed to an all-time peak demand record of 3,683 MW set on August 14, 1995.\n1994 The electric sales margin increased over the prior year primarily as a result of an increase in retail electric rates phased in over a two-year period beginning in June 1993 and an increase in industrial sales which more than offset the negative impact of a six percent decrease in residential sales of electricity due to milder weather in 1994.\nIncreases (decreases) from the prior year in megawatt hour (MWH) sales volume by classes were as follows:\nClassification 1995 1994\nResidential 415,676 (339,620) Commercial 229,565 4,198 Industrial 48,651 274,467 Sale for Resale (excluding interchange) 38,688 18,408 Other 12,776 (6,907) Total territorial 745,356 (49,454) Interchange 24,545 (27,013) Total 769,901 (76,467)\nGas Operations\nGas sales margins for 1995, 1994 and 1993 were as follows:\n1995 1994 1993 (Millions of Dollars)\nGas operating revenues $200.6 $201.7 $174.0 Less: Gas purchased for resale 125.0 127.8 107.7 Margin $ 75.6 $ 73.9 $ 66.3\n1995 The gas sales margin increased over the prior year primarily as a result of increases in interruptible gas sales.\n1994 The gas sales margin increased over the prior year primarily as a result of increases in interruptible gas sales.\nIncreases (decreases) from the prior year in dekatherm (DT) sales volume by classes, including transportation gas, were as follows:\nClassification 1995 1994\nResidential 802,211 (477,886) Commercial 623,533 970,726 Industrial 2,528,974 5,057,404 Transportation gas (1,866,414) (1,524,089) Total 2,088,304 4,026,155\nOther Operating Expenses and Taxes\nIncreases (decreases) in other operating expenses, including taxes, were as follows:\nClassification 1995 1994 (Millions of Dollars)\nOther operation and maintenance $(7.8) $ 3.9 Depreciation and amortization 10.6 5.7 Income taxes 12.9 2.8 Other taxes 5.1 5.0 Total $20.8 $17.4\n1995 Other operation and maintenance expenses decreased primarily as a result of lower pension costs and lower costs at electric generating stations. The increase in depreciation and amortization expense primarily is attributable to additions to plant-in-service and the expensing of software costs. The increase in income tax expense corresponds to the increase in operating income. The increase in other taxes reflects higher property taxes resulting from higher millages and assessments partially offset by lower payroll taxes resulting from early retirements of employees.\n1994 Other operation and maintenance expenses increased primarily due to an increase in the costs of postretirement benefits other than pensions. These costs are accrued in accordance with Financial Accounting Standards Board Statement No. 106. (See Note 1K of Notes to Consolidated Financial Statements.) The increase in depreciation and amortization expenses is attributable to property additions and to increases in depreciation rates. The increase in other taxes reflects an increase in property taxes of approximately $5 million.\nInterest Expense\nIncreases (decreases) in interest expense were as follows:\nClassification 1995 1994 (Millions of Dollars)\nInterest on long-term debt, net $11.0 $8.0 Other interest expense 4.1 (.6) Total $15.1 $7.4\n1995 The increase in interest expense, excluding the debt component of AFC, is due primarily to the issuance of additional debt including commercial paper during the latter part of 1994 and early 1995.\n1994 The increase in interest expense, excluding the debt component of AFC, is primarily attributable to the issuance of $100 million of First Mortgage Bonds in July and $30 million of Pollution Control Facilities Revenue Bonds in November, both to finance utility construction, and to the issuance of long-term debt during 1993.\nITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nPage\nIndependent Auditors' Report....................................... 31\nConsolidated Financial Statements:\nConsolidated Balance Sheets as of December 31, 1995 and 1994... 32\nConsolidated Statements of Income and Retained Earnings for the years ended December 31, 1995, 1994 and 1993............. 34\nConsolidated Statements of Cash Flows for the years ended December 31, 1995, 1994 and 1993............................. 35\nConsolidated Statements of Capitalization as of December 31, 1995 and 1994................................... 36\nNotes to Consolidated Financial Statements..................... 38\nSupplemental financial statement schedules are omitted because of the absence of conditions under which they are required or because the required information is included in the consolidated financial statements or in the notes thereto.\nINDEPENDENT AUDITOR'S REPORT\nSouth Carolina Electric & Gas Company:\nWe have audited the accompanying Consolidated Balance Sheets and Statements of Capitalization of South Carolina Electric & Gas Company (Company) as of December 31, 1995 and 1994 and the related Consolidated Statements of Income and Retained Earnings and of Cash Flows for each of the three years in the period ended December 31, 1995. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 1995 and 1994 and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles.\ns\/Deloitte & Touche LLP DELOITTE & TOUCHE LLP Columbia, South Carolina February 7, 1996\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:\nA. Organization and Principles of Consolidation\nThe Company, a public utility, is a South Carolina corporation organized in 1924 and a wholly owned subsidiary of SCANA Corporation (SCANA), a South Carolina holding company. The Company, through wholly owned subsidiaries is predominately engaged in the generation and sale of electricity to wholesale and retail customers in South Carolina and in the purchase, sale and transportation of natural gas to retail customers in South Carolina.\nThe accompanying Consolidated Financial Statements include the accounts of the Company and South Carolina Fuel Company, Inc. (Fuel Company). (See Note 1N.) Intercompany balances and transactions between the Company and Fuel Company have been eliminated in consolidation.\nAffiliated Transactions\nThe Company has entered into agreements with certain affiliates to purchase gas for resale to its distribution customers and to purchase electric energy. The Company purchases all of its natural gas requirements from Pipeline Corporation and at December 31, 1995 and 1994 the Company had approximately $17.5 million and $16.3 million, respectively, payable to Pipeline Corporation for such gas purchases. The Company purchases all of the electric generation of Williams Station, which is owned by GENCO, under a unit power sales agreement. At December 31, 1995 and 1994 the Company had approximately $8.2 million and $8.8 million, respectively, payable to GENCO for unit power purchases. Such unit power purchases, which are included in \"Purchased power,\" amounted to approximately $83.5 million, $92.8 million and $98.1 million in 1995, 1994 and 1993, respectively.\nTotal interest income, based on market interest rates, associated with the Company's advances to affiliated companies was approximately $174,000, $5,000 and $143,000 in 1995, 1994 and 1993, respectively.\nIncluded in \"Other interest expense\" for 1995, 1994 and 1993 is approximately $114,000, $279,000 and $29,000, respectively, relating to advances from affiliated companies. Intercompany interest is calculated at market rates.\nB. Basis of Accounting\nThe Company prepares its financial statements in accordance with the provisions of Statement of Financial Accounting Standards No. 71 (SFAS 71), \"Accounting for the Effects of Certain Types of Regulations.\" The accounting standard allows cost-based rate-regulated utilities, such as the Company, to recognize in their financial statements revenues and expenses in different time periods than do enterprises that are not rate- regulated. As a result the Company has recorded, as of December 31, 1995, approximately $116 million and $4 million of regulatory assets and liabilities, respectively, excluding net accumulated deferred income tax assets of approximately $33 million. As discussed in Note 2A, the PSC has approved accelerated recovery of substantially all of the Company's electric regulatory assets (approximately $84.8 million). In the future, as a result of deregulation or other changes in the regulatory environment, the Company may no longer meet the criteria for continued application of SFAS 71 and would be required to write off its regulatory assets and liabilities. Such an event could have a material adverse effect on the Company's results of operations in the period the write-off is recorded.\nC. System of Accounts The accounting records of the Company are maintained in accordance with the Uniform System of Accounts prescribed by the FERC and as adopted by the PSC.\nD. Utility Plant\nUtility plant is stated substantially at original cost. The costs of additions, renewals and betterments to utility plant, including direct labor, material and indirect charges for engineering, supervision and an allowance for funds used during construction, are added to utility plant accounts. The original cost of utility property retired or otherwise disposed of is removed from utility plant accounts and generally charged, along with the cost of removal, less salvage, to accumulated depreciation. The costs of repairs, replacements and renewals of items of property determined to be less than a unit of property are charged to maintenance expense.\nThe Company, operator of the Summer Station and PSA are joint owners of Summer Station in the proportions of two-thirds and one-third, respectively. The parties share the operating costs and energy output of the plant in these proportions. Each party, however, provides its own financing. Plant-in-service related to the Company's portion of Summer Station was approximately $925.1 million and $923.1 million as of December 31, 1995 and 1994, respectively. Accumulated depreciation associated with the Company's share of Summer Station was approximately $261.0 million and $297.9 million as of December 31, 1995 and 1994, respectively. (See Note 2A.) The Company's share of the direct expenses associated with operating Summer Station is included in \"Other operation\" and \"Maintenance\" expenses.\nE. Allowance for Funds Used During Construction\nAFC, a noncash item, reflects the period cost of capital devoted to plant under construction. This accounting practice results in the inclusion of, as a component of construction cost, the costs of debt and equity capital dedicated to construction investment. AFC is included in rate base investment and depreciated as a component of plant cost in establishing rates for utility services. The Company has calculated AFC using composite rates of 8.6%, 8.5% and 9.4% for 1995, 1994 and 1993, respectively. These rates do not exceed the maximum allowable rate as calculated under FERC Order No. 561. Interest on nuclear fuel in process and sulfur dioxide emission allowances is capitalized at the actual interest amount.\nF. Deferred Return on Plant Investment\nCommencing July 1, 1987, as approved by a PSC order on that date, the Company ceased the deferral of carrying costs associated with 400 MW of electric generating capacity previously removed from rate base and began amortizing the accumulated deferred carrying costs on a straight-line basis over a ten-year period. Amortization of deferred carrying costs, included in \"Depreciation and amortization,\" was approximately $4.2 million for each of 1995, 1994 and 1993.\nG. Revenue Recognition\nCustomers' meters are read and bills are rendered on a monthly cycle basis. Base revenue is recorded during the accounting period in which the meters are read.\nFuel costs for electric generation are collected through the fuel cost component in retail electric rates. The fuel cost component contained in electric rates is established by the PSC during semiannual fuel cost hearings. Any difference between actual fuel costs and that contained in the fuel cost component is deferred and included when determining the fuel cost component during the next semiannual fuel cost hearing. The Company had overcollected through the electric fuel cost component approximately $3.8 million at December 31, 1995 and undercollected approximately $3.5 million at December 31, 1994 which are included in \"Deferred Credits - Other\" and \"Deferral Debits - Other,\" respectively.\nCustomers subject to the gas cost adjustment clause are billed based on a fixed cost of gas determined by the PSC during annual gas cost recovery hearings. Any difference between actual gas cost and that contained in the rates is deferred and included when establishing gas costs during the next annual gas cost recovery hearing. At December 31, 1995 and 1994 the Company had undercollected through the gas cost recovery procedure approximately $4.6 million and $16.3 million, respectively, which are included in \"Deferred Debits - Other.\"\nThe Company's gas rate schedules for residential, small commercial and small industrial customers include a weather normalization adjustment, which minimizes fluctuations in gas revenues due to abnormal weather conditions.\nH. Depreciation and Amortization\nProvisions for depreciation are recorded using the straight- line method for financial reporting purposes and are based on the estimated service lives of the various classes of property. The composite weighted average depreciation rates were 3.02%, 3.01%, and 2.97% for 1995, 1994 and 1993, respectively.\nNuclear fuel amortization, which is included in \"Fuel used in electric generation\" and is recovered through the fuel cost component of the Company's rates, is recorded using the units-of- production method. Provisions for amortization of nuclear fuel include amounts necessary to satisfy obligations to the United States DOE under a contract for disposal of spent nuclear fuel.\nI. Nuclear Decommissioning\nDecommissioning of Summer Station is presently projected to commence in the year 2022 when the operating license expires. Based on a 1991 study, the expenditures (on a before-tax basis) related to the Company's share of decommissioning activities are estimated, in 2022 dollars assuming a 4.5% annual rate of inflation, to be $545.3 million including partial reclamation costs. The Company is providing for its share of estimated decommissioning costs of Summer Station over the life of Summer Station. The Company's method of funding decommissioning cost is referred to as COMReP (Cost of Money Reduction Plan). Under this plan, funds collected through rates ($3.2 million in each of 1995 and 1994) are used to purchase insurance policies on the lives of certain Company personnel. Through the purchase of insurance contracts, the Company is able to take advantage of income tax benefits and accrue earnings on the fund on a tax- deferred basis at a rate higher than can be achieved using more traditional funding approaches. Amounts for decommissioning collected through electric rates, insurance proceeds, and interest on proceeds less expenses are transferred by the Company to an external trust fund in compliance with the financial assurance requirements of the Nuclear Regulatory Commission. Management intends for the fund, including earnings thereon, to provide for all eventual decommissioning expenditures on an after-tax basis. The trust's sources of decommissioning funds under the COMReP program include investment components of life insurance policy proceeds, return on investment and the cash transfers from the Company described above. The Company records its liability for decommissioning costs in deferred credits.\nThe staff of the Securities and Exchange Commission has questioned certain of the current accounting practices of the electric utility industry regarding the recognition, measurement and classification of decommissioning costs for the financial statements of electric utilities with nuclear generating facilities. 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: (1) annual provisions for decommissioning could increase, and (2) trust fund income from the external decommissioning trusts could be reported as investment income rather than as a reduction of decommissioning expense.\nPursuant to the NEPA passed by Congress in 1992, the Company has recorded a liability for its estimated share of amounts required by the DOE for its decommissioning fund. The liability, approximately $3.6 million at December 31, 1995, has been included in \"Long-Term Debt, Net.\" The Company will recover the cost associated with this liability through the fuel cost component of its rates; accordingly, this amount has been deferred and is included in \"Deferred Debits - Other.\"\nJ. Income Taxes\nThe Company is included in the consolidated Federal income tax return filed by SCANA. Income taxes are allocated to the Company based on its contribution to the consolidated total.\nAs required by Statement of Financial Accounting Standards No. 109, deferred tax assets and liabilities are recorded for the tax effects of temporary differences between the book basis and tax basis of assets and liabilities at currently enacted tax rates. Deferred tax assets and liabilities are adjusted for changes in such rates through charges or credits to regulatory assets or liabilities if they are expected to be recovered from, or passed through to, customers; otherwise, they are charged or credited to income tax expense.\nK. Pension Expense\nThe Company participates in SCANA's noncontributory defined benefit pension plan, which covers all permanent Company employees. Benefits are based on years of accredited service and the employee's average annual base earnings received during the last three years of employment. SCANA's policy has been to fund pension costs accrued to the extent permitted by the applicable Federal income tax regulations as determined by an independent actuary.\nNet periodic pension cost for the years ended December 31, 1995, 1994 and 1993 included the following components:\n1995 1994 1993 (Thousands of Dollars) Service cost--benefits earned during the period $ 5,187 $ 8,684 $ 7,629 Interest cost on projected benefit obligation 19,473 21,711 20,413 Adjustments: Return on plan assets (103,874) 2,365 (50,389) Net amortization and deferral 74,769 (29,760) 25,936 Amounts contributed by the Company's affiliates (203) (130) (175) Net periodic pension (income) expense $ (4,648) $ 2,870 $ 3,414\nThe determination of net periodic pension cost is based upon the following assumptions:\n1995 1994 1993 Annual discount rate 8.0% 7.25% 8.0% Expected long-term rate of return on plan assets 8.0% 8.0% 8.0% Annual rate of salary increases 2.5% 4.75% 5.5%\nThe following table sets forth the funded status of the plan at December 31, 1995 and 1994:\n1995 1994 (Thousands of Dollars) Actuarial present value of benefit obligations: Vested benefit obligation $228,434 $205,364 Nonvested benefit obligation 15,540 13,966 Accumulated benefit obligation $243,974 $219,330\nPlan assets at fair value (invested primarily in equity and debt securities) $447,760 $347,702 Projected benefit obligation 284,145 246,318 Plan assets greater than projected benefit obligation 163,615 101,384 Unrecognized net transition liability 9,022 11,307 Unrecognized prior service costs 9,660 9,374 Unrecognized net gain (146,943) (102,284) Pension asset recognized in Consolidated Balance Sheets $ 35,354 $ 19,781\nThe accumulated benefit obligation is based on the plan's benefit formulas without considering expected future salary increases. The following table sets forth the assumptions used in determining the amounts shown above for the years 1995 and 1994.\n1995 1994\nAnnual discount rate used to determine benefit obligations 7.5% 8.0% Assumed annual rate of future salary increases for projected benefit obligation 3.0% 2.5%\nThe change in the annual discount rate used to determine benefit obligations from 8.0% to 7.5% and the change in the expected salary increase rate from 2.5% to 3.0% as of December 31, 1995 increased the projected benefit obligation and decreased the unrecognized net gain by approximately $28.6 million.\nIn addition to pension benefits, the Company provides certain health care and life insurance benefits to active and retired employees. The costs of postretirement benefits other than pensions are accrued during the years the employees render the service necessary to be eligible for the applicable benefits. Prior to 1993, the Company expensed these benefits, which are primarily health care, as claims were incurred. In its June 1993 electric rate order, the PSC approved the inclusion in rates of the portion of increased expenses related to electric operations. The Company expensed approximately $8.5 million and $8.6 million, net of payments to current retirees, for the years ended December 31, 1995 and 1994, respectively. The PSC has authorized accelerated amortization of the Company's remaining transition obligation for postretirement benefits other than pensions related to electric operations. (See Note 2A.)\nNet periodic postretirement benefit cost for the years ended December 31, 1995, 1994 and 1993, included the following components:\n1995 1994 1993 (Thousands of Dollars)\nService cost--benefits earned during the period $ 2,076 $ 2,417 $ 1,908 Interest cost on accumulated postretirement benefit obligation 7,253 6,644 5,502 Adjustments: Return on plan assets - - - Amortization of unrecognized transition obligation 3,344 3,344 3,344 Other net amortization and deferral 661 860 - Amounts contributed by the Company's affiliates (610) (575) (525) Net periodic postretirement benefit cost $12,724 $12,690 $10,229\nThe determination of net periodic postretirement benefit cost is based upon the following assumptions:\n1995 1994 1993\nAnnual discount rate 8.0% 7.25% 8.0% Health care cost trend rate 11.0% 11.25% 13.0% Ultimate health care cost trend rate (to be achieved in 2004) 6.0% 5.25% 6.0%\nThe following table sets forth the funded status of the plan at December 31, 1995 and 1994:\n1995 1994 (Thousands of Dollars)\nAccumulated postretirement benefit obligations for: Retirees $ 64,989 $ 59,174 Other fully eligible participants 6,685 4,995 Other active participants 27,076 24,889 Accumulated postretirement benefit obligation 98,750 89,058 Plan assets at fair value - - Plan assets less accumulated postretirement benefit obligation (98,750) (89,058) Unrecognized net transition liability 58,237 61,581 Unrecognized prior service costs 5,320 3,453 Unrecognized net loss 13,840 11,156 Postretirement benefit liability recognized in Consolidated Balance Sheets $(21,353) $(12,868)\nThe accumulated postretirement benefit obligation is based upon the plan's benefit provisions and the following assumptions:\n1995 1994 Assumed health care cost trend rate used to measure expected costs 10.5% 12.0% Ultimate health care cost trend rate (to be achieved in 2004) 5.5% 6.0% Annual discount rate 7.5% 8.0% Annual rate of salary increases 3.0% 2.5%\nThe effect of a one percentage-point increase in the assumed health care cost trend rate for each future year on the aggregate of the service and interest cost components of net periodic postretirement benefit cost for the year ended December 31, 1995 and the accumulated postretirement benefit obligation as of December 31, 1995 would be to increase such amounts by $203,000 and $3.4 million, respectively.\nL. Debt Premium, Discount and Expense, Unamortized Loss on Reacquired Debt\nLong-term debt premium, discount and expense are being amortized as components of \"Interest on long-term debt, net\" over the terms of the respective debt issues. Gains or losses on reacquired debt that is refinanced are deferred and amortized over the term of the replacement debt.\nM. Environmental\nThe Company has an environmental assessment program to identify and assess current and former operations sites that could require environmental cleanup. As site assessments are initiated, an estimate is made of the amount of expenditures, if any, necessary to investigate and clean up each site. These estimates are refined as additional information becomes available; therefore, actual expenditures could differ significantly from the original estimates. Amounts estimated and accrued to date for site assessments and cleanup relate primarily to regulated operations; such amounts are deferred and are being amortized and recovered through rates over a ten-year period for electric operations and an eight-year period for gas operations. Such deferred amounts totaled $18.0 million and $20.2 million at December 31, 1995 and 1994, respectively, and are included in \"Deferred Debits - Other.\"\nN. Fuel Inventories\nNuclear fuel and fossil fuel inventories and sulfur dioxide emission allowances are purchased and financed by Fuel Company under a contract which requires the Company to reimburse Fuel Company for all costs and expenses relating to the ownership and financing of fuel inventories and sulfur dioxide emission allowances. Accordingly, such fuel inventories and emission allowances and fuel-related assets and liabilities are included in the Company's consolidated financial statements. (See Note 4.)\nO. Temporary Cash Investments\nThe Company considers temporary cash investments having original maturities of three months or less to be cash equivalents. Temporary cash investments are generally in the form of commercial paper, certificates of deposit and repurchase agreements.\nP. Recently Issued Accounting Standards\nThe Financial Accounting Standards Board has issued Statement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of.\" The provisions of the Statement, which will be implemented by the Company for the fiscal year beginning January 1, 1996, require the recognition of a loss in the income statement and related disclosures whenever events or changes in circumstances indicate that the carrying amount of a long-lived asset may not be recoverable. The Company does not believe that adoption of the provisions of the Statement will have a material impact on its results of operations or financial position.\nThe Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, \"Accounting for Stock- Based Compensation,\" which will be implemented by the Company on January 1, 1996. The Company does not believe that adoption of the provisions of the Statement will have a material impact on its results of operations or financial position.\nQ. Reclassifications\nCertain amounts from prior periods have been reclassified to conform with the 1995 presentation.\nR. Use of Estimates\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period. Actual results could differ from those estimates.\n2. RATE MATTERS:\nA. On July 10, 1995, the Company filed an application with the PSC for an increase in retail electric rates. On January 9, 1996 the PSC issued an order granting the Company an increase of 7.34% which will produce additional revenues of approximately $67.5 million annually. The increase will be implemented in two phases. The first phase, an increase in revenues of approximately $59.5 million annually based on a test year, or 6.47%, commenced on January 15, 1996. The second phase will be implemented in January 1997 and will produce additional revenues of approximately $8.0 million annually, or .87% more than current rates. The PSC authorized a return on common equity of 12.0%. The PSC also approved establishment of a Storm Damage Reserve Account capped at $50 million and collected through rates over a ten-year period. Additionally, the PSC approved accelerated recovery of substantially all (excluding accumulated deferred income taxes) of the Company's electric regulatory assets and the transition obligation for postretirement benefits other than pensions, changing the amortization periods to allow recovery by the end of the year 2000. The Company's request to shift approximately $257 million of depreciation reserves from transmission and distribution assets to nuclear production assets was also approved.\nB. On October 27, 1994 the PSC issued an order approving the Company's request to recover through a billing surcharge to its gas customers the costs of environmental cleanup at the sites of former manufactured gas plants. The billing surcharge, which was effective with the first billing cycle in November 1994 and is subject to annual review, provides for the recovery of approximately $16.2 million representing substantially all site assessment and cleanup costs for the Company's gas operations that had previously been deferred. In October 1995, as a result of the ongoing annual review, the PSC approved the continued use of the billing surcharge. The balance remaining to be recovered amounts to approximately $14.5 million.\nC. In September 1992 the PSC issued an order granting the Company a $.25 increase in transit fares from $.50 to $.75 in both Columbia and Charleston, South Carolina; however, the PSC also required $.40 fares for low-income customers and denied the Company's request to reduce the number of routes and frequency of service. The new rates were placed into effect in October 1992. The Company appealed the PSC's order to the Circuit Court, which on May 23, 1995, ordered the case back to the PSC for reconsideration of several issues including the low-income rider program, routing changes, and the $.75 fare. The Supreme Court declined to review an appeal of the Circuit Court decision and dismissed the case. Another Petition for Reconsideration was filed by the PSC and other intervenors, which was denied by the Circuit Court. Procedural matters in this case are yet to be resolved in the court.\n3. LONG-TERM DEBT:\nThe annual amounts of long-term debt maturities, including amounts due under nuclear and fossil fuel agreements (see Note 4), and sinking fund requirements for the years 1996 through 2000 are summarized as follows:\nYear Amount Year Amount (Thousands of Dollars)\n1996 $ 36,033 1999 $ 17,663 1997 33,252 2000 117,668 1998 114,483\nApproximately $17.3 million of the portion of long-term debt payable in 1996 may be satisfied by either deposit and cancellation of bonds issued upon the basis of property additions or bond retirement credits, or by deposit of cash with the Trustee.\nThe Company has three-year revolving lines of credit totaling $100 million, in addition to other lines of credit, that provide liquidity for issuance of commercial paper. The three- year lines of credit provide back-up liquidity when commercial paper outstanding is in excess of $100 million. The long-term nature of the lines of credit allow commercial paper in excess of $100 million to be classified as long-term debt. The Company had outstanding commercial paper of $111.2 million at December 31, 1994, of which $11.2 million was reclassified to long-term debt.\nCertain outstanding long-term debt of an affiliated company (approximately $35.9 million at both December 31, 1995 and 1994) is guaranteed by the Company.\nSubstantially all utility plant and fuel inventories are pledged as collateral in connection with long-term debt.\n4. FUEL FINANCINGS:\nNuclear and fossil fuel inventories and sulfur dioxide emission allowances are financed through the issuance by Fuel Company of short-term commercial paper. These short-term borrowings are supported by an irrevocable revolving credit agreement which expires July 31, 1998. Accordingly, the amounts outstanding have been included in long-term debt. The credit agreement provides for a maximum amount of $125 million that may be outstanding at any time.\nCommercial paper outstanding totaled $76.8 million and $50.6 million at December 31, 1995 and 1994 at weighted average interest rates of 5.76% and 6.06%, respectively.\n5. COMMON EQUITY:\nThe changes in \"Stockholders' Investment\" (Including Preferred Stock Not Subject to Purchase or Sinking Funds) during 1995, 1994 and 1993 are summarized as follows:\nCommon Preferred Thousands Shares Shares of Dollars\nBalance December 31, 1992 40,296,147 322,877 $989,768 Changes in Retained Earnings: Net Income 145,968 Cash Dividends Declared: Preferred Stock (at stated rates) (6,217) Common Stock (110,300) Equity Contributions from Parent 58,142 Balance December 31, 1993 40,296,147 322,877 1,077,361 Changes in Retained Earnings: Net Income 152,043 Cash Dividends Declared: Preferred Stock (at stated rates) (5,955) Common Stock (113,700) Equity Contributions from Parent 49,710 Balance December 31, 1994 40,296,147 322,877 1,159,459 Changes in Retained Earnings: Net Income 169,185 Cash Dividends Declared: Preferred Stock (at stated rates) (5,687) Common Stock (121,363) Equity Contributions from Parent including transfer of assets 139,505 Balance December 31, 1995 40,296,147 322,877 $1,341,099\nThe Restated Articles of Incorporation of the Company and the Indenture underlying its First and Refunding Mortgage Bonds contain provisions that under certain circumstances could limit the payment of cash dividends on common stock. In addition, with respect to hydroelectric projects, the Federal Power Act requires the appropriation of a portion of the earnings therefrom. At December 31, 1995 approximately $14.5 million of retained earnings were restricted by this requirement as to payment of cash dividends on common stock.\n6. PREFERRED STOCK (Subject to Purchase or Sinking Funds):\nThe call premium of the respective series of preferred stock in no case exceeds the amount of the annual dividend. Retirements under sinking fund requirements are at par values.\nThe aggregate annual amounts of purchase fund or sinking fund requirements for preferred stock for the years 1996 through 2000 are summarized as follows:\nYear Amount Year Amount (Thousands of Dollars)\n1996 $2,439 1999 $2,440 1997 2,440 2000 2,440 1998 2,440\nThe changes in \"Total Preferred Stock (Subject to Purchase or Sinking Funds)\" during 1995, 1994 and 1993 are summarized as follows:\nNumber Thousands of Shares of Dollars\nBalance December 31, 1992 940,529 $ 58,639 Shares Redeemed: $100 par value (7,374) (737) $50 par value (51,187) (2,558) Balance December 31, 1993 881,968 55,344 Shares Redeemed: $100 par value (8,072) (807) $50 par value (51,802) (2,591) Balance December 31, 1994 822,094 51,946 Shares Redeemed: $100 par value (6,809) (681) $50 par value (51,666) (2,583) Balance December 31, 1995 763,619 $ 48,682\n7. INCOME TAXES:\nTotal income tax expense for 1995, 1994 and 1993 is as follows:\n1995 1994 1993 (Thousands of Dollars) Current taxes: Federal $ 94,137 $66,597 $60,577 State 14,265 9,505 6,822 Total current taxes 108,402 76,102 67,399 Deferred taxes, net: Federal (7,319) 7,727 12,197 State (603) 2,118 4,387 Total deferred taxes (7,922) 9,845 16,584 Investment tax credits: Amortization of amounts deferred (credit) (3,230) (3,231) (3,245) Total income tax expense $ 97,250 $82,716 $80,738\nThe difference in actual income taxes and the income taxes calculated from the application of the statutory Federal income tax rate (35% for 1995, 1994 and 1993) to pretax income is reconciled as follows:\n1995 1994 1993 (Thousands of Dollars)\nNet income $169,185 $152,043 $145,968 Total income tax expense: Charged to operating expenses 96,956 84,066 81,280 Charged (credited) to other income 294 (1,350) (542) Total pretax income $266,435 $234,759 $226,706\nIncome taxes on above at statutory Federal income tax rate $ 93,252 $ 82,166 $ 79,347 Increases (decreases) attributable to: Allowance for equity funds used during construction (3,325) (2,796) (2,624) Amortization of deferred return on plant investment 1,486 1,486 1,486 Depreciation differences 3,268 2,994 2,531 Amortization of investment tax credits (3,230) (3,231) (3,245) State income taxes (less Federal income tax effect) 8,880 7,555 7,286 Deferred income tax flowback at higher than statutory rates (3,310) (3,647) (3,641) Other differences, net 229 (1,811) (402) Total income tax expense $ 97,250 $ 82,716 $ 80,738\nThe tax effects of significant temporary differences comprising the Company's net deferred tax liability of $468.9 million at December 31, 1995 and $485.8 million at December 31, 1994 determined in accordance with Statement No. 109 (see Note 1J) are as follows:\n1995 1994 (Thousands of Dollars) Deferred tax assets: Unamortized investment tax credits $ 48,512 $ 50,513 Cycle billing 19,143 17,521 Nuclear operations expenses 3,755 206 Deferred compensation 5,562 5,450 Other postretirement benefits 6,371 3,187 Other 2,929 3,627 Total deferred tax assets 86,272 80,504 Deferred tax liabilities: Property plant and equipment 520,294 533,394 Pension expense 14,191 9,022 Reacquired debt 6,680 7,146 Research and experimentation 6,196 2,276 Other 7,801 14,458 Total deferred tax liabilities 555,162 566,296 Net deferred tax liability $468,890 $485,792\nThe Internal Revenue Service has examined and closed consolidated Federal income tax returns of SCANA Corporation through 1989 and is currently examining SCANA's 1990, 1991 and 1992 Federal income tax returns. Adjustments are currently proposed by the examining agent. SCANA does not anticipate that any adjustments which might result from this examination will have a significant impact on the earnings or financial position of the Company.\n8. FINANCIAL INSTRUMENTS:\nThe carrying amounts and estimated fair values of the Company's financial instruments at December 31, 1995 and 1994 are as follows:\nThe information presented herein is based on pertinent information available to the Company as of December 31, 1995 and 1994. Although the Company is not aware of any factors that would significantly affect the estimated fair value amounts, such financial instruments have not been comprehensively revalued since December 31, 1995, and the current estimated fair value may differ significantly from the estimated fair value at that date.\nThe following methods and assumptions were used to estimate the fair value of the above classes of financial instruments:\nCash and temporary cash investments, including commercial paper, repurchase agreements, treasury bills and notes are valued at their carrying amount.\nFair values of investments and long-term debt are based on quoted market prices of the instruments or similar instruments, or for those instruments for which there are no quoted market prices available, fair values are based on net present value calculations. Settlement of long term debt may not be possible or may not be a prudent management decision.\nShort-term borrowings are valued at their carrying amount.\nThe fair value of preferred stock (subject to purchase or sinking funds) is estimated on the basis of market prices.\nPotential taxes and other expenses that would be incurred in an actual sale or settlement have not been taken into consideration.\n9. SHORT-TERM BORROWINGS:\nThe Company pays fees to banks as compensation for its committed lines of credit. Commercial paper borrowings are for 270 days or less. Details of lines of credit and short-term borrowings, excluding amounts classified as long-term (Notes 3 and 4), at December 31, 1995, 1994 and 1993 and for the years then ended are as follows:\n1995 1994 1993 (Millions of dollars)\nAuthorized lines of credit at year-end $165.0 $165.0 $212.0 Unused lines of credit at year-end $165.0 $165.0 $212.0 Short-term borrowings outstanding at year-end: Commercial paper $ 80.5 $100.0 $ 1.0 Weighted average interest rate 5.83% 6.04% 3.35%\n10. COMMITMENTS AND CONTINGENCIES:\nA. Construction\nThe Company entered into a contract with Duke\/Fluor Daniel in 1991 to design, engineer and build a 385 MW coal-fired electric generating plant near Cope, South Carolina. Construction of the plant started in November 1992. Commercial operation began in January 1996. The cost of the Cope plant, excluding AFC, is $410.9 million. In addition, the transmission lines for interconnection with the Company's system cost $22.5 million.\nUnder the Duke\/Fluor Daniel contract the aggregate amount of required minimum payments remaining at December 31, 1995 is $4.2 million due in 1996. Through December 31, 1995 the Company had paid $378.7 million under the contract.\nB. Nuclear Insurance\nThe Price-Anderson Indemnification Act, which deals with the Company's public liability for a nuclear incident, currently establishes the liability limit for third-party claims associated with any nuclear incident at $8.9 billion. Each reactor licensee is currently liable for up to $79.3 million per reactor owned for each nuclear incident occurring at any reactor in the United States, provided that not more than $10 million of the liability per reactor would be assessed per year. The Company's maximum assessment, based on its two-thirds ownership of Summer Station, would be approximately $52.9 million per incident, but not more than $6.7 million per year.\nThe Company currently maintains policies (for itself and on behalf of the PSA) with Nuclear Electric Insurance Limited (NEIL) and American Nuclear Insurers (ANI) providing combined property and decontamination insurance coverage of $1.9 billion for any losses at Summer Station. The Company pays annual premiums and, in addition, could be assessed a retroactive premium not to exceed 7 1\/2 times its annual premium in the event of property damage loss to any nuclear generating facilities covered under the NEIL program. Based on the current annual premium, this retroactive premium would not exceed $8.2 million.\nTo the extent that insurable claims for property damage, decontamination, repair and replacement and other costs and expenses arising from a nuclear incident at Summer Station exceed the policy limits of insurance, or to the extent such insurance becomes unavailable in the future, and to the extent that the Company's rates would not recover the cost of any purchased replacement power, the Company will retain the risk of loss as a self-insurer. The Company has no reason to anticipate a serious nuclear incident at Summer Station. If such an incident were to occur, it could have a material adverse impact on the Company's financial position and results of operations.\nC. Environmental\nAs described in Note 1M of Notes to Consolidated Financial Statements, the Company has an environmental assessment program to identify and assess current and former operations sites that could require environmental cleanup. As site assessments are initiated, estimates are made of the cost, if any, to investigate and clean up each site. These estimates are refined as additional information becomes available; therefore, actual expenditures could differ significantly from original estimates. Amounts estimated and accrued to date for site assessments and cleanup relate primarily to regulated operations; such amounts are deferred and are being amortized and recovered through rates over a ten-year period for electric operations and an eight-year period for gas operations. Such deferred amounts totaled $18.0 million and $20.2 million at December 31, 1995 and 1994, respectively. Estimates to date include, among other items, the costs estimated to be associated with the matters discussed in the following paragraphs.\nThe Company owns four decommissioned manufactured gas plant sites which contain residues of by-product chemicals. The Company maintains an active review of the sites to monitor the nature and extent of the residual contamination.\nIn September 1992 the EPA notified the Company, the City of Charleston and the Charleston Housing Authority of their potential liability for the investigation and cleanup of the Calhoun Park Area Site in Charleston, South Carolina. This site originally encompassed approximately eighteen acres and included properties which were the locations for industrial operations, including a wood preserving (creosote) plant and one of the Company's decommissioned manufactured gas plants. The original scope of this investigation has been expanded to approximately 30 acres, including adjacent properties owned by the National Park Service and the City of Charleston, and private properties. The site has not been placed on the National Priority List, but may be added before cleanup is initiated. The PRPs have agreed with the EPA to participate in an innovative approach to site investigation and cleanup called \"Superfund Accelerated Cleanup Model,\" allowing the pre-cleanup site investigation process to be compressed significantly. The PRPs have negotiated an administrative order by consent for the conduct of a Remedial Investigation\/Feasibility Study (RI\/FS) and a corresponding Scope of Work. Field work began in November 1993. The Company is also working with the City of Charleston to investigate potential contamination from the manufactured gas plant which may have migrated to the city's aquarium site. In 1994 the City of Charleston notified the Company that it considers the Company to be responsible for a $43.5 million increase in costs of the aquarium project attributable to delays resulting from contamination of the Calhoun Park Area Site. The Company believes it has meritorious defenses against this claim and does not expect its resolution to have a material impact on its financial position or results of operations.\nD. Claims and Litigation\nThe Company is engaged in various claims and litigation incidental to its business operations which management anticipates will be resolved without loss to the Company. No estimate of the range of loss from these matters can currently be determined.\n11. SEGMENT OF BUSINESS INFORMATION:\nSegment information at December 31, 1995, 1994 and 1993 and for the years then ended is as follows:\nElectric Gas Transit Total (Thousands of Dollars) Operating revenues $1,006,566 $ 200,632 $ 3,889 $1,211,087 Operating expenses, excluding depreciation and amortization 657,452 169,768 10,429 837,649 Depreciation and amortization 103,961 12,616 1,007 117,584 Total operating expenses 761,413 182,384 11,436 955,233 Operating income (loss) $ 245,153 $ 18,248 $ (7,547) 255,854\nAdd - Other income, net 9,553 Less - Interest charges 96,222 Net income $ 169,185\nCapital expenditures: Identifiable $ 245,016 $ 19,670 $ 265 $ 264,951\nUtilized for overall Company operations 27,816 Total $ 292,767\nIdentifiable assets at December 31, 1995: Utility plant, net $2,850,647 $ 209,847 $ 1,878 $3,062,372 Inventories 76,697 2,155 561 79,413 Total $2,927,344 $ 212,002 $ 2,439 3,141,785\nOther assets 660,648 Total assets $3,802,433\nElectric Gas Transit Total (Thousands of Dollars) Operating revenues $975,526 $201,746 $ 4,002 $1,181,274 Operating expenses, excluding depreciation and amortization 659,610 173,717 10,577 843,904 Depreciation and amortization 95,666 11,060 226 106,952 Total operating expenses 755,276 184,777 10,803 950,856 Operating income (loss) $ 220,250 $ 16,969 $ (6,801) 230,418\nAdd - Other income, net 7,271 Less - Interest charges 85,646 Net income $ 152,043\nCapital expenditures: Identifiable $ 359,510 $ 40,923 $ 347 $ 400,780\nUtilized for overall Company operations 20,167 Total $ 420,947\nIdentifiable assets at December 31, 1994: Utility plant, net $2,717,147 $201,018 $ 1,791 $2,919,956 Inventories 85,113 2,605 495 88,213 Total $2,802,260 $203,623 $ 2,286 3,008,169\nOther assets 578,922 Total assets $3,587,091\nElectric Gas Transit Total (Thousands of Dollars) Operating revenues $ 940,547 $174,035 $ 3,851 $1,118,433 Operating expenses, excluding depreciation and amortization 639,808 148,349 9,737 797,894 Depreciation and amortization 91,142 9,903 175 101,220 Total operating expenses 730,950 158,252 9,912 899,114 Operating income (loss) $ 209,597 $ 15,783 $(6,061) 219,319\nAdd - Other income, net 6,585 Less - Interest charges 79,936 Net income $ 145,968\nCapital expenditures: Identifiable $ 274,408 $ 11,674 $ 604 $ 286,686\nUtilized for overall Company operations 13,934 Total $ 300,620\nIdentifiable assets at December 31, 1993: Utility plant, net $2,445,466 $178,464 $1,673 $2,625,603 Inventories 66,181 2,526 463 69,170 Total $2,511,647 $180,990 $2,136 2,694,773\nOther assets 495,166 Total assets $3,189,939\n12. QUARTERLY FINANCIAL DATA (UNAUDITED):\n(Thousands of Dollars) First Second Third Fourth Quarter Quarter Quarter Quarter Annual Total operating revenues $308,759 $275,139 $339,937 $287,252 $1,211,087 Operating income 67,189 53,153 87,023 48,489 255,854 Net Income 45,249 30,870 65,040 28,026 169,185\n(Thousands of Dollars) First Second Third Fourth Quarter Quarter Quarter Quarter Annual Total operating revenues $313,321 $263,033 $327,066 $277,854 $1,181,274 Operating income 63,520 43,316 79,133 44,449 230,418 Net Income 45,340 24,348 57,619 24,736 152,043\nITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNONE PART III\nITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nDIRECTORS\nThe directors listed below were elected April 27, 1995 to hold office until the next annual meeting of the Company's stockholders on April 25, 1996.\nName and Year First Became Director Age Principal Occupation; Directorships\nBill L. Amick 52 For more than five years, Chairman of the (1990) Board and Chief Executive Officer of Amick Farms, Inc., Batesburg, SC (vertically integrated broiler operation).\nFor more than five years, Chairman and Chief Executive Officer of Amick Processing, Inc. and Amick Broilers, Inc.\nDirector, SCANA Corporation, Columbia, SC.\nWilliam B. Bookhart, Jr. 54 For more than five years, a partner in (1979) Bookhart Farms, Elloree, SC (general farming).\nDirector, SCANA Corporation, Columbia, SC.\nWilliam T. Cassels, Jr. 66 For more than five years, Chairman of the (1990) Board, Southeastern Freight Lines, Inc., Columbia, SC (trucking business).\nDirector, SCANA Corporation, Columbia, SC; South Carolina National Corporation, Columbia, SC; Wachovia Bank of South Carolina, N.A., Columbia, SC.\nHugh M. Chapman 63 Since January 1, 1992, Chairman of (1988) NationsBank South, Atlanta, GA (a division of NationsBank Corporation, bank holding company).\nFrom September 1, 1990 to December 31, 1991, Vice Chairman and Director, C&S\/Sovran Corporation, Atlanta, GA.\nPrior to September 1, 1990, President and Director, Citizens & Southern Corporation, Atlanta, GA and Chairman of the Board, Citizens & Southern South Carolina Corporation, Columbia, SC.\nDirector, SCANA Corporation, Columbia, SC.\nName and Year First Became Director Age Principal Occupation; Directorships\nJames B. Edwards, D.M.D. 68 For more than five years, President and (1986) Professor of Maxillofacial Surgery, Medical University of South Carolina, Charleston, SC.\nU.S. Secretary of Energy from January 1981 to November 1982.\nGovernor of South Carolina, 1975-1979.\nDirector, Phillips Petroleum Co., Bartlesville, OK; WMX Technologies, Inc., Oak Brook, IL; General Engineering Laboratories, Inc., Charleston SC; GS Industries, Inc., Charlotte, NC; IMO Industries, Inc., Lawrenceville, NJ; National Data Corporation, Atlanta, GA; SCANA Corporation, Columbia, SC.\nElaine T. Freeman 60 For more than five years, Executive Director (1992) of ETV Endowment of South Carolina, Inc. (non-profit organization), Spartanburg, SC.\nDirector National Bank of South Carolina, Columbia, SC; SCANA Corporation, Columbia, SC.\nLawrence M. Gressette, Jr. 64 For more than five years, Chairman of the (1987) Board and Chief Executive Officer of SCANA Corporation and Chairman of the Board and Chief Executive Officer of all SCANA subsidiaries, including the Company.\nFor more than five years prior to December 13, 1995, President of SCANA Corporation.\nDirector, Wachovia Corporation, Winston- Salem, NC; InterCel, Inc., West Point, GA; The Liberty Corporation, Greenville, SC; SCANA Corporation, Columbia, SC.\nBenjamin A. Hagood 68 Since January 1, 1993, Chairman of the (1974) Board William M. Bird and Company, Inc., Inc., Charleston, SC (wholesale distributor of floor covering material).\nFor more than two years prior to January 1, 1993, President and Director, William M. Bird and Company, Inc., Charleston, SC.\nDirector, SCANA Corporation, Columbia, SC.\nName and Year First Became Director Age Principal Occupation; Directorships\nW. Hayne Hipp 56 For more than five years, President and (1983) Chief Executive Officer, The Liberty Corporation, Greenville, SC (insurance and broadcasting holding company).\nDirector, The Liberty Corporation, Greenville, SC; Wachovia Corporation, Winston-Salem, NC; SCANA Corporation, Columbia, SC.\nBruce D. Kenyon 53 For more than five years, President and (1991) Chief Operating Officer of the Company.\nDirector, SCANA Corporation, Columbia, SC.\nF. Creighton McMaster 66 For more than five years, President and (1974) Manager, Winnsboro Petroleum Company, Winnsboro, SC (wholesale distributor of petroleum products).\nDirector, First Union National Bank of South Carolina, Greenville, SC; SCANA Corporation, Columbia, SC.\nHenry Ponder, Ph.D. 67 For more than five years, President, Fisk (1983) University, Nashville, TN.\nDirector, Suntrust Banks, Inc., Nashville, TN; SCANA Corporation, Columbia, SC.\nJohn B. Rhodes 65 For more than five years, Chairman and (1967) Chief Executive Officer, Rhodes Oil Company, Inc., Walterboro, SC (distributor of petroleum products).\nDirector, SCANA Corporation, Columbia, SC.\nWilliam B. Timmerman 49 Since December 13, 1995, President of SCANA (1991) Corporation.\nFrom May 1, 1994 to December 13, 1995, Executive Vice President of SCANA Corporation.\nSince August 25, 1993, Assistant Secretary of SCANA Corporation and all of its subsidiaries, including the Company.\nFrom August 28, 1991 to February 20, 1996, Chief Financial Officer of the Company.\nFor more than five years prior to May 1, 1994, Senior Vice President of SCANA SCANA Corporation.\nFor more than five years prior to February 20, 1996, Controller of SCANA Corporation.\nDirector, SCANA Corporation, Columbia, SC; InterCel, Inc., West Point, GA.\nName and Year First Became Director Age Principal Occupation; Directorships\nE. Craig Wall, Jr. 58 For more than five years, President and (1982) Director, Canal Industries, Conway, SC (forest products industry).\nDirector, Sonoco Products Company, Hartsville, SC; Ruddick Corporation, Charlotte, NC; Nationsbank Corp., Charlotte, NC; Blue Cross\/Blue Shield of South Carolina, Columbia, SC; SCANA Corporation, Columbia, SC.\nEXECUTIVE OFFICERS OF THE COMPANY\nThe Company's officers are elected at the annual organizational meeting of the Board of Directors and hold office until the next such organizational meeting, unless the Board of Directors shall otherwise determine, or unless a resignation is submitted. Positions Held During Name Age Past Five Years Dates\nL.M. Gressette, Jr. (1) 64 Chairman of the Board and Chief Executive Officer *-present President - SCANA *-1995\nB.D. Kenyon (1) 53 President and Chief Operating Officer 1990-present\nW.B. Timmerman (1) 49 President - SCANA 1995-present President of MPX, an affiliate 1996-present Executive Vice President, 1994-1995 SCANA Assistant Secretary 1993-1996 Chief Financial Officer *-1996 Controller, SCANA *-1996 Senior Vice President, *-1994 SCANA\nG.J. Bullwinkel, Jr. 47 Senior Vice President- Retail Electric 1995-present Senior Vice President- Fossil & Hydro Production 1993-1994 Senior Vice President- Production 1991-1992\nW.A. Darby 50 Senior Vice President - Gas, SCANA Gas Group 1996-present Vice President-Gas Operations *-present President and Treasurer of ServiceCare 1996-present General Manager of ServiceCare, Inc., an affiliate 1994-present\nJ. L. Skolds 45 Senior Vice President - 1994-present Generation Vice President - Nuclear Operations 1990-1994\nK. B. Marsh (1) 40 Vice President - Finance, Chief Financial Officer and Controller - SCANA 1996-present Vice President - Finance, Treasurer and Secretary 1992-1996 Vice President - Finance and Treasurer 1991-1992 Vice President - Corporate Planning 1991 Vice President and Controller *-1991\nB.T. Zeigler (1) 40 Vice President - SCANA 1996-present General Counsel of SCE&G 1995-present Associate General Counsel - SCE&G Legal Department 1992-1995 Partner - Lewis, Babcock & Hawkins Law Firm *-1992\n*Indicates position held at least since March 1, 1991\n(1) Also an executive officer of SCANA\nCOMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT\nAll of the Company's common stock is held by its parent, SCANA Corporation, and none of the directors and executive officers of the Company own any of the other classes of equity securities of the Company. The required forms indicate that no equity securities of the Company are owned by the directors and executive officers. Based solely on a review of the copies of such forms and amendments furnished to the Company and written representations from the executive officers and directors, the Company believes that during 1995 all Section 16(a) filing requirements applicable to its executive officers, directors and greater than 10% beneficial owners were complied with except that one report covering initial ownership of the Company's preferred stock was filed late by Kevin B. Marsh and Belton T. Zeigler.\nITEM 11. EXECUTIVE COMPENSATION\nThe following table contains information with respect to compensation paid or accrued during the years 1995, 1994 and 1993 to the Chief Executive Officer of the Company and to each of the other four most highly compensated executive officers of the Company during 1995 who were serving as executive officers of the Company at the end of 1995.\nLong-Term Performance Share Plan\nThe long-term Performance Share Plan for officers of SCANA and its subsidiaries measures SCANA's Total Shareholder Return (\"TSR\") relative to a group of peer companies over a three-year period. The \"PSP Peer Group\" includes 94 electric and gas utilities, none of which have annual revenues of less than $100 million.\nTSR is stock price increase over the three-year period, plus cash dividends paid during the period, divided by stock price as of the beginning of the period. Comparing SCANA's TSR to the TSR of a large group of other utilities reflects SCANA's recognition that investors could have invested their funds in other utility companies and measures how well SCANA did when compared to others operating in similar interest, tax, economic and regulatory environments.\nExecutives eligible to participate in the Performance Share Plan are assigned target award opportunities annually based primarily on their salary level. In determining award sizes, levels of responsibilities and competitive practices also are considered. Awards under this plan represent a significant portion of executives \"at-risk\" compensation. To provide additional incentive for executives, and to ensure that executives are only rewarded when shareholders gain, actual payouts may exceed the median of the market when performance is above the 50th percentile of the peer group. For lesser performance, awards will be at or below the market median.\nPayouts occur when SCANA's TSR is in the top two-thirds of the PSP Peer Group, and vary based on SCANA's ranking against the peer group. Executives earn threshold payouts of 0.4 times target at the 33rd percentile of three-year performance. Target payouts will be made at the 50th percentile of three-year performance. Maximum payouts will be made at 1.5 times target when SCANA's TSR is at or above the 75th percentile of the peer group. Payments will be made on a sliding scale for performance between threshold and target and target and maximum. No payouts will be earned if performance is in the bottom one-third of the peer group. Awards are denominated in shares of SCANA Common Stock and may be paid in either stock or a combination of stock and cash.\nFor the three-year period from 1993 through 1995, SCANA's TSR was at the 98th percentile of the PSP Peer Group. This resulted in payouts in February 1996 at 150% of target shares awarded paid in a combination of stock and cash.\nThe following table shows the target awards made in 1995 for potential payment in 1998 under the long-term Performance Share Plan, and estimated future payouts under that plan at threshold, target and maximum levels for the named executive officers. Mr. Gressette's award for the 1995-1997 performance period is prorated to reflect his retirement in February 1997.\nDEFINED BENEFIT PLANS\nIn addition to the qualified Retirement Plan for all employees, the Company has Supplemental Executive Retirement Plans (\"SERP\") for certain eligible employees, including officers. A SERP is an unfunded plan which provides for benefit payments in addition to those payable under a qualified retirement plan. It maintains uniform application of the Retirement Plan benefit formula and would provide, among other benefits, payment of Retirement Plan formula pension benefits, if any, which exceed those payable under the Internal Revenue Code (\"IRC\") maximum benefit limitations.\nThe following table illustrates the estimated maximum annual benefits payable upon retirement at normal retirement date under the Retirement Plan and the SERPs.\nPension Plan Table\nFinal Service Years Average Pay 15 20 25 30 35\n$150,000 42,311 56,415 70,519 84,623 87,476 200,000 57,311 76,415 95,519 114,623 118,726 250,000 72,311 96,415 120,519 144,623 149,976 300,000 87,311 116,415 145,519 174,623 181,226 350,000 102,311 136,415 170,519 204,623 212,476 400,000 117,311 156,415 195,519 234,623 243,726 450,000 132,311 176,415 220,519 264,623 274,976 500,000 147,311 196,415 245,519 294,623 306,226 550,000 162,311 216,415 270,519 324,623 337,476 600,000 177,311 236,415 295,519 354,623 368,726\nThe compensation shown in the column labeled \"Salary\" of the Summary Compensation Table for the individuals named therein is covered by the Retirement Plan and\/or a SERP. As of December 31, 1995, Messrs. Gressette, Kenyon, Timmerman, Bullwinkel and Skolds had credited service under the Retirement Plan (or its equivalent under the SERP) of 33, 22, 17, 25 and 10 years, respectively. Benefits are computed based on a straight-life annuity with an unreduced 60% surviving spouse benefit. The amounts in this table assume continuation of the primary Social Security benefits in effect at January 1, 1996 and are not subject to any deduction for Social Security or other offset amounts.\nThe Company also has a Key Employee Retention Program (the \"Key Employee Retention Program\") covering officers and certain other executive employees that provides supplemental retirement and\/or death benefits for participants. Under the program, each participant may elect to receive either a monthly retirement benefit for 180 months upon retirement at or after age 65 equal to 25% of the average monthly salary of the participant over his final 36 months of employment prior to age 65, or an optional death benefit payable to a participant's designated beneficiary monthly for 180 months, in an amount equal to 35% of the average monthly salary of the participant over his final 36 months of employment prior to age 65. In the event of the participant's death prior to age 65, the Company will pay to the participant's designated beneficiary for 180 months, a monthly benefit equal to 50% of such participant's base monthly salary in effect at death.\nAll of the executive officers named in the Summary Compensation Table above are participating in the program. Estimated annual retirement benefits payable at age 65 based on projected eligible compensation (assuming increases of 4% per year) to the five executive officers named in the Summary Compensation Table are as follows: Mr. Gressette - $113,790; Mr. Kenyon - $122,658; Mr. Timmerman - $129,942; Mr. Bullwinkel - $90,887; and Mr. Skolds - $93,234.\nTERMINATION, SEVERANCE AND CHANGE OF CONTROL ARRANGEMENTS\nThe Company has a Key Executive Severance Benefit Plan (the \"Severance Plan\") intended to assure the objective judgment of, and to retain the loyalties of, key executives when the Company is faced with a potential change in control or a change in control by providing a continuation of salary and benefits after a participant's employment is terminated by the Company during a potential change in control, after a change in control without just cause, disability, retirement or death or by the participant for good reason after a change in control. All of the executive officers named in the Summary Compensation Table except Mr. Gressette have been designated as participants in the Severance Plan.\nWhen a potential change in control occurs, a participant is obli- gated to remain with the Company for six months unless his employment is terminated for disability or normal retirement or until a change in control occurs. Upon a change in control resulting in an officer's termination, the Severance Plan provides for guaranteed severance payments equal to three times the annual compensation of the officer plus payments under certain of the Company's incentive and retirement plans. The officer also would receive an additional amount (a \"gross- up\" payment) for any IRC Section 4999 excess tax or any such other similar tax applicable to the severance payments. In addition, for 36 months after termination, the officer would receive coverage for medical benefits and life insurance so as to provide the same level of benefits previously enjoyed under group plans or individual policy contracts or otherwise as determined by the Executive Committee of the Board of Directors. Such benefits however would be reduced to the extent that the participant receives similar benefits during the period from another employer.\nIn addition to the Severance Plan, in the event of a merger, consolidation or acquisition in which SCANA is not the surviving corporation, target awards under the Performance Share Plan will become immediately payable based on SCANA's shareholder return performance as of the end of the most recently completed calendar year for each performance period as to which the grant of target shares has occurred at least six months previously.\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\nDuring 1995, no officer, employee or former officer of the Company or its affiliates served as a member of the Long-Term Compensation Committee or the Performance Committee, except Mr. Gressette who served as a member of the Performance Committee. Although Mr. Gressette was an ex-officio, nonvoting member of the Performance Committee during 1995, he did not participate in any of its deliberations concerning executive officer compensation.\nSince January 1, 1995, the Company has engaged in business transactions with entities with which Mr. Chapman (Chairman of both the Performance Committee and the Long-Term Compensation Committee) and Mr. McMaster (a member of the Long-Term Compensation Committee) are executive officers.\nMr. Chapman is Chairman of NationsBank South, a division of NationsBank Corporation. Since January 1, 1995, the Company has engaged in various transactions in which affiliates of NationsBank Corporation acted as lender or provider of lines of credit or credit support to the Company and its affiliates. The amount paid during 1995 by the Company and its affiliates to NationsBank Corporation affiliates on account of such transactions was $3,339,270. It is anticipated that transactions such as described above will continue in the future.\nMr. McMaster is the President and Manager of Winnsboro Petroleum Company. Purchases from Winnsboro Petroleum Company totaling $71,413 for fuel oil and gasoline were made during 1995 by the Company and its affiliates. It is anticipated that such purchases will continue in the future.\nDuring 1995, there existed one executive officer-director interlock where an executive officer of SCANA Corporation served as a director of another company that had an executive officer serving on one of the SCANA Board of Directors' committees which deals with compensation matters. Mr. Gressette, Chairman of the Board and Chief Executive Officer of the Company, served as a director of The Liberty Corporation and Mr. Hipp, President and Chief Executive Officer of The Liberty Corporation, served as a member of the Company's Long-Term Compensation Committee.\nCompensation of Directors\nFees. During 1995, directors who were not employees of the Company were paid $16,000 annually for services rendered, plus $1,800 for each Board meeting attended and $850 for attendance at a committee meeting which is not held on the same day as a regular meeting of the Board. The fee for attendance at a telephone conference meeting is $200. The fee for attendance at a conference is $850. In addition, directors are paid, as part of their compensation, travel, lodging and incidental expenses related to attendance at meetings and conferences. Directors who are employees of the Company or its affiliates receive no compensation for serving as directors or attending meetings.\nDeferral Plan. SCANA has a plan pursuant to which directors may defer all or a portion of their fees for services rendered and meeting attendance. Interest is earned on the deferred amounts at a rate set by the Performance Committee. During 1995 and currently, the rate is set at the announced prime rate of Wachovia Bank of South Carolina. Mr. Cassels and Mr. Rhodes were the only directors participating in the plan during 1995. Mr. Cassels became a participant in January 1994 and Mr. Rhodes in July 1987, and interest credited to their deferral accounts during 1995 was $3,591.94 and $19,557.86, respectively.\nEndowment Plan. Each director participates in the Directors' Endowment Plan, which provides that SCANA make a tax deductible, charitable contribution totaling $500,000 to institutions of higher education nominated by the director. A portion is contributed upon retirement of the director and the remainder upon the director's death. The plan is funded in part through insurance on the lives of the directors. Designated in-state institutions of higher education must be approved by the Chief Executive Officer of SCANA; any out-of- state designation must be approved by the Performance Committee. The designated institutions are reviewed on an annual basis by the Chief Executive Officer to assure compliance with the intent of the program. The plan is intended to reinforce SCANA's commitment to quality higher education and is intended to enhance SCANA's ability to attract and retain qualified board members.\nITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nAll shares of the Company's Common Stock are held, beneficially and of record, by SCANA Corporation.\nThe table set forth below indicates the shares of SCANA's Common Stock beneficially owned as of March 8, 1996 by each director and nominee, each of the executive officers named in the Summary Compensation Table on page 59, and the directors and executive officers of the Company as a group.\nSECURITY OWNERSHIP OF MANAGEMENT\nName of Beneficial Amount and Nature Name of Beneficial Amount and Nature Owner of Ownership 1 Owner of Ownership 1 B. L. Amick 2,486 W. Hayne Hipp 2,800 W. B. Bookhart, Jr. 15,761 B. D. Kenyon 18,883 G. J. Bullwinkel 17,255 F. C. McMaster 5,630 W. T. Cassels, Jr. 2,000 Henry Ponder 12,381 H. M. Chapman 6,000 J. B. Rhodes 7,780 J. B. Edwards 4,665 J. L. Skolds 6,414 E. T. Freeman 4,220 W. B. Timmerman 36,459 L. M. Gressette, Jr. 47,493 E. C. Wall, Jr. 14,000 B. A. Hagood 2,370\nAll directors and executive officers as a group (21 persons) TOTAL 247,243 TOTAL PERCENT OF CLASS 0.2%\nThe information set forth above as to the security ownership has been furnished to the Company by such persons. _____________________\n1 Includes shares owned by close relatives, the beneficial ownership of which is disclaimed by the director or nominee, as follows: Mr. Amick - 480; Mr. Bookhart - 4,498; Mr. Gressette - 1,060; Mr. Hagood - 334; Mr. McMaster - 2,000.\nIncludes shares purchased through December 31, 1995, but not thereafter, by the Trustee under the Savings Plan.\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nFor information regarding certain relationships and related transactions, see Item 11, \"Compensation Committee Interlocks and Insider Participation.\"\nPART IV\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\nFinancial Statements and Schedules\nSee Index to Consolidated Financial Statements and Supplementary Data on page 30.\nExhibits Filed\nExhibits required to be filed with this Annual Report on Form 10-K are listed in the Exhibit Index following the signature page. Certain of such exhibits which have heretofore been filed with the Securities and Exchange Commission and which are designated by reference to their exhibit number in prior filings are hereby incorporated herein by reference and made a part hereof.\nAs permitted under Item 601(b)(4)(iii), instruments defining the rights of holders of long-term debt of less than 10 percent of the total consolidated assets of the Company and its subsidiaries, have been omitted and the Company agrees to furnish a copy of such instruments to the Commission upon request.\nReports on Form 8-K\nNone\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\n(REGISTRANT) SOUTH CAROLINA ELECTRIC & GAS COMPANY BY (SIGNATURE) s\/Bruce D. Kenyon (NAME AND TITLE) Bruce D. Kenyon, President and Chief Operating Officer DATE February 20, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, 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: BY (SIGNATURE) s\/L. M. Gressette, Jr. (NAME AND TITLE) L. M. Gressette, Jr., Chairman of the Board, Chief Executive Officer and Director DATE February 20, 1996\n(ii) Principal financial officer: BY (SIGNATURE) s\/K. B. Marsh (NAME AND TITLE) K. B. Marsh, Chief Financial Officer DATE February 20, 1996\n(iii) Principal accounting officer: BY (SIGNATURE) s\/J. E. Addison (NAME AND TITLE) J. E. Addison, Vice President and Controller DATE February 20, 1996\nBY (SIGNATURE) s\/B. L. Amick (NAME AND TITLE) B. L. Amick, Director DATE February 20, 1996\nBY (SIGNATURE) s\/W. B. Bookhart, Jr. (NAME AND TITLE) W. B. Bookhart, Jr., Director DATE February 20, 1996\nBY (SIGNATURE) s\/W. T. Cassels, Jr. (NAME AND TITLE) W. T. Cassels, Jr., Director DATE February 20, 1996\nBY (SIGNATURE) s\/H. M. Chapman (NAME AND TITLE) H. M. Chapman, Director DATE February 20, 1996\nBY (SIGNATURE) s\/J. B. Edwards (NAME AND TITLE) J. B. Edwards, Director DATE February 20, 1996\nBY (SIGNATURE) s\/E. T. Freeman (NAME AND TITLE) E. T. Freeman, Director DATE February 20, 1996\nBY (SIGNATURE) s\/B. A. Hagood (NAME AND TITLE) B. A. Hagood, Director DATE February 20, 1996\nBY (SIGNATURE) s\/W. Hayne Hipp (NAME AND TITLE) W. Hayne Hipp, Director DATE February 20, 1996\nBY (SIGNATURE) s\/F. C. McMaster (NAME AND TITLE) F. C. McMaster, Director DATE February 20, 1996\nBY (SIGNATURE) s\/Henry Ponder (NAME AND TITLE) Henry Ponder, Director DATE February 20, 1996\nBY (SIGNATURE) s\/W. B. Timmerman (NAME AND TITLE) W. B. Timmerman, Director DATE February 20, 1996\nBY (SIGNATURE) s\/J. B. Rhodes (NAME AND TITLE) J. B. Rhodes, Director DATE February 20, 1996\nBY (SIGNATURE) s\/E. C. Wall, Jr. (NAME AND TITLE) E. C. Wall, Jr., Director DATE February 20, 1996\nSOUTH CAROLINA ELECTRIC & GAS COMPANY Sequentially EXHIBIT INDEX Numbered Number Pages 2. Plan of Acquisition, Reorganization, Arrangement, Liquidation or Succession Not Applicable\n3. Articles of Incorporation and By-Laws\nA. Restated Articles of Incorporation of the Company as adopted on December 15, 1993 (Exhibit 3-A to Form 10-Q for the quarter ended June 30, 1994, File No. 1-3375).................... # B. Articles of Amendment, dated June 7, 1994, filed June 9, 1994 (Exhibit 3-B to Form 10-Q for the quarter ended June 30, 1994, File No. 1-3375).... # C. Articles of Amendment, dated November 9, 1994 (Exhibit 3-C to Form 10-K for the year ended December 31, 1994, File No. 1-3375)...................... # D. Articles of Amendment, dated December 9, 1994 (Exhibit 3-D to Form 10-K for the year ended December 31, 1994, File No. 1-3375)...................... # E. Articles of Correction, dated January 17, 1995 (Exhibit 3-E to Form 10-K for the year ended December 31, 1994, File No. 1-3375)...................... # F. Articles of Amendment, dated January 13, 1995 and filed January 17, 1995 (Exhibit 3-F to Form 10-K for the year ended December 31, 1994, File No. 1-3375)......................................... # G. Articles of Amendment dated March 31, 1995 (Exhibit 3-G to Form 10-Q for the quarter ended March 31, 1995, File No. 1-3375)................... # H. Articles of Correction - Amendment to Statement filed March 31, 1995, dated December 13, 1995 (Filed herewith)......................................... 71 I. Articles of Amendment dated December 13, 1995 (Filed herewith)......................................... 72 J. Copy of By-Laws of the Company as revised and amended thru December 15, 1993 (Exhibit 3-AZ to Form 10-K for the year ended December 31, 1993, File No. 1-3375)......................................... #\n4. Instruments Defining the Rights of Security Holders, Including Indentures A. Indenture dated as of January 1, 1945, from the South Carolina Power Company (the \"Power Company\") to Central Hanover Bank and Trust Company, as Trustee, as supplemented by three Supplemental Indentures dated respectively as of May 1, 1946, May 1, 1947 and July 1, 1949 (Exhibit 2-B to Registration No. 2-26459)................................ # B. Fourth Supplemental Indenture dated as of April 1, 1950, to Indenture referred to in Exhibit 4A, pursuant to which the Company assumed said Indenture (Exhibit 2-C to Registration No. 2-26459)...... # C. Fifth through Fifty-second Supplemental Indentures to Indenture referred to in Exhibit 4A dated as of the dates indicated below and filed as exhibits to the Registration Statements and 1934 Act reports whose file numbers are set forth below.............................................. #\nDecember 1, 1950 Exhibit 2-D to Registration No. 2-26459 July 1, 1951 Exhibit 2-E to Registration No. 2-26459 June 1, 1953 Exhibit 2-F to Registration No. 2-26459 June 1, 1955 Exhibit 2-G to Registration No. 2-26459 November 1, 1957 Exhibit 2-H to Registration No. 2-26459 September 1, 1958 Exhibit 2-I to Registration No. 2-26459 September 1, 1960 Exhibit 2-J to Registration No. 2-26459\n# Incorporated herein by reference as indicated.\nSOUTH CAROLINA ELECTRIC & GAS COMPANY\nExhibit Index (Continued) Sequentially Numbered Number Pages 4. (continued) June 1, 1961 Exhibit 2-K to Registration No. 2-26459 December 1, 1965 Exhibit 2-L to Registration No. 2-26459 June 1, 1966 Exhibit 2-M to Registration No. 2-26459 June 1, 1967 Exhibit 2-N to Registration No. 2-29693 September 1, 1968 Exhibit 4-O to Registration No. 2-31569 June 1, 1969 Exhibit 4-C to Registration No. 33-38580 December 1, 1969 Exhibit 4-Q to Registration No. 2-35388 June 1, 1970 Exhibit 4-R to Registration No. 2-37363 March 1, 1971 Exhibit 2-B-17 to Registration No. 2-40324 January 1, 1972 Exhibit 4-C to Registration No. 33-38580 July 1, 1974 Exhibit 2-A-19 to Registration No. 2-51291 May 1, 1975 Exhibit 4-C to Registration No. 33-38580 July 1, 1975 Exhibit 2-B-21 to Registration No. 2-53908 February 1, 1976 Exhibit 2-B-22 to Registration No. 2-55304 December 1, 1976 Exhibit 2-B-23 to Registration No. 2-57936 March 1, 1977 Exhibit 2-B-24 to Registration No. 2-58662 May 1, 1977 Exhibit 4-C to Registration No. 33-38580 February 1, 1978 Exhibit 4-C to Registration No. 33-38580 June 1, 1978 Exhibit 2-A-3 to Registration No. 2-61653 April 1, 1979 Exhibit 4-C to Registration No. 33-38580 June 1, 1979 Exhibit 4-C to Registration No. 33-38580 April 1, 1980 Exhibit 4-C to Registration No. 33-38580 June 1, 1980 Exhibit 4-C to Registration No. 33-38580 December 1, 1980 Exhibit 4-C to Registration No. 33-38580 April 1, 1981 Exhibit 4-D to Registration No. 33-49421 June 1, 1981 Exhibit 4-D to Registration No. 2-73321 March 1, 1982 Exhibit 4-D to Registration No. 33-49421 April 15, 1982 Exhibit 4-D to Registration No. 33-49421 May 1, 1982 Exhibit 4-D to Registration No. 33-49421 December 1, 1984 Exhibit 4-D to Registration No. 33-49421 December 1, 1985 Exhibit 4-D to Registration No. 33-49421 June 1, 1986 Exhibit 4-D to Registration No. 33-49421 February 1, 1987 Exhibit 4-D to Registration No. 33-49421 September 1, 1987 Exhibit 4-D to Registration No. 33-49421 January 1, 1989 Exhibit 4-D to Registration No. 33-49421 January 1, 1991 Exhibit 4-D to Registration No. 33-49421 February 1, 1991 Exhibit 4-D to Registration No. 33-49421 July 15, 1991 Exhibit 4-D to Registration No. 33-49421 August 15, 1991 Exhibit 4-D to Registration No. 33-49421 April 1, 1993 Exhibit 4-E to Registration No. 33-49421 July 1, 1993 Exhibit 4-D to Registration No. 33-57955 D. Indenture dated as of April 1, 1993 from South Carolina Electric & Gas Company to NationsBank of Georgia, National Association (Filed as Exhibit 4-F to Registration Statement No. 33-49421)......................................... # E. First Supplemental Indenture to Indenture referred to in 4-D dated as of June 1, 1993 (Filed as Exhibit 4-G to Registration Statement No. 33-49421)......................... # F. Second Supplemental Indenture to Indenture referred to in 4-D dated as of June 15, 1993 (Filed as Exhibit 4-G to Registration Statement No. 33-57955)......................... #\n9. Voting Trust Agreement Not Applicable\n10. Material Contracts A. Copy of Supplemental Executive Retirement Plan (Exhibit 10-A to Form 10-K for the year ended December 31, 1980)............................................ # 11. Statement Re Computation of Per Share Earnings Not Applicable\n# Incorporated herein by reference as indicated.\nSOUTH CAROLINA ELECTRIC & GAS COMPANY\nExhibit Index (Continued) Sequentially Numbered Number Pages\n12. Statement re Computation of Ratios (Filed herewith)........ 74\n13. Annual Report to Security Holders, Form 10-Q or Quarterly Report to Security Holders Not Applicable\n16. Letter Re Change in Certifying Accountant Not Applicable\n18. Letter Re Change in Accounting Principles Not Applicable\n21. Subsidiaries of the Registrant Not Applicable\n22. Published Report Regarding Matters Submitted to Vote of Security Holders Not Applicable\n23. Consents of Experts and Counsel Consent of Deloitte & Touche LLP.......................... 78\n24. Power of Attorney Not Applicable\n27. Financial Data Schedule Filed herewith\n28. Information from Reports furnished to State Insurance Regulatory Authorities Not Applicable\n99. Additional Exhibits Not Applicable\n# Incorporated herein by reference as indicated.","section_6":"","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nCOMPETITION\nThe electric utility industry has begun a major transition that could lead to expanded market competition and less regulatory protection. Future deregulation of electric wholesale and retail markets will create opportunities to compete for new and existing customers and markets. As a result, profit margins and asset values of some utilities could be adversely affected. The pace of deregulation, future prices of electricity, and the regulatory actions which may be taken by the PSC in response to the changing environment cannot be predicted. However, the Company is aggressively pursuing actions to position itself strategically for the transformed environment. To enhance its flexibility and responsiveness to change, the Company operates Strategic Business Units. Maintaining a competitive cost structure is of paramount importance in the utility's strategic plan. The Company has undertaken a variety of initiatives, including reductions in operation and maintenance costs and in staffing levels. In January 1996 the PSC approved (as discussed under \"Liquidity and Capital Resources\") the accelerated recovery of the Company's electric regulatory assets and the shift of depreciation reserves from transmission and distribution assets to nuclear production assets. The Company believes that these actions as well as numerous others that have been and will be taken demonstrate its ability and commitment to succeed in the new operating environment to come.\nRegulated public utilities are allowed to record as assets some costs that would be expensed by other enterprises. If deregulation or other changes in the regulatory environment occur, the Company may no longer be eligible to apply this accounting treatment and may be required to eliminate such regulatory assets from its balance sheet. Such an event could have a material adverse effect on the Company's results of operations in the period the write-off is recorded. The Company reported approximately $116 million and $4 million of regulatory assets and liabilities, respectively, excluding amounts related to net accumulated deferred income tax assets of approximately $33 million, on its balance sheet at December 31, 1995.\nLIQUIDITY AND CAPITAL RESOURCES\nThe cash requirements of the Company arise primarily from its operational needs and its construction program. The ability of the Company to replace existing plant investment, as well as to expand to meet future demands for electricity and gas, will depend upon its ability to attract the necessary financial capital on reasonable terms. The Company recovers the costs of providing services through rates charged to customers. Rates for regulated services are generally based on historical costs. As customer growth and inflation occur and the Company expands its construction program, it is necessary to seek increases in rates. As a result, the Company's future financial position and results of operations will be affected by its ability to obtain adequate and timely rate and other regulatory relief.\nDue to continuing customer growth, the Company entered into a contract with Duke\/Fluor Daniel in 1991 to design, engineer and build a 385 MW coal-fired electric generating plant near Cope, South Carolina. Construction of the plant started in November 1992. Commercial operation began in January 1996. The estimated cost of the Cope plant, excluding AFC, is $410.9 million. In addition, the transmission lines for interconnection with the Company's system are expected to cost $22.5 million.\nOn July 10, 1995 the Company filed an application with the PSC for an increase in retail electric rates. On January 9, 1996 the PSC issued an order granting the Company an increase of 7.34% which will produce additional revenues of approximately $67.5 million annually. The increase will be implemented in two phases. The first phase, an increase in revenues of approximately $59.5 annually based on a test year, or 6.47%, commenced on January 15, 1996. The second phase will be implemented in January 1997 and will produce additional revenues of approximately $8.0 million annually, or .87% more than current rates. The PSC authorized a return on common equity of 12.0%. The PSC also approved establishment of a Storm Damage Reserve Account capped at $50 million to be collected through rates over a ten-year period. Additionally, the PSC approved accelerated recovery of substantially all of the Company's electric regulatory assets (excluding accumulated deferred income taxes) and the remaining transition obligation for postretirement benefits other than pensions, changing the amortization periods to allow recovery by the end of the year 2000. The Company's request to shift approximately $257 million of depreciation reserves from transmission and distribution assets to nuclear production assets was also approved.\nThe estimated primary cash requirements for 1996, excluding requirements for fuel liabilities and short-term borrowings, (including notes payable to affiliated companies), and the actual primary cash requirements for 1995 are as follows:\n1996 1995 (Thousands of Dollars) Property additions and construction expenditures, net of allowance for funds used during construction $197,179 $250,870 Nuclear fuel expenditures 21,147 21,045 Maturing obligations, redemptions and sinking and purchase fund requirements 21,197 15,812 Total $239,523 $287,727\nApproximately 45% of total cash requirements (after payment of dividends) was provided from internal sources in 1995 as compared to 22% in 1994.\nThe Company's First and Refunding Mortgage Bond Indenture, dated April 1, 1945 (Old Mortgage), contains provisions prohibiting the issuance of additional bonds thereunder (Class A Bonds) unless net earnings (as therein defined) for twelve consecutive months out of the fifteen months prior to the month of issuance are at least twice the annual interest requirements on all Class A Bonds to be outstanding (Bond Ratio). For the year ended December 31, 1995 the Bond Ratio was 3.97. The issuance of additional Class A Bonds also is restricted to an additional principal amount equal to (i) 60% of unfunded net property additions (which unfunded net property additions totaled approximately $162.3 million at December 31, 1995), (ii) retirements of Class A Bonds (which retirement credits totaled $64.8 million at December 31, 1995), (iii) and cash on deposit with the Trustee.\nThe Company has a new indenture (New Mortgage) dated April 1, 1993 covering substantially all of its electric properties under which its future mortgage-backed debt (New Bonds) will be issued. New Bonds are issued under the New Mortgage on the basis of a like principal amount of Class A Bonds issued under the Old Mortgage which have been deposited with the Trustee of the New Mortgage (of which $185 million were available for such purpose as of December 31, 1995), until such time as all presently outstanding Class A Bonds are retired. Thereafter, New Bonds will be issuable on the basis of property additions in a principal amount equal to 70% of the original cost of electric and common plant properties (compared to 60% of value for Class A Bonds under the Old Mortgage), cash deposited with the Trustee, and retirement of New Bonds. New Bonds will be issuable under the New Mortgage only if adjusted net earnings (as therein defined) for twelve consecutive months out of the eighteen months immediately preceding the month of issuance are at least twice the annual interest requirements on all outstanding bonds (including Class A Bonds) and New Bonds to be outstanding (New Bond Ratio). For the year ended December 31, 1995 the New Bond Ratio was 5.31.\nThe following financing transaction has occurred since December 31, 1994:\nOn April 12, 1995 the Company issued $100 million of First Mortgage Bonds, 7 5\/8% series due April 1, 2025 to repay short-term borrowings.\nWithout the consent of at least a majority of the total voting power of the Company's preferred stock, the Company may not issue or assume any unsecured indebtedness if, after such issue or assumption, the total principal amount of all such unsecured indebtedness would exceed 10% of the aggregate principal amount of all of the Company's secured indebtedness and capital and surplus; provided, however, that no such consent shall be required to enter into agreements for payment of principal, interest and premium for securities issued for pollution control purposes.\nPursuant to Section 204 of the Federal Power Act, the Company must obtain the FERC authority to issue short-term indebtedness. The FERC ha authorized the Company to issue up to $200 million of unsecured promissory notes or commercial paper with maturity dates of twelve months or less, but not later than December 31, 1997.\nThe Company had $165 million authorized and unused lines of credit at December 31, 1995. In addition, the Company has a credit agreement for a maximum of $125 million with the full amount available at December 31, 1995. The credit agreement supports the issuance of short-term commercial paper for the financing of nuclear and fossil fuels and sulfur dioxide emission allowances. Fuel Company commercial paper outstanding at December 31, 1995 was $76.8 million.\nThe Company's Restated Articles of Incorporation prohibit issuance of additional shares of preferred stock without consent of the preferred stockholders unless net earnings (as defined therein) for the twelve consecutive months immediately preceding the month of issuance are at least one and one-half times the aggregate of all interest charges and preferred stock dividend requirements (Preferred Stock Ratio). For the year ended December 31, 1995 the Preferred Stock Ratio was 2.58.\nThe Company anticipates that its 1996 cash requirements of $378.9 million will be met through internally generated funds (approximately 77%, after payment of dividends), the sales of additional equity securities, additional equity contributions from SCANA and the incurrence of additional short-term and long- term indebtedness. The timing and amount of such financing will depend upon market conditions and other factors. Actual 1996 expenditures may vary from the estimates set forth above due to factors such as inflation and economic conditions, regulation and legislation, rates of load growth, environmental protection standards and the cost and availability of capital.\nThe Company expects that it has or can obtain adequate sources of financing to meet its projected cash requirements for the next twelve months and for the foreseeable future.\nEnvironmental Matters\nThe Clean Air Act requires electric utilities to reduce substantially emissions of sulfur dioxide and nitrogen oxide by the year 2000. These requirements are being phased in over two periods. The first phase had a compliance date of January 1, 1995 and the second, January 1, 2000. The Company's facilities did not require modifications to meet the requirements of Phase I. The Company will most likely meet the Phase II requirements through the burning of natural gas and\/or lower sulfur coal in its generating units and the purchase and use of sulfur dioxide emission allowances. Low nitrogen oxide burners are being installed to reduce nitrogen oxide emissions to the levels required by Phase II. Air toxicity regulations for the electric generating industry are likely to be promulgated around the year 2000.\nBy December 31, 1995 the Company had filed compliance plans related to Phase II requirements with DHEC. The Company currently estimates that air emissions control equipment will require capital expenditures of $113 million over the 1996-2000 period to retrofit existing facilities, with increased operation and maintenance cost of approximately $1 million per year. To meet compliance requirements through the year 2005, the Company anticipates total capital expenditures of approximately $150 million.\nThe Federal Clean Water Act, as amended, provides for the imposition of effluent limitations that require various levels of treatment for each wastewater discharge. Under this Act, compliance with applicable limitations is achieved under a national permit program. Discharge permits have been issued for all and renewed for nearly all of SCE&G's and GENCO's generating units. Concurrent with renewal of these permits, the permitting agency has implemented more rigorous control programs. The Company has been developing compliance plans for this program. Amendments to the Clean Water Act proposed in Congress include several provisions which, if passed, could prove costly to the Company. These include limitations to mixing zones and the implementation of technology-based standards.\nThe South Carolina Solid Waste Policy and Management Act of 1991 directed DHEC to promulgate regulations for the disposal of industrial solid waste. DHEC has promulgated a proposed regulation which, if adopted as a final regulation in its present form, would significantly increase the Company's and GENCO's costs of construction and operation of existing and future ash management facilities.\nThe Company has an environmental assessment program to identify and assess current and former operations sites that could require environmental cleanup. As site assessments are initiated, estimates are made of the cost, if any, to investigate and clean up each site. These estimates are refined as additional information becomes available; therefore, actual expenditures could differ significantly from original estimates. Amounts estimated and accrued to date for site assessments and cleanup relate primarily to regulated operations; such amounts are deferred and are being amortized and recovered through rates over a ten-year period for electric operations and an eight- year period for gas operations. Deferred amounts totaled $18.0 million and $20.2 million at December 31, 1995 and 1994, respectively. Estimates include, among other items, the costs associated with the matters discussed in the following paragraphs.\nThe Company owns four decommissioned manufactured gas plant sites which contain residues of by-product chemicals. The Company maintains an active review of the sites to monitor the nature and extent of the residual contamination.\nIn September 1992 the EPA notified the Company, the City of Charleston and the Charleston Housing Authority of their potential liability for the investigation and cleanup of the Calhoun Park Area Site in Charleston, South Carolina. This site originally encompassed approximately eighteen acres and included properties which were the locations for industrial operations, including a wood preserving (creosote) plant and one of the Company's decommissioned manufactured gas plants. The original scope of this investigation has been expanded to approximately 30 acres, including adjacent properties owned by the National Park Service and the City of Charleston, and private properties. The site has not been placed on the National Priority List, but may be added before cleanup is initiated. The PRPs have agreed with the EPA to participate in an innovative approach to site investigation and cleanup called \"Superfund Accelerated Cleanup Model,\" allowing the pre-cleanup site investigation process to be compressed significantly. The PRPs have negotiated an administrative order by consent for the conduct of a Remedial Investigation\/Feasibility Study and a corresponding Scope of Work. Field work began in November 1993. The Company is also working with the City of Charleston to investigate potential contamination from the manufactured gas plant which may have migrated to the City's aquarium site. In 1994 the City of Charleston notified the Company that it considers the Company to be responsible for a $43.5 million increase in costs of the aquarium project attributable to delays resulting from contamination of the Calhoun Park Area Site. The Company believes it has meritorious defenses against this claim and does not expect its resolution to have a material impact on its financial position or results of operations.\nRegulatory Matters\nThe Company filed for electric rate relief in 1995 to encompass primarily the remaining costs of completing the Cope Generating Station. As discussed under \"Liquidity and Capital Resources,\" the PSC issued an order on January 9, 1996 increasing electric retail rates.\nThe Company's regulated business operations are likely to be impacted by the NEPA and FERC Order No. 636. NEPA is designed to create a more competitive wholesale power supply market by creating \"exempt wholesale generators\" and by potentially requiring utilities owning transmission facilities to provide transmission access to wholesalers. Order No. 636 is intended to deregulate the markets for interstate sales of natural gas by requiring that pipelines provide transportation services that are equal in quality for all gas suppliers whether the customer purchases gas from the pipeline or another supplier. In the opinion of the Company, it will be able to meet successfully the challenges of these altered business climates and does not anticipate there to be any material adverse impact on the results of its operations, its financial position or its business prospects.\nStatements of Financial Accounting Standards To Be Adopted\nThe Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of.\" The provisions of the Statement, which will be implemented by the Company for the fiscal year beginning January 1, 1996, require the recognition of a loss in the income statement and related disclosures whenever events or changes in circumstances indicate that the carrying amount of a long-lived asset may not be recoverable. The Company does not believe that adoption of the provisions of the Statement will have a material impact on its results of operations or financial position.\nThe Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, \"Accounting for Stock- Based Compensation,\" which will be implemented by the Company on January 1, 1996. The Company does not believe that adoption of the provisions of the Statement will have a material impact on its results of operations or financial position.\nRESULTS OF OPERATIONS\nNet Income\nNet income and the percent increase (decrease) from the previous year for the years 1995, 1994 and 1993 were as follows:\n1995 1994 1993\nNet income $169,185 $152,043 $145,968 Percent increase (decrease) in net income 11.27% 4.16% 42.9%\n1995 Net income increased for the year primarily due to increases in electric and gas margins and lower operating and maintenance expenses which more than offset increases in fixed costs.\n1994 Net income increased for the year primarily due to an increase in the electric margin which more than offset increases in operating expenses.\nThe Company's financial statements include an allowance for funds used during construction (AFC). AFC is a utility accounting practice whereby a portion of the cost of both equity and borrowed funds used to finance construction (which is shown on the balance sheet as construction work in progress) is capitalized. An equity portion of AFC is included in nonoperating income and a debt portion of AFC is included in interest charges (credits) as noncash items, both which have the effect of increasing reported net income. AFC represented approximately 7.9 % of income before income taxes in 1995, 6.3% in 1994 and 5.6% in 1993.\nElectric Operations\nElectric sales margins for 1995, 1994 and 1993 were as follows:\n1995 1994 1993 (Millions of Dollars)\nElectric revenues $1,006.6 $974.3 $940.2 (Provision) for rate refunds - 1.2 0.3 Net Electric operating revenues 1,006.6 975.5 940.5 Less: Fuel used in electric generation 177.6 176.6 164.2 Purchased power 98.2 112.9 111.1 Margin $ 730.8 $686.0 $665.2\n1995 The electric sales margin increased over the prior year primarily as a result of the combined impact of warmer weather in the third quarter of 1995, colder weather in the fourth quarter of 1995 and the base rate increase received by the Company in mid-1994. These factors more than offset the negative impact of milder weather experienced during the first half of 1995. An increase of 7,943 electric customers to 484,381 total customers contributed to an all-time peak demand record of 3,683 MW set on August 14, 1995.\n1994 The electric sales margin increased over the prior year primarily as a result of an increase in retail electric rates phased in over a two-year period beginning in June 1993 and an increase in industrial sales which more than offset the negative impact of a six percent decrease in residential sales of electricity due to milder weather in 1994.\nIncreases (decreases) from the prior year in megawatt hour (MWH) sales volume by classes were as follows:\nClassification 1995 1994\nResidential 415,676 (339,620) Commercial 229,565 4,198 Industrial 48,651 274,467 Sale for Resale (excluding interchange) 38,688 18,408 Other 12,776 (6,907) Total territorial 745,356 (49,454) Interchange 24,545 (27,013) Total 769,901 (76,467)\nGas Operations\nGas sales margins for 1995, 1994 and 1993 were as follows:\n1995 1994 1993 (Millions of Dollars)\nGas operating revenues $200.6 $201.7 $174.0 Less: Gas purchased for resale 125.0 127.8 107.7 Margin $ 75.6 $ 73.9 $ 66.3\n1995 The gas sales margin increased over the prior year primarily as a result of increases in interruptible gas sales.\n1994 The gas sales margin increased over the prior year primarily as a result of increases in interruptible gas sales.\nIncreases (decreases) from the prior year in dekatherm (DT) sales volume by classes, including transportation gas, were as follows:\nClassification 1995 1994\nResidential 802,211 (477,886) Commercial 623,533 970,726 Industrial 2,528,974 5,057,404 Transportation gas (1,866,414) (1,524,089) Total 2,088,304 4,026,155\nOther Operating Expenses and Taxes\nIncreases (decreases) in other operating expenses, including taxes, were as follows:\nClassification 1995 1994 (Millions of Dollars)\nOther operation and maintenance $(7.8) $ 3.9 Depreciation and amortization 10.6 5.7 Income taxes 12.9 2.8 Other taxes 5.1 5.0 Total $20.8 $17.4\n1995 Other operation and maintenance expenses decreased primarily as a result of lower pension costs and lower costs at electric generating stations. The increase in depreciation and amortization expense primarily is attributable to additions to plant-in-service and the expensing of software costs. The increase in income tax expense corresponds to the increase in operating income. The increase in other taxes reflects higher property taxes resulting from higher millages and assessments partially offset by lower payroll taxes resulting from early retirements of employees.\n1994 Other operation and maintenance expenses increased primarily due to an increase in the costs of postretirement benefits other than pensions. These costs are accrued in accordance with Financial Accounting Standards Board Statement No. 106. (See Note 1K of Notes to Consolidated Financial Statements.) The increase in depreciation and amortization expenses is attributable to property additions and to increases in depreciation rates. The increase in other taxes reflects an increase in property taxes of approximately $5 million.\nInterest Expense\nIncreases (decreases) in interest expense were as follows:\nClassification 1995 1994 (Millions of Dollars)\nInterest on long-term debt, net $11.0 $8.0 Other interest expense 4.1 (.6) Total $15.1 $7.4\n1995 The increase in interest expense, excluding the debt component of AFC, is due primarily to the issuance of additional debt including commercial paper during the latter part of 1994 and early 1995.\n1994 The increase in interest expense, excluding the debt component of AFC, is primarily attributable to the issuance of $100 million of First Mortgage Bonds in July and $30 million of Pollution Control Facilities Revenue Bonds in November, both to finance utility construction, and to the issuance of long-term debt during 1993.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nPage\nIndependent Auditors' Report....................................... 31\nConsolidated Financial Statements:\nConsolidated Balance Sheets as of December 31, 1995 and 1994... 32\nConsolidated Statements of Income and Retained Earnings for the years ended December 31, 1995, 1994 and 1993............. 34\nConsolidated Statements of Cash Flows for the years ended December 31, 1995, 1994 and 1993............................. 35\nConsolidated Statements of Capitalization as of December 31, 1995 and 1994................................... 36\nNotes to Consolidated Financial Statements..................... 38\nSupplemental financial statement schedules are omitted because of the absence of conditions under which they are required or because the required information is included in the consolidated financial statements or in the notes thereto.\nINDEPENDENT AUDITOR'S REPORT\nSouth Carolina Electric & Gas Company:\nWe have audited the accompanying Consolidated Balance Sheets and Statements of Capitalization of South Carolina Electric & Gas Company (Company) as of December 31, 1995 and 1994 and the related Consolidated Statements of Income and Retained Earnings and of Cash Flows for each of the three years in the period ended December 31, 1995. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 1995 and 1994 and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles.\ns\/Deloitte & Touche LLP DELOITTE & TOUCHE LLP Columbia, South Carolina February 7, 1996\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:\nA. Organization and Principles of Consolidation\nThe Company, a public utility, is a South Carolina corporation organized in 1924 and a wholly owned subsidiary of SCANA Corporation (SCANA), a South Carolina holding company. The Company, through wholly owned subsidiaries is predominately engaged in the generation and sale of electricity to wholesale and retail customers in South Carolina and in the purchase, sale and transportation of natural gas to retail customers in South Carolina.\nThe accompanying Consolidated Financial Statements include the accounts of the Company and South Carolina Fuel Company, Inc. (Fuel Company). (See Note 1N.) Intercompany balances and transactions between the Company and Fuel Company have been eliminated in consolidation.\nAffiliated Transactions\nThe Company has entered into agreements with certain affiliates to purchase gas for resale to its distribution customers and to purchase electric energy. The Company purchases all of its natural gas requirements from Pipeline Corporation and at December 31, 1995 and 1994 the Company had approximately $17.5 million and $16.3 million, respectively, payable to Pipeline Corporation for such gas purchases. The Company purchases all of the electric generation of Williams Station, which is owned by GENCO, under a unit power sales agreement. At December 31, 1995 and 1994 the Company had approximately $8.2 million and $8.8 million, respectively, payable to GENCO for unit power purchases. Such unit power purchases, which are included in \"Purchased power,\" amounted to approximately $83.5 million, $92.8 million and $98.1 million in 1995, 1994 and 1993, respectively.\nTotal interest income, based on market interest rates, associated with the Company's advances to affiliated companies was approximately $174,000, $5,000 and $143,000 in 1995, 1994 and 1993, respectively.\nIncluded in \"Other interest expense\" for 1995, 1994 and 1993 is approximately $114,000, $279,000 and $29,000, respectively, relating to advances from affiliated companies. Intercompany interest is calculated at market rates.\nB. Basis of Accounting\nThe Company prepares its financial statements in accordance with the provisions of Statement of Financial Accounting Standards No. 71 (SFAS 71), \"Accounting for the Effects of Certain Types of Regulations.\" The accounting standard allows cost-based rate-regulated utilities, such as the Company, to recognize in their financial statements revenues and expenses in different time periods than do enterprises that are not rate- regulated. As a result the Company has recorded, as of December 31, 1995, approximately $116 million and $4 million of regulatory assets and liabilities, respectively, excluding net accumulated deferred income tax assets of approximately $33 million. As discussed in Note 2A, the PSC has approved accelerated recovery of substantially all of the Company's electric regulatory assets (approximately $84.8 million). In the future, as a result of deregulation or other changes in the regulatory environment, the Company may no longer meet the criteria for continued application of SFAS 71 and would be required to write off its regulatory assets and liabilities. Such an event could have a material adverse effect on the Company's results of operations in the period the write-off is recorded.\nC. System of Accounts The accounting records of the Company are maintained in accordance with the Uniform System of Accounts prescribed by the FERC and as adopted by the PSC.\nD. Utility Plant\nUtility plant is stated substantially at original cost. The costs of additions, renewals and betterments to utility plant, including direct labor, material and indirect charges for engineering, supervision and an allowance for funds used during construction, are added to utility plant accounts. The original cost of utility property retired or otherwise disposed of is removed from utility plant accounts and generally charged, along with the cost of removal, less salvage, to accumulated depreciation. The costs of repairs, replacements and renewals of items of property determined to be less than a unit of property are charged to maintenance expense.\nThe Company, operator of the Summer Station and PSA are joint owners of Summer Station in the proportions of two-thirds and one-third, respectively. The parties share the operating costs and energy output of the plant in these proportions. Each party, however, provides its own financing. Plant-in-service related to the Company's portion of Summer Station was approximately $925.1 million and $923.1 million as of December 31, 1995 and 1994, respectively. Accumulated depreciation associated with the Company's share of Summer Station was approximately $261.0 million and $297.9 million as of December 31, 1995 and 1994, respectively. (See Note 2A.) The Company's share of the direct expenses associated with operating Summer Station is included in \"Other operation\" and \"Maintenance\" expenses.\nE. Allowance for Funds Used During Construction\nAFC, a noncash item, reflects the period cost of capital devoted to plant under construction. This accounting practice results in the inclusion of, as a component of construction cost, the costs of debt and equity capital dedicated to construction investment. AFC is included in rate base investment and depreciated as a component of plant cost in establishing rates for utility services. The Company has calculated AFC using composite rates of 8.6%, 8.5% and 9.4% for 1995, 1994 and 1993, respectively. These rates do not exceed the maximum allowable rate as calculated under FERC Order No. 561. Interest on nuclear fuel in process and sulfur dioxide emission allowances is capitalized at the actual interest amount.\nF. Deferred Return on Plant Investment\nCommencing July 1, 1987, as approved by a PSC order on that date, the Company ceased the deferral of carrying costs associated with 400 MW of electric generating capacity previously removed from rate base and began amortizing the accumulated deferred carrying costs on a straight-line basis over a ten-year period. Amortization of deferred carrying costs, included in \"Depreciation and amortization,\" was approximately $4.2 million for each of 1995, 1994 and 1993.\nG. Revenue Recognition\nCustomers' meters are read and bills are rendered on a monthly cycle basis. Base revenue is recorded during the accounting period in which the meters are read.\nFuel costs for electric generation are collected through the fuel cost component in retail electric rates. The fuel cost component contained in electric rates is established by the PSC during semiannual fuel cost hearings. Any difference between actual fuel costs and that contained in the fuel cost component is deferred and included when determining the fuel cost component during the next semiannual fuel cost hearing. The Company had overcollected through the electric fuel cost component approximately $3.8 million at December 31, 1995 and undercollected approximately $3.5 million at December 31, 1994 which are included in \"Deferred Credits - Other\" and \"Deferral Debits - Other,\" respectively.\nCustomers subject to the gas cost adjustment clause are billed based on a fixed cost of gas determined by the PSC during annual gas cost recovery hearings. Any difference between actual gas cost and that contained in the rates is deferred and included when establishing gas costs during the next annual gas cost recovery hearing. At December 31, 1995 and 1994 the Company had undercollected through the gas cost recovery procedure approximately $4.6 million and $16.3 million, respectively, which are included in \"Deferred Debits - Other.\"\nThe Company's gas rate schedules for residential, small commercial and small industrial customers include a weather normalization adjustment, which minimizes fluctuations in gas revenues due to abnormal weather conditions.\nH. Depreciation and Amortization\nProvisions for depreciation are recorded using the straight- line method for financial reporting purposes and are based on the estimated service lives of the various classes of property. The composite weighted average depreciation rates were 3.02%, 3.01%, and 2.97% for 1995, 1994 and 1993, respectively.\nNuclear fuel amortization, which is included in \"Fuel used in electric generation\" and is recovered through the fuel cost component of the Company's rates, is recorded using the units-of- production method. Provisions for amortization of nuclear fuel include amounts necessary to satisfy obligations to the United States DOE under a contract for disposal of spent nuclear fuel.\nI. Nuclear Decommissioning\nDecommissioning of Summer Station is presently projected to commence in the year 2022 when the operating license expires. Based on a 1991 study, the expenditures (on a before-tax basis) related to the Company's share of decommissioning activities are estimated, in 2022 dollars assuming a 4.5% annual rate of inflation, to be $545.3 million including partial reclamation costs. The Company is providing for its share of estimated decommissioning costs of Summer Station over the life of Summer Station. The Company's method of funding decommissioning cost is referred to as COMReP (Cost of Money Reduction Plan). Under this plan, funds collected through rates ($3.2 million in each of 1995 and 1994) are used to purchase insurance policies on the lives of certain Company personnel. Through the purchase of insurance contracts, the Company is able to take advantage of income tax benefits and accrue earnings on the fund on a tax- deferred basis at a rate higher than can be achieved using more traditional funding approaches. Amounts for decommissioning collected through electric rates, insurance proceeds, and interest on proceeds less expenses are transferred by the Company to an external trust fund in compliance with the financial assurance requirements of the Nuclear Regulatory Commission. Management intends for the fund, including earnings thereon, to provide for all eventual decommissioning expenditures on an after-tax basis. The trust's sources of decommissioning funds under the COMReP program include investment components of life insurance policy proceeds, return on investment and the cash transfers from the Company described above. The Company records its liability for decommissioning costs in deferred credits.\nThe staff of the Securities and Exchange Commission has questioned certain of the current accounting practices of the electric utility industry regarding the recognition, measurement and classification of decommissioning costs for the financial statements of electric utilities with nuclear generating facilities. 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: (1) annual provisions for decommissioning could increase, and (2) trust fund income from the external decommissioning trusts could be reported as investment income rather than as a reduction of decommissioning expense.\nPursuant to the NEPA passed by Congress in 1992, the Company has recorded a liability for its estimated share of amounts required by the DOE for its decommissioning fund. The liability, approximately $3.6 million at December 31, 1995, has been included in \"Long-Term Debt, Net.\" The Company will recover the cost associated with this liability through the fuel cost component of its rates; accordingly, this amount has been deferred and is included in \"Deferred Debits - Other.\"\nJ. Income Taxes\nThe Company is included in the consolidated Federal income tax return filed by SCANA. Income taxes are allocated to the Company based on its contribution to the consolidated total.\nAs required by Statement of Financial Accounting Standards No. 109, deferred tax assets and liabilities are recorded for the tax effects of temporary differences between the book basis and tax basis of assets and liabilities at currently enacted tax rates. Deferred tax assets and liabilities are adjusted for changes in such rates through charges or credits to regulatory assets or liabilities if they are expected to be recovered from, or passed through to, customers; otherwise, they are charged or credited to income tax expense.\nK. Pension Expense\nThe Company participates in SCANA's noncontributory defined benefit pension plan, which covers all permanent Company employees. Benefits are based on years of accredited service and the employee's average annual base earnings received during the last three years of employment. SCANA's policy has been to fund pension costs accrued to the extent permitted by the applicable Federal income tax regulations as determined by an independent actuary.\nNet periodic pension cost for the years ended December 31, 1995, 1994 and 1993 included the following components:\n1995 1994 1993 (Thousands of Dollars) Service cost--benefits earned during the period $ 5,187 $ 8,684 $ 7,629 Interest cost on projected benefit obligation 19,473 21,711 20,413 Adjustments: Return on plan assets (103,874) 2,365 (50,389) Net amortization and deferral 74,769 (29,760) 25,936 Amounts contributed by the Company's affiliates (203) (130) (175) Net periodic pension (income) expense $ (4,648) $ 2,870 $ 3,414\nThe determination of net periodic pension cost is based upon the following assumptions:\n1995 1994 1993 Annual discount rate 8.0% 7.25% 8.0% Expected long-term rate of return on plan assets 8.0% 8.0% 8.0% Annual rate of salary increases 2.5% 4.75% 5.5%\nThe following table sets forth the funded status of the plan at December 31, 1995 and 1994:\n1995 1994 (Thousands of Dollars) Actuarial present value of benefit obligations: Vested benefit obligation $228,434 $205,364 Nonvested benefit obligation 15,540 13,966 Accumulated benefit obligation $243,974 $219,330\nPlan assets at fair value (invested primarily in equity and debt securities) $447,760 $347,702 Projected benefit obligation 284,145 246,318 Plan assets greater than projected benefit obligation 163,615 101,384 Unrecognized net transition liability 9,022 11,307 Unrecognized prior service costs 9,660 9,374 Unrecognized net gain (146,943) (102,284) Pension asset recognized in Consolidated Balance Sheets $ 35,354 $ 19,781\nThe accumulated benefit obligation is based on the plan's benefit formulas without considering expected future salary increases. The following table sets forth the assumptions used in determining the amounts shown above for the years 1995 and 1994.\n1995 1994\nAnnual discount rate used to determine benefit obligations 7.5% 8.0% Assumed annual rate of future salary increases for projected benefit obligation 3.0% 2.5%\nThe change in the annual discount rate used to determine benefit obligations from 8.0% to 7.5% and the change in the expected salary increase rate from 2.5% to 3.0% as of December 31, 1995 increased the projected benefit obligation and decreased the unrecognized net gain by approximately $28.6 million.\nIn addition to pension benefits, the Company provides certain health care and life insurance benefits to active and retired employees. The costs of postretirement benefits other than pensions are accrued during the years the employees render the service necessary to be eligible for the applicable benefits. Prior to 1993, the Company expensed these benefits, which are primarily health care, as claims were incurred. In its June 1993 electric rate order, the PSC approved the inclusion in rates of the portion of increased expenses related to electric operations. The Company expensed approximately $8.5 million and $8.6 million, net of payments to current retirees, for the years ended December 31, 1995 and 1994, respectively. The PSC has authorized accelerated amortization of the Company's remaining transition obligation for postretirement benefits other than pensions related to electric operations. (See Note 2A.)\nNet periodic postretirement benefit cost for the years ended December 31, 1995, 1994 and 1993, included the following components:\n1995 1994 1993 (Thousands of Dollars)\nService cost--benefits earned during the period $ 2,076 $ 2,417 $ 1,908 Interest cost on accumulated postretirement benefit obligation 7,253 6,644 5,502 Adjustments: Return on plan assets - - - Amortization of unrecognized transition obligation 3,344 3,344 3,344 Other net amortization and deferral 661 860 - Amounts contributed by the Company's affiliates (610) (575) (525) Net periodic postretirement benefit cost $12,724 $12,690 $10,229\nThe determination of net periodic postretirement benefit cost is based upon the following assumptions:\n1995 1994 1993\nAnnual discount rate 8.0% 7.25% 8.0% Health care cost trend rate 11.0% 11.25% 13.0% Ultimate health care cost trend rate (to be achieved in 2004) 6.0% 5.25% 6.0%\nThe following table sets forth the funded status of the plan at December 31, 1995 and 1994:\n1995 1994 (Thousands of Dollars)\nAccumulated postretirement benefit obligations for: Retirees $ 64,989 $ 59,174 Other fully eligible participants 6,685 4,995 Other active participants 27,076 24,889 Accumulated postretirement benefit obligation 98,750 89,058 Plan assets at fair value - - Plan assets less accumulated postretirement benefit obligation (98,750) (89,058) Unrecognized net transition liability 58,237 61,581 Unrecognized prior service costs 5,320 3,453 Unrecognized net loss 13,840 11,156 Postretirement benefit liability recognized in Consolidated Balance Sheets $(21,353) $(12,868)\nThe accumulated postretirement benefit obligation is based upon the plan's benefit provisions and the following assumptions:\n1995 1994 Assumed health care cost trend rate used to measure expected costs 10.5% 12.0% Ultimate health care cost trend rate (to be achieved in 2004) 5.5% 6.0% Annual discount rate 7.5% 8.0% Annual rate of salary increases 3.0% 2.5%\nThe effect of a one percentage-point increase in the assumed health care cost trend rate for each future year on the aggregate of the service and interest cost components of net periodic postretirement benefit cost for the year ended December 31, 1995 and the accumulated postretirement benefit obligation as of December 31, 1995 would be to increase such amounts by $203,000 and $3.4 million, respectively.\nL. Debt Premium, Discount and Expense, Unamortized Loss on Reacquired Debt\nLong-term debt premium, discount and expense are being amortized as components of \"Interest on long-term debt, net\" over the terms of the respective debt issues. Gains or losses on reacquired debt that is refinanced are deferred and amortized over the term of the replacement debt.\nM. Environmental\nThe Company has an environmental assessment program to identify and assess current and former operations sites that could require environmental cleanup. As site assessments are initiated, an estimate is made of the amount of expenditures, if any, necessary to investigate and clean up each site. These estimates are refined as additional information becomes available; therefore, actual expenditures could differ significantly from the original estimates. Amounts estimated and accrued to date for site assessments and cleanup relate primarily to regulated operations; such amounts are deferred and are being amortized and recovered through rates over a ten-year period for electric operations and an eight-year period for gas operations. Such deferred amounts totaled $18.0 million and $20.2 million at December 31, 1995 and 1994, respectively, and are included in \"Deferred Debits - Other.\"\nN. Fuel Inventories\nNuclear fuel and fossil fuel inventories and sulfur dioxide emission allowances are purchased and financed by Fuel Company under a contract which requires the Company to reimburse Fuel Company for all costs and expenses relating to the ownership and financing of fuel inventories and sulfur dioxide emission allowances. Accordingly, such fuel inventories and emission allowances and fuel-related assets and liabilities are included in the Company's consolidated financial statements. (See Note 4.)\nO. Temporary Cash Investments\nThe Company considers temporary cash investments having original maturities of three months or less to be cash equivalents. Temporary cash investments are generally in the form of commercial paper, certificates of deposit and repurchase agreements.\nP. Recently Issued Accounting Standards\nThe Financial Accounting Standards Board has issued Statement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of.\" The provisions of the Statement, which will be implemented by the Company for the fiscal year beginning January 1, 1996, require the recognition of a loss in the income statement and related disclosures whenever events or changes in circumstances indicate that the carrying amount of a long-lived asset may not be recoverable. The Company does not believe that adoption of the provisions of the Statement will have a material impact on its results of operations or financial position.\nThe Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, \"Accounting for Stock- Based Compensation,\" which will be implemented by the Company on January 1, 1996. The Company does not believe that adoption of the provisions of the Statement will have a material impact on its results of operations or financial position.\nQ. Reclassifications\nCertain amounts from prior periods have been reclassified to conform with the 1995 presentation.\nR. Use of Estimates\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period. Actual results could differ from those estimates.\n2. RATE MATTERS:\nA. On July 10, 1995, the Company filed an application with the PSC for an increase in retail electric rates. On January 9, 1996 the PSC issued an order granting the Company an increase of 7.34% which will produce additional revenues of approximately $67.5 million annually. The increase will be implemented in two phases. The first phase, an increase in revenues of approximately $59.5 million annually based on a test year, or 6.47%, commenced on January 15, 1996. The second phase will be implemented in January 1997 and will produce additional revenues of approximately $8.0 million annually, or .87% more than current rates. The PSC authorized a return on common equity of 12.0%. The PSC also approved establishment of a Storm Damage Reserve Account capped at $50 million and collected through rates over a ten-year period. Additionally, the PSC approved accelerated recovery of substantially all (excluding accumulated deferred income taxes) of the Company's electric regulatory assets and the transition obligation for postretirement benefits other than pensions, changing the amortization periods to allow recovery by the end of the year 2000. The Company's request to shift approximately $257 million of depreciation reserves from transmission and distribution assets to nuclear production assets was also approved.\nB. On October 27, 1994 the PSC issued an order approving the Company's request to recover through a billing surcharge to its gas customers the costs of environmental cleanup at the sites of former manufactured gas plants. The billing surcharge, which was effective with the first billing cycle in November 1994 and is subject to annual review, provides for the recovery of approximately $16.2 million representing substantially all site assessment and cleanup costs for the Company's gas operations that had previously been deferred. In October 1995, as a result of the ongoing annual review, the PSC approved the continued use of the billing surcharge. The balance remaining to be recovered amounts to approximately $14.5 million.\nC. In September 1992 the PSC issued an order granting the Company a $.25 increase in transit fares from $.50 to $.75 in both Columbia and Charleston, South Carolina; however, the PSC also required $.40 fares for low-income customers and denied the Company's request to reduce the number of routes and frequency of service. The new rates were placed into effect in October 1992. The Company appealed the PSC's order to the Circuit Court, which on May 23, 1995, ordered the case back to the PSC for reconsideration of several issues including the low-income rider program, routing changes, and the $.75 fare. The Supreme Court declined to review an appeal of the Circuit Court decision and dismissed the case. Another Petition for Reconsideration was filed by the PSC and other intervenors, which was denied by the Circuit Court. Procedural matters in this case are yet to be resolved in the court.\n3. LONG-TERM DEBT:\nThe annual amounts of long-term debt maturities, including amounts due under nuclear and fossil fuel agreements (see Note 4), and sinking fund requirements for the years 1996 through 2000 are summarized as follows:\nYear Amount Year Amount (Thousands of Dollars)\n1996 $ 36,033 1999 $ 17,663 1997 33,252 2000 117,668 1998 114,483\nApproximately $17.3 million of the portion of long-term debt payable in 1996 may be satisfied by either deposit and cancellation of bonds issued upon the basis of property additions or bond retirement credits, or by deposit of cash with the Trustee.\nThe Company has three-year revolving lines of credit totaling $100 million, in addition to other lines of credit, that provide liquidity for issuance of commercial paper. The three- year lines of credit provide back-up liquidity when commercial paper outstanding is in excess of $100 million. The long-term nature of the lines of credit allow commercial paper in excess of $100 million to be classified as long-term debt. The Company had outstanding commercial paper of $111.2 million at December 31, 1994, of which $11.2 million was reclassified to long-term debt.\nCertain outstanding long-term debt of an affiliated company (approximately $35.9 million at both December 31, 1995 and 1994) is guaranteed by the Company.\nSubstantially all utility plant and fuel inventories are pledged as collateral in connection with long-term debt.\n4. FUEL FINANCINGS:\nNuclear and fossil fuel inventories and sulfur dioxide emission allowances are financed through the issuance by Fuel Company of short-term commercial paper. These short-term borrowings are supported by an irrevocable revolving credit agreement which expires July 31, 1998. Accordingly, the amounts outstanding have been included in long-term debt. The credit agreement provides for a maximum amount of $125 million that may be outstanding at any time.\nCommercial paper outstanding totaled $76.8 million and $50.6 million at December 31, 1995 and 1994 at weighted average interest rates of 5.76% and 6.06%, respectively.\n5. COMMON EQUITY:\nThe changes in \"Stockholders' Investment\" (Including Preferred Stock Not Subject to Purchase or Sinking Funds) during 1995, 1994 and 1993 are summarized as follows:\nCommon Preferred Thousands Shares Shares of Dollars\nBalance December 31, 1992 40,296,147 322,877 $989,768 Changes in Retained Earnings: Net Income 145,968 Cash Dividends Declared: Preferred Stock (at stated rates) (6,217) Common Stock (110,300) Equity Contributions from Parent 58,142 Balance December 31, 1993 40,296,147 322,877 1,077,361 Changes in Retained Earnings: Net Income 152,043 Cash Dividends Declared: Preferred Stock (at stated rates) (5,955) Common Stock (113,700) Equity Contributions from Parent 49,710 Balance December 31, 1994 40,296,147 322,877 1,159,459 Changes in Retained Earnings: Net Income 169,185 Cash Dividends Declared: Preferred Stock (at stated rates) (5,687) Common Stock (121,363) Equity Contributions from Parent including transfer of assets 139,505 Balance December 31, 1995 40,296,147 322,877 $1,341,099\nThe Restated Articles of Incorporation of the Company and the Indenture underlying its First and Refunding Mortgage Bonds contain provisions that under certain circumstances could limit the payment of cash dividends on common stock. In addition, with respect to hydroelectric projects, the Federal Power Act requires the appropriation of a portion of the earnings therefrom. At December 31, 1995 approximately $14.5 million of retained earnings were restricted by this requirement as to payment of cash dividends on common stock.\n6. PREFERRED STOCK (Subject to Purchase or Sinking Funds):\nThe call premium of the respective series of preferred stock in no case exceeds the amount of the annual dividend. Retirements under sinking fund requirements are at par values.\nThe aggregate annual amounts of purchase fund or sinking fund requirements for preferred stock for the years 1996 through 2000 are summarized as follows:\nYear Amount Year Amount (Thousands of Dollars)\n1996 $2,439 1999 $2,440 1997 2,440 2000 2,440 1998 2,440\nThe changes in \"Total Preferred Stock (Subject to Purchase or Sinking Funds)\" during 1995, 1994 and 1993 are summarized as follows:\nNumber Thousands of Shares of Dollars\nBalance December 31, 1992 940,529 $ 58,639 Shares Redeemed: $100 par value (7,374) (737) $50 par value (51,187) (2,558) Balance December 31, 1993 881,968 55,344 Shares Redeemed: $100 par value (8,072) (807) $50 par value (51,802) (2,591) Balance December 31, 1994 822,094 51,946 Shares Redeemed: $100 par value (6,809) (681) $50 par value (51,666) (2,583) Balance December 31, 1995 763,619 $ 48,682\n7. INCOME TAXES:\nTotal income tax expense for 1995, 1994 and 1993 is as follows:\n1995 1994 1993 (Thousands of Dollars) Current taxes: Federal $ 94,137 $66,597 $60,577 State 14,265 9,505 6,822 Total current taxes 108,402 76,102 67,399 Deferred taxes, net: Federal (7,319) 7,727 12,197 State (603) 2,118 4,387 Total deferred taxes (7,922) 9,845 16,584 Investment tax credits: Amortization of amounts deferred (credit) (3,230) (3,231) (3,245) Total income tax expense $ 97,250 $82,716 $80,738\nThe difference in actual income taxes and the income taxes calculated from the application of the statutory Federal income tax rate (35% for 1995, 1994 and 1993) to pretax income is reconciled as follows:\n1995 1994 1993 (Thousands of Dollars)\nNet income $169,185 $152,043 $145,968 Total income tax expense: Charged to operating expenses 96,956 84,066 81,280 Charged (credited) to other income 294 (1,350) (542) Total pretax income $266,435 $234,759 $226,706\nIncome taxes on above at statutory Federal income tax rate $ 93,252 $ 82,166 $ 79,347 Increases (decreases) attributable to: Allowance for equity funds used during construction (3,325) (2,796) (2,624) Amortization of deferred return on plant investment 1,486 1,486 1,486 Depreciation differences 3,268 2,994 2,531 Amortization of investment tax credits (3,230) (3,231) (3,245) State income taxes (less Federal income tax effect) 8,880 7,555 7,286 Deferred income tax flowback at higher than statutory rates (3,310) (3,647) (3,641) Other differences, net 229 (1,811) (402) Total income tax expense $ 97,250 $ 82,716 $ 80,738\nThe tax effects of significant temporary differences comprising the Company's net deferred tax liability of $468.9 million at December 31, 1995 and $485.8 million at December 31, 1994 determined in accordance with Statement No. 109 (see Note 1J) are as follows:\n1995 1994 (Thousands of Dollars) Deferred tax assets: Unamortized investment tax credits $ 48,512 $ 50,513 Cycle billing 19,143 17,521 Nuclear operations expenses 3,755 206 Deferred compensation 5,562 5,450 Other postretirement benefits 6,371 3,187 Other 2,929 3,627 Total deferred tax assets 86,272 80,504 Deferred tax liabilities: Property plant and equipment 520,294 533,394 Pension expense 14,191 9,022 Reacquired debt 6,680 7,146 Research and experimentation 6,196 2,276 Other 7,801 14,458 Total deferred tax liabilities 555,162 566,296 Net deferred tax liability $468,890 $485,792\nThe Internal Revenue Service has examined and closed consolidated Federal income tax returns of SCANA Corporation through 1989 and is currently examining SCANA's 1990, 1991 and 1992 Federal income tax returns. Adjustments are currently proposed by the examining agent. SCANA does not anticipate that any adjustments which might result from this examination will have a significant impact on the earnings or financial position of the Company.\n8. FINANCIAL INSTRUMENTS:\nThe carrying amounts and estimated fair values of the Company's financial instruments at December 31, 1995 and 1994 are as follows:\nThe information presented herein is based on pertinent information available to the Company as of December 31, 1995 and 1994. Although the Company is not aware of any factors that would significantly affect the estimated fair value amounts, such financial instruments have not been comprehensively revalued since December 31, 1995, and the current estimated fair value may differ significantly from the estimated fair value at that date.\nThe following methods and assumptions were used to estimate the fair value of the above classes of financial instruments:\nCash and temporary cash investments, including commercial paper, repurchase agreements, treasury bills and notes are valued at their carrying amount.\nFair values of investments and long-term debt are based on quoted market prices of the instruments or similar instruments, or for those instruments for which there are no quoted market prices available, fair values are based on net present value calculations. Settlement of long term debt may not be possible or may not be a prudent management decision.\nShort-term borrowings are valued at their carrying amount.\nThe fair value of preferred stock (subject to purchase or sinking funds) is estimated on the basis of market prices.\nPotential taxes and other expenses that would be incurred in an actual sale or settlement have not been taken into consideration.\n9. SHORT-TERM BORROWINGS:\nThe Company pays fees to banks as compensation for its committed lines of credit. Commercial paper borrowings are for 270 days or less. Details of lines of credit and short-term borrowings, excluding amounts classified as long-term (Notes 3 and 4), at December 31, 1995, 1994 and 1993 and for the years then ended are as follows:\n1995 1994 1993 (Millions of dollars)\nAuthorized lines of credit at year-end $165.0 $165.0 $212.0 Unused lines of credit at year-end $165.0 $165.0 $212.0 Short-term borrowings outstanding at year-end: Commercial paper $ 80.5 $100.0 $ 1.0 Weighted average interest rate 5.83% 6.04% 3.35%\n10. COMMITMENTS AND CONTINGENCIES:\nA. Construction\nThe Company entered into a contract with Duke\/Fluor Daniel in 1991 to design, engineer and build a 385 MW coal-fired electric generating plant near Cope, South Carolina. Construction of the plant started in November 1992. Commercial operation began in January 1996. The cost of the Cope plant, excluding AFC, is $410.9 million. In addition, the transmission lines for interconnection with the Company's system cost $22.5 million.\nUnder the Duke\/Fluor Daniel contract the aggregate amount of required minimum payments remaining at December 31, 1995 is $4.2 million due in 1996. Through December 31, 1995 the Company had paid $378.7 million under the contract.\nB. Nuclear Insurance\nThe Price-Anderson Indemnification Act, which deals with the Company's public liability for a nuclear incident, currently establishes the liability limit for third-party claims associated with any nuclear incident at $8.9 billion. Each reactor licensee is currently liable for up to $79.3 million per reactor owned for each nuclear incident occurring at any reactor in the United States, provided that not more than $10 million of the liability per reactor would be assessed per year. The Company's maximum assessment, based on its two-thirds ownership of Summer Station, would be approximately $52.9 million per incident, but not more than $6.7 million per year.\nThe Company currently maintains policies (for itself and on behalf of the PSA) with Nuclear Electric Insurance Limited (NEIL) and American Nuclear Insurers (ANI) providing combined property and decontamination insurance coverage of $1.9 billion for any losses at Summer Station. The Company pays annual premiums and, in addition, could be assessed a retroactive premium not to exceed 7 1\/2 times its annual premium in the event of property damage loss to any nuclear generating facilities covered under the NEIL program. Based on the current annual premium, this retroactive premium would not exceed $8.2 million.\nTo the extent that insurable claims for property damage, decontamination, repair and replacement and other costs and expenses arising from a nuclear incident at Summer Station exceed the policy limits of insurance, or to the extent such insurance becomes unavailable in the future, and to the extent that the Company's rates would not recover the cost of any purchased replacement power, the Company will retain the risk of loss as a self-insurer. The Company has no reason to anticipate a serious nuclear incident at Summer Station. If such an incident were to occur, it could have a material adverse impact on the Company's financial position and results of operations.\nC. Environmental\nAs described in Note 1M of Notes to Consolidated Financial Statements, the Company has an environmental assessment program to identify and assess current and former operations sites that could require environmental cleanup. As site assessments are initiated, estimates are made of the cost, if any, to investigate and clean up each site. These estimates are refined as additional information becomes available; therefore, actual expenditures could differ significantly from original estimates. Amounts estimated and accrued to date for site assessments and cleanup relate primarily to regulated operations; such amounts are deferred and are being amortized and recovered through rates over a ten-year period for electric operations and an eight-year period for gas operations. Such deferred amounts totaled $18.0 million and $20.2 million at December 31, 1995 and 1994, respectively. Estimates to date include, among other items, the costs estimated to be associated with the matters discussed in the following paragraphs.\nThe Company owns four decommissioned manufactured gas plant sites which contain residues of by-product chemicals. The Company maintains an active review of the sites to monitor the nature and extent of the residual contamination.\nIn September 1992 the EPA notified the Company, the City of Charleston and the Charleston Housing Authority of their potential liability for the investigation and cleanup of the Calhoun Park Area Site in Charleston, South Carolina. This site originally encompassed approximately eighteen acres and included properties which were the locations for industrial operations, including a wood preserving (creosote) plant and one of the Company's decommissioned manufactured gas plants. The original scope of this investigation has been expanded to approximately 30 acres, including adjacent properties owned by the National Park Service and the City of Charleston, and private properties. The site has not been placed on the National Priority List, but may be added before cleanup is initiated. The PRPs have agreed with the EPA to participate in an innovative approach to site investigation and cleanup called \"Superfund Accelerated Cleanup Model,\" allowing the pre-cleanup site investigation process to be compressed significantly. The PRPs have negotiated an administrative order by consent for the conduct of a Remedial Investigation\/Feasibility Study (RI\/FS) and a corresponding Scope of Work. Field work began in November 1993. The Company is also working with the City of Charleston to investigate potential contamination from the manufactured gas plant which may have migrated to the city's aquarium site. In 1994 the City of Charleston notified the Company that it considers the Company to be responsible for a $43.5 million increase in costs of the aquarium project attributable to delays resulting from contamination of the Calhoun Park Area Site. The Company believes it has meritorious defenses against this claim and does not expect its resolution to have a material impact on its financial position or results of operations.\nD. Claims and Litigation\nThe Company is engaged in various claims and litigation incidental to its business operations which management anticipates will be resolved without loss to the Company. No estimate of the range of loss from these matters can currently be determined.\n11. SEGMENT OF BUSINESS INFORMATION:\nSegment information at December 31, 1995, 1994 and 1993 and for the years then ended is as follows:\nElectric Gas Transit Total (Thousands of Dollars) Operating revenues $1,006,566 $ 200,632 $ 3,889 $1,211,087 Operating expenses, excluding depreciation and amortization 657,452 169,768 10,429 837,649 Depreciation and amortization 103,961 12,616 1,007 117,584 Total operating expenses 761,413 182,384 11,436 955,233 Operating income (loss) $ 245,153 $ 18,248 $ (7,547) 255,854\nAdd - Other income, net 9,553 Less - Interest charges 96,222 Net income $ 169,185\nCapital expenditures: Identifiable $ 245,016 $ 19,670 $ 265 $ 264,951\nUtilized for overall Company operations 27,816 Total $ 292,767\nIdentifiable assets at December 31, 1995: Utility plant, net $2,850,647 $ 209,847 $ 1,878 $3,062,372 Inventories 76,697 2,155 561 79,413 Total $2,927,344 $ 212,002 $ 2,439 3,141,785\nOther assets 660,648 Total assets $3,802,433\nElectric Gas Transit Total (Thousands of Dollars) Operating revenues $975,526 $201,746 $ 4,002 $1,181,274 Operating expenses, excluding depreciation and amortization 659,610 173,717 10,577 843,904 Depreciation and amortization 95,666 11,060 226 106,952 Total operating expenses 755,276 184,777 10,803 950,856 Operating income (loss) $ 220,250 $ 16,969 $ (6,801) 230,418\nAdd - Other income, net 7,271 Less - Interest charges 85,646 Net income $ 152,043\nCapital expenditures: Identifiable $ 359,510 $ 40,923 $ 347 $ 400,780\nUtilized for overall Company operations 20,167 Total $ 420,947\nIdentifiable assets at December 31, 1994: Utility plant, net $2,717,147 $201,018 $ 1,791 $2,919,956 Inventories 85,113 2,605 495 88,213 Total $2,802,260 $203,623 $ 2,286 3,008,169\nOther assets 578,922 Total assets $3,587,091\nElectric Gas Transit Total (Thousands of Dollars) Operating revenues $ 940,547 $174,035 $ 3,851 $1,118,433 Operating expenses, excluding depreciation and amortization 639,808 148,349 9,737 797,894 Depreciation and amortization 91,142 9,903 175 101,220 Total operating expenses 730,950 158,252 9,912 899,114 Operating income (loss) $ 209,597 $ 15,783 $(6,061) 219,319\nAdd - Other income, net 6,585 Less - Interest charges 79,936 Net income $ 145,968\nCapital expenditures: Identifiable $ 274,408 $ 11,674 $ 604 $ 286,686\nUtilized for overall Company operations 13,934 Total $ 300,620\nIdentifiable assets at December 31, 1993: Utility plant, net $2,445,466 $178,464 $1,673 $2,625,603 Inventories 66,181 2,526 463 69,170 Total $2,511,647 $180,990 $2,136 2,694,773\nOther assets 495,166 Total assets $3,189,939\n12. QUARTERLY FINANCIAL DATA (UNAUDITED):\n(Thousands of Dollars) First Second Third Fourth Quarter Quarter Quarter Quarter Annual Total operating revenues $308,759 $275,139 $339,937 $287,252 $1,211,087 Operating income 67,189 53,153 87,023 48,489 255,854 Net Income 45,249 30,870 65,040 28,026 169,185\n(Thousands of Dollars) First Second Third Fourth Quarter Quarter Quarter Quarter Annual Total operating revenues $313,321 $263,033 $327,066 $277,854 $1,181,274 Operating income 63,520 43,316 79,133 44,449 230,418 Net Income 45,340 24,348 57,619 24,736 152,043\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\nDIRECTORS\nThe directors listed below were elected April 27, 1995 to hold office until the next annual meeting of the Company's stockholders on April 25, 1996.\nName and Year First Became Director Age Principal Occupation; Directorships\nBill L. Amick 52 For more than five years, Chairman of the (1990) Board and Chief Executive Officer of Amick Farms, Inc., Batesburg, SC (vertically integrated broiler operation).\nFor more than five years, Chairman and Chief Executive Officer of Amick Processing, Inc. and Amick Broilers, Inc.\nDirector, SCANA Corporation, Columbia, SC.\nWilliam B. Bookhart, Jr. 54 For more than five years, a partner in (1979) Bookhart Farms, Elloree, SC (general farming).\nDirector, SCANA Corporation, Columbia, SC.\nWilliam T. Cassels, Jr. 66 For more than five years, Chairman of the (1990) Board, Southeastern Freight Lines, Inc., Columbia, SC (trucking business).\nDirector, SCANA Corporation, Columbia, SC; South Carolina National Corporation, Columbia, SC; Wachovia Bank of South Carolina, N.A., Columbia, SC.\nHugh M. Chapman 63 Since January 1, 1992, Chairman of (1988) NationsBank South, Atlanta, GA (a division of NationsBank Corporation, bank holding company).\nFrom September 1, 1990 to December 31, 1991, Vice Chairman and Director, C&S\/Sovran Corporation, Atlanta, GA.\nPrior to September 1, 1990, President and Director, Citizens & Southern Corporation, Atlanta, GA and Chairman of the Board, Citizens & Southern South Carolina Corporation, Columbia, SC.\nDirector, SCANA Corporation, Columbia, SC.\nName and Year First Became Director Age Principal Occupation; Directorships\nJames B. Edwards, D.M.D. 68 For more than five years, President and (1986) Professor of Maxillofacial Surgery, Medical University of South Carolina, Charleston, SC.\nU.S. Secretary of Energy from January 1981 to November 1982.\nGovernor of South Carolina, 1975-1979.\nDirector, Phillips Petroleum Co., Bartlesville, OK; WMX Technologies, Inc., Oak Brook, IL; General Engineering Laboratories, Inc., Charleston SC; GS Industries, Inc., Charlotte, NC; IMO Industries, Inc., Lawrenceville, NJ; National Data Corporation, Atlanta, GA; SCANA Corporation, Columbia, SC.\nElaine T. Freeman 60 For more than five years, Executive Director (1992) of ETV Endowment of South Carolina, Inc. (non-profit organization), Spartanburg, SC.\nDirector National Bank of South Carolina, Columbia, SC; SCANA Corporation, Columbia, SC.\nLawrence M. Gressette, Jr. 64 For more than five years, Chairman of the (1987) Board and Chief Executive Officer of SCANA Corporation and Chairman of the Board and Chief Executive Officer of all SCANA subsidiaries, including the Company.\nFor more than five years prior to December 13, 1995, President of SCANA Corporation.\nDirector, Wachovia Corporation, Winston- Salem, NC; InterCel, Inc., West Point, GA; The Liberty Corporation, Greenville, SC; SCANA Corporation, Columbia, SC.\nBenjamin A. Hagood 68 Since January 1, 1993, Chairman of the (1974) Board William M. Bird and Company, Inc., Inc., Charleston, SC (wholesale distributor of floor covering material).\nFor more than two years prior to January 1, 1993, President and Director, William M. Bird and Company, Inc., Charleston, SC.\nDirector, SCANA Corporation, Columbia, SC.\nName and Year First Became Director Age Principal Occupation; Directorships\nW. Hayne Hipp 56 For more than five years, President and (1983) Chief Executive Officer, The Liberty Corporation, Greenville, SC (insurance and broadcasting holding company).\nDirector, The Liberty Corporation, Greenville, SC; Wachovia Corporation, Winston-Salem, NC; SCANA Corporation, Columbia, SC.\nBruce D. Kenyon 53 For more than five years, President and (1991) Chief Operating Officer of the Company.\nDirector, SCANA Corporation, Columbia, SC.\nF. Creighton McMaster 66 For more than five years, President and (1974) Manager, Winnsboro Petroleum Company, Winnsboro, SC (wholesale distributor of petroleum products).\nDirector, First Union National Bank of South Carolina, Greenville, SC; SCANA Corporation, Columbia, SC.\nHenry Ponder, Ph.D. 67 For more than five years, President, Fisk (1983) University, Nashville, TN.\nDirector, Suntrust Banks, Inc., Nashville, TN; SCANA Corporation, Columbia, SC.\nJohn B. Rhodes 65 For more than five years, Chairman and (1967) Chief Executive Officer, Rhodes Oil Company, Inc., Walterboro, SC (distributor of petroleum products).\nDirector, SCANA Corporation, Columbia, SC.\nWilliam B. Timmerman 49 Since December 13, 1995, President of SCANA (1991) Corporation.\nFrom May 1, 1994 to December 13, 1995, Executive Vice President of SCANA Corporation.\nSince August 25, 1993, Assistant Secretary of SCANA Corporation and all of its subsidiaries, including the Company.\nFrom August 28, 1991 to February 20, 1996, Chief Financial Officer of the Company.\nFor more than five years prior to May 1, 1994, Senior Vice President of SCANA SCANA Corporation.\nFor more than five years prior to February 20, 1996, Controller of SCANA Corporation.\nDirector, SCANA Corporation, Columbia, SC; InterCel, Inc., West Point, GA.\nName and Year First Became Director Age Principal Occupation; Directorships\nE. Craig Wall, Jr. 58 For more than five years, President and (1982) Director, Canal Industries, Conway, SC (forest products industry).\nDirector, Sonoco Products Company, Hartsville, SC; Ruddick Corporation, Charlotte, NC; Nationsbank Corp., Charlotte, NC; Blue Cross\/Blue Shield of South Carolina, Columbia, SC; SCANA Corporation, Columbia, SC.\nEXECUTIVE OFFICERS OF THE COMPANY\nThe Company's officers are elected at the annual organizational meeting of the Board of Directors and hold office until the next such organizational meeting, unless the Board of Directors shall otherwise determine, or unless a resignation is submitted. Positions Held During Name Age Past Five Years Dates\nL.M. Gressette, Jr. (1) 64 Chairman of the Board and Chief Executive Officer *-present President - SCANA *-1995\nB.D. Kenyon (1) 53 President and Chief Operating Officer 1990-present\nW.B. Timmerman (1) 49 President - SCANA 1995-present President of MPX, an affiliate 1996-present Executive Vice President, 1994-1995 SCANA Assistant Secretary 1993-1996 Chief Financial Officer *-1996 Controller, SCANA *-1996 Senior Vice President, *-1994 SCANA\nG.J. Bullwinkel, Jr. 47 Senior Vice President- Retail Electric 1995-present Senior Vice President- Fossil & Hydro Production 1993-1994 Senior Vice President- Production 1991-1992\nW.A. Darby 50 Senior Vice President - Gas, SCANA Gas Group 1996-present Vice President-Gas Operations *-present President and Treasurer of ServiceCare 1996-present General Manager of ServiceCare, Inc., an affiliate 1994-present\nJ. L. Skolds 45 Senior Vice President - 1994-present Generation Vice President - Nuclear Operations 1990-1994\nK. B. Marsh (1) 40 Vice President - Finance, Chief Financial Officer and Controller - SCANA 1996-present Vice President - Finance, Treasurer and Secretary 1992-1996 Vice President - Finance and Treasurer 1991-1992 Vice President - Corporate Planning 1991 Vice President and Controller *-1991\nB.T. Zeigler (1) 40 Vice President - SCANA 1996-present General Counsel of SCE&G 1995-present Associate General Counsel - SCE&G Legal Department 1992-1995 Partner - Lewis, Babcock & Hawkins Law Firm *-1992\n*Indicates position held at least since March 1, 1991\n(1) Also an executive officer of SCANA\nCOMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT\nAll of the Company's common stock is held by its parent, SCANA Corporation, and none of the directors and executive officers of the Company own any of the other classes of equity securities of the Company. The required forms indicate that no equity securities of the Company are owned by the directors and executive officers. Based solely on a review of the copies of such forms and amendments furnished to the Company and written representations from the executive officers and directors, the Company believes that during 1995 all Section 16(a) filing requirements applicable to its executive officers, directors and greater than 10% beneficial owners were complied with except that one report covering initial ownership of the Company's preferred stock was filed late by Kevin B. Marsh and Belton T. Zeigler.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe following table contains information with respect to compensation paid or accrued during the years 1995, 1994 and 1993 to the Chief Executive Officer of the Company and to each of the other four most highly compensated executive officers of the Company during 1995 who were serving as executive officers of the Company at the end of 1995.\nLong-Term Performance Share Plan\nThe long-term Performance Share Plan for officers of SCANA and its subsidiaries measures SCANA's Total Shareholder Return (\"TSR\") relative to a group of peer companies over a three-year period. The \"PSP Peer Group\" includes 94 electric and gas utilities, none of which have annual revenues of less than $100 million.\nTSR is stock price increase over the three-year period, plus cash dividends paid during the period, divided by stock price as of the beginning of the period. Comparing SCANA's TSR to the TSR of a large group of other utilities reflects SCANA's recognition that investors could have invested their funds in other utility companies and measures how well SCANA did when compared to others operating in similar interest, tax, economic and regulatory environments.\nExecutives eligible to participate in the Performance Share Plan are assigned target award opportunities annually based primarily on their salary level. In determining award sizes, levels of responsibilities and competitive practices also are considered. Awards under this plan represent a significant portion of executives \"at-risk\" compensation. To provide additional incentive for executives, and to ensure that executives are only rewarded when shareholders gain, actual payouts may exceed the median of the market when performance is above the 50th percentile of the peer group. For lesser performance, awards will be at or below the market median.\nPayouts occur when SCANA's TSR is in the top two-thirds of the PSP Peer Group, and vary based on SCANA's ranking against the peer group. Executives earn threshold payouts of 0.4 times target at the 33rd percentile of three-year performance. Target payouts will be made at the 50th percentile of three-year performance. Maximum payouts will be made at 1.5 times target when SCANA's TSR is at or above the 75th percentile of the peer group. Payments will be made on a sliding scale for performance between threshold and target and target and maximum. No payouts will be earned if performance is in the bottom one-third of the peer group. Awards are denominated in shares of SCANA Common Stock and may be paid in either stock or a combination of stock and cash.\nFor the three-year period from 1993 through 1995, SCANA's TSR was at the 98th percentile of the PSP Peer Group. This resulted in payouts in February 1996 at 150% of target shares awarded paid in a combination of stock and cash.\nThe following table shows the target awards made in 1995 for potential payment in 1998 under the long-term Performance Share Plan, and estimated future payouts under that plan at threshold, target and maximum levels for the named executive officers. Mr. Gressette's award for the 1995-1997 performance period is prorated to reflect his retirement in February 1997.\nDEFINED BENEFIT PLANS\nIn addition to the qualified Retirement Plan for all employees, the Company has Supplemental Executive Retirement Plans (\"SERP\") for certain eligible employees, including officers. A SERP is an unfunded plan which provides for benefit payments in addition to those payable under a qualified retirement plan. It maintains uniform application of the Retirement Plan benefit formula and would provide, among other benefits, payment of Retirement Plan formula pension benefits, if any, which exceed those payable under the Internal Revenue Code (\"IRC\") maximum benefit limitations.\nThe following table illustrates the estimated maximum annual benefits payable upon retirement at normal retirement date under the Retirement Plan and the SERPs.\nPension Plan Table\nFinal Service Years Average Pay 15 20 25 30 35\n$150,000 42,311 56,415 70,519 84,623 87,476 200,000 57,311 76,415 95,519 114,623 118,726 250,000 72,311 96,415 120,519 144,623 149,976 300,000 87,311 116,415 145,519 174,623 181,226 350,000 102,311 136,415 170,519 204,623 212,476 400,000 117,311 156,415 195,519 234,623 243,726 450,000 132,311 176,415 220,519 264,623 274,976 500,000 147,311 196,415 245,519 294,623 306,226 550,000 162,311 216,415 270,519 324,623 337,476 600,000 177,311 236,415 295,519 354,623 368,726\nThe compensation shown in the column labeled \"Salary\" of the Summary Compensation Table for the individuals named therein is covered by the Retirement Plan and\/or a SERP. As of December 31, 1995, Messrs. Gressette, Kenyon, Timmerman, Bullwinkel and Skolds had credited service under the Retirement Plan (or its equivalent under the SERP) of 33, 22, 17, 25 and 10 years, respectively. Benefits are computed based on a straight-life annuity with an unreduced 60% surviving spouse benefit. The amounts in this table assume continuation of the primary Social Security benefits in effect at January 1, 1996 and are not subject to any deduction for Social Security or other offset amounts.\nThe Company also has a Key Employee Retention Program (the \"Key Employee Retention Program\") covering officers and certain other executive employees that provides supplemental retirement and\/or death benefits for participants. Under the program, each participant may elect to receive either a monthly retirement benefit for 180 months upon retirement at or after age 65 equal to 25% of the average monthly salary of the participant over his final 36 months of employment prior to age 65, or an optional death benefit payable to a participant's designated beneficiary monthly for 180 months, in an amount equal to 35% of the average monthly salary of the participant over his final 36 months of employment prior to age 65. In the event of the participant's death prior to age 65, the Company will pay to the participant's designated beneficiary for 180 months, a monthly benefit equal to 50% of such participant's base monthly salary in effect at death.\nAll of the executive officers named in the Summary Compensation Table above are participating in the program. Estimated annual retirement benefits payable at age 65 based on projected eligible compensation (assuming increases of 4% per year) to the five executive officers named in the Summary Compensation Table are as follows: Mr. Gressette - $113,790; Mr. Kenyon - $122,658; Mr. Timmerman - $129,942; Mr. Bullwinkel - $90,887; and Mr. Skolds - $93,234.\nTERMINATION, SEVERANCE AND CHANGE OF CONTROL ARRANGEMENTS\nThe Company has a Key Executive Severance Benefit Plan (the \"Severance Plan\") intended to assure the objective judgment of, and to retain the loyalties of, key executives when the Company is faced with a potential change in control or a change in control by providing a continuation of salary and benefits after a participant's employment is terminated by the Company during a potential change in control, after a change in control without just cause, disability, retirement or death or by the participant for good reason after a change in control. All of the executive officers named in the Summary Compensation Table except Mr. Gressette have been designated as participants in the Severance Plan.\nWhen a potential change in control occurs, a participant is obli- gated to remain with the Company for six months unless his employment is terminated for disability or normal retirement or until a change in control occurs. Upon a change in control resulting in an officer's termination, the Severance Plan provides for guaranteed severance payments equal to three times the annual compensation of the officer plus payments under certain of the Company's incentive and retirement plans. The officer also would receive an additional amount (a \"gross- up\" payment) for any IRC Section 4999 excess tax or any such other similar tax applicable to the severance payments. In addition, for 36 months after termination, the officer would receive coverage for medical benefits and life insurance so as to provide the same level of benefits previously enjoyed under group plans or individual policy contracts or otherwise as determined by the Executive Committee of the Board of Directors. Such benefits however would be reduced to the extent that the participant receives similar benefits during the period from another employer.\nIn addition to the Severance Plan, in the event of a merger, consolidation or acquisition in which SCANA is not the surviving corporation, target awards under the Performance Share Plan will become immediately payable based on SCANA's shareholder return performance as of the end of the most recently completed calendar year for each performance period as to which the grant of target shares has occurred at least six months previously.\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\nDuring 1995, no officer, employee or former officer of the Company or its affiliates served as a member of the Long-Term Compensation Committee or the Performance Committee, except Mr. Gressette who served as a member of the Performance Committee. Although Mr. Gressette was an ex-officio, nonvoting member of the Performance Committee during 1995, he did not participate in any of its deliberations concerning executive officer compensation.\nSince January 1, 1995, the Company has engaged in business transactions with entities with which Mr. Chapman (Chairman of both the Performance Committee and the Long-Term Compensation Committee) and Mr. McMaster (a member of the Long-Term Compensation Committee) are executive officers.\nMr. Chapman is Chairman of NationsBank South, a division of NationsBank Corporation. Since January 1, 1995, the Company has engaged in various transactions in which affiliates of NationsBank Corporation acted as lender or provider of lines of credit or credit support to the Company and its affiliates. The amount paid during 1995 by the Company and its affiliates to NationsBank Corporation affiliates on account of such transactions was $3,339,270. It is anticipated that transactions such as described above will continue in the future.\nMr. McMaster is the President and Manager of Winnsboro Petroleum Company. Purchases from Winnsboro Petroleum Company totaling $71,413 for fuel oil and gasoline were made during 1995 by the Company and its affiliates. It is anticipated that such purchases will continue in the future.\nDuring 1995, there existed one executive officer-director interlock where an executive officer of SCANA Corporation served as a director of another company that had an executive officer serving on one of the SCANA Board of Directors' committees which deals with compensation matters. Mr. Gressette, Chairman of the Board and Chief Executive Officer of the Company, served as a director of The Liberty Corporation and Mr. Hipp, President and Chief Executive Officer of The Liberty Corporation, served as a member of the Company's Long-Term Compensation Committee.\nCompensation of Directors\nFees. During 1995, directors who were not employees of the Company were paid $16,000 annually for services rendered, plus $1,800 for each Board meeting attended and $850 for attendance at a committee meeting which is not held on the same day as a regular meeting of the Board. The fee for attendance at a telephone conference meeting is $200. The fee for attendance at a conference is $850. In addition, directors are paid, as part of their compensation, travel, lodging and incidental expenses related to attendance at meetings and conferences. Directors who are employees of the Company or its affiliates receive no compensation for serving as directors or attending meetings.\nDeferral Plan. SCANA has a plan pursuant to which directors may defer all or a portion of their fees for services rendered and meeting attendance. Interest is earned on the deferred amounts at a rate set by the Performance Committee. During 1995 and currently, the rate is set at the announced prime rate of Wachovia Bank of South Carolina. Mr. Cassels and Mr. Rhodes were the only directors participating in the plan during 1995. Mr. Cassels became a participant in January 1994 and Mr. Rhodes in July 1987, and interest credited to their deferral accounts during 1995 was $3,591.94 and $19,557.86, respectively.\nEndowment Plan. Each director participates in the Directors' Endowment Plan, which provides that SCANA make a tax deductible, charitable contribution totaling $500,000 to institutions of higher education nominated by the director. A portion is contributed upon retirement of the director and the remainder upon the director's death. The plan is funded in part through insurance on the lives of the directors. Designated in-state institutions of higher education must be approved by the Chief Executive Officer of SCANA; any out-of- state designation must be approved by the Performance Committee. The designated institutions are reviewed on an annual basis by the Chief Executive Officer to assure compliance with the intent of the program. The plan is intended to reinforce SCANA's commitment to quality higher education and is intended to enhance SCANA's ability to attract and retain qualified board members.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nAll shares of the Company's Common Stock are held, beneficially and of record, by SCANA Corporation.\nThe table set forth below indicates the shares of SCANA's Common Stock beneficially owned as of March 8, 1996 by each director and nominee, each of the executive officers named in the Summary Compensation Table on page 59, and the directors and executive officers of the Company as a group.\nSECURITY OWNERSHIP OF MANAGEMENT\nName of Beneficial Amount and Nature Name of Beneficial Amount and Nature Owner of Ownership 1 Owner of Ownership 1 B. L. Amick 2,486 W. Hayne Hipp 2,800 W. B. Bookhart, Jr. 15,761 B. D. Kenyon 18,883 G. J. Bullwinkel 17,255 F. C. McMaster 5,630 W. T. Cassels, Jr. 2,000 Henry Ponder 12,381 H. M. Chapman 6,000 J. B. Rhodes 7,780 J. B. Edwards 4,665 J. L. Skolds 6,414 E. T. Freeman 4,220 W. B. Timmerman 36,459 L. M. Gressette, Jr. 47,493 E. C. Wall, Jr. 14,000 B. A. Hagood 2,370\nAll directors and executive officers as a group (21 persons) TOTAL 247,243 TOTAL PERCENT OF CLASS 0.2%\nThe information set forth above as to the security ownership has been furnished to the Company by such persons. _____________________\n1 Includes shares owned by close relatives, the beneficial ownership of which is disclaimed by the director or nominee, as follows: Mr. Amick - 480; Mr. Bookhart - 4,498; Mr. Gressette - 1,060; Mr. Hagood - 334; Mr. McMaster - 2,000.\nIncludes shares purchased through December 31, 1995, but not thereafter, by the Trustee under the Savings Plan.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nFor information regarding certain relationships and related transactions, see Item 11, \"Compensation Committee Interlocks and Insider Participation.\"\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\nFinancial Statements and Schedules\nSee Index to Consolidated Financial Statements and Supplementary Data on page 30.\nExhibits Filed\nExhibits required to be filed with this Annual Report on Form 10-K are listed in the Exhibit Index following the signature page. Certain of such exhibits which have heretofore been filed with the Securities and Exchange Commission and which are designated by reference to their exhibit number in prior filings are hereby incorporated herein by reference and made a part hereof.\nAs permitted under Item 601(b)(4)(iii), instruments defining the rights of holders of long-term debt of less than 10 percent of the total consolidated assets of the Company and its subsidiaries, have been omitted and the Company agrees to furnish a copy of such instruments to the Commission upon request.\nReports on Form 8-K\nNone\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\n(REGISTRANT) SOUTH CAROLINA ELECTRIC & GAS COMPANY BY (SIGNATURE) s\/Bruce D. Kenyon (NAME AND TITLE) Bruce D. Kenyon, President and Chief Operating Officer DATE February 20, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, 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: BY (SIGNATURE) s\/L. M. Gressette, Jr. (NAME AND TITLE) L. M. Gressette, Jr., Chairman of the Board, Chief Executive Officer and Director DATE February 20, 1996\n(ii) Principal financial officer: BY (SIGNATURE) s\/K. B. Marsh (NAME AND TITLE) K. B. Marsh, Chief Financial Officer DATE February 20, 1996\n(iii) Principal accounting officer: BY (SIGNATURE) s\/J. E. Addison (NAME AND TITLE) J. E. Addison, Vice President and Controller DATE February 20, 1996\nBY (SIGNATURE) s\/B. L. Amick (NAME AND TITLE) B. L. Amick, Director DATE February 20, 1996\nBY (SIGNATURE) s\/W. B. Bookhart, Jr. (NAME AND TITLE) W. B. Bookhart, Jr., Director DATE February 20, 1996\nBY (SIGNATURE) s\/W. T. Cassels, Jr. (NAME AND TITLE) W. T. Cassels, Jr., Director DATE February 20, 1996\nBY (SIGNATURE) s\/H. M. Chapman (NAME AND TITLE) H. M. Chapman, Director DATE February 20, 1996\nBY (SIGNATURE) s\/J. B. Edwards (NAME AND TITLE) J. B. Edwards, Director DATE February 20, 1996\nBY (SIGNATURE) s\/E. T. Freeman (NAME AND TITLE) E. T. Freeman, Director DATE February 20, 1996\nBY (SIGNATURE) s\/B. A. Hagood (NAME AND TITLE) B. A. Hagood, Director DATE February 20, 1996\nBY (SIGNATURE) s\/W. Hayne Hipp (NAME AND TITLE) W. Hayne Hipp, Director DATE February 20, 1996\nBY (SIGNATURE) s\/F. C. McMaster (NAME AND TITLE) F. C. McMaster, Director DATE February 20, 1996\nBY (SIGNATURE) s\/Henry Ponder (NAME AND TITLE) Henry Ponder, Director DATE February 20, 1996\nBY (SIGNATURE) s\/W. B. Timmerman (NAME AND TITLE) W. B. Timmerman, Director DATE February 20, 1996\nBY (SIGNATURE) s\/J. B. Rhodes (NAME AND TITLE) J. B. Rhodes, Director DATE February 20, 1996\nBY (SIGNATURE) s\/E. C. Wall, Jr. (NAME AND TITLE) E. C. Wall, Jr., Director DATE February 20, 1996\nSOUTH CAROLINA ELECTRIC & GAS COMPANY Sequentially EXHIBIT INDEX Numbered Number Pages 2. Plan of Acquisition, Reorganization, Arrangement, Liquidation or Succession Not Applicable\n3. Articles of Incorporation and By-Laws\nA. Restated Articles of Incorporation of the Company as adopted on December 15, 1993 (Exhibit 3-A to Form 10-Q for the quarter ended June 30, 1994, File No. 1-3375).................... # B. Articles of Amendment, dated June 7, 1994, filed June 9, 1994 (Exhibit 3-B to Form 10-Q for the quarter ended June 30, 1994, File No. 1-3375).... # C. Articles of Amendment, dated November 9, 1994 (Exhibit 3-C to Form 10-K for the year ended December 31, 1994, File No. 1-3375)...................... # D. Articles of Amendment, dated December 9, 1994 (Exhibit 3-D to Form 10-K for the year ended December 31, 1994, File No. 1-3375)...................... # E. Articles of Correction, dated January 17, 1995 (Exhibit 3-E to Form 10-K for the year ended December 31, 1994, File No. 1-3375)...................... # F. Articles of Amendment, dated January 13, 1995 and filed January 17, 1995 (Exhibit 3-F to Form 10-K for the year ended December 31, 1994, File No. 1-3375)......................................... # G. Articles of Amendment dated March 31, 1995 (Exhibit 3-G to Form 10-Q for the quarter ended March 31, 1995, File No. 1-3375)................... # H. Articles of Correction - Amendment to Statement filed March 31, 1995, dated December 13, 1995 (Filed herewith)......................................... 71 I. Articles of Amendment dated December 13, 1995 (Filed herewith)......................................... 72 J. Copy of By-Laws of the Company as revised and amended thru December 15, 1993 (Exhibit 3-AZ to Form 10-K for the year ended December 31, 1993, File No. 1-3375)......................................... #\n4. Instruments Defining the Rights of Security Holders, Including Indentures A. Indenture dated as of January 1, 1945, from the South Carolina Power Company (the \"Power Company\") to Central Hanover Bank and Trust Company, as Trustee, as supplemented by three Supplemental Indentures dated respectively as of May 1, 1946, May 1, 1947 and July 1, 1949 (Exhibit 2-B to Registration No. 2-26459)................................ # B. Fourth Supplemental Indenture dated as of April 1, 1950, to Indenture referred to in Exhibit 4A, pursuant to which the Company assumed said Indenture (Exhibit 2-C to Registration No. 2-26459)...... # C. Fifth through Fifty-second Supplemental Indentures to Indenture referred to in Exhibit 4A dated as of the dates indicated below and filed as exhibits to the Registration Statements and 1934 Act reports whose file numbers are set forth below.............................................. #\nDecember 1, 1950 Exhibit 2-D to Registration No. 2-26459 July 1, 1951 Exhibit 2-E to Registration No. 2-26459 June 1, 1953 Exhibit 2-F to Registration No. 2-26459 June 1, 1955 Exhibit 2-G to Registration No. 2-26459 November 1, 1957 Exhibit 2-H to Registration No. 2-26459 September 1, 1958 Exhibit 2-I to Registration No. 2-26459 September 1, 1960 Exhibit 2-J to Registration No. 2-26459\n# Incorporated herein by reference as indicated.\nSOUTH CAROLINA ELECTRIC & GAS COMPANY\nExhibit Index (Continued) Sequentially Numbered Number Pages 4. (continued) June 1, 1961 Exhibit 2-K to Registration No. 2-26459 December 1, 1965 Exhibit 2-L to Registration No. 2-26459 June 1, 1966 Exhibit 2-M to Registration No. 2-26459 June 1, 1967 Exhibit 2-N to Registration No. 2-29693 September 1, 1968 Exhibit 4-O to Registration No. 2-31569 June 1, 1969 Exhibit 4-C to Registration No. 33-38580 December 1, 1969 Exhibit 4-Q to Registration No. 2-35388 June 1, 1970 Exhibit 4-R to Registration No. 2-37363 March 1, 1971 Exhibit 2-B-17 to Registration No. 2-40324 January 1, 1972 Exhibit 4-C to Registration No. 33-38580 July 1, 1974 Exhibit 2-A-19 to Registration No. 2-51291 May 1, 1975 Exhibit 4-C to Registration No. 33-38580 July 1, 1975 Exhibit 2-B-21 to Registration No. 2-53908 February 1, 1976 Exhibit 2-B-22 to Registration No. 2-55304 December 1, 1976 Exhibit 2-B-23 to Registration No. 2-57936 March 1, 1977 Exhibit 2-B-24 to Registration No. 2-58662 May 1, 1977 Exhibit 4-C to Registration No. 33-38580 February 1, 1978 Exhibit 4-C to Registration No. 33-38580 June 1, 1978 Exhibit 2-A-3 to Registration No. 2-61653 April 1, 1979 Exhibit 4-C to Registration No. 33-38580 June 1, 1979 Exhibit 4-C to Registration No. 33-38580 April 1, 1980 Exhibit 4-C to Registration No. 33-38580 June 1, 1980 Exhibit 4-C to Registration No. 33-38580 December 1, 1980 Exhibit 4-C to Registration No. 33-38580 April 1, 1981 Exhibit 4-D to Registration No. 33-49421 June 1, 1981 Exhibit 4-D to Registration No. 2-73321 March 1, 1982 Exhibit 4-D to Registration No. 33-49421 April 15, 1982 Exhibit 4-D to Registration No. 33-49421 May 1, 1982 Exhibit 4-D to Registration No. 33-49421 December 1, 1984 Exhibit 4-D to Registration No. 33-49421 December 1, 1985 Exhibit 4-D to Registration No. 33-49421 June 1, 1986 Exhibit 4-D to Registration No. 33-49421 February 1, 1987 Exhibit 4-D to Registration No. 33-49421 September 1, 1987 Exhibit 4-D to Registration No. 33-49421 January 1, 1989 Exhibit 4-D to Registration No. 33-49421 January 1, 1991 Exhibit 4-D to Registration No. 33-49421 February 1, 1991 Exhibit 4-D to Registration No. 33-49421 July 15, 1991 Exhibit 4-D to Registration No. 33-49421 August 15, 1991 Exhibit 4-D to Registration No. 33-49421 April 1, 1993 Exhibit 4-E to Registration No. 33-49421 July 1, 1993 Exhibit 4-D to Registration No. 33-57955 D. Indenture dated as of April 1, 1993 from South Carolina Electric & Gas Company to NationsBank of Georgia, National Association (Filed as Exhibit 4-F to Registration Statement No. 33-49421)......................................... # E. First Supplemental Indenture to Indenture referred to in 4-D dated as of June 1, 1993 (Filed as Exhibit 4-G to Registration Statement No. 33-49421)......................... # F. Second Supplemental Indenture to Indenture referred to in 4-D dated as of June 15, 1993 (Filed as Exhibit 4-G to Registration Statement No. 33-57955)......................... #\n9. Voting Trust Agreement Not Applicable\n10. Material Contracts A. Copy of Supplemental Executive Retirement Plan (Exhibit 10-A to Form 10-K for the year ended December 31, 1980)............................................ # 11. Statement Re Computation of Per Share Earnings Not Applicable\n# Incorporated herein by reference as indicated.\nSOUTH CAROLINA ELECTRIC & GAS COMPANY\nExhibit Index (Continued) Sequentially Numbered Number Pages\n12. Statement re Computation of Ratios (Filed herewith)........ 74\n13. Annual Report to Security Holders, Form 10-Q or Quarterly Report to Security Holders Not Applicable\n16. Letter Re Change in Certifying Accountant Not Applicable\n18. Letter Re Change in Accounting Principles Not Applicable\n21. Subsidiaries of the Registrant Not Applicable\n22. Published Report Regarding Matters Submitted to Vote of Security Holders Not Applicable\n23. Consents of Experts and Counsel Consent of Deloitte & Touche LLP.......................... 78\n24. Power of Attorney Not Applicable\n27. Financial Data Schedule Filed herewith\n28. Information from Reports furnished to State Insurance Regulatory Authorities Not Applicable\n99. Additional Exhibits Not Applicable\n# Incorporated herein by reference as indicated.","section_15":""}
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{"filename":"882235_1995.txt","cik":"882235","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nLincare Holdings Inc. and subsidiaries (\"Lincare\" or the \"Company\") is one of the nation's largest providers of oxygen and other respiratory therapy services to patients in the home. The Company's customers typically suffer from chronic obstructive pulmonary disease, such as emphysema, chronic bronchitis or asthma, and require supplemental oxygen or other respiratory therapy services in order to alleviate the symptoms and discomfort of respiratory dysfunction. Lincare currently serves over 85,000 customers in 36 states through 216 operating centers.\nOn November 30, 1990, the Company acquired the outstanding capital stock of Lincare Inc. (the \"Buyout\"). The Company was formed by investment partnerships affiliated with the venture capital firms of Welsh, Carson, Anderson & Stowe and Summit Partners, by Dean Witter Capital Corporation, and by members of the Company's current management for the purpose of effecting the Buyout.\nTHE HOME RESPIRATORY MARKET\nThe Company estimates that the home respiratory therapy market (including home oxygen equipment and respiratory therapy services) had revenues of approximately $3.0 billion in 1995, having grown by an estimated 8% to 10% per year over the last five years. This growth reflects the significant increase in the number of persons afflicted with chronic obstructive pulmonary disease, which is attributable, to a large extent, to the increasing proportion of the population over the age of 65.\nBUSINESS STRATEGY\nThe Company's strategy is to increase its market share through internal growth and acquisitions. Lincare will focus primarily on growth within its existing geographic markets, which the Company believes is generally more profitable than adding additional operating centers in new markets. In addition, the Company will expand into new geographic markets on a selective basis, either through acquisitions or by opening new operating centers, when it believes such expansion will enhance its business. In 1995, Lincare acquired 22 local and regional competitors with combined annual revenue of approximately $45.0 million. These acquisitions established Lincare in one new state and expanded its presence in the states where the Company had existing locations.\nRevenue growth will be dependent upon the overall growth rate of the home respiratory care market, as well as on opportunities to increase market share through effective marketing efforts and selective acquisitions of local or regional competitors. The Company believes that the growing cost containment efforts of government and private insurance reimbursement programs and an increasingly competitive environment have accelerated consolidation trends within the home health care industry.\nThe Company will continue to concentrate on providing oxygen and other respiratory therapy services to patients in the home and to provide home medical equipment and other services where it believes such services will enhance the Company's primary business. In 1995, oxygen and other respiratory therapy services accounted for over 90% of the Company's revenues.\nPRODUCTS AND SERVICES OF LINCARE\nLincare primarily provides oxygen and other respiratory therapy services to patients in the home. Lincare also provides a variety of infusion therapies in certain geographic markets. When a patient is referred to one of the Company's operating centers by a physician, hospital discharge planner or other source, the Company's customer representative obtains the necessary medical and insurance coverage information and coordinates the delivery of patient care. The prescribed therapy is administered by one of the Company's representatives in the customer's home, where instructions and training are given to the customer and the customer's family regarding appropriate equipment use and maintenance and the therapy to be administered. Following the\ninitial setup, Company representatives make periodic visits to the customer's home, the frequency of which is dictated by the type of therapy. The Company's services are coordinated with the customer's physician. During the period that the Company performs services for a customer, the customer remains under the physician's care and medical supervision. The Company employs respiratory therapists and nurses to perform certain training and other functions in connection with the Company's services. The respiratory therapists and nurses are licensed where required by applicable law.\nHOME OXYGEN EQUIPMENT. The major types of oxygen delivery equipment are liquid oxygen systems and oxygen concentrators. Each method of delivery has different characteristics that make it more or less suitable to specific patient applications.\nLiquid oxygen systems are thermally insulated containers of liquid oxygen, consisting of a stationary unit and a portable unit, which are most commonly used by ambulatory patients.\nOxygen concentrators are stationary units that provide a continuous flow of oxygen by filtering ordinary room air. Concentrators are most commonly used by patients confined to the home or with only minimal mobility.\nOTHER RESPIRATORY THERAPY SERVICES. The other respiratory therapy services of the Company consist primarily of:\nNebulizers and associated respiratory medications therapy provide aerosol therapy;\nNon-invasive ventilation provides nocturnal ventilatory support for neuromuscular and chronic obstructive pulmonary disease patients. This therapy improves daytime function and decreases incidents of acute illness; and\nApnea monitors provide respiratory alarm systems for infants at risk for sudden infant death syndrome;\nVentilators support respiratory function in severe cases of respiratory failure where the patient can no longer sustain the mechanics of breathing without the assistance of a machine.\nContinuous positive airway pressure devices maintain open airways in patients suffering from obstructive sleep apnea by providing airflow at prescribed pressures during sleep;\nOximeters determine oxygen desaturation during exercise and sleep and assess the effectiveness of oxygen and home respiratory modalities.\nINFUSION THERAPY. Lincare provides a variety of infusion therapies consisting primarily of:\nParenteral nutrition involves the intravenous feeding of life-sustaining nutrients to patients with impaired or altered digestive tracts or conditions that prohibit adequate oral nutritional support.\nIntravenous antibiotic therapy is the infusion of anti-infective medications into the patient's bloodstream for the treatment of a variety of infectious diseases.\nEnteral nutrition is administered to patients who cannot eat as a result of an obstruction to the upper gastrointestinal tract or other medical condition.\nChemotherapy is the administration of cytotoxic drugs to patients suffering from various types of cancer.\nDobutamine infusions are provided to patients with chronic end stage congestive heart failure that has not responded to standard drug therapy. These patients require a long-term venous access device and frequent blood chemistry monitoring.\nImmune globulin (IVIG) therapy is utilized for a variety of immune disorders such as B-cell and T-cell immune deficiency, acute infections, post transplant immunodeficiency and burns.\nContinuous pain management is the administration of analgesic drugs to patients suffering from acute or chronic pain.\nCentral catheter management provides monitoring and supplies to patients requiring access via a peripherally inserted line into the superior vena cava.\nThrough a limited number of operating centers, the Company provides home sleep studies, prenatal care, and prosthetic care.\nLincare also supplies home medical equipment, such as hospital beds, wheelchairs and other supplies that may be required by patients.\nCOMPANY OPERATIONS\nManagement. The Company is managed at the executive level as a portfolio of local businesses. Decentralization of managerial decision-making enables the Company's operating centers to respond promptly and effectively to local market demands and opportunities. The Company believes that the personalized nature of customer requirements and referral relationships characteristic of the home health care business mandates the Company's localized operating structure.\nEach of the Company's 216 operating centers is managed by a center manager who has responsibility and accountability for the operating and financial performance of the center. Service and marketing functions are performed at the local operating level, while strategic development, financial control and operating policies are administered at the executive level. Reporting mechanisms are in place at the operating center level to monitor performance and ensure field accountability.\nA regional management layer consisting of 28 area managers directly supervises individual operating center managers, serving as an additional mechanism for assessing and improving performance of the Company's operations. The Company's operating centers are served by eleven regional billing centers which control all the Company's billing and reimbursement functions.\nMIS Systems. The Company believes that the proprietary management information systems developed by the Company are one of its key competitive advantages and provide management with a critical asset in measuring and evaluating performance levels throughout the Company. Management reviews monthly reports containing information critical to the evaluation process, including revenues and profitability by individual center, accounts receivable and cash collection management, equipment controls and utilization, customer activity, and manpower trends. The Company has a staff of nine full-time computer programmers which permits the Company to continually enhance its computer systems in order to provide timely financial and operational information and to respond promptly to changes in reimbursement regulations and policies.\nAccounts Receivable Management. The Company derives a majority of its revenues from reimbursement by third party payors. The Company accepts assignment of insurance benefits from customers and in most instances invoices and collects payments directly from Medicare, Medicaid and private insurance carriers, as well as directly from customers under co-insurance provisions. The following table sets forth, for the period indicated, the Company's payor mix.\n- ---------------\n(1) The direct payment category is comprised primarily of co-insurance amounts received from beneficiaries of Medicare and private insurance coverage.\nReimbursement is a complicated process which involves submission of claims to multiple payors, each having its own claims requirements. To operate effectively in this environment, the Company has designed and implemented proprietary computer systems to decrease the time required for the submission and processing of\nthird party payor claims. The Company's systems are capable of tailoring the submission of claims to the specifications of the individual payors. The Company's in-house MIS capability also enables it to adjust quickly to any regulatory or reimbursement changes. These features serve to decrease the processing time of claims by payors, resulting in a more rapid turnover of accounts receivable. In addition, the Company is capable of submitting claims electronically to any Medicare carrier or other third party payor that can receive electronic claims submissions.\nThe Company's net accounts receivable in terms of days sales outstanding was 44 days as of December 31, 1995 and 40 days as of December 31, 1994.\nSALES AND MARKETING\nFavorable trends affecting the U.S. population and home health care have created an environment which should produce increasing demand for the services provided by Lincare. The average age of Americans is increasing, and as a person ages more health care services are required. The well-documented major structural changes going on in health care are moving more services into the home and out of institutions.\nSales activities are generally carried out by the Company's full-time sales representatives located at the Company's operating centers with assistance from the center managers. In addition to promoting the high quality of the Company's services, the sales representatives are trained to provide information concerning the advantages of home respiratory care. Sales representatives are often licensed respiratory therapists who are highly knowledgeable in the provision of supplemental oxygen.\nThe Company primarily acquires new customers through referrals. The Company's principal sources of referrals are physicians, hospital discharge planners, prepaid health plans, clinical case managers and nursing agencies. The Company's sales representatives maintain continual contact with these medical professionals in order to strengthen these relationships.\nThe Company's current base of referral sources provides a steady flow of customers in recognition of the Company's reputation for providing high-quality service to patients. While the Company views its referral sources as fundamental to its business, no single referral source accounts for more than 1.0% of the Company's revenues. The Company has more than 85,000 active customers, and the loss of any single customer or group of customers would not materially impact the Company's business.\nJoint Commission on Accreditation of Healthcare Organizations, (\"JCAHO\"). The Company has received accreditation from the JCAHO, a private not-for-profit organization that has established voluntary standards for the provision of home health care services, for all its operating centers.\nAccreditation by the JCAHO represents a marketing benefit to the Company's operating centers and provides for a recognized quality assurance program throughout the Company. The Company anticipates that referral sources may in the future require accreditation as a prerequisite to referring patients to individual home health care companies. Several proposals have been made to require health care providers to be accredited or licensed by independent agencies in order to participate in government reimbursement programs, and such a requirement has been adopted by certain private payors.\nRECENT ACQUISITIONS\nIn 1995, the Company acquired, in unrelated acquisitions, certain operating assets of 10 local and regional competitors, the common stock of 10 companies and, in two separate transactions, certain assets of two related companies and substantially all of the assets of a single company and eight of its wholly-owned subsidiaries. The operations acquired in 1995 had aggregate annualized revenues of approximately $45.0 million at the time of acquisition. These acquisitions resulted in the addition of 27 new operating centers.\nIn 1994, the Company acquired, in unrelated acquisitions, certain operating assets of 16 local and regional competitors, the common stock of three companies and, in a single transaction, certain assets of five related companies. The operations acquired in 1994 had aggregate annualized revenues of approximately $35.0 million at the time of acquisition. These acquisitions resulted in the addition of 35 new operating centers.\nQUALITY CONTROL\nThe Company is committed to providing consistently high quality products and services. The Company's quality control procedures are designed to promote greater responsiveness and sensitivity in dealing with individual customer needs and to provide the highest level of quality assurance and convenience to the referring physician. Licensed respiratory therapists and registered nurses provide professional health care support and assist in the Company's sales and marketing efforts.\nSUPPLIERS\nThe Company purchases its oxygen and equipment needs from a variety of suppliers. The Company is not dependent upon any single supplier and believes that its oxygen and equipment needs can be provided by several manufacturers.\nCOMPETITION\nThe home respiratory care market is a fragmented and highly competitive market that is served by the Company and other national providers and, the Company estimates, by over 2,000 regional and local companies.\nThe quality of service is the single most important competitive factor within the home respiratory care market. The relationships between a home respiratory care company and its customers and referral sources are highly personal. There is no incentive for either the physician or the patient to alter this relationship so long as the home respiratory care company is providing responsive, professional and high-quality service. Other key competitive factors are strength of local ties to the referral community and efficiency of reimbursement and accounts receivable management systems.\nHome respiratory care companies normally compete based on service. Reimbursement levels are established by the fee schedules promulgated by Medicare, Medicaid or by the individual determinations of private insurance companies. Furthermore, marketing efforts by home respiratory care companies are directed toward referral sources which do not share financial responsibility for the payment of services provided to customers.\nMEDICARE REIMBURSEMENT\nAs a supplier of home oxygen and other respiratory therapy services for the home health care market, the Company participates in Medicare Part B, the Supplementary Medical Insurance Program, which was established by the Social Security Act of 1965. Suppliers of home oxygen and other respiratory therapy services have historically been heavily dependent on Medicare reimbursement due to the high proportion of elderly suffering from respiratory disease.\nCongress enacted legislation passed as part of the 1987 Omnibus Budget Reconciliation Act (\"OBRA 1987\") that significantly changed reimbursement for home oxygen, respiratory therapy services and home medical equipment. This legislation changed reimbursement from charge-based pricing by individual suppliers to a single price for each item paid to all suppliers within each Medicare carrier's jurisdiction. Under the provisions of OBRA 1987, home oxygen equipment is generally reimbursed at a set single monthly payment amount, regardless of the type of oxygen equipment provided. OBRA 1987 also defined whether certain home medical equipment would be paid for on a rental or sale basis and established a 15 month rental payment ceiling on certain home medical equipment.\nThe 1990 Omnibus Budget Reconciliation Act (\"OBRA 1990\") provided that the fee schedules established under OBRA 1987 were to be adjusted annually at a rate equal to the change in the Consumer Price Index less 1 percent through December 31, 1992, and increased by the Consumer Price Index in 1993. OBRA 1990 also made new changes to Medicare Part B reimbursement which were implemented in 1991. These changes included a national standardization of Medicare rates for certain equipment categories, as well as reductions in amounts paid for home medical equipment rentals.\nOn August 10, 1993, Congress passed the Omnibus Reconciliation Act of 1993 (\"OBRA 93\") which required changes to be made effective January 1, 1994, in the Medicare reimbursement of certain items of home medical equipment. The Company estimates that these Medicare price changes resulted in a revenue reduction of approximately $4,100,000 for the year ended December 31, 1994. The OBRA 93 legislation provided for a consumer price index update, effective January 1, 1995, which the company estimates increased 1995 revenue by $3,100,000.\nCongress passed the Balanced Budget Act of 1995 (H.R. 2491) on November 30, 1995. The legislation included reductions in the rate of growth of Medicare and Medicaid spending, along with significant tax reductions. The proposal included a $2.5 billion reduction to the home oxygen benefit out of a total seven-year program budget of $10.2 billion. President Clinton vetoed the bill on December 6, 1995 and offered an alternative seven-year balanced budget proposal.\nContinuing efforts between Congress and the Administration to reach agreement on a budget have produced lower proposed reductions in Medicare and Medicaid spending. With respect to the home oxygen benefit, the Clinton Administration and various congressional health care leaders have announced support for program reductions of $1.4 billion over the seven-year period. At this time, it is uncertain whether any budget agreement will be reached in 1996.\nFederal and state budgetary and other cost-containment pressures will continue to impact the home respiratory care industry. The Company cannot predict what new federal and state budgetary proposals will be adopted and, if adopted, what effect, if any, such proposals would have on the Company's business.\nClaims under the federal Medicare program are processed by private insurance companies under contract arrangements with the Health Care Financing Administration (HCFA). In 1993, the federal Medicare program began implementing a plan to reduce the number of carriers administering Part B of the Medicare program from approximately sixty carriers to four regional carriers. This transition to regional carriers was completed in 1994.\nGOVERNMENT REGULATION\nThe federal government and all states in which the Company currently operates regulate various aspects of its business. In particular, the Company's operating centers are subject to federal laws covering the repackaging and dispensing of drugs (including oxygen) and regulating interstate motor-carrier transportation. The Company's locations also are subject to state laws governing, among other things, pharmacies, nursing services and certain types of home health agency activities. Certain of the Company's employees are subject to state laws and regulations governing the ethics and professional practice of respiratory therapy, pharmacy and nursing.\nAs a supplier of services under the Medicare and Medicaid programs, the Company is subject to the Medicare and Medicaid fraud and abuse laws. These laws, among other things, prohibit any payment, kickback or rebate in return for the referral of Medicare or Medicaid patients. Violations of these provisions may result in civil and criminal penalties and exclusion from participation in the Medicare and Medicaid programs.\nHealth care is an area of rapid regulatory change. Changes in the law or new interpretations of existing laws can have an effect on permissible activities, the relative costs associated with doing business, and the amount of reimbursement by government and third party payors. The Company cannot predict the future course of federal, state and local regulation or legislation, including Medicare and Medicaid statutes and regulations, and of possible changes in national health care policies, including those pertaining to managed care organization, which are currently the focus of national political discussion. Future legislative and regulatory changes could have an adverse impact on the Company.\nINSURANCE\nThe Company currently has in force general liability and product liability insurance, each with a coverage limit of $10.0 million. In addition, the Company has professional liability insurance with a coverage limit of\n$1.0 million per occurrence and $3.0 million in the aggregate. The Company's product liability insurance provides coverage on a claims-made basis, while its general and professional liability insurance are on an occurrence basis. All policies are subject to annual renewal and the Company anticipates adequate amounts of insurance coverage to be available at such renewal dates.\nEMPLOYEES\nAs of February 29, 1996, the Company had approximately 2,200 employees. None of the Company's employees are currently covered by collective bargaining agreements. The Company believes that the relations between the Company's management and its employees are good.\nENVIRONMENTAL MATTERS\nManagement believes that the Company is currently in compliance in all material aspects with applicable federal, state and local statutes and ordinances regulating the discharge of materials into the environment. Management does not believe it 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.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nAll but one of the Company's 216 operating center locations are under third party lease arrangements. Each operating center is a combination warehouse and office, with warehouse space generally comprising approximately 50% of the facility. Warehouse space is used for storage of adequate supplies of equipment necessary to conduct the Company's business. The Company also leases a headquarters facility and 10 of its 11 separate billing centers.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIn January 1994, the Company was advised by the United States Attorney for the Middle District of Florida that a grand jury has been investigating certain services provided by the Company to a pharmacy that supplied medications to home respiratory patients. Under its contracts with the pharmacy, the Company was responsible for providing various marketing, field administration and patient services to the pharmacy. The contracts were in effect from February 1989 to April 1992, and accounted for less than one percent of the Company's revenues during such period. The Company is cooperating with the investigation and believes that it will be able to demonstrate that its services for the pharmacy were provided in accordance with all applicable federal laws. However, no assurance can be given that the matter will be resolved promptly or that the United States Attorney will not seek penalties against the Company or its officers.\nThe Company is also involved in certain other claims and legal actions arising in the ordinary course of business. In the opinion of the Company, the ultimate disposition of all matters will not have a material adverse impact on the Company's financial position, results of operations or liquidity.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matters were submitted to a vote of the Company's stockholders during the fourth quarter of 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Company's Common Stock is traded on the NASDAQ National Market System under the symbol LNCR. The following table sets forth the high and low closing sale prices as reported by NASDAQ for the periods indicated.\nThere were approximately 284 holders of record of the common stock as of February 29, 1996.\nThe Company has not paid any cash dividends on its capital stock and does not anticipate paying cash dividends in the foreseeable future. It is the present intention of the Company's Board of Directors to retain all earnings in the Company in order to support the future growth of the Company's business.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe selected consolidated financial data presented below under the caption \"Statements of Operations Data\" for the years ended December 31, 1995, 1994, 1993, 1992, and 1991 are derived from the consolidated financial statements of the Company, which consolidated financial statements have been audited by KPMG Peat Marwick LLP, independent certified public accountants.\nThe data set forth below are qualified by reference to, and should be read in conjunction with, the consolidated financial statements and related notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations included in this report.\n- ---------------\n(1) Related to the abandoned merger between the Company and Coram Healthcare Corporation, the Company recorded a non-recurring expense of $1,921,000 ($1,172,000 or $0.04 per share after taxes). Such non-recurring expense is comprised of (a) $1,448,000 or professional fees, (b) $199,000 of printing and mailing expenses, (c) $153,000 filing fees, and (d) $121,000 of other direct costs. (2) Upon the prepayment of the Company's senior and subordinated debt with the proceeds of the Company's March 1992 initial public offering, the Company recorded an extraordinary loss, net of taxes, of $1,000,000, attributable to (i) a prepayment premium ($300,000), (ii) unamortized loan origination fees related to the senior debt ($990,000) and (iii) unamortized discount on the subordinated debt ($357,000).\n(3) For purposes of the pro forma income (loss) per common share calculations, the Company's March 1992 initial public offering and the application of the proceeds therefrom is assumed to have been completed on January 1, 1991.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nGENERAL\nThe Company continues to pursue its strategy of focusing on increasing market share within its existing geographical markets, through internal growth and through selective acquisitions of regional or local competitors. In addition, the Company will expand into new geographical markets on a selective basis, either through acquisitions or by opening new operating centers, when the Company believes it will enhance its business.\nThe Company's focus remains primarily on oxygen and other respiratory therapy services, and it intends to expand its home infusion therapy services in 1996.\nNET REVENUES\nThe following table sets forth for the periods indicated a summary of the Company's net revenues by source:\nNet revenues for the year ended December 31, 1995 increased by $73,658,000 (or 36.6%) over 1994. Net revenues for the year ended December 31, 1994 increased by $46,636,000 (or 30.2%) over 1993. The increases are attributable to the Company's sales and marketing efforts that emphasize quality and customer service, and the effect of the acquisitions completed by the Company. The Company estimates that approximately $40,627,000 of the increase in revenues for year ended December 31, 1995, and $29,948,000 of the increase in revenues for the year ended December 31, 1994, were attributable to the acquired businesses. Approximately $29,931,000 of the net revenue increase for the year ended December 31, 1995 and $20,788,000 for the year ended December 31, 1994, was attributable to volume growth in the Company's business.\nOn August 10, 1993, Congress passed the Omnibus Reconciliation Act of 1993 (\"OBRA 93\") which required changes to be made effective January 1, 1994, in the Medicare reimbursement of certain items of home medical equipment. The Company estimates that these Medicare price changes resulted in a revenue reduction of approximately $4,100,000 for the year ended December 31, 1994. The OBRA 93 legislation provided for a consumer price index update, effective January 1, 1995, which the company estimates increased 1995 revenue by $3,100,000.\nCongress passed the Balanced Budget Act of 1995 (H.R. 2491) on November 30, 1995. The legislation included reductions in the rate of growth of Medicare and Medicaid spending, along with significant tax reductions. The proposal included a $2.5 billion reduction to the home oxygen benefit out of a total seven-year program budget of $10.2 billion. President Clinton vetoed the bill on December 6, 1995 and offered an alternative seven-year balanced budget proposal.\nContinuing efforts between Congress and the Administration to reach agreement on a budget have produced lower proposed reductions in Medicare and Medicaid spending. With respect to the home oxygen benefit, the Clinton Administration and various congressional health care leaders have announced support for program reductions of $1.4 billion over the seven-year period. At this time, it is uncertain whether any budget agreement will be reached in 1996.\nCOST OF GOODS AND SERVICES\nCost of goods and services as a percentage of net revenues was 15.0% for the year ended December 31, 1995 and was 14.4% and 13.7% for the years ended December 31, 1994 and 1993, respectively. The increase in 1995 is attributable to a change in the product mix related to acquisitions having higher levels of home medical equipment and certain respiratory therapy products.\nOPERATING AND OTHER EXPENSES\nOperating expenses for the year ended December 31, 1995 decreased to 21.9% of net revenues, compared to 22.0% and 22.3% for the years ended December 31, 1994 and 1993, respectively.\nSelling, general and administrative expenses expressed as a percentage of net revenues decreased to 20.8% for the year ended December 31, 1995 compared with 21.5% and 22.4% for the years ended December 31, 1994 and 1993, respectively. This improvement is primarily due to the Company's ability to maintain a cost structure that, with increases in net revenues, has permitted the Company to spread its overhead over a larger base of revenues, resulting in improvement in operating income.\nBad debt expense as a percentage of net revenues was 0.8% for the years ended December 31, 1995 and 1994, and 1.2% for the year ended December 31, 1993.\nThe Company's increased depreciation expense reflects increased capital expenditures primarily for additional oxygen equipment to service the Company's growing customer base. Depreciation expense as a percentage of net revenues decreased to 6.0% for the year ended December 31, 1995 compared with 6.7% and 7.6% for the years ended December 31, 1994 and 1993, respectively.\nAMORTIZATION EXPENSE\nThe Company's net intangible assets were $146,371,000 as of December 31, 1995. Of this total, $9,510,000 (consisting of the value assigned to customer lists) is being amortized over a period of 10 to 36 months, $6,370,000 (consisting of various covenants not to compete) over a period of three to seven years, and $130,491,000 (consisting of goodwill) over a period of 40 years.\nDuring 1995, the Company amortized $11,099,000 of its intangible assets (4.0% of net revenues) compared to $7,281,000 (3.6% of net revenues) in 1994 and $4,695,000 (3.0% of net revenues) in 1993.\nOPERATING INCOME\nAs shown in the table below, operating income before non-recurring expense for the year ended December 31, 1995 increased by $23,866,000 over 1994: The Company recognized a non-recurring charge of $1,921,000 related to the Company's abandoned merger with Coram Healthcare Corporation. Operating income for the year ended December 31, 1994 increased by $16,169,000 over 1993. The percentage increases\nin operating income are attributable to the Company's continued revenue growth, while maintaining effective cost controls over expenses.\nINTEREST EXPENSE\nInterest expense for the year ended December 31, 1995 was $892,000, compared to $473,000 and $387,000 for the years ended December 31, 1994 and 1993, respectively. The increase in 1995 is attributable to the Company's use of its revolving line of credit during the year.\nINCOME TAXES\nThe Company's effective income tax rate was 39.0% for the year ended December 31, 1995, 39.1% for 1994 and 39.3% for 1993.\nACQUISITIONS\nFor a description of business combinations entered into by the Company during 1995 and 1994, see \"Business -- Recent Acquisitions\" and Note 13 to the Consolidated Financial Statements.\nThe intangible assets acquired in the Buyout resulted in amortization expense of $443,000, $443,000 and $1,090,000 in 1995, 1994 and 1993, respectively. Depreciation expense associated with the computer software acquired in the Buyout was $1,344,000 in 1993. The computer software was fully amortized in 1993.\nLIQUIDITY AND CAPITAL RESOURCES\nAt December 31, 1995, the Company's working capital was $16,510,000, as compared to $18,517,000 at December 31, 1994, and $35,642,000 at December 31, 1993.\nNet cash provided by operating activities was $79,523,000 for the year ended December 31, 1995, compared with $66,018,000 for the year ended December 31, 1994, and $51,392,000 for the year ended December 31, 1993. A significant portion of the Company's assets consists of accounts receivables from third party payors that provide reimbursement for the services provided by the Company. Because of the Company's ability to collect its accounts receivable on a timely basis, the Company has not been required to obtain interim financing of its accounts receivable to satisfy operating needs.\nNet cash used in investing and financing activities amounted to $94,537,000, $79,733,000 and $41,530,000 for the years ended December 31, 1995, 1994 and 1993, respectively. Activity in the year ended December 31, 1995 included the Company's investment of $58,590,000 in business acquisitions, investment in capital equipment of $30,148,000, the borrowing of $44,000,000 from its revolving line of credit, payments of $41,000,000 on the revolving line of credit and payments of $13,247,000 related long-term obligations.\nAs of December 31, 1995, the Company's principal sources of liquidity consisted of $16,510,000 of working capital and $45,000,000 available under its revolving line of credit. On February 10, 1995, the Company increased the amount it may borrow under the revolving line of credit from $25,000,000 to $50,000,000. The Company believes that internally generated funds, together with funds that may be borrowed under such credit facility, will be sufficient to meet the Company's anticipated capital requirements over the foreseeable future.\nThe Company anticipates that capital expenditures for 1996 will be approximately $35,000,000 and that over the next several years its capital expenditure requirements will grow no faster than the growth in the Company's revenue. The Company believes that it will be able to generate sufficient funds internally to meet its short-term and long-term capital expenditure requirements.\nThe Company's future liquidity will continue to be dependent upon its operating cash flow and management of accounts receivable. Additionally, the Company is not aware of any impact on liquidity due to pending litigation arising in the ordinary course of business.\nINFLATION\nThe Company has not experienced large increases in either the cost of supplies or operating expenses due to inflation. Because of restrictions on reimbursement by government and private medical insurance programs and the pressures to contain the growth in the costs of such programs, the Company bears the risk that reimbursement rates set by such programs will not keep pace with inflation.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe financial statements required by this item are listed in Item 14(1)(a) and are submitted at the end of this Annual Report on Form 10-K. The supplementary data required by this Item is included on page S-1. The financial statements and supplementary data are herein incorporated 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 response to this item is included in the definitive proxy statement, under \"Information Regarding the Board of Directors\" for the Annual Meeting of Stockholders to be held May 13, 1996, and is herein incorporated by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe response to this item is included in the definitive proxy statement, under \"Executive Compensation\" for the Annual Meeting of Stockholders to be held May 13, 1996, and is herein incorporated by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe response to this item is included in the definitive proxy statement under \"Security Ownership of Principal Stockholders and Management\" for the Annual Meeting of Stockholders to be held May 13, 1996, and is herein incorporated 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) The following consolidated financial statements of Lincare Holdings Inc. and subsidiaries are filed as part of this Form 10-K starting at page:\nIndependent Auditors' Report\nConsolidated Balance Sheets -- December 31, 1995 and 1994\nConsolidated Statements of Operations -- Years ended December 31, 1995, 1994 and 1993.\nConsolidated Statements of Stockholders' Equity -- Years ended December 31, 1995, 1994 and 1993\nConsolidated Statements of Cash Flows -- Years ended December 31, 1995, 1994 and 1993\nNotes to Consolidated Financial Statements\n(2) The following consolidated financial statement schedule of Lincare Holdings Inc. and subsidiaries is included in this Form 10-K at page S-1:\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(3) Exhibits included or incorporated herein:\nSee Exhibit Index.\n(b) The Company did not file a Current Report on Form 8-K during the three months ended December 31, 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.\nLINCARE HOLDINGS INC.\n\/s\/ JAMES M. EMANUEL -------------------------------------- James M. Emanuel Secretary, Chief Financial 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.\nINDEX OF EXHIBITS\n- --------------- + Incorporated by reference to the corresponding exhibit to the Registrant's Registration Statement on Form S-1 (No. 33-44672)\n++ Incorporated by reference to Exhibit A to the Registrant's Form 8-K dated October 14, 1992.\n+++ Incorporated by reference to the corresponding exhibit to the Registrant's Registration Statement on Form S-1 (No. 33-55260).\n++++ Incorporated by reference to the Registrant's Form 8-K dated April 28, 1993.\n+++++ Incorporated by reference to the Registrant's Form 10-K dated March 22, 1994.\n* Incorporated by reference to the Registrant's Form 10-K dated March 22, 1995.\n** Incorporated by reference to the Registrant's Form 8-K dated May 24, 1995.\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Stockholders Lincare Holdings Inc.:\nWe have audited the accompanying consolidated balance sheets of Lincare Holdings Inc. and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1995. 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 Lincare Holdings Inc. and subsidiaries as of December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1995, in conformity with generally accepted accounting principles.\nKPMG PEAT MARWICK LLP\nSt. Petersburg, Florida January 19, 1996\nLINCARE HOLDINGS INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS DECEMBER 31, 1995 AND 1994\nSee accompanying notes to consolidated financial statements.\nLINCARE HOLDINGS INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF OPERATIONS YEARS ENDED DECEMBER 31, 1995, 1994, AND 1993\nSee accompanying notes to consolidated financial statements.\nLINCARE HOLDINGS INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1995, 1994, AND 1993\nSee accompanying notes to consolidated financial statements.\nLINCARE HOLDINGS INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1995, 1994, AND 1993\nSee accompanying notes to consolidated financial statements.\nLINCARE HOLDINGS INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1995, 1994, AND 1993\n(1) DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\n(a) Description of Business\nLincare Holdings Inc. and subsidiaries (the \"Company\") provides oxygen and respiratory therapy services to the home health care market and also supplies home medical equipment, such as hospital beds, wheelchairs and other medical supplies. The Company's customers are located in 36 states. The Company's supplies are readily available and the Company is not dependent on a single supplier or even a few suppliers.\n(b) Use of Estimates\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. Significant estimates included in these financial statements are related to the allowance for uncollectible accounts. Actual results could differ from those estimates.\n(c) Principles of Consolidation\nThe consolidated financial statements include the accounts of Lincare Holdings Inc. and its subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.\n(d) Financial Instruments\nThe Company believes the book value of their cash equivalents, accounts and notes receivable, income taxes receivable, accounts payable, accrued expenses and income taxes payable approximates their fair value due to their short-term nature. The book value of the Company's revolving credit loan and long-term obligations approximates their fair value as the current interest rates approximate rates at which similar types of borrowing arrangements could be currently obtained by the Company.\n(e) Inventories\nInventories, consisting of equipment, supplies and replacement parts, are stated at the lower of cost or market. Cost is determined using the first-in, first-out (FIFO) method.\n(f) Property and Equipment\nProperty and equipment is stated at cost. Depreciation on property and equipment is calculated on the straight-line method over the estimated useful lives of the assets as set forth in the table below.\nLeasehold improvements are amortized on the straight-line method over the lesser of the lease term or estimated useful life of the asset. Amortization is included with depreciation expense.\n(g) Other Assets\nGoodwill results from the excess of cost over net assets of acquired businesses and is amortized on a straight-line basis over 40 years.\nLINCARE HOLDINGS INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nIntangible assets, consisting of customer base and assembled workforce, are amortized on a straight-line basis over the estimated life of the asset, ten to thirty-six months.\nCovenants not to compete are amortized on a straight-line basis over the life of the respective covenants, three to seven years.\nThe Company annually evaluates goodwill and other intangible assets by utilizing an operating income realization test for the applicable businesses acquired. In addition, the Company considers the effects of external changes to the Company's business environment, including competitive pressures, market changes and technological and regulatory changes.\n(h) Income Taxes\nDeferred 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 be recovered or settled. The effect on deferred taxes of a change in tax rate is recognized in income in the period that includes the enactment date.\n(i) Pension Plan\nThe Company has a defined contribution pension plan covering substantially all employees. The Company makes monthly contributions to the plan equal to the amount accrued for pension expense. Employer contributions (net of applied forfeitures) were approximately $1,271,000 in 1995, $1,015,000 in 1994 and $750,000 in 1993.\n(j) Statement of Cash Flows\nFor purposes of the statements of cash flows, the Company considers all short-term investments with a purchased maturity of three months or less to be cash equivalents.\n(k) New Accounting Standards\nThe Company will be required to adopt Statement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation\" in 1996. Statement 123 allows the Company to select either a fair value based method or it's current intrinsic value based method of accounting for employee stock-based compensation. Companies that select the intrinsic value based method will be required to provide pro forma disclosures of net income and earnings per share as if the fair value method was selected. The Company plans to retain it's intrinsic value method of accounting and, therefore, adoption of this standard is not expected to have a material effect on the Company's financial statements.\nLINCARE HOLDINGS INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(2) ACCOUNTS AND NOTES RECEIVABLE\nAccounts and notes receivable at December 31, 1995 and 1994 consist of:\n(3) PROPERTY AND EQUIPMENT\nProperty and equipment at December 31, 1995 and 1994 consists of:\nRental equipment of approximately $94,785,000 in 1995 and $71,324,000 in 1994 is included with equipment and furniture.\n(4) LEASES\nThe Company has several noncancelable operating leases, primarily for buildings, computer equipment and vehicles, that expire over the next five years and provide for purchase or renewal options. Operating lease expense was approximately $9,781,000 in 1995, $6,971,000 in 1994, and $5,469,000 in 1993.\nFuture minimum lease payments under noncancelable operating leases, net of sublease income, as of December 31, 1995 are as follows:\n(5) REVOLVING CREDIT LOAN\nUnder the revolving line of credit, the Company may borrow amounts up to $50,000,000. The maturity date is sixty months from the date of the note. The revolving line of credit bears interest at LIBOR plus 58 basis points (6.55% at December 31, 1995). The line of credit is comprised of three distinct termed loan periods. Each termed loan period commences on the date that is exactly 24, 36 and 48 months from the date of the loan (February 10, 1995). The principal amount outstanding on the first day at each of the three termed loan periods is repaid separately, based on a 60-month amortization plus interest monthly. The unpaid\nLINCARE HOLDINGS INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nprincipal on the maturity date (February 10, 2000) will be paid in one final installment. Interest accrued on the outstanding principal balance that is not termed for repayment is payable monthly. The Loan Agreement contains several financial and other covenants and is secured by, effectively, all of the assets of the Company. At December 31, 1995, $5,000,000 was outstanding under the revolving line of credit. At December 31, 1994, $2,000,000 was outstanding under the revolving line of credit.\nAmortization of loan origination fees amounted to approximately $5,000 in 1995, $4,000 in 1994 and $1,000 in 1993.\n(6) LONG-TERM OBLIGATIONS\nLong-term obligations generally consist of unsecured, non-interest bearing deferred acquisition obligations payable in varying installments through 1998. Unamortized imputed interest at 5.75% to 8.25% was $45,000 in 1995, $47,000 in 1994 and $62,000 in 1993.\nThe aggregate maturities of long-term obligations for each of the five years subsequent to December 31, 1995 are as follows:\n(7) INCOME TAXES\nThe tax effects of temporary differences that account for significant portions of the deferred tax assets and deferred tax liabilities at December 31, 1995 and 1994 are presented below:\nThere was no valuation allowance for deferred tax assets as of January 1, 1995 or December 31, 1995. The Company expects the results of future operations will generate sufficient taxable income to allow for the utilization of deferred tax assets.\nLINCARE HOLDINGS INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nIncome tax expense attributable to operations consists of:\nTotal income tax expense differs from the amounts computed by applying U.S. federal income tax rates (35% in 1995, 1994 and 1993) to income before income taxes as a result of the following:\n(8) STOCKHOLDERS' EQUITY\nThe Company has 4,879,238 authorized and unissued shares of preferred stock. The Board of Directors has the authority to issue up to such number of shares of preferred stock in one or more series and to fix the rights, preferences, privileges, qualifications, limitations and restrictions thereof without any further vote or action by the stockholders.\n(9) STOCK OPTIONS\nThe Company has reserved a total of 2,973,768 shares of common stock for issuance under its Non-Qualified Stock Option Plan (the Plan). Of the options outstanding under the Plan at December 31, 1995, 264,579 are exercisable as of January 1, 1996. At December 31, 1995, there were 76,979 shares available for issue under the Plan.\nThe Company has reserved a total of 1,600,000 shares of common stock for issuance under its 1991 Stock Plan (the 1991 Plan). Options granted vest between December 31, 1992 and December 1, 1998. Of the options outstanding under the 1991 Plan, 74,400 are exercisable as of December 31, 1995 and 334,000 are exercisable between December 1, 1996 and 1998. At December 31, 1995 there were 42,400 shares available for issuance under the 1991 Plan.\nLINCARE HOLDINGS INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nThe Company has reserved a total of 500,000 shares of common stock for issuance under its 1994 Stock Plan (the 1994 Plan). Options granted vest between December 1, 1997 and December 1, 1998. At December 31, 1995, there were 30,000 shares available for issue under the 1994 Plan.\nInformation related to the Plan is as follows:\nIn connection with the exercise of certain stock options in 1995, 1994 and 1993, the Company receives a tax deduction for the difference between the fair value of the common stock at the date of exercise and the exercise price. The related income tax benefit of approximately $5,450,000 in 1995, $6,616,000 in 1994 and $5,934,000 in 1993 has been recorded as a reduction of income taxes payable and an addition to additional paid-in capital.\n(10) NET REVENUES\nIncluded in the Company's net revenues is reimbursement from the federal government under the Medicare and under Medicaid programs which aggregated approximately 60% in 1995, 58% in 1994 and 57% in 1993.\n(11) NON-RECURRING EXPENSE\nRelated to the abandoned merger between the Company and Coram Healthcare Corporation, the Company recorded a nonrecurring expense of $1,921,000. Such non-recurring expense is comprised of (a) $1,448,000 of professional fees, (b) $199,000 of printing and mailing expenses, (c) $153,000 of filing fees, and (d) $121,000 of other direct costs.\n(12) SUPPLEMENTAL STATEMENTS OF CASH FLOWS INFORMATION\n(13) BUSINESS COMBINATIONS\nDuring 1995, the Company acquired the outstanding stock or certain assets of 22 businesses in 22 separate transactions. During 1994, the Company acquired the outstanding stock or certain assets of 26 businesses in 20 separate transactions. Consideration for the acquisitions generally included cash, unsecured non-interest bearing obligations and the assumption of certain liabilities.\nLINCARE HOLDINGS INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNone of the businesses acquired were related to the Company prior to acquisition. Each acquisition during 1995 and 1994 was accounted for as a purchase. The results of operations of the acquired companies are included in the accompanying consolidated statement of operations since the respective date of acquisition. Each of the acquired companies conducted operations similar to that of the Company.\nThe aggregate cost of the above acquisitions was as follows:\nThe aggregate purchase price was allocated as follows:\nThe following unaudited pro forma supplemental information on the results of operations for the years ended December 31, 1995 and 1994 include the acquisitions as if they had been combined at the beginning of the respective years.\nThe unaudited pro forma financial information is not necessarily indicative of either the results of operations that would have occurred had the transactions been effected at the beginning of the respective preceding years or of future results of operations of the combined companies.\n(14) CONTINGENCIES\nIn January 1994, the Company was advised by the United States Attorney for the Middle District of Florida that a grand jury has been investigating certain services provided by the Company to a pharmacy that supplied medications to home respiratory patients. Under its contracts with the pharmacy, the Company was responsible for providing various marketing, field administration and patient services to the pharmacy. The contracts were in effect from February 1989 to April 1992, and accounted for less than one percent of the Company's revenues during such period. The Company is also involved in certain other claims and legal actions arising in the ordinary cause of business. In the opinion of management, the ultimate disposition of all matters will not have a material adverse impact on the Company's financial position, results of operations or liquidity.\nLINCARE HOLDINGS INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(15) QUARTERLY FINANCIAL DATA (UNAUDITED)\nThe following is a summary of quarterly financial results for the years ended December 31, 1995 and 1994:\n- ---------------\n(1) The 1995 third quarter operating income included a nonrecurring expense of $1,921,000 ($1,172,000 or $.04 per share after taxes) (see note 11). (2) Based on the weighted average number of common shares and common share equivalents outstanding for each quarter. The total of the four quarters do not equal the annual amount as a result of the treasury stock method of calculating weighted average number of common shares and common share equivalents outstanding.\nSCHEDULE VIII\nLINCARE HOLDINGS INC. AND SUBSIDIARIES\nVALUATION AND QUALIFYING ACCOUNTS\n- ---------------\n(1) To record allowance on business combinations (2) To record write-offs\nS-1","section_15":""}
{"filename":"100726_1995.txt","cik":"100726","year":"1995","section_1":"Item 1. Business:\nUnifi, Inc., a New York corporation formed in 1969, together with its subsidiaries, hereinafter set forth, (the \"Company\" or \"Unifi\"), is engaged predominantly in the business of processing yarns by: texturing of synthetic filament polyester and nylon fiber; and spinning of cotton and cotton blend fibers.\nThe Company's texturing operation mainly involves purchasing partially oriented yarn (POY), which is either raw polyester or nylon filament fiber, from chemical manufacturers and using high speed machines to draw, heat and twist the POY to produce yarns having various physical characteristics, depending upon its ultimate end-use. The Company's spinning operation mainly involves the spinning on either open-end or ring spindles of cotton, cotton and undyed synthetic blends, and cotton and pre-dyed polyester blends into yarns of different strengths and thickness.\nThe Company currently sells textured polyester yarns, nylon yarns, dyed yarns, covered yarns, spun yarns made of cotton, cotton and un-dyed synthetic blends, and cotton and pre-dyed polyester blends domestically and internationally to weavers and knitters who produce fabrics for the apparel, industrial, hosiery, home furnishing, auto upholstery, activewear, and underwear markets.\nThe Company, internationally, has manufacturing facilities in Letterkenny, County Donegal, Republic of Ireland, which texturizes polyester, as well as producing its own polymer (POY).\nSOURCES AND AVAILABILITY OF RAW MATERIALS:\nA. POY. The primary suppliers of POY to the Company are E. I. DuPont de Nemours and Company, Hoechst Celanese Corporation, and Wellman Industries, with the majority of the Company's POY being supplied by DuPont. Although the Company is heavily dependent upon a limited number of suppliers, the Company has not had and does not anticipate any material difficulty in obtaining its raw POY.\nB. Cotton. The Company buys its cotton, which is a commodity and is traded on established markets, from brokers such as Dunavant Enterprises, HoHenBerg Brothers Co., Staple Cotton, and Stahel (America). The Company has not had and does not anticipate any material difficulty in obtaining cotton.\nPATENTS AND LICENSES: The Company currently has several patents and registered trademarks, including the following:\nI-1\nDATE ISSUED OR PATENT TITLE\/DESCRIPTION PAT\/APP. NO. APPLIED FOR\nDye Tube Spacer For Package 8\/284,305 08\/02\/94 Dyeing\nMethod For Treatment of Yarn 5,387,263 12\/16\/93 in Package Form\nYarn Package Cover 080,654 06\/18\/93\nWallpaper Backing 1,317,705 (Canada) 05\/18\/93\nNylon\/Lycra Composit Yarn 5,237,808 08\/24\/93\nPolyester Substrate (Vinyl) 5,063,108 11\/05\/91\nPolyester Substrate (Vinyl) 5,043,208 08\/27\/91\nContinuous Multi-Filament 4,935,293 06\/19\/90 Polyester Substrate\nWallpaper Backing 4,925,726 05\/15\/90\nWallpaper Backing 4,874,019 10\/17\/89\nWallpaper Backing 325,028 07\/26\/89 (United Kingdom)\nFriction Discs For False- 4,129,980 12\/19\/78 Twist Head\nApparatus for Restarting 4,125,229 11\/14\/78 a Broken Thread or Yarn Strand During a Winding Process\nSafety Guard for the Blade 4,086,698 05\/02\/78 of Carton Openers\nREGISTRATION\/ DATE REGISTRATION TRADEMARK NAME SERIAL NO. FILED\nSheertech 74\/637666 02\/22\/95\nUnifi 299,227 07\/28\/92 Quality Through Pride (Stylized)\nUnifi 261,913 04\/02\/92\nUnifi (Stylized) 261,912 04\/02\/92\nI-2\nTrifi 1,703,349 07\/28\/92\nMactex 1,511,013 11\/01\/88\nBi-Dye 1,105,160 06\/19\/84\nThe Company does not have any patents, trademarks, licenses, or franchises which are material to its business as a whole.\nCUSTOMERS: The Company in fiscal year ended June 25, 1995, sold textured and spun yarns to approximately 1,000 customers, one customer's purchases were approximately 11% of the net sales during said period, the ten largest customers accounted for approximately 32% of the total sales and the Company does not believe that it is dependent on any one customer.\nBACKLOG: The Company, other than in connection with certain foreign sales and for textured yarns that are package dyed according to customers' specifications, does not manufacture to order. The Company's products can be used in many ways and can be thought of in terms of a commodity subject to the laws of supply and demand and, therefore, does not have what is considered a backlog of orders. In addition, the Company does not consider its products to be seasonal ones.\nCOMPETITIVE CONDITIONS: The textile industry in which the Company currently operates is keenly competitive. The Company processes and sells high-volume commodity products, pricing is highly competitive with product quality and customer service being essential for differentiating the competitors within the industry. Product quality insures manufacturing efficiencies for the customer. The Company's polyester and nylon yarns, dyed yarns, covered yarns and cotton and cotton blend yarns compete with a number of other domestic producers of such yarns. In the sale of polyester filament yarns major competitors are Atlas Yarn Company, Inc., Burlington Industries, Inc. and Milliken & Company, in the sale of nylon yarns, dyed yarns, and covered yarns major competitors are Glen Raven Mills, Inc., Jefferson Mills, Inc., Spanco Yarns, Inc., Regal Manufacturing Company and Spectrum Dyed Yarns, Inc., and in the sale of cotton and cotton blend yarns major competitors are Parkdale Mills, Inc., Avondale Mills, Inc., Harriett & Henderson, Mayo Yarns, Inc. and TNS Mills, Inc.\nRESEARCH AND DEVELOPMENT: The estimated amount spent during each of the last three fiscal years on Company-sponsored and Customer-sponsored research and development activities is considered immaterial.\nCOMPLIANCE WITH CERTAIN GOVERNMENT REGULATIONS: Management of the Company believes that the operation of the Company's production facilities and the disposal of waste materials are substantially in compliance with applicable laws and regulations. I-3\nEMPLOYEES: The number of employees of the Company is approximately 6,000 full-time employees.\nFINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC INTERNATIONAL OPERATIONS AND EXPORT SALES: The information included under the heading \"Business Segments and Foreign Operations\" on page 23 of the Annual Report of the Company to the Shareholders for the fiscal year ended June 25, 1995, is incorporated herein by reference.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. DESCRIPTION OF PROPERTY:\nThe following table sets forth the location and general character of the principal plants and other physical properties (properties) of the Company, which contain approximately 6,805,627 sq. ft. of floor space. All properties are well maintained and in good operating condition.\nApproximate Location Of Area Facility (Square Feet) How Held Type of Operation\nYadkinville, NC 1,831,000 Owned Texturizing of POY, ware- housing and office space\nGreensboro, NC 65,000 Leased (1) Executive offices\nStaunton, VA 424,000 Owned Texturizing of POY, ware- housing and office space\nLetterkenny, 488,000 Owned Production of filament County Donegal, polyester fiber, texturiz- Ireland ing facility, warehousing and office space\nArchdale, NC 122,000 Owned (2) Production of covered Plant No. 7 yarns and associated warehousing\n301 N. Hwy St. 126,673 Owned (2) Production of covered Madison, NC yarns and associated Plant No. 14 warehousing\nPiedmont Street 504,000 Owned (2) Texturizing of nylon Madison, NC and polyester, and associ- Plant No. 6 ated warehousing\n200 S Ayersville Rd. 79,000 Owned (2) Transportational Madison, NC Terminal\nMadison, NC 31,000 Owned Nylon Warehouse Decatur Warehouse I-4\nAyersville Road 314,000 Owned (2) Plant 1 - Texturizing Mayodan, NC of nylon, associated ware- Plant 1 housing and office space\nAyersville Road 213,000 Owned (2) Plant 5 - Production Mayodan, NC of covered yarns and asso- Plant 5 ciated warehousing\nCardwell Road 130,000 Owned (2) Dyeing facility Mayodan, NC Plant No. 15\nMayodan, NC 150,000 Owned Central Distribution CDC Center\nVance Street Ext. 485,000 Owned (2) Plants 2 & 4 - Textur- Reidsville, NC izing of polyester, dyeing Plants 2 & 4 and associated warehousing\nSR 770 East 230,000 Owned (2) Texturizing of nylon, Stoneville, NC production of covered Plant No. 8 yarn and associated warehousing\nFort Payne, AL 20,000 Owned (2) Distribution Center Distribution Center and Office Space\nState Road 1366 151,000 Owned (3) Spun Cotton Yarn Pro- Booneville, NC duction and office space Plant No. 1\nOakland Avenue 211,000 Owned (3) Spun Cotton Yarn Pro- Eden, NC duction and office space Plant No. 2\nOakland Avenue 195,000 Owned (3) Spun Cotton Yarn Pro- Eden, NC duction and office space Plant No. 3\nU.S. Route 311 214,000 Owned (3) Spun Cotton Yarn Pro- Walnut Cove, NC duction and office space Plant No. 4\n400 West Franklin St. 172,000 Owned (3) Spun Cotton Yarn Pro- Mt. Pleasant, NC duction and office space Plant No. 6\n420 Elliot 114,600 Owned (4) Spun Cotton Yarn Pro- Edenton, NC duction and office space Edenton Plant\nI-5\n2000 Boone Trail Road 137,850 Owned (4) Spun Cotton Yarn Pro- Sanford, NC duction and office space Pioneer Spinning Plant\n2000 Boone Trail Road 77,520 Owned (4) Spun Cotton Yarn Pro- Sanford, NC duction and office space Pioneer Yarn Plant\n1901 Boone Trail Road 245,200 Owned (4) Spun Cotton Yarn Pro- Sanford, NC duction and office space Pioneer Cotton Plant\n9480 Neuville Avenue 11,200 Owned Nylon Covered Yarn and Hickory, NC Cotton Warehouse\n600 River Road 63,584 Owned Spun Cotton Yarn Pro- Rockingham, NC duction and office space\nThe Company leases sales offices and apartments in New York City and Coleshill, England, and has a representative office in Tokyo, Japan.\n(1) This property consists of a building containing approximately 65,000 square feet which is being used by the Company as its executive offices and is located on a tract of land containing approximately 8.99 acres and is known as 7201 West Friendly Avenue, Greensboro, North Carolina. This property is leased by Unifi, Inc. from NationsBank, Trustee under the Unifi, Inc. Profit Sharing Plan and Trust, and Wachovia Bank & Trust Company, N.A., Independent Trustee. In September, 1991, the Company exercised its option to extend the term of the lease on this property for five (5) years, through March 13, 1997. Reference is made to a copy of the lease agreement attached to the Registrant's Annual Report on Form 10-K as Exhibit (10d) for the year ended June 28, 1987 and which is by reference incorporated herein.\n(2) Acquired pursuant to the merger of Macfield into Unifi on August 8, 1991.\n(3) Acquired pursuant to the Reverse Triangular Merger with Unifi Spun Yarns, Inc. (formerly Vintage Yarns, Inc.) (\"USY\") on April 23, 1993.\n(4) Acquired pursuant to the Triangular Merger of the Pioneer Corporations into USY on August 18, 1993.\nThe information included under \"Leases, Commitments and Concentrations of Credit Risks\" on page 23 of the Annual Report to Shareholders for fiscal year ended June 25, 1995, is incorporated herein by reference.\nI-6\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS:\nThe Company is not currently involved in any litigation which is considered material, as that term is used in Item 103 of the Regulations S-K.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS:\nNo matters were submitted to a vote of security holders during the fourth quarter for the fiscal year ended June 25, 1995.\nI-7\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\n(a)(c) PRICE RANGE OF COMMON STOCK AND DIVIDENDS PAID.\nThe information included under the heading \"Market and Dividend Information (Unaudited)\" on page 27 of the Annual Report of Unifi, Inc. to its shareholders for the year ended June 25, 1995, is incorporated herein by reference.\n(b) Approximate Number of Equity Security Holders:\nTITLE OF CLASS NUMBER OF RECORD HOLDERS (AS OF AUGUST 4, 1995)\nCommon Stock, $.10 par value 1,364\n(c) CASH DIVIDEND POLICY. In April 1990, the Board of Directors of the Company adopted a resolution that it intended to pay a cash dividend in quarterly installments equal to approximately thirty percent (30%) of the earnings after taxes of the Company for the previous year, payable as hereafter declared by the Board of Directors. Prior to this action by the Board of Directors, the Company had since 1978 followed a policy of retaining earnings for working capital, acquisitions, capital expansion and modernization of existing facilities. The Company paid a quarterly dividend of $.10 per share on its common stock for each quarter of the 1995 fiscal year. The Board of Directors in July 1995, declared a cash dividend in the amount of $.13 per share on each issued and outstanding share of the common stock of the Company, payable on August 11, 1995, to shareholders of record at the close of business on August 4, 1995.\n(d) 6% CONVERTIBLE SUBORDINATED NOTES DUE MARCH 15, 2002. The information contained under the heading \"Long-Term Debt\", regarding the Convertible Subordinated Notes, on page 21 of the Annual Report of Unifi, Inc. to its shareholders for the year ended June 25, 1995, is incorporated herein by reference. For additional information regarding the 6% Convertible Subordinated Notes Due 2002 reference is made to Exhibit (4b) of this Form 10-K.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA:\nThe financial data for the five fiscal years included under the heading \"Summary of Selected Financial Data\" on page 26 of the Annual Report of Unifi, Inc. to its shareholders for the year ended June 25, 1995, is incorporated herein by reference.\nII-1\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS:\nThe information included under the heading \"Management's Review and Analysis of Operations and Financial Position\" on pages 24 and 25 of the Annual Report of Unifi, Inc. to its shareholders for the year ended June 25, 1995, is incorporated herein by reference.\nSUBSEQUENT EVENTS:\nOn September 18, 1995, the Company announced restructuring plans to further reduce the Company's cost structure and improve productivity through the consolidation of certain manufacturing operations and the disposition of underutilized assets. The restructuring plan is focused on the consolidation of production facilities acquired via mergers during the preceding four years and reflects the Company's continued efforts to streamline operations. As part of the restructuring action, the Company will close its spun cotton manufacturing facilities in Edenton and Mount Pleasant, North Carolina with the majority of the manufacturing production being transferred to other facilities. Approximately 275 jobs, primarily wage-level positions, will be affected.\nThe estimated cost of restructuring will result in a first quarter fiscal 1996 non-recurring charge to earnings of $23.8 million or an after-tax charge to earnings of $14.9 million ($.22 per share). The significant components of the non-recurring charge include $2.4 million of severance and other employee-related costs from the termination of employees and a $21.4 million write-down to estimated fair value less the cost of disposal of underutilized assets and consolidated facilities to be disposed. Costs associated with the relocation of equipment or personnel will be expensed as incurred.\nThe Company anticipates that all signficant aspects of the consolidation of spun yarn facilities would be accomplished within a one year period. However, the ultimate disposal of the equipment and facilities may take longer due to current market conditions and the physical locations of the properties.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA:\nThe consolidated financial statements and notes beginning on page 15 and ending on page 23 and the information included under the heading \"Quarterly Results (Unaudited)\" on page 26 of the Annual Report of Unifi, Inc. to its shareholders for the year ended June 25, 1995, are incorporated herein by reference.\nII-2\nITEM 9.","section_9":"ITEM 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE:\nThe Company has not changed accountants nor are there any disagreements with its accountants, Ernst & Young LLP, on accounting and financial disclosure that should be reported pursuant to Item 304 of the Regulation S-K.\nII-3\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT AND COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT:\n(a) DIRECTORS OF REGISTRANT: The information included under the headings \"Election of Directors\", \"Vote Required\", \"Security Holding of Directors, Nominees, And Executive Officers\", \"Directors Compensation\", and \"Committees of The Board of Directors\", beginning on page 2 and ending on page 6 of the definitive Proxy Statement filed with the Commission since the close of the Registrant's fiscal year ended June 25, 1995, and within 120 days after the close of said fiscal year, are incorporated herein by reference.\n(b) IDENTIFICATION OF EXECUTIVE OFFICERS:\nCHAIRMAN OF THE BOARD OF DIRECTORS\nG. ALLEN MEBANE Mr. Mebane is 66 and has been an Executive Officer and member of the Board of Directors of the Company since 1971, and served as President and Chief Executive Officer of the Company, relinquishing these positions in 1980 and 1985, respectively. He was the Chairman of the Board of Directors for many years, Chairman of the Executive Committee since 1974, and was elected as one of the three members of the Office of Chairman on August 8, 1991. On October 22, 1992, Mr. Mebane was again elected as Chairman of the Board of Directors.\nVICE CHAIRMAN OF THE BOARD OF DIRECTORS\nWILLIAM J. ARMFIELD, IV Mr. Armfield is 60 and was President of Macfield, Inc. from 1970 until August 8, 1991, when Macfield merged with and into Unifi. He has been a Director of Unifi and was elected as one of the three members of the Office of Chairman on August 8, 1991. On October 22, 1992, Mr. Armfield was elected as Vice Chairman of the Board of Directors. He is a member of the Executive Committee.\nPRESIDENT AND CHIEF EXECUTIVE OFFICER\nWILLIAM T. KRETZER Mr. Kretzer is 49 and served as a Vice President or Executive Vice President from 1971 until 1985. He has been the President and Chief Executive Officer since 1985. He has been a member of the Board of Directors since 1985 and is a member of the Executive Committee.\nEXECUTIVE VICE PRESIDENTS\nJERRY W. ELLER Mr. Eller is 55 and has been a Vice President or Executive Vice President since 1975. He has been a member of the Board of Directors since 1985 and is a member of the Executive Committee. III-1\nROBERT A. WARD Mr. Ward is 55 and has been a Vice President or Executive Vice President since 1974. He has been a member of the Board of Directors since its inception in 1971 and is a member of the Executive Committee.\nG. ALFRED WEBSTER Mr. Webster is 47 and has been a Vice President or Executive Vice President since 1979. He has been a member of the Board of Directors since 1986 and is a member of the Executive Committee.\nSENIOR VICE PRESIDENTS\nGEORGE R. PERKINS, JR. Mr. Perkins is 55 and was the President and a Director of Pioneer Yarn Mills, Inc., Pioneer Spinning, Inc. and Pioneer Cotton Mill, Inc. since each was founded in 1988, 1991, and 1993, respectively, and of Edenton Cotton Mills, Inc., since its acquisition in 1989 (Pioneer Corporations) until August 18, 1993, when the Pioneer Corporations merged with and into USY. He has been a Director of Unifi since August 18, 1993, was President and Chief Executive Officer of USY from August 19, 1993, until December 26, 1994 when USY merged into Unifi, and a Senior Vice President of Unifi since October 21, 1993.\nKENNETH L. HUGGINS Mr. Huggins is 51, had been an employee of Macfield since 1970 and, at the time of the merger, was serving as a Vice President of Macfield, Inc. and President of Macfield's Dyed Yarn Division. He was a Director of Macfield from 1989 until Aug- ust 8, 1991, when Macfield, Inc. merged into and with Unifi, Inc. He is Senior Vice President and also Assistant to the President.\nRAYMOND W. MAYNARD Mr. Maynard is 52 and had been a Vice President of the Company since June 27, 1971, and a Senior Vice President since October 22, 1992.\nThese officers were elected by the Board of Directors of the Registrant at the Annual Meeting of the Board of Directors held on October 20, 1994. Each officer was elected to serve until the next Annual Meeting of the Board of Directors or until his successor was elected and qualified.\n(c) FAMILY RELATIONSHIP: Mr. Mebane, Chairman of the Board, and Mr. C. Clifford Frazier, Jr., the Secretary of the Registrant, are first cousins. Except for this relationship, there is no family relation between any of the Officers.\n(d) COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT: Based solely upon the review of the Form 3's and 4's and amendments thereto, furnished to the Company during the most recent fiscal year, no Form 3's or Form 4's were filed late by a director, officer, or beneficial owner of more than ten percent of any class of equity securities of the Company. The Company received written representation from reporting persons that Form 5's were not required. III-2\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION:\nThe information set forth under the headings \"Compensation And Option Committees Interlocks And Insider Participation In Compensation Decisions\", \"Executive Officers and Their Compensation\", \"Employment And Termination Agreements\", \"Options Granted\", \"Option Exercises and Option\/SAR Values\", and \"Performance Graph-Shareholder Return on Common Stock\" and the Report of The Compensation And Stock Option Committees on Executive Compensation beginning on page 6 and ending on page 11 of the Company's definitive Proxy Statement filed with the Commission since the close of the Registrant's fiscal year ended June 25, 1995, and within 120 days after the close of said fiscal year, are incorporated herein by reference.\nFor additional information regarding executive compensation reference is made to Exhibits (10i), (10j), and (10k) of this Form 10-K.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT:\nSecurity ownership of certain beneficial owners and management is the same as reported under the heading \"Information Relating to Principal Security Holders\" on page 2 of the definitive Proxy Statement and under the heading \"Security Holding of Directors, Nominees and Executive Officers\" beginning on page 4 and ending on page 5 of the definitive Proxy Statement filed with the Commission pursuant to Regulation 14(a) within 120 days after the close of the fiscal year ended June 25, 1995, which are hereby incorporated by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS:\nThe information included under the heading \"Compensation And Option Committees Interlocks And Insider Participation In Compensation Decisions\", on page 6 of the definitive Proxy Statement filed with the Commission since the close of the Registrant's fiscal year ended June 25, 1995, and within 120 days after the close of said fiscal year, is incorporated herein by reference.\nIII-3\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities and Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nUNIFI, INC.\nSeptember 20, 1995 BY: ROBERT A. WARD ----------------------------------- Robert A. Ward, Executive Vice President - Finance and Administration\nSeptember 20, 1995 BY: WILLIAM T. KRETZER ----------------------------------- William T. Kretzer, President (Chief Executive Officer)\nSeptember 20, 1995 BY: WILLIS C. MOORE ----------------------------------- Willis C. Moore, Vice President (Principal Financial and Accounting Officer)\nPursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:\nSeptember 20, 1995 Chairman G. ALLEN MEBANE ------------------------- and Director G. Allen Mebane\nSeptember 20, 1995 Vice Chairman WILLIAM J. ARMFIELD, IV ------------------------- and Director William J. Armfield, IV\nSeptember 20, 1995 President, Chief WILLIAM T. KRETZER ------------------------- Executive Officer William T. Kretzer and Director\nSeptember 20, 1995 Executive Vice ROBERT A. WARD ------------------------- President and Robert A. Ward Director\nSeptember 20, 1995 Executive Vice JERRY W. ELLER ------------------------- President and Jerry W. Eller Director\nSeptember 20, 1995 Executive Vice G. ALFRED WEBSTER ------------------------- President and G. Alfred Webster Director\nSeptember 20, 1995 Director CHARLES R. CARTER ------------------------- Charles R. Carter\nSeptember __, 1995 Director _________________________ Kenneth G. Langone\nSeptember 20, 1995 Director GEORGE R. PERKINS ------------------------- George R. Perkins\nSeptember 20, 1995 Director DONALD F. ORR ------------------------- Donald F. Orr\nSeptember __, 1995 Director _________________________ Timotheus R. Pohl\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(a) 1. Financial Statements\nThe following financial statements and report of independent auditors included in the Annual Report of Unifi, Inc. to its shareholders for the year ended June 25, 1995, are incorporated herein by reference. With the exception of the aforementioned information and the information incorporated by reference in Items 1, 2, 5, 6, 7 and 8 herein, the 1995 Annual Report to shareholders is not deemed to be filed as part of this report.\nAnnual Report Pages\nConsolidated Balance Sheets at June 25, 1995 and June 26, 1994 15 Consolidated Statements of Income for the Years Ended June 25, 1995, June 26, 1994, and June 27, 1993 16 Consolidated Statements of Changes in Shareholders' Equity for the Years Ended June 25, 1995, June 26, 1994 and June 27, 1993 17 Consolidated Statements of Cash Flows for the Years Ended June 25, 1995, June 26, 1994 and June 27, 1993 18 Notes to Consolidated Financial Statements 19-23 Report of Independent Auditors 14\n(a) 2. Financial Statement Schedules\nForm 10-K Pages\nSchedules for the three years ended June 25, 1995:\nII - Valuation and Qualifying Accounts IV - 6\nIV-1\nSchedules other than those above are omitted because they are not required, are not applicable, or the required information is given in the consolidated financial statements or notes thereto.\nIndividual financial statements of the Registrant have been omitted because it is primarily an operating company and all subsidiaries included in the consolidated financial statements being filed, in the aggregate, do not have minority equity interest and\/or indebtedness to any person other than the Registrant or its consolidated subsidiaries in amounts which together exceed 5% of the total assets as shown by the most recent year end consolidated balance sheet.\n(a) 3. Exhibits\n(2a-1) Form of Agreement and Plan of Merger, dated as of May 24, 1991, by and between Unifi, Inc. and Macfield, Inc., including exhibits, filed as Exhibit 2.1 to Unifi, Inc.'s Registration Statement on Form S-4 (Registration No. 33-40828), which is incorporated herein by reference.\n(2a-2) Form 8-K, filed by Unifi, Inc. in relation to the confirmation of the merger of Macfield, Inc. with and into Unifi, Inc. and related exhibits, filed with the Securities and Exchange Commission on August 8, 1991, which is incorporated herein by reference.\n(2a-3) Form of Agreement and Reverse Triangular Merger, dated February 10, 1993, by and between Unifi, Inc. and Vintage Yarns, Inc., filed as Exhibit 2.1 to Unifi, Inc.'s Registration Statement on Form S-4 (Registration No. 33-58282), which is incorporated herein by reference.\n(2a-4) Form 8-K, filed by Unifi, Inc. in relation to the confirmation of the Reverse Triangular Merger, where Vintage Yarns, Inc. became a wholly-owned subsidiary of Unifi, and related exhibits, filed with the Securities and Exchange Commission on May 10, 1993, which is incorporated herein by reference.\n(2a-5) Form of Agreement and Plan of Triangular Merger, dated July 15, 1993, by and between Unifi, Inc. and Pioneer Yarn Mills, Inc., Pioneer Spinning, Inc., Edenton Cotton Mills, Inc., and Pioneer Cotton Mill, Inc., (the \"Pioneer Corporations\"), filed as Exhibit 2.1 to Unifi, Inc's Registrations Statement on Form S-4 (Registration No. 33-65454), which is incorporated herein by reference.\nIV-2\n(2a-6) Form 8-K, filed by Unifi, Inc. for the purpose of reporting the Pioneer Corporations' Interim Combined Financial Statements (Unaudited) and Unifi, Inc.'s, and the Pioneer Corporations' Proforma Combined Interim Financial Information (Unaudited), and related exhibits, filed with the Securities and Exchange Commission on September 2, 1993, which is incorporated herein by reference.\n(2a-7) Form 8-K, filed by Unifi, Inc. for the purpose of reporting the Pioneer Corporations' merger with and into USY, and related exhibits filed with the Securities and Exchange Commission on November 5, 1993, which is incorporated herein by reference.\n(3a) Restated Certificate of Incorporation of Unifi, Inc., dated July 21, 1994, (filed as Exhibit (3a) with the Company's Form 10-K for the Fiscal Year ended June 26, 1994), which is incorporated herein by reference.\n(3b) Restated By-Laws of Unifi, Inc., effective July 21, 1994, (filed as Exhibit (3b) with the Company's Form 10-K for the Fiscal Year ended June 26, 1994), which is incorporated herein by reference.\n(4a) Specimen Certificate of Unifi, Inc.'s common stock, filed as Exhibit 4(a) to the Registration Statement on Form S-1, (Registration No. 2-45405), which is incorporated herein by reference.\n(4b) Unifi, Inc.'s Registration Statement for the 6% Convertible Subordinated Notes Due 2002, filed on Form S-3, (Registration No. 33-45946), which is incorporated herein by reference.\n(10a) *Unifi, Inc. 1982 Incentive Stock Option Plan, as amended, filed as Exhibit 28.2 to the Registration Statement on Form S-8, (Registration No. 33-23201), which is incorporated herein by reference.\n(10b) *Unifi, Inc. 1987 Non-Qualified Stock Option Plan, as amended, filed as Exhibit 28.3 to the Registration Statement on Form S-8, (Registration No. 33-23201), which is incorporated herein by reference.\nIV-3\n(10c) *Unifi, Inc. 1992 Incentive Stock Option Plan, effective July 16, 1992, (filed as Exhibit (10c) with the Company's Form 10-K for the Fiscal year ended June 27, 1993), and included as Exhibit 99.2 to the Registration Statement on Form S-8 (Registration No. 33-53799), which are incorporated herein by reference.\n(10d) *Unifi, Inc.'s Registration Statement for selling Shareholders, who are Directors and Officers of the Company, who acquired the shares as stock bonuses from the Company, filed on Form S-3 (Registration No. 33-23201), which is incorporated herein by reference.\n(10e) Unifi Spun Yarns, Inc.'s 1992 Employee Stock Option Plan filed as Exhibit 99.3 to the Registration Statement on Form S-8 (Registration No. 33-53799), which is incorporated herein by reference.\n(10f) Lease Agreement, dated March 2, 1987, between NationsBank, Trustee under the Unifi, Inc. Profit Sharing Plan and Trust, Wachovia Bank and Trust Co., N.A., Independent Fiduciary, and Unifi, Inc., (filed as Exhibit (10d) with the Company's Form 10-K for the fiscal year ended June 28, 1987), which is incorporated herein by reference.\n(10g) Factoring Contract and Security Agreement and a Letter Amendment thereto, all dated as of May 25, 1994, by and between Unifi, Inc. and the CIT Group\/DCC, Inc., (filed as Exhibit (10g) with the Company's Form 10-K for the Fiscal Year ended June 26, 1994), which are incorporated herein by reference.\n(10h) Factoring Contract and Security Agreement, dated as of May 2, 1988, between Macfield, Inc. and First Factors Corp., and first amendment thereto, dated September 28, 1990, (both filed as Exhibit (10g) with the Company's Form 10-K for the fiscal year ended June 30, 1991), and Second Amendment to the Factoring Contract and Security Agreement, dated March 1, 1992, (filed as Exhibit (10g) with the Company's Form 10-K for the Fiscal Year Ended June 28, 1992), and Letter Agreement dated August 31, 1993 and Amendment To Factoring Contract and Security Agreement, dated January 5, 1994, (filed as Exhibit (10h) with the Company's Form 10-K for the Fiscal Year ended June 26, 1994), which are incorporated herein by reference.\nIV-4\n(10i) *Employment Agreement between Unifi, Inc. and G. Allen Mebane, dated July 19, 1990, (filed as Exhibit (10h) with the Company's Form 10-K for the fiscal year ended June 30, 1991), which is incorporated herein by reference.\n(10j) *Employment Agreement between Unifi, Inc. and William T. Kretzer, dated July 19, 1990, (filed as Exhibit (10i) with the Company's Form 10-K for the fiscal year ended June 30, 1991), and Amendment to Employment Agreement between Unifi, Inc. and William T. Kretzer, dated October 22, 1992 (filed as Exhibit (10j) with the Company's Form 10-K for fiscal year ended June 27, 1993), which are incorporated herein by reference.\n(10k) *Severance Compensation Agreement between Unifi, Inc. and William T. Kretzer, dated July 20, 1993, expiring on July 19, 1996 (similar agreements were signed with G. Allen Mebane, William J. Armfield, IV, Robert A. Ward, Jerry W. Eller and G. Alfred Webster), (filed as Exhibit (10k) for the fiscal year ended July 27, 1993), which is incorporated herein by reference.\n(11) Computation of Earnings per share.\n(13a) Portions of Unifi, Inc.'s 1995 Annual Report to Shareholders which are incorporated herein by reference, as a part of this Form 10-K for fiscal year ended June 25, 1995, filed herewith.\n(13b-1) Report of Independent Auditors\/Ernst & Young LLP - on the Consolidated Financial Statements of Unifi, Inc. as of June 25, 1995 and each of the two years in the period ended June 25, 1995.\n(21) Subsidiaries of Unifi, Inc.\n(23) Consent of Ernst & Young LLP\n(27) Financial Data Schedules\n(b) Reports on Form 8-K (i) No Form 8-K's were filed.\n* NOTE: These Exhibits are management contracts or compensatory plans or arrangements required to be filed as an exhibit to this Form 10-K pursuant to Item 14(c) of this report.\nIV-5\nIV-6","section_15":""}
{"filename":"77098_1995.txt","cik":"77098","year":"1995","section_1":"ITEM 1\nBusiness\nIntroduction\nAmerican Premier Underwriters, Inc. (the \"Company\") was incorporated in Pennsylvania in 1846. The Company changed its name in 1994 from The Penn Central Corporation to American Premier Underwriters, Inc. in order to better reflect its identity as a property and casualty insurance specialist. Its address is One East Fourth Street, Cincinnati, Ohio 45202; its telephone number is (513) 579-6600.\nThe Company's principal operations are conducted by a group of nonstandard private passenger automobile insurance companies (the \"NSA Group\") and by Republic Indemnity Company of America (\"Republic Indemnity\"), a California workers' compensation insurance company.\nOn April 3, 1995, the Company became a wholly-owned subsidiary of American Premier Group, Inc., a new corporation formed by the Company for the purpose of acquiring all of the common stock of the Company and American Financial Corporation (the \"Mergers\"). On June 9, 1995, American Premier Group changed its name to American Financial Group, Inc. (\"AFG\"). Under terms of the Mergers, (a) the Company merged with a subsidiary of AFG and each share of Company Common Stock then outstanding was converted into one share of AFG Common Stock, and (b) American Financial Corporation (\"AFC\") merged with another subsidiary of AFG and all shares of AFC common stock were exchanged for 28.3 million shares of AFG Common Stock. As a result of the Mergers, all of the common stock of the Company and AFC is owned by AFG and AFG is the Company's successor as the issuer of publicly held common stock.\nLargely due to its divestitures of non-insurance assets over recent years, the Company had substantial amounts of cash, short- term investments and marketable securities (other than those held by its insurance operations) at the date of the Mergers. One of the strategic objectives of the Mergers was to provide an opportunity to redeploy most of these Parent Company assets to produce a higher rate of return than has been available on the instruments in which they have been invested. This objective was achieved through the utilization of such assets for the early retirement of relatively expensive debt; approximately $180 million of Company debt was retired and interest-bearing loans of $623 million were made to AFC which retired nearly $600 million of its debt.\nManagement expects that the Company's 1995 consolidated Federal income tax return will report a remaining net operating loss carryforward currently estimated at $476 million, which will expire at the end of 1996 unless previously utilized, and remaining capital loss carryforwards estimated at $311 million, portions of which will expire in various amounts between 1997 and 1999 unless previously utilized. See Note J of Notes to Financial Statements.\nSet forth below is a narrative description of the business operations of the Company's Insurance segment, which is the only reportable industry segment for which financial information is presented in the financial statements in Item 8 of this Report. In addition, information is presented with respect to the Company's \"Non-Insurance Assets.\"\nInsurance Operations\nThe Company's principal operations are conducted through specialty property and casualty insurance subsidiaries that underwrite and market nonstandard automobile and workers' compensation insurance. Each subsidiary is comprised of multiple business units which operate autonomously but with strong central financial controls and full accountability. Decentralized control allows each unit the autonomy necessary to respond to local and specialty market conditions while capitalizing on the efficiencies of centralized investment, actuarial, financial and legal support functions.\nThe primary objective of the Company's insurance operations is to achieve underwriting profitability. Management's focus on underwriting profitability has resulted in a statutory combined ratio averaging 98.5% for the period 1991 to 1995, as compared to 109.3% for the property and casualty industry over the same period (Source: A.M. Best). The statutory combined ratio was 104.8% in 1995, compared with the property and casualty insurance industry estimated average of 107.2% (Source: A.M. Best). The GAAP combined ratio for 1995 was 102.0% compared with 97.0% for 1994. The increase in the 1995 GAAP combined ratio was due primarily to inadequate rate levels in certain markets and weather-related losses, principally from hailstorms in Texas.\nAlthough financial data is reported on a statutory basis for insurance regulatory purposes, it is reported in accordance with GAAP for shareholder and other investment purposes. In general, statutory accounting results in lower capital surplus and net earnings than result from application of GAAP. Major differences include charging policy acquisition costs to expense as incurred rather than spreading the costs over the periods covered by the policies; netting of reinsurance recoverables and prepaid reinsurance premiums against the corresponding liability; requiring additional loss reserves and charging to surplus certain assets, such as furniture and fixtures and agents' balances over 90 days old. Unless otherwise noted, all information presented in this report with respect to the Company's insurance operations is reported on a GAAP basis.\nThe following table presents certain information with respect to the Company's insurance operations (dollars in millions).\n1995 1994 1993\nNet written premiums $1,492.3 $1,635.5 $1,378.9\nNet earned premiums $1,495.4 $1,557.9 $1,273.6 Loss and loss adjustment expenses (\"LAE\") 1,198.5 1,090.7 856.9 Underwriting expenses 331.1 344.8 275.3 Policyholder dividends (a) (5.0) 75.7 93.2 Underwriting profit (loss) $ (29.2) $ 46.7 $ 48.2\nGAAP ratios: Loss and LAE ratio 80.2% 70.0% 67.3% Underwriting expense ratio 22.1 22.1 21.6 Policyholder dividend ratio (a) (.3) 4.9 7.3 Combined ratio 102.0% 97.0% 96.2%\nStatutory ratios: Loss and LAE ratio 80.1% 70.0% 67.9% Underwriting expense ratio 21.7 22.1 21.2 Policyholder dividend ratio (a) 3.0 6.4 4.9 Combined ratio 104.8% 98.5% 94.0%\nIndustry statutory combined ratio (b) 107.2% 108.5% 106.9%\n(a)Reflects a change in the nature of the California workers' compensation business. See \"Management's Discussion and Analysis--Results of Operations--Republic Indemnity.\"\n(b)Industry information was derived from \"Best's Review - Property\/Casualty\" (January 1996 edition).\nNonstandard Automobile Insurance\nGeneral. The NSA Group underwrites private passenger automobile physical damage and liability policies for \"nonstandard risks.\" The NSA Group has four principal operating units comprised of Atlanta Casualty Company, Windsor Insurance Company, Infinity Insurance Company and Leader National Insurance Company and their respective subsidiaries (\"Atlanta Casualty\", \"Windsor\", \"Infinity\" and \"Leader National\", respectively) and includes a total of thirteen domestic insurance companies. In November 1995, A.M. Best, which rates insurance companies based upon factors of concern to policyholders, downgraded its rating of Atlanta Casualty and Windsor from \"A+\" (Superior) to \"A\" (Excellent) and affirmed its rating of \"A\" (Excellent) for Infinity and \"A-\" (Excellent) for Leader National. In announcing the rating adjustments of these companies, A.M. Best expressed its opinion that each of these new ratings reflects primarily the \"significant financial leverage\" of AFG. At the time of the Mergers, AFG's ratio of debt to total capital was nearly 60%; at December 31, 1995, the ratio had improved to approximately 30%.\nNonstandard insureds are those individuals who are unable to obtain insurance through standard market carriers due to factors such as age, record of prior accidents, driving violations, particular occupation or type of vehicle. Premium rates for nonstandard risks are generally higher than for standard risks. Total private passenger automobile insurance premiums written by insurance carriers in the United States in 1995 have been estimated by A.M. Best to be approximately $103 billion. Because it can be viewed as a residual market, the size of the nonstandard private passenger automobile insurance\nmarket changes with the insurance environment and grows when standard coverage becomes more restrictive. When this occurs, the criteria which differentiate standard from nonstandard insurance risks change. The size of the voluntary nonstandard market is also affected by the rate levels adopted by state administered involuntary plans. Although these factors make it difficult to estimate the size of the nonstandard market, management believes that the voluntary nonstandard market has accounted for approximately 15% of total private passenger automobile insurance premiums written in recent years.\nThe NSA Group attributes its premium growth in recent years primarily to entry into additional states, increased market penetration in its existing states, overall growth in the nonstandard market, premium rate increases and its purchase of Leader National. Management believes the nonstandard market has experienced growth in recent years as standard insurers have become more restrictive in the types of risks they will write.\nThe NSA Group writes business in 41 states and holds licenses to write policies in 48 states and the District of Columbia. The U.S. geographic distribution of the NSA Group's statutory written premiums in 1995 compared to 1991 is presented below. All business written in Texas and included in the table was assumed from an affiliate. In addition, the NSA Group writes approximately $50 million (4%) of its net premiums annually in the United Kingdom.\nState 1995 1991 State 1995 1991\nTexas 11.6% - % Pennsylvania 3.8% -% Florida 11.0 21.5 Oklahoma 3.8 1.7 Georgia 9.9 20.5 Indiana 3.6 4.2 California 8.1 - Mississippi 3.4 4.3 Connecticut 5.4 5.6 Alabama 3.1 4.0 Arizona 4.4 2.7 Other 27.8 29.9 Tennessee 4.1 5.6 100.0% 100.0%\nManagement believes that the NSA Group's underwriting success as compared to the automobile insurance industry as a whole has been due, in part, to the refinement of various risk profiles, thereby dividing the consumer market into more defined segments which can be underwritten or priced properly. The NSA Group also generally writes policies of short duration which allow more frequent rating evaluations of individual risks, providing management greater flexibility in the ongoing assessment of the business. In addition, the NSA Group has implemented cost control measures both in the underwriting and claims handling areas.\nThe following table presents certain information for the NSA Group (dollars in millions).\n1995 1994 1993\nNet written premiums $1,203.2 $1,154.1 $ 901.9\nNet earned premiums $1,191.4 $1,071.9 $ 804.4 Loss and LAE 997.0 813.7 575.8 Underwriting expenses 262.1 256.3 204.4 Underwriting profit (loss) $ (67.7) $ 1.9 $ 24.2\nGAAP ratios: Loss and LAE ratio 83.7% 75.9% 71.6% Underwriting expense ratio 22.0 23.9 25.4 Combined ratio 105.7% 99.8% 97.0%\nStatutory ratios: (a) Loss and LAE ratio 83.7% 76.0% 72.5% Underwriting expense ratio 21.4 23.7 24.4 Combined ratio 105.1% 99.7% 96.9%\nIndustry statutory combined ratio (b) 102.3% 101.3% 101.7%\n(a)Excludes non-U.S. operations, for which statutory accounting is not comparable.\n(b)Industry information was derived from \"Best's Review - Property\/Casualty\" (January 1996 edition). The comparison shown is to the private passenger automobile insurance industry. Although the Company believes that there is no reliable regularly published combined ratio data for the nonstandard automobile insurance industry, the Company believes that such a combined ratio would be lower than the private passenger automobile industry average shown above.\nMarketing. Each of the principal units in the NSA Group is responsible for its own marketing, sales, underwriting and claims processing. Sales efforts are primarily directed toward independent agents to convince them to select an NSA Group insurance company for their customers. These units each write policies through several thousand independent agents.\nOf the approximately one million NSA Group policies in force at December 31, 1995, approximately 90% had policy limits of $50,000 or less per occurrence. Most NSA Group policies are written for policy periods of six months or less, and some are as short as one month.\nReinsurance. Due in part to the limited exposure on individual policies, none of the insurance carriers in the NSA Group is involved to a material degree in reinsuring risks with third party insurance companies. Risks written by NSA Group companies in excess of certain limits are in some cases reinsured with a major reinsurance company. In general, the risk retained by the NSA Group companies is $500,000 of ultimate net loss for each occurrence and certain portions of ultimate net losses in excess of such limits. Reinsurance premiums paid by the NSA Group in 1995 amounted to less than 1% of net written premiums of the NSA Group for the period.\nCompetition. A large number of national, regional and local insurers write nonstandard private passenger automobile insurance coverage. Insurers in this market generally compete on the basis of price (including differentiation on liability limits, variety of coverages offered and deductibles), geographic availability and ease of enrollment and, to a lesser\nextent, reputation for claims handling, financial stability and customer service. NSA Group management believes that sophisticated data analysis for refinement of risk profiles has helped the NSA Group to compete successfully. The NSA Group attempts to provide selected pricing for a wider spectrum of risks and with a greater variety of payment options, deductibles and limits of liability than are offered by many of its competitors.\nRegulation. The Company's insurance subsidiaries are subject to regulation in the jurisdictions in which they do business. In general, the insurance laws of the various states establish regulatory agencies with broad administrative powers governing, among other things, premium rates, solvency standards, licensing of insurers, agents and brokers, trade practices, forms of policies, maintenance of specified reserves and capital for the protection of policyholders, deposits of securities for the benefit of policyholders, investment activities and relationships between insurance subsidiaries and their parents and affiliates. Material transactions between insurance subsidiaries and their parents and affiliates generally must be disclosed and prior approval of the applicable insurance regulatory authorities generally is required for any such transaction which may be deemed to be extraordinary. In addition, while regulations differ from state to state, they typically restrict the maximum amount of dividends that may be paid by an insurer to its shareholders in any twelve-month period without advance regulatory approval. Such limitations are generally based on earnings or statutory surplus. Without such approval, the maximum amount of dividends that may be paid by the NSA Group to the Company during 1996 is $50.9 million.\nMost states have created insurance guarantee associations to provide for the payment of claims for which insolvent insurers are liable but which cannot be paid out of such insolvent insurers' assets. In 1995, the NSA Group companies were assessed approximately $100,000 by such associations.\nIn addition, many states have created \"assigned risk\" plans or similar arrangements to provide state mandated minimum levels of automobile liability coverage to drivers whose driving records or other relevant characteristics make it difficult for them to obtain insurance otherwise. Automobile insurers in those states are required to provide such coverage to a proportionate number of those drivers applying as assigned risks. Premium rates for assigned risk business are established by the regulators of the particular state plan and are frequently inadequate in relation to the risks insured, resulting in underwriting losses. Assigned risks accounted for less than 1% of net written premiums of the NSA Group companies in 1995.\nIn 1995, the NSA Group received approximately $91 million in direct written premiums from California. In 1988, California voters approved Proposition 103 which required insurance companies to roll back automobile insurance rates to 80% of year- earlier levels, maintain those rates for one year and obtain prior approval of rate increases thereafter. The Company's acquisition of the NSA Group in 1990 was structured to protect the Company against the consequences of any rate rollback applied to the acquired operations. As for the prior approval requirements, current legislation in California generally provides that applications for rate increases will be deemed approved after 180 days unless disapproved by the Department of Insurance. The Company is unable to predict whether or at what level future rate increases, when applied for, may be approved. Over time, the failure to receive appropriate rate increases could result in reduced underwriting profitability in California for the NSA Group. In addition, the Company could experience loss of premium volume in California as a result of actions it would take to maintain such profitability.\nWorkers' Compensation Insurance\nGeneral. Republic Indemnity has been engaged in the sale of workers' compensation insurance in California for many years. More than 96% of its business in 1995 was written in California. In addition, it is licensed to write business in Arizona, which contributed approximately 3% of direct written premium in 1995, and 22 other states. In November 1995, A.M. Best downgraded its rating of Republic Indemnity from \"A+\" (Superior) to \"A\" (Excellent). In announcing the rating adjustment of Republic Indemnity, A.M. Best expressed its opinion that this new rating reflects primarily the \"significant financial leverage\" of AFG. At the time of the Mergers, AFG's ratio of debt to total capital was nearly 60%; at December 31, 1995, the ratio had improved to approximately 30%.\nWorkers' compensation insurance policies provide coverage for workers' compensation and employer's liability. The workers' compensation portion of the coverage provides for statutorily prescribed benefits that employers are required to pay to employees who are injured in the course of employment including, among other things, temporary or permanent disability benefits, death benefits, medical and hospital expenses and expenses of vocational rehabilitation. The benefits payable and the duration of such benefits are set by statute, and vary with the nature and severity of the injury or disease and the wages, occupation and age of the employee. The employer's liability portion of the coverage provides protection to an employer for its liability for losses suffered by its employees which are not included within the statutorily prescribed workers' compensation coverage. Republic Indemnity generally issues policies for one-year periods.\nWorkers' compensation insurance operations are affected by employment trends in their markets, litigation activities, legal and medical costs, use of vocational rehabilitation programs and the provision of benefits for stress and trauma claims. Historically, the incidence of higher claims costs would ultimately have been reflected in premium rate adjustments. With the advent of the Reform Legislation as defined below under \"Competition\", such increases in claims costs might not necessarily be used in the setting of premium rates, which may unfavorably affect underwriting results.\nThe following table presents certain information for Republic Indemnity (dollars in millions).\n1995 1994 1993\nNet written premiums $287.5 $479.5 $465.8\nNet earned premiums $303.5 $483.8 $458.5 Loss and LAE 202.9 276.7 270.2 Underwriting expenses 68.9 88.3 70.6 Policyholder dividends (5.0) 75.7 93.2 Underwriting profit $ 36.7 $ 43.1 $ 24.5\nGAAP ratios: Loss and LAE ratio 66.8% 57.2% 59.0% Underwriting expense ratio 22.7 18.3 15.4 Policyholder dividend ratio (1.6) 15.6 20.3 Combined ratio 87.9% 91.1% 94.7%\nStatutory ratios: Loss and LAE ratio 66.8% 57.2% 59.0% Underwriting expense ratio 23.1 18.3 15.4 Policyholder dividend ratio 14.8 20.4 13.7 Combined ratio 104.7% 95.9% 88.1%\nIndustry statutory combined ratio (a) 103.0% 101.4% 109.1%\n(a)Industry information was derived from \"Best's Review - Property\/Casualty\" (January 1996 edition).\nMarketing. Republic Indemnity writes insurance through approximately 700 independent property and casualty insurance agents. In 1995, none of these produced more than 4.5% of total premiums. The largest three of these produced approximately 9% of total premiums. Republic Indemnity has in excess of 10,000 policies in force, the largest of which represents approximately three-tenths of 1% of net premiums written.\nReinsurance. In its normal course of business and in accordance with industry practice, Republic Indemnity reinsures a portion of its exposure with other insurance companies so as to limit its maximum loss arising out of any one occurrence. Reinsurance does not legally discharge the original insurer from primary liability. Republic Indemnity retains the first $1.5 million of each loss; the next $1.5 million of each loss is reinsured with a major reinsurance company; the next $2 million of each loss is shared equally by Republic Indemnity and the reinsurance company; and the remaining $145 million of each loss is covered by reinsurance provided by a group of more than 40 reinsurance companies. Premiums for reinsurance ceded by Republic Indemnity in 1995 were less than 1% of net written premiums for the period. Republic Indemnity generally does not assume reinsurance, except as an accommodation to policyholders who have a small percentage of their employees outside the state of California.\nCompetition. Republic Indemnity competes with both the California State Compensation Insurance Fund (the \"State Fund\") and over 275 other companies writing workers' compensation insurance in California. In recent years, the State Fund has written approximately 15% to 20% of the direct written premiums in the insured workers' compensation market in California. In addition, many employers are self-insured.\nIn 1993, California enacted legislation (the \"Reform Legislation\") effecting an immediate overall 7% reduction in workers' compensation insurance premium rates and replaced the workers' compensation insurance minimum rate law, effective January 1, 1995, with a procedure permitting insurers to use any rate within 30 days after filing it with the Insurance Commissioner unless the rate is disapproved by the Insurance Commissioner. Before this \"open rating\" policy went into effect, the Insurance Commissioner ordered additional rate decreases of 12.7% (effective January 1, 1994) and 16% (effective October 1, 1994).\nThe Reform Legislation has had a significant effect on competition within the California workers' compensation market. Prior to the repeal of the minimum rate law, competition was based primarily on an insurer's reputation for paying dividends to policyholders as a refund of premiums paid when experience with such policyholders was more favorable than certain specified levels, subject to the approval of the Board of Directors. Management believes that Republic Indemnity's record and reputation for paying relatively high policyholder dividends had enhanced its competitive position. With the repeal of the minimum rate law, the premium rate levels offered by an insurer, rather than its reputation for paying policyholder dividends, has become the most important factor affecting competition. As a result, Republic Indemnity has modified its rate levels to reflect a change in its mix of business toward non-participating policies which are not subject to payment of policyholder dividends.\nOther competitive factors in the California workers' compensation market include loss control services, claims service, service to agents and commission schedules. While several companies, including certain of the largest writers, specialize in writing California workers' compensation insurance, Republic Indemnity believes its exclusive concentration in the workers' compensation field yields certain cost advantages and other favorable effects upon operations. Republic Indemnity may be at a competitive disadvantage when businesses that purchase general property and casualty insurance are encouraged by other insurers to place their workers' compensation insurance as part of an overall insurance package. Although Republic Indemnity is one of the largest writers of workers' compensation insurance in California, certain competitors are larger and\/or have greater resources than Republic Indemnity.\nThe repeal of the minimum rate law has prompted certain insurers to issue policies with premium rates that are below projected ultimate losses in an effort to gain market share. Republic Indemnity intends to maintain its historically strict underwriting standards as it continues to market its policies at rates that it believes will provide for both long-term underwriting profitability and surplus stability. Republic Indemnity's focus on underwriting performance in an atmosphere of extremely competitive pricing could likely prolong what management believes is a temporary reduction in premium volume. Republic Indemnity has remained competitive in the current marketplace by pricing its policies to reflect, among other things, the absence of policyholder dividend payments as discussed above, and by reducing its expenses and pursuing profitable business in other geographic markets.\nRegulation. The maximum amount of shareholder dividends paid within any twelve-month period from a California property and casualty insurance company to its parent without regulatory approval cannot exceed the greater of 10% of the insurer's statutory policyholders' surplus as of the preceding December 31, or 100% of its net income for the year then ended. Without such approval, the maximum amount of such dividends that may be paid by Republic Indemnity during 1996 is $29.5 million.\nDue to the existence of the State Fund, California does not require participation in any involuntary pools or assigned risk plans for workers' compensation insurance. Although California has guarantee regulations to protect policyholders of insolvent insurance companies, no assessments were billed to Republic Indemnity under such regulations for policy year 1995. However, if current pricing practices were to persist in the marketplace, management would expect assessments in future policy years.\nProposition 103, which is described more fully under \"Nonstandard Automobile Insurance\" above, does not apply to workers' compensation insurance.\nLoss and Loss Adjustment Expense Reserves\nThe consolidated financial statements include the estimated liability for unpaid losses and LAE of the Company's insurance subsidiaries. This liability represents estimates of the ultimate net cost of all unpaid losses and LAE and is determined by using case-basis evaluations and actuarial projections. These estimates are subject to the effects of changes in claim amounts and frequency and are periodically reviewed and adjusted as additional information becomes known. In accordance with industry practices, such adjustments are reflected in current year operations.\nFuture costs of claims are projected based on historical trends adjusted for changes in underwriting standards, policy provisions, the anticipated effect of inflation and general economic trends. These anticipated trends are monitored based on actual development and are reflected in estimates of ultimate claim costs.\nGenerally, reserves for reinsurance and involuntary pools and associations are reflected in the Company's results at the amounts reported by those entities.\nSee Note L to the Financial Statements for an analysis of changes in the Company's estimated liability for losses and LAE, net of reinsurance (and grossed up), over the past three years on a GAAP basis.\nThe following table presents the development of the liability for losses and LAE, net of reinsurance, on a GAAP basis for 1989 (the year the Company acquired its first insurance subsidiary) through 1995. The top line of the table shows the estimated liability (in millions) for unpaid losses and LAE recorded at the balance sheet date for the indicated years. The second line shows the re-estimated liability as of December 31, 1995. The remainder of the table presents development as percentages of the estimated liability. The development results from additional information and experience in subsequent years. The middle line shows a cumulative redundancy which represents the aggregate percentage decrease in the liability initially estimated. The lower portion of the table indicates the cumulative amounts paid as of successive periods as a percentage of the original loss reserves liability.\nThe preceding table does not present accident or policy year development data. As indicated in the preceding table, the Company has developed redundancies for all periods presented. These redundancies were offset, in part, by deficiencies related to workers' compensation in the 1990 and 1991 accident years. Furthermore, in evaluating the re-estimated liability and cumulative redundancy, it should be noted that each percentage includes the effects of changes in amounts for prior periods. For example, a redundancy related to losses settled in 1995, but incurred in 1989, would be included in the re-estimated liability and cumulative redundancy percentage for each of the years 1989 through 1994. Conditions and trends that have affected development of the liability in the past may not necessarily exist in the future. Accordingly, it is not appropriate to extrapolate future redundancies based on this table.\nThe differences between the liability for losses and LAE reported in the annual statements filed with the state insurance departments in accordance with statutory accounting principles (\"SAP\") and that reported in the accompanying consolidated financial statements in accordance with GAAP at December 31, 1995, are as follows (in millions):\nLiability reported on a SAP basis $1,116\nReinsurance recoverables 59 Reserves of foreign operations 20\nLiability reported on a GAAP basis $1,195\nInvestment Portfolio\nGeneral. The following tables present the percentage distribution and yields of the Company's insurance operations' investment portfolio (excluding investment in equity securities of investee corporations) as reflected in its financial statements.\nFixed Maturity Investments. Unlike most insurance groups which have portfolios that are invested heavily in tax-exempt bonds, the Company invests substantial amounts in taxable bonds. The NAIC assigns quality ratings which range from Class 1 (highest quality) to Class 6 (lowest quality). The following table shows the Company's bonds and mandatory redeemable preferred stocks, by NAIC designation (and comparable Standard & Poor's Corporation rating) as of December 31, 1995 (dollars in millions):\nNAIC Amortized Market Value Rating Comparable S&P Rating Cost Amount %\n1 AAA, AA, A $1,264 $1,326 70% 2 BBB 429 447 24 Total investment grade 1,693 1,773 94 3 BB 66 67 4 4 B 42 40 2 5 CCC, CC, C - - - 6 D - - - Total non-investment grade 108 107 6 Total $1,801 $1,880 100%\nRisks inherent in connection with fixed income securities include loss upon default and market price volatility. Factors which can affect the market price of securities include: creditworthiness, changes in interest rates, the number of market makers and investors, defaults by major issuers of securities and public concern about concentrations in certain types of securities by institutions.\nNon-Insurance Assets\nBusinesses Divested. In February 1995, the Company completed the divestiture of its last industrial business with the sale of its Apparatus unit, which manufactured aerial lift trucks, for approximately $13 million.\nCoal Properties. The Company and a subsidiary own fee interests in coal properties in Illinois, Ohio and Pennsylvania. Most of these properties are leased at various royalty rates to coal mining companies under long-term arrangements, including fixed-term leases with renewal options and exhaustion leases. The Company does not produce, prepare or sell coal or conduct mining operations.\nEight mines operated by lessees of the leased coal properties supply steam coal for electrical utilities or industrial customers. The future level of royalties above certain minimum and advance royalties from the reserves presently under lease will depend upon the rate of mining, the change in certain price indices and, in some instances, the sales price of the coal. During 1995, the leased coal properties produced royalties of approximately $6 million.\nGCT and Related Development Rights. Subsidiaries of the Company own Grand Central Terminal (\"GCT\") in New York City and rights (the \"Development Rights\") to develop or transfer approximately 1.7 million square feet of floor space in the GCT area. The Development Rights are derived from such subsidiaries' ownership of the land upon which GCT is constructed. Utilization or transfer of such rights requires the approval of certain New York City agencies. If required governmental approvals are obtained, the floor space may be developed on certain sites in the vicinity of GCT, in each case subject to the requirements of applicable law. The Company leases GCT (but not the Development Rights) and its related Harlem and Hudson rail lines to the Metropolitan Transportation Authority of the State of New York (the \"MTA\") for a term expiring in 2274. Payments received on the lease amount to $2.4 million annually. The MTA also has the option to purchase the leased property in 2019.\nReal Estate. Subsidiaries of the Company own certain land and rights associated with the potential development of areas adjacent to, and above, the rail line at the Scarsdale, New York commuter railroad station. The Village of Scarsdale has designated a subsidiary of the Company as preferred developer for the construction of a residential and retail use project adjacent to such station.\nThe Company also has a program for the sale of real estate assets that relate to its former rail operations and other surplus land and facilities.\nOil and Gas Properties. The Company has fractional interests in oil and gas properties located in the United States. These properties produced revenues of $.8 million, $2.0 million and $2.0 million in 1995, 1994 and 1993, respectively.\nManagement Company. Buckeye Management Company (\"Buckeye\") manages as the sole general partner of, and owns a 2% economic interest in, Buckeye Partners, L.P., which owns and operates refined petroleum products and crude oil pipelines in the northeast and midwestern United States. In March 1996, the Company sold Buckeye to an investment group consisting of members of Buckeye's management and employees.\nEmployees\nThe Company and its consolidated subsidiaries employed approximately 3,700 persons at December 31, 1995.\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2\nProperties\nThe Company's operations are conducted principally within the United States, and the Company believes that its principal facilities are maintained in good operating condition and are adequate for the present needs of its operations.\nInsurance\nThe Company's insurance operations lease offices in the following locations: Square Lease Feet Expiration NSA Group: Birmingham, Alabama 68,000 2005 Atlanta, Georgia 81,000 1998 Norcross, Georgia 147,000 2000 Independence, Ohio 43,000 1998\nRepublic Indemnity: Encino, California 72,000 2003 San Francisco, California 57,000 2001 San Diego, California 11,000 1998 Other 16,000 1996-2000\nNon-Insurance Assets\nCoal Properties The Company and a subsidiary own fee interests in approximately 161,000 acres of coal properties in Illinois, Ohio and Pennsylvania. Approximately two-thirds of these properties remain leased at various royalty rates to coal mining companies under long-term arrangements, including fixed-term leases with renewal options and exhaustion leases.\nGCT and Related Development Rights Subsidiaries of the Company own Grand Central Terminal and rights to develop floor space in New York City.\nReal Estate The Company's real estate inventory at December 31, 1995 included approximately 8,400 acres of real estate spread throughout 12 states.\nOil and Gas Properties The Company owns certain developed and undeveloped oil and gas properties, located primarily in Oklahoma.\nITEM 3","section_3":"ITEM 3\nLegal Proceedings\nPre-Reorganization Matters\nThe following matters arose out of railroad operations disposed of by the Company's predecessor, Penn Central Transportation Company (\"PCTC\"), prior to its bankruptcy reorganization in 1978 and, accordingly, any ultimate liability arising therefrom in excess of previously established loss accruals would be attributable to pre-reorganization events and circumstances. In accordance with the Company's pre- reorganization accounting policy, any such excess will reduce the Company's capital surplus and shareholders' equity, but will not be charged to income.\nUSX Litigation In May 1994, lawsuits were filed against the Company by USX Corporation (\"USX\") and its former subsidiary, Bessemer and Lake Erie Railroad Company (\"B&LE\"), seeking contribution by the Company, as the successor to the railroad business conducted by PCTC prior to 1976, for all or a portion of the approximately $600 million that USX paid in satisfaction of a judgment against B&LE for its participation in an unlawful antitrust conspiracy among certain railroads commencing in the 1950's and continuing through the 1970's. The lawsuits argue that USX's liability for that judgment is attributable to PCTC's alleged activities in furtherance of the conspiracy. On October 13, 1994, the U.S. District Court for the Eastern District of Pennsylvania enjoined USX and B&LE from continuing their lawsuits against the Company, ruling that their claims are barred by the 1978 Consummation Order issued by that Court in PCTC's bankruptcy reorganization proceedings. USX and B&LE appealed the District Court's ruling to the U.S. Court of Appeals for the Third Circuit. On December 13, 1995, the Court of Appeals reversed the U.S. District Court decision. In its opinion, the Court of Appeals only addressed the Company's procedural argument that the claims of USX could not proceed because they are barred by the Consummation Order. The Third Circuit expressly recognized in its opinion that it was not deciding any of the Company's defenses on the merits.\nOn January 8, 1996, the Company filed a petition for rehearing en banc, requesting all of the judges of the Third Circuit to review the three-judge panel's decision. That petition was denied on February 16, 1996. As a result, the Company will petition the U.S. Supreme Court to review the bankruptcy bar issue. In the event that subsequent reviews do not reinstate the District Court's injunction and USX's lawsuits are eventually permitted to go forward, the Company and its outside counsel believe that the Company has substantial defenses to these lawsuits and should not suffer a material loss as a result of this litigation.\nEnvironmental Matters The Company is a party or named as a potentially responsible party in a number of proceedings and claims by regulatory agencies and private parties under various environmental protection laws, including the Comprehensive Environmental Response, Compensation and Liability Act (\"CERCLA\"), seeking to impose responsibility on the Company for hazardous waste remediation costs at certain railroad sites formerly owned by PCTC and at certain other sites where hazardous waste allegedly generated by PCTC's railroad operations is present. It is difficult to estimate the Company's liability for remediation costs at these sites for a number of reasons, including the number and financial resources of other potentially responsible parties involved at a given site, the varying availability of evidence by which to allocate responsibility among such parties, the wide range of costs for possible remediation alternatives, changing technology and the period of time over which these matters develop. Nevertheless, the Company believes that its previously established loss accruals for potential pre-reorganization\nenvironmental liabilities at such sites are adequate to cover the probable amount of such liabilities, based on the Company's estimates of remediation costs and related expenses at such sites and its estimates of the portions of such costs that will be borne by other parties. Such estimates are based on information currently available to the Company and are subject to future change as additional information becomes available. Such estimates do not assume any recovery from the Company's insurance carriers, although the Company does intend to seek reimbursement from certain insurers for such remediation costs as the Company incurs.\nIn terms of potential liability to the Company, the Company believes that the most significant such site is the railyard at Paoli, Pennsylvania (\"Paoli Yard\") which PCTC transferred to Consolidated Rail Corporation (\"Conrail\") in 1976. A Record of Decision issued by the U.S. Environmental Protection Agency in 1992 presented a final selected remedial action for clean-up of polychlorinated biphenyls (\"PCB's\") at Paoli Yard having an estimated cost of approximately $28 million. The Company has accrued its portion of such estimated clean-up costs in its financial statements (in addition to related expenses) but has not accrued the entire amount because it believes it is probable that other parties, including Conrail, will be responsible for substantial percentages of the clean-up costs by virtue of their operation of electrified railroad cars at Paoli Yard that discharged PCB's at higher levels than discharged by cars operated by PCTC.\nIn management's opinion, the outcome of the foregoing environmental claims and contingencies will not, individually or in the aggregate, have a material adverse effect on the financial condition of the Company. In making this assessment, management has taken into account previously established loss accruals in its financial statements and probable recoveries from third parties.\nPART II\nITEM 5\nMarket for Registrant's Common Equity and Related Stockholder Matters\nNot applicable - All of Registrant's outstanding Common Stock is owned by American Financial Group, Inc.\nITEM 6\nSelected Financial Data\nThe following table sets forth certain data for the periods indicated (dollars in millions). Year-to-year comparisons are affected by business dispositions, restructuring provisions and other non-recurring items.\n1995 1994 1993 1992 1991\nEarnings Statement Data (a): Net Written Premiums $1,492 $1,636 $1,379 $1,067 $ 865\nTotal Revenues 1,736 1,759 1,736 1,420 1,272\nEarnings from Continuing Operations before Income Taxes 113 41 190 84 79\nEarnings (loss) from: Continuing Operations 67 1 243 51 50 Discontinued Operations - (1) (11) 1 (47) Extraordinary Items (5) - - - - Cumulative Effect of Accounting Change - - - 253 - Net Earnings 62 - 232 305 3\nBalance Sheet Data: Total Assets $3,955 $4,197 $4,053 $3,493 $3,369\nUnpaid Losses and Loss Adjustment Expenses, Unearned Premiums and Policyholder Dividends 1,684 1,674 1,426 1,069 890\nLong-term Debt: Parent Company 321 500 516 650 650 Subsidiaries 9 10 10 10 20\nCommon Shareholder's Equity 1,552 1,549 1,722 1,503 1,479\n(a) Amounts above include the following pretax items for the years indicated: 1994 - Loss on sale of General Cable securities ($76 million). 1993 - Tax benefit attributable to an increase in the Company's net deferred tax asset ($132 million); Gain on sale of equity investments ($99 million); Provision for asset impairment ($20 million); Loss on sale of subsidiaries ($22 million). 1991 - Provision for asset impairment ($21 million).\nITEM 7\nManagement's Discussion and Analysis of Financial Condition and Results of Operations\nGENERAL\nFollowing is a discussion and analysis of the financial statements and other statistical data that management believes will enhance the understanding of the Company's financial condition and results of operations. This discussion should be read in conjunction with the financial statements beginning on page.\nIn April 1995, the Company became a wholly-owned subsidiary of American Premier Group, Inc., a new corporation formed by the Company for the purpose of acquiring all of the common stock of the Company and American Financial Corporation (the \"Mergers\"). In June 1995, American Premier Group changed its name to American Financial Group, Inc. (\"AFG\"). Under terms of the Mergers, (a) the Company merged with a subsidiary of AFG and each share of Company Common Stock then outstanding was converted into one share of AFG Common Stock, and (b) American Financial Corporation (\"AFC\") merged with another subsidiary of AFG and all shares of AFC common stock were exchanged for 28.3 million shares of AFG Common Stock. As a result of the Mergers, all of the common stock of the Company and AFC is owned by AFG and AFG is the Company's successor as the issuer of publicly held common stock.\nThe Company's insurance operations consist primarily of a group of nonstandard private passenger automobile insurance companies (the \"NSA Group\") and a business which sells workers' compensation insurance principally in California (\"Republic Indemnity\").\nDuring 1995, in connection with its previously announced divestiture effort, the Company completed the sale of its last industrial business. In addition, in March 1996 the Company sold its investment in a subsidiary which holds a 2% general partnership interest in an independent pipeline common carrier of refined petroleum products. See Note C of Notes to Financial Statements.\nLIQUIDITY AND CAPITAL RESOURCES\nRatios The following ratios may be considered relevant indicators of the Company's liquidity and are typically presented by the Company in its prospectuses and similar documents. Management believes that balance sheet ratios (debt-to-equity) are more meaningful on a parent only basis. On the other hand, earnings statement ratios (fixed charges) are more meaningful on a total enterprise basis since the parent only ratio is dependent, to a great degree, on the discretionary nature of dividend payments from subsidiaries.\nThe ratio of the Company's (parent-only) long-term debt to total capital was 17%, 24% and 23% at December 31, 1995, 1994 and 1993, respectively. The Company's ratio of earnings to fixed charges on a total enterprise basis was 3.35, 1.72 and 3.83 for the years ended December 31, 1995, 1994 and 1993, respectively.\nThe National Association of Insurance Commissioners' model law for risk based capital (\"RBC\") determines the amount of capital that an insurance company needs to ensure that it has an acceptable expectation of not becoming financially impaired. At December 31, 1995, the capital ratios of all of the Company's insurance companies substantially exceeded the RBC requirements.\nSources of Funds American Premier is organized as a holding company with almost all of its operations being conducted by subsidiaries. The parent corporation, however, has continuing cash needs for administrative expenses, the payment of principal and interest on borrowings and common stock dividends. Thus, the Company relies primarily on dividends and tax payments from its subsidiaries for funds to meet its obligations.\nPrior to the Mergers, the Company had substantial cash and short-term investments at the parent company level. Subsequent to the Mergers, the Company repurchased approximately $180 million of its subordinated notes and made loans to AFC under a formal credit agreement. At December 31, 1995, amounts outstanding under the AFC agreement totaled $623.2 million. In addition, the Company entered into a formal credit agreement with AFG. At December 31, 1995, amounts payable to AFG under the AFG agreement totaled $84.0 million.\nIn December 1995, Pennsylvania Company (\"Pennco\"), a wholly-owned subsidiary of the Company, entered into a new collateralized five-year reducing revolving credit agreement with several banks, under which it can borrow up to $75 million. At December 31, 1995, the Company had no outstanding borrowings under the agreement.\nThe Company's federal income tax loss carryforward is available to offset taxable income and, as a result, the Company's requirement to pay federal income tax for 1996 is substantially eliminated.\nUncertainties The Company and its subsidiaries are parties in a number of proceedings relating to former operations. See Note K of Notes to Financial Statements. While the results of all such uncertainties cannot be predicted, based upon its knowledge of the facts, circumstances and applicable laws, management believes that sufficient reserves have been provided.\nInvestments Approximately half of the Company's consolidated assets are invested in marketable securities. The Company attempts to optimize investment income while building the value of its portfolio, placing emphasis upon long-term performance. The Company's goal is to maximize return on an ongoing basis rather than focusing on year-by-year performance.\nFixed income investment funds are generally invested in securities with short-term and intermediate-term maturities with an objective of optimizing total return while allowing flexibility to react to changes in market conditions. At December 31, 1995, the average life of the Company's bonds and redeemable preferred stocks was approximately 6 years.\nApproximately 94% of the bonds and redeemable preferred stocks held by the Company were rated \"investment grade\" (credit rating of AAA to BBB) by nationally recognized rating agencies at December 31, 1995. Investment grade securities generally bear lower yields and lower degrees of risk than those that are unrated and non-investment grade. Management believes that the high quality investment portfolio should generate a stable and predictable investment return.\nAt December 31, 1995, the Company's mortgage-backed securities (\"MBSs\"), represented approximately 10% of the Company's bonds and mandatory redeemable preferred stocks. The Company invests primarily in MBSs which are structured to minimize prepayment risk. In addition, the majority of MBSs held by the Company were purchased at discounts to par value. Management believes that the structure and discounted nature of the\nMBSs will minimize the effect of prepayments on earnings over the anticipated life of the MBS portfolio. Substantially all of the Company's MBSs are rated \"AAA\" by Standard & Poor's Corporation and are collateralized primarily by GNMA, FNMA and FHLMC single-family residential pass-through certificates. The market in which these securities trade is highly liquid. Aside from interest rate risk, the Company does not believe a material risk (relative to earnings and liquidity) is inherent in holding such investments.\nRESULTS OF OPERATIONS - THREE YEARS ENDED DECEMBER 31, 1995\nGeneral Pretax earnings were $113 million in 1995 compared to $41 million in 1994 and $190 million in 1993.\nResults for 1995 include a $76 million decrease in underwriting results of the Company's insurance operations and an $8 million decrease in portfolio interest and dividend income. These items were partially offset by $45 million of interest income from loans to AFC, $24 million in realized gains on the sales of securities and an $8 million decrease in interest on borrowed money.\nResults for 1994 include a $76 million loss on the sale of General Cable securities and a $4 million loss on the anticipated sale of one of the Company's non-insurance businesses. These items were partially offset by a $26 million increase in investment income (excluding $25 million of interest income on the General Cable notes recorded in 1993) and a $10 million decrease in interest on borrowed money.\nResults for 1993 include $99 million in gains from the sales of the Company's shares of Tejas Gas Corporation and limited partnership units of Buckeye Partners L.P., a $22 million improvement in underwriting results of the Company's insurance operations and a $13 million increase in interest income on the General Cable notes. These items were partially offset by a $42 million loss recorded on the anticipated sale of the Company's non-insurance operations.\nProperty and Casualty Insurance - Underwriting Underwriting profitability is measured by the combined ratio which is a sum of the ratio of underwriting expenses, losses, and loss adjustment expenses to premiums. When the combined ratio is under 100%, underwriting results are generally considered profitable; when the ratio is over 100%, underwriting results are generally considered unprofitable. The combined ratio does not reflect investment income, other income or federal income taxes.\nThe Company manages and operates its property and casualty business as two major sectors. The NSA Group is a group of nonstandard automobile insurance companies which underwrite physical damage and liability policies for \"nonstandard risks.\" Nonstandard insureds are those individuals who are unable to obtain insurance through standard market carriers due to factors such as age, record of prior accidents, driving violations, particular occupation or type of vehicle. Republic Indemnity is engaged in the sale of workers' compensation insurance in California and, to a lesser extent, in Arizona. Workers' compensation policies provide coverage for statutory prescribed benefits that employers are required to pay employees who are injured in the course of employment and for an employer's liability for losses suffered by its employees which are not included within the statutory prescribed workers' compensation coverage.\nResults for the Company's property and casualty insurance subsidiaries are as follows (dollars in millions):\nYear ended December 31, 1995 1994 1993 Net Written Premiums (GAAP) NSA Group $1,203.2 $1,154.1 $ 901.9 Republic Indemnity 287.5 479.5 465.8 Other Lines 1.6 1.9 11.2 $1,492.3 $1,635.5 $1,378.9\nCombined Ratios (GAAP) NSA Group 105.7% 99.8% 97.0% Republic Indemnity 87.9% 91.1% 94.7% Aggregate 102.0% 97.0% 96.2%\nNSA Group The NSA Group attributes its premium growth in recent years primarily to entry into additional states, increased market penetration in its existing states, overall growth in the nonstandard market, premium rate increases and the purchase of Leader National in May 1993. The increase in the combined ratio for 1995 compared with 1994 was due primarily to inadequate rate levels in certain markets and weather-related losses principally from hailstorms in Texas (1.3 points in the combined ratio). These factors were partially offset by a reduction in the underwriting expense ratio due largely to cost control measures.\nUnderwriting conditions in the private passenger automobile insurance marketplace in 1994 were affected by competitive conditions and the pricing policies of insurers. Also, improving economic conditions contributed to increased driving activity resulting in an increase in the frequency of accidents and severity of claims. These trends caused a deterioration in the NSA Group's underwriting profit margins during 1994. These factors were partially offset by underwriting profit from the NSA Group's entry into certain markets, as well as improved underwriting margins in several markets where the book of business matured and a greater portion of new premium was derived from renewal policies.\nPremium rate increases were implemented in several states during 1994 and 1995. Rate increases implemented in various states during 1995 averaged approximately 10% across the NSA Group's entire book of business. The higher rate levels and competitive pressures in the nonstandard automobile insurance industry adversely impacted premium growth during 1995.\nRepublic Indemnity The decline in California workers' compensation premiums reflects the impact of mandatory premium rate reductions which were phased in over the course of policy terms during 1994 and 1995, and extremely competitive pricing in the marketplace as a result of the repeal of the California workers' compensation minimum rate law effective January 1, 1995. As a consequence of the repeal of this law, Republic's rate levels reflect the change in its mix of business toward non-participating policies which do not require the payment of policyholder dividends. Management expects this change toward non-participating policies to continue. Despite lower premium volume, the combined ratio decreased in 1995 as compared to 1994 mainly because of lower policyholder dividends and a reduction in the amount of policyholder dividends estimated to be incurred, partially offset by an increase in the frequency of claims. Also, the underwriting expense ratio increased for 1995 due primarily to the decline in premiums.\nInvestment Income Changes in investment income reflect fluctuations in market rates and changes in average invested assets.\n1995 compared to 1994 Excluding interest income of $45 million earned in 1995 on amounts due from affiliates, investment income decreased $8 million (5%) due to a decrease in average investments held.\n1994 compared to 1993 Excluding interest income of $25 million on the General Cable notes recorded in 1993, investment income increased $26 million (18%) in 1994 due primarily to an increase in average investments held.\nInvestee Corporations Equity in net earnings (losses) of investee corporations (companies in which the Company owns a significant portion of the voting stock) in 1995 represents the Company's proportionate share of the losses of Chiquita Brands. The Company purchased 3.2 million shares of Chiquita common stock from AFC during the second quarter of 1995.\nOther Income Other income includes revenues from coal, oil and gas properties and gains and losses from real estate sales.\nSales of Other Products and Services Sales of other products and services represents the Company's revenues from its non- insurance businesses, substantially all of which have been sold.\nInterest on Borrowed Money Changes in interest expense result from changes in levels of borrowings. The Company has generally financed its borrowings on a long-term basis which has resulted in higher current costs.\n1995 compared to 1994 Interest expense decreased by $8.3 million (16%) due primarily to the Company's repurchase throughout 1995 of $180 million principal amount of its Subordinated notes.\n1994 compared to 1993 Interest expense decreased by $9.6 million (15%) due primarily to the Company's repurchase of $133 million principal amount of its 11% debentures during the 1993 third quarter.\nProvision for Asset Impairment Provision for asset impairment includes expected losses associated with the intended divestitures of the Company's non-insurance investments.\nOther Operating and General Expenses Operating and general expenses included $39.3 million and $98.6 million in 1994 and 1993, respectively, from divested, non-insurance subsidiaries.\nIncome Taxes See Note J of Notes to Financial Statements for an analysis of the Company's deferred tax asset and other items affecting the Company's effective tax rate.\nThe 1994 provision for income tax reflects less than full realization of the tax benefit attributable to the net realized capital loss recorded in that period. The 1993 income tax benefit was attributable to an increase of $132 million in the Company's net deferred tax asset due to revisions to the estimated future taxable income during the Company's tax loss carryforward period.\nITEM 8\nFinancial Statements and Supplementary Data\nPage Number\nReport of Independent Auditors\nReport of Prior Years' Independent Auditors\nAmerican Premier Underwriters, Inc. and Subsidiaries:\nConsolidated Balance Sheet- December 31, 1995 and 1994\nConsolidated Statement of Earnings- For the years ended December 31, 1995, 1994 and 1993\nConsolidated Statement of Cash Flows- For the years ended December 31, 1995, 1994 and 1993\nNotes to Consolidated Financial Statements\n\"Selected Quarterly Financial Data\" has been included in Note O to the Consolidated Financial Statements.\nITEM 9\nChanges in and Disagreements with Accountants on Accounting and Financial Disclosure\nThe Company filed a report on Form 8-K on August 29, 1995, reporting a change in its independent accountants. The report is incorporated herein by reference.\nPART III\nITEM 10\nDirectors and Executive Officers of the Registrant\nThe directors and executive officers of the Company at March 1, 1996 were as follows:\nExecutive Executive Name Age Position Since\nCarl H. Lindner 76 Chairman of the Board and Chief Executive Officer 1982 Carl H. Lindner III 42 President and a Director 1991 S. Craig Lindner 40 Vice Chairman of the Board 1995 Keith E. Lindner 36 Vice Chairman of the Board 1995 Theodore H. Emmerich 69 Director 1988 James E. Evans 50 Senior Vice President, General Counsel and a Director 1985 Thomas M. Hunt 72 Director 1982 William R. Martin 66 Director 1994 Alfred W. Martinelli 68 Director (resigned March 20, 1996) 1982 Neil M. Hahl 47 Senior Vice President 1982 Thomas E. Mischell 48 Senior Vice President - Taxes 1995 Fred J. Runk 53 Senior Vice President and Treasurer 1995\nCarl H. Lindner has been Chairman of the Board and Chief Executive Officer of the Company for more than five years. Mr. Lindner is Chairman of the Board and Chief Executive Officer of AFG, the Company's parent, and has been Chairman of the Board and Chief Executive Officer of AFC since it was founded over 35 years ago. Mr. Lindner serves as Chairman of the Board of the following additional companies: American Annuity Group, Inc. (\"AAG\"), American Financial Enterprises, Inc. (\"AFEI\"), Chiquita Brands International, Inc. (\"Chiquita\") and Citicasters Inc. (\"Citicasters\"). Carl H. Lindner is the father of Carl H. Lindner III, S. Craig Lindner and Keith E. Lindner.\nCarl H. Lindner III was elected President of the Company in February 1992. He is President and a director of AFG and AFC. He has also been President of Great American Insurance Company for more than five years.\nS. Craig Lindner is a Vice Chairman of the Board of the Company. He is also a Vice Chairman of AFG and AFC. He has been President of AAG since 1993 and President of American Money Management Corporation (\"AMMC\"), an AFG subsidiary providing investment services to the Company and certain of its affiliates, since January 1996. He had been Senior Executive Vice President of AMMC for more than five years. Mr. Lindner is also a director of AAG and Citicasters.\nKeith E. Lindner is a Vice Chairman of the Board of the Company. He is also a Vice Chairman of AFG and AFC. He has been President, Chief Operating Officer and a director of Chiquita for more than five years.\nTheodore H. Emmerich is a retired managing partner of Ernst & Young LLP, certified public accountants, Cincinnati, Ohio. He is also a director of AFG, AFC, Citicasters, Carillon Fund, Inc., Carrillon Investment Trust, Gradison-McDonald Municipal Custodian Trust, Gradison-McDonald Cash Reserve Trust and Summit Investment Trust.\nJames E. Evans is Senior Vice President, General Counsel and a director of the Company. He is also Senior Vice President, General Counsel and a director of AFG and AFC. He has also served as Vice President and General Counsel of AFC for more than five years. Mr. Evans is also a director of AFEI and Citicasters.\nThomas M. Hunt has been Chairman of the Board of Hunt Petroleum Corporation, an oil and gas production company, for more than five years. He is also a director of AFG and AFC.\nWilliam R. Martin has been Chairman of the Board of MB Computing, Inc., a computer software and services company, for more than five years. He is also a director of AFG, AFC and AAG.\nNeil M. Hahl has been a Senior Vice President of the Company for more than five years. He is also a Senior Vice President of AFG.\nThomas E. Mischell is Senior Vice President - Taxes of the Company. He is also Senior Vice President - Taxes of AFG. He has served as a Vice President of AFC for more than five years.\nFred J. Runk is Senior Vice President and Treasurer of the Company. He is also Senior Vice President and Treasurer of AFG. He has served as Vice President and Treasurer of AFC for more than five years.\nIn December 1993, Great American Communications Company, which subsequently changed its name to Citicasters Inc., completed a comprehensive financial restructuring that included a prepackaged plan of reorganization filed in November of that year under Chapter 11 of the Bankruptcy Code. Carl H. Lindner, Thomas E. Mischell and Fred J. Runk had been executive officers of that company within two years before its bankruptcy reorganization.\nThe information required by the following Items will be provided within 120 days after the end of Registrant's fiscal year.\nITEM 11 Executive Compensation\nITEM 12 Security Ownership of Certain Beneficial Owners and Management\nITEM 13 Certain Relationships and Related Transactions\nREPORT OF INDEPENDENT AUDITORS\nBoard of Directors American Premier Underwriters, Inc.\nWe have audited the accompanying consolidated balance sheet of American Premier Underwriters, Inc. and subsidiaries as of December 31, 1995 and the related consolidated statements of earnings and cash flows for the year then ended. Our audit 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 audit.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of American Premier Underwriters, Inc. and subsidiaries as of December 31, 1995, and the consolidated results of their operations and their cash flows for the year then ended, in conformity with generally accepted accounting principles. Also, in our opinion, the related 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\nCincinnati, Ohio March 15, 1996\nREPORT OF PRIOR YEARS' INDEPENDENT AUDITORS\nAmerican Premier Underwriters, Inc.\nWe have audited the financial statements and the financial statement schedules of American Premier Underwriters, Inc. and Consolidated Subsidiaries listed in the Index to Financial Statements and Financial Statement Schedules of American Premier Underwriters, Inc.'s Form 10-K for the year ended December 31, 1994 (not presented separately herein). These financial statements and the financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements and financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, such financial statements present fairly, in all material respects, the financial position of American Premier Underwriters, Inc. and Consolidated Subsidiaries at December 31, 1994 and the results of its operations and its cash flows for each of the two 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 shown therein.\nDELOITTE & TOUCHE LLP\nCincinnati, Ohio February 15, 1995 (March 23, 1995 with respect to the acquisition of American Financial Corporation as discussed in Note B to the financial statements)\nAMERICAN PREMIER UNDERWRITERS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET (In Millions)\nSee notes to consolidated financial statements.\nAMERICAN PREMIER UNDERWRITERS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF EARNINGS (In Millions)\nSee notes to consolidated financial statements.\nAMERICAN PREMIER UNDERWRITERS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS (In Millions)\nSee notes to consolidated financial statements.\nAMERICAN PREMIER UNDERWRITERS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nINDEX TO NOTES\nA. Accounting Policies I. Capital Stock B. Mergers J. Income Taxes C. Divestitures K. Contingencies D. Investments L. Insurance Operations E. Amounts Due from Affiliates M. Statement of Cash Flows F. Cost in Excess of Net Assets N. Transactions With Affiliates Acquired O. Quarterly Operating Results G. Long-Term Debt P. Other Information H. Benefit Plans Q. Subsequent Event\nA. Accounting Policies\nBasis of Presentation The consolidated financial statements include the accounts of the Company and its subsidiaries, with the exception of the Company's defense services operations sold in 1993 which have been classified as discontinued operations. The Company's only industry segment is specialty property and casualty insurance, the operations of which are located primarily within the United States. Certain reclassifications have been made to prior years to conform to the current year's presentation. All significant intercompany balances and transactions have been eliminated. All acquisitions have been treated as purchases. The results of operations of companies since their formation or acquisition are included in the consolidated financial statements.\nThe preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Changes in circumstances could cause actual results to differ materially from those estimates.\nInvestments Debt securities are classified as \"held to maturity\" and reported at amortized cost if the Company has the positive intent and ability to hold them to maturity. Debt and equity securities are classified as \"available for sale\" and reported at fair value with unrealized gains and losses reported as a separate component of shareholders' equity if the debt or equity securities are not classified as held to maturity or bought and held principally for selling in the near term. Only in certain limited circumstances, such as significant issuer credit deterioration or if required by insurance or other regulators, may a company change its intent to hold a certain security to maturity without calling into question its intent to hold other debt securities to maturity in the future.\nIn accordance with guidance issued by the Financial Accounting Standards Board in November 1995, the Company reassessed the classifications of its investments and transferred fixed maturity securities with an amortized cost of approximately $839 million to \"available for sale.\" This \"one-time\" reclassification resulted in an increase of $43 million in carrying value of fixed maturity investments and an increase of $28 million in shareholders' equity. The transfer had no effect on net earnings.\nAMERICAN PREMIER UNDERWRITERS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nPremiums and discounts on mortgage-backed securities are amortized over their expected average lives using the interest method. Gains or losses on sales of securities are recognized at the time of disposition with the amount of gain or loss determined on the specific identification basis. When a decline in the value of a specific investment is considered to be other than temporary, a provision for impairment is charged to earnings and the carrying value of that investment is reduced.\nThe Company's investments in equity securities of companies that are 20% to 50% owned by AFG and its subsidiaries are carried at cost, adjusted for a proportionate share of their undistributed earnings or losses.\nShort-term investments are carried at cost; loans receivable are stated primarily at the aggregate unpaid balance.\nCost in Excess of Net Assets Acquired The excess of cost of subsidiaries over the Company's equity in the underlying net assets (\"goodwill\") is being amortized over 40 years.\nThe Company's management continually monitors whether significant changes in certain industry and regulatory conditions or prolonged trends of declining profitability have occurred which would lead the Company to question the recoverability of the carrying value of its goodwill. The Company's evaluation of its recorded goodwill would be based primarily on estimates of future earnings, as well as all other available factors which may provide additional evidence relevant to the assessment of recoverability of its goodwill.\nInsurance As discussed under \"Reinsurance\" below, unpaid losses and loss adjustment expenses and unearned premiums have not been reduced for reinsurance receivable.\nReinsurance In the normal course of business, the Company's insurance subsidiaries cede reinsurance to other companies to diversify risk and limit maximum loss arising from large claims. To the extent that any reinsuring companies are unable to meet obligations under the agreements covering reinsurance ceded, the Company's insurance subsidiaries would remain liable. Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsurance policies. The Company's insurance subsidiaries report as assets (a) the estimated reinsurance recoverable on unpaid losses, including an estimate for losses incurred but not reported, and (b) amounts paid to reinsurers applicable to the unexpired terms of policies in force. The Company's insurance subsidiaries also assume reinsurance from other companies. Income on reinsurance assumed is recognized based on reports received from ceding reinsurers.\nDeferred Policy Acquisition Costs Policy acquisition costs (principally commissions, premium taxes and other underwriting expenses) related to the production of new business are deferred. The deferral of acquisition costs is limited based upon their recoverability without any consideration for anticipated investment income. Deferred policy acquisition costs are charged against income ratably over the terms of the related policies.\nUnpaid Losses and Loss Adjustment Expenses The net liabilities stated for unpaid claims and for expenses of investigation and adjustment of unpaid claims are based upon (a) the accumulation of case estimates for losses reported prior to the close of the accounting period on the direct business\nAMERICAN PREMIER UNDERWRITERS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nwritten; (b) estimates received from ceding reinsurers and insurance pools and associations; (c) estimates of unreported losses based on past experience and (d) estimates based on experience of expenses for investigating and adjusting claims. These liabilities are subject to the impact of changes in claim amounts and frequency and other factors. In spite of the variability inherent in such estimates, management believes that the liabilities for unpaid losses and loss adjustment expenses are adequate. Changes in estimates of the liabilities for losses and loss adjustment expenses are reflected in the Statement of Earnings in the period in which determined.\nPremium Recognition Premiums are earned over the terms of the policies on a pro rata basis. Unearned premiums represent that portion of premiums written which is applicable to the unexpired terms of policies in force. On reinsurance assumed from other insurance companies or written through various underwriting organizations, unearned premiums are based on reports received from such companies and organizations.\nPolicyholder Dividends Dividends payable to policyholders represent management's estimate of amounts payable on participating policies which share in favorable underwriting results. The estimate is accrued during the period in which the related premium is earned. Changes in estimates are included in the Statement of Earnings in the period determined. Policyholder dividends do not become legal liabilities unless and until declared by the boards of directors of the insurance companies.\nCapital Surplus Adjustments to claims and contingencies arising from events or circumstances preceding the Company's 1978 reorganization are reflected in capital surplus if the adjustments are not clearly attributable to post-reorganization events or circumstances. Such pre-reorganization claims and contingencies consist principally of personal injury claims by former employees of the Company's predecessor and claims relating to the generation, disposal or release into the environment of allegedly hazardous substances arising out of railroad operations disposed of prior to the 1978 reorganization.\nFair Value of Financial Instruments Methods and assumptions used in estimating fair values are described in Note P. These fair values represent point-in-time estimates of value that might not be particularly relevant in predicting the Company's future earnings or cash flows.\nStatement of Cash Flows For cash flow purposes, \"investing activities\" are defined as making and collecting loans and acquiring and disposing of debt or equity instruments and property and equipment. \"Financing activities\" include obtaining resources from owners and providing them with a return on their investments, borrowing money and repaying amounts borrowed. All other activities are considered \"operating\". Short-term investments having original maturities of three months or less when purchased are considered to be cash equivalents for purposes of the financial statements.\nB. Mergers\nIn April 1995, the Company became a wholly-owned subsidiary of American Premier Group, Inc., a new corporation formed by the Company for the purpose of acquiring all of the common stock of the Company and American Financial Corporation (the \"Mergers\"). In June 1995, American Premier Group changed its name to American Financial Group, Inc. (\"AFG\"). Under terms of the Mergers, (a) the Company merged with a subsidiary of AFG and each share\nAMERICAN PREMIER UNDERWRITERS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nof Company Common Stock then outstanding was converted into one share of AFG Common Stock, and (b) American Financial Corporation (\"AFC\") merged with another subsidiary of AFG and all shares of AFC common stock were exchanged for 28.3 million shares of AFG Common Stock. As a result of the Mergers, all of the common stock of the Company and AFC is owned by AFG and AFG is the Company's successor as the issuer of publicly held common stock.\nIn connection with the Mergers, AFG reviewed the classification of all securities held by its subsidiaries. As a result, all securities held by the Parent Company and 44% of those held by the Company's insurance subsidiaries at the date of the Mergers were classified as \"available for sale.\" These classifications reflect transfers from \"held to maturity\" of $273 million for the Parent Company and $274 million for the Insurance companies. The cost of securities transferred approximated market value.\nC. Divestitures\nSale of Non-insurance Businesses The intended divestitures of businesses announced in December 1992 included five small diversified industrial companies, four of which were sold during 1993 and 1994 for aggregate proceeds of $30.9 million. The remaining business was sold in February 1995 for cash and notes of approximately $13 million, net of expenses and post-closing adjustments. A provision of $4.0 million for the anticipated loss on this sale was recorded in 1994.\nIn 1994, the Company sold its 53.5% interest in operations which provided onshore oil and gas contract drilling and well workover services for $14.5 million in cash. No gain or loss was recognized on the transaction.\nIn 1993, the Company sold its investment in Tejas Gas Corporation (\"Tejas\") in an underwritten public offering for net proceeds of $106.6 million. The Company's pretax gain from the sale was approximately $80.0 million.\nIn 1993, the Company sold its limited partnership interest in Buckeye Partners, L.P. (\"Buckeye Units\") in an underwritten public offering for net proceeds of $71.6 million. The Company's pretax gain from the sale was approximately $18.5 million.\nSale of General Cable Corporation Securities As part of the 1992 spin-off of General Cable Corporation, the Company retained a $255 million 9.98% subordinated note due 2007 issued by General Cable (the \"General Cable Note\") and approximately 11.6% of the General Cable shares (\"Retained Shares\"). During 1993, General Cable paid the $31.8 million of interest due on the General Cable Note with additional 9.98% subordinated notes (\"Interest Notes\") in lieu of cash.\nIn February 1994, as a result of General Cable's sale of its Marathon LeTourneau unit to a subsidiary of Rowan Companies, Inc. (\"Rowan\"), General Cable delivered to the Company cash and promissory notes issued by Rowan totalling $52.1 million as a partial payment of the General Cable Note and Interest Notes (collectively, the \"General Cable Notes\"). As a result of these receipts, the Company credited General Cable with $48.1 million of principal and interest on the General Cable Notes.\nAMERICAN PREMIER UNDERWRITERS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nIn June 1994, as part of an agreement for the purchase of all of the outstanding shares of General Cable by Wassall PLC (\"Wassall\"), the Company sold to Wassall the then outstanding $253.5 million principal amount of the General Cable Notes and the Retained Shares for $169.8 million and $6.9 million, respectively. The Company recorded a loss of approximately $75.8 million in 1994 on the disposition, and the Company did not accrue any interest income on the General Cable Notes during 1994. Also as part of the agreement, the Company received a $19.2 million payment from Wassall in consideration of assuming responsibility for certain actual and potential environmental and other liabilities. Immediately prior to the sale of General Cable, AFC, which at that time owned 40.5% of the Company's common stock, also owned 45.6% of the outstanding common stock of General Cable. The Chairman of the Board and Chief Executive Officer of the Company was the Chairman of the Board of General Cable.\nDiscontinued Operations In 1993, the Company sold its defense services operations to an unaffiliated company and recognized a loss of approximately $13.5 million from the sale. Revenues, pretax income and net income of discontinued operations for 1993 amounted to $275 million, $4.8 million and $2.8 million, respectively.\nD. Investments Bonds, redeemable preferred stocks and other stocks at December 31, consisted of the following (in millions):\nAMERICAN PREMIER UNDERWRITERS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nThe table below sets forth the scheduled maturities of bonds and redeemable preferred stocks based on carrying value as of December 31, 1995. Data based on market value is generally the same. Mortgage-backed securities had an average life of approximately 4 years at December 31, 1995.\nHeld to Available Maturity Maturity for Sale One year or less 9% 3% After one year through five years 28 26 After five years through ten years 34 51 After ten years 5 13 76 93 Mortgage-backed securities 24 7 100% 100%\nRealized gains (losses) and changes in unrealized appreciation (depreciation) on fixed maturity and equity security investments are summarized as follows (in millions):\nFixed Equity Tax Maturities Securities Effects Total Realized $ 23.8 $ - $ (9.1) $ 14.7 Change in Unrealized 184.3 .7 (27.2) 157.8\nRealized .1 - - .1 Change in Unrealized (192.9) (1.1) 30.4 (163.6)\nRealized 14.7 108.6 (57.5) 65.8 Change in Unrealized 42.3 (.2) (14.7) 27.4\nTransactions in fixed maturity investments included in the Statement of Cash Flows for 1995 consisted of the following (in millions):\nHeld to Available Maturity for Sale Total\nPurchases $196.0 $318.9 $514.9 Maturities and redemptions 232.9 39.4 272.3 Sales - 851.0 851.0 Gross Gains 4.8 25.2 30.0 Gross Losses (1.9) (4.3) (6.2)\nHeld to Available Maturity for Sale Total\nPurchases $337.5 $508.8 $846.3 Maturities and redemptions 144.0 15.8 159.8 Sales 5.9 65.0 70.9 Gross Gains .2 3.2 3.4 Gross Losses (.1) (3.2) (3.3)\nSecurities classified as \"held to maturity\" having an amortized cost of $5.8 million were sold for a gain of $.1 million in 1994, due to significant deterioration in the issuers' creditworthiness.\nGross gains of $15.6 million and gross losses of $.9 million were realized on sales of fixed maturity investments in 1993.\nAMERICAN PREMIER UNDERWRITERS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nMajor categories of net investment income were as follows (in millions):\n1995 1994 1993\nFixed maturities $164.2 $171.1 $138.8 Loans to affiliates 44.0 - - Equities .2 .1 4.3 Other - .4 28.6 Total investment income 208.4 171.6 171.7 Investment expenses (3.0) (3.3) (3.6) Net investment income $205.4 $168.3 $168.1\nThe Company's investment in investee corporation reflects the Company's 6% ownership (3.2 million shares) of the common stock of Chiquita Brands International, Inc. (\"Chiquita\") which is accounted for under the equity method. AFG and its other subsidiaries own an additional 38% of the common stock of Chiquita. Chiquita is a leading international marketer, processor and producer of quality food products. The market value of the Company's investment in Chiquita was approximately $44.5 million at December 31, 1995.\nE. Amounts Due from Affiliates\nSubsequent to the Mergers, the Company entered into a credit agreement under which loans are available to AFC of up to $675 million (the \"AFC Credit Agreement\"). The credit line bears interest at 11-5\/8% and converts to a four-year term loan in March 2005 with scheduled principal payments to begin in April 2005. At December 31, 1995, amounts outstanding under the AFC Credit Agreement totalled $623.2 million, plus $16.3 million of accrued interest.\nAlso subsequent to the Mergers, the Company entered into a credit agreement with AFG under which the Company and AFG will make loans of up to $125 million available to each other (the \"AFG Credit Agreement\"). The balance outstanding under the credit line bears interest at a variable rate of one percent over LIBOR and is payable on December 31, 2010. At December 31, 1995, amounts payable to AFG under the AFG Credit Agreement totalled $84.0 million, plus $1.1 million of accrued interest.\nF. Cost in Excess of Net Assets Acquired At December 31, 1995 and 1994, accumulated amortization of the excess of cost over net assets of purchased subsidiaries amounted to approximately $63 million and $53 million, respectively. Amortization expense was $11.8 million in 1995, $11.4 million in 1994 and $10.5 million in 1993.\nG. Long-Term Debt\nLong-term debt consisted of the following at December 31, (in millions):\n1995 1994 Parent Company: Subordinated notes, 10 7\/8%, due 2011 $ 50.5 $150.0 Subordinated notes, 10 5\/8%, due 2000 113.0 150.0 Subordinated notes, 9 3\/4%, due 1999 157.1 200.0 320.6 500.0 Subsidiaries: Other 9.1 9.8 Total $329.7 $509.8\nAMERICAN PREMIER UNDERWRITERS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nIn December 1995, Pennsylvania Company (\"Pennco\"), a wholly-owned subsidiary of the Company, entered into a new collateralized five- year reducing revolving credit agreement with several banks, under which it can borrow up to $75 million. Borrowings bear interest at floating rates based on prime or LIBOR and are collateralized by certain stock of an operating subsidiary. At December 31, 1995, the Company had no outstanding borrowings under the agreement.\nIn May 1995, rating agencies downgraded the Company's subordinated notes (the \"Notes\"). As a result of the Mergers and the subsequent ratings downgrade, the holders of the Notes had the right to require the Company to purchase all or any portion of the Notes on August 10, 1995 at par plus accrued interest (the \"Put Right\"). The Put Right was exercised for approximately $40 million of the 9-3\/4% Notes and approximately $4 million of the other two issues.\nIn addition, during 1995, the Company repurchased $2.9 million of its 9-3\/4% subordinated notes, $34.8 million of its 10-5\/8% subordinated notes and $98.3 million of its 10-7\/8% subordinated notes for approximately $142.7 million which resulted in an extraordinary loss of $5.1 million. During the first two months of 1996, the Company repurchased an additional $19.0 million of its 9-3\/4% subordinated notes, $7.5 million of its 10-5\/8% subordinated notes and $2.2 million of its 10-7\/8% subordinated notes.\nIn March 1994, the Company redeemed all $16.2 million principal amount of its 9 1\/2% subordinated debentures due August 2002 at the redemption price of 100% of principal.\nAt December 31, 1995, scheduled principal payments on debt for the subsequent five years were as follows 1996--$.8 million, 1997- - -$.8 million, 1998--$.9 million, 1999--$157.5 million and 2000-- $114.5 million.\nAt December 31, 1995, the Company had outstanding letter of credit facilities totaling $38.6 million which, if drawn, will bear interest at rates which approximate the prime rates offered by various banks.\nCash interest payments of $48.7 million, $52.7 million and $62.7 million were made on debt in 1995, 1994 and 1993, respectively.\nH. Benefit Plans\nThe Company provides retirement benefits, primarily through contributory and noncontributory defined contribution plans, for the majority of its regular full-time employees. Company contributions under the defined contribution plans approximate, on average, 4% of each eligible employee's covered compensation. In addition, the Company sponsors employee savings plans under which the Company matches a specified portion of contributions made by eligible employees. Expense related to defined contribution plans for 1995, 1994 and 1993 totaled $5.6 million, $5.8 million and $5.5 million, respectively.\nThe Company also provides defined benefit pension plan retirement benefits for certain employees. The related amounts included in the accompanying financial statements are not material to the Company's financial condition.\nUnder the Company's Stock Option Plan, options to purchase shares of Common Stock were granted to certain officers and other key employees, and to non-employee directors of the Company. Under the now terminated Career Share\nAMERICAN PREMIER UNDERWRITERS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nPurchase Plan (the \"Career Share Plan\"), officers and other key employees of the Company purchased shares of the Company's Preference Stock (designated Career Shares) which were convertible, at the holder's option, into a specified number of shares of Common Stock. The Company's Employee Stock Purchase Plan (\"ESPP\") provided eligible employees with the opportunity to purchase from the Company, through regular payroll deductions, shares of the Company's Common Stock at 85% of its fair market value on the purchase date. In connection with the Mergers described in Note B, each outstanding Career Share was converted into a share of AFG convertible preferred stock and each stock option outstanding under the Company's Stock Option Plan was converted into an option to purchase AFG common stock. In addition, AFG succeeded the Company under all provisions of the Stock Option Plan, the Career Share Plan and the ESPP.\nI. Capital Stock The Company is authorized to issue 200,000,000 shares of Common Stock. At December 31, 1995, there were 47,000,000 shares of Common Stock outstanding, all of which were owned by AFG. A progression of the Company's shareholder's equity is as follows (dollars in millions):\nAMERICAN PREMIER UNDERWRITERS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nDuring 1994, the Company increased its accruals for its net probable liability for claims and contingencies arising from events and circumstances preceding the Company's 1978 reorganization based on information which became available to it in 1994. The accrual includes the estimated costs to the Company related to remediation of environmental conditions allegedly caused or contributed to by PCTC and pending and expected claims by former PCTC employees of injury or disease allegedly caused by exposure to excessive noise or asbestos in the railroad workplace. The foregoing estimates were based on information available to the Company at that time and are subject to future change as additional information becomes available. Offsetting the increase in these accruals was a $13.8 million credit resulting from a judgment in favor of the Company. In accordance with the Company's reorganization accounting policy, the Company recorded a net charge of $52.0 million to capital surplus to reflect the net effect of the foregoing accruals which the Company believes will be adequate based on information currently available to it.\nAlso during 1994, the Company settled a dispute with former employees of a business that had been acquired in 1990 and subsequently included in the General Cable Spin-off in July 1992.\nDuring 1993, the Company settled a lawsuit it had brought against the former owner of a business that was acquired by the Company in 1990 and was included in the General Cable businesses spun-off to shareholders in July 1992. After the spin-off of General Cable, the Company retained the right to receive any amounts recovered in the lawsuit. The net amount of cash received by the Company in the settlement was accounted for as an adjustment to the distribution of equity to shareholders resulting from the spin-off of General Cable.\nJ. Income Taxes The Company files a consolidated income tax return which includes all 80%-owned U.S. subsidiaries and the AFG parent company.\nFor income tax purposes, the Company had the following carryforwards available at December 31, 1995 (in millions):\nExpiring Amount\nOperating loss 1996 $476 Capital loss 1997-1999 311 Other - tax credits 23\nThe total income tax (provision) credit consists of (in millions):\n1995 1994 1993 Current Federal $ (.5) $(2.8) $(4.4) Foreign .6 (1.3) (.1) State & Local - - (.8)\nDeferred Federal (46.0) (36.3) 59.4 Foreign - - - State & Local - - (1.5) ($45.9) ($40.4) $52.6\nAMERICAN PREMIER UNDERWRITERS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nThe following is a reconciliation of income taxes at the statutory rate of 35% and income taxes as shown in the Statement of Earnings (in millions):\n1995 1994 1993\nEarnings before income taxes and extraordinary items $113.0 $ 41.2 $190.1 Extraordinary items before income taxes (7.8) - - Adjusted earnings before income taxes $105.2 $ 41.2 $190.1\nIncome taxes at statutory rate ($ 36.8) ($ 14.4) ($ 66.5)\nEffect of: Amortization of goodwill (4.0) (4.0) (3.8) Revision to valuation allowance - - 132.0 Loss disallowance - (21.4) (6.9) Other, net (2.4) (.6) (2.2) Total provision (43.2) (40.4) 52.6\nAmounts applicable to extraordinary items (2.7) - - Provision for income taxes as shown on the Statement of Earnings ($ 45.9) ($ 40.4) $ 52.6\nEarnings before income taxes consisted of the following (in millions):\n1995 1994 1993\nSubject to tax in: United States $114.8 $ 38.9 $190.1 Foreign jurisdictions (1.8) 2.3 - $113.0 $ 41.2 $190.1\nThe Company's substantial tax loss carryforwards and temporary differences give rise to deferred tax assets. Based on an analysis of the likelihood of realizing the Company's gross deferred tax asset (taking into consideration applicable statutory carryforward periods), the Company determined that the recognition criteria set forth in SFAS No. 109, \"Accounting for Income Taxes\", are not met for the entire gross deferred tax asset and, accordingly, the gross deferred tax asset is reduced by a valuation allowance. The analysis of the likelihood of realizing the gross deferred tax asset is reviewed and updated periodically. Any required adjustments to the valuation allowance are made in the period in which the developments on which they are based become known. Results for 1993 include tax benefits of $132 million attributable to such adjustments.\nAMERICAN PREMIER UNDERWRITERS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nThe significant components of the deferred tax asset included in the Balance Sheet at December 31, were as follows (in millions):\n1995 1994 Deferred tax assets: Net operating loss carryforward $166.5 $176.7 Capital loss carryforwards 108.7 115.5 Insurance claims and reserves 102.9 120.1 Other, net 91.3 101.3 469.4 513.6 Valuation allowance for deferred tax assets (214.0) (213.5) 255.4 300.1\nDeferred tax liabilities: Deferred acquisition costs (31.2) (32.4) Investment securities (23.8) - (55.0) (32.4)\nNet deferred tax asset $200.4 $267.7\nCash payments for income taxes, net of refunds, were $1.9 million, $3.7 million and $1.0 million for 1995, 1994 and 1993, respectively. Substantially all of such payments were for alternative minimum taxes.\nK. Contingencies\nIn management's opinion, the outcome of the items discussed below will not, individually or in the aggregate, have a material adverse effect on the Company's financial condition or results of operations.\nPre-Reorganization Matters\nThe following matters arose out of railroad operations disposed of by the Company's predecessor, Penn Central Transportation Company (\"PCTC\"), prior to its bankruptcy reorganization in 1978 and, accordingly, any ultimate liability arising therefrom in excess of previously established loss accruals would be attributable to pre-reorganization events and circumstances. In accordance with the Company's pre-reorganization accounting policy, any such ultimate liability will reduce the Company's capital surplus and shareholders' equity, but will not be charged to income.\nUSX Litigation Lawsuits have been filed against the Company by USX Corporation (\"USX\") and its former subsidiary, Bessemer and Lake Erie Railroad Company (\"B&LE\"), seeking contribution by the Company, as the successor to the railroad business conducted by PCTC prior to 1976, for amounts that USX paid in satisfaction of a judgment against B&LE for its participation in an unlawful antitrust conspiracy among certain railroads. The lawsuits argue that USX's liability for that payment was attributable to PCTC's alleged activities in furtherance of the conspiracy. The Company and its outside counsel believe that the Company has substantial defenses to these lawsuits and should not suffer a material loss as a result of this litigation.\nEnvironmental Matters The Company's liability for environmental claims ($64.3 million at December 31, 1995, before claims for recovery of $9.5 million) consists of a number of proceedings and claims seeking to impose responsibility for hazardous waste remediation costs at certain railroad\nAMERICAN PREMIER UNDERWRITERS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nsites formerly owned by PCTC and at certain other sites where hazardous waste was allegedly generated by PCTC's railroad operations. It is difficult to estimate remediation costs for a number of reasons, including the number and financial resources of other potentially responsible parties, the range of costs for remediation alternatives, changing technology and the time period over which these matters develop. The Company's liability is based on information currently available and is subject to future change as additional information becomes available.\nPersonal Injury Matters The Company's liability for occupational injury and disease claims ($80.6 million at December 31, 1995, before claims for recovery of $62.1 million) includes pending and expected claims by former employees of PCTC of injury or disease allegedly caused by exposure to excessive noise, asbestos or other substances in the railroad workplace. Recorded amounts are based on the accumulation of estimates of reported and unreported claims and related expenses and estimates of probable recoveries from insurance carriers.\nOther Matters\nIn connection with the Company's sale of its General Cable Corporation securities, the Company assumed responsibility for certain actual and potential environmental and other liabilities in consideration of an indemnity payment of $19.2 million.\nThe Company has agreed to guarantee several third party obligations which are not material individually or in the aggregate. The Company has also entered into various operating lease agreements related principally to certain administrative facilities and transportation equipment.\nL. Insurance Operations\nRestrictions on Transfers of Funds and Assets The Company's insurance operations are subject to state regulations which limit, by reference to specified measures of statutory operating results and policyholders' surplus, the dividends that can be paid to the Parent Company without prior regulatory approval. Without such approval, the maximum amount of dividends which can be paid to the Parent Company during 1996 by these subsidiaries is $80.4 million. At December 31, 1995 and 1994, statutory capital and surplus totaled $629.6 million and $643.6 million, respectively.\nReinsurance The insurance operations assume and cede a portion of their written business with other insurance companies in the normal course of business. To the extent that any reinsuring companies are unable to meet their obligations under agreements covering reinsurance ceded, the Company's insurance subsidiaries would remain liable. Amounts deducted from insurance losses and loss adjustment expenses (\"LAE\") and net written and earned premiums in\nAMERICAN PREMIER UNDERWRITERS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nconnection with reinsurance ceded to affiliates and non-affiliated companies, as well as amounts included in net written and earned premiums for reinsurance assumed from affiliates and non-affiliated companies, were as follows (in millions):\n1995 1994 1993 Reinsurance ceded: Premiums written Non-affiliates $ 15.5 $20.4 $ 9.3 Premiums earned Non-affiliates 13.6 18.7 8.9 Incurred losses and LAE: Affiliates .6 (1.8) (2.5) Non-affiliates 20.4 15.9 3.8\nReinsurance assumed: Premiums written: Affiliates 134.3 167.6 101.2 Non-affiliates 22.9 36.4 74.4 Premiums earned: Affiliates 128.8 139.4 78.2 Non-affiliates 28.8 50.1 60.1\nDecember 31, 1995 1994 Reinsurance ceded: Reserves for unpaid loss and LAE: Affiliates $ 7.2 $10.2 Non-affiliates 52.2 40.7\nThe allowance for uncollectible reinsurance was $1.5 million at December 31, 1995 and 1994.\nLiability for Losses and Loss Adjustment Expenses The following table provides an analysis of changes in the estimated liability for losses and LAE, net of reinsurance activity (in millions).\n1995 1994 1993 Balance at beginning of year, net of reinsurance $1,080 $ 916 $ 764\nProvision for losses and LAE occurring in the current year 1,247 1,170 915 Net decrease in provision for claims occurring in prior years (49) (79) (58) 1,198 1,091 857 Payments for losses and LAE occurring during: Current year 662 554 413 Prior years 480 386 346 1,142 940 759 Loss and LAE reserves of subsidiaries purchased - 13 54\nBalance at end of year, net of reinsurance 1,136 1,080 916\nReinsurance receivable on unpaid losses and LAE at end of year 59 51 45 Balance at end of period, gross of reinsurance receivable $1,195 $1,131 $ 961\nAMERICAN PREMIER UNDERWRITERS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nThe decreases in the provision for claims occurring in prior years resulted from reductions in the estimated ultimate losses and LAE related to such claims.\nOther Statutory net income for 1995, 1994 and 1993 was $61.0 million, $79.6 million and $93.0 million, respectively. Deferred policy acquisition costs amortized to income were $298.2 million, $292.3 million and $243.8 million for 1995, 1994 and 1993, respectively. Net written premiums for 1995, 1994 and 1993 were $1,492 million, $1,636 million and $1,379 million, respectively.\nAt December 31, 1995 and 1994, reserves for uncollectible premiums receivable were $6.6 million and $5.9 million, respectively.\nDuring 1995, 1994 and 1993, 41%, 89% and 95%, respectively, of net premiums written in the workers' compensation insurance operations were for policies eligible for policyholder dividend consideration.\nM. Statement of Cash Flows\nIn February 1994, General Cable delivered to the Company $41.7 million in promissory notes as a partial payment of the General Cable Notes. During 1993, General Cable elected to pay the $31.8 million of interest due on the General Cable Note with Interest Notes in lieu of cash. These non-cash transactions, which increased the Parent Company investments and decreased accrued investment income, are not included in the Statement of Cash Flows.\nN. Transactions With Affiliates\nVarious business has been transacted between the Company and certain affiliate companies including rentals, investment management services, insurance and sales of assets. Unless otherwise disclosed, none of these transactions had a material effect on the net earnings or equity of the Company. Aggregate charges for these services within the Company and its subsidiaries have been insignificant in relation to consolidated revenues.\nDuring 1995, the Company purchased 3.2 million shares of Chiquita from AFC for $43.7 million. Also during 1995, the Company sold (i) certain properties to a subsidiary of AFC for aggregate proceeds of $15.9 million; (ii) a small reinsurance subsidiary to AFC for $13.7 million; and (iii) shares of an affiliate to AFC for $553,000. The Company recognized a loss of $2.1 million on the sales.\nDuring 1990, the Company acquired the nonstandard automobile insurance business (the \"NSA Group\") from AFC. The purchase price was subject to adjustment in 1995, based on 1991-1994 pretax earnings of the NSA Group, by a reduction of up to $20.0 million or an increase of up to $40.0 million, in each case plus interest. In December 1993, the Company, having concluded that it was highly probable that the maximum adjustment would be payable by the Company, paid $40.0 million, plus $12.8 million of interest, to a subsidiary of AFC, in full settlement in order to cut off the accrual of interest at the relatively high rate prescribed by the acquisition agreement. Also, as part\nAMERICAN PREMIER UNDERWRITERS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nof the agreement for the purchase of the NSA Group, AFC, through a subsidiary, provided stop-loss protection to the Company which, in effect, guaranteed the adequacy of unpaid loss and allocated loss adjustment expense reserves of the NSA Group (net of reinsurance and salvage and subrogation recoveries) related to periods prior to 1991 under policies written and assumed by the NSA Group. By mutual agreement, effective December 31, 1995, the parties cancelled this arrangement and settled all amounts due.\nIn 1988, the Company's workers' compensation insurance operations (\"Republic Indemnity\") entered into a reinsurance contract with Great American Insurance Company (\"GAI\") to cover the aggregate losses on workers' compensation coverage for the accident years 1980-1987, inclusive. The contract provides for coverage by GAI of net aggregate paid losses of Republic Indemnity in excess of a certain threshold, up to a maximum of $35.1 million. Cumulative paid losses at December 31, 1995 pertaining to claims during this period exceeded the threshold amount by approximately $1 million. In addition, GAI has agreed to reimburse Republic Indemnity for its loss adjustment expenses pertaining to this period up to a maximum of $4.9 million.\nO. Quarterly Operating Results (Unaudited)\nSummarized quarterly financial data for 1995 and 1994 are set forth below (in millions).\n1st 2nd 3rd 4th Quarter Quarter Quarter Quarter Total 1995: Revenues $432.8 $437.2 $433.3 $432.2 $1,735.5 Net earnings from continuing operations 16.3 13.6 18.2 19.0 67.1 Net earnings 16.3 9.5 17.6 18.6 62.0\n1994: Revenues 357.3 467.9 475.8 457.9 $1,758.9 Net earnings (loss) from continuing operations (55.9) 16.6 25.2 14.9 .8 Net earnings (loss) (55.9) 15.2 26.1 14.9 .3\nThe first quarter 1994 results include a pretax loss of $76 million on the sale of General Cable securities. Realized gains (losses) on sales of securities amounted to (in millions):\n1st 2nd 3rd 4th Quarter Quarter Quarter Quarter Total 1995 $(.2) $1.6 $7.1 $15.3 $23.8 1994 .6 1.3 (1.0) (.8) .1\nP. Additional Information\nTotal rental expense recorded under various operating leases related to certain administrative facilities and transportation equipment was $13.3 million in 1995, $12.9 million in 1994, and $13.3 million 1993.\nAMERICAN PREMIER UNDERWRITERS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nFuture minimum rentals required under noncancelable lease agreements at December 31, 1995, related principally to certain administrative facilities and transportation equipment, were as follows: 1996--$12.3 million, 1997--$11.5 million, 1998--$9.3 million, 1999--$7.6 million, 2000--$5.8 million and $10.6 million thereafter.\nOther operating and general expenses included charges for possible losses on agents' balances, reinsurance recoverables and other receivables in the following amounts: 1995 - $0, 1994 - $1 million and 1993 - $6 million. The aggregate allowance for such losses amounted to approximately $14 million at December 31, 1995 and 1994.\nFair Value of Financial Instrument The following table presents (in millions) the carrying value and estimated fair value of the Company's financial instruments at December 31. 1995 1994 Carrying Fair Carrying Fair Value Value Value Value Assets: Bonds and redeemable preferred stocks $1,870 $1,880 $2,340 $2,261 Other stocks 4 4 5 5\nLiabilities: Long-term debt: Parent company $ 321 $ 344 $ 500 $ 519 Other subsidiaries 9 9 10 10\nWhen available, fair values are based on prices quoted in the most active market for each security. If quoted prices are not available, fair value is estimated based on present values, discounted cash flows, fair value of comparable securities, or similar methods.\nQ. Subsequent Event (Unaudited)\nIn March 1996, the Company sold the stock of a subsidiary, Buckeye Management Company (\"Buckeye\"), to an investment group consisting of members of Buckeye's management team and employees for approximately $63 million in cash. Buckeye holds, directly and indirectly, a 2% general partnership interest in Buckeye Partners, L.P. which, through its subsidiary entities, is an independent pipeline common carrier of refined petroleum products. The Company's pretax gain of approximately $53 million from the sale will be reported in 1996. The Chairman of the Board and Chief Executive Officer of Buckeye was also a director of the Company, until resigning in March 1996.\nPART IV\nITEM 14\nExhibits, Financial Statement Schedules and Reports on Form 8-K\n(a) Documents filed as part of this Report: 1. Financial Statements are included in Part II, Item 8.\n2. Financial Statement Schedules: A. Selected Quarterly Financial Data is included in Note O to the Consolidated Financial Statements.\nB. Schedules filed herewith for 1995, 1994 and 1993:\nPage III - Condensed Financial Information of Registrant S-2\nAll other schedules for which provisions are made in the applicable regulation of the Securities and Exchange Commission have been omitted as they are not applicable, not required, or the information required thereby is set forth in the Financial Statements or the notes thereto.\n3. Exhibits - see Exhibit Index on page E-1.\n(b) Reports on Form 8-K:\nDate of Report Item Reported\nDecember 13, 1995 Court of Appeals Ruling - USX Litigation\nS-1\nAMERICAN PREMIER UNDERWRITERS, INC. SCHEDULE III - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (In Millions)\nCondensed Statement of Earnings\nS-2\nAMERICAN PREMIER UNDERWRITERS, INC. SCHEDULE III - CONDENSED FINANCIAL INFORMATION OF REGISTRANT - CONTINUED (In Millions)\nCondensed Statement of Cash Flows\nS-3\nSignatures\nPursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, American Premier Underwriters, Inc. has duly caused this Report to be signed on its behalf by the undersigned, duly authorized.\nAmerican Premier Underwriters, Inc.\nSigned: March 27, 1996 BY:s\/CARL H. LINDNER Carl H. Lindner 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 Capacity Date\ns\/CARL H. LINDNER Chairman of the Board March 27, 1996 Carl H. Lindner of Directors\ns\/THEODORE H. EMMERICH Director* March 27, 1996 Theodore H. Emmerich\ns\/JAMES E. EVANS Director March 27, 1996 James E. Evans\ns\/THOMAS M. HUNT Director March 27, 1996 Thomas M. Hunt\ns\/S. CRAIG LINDNER Director March 27, 1996 S. Craig Lindner\ns\/KEITH E. LINDNER Director March 27, 1996 Keith E. Lindner\ns\/CARL H. LINDNER III Director March 27, 1996 Carl H. Lindner III\ns\/WILLIAM R. MARTIN Director* March 27, 1996 William R. Martin\ns\/FRED J. RUNK Senior Vice President and March 27, 1996 Fred J. Runk Treasurer (Principal Financial and Accounting Officer)\n* Member of the Audit Committee\nINDEX TO EXHIBITS\nAMERICAN PREMIER UNDERWRITERS, INC.\nNumber Exhibit Description\nE-1\n10 (c) Premium Payment Agreement, effective as of (*) January 1, 1991, by and between Great American Insurance Company and the Company filed as Exhibit (10)(iii)(q) to the Company's Company's Form 10-K for 1990.\n10 (d) Excess of Loss Agreement, effective (*) March 31, 1988, between Republic Indemnity Company of America and Great American Insurance Company, filed as Exhibit (g)(l) to Amendment No. 1 to Schedule 13E-3, dated January 17, 1989, relating to Republic American Corporation filed by Republic American Corporation, the Company, RAWC Acquisition Corp., American Financial Corporation and Carl H. Lindner (the \"Schedule 13E-3 Amendment\").\n10 (e) First Amendment to Excess of Loss (*) Agreement, effective March 31, 1988, between Republic Indemnity Company of America and Great American Insurance Company, filed as Exhibit (g)(2) to the Schedule 13E-3 Amendment.\n10 (f) Business Assumption Agreement, effective (*) as of December 31, 1990, between Stonewall Insurance Company and Dixie Insurance Company (now Infinity Insurance Company), filed as Exhibit (10)(iii)(o)(i) to the Company's Form 10-K for 1990.\n10 (g) Quota Share Agreements, effective (*) December 31, 1990, between Stonewall Insurance Company and Dixie Insurance Company (now Infinity Insurance Company), filed as Exhibit (10)(iii)(o)(ii) to the Company's Form 10-K for 1990.\n10 (h) Letter dated April 9, 1987 from the (*) Company to Neil M. Hahl, an executive officer of the Company, with respect to severance arrangements, as supplemented by a letter dated June 26, 1987 to Neil M. Hahl, incorporated by reference to Exhibit (10)(iii)(a) to the Company's Form 10-Q Quarterly Report for the Quarter Ended June 30, 1987.\n10 (i) Stock Purchase Agreement Relating to the _____ Acquisition of Buckeye Management Company by BMC Acquisition Company dated January 5, 1996.\n12 Computation of ratio of earnings _____ to fixed charges.\n16 Letter on change in certifying accountant (*) filed as Exhibit 16 to the Company's Form 8-K Current Report for August 29, 1995.\nE-2\n21 Subsidiaries of the Registrant. _____\n27 Financial data schedule (**)\n28 Information from reports furnished to _____ state insurance regulatory authorities.\n(*) Incorporated herein by reference (**) Copy included in Report filed electronically with the Securities and Exchange Commission.\nE-3\nAMERICAN PREMIER UNDERWRITERS, INC. AND CONSOLIDATED SUBSIDIARIES\nEXHIBIT 12 - COMPUTATION OF RATIOS OF EARNINGS TO FIXED CHARGES (Dollars in Millions)\nE-4\nAMERICAN PREMIER UNDERWRITERS, INC.\nEXHIBIT 21 - SUBSIDIARIES OF THE REGISTRANT\nThe following is a list of subsidiaries of American Premier Underwriters, Inc. (the \"Company\") included in the Company's continuing operations at December 31, 1995. All corporations are subsidiaries of the Company and, if indented, subsidiaries of the company under which they are listed.\nJurisdiction Percentage of of Common Equity Incorporation Ownership\nPennsylvania Company Delaware 100% Atlanta Casualty Company (1) Illinois 100 American Premier Insurance Company Indiana 100 Atlanta Specialty Insurance Company Iowa 100 Mr. Agency of Georgia, Inc. Georgia 100 Atlanta Casualty General Agency, Inc. Texas 100 Atlanta Insurance Brokers, Inc. Georgia 100 Treaty House, Ltd. (d\/b\/a Mr. Budget) Nevada 100 Penn Central U.K. Limited United Kingdom 100 Insurance (GB) Limited United Kingdom 100 Buckeye Management Company Delaware 100 Buckeye Pipe Line Company Delaware 100 Great Southwest Corporation Delaware 100 World Houston, Inc. Delaware 100 Hangar Acquisition Corporation Ohio 100 Infinity Insurance Company Florida 100 Infinity Agency of Texas, Inc. Texas 100 The Infinity Group, Inc. Indiana 100 Infinity Select Insurance Company Indiana 100 Infinity Southern Insurance Corporation Alabama 100 Leader National Insurance Company Ohio 100 Budget Insurance Premiums, Inc. Ohio 100 Leader National Agency, Inc. Ohio 100 Leader National Agency of Texas, Inc. Texas 100 Leader National Insurance Agency of Arizona Arizona 100 Leader Preferred Insurance Company Ohio 100 Leader Specialty Insurance Company Indiana 100 PCC Technical Industries, Inc. California 100 ESC, Inc. California 100 Marathon Manufacturing Companies, Inc. Delaware 100 Marathon Manufacturing Company Delaware 100 PCC Maryland Realty Corp. Maryland 100 Penn Camarillo Realty Corp. California 100 Republic Indemnity Company of America California 100 Republic Indemnity Company of California California 100 Timberglen Limited United Kingdom 100 Risico Management Corporation Delaware 100 Windsor Insurance Company (1) Indiana 100 American Deposit Insurance Company Oklahoma 100 Granite Finance Co., Inc. Texas 100 Coventry Insurance Company Ohio 100 El Aguila Compania de Seguros, S.A. de C.V. Mexico 100\nE-5\nAMERICAN PREMIER UNDERWRITERS, INC.\nEXHIBIT 21 - SUBSIDIARIES OF THE REGISTRANT - CONTINUED\nJurisdiction Percentage of of Common Equity Incorporation Ownership\nMoore Group Inc. Georgia 100% Casualty Underwriters, Inc. Georgia 51 Dudley L. Moore Insurance, Inc. Louisiana 100 Hallmark General Insurance Agency, Inc. Oklahoma 100 Middle Tennessee Underwriters, Inc. Tennessee 100 Insurance Finance Company Tennessee 100 Windsor Group, Inc. Georgia 100 Regal Insurance Company Indiana 100 Texas Windsor Group, Inc. Texas 100 PCC Real Estate, Inc. New York 100 PCC Chicago Realty Corp. New York 100 PCC Gun Hill Realty Corp. New York 100 PCC Michigan Realty, Inc. Michigan 100 PCC Scarsdale Realty Corp. New York 100 Scarsdale Depot Associates, L.P. Delaware 80 Penn Central Energy Management Company Delaware 100 ______________\n(1) 90.05% owned by Pennsylvania Company and 9.95% owned by Republic Indemnity Company of America.\nThe names of certain subsidiaries are omitted, as such subsidiaries in the aggregate would not constitute a significant subsidiary.\nE-6\nAMERICAN PREMIER UNDERWRITERS, INC.\nEXHIBIT 28 - INFORMATION FROM REPORTS FURNISHED TO STATE INSURANCE REGULATORY AUTHORITIES\nSchedule P of Annual Statements\nA. CONSOLIDATED PROPERTY AND CASUALTY ENTITIES - See Attached Schedules\nSchedule P (prepared in accordance with the rules prescribed by the National Association of Insurance Commissioners) includes the reserves of American Premier Underwriters, Inc.'s consolidated property and casualty subsidiaries. The following is a summary of Schedule P reserves (in millions):\nSchedule P - Part 1 Summary - col. 33 $ 903 - col. 34 213 Statutory Loss and Loss Adjustment Expense Reserves $1,116\nB. UNCONSOLIDATED SUBSIDIARIES None\nC. 50% OR LESS OWNED PROPERTY AND CASUALTY INVESTEES None\nE-7","section_4":"","section_5":"ITEM 5\nMarket for Registrant's Common Equity and Related Stockholder Matters\nNot applicable - All of Registrant's outstanding Common Stock is owned by American Financial Group, Inc.\nITEM 6","section_6":"ITEM 6\nSelected Financial Data\nThe following table sets forth certain data for the periods indicated (dollars in millions). Year-to-year comparisons are affected by business dispositions, restructuring provisions and other non-recurring items.\n1995 1994 1993 1992 1991\nEarnings Statement Data (a): Net Written Premiums $1,492 $1,636 $1,379 $1,067 $ 865\nTotal Revenues 1,736 1,759 1,736 1,420 1,272\nEarnings from Continuing Operations before Income Taxes 113 41 190 84 79\nEarnings (loss) from: Continuing Operations 67 1 243 51 50 Discontinued Operations - (1) (11) 1 (47) Extraordinary Items (5) - - - - Cumulative Effect of Accounting Change - - - 253 - Net Earnings 62 - 232 305 3\nBalance Sheet Data: Total Assets $3,955 $4,197 $4,053 $3,493 $3,369\nUnpaid Losses and Loss Adjustment Expenses, Unearned Premiums and Policyholder Dividends 1,684 1,674 1,426 1,069 890\nLong-term Debt: Parent Company 321 500 516 650 650 Subsidiaries 9 10 10 10 20\nCommon Shareholder's Equity 1,552 1,549 1,722 1,503 1,479\n(a) Amounts above include the following pretax items for the years indicated: 1994 - Loss on sale of General Cable securities ($76 million). 1993 - Tax benefit attributable to an increase in the Company's net deferred tax asset ($132 million); Gain on sale of equity investments ($99 million); Provision for asset impairment ($20 million); Loss on sale of subsidiaries ($22 million). 1991 - Provision for asset impairment ($21 million).\nITEM 7","section_7":"ITEM 7\nManagement's Discussion and Analysis of Financial Condition and Results of Operations\nGENERAL\nFollowing is a discussion and analysis of the financial statements and other statistical data that management believes will enhance the understanding of the Company's financial condition and results of operations. This discussion should be read in conjunction with the financial statements beginning on page.\nIn April 1995, the Company became a wholly-owned subsidiary of American Premier Group, Inc., a new corporation formed by the Company for the purpose of acquiring all of the common stock of the Company and American Financial Corporation (the \"Mergers\"). In June 1995, American Premier Group changed its name to American Financial Group, Inc. (\"AFG\"). Under terms of the Mergers, (a) the Company merged with a subsidiary of AFG and each share of Company Common Stock then outstanding was converted into one share of AFG Common Stock, and (b) American Financial Corporation (\"AFC\") merged with another subsidiary of AFG and all shares of AFC common stock were exchanged for 28.3 million shares of AFG Common Stock. As a result of the Mergers, all of the common stock of the Company and AFC is owned by AFG and AFG is the Company's successor as the issuer of publicly held common stock.\nThe Company's insurance operations consist primarily of a group of nonstandard private passenger automobile insurance companies (the \"NSA Group\") and a business which sells workers' compensation insurance principally in California (\"Republic Indemnity\").\nDuring 1995, in connection with its previously announced divestiture effort, the Company completed the sale of its last industrial business. In addition, in March 1996 the Company sold its investment in a subsidiary which holds a 2% general partnership interest in an independent pipeline common carrier of refined petroleum products. See Note C of Notes to Financial Statements.\nLIQUIDITY AND CAPITAL RESOURCES\nRatios The following ratios may be considered relevant indicators of the Company's liquidity and are typically presented by the Company in its prospectuses and similar documents. Management believes that balance sheet ratios (debt-to-equity) are more meaningful on a parent only basis. On the other hand, earnings statement ratios (fixed charges) are more meaningful on a total enterprise basis since the parent only ratio is dependent, to a great degree, on the discretionary nature of dividend payments from subsidiaries.\nThe ratio of the Company's (parent-only) long-term debt to total capital was 17%, 24% and 23% at December 31, 1995, 1994 and 1993, respectively. The Company's ratio of earnings to fixed charges on a total enterprise basis was 3.35, 1.72 and 3.83 for the years ended December 31, 1995, 1994 and 1993, respectively.\nThe National Association of Insurance Commissioners' model law for risk based capital (\"RBC\") determines the amount of capital that an insurance company needs to ensure that it has an acceptable expectation of not becoming financially impaired. At December 31, 1995, the capital ratios of all of the Company's insurance companies substantially exceeded the RBC requirements.\nSources of Funds American Premier is organized as a holding company with almost all of its operations being conducted by subsidiaries. The parent corporation, however, has continuing cash needs for administrative expenses, the payment of principal and interest on borrowings and common stock dividends. Thus, the Company relies primarily on dividends and tax payments from its subsidiaries for funds to meet its obligations.\nPrior to the Mergers, the Company had substantial cash and short-term investments at the parent company level. Subsequent to the Mergers, the Company repurchased approximately $180 million of its subordinated notes and made loans to AFC under a formal credit agreement. At December 31, 1995, amounts outstanding under the AFC agreement totaled $623.2 million. In addition, the Company entered into a formal credit agreement with AFG. At December 31, 1995, amounts payable to AFG under the AFG agreement totaled $84.0 million.\nIn December 1995, Pennsylvania Company (\"Pennco\"), a wholly-owned subsidiary of the Company, entered into a new collateralized five-year reducing revolving credit agreement with several banks, under which it can borrow up to $75 million. At December 31, 1995, the Company had no outstanding borrowings under the agreement.\nThe Company's federal income tax loss carryforward is available to offset taxable income and, as a result, the Company's requirement to pay federal income tax for 1996 is substantially eliminated.\nUncertainties The Company and its subsidiaries are parties in a number of proceedings relating to former operations. See Note K of Notes to Financial Statements. While the results of all such uncertainties cannot be predicted, based upon its knowledge of the facts, circumstances and applicable laws, management believes that sufficient reserves have been provided.\nInvestments Approximately half of the Company's consolidated assets are invested in marketable securities. The Company attempts to optimize investment income while building the value of its portfolio, placing emphasis upon long-term performance. The Company's goal is to maximize return on an ongoing basis rather than focusing on year-by-year performance.\nFixed income investment funds are generally invested in securities with short-term and intermediate-term maturities with an objective of optimizing total return while allowing flexibility to react to changes in market conditions. At December 31, 1995, the average life of the Company's bonds and redeemable preferred stocks was approximately 6 years.\nApproximately 94% of the bonds and redeemable preferred stocks held by the Company were rated \"investment grade\" (credit rating of AAA to BBB) by nationally recognized rating agencies at December 31, 1995. Investment grade securities generally bear lower yields and lower degrees of risk than those that are unrated and non-investment grade. Management believes that the high quality investment portfolio should generate a stable and predictable investment return.\nAt December 31, 1995, the Company's mortgage-backed securities (\"MBSs\"), represented approximately 10% of the Company's bonds and mandatory redeemable preferred stocks. The Company invests primarily in MBSs which are structured to minimize prepayment risk. In addition, the majority of MBSs held by the Company were purchased at discounts to par value. Management believes that the structure and discounted nature of the\nMBSs will minimize the effect of prepayments on earnings over the anticipated life of the MBS portfolio. Substantially all of the Company's MBSs are rated \"AAA\" by Standard & Poor's Corporation and are collateralized primarily by GNMA, FNMA and FHLMC single-family residential pass-through certificates. The market in which these securities trade is highly liquid. Aside from interest rate risk, the Company does not believe a material risk (relative to earnings and liquidity) is inherent in holding such investments.\nRESULTS OF OPERATIONS - THREE YEARS ENDED DECEMBER 31, 1995\nGeneral Pretax earnings were $113 million in 1995 compared to $41 million in 1994 and $190 million in 1993.\nResults for 1995 include a $76 million decrease in underwriting results of the Company's insurance operations and an $8 million decrease in portfolio interest and dividend income. These items were partially offset by $45 million of interest income from loans to AFC, $24 million in realized gains on the sales of securities and an $8 million decrease in interest on borrowed money.\nResults for 1994 include a $76 million loss on the sale of General Cable securities and a $4 million loss on the anticipated sale of one of the Company's non-insurance businesses. These items were partially offset by a $26 million increase in investment income (excluding $25 million of interest income on the General Cable notes recorded in 1993) and a $10 million decrease in interest on borrowed money.\nResults for 1993 include $99 million in gains from the sales of the Company's shares of Tejas Gas Corporation and limited partnership units of Buckeye Partners L.P., a $22 million improvement in underwriting results of the Company's insurance operations and a $13 million increase in interest income on the General Cable notes. These items were partially offset by a $42 million loss recorded on the anticipated sale of the Company's non-insurance operations.\nProperty and Casualty Insurance - Underwriting Underwriting profitability is measured by the combined ratio which is a sum of the ratio of underwriting expenses, losses, and loss adjustment expenses to premiums. When the combined ratio is under 100%, underwriting results are generally considered profitable; when the ratio is over 100%, underwriting results are generally considered unprofitable. The combined ratio does not reflect investment income, other income or federal income taxes.\nThe Company manages and operates its property and casualty business as two major sectors. The NSA Group is a group of nonstandard automobile insurance companies which underwrite physical damage and liability policies for \"nonstandard risks.\" Nonstandard insureds are those individuals who are unable to obtain insurance through standard market carriers due to factors such as age, record of prior accidents, driving violations, particular occupation or type of vehicle. Republic Indemnity is engaged in the sale of workers' compensation insurance in California and, to a lesser extent, in Arizona. Workers' compensation policies provide coverage for statutory prescribed benefits that employers are required to pay employees who are injured in the course of employment and for an employer's liability for losses suffered by its employees which are not included within the statutory prescribed workers' compensation coverage.\nResults for the Company's property and casualty insurance subsidiaries are as follows (dollars in millions):\nYear ended December 31, 1995 1994 1993 Net Written Premiums (GAAP) NSA Group $1,203.2 $1,154.1 $ 901.9 Republic Indemnity 287.5 479.5 465.8 Other Lines 1.6 1.9 11.2 $1,492.3 $1,635.5 $1,378.9\nCombined Ratios (GAAP) NSA Group 105.7% 99.8% 97.0% Republic Indemnity 87.9% 91.1% 94.7% Aggregate 102.0% 97.0% 96.2%\nNSA Group The NSA Group attributes its premium growth in recent years primarily to entry into additional states, increased market penetration in its existing states, overall growth in the nonstandard market, premium rate increases and the purchase of Leader National in May 1993. The increase in the combined ratio for 1995 compared with 1994 was due primarily to inadequate rate levels in certain markets and weather-related losses principally from hailstorms in Texas (1.3 points in the combined ratio). These factors were partially offset by a reduction in the underwriting expense ratio due largely to cost control measures.\nUnderwriting conditions in the private passenger automobile insurance marketplace in 1994 were affected by competitive conditions and the pricing policies of insurers. Also, improving economic conditions contributed to increased driving activity resulting in an increase in the frequency of accidents and severity of claims. These trends caused a deterioration in the NSA Group's underwriting profit margins during 1994. These factors were partially offset by underwriting profit from the NSA Group's entry into certain markets, as well as improved underwriting margins in several markets where the book of business matured and a greater portion of new premium was derived from renewal policies.\nPremium rate increases were implemented in several states during 1994 and 1995. Rate increases implemented in various states during 1995 averaged approximately 10% across the NSA Group's entire book of business. The higher rate levels and competitive pressures in the nonstandard automobile insurance industry adversely impacted premium growth during 1995.\nRepublic Indemnity The decline in California workers' compensation premiums reflects the impact of mandatory premium rate reductions which were phased in over the course of policy terms during 1994 and 1995, and extremely competitive pricing in the marketplace as a result of the repeal of the California workers' compensation minimum rate law effective January 1, 1995. As a consequence of the repeal of this law, Republic's rate levels reflect the change in its mix of business toward non-participating policies which do not require the payment of policyholder dividends. Management expects this change toward non-participating policies to continue. Despite lower premium volume, the combined ratio decreased in 1995 as compared to 1994 mainly because of lower policyholder dividends and a reduction in the amount of policyholder dividends estimated to be incurred, partially offset by an increase in the frequency of claims. Also, the underwriting expense ratio increased for 1995 due primarily to the decline in premiums.\nInvestment Income Changes in investment income reflect fluctuations in market rates and changes in average invested assets.\n1995 compared to 1994 Excluding interest income of $45 million earned in 1995 on amounts due from affiliates, investment income decreased $8 million (5%) due to a decrease in average investments held.\n1994 compared to 1993 Excluding interest income of $25 million on the General Cable notes recorded in 1993, investment income increased $26 million (18%) in 1994 due primarily to an increase in average investments held.\nInvestee Corporations Equity in net earnings (losses) of investee corporations (companies in which the Company owns a significant portion of the voting stock) in 1995 represents the Company's proportionate share of the losses of Chiquita Brands. The Company purchased 3.2 million shares of Chiquita common stock from AFC during the second quarter of 1995.\nOther Income Other income includes revenues from coal, oil and gas properties and gains and losses from real estate sales.\nSales of Other Products and Services Sales of other products and services represents the Company's revenues from its non- insurance businesses, substantially all of which have been sold.\nInterest on Borrowed Money Changes in interest expense result from changes in levels of borrowings. The Company has generally financed its borrowings on a long-term basis which has resulted in higher current costs.\n1995 compared to 1994 Interest expense decreased by $8.3 million (16%) due primarily to the Company's repurchase throughout 1995 of $180 million principal amount of its Subordinated notes.\n1994 compared to 1993 Interest expense decreased by $9.6 million (15%) due primarily to the Company's repurchase of $133 million principal amount of its 11% debentures during the 1993 third quarter.\nProvision for Asset Impairment Provision for asset impairment includes expected losses associated with the intended divestitures of the Company's non-insurance investments.\nOther Operating and General Expenses Operating and general expenses included $39.3 million and $98.6 million in 1994 and 1993, respectively, from divested, non-insurance subsidiaries.\nIncome Taxes See Note J of Notes to Financial Statements for an analysis of the Company's deferred tax asset and other items affecting the Company's effective tax rate.\nThe 1994 provision for income tax reflects less than full realization of the tax benefit attributable to the net realized capital loss recorded in that period. The 1993 income tax benefit was attributable to an increase of $132 million in the Company's net deferred tax asset due to revisions to the estimated future taxable income during the Company's tax loss carryforward period.\nITEM 8","section_7A":"","section_8":"ITEM 8\nFinancial Statements and Supplementary Data\nPage Number\nReport of Independent Auditors\nReport of Prior Years' Independent Auditors\nAmerican Premier Underwriters, Inc. and Subsidiaries:\nConsolidated Balance Sheet- December 31, 1995 and 1994\nConsolidated Statement of Earnings- For the years ended December 31, 1995, 1994 and 1993\nConsolidated Statement of Cash Flows- For the years ended December 31, 1995, 1994 and 1993\nNotes to Consolidated Financial Statements\n\"Selected Quarterly Financial Data\" has been included in Note O to the Consolidated Financial Statements.\nITEM 9","section_9":"ITEM 9\nChanges in and Disagreements with Accountants on Accounting and Financial Disclosure\nThe Company filed a report on Form 8-K on August 29, 1995, reporting a change in its independent accountants. The report is incorporated herein by reference.\nPART III\nITEM 10","section_9A":"","section_9B":"","section_10":"ITEM 10\nDirectors and Executive Officers of the Registrant\nThe directors and executive officers of the Company at March 1, 1996 were as follows:\nExecutive Executive Name Age Position Since\nCarl H. Lindner 76 Chairman of the Board and Chief Executive Officer 1982 Carl H. Lindner III 42 President and a Director 1991 S. Craig Lindner 40 Vice Chairman of the Board 1995 Keith E. Lindner 36 Vice Chairman of the Board 1995 Theodore H. Emmerich 69 Director 1988 James E. Evans 50 Senior Vice President, General Counsel and a Director 1985 Thomas M. Hunt 72 Director 1982 William R. Martin 66 Director 1994 Alfred W. Martinelli 68 Director (resigned March 20, 1996) 1982 Neil M. Hahl 47 Senior Vice President 1982 Thomas E. Mischell 48 Senior Vice President - Taxes 1995 Fred J. Runk 53 Senior Vice President and Treasurer 1995\nCarl H. Lindner has been Chairman of the Board and Chief Executive Officer of the Company for more than five years. Mr. Lindner is Chairman of the Board and Chief Executive Officer of AFG, the Company's parent, and has been Chairman of the Board and Chief Executive Officer of AFC since it was founded over 35 years ago. Mr. Lindner serves as Chairman of the Board of the following additional companies: American Annuity Group, Inc. (\"AAG\"), American Financial Enterprises, Inc. (\"AFEI\"), Chiquita Brands International, Inc. (\"Chiquita\") and Citicasters Inc. (\"Citicasters\"). Carl H. Lindner is the father of Carl H. Lindner III, S. Craig Lindner and Keith E. Lindner.\nCarl H. Lindner III was elected President of the Company in February 1992. He is President and a director of AFG and AFC. He has also been President of Great American Insurance Company for more than five years.\nS. Craig Lindner is a Vice Chairman of the Board of the Company. He is also a Vice Chairman of AFG and AFC. He has been President of AAG since 1993 and President of American Money Management Corporation (\"AMMC\"), an AFG subsidiary providing investment services to the Company and certain of its affiliates, since January 1996. He had been Senior Executive Vice President of AMMC for more than five years. Mr. Lindner is also a director of AAG and Citicasters.\nKeith E. Lindner is a Vice Chairman of the Board of the Company. He is also a Vice Chairman of AFG and AFC. He has been President, Chief Operating Officer and a director of Chiquita for more than five years.\nTheodore H. Emmerich is a retired managing partner of Ernst & Young LLP, certified public accountants, Cincinnati, Ohio. He is also a director of AFG, AFC, Citicasters, Carillon Fund, Inc., Carrillon Investment Trust, Gradison-McDonald Municipal Custodian Trust, Gradison-McDonald Cash Reserve Trust and Summit Investment Trust.\nJames E. Evans is Senior Vice President, General Counsel and a director of the Company. He is also Senior Vice President, General Counsel and a director of AFG and AFC. He has also served as Vice President and General Counsel of AFC for more than five years. Mr. Evans is also a director of AFEI and Citicasters.\nThomas M. Hunt has been Chairman of the Board of Hunt Petroleum Corporation, an oil and gas production company, for more than five years. He is also a director of AFG and AFC.\nWilliam R. Martin has been Chairman of the Board of MB Computing, Inc., a computer software and services company, for more than five years. He is also a director of AFG, AFC and AAG.\nNeil M. Hahl has been a Senior Vice President of the Company for more than five years. He is also a Senior Vice President of AFG.\nThomas E. Mischell is Senior Vice President - Taxes of the Company. He is also Senior Vice President - Taxes of AFG. He has served as a Vice President of AFC for more than five years.\nFred J. Runk is Senior Vice President and Treasurer of the Company. He is also Senior Vice President and Treasurer of AFG. He has served as Vice President and Treasurer of AFC for more than five years.\nIn December 1993, Great American Communications Company, which subsequently changed its name to Citicasters Inc., completed a comprehensive financial restructuring that included a prepackaged plan of reorganization filed in November of that year under Chapter 11 of the Bankruptcy Code. Carl H. Lindner, Thomas E. Mischell and Fred J. Runk had been executive officers of that company within two years before its bankruptcy reorganization.\nThe information required by the following Items will be provided within 120 days after the end of Registrant's fiscal year.\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\nREPORT OF INDEPENDENT AUDITORS\nBoard of Directors American Premier Underwriters, Inc.\nWe have audited the accompanying consolidated balance sheet of American Premier Underwriters, Inc. and subsidiaries as of December 31, 1995 and the related consolidated statements of earnings and cash flows for the year then ended. Our audit 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 audit.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of American Premier Underwriters, Inc. and subsidiaries as of December 31, 1995, and the consolidated results of their operations and their cash flows for the year then ended, in conformity with generally accepted accounting principles. Also, in our opinion, the related 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\nCincinnati, Ohio March 15, 1996\nREPORT OF PRIOR YEARS' INDEPENDENT AUDITORS\nAmerican Premier Underwriters, Inc.\nWe have audited the financial statements and the financial statement schedules of American Premier Underwriters, Inc. and Consolidated Subsidiaries listed in the Index to Financial Statements and Financial Statement Schedules of American Premier Underwriters, Inc.'s Form 10-K for the year ended December 31, 1994 (not presented separately herein). These financial statements and the financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements and financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, such financial statements present fairly, in all material respects, the financial position of American Premier Underwriters, Inc. and Consolidated Subsidiaries at December 31, 1994 and the results of its operations and its cash flows for each of the two 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 shown therein.\nDELOITTE & TOUCHE LLP\nCincinnati, Ohio February 15, 1995 (March 23, 1995 with respect to the acquisition of American Financial Corporation as discussed in Note B to the financial statements)\nAMERICAN PREMIER UNDERWRITERS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET (In Millions)\nSee notes to consolidated financial statements.\nAMERICAN PREMIER UNDERWRITERS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF EARNINGS (In Millions)\nSee notes to consolidated financial statements.\nAMERICAN PREMIER UNDERWRITERS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS (In Millions)\nSee notes to consolidated financial statements.\nAMERICAN PREMIER UNDERWRITERS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nINDEX TO NOTES\nA. Accounting Policies I. Capital Stock B. Mergers J. Income Taxes C. Divestitures K. Contingencies D. Investments L. Insurance Operations E. Amounts Due from Affiliates M. Statement of Cash Flows F. Cost in Excess of Net Assets N. Transactions With Affiliates Acquired O. Quarterly Operating Results G. Long-Term Debt P. Other Information H. Benefit Plans Q. Subsequent Event\nA. Accounting Policies\nBasis of Presentation The consolidated financial statements include the accounts of the Company and its subsidiaries, with the exception of the Company's defense services operations sold in 1993 which have been classified as discontinued operations. The Company's only industry segment is specialty property and casualty insurance, the operations of which are located primarily within the United States. Certain reclassifications have been made to prior years to conform to the current year's presentation. All significant intercompany balances and transactions have been eliminated. All acquisitions have been treated as purchases. The results of operations of companies since their formation or acquisition are included in the consolidated financial statements.\nThe preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Changes in circumstances could cause actual results to differ materially from those estimates.\nInvestments Debt securities are classified as \"held to maturity\" and reported at amortized cost if the Company has the positive intent and ability to hold them to maturity. Debt and equity securities are classified as \"available for sale\" and reported at fair value with unrealized gains and losses reported as a separate component of shareholders' equity if the debt or equity securities are not classified as held to maturity or bought and held principally for selling in the near term. Only in certain limited circumstances, such as significant issuer credit deterioration or if required by insurance or other regulators, may a company change its intent to hold a certain security to maturity without calling into question its intent to hold other debt securities to maturity in the future.\nIn accordance with guidance issued by the Financial Accounting Standards Board in November 1995, the Company reassessed the classifications of its investments and transferred fixed maturity securities with an amortized cost of approximately $839 million to \"available for sale.\" This \"one-time\" reclassification resulted in an increase of $43 million in carrying value of fixed maturity investments and an increase of $28 million in shareholders' equity. The transfer had no effect on net earnings.\nAMERICAN PREMIER UNDERWRITERS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nPremiums and discounts on mortgage-backed securities are amortized over their expected average lives using the interest method. Gains or losses on sales of securities are recognized at the time of disposition with the amount of gain or loss determined on the specific identification basis. When a decline in the value of a specific investment is considered to be other than temporary, a provision for impairment is charged to earnings and the carrying value of that investment is reduced.\nThe Company's investments in equity securities of companies that are 20% to 50% owned by AFG and its subsidiaries are carried at cost, adjusted for a proportionate share of their undistributed earnings or losses.\nShort-term investments are carried at cost; loans receivable are stated primarily at the aggregate unpaid balance.\nCost in Excess of Net Assets Acquired The excess of cost of subsidiaries over the Company's equity in the underlying net assets (\"goodwill\") is being amortized over 40 years.\nThe Company's management continually monitors whether significant changes in certain industry and regulatory conditions or prolonged trends of declining profitability have occurred which would lead the Company to question the recoverability of the carrying value of its goodwill. The Company's evaluation of its recorded goodwill would be based primarily on estimates of future earnings, as well as all other available factors which may provide additional evidence relevant to the assessment of recoverability of its goodwill.\nInsurance As discussed under \"Reinsurance\" below, unpaid losses and loss adjustment expenses and unearned premiums have not been reduced for reinsurance receivable.\nReinsurance In the normal course of business, the Company's insurance subsidiaries cede reinsurance to other companies to diversify risk and limit maximum loss arising from large claims. To the extent that any reinsuring companies are unable to meet obligations under the agreements covering reinsurance ceded, the Company's insurance subsidiaries would remain liable. Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsurance policies. The Company's insurance subsidiaries report as assets (a) the estimated reinsurance recoverable on unpaid losses, including an estimate for losses incurred but not reported, and (b) amounts paid to reinsurers applicable to the unexpired terms of policies in force. The Company's insurance subsidiaries also assume reinsurance from other companies. Income on reinsurance assumed is recognized based on reports received from ceding reinsurers.\nDeferred Policy Acquisition Costs Policy acquisition costs (principally commissions, premium taxes and other underwriting expenses) related to the production of new business are deferred. The deferral of acquisition costs is limited based upon their recoverability without any consideration for anticipated investment income. Deferred policy acquisition costs are charged against income ratably over the terms of the related policies.\nUnpaid Losses and Loss Adjustment Expenses The net liabilities stated for unpaid claims and for expenses of investigation and adjustment of unpaid claims are based upon (a) the accumulation of case estimates for losses reported prior to the close of the accounting period on the direct business\nAMERICAN PREMIER UNDERWRITERS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nwritten; (b) estimates received from ceding reinsurers and insurance pools and associations; (c) estimates of unreported losses based on past experience and (d) estimates based on experience of expenses for investigating and adjusting claims. These liabilities are subject to the impact of changes in claim amounts and frequency and other factors. In spite of the variability inherent in such estimates, management believes that the liabilities for unpaid losses and loss adjustment expenses are adequate. Changes in estimates of the liabilities for losses and loss adjustment expenses are reflected in the Statement of Earnings in the period in which determined.\nPremium Recognition Premiums are earned over the terms of the policies on a pro rata basis. Unearned premiums represent that portion of premiums written which is applicable to the unexpired terms of policies in force. On reinsurance assumed from other insurance companies or written through various underwriting organizations, unearned premiums are based on reports received from such companies and organizations.\nPolicyholder Dividends Dividends payable to policyholders represent management's estimate of amounts payable on participating policies which share in favorable underwriting results. The estimate is accrued during the period in which the related premium is earned. Changes in estimates are included in the Statement of Earnings in the period determined. Policyholder dividends do not become legal liabilities unless and until declared by the boards of directors of the insurance companies.\nCapital Surplus Adjustments to claims and contingencies arising from events or circumstances preceding the Company's 1978 reorganization are reflected in capital surplus if the adjustments are not clearly attributable to post-reorganization events or circumstances. Such pre-reorganization claims and contingencies consist principally of personal injury claims by former employees of the Company's predecessor and claims relating to the generation, disposal or release into the environment of allegedly hazardous substances arising out of railroad operations disposed of prior to the 1978 reorganization.\nFair Value of Financial Instruments Methods and assumptions used in estimating fair values are described in Note P. These fair values represent point-in-time estimates of value that might not be particularly relevant in predicting the Company's future earnings or cash flows.\nStatement of Cash Flows For cash flow purposes, \"investing activities\" are defined as making and collecting loans and acquiring and disposing of debt or equity instruments and property and equipment. \"Financing activities\" include obtaining resources from owners and providing them with a return on their investments, borrowing money and repaying amounts borrowed. All other activities are considered \"operating\". Short-term investments having original maturities of three months or less when purchased are considered to be cash equivalents for purposes of the financial statements.\nB. Mergers\nIn April 1995, the Company became a wholly-owned subsidiary of American Premier Group, Inc., a new corporation formed by the Company for the purpose of acquiring all of the common stock of the Company and American Financial Corporation (the \"Mergers\"). In June 1995, American Premier Group changed its name to American Financial Group, Inc. (\"AFG\"). Under terms of the Mergers, (a) the Company merged with a subsidiary of AFG and each share\nAMERICAN PREMIER UNDERWRITERS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nof Company Common Stock then outstanding was converted into one share of AFG Common Stock, and (b) American Financial Corporation (\"AFC\") merged with another subsidiary of AFG and all shares of AFC common stock were exchanged for 28.3 million shares of AFG Common Stock. As a result of the Mergers, all of the common stock of the Company and AFC is owned by AFG and AFG is the Company's successor as the issuer of publicly held common stock.\nIn connection with the Mergers, AFG reviewed the classification of all securities held by its subsidiaries. As a result, all securities held by the Parent Company and 44% of those held by the Company's insurance subsidiaries at the date of the Mergers were classified as \"available for sale.\" These classifications reflect transfers from \"held to maturity\" of $273 million for the Parent Company and $274 million for the Insurance companies. The cost of securities transferred approximated market value.\nC. Divestitures\nSale of Non-insurance Businesses The intended divestitures of businesses announced in December 1992 included five small diversified industrial companies, four of which were sold during 1993 and 1994 for aggregate proceeds of $30.9 million. The remaining business was sold in February 1995 for cash and notes of approximately $13 million, net of expenses and post-closing adjustments. A provision of $4.0 million for the anticipated loss on this sale was recorded in 1994.\nIn 1994, the Company sold its 53.5% interest in operations which provided onshore oil and gas contract drilling and well workover services for $14.5 million in cash. No gain or loss was recognized on the transaction.\nIn 1993, the Company sold its investment in Tejas Gas Corporation (\"Tejas\") in an underwritten public offering for net proceeds of $106.6 million. The Company's pretax gain from the sale was approximately $80.0 million.\nIn 1993, the Company sold its limited partnership interest in Buckeye Partners, L.P. (\"Buckeye Units\") in an underwritten public offering for net proceeds of $71.6 million. The Company's pretax gain from the sale was approximately $18.5 million.\nSale of General Cable Corporation Securities As part of the 1992 spin-off of General Cable Corporation, the Company retained a $255 million 9.98% subordinated note due 2007 issued by General Cable (the \"General Cable Note\") and approximately 11.6% of the General Cable shares (\"Retained Shares\"). During 1993, General Cable paid the $31.8 million of interest due on the General Cable Note with additional 9.98% subordinated notes (\"Interest Notes\") in lieu of cash.\nIn February 1994, as a result of General Cable's sale of its Marathon LeTourneau unit to a subsidiary of Rowan Companies, Inc. (\"Rowan\"), General Cable delivered to the Company cash and promissory notes issued by Rowan totalling $52.1 million as a partial payment of the General Cable Note and Interest Notes (collectively, the \"General Cable Notes\"). As a result of these receipts, the Company credited General Cable with $48.1 million of principal and interest on the General Cable Notes.\nAMERICAN PREMIER UNDERWRITERS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nIn June 1994, as part of an agreement for the purchase of all of the outstanding shares of General Cable by Wassall PLC (\"Wassall\"), the Company sold to Wassall the then outstanding $253.5 million principal amount of the General Cable Notes and the Retained Shares for $169.8 million and $6.9 million, respectively. The Company recorded a loss of approximately $75.8 million in 1994 on the disposition, and the Company did not accrue any interest income on the General Cable Notes during 1994. Also as part of the agreement, the Company received a $19.2 million payment from Wassall in consideration of assuming responsibility for certain actual and potential environmental and other liabilities. Immediately prior to the sale of General Cable, AFC, which at that time owned 40.5% of the Company's common stock, also owned 45.6% of the outstanding common stock of General Cable. The Chairman of the Board and Chief Executive Officer of the Company was the Chairman of the Board of General Cable.\nDiscontinued Operations In 1993, the Company sold its defense services operations to an unaffiliated company and recognized a loss of approximately $13.5 million from the sale. Revenues, pretax income and net income of discontinued operations for 1993 amounted to $275 million, $4.8 million and $2.8 million, respectively.\nD. Investments Bonds, redeemable preferred stocks and other stocks at December 31, consisted of the following (in millions):\nAMERICAN PREMIER UNDERWRITERS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nThe table below sets forth the scheduled maturities of bonds and redeemable preferred stocks based on carrying value as of December 31, 1995. Data based on market value is generally the same. Mortgage-backed securities had an average life of approximately 4 years at December 31, 1995.\nHeld to Available Maturity Maturity for Sale One year or less 9% 3% After one year through five years 28 26 After five years through ten years 34 51 After ten years 5 13 76 93 Mortgage-backed securities 24 7 100% 100%\nRealized gains (losses) and changes in unrealized appreciation (depreciation) on fixed maturity and equity security investments are summarized as follows (in millions):\nFixed Equity Tax Maturities Securities Effects Total Realized $ 23.8 $ - $ (9.1) $ 14.7 Change in Unrealized 184.3 .7 (27.2) 157.8\nRealized .1 - - .1 Change in Unrealized (192.9) (1.1) 30.4 (163.6)\nRealized 14.7 108.6 (57.5) 65.8 Change in Unrealized 42.3 (.2) (14.7) 27.4\nTransactions in fixed maturity investments included in the Statement of Cash Flows for 1995 consisted of the following (in millions):\nHeld to Available Maturity for Sale Total\nPurchases $196.0 $318.9 $514.9 Maturities and redemptions 232.9 39.4 272.3 Sales - 851.0 851.0 Gross Gains 4.8 25.2 30.0 Gross Losses (1.9) (4.3) (6.2)\nHeld to Available Maturity for Sale Total\nPurchases $337.5 $508.8 $846.3 Maturities and redemptions 144.0 15.8 159.8 Sales 5.9 65.0 70.9 Gross Gains .2 3.2 3.4 Gross Losses (.1) (3.2) (3.3)\nSecurities classified as \"held to maturity\" having an amortized cost of $5.8 million were sold for a gain of $.1 million in 1994, due to significant deterioration in the issuers' creditworthiness.\nGross gains of $15.6 million and gross losses of $.9 million were realized on sales of fixed maturity investments in 1993.\nAMERICAN PREMIER UNDERWRITERS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nMajor categories of net investment income were as follows (in millions):\n1995 1994 1993\nFixed maturities $164.2 $171.1 $138.8 Loans to affiliates 44.0 - - Equities .2 .1 4.3 Other - .4 28.6 Total investment income 208.4 171.6 171.7 Investment expenses (3.0) (3.3) (3.6) Net investment income $205.4 $168.3 $168.1\nThe Company's investment in investee corporation reflects the Company's 6% ownership (3.2 million shares) of the common stock of Chiquita Brands International, Inc. (\"Chiquita\") which is accounted for under the equity method. AFG and its other subsidiaries own an additional 38% of the common stock of Chiquita. Chiquita is a leading international marketer, processor and producer of quality food products. The market value of the Company's investment in Chiquita was approximately $44.5 million at December 31, 1995.\nE. Amounts Due from Affiliates\nSubsequent to the Mergers, the Company entered into a credit agreement under which loans are available to AFC of up to $675 million (the \"AFC Credit Agreement\"). The credit line bears interest at 11-5\/8% and converts to a four-year term loan in March 2005 with scheduled principal payments to begin in April 2005. At December 31, 1995, amounts outstanding under the AFC Credit Agreement totalled $623.2 million, plus $16.3 million of accrued interest.\nAlso subsequent to the Mergers, the Company entered into a credit agreement with AFG under which the Company and AFG will make loans of up to $125 million available to each other (the \"AFG Credit Agreement\"). The balance outstanding under the credit line bears interest at a variable rate of one percent over LIBOR and is payable on December 31, 2010. At December 31, 1995, amounts payable to AFG under the AFG Credit Agreement totalled $84.0 million, plus $1.1 million of accrued interest.\nF. Cost in Excess of Net Assets Acquired At December 31, 1995 and 1994, accumulated amortization of the excess of cost over net assets of purchased subsidiaries amounted to approximately $63 million and $53 million, respectively. Amortization expense was $11.8 million in 1995, $11.4 million in 1994 and $10.5 million in 1993.\nG. Long-Term Debt\nLong-term debt consisted of the following at December 31, (in millions):\n1995 1994 Parent Company: Subordinated notes, 10 7\/8%, due 2011 $ 50.5 $150.0 Subordinated notes, 10 5\/8%, due 2000 113.0 150.0 Subordinated notes, 9 3\/4%, due 1999 157.1 200.0 320.6 500.0 Subsidiaries: Other 9.1 9.8 Total $329.7 $509.8\nAMERICAN PREMIER UNDERWRITERS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nIn December 1995, Pennsylvania Company (\"Pennco\"), a wholly-owned subsidiary of the Company, entered into a new collateralized five- year reducing revolving credit agreement with several banks, under which it can borrow up to $75 million. Borrowings bear interest at floating rates based on prime or LIBOR and are collateralized by certain stock of an operating subsidiary. At December 31, 1995, the Company had no outstanding borrowings under the agreement.\nIn May 1995, rating agencies downgraded the Company's subordinated notes (the \"Notes\"). As a result of the Mergers and the subsequent ratings downgrade, the holders of the Notes had the right to require the Company to purchase all or any portion of the Notes on August 10, 1995 at par plus accrued interest (the \"Put Right\"). The Put Right was exercised for approximately $40 million of the 9-3\/4% Notes and approximately $4 million of the other two issues.\nIn addition, during 1995, the Company repurchased $2.9 million of its 9-3\/4% subordinated notes, $34.8 million of its 10-5\/8% subordinated notes and $98.3 million of its 10-7\/8% subordinated notes for approximately $142.7 million which resulted in an extraordinary loss of $5.1 million. During the first two months of 1996, the Company repurchased an additional $19.0 million of its 9-3\/4% subordinated notes, $7.5 million of its 10-5\/8% subordinated notes and $2.2 million of its 10-7\/8% subordinated notes.\nIn March 1994, the Company redeemed all $16.2 million principal amount of its 9 1\/2% subordinated debentures due August 2002 at the redemption price of 100% of principal.\nAt December 31, 1995, scheduled principal payments on debt for the subsequent five years were as follows 1996--$.8 million, 1997- - -$.8 million, 1998--$.9 million, 1999--$157.5 million and 2000-- $114.5 million.\nAt December 31, 1995, the Company had outstanding letter of credit facilities totaling $38.6 million which, if drawn, will bear interest at rates which approximate the prime rates offered by various banks.\nCash interest payments of $48.7 million, $52.7 million and $62.7 million were made on debt in 1995, 1994 and 1993, respectively.\nH. Benefit Plans\nThe Company provides retirement benefits, primarily through contributory and noncontributory defined contribution plans, for the majority of its regular full-time employees. Company contributions under the defined contribution plans approximate, on average, 4% of each eligible employee's covered compensation. In addition, the Company sponsors employee savings plans under which the Company matches a specified portion of contributions made by eligible employees. Expense related to defined contribution plans for 1995, 1994 and 1993 totaled $5.6 million, $5.8 million and $5.5 million, respectively.\nThe Company also provides defined benefit pension plan retirement benefits for certain employees. The related amounts included in the accompanying financial statements are not material to the Company's financial condition.\nUnder the Company's Stock Option Plan, options to purchase shares of Common Stock were granted to certain officers and other key employees, and to non-employee directors of the Company. Under the now terminated Career Share\nAMERICAN PREMIER UNDERWRITERS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nPurchase Plan (the \"Career Share Plan\"), officers and other key employees of the Company purchased shares of the Company's Preference Stock (designated Career Shares) which were convertible, at the holder's option, into a specified number of shares of Common Stock. The Company's Employee Stock Purchase Plan (\"ESPP\") provided eligible employees with the opportunity to purchase from the Company, through regular payroll deductions, shares of the Company's Common Stock at 85% of its fair market value on the purchase date. In connection with the Mergers described in Note B, each outstanding Career Share was converted into a share of AFG convertible preferred stock and each stock option outstanding under the Company's Stock Option Plan was converted into an option to purchase AFG common stock. In addition, AFG succeeded the Company under all provisions of the Stock Option Plan, the Career Share Plan and the ESPP.\nI. Capital Stock The Company is authorized to issue 200,000,000 shares of Common Stock. At December 31, 1995, there were 47,000,000 shares of Common Stock outstanding, all of which were owned by AFG. A progression of the Company's shareholder's equity is as follows (dollars in millions):\nAMERICAN PREMIER UNDERWRITERS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nDuring 1994, the Company increased its accruals for its net probable liability for claims and contingencies arising from events and circumstances preceding the Company's 1978 reorganization based on information which became available to it in 1994. The accrual includes the estimated costs to the Company related to remediation of environmental conditions allegedly caused or contributed to by PCTC and pending and expected claims by former PCTC employees of injury or disease allegedly caused by exposure to excessive noise or asbestos in the railroad workplace. The foregoing estimates were based on information available to the Company at that time and are subject to future change as additional information becomes available. Offsetting the increase in these accruals was a $13.8 million credit resulting from a judgment in favor of the Company. In accordance with the Company's reorganization accounting policy, the Company recorded a net charge of $52.0 million to capital surplus to reflect the net effect of the foregoing accruals which the Company believes will be adequate based on information currently available to it.\nAlso during 1994, the Company settled a dispute with former employees of a business that had been acquired in 1990 and subsequently included in the General Cable Spin-off in July 1992.\nDuring 1993, the Company settled a lawsuit it had brought against the former owner of a business that was acquired by the Company in 1990 and was included in the General Cable businesses spun-off to shareholders in July 1992. After the spin-off of General Cable, the Company retained the right to receive any amounts recovered in the lawsuit. The net amount of cash received by the Company in the settlement was accounted for as an adjustment to the distribution of equity to shareholders resulting from the spin-off of General Cable.\nJ. Income Taxes The Company files a consolidated income tax return which includes all 80%-owned U.S. subsidiaries and the AFG parent company.\nFor income tax purposes, the Company had the following carryforwards available at December 31, 1995 (in millions):\nExpiring Amount\nOperating loss 1996 $476 Capital loss 1997-1999 311 Other - tax credits 23\nThe total income tax (provision) credit consists of (in millions):\n1995 1994 1993 Current Federal $ (.5) $(2.8) $(4.4) Foreign .6 (1.3) (.1) State & Local - - (.8)\nDeferred Federal (46.0) (36.3) 59.4 Foreign - - - State & Local - - (1.5) ($45.9) ($40.4) $52.6\nAMERICAN PREMIER UNDERWRITERS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nThe following is a reconciliation of income taxes at the statutory rate of 35% and income taxes as shown in the Statement of Earnings (in millions):\n1995 1994 1993\nEarnings before income taxes and extraordinary items $113.0 $ 41.2 $190.1 Extraordinary items before income taxes (7.8) - - Adjusted earnings before income taxes $105.2 $ 41.2 $190.1\nIncome taxes at statutory rate ($ 36.8) ($ 14.4) ($ 66.5)\nEffect of: Amortization of goodwill (4.0) (4.0) (3.8) Revision to valuation allowance - - 132.0 Loss disallowance - (21.4) (6.9) Other, net (2.4) (.6) (2.2) Total provision (43.2) (40.4) 52.6\nAmounts applicable to extraordinary items (2.7) - - Provision for income taxes as shown on the Statement of Earnings ($ 45.9) ($ 40.4) $ 52.6\nEarnings before income taxes consisted of the following (in millions):\n1995 1994 1993\nSubject to tax in: United States $114.8 $ 38.9 $190.1 Foreign jurisdictions (1.8) 2.3 - $113.0 $ 41.2 $190.1\nThe Company's substantial tax loss carryforwards and temporary differences give rise to deferred tax assets. Based on an analysis of the likelihood of realizing the Company's gross deferred tax asset (taking into consideration applicable statutory carryforward periods), the Company determined that the recognition criteria set forth in SFAS No. 109, \"Accounting for Income Taxes\", are not met for the entire gross deferred tax asset and, accordingly, the gross deferred tax asset is reduced by a valuation allowance. The analysis of the likelihood of realizing the gross deferred tax asset is reviewed and updated periodically. Any required adjustments to the valuation allowance are made in the period in which the developments on which they are based become known. Results for 1993 include tax benefits of $132 million attributable to such adjustments.\nAMERICAN PREMIER UNDERWRITERS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nThe significant components of the deferred tax asset included in the Balance Sheet at December 31, were as follows (in millions):\n1995 1994 Deferred tax assets: Net operating loss carryforward $166.5 $176.7 Capital loss carryforwards 108.7 115.5 Insurance claims and reserves 102.9 120.1 Other, net 91.3 101.3 469.4 513.6 Valuation allowance for deferred tax assets (214.0) (213.5) 255.4 300.1\nDeferred tax liabilities: Deferred acquisition costs (31.2) (32.4) Investment securities (23.8) - (55.0) (32.4)\nNet deferred tax asset $200.4 $267.7\nCash payments for income taxes, net of refunds, were $1.9 million, $3.7 million and $1.0 million for 1995, 1994 and 1993, respectively. Substantially all of such payments were for alternative minimum taxes.\nK. Contingencies\nIn management's opinion, the outcome of the items discussed below will not, individually or in the aggregate, have a material adverse effect on the Company's financial condition or results of operations.\nPre-Reorganization Matters\nThe following matters arose out of railroad operations disposed of by the Company's predecessor, Penn Central Transportation Company (\"PCTC\"), prior to its bankruptcy reorganization in 1978 and, accordingly, any ultimate liability arising therefrom in excess of previously established loss accruals would be attributable to pre-reorganization events and circumstances. In accordance with the Company's pre-reorganization accounting policy, any such ultimate liability will reduce the Company's capital surplus and shareholders' equity, but will not be charged to income.\nUSX Litigation Lawsuits have been filed against the Company by USX Corporation (\"USX\") and its former subsidiary, Bessemer and Lake Erie Railroad Company (\"B&LE\"), seeking contribution by the Company, as the successor to the railroad business conducted by PCTC prior to 1976, for amounts that USX paid in satisfaction of a judgment against B&LE for its participation in an unlawful antitrust conspiracy among certain railroads. The lawsuits argue that USX's liability for that payment was attributable to PCTC's alleged activities in furtherance of the conspiracy. The Company and its outside counsel believe that the Company has substantial defenses to these lawsuits and should not suffer a material loss as a result of this litigation.\nEnvironmental Matters The Company's liability for environmental claims ($64.3 million at December 31, 1995, before claims for recovery of $9.5 million) consists of a number of proceedings and claims seeking to impose responsibility for hazardous waste remediation costs at certain railroad\nAMERICAN PREMIER UNDERWRITERS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nsites formerly owned by PCTC and at certain other sites where hazardous waste was allegedly generated by PCTC's railroad operations. It is difficult to estimate remediation costs for a number of reasons, including the number and financial resources of other potentially responsible parties, the range of costs for remediation alternatives, changing technology and the time period over which these matters develop. The Company's liability is based on information currently available and is subject to future change as additional information becomes available.\nPersonal Injury Matters The Company's liability for occupational injury and disease claims ($80.6 million at December 31, 1995, before claims for recovery of $62.1 million) includes pending and expected claims by former employees of PCTC of injury or disease allegedly caused by exposure to excessive noise, asbestos or other substances in the railroad workplace. Recorded amounts are based on the accumulation of estimates of reported and unreported claims and related expenses and estimates of probable recoveries from insurance carriers.\nOther Matters\nIn connection with the Company's sale of its General Cable Corporation securities, the Company assumed responsibility for certain actual and potential environmental and other liabilities in consideration of an indemnity payment of $19.2 million.\nThe Company has agreed to guarantee several third party obligations which are not material individually or in the aggregate. The Company has also entered into various operating lease agreements related principally to certain administrative facilities and transportation equipment.\nL. Insurance Operations\nRestrictions on Transfers of Funds and Assets The Company's insurance operations are subject to state regulations which limit, by reference to specified measures of statutory operating results and policyholders' surplus, the dividends that can be paid to the Parent Company without prior regulatory approval. Without such approval, the maximum amount of dividends which can be paid to the Parent Company during 1996 by these subsidiaries is $80.4 million. At December 31, 1995 and 1994, statutory capital and surplus totaled $629.6 million and $643.6 million, respectively.\nReinsurance The insurance operations assume and cede a portion of their written business with other insurance companies in the normal course of business. To the extent that any reinsuring companies are unable to meet their obligations under agreements covering reinsurance ceded, the Company's insurance subsidiaries would remain liable. Amounts deducted from insurance losses and loss adjustment expenses (\"LAE\") and net written and earned premiums in\nAMERICAN PREMIER UNDERWRITERS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nconnection with reinsurance ceded to affiliates and non-affiliated companies, as well as amounts included in net written and earned premiums for reinsurance assumed from affiliates and non-affiliated companies, were as follows (in millions):\n1995 1994 1993 Reinsurance ceded: Premiums written Non-affiliates $ 15.5 $20.4 $ 9.3 Premiums earned Non-affiliates 13.6 18.7 8.9 Incurred losses and LAE: Affiliates .6 (1.8) (2.5) Non-affiliates 20.4 15.9 3.8\nReinsurance assumed: Premiums written: Affiliates 134.3 167.6 101.2 Non-affiliates 22.9 36.4 74.4 Premiums earned: Affiliates 128.8 139.4 78.2 Non-affiliates 28.8 50.1 60.1\nDecember 31, 1995 1994 Reinsurance ceded: Reserves for unpaid loss and LAE: Affiliates $ 7.2 $10.2 Non-affiliates 52.2 40.7\nThe allowance for uncollectible reinsurance was $1.5 million at December 31, 1995 and 1994.\nLiability for Losses and Loss Adjustment Expenses The following table provides an analysis of changes in the estimated liability for losses and LAE, net of reinsurance activity (in millions).\n1995 1994 1993 Balance at beginning of year, net of reinsurance $1,080 $ 916 $ 764\nProvision for losses and LAE occurring in the current year 1,247 1,170 915 Net decrease in provision for claims occurring in prior years (49) (79) (58) 1,198 1,091 857 Payments for losses and LAE occurring during: Current year 662 554 413 Prior years 480 386 346 1,142 940 759 Loss and LAE reserves of subsidiaries purchased - 13 54\nBalance at end of year, net of reinsurance 1,136 1,080 916\nReinsurance receivable on unpaid losses and LAE at end of year 59 51 45 Balance at end of period, gross of reinsurance receivable $1,195 $1,131 $ 961\nAMERICAN PREMIER UNDERWRITERS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nThe decreases in the provision for claims occurring in prior years resulted from reductions in the estimated ultimate losses and LAE related to such claims.\nOther Statutory net income for 1995, 1994 and 1993 was $61.0 million, $79.6 million and $93.0 million, respectively. Deferred policy acquisition costs amortized to income were $298.2 million, $292.3 million and $243.8 million for 1995, 1994 and 1993, respectively. Net written premiums for 1995, 1994 and 1993 were $1,492 million, $1,636 million and $1,379 million, respectively.\nAt December 31, 1995 and 1994, reserves for uncollectible premiums receivable were $6.6 million and $5.9 million, respectively.\nDuring 1995, 1994 and 1993, 41%, 89% and 95%, respectively, of net premiums written in the workers' compensation insurance operations were for policies eligible for policyholder dividend consideration.\nM. Statement of Cash Flows\nIn February 1994, General Cable delivered to the Company $41.7 million in promissory notes as a partial payment of the General Cable Notes. During 1993, General Cable elected to pay the $31.8 million of interest due on the General Cable Note with Interest Notes in lieu of cash. These non-cash transactions, which increased the Parent Company investments and decreased accrued investment income, are not included in the Statement of Cash Flows.\nN. Transactions With Affiliates\nVarious business has been transacted between the Company and certain affiliate companies including rentals, investment management services, insurance and sales of assets. Unless otherwise disclosed, none of these transactions had a material effect on the net earnings or equity of the Company. Aggregate charges for these services within the Company and its subsidiaries have been insignificant in relation to consolidated revenues.\nDuring 1995, the Company purchased 3.2 million shares of Chiquita from AFC for $43.7 million. Also during 1995, the Company sold (i) certain properties to a subsidiary of AFC for aggregate proceeds of $15.9 million; (ii) a small reinsurance subsidiary to AFC for $13.7 million; and (iii) shares of an affiliate to AFC for $553,000. The Company recognized a loss of $2.1 million on the sales.\nDuring 1990, the Company acquired the nonstandard automobile insurance business (the \"NSA Group\") from AFC. The purchase price was subject to adjustment in 1995, based on 1991-1994 pretax earnings of the NSA Group, by a reduction of up to $20.0 million or an increase of up to $40.0 million, in each case plus interest. In December 1993, the Company, having concluded that it was highly probable that the maximum adjustment would be payable by the Company, paid $40.0 million, plus $12.8 million of interest, to a subsidiary of AFC, in full settlement in order to cut off the accrual of interest at the relatively high rate prescribed by the acquisition agreement. Also, as part\nAMERICAN PREMIER UNDERWRITERS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nof the agreement for the purchase of the NSA Group, AFC, through a subsidiary, provided stop-loss protection to the Company which, in effect, guaranteed the adequacy of unpaid loss and allocated loss adjustment expense reserves of the NSA Group (net of reinsurance and salvage and subrogation recoveries) related to periods prior to 1991 under policies written and assumed by the NSA Group. By mutual agreement, effective December 31, 1995, the parties cancelled this arrangement and settled all amounts due.\nIn 1988, the Company's workers' compensation insurance operations (\"Republic Indemnity\") entered into a reinsurance contract with Great American Insurance Company (\"GAI\") to cover the aggregate losses on workers' compensation coverage for the accident years 1980-1987, inclusive. The contract provides for coverage by GAI of net aggregate paid losses of Republic Indemnity in excess of a certain threshold, up to a maximum of $35.1 million. Cumulative paid losses at December 31, 1995 pertaining to claims during this period exceeded the threshold amount by approximately $1 million. In addition, GAI has agreed to reimburse Republic Indemnity for its loss adjustment expenses pertaining to this period up to a maximum of $4.9 million.\nO. Quarterly Operating Results (Unaudited)\nSummarized quarterly financial data for 1995 and 1994 are set forth below (in millions).\n1st 2nd 3rd 4th Quarter Quarter Quarter Quarter Total 1995: Revenues $432.8 $437.2 $433.3 $432.2 $1,735.5 Net earnings from continuing operations 16.3 13.6 18.2 19.0 67.1 Net earnings 16.3 9.5 17.6 18.6 62.0\n1994: Revenues 357.3 467.9 475.8 457.9 $1,758.9 Net earnings (loss) from continuing operations (55.9) 16.6 25.2 14.9 .8 Net earnings (loss) (55.9) 15.2 26.1 14.9 .3\nThe first quarter 1994 results include a pretax loss of $76 million on the sale of General Cable securities. Realized gains (losses) on sales of securities amounted to (in millions):\n1st 2nd 3rd 4th Quarter Quarter Quarter Quarter Total 1995 $(.2) $1.6 $7.1 $15.3 $23.8 1994 .6 1.3 (1.0) (.8) .1\nP. Additional Information\nTotal rental expense recorded under various operating leases related to certain administrative facilities and transportation equipment was $13.3 million in 1995, $12.9 million in 1994, and $13.3 million 1993.\nAMERICAN PREMIER UNDERWRITERS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nFuture minimum rentals required under noncancelable lease agreements at December 31, 1995, related principally to certain administrative facilities and transportation equipment, were as follows: 1996--$12.3 million, 1997--$11.5 million, 1998--$9.3 million, 1999--$7.6 million, 2000--$5.8 million and $10.6 million thereafter.\nOther operating and general expenses included charges for possible losses on agents' balances, reinsurance recoverables and other receivables in the following amounts: 1995 - $0, 1994 - $1 million and 1993 - $6 million. The aggregate allowance for such losses amounted to approximately $14 million at December 31, 1995 and 1994.\nFair Value of Financial Instrument The following table presents (in millions) the carrying value and estimated fair value of the Company's financial instruments at December 31. 1995 1994 Carrying Fair Carrying Fair Value Value Value Value Assets: Bonds and redeemable preferred stocks $1,870 $1,880 $2,340 $2,261 Other stocks 4 4 5 5\nLiabilities: Long-term debt: Parent company $ 321 $ 344 $ 500 $ 519 Other subsidiaries 9 9 10 10\nWhen available, fair values are based on prices quoted in the most active market for each security. If quoted prices are not available, fair value is estimated based on present values, discounted cash flows, fair value of comparable securities, or similar methods.\nQ. Subsequent Event (Unaudited)\nIn March 1996, the Company sold the stock of a subsidiary, Buckeye Management Company (\"Buckeye\"), to an investment group consisting of members of Buckeye's management team and employees for approximately $63 million in cash. Buckeye holds, directly and indirectly, a 2% general partnership interest in Buckeye Partners, L.P. which, through its subsidiary entities, is an independent pipeline common carrier of refined petroleum products. The Company's pretax gain of approximately $53 million from the sale will be reported in 1996. The Chairman of the Board and Chief Executive Officer of Buckeye was also a director of the Company, until resigning in March 1996.\nPART IV\nITEM 14","section_14":"ITEM 14\nExhibits, Financial Statement Schedules and Reports on Form 8-K\n(a) Documents filed as part of this Report: 1. Financial Statements are included in Part II, Item 8.\n2. Financial Statement Schedules: A. Selected Quarterly Financial Data is included in Note O to the Consolidated Financial Statements.\nB. Schedules filed herewith for 1995, 1994 and 1993:\nPage III - Condensed Financial Information of Registrant S-2\nAll other schedules for which provisions are made in the applicable regulation of the Securities and Exchange Commission have been omitted as they are not applicable, not required, or the information required thereby is set forth in the Financial Statements or the notes thereto.\n3. Exhibits - see Exhibit Index on page E-1.\n(b) Reports on Form 8-K:\nDate of Report Item Reported\nDecember 13, 1995 Court of Appeals Ruling - USX Litigation\nS-1\nAMERICAN PREMIER UNDERWRITERS, INC. SCHEDULE III - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (In Millions)\nCondensed Statement of Earnings\nS-2\nAMERICAN PREMIER UNDERWRITERS, INC. SCHEDULE III - CONDENSED FINANCIAL INFORMATION OF REGISTRANT - CONTINUED (In Millions)\nCondensed Statement of Cash Flows\nS-3\nSignatures\nPursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, American Premier Underwriters, Inc. has duly caused this Report to be signed on its behalf by the undersigned, duly authorized.\nAmerican Premier Underwriters, Inc.\nSigned: March 27, 1996 BY:s\/CARL H. LINDNER Carl H. Lindner 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 Capacity Date\ns\/CARL H. LINDNER Chairman of the Board March 27, 1996 Carl H. Lindner of Directors\ns\/THEODORE H. EMMERICH Director* March 27, 1996 Theodore H. Emmerich\ns\/JAMES E. EVANS Director March 27, 1996 James E. Evans\ns\/THOMAS M. HUNT Director March 27, 1996 Thomas M. Hunt\ns\/S. CRAIG LINDNER Director March 27, 1996 S. Craig Lindner\ns\/KEITH E. LINDNER Director March 27, 1996 Keith E. Lindner\ns\/CARL H. LINDNER III Director March 27, 1996 Carl H. Lindner III\ns\/WILLIAM R. MARTIN Director* March 27, 1996 William R. Martin\ns\/FRED J. RUNK Senior Vice President and March 27, 1996 Fred J. Runk Treasurer (Principal Financial and Accounting Officer)\n* Member of the Audit Committee\nINDEX TO EXHIBITS\nAMERICAN PREMIER UNDERWRITERS, INC.\nNumber Exhibit Description\nE-1\n10 (c) Premium Payment Agreement, effective as of (*) January 1, 1991, by and between Great American Insurance Company and the Company filed as Exhibit (10)(iii)(q) to the Company's Company's Form 10-K for 1990.\n10 (d) Excess of Loss Agreement, effective (*) March 31, 1988, between Republic Indemnity Company of America and Great American Insurance Company, filed as Exhibit (g)(l) to Amendment No. 1 to Schedule 13E-3, dated January 17, 1989, relating to Republic American Corporation filed by Republic American Corporation, the Company, RAWC Acquisition Corp., American Financial Corporation and Carl H. Lindner (the \"Schedule 13E-3 Amendment\").\n10 (e) First Amendment to Excess of Loss (*) Agreement, effective March 31, 1988, between Republic Indemnity Company of America and Great American Insurance Company, filed as Exhibit (g)(2) to the Schedule 13E-3 Amendment.\n10 (f) Business Assumption Agreement, effective (*) as of December 31, 1990, between Stonewall Insurance Company and Dixie Insurance Company (now Infinity Insurance Company), filed as Exhibit (10)(iii)(o)(i) to the Company's Form 10-K for 1990.\n10 (g) Quota Share Agreements, effective (*) December 31, 1990, between Stonewall Insurance Company and Dixie Insurance Company (now Infinity Insurance Company), filed as Exhibit (10)(iii)(o)(ii) to the Company's Form 10-K for 1990.\n10 (h) Letter dated April 9, 1987 from the (*) Company to Neil M. Hahl, an executive officer of the Company, with respect to severance arrangements, as supplemented by a letter dated June 26, 1987 to Neil M. Hahl, incorporated by reference to Exhibit (10)(iii)(a) to the Company's Form 10-Q Quarterly Report for the Quarter Ended June 30, 1987.\n10 (i) Stock Purchase Agreement Relating to the _____ Acquisition of Buckeye Management Company by BMC Acquisition Company dated January 5, 1996.\n12 Computation of ratio of earnings _____ to fixed charges.\n16 Letter on change in certifying accountant (*) filed as Exhibit 16 to the Company's Form 8-K Current Report for August 29, 1995.\nE-2\n21 Subsidiaries of the Registrant. _____\n27 Financial data schedule (**)\n28 Information from reports furnished to _____ state insurance regulatory authorities.\n(*) Incorporated herein by reference (**) Copy included in Report filed electronically with the Securities and Exchange Commission.\nE-3\nAMERICAN PREMIER UNDERWRITERS, INC. AND CONSOLIDATED SUBSIDIARIES\nEXHIBIT 12 - COMPUTATION OF RATIOS OF EARNINGS TO FIXED CHARGES (Dollars in Millions)\nE-4\nAMERICAN PREMIER UNDERWRITERS, INC.\nEXHIBIT 21 - SUBSIDIARIES OF THE REGISTRANT\nThe following is a list of subsidiaries of American Premier Underwriters, Inc. (the \"Company\") included in the Company's continuing operations at December 31, 1995. All corporations are subsidiaries of the Company and, if indented, subsidiaries of the company under which they are listed.\nJurisdiction Percentage of of Common Equity Incorporation Ownership\nPennsylvania Company Delaware 100% Atlanta Casualty Company (1) Illinois 100 American Premier Insurance Company Indiana 100 Atlanta Specialty Insurance Company Iowa 100 Mr. Agency of Georgia, Inc. Georgia 100 Atlanta Casualty General Agency, Inc. Texas 100 Atlanta Insurance Brokers, Inc. Georgia 100 Treaty House, Ltd. (d\/b\/a Mr. Budget) Nevada 100 Penn Central U.K. Limited United Kingdom 100 Insurance (GB) Limited United Kingdom 100 Buckeye Management Company Delaware 100 Buckeye Pipe Line Company Delaware 100 Great Southwest Corporation Delaware 100 World Houston, Inc. Delaware 100 Hangar Acquisition Corporation Ohio 100 Infinity Insurance Company Florida 100 Infinity Agency of Texas, Inc. Texas 100 The Infinity Group, Inc. Indiana 100 Infinity Select Insurance Company Indiana 100 Infinity Southern Insurance Corporation Alabama 100 Leader National Insurance Company Ohio 100 Budget Insurance Premiums, Inc. Ohio 100 Leader National Agency, Inc. Ohio 100 Leader National Agency of Texas, Inc. Texas 100 Leader National Insurance Agency of Arizona Arizona 100 Leader Preferred Insurance Company Ohio 100 Leader Specialty Insurance Company Indiana 100 PCC Technical Industries, Inc. California 100 ESC, Inc. California 100 Marathon Manufacturing Companies, Inc. Delaware 100 Marathon Manufacturing Company Delaware 100 PCC Maryland Realty Corp. Maryland 100 Penn Camarillo Realty Corp. California 100 Republic Indemnity Company of America California 100 Republic Indemnity Company of California California 100 Timberglen Limited United Kingdom 100 Risico Management Corporation Delaware 100 Windsor Insurance Company (1) Indiana 100 American Deposit Insurance Company Oklahoma 100 Granite Finance Co., Inc. Texas 100 Coventry Insurance Company Ohio 100 El Aguila Compania de Seguros, S.A. de C.V. Mexico 100\nE-5\nAMERICAN PREMIER UNDERWRITERS, INC.\nEXHIBIT 21 - SUBSIDIARIES OF THE REGISTRANT - CONTINUED\nJurisdiction Percentage of of Common Equity Incorporation Ownership\nMoore Group Inc. Georgia 100% Casualty Underwriters, Inc. Georgia 51 Dudley L. Moore Insurance, Inc. Louisiana 100 Hallmark General Insurance Agency, Inc. Oklahoma 100 Middle Tennessee Underwriters, Inc. Tennessee 100 Insurance Finance Company Tennessee 100 Windsor Group, Inc. Georgia 100 Regal Insurance Company Indiana 100 Texas Windsor Group, Inc. Texas 100 PCC Real Estate, Inc. New York 100 PCC Chicago Realty Corp. New York 100 PCC Gun Hill Realty Corp. New York 100 PCC Michigan Realty, Inc. Michigan 100 PCC Scarsdale Realty Corp. New York 100 Scarsdale Depot Associates, L.P. Delaware 80 Penn Central Energy Management Company Delaware 100 ______________\n(1) 90.05% owned by Pennsylvania Company and 9.95% owned by Republic Indemnity Company of America.\nThe names of certain subsidiaries are omitted, as such subsidiaries in the aggregate would not constitute a significant subsidiary.\nE-6\nAMERICAN PREMIER UNDERWRITERS, INC.\nEXHIBIT 28 - INFORMATION FROM REPORTS FURNISHED TO STATE INSURANCE REGULATORY AUTHORITIES\nSchedule P of Annual Statements\nA. CONSOLIDATED PROPERTY AND CASUALTY ENTITIES - See Attached Schedules\nSchedule P (prepared in accordance with the rules prescribed by the National Association of Insurance Commissioners) includes the reserves of American Premier Underwriters, Inc.'s consolidated property and casualty subsidiaries. The following is a summary of Schedule P reserves (in millions):\nSchedule P - Part 1 Summary - col. 33 $ 903 - col. 34 213 Statutory Loss and Loss Adjustment Expense Reserves $1,116\nB. UNCONSOLIDATED SUBSIDIARIES None\nC. 50% OR LESS OWNED PROPERTY AND CASUALTY INVESTEES None\nE-7","section_15":""}
{"filename":"772784_1995.txt","cik":"772784","year":"1995","section_1":"Item 1. Business\nGeneral\nNational Diversified Services, Inc. (\"National\" or the \"Company\") was incorporated under the laws of the State of Delaware on May 30, 1985.\nNational completed a public offering of 758,570 Units in December 1986 as more fully discussed under \"Item 5\" and raised net proceeds of approximately $600,000. National was a blind pool offering which at the time did not specifically allocate the proceeds raised thereby to any business or operations.\nNational's business purpose is to seek and review acquisition possibilities, and to make one or more acquisitions or enter into business endeavors as best as its limited assets will allow.\nBusiness Strategy\nThe Company is seeking one or more potential business opportunities that in the opinion of Management may provide an ultimate profit to the Company. Such involvement may be by way of the acquisition of existing businesses, the acquisition of assets to establish subsidiary businesses for the Company, a statutory merger or consolidation or the establishment of a new business. However, due to the limited working capital of the Company, it is likely that the Company will enter into only one business transaction.\nThe Company may also seek to acquire one or more majority and\/or wholly owned equity positions in other companies through the direct purchase of stock. Such equity positions will be limited by Section 3(a)(3) of the Investment Company Act of 1940 (the \"1940 Act\"), in that the Company will not be permitted to own or propose to acquire investment securities having a value exceeding 40% of the Company's total assets (exclusive of government securities and cash items) on an unconsolidated basis. The Company may provide debt financing to companies in which it has taken (or intends to take) an equity position. Such financing would generally be made on an unsecured basis. In no event will the Company provide financing for or take equity positions in companies where the aggregate of such investments would cause the Company to be required to register under the 1940 Act.\nPresent Management of the Company may or may not become involved as management in the aforementioned business or subsidiary or may hire qualified but as yet unidentified management personnel. There can, however, be no assurance whatsoever that the Company will be able to acquire a business.\nA potential acquisition of a business may involve the acquisition of, or merger with, a company which does not need additional capital but which desires to establish a public trading market for its shares. A company that seeks the Company's participation in attempting to consolidate its operations through a merger, reorganization, asset acquisition, or some other form of combination may desire to do so to avoid what it may deem to be adverse consequences of itself undertaking a public offering including the inability or unwillingness to comply with various federal and state laws enacted for the protection of investors. Factors considered may include time delays, significant expense, loss of voting control. In connection with such acquisition, it is possible that an amount of stock constituting control of the Company would be purchased from the Company or its current officers, directors and stockholders resulting in substantial profits to such persons without similar profits being realized by other stockholders. Moreover, no assurance can be given with respect to the experience or qualifications of as yet unknown persons who may, in the future, engage in the operations of the Company or any business or subsidiary acquired by the Company. In the event of a change in control of the Company and its Board of Directors, the payment of dividends would be wholly dependent upon such persons. Furthermore, it is impossible as yet to determine what, if any, consequences applicable state law may provide to the Company's shareholders in any merger or reorganization.\nGeneral Policy\nThe Company may establish or acquire a business and\/or invest in one or more new and developing corporations, whether directly or by way of statutory merger, which the Management of the Company determines will offer significant long-term growth potential. In the case of an equity position, the Company will seek to acquire primarily a majority owned and wholly owned capital stock position in such corporation. The Company is not restricted to any particular industry and may engage in any line of business. Accordingly, Management's discretion as to the type of businesses and equity investments is unlimited.\nManagement assumes that any business to be acquired and\/or equity investment made by the Company, whether directly or by way of statutory merger, will involve a business that is new and unseasoned, or a business that has been operating for a limited period of time and has a limited or unsuccessful record of revenues or earnings. Investments in start-up enterprises result in a higher risk of total loss of investment by the Company. Except in cases of a merger or other instances where stockholders' approval may be required by applicable law, the Company's stockholders will not have the opportunity to review the relative merits or weaknesses of any proposed business to be acquired or equity investment to be made and, accordingly, will have to rely upon the discretion of Management in selecting a business or investment.\nThe Company has identified certain general policies which will be considered by the Company in evaluating business acquisition candidates and investment possibilities. These policies are listed below. In no event will the Company provide financing or take equity positions in companies where the aggregate of such investments would cause the Company to be required to register under the 1940 Act.\n1. The Company will examine the products or services of a business being considered to determine whether a market exists for the products or services and whether the business can manufacture and\/or market the products or produce the services at a competitive cost.\n2. The Company will invest in a corporation that it believes has a strong potential for growth. The Company will evaluate the corporation's business and determine the quality and experience of its management.\n3. The Company may invest in an operating corporation that has experienced increases in gross revenues which exceed industry averages. The market for the corporation's products will be evaluated by determining the relationship of size, growth potential and competitive factors in that corporation's industry.\n4. The Company will also consider the following factors: (1) special risks associated with the business and the industry, (2) equity available to the business, (3) capital requirements of the business, (4) potential for profitability and (5) the effect of market and economic conditions and governmental policies on the business and its products.\nIt is unlikely that any one prospective corporation with which the Company may seek to enter a relationship will conform in all respects to the policies described above. Accordingly, this description is intended to serve only as a general guide for the Company's projected investment activities. These policies are not fundamental policies of the Company and may be changed at any time by the Company's Board of Directors.\nThe Company intends to actively participate (through present Management or presently unidentified individuals who may be hired by the Company) in the management of the operations of any business or subsidiary in which it acquires an interest. In order to accomplish this objective in the case of a subsidiary, the Company will be represented on the board of directors of such target corporation through a nominee of its choice. In addition, where the Company deems it beneficial, the Company may also have a nominee of its choice elected as an officer. Such nominee is expected to be an officer or director of the Company. The objective of such acquisition(s) will be to enhance that corporation's capabilities through active management as well as financial support. The Company does not plan to enhance the value of such subsidiaries with the primary objective of resale\nof the subsidiary's stock, but rather to further the Company's long-term investment and management objectives.\nThe Company anticipates that it will be brought into contact with a prospective business acquisition or equity investment primarily through the efforts of its officers, directors and principal stockholders who in the course of their professional activities and employment outside the Company, frequently come into contact with corporations whose products, services or concepts may be subject to successful development and marketing. In such connection, the Company may pay a finder's fee to such officers, directors, principal stockholders or their affiliates. Any such payment would not be higher than that which would ordinarily be paid to a non-affiliated person. The Company proposes to make a business acquisition or equity investment and to provide interim financing which will assist such organization in the development of these products, services and concepts. To date, the Company does not have any contracts or commitments with anyone or any firm with regard to these business activities. The Company also does not have any arrangements or understandings with respect to the acquisition of any business entity or the acquisition of any interest therein.\nThe Company may use independent consultants (who may agree to receive stock of the Company in payment for their services in lieu of cash) to explore areas of, and to seek out, acquisition prospects. Such independent consultants would be expected to have such expertise or knowledge which would be of use to Management in any investment decision. The Company has not engaged any independent consultants as of March 25, 1996.\nAt this time, Management believes the Company's equity investments will be made in private transactions with privately owned corporations. Securities acquired in this manner are restricted from public sale unless they are registered under the Securities Act of 1933, or unless an exemption from registration is available.\nGovernment Regulation\nThe Company may be subject to government regulations promulgated by various local, state and Federal government agencies with regard to its proposed business. Additionally, the Company, in the purchase of equity positions, will be subject to various rules and regulations promulgated by the Securities and Exchange Commission and the various state securities commissions. Company does not intend to engage in the business of investing, reinvesting, owning, holding or trading in securities or otherwise engaging in activities which would render the Company an \"investment company\" as defined in the Investment Company Act of 1940, as amended.\nThe Company's financing activities will be limited by Section 3(a)(3) of the Investment Company Act of 1940 in that the Company will not be permitted to own or propose to acquire\ninvestment securities having a total value exceeding 40% of the value of the Company's total assets (excluding government securities and cash items) on an unconsolidated basis. The Company is permitted under Section 3(a)(3) of the 1940 Act to own or propose to own securities of a majority owned subsidiary which is defined under Section 2(a)(24) of the 1940 Act to mean 50% or more of the outstanding securities of which are owned by the Company or a majority owned subsidiary of the Company. Notwithstanding Section 3(a)(3) of the 1940 Act, the Company would not be considered an investment company where it is engaged directly or indirectly through a wholly-owned subsidiary (which is defined to mean at least 95% ownership of the outstanding voting stock), in a business or businesses, other than that of investing, owning, holding or trading in securities.\nIn addition to the limitations by the Investment Company Act of 1940 as mentioned above, there are a number of other provisions of the Federal securities laws which will affect the Company's proposed investments.\nMost, if not all, of the securities which the Company acquires as equity investments will be \"restricted securities\" within the meaning of the Securities Act of 1933 (\"Securities Act\") and will not be permitted to be resold without compliance with the Securities Act. The registration of securities owned by the Company is likely to be a time consuming and expensive process, and the Company always bears the risk, because of these delays, that it will be unable to resell such securities, or that it will not be able to obtain an attractive price for the securities. In the event the Company does not register securities it acquires for sale, it will seek to rely upon an exemption from registration. Among other exemptions, Rule 144 of the Securities Act of 1933, as amended, imposes a two year holding period prior to the sale of restricted securities and established volume limitations on the amount of any restricted securities that can be sold within certain defined time periods.\nCompetition\nThere are numerous similar companies which are larger, have more experience, and are better financed than the Company. The Company will thus assuredly encounter intense competition from numerous other firms engaged in its field. In view of the Company's lack of operating history, it may be anticipated that the Company will encounter intense competition seeking relatively more desirable equity investments. Accordingly, the Company's proposed equity investments, if any, will entail an unusually high degree of business and financial risk that may result in substantial losses to the Company.\nPersonnel\nThe Company presently has no full-time employees. The day- to-day operations of the Company are managed by George Rubin, the\nCompany's President, who devotes such time to the affairs of the Company which is necessary for the performance of his duties.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nCurrently the Company is utilizing the office space of Mr. George Rubin at no cost to the Company until an acquisition is consummated or a business is established. The amount of office space utilized by the Company is currently insignificant.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThere are no material legal proceedings pending against 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 Securities and Related Stockholder Matters.\nThe Company completed its public offering of 758,570 Units in December 1986, each Unit consisting of one share of Common Stock and six Redeemable Common Stock Purchase Warrants. The Redeemable Warrants expired in July 1990. The Company received net proceeds of approximately $600,000 from the offering. From the completion of the Company's public offering until the present time, the Company's securities have been available to be traded in the over-the-counter market. The Company believes that there is not an active trading market for the Company's Common Stock and quotations for, and transactions in the securities are sporadic. Price quotations for prior periods are not being supplied herein because in view of the infrequent trading in the securities, they would not be meaningful.\nManagement has been advised by its transfer agent (American Stock Transfer Company) that the approximate number of holders of the Company's Common Stock as of March 25, 1996 was 335.\nNo cash dividends have been paid by the Company on its Common Stock and no such payment is anticipated in the foreseeable future.\nOf the Company's issued and outstanding 6,548,870 shares of Common Stock as of March 25, 1996, 5,790,300 shares of the Company's restricted Common Stock may be sold in compliance with Rule 144. Rule 144 provides among other things and subject to certain limitations that a person holding restricted securities for a period of two years may sell those securities in brokerage transactions, in an amount equal to at least 1% of the Company's outstanding Common Stock every three months. Possible or actual sales of the Company's Common Stock under Rule 144 may have a depressive effect upon the price of the Company's Common Stock.\nBroker-Dealer Sales of Company's Registered Securities.\nExcept where the Company's Common Stock has a market price of at least $5.00 per share, the Company's Registered Securities are covered by a Securities and Exchange Commission (\"SEC\") rule that imposes additional sales practice requirements on broker- dealers who sell such securities to persons other than established customers and institutional accredited investors. For transactions covered by the rule, the broker-dealer must make a special suitability determination for the purchaser and receive the purchaser's written agreement to the transaction prior to the sale. Consequently, the rule affects the ability of broker- dealers to sell the Company's securities and also may affect the ability of purchasers in this offering to sell their securities in the secondary market.\nThe SEC recently adopted seven rules (\"Rules\") under the Securities Exchange Act of 1934 requiring broker\/dealers engaging in certain recommended transactions with their customers in specified equity securities falling within the definition of \"penny stock\" (generally non-NASDAQ securities priced below $5 per share) to provide to those customers certain specified information. Unless the transaction is exempt under the Rules, broker\/dealers effecting customer transactions in such defined penny stocks are required to provide their customers with: (1) a risk disclosure document; (2) disclosure of current bid and ask quotations, if any; (3) disclosure of the compensation of the broker\/dealers and its salesperson in the transaction; and (4) monthly account statements showing the market value of each penny stock held in the customer's account. These SEC Rules were adopted in April, 1992 pursuant to the requirements of the Securities Enforcement Remedies and Penny Stock Reform Act of 1990 (\"Penny Stock Act\").\nAs a result of the aforesaid rules regulating penny stocks, the market liquidity for the Company's securities may be severely adversely affected by limiting the ability of broker-dealers to sell the Company's securities and the ability of purchasers of the Company's securities in the secondary market.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nConsolidated Statements of Operations Summary:\n* Less than $.01 per share.\nConsolidated Balance Sheets Summary:\n____________________ (1) If accrued salary which is not included in current liabilities were paid, working capital would have been reduced by $58,750 to $209,595 at December 31, 1995, $210,352 at December 31, 1994 and $208,458 at December 31, 1993.\nThe foregoing is selected financial information only, and is qualified by the consolidated Financial Statements and the Notes thereto, in their entirety, which are set forth elsewhere herein.\nItem 7.","section_7":"Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations.\nResults of Operations\nDuring the past three years, except for interest income, no revenues were received by the Company. The Company is presently exploring various business opportunities that may be available to it. See \"Item 1.\"\nLiquidity and Capital Resources\nFinancing of the Company's activities has been provided from the public sale of its securities for cash amounting to a net of approximately $600,000. At December 31, 1995, the Company's working capital amounted to $268,345 with cash and cash equivalent assets of $272,574. The Company believes that its presently available cash and cash equivalents are sufficient to fund the Company's search for a business opportunity. If successful in entering into such a business opportunity, the Company may require additional financing. No assurances can be given that the Company will be successful in entering into a business opportunity and if successful in securing additional financing for the Company on terms satisfactory to it, if at all. There are no material commitments for capital expenditures or other long term credit arrangements.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nThe information required by Item 8, appears at pages through (inclusive) of this Report, which pages follow this page.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.\nNot applicable.\nINDEPENDENT AUDITORS' REPORT\nTo the Board of Directors and Stockholders National Diversified Services, Inc. New York, New York\nWe have audited the accompanying consolidated balance sheets of National Diversified Services, Inc. and Subsidiaries as at December 31, 1995 and 1994, and the related consolidated statements of operations, cash flows, and changes in stockholders' equity for the years then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of National Diversified Services, Inc. and Subsidiaries as at December 31, 1995 and 1994, and the results of their operations and their cash flows for the years then ended, in conformity with generally accepted accounting principles.\nMILLER, ELLIN & COMPANY CERTIFIED PUBLIC ACCOUNTANTS\nNew York, New York March 18, 1996\nNATIONAL DIVERSIFIED SERVICES, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\nASSETS\nSTOCKHOLDERS' EQUITY\nSee accompanying notes to consolidated financial statements\nNATIONAL DIVERSIFIED SERVICES, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF OPERATIONS\n* Less than $.01 per share\nSee accompanying notes to consolidated financial statements\nNATIONAL DIVERSIFIED SERVICES, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nSee accompanying notes to consolidated financial statements\nNATIONAL DIVERSIFIED SERVICES, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSee accompanying notes to consolidated financial statements\nNATIONAL DIVERSIFIED SERVICES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1995\nNOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nOrganization and History\nThe Company was organized under the laws of the State of Delaware on May 30, 1985 and was in the development stage until 1989. During November 1989, the Company began setting up operations to import to the United States products for sale principally to the hardware and construction markets. Two wholly-owned subsidiaries were formed to conduct these operations. The Company commenced operations during the first three months of 1990 and began billing its customers in April 1990. Billings to customers ended in June 1990 and the Company terminated its import business. Currently, the Company is exploring various business opportunities that may be available to it.\nPrinciples of Consolidation\nThe consolidated financial statements include the accounts of the Company and its subsidiaries, which are all wholly-owned and totally inactive. All significant intercompany accounts and transactions have been eliminated in consolidation.\nConcentrations of Credit Risk\nThe Company places its cash balances with high credit quality financial institutions. At times, such balances may be in excess of the FDIC insurance limit.\nProperty, Plant and Equipment and Depreciation\nProperty, plant and equipment are being depreciated primarily by accelerated methods over the estimated useful lives of the individual classes of assets.\nCash Equivalents\nCash equivalents comprised an investment in short-term commercial paper with a maturity of less than ninety days.\nIncome Taxes\nEffective January 1, 1993, the Company changed its method of accounting for income taxes to comply with SFAS No. 109, \"Accounting for Income Taxes.\" A requirement of SFAS No. 109 is that deferred tax assets and liabilities are recorded for temporary differences between the financial statement and tax bases of assets and liabilities using the currently enacted tax rate expected to be in effect when the taxes are actually paid or recovered.\nNATIONAL DIVERSIFIED SERVICES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1995\nNOTE B - ACCRUED SALARIES - OFFICER\nAccrued salaries, officer represents $58,750 for the period December 1986 to November 22, 1989.\nNOTE C - INCOME TAXES\nAt December 31, 1995, the Company had net operating loss carryforwards of approximately $460,000 which expire from 2001 through 2010. In accordance with SFAS No. 109 (Note A), these operating loss carryforwards result in deferred tax assets to the Company. Management is uncertain as to the utilization of these loss carryforwards and has provided for a 100% valuation allowance for such deferred tax assets as follows:\nFederal net operating loss carryforwards $ 138,000 State net operating loss carryforwards 55,000 -------- Total 193,000 Less valuation allowance 193,000 -------- Net deferred tax assets $-0- ========\nNOTE D - NET INCOME (LOSS) PER SHARE\nNet income (loss) per share is based on the weighted average number of shares of common stock outstanding.\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 names, ages and principal occupations of the Company's present directors, and the date on which their term of office commenced and expires, are as follows:\nFirst Term of Became Principal Name Age Office Director Occupation\nGeorge Rubin 68 (1) 1989 Chairman of the Board of ATC Environmental Inc.\nStacy Goldberg 33 (1) 1995 Office Manager of ATC Environ- mental Inc. __________________ (1) Directors are elected at the annual meeting of stockholders and hold office to the following annual meeting.\n(b) Identification of Executive Officers.\nGeorge Rubin is Chairman of the Board of Directors, President, Chief Executive Officer, Principal Financial Officer and Treasurer of the Company. Stacy Goldberg is Secretary of the Company. George Rubin is the father of Stacy Goldberg and Morry F. Rubin, a principal stockholder. The Company's By-Laws provide that the terms of all officers expire at the annual meeting of directors following the annual stockholders meeting.\n(c) Business Experience\nGeorge Rubin has been Chairman of the Board of Directors of the Company since December 1989 and President, Chief Executive Officer and Chief Financial and Accounting Officer and Treasurer of the Company since August 1995. George Rubin is Chairman of the Board of ATC Environmental Inc. since June 1988. Mr. Rubin is responsible for assisting in long and short term financial planning including reviewing budgets, liaison with financial institutions and in charge of merger and acquisition activities. Mr. Rubin served as President, Treasurer and a director of Staff Builders, Inc. from its organization in 1961 to May, 1987 and as a consultant from May, 1987 to August, 1987. Staff Builders, Inc., was then a publicly held corporation with over $100,000,000 in revenues operating through 100 offices (including franchises), engaged in the business of providing temporary personnel primarily in the health care field. Mr. Rubin devotes such time to the Company as is necessary for the performance of his duties.\nStacy Goldberg, a director and Secretary of the Company since August 1995, has been an Office Manager of ATC Environmental Inc. for more than the past five years.\nPrincipal Stockholder and Founder\nMorry F. Rubin has been President, Chief Executive Officer, Treasurer and a director of ATC Environmental Inc. since January 1988. Mr. Rubin also served as President, Chief Executive Officer and Treasurer of Aurora from May 1985 through June 1995, and as a director of Aurora from September 1983 through June 1995. From June 1985 to August 1995, Mr. Rubin served as an executive officer and director of the Company. From June 1981 to May 1987, Mr. Rubin was employed in sales and as director of acquisitions for Staff Builders, Inc.\nItem 11.","section_11":"Item 11. Executive Compensation.\nDuring 1995, no executive officer has any employment contract with the Company or received any cash or other compensation. The Company presently has an incentive and non- statutory stock option plan; however, no options have been granted under the plan. See \"Stock Option Plan.\" Directors do not presently receive compensation for serving on the board, although the Company will reimburse its directors for out-of- pocket travel expenditures. Depending upon the number of meetings and the time required for the Company's operations, the Company may decide to compensate its directors in the future.\nStock Option Plan\nOn June 30, 1985, the Board of Directors of the Company adopted a Stock Option Plan (the \"Plan\") which was ratified by the stockholders of the Company on September 19, 1985. As of March 25, 1996, no options have been granted under the Plan. The Plan covers 250,000 shares of Common Stock and is intended to strengthen the Company's ability to attract and retain in its employ, and in the employ of its subsidiaries, people of training, experience and ability and to attract other persons to become associated with, and\/or to maintain their association with, the Company in various capacities other than that of an employee, by affording such employees and other persons an opportunity to hold a proprietary interest in the Company and\/or to increase their existing proprietary interest. The Plan authorizes the issuance of the options covered thereby as either \"Incentive Stock Options\" within the meaning of the Internal Revenue Code or as \"Non-Statutory Stock Options.\" While directors are eligible to receive Non-Statutory Options, only persons who are within the class eligible to receive an Incentive Option under the provisions of applicable law may be granted an Incentive Option.\nThe Plan is administered by the Company's Board of Directors, which has the authority to determine the persons to whom options shall be granted, whether any particular option\nshall be an Incentive Option or a Non-Statutory Option, the number of shares to be covered by each option, the time or times at which options will be granted or may be exercised and the other terms and provisions of the options. The Plan also provides that: (i) the exercise price of options granted thereunder shall not be less than 100% (or in the case of an Incentive Option, 110% if the optionee owns 10% or more of the outstanding voting securities of the Company) of the fair market value of such shares on the date of grant, as determined by the Board, and (ii) no option by its terms may be exercised more than ten years (five years in the case of an Incentive Option, where the optionee owns 10% or more of the outstanding voting securities of the Company) after the date of grant. Any options which are canceled or not exercised within the option period become available for future grants.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nAs of March 25, 1996, the only persons of record who held or were known to own (or believed by the Company to own) beneficially more than 5% of the outstanding 6,548,870 shares of Common Stock of the Company (the only voting security) were as indicated in the table below. Such table also sets forth the beneficial ownership of executive officers, directors, both individually and as a group.\n(1) May be deemed to be a founder, control person or affiliate of the Company under the Securities Act of 1933, as amended. (2) George Rubin is the father of Morry F. Rubin and Stacy Goldberg. Shares owned by George Rubin do not include shares owned by Morry F. Rubin and shares owned by Morry F. Rubin do not include shares owned by George Rubin.\n(3) All addresses are 104 East 25th Street, Tenth Floor, New York, New York 10010.\nThe Company does not know of any arrangement or pledge of its securities by persons now considered in control of the\nCompany that might result in a change of control of the Company.\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)(2) Financial Statements and Financial Statement Schedules.\nA list of the Financial Statements and Financial Statement Schedules filed as a part of this Report is set forth in Item 8, and appears at Page of this Report; which list is incorporated herein by reference.\n(a)(3) Exhibits\n3 Certificate of Incorporation and Amendments thereto (1)\n3(A) By-Laws (1)\n21 Subsidiaries of Registrant (2)\n27 Financial Data Schedule (3) ________________________ (1) Exhibits 3 and 3(A) are incorporated by reference from Registration No. 99080 which were filed in a Registration Statement on Form S-18.\n(2) The Company had no active subsidiaries during the year ended December 31, 1995.\n(3) Filed herewith.\n(b) Reports on Form 8-K.\nNo Form 8-K was filed or required to be filed during the fourth quarter of 1995.\nSIGNATURES\nPursuant to the requirements 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.\nNATIONAL DIVERSIFIED SERVICES, INC.\nBY:\/s\/ George Rubin George Rubin, Chairman of the Board, President, Chief Executive Officer, Chief Financial and Accounting Officer\nDated: March 28, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, 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 President, Chief Executive Officer, Treasurer, Principal Financial and \/s\/ George Rubin Accounting Officer March 28, 1996 GEORGE RUBIN\n\/s\/ Stacy Goldberg Director and Secretary March 28, 1996 STACY GOLDBERG","section_15":""}
{"filename":"92472_1995.txt","cik":"92472","year":"1995","section_1":"ITEM 1. BUSINESS\nGeneral Development of Business\nSouthwest Water Company (hereafter together with its subsidiaries referred to as the \"Company\" or \"Registrant\") was incorporated under the laws of the State of California on December 10, 1954. The Company reincorporated in the State of Delaware on June 30, 1988. The Company is engaged in the water management business, providing water and wastewater services to over half a million people located throughout California, New Mexico, Texas, and Mississippi. All regulated water utility operations of the Company are conducted through two wholly-owned subsidiaries, Suburban Water Systems (\"Suburban\") and New Mexico Utilities, Inc. (\"NMUI\"). The Company's wholly-owned subsidiary, ECO Resources, Inc. (\"ECO\"), operates and manages water and wastewater treatment facilities owned by cities, municipalities and private entities.\nGeneral Information\nThere have been no significant changes in the way the Company does business during the year. The focus of the water management industry is customer service, not technology or manufacturing processes; therefore, the Company conducts no significant research or development activities and the Company has no patents, trademarks or licenses. The Company does use certain commodities in its daily operations, such as chemicals and supplies, which are readily available from a number of different suppliers.\nThere are no individual customers of the Company who generated revenues that exceeded 10 percent of the Company's consolidated revenues, or whose loss would have a material adverse effect on the Company's consolidated operations. To date, the Company has experienced no material adverse effects upon its operations or capital expenditures resulting from compliance with governmental regulations relating to protection of the environment. At December 31, 1995, the Company employed 512 persons, none of whom are represented by an employee union.\nA. REGULATED UTILITY OPERATIONS\nSUBURBAN WATER SYSTEMS\nProduct and Business\nSuburban is a public utility water company which produces and supplies water for residential, business, industrial and public authority use, and for private and public fire protection service under the regulation of the California Public Utilities Commission (the \"CPUC\"). Suburban's service areas are located within Los Angeles and Orange Counties, California.\nSuburban or its predecessor entities have been engaged in supplying water since approximately 1907. From the mid 1950s to the late 1960s, Suburban's operations rapidly expanded as the transition from agricultural land use to residential, business and industrial use occurred throughout its service areas. Suburban has experienced moderate customer growth since the late 1960s, primarily due to the population saturation of its existing service areas.\nAt December 31, 1995, Suburban served 66,019 customers, including 62,319 residential customers, 2,645 business and industrial customers, 264 public authority customers and 791 fire protection service customers. During 1995, Suburban's operating revenues were 75% from sales to residential customers, 18% from sales to business and industrial customers, and 7% from sales to other customers.\nSuburban's business is subject to material fluctuations resulting, in large measure, from seasonal temperature and rainfall variations. Since most of Suburban's residential customers use more water in hot, dry weather conditions, the first quarter of each year is usually the lowest in terms of customer consumption, revenues and profitability.\nWells and Other Water Sources\nSuburban owns 14 wells which pump water from two of the major groundwater basins in the Southern California coastal watershed: the Central Basin and the Main San Gabriel Basin (the \"Main Basin\"). The Main Basin is the source of approximately 70% of Suburban's total water production. The rights to pump water from these basins have been fully adjudicated under the laws of the State of California. These adjudications have established Suburban's right to produce water at levels prescribed each year by the Watermaster Boards which manage the basins. As the water levels in the Main Basin increase or decrease, the Watermaster Board adjusts the amount of water Suburban and other producers may pump from this basin without paying an additional charge. When Suburban produces water from either basin in excess of prescribed levels, an additional payment is required to provide for the replenishment of the water supply. Current levels of these basins are sufficient to eliminate any drought concerns; however, there is no assurance that the current allowable pumping levels will continue in the future. These two basins provide the lowest cost of water for Suburban.\nSince 1984, Suburban has voluntarily chosen to stop pumping water from several older, shallower and\/or less efficient wells because of the presence of nitrates and certain contaminants. These wells have been replaced by new, deeper and more efficient wells. In the past, Suburban has been successful in replacing lost production capacity by shutting down certain old wells, by introducing new, deeper wells and by blending water produced from different wells. However, no assurance can be given that Suburban will be able to do so in the future.\nSuburban also purchases water from two mutual water companies. Suburban's ownership of shares in each of these mutual water companies has allowed Suburban to increase its water entitlement and maintain a lower cost of water. In addition, Suburban leases basin pumping rights from other parties which also helps reduce Suburban's cost of water.\nSupplementing this water supply is water occasionally purchased from external sources, which is at a higher cost for Suburban. Suburban has a connection to the \"Lower Feeder\" of the Metropolitan Water District of Southern California (\"MWD\") through which it purchases water to supplement the supply to its Whittier\/La Mirada Service Area. Additionally, Suburban has access to another MWD connection which serves to supplement the supply of water in its San Jose Hills Service Area. Suburban also has interconnections with other water purveyors which can be used as supplemental and emergency sources of supply.\nWater Quality Regulation\nWater supplied by Suburban is subject to regulation by the United States Environmental Protection Agency (the \"EPA\") acting pursuant to the Federal Safe Drinking Water Act (the \"US Act\") and by the Office of Drinking Water of the California Department of Health Services (the \"Health Department\") acting pursuant to the California Safe Drinking Water Act (the \"Cal Act\"). The US Act provides for establishment of uniform minimum national water quality standards, as well as governmental authority to specify the type of treatment processes to be used for public drinking water. The EPA has an ongoing directive to issue regulations under the US Act and to require disinfection of drinking water, specification of maximum contaminant levels (\"MCLs\") and filtration of surface water supplies. The Cal Act and the mandate of the Health Department are similar to the US Act and the mandate of the EPA, and in many instances MCLs and other requirements of the Health Department are more restrictive than those of the EPA.\nBoth the EPA and the Health Department have promulgated regulations and other pronouncements which require periodic testing and sampling of water, and which set MCLs for numerous contaminants. These regulations include permissible levels of radio nuclides (including radon), regulations governing lead and copper and mandating corrosion control studies and sampling, as well as permissible levels of volatile organic compounds (\"VOCs\"), herbicides, pesticides, and inorganic substances.\nSuburban's water quality assurance department regularly monitors and samples the quality of water being distributed. Samples of water from throughout Suburban's system are tested regularly by independent, state-certified laboratories for bacterial contamination, chemical contaminant content and for the presence of pollutants and contaminants for which MCLs have been promulgated. In addition, sampling and testing for certain pollutants such as VOCs is conducted by independent engineers retained by the Boards of the Central Basin and the Main Basin. The results of such sampling and testing are made available to all producers, with the cost of such sampling and testing covered by Board assessments to the producers. Testing, sampling and inspections are conducted at the intervals, locations and frequencies required by EPA and Health Department regulations. In addition, chlorination is currently performed only to provide a chlorine residual required by the Health Department.\nWater supplied by Suburban meets all current requirements of the US Act, the Cal Act and the regulations promulgated under such legislation, and Suburban anticipates no significant capital expenditures to comply with current requirements. There can be no assurance, however, that water supplied by Suburban would meet future EPA or Health Department requirements or that such requirements will not require capital expenditures by Suburban.\nMain San Gabriel Basin Contamination\nIn 1979, VOCs were discovered in the Main Basin. Most of the contamination located in the Main Basin was found in areas not within Suburban's service areas. Subsequently, underground water sampling resulted in the discovery of four large areas of groundwater VOC contamination. The areas include Suburban's Bartolo Well Field, which contains four of Suburban's producing wells and from which Suburban produces approximately 25% of its total water production. Currently, however, Suburban's wells do not contain VOCs in excess of MCLs.\nThe EPA has conducted numerous studies of underground water in the Main Basin (including the Bartolo Well Field). In 1984, the EPA named the Main Basin as a Superfund site and named as potentially\nresponsible parties (\"PRPs\") several large industrial companies that allegedly caused the contamination. Suburban's facilities were not named as sources of VOCs or other contamination in any portion of the Main Basin (i.e., Suburban's operations do not discharge VOCs into the ground or groundwater). However, some officials have suggested that the Main Basin water producers may have clean-up liability with respect to contaminants in the Main Basin under applicable environmental statutes on various theories by virtue of their pumping operations. It is expected that the EPA will continue to identify sources of contamination in order to establish legal responsibility for clean-up costs. Currently, neither the EPA nor any governmental agency has targeted Suburban or other water producers as PRPs.\nCertain industrial companies identified as PRPs are working with their water producers to build a $55 million water treatment facility in Baldwin Park, California. An environmental impact report is currently being reviewed for this project and, once clearance has been obtained, construction of the treatment unit may begin. The treatment plant, if constructed, would treat 19 million gallons per day of contaminated groundwater. Currently, funding for this treatment facility would not be provided directly by Suburban.\nTo date, water produced from the Bartolo Well Field and other wells maintained by Suburban in the Main Basin meets all applicable governmental requirements. The treatment proposed by the EPA, and other measures taken by or available to Suburban, are intended to ensure that Suburban continues to have an adequate supply of potable water which meets all applicable governmental standards. While technology exists to remove VOC contaminants from basin water, there can be no assurance that either (i) such technology will in the future be adequate to reduce the amounts of VOCs and other contaminants in water produced by Suburban in the Main Basin to acceptable levels or (ii) the costs of such removal will be fully recoverable from Suburban's customers. To date, Suburban has been permitted to recover from its ratepayers all expenses associated with water quality maintenance.\nDuring 1992, a statute was passed by the State of California establishing a Water Quality Authority (the \"WQA\") to oversee clean-up of water in the Main Basin. Assessments for this purpose are levied against those who own prescriptive pumping rights in the Main Basin, including Suburban. The amount of Suburban's annual assessment is approximately $348,000. Pursuant to a contract with the WQA, Suburban will operate a WQA-constructed water treatment facility (Big Dalton Treatment Facility) and the third-party well to which the facility is connected. This facility will treat approximately 1.3 billion gallons of water annually which will be distributed to Suburban's customers. Full operation by Suburban is expected to occur in 1996.\nThere can be no assurance that governmental authorities will not seek in the future to recover clean-up costs from Suburban or that source polluters will not seek contribution from water producers for clean-up costs which they may be required to pay. If Suburban were required to pay any such clean-up costs, Suburban would seek to recover such costs, and costs incurred in removing contaminants from water produced, through increased rates to its customers as has been permitted by the CPUC in the past. Moreover, there are over 100 water producers in the Main Basin, and the Company believes that Suburban's share of any clean-up costs assessed against the producers would only be a small a fraction of the total. Due to the potential recovery of the clean-up costs through higher rates, such costs are not expected to have a material impact on Suburban's financial condition or results of operation.\nCompetition and Rate Relief\nSuburban operates under long-term franchises and certificates of indefinite duration granted by the CPUC and other governmental authorities having jurisdiction over water service. The success of Suburban's water service business is dependent upon maintaining these franchises and certificates and upon various contracts and governmental and court decisions affecting Suburban's water rights and service areas.\nUnder current CPUC practices, water rates may be increased by two methods: general rate increases and offsets for certain expense increases. General rate increases typically are for three years and include \"step\" increases in rates for the second and third years. General rate increases are authorized after formal proceedings with the CPUC in which the overall rate structure, expenses and rate base are examined by CPUC staff, and public hearings are held. Formal general rate proceedings require approximately 12 months from the filing of an application to the authorization of new rates by the CPUC. Rates are based on estimated expenses and capital costs for a forecasted two-year period and are established for each of the two years based on these estimates, as approved by the CPUC. Rates for the third year of the three-year rate period are set by assuming that costs and expenses will increase in the same proportion over the second year as the increase projected for the second year over the first. The step rate increases for the second and third years are allowed to compensate for projected cost increases, but are subject to later demonstration that earnings levels in the service area do not exceed the rate of return authorized at the general rate proceeding. In 1995, Suburban filed a general rate increase application with the CPUC and negotiated with the CPUC staff a 4.25% ($1,100,000) rate increase, which is expected to be effective in the second quarter of 1996. Step increases for inflation will occur in 1997 and 1998 after CPUC approval is obtained.\nRate increases to offset increases in certain expenses such as cost of purchased water and energy costs to pump water are accomplished through an abbreviated \"offset\" proceeding that requires approximately two months from the time of filing a request for rate increases to the authorization of new rates. Suburban has been, and believes that it will continue to be, permitted to increase its rates as necessary to achieve a reasonable rate of return. However, any inability to increase rates would adversely affect Suburban's results of operations. On occasion, Suburban has filed for a rate decrease when actual water production costs incurred were less than CPUC-adopted water production costs. As permitted by the CPUC, Suburban records the difference between actual and CPUC-adopted water production costs in balancing accounts in the income statement, with a corresponding adjustment on the balance sheet.\nFuture Development\nIn recent years, Suburban's growth has been limited to minor extensions into new subdivisions along the periphery of its service areas. Because there is little area available for new business or industrial construction and because of recent low levels of residential growth, no significant increases in customers are projected for the near future.\nThe laws of the State of California provide that no public agency can install facilities within the service area of a public utility in order to compete with it, except upon payment of just compensation for all damages incurred by the public utility. Under California law, municipalities and certain other public bodies have the right to acquire private water utility plants and systems within their territorial limits by condemnation after proof of necessity is shown. Suburban is not aware of any impending proceeding relating to the condemnation of any portion of its facilities.\nThe water utility business requires substantial amounts of capital for the construction, extension and replacement of water distribution facilities. This capital is generated from Suburban's operations; from periodic debt financings by Suburban; from lines of credit of the Company; from contributions in aid of construction received from developers, governmental agencies, municipalities or individuals; and from advances received by developers which are repaid under rules of the CPUC. During 1995 and 1994, capital expenditures approximated $4,095,000 and $3,647,000, respectively.\nNEW MEXICO UTILITIES, INC.\nProduct and Business\nIn 1969, Suburban purchased NMUI. On June 1, 1987, the New Mexico Public Utility Commission (\"NMPUC\") authorized Suburban to transfer by stock dividend all of the stock of NMUI to Southwest Water Company which caused NMUI to become a wholly-owned subsidiary of Southwest Water Company. NMUI is a New Mexico regulated public water utility which provides water supply and sewage collection services for residential, commercial, irrigation, and fire protection customers under jurisdiction of the NMPUC. NMUI's service area is located in the northwest part of the City of Albuquerque and in the northern portion of Bernalillo County, New Mexico. NMUI's service area contains a population of approximately 14,000 persons and covers approximately 17 square miles, of which approximately 20% has been developed.\nSince 1969, NMUI has grown from approximately 800 customers to over 4,000 customers. Most of this growth has come from extension of water services and sewage collection services into new residential subdivisions and from the development of commercial property. Continuing economic development in NMUI's service area is expected to lead to increases in the number of customers in the near future. NMUI believes that it has an adequate water capacity to serve its current customer base as well as new customers in the foreseeable future.\nAt December 31, 1995, NMUI provided water service to 4,004 customers including 3,620 residential customers, 358 commercial and industrial customers, one golf course with five service connections, and 21 private fire protection customers. NMUI also provided sewer collection service to 3,701 customers including 3,502 residential customers and 199 commercial and industrial customers. During 1995, NMUI's operating revenues were 41% from sales to residential customers and 59% from sales to commercial and industrial customers.\nNMUI's business is subject to material fluctuations resulting, in large measure, from seasonal temperature and rainfall variations. Since most of NMUI's residential customers use more water in hot, dry weather conditions, the first quarter of each year is usually the lowest in terms of customer consumption, revenues and profitability. The sewer operation revenues remain relatively constant throughout the year.\nWells and Other Water Sources\nNMUI supplies its customers from four wells it owns; one of the wells was constructed and placed in service in 1995. Construction of a new, two-million gallon water storage reservoir is expected to be completed early in 1996. If customer growth continues in NMUI's service area as projected, NMUI may have to increase its water supply capability through additional well construction. To ensure the availability of an emergency supply of water, NMUI has one interconnection with another water purveyor.\nNMUI's wells produce water from the Rio Grande Underground Water Basin. Well water produced by NMUI is of good quality. Chlorination is performed by NMUI to provide an allowable chlorine residual as a safeguard against bacteriological contamination. Samples of water from throughout the system are tested regularly by independent, state-certified laboratories, and the results are sent to the State of New Mexico Environmental Improvement Division. To date, NMUI has experienced no material effects upon its operations or capital expenditures resulting from compliance with governmental regulations relating to protection of the environment.\nCompetition, Regulation and Future Development\nNMUI operates under a long-term franchise and Certificate of Public Convenience and Necessity granted by the NMPUC and is regulated by other state and local governmental authorities having jurisdiction over water and wastewater service and other aspects of its business.\nRequests for rate increases are submitted to the NMPUC with the test year typically being the previous year's actual results. In December 1995, NMUI was granted an 8% general sewer rate increase by the NMPUC, effective January 1996. NMUI has been, and believes that it will continue to be, permitted to increase its rates as necessary to achieve a reasonable rate of return. However, any inability to increase rates would adversely affect NMUI's results of operations.\nAs the City of Albuquerque (the \"City\") has expanded its jurisdiction, it has annexed to the City most of NMUI's service area; however, NMUI has continued to serve the customers located in the annexed areas. Occasionally, representatives of the City have indicated that the City may have an interest in acquiring NMUI's assets and merging them with water and sewer systems currently operated by the City. To date, no formal action has commenced or been approved by the City, and NMUI does not know when, or if, such action will be taken by the City.\nUnder New Mexico law, municipalities and certain other public bodies have the right to acquire private water utility plants and systems within their territorial limits by condemnation. The laws of the State of New Mexico also provide that no public agency can install facilities within the service area of a public utility in order to compete with it, except upon payment of just compensation for all damages incurred by the public utility. NMUI is not aware of any impending proceeding relating to the condemnation of any portion of NMUI's facilities.\nNMUI's operations are capital intensive. This capital is generated from NMUI's operations; from periodic debt financings by NMUI; from lines of credit of NMUI and the Company; from contributions in aid of construction received from developers; and from advances received by developers which are repaid under rules of the NMPUC. During 1995 and 1994, capital expenditures approximated $7,275,000 and $4,295,000, respectively.\nB. CONTRACT OPERATIONS\nECO RESOURCES, INC.\nProduct, Business, and Regulation\nIn 1985, Southwest Water Company purchased all of the outstanding common shares of ECO thereby diversifying into the management and operation of water and wastewater systems owned by others. In addition to managing and operating water and wastewater systems, ECO also performs associated specialized services, such as equipment maintenance and repair, sewer pipeline cleaning, billing and collection, and state-certified laboratory analysis.\nECO has two distinctive types of contractual relationships: municipal utility district contracts and operations and maintenance contracts with cities and municipalities.\nMunicipal Utility Districts (MUDs) Contracts\nECO has 121 contracts with MUDs in Houston and Austin, Texas. A MUD is a utility district created by the Texas Natural Resource Conservation Commission with an objective of providing water, wastewater and drainage services to areas where municipal services are not available. ECO negotiates operating contracts with each MUD's respective Board of Directors.\nAt December 31, 1995, ECO served 58,262 water service connections and 60,863 wastewater service connections through MUD contracts. Most MUD contracts are short-term contracts and are cancelable on 30 or 60 days' notice by either party. Twelve of the MUD contracts have been converted to longer term, three or five-year contracts. In a typical MUD contract, a monthly base fee is charged for which ECO provides the MUD with certain maintenance and operations services, as well as billing, collection and customer services. Additional services beyond those covered by the base fee typically generate revenues on a time and material basis.\nAs the large Texas cities, such as Houston and Austin, expand their territory, they periodically condemn the MUD-owned facilities and annex them to the city- owned facilities. In 1995, four MUD contracts were canceled due to annexation, three MUD contracts were canceled for competitive reasons, and three new MUD contracts were added.\nOperations and Maintenance (O&M) Contracts\nECO has 20 O&M contracts with cities, municipalities, or private entities located in Texas, Mississippi, New Mexico and California. At December 31, 1995, ECO served 59,342 water service connections and 63,882 wastewater service connections through O&M contracts. A typical O&M contract tends to average three to five years in duration and is generally cancelable only upon a specific breach of the contract by either party. Typical O&M contracts provide for a specified level of services with additional billings allowed if the owner of the facilities requires special services. In 1995, four new O&M contracts were added.\nCompetition and Future Development\nECO is operating in an industry undergoing significant and rapid changes. Competition is based on both lowest cost and technical expertise. ECO's competition in the O&M portion of its business includes four significantly larger companies which provide O&M services on a national basis, as well as several regional competitors, both smaller and larger than ECO. In the MUD portion of the business, competitors include one large national company and at least five smaller, local companies.\nECO intends to expand its current base business in Texas, Mississippi, New Mexico and California. This expansion will require aggressive sales and marketing efforts which may affect ECO's liquidity and results of operations.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company leases approximately 5,500 square feet of office space for its Corporate headquarters in West Covina, California.\nA. REGULATED UTILITY OPERATIONS\nThe Company's regulated utility operations lease two office buildings for their headquarters in Covina, California, and Albuquerque, New Mexico, respectively. In addition, Suburban owns two buildings which house its district operations, and NMUI owns a warehouse building that houses its field supplies and equipment.\nSUBURBAN WATER SYSTEMS\nSuburban owns and operates water production and distribution systems consisting of well pumping plants, booster pumping stations, reservoir storage facilities, transmission and distribution mains, and service connections to individual customers. Suburban also has rights-of-way and easements necessary to provide its water services. At December 31, 1995, Suburban owned approximately 704 miles of transmission and distribution mains, 26 storage reservoirs with a total capacity of approximately 53 million gallons and 14 wells with a total pumping capacity of approximately 30,000 gallons per minute. These facilities vary as to age and quality, but each is believed by Suburban to be in good condition and adequate for current operations. Suburban has a master plan which provides for periodic evaluation of the adequacy of system operations. In accordance with this master plan, Suburban will continue its capital expenditure program and construct and replace reservoirs, wells, and transmission and distribution lines in future years, as needed. Normal maintenance and construction work on these facilities is performed by employees of Suburban, and major construction projects are performed by outside contractors chosen through competitive bidding. Ongoing maintenance and repair is performed by Suburban and constitutes a significant portion of its expenses ($1,630,000 in 1995).\nVirtually all property of Suburban, other than 11.4 acres of vacant land in La Puente, California, is subject to the lien of an Indenture of Mortgage and Deed of Trust dated October 1, 1986 (the \"Indenture\"), as amended February 7, 1990, and January 24, 1992, securing Suburban's first mortgage bonds. The Indenture contains certain restrictions regarding the disposition of property and includes various covenants and restrictions common to such types of instruments, including limitations on the amount of cash dividends which Suburban may pay to the Company.\nNEW MEXICO UTILITIES, INC.\nNMUI owns and operates a water production and distribution system consisting of well pumping plants, reservoir storage facilities, booster pumping stations, transmission and distribution mains, and service connections to individual customers. At December 31, 1995, NMUI owned approximately 93 miles of transmission and distribution mains and two storage reservoirs with a total capacity in excess of five million gallons. The four wells operated by NMUI have a total pumping capacity in excess of 7,425 gallons per minute. In addition, NMUI owns and operates a sewer collection system consisting of one lift station and approximately 71 miles of interceptor and collector lines. These facilities vary as to age, and each is believed by NMUI to be adequate for current and foreseeable operations. Normal maintenance and construction work on these facilities is performed by employees of NMUI or outside contractors. Maintenance and repair expenses of $143,000 were incurred in 1995. NMUI also holds rights-of-way or easements in its service area necessary for its water and sewer services.\nVirtually all of NMUI's property is subject to the lien of an Indenture of Mortgage dated February 14, 1992, securing NMUI's first mortgage bonds. The bonds are subject to certain restrictions regarding the disposition of such property, and include various covenants and other restrictions, including limitations on the amount of cash dividends that NMUI may pay to the Company.\nB. CONTRACT OPERATIONS\nECO RESOURCES, INC.\nECO owns 4.3 acres and a 17,000 square foot building that house fleet and maintenance operations in the Houston, Texas, area. ECO also owns 10 acres and a 10,000 square foot building in Austin, Texas that house office, fleet and maintenance operations. In addition, ECO owns or leases 298 vehicles, and other equipment used in daily operations. ECO leases approximately 34,000 square feet of office, warehouse and lab space in nine facilities in the Houston, Texas area; the Rio Grande Valley, Texas area; Mississippi; New Mexico; and California.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nAs described previously in the Company's Form 10-K Reports for the years ended December 31, 1992, 1993, and 1994, its Form 8-K Report filed in January 1994, and its Form 10-Q Reports for the quarters ended March 31, 1995, June 30, 1995, and September 30, 1995, Suburban was a defendant in three lawsuits arising from a chlorine gas leak that occurred in October 1990 at a Suburban water distribution facility. In January 1994, Suburban settled with all of the plaintiffs for aggregate cash payments of approximately $1.5 million. These settlements included releases of all claims against Suburban. At the time of the chlorine gas incident, the Company and Suburban maintained liability insurance coverage; however, the Company's primary and excess liability insurance carrier declined to defend or indemnify Suburban on the basis of applicable exclusions in the policies. In May 1994, the insurance carrier was granted a summary judgment dismissing Suburban's action. Suburban appealed the summary judgment and its appeal was denied by the court in 1995. Suburban and the Company do not intend to pursue this matter any further.\nAs described in the Company's 1994 Form 10-K Report and Form 10-Q Reports for the quarters ended March 31, 1995, June 30, 1995, and September 30, 1995, ECO was named as a defendant in a lawsuit by certain homeowners and Pulte Home Corporation of Texas. The plaintiffs allege that in 1989, ECO, as an\nindependent contractor for Municipal Utility District #81 (\"MUD #8l\") in Houston, Texas, failed to change the treatment of the water supplied to plaintiffs after the plaintiffs made MUD #8l and ECO aware of highly corrosive elements in the water supplied. On June 14, 1995, the court granted ECO's motion for summary judgment on all causes of action and granted MUD #8l's motion for summary judgment on sovereign immunity grounds. On July 13, 1995, plaintiffs filed a motion for new trial and a motion to reconsider and to vacate the court's summary judgments. A date has not been set to hear the motion. As of the date when damages are first alleged to have occurred (1989) and thereafter, the Company and ECO maintained liability insurance coverage of $20 million. ECO's primary liability carrier is providing a defense for the primary cause of action against ECO, but has reserved all rights as to allegations that ECO knowingly committed intentional acts constituting \"deceptive trade practices\" and \"negligence.\" The Company believes the ultimate resolution of this matter will not have a material adverse effect on its consolidated financial condition or results of operations.\nAs described in the Company's 1994 Form 10-K Report, and Form 10-Q Reports for the quarters ended March 31, 1995, June 30, 1995, and September 30, 1995, Suburban is a defendant and cross-defendant in two actions filed in March 1994 and June 1994 in the Superior Court of Los Angeles County and arising out of a slope slide or failure in 1992 in a hilly, residential development in West Covina, California. In addition to Suburban, defendants in the actions include the owners of the lot above and containing the failed slope, and an engineer and a contractor who directed and conducted repair work to the slope after a prior failure in 1978. Claims raised by the plaintiffs and certain cross-defendants are described in the Company's 1994 Form 10-K Report, as is the consolidation of the two cases. At the initiation of Suburban's defense counsel, one of the plaintiffs dismissed his action against Suburban in March 1995, and defense counsel is discussing a similar dismissal with the other plaintiff. Mediation was held for both actions on November 6, 1995. A tentative settlement of $31,000 was reached as to both actions. The settlement process is continuing and the Company expects this settlement to be completed in 1996 with Suburban's insurance carrier to fund any payment in excess of Suburban's deductible. Accordingly, the Company believes this matter will not have a material adverse effect on its consolidated financial condition or results of operations.\nAs described in the Company's 1994 Form 10-K Report and Form 10-Q Report for the quarter ended March 31, 1995, ECO and Southbend Municipal Utility District (\"Southbend\") were named as defendants in two lawsuits filed in February and March 1993, in Harris County, Texas, by homeowner customers. The plaintiffs alleged that ECO, as an independent contractor for Southbend in Houston, Texas, failed to adequately test the water delivered to residents to detect contaminants that would cause harm to persons in the Southbend subdivision. In early 1995, the plaintiffs filed motions requesting dismissal of these actions against ECO. Such motion was granted without prejudice as to all plaintiffs during 1995. As a result, the Company believes these matters will not have a material adverse effect on its consolidated financial condition or results of operations.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\nITEM 4A. EXECUTIVE 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 Stockholders. There are no family relationships between any of the executive officers of the Company, nor are there any agreements or understandings between any such officer and another person pursuant to which he was elected an officer. There are no legal proceedings of the types required to be disclosed pursuant to the instructions to this item involving any executive officer. The executive officers of the Company and its subsidiaries are as follows:\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe information with respect to the market for and number of holders of the Company's common shares as well as quarterly market and dividend information is set forth under the caption \"Market and Dividend Information\" in the Company's 1995 Annual Report to Stockholders and is hereby incorporated by reference. The number of holders of the Company's common shares was computed based on a count of record holders as of December 31, 1995.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe information included under the caption \"Selected Financial Data\" in the Company's 1995 Annual Report to Stockholders is hereby incorporated by reference.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe information included under the caption \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" in the Company's 1995 Annual Report to Stockholders is hereby incorporated by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nConsolidated balance sheets indicating the financial position of the Company at December 31, 1995 and 1994, consolidated financial statements reflecting the results of its operations, and changes in its cash flows for the three-year period ended December 31, 1995, together with the notes thereto and the report thereon of KPMG Peat Marwick LLP, independent auditors, as well as selected quarterly financial information under the caption \"Unaudited Quarterly Financial Information,\" are contained in the Company's 1995 Annual Report to Stockholders, and are hereby incorporated 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 relating to the directors of the Company is set forth in the Company's definitive Proxy Statement, dated April 10, 1996, and to be filed with the Commission, under the caption \"Information Regarding the Board of Directors,\" and is hereby incorporated by reference. In addition, information appearing under the heading \"Compliance with Section 16(a) of the Securities Exchange Act of 1934, As Amended\" is in the Company's definitive Proxy Statement, dated April 10, 1996, and is also hereby incorporated by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation relating to executive compensation is contained in the Company's definitive Proxy Statement, dated April 10, 1996, and to be filed with the Commission, under the captions \"Executive Compensation and Other Information,\" \"Information Regarding the Board of Directors,\" and \"Proposal 2: Adoption of a Non-Employee Director Stock Option Plan,\" and is hereby incorporated 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 of the Company's voting securities is set forth in the Company's definitive Proxy Statement, dated April 10, 1996, and to be filed with the Commission, under the caption \"Beneficial Ownership of the Company's Securities,\" and is hereby incorporated by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation with respect to certain relationships and related transactions is set forth in the Company's definitive Proxy Statement, dated April 10, 1996, and to be filed with the Commission, and 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) The financial statements listed below are incorporated from the Company's 1995 Annual Report to Stockholders included as Exhibit 13.1 to this filing: Consolidated Statements of Income for the years ended December 31, 1995, 1994 and 1993 Consolidated Balance Sheets at December 31, 1995 and 1994 Consolidated Statements of Changes in Common Stockholders' Equity for the years ended December 31, 1995, 1994 and 1993 Consolidated Statements of Cash Flows for the years ended December 31, 1995, 1994 and 1993 Notes to Consolidated Financial Statements Independent Auditors' Report\n(a)(2) The supplementary financial statement schedules required to be filed with this report are as follows:\nPage ----\nIndependent Auditors' Report on Supplementary Note to Consolidated Financial Statements and supporting schedule................................................ 16\nSupplementary Note to Consolidated Financial Statements... 17\nSchedule II - Valuation and Qualifying Accounts........... 18\nSchedules not listed above are omitted because of the absence of conditions under which they are required, or because the information required by such omitted schedules is included in the financial statements or notes thereto.\n(a)(3) Exhibit Index............................................... 19 - 21\n(b) Reports on Form 8-K\nThere were no reports on Form 8-K filed for the three months ended December 31, 1995.\nINDEPENDENT AUDITORS' REPORT\nThe Stockholders and Board of Directors Southwest Water Company:\nUnder date of January 23, 1996, we reported on the consolidated balance sheets of Southwest Water Company and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of income, changes in common stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1995, as contained in the 1995 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 1995. In connection with our audits of the aforementioned consolidated financial statements, we also have audited the related supplementary note and financial statement schedule as listed in the accompanying index. The supplementary note and financial statement schedule is the responsibility of the Registrant's management. Our responsibility is to express an opinion on the supplementary note and financial statement schedule based on our audits.\nIn our opinion, such supplementary note and financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.\nKPMG Peat Marwick LLP\nLos Angeles, California January 23, 1996\nSOUTHWEST WATER COMPANY AND SUBSIDIARIES\nSUPPLEMENTARY NOTE TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nNOTE 14. OPERATING REVENUES AND DIRECT OPERATING EXPENSES\nIncluded in operating revenues and direct operating expenses are the following:\nSOUTHWEST WATER COMPANY AND SUBSIDIARIES\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSOUTHWEST WATER COMPANY AND SUBSIDIARIES\nEXHIBIT INDEX\nSOUTHWEST WATER COMPANY AND SUBSIDIARIES 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.\nSOUTHWEST WATER COMPANY\nBy: \/s\/ ANTON C. GARNIER -------------------- Anton C. Garnier President and Chief Executive Officer (Principal Executive Officer) March 27, 1996\nBy: \/s\/ PETER J. MOERBEEK --------------------- Peter J. Moerbeek Vice President Finance and Chief Financial Officer (Principal Financial and Accounting Officer) March 27, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, 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\/ H. FREDERICK CHRISTIE \/s\/ DONOVAN D. HUENNEKENS - ------------------------- ------------------------- H. Frederick Christie Donovan D. Huennekens Director Director March 27, 1996 March 27, 1996\n\/s\/ MICHAEL J. FASMAN \/s\/ RICHARD KELTON - --------------------- ------------------ Michael J. Fasman Richard Kelton Director Director March 27, 1996 March 27, 1996\n\/s\/ ANTON C. GARNIER \/s\/ RICHARD NEWMAN - -------------------- ------------------ Anton C. Garnier Richard Newman Director Director March 27, 1996 March 27, 1996\n\/s\/ MONROE HARRIS - ----------------- Monroe Harris Director March 27, 1996","section_15":""}
{"filename":"846815_1995.txt","cik":"846815","year":"1995","section_1":"ITEM 1. BUSINESS\nThe Company is a leader in each of its three business segments: Automotive Products, the largest supplier of interior trim products to the North American automotive industry; Interior Furnishings, the largest manufacturer of residential upholstery fabrics in the U.S.; and Wallcoverings, the largest producer of residential wallpaper in the U.S. For certain financial information regarding the Company's business segments, see Note 20 to Consolidated Financial Statements on page 49 of the Company s 1994 Annual Report to Stockholders and Management's Discussion and Analysis of Financial Condition and Results of Operations on page 17 of the Company's 1994 Annual Report to Stockholders, which are incorporated herein by reference. For a discussion of the organization of the Company, certain developments in July 1994 resulting in a recapitalization of the Company and certain related mergers, see Notes 1 and 2 of the Consolidated Financial Statements on page 32 of the Company's 1994 Annual Report to Stockholders and the information under the Caption \"Initial Public Offering and Recapitalization\" on page 17 of the Company's 1994 Annual Report to Stockholders, which are incorporated herein by reference. With respect to market or competitive information, references to the Company as \"a leader\", \"a leading\" or \"one of the leading\" manufacturers in that product category mean that the Company is one of the principal manufacturers in that product category and references to the Company as \"the leader\", \"the largest\" or \"the leading\" manufacturer in a particular product category mean that the Company has the largest product market share based on dollar sales volume in that product category.\nAll references to a year with respect to the Company refer to the fiscal year of the Company which ends on the last Saturday of January of the following year.\nAUTOMOTIVE PRODUCTS\nGeneral\nThe Company is a leading designer and manufacturer of automotive products with 1994 net sales in this segment of $904.9 million. Automotive Products supplies four major interior trim products--automotive seat fabric (\"bodycloth\"), molded floor carpets, accessory floor mats and luggage compartment trim--and convertible top systems. Automotive Products had 1994 net sales in these product lines of $751.6 million. Automotive Products has supplied interior trim products to the automotive industry for over 60 years. While some interior trim suppliers have sales volumes equivalent to or greater than that of the Company in a single product line, management believes that the Company sells a wider variety of interior trim products, has products on more vehicle lines and has a broader, more uniform sales penetration at U. S. automotive equipment manufacturers and foreign owned North American automotive production and assembly facilities (\"Transplants\" and, collectively, \"OEMs\") than any of its competitors.\nThe Company's sales are dependent on certain significant customers. In 1994, direct and indirect sales to each of General Motors Corporation, Ford Motor Company and Chrysler Corporation accounted for 10% or more of the Company's net sales. In 1993 and 1992, direct and indirect sales to each of General Motors Corporation and Chrysler Corporation accounted for 10% or more of the Company's net sales.\nAutomotive industry demand historically has been influenced by both cyclical factors and long-term growth trends in the driving age population and real per capita income.\nAnnual new car and truck sales historically have been cyclical. In the most recent cycle, U.S. light vehicle sales declined from an average of 15.4 million units per year in 1986-1988 to a low of 12.3 million units in 1991. Since late 1993, however, U.S. light vehicles sales have increased.\nProducts\nAutomotive Products manufactures five principal products: automotive seat fabric, molded floor carpets, accessory floor mats, luggage compartment trim and convertible top systems. Automotive Products also produces a variety of other automotive and nonautomotive products.\nAutomotive Seat Fabric. Automotive Products manufactures a wide variety of bodycloth, including flat-wovens, velvets and knits. Automotive Products also laminates foam to bodycloth. In 1994, 1993 and 1992, Automotive Products had net sales of bodycloth of $340.3 million, $221.2 million and $191.1 million, respectively.\nMolded Floor Carpets. Molded floor carpets include polyethylene, barrier-backed and molded urethane underlay carpet. In the Company's automotive molded floor product line, it has developed a \"foam-in-place\" process to provide floor carpeting with enhanced acoustical and fit characteristics, resulting in a substantial gain in unit selling prices. In 1994, 1993 and 1992 net sales of molded floor carpets were $213.2 million, $181.1 million, and $173.1 million, respectively.\nAccessory Floor Mats. Automotive Products produces carpeted automotive accessory floor mats for both North American produced vehicles and imported vehicles. In 1994, management estimates that approximately 63% of all vehicles produced in North America included accessory mats as original equipment.\nLuggage Compartment Trim. Luggage compartment trim includes one-piece molded trunk systems and assemblies, wheelhouse covers, seatbacks, tireboard covers, center pan mats and other trunk trim products.\nConvertible Top Systems. Automotive Products designs, manufactures and distributes convertible top systems through its Dura Convertible Systems subsidiary (\"Dura\"). In October 1993, Dura began shipping its \"Top-in-a-Box\" system, in which it designs and manufactures all aspects of a convertible top, including the framework, trim set, backlight and actuating system.\nOther. Automotive Products also produces a variety of other auto products, including die cuts for automotive interior trim applications, convertible power train units, headliner fabric, and roll goods for export and domestic consumption. Small volumes of certain products, such as residential floor mats, casket and tie linings and sliver knits, are sold to other commercial and industrial markets.\nCompetition\nThe automotive supply business is highly competitive. The primary competitor in bodycloth is Milliken & Company. The primary competitors in molded floor carpets are Masland Corporation and JPS Automotive Products Corp. In accessory floor mats, the Company competes primarily against Pretty Products Company. Automotive Products' primary competitors in luggage compartment trim are Masland Corporation and Gates Corporation. In convertible top stacks, Automotive Products competes primarily against American Sunroof Corporation and Best Top.\nThe Company principally competes for new business at the design stage of new models and upon the redesign of existing models. The Company is vulnerable to a decrease in demand for the models that generate the most sales for the Company, a failure to obtain purchase orders for new or redesigned models and pricing pressure from the major automotive companies.\nFacilities\nAutomotive Products has 34 manufacturing, warehouse and other facilities located in the U.S., Canada and Mexico aggregating approximately 5.9 million square feet. The majority of these facilities are located in North Carolina, Ohio and Michigan and in Ontario and Quebec, Canada. Approximately 90% of the total square footage of these facilities is owned and the remainder is leased. Many facilities are strategically located to provide just-in-time (\"JIT\") inventory delivery to the Company's customers. Capacity at any plant depends, among other things, on the product being produced, the processes and equipment used and tooling. This varies periodically, depending on demand and shifts in production between plants. The Company currently estimates that its Automotive Products plants generally operate at between 50% and 100% of capacity on a six- day basis. During the second half of 1994 the Company experienced capacity constraints with respect to certain automotive seat fabrics. To meet customer expectations, the Company utilized outside weaving and redeployed certain manufacturing capacity from its Decorative Fabrics velvet furniture products. Except for the foregoing constraints, which the Company believes are short term, the Company's capacity utilization in this segment is generally in line with its past experience in similar economic situations, and the Company believes that its existing facilities are sufficient to meet both this segment's existing needs and its anticipated growth requirements. The Company does not anticipate any circumstances that would render its facilities inadequate for its projected needs.\nINTERIOR FURNISHINGS\nInterior Furnishings designs and manufactures residential and commercial upholstery fabrics through its Decorative Fabrics group and high-end specified contract floorcoverings through its Floorcoverings group. In 1994, the Interior Furnishings segment had net sales of $414.5 million.\nDecorative Fabrics\nGeneral. Interior Furnishings' Decorative Fabrics group is the largest designer and manufacturer of upholstery fabrics in the U.S. The Decorative Fabrics group had 1994 net sales of $306.5 million. Decorative Fabrics strives to be the preferred supplier of middle to high-end flat-woven upholstery fabrics to furniture manufacturers and fabric distributors. This group's primary division, Mastercraft, is the leading manufacturer of flat-woven upholstery fabrics. Management believes that Mastercraft has substantially more Jacquard looms and styling capacity dedicated to upholstery fabrics, and offers more patterns (approximately 13,000) in a greater range of price points than any of its competitors. The breadth and size of Mastercraft's manufacturing and design capabilities provide it with exceptional flexibility to respond to changing customer demands and to develop innovative product offerings. In order to accommodate anticipated growth, the Company is in the initial phase of a four year, $85 million modernization program. Investment is targeted toward the purchase of high-speed looms to increase capacity and productivity, new electronic jacquard heads to reduce pattern changeover times, and computer monitoring systems to provide information about the manufacturing processes and to improve quality, productivity and capacity.\nThe three primary types of upholstery fabric are flat-wovens, velvets and prints. Flat-woven fabrics are made in two major styles: Jacquard, which is produced on high- speed computerized looms capable of weaving intricate designs into the fabric, and Dobby, a plain fabric produced on standard looms. Demand for upholstery fabric generally varies with economic conditions, particularly sales of new and existing homes, and is directly associated with sales of upholstered furniture at the retail level. Shifts in consumer taste can also affect demand for upholstery fabric.\nProducts. Decorative Fabrics' two operating divisions are Mastercraft and Cavel. Mastercraft and Cavel design and manufacture jacquards, velvets and other woven fabrics for the furniture, interior design, commercial, recreational vehicle and industrial markets. During 1994, the Company sold the Greeff and Warner product lines through which it had designed and distributed high-end fabrics to interior designers and specialty retailers in the U.S. and U.K., respectively.\nDecorative Fabrics had net sales of flat-woven products in 1994, 1993 and 1992 of $262.8 million, $268.9 million and $254.7 million, respectively.\nCustomers. Decorative Fabrics is a primary supplier to virtually all major furniture manufacturers in the U.S., including La-Z-Boy, Ethan Allen, Thomasville, Flexsteel, Bassett, Broyhill, Baker, Henredon, Rowe and Robert Allen. Due to the breadth of its product offerings, strong design capabilities and superior customer service, the Company has developed close relationships with many of Decorative Fabrics' over 1,000 customers.\nNearly all of Decorative Fabrics' products are made to customer order. This reduces the amount of raw material and finished goods inventory required and greatly reduces product returns, all of which improve profit margins.\nMarketing and Sales. Fabrics are sold domestically by commissioned sales representatives who exclusively represent the Mastercraft and Cavel divisions of Decorative Fabrics. The Mastercraft and Cavel divisions maintain showrooms in seven key locations throughout the United States.\nCompetition. The U.S. upholstery fabrics market is highly competitive. Manufacturers compete on the basis of design, quality, price and customer service. Decorative Fabrics' primary competitors include Quaker Fabric Corporation, Culp, Inc., Joan Fabrics Corp. and the Burlington House Upholstery Division of Burlington Industries, Inc.\nFacilities. Mastercraft operates four weaving plants and one finishing plant in North Carolina aggregating 1.0 million square feet, of which 89% is owned and the remainder leased. Cavel shares manufacturing capacity with Automotive Products at three plants in Roxboro, North Carolina. During the last three years, the Company's capacity utilization in the Mastercraft division of the Decorative Fabrics group has consistently averaged nearly 100% on a six-day basis. The Company believes that its existing facilities are sufficient to meet the Decorative Fabrics group's existing needs, and, after taking into account Mastercraft's $85 million capital investment plan (see page 22 of 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 which is incorporated herein by reference), anticipated growth requirements. Assuming the completion of Mastercraft's capital investment plan, the Company does not anticipate any circumstances that would render its Decorative Fabrics facilities inadequate for its projected needs.\nFloorcoverings\nGeneral. The Floorcoverings group of the Interior Furnishings segment is a leading producer of high-end specified contract carpeting products for institutional and commercial customers. In 1994 Floorcoverings had net sales of $108.0 million. Its principal products are six-foot wide rolls and modular carpet tiles. Floorcoverings produces virtually no product for inventory or for commodity markets.\nSince 1990, Floorcoverings has repositioned its product offerings, shedding those products in which it lacked either a low-cost position or proprietary product advantage. By focusing on areas of competitive advantage, Floorcoverings has prospered, notwithstanding a significant downturn in commercial construction.\nDuring 1994, Floorcoverings initiated its Source OneSM program to sell its products directly to end users which provides them turnkey full service project management.\nApproximately 56% of Floorcoverings' 1994 net sales were to institutional customers such as government, healthcare, and education facilities. Management believes that government, healthcare and educational customers are stable growth sectors.\nProducts. Floorcoverings' key competitive advantage in its principal products, six- foot wide rolls and modular carpet tiles, is its patented Powerbond RS(R) adhesive technology, which has 13 years of patent protection remaining. Because the Powerbond RS(R) system does not use wet adhesives, it permits the installation of floorcoverings directly on floor surfaces, including existing carpeting, with substantially reduced labor costs and without the fumes of conventional wet adhesives. This allows for less disruptive and less time-consuming installation and, for this reason, is particularly attractive to institutions such as schools and hospitals. In addition to reducing installation downtime for customers to as little as one day, management believes Floorcoverings' product exhibits demonstrably superior durability and cleaning characteristics ideally suited for high-traffic areas such as airline terminals and customers such as Discovery Zone and Blockbuster.\nCompetition. The commercial carpet industry is highly competitive, and several of Floorcoverings' competitors also have substantial commercial carpet sales in the commodity segments of the industry, segments in which Floorcoverings does not compete. Floorcoverings' niche products have demanding specifications and generally cannot be manufactured using the equipment that currently supplies most of the industry's commodity products. The Company's primary competitors are Interface, Milliken & Company, Mohawk Industries and Shaw Industries, Inc.\nFacilities. Floorcoverings owns and operates four facilities in Dalton, Georgia aggregating approximately 630,000 square feet. The Company currently estimates that Floorcoverings' plants operate at between 35% and 85% of capacity on a six-day basis. The Company's capacity utilization in the Floorcoverings group is generally in line with its past experience in similar economic situations and the Company believes that its existing facilities are sufficient to meet both this group's existing needs and its anticipated growth requirements. The Company does not anticipate any circumstances that would render its Floorcoverings facilities inadequate for its projected needs.\nWALLCOVERINGS\nGeneral\nWallcoverings, which operates under the name \"Imperial\", is a leading manufacturer and distributor of a full range of wallpaper for the residential and commercial sectors with 1994 net sales of $216.6 million. It is the only producer of wallpaper in the U.S. that is fully integrated from paper production through design and distribution. In addition, management believes that Imperial has a competitive advantage due to its extensive in-house design expertise and licensing arrangements, its low cost, vertically- integrated manufacturing capability, and its advanced customer ordering and service network.\nThe wallcoverings industry experienced significant and consistent growth from the early 1980s through 1987. This growth resulted in part from increases in new construction starts and existing home sales, which peaked during 1986 and 1987. In addition, a one-time surge in demand created a new industry-wide layer of inventory as a result of the rapid growth of large in-stock retailers. Between 1983 and 1987, the industry's physical shipment volume increased from 137 million to 200 million rolls of wallpaper per year, a 9.9% annual growth rate. Between 1987 and 1990, the industry underwent a contraction, with volume declining dramatically from 200 million rolls in 1987 to 174 million rolls in 1990, a 4.5% annual decline. This resulted from a slowdown in the overall economy, particularly in the housing\nmarket, coupled with a reduction in inventory by overstocked retailers. From 1991 to 1994, the industry's physical shipment volume increased at a modest rate.\nThe wallcoverings market can generally be divided into the residential and commercial sectors with the residential sector being the larger of the two sectors. Demand for wallpaper is primarily influenced by levels of construction, renovation and remodeling. In addition to these cyclical factors, shifts in consumer taste between wallpaper and paint can be a factor. The two primary distribution channels in the residential sector are independent retailers (\"dealers\") and retail chains.\nThe industry contraction of the late 1980s and early 1990s left Imperial with unutilized manufacturing capacity, an oversized distribution network and excess product offerings. Between 1989 and 1992, Imperial implemented a comprehensive downsizing program designed to bring Imperial's high fixed-cost structure into better alignment with the changed industry environment. Imperial closed 22 showrooms and 12 warehouses and reduced fixed costs by nearly 15%. Imperial also substantially reduced the annual introduction rate of new collections and virtually eliminated its use of independent distributors in favor of exclusive captive distribution. This restructuring program improved manufacturing efficiencies, but it adversely affected sales and led to a reduction in shelf space and product market share. As a result, Imperial's sales declined during 1992 and 1993, despite what management now believes to have been a moderate upturn in industry conditions.\nA new management team installed in February 1993 determined that the reduction in new collections had been too severe. Accordingly, in late 1993, management instituted a second restructuring program to bolster its new product introduction rate through aggressive product design efforts. This product line renewal led to 57 and 62 collections being introduced in 1994 and 1993, respectively, compared to 45 in 1992. Management is also broadening its selection of in-stock programs and improving its order fulfillment capabilities.\nProducts\nManagement believes Imperial has maintained its leading position in residential wallpaper due to its competitive edge in color and design. Its in-house studio of approximately 35 artists represents a major strategic investment by Imperial that is supplemented by an active licensing program under which Imperial licenses proven designs from well-known designers. Imperial is continuously introducing new designs and color concepts that supplement its already vast library.\nImperial offers a large number of well-known brand names, including Imperial, United, Sterling Prints, Katzenbach & Warren, Albert Van Luit and Plexus. In addition to these in-house brands, Imperial licenses a number of well-known brand names, including Gear, Laura Ashley, Pfaltzgraff, Croscill, Mario Buatta, David and Dash, Louis Nichole, Clarence House and Carlton Varney, for which it converts home furnishing designs into wallpaper designs. Imperial also distributes the lines of John Wilman, Great Britain's largest wallpaper designer and manufacturer.\nIn recent years, there has been increasing demand for wallcoverings coordinated with decorative accessories such as window treatments, bedding, upholstery fabric and other textile products. To satisfy this demand from upscale home furnishings customers, Imperial provides fabrics, which it generally purchases outside the Company, that are coordinated with its wallpaper designs. Some of these fabrics are supplied by the Mastercraft division of the Company.\nIn 1994, 1993 and 1992, net sales of residential wallpaper were $191.7 million, $196.0 million and $214.0 million, respectively.\nCustomers\nDealers and retail chains account for the largest portion of Imperial's customer base. Management believes that the Company is the leader in each of these distribution channels. Management believes that Imperial has the most extensive dealer network in the U.S., selling to approximately 15,000 dealers. Imperial also sells to many of the leading chains in the country, including Home Depot, Lowes, Sears, Sherwin Williams and Target.\nCompetition\nAs a result of the recent economic turndown in the wallcoverings industry, many weaker competitors withdrew from the U.S. wallcoverings market. In addition, further contraction is expected to occur as sales of wallcoverings shift to chain stores, which along with other retailers prefer working with fewer, larger suppliers. Management believes that Imperial is well positioned to benefit from these developments.\nCompetition in the wallcoverings industry is based on design, price and customer service. Imperial's principal competitors in wallpaper are Borden, GenCorp, F.S. Schumacher and Seabrook Wallcoverings.\nFacilities\nImperial operates five manufacturing facilities in the United States and three in Canada, as well as three distribution centers in the United States aggregating 1.5 million square feet. Of this amount approximately 82% is owned and the remainder is leased, including the three U.S. distribution centers. The Company currently estimates that its Wallcoverings facilities that produce surface print paper generally operate at approximately 35% of capacity on a five-day basis and its facilities that produce gravure paper generally operate between approximately 80% and 100% of capacity on a five-day basis. The Company's capacity utilization in this segment is generally in line with its past experience in similar economic situations, and the Company believes that its existing facilities are sufficient to meet both this segment's existing needs and its anticipated growth requirements. The Company does not anticipate any circumstances that would render its Wallcoverings facilities inadequate for its projected needs.\nRAW MATERIALS\nRaw materials and other supplies used in the Company's operations are normally available from a variety of competing suppliers. The loss of a single or few suppliers would not have a material adverse effect on the Company. For a discussion of increasing raw material price trends, see page 24 of 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 which is incorporated herein by reference.\nENVIRONMENTAL MATTERS\nSee \"ITEM 3. LEGAL PROCEEDINGS - Environmental Proceedings\" and Management's Discussion and Analysis of Financial Condition and Results of Operations - Environmental Matters on pages 25-26 of the Company's 1994 Annual Report to Stockholders incorporated herein by reference.\nEMPLOYEES\nAs of January 28, 1995, the Company's subsidiaries employed approximately 12,000 persons on a full-time or full-time equivalent basis. Approximately 2,300 of such employees are represented by labor unions. Management believes that the Company's relations with its employees and with the unions that represent certain of them are good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nFor information concerning the principal physical properties of the Company and its various operating divisions, see \"ITEM 1. BUSINESS\".\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nExcept as described below, the Company and its subsidiaries are not a party to any material pending legal proceedings, other than ordinary routine litigation incidental to their businesses.\nPreferred Stock Redemption Litigation. On August 2, 1991, a Fifth Consolidated Amended Complaint was filed in In re Ivan F. Boesky Securities Litigation (the \"Boesky action\"), a multi-district litigation pending for pre-trial purposes in the United States District Court for the Southern District of New York. In essence, the complaint is an amalgam of numerous class action and individual claims against a variety of defendants relating principally to the activities of, among others, Ivan F. Boesky, Drexel Burnham Lambert Incorporated and Michael R. Milken. Among other things, the complaint alleges that these defendants and various named associates, along with Collins & Aikman Group, Inc. (\"Group\"), a former wholly owned subsidiary of the Company, which was merged into Collins & Aikman Products Co. (\"Products\"), a wholly owned subsidiary of the Company, and certain former officers and directors of Group, conspired to manipulate the price of Group's common stock in April 1986 for the purpose of triggering a redemption of outstanding preferred stock of Group issued in an April 24, 1985 public offering (the \"Preferred Stock\"). The complaint alleges claims for compensatory and punitive damages in unspecified amounts against Group and the individual Group-related defendants for fraud and deceit, breach of fiduciary duty, unjust enrichment and violations of Section 25400 of the California Corporations Code. It does so on behalf of a certified class of persons and entities who, during the period of April 23, 1986 through June 2, 1986, redeemed, converted or sold shares of the Preferred Stock. The complaint also alleges numerous other claims not involving Group or its former officers and directors. The factual allegations in the complaint involving Group are substantially similar to the allegations set forth in Citron v. Wickes Companies, Inc., et al., and Weinberger v. Wickes Companies, Inc., et al., two actions previously filed in the Superior Court of the State of California for the County of Los Angeles which have been stayed in favor of the Boesky action. On February 27, 1995, plaintiffs made a motion to \"clarify or amend the Fifth Amended Complaint, essentially seeking either (i) a declaration that the complaint asserted claims against Group under Section 10(b) of the Securities Exchange Act and the Racketeer Influenced Corrupt Organizations Act (RICO); or (ii) the right to amend the complaint to assert those claims. On April 24, 1995, the court granted plaintiffs motion to the extent of permitting plaintiffs to amend the complaint to assert Section 10(b) and RICO claims against Group and the individual Group-related defendants.\nPOF Arbitration. On or about May 26, 1992, Advanced Development & Engineering Centre (\"ADEC\"), a division of an indirect subsidiary of Group, filed a request for arbitration with the International Chamber of Commerce seeking a resolution of ADEC's dispute with the Pakistan Ordnance Factories Board (\"POF\") concerning ADEC's installation of a munitions facility in Pakistan for a purchase price of $26.5 million. ADEC alleges that POF violated the contract, among other things, by refusing to permit completion of a production run, which would have entitled ADEC to receive $2.65 million, the remaining unpaid portion of the purchase price under the contract. On August 6, 1992, POF filed a reply and counterclaim alleging that as a result of ADEC's alleged breach of the contract, POF's entire investment in the munitions facility was a loss. POF claims damages in excess of $30 million.\nInsurance Coverage Litigation. On November 22, 1994, Products was served with a complaint filed by National Union Fire Insurance Company of Pittsburgh, PA (\"National Union\") in the United States District Court for the Central District of California (the \"California\naction\"). The complaint seeks declaratory relief and the return of approximately $10 million paid by National Union in defense costs and indemnity in respect of a class action, captioned Glass, Molders, Pottery, Plastics and Allied Workers International Union, AFL-CIO et al. v. Wickes Companies, Inc. (the \"OCF Action\"), which was commenced against Wickes Companies, Inc. (the predecessor by merger to Products) in or about July 1988 and settled pursuant to an order entered in or about October 1993. The complaint by National Union alleges, among other things, that National Union did not have a duty to defend or indemnify Wickes and that Wickes was unjustly enriched. On November 21, 1994, Products filed suit against National Union in the United States District Court for the Southern District of New York (the \"New York action\") seeking declaratory relief and damages relating to the amounts paid by National Union in respect of the OCF Action. Both the California action and the New York action have been withdrawn. In accordance with a settlement agreement dated as of January 17, 1995, the parties exchanged mutual releases of all claims related to either the California or New York action, and Products agreed to pay National Union a total of $2,510,000 of which $510,000 is due in 1995; $1,000,000 is due in 1996; and the remaining $1,000,000 is due in 1997. The settlement is covered by established accruals.\nIn the opinion of the Company's management based on the facts presently known to it, the ultimate outcome of any of these legal proceedings will not have a material effect on the Company's consolidated financial condition or future results of operations.\nEnvironmental Proceedings\nDouglas, Michigan. On January 4, 1991, a complaint was filed in the Circuit Court for Allegan County, Michigan, captioned Haworth, Inc. v. Wickes Manufacturing Company (the \"Haworth action\"), in which Haworth, Inc. (\"Haworth\") alleges that predecessors of Wickes Manufacturing Company (\"Wickes Manufacturing\"), an indirect wholly owned subsidiary of the Company, released environmental contaminants on property, now owned by Haworth, located in the Village of Douglas, Michigan. Haworth seeks a declaratory judgment that Wickes Manufacturing is liable for the alleged contamination of the site, indemnification for any costs incurred or to be incurred in connection with the alleged contamination, an affirmative injunction requiring Wickes Manufacturing to implement response actions at the site, damages in connection with alleged diminution in value of the subject property, and other damages, interest, and costs, all in unspecified amounts. Wickes Manufacturing has filed counterclaims against Haworth. On June 28, 1993, the Court entered an order granting Wickes Manufacturing's motion for summary disposition dismissing all of Haworth's claims against Wickes Manufacturing. On July 19, 1993, Haworth appealed the Court's order. On April 21, 1995, the Court of Appeals for the State of Michigan affirmed the Trial Court s order granting Wickes Manufacturing's motion for summary disposition. On October 22, 1993, Haworth filed a complaint in the United States District Court for the Western District of Michigan, captioned Haworth, Inc. v. Wickes Manufacturing Company and Paramount Communications, Inc. (the \"Second Haworth action\"). In the Second Haworth action, Haworth alleges federal and state law claims with respect to Wickes Manufacturing and Paramount Communications Inc. that are factually similar to the state law claims alleged in the Haworth action, and Haworth seeks relief similar to the relief it seeks in the Haworth action. The Michigan Department of Natural Resources, by letter dated December 20, 1989, notified Wickes Manufacturing pursuant to the Michigan Environmental Response Act that Wickes Manufacturing is potentially responsible for undertaking investigation and response actions to address contamination at the site involved in the Haworth action and its possible effect on the water supply of the Village of Douglas.\nNorth Smithfield, Rhode Island. On May 23, 1988, a complaint was filed in the United States District Court for the District of Rhode Island, captioned United States v. Kayser-Roth Corporation and Hydro-Manufacturing, Inc. (the \"Stamina Mills action\"), in which the United States sought to recover response costs under the Comprehensive Environmental Response, Compensation and Liability Act (\"CERCLA\") from Group's former Kayser-Roth Corporation subsidiary (\"Kayser-Roth\") and others in connection with a site formerly operated\nby Stamina Mills, Inc., a former subsidiary of Kayser-Roth, in North Smithfield, Rhode Island. In January 1990, the District Court held Kayser-Roth liable under CERCLA for all past and future response costs. By Amended Administrative Order issued June 4, 1991, the United States Environmental Protection Agency (the \"EPA\") directed Kayser-Roth to implement the remedies set forth in its Record of Decision issued September 18, 1990. Since the beginning of fiscal 1991 to date, Kayser-Roth has paid approximately $3.6 million for past response costs, prejudgment interest and remediation. Kayser-Roth is in the process of complying with the remainder of the order. The Company has agreed to indemnify Kayser-Roth with respect to this matter.\nMiscellaneous Environmental Matters. In addition to the judicial and administrative proceedings listed above, the Company also is legally or contractually responsible or alleged to be responsible for the investigation and remediation of contamination at various other sites. It also has received notices that it is a potentially responsible party (\"PRP\") in a number of proceedings. It is a normal risk of operating a manufacturing business that liability may be incurred for investigating and remediating on-site and off-site contamination. The Company is currently engaged in or alleged to be responsible for investigation or remediation at certain sites. These sites include, among others, the following: a site adjacent to a facility formerly operated by Wickes Manufacturing's former Bohn Heat Transfer division located at Beardstown, Illinois; a site formerly owned and operated by Wickes Manufacturing's alleged former Daybrook Ottawa division located at Bowling Green, Ohio; a site owned and formerly operated by the Company located at Elmira, California; the Beaunit Corporation Superfund Site located near Fountain Inn, South Carolina; the Butterworth Landfill Superfund Site located at Grand Rapids, Michigan; a site owned and formerly operated by Wickes Manufacturing's former Mechanical Components division located at Mancelona, Michigan; the former Albert Van Luit plant site owned by a Company subsidiary located in North Hollywood, California; the Hartley & Hartley landfill site located at Kawkawlin, Michigan; and the Stringfellow Superfund Site located at Riverside County, California. In addition to the environmental sites and proceedings listed above, the Company is and has been a party or PRP at other sites and involved in other proceedings from time to time. In the last three fiscal years, the Company has paid approximately $6.3 million in the aggregate (excluding amounts paid in connection with the Stamina Mills action disclosed above) in connection with its various environmental sites. The majority of such costs have been incurred in connection with the Elmira, California and North Hollywood, California sites.\nIn estimating the total future cost of investigation and remediation, the Company has considered, among other things, the Company's prior experience in remediating contaminated sites, remediation efforts by other parties, data released by the EPA, the professional judgment of the Company's environmental experts, outside environmental specialists and other experts, and the likelihood that other parties which have been named as PRPs will have the financial resources to fulfill their obligations at sites where they and the Company may be jointly and severally liable. Under the scheme of joint and several liability, the Company could be liable for the full costs of investigation and remediation even if additional parties are found to be responsible under the applicable laws. It is difficult to estimate the total cost of investigation and remediation due to various factors including incomplete information regarding particular sites and other PRP's, uncertainty regarding the extent of environmental problems and the Company's share, if any, of liability for such problems, the selection of alternative compliance approaches, the complexity of environmental laws and regulations and changes in cleanup standards and techniques. When it has been possible to provide reasonable estimates of the Company's liability with respect to environmental sites, provisions have been made in accordance with generally accepted accounting principles. The Company records its best estimate when it believes it is probable that an environmental liability has been incurred and the amount of loss can be reasonably estimated. The Company also considers estimates of certain reasonably possible environmental liabilities in determining the aggregate amount of environmental reserves. As of January 28, 1995, the Company has established reserves of approximately $31.7 million for the estimated future\ncosts related to all its known environmental sites. In the opinion of management, based on the facts presently known to it, the environmental costs and contingencies will not have a material adverse effect on the Company's consolidated financial condition or results of operations. However, there can be no assurance that the Company has identified or properly assessed all potential environmental liability arising from the activities or properties of the Company, its present and former subsidiaries and their corporate predecessors.\nThe Company is seeking insurance coverage for a portion of the defense costs and liability it has incurred and may incur in connection with the environmental proceedings described above. Coverage issues have not been resolved. There can be no assurance that any coverage will be provided.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\nEXECUTIVE OFFICERS OF THE REGISTRANT (Pursuant to Instruction G(3) of the General Instructions to Form 10-K, the following information is included herein as an unnumbered item in lieu of being included in the Company's definitive Proxy Statement).\nThe following is a list of the names and ages (as of April 28, 1995) of all the executive officers of the Company and a description of all positions and offices with the Company held by each such person and each such person's principal occupations and employment during the past five years. All executive officers hold office at the pleasure of the Company's Board of Directors.\nName Age Position\nDavid A. Stockman 48 Co-Chairman of the Board\nBruce Wasserstein 47 Co-Chairman of the Board\nRandall J. Weisenburger 36 Vice Chairman\nJohn P. McNicholas 32 Vice Chairman\nThomas E. Hannah 56 Chief Executive Officer\nWilliam J. Brucchieri 52 President of Imperial Wallcoverings\nJohn D. Moose 58 President of Automotive Bodycloth Division\nHarry F. Schoen III 59 President of Mastercraft Division\nElizabeth R. Philipp 38 Executive Vice President, General Counsel and Secretary\nJ. Michael Stepp 51 Executive Vice President and Chief Financial Officer\nDavid A. Stockman has been Co-Chairman of the Board of the Company since July 1993. Mr. Stockman has been a General Partner of The Blackstone Group Holdings L.P. (the \"Blackstone Group\") since 1988. Mr. Stockman is also a director of Edward J. DeBartolo Corporation.\nBruce Wasserstein has been Co-Chairman of the Board of the Company since June 1992. Mr. Wasserstein has been Chairman and Chief Executive Officer of Wasserstein Perella Management Partners, Inc. (\"WP Management\") since June 1992 and Chief Executive Officer and Chairman or President, Wasserstein Perella Group, Inc. (\"WP Group\") since 1988. Mr. Wasserstein is Chairman of the Board of Maybelline, Inc.\nRandall J. Weisenburger has been a director of the Company since August 1989 and Vice Chairman of the Company since April 1994. Mr. Weisenburger was Deputy Chairman of the Company from July 1992 to April 1994 and Vice President from August 1989 to July 1992. Mr. Weisenburger has been Managing Director of Wasserstein Perella & Co., Inc. (\"WP & Co.\") since December 1993. Mr. Weisenburger was a Director of WP & Co. from December 1992 to December 1993 and a Vice President of WP & Co. from December 1989 to December 1992. Mr. Weisenburger is also Vice Chairman of the Board of Maybelline, Inc. and Chairman of the Yardley Lentheric Group.\nJohn P. McNicholas has been Vice Chairman of the Company since April 1994. Mr. McNicholas was Deputy Chairman of the Company from July 1992 to April 1994. Mr. McNicholas has been Vice President of the Blackstone Group since January 1992 and was an Associate of the Blackstone Group from November 1990 to December 1991 and an Associate, Merchant Banking Group - Merrill Lynch Capital Markets from August 1989 to November 1990.\nThomas E. Hannah, has been a director of the Company and Chief Executive Officer of the Company since July 1994. Mr. Hannah was President and Chief Executive Officer of Collins & Aikman Textile and Wallcoverings Group, a division of a wholly owned subsidiary of the Company, from November 1991 until July 1994 and was named an executive officer of the Company for purposes hereof in April 1993. Mr. Hannah was President and Chief Executive Officer of the Collins & Aikman Textile Group from February 1989 to November 1991 and President of Milliken & Company's Finished Apparel Division prior to that.\nWilliam J. Brucchieri has been President of Imperial Wallcoverings since February 1993 and was named an executive officer of the Company for purposes hereof in April 1994. Mr. Brucchieri was Executive Vice President of Imperial from March 1992 to January 1993 and Executive Vice President of the Mastercraft division from January 1990 to February 1992. Mr. Brucchieri was Vice President, Operations of the Mastercraft division from August 1989 to January 1990. Mr. Brucchieri joined a wholly owned subsidiary of the Company in 1988.\nJohn D. Moose has been President of the Automotive Bodycloth division since October 1994 and was President of the North American Auto Group from June 1989 until October 1994. Mr. Moose was named an executive officer of the Company for purposes hereof in April 1994. Mr. Moose joined a wholly owned subsidiary of the Company in 1960.\nHarry F. Schoen III has been President of the Mastercraft division since January 1993 and was named an executive officer of the Company for purposes hereof in April 1994. Mr. Schoen was Executive Vice President and Chief Operating Officer of the Mastercraft division from April 1992 to December 1992. Mr. Schoen was General Manager of Milliken & Company's Greige Fine Goods Group prior to that.\nElizabeth R. Philipp has been Executive Vice President, General Counsel and Secretary of the Company since April 1994. Ms. Philipp was Vice President, General Counsel and Secretary of the Company from April 1993 to April 1994 and Vice President and General Counsel from September 1990 to April 1993. Prior to that, Ms. Philipp was associated with the law firm of Cravath, Swaine and Moore.\nJ. Michael Stepp has been Executive Vice President and Chief Financial Officer since April 1995. Mr. Stepp was Executive Vice President, Chief Financial Officer of Purolator Products Company from December 1992 to March 1995. Prior to that, Mr. Stepp was President of American Corporate Finance Group, Inc.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Company's common stock has been traded on the New York Stock Exchange under the symbol \"CKC\" since July 13, 1994. At April 26, 1995, there were approximately 125 holders of record. The following table lists the high and low sales prices for the common stock for the full quarterly periods since trading commenced.\nFiscal 1994\nHigh Low Third Quarter 10-7\/8 8-5\/8 Fourth Quarter 9-1\/4 7-7\/8\nNo dividend or other distribution with respect to the Common Stock has been paid by the Company since its incorporation in 1988. Any payment of future dividends and the amounts thereof will be dependent upon the Company's earnings, financial requirements and other factors deemed relevant by the Company's Board of Directors. The Company currently does not intend to pay any cash dividends in the foreseeable future; rather, the Company intends to retain earnings to provide for the operation and expansion of its business. Certain restrictive covenants contained in the agreement governing the Company's credit facilities limit the Company's ability to make dividend and other payments. See Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources on pages 22-23 of the Company's 1994 Annual Report to Stockholders incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe information required by this Item is incorporated by reference to page 16 of the Company's 1994 Annual Report to Stockholders.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe information required by this Item is incorporated by reference to pages 17 through 26 of the Company's 1994 Annual Report to Stockholders.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe information required by this Item is incorporated by reference to pages 27 through 54 of the Company's 1994 Annual Report to Stockholders.\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 401 of Regulation S-K regarding executive officers is set forth in Part I hereof under the caption \"Executive Officers of the Registrant\" and the information required by Item 401 of Regulation S-K regarding directors is incorporated herein by reference to that portion of the Registrant's definitive Proxy Statement to be used in connection with its 1995 Annual Meeting of Stockholders, which will be filed in final form with the Commission not later than 120 days after January 28, 1995 (the \"Proxy Statement\"), captioned \"Election of Directors--Information as to Nominees and Other Directors\". Disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Company's knowledge, in the Proxy Statement.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by this Item is incorporated herein by reference to that portion of the Proxy Statement captioned \"Executive Compensation\".\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 those portions of the Proxy Statement captioned \"Voting Securities and Principal Stockholders\" and \"Election of Directors--Information as to Nominees and Other Directors\".\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by this Item is incorporated herein by reference to that portion of the Proxy Statement captioned \"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) Financial Statements:\nThe following Consolidated Financial Statements of Collins & Aikman Corporation and Report of Independent Public Accountants are incorporated by reference to pages 27 through 54 of the Registrant's 1994 Annual Report to Stockholders:\nReport of Independent Public Accountants\nConsolidated Statements of Operations for the fiscal years ended January 28, 1995, January 29, 1994 and January 30, 1993\nConsolidated Balance Sheets at January 28, 1995 and January 29, 1994\nConsolidated Statements of Cash Flows for the fiscal years ended January 28, 1995, January 29, 1994 and January 30, 1993\nConsolidated Statements of Common Stockholders' Deficit for the fiscal years ended January 28, 1995, January 29, 1994 and January 30, 1993\nNotes to Consolidated Financial Statements\n(a) (2) Financial Schedules:\nThe following financial statement schedules of Collins & Aikman Corporation for the fiscal years ended January 28, 1995, January 29, 1994 and January 30, 1993 are filed as part of this Report and should be read in conjunction with the Consolidated Financial Statements of Collins & Aikman Corporation.\nPage Number\nReport of Independent Public Accountants on Schedules . . . . . . . . S-1 Schedule I-Condensed Financial Information of the Registrant . . . . S-2 Schedule II-Valuation and Qualifying Accounts . . . . . . . . . . . S-5\nAll other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are omitted because they are not required, are inapplicable, or the information is included in the Consolidated Financial Statements or Notes thereto.\n(a) (3) Exhibits:\nPlease note that in the following description of exhibits, the title of any document entered into, or filing made, prior to July 7, 1994 reflects the name of the entity a party thereto or filing, as the case may be, at such time. Accordingly, documents and filings described below may refer to Collins & Aikman Holdings Corporation, Collins & Aikman Group, Inc. or Wickes Companies, Inc., if such documents and filings were made prior to July 7, 1994.\nExhibit Number Description\n3.1- Restated Certificate of Incorporation of Collins & Aikman Corporation is hereby incorporated by reference to Exhibit 4.1 of Collins & Aikman Corporation's Report on Form 10-Q for the fiscal quarter ended July 30, 1994.\n3.2- By-Laws of Collins & Aikman Corporation, as amended, are hereby incorporated by reference to Exhibit 4.2 of Collins & Aikman Corporation's Report on Form 10-Q for the fiscal quarter ended July 30, 1994.\n4.1- Specimen Stock Certificate for the Common Stock is hereby incorporated by reference to Exhibit 4.3 of Amendment No. 3 to Collins & Aikman Holdings Corporation's Registration Statement on Form S-2 (Registration No. 33- 53179) filed June 21, 1994.\n4.2- Indenture dated as of May 1, 1985, pursuant to which 11 3\/8% Usable Subordinated Debentures due 1997 of Collins & Aikman Products Co. (the successor by merger to Collins & Aikman Group, Inc. and Wickes Companies, Inc.) were issued is hereby incorporated by reference to Exhibit 4(f) of Wickes Companies, Inc.'s Current Report on Form 8-K dated May 21, 1985 (SEC File No. 1-6761).\n4.3- Credit Agreement dated as of June 22, 1994 between Collins & Aikman Products Co. (formerly Collins & Aikman Corporation) as Borrower, WCA Canada Inc., as Canadian Borrower, the Company, as Guarantor, the lenders named therein, Continental Bank, N.A., and NationsBank, N.A. as Managing Agents, and Chemical Bank as Administrative Agent is hereby incorporated by reference to Exhibit 4.5 of Collins & Aikman Corporation's Report on Form 10-Q for the fiscal quarter ended July 30, 1994.\n4.4- First Amendment dated as of January 30, 1995 to the Credit Agreement dated as of June 22, 1994 among Collins & Aikman Products Co., WCA Canada Inc., Collins & Aikman Corporation, the financial institutions party thereto and Chemical Bank, as administrative agent.\nCollins & Aikman Corporation agrees to furnish to the Commission upon request in accordance with Item 601(b)(4)(iii)(A) of Regulation S-K copies of instruments defining the rights of holders of long-term debt of Collins & Aikman Corporation or any of its subsidiaries, which debt does not exceed 10% of the total assets of Collins & Aikman Corporation and its subsidiaries on a consolidated basis.\n10.1- Amended and Restated Stockholders Agreement dated as of June 29, 1994 among the Company, Collins & Aikman Group, Inc., Blackstone Capital Partners L.P. and Wasserstein Perella Partners, L.P.\n10.2- Employment Agreement dated as of July 18, 1990 between Wickes Companies, Inc. and an executive officer is hereby incorporated by reference to Exhibit 10.3 of Wickes Companies, Inc.'s Report on Form 10-K for the fiscal year ended January 26, 1991.*\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.\nExhibit Number Description\n10.3 - Letter Agreement dated as of May 16, 1991 and Employment Agreement dated as of July 22, 1992 between Collins & Aikman Corporation and an executive officer is hereby incorporated by reference to Exhibit 10.7 of Collins & Aikman Holdings Corporation's Report on Form 10-K for the fiscal year ended January 30, 1993.*\n10.4 - First Amendment to Employment Agreement dated as of February 24, 1994 between Collins & Aikman Corporation and an executive officer is hereby incorporated by reference to Exhibit 10.7 of Collins & Aikman Holdings Corporation's Registration Statement on Form S-2 (Registration No. 33- 53179) filed April 19, 1994.*\n10.5 - Letter Agreement dated as of May 16, 1991 between Collins & Aikman Corporation and an executive officer is hereby incorporated by reference to Exhibit 10.14 of Collins & Aikman Holdings Corporation's Registration Statement on Form S-2 (Registration No. 33-53179) filed April 19, 1994.*\n10.6 - Employment Agreement dated as of March 23, 1992 between Collins & Aikman Group, Inc. and a former executive officer is hereby incorporated by reference to Exhibit 10.6 of Collins & Aikman Holdings Corporation's Report on Form 10-K for the fiscal year ended January 30, 1993.*\n10.7 - First Amendment dated as of April 4, 1994 to Agreement dated as of March 23, 1992 between Collins & Aikman Group, Inc. and a former executive officer is hereby incorporated by reference to Exhibit 10.14 of Collins & Aikman Holdings Corporation's Report on Form 10-K for the fiscal year ended January 29, 1994.*\n10.8 - Lease, executed as of the 1st day of June 1987, between Dura Corporation and Dura Acquisition Corp. is hereby incorporated by reference to Exhibit 10.24 of Amendment No.5 to Collins & Aikman Holdings Corporation's Registration Statement on Form S-2 (Registration No. 33-53179) filed July 6, 1994.\n10.9 - Agreement dated as of October 17, 1994 among Collins & Aikman Products Co. and a former executive officer is hereby incorporated by reference to Exhibit 10.29 of Collins & Aikman Corporation's Report on Form 10-Q for the fiscal quarter ended October 29, 1994.*\n10.10 - The Wickes Equity Share Plan is hereby incorporated by reference to Exhibit 10.11 of Collins & Aikman Holdings Corporation's Report on Form 10-K for the fiscal year ended January 30, 1993.*\n10.11 - Collins & Aikman Corporation 1994 Executive Incentive Compensation Plan is hereby incorporated by reference to Exhibit 10.22 of Amendment No. 4 to Collins & Aikman Holdings Corporation's Registration Statement on Form S-2 (Registration No. 33-53179) filed June 27, 1994.*\n10.12 - Collins & Aikman Corporation Supplemental Retirement Income Plan is hereby incorporated by reference to Exhibit 10.23 of Amendment No. 5 to Collins & Aikman Holdings Corporation's Registration Statement on Form S-2 (Registration No. 33-53179) filed July 6, 1994.*\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.\nExhibit Number Description\n10.13 - 1993 Employee Stock Option Plan is hereby incorporated by reference to Exhibit 10.12 of the Registration Statement on Form S-2 of Collins & Aikman Holdings Corporation (File No. 33-53179) filed April 19, 1994.*\n10.14 - 1994 Employee Stock Option Plan is hereby incorporated by reference to Exhibit 10.13 of the Registration Statement on Form S-2 of Collins & Aikman Holdings Corporation (File No. 33-53179) filed April 19, 1994.*\n10.15 - 1994 Directors Stock Option Plan.*\n10.16 - Acquisition Agreement dated as of November 22, 1993 as amended and restated as of January 28, 1994, among Collins & Aikman Group, Inc., Kayser-Roth Corporation and Legwear Acquisition Corporation is hereby incorporated by reference to Exhibit 2.1 of Collins & Aikman Holdings Corporation's Current Report on Form 8-K dated February 10, 1994.\n10.17 - Warrant Agreement dated as of January 28, 1994 by and between Collins & Aikman Group, Inc. and Legwear Acquisition Corporation is hereby incorporated by reference to Exhibit 10.20 of Collins & Aikman Holdings Corporation's Report on Form 10-K for the fiscal year ended January 29, 1994.\n10.18 - Amended and Restated Receivables Sale Agreement dated as of March 30, 1995 among Collins & Aikman Products Co., Ack-Ti-Lining, Inc., WCA Canada Inc., Imperial Wallcoverings, Inc., The Akro Corporation, Dura Convertible Systems Inc., each of the other subsidiaries of Collins & Aikman Products Co. from time to time parties thereto and Carcorp, Inc.\n10.19 - Servicing Agreement, dated as of March 30, 1995, among Carcorp, Inc., Collins & Aikman Products Co., as Master Servicer, each of the subsidiaries of Collins & Aikman Products Co. from time to time parties thereto and Chemical Bank, as Trustee.\n10.20 - Pooling Agreement, dated as of March 30, 1995, among Carcorp, Inc., Collins & Aikman Products Co., as Master Servicer and Chemical Bank, as Trustee.\n10.21 - Series 1995-1 Supplement, dated as of March 30, 1995, among Carcorp, Inc., Collins & Aikman Products Co., as Master Servicer and Chemical Bank, as Trustee.\n10.22 - Series 1995-2 Supplement, dated as of March 30, 1995, among Carcorp, Inc., Collins & Aikman Products Co., as Master Servicer, the Initial Purchasers parties thereto, Societe Generale, as Agent for the Purchasers and Chemical Bank, as Trustee.\n10.23 - Master Equipment Lease Agreement dated as of September 30, 1994, between NationsBanc Leasing Corporation of North Carolina and Collins & Aikman Products Co. Is hereby incorporated by reference to Exhibit 10.27 of Collins & Aikman Corporation's Report on Form 10-Q for the fiscal quarter ended October 29, 1994.\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.\nExhibit Number Description\n10.24 - Employment Agreement dated as of April 6, 1995 between Collins & Aikman Products Co. and an executive officer.*\n10.25 - Excess Benefit Plan of Collins & Aikman Corporation.*\n11 - Computation of Earnings Per Share.\n13 - Pages 16-54 of Collins and Aikman Corporation s 1994 Annual Report to Stockholders.\n21 - List of subsidiaries of Collins & Aikman Corporation.\n23 - Consent of Arthur Andersen LLP.\n27 - Financial Data Schedule.\n99 - Voting Agreement between Blackstone Capital Partners L.P. and Wasserstein Perella Partners, L.P. is hereby incorporated by reference to Exhibit 99 of Amendment No.4 to Collins & Aikman Holdings Corporation's Registration Statement on Form S-2 (Registration No. 33-53179) filed June 27, 1994.\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.\n(b) Reports on Form 8-K.\nNo reports on Form 8-K were filed during the last quarter of the fiscal year for which this report on Form 10-K was 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, on the 28th day of April, 1995.\nCOLLINS & AIKMAN CORPORATION\nBy: \/s\/ David A. Stockman By: \/s\/ Bruce Wasserstein David A. Stockman Bruce Wasserstein Co-Chairman of the Board of Directors Co-Chairman of the Board 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 and on the dates indicated.\nSignature Title Date\n\/s\/ David A. Stockman Co-Chairman of the April 28, 1995 David A. Stockman Board of Directors\n\/s\/ Bruce Wasserstein Co-Chairman of the April 28, 1995 Bruce Wasserstein Board of Directors\n\/s\/ Thomas E. Hannah Director and Chief Executive April 28, 1995 Thomas E. Hannah Officer (Principal Executive Officer)\n\/s\/ Randall J. Weisenburger Vice Chairman and Director April 28, 1995 Randall J. Weisenburger\n\/s\/ J. Michael Stepp Executive Vice President and April 28, 1995 J. Michael Stepp Chief Financial Officer (Principal Financial Officer)\n\/s\/ Anthony Hardwick Vice President and Controller April 28, 1995 Anthony Hardwick (Principal Accounting Officer)\n\/s\/ Robert C. Clark Director April 28, 1995 Robert C. Clark\n\/s\/ James J. Mossman Director April 28, 1995 James J. Mossman\n\/s\/ Stephen A. Schwarzman Director April 28, 1995 Stephen A. Schwarzman\n\/s\/ W. Townsend Ziebold, Jr. Director April 28, 1995 W. Townsend Ziebold, Jr.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULES\nTo Collins & Aikman Corporation:\nWe have audited, in accordance with generally accepted auditing standards, the consolidated financial statements included in Collins & Aikman Corporation's annual report to stockholders incorporated by reference in this Form 10-K, and have issued our report thereon dated March 23, 1995, except with respect to the refinancing of the receivables facility discussed in Note 23 to the consolidated financial statements, as to which the date is March 31, 1995. Our audits were made for the purpose of forming an opinion on those statements taken as a whole. The schedules listed in Item 14 of this Form 10-K are the responsibility of the Company's management and are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic 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.\nANDERSEN ARTHUR LLP\nCharlotte, North Carolina, March 23, 1995.\nS-1\nCOLLINS & AIKMAN CORPORATION AND SUBSIDIARIES SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT Condensed Balance Sheets (in thousands)\nS-2\nCOLLINS & AIKMAN CORPORATION AND SUBSIDIARIES SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT Condensed Statements of Operations (in thousands)\nS-3\nCOLLINS & AIKMAN CORPORATION AND SUBSIDIARIES SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT Condensed Statements of Cash Flows (in thousands)\nNotes to Condensed Financial Statements\n1. Presentation:\nThese condensed financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and notedisclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to those rules and regulations, although the Company believes that the disclosures made are adequate to make the information presented not misleading. For disclosures regarding redeemable preferred stock and commitments and contingencies, see Notes 15 and 21, respectively, to Consolidated Financial Statements incorporated by reference to pages 27 through 54 of the Registrant's 1994 Annual Report to Stockholders.\n2. Long-Term Debt:\nLong-term debt as of January 29, 1994 consisted of Subordinated PIK Bridge Notes. For additional disclosures regarding long-term debt, see Note 9 to Consolidated Financial Statements incorporated by reference to pages 27 through 54 of the Registrant's 1994 Annual Report to Stockholders\n3. See Notes to Consolidated Financial Statements for additional disclosures.\nS-4\n(a) The fiscal year ended January 30, 1993 has been restated to exclude amounts related to discontinued operations. (b) Reclassification and collection of accounts previously written off.\n(c) Reclassifications and uncollectible amounts written off.\nS-5","section_15":""}
{"filename":"719241_1995.txt","cik":"719241","year":"1995","section_1":"ITEM 1. BUSINESS OF CONSECO.\nBackground\nConseco, Inc. is a financial services holding company engaged primarily in the development, marketing and administration of annuity, supplemental health and individual life products. As used herein the terms \"Conseco\" or the \"Company\" refer to Conseco, Inc. and its consolidated subsidiaries, unless the context requires otherwise. Conseco's earnings result primarily from: (i) operating life insurance companies; and (ii) providing investment management, administrative and other fee-based services to affiliated businesses as well as non-affiliates. Conseco's operating strategy is to grow the insurance business within its subsidiaries by focusing its resources on the development and expansion of profitable products and strong distribution channels. Conseco has supplemented such growth by acquisitions of companies that have profitable niche products, strong distribution systems and progressive management teams who can work with Conseco to implement Conseco's operating and growth strategies. Once a company has been acquired, Conseco's operating strategy has been to consolidate and streamline management and administrative functions, to realize superior investment returns through active asset management, to eliminate unprofitable products and distribution channels, and to expand the profitable distribution channels and products.\nSince 1990, Conseco has been active in acquiring and restructuring life insurance companies in partnership with other investors. In early 1996, Conseco announced the termination of its partnership activity because changes in the regulatory and rating agency environment have made it extremely difficult to structure leveraged acquisitions of life insurance companies.\nIn March 1996, Conseco announced a merger agreement with Life Partners Group, Inc. (\"LPG\") -- a transaction valued at $850 million, including $600 million of common stock to be issued by Conseco and $250 million of existing LPG long-term debt to be assumed by Conseco. Under the merger agreement, LPG would become a wholly owned subsidiary of Conseco.\nSince 1982, Conseco has completed 12 acquisitions of insurance companies and related businesses; the first seven as wholly owned subsidiaries and the last five through its acquisition partnerships. Conseco Capital Partners, L.P. (\"Partnership I\"), Conseco's first acquisition partnership, was dissolved in 1993 after distributing to its partners the securities of the companies it had acquired. In early 1994, Conseco formed Conseco Capital Partners II, L.P. (\"Partnership II\"), its second acquisition partnership, to invest in acquisitions of life insurance companies and related businesses. In early 1996, Conseco announced the termination of its partnership activity. Companies acquired by Partnership II are required to be included in Conseco's financial statements on a consolidated basis because a wholly owned subsidiary of Conseco is the sole general partner of Partnership II; partnership companies, therefore, are deemed to be unilaterally controlled by Conseco.\nConseco currently holds major ownership interests in the following life insurance businesses: (i) Bankers Life Holding Corporation (\"BLH\"), an NYSE-listed company in which Conseco currently holds a 90.5 percent ownership interest (and which is the parent company of Bankers Life and Casualty Insurance Company (\"Bankers Life\")); (ii) Great American Reserve Insurance Company (\"Great American Reserve\") and Beneficial Standard Life Insurance Company (\"Beneficial Standard\"), in which Conseco has had an ownership interest since their acquisition by Partnership I and which became wholly owned subsidiaries in August 1995; (iii) Bankers National Life Insurance Company (\"Bankers National\"), National Fidelity Life Insurance Company (\"National Fidelity\") and Lincoln American Life Insurance Company (\"Lincoln American\"), all of which are wholly owned by Conseco and which have profitable blocks of in-force business, although new sales are currently not being pursued; and (iv) American Life Group, Inc. (\"AGP\", formerly The Statesman Group, Inc. prior to its name change in August 1995), Partnership II's first acquisition in September 1994, in which Conseco holds a 36 percent ownership interest and which is the parent company of American Life and Casualty Insurance Company (\"American Life\")). BLH and its subsidiaries are collectively referred to hereinafter as BLH. Western National Corporation (\"WNC\"), an NYSE-listed company, and its wholly owned subsidiary, Western National Life Insurance Company (\"Western National\"), were wholly owned subsidiaries until February 15, 1994, when WNC completed an initial public offering (\"IPO\"). Conseco sold a 60 percent interest in WNC in connection with the IPO and sold its remaining 40 percent interest in a separate transaction on December 23, 1994. WNC and its subsidiaries are collectively referred to hereinafter as WNC.\nOn August 31, 1995, the Company completed the purchase of all of the shares of common stock of CCP Insurance, Inc. (\"CCP\") it did not previously own (representing 51 percent of CCP's outstanding shares) in a transaction pursuant to which CCP was merged into Conseco, with Conseco being the surviving corporation. The merger and the related transactions are referred to herein as the \"CCP Merger\". As a result of the CCP Merger, CCP's subsidiaries (Great American Reserve and Beneficial Standard) became wholly owned subsidiaries of the Company. The accounts of CCP are consolidated with those of the Company effective January 1, 1995.\nOn June 28, 1995, Conseco completed a program to acquire additional shares of BLH common stock. Shares purchased in open market and negotiated transactions increased Conseco's ownership of BLH to 85 percent (including shares of BLH owned by CCP) at June 30, 1995. Share repurchases by BLH in 1995 and 1996 increased Conseco's ownership interest in BLH to 90.5 percent at March 5, 1996.\nConseco was organized in 1979 as an Indiana corporation and commenced operations in 1982. Its executive offices are located at 11825 N. Pennsylvania Street, Carmel, Indiana 46032, and its telephone number is (317) 817-6100.\nLife Insurance Operations\nThe Company conducts its insurance operations through three segments: (i) senior market operations, consisting of the activities of BLH; (ii) annuity operations, consisting of the activities of Great American Reserve and Beneficial Standard; and (iii) other life insurance operations, consisting of the activities of National Fidelity, Bankers National and Lincoln American.\nSenior Market Operations\nBLH, with total assets of approximately $4.8 billion at December 31, 1995, markets health and life insurance and annuity products primarily to senior citizens through approximately 200 branch offices and approximately 3,300 career agents. Most of BLH's agents sell only BLH policies. Approximately 56 percent of the $1,513.8 million of direct premiums collected by BLH in 1995 was from the sale of individual health insurance products, principally Medicare supplement and long-term care policies. BLH believes that its success in the individual health insurance market is attributable in large part to its career agency force, which permits one-on-one contacts with potential policyholders and builds loyalty to BLH among existing policyholders. Its efficient and highly automated claims processing system is designed to complement its personalized marketing strategy by stressing prompt payment of claims and rapid response to policyholder inquiries.\nAnnuity Operations\nThe annuity companies, with total assets of $5.4 billion at December 31, 1995, market, issue and administer annuity, life and employee-benefit-related insurance products through two cost-effective distribution channels: (i) approximately 3,000 educator market specialists, who sell tax-qualified annuities and certain employee benefit-related insurance products primarily to school teachers and administrators; and (ii) approximately 9,000 professional independent producers, who sell various annuity and life insurance products aimed primarily at the retirement market. Approximately 87 percent of the $709.8 million of total premiums collected in 1995 was from the sale of annuity products.\nOther Life Insurance Operations\nThe Company's other insurance subsidiaries had total assets of approximately $.8 billion at December 31, 1995. These subsidiaries have profitable in-force blocks of annuity and life products, but do not currently market their products to new customers. Premiums collected totaled $80.0 million in 1995, including $6.6 million of premiums from deposit funds maintained by employee benefit plans of the Company.\nPartnership Operations\nPartnership II completed the acquisition of 80 percent of the common stock of AGP in September 1994. AGP, with total assets of approximately $6.2 billion at December 31, 1995, is a financial services holding company engaged primarily in the development, marketing, underwriting, issuance and administration of annuity and life insurance products. AGP collected $825.6 million of insurance premiums and annuity deposits in 1995. Approximately 91 percent of such premiums collected in 1995 were from the sale of deferred annuities.\nConseco believes that the consolidation of the U.S. life insurance industry will continue, and the Company intends to participate in this process. Recently, there has been a change in the financial structure required to acquire life insurance companies while maintaining competitive ratings from A.M. Best Company (\"A.M. Best\") and other rating agencies. As a result, Conseco believes it is no longer feasible to acquire life insurance companies through highly leveraged transactions, such as those previously made by its acquisition partnerships. Conseco terminated its partnership activity in March 1996.\nFee-Based Operations\nThe Company's subsidiaries provide various services to affiliated and unaffiliated clients. Conseco Capital Management, Inc. (\"CCM\") managed $24.7 billion of invested assets at December 31, 1995, including $13.7 billion of assets of affiliated companies. Marketing Distribution Systems Consulting Group, Inc. (\"Bankmark\") provides marketing services to financial institutions related to the distribution of insurance and investment products. Conseco Risk Management, Inc. distributes property and casualty insurance products as an independent agency. Conseco Mortgage Capital, Inc. originates and services mortgages. Other subsidiaries provide policy administration, data processing, product marketing and executive management to Conseco companies, Partnership II and others. Total fees from affiliates and nonaffiliates were $69.2 million, $71.0 million and $49.0 million for the years ended 1995, 1994 and 1993, respectively. To the extent that these services are provided to entities that are included in the financial statements on a consolidated basis, the intercompany fees are eliminated in consolidation. Earnings in this segment increase when the Company adds new clients (either affiliated or unaffiliated) and when the Company increases the fee-producing activities conducted for clients.\nADMINISTRATION\nConseco minimizes operating expenses by centralizing, standardizing and more efficiently performing many functions common to most life insurance companies. These functions include underwriting and policy administration, accounting and financial reporting, marketing, regulatory compliance, actuarial services and asset management.\nConseco's centralized management techniques resulted in significant employee reductions and expense savings in the nine insurance companies acquired between 1985 and 1992. The ratio of aggregate operating expenses (excluding commissions) to premiums collected for these nine companies was reduced from 11 percent for the last year prior to acquisition to 7.9 percent for the second full year following acquisition. The ratio of such expenses to total assets of these companies decreased from 3.4 percent to 1.6 percent in the same periods.\nThe administration of BLH's individual health insurance products, unlike that of life insurance or annuities, involves a high volume of claims processing, multiple contacts with policyholders and generally higher operational costs. In 1995, BLH processed more than 6 million policyholder claims. BLH has developed an efficient and highly automated policyholder administration operation to minimize the costs of such large volume processing and deliver a high level of service to its policyholders, with special emphasis on the prompt payment of claims. In most cases, BLH mails a check within a week of receiving a claim from a policyholder. BLH believes that its promptness in processing policyholder claims is a major reason for its strong reputation for service and the above-average persistency of its Medicare supplement products. Conseco (through certain of its wholly owned subsidiaries) provides BLH with certain investment advisory, executive consulting, data processing, accounting, legal, mortgage loan servicing and origination, and other services.\nINVESTMENTS\nCCM, a registered investment adviser wholly owned by Conseco, manages the investment portfolios of Conseco's wholly owned subsidiaries, BLH, AGP and several unaffiliated clients. CCM had approximately $24.7 billion of assets (at fair value) under management at December 31, 1995, of which $13.7 billion were assets of affiliated companies and $11.0 billion were assets of unaffiliated companies. CCM's investment philosophy is to maintain a largely investment-grade fixed-income portfolio, provide adequate liquidity for expected liability durations and other requirements and maximize total return through active investment management.\nInvestment activities are an integral part of the Company's business; investment income is a significant component of the Company's total revenues. Profitability is significantly affected by spreads between interest yields on investments and rates credited on insurance liabilities. Although substantially all credited rates on single premium deferred annuities and flexible premium deferred annuities may be changed annually, changes in crediting rates may not be sufficient to maintain targeted investment spreads in all economic and market environments. In addition, competition and other factors, including the impact of the level of surrenders and withdrawals, may limit the Company's ability to adjust or to maintain crediting rates at levels necessary to avoid narrowing of spreads under certain market conditions. As of December 31, 1995, the average yield, computed on the cost basis of the Company's investment portfolio, was 8.0 percent and the average interest rate credited on the Company's liability portfolio was 5.3 percent.\nThe Company seeks to balance the duration of its invested assets with the expected duration of benefit payments arising from insurance liabilities. At December 31, 1995, the adjusted modified duration of fixed maturities, trading securities and short-term investments was 5.8 years and the duration of the Company's insurance liabilities was 6.4 years.\nFor information regarding the composition and diversification of the investment portfolio of Conseco's subsidiaries, see \"Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations - Investments\" and note 3 to the consolidated financial statements.\nCOMPETITION\nConseco's businesses operate in a highly competitive environment. The life insurance industry consists of a large number of insurance companies, many of which are substantially larger and have greater financial resources, broader and more diversified product lines and larger staffs than those of Conseco. An expanding number of banks, securities brokerage firms and other financial intermediaries also market insurance products or offer competing products, such as mutual fund products, traditional bank investments and other investment and retirement funding alternatives. Conseco also competes with many of these companies and others in providing services for fees. In most areas, competition is based on a number of factors, including pricing, service provided to distributors and policyholders, and ratings. Conseco's subsidiaries must also compete with other insurers to attract and retain the allegiance of agents.\nFinancial institutions, school districts, marketing companies, agents who market insurance products and policyholders use the financial strength ratings assigned to an insurer by independent rating agencies as one factor in determining which insurer's annuity to market or purchase. Bankers Life, American Life, Great American Reserve and Beneficial Standard are rated \"A- (Excellent)\" by A.M. Best. A.M. Best ratings for the industry currently range from \"A++ (Superior)\" to \"F ( In Liquidation)\". Publications of A.M. Best indicate that the \"A-\" rating is assigned to those companies that, in A.M. Best's opinion, have achieved excellent overall performance when compared to the standards established by A.M. Best and have demonstrated a strong ability to meet their obligations to policyholders over a long period of time. A.M. Best's rating procedure includes quantitative and qualitative evaluations of a company's financial condition and operating performance. Its quantitative evaluation is based on an analysis of a company's financial performance in the areas of profitability, leverage\/capitalization and liquidity. A.M. Best's review also includes a qualitative evaluation of a company's spread of risk, quality and appropriateness of the reinsurance program, quality and diversification of assets, adequacy of policy or loss reserves, adequacy of surplus, capital structure, management experience and objectives, market presence and policyholders' confidence. In addition, Bankers Life has been assigned claims paying ability rating of \"AA-\" from Duff & Phelps Credit Rating Company (\"Duff & Phelps\") and Great American Reserve and Beneficial Standard have been assigned claims-paying ability ratings of \"A+\" from Duff & Phelps. Duff & Phelps' claims-paying ability ratings range from \"AAA (Highest claims-paying ability)\" to \"DD (Company is under an order of liquidation).\" The \"AA-\" rating represents \"Very high claims-paying ability\" and the \"A+\" rating represents \"High claims-paying ability.\" AGP's principal operating subsidiary, American Life, has been assigned claims-paying rating of \"A- (Good)\" from Standard & Poor's Corporation (\"Standard & Poor's\"). An \"A\" is assigned by Standard & Poor's to those companies which, in its opinion, have a secure claims-paying ability and whose financial capacity to meeting policyholder obligations is viewed on balance as sound, but their capacity to meet such policyholder obligations is somewhat more susceptible to adverse changes in economic or underwriting conditions than more highly rated insurers. According to Standard & Poor's a minus sign attached to a Standard & Poor's claim-paying rating shows relative standing within a ratings category. Generally, rating agencies base their ratings upon information furnished to them by the issuer and upon their own investigations, studies and assumptions. A.M. Best's ratings, Duff & Phelps' claims-paying ratings and Standard & Poor's claims-paying ratings are principally based upon factors of concern to policyholders, agents and intermediaries and are not directed toward the protection of investors. Given the competitive nature of the Company's business and the increasing focus placed on the aforementioned ratings, the Company manages its business with the objective of preserving existing ratings and, where possible, achieving more favorable ratings. There can be no assurance that any particular rating will continue for any given period of time or that it will not be changed or withdrawn entirely if in the judgement of the rating agency circumstances so warrant. If the Company's ratings were downgraded from their current levels, sales of its products and the persistency of its in-force policies could be adversely affected in a material way.\nFollowing Conseco's acquisition of additional shares of BLH, A.M. Best lowered its ratings of Bankers Life from \"A (Excellent)\" to \"A- (Excellent)\". Management does not believe the ratings change has had a significant impact on its business or operations. However, it is not possible to determine the extent to which such rating change will affect Bankers Life's level of sales or the persistency of its in-force business.\nFollowing Conseco's March 1996 announcement of an agreement to acquire LPG, A.M. Best affirmed its \"A- (Excellent)\" ratings of Bankers Life, Great American Reserve and Beneficial Standard.\nIn the individual health insurance business, insurance companies compete primarily on the basis of marketing, service and price. The provisions of the Omnibus Budget Reconciliation Act of 1984 and the work of the National Association of Insurance Commissioners (\"NAIC\") (an association of state regulators and their staffs) have resulted in standardized policy features for Medicare supplement products. This increases the comparability of such policies and may intensify competition based on factors other than product features. See \"Underwriting - BLH\" and \"Government Regulation.\" In addition to the products of other insurance companies, Bankers Life's health insurance products compete with health maintenance organizations, preferred provider organizations, and other health care related institutions which provide medical benefits based on contractual agreements.\nThe Company believes that its insurance companies are able to compete effectively because: (i) they emphasize specialized distribution channels where the ability to respond rapidly to changing customer needs yields a competitive edge; (ii) they are experienced in establishing and cultivating relationships with the unique distribution networks and the independent marketing companies operating in these specialized markets; (iii) they can offer competitive rates as a result of their lower-than-average operating costs and increased investment yields achieved by applying active investment portfolio management techniques; and (iv) they have reliable policyholder administrative services, supported by customized data processing systems.\nUNDERWRITING\nUnder regulations promulgated by the NAIC and adopted as a result of the Omnibus Budget Reconciliation Act of 1990 (\"OBRA\"), BLH is prohibited from underwriting its Medicare supplement policies for certain first-time purchasers. If a person applies for insurance within six months following eligibility by reason of age, or disability in certain limited circumstances, the application may not be rejected due to medical conditions. For other prospective policyholders, such as senior citizens who are transferring to BLH's products, BLH's underwriting procedures are relatively limited, except for policies providing prescription drug coverage.\nBLH generally applies detailed underwriting procedures designed to assess and quantify the insurance risks before it issues long-term care or comprehensive major medical products to individuals and groups. BLH's practice is to require medical examinations of applicants (including blood and urine tests, where permitted) for certain health insurance products and for life insurance products which exceed prescribed policy amounts. These requirements are graduated according to the applicant's age and may vary by type of policy or product. BLH also relies on medical records and the potential policyholder's written application, which is generally prepared under the supervision of one of BLH's trained agents.\nSubstantially all the life insurance policies issued by Conseco's subsidiaries are underwritten individually, although standardized underwriting procedures have been adopted for certain low face-amount life insurance coverages. After initial processing, BLH reviews each file and obtains the information needed to make an underwriting decision (such as medical examinations, doctors' statements and special medical tests). After collecting and reviewing the information, BLH either: (i) issues the policy as applied for or with an extra premium charge because of unfavorable factors; or (ii) rejects the application. BLH underwrites group insurance policies based on the characteristics of the group and its past claim experience. Underwriting with respect to single premium deferred annuities (\"SPDAs\") and flexible premium deferred annuities (\"FPDAs\") is minimal.\nREINSURANCE\nConsistent with the general practice of the life insurance industry, the Company's subsidiaries reinsure portions of the coverage provided by their insurance products with other insurance companies under agreements of indemnity reinsurance. Reinsurance assumed from other companies is not significant.\nIndemnity reinsurance agreements are intended to limit a life insurer's maximum loss on a large or unusually hazardous risk or to obtain a greater diversification of risk. Indemnity reinsurance does not discharge the original insurer's primary liability to the insured. The Company's reinsured business is ceded to numerous reinsurers. The amount of business ceded to any one reinsurer is not material. The Company believes the assuming companies are able to honor all contractual commitments, based on the Company's periodic reviews of their financial statements, insurance industry reports and reports filed with state insurance departments.\nAs of December 31, 1995, the policy risk retention limit was $.8 million or less on all of the policies of our subsidiaries. Reinsurance ceded by Conseco's subsidiaries represented 7.8 percent of gross combined life insurance in force and reinsurance assumed by Conseco's subsidiaries represented 1.7 percent of net combined life insurance in force. At December 31, 1995, Conseco's largest reinsurer accounted for less than .06 percent of total insurance liabilities and less than 9 percent of total reinsurance receivables.\nEMPLOYEES\nAt December 31, 1995, Conseco had approximately 3,250 employees, including approximately: (i) 960 home office employees of Conseco; (ii) 1,320 home office employees of BLH; (iii) 440 branch office employees of BLH; (iv) 310 employees of AGP; and (v) 220 employees of Bankmark. None of the Company's employees is covered by a collective bargaining agreement. Conseco believes that it has excellent relations with its employees.\nGOVERNMENTAL REGULATION\nGeneral\nConseco's insurance subsidiaries are subject to regulation and supervision by the states in which they transact business. The laws of these jurisdictions generally establish agencies with broad regulatory authority, including the power to: (i) grant and revoke licenses to transact business; (ii) regulate and supervise trade practices and market conduct; (iii) establish guaranty associations; (iv) license agents; (v) approve policy forms; (vi) approve premium rates for some lines of business; (vii) establish reserve requirements; (viii) prescribe the form and content of required financial statements and reports; (ix) determine the reasonableness and adequacy of statutory capital and surplus; and (x) regulate the type and amount of permitted investments.\nMost states also have enacted legislation which regulates insurance holding company systems, including acquisitions, extraordinary dividends, the terms of surplus debentures, the terms of affiliate transactions, and other related matters. Currently, the Company and its insurance subsidiaries have registered as holding company systems pursuant to such legislation in Texas, Missouri, Tennessee, California, Alabama, Iowa and Illinois, and they routinely report to other jurisdictions. For further information on state laws regulating the payment of dividends by insurance company subsidiaries, see \"Management's Discussion and Analysis of Consolidated Financial Position and Results of Operations - Consolidated Financial Condition\" and note 13 to Conseco's consolidated financial statements.\nThe federal government does not directly regulate the insurance business. However, federal legislation and administrative policies in several areas, including pension regulation, age and sex discrimination, financial services regulation and federal taxation, do affect the insurance business. Recently, a number of state legislatures have considered or have enacted legislative proposals that alter, and in many cases increase, the authority of state agencies to regulate insurance companies and holding company systems. In addition, legislation has been introduced from time to time in recent years which, if enacted, could result in the federal government assuming a more direct role in the regulation of the insurance industry.\nState insurance regulators and the NAIC periodically re-examine existing laws and regulations and their application to insurance companies. In recent years, the NAIC has approved, and recommended to the states for adoption and implementation, several regulatory initiatives designed to decrease the risk of insolvency of insurance companies. These initiatives include risk based capital (\"RBC\") requirements for determining the levels of capital and surplus an insurer must maintain in relation to its insurance and investment risks. Other NAIC regulatory initiatives impose restrictions on an insurance company's ability to pay dividends to its stockholders. These initiatives may be adopted by the various states in which the Company's subsidiaries are licensed; the ultimate content and timing of any statutes and regulations adopted by the states cannot be determined at this time. It 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.\nThe NAIC's RBC requirements, which became effective December 31, 1993, are intended to be used as an early warning tool to help insurance regulators identify deteriorating or weakly capitalized companies in order to initiate regulatory action. Such requirements are not intended as a mechanism for ranking adequately capitalized companies. The formula defines a new minimum capital standard which supplements the low, fixed minimum capital and surplus requirements previously implemented on a state-by-state basis.\nThe NAIC's RBC requirements provide for four levels of regulatory attention, varying with the ratio of the company's total adjusted capital (defined as the total of its statutory capital, surplus, asset valuation reserve and certain other adjustments) to its RBC. If a company's total adjusted capital is less than 100 percent but greater than or equal to 75 percent of its RBC, or if a negative trend (as defined by the regulators) has occurred and total adjusted capital is less than 125 percent of RBC (the \"Company Action Level\"), the company must submit a comprehensive plan to the regulatory authority proposing corrective actions aimed at improving its capital position. If a company's total adjusted capital is less than 75 percent but greater than or equal to 50 percent of its RBC (the \"Regulatory Action Level\") , the regulatory authority will perform a special examination of the company and issue an order specifying corrective actions that must be followed. If a company's total adjusted capital is less than 50 percent but greater than or equal to 35 percent of its RBC (the \"Authorized Control Level\"), the regulatory authority may take any action it deems necessary, including\nplacing the company under regulatory control. If a company's total adjusted capital is less than 35 percent of its RBC (the \"Mandatory Control Level\") the regulatory authority must place the company under its control. At December 31, 1995, the total adjusted capital for each of Bankers Life, American Life, Great American Reserve and Beneficial Standard was approximately equal to or greater than twice the respective Company Action Levels.\nThe Texas Insurance Department adopted its own RBC requirements, the stated purpose of which is to require a minimum level of capital and surplus to absorb the financial, underwriting, and investment risks assumed by an insurer. Texas' RBC requirements differ from those adopted by the NAIC in two principal respects: (i) they use different elements to determine minimum RBC levels in their calculation formulas; and (ii) the Texas Regulations do not stipulate \"Action Levels\" (like those adopted by the NAIC) where corrective actions are required. However, the Commissioner of the Texas Insurance Department does have the power to take similar corrective actions if a company does not maintain the required minimum level of capital and surplus. Under the Texas Regulations, an insurer has met RBC requirements if its admitted assets exceed its liabilities by at least 3 percent. Bankers National and Great American Reserve are domiciled in Texas and must comply with Texas RBC requirements. At December 31, 1995, their admitted assets exceeded liabilities by more than twice the required 3 percent level.\nEffective for statutory annual statements filed for the year ending December 31, 1992, insurance companies are required to establish an asset valuation reserve (\"AVR\") consisting of two components: a \"default component\" which provides for future credit- related losses on fixed maturity investments and an \"equity component\" which provides for losses on all types of equity investments, including real estate. Insurers are also required to establish an interest maintenance reserve (\"IMR\") for fixed maturity realized capital gains and losses, net of tax, related to changes in interest rates. The IMR must be amortized into earnings on a basis reflecting the remaining period to maturity of the fixed maturity securities sold. State regulatory authorities require that these reserves be established as a liability on a life insurer's statutory financial statements. These reserves do not affect financial statements of the Company prepared in accordance with generally accepted accounting principles (\"GAAP\").\nThe Life\/Health Task Force of the NAIC recently adopted Actuarial Guideline No. 33 (the \"Guideline\") which defines minimum reserves for certain annuity products having multiple benefit streams (including certain annuity products of Conseco's insurance subsidiaries). The Guideline affects the accounting for applicable contracts issued on or after January 1, 1981, in financial statements prepared for state regulatory authorities for years ending on or after December 31, 1995. Implementing the Guideline on December 31, 1995, had an immaterial impact on the financial statements prepared for state regulatory authorities by the Company's insurance subsidiaries.\nMost states have enacted legislation or have adopted administrative regulations which affect the acquisition of control of insurance companies as well as transactions between insurance companies and persons controlling them. The nature and extent of such legislation and regulations vary from state to state. Most states, however, require administrative approval of: (i) the acquisition of 10 percent or more of the outstanding shares of an insurance company incorporated in the state; or (ii) the acquisition of 10 percent or more of the outstanding stock of an insurance holding company whose insurance subsidiary is incorporated in the state. The acquisition of 10 percent of such shares is generally deemed to be the acquisition of control for the purpose of the holding company statutes. It requires not only the filing of detailed information concerning the acquiring parties and the plan of acquisition, but also the receipt of administrative approval prior to the acquisition. In many states, however, an insurance authority may determine that control does not exist, even in circumstances in which a person owns or controls 10 percent or a greater amount of securities.\nUnder the solvency or guaranty laws of most states in which they do business, Conseco's insurance subsidiaries may be required to pay guaranty fund assessments (up to certain prescribed limits). Guaranty funds are established by various states to fund policyholder losses or the 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. In certain instances, the assessments may be offset against future premium taxes. Prior to 1991 these assessments were not material. The amount of such assessments has increased in recent years, however, and may increase in future years. The Company's insurance subsidiaries statutory financial statements for the year ended December 31, 1995, include $3.2 million of expenses as a result of such assessments. The likelihood and amount of any other future assessments in addition to estimated amounts accrued at December 31, 1995, cannot be estimated. Such assessments are beyond the control of the Company.\nApproximately once every three years, as part of their routine regulatory oversight process, insurance departments conduct detailed examinations of the books, records and accounts of insurance companies domiciled in their states. Such examinations are generally conducted in cooperation with the departments of two or three other states, under guidelines promulgated by the NAIC. Several examinations of Conseco's life insurance subsidiaries have been recently completed. The conclusions reached did not have a material adverse effect on the Company or its businesses and operations.\nHealth Care\nFederal and state regulations have had, and are expected to continue to have, the effect of increasing the regulation of Medicare supplement plans in all states. OBRA mandated, among other things, standardized policy features in Medicare supplement plans. In July 1991, the NAIC implemented regulations creating 10 model Medicare supplement plans (Plans A through J). Plan A provides the least extensive coverage, while Plan J provides the most extensive coverage. Under NAIC regulations, Medicare insurers must offer Plan A, but may offer any of the other plans at their option. BLH currently offers nine of the model plans. BLH has declined to offer Plan J, due in part to its high benefit levels and consequently high costs to the consumer.\nThe NAIC model regulation concerning Medicare supplement policies also regulates the profits that insurance companies may earn in respect of any such policies by providing that Medicare supplement policies may not be issued unless it can be expected, as estimated for the period for which the prescribed rate thereunder is to provide coverage, to return to policyholders aggregate benefits equal to at least: (i) 75 percent of the aggregate amount of premiums earned on group policies; and (ii) 65 percent of the aggregate amount of premiums earned on individual policies. Technical corrections to OBRA mandate compliance with these calculations for policies issued prior to the original OBRA regulations. Under this regulation, BLH must file a Medicare Supplement Refund Calculation Form each year. If BLH's actual loss ratio falls below ratios prescribed by the Form by more than a de minimis amount, BLH must make a refund to policyholders. BLH has reviewed the loss ratios on business subject to the NAIC model regulations and currently believes that no significant refunds will be required.\nNumerous proposals to reform the current health care system have been introduced in Congress and the state legislatures. Proposals have included, among other things, modifications to the existing employer-based insurance system, a quasi-regulated system of \"managed competition\" among health plans, and a single-payer, public program. Changes in health care policy could significantly affect BLH's business. Federal comprehensive major medical or long-term care programs, if proposed and implemented, could partially or fully replace some of BLH's current products, for example. The institution of such programs, however, also could create new opportunities for supplemental insurance similar to BLH's Medicare supplement policies. Reforms also could standardize major medical or long-term care coverages, impose mandated or targeted loss ratios or rate regulation, require the use of community rating or other means that limit the ability of insurers to differentiate among risks, or mandate utilization review or other managed care concepts to determine what benefits would be paid by insurers. These or other proposals could increase the level of competition among health insurers. In addition, changes could be made in Medicare that could necessitate revisions in BLH's Medicare supplement products. Other potential initiatives, designed to tax insurance premiums or shift medical care costs from government to private insurers, could have an adverse effect on BLH's business, although such taxes and costs might be offset in whole or in part by increasing premiums. Depending on their form, proposals designed to reduce health care costs could reduce benefits payable by BLH. BLH is unable to predict what changes to the country's health care system will be enacted, and if enacted, their scope and effects on its business. However, BLH continues to believe that its opportunities will grow under any realistic and affordable health care reform scenario.\nFEDERAL INCOME TAXATION\nThe annuity and life insurance products marketed and issued by Conseco's subsidiaries generally provide the policyholder with an income tax advantage, as compared to other saving investments such as certificates of deposit and bonds, in that income taxation on the increase in value of the product is deferred until receipt by the policyholder. With other savings investments, the increase in value is taxed as earned. Annuity benefits, and life insurance benefits which accrue prior to the death of the policyholder, are generally not taxable until paid. Life insurance death benefits are generally exempt from income tax. Also, benefits received on immediate annuities (other than structured settlements) are recognized as taxable income ratably as opposed to the economic accrual methods, which tend to accelerate taxable income into earlier years than which are required for other investments. The tax advantage for annuities and life insurance is provided in the Internal Revenue Code (the \"Code\"), and is generally followed in all states and other United States taxing jurisdictions. Accordingly, the tax advantage is subject to change by Congress and by the legislatures of the respective taxing jurisdictions.\nConseco's insurance company subsidiaries are taxed under the life insurance company provisions of the Code. Provisions in the Code require a portion of the expenses incurred in selling insurance products to be deducted over a period of years, as opposed to immediate deduction in the year incurred. This provision increases the tax for statutory accounting purposes which reduces statutory surplus and, accordingly, decreases the amount of cash dividends that may be paid by the life insurance subsidiaries. For 1995, the increase in the Company's current tax due to this provision was $18.4 million.\nThe Company had regular tax loss carryforwards at December 31, 1995, of approximately $408 million, portions of which begin expiring in 1999. However, the amount of such loss that may be offset against current taxable income is subject to the following limitations: (i) losses may be offset against income of other corporate entities only if such entities are included in the same consolidated tax return (AGP is currently not eligible for inclusion in a single consolidated tax return); (ii) losses incurred in non-life companies (which comprise most of the loss carryforwards) may offset only a portion of income from life companies in the same consolidated tax return; and (iii) some loss carryforwards may not be available to offset taxable income of entities acquired after the loss was incurred. However, the Company believes it will be able to utilize the loss carryforwards prior to their expiration.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company's principal operations are located on a 150-acre corporate campus in Carmel, Indiana, immediately north of Indianapolis. These facilities contain approximately 416,000 square feet of space in seven buildings which contain Conseco's executive offices and certain administrative operations of its subsidiaries. These facilities include sufficient capacity for future growth.\nBLH currently leases 300,000 square feet of executive office and administration space in a single facility in downtown Chicago under a 15-year lease agreement. BLH also leases approximately 100,000 square feet of warehouse space in a second Chicago facility under a 10-year lease agreement executed in 1993. BLH leases more than 200 sales offices totaling approximately 350,000 square feet. All of the sales office leases are short-term in length, with remaining lease terms ranging from one to five years.\nAGP owns the building housing its principal operations in Des Moines, Iowa, consisting of approximately 107,000 square feet of space. The land underlying the building is subject to a long-term lease expiring in 2016, at which time title to the building will pass to the lessor. AGP owns another building housing its operations in Birmingham, Alabama, consisting of 44,000 square feet.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nConseco and its subsidiaries are involved in lawsuits primarily related to their operations. Most of these lawsuits involve claims under insurance policies or other contracts of the Company. Even though Conseco may be contesting the validity or extent of its liability in response to such lawsuits, the Company has established reserves in its consolidated financial statements which approximate its estimated potential liability or cost of defense. Accordingly, none of the lawsuits currently pending, either individually or in the aggregate, is expected to have a material adverse effect on the Company's consolidated financial condition or results of operations.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNone.\nOPTIONAL ITEM. EXECUTIVE OFFICERS OF THE REGISTRANT.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS.\nMARKET INFORMATION\nThe common stock of Conseco (trading symbol \"CNC\") has been listed for trading on the New York Stock Exchange (the \"NYSE\") since 1986. The following table sets forth the quarterly dividends paid per share and the ranges of high and low sales prices per share on the NYSE for the last two fiscal years, based upon information supplied by the NYSE. All applicable per share data have been adjusted for the two-for-one stock split to be distributed on April 1, 1996.\nAs of March 5, 1996, there were approximately 13,000 holders of the outstanding shares of common stock, including individual participants in securities position listings.\nDIVIDENDS\nIn October 1988, Conseco's Board of Directors adopted a policy of paying regular quarterly cash dividends on its common stock. The first such dividend was $.00625 per share. Subsequent dividends, which were increased to $.0075 per share effective with the dividend paid October 1, 1990, to $.01 per share effective with the dividend paid October 1, 1991, to $.0125 per share effective with the dividend paid January 4, 1993, to $.0625 per share effective with the dividend paid October 1, 1993, have been paid on the first business day of each calendar quarter, after review by the Board of Directors of the Company's interim operating results. On March 3, 1995, Conseco's Board of Directors reduced the quarterly cash dividend to 1 cent per share, effective with the dividend paid in July 1995. Conseco's Board of Directors increased the quarterly cash dividend to be paid on April 1, 1996, to 2 cents per share from the current rate of 1 cent. The Company's general policy is to retain most of its earnings. Retained earnings have been used: (i) to finance the growth and development of the Company's business through acquisitions or otherwise; and (ii) to finance the repurchase of common stock on those occasions when the Company has determined that the use of funds for stock repurchases would not interfere with other cash needs and that its shares were undervalued in the market.\nIn February 1993, the Company issued $287.5 million liquidation value Series D Cumulative Convertible Preferred Stock (\"Series D Preferred Stock\"), on which dividends ($3.25 per share) are cumulative from the date of original issue and are payable quarterly, commencing April 15, 1993. The terms of the Series D Preferred Stock prohibit the payment of cash dividends on capital stock ranking junior to the Series D Preferred Stock if the Company is not current in its Series D dividend payments. The Company paid dividends on the Series D Preferred Stock of $18.5 million, $18.6 million and $13.5 million during 1995, 1994 and 1993, respectively, and is current on its payments.\nOn January 23, 1996, the Company issued 4.37 million shares of Preferred Redeemable Increased Dividend Equity Securities, 7% Convertible Preferred Stock (\"PRIDES\"). Each share of PRIDES pays dividends at the annual rate of 7 percent of the stated $61.125 liquidation preference per share (equivalent to an annual amount of $4.279 per share), payable quarterly commencing February 1, 1996. The shares of PRIDES rank prior to common stock and on parity with the Series D Preferred Stock, as to payment of dividends.\nThe principal operating subsidiaries of Conseco are life insurance companies organized under state laws and subject to regulation by state insurance departments. These laws and regulations limit the ability of insurance subsidiaries to make cash dividends, loans or advances to a holding company such as Conseco. However, these laws generally permit the payment, without prior approval, of annual dividends which in the aggregate do not exceed the greater of (or in a few states, the lesser of): (i) the subsidiary's prior year net gain from operations; or (ii) 10 percent of surplus attributable to policyholders at the prior year-end, both computed on the statutory basis of accounting prescribed for insurance companies. For further information on state laws regulating the payment of dividends by insurance subsidiaries, see \"Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations - Consolidated Financial Condition\" and note 13 to Conseco's consolidated financial statements.\nITEM 6.","section_6":"ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA (a).\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nThis discussion should be read in conjunction with the accompanying consolidated financial statements, notes thereto and financial statistics. Changes in 1995, 1994 and 1993 balances in the consolidated financial statements are caused primarily by the transactions described in note 1 \"Significant Accounting Policies - Basis of Presentation\" and note 2 \"Acquisitions\/Dispositions\" to the consolidated financial statements.\nRESULTS OF OPERATIONS\nConseco generates earnings primarily by operating life insurance companies and providing services to affiliates and nonaffiliates for fees. In the past, Conseco was also active in acquiring and restructuring life insurance companies in partnership with other investors.\nLife Insurance Company Operations\nThe Company's life insurance operations are conducted through four activities: (i) senior market operations, consisting of the activities of BLH; (ii) annuity operations, consisting of the activities of the Company's annuity companies (Great American Reserve and Beneficial Standard); (iii) other life insurance operations, consisting of the activities of the Company's other wholly owned subsidiaries (National Fidelity, Bankers National and Lincoln American), which have profitable blocks of business but do not currently market their products to new customers; and (iv) Partnership II operations, consisting of the activities of AGP.\nLife insurance operation earnings increase when Conseco: (i) improves the profitability of owned companies by increasing their sales, investment income or product profitability, or by reducing their expenses; (ii) increases its ownership interest in the partially owned companies; or (iii) acquires an interest in additional companies.\nFee-Based Operations\nConseco provides all affiliated and other unaffiliated clients with various services, including investment management, mortgage origination and servicing, policy administration, data processing, product marketing and executive management services. In addition, subsidiaries of Conseco earn fees by: (i) providing marketing services to financial institutions related to the distribution of insurance and investment products; (ii) providing financing services to Partnership II; and (iii) distributing property and casualty insurance products as an independent agency.\nEarnings in this segment increase when Conseco adds new clients (either affiliated or unaffiliated) and when Conseco increases the fee-producing activities conducted for clients.\nRestructuring Activities\nSince commencing operations in 1982, Conseco has acquired 12 life insurance companies and related businesses. Conseco acquired the first seven as wholly owned subsidiaries and the last five through its acquisition partnership. Recent acquisition activity is described in notes 1 and 2 to the consolidated financial statements. All acquisitions have been accounted for as purchases. Therefore, activities of the acquired companies have been included in Conseco's results of operations beginning with the date of purchase.\nOf the first seven companies acquired by Conseco as wholly owned subsidiaries, four were subsequently sold (including WNC through an IPO in February 1994 and the subsequent sale of Conseco's remaining interest in WNC in December 1994, as described in note 2 to the consolidated financial statements). Three remain as wholly owned subsidiaries. The first three companies acquired by Partnership I (two of which were merged at the end of 1994) are now wholly owned subsidiaries of Conseco. The fourth and final acquisition of Partnership I became a wholly owned subsidiary of BLH, in which Conseco currently holds a 90.5 percent interest. In addition, Conseco currently holds a 36 percent interest in the acquisition made by Partnership II. Conseco records the activities of acquired companies in its insurance operations segment. Conseco also provides services to acquired companies, thereby generating income in the fee-based operations segment. Incentive compensation earned by exceeding prescribed returns to the partners and restructuring gains realized from the sale of portions of the acquired entities are reflected in the restructuring segment.\nRecently, there has been a change in the financial structure required to acquire life insurance companies while maintaining competitive ratings from A.M. Best and other rating agencies. As a result, Conseco believes it is no longer feasible to acquire life insurance companies through highly leveraged transactions, such as those made in the past by the acquisition partnerships. Conseco, therefore, terminated Partnership II in March 1996. Conseco may accomplish future acquisitions through different financial structures, including acquisitions using its equity capital or other means.\nIn addition to its life insurance acquisitions, two wholly owned subsidiaries (Conseco Private Capital Group and Conseco Global Investments) make direct strategic investments in growing companies, providing these firms with the capital or financing they need to continue their growth, make acquisitions or realize the potential of their businesses. When these investments are sold, Conseco reports the gains in this segment.\nAnalysis of Net Income and Fully Diluted Earnings Per Share\nThe following table shows the sources of Conseco's net income (after taxes and minority interest) for the last three years:\n(continued from previous page)\nThe following table shows the sources of Conseco's fully diluted earnings per share for the last three years:\n(continued from previous page)\nThe following table analyzes changes in Conseco's fully diluted earnings per share:\nAdditional Discussion of Consolidated Statement of Operations for the Three Years Ended December 31, 1995:\nThe following tables and narratives summarize amounts reported in the consolidated statement of operations. Many of the changes from period to period resulted from: (i) the acquisition of AGP on September 29, 1994; and (ii) changes in Conseco's ownership in BLH, WNC and CCP.\nLife Insurance Operations:\nSenior Market Operations:\nGeneral. Conseco acquired a 44 percent ownership interest in BLH in November 1992, the date BLH was acquired by Partnership I. In March 1993, BLH completed an IPO of its common stock, thus reducing Conseco's ownership to 31 percent. On September 30, 1993, Conseco acquired 13.3 million additional common shares of BLH, increasing its ownership interest to 56 percent. During 1994, BLH acquired 1.8 million shares of its common stock at a cost of $35.7 million, which increased Conseco's ownership interest in BLH to 58 percent. During 1995, BLH repurchased 2.2 million shares of its common stock at a cost of $42.1 million and Conseco acquired 12.8 million shares of BLH common stock for $262.4 million. As a result of these transactions, Conseco's ownership in BLH increased to 88 percent as of December 31, 1995 (it was 90.5 percent as of March 5, 1996). Conseco's weighted average ownership of BLH during 1995 was 74 percent. At December 31, 1995, the BLH shares owned by Conseco had a net carrying value of approximately $958.9 million and a cost of $575.5 million. All activities of BLH are included in Conseco's financial statements on a consolidated basis since November 1, 1992. Conseco's minority interest adjustment, however, removes the portion of BLH's net income applicable to other owners.\nInsurance policy income is comprised primarily of individual health premiums, which increased as a result of increases in Medicare supplement and long-term care premiums, partially offset by the decrease in major medical products that was anticipated due to prior steps taken to improve the profitability of this product.\nNet investment income increased 13 percent in 1995 and 26 percent in 1994. Average invested assets (amortized cost basis) increased 11 percent in 1995, to $3.4 billion, and 32 percent, to $3.0 billion, in 1994. For 1995 compared to 1994, the percentage increase in net investment income was greater than the percentage increase in average invested assets because the yield earned on average invested assets increased to 7.3 percent in 1995 from 7.2 percent in 1994. For 1994 compared to 1993, the percentage increase in net investment income was less than the percentage increase in average invested assets because the yield earned on average invested assets decreased to 7.2 percent in 1994 from 7.6 percent in 1993.\nInvested assets grew as a result of: (i) recurring operations; (ii) the recapture in 1994 and 1993 of reinsurance treaties with related assets totaling $371 million and $182 million, respectively; and (iii) capital transactions in connection with BLH's IPO, as discussed in the notes to the consolidated financial statements.\nNet trading income and losses often fluctuate from year to year, based on market conditions for trading activities.\nNet realized gains and losses often fluctuate from year to year. BLH sold approximately $1.0 billion of fixed maturity securities in 1995, $1.2 billion in 1994 and $2.2 billion in 1993. Net realized gains in 1995 were net of a $2.2 million writedown of certain exchange-rate linked securities as a result of currency fluctuations and a $5.0 million writedown of two corporate securities as a result of changes in conditions which caused BLH to conclude that a decline in their fair values was other than temporary.\nSelling securities at a gain and reinvesting the proceeds at lower yields may, absent other management action, tend to decrease future investment yields. The Company believes, however, the following factors would mitigate the adverse effect of such decreases on net income: (i) the Company recognizes additional amortization of the cost of policies purchased and the cost of policies produced in the same period as the gain in order to reflect reduced future yields (thereby reducing such amortization in future periods); (ii) the Company can reduce interest rates credited to some products thereby diminishing the effect of the yield decrease on the investment spread; and (iii) the investment portfolio grows as a result of reinvesting the realized gains.\nRealized investment gains (losses) affect the timing of the amortization of cost of policies purchased and cost of policies produced. See amortization related to realized gains and losses below.\nInsurance policy benefits and change in future policy benefits have increased primarily because of: (i) the higher incidence of medical provider claims in the Medicare supplement line; and (ii) the increased amount of business in force, on which benefits are incurred. The table below summarizes insurance policy income and the ratio of policy benefits to insurance policy income for the Company's individual health and group products.\nThe ratio of policy benefits to insurance policy income for Medicare supplement policies in 1995 reflects a higher incidence of claims. Additionally, federal legislation regarding the standardization of Medicare supplement plans for policies issued after 1991 (see \"Business of Conseco - Regulation\"), including the establishment of minimum loss ratios, has had the effect of increasing Medicare supplement loss ratios, since a greater percentage of Bankers' in-force premiums now relate to policies issued after 1991.\nChanges in the ratio of policy benefits to insurance policy income for long-term care policies reflect fluctuations in claim experience and reserve development.\nInsurance policy income related to other individual health lines has declined over the last three years. BLH has taken steps to increase the profitability of these products; premiums have decreased as a result. Profitability of this line continues to be favorably impacted by such actions, as reflected in the improved ratio of policy benefits to insurance policy income.\nThe group business consists principally of health insurance products and administrative services. This product effectively shifts most or all of the risks of adverse loss experience to the insured, limiting BLH's underwriting risk over time. These group policies generally permit premiums to be adjusted prospectively to reflect the historical loss experience of the group.\nInterest expense on annuities and financial products increased over the last three years as a result of the increase in annuity reserves due to: (i) the reinsurance recapture transactions described above; and (ii) increased new sales. At December 31, 1995, 1994 and 1993, the weighted average crediting rate for the Company's annuity liabilities, excluding interest bonuses guaranteed for the first year of the annuity contract, was 5.4 percent, 5.4 percent and 5.7 percent, respectively.\nAmortization related to operations was primarily affected by: (i) the increase in the amount of business in force on which acquisition costs are capitalized and amortized in subsequent periods; and (ii) the increase in goodwill related to Conseco's purchases of additional shares of BLH's common stock on September 30, 1994 and in 1995.\nCost of policies produced represents the cost of producing new business (primarily commissions and certain costs of policy issuance and underwriting) which varies with and is primarily related to the production of new business. Costs deferred may represent amounts paid in the period new business is written (such as underwriting costs and first year commissions) or in periods after the business is written (such as commissions paid in subsequent years in excess of ultimate commissions paid).\nCost of policies purchased represents the portion of Conseco's cost to acquire BLH that is attributable to the right to receive cash flows from insurance contracts in force at the acquisition dates. Some costs incurred subsequent to the purchases on policies issued prior to such dates, which otherwise would have been deferred had it not been for the purchases (because they vary with and are primarily related to the production of the acquired interests in policies), are expensed. Such costs are primarily comprised of certain commissions paid in excess of ultimate commissions which have been expensed as operating expense. However, such amounts were considered in determining the cost of policies purchased and its amortization.\nAmortization related to realized gains (losses) fluctuated in the last three years as a result of the changes in realized gains and losses discussed above.\nInterest expense on notes payable decreased over the last three years. Debt was reduced through scheduled and unscheduled principal payments totaling $16.0 million, $11.0 million and $130.0 million in 1995, 1994 and 1993, respectively.\nIncome tax expense fluctuated during the last three years primarily in relationship to pretax income. The effective tax rate of 38 percent for 1995 and 39 percent for 1994 and 1993 exceeded the statutory corporate income tax rate (35 percent) primarily because goodwill amortization is not deductible for federal income tax purposes.\nMinority interest declined in each year as Conseco's ownership interest in BLH increased as previously discussed.\nExtraordinary charge related to BLH's prepayment of debt. The 1995 charge was primarily the result of BLH's retirement of its senior term loan using the proceeds from a $110.0 million credit facility. Conseco's share of this charge was $1.4 million. In 1993 BLH retired all of its junior notes, prepaid a portion of its senior term loan and repurchased $20 million of its Series B Senior Subordinated Notes, resulting in an extraordinary charge of $7.9 million. Conseco's share of this charge was $3.1 million.\nAnnuity Operations:\nGeneral. The annuity operations include earnings from the former CCP subsidiaries, Beneficial Standard and Great American Reserve. As described in the notes to the consolidated financial statements, the CCP subsidiaries became wholly owned subsidiaries of Conseco upon the CCP Merger in August 1995. Conseco's consolidated statement of operations reflects these operations on the equity method in 1994 and 1993 based on Conseco's 42 percent and 37 percent average ownership of CCP during those years. Conseco's consolidated statement of operations reflects these operations on a consolidated basis in 1995, based on Conseco's 49 percent average ownership for the first eight months and 100 percent ownership for the last four months of the year. The minority interest adjustment removes from Conseco's net income the portion applicable to other owners during the 1995 period prior to the CCP Merger.\nInsurance policy income consists of premiums received on traditional life insurance products and policy fund and surrender charges assessed against investment type products. This account decreased in the last three years as a result of a decrease in sales of policies with mortality or morbidity risks, partially offset by an increase in surrender charges resulting from higher annuity policy withdrawals. Surrender charges assessed against annuity withdrawals were $9.8 million, $8.0 million and $9.4 million in 1995, 1994 and 1993, respectively, and annuity withdrawals were $359.5 million, $353.8 million and $245.0 million for the same periods, respectively. Increases in withdrawals were primarily due to the increased size of CCP's annuity portfolio and increased competition from higher yielding alternative investment products.\nNet investment income increased 6.9 percent in 1995 and decreased 11 percent in 1994. Average invested assets (amortized cost basis) increased 3.5 percent in 1995 to $4.8 billion and increased 1.0 percent in 1994 to $4.7 billion. For 1995 compared to 1994, the percentage increase in net investment income was greater than the percentage increase in average invested assets because: (i) the yield earned on average invested assets increased to 8.2 percent in 1995 from 7.9 percent in 1994; (ii) net investment income generated on dollar-roll transactions increased to $11.7 million in 1995 from $6.7 million in 1994; and (iii) net investment income on separate account assets increased to $19.2 million in 1995 from $2.3 million in 1994. Net investment income from separate account assets for all periods is offset by a corresponding change to interest expense on annuities and financial products. For 1994 compared to 1993, the percentage increase in net investment income was less than the percentage increase in average invested assets because: (i) the yield earned on average invested assets decreased to 7.9 percent in 1994 from 8.9 percent in 1993; and (ii) net investment income from separate account assets decreased to $2.3 million from $11.8 million in 1993.\nAlthough investment portfolio yields fluctuated during these periods, CCP maintained a comparable level of profitability from investment spreads by adjusting credited interest rates on annuities and financial products to permit the net spread percentage to remain relatively constant.\nNet realized gains (losses) often fluctuate from period to period. The annuity operations sold $1.7 billion of fixed maturity securities in 1995, $1.2 billion in 1994 and $2.1 billion in 1993. Net realized gains in 1995 included $6.1 million of investment writedowns taken as a result of conditions which caused the Company to conclude that declines in fair value of certain securities were other than temporary.\nThe effect of net realized gains (losses) on the amortization of cost of policies purchased and the cost of policies produced is discussed above under BLH. Also see amortization related to net realized gains (losses) below.\nInsurance policy benefits and change in future policy benefits relate solely to policies with mortality or morbidity features. The decrease in these amounts correspond with the decrease in the in-force block of such policies.\nInterest expense on annuities and financial products increased 10 percent in 1995 over 1994 primarily due to: (i) an increase in the annuity business in force (1995 insurance liabilities increased by $88.7 million, or 2.1 percent, over 1994); and (ii) fluctuations in charges to the account related to investment income from separate account assets as described above under net investment income. Such amount decreased 14 percent in 1994 compared to 1993 primarily due to: (i) lower crediting rates; and (ii) fluctuations in charges to the account related to investment income for separate accounts assets. At December 31, 1995, 1994 and 1993, the weighted average crediting rate for the Company's annuity liabilities, excluding interest bonuses guaranteed for the first year of the annuity contract, was 5.5 percent, 5.7 percent and 6.0 percent, respectively.\nInterest expense on notes payable increased in 1995 as a result of a higher average notes payable balance which were subject to higher interest rates in 1995. The decrease in 1994 resulted from lower interest rates on a lower average notes payable balance. The average principal balance of notes payable during 1995, 1994 and 1993 was $178 million, $143 million and $210 million, respectively.\nCCP issued $200 million of 10.5 percent senior notes in December 1994. Proceeds from the notes were used, in part, to repay outstanding debt. Conseco's 1994 earnings included a $2.1 million extraordinary charge related to such prepayment. After the CCP Merger, these notes became direct obligations of Conseco. The interest expense related to the senior notes is recorded in the \"Interest and Other\" segment after the CCP Merger date.\nInterest expense on investment borrowings in the last three years reflected changes in investment borrowing activities and the higher interest rates paid on such borrowings during 1995.\nAmortization related to operations was primarily affected by the changes in the amount of business in force on which acquisition costs are capitalized and amortized.\nAmortization related to net realized gains (losses) fluctuated in the last three years as a result of the fluctuations in realized gains and losses discussed above.\nOther operating costs and expenses decreased in 1995 as a result of restructurings made under the Company's expense reduction program.\nIncome tax expense fluctuated in relationship to income before income taxes during the last three years.\nOther Life Insurance Operations:\nInsurance policy income related primarily to premiums from products with mortality and morbidity features. Recent declines have resulted from decreased emphasis on generating new premiums from such products.\nNet investment income declined in 1995 as the result of a decrease in invested assets on this segment's closed block of business, as well as decreased yields earned on such assets. The decline in 1994 was primarily a result of the recapture of a block of business by WNC from Conseco's other life insurance subsidiaries on March 31, 1993, which resulted in a decrease of $1.3 billion in insurance liabilities and invested assets. In addition, the redemption of fixed maturity investments prior to their scheduled maturity date resulted in additional investment income (losses) of approximately $(.1) million in 1995, $.1 million in 1994 and $3.7 million in 1993.\nNet trading income and losses often fluctuate from year to year based on market conditions for trading activities.\nNet realized gains and losses often fluctuate from year to year. The other life insurance subsidiaries sold fixed maturity securities of $.2 billion in 1995, $.2 billion in 1994 and $.6 billion in 1993. The effect of these sales on the amortization of cost of policies purchased and cost of policies produced is discussed above under BLH. Net realized gains (losses) increased (decreased) amortization of the cost of policies purchased and the cost of polices produced by $1.0 million in 1995, $(2.1) million in 1994 and $11.5 million in 1993.\nInsurance policy benefits and change in future policy benefits relate solely to policies with mortality and morbidity features. These benefits have decreased over the last three years due to the decreased emphasis on generating new premiums from such products.\nInterest expense on annuities and financial products decreased over the last three years as a result of the reinsurance recapture by WNC. The average rate credited on all insurance liabilities was approximately 7.0 percent at December 31, 1995, 1994 and 1993.\nAmortization related to operations decreased in 1995 and 1994 as a result of the previously discussed reinsurance recapture and recent decline in premiums.\nOther operating costs and expenses did not change materially over the last three years.\nPartnership II Operations:\nGeneral. Conseco's earnings reflect its ownership interest in AGP from September 29, 1994, the date AGP was acquired by Partnership II. Immediately after the Acquisition, Conseco, through its direct investment and through its equity interests in the investments made by BLH, CCP and WNC, had approximately a 27 percent ownership interest in AGP. At December 31, 1994, Conseco's ownership interest in AGP decreased to 25 percent as a result of: (i) the sale of Conseco's 40 percent equity interest in WNC on December 23, 1994; and (ii) the sale by a subsidiary of CCP of a portion of its investment in AGP; partially offset by (iii) Conseco's increased ownership percentage in BLH and CCP due to stock repurchases made by BLH and CCP. At December 31, 1995, Conseco's ownership in AGP increased to 36 percent as a result of: (i) Conseco's increased ownership percentage in BLH due to common stock purchases by Conseco and BLH; (ii) Conseco's increased ownership percentage in CCP as a result of the CCP Merger; and (iii) purchases of AGP common stock as a result of AGP's issuance of common stock in a private placement transaction. While all activities of AGP are required to be included in Conseco's financial statements on a consolidated basis for all periods after September 29, 1994, the minority interest adjustment removes from Conseco's net income the portion applicable to other owners so that net income reflects only Conseco's applicable ownership interest. To enhance comparability, the amounts for the year ended December 31, 1993, and for the nine months ended September 29, 1994, (which were prior to the Acquisition) are presented separately.\nInsurance policy income, which consists of premiums received on traditional life insurance products and policy fund and surrender charges assessed against investment type products, increased 8 percent in 1995 and 1994, primarily because increased annuity policy withdrawals resulted in higher surrender charges. Surrender charges assessed against annuity withdrawals were $15.4 million, $10.2 million and $6.2 million in 1995, the 1994 periods and 1993, respectively, while annuity policy withdrawals were $750.4 million, $532.8 million and $277.9 million for the same periods, respectively. Surrender charges as a percentage of annuity policy withdrawals declined in 1995 and the 1994 periods as a result of increased withdrawals of a certain policy form whose surrender charge expired in 1995 and 1994 upon such policies reaching their sixth anniversary. In addition, AGP has experienced increases in withdrawals due to: (i) the increased size of AGP'S annuity portfolio; and (ii) competition from other investment products in the second half of 1994, which caused some policyholders to surrender policies and incur a surrender charge to invest funds in higher yielding alternative investments.\nNet investment income increased 21 percent in 1995 and 13 percent in the 1994 periods. Average invested assets (amortized cost basis) increased 7 percent to $4.7 billion in 1995 compared to $4.4 billion in the 1994 periods. The percentage increase in net investment income was greater than the percentage increase in average invested assets because the yield earned on average invested assets increased to 8.8 percent in 1995 from 7.9 percent in 1994. The increase in yield primarily resulted from the application of purchase accounting on the Acquisition date, as discussed above. Average invested assets (amortized cost basis) increased 19 percent, to $4.4 billion in 1994 from $3.7 billion in 1993. The percentage increase in net investment income was less than the percentage increase in average invested assets because the yield earned on average invested assets decreased to 7.9 percent in the 1994 periods from 8.3 percent in 1993. The decrease in yield resulted from the cash flows received during 1994 and 1993 being invested in lower yielding securities due to the general decline in interest rates during 1993, partially offset by the increase in yields during the fourth quarter of 1994 because of the application of purchase accounting. Redemption of fixed maturity investments prior to their regularly scheduled maturity dates resulted in additional investment income of approximately $5.9 million in 1993 and insignificant income in both 1995 and 1994.\nNet realized gains (losses) and net trading income (losses) often fluctuate from period to period. AGP sold approximately $2.8 billion of investments (principally fixed maturities) in 1995, $1.1 billion in the 1994 periods and $2.2 billion in 1993. Such sales resulted in net realized gains of $154.9 million and trading income of $1.5 million in 1995, net realized gains of $6.2 million in the 1994 periods and net realized gains of $19.5 million in 1993. Net realized gains from sales of investments in the 1994 periods were offset by a loss on certain interest rate swap contracts that no longer effectively hedged interest rate risks in the second quarter of 1994 and were therefore recorded at fair value, resulting in a net realized loss of $21.3 million. Substantially all of AGP's interest rate swap contracts were terminated after the Acquisition with no additional loss. In addition, during 1995 and the 1994 periods, AGP recorded realized losses on the writedown of investments totaling $7.1 million and $1.2 million, respectively, as a result of changes in conditions which caused AGP to conclude that a decline in fair value of the investments was other than temporary. In 1993, AGP's net realized gains were net of a $.6 million increase to its mortgage loan valuation reserve. Net realized gains increased the amortization of the cost of policies purchased and the cost of policies produced by $83.4 million in 1995, $2.8 million in the 1994 periods and $9.8 million in 1993.\nThe increased level of investment activity in 1995 was the result of more active investment portfolio management since the Acquisition and planned changes in the fixed maturity investment portfolio to reduce the portfolio's duration and exposure to more volatile CMO investments. The declining interest rate environment since the Acquisition date, which increased the market value of fixed maturity investments, contributed to AGP's ability to realize gains on investment sales in 1995.\nThe effect of net realized gains (losses) on the amortization of cost of policies purchased and the cost of policies produced is discussed above under BLH.\nInterest expense on annuities and financial products increased 18 percent in 1995 over the 1994 periods primarily due to: (i) a larger block of annuity business in force in 1995; and (ii) the expensing of the first year interest rate bonuses of approximately $5.9 million in 1995 on policies issued prior to the Acquisition date as a result of the application of purchase accounting on the Acquisition date. Prior to the Acquisition date, such first year interest rate bonuses (related to policies issued prior to the Acquisition date) were capitalized as a cost of policies produced. Interest expense on annuities and financial products increased 12 percent, to $220.1 million in the 1994 periods from $195.9 million in 1993, primarily due to a larger block of annuity business in force in 1994, higher crediting rates, and in the fourth quarter of 1994, the expensing of first year interest rate bonuses on policies issued prior to the Acquisition date on which interest had previously been capitalized as a cost of policies produced. At December 31, 1995, 1994 and 1993, the weighted average crediting rate for the Company's annuity liabilities, excluding interest bonuses guaranteed for the first year of the annuity contract, was 5.3 percent.\nInterest expense on notes payable increased in 1995 and the 1994 periods as a result of the full year effect in 1995 of interest on debt incurred in 1994 to finance the Acquisition, partially offset by reductions in interest expense resulting from: (i) the conversion and retirement of $9.2 million principal amount of the Convertible Debentures during 1995 and $44.8 million in the 1994 periods; and (ii) the repayment of subsidiary bank debt that had been outstanding prior to the Acquisition.\nInterest expense on investment borrowings increased to $7.7 million in 1995 from $2.8 million in the 1994 periods as a result of increased investment borrowing activity and higher interest rates paid on such borrowings during 1995. There was no investment borrowing activity in 1993.\nAmortization related to operations increased 11 percent in 1995 over the 1994 periods and 22 percent in the 1994 periods compared to 1993. Such increase reflects a larger asset balance subject to amortization as a result of the Acquisition and the increase in in-force business.\nExtraordinary charge incurred in 1995 related to debt issuance costs that were written off when the former senior loan was paid off with the proceeds of new bank financing, resulting in a net extraordinary charge of $4.0 million. Conseco's share of this charge was $.7 million.\nAcquisition and merger expenses incurred by AGP include, among other items, compensation expense recognized upon the cash redemption of certain unexercised stock options and stock appreciation rights upon consummation of the Acquisition.\nMinority interest for periods prior to September 30, 1994, represents dividends on preferred stock of a subsidiary of AGP. After that date, minority interest includes such dividends and the portion of earnings applicable to other owners of AGP.\nWNC:\nPrior to the completion of its IPO, WNC was a wholly owned subsidiary of Conseco. Conseco sold 60 percent of WNC in the IPO. Conseco sold its remaining 40 percent equity interest in WNC on December 23, 1994. Amounts included in Conseco's accounts for the year ended December 31, 1994, therefore include: (i) all of WNC's earnings from January 1 through February 15, 1994, the date the IPO was completed; and (ii) 40 percent of WNC's earnings from February 15 through December 23, 1994.\nWNC's operating earnings during the above periods were affected by the growth in invested assets from annuity sales, interest income, and the recapture on March 31, 1993, of a $1.3 billion block of business previously reinsured with subsidiaries of Conseco, offset in part by fluctuations in prepayment income included in net investment income and interest expense on notes payable. WNC's net investment income included prepayment income of $3.1 million in 1994 and $18.0 million in 1993. WNC's net income was affected by these factors, and also changes in realized gains (losses) and trading income.\nFee-Based Operations:\nConseco's fee revenues include: (i) fees for investment management and mortgage origination and servicing; (ii) commissions earned for insurance and investment product marketing and distribution; (iii) administrative fees for policy administration, data processing, product marketing and executive management services; and (iv) fees for financing services provided to Partnership II. Fees earned from services provided to consolidated entities are eliminated. Such eliminations increased during 1995 as a result of the consolidation of the accounts of CCP effective January 1, 1996, and a full year of revenues from AGP in 1995, compared to only one quarter of such revenues in 1994.\nThe growth in investment management revenues in 1995 was the result of fee-producing activities provided to AGP, partially offset by a reduction in the rates charged to WNC. Commission revenues include gains of $2.5 million in 1995 and $4.0 million in 1994 related to the buyouts of marketing agreements by banks. Commission revenues decreased in 1995 as compared to 1994 primarily because of the decrease in such gains and the decrease in commissions generated from such marketing agreements before the sales. The increase in commission revenues in 1994 compared to 1993 was primarily due to the acquisition of Bankmark, an insurance marketing company which helps financial institutions provide insurance and investment products to their customers.\nRestructuring Activities:\nRestructuring income was recorded: (a) in 1993 for: (i) incentive earnings allocations from Partnership I, based on the returns resulting from the value of the BLH shares distributed to the partners; and (ii) from the Company's share of the gain realized from the public sale of shares of BLH; (b) in 1994, from the gain realized from the sale of WNC, net of expenses incurred in conjunction with a terminated merger; and (c) in 1995 for: (i) the release of deferred income tax liabilities that were no longer required as a result of the CCP Merger and the purchase of shares of BLH common stock; and (ii) the gain which resulted from the sale of Conseco's investment in Eagle Credit (a finance subsidiary of Harley-Davidson).\nInterest and Other:\nInterest and other includes financing costs for debt on which Conseco is directly liable and the costs associated with the holding company operations.\nNet investment income fluctuates based on the amount of average invested assets held by this segment during the periods presented. Additionally in 1995, investment income was received on certain fixed maturity investments on which no investment income was accrued in prior periods because they were in default.\nInterest expense on notes payable increased to $50.1 million in 1995 from $27.8 million in 1994 as a result of: (i) increases in borrowings under bank credit facilities primarily used to finance the CCP Merger and the purchase of additional shares of BLH; and (ii) interest expense on the $200 million 10.5 percent senior notes issued by CCP for periods after August 31, 1995, the CCP Merger date (such senior notes became direct obligations of Conseco at the CCP Merger date). These increases were partially offset by the repayment of: (i) a $200 million note in February 1994; and (ii) notes payable with book values totaling $19.2 million in March 1994. The Company prepaid the aforementioned notes in 1994 with the proceeds from the sale of shares of WNC. The prepayment resulted in an extraordinary charge in the first quarter of 1994 of $1.9 million (net of a $1.0 million tax benefit). The decrease in the account in 1994 from 1993 was primarily the result of the aforementioned repayments in 1994.\nOther operating costs and expenses fluctuated over the last three years principally as the result of compensation expense based on the Company's earnings.\nSALES\nIn accordance with generally accepted accounting principles, insurance policy income shown in Conseco's consolidated statement of operations consists of premiums received for policies which have life contingencies or morbidity features. For annuity and universal life contracts without such features, premiums collected are not reported as revenues, but rather are reported as deposits to insurance liabilities. Revenues for these products are recognized over time in the form of investment income and surrender or other charges.\nTotal premium collections by the companies in which Conseco has ownership interests were as follows:\nPremiums collected by senior market operations in 1995 were $1,513.8 million, of which $272.8 million were recorded as deposits to policy liability accounts. This compares with $1,534.5 million collected and $316.3 million recorded as deposits in 1994; and $1,464.7 million collected and $263.7 million recorded as deposits in 1993.\nMedicare supplement policies accounted for approximately 39 percent of BLH's total collected premiums over the last three years. The rate of growth in premiums from Medicare supplement policies decreased in 1995, due to the competitive environment, changes in the commission structure to improve the profitability of this product, and an increased focus on sales of other products. The number of new Medicare supplement policies sold in 1995 decreased 30 percent to 62,800 from 1994, following a 3 percent decrease in 1994 from 1993. Annualized new business premiums from such new sales totaled $56.3 million in 1995 compared with $76.3 million in 1994 and $80.5 million in 1993.\nLong-term care premiums accounted for 10 percent, 8.6 percent and 7.8 percent of total collected premiums in 1995, 1994 and 1993, respectively. The continued growth in this product line reflects new product introductions, the competitiveness of BLH's existing products, the success of agent cross-selling activities, increased consumer awareness and demand and improved persistency on a larger base of renewal premiums. Annualized new business premiums were $40.9 million, $27.9 million and $21.6 million in 1995, 1994 and 1993, respectively.\nAnnuity premiums collected decreased by 10 percent in 1995 following a 22 percent increase in 1994. The decrease in 1995 reflects increased competition from alternative investment products.\nCollected premiums for other individual health products decreased by 20 percent in 1995 following an 18 percent decrease in 1994. This decrease, which was anticipated, follows steps taken previously to improve the profitability of the comprehensive major medical product included in this category.\nPremiums collected by the annuity operations in 1995 were $709.8 million, of which $641.4 million were recorded as deposits to insurance liability accounts. This compared to $522.1 million collected and $450.7 million recorded as deposits to insurance liability accounts in 1994 and $451.0 million collected and $368.5 million recorded as deposits to insurance liability accounts in 1993. The increase in total premiums collected was the result of increased sales of single premium deferred annuities by: (i) professional independent producers ($352.7 million in 1995 versus $201.3 million in 1994 and $48.8 million in 1993), and (ii) educator market specialists ($48.6 million in 1995, $20.5 million in 1994 and $3.8 million in 1993). Total premiums collected through professional independent producers were $413.6 million in 1995, a 58 percent increase over 1994, and comprised 58 percent of collected premiums in 1995. Total premiums collected through educator market specialists were $293.7 million in 1995, a 16 percent increase compared to 1994, and comprised 41 percent of collected premiums in 1995.\nPremiums collected by other life insurance operations were $80.0 million, $83.0 million and $142.2 million in 1995, 1994 and 1993, respectively. These subsidiaries are no longer writing new business, except that during 1995, 1994 and 1993, they collected $6.6 million, $5.6 million and $61.8 million, respectively, of premiums from guaranteed investment contracts and deposit funds for qualified retirement plans maintained by the Company.\nPremiums collected in 1993 include $563.0 million of premiums collected by WNC. As previously discussed, Conseco's equity interest in WNC was sold in 1994.\nPremiums collected by Partnership II operations were $825.6 million in 1995 and $284.4 million for the three months ended December 31, 1994. AGP's products include single premium deferred annuities, flexible premium deferred annuities, interest sensitive life insurance products (including universal life insurance), traditional life insurance products and accident and health insurance products. Of the $825.6 million in premiums collected in 1995, 91 percent was from sales of annuities (primarily SPDAs and FPDAs), 6 percent was from life insurance products, 3 percent from single premium immediate annuities and less than 1 percent from accident and health insurance products.\nFor the full year 1994 and 1993, premiums collected were $1,129.1 million and $1,064.9 million, respectively. Sales of annuities declined in 1995 as the result of several factors. The demand for annuity products offered by all insurance companies decreased during 1995. Such decrease is believed to be attributable to increased competition from products such as mutual funds, traditional bank investments and other investment and retirement funding alternatives. In addition, AGP has generally maintained a less competitive crediting rate position on new business since the Acquisition in order to manage its asset growth relative to its capital position.\nINVESTMENTS\nThe Company's investment strategy is to: (i) maintain a predominately investment grade fixed income portfolio; (ii) provide adequate liquidity to meet the cash flow requirements of policyholders and other obligations; and (iii) maximize current income total investment return through active investment management. Consistent with this strategy, investments in fixed maturity securities, mortgage loans, credit-tenant loans, policy loans and short-term investments comprised 98 percent of the Company's investment portfolio at December 31, 1995. The remainder of the invested assets were in equity securities and other investments. At December 31, 1995, the Company had invested assets of approximately $14.4 billion.\nThe Company's insurance subsidiaries are regulated by insurance statutes and regulations as to the type of investments that they are permitted to make and the amount of funds that may be used for any one type of investment. In light of these statutes and regulations and the Company's business and investment strategy, the Company generally seeks to invest in United States government and government agency securities and corporate securities rated investment grade by established nationally recognized rating organizations or, if not rated, in securities of comparable investment quality.\nThe following table summarizes investment yields earned over the past three years, including AGP from the Acquisition date, WNC until the date of its deconsolidation (effective January 1, 1994), and CCP upon its consolidation (effective January 1, 1995).\nAlthough investment income is a significant component of total revenues, the profitability of Conseco's annuity business is determined primarily by spreads between interest rates earned and rates credited on annuity contracts. At December 31, 1995, the average yield, computed on the cost basis of the Company's investment portfolio, was 8.0 percent and the average interest rate credited on the Company's total liability portfolio was 5.3 percent, excluding interest bonuses guaranteed for the first year of the contract.\nActively Managed Fixed Maturities\nConseco's actively managed fixed maturity portfolio at December 31, 1995, was comprised primarily of debt securities of the United States government, public utilities and other corporations and mortgage-backed securities. Mortgage-backed securities included collateralized mortgage obligations (\"CMOs\") and mortgage-backed pass-through securities.\nAt December 31, 1995, the Company's fixed maturity portfolio had net unrealized gains of $608.2 million (equal to approximately 4.7 percent of the portfolio's carrying value), consisting of $663.3 million of unrealized gains and $55.1 million of unrealized losses. Estimated fair values for fixed maturity investments were determined based on estimates from nationally recognized pricing services (88 percent of the portfolio), broker-dealer market makers (11 percent of the portfolio) and internally developed methods.\nAs discussed in the notes to the consolidated financial statements, when Conseco adjusts carrying values of actively managed fixed maturity securities for changes in fair value, the Company also adjusts the cost of policies purchased, cost of policies produced and insurance liabilities. These adjustments are made in order to reflect the change in amortization that would be needed if those fixed maturity investments had actually been sold at their fair values and the proceeds reinvested at current interest rates.\nAt December 31, 1995, approximately 4.5 percent of Conseco's invested assets and 5.0 percent of fixed maturity investments were rated below investment grade by nationally recognized statistical rating organizations (or, if not rated by such firms, with ratings below Class 2 assigned by the National Association of Insurance Commissioners). Conseco plans to maintain approximately the present level of below investment grade fixed maturities. These securities generally have greater risks than other corporate debt investments, including risk of loss upon default by the borrower, and are often unsecured and subordinated to other creditors. Below investment grade 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. The Company is aware of these risks and monitors its below investment grade securities closely. At December 31, 1995, the Company's below investment grade fixed maturity investments had an amortized cost of $646.8 million and an estimated fair value of $647.2 million.\nConseco periodically evaluates the creditworthiness of each issuer whose securities are held in the portfolio. Special attention is paid to those securities whose market values have declined materially for reasons other than changes in interest rates or other general market conditions. The Company considers available information to evaluate the realizable value of the investment, the specific condition of the issuer, and the issuer's ability to comply with the material terms of the security. Information reviewed may include the recent operational results and financial position of the issuer, information about its industry, recent press releases and other information. Conseco employs a staff of experienced securities analysts in a variety of specialty areas. Among other responsibilities, this staff compiles and reviews such evidence. If evidence does not exist to support a realizable value equal to or greater than the carrying value of the investment and such decline in market value is determined to be other than temporary, Conseco reduces the\ncarrying amount to its net realizable value, which becomes the new cost basis; the amount of the reduction is reported as a realized loss. Conseco recognizes any recovery of such reductions in the cost basis of an investment only upon the sale, repayment or other disposition of the investment. Conseco recorded writedowns of investments of $21.9 million in 1995 as a result of changes in the financial condition of an issuer and changes in the value of the underlying collateral which caused the Company to conclude that the decline in fair value of such investments was other than temporary. The Company's investment portfolio is subject to the risks of further declines in realizable value. The Company, however, attempts to mitigate this risk through the diversification and active management of its portfolio.\nAs of December 31, 1995, the amortized cost and estimated fair value of fixed maturity investments in substantive default (i.e., in default due to nonpayment of interest or principal) were $3.3 million and $3.2 million, respectively. The Company had no fixed maturity investment in technical (but not substantive) default (i.e., in default, but not as to the payment of interest or principal). There were no other fixed maturity investments about which management had serious doubts as to the ability of the issuer to comply on a timely basis with the material terms of the instruments.\nThe Company's policy is to discontinue the accrual of interest and eliminate all previous interest accruals for defaulted securities, if the Company's assessment is that such amounts will not be ultimately realized in full. Investment income forgone due to defaulted securities was $1.6 million, $3.9 million and $2.7 million for the years ended December 31, 1995, 1994 and 1993, respectively. During 1995, the Company recovered approximately $6.0 million of investment income which was not recognized in prior periods due to defaulted securities.\nAt December 31, 1995, fixed maturity investments included $4.0 billion of mortgage-backed securities (31 percent of the fixed maturity security portfolio). CMOs are securities backed by pools of pass-through securities and\/or mortgages that are segregated into sections or \"tranches\" which provide for sequential retirement of principal rather than the pro rata share of principal return which occurs through regular monthly principal payments on pass-through securities.\nThe yield characteristics of mortgage-backed securities differ from those of traditional fixed income 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 repayment 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 declines 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. Those securities purchased at a premium that prepay faster than expected will incur a reduction in yield. 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. As the level of prevailing interest rates increases, prepayments on mortgage-backed securities decrease 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.\nThe following table sets forth the par value, amortized cost and estimated fair value of mortgage-backed securities including CMOs at December 31, 1995, summarized by interest rates on the underlying collateral at December 31, 1995:\nThe amortized cost and estimated fair value of mortgage-backed securities including CMOs at December 31, 1995, summarized by type of security were as follows:\nPass-throughs and sequential and targeted amortization classes have similar prepayment variability. Pass-throughs have historically provided the best liquidity in the mortgage-backed securities market and provide the best price\/performance ratio in a highly volatile interest rate environment. This type of security is also frequently used as collateral in the dollar-roll market. Sequential classes pay in a strict sequence; all principal payments received by the CMO are paid to the sequential tranches in order of priority. Targeted amortization classes provide a modest amount of prepayment protection when prepayments on the underlying collateral increase from those assumed at pricing. Thus, they offer slightly better call protection than sequential classes and pass-throughs.\nSupport classes absorb the prepayment risk from which planned amortization and targeted amortization classes are protected. As such, they are usually extremely sensitive to prepayments. Most of the Company's support classes are higher average life instruments that generally will not lengthen if interest rates rise further and will have a tendency to shorten if interest rates decline. However, since these bonds have costs below par values, higher prepayments will have the effect of increasing yields.\nAccrual bonds are CMOs structured such that the payment of coupon interest is deferred until principal payments begin. On each accrual date, the principal balance is increased by the amount of the interest (based upon the stated coupon rate) that otherwise would have been payable. As such, these securities act much the same as zero coupon bonds until cash payments begin. Cash payments typically do not commence until earlier classes in the CMO structure have been retired, which can be significantly influenced by the prepayment experience of the underlying mortgage loan collateral in the CMO structure. Because of the zero coupon element of these securities and the potential uncertainty as to the timing of cash payments, their market values and yields are more sensitive to changing interest rates than other CMOs, pass-through securities and coupon bonds.\nPlanned amortization classes and accretion directed bonds are some of the most stable and liquid instruments in the mortgage-backed securities market. Planned amortization class bonds adhere to a fixed schedule of principal payments as long as the underlying mortgage collateral experiences prepayments within a certain range. Changes in prepayment rates are first absorbed by support classes. This insulates the planned amortization classes from the consequences of both faster prepayments (average life shortening) and slower prepayments (average life extension).\nSubordinated CMO classes have both prepayment and credit risk. The subordinated classes are used to lend credit enhancement to the senior securities and as such, rating agencies require that this support not deteriorate due to the prepayment of the subordinated securities. The credit risk of subordinated classes is derived from the negative leverage of owning a small percentage of the underlying mortgage loan collateral while bearing a majority of the risk of loss due to homeowner defaults.\nAll mortgage-backed securities are subject to risks associated with variable prepayments. As a result, these securities may have a different actual maturity than planned at the time of purchase. When securities having a cost greater than par are backed by mortgages that prepay faster than expected, Conseco records a charge to investment income. When securities having a cost less than par prepay faster than expected, Conseco records investment income.\nThe degree to which a mortgage-backed security is susceptible to income fluctuations is influenced by: (i) the difference between its cost and par; (ii) the relative sensitivity of the underlying mortgages backing the security to prepayment in a changing interest rate environment; and (iii) the repayment priority of the security in the overall securitization structure. The Company limits the extent of these risks by : (i) purchasing securities which are backed by collateral with lower prepayment sensitivity (such as mortgages priced at a discount to par value and mortgages that are extremely seasoned); (ii) avoiding securities whose values are heavily influenced by changes in prepayments (such as interest-only and principal-only securities); and (iii) investing in securities structured to reduce prepayment risk (such as planned amortization class (\"PAC\") and targeted amortization class (\"TAC\") collateralized mortgage obligations). PAC and TAC instruments represented approximately 30 percent of the Company's mortgage-backed securities at December 31, 1995. The call-adjusted modified duration of the Company's mortgage-backed securities at December 31, 1995, was 6.0 years.\nIf the Company determines that it will dispose of an investment held in the actively managed fixed maturity category, Conseco will either sell the security or transfer it to the trading account at its fair value; the gain or loss is recognized immediately. There were no such transfers in 1995. During 1995, the Company sold actively managed fixed maturity securities with a $5.5 billion book value, resulting in $236.7 million of investment gains (before related expenses, amortization and taxes). Such securities were sold in response to changes in the investment environment which created opportunities to enhance the total return of the investment portfolio without adversely affecting the quality of the portfolio or the matching of expected maturities of assets and liabilities. The realization of gains and losses affects the timing of the amortization of the cost of policies produced and the cost of policies purchased, as explained in note 11 to the consolidated financial statements.\nDuring 1995, fixed maturity investments with par values totaling $170 million were redeemed prior to the scheduled maturity date. As a result of such redemptions, Conseco recognized additional income of approximately $3.8 million which was credited to investment income.\nOther Investments\nCredit-tenant loans are loans on commercial properties where the lease of the principal tenant is assigned to the lender and the principal tenant, or any guarantor of such tenant's obligations, has a credit rating at the time of origination of the loan of at least BBB- or its equivalent. The underwriting guidelines consider such factors as: (i) the lease term of the property; (ii) the mortgagee's management ability, including business experience, property management capabilities and financial soundness; and (iii) such economic, demographic or other factors that may affect the income generated by the property, or its value. The underwriting guidelines also generally require a loan-to-value ratio of 75 percent or less. Credit-tenant loans are carried at amortized cost and were $259.1 million at December 31, 1995, or 2 percent of total invested assets. The total estimated fair value of credit-tenant loans was $258.6 million at December 31, 1995.\nAt December 31, 1995, the Company held mortgage loan investments with a carrying value of $339.9 million (or 2.4 percent of total invested assets) and a fair value of $363.3 million. Substantially all of the mortgage loan investments were commercial loans. Approximately 2 percent of the Company's mortgage loan balance consisted of investments in junior and residual interests of CMOs. Investments in junior and residual interests of CMOs are instruments that entitle the Company to the excess cash flows arising from the difference between: (i) the cash flows required to make principal and interest payments on the related senior interests in the CMOs; and (ii) the actual cash flows received on the mortgage loan assets included in the CMO portfolios. If prepayments vary from projections on the mortgage loan assets included in such CMO portfolios, the total cash flows to the Company from such junior and residual interests could change from projected cash flows, resulting in a gain or loss.\nNon-current mortgage loans were not significant at December 31, 1995. The Company had $2.4 million in realized losses on mortgage loans for the year ended December 31, 1995. At December 31, 1995, the Company had a loan loss reserve of $5.2 million. Approximately 40 percent, 9 percent and 7 percent of the mortgage loans were on properties located in California, Texas and Indiana, respectively. No other state comprised greater than 6 percent of the mortgage loan balance.\nAt December 31, 1995, the Company held no trading account securities. Trading account securities are investments that are purchased with the intent to be traded prior to their maturity, or are believed likely to be disposed of in the foreseeable future as a result of market or issuer developments. Effective December 31, 1993, with the Company's adoption of Statement of Financial Accounting Standards No. 115 (\"SFAS 115\"), trading account securities are carried at estimated fair value, with the changes in fair value reflected in the statement of operations. The net unrealized gain (loss) on trading account securities at December 31, 1995 and 1994, recorded in trading income as a result of adopting SFAS 115, was immaterial.\nShort-term investments totaled $189.9 million, or 1.3 percent of invested assets at December 31, 1995, and consisted primarily of commercial paper and repurchase agreements relating to government securities.\nCONSOLIDATED FINANCIAL CONDITION\nChanges in the consolidated balance sheet of 1995 compared to 1994\nChanges in Conseco's balance sheet of 1995 compared to 1994 principally reflect the growth through operations, consolidation of CCP as the result of the CCP Merger, changes in the fair value of actively managed fixed maturity investments and the capital and financing transactions discussed below.\nAs a result of the CCP Merger, the accounts of the subsidiaries of CCP are consolidated with Conseco's, effective January 1, 1995. The effect of the consolidation on the accounts of Conseco is summarized in note 1 to the consolidated financial statements.\nIn accordance with SFAS 115, Conseco records its actively managed fixed maturity investments at estimated fair value. At December 31, 1995, such investments were increased by $608.2 million as a result of the SFAS 115 adjustment. At December 31, 1994, such investments were decreased by $373.4 million as a result of the SFAS 115 adjustment.\nDuring 1995, insurance liabilities of approximately $70 million resulting from assumed reinsurance were recaptured by a nonaffiliated insurance company. Assets approximately equal to the insurance liabilities were transferred in the reinsurance recapture.\nAs part of its investment strategy, the Company enters into reverse repurchase agreements and dollar-roll transactions (specialized forms of collateralized lending involving mortgage-backed securities) to increase its return on investments and improve liquidity. These transactions are accounted for as short-term collateralized borrowings and are collateralized by pledged securities with fair values approximately equal to the loan value. Conseco had investment borrowings of $298.1 at December 31, 1995, compared with no investment borrowings at December 31, 1994.\nMinority interest increased primarily as a result of : (i) the income attributable to minority interest; (ii) adjustments to minority interest as the result of SFAS 115; and (iii) the sale of common stock by AGP, other than amounts purchased by Conseco and its subsidiaries. Such increases were offset by: (i) Conseco's and BLH's purchase of common stock of BLH; and (ii) Conseco's additional ownership interest in CCP, BLH and AGP as a result of the CCP Merger. Changes in minority interest are further described in note 9 to the consolidated financial statements.\nCommon stock and additional paid-in capital decreased by $8.6 million as a result of share repurchases which reduced common stock and additional paid-in capital by $15.0 million, offset by: (i) .1 million shares of common stock issued pursuant to the Company's stock option plan for net proceeds of $.7 million and tax benefits of $.4 million; and (ii) additions to common stock and paid-in capital of $5.3 million relating to employee benefit plans.\nFinancial Ratios\nLiquidity for Insurance Operations\nConseco's insurance operating companies generally receive adequate cash flow from premium collections and investment income to meet their obligations. Insurance policy liabilities are primarily long-term and generally are paid from future cash flows. Most of the insurance company assets, other than policy loans, are invested in bonds and other securities, substantially all of which are readily marketable. Although there is no present need or intent to dispose of such investments, the life companies could liquidate portions of their investments if such a need arose. To increase their return on investments and improve liquidity, the life companies from time to time will lend U.S. Treasury securities in reverse repurchase agreements or lend mortgage-backed securities in dollar-roll transactions.\nOf the companies' total insurance liabilities at December 31, 1995, only 20 percent could be surrendered by the policyholder without a penalty. Approximately 65 percent could be surrendered by the policyholder subject to penalty. Payment characteristics of the insurance liabilities at December 31, 1995, were as follows (dollars in millions):\nOf the above insurance liabilities under contracts containing fixed payment dates, approximately 36 percent related to payments that will be made for the lifetime of the contract holder. Expected mortality is considered in determining the amount of this liability. The remaining insurance liabilities with fixed payment dates are payable regardless of the contract holder's survival.\nApproximately 13 percent of insurance liabilities were subject to an average interest rate of approximately 7 percent, fixed for the life of the contract. The remaining liabilities generally were subject to interest rates that could be reset at least annually.\nThe Company believes that it has adequate short-term investments and readily marketable investment grade securities to cover the payments under contracts containing fixed payment dates plus any likely cash needs for all other contracts. The Company's investment portfolio at December 31, 1995, included $.2 billion of short-term investments, $4.3 billion of U.S. Government\/agency and mortgage-backed securities and $11.5 billion of publicly traded investment grade bonds. The Company believes that such investments could be readily sold at or near carrying value or used to facilitate borrowings under reverse repurchase agreements. At December 31, 1995, the Company's portfolio of bonds, notes and redeemable preferred stocks had an aggregate unrealized gain of $608.2 million.\nLiquidity of BLH\nAs a holding company whose principal assets are the securities of its insurance subsidiaries, BLH's ability to meet debt service obligations and pay operating expenses and dividends depends primarily on the receipt of sufficient funds from its subsidiaries. Bankers Life Insurance Company of Illinois (\"BLI\", the parent of Bankers Life) provides liquidity to BLH by paying principal and interest on a surplus debenture and by paying dividends.\nBLH provided BLI with funds to acquire Bankers Life. In exchange, BLH received a $500 million surplus debenture from BLI. The surplus debenture was approved by the Illinois Department of Insurance (\"DOI\"). During 1995 and 1994, BLI repaid principal of $30.0 million and $25.0 million, respectively, plus accrued interest on the surplus debenture. BLI may repay principal and interest on the surplus debenture only when the DOI is satisfied that the financial condition of BLI warrants that action; such approval may not be withheld if BLI submits satisfactory evidence of surplus of at least the amount stipulated in the surplus debenture.\nA summary of maturity dates and amounts (dollars in millions) of the surplus debenture is shown below. Interest is payable quarterly generally at 2 percent above the prime rate (10.75 percent at December 31, 1995).\nBLI's ability to service its obligation under the surplus debenture depends upon its ability to receive dividend and tax sharing due from Bankers Life. Bankers Life may pay dividends up to $86.0 million without regulatory approval during 1996. Under an intercompany tax sharing agreement, Bankers Life remits tax payments to BLI based upon its tax liabilities calculated on a separate company basis.\nAt December 31, 1995, BLH's debt service obligations included a $110.0 million principal amount revolving credit facility due in 1996 and $180 million principal amount of senior subordinated notes due in 2002. Future annual debt service requirements are discussed in note 8 to the consolidated financial statements. Significant changes occurring after January 1, 1996, in these debt instruments are discussed in note 16 to the consolidated financial statements.\nAt December 31, 1995, BLH had short-term investments of $42.8 million. Conseco believes that BLH could generate additional liquidity, if needed in the future, by issuing equity or debt securities, borrowing additional amounts on its revolving credit facility discussed in note 16 to the consolidated financial statements, or by converting existing assets to cash (such as the sale or transfer of existing blocks of insurance through reinsurance arrangements).\nIn addition to its debt service obligations, BLH uses cash to pay dividends on its common stock and to pay for administrative services provided by Conseco's wholly owned subsidiaries.\nLiquidity of AGP\nAGP relies on dividends from ALHC and payments under a tax sharing agreement with its subsidiaries to fund its operating expenses, dividends and interest expense. AGP is not expected to pay dividends on its common stock in the near future. Since the Acquisition, AGP's direct obligations for dividends on preferred stock and interest on indebtedness have been substantially reduced as a result of the retirement of certain preferred stock as part of the Acquisition and the conversion of $54.0 million principal amount of the Convertible Debentures. AGP remains obligated to pay interest on the remaining $15.0 million principal balance of the Convertible Debentures as long as such amounts remain outstanding. The former senior term loan required the Company to hold funds in escrow to pay the cash merger consideration to the holders of the Convertible Debentures that remained outstanding. The provisions of the Senior Credit Facility (as discussed hereafter) do not require an escrow account to fund the conversion of the remaining Convertible Debentures outstanding. As such, these funds became available for general corporate purposes on the date the Senior Credit Facility was executed.\nIn the fourth quarter of 1995, AGP: (i) sold 2,142,857 shares of its common stock for $30.0 million in a private placement transaction; (ii) made a $30.0 million unscheduled principal payment on the then outstanding senior term loan; (iii) executed a new credit facility to provide for aggregate borrowings of up to $225.0 million (the \"Senior Credit Facility\"); and (iv) borrowed $125 million under the Senior Credit Facility and repaid in full the remaining principal balance under the then outstanding senior term loan. Eighty percent of the common shares sold were purchased by Partnership II and the remaining shares were purchased by other holders of AGP's common stock. The proceeds from the issuance of the shares were used to make a $30.0 million capital contribution to ALHC to enable ALHC to prepay its prior senior term loan. The general terms and conditions of the Senior Credit Facility are discussed in note 8 of the accompanying consolidated financial statements. AGP believes the Senior Credit Facility provides greater flexibility to ALHC than the prior senior term loan because the Senior Credit Facility: (i) makes available additional working capital by increasing the aggregate maximum borrowings to $225.0 million; (ii) provides for a revolving credit facility; (iii) has more favorable interest rates; (iv) has less restrictive covenants; and (v) has a more favorable repayment schedule.\nAGP is obligated to pay the holders of the Contingent Payment Rights or the holder of the 1988 Series Preferred Stock (depending on the outcome of the Savings Bank Litigation) upon conversion of the 1988 Series Preferred Stock an amount of not less than approximately $30 million. Funds to make these payments are available under the Company's Senior Credit Facility.\nIn addition, depending on the outcome of the AGP Litigation as described in note 2 to the consolidated financial statements, dividends may be payable on the 1988 Series Preferred Stock. The 1988 Series Preferred Stock provides for cumulative annual dividends of approximately $1.1 million. Cumulative dividends in arrears on the 1988 Series Preferred Stock through December 31, 1995, were $7.0 million, of which $5.5 million have been accrued.\nAGP has $64.4 million par value 1994 Series Preferred Stock outstanding. Dividends on such preferred stock accrue annually at 13 percent in additional shares through September 2006.\nALHC needs liquidity primarily to service its debt, pay dividends on two series of preferred stock described below, pay dividends to AGP on common stock and pay operating expenses. The primary sources of funds for these payments are: (i) dividends on the capital stock of American Life and Casualty; (ii) interest payments on surplus notes from American Life and Casualty; and (iii) payments from American Life and Casualty and Vulcan Life under a tax sharing agreement.\nAt December 31, 1995, ALHC has $150.0 million principal indebtedness outstanding under its senior subordinated notes and $125.0 million principal indebtedness under the Senior Credit Facility (see note 8 to the consolidated financial statements). ALHC's annual interest payments for 1996 will be: (i) approximately $16.9 million with respect to the senior notes; and (ii) approximately $9.2 million with respect to the Senior Credit Facility (based on rates in effect and amounts outstanding at December 31, 1995).\nDividends on ALHC's common stock are limited by: (i) the rights of holders of its preferred stock to receive cumulative dividends in full before any dividends may be paid on common stock; and (ii) the covenants of the Senior Credit Facility. Under the most restrictive covenants of the Senior Credit Facility, ALHC is limited to paying dividends of $3.0 million per year to AGP. In the event that AGP is required to pay unpaid dividends on the 1988 Series Preferred Stock, limitations in the Senior Credit Facility would require AGP (absent a waiver from the lenders) to seek sources of funds other than dividends from ALHC or borrowing. AGP believes it will have sufficient resources to pay such preferred stock dividends. ALHC currently has redeemable preferred stock outstanding, on which aggregate dividends of $8.7 million are payable annually. The two series of redeemable preferred stock outstanding must be redeemed in 2007 and 2008 at their respective par values of $69.0 million and $30.0 million. ALHC holds zero coupon U.S. Treasury securities in escrow which will provide adequate funds for the redemption of the preferred shares on their respective mandatory redemption dates.\nLiquidity of Conseco (Parent Company)\nThe parent company (Conseco, Inc.) uses cash primarily to service its debt, pay dividends on preferred and common stock, meet administrative expenses, pay income taxes and invest in affiliates. The wholly owned subsidiaries and BLH provide liquidity to Conseco by paying dividends, tax sharing payments and fees for services provided. The parent company may also issue debt or equity securities, borrow additional amounts under its Credit Agreement with a group of banks as discussed in note 8 to the consolidated financial statements, or sell all or a portion of its investments in subsidiaries or affiliates. These sources have historically provided adequate cash flow to fund: (i) the needs of the parent company's normal operations; (ii) internal expansion, acquisitions and investment opportunities; and (iii) the retirement of debt and equity.\nThe following table shows the cash flow activity of the parent company and its wholly owned non-life subsidiaries:\nAt December 31, 1995, the parent company and its non-life subsidiaries had short-term investments of $24.2 million, of which $5.8 million was expended in January 1996 for accrued interest and dividends. The life subsidiaries are permitted to distribute $97.9 million to the parent company in 1996. The parent company and its non-life subsidiaries had additional investments in nonaffiliates of $11.2 million at December 31, 1995, which, if needed, could be liquidated or contributed to the insurance subsidiaries. Conseco believes that it could generate additional liquidity, if needed in the future, through equity offerings, debt issuance, borrowing additional amounts under its Credit Agreement with a group of banks as discussed in note 8 to the consolidated financial statements, or the conversion of existing assets to cash, including the sale of a partial or entire interest in its affiliates.\nStatutory Limitations on Payments by Life Insurance Subsidiaries to Their Parent\nAs described in the preceding section, Conseco receives funds from its wholly owned insurance subsidiaries from dividends and fees for shared expenses, tax sharing payments, and principal and interest on surplus debentures. Annual dividends in excess of maximum amounts prescribed by state statutes (so-called \"extraordinary dividends\") may not be paid without the approval of the insurance commissioner of each state of domicile.\nStatutory operating results and statutory surplus are determined according to statutes adopted by each state in which the subsidiaries do business. Statutory surplus bears no direct relationship to equity as determined under generally accepted accounting principles (\"GAAP\"). With respect to new business, statutory accounting practices require that: (i) acquisition costs and (ii) reserves for future guaranteed principal payments and interest in excess of statutory rates, be expensed in the year the new business is written. These items cause a statutory loss (\"surplus strain\") on many insurance products in the year they are issued. The Company designs its products to minimize such first-year losses, but certain products continue to cause a statutory loss in the year written. For each product, the Company controls the amount of new premiums written in order to manage the effect of such statutory surplus strain.\nNote 13 to the consolidated financial statements shows the difference between pretax income reported using statutory accounting practices (before deduction of expenses paid to affiliates and transfers to and from amortization of IMR) and GAAP.\nInsurance departments in the states where the Company's life insurance subsidiaries are domiciled or do business require insurance companies to make annual and quarterly filings. Portions of surplus, called the interest maintenance reserve (\"IMR\") and the asset valuation reserve (\"AVR\"), are required to be appropriated and reported as liabilities. The IMR captures all investment gains and losses resulting from changes in interest rates and provides for subsequent amortization of such amounts into statutory net income on a basis reflecting the remaining lives of the assets sold. The AVR captures investment gains and losses related to changes in creditworthiness; it is also adjusted each year based on a formula related to the quality and loss experience of the Company's investment portfolio. These reserves affect the ability of the Company's insurance subsidiaries to reflect investment gains and losses in statutory earnings and surplus.\nINFLATION\nInflation does not have a significant effect on Conseco's balance sheet; the Company has minimal investments in property, equipment or inventories.\nMedical cost inflation has had a significant impact on BLH's operations. In recent years, these costs have increased more than increases in the Consumer Price Index. Medical costs will likely continue to rise. The impact on BLH's operations depends upon its ability to increase its premium rates. Such increases are subject to approval by the insurance departments of each state in which BLH sells its products. Prior to the standardization of Medicare supplement plans, approximately two-thirds of the states permitted rate plans with automatic escalation clauses. This permitted BLH, in periods following initial approval, to adjust premium rates for changes in Medicare deductibles and increases in medical cost inflation without refiling with the regulators. Currently, all rate changes for standardized plans must be individually approved by each state. BLH's pricing of its new standardized supplement plans reflects the impact of these filings and the lengthening of the period required to implement rate increases.\nOUTLOOK\nAs indicated throughout this report, Conseco intends to continue its strategy of growth through operating life insurance companies and providing services for fees to the affiliated companies and others.\nGrowth Through Operations of Life Insurance Companies\nConseco's life insurance operations include: (i) BLH, in which Conseco had an 88 percent ownership interest at December 31, 1995, and a 90.5 percent ownership interest at March 5, 1996; (ii) Great American Reserve and Beneficial Standard which became wholly owned subsidiaries as a result of the CCP Merger; (iii) the wholly owned life insurance subsidiaries, principally Bankers National and National Fidelity; and (iv) AGP, in which Conseco has a 36 percent ownership interest. Upon completion of the merger with Life Partners Group, Inc. (\"LPG\"), announced in March 1996, Conseco will have significant in-force business and marketing activity in multiple segments of the life insurance industry, including universal life, ordinary life, term life, single and flexible premium deferred and immediate annuities (including both variable and fixed), Medicare supplement, long-term care and individual and group health insurance. Pro forma collected premiums for 1995 including LPG ($542.6 million), AGP ($825.6 million) and subsidiaries ($2,303.6 million) were as follows (dollars in millions):\nBLH's strategy is to continue to grow profitably its individual health and other insurance business while maintaining appropriate levels of capital and surplus. A primary area of focus is expanding and enhancing the productivity of the career agency force, which is BLH's main distribution system. BLH's growth strategy also emphasizes increased cross-selling to existing policyholder households and developing products tailored to meet specific consumer needs. As a result of cross-selling, 1995 annualized new business premiums increased 20 percent for long-term care products. While new sales of Medicare supplement insurance in 1995 were below 1994 levels, total Medicare premiums collected increased 1.0 percent. We believe rate increases effected by BLH in 1995 to offset increased claims costs may have caused the BLH Medicare supplement policy to be less competitive. We believe recently announced rate increases for some competitors' products should improve the BLH price competitiveness in 1996.\nThe U.S. Congress and state legislatures are currently considering various proposals relating to the country's health care delivery system. BLH is unable to predict what changes will be enacted and, if enacted, their scope and impact. BLH, however, continues to believe that opportunities for its products will grow under any realistic and affordable health care reform scenario.\nThe annuity operations and AGP have: (i) a sizable and profitable block of in-force business; and (ii) distribution systems that have the potential to generate growth in the SPDA and 403(b) tax sheltered annuity markets.\nLPG is a recognized leader in the sale of universal life insurance and has recently increased its annuity sales results. Upon completion of the LPG merger, Conseco intends to concentrate on programs to increase the effectiveness of LPG's marketing programs and to seek ways to cross-sell LPG products in Conseco's other marketing programs and provide other Conseco products to LPG's marketing force.\nConseco believes that the statutory surplus of its insurance subsidiaries and investees is adequate. Conseco believes that statutory earnings in 1996 will exceed amounts needed by the holding companies for debt service and other requirements. Such excesses would increase statutory capital of the life insurance subsidiaries and investees so that their internal growth can continue.\nServices Provided for Fees\nConseco continues to provide various services to BLH, AGP, the former subsidiaries of CCP and the other wholly owned subsidiaries. These services include investment management, mortgage origination and servicing, policy and claims administration, data processing, product marketing and executive management services. Conseco also provides such services to unaffiliated clients, principally insurance companies. Conseco intends to expand its service fee revenue by seeking other unaffiliated clients. Such arrangements would take advantage of Conseco's ability to administer products and investments without requiring Conseco to provide additional capital needed to support those products. Because of changes in control at two of Conseco's unaffiliated clients in 1995, it expects to lose those clients during 1996. Fee revenue from those clients in 1995 was $2.2 million for investment management and $4.5 million for administrative services (both amounts are before deduction of direct and indirect expenses). In March 1993, Conseco acquired Bankmark, an insurance marketing company which develops relationships with financial institutions to provide insurance and investment products to their customers. After its acquisition by Conseco, Bankmark began a formal program to actively expand its business by developing relationships with a few large money-center banks.\nAcquisition and Restructuring of Life Insurance Companies\nWith the 1996 announcement of the termination of Partnership II, Conseco no longer expects to participate significantly in the process of restructuring life insurance companies in order to realize their increased value through a sale or public offering of the companies. Conseco is currently reviewing alternatives to realize the values represented by AGP. In accordance with the partnership agreement, Partnership II's assets must be distributed within two years of the effective date of dissolution.\nThe Company believes that a number of life insurance companies will be available to be acquired in the next 10 years as a result of strategic restructuring and consolidation within the life industry. The Company may participate directly in such acquisitions, such as its planned merger with LPG, when the acquisition fits Conseco's strategic growth plan and can be achieved with a capital structure that results in both: (i) increased earnings per share and value to Conseco's shareholders; and (ii) favorable rating agency actions that facilitate profitable marketing activities by all Conseco companies.\nConseco's ability to complete acquisitions that achieve those objectives depends on a number of external factors, including: (i) the attitudes of rating agencies toward Conseco's strategic plan and capital structure; (ii) the availability and cost of both debt and equity capital; (iii) pressures that motivate companies to seek to be acquired at a reasonable cost; and (iv) competition from other acquirers, which affects the cost of acquisitions.\nConseco believes it has the resources and capabilities to continue being a successful acquirer of life insurance companies. It also believes that its past record of successfully acquiring, financing and operating life insurance companies will be an advantage compared to others who may attempt to acquire available candidates. As shown in the prior section on liquidity, the pro forma capital structure of Conseco (giving effect to several 1996 events, as if they had occurred at December 31, 1995) includes only 32 percent debt for which Conseco is directly liable to Conseco's capital (40 percent if debt of BLH is included).\nAs part of its program of exploring opportunities to improve its capital structure, Conseco continually reviews its corporate structure and the need and desirability of restructuring the existing debt and equity of the Company and its affiliates.\n------------------------------\nITEM 8.","section_7A":"","section_8":"ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nIndex to Consolidated Financial Statements\nREPORT OF MANAGEMENT\nTo Our Shareholders\nManagement of Conseco, Inc. is responsible for the reliability of the financial information in this annual report. The financial statements are prepared in accordance with generally accepted accounting principles, and the other financial information in this annual report is consistent with that of the financial statements (except for such information described as being in accordance with regulatory or statutory accounting requirements).\nThe integrity of the financial information relies in large part on maintaining a system of internal control that is established by management to provide reasonable assurance that assets are safeguarded and transactions are properly authorized, recorded and reported. Reasonable assurance is based upon the premise that the cost of controls should not exceed the benefits derived from them. The Company's internal auditors continually evaluate the adequacy and effectiveness of this system of internal control and actions are taken to correct deficiencies as they are identified.\nCertain financial information presented depends upon management's estimates and judgments regarding the ultimate outcome of transactions which are not yet complete. Management believes these estimates and judgments are fair and reasonable in view of present conditions and available information.\nThe Company engages independent accountants to audit its financial statements and express their opinion thereon. They have full access to each member of management in conducting their audits. Such audits are conducted in accordance with generally accepted auditing standards and include a review of internal controls, tests of the accounting records, and such other auditing procedures as they consider necessary to express an opinion on the Company's financial statements.\nThe Audit Committee of the Board of Directors, composed solely of nonmanagement directors, meets periodically with management, internal auditors and the independent accountants to review internal accounting control, audit activities and financial reporting matters. The internal auditors and the independent accountants have full and free access to the Audit Committee.\nStephen C. Hilbert Rollin M. Dick Chairman of the Board, Executive Vice President and President and Chief Financial Officer Chief Executive Officer\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholders Conseco, Inc.\nWe have audited the accompanying consolidated balance sheet of Conseco, Inc. and Subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1995. 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 Conseco, Inc. and Subsidiaries as of December 31, 1995 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, 1995, in conformity with generally accepted accounting principles.\nCOOPERS & LYBRAND L.L.P.\nIndianapolis, Indiana March 20, 1996\nCONSECO, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEET December 31, 1995 and 1994 (Dollars in millions)\nCONSECO, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEET (Continued) December 31, 1995 and 1994 (Dollars in millions)\nCONSECO, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENT OF OPERATIONS for the years ended December 31, 1995, 1994 and 1993 (Dollars in millions, except per share data)\nCONSECO, INC. AND SUBSIDIARIES\nCONSECO, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY for the years ended December 31, 1995, 1994 and 1993 (Dollars in millions)\nCONSECO, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENT OF CASH FLOWS for the years ended December 31, 1995, 1994 and 1993 (Dollars in millions)\nCONSECO, INC. AND SUBSIDIARIES\nCONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n------------------------------------\n1. SIGNIFICANT ACCOUNTING POLICIES:\nBasis of Presentation\nThe following summary explains the accounting policies we use to arrive at some of the more significant numbers in our financial statements. We have restated all share and per share amounts for the April 1, 1996 two-for-one stock split. We prepare our financial statements in accordance with generally accepted accounting principles (\"GAAP\"). We follow the accounting standards established by the Financial Accounting Standards Board, the American Institute of Certified Public Accountants and the Securities and Exchange Commission.\nConseco, Inc. (\"We,\" \"Conseco\" or \"the Company\") is a financial services holding company engaged primarily in the development, marketing and administration of annuity, supplemental health and individual life products. Conseco's earnings result primarily from: (i) operating life insurance companies; and (ii) providing investment management, administrative and other fee-based services to affiliated businesses as well as non-affiliates. Conseco's operating strategy is to grow the insurance business within its subsidiaries by focusing its resources on the development and expansion of profitable products and strong distribution channels. Conseco has supplemented such growth by acquisitions of companies that have profitable niche products, strong distribution systems and progressive management teams who can work with Conseco to implement Conseco's operating and growth strategies. Once a company has been acquired, Conseco's operating strategy has been to consolidate and streamline management and administrative functions, to realize superior investment returns through active asset management, to eliminate unprofitable products and distribution channels, and to expand the profitable distribution channels and products. Our principal wholly owned life insurance subsidiaries are Great American Reserve Insurance Company (\"Great American Reserve\"), Beneficial Standard Life Insurance Company (\"Beneficial Standard\"), Bankers National Life Insurance Company ('Bankers National\"), National Fidelity Life Insurance Company (\"National Fidelity\") and Lincoln American Life Insurance Company (\"Lincoln American\"). We also own 88 percent (90.5 percent as of March 5, 1996) of the common stock of Bankers Life Holding Corporation (\"BLH\"), which is the holding company for Bankers Life and Casualty Company (\"Bankers Life\"); and through our interests in Conseco Capital Partners II, L.P. (\"Partnership II\") and our direct investments, we have a 36 percent ownership interest in American Life Group, Inc. (\"AGP\") (formerly known as The Statesman Group, Inc. prior to its name change in August 1995).\nConsolidation issues. During 1990, Conseco formed Conseco Capital Partners, L.P. (\"Partnership I\"), which raised and invested $99.5 million of capital. Approximately half of this capital was provided by Conseco; the balance was provided by other investors. A wholly owned subsidiary of Conseco was the sole general partner of Partnership I. Partnership I was the Company's vehicle for acquiring four insurance companies: Great American Reserve in June 1990, Jefferson National Life Insurance Company (\"Jefferson National\") in November 1990 (it was merged with Great American Reserve in 1994), Beneficial Standard in March 1991 and Bankers Life in November 1992. We accounted for all of these acquisitions as purchases, reflecting the acquired operations in our financial statements beginning with the acquisition dates. As sole general partner, Conseco exercised unilateral control over Partnership I. We were therefore required to include the accounts of Partnership I and its majority-owned subsidiaries in our consolidated financial statements until Partnership I was liquidated on March 31, 1993. See note 2 for a description of the activities of Partnership I.\nCCP Insurance, Inc. (\"CCP\"), a newly organized holding company for Partnership I's first three acquisitions, completed an initial public offering (IPO) in July 1992. As a result of the IPO, we no longer had unilateral control over those entities and stopped including their accounts in our consolidated financial statements. We carried our investment in CCP and its subsidiaries in our financial statements on the equity basis in 1994 and 1993. As described in note 2, in August 1995, Conseco completed the purchase of all the shares of common stock of CCP we did not previously own in a transaction pursuant to which CCP was merged with Conseco, with Conseco being the surviving corporation (the merger and related transactions are referred to herein as the \"CCP Merger\"). As a result, CCP's subsidiaries (Great American Reserve and Beneficial Standard) became wholly owned subsidiaries of the Company. The Company's consolidated statements reflect the operations of CCP on a consolidated basis effective January 1, 1995.\nWe were required to use step-basis accounting when we acquired the shares of CCP common stock in various transactions . As a result, the assets and liabilities of CCP included in our December 31, 1995, consolidated balance sheet represent the following combination of values: (i) the portion of CCP's net assets acquired by Conseco in the initial acquisitions of CCP's subsidiaries made by Partnership I is valued as of those respective acquisition dates; and (ii) the portion of CCP's net assets acquired in the CCP Merger is valued as of August 31, 1995.\nCONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n------------------------------------\nBLH, a company formed by Partnership I to acquire Bankers Life, completed an IPO in March 1993. As a result of the IPO, Conseco owned 31 percent of BLH and no longer had unilateral control of BLH. However, after we acquired additional shares of BLH in September 1993, our ownership position in BLH increased to 56 percent. In June 1995, we purchased additional shares of BLH, increasing the Company's ownership of BLH to 82 percent (85 percent including the shares of BLH owned by CCP). Conseco's ownership of BLH increased to 88 percent at December 31, 1995, and 90.5 percent at March 5, 1996, as a result of share repurchases by BLH in the third and fourth quarters of 1995 and in 1996. The accounts of BLH are consolidated with Conseco's accounts for all periods in the accompanying consolidated financial statements.\nBLH's former owner continued to own 40 percent of BLH following Partnership I's acquisition of BLH in 1992. Partnership I and Conseco were therefore required to account for that acquisition as a \"step acquisition transaction\" in accordance with the guidance provided in Issue Number 88-16 of the Emerging Issues Task Force of the Financial Accounting Standards Board entitled \"Basis in Leveraged Buyout Transactions.\" We also used step acquisition accounting when we bought more BLH stock in September 1993 and during 1995. As a result, the assets and liabilities of BLH included in Conseco's 1995 consolidated balance sheet represent the following combination of values: (i) the portion of BLH's net assets acquired by Conseco in the November 1992 acquisition made by Partnership I is valued as of that acquisition date; (ii) the portion of BLH's net assets acquired in September 1993 is valued as of that date; (iii) the portion of BLH's net assets acquired during 1995 is valued as of the date of their purchase (for accounting convenience June 30, 1995, has been used); and (iv) the portion of BLH's net assets owned by minority interests is valued based on a combination of the former owner's historical bases of net assets acquired in the initial acquisition in 1992 and the values defined in clause (i).\nWestern National Corporation (\"WNC\"), a company formed in October 1993 to be the holding company for Western National Life Insurance Company (\"Western National\"), completed an IPO in February 1994. Prior to the IPO, WNC was a wholly owned subsidiary of Conseco. We sold 60 percent of our equity interest in the IPO. As a result of the IPO, we no longer had unilateral control of WNC and we ceased including the accounts of WNC in our consolidated financial statements as of January 1, 1994. We sold our remaining 40 percent interest in WNC on December 23, 1994 (refer to note 2 for further discussion of the transactions involving WNC). Our equity in earnings of WNC in 1994 therefore reflected: (i) all of WNC's earnings for the period through February 15, 1994; and (ii) 40 percent of WNC's earnings for the period from February 15, 1994, through December 23, 1994.\nPartnership II was organized to invest in privately negotiated acquisitions of specialized annuity, life and accident and health insurance companies and related businesses. Partnership II acquired AGP on September 29, 1994 (as further described in note 2). Partnership II owns 80 percent of the outstanding shares of AGP's common stock. Because Conseco is the sole general partner of Partnership II, Conseco controls Partnership II and AGP even though its ownership interest is less than 50 percent. Because of this control, Conseco's consolidated financial statements are required to include the accounts of Partnership II and AGP. Immediately after the acquisition of AGP, Conseco, through its direct investment and through its equity interests in the investments made by BLH, CCP and WNC, had approximately a 27 percent ownership interest in AGP.\nOn November 30, 1995, AGP issued 2,142,857 shares of its common stock for $30.0 million (including $13.2 million paid by Conseco and its subsidiaries) in a private placement transaction. Eighty percent of the shares were purchased by Partnership II and the remainder were purchased by the other holders of AGP's common stock. Conseco's ownership interest in AGP increased to 36 percent at December 31, 1995, as the result of this transaction and changes in our ownership of BLH and CCP (which have ownership interests in Partnership II and its subsidiaries), partially offset by the following transactions which occurred in December 1994: (i) the sale of Conseco's remaining equity interest in WNC; and (ii) the sale of a portion of its investment in AGP to an unaffiliated company.\nWe accounted for the acquisition of AGP using the purchase method of accounting. Under purchase accounting, we allocated the total purchase cost of AGP to the assets and liabilities acquired based on their fair values, with the excess of the total purchase cost over the fair value of the net assets acquired recorded as goodwill.\nNeither \"consolidation\" nor \"non-consolidation\" changes the net income or shareholders' equity we report. Our consolidated financial statements do not include the results of material transactions between us and our consolidated affiliates, or among our consolidated affiliates. We reclassified some figures in our 1994 and 1993 consolidated financial statements and notes to conform with the 1995 presentation.\nCONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n------------------------------------\nInvestments\nFixed maturities are securities that mature more than one year after issuance. They include bonds, notes receivable and preferred stocks with mandatory redemption features.\nEquity securities include investments in common stocks and non-redeemable preferred stock.\nWe implemented Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" (\"SFAS 115\") as of December 31, 1993. We classify our fixed maturity and equity securities into three categories:\nActively managed - fixed maturity and equity securities that we may sell prior to maturity in response to changes in interest rates, issuer credit quality or our liquidity requirements. We carry actively managed securities at fair value. We record any unrealized gain or loss, net of tax and the related adjustments described below, as a component of shareholders' equity.\nTrading account - fixed maturity and equity securities that we buy principally for the purpose of selling in the near term. We carry trading account securities at estimated fair value. We include any unrealized gain or loss in net trading income. We did not hold any trading account securities at December 31, 1995.\nHeld to maturity - (all other fixed maturities) securities which we have the ability and positive intent to hold to maturity. When we own such securities, we carry them at amortized cost. We may dispose of these securities if the credit quality of the issuer deteriorates, if regulatory requirements change or under other unforeseen circumstances. We have not held any held to maturity securities since implementing SFAS 115.\nWe consider the anticipated returns from investing policyholder balances, including realized gains and losses, in determining the amortization of the cost of policies purchased and the cost of policies produced. When we state actively managed fixed maturities at fair value, we also adjust the cost of policies purchased and the cost of policies produced to reflect the change in cumulative amortization that we would have recorded if we had sold these securities at their fair value and reinvested the proceeds at current yields. If future yields on such securities decline, it may be necessary to increase certain of our insurance liabilities. We are required to adjust such liabilities when their balances and future net cash flows (including investment income) are insufficient to cover future benefits and expenses.\nUnrealized gains and losses and the related adjustments described above have no effect on our earnings. We record them, net of tax, to shareholders' equity. The following table summarizes the effect of these adjustments on Conseco's actively managed fixed maturities as of December 31, 1995:\nWhen there are changes in conditions that cause us to transfer a fixed maturity investment to a different category (i.e., actively managed, trading or held to maturity), we transfer it to the new category at its fair value on the date of the transfer. We account for the security's unrealized gain or loss (such amounts were immaterial in 1995) as follows:\nCONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n------------------------------------\nFor a transfer to the trading category - we recognize the unrealized gain or loss immediately in earnings.\nFor a transfer from the trading category - we do not reverse the unrealized gain or loss already recognized in earnings.\nFor a transfer to actively managed from held to maturity - we recognize the unrealized gain or loss immediately in shareholders' equity.\nFor a transfer to held to maturity from actively managed - we continue to report the unrealized gain or loss at the date of transfer in shareholders' equity, but we amortize the gain or loss over the remaining life of the security as an adjustment of yield.\nCredit-tenant loans are loans for commercial properties. When we make these loans: (i) the lease of the principal tenant must be assigned to Conseco; (ii) the lease must produce adequate cash flow to fund substantially all the requirements of the loan; and (iii) the principal tenant or the guarantor of such tenant's obligations must have an investment-grade credit rating when the loan is made. These loans also must be secured by the value of the related property. Our underwriting guidelines take into account such factors as: (i) the lease term of the property; (ii) the borrower's management ability, including business experience, property management capabilities and financial soundness; and (iii) such economic, demographic or other factors that may affect the income generated by the property, or its value. The underwriting guidelines generally require a loan-to-value ratio of 75 percent or less. We carry both credit-tenant loans and traditional mortgage loans at amortized cost.\nAs part of our investment strategy, we may enter into reverse repurchase agreements and dollar-roll transactions to increase our investment return or improve our liquidity. We account for these transactions as collateral borrowings, where the amount borrowed is equal to the sales price of the underlying securities.\nOther invested assets consist principally of investments in unconsolidated limited partnerships. We generally account for them using the equity method.\nPolicy loans are stated at their current unpaid principal balances.\nShort-term investments include commercial paper, invested cash and other investments purchased with maturities of less than three months. We carry them at amortized cost, which approximates their estimated fair value. We consider all short-term investments to be cash equivalents.\nWe defer any fees received or costs incurred when we originate investments--principally credit-tenant loans and mortgages. We amortize fees, costs, discounts and premiums as yield adjustments over the contractual lives of the investments. We consider anticipated prepayments on mortgage-backed securities in determining estimated future yields on such securities.\nWe record the cost of each individual investment security. When we sell, we report the difference between our sale proceeds and our carrying value of the individual security as a realized gain or loss on investments. If the proceeds result from prepayments by the issuer prior to maturity, then those differences are recorded as an adjustment to investment income.\nWe regularly evaluate all our credit-tenant loans, mortgage loans and other investments based on current economic conditions, credit loss experience and other investee-specific developments. If there is a decline in a security's net realizable value that is other than temporary, we treat it as a realized loss and we reduce our cost basis of the security to its estimated fair value. If a loan becomes impaired (i.e., it becomes probable that we will be unable to collect all amounts due according to the contractual terms of the agreement), we revalue the loan at the present value of expected cash flows, discounted at the loan's effective interest rate. We accrue interest thereafter on the net carrying amount of impaired loans.\nSeparate Accounts\nSeparate accounts are funds on which investment income and gains or losses accrue directly to certain policyholders. The assets of these accounts are legally segregated. They are not subject to the claims which may arise out of any other business of Conseco. We report separate account assets at market value; the underlying investment risks are assumed by the contract holders. We record the related liabilities at amounts equal to the underlying assets; the fair value of these liabilities is equal to their carrying amount.\nCONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n------------------------------------\nCost of Policies Purchased\nWhen we acquire an insurance company, we assign a portion of its cost to the right to receive future cash flows from insurance contracts existing at the date of the acquisition. This cost of policies purchased represents the actuarially determined present value of the projected future cash flows from the acquired policies. To determine this value, we use a method which is consistent with methods commonly used to value blocks of insurance business and with the basic methodology generally used to value assets. It can be summarized as follows:\n- Identify the expected future cash flows from the blocks of business.\n- Identify the risks to realizing those cash flows (i.e., assess the probability that the cash flows will be realized).\n- Identify the rate of return that we must earn in order to accept these risks, based on consideration of the factors summarized below.\n- Determine the value of the policies purchased by discounting the expected future cash flows by the discount rate we need to earn.\nThe expected future cash flows we use in determining such value are based on actuarially determined projections of future premium collections, mortality, surrenders, operating expenses, changes in insurance liabilities, investment yields on the assets held to back the policy liabilities and other factors. These projections take into account all factors known or expected at the valuation date, based on the collective judgment of Conseco's management. Our actual experience on purchased business may vary from projections due to differences in renewal premiums collected, investment spread, investment gains or losses, mortality and morbidity costs and other factors.\nThe discount rate we use to determine the value of the cost of policies purchased is the rate of return we need to earn in order to invest in the business being acquired. In determining this required rate of return, we consider the following factors:\n- The magnitude of the risks associated with each of the actuarial assumptions used in determining expected future cash flows (as described above).\n- Our cost of the capital required to fund the acquisition.\n- The likelihood of changes in projected future cash flows that might occur if there are changes in insurance regulations and tax laws.\n- The acquired company's compatibility with other Conseco activities that may favorably affect future cash flows.\n- The complexity of the acquired company.\n- Recent prices (i.e., discount rates used in determining valuations) paid by others to acquire similar blocks of business.\nAfter we determine the cost of policies purchased, we amortize that amount based on the incidence of the expected cash flows. For acquisitions we made on or before November 19, 1992, we amortize the asset with interest at the same rate used to determine the discounted value of the asset. For acquisitions after November 19, 1992, (including the acquisition of AGP and the acquisitions of additional ownership interests in BLH and CCP in 1995 and 1994), we amortize this asset using the interest rate credited to the underlying policies.\nIf renewal premiums collected, investment spread, investment gains or losses, mortality and morbidity costs or other factors differ from our expectations, we adjust our amortization of the cost of policies purchased. For example, the sale of a fixed maturity investment may result in a gain (or loss). If the sale proceeds are reinvested at a lower (or higher) earnings rate, there may also be a reduction (or increase) in our future investment spread. We must then increase (or decrease) amortization to reflect the change in the incidence of expected cash flows. For acquisitions made on or before November 19, 1992, we adjust amortization in the current and future years to reflect: (i) our revised estimate of future cash flows; and (ii) the revised interest rate at which the\nCONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n------------------------------------\ndiscounted present value of such expected future profits equals the unamortized asset balance (this rate may not exceed the rate initially used and may not be lower than the rate earned on invested assets). For acquisitions made after November 19, 1992, we adjust amortization consistent with the methods used with the cost of policies produced (described below).\nWe evaluate annually the recoverability of the cost of policies purchased. We compare our current estimate of expected future cash flows (discounted at the rate earned on our invested assets) to the unamortized asset balance by line of insurance business. If our current estimate indicates that the existing insurance liabilities, together with the present value of future net cash flows from the blocks of business purchased, will be insufficient to recover the cost of policies purchased, we charge the difference to expense.\nCost of Policies Produced\nThe costs which vary with and are primarily related to producing new business are referred to as cost of policies produced. They consist primarily of commissions, bonus interest and certain costs of policy issuance and underwriting, net of fees charged to the policy in excess of ultimate fees charged. To the extent that they are recoverable from future profits, we defer these costs and amortize them with interest as follows:\n- For universal life-type contracts and investment-type contracts, in relation to the present value of expected gross profits from the contracts, discounted using the interest rate credited to the policy.\n- For immediate annuities with mortality risks, in relation to the present value of benefits to be paid.\n- For traditional life and accident and health products, in relation to future anticipated premium revenue, using the same assumptions that are used in calculating the insurance liabilities.\nWe evaluate annually the recoverability of the unamortized balance of the cost of policies produced. For universal life-type contracts and investment-type contracts, we increase or decrease the accumulated amortization whenever there is a material change in the estimated gross profits expected over the life of a block of business. We do this in order to maintain a constant relationship between the cumulative amortization and the present value (discounted at the rate of interest that accrues to the policies) of expected gross profits. For most other contracts, we reduce the unamortized asset balance (by a charge to income) only when the present value of future cash flows, net of the policy liabilities, is insufficient to recover the asset balance.\nGoodwill\nGoodwill is the excess of the amount we paid to acquire a company over the fair value of its net assets. We amortize goodwill on the straight-line basis over a 40-year period. We continually monitor the value of our goodwill based on our estimates of future earnings. We determine whether goodwill is fully recoverable from projected undiscounted net cash flows from earnings of the subsidiaries over the remaining amortization period. If we were to determine that a material change has occurred in the factors supporting recoverability of goodwill over the remaining amortization period, we would reduce its carrying value with a corresponding charge to expense or shorten the amortization period (no such changes have occurred.).\nProperty and Equipment\nWe carry property and equipment at depreciated cost. We depreciate property and equipment on a straight-line basis over the estimated useful lives of the assets, which average approximately 13 years. Our depreciation expense was $9.3 million in 1995, $8.3 million in 1994 and $6.0 million in 1993.\nInsurance Liabilities, Recognition of Insurance Policy Income and Related Benefits and Expenses\nOur reserves for universal life-type and investment-type contracts are based either on the contract account balance (if future benefit payments in excess of the account balance are not guaranteed) or on the present value of future benefit payments (if such payments are guaranteed). We make additions to insurance liabilities if we determine that future cash flows (including investment income) are insufficient to cover future benefits and expenses.\nCONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n------------------------------------\nFor investment contracts without mortality risk (such as deferred annuities and immediate annuities with benefits paid for a period certain) and for contracts that permit either Conseco or the insured to make changes in the contract terms (such as single- premium whole life and universal life), we record premium deposits and benefit payments as increases or decreases in a liability account, rather than as revenue and expense. We record as revenue any amounts charged against the liability account for the cost of insurance, policy administration and surrender penalties. We record as expense any interest credited to the liability account and any benefit payments which exceed the contract liability account balance.\nOur reserves for traditional and limited-payment life contracts are generally calculated using the net level premium method, based on assumptions as to investment yields, mortality, withdrawals and dividends. We make these assumptions at the time the contract is issued or, in the case of contracts acquired by purchase, at the purchase date. We base these assumptions on projections from past experience, modified as necessary to reflect anticipated trends and making allowance for possible unfavorable deviation.\nFor traditional life insurance contracts, we recognize premiums as income when due or, for short duration contracts, over the period to which the premiums relate. We recognize benefits and expenses as a level percentage of earned premiums. We accomplish this by providing for future policy benefits and by amortizing deferred policy acquisition costs.\nFor contracts with mortality risk, but with premiums paid for only a limited period (such as single premium immediate annuities with benefits paid for the life of the annuitant), our accounting treatment is similar to that used for traditional contracts. An exception is that we defer the excess of the gross premium over the net premium and recognize it in relation to the present value of expected future benefit payments (when accounting for annuity contracts) or in relation to insurance in force (when accounting for life insurance contracts).\nWe establish reserves for the estimated present value of the remaining net cost of all reported and unreported claims. We base our estimates on past experience and on published tables for disabled lives. We believe that the reserves we have established are adequate. Final claim payments, however, may differ from the established reserves, particularly when those payments may not occur for several years. Any adjustments we make to reserves are reflected in the results for the year during which the adjustments are made.\nThe liability for future policy benefits for accident and health policies consists of active life reserves and the estimated present value of the remaining ultimate net cost of incurred claims. The active life reserves include unearned premiums and additional reserves. The additional reserves are computed on the net level premium method using assumptions for future investment yield, mortality and morbidity experience. The assumptions are based on projections of past experience and include provisions for possible adverse deviation.\nFor participating policies, we determine annually the amount of dividends to be paid. We include as an insurance liability the portion of the earnings allocated to participating policyholders.\nReinsurance\nIn the normal course of business, Conseco seeks to limit its exposure to loss on any single insured and to recover a portion of the benefits paid over such limits. We do this by ceding reinsurance to other insurance enterprises or reinsurers under excess coverage and coinsurance contracts. We limit how much risk per policy we will retain. This retention limit does not exceed $.8 million on any of our policies.\nWe report assets and liabilities related to insurance contracts before the effects of reinsurance. We report reinsurance receivables and prepaid reinsurance premiums (including amounts related to insurance liabilities) as assets. We recognize estimated reinsurance receivables in a manner consistent with the liabilities related to the underlying reinsured contracts.\nIncome Taxes\nOur income tax expense includes deferred income taxes arising from temporary differences between the tax and financial reporting basis of assets and liabilities. This liability method of accounting for income taxes also requires us to reflect the effect of a tax rate change on accumulated deferred income taxes in income in the period in which the change is enacted.\nCONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n------------------------------------\nIn assessing the realization of deferred income tax assets, we consider whether it is more likely than not that the deferred income tax assets will be realized. The ultimate realization of deferred income tax assets is dependent upon the generation of future taxable income during the periods in which temporary differences become deductible. If future income does not occur as expected, deferred income taxes may need to be written off.\nMinority Interest\nOur consolidated financial statements include all of the assets, liabilities, revenues and expenses of BLH, AGP (since its acquisition by Partnership II on September 29, 1994), and CCP (since January 1, 1995, as a result of the CCP Merger). We make a charge against consolidated income for the share of earnings allocable to the minority interests. We show the shareholders' equity of such entities allocable to the minority interests separately on our consolidated balance sheet.\nEarnings Per Share\nWe compute primary net income per share by dividing earnings less preferred dividend requirements by the weighted average number of common and common equivalent shares outstanding for the period. We compute fully diluted net income per share on the same basis, except that, if more dilutive: (i) the number of common equivalent shares related to stock options is based on the period- end market value of the shares, instead of the average market value; and (ii) convertible preferred stock is assumed to be converted into common shares. We have restated all share and per share amounts for the April 1, 1996 two-for-one stock split.\nDuring the preparation of financial statements in conformity with GAAP we are required to make estimates and assumptions that affect the reported assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the preparation period. Actual results could differ from those estimates. We utilize significant estimates and assumptions in the calculation of cost of policies produced, cost of policies purchased, goodwill, insurance liabilities, guaranty fund assessment accruals and deferred income taxes. It is reasonably possible that actual experience could differ from the estimates and assumptions utilized which could have a material impact on the financial statements.\nFair Values of Financial Instruments\nWe use the following methods and assumptions to determine the estimated fair values of financial instruments:\nInvestment securities. For fixed maturity securities (including redeemable preferred stocks) and for equity and trading account securities, we use quotes from independent pricing services, where available. For investment securities for which such quotes are not available, we use values obtained from broker-dealer market makers or by discounting expected future cash flows using a current market rate appropriate for the yield, credit quality and, for fixed maturity securities, the maturity of the investment being priced.\nShort-term investments. We use quoted market prices. The carrying amount reported on our consolidated balance sheet for these instruments approximates their estimated fair value.\nMortgage loans, credit-tenant loans and policy loans. We discount future expected cash flows based on interest rates currently being offered for similar loans to borrowers with similar credit ratings. We aggregate loans with similar characteristics in our calculations.\nOther invested assets. We have assumed that these assets, which are not material, have a market value equal to carrying value.\nSecurities segregated for the future redemption of redeemable preferred stock of a subsidiary. Estimated fair values of the U.S. Treasury securities held in escrow for the future redemption of redeemable preferred stock of a subsidiary of AGP are based on quoted market prices.\nInterest rate swaps. Estimated fair values of interest rate swap contracts are based on estimates of fair value from dealers which represent the net value or the cost of terminating the contracts at the balance sheet date.\nCONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n------------------------------------\nInsurance liabilities for investment contracts. We use discounted cash flow calculations based on interest rates currently being offered for similar contracts having maturities consistent with the contracts being valued.\nInvestment borrowings and notes payable. We use either: (i) discounted cash flow analyses based on our current incremental borrowing rates for similar types of borrowing arrangements; or (ii) current market values for publicly traded debt.\nRedeemable preferred stock of a subsidiary of AGP (a component of minority interest). The estimated fair value of redeemable preferred stock which is publicly-traded is based on quoted market prices. The estimated fair value of the privately placed redeemable preferred stock is determined by discounting expected future cash flows using assumed incremental dividend rates for similar duration securities.\nHere are the estimated fair values of our financial instruments:\nCONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n------------------------------------\n2. ACQUISITIONS\/DISPOSITIONS:\nCCP Insurance, Inc.\nIn July 1992, CCP, a newly organized holding company for Partnership I's first three acquisitions, completed an IPO of 8,010,700 shares of common stock. Net proceeds to CCP totaled $111.2 million. The shares issued in the offering represented a 31 percent ownership interest in the common stock outstanding of CCP. The remaining ownership interest in CCP was held by Conseco and others who received common stock of CCP in a liquidating distribution from Partnership I.\nIn September 1993, CCP completed a public offering in which CCP sold 3.0 million shares of its common stock and certain shareholders sold 6.5 million shares of CCP common stock. Proceeds of approximately $80.9 million from the offering of common shares by CCP (after underwriting and issuance costs) were added to CCP's funds for general corporate purposes. CCP received no proceeds from the sale of shares by the selling shareholders. In a separate transaction, Conseco purchased 2.0 million shares of CCP common stock from the selling shareholders for $53.6 million. In addition, Conseco purchased .3 million shares of CCP common stock in open market transactions for $5.9 million during 1993. After these transactions, Conseco owned 40 percent of the common stock of CCP.\nIn early 1994, CCP announced a program to repurchase up to 2.0 million shares of its common stock in the open market or through negotiated transactions. In October 1994, CCP expanded the repurchase program to 4.0 million shares. During 1994, CCP acquired 3.5 million shares of its common stock under this program at a cost of $71.8 million. CCP's repurchases increased Conseco's ownership interest in CCP to 45 percent at December 31, 1994. In early 1995, CCP repurchased an additional 2.2 million shares under this program for $44.5 million increasing Conseco's ownership interest to 49 percent.\nIn August 1995, we completed the purchase of all of the shares of common stock of CCP we did not previously own. A total of 11.8 million shares were purchased for $281.8 million (including transaction costs and the cost to settle outstanding stock options of CCP) in a transaction pursuant to which CCP was merged with Conseco, with Conseco being the surviving corporation. Income tax expense was reduced by $8.4 million in the third quarter of 1995 as a result of the release of deferred income taxes previously accrued on income related to CCP. Such deferred tax is no longer required because the CCP Merger was completed without incurring additional tax.\nWe funded the CCP Merger (including the repayment of our existing $250.0 million revolving credit facility ) with available cash and borrowings from a new $600.0 million credit facility (the \"Credit Agreement\"). The sources and uses of the financing to complete the CCP Merger are summarized below (dollars in millions):\nCONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n------------------------------------\nThe effect of the CCP Merger on the consolidated balance sheet as of the CCP Merger date was as follows (dollars in millions):\nBankers Life Holding Corporation\nOn November 9, 1992, Partnership I formed BLH to acquire Bankers Life from I.C.H. Corporation (\"ICH\"). The purchase price of $600.0 million was funded with the net proceeds of the following securities issued by BLH: (i) $175.0 million senior notes to a group of lending banks; (ii) $200.0 million senior subordinated notes; (iii) $45.0 million payment-in-kind junior subordinated notes (including $8.3 million provided by Conseco and $34.7 million provided by ICH); (iv) $158.3 million of payment-in-kind preferred stock (of which $108.3 million was provided by Conseco and $50.0 million was provided by ICH); and (v) $66.7 million of common stock of BLH, including $16.7 million directly provided by ICH and $50.0 million provided by Partnership I (including $25.5 million provided by Conseco and $9.6 million provided by ICH). None of the BLH notes are direct obligations of Conseco. As a result of this acquisition, Conseco owned approximately 44 percent of the common equity interest in BLH through its direct investments and investments in Partnership I. For accounting convenience, the acquisition was reported as of November 1, 1992, and Conseco made adjustments to reflect financing costs for the period between that date and the actual date of acquisition, November 9, 1992.\nOn March 25, 1993, BLH completed an IPO of 19.6 million shares of its common stock at $22 per share. Proceeds from the offering of $405.3 million (after underwriting and issuance costs) were used by BLH to redeem all outstanding preferred stock, to retire all junior subordinated debt, to prepay a portion of the senior debt and for other corporate purposes. After the offering, Conseco owned 31 percent of the common shares of BLH. As a result of the offering, Conseco recorded a one-time gain of $58.8 million (net of tax of $40.4 million) in the first quarter of 1993, representing Conseco's direct percentage share of the increase in BLH's shareholders' equity account attributable to the proceeds from the offering. In addition, Conseco recorded a gain of $2.2 million (net of tax of $.1 million) in the first quarter of 1993, representing Conseco's indirect percentage share (through the Company's ownership of CCP) of CCP's percentage share of the increase in BLH's shareholders' equity account attributable to the proceeds from the offering. The Partnership I agreement provided for incentive compensation to Conseco as the general partner in the event that returns to the limited partners were in excess of prescribed targeted returns. The distribution of BLH shares to the limited partners caused such targets to be exceeded, resulting in incentive compensation to Conseco of $22.3 million, net of tax of $14.3 million.\nOn September 30, 1993, Conseco acquired 13.3 million shares of BLH common stock from ICH for $287.6 million. The shares purchased represented 25 percent of BLH's outstanding shares. Conseco paid for these shares by surrendering for redemption $50.0 million stated value of ICH preferred stock, and by paying $237.6 million in cash. Conseco funded the cash payment using available cash and the net proceeds from a $200.0 million senior unsecured loan. As described below, the loan was repaid in February 1994, using the proceeds from the IPO of WNC. The transaction with ICH increased Conseco's ownership of BLH to 56 percent.\nCONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n------------------------------------\nIn April 1994, BLH announced a program to repurchase up to 2 million of its common shares in open-market or negotiated transactions. During 1994, BLH acquired 1.8 million shares of its common stock under this program at a cost of $35.7 million. BLH's repurchases increased Conseco's ownership interest in BLH to 58 percent.\nOn June 28, 1995, we completed the program to acquire additional shares of BLH common stock. A total of 12.8 million shares were purchased for $262.4 million in open market and negotiated transactions during 1995. The shares purchased represented 24 percent of the then outstanding shares of BLH common stock increasing our ownership of BLH to 82 percent (85 percent including shares of BLH owned by CCP) as of June 30, 1995. We funded the acquisition with available cash, proceeds from our revolving credit agreements and a $32.0 million loan from CCP. Income tax expense was reduced by $66.5 million in the second quarter of 1995 as a result of the release of deferred income taxes previously accrued on income related to BLH. Such deferred tax is no longer required since we are permitted to file a consolidated tax return with BLH and the income this tax relates to can be distributed to Conseco without the payment of tax. In addition, BLH repurchased 2.2 million shares of its common stock during 1995 at a cost of $42.1 million, increasing our ownership interest in BLH to 88 percent as of December 31, 1995 (90.5 percent as of March 5, 1996).\nThe acquisition of additional shares of BLH common stock by Conseco and share repurchases by BLH in 1995 had the following effects on Conseco's consolidated balance sheet accounts as of the acquisition dates (dollars in millions):\nThe closing price of BLH's shares on the New York Stock Exchange on December 31, 1995, was $20.25 per share, indicating a total fair value of Conseco's investment in BLH of $904.4 million. Conseco's cost of these shares was $575.5 million. Shares held by Conseco are not freely tradable, and sale of such shares may require a registration statement with the Securities and Exchange Commission.\nWestern National Corporation\nIn connection with the organization of WNC and the transfer of the stock of Western National to WNC by Conseco, WNC issued 60 million shares of its common stock and a $150.0 million, 6.75 percent senior note due March 31, 1996 (the \"Conseco Note\") to Conseco. On February 15, 1994, WNC completed the IPO of 37.2 million shares of its common stock. Of these shares, 2.3 million were new shares sold by WNC and 34.9 million were sold by Conseco. In addition, Conseco sold .2 million shares to the president of WNC at the IPO price, less underwriting discounts and commissions. On February 22, 1994, WNC completed a public offering of $150.0 million aggregate principal amount of 7.125 percent senior notes due February 15, 2004. The net proceeds from the offering of $147.5 million (after original issue discount, underwriting discount and offering expenses) together with some of the proceeds from WNC's IPO of common stock, were used to repay the Conseco Note.\nThe shares sold by Conseco represented a 60 percent interest in WNC. Net pre-tax proceeds to Conseco from the repayment of the Conseco Note and the sale of WNC shares totaled $537.3 million. These proceeds were used to repay a $200 million senior unsecured loan and for other general corporate purposes. In the first quarter of 1994, Conseco reported a gain of approximately $42.4 million (net of taxes of $22.9 million) as a result of these transactions.\nCONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n------------------------------------\nOn December 23, 1994, Conseco sold its remaining 40 percent interest in WNC to American General Corporation for $274.4 million in cash, or $11.00 for each of the 24,947,500 WNC shares owned by Conseco. Conseco recognized a gain from the sale of approximately $4.1 million, net of taxes of $11.4 million. Net cash proceeds from the sale were used for general corporate purposes, including the repurchase of common stock of Conseco (see note 10).\nThe disposition of WNC as a result of the IPO was recorded in the consolidated statement of cash flows as follows (dollars in millions):\nMarketing Distribution Systems Consulting Group, Inc. (\"Bankmark\")\nConseco acquired all the outstanding common stock of Bankmark in 1993 and 1995 for $6.6 million. Bankmark is a marketing company which develops marketing relationships with financial institutions to provide insurance and investment products to their customers.\nAmerican Life Group, Inc.\nOn September 29, 1994, Partnership II completed the acquisition of AGP (the \"Acquisition\"). Under an Agreement and Plan of Merger dated May 1, 1994, AGP merged with a subsidiary of Partnership II. AGP's former stockholders received $15.25 in cash per common equivalent share. They also received a contingent payment right to receive up to another $2.00 in cash per common equivalent share (the \"Contingent Consideration\"), based on the outcome of AGP's pending litigation against the U.S. Government concerning AGP's former savings bank subsidiary (the \"AGP Litigation\").\nCONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n------------------------------------\nThe Acquisition and related transactions were funded with: (i) $45.9 million of cash contributions from Partnership II (including $7.4 million provided by Conseco, $1.8 million by BLH, and $1.8 million by CCP); (ii) $57.0 million in cash from the sale in a private placement of payment-in-kind preferred stock (the \"1994 Series PIK Preferred Stock\") (including $25.9 million purchased by BLH and $24.0 million purchased by CCP, $3.0 million of which was sold by CCP in December 1994); (iii) $150.0 million in cash from the sale in a public offering of 11-1\/4% Senior Subordinated Notes due 2004 (the \"Senior Subordinated Notes\"); and (iv) $200.0 million in cash from a senior secured loan (the \"Senior Term Loan\"). The sources and uses of this financing are summarized below (dollars in millions):\nIn accordance with the Partnership II agreement, Conseco earned fees of $2.5 million (net of taxes of $1.3 million) for services related to the financing of the Acquisition.\nOn November 30, 1995, AGP issued 2,142,857 shares of its common stock for $30.0 million (including $13.2 million paid by Conseco and its subsidiaries) in a private placement transaction. Eighty percent of the shares were purchased by Partnership II and the remainder were purchased by the other holders of AGP's common stock. The proceeds from the sale were used to reduce the amount of AGP's outstanding debt (see note 8). In accordance with the Partnership II agreement, Conseco earned fees of $.2 million (net of taxes of $.1 million) for services in connection with such transaction.\nCONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n------------------------------------\nThe acquisitions of CCP, BLH, Bankmark and AGP described above were recorded in the consolidated statement of cash flows as follows:\nThe following unaudited pro forma results of operations of the Company are presented as if the following had occurred as of January 1, 1994: (i) the CCP Merger; (ii) the acquisition of additional shares of BLH common stock in 1995; (iii) the acquisition of AGP by Partnership II; (iv) the IPO of WNC; and (v) the sale by Conseco of its remaining 40 percent equity interest in WNC.\nCONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n------------------------------------\nThe following unaudited pro forma results of operations of the Company are presented as if the following had occurred as of January 1, 1993: (i) Partnership II's acquisition of AGP; (ii) the IPO of WNC; (iii) the sale by Conseco of its remaining 40 percent equity interest in WNC; (iv) the IPO of BLH; and (v) Conseco's purchases in 1993 of additional shares of BLH and CCP. Prior operations of Bankmark are not included in the following table; the effect is not material.\n3. INVESTMENTS:\nAt December 31, 1995, the amortized cost and estimated fair value of actively managed fixed maturities were as follows:\nThe amortized cost and estimated fair value of actively managed fixed maturities were as follows at December 31, 1994:\nCONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n------------------------------------\nThe following table sets forth the amortized cost and estimated fair value of actively managed fixed maturities as of December 31, 1995, based upon the pricing source used to determine estimated fair value:\nThe following table sets forth fixed maturity investments at December 31, 1995, classified by rating categories. The category assigned is the highest rating by a nationally recognized statistical rating organization or, as to $282.9 million fair value of fixed maturities not rated by such firms, the rating assigned by the National Association of Insurance Commissioners (\"NAIC\"). For purposes of the table, NAIC Class 1 is included in the \"A\" rating; Class 2, \"BBB-\"; Class 3, \"BB-\"; and Classes 4-6, \"B+ and below.\"\nCONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n------------------------------------\nThe following table sets forth below investment grade fixed maturity investments as of December 31, 1995, summarized by the amount their amortized cost exceeds fair value:\nThe following table sets forth the amortized cost and estimated fair value of actively managed fixed maturities at December 31, 1995, by contractual maturity. Actual maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties and because most mortgage-backed securities provide for periodic payments throughout their lives.\nEquity securities consisted of the following:\nCONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n------------------------------------\nNet investment income consisted of the following:\nThe carrying value of fixed maturity investments and mortgage loans not accruing investment income totaled $1.5 million, $11.2 million and $19.6 million at December 31, 1995, 1994 and 1993, respectively.\nThe proceeds from sales of fixed maturity investments were $5.8 billion, $1.9 billion and $6.5 billion in 1995, 1994 and 1993, respectively. Proceeds from the sales of trading account securities were $2.1 billion, $.9 billion and $10.0 billion in 1995, 1994 and 1993, respectively.\nTrading income (losses) from sales of trading account securities, net of investment expenses, were included in revenue as follows:\nCONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n------------------------------------\nRealized gains (losses), net of realized gain expenses, were included in revenue as follows:\nChanges in unrealized appreciation (depreciation) on investments were as follows:\nCONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n------------------------------------\nAt December 31, 1995, net appreciation of equity securities (before income tax) was $2.0 million, consisting of $3.2 million of appreciation and $1.2 million of depreciation.\nAt December 31, 1995, the amortized cost and fair value of fixed maturity investments in default as to the payment of principal or interest totaled $3.3 million and $3.2 million, respectively. Conseco recorded writedowns of fixed maturity investments of $21.9 million in 1995, $1.0 million in 1994 and $7.9 million in 1993. These writedowns were the result of changes in conditions which caused the Company to conclude that it would not collect all amounts due according to the terms of the securities.\nInvestments in mortgage-backed securities at December 31, 1995, included collateralized mortgage obligations (\"CMOs\") of $2,055.9 million and mortgage-backed pass-through securities of $1,963.2 million. CMOs are securities backed by pools of pass-through securities and\/or mortgages that are segregated into sections or \"tranches.\" These securities provide for sequential retirement of principal, rather than the pro rata share of principal return which occurs through regular monthly principal payments on pass-through securities.\nThe following table sets forth the par value, amortized cost and estimated fair value of investments in mortgage-backed securities including CMOs at December 31, 1995, summarized by interest rates on the underlying collateral at December 31, 1995:\nThe amortized cost and estimated fair value of mortgage-backed securities including CMOs at December 31, 1995, summarized by type of security were as follows (dollars in millions):\nCONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n------------------------------------\nAt December 31, 1995, approximately 91 percent of the estimated fair value of Conseco's mortgage-backed securities was determined by nationally recognized pricing services and 9 percent was determined by broker-dealer market makers.\nAt December 31, 1995, the mortgage loan balance was primarily comprised of commercial loans, including multifamily residential loans. Approximately 40 percent, 9 percent and 7 percent of the mortgage loan balance were on properties located in California, Texas and Indiana, respectively. No other state comprised greater than 6 percent of the mortgage loan balance. Less than 1 percent of the mortgage loan balance was noncurrent at December 31, 1995. At December 31, 1995, the Company had an allowance for loss on mortgage loans of $5.2 million.\nAs part of its investment strategy, the Company enters into reverse repurchase agreements and dollar-roll transactions to increase its return on investments and improve its liquidity. These transactions are accounted for as short-term collateralized borrowings. Such borrowings averaged approximately $393.7 million during 1995 (compared to an average of $208.0 million during 1994) and were collateralized by investment securities with fair values approximately equal to the loan value. The weighted average interest rate on short-term collateralized borrowings was 5.6 percent in 1995 and 3.7 percent in 1994.\nLife insurance companies are required to maintain certain investments on deposit with state regulatory authorities. Such assets had an aggregate carrying value of $70.4 million at December 31, 1995.\nInvestments (all of which were actively managed fixed maturities) in any single entity in excess of ten percent of shareholders' equity at December 31, 1995, other than asset-backed securities and investments issued or guaranteed by the United States government or a United States government agency, were as follows:\nAsset-backed securities issued by a single entity in excess of ten percent of shareholders' equity at December 31, 1995, other than mortgage-backed securities issued or guaranteed by the United States Government or a United States Government agency, were as follows. Asset-backed securities issued by non-government entities are aggregated by the issuing entity with the number of individual securities (if greater than one) identified parenthetically following the issuer's name. The creditworthiness of such asset- backed securities is based solely on the underlying segregated pools of asset loan collateral and related credit enhancements rather than the general creditworthiness of the issuing entity.\nCONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n------------------------------------\n4. INVESTMENTS IN UNCONSOLIDATED AFFILIATES:\nCCP\nSee note 2 for a description of transactions affecting Conseco's ownership of CCP. As a result of the CCP Merger, CCP was merged with Conseco and CCP's subsidiaries and are now wholly-owned subsidiaries of Conseco. Effective January 1, 1995, the accounts of CCP are consolidated with those of Conseco. Conseco's investment in CCP for 1994 and 1993 was carried on the equity basis. During 1994 and 1993, Conseco amortized the difference of $22.8 million between the carrying value of its investment in CCP and the amount of its underlying equity in net assets on the straight-line basis over a 40-year period.\nIn 1994, CCP repaid its senior loan using a portion of the proceeds of a public offering of $200 million 10.5 percent senior notes due 2004. This repayment resulted in an extraordinary charge of $2.1 million to Conseco in 1994.\nThe following tables summarize financial information of CCP for the periods during which CCP and its subsidiaries were included in Conseco's financial statements on the equity basis:\nCONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n------------------------------------\nIn 1994, the Company received fees totaling $16.3 million for services provided by Conseco to WNC. Conseco also received dividends on WNC common stock totaling $3.0 million in 1994.\nCONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n------------------------------------\n5. INSURANCE LIABILITIES:\nInsurance liabilities consisted of the following:\nParticipating policies represented approximately 12 percent, 8 percent and 11 percent of total life insurance in force at December 31, 1995, 1994 and 1993, respectively. Participating policies represented approximately 1 percent, 2 percent and 3 percent of premium income for 1995, 1994 and 1993, respectively. Dividends on participating policies amounted to $12.3 million, $12.0 million and $16.0 million in 1995, 1994 and 1993, respectively.\nThe sale of fixed maturity investments during 1993 reduced the expected future yields on the investment of policyholder balances to the extent that projected future cash flows on certain products were insufficient to cover future benefits and expenses. Accordingly, Conseco established additional estimated insurance liabilities of $37.1 million by a charge to change in future policy benefits related to realized gains.\n6. REINSURANCE:\nCost of reinsurance ceded where the reinsured policy contains mortality risks totaled $72.6 million, $33.4 million and $35.8 million in 1995, 1994 and 1993, respectively. This cost was deducted from insurance premium revenue. Conseco is contingently liable for claims reinsured if the assuming company is unable to pay. Reinsurance recoveries netted against insurance policy benefits totaled $59.8 million, $23.7 million and $31.0 million in 1995, 1994 and 1993, respectively.\nCONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n------------------------------------\nThe Company has ceded certain policy liabilities under assumption reinsurance agreements. Since all of Conseco's obligations under the insurance contracts have been ceded to another company, insurance liabilities related to such policies were not reported in the balance sheet. Conseco believes the assuming companies are able to honor all contractual commitments under the assumption reinsurance agreements, based on its periodic reviews of financial statements, insurance industry reports and reports filed with state insurance departments.\nEffective April 1, 1994, BLH recaptured certain annuity business previously ceded to an unaffiliated company and retroceded to an affiliate of ICH. The excess of liabilities assumed of $390.2 million over assets acquired of $371.0 million was capitalized as a component of cost of policies purchased. Reserves related to these policies totaling $398.5 million were included in reinsurance receivables at December 31, 1993.\nEffective October 1, 1995, WNC recaptured certain annuity business ceded to Great American Reserve through a reinsurance agreement. Reserves related to these policies totaled $72.8 million. Recapture fees of $.7 million were recognized as income during the fourth quarter of 1995.\nAt December 31, 1995, Conseco's largest reinsurer accounted for less than .06 percent of total insurance liabilities and less than 9 percent of total reinsurance receivables.\n7. INCOME TAXES:\nIncome tax assets (liabilities) were comprised of the following:\nIncome tax expense was as follows:\nCONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n------------------------------------\nIncome tax expense differed from that computed at the applicable federal statutory rate (35 percent) for the following reasons:\nThe Omnibus Budget Reconciliation Act of 1993 (the \"Act\") was enacted on August 10, 1993. The most significant provision of the Act affecting the Company was the increase in the corporate income tax rate to 35 percent from 34 percent, effective for taxable income reported for the year 1993. As a result of the increase in the tax rate in 1993, the Company recognized additional tax expense of $8.9 million, consisting of: (i) $5.6 million related to 1993 income; (ii) $1.9 million related to a one-time adjustment of accumulated deferred taxes relating to prior years' income; and (iii) $1.4 million related to unrealized appreciation of securities at the date the new law was enacted. In addition, Conseco's equity in earnings of CCP was reduced by $1.6 million as a result of the Company's share of the additional tax expense recorded by CCP because of the increase in the tax rate. The impact of other provisions of the Act was not material to the Company.\nAt December 31, 1995, Conseco had federal income tax loss carryforwards of $408.3 million available (subject to various statutory restrictions) for use on future tax returns. Portions of these carryforwards begin expiring in 1999. Of the loss carryforwards, $41.8 million may be used to offset income only from the non-life insurance companies and $51.0 million may be used to offset income only from AGP's life insurance subsidiaries. None of the carryforwards are available to reduce the tax provision for financial reporting purposes. With respect to determining that the Company's net operating loss carryforward will be fully utilized, the Company is relying upon its past history of earnings.\nThe IRS has completed its examination of the Company for years through 1992 and is currently conducting an examination for years 1993 through 1994. All amounts due determined by completed examinations have been either paid or accrued.\nCONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n------------------------------------\n8. NOTES PAYABLE:\nNotes payable that are direct obligations of the Company at December 31, 1995 and 1994, were as follows:\nIn August 1995, the Company executed a $600 million Credit Agreement with a group of banks to finance the CCP Merger and to repay the $250.0 million principal amount outstanding under another credit agreement (which amount was borrowed in 1995 primarily to finance the purchase of BLH common stock by Conseco). The Credit Agreement has two tranches. One tranche permits maximum principal borrowings of $350.0 million (\"Tranche A\") and the other tranche permits maximum principal borrowings of $250.0 million (\"Tranche B\"). On the CCP Merger date, the Company borrowed $280.0 million under Tranche A and $250.0 million under Tranche B.\nTranche A and Tranche B borrowings bear interest based on either an offshore rate or a base rate. Offshore rates are equal to the reserve adjusted Interbank Offered Rate plus an applicable margin based on: (i) our aggregate outstanding bank debt; and (ii) the rating of our senior notes by Moody's and Standard & Poor's. Such margin varies from .75 percent to 1.75 percent. Base rates are equal to the bank's reference rate plus the offshore rate margin less 1.25 percent (provided such margin is not less than zero). At December 31, 1995, borrowings under Tranche A and Tranche B bear interest at a weighted average interest rate of 7.47 percent and 7.32 percent, respectively.\nMaximum borrowings under Tranche A are reduced (requiring principal payments if current borrowings exceed maximum borrowings) as follows: 1997 - $30.0 million; 1998 - $50.0 million; 1999 - $65.0 million; 2000 - $65.0 million; and 2001 - $140.0 million. Tranche B borrowings are due in 1999; such date may be extended to 2001 subject to defined conditions.\nMandatory prepayments are required as follows: (i) from 50 percent of excess cash flow as defined commencing for the year 1997; (ii) upon the sale or disposition of any significant assets other than in the ordinary course of business; and (iii) upon the sale or issuance of debt or equity securities of Conseco or any of its subsidiaries. The Credit Agreement also requires that any mandatory prepayments shall reduce the maximum borrowings permitted under the Credit Agreement by the amount of such prepayment. The Credit Agreement has as collateral, among other things, pledges of the capital stock of Conseco's subsidiaries.\nIn the fourth quarter of 1995, we repaid $50 million principal amount of borrowings under the Credit Agreement. On January 23, 1996, we repaid $245 million principal amount of borrowings under the Credit Agreement using the proceeds of the sale of convertible preferred stock (see note 16) and the maximum amount which may be borrowed under Tranche A was reduced to $250 million and future reductions were changed to: 1997 - $21.4 million; 1998 - $35.7 million; 1999 - $46.4 million; 2000 - $46.5 million; and 2001 - $100.0 million.\nCONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n------------------------------------\nAs the result of the CCP Merger, CCP's $200 million 10.5 percent senior notes due in 2004 became direct obligations of Conseco. The notes are unsecured and rank pari passu with all other unsecured and unsubordinated indebtedness of Conseco. The notes are not redeemable prior to maturity and are publicly traded on the New York Stock Exchange.\nIn February 1993, the Company completed a public offering of $200 million of 8.125% senior notes due in 2003. The notes are unsecured and rank pari passu with all other unsecured and unsubordinated indebtedness of the Company. The notes are not redeemable prior to maturity. Proceeds from the offering of approximately $195.6 million (after original issue discount and other associated costs) were used to repurchase in open market transactions or redeem the remaining outstanding 12.75 percent senior subordinated notes issued in July 1987, and for general corporate purposes. The repurchase and redemption of the senior subordinated notes resulted in an extraordinary charge of $8.4 million, net of a $4.3 million tax benefit, in 1993.\nOn February 15, 1994, the Company repaid a $200 million senior unsecured loan, resulting in an extraordinary charge of $1.2 million (net of a $.6 million tax benefit). In 1994 and 1993, the Company repaid the remaining principal balances outstanding on the promissory notes executed as part of the acquisition of National Fidelity resulting in an extraordinary charge of $.8 million (net of a $.4 million tax benefit) in 1994 and $.4 million (net of a $.3 million tax benefit) in 1993.\nAt December 31, 1995, notes payable of BLH, which are not direct obligations of Conseco, were as follows:\nAs part of its planned debt restructuring, BLH entered into a $110.0 million bridge loan facility in December 1995. Borrowings under the facility bear interest based on a Base Rate or LIBOR Rate, as defined. Such rate in effect at December 31, 1995 was 6.75 percent. BLH used proceeds from the bridge facility to repay and retire the senior term loan. Conseco recognized an extraordinary charge of $1.0 million (net of a $.5 million tax benefit) related to such repayments. In February 1996, the bridge facility was replaced by a new credit agreement (see note 16).\nBLH's $200.0 million senior subordinated notes bear interest at 13 percent. The notes are due November 1, 2002, and may be redeemed, at BLH's option, on or after November 1, 1997, at a redemption price initially at 106.5 percent and declining thereafter. In December 1993, BLH repurchased $20.0 million of the notes in open market transactions for $24.0 million, resulting in an extraordinary charge of $3.1 million, net of tax benefit. Conseco's share of this charge ($1.0 million) was included as an extraordinary charge in the consolidated financial statements. In March 1996, BLH redeemed $148.0 million principal amount of these notes pursuant to a tender offer (see note 16).\nBLH issued $36.7 million of paid-in-kind (\"PIK\") subordinated notes in connection with its acquisition by Partnership I. In 1993, BLH retired all of its PIK subordinated notes totaling $38.3 million and prepaid $55.0 million of its senior term loan. Repayment of this debt resulted in an extraordinary charge for BLH of $4.8 million, net of a $2.5 million tax benefit, in 1993. Conseco's share of this charge ($2.1 million) was included as an extraordinary charge in the consolidated financial statements.\nCONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n------------------------------------\nAt December 31, 1995, notes payable of Partnership II entities, which are not direct obligations of Conseco, were as follows:\nIn connection with the financing of the Acquisition, a subsidiary of AGP executed a $200 million senior term loan with a group of banks. In 1995, the AGP subsidiary made a $15.0 million scheduled payment and a $30.0 million unscheduled payment on the senior term loan. The $30.0 million unscheduled payment was made using the proceeds from the issuance of additional shares of AGP common stock. In addition, the AGP subsidiary executed a $225 million credit facility (the \"Senior Credit Facility\") and simultaneously borrowed $125.0 million. Such proceeds were used for the repayment in full of the remaining principal balance under the existing senior term loan. Conseco recognized an extraordinary charge of $1.1 million (net of $1.0 million income tax benefit) related to such repayments.\nThe Senior Credit Facility provides $225 million comprised of two tranches: the first providing maximum borrowings of $105 million (\"Tranche One\"), and the second providing maximum borrowings under a term loan of $20 million and a revolving credit facility of $100 million ('Tranche Two\"). ALHC borrowed $105.0 million under the Tranche One facility and $20.0 million under the Tranche Two facility. No amounts were drawn under the revolving credit facility during 1995.\nTranche One and Tranche Two borrowings bear interest based on a Base Rate or an Offshore Rate, as defined, plus an applicable margin which varies based on the AGP subsidiary's long-term senior debt rating. Such rates selected at December 31, 1995 were 7.32 percent for Tranche One and 7.82 percent for Tranche Two.\nUnless otherwise extended, the revolving credit agreement will mature, and all principal and interest thereon will become due and payable in October 1998. The revolving credit agreement may be extended in one year increments through October 2001, subject to defined conditions.\nThe Senior Credit Facility provides for mandatory prepayments under certain conditions and is collateralized by, among other things: (i) pledges of the capital stock of AGP's subsidiaries and a surplus note issued by American Life and Casualty Insurance Company (\"American Life,\" AGP's primary operating subsidiary) held by an AGP subsidiary; and (ii) the assignment of investment advisory agreements among AGP's principal subsidiaries and a subsidiary of Conseco. Borrowings under the credit agreement are unconditionally guaranteed by AGP and a non-insurance subsidiary of AGP.\nIn connection with the financing of the Acquisition, the AGP subsidiary issued $150 million of senior subordinated notes in a public offering. The senior subordinated notes bear interest at 11.25 percent and will mature in September 2004. Such notes are unsecured and will be subordinated in the right of payment to the prior payment in full of all senior indebtedness, including the AGP subsidiary's obligations under the Senior Credit Facility. The senior subordinated notes are redeemable at the option of the AGP subsidiary, in whole or in part, at any time on and after September 15, 1999, initially at 105.625 percent of their principal amount, plus accrued interest, declining to 100 percent of their principal amount, plus accrued interest, on and after September 15, 2001.\nCONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n------------------------------------\nOn the Acquisition date, AGP's notes payable included $69.0 million par value convertible subordinated debentures (\"Debentures\") due 2003. The Debentures bear interest at 6.25 percent. Prior to the Acquisition, the Debentures were convertible into shares of AGP's common stock at a conversion ratio of 65.625 shares of common stock for each $1,000 principal amount of Debentures. As a result of the Acquisition, holders of the Debentures are entitled to receive at their option the same consideration given to the holders of AGP common stock for each share of AGP common stock into which such securities were convertible prior to the Acquisition. Through December 31, 1995, Debentures with a principal amount of $54.0 million have been redeemed. The Debentures are redeemable, in whole or in part, at the option of AGP, at any time, on or after May 1, 1996, initially at 106 percent of the principal amount and declining to 100 percent of the principal amount on or after May 1, 1999. The requirement to hold funds in escrow for the conversion of the outstanding convertible debentures was eliminated upon execution of the Senior Credit Facility and repayment of the senior term loan.\nPrincipal amounts by maturity dates of the various notes, including the effects of the transactions which occurred after December 31, 1995, as described in note 16, were as follows:\nCONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n------------------------------------\n9. OTHER DISCLOSURES:\nLeases\nThe Company rents office space, equipment and computer software under noncancellable operating leases. Rental expense during 1995, 1994 and 1993, amounted to $20.8 million, $18.8 million and $11.9 million, respectively. Future required minimum rental payments as of December 31, 1995, were as follows (dollars in millions):\nEmployment Arrangements\nSome officers of the Company are employed pursuant to long-term employment agreements. One of these agreements provides for a base salary plus an annual bonus equal to 3 percent of the Company's consolidated defined pretax profits. This agreement renews annually for a five-year period unless either party notifies the other, in which case the agreement expires five years from the last renewal date. Additionally, a $1.9 million interest-free loan has been granted to the officer. Repayment is due two years after termination of the officer's employment contract.\nThe agreements described above also include provisions pursuant to which the employee may elect to receive, in the event of a termination of the agreement following a change in control of the Company (as defined), a severance allowance equal to 60 months' salary, bonus and other benefits. The employee also may elect to have the Company purchase all Conseco stock and all options to purchase Conseco stock, without deduction of the applicable exercise prices, held by such person at a price per share equal to the highest market price in the preceding six months.\nThe Company has qualified defined contribution plans in which substantially all employees of the Company's wholly owned subsidiaries, BLH and AGP are eligible to participate. Company contributions, which match certain voluntary employee contributions to the plan, totaled $2.2 million, $1.7 million and $1.4 million in the years ended December 31, 1995, 1994 and 1993, respectively, and may be made in cash or the Company's common stock.\nThe Company also has a stock bonus and deferred compensation program for certain officers and directors of Conseco and its wholly owned subsidiaries whereby the participants may voluntarily defer a portion of their compensation. Company contributions vary based on the profitability of the Company and the amount of compensation voluntarily deferred by each participant. Each year's contribution, which is fully funded in the form of Conseco's common stock, vests five years later or upon certain other events. The cost of the program is charged to expense over the vesting period and amounted to $3.7 million, $1.4 million and $2.3 million in 1995, 1994 and 1993, respectively. The market value of Conseco's common stock held under the program (included in other assets and other liabilities) was $46.0 million and $29.9 million at December 31, 1995, and 1994, respectively.\nBLH has a noncontributory, unfunded deferred compensation plan for qualifying members of its career agency force. Benefits are based on years of service and career earnings. The liability recognized in the consolidated balance sheet for the agents' deferred compensation plan was $32.2 million and $29.5 million at December 31, 1995 and 1994, respectively, substantially all of which represents vested benefits. Costs incurred on this plan, primarily representing interest on unfunded benefit costs, were $2.8 million, $2.7 million and $2.8 million during 1995, 1994 and 1993, respectively.\nCONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n------------------------------------\nBLH also provides certain health care and life insurance benefits for eligible retired employees. Benefits are provided under a contributory unfunded plan which includes cost-sharing features determined at the discretion of management. During 1994 and 1993, several modifications were made to postretirement benefit plans that: (i) established cost-sharing for certain future retirees; (ii) established maximum annual costs and benefits; and (iii) revised certain other benefits. Such changes made in 1993 resulted in a $45.0 million decrease in the accumulated postretirement benefit obligation (\"APBO\"). As a result, the APBO was reduced $27.6 million, goodwill was reduced by $17.9 million and deferred income tax liability was increased by $9.7 million. The remaining 1993 changes resulted in an unrecognized net reduction in prior service costs of $11.9 million and an unrecognized gain of $2.0 million. Such changes made in 1994 resulted in a $9.2 million amendment gain and $5.2 million curtailment gain. The amendment gain is amortized over the remaining service period of active plan participants. The curtailment gain is included in other income. Amounts related to the postretirement benefit plan consisted of the following:\nThe net cost of providing these benefits, included in other operating expenses, was comprised of the following:\nThe discount rates used in determining the accumulated postretirement benefit obligation were 7 percent and 8 percent at December 31, 1995 and 1994, respectively. Future increases in salaries and the assumed health care cost trend rates produce no change in the accumulated postretirement benefit obligation at December 31, 1995 and 1994, because of the employer's maximum cost sharing provisions discussed above.\nBLH has a stock option plan which authorizes the grant to employees or directors of options to purchase shares of common stock. A maximum of 3.5 million shares of common stock may be issued under options and related rights granted under the plan. The exercise price may not be less than the fair market value of the underlying shares on the date of the grant. Options may become exercisable immediately or over a period of time and remain exercisable for up to 10 years after grant. At December 31, 1995, options for a total of 1,157,800 shares at prices between $20.00 and $23.63 were outstanding of which 163,660 options were exercisable and approximately 2.3 million shares were available for future grant. The plan also authorizes the issuance of stock appreciation rights or limited rights (rights exercisable only in the event of a tender offer for or acquisition of 25 percent or more of BLH's outstanding common stock), but none have been granted.\nCONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n------------------------------------\nLitigation\nFrom time to time, the Company and its subsidiaries are involved in lawsuits which are related to their operations. In most cases, such lawsuits involve claims under insurance policies or other contracts of the Company. Even though the Company may be contesting the validity or extent of its liability in response to such lawsuits, the Company has established reserves in its consolidated financial statements which approximate its estimated potential liability. Accordingly, none of the lawsuits currently pending, either individually or in the aggregate, is expected to have a material effect on the Company's consolidated financial condition or results of operations.\nGuaranty Fund Assessments\nFrom time to time, mandatory assessments are levied on the Company's insurance subsidiaries by life and health guaranty associations of most states in which these subsidiaries are licensed. These assessments are to cover losses to policyholders of insolvent or rehabilitated insurance companies. The associations levy assessments (up to prescribed limits) on all insurers in a particular state in order to pay claims on the basis of the proportionate share of premiums written by insurers in the lines of business in which the insolvent or rehabilitated insurer is engaged. These assessments may be deferred or forgiven in certain states if they would threaten an insurer's financial strength and, in some states, these assessments can be partially recovered through a reduction in future premium taxes. The balance sheet at December 31, 1995, includes accruals of $16.6 million, which approximate the Company's estimate of all known assessments that will be levied against the Company's insurance subsidiaries by various state guaranty associations based on premiums that have been written through December 31, 1995. Such estimate is subject to change as the associations determine more precisely the losses that have occurred and how such losses will be allocated to insurance companies. The Company's cost for such assessments incurred by its insurance company subsidiaries and equity investees was $3.2 million in 1995, $8.0 million in 1994 and $2.9 million in 1993.\nInterest Rate Swap Agreements\nPrior to the Acquisition, AGP entered into several contracts to hedge interest rate risks. At the date of the Acquisition, these contracts had ceased to effectively hedge the risks and were recorded at their fair value pursuant to purchase accounting. All such contracts were terminated in 1994 and 1995, with no significant gain or loss recognized. The contracts were carried in the balance sheet as a liability at their fair value of $10.6 million at December 31, 1994.\nExpenses Related to Terminated Merger Agreement\nIn November 1994, Conseco and another company agreed to terminate a merger agreement. Conseco incurred pre-tax expenses totaling approximately $35.8 million including: (i) $15.1 million of fees to banks for financing commitments; (ii) $9.8 million loss on the decline in fair value of common stock acquired by Conseco in connection with the proposed merger; and (iii) $10.9 million of legal, accounting and actuarial fees and other expenses.\nMinority Interest\nMinority interest represents the interest of investors other than Conseco in BLH and Partnership II and its subsidiaries. Minority interest at December 31, 1995, included: (i) $73.4 million interest in the common stock of BLH; (ii) $99.0 million interest in the redeemable preferred stock of a subsidiary of AGP; (iii) $11.7 million interest in the AGP 1994 Series PIK Preferred Stock; and (iv) $219.2 million interest in the limited partnership and common stock of Partnership II and its subsidiaries.\nCONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n------------------------------------\nChanges in minority interest during 1995 and 1994 are summarized below:\nCONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n------------------------------------\n10. SHAREHOLDERS' EQUITY:\nAuthorized preferred stock is 20,000,000 shares. Conseco issued 100,000 shares of $55 Series B Redeemable Preferred Stock (\"Series B preferred stock\") with a stated value of $50.0 million ($500 per share) in 1987 and redeemed all of the shares at stated value in 1993. Conseco issued 5,750,000 shares of Series D Cumulative Convertible Preferred Stock (\"Series D preferred stock\") with a stated value of $287.5 million ($50 per share) in January 1993 in a public offering. Annual dividends of $3.25 on each Series D preferred share are cumulative from the date of original issue and are payable quarterly. The Series D preferred stock is convertible at the holder's option into shares of Conseco's common stock at a conversion price of $31.875 per share, equivalent to a ratio of approximately 1.5686 shares of common stock for each share of preferred stock. Proceeds from the offering of approximately $278.5 million (after underwriting and other associated costs) were used to redeem the Series B preferred stock and were added to the Company's general funds. During 1993, 274 Series D preferred shares were converted to 430 common shares. In 1994 and 1995, no Series D preferred shares were converted to common shares. In December 1994, the Company repurchased 80,000 Series D preferred shares in open market transactions in connection with its stock repurchase program at a total cost of $3.3 million. Such preferred shares would have been convertible into 125,490 shares of common stock.\nChanges in the number of shares of common stock outstanding for the years 1995, 1994 and 1993 were as follows:\nDividends declared on common stock for 1995, 1994 and 1993, were $.093, $.25 and $.15 per common share, respectively. A liability was accrued for dividends declared but unpaid at December 31, 1995, totaling $.4 million. Such dividends were paid in January 1996.\nIn 1995 and 1994, the Company repurchased approximately 4 million and 14 million shares of its common stock for $92.4 million and $360.2 million, respectively, in connection with its stock repurchase program.\nThe Company was authorized under its 1983 employee stock option plan to grant options to purchase up to 24 million shares of the Company's common stock at a price not less than its market value on the date the option is granted. The 1983 stock option plan continues to govern options granted thereunder, but expired in all other respects in December 1993. A new plan was adopted in 1994 which authorizes the granting of options to purchase up to 12 million shares of the Company's common stock at a price not less than its market value on the date the option is granted. The options are exercisable for up to 10 years from date of grant and may become exercisable immediately or over a period of time. The plan also permits granting of stock appreciation rights and certain other awards.\nCONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n------------------------------------\nStock options granted were as follows:\nIn addition to 16,942,832 shares of common stock reserved for issuance under the 1983 and 1994 stock option plans, 1,238,833 shares of common stock are reserved for issuance under stock bonus and deferred compensation plans. The common stock and additional paid-in capital account was reduced by $6.1 million at December 31, 1995, for the unearned portion of the incentive deferred compensation program.\nIn February 1994, Conseco implemented an option exercise program under which its chief executive officer and four of its executive vice presidents exercised outstanding options to purchase approximately 7.2 million shares of the Company's common stock. The options would otherwise have remained exercisable until the years 1999 and 2000. As a result of the exercise, the Company realized a tax deduction equal to the aggregate tax gain recognized by the executives. The tax benefit of $67.8 million (net of payroll taxes incurred of $2.9 million) and the proceeds from the exercise of these options of $15.4 million were reflected as increases to common stock and paid-in capital. The Company withheld sufficient shares to cover federal and state taxes owed by the executives as a result of the exercise transactions. Net of withheld shares, the Company issued approximately 3.6 million common shares to the executives. The Company also granted to the executive officers new options to purchase a total of 6,032,000 shares of the Company's common stock at $29.625 per share (the market price at the date of such grant) under the 1994 Stock and Incentive Plan to replace the shares surrendered for taxes and the exercise price on these and other recent option exercises and as the 1994 incentive grant to the executives.\nCONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n------------------------------------\n11. OTHER OPERATING STATEMENT DATA:\nInsurance policy income consisted of the following:\nThe five states with the largest shares of premiums collected in 1995 were Illinois (11 percent), Florida (10 percent), Michigan (7.5 percent), California (6.7 percent) and Texas (6.6 percent). No other state accounted for more than 5 percent of total collected premiums.\nOther operating costs and expenses were as follows:\nConseco considers anticipated returns from the investment of policyholder balances in determining the amortization of the cost of policies purchased and cost of policies produced. Sales of fixed maturity investments change the incidence of profits on such policies because gains (losses) are recognized currently and, if the sale proceeds are reinvested at the current market yields, the expected future yields on the investment of policyholder balances are reduced (increased). Accordingly, amortization of the cost of policies purchased was increased (decreased) by $106.4 million, $(3.9) million and $46.0 million in the years ended December 31, 1995, 1994 and 1993, respectively, and amortization of the cost of policies produced was increased (decreased) by $20.2 million, $(1.4) million and $43.2 million in the years ended December 31, 1995, 1994 and 1993, respectively.\nCONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n------------------------------------\nThe changes in the cost of policies purchased were as follows:\nBased on current conditions and assumptions as to future events on all policies in force, the Company expects to amortize approximately 14 percent of the December 31, 1995, balance of cost of policies purchased in 1996, 13 percent in 1997, 12 percent in 1998, 11 percent in 1999, and 10 percent in 2000. The discount rates used to determine the amortization of the cost of policies purchased prior to November 19, 1992, ranged from 15 percent to 20 percent during the three-year period ended December 31, 1995. The discount rates used to determine the amortization of the cost of policies purchased after November 19, 1992, ranged from 4 percent to 8 percent.\nThe changes in the cost of policies produced were as follows:\nCONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n------------------------------------\n12. CONSOLIDATED STATEMENT OF CASH FLOWS:\nThe following non-cash items were not reflected in the consolidated statement of cash flows in 1995: (i) the redemption of convertible subordinated debentures of a subsidiary with a principal amount of $9.2 million using segregated cash; (ii) the issuance of Conseco's common stock to employee benefit plans of $4.2 million; and (iii) the tax benefit of $.4 million related to the issuance of Conseco's common stock under employee benefit plans. The following non-cash items were not reflected in 1994: (i) recapture of insurance liabilities and invested assets totaling $390.2 million and $371.0 million, respectively, described in note 6; (ii) redemption of convertible subordinated debentures of a subsidiary with a principal amount of $44.8 million using segregated cash; (iii) the issuance of Conseco;'s common stock to employee benefit plans of $2.4 million; and (iv) the tax benefit of $69.2 million related to issuance of Conseco's common stock under employee benefit plans. The following non-cash items were not reflected in 1993: (i) the surrender for redemption of $50.0 million stated value of ICH preferred stock in exchange for common shares of BLH (as described in note 2 to the consolidated financial statements); (ii) recapture of insurance liabilities and invested assets each totaling approximately $338.5 million in connection with the recapture of reinsurance as described in note 6; (iii) the issuance of Conseco's common stock to employee benefit plans of $3.2 million; and (iv) the tax benefit of $15.3 million related to issuance of Conseco's common stock under employee benefit plans.\nCash flows from operations included interest paid on debt of $112.0 million, $54.3 million and $58.8 million in 1995, 1994 and 1993, respectively. Income taxes paid were $90.3 million, $99.8 million and $204.9 million in 1995, 1994 and 1993, respectively.\n13. STATUTORY INFORMATION:\nStatutory accounting practices prescribed or permitted for the Company's insurance subsidiaries by regulatory authorities differ from GAAP. The Company's life insurance subsidiaries reported the following amounts to regulatory agencies, after appropriate eliminations of intercompany accounts among such subsidiaries:\nCombined statutory net income of the Company's life insurance subsidiaries was $183.8 million, $112.5 million and $162.3 million in 1995, 1994 and 1993, respectively, after appropriate eliminations of intercompany amounts among such subsidiaries.\nIn connection with the acquisition of BLH, the capital of one of the life insurance subsidiaries (Bankers Life Insurance Company of Illinois) was increased by providing cash in exchange for a surplus debenture. The remaining balance of the surplus debenture of $430.0 million at December 31, 1995, is considered a part of statutory capital and surplus of the life insurance subsidiary. Payments to BLH of principal and interest on the surplus debenture may be made from available funds only with the approval of the Illinois Department of Insurance when its Director is satisfied that the financial condition of the subsidiary warrants that action. Such approval may not be withheld provided the surplus of the subsidiary exceeds, after such payment, approximately $128 million. Such subsidiary's surplus at December 31, 1995, was $359.1 million.\nCONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n------------------------------------\nAmerican Life and Casualty's capital and surplus includes a surplus note with a balance of $50.0 million at December 31, 1995. Each payment of interest or principal on the surplus notes requires the prior approval of the Iowa Insurance Division. The Iowa insurance law also provides that payments of dividends on capital stock and interest and principal on surplus notes may be made only out of an insurer's earned surplus. At December 31, 1995, American Life and Casualty had earned surplus of $109.5 million. American Life and Casualty follows certain permitted accounting practices which are not specifically prescribed in state laws, regulations, general administrative rules and various NAIC publications. Such permitted accounting practices do not affect statutory surplus.\nAs a result of the acquisitions and subsequent recapitalization transactions of CCP's insurance subsidiaries, a CCP insurance subsidiary issued a surplus debenture to its direct parent company. As required by the state regulatory authorities, the debenture is classified as a part of statutory capital and surplus of the insurance subsidiary to the extent that such capital and surplus equals the level of capital and surplus required by the regulators. The balance of the debenture in excess of such amount is carried as a liability on the statutory balance sheet. This amount, however, would be reclassified to statutory capital and surplus to the extent subsequently needed to meet the level of capital and surplus required by the regulators.\nStatutory accounting practices require the asset valuation reserve (\"AVR\") and the interest maintenance reserve (\"IMR\") be reported as liabilities. The purpose of these reserves is to stabilize statutory surplus against fluctuations in the market value of investments. The IMR captures all realized investment gains and losses, net of income tax, on debt instruments resulting from changes in interest rates and provides for subsequent amortization of such amounts into statutory net income on a basis reflecting the remaining lives of the assets sold. The AVR captures all realized, net of income tax, and unrealized investment gains and losses related to changes in creditworthiness and is also adjusted each year based on a formula related to the quality and loss experience of the Company's investment portfolio.\nIncluded in statutory capital and surplus shown above are the following investments in affiliates, all of which are eliminated in the consolidated financial statements prepared in accordance with GAAP:\nCONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n------------------------------------\nThe following table compares the consolidated pretax income determined on a statutory accounting basis with such income reported herein in accordance with GAAP:\nState insurance laws generally restrict the ability of insurance companies to pay dividends or make other distributions. Net assets of the Company's wholly owned life insurance subsidiaries, determined in accordance with generally accepted accounting principles, aggregated approximately $1.7 billion at December 31, 1995, of which approximately $97.9 million is available for distribution to Conseco in 1995 without the permission of state regulatory authorities.\nMost states have adopted risk-based capital (\"RBC\") rules to evaluate the adequacy of statutory capital and surplus in relation to investment and insurance risks. The RBC formula is designed as an early warning tool to help state regulators identify possible weakly capitalized companies for the purpose of initiating regulatory action. At December 31, 1995, the ratios of total adjusted capital to RBC, as defined by the rules, for the primary insurance subsidiaries of Conseco, BLH and AGP were greater than twice the level at which regulatory attention is triggered.\nCONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n------------------------------------\n14. BUSINESS SEGMENT AND DISTRIBUTION CHANNELS:\nConseco's earnings result from three different activities: (i) operating life insurance companies; (ii) providing services to affiliates and others for fees; and (iii) acquiring and restructuring investments, including life insurance companies held in partnership with other investors. Conseco's life insurance operations are primarily conducted through the following segments: (i) senior market operations (consisting of the activities of BLH, which distributes Medicare supplement policies and other life and health products to the senior citizens market and others through career agents, most of whom sell only BLH's products); (ii) annuity operations (consisting of the operations of Great American Reserve and Beneficial Standard which were subsidiaries of CCP prior to August 31, 1995, and which distribute tax qualified annuities and certain employee benefit-related products primarily to school teachers and administrators through educator market specialists and annuities and life insurance products through other diversified cost effective distribution channels); (iii) other life insurance operations (consisting of the operations of National Fidelity, Bankers National and Lincoln American which have profitable blocks of business, but do not currently market their products to new customers); (iv) partnership operations (consisting of the activities of AGP which distributes annuities and life insurance products through a general agency and brokerage distribution system and which was acquired through Partnership II in September 1994); and (v) WNC (which distributes single premium deferred annuities through financial institutions and other annuity products through personal producing general agents and which was disposed of in 1994).\nCONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n------------------------------------\nFinancial information related to these activities as included in the consolidated financial statements is as follows:\nCONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n------------------------------------\n15. QUARTERLY FINANCIAL DATA (UNAUDITED):\nWe compute earnings per common share for each quarter independently of earnings per share for the year. The sum of the quarterly earnings per share may not equal the earnings per share for the year because of: (i) transactions affecting the weighted average number of shares outstanding in each quarter; and (ii) the uneven distribution of earnings during the year.\nCONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n------------------------------------\nOur quarterly results of operations are based on numerous estimates, principally related to policy reserves, the amortization of cost of policies purchased, the amortization of cost of policies produced and income taxes. We revise all such estimates each quarter and we ultimately adjust them to year-end amounts. When we determine revisions are necessary, we report them as part of operations of the current quarter.\n16. SUBSEQUENT EVENTS (UNAUDITED):\nOn January 23, 1996, Conseco completed the offering of 4.37 million shares of Preferred Redeemable Increased Dividend Equity Securities, 7% Convertible Preferred Stock (\"PRIDES\"). Proceeds from the offering of approximately $258 million (after underwriting and other associated costs) were used to repay amounts outstanding under the Credit Agreement.\nEach share of PRIDES will pay dividends at the annual rate of 7 percent of the $61.125 liquidation preference per share (equivalent to an annual amount of $4.279 per share), payable quarterly. On February 1, 2000, unless either previously redeemed by Conseco or converted at the option of the holder, each share of PRIDES will mandatorily convert into two shares of Conseco common stock, subject to adjustment in certain events. Shares of PRIDES are not redeemable prior to February 1, 1999. During the period February 1, 1999 through February 1, 2000, the Company may redeem any or all of the outstanding shares of PRIDES. Upon such redemption, each holder will receive, in exchange for each share of PRIDES, the number of shares of Conseco common stock equal to (A) the sum of (i) $62.195, declining to $61.125 after February 1, 1999, and (ii) accrued and unpaid dividends divided by (B) the market price of Conseco common stock at such date, but in no event less than 1.71 shares of Conseco common stock. Pro forma fully diluted earnings per share for the year ended December 31, 1995, assuming: (i) the issuance of the PRIDES; and (ii) the use of such proceeds to reduce notes payable of Conseco, would have been $3.71, rather than reported fully diluted earnings per share of $4.22.\nIn March 1996, BLH completed a tender offer pursuant to which it repurchased $148 million principal balance of its 13 percent senior subordinated notes for $172 million. In the first quarter of 1996, Conseco will report an extraordinary charge of approximately $9 million (after applicable income tax) as a result of the repurchase. The repurchase was made using the proceeds from a revolving credit facility entered into in February 1996. Maximum principal amounts which can be borrowed under the agreement total $400 million (including a competitive bid facility in the aggregate principal amount of up to $100 million). Amounts borrowed under the new facility are due in 2001 and accrue interest at a rate of LIBOR plus an applicable margin of between 50 and 75 basis points, depending on BLH's ratio of consolidated net worth (such interest rate was 6.3 percent at March 6, 1996). Proceeds of $30 million were borrowed under the agreement to refinance the existing $110 million principal balance due under the bridge loan facility.\nIn conjunction with the tender offer, holders of a majority of the senior subordinated notes consented to amendments which eliminated substantially all of the restrictive covenants of the senior subordinated notes, including covenants which limited BLH's ability to pay dividends, incur additional indebtedness, repurchase its common stock, and make certain investments.\nBLH's new revolving credit agreement contains a number of covenants with respect to BLH, including among other things, prohibitions or limitations on indebtedness, liens, mergers, acquisitions, sales of assets outside of the normal course of business and certain transactions with affiliates.\nCONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n------------------------------------\nThe following table sets forth the capitalization of the Company as of December 31, 1995, and the pro forma capitalization of the Company to give effect the following transactions as further described above) as if each had occurred on December 31, 1995: (i) the issuance of the PRIDES and use of the proceeds therefrom to reduce notes payable; and (ii) the BLH tender offer and related financing.\nDuring the first quarter of 1996, BLH repurchased 1.3 million shares of its common stock at a cost of $27.5 million, increasing Conseco's ownership interest in BLH to 90.5 percent.\nIn February 1996, Conseco's Board of Directors authorized a two-for-one split of Conseco's common stock. The stock split will be paid April 1, 1996, to the holders of record at the close of business on March 20, 1996. The split will be effected by issuing one additional share of common stock for each share outstanding on the record date. All share data and per share amounts have been restated to reflect the effect of the stock split. The Board of Directors also authorized a quarterly cash dividend to be paid April 1, 1996, of 2 cents per post-split share; an increase of 1 cent over the prior rate.\nIn March 1996, Conseco implemented an option exercise program under which its chief executive officer and four of its executive vice presidents exercised outstanding options to purchase approximately 1.5 million shares of the Company's common stock. The options would otherwise have remained exercisable until the years 2000 through 2002. As a result of the exercise, the Company will be able to realize a tax deduction of approximately $45.3 million, equal to the aggregate tax gain recognized by executives as a result of the exercise. The Company withheld sufficient shares to cover federal and state taxes owed by the executives as a result of the exercise transaction. Net of withheld shares, the Company issued approximately .8 million shares of common stock to the executives. The Company also granted to the executive officers new options to purchase a total of .7 million shares at $32.44 (the market price of a share on the grant date) to replace the shares surrendered for taxes and the exercise price. The tax benefit related to Conseco's tax deduction, together with the proceeds from the exercise of the options, will be reflected as an increase, and the cost of the shares withheld to cover taxes and exercise price will be reflected as a decrease, to paid-in capital.\nCONSECO, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n------------------------------------\nIn March 1996, Conseco and Life Partners Group, Inc. (\"LPG\") signed a definitive merger agreement, whereby LPG would become a wholly owned subsidiary of Conseco. In the merger, each of the issued and outstanding shares of LPG common stock would be converted into the right to receive a fraction of a share of Conseco common stock determined by dividing $21.00 by the average closing price of Conseco common stock during the 20 trading days ending two days prior to the merger (such fraction to be not more than 0.7000 nor less than 0.5833). The total value of the transaction would be approximately $850 million, including $600 million of common stock to be issued by Conseco and $250 million of existing LPG long-term debt to be assumed by Conseco. Consummation of the merger, which is subject to customary terms and conditions, including approval by the stockholders of both LPG and Conseco and regulatory approvals, is expected before the end of June 1996. A termination fee of $20 million is payable under certain circumstances by either party if its shareholders do not approve the transaction. At September 30, 1995, LPG had total assets of $5.1 billion and total shareholders' equity of $.4 billion.\nIn March 1996, Conseco announced that Partnership II would be dissolved. Accordingly, the partners (including Conseco and its subsidiaries) have no further commitment to make additional contributions of capital to Partnership II. In accordance with the partnership agreement, all of Partnership II's assets (primarily its investment in AGP) will be distributed to its partners subject to the conditions contained in the partnership agreement. In any event, Partnership II's assets must be distributed within two years of the effective date of dissolution. In the first quarter of 1996, Conseco will report a one-time loss of approximately $6 million (net of applicable income taxes) as a result of the dissolution.\nITEM 9.","section_9":"ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNone.\nPART III\nThe information required by Part III is hereby incorporated by reference from the Registrant's definitive proxy statement to be filed with the Commission pursuant to Regulation 14A within 120 days after December 31, 1995, except that the information required by Item 10","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(a) 1. Financial Statements. See Index to Financial Statements on page 49 for a list of financial statements included in this Report.\n2. Financial Statement Schedules. The following financial statement schedules are included as part of this Report immediately following the signature page:\nSchedule II -- Condensed Financial Information of Registrant(Parent Company)\nSchedule III -- Supplementary Insurance Information\nSchedule IV -- Reinsurance\nAll other schedules are omitted, either because they are not applicable, not required, or because the information they contain is included elsewhere in the consolidated financial statements or notes.\n3. Exhibits. See Exhibit Index immediately preceding the Exhibits filed with this report\n(b) Reports on Form 8-K.\nNone\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, this 29th day of March, 1996.\nCONSECO, INC.\nBy: \/s\/ STEPHEN C. HILBERT -------------------------- Stephen C. Hilbert, 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:\nREPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULES\nTo the Shareholders and Board of Directors Conseco, Inc.\nOur report on the consolidated financial statements of Conseco, Inc. and Subsidiaries is included on page 51 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 on page 108 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.\nIndianapolis, Indiana March 20, 1996\nCONSECO, INC. AND SUBSIDIARIES\nSCHEDULE II\nCondensed Financial Information of Registrant (Parent Company) Balance Sheet as of December 31, 1995 and 1994 (Dollars in millions)\nCONSECO, INC. AND SUBSIDIARIES\nSCHEDULE II Condensed Financial Information of Registrant (Parent Company) Statement of Operations for the years ended December 31, 1995, 1994 and 1993 (Dollars in millions)\nCONSECO, INC. AND SUBSIDIARIES\nSCHEDULE II\nCondensed Financial Information of Registrant (Parent Company)\nStatement of Cash Flows for the years ended December 31, 1995, 1994 and 1993 (Dollars in millions)\nCONSECO, INC. AND SUBSIDIARIES\nSCHEDULE II\nNote to Condensed Financial Information\nBasis of Presentation\nThe condensed financial information should be read in conjunction with the consolidated financial statements of Conseco, Inc. The condensed financial information includes the accounts and activity of the Parent Company and its wholly-owned non-insurance subsidiaries which act as the holding companies for the Company's life insurance subsidiaries.\nCONSECO, INC. AND SUBSIDIARIES\nSCHEDULE III\nSupplementary Insurance Information (Dollars in millions)\nCONSECO, INC. AND SUBSIDIARIES\nSCHEDULE IV\nReinsurance for the years ended December 31, 1995, 1994 and 1993 (Dollars in millions)\nEXHIBIT INDEX Annual Report on Form 10-K of Conseco, Inc.\nExhibit No. Document - ------- --------\n2.3 Agreement and Plan of Merger dated as of May 1, 1994 by and among Conseco Capital Partners II, L.P., CCP II Acquisition Company and The Statesman Group, Inc. was filed with the Commission as Exhibit 2.1 to the Registrant's Report on Form 8-K dated September 29, 1994, and is incorporated herein by this reference.\n2.4 Agreement and Plan of Merger dated as of May 19, 1995, by and between CCP Insurance, Inc. and Conseco, Inc. was filed with the Commission as Exhibit 2.4 to the Registrant's Report on Form 8-K dated August 31, 1995, and is incorporated herein by this reference.\n2.5 Agreement and Plan of Merger dated as of March 11, 1996, by and among Conseco, Inc., LPG Acquisition Company and Life Partners Group, Inc. was filed with the Commission as Exhibit 2.5 to the Registrant's Report on Form 8-K dated March 11, 1996, and is incorporated herein by this reference.\n3.1 Amended and Restated Articles of Incorporation of the Registrant were filed with the Commission as Exhibit 3.1 to the Registration Statement on Form S-2, No. 33-8498; Articles of Amendment thereto, as filed September 9, 1988 with the Indiana Secretary of State, were filed with the Commission as Exhibit 3.1.1 to the Registrant's Annual Report on Form 10-K for 1988; and Articles of Amendment thereto, as filed June 13, 1989 with the Indiana Secretary of State, were filed with the Commission as Exhibit 3.1.2 to the Registrant's Report on Form 10-Q for the quarter ended June 30, 1989, Articles of Amendment thereto, as filed June 29, 1993 with the Indiana Secretary of State, were filed with the Commission as Exhibit 3.1.3 to the Registrant's Report on Form 10-Q for the quarter ended June 30, 1993, and Articles of Amendment thereto relating to the PRIDES were filed with the Commission as Exhibit 3.(i).3 to the Registrant's Report on Form 8-K dated January 17, 1996, and are incorporated herein by this reference.\n3.2 Amended and Restated By-Laws of the Registrant effective February 10, 1986 were filed with the Commission as Exhibit 3.2 to its Registration Statement on Form S-1, No. 33-4367, and an Amendment thereto was filed with the Commission as Exhibit 3.2.1 to Amendment No. 2 to its Registration Statement on Form S-1, No. 33-4367; and are incorporated herein by this reference.\n4.8 Indenture dated as of February 18, 1993, between the Registrant and Shawmut Bank Connecticut, National Association, as Trustee, for the 8 1\/8 percent Senior Notes due 2003, was filed with the Commission as Exhibit 4.8 to the Registrant's Annual Report on Form 10-K for 1992, and is incorporated herein by this reference.\n4.11 Articles of Amendment to the Registrant's Articles of Incorporation as filed January 22, 1993, with the Indiana Secretary of State establishing the designations, rights and preferences of the Series D Cumulative Convertible Preferred Stock were filed with the Commission as Exhibit 4.11 to the Registrant's Annual Report on Form 10-K for 1992, and is incorporated herein by this reference.\n4.12 Indenture dated as of September 29, 1994 between ALHC Merger Corporation and LTCB Trust Company and First Supplemental Indenture dated as of September 29, 1994 between American Life Holding Company and the Trustee for the 11 1\/4% Senior Subordinated Notes due 2004 were filed with the Commission as Exhibit 4.12 to the Registrant's Report on Form 8-K dated September 29, 1994, and are incorporated herein by this reference.\n*4.13 Indenture dated as of December 15, 1994, between CCP Insurance, Inc., and LTCB Trust Company, as Trustee, for the $200,000,000 aggregate principal amount of 10 1\/2% Senior Notes due 2004.\nExhibit No. Document - ------- -------- 4.13.1 First Supplemental Indenture between Conseco, Inc., as Issuer, and LTCB Trust Company as Trustee, dated as of August 31, 1995, was filed with the Commission as Exhibit 4.13.1 to the Registrant's Report on Form 10-Q for the quarter ended September 30, 1995, and is incorporated herein by this reference.\n4.14 Credit Agreement dated August 31, 1995 by and among Conseco, the financial institutions who are or from time to time become party thereto, The Chase Manhattan Bank, N.A., First Union National Bank of North Carolina, the Managing Banks named therein and Bank of America National Trust and Savings Association, was filed with the Commission as Exhibit 4.14 to the Registrant's Report on Form 10-Q for the quarter ended September 30, 1995, and is incorporated herein by this reference.\n*4.15 Borrower Shared Pledge Agreement dated as of August 31, 1995, between Conseco, Inc. and Bank of America National Trust and Savings Association, as Administrative Agent.\n*4.16 New CIHC Pledge Agreement dated as of August 31, 1995, between CIHC, Incorporated and Bank of America National Trust and Savings Association, as Administrative Agent.\nThe Registrant agrees to furnish the Commission upon its request a copy of any instrument defining the rights of holders of long-term debt of the Company and its consolidated subsidiaries.\n10.1.2 Employment Agreement dated January 1, 1987, between the Registrant and Stephen C. Hilbert was filed with the Commission as Exhibit 10.1.2 to the Registrant's Annual Report on Form 10-K for 1986, and Amendment No. 1 thereto were filed with the Commission as Exhibit 10.1.2 to the Registrant's Annual Report on Form 10-K for 1987; and are incorporated herein by this reference.\n10.1.3 Employment Agreement dated July 1, 1991, between the Registrant and Rollin M. Dick was filed with the Commission as Exhibit 10.1.3 to the Registrant's Report on Form 10-Q for the quarter ended June 30, 1991, and is incorporated herein by this reference.\n10.1.4 Employment Agreement dated July 1, 1991, between the Registrant and Donald F. Gongaware was filed with the Commission as Exhibit 10.1.4 to the Registrant's Report on Form 10-Q for the quarter ended June 30, 1991, and is incorporated herein by this reference.\n10.1.5 Employment Agreement dated July 1, 1991, between the Registrant and Lawrence W. Inlow was filed with the Commission as Exhibit 10.1.5 to the Registrant's Report on Form 10-Q for the quarter ended June 30, 1991, and is incorporated herein by this reference.\n10.1.9 Secured Promissory Note of Stephen C. Hilbert and Pledge Agreement between the Registrant and Stephen C. Hilbert dated February 25, 1988, were filed with the Commission as Exhibit 10.1.9 to the Registrant's Report on Form 10-Q for the quarter ended March 31, 1988, and are incorporated herein by this reference.\n10.1.10 Employment Agreement dated August 17, 1992, between the Registrant and Ngaire E. Cuneo was filed with the Commission as Exhibit 10.1.10 to the Registrant's Report on Form 10-Q for the quarter ended September 30, 1992, and is incorporated herein by this reference.\n*10.1.11 Employment Agreement dated October 1, 1995 between the Registrant and Louis P. Ferrero.\nExhibit No. Document - ------- -------- 10.8 The Registrant's Stock Option Plan was filed with the Commission as Exhibit B to its definitive Proxy Statement dated December 10, 1983; Amendment No. 1 thereto was filed with the Commission as Exhibit 10.8.1 to its Report on Form 10-Q for the quarter ended June 30, 1985; Amendment No. 2 thereto was filed with the Commission as Exhibit 10.8.2 to its Registration Statement on Form S-1, No. 33-4367; Amendment No. 3 thereto was filed with the Commission as Exhibit 10.8.3 to the Registrant's Annual Report on Form 10-K for 1986; Amendment No. 4 thereto was filed with the Commission as Exhibit 10.8 to the Registrant's Annual Report on Form 10-K for 1987; Amendment No. 5 thereto was filed with the Commission as Exhibit 10.8 to the Registrant's Report on Form 10-Q for the quarter ended September 30, 1991; and are incorporated herein by this reference.\n10.8.3 The Registrant's Cash Bonus Plan was filed with the Commission as Exhibit 10.8.3 to the Registrant's Report on Form 10-Q for the quarter ended March 31, 1989, and is incorporated herein by this reference.\n10.8.4 Amended and Restated Conseco Stock Bonus and Deferred Compensation Program was filed with the Commission as Exhibit 10.8.4 to the Registrant's Annual Report on Form 10-K for 1992, and is incorporated herein by this reference.\n10.8.6 Conseco Performance - Based Compensation Bonus Plan for Executive Vice Presidents was filed with the Commission as Exhibit B to the Registrant's definitive Proxy Statement dated April 29, 1994, and is incorporated herein by this reference.\n10.8.7 Conseco, Inc. Amended and Restated Deferred Compensation Plan was filed with the Commission as Exhibit A to the Registrant's definitive Proxy Statement dated April 26, 1995, and is incorporated herein by this reference.\n10.8.8 Amendment to the Amended and Restated Conseco Stock Bonus and Deferred Compensation Program was filed with the Commission as Exhibit 10.8.8 to the Registrant's Annual Report on Form 10-K for 1994, and is incorporated herein by this reference.\n10.8.9 Conseco 1994 Stock and Incentive Plan was filed as Exhibit A to the Registrant's definitive Proxy Statement dated April 29, 1994 and is incorporated herein by this reference.\n*10.8.10 Amendment Number 2 to the Amended and Restated Conseco Stock Bonus and Deferred Compensation Program.\n10.23 Aircraft Lease Agreement dated December 22, 1988, between General Electrical Capital Corporation and Conseco Investment Holding Company was filed with the Commission as Exhibit 10.23 to the Registrant's Annual Report on Form 10-K for 1988, and is incorporated herein by this reference.\n10.23.1 Amendment to Aircraft Lease Agreement dated December 22, 1988, between General Electric Capital Corporation and Conseco Investment Holding Company was filed with the Commission as Exhibit 10.23.1 to the Registrant's Annual Report on Form 10-K for 1993, and is incorporated herein by this reference.\n10.24 Aircraft Lease Agreement dated April 26, 1991 between General Electric Capital Corporation and Conseco Investment Holding Company was filed with the Commission as Exhibit 10.29 to the Registrant's Report on Form 10-Q for the quarter ended September 30, 1991, and is incorporated herein by this reference.\n10.24.1 Amendment to Aircraft Lease Agreement dated April 26, 1991, between General Electric Capital Corporation and Conseco Investment Holding Company was filed with the Commission as Exhibit 10.24.1 to the Registrant's Annual Report on Form 10-K for 1993, and is incorporated herein by this reference.\nExhibit No. Document - -------- -------- 10.25 Aircraft Lease Purchase Agreement dated December 28, 1993, between MetLife Capital Corporation and Conseco Investment Holding Company was filed with the Commission as Exhibit 10.25 to the Registrant's Annual Report on Form 10-K for 1993, and is incorporated herein by this reference.\n10.31 Helicopter Lease Agreement dated April 9, 1992 between General Electric Capital Corporation and Conseco Investment Holding Company was filed with the Commission as Exhibit 10.31 to the Registrant's Report on Form 10-Q for the quarter ended June 30, 1992, and is incorporated herein by this reference.\n10.32 Aircraft Lease Agreement dated October 6, 1993, between General Electric Capital Corporation and Conseco Investment Holding Company and the associated Assignment Agreement dated October 25, 1993, between General Electric Capital Corporation and Nationsbanc Leasing Corporation were filed with the Commission as Exhibit 10.32 to the Registrant's Annual Report on Form 10-K for 1993, and are incorporated herein by this reference.\n10.35 Stock Purchase Agreement dated December 2, 1994 between American General Corporation and Conseco Investment Holding Company was filed with the Commission as Exhibit 10.35 to the Registrant's Report on Form 8-K dated December 23, 1994, and is incorporated herein by this reference.\n10.36 Lease dated as of December 18, 1992 between LaSalle National Trust, N.A. as trustee and Bankers Life and Casualty Company relating to the lease of executive office and administration space by BLH was filed with the Commission as Exhibit 10.17 to Amendment No. 1 to BLH's Registration Statement on Form S-1, No. 33-55026, and is incorporated herein by this reference.\n10.37 Lease dated as of August 20, 1993 between REO Holding Corporation and Bankers Life and Casualty Company relating the lease of warehouse space by BLH was filed with the Commission as Exhibit 10.14 to BLH's Report on Form 10-K for 1994, and is incorporated herein by this reference.\n10.38 Purchase Agreement relating to Preferred Redeemable Increased Dividend Equity Securities, 7% PRIDES, Convertible Preferred Stock was filed with the Commission as Exhibit 1.1 to the Registrant's Report on Form 8-K dated January 17, 1996, and is incorporated herein by this reference.\n*11.1 Computation of Earnings Per Share - Primary.\n*11.2 Computation of Earnings Per Share - Fully Diluted.\n*12.1 Computation of Ratio of Earnings to Fixed Charges and Preferred Dividends.\n*21 List of Subsidiaries.\n*23 Consent of Independent Accountants\n*27 Financial data schedule for Conseco, Inc. dated December 31,\n*Filed herewith\nExhibit No. Document - ------- -------- Compensation Plans and Arrangements\n10.1.2 Employment Agreement dated January 1, 1987, between the Registrant and Stephen C. Hilbert.\n10.1.3 Employment Agreement dated July 1, 1991, between the Registrant and Rollin M. Dick.\n10.1.4 Employment Agreement dated July 1, 1991, between the Registrant and Donald F. Gongaware.\n10.1.5 Employment Agreement dated July 1, 1991, between the Registrant and Lawrence W. Inlow.\n10.1.9 Secured Promissory Note of Stephen C. Hilbert and Pledge Agreement between the Registrant and Stephen C. Hilbert.\n10.1.10 Employment Agreement dated August 17, 1992, between the Registrant and Ngaire E. Cuneo.\n10.1.11 Employment Agreement dated October 1, 1995 between the Registrant and Louis P. Ferrero.\n10.8 The Registrant's Stock Option Plan; Amendment No. 1 thereto; Amendment No. 2 thereto; Amendment No. 3 thereto; Amendment No. 4 thereto; and Amendment No. 5 thereto.\n10.8.3 The Registrant's Cash Bonus Plan.\n10.8.4 Amended and Restated Conseco Stock Bonus and Deferred Compensation Program.\n10.8.6 Conseco Performance - Based Compensation Bonus Plan for Executive Vice Presidents.\n10.8.7 Conseco, Inc. Amended and Restated Deferred Compensation Plan.\n10.8.8 Amendment to the Amended and Restated Conseco Stock Bonus and Deferred Compensation Program.\n10.8.9 Conseco 1994 Stock and Incentive Plan.\n*10.8.10 Amendment No. 2 to the Amended and Restated Stock Bonus and Deferred Compensation Program.","section_15":""}
{"filename":"835582_1995.txt","cik":"835582","year":"1995","section_1":"ITEM 1. BUSINESS\nGeneral\nHomeland Holding Corporation (\"Holding\"), through its wholly-owned subsidiary, Homeland Stores, Inc. (\"Homeland,\" and, together with Holding, the \"Company\"), is a leading supermarket chain in the Oklahoma, southern Kansas and Texas Panhandle region. The Company operates in four distinct market places Oklahoma City, Oklahoma, Tulsa, Oklahoma, Amarillo, Texas and certain rural areas of Oklahoma, Kansas and Texas. As of May 1, 1996, the Company operated 67 stores throughout these markets.\nThe Company's executive offices are located at 2601 N.W. Expressway, Oklahoma City, Oklahoma 73112, and its telephone number is (405) 879-6600.\nRestructuring\nOn or about May 13, 1996, the Company anticipates that it will file chapter 11 petitions with the United States Bankruptcy Court for the District of Delaware (the \"Bankruptcy Court\"). Simultaneous with such filings, the Company will submit a \"pre-arranged\" plan of reorganization and a disclosure statement, which set forth the terms of a proposed restructuring of the Company (the \"Restructuring\"). The Restructuring is designed to reduce substantially the Company's debt service obligations and labor costs and to create a capital and cost structure that will allow the Company to maintain and enhance the competitive position of its business and operations. The Restructuring was negotiated with, and is supported by, the lenders under the Company's existing revolving credit facility, an ad hoc committee (the \"Committee\") representing approximately 80% of the Company's outstanding Senior Notes (as defined under \"Management's Discussion and Analysis of Financial Conditions and Results of Operations - Liquidity and Capital Resources\") and the Company's labor unions. The Company expects to complete the Restructuring by mid-summer 1996.\nPursuant to the Restructuring, the $95 million of the Company's Senior Notes currently outstanding (plus accrued interest) will be canceled, and the noteholders will receive (in the aggregate) $60 million face amount of new senior subordinated notes of the reorganized Company and $1.5 million in cash. The new senior subordinated notes will mature in 2003, bear interest semi-annually at a rate of 10% per annum and will not be secured. In addition, the noteholders and the Company's general unsecured creditors will receive approximately 60% and 35%, respectively, of the equity of reorganized Holding (assuming total unsecured claims of approximately $63 million, including noteholder unsecured claims). Holding's existing equity holders will receive the remaining 5% of the new equity, together with five year warrants to purchase an additional 5% of such equity.\nAn integral part of the Restructuring is the Company's previously-announced deal with its labor unions to modify certain elements of the Company's existing collective bargaining agreements. These modifications will provide for, among other things, wage and benefit modifications, the buyout of certain employees and the issuance and purchase of new equity to a trust acting on behalf of the unionized employees. The modified collective bargaining agreements are conditioned on, and will become effective upon, the consummation of the Restructuring.\nIn order to facilitate the restructuring process, the Company will enter into a DIP Facility (as defined under \"Management's Discussion and Analysis of Financial Conditions and Results of Operations - Liquidity and Capital Resources\") with its existing bank group, which will provide the Company with up to $27 million of working capital financing. On or about May 13, 1996, the Company will file papers with the Bankruptcy Court seeking interim and then final approval of the DIP Facility. The Company believes that this facility will provide it with the financing necessary to maintain its normal business operations during the Restructuring period, including the payment of the postpetition claims of trade creditors and employees.\nBackground\nThe Company was organized in 1987 by a group of investors led by Clayton, Dubilier & Rice, Inc. (\"CD&R\"), a private investment firm specializing in leveraged acquisitions with the participation of management, for the purpose of acquiring substantially all of the assets and assuming specified liabilities of the Oklahoma division (the \"Oklahoma Division\") of Safeway Inc. (\"Safeway\") (the \"Acquisition\"). The stores changed their name to Homeland in order to highlight the Company's regional identity.\nPrior to the Acquisition, the Company did not have any significant assets or liabilities or engage in any activities other than those incidental to the Acquisition. Holding owns all of the outstanding capital stock of Homeland and has no other significant assets. The Clayton & Dubilier Private Equity Fund III Limited Partnership (\"C&D Fund III\"), a Connecticut limited partnership managed by CD&R, currently owns 35.9% of Holding's outstanding Class A Common Stock, par value $.01 per share (including redeemable Class A Common Stock, the \"Common Stock\"). The Clayton & Dubilier Private Equity Fund IV Limited Partnership (\"C&D Fund IV\"), a Connecticut limited partnership also managed by CD&R, currently owns 40.4% of the Class A Common Stock.\nBusiness Strategy\nFollowing the Acquisition, Homeland adopted a business strategy which was designed to maintain and improve its market leadership in its operating area. The Company's business strategy from 1987 through 1993 involved: (a) substantial investment to upgrade and remodel the existing store network and to build or acquire additional stores, which could be serviced by Homeland's existing warehouse and distribution center; and (b) adoption of a value-oriented merchandising concept combining a flexible high-low pricing structure (i.e., pricing of advertised or promotional items below the store's regular price and at or below the price offered by the store's competitors while allocating prime shelf space to high margin items) with a wide selection of products and an emphasis on quality and service. Increased advertising and promotion were used to expand the Company's customer base. The Company's decision to commit significant financing and human resources to upgrade and remodel its existing stores marked a sharp turnaround for the supermarket business that had constituted Safeway's Oklahoma Division.\nThe Company's business has been adversely affected in recent years by the entry of new competition into the Company's key markets, which has resulted in a decline in the Company's comparable store sales. The Company was unable to effectively respond to this increased competition because (i) the high labor costs associated with the Company's unionized workforce made it difficult for the Company to price its goods competitively with competitors (none of which has a unionized workforce), and (ii) the high fixed overhead costs associated with its warehouse operation made the closure of marginal and unprofitable stores financially prohibitive.\nIn the fourth quarter of 1994, the Company developed a plan to improve its financial position and to address the operating problems discussed above. In November 1994, the Company hired James A. Demme, a 35-year veteran of the wholesale and retail food distribution business, to be the Company's new President and Chief Executive Officer. Following the completion of the AWG Transaction (as defined under \"Business -- AWG Transaction\"), Mr. Demme and his new management team began implementing the Company's new marketing plan consisting of the following elements: (a) increasing sales of specialty items and perishables; (b) distinguishing the Company from its competitors by promoting and enhancing the Company's reputation for good service and emphasizing the Company's local identity; (c) increasing utilization of the Company s high-low pricing approach; (d) upgrading the Company's management information systems; (e) introducing the Homeland Savings Card, a frequent-shopper card; and (f) building customer loyalty and improving the Company s pricing image through the Company s private label program.\nAs part of its strategic plan, the Company's management team also implemented a program to close marginal and unprofitable stores. The Company closed 14 stores in 1995 (seven prior to the AWG sale and seven after such sale) and plans close two additional stores during 1996. The Company sold its store in Ponca City, Oklahoma in April 1996.\nFor additional information, see also \"Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources.\"\nAWG Transaction\nOn April 21, 1995, the Company sold 29 of its stores and its warehouse and distribution center to Associated Wholesale Grocers, Inc. (\"AWG\") pursuant to an Asset Purchase Agreement dated as of February 6, 1995 (the \"AWG Purchase Agreement\"), for a cash purchase price of approximately $72.9 million including inventory, and the assumption of certain liabilities by AWG. At the closing, the Company and AWG also entered into a seven-year supply agreement, whereby the Company became a retail member of the AWG cooperative and AWG became the Company's primary supplier. The transactions between the Company and AWG are referred to herein as the \"AWG Transaction.\"\nAWG is a buying cooperative which sells groceries on a wholesale basis to its retail member stores. AWG has 800 member stores located in a ten-state region and is the nation's fourth largest grocery wholesaler, with approximately $2.97 billion in revenues in 1995.\nOf the proceeds from the AWG Transaction, $25.0 million was allocated to the Senior Notes and $12.2 million was allocated to indebtedness under the Revolving Credit Agreement (as hereafter defined under \"Management's Discussion and Analysis of Financial Condition and Results of Operations- -Liquidity and Capital Resources\"). The remaining proceeds from the AWG Transaction were (i) used to pay certain costs, expenses and liabilities required to be paid in connection with the AWG Transaction and (ii) deposited into escrow pending reinvestment by the Company. At December 30, 1995, $1.7 million of the proceeds remained in escrow.\nThe AWG Transaction enabled the Company: (i) to reduce the Company's borrowed money indebtedness in respect of the Senior Notes and under the Revolving Credit Agreement by approximately $37.2 million in the aggregate; (ii) to have AWG assume, or provide certain undertakings with respect to, certain contracts and leases and certain pension liabilities of the Company; (iii) to sell the Company's warehouse and distribution center, which eliminated the high fixed overhead costs associated with the operation of the warehouse and distribution center and thereby permit the Company to close marginal and unprofitable stores; and (iv) to obtain the benefits of becoming a member of the AWG cooperative, including increased purchases of private label products, special product purchases, dedicated support programs and access to AWG's store systems and participation in the membership rebate and patronage programs.\nHomeland Supermarkets\nThe Company's current network of stores features three basic store formats. Homeland's conventional stores are primarily in the 25,000 total square feet range and carry the traditional mix of grocery, meat, produce and variety products. These stores contain more than 20,000 stock keeping units, including food and general merchandise. Sales volumes of conventional stores range from $60,000 to $125,000 per week. Homeland's superstores are in the 35,000 total square feet range and offer, in addition to the traditional departments, two or more specialty departments. Sales volumes of superstores range from $95,000 to $265,000 per week. Homeland's combo store format includes stores of approximately 45,000 total square feet and larger and was designed to enable the Company to expand shelf space devoted to general merchandise. Sales volume of combo stores range from $140,000 to $300,000 per week. The Company's new stores and certain remodeled locations have incorporated Homeland's new, larger superstore and combo formats.\nOf the 67 stores operated by the Company at May 1, 1996, 11 are conventional stores, 44 are superstores and 12 are combo stores. The chart below summarizes Homeland's store development over the last three years: Fiscal Year Ended 12\/30\/95 12\/31\/94 01\/01\/94\nAverage sales per store (in millions)............... $ 7.9 (1) $ 7.1 $ 7.2\nAverage total square feet per store................... 38,204 (1) 34,700 34,700\nAverage sales per square foot................. $207 (1) $205 $208\nNumber of stores: Stores at start of period... 111 112 113 Stores remodeled............ 5 10 3 New stores opened........... 0 0 1 Stores sold or closed....... 43 1 2 Stores at end of period..... 68 111 112\nSize of stores: Less than 25,000 sq. ft..... 8 24 24 25,000 to 35,000 sq. ft..... 24 38 39 35,000 sq. ft. or greater... 36 49 49\nStore formats: Conventional................ 11 29 29 SuperStore.................. 44 65 66 Combo....................... 13 17 17\n(1) Reflects the operations of 68 stores in 1995. The Company's Ponca City store, which was sold in April 1996, was a combo store.\nThe Company's network of stores is managed by district managers on a geographical basis through four districts. Each district manager oversees store operations for approximately 17 stores. Store managers are responsible for determining staffing levels, managing store inventories (within the confines of certain parameters set by the Company's corporate headquarters) and purchasing products. Store managers have significant flexibility with respect to the quantities of items carried, but not necessarily types of products purchased. The Company's corporate headquarters is directly responsible for merchandising, advertising, pricing and capital expenditure decisions.\nMerchandising Strategy and Pricing\nThe Company's merchandising strategy emphasizes competitive pricing through a high-low pricing structure, as well as the Company's leadership in quality products and ser- vice, selection, convenient store locations, specialty departments and perishable products (i.e., meat, produce, bakery and seafood). The Company's strategy is to price com- petitively with each conventional supermarket operator in each market area. In areas with discount store competition, the Company attempts to be competitive on high-volume, price sensitive items. The Company's in-store promotion strategy is to offer all display items at a lower price than the store's regular price and at or below the price offered by the store's competitors. The Company also currently offers double coupons, with some limitations, in all areas in which it operates.\nCustomer Service\nThe Company's stores provide a variety of customer services including, among other things, carry-out services, postal services, automated teller machines, pharmacies, video rentals, check cashing and money orders. The Company believes it is able to attract new customers and retain its existing customers because of its high level of customer service.\nAdvertising and Promotion\nAll advertising and promotion decisions are made by the Company's central merchandising and advertising staff. The Company's advertising strategy is designed to enhance its value-oriented merchandising concept and emphasize its reputation for fast, friendly service, variety and quality. Accordingly, the Company is focused on presenting itself as a competitively-priced, promotions oriented operator that offers value to its customers and an extensive selection of high quality merchandise in clean, attractive stores. This strategy allows the Company to accomplish its marketing goals of attracting new customers and building loyalty with existing customers. In May 1995, the Company introduced a new weekly advertising layout that improved product presentation and enhanced price perception. In addition, new signage was implemented in the stores calling attention to various in- store specials and creating a friendlier and more stimulating shopping experience.\nThe Company currently utilizes a broad range of print and broadcast advertising in the markets it serves, including newspaper advertisements, advertising inserts and circulars, television and radio commercials and promotional campaigns that cover substantially all of the Company s markets. The Company receives co-operative and performance advertising reimbursements from vendors which reduce its advertising costs.\nIn September 1995, the Company introduced a frequent-shopper card called the Homeland Savings Card, in its Amarillo, Texas stores. The Company believes that it is the only supermarket chain that can capitalize on a frequent- shopper card system because of the Company's advertising and market share dominance. The Company expects to introduce the Homeland Savings Card in its other stores in the third quarter of 1996.\nProducts\nThe Company provides a wide selection of name-brand and private label products to its customers. All stores carry a full line of meat, dairy, produce, frozen food, health and beauty aids and selected general merchandise. As of the close of fiscal year 1995, approximately 82% of the Company's stores had service delicatessens and\/or bakeries and approximately 65% had in-store pharmacies. In addition, some stores provide additional specialty departments that offer ethnic food, fresh and frozen seafood, floral services and salad bars.\nThe Company's private label name is Pride of America. The Company's private label program allows customers to purchase high quality products at lower than national brand retail prices. The Company's private label products include over 400 items covering virtually every major category in the Company's stores, including dairy products, meat, frozen foods, canned fruits and vegetables, eggs, health and beauty care products and plastic wrap.\nAs a result of the Company's supply relationship with AWG, the Company's stores also offer certain AWG private label goods, including Best Choice and Always Save .\nPrivate label products generally represent quality and value to customers and typically contribute to a higher gross profit margin than national brands. The promotion of private label products is an integral part of the Company's merchandising philosophy of building customer loyalty as well as improving the Company's pricing image.\nSupply Arrangements\nThe Company is a party to the supply agreement with AWG (the \"Supply Agreement\"), pursuant to which the Company became a member of the AWG cooperative and AWG is the Company's primary supplier. AWG currently supplies approximately 70% of the goods sold in the Company's stores. AWG is a buying cooperative which sells groceries on a wholesale basis to its retail member stores. AWG has approximately 800 member stores located in a ten-state region and is the nation's fourth largest grocery wholesaler, with approximately $2.97 billion in revenues in 1995.\nPursuant to the Supply Agreement, AWG is required to supply products to the Company at the lowest prices and on the best terms available to AWG's retail members from time to time. In addition, the Company is (1) eligible to participate in certain cost-savings programs available to AWG's other retail members and (2) is entitled to receive certain member rebates and refunds based on the dollar amount of the Company's purchases from AWG's distribution center and periodic cash payments from AWG, up to a maximum of approximately $1.3 million per fiscal quarter, based on the dollar amount of the Company's purchases from AWG's distribution centers during such fiscal quarter.\nThe Company purchases goods from AWG on an open account basis. AWG requires that each member's account be secured by a letter of credit or certain other collateral in an amount based on such member's estimated weekly purchases through the AWG distribution center. The Company's open account with AWG is currently secured by an $8.4 million letter of credit (the AWG Letter of Credit ) issued in favor of AWG by National Bank of Canada. In addition, the Company's obligations to AWG are secured by a first lien on all AWG Equity owned from time to time by the Company, which includes, among other things, AWG membership stock, the Company's right to receive monthly payments and certain other rebates, refunds and other credits owed to the Company by AWG (including patronage refund certificates, direct patronage or year-end patronage and concentrated purchase allowances).\nThe amount of the AWG Letter of Credit may be decreased on a biannual basis upon the request of the Company based on the Company's then-current average weekly volume of purchases and by an amount equal to the face amount of the Company's issued and outstanding AWG patronage refund certificates. In the event that the Company's open account with AWG exceeds the amount of the AWG Letter of Credit plus any other AWG Equity held as collateral for the Company's open account, AWG is not required to accept orders from, or deliver goods to, the Company until the amount of the AWG Letter of Credit has been increased to make up for any such deficiency.\nUnder the Supply Agreement, AWG has certain Volume Protection Rights, including (1) the right of first offer (the First Offer Rights ) with respect to any proposed sales of stores supplied under the Supply Agreement (the Supplied Stores ) and proposed transfers of more than 50% of the outstanding stock of the Company or Holding to an entity primarily engaged in the retail or wholesale grocery business, (2) the Company's agreement not to compete with AWG as a wholesaler of grocery products during the term of the Supply Agreement, and (3) the Company's agreement to dedicate the Supplied Stores to the exclusive use of a retail grocery facility owned by a retail member of AWG (the Use Restrictions ). The Company's agreement not to compete and the Use Restrictions contained in the Supply Agreement are terminable with respect to a Supplied Store upon the occurrence of certain events, including the Company's com- pliance with AWG's First Offer Rights with respect to any pro- posed sale of such store. In addition, the Supply Agreement provides AWG with certain purchase rights in the event the Company closes 90% or more of the Supplied Stores.\nEmployees and Labor Relations\nAt April 1, 1996, the Company had a total of 4,384 employees, of whom 2,762, or approximately 63%, were employed on a part-time basis. The Company employs 4,267 in its super- market operations. The remaining employees are corporate and administrative personnel.\nThe Company is the only unionized grocery chain in its market areas. Approximately 91% of the Company's employees are union members, represented primarily by the United Food and Commercial Workers of North America ( UFCWNA ). In 1993, the UFCWNA ratified the existing UFCWNA labor agreement, implementing certain wage and benefit concessions.\nIn March 1996, the Company and representatives of the UFCWNA reached an agreement in principle regarding certain modifications to the Company's existing collective bargaining agreements. The Modified Union Agreement was ratified during the week of March 11, 1996, by substantially all of each of the UFCWNA local union chapters. In addition the local union chapter of the Bakery, Confectionery and Tobacco Workers International Union (the \"BCT\"), representing 30 of the Company's in-store bakery employees, ratified modifications to its union agreement on the same terms and conditions as the modified union agreement with the UFCWNA (the modified union agreements with the UFCWNA and the BCT are referred to collectively as the \"Modified Union Agreements\").\nThe Modified Union Agreements have a term of five years commencing on the Effective Date and are conditioned on the consummation of the Restructuring. The Modified Union Agreements consist of five basic elements: (a) wage rate and benefit contribution reductions and work rule changes; (b) the Employee Buyout Offer, pursuant to which the Company will make up to $6.4 million available for the buyout of certain unionized employees; (c) the establishment of an employee stock option trust (acting on behalf of the Company's unionized employees), which will receive, or be entitled to purchase, up to 522,222 shares of New Common Stock, or 10% of the New Common Stock, pursuant to the terms of the Modified Union Agreements; (d) the UFCWNA's right to designate one member of the Boards of Directors of Homeland and Holding following the Restructuring; and (e) the elimination of certain \"snap back\" provisions, incentive plans and \"maintenance of benefits\" provisions.\nThe Company estimates that the Modified Union Agreements will result in cost savings of approximately $7.2 million (assuming no employees accept the Employee Buyout Offer) to $13.2 million (assuming the Employee Buyout Offer is fully subscribed) during the first full contract year following the Restructuring. There can be no assurance, however, that such cost savings will actually be realized. In addition, cost savings in future contract years may be offset in part by certain wage and benefit increases.\nComputer and Management Information Systems\nDuring 1995, the Company installed new client\/server systems in order to enhance its information management capabilities, improve its competitive position and enable the Company to terminate the MIS Agreement (as defined below). The new system includes the following features: time and attendance, human resource, accounting and budget tracking, and scan support and merchandising systems.\nOn October 1, 1991, the Company entered into an agreement (the MIS Agreement ) with K-C Computer Services, Inc. ( K-CCS ), providing for the outsourcing of the Company's management information system and electronic data processing functions. As a result of the installation of the new systems described above, the Company terminated the MIS Agreement effective as of March 31, 1996. The Company estimates that the termination of the MIS Agreement will reduce the Company s data processing and support costs by (net of replacement costs and other expenses) by approximately $23.9 million over fiscal years 1996 through 2001.\nThe MIS Agreement provides a schedule for the payment of liquidated damages upon termination of the MIS Agreement prior to its expiration in 2001. Pursuant to the terms of the AWG Purchase Agreement, AWG is responsible for 52.3% of the payments under the MIS Agreement, including any termination payment. According to the liquidated damage schedule in the MIS Agreement, if the MIS Agreement is terminated for convenience by Homeland during 1996, the liquidated damage amount is $3 million. The same schedule provides for $2 million in liquidated damages if the MIS Agreement is terminated by the Company as a result of an acquisition. The Company is unable to determine whether the liquidated damage amounts under the MIS Agreement accurately reflect the actual damages incurred by K-CCS as a result of the termination of the MIS Agreement prior to its expiration date. Pursuant to the AWG Purchase Agreement, the Company and AWG are required to take all steps reasonably practicable to achieve cost savings under the MIS Agreement.\nThe Company has installed laser-scanning checkout systems in substantially all of its 67 stores. The Company utilizes the information collected through its scanner systems to track sales and to coordinate purchasing.\nCompetition\nThe supermarket business is highly competitive but very fragmented and includes small independent operators. The Company estimates that these operators represent over 40% of its markets. The Company also competes with larger store chains such as Albertson s and Wal-Mart, which operate 42 stores and 18 stores, respectively, in the Company's market areas, price impact stores such as Mega-Market, large independent store chains such as IGA, regional chains such as United and discount warehouse stores.\nThe Company is a leading supermarket chain in Oklahoma, southern Kansas and the Texas Panhandle region. The Company attributes its leading market position to certain advantages it has over certain of its competitors including significant economies of scale for purchasing and advertising, excellent store locations and a strong reputation within the communities in which the Company operates.\nThe Company's business has been adversely affected in recent years by the entry of new competition into the Company's key markets, which has resulted in a decline in the Company's comparable store sales. In 1994, there were 14 competitive openings in the Company's market areas including 11 new Wal-Mart supercenters, 2 new Albertson s and 1 new Mega Market. In 1995, there were 8 additional competitive openings in the Company's market areas, including 3 new Albertson s and 1 new Wal-Mart. Based on information publicly available, the Company expects that, in late 1996 or early 1997, Albertson's will open 3 new stores, Reasor's will open 1 new store and Crest will open 1 new store in the Company's market areas.\nTrademarks and Service Marks\nDuring the transition from Safeway to Homeland, the Company was able to generate a substantial amount of familiarity with the Homeland name. The Company continues to build and enhance this name recognition through promotional advertising campaigns. The Homeland name is considered material to the Company's business and is registered for use as a service mark and trademark. The Company has received federal and state registrations of the Homeland mark as a service mark and a trademark for use on certain products. The Company also received a federal registration of the service mark A Good Deal Better in early 1994.\nRegulatory Matters\nHomeland is subject to regulation by a variety of local, state and federal governmental agencies, including the United States Department of Agriculture, state and federal pharmacy regulatory agencies and state and local alcoholic beverage and health regulatory agencies. By virtue of this regulation, Homeland is obligated to observe certain rules and regulations, the violation of which could result in suspension or revocation of various licenses or permits held by Homeland. In addition, most of Homeland's licenses and permits require periodic renewals. To date, Homeland has experienced no material difficulties in obtaining or renewing its regulatory licenses and permits.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nOf the 67 supermarkets operated by the Company, 12 are owned and the balance are held under leases which expire at various times between 1996 and 2013. Most of the leases are subject to six five-year renewal options. Out of 55 leased stores, only eight have terms (including option periods) of fewer than 20 years remaining. Most of the leases require the payment of taxes, insurance and maintenance costs and many of the leases provide for additional contingent rentals based on sales. No individual store operated by Homeland is by itself material to the financial performance or condition of Homeland as a whole. The average rent per square foot under Homeland's existing leases is $3.67 (without regard to amortization of beneficial interest).\nSubstantially all of the Company's properties are subject to mortgages securing the Company's Senior Notes. As a result of the Restructuring, the Company anticipates that such mortgages will be released. The Company, however, expects the released properties to be subsequently secured under the New Credit Agreement (see \"Management's Discussion and Analysis of Financial Conditions and Results of Operations Liquidity and Capital Resources\")\nAlthough the Company believes that most of its existing store leases are at or below the current market rate, certain of the Company's stores are subject to burdensome lease terms. As part of the Restructuring, the Company intends to seek permission (pursuant to the Bankruptcy Code) to reject up to seven store leases and may also reject store leases on two underperforming stores to be closed during 1996.\nOn June 12, 1995, the Company relocated its executive offices to a new leased facility located at 2601 Northwest Expressway, Suite 1100 E, Oklahoma City, Oklahoma 73112.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nRoutine Litigation\nThe Company is a party to ordinary routine litigation incidental to its business.\nWithdrawal Liability Dispute\nThe Company received a notice and demand for payment dated June 22, 1995, from Central States, Southeast and Southwest Areas Pension Fund (the Fund ) in the amount of approximately $4.4 million. The Fund has asserted that the Company incurred a withdrawal liability because the Fund contends that the cessation of contributions to the Fund by the Company was not solely because of the AWG Transaction. The Company believes that no liability was incurred because the AWG Sale was in compliance with an exemption from withdrawal liability provided by Section 4204 of the Employee Retirement Income Security Act of 1974, as amended ( ERISA ).\nOn September 29, 1995, the Fund filed a collection action (the Illinois Action ) in the United States District Court for the Northern District of Illinois, Eastern Division, to compel the Company to make payments on the asserted liability. On January 18, 1996, the Company initiated arbitration of the withdrawal liability dispute by filing a Demand for Arbitration with the American Arbitration Association. No arbitration schedule had been set as of May 1, 1996.\nPursuant to the AWG Purchase Agreement, AWG is obligated to reimburse the Company in an amount up to approximately $3.4 million for any withdrawal liability incurred with respect to covered operations resulting from a failure to satisfy the requirements of ERISA Section 4204 in respect of the covered operations. The Company has requested that AWG make the withdrawal liability payments. AWG has denied liability and has refused to reimburse the Com- pany for any withdrawal liability or to make the withdrawal liability payments to the Fund. On March 11, 1996, AWG filed an action in the United States District Court for the District of Kansas for a declaratory judgment as to the rights and legal relations between the Company and AWG arising out of AWG's agreement to reimburse the Company.\nOn March 14, 1996, the Company filed a Motion to Implead AWG as a third party defendant in the Illinois Action. On March 15, 1996, the Fund filed a Motion for Summary Judgment for the entire withdrawal liability assessment of approximately $4.4 million and for an unspecified amount of liquidated damages, attorney's fees and costs. The Company and the Fund have agreed to mediate the dispute and the Judge has appointed a third party mediator. No mediation date had been set as of May 1, 1996.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matters were submitted by Holding to a vote of Holding's security holders during the quarter ended December 30, 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThere is no established public trading market for the Common Stock, the only class of common equity of Holding currently issued and outstanding.\nITEM 6.","section_6":"ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA\nThe following table sets forth selected consolidated financial data of the Company which has been derived from financial statements of the Company for the 52 weeks ended December 30, 1995, December 31, 1994 and January 1, 1994, the 53 weeks ended January 2, 1993 and the 52 weeks ended December 28, 1991 respectively, which have been audited by Coopers & Lybrand L.L.P. See Notes to Selected Consolidated Financial Data for additional information.\nThe selected consolidated financial data should be read in conjunction with the respective consolidated financial statements and notes thereto which are contained elsewhere herein. (In thousands, except per share amounts)\nNOTES TO SELECTED CONSOLIDATED FINANCIAL DATA (In thousands)\n(1) Operational restructuring costs during 1995 included the write-off of software no longer utilized by the Company, the write-off of goodwill in connection with the Restructuring and a termination charge resulting from the cancellation of the Company's computer outsourcing agreement. Operational restructuring costs during 1994 included the estimated losses to be incurred on the AWG Transaction and associated expenses and the estimated losses and expenses in connection with the anticipated closing of 15 stores during 1995.\n(2) Extraordinary items during 1995 included the payment of $906 in premiums and consent fees on the redemption of $15,600 of the Company's Senior Notes and $1,424 in unamortized financing costs related to the Senior Notes so redeemed as well as the replacement of the prior revolving credit facility.\n(3) Extraordinary items during 1993 included the payment of approximately $2,776 in premiums on the redemption of $47,750 in aggregate principal amount of the Company's remaining 15-1\/2% Subordinated Notes due November 1, 1997 (the \"Subordinated Notes\") at a purchase price of 105.8% of the outstanding principal amount, and $1,148 in unamortized financing costs related to the Subordinated Notes so redeemed.\n(4) Extraordinary items during 1992 included the payment of approximately $1,225 in premiums on the repurchase of $12,250 in aggregate principal amount of the Company's Subordinated Notes at a purchase price of 110% of the outstanding principal amount, $371 in unamortized financing costs related to the Subordinated Notes so purchased, and a credit representing the discount of $500 on the Company's prepayment of $1,500 on the $5,000 note payable to Furrs, Inc. issued in connection with the Company's acquisition of certain stores from Furrs, Inc. in September 1991. The extraordinary items have been shown net of income taxes of $219.\n(5) Common Stock held by management investors is presented as redeemable common stock and excluded from stockholders' equity since the Company has agreed to repurchase such shares under certain defined conditions, such as death, retirement or permanent disability. See \"Management -- Management Stock Purchases.\" In addition, net income (loss) per common share reflects the accretion in\/reduction to redemption value as a reduction\/increase in income available to all common stockholders.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nResults of Operations\nGeneral\nThe table below sets forth selected items from the Company's consolidated income statement as a percentage of net sales for the periods indicated:\nPercentage of Net Sales Fiscal Year\nComparison of Fifty-Two Weeks Ended December 30, 1995 with Fifty-Two Weeks Ended December 31, 1994\nSales. Net sales for 1995 declined to $630.3 million, a 19.7% decrease from sales of $785.1 million in 1994. The decrease in net sales was due primarily to the sale of 29 stores to AWG on April 21, 1995 and the closing of 14 underperforming stores over the course of 1995. These stores were closed pursuant to the Company's plan to close certain marginal and underperforming stores. Net sales were also impacted by increased competition in the Company's market area resulting from additional store openings of Wal-Mart supercenter stores and Albertsons stores during 1994. There was one new Wal-Mart supercenter store and three Albertson's stores that opened in the Company's market area during 1995.\nThe Company's comparable stores sales for the 68 stores increased by 0.2% compared to the prior year, due primarily to improved store conditions, a new advertising program and increased promotional pricing.\nCost and Expenses. Gross profit as a percentage of sales decreased to 24.0% in 1995 compared to 25.1% in 1994. The continued erosion of the Company's gross margins was the result of a number of factors including (a) the difficulties in transforming the Company from a self-supplier to a member of a purchasing cooperative and (b) additional competitive openings (there were eight additional competitive openings in the Company's market areas in 1995) and the aggressive pricing practices of certain competitors.\nSelling and administrative expenses as a percentage of sales decreased in 1995 to 24.1% from 24.7% in 1994. The Company was able to implement personnel and other cost reductions at the corporate office as a result of the sale of 29 stores and its distribution center to AWG. This included a reduction of headcount by approximately 50% at the corporate office, lower travel, telephone, and service charges, computer expenses and other related administrative expenses. The decrease was also due to an additional workers compensation accrual during 1994 that did not recur in 1995.\nThe Company is continuing its drive to contain and reduce costs. New systems have recently been installed that allowed the Company to terminate its expensive computer outsourcing agreement, thereby reducing future computer and information systems costs. Furthermore, the Company expects to streamline numerous other processes that will benefit expense reduction efforts.\nOperational Restructuring Costs. Operational restructuring costs for 1995 amounted to $12.6 million which included the write-off of computer software no longer being utilized by the Company, the write-off of goodwill in connection with the Restructuring and a termination fee associated with the cancellation of the Company's computer outsourcing agreement.\nOperating Loss. Operating loss was $13.5 million in 1995 compared to an operating loss of $20.1 million in 1994. The lower operating loss was due primarily to lower operational restructuring costs which declined from $23.2 million in 1994 to $12.6 million in 1995.\nInterest Expense. Interest expense for 1995 decreased to $16.0 million from $18.1 million in 1994. The lower interest expense was due primarily to the redemption of $25.0 million of Senior Notes on June 1, 1995.\nIncome Tax Provision. The Company did not record any provision for income taxes for 1995. At December 30, 1995, the Company had tax net operating loss carryforwards of approximately $48.6 million.\nExtraordinary Items. Extraordinary items for the year consist of the payment of $600,000 in consent fees to the holders of the Senior Notes (as defined in Liquidity and Capital Resources of this section), $306,000 in premiums on the redemption of $15.6 million of New Fixed Rate Notes (as defined in Liquidity and Capital Resources of this section) and $1.4 million in unamortized financing costs related to the redemption of $25.0 million of Senior Notes and the replacement of the prior revolving credit agreement.\nNet Loss. The Company had a net loss of $31.8 million in 1995 compared to a net loss of $40.6 million in 1994. The lower net loss in 1995 was due primarily to a reduction in operational restructuring costs from $23.2 million in 1994 to $12.6 million in 1995.\nComparison of Fifty-Two Weeks Ended December 31, 1994 with Fifty-Two Weeks Ended January 1, 1994.\nSales. Net sales for 1994 decreased to $785.1 million, a 3.2% decrease over 1993 net sales. The decrease in net sales for fiscal 1994 is primarily attributable to the increased competition in the Company's market area resulting primarily from additional store openings of Wal-Mart supercenter stores during 1993 and 1994. There were 11 new Wal-Mart supercenter stores opened in the Company's market area during 1994. The Company's comparable store sales decreased by 2.6% compared to the prior year due primarily to competitors' store openings in the Company's market area.\nCost and Expenses. Gross profit as a percentage of sales for 1994 decreased to 25.1% compared to 25.6% in 1993. The decrease in the gross profit margin was partially due to increased promotional pricing in response to the increased competition in the Company's market area. The decrease was also partially due to a decrease in the period of time for amortizing video rental tapes. The decrease was partially offset by a reduction in the inventory losses accounted for in the Company's retail stores during 1994. The retail store inventory losses were approximately $1.8 million less than inventory losses in 1993, resulting principally from a reduction in the losses in the meat department. The improvement in the meat department losses was due to a change in the procedures to process only the amount of product anticipated to be sold and not processing excessive quantities of fresh beef and pork to fill the display areas.\nThe decline in gross profit margin was also due in part to an increase in warehouse and transportation expense as a percent of sales in 1994 which was due to an increase in the warehouse square footage and an increase in the number of warehouse personnel resulting from converting the former ice cream plant into additional frozen food warehouse space.\nSelling and administrative expenses as a percentage of sales increased in 1994 to 24.7% from 23.5% for 1993. The increase in selling and administrative expenses as a percentage of sales was due in large part to the decrease in sales for 1994 as compared to the prior year. However, the expenses also increased during 1994 due in part to the contractual increase in the monthly fees in connection with the Company's computer services agreement and a one-time change in the administration of the vacation policy which occurred during 1993 and did not recur in 1994. Expenses also increased due to additional reserves recorded for estimated bad debts on accounts receivable due from vendors and wholesale customers which may not be collected in full as a result of the AWG Transaction and the Company wrote down certain fixed assets to fair market value. The Company also recorded an increase of $5.7 million in the accrual for workers' compensation claims in 1994 as compared to the prior year due to an increase in the actuarially projected ultimate costs of the self-insured plans reflecting increases in claims and related settlements. These increases in expense were partially offset by a reduction in retail wages and benefits resulting from the modified collective bargaining agreement entered into with the UFCWNA in December 1993.\nOperational Restructuring Costs. Operational restructuring costs for 1994 were $23.2 million which included an estimate of the expenses to be incurred in connection with the sale of the warehouse and 29 stores to AWG and the closing of 15 stores during 1995. The accrual included the fixed costs of the closed stores from the time they were expected to be closed until they could be sold or the leases expire.\nOperating Loss. Operating loss was $20.1 million for 1994 compared to operating profit of $17.3 million in 1993. The decrease in operating profit was due to the decrease in sales, the decrease in gross profit margin, the increase in selling and administrative expenses and the operational restructuring costs recorded in 1994.\nGain on Sale of Plants. The Company recognized a $2.6 million gain from the sale of equipment and related assets associated with its milk and ice cream plants in 1993.\nInterest Expense. Interest expense for 1994 decreased to $18.1 million from $18.9 million in 1993 due primarily to the redemption of the Company's Subordinated notes which were redeemed by the Company on March 1, 1993.\nIncome Tax Provision. The Company recognized income tax expense of $2.4 million in 1994, compared to an income tax benefit of $3.3 million in 1993. The expense in 1994 was the result of increasing the valuation allowance on the Company's deferred tax asset from the prior year due to the uncertainty of realizing the future tax benefits. The expense was offset in part by the recognition of a tax benefit for alternative minimum tax net operating losses that were carried back to prior years. The income tax benefit for 1993 was the result of the reversal of the prior valuation allowance on the Company's deferred tax asset due to the proposed disposition of assets, net of the estimated amount management believed the Company may be required to pay in connection with the IRS audit (see below).\nThe IRS concluded in December 1993 a field audit of the Company's income tax returns for the fiscal years 1990, 1991 and 1992. On January 31, 1994, the IRS issued a Revenue Agent's Report for those fiscal years proposing adjustments that would result in additional taxes in the amount of $1.6 million (this amount is net of any available operating loss carryforwards, which would be eliminated under the proposed adjustment). The Company filed its protest with the IRS Appeals Office on June 14, 1994. On June 28, 1995, the Company reached a tentative agreement with the IRS Appeals office to settle the above claims. Management has analyzed the proposed settlement and has provided for, in accordance with generally accepted accounting principles, amounts which it currently believes are adequate.\nExtraordinary Items. There were no extraordinary items incurred during fiscal 1994. Extraordinary items in 1993 consisted of the payment of $2.776 million in premiums on the redemption of $47.750 million in aggregate principal amount of the Subordinated Notes at a purchase price of 105.8% of the outstanding principal amount and $1.148 million in unamortized financing costs related to the redemption of the subordinated notes on March 1, 1993. See \"Liquidity and Capital Resources\" in this section.\nIncome or Loss. The Company had net loss of $40.6 million during 1994 compared to net income of $282,000 in 1993. The net loss experienced in 1994 was due primarily to the operational restructuring costs, reduction of sales and gross profit margin, increase in selling and administrative expenses and an increase in income tax expense.\nLiquidity and Capital Resources\nDebt. The major sources of liquidity for the Company's operations and expansion have been internally generated funds and borrowings under revolving credit facilities. In March 1992, the Company refinanced its indebtedness by entering into an Indenture with United States Trust Company of New York, as trustee (the \"Senior Note Indenture\"), pursuant to which the Company issued $45 million in aggregate principal amount of Series A Senior Secured Floating Rate Notes Due 1997, bearing interest at a floating rate of 3% over LIBOR (the \"Old Floating Rate Notes\"), and $75 million in aggregate principal amount of Series B Senior Secured Fixed Rated Rate Notes due 1999, bearing interest at 11-3\/4% per annum (the \"Old Fixed Rate Notes,\" and together with the old Floating Rate Notes, the \"Old Notes\"). The Old Fixed Rate Notes are not redeemable by the Company until on or after March 1, 1997.\nIn October and November 1992, the Company conducted an offer to exchange its Series D Senior Secured Floating Rate Notes Due 1997 (the \"New Floating Rate Notes\") for an equal principal amount of its outstanding Old Floating Rate Notes, and Series C Senior Secured Fixed Rate Notes Due 1999 (the \"New Fixed Rate Notes,\" and together with the New Floating Rate Notes, the \"New Notes\") for an equal principal amount of its Old Fixed Rate Notes. The Old Notes and the New Notes are collectively referred to herein as the \"Senior Notes;\" the Old Floating Rate Notes and the New Floating Rate Notes are collectively referred to herein as the \"Senior Floating Rate Notes;\" and the Old Fixed Rate Notes and the New Fixed Rate Notes are collectively referred to herein as the \"Senior Fixed Rate Notes.\" The New Notes are substantially identical to the Old Notes, except that the offering of the New Notes was registered with the Securities and Exchange Commission. Holders of the New Notes are not entitled to certain rights of holders of the Old Notes, as described in the prospectus relating to the exchange offer. The Company conducted the exchange offer to satisfy its obligations under agreements with the holders of the Senior Notes.\nOn April 21, 1995, the Company and the Senior Note Indenture trustee entered into a supplemental indenture effecting certain amendments to the Senior Note Indenture. The amendments (a) increased the interest rate on each series of Notes by one-half of one percent (0.5%) per annum; (b) amended, added and deleted certain financial covenants and related definitions under the Senior Note Indenture (including modifying the Consolidated Fixed Charge Coverage Ratio covenant, adding a new Debt-to-EBITDA ratio and a new Capital Expenditures covenant, deleting the Adjusted Consolidated Net Worth covenant) to reflect the Company's size, operations and financial position following the AWG Transaction; (c) amended certain provisions of the Senior Note Indenture to permit the Company to incur certain liens and indebtedness and to make an investment in certain membership stock and receive or earn patronage certificates or other equity in connection with the supply agreement to be entered into with AWG; (d) amended certain provisions of the security agreement to provide that AWG will have a first lien on certain collateral to be acquired by the Company in connection with the AWG supply agreement; (e) amended certain other provisions of the Senior Note Indenture to, among other things, limit the Company's ability to incur certain future indebtedness and guarantees, and to provide that a certain amount of net proceeds from future asset sales must be applied to an offer to redeem the Senior Notes; (f) made certain technical amendments to the Senior Notes' Intercreditor Agreement; (g) and amended the Senior Notes' Mortgage to provide that defaults under, or modifications or terminations of, a certain lease related to a store to be closed, will not constitute a default or event of default under the Senior Notes' Mortgage.\nOn June 1, 1995, the Company redeemed $15.6 million of its New Fixed Rate Notes, $6.9 million of New Floating Rate Notes and $2.5 million of Old Floating Rate Notes (collectively the \"Redeemed Notes\"). The redemption price for the Redeemed Notes was equal to 100% of the principal amount and accrued interest of $695,000 plus, in the case of the New Fixed Rate Notes, a premium of $306,000. At May 1, 1996, $59.4 million of New Fixed Rate Notes, $26.1 million of New Floating Rate Notes and $9.5 million of Old Floating Rate Notes were outstanding.\nOn April 21, 1995, the Company entered into a revolving credit agreement (the \"Revolving Credit Agreement\") with National Bank of Canada, (\"NBC\") as agent and as lender, Heller Financial, Inc. and any other lenders thereafter parties thereto. The Revolving Credit Agreement provides a commitment of up to $25 million in secured revolving credit loans, including certain letters of credit. The Revolving Credit Agreement permits borrowings for working capital needs and for the issue of standby letters of credit and documentary letters of credit. Borrowings under the Revolving Credit Agreement bear interest at the NBC Base Rate plus 1.5% for the first year. Subsequent year's interest rates will be dependent upon the Company's earnings but will not exceed the NBC base rate plus 2.0%. All borrowings under the Revolving Credit Agreement are subject to a borrowing base and mature no later than February 27, 1997, with the possibility of extending the maturity date to March 31, 1998 if the Company's Series A Senior Secured Floating Rate Notes due February 27, 1997, are extended or refinanced on terms acceptable to NBC. At May 1, 1996, the net unused and available amount under the Revolving Credit Facility was $6.8 million.\nDespite the completion of the AWG Transaction and the commencement of the Company's new marketing plan, the Company continued to experience operating difficulties in 1995. As a result of the Company's operating difficulties, the Company began experiencing significant liquidity problems in the third quarter of 1995. The Company's liquidity problems reached a critical point in late August immediately prior to the scheduled September 1, 1995 interest payment on the Senior Notes of approximately $4.5 million. Although the Company made the September 1, 1995 interest payment on the Senior Notes, this payment was funded in part from the proceeds of certain accrued AWG receivables and benefits under the Supply Agreement that the Company assigned to AWG.\nThe Company responded to its operating and liquidity problems by (a) seeking ways to improve the Company's gross margins, such as improving sales mix and reducing markdowns and (b) addressing the AWG \"transitional\" issues by monitoring store inventory levels and AWG billings. However, the Company realized that a long-term solution, such as a restructuring of the Company's indebtedness or the sale of the Company to a third party was required for the Company to remain viable.\nIn November and December 1995, the Company retained Alvarez & Marsal, Inc. (\"A&M\") to act as the Company's crisis consultant and Donaldson, Lufkin & Jenrette Securities Corporation (\"DLJ\"), respectively, to act as the Company's financial advisor. In addition, during this time, the Committee was formed.\nIn late 1995 and early 1996, DLJ assisted the Company in exploring certain strategic restructuring alternatives, including the sale of the Company to a third party. In connection with these efforts, DLJ contacted a number of potential buyers and investors. Excluding indications of interest to purchase individual stores or small groups of stores, DLJ received only one offer to purchase the Company as a whole. The Company and the Committee, together with their respective advisors, concluded that this offer was inadequate and should be rejected.\nIn December 1995, the Company informed the lenders under the Revolving Credit Agreement and the trustee under the Senior Note Indenture that it would be unable to comply with certain year-end financial maintenance covenants (the Consolidated Fixed Charge Coverage Ratio and the Debt-to- EBITDA Ratio) contained in the Revolving Credit Agreement and the Senior Note Indenture and requested a temporary waiver of its obligations under such covenants in order to facilitate a global restructuring of all of the Company's indebtedness. The lenders under the Revolving Credit Agreement and the trustee under the Senior Note Indenture (acting at the direction of a majority in principal amount of the Old Notes then outstanding) waived compliance by the Company with these financial covenants through the earlier to occur of April 15, 1995 and the date on which the Company defaulted on any of its payment obligations with respect to the Senior Notes.\nOn March 1, 1996, the Company failed to make the scheduled interest payment on its Senior Notes in the amount of approximately $4.5 million. This payment default resulted in a termination of the December 1995 waiver under the Senior Note Indenture. Notwithstanding such termination, the Committee advised the Company that, so long as restructuring negotiations between the Company and the Committee were proceeding, the Committee would not exercise any contractual or other remedies in response to the interest payment default. Moreover, the lenders under the Revolving Credit Agreement agreed that their waiver would continue to be effective through May 20, 1996, notwithstanding such payment default.\nOn March 27, 1996, the Company entered into an agreement in principle with the Committee with respect to the Restructuring. The agreement in principle provides that, upon completion of the Restructuring, the $95 million of Senior Notes currently outstanding (together with accrued interest of $6.6 million) will be canceled and the Noteholders will receive $60 million in aggregate principal amount of new senior subordinated notes, a majority of the new equity of the reorganized Company and $1.5 million in cash. The new senior subordinated notes, to be issued pursuant to a new indenture, will mature in 2003, bear interest semi-annually at a rate of 10% per annum and will not be secured. In addition, the noteholders and the Company's general unsecured creditors will receive approximately 60% and 35%, respectively, of the equity of reorganized Holding (assuming total unsecured claims of approximately $63 million, including noteholder unsecured claims). Holding's existing equity holders will receive the remaining 5% of the new equity, together with five year warrants to purchase an additional 5% of such equity.\nAn integral part of the Restructuring is the Company's previously-announced deal with its labor unions to modify certain elements of the Company's existing collective bargaining agreements. These modifications will provide for, among other things, wage and benefit modifications, the buyout of certain employees and the issuance and purchase of new equity to a trust acting on behalf of the unionized employees. The modified collective bargaining agreements are conditioned on, and will become effective upon, the consummation of the Restructuring.\nAs a result of these changes to the Company's capital structure and collective bargaining agreements, the Company will significantly reduce its interest and labor cost.\nThe lenders under the Revolving Credit Agreement have agreed to lend the Company (on a revolving basis) up to $27 million (subject to borrowing base availability) for its working capital and other general corporate purposes under a debtor-in-possession facility (the \"DIP Facility\").\nUnder the DIP Facility, the Company is permitted to borrow up to the lesser of $27 million and the \"Borrowing Base.\" The Borrowing Base is an amount equal to the sum of (1) 65% of the net amount of \"eligible inventory,\" (2) 40% of the net amount of \"eligible pharmaceutical inventory,\" (3) 85% of the net amount of \"eligible coupons;\" and (4) 50% of net amount of \"eligible pharmaceutical receivables.\" Borrowings under the DIP Facility bear interest at an interest rate equal to (1) the prime rate announced publicly by National Bank of Canada from time to time in New York, New York plus (2) two percent. Interest is payable quarterly in arrears on the last day of March, June, September and December, commencing on June 30, 1996. The DIP Facility will mature on the earlier of (1) one year from the date of filing of the Company's voluntary petition under Chapter 11 of the Bankruptcy Code, and (2) the effective date of the Company's Plan of Reorganization (the \"Plan\").\nThe DIP Facility provides that National Bank of Canada, on behalf of itself and as agent for the lenders under the DIP Facility, will have liens on, and security interests in, all of the pre-petition and post-petition property of the Company (other than the collateral under the Senior Note Indenture), which liens and security interests will have priority over substantially all other liens on, and security interests in, the Company's property (other than properly perfected liens and security interests which existed prior to the date of filing of the Company's voluntary petition under the Bankruptcy Code).\nThe DIP Facility includes certain customary restrictive covenants, including restrictions on acquisitions, asset dispositions, capital expenditures, consolidations and mergers, distributions, divestitures, indebtedness, liens and security interests and transactions with affiliates. The DIP Facility also requires the Company to comply with certain financial maintenance and other covenants.\nOn the effective date of the Plan (the \"Effective Date\") the Company anticipates that it will enter into a new bank credit agreement or an amendment and restatement of its existing credit agreement (the \"New Credit Agreement\"), the general terms of which must be approved by the Committee. As of the date hereof, the Company is in discussions with a number of banks potentially interested in providing this credit facility, including the lenders under its existing credit facility. There can be no assurance, however, that any bank or group of banks will agree to provide a bank credit facility on terms acceptable to the Company and the Committee.\nThe Company anticipates that the New Credit Agreement will provide for up to $37.5 million in borrowings, including approximately $27.5 million under a revolving credit facility (subject to borrowing base requirements) and a $10 million term loan. Proceeds from the term loan will be used primarily to fund certain obligations under the Modified Union Agreements and to pay certain transaction expenses relating to the Restructuring. The Company expects that its obligations under the New Credit Agreement will be secured by a security interest in, and liens on, substantially all of the Company's assets and will be guaranteed by Holding.\nWorking Capital and Capital Expenditures. The Company's primary sources of capital have been borrowing availability under the Revolving Credit Agreement and cash flow from operations, to the extent available. The Company uses the available capital resources for working capital needs, capital expenditures and repayment of debt obligations.\nThe Company suffered a negative cash flow from operations of $8.0 million in 1995 compared to positive cash flow of $0.3 million in 1994 and $13.0 million in 1993. The cash flow deficit in 1995 is due to the Company incurring a net cash outflow before working capital changes of $7.3 million, which is the net loss of $31.8 million offset by $24.5 million of non-cash charges. The remainder of the cash outflow from operations are from net working capital changes that resulted primarily from the AWG Transaction.\nThe Company's investing activities provided net cash of $65.1 million in 1995 and used net cash of $4.0 million and $3.1 million in 1994 and 1993, respectively. The substantial increase for cash provided by investing activities in 1995 was the result of sale of the warehouse, 29 stores and associated inventory to AWG. Capital expenditures were $4.7 million, $5.4 million and $7.1 million in 1995, 1994 and 1993, respectively. The Company expects to make total capital expenditures of approximately $5.0 million in 1996, primarily for store information systems and remodels. The funds required for the 1996 capital expenditures would come from the remaining escrow funds of approximately $0.7 million available for reinvestment from the AWG Transaction, cash flow from operations, the DIP Facility and the New Credit Agreement.\nFinancing activities of the Company used net cash of $51.0 million in 1995, provided net cash of $1.9 million in 1994 and used net cash of $33.5 million in 1993. The net cash usage in 1995 was primarily due to the paydown of $25.0 million in Senior Notes and $21.0 million of revolving credit facility loans.\nThe Company's ability to continue to meet its working capital needs, meet its debt and interest obligations and capital expenditure requirements is dependent on its future operating performance and the consummation of the Restructuring. Management believes that the Restructuring will have a favorable effect on the Company's future liquidity by (i) reducing future interest cost, (ii) reducing labor costs, (iii) extending the maturities of the Company's long- term debt, (iv) reducing the Company's store lease obligations by the rejection of at least seven store leases and (v) permitting additional borrowings through the release of collateral under the Senior Note Indenture. There can be no assurance that future operating performance will provide positive net cash or that the Restructuring will be successful. If the Company is not able to generate positive cash flow from its operations or if the Restructuring is not successfully consummated, management believes that this could have a material adverse effect on the Company's business and the continuing viability of the Company.\nRecently-Issued Accounting Standards\nThe Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121, (\"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of\" (\"SFAS No. 121\")) in March 1995 to establish accounting standards for the impairment of long-lived assets, certain identifiable intangibles and goodwill related to those assets to be held and used. The Company has not yet adopted this accounting standard, which becomes effective in 1996 for Homeland, nor has it evaluated the potential impact of adoption in 1996. The impact of SFAS no. 121 is not reasonably estimable at this time due to certain factors discussed in Note 2 to the consolidated financial statements. Although this standard may affect reported earnings and the carrying values of long-lived assets, there will be no impact on cash flows.\nInflation\/Deflation\nIn recent years, deflation has not had a material impact upon the Company's operating results. Although the Company does not expect inflation or deflation to have a material impact in the future, there can be no assurance that the Company's business will not be affected by inflation or deflation in future periods.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe Company's consolidated financial statements and notes thereto are included in this report following the signature pages.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone. PART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nSet forth below are the names, ages, present positions and years of service (in the case of members of management) of the directors and management of Homeland:\nYears with the Company and\/or Age Position Safeway\nB. Charles Ames * 70 Chairman of the Board - James A. Demme* 55 President, Chief 1 Executive Officer and Director Larry W. Kordisch* 48 Executive Vice President - 1 Finance, Treasurer, Chief Financial Officer and Secretary Steven M. Mason 41 Vice President - Marketing 26 Terry M. Marczewski* 41 Chief Accounting Officer, 1 Assistant Treasurer, Assistant Secretary Alfred F. Fideline, Sr. 58 Vice President - Retail 39 Operations Prentess E. Alletag, Jr. 49 Vice President - Human 29 Resources John A. Shields 52 Director -- Bernard S. Black 42 Director -- Bernard Paroly 77 Director -- Andrall E. Pearson 70 Director -- Hubbard C. Howe 67 Director -- Michael G. Babiarz 30 Director --\n* Holding's Board of Directors is identical to that of Homeland. Mr. Ames serves as Holding's Chairman of the Board, Mr. Demme serves as Holding's President and Chief Executive Officer, Mr. Kordisch as Executive Vice President - Finance, Treasurer, Chief Financial Officer and Secretary and Mr. Marczewski as Chief Accounting Officer, Assistant Treasurer and Assistant Secretary.\nB. Charles Ames was elected as Chairman of the Board of Holding and Homeland in January 1991. Mr. Ames is a principal of CD&R and has been a director of the Company since January 1988. He is also a general partner of the general partner of C&D Fund IV. He was a limited partner of the general partner of C&D Fund III until October 1990, when he assigned his limited partnership interest to B. Charles Ames as Trustee of the trust created pursuant to a Declaration of Trust, dated July 25, 1982. From October 1987 to December 1990, Mr. Ames was a consultant to CD&R. From January 1988 to May 1990, Mr. Ames served as Chairman and Chief Executive Officer of The Uniroyal Goodrich Tire Company, a major tire manufacturer. From July 1983 to October 1987, Mr. Ames served as Chairman of the Board and Chief Executive Officer of Acme-Cleveland Corporation, a manufacturer of machine tools, telecommunication equipment and electrical and electronic controls, of which he was President and Chief Executive Officer from 1981 to 1983. Mr. Ames is a director of Diamond Shamrock R&M Inc., Warner Lambert Company, M.A. Hanna Company, The Progressive Corporation, Lexmark International, Inc. and its parent Lexmark Holding, Inc., and WESCO Distribution, Inc. and its parent CDW Holding, Inc.\nJames A. Demme became President, Chief Executive Officer and a director of the Company as of November 30, 1994. From 1992 to 1994, Mr. Demme served as Executive Vice President of Retail Operations of Scrivner, Inc. He was responsible for the operations of their 170 retail stores which had a total volume exceeding $2 billion. From 1991 to 1992, Mr. Demme served as Senior Vice President of Marketing of Scrivner, Inc. where he was responsible for restructuring and refocusing the merchandising department to retail orientation. From 1988 to 1991, Mr. Demme was President and Chief Operating Officer of Shaws Supermarkets, which was the nation's fifteenth largest retail chain with sales of $1.7 billion.\nLarry W. Kordisch joined the Company in February 1995 and became Executive Vice President - Finance, Treasurer, Chief Financial Officer and Secretary as of May 1995. Prior to joining Homeland, Mr. Kordisch served as Executive Vice President - Finance and Administration, Chief Financial Officer and member of the Board of Directors of Scrivner, Inc. and was responsible for the Finance, Accounting, Risk Management, Legal and Administrative functions.\nSteven M. Mason joined Safeway in 1970 and the Oklahoma Division in 1986. At the time of the Acquisition, he was serving as Special Projects Coordinator for the Oklahoma Division. In November 1987, he joined Homeland and in October 1988, he was appointed to the position of Vice President - Retail Operations. In October 1993, Mr. Mason was appointed to the position of Vice President - Marketing.\nTerry M. Marczewski joined the Company in April 1995 and became the Chief Accounting Officer, Assistant Treasurer and Assistant Secretary as of May 1995. From July 1994 to April 1995, he was the controller at Fleming Companies, Inc.- Scrivner Group. From 1990 to July 1994, Mr. Marczewski was the Vice President and Controller at Scrivner, Inc., the nation's third largest grocery wholesaler, prior to its acquisition by Fleming Companies, Inc.\nAlfred F. Fideline, Sr. joined Safeway in 1957. At the time of the Acquisition, he was serving as a District Manager of the Oklahoma Division. In November 1987, Mr. Fideline joined Homeland as a District Manager and in May 1994, he was appointed to the position of Vice President - Retail Operations.\nPrentess E. Alletag, Jr. joined the Oklahoma Division in October 1969, where, at the time of the Acquisition, he was serving as Human Resources and Public Affairs Manager. In November 1987, Mr. Alletag joined Homeland as Vice President - Human Resources.\nJohn A. Shields became a director of Homeland in May 1993. Mr. Shields also served as Vice Chairman of the Board of Holding and Homeland from December 1993 to December 1995. He served as President, Chief Executive Officer, Chief Operating Officer, and a member of the Board of Directors of First National Supermarkets from 1983 to 1993. Mr. Shields is also a director of D.I.Y. Home Warehouse, Inc., Shore Bank & Trust, and Shore Bank Corporation.\nBernard S. Black is a Professor of Law at the Columbia Law School. He joined the Columbia law faculty in July 1988. Professor Black served as counsel to Commissioner Joseph A. Grundfest of the Securities and Exchange Commission from January 1987 through July 1988. From 1983 to 1987, he practiced law in New York City, specializing in mergers and acquisitions and corporate and securities law. In September 1989, Professor Black became a director of Homeland.\nBernard Paroly served as Chairman and Chief Executive Officer of Pathmark Supermarkets from mid-1981 to July 1986. In November 1987, Mr. Paroly become a director of Homeland.\nAndrall E. Pearson is a director of the Company. He is a principal of CD&R. He is a limited partner of the general partner of C&D Fund IV. He was a Professor of Business Administration at the Graduate School of Business at Harvard University from 1985 until January 1993. From 1971 through 1985, Mr. Pearson was President and Chief Operating Officer of PepsiCo., Inc. Mr. Pearson is a director of PepsiCo., Inc., May Department Stores Company, The Travelers, Inc. (formerly Primerica Corporation), and Lexmark International, Inc. and its parent Lexmark Holding, Inc.\nHubbard C. Howe became a director of Homeland in August 1995. He has been a principal of CD&R since 1990. Mr. Howe is also a director of Nukote Holdings and APS Holdings.\nMichael G. Babiarz became a director of Homeland in January 1995. Mr. Babiarz has been a professional employee of CD&R since 1990.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nSummary of Cash and Certain Other Compensation\nThe following table provides certain summary information concerning compensation paid or accrued by the Company to or on behalf of the Company's Chief Executive Officer, each of the three other most highly compensated executive officers of the Company and one former executive officer (hereinafter referred to as the \"Named Executive Officers\") for the fiscal years ended December 30, 1995, December 31, 1994, and January 1, 1994:\nSUMMARY COMPENSATION TABLE\nAnnual Compensation\nName and Other Principal Annual All Other Position Year Salary Bonus Compensation Compensation (3)(4)\nJames A. Demme (1) 1995 $200,000 $100,000 (2) $ 4,396 President and 1994 11,538 - (2) - Chief Executive Officer of the Company\nMark S. Sellers (6) 1995 $ 81,922 $140,656 $271,613 (5) $208,207 Former Executive 1994 153,000 130,050 114,474 (5) 43,447 Vice Pres. Finance, 1993 160,192 153,000 80,852 (5) 34,604 Treasurer, Chief Financial Officer and Secretary\nLarry W. Kordisch(7) 1995 $126,923 $100,000 (2) $ 3,907 Executive Vice Pres. Finance, Treasurer, Chief Financial Officer and Secretary\nSteven M. Mason 1995 $130,500 $ 19,575 (2) $ 6,414 Vice President - 1994 130,500 110,925 (2) 8,963 Marketing 1993 107,250 103,500 (2) 3,904\nTerry M. Marczewski(8) 1995 $ 69,32 $ 20,000 (2) $ 43 Chief Accounting Officer, Assistant Treasurer, Assistant Secretary\n(1) Mr. Demme joined the Company as President, Chief Executive Officer and a director as of November 30, 1994.\n(2) Personal benefits provided to the Named Executive Officer under various Company programs do not exceed 10% of total annual salary and bonus reported for the Named Executive Officer.\n(3) All other compensation includes contributions to the Company's defined contribution plan on behalf of each of the Named Executive Officers to match 1993 pre-tax elective deferral contributions (there was no match for 1994 and 1995) (included under Salary) made by each to such plan, as follows: Steven M. Mason, $2,956.\n(4) The Company provides reimbursement for medical benefit insurance premiums for the Named Executive Officers. These persons obtain individual fully-insured private medical benefit insurance policies with benefits substantially equivalent to the medical benefits currently provided under the Company's group plan. The Company also provides for life insurance premiums for executive officers, including the Named Executive Officers and one other executive officer, who obtain fully-insured private term life insurance policies with benefits of $500,000 per person. Amounts paid during 1995 are as follows: James A. Demme, $1,547; Mark S. Sellers, $11,069; Larry W. Kordisch, $2,073; Steven M. Mason, $1,616; and Terry M. Marczewski, $43.\n(5) Includes reimbursement of relocation expenses in the amount of $271,613 in 1995, $95,378 in 1994 and $78,058 in 1993.\n(6) Mr. Sellers was Executive Vice President-Finance and Chief Financial Officer of the Company until his resignation in May 1995.\n(7) Mr. Kordisch joined the Company in February 1995 and was appointed Executive Vice President-Finance, Chief Financial Officer, Treasurer and Secretary of the Company as of May 5, 1995.\n(8) Mr. Marczewski joined the Company in April 1995 and was appointed the Chief Accounting Officer and Controller of the Company as of May 5, 1995.\nDirectors who are not employees of the Company or otherwise affiliated with the Company (presently consisting of Messrs. Black, Paroly and Shields) are paid annual retainers of $15,000 and meeting fees of $1,000 for each meeting of the board or any committee attended. Mr Shields also serves as a consultant to the Company from time to time at the request of CD&R. During 1995, Mr. Shields received $166,662 from CD&R for consulting fees for services provided to the Company.\nEmployment Agreements\nIn November 1994, the Company entered into an employment agreement with James A. Demme, the Company's President and Chief Executive Officer, for an indefinite term. The agreement provides a base annual salary of not less than $200,000 subject to increase from time to time at the discretion of the Board of Directors. The agreement entitles Mr. Demme to participate in the Company's Management Incentive Plan with a maximum annual bonus equal to 100% of base salary. The agreement also provides for awards under a long term incentive compensation plan which is to be established by the Company and authorizes reimbursement for certain business- related expenses. The agreement was amended in April 1996, to provide that, if the agreement is terminated by the Company for other than cause or disability prior to December 31, 1997, or is terminated by Mr. Demme following a change of control or a trigger event (as defined), Mr. Demme is entitled to receive (a) payment, which would not be subject to any offset as a result of his receiving compensation from other employment, equal to two years' salary, plus a pro rata amount of the incentive compensation for the portion of the incentive year that precedes the date of termination, and (b) continuation of welfare benefit arrangements for a period of two years after the date of termination. The Restructuring is a trigger event under the agreement only if Mr. Demme terminates his employment for good reason (as defined) or if, following the Effective Date, a subsequent trigger event occurs, such as a change of control or sale of assets.\nOn September 26, 1995, the Company entered an employment agreement with Larry W. Kordisch, the Company's Executive Vice President-Finance and Chief Financial Officer. The agreement provides for a base annual salary of not less than $150,000, subject to increase from time to time at the discretion of the Board of Directors. Mr. Kordisch is also entitled to participate in the Management Incentive Plan based upon the attainment of performance objectives as the Board of Directors shall determine from time to time. The agreement was amended in April 1996, to provide that, if the agreement is terminated by the Company for other than cause or disability prior to December 31, 1997, or is terminated by Mr. Kordisch following a change of control or a trigger event (as defined), Mr. Kordisch is entitled to receive (a) payment, which would not be subject to any offset as a result of his receiving compensation from other employment, equal to two years' salary, plus a pro rata amount of the incentive compensation for the portion of the incentive year that precedes the date of termination, and (b) continuation of welfare benefit arrangements for a period of two years after the date of termination. The Restructuring is a trigger event under the agreement only if Mr. Kordisch terminates his employment for good reason (as defined) or if, following the Effective Date, a subsequent trigger event occurs, such as a change of control or sale of assets.\nOn September 26, 1995, the Company entered into an employment agreement with Terry M. Marczewski, the Company's Controller and Chief Accounting Officer. The agreement, which is for an indefinite term, provides for a base annual salary of $90,000, subject to increase from time to time at the discretion of the Board of Directors. Mr. Marczewski is also entitled to participate in the Management Incentive Plan based upon the attainment of performance objectives as the Board shall determine from time to time. The agreement was amended in April 1996, to provide that, in the event his employment is terminated prior to December 31, 1997 for any reason other than cause or disability, the Company will pay Mr. Marczewski his annual salary for a period of one year after the termination date or until December 31, 1997, whichever is longer, plus a pro rata amount of the incentive compensation for the portion of the incentive year that precedes the date of terminations.\nIn April 1996, the Company entered into employment agreements with Steve Mason, the Company's Vice President of Marketing, and Alfred F. Fideline, Sr., the Company's Vice President of Retail Operations. The agreements, which are for an indefinite term, provide a base annual salary of $130,500 for Mr. Mason and $80,000 for Mr. Fideline, subject to increase from time to time at the discretion of the Board of Directors. In the event their employment is terminated prior to December 31, 1997 for any reason other than cause or disability, the Company will pay Mr. Mason and Mr. Fideline their annual salaries for a period of one year after the termination date or until December 31, 1997, whichever is longer, plus a pro rata amount of the incentive compensation for the portion of the incentive year that precedes the date of termination\nOn January 30, 1995, the Company entered into an agreement with Mark S. Sellers, the Company's former Executive Vice President-Finance, Chief Financial Officer, Treasurer and Secretary. Pursuant to such agreement, in May 1995, Mr. Sellers was paid $348,139, which included $195,000 of retention payment, $140,656 of pro rata bonus related to the Management Incentive Plan and $12,483 of unpaid vacation and retroactive pay adjustments.\nThe Company entered into a settlement agreement as of August 31, 1995 with Jack M. Lotker, the Company's former Senior Vice President-Administration, in connection with the termination of his employment with the Company. In connection with the settlement, the Company agreed to grant to Mr. Lotker warrants to purchase 100,000 shares of Holding's Class A Common Stock at an exercise price of $0.50 per share and at Mr. Lotker's discretion, the Company agreed to either (a) pay Mr. Lotker a single lump sum of $188,000 or (b) cause PHH Home Equity to purchase Mr. Lotker's current principal residence at a price equal to the appraised value but not less than $575,000. In November 1995, Mr. Lotker elected for the Company to pay him a single lump sum of $188,000. However, due to the Company's liquidity constraints, the Company has not been able to make this payment and accordingly the Company is in default with respect to the settlement agreement. Mr. Lotker has filed a suit against the Company, demanding recovery under the settlement agreement, together with penalties and interest.\nManagement Incentive Plan\nHomeland maintains a Management Incentive Plan to provide incentive bonuses for members of its management and key employees. Bonuses are determined according to a formula based on both corporate, store and individual performance and accomplishments or other achievements and are paid only if minimum performance and\/or accomplishment targets are reached. Minimum bonuses range from 0 to 100% of salary for officers (as set forth in the plan), including the Chief Executive Officer. Maximum bonus payouts range from 75% to 200% of salary for officers and up to 200% of salary for the Chief Executive Officer. Performance levels must significantly exceed target levels before the maximum bonuses will be paid. Under limited circumstances, individual bonus amounts can exceed these levels if approved by the Compensation Committee of the Board. Incentive bonuses paid to managers and supervisors vary according to their reporting and responsibility levels. The plan is administered by a committee consisting, unless otherwise determined by the Board of Directors, of members of the Board who are ineligible to participate in the plan. Incentive bonuses earned for certain highly compensated executive officers under the plan for performance during fiscal year 1995 are included in the Summary Compensation Table.\nRetirement Plan\nHomeland maintains a retirement plan in which all non-union employees, including members of management, participate. Under the plan, employees who retire at or after age 65 and after completing five years of vesting service (defined as calendar years in which employees complete at least 1,000 hours of service) will be entitled to retirement benefits equal to 1.50% of career average annual compensation (including basic, overtime and incentive compensation) plus .50% of career average annual compensation in excess of the social security covered compensation, such sum multiplied by years of benefit service (not to exceed 35 years). Service with Safeway prior to the Acquisition is credited for vesting purposes under the plan. Retirement benefits will also be payable upon early retirement beginning at age 55, at rates actuarially reduced from those payable at normal retirement. Benefits are paid in annuity form over the life of the employee or the joint lives of the employee and his or her spouse or other beneficiary.\nUnder the retirement plan, estimated annual benefits payable to the named executive officers of Homeland upon retirement at age 65, assuming no changes in covered compensation or the social security wage base, would be as follows: James A. Demme, $27,280; Larry W. Kordisch, $44,375; Steven M. Mason, $85,129; and Terry M. Marczewski, $35,372.\nCompensation Committee Interlocks and Insider Participation\nMessrs. Ames, Babiarz, Paroly and Shields served on the Company's Compensation and Benefits Committee of the Board of Directors for the 1995 fiscal year. Mr. Ames, Chairman of the Board, is a principal of CD&R, the holder of an economic interest in the general partner of C&D Fund III and a general partner of the general partner of C&D Fund IV. See \"Certain Relationships and Related Transactions\". Mr. Shields serves as a consultant to the Company from time to time at the request of CD&R. During 1995 Mr. Shields received $166,662 from CD&R for consulting fees for services provided to the Company.\nManagement Stock Purchases\nShares of Common Stock purchased by management and key employees (the \"Management Investors\"), directly and indirectly through an individual retirement account, are subject to certain transfer restrictions (including successive rights of first refusal on the part of Holding and C&D Fund III or, with respect to certain shares, C&D Fund IV) and repurchase rights (including successive rights by Holding and C&D Fund III or with respect to certain shares, C&D Fund IV, to purchase shares from Management Investors whose employment with Homeland terminates). In addition, the Management Investors have the right to require Holding to repurchase their shares upon the occurrence of certain events, such as a termination without \"cause\" (as defined) or death, retirement or permanent disability, subject to (a) there being no default under the Company's prior credit agreement with Manufacturers Hanover Trust Company, as agent and certain other banks (the \"Prior Credit Agreement\"), the Subordinated Note Indenture, any other financing or security agreement or document permitted under the Prior Credit Agreement or the Subordinated Note Indenture (including the Senior Note Indenture and the Revolving Credit Agreement), or certain other financing or security agreements or documents, (b) the repurchase not violating any such agreement or document or Holding's certificate of incorporation and (c) Holding having sufficient funds legally available for such repurchase under Delaware law. Holding has also agreed to use its best efforts to repurchase shares from any Management Investor who experiences certain unforeseen personal hardships, subject to the authorization of Holding's Board of Directors.\nThe shares held by each Management Investor, directly and indirectly through an individual retirement account, are entitled to the benefits of and are bound by the obligations set forth in certain registration and participation agreements. See \"Security Ownership of Certain Beneficial Owners and Management -- Registration and Participation Agreements.\" For information concerning the holdings of Common Stock as of May 1, 1996 by certain officers and directors, see \"Security Ownership of Certain Beneficial Owners and Management -- Ownership of Certain Holders.\" The Common Stock sold to members of management and key employees has been accounted for as redeemable Common Stock. Homeland has made certain temporary loans which are due July 21, 1996, to certain members of management and key employees to enable such persons to make principal payments under loans to finance such persons' purchase of redeemable Common Stock. See \"Certain Relationships and Related Transactions.\"\nOn April 21, 1995, the Company made an offer to repurchase shares of its Common Stock owned by certain officers and employees of the Company at a cash purchase price of $0.50 per share, plus a warrant equal to the number of shares purchased with an exercise price of $0.50. As a result of this offer, the Company redeemed 1,688,493 shares of its Common Stock and issued 1,550,493 warrants.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nOwnership of Certain Holders\nSet forth below is information as of May 1, 1996, concerning certain holders of the currently outstanding shares of Common Stock (including Named Executive Officers, officers and directors of the Company and holders of 5% or more of the Common Stock). Shares Percent of Name of Beneficial Owner Beneficially Owned Class\nThe Clayton & Dubilier Private Equity Fund III Limited Partnership, 270 Greenwich Avenue, Greenwich, CT 06830 11,700,000 35.9% The Clayton & Dubilier Private Equity Fund IV Limited Partnership, 270 Greenwich Avenue, Greenwich, CT 06830 13,153,089 40.4 B. Charles Ames (1)(2) 13,153,089 40.4 Joseph L. Rice, III (1)(3) 24,853,089 76.3 Alberto Cribiore (1)(3) 24,853,089 76.3 Donald J. Gogel (1) 13,153,089 40.4 Leon J. Hendrix, Jr. (1) 13,153,089 40.4 William A. Barbe (1) 13,153,089 40.4 Andrall E. Pearson (1) 13,153,089 40.4 Hubbard C. Howe (1) 13,153,089 40.4 James A. Demme -- -- Larry W. Kordisch -- -- Terry M. Marczewski -- -- Steven M. Mason (4) 41,912 * Alfred F. Fideline, Sr. 1,000 * Bernard S. Black (5) 70,000 * Bernard Paroly 50,000 * John A. Shields -- -- Michael G. Babiarz -- --\nOfficers and directors as a group (13 persons) (6)(7) 13,366,001 41.0\n*Indicates less than 1%\n(1) Messrs. Ames, Rice, Cribiore, Gogel, Hendrix, Barbe, Pearson and Howe may be deemed to share beneficial ownership of the shares owned of record by C&D Fund IV by virtue of their status as general partners of the general partner of C&D Fund IV, but Messrs. Ames, Rice, Cribiore, Gogel, Hendrix, Barbe, Pearson and Howe each expressly disclaims such beneficial ownership of the shares owned by C&D Fund IV. Messrs. Ames, Rice, Cribiore, Gogel, Hendrix, Barbe, Pearson and Howe share investment and voting power with respect to securities owned by C&D Fund IV. The business address for Messrs. Ames, Rice, Cribiore, Gogel, Hendrix, Barbe, Pearson and Howe is c\/o Clayton, Dubilier & Rice, Inc., 375 Park Avenue, 18th Floor, New York, NY 10152.\n(2) Mr. Ames was a limited partner in the general partner of C&D Fund III until October 1990, when he assigned his limited partnership interest to B. Charles Ames as Trustee of the trust created pursuant to a Declaration of Trust, dated July 25, 1982. Thus, he does not share investment discretion with respect to securities held by C&D Fund III.\n(3) Messrs. Rice and Cribiore may be deemed to share beneficial ownership of the shares owned of record by C&D Fund III by virtue of their status as general partners of the general partner of C&D Fund III, but Messrs. Rice and Cribiore each expressly disclaims such beneficial ownership of the shares owned by C&D Fund III. Messrs. Rice and Cribiore share investment and voting power with respect to securities owned by C&D Fund III.\n(4) Includes 27,900 shares held in Mr. Mason's individual retirement account. Shares held by officers in their respective individual retirement accounts (\"IRA\") are subject to a power of attorney to instruct the trustee of the IRA to take certain actions with respect to the shares held in the IRA in accordance with the stock subscription agreements executed by such officers.\n(5) Includes 13,000 shares held in Mr. Black's individual retirement account. See note 4.\n(6) Includes shares owned by C&D Fund IV, over which Mr. Ames, a director of the Company, shares investment and voting control. See notes 1 and 2.\n(7) Includes 90,900 shares held by officers and directors in their respective individual retirement accounts. See note 4.\nRegistration and Participation Agreements\nHolders of the 20,180,000 shares of Common Stock outstanding prior to the August 1990 private offering, net of 85,000 shares repurchased by the Company from former key employees (the \"Existing Holders\"), are entitled to the benefits of and are bound by the obligations set forth in a Registration and Participation Agreement, dated as of November 24, 1987 (the \"1987 Registration and Participation Agreement\"), among Holding, C&D Fund III and the other initial purchasers of Common Stock. Under the 1987 Registration and Participation Agreement, the holders of specified percentages of Common Stock may require the registration of such Common Stock, subject to certain limitations. Any number of such registrations may be requested, and Holding is required to bear all expenses in connection with the first three requests for registration. Prior to an initial public offering of Holding Common Stock, a demand for such registration can be made only by the holders of at least 40% of the Common Stock subject to the 1987 Registration and Participation Agreement (but not less than 3 million shares); thereafter, or at any time after November 24, 1994, such a demand may be made by the holders of at least 10% of the Common Stock subject to the Agreement (but not less than l.2 million shares). Holders of Common Stock also have the right to participate in any registered offering initiated by Holding, subject to certain conditions and limitations. In addition, the 1987 Registration and Participation Agreement entitles holders of Common Stock to participate proportionately in certain \"qualifying sales\" of Common Stock by C&D Fund III. Subject to certain qualifications, \"qualifying sales\" are sales by C&D Fund III of more than one million shares of Common Stock. Under the 1987 Registration and Participation Agreement, Holding must offer certain stockholders the right to purchase their pro rata share of Common Stock in connection with any proposed issuance of additional shares of Common Stock to C&D Fund III or any of its affiliates (other than persons who may be deemed affiliates solely by reason of being members of the management of the Company).\nHolders of the 15,000,000 shares of Common Stock purchased in the August 1990 private offering are entitled to the benefits of and are bound by the obligations set forth in the Registration and Participation Agreement dated as of August 13, 1990 (the \"1990 Registration and Participation Agreement\") among Holding, C&D Fund IV and those purchasers of such Common Stock (the \"New Holders\"). The registration rights are, however, expressly subordinate in nearly all respects to the registration rights granted to the Existing Holders with respect to the Common Stock that is covered by the 1987 Registration and Participation Agreement. The 1990 Registration and Participation Agreement provides, among other things, that New Holders of specified percentages of registrable Common Stock may initiate one or more registrations at Holding's expense, provided that the Existing Holders shall have the right to include their own shares of Common Stock in any such registration on a pro rata basis. In addition, if Holding proposes to register any equity securities, and certain conditions are met, New Holders will be entitled to include shares in the registration, provided that the Existing Holders shall have been given the opportunity to include all of their shares in such offering. The 1990 Registration and Participation Agreement does not entitle the New Holders to participate in sales of Common Stock by C&D Fund IV, but does give each New Holder the right to be offered additional shares of Common Stock if additional shares are proposed to be issued to C&D Fund IV or its affiliates.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe Company's largest stockholders, C&D Fund III and C&D Fund IV, are private investment funds managed by CD&R. Amounts contributed to C&D Fund III and C&D Fund IV by the limited partners thereof are invested at the discretion of the general partner in the equity of corporations organized for the purpose of carrying out leveraged acquisitions involving the participation of management, or, in the case of C&D Fund IV, in corporations where the infusion of capital coupled with the provision of managerial assistance by CD&R can be expected to generate returns on investments comparable to returns historically achieved in leveraged buy-out transactions. The general partner of C&D Fund III is Clayton & Dubilier Associates III Limited Partnership, a Connecticut limited partnership (\"Associates III\"). The general partner of C&D Fund IV is Clayton & Dubilier Associates IV Limited Partnership, a Connecticut limited partnership (\"Associates IV\"). B. Charles Ames, a principal of CD&R, a holder of an economic interest in Associates III and a general partner of Associates IV, also serves as Chairman of the Board of the Company. Andrall E. Pearson, a principal of CD&R and director of the Company, is a general partner of Associates IV. Michael G. Babiarz, a director of the company, is a professional employee of CD&R. Hubbard C. Howe, a principal of CD&R and a director of the Company, is a general partner of Associates IV.\nCD&R receives an annual fee for management and financial consulting services provided to the Company and reimbursement of certain expenses. The consulting fees paid to CD&R were $125,000 in 1995, $150,000 in 1994 and $200,000 in 1993. CD&R has agreed to forgo the consulting fee after October 1995, in view of the Company's financial position and in order to facilitate the proposed Restructuring.\nCD&R, C&D Fund III and the Company entered into an Indemnification Agreement on August 14, 1990, pursuant to which the Company agreed to indemnify CD&R, C&D Fund III, Associates III and their respective directors, officers, partners, employees, agents and controlling persons against certain liabilities arising under the federal securities laws and certain other claims and liabilities.\nCD&R, C&D Fund III, C&D Fund IV and the Company entered into a separate Indemnification Agreement, dated as of March 4, 1992, pursuant to which the Company agreed, subject to any applicable restrictions in the Senior Note Indenture, the Revolving Credit Agreement, the Subordinated Note Indenture, the 1987 Registration and Participation Agreement, and the 1990 Registration and Participation Agreement, to indemnify CD&R, C&D Fund III, C&D Fund IV, Associates III, Associates IV and their respective directors, officers, partners, employees, agents and controlling persons against certain liabilities arising under the federal securities laws and certain other claims and liabilities.\nHomeland has made temporary loans to certain members of management to enable such persons to make principal payments under loans from third-party financial institutions. As of May 1, 1996, $81,500 of such loans remains outstanding and are currently due on July 21, 1996. The loans bear interest at a variable rate equal to the rate applicable to the Company's borrowings under the Revolving Credit Agreement plus one percent.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\nThe following documents are filed as part of this Report:\n(a) Financial Statements and Exhibits.\n1. Financial Statements. The Company's financial statements are included in this report following the signature pages. See Index to Financial Statements and Financial Statement Schedules on page.\n2. Exhibits. See attached Exhibit Index on page E-1.\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.\nSUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT TO SECTION 15(d) OF THE ACT BY REGISTRANTS WHICH HAVE NOT REGISTERED SECURITIES PURSUANT TO SECTION 12 OF THE ACT\nThe Company has previously furnished to the Commission its proxy material in connection with the 1995 annual meeting of security holders. No separate annual report was distributed to security holders covering the Company's last fiscal year. The Company intends to furnish to its security holders proxy material in connection with the 1996 annual meeting of security holders. The Company will furnish copies of such material to the Commission when it is sent to security holders.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nHOMELAND HOLDING CORPORATION\nDate: May 13, 1996 By: \/s\/ James A. Demme James A. Demme, President\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nSignature Title Date\n\/s\/ B. Charles Ames Chairman of the Board May 13, 1996 B. Charles Ames\n\/s\/ James A. Demme President, Chief Executive May 13, 1996 Officer and Director (Principal Executive Officer)\n\/s\/ Larry A. Kordisch Executive Vice President\/ May 13, 1996 Larry A. Kordisch Finance, Treasurer, C.F.O. and Secretary (Principal Financial Officer)\n\/s\/ Terry M. Marczewski Chief Accounting Officer May 13, 1996 Terry M. Marczewski Assistant Treasurer and Assistant Secretary (Principal Accounting Officer)\nSignature Title Date\n\/s\/ John A. Shields Director May 13, 1996 John A. Shields\n\/s\/ Bernard S. Black Director May 13, 1996 Bernard S. Black\n\/s\/ Bernard Paroly Director May 13, 1996 Bernard Paroly\n\/s\/ Andrall E. Pearson Director May 13, 1996 Andrall E. Pearson\n\/s\/ Hubbard C. Howe Director May 13, 1996 Hubbard C. Howe\n\/s\/ Michael G. Babiarz Director May 13, 1996 Michael G. Babiarz\nHOMELAND HOLDING CORPORATION Consolidated Financial Statements\nReport of Independent Accountants . . . . . . . . . . Consolidated Balance Sheets as of December 30, 1995 and December 31, 1994. . . . . . . . . . . . . . . . Consolidated Statements of Operations for the 52 weeks ended December 30, 1995, December 31, 1994 and January 1, 1994 . . . . . . . . . . . . . . . . Consolidated Statements of Stockholders' Equity (Deficit) for the 52 weeks ended December 30, 1995, December 31, 1994 and January 1, 1994 . . . . . . . Consolidated Statements of Cash Flows for the 52 weeks ended December 30, 1995, December 31, 1994 and January 1, 1994 . . .. . . . . . . . . . . . . Notes to Consolidated Financial Statements . . . . .\nReport of Independent Accountants\nTo the Board of Directors and Stockholders of Homeland Holding Corporation\nWe have audited the accompanying consolidated financial statements of Homeland Holding Corporation and Subsidiary listed in the index on page F- 1 of this Form 10-K. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe 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 Homeland Holding Corporation and Subsidiary as of December 30, 1995 and December 31, 1994, and the consolidated results of their operations and their cash flows for the 52 weeks ended December 30, 1995, December 31, 1994 and January 1, 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 financial statements, the Company has incurred recurring losses from operations, negative cash flows from operations for the year ended December 30, 1995, a stockholders' deficit as of December 30, 1995 and has been unable to comply with its debt covenants. In addition, on March 27, 1996, the Company reached an agreement in principle with members of an ad-hoc noteholders committee with respect to a financial restructuring of the Company. The Company and the ad-hoc noteholders committee have agreed to implement the financial restructuring under a pre-arranged plan of reorganization to be filed under Chapter 11 of the United States Federal Bankruptcy Code. These factors raise substantial doubt about the Company's ability to continue as a going concern. The continuation of its business as a going concern is contingent upon, among other things, the ability to (1) complete the pre-arranged plan of reorganization and (2) sustain satisfactory levels of future earnings and cash flows. Management's plans with regard to such financial restructuring are set forth in Note 15 to the financial statements. The financial statements do not include any adjustments that might result from the outcome of these uncertainties or adjustments relating to the establishment, settlement and classification of liabilities that may be required in connection with the pre-arranged plan of reorganization of Homeland Holding Corporation and Subsidiary under Chapter 11 of the United States Federal Bankruptcy Code.\nCoopers & Lybrand, L.L.P. New York, New York March 27, 1996\nHOMELAND HOLDING CORPORATION AND SUBSIDIARY\nCONSOLIDATED BALANCE SHEETS\n(In thousands, except share and per share amounts)\nASSETS (Note 4)\nDecember 30, December 31, 1995 1994\nCurrent assets: Cash and cash equivalents (Notes 3 and 5) $ 6,357 $ 339 Receivables, net of allowance for uncollectible accounts of $2,661 and $2,690 8,051 12,235 Receivable for taxes (Note 6) - 2,270 Inventories 42,830 89,850 Prepaid expenses and other current assets 2,052 6,384\nTotal current assets 59,290 111,078\nProperty, plant and equipment: Land 9,919 10,997 Buildings 22,101 29,276 Fixtures and equipment 44,616 61,360 Land and leasehold improvements 23,629 32,410 Software (Note 3) 1,991 17,876 Leased assets under capital leases (Note 9) 29,062 46,015 Construction in progress 4,201 2,048\n135,519 199,982\nLess, accumulated depreciation and amortization 63,827 82,603\nNet property, plant and equipment 71,692 117,379\nExcess of purchase price over fair value of net assets acquired, net of amortization of $830 in fiscal 1994 (Note 3) - 2,475\nOther assets and deferred charg es 6,600 8,202\nTotal assets $137,582 $239,134\nThe accompanying notes are an integral part of these consolidated financial statements.\nHOMELAND HOLDING CORPORATION AND SUBSIDIARY\nCONSOLIDATED BALANCE SHEETS, Continued\n(In thousands, except share and per share amounts)\nLIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)\nDecember 30, December 31, 1995 1994 Current liabilities: Accounts payable - trad $ 17,732 $ 30,317 Salaries and wages 1,609 1,925 Taxes 4,876 6,492 Accrued interest payable 2,891 3,313 Other current liabilities 14,321 15,050 Current portion of long-term debt (Notes 4, 5 and 15) - 2,250 Long-term obligations in default classified as current (Notes 4, 5 and 15) 100,467 - Current portion of obligations under capital leases (Note 9) 2,746 7,828 Current portion of restructuring reserve (Note 14) 3,062 -\nTotal current liabilities 147,704 67,175\nLong-term obligations: Long-term debt (Notes 4, 5 and 15) - 145,000 Obligations under capital leases (Note 9) 9,026 11,472 Other noncurrent liabilities 6,133 5,176 Noncurrent restructuring reserve (Note 14) 2,808 5,005\nTotal long-term obligations 17,967 166,653\nCommitments and contingencies (Notes 8, 9 and 12) - -\nRedeemable common stock, Class A, $.01 par value, 1,720,718 shares at December 30, 1995 and 3,864,211 shares at December 31, 1994, at redemption value (Notes 10 and 11) 17 1,235\nStockholders' equity (deficit): Common stock (Note 10): Class A, $.01 par value, authorized - 40,500,000 shares, issued - 33,748,482 shares at December 30, 1995 and 31,604,989 at December 31, 1994, outstanding - 30,878,989 shares 337 316 Additional paid-in capital 55,886 53,896 Accumulated deficit (80,188) (48,398) Minimum pension liability adjustment (Note 8) (1,327) - Treasury stock, 2,869,493 shares at December 30, 1995 and 726,000 shares at December 31, 1994, at cost (2,814) (1,743)\nTotal stockholders' equity (deficit) (28,106) 4,071\nTotal liabilities and stockholders' equity(deficit) $137,582 $239,134\nThe accompanying notes are an integral part of these consolidated financial statements. HOMELAND HOLDING CORPORATION AND SUBSIDIARY\nCONSOLIDATED STATEMENTS OF OPERATIONS\n(In thousands, except share and per share amounts)\nThe accompanying notes are an integral part of these consolidated financial statements.\nHOMELAND HOLDING CORPORATION AND SUBSIDIARY\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)\n(In thousands, except share and per share amounts)\nThe accompanying notes are an integral part of these consolidated financial statements.\nHOMELAND HOLDING CORPORATION AND SUBSIDIARY\nCONSOLIDATED STATEMENTS OF CASH FLOWS\n(In thousands, except share and per share amounts)\nContinued HOMELAND HOLDING CORPORATION AND SUBSIDIARY\nCONSOLIDATED STATEMENTS OF CASH FLOWS, Continued\n(In thousands, except share and per share amounts)\nThe accompanying notes are an integral part of these consolidated financial statements.\nHOMELAND HOLDING CORPORATION AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(In thousands, except share and per share amounts)\n1. Organization:\nHomeland Holding Corporation (\"Holding\"), a Delaware corporation, was incorporated on November 6, 1987, but had no operations prior to November 25, 1987. Effective November 25, 1987, Homeland Stores, Inc. (\"Homeland\"), a wholly-owned subsidiary of Holding, acquired substantially all of the net assets of the Oklahoma Division of Safeway Inc. Holding and its consolidated subsidiary, Homeland, are collectively referred to herein as the \"Company\".\nHolding has guaranteed substantially all of the debt issued by Homeland. Holding is a holding company with no significant operations other than its investment in Homeland. Separate financial statements of Homeland are not presented herein since they are identical to the consolidated financial statements of Holding in all respects except for stockholder's equity (which is equivalent to the aggregate of total stockholders' equity and redeemable common stock of Holding) which is as follows:\nDecember 30, December 31, 1995 1994\nHomeland stockholder's equity: Common stock, $.01 par value, authorized, issued and outstanding 100 shares 1 1 Additional paid-in capital 53,435 53,713 Accumulated deficit (80,198) (48,408) Minimum pension liability adju (1,327) -\nTotal Homeland stockholder's equity (deficit) $(28,089) $ 5,306\n2. Basis of Presentation:\nThe accompanying consolidated financial statements of Holding have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the ordinary course of business. Accordingly, the consolidated financial statements do not include any adjustments relating to the recoverability or classification of recorded asset amounts or the amount and classification of liabilities that might be necessary should Holding be unable to successfully complete the financial restructuring described in Note 15 and continue as a going concern.\n2. Basis of Presentation, continued:\nAs shown in the accompanying financial statements, the Company incurred significant losses in 1995 and 1994 and, at December 30, 1995, had a stockholders' deficit of $28,106. As discussed in Note 4, at December 30, 1995, as a consequence of Homeland's financial position and the results of its operations for the year ended December 30, 1995, the Company was not in compliance with the Consolidated Fixed Charge Coverage Ratio and Debt-to-Equity Ratio covenants under its Senior Note Indenture and Revolving Credit Agreement; however, waivers of such noncompliance through April 15, 1996 and May 20, 1996, respectively, have been received. In addition, the Company failed to make a scheduled interest payment under its Senior Note Indenture, due March 1, 1996, and the waiver under such Senior Note Indenture thereby expired. Furthermore, as discussed in Note 15, negotiations for the restructuring of the Company's long-term debt and union agreements are being conducted which, if unsuccessful, could have a material adverse effect on the Company's financial condition.\n3. Summary of Significant Accounting Policies:\nFiscal year - The Company has adopted a fiscal year which ends on the Saturday nearest December 31.\nBasis of consolidation - The consolidated financial statements include the accounts of Homeland Holding Corporation and its wholly owned subsidiary. All significant intercompany balances and transactions have been eliminated in consolidation.\nRevenue recognition - The Company recognizes revenue at the \"point of sale\", which occurs when groceries and related merchandise are sold to its customers.\n3. Summary of Significant Accounting Policies, continued:\nConcentrations of credit and business risk - Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of temporary cash investments and receivables. The Company places its temporary cash investments with high quality financial institutions. Concentrations of credit risk with respect to receivables are limited due to the diverse nature of those receivables, including a large number of retail customers within the region and receivables from vendors throughout the country. The Company purchases approximately 70% of its products from Associated Wholesale Grocers, Inc. (\"AWG\"). Although there are similar wholesalers that could supply the Company with merchandise, if AWG were to discontinue shipments, this could have a material adverse effect on the Company's financial condition.\nRestricted Cash - The Company has two escrow accounts at United States Trust Company of New York, one for reinvestment in capital expenditures to which the Company is committed (\"Capital Escrow\") and one for the redemption of Senior Notes (as subsequently defined in Note 4) (\"Redemption Escrow\"). As of December 30, 1995, the Company has $1,729 deposited in the Capital Escrow and $800 deposited in the Redemption Escrow. The deposited funds in the Capital Escrow is restricted for reinvestment in capital expenditures to which the Company is committed or must be used to permanently pay down the Senior Notes. The Redemption Escrow consisting of net proceeds from asset sales occurring after the AWG Transaction (as subsequently defined in Note 14) is restricted to permanently pay down the Senior Notes when the aggregate amount reaches $2,000.\nInventories - Inventories are stated at the lower of cost or market, with cost being determined primarily using the retail method. 3. Summary of Significant Accounting Policies, continued:\nProperty, plant and equipment - Property, plant and equipment obtained at acquisition are stated at appraised fair market value as of that date; all subsequently acquired property, plant and equipment are stated at cost or, in the case of assets under capital leases, at the lower of cost or the present value of future lease payments. Depreciation and amortization, including amortization of leased assets under capital leases, are computed on a straight-line basis over the lesser of the estimated useful life of the asset or the remaining term of the lease. Depreciation and amortization for financial reporting purposes are based on the following estimated lives: Estimated lives Buildings 10 - 40 Fixtures and equipment 5 - 12.5 Leasehold improvements 15 Transportation equipment 5 - 10 Software 5 - 10\nThe costs of repairs and maintenance are expensed as incurred, and the costs of renewals and betterments are capitalized and depreciated at the appropriate rates. Upon sale or retirement, the cost and related accumulated depreciation are eliminated from the respective accounts and any resulting gain or loss is included in the results of operations for that period. In the fourth quarter of 1995, approximately $7.9 million of capitalized software costs, net of accumulated depreciation, have been charged to operational restructuring costs in the Statement of Operations as a result of management's decision to replace such software as part of its operational restructuring initiatives.\nExcess of purchase price over fair value of net assets acquired - As discussed in Notes 2 and 14, the Board of Directors approved a strategic plan in December 1995 to refocus the Company's restructuring efforts, which commenced in 1994, to address continuing significant losses from operations as well as evaluating various financial restructuring alternatives in an effort to improve cash flows from operations and reduce interest costs on the Company's long-term debt. There is no assurance that such restructuring efforts will be successful and, accordingly, the Company determined during the fourth quarter of 1995 that the recovery of any remaining unamortized excess of purchase price over fair value of net assets acquired could not be assured from future operating cash flows. Consequently, the unamortized\n3. Summary of Significant Accounting Policies, continued:\nbalance of the excess of purchase price over fair value of net assets acquired was charged to operational restructuring costs in the statement of operations.\nOther assets and deferred charges - Other assets and deferred charges consist primarily of financing costs amortized using the effective interest rate method over the term of the related debt and beneficial interests in operating leases amortized on a straight-line basis over the remaining terms of the leases, including all available renewal option periods.\nNet income (loss) per common share - Net income (loss) per common share is computed based on the weighted average number of shares, including shares of redeemable common stock outstanding during the period. Net income (loss) is reduced (increased) by the accretion to (reduction in) redemption value to determine the net income (loss) available to common stockholders.\nCash and cash equivalents - For purposes of the statements of cash flows, the Company considers all short-term investments with an original maturity of three months or less when purchased to be cash equivalents.\nCapitalized interest - The Company capitalizes interest as a part of the cost of acquiring and constructing certain assets. No interest cost was capitalized in 1995. Interest costs of $35 and $44 were capitalized in 1994 and 1993, respectively.\nAdvertising costs - Costs of advertising are expensed as incurred. Gross advertising costs for 1995, 1994 and 1993, respectively, were $10,700, $13,615 and $14,100.\nUse of estimates - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. The most significant assumptions and estimates relate to the reserve for restructuring, the reserve for self-insurance programs, the deferred income tax valuation allowance, the accumulated benefit obligation relating to the employee retirement plan, the allowance for bad debts and depreciation rates of property and equipment. Actual results could differ from those estimates. 3. Summary of Significant Accounting Policies, continued:\nIncome taxes - The Company provides for income taxes based on enacted tax laws and statutory tax rates at which items of income and expense are expected to be settled in the Company's income tax return. Certain items of revenue and expense are reported for Federal income tax purposes in different periods than for financial reporting purposes, thereby resulting in deferred income taxes. Deferred taxes also are recognized for operating losses that are available to offset future taxable income and tax credits that are available to offset future Federal income taxes. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized.\nSelf-insurance reserves - The Company is self-insured for property loss, general liability and automotive liability coverage and was self-insured for workers' compensation coverage until June 30, 1994, subject to specific retention levels. Estimated costs of these self-insurance programs are accrued at their present value based on projected settlements for claims using actuarially determined loss development factors based on the Company's prior history with similar claims. Any resulting adjustments to previously recorded reserves are reflected in current operating results.\nImpact of Recently Issued Accounting Pronouncement - The Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121, \" Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of\" (\"SFAS No.121\"), in March 1995 to establish standards for the impairment of long-lived assets, certain identifiable intangibles and goodwill related to those assets to be held and used. The Company has not yet adopted this accounting standard, which becomes effective in 1996 for Homeland, nor has it evaluated the potential impact of adoption in 1996. The impact of SFAS No. 121 is not reasonably estimable at this time due to certain factors discussed in Note 2 to the consolidated financial statements; although this standard may affect reported earnings and the carrying values of long-lived assets, there will be no impact on cash flows.\n4. Current and long-term Debt:\nIn March 1992, the Company entered into an Indenture with United States Trust Company of New York, as trustee, pursuant to which the Company issued $45,000 in aggregate principal amount of Series A Senior Secured Floating Rate Notes due 1997 (the \"Old Floating Rate Notes\") and $75,000 in aggregate principal amount of Series B Senior Secured Fixed Rate Notes due 1999 (the \"Old Fixed Rate Notes\", and collectively, the \"Old Notes\"). Certain proceeds from this issuance were used to repay all outstanding amounts under the previous credit agreement. In October and November 1992, the Company exchanged a portion of its Series D Senior Secured Floating Rate Notes due 1997 (the \"New Floating Rate Notes\") and its Series C Senior Secured Fixed Rate Notes due 1999 (the \"New Fixed Rate Notes\", and collectively, the \"New Notes\") for equal principal amounts of the Old Notes. The New Notes are substantially identical to the Old Notes, except that the offering of the New Notes was registered with the Securities and Exchange Commission. At the expiration of the exchange offer in November 1992, $33,000 in principal amount of the Old Floating Rate Notes and $75,000 in principal amount of the Old Fixed Rate Notes had been tendered and accepted for exchange.\nOn March 1, 1993, the Company redeemed all remaining outstanding subordinated notes ($47,750 principal amount) at the optional redemption price, including a premium of $2,776 or 5% of the outstanding principal amount specified in the subordinated note agreement, together with accrued interest.\nOn April 21, 1995, the Company and the Indenture trustee entered into a supplemental indenture effecting certain amendments to the Indenture. On June 1, 1995, the Company redeemed $15,625 of its New Fixed Rate Notes, $6,874 of New Floating Rate Notes and $2,501 of Old Floating Rate Notes.\nAlso on April 21, 1995, the Company entered into a revolving credit agreement (the \"Revolving Credit Agreement\") with National Bank of Canada (\"NBC\") as agent and lender, Heller Financial, Inc. and any other lenders thereafter parties thereto. The Revolving Credit Agreement provides a commitment of up to $25 million in collateralized revolving credit loans, including certain documentary and standby letters of credit.\n4. Current and long-term Debt, continued:\nAs a result of the 1995 and 1993 redemptions, the Company incurred the following extraordinary losses:\n1995 1993 Premium on redemption\/repurchase of the Company's 15.5% subordinated notes due November 1, 1997 $ - $(2,776)\nUnamortized financing costs relating to the redemption\/ repurchase of the Company's 15.5% subordinated notes due November 1, 1997 - (1,148)\nConsent fee equal to $5,000 for each principal amount of the $120.0 million Senior Notes (600) -\nPremium on redemption of $15.6 million of the Senior Secured Fixed Rate Notes, due March 1, 1999 (306) -\nUnamortized financing costs relating to the redemption of $25.0 million of the Senior Notes and the replacement of the prior revolving credit agreement (1,424) -\nNet extraordinary loss $(2,330) $(3,924)\n4. Current and long-term Debt, continued:\nLong-term debt at year end consists of:\nDecember 30, December 31, 1995 1994 Note payable* $ - $ 750 Senior Notes Series A** 9,499 12,000 Senior Notes Series D** 26,126 33,000 Senior Notes Series C** 59,375 75,000 Revolving credit loans*** 5,467 26,500\n100,467 147,250 Less current portion - 2,250 Less long-term debt obligation in default classified as current 100,467 - Long-term debt due after one year $ - $145,000\n* The Company issued a $3,000 note payable in 1992 for the purchase of fixed assets related to the acquisition of five stores. The note matured on March 1, 1995 and was repaid.\n** The Series A and Series D Senior Secured Floating Rate Notes mature on February 27, 1997. Interest payments are due quarterly and bear interest at the applicable LIBOR rate, as defined in the Indenture (8.43% at December 30, 1995). The Series C Senior Secured Fixed Rate Notes mature on March 1, 1999. Interest payments are due semiannually at an annual rate of 12.25%. The notes are collateralized by substantially all of the consolidated assets of the Company except for accounts receivable and inventories.\nThe notes, among other things, require the maintenance of a Debt-to-EBITDA and a consolidated fixed charge coverage ratio, as defined, and a capital expenditure covenant, as well as limiting the incurrence of additional indebtedness, providing for mandatory prepayment of the Senior Floating Rate Notes in an amount equal to 80% of excess cash flow, as defined, upon certain conditions and limiting the payment of dividends. At December 30, 1995, the Company was not in compliance with the Debt-to-EBITDA and the fixed charge coverage ratio covenants.\n4. Current and long-term Debt, continued:\nAlthough a waiver was received by the Company for such noncompliance through April 15, 1996, the Company failed to make a scheduled interest payment on March 1, 1996 and, accordingly, such waiver expired. As the Company may not be able to comply with these debt covenants in 1996, the aggregate principal amount of the outstanding debt was classified as current obligations.\n*** Borrowings under the Revolving Credit Agreement bear interest at the NBC Base Rate plus 1.5% for the first year, payable on a quarterly basis in arrears. At December 30, 1995, the interest rate on borrowings under the Revolving Credit Agreement was 10.0%. Subsequent year's interest rates will be dependent upon the Company's earnings but will not exceed the NBC base rate plus 2.0%. All borrowings under the Revolving Credit Agreement are subject to a borrowing base, which was $23.7 million as of December 30, 1995, and mature no later than February 27, 1997, with the possibility of extending the maturity date to March 31, 1998 if the Company's Series A Senior Secured Floating Rate Notes due February 27, 1997, are extended or refinanced on terms acceptable to NBC.\nThe Revolving Credit Agreement, among other things, requires the maintenance of a Debt-to-EBITDA ratio and consolidated fixed charge coverage ratio, as defined, and limits the Company's net capital expenditures, incurrence of additional indebtedness and the payment of dividends. The notes are collateralized by accounts receivable and inventories of the Company. At December 30, 1995, the Company was not in compliance with the Debt-to-EBITDA coverage ratio and the consolidated fixed charge coverage ratio. The lenders waived compliance of such default through May 20, 1996. As the Company may not be able to comply with existing covenants in 1996, the outstanding borrowings have been classified as current obligations (See Note 2 -Basis of Presentation and Note 15 - Subsequent Events).\n5. Fair Value of Financial Instruments:\nThe estimated fair value of financial instruments has been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is necessarily required in interpreting market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that the Company could realize in a current market exchange. The use of different market assumptions and\/or estimation methodologies may have a material effect on the estimated fair value amounts. The carrying amount and fair value of financial instruments as of December 30, 1995 and December 31, 1994 are as follows:\nDecember 30, 1995 December 31, 1994 Carrying Fair Carrying Fair Amount Value Amount Value Assets: Cash and Cash Equivalents $6,357 $6,357 $339 $339 Liabilities: Current and Long-Term Obligations in default classified as current $100,467 $56,411 - - Long-Term Debt - - $147,250 141,250\nCash and cash equivalents - The carrying amount of this item is a reasonable estimate of its fair value due to its short- term nature.\nCurrent and long-term obligations in default classified as current; long-term debt - The fair value of publicly traded debt (the Senior Secured Notes) is valued based on quoted market values. The amount reported in the balance sheet for the remaining long-term obligations in default classified as current approximates fair value based on quoted market prices of comparable instruments or by discounting expected cash flows at rates currently available for debt of the same remaining maturities.\n6. Income Taxes:\nThe components of the income tax benefit (provision) for fiscal 1995, 1994 and 1993 were as follows:\n1995 1994 1993 Federal: Current - AMT $ - $ 1,551 $ (36) Deferred - (3,997) 3,288 Total income tax benefit (provision) $ - $(2,446) $3,252\nA reconciliation of the income tax benefit (provision) at the statutory Federal income tax rate to the Company's effective tax rate is as follows:\n1995 1994 1993 Federal income tax at statutory rate $11,127 $13,370 $1,010 AMT in excess of regular tax - - (36) AMT loss carryback - 1,551 - Change in valuation allowance (10,074) (16,075) 3,288 Other - net (1,053) (1,292) (1,010) Total income tax benefit (provision) $ - $(2,446) $3,252\nDuring the year ended December 30, 1995, the Company received an income tax refund amounting to $1,339, due to the recognition of a tax benefit from its year ended December 31, 1994 for net alternative minimum tax operating losses that were carried back to prior tax years.\n6. Income Taxes, continued:\nThe components of deferred tax assets and deferred tax liabilities are as follows:\nDecember 30, December 31, 1995 1994\nCurrent assets (liabilities): Allowance for uncollectible receivables $ 1,090 $ 942 Termination of Borden supply agreement - 789 Operational restructuring re 1,282 5,918 Other, net 406 (800)\nNet current deferred tax assets 2,778 6,849\nNoncurrent assets (liabilities): Property, plant and equipment 251 (4,577) Targeted job credit carryforward 815 815 Self-insurance reserves 2,150 3,183 Operational restructuring reserve 969 1,745 Net operating loss carryforwards 17,001 7,048 AMT credit carryforwards 630 507 Capital leases 1,111 600 Other, net 444 (95) Net noncurrent deferred tax assets 23,371 9,226\nTotal net deferred assets 26,149 16,075 Valuation allowance (26,149) (16,075)\nNet deferred tax assets $ - $ -\nDue to the uncertainty of realizing the future tax benefits, the full valuation allowance established in fiscal 1994 was increased to entirely offset the net deferred tax assets as of December 30, 1995. At December 30, 1995, the Company had the following operating loss and tax credit carryforwards available for tax purposes:\n6. Income Taxes, continued:\nExpiration Amount Dates\nFederal regular tax net operating loss carryforwards $48,575 2002-2010 Federal AMT credit carryforwards against regular tax $ 630 indefinite Federal tax credit carryforwards (Targeted Jobs Credit) $ 815 2003-2009\nThe Internal Revenue Service (\"IRS\") concluded a field audit of the Company's income tax returns for the fiscal years 1990, 1991 and 1992. On January 31, 1994, the IRS issued a Revenue Agent's Report for those fiscal years proposing adjustments that would result in additional taxes of $1,589 (this amount is net of any available operating loss carryforwards which would be eliminated under the proposed adjustment). The Company filed its protest with the IRS Appeals Office on June 14, 1994. On June 28, 1995, the Company reached a tentative agreement with the IRS appeals office to settle the above claim. Management has analyzed the proposed settlement and has provided for amounts which it believes are adequate.\n7. Incentive Compensation Plan:\nThe Company has bonus arrangements for store management and other key management personnel. During 1995, 1994, and 1993, approximately $934, $1,939, and $2,900, respectively, was charged to costs and expenses for such bonuses.\n8. Retirement Plans:\nEffective January 1, 1988, the Company adopted a non- contributory, defined benefit retirement plan for all executive and administrative personnel. Benefits are based on length of service and career average pay with the Company. The Company's funding policy is to contribute an amount equal to or greater than the minimum funding requirement of the Employee Retirement Income Security Act of 1974, but not in excess of the maximum deductible limit. (Assets were held in investment mutual funds during 1995 and 1994.)\nIn accordance with the provisions of Statement of Financial Accounting Standards No. 87, \"Employers' Accounting for Pensions\", the Company recorded an additional minimum liability at December 30, 1995 and January 1, 1994 representing the excess of the accumulated benefit obligation over the fair value of plan assets and accrued pension liability. The liabilities have been offset by intangible assets to the extent of previously unrecognized prior service cost. The accumulated benefit obligation for December 30, 1995 was determined using a 7.25% discount rate; if the discount rate used had been at least 7.35%, the additional minimum liability would not have been recorded.\nNet pension cost consists of the following:\n1995 1994 1993\nService cost $ 517 $709 $663 Interest cost 465 366 292 Loss (return) on assets (1,140) 63 (319) Net amortization and deferral 690 (419) 43 Curtailment charge (37) - -\nNet periodic pension cost $ 495 $719 $680\nThe funded status of the plan and the amounts recognized in the Company's balance sheet at December 30, 1995 and December 31, 1994 consist of the following:\n1995 1994 Actuarial present value of benefit obligations: Vested benefits $(6,928) $(4,499) Non-vested benefits (88) (151) Accumulated benefit obligations $(7,016) $(4,650)\n8. Retirement Plans, continued:\n1995 1994\nProjected benefit obligations $(7,693) $(5,441) Plan assets at fair value 6,902 4,960 Projected benefit obligations in excess of plan assets (791) (481) Unrecognized prior service cost (95) (144) Unrecognized net loss from past experience different from that assumed and changes in actuarial assumptions 2,096 1,340 Adjustment to recognize minimum liability (1,327) - Net pension asset (liability) recognized in statement of financial position $ (117) $ 715\nActuarial assumptions used to determine year-end plan status were as follows:\n1995 1994\nAssumed rate for determination of net periodic pension cost 9.0% 7.5%\nAssumed discount rate to determine the year-end plan disclosures 7.25% 9.0%\nAssumed long-term rate of return on plan assets 9.0% 9.0%\nAssumed range of rates of future compensation increases (graded by age) for net periodic pension cost 5.0% to 7.0% 3.5% to 5.5%\nAssumed range of rates of future compensation increases (graded by age) for year-end plan disclosures 3.5% to 5.5% 5.0% to 7.0%\nThe prior service cost is being amortized on a straight line basis over approximately 13 years.\n8. Retirement Plans, continued:\nAs a result of the sale of the Company's warehouse and distribution center and 29 stores to AWG, as well as the closure of 14 under-performing stores during 1995 (See Note 14), a significant number of employees were terminated that participated in the Company's non-contributory defined benefit retirement plan. The effect of the curtailment resulting from the terminations of such employees was not material to the Statement of Operations for the year ended December 30, 1995.\nThe Company also contributes to various union-sponsored, multi-employer defined benefit plans in accordance with the collective bargaining agreements. The Company could, under certain circumstances, be liable for the Company's unfunded vested benefits or other costs of these multi-employer plans. The allocation to participating employers of the actuarial present value of vested and nonvested accumulated benefits in multi-employer plans as well as net assets available for benefits is not available and, accordingly, is not presented. The costs of these plans for 1995, 1994, and 1993 were $2,110, $3,309, and $3,565, respectively.\nEffective January 1, 1988, the Company adopted a defined contribution plan covering substantially all non-union employees of the Company. Prior to 1994, the Company contributed a matching 50% for each one dollar the participants contribute in pre-tax matched contributions. Participants may contribute from 1% to 6% of their pre-tax compensation which was matched by the Company. Participants may make additional contributions of 1% to 6% of their pre-tax compensation, but such contributions were not matched by the Company. Effective January 2, 1994, the plan was amended to allow a discretionary matching contribution formula based on the Company's operating results. The cost of this plan for 1995, 1994, and 1993, was $0, $0, and $425, respectively.\n9. Leases:\nThe Company leases substantially all of its retail store properties under noncancellable agreements, the majority of which range from 15 to 25 years. These leases, which include both capital leases and operating leases, generally are subject to six five-year renewal options. Most leases also require the payment of taxes, insurance and maintenance costs and many of the leases covering retail store properties provide for additional contingent rentals based on sales. Leased assets under capital leases consists of the following:\nDecember 30, December 31, 1995 1994\nBuildings $16,670 $21,616 Equipment 7,014 8,340 Beneficial interest in capital s 5,378 16,059 29,062 46,015 Accumulated amortization 17,851 21,010\nNet leased assets $11,211 $25,005\nFuture minimum lease payments under capital leases and noncancellable operating leases as of December 30, 1995 are as follows:\n9. Leases, continued:\nCapital Operating Fiscal Year Leases Leases\n1996 $ 4,035 $ 8,849 1997 2,754 8,239 1998 2,134 5,779 1999 1,707 5,448 2000 982 4,899 Thereafter 9,350 38,891\nTotal minimum obligations 20,962 $72,105 Less estimated interest 9,190 Present value of net minimum obligations 11,772 Less current portion 2,746 Long-term obligations under capital leases $ 9,026\nRent expense is as follows: 1995 1994 1993\nMinimum rents $10,264 $12,560 $12,642 Contingent rents 107 178 214\n$10,371 $12,738 $12,856\n10. Common Stock and Warrants:\nHolding has agreed to repurchase shares of stock held by management investors under certain conditions (as defined), such as death, retirement, or permanent disability.\nPursuant to requirements of the Securities and Exchange Commission, the shares of Class A common stock held by management investors have been presented as redeemable common stock and excluded from stockholders' equity.\nThe changes in the number of shares outstanding and the value of the redeemable common stock is as follows:\n10. Common Stock and Warrants, continued: Shares Amount\nBalance, January 2, 1993 4,104,211 $ 9,470 Repurchase of common stock (134,000) (323) Increase in management stock loans - (294)\nBalance, January 1, 1994 3,970,211 8,853 Repurchase of common stock (106,000) (255) Reduction in redemption value - (7,284) Increase in management stock loans - (79)\nBalance, December 31, 1994 3,864,211 1,235 Repurchase of common stock (2,143,493) (1,071) Reduction in redemption value - (940) Decrease in management stock loans - 793\nBalance, December 30, 1995 1,720,718 $ 17\nThe shares of redeemable common stock are reported on the balance sheets at redemption value (estimated fair value). The reduction in redemption value has been reflected as an increase in additional paid-in capital.\nThe shares of treasury stock are reported on the balance sheets at cost.\nHolding also has 40,500,000 shares of Class B nonvoting common stock authorized at December 30, 1995 and December 31, 1994 with a $.01 par value. No shares were issued or outstanding at either December 30, 1995 or December 31, 1994.\nIn 1995, Holding repurchased 2,143,493 shares of its Common Stock from certain officers and employees of the Company at a cash price of $0.50 per share plus, at the election of seller, warrants up to the number of shares purchased. As a result of the purchase, Holding issued 2,105,493 warrants to such officers and employees of the Company. The warrant and the shares issuable upon exercise, are subject to certain restrictions on transferability, including certain first refusal rights, as set forth in the warrant.\n10. Common Stock and Warrants, continued:\nThe holders of the warrants may, at any time prior to the expiration date (defined as five years after issuance date), purchase from Holding the amount of Common Stock indicated on such warrant, in whole or in part, at a purchase price of $0.50 per share.\n11. Related Party Transactions:\nClayton, Dubilier & Rice, Inc., a private investment firm of which four directors of the Company are employees, received $125 in 1995, $150 in 1994, and $200 in 1993, for financial advisory and consulting services.\nThe Company made loans during 1995 and 1994 to certain members of management and key employees for principal payments on their loans made by the credit union in connection with their purchase of common stock. The loans bear interest at a variable rate equal to the Company's prime lending rate plus 1.0%. Loans outstanding at December 30, 1995 and December 31, 1994 were $82 and $794, respectively. The outstanding loans mature in July 1996.\n12. Commitments and Contingencies:\nEffective January 1, 1989, the Company implemented stock appreciation rights (\"SAR's\") plans for certain of its hourly union and non-union employees as well as salaried employees. Participants in the plans are granted at specified times \"appreciation units\" which, upon the occurrence of certain triggering events, entitle them to receive cash payments equal to the increase in value of a share of the common stock over $1.00 from the date of the plan's establishment. The Company expects the SAR's to be triggered as a result of the restructuring, discussed in Note 14, at no liability to the Company due to the continued decline in per share value below $1.00.\nEffective October 1, 1991, the Company entered into an outsourcing agreement whereby an outside party provides virtually all of the Company's EDP requirements and assumed substantially all of the Company's existing hardware and software leases and related maintenance agreements. The ten year agreement calls for minimum annual service charges, increasing over its term, as well as other variable charges. The Company terminated the outsourcing agreement as of March 31, 1996. Pursuant to the outsourcing agreement, there is a\n12. Commitments and Contingencies, continued:\n$3.0 million charge for the termination, of which AWG is responsible for 52%. The Company has provided for amounts in the financial statements that management believes to be reasonable and adequate.\nThe Company has entered into employment contracts with certain key executives providing for the payment of minimum salary and bonus amounts in addition to certain other benefits in the event of termination of the executives or change of control of the Company.\nThe Company is also a party to various lawsuits arising in the normal course of business. Management believes that the ultimate outcome of these matters will not have a material effect on the Company's consolidated financial position, results of operations and cash flows.\nThe Company has outstanding at December 30, 1995, $12,000 in letters of credit which are not reflected in the accompanying financial statements. The letters of credit are issued under the Revolving Credit Agreement and the Company paid associated fees of $335 and $195 in 1995 and 1994, respectively.\n13. Sale of Plants:\nIn November 1993 the Company entered into an asset purchase agreement with Borden, Inc. (\"Borden\") whereby certain of the Company's milk and ice cream processing equipment and certain other assets and inventory relating to its milk and ice cream plants was sold. In connection with the sale, the Company entered into a seven-year agreement with Borden under which Borden would supply all of the Company's requirements for most of its dairy, juice and ice cream products and the Company agreed to purchase minimum volumes of products. The Company recognized a gain on the sale of personal property in the amount of $2,618. A $4,000 payment received in connection with the supply agreement was deferred and was to be recognized as earned over the term of the supply agreement.\nIn December 1994, the Company entered into a settlement agreement with Borden whereby the seven-year supply agreement entered into in November 1993 was terminated and a temporary supply agreement for a maximum period of 120 days was entered into. As part of the settlement agreement, the Company repaid $1,650 plus interest in December 1994 and $1,650 plus interest in April 1995. Upon final settlement payment, the Company\n13. Sale of Plants, continued:\nrecognized an additional gain of approximately $700 in 1995. The Company has made arrangements with another dairy supplier to begin supplying its dairy and ice cream requirements in April 1995.\n14. Restructuring:\nIn the fourth quarter of 1995, the Company refocused its restructuring plan, which commenced in 1994. The intent of the revised restructuring program and new business plan is to further reduce the Company's indebtedness in respect of its Senior Notes and its Revolving Credit Agreement, restructure certain of its lease obligations and negotiate modifications to certain of its union agreements in an effort to reduce costs and improve profitability and cash flow.\nIn connection with the closing of stores following the sale of 29 stores and the warehouse facility to AWG, the Company recognized charges aggregating $12,639 in 1995 and $23,205 in 1994. The major components of the restructuring charges in 1995 are summarized as follows:\nWrite-off of capitalized software costs replaced as part of operational restructuring initiatives $ 7,971\nWrite-off of unamortized balance of the excess of purchase price over fair value of net assets acquired due to uncertainty of recovery from future operating cash flows 2,360\nExpense associated with the termination of an EDP outsourcing agreement 1,410\nExpenses associated with the remaining store closings, primarily occupancy costs from closing date to lease termination or revised sublease date 898\nTotal restructuring charges $12,639\nThe asset write-offs described above, aggregating $10,331, have been reflected in their respective balance sheet account classifications, the EDP expense is included in Other current liabilities and the expenses associated with the remaining\n14. Restructuring, continued:\nstore closings are included in the Noncurrent restructuring reserve as of December 30, 1995. In accordance with a strategic plan approved by the Board of Directors in December 1994, the company entered into an aggreeent with Associated Wholesale Grocers, Inc. (\"AWG\") on February 6, 1995, pursuant to which the company sold 29 of its stores and its warehouse and distribution center to AWG on April 21, 1995. In connection with this strategic plan, the Company closed fourteen under-performing stores during 1995 and expects to close an additional store and sell one store by the second quarter of 1996. During fiscal 1995, the Company incurred expenses associated with the operational restructuring as follows:\n15. Subsequent Events:\nOn March 27, 1996, the Company entered into an agreement in principle (the \"Noteholder Agreement\") with members of an ad- hoc noteholders committee (the \"Committee\") with respect to a financial restructuring of the Company. The Committee has advised the Company that it represents approximately 80% of the Company's outstanding Senior Notes. The Noteholder Agreement provides for the filing by the Company of a bankruptcy petition and simultaneously the submission of a \"pre-arranged\" plan of reorganization and disclosure statement under Chapter 11 of the United States Federal Bankruptcy Code. (the \"Restructuring\"), all of which is expected to occur on or about May 13, 1996. If approved by the United States Bankruptcy Court (the \"Bankruptcy Court\"), the Company's creditors and labor unions, the Restructuring will result in a reduction of the Company's debt service obligations and labor costs and a capital and cost structure that will allow the Company to maintain and enhance the competitive position of its business and operations.\n15. Subsequent Events, continued:\nPursuant to the Noteholder Agreement, upon completion of the Restructuring, the $95 million of Senior Notes currently outstanding (together with accrued interest) will be canceled and the noteholders will receive $60 million in aggregate principal amount of new senior subordinated notes, a majority of the new equity of the reorganized Company and approximately $1.5 million in cash. The new senior subordinated notes will mature in 2003, bear interest semi-annually at a rate of 10% per annum and will not be secured.\nIn March 1996, the Company also reached agreements with representatives of its unionized workforce regarding certain modifications to the Company's existing collective bargaining agreements. These modifications will provide for, among other things, wage and benefit concessions, the severance of certain employees and the issuance and purchase of new equity of the reorganized Company to a trust acting on behalf of the unionized employees. The modifications to the collective bargaining agreements have been ratified by the union membership and are conditioned on, and will be effective upon, completion of the Restructuring.\nIn order to facilitate the Restructuring, as provided under the Noteholder Agreement the Company intends to file papers with the Bankruptcy Court seeking approval of a debtor-in- possession financing facility. The Company anticipates that such facility will provide it with the financing necessary to maintain its normal business operations during its period of operations under supervision of the Bankruptcy Court, including the payment of postpetition claims of trade creditors and salaries, wages and benefits of employees. The Company anticipates that the Restructuring will be completed by the third quarter of 1996.\nEXHIBIT INDEX\nExhibit No. Description\n3a Restated Certificate of Incorporation of Homeland Holding Corporation (\"Holding\"), dated August 2, 1990. (Incorporated by reference to Exhibit 3a to Form 10-Q for quarterly period ended September 8, 1990)\n3b By-laws of Holding, as amended and restated on November 14, 1989 and further amended on September 23, 1992. (Incorporated by reference to Exhibit 3b to Form 10-Q for quarterly period ended June 19, 1993)\n3c Restated Certificate of Incorporation of Homeland Stores, Inc. (\"Homeland\"), dated March 2, 1989. (Incorporated by reference to Exhibit 3c to Form 10-K for fiscal year ended December 31, 1988)\n3d By-laws of Homeland, as amended and restated on November 14, 1989 and further amended on September 23, 1992. (Incorporated by reference to Exhibit 3d to Form 10-Q for quarterly period ended June 19, 1993)\n4a Indenture, dated as of November 24, 1987, among Homeland, The Connecticut National Bank (\"CNB\"), as Trustee, and Holding, as Guarantor. (Incorporated by reference to Exhibit 4a to Form S-1 Registration Statement, Registration No. 33-22829)\n4a.1 First Supplement to Indenture, dated as of August 15, 1988, among Homeland, CNB and Holding. (Incorporated by reference to Exhibit 4a.1 to Form S-1 Registration Statement, Registration No. 33-22829)\n4b Purchase Agreement, dated November 24, 1987, among Homeland, Holding and initial purchasers of Subordinated Notes. (Incorporated by reference to Exhibit 4b to Form S-1 Registration Statement, Registration No. 33-22829)\n4c Form of Registration Rights Agreement, dated as of November 24, 1987, among Homeland, Holding and initial purchasers of Subordinated Notes. (Incorporated by reference to Exhibit 4c to Form S-1 Registration Statement, Registration No. 33-22829)\n4d Indenture, dated as of March 4, 1992, among Homeland, United States Trust Company of New York (\"U.S.Trust\"), as Trustee, and Holding, as Guarantor. (Incorporated by reference to Exhibit 4d to form 10-K for fiscal year ended December 28, 1991)\n4d.1 First Supplement to Indenture, dated as of June 17, 1992, among Homeland, Holding and U.S. Trust. (Incorporated by reference to Exhibit 4d.1 to Form S-1 Registration Statement, Registration No. 33- 48862)\n4d.3 Partial Release of Collateral, dated as of May 22, 1992, by U.S. Trust, as Collateral Trustee, in favor of Homeland. (Incorporated by reference to Exhibit 4d.3 to Form S-1 Registration Statement, Registration No. 33-48862)\n4e Form of Purchase Agreement, dated as of March 4, 1992, among Homeland and initial purchasers of Senior Notes. (Incorporated by reference to Exhibit 4e to Form 10-K for fiscal year ended December 28, 1991)\n4f Form of Registration Rights Agreement, dated as of March 4, 1992, among Homeland and the initial purchasers of Senior Notes. (Incorporated by reference to Exhibit 4f to Form 10-K for fiscal year ended December 28, 1991)\n10a Asset Purchase Agreement, dated as of September 15, 1987. (Incorporated by reference to Exhibit 10a to Form S-1 Registration Statement, Registration No. 33-22829)\n10b First Amendment to Asset Purchase Agreement, dated November 24, 1987. (Incorporated by reference to Exhibit 10b to Form S-1 Registration Statement, Registration No. 33-22829)\n10c Stock Subscription Agreement, dated as of November 24, 1987, between Holding and The Clayton & Dubilier Private Equity Fund III Limited Partnership. (Incorporated by reference to Exhibit 10c to Form S-1 Registration Statement, Registration No. 33-22829)\n10e Purchase Agreement for Safeway Brand Products, dated as of November 24, 1987, between Homeland and Safeway. (Incorporated by reference to Exhibit 10e to Form S-1 Registration Statement, Registration No. 33-22829)\n10f Manufacturing and Supply Agreement, dated as of November 24, 1987, between Homeland and Safeway. (Incorporated by reference to Exhibit 10f to Form S-1 Registration Statement, Registration No. 33-22829)\n10g Form of Common Stock Purchase Agreement, dated November 24, 1987, between Holding and certain institutional investors. (Incorporated by reference to Exhibit 10g to Form S-1 Registration Statement, Registration No. 33-22829)\n10h (1) Form of Management Stock Subscription Agreement, dated as of October 20, 1988, between Holding and the purchasers named therein, involving purchase of Holding common stock for cash. (Incorporated by reference to Form 10-K for fiscal year ended December 31, 1988)\n10h.1 (1) Form of Management Stock Subscription Agreement, dated as of October 20, 1988, between Holding and the purchasers named therein, involving purchase of Holding common stock using funds held under purchasers' individual retirement accounts. (Incorporated by reference to Form 10-K for fiscal year ended December 31, 1988)\n10h.2 (1) Form of Management Stock Subscription Agreement, dated as of November 29, 1989, between Holding and the purchasers named therein, involving purchase of Holding common stock for cash. (Incorporated by reference to Form 10-K for fiscal year ended December 30, 1989)\n10h.3 (1) Form of Management Stock Subscription Agreement, dated as of November 29, 1989, between Holding and the purchasers named therein, involving purchase of Holding common stock using funds held under purchasers' individual retirement accounts. (Incorporated by reference to Form 10-K for fiscal year ended December 30, 1989)\n10h.4 (1) Form of Management Stock Subscription Agreement dated as of August 14, 1990, between Holding and the purchasers named therein, involving purchase of Holding common stock for cash. (Incorporated herein by reference to Exhibit 10h.4 to Form 10-K for fiscal year ended December 29, 1990)\n10h.5 (1) Form of Management Stock Subscription Agreement dated as of August 14, 1990, between Holding and the purchasers named therein, involving purchase of Holding common stock using funds held under purchasers' individual retirement accounts. (Incorporated herein by reference to Exhibit 10h.5 to Form 10-K for fiscal year ended December 29, 1990)\n10i.1 Form of Registration and Participation Agreement, dated as of November 24, 1987, among Holding, The Clayton & Dubilier Private Equity Fund III Limited Partnership, and initial purchasers of Common Stock. (Incorporated by reference to Exhibit 10i to Form S-1 Registration Statement, Registration No. 33-22829)\n10i.2 1990 Registration and Participation Agreement dated as of August 13, 1990, among Homeland Holding Corporation, Clayton & Dubilier Private Equity Fund IV Limited Partnership and certain stockholders of Homeland Holding Corporation. (Incorporated by reference to Exhibit 10y to Form 10-Q for quarterly period ended September 8, 1990)\n10i.3 Form of Store Managers Stock Purchase Agreement. (Incorporated by reference to Exhibit 10z to Form 10-Q for quarterly period ended September 8, 1990)\n10j Indenture, dated as of November 24, 1987. (Incorporated by reference to Exhibit 10j to Form S-1 Registration Statement, Registration No. 33-22829)\n10j.1 First Supplement to Indenture, dated as of August 15, 1988. (Incorporated by reference to Exhibit 10j.1 to Form S-1 Registration Statement, Registration No. 33-22829)\n10k Form of Purchase Agreement, dated November 24, 1987, among Homeland, Holding and initial purchasers of Subordinated Notes (Filed as Exhibit 4b). (Incorporated by reference to Exhibit 10k to Form S-1 Registration Statement, Registration No. 33-22829)\n10l Form of Registration Rights Agreement, dated as of November 24, 1987, among Homeland, Holding and initial purchasers of Subordinated Notes. (Incorporated by reference to Exhibit 10l to Form S-1 Registration Statement, Registration No. 33-22829)\n10q (1) Homeland Profit Plus Plan, effective as of January 1, 1988. (Incorporated by reference to Exhibit 10q to Form S-1 Registration Statement, Registration No. 33-22829)\n10q.1 (1) Homeland Profit Plus Plan, effective as of January 1, 1989 (Incorporated by reference to Exhibit 10q.1 to Form 10-K for the fiscal year ended December 29, 1990)\n10r Homeland Profit Plus Trust, dated March 8, 1988, between Homeland and the individuals named therein, as Trustees. (Incorporated by reference to Exhibit 10r to Form S-1 Registration Statement, Registration No. 33-22829)\n10r.1 Homeland Profit Plus Trust, dated January 1, 1989, between Homeland and Bank of Oklahoma, N.A., as Trustee (Incorporated by reference to Exhibit 10r.1 to Form 10-K for the fiscal year ended December 29, 1990)\n10s (1) 1988 Homeland Management Incentive Plan. (Incorporated by reference to Exhibit 10s to Form S-1 Registration Statement, Registration No. 33-22829)\n10s.1 (1) 1989 Homeland Management Incentive Plan. (Incorporated by reference to Exhibit 10s.1 to Form 10-K for fiscal year ended December 31, 1988)\n10s.2 (1) 1990 Homeland Management Incentive Plan. (Incorporated by reference to Exhibit 10s.2 to Form S-1 Registration Statement, Registration No. 33- 48862)\n10s.3 (1) 1991 Homeland Management Incentive Plan. (Incorporated by reference to Exhibit 10s.3 to Form S-1 Registration Statement, Registration No. 33- 48862)\n10s.4 (1) 1992 Homeland Management Incentive Plan. (Incorporated by reference to Exhibit 10s.4 to Form S-1 Registration Statement, Registration No. 33-48862)\n10s.5 (1) 1993 Homeland Management Incentive Plan. (Incorporated by reference to Exhibit 10s.5 to Form 10-K for fiscal year ended January 1, 1994)\n10s.6 (1) 1994 Homeland Management Incentive Plan.\n10s.7* (1) 1995 Homeland Management Incentive Plan.\n10t (1) Form of Homeland Employees' Retirement Plan, effective as of January 1, 1988. (Incorporated by reference to Exhibit 10t to Form S-1 Registration Statement, Registration No. 33-22829)\n10t.1 (1) Amendment No. 1 to Homeland Employees' Retirement Plan effective January 1, 1989. (Incorporated herein by reference to Form 10-K for fiscal year ended December 30, 1989)\n10t.2 (1) Amendment No. 2 to Homeland Employees' Retirement Plan effective January 1, 1989. (Incorporated herein by reference to Form 10-K for fiscal year ended December 30, 1989)\n10t.3 (1) Third Amendment to Homeland Employees' Retirement Plan effective as of January 1, 1988. (Incorporated herein by reference to Exhibit 10t.3 to Form 10-K for fiscal year ended December 29, 1990)\n10t.4 (1) Fourth Amendment to Homeland Employees' Retirement Plan effective as of January 1, 1989. (Incorporated herein by reference to Exhibit 10t.4 to Form 10-K for the fiscal year ended December 28, 1991)\n10t.5 (1) Fifth Amendment to Homeland Employees' Retirement Plan effective as of January 1, 1989 (Incorporated herein by reference to Form 10-Q for the quarterly period ended September 9, 1995)\n10u (1) Employment Agreement, dated as of January 11, 1988, between Homeland and Jack M. Lotker. (Incorporated by reference to Exhibit 10u to Form S-1 Registration Statement, Registration No. 33- 22829)\n10v UFCW Stock Appreciation Rights Plan of Homeland. (Incorporated by reference to Exhibit 10v to Form 10-Q for quarterly period ended March 25, 1989)\n10v.1 Stock Appreciation Rights Plan of Homeland for Non-Union Employees. (Incorporated by reference to Exhibit 10v.1 to Form 10-Q for quarterly period ended March 25, 1989)\n10v.2 Teamsters Stock Appreciation Rights Plan of Homeland. (Incorporated by reference to Exhibit 10v.2 to Form S-1 Registration Statement, Registration No. 33-48862)\n10v.3 BC&T Stock Appreciation Rights Plan of Homeland. (Incorporated by reference to Exhibit 10v.3 to Form S-1 Registration Statement, Registration No. 33-48862)\n10w (1) Employment Agreement, dated as of September 26, 1989, between Homeland and Max E. Raydon. (Incorporated by reference to Exhibit 10w to Form 10-Q for quarterly period ended September 9, 1989)\n10x Indemnification Agreement, dated as of August 14, 1990, among Holding, Homeland, Clayton & Dubilier, Inc. and The Clayton & Dubilier Private Equity Fund III Limited Partnership. (Incorporated by reference to Exhibit 10x to Form 10-Q for quarterly period ended September 8, 1990)\n10y Indenture, dated as of March 4, 1992, among Homeland, United States Trust Company of New York, as Trustee, (\"U.S. Trust\") and Holding, as Guarantor. (Filed as Exhibit 4d)\n10y.1 First Supplement to Indenture, dated as of June 17, 1992, among Homeland, Holding and U.S. Trust. (Filed as Exhibit 4d.1)\n10y.2 Second Supplement to Indenture, dated as of April 21, 1995, among Homeland, Holding and United States Trust Company of New York, as Trustee. (Incorporated by reference to Exhibit 10y.2 to Form 10-Q for the quarterly period ended March 25, 1995)\n10y.3 Amendment No. 2 to the Company Security Agreement, dated as of April 21, 1995, between Homeland and United States Trust Company of New York as Collateral Trustee. (Incorporated by reference to Exhibit 10y.3 to Form 10-Q for the quarterly period ended March 25, 1995)\n10y.4 Amendment No. 1 to the Intercreditor Agreement, dated as of April 21, 1995, among National Bank of Canada, United States Trust Company of New York and such other persons as may become parties to the Intercreditor Agreement as provided therein. (Incorporated by reference to Exhibit 10y.4 to Form 10-Q for the quarterly period ended March 25, 1995)\n10y.5 Amendment No. 1 to the Mortgage Security Agreement and Financing Statement, dated as of April 21, 1995, from Homeland to United States Trust Company of New York as Collateral Trustee. (Incorporated by reference to Exhibit 10y.5 to Form 10-Q for the quarterly period ended March 25, 1995)\n10z Form of Purchase Agreement, dated as of March 4, 1992, among Homeland, Holding and the initial purchasers of Senior Notes. (Filed as Exhibit 4e)\n10aa Form of Registration Rights Agreement, dated as of March 4, 1992, among Homeland and the initial purchasers of Senior Notes. (Filed as Exhibit 4f)\n10bb Form of Parent Pledge Agreement, dated as of March 4, 1992, made by Holding in favor of U.S. Trust, as collateral trustee for the holders of the Senior Notes. (Incorporated by reference to Exhibit 10bb to Form 10-K for the fiscal year ended December 28, 1991)\n10cc Revolving Credit Agreement, dated as of March 4, 1992, among Homeland, Holding, Union Bank of Switzerland, New York Branch, as Agent and lender, and any other lenders and other financial institutions thereafter parties thereto. (Incorporated by reference to Exhibit 10cc to Form 10-K for the fiscal year ended December 28, 1991)\n10cc.1 Letter Waiver (Truck Sale), dated as of May 19, 1992, among Homeland, Holding, UBS, as agent, and the other lenders and financial institutions parties to the Revolving Credit Agreement. (Incorporated by reference to Exhibit 10cc.1 to Form S-1 Registration Statement, Registration No. 33-48862)\n10cc.2 Form of Amendment Agreement, dated as of June 15, 1992, among Homeland, Holding, UBS, as agent, and the other lenders and financial institutions parties to the Revolving Credit Agreement. (Incorporated by reference to Exhibit 10cc.2 to Form S-1 Registration Statement, Registration No. 33-48862)\n10cc.3 Form of Second Amendment Agreement, dated as of September 23, 1992, among Homeland, Holding, UBS, as agent, and the other lenders and financial institutions parties to the Revolving Credit Agreement. (Incorporated by reference to Exhibit 10cc.3 to Form S-1 Registration Statement, Registration No. 33-48862)\n10cc.4 Third Amendment Agreement, dated as of February 10, 1993, among Homeland, Holding, UBS, as agent, and the other lenders and financial institutions parties to the Revolving Credit Agreement.\n10cc.5 Fourth Amendment Agreement, dated as of June 8, 1993, among Homeland, Holding, UBS, as agent, and the other lenders and financial institutions parties to the Revolving Credit Agreement. (Incorporated by reference to Exhibit 10cc.5 to Form 10-Q for the quarterly period ended June 19, 1993)\n10cc.6 Fifth Waiver and Amendment Agreement, dated as of April 14, 1994, among Homeland, Holding, UBS, as agent, and the other lenders and financial institutions parties to the Revolving Credit Agreement. (Incorporated by reference to Exhibit 10cc.6 to Form 10-K for the fiscal year ended January 1, 1994)\n10cc.7 Sixth Waiver and Amendment Agreement, dated as of February 7, 1995, among Homeland, Holding, UBS, as agent, and the other lenders and financial institutions parties to the Revolving Credit Agreement.\n10dd Agreement for Systems Operations Services, effective as of October 1, 1991, between Homeland and K-C Computer Services, Inc. (Incorporated by reference to Exhibit 10dd to Form 10-K for the fiscal year ended December 28, 1991)\n10dd.1 Amendment No. 1 to Agreement for Systems Operations Services, dated as of September 10, 1993, between Homeland and K-C Computer Services, Inc. (Incorporated by reference to Exhibit 10dd.1 to Form 10-K for the fiscal year ended January 1, 1994)\n10ee Form of Indemnification Agreement, dated as of March 4, 1992, among Homeland, Holding, Clayton & Dubilier, Inc., The Clayton & Dubilier Private Partnership Equity Fund III Limited Partnership, and The Clayton & Dubilier Private Equity Fund IV Limited Partnership. (Incorporated by reference to Exhibit 10ee to Form 10-K for the fiscal year ended December 28, 1991)\n10ff Product Transportation Agreement, dated as of March 18, 1992, between Homeland and Drake Refrigerated Lines, Inc. (Incorporated by reference to Exhibit 10ff to Form 10-K for the fiscal year ended December 28, 1991)\n10gg Assignment and Pledge Agreement, dated March 5, 1992, made by Homeland in favor of Manufacturers Hanover Trust Company. (Incorporated by reference to Exhibit 10gg to Form 10-K for the fiscal year ended December 28, 1991)\n10hh Transportation Closure Agreement Summary, dated May 28, 1992, between Homeland and the International Brotherhood of Teamsters, Chauffeurs, Warehousemen and Helpers of America. (Incorporated by reference to Exhibit 10hh to Form S-1 Registration Statement, Registration No. 33-48862)\n10ii (1) Description of terms of employment with Mark S. Sellers. (Incorporated by reference to Exhibit 10ii to Form 10-K for the fiscal year ended January 2, 1993)\n10jj (1) Settlement Agreement, dated as of July 26, 1993, between Homeland and Donald R. Taylor. (Incorporated by reference to Exhibit 10jj to Form 10-K for the fiscal year ended January 1, 1994)\n10kk (1) Executive Officers Medical\/Life Insurance Benefit Plan effective as of December 9, 1993. (Incorporated by reference to Exhibit 10kk to Form 10-K for the fiscal year ended January 1, 1994)\n10ll (1) Employment Agreement, dated as of August 11, 1994, between Homeland and Max E. Raydon. (Incorporated by reference to Exhibit 10ll to Form 10-Q for the quarterly period ended September 10, 1994)\n10mm (1) Employment Agreement, dated as of August 11, 1994, between Homeland and Jack M. Lotker. (Incorporated by reference to Exhibit 10mm to Form 10-Q for the quarterly period ended September 10, 1994)\n10nn (1) Employment Agreement, dated as of August 11, 1994, between Homeland and Steve Mason. (Incorporated by reference to Exhibit 10nn to Form 10-Q for the quarterly period ended September 10, 1994)\n10oo (1) Employment Agreement, dated as of August 11, 1994, between Homeland and Al Fideline. (Incorporated by reference to Exhibit 10oo to Form 10-Q for the quarterly period ended September 10, 1994)\n10pp Letter of Intent, executed on November 30, 1994, between Homeland and Associated Wholesale Grocers, Inc. (Incorporated by reference to Exhibit 10pp to Form 8-K dated November 29, 1994)\n10pp.1 Asset Purchase Agreement, dated as of February 6, 1995, between Homeland and Associated Wholesale Grocers, Inc.\n10qq Solicitation Statement, dated April 4, 1995. (Incorporated by reference to Exhibit 10qq to Form 8-K dated April 4, 1995)\n10rr (1) Employment Agreement, dated as of November 22, 1994, between Homeland and James A. Demme.\n10rr.1* (1) Amendment to Employment Agreement between Homeland and James A. Demme, dated as of April 29, 1996\n10ss (1) Settlement Agreement, dated as of December 31, 1994, between Homeland and Max E. Raydon.\n10tt (1) Employment Agreement, dated as of January 30, 1995, between Homeland and Mark S. Sellers.\n10uu Amended and Restated Revolving Credit Agreement, dated as of April 21, 1995, among Homeland, Holding, National Bank of Canada, as Agent and lender, Heller Financial, Inc. and any other lenders thereafter parties thereto. (Incorporated by reference to Exhibit 10uu to Form 8-K dated March 14, 1996)\n10uu.1 Waiver Agreement, dated as of December 29, 1995 among Homeland, Holding, National Bank of Canada and Heller Financial, Inc. (Incorporated by reference to Exhibit 10uu.1 to Form 8-K dated March 14, 1996)\n10uu.2 Second Waiver Agreement, dated as of March 1, 1996 among Homeland, Holding, National Bank of Canada and Heller Financial, Inc. (Incorporated by reference to Exhibit 10uu.2 to Form 8-K dated March 14, 1996)\n10vv (1) Employment Agreement dated as of July 10, 1995 and as amended September 26, 1995, between Homeland and Larry W. Kordisch. (Incorporated by reference to Exhibit 10pp to Form 10-K dated September 9, 1995) 10vv.1* Amendment to Employment Agreement between Homeland and Larry W. Kordisch, dated as of April 29, 1996\n10ww* (1) Employment Agreement dated as of April 29, 1996, between Homeland and Terry M. Marczewski.\n10xx* (1) Settlement Agreement, dated as of August 31, 1995, between Homeland and Jack M. Lotker.\n10yy* (1) Employment Agreement, dated as of April 29, 1996, between Homeland and Steve M. Mason\n10zz* (1) Employment Agreement, dated as of April 29, 1996, between Homeland and Alfred Fideline\n22 Subsidiaries. (Incorporated by reference to Exhibit 22 to Form S-1 Registration Statement, Registration No. 33-22829)\n24* Consent of Coopers & Lybrand, L.L.P.\n27* Financial Data Schedule.\n99a Press release issued by Homeland on November 30, 1994. (Incorporated by reference to Exhibit 99a to Form 8-K dated November 29, 1994)\n99b Unaudited Summary Financial Data for the 52 weeks ended December 31, 1994. (Incorporated by reference to Exhibit 99b to Form 8-K dated November 29, 1994)\n99c Press Release issued by Homeland on April 13, 1995. (Incorporated by reference to Exhibit 99c to Form 8-K\/A dated April 21, 1995)\n99d Press Release issued by Homeland on April 24, 1995. (Incorporated by reference to Exhibit 99d to Form 8-K\/A dated April 21, 1995)\n99e Press Release issue by Homeland Stores, Inc. on March 1, 1996. (Incorporated by reference to Exhibit 99e to Form 8-K dated March 14, 1996)\n99f* Press Release issued by Homeland Stores, Inc. on\nMarch 27, 1996","section_15":""}
{"filename":"788043_1995.txt","cik":"788043","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"ITEM 2 - PROPERTIES - ------ ---------- VWR owns and leases office and warehouse space throughout the United States and Canada for distribution of the products supplied by it as follows:\nBatavia, Illinois Owned Bridgeport, New Jersey Owned Buffalo Grove, Illinois Owned Tempe, Arizona Leased Cerritos, California Leased San Francisco, California Leased San Dimas, California Leased Houston, Texas Leased Marietta, Georgia Leased Bridgeport, New Jersey Leased Morrisville, North Carolina Leased Tualatin, Oregon 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-eight smaller facilities throughout the United States and three smaller facilities in Canada which support the sales and warehouse functions. All facilities have been designed to serve the Company's purposes (warehouse functions and generic office). The facilities have been sufficient for its current operations and certain expansions are underway in order to service the acquired Baxter Industrial business.\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.\nLitigation relating to the issuance by VWR of common shares and the Debenture to EML pursuant to the terms of a Common Share and Debenture Purchase Agreement (the \"Securities Purchase Agreement\") dated May 24, 1995 between VWR and EML was commenced in the Delaware Court of Chancery on July 21, 1995 against VWR, VWR's President and Chief Executive Officer, seven members of VWR's Board of Directors and EML. In the complaint, the plaintiff seeks to have the action certified as a class action and, on behalf of all shareholders of VWR (except those named as defendants), to enjoin VWR from consummating the transactions contemplated by the Securities Purchase Agreement, an award of class rescissory and\/or compensatory damages, an award of costs and disbursements (including fees of attorneys and experts) and such other further relief as the court might deem just and proper. In addition, the plaintiff, on behalf of the shareholders, seeks an order that the director\ndefendants take appropriate measures to maximize shareholder value, including, without limitation, creating an active auction for VWR.\nThe plaintiff alleged, among other things, that the consummation of the transactions contemplated by the Securities Purchase Agreement would transfer control of VWR to EML and because EML would own nearly 50% of VWR, no third party will make a bid for VWR. The plaintiff also alleged that the individual defendants participated in unfair dealings towards plaintiff and the other shareholders by failing to implement procedures for maximization of shareholder value and permitting the transfer of control of VWR at a value which fails to reflect the long-term value of VWR's common shares, particularly in light of VWR's future prospects upon consummation of VWR's acquisition of Baxter Industrial.\nVWR believes that this suit is without merit and VWR, EML and the individual defendants intend to vigorously defend this action. VWR believes that the Standstill Agreement dated February 27, 1995 by and between VWR and EML, as amended pursuant to the Securities Purchase Agreement, will protect shareholder value following the consummation of the transactions contemplated by the Securities Purchase Agreement.\nOn September 15, 1995, VWR and the individual defendants filed motions to dismiss this action on both procedural and substantive grounds.\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, 1995.\nPART II. - --------\nITEM 5","section_5":"ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS - ------------------------------------------------------------------------\nVWR common shares, $1.00 par value, are traded on the NASDAQ Stock Market under the VWRX symbol. On February 29, 1996, there were approximately 6,400 shareholders represented by 1,666 holders of record.\nThe quarterly ranges of high and low bid prices of the Corporation's common shares during the years ended December 31, 1995, and 1994 as reported by NASDAQ are set forth below.\nThe Corporation declared dividends of $0.04 per share in April and August during the year ended December 31, 1995. The 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. The Corporation's Credit Facility entered into on September 14, 1995 prohibits the Corporation from paying dividends during the term of the Credit Facility.\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.\nAll data presented for continuing operations only.\n* Results before cumulative effect of accounting change include restructuring and other charges of $3.3 million pretax ($1.9 million net of tax).\n** All share and per share data reflect a two-for-one stock split effective May 9, 1992.\n*** Prior-year amounts have been restated to conform to current year calculation.\nITEM 7","section_7":"ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION - ----------------------------------------------------------------------- The following commentary should be read in conjunction with the Consolidated Financial Statements, Notes to Consolidated Financial Statements (\"Notes\"), and Selected Financial Data included elsewhere herein. Capitalized terms have the same meanings as defined in the Consolidated Financial Statements and the Notes.\nResults of Operations - ---------------------\nThe gross margin percentage over the last four years is as follows:\n1995 1994 1993 1992 ---- ---- ---- ---- 22.1% 21.2% 22.8% 23.3%\nTotal operating expenses as a percentage of sales over the last four years is as follows:\n1995 1994 1993* 1992 ----- ----- ----- ----- 19.7% 19.6% 20.6% 19.4%\n* 20.0% before restructuring charge.\n1995 versus 1994 - ----------------\n1995 results have been impacted by the acquisitions of the Industrial Distribution Business (\"Baxter Industrial\") of Baxter Healthcare Corporation (\"Baxter Healthcare\"), a subsidiary of Baxter International on September 15, 1995 and Canlab, the Toronto-based distribution division of Baxter International, on October 31, 1994.\nSales increased by 34.3% in 1995 to $718.7 million. The Baxter Industrial acquisition accounted for 74% of the increase in sales. The full-year effect of the Canlab acquisition accounted for 19% of the increase. The remainder of the sales growth occurred in the existing VWR business.\nGross margins increased from 21.2% in 1994 to 22.1% in 1995. The increase is the result of the implementation of internal programs to improve margins of VWR's Domestic and Canadian businesses.\nTotal operating expenses have remained relatively constant as a percentage of sales. Approximately 62% of the increase in expenses is due to the Baxter Industrial acquisition and 13% is due to the full-year effect of the Canlab acquisition in the fourth quarter of 1994. Depreciation and amortization expense has increased primarily as a result of amortization of the Baxter Industrial excess of cost over net assets of business acquired. Acquisition- related expenses consist of lease termination, severance, relocation,\ntraining, and transition expenses directly attributable to the acquisitions of Baxter Industrial and Canlab in 1995 and 1994, respectively.\nIn December 1994, the Company made the decision to consolidate certain sales offices and functions. As a result, the Company incurred approximately $1.2 million in charges which were primarily for severance and other personnel- related costs. The costs were recognized prior to the Baxter Industrial acquisition in September 1995. Due to the effects of the Baxter Industrial acquisition, the Company is not able to measure the benefits related to these costs and has classified these costs as operating expenses.\nInterest expense and other increased in 1995 primarily due to the effect of the debt incurred for the Baxter Industrial acquisition. In order to partially fund the acquisition, the Company issued a $135 million Debenture and incurred incremental borrowings under a new Credit Facility of approximately $170 million. The interest on the Debenture and the incremental borrowings on the Credit Facility account for 94% of the increase in interest expense. In addition, average borrowings under the former credit facility had increased due to the Canlab acquisition in the fourth quarter of 1994.\nNote 8 of the Notes describes the difference between the statutory and effective income tax rates. In 1995, the effective tax rate increased from 32.0% to 36.1% because in 1994, the Company recognized a tax benefit on prior year losses from the Canadian operations. In 1995, due primarily to programs to improve gross margin and the effect of the Canlab acquisition, the Canadian operations recognized a profit.\nEarnings per share in 1995 reflect the weighted average shares issued to affiliates of Merck KGaA, Darmstadt, Germany as more fully discussed in Note 9.\n1994 versus 1993 - ----------------\nThe sales increase in 1994 was due to growth in all areas of our business. The acquisition of Canlab in the fourth quarter of 1994 accounted for approximately 20% of the sales growth for the year. During the second half of 1994, Canadian operations showed strong sales growth, improving margins and operating results.\nIn 1994, gross margin as a percent of sales declined primarily as a result of continued competitive price pressures and customer mix.\nOperating 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 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 $2 million related to the consolidation of functions and facilities (consisting primarily of severance and other personnel-related costs) and non-cash charges of $1.3\nmillion (primarily for software development costs that did not have continuing value). These efforts were completed in 1994.\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 offset those savings in 1994.\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 rate swaps.\nThe lower effective tax rate in 1994 reflects the recognition of the benefits of a portion of the Canadian net operating loss carryforwards and lower state taxes. The higher effective tax rate in 1993 reflects the carryforward to future years of Canadian tax benefits not recognized in 1993.\nFinancial Condition and Liquidity - --------------------------------- The ratio of debt to equity at December 31 of each of the past four years is as follows:\n1995 1994 1993 1992 - -------------------------------------------------------------- 2.2 2.0 1.5 1.1\nThe ratio of operating income, plus depreciation and amortization, to interest paid over the past four years is as follows:\n1995 1994 1993 1992 - -------------------------------------------------------------- 3.5 3.9 5.0 7.9\nVWR's current ratio was 1.8 at December 31, 1995 as compared to 2.7 at December 31, 1994. The increase in accounts receivable is due to the Baxter Industrial acquisition. The increase in inventory is primarily due to various marketing programs, supporting new supplier partnerships with several customers, and stocking of inventory in advance of the transition of the Baxter Industrial business to VWR operations. The increase in accounts payable is due to amounts payable for goods shipped under the Services Agreement and also due to the increase in inventory. Excess of cost over net assets of businesses acquired increased due to the Baxter Industrial acquisition. Debt has increased as a result of the Debenture and incremental borrowings used to partially finance the Baxter Industrial acquisition. Equity increases reflect the initial issuance of 1.8 million shares to an affiliate of Merck KGaA in April 1995 and 7.8 million additional shares to an affiliate of Merck KGaA in September 1995. The proceeds from the additional shares issued in September were used to partially fund the Baxter Industrial acquisition. Sufficient credit availability existed at December 31, 1995 to provide for the amount of bank checks outstanding less cash in bank of $1.7 million.\nIn 1995, operations generated $59.5 million of cash flow. The Services Agreement (as described in Note 14) accounted for $32.8 million primarily because the Company does not pay for inventory for Baxter Industrial sales until the items are shipped. As the Baxter Industrial business is transitioned to VWR facilities on a regional basis during 1996, the Company will be required to carry additional inventory. Inventory on-hand at Baxter Healthcare for sale to Baxter Industrial customers was approximately $46 million at December 31, 1995.\nAs discussed in Note 2, VWR completed the Baxter Industrial acquisition on September 15, 1995 for a cash purchase price of approximately $434 million. During the period over the next twelve to fifteen months, the servicing of former Baxter Industrial customers is expected to be moved by VWR into its facilities, and the Company will be required to purchase from Baxter Healthcare the inventory of laboratory supplies and equipment for sale to customers of the Baxter Industrial business held by Baxter Healthcare.\nAs discussed in Note 14, the Company entered into a Distribution Agreement with Baxter Healthcare. The Distribution Agreement, which has a term ending on September 30, 2000, provides, among other things, that the Company is obligated during each year to either purchase a minimum dollar amount of products for sale in each of the United States and internationally, or, if such minimum requirements have not been met during such year, purchase products or pay to Baxter Healthcare an amount, in each case, equal to any such deficiency. The minimum aggregate domestic and international requirements for each of the five years of the Distribution Agreement are as follows: Year 1 - $63 million; Year 2 - $74 million; Year 3 - $82 million; Year 4 - $89 million; and Year 5 - $96 million. During 1995, purchases under this agreement were $14 million. The Company expects that such minimums will be met.\nAs discussed in Note 7, the Company and certain of its subsidiaries entered into a Credit Facility. Pursuant to the Credit Facility, the Banks have extended the Company a five-year amortizing term loan in the original principal amount of $135 million (\"Term Loan\") and established for the Company from September 14, 1995 until September 13, 2000 a revolving line of credit (\"Revolver\") in an amount not to exceed $150 million. Approximately $84.3 million was outstanding at December 31, 1995 under the Revolver. The Term Loan and Revolver are secured by liens in favor of the banks on substantially all of the Company's tangible and intangible property, excluding real estate.\nThe Credit Facility includes various financial covenants of the Company, including covenants with respect to minimum earnings before taxes; depreciation and amortization; maximum senior leverage ratio; minimum interest coverage; minimum net worth; and minimum fixed coverage ratio. The Credit Facility prohibits the Company from paying dividends and making other distributions (except for the issuance of shares as required by the Debenture) and has change- of-control provisions.\nAs discussed in Note 7, the Company incurred indebtedness of $135 million evidenced by the Debenture. The Debenture matures in a single installment on September 15, 2005. The Debenture is subordinated to the Company's obligations to its primary bank lending institutions. Interest is payable on the unpaid\nprincipal of the Debenture quarterly at 13% per annum, but until such time as EML and its affiliates own 49.89% of the aggregate number of issued and outstanding common shares, interest shall be payable solely in common shares at a price of $12.44 per share. Thereafter and until September 15, 1997, the payment of any cash interest otherwise accruing will be deferred until maturity of the Debenture.\nOn April 13, 1995, EML purchased from the Company 1.8 million common shares at $11 per share and the Warrant for 1.0 million shares, exercisable at $11 per share. On September 15, 1995, in conjunction with the Baxter Industrial acquisition, EML exercised the Warrant and purchased an additional 6.8 million common shares at a price of $12.44 per share.\nWhile management believes the Baxter Industrial acquisition enhances the potential to increase shareholder value, the achievement of such an increase is dependent upon various factors including: a successful and timely integration of the business into VWR's infrastructure; realization of expected operating efficiencies; retention of the combined customer base; satisfying the obligations under the Distribution Agreement; the provision of distribution services by Baxter Healthcare under the Services Agreement; general state of economic growth in the U.S.; competitive and pricing pressures; and changes in prices paid to manufacturers for distributed products.\nThe Company has entered into various interest rate swap agreements with financial institutions which effectively change the Company's interest-rate exposure on a notional amount of debt from variable rates to fixed rates. The notional amounts of the interest rate 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. At December 31, 1995, the Company had a notional amount of $120 million of swaps in effect and had committed another $60 million to take effect in 1996. These swaps expire between 1996 and 2000. The amount of floating rate debt protected by the swaps ranges from $180 million to $25 million during the period outstanding with fixed rates ranging from 4.9% to 6.4%. 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, 1995, the fair market value of the swap agreements, which is not recorded in the consolidated financial statements, is a net payable of approximately $1.9 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. The Company also 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%.\nThe Company's use of swaps and collars for interest rate protection increased interest expense by $.3 million, $1.2 million, and $2.2 million in 1995, 1994, and 1993, respectively. Pursuant to the Credit Facility, the Company is obligated to provide interest rate protection on at least 25% of the Credit Facility.\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, 1995, the estimated cost for capital improvement projects is between $18 million and $23 million in 1996 related primarily to expansion of facilities required to transfer the Baxter Industrial business to VWR facilities. In addition, management estimates that acquisition-related expenses totalling $3 million to $4 million will be incurred in 1996.\nThe Company expects that estimated working capital requirements and estimated capital expenditures will be funded by cash from operations and availability under the Credit Facility.\nOperating Income Return on Average Invested Capital** - ---------------------------------------------------\n1995 1994 1993 1992 - ---------------------------------------------------------------------\n7.3% 7.5% 11.1% 21.7%\n1993 before restructuring charges 14.4%\nOperating Income to Sales - ------------------------- 1995 1994 1993 1992 - ---------------------------------------------------------------------\n2.5% 1.5% 2.2% 3.9%\n1993 before restructuring charges 2.9%\nAverage Invested Capital to Sales** - --------------------------------- 1995 1994 1993 1992 - ---------------------------------------------------------------------\n34.2% 20.4% 19.9% 18.0%\nDays Sales in Accounts Receivable - --------------------------------- 1995* 1994* 1993 1992 - ---------------------------------------------------------------------\n45.7 45.7 42.6 41.5\nInventory Turnover (Before LIFO) - -------------------------------- 1995* 1994* 1993 1992 - ---------------------------------------------------------------------\n5.5 6.7 6.9 6.4\n*Excludes the effect of the Baxter Industrial acquisition in 1995 and the Canlab acquisition in 1994.\n**Prior year amounts have been restated to conform to current year calculations.\nITEM 8.","section_7A":"","section_8":"ITEM 8. - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - ------- -------------------------------------------\nVWR SCIENTIFIC PRODUCTS CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS\nSee Notes to Consolidated Financial Statements.\nVWR SCIENTIFIC PRODUCTS CORPORATION CONSOLIDATED BALANCE SHEETS\n(Thousands of dollars, except share data)\nSee Notes to Consolidated Financial Statements.\nVWR SCIENTIFIC PRODUCTS CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS\nSee Notes to Consolidated Financial Statements.\nVWR SCIENTIFIC PRODUCTS CORPORATION CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY\nSee Notes to Consolidated Financial Statements.\nVWR SCIENTIFIC PRODUCTS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ------------------------------------------\nPrinciples of Consolidation - --------------------------- The accompanying consolidated financial statements include the accounts of VWR Scientific Products Corporation (formerly VWR Corporation) and all of its subsidiaries (the \"Company\" or \"VWR\"). All significant intercompany accounts and transactions have been eliminated.\nCapitalization, Depreciation and Amortization - --------------------------------------------- Land, buildings, and equipment are recorded at cost. Depreciation is computed 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.\nExcess of Cost Over Net Assets of Businesses Acquired - ----------------------------------------------------- Excess of cost over net assets of businesses acquired is primarily the result of the acquisitions of the Industrial Distribution Business of Baxter Healthcare in 1995 and Canlab in 1994 and is being amortized over 40 years. Accumulated amortization at December 31, 1995 and 1994 was $3.6 million and $.6 million, respectively. The carrying value of excess of cost over net assets of businesses acquired will be evaluated periodically in relation to the operating performance and expected future undiscounted cash flows of the underlying businesses.\nIncome Taxes - ------------ In 1993, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes,\" which 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 was a change from the Company's prior practice of recording these costs when incurred.\nEarnings Per Share - ------------------ Earnings per share are based on the weighted average number of shares and dilutive common share equivalents outstanding during the period. Shares issued in payment of Debenture interest are included in the share calculation as interest expense is recognized (See Note 7).\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, 1995, the Company had no significant concentrations of credit risk.\nUse of Estimates - ---------------- The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.\nNew Accounting Standards - ------------------------ In March 1995, the FASB issued SFAS No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,\" which requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amount. SFAS 121 also addresses the accounting for long-lived assets that are expected to be disposed of. The Company will adopt SFAS 121 in the first quarter of 1996 and, based on current circumstances, does not believe the effect of adoption will be material.\nSFAS No. 123, \"Accounting for Stock Based Compensation,\" is effective for fiscal years beginning after December 15, 1995. SFAS 123 provides companies with a choice to follow the provisions of SFAS 123 in determining stock-based compensation expense or to continue with the provisions of APB 25, \"Accounting for Stock Issued to Employees.\" The Company will continue to follow APB 25 and will provide the pro forma disclosures as required by SFAS 123 in the December 31, 1996 notes to the consolidated financial statements.\nReclassifications - ----------------- Certain prior years' amounts have been reclassified to conform to the current year's presentation.\n2. ACQUISITIONS ------------ Baxter Industrial - ----------------- On September 15, 1995, VWR purchased certain assets and assumed certain liabilities of the Industrial Distribution Business (\"Baxter Industrial\") of Baxter Healthcare Corporation (\"Baxter Healthcare\"), a subsidiary of Baxter International, including, but not limited to, all of the domestic trade accounts receivable, certain tangible personal property, rights and benefits under certain contracts and certain rights in specified trademarks for approximately $434 million. In addition to the $400 million paid at closing, $28.6 million was paid over a 52-day period for accounts receivable in the same amount and approximately $5 million of additional liabilities were assumed. The purchase price paid by the Company is subject to adjustment which the Company does not believe will materially affect its financial position or results of future operations.\nThe acquisition has been accounted for under the purchase method of accounting and, accordingly, the results of Baxter Industrial have been included in the consolidated operating results since the date of acquisition. The Company's balance sheet at December 31, 1995 includes estimates of the fair value of the assets and liabilities acquired in connection with the acquisition of Baxter Industrial. Cost in excess of net assets acquired amounted to $365 million which is being amortized on a straight-line basis over 40 years. Changes in purchase accounting estimates related to the resolution of issues that existed at the date of acquisition and related restructuring decisions may result in a reallocation of the purchase price within one year of the date of acquisition.\nThe purchase price was financed by the proceeds received by the Company from: (i) the sale of 6,832,797 common shares of the Company (the \"Purchase Shares\") at a price of $12.44 per share to EM Laboratories, Incorporated, (\"EML\"), an affiliate of Merck KGaA, Germany; (ii) the issuance of a $135.0 million subordinated debenture (the \"Debenture\") of the Company to EML; (iii) the exercise by EML of a warrant to purchase 967,015 common shares of the Company for approximately $10.6 million; and (iv) borrowings under the Company's $285.0 million credit agreement entered into by the Company on September 14, 1995.\nDuring the next twelve to fifteen months, the servicing of former Baxter Industrial customers will be moved to VWR facilities and systems, and the Company will be required to purchase from Baxter Healthcare the inventory of laboratory supplies and equipment held for sale to customers of Baxter Industrial at Baxter Healthcare's facilities. At December 31, 1995, the Baxter Industrial inventory held by Baxter Healthcare was approximately $46 million. During 1995, the Company purchased $31.3 million of inventory from affiliates of Merck KGaA, of which $4.5 million was payable at December 31, 1995.\nCanlab - ------ 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 then-outstanding secured term\nloan. Canlab's results of operations have been included in the consolidated results of operations since the date of acquisition. The acquisition resulted in $5.1 million of excess of cost over net assets acquired which is being amortized over 40 years. 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.\nThe following unaudited pro forma information has been prepared assuming that the Baxter Industrial acquisition and the Canlab acquisition and related financings had occurred on January 1, 1994 and January 1, 1993, respectively. Pro forma adjustments include: increased amortization for the cost over net assets acquired; increased interest expense from the acquisition debt; and related income tax effects. Potential cost savings from combining the operations are not reflected because Baxter Industrial's and VWR's businesses are not expected to be fully integrated until after the first anniversary date of the closing. Also, Baxter Industrial's inventory, as reflected in cost of sales, is valued at the lower of cost (determined on a \"first-in, first-out\" basis) or market in the pro forma information below. Cost of sales has not been adjusted to give the pro forma effect of adopting VWR's accounting policy of valuing inventory on the \"last-in, first-out\" method because it is not possible to calculate the pro forma adjustments.\nThe unaudited pro forma information is provided for information purposes only and does not purport to be indicative of VWR's results of operations that would actually have been achieved had the Baxter Industrial and Canlab acquisitions and related financing transactions been completed for the periods presented, or results that may be obtained in the future.\nIn connection with the combination of the Baxter Industrial business with VWR, the Company has made organizational and facility location decisions involving the Company's selling and distribution activities. At December 31, 1995, while the overall plans had been substantially finalized, they had not been\nfully communicated or implemented. The implementation will result in additional inventory relocation, severance, personnel relocation, and other costs being incurred in 1996. Certain costs related to activities of the Baxter Industrial business will be considered in the final allocation of the purchase price of the acquired business, and the additional costs related to VWR's existing operations were or will be expensed. In 1995, the Company accrued $2.4 million in connection with the Baxter Industrial business and expensed $3.8 million as acquisition-related expenses including: lease termination costs related to the decision to upgrade the Company's computer hardware; severance and relocation of VWR employees; training of the combined sales force regarding the transition; consulting services; and other incremental costs related to the acquisition. Although these efforts are continuing, it is estimated that additional costs related to VWR's existing operations may range between $3 million and $4 million in 1996.\n3. INVENTORIES ----------- Inventories consist of purchased goods for sale and are valued at the lower of cost or market. Cost determined using the last-in, first-out (LIFO) method comprised 81% and 75% of inventory carrying value at December 31, 1995 and 1994, respectively. Cost of the remaining inventories is determined using the first- in, first-out (FIFO) method.\nLIFO cost at December 31, 1995 and 1994, was approximately $28.8 million and $27.7 million, respectively, less than current cost. The effect of LIFO layer liquidations decreased cost of sales by $.6 million in 1993.\n4. FIXED ASSETS ------------ Net property and equipment at December 31, 1995 and 1994, is:\nDepreciation expense for the years ended December 31, 1995, 1994 and 1993, was $6.6 million, $6.3 million and $5.4 million, respectively.\n5. ACCRUED LIABILITIES ------------------- Included in accrued liabilities at December 31, 1995 is accrued compensation of approximately $9.0 million and accrued service costs under the Baxter\nIndustrial Services Agreement (see Note 14) of $6.6 million. At December 31, 1994, accrued compensation was approximately $3.3 million.\n6. FOREIGN 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, 1995, the Company had approximately $6.9 million of forward exchange contracts outstanding. Net transaction gains and losses under the contracts are not material and are included in interest expense and other.\n7. LONG-TERM DEBT AND REVOLVING CREDIT FACILITIES ---------------------------------------------- On September 14, 1995, the Company entered into a five-year $285 million Credit Facility consisting of a five-year $135 million amortizing term loan (the \"Term Loan\") and a $150 million revolving line of credit (the \"Revolver\"). The Revolver provides for the ability to borrow the equivalent in Canadian dollars up to $17 million U.S. dollars. The Term Loan and Revolver are secured by liens on substantially all of the Company's tangible and intangible property, excluding real estate. Borrowings under the Revolver are limited to 85% of eligible accounts receivable and 50% of eligible inventory. The proceeds of the Term Loan and the initial advance under the Revolver were used by the Company principally to repay indebtedness of $74 million outstanding under the Company's former credit facility and to pay $170 million of the purchase price for the Baxter Industrial acquisition. Both the Term Loan and the Revolver bear interest rates based on the London Interbank Offered Rate (\"LIBOR\") or the prime rate, plus the applicable margin. The Company is required to pay commitment fees on the unused portion of the Revolver of between .20% and .50%. The margin on interest and the commitment fees will vary depending on the relationship between the Company's earnings before interest, taxes, depreciation and amortization (\"EBITDA\") and aggregate borrowings under the Credit Facility.\nThe Credit Facility includes various financial covenants of the Company, including covenants with respect to minimum EBITDA, maximum senior leverage ratio, minimum interest coverage, minimum net worth, and minimum fixed-charge coverage ratio. The Credit Facility prohibits the Company from paying dividends and making other distributions (except for the issuance of common shares as required by the Debenture) and has change-of-control provisions.\nThe terms of the Revolver provide that the Company must have at least $20 million undrawn on the Revolver for at least thirty consecutive days in the first twelve months following the closing and at least $30 million undrawn for at least thirty consecutive days during each twelve-month period thereafter.\nOn September 15, 1995, in conjunction with the Baxter Industrial acquisition, the Company issued the Debenture to EML in the principal amount of $135.0 million. The Debenture was subsequently assigned to another affiliate of EML. The Debenture matures in a single installment on September 15, 2005 and is subordinated to the Company's obligations under the Credit Facility. Interest is payable on the unpaid principal of the Debenture quarterly at 13% per annum\nby: issuance of common shares of the Company in the first year up to an amount that will enable EML to obtain an ownership percentage of 49.89% in the Company based on a fixed price of $12.44 per share; is deferred in year two to be paid with accumulated interest thereon at maturity; and is payable in cash beginning in year three.\nAt December 31, 1995 and 1994, the approximate weighted average interest rate on borrowings under the outstanding Credit Facility was 7.8% and 7.4%, respectively. Interest expense under the credit facilities for the years ended December 31, 1995, 1994, and 1993, was $9.6 million, $4.8 million, and $4.5 million, respectively, resulting in a weighted average interest rate of 8.2%, 7.0%, and 7.9%, respectively.\nThe carrying values of the Revolver and Term Loan approximate their fair values. The fair value of the Debenture is not readily determinable.\nIn connection with the Credit Facility and Debenture, the Company incurred approximately $5.0 million of debt issuance cost. Such amounts are included in other assets and are being amortized to interest expense using the effective interest rate method related to the Term Loan and Debenture, and the straight- line method related to the Revolver. Total amortization of debt issuance costs (included in interest expense and other) was $.3 million in 1995.\nAggregate maturities of long-term debt are as follows: 1996-$20.0 million; 1997-$22.5 million; 1998-$30.0 million; 1999-$32.5 million; 2000-$114.3 million; and $135.0 million in 2005.\nThe Company has entered into various interest rate swap agreements with financial institutions which effectively changes the Company's interest rate exposure on a notional amount of debt from variable rates to fixed rates. The notional amounts of the swaps are based upon obligations under the Credit Facility and expected actual debt levels during a five-year period. The Company provides protection to meet actual exposures and does not speculate in derivatives. At December 31, 1995, the Company had a notional amount of $120 million of swaps in effect and had committed another $60 million to take effect in 1996. These swaps expire between 1996 and 2000. The amount of floating rate debt protected by the swaps ranges from $180 million to $25 million during the period outstanding with fixed rates ranging from 4.9% to 6.4%. 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, 1995 the fair market value of the swap agreements, which is not recorded in the consolidated financial statements, is a net payable of approximately $1.9 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 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\ncollar 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.\n8. INCOME TAXES ------------ Taxes on income are based on income (loss) before income taxes and cumulative effect of accounting change as follows:\nThe provision for income taxes on income before cumulative effect of accounting change consists of:\nThe reconciliation of tax computed at the federal statutory tax rate of 35% of income before income taxes and cumulative effect of accounting change to the actual income tax provision is as follows:\nDeferred tax liabilities (assets) as of December 31, 1995 and 1994 are comprised of the following:\nIncluded in other current assets at December 31, 1995 and 1994, are net current deferred tax assets of $1.6 million and $.8 million, respectively, and at December 31, 1994 are refundable income taxes of approximately $.4 million. The Company has Canadian tax loss carryforwards of approximately $1.3 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 continued improved profitability.\n9. SHAREHOLDERS' EQUITY -------------------- In April 1995, EML purchased from the Company 1,818,181 common shares (at a price per share of $11) and a warrant (the \"Warrant\") to purchase an additional 967,015 shares (at a price per share of $11). In connection with the Baxter Industrial acquisition on September 15, 1995, EML purchased\n6,832,797 common shares at a price of $12.44 and exercised the Warrant, raising its beneficial ownership of the Company to 46%. In connection with the agreement to purchase such securities, EML entered into a Standstill Agreement with the Company, pursuant to which EML agreed that it and its affiliates would not, subject to certain specified exceptions, for a period of four years, increase its beneficial ownership of the Company's common shares above 49.89% without the prior consent of the Company. EML presently owns approximately 47.1% of the issued and outstanding common shares. Under the terms of the Debenture, interest is payable in common shares, at an issue price per share of $12.44, until EML's beneficial ownership reaches 49.89%. Pursuant to the Standstill Agreement, six persons nominated by EML were elected to the Company's Board of Directors, which consists of fourteen members.\nDuring 1995, the Company retired 253,551 shares of treasury stock resulting in a $.9 million and $1.4 million reduction of additional paid-in capital and retained earnings, respectively.\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\" to exclude any purchaser who has an agreement with the Company, executed prior to the date of acquiring 20% or more of the Company's common stock, which imposes one or more thresholds on the amount of the purchasers' ownership of the Company's common stock. The Amendment also provides 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, as defined, 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 Acquiring Person, to purchase, at the 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.\n10. STOCK AND INCENTIVE PROGRAMS ---------------------------- The Company has two stock incentive plans, the 1986 Stock Incentive Plan (\"1986 Plan\"), which expires in 1996, and the 1995 Stock Incentive Plan (\"1995 Plan\"). The Board of Directors adopted the 1995 Plan, subject to the approval of the shareholders, pursuant to which 2,000,000 common shares are available for issuance. Shares of the Company granted under these two plans are in non-\nqualified and incentive stock options or restricted stock awards. Under the stock incentive plans, in addition to outstanding options, 198,809 shares and 1,060,000 shares were available for issuance under the 1986 Plan and 1995 Plan, respectively, at December 31, 1995.\nRestricted Stock Awards - ----------------------- The Company's restricted stock awards provide 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, 1995, 1994 and 1993, the Company granted 52,589, 21,816 and 45,219 shares, respectively, at fair market values of approximately $.6 million, $.2 million and $.7 million, respectively.\nStock Options - ------------- Under the 1986 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 the date of grant. Options were granted under the 1995 Plan to purchase 1,020,000 common shares (of which 80,000 were canceled) at the then-fair market value, subject to shareholder approval. The options under the 1995 Plan become exercisable at the earlier of nine years following issuance or 50% when the market value (as defined) of the Company's common stock reaches $18 per share for 20 consecutive days and 50% when the market value (as defined) reaches $21 per share for 20 consecutive days.\nChanges in options outstanding were:\nAt December 31, 1995, there were 139,721 options exercisable at an average price of $7.71.\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 common shares of the Company. Expenses under this plan for the years ended December 31, 1995, 1994, and 1993, were $.7 million, $.6 million and $.5 million, respectively.\nEmployee Stock Ownership Plan - ----------------------------- In September 1990, the Company established an employee stock ownership plan (ESOP) by, in effect, contributing 400,000 treasury shares ($2.9 million fair value) to the ESOP of which 157,560 shares are allocated to participants at December 31, 1995. 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 allocated for the year and have been reduced for dividends paid on unallocated shares.\n11. POSTRETIREMENT BENEFITS ------------------------ Pension Plans - ------------- The 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 plans' funding status and the amounts recognized in the Company's Consolidated Balance Sheets at December 31, 1995 and 1994, are:\nThe assets of the Company plans consist primarily 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:\nThe Company maintains a supplemental pension plan for certain senior officers. Expenses incurred under this plan in 1995, 1994 and 1993 were approximately $.1 million, $.2 million and $.3 million, respectively.\nCertain employees are covered under union-sponsored, collectively bargained plans. Expenses under these plans for each of the years ended December 31, 1995, 1994 and 1993, were $.3 million, $.2 million and $.2 million, respectively, 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\nliability 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, 1995 and 1994 is as follows:\nThe net periodic postretirement benefit cost includes the following components:\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. A 7.5% discount rate was used in determining the accumulated postretirement benefit obligation at December 31, 1995 and 8.75% was used at December 31, 1994.\n12. LEASES ------ The Company leases office and warehouse space, computer equipment, and automobiles under operating leases, certain of which extend up to 19 years, subject to renewal options.\nRental expense was approximately $5.4 million for the year ended December 31, 1995 and $5.2 million for the years ended December 31, 1994 and 1993.\nFuture minimum lease payments as of December 31, 1995, under noncancelable operating leases having initial lease terms of more than one year are:\n13. CONTINGENCIES AND COMMITMENTS ----------------------------- The Company is involved in various environmental, contractual, and product 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.\nLitigation relating to the issuance by VWR of the shares sold to EML and the Debenture was commenced in the Delaware Court of Chancery in July 1995 against VWR, VWR's President and Chief Executive Officer, seven members of VWR's Board of Directors and EML. In the complaint, the plaintiff seeks to have the action certified as a class action, to enjoin VWR from consummating the issuance of the shares sold to EML and the Debenture, and to obtain an award of compensatory and other damages. In addition, the plaintiff, on behalf of the shareholders, seeks an order that the Director defendants take appropriate measures to maximize shareholder value, including, without limitation, creating an active auction for VWR.\nVWR believes that this suit is without merit and VWR, EML and the individual defendants intend to vigorously defend this action. On September 15, 1995, VWR and the individual defendants filed motions to dismiss this action on both procedural and substantive grounds.\n14. MATERIAL AGREEMENTS -------------------\nServices Agreement - ------------------ On September 15, 1995, the Company entered into a Services Agreement with Baxter Healthcare that provides for an orderly transfer of the Baxter Industrial business to the Company. Under the Services Agreement, Baxter Healthcare is required to continue to provide the same type of services to the customers of the Baxter Industrial business as it had provided prior to VWR's completion of the Baxter Industrial acquisition. Such services include order entry, shipping, invoicing, credit and collection, and inventory stocking and replenishment.\nWhile the term of the Services Agreement is for two years, upon prior notice, the Company may direct Baxter Healthcare to discontinue the provision of services in any particular region. No service fees were payable for services under the Services Agreement during the first three months of the term of such agreement. The Company is required to make monthly payments during the remaining term of the Services Agreement to Baxter Healthcare at the rate of 5.5% of the total sales to customers of the Baxter Industrial business which are serviced by Baxter Healthcare; provided, however, the Company is obligated to pay a minimum of $18.6 million to Baxter Healthcare during the first fifteen months of such agreement. During 1995, the Company expensed $6.6 million under the Services Agreement using an effective-rate method. Upon the cessation of services by Baxter Healthcare at a particular facility, the Company is required to purchase from Baxter Healthcare the inventory of laboratory supplies and equipment held by Baxter Healthcare for sale to customers of the Baxter Industrial business.\nDistribution Agreement - ---------------------- On September 15, 1995, the Company entered into a Distribution Agreement with Baxter Healthcare pursuant to which Baxter Healthcare has granted to the Company the right to sell and distribute for non-patient use (anywhere except in Canada and Japan) certain products and accessories manufactured by Baxter Healthcare and its affiliates. The Distribution Agreement, which has a term ending on September 30, 2000, provides, among other things, that the Company is obligated during each year to either purchase a minimum dollar amount of products for sale in each of the United States and internationally, or, if such minimum requirements have not been met during such year, purchase products or pay to Baxter Healthcare an amount, in each case, equal to any such deficiency. The minimum aggregate domestic and international requirements for each of the five years of the Distribution Agreement are as follows: Year 1 - $63 million; Year 2 - $74 million; Year 3 - $82 million; Year 4 -$89 million; and Year 5 - $96 million. During 1995, purchases under this agreement were $14 million.\n15. JOINT VENTURE ------------- On January 1, 1994, the Company formed a joint venture with Merck KGaA of Germany and acquired an interest in Bender & Hobein GmbH, a distributor of laboratory supplies and equipment in Germany. VWR has exercised its right under the agreement to sell its interest. The sale was closed in February 1996 at no gain or loss to the Company and the $2.9 million investment has been included in other receivables at December 31, 1995.\n16. RESTRUCTURING AND OTHER CHARGES ------------------------------- In December 1994, the Company made the decision to consolidate certain sales offices and functions. As a result, the Company incurred in 1995 approximately $1.2 million in charges which were primarily for severance and other personnel- related costs. Due to the effects of the Baxter Industrial acquisition, the Company is not able to measure the benefits related to these costs which are classified as operating expenses.\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.\n17. FOREIGN AND DOMESTIC OPERATIONS ------------------------------- For the years ended December 31, 1995 and 1993, sales and identifiable assets attributable to the Canadian operations were less than 10% of the Company's totals in each category. At December 31, 1994, identifiable assets of the Company's Canadian operations were $28 million. Approximately half of the Canadian assets at December 31, 1994 were 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 were in each case less than 10 percent of the consolidated total for such amounts.\n18. QUARTERLY FINANCIAL DATA (Unaudited)\nNote: The quarterly results of operations are impacted by the Baxter Industrial acquisition in September 1995 and the Canlab acquisition in October 1994. Third and fourth quarter 1995 amounts include Baxter Industrial acquisition-related expenses of $2,067 and $1,694, respectively. Fourth quarter 1994 amounts include Canlab acquisition-related expenses of $916.\n* The sum of the quarterly earnings (loss) per share does not equal the total earnings per share due to different weighted average share amounts outstanding for quarterly and annual reporting purposes.\nREPORT OF INDEPENDENT AUDITORS - ------------------------------ To the Shareholders of VWR Scientific Products Corporation:\nWe have audited the consolidated balance sheets of VWR Scientific Products Corporation as of December 31, 1995 and 1994, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1995. 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 VWR Scientific Products Corporation at December 31, 1995 and 1994, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, 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 11 to the consolidated financial statements, in 1993 the Company changed its method of accounting for postretirement benefits other than pensions.\nBY (SIGNATURE)\nERNST & YOUNG LLP\nPhiladelphia, Pennsylvania February 20, 1996\nITEM 9.","section_9":"ITEM 9. - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE - ------ -------------------------------------------------------------- None\nPART III. - -------- The following information contained in the Company's definitive Proxy Statement mailed to Shareholders on or about March 15, 1996, is incorporated by reference.\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - -------- --------------------------------------------------- Section captioned \"Election of Directors\" on pages 2, 3, and 4.\n(Information regarding executive officers of the Company is included in Part I of this Form 10-K.)\nITEM 11.","section_11":"ITEM 11. - EXECUTIVE COMPENSATION - ------- ---------------------- Section \"Fees to Directors and Committees of the Board\" on page 5, and information on pages 9-12.\nITEM 12.","section_12":"ITEM 12. - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - ------- ---------------------------------------------------------- Table captioned \"Ownership of VWR Scientific Products Corporation Common Shares\" on page 4 and related footnotes.\nITEM 13.","section_13":"ITEM 13. - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - ------- ---------------------------------------------- None\nPART 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 22 Consolidated Balance Sheets 23 Consolidated Statements of Cash Flows 25 Consolidated Statements of Shareholders' Equity 27 Notes to Consolidated Financial Statements 30 Report of Independent Auditors 48\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(a) Asset Purchase Agreement dated as of May 24, 1995 by and among VWR Corporation, Baxter Healthcare Corporation and EM Laboratories, Incorporated; incorporated by reference to Exhibit VI of Registrant's definitive proxy statement filed with the Commission on August 11, 1995.\n2(b) Amendment to Asset Purchase Agreement dated as of September 15, 1995 by and among VWR Corporation, Baxter Healthcare Corporation and EM Laboratories, Incorporated; incorporated by reference to Exhibit 2(b) of the Registrant's Form 8-K dated September 15, 1995.\n2(c) Agreement and Plan of Merger between VWR Corporation and VWR New Corporation; incorporated by reference to Exibit 2 of the Registrant's Form 10-K for the year ended December 31, 1994.\n3(a) Amended and Restated Articles of Incorporation; incorporated by reference to Exibit 3 of the Registrant's Form 10-K for the year ended December 31, 1994.\n3(b) Amendment to Articles of Incorporation dated September 15, 1995; incorporated by reference to Exhibit 1 of the Registrant's Form 8-K dated September 15, 1995.\n3(c) Amended and Restated Bylaws; incorporated by reference to Exibit 3.1 of the Registrant's Form 10-K for the year ended December 31, 1994.\n4(a) Rights Agreement dated as of May 20, 1988 between VWR Corporation and The First Jersey National Bank (filed as an exhibit to the Registrant's Form 8-A dated May 23, 1988, and incorporated herein by reference).\n4(b) Amendment No. 1, dated as of February 23, 1995, to Rights Agreement, dated as of May 20, 1988, between VWR Corporation and First Interstate Bank of Washington, N.A., successor to The First Jersey National Bank; incorporated by reference to Exhibit 4 of the Registrant's Form 8-K dated February 23, 1995.\n4(c) Standstill Agreement between VWR Corporation and EM Industries, Incorporated dated February 27, 1995; incorporated by reference to Exhibit 4(a) of Registrant's Form 8-K dated April 13, 1995.\n4(d) Amendment Number One to the Standstill Agreement dated September 15, 1995 by and among VWR Corporation, EM Industries, Incorporated and EM Laboratories, Incorporated; incorporated by reference to Exhibit 4(b) of the Registrant's Form 8-K dated September 15, 1995.\n4(e) Subordinated Debenture dated as of September 15, 1995 in the principal amount of $135,000,000 payable to the order of EM Laboratories, Incorporated; incorporated by reference to Exhibit 4(c) of the Registrant's Form 8-K dated September 15, 1995.\n4(f) Credit Agreement dated as of September 14, 1995 by and among the Registrant, Bank of America National Trust and Savings Association, PNC Bank, N.A., CoreStates Bank, N.A., et al; incorporated by reference to Exhibit 4(d) of the Registrant's Form 8-K dated September 15, 1995.\n4(g) Term Note dated September 15, 1995 in the principal sum of $135,000,000; incorporated by reference to Exhibit 4(e) of the Registrant's Form 8-K dated September 15, 1995.\n4(h) Revolving Credit Note dated September 15, 1995 in the principal sum of $150,000,000; incorporated by reference to Exhibit 4(f) of the Registrant's Form 8-K dated September 15, 1995.\n4(i) Warrant to Purchase Common Shares of VWR Corporation dated April 13, 1995; incorporated by reference to Exhibit 4 of the Registrant's Form 8-K dated April 13, 1995.\n4(j) 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.\n10(a) Common Share and Debenture Purchase Agreement dated as of May 24, 1995 between VWR Corporation and EM Industries, Incorporated; incorporated by reference to Exhibit II of Registrant's definitive proxy statement filed with the Commission on August 11, 1995.\n10(b) Distribution Agreement between VWR Corporation and Baxter Healthcare Corporation dated as of September 15, 1995; incorporated by reference to Exhibit 10(b) of the Registrant's Form 8-K dated September 15, 1995.\n10(c) Services Agreement between VWR Corporation and Baxter Healthcare Corporation dated as of September 15, 1995; incorporated by reference to Exhibit 10(c) of the Registrant's Form 8-K dated September 15, 1995.\n10(d) Employment Agreement between Jerrold B. Harris and VWR Corporation dated as of September 15, 1995; incorporated by reference to Exhibit 10(e) of the Registrant's Form 8-K dated September 15, 1995. (1)\n10(e) Change of Control agreement between VWR Corporation and Paul J. Nowak; incorporated by reference\nto Exhibit 10 of the Registrant's Form 10-K Report for the year ended December 31, 1992. (1)\n10(f) VWR Corporation Executive Bonus Plan dated January 1, 1990; incorporated by reference to Exhibit 10 of the Registrant's Form 10-K for the year ended December 31, 1991. (1)\n10(g) VWR Corporation Supplemental Benefits Plan dated November 1, 1990; incorporated by reference to Exhibit 10 of the Registrant's Form 10-K for the year ended December 31, 1991. (1)\n11 Computation of Per Share Earnings\n21 Subsidiaries of the Company\n23 Consent of Independent Auditors\n24 Power of Attorney\n27 Financial Data Schedule for year ended December 31, 1995. (Submitted only in electronic format pursuant to Item 601(c)(1)(v) of Regulation S-K).\n(1) May be deemed a management contract or compensatory plan or arrangement.\n(b) Reports on Form 8-K\nNone\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nVWR SCIENTIFIC PRODUCTS CORPORATION\nDate BY (SIGNATURE)\n\/s\/ Jerrold 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 BY (SIGNATURE)\n\/s\/ David M. Bronson Senior Vice President Finance (Principal Financial and 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 \/s\/ Jerrold B. Harris James H. Wiborg Attorney-in-fact Walter W. Zywottek Power of Attorney Stephen J. Kunst dated February 28, 1996 Max J. Walser Wolfgang Honn Date: Harald J. Schroeder Alfred Koch\nVWR SCIENTIFIC PRODUCTS CORPORATION -----------------------------------\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS ----------------------------------------------- (Thousands of dollars)\n(1) Uncollectible accounts written off, net of recoveries. (2) Reserves established in connection with the Canlab acquisition.\nExhibit Index Exhibit Number and Description ------------------------------\n2(a) Asset Purchase Agreement dated as of May 24, 1995 by and among VWR Corporation, Baxter Healthcare Corporation and EM Laboratories, Incorporated; incorporated by reference to Exhibit VI of Registrant's definitive proxy statement filed with the Commission on August 11, 1995.\n2(b) Amendment to Asset Purchase Agreement dated as of September 15, 1995 by and among VWR Corporation, Baxter Healthcare Corporation and EM Laboratories, Incorporated; incorporated by reference to Exhibit 2(b) of the Registrant's Form 8-K dated September 15, 1995.\n2(c) Agreement and Plan of Merger between VWR Corporation and VWR New Corporation; incorporated by reference to Exibit 2 of the Registrant's Form 10-K for the year ended December 31, 1994.\n3(a) Amended and Restated Articles of Incorporation; incorporated by reference to Exibit 3 of the Registrant's Form 10-K for the year ended December 31, 1994.\n3(b) Amendment to Articles of Incorporation dated September 15, 1995; incorporated by reference to Exhibit 1 of the Registrant's Form 8-K dated September 15, 1995.\n3(c) Amended and Restated Bylaws; incorporated by reference to Exibit 3.1 of the Registrant's Form 10-K for the year ended December 31, 1994.\n4(a) Rights Agreement dated as of May 20, 1988 between VWR Corporation and The First Jersey National Bank (filed as an exhibit to the Registrant's Form 8-A dated May 23, 1988, and incorporated herein by reference).\n4(b) Amendment No. 1, dated as of February 23, 1995, to Rights Agreement, dated as of May 20, 1988, between VWR Corporation and First Interstate Bank of Washington, N.A., successor to The First Jersey National Bank; incorporated by reference to Exhibit 4 of the Registrant's Form 8-K dated February 23, 1995.\n4(c) Standstill Agreement between VWR Corporation and EM Industries, Incorporated dated February 27, 1995; incorporated by reference to Exhibit 4(a) of Registrant's Form 8-K dated April 13, 1995.\n4(d) Amendment Number One to the Standstill Agreement dated September 15, 1995 by and among VWR Corporation, EM Industries, Incorporated and EM Laboratories, Incorporated; incorporated by reference to Exhibit 4(b) of the Registrant's Form 8-K dated September 15, 1995.\n4(e) Subordinated Debenture dated as of September 15, 1995 in the principal amount of $135,000,000 payable to the order of EM Laboratories, Incorporated; incorporated by reference to Exhibit 4(c) of the Registrant's Form 8-K dated September 15, 1995.\n4(f) Credit Agreement dated as of September 14, 1995 by and among the Registrant, Bank of America National Trust and Savings Association, PNC Bank, N.A., CoreStates Bank, N.A., et al; incorporated by reference to Exhibit 4(d) of the Registrant's Form 8-K dated September 15, 1995.\n4(g) Term Note dated September 15, 1995 in the principal sum of $135,000,000; incorporated by reference to Exhibit 4(e) of the Registrant's Form 8-K dated September 15, 1995.\n4(h) Revolving Credit Note dated September 15, 1995 in the principal sum of $150,000,000; incorporated by reference to Exhibit 4(f) of the Registrant's Form 8-K dated September 15, 1995.\n4(i) Warrant to Purchase Common Shares of VWR Corporation dated April 13, 1995; incorporated by reference to Exhibit 4 of the Registrant's Form 8-K dated April 13, 1995.\n4(j) 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.\n10(a) Common Share and Debenture Purchase Agreement dated as of May 24, 1995 between VWR Corporation and EM Industries, Incorporated; incorporated by reference to Exhibit II of Registrant's definitive proxy statement filed with the Commission on August 11, 1995.\n10(b) Distribution Agreement between VWR Corporation and Baxter Healthcare Corporation dated as of September 15, 1995; incorporated by reference to Exhibit 10(b) of the Registrant's Form 8-K dated September 15, 1995.\n10(c) Services Agreement between VWR Corporation and Baxter Healthcare Corporation dated as of September 15, 1995; incorporated by reference to Exhibit 10(c) of the Registrant's Form 8-K dated September 15, 1995.\n10(d) Employment Agreement between Jerrold B. Harris and VWR Corporation dated as of September 15, 1995; incorporated by reference to Exhibit 10(e) of the Registrant's Form 8-K dated September 15, 1995.\n10(e) Change of Control agreement between VWR Corporation and Paul J. Nowak; incorporated by reference\nto Exhibit 10 of the Registrant's Form 10-K Report for the year ended December 31, 1992.\n10(f) VWR Corporation Executive Bonus Plan dated January 1, 1990; incorporated by reference to Exhibit 10 of the Registrant's Form 10-K for the year ended December 31, 1991.\n10(g) VWR Corporation Supplemental Benefits Plan dated November 1, 1990; incorporated by reference to Exhibit 10 of the Registrant's Form 10-K for the year ended December 31, 1991.\n11 Computation of Per Share Earnings\n21 Subsidiaries of the Company\n23 Consent of Independent Auditors\n24 Power of Attorney\n27 Financial Data Schedule for year ended December 31, 1995. (Submitted only in electronic format pursuant to Item 601(c)(1)(v) of Regulation S-K).","section_15":""}
{"filename":"356080_1995.txt","cik":"356080","year":"1995","section_1":"ITEM 1. BUSINESS\nA. H. Belo Corporation (the \"Company\" or \"Belo\") owns and operates seven network-affiliated VHF television stations in the top 60 U.S. television markets and the largest daily newspaper in the Dallas-Fort Worth metropolitan area. The Company's broadcast group reaches 8 percent of all U.S. television households and its principal newspaper, The Dallas Morning News, has the country's seventh largest Sunday circulation (800,147) and eighth largest daily circulation (534,197). The Company believes the success of its media franchises is built upon providing local news, information and community service of the highest caliber. These principles have attracted and built relationships with viewers, readers and advertisers and have guided the Company's success for 154 years.\nThree of the Company's seven stations are in the top 12 television markets: WFAA (ABC) Dallas-Fort Worth; KHOU (CBS) Houston; and KIRO (UPN) Seattle-Tacoma. These major metropolitan areas are among the fastest growing in the country. All of the Company's stations are ranked either number one or two in overall sign-on\/sign-off audience delivery, with the exception of KIRO, which was acquired by the Company in 1995. The Company, through its subsidiary Belo Productions, Inc. and a partnership with Universal Press Syndicate, produces and distributes original programming to its station group and to various outside purchasers.\nThe Dallas Morning News is one of the leading newspaper franchises in America. The Dallas Morning News' success is founded upon the highest standards of journalistic excellence, with a special emphasis on local news, information and community service. The newspaper's outstanding reporting and editorial initiatives have earned six Pulitzer Prizes since 1986. As the leading newspaper in the Dallas-Fort Worth market, The Dallas Morning News' success is measured by its high circulation and volume of advertising. In late 1995 and early 1996, the Company expanded its publishing division by acquiring two daily newspapers serving Bryan-College Station, Texas and Owensboro, Kentucky. The Company also publishes nine other community newspapers in the Dallas-Fort Worth suburban area and operates a commercial printing business.\nNote 13 to the Consolidated Financial Statements contains information about the Company's industry segments for the years ended December 31, 1995, 1994 and 1993.\nTELEVISION BROADCASTING\nThe Company's television broadcast operations began in 1950 with the acquisition of WFAA in Dallas-Fort Worth shortly after the station commenced operations. In 1984, the Company significantly expanded its television broadcast operations with the purchase of its four stations in Houston, Sacramento, Hampton-Norfolk and Tulsa. In June 1994 and February 1995, the Company acquired its stations in New Orleans and Seattle, respectively.\nThe following table sets forth information for each of the Company's stations and their markets:\n- --------------- * Tied with one or more other stations in the market.\n(1) Market rank is based on the relative size of the television market or Designated Market Area (\"DMA\") among the 211 generally recognized DMAs in the United States, based on November 1995 Nielsen estimates.\n(2) Represents the number of television stations (both VHF and UHF) broadcasting in the market, excluding public stations and national cable channels.\n(3) Station rank is derived from the station's rating which is based on November 1995 Nielsen estimates of the number of television households tuned to the Company's station for the Sunday-Saturday, 7:00 a.m. to 1:00 a.m. period (\"sign-on\/sign-off\") as a percentage of the number of television households in the market.\n(4) Station audience share is based on November 1995 Nielsen estimates of the number of television households tuned to the Company's station as a percentage of the number of television households with sets in use in the market for the sign-on\/sign-off period.\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.\nCommercial television stations generally fall into one of three categories. The first category of stations historically consisted of stations affiliated with one of the three major national networks (ABC, CBS and NBC). In recent years, Fox has effectively evolved into the fourth major network. The second category is comprised of stations affiliated with newer national networks, such as 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.\nThree of the Company's stations are affiliated with ABC, three are affiliated with CBS and one is affiliated with UPN. Each of the Company's network affiliation agreements provides the affiliated station with the right to broadcast all programs transmitted by the network with which the station is affiliated. In return, the network has the right to sell most of the advertising time during such broadcasts. Each station receives a specified amount of network compensation for broadcasting network programming, with the exception of the Company's UPN affiliate. To the extent a station's preemptions of network programming exceed a designated amount, such compensation may be reduced. Such payments are also subject to decreases by the network during the term of an affiliation agreement under other circumstances with provisions for advance notice and right of termination by the station in the event of a reduction in such payments. The Company has renegotiated its affiliation agreements with both CBS and ABC, resulting in an increase in the compensation paid by each network to the Company in return for a long-term extension of each of the agreements. Final documentation of the new ABC affiliation agreements has not been completed although the Company is receiving its increased compensation under the new agreements.\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 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.\nNEWSPAPER PUBLISHING\nThe Company's principal newspaper, The Dallas Morning News, was established in 1885. It is published seven days a week. In 1963, the Company acquired its suburban newspaper operation. In late 1991, after years of intense competition, The Dallas Morning News' principal newspaper competitor, the Dallas Times Herald, ceased operations and the Company purchased its assets. In late 1995 and early 1996, the Company expanded its publishing division by acquiring two daily newspapers serving Bryan-College Station, Texas and Owensboro, Kentucky.\nThe following table sets forth information concerning the Company's daily newspaper operations:\n- --------------- (1) Average paid circulation for the six months ended September 30, 1995, according to the unaudited Publisher's Statement of the Audit Bureau of Circulations, an independent agency (the \"Audit Bureau\").\nThe Dallas Morning News provides coverage of local, state, national and international news. The Dallas Morning News is distributed throughout the Southwest, though its circulation is concentrated primarily in the twelve counties surrounding Dallas.\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, 1995 was 534,197 daily, up 1.8 percent from the 1994 average daily circulation of 524,567. Sunday's average paid circulation was 800,147, up slightly from the six months ended September 30, 1994 average of 797,206.\nThe basic material used in publishing The Dallas Morning News is newsprint. The average unit cost of newsprint consumed during 1995 was sharply higher than that of the prior year due to market-wide price increases throughout the year. The Company expects the full-year effect of the 1995 newsprint price increases to result in even higher newsprint expense in 1996. The Company cannot predict at this time whether newsprint prices will increase further in 1996. At present, newsprint is purchased from nine suppliers. During 1995, the Company's three largest providers of newsprint supplied approximately one-half of the newspaper's 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 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., which, in addition to printing the suburban newspapers, is the site of the Company's commercial printing operations. The Company also publishes a newspaper twice-a-week and a free weekly in Rockwall, Texas.\nCOMPETITION\nThe success of broadcast operations depends on a number of factors, including the general strength of the 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. The Company's television broadcast stations compete for advertising revenues directly with other media such as newspapers (including those owned and operated by the Company), other television stations, radio stations, cable\ntelevision systems, outdoor advertising, magazines and direct mail advertising.\nThe four major national television networks are represented in each television market in which the Company has a television broadcast station. Competition for advertising sales and local viewers within each market is intense, particularly among the network-affiliated television stations.\nThe entry of local telephone companies into the market for video programming services, as permitted under the Telecommunications Act of 1996, (the \"1996 Act\"), can be expected to have a significant impact on competition in the television industry. The Company is unable to predict the effect that these or other technological and related regulatory changes will have on the broadcast television industry or the future results of the Company's operations.\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 other newspapers owned and operated by the Company). Also competing with The Dallas Morning News is the Fort Worth Star-Telegram, owned by The Walt Disney Company.\nREGULATION OF TELEVISION BROADCASTING\nThe Company's television broadcasting operations are subject to the jurisdiction of the Federal Communications Commission (\"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, foreign governments or their representatives, or by corporations formed under the laws of foreign countries. The Act previously would have prohibited the Company's subsidiaries from continuing as broadcast licensees if any officer or more than one-fourth of the directors of the Company were aliens. The 1996 Act, however, eliminated the restriction on alien officers and directors.\nPrior to the passage of the 1996 Act, television broadcast licenses were granted for a period of five years. Renewal applications were granted without a hearing if there were no competing applications or issues raised by petitioners to deny such applications that would cause the FCC to order a hearing. If competing applications were filed, a full comparative hearing was required. Under the 1996 Act, the statutory restriction on the length of a broadcast term was amended to allow the FCC to grant broadcast licenses for terms of up to eight years. The 1996 Act also requires renewal of a broadcast license if the FCC finds that (1) the station has served the public interest, convenience, and necessity; (2) there have been no serious violations of either the Act or the FCC's rules and regulations by the licensee; and (3) there have been no other serious violations which taken together constitute a pattern of abuse. In making its determination, the FCC cannot consider whether the public interest would be better served by a person other than the renewal applicant. Under the 1996 Act competing applications for the same frequency may be accepted only after the Commission has denied an incumbent's application for renewal of license.\nAn application for renewal of the broadcast license for WFAA, which expired August 1, 1993, 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 other television broadcast stations are as follows: KHOU, August 1, 1998; KIRO, February 1, 1999; KXTV, December 1, 1998; WVEC, October 1, 1996; WWL, June 1, 1997; and KOTV, June 1, 1998.\nFCC ownership 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\nstations and daily newspapers serving the same area and (c) television broadcast stations and cable systems serving the same area. The 1996 Act eliminated a statutory prohibition against common ownership of television broadcast stations and cable systems serving the same area, but left the FCC rule in place. The 1996 Act also stipulates that the FCC should not consider the repeal of the statutory ban in any review of its applicable rules. The Company's ownership of The Dallas Morning News and WFAA, 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 has been \"grandfathered\" by the FCC.\nThe FCC ownership 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 generally 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 (as modified in the 1996 Act) provide that waivers of these restrictions would be available to permit the Company's acquisition of radio stations in any of the markets in which the Company currently owns television stations (other than Tulsa) or of \"satellite\" television stations located within a parent station's grade B service contour which rebroadcast all or most of the parent station's programming.\nThe FCC has instituted proceedings looking toward possible relaxation of certain of its rules regulating television station ownership and changes in the standards used to determine what type of interests are considered to be attributable under its rules. In addition, the 1996 Act directs the FCC to (a) eliminate the restrictions on the number of television stations (nationwide) that a person or entity may directly or indirectly own, operate or control or have a cognizable interest in and raise the limitation on the aggregate audience reach of commonly owned stations from 25 percent to 35 percent of the total national audience, and (b) conduct a rule making proceeding to determine whether to modify its limitations on the number of television stations that one entity may own or have an interest in within the same television market.\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 eliminated its former rules which restricted network participation in program production and syndication. The FCC also recently eliminated the prime time access rule (\"PTAR\"), effective August 30, 1996. The PTAR currently limits the ability of some stations within the fifty largest television markets to broadcast network programming (including syndicated programming previously broadcast over a network) during prime time hours. The elimination of PTAR could increase the amount of network programming broadcast over a station affiliated with ABC, NBC or CBS. The U.S. Supreme Court 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.\nThe 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. The Commission is currently considering proposals for stricter children's programming requirements. Most significant among the FCC's suggested new rules is a requirement that broadcasters provide a specific hourly minimum amount of children's programming on a regular basis. Although the FCC has not yet proposed an explicit quantitative requirement, it has called for comment on various examples, such as a three to five hour-per-week minimum obligation.\nThe FCC also 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. Moreover, the 1992 Cable Act was amended in certain important respects by the 1996 Act. Most notably, the 1996 Act repeals the cross-ownership ban between cable and telephone entities and\nthe FCC's current video dial tone rules. These provisions, among others, foreshadow significant future involvement in the provision of video services by telephone companies.\nThe FCC recently proposed the adoption of rules for implementing digital advanced television (\"ATV\") service in the United States. Implementation of digital ATV would improve the technical quality of television signals receivable by viewers and give television broadcasters the flexibility to provide new services, including high-definition television (\"HDTV\") simultaneously with multiple programs of standard definition television (\"SDTV\") and data transmission. Within the next few months, the FCC is expected to release two additional proposals that address, respectively, the ATV broadcasting standard and an ATV channel allotment and assignment plan. As currently proposed, each existing broadcaster would be loaned, for a finite transition period, a second channel on which to transmit ATV signals simultaneously with the current analog television broadcast. At the end of the transition, analog TV transmissions would cease and the ATV channels might be reassigned to a smaller segment of the broadcasting spectrum, and the vacated spectrum would be reallocated and auctioned for use by other radio services.\nRecent debates in Congress, however, call into question whether the transition to ATV will proceed as planned. Several senators favor giving the FCC the authority -- or even requiring the Commission -- to auction the second channels. Such authority or direction could be contained in budget legislation or a stand-alone spectrum law. 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. Proposals for additional or revised regulations and requirements are pending before and are being considered by Congress and federal regulatory agencies from time to time. 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, 1995, the Company had 3,489 full-time employees. An additional 173 employees were added on January 1, 1996 following the Owensboro acquisition. Of the total workforce of 3,662, Belo has 234 employees, located principally at its Dallas, Texas; Seattle, Washington; and New Orleans, Louisiana television stations, that are represented by various employee unions. The Company believes its relations with all of its employees are good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe studios and offices of WFAA occupy Company-owned facilities in downtown Dallas. The station's transmitting tower and antennas, which are located in Cedar Hill, Texas, are jointly owned by the Company and the owner and operator of the Fox television affiliate in Dallas.\nKHOU operates from Company-owned facilities located in Houston. The station's transmitter and tower are located near DeWalt, Texas.\nKIRO operates from Company-owned facilities located in Seattle, Washington. This property also includes a production facility and other office space. The station's transmitting facility and tower are also located in Seattle.\nKXTV operates from Company-owned facilities located in Sacramento, California. The station's tower and transmitter building, which are located in Sacramento County, California, are owned by a joint venture between the Company and the owner and operator of the CBS television affiliate in West Sacramento. KXTV leases the transmitter site from the joint venture.\nWVEC operates from Company-owned facilities in Hampton and Norfolk, Virginia. The transmitting facility in Driver, Virginia includes a tower and antenna. WVEC also leases additional building space adjacent to the Company-owned facilities that is used by the marketing and business departments.\nWWL operates from Company-owned facilities in New Orleans, Louisiana. The transmitting facility and tower are located in Gretna, Louisiana. WWL 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 tower are owned by a joint venture between the Company and the owner and operator of the NBC television affiliate in Tulsa.\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 Dallas 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.\nThe Bryan-College Station Eagle operates from Company-owned facilities in Bryan, Texas and the Owensboro Messenger-Inquirer's Company-owned facilities are in Owenbsoro, Kentucky.\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. The Company also owns a small facility in Rockwall, Texas.\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.\nAll of the foregoing operations utilize additional leasehold interests in their respective activities.\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 would not have a material adverse effect on the consolidated results of 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 shareholders, 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 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. On February 28, 1996, the Company's Board of Directors authorized the amendment and restatement of the Company's preferred share purchase rights plan which was originally adopted in 1986 and was scheduled to expire in March 1996. See Note 8 to the Consolidated Financial Statements.\nOn June 9, 1995, the Company completed 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 was issued for each share of Series A and Series B Common Stock outstanding on May 19, 1995, the record date for the split. The effect of the stock split was to double the number of shares outstanding and reduce per share amounts by one-half. Total shareholders' equity and the proportionate ownership in the Company of individual shareholders was not affected by the stock split. All earnings and dividends per share, weighted average shares outstanding and share trading prices in this report have been restated to reflect the stock split.\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.\nEffective for the second quarter of 1996, the Company will increase its quarterly dividend to $.11 per share.\nOn January 31, 1996, the closing price for the Company's Series A Common Stock, as reported on the New York Stock Exchange, was $35 3\/4. The approximate number of shareholders of record of the Series A and Series B Common Stock at the close of business on such date was 684 and 549, respectively.\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, 1995. 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 1995 include 11 months of KIRO, which was purchased by the Company on February 1, 1995. Broadcasting revenues for 1994 include seven months of WWL, which was purchased by the Company on June 1, 1994. (B) In December 1991, the Company purchased substantially all of the operating assets of the Dallas Times Herald newspaper. (C) Other includes revenues associated with the Company's television production subsidiary and programming distribution partnership. The Company sold its interest in the partnership in February 1996. (D) Net earnings for 1993 include an increase of $6,599,000 (16 cents per share) representing the cumulative effect of adopting Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes,\" effective January 1, 1993. (E) Per share amounts have been adjusted to reflect the two-for-one common stock split effected as a stock dividend on June 9, 1995.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe Company is an owner and operator of seven network-affiliated television stations and an established newspaper publisher. The Company's television broadcast operations began in 1950 with the acquisition of WFAA in Dallas. In 1984, the Company expanded its broadcast operations through the acquisition of four television stations in Houston, Sacramento, Hampton-Norfolk and Tulsa. In June 1994 and February 1995, the Company acquired television stations in New Orleans and Seattle, respectively. The Company's principal newspaper is The Dallas Morning News. In December 1995, the Company purchased a daily newspaper in Bryan-College Station, Texas. Comparability of year-to-year results and financial condition are affected by these acquisitions. In the first quarter of 1996, the Company acquired a daily newspaper in Owensboro, Kentucky and sold its interest in its programming distribution partnership, Maxam Entertainment.\nThe Company depends on advertising as its principal source of revenues. As a result, the Company's operations are sensitive to changes in the economy, particularly in the Dallas-Fort Worth metropolitan area. The Company also derives revenues, to a much lesser extent, from the circulation revenue of its newspaper operations and from compensation paid by the networks to its television stations for broadcasting network programming.\nCONSOLIDATED RESULTS OF OPERATIONS\n1995 Compared to 1994\nThe Company recorded 1995 net earnings of $66,576,000 or $1.68 per share, compared to $68,867,000 or $1.70 per share in 1994. Results for 1995 include a non-recurring charge for early retirement costs of $1,254,000 (2 cents per share) and a non-recurring gain of $2,406,000 ($1,564,000 after tax, or 4 cents per share) on the sale of the Company's remaining investment in Stauffer Communications, Inc. (\"Stauffer\") stock. Excluding these non-recurring items, 1995 adjusted net earnings were $1.66 per share. Net earnings for 1994 included the reversal of $631,000 of accrued music license fees (1 cent per share) and a net after-tax charge of $1,567,000 (4 cents per share) for the donation of Stauffer stock to a charitable foundation. The donation of Stauffer stock 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 the shares, and a related income tax benefit of $5,837,000. Excluding these non-recurring items, adjusted 1994 net earnings were $1.73 per share.\nInterest expense in 1995 was $29,987,000 compared to $16,112,000 in 1994. A significant portion of this increase resulted from the increase in average interest rates in 1995 to approximately 6.3 percent from 4.8 percent in 1994. Additionally, higher debt levels as a result of the two recent broadcast acquisitions (KIRO in Seattle, Washington in February 1995 for $162,500,000 and WWL in New Orleans, Louisiana in June 1994 for $110,000,000) contributed to the increase in 1995 interest expense. Other, net for 1995 included the gain on the sale of the Company's remaining investment in Stauffer stock while 1994 included the charge for the donation of Stauffer shares to a charitable foundation. The effective tax rate for 1995 of 40 percent is higher than the 1994 effective tax rate of 36.2 percent due to the tax benefit associated with the Stauffer stock donation in 1994.\n1994 Compared to 1993\nThe Company recorded 1994 net earnings of $68,867,000 or $1.70 per share, compared to $51,077,000 or $1.26 per share in 1993. Results for 1993 included a $6,599,000 increase (16 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 the Company recorded a $2,249,000 (6 cents per share) adjustment to deferred taxes following an increase in the federal income tax rate. Earnings in 1993 also included a $5,822,000 (9 cents per share) non-recurring restructuring charge related primarily to the write-off of goodwill and a reduction in the carrying value of production assets associated with the Company's suburban newspaper operations. The Company also recorded a reversal of accrued music license fees in 1993 of $3,349,000 (5 cents per share). Excluding these items, adjusted net earnings for 1993 were $1.20 per share.\nInterest expense in 1994 was $16,112,000 compared to $15,015,000 in 1993. The increase from 1993 to 1994 was due primarily to higher debt levels associated with the purchase of the New Orleans station, offset by savings from lower interest rates. Average interest rates on total debt were 4.8 percent and 5.4 percent in 1994 and 1993, respectively. Other, net for 1994 included the net charge for the Stauffer transaction while 1993 included a gain on the sale of two parcels of non-operating real estate. The effective tax rate for 1994, including the tax benefit from the Stauffer stock donation, was 36.2 percent. The 1993 effective rate of 41.1 percent included the increase in deferred tax expense associated with the increase in the federal income tax rate, partially offset by the reversal of certain tax accruals due to other aspects of the tax legislation. Excluding these unusual items, the comparable effective tax rates for 1994 and 1993 were 38.9 percent and 39.5 percent, respectively.\nBROADCASTING\n1995 Compared to 1994\nBroadcast revenues in 1995, which include 11 months of revenue for the Seattle station, were $322,642,000. These revenue totals represent an increase of 25 percent (3.3 percent on a same-station basis) over 1994 revenues of $258,040,000, which included seven months of revenue for the New Orleans station. The Company's television broadcast subsidiaries contributed 43.9 percent of total 1995 revenues compared to 41.1 percent in 1994.\nRevenues in all broadcast advertising categories, with the exception of political advertising, were higher during 1995 compared to 1994, both as reported and on a same-station basis. Political advertising revenues in 1994 were\nstrong due to several active gubernatorial and senate races, while 1995 political activity was relatively slow. Local advertising revenues increased by 28.5 percent overall (6.8 percent on a same-station basis), primarily due to increases at the Dallas, Hampton-Norfolk and New Orleans stations. The Company's Sacramento station, which changed its network affiliation during 1995 and experienced a sizable shift from local to national advertising, showed a slight decline in local advertising revenues. Automobile advertising was a significant factor in the stations' local market gains. National advertising revenues increased in 1995 over 1994 as well, primarily during the first half of the year. However, the majority of the 20.6 percent increase in national advertising in 1995 was due to the addition of the Seattle station in February and a full-year effect of the New Orleans station. On a same-station basis, national revenues were up 2.1 percent year-to-year. The most significant increases in national advertising occurred at the Sacramento and Hampton-Norfolk stations, although all other Company stations demonstrated a slight increase in national advertising revenues as well. Network compensation payments increased in 1995 following the renegotiation of the Company's network affiliation contracts in the latter part of 1994.\nBroadcast earnings from operations were $83,921,000 in 1995 compared to $81,319,000 in 1994, an increase of 3.2 percent (2.7 percent on a same-station basis). Broadcast earnings from operations in 1995 included 11 months of the Seattle station's operations while 1994 results included seven months of the New Orleans station's operations. Operating margins in 1995 and 1994 were 26 percent and 31.5 percent, respectively. On a same-station basis, margins in 1995 and 1994 were 32.1 percent and 32.3 percent, respectively. Higher 1995 operating costs and lower margins were due in part to significant increases in news and programming costs as the Seattle station began developing a new format when its affiliation changed from CBS to UPN. Salaries, wages and employee benefits increased 35.7 percent over 1994 due to the addition of the Seattle station and the full-year effect of the New Orleans station. On a same-station basis, these costs increased 4.7 percent due to merit increases and more employees. Other production, distribution and operating costs for 1995 increased only marginally over 1994 on a same-station basis. Depreciation and amortization expenses increased in 1995 due to the broadcast acquisitions in mid-1994 and early 1995.\n1994 Compared to 1993\nBroadcast revenues in 1994, which included seven months of revenue for the New Orleans station were $258,040,000, an increase of 23.4 percent over 1993 revenues of $209,083,000. The Company's television broadcast subsidiaries contributed 41.1 percent of total 1994 revenues compared to 38.4 percent in 1993.\nEach station contributed to the increase in revenues during 1994 with improvement in every revenue category. Local advertising revenues, which improved 25.5 percent overall (12.7 percent on a same-station basis), were up most significantly at the Dallas, Houston and Tulsa stations. Automobile advertising was a significant factor in each of the stations' local market gains in 1994. National revenues benefited from the broadcast of the 1994 Winter Olympics on the Company's CBS-affiliated stations, but were offset somewhat by revenue 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. Network compensation increases from the renegotiation of the Company's network affiliation agreements began in the third quarter of 1994.\nBroadcast earnings from operations were $81,319,000 in 1994 compared to $63,317,000 in 1993. Broadcast earnings from operations in 1994 included seven months of the New Orleans station's operations. Also included in broadcast earnings from operations in 1994 and 1993 were increases in 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, broadcast earnings from operations for 1994 and 1993 were $80,688,000 and $59,968,000, respectively. The increase was due to revenue improvements, 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 performance-based 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 increased contract rates for several syndicated program packages and costs to produce a new local morning show and weekly news show at the Dallas station. 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 expenses increased as a result of the acquisition of the New Orleans station.\nNEWSPAPER PUBLISHING\n1995 Compared to 1994\nIn 1995, newspaper publishing revenues represented 55.6 percent of total revenues, compared to 58.8 percent in 1994. Although publishing revenues increased 10.8 percent in 1995 from 1994, they decreased as a percent of total revenues due to broadcast acquisitions. Advertising revenues account for approximately 88 percent of publishing revenues, while circulation revenues represent approximately 10 percent. Other publishing revenues, primarily commercial printing, contribute the remainder.\nNewspaper advertising volume for The Dallas Morning News, the Company's principal newspaper, is measured in column inches. Volume for the last three years was as follows:\n(1) Full-run ROP inches refers to the number of column inches of display and classified advertising that is printed and distributed in all editions of the newspaper.\nRevenues from newspaper publishing in 1995 were $409,099,000, an increase of 10.8 percent over 1994 revenues of $369,366,000. Due to dramatically higher newsprint prices in 1995, a series of advertising rate increases were put into effect during the year at The Dallas Morning News. These rate increases resulted in higher revenues in the three major advertising categories despite the volume declines that resulted from the higher rates. Classified advertising linage was down 2.9 percent from 1994 while revenues were up 18.6 percent. Retail advertising revenues increased 4.2 percent due to higher rates, while volumes were lower by 6.2 percent. General advertising revenues improved 7.9 percent, although auto and bank advertising volumes decreased significantly, contributing to the overall 6.3 percent decline in linage. Preprint revenues increased 9.3 percent in 1995 from 1994 due to increased activity from electronics retailers. The Dallas Morning News' circulation revenues increased 8.8 percent over 1994 due to an increase in daily single copy prices and the full-year effect of 1994 increases in home delivery and Sunday single copy prices. Circulation volume increased slightly in 1995 over 1994.\nDespite significant increases in newsprint prices, newspaper publishing earnings from operations for 1995 were $69,999,000, up 5.2 percent over 1994 earnings of $66,568,000. Operating margins were 17.1 percent in 1995 compared to 18 percent in 1994. Revenue increases were partially offset by total operating costs that were 12 percent higher than 1994. Newsprint, ink and other supplies expense in 1995 increased 29.2 percent over last year. Driving this increase were market-wide newsprint price increases. The average cost per ton in 1995 at The Dallas Morning News increased 44.2 percent over 1994. A reduction in tons used during 1995 helped offset the effect of these price increases to some extent. Reductions in newsprint usage came as a result of better waste control, fewer news columns, lower ad linage and promotional space and the elimination of a marginally profitable Sunday magazine. All other cost categories for the newspaper publishing segment increased only slightly due to efforts to control costs to offset the effect of the newsprint price increases.\nThe Company expects 1996 newsprint, ink and other supplies expense to increase over 1995, due to the full-year effect of the 1995 newsprint price increases. The Company anticipates that the higher expense will be offset by advertising rate increases implemented in the second half of 1995 and at the beginning of 1996. The Company cannot predict at this time the effect of proposed newsprint price increases for 1996.\n1994 Compared to 1993\nRevenues from newspaper publishing in 1994 were $369,366,000, an increase of 10 percent over 1993 revenues of $335,651,000. Classified and general advertising revenues at The Dallas Morning News contributed the majority of the increase in year-to-year revenue gains. Linage in these two categories increased 5.8 percent and 3.3 percent,\nrespectively, which, combined with rate increases, resulted in an increase in classified and general advertising revenues of $27,580,000. Strong demand for employment advertising and a strong automotive market accounted for the improvement in classified linage. The telecommunications industry was a significant component of the general advertising increase. Retail ROP revenues for 1994 decreased slightly when compared to 1993 due to volume declines of 8.3 percent, offset by a rate increase. The retail volume declines were primarily attributable to a shift by certain department stores to preprints, revenues from which increased 15.6 percent over 1993. 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.\nNewspaper publishing earnings from operations in 1994 were $66,568,000 compared to $44,293,000 in 1993. Earnings from operations in 1993 included the $5,822,000 restructuring charge related to the Company's suburban newspaper operations. Excluding this one-time charge, comparable 1993 earnings from operations were $50,115,000. The 32.8 percent increase in 1994 from adjusted 1993 earnings from operations was due to the revenue increase, partially offset by a 6 percent increase in operating expenses. Salaries, wages and employee benefits increased in 1994 due to more employees, 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 a Sunday single copy price increase also contributed to higher 1994 expense. Depreciation expense increased due to a full year's depreciation of The Dallas Morning News' North Plant expansion project that was completed in late 1993. Newsprint expense was only slightly higher in 1994 compared to 1993. The increase was primarily due to slightly higher consumption, which was offset somewhat by lower average prices.\nLIQUIDITY AND CAPITAL RESOURCES\nNet cash provided by operations is the Company's primary source of liquidity. During 1995, net cash provided by operations was $96,601,000, compared to $138,785,000 in 1994. The decrease was due primarily to changes in working capital. One of the most significant working capital changes was in the value of on-hand inventory at the end of 1995, due to both higher newsprint tonnage in inventory and substantially higher prices. The timing of accounts payable and income tax payments also contributed significantly to the decrease in 1995 net cash provided by operations. Net cash provided by operations was sufficient to fund capital expenditures, common stock dividends and a portion of current year stock repurchases.\nOn February 1, 1995, the Company acquired KIRO in Seattle, Washington. The purchase price was $162,500,000 in cash, plus transaction costs. KIRO was purchased using funds from the Company's revolving credit agreement described below. On December 26, 1995, the Company again used the revolving credit agreement to complete the acquisition of the Bryan-College Station Eagle. On January 1, 1996, the Company acquired the Owensboro Messenger-Inquirer by issuing notes payable to the seller. These notes are due in various installments over the next four years.\nAt December 31, 1995, the Company had access to an $800,000,000 variable rate revolving credit agreement, on which borrowings at that time were $480,000,000. The agreement expires and the debt thereunder matures on July 28, 2000 with an extension to July 28, 2001 at the request of the Company and with the consent of the participating banks. 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, 1995, $71,000,000 in short-term notes were outstanding. Total debt outstanding increased by $227,000,000 from December 31, 1994, primarily due to acquisitions and share repurchases.\nBecause substantially all of the Company's outstanding debt is currently at floating interest rates, the Company is subject to interest rate volatility. Weighted average interest rates at the end of 1995 were approximately 6.1 percent.\nDuring 1995, the Company spent $63,400,000 to repurchase treasury stock at an average price of $31.28 per share. The Company has in place a stock repurchase program authorizing the purchase of up to $2,500,000 of Company stock annually, and the Company has authority to purchase an additional 3,591,200 shares under another Board authorization.\nAt December 31, 1995, the Company's ratio of long-term debt to total capitalization was 58.9 percent, compared to 46.3 percent at the end of 1994. The change during 1995 was due to additional borrowings to finance acquisitions and the effect on debt and shareholders' equity of the share repurchases.\nCapital expenditures in 1995 were $40,830,000. Capital projects included additional production equipment and major building renovations at The Dallas Morning News, the completion of a building and studio remodeling project at the Company's Houston station and the purchase of broadcast equipment for other stations. The Company expects to finance future capital expenditures using cash generated from operations and, when necessary, borrowings under the revolving credit agreement. Total capital expenditures in 1996 are expected to be approximately $45,000,000 and relate primarily to additional newspaper publishing equipment, the renovation of certain operating facilities and the purchase of certain broadcast equipment. As of December 31, 1995, required future payments for capital expenditures in 1996 were $7,881,000.\nThe Company paid dividends of $12,279,000 or 31 1\/2 cents per share on Series A and Series B Common Stock outstanding during 1995 compared to $11,984,000 or 30 cents per share in 1994. The Company expects to pay higher dividends in 1996 due to an increase in the quarterly dividend rate beginning in the second quarter of 1996 and an increase in shares outstanding upon consummation of an equity offering discussed below.\nThe Company believes its current financial condition and credit relationships are adequate to fund current obligations and near-term growth. The Company has filed a registration statement relating to a public offering of 5,000,000 shares of Series A Common Stock. It is expected that the net proceeds from the offering will be used to repay existing debt to provide liquidity for general corporate purposes, including possible future acquisitions.\nOTHER MATTERS\nIn early 1996, Congress passed the Telecommunications Act of 1996 (the \"1996 Act\"), the most comprehensive overhaul of the country's telecommunications laws in more than 60 years. The Company cannot predict the effect on its business of the 1996 Act or of proposed or possible future legislation, regulations and policies. During the debate prior to the passage of the 1996 Act, Congress considered whether to grant the FCC authority to auction the second channels necessary for the implementation of digital advanced television. The 1996 Act did not grant the FCC such authority, but such authority could be contained in future budget legislation or in a stand-alone spectrum law. See \"Regulation of Television Broadcasting\".\nNEW ACCOUNTING STANDARD\nIn March 1995, the Financial Accounting Standards Board issued SFAS No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of\". This Statement established accounting standards for the impairment of long-lived assets, certain identifiable intangibles and goodwill related to those assets to be held and used and for long-lived assets and certain identifiable intangibles to be disposed of. SFAS No. 121 will be effective beginning in 1996. Management does not anticipate that the adoption of SFAS No. 121 will have any effect on the consolidated financial position of the Company.\nINFLATION\nThe net effect of inflation on the Company's revenues and earnings from operations has not been material in the last few years.\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 elsewhere in 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 8, 1996, 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 8, 1996, 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 8, 1996, 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 8, 1996, 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\nExhibits marked with an asterisk (*) are incorporated by reference to documents previously filed by A.H. Belo Corporation with the Securities and Exchange Commission, as indicated. Exhibits marked with a tilde (~) are management contracts or compensatory plan contracts or arrangements filed pursuant to Item 601 (b)(10)(iii)(A) of Regulation S-K. All other documents are filed with this report.\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: February 28, 1996\nPursuant 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, 1995 and 1994, and the related consolidated statements of earnings, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1995. 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, 1995 and 1994, and the consolidated results of their operations and cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\nAs discussed in Note 4 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 24, 1996\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 $5,888,000, $4,506,000 and $4,617,000 in 1995, 1994 and 1993, respectively. Accounts written off during these years were $5,683,000, $4,231,000 and $4,408,000, 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 Intangible assets, net consists of excess cost over values assigned to tangible assets of purchased subsidiaries and is amortized primarily on a straight-line basis over 40 years. At December 31, 1995 and 1994, approximately $27,683,000 and $18,949,000, respectively, of intangible assets, net is attributable to subscriber lists associated with certain newspaper transactions. These assets are carried at their appraised values and are amortized on a straight-line basis over estimated useful lives of 18 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 9). Accumulated amortization of intangible assets was $143,503,000 and $126,326,000 at December 31, 1995 and 1994, respectively.\nG) Stock options Stock options granted to employees are accounted for using the intrinsic value of the options granted. Because it is the Company's policy to grant stock options at market price on the date of the grant, the intrinsic value is zero and therefore, no compensation expense is recorded.\nH) 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. Earnings per share and certain other share amounts have been restated to reflect a two-for-one stock split. (See Note 8).\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS A. H. BELO CORPORATION AND SUBSIDIARIES\nI) Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.\nNOTE 2: ACQUISITIONS - --------------------------------------------------------------------------------\nOn June 1, 1994, Belo acquired the assets of television station WWL-TV, the CBS affiliate in New Orleans, Louisiana, for $110,000,000 in cash plus transaction costs. On February 1, 1995, Belo acquired television station KIRO-TV in Seattle, Washington. The purchase price was $162,500,000 in cash plus transaction costs. These acquisitions have been accounted for as purchases.\nThe costs of the acquisitions have been allocated on the basis of the estimated fair market value of the assets acquired. These allocations resulted in intangibles of $81,673,000 for WWL-TV and $122,753,000 for KIRO-TV. These amounts are being amortized on a straight-line basis over 40 years.\nThe pro forma financial results of operations below assume the transactions were financed with the revolving credit facility at the average rates paid in each of these periods, and include certain other purchase price adjustments regarding depreciation, amortization and income taxes. The pro forma financial results further assume the transactions were completed at the beginning of January 1994:\nA change of .125 percent in revolving debt rates would affect the pro forma net earnings by $215,000. The 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 acquisitions been completed as of the indicated date, nor are they indicative of future operating results.\nOn December 26, 1995, Belo completed the acquisition of the Bryan-College Station Eagle, a daily newspaper serving Bryan-College Station, Texas. The acquisition, which was financed with the revolving credit facility, has been accounted for as a purchase. The pro forma financial information above does not include the operations of this acquisition due to immateriality.\nNOTE 3: LONG TERM DEBT - --------------------------------------------------------------------------------\nLong-term debt consists of the following:\nAt the end of 1995, the Company had a revolving credit facility for $800,000,000. Borrowings of revolving debt were $480,000,000 and $305,000,000 at December 31, 1995 and 1994, 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. At December 31, 1995, the weighted average borrowing rate was 6.1 percent. The agreement also provides for a facility fee of .125 percent on the total commitment. Borrowings\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS A. H. BELO CORPORATION AND SUBSIDIARIES\nunder the agreement mature upon expiration of the agreement on July 28, 2000, with an extension to July 28, 2001, at the request of the Company and with the 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, 1995.\nDuring 1995, the Company used various short-term unsecured notes as an additional source of financing. For the years ended December 31, 1995 and 1994, the average interest rate on this debt was slightly lower than the revolving debt rate. 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, $71,000,000 and $19,000,000 of short-term notes outstanding at December 31, 1995 and 1994, respectively, have been classified as long-term.\nIn 1995, 1994 and 1993, the Company incurred interest costs of $30,944,000, $16,250,000 and $16,976,000, respectively, of which $957,000, $138,000 and $1,961,000, respectively, were capitalized as components of construction cost.\nAverage interest rates on total debt were approximately 6.3 percent, 4.8 percent and 5.4 percent during 1995, 1994 and 1993, respectively.\nAt December 31, 1995, the Company had outstanding letters of credit of $7,708,000 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 4: 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 16 cents per share.\nIncome tax expense for the years ended December 31, 1995, 1994 and 1993 consists of the following:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS A. H. BELO CORPORATION AND SUBSIDIARIES\nIncome tax provisions for the years ended December 31, 1995, 1994 and 1993 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, 1995 and 1994, are as follows:\nNOTE 5: EMPLOYEE RETIREMENT PLANS - --------------------------------------------------------------------------------\nThe 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 consecutive 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.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS A. H. BELO CORPORATION AND SUBSIDIARIES\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, 1995 and 1994:\nThe net periodic pension cost (benefit) for the years ended December 31, 1995, 1994 and 1993 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 $3,170,000, $2,568,000 and $1,825,000 in 1995, 1994 and 1993, respectively.\nThe Company also sponsors non-qualified retirement plans for key employees. Expense for the plans recognized in 1995, 1994 and 1993 was $1,089,000, $1,232,000 and $1,412,000, respectively.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS A. H. BELO CORPORATION AND SUBSIDIARIES\nNOTE 6: LONG TERM INCENTIVE PLANS - --------------------------------------------------------------------------------\nThe Company has long-term incentive plans under which awards 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. Cash-based bonus awards are also available under one of the plans. The plans also provide for grants of non-qualified stock options to non-employee directors.\nStock-based activity in the long-term incentive plans is summarized in the following table:\nThe non-qualified options granted to employees under the Company's long-term incentive plans become exercisable in cumulative installments over a period of three years. On December 31, 1995, of the 3,097,777 options outstanding, 1,827,884 were exercisable at prices ranging from $12 to $27. Shares of Common Stock reserved for grants under the plans were 3,849,727 and 250,531 at December 31, 1995 and 1994 respectively.\nA provision for the restricted shares is made ratably over the restriction period. Expense recognized under the plans for restricted shares was $2,223,000, $2,146,000 and $3,598,000 in 1995, 1994 and 1993, respectively.\nNOTE 7: 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 would not have a material adverse effect on the consolidated financial position or results of operations of the Company.\nCommitments for the purchase of broadcast film contract rights totaled approximately $131,383,000 at December 31, 1995 for broadcasts scheduled through August 2000.\nAdvance payments on plant and equipment expenditures at December 31, 1995 primarily relate to newspaper production equipment, broadcast equipment and building renovations and improvements. Required future payments for capital expenditures for 1996 and 1997 are $7,881,000 and $2,275,000, respectively.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS A. H. BELO CORPORATION AND SUBSIDIARIES\nTotal lease expense for property and equipment was $3,435,000, $3,131,000 and $5,447,000 in 1995, 1994 and 1993, 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 leases are not material.\nNOTE 8: COMMON AND PREFERRED STOCK - --------------------------------------------------------------------------------\nThe 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\/100 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. At such time, each holder of a right (other than the acquiring person or group) will have the right to purchase common stock of the Company with a value equal to two times the exercise price of the right, which is initially $150 (subject to adjustment). In addition, if the Company is acquired in a merger or business combination, each right can be used to purchase the common stock of the surviving company having a market value of twice the exercise price of each right. Once a person or group has acquired 30 percent of the common stock but before 50 percent of the voting power of the common stock has been acquired, the Company may exchange each right (other than those held by the acquiring person or group) for one share of Company common stock (subject to adjustment). The Company may reduce the 30 percent threshold or may redeem the rights. The number of shares of Series A Junior Participating Preferred Stock reserved for possible conversion of these rights is equivalent to 1\/100 of the number of shares of common stock issued and outstanding plus the number of shares reserved for options outstanding and for grant under the 1995 Executive Compensation Plan. The rights will expire in 2006, unless extended.\nOn June 9, 1995, the Company completed a two-for-one stock split in the form of a dividend, issuing one additional share of Series A and Series B common stock for each corresponding share outstanding, as of the May 19, 1995 record date. The effect of the stock split was to double the number of shares outstanding and reduce per share amounts by one-half. All earnings and dividends per share, weighted average shares outstanding and share trading prices in this report have been restated to reflect the stock split.\nThe Company has in place a stock repurchase program authorizing the purchase of up to $2,500,000 of Company stock annually, and the Company has authority to purchase an additional 3,591,200 shares under another Board authorization.\nNOTE 9: RESTRUCTURING CHARGE - --------------------------------------------------------------------------------\nThe Consolidated Statement of Earnings for 1993 includes a $5,822,000 (9 cents per share) 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 10: OTHER INCOME AND EXPENSE - --------------------------------------------------------------------------------\nIn 1994, Belo donated 58,835 shares of Stauffer Communications, Inc. stock to The A. H. Belo Corporation 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 the shares in the amount 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 (4 cents per share). In 1995, Belo sold its remaining investment in Stauffer Communications, Inc., resulting in a gain of $2,406,000 ($1,546,000 after-tax or 4 cents per share).\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS A. H. BELO CORPORATION AND SUBSIDIARIES\nNOTE 11: SUPPLEMENTAL CASH FLOW INFORMATION - --------------------------------------------------------------------------------\nNet cash provided by operations reflects cash payments for interest and income taxes during the years ended December 31, 1995, 1994 and 1993 as follows:\nNOTE 12: SUBSEQUENT EVENTS - --------------------------------------------------------------------------------\nEffective January 1, 1996, the Company acquired the Owensboro Messenger-Inquirer, a daily newspaper serving Owensboro, Kentucky. Notes payable, which are due in various installments over the next four years and are backed by letters of credit, were issued to complete the transaction. The acquisition was accounted for as a purchase.\nSubsequent to year-end, Belo completed the sale of its interest in its programming distribution partnership, Maxam Entertainment. The Company will record a gain on the transaction in the first quarter of 1996.\nNOTE 13: INDUSTRY SEGMENT INFORMATION - --------------------------------------------------------------------------------\nThe Company operates in two primary industries: television broadcasting and newspaper publishing. Operations in the broadcast industry involve the sale of air time for advertising and the broadcast of entertainment, news and other programming. The Company's television stations are located in Dallas and Houston, Texas; Seattle, Washington; Sacramento, California; Norfolk, Virginia; New Orleans, Louisiana; and Tulsa, Oklahoma. Operations in the newspaper publishing industry, which are located primarily in the Dallas-Fort Worth metropolitan area, involve the sale of advertising space in published issues, the sale of newspapers to distributors and individual subscribers and commercial printing. The Company's other industry segment is comprised of miscellaneous operating ventures associated primarily with television production and distribution. Prior to 1995, these operations were grouped with the broadcasting segment. Information for periods prior to 1995 has been reclassified to conform to the current year presentation.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS A. H. BELO CORPORATION AND SUBSIDIARIES\nSelected segment data for the years ended December 31, 1995, 1994 and 1993 is as follows:\n(A) In 1995, Broadcasting segment data includes the operations of KIRO-TV, which Belo purchased on February 1, 1995. Results for 1994 include the operations of WWL-TV, which Belo purchased on June 1, 1994. (See Note 2). (B) Broadcasting earnings from operations include the reversal of certain music license fee accruals of $631,000 (1 cent per share) in 1994 and $3,349,000 (5 cents per share) in 1993. (C) Included in Newspaper publishing earnings from operations in 1993 is a $5,822,000 (9 cents per share) 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 9). (D) Publishing assets at December 31, 1995 include the assets of the Bryan-College Station Eagle, which was purchased by the Company on December 26, 1995.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS A. H. Belo Corporation and Subsidiaries\nNOTE 14: QUARTERLY RESULTS OF OPERATIONS (UNAUDITED) - --------------------------------------------------------------------------------\nFollowing is a summary of the unaudited quarterly results of operations for 1995 and 1994:\n(A) Broadcasting results include the operations of KIRO-TV since February 1, 1995 and WWL-TV since June 1, 1994. (See Note 2.) (B) 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). A corresponding after-tax gain of $1,564,000 related to the sale of Belo's remaining investment in Stauffer Communications, Inc. is reflected in second quarter 1995 net earnings.\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, 1995, 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","section_15":""}
{"filename":"791024_1995.txt","cik":"791024","year":"1995","section_1":"ITEM 1 -- BUSINESS\nGENERAL\nHome Shopping Network, Inc. (\"HSN\" or the \"Company\") is a holding company, the subsidiaries of which conduct the day-to-day operations of the Company's various business activities. The Company's primary business, and principal source of revenue, is electronic retail sales by Home Shopping Club, Inc. (\"HSC\"), a wholly-owned subsidiary of the Company and a leader in the electronic retailing industry.\nThe Company experienced a downturn in its business during 1995, reporting a net loss of $61.9 million, a decline in net sales, significant operating losses and negative cash flow from operations.\nThe Company believes that its negative performance in 1995 was due in part to the adverse effects of certain merchandising and programming strategies which had been implemented in late 1994 and 1995. In November 1995, the Company appointed Barry Diller as Chairman of the Board of Directors and James Held as President and Chief Executive Officer. The Company sought the services of Messrs. Diller and Held because of their significant experience in electronic retailing and programming.\nThe new senior management of HSN has undertaken a comprehensive review of HSN's merchandising and programming strategies, operations, budget and financial condition. Although the Company believes that new management's operating and merchandising strategies will improve the Company's operating results, there can be no assurance that management will be successful in these efforts.\nOn March 1, 1996, the Company obtained additional financing through a private placement of $100.0 million of Convertible Subordinated Debentures.\nIn November 1995, Tele-Communications, Inc. (\"TCI\"), which, through its wholly owned subsidiary Liberty Media Corporation (\"Liberty\"), beneficially owns approximately 41% of the outstanding equity securities of the Company, representing approximately 80% of the voting power, entered into certain agreements with Mr. Diller and Silver King Communications, Inc. (\"SKC\") pursuant to which, among other things, TCI has agreed to transfer these equity securities of the Company to SKC. Pursuant to a separate proposed transaction between Mr. Diller and Liberty, an entity controlled by Mr. Diller would acquire equity securities representing a majority of the voting power of SKC. As a result, assuming the consummation of these transactions, Mr. Diller would acquire indirect voting control of the Company through his voting interest in SKC. The consummation of each of these transactions is subject to a number of conditions including, but not limited to, the receipt of necessary regulatory and SKC shareholder approvals.\nHOME SHOPPING CLUB, INC.\nHSC sells a variety of consumer goods and services by means of HSC's live, customer-interactive electronic retail sales programs which are transmitted twenty-four hours a day, seven days per week, via satellite to cable television systems, affiliated broadcast television stations and satellite dish receivers. HSC's retail sales programming is currently carried on two separate networks, HSN and Spree!. Both networks are carried by cable television systems and broadcast television stations throughout the country. Spree! programming is available in one hour segments, which enable broadcast and cable affiliates to air Spree! in available time slots that would not otherwise produce revenue for the affiliate.\nThe Company's electronic retail marketing and programming is intended to promote sales and customer loyalty through a combination of information, entertainment and the creation of confidence in HSC and its products. HSC programming is divided into segments which are televised live with a show host who presents the merchandise and conveys information relating to the product, including price, quality, features and benefits. Viewers place orders for products by calling a toll-free telephone number. Show hosts engage callers in on-air discussions regarding the currently featured product or the caller's previous experience with the Company's products. This format creates a spontaneous and entertaining program. HSC attempts to stimulate\ncustomer loyalty by providing, among other things, marketing materials such as the \"Bargaineer(R) HomeView(sm)\" magazine which offers discounts on HSC purchases, features articles on the Company's products and programming, and includes schedules of upcoming shows.\nOn August 5, 1995, the Company relaunched HSN with more scheduled programs and theme related shows, new sets, graphics and music. During the third quarter of 1995, the Company relaunched Spree! with a more spontaneous format, new graphics and music. These changes were designed to distinguish the networks and reach a broader range of potential customers.\nThe following table highlights the changes in the estimated unduplicated television household reach of HSN, the Company's primary network, by category for the year ended December 31, 1995:\n- ---------------\n* Households capable of receiving both broadcast and cable transmissions are included under cable.\nAccording to industry sources, as of December 31, 1995, there were 95.3 million homes in the United States with a television set, 62.1 million basic cable television subscribers and 3.8 million homes with satellite dish receivers.\nIn addition to the households in the above table, as of January 1, 1996, approximately 12.0 million cable television households were reached by Spree!, of which 3.4 million were on a part-time basis. Of the total cable television households receiving Spree!, 9.7 million also receive HSN.\nCUSTOMER SERVICE AND RETURN POLICY\nHSC believes that satisfied customers will be loyal and will purchase merchandise on a regular basis. Accordingly, HSC has customer service personnel and computerized voice response units (the \"VRU\") available to handle calls relating to customer inquiries seven days a week, twenty-four hours a day.\nGenerally, any item purchased from HSC may be returned within thirty days for a full refund of the purchase price, including the original shipping and handling charges.\nDISTRIBUTION, DATA PROCESSING AND TELECOMMUNICATIONS\nThe Company's fulfillment subsidiaries store, service and ship merchandise from warehouses located in St. Petersburg, Florida, Salem, Virginia and Waterloo, Iowa. During 1995, the Company closed its distribution warehouse in Reno, Nevada. Generally, merchandise is delivered to customers within 7 to 10 business days of placing an order.\nHSN currently operates several Unisys main frame computers and has extensive computer systems which track purchase orders, inventory, sales, payments, credit authorization, and delivery of merchandise to customers.\nHSC has digital telephone and switching systems and utilizes the VRU which allows callers to place their orders by means of touch tone input or to be transferred to an operator.\nThe Company is developing plans for upgrading or replacing many of these systems during 1996 and 1997.\nPRODUCT PURCHASING AND LIQUIDATION\nHSC purchases merchandise made to its specifications, merchandise from manufacturers' lines and overstock inventories of wholesalers. During 1995, the Company continued to change its purchasing strategy to emphasize product sourcing, variety, development of new private label lines and name brand merchandise. This strategy is likely to change in 1996 based on determinations to be made by new management. The mix of products and source of such merchandise depends upon a variety of factors, including price and availability. HSC has no long-term commitments with any of its vendors, and there are various sources of supply available for each category of merchandise sold.\nHSC's product offerings include: jewelry; hardgoods, which include consumer electronics, collectibles, housewares, and consumables; softgoods, which consist primarily of clothing and fashion accessories, and cosmetics. For 1995, jewelry, hardgoods, softgoods and cosmetics accounted for approximately 39%, 37%, 14% and 10%, respectively, of HSC's net sales.\nThe Company liquidates short lot and returned merchandise through its five outlet stores and two liquidation centers located in Florida. Merchandise that is damaged is liquidated by the Company through traditional channels.\nTRANSMISSION AND PROGRAMMING\nHSC produces retail sales programs in its studios located in St. Petersburg, Florida. These programs are distributed to cable television systems, broadcast television stations, a direct broadcast satellite service and satellite dish receivers by means of HSN's satellite uplink facilities to satellite transponders leased by HSN. Any cable television system, broadcast television station or individual satellite dish owner in the United States and the Caribbean Islands equipped with standard satellite receiving facilities is capable of receiving HSC programming.\nHSN has lease agreements securing full-time use of three transponders on three domestic communications satellites. Each of the transponder lease agreements grants HSN \"protected\" rights. When the carrier provides services to a customer on a \"protected\" basis, replacement transponders (i.e., spare or unassigned transponders) on the satellite may be used in the event the \"protected\" transponder fails. Should there be no replacement transponders available, the \"protected\" customer will displace a \"preemptible\" transponder customer on the same satellite. The carrier also maintains a protection satellite and should a satellite fail completely, all \"protected\" transponders would be moved to the protection satellite which is available on a \"first fail, first served\" basis.\nOne transponder leased by HSN may, however, be preempted in order to satisfy the owner's obligations to provide the transponder to another lessee on the satellite in the event that the other lessee cannot be restored to service through the use of spare or reserve transponders (the \"Special Termination Right\"). As of June 5, 1995, the Company discontinued use of this satellite transponder for which it has a non-cancelable operating lease calling for monthly payments of approximately $150,000 through December 31, 2006. The Company subleased this satellite transponder to a related party during 1995. The sublease expired on February 15, 1996, and the Company is currently seeking to sublease the transponder or to sell its rights with respect to this satellite transponder. The Company does not expect any material adverse financial impact in connection with the lease.\nA transponder failure that would necessitate a move to another transponder on the same satellite would not result in any significant interruptions of service to the cable systems and\/or television stations which receive HSC's programming. However, a failure that would necessitate a move to another satellite may temporarily affect the number of cable systems and\/or television stations which receive HSC's programming (as well as all other programming carried on the failed satellite) because of the need to install equipment or to reorient earth stations.\nThe terms of two of the leases are for the life of the satellites, which are projected to be through 2004. The term of the third lease is through December 31, 2006, subject to earlier implementation of the Special Termination Right.\nHSN's access to three transponders pursuant to long-term agreements would enable HSC to continue transmission of its two programming services, HSN and Spree!, should any one of the satellites fail. Although HSN believes it is taking every reasonable measure to ensure its continued satellite transmission capability, there can be no assurance that termination or interruption of satellite transmissions will not occur. Such a termination or interruption of service by one or more of these satellites could have a material adverse effect on the operation and financial condition of the Company.\nThe availability of replacement satellites and transponder time beyond current leases is dependent on a number of factors over which HSN has no control, including competition among prospective users for available transponders and the availability of satellite launching facilities for replacement satellites.\nThe Federal Communications Commission (\"FCC\") grants licenses to construct and operate satellite uplink facilities which transmit signals to satellites. These licenses are generally issued without a hearing if suitable frequencies are available. HSN has been granted two licenses for operation of C-band satellite transmission facilities and two licenses for operation of KU-band satellite transmission facilities on a permanent basis in Clearwater and St. Petersburg, Florida.\nREGULATORY MATTERS\nOn October 5, 1992, the Cable Television Consumer Protection and Competition Act of 1992 (the \"1992 Cable Act\") was enacted into law. Among the many provisions of this law is one that mandates that cable systems carry the signals of local commercial television stations (\"must carry\") or, at the station's option, that cable systems and television stations negotiate a fee to be paid by cable systems for the retransmission by such cable systems of the local television station's broadcast signal. HSC's full-time, full power broadcast affiliates have all requested \"must carry\" status in lieu of a retransmission fee and most have obtained \"must carry\" status. The U. S. District Court for the District of Columbia has twice upheld the constitutionality of the \"must carry\" rules. The Supreme Court will review this issue in late 1996 or early 1997.\nDuring 1993 and 1994, \"must carry\" was important to the Company in obtaining carriage by cable operators. Due to HSC's success in obtaining long-term carriage commitments, in the event \"must carry\" is ruled unconstitutional, the Company does not believe the ruling will have a material adverse impact on the Company or result in any significant loss in carriage.\nIn November 1994, the FCC issued \"going forward\" rules pursuant to the 1992 Cable Act regarding the fees cable operators can charge subscribers for new programming. The going forward rules provide that cable operators can increase the charges to subscribers for new programming but must offset the charges by revenues, including sales commissions, they receive from the programmer. The Company and other electronic retailing companies filed Petitions for Reconsideration with the FCC which requested that shop-at-home programming revenues be excluded from the cable operator's offset to revenues, and this petition was granted in August 1995.\nIn January 1996, the Telecommunications Act of 1996 became law, providing for, among other things, the deregulation of the telephone and cable industries to permit increased competition and technological developments. Although the effect of this law on the telecommunications industry cannot yet be determined, the Company does not believe it will have an adverse impact on its business.\nAFFILIATION AGREEMENTS WITH CABLE OPERATORS\nHSC enters into affiliation agreements with cable system operators to carry HSN, Spree! or both. HSC has a standard form of affiliation agreement which has a term of five years, is automatically renewable for subsequent one year terms, and obligates the cable operator to assist the promotional efforts of HSC by carrying commercials regarding HSN and Spree! and distributing HSC's marketing materials to the cable operator's subscribers. The standard form of affiliation agreement provides that the cable operator will receive a commission of five percent of the net sales of merchandise sold within the cable operator's franchise area (from both cable and non-cable households). However, particularly with larger, multiple system operators, HSC has agreed to provide additional compensation. In the past, this has included the purchase of advertising\navailabilities from cable operators on other programming networks and the establishment of commission guarantees committing HSC to a certain level of payments. Although a number of these contracts remain in effect, as a general rule, HSC is no longer entering into agreements that provide for advertising availability and commission guarantee compensation. These forms of compensation were replaced with cable distribution fees or performance bonus commissions that are intended to increase sales by compensating the cable operators for promotional efforts which result in higher net sales levels.\nDue to the possibility of \"must carry\" being found unconstitutional, HSC embarked on an aggressive campaign to bring the \"must carry\" households under contract by volunteering to pay commissions to cable operators required to transmit HSC's programming. As an additional contract incentive, HSC offered to make payments of cable distribution fees, primarily consisting of up-front payments, based on a commitment to transmit HSC programming to a certain number of subscribers. In exchange for these payments, HSC required significant commitments for both the \"must carry\" and \"non-must carry\" households and original terms of five to fifteen years.\nAFFILIATION AGREEMENTS WITH BROADCAST TELEVISION STATIONS\nSKC, through its subsidiaries, owns twelve broadcast television stations, including one television satellite station. These stations are located in many of the top markets in the United States and exclusively broadcast HSC programming, except for a portion of broadcast time which is used to provide public affairs and other non-entertainment programming and advertising inserts.\nEach of the full power SKC stations has an affiliation agreement with HSC to carry HSC's programming through December 28, 1997 providing for an hourly fee, and upon reaching certain sales levels, commissions on net sales. These agreements are automatically renewable at SKC's option for a five-year term, unless written notice is given by SKC at least 18 months prior to the expiration date. The Company has agreed in principle with SKC that the period for delivery of the notice of non-renewal by SKC will be extended until December 28, 1996. SKC has informed the Company that it has not made any final decision regarding whether it will renew any or all of the affiliation agreements but presently contemplates that it will not renew the affiliation agreements. The Company believes, based on its preliminary analysis, that the orderly termination of the affiliation agreements may be in the Company's best interests because of the potential cost savings and the existing cable carriage of the HSC programming in many of the SKC markets. The Company is evaluating the affected markets to determine the need for obtaining additional program carriage and the related costs of such carriage. There can be no assurance that SKC will in fact terminate any or all of the affiliation agreements or that, if so terminated, that the Company will be able to find other means of distributing HSC programming by broadcast or cable to the households in the broadcast areas currently served by SKC stations.\nSKC also owns 26 low power television (\"LPTV\") stations that broadcast HSC's programming services. Fourteen stations are currently under existing affiliation agreements, and the Company contemplates entering into contracts with the remaining stations in 1996. LPTV stations have lower power transmitters than conventional television stations, and therefore, the broadcast signal of an LPTV station does not cover as broad a geographical area as conventional broadcast stations.\nIn addition to affiliation agreements with the SKC broadcast television and LPTV stations, HSC has entered into affiliation agreements with other broadcast television stations and LPTV stations to carry either HSN or Spree! for a predetermined number of hours per day. The broadcast station affiliation agreements may generally be terminated upon notice by either party and specify the payment of fixed hourly fees for the carriage of HSC programming.\nADDITIONAL SUBSIDIARY BUSINESSES\nIn addition to the electronic retailing business, the Company's subsidiaries are involved in mail order, insurance and other businesses complementary to electronic retailing.\nHSN Mail Order, Inc. (\"Mail Order\") markets a variety of merchandise through five mail order catalogs. The catalogs include HSN By Mail(sm), HSN By Mail(sm) -- Signature Gem Collection(sm), HSN by Mail(sm) -- The Gallery of Dolls(sm), HSN By Mail(sm) -- Private Showing(R) Jewelry, and Bargaineer(R) Homeview(sm). Mail Order also markets a variety of products by inserting marketing materials, including its catalogs, in packages containing HSC products shipped to customers. In addition, through its Life Way(R) name, Mail Order markets natural vitamin and mineral supplements, over-the-counter items, health and wellness merchandise and a complete line of skin and hair products.\nVela Research, Inc. develops and markets high technology audio and video MPEG compression\/decompression products to the cable, broadcast, computer and telecommunications industries.\nHSN Direct Joint Venture (\"HSND\") develops, produces, and markets infomercials and short form direct response spots on a national and international basis. The Company presently owns a majority interest in HSND. The Company has entered into negotiations with FlexTech p.1.c., an affiliate of TCI, (\"FlexTech\") pursuant to which FlexTech (or a subsidiary thereof) would make a substantial investment in HSND and become the majority owner of HSND. If this transaction is consummated upon the terms presently proposed, FlexTech would own approximately 79% of the business of HSND, and the Company's interest would be reduced to 15%. In connection with this transaction, the Company would receive approximately $5.0 million. There can be no assurance that this transaction will be consummated or, if consummated, will be consummated on the currently proposed terms.\nInternet Shopping Network, Inc. (\"ISN\") is a wholly-owned subsidiary which operates an interactive shopping service on the Internet specializing in small office and computer equipment. ISN is also engaged in exploring business opportunities for merchandising products via digital interactive television services and other new digital retailing vehicles.\nHSN Insurance, Inc. (\"HSI\") is a full-service insurance agency marketing a wide range of insurance products such as life, health, auto, homeowners and commercial policies to the public and HSC customers. Mass-marketing of other insurance and service-related products such as a private-label travel club, an auto club, a health and dental discount program, an AD & D insurance product and an extended service plan for electronics are offered to HSC customers nationally. HSI also handles the placement of all property and liability insurance for HSN and its subsidiaries, as well as employee benefits insurance products.\nCOMPETITION\nThe Company operates in a highly competitive environment. It is in direct competition with businesses which are engaged in retail merchandising, other electronic retailers, direct marketing retailers such as mail order companies, companies that sell from catalogs, other discount retailers and companies that market through computer technology. The Company also competes for access to its customers with broadcasters and alternative forms of entertainment and information, such as programming for network and independent broadcast television stations, basic and pay cable television services, satellite master antenna systems, home satellite dishes and home entertainment centers. In particular, the price and availability of programming for cable television systems affects the availability of these channels for the Company's programs and the compensation which must be paid to the cable operators for carriage of HSC programming. In addition, the Company believes that due to a number of factors, including the development by cable operators of alternative sources of cable operator owned programming, the competition for channel capacity has substantially increased. With the advent of new compression technologies on the horizon, this competition for channel capacity may substantially decrease, although additional competitors may have the opportunity to enter the marketplace. No predictions can be made with respect to the viability of these technologies or the extent to which they will ultimately impact the availability of channel capacity.\nThe Company and QVC, Inc. (\"QVC\") are currently the two leading electronic retailing companies. There are other companies, some having an affiliation or common ownership with cable operators, that now market merchandise by means of live television. A number of other entities are engaged in direct retail sales businesses which utilize television in some form and which target the same markets in which the Company\noperates. Some of the Company's competitors are larger and more diversified than the Company, or are also affiliated with cable operators which have a substantial number of subscribers. The Company cannot predict the degree of success with which it will meet competition in the future. TCI currently owns 43% of QVC but has entered into a stockholders agreement with Comcast Corporation (which owns 57% of QVC) pursuant to which Comcast Corporation controls the day to day operations of QVC.\nIn addition to the above factors, the Company's affiliation with broadcast television stations creates another set of competitive conditions. These stations compete for television viewers primarily within local markets. The Company's affiliated broadcast television stations are located in highly competitive markets and compete against both VHF and UHF stations. Due to technical factors, a UHF television station generally requires greater power and a higher antenna to secure substantially the same geographical coverage as a VHF television station. Under present FCC regulations, additional UHF commercial television broadcasting stations may be operated in all such markets, with the possible exception of New York City. The Company also competes with new entertainment and shopping networks for carriage on broadcast television stations. The Company cannot quantify the competitive effect of the foregoing or any other sources of video programming on any of the Company's affiliated television stations, nor can it predict whether such competition will have a material adverse effect on its operations.\nIn summary, the Company operates in a highly competitive environment in which, among other things, technological change, changes in distribution patterns, media innovations, data processing improvements and new entrants make the competitive position of both the Company and its competitors extremely difficult to predict.\nTRADEMARKS, TRADENAMES AND COPYRIGHTS\nThe Company has registered and continues to register, when appropriate, its trade and service marks as they are developed and used, and the Company vigorously protects its trade and service marks. The Company believes that its marks are a primary marketing tool.\nEMPLOYEES\nDuring 1995, the Company instituted a number of cost cutting measures including a reduction in work force of 262 employees. At December 31, 1995, the Company had 3,804 full-time employees and 491 part-time employees. The Company believes it has generally good employee relationships.\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2 -- PROPERTIES\nThe Company owns an approximately 480,000 square foot facility in St. Petersburg, Florida, which houses its television studios, broadcast facilities, and most of the Company's administrative offices and training facilities.\nThe Company operates four warehouse type facilities totaling approximately 115,000 square feet near the Company's main campus in St. Petersburg, Florida. These facilities are used for returns processing, retail distribution and general storage.\nThe Company leases a 21,000 square foot facility in Clearwater, Florida for its video and post production operations.\nThe Company owns and operates a warehouse consisting of approximately 163,000 square feet located in Waterloo, Iowa which is used as a fulfillment center.\nThe Company operates a warehouse located in Salem, Virginia, consisting of approximately 650,000 square feet which is leased from the City of Salem Industrial Development Authority. On November 1, 1999, the Company will have the option to purchase the property for $1.\nThe Company's retail outlet subsidiary leases seven retail stores in the Tampa Bay and Orlando areas totaling approximately 173,000 square feet.\nThe Company and its other subsidiaries also lease office space in California, Colorado and New Jersey.\nThe Company considers its properties suitable and adequate for its present needs.\nITEM 3","section_3":"ITEM 3 -- LEGAL PROCEEDINGS\nThe Company has agreed to settle a consolidated class action initiated in 1990 pending in the Court of Common Pleas of Bucks County, Pennsylvania, entitled Mauger v. Home Shopping Network, Inc.; Powell v. Home Shopping Network, Inc. (case number 91-6152-20-1). The complaints allege violation of the Pennsylvania Unfair Trade Practices and Consumer Protection Law in relation to the Company's pricing practices with respect to diamond and imitation diamond jewelry sold to Pennsylvania residents between December 27, 1984 and May 20, 1991. Under the proposed settlement, customers who present adequate proof of purchase of cubic zirconia or diamond jewelry during the class period will have the option of receiving a cash payment or a discount certificate usable for the purchase of HSN merchandise during the following twelve months. The maximum cash payment required from the Company with respect to all costs relating to the settlement is $2.5 million, which will be placed in an escrow account following preliminary court approval of the settlement. The Company will be entitled to a refund of any balance not used for these purposes. If certificates representing a maximum discount of more than $5.2 million would be issuable under the settlement, the Company has the right to require that the certificates be pro-rated among those who elect to receive them. The settlement is subject to approval by the Court after notice and hearing.\nOn March 2, 1995, the Federal Trade Commission (\"FTC\") issued an administrative complaint against the Company, HSC and HSN Lifeway Health Products, Inc., In Re Home Shopping Network, Inc. et al., No. D-9272, in connection with the on-air presentation in 1993 of certain spray vitamin and nutritional supplement products. The FTC alleged that the Company did not have a reasonable basis to support certain on-air claims, and proposed a settlement based upon a cease and desist order that would require the Company to obtain scientific evidence that would meet certain defined standards. The Company did not agree that the consent order proposed by the FTC was warranted, and the complaint, which seeks no monetary damages, will be heard by an FTC administrative law judge during the first half of 1996.\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\nPRICE RANGE OF COMMON STOCK\nThe following table sets forth, for the quarterly periods indicated, the high and low sales prices of the Company's common stock on the New York Stock Exchange (Symbol: HSN).\nThe closing price per share as of March 6, 1996 was $11.50 and there were 8,050 stockholders of record as of that date.\nThe Company has paid no dividends on its common stock to date and does not anticipate that it will pay cash dividends in 1996. Any payment of future dividends and the amounts thereof will be dependent upon the Company's earnings, financial requirements and other factors deemed relevant by the Board of Directors.\nITEM 6","section_6":"ITEM 6 -- SELECTED FINANCIAL DATA\nSUMMARY FINANCIAL DATA - -------------------------------------------------------------------------------- (Table amounts in thousands, except per share data) - --------------------------------------------------------------------------------\n- --------------------------------------------------------------------------------\n- ---------------\n(1) The gross profit declined to 31.1% for the year ended December 31, 1995, from 35.2% for the year ended December 31, 1994. This was due to warehouse sales and other promotional events and an inventory carrying value adjustment of $14,500,000 primarily relating to new management's evaluation of existing inventory and determining that certain merchandise would not fit the Company's future sales and merchandising strategy. (2) During 1995 the Company recorded a $4,114,000 restructuring charge related to closing its fulfillment center in Reno, Nevada. The Company also recorded $11,893,000 of other charges, including $3,978,000 of severance pay related to a reduction in work force, $4,800,000 of payments to certain executives as provided for under their employment agreements in connection with the termination of their employment and $1,303,000 related to the write-down of inventory to net realizable value for Ortho-Vent, one of the Company's mail order subsidiaries. An additional $2,400,000 related to name lists of Ortho-Vent were\nwritten off and included in depreciation and amortization. Other charges also include the write-off of certain equipment maintenance and contractual fees totaling $1,812,000 related to service contracts which the Company will no longer utilize. (3) During 1995, the Company recorded additional interest expense of $773,000 related to bank fees that were amortized, miscellaneous expense of $4,700,000 for the write-down of computer equipment, and $6,383,000 of additional litigation expense. (4) The gross profit declined to 32.7% for the year ended December 31, 1993, from 37.0% for the year ended August 31, 1992. This was primarily due to the liquidation of inventory at less than cost. (5) In the fourth quarter of 1993, the Company charged $13,000,000 to other income (expense) for the settlement of various lawsuits. (6) During 1991, the Company recorded $44,500,000 in pre-tax non-recurring special charges. Additionally, the Company increased its income tax provision $10,382,000 relating to certain adjustments proposed by the IRS. (7) At December 31, 1993 and 1992, and August 31, 1992, $25,000,000, $3,200,000 and $27,500,000, respectively was classified as a current liability reflecting management's ability and intent to satisfy a portion of the debt from funds provided from operations.\nITEM 7","section_7":"ITEM 7 -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nGENERAL\nHome Shopping Network, Inc. (the \"Company\") is a holding company, the subsidiaries of which conduct the day-to-day operations of the Company's various business activities. The Company's primary business is electronic retailing conducted by Home Shopping Club, Inc. (\"HSC\"), a wholly-owned subsidiary of the Company.\nThe following discussion presents the material changes in the consolidated results of operations of the Company which have occurred between the years ended December 31, 1995 and 1994, along with material changes between the years ended December 31, 1994 and 1993. Reference should also be made to the Consolidated Financial Statements and Summary Financial Data included herein.\nThe Company expects to sell a majority of its interest in its infomercial joint venture, HSN Direct Joint Venture (\"HSND\") in early 1996. This transaction will result in a reduction in net sales, cost of sales and certain operating expenses in 1996. The sale of HSND should not have a material impact on the Company's results of operations in 1996 or future periods.\nAll tables and discussion included herein calculate the percentage changes using actual dollar amounts, versus rounded dollar amounts.\nYEAR ENDED DECEMBER 31, 1995 VS. YEAR ENDED DECEMBER 31, 1994\nNET SALES\nFor the year ended December 31, 1995, net sales for the Company decreased $107.9 million, or 9.6%, to $1.019 billion from $1.127 billion for the year ended December 31, 1994. Net sales of HSC decreased $140.6 million, or 13.9%, for the year ended December 31, 1995, reflecting a 19.4% decrease in the number of packages shipped and a 9.1% increase in the average price per unit sold compared to the year ended December 31, 1994. The decrease in HSC sales was partially offset by sales increases by HSND, and wholly-owned subsidiaries, HSN Mail Order, Inc. (\"Mail Order\") and Vela Research, Inc. (\"Vela\"), totaling $32.0 million for the year ended December 31, 1995.\nSince June 5, 1995, the Company has operated two full-time networks renamed HSN, the primary network, and Spree!. On August 5, 1995, the Company relaunched the HSN network with more scheduled programs and theme related shows, new sets, graphics and music. During the third quarter of 1995, the Company relaunched the Spree! network with a more spontaneous format and new graphics and music. These changes were designed to reduce programming redundancies, distinguish the networks and reach a broader range of potential customers.\nManagement also instituted promotional programs to help increase sales, including a national advertising campaign and a \"no interest-no payments\" credit promotion through February 1996 for certain purchases made during the third and fourth quarters of 1995 using the Company's private label credit card. Although the credit promotion program was successful, its effect was not enough to offset the overall decrease in sales.\nThe Company believes that its negative performance in 1995 was due, in part, to the adverse effects of certain merchandising and programming strategies which had been implemented in late 1994 and 1995. Consequently, in November 1995, the Company appointed a new chairman of the board and a new president and chief executive officer, both with significant experience in the electronic retailing and programming areas. Immediate changes were made to the Company's merchandising and programming strategies which management believes resulted in the improved sales in December 1995 and January 1996 when compared to the same months in the prior years. Further plans include improving inventory mix with respect to product assortment and price point designed to attract both first-time buyers and active buyers, improving inventory management and better planning of programmed shows. While management is optimistic that results will continue to improve and the Company will return to profitability, there can be no assurance that changes to the Company's merchandising and programming strategies will achieve management's intended results.\nFor the year ended December 31, 1995, HSC's merchandise return percentage increased to 25.7% from 24.4% compared to 1994. The increase in return rate is attributable, in part, to an increase in average price per unit and, in part, to returns resulting from promotional events. New management's merchandising strategy is designed to reduce return rates in 1996. Promotional price discounts increased to 2.8% from 2.7% of HSC sales for the year ended December 31, 1995 compared to 1994.\nAt December 31, 1995, HSC had approximately 4.8 million active members representing a 3.1% decline from December 31, 1994. An active member is defined as a customer that has completed a transaction within the last 18 months or placed an order within the last seven months. In addition, 59.2% of active members have made more than one purchase in the last 18 months, compared to 59.4% at December 31, 1994.\nThe Company has significantly increased its program carriage and believes that future levels of net sales of HSC will be dependent on the success of new management's plans, as discussed above, in increasing market penetration. Market penetration represents the level of active customers within a market.\nThe following table highlights the changes in the estimated unduplicated television household reach of HSN, the Company's primary network, by category for the year ended December 31, 1995:\n- ---------------\n* Households capable of receiving both broadcast and cable transmissions are included under cable.\nAccording to industry sources, as of December 31, 1995, there were 95.3 million homes in the United States with a television set, 62.1 million basic cable television subscribers and 3.8 million homes with satellite dish receivers.\nThe cable television household growth was achieved through increased cable system carriage of HSC's broadcast signal due to the implementation of \"must carry\" beginning in September 1993, and the Company's aggressive campaign to obtain contracts for cable carriage of HSC programming. In areas where HSC programming is now carried by a cable operator, former broadcast households that are cable subscribers can more easily access HSC programming. In addition to the households in the above table, as of January 1, 1996 approximately 12.0 million cable television households were reached by the Spree! network, of which 3.4 million were on a part-time basis. Of the total cable television households receiving Spree!, 9.7 million also receive HSN.\nDuring 1996, cable system contracts covering 4.2 million cable subscribers are subject to termination or renewal. This represents 9.4% of the total number of unduplicated cable households receiving HSN. The Company is pursuing both renewals and additional cable television system contracts, but channel availability, competition, consolidation within the cable industry and cost of carriage are some of the factors affecting the negotiations for cable television system contracts. Although management cannot determine the percentage of expiring contracts that will be renewed or the number of households that will be added through new contracts, management believes that a majority of these contracts will be renewed.\nHSC's market penetration lags behind increases in carriage. As a result of the increase in carriage which began in late 1993, and previous changes in merchandising and programming strategies, the Company has experienced a decrease in its market penetration. As the new households mature and new management's plans are fully implemented, the Company expects market penetration to improve, but there can be no assurance that this will occur.\nCOST OF SALES\nFor the year ended December 31, 1995, cost of sales decreased $28.8 million, or 3.9%, to $701.7 million from $730.5 million for the year ended December 31, 1994. As a percentage of net sales, cost of sales increased to 68.9% from 64.8% compared to the year ended December 31, 1994.\nCost of sales of HSC decreased $49.1 million for the year ended December 31, 1995. This was partially offset by increases in cost of sales of HSND, Mail Order and Vela totaling $21.4 million for the year ended December 31, 1995. As a percentage of HSC's net sales, cost of sales increased to 71.8% from 66.9% for the year ended December 31, 1995, compared to 1994.\nThe 1995 dollar decreases in consolidated and HSC's cost of sales, compared to 1994, relate to the lower sales volume. The comparative increases in cost of sales percentages primarily relate to warehouse sales and other promotional events. These events offered price discounts to facilitate the Company's distribution center restructuring and sales of existing merchandise to make room for new merchandise for the holiday selling season and to correct excessive inventory levels and product mix in December 1995. In addition, consolidated and HSC's cost of sales for the year ended December 31, 1995, reflect a $14.5 million increase in HSC's inventory carrying value adjustment primarily related to product which is inconsistent with HSC's new sales and merchandising philosophy.\nOPERATING EXPENSES\nThe following table highlights the operating expense section from the Company's Consolidated Statements of Operations:\nAs a percentage of net sales, operating expenses increased to 39.0% from 32.8% compared to the year ended December 31, 1994.\nIn 1995 and early 1996, management instituted measures aimed at streamlining operations primarily by reducing its work force and taking other actions to reduce operating expenses. Although these changes resulted in some reduction in individual categories of operating expenses in 1995 and will result in future reductions to operating expenses, the Company incurred additional costs in 1995 as a result of these measures. See \"Other Charges\" and \"Restructuring Charges.\"\nSELLING AND MARKETING\nFor the year ended December 31, 1995, selling and marketing expenses, as a percentage of net sales, increased to 16.4% from 14.4% compared to the year ended December 31, 1994.\nThe major components of selling and marketing expenses are detailed below:\nTelephone, operator and customer service expenses are typically related to sales, call volume and the number of packages shipped. For the year ended December 31, 1995, telephone costs decreased due to a $1.4 million rebate for past telephone charges from the Company's long distance telephone carrier in connection with a new contract for telephone services. This contract will also result in lower future telephone rates compared to prior periods. HSC telephone and operator costs decreased $2.2 million for the year ended December 31, 1995, due to lower call volume. In addition, the sale in the second quarter of 1994 of the Company's former wholly-owned subsidiary, HSN Mistix Corporation (\"Mistix\"), resulted in a $2.0 million decrease in telephone and operator costs for the year ended December 31, 1995. These decreases were primarily offset by increased telephone and operator costs incurred by Mail Order and the Company's telemarketing subsidiary, National Call Center, Inc., totaling $2.9 million for the year ended December 31, 1995. Management expects HSC operator costs to fluctuate in relation to call and package volume in 1996. Customer service costs increased $.3 million for the year ended December 31, 1995, due to the expansion of customer service operating hours, in March 1995, to seven days a week, twenty-four hours a day.\nFor the year ended December 31, 1995, commissions to cable system operators decreased as a result of the decrease in sales.\nMarketing payments for cable advertising, which relate primarily to previous contractual commitments, decreased for the year ended December 31, 1995. As older agreements expire or are renegotiated and new cable carriage agreements are executed, marketing payments for cable advertising are being replaced by other forms of incentive compensation to cable operators. These include payment of cable distribution fees, as discussed in \"Depreciation and Amortization,\" and performance bonus commissions which require payments based upon HSC attaining certain sales levels in the cable operator's franchise area. Accordingly, marketing payments for cable advertising are expected to decrease, and depreciation and amortization will increase in 1996. Performance bonus commissions are expected to fluctuate in relation to sales in 1996.\nIn addition, cable operators which have executed affiliation agreements to carry the Company's programming are generally compensated for all sales within their franchise areas, regardless of whether a customer's order results from watching the program via cable, satellite dish, or on a broadcast television station. Thus, with the advent of \"must carry,\" HSC is paying commissions to cable operators in addition to the hourly affiliation payments made to broadcast television stations. As a result of the above factors, subject to sales volume, fees paid to cable system operators are expected to remain at higher levels in future periods.\nSelling and marketing expenses related to HSND primarily consist of media and telephone, operator and customer service expenses. The remaining net increase in selling and marketing expenses is attributable to promotional expenses incurred in connection with the Company's programming strategies which were implemented in 1995, increased Mail Order catalog costs and advertising and promotional expenses of the Company's other subsidiary operations, totaling $12.4 million. As a result of the Company's promotional program related to its private label credit card, the Company incurred an additional $1.4 million of interest charges in the fourth quarter of 1995. Management believes that total selling and marketing expenses in future periods will be at higher levels as the Company maintains its efforts to increase the number of cable systems carrying the Company's programming and increase market penetration through expanded direct mailings and other advertising, as discussed in \"Net Sales.\"\nENGINEERING AND PROGRAMMING\nFor the year ended December 31, 1995, engineering and programming expenses, as a percentage of net sales, increased to 9.6% from 8.8% compared to the year ended December 31, 1994 primarily as a result of the decrease in net sales.\nThe decrease in engineering and programming expenses for the year ended December 31, 1995, compared to 1994, was primarily due to lower broadcast costs of $2.3 million. In addition, based on sales within the broadcast markets of Silver King Communications, Inc. (\"SKC\"), for the year ended December 31, 1995, the Company incurred lower broadcast commission expense of $1.1 million, compared to the year ended December 31, 1994. Broadcast commission expense is expected to fluctuate in relation to sales for 1996. These decreases were offset by increases totaling $2.3 million for the year ended December 31, 1995, in production costs incurred in connection with the Company's new programming strategies, as discussed in \"Net Sales\", and HSND programming costs. Engineering and programming expenses are expected to remain relatively constant in 1996.\nGENERAL AND ADMINISTRATIVE\nFor the year ended December 31, 1995, general and administrative expenses, as a percentage of net sales, increased to 7.6% from 7.0% compared to the year ended December 31, 1994.\nFor the year ended December 31, 1995, decreases in legal expense and expense in connection with the Company's executive stock award program and repairs and maintenance totaling $4.9 million were primarily offset by increases in expenses for consulting, Stock Appreciation Rights (\"SAR's\"), the Company's employee equity participation plan, and other administrative expenses totaling $2.7 million.\nBased on savings expected to be realized in connection with the reduction of the Company's work force, as discussed in Note F to the Consolidated Financial Statements included herein, and other expense reduction initiatives, management expects general and administrative expenses to decrease in 1996.\nDEPRECIATION AND AMORTIZATION\nThe increase in depreciation and amortization was primarily due to the amortization of cable distribution fees, which increased $8.8 million to $12.7 million for the year ended December 31, 1995. Amortization of these fees is expected to total $15.7 million in 1996 based on existing agreements. This amortization could increase if additional long-term cable contracts are entered into during 1996, as discussed in \"Net Sales.\" The expected increase in depreciation expense in 1996 will be partially offset by a decrease related to the retirement of certain equipment as discussed in \"Other Income (Expense).\" In addition, amortization expense increased $2.4 million for the year ended December 31, 1995, in connection with the sale of the assets of Ortho-Vent, Inc. (\"Ortho-Vent\"), as discussed in Note F to the Consolidated Financial Statements included herein.\nOTHER CHARGES\nThe other charges of $11.9 million for the year ended December 31, 1995 consist of severance costs of $4.0 million related to a reduction in work force, $4.8 million of payments to certain executives as provided for under their employment agreements in connection with the termination of their employment and the write-off of certain equipment maintenance and contractual fees totaling $1.8 million related to service contracts which the Company will no longer utilize. In addition, the Company recorded a write-down of inventory totaling $1.3 million to net realizable value based on the disposition of Ortho-Vent's assets. See Note F to the Consolidated Financial Statements, included herein. The sale of Ortho-Vent should not have a material impact on the Company's net sales or results of operations in future periods.\nRESTRUCTURING CHARGES\nRestructuring charges for the year ended December 31, 1995, of $4.1 million, represent management's estimate of costs to be incurred in connection with the closing of the Company's Reno, Nevada, distribution\ncenter, which was accomplished in June 1995. The decision to close the Reno distribution center was based on an evaluation of the Company's overall distribution strategy. Management believes that consolidation of the Company's distribution facilities will result in operating efficiencies and improved service to customers.\nOTHER INCOME (EXPENSE)\nFor the year ended December 31, 1995, the Company had net other expense of $(14.9) million compared to net other income of $3.6 million for the year ended December 31, 1994.\nInterest income decreased $7.6 million for the year ended December 31, 1995, compared to 1994, primarily due to the repayment by SKC in August 1994, of its indebtedness to the Company. Interest income is expected to further decrease in 1996, compared to 1995.\nInterest expense increased $4.6 million for the year ended December 31, 1995, due to borrowings by the Company under its Secured $150.0 million Revolving Credit Facility (\"Credit Facility\") in late 1994 and 1995. On March 1, 1996, the Company obtained additional financing through a private placement of $100.0 million of convertible subordinated debentures, as discussed in \"Financial Position, Liquidity and Capital Resources.\" Interest expense for 1996 will increase compared to 1995.\nFor the years ended December 31, 1995 and 1994, net miscellaneous expenses remained constant at $.4 million. In 1995, $6.0 million in losses recorded in connection with the retirement of equipment was offset by receipts from lawsuit settlements, royalty income and other miscellaneous income totaling $5.6 million. In 1994, a $(2.9) million loss on the sale of the common stock of Mistix was offset by receipts from lawsuit settlements and other miscellaneous income totaling $2.5 million.\nLitigation expense for the year ended December 31, 1995, of $6.4 million, represents litigation settlements and anticipated costs in connection with the resolution of certain pending litigation.\nINCOME TAXES\nThe Company's effective tax rate was a benefit of (35.0)% for the year ended December 31, 1995, and an expense of 42.0% for the year ended December 31, 1994. The Company's effective tax rate for these periods differed from the statutory rate due primarily to the amortization of goodwill, state income taxes and the provision for interest on adjustments proposed by the Internal Revenue Service (\"IRS\"). The Company anticipates full realization of its net operating loss carryforward and accordingly no valuation allowance has been provided. See Note D to the Consolidated Financial Statements included herein.\nEXTRAORDINARY ITEM -- LOSS ON EARLY EXTINGUISHMENT OF LONG-TERM OBLIGATIONS\nIn the year ended December 31, 1994, the Company repaid the remaining $85.0 million outstanding balance on its Senior Term Loans. This resulted in an extraordinary item -- loss on early extinguishment of long-term obligations, net of taxes as discussed in Note C to the Consolidated Financial Statements included herein.\nNET EARNINGS (LOSS)\nThe Company had a net loss of $(61.9) million, or $(.69) per share, for the year ended December 31, 1995, compared to net earnings of $16.8 million, or $.18 per share, for the year ended December 31, 1994. The loss for the year ended December 31, 1995 compared to the year ended December 31, 1994, was primarily attributable to the decrease in net sales of $107.9 million, the decrease in gross profit of $79.1 million and increased operating expenses and other charges as discussed above. The results for the year ended December 31, 1994, include an extraordinary loss of $(.9) million, or $(.01) per share, on the early extinguishment of long-term obligations.\nYEAR ENDED DECEMBER 31, 1994 VS. YEAR ENDED DECEMBER 31, 1993\nNET SALES\nFor the year ended December 31, 1994, net sales for the Company increased $79.9 million, or 7.6%, to $1.127 billion from $1.047 billion for the year ended December 31, 1993. Net sales of HSC increased $65.2 million, or 6.8%, for the year ended December 31, 1994, reflecting a 19.5% increase in the number of packages shipped and a 10.2% decrease in the average price per unit sold compared to the year ended December 31, 1993. Promotional price discounts, used to enhance HSC merchandise sales, increased to 2.7% of HSC sales for the year ended December 31, 1994, from 1.8% in 1993. In addition, sales by HSND, which commenced operations during the third quarter of 1994, totaled $13.5 million and sales by the Company's retail outlets increased $6.7 million for the year ended December 31, 1994 compared to the prior year.\nThe increases for the year ended December 31, 1994 were primarily offset by a decline in sales of $6.9 million attributable to the sale of Mistix in the second quarter of 1994.\nThe sales increases for the year ended December 31, 1994 versus 1993, occurred primarily in the first nine months of the year and were the continuation of a trend that began in the latter part of the third quarter of 1993. Management believes that 1994 sales levels were positively affected by several factors, most significantly the addition of new cable subscribers beginning in September 1993 as a result of the \"must carry\" provisions of the cable re-regulation law.\nIn September 1994, the Company appointed senior management personnel with expertise in merchandising. The Company had also instituted procedures intended to improve purchasing and other merchandising practices. Management's emphasis included evaluating new product sources and programs to boost customer loyalty, offering higher quality and a greater variety of products, developing strong private label lines, selling higher margin items and offering name brand merchandise.\nDuring the fourth quarter of 1994, in addition to reorganizing its merchandising and sales practices, the Company continued to significantly restyle its programming. This included new on-air presentations, offering regularly scheduled themed shows, increasing the number of items aired per hour and the display of item numbers which enables a customer to order an item when it is off the air.\nThese changes in merchandising and programming strategy were aimed at long-term improvements in sales by attempting to attract new customers and increase the frequency of sales. However, the impact of these changes was a slowdown in sales, such that consolidated net sales for the quarter ended December 31, 1994 increased only 1.8% over the same period in 1993.\nFor the years ended December 31, 1994 and 1993, HSC's merchandise return percentage remained constant at 24.4%. The return rate continued to be affected by high returns in jewelry and electronics merchandise categories which typically experience higher return rates than other merchandise categories.\nThe following table highlights the changes in the estimated unduplicated television household reach of HSN programming by category for the year ended December 31, 1994:\n- ---------------\n* Households capable of receiving both broadcast and cable transmissions are included under cable.\nCOST OF SALES\nFor the year ended December 31, 1994, cost of sales increased $26.5 million, or 3.7%, to $730.5 million from $704.0 million for the year ended December 31, 1993. As a percentage of net sales, cost of sales decreased to 64.8% from 67.3% compared to year ended December 31, 1993.\nCost of sales of HSC increased $22.5 million for the year ended December 31, 1994. As a percentage of HSC sales, cost of sales decreased to 66.9% from 69.1%, compared to the year ended December 31, 1993. In addition, cost of sales for HSND and the Company's retail outlets for the year ended December 31, 1994, increased $5.0 million and $3.7 million, respectively, compared to the year ended December 31, 1993.\nThe remaining decrease in cost of sales for the year ended December 31, 1994, compared to 1993, was primarily attributable to the sale of Mistix, as discussed in \"Net Sales.\"\nThe decreases in consolidated and HSC's cost of sales percentages in 1994 compared to 1993 relate primarily to an additional $20.1 million adjustment made to HSC's inventory carrying amount, which increased cost of sales in the first quarter of 1993, in connection with a change in management's merchandising philosophy.\nOPERATING EXPENSES\nThe following table highlights the operating expense section from the Company's Consolidated Statements of Operations:\nAs a percentage of net sales, operating expenses decreased to 32.8% from 33.4% compared to year ended December 31, 1993.\nSELLING AND MARKETING\nFor the year ended December 31, 1994, selling and marketing expenses, as a percentage of net sales, increased to 14.4% from 13.2% compared to the year ended December 31, 1993.\nThe major components of selling and marketing expenses are detailed below:\nTelephone, operator and customer service expenses are typically related to sales, call volume and the number of packages shipped, and for the year ended December 31, 1994, compared to the year ended December 31, 1993, these expenses increased as a result of increases in call and package volume.\nFor the year ended December 31, 1994, commissions to cable system operators increased at a higher rate than sales as a result of increased cable system carriage of the Company's programming due to the implementation of the \"must carry\" provisions of the cable re-regulation law.\nMarketing payments for cable advertising, related primarily to previous contractual commitments, decreased for the year ended December 31, 1994, compared to the year ended December 31, 1993.\nSelling and marketing expenses related to HSND totaled $6.7 million for the year ended December 31, 1994. The remaining net increase in selling and marketing expenses was attributable to other advertising and promotional expenses of the Company's other subsidiary operations.\nENGINEERING AND PROGRAMMING\nFor the year ended December 31, 1994, engineering and programming expenses, as a percentage of net sales, decreased to 8.8% from 9.0% compared to the year ended December 31, 1993.\nIncreases in expense related to broadcast affiliates in additional markets totaled $3.7 million compared with the year ended December 31, 1993. In addition, based on sales within the broadcast markets of SKC for the year ended December 31, 1994, the Company incurred additional broadcast commission expense of $1.3 million, compared to the year ended December 31, 1993.\nGENERAL AND ADMINISTRATIVE\nFor the year ended December 31, 1994, general and administrative expenses, as a percentage of net sales, decreased to 7.0% from 8.9% compared to the year ended December 31, 1993.\nFor the year ended December 31, 1994, consulting and stockholder relations expenses decreased $5.3 million, due to expenses incurred in 1993, in connection with a merger proposal by Liberty Media Corporation (\"Liberty\") following the acquisition, in February 1993, of a controlling interest in the Company by a wholly-owned subsidiary of Liberty and the unsolicited merger proposal by QVC, Inc. that was not consummated. Expenses in connection with the Company's executive stock award program, SAR's, settlement of sales tax issues, legal expense, repairs and maintenance and equipment rental decreased $13.8 million for the year ended December 31, 1994, compared to the year ended December 31, 1993. The above decreases were offset by increases for the year ended December 31, 1994, totaling $5.0 million, in payroll expense and other administrative expenses.\nDEPRECIATION AND AMORTIZATION\nFor the year ended December 31, 1994, depreciation and amortization increased $3.9 million due to the amortization of cable distribution fees for the year ended December 31, 1994. The balance of the increase in depreciation and amortization was attributable to capital asset additions during the year ended December 31, 1994.\nOTHER INCOME (EXPENSE)\nFor the year ended December 31, 1994, the Company had net other income of $3.6 million compared to net other expense of $(12.6) million for the year ended December 31, 1993.\nInterest income decreased $4.1 million for the year ended December 31, 1994, compared to the year ended December 31, 1993, due to the repayment by SKC, in August 1994, of its indebtedness to the Company.\nInterest expense decreased $5.4 million for the year ended December 31, 1994, primarily as a result of the repayment by the Company, in August 1994, of its Senior Term Loans.\nFor the year ended December 31, 1994, net miscellaneous expense decreased $2.0 million compared to the year ended December 31, 1993. Net miscellaneous expense for the year ended December 31, 1993 included nonrecurring costs totaling $3.8 million. For the year ended December 31, 1994, net miscellaneous\nexpense included a $(2.9) million loss on the sale of Mistix. In addition, 1994 included the receipt of proceeds from a lawsuit settlement totaling $.8 million.\nNet other expense for the year ended December 31, 1993 also included litigation settlements totaling $13.0 million.\nINCOME TAXES\nThe Company's effective tax rate was an expense of 42.0% for the year ended December 31, 1994 and a benefit of (20.6)% for the year ended December 31, 1993. The Company's effective tax rate for these periods differed from the statutory rate due primarily to the amortization of goodwill and other acquired intangible assets relating to acquisitions from prior years, state income taxes and the provision for interest on adjustments proposed by the IRS, as discussed in Note D to the Consolidated Financial Statements included herein.\nEXTRAORDINARY ITEM -- LOSS ON EARLY EXTINGUISHMENT OF LONG-TERM OBLIGATIONS\nIn the year ended December 31, 1994, the Company repaid the remaining $85.0 million outstanding balance on its Senior Term Loans. In the year ended December 31, 1993, the Company refinanced and retired the remaining $143.3 million of its 11 3\/4% Senior Notes and retired the remaining $16.9 million of its 5 1\/2% Convertible Subordinated Debentures. These transactions resulted in extraordinary items -- loss on early extinguishment of long-term obligations, net of taxes as discussed in Note C to the Consolidated Financial Statements included herein.\nNET EARNINGS (LOSS)\nThe Company had net earnings of $16.8 million, or $.18 per share, for the year ended December 31, 1994, compared to a net loss of $(22.8) million, or $(.26) per share, for the year ended December 31, 1993. The increase in net earnings for the year ended December 31, 1994, was primarily attributable to an increase in net sales of $79.9 million and an increase in gross profit of $53.5 million compared to the year ended December 31, 1993. As discussed in \"Cost of Sales,\" the results for the year ended December 31, 1993, included an additional adjustment of $20.1 million to the inventory carrying amount. The results for the year ended December 31, 1993 were also affected by the litigation settlements of $13.0 million, as discussed in \"Other Income (Expense).\" As previously discussed, the Company recorded a loss of $(2.9) million on the sale of the common stock of Mistix. In addition, the consolidated results for the year ended December 31, 1994 included a pre-tax loss for Mistix of $(1.6) million. Consolidated results also included extraordinary losses, net of taxes, of $(.9) million, or $(.01) per share, for the year ended December 31, 1994, and $(7.2) million, or $(.08) per share, for the year ended December 31, 1993.\nSEASONALITY\nThe Company believes that seasonality does impact its business but not to the same extent it impacts the retail industry in general.\nFINANCIAL POSITION, LIQUIDITY AND CAPITAL RESOURCES\nThe following table highlights various balances and ratios from the Consolidated Financial Statements included herein:\nThe principal source of cash for the year ended December 31, 1995, was borrowings by the Company under its Credit Facility, which were used principally to pay cable distribution fees of $72.1 million, purchase treasury stock, pay litigation settlements of $14.5 million and pay for capital expenditures. The net loss adjusted for non-cash items totaled $(32.2) million for the year ended December 1995.\nThe primary reason for the decrease in accounts and notes receivable is \"FlexPay\" accounts receivable which totaled $13.0 million at December 31, 1995, compared to $23.6 million at December 31, 1994. The Company's financing of \"FlexPay\" accounts receivable has not had a significant impact on its liquidity position. In addition, on March 27, 1995, Precision Systems, Inc. (\"PSi\") repaid $2.7 million, plus accrued interest, of its $5.0 million loan from the Company. Under an agreement between the Company and PSi, the remaining principal balance of the loan was recorded as a prepayment of monthly software maintenance payments due PSi from the Company through December 1995.\nInventories decreased due to promotional sales events held in December 1995 and a $14.5 million increase in HSC's inventory carrying value adjustment primarily related to product which is inconsistent with HSC's new sales and merchandising philosophy. The inventory balance is net of a carrying value adjustment of $33.3 million at December 31, 1995, which represents an increase from $18.8 million at December 31, 1994.\nCapital expenditures for the year ended December 31, 1995, were $13.0 million. The Company estimates capital expenditures will range between $18.0 million and $21.0 million for 1996.\nThe Company's Credit Facility was amended on September 28, 1995 and the maximum borrowing availability was increased from $100.0 million to $150.0 million at that time. On that date, HSN pledged the capital stock of HSC and HSN Realty, Inc. (\"Realty\"), the guarantors of the Credit Facility, to secure the Company's obligation under the Credit Facility. On February 13, 1996, the covenants in the Credit Facility were further amended to include the effect of, among other things, certain of the restructuring and other charges as discussed in Note F to the Consolidated Financial Statements included herein, to allow for additional subordinated financing as discussed in Notes P and R to the Consolidated Financial Statements included herein and, upon conclusion of the additional financing, to reduce the maximum borrowing availability under the Credit Facility to $120.0 million. Restrictions remain on repurchases of the Company's common stock based upon future cash flow levels. On March 1, 1996, the Company completed a private placement of $100.0 million of Convertible Subordinated Debentures due March 1, 2006. The Company used the net proceeds to repay borrowings under the Credit Facility leaving an outstanding loan balance of $30.0 million with $90.0 million available for borrowing. The Company anticipates that it will use its additional borrowing capacity to finance working capital requirements, capital expenditures and general corporate purposes.\nDuring 1996, management expects to pay cable distribution fees, totaling $12.3 million, relating to current contracts with cable system operators to carry HSC programming. Of this amount, $2.3 million is payable to a related party.\nIn July 1995, the Company paid $4.0 million for a 20.0% interest in Body By Jake Enterprises, L.L.C. This investment is accounted for under the cost method.\nIn management's opinion, available cash, internally generated funds and the Credit Facility will provide sufficient capital resources to meet the Company's foreseeable needs.\nAs of February 29, 1996, the Company had a $25.0 million committed bank credit line collateralized by the capital stock of HSC and Realty. In addition, the Company had an additional uncommitted unsecured bank credit line offered on a conditional basis. These credit lines back letters of credit which are used exclusively to facilitate the purchase of imported inventory. Presentation of letters of credit by vendors results in an immediate charge to the Company's account with no interest charges incurred. Outstanding letters of credit, which cannot exceed $25.0 million in total in accordance with the Credit Facility, amounted to $11.6 million at February 29, 1996, on the committed and uncommitted lines, leaving $13.4 million available.\nFor the year ended December 31, 1995, the Company did not pay any cash dividends and does not anticipate paying cash dividends in the immediate future.\nIn 1994, the Company's Board of Directors authorized the repurchase of up to an additional $75.0 million of the Company's common stock. In 1994, the Company repurchased 1.3 million shares at a total cost of $13.1 million and in the quarter ended March 31, 1995, the Company repurchased an additional 2.6 million shares at a total additional cost of $21.6 million. Under the terms of the Credit Facility the Company is restricted from purchasing its common stock until it meets certain cash flow ratios.\nNEW ACCOUNTING PRONOUNCEMENTS\nIn October 1995, the Financial Accounting Standards Board (\"FASB\") issued Statement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation\" (\"FAS 123\") effective for transactions entered into after December 15, 1995. FAS 123 provides alternatives for the methods used by entities to record compensation expense associated with its stock-based compensation plans. Additionally, FAS 123 provides further guidance on the disclosure requirements relating to stock-based compensation plans. Management believes that the adoption of FAS 123 will not have a material impact on the financial condition or the results of operations of the Company.\nITEM 8","section_7A":"","section_8":"ITEM 8 -- CONSOLIDATED FINANCIAL STATEMENTS\nINDEPENDENT AUDITORS' REPORT\nHOME SHOPPING NETWORK, INC. AND SUBSIDIARIES\nTHE BOARD OF DIRECTORS HOME SHOPPING NETWORK, INC.\nWe have audited the accompanying consolidated balance sheets of Home Shopping Network, Inc. and subsidiaries as of December 31, 1995 and 1994 and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the years in the three year period ended December 31, 1995. 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 Home Shopping Network, Inc. and subsidiaries as of December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the years in the three year period ended December 31, 1995 in conformity with generally accepted accounting principles.\n\/s\/ KPMG PEAT MARWICK LLP St. Petersburg, Florida February 21, 1996\nHOME SHOPPING NETWORK, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\nThe accompanying Notes to Consolidated Financial Statements are an integral part of these statements.\nHOME SHOPPING NETWORK, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF OPERATIONS\nThe accompanying Notes to Consolidated Financial Statements are an integral part of these statements.\nHOME SHOPPING NETWORK, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY\nThe accompanying Notes to Consolidated Financial Statements are an integral part of these statements.\nHOME SHOPPING NETWORK, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nThe accompanying Notes to Consolidated Financial Statements are an integral part of these statements.\nHOME SHOPPING NETWORK, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE A -- ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nHome Shopping Network, Inc. (the \"Company\" or \"HSN\") is a holding company, the subsidiaries of which conduct the day-to-day operations of the Company's various business activities. The Company's primary business is electronic retailing conducted by Home Shopping Club, Inc. (\"HSC\"), a wholly-owned subsidiary of the Company.\nThe following is a summary of the significant accounting policies of the Company consistently applied in the preparation of the accompanying consolidated financial statements.\n1. CONSOLIDATION\nThe consolidated financial statements include the accounts of the Company and all wholly-owned subsidiaries. All significant intercompany transactions and accounts have been eliminated.\n2. CASH AND CASH EQUIVALENTS\nFor purposes of reporting cash flows, cash and cash equivalents include cash and short-term investments. Short-term investments consist primarily of U.S. Treasury Securities, auction preferred shares, U.S. Government agencies and certificates of deposit with original maturities of less than 91 days.\n3. ACCOUNTS AND NOTES RECEIVABLE\nHSN has a sales program with a deferred payment arrangement, \"FlexPay\", which allows customers to charge their purchases to third party credit cards in installments, generally over three consecutive months. FlexPay receivables totaled $13,015,000 and $23,621,000 at December 31, 1995 and 1994, respectively. At December 31, 1994 accounts and notes receivable included $3,000,000 due from a former chairman of the Company's Board of Directors and a $5,000,000 note receivable from a former wholly-owned subsidiary, Precision Systems, Inc. (\"PSi\").\n4. INVENTORIES, NET\nMerchandise inventories are valued at the lower of cost or market, cost being determined using the first-in, first-out method. Cost includes freight, certain warehousing costs and other allocable overhead. Market is determined on the basis of net realizable value, giving consideration to obsolescence and other factors. Inventories are presented net of an inventory carrying adjustment of $33,259,000 and $18,791,000 at December 31, 1995 and 1994, respectively.\n5. PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment, including significant improvements, are recorded at cost. Repairs and maintenance and any gains or losses on dispositions are included in operations.\nDepreciation and amortization are provided on a straight-line basis to allocate the cost of depreciable assets to operations over their estimated service lives as follows:\nHOME SHOPPING NETWORK, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nDepreciation and amortization expense on property, plant and equipment was $20,452,000, $22,540,000 and $21,911,000 for the years ended December 31, 1995, 1994 and 1993, respectively.\nFor income tax purposes, certain assets are depreciated using allowable accelerated methods which result in different depreciation amounts than would be calculated for financial statement purposes.\n6. CABLE DISTRIBUTION FEES, NET\nThe Company pays upfront fees for long-term cable contracts for carriage of the Company's programming. These fees are amortized to expense on a straight-line basis, over the terms of the respective contracts which range from 5 to 15 years. Amortization expense for cable distribution fees for the years ended December 31, 1995 and 1994 was $12,692,000 and $3,893,000, respectively. Accumulated amortization as of December 31, 1995 and 1994 was $16,585,000 and $3,893,000, respectively.\nThe Company periodically analyzes the value of its cable distribution fees to determine if an impairment has occurred. The Company measures the potential impairment of recorded cable distribution fees by the undiscounted value of expected future operating cash flows in relation to its net capital investment. Based on its analysis, the Company does not believe that an impairment of its cable distribution fees has occurred.\n7. OTHER NON-CURRENT ASSETS\nOther non-current assets consists primarily of goodwill which is recorded at cost and amortized on a straight-line basis over its economic life, primarily three years. In connection with the purchase of Internet Software, Inc. (\"ISN\") during 1994, as discussed in Note E, goodwill increased by $5,239,000.\nAmortization expense for other non-current assets was $5,710,000, $2,633,000 and $2,261,000 for the years ended December 31, 1995, 1994 and 1993, respectively. The increase in amortization expense during 1995 was related to the sale of name lists for Ortho-Vent, Inc. (\"Ortho-Vent\"), one of the Company's mail order subsidiaries, as discussed below and in Note F.\nCosts in connection with mailing lists developed for the Company's direct response advertising business are amortized over a two year period. The total amount of direct response advertising included in amortization expense for the years ended December 31, 1995, 1994, and 1993, was $3,868,000, $1,982,000, and $1,988,000, respectively. Due to the sale of the Ortho-Vent assets, the Company no longer incurs these costs and all previously capitalized amounts were written-off in 1995. All non-direct response advertising is expensed in the period incurred.\n8. NET SALES\nRevenues include merchandise sales and shipping and handling revenues, and are reduced by incentive discounts and sales returns to arrive at net sales. Revenues are recorded for credit card sales upon transaction authorization, and for check sales upon receipt of customer payment, which does not vary significantly from the time goods are shipped. The Company's sales policy allows merchandise to be returned at the customer's discretion, generally up to 30 days. An allowance for returned merchandise is provided based upon past experience.\n9. INCOME TAXES\nThe Company accounts for income taxes pursuant to Statement of Financial Accounting Standards No. 109 \"Accounting for Income Taxes\" (\"Statement 109\"). Under 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 in effect for the year in which those temporary differences\nHOME SHOPPING NETWORK, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nare 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.\n10. EARNINGS (LOSS) PER SHARE\nPrimary earnings (loss) per common share is based on net earnings (loss) divided by the weighted average number of common shares outstanding giving effect to stock options and convertible debt, when dilutive. Fully diluted earnings per share is not materially different from primary earnings per share in any period presented.\nThe weighted average number of common shares outstanding was 90,782,000, 95,061,000 and 91,192,000 for the years ended December 31, 1995, 1994 and 1993, respectively.\n11. RECLASSIFICATIONS\nCertain amounts in the prior year's consolidated financial statements have been reclassified to conform to the 1995 presentation.\nNOTE B -- LONG-TERM INVESTMENTS\nIn July 1995, the Company paid $4,000,000 for a 20% interest in Body By Jake Enterprises, L.L.C. (\"BBJ\"). This investment is accounted for under the cost method. Simultaneously, the Company entered into a long-term joint marketing agreement with BBJ to provide for the sale and promotion of merchandise through HSC and other distribution channels.\nThe Company has a $10,000,000 investment consisting of 100,000 shares of Series A non-voting preferred stock, $.01 par value, with a liquidation preference of $100 per share, in The National Registry Inc. (\"NRI\"), which is accounted for under the cost method. This investment is convertible into 6,336,154 shares of NRI common stock at the Company's option, however, conversion to common stock is automatic in the event that cumulative gross revenues for NRI reach $15,000,000. At December 31, 1995, one of the Company's executive officers served as a director of NRI. J. Anthony Forstmann, a director of the Company, is Chairman of NRI and had voting rights with respect to 28.3% of NRI's common stock as of December 31, 1995.\nNOTE C -- LONG-TERM OBLIGATIONS AND CREDIT FACILITIES\nHOME SHOPPING NETWORK, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nAggregate contractual maturities of long-term obligations are as follows:\nThe Company's Credit Facility was amended on September 28, 1995 and the maximum borrowing availability was increased from $100,000,000 to $150,000,000 at that time. On that date, HSN pledged the stock of HSC and HSN Realty, Inc. (\"Realty\"), the guarantors of the Credit Facility, to secure the Company's obligation under the Credit Facility. On February 13, 1996, the covenants in the Credit Facility were further amended to include the effect of, among other things, certain of the restructuring and other charges as discussed in Note F and to allow for additional subordinated financing as discussed in Note P. The Credit Facility has yearly extension options beyond April 1997, if requested by the Company, subject to approval of the participating banks. Under the Credit Facility, the interest rate on borrowings is tied to the LIBOR, Federal Funds Rate, or Prime Rate, at the Company's option, plus an applicable margin. Commitment fee payments relating to the Credit Facility totaled $2,720,000 and $170,000, respectively, during 1995 and 1994. The unamortized commitment fee balance of $1,170,000 at December 31, 1995 is being amortized over the expected remaining life of the agreement.\nRestrictions contained in the Credit Facility include, but are not limited to, limitations on the encumbrance and disposition of assets, certain restrictions on repurchases of the Company's common stock and the maintenance of various financial covenants and ratios.\nThe Company also has a $25,000,000 committed bank credit line secured by the capital stock of HSC and Realty. In addition, the Company has an uncommitted unsecured bank credit line offered on a conditional basis. On February 13, 1996, the committed bank credit line was amended on the same terms as the Credit Facility discussed above. These facilities back letters of credit, used exclusively to facilitate the purchase of imported inventory. Presentation of letters of credit by vendors results in an immediate charge to the Company's account with no interest charges incurred. Outstanding letters of credit are limited to a total of $25,000,000 at any time, under the terms of the Credit Facility. At December 31, 1995, outstanding letters of credit amounted to $14,052,000 leaving $10,948,000 of these bank credit lines available.\nThe Company recognized extraordinary losses on the early extinguishment of its long-term obligations as follows:\nThere was no early extinguishment of long-term obligations during the year ended December 31, 1995.\nHOME SHOPPING NETWORK, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE D -- INCOME TAXES\nA reconciliation of total income tax expense (benefit) to the amounts computed by applying the statutory federal income tax rate to earnings (loss) before income tax expense (benefit) and extraordinary item is shown as follows:\nThe Company's effective tax expense (benefit) rate was (35.0)% for 1995, 42.0% for 1994; and (20.6)% for 1993.\nThe components of income tax expense (benefit) attributable to operations are as follows:\nDuring the years ended December 31, 1994 and 1993, the Company recorded an extraordinary item, loss on early extinguishment of long-term obligations, net of the income tax effect. See Note C.\nHOME SHOPPING NETWORK, 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 are presented below:\nThe Company had taxable income (loss) and pre-tax book income (loss) for the periods presented as follows:\nThe primary differences between taxable income (loss) and pre-tax book income (loss) are the gross effects of the deferred income taxes, exclusive of the net operating loss carry over as detailed above. In addition to these reconciling items, the Company recognized income tax deductions relating to the issuance of common stock pursuant to the Company's executive stock award program and the exercise of stock options (\"Common Stock Deductions\"), the income tax benefit of which was recorded as an increase to additional\nHOME SHOPPING NETWORK, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\npaid-in capital. During the years ended December 31, 1995, 1994 and 1993, the Company incurred Common Stock Deductions of $1,445,000, $7,308,000 and $31,697,000, respectively.\nExcept for the effects of the reversal of net deductible temporary differences and the effects of future Common Stock Deductions, the Company is not currently aware of any factors which would cause any significant differences between taxable income and pre-tax book income in future years. There can be no assurances that there will not be significant differences in the future between taxable income and pre-tax book income if circumstances change (for example, changes in tax laws or the Company's financial condition or performance).\nDuring 1995, the Company incurred a tax loss of $72,849,000. The Company will carryback $8,900,000 to prior taxable years to obtain an income tax refund. The remaining tax loss of $63,949,000 will be carried forward and will expire on December 31, 2010. Management believes that it will generate future taxable income sufficient to realize this tax benefit prior to its expiration. New management, which has substantial experience in the television retail business, has been appointed and is establishing a new direction for the Company intended to reverse operating losses experienced in 1995. The Company's plans are to provide a proper inventory mix with respect to product assortment and price point that attracts both first-time buyers and active buyers, and improved inventory management.\nManagement of the Company believes that through minimal growth in net sales, calculated at cost of living increases of 3.5%, cost reduction measures implemented during late 1995 and early 1996, and further anticipated reductions resulting from expected capital expenditures, that both the net operating loss carryforwards of $63,949,000 and a substantial portion of other deferred tax assets presented above will be recovered within a three-year period. Accordingly, the Company has recognized an asset related to these carryforward and no valuation allowance has been provided. There can be no assurance, however, that the Company will generate any earnings or any specific level of continuing earnings in order to allow the Company to realize the benefits of the net operating loss carryforward or other deferred tax assets.\nDuring 1994, the IRS completed its examination of the Company's federal income tax returns for fiscal years 1986 through 1989 and proposed various adjustments. The Company and the IRS agreed to settle all of the outstanding issues with the exception of the deductibility of royalty payments made to a then related party. The Company paid the assessments, totaling $15,000,000 including interest, related to all the issues except the royalty payments covering all taxable periods through August 31, 1993. These assessments had previously been accrued.\nAlso in 1994, the IRS issued a Statutory Notice of Deficiency for fiscal years 1986 through 1989 related to the royalty payments issue. The Company paid the assessments, totaling $4,600,000 including interest, which had previously been accrued. The Company continues to maintain that it has meritorious positions regarding the deductibility of these payments and will file a refund claim with the IRS during 1996.\nOn May 12, 1995, the IRS completed its examination of the Company's federal income tax returns for fiscal years 1990 and 1991, and proposed adjustments resulting in income tax and interest deficiencies of $4,200,000, primarily related to the royalty payments issue. On October 31, 1995, the Company and the IRS agreed to settle all of the outstanding issues, except the royalty payments issue, and the Company paid the resulting assessment of $1,100,000, including interest. These assessments had previously been accrued. The Company has not yet received a Statutory Notice of Deficiency relating to the royalty payments issue. The Company will protest such assessment when received.\nThe Company also made such royalty payments during fiscal years 1992 through 1993. The deductibility of these payments will also be challenged by the IRS upon audit. The Company has made adequate provision for this issue for these years.\nHOME SHOPPING NETWORK, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nThe Company's federal income tax returns for fiscal years 1992, 1993 and 1994 are currently under examination by the IRS. No proposed material adjustments relating to such years, other than those discussed above, have been brought to management's attention.\nNOTE E -- BUSINESS COMBINATION\nOn September 1, 1994, a wholly-owned subsidiary of the Company purchased all the outstanding shares of ISN for cash of $2,097,000 and notes payable of $2,903,000, see Note C, for a total of $5,000,000. The purchase method of accounting was used to account for this business combination. Goodwill acquired in connection with this transaction is being amortized over three years.\nConsolidated results of operations for the year ended December 31, 1994 include the results of ISN from its acquisition date. The results of operations prior to the date of acquisition, were not significant to the Company's consolidated results of operations and therefore pro forma effects are not presented.\nNOTE F -- OTHER CHARGES AND RESTRUCTURING CHARGES\nDuring 1995, the Company recorded $42,340,000 in pre-tax special charges.\nIn connection with new management's sales and merchandising philosophy an overall analysis of the Company's inventory was conducted and determined that certain merchandise was not compatible with this new philosophy. As a result, such merchandise will be liquidated through other than the Company's normal retailing channels. Accordingly, management increased the Company's inventory carrying value adjustment by $12,077,000 to $33,259,000 at December 31, 1995 to reflect the net realizable value of the Company's inventory.\nDuring 1995, the Company recorded $11,893,000 in \"Other Charges.\" These consisted of severance pay of $3,978,000 related to a reduction in work force, $4,800,000 of payments to certain executives as provided for under their employment agreements in connection with the termination of their employment and the write-off of certain equipment maintenance and contractual fees totaling $1,812,000 related to service contracts which the Company will no longer utilize. In addition, the Company recorded a write-down of inventory totaling $1,303,000 to net realizable value based on the disposition of Ortho-Vent's assets. An additional $2,400,000, related to name lists of Ortho-Vent were written off and included in \"Depreciation and Amortization.\"\nDuring 1995 the Company recorded restructuring charges of $4,114,000 covering employee and other costs related to the closing of its fulfillment center in Reno, Nevada. The facility was closed by June 30, 1995. During 1995, payments totaling $1,214,000 were made related to this charge leaving $2,900,000 accrued for future charges, at December 31, 1995.\nInterest expense includes $773,000 of bank fees related to the Company's Credit Facility which have been amortized based on the Company's intent to seek refinancing of this debt prior to its contractual maturity. Miscellaneous expense includes the write-down of computer equipment no longer in use with a net book value of $4,700,000.\nEstimated costs related to pending and settled litigation for the year ended December 31, 1995 totaled $6,383,000.\nNOTE G -- EMPLOYEE BENEFIT PLANS\nThe Company offers a plan pursuant to Section 401(k) of the Internal Revenue Code covering substantially all full-time employees. Matching employer contributions are set at the discretion of the Board of Directors. The Company's contributions for the years ended December 31, 1995, 1994 and 1993 were $864,000, $824,000 and $667,000, respectively.\nHOME SHOPPING NETWORK, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nOn December 28, 1994, the Board of Directors adopted the Home Shopping Network, Inc. Employee Equity Participation Plan (the \"Equity Plan\"), effective December 31, 1994. In January 1996, the Company received a favorable determination letter stating that the Equity Plan is a qualified plan for IRS purposes.\nThe Equity Plan covers all employees who have completed one year of service, at least 1,000 hours of service during that year, are at least 21 years of age, are not highly compensated, and do not hold options to purchase shares of HSN common stock.\nThe Company contributed $5,000,000 which was used to purchase a total of 499,000 shares of common stock in 1994 and 1995 to fund the Equity Plan. Employees who met the eligibility requirements on December 31, 1994 and June 30, 1995, will receive grants under the Equity Plan. The stock vests ratably at 20% a year with the first vesting being effective as of the calendar year in which the eligible employee has worked at least 1,000 hours. The Board of Directors have not made the decision regarding any additional grants for any period subsequent to June 30, 1995. The common stock in the Equity Plan is included in the weighted average number of shares for the Company's earnings per share calculation.\nThe common stock when purchased was recorded as unearned compensation. For the years ended December 31, 1995 and 1994, $1,020,000 and $810,000, respectively, has been charged to expense based on the shares authorized for granting and the vesting schedule discussed above. The fair value of the shares which were unvested and as yet not authorized for grants at December 31, 1995 is $2,858,000. Any future contributions to the Equity Plan will be subject to the Board of Directors' approval.\nNOTE H -- COMMITMENTS AND CONTINGENCIES\nThe Company leases satellite transponders, computers, warehouse and office space used in connection with its operations under various operating leases.\nFuture minimum payments under non-cancellable operating leases are as follows:\nRent and lease expenses charged to operations were $13,263,000, $13,978,000 and $15,185,000 for the years ended December 31, 1995, 1994 and 1993, respectively.\nDuring June 1995, in connection with the restructuring of its programming the Company discontinued use of a satellite transponder which is under a non-cancellable operating lease calling for monthly payments ranging from $140,000 to $150,000 through December 2006. The Company subleased this satellite transponder to a related party during 1995, as discussed in Note M. The sublease expired on February 15, 1996, and the Company is currently seeking to sublease the transponder or to sell its rights with respect to this satellite transponder. The Company does not expect any material adverse financial impact in connection with the lease.\nOn December 28, 1992, HSC entered into affiliation agreements with Silver King Communications, Inc. (\"SKC\") which provide for SKC's broadcast television stations to air HSC programming on a full-time basis. The agreements have an original term of five years, and are renewable for two successive five year terms at\nHOME SHOPPING NETWORK, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nSKC's sole option. The affiliation agreements are cancelable by SKC with eighteen months' written notice prior to the end of any scheduled term. The notice period of non-renewal of the first term is scheduled to end on June 28, 1996, but is being extended by mutual agreement between SKC and the Company to December 28, 1996. HSC pays an affiliation fee to SKC based on hourly rates and, upon reaching certain sales levels, commissions on net sales. Expense related to affiliation agreements with SKC for the years ended December 31, 1995, 1994 and 1993, was $41,332,000, $42,415,000 and $41,135,000, respectively, of which $778,000, $1,865,000 and $996,000, respectively, represents commissions.\nIn December 1995, the Company entered into a four-year employment agreement with the Company's Executive Vice President of Administration, which is automatically renewable for successive one-year terms unless either party provides at least 180 days' written notice. The employment agreement provides for an annual base salary of $235,000 per annum until December 1999, a signing bonus of $50,000, and options to purchase 50,000 shares of the Company's common stock at $8.50 per share. These options were granted under the terms of the 1996 Stock Option Plan for Employees (\"1996 Employee Plan\"), which plan is subject to shareholder approval. See Note L.\nIn November 1995, the Company entered into a four-year employment agreement with the Company's President, which is automatically renewable for successive one-year terms unless either party provides at least 180 days' written notice. The employment agreement provides for an annual base salary of not less than $500,000 and a $1,000,000 loan, evidenced by a note, bearing interest at 5.00% per annum, with only interest, payable monthly. The loan will be used for the purchase or renovation of a residence and will be secured by this property. The note, which has not yet been drawn against, will be due upon the first anniversary of the termination of the President. The employment agreement also provides options to purchase 2,500,000 shares of the Company's common stock at $8.50 per share. These options were granted under the terms of the 1996 Employee Plan, which plan is subject to shareholder approval. See Note L.\nIn September 1994, the Company entered into a three-year employment agreement with its General Counsel which is automatically renewable for successive one-year terms unless either party provides written notice by April 30 in any year. The agreement calls for an annual base salary of at least $225,000 per year until August 1997 and options to purchase 100,000 shares of the Company's common stock at $11.75 per share under the terms of the 1986 Stock Option Plan for Employees.\nTermination of the above employment agreements by the Company other than for cause will result in payment of the annual base salary amounts that would have been payable had employment continued until the expiration of the employment terms plus any annual bonus for the year of termination. In addition, termination of employment following a change in control of the Company may result in entitlement to all unpaid compensation and other benefits through the term of the contracts.\nOn August 11, 1993 a former Chairman of the Board of the Company, upon his resignation, commenced a five-year consultancy and non-competition arrangement with the Company during which period he receives $500,000 per year.\nThe Company has entered into an amended five year agreement for inbound 800 service usage with MCI Telecommunications Corporation (\"MCI\") ending in August 2000 which requires minimum annual payments of $9,600,000. If the Company terminates the agreement for reasons other than cause, payment of 50% of the aggregate of the minimum amounts for the remainder of the unexpired term will be due 30 days after the termination. The Company's payments to MCI for phone services during the years ended December 31, 1995 and 1994 substantially exceeded the above mentioned minimum.\nIn addition, the Company has entered into an agreement with MCI covering equipment maintenance for a term from April 1, 1996 through April 1, 2001, requiring minimum annual payments of $2,676,000. Upon payment of $13,380,000 under the terms of the contract, the Company is no longer required to pay any fees for these services. The Company will receive a credit for any annual fees over $3,211,000.\nHOME SHOPPING NETWORK, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE I -- LITIGATION\nThe Company has reached an agreement to settle a consolidated class action pending in the Court of Common Pleas of Bucks County, Pennsylvania, relating to the Company's pricing practices with respect to diamond and imitation diamond jewelry sold to Pennsylvania residents between December 27, 1984 and May 20, 1991. Under the proposed settlement, customers who present adequate proof of purchase of cubic zirconia or diamond jewelry during the class period will have the option of receiving a cash payment or a discount certificate usable for the purchase of HSN merchandise during the following twelve months. The maximum cash payment required from the Company with respect to all costs relating to the settlement is $2,500,000. The Company will be entitled to a refund of any balance not used for these purposes. If certificates representing a maximum discount of more than $5,200,000 would be issuable under the settlement, the Company has the right to require that the certificates be pro-rated among those who elect to receive them. The settlement is subject to approval by the Court after notice and hearing.\nThe Company believes it has accrued a balance sufficient to cover anticipated costs in connection with the resolution of this and other pending litigation.\nDuring 1995, the Company paid $14,450,000 relating to litigation settlements accrued in 1993.\nThe Company is also involved in various other lawsuits either as plaintiff or defendant. In the opinion of management, the ultimate outcome of these various lawsuits should not have a material impact on the Company's liquidity, results of operations or financial condition.\nNOTE J -- STOCKHOLDERS' EQUITY\nThe holders of both classes of the Company's common stock are entitled to receive ratably such dividends, if any, as may be declared by the Board of Directors out of funds legally available for the payment of dividends. In the event of the liquidation, dissolution or winding up of the Company, the holders of both classes of common stock are entitled to share ratably in all assets of the Company remaining after provision for payment of liabilities. Shares of Class B common stock are convertible at the option of the sole holder, Liberty Media Corporation (\"Liberty\"), a wholly-owned subsidiary of Tele-Communications, Inc. (\"TCI\"), into shares of common stock of the Company on a share-for-share basis. In the event of conversion of the Class B common stock, the Class B shares so converted will be retired and not subject to reissue.\nThe holder of the Class B common stock votes together with the holders of common stock on all matters submitted to stockholders, except that it has no vote in the election of 25% of the Board of Directors. The holder of the Class B common stock is entitled to cast ten votes per share on all other matters.\nAs of December 31, 1995, Liberty's beneficial ownership and voting rights were 41.4% and 80.4%, respectively.\nNOTE K -- ANTICIPATED CHANGE IN CONTROL\nIn November 1995, Liberty and the new Chairman of the Company's Board of Directors (the \"Chairman\"), entered into an agreement, which related to, among other things, SKC's acquisition of control of the Company through the transfer to SKC of the common stock and Class B common stock owned by Liberty (\"Company Shares\"). Pursuant to the agreement between the Chairman and Liberty and certain other agreements entered into at such time, SKC would acquire the Company Shares (which shares represent a majority of the voting power of the outstanding equity securities of the Company) in exchange for additional shares of SKC's common stock and Class B stock. If such transactions are consummated, the Chairman, who became Chairman of the Board and Chief Executive Officer of SKC in August 1995 and acquired a significant number of options to acquire SKC common stock at such time, would also control securities of SKC representing a majority of the outstanding voting power of that entity. In addition, in connection with such\nHOME SHOPPING NETWORK, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\ntransfer of the Company Shares, TCI would acquire beneficial ownership of a substantial additional equity interest in SKC and, through such ownership of SKC securities, would continue to have a substantial equity interest in the Company.\nThe consummation of each of the foregoing transactions is subject to the satisfaction of certain conditions, including, but not limited to, receipt of FCC approval, and approval of transaction in which it is to acquire the Company Shares by the stockholders of SKC. In addition, SKC's acquisition of control of the Company referred to above, will constitute a \"change in control\" of the Company which will require an amendment to the Credit Facility. See Note P. There can be no assurance that the transactions described above will be consummated.\nNOTE L -- STOCK OPTIONS AND AWARDS\nThe Company has granted options to purchase common stock under option plans as follows:\nThe Board of Directors authorized the issuance of a total of 18,700,000 shares for the 1996 Employee Plan and the 1996 Stock Option Plan for Directors (\"1996 Director Plan\"), subject to shareholder approval at the Company's annual meeting of shareholders.\nThe 1996 Employee Plan provides for the grant of options to purchase common stock at fair market value, subject to the discretion of the Compensation\/Benefits Committee of the Board of Directors, as of the date of grant. The options vest annually and equally over five years, unless otherwise specified by the Compensation\/Benefits Committee of the Board of Directors, beginning one year from the date of grant, and expire ten years from the date of grant. During 1995, the Company granted options for 15,950,000 shares which vests over a four year period of which 13,400,000 were to the Chairman of the Board, 2,500,000 were to the new President and Chief Executive Officer, and 50,000 were to the Executive Vice President of Administration, all at $8.50 per share.\nThe 1996 Director Plan provides for issuance of options to outside directors. Options for 5,000 shares of common stock are automatically granted upon appointment to the Board of Directors, and options for an additional 5,000 shares are granted annually thereafter. Options provide for purchase at fair market value on the date of grant, vest over three years, and expire five years from the date of vesting.\nThe 1987 Cable Operators Stock Option Plan, as amended, provided for the issuance of options to purchase common stock at or above the fair market value at the date of grant in exchange for entering into affiliation agreements to carry the Company's programming for up to seven years. All outstanding options were exercised or cancelled on or before June 1, 1994. The price of these options ranged between $5.56 and $6.49.\nThe 1986 Stock Option Plan for Employees, as amended, provides for the grant of options to purchase common stock at the fair market value at date of grant. The options generally vest annually and equally over five years beginning one year from the date of grant, and expire ten years from the date of grant.\nThe 1986 Stock Option Plan for Outside Directors, as amended, provides for the grant of options to purchase common stock at fair market value as of the date of grant. The options vest equally over two years beginning on the date of grant and expire five years from the date they vest. During 1992, the Board of Directors and shareholders approved certain amendments to the plan. The amendments provide for additional option grants after five years of service and, in addition, the number of shares of common stock subject to option under the plan was increased to 1,630,000 shares.\nHOME SHOPPING NETWORK, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nA summary of changes in outstanding options under the stock option plans except for the 1996 Employee Plan and the 1996 Director Plan, which are subject to shareholder approval, as discussed above, is as follows:\nDuring the year ended December 31, 1995, 165,050 shares of common stock were issued in connection with the exercise of stock options for which the Company received $903,000 in cash.\nIn October 1990, the Company adopted the 1990 Executive Stock Award Program (the \"Program\") pursuant to which 2,990,000 shares of common stock were granted to certain key employees and consultants. The Program was funded exclusively by the contribution of shares of common stock owned by a former chairman of the board and a former president of the Company. The Company did not issue any additional shares of stock in connection with the Program. The shares granted under the Program are distributed in five equal annual installments commencing one year from the grant date. Participants in the Program are entitled to receive dividends, if declared, on their unvested shares and certain officers are entitled to voting rights with respect to their unvested shares. Forfeitures are reissued at the discretion of the Compensation\/Benefits Committee of the Board of Directors.\nUnder this Program and another award of stock, the amount amortized and expensed relating to the compensation earned was $795,000, $2,047,000, and $5,615,000 for the years ended December 31, 1995, 1994 and 1993, respectively.\nIn 1993, the former president and chief executive officer of HSN received SAR's with respect to 984,876 shares of the Company's common stock at an exercise price of $8.25 per share. The SAR's vested upon termination of his employment and were exercised during September 1995, at $10.13 per share. Compensation expense (benefit) recognized by the Company for the SAR's during the years ended December 31, 1995, 1994 and 1993 was ($758,000), ($1,547,000) and $2,834,000, respectively. In addition, $1,345,000 of expense related to the exercise of these SAR's is included in \"Other Charges.\"\nHOME SHOPPING NETWORK, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE M -- RELATED PARTY TRANSACTIONS\nCurrently, the Company is involved in several agreements with related parties and has made payments to those related parties as follows.\nEffective August 25, 1995 the Chairman and Chief Executive Officer of SKC was appointed to the Company's board of directors and was appointed Chairman of the Company's Board of Directors effective November 27, 1995. The Company has affiliation agreements with SKC for which the Company paid $42,651,000 in 1995. See Note H.\nHSC has entered into affiliation agreements with cable operators which are wholly or partially owned by TCI. In addition, certain officers of Liberty and TCI served, or continue to serve, on the Company's Board of Directors. The managing general partner of certain cable systems which carry the Company's programming, was appointed to HSN's Board of Directors in July 1993. TCI also has an ownership interest in these cable systems. Payments to the above related parties for cable commissions and advertising were $7,150,000, $7,269,000, and $4,300,000 for the years ended December 31, 1995, 1994 and 1993, respectively. Cable distribution fees paid to related parties were $28,715,000 and $8,673,000 for the years ended December 31, 1995 and 1994, respectively. Additional commitments for cable distribution fees to related parties totaled $1,630,000 at December 31, 1995. In addition, the Company received $896,000 in payments for rental of a satellite transponder during 1995 from a wholly owned subsidiary of TCI.\nOn April 28, 1992, the Company purchased 100,000 shares of Series A Preferred Stock of NRI. Pursuant to the purchase of these shares, HSN provides office space to NRI beginning in 1993. The Company charged NRI $68,000 and $65,000, respectively, for rent during the years ended December 31, 1995 and 1994. The Chairman and Chief Executive Officer of NRI was appointed to the Board of Directors of the Company on April 30, 1992. At December 31, 1995, one of the Company's executive officers served as a director of NRI. See Notes B and Q.\nPrior to 1994, the Company received a variety of products and services from entities related through common ownership and management with the former Chairman of the Company's Board of Directors and his immediate family members. These transactions were considered related party transactions until the resignation of the former Chairman of the Company's Board of Directors in August 1993. Subsequent to his resignation, these transactions are no longer considered related party, but are included for disclosure purposes for periods prior to January 1, 1994. Transactions with these entities are summarized as follows:\n1. COMPUTER SOFTWARE LICENSE AGREEMENT: In 1985, the Company entered into a license agreement for computer software with Pioneer Data Processing, Inc., which provided for continuing monthly payments of 1% of HSC's gross profit, as defined. The amount expensed in connection with this agreement was $297,000 for the year ended December 31, 1993.\n2. COMMISSIONS ON INVENTORY: Certain inventory in the form of returned merchandise, rejects and small lot saleable inventory were disposed of through Western Hemisphere, Inc. (\"Western\") for a 15% commission. Sales by the related party were less than 1% of total sales. The Company also provided certain equipment and space located at or in close proximity to each of the Company's four fulfillment centers, free of charge. The Company terminated this arrangement in 1993. Commissions were $561,000 for the year ended December 31, 1993.\nAs of December 31, 1994 and 1993, the Company had a $4,500,000 liability recorded to Western which was paid during 1995. This amount related to cancellation of the computer software license agreement pursuant to which Western provided certain liquidation and related services, as noted above, and all other existing agreements and arrangements excluding certain assignment, secrecy and non-compete agreements. In connection with this and other litigation settlements, the former chairman of the Company's board of directors\nHOME SHOPPING NETWORK, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\npaid HSN $3,000,000 during 1995. This amount was recorded in accounts and notes receivable, as of December 31, 1994.\nThe Company purchased certain equipment from PSi and paid license and system maintenance fees related to this equipment of $1,316,000 and $3,545,000, respectively, for the year ended December 31, 1993. The former chairman of HSN owns a controlling position in PSi's outstanding stock. Until August 1993, HSN and PSi also shared a common board member, and officer. Subsequent to August 11, 1993, PSi is no longer considered a related party due to the resignation of certain members of PSi's board of directors, and the resignation of a former chairman of the board of the Company.\nNOTE N -- CONSOLIDATED STATEMENTS OF CASH FLOWS\nSupplemental disclosure of cash flow information:\nSupplemental information of non-cash investing and financing activities:\n- - During 1995 and 1994, the Company purchased 1,335,000 and 2,545,000 shares, respectively, of treasury stock for which the Company paid $34,691,000 in 1995.\n- - During the year ended December 31, 1993, $15,000 of the Company's 5 1\/2% Convertible Subordinated Debentures were converted into 2,293 shares of common stock.\n- - As discussed in Note E, in connection with the purchase of ISN, the Company issued notes payable totaling $2,903,000.\n- - During the years ended December 31, 1994 and 1993, RMS converted 559,456 and 3,600,000 shares, respectively, of Class B common stock into shares of common stock.\n- - On March 27, 1995, PSi repaid $2,700,000, plus accrued interest, of its $5,000,000 loan from the Company. Under an agreement between the Company and PSi, the remaining principal balance of the loan was recorded as a prepayment of future monthly software maintenance payments through December 1995.\nNOTE O -- QUARTERLY RESULTS (UNAUDITED)\nHOME SHOPPING NETWORK, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n- ---------------\n(a) The quarter ended March 31, 1995 included $2,041,000 of \"Restructuring Charges\". (b) During the quarter ended September 30, 1995, the Company recorded \"Other Charges\" of $5,427,000, litigation expense of $3,200,000, and $2,400,000 of additional \"Depreciation and Amortization\". (c) During the quarter ended December 31, 1995, cost of sales included an additional inventory carrying value adjustment of $12,077,000. (d) The fourth quarter of 1995 included $6,466,000 of \"Other Charges\", $2,073,000 in additional \"Restructuring Charges,\" and $8,656,000 of other expense items, including $3,183,000 of litigation expense. (e) The difference between earnings before extraordinary item and net earnings for the quarter ended September 30, 1994 represents a loss from the early extinguishment of long-term obligations.\nThe Company believes that seasonality does impact its business, but not to the same extent it impacts the retail industry in general.\nNOTE P -- SUBSEQUENT EVENT\nOn February 15, 1996, the Company announced it was seeking $100,000,000 of additional financing through a proposed private placement of convertible subordinated debentures that will not be registered under the Securities Act of 1933.\nOn February 13, 1996, the Company amended its Credit Facility, as discussed in Note C, and agreed that upon consummation of the sale of the subordinated debentures the amount available for borrowing under the Credit Facility would be reduced by 30% of the principal amount of subordinated debentures sold. In addition, the covenants were amended to give consent to the anticipated change in control, as discussed in Note K, subject to the Company obtaining at least $50,000,000 in net proceeds from the sale of the subordinated debentures. There can be no assurance that such private placement can be completed on terms satisfactory to the Company.\nHOME SHOPPING NETWORK, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE Q -- FINANCIAL INSTRUMENTS\nThe additional disclosure below of the estimated fair value of financial instruments was made in accordance with the requirements of Statements of Financial Accounting Standards No. 107. The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies, when available.\nThe carrying value of cash and cash equivalents and other non-current assets are a reasonable estimate of their fair value.\nThere are no available current market prices for the $4,000,000 long-term investment in Body by Jake Enterprises LLC as the investment is in a private company. The Company has no reason to believe there has been a deterioration in the investment value below its cost basis, and as such a total of $4,000,000 is included in the 1995 Fair Value table above.\nThe amount set out in the table above as the fair value of long-term investment in NRI at December 31, 1995 and 1994 has been determined using the trading price of NRI's common stock on those dates. Management is of the opinion, however, that the fair value of this investment is not readily determinable. The Company's investment is in the preferred stock of NRI which is not publicly traded and, therefore, does not have an established market price. In addition, if the Company were to convert its investment to common stock, its investment would represent 20.7% of NRI's outstanding common stock at December 31, 1995. It is not anticipated that the Company would be able to sell its holdings without adversely affecting the market price of the NRI common stock and the amount realized in the event of a sale.\nIn early 1995, NRI indicated that it believes the adequacy of cash resources and the ability to continue operations is dependent upon achieving sales and obtaining additional capital to continue, among other things, the development, testing and marketing of its products. On March 15, 1995, NRI sold 4,000,000 shares of common stock to a third party investor for $4,000,000. In addition, on January 30, 1996 NRI completed an equity financing pursuant to which certain investors purchased from NRI 800 shares of NRI Series B Preferred Stock for a gross cash purchase price of $8,000,000, before commissions and expenses. Based in part on these capital infusions, which provided NRI funds to continue the development, testing and marketing of its products, management believes that continuing to carry the Company's investment in NRI at cost is appropriate. The Company's maximum exposure on the NRI investment is the $10,000,000 carrying value.\nThe fair value of the Company's long-term obligations at December 31, 1995 and 1994 approximates the carrying value because the underlying instrument is a variable rate note that reprices frequently.\nNOTE R -- EVENT (UNAUDITED) SUBSEQUENT TO THE DATE OF THE INDEPENDENT AUDITORS' REPORT\nOn March 1, 1996, the Company completed a private placement of $100,000,000 of Convertible Subordinated Debentures due March 1, 2006, (the \"Debentures\"). The Debentures, which are unsecured and subordinated to all existing and future senior debt of the Company, bear interest at 5 7\/8% per annum payable in arrears each March 1 and September 1. The Debentures are convertible into shares of the Company's common stock at any time prior to redemption, repurchase or maturity, at a conversion price of $12.00 per\nHOME SHOPPING NETWORK, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nshare, subject to adjustment in certain circumstances. The Debentures are not redeemable by the Company prior to March 1, 1998. Thereafter, the Debentures may be redeemed at the option of the Company in whole or in part at specified prices provided that until March 1, 1999, the debentures may not be redeemed unless the closing price of the common stock equals or exceeds 140% of the specified conversion price for at least 20 out of 30 consecutive trading days ending within 20 calendar days before the notice of redemption is mailed. Based on the terms of the Credit Facility amendment discussed in Note P, the maximum borrowing availability under the Credit Facility was reduced to $120,000,000. The Company used the net proceeds to repay borrowings under its Credit Facility leaving an outstanding loan balance of $30,000,000 with $90,000,000 available for borrowing.\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 \"Election of Directors\" in the Proxy Statement dated March 1996, for the Annual Meeting of Stockholders to be held May 9, 1996, is incorporated herein by reference.\nITEM 11","section_11":"ITEM 11 -- EXECUTIVE COMPENSATION\nThe information set forth under the captions \"Summary Compensation Table\" and \"Employment Agreements\" in the Proxy Statement dated March 1996, for the Annual Meeting of Stockholders to be held May 9, 1996, is incorporated herein by reference.\nITEM 12","section_12":"ITEM 12 -- SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nSecurity ownership by management as outlined under the caption \"Security Ownership of Certain Beneficial Owners and Management\" in the Proxy Statement dated March 1996, for the Annual Meeting of Stockholders to be held May 9, 1996, is incorporated herein by reference.\nITEM 13","section_13":"ITEM 13 -- CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information set forth under the captions \"Compensation of Directors and Executive Directors\" and \"Certain Transactions and Business Relationships\" in the Proxy Statement dated March 1996, for the Annual Meeting of Stockholders to be held on May 9, 1996, 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) List of Documents filed as part of this Report:\n(1) Financial Statement Schedule\nThe report of the Company's independent auditors with respect to the above listed financial statement schedule appears on page 55.\nAll other financial statements and schedules not listed have been omitted since the required information is included in the Consolidated Financial Statements or the notes thereto, or is not applicable or required.\n(2) Exhibits (numbered in accordance with Item 601 of Regulation S-K)\n- ---------------\n* Reflects management contracts and compensatory plans.\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 28, 1996 HOME SHOPPING NETWORK, INC.\nBy: \/s\/ JAMES G. HELD\n------------------------------------ James G. Held 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 REGISTRANT AND IN THE CAPACITIES INDICATED ON MARCH 28, 1996.\nEXHIBIT 11\nHOME SHOPPING NETWORK, INC. AND SUBSIDIARIES\nCOMPUTATION OF NET EARNINGS (LOSS) PER SHARE\n- ---------------\n(1) Interest expense, net of taxes, that would not have been incurred had conversion of the Company's 5 1\/2% convertible debentures taken place at the beginning of the period. (2) The amounts in earnings (loss) per share on the fully diluted basis are solely shown in this exhibit. Because the amounts are the same as the primary calculation for the year ended December 31, 1994 and are antidilutive for the years ended December 31, 1995 and 1993, respectively, (decrease the loss per share), they are not required to be presented elsewhere in this Form 10-K.\nEXHIBIT 21\nLIST OF SUBSIDIARIES OF HOME SHOPPING NETWORK, INC.\nA DELAWARE CORPORATION\nAS OF MARCH 1, 1996\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors Home Shopping Network, Inc.\nUnder date of February 21, 1996, we reported on the consolidated balance sheets of Home Shopping Network, Inc. and subsidiaries as of December 31, 1995 and 1994 and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the years in the three year period ended December 31, 1995, as contained in Item 8 of the Company's 1995 Form 10-K. In connection with our audits of the aforementioned consolidated financial statements, we also have audited the related financial statement schedule as listed in Item 14. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement schedule based on our audits.\nIn our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.\n\/s\/ KPMG Peat Marwick LLP\nSt. Petersburg, Florida February 21, 1996\nSCHEDULE II\nHOME SHOPPING NETWORK, INC. AND SUBSIDIARIES\nVALUATION AND QUALIFYING ACCOUNTS\n- ---------------\n(1) Accounts written off as uncollectible.\nBOARD OF DIRECTORS BARRY DILLER Chairman Home Shopping Network Chairman and Chief Executive Officer Silver King Communications, Inc. New York, NY\nJAMES G. HELD President and Chief Executive Officer Home Shopping Network, Inc.\nPETER R. BARTON President Liberty Media Corporation Englewood, Colorado\nROBERT R. BENNETT Senior Vice President and Chief Financial Officer Liberty Media Corporation Englewood, Colorado\nJOHN M. DRAPER Consultant to Liberty Media Corporation Englewood, Colorado\nJ. ANTHONY FORSTMANN Chairman The National Registry Inc. St. Petersburg, Florida\nLEO J. HINDERY, JR. Managing General Partner InterMedia Partners San Francisco, California\nJOHN C. MALONE, PH.D. President and Chief Executive Officer Tele-Communications, Inc. Denver, Colorado\nGEORGE C. MCNAMEE Chairman First Albany Companies, Inc. Albany, New York\nELI J. SEGAL Former assistant to the President of the United States Washington, DC\nOFFICERS JAMES G. HELD President and Chief Executive Officer\nBARRY S. AUGENBRAUN Executive Vice President, General Counsel and Secretary\nBRIAN J. FELDMAN Vice President and Controller\nHONORE A. LE BRUN, III Executive Vice President Broadcast and Cable Affiliate Sales\nKEVIN J. MCKEON Executive Vice President, Chief Financial Officer and Treasurer\nMARY ELLEN POLLIN Executive Vice President Administration\nSTOCKHOLDER INFORMATION\nCORPORATE HEADQUARTERS 2501 118th Avenue North St. Petersburg, Florida 33716-1900 (813) 572-8585 Mailing address: Post Office Box 9090 Clearwater, Florida 34618-9090\nSTOCK EXCHANGE Home Shopping Network is listed on the New York Stock Exchange. The ticker symbol is HSN.\nTRANSFER AGENT AND REGISTRAR For address changes, account consolidation, registration changes, lost stock certificates and other stockholder services, contact: The Bank of New York 101 Barclay Street New York, New York 10286 (800) 524-4458\nINVESTOR RELATIONS AND CORPORATE COMMUNICATIONS The Company maintains an office to assist analysts, investment professionals, stockholders, potential stockholders, press and media. Inquiries are welcome by telephone or letter at the corporate headquarters.\nINDEPENDENT AUDITORS KPMG Peat Marwick LLP Barnett Tower, Suite 1600 200 Central Avenue St. Petersburg, Florida 33701\nANNUAL MEETING The Annual Meeting of Stockholders will be held on May 9, 1996 at 10:00 a.m. at the Holiday Inn, 3535 Ulmerton Road, St. Petersburg\/Clearwater, Florida\nGETTING ON-LINE WITH HSN INTERNET SHOPPING NETWORK (ISN) At the World Wide Web (WWW) access line, type \"http:\/\/www.internet.net\".\nHOME SHOPPING NETWORK, INC. 1995 ANNUAL REPORT","section_15":""}
{"filename":"811640_1995.txt","cik":"811640","year":"1995","section_1":"ITEM 1 - BUSINESS - -----------------\nGENERAL\nDavox Corporation (\"Davox\" or the \"Company\") is principally a software and systems integration company which develops, markets, implements, supports and services management systems for call center operations. These call center operations are responsible for business applications including credit\/collections, customer service, telephone sales, and fund raising. Davox systems help calling operations integrate existing voice and data systems, manage outbound and inbound calling applications and focus on improving the quality of each customer contact, as well as the quantity of calls handled. This increased productivity and efficiency, documented by Davox users, has resulted in lower labor costs, increased revenue and\/or increased transaction capacity for the user organization, and improved service levels. Davox systems include intelligent outbound calling, inbound call handling, inbound\/outbound call integration and call center network management.\nDavox has provided unified call center solutions to banks, consumer finance organizations, retailers, entertainment companies, telemarketing organizations, and utilities. Among the company's current customers are: Chemical Bank, Bancomer, General Electric Capital Corporation (GECC), Household Finance, NationsBank, May Companies, AT&T, NYNEX, British Telecom, Australian Telecom, Precision Response Corporation, Superstar Satellite Entertainment, Gottschalks Department Stores, USAA Federal Savings Bank, and WGBH television.\nStatements in this Form 10-K which are not historical facts, so-called \"forward-looking statements,\" are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Investors are cautioned that all forward-looking statements involve risks and uncertainties, including those detailed in the Company's filings with the Securities and Exchange Commission. See also \"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations--Certain Factors That May Affect Future Results.\"\nThe Company was incorporated in Massachusetts in 1981 and reorganized in Delaware in 1982. The Company's principal offices are located at 6 Technology Park Drive, Westford, Massachusetts 01886 and its telephone number is (508) 952-0200.\nOVERVIEW\nToday's businesses realize that their most important asset and source for additional business is their customer; therefore, within most corporations, several departments are in\nalmost constant contact with buyers or users of their goods or services. These departments, or call centers, place and\/or receive phone calls, supplying information to the customer or processing account information from a database. The mission of call center management is to increase the productivity of telephone agents, improve the efficiency of the calling operation and enhance the quality of customer service.\nTo achieve the mission of the call center, businesses have invested in different types of technology to accommodate different types of customer contact, such as incoming and outgoing calls. However, these discrete proprietary systems result in an environment characterized as \"islands of technology\" which limit the productivity and efficiency of the call center and degrade customer service. The majority of today's businesses are under economic and competitive pressure to protect their investment in technology, and require a method for integrating existing disparate technologies. By integrating these technologies, a business can share its resources, and provide its customers a higher quality of service.\nDavox recognized the growing demand for systems that would unify these disparate resources and calling applications. To deliver the level of integration necessary to unite a business' customer contact applications, Davox introduced in late 1993 a system which represented a new generation technology for the call center market.\nThe Unison(R) call center management system relies on open system, client\/server architecture to communicate with a call center's existing and future voice and data systems, allowing call centers to share valuable system resources and a single data source, and to manage a more efficient customer contact operation.\nTHE UNISON(R) OPEN SYSTEMS ENVIRONMENT - --------------------------------------\nThe Unison(R) system's open systems-based architecture creates a flexible environment that enables customers to realize the full potential of their call center investments now and in the future. A customer's PBX (Private Branch Exchange), ACD (Automatic Call Distributor) and VRU (Voice Response Unit) are usually made by different vendors and installed at different times and even at different locations. Furthermore, information about a specific customer may reside on one or more databases within a legacy system(s).\nA single Unison(R)-based agent workstation can handle all voice\/data tasks associated with any call -- incoming or outgoing, regardless of point of origin. The system can track all calls in real-time, allowing managers to identify quickly both positive and negative trends as they develop. As a result, adjustments can be made instantly to correct unfavorable trends and exploit positive ones.\nA unique characteristic of the Unison\/(R)\/ system is its Rules-Based(TM) software product which allows a call center manager to design, adjust, refine and implement calling strategies in real time. With this Rules-Based(TM) management capability, the Unison(R) system's user can target outbound calling campaigns based on user-defined criteria such as location, income level, or outstanding balance.\nThis capability also allows call centers to match specific customers with telephone agents who have the necessary skills to handle these customer accounts. For example, foreign speaking agents can be automatically assigned to handle calls to or from households where only that language is spoken; or agents skilled in handling a specific product can be assigned to those accounts.\nUsing the Unison(R) system's Rules-Based(TM) management capability, a call center manager can set the calling \"rules\" for each campaign, such as:\n. The order in which phone numbers will be called, . Acceptable talk time, . The time of day clients will be called, . Acceptable after call work time, and . Which accounts will be called.\nEach campaign is monitored in real-time, notifying the call center's supervisors immediately if performance deviates from the prescribed norm, enabling the supervisor to take immediate corrective action. The Rules-Based(TM) management capability provides Unison(R) system users with real time information to adapt their system \"on the fly\" to changing priorities within the call center. This Rules-Based(TM) capability also helps Unison users maintain compliance with FTC\/FCC regulations.\nUNISON(R) Functional Overview - -----------------------------\nThe Unison(R) family of call center management systems combines open system, client\/server, and relational database technology with sophisticated applications. The Unison(R) system's open architecture performs equally well in all call center environments:\n. Outbound, . Outbound\/Inbound blended, and . Inbound.\nUNISON(R) Technology for a New Generation of Call Centers - ---------------------------------------------------------\nThe SMART MANAGEMENT CENTER(R) (SMC(R)) is the central management engine which implements the Unison(R) system's Rules-Based(TM) management strategies and a broad range of software-driven features that allow the intelligent, strategic integration of all call center resources. The SMC(R) (a UNIX RISC-based management system built on the Sun Microsystems, Inc. SPARC architecture) manages, monitors, processes, reports, communicates, integrates and controls a broad range of telephony and data-oriented call center tasks -- all in real-time and using a friendly, point-and-click graphical user interface (GUI). The SMC(R) utilizes Sybase Incorporated relational database management software which supports the Rules-Based(TM) management capability and is integral to call center improvements in the areas of quality of contact, productivity, effectiveness and resource management.\nONESTATION(TM) software product provides universal agent audio connectivity to an existing PBX\/ACD. In conjunction with installed data resources, ONEStation(TM) functionality allows\nagents to access available voice and data resources from any single existing workstation anywhere in the company's data network.\nSmart Access(TM) software product provides a flexible management network allowing users to: . Access, monitor, and control multiple calling sites in real-time, and . Distribute information and outbound call campaigns to any center on the network.\nCALL MANAGEMENT FEATURES AUTOMATE, STREAMLINE OUTBOUND OPERATIONS\nThe Unison(R) system's sophisticated dial and pacing technology, campaign flow, dynamic campaign generation and filter capabilities streamline outbound call operations by automating unproductive or time-consuming processes. Supervisors control the parameters which affect the actual call placement, freeing agents to focus on engaging in productive conversations with customers. Layered upon this powerful dialing engine is Davox's broad array of real-time campaign management\/measurement capabilities.\nINTELLIGENT INTEGRATION OPTIONS FOR CALL BLENDING\nBecause Davox understands that a single call blending solution may not be appropriate for every call center, the Company offers both a Computer Telephony Integration (CTI) and a non-CTI Unison(R) system option.\nSMART ACD(TM) software product provides non-CTI inbound\/outbound notification. Smart ACD(TM) software:\n. Interfaces with a call center's existing ACD and PBX, . Monitors all designated ACD queues and displays inbound traffic information in real-time, and . Automatically and intelligently instructs agents to handle ACD queues and outbound calling lists as necessary to maximize productivity while maintaining the proper service levels.\nSCALE(TM) (Seamless Call and Agent Load Equalization) software is available for call centers that wish to utilize CTI for their call handling. With SCALE(TM) functionality, all designated agents function as both inbound and outbound agents, and the movement of those agents from inbound to outbound calls is automatic; no separate login procedures are required. The standard Unison(R) system campaign management capabilities are available to SCALE(TM) users. In addition, Unison(R) agent management and real-time voice and data reporting features are available for inbound as well as outbound agents.\nSOFTWARE THAT DELIVERS VALUE THROUGHOUT A CALL CENTER\n. UNISON STRATEGIST(TM) Applications Software lets supervisors specify and modify comprehensive calling strategies.\n. UNISON TACTICIAN(TM) Applications Software makes it easy for supervisors to monitor agent productivity during individual campaigns and shift resources quickly when needed. . UNISON PRECISION DIAL(TM) Applications Software streamlines call center operations by automating processes and eliminating unproductive time- consuming tasks.\nThe Unison(R) system price begins at approximately $90,000. Specific and variable customer requirements, such as the number of agent positions, extent of inbound integration and multi-site connectivity determine actual Unison(TM) system prices.\nMARKETS AND APPLICATIONS\nDavox markets its unified call center solutions to corporations that rely heavily on the telephone to conduct business with their customers. These corporations have typically made large investments in building inbound and\/or outbound calling operations. The function of these operations is to place and receive customer calls. In many cases, these calling operations are responsible for specific business applications such as collections, customer service, fund raising or telephone sales.\nIn 1991, new trends emerged in the marketplace. Customers began augmenting outbound calling applications with inbound call handling applications, allowing them to share system and labor resources, reduce overhead and improve the quality of their customer contacts and overall customer service.\nThe Company believes that Unison(R) systems can significantly increase productivity in many applications where repetitive tasks can be automated. Additionally, Davox believes that its products are well suited to meet evolving CTI standards due to their multi-protocol capabilities, integrated voice functions, and flexible software design.\nSIGNIFICANT CUSTOMERS\nIn 1995 the Company's largest single customer was AT&T, accounting for 12% of total revenues. In 1994 and 1993, Chemical Bank was the largest single customer, accounting for 9% and 12% of its total revenues, respectively. Total revenues from the Company's top three customers amounted to 20%, 19%, and 30% of total revenue in 1995, 1994 and 1993, respectively. The Company believes that its dependence on any one end user customer is not likely to increase significantly as the Company continues to penetrate the broader call center market and expand its alternate distribution channels.\nMARKETING AND SALES\nDavox takes a solutions-oriented approach to marketing its Unison(R) systems. The integration and management capabilities of the systems are presented as tools to help customers meet their business goals and objectives for customer service. This approach has two major benefits:\n. First, as Davox's relationship with a client grows, the Company is able to increase sales by developing additional call center capabilities for the client.\n. Second, Davox can identify additional applications in other areas of the customer's business.\nAdditionally, by focusing on common applications and identifying industries with similar organizational or functional structures, Davox can address new markets with relatively small incremental development costs and a short training period for its sales force.\nThe Company's sales force follows a disciplined selling program that focuses on selling business solutions, rather than stressing the features of individual products. Having identified departments in which Unison(R) systems may provide significant productivity increases, Davox sales representatives and technical consultants (system\/application specialists) work with the customer to analyze the business and production objectives for the calling operation. Davox then presents a system model with a pay back schedule. This consultative, \"team\" approach is taken to establish a long-term relationship with the client.\nThe Company is working to expand market penetration through its Business Partners Program. This program represents a third party distribution channel through joint marketing and reseller relationships. Examples of third party partners include telecommunication system manufacturers, software vendors, computer manufacturers, and systems integrators. The Company plans to continue to expand its Business Partners Program, with particular emphasis on customer contact software vendors and telecommunication system providers.\nIn North America, the Company markets its products primarily through a direct sales force with contributions from the Business Partners Program. Direct sales personnel are supported by a team of marketing professionals based at the Company's headquarters.\nDavox manages international activities for three global regions -- Europe, Latin America and the Pacific Rim. The Company's products are offered in these regions primarily through a series of mostly nonexclusive distribution agreements. In 1995, Davox established a European headquarters in the United Kingdom which will provide marketing, technical support, and service to its European distributors and end users. Also in 1995, Davox signed a distributor agreement with LaKe Corporation of Australia to distribute the company's products in a select number of countries throughout the Pacific region, which do not include Japan. Davox also entered into a new agreement extending its previous relationship with Datapoint Corporation to resell the company's products in select countries in Europe. Davox entered into a distributor agreement for Japan in early 1996.\nIn connection with sales outside the United States, Davox products are subject to regulation by foreign governments, which requires the Company to follow certification procedures for some countries. Failure to obtain necessary local country approvals or certifications will restrict Davox's ability to sell into some countries. International product revenue was $4.5 million, $3.3 million and $4.5 million in 1995, 1994 and 1993 respectively.\nSUPPORT AND SERVICE\nDavox's Customer Service Organization provides maintenance and systems integration services that include not only call center system installation and training, but also:\n. Network planning, design, and implementation services, and\n. Professional services that include call center consulting, custom application design, and development services.\nDavox customer support comprises:\n. Support teams responsible for on-going account management and customer satisfaction of the installed base,\n. On-site hardware and software support,\n. A Worldwide Support Center located in the corporate offices in Westford, Massachusetts that provides centralized access to hardware and software support as required on a worldwide basis to end-users and distributors,\n. Software services that enhance or modify current systems, and\n. Professional services that deliver consulting and customized project services as required.\nUnder the terms of an agreement with Grumman Systems Support Corporation (GSSC) of Bohemia, New York, GSSC delivers hardware support services for the Unison(R) system and older CAS(R) and SMC(R) product lines within the continental United States and Canada while Davox continues to deliver software support services. In addition, GSSC provides network design and systems integration services allowing Davox to focus its expertise on customizing advanced calling centers for its clients.\nThrough its Continuum(R) customer support program, Davox offers several support options from which Unison(R) system customers can choose. Services range from customer participation in the repair and software upgrade process, to full hardware and software support by Davox.\nCustomer service revenues accounted for $14,174,000, or 37.7% of the Company's total revenue in 1995, an increase in revenue from $13,078,000, or 43.5% of the Company's revenue in 1994, and an increase from $12,857,000, or 38.1% of revenue in 1993. Customer service revenues as a percentage of total revenues decreased in 1995 as compared to 1994 due largely to the higher product revenues in 1995.\nRESEARCH, DEVELOPMENT AND ENGINEERING\nThe Company employs an open system, client\/server, relational database approach in developing its unified call center solutions. The platform selected for this approach is the SPARC Station from SUN Microsystems Inc.. The Company's development efforts are focused on enhancing and expanding the functionality of these systems while reducing their cost. Davox currently anticipates that areas of potential product development may include integration links to additional call center telephony components and the development of additional telephone management and reporting capabilities.\nThe Company's continued success depends on, among other factors, maintaining close working relationships with its customers and resellers, and anticipating and responding to their evolving applications needs. The Company is committed to the development of new products, the improvement of existing products and the continuing evaluation of new technologies.\nDuring 1995, 1994 and 1993 the Company's research, development and engineering costs were approximately $4,020,000, $3,540,000 and $3,391,000, respectively, representing approximately 10.7%, 11.8% and 10.1%, respectively of total revenues during these periods. In the future, the Company expects to incur approximately the same level of research, development and engineering expenditures as it did during 1995. In addition, the Company did not capitalize any of it's software development costs in 1995, while it spent approximately $310,000 and $784,000 on capitalized software development costs during 1994 and 1993, respectively.\nOPERATIONS\nWhile the majority of the Company's hardware needs are met by readily available off-the-shelf technology, a small portion remains proprietary. These proprietary hardware components are manufactured by third party contractors, and the Company believes there are many qualified vendors for these services. The Company's production process consists primarily of final test, quality assurance, and systems integration which occurs at its Westford facility. The Company purchases certain equipment for Unison(R) through an industry remarketer agreement with SUN Microsystems.\nThe Company attempts to maintain multiple sources of supply for key items and believes it has adequate sources of supply for its expected needs. While any of these sources could be replaced if necessary, the Company might face significant delays in establishing replacement sources or in modifying its products to incorporate replacement components or software code. There can be no assurance that the Company will not suffer delays resulting from non-performance by its vendors or cost increases due to a variety of factors, including component shortages or changes in laws or tariffs applicable to items imported by the Company.\nCOMPETITION\nDavox systems compete against various outbound calling systems. Companies such as Digital Systems International, Inc., Melita International Corporation and EIS International, Inc. offer predictive dialers, but with varying levels of functionality in terms of system management, integration and workstation support.\nCertain of the Company's potential competitors may be large companies which have greater financial, technical and marketing resources. It is possible that competitors could produce products that perform the same or similar functions as those performed by the Company's products.\nThe Company believes that the principal factors affecting competition are ease of use and range of functionality, reliability, performance, price and customer service, and that the Company competes favorably as to these factors.\nRELIANCE ON INTELLECTUAL PROPERTY\nThe Company relies on a combination of patent, copyright, contract and trade secret laws to establish and protect its proprietary rights in its technology. Software products are furnished under software license agreements which grant customers licenses to use, rather than to own, the products. The license agreements contain provisions protecting the Company's\nownership of the underlying technology. Upon commencement of employment, employees execute an agreement under which inventions developed during the course of employment will, at the election of the Company, be assigned to the Company, and which further prohibits disclosure of confidential Company information. Despite the precautions undertaken by the Company, it may be possible to copy or otherwise obtain and use the Company's products or technology without authorization. In addition, effective protection of intellectual property rights may be limited or unavailable in certain foreign countries.\nThe Company owns and licenses a number of patents relating to predictive dialing, real time telecommunication management and user interfaces. Davox is very active in pursuing patents in its key technology and applications areas. The Company does not rely on the licensed patents as its sole competitive advantage.\nEMPLOYEES\nAs of December 31, 1995, the Company had 164 full-time employees, of whom 18 were engaged in operations, 102 in sales, marketing and customer support, 27 in research, development and engineering and 17 in general and administrative functions. The Company's ability to attract and retain qualified personnel is essential to its continued success. None of the Company's employees is represented by a collective bargaining agreement, nor has the Company ever experienced any work stoppage. The Company believes that its employee relations are good.\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2 PROPERTIES - -----------------\nDuring January 1994, the Company moved its administrative offices and its operations and development facilities to a 60,000 square foot, two story building in Westford, Massachusetts. The facility is occupied under a lease which expires in September 1997. The Company incurred approximately $480,000 for various expenditures related to this move, of which $190,000 represents property under a capital lease. In addition, the Company leases facilities for district and regional sales and service offices in eight states. The current aggregate annual rental payments for all of the Company's facilities are approximately $551,000.\nITEM 3","section_3":"ITEM 3 LEGAL PROCEEDINGS - ------------------------\nThe Company is from time to time subject to claims arising in the ordinary course of business. While the outcome of the claims cannot be predicted with certainty, management does not expect these matters to have a material adverse effect on the results of operations and financial condition 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 last quarter of the fiscal year ended December 31, 1995.\nITEM 4A EXECUTIVE OFFICERS OF THE REGISTRANT - --------------------------------------------\nThe executive officers of the Company, the age of each, and the period during which each has served in his present office are as follows:\nMR. ALPHONSE M. LUCCHESE (60) has served as Chairman, President and Chief Executive Officer since July 1994. Mr. Lucchese joined Davox following seven years as President and Chief Executive Officer at Iris Graphics, Inc., a manufacturer of quality color printers. Prior to joining Iris, Mr. Lucchese had served as Vice President of Sales at Xyvision, Inc., a manufacturer of computer- integrated publishing systems sold to Fortune 500 companies, commercial printers and typesetters, and government agencies. Mr. Lucchese was Vice President of Sales for Davox Corporation from 1983 until 1984. Earlier, he had spent six years at Raytheon Data Systems, where he attained the position of Vice President and General Manager of Northeastern Operations. Following service in the U.S. Army during the mid-1950's, Mr. Lucchese began his professional career at IBM as a systems engineer, later moving into the position of marketing representative.\nMR. JOHN J. CONNOLLY (39) has served as Vice President, Finance and Chief Financial Officer since August 1, 1994. Mr. Connolly joined Davox from Iris Graphics where he had been Vice President of Finance since 1989. Prior to joining Iris, Mr. Connolly held finance and accounting positions of increasing responsibilities at Instrumentation Laboratory, a manufacturer of medical equipment.\nMR. JAMES F. MITCHELL (49) is a founder of the Company and has served as Senior Vice President and Chief Technical Officer since 1983. From September 1993 to August 1994, Mr. Mitchell managed the domestic sales operations. From 1981 to 1983, he was Vice President, Engineering of the Company. Prior to joining Davox in 1981, Mr. Mitchell served as Manager of Systems Development at Applicon, Inc., a producer of CAD\/CAM products.\nMR. DOUGLAS W. SMITH (53) has served as served as Vice President, Sales and Marketing since September 1, 1994. Mr. Smith is responsible for the company's worldwide direct and reseller sales, as well as product and industry marketing, sales support and marketing communications. Mr. Smith joined Davox following seven years at Iris Graphics. Prior to joining Iris, Mr. Smith worked for nearly 20 years in sales, managerial, and executive-level capacities for General Electric Information Systems, Honeywell Information Systems, Raytheon Data Systems, and Phoenix Data Systems.\nMR. MARK DONOVAN (41) has served as Vice President, Operations since August 1994. Since joining Davox in 1983, Mr. Donovan has held management positions of increasing responsibility, including Vice President, Customer Service. He has also held various materials and manufacturing management positions within the company. Prior to joining Davox, Mr. Donovan held various management positions with Applicon, Inc. and Raytheon Corporation.\nMR. JOHN E. CAMBRAY (40) has served as Vice President, Product Development since August 1993. Mr. Cambray has been with Davox since early 1982 and has held various software development and engineering management positions during this time. Prior to joining Davox, Mr. Cambray held various design and management positions with FASFAX Corporation and Sanders Associates.\nITEM 4A EXECUTIVE OFFICERS OF THE REGISTRANT (CONTINUED) - --------------------------------------------------------\nMR. EDWARD D. KAY (53) has served as Vice President, Customer Service since 1994. Mr. Kay joined Davox in 1992 and held the position of Director of Technical Sales Support until he was named Vice President, Customer Service. Prior to joining Davox, Mr. Kay was European Customer Service Manager for Silicon Graphics in Neuchatel, Switzerland. Mr. Kay has also held customer service and program management positions at Codex Corporation and Digital Equipment Corporation.\nMR. PHILIP D. TOLMAN (42) joined the Company in December 1990 and has served as Treasurer since 1992. Mr. Tolman is also an attorney admitted to the bar in Massachusetts, and serves as In-house counsel on general commercial transactional matters. Prior to joining Davox, Mr. Tolman held various financial, administrative and planning management positions with Prime Computer, Inc., with his last assignment being as Director, Business Planning.\nOfficers are elected by and serve at the discretion of the Board of Directors.\nPART II\nITEM 5","section_5":"ITEM 5 MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS - --------------------------------------------------------------------------------\nDavox's Common Stock has been traded on the NASDAQ stock market under the symbol \"DAVX\" since its initial public offering on April 28, 1987. Prior to that date there was no public market for Davox's Common Stock. The following table sets forth the range of high and low sale prices per share of Common Stock on the National Market System for each quarter of the years ended December 31, 1995 and 1994 as reported by the National Association of Securities Dealers Automated Quotation System (NASDAQ).\nAs of February 7, 1996, there were approximately 360 holders of record of the Company's Common Stock and approximately 700 beneficial shareholders of the Company's Common Stock.\nThe Company has never paid cash dividends on its Common Stock and has no present intentions to pay cash dividends in the future. The Company intends to retain any future earnings to finance the growth of the Company.\nITEM 6","section_6":"ITEM 6 SELECTED FINANCIAL DATA - -------------------------------\nThe following table sets forth certain financial data with respect to the Company for each of the five years in the period ended December 31, 1995:\nITEM 7","section_7":"ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION - --------------------------------------------------------------------- AND RESULTS OF OPERATIONS - -------------------------\nThe following table sets forth, for the periods indicated, the percentage of revenues represented by items as shown in the Company's statement of operations. This table should be read in conjunction with the Selected Financial Data, Consolidated Financial Statements and Notes to Consolidated Financial Statements contained elsewhere herein.\nITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\nTotal revenues were approximately $37,556,000, $30,047,000, and $33,756,000 in the fiscal years ended December 31, 1995, 1994 and 1993, respectively. Total revenues increased 25.0% for the year ended December 31, 1995 compared to the same period in 1994 and decreased 11.0% for fiscal year 1994 compared to fiscal year 1993. Total cost of revenues as a percentage of total revenues was 43.8% in fiscal year 1995, 54.0% in fiscal year 1994, and 51.8% in fiscal year 1993.\nProduct revenue was approximately $23,382,000, $16,969,000, and $20,899,000 in fiscal years 1995, 1994 and 1993, respectively. Product revenue increased by 37.8% from 1994 to 1995 and decreased by 18.8% from 1993 to 1994. The increase in 1995 was mainly attributable to strong demand for our core collections call center products, sales of the new telemarketing product, and expansion in international markets. The decrease in 1994 was mainly attributable to lower international revenues and declining workstation and autodialer revenues.\nProduct cost of revenues as a percentage of product revenues was 30.6%, 39.6%, and 41.0% in fiscal years 1995, 1994 and 1993, respectively. In 1995, the continued improvements in product margin represent the favorable impact of increased volume as well as reduced costs related to inventory provisions and amortization. The increase in product margin in 1994 was attributable to a shift to higher margin software products associated with the Unison(R) product line, but was offset by provisions for inventory valuation and amortization of the Company's capitalized software costs also related to the Unison(R) product.\nService revenue was approximately $14,174,000, $13,078,000, and $12,857,000 in fiscal years 1995, 1994 and 1993, respectively. Service revenue increased by 8.4% from 1994 to 1995 and by 1.7% from 1993 to 1994. The increases in 1995 and 1994 were due to an increase in installation and maintenance revenues resulting from the growth in the number of the Company's customers.\nService cost of revenues as a percentage of service revenues was 65.6%, 72.8%, and 69.3% in 1995, 1994 and 1993, respectively. The decrease in 1995 is primarily related to the increase in revenue, while also being favorably impacted by slightly reduced third-party maintenance costs. The increase in service costs in 1994 was attributable to increased third-party maintenance costs which the Company had expected to offset by reducing its service operations. This reduction did not occur, however, because the Company, in connection with its introduction of the Unison(R) product, was required to increase support services in order to address these additional service needs.\nRevenues from the Company's largest single customers were 12%, 9%, and 12% of total revenues in 1995, 1994 and 1993, respectively. Revenues from the Company's three largest customers amounted to 20%, 19%, and 30% of total revenues in 1995, 1994 and 1993, respectively. One of the three largest customers in 1993 was one of the Company's international distributors, not a single end user customer. The Company intends to broaden its base of existing and new customers by penetrating new markets, expanding it's direct\ninternational sales force, and using alternate channels of distribution, thereby decreasing its dependence on its largest customers.\nResearch, development and engineering expenses were approximately $4,020,000, $3,540,000, and $3,391,000, representing 10.7%, 11.8%, and 10.1% of total revenues during 1995, 1994 and 1993, respectively. In addition, due to a change in the Company's current development cycle; no software development costs were capitalized in 1995, while the Company spent approximately $310,000 and $784,000 on capitalized software development costs during 1994 and 1993, respectively. The decrease in capitalized development costs from 1993 to 1994 was related to software development on Unison(R), which was completed in September of 1993.\nSelling, general and administrative expenses were approximately $12,165,000, $12,681,000, and $12,472,000, representing 32.4%, 42.2%, and 36.9% of total revenues during 1995, 1994, and 1993, respectively. The decrease in 1995 was mostly attributable to the significant increase in revenues. The increase in 1994 as compared to 1993 was attributable to documentation, advertising, and certification expense related to the Unison(R) product, higher personnel costs including benefits, and indirect selling expenses. These increases were partially offset by a decrease in legal fees related to the settlement of a patent dispute with Digital Systems International in 1994.\nInterest income, derived primarily from money market investments, increased by 559.2% from 1994 to 1995 and by 63.8% from 1993 to 1994. These increases were due to the significantly higher average cash balances from year to year. Interest expense decreased by 35.5% from 1994 to 1995. This decrease reflects an overall decrease in outstanding debt attributable to capital lease obligations. Interest expense increased 47.1% from 1993 to 1994. This increase reflected additional interest expense on capital lease obligations related to the new Westford facility.\nRESTRUCTURING\nIn the second quarter of 1994, in response to lower revenue, the Company implemented a restructuring program. The restructuring was intended to refocus the strategic direction of the Company to exploit the full potential of the Unison(R) product line and maintain the Company's operating expenses in line with the revised revenue plan. As result of this program, the Company hired a new Chief Executive Officer and new Chief Financial Officer. This restructuring resulted in a 21% reduction in the Company's work force worldwide.\nThe Company offered or was contractually committed to severance packages of up to fifteen months' salary. Additionally, the Company accelerated the phaseout of certain older product lines, necessitating the write-down of certain assets. In total, the restructuring cost was approximately $3,379,000, of which approximately $82,000 of other costs have yet to be paid as of December 31, 1995. The restructuring charge reflects approximately $1,487,000 of severance related costs and $1,892,000 related to the phase out of certain older product lines.\nLIQUIDITY AND CAPITAL RESOURCES\nAs of December 31, 1995, the Company's principal sources of liquidity were its cash and cash equivalent balances of approximately $12,936,000. As of the end of fiscal 1994, the Company's cash and cash equivalent balances were approximately $5,278,000. The increase in cash is a result of the Company's operating results and an increase in customer deposits. During the fourth quarter of 1994, the Company entered into an agreement for a secured, working capital line of credit with a bank for up to $2,000,000 based on eligible receivables, as defined. There were no outstanding balances as of December 31, 1995 or 1994.\nWorking capital as of December 31, 1995 was approximately $8,589,000 as compared to $1,807,000 as of December 31, 1994 and $3,627,000 as of December 31, 1993. Total assets as of December 31, 1995 were approximately $20,825,000 compared to $14,777,000 as of December 31, 1994 and $17,681,000 as of December 31, 1993. The increase from 1994 to 1995 was primarily attributable to the cash generated by operations.\nManagement believes, based on the current operating plan, that the Company's existing cash and cash equivalents, cash generated from operations, and amounts available under its secured, working capital line of credit will be sufficient to meet the Company's cash requirements for the foreseeable future.\nIMPACT OF INFLATION\nThe Company believes that inflation did not have a material effect on the results of operations in 1995.\nCERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS\nFrom time to time, information provided by the Company, statements made by its employees or information included in its filings with the Securities and Exchange Commission (including this Form 10-K) may contain statements which are not historical facts, so-called \"forward-looking statements,\" which involve risks and uncertainties. In particular, statements in \"Item 1. Business\" relating to expansion of the Business Partners Program, and in \"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\" relating to the Company's intent to broaden its customer base and decrease reliance on its largest customers and the sufficiency of working capital, may be forward-looking statements. The Company's actual future results may differ significantly from those stated in any forward-looking statements. Factors that may cause such differences include, but are not limited to, the factors discussed below. Each of these factors, and others, are discussed from time to time in the Company's filings with the Securities and Exchange Commission.\nThe Company's future results may be subject to substantial risks and uncertainties. The Company purchases certain equipment for its products from third party suppliers and licenses certain components of its software code from a number of third party vendors. While the Company believes that third party equipment and software vendors could be replaced if necessary, the Company might face significant delays in establishing replacement sources or in modifying its products to incorporate replacement components or software code. There can be no assurance that the Company will not suffer delays resulting from non- performance by its\nvendors or cost increases due to a variety of factors, including component shortages or changes in laws or tariffs applicable to items imported by the Company. Also, the Company relies on certain intellectual property protections to preserve its intellectual property rights. Any invalidation of the Company's intellectual property rights or lengthy and expensive defense of those rights could have a material adverse affect on the Company. The development of new products, the improvement of existing products and the continuing evaluation of new technologies is critical to the Company's success. Successful product development and introduction depends upon a number of factors, including anticipating and responding to the evolving applications needs of customers and resellers, timely completion and introduction of new products, and market acceptance of the Company's products. The telecommunications industry is extremely competitive. Certain current and potential competitors of the Company are more established, benefit from greater market recognition and have substantially greater financial, development and marketing resources than the Company.\nThe Company's quarterly and annual operating results are affected by a wide variety of factors that could materially adversely affect revenues and profitability, including: the timing of customer orders; the Company's ability to introduce new products on a timely basis; introduction of products and technologies by the Company's competitors; and market acceptance of the Company's and its competitors' products. As a result of the foregoing and other factors, the Company may experience material fluctuations in future operating results on a quarterly or annual basis which could materially and adversely affect its business, financial condition, operating results and stock price.\nITEM 8","section_7A":"","section_8":"ITEM 8 CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - ---------------------------------------------------------------\nIndex to Consolidated Financial Statements - ------------------------------------------\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo Davox Corporation:\nWe have audited the accompanying consolidated balance sheets of Davox Corporation (a Delaware corporation) and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1995. 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 Davox Corporation and subsidiaries as of December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles.\nARTHUR ANDERSEN LLP\nBoston, Massachusetts January 22, 1996\nDAVOX CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS\nThe accompanying notes are an integral part of these consolidated financial statements.\nDAVOX CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS\nThe accompanying notes are an integral part of these consolidated financial statements.\nDAVOX CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY\nThe accompanying notes are an integral part of these consolidated financial statements.\nDAVOX CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS\nThe accompanying notes are an integral part of these consolidated financial statements.\nDAVOX CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1995\n(1) Operations and Significant Accounting Policies\nDavox Corporation (the Company) is a software and systems integration company which develops, markets, supports and services management systems for call center operations. These systems are marketed directly, through joint marketing relationships, and distribution agreements. The Company provides its systems to banks, consumer finance organizations, retailers, entertainment companies, telemarketing organizations, and utilities.\nThese consolidated financial statements reflect the application of certain significant accounting policies, as described below and elsewhere in the accompanying consolidated financial statements.\n(a) Management Estimates\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\n(b) Revenue Recognition\nThe Company recognizes revenue when products are shipped, provided that no significant vendor obligations remain outstanding, and the collection of the resulting receivable is deemed probable. The Company's policy is to defer the revenue associated with any significant vendor obligations remaining at the time of shipment until the related services are satisfied.\nService revenues are recognized when the services are performed. Support revenues are recognized ratably over the period to which they relate.\n(c) Warranty Costs\nThe Company warrantees its products for 90 days and provides for estimated warranty costs upon shipment of such products. Warranty costs have not been and are not anticipated to be significant.\nDAVOX CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1995\n(Continued)\n(1) Operations and Significant Accounting Policies (Continued)\n(d) Principles of Consolidation\nThe accompanying 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(e) Postretirement Benefits\nThe Company has no obligations for postretirement or general postemployment benefits.\n(f) Cash and Cash Equivalents\nThe Company considers all highly liquid investments with original maturities of three months or less at the time of acquisition to be cash equivalents.\nIn 1994, the Company adopted Statement of Financial Accounting Standard (SFAS) No. 115, Accounting for Certain Investments in Debt and Equity Securities, effective July 1, 1994. The adoption of SFAS No. 115 did not have a material effect on the Company's financial statements.\n(g) Inventories\nInventories are stated at the lower of first-in, first out (FIFO) cost or market and consist of the following:\nSubassemblies, work-in-process and finished goods inventories include material, and sub-contract labor. Internal labor and overhead are not significant.\nDAVOX CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1995\n(Continued)\n(1) Operations and Significant Accounting Policies (Continued)\n(h) Property and Equipment\nThe Company provides for depreciation and amortization of property and equipment using the straight-line and declining-balance methods by charges to operations in amounts to allocate the cost of the property and equipment over their estimated useful lives. The cost of property and equipment and their useful lives are summarized as follows:\n(i) Research and Development and Software Development Costs\nResearch and development expenses other than software development costs are charged to operations as incurred. In compliance with SFAS No. 86, Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed, certain computer software development costs are capitalized in the accompanying consolidated balance sheets. A change has occurred in the Company's current development cycle, such that the period between the attainment of technological feasibility and the first commercial shipment of a software enhancement has shortened, and the level of capitalizable costs incurred are no longer material. Accordingly, there were no software development costs capitalized during the year ended December 31, 1995. Approximately $310,000 and $784,000 of software costs were capitalized during the years ended December 31, 1994 and 1993, respectively. The Company\nDAVOX CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1995\n(Continued)\n(l) Operations and Significant Accounting Policies (Continued)\n(I) Research and Development and Software Development Costs (continued)\namortizes capitalized software development costs over the resulting products' estimated useful lives of 12 to 36 months beginning with the first shipment of the related product. Approximately $579,000, $685,000, and $614,000 of capitalized software development costs were amortized to expense during the years ended December 31, 1995, 1994 and 1993, respectively.\n(j) Net Income (Loss) per Common and Common Equivalent Share\nNet income per common and common equivalent share has been computed using the weighted average number of common and common equivalent shares outstanding during each period. Common stock and common stock issuable pursuant to stock options and warrants have been reflected as outstanding using the treasury stock method. Common equivalent shares (stock options and warrants) have not been considered in the calculation of net loss per share for the year ended December 31, 1994, as their effect would be antidilutive. Fully diluted net income per common and common equivalent share has not been separately presented as the amounts are not materially different from primary net income per share.\n(k) Recently Issued Accounting Standards\nDuring March 1995, the Financial Accounting Standards Board (FASB) issued SFAS No. 121, Accounting for the Impairment of Long Lived Assets, which is effective for fiscal years beginning after December 15, 1995. The Company does not expect the adoption of these standards to have a material effect on its financial position or results of operations.\n(2) Line of Credit\nThe Company has a secured working capital line of credit (line of credit) with a bank which expires in June 1996, pursuant to which the Company may borrow up to the lesser of $2,000,000 or a percentage of accounts receivable, as defined. Borrowings under the line of credit, will bear interest at the bank's prime rate (8.5% at December 31, 1995) plus 1%. The line of credit is collateralized by a first lien on all corporate assets including intellectual property. There were no borrowings under the line of credit during 1995.\nDAVOX CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1995\n(Continued)\n(3) Accrued Expenses\nAccrued expenses consist of the following:\n(4) Long-term debt\nLong-term debt consists of capital lease purchase obligations at interest rates ranging from 9.8% to 13.15%, collateralized by certain equipment. Total debt was $137,787 and $246,247 with current maturities of $92,896 and $108,459, and long term debt of $44,891 and $137,788 for the years ended December 31, 1995 and 1994, respectively.\n(5) Employee Benefit Plan\nThe Company maintains an Employee Deferred Compensation Savings Plan that covers all employees over 21 years of age who have completed at least six months of service with the Company. Contributions by the Company are discretionary and are determined by the Company's Board of Directors. There were no Company contributions in 1995, 1994 or 1993.\n(6) Income Taxes\nThe Company accounts for income taxes under the liability method in accordance with SFAS No. 109, Accounting for Income Taxes.\nDAVOX CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1995\n(Continued)\n(6) Income Taxes (Continued)\nThe approximate income tax effect of each type of temporary difference comprising the deferred tax asset is approximately as follows:\nThe valuation allowance has been provided to offset the potential deferred tax assets for which realization is not assured.\nAt December 31, 1995, the Company has available net operating loss carryforwards and tax credit carryforwards of approximately $22,154,000 and $577,000 respectively, expiring through 2009. These carryforwards may be used to offset future income taxes payable, if any, and are subject to review by the Internal Revenue Service.\nThe Internal Revenue Code provides that net operating loss carryforwards available to be used in any given year may be limited in the event of certain circumstances, including significant changes in ownership, as defined.\n(7) Commitments\n(a) Operating Lease Commitments\nThe Company leases its facilities and sales offices under operating leases that expire at various dates through May 1999. The Company's lease for its corporate headquarters expires in September 1997. Pursuant to the lease agreements, the Company is responsible for maintenance costs and real estate taxes. Total rental expense for all operating leases for the years ended December 31, 1995, 1994 and 1993 amounted to approximately $551,000, $684,000 and $1,221,000, respectively.\nDAVOX CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1995\n(Continued)\n(7) Commitments (Continued)\n(a) Operating Lease Commitments (continued)\nFuture minimum lease payments by year in the aggregate under operating leases, are approximately as follows at December 31, 1995:\n(b) Capital Lease Commitments\nThe Company leases certain equipment that has been reported as equipment under capital lease and as lease obligations in the accompanying consolidated financial statements. The cost and accumulated amortization of this equipment were approximately $354,000 and $230,000, respectively, at December 31, 1995 and approximately $530,000 and $291,000, respectively, at December 31, 1994.\nFuture minimum lease payments under capital leases are as follows at December 31, 1995:\nDAVOX CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1995\n(Continued)\n(c) Employment and Severance Agreements\nThe Company has entered into employment and severance agreements with certain officers and employees whereby the Company may be required to pay the officers and employees a total of approximately $919,000 upon termination of employment by the Company.\n(8) Litigation\nThe Company is presently engaged in various legal actions and its ultimate liability, if any, cannot be determined at the present time. However, management has consulted with legal counsel and management believes that any such liability will not materially effect the Company's financial position or results of operations.\n(9) Stockholders' Equity\n(a) 1986 Stock Option Plan\nThe Company's 1986 Stock Option Plan (the 1986 Plan) administered by the Board of Directors, authorizes the issuance of a maximum of 1,114,286 shares of common stock for the exercise of options in connection with awards or direct purchases of stock. In August 1994, the Shareholders approved an amendment to increase the number of shares authorized for issuance under the 1986 Plan to 2,114,286. Options granted under the 1986 Plan may be either nonstatutory stock options or options intended to constitute \"incentive stock options\" under the Internal Revenue Code. Stock options may be granted to employees, officers, employee-directors or consultants of the Company and are exercisable in such installments as the Board of Directors may specify. The shares currently vest to the individual over a four-year period. There were 184,261 shares available for future grants under the 1986 Plan at December 31, 1995.\nIn August 1992, the Board of Directors approved an amendment to the Stock Option Agreements under the 1986 Plan, whereby the options expire 10 years from date of grant. The Board of Directors also approved an opportunity for the employees to exchange their existing stock options for new options at the current fair market value. Included in the options granted and canceled during the year ended 1992 are 285,217 options exchanged per this action.\nDAVOX CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1995\n(Continued)\n(9) Stockholders' Equity (Continued)\n(b) Stock Options to Directors\nThe Company's 1988 Non-Employee Director Stock Option Plan (the 1988 Plan), as amended, is administered by the Board of Directors and authorizes the issuance of a maximum of 400,000 shares of common stock for the exercise of options. The 1988 Plan provided for the automatic grant of 40,000 options for each non-employee director in office at the time of the amendment and provides for additional grants of 10,000 options per non-employee director on each biennial anniversary of amendment approval. The 1988 Plan also provides for the automatic grant of 40,000 options to each newly elected non-employee director and additional grants of 10,000 options per biennial anniversary of election to the Board of Directors. Options granted under the 1988 Plan vest 25% per year beginning one year from the date of grant and expire five years from the date of grant. There are 247,500 shares available for future grants under the 1988 Plan.\nThe following is a summary of the stock option activity for all plans for the years ended December 31, 1995, 1994 and 1993:\nDAVOX CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1995\n(Continued)\n(9) Stockholders' Equity (Continued)\n(c) Employee Stock Purchase Plan\nThe Company has adopted an Employee Stock Purchase Plan (the \"Purchase Plan\"), under which a maximum of 100,000 shares of Common Stock may be purchased by eligible employees. Substantially all full-time employees of the Company are eligible to participate in the Purchase Plan.\nThe Purchase Plan provides for two \"purchase periods\" within each of the Company's fiscal years, the first commencing on January 1 of each calendar year and continuing through June 30 of such calendar year, and the second commencing on July 1 of each year and continuing through December 31 of such calendar year. Eligible employees may elect to become participants in the Purchase Plan for a purchase period by completing a stock purchase agreement prior to the first day of the purchase period for which the election is made. Shares are purchased through accumulation of payroll deductions (of not less than 0.5% nor more than 10% of compensation, as defined) for the number of whole shares determined by dividing the balance in the employee's account on the last day of the purchase period by the purchase price per share for the stock determined under the Purchase Plan. The purchase price for the shares will be the lower of 85% of the fair market value of the Common Stock at the beginning of the purchase period, or 85% of such value at the end of the purchase period (rounded to the nearest quarter). During 1995 and 1994, 8,736 and 5,932 shares, respectively were purchased under the Purchase Plan.\n(10) Significant Customers\nRevenues from the Company's largest single customers were 12%, 9%, and 12% of total revenues in 1995, 1994 and 1993, respectively. Revenues from the Company's three largest customers amounted to 20%, 19%, and 30% of total revenues in 1995, 1994 and 1993, respectively.\n(11) Export Sales\nExport product sales, primarily to Canada, Europe, Mexico, Australia and Japan accounted for 12%, 11% and 13% of total net revenues in 1995, 1994 and 1993, respectively.\nDAVOX CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1995\n(Continued)\n(12) Restructuring Costs\nIn the second quarter of 1994, the Company restructured by downsizing in all areas of its operations. This downsizing resulted in a 21% reduction in the Company's work force worldwide. As a result, the Company recorded restructuring costs as follows:\nAs of December 31, 1994, the restructuring had been completed, and there were no additional restructuring charges taken in 1995. The Company had approximately $82,000 of accrued restructuring charges remaining at December 31, 1995. None of the previously accrued expenses were reversed to the Statement of Operations.\nDAVOX CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1995\n(Continued)\n(13) Quarterly Results of Operations (Unaudited)\nThe following table presents a summary of quarterly results of operations for the years ended December 31, 1995 and 1994:\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nON FINANCIAL STATEMENT SCHEDULE\nTo Davox Corporation:\nWe have audited, in accordance with generally accepted auditing standards, the consolidated financial statements of Davox Corporation and subsidiaries included in this Form 10-K, and have issued our report thereon dated January 22, 1996. Our audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule listed in the index 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\nBoston, Massachusetts January 22, 1996\nDAVOX CORPORATION AND SUBSIDIARIES\nSCHEDULE II\nVALUATION AND QUALIFYING ACCOUNTS\n(1) Amounts deemed uncollectible and recoveries of previously reserved amounts.\nACCUMULATED AMORTIZATION OF INTANGIBLE ASSETS:\nITEM 9","section_9":"ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND --------------------------------------------------------------- FINANCIAL DISCLOSURE --------------------\nNot Applicable.\nPART III\nITEM 10","section_9A":"","section_9B":"","section_10":"ITEM 10 DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - -----------------------------------------------------------\nDirectors\nThe information concerning directors of the Company required under this item is incorporated herein by reference to the Company's definitive proxy statement pursuant to Regulation 14A, to be filed with the Commission not later than 120 days after the close of the Company's 1995 fiscal year ended December 31, 1995 under the heading \"Election of Directors.\"\nExecutive Officers\nSee Item 4A.\nITEM 11","section_11":"ITEM 11 EXECUTIVE COMPENSATION - -------------------------------\nThe information required under this item is incorporated herein by reference to the Company's definitive proxy statement pursuant to Regulation 14A, to be filed with the Commission not later than 120 days after the close of the Company's 1995 fiscal year ended December 31, 1995, under the heading \"Compensation and Other Information Concerning Directors and Officers.\"\nITEM 12","section_12":"ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - -----------------------------------------------------------------------\nThe information required under this item is incorporated herein by reference to the Company's definitive proxy statement pursuant to Regulation 14A, to be filed with the Commission not later than 120 days after the close of the Company's 1995 fiscal year ended December 31, 1995, under the headings \"Principal Holders of Voting Securities\" and \"Election of Directors.\"\nITEM 13","section_13":"ITEM 13 CERTAIN RELATIONSHIPS AND TRANSACTIONS - -----------------------------------------------\nThe information required under this item is incorporated herein by reference to the Company's definitive proxy statement pursuant to Regulation 14A, to be filed with the Commission within 120 days after the close of the Company's 1995 fiscal year ended December 31, 1995, under the headings \"Principal Holders of Voting Securities\" and \"Election of Directors.\"\nPART IV\nITEM 14","section_14":"ITEM 14 EXHIBITS, FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON FORM 8-K - --------------------------------------------------------------------------\n(a) Financial Statements and Financial Statement Schedules\n1. Financial Statements.\nThe following financial information is incorporated in Item 8 above.\nReport of Independent Public Accountants\nConsolidated Balance Sheets as of December 31, 1995 and 1994.\nConsolidated Statements of Operations for the years ended December 31, 1995, 1994, and 1993.\nConsolidated Statements of Stockholders' Equity for the years ended December 31, 1995, 1994 and 1993.\nConsolidated Statements of Cash Flows for the years ended December 31, 1995, 1994 and 1993.\nNotes to Consolidated Financial Statements.\n2. Financial Statement Schedule.\nThe following financial information is incorporated in Item 8 above.\nReport of Independent Public Accountants on Schedule II - Valuation and Qualifying Accounts.\nAll other schedules are not submitted because they are not applicable, not required or because the information is included in the Financial Statements or Notes to Financial Statements.\n(b) Reports on Form 8-K\nThe Company did not file any Current Report on Form 8-K during the fourth quarter of the fiscal year ended December 31, 1995.\n(c) List of Exhibits.\nExhibit Number Description of Exhibit ------ ----------------------\n3.01(8) Restated Certificate of Incorporation of the Registrant, as amended.\n(c). List of Exhibits (continued)\n3.02(3) By-laws of the Registrant, as amended.\n4.01(8) Description of Capital Stock contained in the Registrant's Restated Certificate of Incorporation, as amended, filed as Exhibit 3.01.\n4.02(4) Registrant's 10% Subordinated Term Note in the principal amount of $2.3 million due September 1, 1993.\n10.01(12) 1986 Stock Option Plan, as amended, of the Registrant.\n10.02(10) Form of Incentive Stock Option Agreement under the Registrant's 1986 Stock Option Plan.\n10.03(3) Form of Non-Statutory Stock Option Agreement under the Registrant's 1986 Stock Option Plan.\n10.04(3) Incorporation Agreement of the Registrant dated June 1982.\n10.05(5) Manufacturing Agreement dated as of February 20, 1987, between the Registrant and Wong's Electronics Company, Ltd.\n10.06(9) Amended Employment Agreement, dated as of July 20, 1991, by and between the Registrant and Daniel A. Hosage.\n10.07(3) Form of Nondisclosure Agreement.\n10.08(5) Lease Agreement dated June 3, 1987, between the Registrant and William J. Callahan, Trustee.\n10.09(4) Stock Purchase Agreement among the Registrant, The Dispatch Printing Company and TBS International, Inc. dated as of September 15, 1987.\n10.10(9) Amended and Restated 1988 Non-Employee Director Stock Option Plan of the Registrant.\n10.11(5) Form of Option Agreement under the Registrant's 1988 Non-Employee Director Stock Option Plan.\n10.12(6) Asset Purchase Agreement dated August 9, 1988 between the Registrant, DAVOX\/VCT Corporation and Voice Computer Technologies Corporation.\n(c). List of Exhibits (continued)\n10.13(1) Merger Agreement dated December 15, 1988 between the Registrant, DAVOX\/VCT Corporation and TBS International, Inc.\n10.14(10) International Distribution Agreement between the Registrant and Datapoint Corporation dated January 8, 1993.\n10.15(1) Employee Deferred Compensation Savings Plan of the Registrant.\n10.16(8) Pledge Agreement dated September 12, 1990 between the Registrant and Daniel A. Hosage.\n10.17(8) Promissory Note dated September 12, 1990 from Daniel A. Hosage in the principal amount of $100,000.\n10.18(9) Severance Agreement dated June 26, 1991 between the Registrant and Charles E. Carney.\n10.19(9) Severance Agreement dated June 10, 1991 between the Registrant and James F. Mitchell.\n10.20(9) Severance Agreement dated June 10, 1991 between the Registrant and J. Lawrence Doherty.\n10.21(9) 1991 Employee Stock Purchase Plan.\n10.22(10) Third party maintenance agreement dated August 3, 1992 between the Registrant and Grumman Systems Support Corporation.\n10.23(11) Surrender Agreement dated March 23, 1993 between the Registrant and Daniel A. Hosage.\n10.24(11) Notice of Settlement dated November 12, 1993 between the Registrant and Daniel A. Hosage.\n10.25(11) Sublease Agreement dated October 22, 1993 between the Registrant and Digital Equipment Corporation.\n10.26(12) Common Stock Purchase Agreement dated September 23, 1994 between the Registrant and the purchasers named therein.\n(c). List of Exhibits (continued)\n10.27(12) Letter agreement dated December 30, 1994 between the Registrant and Fleet Bank of Massachusetts, N.A.\n10.28 Third party service provider agreement between the Registrant and Grumman Systems Support Corporation.\n22. Subsidiaries of the Registrant.\n24. Consent of Arthur Andersen LLP.\n27. Article 5-Summary Financial Data.\n(1) Previously filed as an exhibit to Form 10-K for the fiscal year ended December 31, 1988.\n(2) Previously filed as an exhibit to Form 10-Q filed on November 11, 1988.\n(3) Previously filed as an exhibit to Registration Statement No. 33-12689 filed on March 17, 1987.\n(4) Previously filed as an exhibit to Form 8-K filed on September 29, 1987.\n(5) Previously filed as an exhibit to Form 10-K for the fiscal year ended December 31, 1987.\n(6) Previously filed as an exhibit to Form 8-K filed on September 15, 1988.\n(7) Previously filed as an exhibit to Form 10-K for the fiscal year ended December 31, 1989.\n(8) Previously filed as an exhibit to Form 10-K for the fiscal year ended December 31, 1990.\n(9) Previously filed as an exhibit to Form 10-K for the fiscal year ended December 31, 1991.\n(10) Previously filed as an exhibit to Form 10-K for the fiscal year ended December 31, 1992.\n(11) Previously filed as an exhibit to Form 10-K for the fiscal year ended December 31, 1993.\n(12) Previously filed as an exhibit to Form 10-K for 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, in the Town of Westford, Commonwealth of Massachusetts, on the 21st day of February 1996.\nDAVOX Corporation\nBy: \/s\/ Alphonse M. Lucchese -------------------------- Alphonse M. Lucchese President, Chief Executive Officer and Chairman\nPOWER OF ATTORNEY\nEach person whose signature appears below this Annual Report on Form 10-K hereby constitutes and appoints Alphonse M. Lucchese and Timothy C. Maguire and each of them, with full power to act without the other, his true and lawful attorney-in- fact and agent, with full power of substitution and resubstitution, for him or her and in his or her name, place and stead in any and all capacities (until revoked in writing) to sign all amendments (including post-effective amendments) to this Annual Report on Form 10-K of Davox Corporation, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary fully to all intents and purposes as he might or could do in person thereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their or his or her substitute, may lawfully do or cause to be done by virtue hereof.\nSIGNATURES\nPursuant to the requirements of the Securities Act of 1934, this Annual report or amendment thereto has been signed below by the following persons in the capacities and on the date indicated.\nSignature Title Date - --------- ----- ----\n\/s\/ Alphonse M. Lucchese President, Chief - ------------------------ Alphonse M. Lucchese Executive Officer and Chairman (Principal Executive Officer) February 21, 1996\n\/s\/ John J. Connolly Vice President of - -------------------- John J. Connolly Finance and Chief Financial Officer (Principal Financial Officer) February 21, 1996\n\/s\/ Michael D. Kaufman Director February 21, 1996 - ---------------------- Michael D. Kaufman\n\/s\/ R. Scott Asen Director February 21, 1996 - ----------------- R. Scott Asen\n\/s\/ Walter J. Levison Director February 21, 1996 - --------------------- W. Levison","section_15":""}
{"filename":"45599_1995.txt","cik":"45599","year":"1995","section_1":"ITEM 1. BUSINESS\nGeneral\nJohn H. Harland Company (the \"Company\" or the \"Registrant\") was founded in 1923 as a general printer and lithographer. The Company, incorporated under the laws of the State of Georgia, with its headquarters in Atlanta, is one of the nation's leading providers of checks, forms and business documents to financial institutions, consumers, brokerage firms and financial software companies. The Company also provides value-added products and services to financial institutions, including database management software systems, and loan origination and platform automation systems. Educational technology products and services are provided by the Company through its Scantron Corporation (\"Scantron\") subsidiary.\nOn October 31, 1995, the Company named Robert J. Amman President and Chief Executive Officer. Robert R. Woodson, formerly President, Chief Executive Officer and Chairman of the Board of Directors, remains as Chairman of the Board Of Directors.\nThe Company serves its major markets through two primary business segments, each of which is described below. Reference is made to Note 14 of the Notes to Consolidated Financial Statements on page of this Annual Report on Form 10-K with respect to information concerning the Company's business segments.\nFinancial Markets\nThe Financial Markets (\"FM\") division is focused on providing products and services to banks, credit unions, brokerage firms and financial software companies. As a result of this focus, the value-added products consisting of compliance solutions and targeted marketing and consulting services provided to financial institutions previously shown as part of the Company's Information Services Group have been combined with the Company's traditional checks and forms printed products (\"core business\").\nIn August 1995, the Company acquired the net assets of dataPRINT, a division of Seattle-based Data Print, Inc. The new entity, Harland dataPRINT, Inc., produces computer-compatible checks and forms, used primarily with personal finance software. Harland dataPRINT, Inc. operates within the FM division.\nFM provides MICR encoded documents and related forms to financial institutions and their customers. FM's product line includes personal and business checks in a variety of multi-colored scenic styles, as well as three- to-a-page, carbonized payroll, voucher, window, and continuous and laser printed computer check formats. Through its specialty print operations, FM produces a variety of small-volume generic and customized products and computer-related documents for financial institutions and other commercial establishments. Such items include custom designed checks, deposit tickets and related products printed with an individual's design and\/or personalization, MICR encoded internal control documents and carbon-interleaved forms.\nThrough strategic alliances with independent companies, FM addresses security and fraud concerns of financial institutions (via TeleCheck Services, Inc.); provides full-service plastic card programs for financial institutions (via Cardpro Services, Inc.); offers point-of-service capability for the\n- 3 -\nproduction of MICR readable documents (via Bottomline Technologies, Inc.); and markets recyclable deposit bags to financial institutions (via Learoyd Packaging, Inc.).\nFM's documents are printed on stock lithographed at six base stock plants. FM imprints checks and related related product documents at 41 check printing facilities in 29 states and in Puerto Rico. All of these plants are principally devoted to printing checks, deposit tickets and related forms. Additionally, FM has five facilities dedicated to specialty print operations.\nFM markets products across the United States, Puerto Rico, the West Indies, Mexico, and Panama. The FM sales and marketing organization solicits customers by type (financial, non-financial and international) to provide solutions that meet the customer's individual needs. Financial customers include community-based and regional financial institutions. Non-financial customers consist of selected retail markets such as superstores, software companies, catalog merchandisers and affinity groups. International customers include financial and non-financial customers in international markets.\nFM also provides value-added products and services to financial institutions, including database management software systems, and loan origination and platform automation systems. These products and services are delivered by two of the Company's subsidiaries; Marketing Profiles, Inc. (\"MPI\") and FormAtion Technologies, Inc. (\"FormAtion\"), and are designed to increase efficiency and profitability within financial institutions. These products and services consist primarily of computer software and related services, database marketing, consulting and direct mail services, and automated compliance solutions.\nThe FM division's principal raw materials are safety paper, form paper and MICR bond paper, which it purchases from a number of large domestic manufacturers. Other raw materials, such as vinyl, inks, checkboards, packaging materials and miscellaneous supplies, are purchased from a number of suppliers. The Company believes that, while recent market conditions have resulted in temporary price volatility with respect to paper purchases, adequate raw materials will be available to support FM's operations.\nFM's primary competitors in the sale of MICR encoded documents and related forms to financial institutions are two other large national printers specializing in check printing, one of which possesses substantially greater sales and financial resources than FM. The Company believes that the primary competitive factors influencing customer buying decisions are printing accuracy, service capabilities, price and the availability of a complete product line. FM compares favorably with its competitors with respect to the factors mentioned above. While accurate statistics with respect to the aggregate level of check production are not readily available, the Company believes that FM is among the largest producers of MICR encoded documents and related forms in the United States. Technological advancements in electronics and personal computers have created possible alternatives to the check as a means for transferring funds. While these alternatives have gained increased market acceptance, the Company believes that they have achieved only limited acceptance among consumers as a preferred method of payment. At this time, the Company cannot accurately predict what future impact these advances in technology may have on FM's check printing business.\nThe market for providing database marketing and automated compliance solutions is growing rapidly within the financial services industry. The Company believes that MPI is a leading provider of database marketing software\n- 4 -\nand related solutions to financial institutions. Competition within the market for supplying automated compliance solutions varies by size of financial institution, and FormAtion competes with many other companies to provide solutions for small as well as large financial institutions.\nThe Company believes that the loss of any one FM customer would not have a materially adverse effect on the Company's consolidated results of operations.\nEducation Markets\nThe Education Markets (\"EM\") segment is focused on providing educational technology products, services and solutions to educational institutions. These products and services are provided by the Company through Scantron.\nIn July 1995, Scantron purchased the net assets of Detroit-based Quality Computers & Applications. This new entity, Scantron Quality Computers, Inc. (\"Quality Computers\"), utilizes catalogs and other direct mail to market a proprietary line of software products and peripheral items. Quality Computers is also an authorized distributor of educational products from industry leaders such as Microsoft, Apple, Claris and Broderbund.\nThe EM segment provides an array of data management solutions for educational institutions. These data management solutions are generated through EM's principal products and services which include data collection (through optical mark reading, optical character recognition and imaging systems), forms printing, field service and a service bureau. EM serves its primary educational market with forms and equipment used to capture, tabulate and analyze data for test scoring and grade reporting. EM also provides educational technology solutions through a proprietary line of software products and peripheral equipment, and is also an authorized distributor of educational software products from a number of leaders in the educational software industry.\nThe EM segment's products are supported through its field service division, which offers maintenance services for the scanning machines and software products related to data collection and analysis activities. EM also operates a service bureau which provides turnkey survey and other data collection solutions to organizations that may or may not own scanning equipment.\nEM markets its products primarily through sales and service representatives throughout the United States and also in Canada. Representatives sell systems, distribute new equipment and provide ongoing assistance, such as machine servicing and forms development to customers. EM's products are also marketed internationally through distributorships, and via direct mail channels.\nThe components used in the assembly and manufacturing of OMR equipment are purchased from equipment manufacturers, supply firms and others. The Company has no reason to believe that the EM segment cannot continue to obtain such materials or suitable substitutes for its operation. EM purchases software for resale from a number of leaders in the educational software industry, and has no reason to believe that it cannot continue to obtain such software in acceptable quantities and at acceptable prices for its operation.\nThe data collection market is a highly fragmented industry, with many\n- 5 -\nlarge and small competitors. EM has focused its efforts within the education market, where scanning technologies utilized by EM are perceived to have an advantage over other methods of data capture and tabulation. The Company believes that Scantron is a leading provider of OMR stand-alone equipment to the educational market in the United States. EM's forms printing operation competes with commercial and specialized forms printers, principally on the basis of product quality, customer service, availability of a complete product line and price to the end user. EM's field service operation competes with various organizations which provide maintenance services, including manufacturers and other national and local field service and maintenance companies. The market for educational software is also highly fragmented, with many large and small competitors. The Company believes that Quality Computers is a leading provider of educational software to educational institutions. The Company believes that the primary factors influencing customer buying decisions in the educational software industry include availability of a broad product line, customer service and price to the end user. EM compares favorably with its competitors with respect to the factors mentioned above.\nThere is a seasonal nature to EM's business in the educational market, but it does not significantly affect the Company's consolidated results.\nThe Company believes that the loss of any one EM customer would not have a materially adverse effect on the Company's consolidated results of operations.\nPatents and Trademarks\nIn 1992, the Company received a patent on a Scannable Form and System developed by Scantron. This patent expires in 2009. Also, the Company has trademarks on names of several of its products and services. While the Company believes these patents and trademarks to be of value, it does not consider any of them to be critical to its operations.\nEmployees\nAs of February 29, 1996, the Company and its subsidiaries employed 6,887 people.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nAs of December 31, 1995, the Company and its subsidiaries owned 47 facilities located in 29 states, all but 3 of which were primarily production and service facilities. The Company leases 16 facilities for printing and\/or warehouse activities. The Company also leases office space for sales and service activities where there are no production facilities, as well as space for 3 of its subsidiaries. These leases have expiration dates ranging from 1996 to 2006. The Company owns its executive offices in Atlanta, Georgia.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIn the ordinary course of business, the Company is subject to various legal proceedings and claims. The Company believes that the ultimate outcome of these matters will not have a material effect on its financial statements.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNot applicable.\n- 6 -\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe following table sets forth information with respect to all executive officers of the Company.\nName Age Office Held Robert R. Woodson 63 Chairman Robert J. Amman 57 President and Chief Executive Officer Joseph M. O'Connell 40 Senior Vice President and Chief Information Officer Mark C. Perlberg 39 Senior Vice President and President, International Markets Division Earl W. Rogers Jr. 47 Senior Vice President and President, Printed Products Division John C. Walters 55 Senior Vice President and General Counsel William M. Dollar 47 Vice President, Finance and Treasurer\nMessrs. Woodson, Rogers and Dollar have been employed as executive officers of the Company for more than the past five years.\nMr. Amman joined the Company in October 1995. Previously, he served as Vice Chairman of First Financial Management Corporation, a diversified information and financial services company, from November 1994 through October 1995. Prior to such time he served as President and Chief Executive Officer of New Valley Corporation, a financial services company, and its Western Union Financial Services subsidiary (\"Western Union\"), since 1988. A petition under Chapter 11 of the Federal Bankruptcy Code was entered against New Valley Corporation in March 1993, and it emerged from bankruptcy in January 1995.\nMr. O'Connell joined the Company in February 1996. He previously served as Chief Operating Officer of National Bancard Corporation (NaBANCO), the world's largest merchant credit card processor, from August 1995 until February 1996. He was employed by Western Union for more than the prior five years, last serving as a corporate Vice President.\nMr. Perlberg joined the Company in February 1996. He was previously employed by Western Union since 1989, last serving as an area Vice President in its international operations.\nMr. Walters joined the Company in January 1996. He previously served as Executive Vice President of First Financial Management Corporation from November 1994 until December 1995. From 1988 until November 1994 he served as Senior Vice President and General Counsel of New Valley Corporation.\nMessrs. Woodson and Amman are also members of the Board of Directors. Officers are elected annually and 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 STOCKHOLDER MATTERS\nSee the information with respect to the market for and number of holders of the Company's common stock, quarterly market information and dividend information which is set forth on page of this Annual Report on Form 10-K. The Company has an established policy of making quarterly dividend payments to shareholders. The Company expects to pay future cash dividends depending upon\n- 7 -\nthe Company's pattern of growth, profitability, financial condition and other factors which the Board of Directors may deem appropriate.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nSee the information with respect to selected financial data on page 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\nSee the information under the caption Management's Discussion and Analysis of Results of Operations and Financial Condition on pages through of this Annual Report on Form 10-K.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nSee the information with respect to Financial Statements and Supplementary Data on pages through and page, respectively, 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 required herein is incorporated by reference to the information under the caption \"Election of Directors\" in the Registrant's Definitive Proxy Statement for the Annual Shareholders' Meeting dated March 14, 1996 (the \"Proxy Statement\"). The information regarding Executive Officers required herein is included in Part I of this report and incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information regarding executive compensation is incorporated by reference to the information under the caption \"Executive Compensation and Other Information\" in the Registrant's Proxy Statement.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required herein is incorporated by reference to the information under the caption \"Election of Directors -- Beneficial Ownership\" in the Registrant's Proxy Statement.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nNot applicable.\n- 8 -\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K Page in this Annual Report on Form 10-k ------------- (a)1. Financial Statements:\nManagement Responsibility for Financial Statements Independent Auditors' Report Consolidated Balance Sheets Consolidated Statements of Income Consolidated Statements of Cash Flows Consolidated Statements of Shareholders' Equity Notes to Consolidated Financial Statements Quarterly Financial Information (unaudited)\n(a)2. Financial Statement Schedules:\nSchedule II. Valuation and Qualifying Accounts S1\n(a)3. Exhibits (Asterisk indicates exhibit previously filed with the Securities and Exchange Commission as indicated in parentheses and incorporated herein by reference.)\n3.1 * Amended and Restated Articles of Incorporation (Exhibit 3.1 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993 (the \"1993 10-K\")). 3.2 * By-Laws, as amended (Exhibit 3(D) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1990 (the \"1990 10-K\")). 4.1 Indenture, as supplemented and amended, relating to 6.75% Convertible Subordinated Debentures due 2011 of Scantron Corporation (omitted pursuant to Item 601(b)(4)(iii) of Regulation S-K; will be furnished to the Commission upon request). 4.2 * Form of Rights Agreement dated as of June 9, 1989, between the Registrant and Citizens and Southern Trust Company (Exhibit 1 to the Registrant's Current Report on Form 8-K dated June 9, 1989). 4.3 * First Amendment dated June 12, 1992 to Rights Agreement dated June 9, 1989 between the Registrant and NationsBank of Georgia Inc., N.A., successor to Citizens and Southern Trust Company (Exhibit 4.1 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1992). 4.4 * Second Amendment dated July 24, 1992 to Rights Agreement dated June 9, 1989 between the Registrant and Trust Company Bank, successor to NationsBank of Georgia Inc., N.A., and to Citizens and Southern Trust Company (Exhibit 4.2 to the Registrant's Quarterly Report on Form 10- Q for the quarter ended September 30, 1992). 4.5 * Note Agreement dated as of December 1, 1993 between the Registrant and the purchasers listed on Schedule I of the agreement, for the issuance and sale of $85,000,000 aggregate principal amount of 6.60% Series A Senior Notes Due December 30, 2008 (Exhibit 4.5 to the 1993 10-K ). 4.6 See Articles IV, V and VIII of the Registrant's Amended and Restated Articles of Incorporation, filed as Exhibit 3.1, and Articles I, V, and VIII of the Registrant's By-Laws, as amended, filed as Exhibit 3.2. 10.1 * Form of Deferred Compensation Agreement between the Registrant and\n- 9 -\nRobert R. Woodson (Exhibit 10.1 to the 1993 10-K). 10.2 * Form of Monthly Benefit Amendment to Deferred Compensation Agreement between the Registrant and Mr. Woodson (Exhibit 10(H) to the 1990 10- K). 10.3 * Form of Deferred Compensation Agreement between the Registrant and William M. Dollar and Earl W. Rogers Jr. (Exhibit 10.3 to the 1993 10-K). 10.4 * Form of Amendment to Deferred Compensation Agreement between the Registrant and Messrs. Woodson, Dollar and Rogers (Exhibit 10.6 to the 1993 10-K). 10.5 * Form of Non-Compete and Termination Agreement between the Registrant and Messrs. Woodson, Dollar and Rogers (Exhibit 10.7 to the 1993 10- K). 10.6 Form of Noncompete and Termination Agreement between the Registrant and Joseph M. O'Connell, Mark C. Perlberg and John C. Walters. 10.7 * Form of Executive Life Insurance Plan between the Registrant Messrs. Woodson, Dollar and Rogers (Exhibit 10.8 to the 1993 10-K). 10.8 * John H. Harland Company 1981 Incentive Stock Option Plan, As Extended (Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1993). 10.9 Amendment to John H. Harland Company 1981 Incentive Stock Option Plan, as Extended, effective April 26, 1996. 10.10 John H. Harland Company Employee Stock Purchase Plan, as amended. 10.11 * Term Loan Agreement dated as of October 25, 1993 between the Registrant and Trust Company Bank for a $15,000,000 Term Loan due 2003 (Exhibit 10.14 to the 1993 10-K). 21.1 Subsidiaries of the Registrant. 23.1 Consent of Independent Auditors. 27 Financial Data Schedule.\n(b) Reports on Form 8-K\nNo reports on Form 8-K were filed by the Registrant during the last quarter of the period covered by this report.\n- 10 -\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nJOHN H. HARLAND COMPANY\nWilliam M. Dollar ____________________ William M. Dollar Vice President, Finance and Treasurer March 29, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, 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 J. Amman 3\/26\/96 Robert R. Woodson 3\/29\/96 ______________________ ________ ______________________ ________ Robert J. Amman Date Robert R. Woodson Date President and Director Chairman and Director (Principal Executive Officer)\nWilliam M. Dollar 3\/29\/96 G. Harold Northrop 3\/26\/96 ______________________ ________ ______________________ ________ William M. Dollar Date G. Harold Northrop Date Vice President, Finance and Treasurer Director (Principal Financial and Accounting Officer)\nH.G. Pattillo 3\/26\/96 ______________________ ________ ______________________ ________ Juanita Powell Baranco Date H.G. Pattillo Date Director Director\nLawrence L. 3\/26\/96 Gellerstedt Jr Larry L. Prince 3\/26\/96 ______________________ ________ ______________________ ________ Lawrence L. Date Larry L. Prince Date Gellerstedt Jr Director Director\nJohn H. Weitnauer, Jr. 3\/25\/96 ______________________ ________ ______________________ ________ Edward J. Hawie Date John H. Weitnauer, Jr. Date Director Director\nJohn J. McMahon, Jr. 3\/25\/96 ______________________ ________ ______________________ ________ John J. McMahon, Jr. Date Robert A. Yellowlees Date Director Director\n- 11 -\nThis page is intentionally left blank.\n- 12 -\nJOHN H. HARLAND COMPANY AND SUBSIDIARIES\nIndex to Information For Inclusion\nin the Annual Report on Form 10-K\nto the Securities and Exchange Commission\nfor the year ended December 31, 1995\nManagement Responsibility For Financial Statements\nIndependent Auditors' Report\nConsolidated Financial Statements and Notes to Consolidated Financial Statements\nSupplemental Financial Information\nManagement's Discussion and Analysis of of Operations and Financial Condition\nSupplemental Financial Statement Schedule S1\n- -\nJOHN H. HARLAND COMPANY AND SUBSIDIARIES MANAGEMENT RESPONSIBILITY FOR FINANCIAL STATEMENTS\nThe financial statements included in this report were prepared by the Company in conformity with generally accepted accounting principles consistently applied. Management's best estimates and judgments were used, where appropriate. Management is responsible for the integrity of the financial statements and for other financial information included in this report. The financial statements have been audited by the Company's independent auditors, Deloitte & Touche LLP. As set forth in their report, their audits were conducted in accordance with generally accepted auditing standards and formed the basis for their opinion on the accompanying financial statements. They consider the Company's control structure and perform such tests and other procedures as they deem necessary to express an opinion on the fairness of the financial statements.\nThe Company maintains a control structure which is designed to provide reasonable assurance that assets are safeguarded and that the financial records reflect the authorized transactions of the Company. As a part of this process, the Company has an internal audit function which assists management in evaluating the adequacy and effectiveness of the control structure.\nThe Audit Committee of the Board of Directors is composed of directors who are neither officers nor employees of the Company. The Committee meets periodically with management, the Director of Internal Audit and the independent auditors to discuss auditing, the Company's control structure and financial reporting matters. The Director of Internal Audit and the independent auditors have full and free access to the Audit Committee.\nWilliam M. Dollar\nWilliam M. Dollar Vice President, Finance and Treasurer\n- -\nINDEPENDENT AUDITORS' REPORT\nTo the Board of Directors and Shareholders of John H. Harland Company:\nWe have audited the accompanying consolidated balance sheets of John H. Harland Company and its subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of income, cash flows and shareholders' equity for each of the three years in the period ended December 31, 1995. Our audits also included the 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 John H. Harland Company and its subsidiaries as of December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.\nDELOITTE & TOUCHE LLP\nDELOITTE & TOUCHE LLP\nAtlanta, Georgia January 26, 1996\n- -\n- -\n- -\n- -\n- -\n- -\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SIGNIFICANT ACCOUNTING POLICIES: Consolidation - The consolidated financial statements include the financial statements of John H. Harland Company and its wholly-owned subsidiaries (the \"Company\"). Intercompany balances and transactions have been eliminated. The Company's 50% investment in an affiliated company is accounted for on the equity method. Use of Estimates - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Cash Equivalents - The Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents. Inventories - Inventories are stated at the lower of cost or market. Cost of inventory for checks and related forms is determined by average costing. Cost of scannable forms and hardware component parts inventories is determined by the first-in, first-out method. Cost of data entry terminals is determined by the specific identification method. Investments - Short-term investments are carried at cost plus accrued interest, which approximates market, and consist primarily of certificates of deposit and demand notes with original maturities in excess of three months. Marketable equity securities included in long- term investments, which are insignificant, are carried at cost which approximates market. Other long-term investments are carried principally at cost. Property, Plant and Equipment - Property, plant and equipment are carried at cost. Depreciation of buildings is computed primarily by the declining balance method. Depreciation of equipment, furniture and fixtures is calculated by the straight-line or sum-of-the-years digits methods. Leasehold improvements are amortized by the straight-line method over the life of the lease or the life of the property, whichever is shorter. Accelerated methods are used for income tax purposes for all property where it is allowed. Goodwill and Other Intangibles - Goodwill represents the excess of acquisition costs over the fair value of net assets of businesses acquired and is amortized on a straight-line basis over periods from 10 to 40 years. Other intangible assets consist primarily of purchased customer lists and non-compete covenants which are amortized on a straight-line basis over periods ranging from 2 to 8 years. Carrying values of goodwill and other intangibles are periodically reviewed to assess recoverability based on expectations of undiscounted cash flows and operating income for each related business unit. Impairments would be recognized in operating results if a permanent diminution in value were expected. The Company also evaluates the amortization periods of intangible assets to determine whether events or circumstances warrant revision to estimated useful lives. The Company believes that no material impairment of goodwill and other intangibles exists at December 31, 1995. Revenue 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 over the period of the agreements. Net Income Per Share - Net income per common share is based on the weighted average number of shares of common stock and common share equivalents outstanding during each year which was 30,557,594 for 1995; 30,516,799 for 1994 and 32,460,128 for 1993. Common share equivalents include the number of shares issuable upon the exercise of the Company's stock options and the conversion of convertible securities, if dilutive.\n- -\nThe difference between primary and fully diluted common share equivalents is not significant. Income Taxes - Effective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS 109\") in which 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. Reclassifications - Certain reclassifications have been made in the 1993 and 1994 financial statements to conform to the 1995 classifications. New Accounting Standards - In March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long- Lived Assets to Be Disposed Of\" (\"SFAS 121\"). SFAS 121 addresses issues surrounding the measurement and recognition of losses when the value of certain assets has been deemed to be permanently impaired. The Company plans to adopt SFAS 121 in 1996 and believes that there will be no material effect on its financial position or results of operations from adopting SFAS 121. In October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation\" (\"SFAS 123\"). SFAS 123 establishes fair value methods of accounting for stock options and other forms of stock-based transactions and is effective for fiscal years beginning after December 15, 1995. Under SFAS 123, companies are not required to adopt a fair value method of accounting for employee stock-based transactions. They are permitted to continue to account for such transactions pursuant to Accounting Principles Board Opinion No. 25 (\"APB 25\") but must disclose pro forma net income and earnings per share as if a fair value method of accounting had been applied. The Company intends to continue accounting for employee stock option transactions in accordance with the requirements of APB 25.\n2. ACQUISITIONS: During 1995, 1994 and 1993, the Company acquired the businesses described below, which were accounted for using the purchase method of accounting. The results of operations of each acquisition are included in the consolidated financial statements from the date of acquisition. Certain of these purchase agreements provide for subsequent contingent payments which, if paid, will be recorded as an increase in goodwill and will be amortized over the remaining life of the associated goodwill. On July 3, 1995, the Company's wholly-owned subsidiary, Scantron Corporation, acquired the net assets of Quality Computers & Applications Inc. (\"QCA\") for cash paid at closing and a contingent purchase payment payable in 1999. The contingent purchase payment is based upon a multiple of QCA 1998 operating results as defined in the acquisition agreement. The acquisition price was funded with proceeds from short-term borrowings. QCA is based in Detroit, Michigan and is a mail-order retailer of software and hardware to the educational technology market.The new entity operates under the name Scantron Quality Computers, Inc. On August 31, 1995, the Company acquired the net assets of dataPRINT (\"dataPRINT\"), a division of Data Print, Inc., for cash and a note payable. The cash paid at closing was funded with proceeds from short- term borrowings. dataPRINT is based in Seattle, Washington and produces computer-compatible forms, particularly forms utilized by personal finance software packages. The new entity operates under the name Harland dataPRINT, Inc. Assets acquired through acquisitions in 1995 totaled $23.1 million, net of liabilities assumed of $1.8 million. Cash paid out for these acquisitions totaled $11.1 million along with a note payable made by the\n- -\nCompany for $12.0 million which was paid in January 1996. Of the total acquisition costs, $20.3 million was preliminarily allocated to intangible assets, of which $10.6 million represented goodwill which is being amortized over 15-20 year periods. On January 7, 1994, the Company acquired Marketing Profiles, Inc. (\"MPI\") for cash paid at closing and a contingent purchase payment payable in 1997 to the former MPI shareholders. The contingent purchase payment is based upon a multiple of MPI's 1996 operating results as defined in the acquisition agreement. In October 1995, the acquisition agreement related to the MPI acquisition was amended to redefine the calculation of the contingent purchase payment and the related terms of payment. In accordance with this amendment, the Company paid $22.7 million in October 1995 to former MPI shareholders for a portion of the contingent purchase payment. The payment was recorded as an increase in goodwill and is being amortized over the remaining estimated life which was approximately 13 years at the time of payment. MPI is a database marketing and consulting company which provides software products and related marketing services to the financial industry. On March 31, 1994, the Company acquired the net assets of FormAtion Technologies, Inc. (\"FormAtion\") for cash paid at closing and a contingent purchase payment payable in 1997 to the former FormAtion shareholders. The contingent purchase payment is based upon a multiple of FormAtion's operating results during the three-year period ending in 1996 as defined in the acquisition agreement. In 1995, the Company paid $2.7 million for early settlement and termination of the contingent purchase agreement. FormAtion develops, markets and supports lending and platform automation software for the financial industry. On September 30, 1994, the Company's wholly-owned subsidiary, Scantron Corporation, acquired the net assets of Financial Products Corporation (\"FPC\") for cash paid at closing. FPC is a provider of maintenance and repair services for a broad variety of computers, peripherals, networks and operating systems. FPC serves financial, commercial, governmental and medical markets. Assets acquired through acquisitions in 1994 totaled $65.4 million, net of liabilities assumed of $18.9 million. The cash paid for these acquisitions totaled $65.0 million and estimated acquisition-related costs totaled $0.4 million. The purchases were funded with a portion of the proceeds received in the December 1993 issuance of long-term debt, proceeds from short-term borrowings and from internally generated funds. In 1995, contingent purchase payments of $25.4 million were made related to these acquisitions. Of the total acquisition costs (including contingent purchase price payments), $84.7 million was allocated to intangible assets, of which $78 million represented goodwill which is being amortized over 10-25 year periods. On January 1, 1993, the Company completed the acquisition of substantially all the net assets of the Denver-based Rocky Mountain Bank Note Company (\"RMBN\") for cash of $37.9 million and acquisition-related costs of approximately $8.9 million. The purchase was funded through short-term borrowings of $18.0 million and by internally generated funds. Assets acquired totaled $46.8 million, net of liabilities assumed of $2.0 million. Of the total acquisition cost, $25.7 million was allocated to intangible assets, of which $10.7 million represented goodwill which is being amortized over a 40 year period. Goodwill and other intangible assets acquired in acquisitions consist of the following as of December 31, (in thousands):\n- -\nThe following represents the unaudited pro forma results of operations which assume the acquisitions occurred at the beginning of the respective year in which the assets were acquired as well as the beginning of the immediately preceding year. These results include certain adjustments, primarily increased amortization of intangible assets, increased interest expense, and reduced interest income and depreciation expense (in thousands of dollars, except per share amounts):\nThe pro forma financial information presented above does not purport to be indicative of either the results of operations that would have occurred had the acquisitions taken place at the beginning of the periods presented or of future consolidated results of operations.\n3. INVESTMENTS AND OTHER ASSETS: Effective January 1, 1994, the Company adopted Statement of Financial Accounting Standards No. 115 \"Accounting for Certain Investments in Debt and Equity Securities\" (\"SFAS 115\"), and accordingly, certain of the Company's investments have been classified as available-for-sale securities. The impact of the adoption of SFAS 115 was not significant to the Company's financial statements. The difference between market value of such investments and cost is not significant at December 31, 1995 and 1994. In 1994, the Company invested $2.3 million in Galas Harland, S.A. de C.V. (\"Galas Harland\"), a check printing joint venture in Mexico. The investment in Galas Harland is accounted for using the equity method. At December 31, 1994, the Company's long-term investments primarily consisted of investments in limited partnerships, Galas Harland and other investments. Other assets consist primarily of capitalized software development costs, which are amortized over a period of three years, prepaid customer incentive payments, which are amortized as a reduction of sales over the life of the related contract and field service parts.\n4. SHORT-TERM DEBT: At December 31, 1995, the Company had available unsecured lines of credit under which it could borrow up to $111 million in the form of short-term notes, for which no compensating balances or commitment fees are required. At December 31, 1995, $23 million was outstanding under these unsecured lines of credit, bearing an average variable interest rate of 6.16%. At December 31, 1994, $14 million was outstanding under these unsecured lines of credit, bearing an average variable interest rate of 6.41%. On August 31, 1995, the Company issued a note payable in the amount of $12 million in conjunction with its acquisition of the net assets of dataPRINT (see note 2). This note payable bears interest at a fixed rate of 4% and was paid in January 1996.\n- -\n5. LONG-TERM DEBT: The Company's long-term debt consisted of the following as of December 31, (in thousands):\nIn December 1993, the Company issued $85 million of Series A Senior Notes (\"Senior Notes\") and arranged a $15 million Term Loan (\"Term Loan\"). The Senior Notes and the Term Loan bear interest at fixed interest rates of 6.60% and 6.63%, respectively. The Senior Notes mature from 2004 to 2008 and the Term Loan is due 2003. The Company's 6.75% convertible subordinated debentures are convertible into common stock of the Company at any time prior to maturity, at a conversion price of $25.17 per share, subject to adjustment in certain events. At December 31, 1995, 328,249 shares of common stock were reserved for conversion of the debentures. The debentures are entitled to an annual mandatory sinking fund, commencing June 1, 1996, calculated to retire 75% of the debentures prior to maturity in 2011. In 1995, the Company acquired $500 thousand face value of debentures and intends to utilize the reacquired debentures to partially satisfy the 1996 sinking fund requirement. The debentures are redeemable, in whole or in part, at any time at the option of the Company at specific redemption prices plus accrued interest. The debentures are subordinated to all senior debt. On July 1, 1994, the Company executed certain agreements under which $4 million face value of Industrial Development Refunding Revenue Bonds - Series 1994 (\"the Bonds\") were issued with interest at variable rates which averaged 3.96% in 1995 and are due 2004. Proceeds from the issuance were used to repay in full the Company's existing Industrial Development Revenue Bond, which matured on July 1, 1994. The debt agreements relating to the Senior Notes, the Term Loan and the Bonds contain certain covenants, the most restrictive of which limit the amount of funded indebtedness of the Company and require the Company to maintain a minimum fixed charge coverage ratio. At December 31, 1995, the Company was in compliance with the covenants associated with these debt instruments. Other long-term debt relates principally to capitalized lease obligations. Annual maturities of long-term debt including sinking fund requirements (less subordinated debentures reacquired) during the next five years are: 1996-$450,000; 1997-$831,000; 1998-$686,000; 1999- $590,000; and 2000-$590,000.\n6. INCOME TAXES: The provision for income taxes for the years ended December 31, 1995, 1994 and 1993 includes the following (in thousands):\n- -\nThe tax effects of significant items comprising the Company's net deferred tax asset and liability as of December 31 are as follows (in thousands):\nA reconciliation between the Federal income tax statutory rate and the Company's effective income tax rate is as follows:\n7. SHAREHOLDERS' EQUITY: Each share of common stock includes a stock purchase right which is not currently exercisable but would become exercisable upon occurrence of certain events as provided for in the Rights Agreement. The rights expire on July 5, 1999.\n- -\n8. EMPLOYEE STOCK PURCHASE PLAN: The Company has an Employee Stock Purchase Plan under which employees are granted an option to purchase shares of the Company's common stock during the quarter in which the option is granted. The option price is 85% of the fair market value of the stock at the beginning or end of the quarter, whichever is lower. Options for shares were exercised at prices ranging from $16.89 to $19.23 in 1995, $17.16 to $18.70 in 1994 and $18.70 to $23.06 in 1993. At December 31, 1995, there were 1,012,090 shares of common stock reserved for purchase under the plan.\n9. STOCK OPTION PLANS: The Company has granted incentive and non- qualified stock options to certain key employees to purchase shares of the Company's common stock at no less than fair market value of the common stock on the date of grant. Prior to 1995, the options generally became fully exercisable one year from date of grant. One grant in 1995, subject to shareholders' approving additional shares for the plan, will vest over a five-year period. Option transactions during the three years ended December 31, 1995 are as follows:\nAt December 31, 1995, there were options for 295,423 shares exercisable and 1,270,952 shares of common stock reserved for options under the plans.\n10. PROFIT SHARING, 401(k) AND DEFERRED COMPENSATION: The Company has a non-contributory profit sharing plan to provide retirement income for most of its employees. The Company is required to contribute to the profit sharing plan's trust fund an amount equal to 7.5% of its income before income taxes and profit sharing contribution plus such additional amount as the Board of Directors may determine, up to a maximum of 15% of the aggregate compensation of participating employees (see Consolidated Statements of Income). The Company has a 401(k) plan for all of its employees and matches a portion of employees' contribution for certain of the company's subsidiaries which do not participate in the previously mentioned profit sharing plan. In January 1996, the Company's Board of Directors approved the merger of the profit sharing plan into the 401(k) plan.\n- -\nThe Company has unfunded deferred compensation agreements with certain officers. The present value of cash benefits payable under the agreements is being provided over the periods of active employment and totaled approximately $4.2 million at December 31, 1995. The charge to expense for the agreements was $317,000 in 1995, $365,000 in 1994 and $345,000 in 1993.\n11. POSTRETIREMENT AND POSTEMPLOYMENT BENEFITS: The Company sponsors two defined postretirement benefit plans that cover qualifying salaried and non-salaried employees. One plan provides health care benefits and the other provides life insurance benefits. The medical plan is contributory and contributions are adjusted annually based on actual claims experience, while the life insurance plan is noncontributory. The Company's intent is that the retiree provide approximately 50% of the actual cost of providing the medical plan. Neither plan is funded. As of December 31, 1995, the accumulated postretirement benefit obligation (\"APBO\") under such plans was $8,657,123. The following table reconciles the plans' status to the accrued postretirement health care and life insurance liability as reflected on the balance sheet as of December 31 (in thousands):\nNet postretirement costs are summarized as follows (in thousands):\nFor measurement purposes, the cost of providing medical benefits was assumed to increase by 10.0% in 1995, decreasing to an annual rate of 7.5% after 1998. The medical cost trend rate assumption could have a significant effect on amounts reported. An increase of 1.0% in the assumed rate of increase would have had the effect of increasing the APBO by $881,000 and the net periodic postretirement cost by $119,000. The weighted average discount rate used in determining the APBO was 7.75% in 1995, 8.0% in 1994 and 7.5% in 1993 and employee earnings were estimated to increase 4.5% annually until age 65. Effective January 1, 1994, the Company adopted Statement of Financial Accounting Standards No. 112 \"Employers' Accounting for Postemployment Benefits\" (\"SFAS 112\"). The adoption of SFAS 112 was not significant to the Company's financial position or results of operations.\n12. 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:\n- -\nShort-term investments - The carrying value approximates fair value because of the short maturity of those instruments. Long-term investments - The fair values of certain investments are estimated based on quoted market prices. The fair values of the Company's investments in limited partnerships are based on estimates by general partners in the absence of readily ascertainable market values. For the Company's other investments, which are not actively traded and are immaterial, fair value is based on an estimate of the net realizable value of those investments. Short-term debt - The carrying value approximates fair value. Long-term debt - The fair value of the Company's convertible debentures is based on recent market quotes. The carrying value of the Company's Industrial Development Refunding Revenue Bonds approximates fair value.The fair value of other long-term debt is based on estimated rates currently available to the Company for debt with similar terms and maturities. The carrying value and estimated fair values of the Company's financial instruments at December 31 are as follows (in thousands):\n13. COMMITMENTS AND CONTINGENCIES: In the ordinary course of business, the Company is subject to various legal proceedings and claims. The Company believes that the ultimate outcome of these matters will not have a material effect on its financial statements. Total rental expense was $8,081,000 in 1995, $9,147,000 in 1994 and $12,257,000 in 1993. Minimum annual rentals under non-cancellable operating leases total $22,920,000 and range from $7,968,000 in 1996 to $1,819,000 in 2000.\n14. BUSINESS SEGMENTS: In 1995, the Company redefined its business based upon markets served. The Financial Markets (\"FM\") segment focuses on providing products and services to banks, credit unions, brokerage firms and financial software companies. As a result, the products consisting of compliance solutions and targeted marketing and consulting services provided to financial institutions previously shown as part of the Information Services Group have been combined with the traditional check and forms printing products in the FM segment. The Education Markets (\"EM\") segment is comprised of products targeted for educational institutions and include data collection\/tabulation solutions, and equipment maintenance solutions. Remaining operations consist primarily of data collection\/tabulation and equipment maintenance solutions for commercial, international and governmental markets. EM and other operations' financial information is not significant and both are combined with corporate items. The Company's operations are primarily in the United States and Puerto Rico. There were no significant intersegment sales and no material amounts of the Company's sales are dependent upon a single customer. Equity investments as well as foreign assets are not significant to the consolidated results of the Company. Operating income excludes interest income, interest expense and other non-operating gains and losses. Corporate assets consist primarily of cash and cash equivalents, investments and other assets not employed in production. Summarized financial information by business segment for 1995, 1994 and 1993 is as follows (in thousands):\n- -\n- -\nJOHN H. HARLAND COMPANY AND SUBSIDIARIES - Supplemental Financial Information\nThe Company's common stock (symbol:JH) is listed on the New York Stock Exchange. At December 31, 1995 there were 8,657 shareholders of record.\n- -\nJOHN H. HARLAND COMPANY AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION\nIn 1995, the Company redefined its business based upon markets served. The Financial Markets (\"FM\") segment is focused on providing products and services to banks, credit unions, brokerage firms and financial software companies. As a result of this focus, the value-added products consisting of compliance solutions and targeted marketing and consulting services provided to financial institutions previously shown as part of the Company's Information Services Group have been combined with the Company's traditional check and forms printing products. The Education Markets (\"EM\") segment is comprised of products targeted for educational institutions and includes data collection\/tabulation and equipment maintenance solutions. The Company's remaining operations consist primarily of data collection\/tabulation and equipment maintenance solutions for commercial, international and governmental markets. Results of Operations 1995 versus 1994 Consolidated net sales increased $40.4 million or 7.7% and represented the Company's 46th consecutive year of sales increases. FM sales totaled $484.3 million, an increase of $21.5 million over the 1994 period. This increase is due in part to the acquisition of dataPRINT (\"dataPRINT\") in August 1995, the growth of a new business established in 1994 and an increase in FM's targeted marketing and consulting services sales. Sales for core check and forms products increased $3.8 million or 0.9% in 1995. This change consisted of a 5.0% decrease in units and a price and product mix increase of 5.9%. The positive price and product mix is attributable in part to price increases implemented in December 1994 and 1995, the acquisition of dataPRINT and revenues from expedited delivery programs. The unit decrease is partially due to the loss during 1994 of one large customer, the loss during 1995 of another large customer and the loss of check orders to direct-to-consumer markets. EM sales increased $4.7 million or 13.0% from the same period in 1994. This increase was principally due to the acquisition of Quality Computers & Applications Inc. (\"QCA\") in July 1995. Sales from the Company's other businesses increased $14.5 million or 66% primarily due to the acquisition of Financial Products Corporation (\"FPC\") in September 1994. Consolidated gross profit increased $10.0 million but decreased as a percentage of sales from 47.9% in 1994 to 46.2% in 1995. FM's gross margin decreased to 46.0% in 1995 from 47.6% in 1994, largely due to paper price increases during 1995, competitive pricing pressures in the core business and increased sales activity in non-traditional printing activities. FM's gross margin decrease was mitigated by gains in production efficiencies and by margin improvements attributable to price increases. EM's gross margin decreased from 52.1% in 1994 to 49.9% in 1995 primarily due to product mix changes and increases in paper costs. Consolidated selling, general and administrative expenses increased by $17.7 million or 13.0%, and increased as a percentage of sales from 26.1% in 1994 to 27.4% in 1995. This increase is primarily due to marketing expenditures associated with The Check Store, Inc. (\"The Check Store\") and expenses attributable to acquired operations. These increases were partially offset by a decrease in FM administrative expenses due primarily to plant consolidation in 1994. Profit sharing costs decreased $2.0 million or 20.6% from 1994. Amortization of intangibles increased by $3.3 million or 28.0%, and increased as a percentage of sales from 2.2% in 1994 to 2.6% in 1995. This increase is primarily attributable to acquisitions during 1994 and 1995: FormAtion Technologies, Inc. (\"FormAtion\"), FPC, QCA and dataPRINT\n- -\nand partial settlement of an earnout with the former owners of Marketing Profiles, Inc. (\"MPI\"). Of the total 1995 amortization of intangibles, $8.7 million relates to assets which are being amortized over five years or less. Other income (expense) decreased from an expense of $6.9 million in 1994 to an expense of $6.3 million in 1995. Gains on sales of certain investments offset an increase in interest expense in 1995. Interest expense increased $1.0 million due to higher average levels of short-term debt in 1995. Income before income taxes decreased $8.2 million or 9.7% and decreased as a percentage of sales from 16.3% in 1994 to 13.7% in 1995. The Company's consolidated effective 1995 income tax rate was 40.2% compared to 39.8% in 1994. Net income decreased $5.2 million or 10.2% and decreased as a percentage of sales from 9.8% in 1994 to 8.2% in 1995. Net income per share in 1995 was $1.51, a 10.1% decrease from $1.68 in 1994. Increases in paper prices had a net dilutive impact of 14 cents per share in 1995 and new businesses (MPI, FormAtion, FPC, QCA, dataPRINT and The Check Store) had a net dilutive impact of 25 cents per share in 1995 as compared to 12 cents per share in 1994. 1994 versus 1993 Consolidated net sales increased $1.8 million or 0.3% over 1993. FM sales totaled $462.8 million, a decrease of $1.7 million from 1993. The Company's core check and forms business experienced a net sales decrease of 6.6% from 1993 comprised of a 9.0% decrease in units and a price and product mix increase of 2.4%. Core check volumes were impacted by the loss of several former Rocky Mountain Bank Note (\"RMBN\") accounts, which had been anticipated when RMBN was acquired in January 1993. Units were also impacted by the loss of a large customer and by a reduction of business under contract with another large customer, although the business retained was renewed at more favorable pricing. The positive price and product mix is attributable in part to a price increase implemented in December 1993 and by the loss of business with certain customers which was priced at a greater discount than average. FM's sales decrease was offset by $26 million in sales and revenues gained from MPI and FormAtion, which were acquired by the Company in January 1994 and March 1994, respectively. Net sales attributable to the EM business segment decreased $1.6 million or 4.2% in 1994. Sales from the Company's other operations increased $5.1 million over 1993 primarily due to the acquisition of FPC in September 1994 which contributed $4.0 million of sales. The remaining increase related to sales to commercial markets which experienced increased revenues from maintenance and other services related to new products and services introduced during 1993 and 1994. Consolidated cost of goods sold decreased $17.1 million or 5.9% from 1993 and decreased as a percentage of sales from 55.6% in 1993 to 52.1% in 1994. FM gross margin improved from 44.0% in 1993 to 47.6% in 1994 attributable to cost reductions realized from consolidations of imprint and base stock facilities, process improvements and other cost reduction efforts. EM and other operations experienced an improvement in gross margin from 48.2% in 1993 to 50.0% in 1994. Cost control improvements and increases in sales of higher margin products and services are the primary reasons for these improvements. Consolidated selling, general and administrative expenses increased by $11.0 million or 8.8% in 1994 and increased as a percentage of consolidated sales from 24.1% in 1993 to 26.1% in 1994. The primary components of this dollar increase were expenses from acquired operations and marketing costs associated with The Check Store. These increases were partially offset by a decrease in FM's core business administrative expenses due to consolidation of RMBN operations acquired in 1993. Profit sharing costs increased $0.3 million or 3.1% over 1993. Amortization of intangibles increased $2.9 million or 33.2% over 1993,\n- -\nand increased as a percentage of consolidated sales from 1.7% in 1993 to 2.2% in 1994. This increase is primarily attributable to the acquisitions of MPI and FormAtion. Of the total 1994 amortization of intangibles, $8.1 million relates to intangible assets which are being amortized over 5 years. Other income (expense) increased from an expense of $1.6 million in 1993 to an expense of $6.9 million in 1994. This increase is principally due to interest associated with the issuance of $100 million in long-term debt in December 1993 at an annual interest rate of 6.6%. Income before income taxes decreased $0.5 million or 0.6% from 1993 and decreased as a percentage of consolidated sales from 16.5% in 1993 to 16.3% in 1994. The effective consolidated income tax rate for 1994 was 39.8% compared to 38.7% in 1993. The primary factors contributing to the increase in the effective rate are impacts of the Omnibus Tax Reconciliation Act of 1993, along with non-deductible intangible assets associated with acquired businesses. For 1994, net income was $51.2 million compared to $52.5 million in 1993, a decrease of $1.3 million or 2.4%. However, net income per share was $1.68 in 1994 versus $1.62 in 1993 or a 3.7% increase. Net income per share increased due to fewer average shares outstanding in 1994, a result of the repurchase of 3.8 million shares of the common stock during 1993. New businesses had a net dilutive impact of 12 cents per share in 1994. Financial Condition, Capital Resources and Liquidity Cash flows provided by operations in 1995 were $78.7 million compared to $107.8 million in 1994. This decrease was primarily due to increases in accounts receivable and inventories in 1995 versus a decrease of the same in 1994. The Company increased its paper stock inventory levels in 1995 to reduce the impact of increases in the cost of paper. Changes in accounts receivable balances generally are a result of the changes in the levels of revenues. The primary uses of funds during 1995 were for acquisitions ($11.1 million for new acquisitions and $25.4 million for contingent purchase payments related to 1994 acquisitions), payments of quarterly dividends to the Company's shareholders, and for capital expenditures. Purchases of property, plant and equipment were $33.4 million in 1995, compared to $37.5 million in 1994. The Company has unsecured lines of credit providing for borrowings up to $111.0 million. At December 31, 1995, $23.0 million was outstanding under these lines of credit. The Company also had a note payable outstanding at December 31,1995 for $12.0 million related to the acquisition of dataPRINT which was paid in January 1996. On December 31, 1995, the Company had $13.3 million in cash and cash equivalents and short-term investments. The Company believes that its current cash position, funds from operations and the availability of funds under its unsecured lines of credit will be sufficient to meet anticipated requirements for working capital, dividends, capital expenditures and other corporate needs, and management is not aware of any condition that would materially alter this trend. The Company also believes that it has sufficient unused debt capacity and access to equity capital markets to pursue additional acquisition opportunities. New Accounting Standards In March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of\" (\"SFAS 121\"). SFAS 121 addresses issues surrounding the measurement and recognition of losses when the value of certain assets has been deemed to be permanently impaired. The Company plans to adopt SFAS 121 in 1996 and believes that there will be no material effect on its financial position or results of operations from adopting SFAS 121. In October 1995, the Financial Accounting Standards Board issued\n- -\nStatement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation\" (\"SFAS 123\"). SFAS 123 establishes fair value methods of accounting for stock options and other forms of stock-based transactions and is effective for fiscal years beginning after December 15, 1995. Under SFAS 123, companies are not required to adopt a fair value method of accounting for employee stock-based transactions. They are permitted to continue to account for such transactions pursuant to Accounting Principles Board Opinion No. 25 (\"APB 25\") but must disclose pro forma net income and earnings per share as if a fair value method of accounting had been applied. The Company intends to continue accounting for employee stock option transactions in accordance with the requirements of APB 25. Outlook In 1996, the Company will conduct an extensive review of its businesses. This review will focus on lowering costs by standardizing and streamlining products, simplifying procedures, eliminating inefficient activities, automating functions and consolidating operations. In addition, the Company will implement a strategy of offering value-added products and services to the financial services marketplace. Future product development activities, tactical acquisitions and the integration of the sales and marketing functions of MPI and FormAtion with the core sales force will reinforce this strategy. The Company expects paper prices to moderate in 1996, but the price increases experienced in 1995 will continue to impact the Company's earnings on a comparative basis. Competitive pricing pressures in the check printing markets are expected to continue for the foreseeable future and will impact the Company's profitability. The Company's focus in the educational and other markets will be on those products and services which are presently profitable. Nonprofitable areas are under evaluation and their ultimate disposition will be based on the immediate prospects.\n- -\n- S1 -\nEXHIBIT INDEX (* indicates document is incorporated by reference) Exhibit Desig- nation Description ______ ___________ 3.1 * Amended and Restated Articles of Incorporation. 3.2 * By-Laws, as amended. 4.1 Indenture, as supplemented and amended, relating to 6.75% Convertible Subordinated Debentures due 2011 of Scantron Corporation (omitted pursuant to Item 601(b)(4)(iii) of Regulation S-K; will be furnished to the Commission upon request). 4.2 * Form of Rights Agreement dated as of June 9, 1989, between the Registrant and Citizens and Southern Trust Company. 4.3 * First Amendment dated June 12, 1992 to Rights Agreement dated June 9, 1989 between the Company and NationsBank of Georgia Inc., N.A., successor to Citizens and Southern Trust Company. 4.4 * Second Amendment dated July 24, 1992 to Rights Agreement dated June 9, 1989 between the Company and Trust Company Bank, successor to NationsBank of Georgia Inc., N.A., and to Citizens and Southern Trust Company. 4.5 * Note Agreement dated as of December 1, 1993 between the Company and the purchasers listed on Schedule I of the agreement, for the issuance and sale of $85,000,000 aggregate principal amount of 6.60% Series A Senior Notes Due December 30, 2008. 4.6 See Articles IV, V and VIII of the Registrant's Amended and Restated Articles of Incorporation, filed as Exhibit 3.1, and Articles I, V, and VIII of the Registrant's By-Laws, as amended, filed as Exhibit 3.2. 10.1 * Form of Deferred Compensation Agreement between the Registrant and Robert R. Woodson. 10.2 * Form of Monthly Benefit Amendment to Deferred Compensation Agreement between the Registrant and Mr. Woodson. 10.3 * Form of Deferred Compensation Agreement between the Registrant and William M. Dollar and Earl W. Rogers Jr. 10.4 * Form of Amendment to Deferred Compensation Agreement between the Registrant and Messrs. Woodson, Dollar and Rogers. 10.5 * Form of Non-Compete and Termination Agreement between the Registrant and Messrs. Woodson, Dollar and Rogers. 10.6 Form of Noncompete and Termination Agreement between the Registrant and Joseph M. O'Connell, Mark C. Perlberg and John C. Walters. 10.7 * Form of Executive Life Insurance Plan between the Registrant and Messrs. Woodson, Dollar and Rogers. 10.8 * John H. Harland Company 1981 Incentive Stock Option Plan, As Extended.\n- X1 -\n10.9 Amendment to John H. Harland Company 1981 Incentive Stock Option Plan, as Extended, effective April 26, 1996. 10.10 John H. Harland Company Employee Stock Purchase Plan, as amended. 10.11 * Term Loan Agreement dated as of October 25, 1993 between the Company and Trust Company Bank for a $15,000,000 Term Loan due 2003. 21.1 Subsidiaries of the Registrant. 23.1 Consent of Independent Auditors 27 Financial Data Schedule\n- X2 -","section_15":""}
{"filename":"203527_1995.txt","cik":"203527","year":"1995","section_1":"Item 1. Business\nVarian Associates, Inc. together with its subsidiaries (hereinafter referred to as the \"Company\" or the \"Registrant\") is a high-technology enterprise which was founded in 1948. It is engaged in the research, development, manufacture, and marketing of products and services for the fields of health care, industrial production, scientific and industrial research, and environmental monitoring. The Company's principal products are health care systems, analytical instruments, and semiconductor production equipment. Its foreign subsidiaries engage in some of the aforementioned businesses and market the Company's products outside the United States. As of September 29, 1995, the Company employed approximately 6,900 people worldwide.\nThe Company sells its products throughout the world and has 34 field sales offices in the U.S. and 53 sales offices in other countries. In general, its markets are quite competitive, characterized by the application of advanced technology and by the development of new products and applications. Many of the Company's competitors are large, well-known manufacturers, and no reliable information is generally available on their sales of similar products.\nThere were no material changes in the kinds of products produced or in the methods of distribution since the beginning of the fiscal year other than the completion of the sale of the Electron Devices business as described under the caption \"Discontinued Operation\" on page 32 of the Annual Report, which information is incorporated herein by reference. The Company anticipates adequate availability of raw materials.\nThe Company's sales to customers outside of the U.S. for 1995 were $797 million. The profitability of such sales is subject to greater fluctuation than U.S. sales because of generally higher marketing costs and changes in the relative value of currencies. Additional information concerning the method of accounting for the Company's foreign currency translation is set forth under the caption \"Foreign Currency Translation\" on page 24 of the Annual Report, which information is incorporated herein by reference.\nThe Company's operations are grouped into three segments. These segments, their products, and the markets they serve are described in the following paragraphs.\nThe Health Care Systems business manufactures and markets linear accelerators, simulators for planning cancer treatments, brachytherapy systems and data management systems for radiation oncology centers. It also designs and manufactures a wide range of X-ray generating tubes for the medical diagnostic imaging market worldwide. Linear accelerators are used in cancer therapy and for industrial radiographic applications. The Company's leading CLINAC(R) series of medical linear accelerators, marketed to hospitals and clinics worldwide, generates therapeutic X-rays and electron beams for cancer treatment. LINATRON(R) linear accelerators are used in industrial applications to X-ray heavy metallic structures for quality control. The Company is active in four primary medical X-ray imaging market segments: CT scanner; diagnostic radiographic\/fluoroscopic; special procedures; and mammography. Backlog for the Health Care Systems business amounted to $293 million and $281 million in fiscal 1995 and 1994, respectively.\nThe Instruments business manufactures, sells, and services a variety of scientific instruments for analyzing chemical substances including metals, inorganic materials, organic compounds, polymers, natural substances, and biochemicals. The products include liquid and gas\nItem 1. (continued)\nchromatographs, gas chromatograph\/mass spectrometers, NMR spectrometers, ultraviolet visible near infrared spectrometers, atomic absorption spectrometers, inductively coupled plasma spectrometers, inductively coupled plasma\/mass spectrometers, data systems, and small, disposable tools used to prepare chemical samples for analysis. Typical applications are biochemical and organic chemical research, measurement of the chemical composition of mixtures, studies of the chemical structure of pure compounds, quality control of manufactured materials, chemical analysis of natural products, and environmental monitoring and measurement. The major markets served are environmental laboratories; pharmaceutical and chemical industries; chemical, life science, and academic research; government laboratories; and specific areas of the health care industry. The Instruments business includes a facility located in Tempe, Arizona, that fabricates circuit boards and sub-assemblies for customers inside and outside the Company. This facility was formerly a part of the Electron Devices business which was sold as of August 11, 1995. Backlog for the Instruments business amounted to $111 million and $97 million in fiscal 1995 and 1994, respectively.\nThe Company's Semiconductor Equipment business manufactures processing systems which are essential to making integrated circuits. A world leader in the development, manufacture, and application of ion implantation and sputtercoating systems, Varian equipment is operating in every major wafer fabrication facility in the world, and its latest models are being used to develop tomorrow's state-of-the-art devices. Backlog for this business amounted to $248 million and $245 million in fiscal 1995 and 1994, respectively. The discontinuance of the semiconductor equipment distribution agreement with Tokyo Electron Limited in the U.S. and Europe was completed effective September 30, 1994.\nAdditional information regarding the Company's lines of business and international operations are incorporated herein by reference from the information provided under the captions \"Industry Segments\" and \"Geographic Segments\" on pages 32-33 of the Annual Report.\nThe Company maintains in-house patent attorneys, holds numerous patents in the United States and in other countries, and has many patent applications pending in the U.S. and in other countries. The Company considers the development of patents through creative research and the maintenance of an active patent program to be advantageous in the conduct of its business, but does not regard the holding of patents as essential to its operations. The Company grants licenses to reliable manufacturers on various terms and cross-licensing arrangements with other parties. Information regarding the Company's research and development costs is incorporated herein by reference from the information provided under the caption \"Research and Development\" on pages 25-26 of the Annual Report.\nThe Company's operations are subject to various federal, state, and\/or local laws regulating the discharge of materials to the environment or otherwise relating to the protection of the environment. The Company is also involved in various stages of environmental investigation and\/or remediation under the direction of or in consultation with federal, state, and\/or local agencies at certain current or former Company facilities (see the information provided under the captions \"Management's Discussion and Analysis\" and \"Contingencies\" on pages 17-19 and 30-32 , respectively, of the Annual Report, which information is incorporated herein by reference). The Company has established reserves for these matters, which reserves management believes are adequate. Based on information currently available, management believes that the Company's compliance with laws which have been adopted regulating the discharge of materials to the environment or relating to the protection of the environment is otherwise not reasonably\nItem 1. (continued)\nlikely to have a material adverse effect on the capital expenditures, earnings or competitive position of the Company. Also, estimated capital expenditures for environmental control facilities are not expected to be material in fiscal 1996, nor are they expected to be material in fiscal 1997.\nExecutive Officers of the Registrant\nThe following table sets forth the names and ages of the Registrant's executive officers, together with positions and offices held within the last five years by such executive officers. Officers are appointed to serve until the meeting of the Board of Directors following the next Annual Meeting of Stockholders and until their successors have been elected and have qualified. Ages are as of December 18, 1995.\nThere is no family relationship between any of the executive officers.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company's executive offices and principal research and manufacturing facilities are located in Palo Alto, California, on 55 acres of land held under leaseholds which expire in the years 2012 through 2058. These facilities are owned by the Company, and provide floor space totaling 735,400 square feet. The following is a summary of the Company's properties at September 29, 1995:\nUtilization of facilities by segment is shown in the following table:\nOther Operations includes manufacturing support.\nThe capacity of these facilities is sufficient to meet current demand. The Company owns substantially all of the machinery and equipment in use in its plants. It is the Company's policy to maintain its plants and equipment in excellent condition and at a high level of efficiency.\nItem 2. (continued)\nManufacturing sites by geographical location are as follows:\nHealth Care Systems California, Illinois, South Carolina, Utah, England, Finland, France, Switzerland\nInstruments California, Massachusetts, Arizona, Australia, Italy\nSemiconductor Equipment California, Massachusetts, Korea\nCompany-owned and staffed sales offices throughout the world are located in North and South America: Brazil, Canada, Mexico, United States; Europe: Austria, Belgium, Denmark, France, Italy, the Netherlands, Spain, Sweden, Switzerland, Finland, England, Germany; and Pacific Basin: Australia, People's Republic of China, Hong Kong, India, Japan, Korea, Singapore, Taiwan.\nItem 3.","section_3":"Item 3. Legal Proceedings\nInformation required by this Item is incorporated herein by reference from the information provided under the caption \"Contingencies\" on pages 30-32 of the Annual Report.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNot applicable.\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters\nThe information required by this Item is incorporated herein by reference from the information provided under the caption \"Common Stock Prices (Unaudited)\" on page 34 of the Annual Report, and the information provided under the caption \"Long-Term Debt\" on page 27 of the Annual Report.\nThe Company's common stock is listed on the New York and Pacific Stock Exchanges under the trading symbol VAR.\nThere were 6,083 holders of record of the Company's common stock on December 1, 1995.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nNote: Certain amounts in prior years have been restated to reflect discontinued operations.\nThis selected financial data should be read in conjunction with the related consolidated financial statements and notes thereto, incorporated herein by reference pursuant to Item 8.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nThe information required by this Item is incorporated herein by reference from the information provided under the caption \"Management's Discussion and Analysis\" on pages 17-19 of the Annual Report.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe information required by this Item is incorporated herein by reference from the Report of Independent Accountants on page 35 of the Annual Report and the Consolidated Financial Statements, Notes to the Consolidated Financial Statements, and Supplementary Data on pages 20-34 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\nThe information required by this Item with respect to the Company's executive officers is incorporated herein by reference from the information under Item 1 of Part I of this Report. The information required by this Item with respect to the Company's directors is incorporated herein by reference from the information provided under the caption \"Election of Directors\" of the Proxy Statement which will be filed with the Commission. The information required by Item 405 of Regulation S-K is incorporated herein by reference from the information provided under the caption \"Securities Exchange Act of 1934\" of the Proxy Statement.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe information required by this item is incorporated herein by reference from the information provided under the caption \"Certain Executive Officer Compensation and Other Information\" 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 herein by reference from the information provided under the caption \"Stock Ownership of Certain Beneficial Owners\" of 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 from the information provided under the captions \"Management Indebtedness and Certain Transactions\" and \"Change in Control Arrangements\" 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 a part of this report:\n(1) Financial Statements The following financial statements of the Registrant and its subsidiaries, and Report of Independent Accountants, are incorporated herein by reference from pages 20 through 33 and page 35 of the Annual Report:\nConsolidated Financial Statements:\nConsolidated Statements of Earnings for fiscal years 1995, 1994, and 1993\nConsolidated Balance Sheets at fiscal year-end 1995 and 1994\nConsolidated Statements of Stockholders' Equity for fiscal years 1995, 1994, and 1993\nConsolidated Statements of Cash Flows for fiscal years 1995, 1994, and 1993\nNotes to the Consolidated Financial Statements\nReport of Independent Accountants\nItem 14. (continued)\n(2) Financial Statement Schedules The following financial statement schedule of the Registrant and its subsidiaries for fiscal years 1995, 1994, and 1993, and the related Reports of Independent Accountants are filed as a part of this Report and should be read in conjunction with the Consolidated Financial Statements of the Registrant and its subsidiaries which are incorporated herein by reference.\nAll other required 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 the notes thereto.\n(3) Exhibits:\n3-a Registrant's Restated Certificate of Incorporation\n3-b Registrant's Bylaws (incorporated herein by reference to the Registrant's Form 10-K for the year ended October 2, 1992).\n4.1 Registrant's Rights Agreement with the First National Bank of Boston, dated August 25, 1986, and Amendment No. 1 dated July 7, 1989 (incorporated herein by reference to Registrant's Form 10-K for the year ended October 1, 1993).\n4.2 Second Amendment to Registrant's Rights Agreement, dated as of November 3, 1995 (incorporated herein by reference to Registrant's Form 8-A\/A Registration Statement filed with the Securities and Exchange Commission on November 6, 1995).\n10.1 Registrant's Omnibus Stock Plan (incorporated herein by reference to Registrant's Form 10-Q for the quarter ended March 31, 1995).\n10.2 Registrant's 1982 Non-Qualified Stock Option Plan (incorporated herein by reference to Exhibit 4.6 to the Registration Statement on Form S-8; File No. 33-33660).\n10.3 Registrant's Restricted Stock Plan (incorporated herein by reference to Exhibit 4 to the Registration Statement on Form S-8; File No. 33-33661).\nItem 14. (continued)\n10.4 Registrant's Management Incentive Plan (incorporated herein by reference to Registrant's Form 10-Q for the quarter ended March 31, 1995).\n10.5 Registrant's Supplemental Retirement Plan (incorporated herein by reference to Registrant's Form 10-Q for the quarter ended June 30, 1995).\n10.6 Registrant's form of Indemnity Agreement with Directors and Executive Officers (incorporated herein by reference to Registrant's Form 10-K for the year ended October 1, 1993).\n10.7 Registrant's form of Change in Control Agreement with Executive Officers other than the Chief Executive Officer (incorporated herein by reference to Registrant's Form 10-K for the year ended October 1, 1993).\n10.8 Registrant's Change in Control Agreement with J. Tracy O'Rourke (incorporated herein by reference to Registrant's Form 10-K for the year ended October 1, 1993).\n10.9 Description of Certain Compensatory Arrangements between Registrant and Directors (incorporated herein by reference to Registrant's Form 10-Q for the quarter ended December 31, 1993).\n10.10 Description of Certain Compensatory Arrangements between Registrant and Executive Officers (incorporated herein by reference to Registrant's Form 10-K for the year ended September 30, 1994).\n10.11 Description of Certain Relocation Arrangements between Registrant and Executive Officers (incorporated herein by reference to Registrant's Form 10-Q for the quarter ended December 30, 1994).\n10.12 Registrant's September 14,1994 Incentive and Separation Agreement with Al D. Wilunowski (incorporated herein by reference to Registrant's Form 10-K for the year ended September 30, 1994).(1)\n11 Computation of earnings per share.\n- -------- (1) Confidential treatment was requested of and granted by the Commission with respect to portions of this exhibit.\nItem 14. (continued)\n13 Registrant's 1995 Annual Report to Stockholders (furnished for the information of the Securities and Exchange Commission only and not deemed to be filed except for those portions expressly incorporated by reference herein).\n21 Subsidiaries of the Registrant.\n23 Consent of Independent Accountants.\n24 Power of Attorney by directors of the Company authorizing certain persons to sign this Annual Report on Form 10-K on their behalf.\n27 Financial Data Schedule for the fiscal year ended September 29, 1995.\n27.1 Restated Financial Data Schedule for the fiscal year ended September 30, 1994.\n27.2 Restated Financial Data Schedule for the quarter ended December 30, 1994\n27.3 Restated Financial Data Schedule for the quarter ended March 31, 1995.\n27.4 Restated Financial Data Schedule for the quarter ended June 30, 1995.\n(b) Reports on Form 8-K:\nA report on Form 8-K was filed on August 23, 1995, regarding the Registrant's sale of its Electron Devices business to a company formed at the direction of Leonard Green & Partners, L.P.\nItem 14. (continued)\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Varian Associates, Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nVARIAN ASSOCIATES, INC. (Registrant)\nDated: December 14, 1995 By: \/s\/ Robert A. Lemos -------------------- Robert A. Lemos Vice President, Finance, 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 below.\n- ------------------------------------- ** By authority of powers of attorney filed herewith.\nReport of Independent Accountants on\nFinancial Statement Schedules\nTo the Board of Directors and Stockholders of Varian Associates, Inc.\nOur report on the consolidated financial statements dated October 18,1995 appears on page 35 of the 1995 Annual Report to Stockholders of Varian Associates, Inc. and subsidiary companies (which report and consolidated financial statements are incorporated by reference in this Annual Report on Form 10-K). In connection with our audits of such financial statements, we have also audited the Financial Statement Schedule listed in the index on page 10 of this Form 10-K.\nIn our opinion, the financial statement schedule referred to above, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.\n\/s\/ Coopers & Lybrand L.L.P. ----------------------------- Coopers & Lybrand L.L.P.\nSan Jose, California October 18, 1995\nSCHEDULE II\nVARIAN ASSOCIATES, INC. AND SUBSIDIARY COMPANIES VALUATION AND QUALIFYING ACCOUNTS (1) for the fiscal years ended 1995, 1994, and 1993 (Dollars in Thousands)\n(1) As to column omitted the answer is \"none\".\nINDEX OF EXHIBITS\n- ----------- (1) Confidential treatment was requested of and granted by the Commission with respect to portions of this exhibit.","section_15":""}
{"filename":"102741_1995.txt","cik":"102741","year":"1995","section_1":"ITEM 1. BUSINESS\nDESCRIPTION\nThe Valspar Corporation (the \"Company\") is a paint and coatings manufacturer and has one reportable industry segment. Operating groups of the Company are organized so as to reflect classes of similar products, and the following table shows the percentage of net sales for these groups for the past three fiscal years.\nClass of Products 1995 1994 1993 ----------------- ---- ---- ----\nConsumer Coatings 34% 31% 30% Packaging Coatings 27 25 27 Industrial Coatings 25 23 23 Special Products 14 21 20\nPRODUCTS AND DISTRIBUTION METHODS\nThe Company is engaged in the manufacture and distribution of paint and coatings through its Consumer Coatings, Industrial Coatings, Packaging Coatings and Special Products groups.\nThe CONSUMER COATINGS group manufactures and distributes a full line of latex and oil-based paints, stains and varnishes serving primarily the do-it-yourself market. Its products are marketed under proprietary brands (Colony, Valspar, Enterprise, Magicolor, McCloskey, BPS and Masury) and under private labels. Colony, Valspar, Enterprise and McCloskey paint sales are directed primarily to home improvement centers. Magicolor's marketing focus is mass merchants and the branded products of Masury and Valspar are sold directly to paint specialty stores and independent building material outlets. Private label and BPS consumer products are primarily sold to hardware wholesalers, home center chains, farm store chains and farm cooperatives. A group of specialty products, which includes Valspar and McCloskey varnishes, clear polyurethanes, interior stains and marine paints, is sold nationally through all of these channels. Merchandising assistance is provided to consumer customers in the form of seasonal promotion programs, cooperative advertising on a local basis, informational literature and self-merchandised displays. Consumer products are distributed throughout the United States, primarily from factory warehouses and warehouse distribution centers.\nThe primary manufacturing plants for CONSUMER COATINGS are located in Azusa, California; Garland, Texas; Philadelphia, Pennsylvania; Rockford, Illinois; Tampa, Florida; and Wheeling, Illinois. The latex manufacturing plant in Wheeling is one of the most modern facilities in the consumer paint industry. The Garland plant is also a very modern manufacturing facility providing needed capacity for producing consumer latex paint, industrial coatings, packaging coatings and resins. During 1995, production began at our newest facility in Statesville, North Carolina.\nThe PACKAGING COATINGS group is the largest coatings supplier to the rigid packaging industry in North America and a major licensor of the related technology to coatings companies throughout the world. Packaging coatings for application to food and beverage can bodies and ends comprise the largest volume of sales by this group. Great care is taken to ensure that these coatings meet F.D.A. and U.S.D.A. standards. Also produced are coatings for aerosol cans, bottle crowns, closures for glass bottles, and coatings for flexible packaging-paper, film and foil substrates. In 1995, the Packaging Coatings Group expanded its operations to the Far East by opening a sales office in Hong Kong to sell to and service customers in the Peoples Republic of China and in Southeast Asia. The group also entered into a joint venture with a large Chinese company for the manufacture of packaging coatings in the Peoples Republic of China which is expected to begin operations in mid 1996. During 1995, the Packaging Group expanded its international operations by establishing wholly-owned foreign subsidiaries in the United Kingdom, The Valspar (UK) Corporation, Limited, and Australia, The Valspar (Australia) Corporation Pty, Limited. Toll manufacturing arrangements were contracted and sales representatives hired to support these subsidiaries.\nThe primary manufacturing plants for the PACKAGING COATINGS group are in Azusa, California; Covington, Georgia; Garland, Texas; Pittsburgh, Pennsylvania; Rochester, Pennsylvania; and West Hill, Ontario, Canada.\nThe INDUSTRIAL COATINGS group manufactures and distributes, primarily in the United States and Canada, decorative and protective coatings for application to wood, metal and plastic substrates. The Company is a major supplier of finishes to the furniture and wood paneling industry. Products include fillers, primers, stains and topcoats which are sold for such diversified end uses as exterior siding, prefinished flooring, interior wall paneling, kitchen cabinets, pianos and furniture. For metal and plastic substrates a large variety of coatings are formulated to meet customers' needs and, when required, to meet EPA requirements through the use of such technologies as electrodeposition, powder, high solids, water-borne and UV light cured coatings. These products are used by a wide range of industries including the railcar, appliance, office furniture, agricultural and construction equipment and metal fabrication industries. The Company also supplies coating systems to the coil coatings industry which are used to coat coils of metal prior to fabrication into products for such markets as pre-engineered buildings, doors, lighting fixtures and appliances. In late 1994, the Industrial Group established a foreign subsidiary in Singapore, The Valspar (Singapore) Corporation Pte Ltd, to manufacture and sell fluorocarbon coatings for architectural applications in the Far East. The Company does not sell to original equipment manufacturers. The acquisition of Sunbelt Coatings, a manufacturer of automotive and fleet refinish coatings, was completed in March 1995. The new company, Valspar Sunbelt, established a sales force and distribution network throughout the United States and Canada. The Company is focusing on strengthening its presence in the fleet, refinish, coatings sector and the production shop\/light industrial refinish sector. The Company is also a supplier for auto under-body, under-hood, exterior and interior trim parts.\nThe manufacturing plants for the INDUSTRIAL COATINGS group are located at Fort Wayne, Indiana; Garland, Texas; High Point, North Carolina; Jackson, Tennessee; Kankakee, Illinois; and West Hill, Ontario, Canada.\nThe SPECIAL PRODUCTS group is engaged in the production and marketing, primarily in the United States, of resins and emulsions for coatings, heavy duty maintenance and marine coatings, high performance floor coatings for industrial and commercial use, colorants and colorant systems. Emulsions and resins are produced at the Company's facilities in Los Angeles, California; Garland, Texas; Kankakee, Marengo and Rockford, Illinois for use by the Company and for sale to other coatings manufacturers. Certain resin operations previously included in the Company's McWhorter subsidiary were distributed to the Company's shareholders in the form of a stock dividend at the time of the spin-off of McWhorter Technologies, Inc. in April 1994. Following the spin-off, the Company retained the resin operations located in Los Angeles, Rockford, Kankakee and Garland as described above. The spin-off is described in Note C to the Consolidated Financial Statements on pages 15 and 16 of Valspar's 1995 Annual Report to Stockholders incorporated by reference into this Form 10-K. In May 1995, production of emulsions began at a new resin plant in Marengo, Illinois to support the growth of the Company's consumer paint business and to better service external customers. Heavy duty maintenance coatings are formulated for applicators with highly corrosive and other harsh environmental exposures requiring specialized coatings technology. Major markets are petrochemical units, utilities, nuclear plants, paper mills, food processing and pharmaceutical plants, waste and water treatment facilities, off-shore oil structures and the marine industry. Heavy duty maintenance and marine coatings are primarily manufactured in Beaumont, Texas and Garland, Texas. Also distributed through its Federal International Chemical division are specialty coatings and resurfacers for concrete and wood floors. These products are produced at Federal's plant in Chicago, Illinois. Paint colorants, manufactured at the Company's facility in Rockford, Illinois, are used by retail paint dealers to color paint to customer specification. These colorants are used to support the Company's consumer business and are sold directly to external customers. During 1994, new colorant capacity was added to the Company's Louisville, Kentucky plant. This state-of-the-art facility primarily produces colorants to serve the industrial segment as well as provide additional trade sales colorant capacity.\nThe Company invested in two joint ventures during the first quarter of 1993. To expand coatings sales in the Mexican and Central American markets, the Company formed a joint venture with Pinturas Atlas Marlux called Valspar-Marlux to engage in the marketing, sales, distribution and technical service of packaging, coil, wood and general metals coatings. To further develop the professional paint market served by home centers, the Company entered into a sales and marketing joint venture with Smiland Paint Company called Conco Paint Company. In each venture, both the Company and its joint venture partner manufacture the products sold by the joint venture.\nRAW MATERIALS\nMaterials are procured from a number of suppliers. Many of these raw materials are petroleum based derivatives, including olefin and natural gas derivatives, as well as mined products. Under normal conditions all of these materials are generally available on the open market, although prices and availability are subject to fluctuation from time to time.\nPATENTS\nThe Company's business is not materially dependent upon franchises, licenses or similar rights, or on any single patent or trademark or group of related patents or trademarks.\nSEASONALITY AND WORKING CAPITAL ITEMS\nThe Company's sales volume is traditionally highest during the third quarter of the fiscal year. This seasonality is due to the buying cycle of the consumer paint and heavy duty maintenance businesses. During the first quarter, when sales are generally lowest, the Company builds inventory, the financing for which is provided primarily by internally generated funds and short-term credit lines discussed in Note F of the Notes to Consolidated Financial Statements on page 17 of Valspar's 1995 Annual Report to Stockholders incorporated by reference into this Form 10-K.\nSIGNIFICANT CUSTOMERS\nIn 1995, the Company's sales to Lowe's Companies, Inc. exceeded 10% of consolidated net sales.\nBACKLOG AND GOVERNMENT CONTRACTS\nThe Company has no significant backlog of orders and generally is able to fill orders on a current basis.\nNo material portion of the business of the Company is subject to renegotiation of profit or termination of contracts or subcontracts at the election of the government.\nCOMPETITION\nAll aspects of the paint and coatings business are highly competitive. There are approximately 800 domestic paint and coatings manufacturers, and the Company now ranks sixth in North America with less than 5% of the market.\nPrincipal methods of competition for consumer coatings and specialty paint products include price, consumer recognition, product innovation, product quality and rapid response to customer orders. The Company offers merchandising and promotion programs to its consumer customers to counter the extensive advertising programs of some of its competitors, and has maintained product recognition through high quality, well-designed products.\nPrincipal methods of competition for industrial and packaging coatings are technical capabilities for specific product formulation, ability to meet customer delivery requirements, technical assistance to the customer in product application, price and new product concepts. The Company believes that its industrial and packaging coatings are competitive in these respects in the industries it serves. The markets for these coatings are increasingly global and the Company is taking measures to establish a presence in Asia and Europe to address these important markets.\nPrincipal methods of competition for resins and emulsions, heavy duty maintenance coatings and high performance floor coatings are product quality, rapid response to customer orders, technical assistance to the customer in product application, price and new product development. The Company believes it is competitive in these respects in the Special Products business discussed previously.\nThe Company competes in the colorant and colorant systems business with fewer than five colorant manufacturers. The Company ranks second in sales to the largest colorant producer, which has greater than 50% of U.S. colorant sales. Competitive factors include color design and range, product quality, compatibility with various types of paint bases, dealer merchandising assistance and price. The Company believes that it is competitive in these respects.\nRESEARCH AND DEVELOPMENT\nResearch and development costs for fiscal 1995 were $27,746,000, representing a 1.2% increase over fiscal 1994 ($27,430,000). Fiscal 1994 costs increased 9.9% over those of fiscal 1993 ($24,955,000). Primary emphasis has been in emerging technologies in the industrial and packaging coatings markets.\nENVIRONMENTAL COMPLIANCE\nThe Company undertakes to comply with applicable regulations relating to protection of the environment and workers' safety. Capital expenditures for this purpose were not material in fiscal 1995, and capital expenditures for 1996 to comply with existing laws and regulations are also not expected to be material.\nEMPLOYEES\nThe Company employs approximately 2,500 persons, approximately 482 of whom are members of unions.\nFOREIGN OPERATIONS AND EXPORT SALES\nThe Company's plant in West Hill, Ontario, Canada manufactures and distributes packaging, coil and general industrial coatings for the Canadian market. Other than the business of the Canadian subsidiary, the Company's foreign operations consist primarily of licensing and joint venture arrangements. Technologies for packaging and heavy duty maintenance coatings, colorants, powder coatings and general industrial coatings are currently licensed to paint and coating manufacturers in over twenty foreign countries. The markets for industrial and packaging coatings are becoming increasingly global. To capitalize on this globalization, the Company is reducing its reliance on licensing agreements in various foreign countries and placing greater emphasis on joint ventures which provide the Company an equity interest and permit the Company to exert greater control over the use of its technology. Export sales are not material.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's principal offices in Minneapolis, Minnesota are owned. Operations are conducted at eighteen locations, primarily in Illinois, California, Texas and Pennsylvania with one plant in West Hill, Ontario, Canada. Fifteen plants with square footage of 2,270,000 are owned and three of the plants with square footage of 250,000 are leased. The Statesville, North Carolina plant with 50,000 square footage and the Marengo, Illinois plant with 52,000 square footage began production in 1995.\nThe Company considers that the principal properties and facilities owned or leased by it are adequately maintained, in good operating condition and are adequate for the purposes for which they are being used. Operating capacity varies by division, but for most of the Company's businesses, additional productive capacity is available by increasing the number of shifts worked.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is involved in various claims relating to environmental and waste disposal matters at the sites of a number of current and former plants. The Company participates in remedial and other environmental compliance activities at certain of these sites. At other sites, the Company has been named as a potentially responsible party (PRP) under federal and state environmental laws for the remediation of hazardous waste. While uncertainties exist with respect to the amounts and timing of the Company's ultimate environmental liabilities, the Company believes that such liabilities, individually and in the aggregate, will not have a material adverse effect on the Company's financial condition or results of operations. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" on pages 8 through 10 of the Company's 1995 Annual Report to Stockholders incorporated by reference into this Form 10-K.\nThe Company is a defendant in a number of other legal proceedings which it believes are not out of the ordinary in a business of the type and size in which it is engaged. The Company believes that these legal proceedings, individually and in the aggregate, will not have a material adverse effect on its business or financial condition.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThere was no matter submitted during the fourth quarter of fiscal year 1995 to a vote of security holders.\n- --------------------------------\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe names and ages of all of the registrant's executive officers, all of whose terms expire in February 1996, and the positions held by them are as listed below. There are no family relationships between any of the officers or between any officer and director.\nThe foregoing executive officers have served in the stated capacity for the registrant during the past five years, except for the following:\nPrior to October 1995, Mr. Wurtele was Chief Executive Officer since February 1973.\nPrior to March 1994, Mr. Pajor was President and Chief Operating Officer since June 1981.\nPrior to March 1994, Mr. Rompala was Group Vice President-Coatings and Resins since January 1992 and Group Vice President -Chemicals since June 1987 at PPG Industries, Inc.\nPrior to August 1993, Mr. Briggs was Vice President, Consumer Sales since February 1992. Previously he held the position of Vice President, Color Corporation of America and McCloskey since December 1991 and was General Manager, Color Corporation of America since November 1989.\nPrior to April 1993, Mr. Engh was a partner of Lindquist & Vennum, a Minneapolis, Minnesota law firm, since 1986.\nPrior to June 1991, Mr. Erdahl was Vice President, Metal Coatings since October 1989.\nPrior to February 1991, Mr. Mansfield was Vice President, Packaging Coatings since July 1990.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe information in the section titled \"Stock Information and Dividends\" on page 7 of Valspar's 1995 Annual Report to Stockholders is incorporated herein by reference. All market prices indicated in this section represent transactions on the New York Stock Exchange. The number of record holders of the Company's Common Stock at December 29, 1995 was 1,845.\nThe quarterly dividend declared December 13, 1995, which was paid January 15, 1996 to Common Stockholders of record December 29, 1995, was increased to 16.5(cent) per share.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe information in the section titled \"Eleven Year Financial Summary\" for the years 1991 through 1995 on pages 6 and 7 of Valspar's 1995 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\nThe information in the section titled \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" on pages 8 through 10 of Valspar's 1995 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 and notes thereto on pages 11 through 19 of Valspar's 1995 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 regarding directors set forth on pages 2 and 3 of Valspar's Proxy Statement dated January 26, 1996 is incorporated herein by reference. The information regarding executive officers is set forth in Part I of this report.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information in the section titled \"Executive Compensation\" on pages 6 through 8 and the section titled \"Director Compensation\" on pages 4 and 5 of Valspar's Proxy Statement dated January 26, 1996 is incorporated herein by reference. The information on pages 8 through 11 of Valspar's Proxy Statement dated January 26, 1996 is not incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information in the section titled \"Share Ownership of Certain Beneficial Owners\" and \"Share Ownership of Management\" on pages 15 and 16 of Valspar's Proxy Statement dated January 26, 1996 is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information in the section titled \"Certain Transactions\" on page 5 of Valspar's Proxy Statement dated January 26, 1996 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) For financial statements and financial statement schedule filed as a part of this report, reference is made to \"Index to Financial Statements and Financial Statement Schedule\" on page of this report. For a list of exhibits filed as a part of this report, see Item 14(c) below. Compensatory Plans listed in Item 14(c) are denoted by a double asterisk.\n(b) No reports on Form 8-K were filed during the fourth quarter of the year ended October 27, 1995.\n(c) The following exhibits are filed as part of this report.\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K (CONTINUED)\nPortions of the 1996 Proxy Statement are incorporated herein by reference as set forth in Items 10, 11, 12 and 13 of this report. Only those portions expressly incorporated by reference herein shall be deemed filed with the Commission.\n(d) See page 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.\nTHE VALSPAR CORPORATION\nJanuary 22, 1996 \/s\/ Rolf Engh Rolf Engh, 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.\nAnnual Report on Form 10-K\nItem 14(a)(1) and (2), (c) and (d)\nFinancial Statements and Financial Statement Schedule\nCertain Exhibits\nYear ended October 27, 1995\nTHE VALSPAR CORPORATION Minneapolis, Minnesota\nThe Valspar Corporation\nForm 10-K--Item 14(a)(1) and (2) and Item 14(d)\nIndex to Financial Statements and Financial Statement Schedule\nThe following consolidated financial statements of The Valspar Corporation and subsidiaries are incorporated in Part II, Item 8, and Part IV, Item 14(a) of this report by reference to the Registrant's Annual Report to Stockholders for the year ended October 27, 1995:\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(1) Uncollectible accounts written off.\n(2) Recoveries on accounts previously written off.\n(3) Amount spun off to McWhorter Technologies, Inc. on April 29, 1994 (see Note B in Annual Report.)\nINDEX TO EXHIBITS FILED WITH THIS REPORT\nTHE VALSPAR CORPORATION\nINDEX TO EXHIBITS FILED WITH THIS REPORT (continued)\nTHE VALSPAR CORPORATION","section_15":""}
{"filename":"752743_1995.txt","cik":"752743","year":"1995","section_1":"Item 1. Business\nT. Rowe Price Realty Income Fund I, A No-Load Limited Partnership (the \"Partnership\"), was formed on August 31, 1984, under the Maryland Revised Uniform Limited Partnership Act for the purpose of acquiring, operating and disposing of existing income-producing commercial and industrial real estate properties. On December 7, 1984, the Partnership commenced an offering of $100,000,000 of Limited Partnership Units ($1,000 per Unit) pursuant to a Registration Statement on Form S-11 under the Securities Act of 1933 (Registration No. 2-93160) (the \"Registration Statement\"). The Prospectus filed pursuant to Rule 424(b) under the Securities Act of 1933 (the \"Prospectus\") as supplemented on April 24, 1985 (the \"Supplement\") sets forth a complete description of the business of the Partnership in the sections entitled \"Investment Objectives\" and \"Fund Policies,\" on pages 19-29 of the Prospectus which pages are incorporated by reference herein. The Gross Proceeds from the offering, combined with the contribution of $10,000 from the Initial Limited Partners totaled $90,622,000. The offering terminated in May 1985, and no additional Units will be sold. As of December 15, 1995 there were 17,758 Limited Partners.\nIn December of 1991, LaSalle Advisors Limited Partnership (\"LaSalle\") entered into a contract with the Partnership and T. Rowe Price Realty Income Fund I Management, Inc. (the \"General Partner\") to perform day-to-day management and real estate advisory services for the Partnership under the supervision of the General Partner and its Affiliates. LaSalle's duties under the contract include disposition and asset management services, including recordkeeping, contracting with tenants and service providers, and preparation of financial statements and other reports for management use. The General Partner continues to be responsible for overall supervision and administration of the Partnership's operations, including setting policies and making all disposition decisions, and the General Partner and its Affiliates continue to provide administrative, advisory, and oversight services to the Partnership. Compensation to LaSalle from the Partnership consists of accountable expense reimbursements, subject to a fixed maximum amount per year. All other compensation to LaSalle is paid out of compensation and distributions paid to the General Partner by the Partnership.\nThe Partnership is engaged solely in the business of real estate investment, therefore, presentation of information about industry segments is not applicable. In the current period, three of the Partnership's properties were responsible for 15% or more of revenues from operating activities. Montgomery Executive Center provided 27%, The Business Park provided 17%, and Royal Biltmore provided 15%. In fiscal 1994, two properties were responsible for 15% or more of revenues from operating\nactivities: Montgomery Executive Center provided 28%, and The Business Park provided 15%. In fiscal 1993, only Montgomery Executive Center was responsible for 15% or more of revenues from operations, providing 25% thereof.\nThe Partnership currently owns the properties set forth in Schedule III to this Report, \"Consolidated Real Estate and Accumulated Depreciation,\" which is incorporated by reference herein and contains information as to acquisition date and total cost of each of the properties. In all cases the interests were purchased for cash, and in all cases land and improvements are owned 100% in fee simple. Additional information regarding these properties, including size and percentage leased as of September 30, 1995, is set forth in Exhibit 28(b) to this Report, \"Real Estate Investments,\" which is incorporated by reference herein. A brief narrative description of each property the Partnership currently owns follows.\nSpring Creek (Richardson, Texas)\nThe Spring Creek building is one of eight similarly designed research and development buildings that collectively comprise the Spring Creek Business Park, located in the high-tech area of Richardson, Texas. This 51,000 square foot property became 100% leased in May 1993 when the single tenant, JM Computers, expanded (as required per their lease) into the entire building. In 1993 the Partnership approved a plan submitted by LaSalle for the disposition of Spring Creek, and in 1995 began actively marketing the property for sale. In connection therewith the property's valuation allowance which was established in 1993 has been adjusted to $1,437,000 as of fiscal year-end 1995. This allowance is based on management's estimate of the net realizable proceeds of such a sale.\nThe Spring Creek building is part of the Richardson Tech Corridor industrial submarket which is situated along Dallas' Far North Central Expressway. This area has the highest concentration of high technology companies in the Dallas-Ft. Worth marketplace including such firms as Texas Instruments, MCI, EDS, DSC Communications, and Convex. The current submarket vacancy of 10% is down somewhat from last year's 12% vacancy rate. The market has continued to show signs of strengthening with positive absorption for technology and warehouse space. Thus, rental rates have risen approximately 6% over the previous year.\nThis property competes in the Richardson\/Plano flex space submarket which totals approximately 8.0 million square feet. Within that submarket, it competes directly with a group of facilities ranging from 35,000 square feet to 108,000 square feet. All are located within a one mile radius of Spring Creek. Market rates are quoted between $3.55 to $4.55 per square foot per year for warehouse space and between $6.25 and $7.00 per square foot for flex space. Market rates for flex space such as that offered by\nSpring Creek are expected to continue to rise. The tenant at Spring Creek is currently paying $5.25 per square foot per year, and under the terms of the lease the rental payments increase to $5.50 in 1996. The lease expires in 1999.\nAirport Perimeter Business Center (College Park, Georgia)\nThis property consists of three multi-tenant office\/service\/warehouse buildings containing just under 121,000 square feet and is situated on 9.2 acres of land immediately south of William B. Hartsfield Atlanta International Airport. This property is part of Airport Perimeter Business Park, a master-planned, commercial\/industrial business park containing approximately 800,000 square feet of office\/service\/warehouse facilities on approximately 137 acres of land, with good access to major north-south and east-west Interstate highways. This parcel is also located in an area which has been targeted for the potential expansion of the Hartsfield Airport. Thus, the possibility exists that the Partnership might be forced to sell this property to a government agency to accommodate such an expansion. This uncertainty has made leasing the three buildings difficult and will continue to do so until the issue is resolved. In fiscal 1995, the Partnership recorded a provision for value impairment in connection with Airport Perimeter of $189,000. The General Partner determined that this adjustment was a prudent course of action based upon the uncertainty of the Partnership's ability to recover the net carrying value of Airport Perimeter through future operations and sale. This determination was based upon current market conditions and future performance expectations of both the property and the Airport\/South Atlanta market.\nThe property is part of the approximately 15.8 million square foot Service and Distribution sectors of the Atlanta Airport\/South Atlanta submarket which represents approximately 11% of Atlanta's total service and distribution space. This sector of the submarket absorbed around 50,000 square feet during the first six calendar months of 1995 as it captured around 2% of Atlanta's Service and Distribution absorption. Vacancy in the submarket declined slightly to approximately 7% from the previous year's 8%. In general, the distribution sector is substantially outperforming the Service Sector, which experienced a small net decrease in absorption. Airport Perimeter competes in both sectors. Absorption is expected to continue to be positive, primarily from expansion by existing tenants. For this reason, more speculative projects for this submarket are expected. Net effective rental rates for Class B space such as Airport Perimeter remained around last year's range of $2.50 to $3.75 per square foot, including taxes, insurance and utilities.\nAirport Perimeter Business Center gained two new tenants totaling 10,970 square feet, renewed five tenants (two of which expanded) totalling 34,003 square feet, lost one tenant who did not renew and one tenant due to\nfinancial problems for a total loss of 7,895 square feet. This resulted in a net increase in leased space of over 4,800 square feet. Thus, the property rose to a level of 80% leased at fiscal year end, versus 69% at the end of the prior fiscal year. The upcoming Olympics are expected to positively impact absorption, albeit for only a short time. Airport Perimeter has experienced difficulty in leasing due to the lingering possibility that the Partnership might be forced to sell this property to a government agency to accommodate an airport expansion. The Partnership does not know when the issue will be resolved.\nMontgomery Executive Center (Gaithersburg, Maryland)\nThis property consists of a six-story office building containing 117,200 square feet and is situated on 4.1 acres of land in the City of Gaithersburg, Maryland, 19 miles northwest of Washington, D.C. Montgomery Executive Center, whose tenants are principally engaged in providing services to the local business community, is located at the intersection of two major thoroughfares with direct access to Interstate 270, which in turn provides access to the Capital Beltway and the Washington metropolitan area.\nAs of September 30, 1995, this property was 67% leased which was down 21 percentage points from last year due to the expiration of one major tenant lease and one smaller one, totalling 21,807 square feet. Renewals and expansions combined to total 22,603 square feet on four separate transactions, while 5,292 square feet of occupancy was lost due to tenant credit reasons and\/or downsizing. The net impact of this activity was a decline in occupancy totalling 25,071 square feet.\nMontgomery Executive Center is in the Gaithersburg submarket and competes with 80 buildings totaling approximately 3.9 million square feet; it is part of a suburban office building market extending in both directions along Interstate 270, including the communities of Germantown to the north and Rockville to the south. The Gaithersburg submarket's net absorption for the past twelve months was approximately 140,000 square feet. This level of absorption is significantly better than the prior year's level which was negative and reflected the effects of IBM's reduction of its occupancy by 420,000 square feet. The current vacancy rate in the submarket has fallen from over 20% in the prior year to its current 18% level. Asking rental rates increased modestly during the year indicating that leasing momentum may be increasing in the marketplace and a further decline in vacancy may be on the horizon. Rates range from $14.00 per square foot including taxes, insurance, and operating expenses (\"gross\") for Class B space to $18.00 gross for Class A space. Montgomery Executive Center is generally considered to be among the best Class B space in the market and should begin to benefit from improving market conditions should they persist.\nRoyal Biltmore (Phoenix, Arizona)\nThis property consists of a two story, garden style office building containing 71,000 rentable square feet and a parking garage containing 48,000 square feet. It is situated on 2.9 acres of land in the East Camelback Road Corridor (\"Camelback Corridor\") of Phoenix, Arizona. This area of Phoenix has benefited from the improved economic conditions in the region and the corresponding increase in demand for office space near executive housing. These factors have generated a great deal of investor interest in office properties in the Camelback Corridor causing values to rise. Accordingly the Partnership is considering offering the property for sale during fiscal 1996.\nWith the signing of two new tenants totaling 2,807 square feet and renewals and\/or expansions totaling 2,160 square feet, the property experienced only a two percentage point decline in occupancy over the past fiscal year. This decline in occupancy reflects the downsizing of one tenant and the Partnership's decision to market the vacant space at the highest possible rate as space in the marketplace has continued to become increasingly scarce.\nThe Camelback Corridor office submarket contains approximately 5.7 million square feet of office space and demand has accelerated; positive absorption during the first six months of the calendar year of approximately 100,000 square feet has been recorded. This positive net absorption has reduced the market vacancy to approximately 11% as of June 30, 1995. Rents have risen sharply. Gross office rents in the market for better Class B space, such as Royal Biltmore, are currently stabilized in the $13.00 to $19.00 per square foot per year range, including taxes, insurance, and utilities versus a range of $13.00 to $16.00 per square foot the previous year. Rents are expected to continue to increase as vacancy rates decline.\nSpringdale Commerce Center (Santa Fe Springs, California)\nSpringdale Commerce Center consists of two multi-tenant industrial\/warehouse\/distribution buildings, containing 144,000 square feet on 6.9 acres of land. It is located in the City of Santa Fe Springs, California, 13 miles southeast of downtown Los Angeles. Because of its central location, Santa Fe Springs is one of the primary industrial centers in the area with excellent access to major shipping routes.\nSpringdale Commerce Center was 100% occupied as of September 30, 1995, unchanged from the prior year level. The one tenant lease which matured during the year (14,400 square feet) was renewed.\nThe Santa Fe Springs submarket, of which the property is a part, is one of four major warehouse distribution centers in the greater Los Angeles basin. It represents over one-half of the Mid-Counties market which comprises\napproximately 99 million square feet of industrial space in parts of Los Angeles and Orange Counties. The Santa Fe Springs submarket consists primarily of small and medium sized, \"master planned\" business parks with a number of pockets containing older warehouse facilities. Most of the area was fully developed by the 1970's, and no new buildings have been constructed recently. The current vacancy level has declined to approximately 6% in this submarket versus approximately 8% the previous year.\nThere are at least eight projects directly competitive to Springdale Commerce Center ranging in size from 12,000 square feet to just over 100,000 square feet. Class B rates in the market are being quoted in the range of $3.55 to $4.20 per square foot, including taxes, insurance, and utilities, with one month of free rent for each year of the lease term, approximately 5% over the prior year. Tenant improvement allowances are ranging from $1.50 to $4.50 per square foot. It appears that the market has begun to improve and with vacancy levels at their lowest point during the last several years, further upward pressure on rentals can be expected.\nVan Buren Industrial Center (Phoenix, Arizona)\nVan Buren Industrial Center consists of five multi-tenant industrial warehouse\/distribution buildings, containing 174,000 square feet, situated on 9 acres of land, ten minutes from central Phoenix and 20 minutes from the principal Phoenix airport.\nVan Buren Industrial Center was 92% leased as of September 30, 1995 equal to 1994's level. Leasing activity during the year was strong as over 50,000 square feet of new tenancy and 14,000 square feet of renewals offset 64,000 square feet of expirations.\nVan Buren Industrial Center is located in the Southwest submarket of the Phoenix metro industrial market. The property's occupancy level is comparable to the approximately 93% average occupancy level for 8 directly competitive multi-tenant projects representing 1.2 million square feet of warehouse\/distribution space. The current submarket occupancy is 5 percentage points better than the prior year and reflects continued improvement in the Phoenix area economy and the corresponding increase in the demand for space. Market rents have also benefited from the improving economy, rising from a range of $2.90 - $3.50 per square foot per year in 1994 to a range of $3.24 - $3.84 per square foot per year for 1995. Investor interest in industrial space remains high and the continued improvement in the Phoenix area markets has drawn considerable attention and put upward pressure on values. Accordingly, the General Partner is considering a sale of the property during fiscal 1996, but no firm decision has yet been made.\nThe Business Park (Gwinnett County, Georgia)\nThe Business Park is located in Gwinnett County, Georgia, approximately 17 miles northeast of downtown Atlanta. The Business Park consists of eight multi-tenant office\/warehouse buildings, containing just over 157,000 square feet, situated on 13 acres of land. It is located in a suburban area known as the \"Peachtree Corridor,\" which contains a wide selection of business facilities and homes in a park-like setting. In fiscal 1995, the Partnership recorded a provision for value impairment in connection with The Business Park of $165,000. The General Partner determined that this adjustment was a prudent course of action based upon the uncertainty of the Partnership's ability to recover the net carrying value of The Business Park through future operations and sale. This determination was based upon current market conditions and future performance expectations of both the property and the Atlanta office\/warehouse market.\nAs of September 30, 1995, The Business Park was 92% leased. The property experienced a six percentage point increase in occupancy during the year primarily due to the signing of seven new tenants totaling 22,500 square feet. Additionally, ten tenants renewed and\/or expanded. Only two tenants totaling 5,400 square feet vacated upon expiration and one 2,500 square foot tenant was lost after it defaulted on its lease obligations.\nThe Peachtree Corridor is part of the Gwinnett\/I-85 Corridor submarket of Atlanta, which contains approximately 9.7 million of Service center space and makes up The Business Park's competitive area. Activity marketwide has been very strong with net absorption during the first six months of 1995 totaling 353,000 square feet. Net absorption in this market is expected to continue improving as tenants from other Atlanta sub-markets continue to relocate to this submarket due to its superior highway access. As a result, build to suit and speculative construction of distribution buildings, which began in fiscal 1994, is expected to also continue. Activity related to the upcoming Olympic games has also contributed to the increase in absorption, but this is only expected to be of effect over the short term. Net effective rents in the market for Class A space such as The Business Park have increased to $5.00 a square foot, up dramatically from 1994's level.\nNewport Center Business Park, Buildings 1 and 2 (Deerfield Beach, Florida)\nThis property consists of two multi-tenant office\/light industrial buildings containing just over 62,000 square feet, and is situated on approximately 5.9 acres of land. Newport Center is located in the City of Deerfield Beach, Florida, immediately south of Palm Beach County and the City of Boca Raton. It is part of the Newport Center Business Park, a 119 acre development which includes research and development facilities, warehousing, and corporate offices as well as two hotels.\nAs of September 30, 1995, this property was 93% leased, which was up from the 89% occupancy a year ago. This is primarily due to the signing of two new tenants totaling 5,500 square feet. These gains were partially offset by the loss of one 1,300 square foot tenant who vacated after its lease expired and one 2,000 square foot tenant who experienced financial difficulties. In addition seven tenants totalling 17,300 renewed their leases.\nNewport Center compares favorably to its competition in the Boca Raton submarket of the South Florida market. This submarket contains approximately 5.5 million square feet of office and flex-space, approximately 12% of which is vacant as of September 30, 1995, down significantly from the prior year's level. Net absorption for the first six calendar months of the year totaled approximately 106,000 square feet. Over the past year, office\/service rents have increased to around $8.00 - $10.00 gross per square foot, $1.00 per square foot higher than 1994 on both ends of the range. Concessions are minimal and \"as is\" deals are frequently being made on second generation space.\nThe Newport Center\/Deerfield area is attractive to developers as it is close to I-95 and the Turnpike, and is a good location for covering a tri- county area business. Inexpensive land is being bought up and build-to- suit facilities are being built, but no speculative construction is anticipated in the immediate future.\nEmployees\nThe Partnership has no employees and, accordingly, the General Partner, the Partnership's investment adviser, LaSalle, and their affiliates perform services on behalf of the Partnership in connection with administering the affairs of the Partnership, and operating and selling the Partnership's properties. The General Partner, LaSalle, and their affiliates receive compensation in connection with such activities, as described above. Compensation to the General Partner and its affiliates and the terms of transactions between the Partnership and the General Partner and its Affiliates are set forth in Items 11. and 13. below, to which reference is made for a description of those terms and the transactions involved.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Partnership owns the properties discussed in Item 1, to which reference is made for the name, location and description of each property. See also Schedule III to the Financial Statements of the Partnership, which is filed hereinwith as Exhibit 99(c). All properties were acquired on an all-cash basis.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe Partnership is not subject to any material pending legal proceedings.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNone.\nPART II\nItem 5.","section_5":"Item 5. Market for the Partnership's Limited Partnership Interests and Related Security Holder Matters\nAt December 15, 1995, there were 17,758 Limited Partners. There is no public market for the Units, and it is not anticipated that a public market for the Units will develop. T. Rowe Price Investment Services, Inc. (\"Investment Services\") provides certain information to investors which may assist Limited Partners desiring to sell their Units, but provides only ministerial services in connection with such transactions. Since this arrangement does not constitute a market for the Units, it is possible that no prospective purchaser will be willing to pay the price specified by a prospective seller. The Partnership will not redeem or repurchase the Units.\nIn 1987 Congress adopted certain rules concerning \"publicly traded partnerships\". The effect of being classified as a publicly traded partnership would be that income produced by the Partnership would be classified as portfolio income rather than passive income. On November 29, 1995, the Internal Revenue Service adopted final regulations (\"Final Regulations\") describing when interests in partnerships will be considered to be publicly traded. The Final Regulations do not take effect with respect to existing partnerships until the year 2006. Due to the nature of the Partnership's income and to the low volume of transfers of Units, it is not anticipated that the Partnership will be treated as a publicly traded partnership under currently applicable rules and interpretations or under the Final Regulations.\nCash distributions declared to the Limited Partners during the two most recent fiscal years are as follows:\nDistribution for the Amount of Quarter Ended Distributions per Unit\nDecember 31, 1993 $ 4.00 March 31, 1994 $37.00 June 30, 1994 $ 4.00 September 30, 1994 $ 5.00 December 31, 1994 $ 4.00 March 31, 1995 $ 4.00 June 30, 1995 $ 4.00 September 30, 1995 $18.00\nAll of the foregoing distributions were paid from cash flows from operating activities with the exception of the distribution for the quarter ended March 31, 1994, which included a distribution of $33.00 per Unit representing a portion of the sale proceeds of Corporate Square, the distribution for the quarter ended September 30, 1994, which included a distribution of $1.00 per Unit representing a portion of the sale proceeds of Corporate Square, and the distribution for the quarter ended September 30, 1995 which included a distribution with $9.00 per Unit representing previously retained proceeds from the sales of Corporate Square and Dupont Business Park and also includes cash flow from operating activities for prior quarters of 1995.\nThere are no material legal restrictions on the Partnership's present or future ability to make distributions in accordance with the provisions of the Agreement of Limited Partnership, annexed to the prospectus as Exhibit A thereto. Reference is made to Item 7 below, for a discussion of the Partnership's ability to continue to make future distributions.\nAt the end of the 1995 fiscal year, the Partnership conducted its annual formal unit valuation. The valuation of the Partnership's properties was performed by the General Partner, and then reviewed and approved by an independent professional appraiser. The estimated investment value of limited partnership Units resulting from this process is $424 per Unit. After a $9 per unit distribution for the September 1995 quarter representing a portion of the sales proceeds of Corporate Square and Dupont Business Park, and after the distribution of prior quarter operating cash flows, the estimated valuation is $411 per unit. There is no assurance that Units can be sold at a price equal to this estimated value, and this valuation is not necessarily representative of the value of the Units when the Partnership ultimately liquidates its holdings.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe following table sets forth a summary of the selected financial data for the Partnership.\nYears Ended September 30, (Dollars in thousands except per-unit amounts)\n1995 1994 1993\nAssets at year end $46,133 $47,844 $52,710 Revenues $ 6,043 $ 5,993 $ 6,339 Net income (loss) $ 8 $ 165 $(6,610) Net income (loss) per L.P. Unit $ 0.08 $ 1.64 $(65.65) Cash distributions paid to: Limited Partners $ 1,540 $ 4,440 $ 1,541 General Partner $ 165 $ 286 $ 171\n1992 1991\nAssets at year end $61,260 $68,272 Revenues $ 6,542 $ 7,033 Net income (loss) $(3,012) $ 434 Net income (loss) per L.P. Unit $(29.91) $ 4.31 Cash distribution paid to: Limited Partners $ 3,987 $ 2,900 General Partners $ 305 $ 322\nNOTES:\n1. The above financial data should be read in conjunction with the financial statements and the related notes appearing elsewhere in this report.\n2. The figures above for Assets at year end and Net income (loss)include provisions for value impairment of $189 for Airport Perimeter, and $165 for the Business Park in 1995, $365 for the Business Park in 1994, $1,682 for Royal Biltmore and $495 for The Business Park in 1993, and $489 for Spring Creek and $2,629 for Royal Biltmore in 1992. These figures also include valuation allowance adjustments for Spring Creek of $193 in 1995, and for Spring Creek and Corporate Square in 1994 of $(119) and $(248), respectively, and for Spring Creek and Corporate Square in 1993 of $1,363 and $3,499, respectively.\n3. The figures above for Net income (loss) per Limited Partnership Unit include $(5.43)per Unit attributable to the provisions for value impairment and valuation allowances discussed at note 2 above in 1995, and $.02 per Unit attributable to the provision for value impairment and valuation allowances discussed at note 2 above in 1994, $(69.91) per Unit in 1993, and $(30.97) in 1992.\nDistributions declared per unit of limited partnership interest from fiscal 1991 through fiscal 1995 were as follows:\nYear Ended Distributions per Unit\nSeptember 30, 1991 $32.00 September 30, 1992 $41.00 September 30, 1993 $16.00 September 30, 1994 $50.00 September 30, 1995 $30.00\nAll of the foregoing distributions were paid from cash flows from operating activities with the exception of the distributions for 1992, which included $21.00 of proceeds from the sale of Dupont, the distributions for 1994, which included $34.00 of proceeds from the sale of Corporate Square, and the distributions for 1995, which included $9.00 of proceeds from the sale of Corporate Square and Dupont Business Park.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nLiquidity and Capital Resources\nThe Partnership sold 90,612 Units for a total of $90,612,000. Combined with the initial contribution of $10,000 from the Initial Limited Partners, the total Limited Partners' capital contributions were $90,622,000. The offering was terminated in May 1985 and no additional Units will be sold. After deduction of organizational and offering costs of $5,212,617, the Partnership was left with $85,409,383 available for investment.\nThe Partnership originally purchased ten properties on an all-cash basis, completing the initial acquisition phase of its business plan, and has sold two property investments, its interest in Dupont and the Corporate Square property. The initial cost of the Partnership's current real estate investments was $67,024,000. Subsequent to acquisition of the properties, the Partnership has incurred $8,425,000 in additional capital costs for these properties. The Partnership has also recorded provisions for value impairments, and valuation allowances totalling $7,451,000. Accumulated depreciation and amortization equals $25,613,000. Therefore, investment in real estate after accumulated depreciation, amortization and valuation allowances for financial reporting purposes is $42,385,000 as of September 30, 1995.\nThe Partnership expects to incur capital expenditures during fiscal 1996 totaling approximately $945,000 for tenant improvements, lease commissions, and other major repairs and improvements; the majority of these expenditures are dependent on the execution of leases with new and renewing tenants. These capital costs have been high in recent years, primarily due to high tenant improvement and leasing commission costs resulting from leasing concessions made in depressed market conditions. The level of these expenses is expected to decrease over the near term, if market conditions continue to improve. In addition, the Partnership anticipates a lower volume of gross leasing in 1996, due to improved tenant credit quality.\nThe Partnership maintains cash balances to fund its operating and investing activities including the costs of tenant improvements and leasing commissions, costs which must be disbursed prior to the collection of any resultant revenues. The General Partner believes that year-end cash balances and cash generated from operating activities in 1996 will be adequate to fund the Partnership's current investing and operating needs. Based on current expectations, Management expects distributions from operating activities will be $4.75 per Unit per quarter for the first three quarters of fiscal 1996, with an adjustment to this rate in the fourth quarter, if necessary, to reflect operating results.\nAs of September 30, 1995, the Partnership held cash and cash equivalents aggregating $2,832,000, an increase of $229,000 from the prior year end. This increase resulted primarily because of the retention of operating cash flows during the fiscal year, substantially all of which were distributed after fiscal year-end. Net cash provided by operating activities increased by $457,000 from 1994, primarily due to improved operating results. Net cash provided by investing activities decreased by $3,423,000, primarily because the Partnership received the proceeds of the Corporate Square sale in 1994, and did not sell a property in 1995. Cash used in financing activities decreased by $3,021,000, reflecting the lower distributions during the current year.\nOperations\n1995 v. 1994\nRental income from properties owned during all of fiscal 1995 was up $317,000 over 1994, and expenses, excluding the effect of the Corporate Square sale and valuation adjustments, were down $62,000. Without the adjustments, net income from these properties' operations would have increased by $379,000 over last year to $555,000. Corporate Square, which was sold in January 1994, contributed $264,000 to rental income and $234,000 to net income in fiscal 1994 and nothing in the current fiscal year. In addition, the carrying values of three properties still owned declined a total of $547,000. At Airport Perimeter, an initial permanent value impairment of $189,000 was recorded, while at the Business Park there was permanent impairment of $165,000 in addition to $860,000 of impairment recorded in 1993 and 1994. Spring Creek, which the Partnership is trying to sell, incurred a net downward valuation adjustment of $193,000. (This property had previously recorded $489,000 of permanent impairment in 1992, and a total of $1,244,000 of net valuation allowances in 1993 and 1994.)\nThe biggest gain in rental income from the current portfolio of properties was experienced by Royal Biltmore, whose average leased status was up from 91% in fiscal 1994 to 98% this year, resulting in $123,000 of additional income. The Business Park, Springdale, and Newport Center also experienced higher leased levels, while rental rates being paid by new tenants at the first two properties were also up over those in prior leases.\nBad debt expense was down or flat for all properties relative to 1994, with Montgomery and Newport Center showing the greatest improvement in tenant credit quality. Savings in this property operating expense category,\nexcluding Corporate Square, totaled $71,000, and repairs and maintenance costs at Montgomery declined by $44,000 relative to last year. Increased tax assessments at The Business Park and Royal Biltmore more than offset the absence of taxes for Corporate Square, pushing real estate taxes higher. Excluding the effect of Corporate Square, depreciation on continuing properties remained flat. There were significant fluctuations on several properties (Newport Center down $120,000, Van Buren up $56,000, Montgomery Executive Center up $48,000, and Airport Perimeter up $17,000) resulting from variations in the write off of tenant improvements for vacating and expiring leases.\nLeases representing 23% of the portfolio's leasable square footage are scheduled to expire in fiscal 1996. These leases represented approximately 15% of the portfolio's rental income for fiscal 1995. This amount of potential lease turnover is normal for the types of properties in the portfolio, which, typically lease to tenants under three to five year leases. The overall portfolio occupancy was 89% as of the end of fiscal 1995. Management anticipates that occupancy levels will improve modestly in fiscal 1996. In most markets, newer leases are generally expected to reflect level to higher market rental rates in comparison to the rates of expiring leases.\nThe Spring Creek property is the only single-tenant property in the Partnership's portfolio. The tenant in this property, JM Computers, accounted for substantially less than 10% of the Partnership's revenue in fiscal 1995, and is anticipated to achieve the same result in 1996. In addition, the Partnership is currently marketing the property for sale. The Partnership therefore does not expect any material adverse effect on total partnership revenue on account of this lease in 1996.\nAs discussed in Item 1, above, Montgomery Executive Center accounted for 27% of the Partnership's revenue from operating activities in fiscal 1995. Leases covering 7% of the space in this property expire in 1995, and the property is currently 33% vacant. The Partnership expects that rents ultimately obtained on this space will in some cases be slightly lower than that received under the previous leases, which were executed several years ago in stronger markets. Expenditures for tenant improvement work are anticipated in connection with any new leases. The Partnership anticipates that approximately half the vacant space will be leased during fiscal 1996. Thus, revenues from Montgomery Executive Center are anticipated to decrease somewhat in the short term, but this decrease is not expected to have a material effect on total partnership revenue.\nAlso as noted in Item 1 above, The Business Park provided 17% of the Partnership's revenue from operations in fiscal 1995. This property did well in renewing tenants whose leases expired in 1995, and conditions in its competitive market are expected to continue to improve. Thus, even though leases covering 47% of the space in this property expire in fiscal 1996, the Partnership does not expect this property to have any material adverse effect on total partnership revenue in 1996.\nFinally, Royal Biltmore provided 15% of the Partnership's revenue from operations in 1995. Only 1% of its leases expire in 1996, and therefore\nthe Partnership does not expect this property to have any material adverse effect on total partnership revenue in 1996.\n1994 v. 1993\nExcluding the operating results of Corporate Square and the effects of valuation adjustments, income from operations was $176,000 in 1994, up from $146,000 in 1993. While overall rental income from the currently held properties was up over the comparable 1993 number, expenses were also higher, primarily because of noncash depreciation charges on leasing commissions for and tenant improvements made to Airport Perimeter, Montgomery Executive Center, and Newport Center.\nThe leased status of the portfolio increased for the second year in a row, with the greatest improvement at Royal Biltmore. Occupancy gains at this property over the course of the year produced increased rental income which more than offset the decline in rents at Newport Center. Although the leased status at Newport Center was higher on September 30, 1994, than on the comparable 1993 date, its average occupancy throughout fiscal 1994 was well below the 1993 level.\nAside from the effects of the sale of Corporate Square and the allowances, several changes in expense categories were significant. First, the impact of lower property tax assessments on Royal Biltmore and The Business Park more than offset the effect of a higher assessment on Montgomery Executive Center and contributed to the overall decline in real estate taxes. Second, significant improvements related mainly to renewal and expansion leases signed with seven tenants caused depreciation at Montgomery Executive Center, and for the overall portfolio, to rise. Finally, also at Montgomery Executive Center, additional bad debt expense provisions were judged to be in order. This latter cost is included in the property operating expense category.\nIn addition to the results achieved at the properties which are currently in the portfolio, the sale of Corporate Square and valuation adjustments affected performance relative to 1993. Writedowns in 1993 totaled $7 million and resulted in a sharp decline in net income that year. In 1994, however, there were no additional valuation allowances, and the effect of an additional $365,000 permanent value impairment at The Business Park was completely offset by positive adjustments of the valuation allowances for Spring Creek and Corporate Square.\nThe Corporate Square sale accounted for the decline in rental income and contributed to decreases in expenses such as property operating costs and real estate taxes relative to 1993. Because the sale proceeds remained in the Partnership's cash account for more than three months it also had a positive effect on interest income in 1994.\nReconciliation of Financial and Tax Results\nFor 1995, the Partnership's financial statement net income was $8,000, and its taxable net income is estimated at $613,000. The primary difference between the two is allowances for property valuation of $547,000. For\n1994, the Partnership's financial statement net income was $165,000, and its taxable net loss is estimated at $2,938,000. The primary difference between the two is the net loss for tax purposes of $3,133,000 resulting from the sale of the Corporate Square property. For 1993, the Partnership's financial statement net loss was $6,610,000, and its taxable net income was $71,000. The provision for value impairment in connection with the Royal Biltmore and Business Park properties, and the valuation allowances for Spring Creek and Corporate Square accounted for most of the difference. For complete reconciliations, see Note 6 to the Partnership's financial statements, which note is hereby 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 KPMG Peat Marwick LLP dated October 20, 1995, appearing on pages 6 through 14 of the Partnership's 1995 Annual Report to Limited Partners are incorporated by reference in this Form 10-K Annual Report. Financial Statement Schedule III, Consolidated Real Estate and Accumulated Depreciation, is filed as Exhibit 99(c) to this Form 10-K Annual Report, and is hereby incorporated by reference herein. All other schedules are omitted either because the required information is not applicable or because the information is shown in the financial statements or notes thereto.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nThe General Partner of the Partnership is T. Rowe Price Realty Income Fund I Management, Inc., (\"Fund I Management\"), 100 East Pratt Street, Baltimore, Maryland 21202. The General Partner has the primary responsibility for overseeing the selection, evaluation, structuring, negotiation, management, and liquidation of the Partnership's investments as well as the cash management of the Partnership's liquid assets and the administration of investor services of the Partnership including general communications, periodic reports and distributions to Limited Partners, and filings with the Securities and Exchange Commission. Fund I Management is a wholly-owned subsidiary of T. Rowe Price Real Estate Group, Inc. (\"Real Estate Group\"), which is, in turn, a wholly-owned subsidiary of T. Rowe Price Associates, Inc. (\"Associates\"). Affiliates of the General Partner, T. Rowe Price Realty Income Fund II Management, Inc. (\"Fund II Management\"), T. Rowe Price Realty Income Fund III Management, Inc. (\"Fund III Management\"), and T. Rowe Price Realty Income Fund IV Management, Inc. (\"Fund IV Management\") are the General Partners of other real estate limited partnerships sponsored by Associates. Real Estate Group, which is also an affiliate, is investment manager to T. Rowe Price Renaissance Fund, Ltd., A Sales-Commission-Free Real Estate Investment (\"Renaissance Fund\"),\na real estate investment trust sponsored by Associates. Total assets under management by Associates and its subsidiaries totalled $71.5 billion at September 30, 1995.\nAs more fully discussed in Item 1, above, LaSalle is providing certain real estate advisory and other services to the Partnership. Upon execution of the formal contract between the Partnership and LaSalle, Gary C. Younker, Senior Vice President of LaSalle Partners Asset Management Limited, (an Affiliate of LaSalle) became the Chief Accounting Officer for the Partnership. Born in 1948, Mr. Younker has been associated with LaSalle since 1976, and has served in his current position since 1988.\nThe directors and executive officers of Fund I Management are as follows:\nPosition with T. Rowe Price Name Realty Income Fund I Management, Inc.\nJames S. Riepe Chairman of the Board, President, also Principal Executive Officer for the Partnership Charles E. Vieth Vice President and Director Douglas O. Hickman Vice President and Director Henry H. Hopkins Vice President and Director Mark E. Rayford Vice President Lucy B. Robins Vice President and Secretary Mark B. Ruhe Vice President Alvin M. Younger, Jr. Treasurer and Director Joseph P. Croteau Controller, also Principal Financial Officer for the Partnership Kenneth J. Rutherford Assistant Vice President\nMr. Riepe was elected President in July, 1991. Ms. Robins was first elected to her current offices in April, 1987, and Mr. Ruhe was first elected in May, 1988. Mr. Hopkins was first elected a director in January, 1987. Mr. Vieth was first elected an officer and director in February 1993. Mr. Croteau was first elected as Controller in May, 1988 and designated as Principal Financial Officer for the Partnership in 1992. Mr. Rutherford was first elected an officer in 1994. In all other cases these individuals have served in these capacities since the inception of Fund I Management in 1984. There is no family relationship among the foregoing directors or officers.\nThe background and business experience of the foregoing individuals is as follows:\nJames S. Riepe (Born 1943) is Chairman of the Board and President of Fund I Management, Fund II Management, Fund III Management, Fund IV Management, the Renaissance Fund, and Real Estate Group. He is also a Director, Managing Director and member of the Management Committee of Associates. In addition, Mr. Riepe is President and Director of T. Rowe Price Investment Services, Inc. (\"Investment Services\"), T. Rowe Price Trust Company (\"Trust Company\"), T. Rowe Price Insurance Agency, Inc. and T. Rowe Price Services, Inc. (\"Price Services\") and Chairman of T. Rowe Price Stable Asset Management, Inc. T. Rowe Price Retirement Plan Services, Inc. (\"Retirement Service\"). He is also an Officer and\/or\nDirector of all of the mutual funds managed by Associates, and a Director of Rh ne-Poulenc Rorer Inc. Mr. Riepe joined Associates in 1982.\nCharles E. Vieth (Born 1956) is a Managing Director of T. Rowe Price Associates, Inc., President and Director of T. Rowe Price Retirement Plan Services (\"Retirement Services\") and Director and Vice President of Fund I Management, Fund II Management, Fund III Management, Fund IV Management, Investment Services and Price Services, and Vice President of the Renaissance Fund. Mr. Vieth joined Associates in 1982.\nDouglas O. Hickman (Born 1949) is President of Threshold Fund Associates, a Vice President and Investment Manager for Associates. He is also a Vice President and Director of Fund I Management, Fund II Management, Fund III Management, and Fund IV Management. He also serves as a member of the investment committees for the T. Rowe Price Threshold Funds. Mr. Hickman joined Associates in 1985.\nHenry H. Hopkins (Born 1942) is a Managing Director, Director, and Legal Counsel of Associates. In addition, Mr. Hopkins is Vice President and Director of Fund I Management, Fund II Management, Fund III Management, Fund IV Management, Investment Services, Price Services, and the Trust Company. In addition, Mr. Hopkins is Director of T. Rowe Price Insurance Agency, Inc., and Director and Vice President of Investment Services, Price Services, and the Trust Company. He is also a Vice President of Real Estate, Retirement Services, T. Rowe Price Stable Asset Management, Inc., and certain of the mutual funds managed by Associates. Mr. Hopkins joined Associates in 1972.\nMark E. Rayford (Born 1951) is a Managing Director of Associates and Manager of Retail Operations. In addition, Mr. Rayford is President of Price Services, and Vice President of the Trust Company, Fund I Management, Fund II Management, Fund III Management, and Fund IV Management. He is also Director of T. Rowe Price Insurance Agency, Inc., Investment Services, and Retirement Services. Mr. Rayford joined Associates in 1982.\nLucy B. Robins (Born 1952) is a Vice President and Associate Legal Counsel of Associates. In addition, Ms. Robins is Vice President and Secretary of Fund I Management, Fund II Management, Fund III Management, and Fund IV Management, and Vice President of the Renaissance Fund. She is also Vice President of Investment Services and Price Services. Ms. Robins joined Associates in 1986.\nMark B. Ruhe (Born 1954) is a Vice President of Fund I Management, Fund II Management, Fund III Management, Fund IV Management, and the Renaissance Fund. Mr. Ruhe joined Associates in 1987.\nJoseph P. Croteau (Born 1954) is a Vice President of Associates and Controller and Director of Financial Reporting, as well as Controller of several subsidiaries of Associates, including Fund I Management, Fund II Management, Fund III Management, Fund IV Management, T. Rowe Price Insurance Agency, Inc., Real Estate Group, Retirement Services, Price Services, and T. Rowe Price Stable Asset Management., Inc. Mr. Croteau joined Associates in 1987.\nAlvin M. Younger, Jr. (Born 1949) is Treasurer and Director of Fund I Management, Fund II Management, Fund III Management, and Fund IV Management and a Managing Director, Secretary and Treasurer of Associates, and Secretary and Treasurer of T. Rowe Price Insurance Agency, Inc., Investment Services, Real Estate Group, Retirement Services, T. Rowe Price Stable Asset Management, Inc., Price Services, and the Trust Company. He is also Treasurer of Rowe Price-Fleming International, Inc. Mr. Younger joined Associates in 1973.\nKenneth J. Rutherford. (Born 1963) is Assistant to the Director of Associates' Investment Services Division. He is also Assistant Vice President of Fund I Management, Fund II Management, Fund III Management, Fund IV Management, and the Renaissance Fund. Mr. Rutherford joined Associates in 1992. From 1990 to 1992. Mr. Rutherford attended the Stanford Graduate School of Business, and from 1989 to 1990 he was with Trans National Services, a marketing firm, as Manager.\nNo Form 3s, Form 4s, Form 5s, or any amendments to any of them, were furnished to the Partnership during its most recent fiscal year. Based on written representations pursuant to Item 405(b)(2)(i) of Regulation S-K, none of the directors, officers, or beneficial owners of more than 10% of the Units nor the General Partner failed to file on a timely basis reports required by Section 16(a) of the Exchange Act during the most recent fiscal or prior fiscal years.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe directors and officers of the General Partner receive no current or proposed remuneration from the Fund.\nThe General Partner is entitled to receive a share of cash distributions and a share of profits or losses as described under the captions \"Compensation and Fees,\" and \"Profits and Losses for Tax Purposes, Depreciation and Cash Distributions\" of the Prospectus, on pages 7-9 and 36-50 respectively, which pages are incorporated by reference herein.\nFor a discussion of compensation and fees to which the General Partner is entitled, see Item 13., which is incorporated herein by reference.\nAs discussed in Item 1, above, LaSalle receives reimbursement from the Partnership for certain expenses incurred in performance of its responsibilities under its advisory contract with the Partnership and the General Partner. In addition, under the contract, LaSalle receives from the General Partner a portion of the compensation and distributions received by the General Partner from the Partnership. Mr. Younker is a limited partner of LaSalle and therefore indirectly receives compensation with respect to payments made to LaSalle by the Partnership or the General Partner. However, the amount of this compensation attributable to services he performs for the Partnership is not material.\nIn addition to the foregoing, certain officers and directors of the General Partner receive compensation from Associates and\/or its affiliates (but not from the Partnership) for services performed for various affiliated entities, which may include services performed for the Partnership. Such\ncompensation may be based, in part, on the performance of the Partnership.\nAny portion of such compensation which may be attributable to such performance is not material.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThe Partnership is a limited partnership which issued units of limited partnership interest. No limited partner is known by the Partnership to own beneficially more than 5% of the outstanding interests of the Partnership.\nThe percentage of outstanding interests of the Partnership held by all directors and officers of the General Partner is less than 1%. Certain officers and\/or directors of the General Partner presently own securities in Associates. As of November 15, 1995, the directors and officers of the General Partner, as a group, beneficially owned 5.48% of the common stock of Associates, including options to purchase 279,600 shares exercisable within 60 days of November 15, 1995, and shares as to which voting power is shared with others. Of this amount, Mr. Riepe owned 2.27% of such stock (657,539 shares, including 27,600 shares which may currently be acquired by Mr. Riepe upon the exercise of stock options, 70,000 shares held in trusts for members of Mr. Riepe's family as to which Mr. Riepe disclaims beneficial ownership, 20,000 shares owned by a member of Mr. Riepe's family as to which Mr. Riepe disclaims beneficial ownership, and 41,000 shares held in a charitable foundation of which Mr. Riepe is a trustee and as to which Mr. Riepe has voting and disposition power). Mr. Hopkins owned 1.07% (310,884 shares, including 45,400 shares which may be acquired by Mr. Hopkins upon the exercise of stock options within 60 days). Mr. Younger owned 1.02% (294,000 shares, including 18,000 shares which may be acquired by Mr. Younger upon the exercise of stock options within 60 days). No other director or officer owns 1% or more of the common stock of Associates.\nThere exists no arrangement known to the Partnership, the operation of which may at any subsequent date result in a change in control of the Partnership.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThe General Partner and its Affiliates are permitted to engage in transactions with the Partnership as described under the captions \"Compensation and Fees,\" and \"Conflicts of Interest\" of the Prospectus, on pages 7-11, which pages are hereby incorporated by reference herein.\nThe General Partner has been reimbursed for expenses incurred by it in the administration of the Partnership and the operation of the Partnership's investments, which amounted to $123,000 in fiscal 1995 ($134,000 in fiscal 1994). The General Partner's share of cash distributions declared for fiscal 1995 was $245,000, of which $211,000 was distributable cash, and $34,000 was sales proceeds, and for 1994 was $289,000, of which $161,000 was distributable cash and $128,000 was sales proceeds. Another affiliate,\nT. Rowe Price Associates, Inc., earned $9,000 for cash management services rendered in 1995.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(a) The following documents are filed as part of this report: PAGES IN ANNUAL REPORT* (1) Financial Statements: Balance Sheets at September 30, 1995 and 1994 7 Statements of Operations for each of the three years in the period ended September 30, 1995 8 Statements of Partners' Capital for each of the three years in the period ended September 30, 1995 8-9 Statements of Cash Flows for each of the three years in the period ended December 31, 1995 9-10 Notes to Financial Statements 10-14 Independent Auditors' Report 14\n* Incorporated by reference from the indicated pages of the Partnership's 1995 Annual Report to Limited Partners.\n(2) Financial Statement Schedules:\nIII - Consolidated Real Estate and Accumulated Depreciation, incorporated by reference to Exhibit 99(c) hereof.\nAll other schedules are omitted because they are not applicable or the required information is presented in the financial statements and notes hereto.\n(3) Exhibit\n3, 4. (a) Prospectus of the Partnership dated December 7, 1984, which includes the Partnership Agreement File Number 2-93160, and supplement thereto dated April 24, 1984, filed with the Commission pursuant to Rule 424(c), incorporated by reference herein.\n(b) Amendment to the Partnership Agreement dated January 1, 1988, incorporated by reference to Exhibits 3, 4.(h) of the registrant's report on Form 10-K for the year ended September 30, 1988, File Number 0-14308 (the \"1988 10-K\").\n(c) Amendment to the Partnership Agreement dated March 28, 1988, incorporated by reference to Exhibits 3, 4.(j) of the 1988 10-K.\n10. Advisory Agreement dated as of July 15, 1991 by and between the Partnership, the General Partner, and LaSalle Advisors Limited Partnership, incorporated by reference to Exhibit 10 of the registrant's report on Form 10-K for the year ended September 30, 1991.\n13. Annual Report for fiscal 1995, distributed to Limited Partners on or about November 15, 1995.\n27. Financial Data Schedule\n99. (a) Pages 7-11, 19-29 and 36-50 of the Prospectus of the Partnership dated December 7, 1984, incorporated by reference to Exhibit 99(a)of the registrant's report on Form 10-K for the year ended September 30, 1994, File Number 0- 14308.\n(b) Real Estate Holdings, incorporated by reference from page 6 of the Partnership's 1995 Annual Report to Limited Partners.\n(c) Financial Statement Schedule III - Consolidated Real Estate and Accumulated Depreciation. (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:\nDated: December __, 1995 T. ROWE PRICE REALTY INCOME FUND I, A NO-LOAD LIMITED PARTNERSHIP\nBy: T. Rowe Price Realty Income Fund I Management, Inc., General Partner\n\/s\/ James S. Riepe By: James S. Riepe, 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 Partner) and on the dates indicated:\n\/s\/ James S. Riepe Date: December __, 1995 James S. Riepe Director, Chairman of the Board and President T. Rowe Price Realty Income Fund I Management, Inc., Principal Executive Officer for the Partnership\n\/s\/ Henry H. Hopkins Date: December __, 1995 Henry H. Hopkins, Director and Vice President, T. Rowe Price Realty Income Fund I Management, Inc.\n\/s\/ Charles E. Vieth Date: December __, 1995 Charles E. Vieth, Director and Vice President, T. Rowe Price Realty Income Fund I Management, Inc.\n\/s\/ Douglas O. Hickman Date: December __, 1995 Douglas O. Hickman, Director and Vice President, T. Rowe Price Realty Income Fund I Management, Inc.\n\/s\/ Alvin M. Younger, Jr. Date: December __, 1995 Alvin M. Younger, Jr., Director and Treasurer, T. Rowe Price Realty Income Fund I Management, Inc.\n\/s\/ Joseph P. Croteau Date: December __, 1995 Joseph P. Croteau, Controller and Principal Financial Officer for the Partnership\n\/s\/ Gary C. Younker Date: December __, 1995 Gary C. Younker, Principal Accounting Officer of the Partnership","section_15":""}
{"filename":"726927_1995.txt","cik":"726927","year":"1995","section_1":"Item 1. Business - ----------------\nBalcor Realty Investors-84 (the \"Registrant\") is a limited partnership formed in 1982 under the laws of the State of Illinois. The Registrant raised $140,000,000 from sales of Limited Partnership Interests. The Registrant's operations consist exclusively of investment in and operation of real property, and all information included in this report relates to this industry segment.\nThe Registrant utilized the net offering proceeds to acquire twenty-three real property investments and a minority joint venture interest in one additional property. The Registrant has since disposed of twelve of these properties, including the Chimney Ridge Apartments which was sold in February 1996 and the property in which the Registrant had a minority joint venture interest. As of December 31, 1995, the Registrant owned the thirteen properties described under \"Properties\" (Item 2). The Partnership Agreement provides that the proceeds of any sale or refinancing of the Registrant's properties will not be reinvested in new acquisitions.\nOverall, the investment real estate market saw gradual improvement over the last year. This improvement has taken place in an environment of generally low interest rates and little or no new supply, parameters which may not exist in the next few years. Demand for real estate space, while projected to improve in line with the overall economy, is also vulnerable to external forces. The major challenges facing the real estate industry today include increased international competition, corporate restructurings, new computer and communications technologies, an aging population and potential revisions of the tax code. In addition, the increased flow of capital to real estate through new vehicles such as commercial mortgage-backed securities and REITs could spur new construction at unsupportable levels, as well as impact existing property values.\nOperationally, existing apartment properties continued to register occupancy percentages in the 90s, with average rents rising at an annual rate of between 3 and 4 percent. Apartments are still considered one of the top real estate asset classes in terms of performance. However, some markets are experiencing new construction of rental units which, if unrestrained, could impact the performance of existing properties. Most of the new construction is aimed at the two segments of the rental market which are growing the fastest: low-income households and upper-income households who prefer to rent rather than own. Of all the major asset classes, apartments typically display the least volatility in terms of property values.\nThe General Partner had previously advised Limited Partners that its strategy was to sell the Registrant's remaining assets over the next three to four years. The General Partner also stated that the timing of the liquidation could be lengthened or shortened due to changes in market conditions, economic factors, interest rates and unforeseen events. Since November 1995, the General Partner believes that the market for multifamily housing properties has become increasingly favorable to sellers of these properties. This belief is based on the results of the sales and marketing activities of the Registrant as described below and based upon the similar results of such activities by various other partnerships affiliated with the Registrant. These favorable market conditions are in part attributable to the increasing strength of the capital markets and the reentry of REITs into the acquisition market. Since\nNovember 1995, the Registrant has sold one of its properties. Of its remaining twelve properties, the General Partner (i) has entered into letters of intent to sell two additional properties; (ii) has begun or is actively marketing two of its properties for sale; and (iii) if the market remains favorable, intends to begin actively marketing more of the remaining properties for sale. If the current market conditions for sales remain favorable and the General Partner can obtain appropriate sales prices, the Registrant's liquidation strategy may be accelerated.\nThe Registrant received notice of an unsolicited offer for the purchase of Limited Partnership Interests (\"tender offer\") in November 1995. The tender offer was made by Walton Street Capital Acquisition Co. L.L.C. (\"Walton Street\"). Walton Street stated that their primary motive in making the offer was to make a profit from the purchase of the interests. Walton Street acquired 7.76 % of the total interests outstanding in the Registrant and assigned the interests to its affiliate, WIG 84 Partners. The Registrant incurred administrative costs in responding to the tender offer.\nThe Registrant received notice of an unsolicited offer for the purchase of Limited Partnership Interests (\"tender offer\") on March 11, 1996. The tender offer was made by Metropolitan Acquisition VII, L.L.C. (\"Metropolitan\"). Metropolitan has an affiliate of Insignia Financial Group, Inc., which provides property management services to all of the Registrant's properties. Metropolitan stated that their primary motive in making the offer is to make a profit from the purchase of the interests. Metropolitan is seeking to acquire up to 30% of the total interests outstanding in the Registrant. The Registrant will incur administrative costs in responding to the tender offer and may incur additional costs if additional tender offers are made in the future. The General Partner cannot predict with any certainty what impact this tender offer or any future tender offers will have on the operations or management of the Registrant.\nThe Registrant sold two properties during 1995. See Item 7. Liquidity and Capital Resources for additional information. The Registrant sold one additional property in 1996. See below, Other Information.\nThe Registrant, by virtue of its ownership of real estate, is subject to federal and state laws and regulations covering various environmental issues. Management of the Registrant utilizes the services of environmental consultants to assess a wide range of environmental issues and to conduct tests for environmental contamination as appropriate. The General Partner is not aware of any potential liability due to environmental issues or conditions that would be material to the Registrant.\nThe officers and employees of Balcor Partners-XV, the General Partner of the Registrant, and its affiliates perform services for the Registrant. The Registrant currently has no employees engaged in its operations.\nOther Information - -----------------\nChimney Ridge Apartments - ------------------------\nIn June 1983, the Registrant acquired the Chimney Ridge Apartments utilizing approximately $3,706,120 in offering proceeds. The property was acquired subject to first mortgage financing of $6,845,000. In October 1993 the Registrant refinanced the first mortgage loan and received $1,295,160 in excess financing proceeds.\nOn February 8, 1996 (\"Closing\"), the Registrant sold the property for a sale price of $13,650,000 to Sentinel Acquisitions Corp., a Delaware Corporation (the \"Purchaser\"). The Purchaser took title to the property subject to the existing first mortgage loan, which had an outstanding principal balance of $7,242,788 as of the Closing. The remaining portion of the sale price was paid in cash at Closing. From the sale proceeds, the Registrant paid $63,642 in closing and other costs, $273,000 to an unaffiliated party as a sales commission, and received the remaining $6,070,571 of sale proceeds. The General Partner will be reimbursed by the Registrant for actual expenses incurred in connection with the sale.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties - ------------------\nAs of December 31, 1995, the Registrant owned the 13 properties described below:\nLocation Description of Property - -------- -----------------------\nJacksonville, Florida Antlers Apartments: a 400-unit apartment complex located on approximately 43 acres.\nChandler, Arizona Briarwood Place Apartments: a 268-unit apartment complex located on approximately 15 acres.\nPhoenix, Arizona Canyon Sands Village Apartments: a 412-unit apartment complex located on approximately 20 acres.\nHarris County, Texas Chesapeake Apartments: a 320-unit apartment complex located on approximately 11 acres.\nFort Worth, Texas Chestnut Ridge Apartments (Phase II): a 160-unit apartment complex located on approximately 6 acres.\nColorado Springs, Colorado *Chimney Ridge Apartments: a 280-unit apartment complex located on approximately 9 acres.\nDade County, Florida Courtyards of Kendall Apartments: a 300-unit apartment complex located on approximately 20 acres.\nTulsa, Oklahoma Creekwood Apartments (Phase I): a 276-unit apartment complex located on approximately 13 acres.\nOklahoma City, Oklahoma Quail Lakes Apartments: a 384-unit apartment complex located on approximately 19 acres.\nDallas, Texas Ridgetree Apartments (Phase I): a 444-unit apartment complex located on approximately 11 acres.\nLas Vegas, Nevada Somerset Pointe Apartments: a 452-unit apartment complex located on approximately 26 acres.\nOverland Park, Kansas Sunnyoak Village Apartments: a 548-unit apartment complex located on approximately 33 acres.\nIrving, Texas Woodland Hills Apartments: a 250-unit apartment complex located on approximately 10 acres.\n* This property was sold during February 1996. See Item 1. Business and Note 15 of Notes to Financial Statements for additional information.\nEach of the above properties is held subject to various forms of financing.\nIn the opinion of the General Partner, the Registrant has provided for adequate insurance coverage for its real estate investment properties.\nSee Notes to Financial Statements for other information regarding real property investments.\nItem 3.","section_3":"Item 3. Legal Proceedings - -------------------------\nProposed class action - ----------------------\nOn February 29, 1996, a proposed class action complaint was filed, Raymond Masri vs. Lehman Brothers, Inc., et al., Case No. 96\/103727 (Supreme Court of the State of New York, County of New York). The Registrant, additional limited partnerships which were sponsored by The Balcor Company, three limited partnerships sponsored by the predecessor of Lehman Brothers, Inc. (together with the Registrant and the affiliated partnerships, the \"Defendant Partnerships\"), Lehman Brothers, Inc. and Smith Barney Holdings, Inc. are defendants. The complaint alleges, among other things, common law fraud and deceit, negligent misrepresentation and breach of fiduciary duty relating to the disclosure of information in the offering of limited partnership interests in the Defendant Partnerships. The complaint seeks judgment for compensatory damages equal to the amount invested in the Defendant Partnerships by the proposed class plus interest accrued thereon; general damages for injuries arising from the defendants' actions; recovery from the defendants of all profits received by them as a result of their actions relating to the Defendant Partnerships; exemplary damages; attorneys' fees and other costs.\nThe defendants intend to vigorously contest this action. No class has been certified as of this date. Management of each of the defendants believes they have meritorious defenses to contest the claims. It is not determinable at this time whether or not an unfavorable decision in this action would have a material adverse impact on the Registrant.\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 1995.\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.\nAs of December 31, 1995, the number of record holders of Limited Partnership Interests of the Registrant was 13,402.\nItem 6.","section_6":"Item 6. Selected Financial Data - -------------------------------\nYear ended December 31, ------------------------------------------------------------ 1995 1994 1993 1992 1991 ----------- ----------- ----------- ------------ ----------- Total income $ 28,134,122 $ 30,392,509$ 30,159,179 $30,525,777 $31,274,909 Loss before gains on sale of assets and extraordinary items (1,166,028) (2,814,657) (3,588,955) (5,092,181) (6,901,927) Net income (loss) 3,004,923 5,572,852 2,809,966 (5,092,181) (3,093,431) Net income (loss) per Limited Partnership Interest 21.25 39.41 19.87 (36.01) (21.88) Total assets 84,442,075 98,385,353 117,468,061 128,763,485 132,982,864 Mortgage notes payable 103,293,307 114,779,433 136,404,898 149,910,843 150,663,629\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and - ----------------------------------------------------------------------- Results of Operations - ---------------------\nOperations - ----------\nSummary of Operations - ---------------------\nDuring 1993, the Ridgetree Phase I first mortgage loan was purchased at a discount and title to the Highland Glen apartment complex was relinquished through foreclosure. Balcor Realty Investors-84 (the \"Partnership\") sold two properties in August 1994 and repaid certain of the related loans at a discount. The Partnership also sold two additional properties in 1995. As a result of these transactions and the timing of their related gains, the Partnership generated decreased net income during 1995 as compared to 1994 and generated increased net income during 1994 as compared to 1993. Further discussion of the Partnership's operations is summarized below.\nOperations - ----------\n1995 Compared to 1994 - ---------------------\nIn August 1994, the Partnership sold the Ridgepoint Hill and Ridgepoint View apartment complexes and repaid the first mortgage loans held by a third party. In addition, sales proceeds were used to repay the second mortgage loans and unsecured third mortgage loan from an affiliate of the General Partner at a discount. The Partnership also sold the Pinebrook and Drayton Quarter apartment complexes in February and July 1995, respectively. As a result, the Partnership recognized gains of $4,080,592 and $5,596,294 on the sales of the properties during 1995 and 1994, respectively, and extraordinary gains on forgiveness of debt of $2,791,215 during 1994. These sales also resulted in decreases in rental and service income, interest expense on mortgage notes payable, depreciation, property operating expenses, real estate taxes and property management fees during 1995 as compared to 1994.\nAll thirteen of the Partnership's remaining properties experienced improved occupancy and\/or higher rental rates in 1995 which resulted in increased rental and service income and property management fees and partially offset the decreases from the four property sales.\nDue to higher average cash balances and higher average interest rates on short-term interest bearing instruments, interest income on short-term investments increased during 1995 as compared to 1994.\nDue to decreases in the short term loan balance, interest expense on short-term loans from an affiliate decreased during 1995 as compared to 1994. This decrease was partially offset by increases in interest rates during 1995.\nThe March 1994 refinancing of the Chestnut Ridge Phase II mortgage loan and the August 1994 sale of the Ridgepoint Hill and Ridgepoint View apartment complexes resulted in the full amortization during 1994 of deferred expenses related to the prior loans. This resulted in a decrease in amortization expense during 1995 as compared to 1994.\nThe gain recognized in connection with the sale of the Pinebrook Apartments resulted in affiliate's participation in income from joint venture during 1995 as compared to a loss during 1994.\nDuring 1995, the Partnership recognized an extraordinary gain on forgiveness of debt of $90,359 in connection with the settlement reached with the seller of certain of the Partnership's properties.\n1994 Compared to 1993 - --------------------- In August 1994, the Partnership sold the Ridgepoint Hill and Ridgepoint View apartment complexes as described above. During May 1993, title to the Highland Glen apartment complex was relinquished to the mortgage holder through foreclosure. As a result, the Partnership recognized an extraordinary gain on foreclosure. The 1994 property sales and the 1993 foreclosure resulted in decreases in rental and service income, interest expense on mortgage notes payable, depreciation, property operating expenses, real estate taxes and property management fees during 1994 as compared to 1993. These decreases were partially or, in certain cases, fully offset by the events described below.\nTwelve of the Partnership's remaining properties experienced improved occupancy and\/or higher rental rates in 1994, resulting in increased rental and service income and property management fees during 1994 as compared to 1993, which fully offset the decreases from the property sales and foreclosure.\nDue to higher average cash balances and higher market interest rates on short-term interest bearing instruments, interest income on short-term investments increased during 1994 as compared to 1993.\nIn accordance with the loan agreements, the interest rates on the Briarwood, Canyon Sands, Somerset Pointe and Sunnyoak Village mortgage notes decreased in 1993 based on lower market rates and resulted in a decrease in interest expense on these loans. In addition, during 1994 and 1993, the Chestnut Ridge Phase II mortgage note and the Ridgetree Phase I and Woodland Hills mortgage notes were refinanced at lower interest rates and reduced total principal balances. These decreases in interest expense, as well as the decreases discussed above, were partially offset during 1994 by interest expense recognized on the Chesapeake mortgage note, which was obtained during June 1993, and on the Quail Lakes loan, which had principal-only payments until June 1993 at which time the payments increased to principal and interest. In addition, the Partnership recognized extraordinary gains on forgiveness of debt during 1993 in connection with the refinancings of the Ridgetree Phase I and Chimney Ridge mortgage loans.\nDue to increases in the short-term loan balance payable to an affiliate and interest rates during 1994, interest expense on short-term loans from an affiliate increased during 1994 as compared to 1993.\nHigher costs for insurance premiums, payroll expenses, contract services and repair and maintenance expenditures, which included roof and pavement repairs, landscaping and replacement of floor coverings at many of the Partnership's properties, resulted in increased property operating expense during 1994 as compared to 1993. This increase fully offset the decrease from the property sales and foreclosure.\nDue primarily to a higher tax assessment for the Ridgetree Phase I apartment complex, real estate taxes increased during 1994 as compared to 1993, which fully offset the decrease from the property sales and foreclosure.\nPrimarily as a result of increased legal fees relating to the Pinebrook bankruptcy settlement and increased portfolio management and data processing expenses, administrative expenses increased during 1994 as compared to 1993. This increase was partially offset by a decrease in accounting fees during 1994 as compared to 1993.\nThe Pinebrook apartment complex was owned by a joint venture consisting of the Partnership and an affiliate. The joint venture recognized other income during 1993 in connection with the purchase of a note investment related to the property. During 1994, default interest expense was recognized on the fourth mortgage loan in connection with the bankruptcy plan of reorganization. These transactions, as well as higher property operating and repairs and maintenance expenditures at the property which had been deferred due to the bankruptcy, resulted in an increase in affiliate's participation in loss from joint venture during 1994 as compared to 1993.\nLiquidity and Capital Resources - -------------------------------\nThe cash position of the Partnership decreased as of December 31, 1995 as compared to December 31, 1994. The Partnership received cash from its operating activities which consisted primarily of cash flow generated from property operations which were partially offset by the payment of administrative expenses and short-term interest expense. The Partnership also received cash from its investing activities relating to the redemption of a restricted certificate of deposit and the sales of the Pinebrook and Drayton Quarter apartment complexes. A portion of the proceeds from the property sales was used in the Partnership's financing activities to repay the related mortgage notes. The Partnership also used cash to fund its other financing activities which consisted primarily of a partial repayment of the loan from the General Partner and principal payments on mortgage notes payable.\nThe Partnership owes approximately $6,623,000 to the General Partner at December 31, 1995 in connection with the funding of operating deficits and borrowings needed for loan refinancings. These loans were repaid in full during March 1996 primarily from proceeds received in connection with the sale of the Chimney Ridge Apartments.\nThe General Partner may continue to provide short-term loans to the Partnership to fund working capital needs or operating deficits, although there is no assurance that such loans will be available. Should such borrowings be needed and not be available either through the General Partner or third parties, the Partnership may be required to dispose of some of its properties to satisfy its 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 property's rental and service income. The Partnership defines cash flow generated from its properties as an amount equal to the property's revenue receipts less property related expenditures, which include debt service payments. During 1995, twelve of the thirteen remaining properties owned by the Partnership as of December 31, 1995 generated positive cash flow and one generated a marginal cash flow deficit. During 1994, of these thirteen properties, nine generated positive cash flow and four generated marginal cash flow deficits. The Chestnut Ridge Phase II, Courtyards of Kendall and Woodland Hills apartment complexes improved from marginal deficits during 1994 to positive cash flow during 1995 due to increased rental and service income resulting primarily from higher rental rates. In addition, the Pinebrook and Drayton Quarter apartment complexes, which were sold in February and July 1995, respectively, generated marginal deficits during 1994 and prior to their sales in 1995. As of December 31, 1995, the occupancy rates of the Partnership's properties ranged from 91% to 97%.\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 the refinancing of mortgage loans, improving operating performance, and seeking rent increases where market conditions allow.\nThe General Partner had previously advised Limited Partners that its strategy was to sell the Partnership's remaining assets over the next three to four years. The General Partner also stated that the timing of the liquidation could be lengthened or shortened due to changes in market conditions, economic factors, interest rates and unforeseen events. Since November 1995, the General Partner believes that the market for multifamily housing properties has become increasingly favorable to sellers of these properties. This belief is based on the results of the sales and marketing activities of the Partnership as described below and based upon the similar results of such activities by various other partnerships affiliated with the Partnership. These favorable market conditions are in part attributable to the increasing strength of the capital markets and the reentry of REITs into the acquisition market. Since November 1995, the Partnership has sold one of its properties. Of its remaining twelve properties, the General Partner (i) has entered into letters of intent to sell two additional properties; (ii) has begun or is actively marketing two of its properties for sale; and (iii) if the market remains favorable, intends to begin actively marketing more of the remaining properties for sale. If the current market conditions for sales remain favorable and the General Partner can obtain appropriate sales prices, the Partnership's liquidation strategy may be accelerated.\nEach of the Partnership's properties is owned through the use of third-party mortgage loan financing and, therefore, the Partnership is subject to the financial obligations required by such loans. As a result of the General Partner's efforts to obtain loan refinancings, as well as the repayment of certain loans with proceeds from property sales and cash reserves, the Partnership has no third party financing which matures prior to 1997.\nThe Pinebrook Apartments was owned by Pinebrook Investors, a joint venture consisting of the Partnership and an affiliate. In February 1995, Pinebrook Investors sold the property in a cash sale for $6,140,000. From the proceeds, Pinebrook Investors paid $5,058,226 to the third party mortgage holders in full satisfaction of the first, second and fourth mortgage loans. Additionally, Pinebrook Investors paid $716,729 in full satisfaction of the third mortgage note payable to Pinebrook Limited Partnership, a separate joint venture consisting of the Partnership and the affiliate. Net proceeds received from this transaction were $871,599, of which $449,484 was the Partnership's share. See Notes 4, 9 and 11 of Notes to Financial Statements for additional information.\nIn July 1995, the Partnership sold the Drayton Quarter Apartments in a cash sale for $6,250,000. From the sale proceeds, the Partnership paid $4,775,677 to the third party mortgage holder in full satisfaction of the first mortgage loan, as well as other closing costs. The Partnership received $1,074,318 of net proceeds. See Note 9 of Notes to Financial Statements for additional information.\nIn February 1996, the Partnership sold the Chimney Ridge Apartments in a cash sale for $13,650,000. The purchaser of the Chimney Ridge Apartments took title subject to the existing first mortgage loan which had a balance of $7,242,788. The Partnership received $6,070,571 of net proceeds. See Note 15 of Notes to Financial Statements for additional information.\nA certificate of deposit of $700,000 had been pledged as additional collateral for the mortgage loan relating to the Canyon Sands Apartments. In March 1995, the certificate was released to the Partnership.\nIn 1995 the Financial Accounting and Standards Board issued Statement No. 121 \"Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of\" which establishes accounting standards for impairment of long-lived assets and long-lived assets to be disposed of. This statement has been adopted by the Partnership as of January 1, 1995 and did not have a material impact on the financial position or results of operations of the Partnership.\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, 1995 December 31, 1994 ------------------------- ------------------------- Financial Tax Financial Tax Statements Returns Statements Returns ---------- --------- ---------- ---------\nTotal assets $84,442,075 $55,195,888 $98,385,353 $67,625,335 Partners' capital accounts (deficit): General Partner (1,515,346) (11,049,547) (1,545,395) (11,230,881) Limited Partners(26,027,546) (45,083,915) (29,002,420) (49,329,122) Net income: General Partner 30,049 181,334 55,728 7,623,711 Limited Partners 2,974,874 4,245,205 5,517,124 1,520,090 Per Limited Part- nership Interest 21.25 30.32 39.41 10.86\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-XV, its General Partner, has a Board of Directors.\n(b, c & e) The names, ages and business experience of the executive officers and significant employees of the General Partner of the Registrant are as follows:\nTITLE OFFICERS ----- --------\nChairman, President and Chief Thomas E. Meador Executive Officer Senior Vice President Alexander J. Darragh Senior Vice President Josette V. Goldberg Senior Vice President Alan G. Lieberman Senior Vice President, Chief Brian D. Parker Financial Officer, Treasurer and Assistant Secretary Senior Vice President John K. Powell, Jr.\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. He is also Senior Vice President of American Express Company and is responsible for its real estate operations worldwide. 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.\nAlexander J. Darragh (February 1955) joined Balcor in September 1988 and is responsible for due diligence analysis and real estate advisory services for Balcor and American Express Company. He also has supervisory responsibility for Balcor's environmental matters. Mr. Darragh received masters' degrees in Urban Geography from Queen's University and in Urban Planning from Northwestern University.\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 MIS functions. 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 Balcor's property sales and capital markets functions. Mr. Lieberman is a Certified Public Accountant.\nBrian D. Parker (June 1951) joined Balcor in March 1986 and, as Chief Financial Officer and Chief Accounting Officer, is responsible for Balcor's financial, legal and treasury functions. He is a Director of The Balcor Company. 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 portfolio and asset management matters relating to Balcor's partnerships. Mr. Powell also has supervisory responsibility for Balcor's risk management and investor services functions. He received a Master of Planning degree from the University of Virginia. Mr. Powell 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.\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 1995.\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 8 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) The following entity is the sole Limited Partner which owns beneficially more than 5% of the outstanding Limited Partnership Interests of the Registrant:\nName and Amount and Address of Nature of Percent Beneficial Beneficial of Title of Class Owner Ownership Class - ---------------------------------------------------------\nLimited WIG 84 10,869 7.76% Partnership Partners Limited Interests Chicago, Partnership Illinois Interests\n(b) Balcor Partners-XV and its officers and partners own as a group the following Limited Partnership Interests of the Registrant:\nAmount Beneficially Title of Class Owned Percent of Class -------------- ------------- ----------------\nLimited Partnership Interests 116 Interests Less than 1%\nRelatives and affiliates of the partners and officers of the General Partner own 83 additional 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 3 of Notes to Financial Statements for information relating to the Partnership Agreement and the allocation of distributions and profits and losses.\nSee Note 8 of Notes to Financial Statements for information relating to transactions with affiliates.\n(c) No management person is indebted to the Registrant.\n(d) The Registrant has no outstanding agreements with any promoters.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K - -------------------------------------------------------------------------\n(a) (1 & 2) See Index to Financial Statements and Financial Statement Schedule in this Form 10-K.\n(3) Exhibits:\n(3) The Amended and Restated Agreement of Limited Partnership and Amended and Restated Certificate of Limited Partnership, previously filed as Exhibits 3 and 4.1 to Amendment No. 1 to the Registrant's Registration Statement on Form S-11 dated December 16, 1983 (Registration No. 2-86317) are incorporated herein by reference.\n(4) Form of Confirmation regarding Interests in the Registrant set forth as Exhibit 4.2 to the Registrant's Report on Form 10-Q for the quarter ended June 30, 1992 (Commission File No. 0-13349) are incorporated herein by reference.\n(27) Financial Data Schedule of the Registrant for 1995 is attached hereto.\n(b) Reports on Form 8-K: No Reports on Form 8-K were filed during the quarter ended December 31, 1995.\n(c) Exhibits: See Item 14(a)(3) above.\n(d) Financial Statement Schedules: See Index to Financial Statements and Financial Statement Schedule in this Form 10-K.\n(99) Agreement of Sale and attachment thereto relating to the sale of the Chimney Ridge apartment complex.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of l934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nBALCOR REALTY INVESTORS-84\nBy: \/s\/Brian D. Parker ---------------------- Brian D. Parker Senior Vice President, and Chief Financial Officer (Principal Accounting and Financial Officer) of Balcor Partners-XV, the General Partner\nDate: March 29, 1996 ------------------\nPursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nSignature Title Date - ---------------------- ------------------------------- ------------ President and Chief Executive Officer (Principal Executive Officer) of Balcor Partners-XV, \/s\/Thomas E. Meador the General Partner March 29, 1996 - ---------------------- -------------- Thomas E. Meador\nSenior Vice President, and Chief Financial Officer (Principal Accounting and Financial Officer) of Balcor Partners-XV, \/s\/Brian D. Parker the General Partner March 29, 1996 - ---------------------- -------------- Brian D. Parker\nINDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE\nReport of Independent Accountants\nFinancial Statements:\nBalance Sheets, December 31, 1995 and 1994\nStatements of Partners' Deficit, for the years ended December 31, 1995, 1994 and 1993\nStatements of Income and Expenses, for the years ended December 31, 1995, 1994 and 1993\nStatements of Cash Flows, for the years ended December 31, 1995, 1994 and 1993\nNotes to Financial Statements\nFinancial Statement Schedule:\nIII - Real Estate and Accumulated Depreciation, as of December 31, 1995\nFinancial Statement Schedules, other than that listed, are omitted for the reason that they are inapplicable or equivalent information has been included elsewhere herein.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Partners of Balcor Realty Investors-84:\nWe have audited the financial statements and the financial statement schedule of Balcor Realty Investors-84 (An Illinois Limited Partnership) as listed in the index of this Form 10-K. These financial statements and 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-84 at December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, 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 27, 1996\nBALCOR REALTY INVESTORS-84 (An Illinois Limited Partnership)\nBALANCE SHEETS December 31, 1995 and 1994\nASSETS\n1995 1994 --------------- -------------- Cash and cash equivalents $ 394,701 $ 1,311,019 Certificate of deposit - restricted 700,000 Escrow deposits 1,928,712 2,501,015 Accounts and accrued interest receivable 663,602 880,932 Prepaid expenses 316,982 33,795 Deferred expenses, net of accumulated amortization of $1,167,664 in 1995 and $952,643 in 1994 1,070,357 1,353,111 --------------- -------------- 4,374,354 6,779,872 --------------- -------------- Investment in real estate: Land 17,612,218 18,397,507 Buildings and improvements 118,352,136 130,982,523 --------------- -------------- 135,964,354 149,380,030 Less accumulated depreciation 55,896,633 57,774,549 --------------- -------------- Investment in real estate, net of accumulated depreciation 80,067,721 91,605,481 --------------- -------------- $ 84,442,075 $ 98,385,353 =============== ==============\nLIABILITIES AND PARTNERS' DEFICIT\nLoans payable - affiliate $ 6,623,202 $ 12,153,202 Accounts payable 255,150 328,647 Due to affiliates 122,609 197,822 Accrued liabilities, principally real estate taxes 1,133,571 1,201,714 Security deposits 557,128 582,347 Mortgage notes payable 101,440,696 112,812,222 Mortgage notes payable - affiliate 1,852,611 1,967,211 --------------- -------------- Total liabilities 111,984,967 129,243,165 --------------- -------------- Affiliate's participation in joint venture (309,997) -------------- Limited Partners' deficit (140,000 Interests issued and outstanding) (26,027,546) (29,002,420)\nGeneral Partner's deficit (1,515,346) (1,545,395) --------------- -------------- Total partners' capital (27,542,892) (30,547,815) --------------- -------------- $ 84,442,075 $ 98,385,353 =============== ==============\nThe accompanying notes are an integral part of the financial statements.\nBALCOR REALTY INVESTORS-84 (An Illinois Limited Partnership)\nSTATEMENTS OF PARTNERS' DEFICIT for the years ended December 31, 1995, 1994 and 1993\nPartners' Deficit Accounts -------------- -------------- -------------- General Limited Total Partner Partners (A) -------------- -------------- --------------\nBalance at December 31, 1992 $ (38,930,633) $ (1,629,223) $ (37,301,410)\nNet income for the year ended December 31, 1993 2,809,966 28,100 2,781,866 -------------- -------------- -------------- Balance at December 31, 1993 (36,120,667) (1,601,123) (34,519,544)\nNet income for the year ended December 31, 1994 5,572,852 55,728 5,517,124 -------------- -------------- -------------- Balance at December 31, 1994 (30,547,815) (1,545,395) (29,002,420)\nNet income for the year ended December 31, 1995 3,004,923 30,049 2,974,874 -------------- -------------- -------------- Balance at December 31, 1995 $ (27,542,892) $ (1,515,346) $ (26,027,546) ============== ============== ==============\n(A) Includes a $110,000 investment by the General Partner, which is treated on the same basis as the other Limited Partnership Interests.\nThe accompanying notes are an integral part of the financial statements.\nBALCOR REALTY INVESTORS-84 (An Illinois Limited Partnership)\nSTATEMENTS OF INCOME AND EXPENSES for the years ended December 31, 1995, 1994 and 1993\n1995 1994 1993 -------------- -------------- -------------- Income: Rental and service $ 28,010,225 $ 30,283,700 $ 29,915,125 Interest on short-term investments 123,897 108,809 76,829 Other Income 167,225 -------------- -------------- -------------- Total income 28,134,122 30,392,509 30,159,179 -------------- -------------- -------------- Expenses: Interest on mortgage notes payable 8,828,989 10,764,902 12,047,956 Interest on short-term loans from an affiliate 568,140 635,617 484,932 Depreciation 3,838,532 4,461,058 4,617,794 Amortization of deferred expenses 282,754 455,911 471,567 Property operating 10,411,317 12,034,798 11,292,951 Real estate taxes 2,146,633 2,535,394 2,492,324 Property management fees 1,393,102 1,502,309 1,481,954 Administrative 1,075,097 1,049,594 923,660 -------------- -------------- -------------- Total expenses 28,544,564 33,439,583 33,813,138 -------------- -------------- -------------- Loss before gains on sales of properties, affiliate's participation in joint venture and extraordinary items (410,442) (3,047,074) (3,653,959) Gains on sales of properties 4,080,592 5,596,294 Affiliate's participation in (income) loss from joint venture (755,586) 232,417 65,004 -------------- -------------- -------------- Income (loss) before extraordinary items 2,914,564 2,781,637 (3,588,955) -------------- -------------- -------------- Extraordinary items: Gains on forgiveness of debt 90,359 2,791,215 2,058,078 Gain on foreclosure of property 4,340,843 -------------- -------------- -------------- Total extraordinary items 90,359 2,791,215 6,398,921 -------------- -------------- -------------- Net income $ 3,004,923 $ 5,572,852 $ 2,809,966 ============== ============== ==============\nThe accompanying notes are an integral part of the financial statements.\nBALCOR REALTY INVESTORS-84 (An Illinois Limited Partnership)\nSTATEMENTS OF INCOME AND EXPENSES for the years ended December 31, 1995, 1994 and 1993 (Continued)\n1995 1994 1993 -------------- -------------- -------------- Income (loss) before extraordinary items allocated to General Partner $ 29,145 $ 27,816 $ (35,890) ============== ============== ============== Income (loss) before extraordinary items allocated to Limited Partners $ 2,885,419 $ 2,753,821 $ (3,553,065) ============== ============== ============== Income (loss) before extraordinary items per Limited Partnership Interest (140,000 issued and outstanding) $ 20.61 $ 19.67 $ (25.38) ============== ============== ============== Extraordinary items allocated to General Partner $ 904 $ 27,912 $ 63,989 ============== ============== ============== Extraordinary items allocated to Limited Partners $ 89,455 $ 2,763,303 $ 6,334,932 ============== ============== ============== Extraordinary items per Limited Partnership Interest (140,000 issued and outstanding) $ 0.64 $ 19.74 $ 45.25 ============== ============== ============== Net income allocated to General Partner $ 30,049 $ 55,728 $ 28,100 ============== ============== ============== Net income allocated to Limited Partners $ 2,974,874 $ 5,517,124 $ 2,781,866 ============== ============== ============== Net income per Limited Partnership Interest (140,000 issued and outstanding) $ 21.25 $ 39.41 $ 19.87 ============== ============== ==============\nThe accompanying notes are an integral part of the financial statements.\nBALCOR REALTY INVESTORS-84 (An Illinois Limited Partnership)\nSTATEMENTS OF CASH FLOWS for the years ended December 31, 1995, 1994 and 1993\n1995 1994 1993 Operating activities: -------------- -------------- -------------- Net income $ 3,004,923 $ 5,572,852 $ 2,809,966 Adjustments to reconcile net income to net cash provided by operating activities: Extraordinary items: Gains on forgiveness of debt (90,359) (2,791,215) (2,058,078) Gain on foreclosure of property (4,340,843) Gains on sales of properties (4,080,592) (5,596,294) Affiliate's participation in income (loss) from joint venture 755,586 (232,417) (65,004) Depreciation of properties 3,838,532 4,461,058 4,617,794 Amortization of deferred expenses 282,754 455,911 471,567 Amortization of discount on note (112,816) receivable Deferred interest on note receivable (131,475) (424,168) Net change in: Escrow deposits 155,355 295,653 (1,083,694) Accounts and accrued interest receivable 217,330 735,033 (926,249) Prepaid expenses (283,187) (33,795) Accounts payable (73,497) (711,561) 72,914 Due to affiliates (75,213) (9,622) (10,263) Accrued liabilities (68,143) (241,377) 1,365,981 Security deposits (25,219) (17,488) (13,309) -------------- -------------- -------------- Net cash provided by operating activities 3,558,270 1,755,263 303,798 -------------- -------------- -------------- Investing activities: Proceeds from redemption of restricted investments 700,000 100,000 Additions to properties (48,774) Proceeds from sales of properties 12,390,000 18,659,285 Payment of selling costs (610,180) (250,816) -------------- -------------- -------------- Net cash provided by investing activities 12,479,820 18,408,469 51,226 -------------- -------------- --------------\nThe accompanying notes are an integral part of the financial statements.\nBALCOR REALTY INVESTORS-84 (An Illinois Limited Partnership)\nSTATEMENTS OF CASH FLOWS for the years ended December 31, 1995, 1994 and 1993 (Continued)\n1995 1994 1993 -------------- -------------- -------------- Financing activities: Capital contribution by joint venture partner - affiliate $ 4,953 Distributions to joint venture partner - affiliate $ (445,589) (22,802) $ (23,780) Proceeds from loan payable - affiliate 764,128 5,918,837 Repayment of loan payable - affiliate (5,530,000) (1,218,432) (7,164,610) Proceeds from issuance of mortgage notes payable 8,828,700 27,532,897 Repayment of mortgage notes payable (9,833,903) (20,626,168) (21,205,963) Repayment of mortgage notes payable-affiliate (5,668,638) (1,912,948) Principal payments on mortgage notes payable (1,447,264) (1,574,407) (1,579,971) Principal payments on mortgage notes payable - affiliate (114,600) (133,699) (7,675) Payment of deferred expenses (198,136) (967,631) Payment of financing escrows (113,250) (896,083) Release of financing escrows 416,948 368,609 32,228 -------------- -------------- -------------- Net cash used in financing activities (16,954,408) (19,589,142) (274,699) -------------- -------------- -------------- Net change in cash and cash equivalents (916,318) 574,590 80,325\nCash and cash equivalents at beginning of year 1,311,019 736,429 656,104 -------------- -------------- -------------- Cash and cash equivalents at end of year $ 394,701 $ 1,311,019 $ 736,429 ============== ============== ==============\nThe accompanying notes are an integral part of the financial statements.\nBALCOR REALTY INVESTORS-84 (An Illinois Limited Partnership)\nNOTES TO FINANCIAL STATEMENTS\n1. Balcor Realty Investors-84 (the \"Partnership\") is engaged principally in the operation of residential real estate located in various markets within the United States.\n2. Accounting Policies:\n(a) The preparation of the financial statements in conformity with generally accepted accounting principles requires the General Partner 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 vary from those estimates.\n(b) Depreciation expense is computed using straight-line and accelerated methods. Rates used in the determination of depreciation are based upon the following estimated useful lives:\nBuildings and improvements 20 to 30 years Furniture and fixtures 5 to 7 years\nMaintenance and repairs are charged to expense when incurred. Expenditures for improvements are charged to the related asset account.\nInterest incurred while properties were under construction was capitalized.\nAs properties are sold, the related costs and accumulated depreciation are removed from the respective accounts. Any gain or loss on disposition is recognized in accordance with generally accepted accounting principles.\n(c) Effective January 1, 1995 the Partnership adopted Statement of Financial Accounting Standards, No. 121 (SFAS 121), (\"Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of\"). Under SFAS 121, the Partnership records its investments in real estate at the lower of cost or fair value, and periodically assesses, but not less than on an annual basis, possible impairment to the value of its properties. The General Partner estimates the fair value of its properties by dividing the property's expected net operating income by a risk adjusted rate of return which considers economic and demographic conditions in the market. In the event the General Partner determines an impairment in value has occurred, and the carrying amount of the real estate asset will not be recovered, a provision is recorded to reduce the carrying basis of the property to its estimated fair value. The General Partner considers the method referred to above to result in a reasonable measurement of a property's fair value, unless other factors affecting the property's value indicate otherwise.\n(d) Deferred expenses consist of financing fees which are amortized over the terms of the respective agreements.\n(e) The Financial Accounting Standard Board's Statement No. 107, \"Disclosures About Fair Value of Financial Instruments\", requires disclosure of fair value information about financial instruments for which it is practicable to estimate that value. Since quoted market prices are not available for the Partnership's financial instruments, fair values have been based on estimates using present value techniques. These techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, may not be realized in immediate settlement of the instrument. Statement No. 107 does not apply to all balance sheet items and excludes certain financial instruments and all non-financial instruments such as real estate from its disclosure requirements.\n(f) Cash and cash equivalents include all unrestricted, highly liquid investments with an original maturity of three months or less.\n(g) The Partnership is not liable for Federal income taxes and each partner recognizes his proportionate share of the Partnership income or loss in his tax return; therefore, no provision for income taxes is made in the financial statements of the Partnership.\n(h) Revenue is recognized on an accrual basis in accordance with generally accepted accounting principles.\n(i) Reclassifications have been made to the previously reported 1994 and 1993 financial statements to conform with the classification used in 1995. These reclassifications have not changed the 1994 or 1993 results.\n3. Partnership Agreement:\nThe Partnership was organized in September 1982. The Partnership Agreement provides for Balcor Partners-XV to be the General Partner and for the admission of Limited Partners through the sale of up to 150,000 Limited Partnership Interests at $1,000 per Interest, 140,000 of which were sold on or prior to June 27, 1984, the termination date of the offering.\nThe Partnership Agreement provides that the General Partner generally will be allocated 1% of the profits and losses. One hundred percent of \"Net Cash Receipts\" available for distribution shall be distributed to the holders of Interests in proportion to their participating percentages as of the record date for such distributions. In addition, there shall be accrued for the benefit of the General Partner as its distributive share from operations an amount equivalent to approximately 1% of the total Net Cash Receipts being distributed, which will be paid only out of Net Cash Proceeds.\nUnder certain circumstances, the General Partner may also participate in the Net Cash Proceeds of the sale or refinancing of Partnership properties. When and as the Partnership sells or refinances its properties, the Net Cash Proceeds resulting therefrom, which are available for distribution, will be distributed only to holders of Interests until such time as holders of Interests have received an amount equal to their Original Capital plus certain levels of return as specified by the Partnership Agreement. Only after such returns are made to the Limited Partners will the General Partner receive 15% of further distributed Net Cash Proceeds, which will include the accrued distributive share of Net Cash Receipts, subject to increase by an amount equal\nto certain acquisition fees the General Partner would otherwise have been entitled to pursuant to the Partnership Agreement.\n4. Mortgage Notes Payable:\nMortgage notes payable at December 31, 1995 and 1994 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\/95 12\/31\/94 Rate Date Payment Payment - --------------- ---------- ---------- ------ ------ -------- ----------\nMortgage Notes Payable - Non-affiliates:\nApartment Complexes: Antlers $10,161,114 $10,309,549 8.25% 1998 $82,787 $9,731,000 Briarwood Place 6,018,798 6,137,179 6.498% 1998 43,961 5,606,000 Canyon Sands Village 9,055,999 9,265,525 6.498% 1998 66,130 8,460,000 Chesapeake 5,108,001 5,140,624 7.875% 2028 36,357 None Chimney Ridge(A) 7,249,103 7,321,840 Chestnut Ridge (Phase II) (B) 3,090,142 3,112,914 9.02% 2001 25,219 2,934,000 Courtyards of Kendall (C) 8,990,100 9,137,019 9.50% 1997 83,906 9,014,000 Creekwood (D) 5,635,134 5,677,152 8.88% 1999 45,372 5,465,000 Drayton Quarter (E) 4,796,013 Pinebrook (F) 5,068,603 Quail Lakes (G) 6,743,445 6,801,164 8.25% 2001 51,295 6,350,000 Ridgetree(Phase I) 9,506,559 9,569,351 10.05% 2000 85,139 9,157,000 Somerset Pointe 11,221,088 11,473,744 6.498% 1998 80,531 10,501,000 Sunnyoak Village 13,711,573 14,008,532 7.33% 2015 106,091 None Woodland Hills 4,949,640 4,993,013 8.54% 1998 39,009 4,828,000 ----------- ----------- Subtotal 101,440,696 112,812,222 ----------- -----------\nMortgage Notes Payable - Affiliates:\nApartment Complexes: Chestnut Ridge (H) 1,515,739 1,515,739 10.50% 2002 (H) 1,516,000 Woodland Hills (I) 336,872 451,472 10.50% 1999 (I) 451,000 ----------- ----------- Subtotal 1,852,611 1,967,211 ----------- ----------- Total $103,293,307$114,779,433 ============ ===========\n(A) In February 1996, this property was sold. The mortgage maturity amount is included in the 1996 maturity schedule amount below. See Note 15 of Notes to Financial Statements for additional information.\n(B) In March 1994, this loan was refinanced. The interest rate decreased from 9.75% to 9.02%, the maturity date was changed from January 2002 to April 2001 and the monthly payments increased from $24,073 to $25,219. Proceeds from the new $3,128,700 first mortgage loan were used to repay the existing $2,841,601 first mortgage loan as well as $287,099 of the secured loan from The Balcor Company (\"TBC\"), an affiliate of the General Partner as successor to Balcor Real Estate Holdings, Inc. (\"BREHI\") loan.\n(C) The Partnership is obligated to pay the lender (upon the earlier of maturity or the sale or refinancing of the property) additional interest equal to the lesser of: (i) 25% of the amount by which the agreed upon value of the property at maturity or upon sale or refinancing exceeds $10,100,000, or (ii) interest which would have accrued on the loan from June 1, 1992 through the earlier of maturity or the sale or refinancing of the property at a rate of 15% per annum.\n(D) In May 1994, this loan was refinanced. The interest rate changed from a floating rate to a fixed rate of 8.88%, the maturity date was extended from September 1994 to June 1999, and the monthly payments decreased from $49,953 to $45,372. Proceeds from the new $5,700,000 first mortgage loan were used to repay the existing first mortgage loan of $5,246,568.\n(E) In July 1995, this property was sold. See Note 9 of Notes to Financial Statements for additional information.\n(F) In December 1992, Pinebrook Investors, the joint venture which owned the property filed for protection under the U.S. Bankruptcy Code. In 1994, a plan of reorganization was approved by the Bankruptcy Court. Under the plan, the wrap-around features of the various mortgage notes were eliminated and the notes became first, second, third and fourth mortgage notes upon which the joint venture made monthly payments totaling $40,761, a portion of which would be deferred based on availability of cash flow, at interest rates ranging from 8.875% to 10%. Under the plan of reorganization, the new first, second and fourth mortgage loan balances became $2,294,722, $1,712,135 and $1,006,029, respectively. The third mortgage note payable was eliminated, along with its monthly payments, through consolidation of the financial statements. In February 1995, Pinebrook Investors sold the property. See Notes 9 and 11 of Notes to Financial Statements for additional information.\n(G) In March 1994, this loan was modified. Effective February 1994, the interest rate increased from 6.745% to 8.25%, the maturity date was extended from March 1995 to March 2001 and the monthly payments increased from $44,612 to $51,295.\n(H) This note represents a subordinate nonrecourse loan of $1,315,739 payable to TBC and a preferred limited partnership interest of $200,000 in the subsidiary partnership which holds title to the property. During 1994, $287,099 of the proceeds from the new first mortgage loan were used to repay a portion of the $414,897 deferred interest on the previous junior loans from affiliates. In addition, as a requirement of the first mortgage loan, of the remaining balances of the junior loans and deferred interest, $1,441,300 was retired and replaced with a General Partner loan and the remainder was retired and replaced with the current notes and preferred limited partnership interest. The contract rate on the TBC loan remains unchanged at 10.5%, which is the rate of return earned on the preferred limited partnership interest as well. The interest pay rate on the TBC loan is the lower of the contract rate or the net cash flow from the property. Any deferred interest on the TBC loan will be payable at\nmaturity. The Limited Partners' position is unaffected by this conversion of a portion of the junior loans to an equity position as Limited Partners' equity is subordinate to the preferred interest just as it was subordinate to the junior loans prior to the recharacterization.\n(I) This note represents a second mortgage loan payable to TBC. Repayment of the TBC loan is subordinated to a payment to the Partnership from sale or refinancing proceeds from this property of $1,800,000. The interest pay rate is the lower of the contract rate or the net cash flow from the property, after payment of interest on the first mortgage loan, limited to a maximum annual deficit of $62,500. Deferred interest on the second mortgage loan is accumulated and bears interest at the contract rate.\nThe Partnership's mortgage loans payable to non-affiliates described above require current monthly payments of principal and interest. During the years ended December 31, 1995, 1994 and 1993, the Partnership incurred interest expense on mortgage notes payable to non-affiliates of $8,605,824, $10,132,223 and $10,882,258, respectively. The Partnership paid interest expense of $8,611,797 in 1995, $10,140,419 in 1994, and $10,655,057 in 1993. See Note 8 of Notes to Financial Statements for interest paid and incurred on loans payable to affiliates.\nReal estate held for investment with an aggregate carrying value of $80,067,721 at December 31, 1995 was pledged as collateral for repayment of mortgage loans.\nFuture annual maturities of the mortgage notes payable - non-affiliates and mortgage note payable - affiliates during each of the next five years are approximately as follows:\n1996 $ 8,702,000 1997 10,225,000 1998 40,397,000 1999 6,431,000 2000 9,724,000\n5. Management Agreements:\nAs of December 31, 1995, all of the properties owned by the Partnership are under management agreements with a third-party management company. These management agreements provide for annual fees of 5% of gross operating receipts.\n6. Affiliate's Participation in Joint Venture:\nThe Pinebrook apartment complex was purchased by Pinebrook Investors, a joint venture between the Partnership and an affiliated partnership. Profits and losses were allocated 51.57% to the Partnership and 48.43% to the affiliate. All assets, liabilities, income and expenses of the joint venture were included in the financial statements of the Partnership with the appropriate adjustment for profit or loss for each affiliate's participation. Net distributions of $445,589, $17,849 and $23,780 were made to the joint venture partner in 1995, 1994 and 1993, respectively.\n7. 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 income for 1995 in the financial statements is $1,421,616 less than the tax income of the Partnership for the same period.\n8. Transactions with Affiliates:\nFees and expenses paid and payable by the Partnership to affiliates are:\nYear Ended Year Ended Year Ended 12\/31\/95 12\/31\/94 12\/31\/93 ----------------- -------------------- ------------------- Paid Payable Paid Payable Paid Payable\n-------- -------- ---------- --------- --------- --------- Property manage- ment fees None None $1,401,854 None $1,477,069 $135,884 Reimbursement of expenses to General Partner at cost: Accounting $ 56,140 $ 4,699 119,390 $39,870 64,346 5,325 Data processing 60,314 5,838 102,770 20,814 57,699 10,401 Investor communications 6,984 None 12,677 4,234 10,210 845 Legal 65,226 9,053 35,233 11,767 27,006 2,235 Other 8,920 370 43,319 14,467 32,012 2,649 Portfolio mgmt. 217,759 32,529 127,397 38,107 118,754 9,356\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; however, the General Partner is reimbursed for program expenses. The Partnership paid premiums to the deductible insurance program of $192,179, $310,984, and $208,938 for 1995, 1994 and 1993, respectively.\nAllegiance Realty Group, Inc., an affiliate of the General Partner, managed the Partnership's properties until the affiliate was sold to a third party in November 1994.\nDuring 1994, $1,441,300 of an unsecured affiliate loan relating to the Chestnut Ridge Phase II Apartments was retired and replaced with a General Partner loan as a result of the March 1994 refinancing of that property. In addition, the Partnership borrowed an additional $764,128 during 1994 to meet working capital requirements. The Partnership repaid $5,530,000 of these loans from the General Partner during 1995. As of December 31, 1995, the Partnership had outstanding short-term loans totaling $6,623,202 from the General Partner with accrued interest payable on these loans totaling $70,120. The Partnership repaid the balance outstanding at December 31, 1995 during March 1996 primarily with\nproceeds from the sale of Chimney Ridge Apartments. (See Note 15 of Notes to Financial Statements for additional information.) During 1995, 1994 and 1993, the Partnership incurred interest expense of $568,140, $635,617 and $484,932 and paid interest expense of $566,583, $607,803 and $511,973 on these loans, respectively. Interest expense is computed at the American Express Company cost of funds rate plus a spread to cover administrative costs. As of December 31, 1995, this rate was 6.307%.\nIn March 1994, the Partnership refinanced the Chestnut Ridge Phase II mortgage loans payable, including a second mortgage loan previously outstanding to TBC, an affiliate of the General Partner, and the unsecured loan described above. See Note 4 of Notes to Financial Statements for additional information.\nIn August 1994, the Partnership repaid the Ridgepoint Hill and Ridgepoint View TBC loans at a discount in connection with the sale of these properties. See Note 9 of Notes to Financial Statements for additional information.\nAs of December 31, 1995, the Partnership had junior loans outstanding from TBC relating to the Chestnut Ridge Phase II and Woodland Hills apartment complexes in the aggregate amount of $1,852,611 with accrued interest payable on these loans totaling $38,267. See Note 4 of Notes to Financial Statements for additional information. During 1995, 1994 and 1993, the Partnership incurred interest expense of $223,165, $632,679 and $1,165,698 and paid interest expense of $214,521, $913,199 and $770,479 on these affiliated mortgage loans, respectively.\nThe General Partner may continue to make arrangements to provide 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 borrowings be needed and not be available either through the General Partner or third parties, the Partnership may be required to dispose of some of its properties to satisfy its obligations.\n9. Property Sales:\nThe Pinebrook Apartments, which was owned by a joint venture consisting of the Partnership and an affiliate, and the Drayton Quarter Apartments were sold during 1995 and the Ridgepoint Hill and Ridgepoint View apartment complexes were sold during 1994 in separate all cash sales totaling $12,390,000 and $18,659,285, respectively.\nFrom the proceeds of the sales, $9,833,903 and $12,658,037, which included accrued interest, was paid to the third party mortgage holders in full satisfaction of the underlying mortgage loans, respectively, as well as brokerage commissions and other closing costs. The remaining $1,945,917 of 1995 sale proceeds were used to repay loans from the General Partner. The remaining $5,381,539 of 1994 sales proceeds were paid to an affiliate of the General Partner in full satisfaction of the second mortgage loan and an unsecured third mortgage loan. This represented a discount of $2,791,215 from the outstanding balance of the affiliate loans and accrued interest. The Partnership did not receive any proceeds from the 1994 sale of the properties.\nThe bases of these properties totaled $7,699,228 and $12,812,175 which is net of accumulated depreciation of $5,716,448 and $6,249,032, respectively. For financial statement purposes, the Partnership recognized gains totaling $4,080,592 and $5,596,294 from the sales of these properties during 1995 and\n1994, respectively, of which $780,279 was the affiliate minority joint venture partner's share relating to Pinebrook Apartments.\n10. Restricted Investments:\nAs of December 31, 1993, a certificate of deposit of $700,000 was pledged as additional collateral related to the Canyon Sands mortgage loan. This amount was invested in short-term instruments pursuant to the terms of the agreement with the lending institution. Interest earned on the collateral accumulated to the benefit of the Partnership. In March 1995, the certificate was released to the Partnership.\nIn addition, an affiliate of the General Partner had been providing a guarantee against a letter of credit in the amount of $250,000 posted as additional collateral for the funding of capital improvements on the Courtyards of Kendall apartment complex. During 1994, the letter of credit was cashed and applied to the principal balance of the underlying mortgage loan.\n11. Net Investment in Note Receivable:\nThe Pinebrook apartment complex was owned by Pinebrook Investors, a joint venture consisting of the Partnership and an affiliate, and was financed with a $5,185,000 wrap-around mortgage note payable to Lexington Associates, the seller of the property (\"Lexington\"), which wrapped two underlying mortgage notes payable to Pinebrook Limited Partnership, a separate joint venture consisting of the Partnership and the affiliate. These notes in turn wrapped a mortgage note payable to Tates Creek Place (\"Tates Creek\"). As of December 31, 1993, the Partnership's net investment in the notes was $914,040, consisting of the wrap-around notes receivable from Lexington of $4,885,918, offset by the mortgage note payable to Tates Creek of $3,971,878. In December 1992, Pinebrook Investors filed for protection under the U.S. Bankruptcy Code and a plan of reorganization was approved by the Bankruptcy Court and made effective in May 1994. Under the plan of reorganization, the wrap-around features of the various mortgage notes were eliminated and the mortgage notes payable by Pinebrook Investors to third parties became first, second and fourth mortgage notes. The net investment of $914,040 described above was recharacterized as a third mortgage note payable by Pinebrook Investors to Pinebrook Limited Partnership. The operations of these joint ventures have been consolidated within the Partnership's financial statements, and the related intercompany mortgage notes transactions have been eliminated. In February 1995, the Partnership sold the Pinebrook apartment complex. See Note 9 of Notes to Financial Statements for additional information.\n12. Extraordinary Items:\n(a) During 1995, the Partnership recognized an extraordinary gain on forgiveness of debt of $90,359 in connection with the settlement reached with the seller of the Canyon Sands Village, Somerset Pointe and Sunnyoak Village apartment complexes.\n(b) During 1994, the Ridgepoint Hill and Ridgepoint View apartment complexes were sold. In connection with the sale, the Partnership repaid the second mortgage loans and an unsecured third mortgage loan due to an affiliate of the General Partner at a discount. This transaction resulted in an extraordinary gain on forgiveness of debt of $2,791,215 during 1994 for financial statement purposes. See Note 9 of Notes to Financial Statements for additional information.\n(c) During 1993, the Ridgetree Phase I and the Chimney Ridge mortgage notes were refinanced. The mortgage notes which had outstanding balances totaling $18,322,426, including accrued interest, were repaid for $16,264,348. These transactions resulted in extraordinary gains on forgiveness of debt totaling $2,058,078 during 1993 for financial statement purposes.\n(d) During 1993, title to the Highland Glen Apartments was relinquished through foreclosure. The Partnership wrote-off the property basis of $10,613,575, net of accumulated depreciation of $4,252,309, a mortgage loan balance of $14,918,362 and accrued real estate taxes of $36,056. The Partnership recognized an extraordinary gain on foreclosure of property of $4,340,843 during 1993 for financial statement purposes.\n13. Contingency:\nThe Briarwood apartment complex is located in the path of a planned expansion of a road, which is adjacent to the property. Discussions for this expansion have been ongoing, and the General Partner has been attending the public hearings due to its opposition to this expansion. If the current plans are approved, approximately 68 of the complex's 268 units would be condemned, which would have a significant impact on the property's value. Currently it is unclear whether the future approvals for the expansion and funding for the road project will be obtained and, if obtained, what compensation the Partnership would receive for the units or when the work would begin.\n14. Fair Value of Financial Instruments:\nThe carrying amounts and fair values of the Partnership's financial instruments at December 31, 1995 are as follows:\nThe carrying values of cash and cash equivalents, accounts and accrued interest receivable, accounts and accrued interest payable approximate fair value.\nMortgage notes payable: Based on borrowing rates available to the Partnership at the end of 1995 for mortgage loans with similar terms and maturities, the fair value of the mortgage notes payable approximate the carrying value.\n15. Subsequent Events:\n(a) In February 1996, the Partnership sold the Chimney Ridge Apartments in an all cash sale for $13,650,000. The purchaser took title subject to the existing first mortgage loan which had a balance of $7,242,788. From the proceeds of the sale, the Partnership paid $336,642 in closing costs, and received $6,070,571 of net sale proceeds. The basis of the property was $4,427,342, net of accumulated depreciation of $3,137,301. The Partnership will recognize a gain of $8,886,016 in its 1996 financial statements.\n(b) On February 29, 1996, a proposed class action complaint was filed, Raymond Masri vs. Lehman Brothers, Inc., et al., Case No. 96\/103727 (Supreme Court of the State of New York, County of New York). The Partnership, additional limited partnerships which were sponsored by The Balcor Company, three limited partnerships sponsored by the predecessor of Lehman Brothers, Inc. (together with the Partnership and the affiliated partnerships, the \"Defendant Partnerships\"), Lehman Brothers, Inc. and Smith Barney Holdings, Inc. are defendants. The complaint alleges, among other things, common law fraud and deceit, negligent misrepresentation and breach of fiduciary duty relating to the disclosure of information in the offering of limited partnership interests in the Defendant Partnerships. The complaint seeks judgment for compensatory damages equal to the amount invested in the Defendant Partnerships by the proposed class plus interest accrued thereon; general damages for injuries arising from the defendants' actions; recovery from the defendants of all profits received by them as a result of their actions relating to the Defendant Partnerships; exemplary damages; attorneys' fees and other costs.\nThe defendants intend to vigorously contest this action. No class has been certified as of this date. Management of each of the defendants believes they have meritorious defenses to contest the claims. It is not determinable at this time whether or not an unfavorable decision in this action would have a material adverse impact on the Registrant.\nBALCOR REALTY INVESTORS-84 (An Illinois Limited Partnership)\nBALCOR REALTY INVESTORS-84 (An Illinois Limited Partnership)\nBALCOR REALTY INVESTORS-84 (An Illinois Limited Partnership)\nNOTES TO SCHEDULE III\n(a) See description of mortgage notes payable in Note 4 of Notes to Financial Statements.\n(b) Consists of legal fees, appraisal fees, title costs, other related professional fees and capitalized construction period interest.\n(c) Guaranteed income earned on properties under the terms of certain management and guarantee agreements was recorded by the Partnership as a reduction of the basis of the property to which the guaranteed income related.\n(d) A reduction of basis was made to write down the property to its December 31, 1988 mortgage liability balance.\n(e) The aggregate cost of land for Federal income tax purposes is $18,674,642 and the aggregate cost of buildings and improvements for Federal income tax purposes is $112,035,345. The total of these is $130,709,987.\n(f) Reconciliation of Real Estate ----------------------------- 1995 1994 1993 ------------- ------------ ------------ Balance at beginning of year $149,380,030 $168,441,237 $183,258,347 Additions during year: Improvements None None 48,774 Deductions during year Foreclosure of investment properties None None (14,865,884) Cost of real estate sold (13,415,676) (19,061,207) None ------------ ------------ ------------ Balance at close of year $135,964,354 $149,380,030 $168,441,237 ============ ============ ============\nReconciliation of Accumulated Depreciation ------------------------------------------ 1995 1994 1993 ---------- ---------- ---------- Balance at beginning of year $57,774,549 $59,562,523 $ 59,197,038 Depreciation expense for the year 3,838,532 4,461,058 4,617,794 Accumulated depreciation of foreclosed investment properties None None (4,252,309) Accumulated depreciation of real estate sold (5,716,448) (6,249,032) None ------------ ------------ ------------ Balance at close of year $55,896,633 $ 57,774,549 $ 59,562,523 ============ ============ ============\n(g) Depreciation expense is computed based upon the following estimated useful lives: Years ----- Buildings and improvements 20 to 30 Furniture and fixtures 5 to 7","section_15":""}
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{"filename":"713571_1995.txt","cik":"713571","year":"1995","section_1":"ITEM 1. BUSINESS --------\nCapital Realty Investors-II Limited Partnership (the Partnership) is a limited partnership which was formed under the Maryland Revised Uniform Limited Partnership Act on March 23, 1983. On May 6, 1983, the Partnership commenced offering 50,000 limited partnership interests through a public offering which was managed by Merrill Lynch, Pierce, Fenner and Smith, Incorporated. The Partnership closed the offering on June 20, 1983 when it became fully subscribed.\nThe General Partners of the Partnership are C.R.I., Inc. (CRI), which is the Managing General Partner, and current and former shareholders of CRI. Services for the Partnership are performed by CRI, as the Partnership has no employees of its own.\nThe Partnership was formed to invest in real estate, which is the Partnership's principal business activity, by acquiring and holding a limited partnership interest in limited partnerships (Local Partnerships). As of December 31, 1995, the Partnership has invested in twenty-two Local Partnerships. Each of these Local Partnerships owns a federal or state government-assisted or conventionally financed apartment complex, which provides housing principally to the elderly or to individuals and families of low or moderate income. The original objectives of these investments, not necessarily in order of importance, were to:\n(1) preserve and protect the Partnership's capital; (2) provide, during the early years of the Partnership's operations, current tax benefits to the partners in the form of tax losses which the partners may use to offset income from other sources; (3) provide capital appreciation through increases in the value of the Partnership's investments and increased equity through periodic payments on the indebtedness on the apartment complexes; and (4) provide cash distributions from sale or refinancing of the Partnership's investments and, on a limited basis, from rental operations.\nSee Part II, Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, for a discussion of factors affecting the original investment objectives.\nThe Local Partnerships in which the Partnership has invested were organized by private developers who acquired the sites, or options thereon, applied for applicable mortgage insurance and\/or subsidies, and remain as the local general partners in the Local Partnerships. The Partnership became the principal limited partner in these Local Partnerships pursuant to negotiations with these developers who act as the local general partners. However, in the event of non-compliance with the Local Partnerships' partnership agreements, the local general partner may be removed and replaced with another local general partner or with an affiliate of the Partnership's Managing General Partner. As a limited partner, the Partnership's legal liability for obligations of the Local Partnership is limited to its investment. An affiliate of the Managing General Partner of the Partnership is also generally a general partner of the Local Partnerships. In most cases, the local general partners of the Local Partnerships retain responsibility for developing, constructing, maintaining, operating and managing the project. Additionally, the local general partners and affiliates of the Managing General Partner may operate other apartment complexes which may be in competition for eligible tenants with the Local Partnerships' apartment complexes.\nI-1\nPART I ------ ITEM 1. BUSINESS - Continued --------\nAlthough each of the Local Partnerships in which the Partnership has invested owns an apartment complex which must compete in the market place for tenants, interest subsidies and\/or rent supplements from governmental agencies generally make it possible to offer certain of these dwelling units to eligible tenants at a cost significantly below the market rate for comparable conventionally financed dwelling units. Based on available data, the General Partners believe there to be no material risk of market competition in the operations of the apartment complexes described below which adversely impact the Partnership, except in specific circumstances as described in Part II, Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations.\nThe following is a schedule of the apartment complexes owned by Local Partnerships in which the Partnership is a limited partner:\nI-2\nSCHEDULE OF PROJECTS OWNED BY LOCAL PARTNERSHIPS IN WHICH CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP HAS AN INVESTMENT(1)\nI-3\nPART I ------ ITEM 1. BUSINESS - Continued --------\nSCHEDULE OF PROJECTS OWNED BY LOCAL PARTNERSHIPS IN WHICH CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP HAS AN INVESTMENT(1)\nI-4\nSCHEDULE OF PROJECTS OWNED BY LOCAL PARTNERSHIPS IN WHICH CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP HAS AN INVESTMENT(1) - Continued\nI-5\nSCHEDULE OF PROJECTS OWNED BY LOCAL PARTNERSHIPS IN WHICH CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP HAS AN INVESTMENT(1) - Continued\n(1) All properties are multifamily housing complexes. No single tenant\/resident rents 10% or more of the rentable square footage. Residential leases are typically one year or less in length, with varying expiration dates, and substantially all rentable space is for residential purposes.\n(2) The amounts provided are the balances of first mortgage loans payable by the Local Partnerships as of December 31, 1995.\n(3) The totals for the percentage of units occupied and the average effective annual rental per unit are based on a simple average.\nFor additional information regarding the real estate of Local Partnerships in which the Partnership has invested, see Part IV, Schedule III - \"Real Estate and Accumulated Depreciation of Local Partnerships in which Capital Realty Investors-II Limited Partnership has invested.\"\nOn January 31, 1996, the Local Managing General Partner of Palatine- Barrington Associates Limited Partnership (Deer Grove) received an offer for the property from an unaffiliated entity. The Local Managing General Partner is currently evaluating this offer.\nI-6\nPART I ------\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES ----------\nThrough its ownership of limited partnership interests in Local Partnerships, Capital Realty Investors-II Limited Partnership indirectly holds an interest in the underlying real estate. See Part I, Item 1 and Schedule III of Part IV, Item 14 for information pertaining to these properties.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS -----------------\nInformation concerning potential future legal proceedings is contained in Part II, Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations and Note 6 of the notes to financial statements in Part IV, Item 14.\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 1995.\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S PARTNERSHIP INTERESTS AND ----------------------------------------------------- RELATED PARTNERSHIP MATTERS ---------------------------\n(a) It is not anticipated that there will be any market for resale of interests in the Partnership. As a result, investors may be unable to sell or otherwise dispose of their interest in the Partnership.\n(b) As of March 8, 1996, there were approximately 4,100 registered holders of limited partnership interests in the Partnership.\n(c) No distributions were declared or paid by the Partnership during 1995 or 1994. The Partnership received distributions of $870,339 and $793,007 from Local Partnerships during 1995 and 1994, respectively. Some of the Local Partnerships operate under restrictions imposed by the pertinent government agencies that limit the cash return available to the Partnership.\nI-1\nPART II -------\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA -----------------------\nII-2\nPART II -------\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL ------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS -----------------------------------\nGeneral -------\nThe Partnership has invested, through Local Partnerships, primarily in federal or state government-assisted apartment complexes intended to provide housing to low and moderate income tenants. In conjunction with such government assistance, which includes federal and\/or state financing at below-market interest rates and rental subsidies, the Local Partnerships agreed to regulatory limitations on (i) cash distributions, (ii) use of the properties and (iii) sale or refinancing. These limitations typically were designed to remain in place for the life of the mortgage.\nThe original investment objectives of the Partnership primarily were to deliver tax benefits, as well as cash proceeds upon disposition of the properties through the Partnership's investment in local limited partnerships. Only limited annual cash distributions from property operations were projected because of the regulatory restrictions on cash distributions from the properties.\nThe original investment objectives of the Partnership have been affected by the Tax Reform Act of 1986, which virtually eliminated many of the incentives for the new construction of or the sale of existing low income housing properties by limiting the use of passive loss deductions. Therefore, the Managing General Partner continues to concentrate on transferring the source of investment yield from tax benefits to cash flow wherever possible and potentially enhancing the ability of the Partnership to share in the appreciated value of the properties.\nThe acquisition of interests in certain Local Partnerships resulted in purchase money note obligations of the Partnership. The purchase money notes are non-recourse obligations of the Partnership which typically mature fifteen years from the dates of acquisition of the interests in particular Local Partnerships.\nThe Managing General Partner has been working to develop a strategy to sell certain properties by utilizing opportunities presented by federal affordable housing legislation, favorable financing terms and preservation incentives available to nonprofit purchasers. The Managing General Partner intends to utilize part or all of the Partnership's net proceeds (after 50% distribution to limited partners) received from the sale of properties to fund reserves for paying at maturity, prepaying or purchasing prior to maturity, at a discount where possible, currently outstanding purchase money notes. The Managing General Partner believes that this represents an opportunity to reduce the Partnership's long-term obligations.\nMany of the rental properties owned by the Local Partnerships have mortgages which are federally insured under Section 236 or Section 221(d)(3) of the National Housing Act, as amended. These properties may be eligible for sale or refinancing, subject to numerous requirements, under the Low Income Housing Preservation and Resident Homeownership Act of 1990 (LIHPRHA). This program may provide incentives to owners of qualifying multifamily housing who commit to permanently maintain their properties as low to moderate income housing. Incentives available under LIHPRHA include selling the property to qualified buyers or obtaining supplemental financing for the property. As of March 8, 1996, members of Congress were recommending substantial changes to the LIHPRHA\nII-3\nPART II -------\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL ------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS - Continued -----------------------------------\nprogram ranging from the elimination of the program to the redesigning of the program. Substantial uncertainty exists as to whether any properties which have already filed the notice of intent to participate under LIHPRHA will qualify under a redesigned program or as to whether the program will continue at all.\nSome of the rental properties owned by the Local Partnerships are financed by state housing agencies. The Managing General Partner has been working to develop a strategy to sell or refinance certain properties by utilizing programs developed by these agencies. These programs may include opportunities to sell the property to a qualifying purchaser who would agree to maintain the property as low to moderate income housing in perpetuity, or may include opportunities to refinance the property through supplemental financing. The Managing General Partner continues to monitor these programs to ascertain whether the properties would qualify within the parameters of these programs and whether these programs would provide an appropriate economic benefit to the limited partners of the Partnership.\nMany of the rental properties owned by the Local Partnerships are dependent on the receipt of housing assistance payments guaranteed by contract under the Department of Housing and Urban Development (HUD) Section 8 program. The level of funding for the Section 8 program, and HUD-insured multifamily housing in general, is dependent upon the continuation of appropriations approved by Congress for subsidy payments. In the event that the rental subsidy programs are reduced or phased out, there is no assurance that the rental properties will be able to maintain the occupancy levels necessary to pay debt service and operating costs or that the rents necessary to pay debt service and operating costs will be competitive with rents for comparable units in the rental properties' market areas. While the Managing General Partner has no reason to believe that HUD will not honor its obligations under the contracts, some uncertainty exists in light of the recent Congressional scrutiny of appropriations for HUD programs.\nIn 1990, CRI, as Managing General Partner of the Partnership and various other entities, subcontracted certain property-level asset management functions for certain properties to Capital Management Strategies, Inc. (CMS). Among these properties were properties owned by certain of the Local Partnerships in which the Partnership invested. CMS was formed by Martin C. Schwartzberg, a nominal general partner of the Partnership and a former stockholder of CRI, when he cashed out of CRI and its related businesses as of January 1, 1990. Mr. Schwartzberg agreed not to act as a general partner with respect to any of the CRI-sponsored partnerships, including this Partnership, and has not done so since that time. In late 1995, a dispute arose between CRI and CMS over the funding level of the 1996 contract for CMS. On November 9, 1995, CRI filed a complaint against CMS to determine the proper amount of fees to be paid in 1996 under the asset management agreement. CMS answered on January 10, 1996, but asserted no counterclaims.\nThereafter, Mr. Schwartzberg launched a hostile consent solicitation to be designated as managing general partner of approximately 125 private partnerships sponsored by CRI. On January 18, 1996, Mr. Schwartzberg and CMS filed a complaint in the Circuit Court of Montgomery County, Maryland (the Circuit Court), against CRI and Messrs. Dockser and Willoughby (who are general partners of the Partnership) alleging, among other things, that CRI and Messrs. Dockser and Willoughby have breached the asset management agreement pursuant to which\nII-4\nPART II -------\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL ------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS - Continued -----------------------------------\nMr. Schwartzberg's company, CMS, agreed to perform limited functions related to property-level issues for a portion of CRI's subsidized housing portfolio (including some of the properties in which the Partnership invested), by reducing the proposed budget for 1996. The Partnership is not named as a defendant in this action. Messrs. Dockser and Willoughby have entered an answer denying all of Mr. Schwartzberg's claims. Messrs. Dockser and Willoughby have publicly responded that Mr. Schwartzberg's suit is motivated by his budget dispute with CRI and personal animosity. On February 6, 1996, CRI terminated the CMS contract for cause. Mr. Schwartzberg and CMS responded by filing a motion for injunctive relief in the Circuit Court, asking the court to enjoin CRI from terminating the contract. In a ruling issued on February 12, 1996, the Circuit Court, among other things, refused to grant the injunction requested by CMS. A hearing in this case is scheduled for April 29, 1996. On February 12, 1996, the Circuit Court also issued a memorandum opinion and order enjoining CMS and Mr. Schwartzberg from disclosing information made confidential under the asset management agreement.\nOn February 1, 1996 and February 16, 1996, Mr. Schwartzberg sent letters to the Partnership requesting investor lists and other forms of investor information. On February 5, 1996, the Partnership, acting through its managing general partner, CRI, denied Mr. Schwartzberg's request. On February 20, 1996, counsel for the Partnership responded to Mr. Schwartzberg's second request, denying that Mr. Schwartzberg had standing or a proper purpose for requesting the investor lists. In view of Mr. Schwartzberg's solicitation efforts against other CRI-sponsored partnerships, CRI anticipates that litigation may arise from this request.\nFinancial Condition\/Liquidity -----------------------------\nAs of December 31, 1995, the Partnership had approximately 4,100 investors who subscribed to a total of 50,000 units of limited partnership interests in the original amount of $50,000,000. The Partnership has made investments in twenty-two Local Partnerships. The Partnership's liquidity, with unrestricted cash resources of $3,192,539 as of December 31, 1995, along with anticipated future cash distributions from the Local Partnerships, is expected to meet its current and anticipated operating cash needs. As of March 8, 1996, there were no material commitments for capital expenditures. Statement of Financial Accounting Standards No. 107, \"Disclosures About Fair Value of Financial Instruments\" (SFAS 107), requires the disclosure of fair value information about financial instruments for which it is practicable to estimate that value. The Partnership implemented SFAS 107 in 1995, and has determined that the carrying amount of its cash and cash equivalents approximates fair value.\nDuring 1995, 1994 and 1993, the Partnership received cash distributions of $870,339, $793,007 and $1,092,917, respectively, from the Local Partnerships.\nAs of December 31, 1995, the Partnership's obligations with respect to its investments in Local Partnerships, in the form of purchase money notes of $22,420,678 (exclusive of unamortized discount on purchase money notes of $8,206,853) plus accrued interest of $29,256,224, are payable upon the earliest of: (1) sale or refinancing of the respective Local Partnership's rental property; (2) payment in full of the respective Local Partnership's permanent\nII-5\nPART II -------\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL ------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS - Continued -----------------------------------\nloan; or (3) maturity. Purchase money notes in an aggregate principal amount of $2,380,000 matured on August 1, 1995 but have not been paid, as discussed below. A purchase money note in the principal amount of $2,280,000 matured on August 1, 1995 and was subsequently paid off at a discount on January 11, 1996, as discussed below. Purchase money notes in an aggregate principal amount of $2,100,000 are scheduled to mature on December 31, 1996, as discussed below. The remaining purchase money notes mature in 1998 and 1999. The purchase money notes are generally secured by the Partnership's interest in the respective Local Partnership. There is no assurance that the underlying properties will have sufficient appreciation and equity to enable the Partnership to pay the purchase money notes' principal and accrued interest when due. If a purchase money note is not paid in accordance with its terms, the Partnership will either have to renegotiate the terms of repayment or risk losing its partnership interest in the Local Partnership. The Managing General Partner is continuing to investigate possible alternatives to reduce the Partnership's long-term debt obligations. These alternatives include, among others, retaining the cash available for distribution to meet the purchase money note requirements, buying out certain purchase money notes at a discounted price, extending the due dates of certain purchase money notes, or refinancing the respective properties' underlying debt and using the Partnership's share of the proceeds to pay off or buy down certain purchase money note obligations.\nThe Partnership defaulted on its purchase money note relating to Rock Glen Limited Partnership (Rock Glen) on August 1, 1995 when the note matured and was not paid. A standstill agreement from the noteholder was granted until October 31, 1995. The Managing General Partner made an offer to the noteholder to extend the purchase money note due date to August 2000. This offer was rejected by the noteholder. On January 11, 1996, the Partnership paid off the purchase money note at a discount, resulting in a gain on extinguishment of debt of approximately $1.8 million.\nThe Partnership defaulted on its purchase money note relating to Beech Hill Development Co. (Beech Hill I) on August 1, 1995 when the note matured and was not paid. The default amount included principal and accrued interest of $1,480,000 and $1,473,498, respectively. As of March 8, 1996, principal and accrued interest totalling $1,480,000 and $1,553,687, respectively, were due. In addition, the Partnership defaulted on its purchase money note relating to Beech Hill Development Co. II (Beech Hill II) on August 1, 1995 when the note matured and was not paid. The default amount included principal and accrued interest of $900,000 and $905,047, respectively. As of March 8, 1996, principal and accrued interest totalling $900,000 and $953,810, respectively, were due. The Managing General Partner is currently negotiating with the noteholders of Beech Hill I and Beech Hill II to extend the purchase money note due dates to January 1, 1998. Under the proposed agreement, the Partnership would pay the purchase money noteholders of Beech Hill I and Beech Hill II all annual cash flow distributions received from the related Local Partnerships in excess of $5,000 and $2,500, respectively. There were no annual cash flow distributions made to the Partnership from the related Local Partnerships during 1995, 1994 or 1993. Also under the proposed agreement, transfer documents relating to foreclosure by the noteholders upon the Partnership's interests in the related Local Partnerships would be placed in escrow and released to the noteholders upon a future default by the Partnership on the respective purchase money notes. There is no assurance that an agreement will be reached between the Managing General Partner and the noteholders. As such, there is no assurance that the\nII-6\nPART II -------\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL ------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS - Continued -----------------------------------\nPartnership will be able to retain its interest in either Beech Hill I or Beech Hill II.\nPurchase money notes relating to Chevy Chase Park Limited (Chevy Chase) in the aggregate principal amount of $2,100,000 mature on December 31, 1996. The Managing General Partner is currently negotiating with the noteholders to extend the purchase money note due dates to coincide with potential future LIHPRHA processing, or to accept a discounted pay-off. There is no assurance that any agreement will be reached with the noteholders. As such, there is no assurance that the Partnership will be able to retain its interest in Chevy Chase.\nThe uncertainty about the continued ownership of the Partnership's interests in Beech Hill I, Beech Hill II or Chevy Chase does not impact the Partnership's financial condition because the related purchase money notes are nonrecourse and secured solely by the Partnership's interest in the related Local Partnerships. Therefore, should the investment in Beech Hill I, Beech Hill II and Chevy Chase not produce sufficient value to satisfy the related purchase money notes, the Partnership's exposure to loss is limited since the amount of the nonrecourse indebtedness exceeds the carrying amount of the investment in and advances to the Local Partnerships. Thus, even a complete loss of any of these investments would not have a material impact on the operations of the Partnership. However, should the Partnership be unable to retain its interest in all of the Local Partnerships, the investments in and advances to Local Partnerships would be reduced by the Partnership's basis in these Local Partnerships, which at December 31, 1995 was approximately 17% of the Partnership's total investment in Local Partnerships.\nSFAS 107 requires the disclosure of fair value information about financial instruments for which it is practicable to estimate that value. The Partnership has determined that it is not practicable to estimate the fair value of the purchase money notes, either individually or in the aggregate, due to: (1) the lack of an active market for this type of financial instrument, (2) the variable nature of purchase money note interest payments as a result of fluctuating cash flow distributions received from the related Local Partnerships, and (3) the excessive costs associated with an independent appraisal of the purchase money notes.\nThe Partnership closely monitors its cash flow and liquidity position in an effort to ensure that sufficient cash is available for operating requirements. In 1995, the receipt of distributions from Local Partnerships was adequate to support operating cash requirements.\nIn 1994, the receipt of distributions from Local Partnerships was adequate to support operating cash requirements. Cash and cash equivalents decreased in 1994 from 1993.\nResults of Operations ---------------------\nThe Partnership's net loss increased in 1995 from 1994 primarily due to an increase in interest expense as a result of the amortization of imputed interest. Partially offsetting the increase in net loss was an increase in share of income from Local Partnerships principally due to the loss in 1994 resulting from the pay-off of the remaining Country Place I and II purchase\nII-7\nPART II -------\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL ------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS - Continued -----------------------------------\nmoney notes, as discussed below. Also partially offsetting the increase in net loss was an increase in interest income resulting from increased yields on investments and higher cash balances during 1995.\nThe Partnership's net loss increased in 1994 from 1993 primarily due to an increase in interest expense as a result of the amortization of imputed interest. Contributing to the increase in net loss was an increase in share of loss from Local Partnerships principally due to the loss resulting from the pay- off of the remaining Country Place I and II purchase money notes, as discussed above. Partially offsetting the increase in net loss was a decrease in general and administrative expenses primarily due to the payment of 1992 expenses in 1993 and a decrease in annual report printing costs. Also partially offsetting the increase in net loss was a decrease in proxy solicitation costs relating to the proxy solicitation submitted to investors during the first quarter of 1993, as well as a decrease in professional fees primarily due to the payment of 1992 expenses in 1993.\nThe purchase money notes originated from 1983 through 1984. When they were issued, the market interest rate was approximately 15%, while the stated interest rates ranged from 9% to 12%. The notes were discounted as required by Generally Accepted Accounting Principles, and a simple\/compound method was used at the stated interest rate for tax purposes and the compound method at the market interest rate was used for book purposes. As the book interest is being compounded, the interest expense for book purposes will eventually surpass the interest expense for tax purposes, thereby reducing the discount and increasing the interest expense. In fiscal year 1995, all properties with purchase money notes had book interest which exceeded the tax interest. This increase in interest expense and the resulting reduction in the discount is expected to increase in future years.\nFor financial reporting purposes, the Partnership, as a limited partner in the Local Partnerships, does not record losses from the Local Partnerships in excess of its investment to the extent that the Partnership has no further obligation to advance funds or provide financing to the Local Partnerships. As a result, the Partnership's recognized losses for the years ended December 31, 1995, 1994 and 1993 did not include losses of $3,522,606, $3,493,216 and $3,605,305, respectively. The Partnership's net loss recognized from the Local Partnerships is generally expected to decrease in subsequent years as the Partnership's investments in the Local Partnerships are reduced to zero. Accord- ingly, excludable losses are generally expected to increase. Distributions of $248,235, $113,392 and $394,949, received from six, five and six Local Partnerships, respectively, during 1995, 1994 and 1993, respectively, were offset against the respective years' recorded losses because these amounts were in excess of the Partnership's investment.\nThe local general partner of Frenchman's Wharf Apartments Associates II (Frenchman's Wharf II), in conjunction with the Managing General Partner, applied to HUD, holder of the mortgage on the property, for a three-year extension of the previous workout arrangement, which expired in December 1990. The local HUD office verbally agreed to an extension expiring December 31, 1993 and recommended approval of the extension to the HUD central office in Washington, D.C. In December 1993, the local HUD office requested that a new workout proposal be submitted, and in January 1994, the local general partner met with HUD to discuss the long-term capital needs of the property in\nII-8\nPART II -------\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL ------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS - Continued -----------------------------------\nconnection with a workout proposal. On March 1, 1994, the local general partner submitted a nine-year workout proposal to HUD. This proposal was rejected by HUD in December 1995. As of March 8, 1996, the local general partner is continuing to work directly with the HUD central office to submit a five-year workout proposal. There is no assurance that approval for a workout will be received. If a workout proposal is not accepted and another alternative is not found, then HUD could foreclose on the property. Frenchman's Wharf II was notified by HUD that HUD had planned to offer its mortgage loan for sale in September of 1995. HUD later notified Frenchman's Wharf II that its loan was not included in the pool of loans sold by HUD in September 1995. As of March 8, 1996, Frenchman's Wharf II has not been notified as to whether HUD will offer the Frenchman's Wharf II loan for sale at a later date. If the mortgage is eventually sold by HUD, a new mortgagee would service the loan and could foreclose on the property. Currently, debt service payments are being made from available cash flow. To cover operating deficits incurred in prior years for Frenchman's Wharf II, the Partnership advanced funds totalling $324,410 as of both December 31, 1995 and 1994. The last advance was made to Frenchman's Wharf II in March 1987. The Partnership does not expect to advance any additional funds in connection with Frenchman's Wharf II's loan workout with HUD. These loans, together with accrued interest of $187,372 as of both December 31, 1995 and 1994, are payable from cash flow of Frenchman's Wharf II after payment of first-mortgage debt service and after satisfaction by the Partnership of certain other interest obligations on the purchase money notes due from the Local Partnership. There is no assurance that the Local Partnership, upon expiration of any workout, will be able to repay any loans in accordance with the terms.\nIn addition, the Local Partnership has entered into an agreement with the Frenchman's Wharf II's purchase money noteholder which, among other things, provides that, in the event of a default under the purchase money note and related pledge agreement, the noteholder will not exercise any rights or remedies under the purchase money note and related pledge agreement during the term of any subsequent loan modification or workout agreement, as long as HUD does not commence foreclosure action under the mortgage loan. The purchase money note was made by the Partnership in connection with its investment in the Local Partnership, and is a nonrecourse note secured only by the Partnership's interest in the Local Partnership.\nThe report of the auditors on the financial statements of Frenchman's Wharf II for the years ended December 31, 1995 and 1994 indicates that substantial doubt exists about the ability of Frenchman's Wharf II to continue as a going concern due to the property's recurring operating deficits and the Local Partnership's default on its mortgage. The uncertainty about the Local Partnership's continued ownership of the property does not impact the Partnership's financial condition because the related purchase money note is nonrecourse and secured solely by the Partnership's interest in the Local Partnership. Therefore, should the investment in Frenchman's Wharf II not produce sufficient value to satisfy the related purchase money note, the Partnership's exposure to loss is limited since the amount of the nonrecourse indebtedness exceeds the carrying amount of the investment in and advances to the Local Partnership. Thus, even a complete loss of this investment would not have a material impact on the operations of the Partnership.\nII-9\nPART II -------\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL ------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS - Continued -----------------------------------\nIn September 1995, HUD sold the mortgage of Palatine-Barrington Associates Limited Partnership (Deer Grove) to a new mortgagee. The new mortgagee now services the loan and Deer Grove is no longer subject to HUD regulatory requirements.\nOn January 31, 1996, the local general partner of Deer Grove received an offer for the property from an unaffiliated entity. The Local Managing General Partner is currently evaluating this offer.\nPosada Associates Limited Partnership (Posada Vallarta Apartments) is currently operating under an extension of a three-year workout agreement with HUD, the holder of the mortgage. The workout provides for, among other things, a minimum monthly debt-service payment with excess cash, if any, being applied to delinquent interest. Currently, debt-service payments are being made in accordance with the workout. In June 1995, the three-year workout which originally expired on October 1, 1995 was extended to October 1, 1996.\nOn December 15, 1995, Posada Vallarta Apartments was notified by HUD that HUD plans to offer its mortgage loan for sale in April 1996. If the mortgage is sold by HUD, a new mortgagee would service the loan, and Posada Vallarta Apartments would no longer be subject to HUD regulatory requirements.\nOn July 7, 1992, the Partnership received a distribution from Country Place I totalling $653,444 as a result of the removal of the limited dividend restriction on the Local Partnership. In 1993, the Partnership purchased, at a discount, three purchase money notes for Country Place I and II with an aggregate original principal amount of $405,000, resulting in an aggregate loss from extinguishment of debt of $45,452. In 1994, the Partnership purchased the remaining six purchase money notes for Country Place I and II, two at a discount, with an aggregate original principal amount of $495,000, resulting in an aggregate loss from extinguishment of debt of $117,353. The losses from extinguishment of debt are included in share of loss from partnerships in the statements of operations.\nThe Wexford Ridge Associates Local Partnership (located in Madison, Wisconsin), the local general partner, and its management agent have been named in eight sexual harassment and discrimination complaints filed with HUD. The Managing General Partner and the Partnership have also been named in four of the complaints. The Managing General Partner is monitoring the situation and is investigating its rights with regard to the local general partner and\/or the management agent if the situation is not dealt with to the satisfaction of the Managing General Partner. The Managing General Partner believes the claims will have no aggregate material effect on the financial statements of the Partnership and that legal costs associated with the claims will be borne by the management agent.\nThe local general partners of the following properties have each filed a notice of intent to participate under the LIHPRHA program:\nII-10\nPART II -------\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL ------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS - Continued -----------------------------------\nThis program is discussed above in the General section. There is no assurance that a sale or refinancing of these properties will occur.\nInflation ---------\nInflation allows for increases in rental rates, usually offsetting any higher operating and replacement costs. Furthermore, inflation generally does not impact the fixed rate long-term financing under which real property investments were purchased. Future inflation could allow for appreciated values of the Local Partnerships' properties over an extended period of time as rental revenues and replacement values gradually increase.\nThe following table reflects the combined rental revenues of the properties for the five years ended December 31, 1995:\nII-11\nPART II -------\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL ------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS - Continued -----------------------------------\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA -------------------------------------------\nThe information required by this item is contained in Part IV.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING ----------------------------------------------------------- AND FINANCIAL DISCLOSURE ------------------------\nNone.\nII-12\nPART III --------\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT --------------------------------------------------\n(a), (b) and (c) The Partnership has no directors, executive officers or significant employees of its own.\n(a), (b), (c) and (e) The names, ages and business experience of the directors and executive officers of C.R.I., Inc. (CRI), the Managing General Partner of the Partnership, are as follows:\nWilliam B. Dockser, 59, has been the Chairman of the Board of CRI and a Director since 1974. Prior to forming CRI, he served as President of Kaufman and Broad Asset Management, Inc., an affiliate of Kaufman and Broad, Inc., which managed a number of publicly held limited partnerships created to invest in low and moderate income multifamily apartment complexes. For a period of 2-1\/2 years prior to joining Kaufman and Broad, he served in various positions at HUD, culminating in the post of Deputy FHA Commissioner and Deputy Assistant Secretary for Housing Production and Mortgage Credit, where he was responsible for all federally insured housing production programs. Before coming to Washington, Mr. Dockser was a practicing attorney in Boston and also was a special Assistant Attorney General for the Commonwealth of Massachusetts. He holds a Bachelor of Laws degree from Yale University Law School and a Bachelor of Arts degree, cum laude, from Harvard University. He is also Chairman of the Board of CRIIMI MAE Inc., CRIIMI, Inc. and CRI Liquidating REIT, Inc.\nH. William Willoughby, 49, President, Secretary and a Director of CRI since January 1990 and Senior Executive Vice President, Secretary and a Director of CRI from 1974 to 1989. He is principally responsible for the financial management of CRI and its associated partnerships. Prior to joining CRI in 1974, he was Vice President of Shelter Corporation of America and a number of its subsidiaries dealing principally with real estate development and equity financing. Before joining Shelter Corporation, he was a Senior Tax Accountant with Arthur Andersen & Company. He holds a Juris Doctorate degree, a Master of Business Administration degree and a Bachelor of Science degree in Business Administration from the University of South Dakota. He is also a Director and executive officer of CRIIMI MAE Inc., CRIIMI, Inc. and CRI Liquidating REIT, Inc.\nRichard J. Palmer, 44, Senior Vice President-Chief Financial Officer. Prior to joining CRI in 1983 as Director of Tax Policy, he was a Tax Manager at Grant Thornton (formerly Alexander Grant & Company). He also served in the Tax and Audit Departments of Peat, Marwick, Main and Company (formerly Peat, Marwick, Mitchell and Company) prior to his seven years at Grant Thornton. He holds a Bachelor of Business Administration degree from the Florida Atlantic University and is also a Certified Public Accountant.\nRonald W. Thompson, 49, Group Executive Vice President-Hotel Asset Management. Prior to joining CRI in 1985, he was employed at the Hyatt Organization where he most recently served as the General Manager of the Hyatt Regency in Flint, Michigan. During his nine year tenure with Hyatt, he held senior management positions with the Hyatt Regency in Dearborn, Michigan, the Hyatt in Richmond, Virginia, the Hyatt in Winston-Salem, North Carolina and the Hyatt Regency in Atlanta, Georgia. Before joining Hyatt, Mr. Thompson worked in London, England for the English Tourist Board as well as holding management positions in Europe, Australia, and New Zealand in the hotel industry. Mr. Thompson received his education in England where he received a business degree in Hotel Administration from Winston College.\nIII-1\nPART III --------\nITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - Continued --------------------------------------------------\nSusan R. Campbell, 37, Senior Vice President-CRI Realty Services. Prior to joining CRI in March 1985, she was a budget analyst for the B. F. Saul Advisory Company. She holds a Bachelor of Science degree in General Business from the University of Maryland.\nMelissa Cecil Lackey, 40, Senior Vice President and General Counsel. Prior to joining CRI in 1990, she was associated with the firms of Zuckerman, Spaeder, Goldstein, Taylor & Kolker in Washington, D.C. and Hirsch & Westheimer in Houston, Texas. She holds a Juris Doctorate from the University of Virginia School of Law and a Bachelor of Arts degree from the College of William & Mary.\n(d) There is no family relationship between any of the foregoing directors and executive officers.\n(f) Involvement in certain legal proceedings.\nNone.\n(g) Promoters and control persons.\nNot applicable.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION ----------------------\n(a), (b), (c) and (d)\nThe Partnership has no officers or directors. However, in accordance with the Partnership Agreement, and as disclosed in the public offering, various kinds of compensation and fees were paid or are payable to the General Partners and their affiliates. Additional information required in these sections is included in Notes 3 and 4 of the financial statements contained in Part IV, Item 14.\nAdditionally, the General Partners may receive an annual distribution from the Partnership if there is cash available for distribution, as defined in the Partnership Agreement. The General Partners are also entitled to the following payments:\n(1) Annual incentive management fee for managing the affairs and business of the Partnership in an amount not to exceed .25% of invested assets, including the Partnership's allocable share of the mortgages, payable first, in an annual amount equal to $250,000; and second, after distributions to investors in the amount of 1% of the gross proceeds of the offering, the balance of such .25% of invested assets. The annual incentive management fee amounted to $249,996 for each of the years ended December 31, 1995, 1994 and 1993.\n(2) 15% of sale and refinancing proceeds remaining after the limited partners have received a return of all their capital contributions, adjusted as provided in the Partnership Agreement, and the General Partners have received a return of all their capital contributions and the property disposition fees described below. The General Partners may also receive a return of their capital contributions and repayment of any loans made to the Partnership. No sale or refinancing proceeds were paid to the General Partners during the years ended December 31, 1995, 1994 and 1993.\nIII-2\nPART III --------\nITEM 11. EXECUTIVE COMPENSATION - Continued ----------------------\n(3) 1% of the aggregate selling prices, including any amounts previously unpaid upon prior sales of apartment complexes, payable after the limited partners have received a return of all their capital contributions, adjusted as provided in the Partnership Agreement. This amount and any other commissions or fees payable upon the sale of apartment complexes shall not in the aggregate exceed the lesser of the competitive rate or 6% of the sales price of the apartment complexes. No such amounts were paid to the General Partners during the years ended December 31, 1995, 1994 and 1993.\n(4) In addition, the Managing General Partner and\/or its affiliates may receive a fee in an amount of not more than 2% of the sales price of the investment in a Local Partnership or the property it owns. The fee would only be payable upon the sale of the investment in a Local Partnership or the property it owns and would be subject to certain restrictions, including achievement of a certain level of sales proceeds and making certain minimum distributions to limited partners. No such fees were paid to the Managing General Partner and\/or its affiliates during the years ending December 31, 1995, 1994 and 1993.\n(e) Termination of employment and change in control arrangements.\nNone.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND --------------------------------------------------- MANAGEMENT ----------\n(a) Security ownership of certain beneficial owners.\nNo person or \"group\", as that term is used in Section 13(d)(3) of the Securities Exchange Act of 1934, is known by the Partnership to be the beneficial owner of more than 5% of the issued and outstanding partnership units at December 31, 1995.\n(b) Security ownership of management.\nThe following table sets forth certain information concerning all units beneficially owned, as of December 31, 1995, by each director and by all directors and officers as a group of the Managing General Partner of the Partnership.\nName of Amount and Nature % of total Beneficial Owner of Beneficial Ownership Units issued ---------------- ----------------------- ------------\nWilliam B. Dockser None 0% H. William Willoughby None 0% All Directors and Officers as a Group (6 persons) None 0%\n(c) Changes in control.\nIII-3\nPART III --------\nITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND --------------------------------------------------- MANAGEMENT - Continued -----------\nThere exists no arrangement known to the Partnership, the operation of which may, at a subsequent date, result in a change in control of the Partnership. There is a provision in the Limited Partnership Agreement which allows, under certain circumstances, the ability to change control.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ----------------------------------------------\n(a) Transactions with management and others.\nThe Partnership has no directors or officers. In addition, the Partnership has had no transactions with individual officers or directors of the Managing General Partner of the Partnership other than any indirect interest such officers and directors may have in the amounts paid to the Managing General Partner or its affiliates by virtue of their stock ownership in CRI. Item 11 of this report, which contains a discussion of the fees and other compensation paid or accrued by the Partnership to the General Partners or their affiliates, is incorporated herein by reference. Note 3 of the notes to financial statements, which contains disclosure of related party transactions, is also incorporated herein by reference.\n(b) Certain business relationships.\nThe Partnership's response to Item 13(a) is incorporated herein by reference. In addition, the Partnership has no business relationship with entities of which the officers and directors of the Managing General Partner of the Partnership are officers, directors or equity owners other than as set forth in the Partnership's response to Item 13(a).\n(c) Indebtedness of management.\nNone.\n(d) Transactions with promoters.\nNot applicable.\nIII-4\nPART IV -------\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON ------------------------------------------------------ FORM 8-K --------\n(a) 1. Financial Statements Page -------------------- ----\nReport of Independent Certified Public Accountants - Capital Realty Investors-II Limited Partnership IV-4\nReports of Independent Certified Public Accountants - Local Partnerships in which Capital Realty Investors-II Limited Partnership has invested IV-5\nBalance Sheets as of December 31, 1995 and 1994 IV-6\nStatements of Operations for the years ended December 31, 1995, 1994 and 1993 IV-7\nStatements of Changes in Partners' Deficit for the years ended December 31, 1995, 1994 and 1993 IV-8\nStatements of Cash Flows for the years ended December 31, 1995, 1994 and 1993 IV-9\nNotes to Financial Statements IV-10\n(a) 2. Financial Statement Schedules -----------------------------\nIncluded in Part IV of this report are the following schedules for the year ended December 31, 1995, which are applicable to the Local Partnerships in which Capital Realty Investors-II Limited Partnership has invested:\nReport of Independent Certified Public Accountants on Financial Statement Schedule IV-27\nSchedule III - Real Estate and Accumulated Depreciation IV-28\nThe remaining schedules are omitted because the required information is included in the financial statements and notes thereto or they are not applicable or not required.\n(a) 3. Exhibits (listed according to the number assigned in the table in Item 601 of Regulation S-K)\nExhibit No. 3. - Articles of Incorporation and Bylaws\nIV-1\nPART IV -------\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON ------------------------------------------------------ FORM 8-K - Continued --------\na. Certificate of Limited Partnership of Capital Realty Investors-II Limited Partnership. (Incorporated by reference from Exhibit 4 to Registrant's Registration Statement on Form S-11, as amended, dated April 28, 1983.)\nExhibit No. 4. - Instruments defining rights of security holders including indentures.\na. Limited Partnership Agreement of Capital Realty Investors-II Limited Partnership. (Incorporated by reference from Exhibit 4 to Registrant's Registration Statement on Form S-11, as amended, dated April 28, 1983.)\nExhibit No. 10. - Material contracts\na. Management Services Agreement between CRI and Capital Realty Investors-II Limited Partnership. (Incorporated by reference from Exhibit 10B to Registrant's Registration Statement on Form S-11, as amended, dated April 28, 1983.)\nExhibit No. 27 - Financial Data Schedule\nExhibit No. 99 - Additional Exhibits\na. Prospectus of the Partnership, dated May 6, 1983 (Incorporated by reference to the Registrant's Registration Statement on Form S-11, as amended, dated April 28, 1983).\n(b) Reports on Form 8-K -------------------\nNo reports on Form 8-K were filed during the quarter ended December 31, 1995.\n(c) Exhibits --------\nThe list of Exhibits required by Item 601 of Regulation S-K is included in Item (a)3., above.\n(d) Financial Statement Schedules -----------------------------\nSee Item (a)2., above.\nIV-2\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.\nCapital Realty Investors-II Limited Partnership\nBy: C.R.I., Inc. General Partner\nMarch 25, 1996 \/s\/ William B. Dockser - ------------------------------ ----------------------------------- DATE William B. Dockser, Director Chairman of the Board, Treasurer and Principal Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:\nMarch 25, 1996 \/s\/ H. William Willoughby - ------------------------------ ----------------------------------- DATE H. William Willoughby Director, President and Secretary\nMarch 25, 1996 \/s\/ Richard J. Palmer - ------------------------------ ----------------------------------- DATE Richard J. Palmer Senior Vice President, Chief Financial Officer, Principal Financial and Principal Accounting Officer\nIV-3\nREPORT OF INDEPENDENT CERTIFIED ------------------------------ PUBLIC ACCOUNTANTS -------------------\nTo the Partners Capital Realty Investors-II Limited Partnership\nWe have audited the balance sheets of Capital Realty Investors-II Limited Partnership as of December 31, 1995 and 1994, and the related statements of operations, changes in partners' deficit and cash flows for the years ended December 31, 1995, 1994 and 1993. These financial statements are the responsi- bility of the Partnership's management. Our responsibility is to express an opinion on these financial statements based on our audit. We did not audit the financial statements for nineteen of the Local Partnerships in 1995, 1994 and 1993, which are accounted for as described in Note 1c. The financial statements of these Local Partnerships were audited by other auditors whose reports thereon have been furnished to us, and our opinion expressed herein, insofar as it relates to the amounts included for these Local Partnerships, is based solely upon the reports of the other auditors.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the 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, based upon our audits and the reports of other auditors, the financial statements referred to above present fairly, in all material respects, the financial position of Capital Realty Investors-II Limited Partnership as of December 31, 1995 and 1994, and the results of its operations, changes in partners' deficit and cash flows for the years ended December 31, 1995, 1994 and 1993, in conformity with generally accepted accounting principles.\nGrant Thornton LLP\nVienna, VA March 8, 1996\nIV-4\nREPORTS OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS -\nLOCAL PARTNERSHIPS IN WHICH\nCAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP\nHAS INVESTED*\n* The reports of independent certified public accountants - Local Partnerships in which Capital Realty Investors-II Limited Partnership has invested were filed in paper format under Form SE on March 25, 1996, in accordance with the Securities and Exchange Commission's continuing hardship exemption granted December 21, 1995.\nIV-5\nCAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP\nBALANCE SHEETS\nASSETS\nThe accompanying notes are an integral part of these financial statements.\nIV-6\nCAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP\nSTATEMENTS OF OPERATIONS\nThe accompanying notes are an integral part of these financial statements.\nIV-7\nCAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP\nSTATEMENTS OF CHANGES IN PARTNERS' DEFICIT\nFor the years ended December 31, 1995, 1994 and 1993\nThe accompanying notes are an integral part of these financial statements.\nIV-8\nCAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP\nSTATEMENTS OF CASH FLOWS\nThe accompanying notes are an integral part of these financial statements.\nIV-9\nCAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP\nNOTES TO FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\na. Organization ------------\nCapital Realty Investors-II Limited Partnership (the Partnership) was formed under the Maryland Revised Uniform Limited Partnership Act on March 23, 1983 and shall continue until December 31, 2037 unless sooner dissolved in accordance with the Partnership Agreement. The Partnership was formed to invest in real estate by acquiring and holding a limited partnership interest in limited partnerships (Local Partnerships) which own and operate federal or state government-assisted or conventionally financed apartment complexes throughout the United States, which provide housing principally to the elderly and to individuals and families of low or moderate income.\nThe General Partners of the Partnership are C.R.I., Inc. (CRI), which is the Managing General Partner, and current and former shareholders of CRI. The Initial Limited Partner is Rockville Pike Associates Limited Partnership-II, a limited partnership which includes certain officers and former employees of CRI or its affiliates. The Special Limited Partner is Two Broadway Associates II, a limited partnership comprised of an affiliate and employees of Merrill Lynch, Pierce, Fenner & Smith, Incorporated.\nThe Partnership sold 50,000 units at $1,000 per unit of Additional Limited Partnership Interest through a public offering. The offering period was terminated on June 20, 1983.\nb. Method of accounting --------------------\nThe financial statements of the Partnership are prepared on the accrual basis of accounting in accordance with generally accepted accounting principles.\nc. Investments in and advances to partnerships -------------------------------------------\nThe investments in and advances to Local Partnerships (see Note 2) are accounted for by the equity method because the Partnership is a limited partner in the Local Partnerships. Under this method, the carrying amount of the investments in and advances to Local Partnerships is (i) reduced by distributions received and (ii) increased or reduced by the Partnership's share of earnings or losses, respectively, of the Local Partnerships. As of December 31, 1995 and 1994, the Partnership's share of cumulative losses of nine of the Local Partnerships exceeds the amount of the Partnership's investments in and advances to those Local Partnerships by $24,699,157 and $21,176,551, respectively. Since the Partnership has no further obligation to advance funds or provide financing to these Local Partnerships, the excess losses have not been reflected in the accompanying financial statements. As of December 31, 1995 and 1994, cumulative cash distributions of approximately $1,900,649 and $1,652,414, respectively, have been received from the Local Partnerships for which the Partnership's carrying value is zero. These distributions are recorded as increases in the Partnership's share of income from partnerships.\nCosts incurred in connection with acquiring these investments have been capitalized and are being amortized using the straight-line method over the estimated useful lives of the properties owned by the Local Partnerships.\nIV-10\nCAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP\nNOTES TO FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued\nd. Fair value of financial instruments -----------------------------------\nStatement of Financial Accounting Standards No. 107, \"Disclosures About Fair Value of Financial Instruments\" (SFAS 107), requires the disclosure of fair value information about financial instruments for which it is practicable to estimate that value. The Partnership implemented SFAS 107 in 1995.\ne. Cash and cash equivalents -------------------------\nCash and cash equivalents consist of all money market funds, time and demand deposits, repurchase agreements and commercial paper with original maturities of three months or less. The Partnership has determined that the carrying amount of its cash and cash equivalents approximates fair value.\nf. Offering costs --------------\nThe Partnership incurred certain costs in connection with the offering and selling of limited partnership interests. Such costs were recorded as a reduction of partner's capital when incurred.\ng. Income taxes ------------\nFor federal and state income tax purposes, each partner reports on his or her personal income tax return his or her share of the Partnership's income or loss as determined for tax purposes. Accordingly, no provision (credit) has been made for income taxes in these financial statements.\nh. Use of estimates ----------------\nIn preparing financial statements in conformity with generally accepted accounting principles, the Partnership is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses during the reporting period. Actual results could differ from those estimates.\n2. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS\na. Due on investments in partnerships ----------------------------------\nAs of December 31, 1995 and 1994, the Partnership had acquired limited partnership interests in twenty-two Local Partnerships, which were organized to develop, construct, own, maintain and operate apartment complexes which provide housing principally to the elderly and to individuals and families of low or moderate income. The remaining principal amounts due on investments in the Local Partnerships as of December 31, 1995 and 1994 are as follows:\nIV-11\nCAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP\nNOTES TO FINANCIAL STATEMENTS\n2. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS - Continued\nThe purchase money notes have stated interest rates ranging from 9% to 12%, certain of which are compounded annually. Unamortized discounts are based upon an imputed interest rate of 15% to reflect market interest rates which prevailed when the notes were issued. The resulting discount has been recorded by the Partnership and is being amortized to interest expense over the life of the respective purchase money notes using the effective interest method. The purchase money notes are payable upon the earliest of: (1) sale or refinancing of the respective Local Partnership's rental property; (2) payment in full of the respective Local Partnership's permanent loan; or (3) maturity. Purchase money notes in an aggregate principal amount of $2,380,000 matured on August 1, 1995 but have not been paid, as discussed below. A purchase money note in the principal amount of $2,280,000 matured on August 1, 1995 and was subsequently paid off at a discount on January 11, 1996, as discussed below. Purchase money notes in an aggregate principal amount of $2,100,000 are scheduled to mature on December 31, 1996, as discussed below. The remaining purchase money notes mature in 1998 and 1999. The purchase money notes are generally secured by the Partnership's interest in the respective Local Partnership. There is no assurance that the underlying properties will have sufficient appreciation and equity to enable the Partnership to pay the purchase money notes' principal and accrued interest when due. If a purchase money note is not paid in accordance with its terms, the Partnership will either have to renegotiate the terms of repayment or risk losing its partnership interest in the Local Partnership. The Managing General Partner is continuing to investigate possible alternatives to reduce the Partnership's long-term debt obligations. These alternatives include, among others, retaining the cash available for distribution to meet the purchase money note requirements, buying out certain purchase money notes at a discounted price, extending the due dates of certain purchase money notes, or refinancing the respective properties' underlying debt and using the Partnership's share of the proceeds to pay off or buy down certain purchase money note obligations.\nInterest expense on the Partnership's purchase money notes for the years ended December 31, 1995, 1994 and 1993 was $5,759,461, $5,113,326 and $4,538,562, respectively. The accrued interest on the purchase money notes of $29,256,224 and $26,951,287 as of December 31, 1995 and 1994, respectively, is due on the respective maturity dates of the purchase money notes or earlier if the Local Partnerships have distributable net cash flow, as defined in the relevant Local Partnership agreements.\nIV-12\nCAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP\nNOTES TO FINANCIAL STATEMENTS\n2. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS - Continued\nThe Partnership defaulted on its purchase money note relating to Rock Glen Limited Partnership (Rock Glen) on August 1, 1995 when the note matured and was not paid. A standstill agreement from the noteholder was granted until October 31, 1995. The Managing General Partner made an offer to the noteholder to extend the purchase money note due date to August 2000. This offer was rejected by the noteholder. On January 11, 1996, the Partnership paid off the purchase money note at a discount, resulting in a gain on extinguishment of debt of approximately $1.8 million.\nThe Partnership defaulted on its purchase money note relating to Beech Hill Development Co. (Beech Hill I) on August 1, 1995 when the note matured and was not paid. The default amount included principal and accrued interest of $1,480,000 and $1,473,498, respectively. As of March 8, 1996, principal and accrued interest totalling $1,480,000 and $1,553,687, respectively, were due. In addition, the Partnership defaulted on its purchase money note relating to Beech Hill Development Co. II (Beech Hill II) on August 1, 1995 when the note matured and was not paid. The default amount included principal and accrued interest of $900,000 and $905,047, respectively. As of March 8, 1996, principal and accrued interest totalling $900,000 and $953,810, respectively, were due. The Managing General Partner is currently negotiating with the noteholders of Beech Hill I and Beech Hill II to extend the purchase money note due dates to January 1, 1998. Under the proposed agreement, the Partnership would pay the purchase money noteholders of Beech Hill I and Beech Hill II all annual cash flow distributions received from the related Local Partnerships in excess of $5,000 and $2,500, respectively. There were no annual cash flow distributions made to the Partnership from the related Local Partnerships during 1995, 1994 or 1993. Also under the proposed agreement, transfer documents relating to foreclosure by the noteholders upon the Partnership's interests in the related Local Partnerships would be placed in escrow and released to the noteholders upon a future default by the Partnership on the respective purchase money notes. There is no assurance that an agreement will be reached between the Managing General Partner and the noteholders. As such, there is no assurance that the Partnership will be able to retain its interest in either Beech Hill I or Beech Hill II.\nPurchase money notes relating to Chevy Chase Park Limited (Chevy Chase) in the aggregate principal amount of $2,100,000 mature on December 31, 1996. The Managing General Partner is currently negotiating with the noteholders to extend the purchase money note due dates to coincide with potential future LIHPRHA processing, or to accept a discounted pay-off. There is no assurance that any agreement will be reached with the noteholders. As such, there is no assurance that the Partnership will be able to retain its interest in Chevy Chase.\nThe uncertainty about the continued ownership of the Partnership's interests in Beech Hill I, Beech Hill II or Chevy Chase does not impact the Partnership's financial condition because the related purchase money notes are nonrecourse and secured solely by the Partnership's interest in the related Local Partnerships. Therefore, should the investment in Beech Hill I, Beech Hill II and Chevy Chase not produce sufficient value to satisfy the related purchase money notes, the Partnership's exposure to loss is limited since the amount of the nonrecourse indebtedness exceeds the carrying amount of the investment in and advances to the Local Partnerships. Thus, even a complete loss of any of these investments would not have a material impact on the operations of the Partnership. However,\nIV-13\nCAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP\nNOTES TO FINANCIAL STATEMENTS\n2. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS - Continued\nshould the Partnership be unable to retain its interest in all of the Local Partnerships, the investments in and advances to Local Partnerships would be reduced by the Partnership's basis in these Local Partnerships, which at December 31, 1995 was approximately 17% of the Partnership's total investment in Local Partnerships.\nSFAS 107 requires the disclosure of fair value information about financial instruments for which it is practicable to estimate that value. The Partnership has determined that it is not practicable to estimate the fair value of the purchase money notes, either individually or in the aggregate, due to: (1) the lack of an active market for this type of financial instrument, (2) the variable nature of purchase money note interest payments as a result of fluctuating cash flow distributions received from the related Local Partnerships, and (3) the excessive costs associated with an independent appraisal of the purchase money notes.\nb. Interests in profits, losses and cash distributions ---------------------------------------------------\nThe Partnership has a 92.99% to 98.99% interest in profits, losses and cash distributions (as restricted by various federal and state housing agencies) of each Local Partnership. An affiliate of the General Partners of the Partnership is also a general partner of each Local Partnership. The Partnership received cash distributions from the rental operations of the Local Partnerships of $870,339, $793,007, and $1,092,917 during the years ended December 31, 1995, 1994 and 1993, respectively. As of December 31, 1995 and 1994, seventeen and sixteen of the Local Partnerships had surplus cash, as defined by their respective agencies, in the amount of $2,475,456 and $2,435,473, respectively, which is available for distribution in accordance with their respective agencies' regulations.\nThe cash distributions to the Partnership from the operations of the rental properties may be limited by Department of Housing and Urban Development (HUD) regulations. Such regulations limit annual cash distributions to a percentage of the owner's equity investment in a rental property. Funds in excess of those which may be distributed to owners are required to be placed in a residual receipts account held by the governing state or federal agency for the benefit of the property.\nUpon sale or refinancing of the property owned by the Local Partnerships or upon the liquidation of each Local Partnership, the proceeds from the sale, refinancing or liquidation shall be distributed in accordance with the respective provisions of each Local Partnership's partnership agreement. In accordance with such provisions, the Partnership would receive from such proceeds its respective percentage interest of any remaining proceeds, after payment of (1) all debts and liabilities of the Local Partnership and certain other items, (2) the Partnership's capital contributions plus certain specified amounts as outlined in each partnership agreement, and (3) certain special distributions to general partners and related entities of the Local Partnership.\nc. Property matters ----------------\nThe following table reflects the amounts of advances made to the Local Partnerships as of December 31, 1995 and 1994.\nIV-14\nCAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP\nNOTES TO FINANCIAL STATEMENTS\n2. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS - Continued\nThe local general partner of Frenchman's Wharf Apartments Associates II (Frenchman's Wharf II), in conjunction with the Managing General Partner, applied to HUD, holder of the mortgage on the property, for a three-year extension of the previous workout arrangement, which expired in December 1990. The local HUD office verbally agreed to an extension expiring December 31, 1993 and recommended approval of the extension to the HUD central office in Washington, D.C. In December 1993, the local HUD office requested that a new workout proposal be submitted, and in January 1994, the local general partner met with HUD to discuss the long-term capital needs of the property in connection with a workout proposal. On March 1, 1994, the local general partner submitted a nine-year workout proposal to HUD. This proposal was rejected by HUD in December 1995. As of March 8, 1996, the local general partner is continuing to work directly with the HUD central office to submit a five-year workout proposal. There is no assurance that approval for a workout will be received. If a workout proposal is not accepted and another alternative is not found, then HUD could foreclose on the property. Frenchman's Wharf II was notified by HUD that HUD had planned to offer its mortgage loan for sale in September of 1995. HUD later notified Frenchman's Wharf II that its loan was not included in the pool of loans sold by HUD in September 1995. As of March 8, 1996, Frenchman's Wharf II has not been notified as to whether HUD will offer the Frenchman's Wharf II loan for sale at a later date. If the mortgage is eventually sold by HUD, a new mortgagee would service the loan and could foreclose on the property. Currently, debt- service payments are being made from available cash flow. To cover operating deficits incurred in prior years for Frenchman's Wharf II, the Partnership advanced funds totalling $324,410 as of both December 31, 1995 and 1994. The last advance was made to Frenchman's Wharf II in March 1987. The Partnership does not expect to advance any additional funds in connection with Frenchman's Wharf II's loan workout with HUD. These loans, together with accrued interest of $187,372 as of both December 31, 1995 and 1994, are payable from cash flow of Frenchman's Wharf II after payment of first-mortgage debt service and after satisfaction by the Partnership of certain other interest obligations on the purchase money notes due from the Local Partnership. There is no assurance that the Local Partnership, upon expiration of any workout, will be able to repay any loans in accordance with the terms.\nIn addition, the Local Partnership has entered into an agreement with the Frenchman's Wharf II's purchase money noteholder which, among other\nIV-15\nCAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP\nNOTES TO FINANCIAL STATEMENTS\n2. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS - Continued\nthings, provides that, in the event of a default under the purchase money note and related pledge agreement, the noteholder will not exercise any rights or remedies under the purchase money note and related pledge agreement during the term of any subsequent loan modification or workout agreement, as long as HUD does not commence foreclosure action under the mortgage loan. The purchase money note was made by the Partnership in connection with its investment in the Local Partnership, and is a nonrecourse note secured only by the Partnership's interest in the Local Partnership.\nThe report of the auditors on the financial statements of Frenchman's Wharf II for the years ended December 31, 1995 and 1994 indicates that substantial doubt exists about the ability of Frenchman's Wharf II to continue as a going concern due to the property's recurring operating deficits and the Local Partnership's default on its mortgage. The uncertainty about the Local Partnership's continued ownership of the property does not impact the Partnership's financial condition because the related purchase money note is nonrecourse and secured solely by the Partnership's interest in the Local Partnership. Therefore, should the investment in Frenchman's Wharf II not produce sufficient value to satisfy the related purchase money note, the Partnership's exposure to loss is limited since the amount of the nonrecourse indebtedness exceeds the carrying amount of the investment in and advances to the Local Partnership. Thus, even a complete loss of this investment would not have a material impact on the operations of the Partnership.\nIn September 1995, HUD sold the mortgage of Palatine-Barrington Associates Limited Partnership (Deer Grove) to a new mortgagee. The new mortgagee now services the loan and Deer Grove is no longer subject to HUD regulatory requirements.\nOn January 31, 1996, the local general partner of Deer Grove received an offer for the property from an unaffiliated entity. The Local Managing General Partner is currently evaluating this offer.\nPosada Associates Limited Partnership (Posada Vallarta Apartments) is currently operating under an extension of a three-year workout agreement with HUD, the holder of the mortgage. The workout provides for, among other things, a minimum monthly debt-service payment with excess cash, if any, being applied to delinquent interest. Currently, debt-service payments are being made in accordance with the workout. In June 1995, the three- year workout which originally expired on October 1, 1995 was extended to October 1, 1996.\nOn December 15, 1995, Posada Vallarta Apartments was notified by HUD that HUD plans to offer its mortgage loan for sale in April 1996. If the mortgage is sold by HUD, a new mortgagee would service the loan, and Posada Vallarta Apartments would no longer be subject to HUD regulatory requirements.\nOn July 7, 1992, the Partnership received a distribution from Country Place I totalling $653,444 as a result of the removal of the limited dividend restriction on the Local Partnership. In 1993, the Partnership purchased, at a discount, three purchase money notes for Country Place I and II with an aggregate original principal amount of $405,000, resulting in an aggregate loss from extinguishment of debt of $45,452. In 1994, the\nIV-16\nCAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP\nNOTES TO FINANCIAL STATEMENTS\n2. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS - Continued\nPartnership purchased the remaining six purchase money notes for Country Place I and II, two at a discount, with an aggregate original principal amount of $495,000, resulting in an aggregate loss from extinguishment of debt of $117,353. The losses from extinguishment of debt are included in share of loss from partnerships in the statements of operations.\nThe Wexford Ridge Associates Local Partnership (located in Madison, Wisconsin), the local general partner, and its management agent have been named in eight sexual harassment and discrimination complaints filed with HUD. The Managing General Partner and the Partnership have also been named in four of the complaints. The Managing General Partner is monitoring the situation and is investigating its rights with regard to the local general partner and\/or the management agent if the situation is not dealt with to the satisfaction of the Managing General Partner. The Managing General Partner believes the claims will have no aggregate material effect on the financial statements of the Partnership and that legal costs associated with the claims will be borne by the management agent.\nMany of the rental properties owned by the Local Partnerships have mortgages which are federally insured under Section 236 or Section 221(d)(3) of the National Housing Act, as amended. These properties may be eligible for sale or refinancing, subject to numerous requirements, under the LIHPRHA program. This program may provide incentives to owners of qualifying multifamily housing who commit to permanently maintain their properties as low to moderate income housing. Incentives available under LIHPRHA include selling the property to qualified buyers or obtaining supplemental financing for the property. As of March 8, 1996, members of Congress were recommending substantial changes to the LIHPRHA program ranging from the elimination of the program to the redesigning of the program. Substantial uncertainty exists as to whether any properties which have already filed the notice of intent to participate under LIHPRHA will qualify under a redesigned program or as to whether the program will continue at all.\nThe local general partners of the following properties have each filed a notice of intent to participate under the LIHPRHA program:\nThere is no assurance that a sale or refinancing of these properties will occur.\nIV-17\nCAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP\nNOTES TO FINANCIAL STATEMENTS\n2. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS - Continued\nSome of the rental properties owned by the Local Partnerships are financed by state housing agencies. The Managing General Partner has been working to develop a strategy to sell or refinance certain properties by utilizing programs developed by these agencies. These programs may include opportunities to sell the property to a qualifying purchaser who would agree to maintain the property as low to moderate income housing in perpetuity, or may include opportunities to refinance the property through supplemental financing. The Managing General Partner continues to monitor these programs to ascertain whether the properties would qualify within the parameters of these programs and whether these programs would provide an appropriate economic benefit to the limited partners of the Partnership.\nMany of the rental properties owned by the Local Partnerships are dependent on the receipt of housing assistance payments guaranteed by contract under the HUD Section 8 program. The level of funding for the Section 8 program, and HUD-insured multifamily housing in general, is dependent upon the continuation of appropriations approved by Congress for subsidy payments. In the event that the rental subsidy programs are reduced or phased out, there is no assurance that the rental properties will be able to maintain the occupancy levels necessary to pay debt service and operating costs or that the rents necessary to pay debt service and operating costs will be competitive with rents for comparable units in the rental properties' market areas. While the Managing General Partner has no reason to believe that HUD will not honor its obligations under the contracts, some uncertainty exists in light of the recent Congressional scrutiny of appropriations for HUD programs.\nd. Summarized financial information --------------------------------\nSummarized financial information for the Local Partnerships as of December 31, 1995 and 1994 and for the years ended December 31, 1995, 1994 and 1993 is as follows:\nIV-18\nCAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP\nNOTES TO FINANCIAL STATEMENTS\n2. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS - Continued\nCOMBINED BALANCE SHEETS\nIV-19\nCAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP\nNOTES TO FINANCIAL STATEMENTS\n2. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS - Continued\nCOMBINED STATEMENTS OF OPERATIONS\ne. Reconciliation of the Local Partnerships' financial statement net ----------------------------------------------------------------- loss to income tax loss -----------------------\nFor federal income tax purposes, the Local Partnerships report on a basis whereby: (1) certain revenue and the related assets are recorded when received rather than when earned; (2) certain costs are expensed when paid or incurred rather than capitalized and amortized over the period of benefit; and (3) a shorter life is used to compute depreciation of the property for tax purposes as permitted by Internal Revenue Service (IRS) Regulations. These returns are subject to audit and, therefore, possible adjustment by the IRS.\nA reconciliation of the Local Partnerships' financial statement net loss reflected above to the income tax loss for the years ended December 31, 1995, 1994 and 1993 is as follows:\nIV-20\nCAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP\nNOTES TO FINANCIAL STATEMENTS\n2. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS - Continued\n3. RELATED-PARTY TRANSACTIONS\nIn accordance with the Partnership Agreement, the Partnership paid the Managing General Partner a fee for services in connection with the review, selection, evaluation, negotiation and acquisition of the interests in the Local Partnerships. The fee amounted to $1,000,000 which is equal to 2% of the Additional Limited Partners' capital contributions to the Partnership. The acquisition fee was capitalized and is being amortized over a thirty-year period using the straight-line method.\nIn accordance with the terms of the Partnership Agreement, the Partnership is obligated to reimburse the Managing General Partner for its direct expenses in managing the Partnership and to pay an annual incentive management fee (the Management Fee), after all other expenses of the Partnership are paid. For the years ended December 31, 1995, 1994 and 1993, the Partnership paid $84,613, $87,104 and $81,666, respectively, as direct reimbursement of expenses incurred on behalf of the Partnership. Such expenses are included in the statements of operations as general and administrative expenses.\nThe amount of the Management Fee shall not exceed .25% of invested assets, as defined in the Partnership Agreement, and shall be payable from the Partnership's cash available for distribution, as defined in the Partnership Agreement, as of the end of each calendar year, as follows:\na. First, on a monthly basis as an operating expense before any distributions to limited partners in the amount computed as described in the Partnership Agreement, provided that such amount shall not be greater than $250,000 and; b. Second, after distributions to the limited partners in the amount of 1% of the gross proceeds of the offering, the balance of such .25% of invested assets.\nIV-21\nCAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP\nNOTES TO FINANCIAL STATEMENTS\n3. RELATED-PARTY TRANSACTIONS - Continued\nFor each of the years ended December 31, 1995, 1994 and 1993, the Partnership paid the Managing General Partner a Management Fee of $249,996.\nFrom July 1990 through January 1994, CRICO Management Corporation (CRICO), an affiliate of the Managing General Partner, provided consulting, accounting and other services to Country Place I and II. From August 1990 through January 1994, CRICO provided these services to Rock Glen. Fees paid or accrued to CRICO for these services amounted to $6,704, $4,231 and $5,580, respectively, for the month ended January 31, 1994. Fees paid or accrued were $83,566, $52,268 and $68,140, respectively, for the year ended December 31, 1993. On February 1, 1994, CRICO contributed its consulting contracts and personnel to CAPREIT Residential Corporation (CAPREIT). CAPREIT was formed by CRI but is not currently owned or controlled by CRI and\/or its affiliates. On April 12, 1995, HUD approved CAPREIT as the new management agent.\n4. PARTNERSHIP PROFITS AND LOSSES AND DISTRIBUTIONS\nAll profits and losses prior to the first date on which Additional Limited Partners were admitted were allocated 98.49% to the Initial Limited Partner and 1.51% to the General Partners. Upon admission of the Special Limited Partner and the Additional Limited Partners, the interest of the Initial Limited Partner was reduced to .49%. The net proceeds resulting from the liquidation of the Partnership or the Partnership's share of the net proceeds from any sale or refinancing of the projects or their rental properties which are not reinvested shall be distributed and applied as follows:\n(i) to the payment of debts and liabilities of the Partnership (including all expenses of the Partnership incident to the sale or refinancing) other than loans or other debts and liabilities of the Partnership to any partner or any affiliate, such debts and liabilities, in the case of a non-liquidating distribution, to be only those which are then required to be paid or, in the judgment of the Managing General Partner, required to be provided for; (ii) to the establishment of any reserves which the Managing General Partner deems reasonably necessary for contingent, unmatured or unforeseen liabilities or obligations of the Partnership; (iii) to each partner in an amount equal to the positive balance in his capital account as of the date of the sale or refinancing, adjusted for operations and distributions to that date, but before allocation of any profits for tax purposes realized from such sale or refinancing and allocated pursuant to the Partnership Agreement; (iv) to the Additional Limited Partners (A) an aggregate amount of proceeds from sale or refinancing and all prior sales or refinancings equal to their capital contributions, without reduction for prior cash distributions other than prior distributions of sale and refinancing proceeds, plus (B) an additional amount equal to a cumulative non-compounded 6% return on each limited partner's capital contribution, reduced, but not below zero, by (1) an amount equal to 50% of the losses for tax purposes plus tax credits allocated to such limited partner and (2) distributions of net cash flow to each limited partner, such return, losses for tax purposes and net cash flow distributions commencing on the first day of the month in which the capital contribution was made;\nIV-22\nCAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP\nNOTES TO FINANCIAL STATEMENTS\n4. PARTNERSHIP PROFITS AND LOSSES AND DISTRIBUTIONS - Continued\n(v) to the repayment of any unrepaid loans theretofore made by any partner or any affiliate to the Partnership for Partnership obligations and to the payment of any unpaid amounts owing to the General Partners pursuant to the Partnership Agreement; (vi) to the General Partners in the amount of their capital contributions; (vii) thereafter, for their services to the Partnership, in equal shares to certain general partners (or their designees), whether or not any is then a general partner, an aggregate fee of 1% of the gross proceeds resulting from (A) such sale (if the proceeds are from a sale rather than a refinancing) and (B) any prior sales from which such 1% fee was not paid to the General Partners or their designees and, (viii) the remainder, 12% to the General Partners (or their assignees), 3% to the Special Limited Partner and 85% to the Initial and Additional Limited Partners (or their assignees).\nFees payable to certain general partners (or their designees) under (vii) above, together with all other property disposition fees and any other commissions or fees payable upon the sale of apartment complexes, shall not in the aggregate exceed the lesser of the competitive rate or 6% of the sales price of the apartment complexes.\nIn addition, the Managing General Partner and\/or its affiliates may receive a fee in an amount of not more than 2% of the sales price of the investment in a Local Partnership or the property it owns. The fee would only be payable upon the sale of the investment in a Local Partnership or the property it owns and would be subject to certain restrictions, including achievement of a certain level of sales proceeds and making certain minimum distributions to limited partners. No such amounts were paid to the Managing General Partner and\/or its affiliates during 1995, 1994 and 1993.\nPursuant to the Partnership Agreement, all cash available for distribution, as defined, shall be distributed, not less frequently than annually, 97% to the Additional Limited Partners, 1% to the Special Limited Partner, .49% to the Initial Limited Partner and 1.51% to the General Partners after payment of the Management Fee, as specified in the Partnership Agreement. As defined in the Partnership Agreement, prior to the establishment of any reserves deemed necessary by the Managing General Partner and after payment of the Management Fee, the Partnership had cash available for distribution of approximately $368,000, $253,000 and $310,000 for the years ended December 31, 1995, 1994 and 1993, respectively. No distributions were declared or paid during 1995, 1994 or 1993 because any cash available for distribution is currently being retained by the Partnership, as previously discussed.\n5. RECONCILIATION OF THE PARTNERSHIP'S FINANCIAL STATEMENT NET LOSS TO INCOME TAX LOSS\nFor federal income tax purposes, the Partnership reports on a basis whereby: (1) certain expenses are amortized rather than expensed when incurred; (2) certain costs are amortized over a shorter period for tax purposes, as permitted by IRS Regulations, and (3) certain costs are amortized over a longer period for tax purposes. The Partnership records its share of losses from its investments in limited partnerships for federal income tax purposes as reported on the Local Partnerships' federal income tax returns (see Note 2e), including losses in excess of related investments amounts. In addition, adjustments\nIV-23\nCAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP\nNOTES TO FINANCIAL STATEMENTS\n5. RECONCILIATION OF THE PARTNERSHIP'S FINANCIAL STATEMENT NET LOSS TO INCOME TAX LOSS - Continued\narising from the imputation of interest on the Partnership's purchase money notes for financial reporting purposes are eliminated for income tax purposes (see Note 2a). These returns are subject to audit and, therefore, possible adjustment by the IRS.\nA reconciliation of the Partnership's financial statement net loss to the income tax loss for the years ended December 31, 1995, 1994 and 1993 is as follows:\nIV-24\nCAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP\nNOTES TO FINANCIAL STATEMENTS\n5. RECONCILIATION OF THE PARTNERSHIP'S FINANCIAL STATEMENT NET LOSS TO INCOME TAX LOSS - Continued\n6. CONTINGENCIES\nIn 1990, CRI, as Managing General Partner of the Partnership and various other entities, subcontracted certain property-level asset management functions for certain properties to Capital Management Strategies, Inc. (CMS). Among these properties were properties owned by certain of the Local Partnerships in which the Partnership invested. CMS was formed by Martin C. Schwartzberg, a nominal general partner of the Partnership and a former stockholder of CRI, when he cashed out of CRI and its related businesses as of January 1, 1990. Mr. Schwartzberg agreed not to act as a general partner with respect to any of the CRI-sponsored partnerships, including this Partnership, and has not done so since that time. In late 1995, a dispute arose between CRI and CMS over the funding level of the 1996 contract for CMS. On November 9, 1995, CRI filed a complaint against CMS to determine the proper amount of fees to be paid in 1996 under the asset management agreement. CMS answered on January 10, 1996, but asserted no counterclaims.\nThereafter, Mr. Schwartzberg launched a hostile consent solicitation to be designated as managing general partner of approximately 125 private partnerships sponsored by CRI. On January 18, 1996, Mr. Schwartzberg and CMS filed a complaint in the Circuit Court of Montgomery County, Maryland (the Circuit Court), against CRI and Messrs. Dockser and Willoughby (who are general partners of the Partnership) alleging, among other things, that CRI and Messrs. Dockser and Willoughby have breached the asset management agreement pursuant to which Mr. Schwartzberg's company, CMS, agreed to perform limited functions related to property-level issues for a portion of CRI's subsidized housing portfolio (including some of the properties in which the Partnership invested), by reducing the proposed budget for 1996. The Partnership is not named as a defendant in this action. Messrs. Dockser and Willoughby have entered an answer denying all of Mr. Schwartzberg's claims. Messrs. Dockser and Willoughby have\nIV-25\nCAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP\nNOTES TO FINANCIAL STATEMENTS\n6. CONTINGENCIES - Continued\npublicly responded that Mr. Schwartzberg's suit is motivated by his budget dispute with CRI and personal animosity. On February 6, 1996, CRI terminated the CMS contract for cause. Mr. Schwartzberg and CMS responded by filing a motion for injunctive relief in the Circuit Court, asking the court to enjoin CRI from terminating the contract. In a ruling issued on February 12, 1996, the Circuit Court, among other things, refused to grant the injunction requested by CMS. A hearing in this case is scheduled for April 29, 1996. On February 12, 1996, the Circuit Court also issued a memorandum opinion and order enjoining CMS and Mr. Schwartzberg from disclosing information made confidential under the asset management agreement.\nOn February 1, 1996 and February 16, 1996, Mr. Schwartzberg sent letters to the Partnership requesting investor lists and other forms of investor information. On February 5, 1996, the Partnership, acting through its managing general partner, CRI, denied Mr. Schwartzberg's request. On February 20, 1996, counsel for the Partnership responded to Mr. Schwartzberg's second request, denying that Mr. Schwartzberg had standing or a proper purpose for requesting the investor lists. In view of Mr. Schwartzberg's solicitation efforts against other CRI-sponsored partnerships, CRI anticipates that litigation may arise from this request.\nIV-26\nFINANCIAL STATEMENT SCHEDULES\nIV-27\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS ON ----------------------------------------------------- FINANCIAL STATEMENT SCHEDULE -----------------------------\nPartners Capital Realty Investors-II Limited Partnership\nIn connection with our audit of the financial statements of Capital Realty Investors-II Limited Partnership referred to in our report dated March 8, 1996, which is included in this Form 10-K, we have also audited Schedule III as of December 31, 1995, 1994 and 1993. We did not audit the financial statements for nineteen of the Local Partnerships in 1995, 1994 and 1993, which are accounted for as described in Note 1c. In our opinion, this schedule presents fairly, in all material respects, the information required to be set forth therein.\nGrant Thornton LLP\nVienna, VA March 8, 1996\nIV-28\nCAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP\nSCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION OF LOCAL PARTNERSHIPS IN WHICH CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP HAS INVESTED\nDecember 31, 1995\nIV-29\nCAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP\nSCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION OF LOCAL PARTNERSHIPS IN WHICH CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP HAS INVESTED - Continued\nDecember 31, 1995\nIV-30\nCAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP\nNOTES TO SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION OF LOCAL PARTNERSHIPS IN WHICH CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP HAS INVESTED\nDecember 31, 1995\n(A) Secured by mortgage loans. (B) Consists of capitalized construction period interest and real estate taxes during construction. (C) The aggregate cost of land for federal income tax purposes is $12,967,031 and the aggregate costs of buildings and improvements for federal income tax purposes is $161,260,376. The total of the above-mentioned items is $174,227,407.\nIV-31\nCAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP\nNOTES TO SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION OF LOCAL PARTNERSHIPS IN WHICH CAPITAL RELTY INVESTORS-II LIMITED PARTNERSHIP HAS INVESTED - Continued\nDecember 31, 1995\n(D) Reconciliation of real estate -----------------------------\nReconciliation of accumulated depreciation ------------------------------------------\nIV-32\nEXHIBIT INDEX -------------\nExhibit Method of Filing - ------- -----------------------------\n27 Financial Data Schedule Filed herewith electronically\nIV-33","section_15":""}
{"filename":"109831_1995.txt","cik":"109831","year":"1995","section_1":"ITEM 1. BUSINESS.\nGENERAL DEVELOPMENT OF BUSINESS\nINAMED Corporation (\"INAMED\") (formerly First American Corporation) was incorporated under the laws of the state of Florida on February 6, 1961. In 1985, First American Corporation acquired all of the outstanding shares of McGhan Medical Corporation (\"MMC\") in a stock-for-stock, reverse merger transaction. The Company changed its name in 1986 from First American Corporation to INAMED Corporation in order to better reflect its involvement in the medical field. The name was chosen to promote the recognition of the concepts \"Innovation and Medicine\". MMC now operates as a wholly-owned subsidiary of INAMED Corporation. MMC entered the medical device business on August 3, 1984, through the acquisition of assets related to Minnesota Mining and Manufacturing (\"3M\") Company's silicone implant product line.\nSpecialty Silicone Fabricators, Inc. (\"SSF\") was a wholly-owned subsidiary of McGhan Medical Corporation at the time McGhan Medical was acquired by First American Corporation. As a result of the acquisition, SSF became a wholly-owned subsidiary of First American Corporation, and operated as such until it was divested in August 1993.\nUnless otherwise indicated by context, the term \"Company\" as used herein refers to INAMED and its subsidiaries. The purpose of this method of filing as one company is to reflect consolidation for the sole purpose of reporting in the required SEC method and is not intended for any other purpose. INAMED Corporation is the subsidiaries' parent through stock ownership. INAMED's subsidiaries operate as individual corporations corresponding to their state corporate filings, and under their own daily management, to assist INAMED in accomplishing its corporate objectives.\nSince 1985, the Company has incorporated or acquired several companies, which it has structured as subsidiaries, in order to strengthen its position as a leading medical products company. INAMED Development Company (\"IDC\") was incorporated in 1986 as a wholly-owned subsidiary to pursue research and development of new medical devices primarily using silicone-based technology.\nIn May 1989, the Company acquired 100% of the outstanding shares of Cox-Uphoff Corporation and subsidiaries (\"CUC\"), a competitor of MMC in the silicone implant market. Upon the acquisition, the company name was changed to CUI Corporation (\"CUI\") which now operates as a wholly-owned subsidiary of the Company.\nIn October 1989, INAMED incorporated its McGhan Limited subsidiary which has designed and equipped a new medical device manufacturing plant in Arklow, County Wicklow, Ireland, to supplement production of the Company's current and future products. The location in Ireland was selected because it offers many favorable conditions such as availability of labor at reasonable rates, availability of attractive grants from the Industrial Development Authority (IDA), geographic proximity to INAMED B.V., favorable local tax treatment and their membership in the European Economic Community or EEC. The manufacturing plant in Ireland was fully operational in 1993, and is capable of supplying nearly all of the products sold in the international market. Future new products will be produced by McGhan Limited for sale\n- 2 -\ninternationally with limited support shipments from the Company's U.S. manufacturing plants. In support of expected future growing international demand the Company incorporated its Chamfield Limited subsidiary in 1993. Chamfield Limited's manufacturing facilities, which are not yet fully operational, are located adjacent to McGhan Limited's facilities.\nIn November 1989, INAMED incorporated its INAMED B.V. subsidiary in Breda, the Netherlands, to warehouse and distribute the Company's products to the European Community, Asia and other international locations. INAMED B.V. also markets products on a direct sales basis throughout the Netherlands. In conjunction with, and to further accomplish its long-range plans, the Company incorporated INAMED GmbH in Germany and INAMED B.V.B.A. in Belgium as subsidiaries in December 1989, thereby establishing a base from which to initiate direct sales of its products in two additional countries.\nIn 1991, INAMED concentrated on continued expansion into the European and international market, increasing production in its Irish manufacturing facility, continued efficiency and quality evaluation of its other manufacturing facilities and continued sales growth. The Company expanded its marketing base in Europe by incorporating INAMED S.R.L. as a direct marketing and distribution center for the Company's products in Italy in May 1991.\nIn 1991, the Company also incorporated its BioEnterics Corporation subsidiary in Carpinteria, California. BioEnterics was incorporated in order to focus on the development, production and international distribution of high-quality, proprietary implantable devices and associated instrumentation to the bariatric and general surgery markets for the treatment of gastrointestinal disorders and serious obesity.\nIn 1992, the Company incorporated its Biodermis Corporation subsidiary in Las Vegas, Nevada, in order to focus on the development, production and international distribution of premium products for dermatology, wound care and burn treatment.\nIn 1992, the Company also incorporated its Medisyn Technologies Corporation subsidiary to focus on the development and promotion of the merits of the use of silicone chemistry in the fields of medical devices, pharmaceuticals and biotechnology. This subsidiary is located in Las Vegas, Nevada.\nThe Company also continued development of its international market base in 1992 by incorporating INAMED Ltd. to market and distribute the Company's products in the United Kingdom.\nIn 1993, the Company incorporated Bioplexus Corporation, a wholly-owned subsidiary which is a research and development company that develops, produces and distributes specialty medical products for use by the General Surgery Profession.\nThe Company also incorporated Flowmatrix Corporation as a wholly-owned subsidiary in 1993. Flowmatrix manufactures high-quality silicone components and devices for INAMED's wholly-owned subsidiaries, and produces and distributes a line of proprietary silicone surgical products internationally.\n- 3 -\nThe Company continued to expand its international marketing base in 1993 by incorporating INAMED S.A.R.L. in Paris, France. The new subsidiary operates as a wholly-owned subsidiary of INAMED B.V.\nIn 1993, the Company sold its Specialty Silicone Fabricators (\"SSF\") subsidiary and SSF's Innovative Surgical Products subsidiary to Innovative Specialty Silicone Acquisition Corporation (ISSAC), a private investment group which included certain members of Specialty Silicone Fabricators' management. The transaction was valued at approximately $10.8 million, including $2.7 million in cash, $5.9 million in structured short-term and long-term notes, and the retirement of $2.2 million in intercompany notes due to SSF by the Company's subsidiaries.\nEffective January 1994, the Company acquired the assets of Novamedic, S.A. in Barcelona, Spain. Novamedic, S.A. is a well-established distributor of medical products in Spain which further strengthens the Company's presence in the international market. The new subsidiary was renamed INAMED, S.A. and operates as a wholly-owned subsidiary of the Company.\nThe Company has identified Spain, Portugal, South America, Central America, and Mexico as the IberoLatinoAmerican area. The incorporation of INAMED do Brazil in 1995 has strengthened the Company's presence in this area. INAMED do Brazil operates as a wholly-owned subsidiary of INAMED, S.A.\nThe Company incorporated its INAMED Japan subsidiary in Las Vegas, Nevada in 1995. INAMED Japan subsequently acquired 95% of INAMED Medical Group, a Japanese corporation. Additionally, the Company's McGhan Medical Corporation subsidiary incorporated its McGhan Medical Asia Pacific subsidiary in 1995. The formation of INAMED Japan and McGhan Medical Asia Pacific has enabled the Company to continue its expansion into the Asia-Pacific Rim market.\nPRINCIPAL PRODUCTS AND MARKETS\nThe Company is engaged in the development, manufacture and marketing of a number of implantable products, including mammary prostheses, tissue expanders and facial implants for plastic and reconstructive surgeons as well as custom prostheses for a variety of surgical applications and procedures.\nMammary prostheses are used for breast reconstruction and augmentation. As part of its mammary prosthesis product line, the Company produces different models, shapes and sizes of mammary implants including but not limited to double-lumen, saline and gel-filled mammary implants. In addition, the Company manufactures the Biocell-Registered Trademark- implant which incorporates the Company's patented low-bleed technology. The resulting implant has an open-cell silicone surface bio-engineered for a more favorable implant-to-tissue interface. The Biocell product line has received notably favorable market acceptance.\nThe Company is one of the leading world-wide manufacturers of saline-filled mammary prostheses. Saline implants are manufactured at two different subsidiaries: McGhan Medical Corporation and McGhan Limited. These products are made in various shapes and sizes, and utilize various valve designs. The surface construction of the finished\n- 4 -\nimplants provide the surgeon the opportunity to select from a smooth silicone, the BioCell textured surface or the patented MicroCell-Registered Trademark- textured surface.\nThe Company has developed and currently manufactures and markets a line of implantable and intraoperative tissue expanders. A typical tissue expander may consist of two unequal-size chambers which are implanted at a site where new tissue can be generated. After the device is implanted fluid can be injected into the smaller receiving chamber, or injection port, which then flows into the larger expanding chamber thus causing increased pressure under the skin resulting in tissue growth over a reduced period of time. The expanded tissue can then be used to cover defects, burns and injury sites or prepare a healthy site for an implant with the extra tissue available without the trauma of skin grafting. The Company has further developed its tissue expander product line by incorporating a patented integral valve injection area that is located by a magnetic detection system to enable the doctor to determine location of the injection port.\nThe Company manufactures and markets its patented BioSpan-Registered Trademark- tissue expander product line that utilizes the BioCell textured surface which allows more precise surgical placement. The BioSpan tissue expander surface subsequently decreases capsular contracture and yields greater tissue laxity during expansion.\nThe Company introduced the BioDimensional-TM- system for breast reconstruction following radical mastectomy procedures. The BioSpan tissue expanders and BioCell mammary implants used for this system were designed using a computer-assisted modeling study to determine the ideal dimensions and also utilized computer imaging programs to evaluate the expected aesthetic results. The BioDimensional system matches the specific size tissue expander to the mammary implant that will be used for the breast reconstruction procedure.\nThe Company also manufactures and markets the Ruiz-Cohen intraoperative expander. The Ruiz-Cohen intraoperative expander utilizes rapid intraoperative expansion as an effective means of arterial elongation to provide the additional tissue needed for end-to-end anastomosis. By eliminating the need for arterial grafting, patient discomfort is greatly reduced and the time and associated costs required to complete arterial anastomosis are minimized. The Company has license agreements and patents covering this product line, as well as patents pending for the next generation of the product. Additionally, the Company has patents and patent applications in eight countries outside of the United States for the product.\nThe Company's group of products allows the plastic or reconstructive surgeon a range of options. If requested, the Company works with a surgeon to design, to the surgeon's specifications, a custom implant suited to individual patients' needs.\nThe Company manufactures silicone gel sheeting intended for use in the treatment and control of old and new hypertrophic or keloid scarring. The products are sold under the tradenames TopiGel-TM-, Epi-Derm-TM-, and DemaSof-TM-.\nDuring 1994 and 1995, the Company's proprietary products accounted for 100% of net sales. Comparatively, in 1993, silicone implant products and silicone components accounted for 90% and 10% of net sales, respectively. The percentage of sales represented\n- 5 -\nby proprietary products has increased due to the sale of Specialty Silicone Fabricators in August 1993.\nMARKETING\nIn the United States, the Company's implant products are sold to plastic and reconstructive surgeons, facial and oral surgeons, outpatient surgery centers and hospitals through its own staff of direct sales people and independent distributors. In Canada and Hawaii, the Company is represented by independent distributors. The Company reinforces its sales and marketing program through the use of telemarketing which produces sales by providing follow up on leads and distributing product information to potential customers. The Company also supplements its marketing effort through its subsidiaries' appearances at trade shows and advertisements in trade journals and sales brochures.\nThe Company has a direct sales and distribution network in the Netherlands, Belgium, Germany, Italy, France, Spain, the United Kingdom, Brazil, Japan, and China. The Company's Netherlands subsidiary markets to and supports independent distributors in Denmark, Finland, Iceland, Italy, Norway, Sweden, and Switzerland. The Company also sells its products to independent distributors in Argentina, Australia, India, Korea, New Zealand and Taiwan. Sales outside the United States and Canada are made directly to these and other independent distributors and sales organizations through the Netherlands subsidiary's inventory of the Company's products. The Company believes its direct sales efforts and increased support of its international independent distributors has greatly enhanced overall sales which will continue throughout calendar 1996.\nThe Company maintains inventories of finished implant products in the United States and in the Netherlands to support and facilitate direct and immediate delivery on a normal basis. However, a back-order situation may occur from time to time due to a product's unusually high demand or unusual circumstances such as regulatory restrictions or new product release. As a direct result of the regulatory activity by the Food and Drug Administration (\"FDA\") in 1991 and 1992, the Company reduced its inventory levels and wrote off certain inventories impacted by FDA actions. To comply with FDA regulations, the Company voluntarily recalled all silicone gel-filled mammary implants which had previously been sold to its customers but not used. In 1992 the Company wrote off approximately $2.0 million of certain inventories and intangible assets related to the products covered by the FDA's request relating to the return of gel-filled implants and regulations. All the Company's silicone implant products manufactured or sold in the United States are classified as medical devices subject to regulation by the FDA, as more fully described under \"Government Regulations.\"\nCOMPETITION\nThe Company competes with one other manufacturer in the production and sale of mammary prostheses in the domestic market. Three other competitors discontinued production of mammary prostheses in 1992 largely as a result of regulatory action by the FDA. The Company believes that the principal factors permitting its products to compete effectively are its high-quality product consistency, variety of product designs, management's knowledge of and sensitivity to market demands, and the Company's ability to identify, develop and\/or obtain license agreements for patented products embodying new technology. In compliance with certain FDA regulations, the Company is allowed to sell one type of silicone gel-filled mammary prosthesis to a limited number of customers in the United States under stringent guidelines.\n- 6 -\nInternationally, the Company competes with several other manufacturers in the production and sale of its mammary prostheses. Major competitors in Europe include Mentor Corporation, Silimed, Laboratories Sebbin, L.P.I., Nagor, and LipoMatrix. However, the Company believes that its extensive network of marketing and distribution centers throughout Europe create the strongest presentation of its products in the international market, as well as the most favorable acceptance by physicians.\nThe tissue expander products' competition comes generally from the same corporations as in the manufacture and sale of mammary prostheses. Management believes the Company's implant market position will continue to grow due to its superior design, strong product features and future additions to its product lines.\nThrough August 1993, the Company competed in a highly diverse field in the sale of silicone components for the health care industry. These competitors included Dow Corning Corporation, Furon, Inc., Mox-Med, Inc., SF Medical, Surgical Technologies, Inc. and Helix Medical. The Company's products, although not proprietary, received good customer acceptance through the development of process technology, such as injection molding of liquid silicone, and the ability to achieve close tolerances. The Company no longer competes in this market since the sale of its Specialty Silicone Fabricators subsidiary in August 1993.\nRESEARCH AND PRODUCT DEVELOPMENT\nA qualified staff of doctorates, scientists, engineers and technicians, working in material technology and product design configurations, presently guide the Company's research and development efforts. The Company is directing its research toward new and improved products based on scientific advances in technology and medical knowledge together with qualified input from the surgical profession.\nThe Company has introduced the LAP-BAND-Registered Trademark- Adjustable Gastric Banding (LAGB-Registered Trademark-) System to the international market as an improvement to the earlier adjustable banding design. The LAGB System is in clinical trials in the United States. The LAGB System is designed to permit a laparoscopic procedure for severe obesity. During the operation, which is usually done without any large incision but under general anesthesia, the adjustable gastric band is placed around the stomach to constrict the stomach, forming a stoma between the stomach and a small stomach pouch above the band. The system utilizes special pouch and stoma measuring equipment, including an electronic device, and a special laparoscopic band placement instrument. Unlike \"stomach stapling\" or \"stomach bypass\" procedures, no cutting or stapling of the stomach is required and, usually, no major incision. the band is designed to be adjustable postoperatively without additional surgery. The LAGB System is currently being used for the long-term treatment of severe obesity throughout Europe, as well as in Australia, Latin America and the Middle East. The Company holds a license for the patent and patent pending applications.\nThe Company also holds a license for the patent and patent pending applications for EndoLumina-Registered Trademark- Illuminated Bougies, devices designed to transilluminate the esophagus and other organs of the body for improved visualization during a variety of laparoscopic and other surgical procedures. These products are on the market internationally and in the United States. The Company is currently conducting research into special materials and manufacturing techniques for providing increased transillumination and miniaturization for new indications.\n- 7 -\nThe Company holds a license for the U.S. and international patents for a new device for the treatment of severe gastroesophageal reflux. This device, with a cuff-like design and a self-locking mechanism, is designed to improve the safety and reliability of the laparoscopic treatment of gastroesophageal reflux. It is anticipated that clinical use of this device will start during 1996.\nThe Company's BioEnterics-Registered Trademark- Intragastric Balloon (BIB-Registered Trademark-) is being marketed on a limited basis in Europe for preoperative weight loss in severely obese patients, and as an aid to weight reduction in moderately obese patients. The balloon is endoscopically (non-surgically) placed in the patient's stomach and inflated with saline. The balloon partially fills the stomach, inducing weight loss. Severely obese patients have a higher incidence of surgical and perioperative complications, and weight loss also facilitates laparoscopic procedures in these patients.\nThe Company is also continuing efforts to add to its existing line of breast prostheses.\nThe Company depends on the efforts and accomplishments of the dedicated staff in its Research and Development groups, and will continue to support its current and future R & D projects and activities.\nPATENTS AND LICENSE AGREEMENTS\nIt is the Company's policy to actively seek patent protection for its products and\/or processes when appropriate. The Company developed and currently owns patents and trademarks for both the product and processes used to manufacture low-bleed mammary prostheses and for the resulting barrier coat mammary prostheses. Intrashiel-Registered Trademark- is the Company's registered trademark for the products using this technology. Beginning in 1984, such patents were granted in the United States, Australia, Canada, France, the Netherlands, the United Kingdom and West Germany. Trademarks for this product have been granted in the United States and France. The Company has license agreements allowing other companies to manufacture products using the Company's select technology, such as the Company's patented Intrashiel process, in exchange for royalty and other agreed to compensation or benefits.\nThe Company's other patents include patents relating to its mammary prostheses, tissue expanders, textured surfaces, injection ports, and valve systems. The Company also has various patent assignments or license agreements which grant the Company the right to manufacture and market certain products.\nThe Company believes its patents are valuable; however, it has been the Company's experience that the knowledge, experience and creativity of its product development and marketing staffs, and trade secret information with respect to manufacturing processes, materials and product design, have been equally important in maintaining proprietary product lines. Staying at the forefront of rapidly advancing medical technology by being responsive to the needs and concerns of health care professionals and their patients is the key to the Company's plans for future business expansion and financial success. As a condition of employment, the Company requires each of its employees to execute an agreement relating to confidential information and patent rights.\n- 8 -\nMANUFACTURING AND PRODUCT DEPENDABILITY\nThe Company manufactures its silicone devices under controlled conditions. The majority of the manufacturing process is accomplished manually, in conjunction with specialized equipment for precision measurement, quality control, packaging and sterilization. Quality control procedures begin upon the receipt of raw components and materials and continue throughout production and final packaging. The Company maintains quality control and production records of each product manufactured and encourages the return of any explanted units for analysis by its personnel. A majority of the Company's silicone products are supplied to the customer in a sterile condition requiring quarantine for appropriate periods of time to permit confirmation of sterility. All of the Company's activities are subject to FDA regulations and guidelines, and the Company's products and manufacturing procedures are continually monitored and\/or reviewed by the Food and Drug Administration.\nIn the Company's continued efforts to develop state-of-the-art processes that are environmentally responsible, a dry-heat sterilization process has been developed and is in place in the Company's manufacturing plants in the United States at McGhan Medical Corporation and in Ireland at McGhan Limited. Development of this dry heat packaging and sterilization cycle was the result of over three years of equipment design, identification and testing of materials and products, and process development, replacing a sterilization process that used ethylene oxide (EtO), as the standard.\nThe Company had more than one source of supply for all silicone materials used in the manufacture of its products until Dow Corning Corporation (\"DCC\"), a major supplier of medical grade silicone materials, announced it would discontinue the sale of implant grade silicone materials as of March 31, 1993. A majority of the silicone raw materials utilized by the Company have been purchased from a supplier other than DCC. The Company has studied the impact of the discontinuation of the supply of certain raw materials on the Company's ongoing business, and has established reliable alternate sources of high-quality critical silicone materials. The Company has experienced increased costs for its silicone materials, however, the cost increase is not significant to the overall cost of the finished products.\n- 9 -\nLIMITED WARRANTIES\nThe Company provides a limited warranty to the effect that it will replace without charge any product that proves defective with a new product of comparable type.\nMcGhan Medical Corporation's Product Service Program (PSP-TM-) is designed to provide limited financial assistance to cover non-reimbursed operating room or surgical expenses due to a loss of shell integrity for inflatable mammary implants for a period of five years from the date of implantation; in addition, a no charge replacement of the same or similar product is provided for returned McGhan Medical mammary implant products covered within the program. The Company reserves the right to make changes to its warranty policy from time to time within the confines of its warranty documents.\n- 10 -\nGOVERNMENT REGULATIONS\nAll the Company's silicone implant products manufactured or sold in the United States are classified as medical devices subject to regulation by the Food and Drug Administration (\"FDA\"). FDA regulations classify medical devices into three classes that determine the degree of regulatory control to which the manufacturer of the device is subject. In general, Class I devices involve compliance with labeling and record keeping requirements and are subject to other general controls. Class II devices are subject to performance standards in addition to general controls. A notification must be submitted to the FDA prior to the commercial sale of some Class I and all Class II products. Class II products are subject to fewer restrictions than Class III products on their commercial distribution, such as compliance with general controls and performance standards relating to one or more aspects of the design, manufacturing, testing and performance or other characteristics of the product. Tissue expanders are currently proposed to be classified as Class II devices. The Company's mammary prostheses, silicone intragastric balloon and gastric band system are Class III devices. Class III devices require the FDA's Pre-Market Approval (PMA) or an FDA Investigational Device Exemption (IDE) before commercial marketing to assure the products' safety and effectiveness.\nOn April 10, 1991, the FDA issued a final ruling requiring all manufacturers of silicone gel filled mammary prostheses to file a PMA application for their version(s) of the product(s) within 90 days after the effective date of the regulation or cease sale and\/or distribution of their product(s). The ruling reflects the FDA's discretion to require PMA's for any device which predates the 1976 Medical Device Act. This ruling is also in line with the FDA's stated priorities and Congress' requirement that all Class III devices be submitted to PMA review. In anticipation of this ruling, the Company had, for some time, been gathering the required data, including the results of laboratory, animal and clinical investigation and testing. In July 1991 the Company submitted an application to the FDA in response to the ruling. In November 1991 an FDA advisory panel voted unanimously to recommend that the Company's silicone gel-filled breast implants remain on the market while more safety data was gathered and evaluated by the agency. While the advisory panel concluded that the original PMA submitted by the Company's McGhan Medical subsidiary had failed to provide sufficient data concerning the safety of the implants, the FDA staff had not provided the panel members with updated and additional test results that had been submitted to the PMA application in late September 1991.\nIn January 1992, FDA Commissioner, David Kessler, requested that all United States silicone breast implant manufacturers stop manufacturing and marketing their silicone gel-filled implants as a voluntary action and that surgeons refrain from implanting the devices in patients pending further review of information relating to the safety of the products. The FDA advisory panel reconvened in February 1992 and, after review of the new information, recommended that the gel-filled mammary implants remain available for all patients wishing reconstruction following mastectomies and\/or to correct severe deformities, and, under strictly controlled clinical studies, be available on a limited basis to patients wishing augmentation. On April 16, 1992, the FDA announced that silicone gel-filled breast implants would be available only under controlled clinical studies. Under an Urgent Need protocol, the products would be available immediately to patients requiring completion of reconstructive surgery which was begun prior to the January 1992 moratorium. All patients are required to sign detailed informed consent forms prior to surgery under the Urgent Need program. Under an Adjunct Study Program developed by the FDA, gel-filled implants would also be available to women desiring them for reconstruction, including the correction of severe deformities. - 11 -\nAs of December 31, 1994, the Company has not been a participant in the Adjunct Study.\nIn the ongoing process of compliance with the Medical Device Act, the Company has incurred, and will continue to incur, substantial costs which relate to laboratory and clinical testing of new products, data preparation and filing of documents in the proper outline or format as required by the FDA under the Medical Device Act. Further, the FDA is expected to issue a call for PMA applications for saline-filled breast implants in 1998. Although the Company has agreed to conduct clinical trials and is collecting data in anticipation of FDA action, there can be no assurance that the Company can prepare or file a PMA in a timely manner or whether said PMA will be accepted by the FDA, regardless of the time and money that the Company has incurred. The Company will decide on a product by product and subsidiary by subsidiary basis whether to respond to any future calls for PMA's and regulatory requirements, requested response or Company action. The cost of any PMA filings is unknown until the call for a PMA occurs and the Company has had an opportunity to review the filing requirements.\nThere can be no assurance that other products under development by the Company will be classified as Class I or Class II products or that additional regulations restricting the sale of its present or proposed products will not be promulgated by the FDA. The Company is not aware of any changes to be put in place by the FDA that would be so restrictive as to remove the Company from the market place. However, the FDA has significantly restricted the Company's right to manufacture and sell gel-filled breast implants in the United States. As a result, the Company's sales of saline-filled breast implant products have increased significantly, and are expected to continue to be the Company's main product line for 1996.\nAs a manufacturer of medical devices, the Company's manufacturing processes and facilities are subject to continuing review by the FDA, responsible state or local agencies such as the State Department of Health Services and other regulatory agencies to insure compliance with good manufacturing practices and public safety compliance. The Company's manufacturing plants are also subject to regulation by the local Air Pollution Control District and by the Environmental Protection Agency as a user of certain solvents.\nDue to the ongoing requirements, FDA reviews, and changing policies and inspection procedures, the Company, from time to time, receives inspections from the FDA. Early in 1993, Dow-Corning, the leading supplier of medical grade silicone material, announced that it would no longer be supplying medical grade silicone to medical device manufacturers. On July 6, 1993, The FDA announced, through the Federal Register, a notice identifying plans for handling products that did use Dow-Corning silicone. The notice provided guidance regarding tests required to demonstrate the equivalence of silicone material from an alternate supplier and the overall policy relating to regulatory submissions. As McGhan Medical had certain devices and\/or components produced from Dow-Corning silicone materials, it was necessary to plan for this material changeover. Since some of the materials directly or indirectly affected the gel-filled mammary implant product line, the availability of the materials hampered the Company's efforts in further validation testing for its manufacturing processes involving gel-filled mammary implants. On March 1, 1994, the FDA inspected McGhan Medical to review its validation processes for the manufacturing of gel-filled mammary implants. These mammary implants are currently not marketed because of the FDA moratorium on gel-filled mammary implants which limited their use for reconstruction and restricted their use for augmentation.\n- 12 -\nMcGhan was limited to marketing its style 153 gel mammary implant for reconstruction use only under an Urgent Need basis. No other gel-filled products have been manufactured by McGhan over the last three years. The inspection conducted by the FDA was to evaluate whether McGhan's manufacturing processes were sufficiently validated to authorize the further manufacturing of both the 153 and other styles of gel-filled mammary implants. At the conclusion of the inspection, the FDA issued an FD483, list of observations, which specifically dealt with the inadequacies of the validation for the shell dipping operations. McGhan responded to the FD483 by March 11, 1994. Subsequently, the FDA conducted a follow-up inspection and concluded that Mcghan had not satisfactorily addressed the inadequacies noted in the FD483. As a result, the FDA issued McGhan a warning letter. McGhan has responded to the warning letter, is addressing the completion of the FD483 responses, and expects to achieve compliance. McGhan continues to market its saline-filled mammary implants and expects to be inspected by the FDA again specific to saline manufacturing at the FDA's discretion.\nEMPLOYEES\nAs of December 31, 1995, the Company employed 832 persons: 13 persons were employees of INAMED; 13 persons were employees of INAMED Development Company working on its research and development projects; 555 persons were employed by the various operating subsidiaries within the United States; and 251 persons were employed by the Company in Europe, Asia-Pacific Rim, and IberoLatinoAmerica performing production operations, marketing and sales functions.\nExcept for the manufacturing operation in Ireland, the employees are not represented by a labor union. The Company offers its employees competitive benefits and wages comparable with like employee status for the type of business and the location\/country in which the employment occurs. The Company considers its employee relations to be good throughout its operations.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company leases a total of 18,681 square feet of office and warehouse space in three locations in Las Vegas, Nevada. The Company's corporate headquarters comprise 4,449 square feet of office space located in a multi-story office building for a current rental rate of $13,289 per month. The lease on this space expires July 1, 1998. The Company leases 6,895 square feet of office space in a building adjacent to the corporate headquarters which it subleases to Medisyn Technologies Corporation. The current monthly lease rate is $12,066 with the lease expiring in May 1996. This lease is currently being renegotiated. The Company leases 7,337 square feet of office and warehouse space in an industrial complex adjacent to the Las Vegas Airport. This space is subleased to Flowmatrix Corporation. The current rental rate is $2,861 with the lease expiring in August 1996. This lease is currently being renegotiated.\nThe Company also leases office and industrial space which is comprised of three buildings with an aggregate of 33,939 square feet in Carpinteria, California. BioEnterics Corporation subleases one building totaling 4,900 square feet. INAMED Development Company occupies 6,900 square feet in the second building, with the remaining 4,900 being used for storage. The Company has exercised the option to extend the lease term to May\n- 13 -\n1996. The current rental rate is $14,657 per month (with cost of living escalation in June of every year). The third building, which has 17,239 square feet, is subleased to CUI Corporation. The current rental rate is $12,857 per month with the lease expiring in February 1996, and continuing month to month thereafter.\nMcGhan Medical Corporation leases manufacturing facilities in Santa Barbara, California, aggregating 44,800 square feet for $39,947 per month, with cost of living escalations in July of every year. The lease for these buildings expires in 1996, with four one-year options to extend. McGhan Medical Corporation also leases 27,992 square feet of office space in an adjacent building. The lease term expires in July 1996 with a seven year option to extend. The rent is $32,354 per month, with cost of living escalations in January of every year. Additionally, McGhan Medical Corporation leases a total of 27,123 square feet of adjacent office and warehouse space with monthly rentals aggregating $18,206 and lease terms expiring through February 1997. In June 1994, McGhan Medical Corporation entered into a lease for a manufacturing facility aggregating 57,897 square feet with a monthly rental rate of $59,024 (with cost of living escalation in June of every year) expiring in July 2006. In March 1995, McGhan Medical Corporation entered into a lease for office space of 23,697 square feet with a monthly rental rate of $16,114 expiring in April 2000.\nMcGhan Limited's and Chamfield Limited's manufacturing facilities are located in Arklow, County Wicklow, Ireland. McGhan Limited leases a 28,000 square foot building from the Ireland IDA at a current annual rate of 84,996 Irish Punts for a term ending in 2017. Chamfield Limited leases a 23,000 square foot building at a current annual rental rate of 74,352 Irish Punts for a term ending in 2029.\nINAMED B.V. in the Netherlands leases 1,407 square meters of office and warehouse space at a quarterly rate of 84,118 Guilders, with cost of living escalation in May of each year, for a lease term ending in April 2000.\nINAMED B.V.B.A. leases 220 square meters of office and warehouse space in Turnhout, Belgium at a rate of 28,346 Belgian Francs per month (with a cost of living escalation in September of each year) with a lease term expiring in November 1998.\nINAMED GmbH currently rented 210 square meters of office and warehouse space at a rate of 7,173 German Marks per month on a three year lease expiring in January 1996. Starting December 1995 INAMED GmBH is renting 286 square meters of office and warehouse space in Dusseldorf, Germany at a rate of 7,150 German Marks per month on a five year lease expiring in December 2000. The lease provides for an automatic yearly extension thereafter unless the contract is terminated 9 months before renewal date of the lease.\nINAMED S.R.L. leases 460 square meters of office and warehouse space in Verona, Italy for 4,460,000 Italian Lira per month with a lease term expiring in August 2000. INAMED S.R.L. also leases 60 square meters of office space in Rome, Italy for 1,600,000 Italian Lira per month with a lease expiration of August 2000.\nINAMED Ltd. rents 1,550 square feet of office and warehouse space in Wokingham, United Kingdom under a five year lease expiring in July 1997. Under the terms of the lease, payments are made on a quarterly basis. The current rate is L5,426 per quarter.\n- 14 -\nINAMED SARL rents 243 square meters of office and warehouse space in Paris, France for an annual rent of 345,825 Francs. The lease term is nine years with expiration in December 2004. The first eight months of rent were free, therefore the first rent was due in August of 1996. Rent is paid in quarterly installments in advance.\nINAMED, S.A. rents 950 square meters of office and warehouse space in Barcelona, Spain at a monthly rate of 864,438 Pesetas under a lease expiring in February 1998.\nINAMED do Brazil rents 345 square meters of office and warehouse space in Sao Paulo, Brazil at a monthly rate of $2,000 under a lease expiring in May 1998.\nMcGhan Medical Asia Pacific rents 389 square feet of office space in Hong Kong at a monthly rate of $7,124 under a lease expiring in September 1996. The Company intends to renegotiate this lease prior to its expiration.\nINAMED Medical Group(Japan) rents 155 square meters of office space in Tokyo, Japan at a monthly rate of $3,000 under a lease which is automatically renewed upon expiration.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nIn 1987 the Company acquired two health insurance subsidiaries. In 1988 the Company sold both subsidiaries. In 1991, the Company was sued for third party resolution in the amount of $500,000, related to the acquiring company's inability or failure to meet asset deposit requirements of the Illinois Director of Insurance. The Company reached settlement with the Illinois Department of Insurance in February 1993, whereby the Company paid the third party demand of $500,000 for full release.\nIn October, 1990, the Company's CUI Corporation subsidiary brought action against a former employee for violation of a contractual non-compete agreement entered into with the Company. A settlement was reached in August of 1992 whereby the Company repurchased common stock acquired by the former employee in exchange for the resolution of all issues and legal proceedings and the elimination of any future Company obligation to the former employee as to the non-compete agreement. The Company made final payment under this settlement in 1994.\nDuring 1992 an action against the Company and two of its subsidiaries and one of its officers was filed in California Superior Court for the County of Santa Barbara (State Court). The Company, through one of its subsidiaries, filed a lawsuit against the plaintiff in the United States District Court for the Central District of California (Federal Court). The State Court action was filed as a contract dispute over an Exclusive License Agreement and the Federal Court action was filed over the same Exclusive License Agreement, but with different issues as subject matter. The State action was settled in April 1993 and discharged as an action with the Plaintiff Agreement remaining in force as written, and the Company's subsidiaries agreed to and complied with the terms as written in the Agreement. No changes were made with the outcome that both of the Company's subsidiaries will comply with the\n- 15 -\nterms of the Agreement, as written, for the subsidiaries' products over the life of the patent. The Federal action was terminated by mutual agreement in 1994.\nIn 1992, the County of Santa Barbara, California, filed a complaint against the Company's McGhan Medical Corporation subsidiary alleging that MMC supplied false and inaccurate information regarding xylene emissions to the Air Pollution Control District and had engaged in a pattern of unfair business practices by failing to control its emissions. In March 1993 MMC reached a settlement with the County of Santa Barbara Air Pollution Control District. The parties agreed to a settlement to avoid prolonged litigation surrounding alleged emission violations. By entering the agreement, the Company made no admission of wrongdoing but assented to a one time payment of $100,000 and installation of emissions control equipment at MMC's facility. MMC's decision to settle allowed it to allocate the Company's manpower and funds to the installation of the control equipment rather than expending these resources on successful defense against the complaint.\nPRODUCT LIABILITY\nINAMED and\/or its subsidiaries are defendants in numerous State court actions and a Federal class action in the United States District Court, Northern District of Alabama, Southern Division, under Chief Judge Sam C. Pointer, Jr., U.S. District Court, regarding Master File No. C892-P-10000-S (Silicone Gel Breast Implants Product Liability Litigation MDL 926). The claims are for general and punitive damages substantially exceeding provisions made in the Company's consolidated financial statements. The accompanying consolidated financial statements have been prepared assuming that the Company will withstand the financial results of said litigation.\nSeveral U.S. based manufacturers negotiated settlement with the Plaintiffs' Negotiating Committee (\"PNC\"), and on March 29, 1994 filed a Proposed Non-Mandatory Class Action Settlement in the Silicone Breast Implant Products Liability (the \"Settlement Agreement\") providing for settlement of the claims as to the class (the \"Settlement\") as described in the Settlement Agreement. The Settlement Agreement, upon approval, will provide resolution of any existing or future claims, including claims for injuries not yet known, under any Federal or State law, from any claimant who received a silicone breast implant prior to June 1, 1993. A fairness hearing for the non-mandatory class was held before Judge Pointer on August 18, 1994. On September 1, 1994, Judge Pointer gave final approval to the non-mandatory class action settlement. The deadline for plaintiffs to enter the Settlement was March 1, 1995.\nThe Company was not originally a party to the Settlement Agreement. However, on April 8, 1994 the Company and the PNC reached an agreement which would join the Company into the Settlement. The agreement reached between the Company and the PNC added great value to the Settlement by enabling all plaintiffs and U.S. based manufacturers to participate in the Settlement, and facilitating the negotiation of individual contributions by the Company, Minnesota Mining and Manufacturing Company (\"3M\"), and Union Carbide Corporation which total more than $440 million.\nUnder the terms of the Settlement Agreement, the parties stipulate and agree that all claims of the Settlement Class against the Company regarding breast implants and breast implant materials shall be fully and finally settled and resolved on the terms and conditions set forth in the Settlement Agreement.\n- 16 -\nUnder the terms of the Settlement Agreement, the Company will pay $1 million to the Settlement fund for each of 25 years starting three years after Settlement approval by the Court. The Company recorded a pre-tax charge of $9.1 million in the fourth quarter of 1993. The charge represents the present value (discounted at 8%) of the Company's settlement of $25 million over a payment period of 25 years, $1 million per year starting three years from the date of Settlement approval.\nUnder the Settlement, $1.2 billion had been provided for \"current claims\" (disease compensation claims). In May 1995, Judge Pointer completed a preliminary review of current claims which had been filed as of September 1994, in compliance with deadlines set by the court. Judge Pointer determined that based on the preliminary review, it appears that projected amounts of eligible current claims exceed the $1.2 billion provided in the Settlement. The Settlement provided that in the event of such over subscription, the amounts to be paid to eligible current claimants would be reduced and claimants would have a right to \"opt-out\" of the Settlement at that time.\nOn October 1, 1995, Judge Pointer finalized details of a scaled-back breast implant injury settlement involving defendants Bristol-Myers Squibb, Baxter International, and 3M, allowing plaintiffs to reject this settlement and file their own lawsuits if they believe payments are too low. On November 14, 1995, McGhan Medical and Union Carbide were added to this list of settling defendants to achieve the Bristol, Baxter, 3M, McGhan and Union Carbide Revised Settlement Program (the \"Revised Settlement Program\").\nThe Company has opposed the plaintiffs' claims in these complaints and other similar actions, and continues to deny any wrongdoing or liability to the plaintiffs of any kind. However, the extensive burdens and expensive litigation the Company would continue to incur related to these matters prompted the Company to work toward and enter into the Settlement which insures a more satisfactory method of resolving claims of women who have received the Company's breast implants.\nManagement's commitment to the Settlement does not alter the Company's need for complete resolution sought under a mandatory (\"non-opt-out\") settlement class (the \"Mandatory Class\"). Therefore, the company has petitioned the United States District Court, Northern District of Alabama, Southern Division, for certification of a Mandatory Class under the provisions of Federal Rule of Civil Procedure.\nThe Company was a defendant with 3M in a case involving three plaintiffs in Houston, Texas, in March 1994, in which the jury awarded the plaintiffs $15 million in punitive damages and $12.9 million in damages plus fees and costs. However, the decision was reversed in March 1995 resulting in no financial responsibility on the part of the Company.\nThe cost of the foregoing litigation has adversely affected the liquidity of the Company. Management believes that the Company may not continue as a going concern if its request to the Court for Mandatory Class resolution of the breast implant litigation actions against the Company is not approved. Although management is optimistic that the Mandatory Class will be approved by the Court, there can be no assurances that this outcome will be achieved.\n- 17 -\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNot applicable.\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDERS MATTERS.\nThe Company's common stock is traded in the over-the-counter market and was listed on NASDAQ beginning in June 1986. The Company's common stock also began trading on the Pacific Stock Exchange on December 1, 1987. On March 28, 1996, the Company had stockholders of record.\nEffective December 20, 1995, the Company has been granted a temporary exception to the capital and surplus requirement of the NASDAQ Small Cap Market-TM- by the NASDAQ Listing Qualifications Committee. As part of its conditional listing, the Company's stock symbol was changed from IMDC to IMDCC. The fifth character \"C\" appended to the Company's stock symbol will remain until such time that the Company is able to evidence compliance with all NASDAQ listing criteria in a manner deemed acceptable by the Listing Qualifications Committee. The Company expects to evidence this compliance in 1996.\nThe Table below sets forth the high and low bid prices of the Company's common stock for the periods indicated. Quotations reflect prices between dealers, do not reflect retail markups, markdowns or commissions, and may not necessarily represent actual transactions. No cash dividends have been paid by the Company during such periods.\n1994 HIGH LOW ---- ---- ---- 1st Quarter 4-3\/4 2-1\/2 2nd Quarter 4-1\/2 2-3\/4 3rd Quarter 3-3\/4 2-3\/8 4th Quarter 3-1\/8 2-3\/8\n---- 1st Quarter 4-1\/4 3 2nd Quarter 4-1\/8 3 3rd Quarter 14 3 4th Quarter 12-5\/8 8-1\/4\nThe Company has never paid a cash dividend. It is the present policy of the Company to retain earnings to finance the growth and development of its business and to fund ultimate litigation settlements. Therefore, the Company does not anticipate paying cash dividends on its common stock in the foreseeable future.\n- 18 -\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe following table summarizes certain selected financial data of the Company and should be read in conjunction with the related Consolidated Financial Statements of the Company and accompanying Notes to Consolidated Financial Statements.\n(1) Includes a pre-tax charge of $9.1 million under the terms of the proposed class action settlement.\n(2) Includes write-offs of assets for product inventory aggregating $1,974,423 in 1992 and $4,428,527 in 1991.\n- 19 -\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nRESULTS OF OPERATIONS\nThe Company experienced continued sales growth in 1995 with net sales of $81.6 million. This represented a 1.5% increase over the year ended December 31, 1994. Net sales for 1994 increased 7.9% over 1993. Domestic sales growth in 1995 was adversely affected by shortages of raw materials and by changes made by the Company in certain processes and procedures in its domestic manufacturing plant in order to achieve regulatory approvals and attain higher standards of control. These changes made by the Company limited the domestic outputs of finished goods in 1995, but are expected to benefit future periods. The Company expects international sales to represent an increasing percentage of net sales in future years, since this market is experiencing increasing demand. Management anticipates the market growth, continued increase of production capacity, both domestically and internationally, and expansion of the international sales force will allow an increase in sales growth throughout 1996.\nCost of goods sold as a percent of net sales was 37% for the year ended December 31, 1995, compared to 33% for the year ended December 31, 1994 and 31% for the year ended December 31, 1993. Management anticipates that the Company may experience future quarters with higher costs of production as modifications are made to accommodate changing FDA views and regulations.\nMarketing expenses as a percent of net sales were 29% for the year ended December 31, 1995, compared to 25% for the year ended December 31, 1994 and 23% for the year ended December 31, 1993. Royalty expense continued to increase as sales of licensed products continued to grow. As was expected, while INAMED GmbH, INAMED S.R.L., INAMED Ltd. and INAMED SARL have been in the start-up phases, marketing expenses as a percent of net sales for their individual distribution networks have been somewhat higher than the consolidated percentages. Moderating this increase is the relative stability of other marketing expenses on a Company wide basis.\nGeneral and administrative expenses have increased as the Company has grown. These expenses have increased from $25,904,000 in 1993, to $27,099,000 in 1994, and $31,365,000 in 1995. A portion of the increase relates to the current expansion of international facilities and the overall growth in sales and production volume which has been experienced by the Company. Legal fees related to the breast implant litigation also contributed to the increase.\nResearch and development expenses have increased from $3,074,000 to $3,724,000 to $4,392,000 in 1993, 1994, and 1995 respectively, reflecting the Company's continuing commitment to development of new and advanced medical products. As a percentage of net sales, this expense has consistently been between 4.1% and 5.3%. Diversification into other facets of medical devices within the industry through use of new technology has always been and remains a goal of the Company. The silicone gastric band and a silicone hemorrhoidal pessary are products which were developed by the Company and are now in clinical trials internationally. A government research grant has been approved for the clinical research of the Company's silicone intragastric balloon. R & D expenses are expected to increase in 1996. The Company is also increasing R & D overseas due to the FDA backlog on approval of new devices in the U.S.\n- 20 -\nAdditionally, increased costs to obtain FDA PMA approvals are anticipated in 1996. Beginning in 1989, the Company began the necessary work to address FDA regulations related to premarket approval of silicone gel filled mammary implants and the Company anticipates continued investment of employee hours and Company funds throughout calendar 1996 to facilitate compliance with all FDA regulations as determined by the PMA study and any new regulations which may be adopted.\nInterest expense was $504,734 in 1993, $624,261 in 1994 and $833,086 in 1995. The increase in 1995 is due to interest incurred on outstanding federal and state income tax liabilities.\nThe Company had a net loss of $6,893,061 or $.91 per share in 1995. This compares to net income of $2,746,311 or $.37 per share in 1994. Increased regulatory and legal costs relating to breast implants continue to be a significant burden on the Company's bottom line profitability. Management believes that resolution of the breast implant litigation through the Revised Settlement Program and achievement of provisional certification of the Mandatory Settlement Class will allow the Company to anticipate and manage costs associated with the litigation and move the Company forward toward greater profitability in the future.\nFINANCIAL CONDITION\nLIQUIDITY\nThe current ratio (current assets to current liabilities) of 0.9 to 1 as of December 31, 1995 is less than the ratio of 1.0 to 1 as of December 31, 1994. The Company's ratio was negatively affected in 1995 and 1994 by increased legal costs due to breast implant litigation, and breast implant returns. In addition, the Company's expansion both domestically and internationally used significant cash resources throughout 1995.\nBreast implant product liability related issues are expected to draw on the Company's liquidity throughout 1996. The Company is in the process of negotiating extended payment terms on these expenses which the Company feels will reduce the adverse effect on short-term and long-term liquidity. However, there is no assurance that the extended payment terms will be granted by the legal firms involved.\nThe cost of the foregoing litigation has adversely affected the liquidity of the Company. Management believes that the Company may not continue as a going concern if its request to the Court for Mandatory Class resolution of the breast implant litigation actions against the Company is not approved. Although management is optimistic that the Mandatory Class will be approved by the Court, there can be no assurances that this outcome will be achieved.\nIn January 1996, the Company completed a private placement offering by issuing three-year collateralized convertible, non-callable notes due March 31, 1999 bearing an interest rate of 11%. The Company received $35 million in proceeds from the offering to be used for the anticipated litigation settlement, for capital investments and improvements to expand production capacity, and for working capital purposes. Of the proceeds received from the offering, $15 million is held in an escrow account to be released upon the granting and court approval of mandatory class certification.\n- 21 -\nThe Company forecasts that the majority of cash necessary for U.S. operations will continue to be generated by operations. The Company will continue to utilize a combination of working capital and available credit facilities. Increased sales activity throughout 1996 is expected to increase the availability of cash resources. If cash is determined to be inadequate for the level of activity, the Company may reduce expenses such as those related to R & D projects. The future of any affected project would then be uncertain. As cash flow becomes more available, management may restart projects, or elect to terminate projects, based on a business decision and on a project by project basis.\nThe Company intends to seek out a suitable partner in banking to achieve current and future credit facility needs for domestic subsidiaries' support. Additionally, the Company intends to develop other methods to achieve increased working capital. These methods may be achieved through both the private and\/or public sector. However, there can be no assurance that such financings will be available at acceptable terms, if at all. Settlement of the breast implant litigation will greatly enhance the Company's ability to obtain financing from banks or other lending institutions.\nIn June of 1990, the Company established a $4.5 million financing package for working capital with a major bank that utilizes the domestic accounts receivable, inventories and certain other assets as collateral. In December 1990, the line of credit was increased to $5.3 million. As of December 31, 1995, approximately $328,000 had been drawn on the line of credit. The weighted average interest rate during 1995 was 11.3%.\nThe Company's line of credit was due for renewal in August,1993. The present bank line was not renewable under acceptable terms and conditions and was extended through March 31, 1996. On January 24, 1996, the Company paid all amounts due under the line of credit. The Company believes that it can start reasonable discussions with lenders for a new credit facility now that the Company has entered into global settlement agreements. Although there are no assurances that the Company will be successful in the engagement of a lender, the Company has made progress in addressing lender concern surrounding the breast implant litigation through settlement agreements which include mandatory class certification. However, there can be no assurance that such financings will be available at acceptable terms, if at all.\nIn April 1994, the Company increased its international line of credit with a major Dutch bank. The current line is $1,540,000 and is collateralized by the accounts receivable, inventories and certain other assets of INAMED B.V. The line of credit expires on March 31, 1996. It is currently being renegotiated and is expected to be renewed. As of December 31, 1995, approximately $900,000 had been drawn on the line of credit. The interest rate on the line of credit is 7% per annum.\nThe Company's international sales subsidiaries achieved significant sales growth in 1995. In Ireland, grants have been approved by the Irish Industrial Development Authority (IDA) to fund portions of the costs of operations of McGhan Limited, including reimbursement for training expenses, leasehold improvements and capital equipment. As of December 31, 1995, McGhan Limited had received grants from the IDA for approximately $2.7 million and had obtained approval for additional grants from other funding agencies for approved research and development programs for up to $1.1 million.\nThe Company currently does not utilize forward contracts to hedge against foreign currency gains or losses.\nManagement believes liquidity will improve as a result of increased sales throughout 1996, due to increased sales areas, new product introductions and decreased litigation costs as a result of projected global settlement and mandatory class certification, and efforts by the Company to raise future funding through a bank line or private offering. However, no assurances can be given as to the outcome of such efforts.\nCAPITAL EXPENDITURES\nExpenditures on property and equipment approximated $4.7 million in 1995 compared to $2.9 million in 1994. Additionally, capital lease obligations of approximately $89,000 were incurred during 1995 compared to capital lease obligations of approximately\n- 22 -\n$21,000 incurred during 1994. The majority of the expenditures in each year were for building improvements and equipment to increase production capacity and efficiency. The Company is working on several development projects, any one of which may require additional capital resources for completion, production, and marketing.\nSIGNIFICANT FOURTH QUARTER ADJUSTMENTS\nThe Company had significant fourth quarter adjustments to financial results in 1995. The Company recorded a provision for doubtful accounts and returns and allowances of $1,424,734, or 1.7% of net sales, and compensation of $891,200, or 1.1% of net sales. An offsetting adjustment was made to reduce income tax expense by $4,162,607, or 5.1% of net sales.\nThe Company had significant fourth quarter adjustments to financial results in 1994. The Company recorded a provision for doubtful accounts and returns and allowances of $546,054, or 0.7% of net sales, a provision for inventory obsolescence of $221,590, or 0.3% of net sales, a provision for product liability of $1,123,605, or 1.4% of net sales, and compensation expense of $187,500, or 0.2% of net sales. Offsetting adjustments were made to reduce income tax expense by $3,396,858, or 4.2% of net sales, reduce rental expense of $800,000, or 1.0% of net sales, and record royalty income receivable of $325,301, or 0.4% of net sales.\nIMPACT OF INFLATION\nThe Company believes that inflation has had a negligible effect on operations over the past three years. There exists the opportunity to offset inflationary increases in the cost of materials and labor by increases in sales prices and by improved operating efficiencies.\n- 23 -\nITEM 8(A). FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nREPORT OF INDEPENDENT ACCOUNTANTS\nThe Stockholders and Board of Directors INAMED Corporation:\nWe have audited the accompanying consolidated balance sheets of INAMED Corporation and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations, stockholders' (deficit) equity, and cash flows, for each of the three years in the period ended December 31, 1995. In connection with our audits of the consolidated financial statements, we have also audited the financial statement schedule listed under item 14(a)(2) of this Annual Report on Form 10-K for each of the three years in the period ended December 31, 1995. These consolidated financial statements and the financial statement schedule are the responsibility of the Company' s management. Our responsibility is to express an opinion on these consolidated financial statements and the financial statement schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatements. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of INAMED Corporation and subsidiaries as of December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995 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.\nThe accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 14 to the consolidated financial statements, the Company, through certain subsidiaries, has been a defendant in substantial litigation related to breast implants which has adversely affected the liquidity and financial condition of the Company. This raises substantial doubt about the Company's ability to continue as a going concern. Management's plans in this regard are discussed in Note 14 to the consolidated financial statements and do not include any adjustments that might result from the outcome of this uncertainty.\nCOOPERS & LYBRAND L.L.P.\nLas Vegas, Nevada March 28, 1996\n- 24 -\nINAMED CORPORATION AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\nSee accompanying notes to consolidated financial statements.\n- 25 -\nINAMED CORPORATION AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\nSee accompanying notes to consolidated financial statements.\n- 26 -\nINAMED CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF OPERATIONS\nYears ended December 31, 1995, 1994 and 1993\nSee accompanying notes to consolidated financial statements.\n- 27 -\nINAMED CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY\nYears ended December 31, 1995, 1994 and 1993\nSee accompanying notes to consolidated financial statements.\n- 28 -\nINAMED CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nYears ended December 31, 1995, 1994 and 1993\nSee accompanying notes to consolidated financial statements.\n- 29 -\nINAMED CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED\nSee accompanying notes to consolidated financial statements.\n- 30 -\nSupplemental schedule of noncash investing and financing activities:\nYear ended December 31, 1995: In 1995 the Company issued 75,000 shares of common stock and recorded a corresponding $165,000 reduction of a liability which had been incurred in connection with the acquisition of INAMED, S.A.\nYear ended December 31, 1994: The 1994 statement of cash flows is presented net of the noncash effects of the acquisition of INAMED, S.A. In connection with the acquisition of INAMED, S.A., the Company initially made cash payments of $250,050, recorded a note payable for future cash payments of $700,000 and recorded a liability of $385,000 for the future issuance of 175,000 shares of common stock. As of December 31, 1994, the Company had paid $150,000 on the note payable and had issued 100,000 shares of common stock.\nYear ended December 31, 1993: In connection with the sale of Specialty Silicone Fabricators, Inc. and Innovative Surgical Products, Inc., the Company repurchased approximately 461,120 shares of common stock in exchange for a reduction in notes receivable of $685,916.\nSee accompanying notes to consolidated financial statements.\n- 31 -\nINAMED CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(1) BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nTHE COMPANY\nThe Company and its subsidiaries are engaged primarily in the development, manufacture and distribution of implantable medical devices for the plastic and general surgery fields. Its primary products include mammary prostheses and tissue expanders. The Company operates in both domestic and foreign markets.\nBASIS OF PRESENTATION\nThe consolidated financial statements include the accounts of INAMED Corporation and its wholly-owned subsidiaries (collectively referred to as the Company). All significant intercompany balances and transactions have been eliminated in consolidation.\nUSE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates (also see Note 14).\nCASH EQUIVALENTS\nThe Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.\nACCOUNTS RECEIVABLE AND CREDIT RISK\nThe Company grants credit terms in the normal course of business to its customers, primarily hospitals, doctors and distributors. As a part of its ongoing control procedures, the Company monitors the credit worthiness of its customers. Bad debts have been minimal. The Company does not normally require collateral or other security to support credit sales. An estimated provision for returns and credit losses has been provided for in the financial statements and has generally been within management's expectations.\nREVENUE RECOGNITION\nRevenues are recognized when product is shipped. Revenues are recorded net of estimated sales returns and allowances. The Company ships product with the right of return and has provided an estimate of the allowance for sales returns.\n- 32 -\nINAMED CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(1) BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED\nINVENTORIES\nInventories are stated at the lower of cost (first-in, first-out) or market (net realizable value). Estimated inventory obsolescence has been provided for in the financial statements and has generally been within management's expectations.\nCURRENT VULNERABILITY DUE TO CERTAIN CONCENTRATIONS\nThe Company has primarily one source of supply for certain raw materials which are significant to its manufacturing process. Although there are a limited number of manufacturers of the particular raw materials, management believes that other suppliers could provide similar raw materials on comparable terms. A change in suppliers, however, could cause a delay in manufacturing and a possible loss of sales, which would affect operating results adversely.\nPROPERTY AND EQUIPMENT\nProperty and equipment are stated at cost less accumulated depreciation and amortization. Significant improvements and betterments are capitalized while maintenance and repairs are charged to operations as incurred.\nDepreciation of property and equipment is computed using the straight-line method based on estimated useful lives ranging from five to ten years. Leasehold improvements are amortized on the straight-line basis over their estimated economic useful lives or the lives of the leases, whichever are shorter.\nINTANGIBLE AND LONG-TERM ASSETS\nIntangible and long term assets are stated at cost less accumulated amortization, and are amortized on a straight-line basis over their estimated useful lives as follows:\nCustomer lists 5 years Organization costs 5 years Patents 17 years Trademarks and technology 5 years Goodwill 10-12 years\nThe Company classifies as goodwill the cost in excess of fair value of the net assets acquired in purchase transactions. The Company periodically evaluates the realizability of goodwill. Based upon its most recent analysis, no material impairment of goodwill exists at December 31, 1995.\n- 33 -\nINAMED CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(1) BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED\nINTANGIBLE AND LONG-TERM ASSETS, continued\nThe carrying value of long-term assets is periodically reviewed by management, and impairment losses, if any, are recognized when the expected nondiscounted future operating cash flows derived from such assets are less than their carrying value. In 1995, Statement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of\" (SFAS No. 121), was issued and was adopted by the Company for the year ended December 31, 1995. This statement requires that long-lived assets and certain identifiable intangible assets to be held and used be reviewed for impairment whenever events or changes in circumstances indicate the carrying amount of such assets may not be recoverable. The adoption of SFAS No. 121 did not have any impact on the financial position, results of operations, or cash flows of the Company.\nINCOME TAXES\nThe Company accounts for its income taxes using the liability method, under which deferred taxes 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 years in which the differences are expected to reverse. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized.\nNET INCOME\/LOSS PER SHARE\nNet income\/loss per share is computed using the weighted average number of shares outstanding, and when dilutive, common stock equivalents (stock options).\n- 34 -\nINAMED CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(1) BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED\nFOREIGN CURRENCY TRANSLATION\nThe functional currencies of the Company's foreign subsidiaries are their local currencies, and accordingly, the assets and liabilities of these foreign subsidiaries are translated at the rate of exchange at the balance sheet date. Revenues and expenses have been translated at the average rate of exchange in effect during the periods. Unrealized translation adjustments do not reflect the results of operations and are reported as a separate component of stockholders' (deficit) equity, while transaction gains and losses are reflected in the consolidated statement of operations. To date, the Company has not entered into hedging transactions to protect against changes in foreign currency exchange rates.\nRECENTLY ISSUED ACCOUNTING STANDARD\nIn October 1995, the Financial Accounting Standards Board issued SFAS No. 123, \"Accounting for Stock-Based Compensation.\" The accounting or disclosure requirements of this statement are effective for the Company's fiscal year 1996. The Company has not yet determined whether it will adopt the accounting requirements of this standard or whether it will elect only the disclosure requirements and continue to measure compensation expense using Accounting Principles Board Opinion No.25.\nRECLASSIFICATION\nCertain reclassifications were made to the 1993 and 1994 consolidated financial statements to conform to the 1995 presentation.\n- 35 -\nINAMED CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(2) INVENTORIES\nInventories are summarized as follows:\nDecember 31 --------------------------- 1995 1994 ---------- ---------- Raw materials $ 2,513,862 $ 2,187,689 Work in progress 3,773,579 3,268,947 Finished goods 12,167,768 9,873,664 ----------- ----------- $18,455,209 $15,330,300 Less allowance for obsolescence (759,362) (450,730) ----------- ----------- $17,695,847 $14,879,570 =========== ===========\n(3) INTANGIBLE ASSETS\nIntangible assets, at cost are summarized as follows:\nDecember 31 --------------------------- 1995 1994 ------------ --------- Customer lists $ 125,000 125,000 Organization and acquisition costs 251,539 237,814 Patents, trademarks and technology 2,585,961 2,585,961 Goodwill 1,785,451 1,841,234 Other 337,827 337,827 ------------ ---------- 5,085,778 5,127,836 Less accumulated amortization (3,426,852) (3,171,188) ------------ ---------- $1,658,926 1,956,648 ============ ==========\nEffective January 1994, the Company acquired the assets of Novamedic, S.A. The cost in excess of fair value of the net assets acquired of $797,294 is classified as goodwill.\n(4) LINES OF CREDIT\nAs of December 31, 1995 and 1994, the Company had outstanding borrowings in the amount of $328,366 and $718,366, respectively, under a $5,300,000 revolving line of credit agreement with a domestic bank which expired August 31, 1993 and was extended through March 31, 1996. The terms of the agreement required the Company to make monthly principal payments ($30,000 per month at December 31, 1995) and monthly interest payments at prime plus 2.5% per annum (11.0% per annum at December 31, 1995). Interest of $62,519, $105,417, and $203,186 was paid on the line of credit in 1995, 1994, and 1993, respectively. The line of credit is collateralized by the Company's domestic accounts receivable, inventories and certain other assets. In September 1994, the company entered into an agreement with the bank which deleted the financial covenants which had been part of the original line of credit agreement. In January, 1996, the obligation to the bank was satisfied.\n- 36 -\nINAMED CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(4) LINES OF CREDIT, CONTINUED\nThe Company's Dutch subsidiary has a line of credit with a major Dutch bank, totaling $1,540,000, which is collateralized by the accounts receivable, inventories and certain other assets of its Dutch subsidiary. The line of credit expires on March 31, 1996. As of December 31, 1995 and 1994, approximately $900,000 and $1,100,000, respectively, had been drawn on the line of credit. The interest rate on the line of credit is 7% per annum.\nThe Company's weighted average interest rate on short-term borrowings was 8.9% and 8.4% in 1995 and 1994, respectively.\nThe Company is currently seeking alternative lending sources from other financial institutions. However, no agreements have been finalized to replace the line of credit.\n(5) LONG-TERM DEBT\nLong-term debt is summarized as follows:\nThe aggregate installments of long-term debt as of December 31, 1995 are as follows:\nYear ending December 31: 1996 $ 51,735 1997 65,993 1998 23,444 -------- $141,172 ========\n(6) DEFERRED GRANT INCOME\nDeferred grant income represents grants received from the Irish Industrial Development Authority (IDA) for the purchase of capital equipment, and is amortized over the life of the related assets against the related depreciation expense. Amortization for the years ended December 31, 1995, 1994 and 1993 was approximately $78,000, $61,000, and $42,000, respectively.\nIn addition, for the years ended December 31, 1994 and 1993, respectively, approximately $125,000, and $225,000 was received for training grants. For the year ended December 31, 1993 approximately $41,000 was received for rent subsidy grants. This amount has been offset against the related expenses on the accompanying consolidated statements of operations.\n- 37 -\nINAMED CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(6) DEFERRED GRANT INCOME, CONTINUED\nThe Company has a contingent liability to the IDA for deferred grant income if certain conditions of the agreement with the IDA are not maintained.\n(7) INCOME TAXES\nIncome tax expense (benefit) at December 31, is summarized as follows:\n1995 1994 1993 ----------- --------- --------- Current: Federal $(2,267,198) 1,577,188 2,823,052 State (195,969) 310,816 934,374 Foreign 551,893 172,891 241,184 ----------- --------- --------- Total (1,911,274 2,060,895 3,998,610 ----------- --------- --------- Deferred: Federal $ 530,419 (70,778) 353,280 State (157,016) (39,984) 181,252 Foreign (144,928) 310,659 -- ----------- --------- --------- Total 228,475 199,897 534,532 ----------- --------- --------- $(1,682,799) 2,260,792 4,533,142 =========== ========= =========\n- 38 -\nINAMED CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(7) INCOME TAXES, CONTINUED\nThe primary components of temporary differences which comprise the Company's net deferred tax assets during 1995 and 1994 are as follows:\nDECEMBER 31, DECEMBER 31, 1995 1994 ---------- ---------- Deferred tax assets: Allowance for doubtful accounts $ 576,350 $ 203,113 Allowance for returns 2,895,564 2,102,447 Inventory reserves 90,090 36,159 Inventory capitalization 481,456 458,583 Accrued liabilities 599,605 666,117 Net operating losses 1,103,248 510,032 State taxes 2,554 165,114 Intangible assets 168,151 161,296 Litigation settlement 3,651,648 3,651,648 Tax credits 145,748 -- Other 8,322 16,023 ---------- ---------- Deferred tax assets 9,722,736 7,970,532 Valuation allowance (7,377,074) (5,000,080) ---------- ---------- Net deferred tax assets 2,345,662 2,970,452 ---------- ---------- Deferred tax liabilities: Depreciation and amortization (46,456) (33,210) Installment sale (358,584) (592,645) Other foreign (175,275) (335,026) ---------- ---------- Deferred tax liability (580,315) (960,881) ---------- ---------- Net deferred tax asset $1,765,347 $2,009,571 ========== ==========\nAlthough realization is not assured, management believes it is more likely than not that the net deferred tax asset is fully recoverable against taxes previously paid and thus no further valuation allowance for these amounts is required.\n- 39 -\nINAMED CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(7) INCOME TAXES, CONTINUED\nThe difference between actual tax expense (benefit) and the \"expected\" tax expense (benefit) computed by applying the Federal corporate tax rate of 34% for the years ended December 31, 1995, 1994 and 1993 is as follows:\nThe Company had net operating loss carryovers at the foreign companies aggregating approximately $2,260,000 at December 31, 1995 (based on exchange rates at that date), to be used by the individual foreign companies that incurred the losses. These net operating loss carryovers have various expiration dates. As of December 31, 1995, the Company had a net operating loss carryover of approximately $2,400,000 for California franchise tax purposes. These loss carryovers expire in 2000.\n(8) ROYALTIES\nThe Company has entered into various license agreements whereby the Company has obtained the right to produce, use and sell patented technology. The Company pays royalties ranging from 5% to 10% of the related net sales, depending upon sales levels. Royalty expense under these agreements was approximately $5,511,000, $4,326,000, and $3,352,000, for the years ended December 31, 1995, 1994 and 1993, respectively, and is included in marketing expense. The license agreements expire at the expiration of the related patents.\n- 40 -\nINAMED CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(9) STOCKHOLDERS' EQUITY\nThe Company has adopted several incentive and non-statutory stock option plans. Under the terms of the plans, 610,345 shares of common stock are reserved for issuance to key employees at prices generally not less than the market value of the stock at the date the options are granted, unless previously approved by the Board of Directors.\nActivity under these plans for the years ended December 31, 1995, 1994 and 1993 is as follows:\nThe exercise price of all options outstanding under the stock option plans range from $1.45 to $2.49 per share. At December 31, 1995, there were 114,754 shares available for future grant under these plans. Under certain plans, the Company granted options at $1.45, which was below the fair market value of the common stock at the date of grant. Accordingly, the Company is amortizing the difference between the fair market value and the exercise price of the related outstanding options over the vesting period of the options. Stock option compensation expense for the years ended December 31, 1995, 1994 and 1993 aggregated $9,000, $10,000, and $38,000, respectively.\nIn 1984, McGhan Medical Corporation adopted an incentive stock option plan (the 1984 plan). Under the terms of the plan, 100,000 shares of its common stock were reserved for issuance to key employees at prices not less than the market value of the stock at the date the option is granted. In 1985, INAMED Corporation agreed to substitute options to purchase its shares (on a two-for-one basis) for those of McGhan Medical Corporation. 80,000 options were granted under this plan during 1995.\nIn 1986, the Company adopted an incentive and nonstatutory stock option plan (the 1986 plan). Under the terms of the plan, 300,000 shares of common stock have been reserved for issuance to key employees. No options were granted under this plan during 1995.\nIn 1987, the Company also adopted an incentive stock award plan. Under the terms of this plan, 300,000 shares of common stock were reserved for issuance to employees at the discretion of the Board of Directors. The Directors awarded 11,800 shares in 1995 and 11,600 shares in 1994 with aggregate values of $29,500 and $29,000,\n- 41 -\nINAMED CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(9) STOCKHOLDERS' EQUITY, CONTINUED\nrespectively. No shares were awarded in 1993. At December 31, 1995, there were 119,612 shares available for future grant under this plan.\nThe Company has a stock appreciation rights plan that became effective in 1989. Under the terms of this plan, 500,000 shares of common stock were reserved for issuance to employees at the discretion of the Board of Directors. In 1992, the Directors granted 250,000 shares each to the two Officers\/Directors of the Company; these were exercised in 1992.\nIn 1993 the Company adopted a Non-employee Director Stock Option Plan which authorized the Company to issue up to 150,000 shares of common stock to directors who are not employees of or consultants to the Company and who are thus not eligible to receive stock option grants under the Company's stock option plans. Pursuant to the Plan, each non-employee director is automatically granted an option to purchase 5,000 shares of common stock on the date of his or her initial appointment or election as a director, and an option to purchase an additional 5,000 shares of common stock on each anniversary of his or her initial grant date on which he or she is still serving as a director. The exercise price per share is the fair market value per share on the date of grant. As of December 31, 1995 no options were granted under this plan.\n(10) FOREIGN SALES INFORMATION\nNet sales to customers in foreign countries for the years ended December 31, 1995, 1994 and 1993 represented the following percentages of net sales:\n1995 1994 1993 ------ ------ ------- Europe 22.3% 21.5% 14.3% Asia - Pacific Rim 3.5 2.7 3.1 IberoLatinoAmerica 5.4 1.4 1.4 Other 0.3 0.7 0.7 ------- ------- ------- 31.5% 26.3% 19.5% ======= ======= =======\n(The IberoLatinoAmerican classification above includes Central America, South America, Spain, and Portugal.)\n- 42 -\nINAMED CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(11) GEOGRAPHIC SEGMENT DATA\nThe following table shows net sales, operating income (loss) and identifiable assets by geographic segment for the years ended December 31, 1995, 1994, and 1993:\n1995 1994 1993 ----------- ---------- ---------- Net sales: United States $55,881,262 59,196,401 59,943,525 International 25,744,319 21,188,941 14,554,421 ----------- ---------- ---------- $81,625,581 80,385,342 74,497,946 =========== ========== ========== Operating income (loss): United States $(7,601,277) 4,717,154 (4,304,047) International (1,588,628) (1,139,129) 832,540 ----------- ---------- ---------- $(9,189,905) 3,578,025 (3,471,507) =========== ========== ========== Identifiable assets: United States $25,976,480 29,337,456 27,618,672 International 24,408,464 18,472,945 10,238,633 ----------- ---------- ---------- $50,384,944 47,810,401 37,857,305 =========== ========== ==========\n(12) RELATED PARTY TRANSACTIONS\nIncluded in assets is an unsecured note receivable from an officer of the Company. This receivable approximated $386,000 and $688,000 as of December 31, 1995 and 1994, respectively. The note bears interest at 9.5% per annum and is due in June 1996. The note is primarily for various personal activities and certain relocation allowances. On March 4, 1996, the officer paid the balance of the note in full.\nIncluded in liabilities are notes payable to an officer of the Company and to a corporation in which an officer is the chief executive officer. These payables approximated $1,209,000 and $421,000 as of December 31, 1995 and 1994, respectively. The notes bear interest at prime plus 2% per annum (10.5% per annum at December 31, 1995) and are due June 30, 1996, or on demand. The Company paid the balance of these notes in full on January 25, 1996. Also included in liabilities is a note payable of approximately $550,000 to an officer of INAMED, S.A. in connection with the Company's acquisition of this subsidiary. Final payment on this note was made on February 6, 1996.\nDuring 1992, the Company entered into a lease arrangement with an entity controlled by an officer of the Company for rental of an aircraft to provide transportation between Company facilities for corporate purposes. The minimum rental through December 31, 1993 was $95,000 per month. In January 1994 this lease was renegotiated to a month-to-month arrangement with a monthly rent of $74,000 during 1994. Rent expense for 1995, 1994 and 1993 was $900,000, $888,000, and $1,260,000, respectively. In February 1995, the Company received a credit voucher from the carrier for $800,000. This amount represents payments made during 1994 in excess of actual rent and has been included in other current assets at December 31, 1994. At December 31, 1995, the credit voucher had an outstanding balance of $107,670. This balance was paid to the Company on March 11, 1996. The lease arrangement was terminated effective December 31, 1995.\n- 43 -\nINAMED CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(13) EMPLOYEE BENEFIT PLANS\nEffective January 1, 1990, the Company adopted a 401(k) Defined Contribution Plan for all U.S. employees. After six months of service, employees become eligible to participate in the Plan. Participants may contribute to the plan up to 20% of their compensation annually, subject to the limitations in the Internal Revenue Code. The Company can match contributions equal to 10% of each participant's contribution, limited to 5% of the participant's compensation. The participants are 100% vested in their own contributions and vesting in the Company's contributions is based on years of credited service. Participants become 100% vested after five years of credited service. The Company's contributions to the plan amounted to $0, $0, and $96,519 for the years ended December 31, 1995, 1994, and 1993, respectively.\nEffective January 1, 1990, a certain subsidiary adopted a Defined Benefit Plan for all employees. After one year of service, employees become eligible to participate in the plan. Employees in active employment on January 1, 1990 were immediately eligible. Plan benefits, including pension upon retirement or complete disability, are based on an employee's years of service and average compensation prior to retirement. Participants share in the cost of the plan by making contributions of 3% to 5% of the pension basis. The funding policy is to pay the accrued pension contribution currently. Contributions to the defined benefit pension plan approximated $75,000, $49,000, and $55,000 for the years ended December 31,1995, 1994, and 1993, respectively.\nEffective February 1, 1990, a certain subsidiary adopted a Defined Contribution Plan for all non-production employees. Upon commencement of service, employees become eligible to participate in the plan and may contribute to the plan up to 5% of their compensation. The Company's matching contribution is equal to 200% of the participant's contribution. The employee is immediately and fully vested in the Company's contribution. The Company's contributions to the plan approximated $198,000, $144,000, and $77,000 for the years ended December 31, 1995, 1994, and 1993, respectively.\nEffective January 1, 1991, a certain subsidiary adopted a Defined Benefit Plan for all employees. After one year of service, employees become eligible to participate in the plan. Plan benefits, including pension upon retirement or complete disability, are based on an employee's years of service and average compensation prior to retirement. Participants share in the cost of the plan by making contributions of 2% to 3% of the pension basis. The funding policy is to pay the accrued pension contribution currently. Contributions to the defined benefit pension plan approximated $17,000, $14,000,and $15,000 for the years ended December 31, 1995, 1994, and 1993, respectively.\nEffective February 1, 1991, a certain subsidiary adopted a Defined Benefit Plan for all employees. After one year of service, employees become eligible to participate in the plan. Plan benefits, including additional pension upon retirement or complete disability, are based on an employee's years of service and average compensation prior to\n- 44 -\nINAMED CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(13) EMPLOYEE BENEFIT PLANS, CONTINUED\nretirement. Participants do not share in the cost of the plan. The funding policy is to pay the accrued pension contribution currently. The Company's contributions to the plan approximated $24,000, $10,000, and $12,000 for the years ended December 31, 1995, 1994, and 1993, respectively.\nEffective July 1, 1992, a certain subsidiary adopted a Defined Contribution Plan for all employees. After six months of service, employees become eligible to participate in the plan. They may contribute to the plan up to 5% of their compensation. The Company's matching contribution is equal to 100% of the participant's contribution. The employee is immediately and fully vested in the Company's contribution. The Company's contributions to the plan approximated $9,000, $7,000, and $6,000 for the years ended December 31, 1995, 1994 and 1993, respectively.\nEffective July 1, 1993, a certain subsidiary adopted a Defined Benefit Plan for all employees. After one year of service, employees become eligible to participate in the plan. Plan benefits, including pension upon retirement or complete disability, are based on an employee's years of service and average compensation prior to retirement. Participants do not share in the cost of the plan. The funding policy is to pay the accrued pension contribution currently. The Company's contributions to the plan approximated $15,000 and $12,000 for the years ended December 31, 1995 and 1994, respectively.\nEffective January 1, 1995, a certain subsidiary adopted a Defined Benefit Plan for all employees. After one year of service, employees become eligible to participate in the plan. The Company contributes 7% of the employees' fixed salaries. The Company's contributions to the plan approximated $15,000 for the year ended December 31, 1995.\nEffective January 1, 1995, a certain subsidiary adopted a Defined Contribution Plan for non-production employees. Upon commencement of service, these employees become eligible to participate in the plan. They may contribute to the plan up to 5% of their compensation. The Company's matching contribution is equal to 10% of the participant's contribution. The employee is immediately and fully vested in the Company's contribution. The Company's contribution to the plan approximated $17,000 for the year ended December 31, 1995.\n(14) LITIGATION\nINAMED and\/or its subsidiaries are defendants in numerous State court actions and a Federal class action in the United States District Court, Northern District of Alabama, Southern Division, under Chief Judge Sam C. Pointer, Jr., U.S. District Court, regarding Master File No. C892-P-10000-S (Silicone Gel Breast Implants Product Liability Litigation MDL 926). The claims are for general and punitive damages substantially exceeding provisions made in the Company's consolidated financial statements. The accompanying consolidated financial statements have been prepared assuming that the Company will withstand the financial results of said litigation.\nSeveral U.S. based manufacturers negotiated a settlement with the Plaintiffs' Negotiating Committee (\"PNC\"), and on March 29, 1994 filed a Proposed Non-Mandatory Class Action Settlement in the Silicone Breast Implant Products Liability (the \"Settlement Agreement\") providing for settlement of the claims as to the class (the \"Settlement\") as described in the Settlement Agreement. The Settlement Agreement provides for resolution of any existing or future claims, including claims for injuries not yet known, under any Federal or State law, from any claimant who received a silicone breast implant prior to June 1, 1993. A fairness hearing for the non-mandatory class was held before Judge Pointer on August 18, 1994. On September 1, 1994, Judge Pointer gave final approval to the non-mandatory class action settlement.\n- 45 -\nINAMED CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(14) LITIGATION, CONTINUED\nThe Company was not originally a party to the Settlement Agreement. However, on April 8, 1994 the Company and the PNC reached an agreement which would join the Company into the Settlement. The agreement reached between the Company and the PNC added great value to the Settlement by enabling all plaintiffs and U.S. based manufacturers to participate in the Settlement, and facilitating the negotiation of individual contributions by the Company, Minnesota Mining and Manufacturing Company (\"3M\"), and Union Carbide Corporation which total more than $440 million.\nUnder the terms of the Settlement Agreement, the parties stipulate and agree that all claims of the Settlement Class against the Company regarding breast implants and breast implant materials shall be fully and finally settled and resolved on the terms and conditions set forth in the Settlement Agreement.\nUnder the terms of the Settlement Agreement, the Company will pay $1 million to the Settlement fund for each of 25 years starting three years after Settlement approval by the Court. The Company recorded a pre-tax charge of $9.1 million in the fourth quarter of 1993. The charge represents the present value (discounted at 8%) of the Company's settlement of $25 million over a payment period of 25 years.\nUnder the Settlement, $1.2 billion had been provided for \"current claims\" (disease compensation claims). In May 1995, Judge Pointer completed a preliminary review of current claims which had been filed as of September 1994, in compliance with deadlines set by the court. Judge Pointer determined that based on the preliminary review, it appears that projected amounts of eligible current claims exceed the $1.2 billion provided in the Settlement. The Settlement provided that in the event of such over subscription, the amounts to be paid to eligible current claimants would be reduced and claimants would have a right to \"opt-out\" of the Settlement at that time.\nOn October 1, 1995, Judge Pointer finalized details of a scaled-back breast implant injury settlement involving defendants Bristol-Myers Squibb, Baxter International, and 3M, allowing plaintiffs to reject this settlement and file their own lawsuits if they believe payments are too low. On November 14, 1995, McGhan Medical and Union Carbide were added to this list of settling defendants to achieve the Bristol, Baxter, 3M, McGhan and Union Carbide Revised Settlement Program (the \"Revised Settlement Program\").\nAt December 31, 1995, the Company's reasonable estimate of its liability to fund the Revised Settlement Program is a range between $9.1 million, the original estimate as noted above, and $50 million, with no amount within the range a better estimate. Due to the uncertainty of the ultimate resolution and acceptance of the Revised Settlement Program by the PNC, as well as a lack of information related to the total claims, the financial statements do not reflect any additional provision for the litigation settlement.\nThe Company has opposed the plaintiffs' claims in these complaints and other similar actions, and continues to deny any wrongdoing or liability to the plaintiffs of any kind. However, the extensive burdens and expensive litigation the Company would continue to incur related to these matters prompted the Company to work toward and enter into the Revised Settlement Agreement which insures a more satisfactory method of resolving claims of women who have received the Company's breast implants.\nManagement's commitment to the Settlement does not alter the Company's need for complete resolution sought under a mandatory (\"non-opt-out\") settlement class (the \"Mandatory Class\"). Therefore, the Company has petitioned the United States District Court, Northern District of Alabama, Southern Division, for certification of a Mandatory Class under the provisions of Federal Rule of Civil Procedure.\n- 46 -\nINAMED CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(14) LITIGATION, CONTINUED\nThe Company was a defendant with 3M in a case involving three plaintiffs in Houston, Texas, in March 1994, in which the jury awarded the plaintiffs $15 million in punitive damages and $12.9 million in damages plus fees and costs. However, the decision was reversed in March 1995 resulting in no financial responsibility on the part of the Company.\n(15) COMMITMENTS AND CONTINGENCIES\nThe Company leases facilities under operating leases. The leases are generally on an all-net basis, whereby the Company pays taxes, maintenance and insurance. Leases that expire are expected to be renewed or replaced by leases on other properties. Rent expense for the years ended December 31, 1995, 1994 and 1993 aggregated $4,927,677, $4,913,327, and $4,040,430, respectively.\nMinimum lease commitments under all noncancelable leases as of December 31, 1995 are as follows:\nYear ending December 31: 1996 $ 3,068,534 1997 1,831,633 1998 1,548,876 1999 1,291,402 2000 1,086,974 Thereafter 9,899,150 ----------- $18,726,569 =========== (16) SALE OF SUBSIDIARIES\nAs of August 31, 1993, the Company announced the sale of its wholly-owned subsidiary, Specialty Silicone Fabricators, Inc. (SSF), a manufacturer of silicone components for the medical device industry with production facilities in Paso Robles, California. The sale included SSF's wholly- owned subsidiary, Innovative Surgical Products, Inc. located in Santa Ana, California, which assembles, packages and sterilizes products for other medical device companies. The Company received total consideration of approximately $10.8 million from the buyer, Innovative Specialty Silicone Acquisition Corporation (ISSAC), a private investment group which included certain members of SSF's management.\nThe consideration consisted of $2.7 million in cash, the forgiveness of $2.2 million in intercompany notes due to SSF, and $5.9 million in structured notes with various terms, due through August 31, 2003. The notes bear interest ranging from 6% to 10% per annum and have been reflected on the balance sheet net of a discount of $643,663 and settlement of certain intercompany amounts totaling approximately $957,000. The notes are collateralized by all of the assets of ISSAC. The Company has filed a UCC1 and its position is subordinated only to that of ISSAC's primary lender.\nAt December 31, 1995, the current portion due from ISSAC under the terms of the note agreement is in dispute. The Company has classified all current amounts due as long-term and an estimated provision for credit loss has been provided for in the financial statements.\n(17) SUBSEQUENT EVENT\nIn January 1996, the Company completed a private placement offering by issuing three-year secured convertible, non-callable notes due March 31, 1999 bearing an interest rate of 11%. The Company received $35 million in proceeds from the offering to be used for the anticipated litigation settlement, for capital investments and improvements to expand production capacity, and for working capital purposes. Of the proceeds received from the offering, $15 million is held in an escrow account to be released upon the granting and court approval of mandatory class certification. At December 31, 1995 proceeds of approximately $500,000 were received and classified as a current liability. The notes are collateralized by all the assets of the Company.\nThe notes become convertible into shares of common stock at the option of the noteholders on April 22, 1996. The conversion rate is one share of common stock for each $10 principal amount of notes. Alternatively, the notes may automatically convert into shares of common stock upon the occurrence of certain events in connection with the certification of the Company's Mandatory Class.\nUnder the terms of the note agreement, the Company may obtain up to $5 million in structured debt or make an equity offering without restriction. However, the terms of the note agreement restrict the Company's ability to make a debt offering.\n- 47 -\nINAMED CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(18) QUARTERLY SUMMARY OF OPERATIONS (UNAUDITED)\nThe following is a summary of selected quarterly financial data for 1995 and 1994:\nSIGNIFICANT FOURTH QUARTER ADJUSTMENTS, 1995\nDuring the fourth quarter of the year ended December 31, 1995, significant adjustments to the results of operations were as follows:\nProvision for income taxes $(4,162,607) Provision for doubtful accounts and returns and allowances 1,424,734 Compensation expense 891,200 - 48 -\nINAMED CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(18) QUARTERLY SUMMARY OF OPERATIONS (UNAUDITED), CONTINUED\nSignificant Fourth Quarter Adjustments, 1994\nDuring the fourth quarter of the year ended December 31, 1994, significant adjustments to the results of operations were as follows:\nProvision for income taxes $(3,396,858) Provision for doubtful accounts and returns and allowances 546,054 Provision for inventory obsolescence 221,590 Provision for product liability 1,123,605 Rental expense (800,000) Royalty income (325,301) Compensation expense 187,500\n- 49 -\nITEM 9.","section_7A":"","section_8":"","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND DISCLOSURE.\nNot applicable.\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nThe following table sets forth the names of the directors and executive officers of the Company, together with their ages and positions. There are no family relationships among these directors and officers.\nName Age Position ----- ---- --------\nDonald K. McGhan 62 Chairman of the Board and President\nMichael D. Farney 52 Chief Executive Officer, Chief Financial Officer, Treasurer and Secretary\nDONALD K. MCGHAN\nMr. McGhan has served as Chairman of the Board of INAMED since October 1985 and President of INAMED since January 1987. He served as Chief Executive Officer of INAMED from April 1987 until June 1992. He is also Chairman of the Board of McGhan Medical Corporation, INAMED Development Company, BioEnterics Corporation, Biodermis Corporation, Bioplexus Corporation, Flowmatrix Corporation, Medisyn Technologies Corporation, McGhan Limited, INAMED B.V., INAMED B.V.B.A., INAMED GmbH., INAMED S.R.L., INAMED Ltd., INAMED, S.A., INAMED SARL, INAMED Japan, and INAMED Medical Group (Japan).\nMICHAEL D. FARNEY\nMr. Farney has served as Chief Financial Officer and Treasurer of INAMED since April 1987. He was appointed Chief Executive Officer and Secretary of INAMED Corporation in 1992. He also serves as Chief Executive Officer and Chief Financial Officer of McGhan Medical Corporation, INAMED Development Company, BioEnterics Corporation, Biodermis Corporation, Bioplexus Corporation, Flowmatrix Corporation, Medisyn Technologies Corporation, McGhan Limited, INAMED B.V., INAMED B.V.B.A., INAMED GmbH., INAMED S.R.L., INAMED Ltd., INAMED, S.A., and INAMED SARL. He is also a Director of INAMED Japan and INAMED Medical Group (Japan).\n- 50 -\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe Company has no standing Compensation Committee of the Board of Directors.\nThe Company believes that executive compensation should be closely related to the value delivered to shareholders. This belief has been adhered to by developing incentive pay programs which provide competitive compensation and reflect Company performance. Both short-term and long-term incentive compensation are based on Company performance and the value received by shareholders.\nCOMPENSATION PHILOSOPHY\nIn designing its compensation program, the Company follows its belief that compensation should reflect the value created for shareholders while supporting the Company's strategic business goals. In doing so, the compensation programs reflect the following themes:\n- Compensation should encourage increased stockholder value.\n- Compensation programs should support the short and long-term strategic business goals and objectives of the Company.\n- Compensation programs should reflect and promote the Company's values, and reward individuals for outstanding contributions toward business goals.\n- Compensation programs should enable the Company to attract and retain highly qualified professionals.\nCOMPENSATION MAKE-UP AND MEASUREMENT\nThe Company's executive compensation is based on three components, base salary, short-term incentives and long-term incentives, each of which is intended to serve the overall compensation philosophy.\nBASE SALARY\nThe Company's salary levels are intended to be consistent with competitive pay practices and level of responsibility, with salary increases reflecting competitive trends, the overall financial performance of the Company, general economic conditions as well as a number of factors relating to the particular individual, including the performance of the individual executive, and level of experience, ability and knowledge of the job.\nSHORT-TERM INCENTIVES\nAt the start of each fiscal year, target levels of pre-tax profits and revenue growth are established by senior management of the Company during the budgeting process and approved by the Board of Directors. An incentive award opportunity is established for each employee based on the employee's level of responsibility, potential contribution, the success of the Company and competitive conditions. Generally, approximately 25% of an executive's potential bonus relates to his or her achievement of personal objectives and 75% relates to the Company's achievement of its pre-tax profit and revenue goals.\nThe employee's actual award is determined at the end of the fiscal year based on the Company's achievement of its pre-tax profit and revenue goals and an assessment of the employee's individual performance, including achievement of personal objectives. This ensures that individual awards reflect an individual's specific contributions to the success of the Company.\n- 51 -\nStock options are granted from time to time to reward key employees' contributions. The grant of options is based primarily on a key employee's potential contribution to the Company's growth and profitability. Options are granted at an in-the-money option price of $1.45 per share, and will increase in value if the Company's stock price increases above that price. An in-the-money option is an option which has an exercise price for the common stock which is lower than the fair market value of the common stock on a specified date. Generally, grants of options vest over seven years and employees must be employed by the Company for such options to vest.\nEMPLOYMENT, SEVERANCE, AND CHANGE OF CONTROL AGREEMENTS\nThe Company has entered into employment agreements with a number of key personnel for various contract periods. Each of the contracts grants the Board of Directors of the Company the right to increase the employee's base salary and provides for other specified forms of compensation.\nSTOCK OPTION PLANS\nIn 1984, McGhan Medical Corporation adopted an incentive stock option plan (the 1984 plan). Under the terms of the plan, 100,000 shares of its common stock were reserved for issuance to key employees at prices not less than the market value of the stock at the date the option is granted. In 1985, INAMED Corporation agreed to substitute options to purchase its shares (on a two-for- one basis) for those of McGhan Medical Corporation. 80,000 options were granted under this plan during 1995.\nIn 1986, the Company adopted an incentive and nonstatutory stock option plan (the 1986 plan). Under the terms of the plan, 300,000 shares of common stock have been reserved for issuance to key employees. No options were granted under this plan during 1995.\nSTOCK AWARD PLAN\nIn 1987, the Board of Directors adopted a stock award plan (the 1987 plan) whereby 300,000 shares of the Company's common stock were reserved for issuance to selected employees of the Company. The plan was adopted to further the Company's growth, development and financial success by providing additional incentives to employees by rewarding them for their performance and providing them the opportunity to become owners of common stock of the Company, and thus to benefit directly from its growth, development and financial success. Shares are awarded under the plan to employees as selected by a committee appointed by the Board of Directors to administer the plan. Stock awards totaling 180,388 have been granted as of December 31, 1995.\n- 52 -\nSTOCK APPRECIATION RIGHTS PLAN\nThe Company has approved a stock appreciation rights (SAR) plan whereby key employees may be issued cash or common stock based on the increase in the stock value. The plan was adopted in 1988 by the Board of Directors. As of December 31, 1992, 500,000 shares had been granted under the SAR. At December 31, 1995 and during the year then ended, there were no SARs which were outstanding.\nSUMMARY COMPENSATION TABLE\nThe following table sets forth information with respect to the compensation of the Company's executive officers for services in all capacities to the Company in 1993, 1994 and 1995:\n_________________\n(1) Mr. Ehrens commenced employment with the Company on May 1, 1992 , and terminated employment with the Company in September of 1994.\n(2) During 1993 the Company made matching contributions to the employee savings plan under Section 401(k) of the Internal Revenue Code in the following amounts: Mr. McGhan, $1,745; Mr. Farney, $1,745; Mr. Ehrens, $1,745.\nTABLE OF STOCK OPTION EXERCISES IN 1995 AND YEAR-END OPTION VALUES\nNot applicable.\n- 53 -\nCOMPARISON OF TOTAL SHAREHOLDER RETURN\nThe following graph sets forth the Company's total shareholder return as compared to the NASDAQ Market Index and the Standard & Poor's Medical Products and Supplies Index over the period from December 31, 1990 until December 31, 1995. The total shareholder return assumes $100 invested at December 31, 1990 in the Company's Common Stock, the NASDAQ Market Index and the Standard & Poor's Medical Products and Supplies Index. It also assumes reinvestment of all dividends.\nCOMPARISON OF 5-YEAR CUMULATIVE RETURN\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe following table sets forth information as to the shares of common stock owned as of March 28, 1996, by (i) each person who, insofar as the Company has been able to ascertain, beneficially owned more than five percent of the outstanding common stock of the Company, (ii) each director, and (iii) all the directors and officers as a group. Unless otherwise indicated in the footnotes following the table and subject to community property laws where applicable, the person(s) as to whom the information is given had sole voting and investment power over the shares of common stock shown as beneficially owned.\nName of Beneficial Owner or Identity Number Percent of Group(1) of Shares of Class --------------- --------- -------- Donald K. McGhan 1,221,829(2) 16.1% Michael D. Farney 344,285 4.5% All officers and directors as a group 1,566,114 20.6%\n- ---------------- (1) Unless otherwise noted, the business address of all individuals listed in the table is 3800 Howard Hughes Parkway, Suite 900, Las Vegas, Nevada 89109.\n(2) Includes 207,310 shares of common stock owned by Shirley M. McGhan, the wife of Donald K. McGhan, as to which Mr. McGhan disclaims beneficial ownership; 107,935 shares owned by a corporation of which Mr. McGhan is the president; and 270,980 shares owned by a limited partnership of which Mr. McGhan is the general partner.\n- 54 -\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nIncluded in assets is a note receivable from an officer of the Company. The total amount of this receivable approximated $386,000 and $688,000 as of December 31, 1995 and 1994, respectively. The note bears interest ranging from 8% to 10% per annum and is due in June, 1996. On March 4, 1996, the officer paid the balance of the note in full.\nIncluded in liabilities are notes payable to an officer and to a corporation in which an officer is the chief executive officer. These payables approximated $1,209,000 and $421,000 as of December 31, 1995 and 1994, respectively. The notes bear interest at prime plus 2% per annum (10.5% per annum at December 31, 1995) and are due June 30, 1996, or on demand. The Company paid these notes in full on January 25, 1996. Also included in liabilities is a note payable of $550,000 to an officer of INAMED, S.A. in connection with the Company's acquisition of this subsidiary. Final payment on this note was made on February 6, 1996.\nDuring 1995, the Company incurred fees in the amount of $900,000, or $75,000 per month, for services rendered by an entity controlled by an officer\/director of the Company. In February 1995, the Company received a credit voucher from this entity for $800,000. This amount represented payments made during 1994 in excess of actual rent and was included in other current assets at December 31, 1994. At December 31, 1995, the credit voucher had an outstanding balance of $107,670. This balance was paid to the Company on March 11, 1996. The lease arrangement was terminated effective December 31, 1995.\n- 55 -\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(a)(1) CONSOLIDATED FINANCIAL STATEMENTS: PAGE(S) --------------------------------- ------ Report of Independent Accountants 26 Consolidated Balance Sheets as of December 31, 1995, and 1994 27-28 Consolidated Statements of Operations for the years ended December 31, 1995, 1994 and 1993 29 Consolidated Statements of Stockholders' Equity for the years ended December 31, 1995, 1994, and 1993 30 Consolidated Statements of Cash Flows for the years ended December 31, 1995, 1994 and 1993 31-33 Notes to Consolidated Financial Statements 34-51\n(a)(2) CONSOLIDATED FINANCIAL STATEMENT SCHEDULES:\nSchedule II - Valuation and Qualifying Accounts 59\nAll other schedules are omitted because 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 given in the consolidated financial statements or notes thereto.\n(a)(3) EXHIBITS:\n3.1 Registrant's Articles of Incorporation 3.2 Registrant's Bylaws 10.1 Stock Option Plan, together with form of Incentive Stock Option Agreement and Nonstatutory Stock Option Agreement 10.2 Stock Award Plan 10.3 Non-Employee Directors' Stock Option Plan 21 Registrant's Subsidiaries 23.1 Consent of Independent Accountants 27 Financial Data Schedule\n(b) REPORTS ON FORM 8-K:\nNone\n- 56 -\nSCHEDULE II\nINAMED CORPORATION AND SUBSIDIARIES\nVALUATION AND QUALIFYING ACCOUNTS\nYears ended December 31, 1995, 1994 and 1993\n- 57 -\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.\nINAMED CORPORATION\nBy \/s\/ MICHAEL D. FARNEY ------------------------------- Michael D. Farney Chief Executive 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 Registrant in the capacities and on the dates indicated:\n- 58 -\nSUBSIDIARIES OF INAMED CORPORATION\nState\/Country of Name Incorporation ---- ---------------- BIODERMIS CORPORATION Nevada BIODERMIS LTD. Ireland BIOENTERICS CORPORATION California BIOENTERICS LTD. Ireland BIOPLEXUS CORPORATION Nevada BIOPLEXUS LTD. Ireland CHAMFIELD LTD. Ireland CUI CORPORATION California FLOWMATRIX CORPORATION Nevada INAMED B.V. The Netherlands INAMED B.V.B.A. Belgium INAMED DEVELOPMENT COMPANY California INAMED do BRASIL, LTDA Brazil INAMED GmbH Germany INAMED LTD. United Kingdom INAMED JAPAN Nevada INAMED MEDICAL GROUP Japan INAMED, S.A. Spain INAMED S.A.R.L. France INAMED S.R.L. Italy McGHAN LTD. Ireland McGHAN MEDICAL CORPORATION California McGHAN MEDICAL ASIA PACIFIC Hong Kong MEDISYN TECHNOLOGIES CORPORATION Nevada MEDISYN TECHNOLOGIES LTD. Ireland\nEXHIBIT 23.1\nCONSENT OF INDEPENDENT ACCOUNTANTS\nWe consent to the incorporation by reference in the registration statement of INAMED Corporation on Form S-3 filed on March 29, 1996 (File No. 33- ) of our report dated March 28, 1996, on our audits of the consolidated financial statements and consolidated financial statement schedule of INAMED Corporation as of December 31, 1995 and 1994, and for the years ended December 31, 1995, 1994, and 1993, which report is included in this Annual Report on Form 10-K.\n\/s\/ Coopers & Lybrand L.L.P.\nLas Vegas, Nevada March 28, 1996","section_15":""}
{"filename":"829547_1995.txt","cik":"829547","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"Item 3. Legal Proceedings\n\t None.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\n\t None.\nPart II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Stockholder \t Matters\na) There is no established trading market for the certificates \t representing ownership of the beneficial interest in the Trust.\nb) As of March 29, 1996 there were two holders of certificates \t representing ownership of the beneficial interest in the Trust.\nItem 8.","section_6":"","section_7":"","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\n\t See attached audited financial statements.\nItem 9.","section_9":"Item 9. Disagreements on Accounting and Financial Disclosure\n\t None.\nPart III\nItem 13.","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"Item 13. Certain Relationships and Related Transactions\n\t None.\nPart IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports \t on Form 8-K\na) The following documents are filed as part of this report:\n\t 1. Financial Statements \t Report of Independent Public Accountants \t Statement of Assets and Liabilities as of \t\tDecember 31, 1995 and 1994 \t Statement of Income and Expenses, for the Years Ended \t\tDecember 31, 1995, 1994 and 1993 \t Statement of Cash Flows, for the Years Ended \t\tDecember 31, 1995, 1994 and 1993 \t Notes to Financial Statements\n\t 2. Financial Statement Schedules are omitted because they are \t inapplicable.\n\t 3. Exhibits\n\t Exhibit \t Number Description of Exhibit\n\t\t4.1 Form of Trust Agreement, including the form of \t\t\t Rural Electric Cooperative Grantor Trust \t\t\t Certificate (incorporated by reference to Exhibit \t\t\t 4.1 to Registration Statement on Form S-1 [No. 33- \t\t\t 20166]).\n\t 10.1 Loan Agreement (incorporated by reference to \t\t\t Exhibit 10.1 to Registration Statement on Form S-1 \t\t\t [No. 33-20166]).\n\t 10.2 Loan Guarantee and Servicing Agreement \t\t\t (incorporated by reference to Exhibit 10.2 to \t\t\t Registration Statement on Form S-1 [No. 33-20166]).\nb) Form 8-K dated December 20, 1995. \t Semi-annual Report to Certificateholders dated December 15, 1995.\nSupplemental information to be furnished with reports filed pursuant to Section 15(d) of the Act by Registrants which have not registered securities pursuant to Section 12 of the Act.\nNo annual report, proxy statement, form of proxy or other proxy soliciting material has been sent to Certificateholders, and the Registrant does not presently contemplate sending any such material subsequent to the filing of this report.\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, in the County of Fairfax, Commonwealth of Virginia on the 29th day of March, 1996.\n\t RURAL ELECTRIC COOPERATIVE GRANTOR TRUST (TEX-LA) 1988 T-1\n\t By: NATIONAL RURAL UTILITIES COOPERATIVE \t\t FINANCE CORPORATION as Servicer\n\t\t By: \/s\/ Sheldon C. Petersen \t\t\t Sheldon C. Petersen, Governor and \t\t\t Chief Executive Officer\n\t\t RURAL ELECTRIC COOPERATIVE GRANTOR \t\t\t TRUST (TEX-LA) 1988-T1\n\t FINANCIAL STATEMENTS AS OF DECEMBER 31, 1995, 1994 AND 1993 \t\t\tTOGETHER WITH AUDITORS' REPORT\n\t\t Report of Independent Public Accountants\nTo the Trustee of Rural Electric Cooperative Grantor Trust (Tex-La) 1988-T1, and\nTo the Board of Directors of National Rural Utilities Cooperative Finance Corporation\nWe have audited the accompanying statements of assets and liabilities of Rural Electric Cooperative Grantor Trust (Tex-La) 1988-T1 as of December 31, 1995 and 1994, and the related statements of income and expenses and cash flows for each of the three years in the period ended December 31, 1995. These financial statements are the responsibility of the Trust's management. Our responsi- bility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform 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 Rural Electric Cooperative Grantor Trust (Tex-La) 1988-T1 as of December 31, 1995 and 1994, and its operations and its cash flows for the years ended December 31, 1995, 1994 and 1993, in conformity with generally accepted accounting principles.\nMarch 11, 1996 \/s\/ Arthur Andersen LLP Washington, D. C.\n\t RURAL ELECTRIC COOPERATIVE GRANTOR TRUST (TEX-LA) 1988-T1\n\t\t STATEMENTS OF ASSETS AND LIABILITIES\n\t\t AS OF DECEMBER 31, 1995 AND 1994\n\t\t\t\t\t\t1995 1994\nA S S E T S\nInterest Receivable $ 86,689 $94,601\nNote Receivable 12,325,000 13,450,000\nTotal Assets $12,411,689 $13,544,601\nL I A B I L I T I E S\nInterest Payable - Grantor Trust $ 84,118 $ 91,796 Certificates\nServicer Fees Payable 2,571 2,805\nRural Electric Cooperative Grantor Trust Certificates 12,325,000 13,450,000\nTotal Liabilities $12,411,689 $13,544,601\n\tRURAL ELECTRIC COOPERATIVE GRANTOR TRUST (TEX-LA) 1988-T1\n\t\t NOTES TO FINANCIAL STATEMENTS\n\t\t DECEMBER 31, 1995, 1994 AND 1993\n1. ORGANIZATION AND OPERATIONS\nRural Electric Cooperative Grantor Trust (Tex-La) 1988-T1 (the \"Trust\") was formed under a Trust Agreement dated February 15, 1988 among National Rural Utilities Cooperative Finance Corporation (\"CFC\"), Tex-La Electric Cooperative of Texas, Inc. (the \"Cooperative\") and The First National Bank of Chicago (the Trustee\"). On that date, CFC made a loan to the Cooperative which issued a note (the \"Note\"), evidencing the borrowing, to the Trust. The Trust issued to CFC Rural Electric Cooperative Grantor Trust (Tex-La) 9.10% Certificates Due 2002 (the \"Certificates\") in the amount of $17,120,000. The Certificates are solely the obligations of the Trust and are not insured or guaranteed by CFC, the Cooperative, the Trustee, the Rural Utilities Service (\"RUS\") of the United States Department of Agriculture (\"USDA\") nor any other governmental agency. Each Certificate represents an undivided fractional interest in the Trust. CFC is the depositor of the Trust and acts as Servicer of the Note. CFC filed, on behalf of the Trust, a Registration Statement on Form S-1 (Registration No. 33-20166) which become effective on March 9, 1988, and CFC resold the Certificates thereunder.\nThe assets of the Trust consist primarily of the Note which is guaranteed (the \"Guarantee\") as to timely payment of principal and interest by the United States of America, acting through the Administrator of RUS. The amounts of principal and interest payments on the Note held by the Trust are sufficient to cover the scheduled principal and interest payments on the Certificates issued by the Trust and the scheduled amounts of servicer fees. The General Counsel of the USDA has issued an opinion that the Guarantee is supported by the full faith and credit of the United States of America.\nDebt service and servicer fee payments on the Note are made to the Trustee semi-annually (June 4 and December 4) by the Cooperative. The Trustee deposits all such receipts in the Trust account. The Trustee is authorized by the Trust Agreement to invest all funds in the Trust account at the direction of CFC in certain eligible investments that mature no later than the business day next preceding the day (June 15 and December 15) such amounts are to be distributed to the Certificateholders and the Servicer. The interest earned on the investments is distributed to the Cooperative. Any funds that are not so invested must be held by the Trustee in the Trust account. The Trustee may not reinvest any returns of principal or investment earnings on eligible invest- ments and the Trustee may not sell any eligible investment prior to its maturity except, at the direction of CFC, to preserve the value of the corpus of the Trust.\nOn or before five business days after each date on which payments are made on the Certificates, the Trustee is obligated to supply the holders of such Certificate a report provided by the Servicer, which includes certain pertinent information as to how the payment is to be allocated to principal, interest, servicer fees and premium, if any, as well as the principal balance outstanding after such payment.\nThe fiscal year of the Trust is the calendar year. Within the prescribed period of time for tax reporting purposes, after the end of each calendar year during the term of the Trust Agreement, the Trustee is obligated to prepare and mail to each Certificateholder of record for the Trust, at any time during each year, a report setting forth the information as is reasonably necessary for the preparation of such Certificateholder's Federal income tax return.\nPayments of principal on the Certificates are scheduled to be repaid over a period of thirteen years which began in 1990. The principal payments over the next 5 years and thereafter are as follows:\n\t\t 1996 $ 1,250,000 \t\t 1997 1,400,000 \t\t 1998 1,550,000 \t\t 1999 1,725,000 \t\t 2000 1,925,000 \t Thereafter 4,475,000\n\t\t Total $ 12,325,000\nThe Certificates are not subject to full redemption prior to December 15, 1997. Thereafter, such Certificates are subject to optional redemption, for the entire remaining balance and without premium, upon redemption or purchase of the related Note. The Trust Agreement will terminate after payment in full has been made on the Certificates issued thereunder.\n2. TAX STATUS OF THE TRUST\nMilbank, Tweed, Hadley & McCloy, counsel to CFC, has advised CFC with respect to the Trust that, in its opinion, (i) the Trust will not be classified as an association taxable as a corporation, but will be classified as a grantor trust and (ii) each Certificateholder will be treated for Federal income tax purposes as the owner of an undivided fractional interest in each of the assets held by the Trust.\nIt is expected that the Trust will not have any liability for Federal or state income taxes for the current or future years.\n3. INTEREST AND SERVICER FEE ACCOUNTING\nThe Trust records interest income as it is earned and accrues interest expense and servicer fees as they are incurred. Servicer fees represent ten basis points of the outstanding principal balance of the Certificates and the Note.\n4. FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe following disclosure of the estimated fair value of financial instruments is made in accordance with FASB Statement 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 December 31, 1995, along with other valuation methodologies which are summarized below. Below is a summary of significant methodologies used in estimating fair value amounts and a schedule of fair values at December 31, 1995.\nThe carrying amounts reported for Interest Receivable, Interest Payable - Grantor Trust Certificates, and Servicer Fees Payable approximate fair values due to the short term maturity of these instruments.\nNote Receivable\nFair value 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.\nRural Electric Cooperative Grantor Trust Certificates\nThe fair value of the Certificate is estimated using quoted market prices for similar notes over the same remaining maturities.\nThe carrying and estimated fair values of the Trust's financial instruments as of December 31, 1995, are as follows:\n\t\t\t\t\t Carrying Fair \t\t\t\t\t Value Value\nAssets: Interest Receivable 86,689 86,689 Note Receivable 12,325,000 15,248,661\nLiabilities: Interest Payable - Grantor Trust Certificates 84,118 84,118 Servicer Fees Payable 2,571 2,571 Rural Electric Cooperative Grantor Trust Certificates 12,325,000 15,257,064\n\t RURAL ELECTRIC COOPERATIVE GRANTOR TRUST (TEX-LA) 1988 T-1\n\t\t\t\t Exhibit Index\nExhibit Number Description of Exhibit\n4.1 Form of Trust Agreement, including the form of Rural Electric \t Cooperative Grantor Trust Certificate (incorporated by reference \t to Exhibit 4.1 to Registration Statement on Form S-1 \t [No. 33-20166]).\n10.1 Loan Agreement (incorporated by reference to Exhibit 10.1 to \t Registration Statement on Form S-1 [No. 33-20166]).\n10.2 Loan Guarantee and Servicing Agreement (incorporated by reference to \t Exhibit 10.2 to Registration Statement on Form S-1 [No. 33-20166]).","section_15":""}
{"filename":"814361_1995.txt","cik":"814361","year":"1995","section_1":"Item 1 regarding foreign and domestic sales and Part II, Items 5, 6, 7 and 8 of this report. Portions of the Registrant's definitive Proxy Statement for the 1995 Annual Meeting of Stockholders to be filed pursuant to Regulation 14A are incorporated by reference in Part III of this report.\nThe Exhibits Index appears on page 10 of this report. - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------\nPART I\nITEM 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 indicates otherwise). The Company designs, develops, engineers, markets and distributes men's and women's premium-quality footwear, apparel and accessories under the Timberland(R) brand. Timberland(R) products are sold primarily through better-grade department stores, independent retailers, athletic stores and other retail stores in the United States and in more than 60 countries worldwide. Timberland products are also sold through Timberland(R) specialty stores and factory outlet stores devoted exclusively to Timberland products. These two types of stores are operated by the Company in the United States and in parts of Europe and by certain of the Company's distributors in parts of Europe, South America, Mexico, the Middle East and the Asia\/Pacific region.\nThe Company offers high-quality products that provide durability, functional performance, comfort, classic styling and lasting protection from the elements. The Company believes that the combination of these features distinguishes the Timberland brand from competing brands and makes Timberland products an outstanding value.\nDuring 1995, the Company focused on improving its balance sheet through better working capital management. As part of this focus, the Company enhanced its business controls and exercised greater discipline in the day-to-day operation of its business. The Company reorganized into profit centers for its footwear, apparel and accessories, retail and international divisions. The Company also realigned the structure of its domestic wholesale sales organization from a structure organized by geographic regions to a structure organized by distribution channels. In addition, the Company strengthened its credit and cash collection procedures and policies. The Company closed two of its manufacturing facilities, downsized a third facility, and reorganized and consolidated the management of its remaining manufacturing facilities. The Company shifted the production which was performed formerly by these facilities to third party manufacturers. As a result of these actions, at the end of 1995, the Company reported a reduction in inventory, debt levels and days sales outstanding and an improvement in its cash position compared to the end of 1994.\nIn 1995, the Company also developed a marketing and merchandising strategy that defines its footwear and apparel and accessories products within the dress casual, rugged casual and performance categories. This strategy is designed to further integrate the Timberland brand and make it easier for wholesale customers to sell Timberland products to consumers based on end-user needs.\nCURRENT PRODUCTS\nThe Company's products fall into two broad categories -- footwear (shoes, boots and sandals) and apparel and accessories. The Company's footwear sales represented 74.9%, 80.5% and 83.4% of total product sales for 1995, 1994 and 1993, respectively. Sales of apparel and accessories represented 25.1%, 19.5% and 16.6% of total product sales for 1995, 1994 and 1993, respectively.\nFootwear\nIn 1973, the first pair of waterproof leather boots under the Timberland brand were produced. The Company currently offers a broad variety of footwear products for men and women featuring premium waterproof or water resistant leathers, fabric uppers, selected use of waterproof fabric linings and, in certain models, hand-sewn construction.\nThe Company's footwear lines included over 240 models and colors for Spring 1995 and over 250 models and colors for Fall 1995. New footwear product introductions in 1995 included a dressier line of waterproof Pinnacle Weatherbucks, Gore-Tex(R) chukka boots, canvas boots and shoes, performance sandals and the Treeline(TM) Aggressive Series of multi-purpose outdoor footwear, which will be available at retail in Spring\n1996. The Company also expanded the number and levels of products featuring the Active Comfort Technology(TM) (ACT(TM)) system, a moisture management and climate control system developed by the Company.\nIn 1995, the Company focused the design and development of its footwear lines for Fall 1996 into the dress casual, rugged casual and performance categories. The dress casual category has been expanded from the classic Weatherbuck collection and loafers to include cap toes, wing tips, tassel slip-ons and oxfords for men and more fashion-focused hand-sewn wovens, pumps, slip-ons and loafers for women. The rugged casual category includes rugged hand-sewn shoes, Bush Hikers, classic work boots and boat shoes. Timberland(R) performance footwear products include hiking boots, field boots and multi-purpose outdoor footwear featuring the ACT system and other advanced technologies.\nThe Company also designs, develops, engineers, markets and distributes, under the Timberland(R) Work Division, a line of boots designed to fit the needs of construction workers, carpenters, assembly-line workers and skilled workers in other crafts and trades. These boots are sold in the United States and Italy through leading consumer product and independent retail stores. The Company expects to market these products under the name Timberland Mill River(TM) beginning in Fall 1996.\nApparel and Accessories\nTimberland(R) apparel products consist primarily of rugged outerwear, sweaters, shirts, pants, shorts and skirts. These products feature, in certain models, premium waterproof leathers, waterproof and water resistant fabric, rust-proof hardware, canvas, denim, high-quality specialty cotton, wool and other quality performance materials. During 1995, the Company implemented a forecasting and delivery system designed specifically for its apparel products. The Company's men's apparel offerings for 1995 were coordinated and merchandised into apparel collections to compete in the collection sportswear market. The Company targeted its women's apparel offerings for 1995 to focus on classic items distributed principally through Timberland(R) specialty stores and several premium retailers. For 1996, the Company plans to expand its Men's Collection Sportswear line and to continue the limited focus of its women's line. The Company plans to promote its apparel products in a manner consistent with its dress casual, rugged casual and performance product categories.\nTimberland(R) accessories products for 1995 focused principally on leather goods -- luggage, briefcases, handbags, wardrobe accessories and other small leather goods -- with a lesser focus on caps, hats and leather care products and, through Timberland specialty stores only, gloves and socks. Beginning in the second half of 1996, many Timberland accessories, including day packs, travel gear, socks, legwear, gloves and leather care products, will be more widely distributed through licensing arrangements with third parties, as further described in the \"Licensing\" section of this report.\nIn 1995, the Company introduced City Year Gear(TM), a limited line of T-shirts, caps and bags. City Year Gear products are sold exclusively through Timberland specialty stores. Any profits from the sale of these products will help support City Year(R), an urban youth corps sponsored partially by the Company, and other Company-sponsored community service activities.\nDISTRIBUTION\nThe Company's strategy is to distribute its products through its specialty stores and through better-grade department stores, independent retailers and athletic stores which reinforce the Timberland image of quality, performance and service. For 1996, the Company plans to continue the integrated presentation of the Timberland(R) brand, which will be based on showcasing Timberland(R) footwear, apparel and accessories within the dress casual, rugged casual and performance categories. The Company also plans to expand the presentation of its Men's Collection Sportswear apparel offerings in selected collection sportswear locations during 1996.\nUnited States Operations\nIn 1995, 1994 and 1993, 70.2%, 73.5% and 70.8%, respectively, of the Company's revenues were generated in the United States. The Company's wholesale customer accounts within the United States range\nfrom better-grade department stores and retail stores to athletic and sporting goods stores, marinas and specialty retailers. These accounts are serviced through a combination of field and corporate-based sales teams and through the Company's six showrooms. The Company's principal showroom is located on Fifth Avenue in New York City. The Company's regional showrooms are located in Chicago, Dallas, Atlanta, Denver and Seattle.\nAt the end of 1995, the Company had 157 concept shops featuring Timberland(R) footwear and apparel, including 82 apparel shops in men's collection sportswear departments. Concept shops are areas of third-party stores dedicated exclusively to the presentation, merchandising and sale of Timberland(R) products. Some existing concept shops were also expanded during 1995.\nThe Company operates footwear distribution facilities in Danville, Kentucky and Hampton, New Hampshire. The Company also fills footwear orders from a third-party operated distribution facility in Industry, California. All apparel and accessories orders are centrally distributed from the Company's facility in Grove City, Ohio. In 1995 and early 1996, the Company closed its Portsmouth, New Hampshire and Wilmington, Massachusetts distribution facilities, as part of the consolidation of its domestic distribution operations.\nInternational Operations\nIn 1995, international revenues accounted for 29.8% of the Company's revenues, compared to 26.5% in 1994 and 29.2% in 1993. Timberland products are sold internationally through distributors and commission agents and by the Company through its operating divisions in England, France, Germany, Italy, Spain and Austria. The Company's European operating divisions provide sales, administrative and, in some cases, warehousing support for the sale of Timberland products to wholesale customers in their respective countries, and in certain instances, to distributors and commission agents in other countries. Additionally, certain of the Company's international distributors operate specialty stores and concept shops devoted exclusively to Timberland products in Europe, South America and the Asia\/Pacific region. The Company's international distributors opened nine such specialty stores and 24 such concept shops in 1995.\nReference is made to the information set forth in Note 13 to the Company's consolidated financial statements, entitled \"Industry Segment and Geographical Area Information,\" appearing in the Company's 1995 Annual Report to security holders, which information is incorporated herein by reference.\nRETAIL\nIn 1995, revenues from the specialty and outlet stores operated by the Company accounted for 19.6% of the Company's revenues, compared to 11.3% in 1994 and 10.2% in 1993. This increase reflects the expansion of the Company's retail operations. In 1995, the Company opened six specialty stores, bringing to 29 the total number of specialty stores operated by the Company worldwide. In addition to providing an environment to showcase the Timberland(R) brand as an integrated source of footwear, apparel and accessories, these specialty stores provide sales and consumer-trend information which assists the Company in developing its marketing strategies, including point-of-purchase marketing materials. The training and customer service programs established in the Company's specialty stores also serve as a model which may be adopted by the Company's other retail accounts. In 1995, the Company opened fifteen outlet stores, bringing to 33 the total number of outlet stores operated by the Company worldwide. These outlet stores serve as the primary channel for the sale of factory-second and close-out product offerings, and enable the Company to protect and control the integrity of the Timberland brand and maximize the return associated with the sale of such products.\nLICENSING\nIn 1995, the Company sought to broaden the reach of the Timberland brand by capitalizing on several licensing opportunities. These licensing agreements enable the Company to expand the Timberland brand to appropriate and well-defined product categories and geographical territories in which the Company has not had an appreciable presence, in a manner designed to reduce the risk and investment associated with pursuing such opportunities.\nProduct Licensing\nUnder a licensing agreement with Timex Nederland B.V., Timberland offers a line of outdoor watches which were available for distribution in late 1995. During 1995 and early 1996, the Company entered into licensing agreements with other industry leaders for the manufacture and distribution of several new product categories, including: The Coleman Company for fabric and leather-accented day packs and travel gear, Kayser-Roth Corporation for socks and legwear and SWANY America for gloves. The Company anticipates that products under each of these new licensing agreements will be available for distribution beginning in late 1996.\nTerritory Licensing\nIn 1995, the Company entered into two license agreements with distributors to expand the reach of the Timberland(R) brand. The Company appointed Inchcape plc as the exclusive distributor and retailer of Timberland(R) products throughout most of the Asia\/Pacific region. The transaction also included Inchcape's acquisition of the Company's Australian and New Zealand subsidiaries and the operation of existing Timberland(R) specialty stores and concept shops in these countries. In 1995, the Company also appointed Sao Paulo Alpargatas S.A. as the exclusive distributor and retailer, as well as a non-exclusive manufacturer, of Timberland products throughout much of South America. Both of these agreements provide for the opening of new specialty stores and concept shops devoted exclusively to Timberland products and require the licensee to exceed minimum purchases of Timberland products during each year. The license agreement with Sao Paulo Alpargatas S.A. also requires the licensee to achieve specified annual minimum sales increases.\nADVERTISING AND MARKETING\nThe Company's advertising campaigns are designed to increase brand awareness among consumers and to emphasize the features that distinguish the Timberland brand from competing brands and make Timberland products an outstanding value. During 1995, the Company's national and regional advertising campaigns appeared mainly in various trade press outlets and active-lifestyle, fashion and sports-focused consumer periodicals. The Company reinforced these advertising campaigns with a variety of in-store promotions, point-of-purchase marketing materials and a cooperative advertising program with its retailers, as well as retail sales clerk training and other sales incentive programs and promotional campaigns. Timberland's product and territory licensing arrangements also require licensees to fund marketing campaigns, over which Timberland maintains approval and design rights to ensure consistent and effective brand presentation.\nDuring 1995, the Company expanded its internal creative resource staff to enhance the Company's corporate and promotional communication capabilities and to better manage the presentation of the Timberland brand. The Company plans to produce internally all advertising, product catalogs and point-of-purchase marketing materials and all packaging and hang-tag designs for its 1996 product offerings.\nSEASONALITY\nIn 1995, as has traditionally been the case, the Company's revenues were higher in the last two quarters of the year than in the first two quarters. The Company expects this seasonality to continue in 1996.\nBACKLOG\nAt December 31, 1995, Timberland's backlog of orders from its customers was approximately $102 million, compared to $132 million at December 31, 1994 and $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 1996. The Company does not believe that its backlog of orders at year-end is representative of the orders which will be filled during 1996, due to the shift towards \"at-once orders\" being adopted by many retailers.\nMANUFACTURING\nDuring 1995, approximately 40% of the unit volume of the Company's footwear products was manufactured by the Company, compared to approximately 60% during 1994. The remainder of the Company's footwear products and all of its apparel and accessories were produced by independent manufacturers in Asia, Europe and the Americas. Over 20% and 15% of the unit volume of the Company's footwear products was produced in Thailand and Taiwan, respectively.\nDuring 1995, the Company closed its footwear manufacturing facilities located in Boone, North Carolina and Mountain City, Tennessee, and downsized its footwear manufacturing facility in the Dominican Republic. The Company increased its use of independent manufacturers to replace most of the manufacturing operations conducted formerly at its manufacturing facilities. This restructuring was a result of the Company's overall effort to improve product quality, to reduce manufacturing overhead and product costs, and to increase the Company's flexibility to meet consumer demand for particular product lines. The Company currently plans to retain its internal manufacturing capability in order to continue benefiting from expertise the Company has gained with respect to the footwear manufacturing methods and from the research and development activities conducted at its manufacturing facilities.\nAs part of the Company's efforts to improve the reliability and quality of the manufacturing operations conducted by the Company and its independent manufacturers, the Company in 1995 reorganized and consolidated the management of these functions and expanded its quality control group. The Company's quality and production standards were reviewed and updated, and product quality audits were conducted at the factories and distribution centers to ensure such standards were being met. In 1995, the Company also opened offices in Bangkok, Thailand and Taichung, Taiwan in order to more closely supervise the Company's sourcing activities conducted in the Asia\/Pacific region. In addition, the Company enhanced and expanded the data available through its information systems to enable the Company to better match product supply and demand.\nTo the extent the Company manufactures its products 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, among other risks, import restrictions, anti-dumping investigations, political or labor disturbances, expropriation and acts of war.\nRAW MATERIALS\nDuring 1995, the Company consolidated its base of raw materials suppliers; however, only two suppliers provided more than 10% each of the Company's leather purchases for 1995. The Company has no reason to believe that leather will not continue to be available from these or alternative sources. The Company also began to establish a central network of suppliers through which the Company's manufacturing facilities and independent manufacturers could purchase raw materials. The Company believes that this approach will reduce the cost and provide greater consistency of the raw materials procured to produce Timberland(R) products, and increase compliance with the Company's production standards.\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 [TIMBERLAND LOGO], which have been registered in the United States and in certain foreign countries. Other Company trademarks or registered trademarks are Treeline; Weathergear; [WORK LOGO]; [MILL RIVER LOGO]; More Quality Than You May Ever Need; Active Comfort Technology; ACT; Mountain to River; Toporelief; Topozoic; Boots, Shoes, Clothing, Wind, Water, Earth & Sky; Wind, Water, Earth & Sky; Elements; The Elements of Design are the Elements themselves, Wind, Water, Earth and Sky; Nothing Can Stop You; Blackridge Mountain; Blackridge Mountain Logo Design; Mill River; Mill River Logo Design; 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(R) brand. It is the policy of the Company to protect and defend vigorously its trade name and\ntrademarks 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 of its proprietary rights under applicable laws.\nThe Company conducts research, design and development efforts for its footwear, apparel and accessories. The Company tests a number of its products under actual field conditions to evaluate and improve product performance. The Company's expenses relating to research, design and development, however, have not represented a material expenditure relative to its other expenses.\nCOMPETITION\nThe Company does not believe any of its principal competitors offers a complete line of products that provide the same quality and performance as the complete line of Timberland(R) footwear, apparel and accessories products. The Company does, however, have a variety of major competitors in each of its separate footwear, apparel and accessories product offerings.\nThe Company's footwear and apparel and accessories products are marketed in highly competitive environments which are 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 some of 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 nine major competitors in classic work boot sales, at least seven major competitors in sales of rugged casual footwear sales, at least twelve major competitors in sales of performance boots and sandals, and at least thirteen major competitors in sales of dress casual footwear. The Company's major competitors for its footwear products are located principally in the United States. The Company also faces competition from many international footwear manufacturers.\nThe Company's line of men's and women's apparel faces competition from at least ten major apparel companies in the United States and from a variety of major apparel companies internationally. The Company's men's and women's lines of footwear and apparel face competition from at least two direct mail companies in the United States.\nThe Company's accessories products line faces competition from at least seven major companies in the United States and from several major accessories companies internationally.\nProduct quality, performance, design, styling and pricing, as well as consumer awareness, 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(R) products are designed primarily for functionality and performance, demand for Timberland products (except for the new, more fashion-focused models introduced under Timberland's Fall 1996 dress casual footwear line) is less sensitive to changing trends in fashion than 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, based on information and circumstances currently known to the Company.\nEMPLOYEES\nAs of December 31, 1995, the Company had approximately 5,500 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, which are due in 2014. These bonds bear interest at 6.20% through 1999 and thereafter at rates adjusted every five years, through maturity. These bonds are secured by a mortgage on such real estate and by a security interest on assets located there.\nThe Company also leases distribution facilities in Grove City, Ohio and Wilmington, Massachusetts, for the distribution of certain products, under lease agreements which expire in May 1998 and April 1996, respectively. In February 1996, the Company acquired its distribution facility in Danville, Kentucky.\nSince April 1994, the Company has leased property in Stratham, New Hampshire that serves as its worldwide headquarters, under a lease which 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 manufacturing facilities which are located in Isabela, Puerto Rico and Santiago, Dominican Republic. These manufacturing facilities are occupied under 11 leasing arrangements which expire at various times through February 1998.\nThe Company leases 19 domestic specialty stores, ten international specialty stores, six domestic showrooms, 29 domestic factory outlet stores, and four international factory outlet stores. The Company's subsidiaries also lease office and warehouse space to meet their individual requirements.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is involved in various litigation and legal matters 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 consolidated financial statements.\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. On April 24, 1995, the District Court granted plaintiffs' motion, assented to by defendants, to consolidate the two actions. On June 23, 1995, plaintiffs filed a consolidated amended complaint (the \"Amended Complaint\") with the District Court. The Amended Complaint alleges that defendants violated the federal securities laws by making material misstatements and omissions in certain of the Company's public filings and statements in 1994. Specifically, the Amended Complaint alleges that such statements and omissions had the effect of artificially inflating the market price for the Company's Class A 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. Damages are unspecified. On March 18, 1996, the Court denied defendants' motion to dismiss the Amended Complaint. On March 19, 1996, the Court granted plaintiffs' motion for class certification for all purchasers of the Company's Class A Common Stock between May 12, 1994 and December 9, 1994. Management believes this action is without merit and intends to defend it vigorously. Accordingly, at this time, management does not expect the outcome of such litigation to 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\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\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 security holders 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 as 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.\nGregory W. VanWormer joined the Company in May 1994 as Senior Vice President-Retail. Effective January 1, 1995, Mr. VanWormer's title was changed to Senior Vice President-General Manager Apparel\/Retail. 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).\nDennis W. Hagele joined the Company in October 1994 as Vice President-Finance and Corporate Controller. 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 1995 Annual Report to security holders 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 1995 Annual Report to security holders 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 1995 Annual Report to security holders 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 1995 Annual Report to security holders 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 1996 Proxy Statement\") relating to its 1996 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, 1995, which information is incorporated herein by reference. Reference is also made to the information set forth in the Registrant's 1996 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 1996 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 1996 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 1, 1996, 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 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 1996 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.\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 1995.\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\n\/S\/ SIDNEY W. SWARTZ By:................................. SIDNEY W. SWARTZ, PRESIDENT\nMarch 28, 1996\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)\nINDEPENDENT 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, 1995 and 1994 and for the three years in the period ended December 31, 1995, and have issued our report thereon dated February 7, 1996; such consolidated financial statements and report are included in your 1995 Annual Report to security holders and are incorporated herein by reference. Our audits also included the consolidated financial statement schedule of The Timberland 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 audit. 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 7, 1996\nSCHEDULE VIII\nTHE TIMBERLAND COMPANY\nTimberland; [TIMBERLAND LOGO]; Treeline; Weathergear; [WORK LOGO]; [MILL RIVER LOGO]; More Quality Than You May Ever Need; Active Comfort Technology; ACT; Mountain to River; Toporelief; Topozoic; Boots, Shoes, Clothing, Wind, Water, Earth & Sky; Wind, Water, Earth & Sky; Elements; The Elements of Design are the Elements themselves, Wind, Water, Earth and Sky; Nothing Can Stop You; Blackridge Mountain; Blackridge Mountain Logo Design; Mill River; Mill River Logo Design; TBL 30; Timberland 1049; Trail Grip; and Tims are trademarks or registered trademarks of The Timberland Company.\nGore-Tex is a registered trademark of W.L. Gore & Associates, Inc.\n(C) The Timberland Company 1996 All Rights Reserved.","section_15":""}
{"filename":"9626_1995.txt","cik":"9626","year":"1995","section_1":"ITEM 1. BUSINESS - -----------------\nCAUTIONARY STATEMENT\nTo the extent that any forward looking statements are made, the Company is necessarily unable to predict future changes in interest rates, economic activity and loan demand. As a result of variations in such factors, actual results may differ materially from any forward looking statements.\nINTRODUCTION\nThe business of The Bank of New York Company, Inc. (the \"Company\") and its subsidiaries is described in the \"Business Review\" section of the Company's 1995 Annual Report to Shareholders which description is included in Exhibit 13 to this report and incorporated herein by reference. Also, the \"Management's Discussion and Analysis\" section included in Exhibit 13 contains financial and statistical information on the operations of the Company. Such information is herein incorporated by reference.\nCOMPETITION\nThe businesses in which the Company operates are very competitive. Competition is provided by both unregulated and regulated financial services organizations, whose products and services span the local, national, and global markets in which the Company conducts operations.\nSavings banks, savings and loan associations, and credit unions actively compete for deposits, and money market funds and brokerage houses offer deposit-like services. These institutions, as well as consumer and commercial finance companies, national retail chains, factors, insurance companies and pension trusts, are important competitors for various types of loans. Issuers of commercial paper compete actively for funds and reduce demand for bank loans. For personal and corporate trust services and investment counseling services, insurance companies, investment counseling firms, and other business firms and individuals offer active competition. A wide variety of domestic and foreign companies compete for processing services.\nCERTAIN REGULATORY CONSIDERATIONS\nGeneral\nAs a bank holding company, the Company is subject to the regulation and supervision of the Federal Reserve Board under the Bank Holding Company Act (\"BHC Act\"). The Company is also subject to regulation by the New York State Department of Banking. Under the BHC Act, bank holding companies may not directly or indirectly acquire the ownership or control of more than 5% of the voting shares or substantially all of the assets of any company, including a bank, without the prior approval of the Federal Reserve Board. In addition, bank holding companies are generally prohibited under the BHC Act from engaging in nonbanking activities, subject to certain exceptions.\nThe Company's subsidiary banks are subject to supervision and examination by applicable federal and state banking agencies. The Bank of New York (\"BNY\"), a New York chartered banking corporation and The Bank of New York (NJ) (\"BNYNJ\"), a New Jersey chartered banking corporation are members of the Federal Reserve System and are subject to regulation and supervision principally by the Federal Reserve Board. As banks insured by the FDIC, BNY and BNYNJ are also subject to examination by that agency. The Bank of New York (Delaware) (\"BNY Del.\"), chartered in Delaware, and The Putnam Trust Company (\"PTC\"), chartered in Connecticut, are FDIC-insured non-member banks and therefore subject to regulation and supervision principally by the FDIC. BNY, BNYNJ, BNY (Del.), and PTC are also subject to supervision and examination by their respective state regulators,\nthe New York Banking Department, the New Jersey Banking Department, the Office of State Bank Commissioner of the State of Delaware, and the Connecticut Banking Department.\nBoth federal and state laws extensively regulate various aspects of the banking business, such as permissible types and amounts of loans and investments, permissible activities, and reserve requirements. These regulations are intended primarily for the protection of depositors rather than the Company's stockholders.\nCapital Adequacy\nBank regulators have adopted risk-based capital guidelines for bank holding companies and banks. The minimum ratio of qualifying total capital to risk-weighted assets (including certain off-balance sheet items) is 8%. At least half of the total capital is to be comprised of common stock, retained earnings, noncumulative perpetual preferred stock, minority interests and for bank holding companies, a limited amount of qualifying cumulative perpetual preferred stock, less certain intangibles including goodwill (\"Tier 1 capital\"). The remainder (\"Tier 2 capital\") may consist of other preferred stock, certain other instruments, and limited amounts of subordinated debt and allowance for loan losses.\nIn addition, the Federal Reserve Board has established minimum Leverage Ratio (Tier 1 capital to average total assets) guidelines for bank holding companies and banks, and the FDIC has established substantially identical minimum leverage requirements for state chartered FDIC-insured, nonmember banks. The Federal Reserve Board's guidelines provide for a minimum Leverage Ratio of 3% for bank holding companies and banks that meet certain specified criteria, including those having the highest regulatory rating. All other banking organizations will be required to maintain a Leverage Ratio of at least 3% plus an additional cushion of 100 to 200 basis points. The guidelines also provide that banking organizations experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels, without significant reliance on intangible assets. Furthermore, the guidelines indicate that the Federal Reserve Board will continue to consider a \"Tangible Tier 1 Leverage Ratio\" in evaluating proposals for expansion or new activities. The Tangible Tier 1 Leverage Ratio is the ratio of Tier 1 capital, less intangibles not deducted from Tier 1 capital, to average total assets. The Federal Reserve Board has not advised the Company of any specific minimum Leverage Ratio applicable to it. See \"FDICIA\" below.\nFederal banking agencies have proposed or are considering regulations that would modify existing rules related to capital ratios with respect to various areas of risk including interest rate exposure and other market risk. The Company does not believe that the aggregate impact of these modifications would have a significant impact on its capital position.\nFDICIA\nThe Federal Deposit Insurance Corporation Improvement Act of 1991 (\"FDICIA\"), substantially revised the depository institution regulatory and funding provisions of the Federal Deposit Insurance Act (\"FDIA\") and made revisions to several other federal banking statutes. Among other things, FDICIA requires the federal banking regulators to take prompt corrective action in respect of FDIC-insured depository institutions that do not meet minimum capital requirements. FDICIA establishes five capital tiers: \"well capitalized,\" \"adequately capitalized,\" \"undercapitalized,\" \"significantly undercapitalized\" and \"critically undercapitalized.\" Under applicable regulations, an FDIC-insured bank is defined to be well capitalized if it maintains a Leverage Ratio of at least 5%, a Tier 1 Capital Ratio of at least 6% and a Total Capital Ratio of at least 10% and is not otherwise in a \"troubled condition\" as specified by its appropriate federal regulatory agency. A bank is generally considered to be adequately capitalized if it is not defined to be well capitalized but meets all of its minimum capital requirements, i.e., if it has a Total Capital Ratio of 8% or greater, a Tier 1 Capital Ratio of 4% or greater and a Leverage Ratio of 4% or greater. A bank will be considered undercapitalized if it fails to meet any minimum required measure, significantly undercapitalized if it is significantly below any such measure and critically undercapitalized if it maintains a\nlevel of tangible equity capital equal to or less than 2% of total assets. A bank may be deemed to be in a capitalization category that is lower than is indicated by its actual capital position if it receives an unsatisfactory examination rating.\nFDICIA generally prohibits an FDIC-insured depository institution from making any capital distribution (including payment of dividends) or paying any management fee to its holding company if the depository institution would thereafter be undercapitalized. Undercapitalized depository institutions are subject to restrictions on borrowing from the Federal Reserve System. In addition, undercapitalized depository institutions are subject to growth limitations and are required to submit capital restoration plans. For an undercapitalized depository institution's capital restoration plan to be acceptable, its holding company must guarantee the capital plan up to an amount equal to the lesser of 5% of the depository institution's assets at the time it becomes undercapitalized or the amount of the capital deficiency when the institution fails to comply with the plan. In the event of the parent holding company's bankruptcy, such guarantee would take priority over the parent's general unsecured creditors. The federal banking agencies may not accept a capital plan without determining, among other things, that the plan is based on realistic assumptions and is likely to succeed in restoring the depository institution's capital. If a depository institution fails to submit an acceptable plan, it is treated as if it is significantly undercapitalized.\nSignificantly undercapitalized depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become adequately capitalized, requirements to reduce total assets and cessation of receipt of deposits from correspondent banks. Critically undercapitalized depository institutions are subject to appointment of a receiver or conservator.\nThe Company's major banking subsidiaries are well capitalized.\nThe table below indicates capital ratios of the Company and its major banking subsidiaries at December 31, 1995 and 1994 and the respective guidelines for well capitalized institutions under FDICIA.\nDecember 31, 1995 December 31, 1994\nBNY BNY Company BNY Del. BNYNJ Company BNY Del. BNYNJ ------- --- ---- ----- ------- --- ---- ----- Well Capitalized Guidelines -----------\nTier 1 8.42% 7.84% 7.87% 15.27% 8.45% 8.26% 7.27% 18.04% 6% Total Capital 13.08 11.61 11.55 16.54 13.43 12.36 11.34 19.30 10 Leverage 8.46 7.63 8.48 7.85 7.89 7.28 7.72 8.58 5 Tangible Common Equity 8.00 7.71 7.78 7.89 7.39 7.66 7.28 8.76\nAt December 31, 1995, the amounts of capital by which the Company and its major banking subsidiaries exceed the well capitalized guidelines are as follows:\nBNY Company BNY Del. BNYNJ (in millions) ------- --- ---- -----\nTier 1 $1,293 $767 $167 $200 Total Capital 1,650 669 138 141 Leverage 1,841 1,125 288 120\nThe following table presents the components of the Company's risk-based capital at December 31, 1995 and 1994:\n(in millions) 1995 1994 ---- ---- Common Stock $5,119 $4,177 Preferred Stock 113 119 Adjustments: Intangibles (672) (330) Securities Valuation Allowance (58) 58 ------ ------ Tier 1 Capital 4,502 4,024\nQualifying Long-term Debt 1,827 1,774 Qualifying Allowance for Loan Losses 670 597 ------ ------ Tier 2 Capital 2,497 2,371 ------ ------ Total Risk-based Capital $6,999 $6,395 ====== ======\nThe following table presents the components of the Company's risk adjusted assets at December 31, 1995 and 1994: 1995 1994 -------------------- -------------------- Balance Balance sheet\/ Risk sheet\/ Risk notional adjusted notional adjusted (in millions) amount balance amount balance -------- -------- -------- -------- Assets - ------ Cash, Due From Banks and Interest- Bearing Deposits in Banks $ 5,693 $ 731 $ 3,895 $ 567 Securities 4,870 819 4,651 671 Trading Assets 762 60 940 124 Fed Funds Sold and Securities Purchased Under Resale Agreements 936 17 3,019 3 Loans 37,687 34,826 33,083 30,814 Allowance for Loan Losses (756) - (792) - Other Assets 4,528 3,441 4,083 3,273 ------- ------- -------- ------- Total Assets $53,720 39,894 $ 48,879 35,452 ======= ------- ======== ------- Off-Balance Sheet Exposures - --------------------------- Commitments to Extend Credit $ 54,274 9,220 $ 37,771 7,520 Securities Lending Indemnifications 15,068 - 15,326 - Standby Letters of Credit and Other Guarantees 6,081 4,228 7,240 4,515 Interest Rate Contracts 27,800 96 28,632 81 Foreign Exchange Contracts 28,005 140 51,021 236 -------- ------- -------- ------- Total Off-Balance Sheet Exposures $131,228 13,684 $139,990 12,352 ======== ------- ======== ------- Gross Risk Adjusted Assets 53,578 47,804\nLess: Allowance for Loan Losses not Qualifying as Risk Based Capital 86 195 ------- ------- Risk Adjusted Assets $53,492 $47,609 ======= =======\nA discussion of the Company's capital position is incorporated by reference from the caption \"Capital Resources\" in the \"Management's Discussion and Analysis\" section of Exhibit 13.\nBrokered Deposits\nThe FDIC has adopted regulations under FDICIA governing the receipt of brokered deposits. Under the regulations, a bank cannot accept, rollover or renew brokered deposits unless (i) it is well capitalized or (ii) it is adequately capitalized and receives a waiver from the FDIC. A bank that cannot receive brokered deposits also cannot offer \"pass-through\" insurance on certain employee benefit accounts. Whether or not it has obtained such a waiver, an adequately capitalized bank may not pay an interest rate on any deposits in excess of 75 basis points over certain prevailing market rates specified by regulation. There are no such restrictions on a bank that is well capitalized. Because BNY and BNY Del. are well capitalized, the Company believes the brokered deposits regulation will have no material effect on the funding or liquidity of BNY and BNY Del. BNYNJ and PTC are well capitalized, but have no brokered deposits.\nFDIC Insurance Assessments\nBNY, BNY Del., BNYNJ, and PTC are subject to FDIC deposit insurance assessments. As required by FDICIA, the FDIC adopted a risk-based premium schedule to determine the assessment rates for most FDIC-insured depository institutions. Effective January 1, 1996, under the schedule, the premiums range from zero to $.27 for every $100 of deposits compared to a range of $.04 to $.31 for every $100 of deposits from June 1, 1995 to December 31, 1995 and a previous range of $.23 to $.31 for every $100 of deposits. Each financial institution is assigned to one of nine categories based on the institutions capital ratios and supervisory evaluations, and the premium paid by the institution is based on the category. Under the present schedule institutions in the highest of the three capital categories and the highest of three supervisory categories pay no premium and institutions in the lowest of these categories pay $.27 per $100 of deposits.\nThe FDIC is authorized to raise insurance premiums in certain circumstances. Any increase in premiums would have an adverse effect on the Company's earnings.\nUnder the FDIA, insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order, or condition imposed by a bank's federal regulatory agency.\nDepositor Preference\nThe Omnibus Budget Reconciliation Act of 1993 provides for a national depositor preference on amounts realized from the liquidation or other resolution of any depository institution insured by the FDIC. That act requires claims against insured depositary institutions to be paid in the following order of priority: the receiver's administrative expenses; deposits; other general or senior liabilities of the institution; obligations subordinated to depositors or general creditors; and obligations to shareholders. Under an FDIC interim rule, which became effective August 13, 1993, \"administrative expenses of the receiver\" are defined as those incurred by the receiver in liquidating or resolving the affairs of a failed insured depository institution.\nAcquisitions\nThe BHC Act generally limits acquisitions by the Company to commercial banks and companies engaged in activities that the Federal Reserve Board has determined to be so closely related to banking as to be a proper incident thereto. The Company's direct activities are generally limited to furnishing services to its subsidiaries and activities that qualify under the \"closely related\" and \"proper incident\" tests. Prior Federal Reserve Board approval is required under the BHC Act for new activities and acquisitions of most nonbanking companies.\nThe BHC Act, the Federal Bank Merger Act, and the New York Banking Law regulate the acquisition of commercial banks. The BHC Act requires the prior approval of the Federal Reserve Board for the direct or indirect acquisition of more than 5% of the voting shares of a commercial bank.\nEffective September 29, 1995, The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (\"IBBEA\") permits bank holding companies, with Federal Reserve Board approval, to acquire banks located in states other than the bank holding company's home state without regard to whether the transaction is permitted under state law. In addition, IBBEA provides that, commencing June 1, 1997, national banks and state banks with different home states will be permitted to merge across state lines, with the approval of the appropriate federal banking agency, unless the home state of a participating bank passes legislation between the date of enactment of IBBEA and May 31, 1997 expressly prohibiting interstate mergers. IBBEA further provides that states may enact laws permitting interstate bank merger transactions prior to June 1, 1997 (opt-in statutes). A bank may also 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. One effect of this legislation, will be to permit the Company to merge two or more of its banking subsidiaries which, as a result, may create greater efficiency in its operations. New York and Connecticut have enacted opt-in statutes.\nThe merger of BNY with another bank would require the approval of the Federal Reserve Board or other federal bank regulatory authority and, if the surviving bank is a New York state bank, the New York Superintendent of Banks.\nIn reviewing bank acquisition and merger applications, the bank regulatory authorities will consider, among other things, the competitive effect of the transaction, financial and managerial issues including the capital position of the combined organization, and convenience and needs factors, including the applicant's record under the Community Reinvestment Act.\nUnder Federal Reserve Board policy, the Company is expected to act as a source of financial strength to its banks and to commit resources to support such banks in circumstances where it might not do so absent such policy. In addition, any loans by the Company to its banks would be subordinate in right of payment to deposits and to certain other indebtedness of its banks.\nRestrictions on Transfer of Funds\nRestrictions on the transfer of funds to the Company and subsidiary bank dividend limitations are discussed in Note 9 to the Consolidated Financial Statements included in Exhibit 13. Such discussion is incorporated herein by reference.\nFDIA\nUnder the FDIA, 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.\nGovernment Monetary Policies\nThe Federal Reserve Board has the primary responsibility for monetary policy; accordingly, its actions have an important influence on the demand for credit and investments and the level of interest rates and thus on the earnings of the Company.\nProposed Legislation\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 the Company and its subsidiaries, however, cannot be determined at this time.\nADDITIONAL FINANCIAL INFORMATION - -------------------------------------------------------------------------------- Average Balances and Rates on a Taxable Equivalent Basis (dollars in millions) 1995 1994 1993 ================================================================= Aver- Aver- Aver- Average Inter- age Average Inter- age Average Inter- age Balance est Rate Balance est Rate Balance est Rate ----------------------------------------------------------------- Assets - ------ Interest -Bearing Deposits in Banks (Primarily Foreign) $ 1,682 $ 106 6.28% $ 1,266 $ 68 5.33% $ 452 $ 24 5.42% Federal Funds Sold and Securities Purchased Under Resale Agreements 3,280 193 5.89 3,653 161 4.39 3,149 97 3.06 Loans Domestic Offices Consumer 11,151 1,381 12.39 9,549 1,015 10.62 8,259 806 9.76 Commercial 13,215 1,047 7.92 12,340 833 6.76 11,998 741 6.18 Foreign Offices 11,055 805 7.28 10,140 564 5.56 10,170 485 4.77 ------- ------ ------- ------ ------- ------ Total Loans 35,421 3,233* 9.13 32,029 2,412* 7.53 30,427 2,032* 6.68 ------- ------ ------- ------ ------- ------ Securities U.S. Government Obligations 3,301 191 5.78 3,516 197 5.61 3,732 215 5.78 Obligations of States and Political Subdivisions 650 68 10.50 893 89 10.02 1,070 110 10.29 Other Securities, including Trading Securities Domestic Offices 1,076 65 6.10 1,341 70 5.25 1,358 64 4.74 Foreign Offices 233 14 6.31 191 11 5.64 192 14 7.36 ------- ------ ------- ------ ------- ------ Total Other Securities 1,309 79 6.13 1,532 81 5.30 1,550 78 5.06 ------- ------ ------- ------ ------- ------ Total Securities 5,260 338 6.45 5,941 367 6.19 6,352 403 6.36 ------- ------ ------- ------ ------- ------ Total Interest- Earning Assets 45,643 $3,870 8.48% 42,889 $3,008 7.01% 40,380 $2,556 6.33% ====== ====== ====== Allowance for Loan Losses (739) (906) (1,045) Cash and Due from Banks 2,971 2,827 2,735 Other Assets 5,178 5,470 4,574 ------- ------- ------- Total Assets $53,053 $50,280 $46,644 ======= ======= ======= Assets Attributable to Foreign Offices 25.73% 24.30% 24.37% ===== ===== =====\n*Includes fees of $134 million in 1995, $118 million in 1994, and $103 million in 1993. Nonaccrual loans are included in the average loan balance; the associated income, recognized on the cash basis, is included in interest. Taxable equivalent adjustments were $40 million in 1995, $46 million in 1994, and $54 million in 1993, and are based on the federal statutory tax rate (35%) and applicable state and local taxes.\nContinued on page 10\nAverage Balances and Rates on a Taxable Equivalent Basis (dollars in millions)\n1995 1994 1993 ============================================================== Aver- Aver- Aver- Average Inter- age Average Inter- age Average Inter- age Balance est Rate Balance est Rate Balance est Rate -------------------------------------------------------------- Liabilities and Shareholders' Equity - --------------- Interest-Bearing Deposits Domestic Offices Money Market Rate Accounts $ 3,451 $ 153 4.44% $ 3,593 $ 108 3.01% $ 3,666 $ 91 2.48% Savings 7,909 243 3.07 8,166 190 2.32 8,379 198 2.37 Certificates of Deposit of $100,000 or More 1,673 95 5.68 1,041 42 4.03 1,189 36 3.00 Other Time Deposits 2,560 143 5.60 2,296 97 4.24 2,701 119 4.39 ------- ------ ------- ------ ------- ------ Total Domestic Offices 15,593 634 4.07 15,096 437 2.90 15,935 444 2.78 ------- ------ ------- ------ ------- ------ Foreign Offices Banks in Foreign Countries 3,968 218 5.48 2,917 125 4.30 2,829 93 3.28 Government and Official Institutions 1,394 81 5.78 1,384 60 4.37 1,306 57 4.34 Other Time and Savings 6,041 332 5.52 5,689 220 3.84 3,752 107 2.87 ------- ------ ------- ------ ------- ------ Total Foreign Offices 11,403 631 5.54 9,990 405 4.05 7,887 257 3.26 ------- ------ ------- ------ ------- ------ Total Interest- Bearing Deposits 26,996 1,265 4.69 25,086 842 3.35 23,822 701 2.94 ------- ------ ------- ------ ------- ------ Federal Funds Purchased and Securities Sold Under Repurchase Agreements 2,804 161 5.75 2,843 106 3.73 3,467 102 2.94 Other Borrowed Funds 3,962 246 6.22 4,135 191 4.63 2,348 86 3.66 Long-Term Debt 1,773 130 7.30 1,530 106 6.93 1,729 117 6.79 ------- ------ ------- ------ ------- ------ Total Interest- Bearing Liabilities 35,535 $1,802 5.07% 33,594 $1,245 3.71% 31,366 $1,006 3.21% ====== ====== ====== Noninterest- Bearing Deposits Domestic Offices 9,012 8,897 8,946 Foreign Offices 53 58 69 ------- ------- ------- Total Noninterest- Bearing Deposits 9,065 8,955 9,015 ------- ------- ------- Other Liabilities 3,685 3,594 2,366 Preferred Stock 115 157 334 Common Shareholders' Equity 4,653 3,980 3,563 ------- ------- ------- Total Liabilities and Shareholders' Equity $53,053 $50,280 $46,644 ======= ======= ======= Net Interest Earnings and Interest Rate Spread $2,068 3.41% $1,763 3.30% $1,550 3.12% ====== ====== ====== Net Yield on Interest-Earnings Assets 4.53% 4.11% 3.84% ==== ==== ===== Liabilities Attributable to Foreign Offices 24.94% 22.79% 19.74% ===== ===== =====\nRate\/Volume Analysis on a Taxable Equivalent Basis (in millions) - ---------------------------------------------------------------- 1995 vs. 1994 1994 vs. 1993 -------------------------------------------------------- Increase (Decrease) Increase (Decrease) due to change in: due to change in: ---------------- Total ----------------- Total Average Average Increase Average Average Increase Balance Rate (Decrease) Balance Rate (Decrease) ------- ------- ---------- ------- ------- --------- Interest Income - --------------- Interest-Bearing Deposits in Banks $ 25 $ 13 $ 38 $ 44 $ - $ 44 Federal Funds Sold and Securities Purchased Under Resale Agreements (18) 50 32 17 47 64 Loans Domestic Offices Consumer 184 182 366 134 75 209 Commercial 62 152 214 22 70 92 Foreign Offices 54 187 241 (1) 80 79 ----- ----- ----- ----- ----- ----- Total Loans 300 521 821 155 225 380 Securities U.S. Government Obligations (12) 6 (6) (12) (6) (18) Obligations of States and Political Subdivisions (25) 4 (21) (18) (3) (21) Other Securities, including Trading Assets Domestic Offices (15) 10 (5) (1) 7 6 Foreign Offices 2 1 3 - (3) (3) ----- ----- ----- ----- ----- ----- Total Other Securities (13) 11 (2) (1) 4 3 ----- ----- ----- ----- ----- ----- Total Securities (50) 21 (29) (31) (5) (36) ----- ----- ----- ----- ----- ----- Total Interest Income 257 605 862 185 267 452 ----- ----- ----- ----- ----- ----- Interest Expense - ---------------- Interest-Bearing Deposits Domestic Offices Money Market Rate Accounts (4) 49 45 (2) 19 17 Savings (6) 59 53 (5) (3) (8) Certificate of Deposits of $100,000 or More 32 21 53 (5) 11 6 Other Time Deposits 12 34 46 (18) (4) (22) ----- ----- ----- ----- ----- ----- Total Domestic Offices 34 163 197 (30) 23 (7) ----- ----- ----- ----- ----- ----- Foreign Offices Banks in Foreign Countries 52 41 93 3 29 32 Government and Official Institutions - 21 21 3 - 3 Other Time and Savings 14 98 112 67 46 113 ----- ----- ----- ----- ----- ----- Total Foreign Offices 66 160 226 73 75 148 ----- ----- ----- ----- ----- ----- Total Interest- Bearing Deposits 100 323 423 43 98 141 Federal Funds Purchased and Securities Sold Under Repurchase Agreements (1) 56 55 (20) 24 4 Other Borrowed Funds (8) 63 55 77 28 105 Long-Term Debt 18 6 24 (13) 2 (11) ----- ----- ----- ----- ----- ----- Total Interest Expense 109 448 557 87 152 239 ----- ----- ----- ----- ----- ----- Change in Net Interest Income $ 148 $ 157 $ 305 $ 98 $ 115 $ 213 ===== ===== ===== ===== ===== =====\nChanges which are not solely due to balance changes or rate changes are allocated to such categories on the basis of the respective percentage changes in average balances and average rates.\nInterest-Rate Sensitivity - -------------------------\nThe Company actively manages interest-rate sensitivity (the exposure of net interest income to interest rate movements). The relationship between interest-earning assets and interest-bearing liabilities is closely monitored. The Company attempts to develop and follow policies which are flexible enough to capitalize on opportunities, while minimizing adverse effects on earnings when changes in short-term and long-term interest rates occur. The Company uses complex simulation models to adjust the structure of its assets and liabilities in response to interest rate exposures. The Company considers three basic scenarios to model interest rate sensitivity; these are base line, high rate, and low rate. The base line scenario is the Company's estimated most likely path for future short-term interest rates. The base line scenario forecast in January 1996 assumes rates will decline slightly during the first quarter of 1996 and then rise back to year end 1995 levels during the fourth quarter of 1996. The \"high rate\" scenario assumes a 153 basis point increase from the base line scenario. The \"low rate\" scenario assumes the average rate declines 50 basis points under the base line scenario. Additionally, other scenarios are reviewed to examine the impact of other interest rate changes. The Company quantifies interest rate sensitivity by calculating the change in net interest income between the three scenarios over a 12 month measurement period. Net interest income as calculated by the earnings simulation model under the base line scenario becomes the standard. The measurement of interest rate sensitivity is the percentage change in net interest income calculated by the model under high rate versus base-line scenario and under low rate versus base-line scenario. The scenarios do not include the adjustments that management would make as rate expectations change. The Company's policy limit for fluctuations in net interest income resulting from either the high rate or low rate scenario is 6.00 percent. Based upon the January 1996 outlook, if interest rates were to rise to follow the high rate scenario, then net interest income during the policy measurement period would be positively affected by 2.26 percent. If interest rates were to follow the low rate scenario, then net interest income would be negatively affected by 0.22 percent (assuming management took no actions). In addition to the policy limit discussed above, the Company also has a global mismatch limit to control the impact of interest rate fluctuations on the Company's earnings. The Company's global mismatch is defined as the absolute value of the Company's asset repricings less liability repricings in 24 maturity bands ranging from one day to over 10 years. Off balance sheet instruments, such as swaps and futures used to hedge balance sheet items are included in the calculation of the global mismatch. Each year the Company's Board of Directors approves both mismatch limits and earnings at risk limits. The global mismatch is reviewed weekly by senior management. Estimated market value changes under various interest rate scenarios are also monitored. The following table reflects the year-end position of the Company's interest-earning assets and interest-bearing liabilities that either reprice or mature within the designated time periods. The interest sensitivity indicated by this table is not necessarily indicative of the Company's interest sensitivity models discussed above because within each time period, assets and liabilities reprice on different dates and at different levels, and interest sensitivity gaps change daily. A positive interest sensitivity gap, for a particular time period, is one in which more assets reprice or mature than liabilities. A negative interest sensitivity gap results from a greater amount of liabilities repricing or maturing. A positive gap implies that there are more rate sensitive assets than liabilities which suggests that as interest rates rise, the return on assets will rise faster than the funding costs. Conversely, a negative gap indicates a higher ratio of rate sensitive liabilities than assets. In such case, if interest rates rise, then funding costs will rise at a faster rate than the return on assets. The cumulative gap is the sum of the dollar gap for sequential time periods.\nDecember 31, 1995 -------------------------------------------------- Within Within Within Greater Within 2-3 4-6 7-12 Than 1 Mo. Mos. Mos. Mos. 12 Mos. Total ------ ------ ------ ------ ------- ------- (in millions) Interest-Earning Assets - ----------------------- Foreign Offices $ 6,512 $ 3,995 $ 2,021 $ 384 $ 172 $13,084 Domestic Offices Loans 18,999 599 933 693 4,910 26,134 Securities 107 110 113 487 3,161 3,978 Trading Assets 629 - - - - 629 Federal Funds Sold and Securities Purchased Under Resale Agreement 933 - - - - 933 ------- ------- ------- ------ ------- ------- Total 27,180 4,704 3,067 1,564 8,243 $44,758 ------- ------- ------- ------ ------- =======\nInterest-Bearing Liabilities - ---------------------------- Foreign Offices 8,390 610 620 111 - 9,731 Domestic Offices Interest-Bearing Deposits Money Market Rate Accounts 4,057 - - - - 4,057 Savings 6,962 - - 13 1,243 8,218 Certificates of Deposit of $100,000 or More 617 552 213 164 568 2,114 Other Time Deposits 365 270 352 256 373 1,616 ------- ------- ------- ------ ------- ------- 20,391 1,432 1,185 544 2,184 25,736 ------- ------- ------- ------ ------- ------- Federal Funds Purchased and Other Borrowed Funds 5,716 291 896 451 3 7,357 Long-Term Debt - - 57 - 1,791 1,848 ------- ------- ------- ------ ------- -------\nNoninterest-Bearing Sources of Funds 4,065 158 237 474 4,883 9,817 - ------------------- ------- ------- ------- ------ ------- ------- Total 30,172 1,881 2,375 1,469 8,861 $44,758 ======= Effect of Financial Futures and Swaps 827 (1,354) 112 173 242 - ------------------- ------- ------- ------- ------ ------- Interest-Sensitive Gap $(2,165) $ 1,469 $ 804 $ 268 $ (376) - ---------------------- ======= ======= ======= ====== ======= Cumulative Interest- Sensitivity Gap $(2,165) $ (696) $ 108 $ 376 $ - - -------------------- ======= ======= ======= ====== =======\nLOANS AND PROVISION AND ALLOWANCE FOR LOAN LOSSES - -------------------------------------------------\nThe provision for loan losses was $330 million in 1995, compared with $162 million in 1994 and $284 million in 1993. The increase in the provision compared with 1994 was principally related to charge-offs in the credit card portfolio. In 1995, the Company continued to experience improvement in the asset quality of business loans as nonperforming loans dropped.\nAt December 31, 1995, the domestic commercial real estate portfolio had approximately 81% of its loans in New York and New Jersey, 4% in California, 3% in New England, and 2% in Pennsylvania; no other state accounts for more than 1% of the portfolio. This portfolio consists of the following types of properties:\nBusiness loans secured by real estate 44% Offices 26 Retail 9 Mixed-Used 5 Hotels 4 Condominiums and cooperatives 4 Industrial\/Warehouse 2 Land 1 Other 5 ---- 100% ====\nAt December 31, 1995 and 1994, the Company's nonperforming real estate loans and real estate acquired in satisfaction of loans aggregated $114 million and $119 million, respectively. Net charge-offs of real estate loans were $16 million in 1995 and $6 million in 1994. In addition, other real estate charges were $5 million and $11 million in 1995 and 1994.\nAt December 31, 1995 the Company's LDC exposures consisted of $49 million in medium-term loans (and no material commitments), $447 million in short-term loans, $9 million in accrued interest, and $148 million in equity investments. At December 31, 1995, the allowance for loan losses associated with LDC loans was $74 million. In addition, the Company has $316 million of debt securities to emerging market countries, including $280 million (book value) of bonds whose principal payments are collateralized by U.S. Treasury zero coupon obligations and whose interest payments are partially collateralized.\nThe Company's consumer loan portfolio is comprised principally of credit card, other installment, and residential loans. Residential and auto loans are collateralized, thereby reducing the risk. Credit card delinquencies and charge-offs increased compared to last year. Credit card accounts past due over 30 days were 4.50% of managed outstandings at the end of 1995 compared with 3.34% at the end of 1994. Credit card net charge-offs were $267 million in 1995 compared to $149 million in 1994. The 1995 and 1994 amounts exclude $2 million and $32 million in net charge-offs related to the portion of the portfolio that was securitized. As a percentage of average credit card outstandings, net charge-offs were 3.44% in 1995 compared to 2.47% in 1994. On a managed receivables basis, net charge-offs as a percentage of average outstandings were 3.44% in 1995 compared to 2.68% in 1994. Other consumer net charge-offs were $5 million in 1995 and $7 million in 1994.\nThe Company's loans to the energy industry primarily consist of credits with investor-owned electric and gas utilities, and oil, gas and mining companies. Nonperforming loans in this industry amounted to $11 million at year-end 1995 and 1994. There were no charge-offs in 1995 and 1994.\nThe Company's loans to the communications, entertainment, and publishing industries primarily consist of credits with cable television operators, broadcasters, magazine and newspaper publishers, motion picture theaters and regional telephone companies. There were no nonperforming communications loans at December 31, 1995 and 1994, and there were no charge-offs in 1995 and 1994.\nThe Company's portfolio of loans for purchasing or carrying securities is comprised largely of overnight loans which are fully collateralized, with appropriate margins, by marketable securities. Throughout its many years of experience in this area, the Company has rarely experienced a loss.\nThe Company makes short-term, collateralized loans to mortgage bankers to fund mortgages sold to investors. There were no nonperforming loans at December 31, 1995 and 1994, and there were no charge-offs in 1995 and 1994.\nBased on an evaluation of individual credits, historical loan losses, and global economic factors, the Company has allocated its allowance for loan losses as follows:\n1995 1994 1993 1992 1991 ---- ---- ---- ---- ---- Real Estate Loans 7% 9% 8% 9% 10% Other Domestic Commercial and Industrial Loans 57 56 64 64 62 Consumer Loans 25 16 10 9 10 Foreign Loans (excluding medium-term LDC loans) 1 7 6 6 6 LDC Loans 10 12 12 12 12 ---- ---- ---- ---- ---- 100% 100% 100% 100% 100% ==== ==== ==== ==== ====\nSuch an allocation is inherently judgmental, and the entire allowance for loan losses is available to absorb loan losses regardless of the nature of the loan.\nThe following table details changes in the Company's allowance for loan losses for the last five years.\n(dollars in millions) 1995 1994 1993 1992 1991 ---- ---- ---- ---- ---- Loans Outstanding, December 31, $37,687 $33,083 $30,570 $29,497 $30,335 Average Loans Outstanding 35,421 32,029 30,427 30,345 32,719\nAllowance for Loan Losses - ------------------------- Balance, January 1 Regular Domestic $ 637 $ 794 $ 878 $ 889 $ 831 Foreign 57 60 70 60 62 Less Developed Countries 98 116 124 135 218* ------- ------- ------- ------- ------- Total, January 1 792 970 1,072 1,084 1,111 ------- ------- ------- ------- ------- Allowance of Acquired Companies and Other Changes 8 - - 56 (10) Credit Card Securitizations 3 14 1 - (18) Charge-Offs Domestic Commercial and Industrial (56) (158) (142) (311) (358) Real Estate & Construction (19) (6) (71) (103) (165) Consumer Loans (309) (191) (173) (181) (226) Foreign (24) (38) (54) (20) (32) Less Developed Countries (24) (18) (9) (13) (39) ------- ------- ------- ------- ------- Total (432) (411) (449) (628) (820) ------- ------- ------- ------- ------- Recoveries Domestic Commercial and Industrial 14 14 28 66 11 Real Estate & Construction 3 - 2 13 1 Consumer Loans 37 35 29 26 21 Foreign 1 8 2 10 4 Less Developed Countries - - 1 2 6 ------- ------- ------- ------- ------- Total 55 57 62 117 43 Net Charge-Offs (377) (354) (387) (511) (777) ------- ------- ------- ------- ------- Provision Domestic 356 135 242 423 742 Foreign (26) 27 42 20 36 ------- ------- ------- ------- ------- Total 330 162 284 443 778 ------- ------- ------- ------- ------- Balance, December 31, Regular Domestic 674 637 794 878 889* Foreign 8 57 60 70 60 Less Developed Countries 74 98 116 124 135* ------- ------- ------- ------- ------- Total, December 31, $ 756 $ 792 $ 970 $ 1,072 $ 1,084 ======= ======= ======= ======= ======= Ratios - ------ Net Charge-Offs to Average Loans Outstandings 1.06% 1.11% 1.27% 1.68% 2.37% ======= ======= ======= ======= ======= Net Charge-Offs to Total Allowance 49.87% 44.70% 39.90% 47.67% 71.68% ======= ======= ======= ======= ======= Total Allowance to Year-End Loans Outstanding 2.01% 2.40% 3.17% 3.63% 3.57% ====== ======= ======= ======= =======\n*Includes a $50 million transfer from the LDC Allowance for Loan Losses to the Regular Allowance.\nNonperforming Assets - -------------------- A summary of nonperforming assets is presented in the following table.\n(in millions) December 31,\n1995 1994 1993 1992 1991 ---- ---- ---- ---- ---- Nonaccrual - ---------- Domestic $ 184 $ 220 $ 408 $ 581 $1,014 Foreign (including Medium-term LDC) 41 77 130 198 146 ------ ------ ------ ------ ------ 225 297 538 779 1,160\nReduced Rate (Domestic) - - 2 9 13 - ------------ ------ ------ ------ ------ ------ 225 297 540 788 1,173\nReal Estate Acquired in - ----------------------- Satisfaction of Loans 72 56 99 268 369 - --------------------- ----- ------ ------ ------- ------\n$ 297 $ 353 $ 639 $1,056 $1,542 ===== ====== ====== ====== ====== Past Due 90 Days or More - ------------------------ and Still Accruing Interest - --------------------------- Domestic $ 270 $ 163 $ 156 $ 218 $ 178 Foreign - - - - 66 ------ ------ ------ ------ ------ $ 270 $ 163 $ 156 $ 218 $ 244 ====== ====== ====== ====== ======\nSecurities - ---------- The following table shows the maturity distribution by carrying amount and yield (not on a taxable equivalent basis) of the Company's securities portfolio at December 31, 1995.\nStates and U.S. Government Political U.S. Government Agency Subdivisions --------------- --------------- ------------ Amount Yield Amount Yield Amount Yield ------ ----- ------ ----- ------ ----- (dollars in millions)\nSecurities Held- - ---------------- to-Maturity ----------- One Year or Less $ 14 5.35% $ 40 4.60% $ 143 4.41% Over 1 through 5 Years 2 5.21 179 5.55 62 5.69 Over 5 through 10 Years - - 2 7.00 65 6.44 Over 10 years - - - - 97 7.07 Mortgage-Backed Securities - - - - - - ------ ----- ------ $ 16 5.33% $ 221 5.39% $ 367 5.69% ====== ===== ====== Securities Available- - -------------------- for-Sale - ---------- One Year or Less $ 481 5.62% $ - -% $ 31 8.93% Over 1 through 5 Years 1,512 5.33 - - 35 6.78 Over 5 through 10 Years 836 5.75 - - 42 6.32 Over 10 years 8 7.65 - - 153 6.40 Equity Securities - - - - - - ----- ----- ----- $2,837 5.51% $ - - $ 261 6.74% ====== ===== =====\nOther Bonds, Mortgage-Backed Notes and and Equity Debentures Securities ------------- ------------ Amount Yield Amount Yield Total ------ ----- ------ ----- ----- (dollars in millions)\nSecurities Held- - ---------------- to-Maturity ----------- One Year or Less $ 24 3.43% $ - -% $ 221 Over 1 through 5 Years 67 6.40 - - 310 Over 5 through 10 Years 60 4.31 - - 127 Over 10 years 273 5.81 - - 370 Mortgage-Backed Securities - - 224 7.34 224 ---- ---- ------ $424 5.56% $224 7.34% $1,252 ==== ==== ====== Securities Available- - -------------------- for-Sale - ---------- One Year or Less $ 12 5.66% $ - -% $ 524 Over 1 through 5 Years 15 3.73 - - 1,562 Over 5 through 10 Years 12 0.08 - - 890 Over 10 years 11 6.07 - - 172 Equity Securities - - 470 3.39 470 ----- ---- ------ $ 50 3.87% $470 3.39% $3,618 ===== ==== ======\nLoans - -----\nThe following table shows the maturity structure of the Company's commercial loan portfolio at December 31, 1995. Over 1 Year 1 Year Through Over or Less 5 Years 5 Years Total ------- ----------- ------- ----- (in millions) Domestic - -------- Real Estate, Excluding Loans Collateralized by 1-4 Family Residential Properties $ 454 $1,443 $ 962 $ 2,859 Commercial and Industrial Loans 3,803 5,139 3,083 12,025 Other, Excluding Loans to Individuals and those Collateralized by 1-4 Family Residential Properties 4,268 750 202 5,220 ------- ------ ------ ------- 8,525 7,332 4,247 20,104 Foreign 1,731 902 1,711 4,344 - ------- ------- ------ ------ ------- Total $10,256 $8,234 $5,958 $24,448 ======= ====== ====== =======\nLoans with: Predetermined Interest Rates $ 638 $ 384 $1,244 $ 2,266 Floating Interest Rates 9,618 7,850 4,714 22,182 ------- ------ ------ ------- Total $10,256 $8,234 $5,958 $24,448 ======= ====== ====== =======\nDeposits - -------- The aggregate amount of deposits by foreign customers in domestic offices was $4.0 billion, $3.2 billion, and $2.1 billion at December 31, 1995, 1994, and 1993. The following table shows the maturity breakdown of domestic time deposits of $100,000 or more at December 31, 1995.\nTime (in millions) Certificates Deposits- of Deposits Other Total -----------------------------------------------\n3 Months or Less $1,092 $2,104 $3,196 Over 3 Through 6 Months 219 6 225 Over 6 Through 12 Months 169 12 181 Over 12 Months 616 34 650 ------ ------ ------ Total $2,096 $2,156 $4,252 ====== ====== ======\nThe majority of deposits in foreign offices are time deposits in denominations of $100,000 or more.\nOther Borrowed Funds - --------------------- Information related to other borrowed funds in 1995, 1994, and 1993 is presented in the table below. 1995 1994 1993 ---------------- --------------- --------------- (dollars in millions) Average Average Average Amount Rate Amount Rate Amount Rate ------ ------- ------ ------- ------ -------\nFederal Funds Purchased - ----------------------- and Securities Sold Under ------------------------- Repurchase Agreements --------------------- At December 31 $3,933 4.61% $1,502 4.91% $2,711 2.85% Average During Year 2,804 5.75 2,843 3.73 3,467 2.94 Maximum Month-End Balance During Year 3,991 5.96 6,415 3.36 4,894 2.80\nOther* - ----- At December 31 3,106 5.73% 4,176 5.79 2,781 3.61 Average During Year 3,962 6.22 4,135 4.63 2,348 3.66 Maximum Month-End Balance During Year 5,025 5.74 5,639 4.57 3,161 3.60\n*Other borrowings consist primarily of commercial paper, bank notes, extended federal funds purchased, and amounts owed to the U.S. Treasury.\nForeign Assets - -------------- At December 31, 1995, the Company had assets in excess of .75% of year end total assets in Greece, totaling $527 million, and in South Korea, totaling $480 million. There were no foreign countries in which the Company's assets exceeded .75% of year end total assets in 1994.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES - ------------------- In New York City, the Company owns the thirty story building housing its executive headquarters at 48 Wall Street, a forty-nine story office building at One Wall Street, and an operations center at 101 Barclay Street. In addition, the Company owns and\/or leases administrative and operations facilities in New York City; various locations in New Jersey and Connecticut; Harrison, New York; Newark, Delaware; Brussels, Belgium; London, England;\nand Utica, New York. Other real properties owned or leased by the Company, when considered in the aggregate, are not material to its operations.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS - -------------------------- Litigation regarding Northeast Bancorp., Inc. is described in Note 12 to the Consolidated Financial Statements included in Exhibit 13, and such description is incorporated herein by reference.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - ------------------------------------------------------------ There were no matters submitted to a vote of security holders of the registrant during the fourth quarter of 1995.\nPART II - ------- ITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS - ------------------------------------------------------------------------------ Information with respect to the market for the Company's common equity and related stockholder matters is incorporated herein by reference from the \"Quarterly Data\" section included in Exhibit 13. The Company's securities that are listed on the New York Stock Exchange (NYSE), are indicated as such on the front cover of this report. The NYSE symbol for the Company's Common Stock is BK. The Warrants (to purchase the Company's Common Stock) are traded over the counter. All of the Company's other securities are not currently listed. The Company had 26,366 common shareholders of record at February 29, 1996.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA - -------------------------------- Selected financial data are incorporated herein by reference from the \"Financial Highlights\" section included in Exhibit 13.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL - ---------------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS ----------------------------------- Management's discussion and analysis of financial condition and results of operations is incorporated herein by reference from the corresponding section of Exhibit 13.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - ---------------------------------------------------- Consolidated financial statements and notes and the independent auditors' report are incorporated herein by reference from Exhibit 13 to this report. Supplementary financial information is incorporated herein by reference from the \"Quarterly Data\" section included in Exhibit 13.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE - ------------------------------------------------------------------------ On March 12, 1996, the Company's Board of Directors, acting upon the recommendation of the Audit Committee of the Company's Board of Directors dismissed Deloitte & Touche LLP as the Company's independent public accountants and appointed Ernst & Young LLP to serve as the Company's independent public accountants for the year 1996. Deloitte & Touche LLP's reports on the Company's financial statements for the last two years did not contain an adverse opinion or a disclaimer of opinion and were not qualified or modified as to uncertainty, audit scope, or accounting principles. During the two fiscal years ended December 31, 1995 and during the period from December 31, 1995 through March 12, 1996, there were no disagreements between the Company and Deloitte & Touche LLP on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements would have caused Deloitte & Touche LLP to make reference to the subject matter of such disagreements in connection with its reports.\nPART III - --------\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - ------------------------------------------------------------\nThe directors of the registrant are identified on pages 28 and 29 of this report. Additional material responsive to this item is contained in the Company's definitive Proxy Statement for its 1996 Annual Meeting of Shareholders, which information is incorporated herein by reference.\nEXECUTIVE OFFICERS OF THE REGISTRANT AND BUSINESS EXPERIENCE DURING THE PAST FIVE YEARS - ----------------------------------------------------------------------------- Company Officer Name Office and Experience Age Since ---- --------------------- --- -----\nJ. Carter Bacot 1995-1996 Chairman and Chief Executive Officer of the Company, Chairman of the Bank 63 1975 1991-1995 Chairman and Chief Executive Officer of the Company and the Bank\nThomas A. Renyi 1995-1996 President of the Company and 50 1992 President and Chief Executive Officer of the Bank 1994-1995 President of the Company and President and Chief Operating Officer of the Bank 1992-1994 President of the Company and Vice Chairman of the Bank 1991-1992 Senior Executive Vice President and Chief Credit Officer of the Bank\nAlan R. Griffith 1994-1996 Vice Chairman of the Company 54 1990 and the Bank 1991-1994 Senior Executive Vice President of the Company, and President and Chief Operating Officer of the Bank\nSamuel F. Chevalier 1991-1996 Vice Chairman of the Company 62 1989 and the Bank\nDeno D. Papageorge 1991-1996 Senior Executive Vice President of 57 1980 the Company, Senior Executive Vice President and Chief Financial Officer of the Bank\nRichard D. Field 1991-1996 Executive Vice President of the 55 1987 Company, Senior Executive Vice President of the Bank\nRobert E. Keilman 1991-1996 Comptroller of the Company and 50 1984 the Bank, Senior Vice President of the Bank\nPhebe C. Miller 1995-1996 Secretary and Chief Legal Officer 46 1995 of the Company, Senior Vice President and Chief Legal Officer of the Bank 1994-1995 Senior Vice President of the Bank 1991-1994 Managing Director, General Counsel and Secretary, Discount Corporation of New York 1991 Vice President and Counsel, Discount Corporation of New York\nRobert J. Goebert 1991-1996 Auditor of the Company, Senior Vice 54 1982 President of the Bank\nOfficers of BNY who perform major policy making functions: Bank Executive Officer Name Office and Experience Age Since ---- --------------------- --- ------\nGerald L. Hassell 1994-1996 Senior Executive Vice President and 44 1990 Chief Commercial Banking Officer 1992-1994 Executive Vice President - Special Industries Banking 1991 Executive Vice President - Communications, Entertainment, and Publishing Division\nRobert J. Mueller 1992-1996 Senior Executive Vice President - 54 1989 Chief Credit Policy Officer 1991-1992 Executive Vice President - Mortgage & Construction Lending\nNewton P.S. Merrill 1994-1996 Senior Executive Vice President - 56 1994 Trust, Investment Management and Private Banking 1991-1993 Senior Executive Vice President- The Bank of Boston\nRichard A. Pace 1991-1996 Executive Vice President and Chief 50 1989 Technologist\nThere are no family relationships between the executive officers of the Company. The terms of office of the executive officers of the Company extend until the annual organizational meeting of the Board of Directors.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION - -------------------------------- The material responsive to such item in the Company's definitive Proxy Statement for its 1996 Annual Meeting of Shareholders is incorporated by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - ------------------------------------------------------------------------ The material responsive to such item in the Company's definitive Proxy Statement for its 1996 Annual Meeting of Shareholders is incorporated by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - -------------------------------------------------------- The material responsive to such item in the Company's definitive Proxy Statement for its 1996 Annual Meeting of Shareholders is incorporated by reference.\nPART IV - -------\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K - -------------------------------------------------------------------------- (a) 1 Financial Statements:\nSee Item 8.\n(a) 2 Financial Statement Schedules:\nFinancial statement schedules are omitted since the required information is either not applicable, not deemed material, or is shown in the respective financial statements or in the notes thereto.\n(a) 3 Listing of Exhibits:\nExhibit No. Per Regulation S-K Description - -------------- -----------\n3 (a) The By-Laws of The Bank of New York Company, Inc. as amended through October 13, 1987. (Filed as Exhibit 3(a) to the Company's 1987 Annual Report on Form 10-K and incorporated herein by reference.)\n(b) Restated Certificate of Incorporation of The Bank of New York Company, Inc. dated July 20, 1994. (Filed as Exhibit 4 to Form 10-Q filed by the Company on November 10, 1994 and incorporated herein by reference.)\n4 (a) None of the outstanding instruments defining the rights of holders of long-term debt of the Company represent long-term debt in excess of 10% of the total assets of the Company. The Company hereby agrees to furnish to the Commission, upon request, a copy of any of such instruments.\n(b) Rights Agreement, including form of Preferred Stock Purchase Rights, incorporated herein by reference to the Company's Registration Statement on Form 8-A dated December 18, 1985.\n(c) First Amendment, dated as of June 13, 1989, to the Rights Agreement,including form of Preferred Stock Purchase Right, dated as of December 10, 1985, between The Bank of New York Company, Inc. and The Bank of New York, as Rights Agent, incorporated by reference to the amendment on Form 8, dated June 14, 1989, to the registrant's Registration Statement on Form 8-A, dated December 18, 1985.\n(d) Second Amendment, dated as of April 30, 1993, to the Rights Agreement, including form of Preferred Stock Purchase Right, dated as of December 10, 1985, between The Bank of New York Company, Inc. and The Bank of New York, as Rights Agent, incorporated by reference to the amendment on Form 8-A\/A, dated April 30, 1993, to the registrant's Registration Statement on Form 8-A dated December 18, 1985.\n(e) Third Amendment, dated as of March 8, 1994, to the Rights Agreement, dated as of December 10, 1985, between The Bank of New York Company, Inc. and The Bank of New York, as Rights Agent, incorporated by reference to Exhibit 4(a) to the Company's Current Report on Form 8-K for the Report Date March 8, 1994.\n10 (a) 1984 Stock Option Plan of The Bank of New York Company, Inc. as amended through February 23, 1988. (Filed as Exhibit 10(a) to the Company's 1988 Annual Report on Form 10-K and incorporated herein by reference.)*\n(b) Amendment dated October 11, 1994 to 1984 Stock Option Plan of The Bank of New York Company, Inc. (Filed as Exhibit 10(b) to the Company's 1994 Annual Report on Form 10-K and incorporated herein by reference.)*\n(c) The Bank of New York Company, Inc. Excess Contribution Plan as amended through July 10, 1990. (Filed as Exhibit 10(b) to the Company's 1990 Annual Report on Form 10-K and incorporated herein by reference.)*\nExhibit No. Per Regulation S-K Description - -------------- -----------\n10 (d) Amendments to The Bank of New York Company, Inc. Excess Contribution Plan dated February 23, 1994 and November 9, 1993. (Filed as Exhibit 10(c) to the Company's 1993 Annual Report on Form 10-K and incorporated herein by reference.)*\n(e) Amendment to The Bank of New York Company, Inc. Excess Contribution Plan dated November 14, 1995.*\n(f) The Bank of New York Company, Inc. Excess Benefit Plan as amended through December 8, 1992. (Filed as Exhibit 10(d) to the Company's 1992 Annual Report on Form 10-K and incorporated herein by reference.)*\n(g) Amendments to The Bank of New York Company, Inc. Excess Benefit Plan dated February 23, 1994 and November 9, 1993. (Filed as Exhibit 10(e) to the Company's 1993 Annual Report on Form 10-K and incorporated herein by reference.)*\n(h) Amendment dated May 10, 1994 to The Bank of New York Company, Inc. Excess Benefit Plan. (Filed as Exhibit 10(g) to the Company's 1994 Annual Report on Form 10-K and incorporated herein by reference.)*\n(i) Amendment to The Bank of New Company, Inc. Excess Benefit Plan dated November 14, 1995.*\n(j) 1994 Management Incentive Compensation Plan of The Bank of New York Company, Inc. (Filed as Exhibit 10(g) to the Company's 1993 Annual Report on Form 10-K and incorporated herein by reference.)*\n(k) 1988 Long-Term Incentive Plan as amended through December 8, 1992. (Filed as Exhibit 10(f) to the Company's 1992 Annual Report on Form 10-K and incorporated herein by reference.)*\n(l) Amendment dated October 11, 1994 to the 1988 Long-Term Incentive Plan of The Bank of New York Company, Inc. (Filed as Exhibit 10(j) to the Company's 1994 Annual Report on Form 10-K and incorporated herein by reference.)*\n(m) The Bank of New York Company, Inc. 1993 Long-Term Incentive Plan. (Filed as Exhibit 10(m) to the Company's 1992 Annual Report on Form 10-K and incorporated herein by reference.)*\n(n) Amendment dated October 11, 1994 to the 1993 Long-Term Incentive Plan of The Bank of New York Company, Inc. (Filed as Exhibit 10(l) to the Company's 1994 Annual Report on Form 10-K and incorporated herein by reference.)*\n(o) The Bank of New York Company, Inc. Supplemental Executive Retirement Plan. (Filed as Exhibit 10(n) to the Company's 1992 Annual Report on Form 10-K and incorporated herein by reference.)*\n(p) Amendment to The Bank of New York Company, Inc. Supplemental Executive Retirement Plan dated March 9, 1993. (Filed as Exhibit 10(k) to the Company's 1993 Annual Report on Form 10-K and incorporated herein by reference.)*\nExhibit No. Per Regulation S-K Description - --------------- ------------ 10 (q) Amendment effective October 11, 1994 to The Bank of New York Company, Inc. Supplemental Executive Retirement Plan. (Filed as Exhibit 10(o) to the Company's 1994 Annual Report on Form 10-K and incorporated herein by reference.)*\n(r) Trust Agreement dated April 19, 1988 related to certain executive compensation plans and agreements. (Filed as Exhibit 10(h) to the Company's 1988 Annual Report on Form 10-K and incorporated herein by reference.)*\n(s) Trust Agreement dated November 16, 1993 related to certain executive compensation plans and agreements. (Filed as Exhibit 10(m) to the Company's 1993 Annual Report on Form 10-K and incorporated herein by reference.)*\n(t) Amendment dated October 11, 1994 to Trust Agreement dated November 16, 1993, related to certain executive compensation plans and agreements.* (Filed as Exhibit 10(r) to the Company's 1994 Annual Report on Form 10-K and incorporated herein by reference.)*\n(u) Trust Agreement dated December 15, 1994 related to certain executive compensation plans and agreements.* (Filed as Exhibit 10(s) to the Company's 1994 Annual Report on Form 10-K and incorporated herein by reference.)*\n(v) Form of Remuneration Agreement between the Company and two of the five most highly compensated executive officers of the Company. (Filed as Exhibit 10 to the Company's 1982 Annual Report on Form 10-K and incorporated herein by reference.)*\n(w) Form of Tax Reimbursement Agreement dated as of July 13, 1994 between the Company and two of the five most highly compensated executive officers of the Company.* (Filed as Exhibit 10(u) to the Company's 1994 Annual Report on Form 10-K and incorporated herein by reference.)*\n(x) Form of Remuneration Agreement dated October 11, 1994 between the Company and three of the five most highly compensated officers of the Company.* (Filed as Exhibit 10(v) to the Company's 1994 Annual Report on Form 10-K and incorporated herein by reference.)*\n(y) The Bank of New York Company, Inc. Retirement Plan for Non-Employee Directors. (Filed as Exhibit 10(r) to the Company's 1993 Annual Report on Form 10-K and incorporated herein by reference.)*\n(z) Amendment dated November 8, 1994 to The Bank of New York Company, Inc. Retirement Plan for Non-Employee Directors.* (Filed as Exhibit 10(x) to the Company's 1994 Annual Report on Form 10-K and incorporated herein by reference.)*\n(aa) Deferred Compensation Plan for Non-Employee Directors of The Bank of New York Company, Inc. (Filed as Exhibit 10(s) to the Company's 1993 Annual Report on Form 10-K and incorporated herein by reference.)*\nExhibit No. Per Regulation S-K Description - -------------- -----------\n(bb) Amendment dated November 8, 1994 to the Deferred Compensation Plan for Non-Employee Directors of The Bank of New York Company, Inc.* (Filed as Exhibit 10(z) to the Company's 1994 Annual Report on Form 10-K and incorporated herein by reference.)*\n11 Statement - Re: Computation of Per Common Share Earnings\n12 Statement - Re: Computation of Earnings to Fixed Charges Ratios\n13 Portions of the 1995 Annual Report to Shareholders\n21 Subsidiaries of the Registrant\n23 Consent of Deloitte & Touche LLP\n27 Financial Data Schedule\n- ------------------- * Indicates a management contract or compensatory plan or arrangement.\n(b) Reports on Form 8-K:\nOctober 16, 1995: Unaudited interim financial information and accompanying discussion for the third quarter of 1995.\nNovember 14, 1995: A press release announcing the Company's plan to buy back up to 16 million of its outstanding common shares.\nJanuary 16, 1996: Unaudited interim financial information and accompanying discussion for the fourth quarter of 1995.\nMarch 12, 1996: The Company's disclosure statement with respect to dismissing Deloitte & Touche LLP and appointing Ernst & Young LLP as the Company's independent accountants, and a letter to the Securities and Exchange Commission from Deloitte & Touche LLP agreeing with the Company's disclosure statement; as subsequently amended on From 8-K\/A.\n(c) Exhibits:\nSubmitted as a separate section of this report.\n(d) Financial Statements Schedules:\nNone\nSIGNATURES - ----------\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized in New York, New York, on the 12th day of March, 1996.\nTHE BANK OF NEW YORK COMPANY, INC.\nBy: \\s\\ Deno D. Papageorge ------------------------------------- (Deno D. Papageorge, Senior Executive Vice President)\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been duly signed below by the following persons on behalf of the registrant and in the capacities indicated on the 12th day of March, 1996.\nSignature Title --------- -----\n\\s\\J. Carter Bacot Chairman and - ----------------------------------- Chief Executive Officer (J. Carter Bacot) (principal executive officer)\n\\s\\ Deno D. Papageorge Senior Executive Vice President - ----------------------------------- (principal financial officer) (Deno D. Papageorge)\n\\s\\ Robert E. Keilman Comptroller - ------------------------------------ (principal accounting officer) (Robert E. Keilman)\n\\s\\ Richard Barth Director - ------------------------------------ (Richard Barth)\n\\s\\ Frank J. Biondi, Jr. Director - ------------------------------------ (Frank J. Biondi, Jr.)\n\\s\\ William R. Chaney Director - ------------------------------------ (William R. Chaney)\n\\s\\ Samuel F. Chevalier Vice Chairman and Director - ------------------------------------ (Samuel F. Chevalier)\n\\s\\ Anthony P. Gammie Director - ------------------------------------ (Anthony P. Gammie)\n\\s\\ Ralph E. Gomory Director - ------------------------------------ (Ralph E. Gomory)\n\\s\\ Alan R. Griffith Vice Chairman - ------------------------------------ and Director (Alan R. Griffith)\n\\s\\ Edward L. Hennessy, Jr. Director - ------------------------------------ (Edward L. Hennessy, Jr.)\n\\s\\ John C. Malone Director - ------------------------------------ (John C. Malone)\n\\s\\ Donald L. Miller Director - ------------------------------------ (Donald L. Miller)\n\\s\\ H. Barclay Morley Director - ------------------------------------ (H. Barclay Morley)\n\\s\\ Martha T. Muse Director - ------------------------------------ (Martha T. Muse)\n\\s\\ Catherine A. Rein Director - ------------------------------------ (Catherine A. Rein)\n\\s\\ Thomas A. Renyi President and - ------------------------------------ Director (Thomas A. Renyi)\n\\s\\ Harold E. Sells Director - ------------------------------------ (Harold E. Sells)\n\\s\\ W. S. White, Jr. Director - ------------------------------------ (W. S. White, Jr.)\nINDEX TO EXHIBITS Exhibit No. - ------------ 3 (a) The By-Laws of The Bank of New York Company, Inc. as amended through October 13, 1987.*\n(b) Restated Certificate of Incorporation of The Bank of New York Company, Inc. dated July 20, 1994.*\n4 (a) None of the outstanding instruments defining the rights of holders of long-term debt of the Company represent long-term debt in excess of 10% of the total assets of the Company. The Company hereby agrees to furnish to the Commission, upon request, a copy of any of such instruments.\n(b) Rights Agreement, including form of Preferred Stock Purchase Rights.*\n(c) First Amendment, dated as of June 13, 1989, to the Rights Agreement, including form of Preferred Stock Purchase Right, dated as of December 10, 1985, between The Bank of New York Company, Inc. and The Bank of New York, as Rights Agent.*\n(d) Second Amendment, dated as of April 30, 1993, to the Rights Agreement, including form of Preferred Stock Purchase Right, dated as of December 10, 1985, between The Bank of New York Company, Inc. and The Bank of New York, as Rights Agent.*\n(e) Third Amendment, dated as of March 8, 1994, to the Rights Agreement, dated as of December 10, 1985, between The Bank of New York Company, Inc. and The Bank of New York, as Rights Agent.*\n10 (a) 1984 Stock Option Plan of The Bank of New York Company, Inc. as amended through February 23, 1988.*\n(b) Amendment dated October 11, 1994 to 1984 Stock Option Plan of The Bank of New York Company, Inc.*\n(c) The Bank of New York Company, Inc. Excess Contribution Plan as amended through July 10, 1990.*\n(d) Amendments to The Bank of New York Company, Inc. Excess Contribution Plan dated February 23, 1994 and November 9, 1993.*\n(e) Amendment to The Bank of New York Company, Inc. Excess Contribution Plan dated November 14, 1995.\n(f) The Bank of New York Company, Inc. Excess Benefit Plan as amended through December 8, 1992.*\n(g) Amendments to The Bank of New York Company, Inc. Excess Benefit Plan dated February 23, 1994 and November 9, 1993.*\n(h) Amendment dated May 10, 1994 to The Bank of New York Co., Inc. Excess Benefit Plan.*\n(i) Amendment to The Bank of New York Company, Inc. Excess Benefit Plan dated November 14,1995.\n(j) 1994 Management Incentive Compensation Plan of The Bank of New York Company, Inc.*\n(k) 1988 Long-Term Incentive Plan as amended through December 8, 1992.*\n(l) Amendment dated October 11, 1994 to the 1988 Long-Term Incentive Plan of The Bank of New York Company, Inc.*\nINDEX TO EXHIBITS Exhibit No. - ----------- 10 (m) The Bank of New York Company, Inc. 1993 Long-Term Incentive Plan.*\n(n) Amendment dated October 11, 1994 to the 1993 Long-Term Incentive Plan of The Bank of New York Company, Inc.*\n(o) The Bank of New York Company, Inc. Supplemental Executive Retirement Plan.*\n(p) Amendment to The Bank of New York Company, Inc. Supplemental Executive Retirement Plan dated March 9, 1993.*\n(q) Amendment effective October 11, 1994 to The Bank of New York Company, Inc. Supplemental Executive Retirement Plan.*\n(r) Trust Agreement dated April 19, 1988 related to executive compensation agreements.*\n(s) Trust Agreement dated November 16, 1993 related to deferred executive compensation agreements.*\n(t) Amendment dated October 11, 1994 to Trust Agreement dated November 16, 1993, related to executive compensation agreements.*\n(u) Trust Agreement dated December 15, 1994 related to certain executive compensation plans and agreements.*\n(v) Form of Remuneration Agreement between the Company and two of the five most highly compensated executive officers of the Company.*\n(w) Form of Tax Reimbursement Agreement dated as of July 13, 1994 between the Company and two of the five most highly compensated executive officers of the Company.*\n(x) Form of Remuneration Agreement dated October 11, 1994 between the Company and three of the five most highly compensated officers of the Company.\n(y) The Bank of New York Company, Inc. Retirement Plan for Non-Employee Directors.*\n(z) Amendment dated November 8, 1994 to The Bank of New York Company, Inc. Retirement Plan for Non-Employee Directors.*\n(aa) Deferred Compensation Plan for Non-Employee Directors of The Bank of New York Company, Inc.*\n(bb) Amendment dated November 8, 1994 to the Deferred Compensation Plan for Non-Employee Directors of The Bank of New York Company, Inc.*\n11 Statement - Re: Computation of Per Common Share Earnings\n12 Statement - Re: Computation of Earnings to Fixed Charges Ratios\n13 Portions of the 1995 Annual Report to Shareholders\n21 Subsidiaries of the Registrant\n23 Consent of Deloitte & Touche LLP\n27 Financial Data Schedule - ------------------- * Incorporated by reference","section_15":""}
{"filename":"73756_1995.txt","cik":"73756","year":"1995","section_1":"Item 1. BUSINESS.\nGeneral Development of Business\nOceaneering International, Inc., (together with its subsidiaries, \"Oceaneering\" or the \"Company\") is an advanced applied technology company which provides engineered services and hardware to customers who operate in marine, space and other harsh environments. The Company supplies a comprehensive range of integrated technical services to a wide array of industries and is one of the world's largest underwater services contractors. Principal services are provided to the oil and gas industry and include drilling support, subsea construction, production systems, facilities maintenance and repair, survey and positioning and specialized onshore and offshore engineering and inspection. Oceaneering was organized in 1969 out of the combination of three diving service companies founded in the early 1960s. Since its establishment, the Company has concentrated on the development and marketing of underwater services requiring the use of advanced deepwater technology. The Company conducts operations in the United States and 28 other countries. The Company's international operations, principally in the North Sea, Far East, Africa and the Middle East, accounted for approximately 51% of its 1995 fiscal year revenues, or $122,000,000.\nIn January 1990, the Company acquired all of the outstanding capital stock of Sonsub Limited, a United Kingdom company (\"Sonsub\"), whose principal assets were ten large and four small Remotely Operated Vehicles (\"ROVs\"). ROVs are unmanned submersible vehicles operated from the surface that are used widely in the offshore oil and gas industry.\nIn December 1990, the Company was awarded a contract by a major oil company to provide and maintain a Floating Production, Storage and Offloading (\"FPSO\") system offshore Gabon. This represented the first major project for the Company's Offshore Production Systems division (\"OPS\") which was formed to develop economical production alternatives for offshore oil and gas fields. A 78,000 deadweight ton (\"dwt\") tanker was purchased and converted into an FPSO for this project and was delivered to its first location in December 1991. The unit is currently operating offshore Angola. See Item 7 - \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nIn August 1992, the Company acquired Eastport International, Inc., (\"Eastport\"), a designer, developer and operator of advanced robotic systems and ROVs specializing in the non-oilfield market, in a transaction accounted for as a pooling of interests. All financial information herein has been restated to include the results of Eastport from Eastport's inception (June 21, 1989). Eastport's assets included two ROVs, one of which is rated for water depths to 25,000 feet, a deep tow sonar system and two other work ROVs.\nIn May 1993, the Company purchased the business and assets of the Space Systems Division of ILC Dover, Inc., (\"ILC\") which were consolidated with the Company's Oceaneering Space Systems division. This business designs, develops and fabricates spacecraft hardware and high temperature insulation products.\nIn July 1993, the Company purchased Oil Industry Engineering, Inc., a designer and fabricator of subsea control systems, which now operates as the Oceaneering Intervention Engineering division (\"OIE\"). In March 1994, the Company purchased the operating subsidiaries of Multiflex International Inc., a manufacturer of subsea control umbilical cables, which now operates as the Oceaneering Multiflex division (\"Multiflex\"). Together with the Company's existing Offshore Production Systems division, these acquisitions form the basis of the Company's continuing expansion in the Offshore Field Development business.\nThe Company intends to pursue a strategy of acquiring, as opportunities arise, additional assets or businesses, either directly through merger, consolidation, or purchase or indirectly through joint ventures. The Company is also applying its skills and technology in further developing business unrelated to the oil and gas industry and performing services for the United States and foreign governments and the telecommunications, aerospace, insurance, marine and environmental remediation industries. Financial Information About Industry Segments\nThe table containing revenues, operating income and assets by business segment for the fiscal years ended March 31, 1995, 1994 and 1993 is incorporated herein by reference from Note 6 of the Notes to Consolidated Financial Statements.\nDescription of Business\nOILFIELD MARINE SERVICES\nThe Company's Oilfield Marine Services business consists of underwater construction, underwater and above-water inspection and maintenance (including repair) and survey. All of these services are frequently provided to customers on an integrated basis.\nUnderwater Construction, Maintenance and Inspection. The Company provides underwater support services for all phases of offshore oil and gas operations - exploration, development and production. During the exploration phase, the Company provides positioning, placement and monitoring of subsea exploration equipment, collects data on seafloor characteristics at proposed drilling sites and assists with the navigational positioning of drilling rigs. During the development phase, the Company's underwater crews assist with the installation of production platforms and the connection of subsea pipelines. During the production phase, the Company inspects, maintains and repairs offshore platforms, pipelines and subsea equipment. Such services include testing, monitoring and replacing cathodic protection devices and inspecting platforms and pipelines for defects and unsupported spans, which the Company may then be contracted to repair or replace. Following production, the Company's salvage crews assist with the removal of the platforms and restoration of the seabed to its original condition.\nThe Company's underwater services require the use of a variety of techniques and equipment. Underwater services are performed by divers or through the use of advanced work systems such as manned Atmospheric Diving Systems (\"ADSs\") and unmanned ROVs. The Company uses ROVs to provide underwater services at depths or in situations in which diving would be uneconomical or infeasible. An ROV may be outfitted with manipulators, sonar, television cameras, specialized tooling packages and other equipment or features to facilitate the performance of underwater tasks. The Company currently owns over 70 ROVs.\nWhen a project requires manned intervention, the Company uses divers or ADS technology. An ADS encloses the operator in a one-atmosphere (surface pressure) diving suit or manipulator diving bell. The Company operates two types of ADSs. The first type, the WASP, is a one-man suit equipped with manipulators to allow the operator to perform gripping and turning actions. The WASP ADSs work in water depths from the surface to 2,000 feet. The other type of ADS is a tethered diving bell equipped with a manipulator arm. The bell carries two operators to water depths of 3,000 feet. The WASP and the tethered manipulator diving bell have onboard life-support systems and are capable of providing audiovisual transmissions to the surface. The Company does not use divers (as distinguished from ADS operators) to perform functions in water depths greater than 1,000 feet. Revenues of the Company from all business segments attributable to ADS and ROV services for the fiscal years ended March 31, 1995, 1994 and 1993 were $55,000,000, $57,000,000 and $49,000,000 respectively.\nUnderwater services using all of these techniques are performed from drilling rigs, platforms, barges and vessels.\nAbove-Water Inspection Services. Through its Solus Schall division (\"Solus Schall\"), the Company offers a wide range of inspection services to customers required to obtain third party inspections to satisfy contractual structural specifications and requirements, internal safety standards or regulatory requirements. Historically, the Company has focused on the inspection of pipelines and onshore fabrication of offshore facilities for the oil and gas industry. The Company also conducts onsite inspections of refineries, nuclear and conventional power stations and operates laboratory facilities for the testing of aero-engine components and other manufacturing equipment. Certain of Solus Schall's pipeline inspection activities are performed through the use of specialized X-ray crawlers, which travel independently inside pipelines, stopping to perform radiographic inspection of welds. Solus Schall derives the majority of its revenues from foreign operations.\nIn connection with Solus Schall's inspection services (both onshore and offshore), the Company developed a computer-aided method of managing inspection data, which consists of a software package that provides a standardized format for the storage, retrieval and analysis of multi-year inspection data. Originally developed for platform inspections, the software has been expanded for use in the inspection of pipelines, vessels and refinery piping. Survey Services. The Company provides a range of survey and navigational positioning services for the oil and gas industry, as well as ocean search and recovery projects. Applications include surface positioning for rig moves and the installation of pipelines and platforms, subsea positioning and acoustics, geophysical surveys, deep tow surveys and pipeline surveys.\nOFFSHORE FIELD DEVELOPMENT\nMobile Offshore Production Systems. OPS was established as a group during fiscal 1989 to provide subsea intervention services and the engineering, procurement, construction, installation and operation of mobile offshore production systems (\"MOPS\") to customers for marginal and remote field production and extended well testing. OPS has been awarded several contracts pertaining to MOPS activities and subsea workover and maintenance needs, including deepwater extended well testing in the Gulf of Mexico and has served as prime contractor on an extended well testing project in the North Sea. In December 1990, the Company was awarded its first major MOPS contract for the provision of an FPSO involving the conversion of a 78,000 dwt tanker into an FPSO for the production, processing, storage and offloading of oil into shuttle tankers. The unit has been operating offshore West Africa since December 1991.\nSubsea Products. OIE, Multiflex and the Pipeline Repair Systems unit of the Company form the Subsea Products group which complements the activities of the OPS group. OIE includes the subsea intervention business previously carried out by OPS and the subsea control systems business acquired in July 1993. OIE now provides subsea intervention services, design and fabrication of ROV interface tooling, including ROV replaceable and ROV operable valves, and design and fabrication of subsea control systems.\nIn March 1994, the Company acquired the business of Multiflex which has facilities in Houston, Texas and Edinburgh, Scotland for the production of subsea control umbilical cables. These cables are used for the remote operation of subsea installations and equipment and typically incorporate both electrical and hydraulic control lines.\nADVANCED TECHNOLOGIES\nSince fiscal 1986, the Company has provided project management, engineering services and equipment to non-oilfield customers for applications in harsh environments. The Company serves government, industrial marine, space and environmental remediation services markets by using existing assets for new customers and by extending the use of technology developed in oilfield operations to new applications. Two separate divisions of Oceaneering - Oceaneering Technologies (\"OTECH\") and Oceaneering Space Systems (\"OSS\") - perform these services.\nMarine. OTECH performs work for customers having specialized requirements underwater or in other harsh environments. Customers include U.S. and foreign governments and the telecommunications, aerospace, insurance and environmental remediation industries. Since 1982, the Company has provided deep ocean search and recovery services on behalf of the United States government, including the U.S. Navy and the National Aeronautics and Space Administration (\"NASA\"). In other services for the Navy, Oceaneering provides various engineering and underwater services ranging from aircraft salvage and recovery operations to inspection and maintenance of the Navy's fleet of surface ships and submarines. The Company also maintains and operates deepwater cable lay and maintenance vehicles on behalf of American Telephone & Telegraph Company.\nOTECH operates ROVs that are rated for work in water depths from the surface to 25,000 feet. In June 1990, the Company purchased an ROV that has worked in water depths to 14,700 feet and is capable of working in water depths to 20,000 feet. Assets acquired with Eastport include an ROV designed for use in water depths to 25,000 feet. The more advanced ROVs owned by the Company are equipped with lighter umbilical cords containing optic fibers which allow for improved communications with the surface. Other specialized equipment owned by the Company includes ROV cable lay and maintenance equipment and deep tow, side scan sonar systems which are rated for use in 20,000 feet. One of the Company's deep tow systems has been used to locate downed aircraft in water depths to 14,700 feet.\nEngineering. OSS directs the Company's efforts towards applying undersea technology and experience in the space industry. The Company has worked with NASA and NASA subcontractors on a variety of projects including portable life-support systems, decompression techniques, tools and robotic systems, and standards and guidelines to ensure robotic compatibility for space station equipment and payloads. OSS is developing cryogenic life- support system technology for neutral buoyancy testing and future space missions. Related life-support technology has been developed for future use by environmental remediation workers and fire fighters. OSS was expanded in fiscal 1994 by the purchase of the assets of ILC. ILC had supported NASA by producing space shuttle crew support equipment, including the design, development and fabrication of spacecraft extravehicular and intravehicular hardware and soft goods, air crew life-support equipment, mechanical and electromechanical devices and high temperature insulation. These activities have continued, and the Company is providing advanced refrigeration equipment for use on the International Space Station. The activities of OSS are substantially dependent on continued government funding for the nation's space program. OTECH designs and develops specialized tools and builds ROV systems to customer specifications for use in deepwater and hazardous environments. It also develops ROVs for the Company including associated ROV control vans and computer-based control systems. In April 1990, the Company delivered a remotely operated cable burial and repair system to a group of international telecommunications companies, and in fiscal 1992, delivered a second remotely operated cable burial and repair system for telecommunications use and an ROV system for salvage work.\nMARKETING\nOilfield Marine Services. The Company markets its services primarily to international and foreign national oil and gas companies. It also provides services as a subcontractor to companies operating as prime contractors. Contracts are typically awarded on a competitive bid basis and are for the most part short-term. See Item 7 - \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.\"\nOffshore Field Development. The Company markets both its mobile offshore production systems and subsea products primarily to international and foreign national oil and gas companies, utilizing the Company's existing administrative structure to identify potential business opportunities. MOPS are offered for extended well testing, early production and development of marginal fields and prospects in areas lacking pipelines and processing infrastructure. Contracts are typically awarded on a competitive basis, generally for periods of one or more years. The Company owns one MOPS unit, which is currently contracted. Further equipment will be added as profitable opportunities arise. The Company believes that Multiflex enables it to identify market opportunities at an earlier stage as umbilical design is typically part of the initial planning phase in field development. The Company is able to offer an integrated service consisting of design, engineering, project management and provision of hardware.\nAdvanced Technologies. The Company markets its marine services and related engineering services to government agencies, major defense contractors, NASA subcontractors and to telecommunications, construction and other industrial customers outside the energy sector. The Company also markets to insurance companies, salvage associations and other customers who have requirements for specialized operations in deep water. Marketing efforts in the environmental remediation business are directed towards the petrochemical industry.\nMajor Customers. Five principal customers of the Company accounted for approximately 34%, 36% and 31% of the Company's consolidated revenues in fiscal 1995, 1994 and 1993, respectively. The Royal Dutch Shell group of companies accounted for more than 10% of the Company's consolidated revenues in fiscal 1995, 1994 and 1993. Also see Note 6 of the Notes to Consolidated Financial Statements.\nCOMPETITION\nThe Company's businesses are highly competitive.\nOilfield Marine Services. The Company believes that it is one of five companies that provides underwater services on a worldwide basis. The Company competes for contracts with the other four worldwide companies and with numerous companies operating locally in various areas. Competition for underwater services historically has been based on the type of underwater equipment available, location of or ability to deploy such equipment, quality of service and price. In recent years, price has been the most important factor in obtaining contracts; however, the ability to develop improved equipment and techniques and to attract and retain skilled personnel is also an important competitive factor in the Company's markets. The number of the Company's competitors is inversely correlated with water depth, as less sophisticated equipment and technology is required in shallow water. With respect to projects that require less sophisticated equipment or diving techniques, small companies have sometimes been able to bid for contracts at prices uneconomic to the Company.\nThe Company believes that its ability to provide a wide range of underwater services, including technological applications in deeper water on a worldwide basis, should enable it to compete effectively in the oilfield exploration and development market. As a result of uncertainty and volatility in oil and gas pricing generally, oil and gas exploration and development expenditures fluctuate from year to year. In particular, budgetary approval for more expensive drilling and production in deeper water or harsh environments, areas in which the Company believes it has a competitive advantage, may be postponed or suspended. In some areas, the ability of the Company to obtain contracts depends upon its ability to charter vessels for use as work platforms. On occasion, the Company will bid jointly with vessel owners for contracts, and it endeavors to develop ongoing relations with various vessel owners.\nThe worldwide inspection market consists of a wide range of inspection and certification requirements in many industries. Solus Schall competes in only selected portions of this market. The Company believes that its broad geographic sales and operational coverage, long history of operations, technical reputation, application of X-ray crawler pipeline radiography and accreditation to international quality standards enable it to compete effectively in its selected inspection services market segments.\nIn the North Sea and, to a lesser extent, in other areas, oil and gas companies utilize prequalification procedures that reduce the number of prospective bidders for their projects. In certain countries political considerations tend to favor local contractors.\nOffshore Field Development. The Company believes that it is well positioned to compete in the offshore field development market through its ability to identify and offer optimum solutions, supply equipment, provide capital on a limited basis and utilize the expertise in associated subsea technology and offshore construction and operations gained through its extensive operational experience worldwide. The Company is one of several companies that offer leased MOPS units. Potential competitors include companies having underutilized assets such as drilling rigs and tankers, although access to the capital needed to convert units to MOPS may be a limiting factor.\nAlthough there are several competitors offering either specialized products or operating in limited geographic areas, the Company believes that it is one of two companies who compete on a worldwide basis for the provision of subsea control umbilical cables.\nAdvanced Technologies. The Company believes that its specialized ROV assets and experience in deep water operations give it a competitive advantage in obtaining contracts in water depths greater than 5,000 feet. The number of the Company's competitors is inversely correlated with water depth, due to the advanced technical knowledge and sophisticated equipment required for deep water operations.\nEngineering services is a very broad market with a large number of competitors. The Company competes in specialized areas in which it can combine its extensive program management experience, engineering services and the capability to continue the development of conceptual project designs into the manufacture of prototype equipment.\nThe Company also utilizes the administrative structure of the Oilfield Marine Services business to identify opportunities in foreign countries and to provide additional local support for non-oil and gas customers.\nSEASONALITY, BACKLOG AND RESEARCH AND DEVELOPMENT\nA material amount of the Company's revenues is generated by contracts for marine services in the Gulf of Mexico and North Sea, which are usually seasonal from April through November. Revenues in the Offshore Field Development and Advanced Technologies segments are generally not seasonal.\nThe amounts of backlog orders believed to be firm for Oilfield Marine Services as of March 31, 1995 and 1994 were $94,000,000 and $69,000,000, respectively. Of these amounts, $39,000,000 and $28,000,000, respectively, were not expected to be performed within the fiscal year following such respective dates. At March 31, 1995 and 1994, the Company had approximately $27,000,000 and $25,000,000, respectively, in backlog for Offshore Field Development, all of which was expected to be completed within the fiscal year following such respective dates. At March 31, 1995 and 1994, the Company had approximately $39,000,000 and $22,000,000, respectively, in backlog for Advanced Technologies. Of these amounts, $12,000,000 and none, respectively, were not expected to be performed within the fiscal year following such respective dates. At March 31, 1995 the Company had approximately $7,000,000 of additional contracted work for Advanced Technologies which is not funded and is substantially dependent upon continued government funding for the nation's space program.\nNo material portion of the Company's business is subject to renegotiation of profits or termination of contracts by the United States government.\nThe Company's research and development expenditures were approximately $3,600,000, $3,700,000 and $6,500,000 during fiscal 1995, 1994 and 1993, respectively. These amounts do not include, nor is the Company able to determine, the expenditures by others in connection with joint research activities in which the Company participated or expenditures by the Company in connection with research conducted during the course of performing field operations.\nREGULATION\nThe Company's operations are subject to various types of governmental regulation. The Company's operations are affected from time to time and in varying degrees by foreign and domestic political developments and foreign, federal and local laws and regulations. In particular, oil and gas production operations and economics are affected by price control, tax, environmental and other laws relating to the petroleum industry, by changes in such laws and by constantly changing administrative regulations. Such developments may directly or indirectly affect the Company's operations and those of its customers.\nCompliance with federal, state and local provisions regulating the discharge of materials into the environment or relating to the protection of the environment has not had a material impact on the Company's capital expenditures, earnings or competitive position.\nIn connection with its foreign operations, the Company is required in some countries to obtain licenses or permits in order to bid on contracts or otherwise to conduct business operations. Some foreign countries require that the Company enter into a joint venture or similar business arrangement with local individuals or businesses in order to conduct business.\nWhile not a formal requirement, Oceaneering's quality management systems are certified to the British Standard BS 5750 Part 2:1987, which is the equivalent of ISO 9002, covering the full range of subsea and topside services offered in the United Kingdom. The quality management systems of both the OIE and Multiflex units of the Subsea Products Group are certified to ISO 9001 for their products and services.\nRISKS AND INSURANCE\nThe Company's operations are subject to all the risks normally incident to offshore exploration, development and production, including claims under U.S. maritime laws. These risks could result in damage to or loss of property, suspension of operations and injury to or death of personnel. The Company insures its real and personal property and equipment. The Company's vessels are insured against damage or loss, including war and pollution risks. The Company also carries workers' compensation, maritime employer's liability, general liability, including third party pollution, and other insurance customary in its businesses. All insurance is carried at levels of coverage and deductibles which the Company considers financially prudent. On some contracts, the Company may have certain exposures for loss or damage to the customer's facilities or for unexpected weather delays, which the Company may cover by special insurance when it deems advisable. Due to the very high costs for limited coverage and, in the Company's opinion, limited exposure, the Company does not carry professional liability insurance. In some jurisdictions, legal pleadings in personal injury actions may include a claim for an amount of punitive damages which may not be covered by insurance. A significant part of the Company's operations is conducted outside the United States. For the fiscal years ended March 31, 1995, 1994 and 1993, foreign operations accounted for 51%, 61% and 66% of the Company's revenues, respectively.\nForeign operations are subject to additional political and economic uncertainties, including the possibility of repudiation of contracts and confiscation of property, fluctuations in currency exchange rates, limitations on repatriation of earnings and foreign exchange controls. Typically, the Company is able to limit the currency risks by arranging compensation in United States dollars or freely convertible currency and, to the extent possible, limiting acceptance of blocked currency to amounts which match its expense requirements in local currencies.\nCertain of the countries in which the Company operates have enacted exchange controls to regulate foreign currency exchange. Exchange controls in some of the countries in which the Company operates provide for conversion of local currency into foreign currency for payment of debts, equipment rentals, technology transfer, technical assistance and other fees or repatriation of capital. Transfers of profits and dividends can be restricted or limited by exchange controls.\nEMPLOYEES\nAs of March 31, 1995, the Company had approximately 1,900 employees. The Company's work force varies seasonally and peaks during the summer months. None of the Company's domestic employees is currently represented by a labor union. Approximately 6% of the Company's employees are represented by unions in foreign countries. The Company considers its relations with its employees to be satisfactory. Foreign and Domestic Operations and Export Sales\nThe table presenting revenues, profitability and assets attributable to each of Oceaneering's geographic areas for the fiscal years 1995, 1994 and 1993 is incorporated herein by reference from Note 6 of the Notes to Consolidated Financial Statements.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES.\nSee Item 1 - \"Business - Description of Business - Oilfield Marine Services, Offshore Field Development and Advanced Technologies\" for a description of equipment used in providing the Company's services.\nOceaneering maintains office, shop and yard facilities in various parts of the world. In these locations, the Company typically leases office facilities to house its administrative and engineering staff, shops equipped for fabrication, testing, repair and maintenance activities and warehouses and yard areas for storage and mobilization of equipment en route to work sites. The largest of such properties is located in Morgan City, Louisiana and consists of 146,500 total square feet, of which 25,300 square feet are covered office and storage space owned by the Company and the remainder is leased. The Company owns and leases property in Singapore of approximately 28,700 square feet, of which 16,200 square feet are owned. The Company leases 31,000 square feet of office space and 42,800 square feet of yard area in Aberdeen, Scotland. Other major leased properties include approximately 24,600 square feet in Dubai, United Arab Emirates, and 37,000 square feet in Port Harcourt, Nigeria. These properties are used primarily by the Oilfield Marine Services business segment of the Company. Leased properties utilized primarily by the Offshore Field Development segment consist of 53,500 square feet of workshop and office space in Houston, Texas and manufacturing facilities in Houston, Texas and Edinburgh, Scotland, of 96,000 square feet and 70,000 square feet, respectively. In addition, the Company owns manufacturing facilities in Magnolia, Texas of 65,000 square feet. The Company also leases approximately 116,000 square feet in Upper Marlboro, Maryland, which includes 86,000 square feet of offices and workshops and approximately 50,000 square feet of offices and workshops in Houston, Texas, which are utilized by the Advanced Technologies business segment.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS.\nThe business of Oceaneering ordinarily results in actions for damages alleging personal injury under the general maritime laws of the United States, including the Jones Act, for alleged negligence. The Company reports actions for personal injury to its insurance carriers and believes that the settlement or disposition of such suits will not have a material effect on its financial position or results of operations. The information set forth under \"Commitments and Contingencies - Litigation\" in Note 5 of the Notes to Consolidated Financial Statements 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, through the solicitation of proxies or otherwise, during the fourth quarter of the fiscal year ended March 31, 1995.\nItem 4a. EXECUTIVE OFFICERS OF THE REGISTRANT.\nExecutive Officers. The following is information with respect to the executive officers of Oceaneering International, Inc., as of June 1, 1995:\nOFFICER EMPLOYEE NAME AGE POSITIONS SINCE SINCE\nJohn R. Huff 49 Chairman of the Board, 1986 1986 President and Chief Executive Officer\nT. Jay Collins 48 Executive Vice President - 1993 1993 Oilfield Marine Services\nStephen Helburn 48 Senior Vice President - 1984 1982 Asia\nF. Richard Frisbie 52 Senior Vice President - 1981 1974 Marketing and Technology\nMarvin J. Migura 44 Senior Vice President and 1995 1995 Chief Financial Officer\nGeorge R. 47 Vice President, General 1988 1988 Haubenreich, Jr. Counsel and Secretary\nRichard V. Chidlow 51 Controller and Chief 1990 1987 Accounting Officer\nEach executive officer serves at the discretion of the Chief Executive Officer and the Board of Directors and is subject to reelection or reappointment each year after the annual meeting of shareholders.\nOceaneering does not know of any arrangement or understanding between any of the above persons and any other person or persons pursuant to which he was selected or appointed as an officer.\nFamily Relationships. There are no family relationships between any director or executive officer.\nBusiness Experience. John R. Huff has been a director, President and Chief Executive Officer of the Company since 1986. He was elected Chairman of the Board in August 1990. Prior to joining the Company in August 1986, he served from May 1980 until January 1986 as Chairman and President of Western Oceanic Inc., the offshore drilling subsidiary of The Western Company of North America (\"Western Oceanic\"). From February 1986 through July 1986, he was Managing Partner of an investment banking group specializing in the energy industry. He is a director of BJ Services Company, Triton Energy Corporation and Production Operators Corp.\nT. Jay Collins, Executive Vice President, joined the Company in October 1993 as Senior Vice President and Chief Financial Officer. In May 1995, he was appointed Executive Vice President of the Company's Oilfield Marine Services business. From 1986 to 1992 he was with Teleco Oilfield Services, Inc., most recently as Executive Vice President of Finance and Administration and previously as Senior Vice President of Operations. Prior to Teleco, he spent twelve years with Sonat, Inc., serving as Senior Vice President of Finance at Sonat Offshore Drilling and President of Houston Systems Manufacturing. His operational experience with Sonat Offshore Drilling includes international management in Venezuela, Singapore, Egypt and Ivory Coast.\nStephen Helburn, Senior Vice President - Asia, joined the Company in 1982 as General Manager of the Gulf Coast Division and served as Vice President - Americas Region from 1987 to 1990 and as Senior Vice President - Worldwide Operations from 1990 to 1995. He has over 20 years of experience in the underwater services industry. From 1972 to 1978, he was an engineer with Chicago Bridge & Iron Industries, Inc., (\"CBI\"), where he was responsible for a variety of projects including wet welding development research, project management and construction. From 1979 to 1982, he was manager of the underwater welding division of Seacon Services, Inc., the offshore subsidiary of CBI.\nF. Richard Frisbie, Senior Vice President - Marketing and Technology, joined the Company in 1984 when Solus Ocean Systems, Inc., (\"SOSI\") was acquired. From 1974 to 1984, he held various engineering and management positions with SOSI and its predecessors. Over the past 20 years, he has been responsible for various technical developments in remotely operated underwater vehicle designs and the use of robotics and remotely operated devices for applications in harsh environments, including nuclear power plants. He also has previous experience in the aerospace industry.\nMarvin J. Migura, Senior Vice President and Chief Financial Officer, joined the Company in 1995. From 1987 to 1994, he was employed as Senior Vice President and Chief Financial Officer with Zapata Corporation, a diversified energy services company. From 1975 to 1987 he held various financial positions with Zapata Corporation.\nGeorge R. Haubenreich, Jr. joined the Company in June 1988 as Vice President, General Counsel and Secretary. From 1979 until joining the Company, he held various legal positions with The Coastal Corporation, a diversified energy company, his last being Senior Staff Counsel. From 1974 until 1979, he was an attorney with Exxon Company, U.S.A.\nRichard V. Chidlow joined the Company in January 1987 as Controller for the Americas Region. From September 1988 until May 1990, he was Controller for the Europe, Africa and Asia group in Aberdeen, and was appointed Controller and Chief Accounting Officer in June 1990. From 1975 until joining the Company he held various positions with Western Oceanic, his last being Manager of Accounting.\nPART II\nItem 5.","section_5":"Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS.\nOceaneering's Common Stock is listed on the New York Stock Exchange (symbol OII). The following table sets forth, for the fiscal periods indicated, the high and low closing sales prices for Oceaneering's Common Stock as reported on the New York Stock Exchange (consolidated transaction reporting system):\nFiscal 1995 Fiscal 1994\nHigh Low High Low For the quarter ended:\nJune 30 $14-1\/4 $11 $16 $12-3\/4 September 30 14-1\/8 12-1\/4 17-1\/8 13-1\/2 December 31 13-1\/8 9-3\/4 18 12-1\/8 March 31 10-5\/8 7-7\/8 14-1\/2 12-1\/8\nOn June 1, 1995, Oceaneering had 804 holders of record of its Common Stock, par value $0.25. On that date, the closing sales price of the shares, as quoted on the New York Stock Exchange, was $9-5\/8.\nOceaneering has made no Common Stock dividend payments since 1977. Its present bank credit agreement restricts aggregate dividends to 50% of cumulative net earnings from December 31, 1994.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA.\nResults of Operations:\nFiscal Years Ended March 31,\n1995 1994 1993 1992 1991 (in thousands, except per share figures)\nRevenues $239,936 $229,760 $215,603 $193,582 $168,928\nCost of services 190,772 177,199 157,048 143,117 120,775\nGross margin 49,164 52,561 58,555 50,465 48,153 Selling, general and administrative expenses 36,410 31,631 32,903 30,239 29,683\nIncome from operations $ 12,754 $ 20,930 $ 25,652 $ 20,226 $18,470\nNet income applicable to common stock $ 5,496 $ 14,931 $ 19,401 $ 16,115 $16,870\nNet income per common share equivalent 0.23 0.62 0.82 0.68 0.72\nDepreciation and amortization 16,232 12,196 11,528 8,013 7,731\nCapital expenditures 32,057 36,730 11,996 35,312 21,310\nOther Financial Data: As of March 31, 1995 1994 1993 1992 1991 (in thousands, except ratios) Working capital ratio 1.44 1.74 1.92 1.65 2.26\nCash and cash equivalents $12,865 $ 26,486 $ 33,973 $ 23,281 $ 18,364\nWorking capital 23,106 34,425 42,492 28,556 42,406\nTotal assets 187,752 171,993 154,524 144,905 120,670\nShort-term debt 118 124 96 2,065 1,243\nLong-term debt 9,472 171 235 2,311 3,184\nTotal debt 9,590 295 331 4,376 4,427\nShareholders' equity 115,140 113,353 98,331 86,622 70,111\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nLiquidity and Capital Resources\nAt March 31, 1995, the Company had working capital of $23,100,000, including $11,400,000 of unrestricted cash. Additionally, as of April 12, 1995 the Company had $65,600,000 available for borrowings under its new $75,000,000 credit facility and $12,600,000 was unused under its uncommitted line of credit. See Note 3 of the Notes to Consolidated Financial Statements. The Company expects to meet its ongoing annual cash requirements out of operating cash flow; if significant investment opportunities arise, the Company may use external financing. Current maturities under capital lease obligations are not material and none of the $9,400,000 of long-term bank debt is required to be repaid prior to fiscal 1999.\nWhile liquidity and capital resources are considered adequate, the Company's working capital has declined over the last two years. A higher level of capital expenditures, including business acquisitions, during a period of lower cash flows from operations contributed to the decline. The $23,100,000 of working capital at March 31, 1995 compared to $34,400,000 and $42,500,000 as of March 31, 1994 and 1993, respectively. Likewise, the working capital ratio of 1.44 at March 31, 1995 was lower than the ratio of 1.74 and 1.92 at the end of fiscal years 1994 and 1993, respectively.\nCapital expenditures for the fiscal years ended March 31, 1995, 1994 and 1993 were $32,100,000, $36,700,000 and $12,000,000, respectively. Capital expenditures for fiscal 1995 consisted of the purchase and upgrade of a dynamically positioned offshore support vessel, acquisition of the remainder of the capital stock of a jointly owned company which owned an offshore support vessel, upgrades to ROVs and the acquisition of environmental services equipment. Capital expenditures for fiscal 1994 include the acquisition costs of the ILC, OIE and Multiflex businesses, additions and upgrades to the Company's fleet of ROVs and improvements to the FPSO. Capital expenditures for fiscal 1993 consisted primarily of upgrades to the Company's fleet of ROVs, including the addition of two new large ROV systems. There were no material commitments for capital expenditures at the close of fiscal 1995.\nDuring fiscal 1995 the Company completed the purchase of 1,000,000 shares of its stock pursuant to a plan approved in June 1994. After re-issue of shares to meet the Company's regular obligations to the Oceaneering Retirement Investment Plan and to satisfy share option exercises there was a balance of 977,363 shares of treasury stock remaining at March 31, 1995. The purchases were financed primarily by bank borrowings.\nThe primary industry that the Company serves, oil and gas, is a cyclical industry and remains volatile, resulting in potentially large fluctuations in demand for the Company's primary services, which could result in significant changes in the Company's revenues and profits. Although the oil and gas industry continues to be the Company's principal market, the Company also performs services for the United States and foreign governments, and the telecommunications, aerospace, insurance and environmental remediation industries. The Company is continually seeking opportunities for business combinations to improve its market position or expand into related service lines.\nThe Company operates primarily as a subcontracting services company under short-term day-rate contracts. However, the Company owns certain specialized capital assets, in particular the FPSO, which if not fully utilized could have a negative effect on cash resources as a result of continuing fixed operating costs and reduced revenues. The FPSO is currently operating profitably offshore Angola under a contract which has been extended for a second year expiring in January 1996.\nBecause of its significant foreign operations, the Company is exposed to currency fluctuations and exchange risks. Oceaneering minimizes these risks primarily through matching, to the extent possible, revenues and expenses in the various currencies in which it operates. Cumulative translation adjustments as of March 31, 1995, relate primarily to the Company's permanent investment in and loans to its United Kingdom subsidiary. See Item 1 - \"Business - Description of Business - Risks and Insurance.\" Inflation has not had a material effect on the Company in the past two years and no such effect is expected in the near future.\nResults of Operations\nRevenues for fiscal 1995 were $239,936,000 as compared to $229,760,000 and $215,603,000 for fiscal 1994 and 1993, respectively. Gross margin was 20% for fiscal 1995, compared with 23% and 27% for fiscal 1994 and 1993, respectively. Net income in fiscal 1995, 1994 and 1993 was $5,496,000, $14,931,000 and $19,401,000, respectively.\nInformation on the Company's business segments is shown in Note 6 of the Notes to Consolidated Financial Statements.\nOilfield Marine Services. Historically, a major part of the Company's revenues, operating income and cash flow had been generated by the oilfield marine services segment of its business. In fiscal 1995, however, revenues for this segment continued to decline and the operations resulted in a loss for the year. Operating cash flow for fiscal 1995 from oilfield marine services remained positive and the Company increased its capital spending during the year with the intent of enhancing future operating results. The segment's capital expenditures consisted primarily of the acquisition and upgrade of a dynamically positioned offshore support vessel. Capital expenditure requirements are related mainly to replacement and upgrade of its existing equipment and for equipment purchased to service specific contracts, although the Company does add selected assets in existing service lines as opportunities arise. The table below sets out revenues and profitability for this segment for fiscal 1995, 1994 and 1993.\nFor the Years Ended March 31, 1995 1994 1993 (in thousands, except percentages)\nRevenues $106,294 $122,625 $144,790 Gross Margins 19,872 31,355 38,021 Gross Margin % 19% 26% 26%\nOperating Margins (2,485) 9,194 16,012 Operating Margin % (2)% 7% 11%\nRevenues and margins declined in fiscal 1995 compared to fiscal 1994 as a result of reduced demand principally in the North Sea and West Africa operating areas. In addition, gross margins were negatively impacted in fiscal 1995 by an unfavorable arbitration ruling relating to a contract executed in fiscal 1991 and difficulties experienced in collection of the amounts due under a foreign contract.\nRevenues and margins for fiscal 1994 decreased from fiscal 1993 reflecting reduced demand in all major operating areas. Lower oil prices and resulting oil company project delays contributed to this decline.\nGross margin percentage in West Africa during fiscal 1994 was lower than for fiscal 1993 reflecting increased competitive pressures. This decline was offset by improved performance from ROV operations and total gross margin percentage for this segment for fiscal 1994 was maintained at the same percentage level as the prior year.\nOffshore Field Development. This segment includes FPSO operations, other MOPS related work for customers requiring engineering, design and project management services and subsea products.\nThe table below sets out revenues and profitability for this segment for fiscal 1995, 1994 and 1993.\nFor the Years Ended March 31, 1995 1994 1993 (in thousands, except percentages)\nRevenues $62,918 $37,121 $17,580 Gross Margins 13,726 4,432 6,326 Gross Margin % 22% 12% 36%\nOperating Margins 6,676 1,191 3,031 Operating Margin % 11% 3% 17%\nRevenue and gross margins for the Offshore Field Development segment for fiscal 1995 were higher than for fiscal 1994 as a result of the contribution of Multiflex which was acquired in March 1994, increased activity in the OIE division and a full year of profitable FPSO operations. The FPSO contract was extended for a second year expiring in January 1996.\nRevenue and gross margins for the Offshore Field Development segment for fiscal 1994 were negatively impacted by the operations of the FPSO which was contracted on a month to month basis for the first two quarters at rates which were sufficient only to cover cash expenses. From the fourth quarter of fiscal 1994 the FPSO operated under a contract providing substantially higher rates than its previous contract. MOPS revenues and margins for fiscal 1994 were favorably impacted by a large project which the Company completed in the North Sea; the Company did not have any similar contracts in fiscal 1995.\nResults for the FPSO for fiscal 1993 reflect the terms of the original contract up to the date of termination on December 10, 1992; the FPSO continued to operate under another contract at a substantially reduced rate that generated lower revenues, margins and profits for the remainder of the fiscal year. Revenues from the FPSO for fiscal 1995, 1994 and 1993 were $16,685,000, $10,405,000 and $11,649,000, respectively. Gross margins from the FPSO for fiscal 1995, 1994 and 1993 were $8,717,000, $2,074,000 and $5,291,000, respectively. For any period of time that the FPSO is not contracted or contracted at reduced rates, there will be a negative impact on the Company's revenues, margins and earnings.\nExpansion of this business will require access to additional assets suitable for MOPS applications which may be accomplished by outright purchase, leasing or other financing arrangement. The Company expects to continue to invest in other MOPS assets as profitable opportunities arise. Funds for such investments are available from cash flows from operations, existing cash or credit facilities.\nAdvanced Technologies. The table below sets out revenues and profitability for this segment for fiscal 1995, 1994 and 1993.\nFor the Years Ended March 31, 1995 1994 1993 (in thousands, except percentages)\nRevenues $70,724 $70,014 $53,233 Gross Margins 15,566 16,774 14,208 Gross Margin % 22% 24% 27%\nOperating Margins 8,563 10,545 6,609 Operating Margin % 12% 15% 12%\nRevenues for fiscal 1995 were at the same level as for fiscal 1994. Gross margins decreased as a result of lower demand for engineering services and costs associated with entry into the environmental services business.\nRevenues for fiscal 1994 improved over fiscal 1993 primarily as a result of the contribution from the ILC acquisition which was finalized in May 1993. Demand for ROV services from non-oilfield customers remained firm in fiscal 1994 compared to fiscal 1993; revenues in other areas were at or below the prior year.\nGross margins for this segment decreased to 24% in fiscal 1994 from 27% in fiscal 1993. Increased revenues generated by the ILC acquisition were at lower margins primarily due to the higher level of subcontract work in certain contracts. This was partially offset by higher margins earned on engineering work in fiscal 1994 compared with the prior year.\nOther. Selling, general and administrative expenses were $36,410,000 in fiscal 1995 compared to $31,631,000 in fiscal 1994 and $32,903,000 in fiscal 1993. Fiscal 1995 reflects the addition of the Multiflex operations and includes $500,000 of nonrecurring cost related to the consolidation of operational bases in Scotland. Fiscal 1993 includes $1,200,000 of nonrecurring costs incurred in connection with the acquisition of Eastport.\nThe Company's effective tax rate increased during fiscal 1995 compared to fiscal 1994 as a result of an increase in the amount of pre-tax income subject to taxing jurisdictions with higher effective tax rates, primarily the United States, and losses in fiscal 1995 in areas, primarily the North Sea, where the Company derives no tax benefit as it already has net operating loss carryforwards.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nIn this report, the consolidated financial statements and supplementary data of the Company appear in Part IV, Item 14 and are hereby incorporated by reference. See Index to Financial Statements and Schedules.\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.\nThe information with respect to the directors and nominees for election to the Board of Directors of Oceaneering International, Inc., is incorporated by reference from Oceaneering International, Inc.'s definitive proxy statement to be filed on or before July 31, 1995, pursuant to Regulation 14A under the Securities Exchange Act of 1934. The information with respect to the executive officers of Oceaneering International, Inc., is provided under Item 4a of Part I of this Annual Report on Form 10-K.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION.\nThe information required by Item 11 is incorporated by reference from the proxy statement described in Item 10 above.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe information required by Item 12 is incorporated by reference from the proxy statement described in Item 10 above.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe information required by Item 13 is incorporated by reference from the proxy statement described in Item 10 above.\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. (i) Report of Independent Public Accountants (ii) Consolidated Balance Sheets (iii) Consolidated Statements of Income (iv) Consolidated Statements of Cash Flows (v) Consolidated Statements of Shareholders' Equity (vi) Notes to Consolidated Financial Statements\n2. Exhibits:\nRegistration or File Form or Exhibit Exhibit Number Report Date Number\n3 Articles of Incorporation and By-laws *3.01 Certificate of Incorporation, as amended 0-8418 10-K March 1988 3(a) *3.02 By-laws, as amended 0-8418 10-K March 1987 3(b) *3.03 Amendment to Certificate of Incorporation 33-36872 S-8 Sept. 1990 4(b) *3.04 Amendment to By-laws 0-8418 10-K March 1991 3(d) *3.05 Amendment to By-laws 1-10945 8-K Nov. 1992 2 4 Instruments defining the rights of security holders, including indentures *4.01 Specimen of Common Stock Certificate 1-10945 10-K March 1993 4(a) *4.02 Interest Rate and Currency Exchange Agreement dated July 29, 1991 0-8418 10-Q Sept. 1991 4(a) *4.03 Shareholder Rights Agreement dated November 20, 1992 1-10945 8-K Nov. 1992 1 4.04 Bank Credit Agreement dated April 12, 1995 10 Material contracts *10.01 1981 Incentive Stock Option Plan, as amended 2-80506 S-8 Sept. 1987 28(e) *10.02 Oceaneering Retirement Investment Plan, as amended 2-77451 S-8 Oct. 1985 4(f) *10.03 Employment Agreement dated August 15, 1986 between John R. Huff and Registrant 0-8418 10-K March 1987 10(l) *10.04 1987 Incentive and Non- Qualified Stock Option Plan 33-16469 S-1 Sept. 1987 10(o) *10.05 Oceaneering International, Inc. Special Incentive Plan 33-16469 S-1 Sept. 1987 10(n) *10.06 Senior Executive Severance Plan, as amended 0-8418 10-K March 1989 10(k) *10.07 Supplemental Senior Executive Severance Agreements, as amended 0-8418 10-K March 1989 10(l) 10.08 Oceaneering International, Inc. Executive Retirement Plan, as amended *10.09 Share Purchase Agreement related to the purchase of Sonsub Limited 0-8418 8-K Jan. 1990 2 *10.10 1990 Long-Term Incentive Plan 33-36872 S-8 Sept. 1990 4(f) *10.11 1990 Nonemployee Directors Stock Option Plan 33-36872 S-8 Sept. 1990 4(g) *10.12 Indemnification Agreement between Registrant and its Directors 0-8418 10-Q Sept. 1991 10(a) *10.13 1991 Executive Incentive Agreements 0-8418 10-K March 1992 10(p) 10.14 Restricted Stock Award Agreement *10.15 Restricted Stock Award 1-10945 10-K March 1994 10(q) Incentive Agreements 10.16 Bank Uncommitted Credit Line Agreement dated March 31, 1995 10.17 1995 Bonus Award Plan 21 Subsidiaries of the Registrant 23 Consent of Independent Public Accountants 24 Powers of Attorney 27 Financial Data Schedule\n* Indicates exhibit previously filed with the Securities and Exchange Commission as indicated and incorporated herein by reference.\n(b) Reports on Form 8-K.\nThe registrant filed no reports on Form 8-K during the last quarter of the period covered by this report.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nOCEANEERING INTERNATIONAL, INC.\nDate: June 21, 1995 By: \/\/s\/\/JOHN R. HUFF John R. Huff 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\/\/ JOHN R. HUFF President, Principal June 21, 1995 John R. Huff Executive Officer, Director\n\/\/s\/\/ MARVIN J. MIGURA Senior Vice President, June 21, 1995 Marvin J. Migura Principal Financial Officer\n\/\/s\/\/ RICHARD V. CHIDLOW Controller, Principal June 21, 1995 Richard V. Chidlow Accounting Officer\nGORDON M. ANDERSON* Director CHARLES B. EVANS* Director DAVID S. HOOKER* Director D. MICHAEL HUGHES* Director\n*By: \/\/s\/\/ GEORGE R. HAUBENREICH, JR. June 21, 1995 George R. Haubenreich, Jr. Attorney-in-Fact\nOCEANEERING INTERNATIONAL, INC. AND SUBSIDIARIES INDEX TO FINANCIAL STATEMENTS AND SCHEDULES\nReport of Independent Public Accountants\nConsolidated Balance Sheets\nConsolidated Statements of Income\nConsolidated Statements of Cash Flows\nConsolidated Statements of Shareholders' Equity\nNotes to Consolidated Financial Statements\nSelected Quarterly Financial Data\nIndex to Schedules\nSchedules have been omitted because of the absence of the condition under which they are required or because the required information is included in the financial statements or related footnotes thereto.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo Oceaneering International, Inc.:\nWe have audited the accompanying consolidated balance sheets of Oceaneering International, Inc. (a Delaware corporation) and subsidiaries as of March 31, 1995 and 1994, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended March 31, 1995. 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 Oceaneering International, Inc. and subsidiaries as of March 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended March 31, 1995 in conformity with generally accepted accounting principles.\nARTHUR ANDERSEN LLP\nHouston, Texas May 18, 1995\nOCEANEERING INTERNATIONAL, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS (in thousands)\nASSETS\nMarch 31, 1995 March 31, 1994\nCURRENT ASSETS:\nCash and cash equivalents $ 12,865 $ 26,486 Accounts receivable, net of allowances for doubtful accounts of $1,238 and $1,023 58,360 51,563\nPrepaid expenses and other 4,613 2,764\nTotal current assets 75,838 80,813\nPROPERTY AND EQUIPMENT, at cost:\nMarine services equipment 175,528 136,799 Mobile offshore production equipment 24,694 24,464 Other 28,648 25,658\n228,870 186,921 Less accumulated depreciation 134,515 114,153\nNet property and equipment 94,355 72,768\nINVESTMENTS AND OTHER ASSETS:\nGoodwill, net of amortization of $1,546 and $576 13,051 14,021\nOther 4,508 4,391\nTOTAL ASSETS $187,752 $171,993\nSee Notes to Consolidated Financial Statements\nOCEANEERING INTERNATIONAL, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS (in thousands, except share data)\nLIABILITIES AND SHAREHOLDERS' EQUITY\nMarch 31, 1995 March 31, 1994\nCURRENT LIABILITIES:\nAccounts payable $ 15,110 $ 13,773 Accrued liabilities 29,870 25,808 Income taxes payable 7,634 6,683 Current portion of long-term debt 118 124\nTotal current liabilities 52,732 46,388\nLONG-TERM DEBT 9,472 171\nOTHER LONG-TERM LIABILITIES 9,507 10,912\nMINORITY INTERESTS 901 1,169\nCOMMITMENTS AND CONTINGENCIES\nSHAREHOLDERS' EQUITY: Common Stock, par value $0.25; 90,000,000 shares authorized; 24,017,046 and 23,995,796 shares issued 6,004 5,999 Additional paid-in capital 80,800 80,062 Treasury stock, 977,363 shares at cost (8,596) -- Retained Earnings 44,199 38,703 Cumulative translation adjustments (7,267) (11,411)\nTotal shareholders' equity 115,140 113,353\nTOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $187,752 $171,993\nSee Notes to Consolidated Financial Statements\nOCEANEERING INTERNATIONAL, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF INCOME (in thousands, except share data)\nFor the Years Ended March 31,\n1995 1994 1993\nREVENUES $239,936 $229,760 $215,603 COST OF SERVICES 190,772 177,199 157,048 SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 36,410 31,631 32,903\nIncome from operations 12,754 20,930 25,652\nINTEREST INCOME 547 831 1,104 INTEREST EXPENSE (695) (951) (1,353) OTHER INCOME (EXPENSE), NET (383) 48 (21) MINORITY INTERESTS 287 (99) (225)\nIncome before income taxes 12,510 20,759 25,157\nPROVISION FOR INCOME TAXES (7,014) (5,828) (5,756)\nNET INCOME $ 5,496 $ 14,931 $ 19,401\nNET INCOME PER COMMON SHARE EQUIVALEN $ 0.23 $ 0.62 $ 0.82\nSee Notes to Consolidated Financial Statements\nOCEANEERING INTERNATIONAL, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)\nFor the Years Ended March 31, 1995 1994 1993\nCASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 5,496 $14,931 $19,401 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 16,232 12,196 11,528 Currency translation adjustments and other 1,221 (174) (2,463) Decrease (increase) in accounts receivable (6,797) 2,601 (4,696) Decrease (increase) in prepaid expenses and other current assets (1,849) 2,433 (1,034) Decrease (increase) in other assets (1,986) (41) 161 Increase (decrease) in accounts payable 1,331 (4,048) 4,176 Increase (decrease) in accrued liabilities 4,062 (1,840) (1,116) Increase in income taxes payable 951 265 1,628 Increase (decrease) in other long- term liabilities (1,673) 1,564 (2,500)\nTotal adjustments to net income 11,492 12,956 5,684\nNET CASH PROVIDED BY OPERATING ACTIVITIES 16,988 27,887 25,085\nCASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment (32,057) (15,394)(11,996) Business acquisitions, net of cash acquired -- (21,336) -- Other investing activities -- 528 244\nNET CASH USED IN INVESTING ACTIVITIES (32,057) (36,202)(11,752)\nCASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from long-term bank borrowings 9,400 -- -- Payments on revolving note payable -- -- (1,314) Payments on long-term debt (99) (96) (2,731) Proceeds from issuance of common stock 743 924 1,404 Purchases of treasury stock (8,596) -- --\nNET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 1,448 828 (2,641) NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (13,621) (7,487) 10,692 CASH AND CASH EQUIVALENTS - BEGINNING OF YEAR 26,486 33,973 23,281 CASH AND CASH EQUIVALENTS - END OF YEAR $12,865 $26,486 $33,973\nSee Notes to Consolidated Financial Statements\nOCEANEERING INTERNATIONAL, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SUMMARY OF MAJOR ACCOUNTING POLICIES\nPrinciples of Consolidation\nThe consolidated financial statements include the accounts of Oceaneering International, Inc., (the \"Company\") and its 50% or more owned and controlled subsidiaries. The Company accounts for its investments in unconsolidated affiliated companies under the equity method. All significant intercompany accounts and transactions have been eliminated.\nIn August 1992, the Company exchanged 807,501 shares of its Common Stock for all of the outstanding shares of Eastport International, Inc., (\"Eastport\") in a transaction accounted for as a pooling of interests. Eastport was a designer, developer and operator of advanced robotic systems and Remotely Operated Vehicles (\"ROVs\") specializing in the non-oilfield market.\nIn May 1993, the Company purchased the business and assets of the Space Systems Division of ILC Dover, Inc. (\"ILC\"). ILC designs, develops and fabricates spacecraft hardware and high temperature insulation products. In July 1993, the Company purchased Oil Industry Engineering, Inc., a designer and fabricator of subsea control systems and in March 1994, the Company purchased the operating subsidiaries of Multiflex International Inc., a manufacturer of subsea control umbilical cables. Total cost of the three acquisitions was $21,336,000 cash. The acquisitions were accounted for under the purchase method and the operating results of the businesses acquired are included in the consolidated financial statements of the Company from the respective dates of acquisition. The costs of acquisition have been allocated on the basis of the estimated fair value of the assets acquired and liabilities assumed. This allocation resulted in goodwill of approximately $14,000,000. Had these acquisitions taken place at the beginning of fiscal 1993, unaudited pro forma revenues, net income, and net income per common share equivalent of the Company for fiscal 1994 and 1993 would have been $259,282,000, $15,400,000 and $0.64, and $256,465,000, $19,626,000 and $0.83, respectively. The pro forma information has been prepared for comparative purposes only and is not necessarily indicative of the operating results that would have occurred had the acquisitions taken place at the beginning of fiscal 1993 nor are they necessarily representative of operating results which may occur in the future.\nCash and Cash Equivalents\nCash and cash equivalents include demand deposits and highly liquid investments with original maturities of three months or fewer from the date of the investment. Approximately $1,500,000 and $1,300,000 of the Company's cash at March 31, 1995 and 1994, respectively, was restricted and is deposited as security in interest bearing accounts in connection with legal proceedings.\nDepreciation and Amortization\nThe Company provides for depreciation of Property and Equipment primarily on the straight-line method over estimated useful lives of 3 to 12 years for marine services equipment, 10 years for mobile offshore production equipment and 3 to 25 years for buildings, improvements and other equipment.\nThe costs of repair and maintenance of Property and Equipment are charged to operations as incurred, while the costs of improvements are capitalized. Upon the disposition of property and equipment, the related cost and accumulated depreciation accounts are relieved and the resulting gain or loss is included in other income (expense).\nGoodwill arising from business acquisitions is amortized on the straight- line method over 15 years.\nRevenue Recognition\nSubstantially all of the Company's revenue is derived from billings under contracts that provide for specific time, material and equipment charges, which are accrued daily and billed monthly. Significant lump-sum contracts are accounted for using the percentage-of-completion method. Revenues on contracts with a substantial element of research and development are recognized to the extent of cost until such time as the probable final profitability can be determined. Anticipated losses on contracts, if any, are recorded in the period that such losses are first determinable.\nIncome Taxes\nEffective fiscal 1994, the Company adopted Financial Accounting Standards Board standard number (\"SFAS\") 109, \"Accounting for Income Taxes\", which supersedes SFAS 96. The cumulative impact of the adoption of this standard was not material.\nForeign Currency Translation\nAll balance sheet asset and liability accounts of foreign subsidiaries are translated into U.S. dollars at the rate of exchange in effect at the balance sheet date. All income statement accounts are translated at average exchange rates during the year. Adjustments arising from these translations are accumulated in a separate account within Shareholders' Equity.\nNet Income Per Common Share Equivalent\nNet income per common share equivalent has been computed on the basis of the weighted average number of shares of Common Stock and Common Share Equivalents outstanding in each fiscal year (24,047,000, 24,069,000 and 23,788,000 in 1995, 1994 and 1993, respectively).\nOther Long-Term Liabilities\nOther long-term liabilities include $6,566,000 and $7,289,000 at March 31, 1995 and 1994, respectively, for self-insurance reserves not expected to be paid out in the following fiscal year and $2,441,000 and $2,623,000, respectively, for deferred income taxes.\nReclassifications\nCertain amounts from prior years have been reclassified to conform with the current year presentation.\n2. INCOME TAXES\nThe Company and its domestic subsidiaries, including acquired companies from the respective dates of acquisition, file a consolidated federal income tax return. The Company conducts its operations in a number of foreign locations which have varying codes and regulations with regard to income and other taxes, some of which are subject to interpretation. Foreign income taxes are provided at the appropriate tax rates in accordance with the Company's interpretation of the respective tax regulations after review and consultation with its internal tax department, tax consultants and, in some cases, legal counsel in the various foreign locations. Management believes that adequate provisions have been made for all taxes which will ultimately be payable.\nDeferred income taxes are provided for temporary differences in the recognition of income and expenses for financial and tax reporting purposes. The Company's policy is to provide for deferred U.S. income taxes on unrepatriated foreign income only to the extent such income is not to be invested indefinitely in the related foreign entity.\nThe provision for income taxes for the year ended March 31, 1995, includes a provision for U.S. federal and state income taxes of $5,080,000 and foreign taxes of $1,934,000. The provision for income taxes for the year ended March 31, 1994, included a provision for U.S. federal and state income taxes of $3,120,000 and foreign taxes of $2,708,000. The provision for income taxes for the year ended March 31, 1993, included a provision for U.S. federal and state income taxes of $2,248,000 and foreign taxes of $3,508,000. As of March 31, 1995, the Company had loss carryforwards of approximately $18,000,000 which are available to reduce future United Kingdom Corporation Tax which would otherwise be payable.\nThe provision for income taxes for the year ended March 31, 1995, consists of $9,021,000 for current taxes less a $2,007,000 change in net deferred taxes. The provisions for the years ended March 31, 1994 and 1993 consisted primarily of current taxes.\nCash taxes paid were $8,070,000, $5,785,000 and $4,949,000 for the fiscal years ended March 31, 1995, 1994 and 1993, respectively. As of March 31, 1995, the Company's worldwide deferred tax assets and liabilities and related valuation reserves were as follows:\nMarch 31, 1995 1994 (in thousands)\nGross deferred tax assets $10,807 $10,774 Valuation allowance (7,002) (8,794) Net deferred tax assets $3,805 $1,980\nDeferred tax liabilities $2,441 $2,623\nThe Company's deferred tax assets consist primarily of net operating loss carryforwards (\"NOLs\") in its United Kingdom subsidiary; these NOLs have no expiration date. Deferred tax liabilities consist primarily of depreciation and amortization.\nThe Company has established a valuation allowance for deferred tax assets after taking into account factors that are likely to affect the Company's ability to utilize the tax assets. In particular, the Company conducts its business through several foreign subsidiaries and, although the Company expects its consolidated operations to be profitable, there is no assurance that profits will be earned in entities or jurisdictions which have NOLs available. Since April 1, 1994, changes in the valuation allowance primarily relate to the expected utilization of foreign NOLs and realization of foreign tax credits.\nIncome taxes, computed by applying the federal statutory income tax rate to income before income taxes and minority interests, are reconciled to the actual provisions for income taxes as follows:\nFor the Years Ended March 31, 1995 1994 1993 (in thousands)\nComputed U.S. statutory expense $ 4,278 $ 7,300 $ 8,630 Utilization of foreign NOL carryforwards -- -- (3,166) Change in valuation allowances 333 (1,723) -- Withholding taxes and foreign earnings taxed at rates different from U.S. statutory rates and other, net 2,403 251 292\nTotal provision for income taxes $ 7,014 $ 5,828 $ 5,756\n3. DEBT\nLong-term debt: March 31, 1995 1994 (in thousands)\nBank debt $9,400 $ -- Capital lease obligations 190 295 Less: Current portion (118) (124) Total long-term debt $9,472 $ 171\nMaturity Schedule (in thousands)\nFiscal Year 1996 $ 118 1997 72 1998 -- 1999 4,700 2000 4,700\nCredit Agreement\nOn April 12, 1995 the Company and a group of banks signed a new credit agreement in the amount of $75,000,000 (the \"Credit Agreement\"). Existing short-term bank borrowings of $9,400,000 were subsequently refinanced under the Credit Agreement at an interest rate of 6.75% per annum. Consequently, $65,600,000 of the $75,000,000 was available at that date. There is a commitment fee of .225% per annum on the unused portion of the Credit Agreement.\nUnder the Credit Agreement, the Company has the option to borrow dollars through Euro-Dollar loans at the London Interbank Offered Rate (\"LIBOR\") plus 5\/8%, certificate of deposit loans at the reserve adjusted certificate of deposit rate plus 3\/4%, or base rate loans at the agent bank's prime rate. The agreement contains certain restrictive covenants relative to consolidated debt, tangible net worth and fixed charge coverage. Loans under the agreement are unsecured. Under the agreement, dividends may not exceed 50% of cumulative consolidated net income from December 31, 1994.\nThe Company has an uncommitted credit agreement dated March 31, 1995 with a bank in the amount of $20,000,000 for use for borrowings and letters of credit (the \"Uncommitted Line\"). As of March 31, 1995, the Company had approximately $7,400,000 in letters of credit outstanding issued through credit lines available under a prior loan agreement. These were included within the Uncommitted Line on April 12, 1995, and the prior agreement was terminated.\nEffective October 1, 1991, the Company entered into an interest rate swap agreement to reduce the impact of changes in interest rates under a previous term loan facility. The notional amount declines by $1,500,000 on the first business day of each calendar quarter and was $10,500,000 at March 31, 1995. The fixed rate in the swap is 7.9% and the floating rate is the three-month LIBOR. The differential to be paid or received is recognized as interest expense or income on a current basis.\nCash interest payments of $889,000, $1,136,000 and $1,247,000 were made in fiscal 1995, 1994 and 1993, respectively.\n4. EMPLOYEE BENEFIT PLANS\nRetirement Investment Plans\nThe Company currently has four separate employee retirement investment plans which cover its full-time employees. The Oceaneering Retirement Investment Plan is a deferred compensation plan in which domestic employees may participate by deferring a portion of their gross monthly salary and directing the Company to contribute the deferred amount to the plan. The Company matches a portion of the deferred compensation. The Company's contributions to the plan were $992,000, $807,000 and $409,000 for the plan years ended December 31, 1994, 1993 and 1992, respectively. When acquired, Eastport had a defined contribution plan covering substantially all its employees. Eastport's contributions to its plan were $17,000 for the six- month period ended December 31, 1992, and $285,000 for the plan year ended June 30, 1992. The Eastport plan was merged with the Oceaneering Retirement Investment Plan on December 31, 1992. The second plan is the Oceaneering International Services Pension Scheme for employees in the United Kingdom. The Company provides funding for this plan based on actuarial calculations. The plan assets exceed vested benefits and are not material to the assets of the Company. Company contributions were $67,000, $85,000 and $105,000 for the years ended March 31, 1995, 1994 and 1993, respectively. There have been no new participants in this plan since March 1990. The third plan is the Personal Pension Plan for employees in the United Kingdom. Under this plan, which became effective May 1991, employees may contribute a portion of their gross monthly salary. The Company also contributes a portion of the participants' gross monthly salary. Company contributions to this plan for the years ended March 31, 1995, 1994 and 1993, were $108,000, $62,000 and $57,000, respectively. The fourth plan, the Oceaneering International, Inc. Executive Retirement Plan, covers selected key management employees and executives of the Company as approved by the Compensation Committee of the Company's Board of Directors (\"Compensation Committee\"). The participants in this plan may contribute a portion of their gross monthly salary and the Company matches up to 100% of that contribution. Company expense related to the plan during the years ended March 31, 1995, 1994 and 1993, was $287,000, $220,000 and $221,000, respectively.\nIncentive and Stock Option Plans\nThe Company has in effect shareholder approved nonemployee director stock option and long-term incentive plans. Under the 1990 Nonemployee Director Stock Option Plan (\"Nonemployee Director Plan\"), options to purchase up to an aggregate of 100,000 shares of the Company's Common Stock may be granted to nonemployee directors of the Company. Each director of the Company is automatically granted an option to purchase 2,000 shares of Common Stock on the date the director becomes a nonemployee director of the Company and each year thereafter at an exercise price per share equal to 50% of the fair market value of a share of Common Stock on the date the option is granted. The options granted are not exercisable until the later to occur of six months from the date of grant or the date the optionee has completed two years of service as a director of the Company. Expense is recorded related to these options which have an exercise price less than fair market value on the date the option is granted. Expense recorded in fiscal 1995, 1994 and 1993 was not material.\nUnder the 1990 Long-Term Incentive Plan (\"Incentive Plan\"), a total of 1,600,000 shares of Common Stock, or cash equivalents of Common Stock, are available for awards to employees and other persons (excluding nonemployee directors) having an important business relationship with the Company and its subsidiaries. The Incentive Plan is administered by the Compensation Committee, which determines the type or types of award(s) to be made to each participant and sets forth in the related award agreement the terms, conditions and limitations applicable to each award. The Compensation Committee may grant stock options, stock appreciation rights, stock and cash awards. Options are normally granted at not less than fair market value of the optioned shares at the date of grant. Options outstanding are exercisable over a period up to ten years, vesting at the rate of 20% per year for three years beginning one year after grant and 40% at the end of the fourth year. In fiscal 1992, the Compensation Committee granted to certain key executives of the Company contingent cash incentive awards totaling a maximum aggregate amount of $2,000,000 payable over a three-year period, conditional upon the achievement of certain performance goals for the Company's Common Stock and continued employment of participants. In September 1992, the performance requirement for the Company's Common Stock was met; in September 1993 and September 1994, respectively, the second and third of four equal installments were paid to the participants. After taking into account amounts paid and forfeitures, the maximum amount of the awards remaining to be paid is $412,500, conditional upon continued employment of participants. During fiscal 1994, the Compensation Committee granted to certain key executives of the Company restricted Common Stock of the Company designed (i) to make a material portion of their potential future compensation contingent on performance of the Company's Common Stock and (ii) to retain their employ with the Company. These grants are subject to earning requirements on the basis of a percentage change between the price of the Common Stock of the Company versus the average of the Common Stock price of a peer group of companies over a three-year time period. Up to one-third of the total grant may be earned each year depending upon the cumulative Company's Common Stock performance, with any amount earned subject to vesting in four equal installments over three years conditional upon continued employment. At the time of each vesting, a participant receives a tax assistance payment which the participant must reimburse the Company if the vested Common Stock is sold by the participant within three years after the vesting date. In June 1994, the entire one-third of the total grant was earned, subject to vesting requirements. At March 31, 1995, a total of 28,250 shares was vested and a total of 310,750 shares of restricted stock was outstanding under these grants, of which 84,750 shares were earned, subject to vesting requirements.\nThe Company also has in effect three other stock option plans under which options to purchase have been issued to employees and other persons affiliated with the Company. Since approval of the Incentive Plan, no further grants or awards under these three stock option plans have been made or can be made or granted. All of these stock option plans are administered by the Compensation Committee. Options were normally granted at not less than the fair market value of the optioned shares at the date of grant.\nOptions outstanding, under these three plans which were granted periodically from May 1988 to December 1992, are normally exercisable over a five-year or ten-year term with vesting at the rate of 20% per year for three years beginning one year after the date of grant and 40% at the end of the fourth year. Options issued under one of these plans, the 1987 Special Incentive Plan, are exercisable in 20% increments on each of the first five anniversaries of the date of grant.\nDuring fiscal 1995, under the Incentive Plan, options to purchase 408,500 shares were granted at prices ranging from $6.5625 to $12.0625. At March 31, 1995, options to purchase 1,422,080 shares at prices ranging from $4.00 to $16.00 were outstanding and options to purchase 671,130 shares at prices ranging from $4.00 to $16.00 were exercisable. At March 31, 1995, there were 294,150 shares under the plans available for grant, of which 232,150 could be used for awarding stock options, stock appreciation rights, stock and cash awards.\n5. COMMITMENTS AND CONTINGENCIES\nLease Commitments\nAt March 31, 1995, the Company occupied several facilities under noncancellable operating leases expiring at various dates through 2065. Future minimum rentals under these leases are as follows:\n1996 $2,259,000 1997 1,689,000 1998 1,573,000 1999 1,429,000 2000 728,000 Thereafter 1,574,000\nTOTAL LEASE COMMITMENTS $9,252,000\nRental expense, which includes hire of vessels, specialized equipment and real estate rental, was approximately $12,680,000, $15,976,000 and $18,531,000 for the years ended March 31, 1995, 1994 and 1993, respectively.\nInsurance\nThe Company self-insures for workers' compensation, maritime employer's liability and comprehensive general liability claims to levels it considers financially prudent and carries insurance after the initial claim levels, which can be by occurrence or in the aggregate, are met by the Company. Management believes that adequate accruals have been established for expected liabilities arising from such obligations.\nLitigation\nVarious actions and claims are pending against the Company and its subsidiaries, most of which are covered by insurance. In the opinion of management, the ultimate liability, if any, which may result from these actions and claims will not materially affect the consolidated financial position or results of operations of the Company.\nLetters of Credit\nThe Company had $7,600,000 and $6,600,000 in letters of credit outstanding as of March 31, 1995 and 1994, respectively, as guarantees in force for various performance and bid bonds which are usually for a period of one year or the duration of the contract.\nFinancial Instruments and Risk Concentration\nFinancial instruments which potentially subject the Company to concentrations of credit risk are primarily cash and cash equivalents, bank borrowings and accounts receivable. The carrying value of cash and cash equivalents and bank borrowings approximates fair value due to the short maturity of those instruments. Accounts receivable are generated from a broad and diverse group of customers primarily from within the energy industry, which is the Company's major source of revenues. The Company maintains an allowance for doubtful accounts based upon expected collectibility.\n6. OPERATIONS BY BUSINESS SEGMENT AND GEOGRAPHIC AREA\nBusiness Segment Information\nThe Company supplies a comprehensive range of integrated technical services to a wide array of industries and is one of the world's largest underwater services contractors. The Company's Oilfield Marine Services business consists of underwater construction, underwater and above-water inspection and maintenance (including repair), survey and engineering. The Company's Offshore Field Development business includes the engineering, procurement, construction and installation of mobile offshore production systems, subsea intervention services and the production of subsea control umbilical cables. The Company's Advanced Technologies business provides project management, engineering services and equipment for applications in harsh environments, primarily in non-oilfield markets.\nThe following summarizes certain financial data by business segment:\nFor the Years Ended March 31, 1995 1994 1993 (in thousands) Revenues\nOilfield Marine Services $106,294 $122,625 $144,790 Offshore Field Development 62,918 37,121 17,580 Advanced Technologies 70,724 70,014 53,233 Total $239,936 $229,760 $215,603\nIncome from Operations\nOilfield Marine Services $ (2,485) $ 9,194 $ 16,012 Offshore Field Development 6,676 1,191 3,031 Advanced Technologies 8,563 10,545 6,609 Total $ 12,754 $ 20,930 $ 25,652\nIdentifiable Assets\nOilfield Marine Services $ 86,422 $ 70,259 $ 78,985 Offshore Field Development 53,124 45,153 24,192 Advanced Technologies 28,520 24,393 10,050 Total $168,066 $139,805 $113,227\nCapital Expenditures\nOilfield Marine Services $ 25,916 $ 9,261 $ 9,819 Offshore Field Development 1,263 16,465 -- Advanced Technologies 4,878 11,004 2,177 Total $ 32,057 $ 36,730 $ 11,996\nDepreciation and Amortization Expenses\nOilfield Marine Services $ 7,861 $ 6,950 $ 6,553 Offshore Field Development 4,690 2,276 2,780 Advanced Technologies 3,681 2,970 2,195 Total $ 16,232 $ 12,196 $ 11,528\nIncome from operations for each business segment is determined before interest income or expense, other expense, minority interests and the provision for income taxes. An allocation of these items is not considered practical. All assets specifically identified with a particular business segment have been segregated. Cash and cash equivalents, prepaid expenses and other current assets, investments and other assets and long-term debt have not been allocated to particular business segments.\nRevenues of approximately $34,000,000 in fiscal 1995, $26,000,000 in fiscal 1994 and $26,000,000 in fiscal 1993 were from the Royal Dutch Shell group of companies. No other individual customer accounted for more than 10% of revenues in fiscal 1995, 1994 or 1993.\nGeographic Operating Areas\nFinancial data by geographic area is summarized as follows:\nFOR THE YEARS ENDED MARCH 31, 1995 1994 1993 (in thousands)\nREVENUES United States $117,630 $ 89,401 $ 72,983 North Sea 48,934 60,515 50,587 Far East 22,924 24,343 29,753 Africa 36,361 36,510 45,802 Other 14,087 18,991 16,478 TOTAL $239,936 $229,760 $215,603\nINCOME BEFORE INCOME TAXES AND MINORITY INTERESTS United States $ 2,856 $ 5,003 $ 4,802 North Sea 188 6,451 5,114 Far East 353 804 2,352 Africa 6,582 4,051 9,112 Other 2,244 4,549 4,002 TOTAL $ 12,223 $ 20,858 $ 25,382\nTOTAL ASSETS United States $ 87,405 $ 91,281 $ 68,054 North Sea 52,449 30,235 29,902 Far East 9,386 8,206 12,007 Africa 33,374 39,459 43,290 Other 5,138 2,812 1,271 TOTAL $187,752 $171,993 $154,524\n7. ACCRUED LIABILITIES\nAccrued liabilities consisted of the following:\nMarch 31, 1995 1994 (in thousands)\nPayroll and related costs $11,899 $10,437 Accrued job costs 9,587 6,906 Other 8,384 8,465\nTOTAL ACCRUED LIABILITIES $29,870 $25,808\nSELECTED QUARTERLY FINANCIAL DATA\n(in thousands, except per share data) (unaudited)\nFiscal Year Ended March 31, 1995 Quarter Ended\nJune 30 Sept. 30 Dec. 31 Mar. 31 Total\nRevenues $63,370 $66,898 $55,203 $54,465 $239,936\nGross profit 14,094 15,383 8,622 11,065 49,164\nIncome(loss) from operations 5,728 6,572 (1,196) 1,650 12,754\nNet income(loss) 3,666 4,260 (2,850) 420 5,496\nEarnings(loss) per common share equivalent $ 0.15 $ 0.18 $(0.12) $ 0.02 $ 0.23\nWeighted average number of shares outstanding 24,183 24,204 24,150 23,650 24,047\nFiscal Year Ended March 31, 1994 Quarter Ended\nJune 30 Sept. 30 Dec. 31 Mar. 31 Total\nRevenues $59,394 $65,535 $55,492 $49,339 $229,760\nGross profit 13,531 13,878 12,982 12,170 52,561\nIncome from operations 6,168 6,254 5,223 3,285 20,930\nNet income 4,717 4,766 3,889 1,559 14,931\nEarnings per common share equivalent $ 0.20 $ 0.20 $ 0.16 $ 0.06 $ 0.62\nWeighted average number of shares outstanding 23,830 24,137 24,169 24,140 24,069\nEXHIBIT INDEX\nRegistration or File Form or Exhibit Exhibit Number Report Date Number\n3 Articles of Incorporation and By-laws *3.01 Certificate of Incorporation, as amended 0-8418 10-K March 1988 3(a) *3.02 By-laws, as amended 0-8418 10-K March 1987 3(b) *3.03 Amendment to Certificate of Incorporation 33-36872 S-8 Sept. 1990 4(b) *3.04 Amendment to By-laws 0-8418 10-K March 1991 3(d) *3.05 Amendment to By-laws 1-10945 8-K Nov. 1992 2 4 Instruments defining the rights of security holders, including indentures *4.01 Specimen of Common Stock Certificate 1-10945 10-K March 1993 4(a) *4.02 Interest Rate and Currency Exchange Agreement dated July 29, 1991 0-8418 10-Q Sept. 1991 4(a) *4.03 Shareholder Rights Agreement dated November 20, 1992 1-10945 8-K Nov. 1992 1 4.04 Bank Credit Agreement dated April 12, 1995 10 Material contracts *10.01 1981 Incentive Stock Option Plan, as amended 2-80506 S-8 Sept. 1987 28(e) *10.02 Oceaneering Retirement Investment Plan, as amended 2-77451 S-8 Oct. 1985 4(f) *10.03 Employment Agreement dated August 15, 1986 between John R. Huff and Registrant 0-8418 10-K March 1987 10(l) *10.04 1987 Incentive and Non- Qualified Stock Option Plan 33-16469 S-1 Sept. 1987 10(o) *10.05 Oceaneering International, Inc. Special Incentive Plan 33-16469 S-1 Sept. 1987 10(n) *10.06 Senior Executive Severance Plan, as amended 0-8418 10-K March 1989 10(k) *10.07 Supplemental Senior Executive Severance Agreements, as amended 0-8418 10-K March 1989 10(l) 10.08 Oceaneering International, Inc. Executive Retirement Plan, as amended *10.09 Share Purchase Agreement related to the purchase of Sonsub Limited 0-8418 8-K Jan. 1990 2 *10.10 1990 Long-Term Incentive Plan 33-36872 S-8 Sept. 1990 4(f) *10.11 1990 Nonemployee Directors Stock Option Plan 33-36872 S-8 Sept. 1990 4(g) *10.12 Indemnification Agreement between Registrant and its Directors 0-8418 10-Q Sept. 1991 10(a) *10.13 1991 Executive Incentive Agreements 0-8418 10-K March 1992 10(p) 10.14 Restricted Stock Award Agreement *10.15 Restricted Stock Award 1-10945 10-K March 1994 10(q) Incentive Agreements 10.16 Bank Uncommitted Credit Line Agreement dated March 31, 1995 10.17 1995 Bonus Award Plan 21 Subsidiaries of the Registrant 23 Consent of Independent Public Accountants 24 Powers of Attorney 27 Financial Data Schedule * Indicates exhibit previously filed with the Securities and Exchange Commission as indicated and incorporated herein by reference.","section_15":""}
{"filename":"789459_1995.txt","cik":"789459","year":"1995","section_1":"Item 1. Business. ---------\nRegistrant is engaged in the business of investing in commercial and industrial real estate properties which are net leased to commercial and industrial entities. Registrant was organized as a California limited partnership on February 3, 1986. The General Partners of Registrant are Seventh Carey Corporate Property, Inc. (the \"Corporate General Partner\"), a Delaware corporation, and William Polk Carey (the \"Individual General Partner\"). The Corporate General Partner is 79.9% owned by W. P. Carey & Co., Inc. (\"W.P. Carey\") and 20.1% owned by the Individual General Partner. Affiliates of the Corporate General Partner and the Individual General Partner are also the General Partners of affiliates of Registrant, Corporate Property Associates (\"CPA(R):1\"), Corporate Property Associates 2 (\"CPA(R):2\"), Corporate Property Associates 3 (\"CPA(R):3\"), Corporate Property Associates 4, a California limited partnership (\"CPA(R):4\"), Corporate Property Associates 5 (\"CPA(R):5\"), Corporate Property Associates 6 - a California limited partnership (\"CPA(R):6\"), Corporate Property Associates 8, L.P., a Delaware limited partnership (\"CPA(R):8\"), Corporate Property Associates 9, L.P., a Delaware limited partnership (\"CPA(R):9\"), and the advisor of Corporate Property Associates 10 Incorporated (\"CPA(R):10\"), Carey Institutional Properties Incorporated (\"CIP(TM)\") and Corporate Property Associates 12 Incorporated (\"CPA(R):12\"). Jupiter Food Service, Inc. is a wholly-owned subsidiary of Registrant. Registrant has a management agreement with Carey Property Management Company (\"Carey Management\"), a division of W.P. Carey. According to the terms of this agreement, Carey Management performs a variety of management services for Registrant. Registrant has entered into an agreement with Fifth Rock L.P., an affiliate, for the purpose of leasing office space. Reference is made to the Prospectus of Registrant dated April 25, 1986 filed pursuant to Rule 424(b), as supplemented by Supplements dated September 2, 1986, December 18, 1986, March 30, 1987, April 27, 1987 and July 14, 1987 under the Securities Act of 1933 and such Prospectus and such Supplements are incorporated herein by reference (said Prospectus, as so supplemented, is hereinafter called the \"Prospectus\").\nRegistrant has two industry segments, the investment in and the leasing of industrial and commercial real estate and the operation of a hotel business which was assumed subsequent to a lease termination. As described hereafter, Registrant sold its food service operation in December 1995. By assuming the operation of the hotel business, Management is seeking to preserve the value of the underlying investment while generating a contribution to Registrant's cash flow. See Selected Financial Data in Item 6 and Management's Discussion and Analysis in Item 7 for a summary of Registrant's operations. Also see the material contained in the Prospectus under the heading INVESTMENT OBJECTIVES AND POLICIES.\nThe properties owned by Registrant are described in Item 2.","section_1A":"","section_1B":"","section_2":"","section_3":"Item 3. Legal Proceedings. ------------------\nAs of the date hereof, Registrant is not a party to any material pending legal proceedings.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders. ----------------------------------------------------\nNo matter was submitted during the fourth quarter of the year ended December 31, 1995 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 Common Equity and Related ------------------------------------------------- Stockholder Matters. --------------------\nInformation with respect to Registrant's common equity is hereby incorporated by reference to page 30 of Registrant's Annual Report contained in Appendix A.\nItem 6.","section_6":"Item 6. Selected Financial Data. ------------------------\nSelected Financial Data are hereby incorporated by reference to page 1 of Registrant's Annual Report contained in Appendix A.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition ----------------------------------------------------------- and Results of Operations. -------------------------- Management's Discussion and Analysis are hereby incorporated by reference to pages 2 to 5 of Registrant's Annual Report contained in Appendix A.\nItem 8.","section_7A":"","section_8":"Item 8. Consolidated Financial Statements and Supplementary Data. ---------------------------------------------------------\nThe following financial statements and supplementary data are hereby incorporated by reference to pages 6 to 23 of Registrant's Annual Report contained in Appendix A:\n(i) Report of Independent Accountants. (ii) Consolidated Balance Sheets as of December 31, 1994 and 1995. (iii) Consolidated Statements of Income for the years ended December 31, 1993, 1994 and 1995. (iv) Consolidated Statements of Partners' Capital for the years ended December 31, 1993, 1994 and 1995. (v) Consolidated Statements of Cash Flows for the years ended December 31, 1993, 1994 and 1995. (vi) Notes to Consolidated Financial Statements.\n- 8 -\nItem 9.","section_9":"Item 9. Disagreements on Accounting and Financial Disclosure. -----------------------------------------------------\nNONE\n- 9 -\nPART III --------\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant. ---------------------------------------------------\nRegistrant has no directors or officers. The directors and executive officers of the Corporate General Partner are as follows:\n(1) Each officer and director of the Corporate General Partner will hold office until the next annual meeting of the Board of Directors and thereafter until his successor shall have been elected and shall have qualified or until his prior death, resignation or removal.\nWilliam Polk Carey and Francis J. Carey are brothers and Raymond S. Clark is their brother-in-law. H. Augustus Carey is the nephew of William Polk Carey and Raymond S. Clark and the son of Francis J. Carey.\nA description of the business experience of each officer and director of the Corporate General Partner is set forth below:\nWilliam Polk Carey, Chairman and Chief Executive Officer, has been active in lease financing since 1959 and a specialist in net leasing of corporate real estate property since 1964. Before founding W.P. Carey & Co., Inc. (\"W.P. Carey\") in 1973, he served as Chairman of the Executive Committee of Hubbard,\n- 10 -\nWestervelt & Mottelay (now Merrill Lynch Hubbard), head of Real Estate and Equipment Financing at Loeb Rhoades & Co. (now Lehman Brothers), head of Real Estate and Private Placements, Director of Corporate Finance and Vice Chairman of the Investment Banking Board of duPont Glore Forgan Inc. A graduate of the University of Pennsylvania's Wharton School of Finance, Mr. Carey is a Governor of the National Association of Real Estate Investment Trusts (NAREIT). He also serves on the boards of The Johns Hopkins University and its medical school, The James A. Baker III Institute for Public Policy at Rice University, and other educational and philanthropic institutions. He founded the Visiting Committee to the Economics Department of the University of Pennsylvania and co-founded with Dr. Lawrence R. Klein the Economics Research Institute at that university.\nFrancis J. Carey was elected President and a Managing Director of W.P. Carey in April 1987, having served as a Director since its founding in 1973. He served as a member of the Executive Committee and Board of Managers of the Western Savings Bank of Philadelphia from 1972 until its takeover by another bank in 1982 and is former chairman of the Real Property, Probate and Trust Section of the Pennsylvania Bar Association. Mr. Carey served as a member of the Board of Overseers of the School of Arts and Sciences of the University of Pennsylvania from 1983 through 1990 and has served as a member of the Board of Trustees of the Investment Program Association since 1990. From April 1987 until August 1992, he served as counsel to Reed Smith Shaw & McClay, counsel for Registrant, the General Partners, the CPA(R) Partnerships and W.P. Carey and some of its affiliates. A real estate lawyer of more than 30 years' experience, he holds A.B. and J.D. degrees from the University of Pennsylvania.\nGeorge E. Stoddard, Chief Investment Officer, was until 1979 head of the bond department of The Equitable Life Assurance Society of the United States, with responsibility for all activities related to Equitable's portfolio of corporate investments acquired through direct negotiation. Mr. Stoddard was associated with Equitable for over 30 years. He holds an A.B. degree from Brigham Young University, an M.B.A. from Harvard Business School and an LL.B. from Fordham University Law School.\nRaymond S. Clark is former President and Chief Executive Officer of the Canton Company of Baltimore and the Canton Railroad Company. A graduate of Harvard College and Yale Law School, he is presently a Director and Chairman of the Executive Committee of W.P. Carey and served as Chairman of the Board of W.P. Carey from its founding in 1973 until 1982. He is past Chairman of the Maryland Industrial Development Financing Authority.\nMadelon DeVoe Talley, Vice Chairman, is a member of the New York State Controller's Investment Committee, a Commissioner of the Port Authority of New York and New Jersey, former CIO of New York State Common Retirement Fund and New York State Teachers Retirement System. She also served as a managing director of Rothschild, Inc. and as the President of its asset management division. Besides her duties at W.P. Carey, Mrs. Talley is also a former Governor of the N.A.S.D. and a director of Biocraft Laboratories, a New York Stock Exchange company. She is an alumna of Sarah Lawrence College and the graduate school of International Affairs at Columbia University.\nStephen H. Hamrick is the former Executive Vice President and Managing Director of Wall Street Investor Services where he completed the sale and turnaround of its bank based brokerage business. Previously, he served six years as the Director of Private Investments for PaineWebber Incorporated. From 1975 until joining PaineWebber in 1988, Mr. Hamrick was associated with E.F. Hutton & Company (and the successor firm Shearson Lehman Hutton Inc.), where he held the position of First Vice President and National Director of Private Placements. Mr. Hamrick is a former Chairman of the Securities Industry Association's Direct Investment Committee and the Investment Program Association. He is a Certified Financial Planner and was graduated with degrees in English and Economics from Duke University.\nBarclay G. Jones III, Executive Vice President, Managing Director, and co-head of the Investment Department. Mr. Jones joined W.P. Carey as Assistant to the President in July 1982 after his graduation from the Wharton School of the University of Pennsylvania, where he majored in Finance and Economics. He was elected to the Board of Directors of W.P. Carey in April 1992. Mr. Jones is also a Director of the Wharton Business School Club of New York.\n- 11 -\nLawrence R. Klein, Chairman of the Economic Policy Committee since 1984, is Benjamin Franklin Professor of Economics Emeritus at the University of Pennsylvania, having joined the faculty of Economics and the Wharton School in 1958. He holds earned degrees from the University of California at Berkeley and Massachusetts Institute of Technology and has been awarded the Nobel Prize in Economics as well as over 20 honorary degrees. Founder of Wharton Econometric Forecasting Associates, Inc., Dr. Klein has been counselor to various corporations, governments, and government agencies including the Federal Reserve Board and the President's Council of Economic Advisers.\nClaude Fernandez, Chief Administrative Officer, Managing Director, and Executive Vice President, joined W.P. Carey in 1983. Previously associated with Coldwell Banker, Inc. for two years and with Arthur Andersen & Co., he is a Certified Public Accountant. Mr. Fernandez received his B.S. degree in Accounting from New York University in 1975 and his M.B.A. in Finance from Columbia University Graduate School of Business in 1981.\nHoward J. Altmann, Senior Vice President, Investment Department, joined W.P. Carey in August 1990. He was a securities analyst at Goldman Sachs & Co. for the retail industry from 1986 to 1988. Mr. Altmann received his undergraduate degree in economics and finance from McGill University and his M.B.A. from the Stanford University Graduate School of Business.\nH. Augustus Carey, Senior Vice President, returned to W.P. Carey in 1988. Mr. Carey previously worked for W.P. Carey from 1979 to 1981 as Assistant to the President. Prior to rejoining W.P. Carey, Mr. Carey served as a loan officer of the North American Department of Kleinwort Benson Limited in London, England. He received an A.B. from Amherst College in 1979 and an M.Phil. in Management Studies from Oxford University in 1984. Mr. Carey is a trustee of the Oxford Management Centre Associates Council.\nJohn J. Park, Senior Vice President and Treasurer, joined W.P. Carey as an Investment Analyst in December 1987. Mr. Park received his undergraduate degree from Massachusetts Institute of Technology and his M.B.A. in Finance from New York University.\nMichael D. Roberts joined W. P. Carey as a Second Vice President and Assistant Controller in April 1989 and is currently First Vice President and Controller. Prior to joining W.P. Carey, Mr. Roberts was employed by Coopers & Lybrand, where he attained the title of audit manager. A certified public accountant, Mr. Roberts received a B.A. from Brandeis University and an M.B.A. from Northeastern University.\nThe officers and directors of W.P. Carey are substantially the same as above.\nItem 11.","section_11":"Item 11. Executive Compensation. -----------------------\nUnder the Amended Agreement of Limited Partnership of Registrant (the \"Agreement\"), 5% of Distributable Cash From Operations, as defined, is payable to the Corporate General Partner and 1% of Distributable Cash From Operations is payable to the Individual General Partner. The Corporate General Partner's and the Individual General Partner's share of Distributable Cash From Operations from Registrant during the year ended December 31, 1995 was $178,780 and $104,353, respectively. As owner of 100 Limited Partnership Units, the Corporate General Partner received cash distributions of $22,425 during the year ended December 31, 1995. See Item 6 for the net income allocated to the General Partners under the Agreement. Registrant is not required to pay, and has not paid, any remuneration to the officers or directors of the Corporate General Partner, W.P. Carey or any other affiliate of Registrant during the year ended December 31, 1995.\nIn the future, the Corporate General Partner will expect to receive 5% of Distributable Cash From Operations, the Individual General Partner will expect to receive 1% of Distributable Cash From Operations and each General Partner will continue to be allocated the same percentage of the profits and losses of Registrant as had been allocated in prior years. For a description of the subordinated interest of the Corporate General Partner and the Individual General Partner in Cash From Sales and Cash From Financings, reference is made to the materials contained in the Prospectus under the heading MANAGEMENT COMPENSATION.\n- 12 -\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and --------------------------------------------------- Management. -----------\nAs of December 31, 1995, no person owned of record or was known by Registrant to own beneficially more than 5% of the Limited Partnership Units.\nThe following table sets forth as of March 20, 1996 certain information as to the ownership by directors and executive officers of securities of Registrant:\n(1) As of March 20, 1996, the Corporate General Partner, Seventh Carey Corporate Property, Inc., owned 100 Limited Partnership Units of Registrant. William Polk Carey, the majority shareholder of the Corporate General Partner, is the beneficial owner of these Units.\nThere exists no arrangement, known to Registrant, the operation of which may at a subsequent date result in a change of control of Registrant.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions. -----------------------------------------------\nFor a description of transactions and business relationships between Registrant and its affiliates and their directors and officers, see Notes 2 and 3 to the Consolidated Financial Statements in Item 8. Michael B. Pollack, First Vice President and Secretary of the Corporate General Partner, is a partner of Reed Smith Shaw & McClay which is engaged to perform legal services for Registrant.\nNo officer or director of the Corporate General Partner, W.P. Carey or any other affiliate of Registrant or any member of the immediate family or associated organization of any such officer or director was indebted to Registrant at any time since the beginning of Registrant's last fiscal year.\n- 13 -\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 are filed as a part of this Report:\nReport of Independent Accountants.\nConsolidated Balance Sheets, December 31, 1994 and 1995.\nConsolidated Statements of Income for the years ended December 31, 1993, 1994 and 1995.\nConsolidated Statements of Partners' Capital for the years ended December 31, 1993, 1994 and 1995.\nConsolidated Statements of Cash Flows for the years ended December 31, 1993, 1994 and 1995.\nNotes to Consolidated Financial Statements.\nThe financial statements are hereby incorporated by reference to pages 6 to 23 of Registrant's Annual Report contained in Appendix A.\n(a) 2. Financial Statement Schedule: -----------------------------\nThe following schedule is filed as a part of this Report:\nSchedule III -Real Estate and Accumulated Depreciation as of December 31, 1995.\nNotes to Schedule III.\nSchedule III and notes thereto are hereby incorporated by reference to pages 24 to 27 of Registrant's Annual Report contained in Appendix A.\nFinancial Statement Schedules other than those listed above are omitted because the required information is given in the Consolidated Financial Statements, including the Notes thereto, or because the conditions requiring their filing do not exist.\n- 14 -\n(a) 3. Exhibits: ---------\nThe following exhibits are filed as part of this Report. Documents other than those designated as being filed herewith are incorporated herein by reference.\n- 15 -\n- 16 -\n- 17 -\n- 18 -\n- 19 -\n- 20 -\n- 21 -\n- 22 -\n- 23 -\n- 24 -\n- 25 -\n- 26 -\n- 27 -\n- 28 -\n- 29 -\n- 30 -\n- 31 -\n(b) Reports on Form 8-K -------------------\nDuring the quarter ended December 31, 1995, Registrant was not required to file any reports on Form 8-K.\n- 32 -\nSIGNATURES ----------\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nCORPORATE PROPERTY ASSOCIATES 7 -a California limited partnership and SUBSIDIARIES\nBY: SEVENTH CAREY CORPORATE PROPERTY, INC.\n04\/01\/96 BY: \/s\/ Claude Fernandez -------------- --------------------- Date Claude Fernandez Executive Vice President and Chief Administrative Officer (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.\nBY: SEVENTH CAREY CORPORATE PROPERTY, INC.\nWilliam P. Carey Chairman of the Board and Director (Principal Executive Officer)\nFrancis J. Carey President and Director\nGeorge E. Stoddard BY: \/s\/ George E. Stoddard Chairman of the Investment ----------------------- Committee and Director George E. Stoddard Attorney in fact April 1, 1996 Raymond S. Clark Chairman of the Executive Committee and Director\nDr. Lawrence R. Klein Chairman of the Economic Policy Committee and Director\nMadelon DeVoe Talley Vice Chairman of the Board of Directors and Director\n04\/01\/96 BY: \/s\/ Claude Fernandez - ------------ --------------------- Date Claude Fernandez Executive Vice President and Chief Administrative Officer (Principal Financial Officer)\n04\/01\/96 BY: \/s\/ Michael D. Roberts - ------------ ----------------------- Date Michael D. Roberts First Vice President and Controller (Principal Accounting Officer)\n- 33 -\nAPPENDIX A TO FORM 10-K\nCORPORATE PROPERTY ASSOCIATES 7 - A CALIFORNIA LIMITED PARTNERSHIP AND SUBSIDIARIES\n1995 ANNUAL REPORT\nSELECTED FINANCIAL DATA\n- -------------------------------------------------------------------------------\n(In thousands except per unit amounts)\n(1) 1994 income includes an extraordinary loss of $511,503. 1993 and 1995 net income includes extraordinary gains of $879,000 and $1,324,000 respectively, on the extinguishment of debt. (2) Includes distributions attributable to the fourth quarter of each fiscal year payable in the following fiscal year less distributions in the first fiscal quarter attributable to the prior year. (3) Includes a special distribution of $150 per Limited Partnership Unit paid in January 1995. (4) Represents scheduled principal amortization paid. (5) Represents mortgage and note obligations due after more than one year.\n- 1 -\nMANAGEMENT'S DISCUSSION AND ANALYSIS - -------------------------------------------------------------------------------- Results of Operations\nNet income for the year ended December 31, 1995 decreased by $6,468,000 from the prior year to $5,526,000, largely as the result of a number of nonrecurring items in 1994 which are classified as other income in the accompanying Consolidated Financial Statements, as well as gains and losses from asset sales and the extinguishment of mortgage debt in both years. In addition, the Partnership discontinued operating its food service business segment in December 1995.\nThe gains on the sale of the Mid-Continent Bottlers, Inc. (\"Mid- Continent\") properties and of related limited partnership units of a Mid- Continent affiliate contributed $8,497,000 to 1994 net income, representing 71% of 1994 earnings. After adjusting for the effects of gains and losses, nonrecurring items included in other income, discontinued operations and property writedowns, income from continuing operations would have reflected an increase of $317,000 in 1995. The Partnership realized this increase even though its asset base was reduced by using a portion of the proceeds from the Mid- Continent sales to pay a special distribution of $150 per Limited Partnership Unit.\nThe increase in income in 1995 from continuing operations, as adjusted, was primarily due to decreases in both interest and depreciation expense and improved earnings from the hotel operation. This was partially offset by decreases in lease revenues and other interest income and an increase in general and administrative expense. Of the $1,082,000 decrease in interest expense, $850,000 was due to the prepayment of mortgages in December 1994 on properties which are still subject to leases. The remaining decrease was attributable to the payoff of the Mid-Continent mortgage in connection with the sale of the properties and the decline in interest expense on the Advanced System Applications, Inc. (\"ASA\") mortgage loan which will fully amortize in March 1996. Lease revenues decreased by $818,000. This decrease was due to the 1994 disposition of the Mid-Continent properties which contributed $1,287,000 of lease revenues in 1994. This was partially offset by an increase of $434,000 in ASA lease revenues pursuant to a lease modification. The ASA lease will terminate in June 1997. The decrease in other interest income occurred because the Partnership held substantially higher cash balances between October 1994, when it sold the Mid-Continent properties, and December 1994, when a portion of that cash was used to retire mortgage debt. General and administrative expenses increased due to an increase in partnership level state franchise tax paid in 1995, due in part to increased income attributable to Illinois from the ASA property.\nEarnings for the hotel in Livonia, Michigan increased by 8% or $101,000 as the result of a rise in occupancy rates from 75% to 77% and an 8% increase in the average room rate. The Livonia hotel's earnings reflect a trend of continuing improvement since 1993. The earnings of the hotel operation are affected by economic conditions in the Detroit metropolitan area.\nSince November 1988, when a lessee terminated its lease subject to a voluntary bankruptcy petition, the Partnership had operated a restaurant in Jupiter, Florida. On December 20, 1995, the Partnership sold the Jupiter property and the restaurant business for $4,140,000, recognizing gains of $1,019,000 on the sale of the property and $1,324,000 on the forgiveness of a mortgage note collateralized by the property. Although the food service segment had been profitable over the last several years, 1995 sales had declined by approximately 5% due to increasing price competition. Over the past two years, the Partnership had benefited from a restructuring of the limited recourse mortgage debt on the Jupiter property. Under the restructuring, the mortgage loan was bifurcated into two notes. One note (for $2,700,000) required making a principal payment of $600,000 in December 1995 to extend the loan for two years. Pursuant to the restructuring agreement, if this note was paid off entirely, the second note would be forgiven. All payments on this second note, including interest, had been deferred during the initial two years. Management concluded that committing additional cash to pay down or pay the first mortgage note and continue operating the restaurant in an increasingly competitive environment would not yield an adequate return on its investment. Accordingly, Management accepted an offer for the purchase of the property from a third party which wanted to open a new restaurant at the property.\n- 2 -\nNet income increased by $11,749,000 and cash provided by operating activities increased by $1,247,000 for 1994 as compared with 1993. The change in net income for 1994 as compared with 1993 was largely the result of $8,497,000 of gains recognized in 1994, $3,303,000 of noncash charges for property writedowns in 1993, including a writedown of $2,900,000 on the Jupiter property, and the effect of extraordinary gains and losses on extinguishment of debt in both 1994 and 1993. In addition to these items, there were a number of other nonrecurring items which affected the comparability of the results of operations in both 1994 and 1993, including the gain on sale of securities and the loss on sale of real estate in 1993, a series of other items in 1994 and 1993 which are reflected on the financial statements as other income and $642,000 of property writedowns during 1994 on properties which were held for sale. Operating income (net income before nonrecurring items, gains and losses and discontinued operations) would have reflected an increase of 19% for 1994 as compared with 1993. The increase in operating income is due to a substantial increase in the profits of the hotel operations, an increase in other interest income and a decrease in property expenses. This increase in income was partially offset by an increase in interest expense. Interest expense increased as a result of the increase in interest rates on a variable rate debt. Interest income increased as a result of interest received on the NVRyan L.P. (\"NVRyan\") restructuring fees and a note received from Hallwood Group, Inc. as well as from both an increase in cash balances and an increase in interest rates on short-term cash instruments. Property expenses declined in 1994 as 1993 property expenses were affected by costs incurred in resolving various property related issues. Lease revenues were unchanged in 1994 as compared with 1993. The increase from the ASA restructuring was offset by the termination of the Mid-Continent lease after the sale of the properties in October 1994.\nThe occupancy rate at the Livonia hotel was 75% for 1994 and 1993; while the average room rate increased by approximately 10% in 1994 as compared to 1993. As a result of the ability to achieve a higher room rate, the Partnership's share of hotel operating income increased by 32%. To some extent, the increase reflects an improved economy in the Detroit metropolitan area.\nThe ASA lease restructuring had a very beneficial effect on the Partnership's income and cash flow in 1995, and it will be even more beneficial in 1996 as a result of the full amortization of the mortgage loan on that property in March 1996. Rental payments will be $1,749,000 before any reductions for any rents on space vacated by ASA. The ASA agreement ends in June 1997 and, although the Partnership has already been successful in remarketing some of the space already vacated by ASA, future cash flow from this property cannot be expected to rise to the level that will be achieved in 1996. Beginning on May 1, 1995, approximately 35% of the leasable space of the ASA property will be leased to the United States Postal Service (the \"Postal Service\"). The Partnership's share of rents will be $243,000. The Postal Service lease is not a net lease, and the Partnership will be responsible for certain operating costs. ASA will be entitled to one-third of rents, net of landlord costs, through the end of its lease term. Accordingly, the net cash flow which will be provided from the Postal Service lease will vary based on the level of operating costs incurred by the Partnership. Cash flow will not be significantly impacted by the disposition of the food service segment since its contribution to cash flow, net of debt service payments on the property, was only slightly positive. In addition, there are no rent increases scheduled in 1996. Rent increases are scheduled on three leases in 1997 and one lease in 1998. Interest on mortgage loans is expected to decrease as the Partnership's outstanding mortgage balances decreased by more than 30% between 1994 and 1995. The Partnership's $9,607,000 note payable is a variable rate obligation and interest will vary based on the short-term interest rate environment.\nBecause of the long-term nature of the Partnership's net leases, inflation and changing prices have not unfavorably affected the Partnership's leasing revenues and net income. The Partnership's net leases generally provide for rent increases indexed to increases in the Consumer Price Index (\"CPI\") and may include caps on such CPI increases or other periodic mandated increases which should increase leasing revenues in the future. Future rent increases may be affected by changes in the method of calculating the CPI. Although there are indications that there may be legislation which considers changes to the CPI methodology, the Partnership cannot predict the outcome of any proposed changes relating the CPI formula. As the rate of inflation has been moderate in recent years, Management believes that hotel operations may not be significantly impacted by changing prices. In addition, Management believes that reasonable increases in costs may be partially or entirely offset by increases in room rates.\n- 3 -\nFinancial Condition -------------------\nExcept for the hotel property, substantially all of the Partnership's properties are leased to corporate tenants under long-term net leases which generally require tenants to pay all operating expenses relating to the leased properties. The Partnership depends on cash flow from its net leases to meet operating expenses, service its debt, fund distributions and maintain adequate cash reserves. In addition, the Partnership maintains cash reserves to fund major outlays such as capital improvements and balloon debt payments. Such expenditures may also be funded from additional borrowing on the Partnership's real estate portfolio. The Partnership's cash and cash equivalents at December 31, 1995 of $4,968,000 decreased by $5,558,000 during the year. The decrease in cash was due to payment of a special distribution to partners of $6,860,000 ($150 per Limited Partnership Unit).\nIn 1995, the Partnership's cash flows provided from operating activities and distributions received from the operating cash flow of an equity investment, together totalled $5,121,000. This amount was sufficient to pay quarterly distributions to partners of $3,575,000 and contribute $1,546,000 toward the payment of scheduled principal payment installments of $1,567,000.\nThe Partnership's investing activities consisted of selling the Jupiter property and replacing furniture, fixtures and equipment at the hotel in the ordinary course of business and which are necessary for the hotel to remain competitive. A portion of the proceeds received on the sale were used to satisfy the mortgage loan on the property. As a result of successful negotiations with Holiday Inn, the hotel is currently in compliance with the Holiday Inn core modernization plan and will not be required to make any required capital improvements. The Partnership had originally estimated that it would be necessary to make $280,000 in improvements to remain in compliance.\nThe Partnership's financing activities consist primarily of utilizing the cash flow from operations to pay distributions and meet scheduled principal payment obligations. During 1995, the Partnership used the remaining proceeds of the Mid-Continent sale to make a special distribution of $150 per Limited Partnership Unit representing a return to Limited Partners of 15% of the initial cost of a Unit. Based on current cash flow and cash balances, which remain above the historical levels prior to the Mid-Continent sale, the Partnership expects to continue to increase the rate of distributions paid to its partners. This may be affected by the Partnership's ability to remarket space at the ASA property after the termination of the ASA lease. The Partnership has significant unused borrowing capacity as it paid off a number of mortgage loans over the past several years and has several unleveraged properties subject to long-term leases including properties leased to The Gap, Inc., NYNEX and AutoZone, Inc.\nAll of the Partnership's mortgage loans either fully amortize or come due over the next three years. A $1,000,000 balloon payment on the limited recourse mortgage loan collateralized by the Winn-Dixie Stores, Inc. is due in September 1996. The Livonia hotel and Swiss M-Tex, L.P. (\"M-Tex\") mortgage loans have balloon payments which total approximately $6,700,000 and are due in 1997. A balloon payment on the Sybron Acquisition Company (\"Sybron\") mortgage loan is due in 1998. As these properties, except for the hotel, remain subject to long- term leases and the hotel generates strong operating cash flow, the Partnership believes that its prospects for refinancing the loans are good. In the case of limited recourse mortgage financing which does not fully amortize over its term, the Partnership would be responsible for the balloon payment required, but only to the extent of its interest in the encumbered property since the holder of each such obligation has recourse only to the property collateralizing the debt. The balloon payment could be funded from several alternative sources as determined by management to be in the best interest of the Partnership at the time, such as obtaining new mortgage financing to satisfy the loan, seeking an extension of the loan with the existing lender, evaluating whether a payment could be funded from existing cash reserves, financing unleveraged properties, the sale of a property and use of proceeds from such sale or an increase in Partnership level unsecured debt. The Partnership also has a $9,606,837 loan obligation which matures in 1999 and is recourse to the Partnership's assets. The Partnership is in compliance with the financial covenants of the loan obligation at December 31, 1995.\n- 4 -\nThree of the Partnership's lessees have purchase options which are exercisable as follows: 1997 - KSG, Inc. and M-Tex and 1998 - Sybron. The purchase options are all exercisable at the higher of (i) the Partnership's purchase cost for the properties and any prepayment charge that the Partnership would incur in paying off the mortgage loans on the properties or (ii) the fair market value of the properties as encumbered by their leases. In the event that both options are exercised in 1997, the Partnership would expect to receive proceeds, net of the amount necessary to pay off the M-Tex mortgage loan, of no less than $6,138,000. If the properties are sold, annual cash flow would be reduced by approximately $1,056,000.\nIn connection with the purchase of its properties, the Partnership required sellers of such properties to perform environmental reviews. Management believes, based on the results of such reviews, that the Partnership's properties were in substantial compliance with Federal and state environmental statutes at the time properties were acquired. However, portions of certain properties have been subject to a limited degree of contamination, principally in connection with either leakage from underground storage tanks or surface spills from facility activities. In most instances where contamination has been identified, tenants are actively engaged in the remediation process and addressing identified conditions. Tenants are generally subject to environmental statutes and regulations regarding the discharge of hazardous materials and any related remediation obligations. In addition, the Partnership's leases generally require tenants to indemnify the Partnership from all liabilities and losses related to the leased properties. Accordingly, Management believes that the ultimate resolution of environmental matters will not have a material adverse effect on the Partnership's financial condition or liquidity.\nEffective January 1, 1995, the Partnership adopted the provisions of Statement of Financial Accounting Standards No. 121 - Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of (\"SFAS 121\"). Pursuant to SFAS 121, the Partnership assesses the recoverability of its real estate assets, including residual interests, based on projections of cash flows over the life of such assets. In the event that such cash flows are insufficient, the assets are adjusted to their estimated net realizable value. The adoption of SFAS 121 did not have a material effect on the Partnership's financial condition or results of operations.\n- 5 -\nREPORT of INDEPENDENT ACCOUNTANTS\nTo the Partners of Corporate Property Associates 7 - a California limited partnership and Subsidiaries:\nWe have audited the accompanying consolidated balance sheets of Corporate Property Associates 7 - a California limited partnership and Subsidiaries as of December 31, 1994 and 1995, and the related consolidated statements of income, partners' capital and cash flows for each of the three years in the period ended December 31, 1995. We have also audited the financial statement schedule included on pages 24 to 27 of this Form 10-K. These financial statements and financial statement schedule are the responsibility of the General Partners. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by the General Partners, as 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 Corporate Property Associates 7 - a California limited partnership and Subsidiaries as of December 31, 1994 and 1995, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles. In addition, in our opinion, Schedule of Real Estate and Accumulated Depreciation as of December 31, 1995, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the financial information required to be included therein pursuant to Securities and Exchange Commission Regulation S-X Rule 12-28.\n\/s\/Coopers & Lybrand L.L.P. New York, New York March 22, 1996\n- 6 -\nCORPORATE PROPERTY ASSOCIATES 7 - a California limited partnership and SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\nDecember 31, 1994 and 1995\nThe accompanying notes are an integral part of the consolidated financial statements.\n- 7 -\nCORPORATE PROPERTY ASSOCIATES 7 - a California limited partnership and SUBSIDIARIES\nCONSOLIDATED STATEMENTS of INCOME For the years ended December 31, 1993, 1994 and 1995\n- 8 -\nCORPORATE PROPERTY ASSOCIATES 7 - a California limited partnership and SUBSIDIARIES\nCONSOLIDATED STATEMENTS of INCOME, Continued For the years ended December 31, 1993, 1994 and 1995\nThe accompanying notes are an integral part of the consolidated financial statements.\n- 9 -\nCORPORATE PROPERTY ASSOCIATES 7 - a California limited partnership and SUBSIDIARIES\nCONSOLIDATED STATEMENTS of PARTNERS' CAPITAL For the years ended December 31, 1993, 1994 and 1995\n(a) Based on weighted average Units issued and outstanding during the periods.\nThe accompanying notes are an integral part of the consolidated financial statements.\n- 10 -\nCORPORATE PROPERTY ASSOCIATES 7 - a California limited partnership and SUBSIDIARIES CONSOLIDATED STATEMENTS of CASH FLOWS For the years ended December 31, 1993, 1994 and 1995\nThe 1995 extraordinary gain on extinguishment of debt of $1,323,858 was comprised of $1,215,566 forgiveness of principal and $108,292 of accrued interest thereon.\nThe accompanying notes are an integral part of the consolidated financial statements.\n- 11 -\nCORPORATE PROPERTY ASSOCIATES 7 - a California limited partnership and SUBSIDIARIES\nNOTES to CONSOLIDATED FINANCIAL STATEMENTS\n1. Summary of Significant Accounting Policies: -------------------------------------------\nBasis of Consolidation: - -----------------------\nThe consolidated financial statements include the accounts of Corporate Property Associates 7, a wholly-owned subsidiary and a 99% owned subsidiary (collectively, the \"Partnership\").\nUse of Estimates: - -----------------\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nReal Estate Leased to Others: - -----------------------------\nReal estate is leased to others on a net lease basis, whereby the tenant is generally responsible for all operating expenses relating to the property, including property taxes, insurance, maintenance, repairs, renewals and improvements.\nThe Partnership diversifies its real estate investments among various corporate tenants engaged in different industries and by property type throughout the United States.\nThe leases are accounted for under either the direct financing or operating methods. Such methods are described below:\nDirect financing method - Leases accounted for under the direct ----------------------- financing method are recorded at their net investment (Note 5). Unearned income is deferred and amortized to income over the lease terms so as to produce a constant periodic rate of return on the Partnership's net investment in the lease.\nOperating method - Real estate is recorded at cost, revenue is ---------------- recognized as rentals are earned and expenses (including depreciation) are charged to operations as incurred. When scheduled rents vary during the lease term, income is recognized on a straight-line basis so as to produce a constant periodic rent.\nSubstantially all of the Partnership's leases provide for either scheduled rent increases, periodic rent increases based on formulas indexed to increases in the Consumer Price Index or sales overrides.\nOperating Real Estate: - ----------------------\nLand, buildings and personal property are carried at cost. Major renewals and improvements are capitalized to the property accounts, while replacements, maintenance and repairs which do not improve or extend the lives of the respective assets are expensed currently.\nLong-Lived Assets: - ------------------\nEffective January 1, 1995, the Partnership adopted the provisions of Statement of Financial Accounting Standards No. 121 - Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of (\"SFAS 121\"). Pursuant to SFAS 121, the Partnership assesses\n- 12 -\nCORPORATE PROPERTY ASSOCIATES 7 - a California limited partnership and SUBSIDIARIES\nNOTES to CONSOLIDATED FINANCIAL STATEMENTS, Continued\nthe recoverability of its real estate assets, including residual interests, based on projections of cash flows over the life of such assets. In the event that such cash flows are insufficient, the assets are adjusted to their estimated net realizable value. The adoption of SFAS 121 did not have a material effect on the Partnership's financial condition or results of operations.\nReal Estate Held for Sale: - --------------------------\nReal estate held for sale is accounted for at the lower of cost or net realizable value.\nDepreciation: - -------------\nDepreciation is being computed using the straight-line method over the estimated useful lives of the properties which range from 5 to 30 years.\nCash Equivalents: - -----------------\nThe Partnership considers all short-term, highly liquid investments that are both readily convertible to cash and have a maturity of generally three months or less at the time of purchase to be cash equivalents. Items classified as cash equivalents include commercial paper and money market funds. Substantially all of the Partnership's cash and cash equivalents at December 31, 1994 and 1995 were held in the custody of three financial institutions.\nOther Assets: - -------------\nIncluded in other assets are deferred rental income, deferred charges, inventory (principally food and beverages for the hotel), organization costs and an investment in a limited partnership. Deferred rental income is the aggregate difference for operating method leases between scheduled rents which vary during the lease term and income recognized on a straight-line basis. Inventory is stated at the lower of cost or market using the FIFO (first in, first out) method. Deferred charges are primarily costs incurred in connection with mortgage note financings and refinancings and are deferred and amortized on a straight-line basis over the terms of the mortgages. The Partnership's 50% interest in a limited partnership is accounted for under the equity method, i.e. at cost, increased or decreased by the Partnership's share of earnings or losses, less distributions.\nDeferred Rental Income: - -----------------------\nDeferred rental income recognized in connection with the amendment of two of the Partnership's leases, one of which was terminated in October 1994, is being amortized on a straight-line basis from the date of the amendments through the end of the initial terms of the leases (20.5 and 23 years) or date of sale, if sooner.\nIncome Taxes: - -------------\nA partnership is not liable for income taxes as each partner recognizes his proportionate share of the partnership income or loss in his tax return. Accordingly, no provision for income taxes is recognized for financial statement purposes.\nReclassifications: - ------------------ Certain 1993 and 1994 amounts have been reclassified to conform to the 1995 presentation.\n- 13 -\nCORPORATE PROPERTY ASSOCIATES 7 - a California limited partnership and SUBSIDIARIES\nNOTES to CONSOLIDATED FINANCIAL STATEMENTS, Continued\n2. Partnership Agreement: ----------------------\nThe Partnership was organized on February 3, 1986 under the Revised Uniform Limited Partnership Act of the State of California for the purpose of engaging in the business of investing in and leasing industrial and commercial real estate. The Corporate General Partner purchased 100 Limited Partnership Units in connection with the Partnership's public offering. The Partnership will terminate on December 31, 2010, or sooner, in accordance with the terms of the Amended Agreement of Limited Partnership (the \"Agreement\").\nThe Agreement provides that the General Partners are allocated 6% (1% to the Individual General Partner, William P. Carey, and 5% to the Corporate General Partner, Seventh Carey Corporate Property, Inc.) and the Limited Partners are allocated 94% of the profits and losses as well as distributions of Distributable Cash From Operations, as defined, except as described below. The General Partners may be entitled to certain incentive fees during the liquidation stage of the Partnership. A division of W.P. Carey & Co., Inc. (\"W.P. Carey\"), is engaged in the real estate brokerage business and the Partnership may sell properties through the division and pay subordinated real estate commissions as provided in the Agreement. The division could ultimately earn up to approximately $724,000 of real estate commissions due to the sales of properties between 1990 and 1995, which amount will be retained by the Partnership unless subordination provisions of the Agreement are satisfied.\nIn accordance with the Agreement, the General Partners were allocated a portion of the 1993 and 1994 gains on sale in order to eliminate their negative balances as well as a portion of the related tax gains. This did not affect the allocation of cash distributions to Partners. The Partnership paid a special distribution of $6,859,597 in 1995 related to the sales which distribution was allocated 1% to the Individual General Partner and 99% to the Limited Partners in accordance with the Agreement.\n3. Transactions with Related Parties: ----------------------------------\nUnder the Agreement, W.P. Carey and other affiliates are also entitled to receive property management and leasing fees and reimbursement of certain expenses incurred in connection with the Partnership's operations. General and administrative expense reimbursements consist primarily of the actual cost of personnel needed in providing administrative services necessary for the operation of the Partnership. Property management and leasing fees and general and administrative expense reimbursements incurred are summarized as follows:\nDuring 1993, 1994 and 1995, fees aggregating $75,799, $23,426 and $67,230 respectively, were incurred for legal services performed by a firm in which the Secretary of the Corporate General Partner and other affiliates is a partner.\nThe Partnership is a participant in an agreement with W.P. Carey and other affiliates for the purpose of leasing office space used for the administration of real estate entities and W.P. Carey and for sharing the associated costs. Pursuant to the terms of the agreement, the Partnership's share of rental, occupancy and leasehold improvement costs is based on adjusted gross revenues, as defined. Net expenses incurred in 1993, 1994 and 1995 were $39,995 $51,874, and $90,569,\n- 14 -\nCORPORATE PROPERTY ASSOCIATES 7 - a California limited partnership and SUBSIDIARIES\nNOTES to CONSOLIDATED FINANCIAL STATEMENTS, Continued\nrespectively. The increase in 1995 is due, in part, to certain nonrecurring costs incurred in connection with the relocation of the Partnership's offices.\nThe Partnership's ownership interests in certain properties are jointly held with affiliated entities as tenants-in-common or limited partners with the Partnership's interests in such jointly held properties ranging from 24.74% to 65.5172%. The Partnership accounts for its assets and liabilities relating to tenants-in-common interests on a proportional basis.\n4. Real Estate Leased to Others Accounted for Under the Operating Method --------------------------------------------------------------------- and Operating Real Estate: --------------------------\nA. Real Estate Leased to Others: -----------------------------\nThe scheduled minimum future rentals, exclusive of renewals, under noncancellable operating leases amount to approximately $4,218,000 in 1996, $3,286,000 in 1997, $2,410,000 in 1998, $2,412,000 in 1999, $2,315,000 in 2000 and aggregate approximately $23,421,000 through 2013. Contingent rentals were approximately $129,000, $139,000 and $138,000 in 1993, 1994 and 1995, respectively.\nB. Operating Real Estate: ---------------------- Operating real estate, at cost, is summarized as follows:\n5. Net Investment in Direct Financing Leases: ------------------------------------------\nNet investment in direct financing leases is summarized as follows:\nThe scheduled minimum future rentals, exclusive of renewals, under noncancellable direct financing leases amount to approximately $1,888,000 in 1996, $1,885,000 in each of the years 1997 to 2000 and aggregate approximately $31,518,000 through 2014.\nContingent rentals were approximately $394,000, $490,000 and $322,000 in 1993, 1994 and 1995, respectively.\n- 15 -\nCORPORATE PROPERTY ASSOCIATES 7 - a California limited partnership and SUBSIDIARIES NOTES to CONSOLIDATED FINANCIAL STATEMENTS, Continued\nFuture minimum ground lease commitments for certain properties occupied by AutoZone, Inc. aggregate $946,000 through 2005.\n6. Mortgage Notes Payable and Note Payable: ----------------------------------------\nA. Mortgage Notes Payable: -----------------------\nMortgage notes payable, all of which are nonrecourse to the Partnership and the partners, are collateralized by real property with a carrying amount of approximately $29,785,000, before accumulated depreciation and the assignment of various leases. As of December 31, 1995, mortgage notes payable bear interest at rates varying from 9.22% to 11.25% per annum and mature from 1996 to 1998. Scheduled principal payments during each of the next three years following December 31, 1995 are as follows:\nYear Ending December 31, ------------------------ 1996 $ 1,706,980 1997 6,753,569 1998 3,468,202 ----------- Total $11,928,751 ===========\nB. Note Payable: -------------\nThe $9,606,837 note payable is a recourse obligation of the Partnership and provides for quarterly payments of interest at a floating rate equal to the London Inter-Bank Offered Rate (\"LIBOR\") plus 4.25% per annum (9.97% at December 31, 1995). The note payable matures in July 1999, at which time a balloon payment for the entire outstanding principal will be due.\nCovenants under the credit agreement include a requirement that the Partnership may not incur any additional debt unless the new debt replaces existing debt and does not exceed a maximum nonrecourse debt limitation of $36,897,696 less an adjustment for subsequent scheduled principal amortization on existing nonrecourse loans plus closing costs of any new nonrecourse loans. Additionally, the Partnership must maintain certain debt coverage ratios and maintain a minimum consolidated net worth and aggregate appraised property value of $15,000,000. The debt coverage ratio requires the Partnership to maintain ratios of free operating cash flow to the debt service on the note ranging from 3:1 to 3.4:1 over the terms of the agreement. The Partnership is in compliance with such terms at December 31, 1995.\nThe credit agreement requires the Partnership to offer the lender the proceeds from property sales as a prepayment of the note payable. The lender has declined to accept all mandatory offers of proceeds by the Partnership to date.\nInterest paid was $4,010,425, $3,426,650 and $2,467,322 in 1993, 1994 and 1995, respectively.\nContinued\n- 16 -\nCORPORATE PROPERTY ASSOCIATES 7 - a California limited partnership and SUBSIDIARIES\nNOTES to CONSOLIDATED FINANCIAL STATEMENTS, Continued\n7. Distributions to Partners: --------------------------\nDistributions are declared and paid to partners quarterly and are summarized as follows:\nDistributions of $51,827 to the General Partners and $811,954 to the Limited Partners for the quarter ended December 31, 1995 were declared and paid in January 1996.\n8. Income for Federal Tax Purposes: --------------------------------\nIncome for financial statement purposes differs from income for Federal income tax purposes, because of the difference in the treatment of certain items for income tax purposes and financial statement purposes. A reconciliation of accounting differences is as follows:\nContinued\n- 17 -\nCORPORATE PROPERTY ASSOCIATES 7 - a California limited partnership and SUBSIDIARIES\nNOTES to CONSOLIDATED FINANCIAL STATEMENTS, Continued\n9. Industry Segment Information: -----------------------------\nThe Partnership's operations consist of the investment in and the leasing of industrial and commercial real estate and the operation of a food service facility and a hotel business.\nIn 1993, 1994 and 1995, the Partnership earned its total commercial and industrial leasing revenues (rental income plus interest income from financing leases) from the following lease obligors:\n(1) Rental income is net of ground lease rental expense of $93,000, $97,000 and $101,000 in 1993, 1994 and 1995, respectively (see Note 5).\nThe summarized results of the Partnership's share of the hotel operations are as follows:\n10. Discontinued Operations: ------------------------\nOn December 20, 1995, the Partnership sold the food service facility in Jupiter, Florida, at which it operated a restaurant, for $4,140,000, recognizing a gain on the sale of $1,019,362. In connection with the sale, it satisfied the two mortgage note obligations on the property and recognized an extraordinary gain on extinguishment of debt of $1,323,858.\nContinued\n- 18 -\nCORPORATE PROPERTY ASSOCIATES 7 - a California limited partnership and SUBSIDIARIES\nNOTES to CONSOLIDATED FINANCIAL STATEMENTS, Continued\nIn January 1994, the terms of the loan collateralized by the property were modified by dividing the loan into two notes with balances of $2,700,000 (\"Note A\") and $1,082,883 (\"Note B\"), respectively. Under the modification, interest and principal payments on Note B were deferred. In accordance with the terms of the 1994 loan modification agreement, the $1,082,883 balance of Note B plus accrued interest thereon was forgiven upon payment of Note A, resulting in an extraordinary gain of $1,323,858 on extinguishment of debt. The Partnership used a portion of the sales proceeds to pay off the $2,603,000 balance of Note A.\nDuring 1993, Management determined that the net realizable value of its investment in the Jupiter property was impaired. As a result, the Partnership recorded a writedown to estimated net realizable value of $2,900,000 in 1993.\nIn connection with sale of the Jupiter property, the Partnership did not incur any gain or loss on the disposal of the food service business. Results for the food service operation business segment for 1993, 1994 and 1995 have been reclassified in the accompanying Consolidated Financial Statements as discontinued operations and are as follows:\n11. Hotel Property in Livonia, Michigan: ------------------------------------\nOn November 20, 1987, the Partnership and Corporate Property Associates 6 (\"CPA(R):6\"), an affiliate, purchased a Holiday Inn in Livonia, Michigan as tenants-in-common with 65.5172% and 34.4828% interests, respectively, and entered into a net lease with Brock Hotel Corporation which subsequently changed its name to Integra - A Hotel and Restaurant Company (\"Integra\"). Integra subsequently assigned its interest in the lease to a wholly-owned subsidiary, Livonia Inn Management, Inc., while Integra remained the guarantor of the lease.\nAs a result of Integra's financial condition, the subsidiary stopped paying rent in May 1992 with Integra subsequently filing a voluntary bankruptcy petition in July 1992. Both of these events were defaults under the lease as well as the mortgage note collateralized by the Livonia property. In August 1992, pursuant to a letter of agreement, the Partnership and CPA(R):6 assumed control of the hotel operations.\nIn September 1993, the mortgage loan on the property of approximately $12,000,000 (of which the Partnership's share was approximately $7,862,064) was restructured. In consideration for a mortgage principal payment of $4,000,000, the annual interest rate on the mortgage loan was reduced from a fixed rate of 10.9% to LIBOR plus 3.5% retroactive to June 1992 and the lender agreed not to accelerate the loan. CPA(R):6 advanced the Partnership's share of the mortgage prepayment which was repaid in November 1993. In connection with providing the advance, CPA(R):6 received $90,000 from the Partnership based on a formula pursuant to a fairness opinion provided by an independent investment banking firm.\nContinued\n- 19 -\nCORPORATE PROPERTY ASSOCIATES 7 - a California limited partnership and SUBSIDIARIES\nNOTES to CONSOLIDATED FINANCIAL STATEMENTS, Continued\nOn March 8, 1994, the Partnership and CPA(R):6, executed a settlement agreement with the Hallwood Group, Inc. (\"Hallwood Group\"), Integra's largest shareholder, under which the Partnership and CPA(R):6 agreed to surrender a promissory note made by Hallwood Group, which had been pledged by Integra to the Partnership and CPA(R):6 as additional security to Integra's lease obligation, in exchange for $150,000 in cash, a $500,000 promissory note from Hallwood Group and an equity participation having a potential value of up to $500,000 from the Hallwood Group. The $500,000 note bears interest at 8% per annum and matures no later than March 8, 1998 and, subject to certain conditions, is redeemable at an earlier date. The note is collateralized by the Hallwood Group's pledge of 446,345 of its limited partnership units of Hallwood Realty Partners, L.P. (\"Hallwood Realty\"), a publicly traded limited partnership. The pledged units represent 5.2% of all outstanding limited partnership units of Hallwood Realty. Under the settlement agreement, the Hallwood Group has the obligation to pay to the Partnership and CPA(R):6 an amount equal to 25% of the increase in value of the Hallwood Realty units of up to $500,000, from March 1994 to the note maturity date. If the price per unit increases to $9 or greater, the Partnership and CPA(R):6 may, subject to certain restrictions, receive a payment from the Hallwood Group representing the 25% appreciation of the pledged units prior to the note maturity date. At December 31, 1995, the pledged limited partner units had a market value of $16.50 per unit.\nThe Partnership's share of the cash proceeds and the note receivable of $425,862 are included in other income in 1994.\n12. Gains and Losses on Sale: -------------------------\nA. In October 1994, the Partnership sold its properties leased to Mid- Continent Bottlers, Inc.'s (\"Mid-Continent\") to the lessee for $17,800,000 and sold the Partnership's 3.29% limited partnership interest in Midcon Bottlers, L.P., an affiliate of Mid-Continent, for $700,000.\nIn connection with the sales, the Partnership recognized gains of $7,814,474 and $682,500, respectively. The Partnership used $3,895,320 of the sales proceeds to satisfy the Mid-Continent mortgage loan. In addition, the Partnership used a portion of the proceeds to prepay certain mortgage loans on properties which remain subject to leases. In January 1995, the Partnership used a portion of the proceeds to pay a special distribution to limited partners of $6,791,000 ($150 per Limited Partnership Unit) and $68,597 to a general partner.\nThe Partnership purchased the Mid-Continent properties in December 1986 for $9,984,200. Upon sale of the properties, $321,000 of deferred rental income was recognized and included in other income in 1994.\nB. In August 1993, the Partnership sold excess land on property in Travelers Rest, South Carolina leased to Swiss M-Tex, L.P. (\"M Tex\"). The Partnership realized a gain of $156,486 from the sale and used the net proceeds of $166,600 to prepay a portion of the mortgage note collateralized by the property.\nContinued\n- 20 -\nCORPORATE PROPERTY ASSOCIATES 7 - a California limited partnership and SUBSIDIARIES\nNOTES to CONSOLIDATED FINANCIAL STATEMENTS, Continued\nIn December 1993, the Partnership sold a property in Phoenix, Arizona to its lessee, Overnite Transportation Company (\"Overnite\"), and incurred a loss on the sale of $708,869. The Overnite lease included an option to purchase the property for $925,000.\nIn connection with the transfer of Mid-Continent's interest in the Hazelwood, Missouri property to Tandem Holdings, Inc. (\"Tandem\") in 1986, the Partnership received warrants to purchase shares of Tandem's common stock. In February 1993, in connection with the merger of Tandem with another company, the Partnership sold the warrants and realized a gain of $283,740.\n13. Properties Formerly Leased to NVRyan, L.P.: -------------------------------------------\nPursuant to a restructuring agreement with NVRyan L.P. (\"NVRyan\") in September 1993, which was reached in connection with the confirmation by the Bankruptcy Court of NVRyan's reorganization plan, NVRyan was permitted to sever four properties from its lease in exchange for restructuring fees of $2,600,000 (of which the Partnership's share was $962,962). For financial reporting purposes, the fees were deferred and are being amortized over the remaining term of the NVRyan lease. In connection with the sale of the two properties in 1994, $490,101 of such deferred fees were recognized and included in other income.\nIn August 1994, the Partnership and CPA(R):8 sold a property formerly leased to NVRyan in Jefferson, Georgia for $844,778 (of which the Partnership's share was $312,880), net of costs. In addition, the Partnership and CPA(R):8 sold the property in Plant City, Florida in April 1994 to an NVRyan sublessee for $1,200,000 (of which the Partnership's share was $444,444). No gain or loss was recognized on the sales as the properties were written down prior to the sales to an amount equal to the estimated sales proceeds. A writedown of $484,296 was recognized on the Jefferson property in 1994 and a writedown of $403,328 was recognized on the Plant City property in 1993.\nIn June 1994, the Partnership and Corporate Property Associates 8, L.P. (\"CPA(R):8\"), an affiliate, entered into a contract to sell the vacant Fredricksburg, Virginia property for $728,500 (of which the Partnership's share was $269,815), net of costs. Subsequently, the potential buyer withdrew its offer to buy the Fredricksburg, Virginia property. Although the transaction was not consummated, the Partnership's interest in the property was written down in 1994 by $157,433 to an amount equal to the anticipated net proceeds.\n14. Equity Investment: ------------------\nThe Partnership and CPA(R):8 own 50% interests in a limited partnership which in September 1993 purchased a leasehold interest in a hotel property in Topeka, Kansas subleased to Hotel Corporation of America. Summarized financial information of the limited partnership is as follows:\n- 21 -\nCORPORATE PROPERTY ASSOCIATES 7 - a California limited partnership and SUBSIDIARIES\nNOTES to CONSOLIDATED FINANCIAL STATEMENTS, Continued\n15. Extraordinary Gains and Losses on Extinguishment of Debt: ---------------------------------------------------------\nA. As fully described in Note 10, in connection with the sale of the Jupiter, Florida property in December 1995, the Partnership recognized an extraordinary gain on extinguishment of debt of $1,323,808.\nB. In December 1994, the Partnership paid off $1,886,148 of the mortgage loan on the AutoZone, Inc. (\"AutoZone\") and NYNEX properties. In connection with paying off the mortgage loan, the Partnership incurred an extraordinary charge of $136,260 on the extinguishment of debt consisting of a prepayment premium of $94,307 and the writeoff of $41,953 in unamortized financing costs.\nIn December 1994, the Partnership, through a newly formed subsidiary, paid off mortgage loans of $4,587,600 and $1,902,158 on The Gap, Inc. (\"Gap\") and KSG, Inc. (\"KSG\") properties, respectively. In connection with the paying off of the Gap mortgage loan, the Partnership incurred a prepayment premium of $375,243, resulting in an extraordinary charge on the extinguishment of debt.\nC. In November 1993, the Partnership obtained financing of $9,606,837 and used a portion of the proceeds to pay off the mortgage loans collateralized by the properties formerly leased to Yellow Front Stores, Inc. (\"Yellow Front\"). The Yellow Front loan, which had a principal balance of $4,725,516 was satisfied with a payment of $3,800,000, resulting in an extraordinary gain of $879,433 in 1993 on the extinguishment of debt, net of related costs incurred.\n16. Properties Leased to Advanced System Applications, Inc.: --------------------------------------------------------\nThe Partnership and CPA(R):8 own property in Bloomingdale, Illinois, as tenants- in-common with 33.64% and 66.36% ownership interests, respectively which is leased to Advanced System Applications, Inc. (\"ASA\"). In July 1994 the Partnership and CPA(R):8 entered into a lease modification agreement with ASA which allows ASA to terminate its lease in June 1997 instead of June 2003. Under the modification agreement, annual rent increased to $5,200,000 (of which the Partnership's share is $1,749,280) from $1,850,000 (of which the Partnership's share was $622,340). In consenting to the modification, the mortgage loan payments were substantially increased so that the loan fully amortized on March 1, 1996. Although ASA is obligated to make its lease payments through June 1997, it is in the process of vacating the property. To the extent that the Partnership and CPA(R):7 enter into new leases for any vacated space, ASA is entitled to one-third of all rentals received, net of any landlord costs, during the remaining term of its lease.\n- 22 -\nCORPORATE PROPERTY ASSOCIATES 7 - a California limited partnership and SUBSIDIARIES\nNOTES to CONSOLIDATED FINANCIAL STATEMENTS, Continued\nOn January 31, 1996, the Partnership and CPA(R):8 entered into a lease with the United States Postal Service (the \"Postal Service\"). The lease has a 10-year term commencing May 1, 1996 with annual rentals of $722,800 (of which the Partnership's share will be $243,150), increasing to $822,800 after five years. The Partnership and CPA(R):8 retain the obligation to provide maintenance and support services to the lessee. The lease provides for rent escalations in 1998 based on increases in certain operating costs incurred by the Partnership and CPA(R):8. In addition, the Postal Service will reimburse the Partnership and CPA(R):8 for its pro rata share of real estate taxes. The Postal Service has an option to terminate the lease after five years and right of first refusal on space vacated by ASA.\nThe Partnership and CPA(R):8 will provide the Postal Service a tenant improvement allowance of up to $600,000 (of which the Partnership's share is $201,840).\n17. Subsequent Events: ------------------\nOn February 12, 1996, the Partnership sold a property located in Denham Springs, Louisiana and leased to AutoZone, Inc. (\"AutoZone\") for $431,779, net of costs. AutoZone's lease allows it to purchase back those leased retail stores it judges to be uneconomical and the Denham Springs property was so deemed. On February 14, 1996, the Partnership sold its property in Monte Vista, Colorado for $186,090, net of costs. No gain or loss will be reported in 1996, as the Monte Vista property was written down by $319,685 at December 31, 1995 to an amount equal to the net sales proceeds received by the Partnership.\nThe two properties have been reclassified as real estate held for sale in the accompanying consolidated financial statements. Solely as a result of the sales, annual cash flow will decrease by approximately $61,000.\n18. Disclosures About Fair Value of Financial Instruments: ------------------------------------------------------\nThe carrying amounts of cash, accounts receivable and amounts payable and accrued expenses approximate fair value because of the short maturity of these items.\nThe Partnership estimates that the fair value of mortgage notes payable approximates the carrying amount of such mortgage notes at December 31, 1995. The fair value of debt instruments was evaluated using a discounted cash flow model with discount rates which take into account the credit of the tenants and interest rate risk.\nThe Partnership's note payable is a variable rate obligation indexed to the London Inter-Bank Offered Rate. Accordingly, the carrying amount of the note payable approximates fair value as of December 31, 1995.\n- 23 -\nCORPORATE PROPERTY ASSOCIATES 7 - a California limited partnership and SUBSIDIARIES SCHEDULE of REAL ESTATE AND ACCUMULATED DEPRECIATION as of December 31, 1995\nSee accompanying notes to Schedule.\n- 24 -\nCORPORATE PROPERTY ASSOCIATES 7 - a California limited partnership and SUBSIDIARIES SCHEDULE of REAL ESTATE AND ACCUMULATED DEPRECIATION as of December 31, 1995\nSee accompanying notes to Schedule.\nCORPORATE PROPERTY ASSOCIATES 7 - a California limited partnership and SUBSIDIARIES NOTES TO SCHEDULE of REAL ESTATE AND ACCUMULATED DEPRECIATION\n(a) Consists of acquisition costs including legal fees, appraisal fees, title costs as well as other related professional fees and capital improvements at various properties.\n(b) At December 31, 1995, the aggregate cost of real estate owned for Federal income tax purposes is $61,148,788.\n(c) The decrease in net investment is due to the writedowns and sales of properties.\n(d)\n(Continued)\n- 26 -\nCORPORATE PROPERTY ASSOCIATES 7 - a California limited partnership and SUBSIDIARIES NOTES TO SCHEDULE of REAL ESTATE AND ACCUMULATED DEPRECIATION - Continued\n(e)\n- 27 -\nPROPERTIES\n- 28 -\n(1) These properties are encumbered by mortgage notes payable. (2) These properties are operated by Registrant. (3) Ownership of building with ground lease of land. (4) This property is vacant.\n- 29 -\nMARKET FOR THE PARTNERSHIP'S EQUITY AND RELATED UNITHOLDER MATTERS - --------------------------------------------------------------------------------\nExcept for limited or sporadic transactions, there is no established public trading market for the Limited Partnership Units of the Partnership.\nAs of December 31, 1995, there were 2,269 holders of record of the Limited Partnership Units of the Partnership.\nIn accordance with the requirements of the Partnership's Amended Agreement of Limited Partnership (the \"Agreement\") contained as Exhibit A to the Prospectus, the Corporate General Partner expects to continue to make quarterly distributions of Distributable Cash From Operations, as defined, in the Agreement. The following table shows the frequency and amount of distributions paid per Unit since 1992:\n(a) Includes a special distribution of $150 per Limited Partnership Unit.\nREPORT ON FORM 10-K - --------------------------------------------------------------------------------\nThe Corporate General Partner will supply to any owner of Limited Partnership Units, upon written request and without charge, a copy of the Annual Report on Form 10-K for the year ended December 31, 1995 as filed with the Securities and Exchange Commission.\n- 30 -\nDIRECTORS AND SENIOR OFFICERS\nThe Partnership has no directors or officers. The directors and senior officers of the Corporate General Partner are as follows:\nWilliam Polk Carey Chairman of the Board Director\nFrancis J. Carey President Director\nGeorge E. Stoddard Chairman of the Investment Committee Director\nRaymond S. Clark Chairman of the Executive Committee Director\nMadelon DeVoe Talley Vice Chairman of the Board Director\nStephen H. Hamrick Director\nBarclay G. Jones III Executive Vice President Director\nLawrence R. Klein Chairman of the Economic Policy Committee Director\nClaude Fernandez Executive Vice President Chief Administrative Officer\nHoward J. Altmann Senior Vice President\nH. Augustus Carey Senior Vice President\nJohn J. Park Senior Vice President Treasurer\nDebra E. Bigler First Vice President\nTed G. Lagried First Vice President\nAnthony S. Mohl First Vice President\nMichael D. Roberts First Vice President Controller\nThe directors and senior officers of W. P. Carey & Co., Inc. are substantially the same as above.\nA description of the business experience of each director of the Corporate General Partner is set forth below:\nWilliam Polk Carey, Chairman and Chief Executive Officer, has been active in lease financing since 1959 and a specialist in net leasing of corporate real estate property since 1964. Before founding W.P. Carey & Co., Inc. (\"W.P. Carey\") in 1973, he served as Chairman of the Executive Committee of Hubbard, Westervelt & Mottelay (now Merrill Lynch Hubbard), head of Real Estate and Equipment Financing at Loeb Rhoades & Co. (now Lehman Brothers), head of Real Estate and Private Placements, Director of Corporate Finance and Vice Chairman of the Investment Banking Board of duPont Glore Forgan Inc. A graduate of the University of Pennsylvania's Wharton School of Finance, Mr. Carey is a Governor of the National Association\n- 31 -\nof Real Estate Investment Trusts (NAREIT). He also serves on the boards of The Johns Hopkins University and its medical school, The James A. Baker III Institute for Public Policy at Rice University, and other educational and philanthropic institutions. He founded the Visiting Committee to the Economics Department of the University of Pennsylvania and co-founded with Dr. Lawrence R. Klein the Economics Research Institute at that university.\nFrancis J. Carey was elected President and a Managing Director of W.P. Carey in April 1987, having served as a Director since its founding in 1973. He served as a member of the Executive Committee and Board of Managers of the Western Savings Bank of Philadelphia from 1972 until its takeover by another bank in 1982 and is former chairman of the Real Property, Probate and Trust Section of the Pennsylvania Bar Association. Mr. Carey served as a member of the Board of Overseers of the School of Arts and Sciences of the University of Pennsylvania from 1983 through 1990 and has served as a member of the Board of Trustees of the Investment Program Association since 1990. From April 1987 until August 1992, he served as counsel to Reed Smith Shaw & McClay, counsel for Registrant, the General Partners, the CPA(R) Partnerships and W.P. Carey and some of its affiliates. A real estate lawyer of more than 30 years' experience, he holds A.B. and J.D. degrees from the University of Pennsylvania.\nGeorge E. Stoddard, Chief Investment Officer, was until 1979 head of the bond department of The Equitable Life Assurance Society of the United States, with responsibility for all activities related to Equitable's portfolio of corporate investments acquired through direct negotiation. Mr. Stoddard was associated with Equitable for over 30 years. He holds an A.B. degree from Brigham Young University, an M.B.A. from Harvard Business School and an LL.B. from Fordham University Law School.\nRaymond S. Clark is former President and Chief Executive Officer of the Canton Company of Baltimore and the Canton Railroad Company. A graduate of Harvard College and Yale Law School, he is presently a Director and Chairman of the Executive Committee of W.P. Carey and served as Chairman of the Board of W.P. Carey from its founding in 1973 until 1982. He is past Chairman of the Maryland Industrial Development Financing Authority.\nMadelon DeVoe Talley, Vice Chairman, is a member of the New York State Controller's Investment Committee, a Commissioner of the Port Authority of New York and New Jersey, former CIO of New York State Common Retirement Fund and New York State Teachers Retirement System. She also served as a managing director of Rothschild, Inc. and as the President of its asset management division. Besides her duties at W.P. Carey, Mrs. Talley is also a former Governor of the N.A.S.D. and is a director of Biocraft Laboratories, a New York Stock Exchange company. She is an alumna of Sarah Lawrence College and the graduate school of International Affairs at Columbia University.\nStephen H. Hamrick is the former Executive Vice President and Managing Director of Wall Street Investor Services where he completed the sale and turnaround of its bank based brokerage business. Previously, he served six years as the Director of Private Investments for PaineWebber Incorporated. From 1975 until joining PaineWebber in 1988, Mr. Hamrick was associated with E.F. Hutton & Company (and the successor firm Shearson Lehman Hutton Inc.), where he held the position of First Vice President and National Director of Private Placements. Mr. Hamrick is a former Chairman of the Securities Industry Association's Direct Investment Committee and the Investment Program Association. He is a Certified Financial Planner and was graduated with degrees in English and Economics from Duke University.\nBarclay G. Jones III, Executive Vice President, Managing Director, and co-head of the Investment Department. Mr. Jones joined W.P. Carey as Assistant to the President in July 1982 after his graduation from the Wharton School of the University of Pennsylvania, where he majored in Finance and Economics. He was elected to the Board of Directors of W.P. Carey in April 1992. Mr. Jones is also a Director of the Wharton Business School Club of New York.\nLawrence R. Klein, Chairman of the Economic Policy Committee since 1984, is Benjamin Franklin Professor of Economics Emeritus at the University of Pennsylvania, having joined the faculty of Economics and the Wharton School in 1958. He holds earned degrees from the University of California at Berkeley and Massachusetts Institute of Technology and has been awarded the Nobel Prize in Economics as\n- 32 -\nwell as over 20 honorary degrees. Founder of Wharton Econometric Forecasting Associates, Inc., Dr. Klein has been counselor to various corporations, governments, and government agencies including the Federal Reserve Board and the President's Council of Economic Advisers.\nClaude Fernandez, Chief Administrative Officer, Managing Director, and Executive Vice President, joined W.P. Carey in 1983. Previously associated with Coldwell Banker, Inc. for two years and with Arthur Andersen & Co., he is a Certified Public Accountant. Mr. Fernandez received his B.S. degree in Accounting from New York University in 1975 and his M.B.A. in Finance from Columbia University Graduate School of Business in 1981.\nHoward J. Altmann, Senior Vice President, Investment Department, joined W.P. Carey in August 1990. He was a securities analyst at Goldman Sachs & Co. for the retail industry from 1986 to 1988. Mr. Altmann received his undergraduate degree in economics and finance from McGill University and his M.B.A. from the Stanford University Graduate School of Business.\nH. Augustus Carey, Senior Vice President, returned to W.P. Carey in 1988. Mr. Carey previously worked for W.P. Carey from 1979 to 1981 as Assistant to the President. Prior to rejoining W.P. Carey, Mr. Carey served as a loan officer of the North American Department of Kleinwort Benson Limited in London, England. He received an A.B. from Amherst College in 1979 and an M.Phil. in Management Studies from Oxford University in 1984. Mr. Carey is a trustee of the Oxford Management Centre Associates Council.\nJohn J. Park, Senior Vice President and Treasurer, joined W.P. Carey as an Investment Analyst in December 1987. Mr. Park received his undergraduate degree from Massachusetts Institute of Technology and his M.B.A. in Finance from New York University.\nDebra E. Bigler, First Vice President, joined W.P. Carey in 1989 as an assistant marketing director, rising to her present position where she bears responsibility for investor services throughout the southern United States. She was previously employed by E. F. Hutton & Company for nine years where she began as a Marketing Associate in Private Placement, Sales and Marketing and was then promoted to Regional Director.\nTed G. Lagreid, First Vice President, joined W.P. Carey in 1994 and is regional director responsible for investor services in the western United States. Prior to joining the firm, he was a Vice President with Shurgard Capital Group, then for Sun America where he was an executive in its mutual funds group. He earned an A.B. from the University of Washington, received an M.P.A. from the University of Puget Sound and then spent eight years in the city of Seattle's Office of Management and Budget and Department of Community Development. Mr. Lagreid was a commissioner of the City of Oakland, California, serving on its Community and Economic Advisory Commission.\nAnthony S. Mohl, First Vice President, Director of Portfolio Management, joined W.P. Carey as Assistant to the President after receiving his M.B.A. from the Columbia University Graduate School of Business. Mr. Mohl was employed as an analyst in the strategic planning group at Kurt Salmon Associates after receiving an undergraduate degree from Wesleyan University.\nMichael D. Roberts joined W. P. Carey as a Second Vice President and Assistant Controller in April 1989 and is currently First Vice President and Controller. Prior to joining W.P. Carey, Mr. Roberts was employed by Coopers & Lybrand, where he attained the title of audit manager. A certified public accountant, Mr. Roberts received a B.A. from Brandeis University and an M.B.A. from Northeastern University.\n- 33 -","section_15":""}
{"filename":"790228_1995.txt","cik":"790228","year":"1995","section_1":"Item 1. Business.\nGeneral\nThe Company primarily develops health care products that limit or prevent the risk of accidental needle sticks which may cause the spread of blood- borne diseases such as HIV and hepatitis B, and secondarily develops other products for use in the health care industry.\nThe Company has created a portfolio of proprietary health care products that are in various stages of production, pre-production, development and research. The Company's products include those being currently commercialized, those utilizing the ExtreSafe(TM) medical needle technology and those relating to certain filmless digitized imaging technology. In December 1994, the Company introduced the first in its line of newly developed containers for the disposal of contaminated \"sharps\" (i.e.,needles, syringes, blood collection systems, intravenous catheters, surgical blades, lancets, etc.). Additional sizes and versions of its Safety Cradle(R) sharps containers were released in the third and forth quarters of 1995. The Company is developing a safety lancet (the \"SafetyStrip(TM)\"), a small hand- held device for penetrating the skin to obtain blood for analysis. Commercial production of the SafetyStrip(TM) is anticipated to commence in 1996.\nThe Company is also developing a line of products using the Company's ExtreSafe(TM) medical needle technology (the\"ExtreSafe(TM) Products\"), which incorporates a system to allow a contaminated needle to be automatically retracted directly from a patient and immediately encapsulated without exposure to the health care worker. Products under development that incorporate the ExtreSafe(TM) medical needle technology include the ExtreSafe(TM) blood draw system, ExtreSafe(TM) catheter and ExtreSafe(TM) syringe. The Company expects to introduce additional products using this technology. Prototypes of the first product using the ExtreSafe(TM) medical needle technology were completed in April 1995 and commercial production is anticipated to commence in December 1996, provided the necessary FDA approvals are obtained, of which there is no assurance. Prototypes of the ExtreSafe(TM) catheter and ExtreSafe(TM) syringe were completed in the second half of 1995. The Company's concepts for a safety intravenous flow gauge and blood collection needle are in the research stage.\nThe Company has also entered into a joint venture to design and produce an improved filmless digitized imaging technology, to be used in the medical field (the \"Imaging Products\") which is in the research stage.\nCompany Background and 1995 Reorganization\nThe Company was incorporated in 1986 as Santian Ventures, Inc., a Utah corporation. Santian Ventures, Inc. was organized to engage in the business of acquiring assets and properties of any kind without regard to any specific type of business or industry. In 1989 the Company changed its name to Ware\/Hadley Ventures, Inc. Subsequently, the Company's corporate domicile was changed to the State of Delaware, and its name was changed to Russco, Inc., effective December 20, 1990, by merger into a newly created Delaware corporation. The Company had no operations until July 28, 1995. On that date and pursuant to the terms of a Placement Agreement, the terms of which were proposed by Capital Growth International (\"Capital Growth\") the Company acquired Specialized Health Products, Inc. (\"SHP\"), a Utah corporation (the \"Acquisition\"), through a merger with a subsidiary of the Company, and the Company changed its name to \"Specialized Health Products International, Inc.\" Pursuant to an Agreement and Plan of Merger dated June 23, 1995, among the Company, SHP and Scott R. Jensen, the sole officer and director of the Company prior to the Acquisition (the \"Merger Agreement\"), Scott R. Jensen resigned as the sole officer and director of the Company effective upon consummation of the Acquisition wherein SHP became a wholly owned subsidiary of the Company. The persons serving as officers and directors of SHP immediately prior to the consummation of the Acquisition were elected to the same offices with the Company and retained their positions as directors and officers of SHP. In addition, the outstanding securities of SHP became outstanding securities of the Company. Prior to the Acquisition, neither SHP nor any affiliate of SHP had an interest in Russco, Inc.\nProducts\nSharps Containers\nIn January 1994, SHP acquired the Sharp-Trap(R) name and all technology developed by Sharp-Trap, Inc., a Michigan corporation, relating to a patented container entry system that is designed to reduce the risk of accidental needle sticks and exposure to contaminated instruments when disposing of contaminated instruments. At the time of SHP's purchase of the Sharp-Trap(R) technology, Sharp-Trap, Inc. was already manufacturing two sharps container product configurations, a 0.5 quart and a 1.5 quart (the \"Sharp-Trap(R)\" containers).\nFollowing additional research and discussions with medical product distributors and end users, SHP designed an improved line of Safety Cradle(R) sharps containers (the \"Safety Cradle(R)\") which retained the basic container closure technology and incorporated improvements to make them safer, higher quality, easier to use and less costly to manufacture than the Sharp-Trap(R) containers. The self-closing Safety Cradle(R) containers allow for disposal of sharps in a container that incorporates a self closing sharps containment flap open\/close\/lock mechanism. Especially adapted for alternate site use, SHP's new line of Safety Cradle(R) sharps containers provide convenience and safety for portable applications. In addition, each of SHP's sharps containers is designed to be used as a self-contained shipping container, used in the transport of unused medical material, and readily converted at a users site for use as a safe and efficacious sharps container. The Safety Cradle(R) sharps container's novel, single-molded-part lid fits three sizes of container wells to fill a broad spectrum of sharps containment applications, especially alternate site use which includes, emergency vehicle, in-home and insurance testing. As each Safety Cradle(R) sharps container is formed from only two molded parts, unit manufacturing cost places SHP's sharps containers in a competitive position, while the special design for transportability permits the Safety Cradle(R) container to fill a unique market niche. These containers are made of environmentally safe polypropylene material.\nSHP has developed three sizes of the Safety Cradle(R) container wells. Each container well uses the same top, but the bottom section varies in size to allow different volumes to be accommodated (i.e., a 3 inch, a 5 inch and a 9 inch). By manufacturing the top separately, savings in manufacturing cost are achieved. Also, the containers may be used not only as Safety Cradle(R) sharps containers and transporters, but also as recyclers.\nThe Safety Cradle(R) products can be used for a variety of purposes, including:\nSafety Cradle(R) Sharps Container - all three sizes will be used as Safety Cradle(R) sharps containers to contain and dispose of contaminated sharps. Sale of the 3 inch and the 5 inch sizes began in March 1995 with earlier models. Sales of the latest models began in December of 1995.\nTransporter - all three sizes are designed to house medical kits and new syringes for shipping to the customer. Upon arrival at a customer site, each Safety Cradle(R) sharps container can be utilized as a sharps disposal container. The first sales of Safety Cradle(R) products as transporter\/sharps containers are anticipated to take place in the second quarter of 1996.\nRecycler - all three sizes are designed for use by medical product manufacturers as a secured container, so that discarded sharps may be shipped back to the manufacturer or to a sharps disposer for recycling. The Company anticipates that it will be prepared to execute orders for its SafetyCradle(R) products used as recyclers by the fourth quarter of 1996.\nClosed lid design - an improved lid design was completed in March 1995. The initial molds were completed in October 1995. In the new lid design, the Safety Cradle(R) is located under the lid which closes over the Safety Cradle(R) to drop the sharps into the safe holding compartment. This model is designed for use in the home and home health care markets due to the need to have a sharps container with a lid covering and locking over the entry area for the sharps. The first sales took place in the fourth quarter of 1995.\nProducts Under Development\nThe SafetyStripO Lancet\nLancets are small devices used to penetrate the skin, usually a finger, to obtain a few drops of blood for analysis. Lancets are used by health care workers and are self-administered by individuals, especially insulin users. The same safety concerns exist with the handling of lancets as with needles, because lancets become contaminated after they come into contact with blood.\nThere are a number of lancets on the market today, the most common of which is a small \"nail\" type instrument which is pressed against the finger, and the \"nail\" is then triggered to penetrate the skin by hand pressure. Some lancets penetrate the skin with a blade, which is commonly considered to be less painful to the patient than the \"nail\" and generally is more successful in blood production. The nail type lancet is often inserted into a spring loaded hand held device, about the size of a large pen. The device is pressed against the skin of the patient's finger which is penetrated when the spring is triggered. After triggering, the lancet handle must be emptied and then reloaded with another single lancet for use on the next patient. The Company is unaware of any lancets on the market today that provide absolute protection against being used more than once on different patients. Furthermore, existing lancet handle parts may become contaminated by blood splattering when the finger is pierced. To help prevent contamination, contaminated lancets parts should be sterilized or disposed of after each use. In practice, however, sterilization usually does not take place on all such parts after each use and some lancet parts are commonly used more than once.\nThe Company's SafetyStrip(TM) lancets will be easy-to-use and provide protection against being used more than once. SafetyStrip(TM) lancets will be provided in cartridge strip housings of six lancets per strip. The strip configuration is patent protected. Lancets are used one at a time, by breaking off and discarding lancets immediately after use. A strip housing is loaded into a convenient low-cost hand held carrier which also provides a means for safely and conveniently triggering each lancet. After penetrating the skin, the SafetyStrip(TM) automatically returns inside its housing and cannot be refired for further use. The used lancet, encased by its protective housing, is then broken off from the cartridge strip and appropriately discarded. Reloading the handle with another cartridge is a simple process. Use of the Company's SafetyStrip(TM) will be easier and faster than use of existing lancets. Testing has shown the Company's SafetyStrip(TM) to be less painful to the patient than traditional lancets because of the revolutionary design of the blade and its rotary spring motio which drives the blade both outward to lance and inward for retraction. It is also noteworthy that part of the lancet in contact with the patient's skin prior to lancing is sterile until contaminated by use. A prototype of the SafetyStrip(TM) lancet was completed earlier this year and the Company anticipates that commercial production will begin in July 1996.\nExtreSafe(TM) Blood Collection Needle\nFor certain blood tests it is necessary to draw blood from the patient for analysis. The present method for obtaining a draw of blood involves the insertion of a needle into a blood vessel an the drawing of blood by way of vacuum pressure most often into a small evacuated tube-like container commonly known as a Vacutainer(R) (the Vacutainer(R) is not a trademark of the Company). After the blood draw, the needle is manually removed from the patient and, while continuing to attend to the patient, the Vacutainer(R) and needle are often placed on a tray or set aside. Afterward, the needle is usually unscrewed and discarded into a sharps container. The Company's ExtreSafeO blood collection needle provides a safer method. The device retracts the inserted needle directly from the patient into a safe housing quickly and automatically, minimizing the chance of an inadvertent stick by a \"dirty\" needle. Retraction is initiated by a simple depression of a selected distortable portion of the housing assuring that there is no action directed toward or away from the patient which might affect the depth of needle penetration. The Company's ExtreSafe(TM) medical needle technology has a number of other applications, including an ExtreSafe(TM) catheter and ExtreSafe(TM) syringe described hereafter. Prototypes of the ExtreSafe(TM) blood collection needle were completed in 1995 and the Company anticipates that commercial production will begin in December 1996 provided the necessary FDA approvals are obtained, of which there is no assurance.\nExtreSafe(TM) Catheter\nContemporary catheter use has problems similar to those faced in blood draw. Inserting a catheter involves a percutaneous needle stick followed by threading the catheter over the needle into a patient's vein or artery. This method is unsafe in two respects. First, when the needle is pulled out of the catheter there is a discharge of blood which could contaminate the health care worker. Second, needle sticks occur when the needle is withdrawn from the catheter because, in some instances, the needle is temporarily left exposed while the patient is being attended to by the health care worker. Like the ExtreSafe(TM) blood collection needle, the Company's ExtreSafe(TM) catheter is a needle extractor which retracts a contaminated needle from a patient and encloses the needle in a safe housing when an operator squeezes a portion of the housing at the time the needle is to be extracted from the patient and catheter. Further, in one version of the ExtreSafe(TM) catheter, a manually closeable portion of the catheter stem permits the catheter channel to be held closed until a connection is made to a medical line thereby restricting blood loss. Prototypes of one version of the ExtreSafe(TM) catheter were completed earlier this year and the Company anticipates that commercial production will begin in 1997 provided the necessary FDA approvals are obtained, of which there is no assurance.\nExtreSafeTM Syringe\nAnother area where there is significant risk of needle sticks is in syringe use. Contemporarily, there are many different aspects of syringe use which range from integral units which combine a filled syringe and attached needle for unit dose applications to syringe needles which are attached to separate syringes by leur-lock connectors. Generally, access to the needle for a medical procedure involves removing a protective needle cover just prior to performing the procedure. In the past, medical personnel attempted needle protection by replacing the needle cover after performing the procedure, but the volume of accidental needle sticks related to needle replacement resulted in the banning of such needle cover replacement. Following this ban, medical personnel attempted to supplant cover replacement by carrying the needles to sharps containers (normally found within each patient care room) and by providing needle\/syringe apparatus having a shroud which can be extended over the exposed needle after the procedure. The ExtreSafeTM syringe provides an extendible needle which is retractable into a safe housing in a manner similar to the retraction of the ExtreSafe(TM) blood draw and catheter systems described above. Prototypes of the ExtreSafeTM syringe were completed in 1995. Production is forecast for 1997 provided the necessary FDA approvals are obtained, of which there is no assurance.\nFilmless Digitized Imaging Technology\nThe procedure for taking a large area x-ray image having generally acceptable resolution and presenting the x-ray to the attending physician for interpretation, has changed little over the past forty years. The most common x-ray image today is taken by way of a film which requires development in a darkroom. The physician personally handles the x-ray, which is generally imprinted on a 14\" x 17\" film sheet. For record keeping purposes, hospitals usually maintain an inventory of x-rays for at least six years. X-ray storage and retrieval is a costly problem for many medical facilities. While some filmless x-ray systems have recently been introduced, none fulfill desired and necessary resolution requirements of commonly performed x-ray procedures.\nIn October 1995, the Company entered into a joint venture with Zerbec, Inc., a Texas corporation, to develop, manufacture, distribute and market products and technologies using a patented solid state filmless digitized imaging technology through Quantum Imaging Corporation, a newly formed Utah corporation. The filmless digitized imaging technology involves a method o directly producing an electrical signal from an image recorded on an x-ray plate. The signal is instantly digitized and stored on a CD-ROM and the same x-ray plate is then available for a later procedure. The filmless digitized imaging technology will eliminate film as the x-ray image recording form and will also enable x-ray films to be translated to a CD-ROM format to simplify their storage, retrieval and handling. The Company believes the filmless digitized imaging technology will provide a unique method for revolutionizing the way in which x-ray images are taken, interpreted and stored, while also providing clearer images having high resolution that are more easily interpreted than x-ray films. Furthermore, the technology will provide a breakthrough for the use of x-ray facilities in mobile medical emergency units which has not been achieved to date because of the necessity for local chemical handling equipment associated with film processing.\nUnder the terms of the joint venture agreement, Zerbec, Inc. and the Company formed Quantum Imaging Corporation, a Utah corporation, to finish the development and commercialize the filmless digitized imaging technology. A research prototype of the filmless digitized imaging technology has been demonstrated. A new prototype which is being produced to demonstrate picture resolution compatible with breast cancer diagnosis was fabricated and demonstration in the first quarter of 1996, provided timely funding is obtained. An alpha test system is scheduled for completion in 1996. A beta test system is scheduled for completion in 1997 and production is scheduled for 1998.\nAt present, the Company and Zerbec, Inc. are the sole and equal owners of Quantum Imaging Corporation. Pursuant to the terms of the joint venture agreement, Zerbec, Inc. assigned the patented filmless digitized imaging technology to Quantum Imaging Corporation, and will provide ongoing support in the development and commercialization of the technology. The joint venture agreement also provides that the Company will support the development and commercialization of the technology, in part, by contributing up to $30,000 per month for a twelve month period to Quantum Imaging Corporation, which funds shall be used to support the company's operations. For Quantum Imaging Corporation to be successful, the Company estimates that between $3,000,000 and $6,000,000 will have to be raised through available financing channels, if any. It is anticipate that at least one-third of the outstanding shares of Quantum Imaging Corporation will be sold to fund development through initial production of related filmless digitized imaging systems. The Company and Zerbec, Inc., are seeking to bring in additional venturers to provide funding, depending on financing needs. As a result, the Company's ownership interest may decrease, but its financial and other obligations to support the development and commercialization of the technology may not decrease.\nCompany Strategy\nThe Company's primary objective is to establish itself as a leading provider of safety medical products and devices. The manufacture of these products will be subcontracted to reputable manufacturers. To achieve this objective, the Company's growth strategy is focused on the following four principal elements.\n- Capturing significant market share of the sharps container, lancet, blood draw, IV catheter and syringe markets.\n- Broadening the Company's existing products lines and developing product lines to increase penetration into closely related markets.\n- Seeking additional market opportunities based on the Company's proprietary technology.\n- Developing agreements with large medical product marketing and distributing organizations.\nSharps Containers\nThe Company was only able to produce sharps containers on a limited basis in 1995 because the related molds had not been completed. Full scale production of the Company's SafetyCradle(R) sharps containers is currently beginning and the Company anticipates significantly expanding its production of Safety Cradle(R) sharps container products in 1996. The Company believes the manufacture and sale of its Safety Cradle(R) products should find a significant niche in home sharps container and combined new instrument transport\/sharps container applications.\nThe Company also intends to develop license\/joint venture agreements in international markets. Entrance into such markets is not anticipated until after the Company's Safety Cradle(R) sharps container products are being successfully marketed in the United States.\nProducts in Development\nThe Company's SafetyStrip(TM), ExtreSafe(TM) blood collection needle, ExtreSafe(TM) catheter, ExtreSafe(TM) syringe, intravenous flow gauge, blood collection system, other ExtreSafe(TM) medical needle technology products and the filmless digitized imaging technology are in various stages of research and\/or development. The Company plans to continue development of each of these products\/systems. The necessary production equipment and testing, however, must be completed before such products are brought to market.\nThe Company intends to minimize the cost and time necessary to bring these products to market by using the information and experience gained in the design, development and assembly of its Safety Cradle(R) sharps containers. In addition, the Company is seeking alliances with large medical product marketing, sales and distribution companies to sell its Safety Cradle(R) sharps container products and these follow-on products. There can be no assurance, however, that the Company will be able to form an alliance and that the Company will be able to complete development of these products.\nFuture Market Opportunities\nThe Company will seek to enter additional markets in situations where it believes that it can gain significant market share based on patent protected intellectual properties or by capitalizing on its sales channels for complementary products. There are a number of possible future applications for the Company's technology, but there can be no assurance that the Company will commence development of any such products.\nMarketing and Sales\nThe Company currently intends to market and sell its products in the United States and possibly in select foreign countries through third party manufacturers and distributors. The Company's plan for the distribution and sales of its products will target major segments of the respective markets for those products, including, major hospital and institutional buying groups, pharmaceutical companies, distributors and wholesalers, and government and military agencies. The Company intends to market and distribute its products through one or more companies that have a major presence in these markets.\nThe Company will not sell its ExtreSafe(TM) medical needle technology for commercial use in the United States until proper regulatory approval is obtained. See \"Business -- Government Regulation.\" The Company must also comply with the laws and regulations of the various foreign countries in which the Company plans to sell its products prior to selling such products in such foreign countries. Certain foreign countries may only require the Company to submit evidence of the FDA's pre-market clearance of the relevant products prior to selling in such countries. However, some foreign countries may have more stringent requirements and require additional testing and approvals. See \"Business -- Government Regulation.\"\nThe Company currently plans to hire a limited number of sales and marketing personnel; however, the number will vary depending on the extent to which the Company contracts with third parties or forms strategic alliances with other parties to market and sell its products. The Company may seek third parties to market and distribute its products in select foreign countries. The Company will seek third parties to market and distribute its products in the United States. The Company may enter into contracts, licensing agreements and joint ventures with such third parties whereby the Company would receive a licensing fee and\/or royalty payments based on the licensee's revenues. The Company would likely enter into such licensing arrangements with several companies, possibly by country, geographical regions and\/or product types but may enter into an exclusive arrangement with a single company having a major presence in all markets the Company seeks to penetrate. The Company has not entered into any such licensing arrangements and there can be no assurance that the Company will be able to enter into such licensing arrangements on acceptable terms.\nThe Company intends to market its products by, among other things, attending trade shows and advertising in industry publications. The Company intends to distribute samples of some or all of its products free of charge to various health care institutions and professionals in the United States and in selected foreign countries to introduce and create a demand for the products in the marketplace.\nIndustry\nMarket\nHealth care is one of the largest industries in the world and continues to grow. There is increasing demand in the health care market for products that are safer, more efficacious and cost-effective. The Company's products target segments of this market. While traditional, non-safety, products in the market segments which the Company seeks to address compete primarily on the basis of price, the Company expects to compete on the basis of healthcare worker safety, ease of use, reduced cost of disposal, patient comfort and compliance with OSHA regulations, but not on the basis of purchase price. However, the Company believes that when all indirect costs (disposal of needles, and testing , treatment and workers compensation expense related to needle stick injuries) are considered, the Company's products will compete effectively both with \"traditional\" products and the safety products of the Company's competitors.\nAccidental Needle Sticks\nNeedles for hypodermic syringes, phlebotomy sets and intravenous catheters are used for introducing drugs and other fluids into the body and drawing out blood and other bodily fluids. Among the applications for needles are the injection of drugs (hypodermic needles), the drawing of blood (phlebotomy sets) and the infusion of drugs and nutrients (catheters). There is an increasing awareness of the potential danger of infections and illness that result from accidental needle sticks and of the need for safer needle devices which reduce the number of accidental needle sticks that occur each year.\nInfections contracted as a result of accidental needle sticks are a major concern to health care institutions, health care workers, sanitation and environmental services workers and the regulatory agencies charged with the task of making their working environment safe. Accidental needle sticks may result in the spread of infectious diseases such as hepatitis B, HIV (which may lead to AIDS), diphtheria, gonorrhea, typhus, herpes, malaria, rocky mountain spotted fever, syphilis and tuberculosis. According to The American Hospital Association's (the \"AHA\") report dated December 1992, an estimated 800,000 occupational needle sticks occur nationwide each year. The number of reported needle sticks, however, is believed to be only a portion of the actual number of occurrences. The AHA report estimates that the direct costs (excluding costs such as time lost from work and other administrative activities) for medical evaluation and follow-up treatment after a single needle stick injury range from $200 to $1,200. While it is difficult to estimate the total costs associated with treating accidental needle stick injuries with any degree of confidence, Theta Corporation, in its Report No. 346 on Medical Needles and Syringes dated January 1994, estimates that the total cost associated with treating accidental needle sticks in the United States averages $3 billion each year. The AHA and other authorities have also stated that the benefits resulting from the prevention of accidental needle sticks (and the resulting incidence of infection, illness, time lost from work and death) cannot be measured solely by savings in the costs of medical treatment. Currently available safety needle devices are priced at approximately two to twelve times that of standard devices. Notwithstanding the price differential, the Company believes that, based upon the estimated costs associated with accidental needle sticks, its products should be considered cost-effective by the marketplace.\nThe possibility of health care workers becoming infected from contaminated needles has caused and continues to cause a great deal of concern in the health care field and the agencies regulating that area. OSHA has adopted regulations requiring employers to institute universal precautions to prevent contact with blood and other potentially infectious materials. OSHA's regulations also require employers to establish engineering controls (e.g., sharps disposal containers and self-sheathing needles) and safe work practices to insure compliance with these universal precautions. OSHA does not mandate specific technologies; rather, employers are permitted to choose the most appropriate and effective safety control devices to meet their specific institutional needs. According to OSHA guidelines, while employers do not have to institute the most sophisticated engineering controls, it is the employer's responsibility to evaluate the effectiveness of existing controls and the evaluate the feasibility of instituting more advanced engineering controls. OSHA specifically prohibits the recapping, bending or removal of needles, unless there is no feasible alternative or if required for a specific medical procedure. If recapping, bending or removal is necessary, workers must use either a mechanical device or a one-handed technique. In April 1992, the FDA issued a safety alert to hospitals warning of the risks of needle stick injuries from the use of hypodermic needles with intravenous equipment. Among other things, the safety alert stated that although the FDA could not recommend specific products, it urged the use of needleless systems or recessed needle system devices with a fixed safety feature. According to the alert, (1) a fixed safety feature should provide a barrier between the hands and needle after use; (2) the safety feature should allow or require the worker's hand to remain behind the needle at all times; (3) the safety feature should be an integral part of the device, and not an accessory; (4) the safety feature should be in effect before disassembly and remain in effect after disposal to protect the users and trash haulers and for environmental safety; and (5) the safety feature should be as simple as possible, and require little or no training to use effectively.\nThe majority of health care workers' adverse exposures to blood are either product-mediated (e.g., needle sticks) or could be prevented by the use of appropriate products (e.g., sharps containers). Increasing pressure is mounting from the government and private sectors for the health care industry to develop medical devices that will provide a safer working environment for health care workers and their patients. The Company's products attempt to address the growing demand for medical devices that reduce the risk of accidental exposure to blood-borne diseases.\nDisposal of Sharps\nThere is extensive everyday use of \"sharps\" (i.e., needles, syringes, blood collection systems, intravenous catheters,surgical blades, lancets, etc.) by doctors, nurses and other health care workers who are in danger of accidenta exposure to transmittable blood-borne diseases such as AIDS and hepatitis B. The most extensively used sharp is the medical needle. About six billion needles a year are used in U.S. hospitals. Needle stick injuries are the most common cause of disease transmission in the health care industry. More than once each minute, about eight hundred thousand times a year, a health care worker is accidentally injured by a potentially contaminated needle. Every year as many as 12,000 workers become infected by accidental exposure to hepatitis B, which is more contagious than AIDS. OSHA mandates the use of special containers for sharps disposal purposes to reduce the incidence of accidental transmission of blood-borne diseases. OSHA requires that the design of sharps containers meet certain minimum standards of safety. It also makes recommendations with respect to the safe handling of needles. One of the most common causes of accidental needle sticks occurs when a worker tries to recap a needle. The most recent OSHA regulations require that needles not be recapped or purposely bent or broken. After they are used, disposable syringes, needles, and other sharp items should be placed in closeable, disposable, puncture-resistant containers that are leak proof on the sides and bottom and labeled, according to OSHA guidelines.\nFacilities now being affected by current state and federal legislation regarding the disposal of biohazardous items include hospitals, laboratories, clinics, nursing homes, blood banks, physicians' offices and mortuaries. Stricter legislation may be introduced that relates to all environments where sharps can befound (e.g., homes, public facilities, etc.). In addition, some states have passed legislation and others considering legislation relating to the disposal of sharps.\nPatents and Proprietary Rights\nThe Company owns four United States patents and has other patent applications pending in the United States and in other countries which are directly applicable to the Company's Safety Cradle(R) sharps container products. The Company also owns two United States patents relating to its SafetyStrip(TM), and four United States patents and allowed patent applications relating to its ExtreSafeO medical needle technology. The Company has three additional United States patent applications pending relating to its safe-needle retraction technology. None of the above referenced patents expire before April 1, 2006. Quantum Imaging Corporation, an affiliate of the Company, owns three United States patents and has three Canadian patents relating to the filmless digitized imaging technology. These patents expire in May 2001, September 2002 and September 2005. The Company expects that additional patents will be applied for relating to the technology owned by Quantum Imaging Corporation.\nThe future success of the Company may depend upon the strength of its intellectual property. The Company believes that the scope of its patents\/patent applications is sufficiently broad to prevent competitors from introducing devices of similar novelty and design to compete with its current products and that such patents and patent applications are or will be valid and enforceable. This belief, however, may prove to be incorrect if such patents are challenged. In addition, patent applications filed in foreign countries and patents granted in such countries are subject to laws, rules and procedures which differ from those in the United States. Patent protection in such countries may be different from patent protection provided by U.S. laws and may not be as favorable to the Company. The Company plans to timely file international patents in all countries in which the Company is seeking market share.\nThe Company is not aware of any patent infringement claims against the Company. Litigation to enforce patents issued to the Company, to protect proprietary information owned by the Company, or to defend the Company against claimed infringement of the rights of others, may occur. Such litigation would be costly and could divert the resources of the Company from other planned activities. There can be no assurance that the Company would be successful in any such litigation.\nThe Company's policy is to seek patent protection for all developments, inventions and improvements that are patentable and which have potential value to the business of the Company and to protect as trade secrets other confidential and proprietary information. The Company intends to vigorously defend its intellectual property rights.\nManufacturing\nThe Company has designed and paid for the construction of various molds and machinery used to manufacture its Safety Cradle(R) sharps containers. The Company owns all molds used to manufacture its Safety Cradle(R) sharps containers. The Company contracts for the manufacture of its Safety Cradle(R) sharps containers from outside sources. Presently a single corporation is manufacturing the Company's Safety Cradle(R) sharps container products. In the past, polypropylene resin, the major plastic material used in the Company's Safety Cradle(R) sharps containers, has been in short supply for limited periods of time. While alternative manufacturers exist, changes in the Company's manufacturer or an unforeseen short supply of polypropylene could disrupt production schedules and could materially and adversely affect the Company. Final arrangements have not been made for the manufacture of the SafetyStrip(TM), ExtreSafe(TM) blood collection needle protection system, ExtreSafe(TM) catheter, ExtreSafe(TM) syringe, intravenous flow gauge, blood collection needle, other ExtreSafe(TM) medical needle technology products or filmless digitized imaging technology although one molding company has been preliminarily selected to build pre-production molds for the ExtreSafe(TM) blood collection needle. A company has also been selected to produce molds and pre-production parts for the SafetyStrip(TM). Effective May 1995, prototype drawings for lancet molds were approved. The company chosen to produce molds for the ExtreSafe blood collection needle is targeting completion of preproduction prototypes for the ExtreSafeO blood collection needle for June 1996. The materials that the Company plans to use to produce these products are generally widely available. The Company does not anticipate difficulty in obtaining such materials. At present, there are a number of manufacturers that could produce lancet and needle retraction products and a number of suppliers could supply necessary parts. Any difficulties that may arise, however, with respect to the availability of manufacturers and\/or suppliers could disrupt the planned production of each such product and could materially and adversely affect the Company.\nCompetition\nThe leading manufacturers in the sharps container market are Sage Products, Inc., Devon Industries, Inc., Becton Dickinson and Company, and Baxter International, Inc. There are also numerous smaller manufacturers. A variety of sharps disposal products have been introduced into the marketplace. Some of these disposal containers accommodate only the needle while others accommodate the needle, syringe and limited surgical instruments. The majority of the sharps containers on the market, however, allow contaminated instruments to fall out when inverted. Many of the products are unstable if not supported by wall supports or other apparatus. Access to many sharps containers are too accessible. In addition, there are no sharps disposable transporters or recycler\/transporter type products on the market today.\nThe leading manufacturers in the lancet market are Becton Dickinson and Company, Surgicutt, Inc., Miles, Inc., Diagnostic Corporation, Boehringer Mannheim, Inc., and Sherwood Medical Company, a subsidiary of American Home Products Corporation. There are also numerous smaller manufacturers. To the best of the Company's knowledge, there are no safety lancets on the market today that operate in a manner similar to the Company's SafetyStrip(TM) lancet.\nThe leading manufacturers of standard needles are Becton Dickinson and Company, Sherwood Medical Company, Inc. and Terumo Medical Corporation of Japan. The Company is aware of no products on the market today that are comparable to the ExtreSafe(TM) blood collection needle (i.e., that is transversely activated to automatically extract a contaminated needle from a patient and immediately retracts the needle into a safe housing). Applications for the Company's needle retraction technologies may also be found in percutaneous catheter insertion, syringes, and other medical needle devices.\nWhile traditional, non-safety, products in the market segments which the Company seeks to address compete primarily on the basis of price, the Company expects to compete on the basis of healthcare worker safety, ease of use, reduced cost of disposal, patient comfort and compliance with OSHA regulations, but not on the basis of purchase price. However, the Company believes that when all indirect costs (disposal of needles, and testing , treatment and workers compensation expense related to needle stick injuries) are considered, the Company's products will compete effectively both with \"traditional\" products and the safety products of the Company's competitors.\nIt should be noted, however, that the health care products market is highly competitive. Many of the Company's competitorshave longer operating histories and are substantially larger, better financed and better situated in the market than the Company.\nAcquisition of Technology\/Research and Development\nThe Company has devoted substantially all of its efforts since the formation of SHP to acquiring its health care products and research and development relating thereto. Research and development costs were $290,950 for the year ended December 31, 1994 and $568,787 for the year ended December 31, 1995. The Company plans to acquire additional technologies that it determines are advantageous to acquire. In addition, the Company plans to continue research and development on its current products. See \"Business -- Products Under Development\"\nGovernment Regulation\nThe Company and its products are regulated by the FDA, pursuant to various statutes, including the FD&C Act, as amended and supplemented by the Medical Device Amendments of 1976 (the \"1976 Amendments\") and the Safe Medical Devices Act of 1990. Pursuant to the 1976 Amendments, the FDA classifies medical devices intended for human use into three classes, Class I, Class II and Class III. The controls applied to the different classifications are those the FDA believes are necessary to provide reasonable assurance that a device is safe and effective. Class I devices are products not requiring pre-market notification, which can be adequately regulated by the same types of controls the FDA has used on devices since the passage of the FD&C Act in 1938. These \"general controls\" include provisions related to labeling, producer registration, defect notification, records and reports and good manufacturing practices (\"GMPs\"). GMPs include implementation of quality assurance programs, written manufacturing specifications and processing procedures, written distribution procedures and record keeping requirements. Class II devices are products for which the general controls of Class I devices are deemed not sufficient to assure the safety and effectiveness of the device and require special controls. Special controls for Class II devices include performance standards, post-market surveillance, patient registries and the use of FDA guidelines. Standards may include both design and performance requirements. Class III devices have the most restrictive controls and require pre-market approval by the FDA. Generally, Class III devices are limited to life-sustaining, life-supporting or implantable devices.\nSection 510(k) of the FD&C Act requires individuals or companies manufacturing medical devices intended for human use to file a notice with the FDA at least ninety (90) days before introducing the product into the marketplace. The notice (a \"510(k) Notification\") must state the class in which the device is classified and the actions taken to comply with performanc standards or pre-market approval which may be needed if the device is a Class II registrant states the device is unclassified, it must explain the basis for that determination. In some cases obtaining pre-market approval can take several years. Clearance pursuant to a 510(k) Notification can be obtained in much less time. In general, clearance of a 510(k) Notification for a Class II device may be obtained if the registrant can establish that the new device is \"substantially equivalent\" to another device of such Class that is already on the market. This requires the new device to have the same intended use as a legally marketed predicate device and have the same technological characteristics as the predicate device. If the technological characteristics are different, the new device can still be found to be \"substantially equivalent\" if information submitted by the applicant (including clinical data if requested) supports a finding that the new device is as safe and effective as a legally marketed device and does not raise questions of safety and efficacy that are different from the predicate device.\nThe Company has a notification from the FDA that its Sharp Trap(R) sharps containers are substantially equivalent to legally marketed predicate devices. The Company's Safety Cradle(R) sharps containers are subject to the general controls of the FD&C Act and the additional controls applicable to Class II devices. The Company believes that its Safety Cradle(R) sharps container is sufficiently similar to the Sharp Trap(R) container to preclude necessity for another FDA submittal. OSHA also insists, in part, that sharps containers are closeable, disposable, puncture-resistant, leak proof on the sides and bottom and appropriately labeled. The Company's Safety Cradle(R) sharps containers are in compliance with present OSHA regulations. Future regulations, however, may be imposed which might have a material adverse effect on the Company and\/or one or more of its products.\nThe Company's follow-on products (i.e., the SafetyStrip(TM), ExtreSafe(TM) medical needle technology, intravenous flow gauge and blood collection needle) are still in the development stage. The Company expects the SafetyStrip(TM) to be a Class I device and to be subject to lower level controls than are imposed on its Safety Cradle(R) sharps containers.\nIn March 1995, the FDA issued a draft guidance document on 510(k) Notifications for medical devices with sharps injury prevention features, a category that would cover most of the Company's follow-on ExtreSafe(TM) technology products. The draft guidance provisionally placed this category of products into Class II Tier 3 for purposes of 510(k) review, meaning that such products will be subject to the FDA's most comprehensive and rigorous review for 510(k) products. However, review under this classification is expedited. The draft guidance also states that in most cases, FDA will accept, in support of a 510(k) notification, data from tests involving simulated use of such a product by health care professionals, although in some cases the agency might require actual clinical data.\nThe Company expects its other follow-on products to be Class II devices. The Company also expects that its follow-on products will not require pre-market approval applications but will be eligible for marketing clearance through the 510(k) notifications procedure based upon its substantial equivalence to a previously marketed device or devices. Although the 510(k) pre-market clearance process is ordinarily simpler and faster than the pre- market approval application process, there can be no assurance that the Company will obtain 510(k) pre-market clearance to market its follow-on products, or that the Company's follow-on products will be classified as set forth above, or that, in order to obtain 510(k) clearance, the Company will not be required to submit additional data or meet additional FDA requirements that may substantially delay the 510(k) process and add to the Company's expenses. Moreover, such 510(k) pre-market clearance, if obtained, may be subject to conditions on the marketing or manufacturing of the corresponding follow-on products that may impede the Company's ability to market and\/or manufacture such products.\nIn addition to the requirements described above, the FD&C Act requires that all medical device manufacturers and distributors register with the FDA annually and provide the FDA with a list of those medical devices which they distribute commercially. The FD&C Act also requires that all manufacturers of medical devices comply with labeling requirements and manufacture devices in accordance with GMPs, which require that companies manufacture their products and maintain their documents in a prescribed manner with respect to manufacturing, testing, and quality control activities. The FDA's Medical Device Reporting regulation requires that companies provide information to the FDA on death or serious injuries alleged to have been associated with the use of their products, as well as product malfunctions that would likely cause or contribute to death or serious injury if the malfunction were to recur. The FDA further requires that certain medical devices not cleared for marketing in the United States have FDA approval before they are exported.\nThe FDA inspects medical device manufacturers and distributors, and has broad authority to order recalls of medical devices, to seize noncomplying medical devices, to enjoin and\/or to impose civil penalties on manufacturers and distributions marketing non-complying medical devices, and to criminally prosecute violators.\nIn addition to laws and regulations enforced by the FDA and OSHA, the Company is subject to government regulations applicable to all businesses, including, among others, regulations related to occupational health and safety, workers' benefits and environmental protection.\nDistribution of the Company's products in countries other than the United States may be subject to regulations in those countries. There can be no assurance that the Company will be able to obtain the approvals necessary to market its blood collection needle or any other product outside the United States.\nSeasonality of Business\nThe Company products sales are not subject to seasonal variations.\nBacklog\nAs a result of purchasing practices typical to the medical supply industry in which the Company operates, there is no material backlog of unfilled orders.\nEmployees\nAs of March 1, 1996, the Company employed ten people, including five research and development employees, two sales and marketing employees and three administrative employees. The Company expects to add to the number of employees, principally in the areas of sales and marketing. The planned increase in personnel is based primarily on expected increases in production and sales. The Company's employees are not represented by a labor union, and the Company believes its employee relations are good.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nThe Company's offices are located at 655 East Medical Drive, Bountiful, Utah, under terms of a lease with an unaffiliated lessor which expires in June 1998, with an annual rent of approximately $72,000. The lease covers approximately 4,400 square feet of space.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nDuring 1994, SHP entered into various agreements with Mold Threads, Inc., a Connecticut corporation (\"MT\"), whereby MT would construct various molds and manufacture sharps containers for SHP. SHP alleges that MT did not complete its obligations in a timely or satisfactory manner. When SHP attempted to move the mold work and production to another mold maker\/manufacturer MT refused to release SHP's molds. In January 1995, SHP filed suit in the United States District Court for the District of Utah against MT alleging breach of contract, conversion, and intentional interference with business relations. Thereafter, MT agreed to release SHP's molds. In January 1996, MT counterclaimed in the amount of $22,328, exclusive of attorney's fees and costs, for funds it alleges are owed on a purchase order. SHP believes that MT waived its right to assert any additional counterclaims. The litigation is in the early stages, is subject to all of the risks and uncertainties of litigation and the outcome cannot presently be predicted. Specifically, there is no assurance that SHP will be successful in this lawsuit or that the lawsuit will be resolved on acceptable terms, and SHP may incur significant costs in asserting its claims.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNo matters were submitted to a vote of the Company's stockholders during the fourth quarter of 1995.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.\nDividend Policy\nTo date, the Company has not paid dividends on its common stock. The payment of dividends, if any, in the future is within the discretion of the Board of Directors and will depend upon the Company's earnings, its capital requirements and financial condition, and other relevant factors. The Board of Directors does not intend to declare any dividends in the foreseeable future, but instead intends to retain all earnings, if any, for use in the Company's operations.\nShare Price History\nThe Company's common stock (the \"Common Stock\") has been quoted on Nasdaq Small-Cap Market since October 1995 under the trading symbol \"SHPI.\" From July 1995 through October 1995 the Common Stock was quoted on the NASD Over-the-Counter market. Prior to July 1995, 294,872 shares of Common Stock were effectively free trading, although no active trading market existed for the Company's Common Stock. On March 26, 1996, the reported high and low bid and ask prices of the Common Stock were $11.0625 and $10.875, respectively. The following table sets forth the high and low bid information of the Common Stock for the periods indicated. It should be understood that only 294,872 shares of Common Stock have been available for trading to date, and that such over the counter market quotations reflect inter-dealer prices without retail markup, markdown or commission, and the quotations may not reflect any actual market transactions in the Common Stock.\nHolders of Record\nAt March 27, 1996 there were 340 holders of record of the Company's Common Stock.\n[REMAINDER OF PAGE INTENTIONALLY LEFT BLANK]\nItem 6.","section_6":"Item 6. Selected Financial Data.\nThe following data have been derived from consolidated financial statements that have been audited by KPMG Peat Marwick LLP, independent auditors. The information set forth below is not necessarily indicative of the results of future operations and should be read in conjunction with the Financial Statements and related Notes appearing elsewhere in this Form 10-K:\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nThe following discussion and analysis provides information which management believes is relevant to an assessment and understanding of the Company's consolidated results of operations and financial condition. The discussion should be read in conjunction with the consolidated financial statements and notes thereto. Wherever in this discussion the term \"Company\" is used, it should be understood to refer to the Company and SHP, on a consolidated basis, except where the context clearly indicates to the contrary. Prior to the Acquisition wherein the Company acquired SHP (See note 1 to the consolidated financial statements) the Company had no operations.\nOverview\nFrom its inception, the Company has incurred losses from operations. As of December 31, 1995, the Company had cumulative net losses totaling $3,858,056. To date, the Company's principal focus has been the design, development, testing, and evaluation of its Safety Cradle(R) sharps containers, SafetyStripO, ExtreSafe(TM) medical needle technology, intravenous flow gauge system, blood collection needle, and other products, and the design and development of its molds and production processes relating to its Safety Cradle(R) sharps containers.\nIn 1994, the Company had limited sales of its sharps containers due, in part, to the fact the molds used to produce the sharps containers had not been completed and come on line. Certain of the Company's Safety Cradle(R) sharps container molds were completed in the first half of 1995, and additional Safety Cradle(R) sharps container molds were completed in the second half of 1995. As molds were completed, the Company's sales increased from $33,256 for 1994 to $447,844 for 1995. During the fourth quarter of 1995 the Company had sales of $5,503. The decrease in sales was related to the Company inability to use the molds during a good part of the fourth period of 1995 due to improvements that were being made to the molds. Said improvements were completed in January 1996.\nDuring the fourth quarter of 1995, the aggregate effect of year end adjustments, which related to prior quarters, increased the net loss by approximately $457,000. These adjustments were primarily the result of a write off of operating assets and amounts capitalized as research and development and adjustments to consulting and expense reimbursement.\nThe Company anticipates that commercial production of its SafetyStrip(TM) lancet, will commence in July 1996. Provided the necessary FDA approvals are obtained, of which there is no assurance, the Company anticipates commercial production of the following products will commence as follows: ExtreSafe(TM) catheter in October 1997, ExtreSafeO blood collection needle in December 1996 and the ExtreSafeO syringe in July 1997. The Company's other ExtreSafe(TM) medical needle technology products, intravenous flow gauge and blood collection needle are conceptual ideas in the research stage. No assurance can be given, however, that the Company will be able to adhere to these time frames or that such products will ever go to market.\nYears Ended December 31, 1995 and December 31, 1994\nThe Company had sales of $447,844 for the year ended December 31, 1995, and sales of $33,256 for the year ended December 31, 1994. The 1994 revenues were derived largely from the sale of sharps containers that were produced on a limited basis during 1994. Commercial manufacture and sale of additional sizes and versions of the Company's sharps containers were introduced in the third and fourth quarters of 1995. At present, the only product the Company is selling is its Safety Cradle(R) sharps container products. Moreover, during fiscal 1995 $418,509 or ninety-three percent of the Company's sales were through Moore Medical Corp., a non-exclusive distributor for the Safety Cradle(R) sharps container products.\nResearch and development expenses were $568,787 for the year ended December 31, 1995, compared with $290,950 for the year ended December 31, 1994. The Company's efforts in the year ended December 31, 1995, were focused on refining the design and molds for its Safety Cradle(R) sharps container products, and upon the design and development of its SafetyStrip(TM) and ExtreSafe(TM) medical needle technology, intravenous flow gauge system, and blood collection needle. The Company's efforts in the year ended December 31, 1994, were focused on refining the design and molds for its Safety Cradle(R) sharps container products.\nGeneral and administrative expenses were $2,368,873 for the year ended December 31, 1995, compared to $620,022 for the year ended December 31, 1994. The increased costs resulted largely from the following increases in expenditures. First, selling and consulting costs increased from $4,563 for the year ended December 31, 1994 to $360,694 for the year ended December 31, 1995. The increase in selling and consulting costs were primarily a result of an increase in the expenditures made by the Company to market and sell its Safety Cradle(R) sharps container products. Next, salaries and benefit increased from $344,519 for the year ended December 31, 1994 to $791,434 for the year ended December 31, 1995. The increase resulted primarily from the hiring of additional product development, sales and marketing personnel to support sales and commercialization of the Company's products as well as pay increases made to certain of the Company's employees. Next, legal and accounting fees increased from $259,674 for the year ended December 31, 1994 to $553,527 for the year ended December 31, 1995. The increase in costs was primarily from accounting and legal expenses associated with the Acquisition, the filing of an Form S-1 registration statement, increased financing activities and expenses associated with litigation. Finally, travel and entertainment costs increased from $113,623 for the year ended December 31, 1994 to $182,989 for the year ended December 31, 1995. The increase resulted primarily from increased costs associated with financing, manufacturing, selling, and marketing activities.\nNet interest income was $119,570 for the year ended December 31, 1995, compared with net interest expense of $7,563 for the year ended December 31, 1994. The interest income for year ended December 31, 1995, relates to interest earned on funds derived from the sale of the Company's equity securities which closed in August 1995 wherein the Company raised gross proceeds of $8,602,500 (net proceeds of $7,519,060). Net interest expense was $7,563 for the year ended December 31, 1994. The interest expense relates to the accrued interest on certain notes payable and the interest on the Company's line of credit.\nYear Ended December 31, 1993\nDuring this period the Company (not including SHP) had no operations and its financial results were immaterial.\nLiquidity and Capital Resources\nThe Company's need for funds has increased from period to period as it has increased its research and development activities, expanded staff, and commenced the purchase and construction of molds and production equipment. To date the Company has financed its operations principally through borrowings and private placements of equity securities and debt. Through December 31, 1995 the Company had received net proceeds of approximately $9,100,000 through financing activities. The bulk of the proceeds from the Company's financing activity resulted from the sale of equity securities. As of December 31, 1995, the Company's liabilities totaled $580,924. All of these liabilities are current liabilities. The Company had working capital at the year ended December 31, 1995 of $4,194,567 and the Company used net cash in operating activities of $2,605,616.\nThe Company has 3,110,875 Series A Warrants and 1,290,375 Series B Warrants outstanding which are exercisable for shares of Common Stock of the Company at a price of $3.00 per share in the case of Series A Warrants and $2.00 per share in the case of Series B Warrants, and expire on the earlier of (a) two years from the date of effectiveness of a registration statement under the Securities Act covering the issuance of the shares of Common Stock underlying such Warrants upon issuance by the Company or for resale of such stock by the holder, which period shall be extended day-for-day for any time that a prospectus meeting the requirements of the Securities Act is not available, or (b) the date specified in a notice of redemption from the Company (subject to the prior right of the holder to exercise the Warrants for at least 20 days following the date of such notice) in the event that the closing price of the Common Stock for any ten consecutive trading days preceding such notice exceeds $6.00 per share and subject to the availability of a current prospectus covering the underlying stock. Thus, the Company may accelerate the expiration of the Warrants in the event that the average market price of the Common Stock exceeds $6.00 per share, in which event the holders of the Warrants would be permitted to exercise the Warrants during a period of not less than 20 days following notice of such an event. The exercise of all the Series A and Series B Warrants would result in a gross cash inflow to the Company of $11,913,375. The Company presently intends to accelerate the expiration of the Warrants when and if such conditions are met. All of the Warrants are currently outstanding. There can be no assurance, however, that any of theWarrants will be exercised.\nPrior to the Acquisitions, SHP issued to a nonaffiliated shareholder a warrant to purchase 45,000 shares of Common Stock at $1.67 per share. Said warrant was issued by SHP in exchange for cash. This warrant expires in 1996 and became an outstanding obligation of the Company, rather than of SHP, on July 28, 1995 (the date of the Acquisition).\nOn September 1, 1995, the Company adopted a Company's non-qualified stock option plan (\"NQSOP\") wherein the Company is authorized to grant options to purchase up to 1,284,998 shares of Common Stock of the Company. Pursuant to the NQSOP, in September 1995, the Company granted Stock Options to purchase 1,151,810 shares of Common Stock, and in November, the Company issued Stock Options to purchase 20,000 shares of Common Stock. All of these Stock Options are immediately exercisable. These options expire in 2000.\nIn addition to the options outstanding under the NQSOP, the Company also has 108,000 options outstanding that were issued under the SHP NQSOP and that became obligations of the Company pursuant to the terms of the Acquisition. The SHP NQSOP options allows the holders thereof to purchase 108,000 shares of the Company's common stock at $0.39 per share. The SHP NQSOP options expire in 2004.\nThe Company has also given certain officers and directors of the Company the opportunity to receive up to an aggregate of 2,000,000 shares of Common Stock (the \"Earn-Out Shares\"). Any issuance of Earn-Out Shares would be based upon the level of pre-tax consolidated net income, adjusted to exclude any expense arising from the obligation to issue or the issuance of the Earn- Out Shares and any income or expense associated with non-recurring or extraordinary items as determined in accordance with generally accepted accounting principles (\"Adjusted PTNI\").\nThe Company expects that the issuance of Earn-Out Shares will be deemed to be the payment of compensation to the recipients and will result in a charge to the earnings of the Company in the year or years the Earn-Out Shares are earned, in an amount equal to the fair market value of the Earn-Out Shares. This charge to earnings could have a substantial negative impact on the earnings of the Company in the year or years in which the compensation expense is recognized.\nThe effect of the charge to earnings associated with the issuance of Earn-Out Shares could place the Company in a net loss position for the relevant year, even though the Adjusted PTNI was at a level requiring the issuance of Earn-Out Shares. Because Earn-Out Shares are issuable based on the results of a single year, the Adjusted PTNI in a particular year could require the issuance of Earn-Out Shares even thought he cumulative Adjusted PTNI for the three years 1996, 1997 and 1998, or any combination of those years, could reflect a lower amount of Adjusted PTNI that would not require the Company to issue such Earn-Out Shares or even a loss at the Adjusted PTNI line. There is no assurance that years subsequent to the year or years in which Earn-Out Shares are issued will produce the same level of Adjusted PTNI or will be profitable. The management of the Company may have the discretion to accelerate or defer certain transactions that could shift revenue or expense between years or otherwise affect the Adjusted PTNI in any year or years.\nThe Company has agreed to file a registration statement under the Securities Act with respect to the Earn-Out Shares, when issued. The issuance of the Earn-Out Shares, or the perception that the issuance of such stock may occur, could adversely affect prevailing market prices for the Common Stock.\nThe Company has entered into an agreement with a third party (Zerbec, Inc.) to form a Joint Venture (the \"Venture\") to develop, make and distribute an improved filmless digitized imaging system. The Venture is seeking funding to provide an alpha test system in 1996, beta test systems in 1997 and production deliveries in 1998. For a 50% interest in the Venture (before dilution by financing investors), the Company is providing up to $360,000 to support the operations of the Venture over a 12-month period of which approximately $83,000 was paid and expensed in 1995. For the Venture to be successful, the Company estimates that between $3,000,000 and $6,000,000 must be raised. It is anticipated that at least one-third of the outstanding shares of the Venture will be sold to fund development through initial production of related filmless digitized imaging systems. No assurance can be given that the system will find profitable acceptance in the marketplace. See \"Business -- Products Under Development.\"\nThe Company's working capital and other capital requirements during the next year or more will vary based upon a number of factors, including the cost to complete development and bring the SafetyStrip(TM) and ExtreSafe(TM) medical needle technology, intravenous flow gauge system, blood collection needle and other products, to commercial viability, the cost and effort needed to complete production of the Sharp-Trap(R) molds, the level of sales and marketing for the Safety Cradle(R) sharps containers, and the resources that are expended in SHP's lawsuit against Mold Threads, Inc. See \"Legal Proceedings\" At present, the Company has committed to spend $103,805 during fiscal 1996 on projects relating to the development and manufacture of its products. The Company believes that the funds described above and funds generated from the sale of its Safety Cradle(R) sharps containe products, will be sufficient to support the Company's operations and planned capital expenditures at least through fiscal 1996. The Company's failure either to produce or sell sufficient quantities of Safety Cradle(R) sharps container products could materially and adversely affect the Company's cash flows. In addition, the Company's business plans may change or unforeseen events may occur which require the Company to raise additional funds.\nInflation\nThe Company does not expect the impact of inflation on operations to be significant.\nFuture Results\nThis report contains both historical facts and forward-looking statements. Any forward-looking statements involves risks and uncertainties, including but not limited to risk of product demand, market acceptance, economic conditions, competitive products and pricing, difficulties in product development, commercialization, and technology, and other risks. As a result, the Company's actual future operations could differ significantly from those discussed in the forward-looking statements.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nSee index to financial statements and financial statement schedules included herein as Item 14.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.\nOn November 10, 1995 the Company's Board of Directors elected to retain KPMG Peat Marwick, LLP (\"KPMG\") as its independent auditor. Prior to that time Nielson, Grimmett & Company (\"NGC\") had acted as the Company's independent auditor. The decision to change auditors was recommended by the Company's Board of Directors, in part, because KPMG had acted as SHP's auditor prior to the Acquisition.\nThe reports of NGC on the financial statements of the Company for each of the two fiscal years in the period ended December 31, 1994, did not contain any adverse opinion or disclaimer of opinion and were not qualified or modified as to uncertainty, audit scope or accounting principles.\nDuring the Company's two most recent fiscal years and all subsequent interim periods preceding such change in auditors, there were no disagreements with NGC on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements(s), if not resolved to the satisfaction of the former accountant, would have caused it to make a reference to the subject matter of the disagreements(s) in connection with its report; nor has NGC ever presented a written report, or otherwise communicated in writing to the Company or its Board of Directors the existence of any \"disagreement\" or \"reportable event\" within the meaning of Item 304 of Regulation S-K.\nThe Company authorized NGC to respond fully to the inquiries of the Company's successor accountant and NGC provided the Company with a letter addressed to the SEC, as required by Item 304(a)(3) of Regulations S-K, which letter has been filed with the SEC.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of Registrant.\nIn connection with the Acquisition, the individual serving as the sole director and officer of the Company at the effective date resigned on July 28, 1995. The persons serving as directors and officers of SHP immediately prior to that date were elected to the same offices with of the Company and retained their positions as directors and officers of SHP. In addition, Stanley Hollander and J. Clark Robinson were subsequently appointed to fill vacancies on the Company's Board of Directors. Mr. Hollander and Mr. Clarke then resigned from the Board of Directors in March 1996 for personal reasons.\nSet forth below is certain information concerning each of the directors and executive officers of the Company as of March 15, 1996:\nDavid A. Robinson. Mr. Robinson is the President and Chief Executive Officer of the Company. He has been a Director since November 1993. From November 1992 to November 1993, Mr. Robinson was President of EPC Products, Inc., a packaging company based in Bountiful, Utah. From 1981 to 1992, Mr. Robinson was President of Royce Photo\/Graphics Supply, Inc., a distributor of photographic and graphic arts equipment and supplies and parts based in Glendale, California. He holds a Masters degree in Business Administration and a Masters degree in Management Science from the University of Southern California. Mr. Robinson is the brother of J. Clark Robinson, Vice President, Chief Financial Officer, Secretary and a Director of the Company, and an uncle of Bradley C. Robinson, Vice President, Operations, and a Director of the Company.\nBradley C. Robinson. Mr. Robinson is the Vice President, Operations and Investor Relations, of the Company. He has been a Director since November 1993. From November 1992 to November 1993, Mr. Robinson was Vice President of EPC Products, Inc., a packaging company based in Bountiful, Utah. From 1990 to 1992, Mr. Robinson was employed by Cargo Link, a Salt Lake City, Utah, import-export broker. Mr. Robinson is the son of J. Clark Robinson, Vice President, Chief Financial Officer, Secretary and a Director of the Company, a nephew of David A. Robinson, President, Chief Executive Officer, and a Director of the Company, and a son-in-law of Gary W. Farnes, a Director of th Company.\nGale H. Thorne. Dr. Thorne is the Vice President, Product Development, for the Company. He has been a Director since January 1995, and has held his present position as Vice President, Product Development, since October 1994. From 1993 to 1994, Dr. Thorne was a Vice President, Engineering, of Eneco, Inc., a Salt Lake City, Utah, corporation engaged in the business of developing cold-fusion products. During Dr. Thorne's tenure at Eneco, Inc. the company was engaged primarily in the business of prosecuting patent applications relating to the cold-fusion technology. From 1989 to 1993, Dr. Thorne was employed as a patent consultant and patent agent with Foster & Foster, a Salt Lake City intellectual property law firm. Dr. Thorne holds eighteen patents and has published numerous technical publications. He has been a technical consultant and a member of Board of the Small Business Innovation Program of the State of Utah. Dr. Thorne manages all the patent and product development work for the Company. He holds a Ph.D. in Biophysics from the University of Utah.\nJ. Clark Robinson. Mr. Robinson became a Vice President, Chief Financial Officer, Secretary and Director of the Company in September 1995. From 1974 to the present, Mr. Robinson has been General Manager of Lagoon Corporation, which operates an amusement park in the Salt Lake City, Utah, area. At present, Mr. Robinson spends approximately one-half of his time working for the Company and one-half of his time working for Lagoon Corporation. Mr. Robinson has also been President of the International Association of Amusement Parks and Attractions, an international industry trade group. He holds a Masters degree in Business Administration from the University of Utah. Mr. Robinson is the brother of David A. Robinson, President, Chief Executive Officer and a Director of the Company, and the father of Bradley C. Robinson, Vice President, Operations, and a Director of the Company.\nGary W. Farnes. Mr. Farnes is a Director of the Company. He has been a Director since 1995 and is currently the Senior Executive Vice President of Holy Cross Health System, a multi-hospital health care system headquartered in South Bend, Indiana. From 1977 to 1995, Mr. Farnes was employed by Intermountain Health Care, a regional hospital company. At the time that Mr. Farnes left Intermountain Health Care, he held the position of Vice President, Hospital Division. He holds a Bachelors degree in Business and Psychology from Brigham Young University and a Masters degree in Business Administration from George Washington University. Mr. Farnes is the father-in-law of Bradley C. Robinson, Vice President, Operations, of the Company.\nRobert R. Walker. Mr. Walker is a Director of the Company. Mr. Walker has been a Director since March 1994. He is currently self-employed as a consultant in the health care industry primarily in the area of start-up medical device companies. From 1976 to 1992, Mr. Walker was employed by IHC Affiliated Services Division of Intermountain Health Care, a regional hospital company, from which he retired as President of IHC Affiliated Services. He recently retired as the Chairman of the Board of AmeriNet, Inc., which is a national group purchasing organization for hospitals, clinics, detox\/drug centers, emergency, nursing homes, private laboratories, psychiatric centers, rehabilitation facilities, surgical centers and institutions such as schools and prisons. Mr. Walker is a member of the American Hospital Association and the Hospital Financial Management Association. He holds a Bachelor of Science degree in Business Administration.\nMr. Hollander was nominated to serve as a Director of the Company in August 1995, pursuant to an agreement between the Company and Capital Growth, as placement agent for certain securities of the Company. The agreement provided that Mr. Hollander, or another person nominated by Capital Growth, be elected for at least three one-year terms. Mr. Hollander resigned from the Board of Directors for personal reasons in March 1996. In addition, Mr. John T. Clark, who was a Directo of the Company since November 1993, also resigned from the Board of Directors for personal reasons on March 5, 1996. The Company's Board is currently reviewing independent persons to fill the two vacancies existing on the Board. Other than as described above, there are no family relationships among any of the executive officers or directors of the Company.\nExecutive officers of the Company are elected by the Board of Directors on an annual basis and serve at the discretion of the Board. The Company's Board of Directors is divided into three classes. Beginning with the annual meeting of stockholders in 1996, one class of directors will be elected at each annual meeting of stockholders for a three-year term. Each year a different class of directors will be elected on a rotating basis. The terms of Gary W. Farnes and Robert R. Walker will expire in 1996. The terms of Gale H. Thorne and Brad C. Robinson will expire in 1997 and the term of David A. Robinson and J. Clark Robinson will expire in 1998.\nThe Board of Directors has an Executive Committee and Compensation Committee. The Executive Committee has the authority to act on various matters requiring Board of Directors action. The Compensation Committee makes decisions regarding salaries and other compensation. As part of its responsibilities, the Compensation Committee administers the Company's \"NQSOP\".\nItem 11.","section_11":"Item 11. Executive Compensation.\nIncorporated by reference to the Company's proxy statement which the Company intends to file with the Securities and Exchange Commission within 120 days after the close of its fiscal year.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nIncorporated by reference to the Company's proxy statement which the Company intends to file with the Securities and Exchange Commission within 120 days after the close of its fiscal year.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nIncorporated by reference to the Company's proxy statement which the Company intends to file with the Securities and Exchange Commission within 120 days after the close of its 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:\n(1) Financial Statements\nListed on page of the Financial Statements.\n(2) Financial Statement Schedules\nListed on page of the Financial Statements.\n(b) Reports on Form 8-K\nNo reports on Form 8-K were filed by the Registrant during the fourth quarter ended December 31, 1995.\n(c) Exhibits\nListed on page 27 hereof.\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 hereunto duly authorized.\nSpecialized Health Products International, Inc. (Registrant)\nDate: March 29, 1996 By \/s\/ David A. Robinson -------------- ----------------------------- David A. Robinson President, Chief Executive Officer and Director\nPursuant to the requirements of the Securities Act of 1933, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated.\nIndependent Auditors' Report ----------------------------\nThe Board of Directors and Stockholders Specialized Health Products International, Inc.:\nWe have audited the accompanying consolidated balance sheets of Specialized Health Products International, Inc. and subsidiary as of December 31, 1994 and 1995, and the related consolidated statements of operations, stockholders' equity (deficit), and cash flows for the years then ended and for the period from November 19, 1993 (date of inception) to December 31, 1993. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Specialized Health Products International, Inc. and subsidiary as of December 31, 1994 and 1995, and the results of their operations and their cash flows for the years then ended and for the period from November 19, 1993 (date of inception) to December 31, 1993, in conformity with generally accepted accounting principles.\n\/s\/ KPMG Peat Marwick LLP\nSalt Lake City, Utah February 2, 1996\nSee accompanying notes to consolidated financial statements\nSee accompanying notes to consolidated financial statements.\nSPECIALIZED HEALTH PRODUCTS INTERNATIONAL, INC. Consolidated Statements of Stockholders' Equity (Deficit) For the period from November, 19, 1993 (date of inception) to December 31, 1993, and for the years ended December 31, 1994 and 1995\nSee accompanying notes to consolidated financial statements.\nSPECIALIZED HEALTH PRODUCTS INTERNATIONAL, INC.\nStatements of Cash Flows\nFor the period from November, 19, 1993 (date of inception) to December 31, 1993, and for the years ended December 31, 1994 and 1995\nSPECIALIZED HEALTH PRODUCTS INTERNATIONAL, INC.\nConsolidated Statements of Cash Flows (continued)\nFor the period from November, 19, 1993 (date of inception) to December 31, 1993, and for the years ended December 31, 1994 and 1995\nSee accompanying notes to consolidated financial statements.\nSPECIALIZED HEALTH PRODUCTS INTERNATIONAL, INC.\nNotes to Consolidated Financial Statements\nFor the period from November 19, 1993 (date of inception) to December 31, 1993, and for the years ended December 31, 1994 and 1995\n(1)Summary of Significant Accounting Policies\n(a)Organization and Business Description\nSpecialized Health Products, Inc. (Specialized Health) was organized November 19, 1993, with a commercial objective to develop, manufacture, and market safe, easy-to-use and cost-effective products for the health care industry. Initial development has focused on products that limit or prevent the spread of blood-borne diseases. The Company has several products currently in the production or development stage. The sharps container is the only product which is currently in the production stage. This device is designed to provide means for disposing of sharps in order to reduce the potential for accidental needle sticks. The other two major product lines are the lancet and the needle withdrawal technology; both are in the development stage. The lancet device is designed to provide a nonreusable,safer, and less painful way of obtaining small blood samples from patients. The needle withdrawal technology is designed to automatically retract needles directly from the injection site while providing permanent and safe containment of the needle. Specialized Health's activities since inception have principally consisted of obtaining financing, recruiting personnel, conducting research and development, developing products, and identifying and contracting with manufacturers. The Company conducts its operations primarily in the Continental United States.\nSpecialized Health entered into a business combination in July 1995 with Russco, Inc. (Russco) wherein Specialized Health became a wholly-owned subsidiary of Russco and Russco's name was changed to Specialized Health Products International, Inc. (the Company). Russco was organized in February 1986 as a public blind pool company to evaluate, structure, and complete a merger with, or acquisition of, any privately held business seeking to obtain the perceived advantages of being a publicly owned Company. Russco had no significant operations and minimal capital with which to conduct its operations.\nAt the closing of the business combination, (a) the 300,000 shares of Russco's common stock previously outstanding (as adjusted for a reverse stock split) remained outstanding as common stock of the Company and (b) Russco issued 3,602,403 shares of its common stock for all of the issued and outstanding shares of Specialized Health's common stock and preferred stock. The business combination has been treated for accounting purposes as a \"reverse merger\" wherein Specialized Health has been shown as the acquiring company even though Russco issued its common shares to acquire Specialized Health because the stockholders of Specialized Health received the significant majority of the outstanding common stock of the Company and management of Specialized Health became the management of the Company. Because Russco had limited operations, the business combination has been accounted for as a purchase transaction with the net assets of Russco (which were insignificant) being recorded at their fair value at the date of closing and operating results of Russco prior to the business combination not being included with the historical operating results of Specialized Health.\nContemporaneously with the business combination, Specialized Health engaged in a private placement of securities wherein 4,376,250 shares of the Company's common stock were issued, net of offering costs, for consideration of $7,519,060, as more fully discussed in note 7.\nSPECIALIZED HEALTH PRODUCTS INTERNATIONAL, INC.\nNotes to Consolidated Financial Statements\nFor the period from November 19, 1993 (date of inception) to December 31, 1993, and for the years ended December 31, 1994 and 1995\n(a)Organization and Business Description (continued) -------------------------------------\nThe accompanying consolidated financial statements subsequent to the business combination include the accounts of the Company and its wholly-owned subsidiary Specialized Health. All intercompany accounts and transactions have been eliminated in consolidation. Prior to the business combination Specialized Health had no subsidiary.\n(b)Cash and Cash Equivalents -------------------------\nCash and cash equivalents are comprised of a checking and money market account. The Company considers all investments with original maturities of three months or less to be cash equivalents.\n(c)Inventories -----------\nInventories which consist primarily of finished goods are stated at the lower of cost or market. Cost is determined using the first-in first-out method.\n(d) Other Assets ------------\nThe Company has included in other assets at December 31, 1994 and 1995, the cost of purchased technology and patents, and related patent costs amounting to $388,752 and $453,502, respectively, which is being amortized using the straight-line method over seven years. These assets include the following technologies: acquisitions from third parties include a catheter closure patent; lancet patent; the sharps container technology acquired from Sharp-Trap, Inc.; and an Automatic Needle Withdrawing and Securing System purchased from Gale H. Thorne, a director and employee. Management evaluates the recoverability of these costs on a periodic basis, based on sales of the product related to the technology, revenue trends, and projected cash flows based on estimates of future sales.\n(e)Equipment and Furnishings -------------------------\nEquipment and furnishings are stated at cost and consist primarily of manufacturing molds and equipment, and office furniture and fixtures. Depreciation is computed using the straight-line method based on the estimated useful lives of the related assets which is 5 years with the exception of manufacturing equipment which is depreciated on the straight-line method over 7 years or the units-of-production method whichever is greater.\n(f)Revenue Recognition -------------------\nRevenues are recognized upon shipment of products. Sales recorded in the year ended December 31, 1994, relate primarily to products received upon acquisition of technology and patents.\nSPECIALIZED HEALTH PRODUCTS INTERNATIONAL, INC.\nNotes to Consolidated Financial Statements\nFor the period from November 19, 1993 (date of inception) to December 31, 1993, and for the years ended December 31, 1994 and 1995\n(g)Research and Development Costs ------------------------------\nResearch and development costs are expensed as incurred.\n(h)Income Taxes ------------\nIncome taxes are recorded using the asset and liability method for all periods presented in accordance with the provisions of Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes. 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, 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. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.\n(i)Net Loss Per Common Share -------------------------\nNet loss per common share is based on the weighted average number of common shares outstanding. Stock options, warrants, and preferred shares prior to conversion are not included in the calculation because their inclusion would be antidilutive and reduce the net loss per share amount.\n(j)Reclassification ----------------\nCertain amounts in 1994 have been reclassified to conform with 1995 classifications.\n(k)Fair Value Disclosure ---------------------\nAt December 31, 1995, the book value of the CompanyOs financial instruments approximates fair value.\n(l)Use of Estimates ----------------\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that effect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nSPECIALIZED HEALTH PRODUCTS INTERNATIONAL, INC.\nNotes to Consolidated Financial Statements\nFor the period from November 19, 1993 (date of inception) to December 31, 1993, and for the years ended December 31, 1994 and 1995\n(2)Investments -----------\nIn October 1995, the Company entered into an agreement with a third party to form a joint venture Quantum Imaging Corporation (Venture) to develop an improved filmless X-Ray system. For a fiftyEpercent interest in the Venture (before dilution by financing investors), the Company is obligated to pay to the Venture $15,000 a month, which is paid to the other Venture partner to perform research and development on the VentureOs behalf. Additionally, the Company is obligated to pay the general and administrative expenses of the Venture up to $15,000 per month. These obligations continue through September of 1996, and are cancelable only upon 30 days written notice and failure of the other Venture partner to meet requirements as specified in the Venture agreement. Unless this agreement is terminated, the Company is obligated at December 31, 1995 for a minimum of $135,000 and up to an additional $135,000 as general and administrative expenses are incurred by the Venture. In managementOs opinion, for the Venture to be successful, it must raise between $3,000,000 and $6,000,000. The Company contributed total capital of $83,624 to the joint venture during 1995, all of which the Company expensed and the Venture used to fund research and development and administrative expenses. Assets and liabilities as of December 31, 1995 were immaterial.\n(3)Equipment and Furnishings -------------------------\nEquipment and furnishings consist of the following:\nDuring 1995, operating assets comprised primarily of manufacturing molds totaling $255,072 were written off. The molds became obsolete due to design changes in the sharp container technology.\nSPECIALIZED HEALTH PRODUCTS INTERNATIONAL, INC.\nNotes to Consolidated Financial Statements\nFor the period from November 19, 1993 (date of inception) to December 31, 1993, and for the years ended December 31, 1994 and 1995\n(4)Stockholders' Loans -------------------\nDuring 1994 and 1995, prior to the business combination certain existing stockholders made direct loans to Specialized Health aggregating $385,000 and bearing interest at ten percent under a bridge loan agreement. Subscriptions under the bridge loan agreement were offered proportionately to stockholders based on the number of shares held. The subscribers to the bridge loan agreement were issued a total of 346,500 warrants permitting them to acquire an equal number of shares of common stock at $1.11 per share on or before December 31, 1996. No value was ascribed to the warrants. In connection with the business combination discussed in note 1, the 346,500 warrants were exercised through conversion of the outstanding loans.\n(5)Leases ------\nThe Company leases office space, equipment, and vehicles under noncancelable operating leases. Future minimum lease payments under these leases are as follows:\nRent expense was $1,881 for the period from November 19, 1993 (date of inception) to December 31, 1993, $52,051 in 1994, and $67,091 in 1995.\n(6)Stock Options -------------\nIn 1995, the Company adopted a nonqualified stock option plan whereby it has reserved 1,284,998 shares of its common stock for issuance to officers, directors, and employees. At the time of adoption, the Company granted options to acquire 1,171,810 shares of common stock at $2.00 per share of which 1,117,000 vested immediately, and 54,810 vest at various times over the next three years. The options expire five years from date of grant.\nDuring 1994, the Board of Directors of Specialized Health approved a nonqualified stock option plan for its officers, directors, and employees and authorized 396,000 shares of common stock for issuance upon the exercise of options granted under this plan. The exercise price of the options is equivalent to the estimated fair market value of the stock as determined by the Board of Directors at the date of grant. The number of shares, terms, and exercise period are determined by the Board of Directors on an option-by-option basis. During 1994, options to acquire 396,000 common shares were granted at a price range of $.39 to $1.11 per share. No options were exercised or lapsed during 1994. On September 1, 1995, options to acquire 288,000 shares were exercised from which the Company received $209,500 in a common stock subscription receivable. All common stock subscription receivables are due within one year. The remaining 108,000 shares will become exercisable over the next eighteen months, have an option price of $.39 per share, and expire in 2004.\nSPECIALIZED HEALTH PRODUCTS INTERNATIONAL, INC.\nNotes to Consolidated Financial Statements\nFor the period from November 19, 1993 (date of inception) to December 31, 1993, and for the years ended December 31, 1994 and 1995\n(7)Preferred and Common Stock --------------------------\nThe Company has authorized 50,000,000 shares of common stock with $.02 par value and 5,000,000 shares of preferred stock with a par value of $.001 per share.\nIn connection with the business combination discussed in note 1, Specialized Health completed a 9 for 1 forward stock split of both its common and preferred stock. The number of common and preferred shares and per share amounts presented in the accompanying consolidated financial statements have been restated for the effect of this split. In addition, the Company issued 90,000 shares of common stock to non- affiliated shareholders existing at the time of the private placement under antidilutive provisions.\nSpecialized Health and the Company engaged in a private placement of securities in July 1995, wherein 860.25 units were sold for $10,000 per unit for total consideration, net of expenses of $7,519,060. This consideration was comprised of $7,279,060 of cash, $100,000 of debt converted to common stock, and a common stock subscription receivable of $140,000. The private placement was completed contemporaneously with the business combination. In the private placement, the Company sold an aggregate of $4,301,250 shares of the Company's $.02 par value common stock and Series A warrants to purchase an aggregate of 2,580,750 shares of the Company's common stock at a price of $3.00 per share, exercisable for a period of two years from the date of effectiveness of a registration statement covering the issuance of the shares of common stock underlying the Series A warrants.\nFor services provided in connection with the private placement of securities, the underwriter received a commission of $860,251 in cash, 75,000 shares of common stock, Series A warrants to purchase 530,125 shares of common stock for $3.00 per share, and Series B warrants to purchase 1,290,375 shares of common stock for $2.00 per share. The warrants expire on the earlier of (a) two years from the effective date of a registration statement under the Securities Act covering the issuance of the shares of common stock underlying such warrants or (b) the date specified in a notice of redemption from the Company in the event that the closing price of the common stock for any ten consecutive trading days preceding such notice exceeds $6.00 per share and subject to the availability of a current prospectus covering the underlying shares. The Company may redeem all or a portion of the warrants, in each case at $.001 per warrant upon at least 20 days prior written notice to the warrant holders. The warrants may only be redeemed if a current prospectus is available with respect to the issuance of shares of common stock upon the exercise thereof. At December 31, 1995 the Company has a common stock subscription receivable amounting to $50,000 from the underwriter.\nThe underwriter had a continuing relationship with the Company pursuant to which the underwriter was to provide financial advisory and investment banking services to the Company through July 1997. The Company was to pay the underwriter $4,000 per month for such services. Additionally, the underwriter had the right of first refusal to undertake any financings of the Company during this period. Subsequent to year end, the Company amended their agreement with the underwriter canceling the monthly service fees and the underwriters right of first refusal. The Company signed a new agreement with PaineWebber to act as its exclusive financial advisor and to assist in the development of strategic alliances.\nAlso, during 1995 the Company issued a warrant to a nonaffiliated stockholder of the Company to purchase 45,000 shares of common stock at $1.67 per share. This warrant expires in 1996.\nSPECIALIZED HEALTH PRODUCTS INTERNATIONAL, INC.\nNotes to Consolidated Financial Statements\nFor the period from November 19, 1993 (date of inception) to December 31, 1993, and for the years ended December 31, 1994 and 1995\n(7)Preferred and Common Stock (continued) ---------------------------------------\nEach preferred and common share of Specialized Health was converted into one common share of the Company in connection with the business combination.\nThe Company has granted to a director and certain officers the right to receive up to an aggregate of 2,000,000 additional shares of common stock based upon the level of pre- tax consolidated net income (PTNI) for 1996, 1997, or 1998. If PTNI equals of exceeds $1,500,000, $5,000,000, or $8,000,000 in any of these years these individuals will receive an aggregate of 350,000, 1,100,000, or 2,000,000 common shares, respectively, less shares previously received but no more than an aggregate of 2,000,000 shares.\nThe Company expects that the issuance of such shares will be deemed to be the payment of compensation to the recipients and will result in a charge to the earnings of the Company in the year or years the shares are earned, in an amount equal to the fair market value of the shares. This charge to earnings could have a substantial negative impact on the earnings of the Company in the year or years in which the compensation expense is recognized.\nThe effect of the charge to earnings associated with the issuance of the shares could place the Company in a net loss position for the relevant year, even though the PTNI was at a level requiring the issuance of the shares. Because the shares are issuable based on the results of a single year, the PTNI in a particular year could require the issuance of shares even though the cumulative PTNI for the three years 1996, 1997, and 1998, or any combination of those years, could reflect a lower amount of PTNI that would not require the Company to issue such shares or even a pre-tax net loss.\n(8)Redeemable Preference Stock ---------------------------\nSpecialized Health had authorized 250,000 shares of redeemable preference stock with a par value of $1.50 per share, of which 160,000 shares were issued and outstanding at December 31, 1994. Each redeemable preference share was entitled to a cumulative annual dividend of nine percent of the par value from the date of original issue. Dividends were payable when and as declared by the Board of Directors. The preference stock and related dividends were paid in cash at the time of the business combination.\nSPECIALIZED HEALTH PRODUCTS INTERNATIONAL, INC.\nNotes to Consolidated Financial Statements\nFor the period from November 19, 1993 (date of inception) to December 31, 1993, and for the years ended December 31, 1994 and 1995\n(9)Income Taxes ------------\nThere was no income tax expense in 1993, 1994, and 1995, due to net operating losses. The difference between the expected tax benefit and the actual tax benefit is primarily attributable to the effect of start-up costs and net operating losses being offset by an increase in the Company's valuation allowance. The 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 December 31, 1995, are presented below:\nThe net change in the total valuation allowance for the years ended December 31, 1994 and 1995, was an increase of $338,292 and $1,078,331, respectively. Subsequently recognized tax benefits relating to the valuation allowance for deferred tax assets will be recognized as an income tax benefit to be reported in the statement of operations.\nAt December 31, 1995, the Company had total tax net operating losses of approximately $3,684,177, that can be carried forward to reduce federal income taxes. If not utilized, the tax loss carryforwards expire beginning in 2009.\nUnder the rules of the Tax Reform Act of 1986, the Company has undergone a greater than 50Epercent change of ownership. Consequently, a certain amount of the Company's net operating loss carryforward available to offset future taxable income in any one year may be limited. The maximum amount of carryforwards available in a given year is limited to the product of the Company's value on the date of ownership change and the federal long-term tax-exempt rate, plus any limited carryforwards not utilized in prior years.\nSPECIALIZED HEALTH PRODUCTS INTERNATIONAL, INC.\nNotes to Consolidated Financial Statements\nFor the period from November 19, 1993 (date of inception) to December 31, 1993, and for the years ended December 31, 1994 and 1995\n(10)Commitments and Contingencies -----------------------------\nThe Company is party to litigation and claims arising in the normal course of business. Management, after consultation with legal counsel, believes that such matters will not have a material impact on the Company's financial position or results of operations.\nAs a result of the acquisition of certain product rights and related patents the Company is required to pay a specified royalty on future sales of products related to these rights and patents.\n(11)Related Party Transactions --------------------------\nRelated party receivables at December 31, 1995 represent advances to certain related parties. During 1995 the Company paid to an entity, owned in part by a shareholder of the Company, $231,475 as reimbursement for expenses it expended on behalf of the Company and as consulting fees.\nAmounts due to stockholders in 1994 consisted of unpaid consulting expenses of $154,500 and a $40,000 note payable. The note payable was replaced subsequent to year-end with a line of credit from a commercial bank in the amount of $100,000 due November 1995 bearing interest at prime plus two percent. Long-term amounts due to a stockholder related to the acquisition of purchased technology, and are non-interest bearing. These amounts were repaid in 1995, and as of December 31, 1995 there were no remaining amounts due.\n(12)Business and Credit Concentrations ----------------------------------\nDuring 1995, the CompanyOs revenues were solely from the sale of the sharps container of which $418,509 represented sales to a single distributor. At December 31, 1995, the Company had $348,266 of trade accounts receivable due from this customer for which payment was received subsequent to year- end.\nThe Company currently buys all of its sharp containers, the CompanyOs only device in production, from one supplier. Although there are a limited number of manufacturers who could manufacture this device, management believes that other suppliers could provide similar services on comparable terms. A change in suppliers, however, could cause a delay in manufacturing and a possible loss of sales.\nAdditionally, the Company has a limited direct sales force and no third party agreements to distribute its products which may result in limited sales of the CompanyOs products.\n(13)Fourth Quarter Results ----------------------\nDuring the fourth quarter, the aggregate effect of year end adjustments, which related to prior quarters, increased the net loss approximately $457,000.\nSPECIALIZED HEALTH PRODUCTS INTERNATIONAL, INC.\nNotes to Consolidated Financial Statements\nFor the period from November 19, 1993 (date of inception) to December 31, 1993, and for the years ended December 31, 1994 and 1995\n(14)Accounting Standards Issued Not Yet Adopted -------------------------------------------\nIn March of 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121 Accounting for the Impairment of Long-lived Assets and for Long-lived Assets to be Disposed of (FASB 121). The Company is required to adopt the provisions of this statement for years beginning after December 15, 1995. This statement requires that long-lived assets and certain identifiable intangibles to be disposed of be reported at the lower of carrying amount or fair value less cost to sell. The impact of FASB 121 is not expected to have a material affect on the Company.\nIn October of 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, Accounting for Stock Based Compensation (FASB 123). The Company is required to adopt the provisions of this statement for years beginning after December 15, 1995. This statement encourages all entities to adopt a fair value based method of accounting for employee stock options or similar equity instruments. However, it also allows an entity to continue to measure compensation cost for those plans using the intrinsic-value method of accounting prescribed by APB opinion No. 25, Accounting for Stock Issued to Employees (APB 25). Entities electing to remain with the accounting in APB 25 must make pro forma disclosures of net income and earnings per share as if the fair value based method of accounting defined in this statement had been applied. It is currently anticipated that the Company will continue to account for employee stock options or similar equity instruments in accordance with APB 25 and provide the disclosures required by FASB 123.\nSECURITIES AND EXCHANGE COMMISSION\nWashington, D.C. 20549\n_______________\nEXHIBITS\nto\nFORM 10-K REGISTRATION STATEMENT\nUnder the Securities Exchange Act of 1934\n_______________\nSpecialized Health Products International, Inc.\nExhibits.\nExhibit No. Description Page* ---------- ----------- -----\n3(i).1 Restated Certificate of Incorporation of the Company\n3(i).2 Articles of Incorporation of SHP\n3(i).3 Articles of Amendment of SHP\n3(i).4 Plan and Articles of Merger of Russco Resources, Inc., into SHP (Incorporated by reference to Exhibit 3(i).1 to the Company's Current Report on Form 8-K dated July 28, 1995)\n3(ii).1 Bylaws of the Company\n3(ii).2 Bylaws of SHP\n4.1 Form of Series A Warrant\n4.2 Form of Series B Warrant\n10.1 Agreement and Plan of Reorganization dated as of June 23, 1995, among the Company, Russco Resources, Inc., Scott R. Jensen and Specialized Health Products, Inc.(Incorporated by reference to Exhibit 2.1 of the Company's Current Report on Form 8-K, dated July 28, 1995.\n10.2 Placement Agreement between the Company, SHP and U.S. Sachem Financial Consultants, L.P., dated June 23, 1995\n10.3 Form of Employment Agreement with Executive Officers\n10.4 Form of Indemnity Agreement with Executive Officers and Directors\n10.5 Form of Confidentiality Agreement\n10.6 Joint Venture Agreement between SHP and Zerbec, Inc., dated as of October 30, 1995\n16.1 Letter re change in certifying accountant\n21.1 Schedule of Subsidiaries\n27.1 Financial Date Schedule _______________\n* To be filed by amendment. ** Refers to sequentially numbered copy.","section_15":""}
{"filename":"912605_1995.txt","cik":"912605","year":"1995","section_1":"Item 1 - Business Prospectus of Cronos Global Income Fund XV, L.P., dated December 17, 1993 included as part of Registration Statement on Form S-1 (No. 33-69356)\nCertificate of Limited Partnership of Cronos Global Income Fund XV, L.P., filed as Exhibit 3.2 to the Registration Statement on Form S-1 (No. 33-69356)\nForm of Leasing Agent Agreement with Cronos Containers Limited, filed as Exhibit 10.2 to the Registration Statement on Form S-1 (No. 33-69356)\nPART I - FINANCIAL INFORMATION\nItem 1. Business\n(a) General Development of Business\nThe Registrant is a limited partnership organized under the laws of the State of California on August 26, 1993, for the purpose of owning and leasing marine cargo containers, special purpose containers and container-related equipment. The Registrant was initially capitalized with $100 and commenced offering its limited partnership interests to the public subsequent to December 17, 1993, pursuant to its Registration Statement on Form S-1 (File No. 33-69356). On October 12, 1994, the Registrant filed a Post-Effective Amendment to its Registration Statement on Form S-1. The offering terminated on December 15, 1995.\nThe Registrant raised $143,031,380 in subscription proceeds. The following table sets forth the use of said subscription proceeds as of January 31, 1996.\nOn July 22, 1994, the Registrant secured a $25 million bridge loan from a bank. The loan allowed the Registrant to take advantage of equipment purchasing opportunities pending the raising of sufficient net proceeds that would otherwise be available to purchase such equipment. The bridge loan had the characteristics of a revolving credit facility, permitting the Registrant the flexibility to borrow amounts thereunder (up to a maximum of $25 million), repay from net proceeds the amounts borrowed, to borrow additional amounts prior to the termination of the offering. At December 15, 1995, the termination date of the offering, the bridge loan expired and was repaid in full from net proceeds raised by the Registrant.\nThe general partner of the Registrant is Cronos Capital Corp. (\"CCC\"), a wholly-owned subsidiary of Cronos Holdings\/Investments (U.S.), Inc., a Delaware corporation, which is in turn a wholly-owned subsidiary of Cronos Investments B.V., a Dutch company. These and other affiliated companies are ultimately wholly-owned by The Cronos Group, a holding company registered in Luxembourg (\"Holding Company\") and are collectively referred to as the \"Group\". The activities of the container division of the Group are managed through the Group's subsidiary in the United Kingdom, Cronos Containers Limited (\"the Leasing Company\"). The Leasing Company manages the leasing operations of all equipment owned or managed by the Group on its own behalf or on behalf of other third-party container owners, including all other programs organized by CCC.\nOn December 1, 1993, the Leasing Company entered into a Leasing Agent Agreement with the Registrant assuming the responsibility for all container leasing activities.\nFor information concerning the containers acquired by the Registrant, see Item 2, \"Properties.\"\n(b) Financial Information About Industry Segments\nInapplicable.\n(c) Narrative Description of Business\n(c)(1)(i) A marine cargo container is a reusable metal container designed for the efficient carriage of cargo with a minimum of exposure to loss from damage or theft. Containers are manufactured to conform to worldwide standards of container dimensions and container ship fittings adopted by the International Standards Organization (\"ISO\") in 1968. The standard container is either 20' long x 8' wide x 8'6\" high (one twenty-foot equivalent unit (\"TEU\"), the standard unit of physical measurement in the container industry) or 40' long x 8' wide x 8'6\" high (two TEU). Standardization of the construction, maintenance and handling of containers allows containers to be picked up, dropped off, stored and repaired effectively throughout the world. This standardization is the foundation on which the container industry has developed.\nStandard dry cargo containers are rectangular boxes with no moving parts, other than doors, and are typically made of steel. They are constructed to carry a wide variety of cargos ranging from heavy industrial raw materials to light-weight finished goods. Specialized containers include, among others, refrigerated containers for the transport of temperature- sensitive goods and tank containers for the carriage of liquid cargo. Dry cargo containers constitute approximately 85% of the worldwide container fleet. Refrigerated and tank containers constitute approximately 7% of the worldwide container fleet, with open-tops and other specialized containers constituting the remainder.\nOne of the primary benefits of containerization has been the ability of the shipping industry to effectively lower freight rates due to the efficiencies created by standardized intermodal containers. Containers can be handled much more efficiently than loose cargo and are typically shipped via several modes of transportation, including truck, railway and ship. Containers require loading and unloading only once and remain sealed until arrival at the final destination, significantly reducing transport time, labor and handling costs and losses due to damage and theft. Efficient movement of containerized cargo between ship and shore reduces the amount of time that a ship must spend in port and reduces the transit time of freight moves.\nThe logistical advantages and reduced freight rates brought about by containerization have been a major catalyst for world trade growth during the last twenty-five years, which in turn has generated increased demand for containerization. The world container fleet has grown from an estimated 270,000 TEU in 1969 to 9,198,000 TEU at the end of 1995, and according to recent industry data, growth of containerized shipping since 1987 has generally averaged two to three times that of average GDP growth in industrialized countries.\nThe Registrant believes that growth of containerization will continue to outpace GDP growth and the growth in world trade over the next five years for the following reasons:\n- Lower freight rates resulting from containerization are generating new cargos that previously were not economical to export. Containerization provides inexpensive, timely and secure transport to manufacturers allowing them to take advantage of regional opportunities in technology or labor, and to move products to different locations at various stages of production;\n- Intermodal traffic is expected to continue to grow, and industrialized countries are continuing to improve intermodal infrastructure (i.e., railways, roads and ports);\n- Shippers continue to demand transportation of cargo by containers rather than break-bulk;\n- Countries with rapidly-growing economies in emerging markets are continuing to build new container port facilities that accommodate an increased flow of containerized trade; and\n- Recent trade agreements, such as the North American Free Trade Agreement (\"NAFTA\") and the General Agreement on Tariffs and Trade (\"GATT\"), should further stimulate world trade, and, therefore containerized trade.\nThe container leasing industry has been a significant contributor to the growth of containerization, and, in 1995, had an approximately 47% share of the total world container fleet with ocean carriers holding most of the remainder. To an ocean carrier, the primary benefits of leasing rather than owning containers are the following:\n- Reduced Capital Expenditures. Leasing is an attractive option to ocean carriers because ownership of containers requires significant capital expenditures. Carriers constantly evaluate their investment strategy, with container purchasing competing directly with other expenditure requirements, such as ship purchases, ship conversions and terminal improvements. Container leasing allows ocean carriers to invest capital in assets that are more central to their business.\n- Improved Asset Management. Trade flow imbalances and seasonal demands frequently leave ocean carriers with regional surpluses or shortages of containers, requiring costly repositioning of empty containers. Leasing companies help ocean carriers manage these trade imbalances by providing the inventory to service demand, reducing the costs of maintaining local inventories and minimizing repositioning expenses. By matching different carriers' container needs, leasing companies can reduce their own risks of container inventory imbalances and seasonality through a portfolio of lessees as well as variations in lease terms.\n- Increased Container Fleet Flexibility. Ocean carriers benefit from the variety of lease types offered by leasing companies such as the master lease, long-term and short-term lease and direct financing lease. These various leases give ocean carriers flexibility in sizing their fleets while minimizing capital costs. For example, master lease agreements give ocean carriers the option of adjusting the size of their fleets, with the flexibility to pick-up and drop- off containers at various locations around the world.\nDry cargo containers are the most-commonly used type of container in the shipping industry. The Registrant's dry cargo container fleet is constructed of all Corten(R) steel (Corten(R) roofs, walls, doors and undercarriage), a high-tensile steel yielding greater damage and corrosion resistance than mild steel.\nRefrigerated containers are used to transport temperature-sensitive products such as meat, fruit, vegetables and photographic film. All of the Registrant's refrigerated containers have high-grade stainless steel interiors. The Registrant's 20-foot refrigerated containers have high-grade stainless steel walls, while the Registrant's 40-foot refrigerated containers are steel framed with aluminum outer walls to reduce weight. As with the dry cargo containers, all refrigerated containers are designed to minimize repair and maintenance and maximize damage resistance. The Registrant's refrigerated containers are designed and manufactured to include the latest generation refrigeration equipment, with modular microprocessors controlling and monitoring the container.\nThe Registrant's tank containers are constructed in compliance with International Maritime Organization (\"IMO\") standards and recommendations. The tanks purchased by the Registrant are all IMO-1 type tanks, constructed to comply with IMO recommendations which require specific pressure ratings and shell thicknesses. These containers are designed to carry highly-inflammable materials, corrosives, toxics and oxidizing substances, but are also capable of carrying nonhazardous materials and foodstuffs. They have a capacity of 21,000-24,000 liters and are insulated and equipped with steam and\/or electrical heating.\nThe Registrant's containers are leased primarily to ocean-going steamship companies operating in major trade routes (see Item 1(d)). Most if not all of the Registrant's marine dry cargo containers are leased pursuant to operating leases, primarily master leases, where the containers are leased to the ocean carrier on a daily basis for any desired length of time, with the flexibility of picking up and dropping off containers at various agreed upon locations around the world and, secondarily, term leases (1-5 years) and one-way or round-trip leases. Special purpose containers acquired by the Registrant, including refrigerated and tank containers, are generally committed to term leases, where the high cost of interchanging the higher value specialized container makes master lease agreements less attractive to customers.\nMaster lease agreements. A master lease is designed to provide greater flexibility by allowing customers to pick-up and drop-off containers where and when needed, subject to restrictions and availability, on pre-agreed terms. The commercial terms of master leases are generally negotiated annually. Master leases also define the number of containers that may be returned within each calendar month and the return locations and applicable drop-off charges. Because of the increased flexibility they offer, master leases usually command higher per-diem rates and generate more ancillary fees (including pick-up, drop-off, handling and off-hire fees) than term leases.\nTerm lease agreements. Term lease agreements include short-term and long-term leases. Long-term lease agreements define the number of containers to be leased, the pick-up and drop-off locations, the applicable per-diem rate for the duration of the lease and the early termination penalties that may apply in the event of early redelivery. Ocean carriers use long-term leases when they have a need for identified containers for a specified term. Long-term leases usually are not terminated early by the customer and provide the Registrant with stable and relatively predictable sources of revenue, although per-diem rates and ancillary charges are lower under long-term leases than under master lease agreements. Short-term lease agreements have a duration of less than one year and include one-way, repositioning and round-trip leases. They differ from master leases in that they define the number and the term of containers to be leased. Ocean carriers use one-way leases to manage trade imbalances (where more containerized cargo moves in one direction than another) by picking up a container in one port and dropping it off at another after one or more legs of a voyage. Except for direct financing leases, lease rates typically are highest for short-term leases.\nUnder these leases, customers are responsible for paying all taxes and service charges arising from container use, maintaining the containers in good and safe operating condition while on lease and paying for repairs upon redelivery, other than ordinary wear and tear. Some leases provide for a \"damage protection plan\" whereby lessees, for an additional payment (which may be in the form of a higher per-diem rate), are relieved of the responsibility of paying some of the repair costs upon redelivery of the containers. The Leasing Company has historically provided this service on a limited basis to selected customers. Repairs provided under such plans are carried out by the same depots, under the same procedures, as are repairs to containers not covered by such plans. Customers also are required to insure leased containers against physical damage and loss, and against third party liability for loss, damage, bodily injury or death.\nAll containers are inspected and repaired when redelivered by a customer, and customers are obligated to pay for all damage repair, excluding wear and tear, according to standardized industry guidelines. Depots in major port areas perform repair and maintenance which is verified by independent surveyors or the Leasing Company's technical and operations staff.\nBefore any repair or refurbishment is authorized on older containers in the Registrant's fleet, the Leasing Company's technical and operations staff reviews the age, condition and type of container and its suitability for continued leasing. The Leasing Company compares the cost of such repair or refurbishment with the prevailing market resale price that might be obtained for that container and makes the appropriate decision whether to repair or sell the container.\nThe non-cancelable terms of the operating leases of the Registrant's containers will not be sufficient to return to the Registrant as lessor the purchase price of the equipment. In order to recover the original investment in the equipment and achieve an adequate return thereon, it is necessary to renew the lease, lease the equipment to another lessee at the end of the initial lease term, or sell the equipment.\nThe Registrant estimates that a dry cargo or refrigerated container may be used as a leased marine cargo container for a period ranging from 10 to 15 years. Tank containers generally may be used for 12 to 18 years. The Registrant disposes of used containers in a worldwide market for used containers in which buyers include wholesalers, mini-storage operators, construction companies and others. The market for used refrigerated and tank containers is not as developed as the market for used dry cargo containers. Although used refrigerated and tank containers will command a higher price than a dry cargo container, a dry cargo container will bring a higher percentage of its original price. As the Registrant's fleet ages, a larger proportion of its revenues will be derived from selling its containers.\nOf the 22,623 twenty-foot, 7,070 forty-foot and 1,197 forty-foot high-cube marine dry cargo containers, the 163 twenty- foot and 100 forty-foot refrigerated marine cargo containers, and the 165 twenty-four thousand liter tanks owned by the Registrant as of December 31, 1995, 19,687 twenty-foot (or 87% thereof), 5,428 forty-foot (or 77% thereof) and 912 forty- foot high-cube marine dry cargo containers (or 76% thereof), 154 twenty-foot (or 94% thereof) and 100 forty-foot refrigerated containers (or 100% thereof), and 162 twenty-four thousand liter tanks (or 98% thereof) were on lease. The following table sets forth the information on the lease terms with respect to the containers on lease:\nThe Leasing Company will make payments to the Registrant based upon rentals collected from ocean carriers after deducting certain operating expenses associated with the containers, such as the base management fee payable to the Leasing Company, certain expense reimbursements to CCC, the Leasing Company, and its affiliates, the costs of maintenance and repairs not performed by lessees, independent agent fees and expenses, depot expenses for handling, inspection and storage, and additional insurance.\nThe Registrant's sales and marketing operations are conducted through the Leasing Company, in the United Kingdom, with support provided by area offices and dedicated agents located in San Francisco, California; Iselin, New Jersey; Windsor, England; Hamburg; Antwerp; Auckland; Genoa; Singapore; Hong Kong; Sydney; Tokyo; Taipei; Seoul; Rio de Janeiro; and Shanghai. Each of the Leasing Company's area offices and dedicated agents is staffed with local people familiar with the customers and language of the region. The Leasing Company's marketing directors have been employed in the container industry in their respective regions for an average of 15 years, building direct personal relationships with the local ocean carriers and locally based representatives of other ocean carriers.\nThe Leasing Company also maintains agency relationships with over 20 independent agents around the world, who are generally paid a commission based upon the amount of revenues they generate in the region or the number of containers that are leased from their area on behalf of the Registrant. They are located in jurisdictions where the volume of the Leasing Company's business necessitates a presence in the area but is not sufficient to justify a fully-functioning Leasing Company office or dedicated agent. These agents provide marketing support to the area offices covering the region, together with limited operational support.\nIn addition, the Leasing Company relies on the services of over 300 independently-owned and operated depots around the world to inspect, repair, maintain and store containers while off-hire. The Leasing Company's area offices authorize all container movements into and out of the depot and supervise all repair and maintenance performed by the depot. The Leasing Company's technical staff sets the standards for repair of its owned and managed fleet throughout the world and monitors the quality of depot repair work. The depots provide a vital link to the Leasing Company's operations, as the redelivery of a container into a depot is the point at which the container is off-hired from one customer and repaired in preparation for re-leasing to the next, and the point when the Leasing Company's area offices report the container's movements onto the Leasing Company's equipment tracking system. The Leasing Company's computer system has the capability to accommodate future developments, such as allowing depots access to record directly on the system the on-hire and off-hire activity of containers delivered into the depot. It also has the capability of verifying the terms of redelivery authorized by the area offices. These functions are currently being performed by the Leasing Company's area offices.\n(c)(1)(ii) Inapplicable.\n(c)(1)(iii) Inapplicable.\n(c)(1)(iv) Inapplicable.\n(c)(1)(v) The Registrant's containers are leased globally, therefore, seasonal fluctuations are minimal. Other economic and business factors to which the transportation industry in general and the container leasing industry in particular are subject, include fluctuations in supply and demand for equipment resulting from, among other things, obsolescence, changes in the methods or economics of a particular mode of transportation or changes in governmental regulations or safety standards.\n(c)(1)(vi) The Registrant established a working capital reserve of approximately 1% of subscription proceeds raised. In addition, the Registrant may reserve additional amounts from anticipated cash distributions to the partners to meet working capital requirements.\nAmounts due under master leases are calculated at the end of each month and billed approximately six to eight days thereafter. Amounts due under short-term and long-term leases are set forth in the respective lease agreements and are generally payable monthly. Past due penalties are not customarily collected from lessees, and accordingly are not generally levied by the Leasing Company against lessees of the Registrant's containers.\n(c)(1)(vii) For the year ended December 31, 1995, no single lessee accounted for 10% or more of the Registrant's rental income. The Registrant does not believe that its ongoing business is dependent upon a single customer, although the loss of one or more of its largest customers could have an adverse effect upon its business.\n(c)(1)(viii) Inapplicable.\n(c)(1)(ix) Inapplicable.\n(c)(1)(x) Competition among container leasing companies is based upon several factors, including the location and availability of inventory, lease rates, the type, quality and condition of the containers, the quality and flexibility of the service offered and the confidence in and professional relationship with the lessor. Other factors include the speed with which a leasing company can prepare its containers for lease and the ease with which a lessee believes it can do business with a lessor or its local area office. The Leasing Company believes that it, on behalf of the Registrant, competes favorably on all of these factors.\nThe Leasing Company, on behalf of the Registrant, competes with various container leasing companies in the markets in which it conducts business, including Genstar Container Corp., Transamerica Leasing, Triton Container International Ltd., Trans Ocean Ltd., Textainer Corp. and others. In a series of recent consolidations, one of the major leasing companies, as well as some smaller ones, have been acquired by competitors. It is estimated that at the end of 1995, the ten largest leasing companies (including the Leasing Company) represented 94% of the global leased fleet. Genstar Container Corp. and Transamerica Leasing, the two largest container leasing companies, had approximately 50% of the worldwide leased container fleet at the end of 1995. Some of the Leasing Company's competitors have greater financial resources than the Leasing Company and may be more capable of offering lower per-diem rates on a larger fleet. In the Leasing Company's experience, however, ocean carriers will generally lease containers from more than one leasing company in order to minimize dependence on a single supplier. In addition, not all container leasing companies compete in the same market, as some supply only dry cargo containers and not specialized containers, while others offer only long-term leasing.\n(c)(1)(xi) Inapplicable.\n(c)(1)(xii) Environmental Matters\nA portion of the Registrant's equipment portfolio consists of special purpose containers, primarily refrigerated containers. Historically, refrigerated containers have utilized a refrigerant gas which is a chlorofluorocarbon (\"CFC\") compound. It is generally assumed that CFCs are harmful to the Earth's ozone layer when released into the atmosphere. Many nations, including the United States, have taken action, both collectively and individually, to regulate CFCs. These nations set various targets for the reduction in production and use of CFCs starting as early as 1993, and their eventual elimination. There has been substantial progress recently to determine a viable substitute for the refrigerant used in containers, such that both the Leasing Company and the container leasing industry association have selected a replacement refrigerant. Production of new container refrigeration units operating with the replacement refrigerant became generally available in 1993. All refrigerated containers purchased by the Partnership contain the new refrigerant compound and comply with all current environmental regulations.\nUnder the state and Federal laws of the United States, and possibly under the laws of other nations, the owner of a container may be liable for environmental damage and\/or cleanup and\/or other sums in the event of actual or threatened discharge or other contamination by material in a container. This liability may be imposed on a container owner, such as the Registrant, even if the owner is not at fault. The Leasing Company intends, subject to availability and prevailing market conditions, to obtain insurance on behalf of the Registrant against these risks on such terms and in such amounts as the Leasing Company deems reasonable. In addition, subject to availability and applicable insurance and container industry market conditions, the Leasing Company intends to require lessees of containers to obtain insurance which protects against these risks and further to compel lessees to indemnify and defend the Registrant in the case of an occurrence giving rise to possible liability under applicable environmental laws.\n(c)(1)(xiii) The Registrant, as a limited partnership, is managed by CCC, the general partner, and accordingly does not itself have any employees. CCC has 27 employees, consisting of 5 officers, 4 other managers and 18 clerical and staff personnel.\n(d) Financial Information about Foreign and Domestic Operations and Export Sales\nThe Registrant's business is not divided between foreign or domestic operations. The Registrant's business is the leasing of containers worldwide to ocean-going steamship companies. To this extent, the Registrant's operations are subject to the fluctuations of worldwide economic and political conditions that may affect the pattern and levels of world trade.\nRental income from leases to foreign customers constituted approximately 90% of the Registrant's total rental income for the years 1995 and 1994. The Registrant believes that the profitability of, and risks associated with, leases to foreign customers is generally the same as those of leases to domestic customers. The Leasing Company's leases generally require all payments to be made in United States currency.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nPursuant to undertakings made in Section 7.2 (h) of the Partnership Agreement in its Registration Statement No. 33- 69356, the Registrant purchased the following types of equipment through December 31, 1995:\nThe aggregate purchase price (excluding acquisition fees) of the equipment acquired by the Registrant through December 31, 1995, was $96,134,945, of which $91,884,445 was paid from the net proceeds of this offering, and $4,250,500 remained payable to equipment manufacturers. Of this equipment, $39,848,185 thereof had been acquired from CCC and $56,286,760 thereof had been acquired from third-party container manufacturers located in Taiwan, South Korea, India, Indonesia, the People's Republic of China, Italy, and the United Kingdom. Equipment acquired from CCC had been purchased by CCC as new equipment, and was resold to the Registrant at cost, minus the net revenues earned by CCC in operating the equipment prior to its resale to the Registrant.\nAt December 31, 1995, the Registrant had committed to purchase from container manufacturers an additional 1,000 twenty-foot and 400 forty-foot marine dry cargo containers and 100 twenty-foot refrigerated cargo containers at an aggregate manufacturers' invoice cost of $6,096,300. The Registrant expects to fully invest the remaining unused proceeds from this offering in container equipment by the end of June 1996.\nItem 3.","section_3":"Item 3. Legal Proceedings\nInapplicable.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nInapplicable.\n- ----------------------------\n(1) Amount reflects twenty-foot refrigerated container components accepted by the Registrant. At December 31, 1995, the process of manufacturing these components into a refrigerated cargo container was not complete. The containers are expected to be completed and delivered to the Registrant during the first quarter of 1996. The average cost of these refrigerated containers is expected to be $20,250 per container.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters\n(a) Market Information\n(a)(1)(i) The Registrant's outstanding units of limited partnership interests are not traded on any market nor does an established public trading market exist for such purposes.\n(a)(1)(ii) Inapplicable.\n(a)(1)(iii) Inapplicable.\n(a)(1)(iv) Inapplicable.\n(a)(1)(v) Inapplicable.\n(a)(2) Inapplicable.\n(b) Holders\n(c) Dividends\nInapplicable. For the distributions made by the Registrant to its limited partners, see Item 6","section_6":"Item 6. Selected Financial Data\n- -------------------------\n(1) For the period February 22, 1994 (commencement of operations) to December 31, 1994.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nLiquidity and Capital Resources\nThe Registrant's primary objective is to generate cash flow from operations for distribution to its limited partners and, during the initial years of its operations, to reinvest excess cash flow in additional equipment. Aside from the initial working capital reserve retained from gross proceeds (equal to approximately 1% of such proceeds), the Registrant relies primarily on net lease revenue receipts to meet this objective. No credit lines are maintained to finance working capital.\nThe Registrant initiated its offering of limited partnership interests to the public subsequent to December 17, 1993. The Registrant commenced operations on February 22, 1994 when the minimum subscription proceeds of $2,000,000 was obtained from at least 100 investors (excluding from such count, Pennsylvania residents, CCC, and affiliates of CCC). At December 15, 1995, the termination date of the offering, the Registrant had raised $143,031,380 through the offering of limited partnership interests, from which it had paid brokerage commissions, reimbursed CCC for public offering expenses, and purchased equipment.\nIn addition to the net proceeds used to purchase equipment from CCC and equipment manufacturers, the Registrant financed the purchase of additional equipment with proceeds from a $25,000,000 bridge loan. The loan was obtained on July 22, 1994 from one lending source, allowing the Registrant to take advantage of equipment purchasing opportunities. On December 15, 1995, the termination date of the offering, the bridge loan expired and was repaid in full from net proceeds raised by the Registrant. The weighted average annualized interest rate on monies borrowed under the facility during January 1, 1995 to December 15, 1995 was 8.12%.\nThe Registrant's cash and short-term investment balances as of December 31, 1995 included $20,709,881 in unused proceeds from the offering of limited partnership interests, together with interest earned thereon, and amounts reserved as working capital. At December 31, 1995, the Registrant had committed to purchase from container manufacturers an additional 1,000 twenty-foot and 400 forty-foot marine dry cargo containers and 100 twenty-foot refrigerated cargo containers at an aggregate manufacturer's invoice cost of $6,096,300. The Registrant expects to fully invest the remaining unused proceeds from this offering in container equipment by the end of June 1996.\nNet lease receivables due from the Leasing Company are determined by deducting direct operating payables and accrued expenses, base management fees payable, and reimbursed administrative expenses payable to CCC and its affiliates from the rental billings payable by the Leasing Company to the Registrant. During 1994, the Registrant's first year of operations, CCC and its affiliates deferred the payment of all management and reimbursable administrative expenses deducted from the lease receivables due to the Registrant. During 1995, all remaining deferred fees and expenses were paid to CCC and the Leasing Company.\nThe purchase prices of the Registrant's initial containers have been favorable, as an oversupply of containers in the industry has resulted in a period of relatively low container prices. The favorable container prices and the Registrant's ability to utilize the aforementioned revolving credit facility to accelerate the build-up of its fleet should benefit the Registrant's operations in subsequent periods.\nCash distributions from operations are allocated 5% to the general partner and 95% to the limited partners. Distribution of sales proceeds are allocated 1% to the general partner and 99% to the limited partners. This sharing arrangement will remain in place until the limited partners have received aggregate distributions in an amount equal to their capital contributions plus an 8% cumulative, compounded (daily) annual return on their adjusted capital contributions. Thereafter, all distributions will be allocated 15% to the general partner and 85% to the limited partners. Distributions are paid monthly, based upon cash flow from operations and cash generated from container sales proceeds. During the reinvestment phase of operations, the Registrant will use excess cash generated from operations and sales proceeds to purchase additional containers. During the period from February 22, 1994 (commencement of operations) through December 31, 1995, the Registrant distributed $8,213,395 and $432,284 to the limited partners and the general partner, respectively.\nThe container leasing market generally softened during the fourth quarter of 1995 and has remained so during the early months of 1996. Demand for leased containers remains stable in some areas of the world; however, sluggish activity in other markets, particularly in Southeast Asia, has resulted in an increase in container inventories. The current market conditions cannot be attributed to any one factor; rather, a series of factors, in combination, have resulted in a slowdown in leasing activity. Some of the contributing factors are: a slowdown in some European economies, as well as in some Far East exporting countries; increased efficiencies in the shipping industry through the formation of alliances between shipping lines; and a prolonged seasonal slowdown in container demand during the holiday season. Although some further softening in market conditions may be anticipated, the volume of world trade continues to grow and the long-term outlook is a positive one.\nResults of Operations\n1995 - 1994\nThe Registrant commenced operations on February 22, 1994, and continued to offer limited partnership interests to the public until December 15, 1995. During 1995, the second build-up year of operations, the Registrant continued to purchase equipment from the net proceeds of the offering. Therefore, as a result of the larger operating fleet, net lease revenue, other operating expenses, other income and expenses, and net earnings for 1995 increased significantly when compared to 1994, as the Registrant did not commence operations until February 22, 1994. Net earnings were $6,534,636 in 1995 and were comprised of net lease revenue, less depreciation and amortization of $5,459,259 and interest expense of $765,750, as well as interest income, gain on disposal of equipment and general and administrative expense.\nThe Registrant's net lease revenue is determined by deducting direct operating expenses, management fees and reimbursed administrative expenses from the rental revenues billed by the Leasing Company from the Registrant's containers. The Registrant's net lease revenue is directly related to the size of its fleet as well as the utilization and lease rates of the equipment owned by the Registrant. Direct operating expenses include repositioning costs, storage and handling expenses, agent fees and insurance premiums, as well as provisions for doubtful accounts and repair costs for containers covered under damage protection plans.\nThe Registrant's fleet size, as measured in twenty-foot equivalent units (\"TEU\"), and average utilization rates at December 31, 1995 and December 31, 1994 were as follows:\nUtilization rates of the Registrant's fleet may continue to fluctuate and will eventually stabilize, as the Registrant fully invests the remaining unused net proceeds from its offering in container equipment through the first half of 1996.\nThe Registrant disposed of 54 twenty-foot and 13 forty-foot marine dry cargo containers during 1995, as compared to seven twenty-foot and two forty-foot marine dry cargo containers during 1994. The decision to repair or dispose of a container is made when it is returned by a lessee. This decision is influenced by various factors including the age, condition, suitability for continued leasing, as well as the geographical location of the container when disposed. These factors also influence the amount of sales proceeds received and the related gain on container disposals.\n1994-1993\nThe Registrant did not commence operations until February 22, 1994. For the period February 22, 1994 to December 31, 1994, the Registrant's net earnings were $3,862,148 and were comprised of net lease revenue, less depreciation and amortization of $1,561,826 and interest expense of $409,623, as well as interest income, gain on disposal of equipment and general and administrative expenses.\nDirect operating expenses included repositioning costs, storage and handling expenses, agent fees and insurance premiums, as well as provisions for doubtful accounts and repair costs for containers covered under damage protection plans. Direct operating costs were affected by the quantity of off-hire containers as well as the frequency at which the containers were redelivered. During the build-up phase of the Registrant's fleet, direct operating costs were greater for those containers purchased directly from container manufacturers which, in most cases, experienced an off-hire period while marketed and repositioned for initial lease-out. During this period, the Registrant experienced storage, handling and repositioning costs. At the same time, direct operating costs were lessened with respect to containers purchased directly from the general partner which were generally on-hire and in most cases, generating revenues at the time of purchase.\nThe Registrant's fleet size, as measured in twenty-foot equivalent units (\"TEU\"), and utilization rates at March 31, June 30, September 30 and December 31, 1994 were as follows:\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nThe Partners Cronos Global Income Fund XV, L.P.:\nWe have audited the accompanying balance sheets of Cronos Global Income Fund XV, L.P., as of December 31, 1995 and 1994, and the related statements of operations, partners' capital and cash flows for the year ended December 31, 1995 and for the period February 22, 1994 (commencement of operations) to December 31, 1994. These 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 financial statements and schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Cronos Global Income Fund XV, L.P., as of December 31, 1995 and 1994, and the results of its operations and its cash flows for the year ended December 31, 1995 and for the period February 22, 1994 (commencement of operations) to 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 supplementary information included in Schedule 1 is presented for purposes of additional analysis and is not a required part of the basic financial statements. This information has been subjected to the auditing procedures applied in our audits of the basic financial statements and, in our opinion, is fairly stated in all material respects in relation to the basic financial statements taken as a whole.\nArthur Andersen LLP\nSan Francisco, California, March 15, 1996\nCRONOS GLOBAL INCOME FUND XV, L.P.\nBALANCE SHEETS\nDECEMBER 31, 1995 AND 1994\nThe accompanying notes are an integral part of these statements.\nCRONOS GLOBAL INCOME FUND XV, L.P.\nSTATEMENTS OF OPERATIONS\nFOR THE YEAR ENDED DECEMBER 31, 1995 AND THE PERIOD FEBRUARY 22, 1994 (COMMENCEMENT OF OPERATIONS) TO DECEMBER 31, 1994\nThe accompanying notes are an integral part of these statements.\nCRONOS GLOBAL INCOME FUND XV, L.P.\nSTATEMENTS OF PARTNERS' CAPITAL\nFOR THE YEAR ENDED DECEMBER 31, 1995 AND FOR THE PERIOD FEBRUARY 22, 1994 (COMMENCEMENT OF OPERATIONS) TO DECEMBER 31, 1994\nThe accompanying notes are an integral part of these statements.\nCRONOS GLOBAL INCOME FUND XV, L.P.\nSTATEMENTS OF CASH FLOWS\nFOR THE YEAR ENDED DECEMBER 31, 1995 AND FOR THE PERIOD FEBRUARY 22, 1994 (COMMENCEMENT OF OPERATIONS) TO DECEMBER 31, 1994\nThe accompanying notes are an integral part of these statements.\nCRONOS GLOBAL INCOME FUND XV, L.P. NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1995 AND 1994\n(1) Summary of Significant Accounting Policies\n(a) Nature of Operations\nCronos Global Income Fund XV, L.P. (the \"Partnership\") is a limited partnership organized under the laws of the State of California on August 26, 1993, for the purpose of owning and leasing marine cargo containers, special purpose containers and container related equipment. Cronos Capital Corp. (\"CCC\") is the general partner and, with its affiliate Cronos Containers Limited (the \"Leasing Company\"), manages and controls the business of the Partnership.\nThe Partnership commenced operations on February 22, 1994, when the minimum subscription proceeds of $2,000,000 were received from over 100 subscribers (excluding from such count Pennsylvania residents, the general partner, and all affiliates of the general partner). The Partnership offered 7,500,000 units of limited partnership interest at $20 per unit or $150,000,000. The offering terminated on December 15, 1995, at which time 7,151,569 limited partnership units had been purchased.\nAs of December 31, 1995, the Partnership operated 22,623 twenty-foot, 7,070 forty-foot and 1,197 forty-foot high-cube marine dry cargo containers, 163 twenty-foot and 100 forty-foot refrigerated containers and 165 twenty four thousand-liter tanks.\n(b) Leasing Company and Leasing Agent Agreement\nThe Partnership has entered into a Leasing Agent Agreement whereby the Leasing Company has the responsibility to manage the leasing operations of all equipment owned by the Partnership. Pursuant to the Agreement, the Leasing Company is responsible for leasing, managing and re-leasing the Partnership's containers to ocean carriers and has full discretion over which ocean carriers and suppliers of goods and services it may deal with. The Leasing Agent Agreement permits the Leasing Company to use the containers owned by the Partnership, together with other containers owned or managed by the Leasing Company and its affiliates, as part of a single fleet operated without regard to ownership. Since the Leasing Agent Agreement meets the definition of an operating lease in Statement of Financial Accounting Standards (SFAS) No. 13, it is accounted for as a lease under which the Partnership is lessor and the Leasing Company is lessee.\nThe Leasing Agent Agreement generally provides that the Leasing Company will make payments to the Partnership based upon rentals collected from ocean carriers after deducting direct operating expenses and management fees to CCC and the Leasing Company. The Leasing Company leases containers to ocean carriers, generally under operating leases which are either master leases or term leases (mostly one to five years). Master leases do not specify the exact number of containers to be leased or the term that each container will remain on hire but allow the ocean carrier to pick up and drop off containers at various locations; rentals are based upon the number of containers used and the applicable per-diem rate. Accordingly, rentals under master leases are all variable and contingent upon the number of containers used. Most containers are leased to ocean carriers under master leases; leasing agreements with fixed payment terms are not material to the financial statements. Since there are no material minimum lease rentals, no disclosure of minimum lease rentals is provided in these financial statements.\nCRONOS GLOBAL INCOME FUND XV, L.P.\nNOTES TO FINANCIAL STATEMENTS\n(c) Basis of Accounting\nThe Partnership utilizes the accrual method of accounting. Revenue is recorded when earned.\nThe preparation of financial statements in conformity with generally accepted accounting principles (GAAP) requires the Partnership 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 reported period.\n(d) Allocation of Net Earnings and Partnership Distributions\nNet earnings have been allocated between general and limited partners in accordance with the Partnership Agreement.\nActual cash distributions differ from the allocations of net earnings between the general and limited partners as presented in these financial statements. Partnership distributions are paid to its partners (general and limited) from distributable cash from operations, allocated 95% to the limited partners and 5% to the general partner. Sales proceeds are allocated 99% to the limited partners and 1% to the general partner. The allocations remain in effect until such time as the limited partners have received from the Partnership aggregate distributions in an amount equal to their capital contributions plus an 8% cumulative, compounded (daily), annual return on their adjusted capital contributions. Thereafter, all Partnership distributions will be allocated 85% to the limited partners and 15% to the general partner.\n(e) Acquisition Fees\nPursuant to Article IV Section 4.2 of the Partnership Agreement, acquisition fees paid to CCC are based on 5% of the equipment purchase price. These fees are capitalized and included in the cost of the rental equipment. The fees are payable in full from gross proceeds raised from the sale of limited partnership units. No acquisition fees are paid with respect to the Partnership's purchase of equipment financed by borrowing in anticipation of the sale of limited partnership units until such time as net proceeds are raised to repay the loan incurred to purchase such equipment.\n(f) Depreciation of Containers\nRental equipment is depreciated over a twelve-year life on a straight-line basis to its estimated salvage value.\n(g) Amortization\nThe Partnership's organization costs will be amortized over 60 months on a straight-line basis. Loan origination fees were amortized over the term of the loan.\n(h) Underwriting Commissions\nUnderwriting commissions of 10% on the gross proceeds from sale of limited partnership units (not applicable to certain sales outside California) were deducted in the determination of net limited partnership contributions. The commissions were paid to Cronos Securities Corp., a wholly-owned subsidiary of CCC, and to other broker\/dealers who participated in the offering.\nCRONOS GLOBAL INCOME FUND XV, L.P.\nNOTES TO FINANCIAL STATEMENTS\n(i) Income Taxes\nThe Partnership is not subject to income taxes, consequently no provision for income taxes has been made. The Partnership files an annual information tax return, prepared on the accrual basis of accounting. At December 31, 1995, the tax basis of total partners' capital was $131,641,557.\n(j) Foreign Operations\nThe Partnership's business is not divided between foreign or domestic operations. The Partnership's business is the leasing of containers worldwide to ocean-going steamship companies and does not fit the definition of reportable foreign operations within Financial Accounting Standards Board Statement No. 14 \"Financial Reporting for Segments of a Business Enterprise.\" Any attempt to separate \"foreign\" operations from \"domestic\" operations would be dependent on definitions and assumptions that are so subjective as to render the information meaningless and potentially misleading.\n(k) Financial Statement Presentation\nThe Partnership has determined that for accounting purposes the Leasing Agent Agreement is a lease, and the receivables, payables, gross revenues and operating expenses attributable to the containers managed by the Leasing Company are, for accounting purposes, those of the Leasing Company and not of the Partnership. Consequently, the Partnership's balance sheets and statements of operations display the payments to be received by the Partnership from the Leasing Company as the Partnership's receivables and revenues.\nCertain reclassifications have been made to prior year amounts to present them on a basis consistent with 1995 classifications.\n(2) Short-Term Investments\nShort-term investments are carried at cost which approximates market value. Short-term investments with an original maturity of less than three months are considered cash equivalents.\n(3) Organization Costs, Net\nThe Partnership incurred $2,968,541 in offering and organizational costs and loan origination fees during its offering period. Amortization of these costs was $497,402 and $141,658 in 1995 and 1994, respectively.\nCRONOS GLOBAL INCOME FUND XV, L.P.\nNOTES TO FINANCIAL STATEMENTS\n(4) Net Lease Receivables Due from Leasing Company\nNet lease receivables due from the Leasing Company are determined by deducting direct operating payables and accrued expenses, base management fees payable, and reimbursed administrative expenses payable to CCC and its affiliates from the rental billings payable by the Leasing Company to the Partnership under operating leases to ocean carriers for the containers owned by the Partnership. Net lease receivables at December 31, 1995 and December 31, 1994 were as follows:\n(5) Due to General Partner\nThe amounts due to CCC and its affiliates at December 31, 1995 and December 31, 1994 were as follows:\n(6) Damage Protection Plan\nThe Leasing Company offers a repair service to several lessees of the Partnership's containers, whereby the lessee pays an additional rental fee for the convenience of having the Partnership incur the repair expense for containers damaged while on lease. This revenue is recorded when earned according to the terms of the rental contract. A reserve has been established to provide for the estimated costs incurred by this service. This reserve is a component of net lease receivables due from the Leasing Company (see note 4). The Partnership is not responsible in the event repair costs exceed predetermined limits, or for repairs that are required for damages not defined by the damage protection plan agreement.\nCRONOS GLOBAL INCOME FUND XV, L.P.\nNOTES TO FINANCIAL STATEMENTS\n(7) Equipment Debt\nOn July 22, 1994, the Partnership entered into an agreement with a bank, obtaining a $25,000,000 revolving credit facility for the purpose of taking advantage of purchase opportunities pending the raising of sufficient net proceeds from the offering and sale of limited partnership units. At December 31, 1994, the existing bank debt was $16,534,256. On December 15, 1995, the termination date of the offering, the bridge loan expired and was repaid in full from net proceeds raised by the Partnership.\nThe facility provided for various interest rate options in addition to requiring a commitment fee on the average unused portion of the facility. The weighted average interest rate from January 1, 1995 to December 15, 1995 was 8.12%. From July 31, 1994 to December 31, 1994, the weighted average interest rate was 7.01%.\n(8) Equipment Purchases\nAs of December 31, 1995, the Partnership had purchased the following types of equipment:\n- -------------------------\n(1) Amount reflects twenty-foot refrigerated container components accepted by the Partnership. At December 31, 1995, the process of manufacturing these components into a refrigerated cargo container was not complete. The containers are expected to be completed and delivered to the Partnership during the first quarter of 1996. The average cost of these refrigerated containers is expected to be $20,250 per container.\nCRONOS GLOBAL INCOME FUND XV, L.P.\nNOTES TO FINANCIAL STATEMENTS\n(8) Equipment Purchases - Continued\nThe aggregate purchase price (excluding acquisition fees) of the equipment acquired by the Partnership through December 31, 1995 was $96,134,945, of which $91,884,445 was paid from the net proceeds of this offering, and $4,250,500 remained payable to equipment manufacturers. Of the aggregate equipment, $39,848,185 thereof had been acquired from CCC and $56,286,760 thereof had been acquired from third-party container manufacturers located in Taiwan, South Korea, India, Indonesia, the People's Republic of China, Italy and the United Kingdom. Equipment acquired from CCC had been purchased by CCC as new equipment, and was resold to the Partnership at cost, minus the net revenues earned by CCC in operating the equipment prior to its resale to the Partnership. At December 31, 1995, the Partnership had committed to purchase from container manufacturers an additional 1,000 twenty-foot and 400 forty-foot marine dry cargo containers and 100 twenty-foot refrigerated cargo containers at an aggregate manufacturers' invoice cost of $6,096,300. The Partnership expects to fully invest the remaining unused proceeds from this offering in container equipment by the end of June 1996.\n(9) Net Lease Revenue\nNet lease revenue is determined by deducting direct operating expenses, management fees and reimbursed administrative expenses to CCC and its affiliates from the rental revenue billed by the Leasing Company under operating leases to ocean carriers for the containers owned by the Partnership. Net lease revenue for the year ended December 31, 1995 and for the period February 22, 1994 (commencement of operations) to December 31, 1994 was as follows:\n(10) Compensation to General Partner and its Affiliates\nBase management fees are equal to 7% of gross lease revenues attributable to operating leases pursuant to Section 4.3 of the Partnership Agreement. Reimbursed administrative expenses are equal to the costs expended by CCC and its affiliates for services necessary to the prudent operation of the Partnership pursuant to Section 4.4 of the Partnership Agreement. Underwriting commissions are equal to 10% of the gross subscription proceeds, less commissions to other broker\/dealers. The following compensation was paid or will be paid by the Partnership to CCC or its affiliates:\nCRONOS GLOBAL INCOME FUND XV, L.P.\nNOTES TO FINANCIAL STATEMENTS\n(11) Limited Partners' Capital\nThe limited partners' per unit share of capital at December 31, 1995 and 1994 was $17.97 and $18.22, respectively. This is calculated by dividing the limited partners' capital at the end of 1995 and 1994 by 7,151,569 and 2,301,474, the total number of limited partnership units, respectively. The weighted average number of partnership units used in determining the limited partners' per unit share of net earnings at December 31, 1995 and 1994 was 4,048,983 and 1,155,682, respectively.\n(12) Major Lessees\nNo single lessee contributed more than 10% of the rental revenue earned for the year ended December 31, 1995 and for the period February 22, 1994 (commencement of operations) to December 31, 1994.\nSchedule 1\nCRONOS GLOBAL INCOME FUND XV, L.P.\nSCHEDULE OF REIMBURSED ADMINISTRATIVE EXPENSES PURSUANT TO ARTICLE IV SECTION 4.4 OF THE PARTNERSHIP AGREEMENT\nFOR THE YEAR ENDED DECEMBER 31, 1995 AND FOR THE PERIOD FEBRUARY 22, 1994 (COMMENCEMENT OF OPERATIONS) TO DECEMBER 31, 1994\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nInapplicable.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nThe Registrant, as such, has no officers or directors, but is managed by CCC, the general partner. The officers and directors of CCC at January 31, 1996, are as follows:\nName Office - --------------------- ----------------------------------------------------\nDennis J. Tietz President, Chief Executive Officer, and Director John P. McDonald Vice President\/Sales Elinor Wexler Vice President\/Administration and Secretary John Kallas Vice President\/Treasurer and Chief Financial Officer Laurence P. Sargent Director Stefan M. Palatin Director A. Darrell Ponniah Director\nDENNIS J. TIETZ Mr. Tietz, 43, as President and Chief Executive Officer, is responsible for the general management of CCC. From 1986 until August 1992, Mr. Tietz was responsible for the organization, marketing and after-market support of CCC's investment programs. Mr. Tietz is also President and a director of Cronos Securities Corp. and a director of The Cronos Group. Mr. Tietz was a regional manager for CCC, responsible for various container leasing activities in the U.S. and Europe from 1981 to 1986. Prior to joining CCC in December 1981, Mr. Tietz was employed by Trans Ocean Leasing Corporation as Regional Manager based in Houston, with responsibility for all leasing and operational activities in the U.S. Gulf.\nMr. Tietz holds a B.S. degree in Business Administration from San Jose State University and is a Registered Securities Principal with the NASD.\nJOHN P. MCDONALD Mr. McDonald, 34, was elected Vice President - National Sales Manager of CCC in August 1992, with responsibility for marketing CCC's investment programs. Since 1988, Mr. McDonald had been Regional Marketing Manager for the Southwestern U.S. From 1983 to 1988, Mr. McDonald held a number of container leasing positions with CCC, the most recent of which was as Area Manager for Belgium and the Netherlands, based in Antwerp.\nMr. McDonald holds a B.S. degree in Business Administration from Bryant College, Rhode Island. Mr. McDonald is also a Vice President of Cronos Securities Corp.\nELINOR A. WEXLER Ms. Wexler, 47, was elected Vice President - Administration and Secretary of CCC in August 1992. Ms. Wexler has been employed by the General Partner since 1987, and is responsible for investor services, compliance and securities registration. From 1983 to 1987, Ms. Wexler was Manager of Investor Services for The Robert A. McNeil Corporation, a real estate syndication company, in San Mateo, California. From 1971 to 1983, Ms. Wexler held various positions, including securities trader and international research editor, with Nikko Securities Co., International, based in San Francisco.\nMs. Wexler attended the University of Oregon, Portland State University and the Hebrew University of Jerusalem, Israel. Ms. Wexler is also Vice President and Secretary of Cronos Securities Corp. and a Registered Principal with the NASD.\nJOHN KALLAS Mr. Kallas, 33, was elected Vice President\/Treasurer and Chief Financial Officer of CCC in December 1993 and is directly responsible for CCC's accounting operations and reporting activities. Mr. Kallas has held various accounting positions since joining CCC in 1989, including Controller, Director of Accounting and Corporate Accounting Manager. From 1985 to 1989, Mr. Kallas was an accountant with KPMG Peat Marwick, San Francisco, California.\nMr. Kallas holds a B.S. degree in Business Administration from the University of San Francisco and is a certified public accountant. Mr. Kallas is also Treasurer of Cronos Securities Corp.\nLAURENCE P. SARGENT Mr. Sargent, 66, joined the Board of Directors of CCC in 1991. Mr. Sargent was a founder of Leasing Partners International (\"LPI\") and served as its Managing Director from 1983 until 1991. From 1977 to 1983, Mr. Sargent held a number of positions with Trans Ocean Leasing Corporation, the last of which was as a director of its refrigerated container leasing activities. From 1971 to 1977, Mr. Sargent was employed by SSI Container Corporation (later Itel Container International), ultimately serving as Vice President \/ Far East. Prior to that, Mr. Sargent was a Vice President of Pacific Intermountain Express, a major U.S. motor carrier, responsible for its bulk container division. Mr. Sargent holds a B.A. degree from Stanford University. Mr. Sargent also serves as a director of the Institute of International Container Lessors (\"IICL\"), an industry trade association. Mr. Sargent is also a director of Cronos Securities Corp.\nMr. Sargent retired as Deputy Chairman of the Group as of January 1, 1996. He will remain a director of CCC, The Cronos Group, as well as other various subsidiaries of The Cronos Group.\nSTEFAN M. PALATIN Mr. Palatin, 42, joined the Board of Directors of CCC in January 1993. Mr. Palatin is Chairman and CEO of The Cronos Group, and was a founder of LPI in 1983. From 1980 to 1991, Mr. Palatin was an executive director of the Contrin Group, which has provided financing to the container leasing industry, as well as other business ventures, and has sponsored limited partnerships organized in Austria. From 1977 to 1980, Mr. Palatin was a consultant to a number of companies in Austria, including Contrin. From 1973 to 1977, Mr. Palatin was a sales manager for Generali AG, the largest insurance group in Austria.\nMr. Palatin, who is based in Austria, holds a Doctorate in Business Administration from the University of Economics and World Trade in Vienna. Mr. Palatin is also a director of The Cronos Group.\nA. DARRELL PONNIAH Mr. Ponniah, 46, was elected to the Board of Directors of CCC in January 1993. Mr. Ponniah is Chief Financial Officer of The Cronos Group and is based in the United Kingdom. Prior to joining Cronos in 1991, Mr. Ponniah was employed by the Barclays Bank Group and served as Chief Operating Officer of Barclays European Equipment Finance. From 1973 to 1988, Mr. Ponniah was employed by Rank Xerox, the European-based subsidiary of Xerox Corporation of the U.S.A., in a number of positions, the most recent of which was as Group Controller and Chief Financial Officer of the International Equipment Financing Division of Rank Xerox Limited.\nMr. Ponniah is an honors graduate of Manchester University in England and holds post graduate degrees in operational research from Brunel University and in Business Administration from the Manchester Business School. Mr. Ponniah is also a director of The Cronos Group and Cronos Securities Corp.\nThe key management personnel of the Leasing Company at January 31, 1996, were as follows:\nName Title --------------------- -----------------------------------------------\nNigel J. Stribley President John M. Foy Vice President\/Americas Geoffrey J. Mornard Vice President\/Europe, Middle East and Africa Danny Wong Vice President\/Asia Pacific David Heather Vice President\/Technical Services John C. Kirby Vice President\/Operations J. Gordon Steel Vice President\/Tank Container Division\nNIGEL J. STRIBLEY Mr. Stribley, 42, has been responsible for the general management of the Leasing Company since September 1991. From 1985 to 1991, Mr. Stribley was a director of LPI, based in the United Kingdom and responsible for worldwide lease marketing and operations of refrigerated containers. From 1978 to 1985, Mr. Stribley was employed by Sea Containers Limited, London, where he was involved in refrigerated container leasing, ultimately as Manager of Refrigerated Containers with responsibility for world-wide activities. From 1975 to 1978, Mr. Stribley was employed by Sealand Containerships, Ltd., the United Kingdom subsidiary of a major U.S. container shipping company, as a management trainee and later as Operations Manager and a Container Terminal Manager.\nMr. Stribley holds a BA degree with honors from Bristol University in England. Mr. Stribley is a director of The Cronos Group.\nJOHN M. FOY Mr. Foy, 50, is directly responsible for the Leasing Company's lease marketing and operations in North America, Central America, and South America, and is based in San Francisco. From 1985 to 1993, Mr. Foy was Vice President\/Pacific with responsibility for dry cargo container lease marketing and operations in the Pacific Basin. From 1977 to 1985 Mr. Foy was Vice President of Marketing for Nautilus Leasing Services in San Francisco with responsibility for worldwide leasing activities. From 1974 to 1977, Mr. Foy was Regional Manager for Flexi-Van Leasing, a container lessor, with responsibility for container leasing activities in the Western United States. Mr. Foy holds a B.A. degree in Political Science from University of the Pacific, and a Bachelor of Foreign Trade from Thunderbird Graduate School of International Management.\nGEOFFREY J. MORNARD Mr. Mornard, 36, is directly responsible for the Leasing Company's lease marketing and operations in Europe, the Middle East and Africa. From 1991 to 1993, Mr. Mornard was Director of Marketing for refrigerated containers in Australia and New Zealand. From 1989 to 1991, Mr. Mornard held the same position with LPI. From 1979 to 1989, Mr. Mornard was employed by Cooltainer Services, Ltd., a refrigerated container carrier company, initially as Melbourne Branch Manager, later as Sydney Branch Manager, and ultimately as Australian Trade Manager, responsible for marketing and operations of all container traffic to and from Australia.\nDANNY WONG Mr. Wong, 42, is responsible for the Leasing Company's lease marketing and operations in Asia, Australia and the Indian sub-continent, and is based in Singapore. From 1991 to 1993, Mr. Wong was Vice President\/Refrigerated Containers, responsible for the marketing of refrigerated containers worldwide for the Leasing Company. From 1988 to 1991, Mr. Wong was employed by LPI, as Director of Marketing for the Far East and Southeast Asia based in Singapore. From 1987 to 1988, Mr. Wong was a district manager in Singapore covering leasing activities in Southeast Asia for Gelco CTI, a major container leasing company. From 1979 to 1987, Mr. Wong was employed by Flexi-Van Leasing in Singapore as a sales manager and later as Regional Manager for Southeast Asia and the Indian sub-continent. Mr. Wong holds a Diploma in Marketing Management from the Singapore Institute of Management.\nDAVID HEATHER Mr. Heather, 48, is responsible for all technical and engineering activities of the fleet managed by the Leasing Company. Mr. Heather was Technical Director for LPI, based in the United Kingdom, from 1986 to 1991. From 1980 to 1986, Mr. Heather was employed by ABC Containerline NV as Technical Manager with technical responsibility for the shipping line's fleet of dry cargo, refrigerated and other specialized container equipment. From 1974 to 1980, Mr. Heather was Technical Supervisor for ACT Services Ltd., a shipping line, with responsibility for technical activities related to refrigerated containers. Mr. Heather holds a Marine Engineering Certificate from Riversdale Marine Technical College in England.\nJOHN C. KIRBY Mr. Kirby, 42, is responsible for container purchasing, contract and billing administration, container repairs and leasing-related systems, and is based in the United Kingdom. Mr. Kirby joined CCC in 1985 as European Technical Manager and advanced to Director of European Operations in 1986, a position he held with CCC, and later the Leasing Company, until his promotion to Vice President\/Operations of the Leasing Company in 1992. From 1982 to 1985, Mr. Kirby was employed by CLOU Containers a container leasing company, as Technical Manager based in Hamburg, Germany. Mr. Kirby acquired a professional engineering qualification from the Mid-Essex Technical College in England.\nJ. GORDON STEEL Mr. Steel, 63, is directly responsible for the overall lease marketing activity for the Leasing Company's Tank Container Division. From 1990 to 1992, Mr. Steel held the position of Director\/General Manager for Tiphook Container's Tank Division. From 1977 to 1990, Mr. Steel held various managerial positions, involving manufacturing and transportation of hazardous materials, with Laporte Industries and ICI, major chemical distribution companies. Mr. Steel is a qualified Chemical Engineer and attended the Associate Royal Technical College in Scotland.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe Registrant commenced monthly distributions to its partners (general and limited) from distributable cash from operations beginning in the second quarter of 1994. Such distributions are allocated 95% to the limited partners and 5% to the general partner. Sales proceeds will be allocated 99% to the limited partners and 1% to the general partner. The allocations will remain in effect until such time as the limited partners have received from the Registrant aggregate distributions in an amount equal to their capital contributions plus an 8% cumulative, compounded (daily), annual return on their adjusted capital contributions. Thereafter, all Partnership distributions will be allocated 85% to the limited partners and 15% to the general partner.\nThe Registrant will not pay or reimburse CCC or the Leasing Company for any remuneration payable by them to their executive officers, directors or any other controlling persons. However, the Registrant will reimburse the general partner and the Leasing Company for certain services pursuant to Section 4.4 of the Partnership Agreement. These services include but are not limited to (i) salaries and related salary expenses for services which could be performed directly for the Registrant by independent parties, such as legal, accounting, transfer agent, data processing, operations, communications, duplicating and other such services; (ii) performing administrative services necessary to the prudent operations of the Registrant.\nThe following table sets forth the fees the Registrant paid (on a cash basis) to CCC or the Leasing Company (\"CCL\") for the year ended December 31, 1995.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management - (Continued)\n(a) Security Ownership of Certain Beneficial Owners\nThere is no person or \"group\" of persons known to the management of CCC, the general partner of the Registrant, to be the beneficial owner of more than five percent of the outstanding units of limited partnership interests of the Registrant.\n(b) Security Ownership of Management\nThe Registrant has no directors or officers. It is managed by CCC, the general partner. CCC owns five units, representing 0.00007% of the total amount of units outstanding.\n(c) Changes in Control\nInapplicable.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\n(a) Transactions with Management and Others\nThe Registrant's only transactions with management and other related parties during 1995 were limited to those fees paid or amounts committed to be paid (on an annual basis) to CCC, the general partner, and its affiliates. See Item 11, \"Executive Compensation,\" herein. Additionally, see Part I, Item 2 and Part II, Item 7 hereof, for a description of its purchase of marine containers from the general partner.\n(b) Certain Business Relationships\nInapplicable.\n(c) Indebtedness of Management\nInapplicable.\n(d) Transactions with Promoters\nInapplicable.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\n(a)1. Financial Statements\nAll other schedules are omitted as the information is not required or the information is included in the financial statements or notes thereto.\n(a)3. Exhibits\n- --------------------------\n* Incorporated by reference to Exhibit \"A\" to the Prospectus of the Registrant dated December 17, 1993, included as part of Registration Statement on Form S-1 (No. 33-69356)\n** Incorporated by reference to Exhibit 3.2 to the Registration Statement on Form S-1 (No. 33-69356)\n*** Incorporated by reference to Exhibit 10.2 to the Registration Statement on Form S-1 (No. 33-69356)\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nCRONOS GLOBAL INCOME FUND XV, L.P.\nBy Cronos Capital Corp. The General Partner\nBy \/s\/ John Kallas ------------------------------------------ John Kallas Vice President\/Treasurer and Chief Financial Officer Principal Accounting Officer\nDate: March 28, 1996\nPursuant to the requirement of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of Cronos Capital Corp., the general partner of the Registrant, in the capacities and on the dates indicated:\nSUPPLEMENTAL INFORMATION\nThe Registrant's annual report will be furnished to its limited partners on or about April 30, 1996. Copies of the annual report will be concurrently furnished to the Commission for information purposes only, and shall not be deemed to be filed with the Commission.\nEXHIBIT INDEX\n- -------------------\n* Incorporated by reference to Exhibit \"A\" to the Prospectus of the Registrant dated December 17, 1993, included as part of Registration Statement on Form S-1 (No. 33-69356)\n** Incorporated by reference to Exhibit 3.2 to the Registration Statement on Form S-1 (No. 33-69356)\n*** Incorporated by reference to Exhibit 10.2 to the Registration Statement on Form S-1 (No. 33-69356)","section_15":""}
{"filename":"702756_1995.txt","cik":"702756","year":"1995","section_1":"ITEM 1. BUSINESS\nSEEQ Technology Incorporated (herein \"SEEQ\" or the \"Company\") is a leading supplier of Ethernet data communications products for networking applications. As an Ethernet silicon pioneer, SEEQ introduced the industry's first Ethernet chip set in 1982. Ethernet is the dominant local area network (LAN) technology today and was originally developed by Xerox and Digital Equipment Corporation in the late 1970s. SEEQ combines its strengths in digital circuit and analog design with its communications systems expertise to produce mixed-signal data communication solutions that provide increased functionality and greater reliability that result in lower total system cost. In 1983, the Company successfully developed the industry's first integrated Ethernet data communications controller. In 1994, the Company introduced the industry's first Fast Ethernet (100 megabits per second \"Mbps\") four-port controller.\nSEEQ's product development and marketing strategy is to sell its products to systems manufacturers who are performance and volume leaders in the information networking, telecommunications, personal computer, workstation and printer markets. The Company's more than 150 customers worldwide include such industry leaders as Apple Computer, Bay Networks, Cabletron, Cisco Systems, Compaq, Hewlett Packard, Intel, and 3COM. SEEQ's Ethernet data communications products are sold in numerous market applications of Ethernet adapter cards, workstations, media attachment units, print servers, file servers, multiport repeaters, standard hubs, switching hubs, bridges and routers.\nSEEQ's complete product line includes Ethernet data communication controllers, AutoDUPLEX(TM) Ethernet chip sets for automatic full duplex switched Ethernet applications, encoders\/decoders, coaxial cable CMOS transceivers and unshielded twisted pair cable CMOS transceivers, and networking modules. In order to meet customers' needs for higher-speed LAN solutions, the Company has developed a new generation of products for Fast Ethernet, a new high-speed LAN technology. Fast Ethernet is a 100Mbps version of traditional 10Base-T Ethernet (10Mbps). The Company also sells media signaling integrated circuits for another emerging high speed LAN market, Asynchronous Transfer Mode (\"ATM\").\nThe Company was founded in 1981 to develop, manufacture and market products incorporating metal-oxide-silicon (\"MOS\") reprogrammable, nonvolatile memory integrated circuit technology. In February 1994, the Company sold its nonvolatile memory technology and related assets to focus on the data communications market.\nINDUSTRY BACKGROUND\nCorporate computing networks during the late 1960s and 1970s were characterized by expensive resources which were concentrated in a central location and accessed by remote display terminals. As the declining cost of computing power made distributed data processing possible, LANs developed in the early 1980s which provided departmental level processing in the form of powerful small personal computers (\"PCs\") and microprocessor-based workstations. LANs are used at the departmental level for information exchange among the local computers and sharing of peripherals.\nAlthough the computer industry initially favored proprietary LAN solutions, a cooperative effort between computer and communications vendors under the sponsorship of the Institute of Electrical and Electronic Engineers (\"IEEE\") resulted in several LAN protocol standards including Ethernet and Token Ring. These standard-based LANs provide a local shared communications facility which can be accessed by products from multiple vendors, even though the higher level of protocols for these products may be incompatible. Under these standards, the installation of LANs has expanded significantly, with over half of the worldwide PCs now connected to some form of LAN.\nThe PC LAN network consists of the following three major hardware elements allowing data communication through a network operating system: network interface cards (\"NICs\"), physical media transfer communication hardware and file servers. The NIC is the hardware which allows a PC or workstation to link via the physical media of transmission to the other network users and peripherals. The physical media transfer communication hardware are the\nconnectors used to connect the NICs to the network and the type of wire the transmission media used through the LAN. The choices of wiring include thick and thin Ethernet cable, shielded and unshielded twisted pair (telephone cable), and fiber optic cabling. The use of the growing installed base of twisted-pair copper telephone lines is expected to remain the primary means for local connectivity to the information superhighway. Currently, unshielded twisted-pair copper wire is the most cost-effective means of transmitting information at the data rates typically required for local connectivity.\nDemand for LAN products has grown rapidly in recent years, as a result of the growth in corporate networks, the introduction of client\/server computing, the expansion of personal computer and workstations markets, and the development of new applications, including video conferencing, image processing and multimedia. As networks grow in size and these new applications require faster data rates, business networks will require more throughput capacity than is currently provided by current implementations such as 10 Mbps Ethernet or 16 Mbps Token Ring. Fast Ethernet and ATM technologies are expected to satisfy the requirement for greater bandwidth capacity on most local area networks.\nBUSINESS STRATEGY\nSEEQ's objective is to be a leading provider of digital and mixed-signal silicon \"connectivity\" solutions for data communication applications. Key elements of the Company's business strategy include the following:\nDELIVER A BROAD RANGE OF PRODUCT OFFERINGS TO FAST GROWING SYSTEMS MANUFACTURERS\nThe primary focus of SEEQ's business strategy is to provide \"connectivity solutions\" to leading systems manufacturers in rapidly growing Ethernet and ATM based data communications markets. The Company strives to maintain close contact with its customers and prospective customers to identify opportunities to design products to meet customer specific functional requirements and to bring added value to the end product. The Company also strives to continuously expand its data communication product offerings in order to increase the capability and operational and cost efficiencies for most LAN applications.\nEXPAND \"FAST\" ETHERNET PRODUCT OFFERINGS AND CUSTOMER BASE\nThe Company is committed to the introduction of new data communication products into existing and new high-speed LAN market segments (such as Fast Ethernet and ATM), which enable system OEM's to improve performance, address new applications and further integrate higher levels of system functionality. The Company's existing line of Fast Ethernet products enable SEEQ to provide a full range of LAN data communication solutions to its customers. SEEQ has been successful in expanding its customer base by developing business relationships with both established and emerging systems manufacturers. As the data communications market, and specifically LAN equipment suppliers, adopt new, more complex protocol standards, such as Fast Ethernet and ATM, and demand a higher level of functional integration, SEEQ believes its' new product offerings will satisfy most LAN connectivity requirements.\nCAPITALIZE ON MIXED-SIGNAL AND COMMUNICATIONS SYSTEMS EXPERTISE\nThe Company has assembled a talented group of engineers possessing both mixed-signal integrated circuit and communications systems design skills. SEEQ believes that its design staff is one of the leading mixed-signal teams in the industry and represents one of the Company's core competitive strengths. The Company's strategy is to utilize its process development and LAN technology expertise, together with its manufacturing knowledge, to supply highly integrated connectivity solutions at lower system cost than competitors' products.\nMAINTAIN COST-EFFECTIVE SILICON FOUNDRY RELATIONSHIPS\nSEEQ obtains the necessary supply of finished wafers to meet its manufacturing needs through selective foundry arrangements with major semiconductor manufacturers. These relationships are intended to provide SEEQ with the required wafer fabrication capacity, and to provide the Company with access to next generation silicon process\ntechnology. Due to the high demand for world-wide foundry capacity, it is the Company's objective to maintain two suppliers for each of its \"high-volume\" products. Presently, SEEQ has foundry arrangements with seven semiconductor manufacturers; AMI Semiconductor, Hualon Microelectronics Corporation (\"HMC\"), International Microelectronics Products, Inc. (\"IMP\"), Ricoh, Rohm, Samsung Semiconductor and VLSI.\nEXTEND STRATEGIC RELATIONSHIPS WITH INDUSTRY LEADERS\nSEEQ continues to work closely with systems manufacturers that are market and technology leaders, which in selected cases has led to strategic sole-source supplier arrangements. At the heart of customer relationships, the product design and applications team at the Company focuses on meeting a customer's specific system requirements. This close working relationship also enables SEEQ to identify requirements for future systems being developed by the customer. In addition, the Company plays an active role in industry-wide alliances aimed at developing standards for new LAN technologies. SEEQ is a contributing member of the Fast Ethernet Alliance, Full Duplex Switched Ethernet Consortium and the Desktop ATM25 Alliance.\nBASE INITIAL TARGET MARKET FOR CERTAIN FAST ETHERNET PRODUCTS ON 100BASE T4 STANDARDS\nSEEQ has developed its Fast Ethernet product-line based on the IEEE 100Base-T4 standard for copper wire. Two standards currently exist for 100Base-T Fast Ethernet, 100Base-T4 (consisting of four twisted pair wire) and 100Base-TX (consisting of two twisted pair wire). It is estimated that the majority of the existing structures in the United States are wired with Category 3 type wire, which requires 100Base-T4 standard protocol. Newer buildings are generally wired using Category 5 wiring, which requires 100Base-TX standard protocol. SEEQ's Fast Ethernet products are fully functional on either Category 3 or 5 wire. Presently, the cost per connection is significantly lower using a 100Base-T4 product solution than the 100Base-TX. While the Company's Fast Ethernet Controllers support both 100Base-T4 and 100Base-TX protocols, its new physical layer devices presently only support the 100 Base-T4 standard protocol.\nPRODUCTS\nElectronic data communications is one of the largest and fastest growing segments of the integrated electronics market. LANs, representing networks connecting two or more computers and peripherals within a localized geographical area (e.g., office floor, building, or campus), address the need to share information among individuals in close proximity. The most popular data communication LAN technology in the market is Ethernet. The speed of standard Ethernet is 10Mbps. Signal detection on Ethernet is based upon the concept of carrier sense multiple access with collision detection (\"CSMA\/CD\"). Today the vast majority of Ethernet products are based on IEEE 802.3 standards. The most popular Ethernet standard is 10Base-T, the operation of Ethernet over unshielded twisted pair (\"UTP\") wiring.\nThe Company's Ethernet data link controllers are used in local area network systems that can interconnect a wide variety of computers and peripheral devices. They are generally used in Ethernet-compatible systems, and replace a substantial number of discrete components previously contained on a printed circuit board. The Company also produces a set of Ethernet encoder\/decoder circuits, media interface adapters (\"MIAs\"), and Ethernet transceiver circuits. The Company's data communications products have significantly reduced the cost of Ethernet connections for local area network manufacturers.\nThe Company is also a leader in the application of automatic full duplex technology to Ethernet LANs. SEEQ's AutoDuplex feature uses specially coded link pulses to determine if the channel has duplex capabilities. The SEEQ patented technique allows any node in a 10Base-T network to determine if it has a full duplex channel for its use and to automatically modify its behavior when establishing independent transmit and receive communication channels. This technique effectively doubles the communications channel bandwidth available to the node. In a 10Base-T network with full duplex nodes connected to a switching hub or multiport bridge, the effective network bandwidth is doubled to 20 Mbits\/sec. SEEQ has extended this technique to Fast Ethernet to effectively increase the network bandwidth to 200 Mbits\/sec.\nIn order to meet customers' needs for higher-speed LAN solutions, the Company has developed a new generation of products for the new LAN technology called Fast Ethernet. During 1994, the Company introduced its first Fast Ethernet product, the 100Mbps four port Fast Ethernet controller. Recently, SEEQ has introduced a second major product in its Fast Ethernet product-line, a 100Mbps physical layer device.\nMARKETING AND SALES\nThe Company sells its products to OEMs and distributors representing a wide range of markets, including computer systems, facsimile equipment, engineering workstations, modems, process controllers, and commercial data processing systems. The Company's ten largest customers accounted for approximately 34%, 54% and 68% of net revenues for fiscal years 1993, 1994 and 1995, respectively. No one customer accounted for 10 percent or more of revenues in fiscal 1993. Two customers, Apple Computer and Cisco Systems, accounted for approximately 16% and 11% of revenues in fiscal 1994, respectively. Apple Computer and Serial Systems (an agent for Hewlett Packard and Compaq) accounted for approximately 17% and 16% of revenues in fiscal 1995, respectively.\nThe Company coordinates all domestic sales through two regional sales offices in addition to its Fremont, California headquarters. The Company's four OEM sales managers work closely with manufacturers' representatives and distributors to secure design-ins and production orders.\nThe Company markets its products through a network of independent manufacturers' representatives and independent distributors. The Company has contracted with five national distributors to stock and sell the Company's products from an aggregate of approximately eight stocking locations. In addition, the Company has contracted approximately 14 independent manufacturers' representatives throughout the United States, representing approximately 160 individual salespeople. The representatives obtain orders for SEEQ, which the Company fills by shipping directly to the purchaser and for which the Company pays the representatives commissions based on the sales.\nInternational sales were approximately $6.3 million, $7.1 million and $8.6 million, representing approximately 19%, 33% and 38% of product sales, for fiscal years 1993, 1994 and 1995, respectively. International sales are accomplished through a network of approximately 28 stocking representatives, together with international sales management in Fremont, California. Sales to foreign customers are shipped from the Company's headquarters F.O.B. and are usually billed and paid in United States dollars. Although sales may be made subject to tariffs in certain countries or with regard to certain products, at present the Company's average selling prices for foreign sales are not significantly different from those for domestic sales. Foreign sales are subject to certain control restrictions imposed by the United States and foreign governments, but the Company has not encountered any such limitations that have materially affected its foreign sales.\nSEEQ's volume purchase orders do not necessarily result in sales as they are generally terminable by the customer without significant penalty. Consequently, backlog figures are not necessarily indicative of future sales.\nRESEARCH AND DEVELOPMENT\nExpertise in a variety of related disciplines and functions is necessary to design, develop and manufacture mixed signal semiconductor integrated circuits which combine both digital and analog circuits. These disciplines include systems and application engineering, computer aided design, device physics, semiconductor process engineering, circuit design, reliability physics and test engineering. The Company has committed and will continue to commit substantial resources over an extended period to develop new products and technologies utilizing all of these disciplines.\nThe Company is concentrating on the application of its proprietary technologies for the development of mixed signal integrated circuits for the data communications market. Present research and development efforts are focused on the development of Ethernet controllers and media signaling integrated circuits for the 100Mbps Fast Ethernet market\nand ATM market, and more highly integrated signaling devices for the 10Mbps Ethernet market. The Company invented the AutoDUPLEX technique for automatic full duplex operation in switched Ethernet applications running over twisted pair cabling. The Company has one issued patent pertaining to automatic full duplex and other applications pending.\nThe Company's research and development expenditures were approximately $3,289,000, $3,278,000 and $3,069,000 for the fiscal years 1993, 1994 and 1995, respectively. As of September 30, 1995, 17 employees were engaged in research and development activities.\nMANUFACTURING\nThe manufacturing process for semiconductors is divided into three basic operations: silicon wafer fabrication, assembly and testing. SEEQ has chosen to use independent silicon foundries and assembly subcontractors to fabricate and assemble its integrated circuits. This strategy enables the Company to focus its resources on the design and test areas, where the Company believes it has greater competitive advantages, and to eliminate the high cost of owning and operating a semiconductor silicon fabrication and assembly facilities.\nPresently, SEEQ has a business relationship with seven foundries. As SEEQ does not have its own wafer fabrication capability, it must compete for foundry capacity with other, larger semiconductor suppliers. During the fourth quarter of fiscal 1995, the Company agreed to phase out its long term foundry arrangement with IMP, which manufactured a number of SEEQ's older Ethernet mixed-signal chips. Consequently, during the fourth quarter fiscal 1995, the Company was unable to manufacture enough product to meet demand. While IMP will continue to manufacture wafers for supply to SEEQ through March 1996, the Company has re-established a foundry relationship with Hualon Microelectronics Company (\"HMC\") of Taiwan. HMC will manufacture 10Mbps Ethernet mixed-signal products under a foundry agreement which extends through July 1998. In re-establishing the production process with HMC, due to the complexity of the process, there can be no assurance that significant costs or time delays will not be incurred in the pre-production process or that such costs and\/or time delays will not have an adverse effect on future operating results.\nSEEQ works closely with its foundry partners to obtain a steady and predictable supply of integrated circuits and is in the process of adding new foundry partners to increase capacity. While the Company believes it can obtain fabrication capacity with its current foundry resources to meet current and future expected demand, the Company could experience a shortfall in product availability if any of its foundry partners are unable to meet planned capacity requirements or production schedules. Additionally, no one foundry partner is capable of supplying sufficient capacity to meet total current or future expected demand.\nTest operations are performed during each phase of the manufacturing process. SEEQ uses sophisticated testing equipment to test the die on each silicon wafer prior to shipment for assembly. After assembly, each unit (i.e. packaged die) undergoes final electrical testing at the Company. For certain mature 10Mbps products, the Company subcontracts the final testing in order to increase overall test capacity. SEEQ's Ethernet controller products are manufactured, including final testing, by two of its foundries.\nAlthough the manufacturing process is highly controlled, equipment malfunctions, process complexities, minute impurities, or defects in the masks may cause a substantial percentage of the silicon wafers to be rejected or individual chips to be non-functional, a problem indigenous to the semiconductor industry. There can be no assurance that the Company or any of its foundry suppliers will not experience yield problems in the future.\nCOMPETITION\nThe semiconductor industry is intensely competitive. SEEQ believes that no single competitor offers similar products across SEEQ's entire product line. However, several semiconductor manufacturers offer products competitive\nwith certain of those offered by the Company. The Company competes principally on the basis of the timely and successful development and introduction of new products and technologies, the quality, functionality, price and performance characteristics of its products and the adaptability of such products to specific applications. SEEQ believes that it competes favorably with respect to most of these factors. In addition, SEEQ believes that its principal competitive strengths arise from its technological capabilities in the development of both mixed-signal integrated circuit and communications systems designs. Many of SEEQ's competitors have substantially greater, technical, financial, manufacturing and marketing resources than the Company, and no assurance can be given that the Company can continue to compete successfully in the future.\nPATENTS, TRADEMARKS AND LICENSES\nThe Company pursues a policy of obtaining patents for appropriate inventions, although the Company believes its success depends primarily upon the experience and creative skills of its employees rather than the ownership of patents. The Company has obtained nonexclusive licenses from certain other organizations, such as Texas Instruments, Incorporated, Xerox Corporation, and AT&T, for use of product designs or specifications in the development of the Company's products. Such license arrangements on a non-exclusive basis are customary in the industry.\nThe Company has one United States patent issued which expires in May 2011. In addition, the Company has a patent application which has been allowed and will be issued by the U.S. Patent Office in due course. However, there can be no assurance that the patent will provide SEEQ with any meaningful protection. The Company also has certain federally registered trademarks. The Company is pursuing a systematic strategy of submitting patent applications whenever justified by a combination of business and technical considerations. In addition, the Company avails itself of mask work protection for its designs.\nAs is the case with many companies in the semiconductor industry, it may become necessary or desirable in the future for SEEQ to obtain licenses relating to its products from others. SEEQ has in the past received notification of possible infringement of patents from certain other semiconductor manufacturers and these matters are under consideration. Although patent holders in the industry typically offer licenses, and SEEQ in the past has entered into license agreements, there can be no assurance that licenses can be obtained on acceptable terms.\nThe Company, from time to time, enters into technology and second source agreements. The Company has not granted any rights relative to its process or design technology which are or will be exclusive.\nENVIRONMENTAL REGULATIONS\nThe manufacture of semiconductors requires the use and storage of substantial amounts of toxic chemicals and other hazardous materials. There have been several incidents in the semiconductor industry of environmental pollution or personal injury related to improper storage or use of these substances. The Company believes that its facilities are in compliance with applicable environmental regulations, and that its operations have not caused any significant environmental problems. The regulations concerning environmental protection have grown increasingly complex and rigorous. Accordingly, there can be no assurance that the Company will not violate environmental regulations in the future which may require it to incur substantial expenses.\nEMPLOYEES\nAs of September 30, 1995, the Company had 67 employees, including 11 in marketing and sales, 17 in research, development and engineering related functions, 32 in manufacturing and 7 in management, administration and finance. The Company's success depends on a number of key employees, the loss of one or more of whom could adversely affect the Company. The Company believes that its future success will depend in large part upon its ability to attract, retain and motivate highly skilled employees. The Company has never had a work stoppage, slow-down or\nstrike. None of the Company's employees are represented by a labor union. The Company considers its employee relations to be good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company's executive offices and manufacturing and principal research and design facilities currently occupy a 54,000 square foot building located in Fremont, California. The building is leased by the Company under a lease scheduled to expire in 2005 with one five-year renewal option. The Company also leases additional offices for its area sales managers in Westlake, California and Burlington, Massachusetts.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nPursuant to the Asset Purchase Agreement dated February 7, 1994, (the \"Asset Purchase Agreement\") by and between SEEQ and Atmel Corporation (\"Atmel\"), Atmel purchased the assets of SEEQ related to its electrically erasable programmable read only memory (\"EEPROM\") products (the \"EEPROM Asset Sale\"). A substantial portion of the consideration received by the Company in connection with the EEPROM Asset Sale was placed in escrow subject to certain claims of indemnity by Atmel under the Asset Purchase Agreement. As of September 30, 1995, $4,029,000 was on deposit in escrow (excluding interest earned thereon to such date). Such amount is subject to any future claims that may be made by Atmel with respect to the EEPROM technology sold to Atmel in the EEPROM Asset Sale under the terms of the Asset Purchase Agreement. Atmel has notified SEEQ that, based on certain claims asserted by Hualon Microelectronics Corporation (\"HMC\"), one of SEEQ's foundries and joint development partners, that SEEQ previously granted HMC certain license rights to the EEPROM technology pursuant to an alleged license agreement, Atmel believes it may be entitled to assert a claim against this escrow account, although Atmel has not done so to date. The funds in this escrow account will remain in escrow until a determination is made that SEEQ is entitled to such funds under any release condition in the escrow agreement, or, if Atmel makes a claim prior to such date under such escrow, then until such claim is resolved by a court. The Company will be entitled to receive such funds if it is determined that the alleged license agreement is invalid, or, if no such determination is made, to the extent that any claims made by Atmel that Atmel has suffered damages as a result of the alleged license agreement are unsuccessful, or if Atmel does not make a claim to such funds by February 1999, or as otherwise agreed by the Company and Atmel. On March 30, 1994, the Company filed a lawsuit against HMC in which, among other things, the Company sought a declaration by the court that the alleged license agreement is invalid. On August 16, 1995, the Company and HMC entered into a Settlement Agreement, Release and Tolling Agreement. Under the terms of such Agreement, the Company agreed, among other things, that the claims asserted against HMC in respect of the alleged license agreement would be tolled for such time and on such terms as provided therein. As a result, the Company is not currently pursuing such claims. The Company is entitled to pursue such claims in the future, however, subject to the terms of the Settlement Agreement, Release and Tolling Agreement. In the event that the Company does not cause the alleged license agreement to be invalidated, Atmel may assert a claim against the Company under the Asset Purchase Agreement, including a claim for damages, if suffered by Atmel as a result of HMC's use of any of such technology, and, in the event any such claim by Atmel is determined to be valid, Atmel may recover any such damages from the escrow described above. The Company believes that, in the event of any claim by Atmel, the amount of damages that may be payable by the Company upon a resolution thereof will not have a material adverse effect on the Company's cash flow, financial position or results of operations. However, there can be no assurance as to such matters. Under the terms of the settlement, the Company agreed to pay HMC $500,000 due in three consecutive monthly installments beginning in August 1995. The Company further agreed to issue to HMC 100,000 shares of SEEQ's common stock and reactivate and modify the 1990 Foundry and Co-Development Agreement (see Note 10 of Notes to Consolidated Financial Statements).\nOn November 28, 1995, Level One Communications Incorporated (\"Level One\") filed a complaint against the Company, in the United States District Court of Northern California, alleging patent infringement. In the complaint, Level One claims that the Company has used and sold products in violation of two of Level One's patents. Level One seeks immediate and permanent injunctive relief preventing the Company from making, using, or selling any devices that infringe such patents and unspecified damages. Based on the Company's limited review to date, management\nbelieves that the outcome of these legal proceedings will not have a material adverse effect on the Company's financial position or results of operations.\nIn addition, SEEQ is involved in certain other routine litigation in the ordinary course of its business. SEEQ believes that the outcome of these legal proceedings 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\nNo matters were submitted to a vote of security holders during the quarter ended September 30, 1995.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Stock and Related Stockholder Matters\nThe Company's stock is listed on the Nasdaq National Market under the symbol \"SEEQ\". The tables below present the high and low market prices for fiscal years 1995 and 1994. The Company has never paid dividends on common shares and has no present plans to do so.\nThe approximate number of stockholders of record at September 30, 1995 was 1,000.\nOn April 21, 1995, the Company declared a dividend distribution of one Preferred Share Purchase Right on each outstanding share of its common stock. The Rights are designed to assure that all stockholders receive fair and equal treatment in the event of any proposed takeover of the Company, to guard against partial tender offers, squeeze-outs, open market accumulations and other tactics that might be employed to gain control of the Company without paying all stockholders a control premium. The Rights will be exercisable if a person or group acquires 15% or more of the Company's common stock or announces a tender offer the consummation of which would result in ownership by a person or group of 15% or more of the Company's common stock.\nEach Right will entitle stockholders to buy one one-hundredth of a share of a new series of junior participating preferred stock at an exercise price of $15.00 upon certain events. If, after the Rights become exercisable, the Company is acquired in a merger or other business combination transaction, or sells 50% or more of its assets or earnings power, each Right will entitle its holder to purchase, at the Right's then-current price, a number of the acquiring company's common shares having a market value at the time of twice the Right's exercise price. In addition, if a person or group acquires 15% or more of the Company's outstanding common stock, each Right will entitle its holder (other than such person or members of such group) to purchase, at the Right's then-current exercise price, a number of the Company's common shares (or cash, other securities or property) having a market value of twice the Right's exercise price. At any time within ten days after a person or group has acquired beneficial ownership of 15% or more of the Company's common stock, the Rights are redeemable for one cent per Right at the option of the Board of Directors. The Rights are intended to enable all stockholders to realize the long-term value of their investment in the Company. The Rights will not prevent a takeover, but should encourage anyone seeking to acquire the Company to negotiate with the Board of Directors prior to attempting a takeover. The dividend distribution was made on May 2, 1995 payable to stockholders of record on that date. The Rights will expire on May 2, 2005.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe consolidated selected financial data presented below as of September 30, 1991, 1992, 1993, 1994 and 1995, and for each of the five-year period ended September 30, 1995, are derived from the consolidated financial statements of the Company. The consolidated financial statements as of September 30, 1994 and 1995, and for each of the years in the three-year period ended September 30, 1995, have been audited by Price Waterhouse LLP, independent accountants.\n(1) The Selected Financial Data for fiscal years ended September 30, 1991 through September 30, 1993 does not give effect to the sale of assets in the EEPROM Asset Sale on February 7, 1994, which constituted a significant portion of the Company's operations during these fiscal years. See the discussions under Notes 3 and 4 of Notes to Consolidated Financial Statements.\n(2) The Company recorded $7,431,000 in charges against operations in fiscal 1992 associated with closing its wafer fabrication facility.\n(3) The Company recorded $3,236,000 in charges against operations in fiscal 1993 reflecting an adjustment to its prior estimates in connection with closing its wafer fabrication facility and costs associated with the resignation the Company's previous president and chief executive officer.\n(4) The Company recorded $4,932,000 in charges against operations in fiscal 1994 representing a loss and other restructuring costs associated with the EEPROM Asset Sale and the discontinuation of the Company's end-user Ethernet adapter board products. See Notes 3 and 4 of Notes to Consolidated Financial Statements.\n(5) The Company recorded $399,000 as a benefit against operations in fiscal 1995 representing a change in the estimates of its restructuring reserves. See Note 4 of Notes to Consolidated Financial Statements.\n(6) The Company recorded a gain on the sale of stock in the amount of $1,693,000. See Note 3 of Notes to Consolidated Financial Statements.\nThe following table sets forth consolidated statements of operations data for each of the eight quarters beginning October 1, 1993 and ending September 30, 1995. This information has been derived from unaudited consolidated\nquarterly financial statements of the Company, which include all adjustments, consisting only of normal recurring adjustments, except for adjustments relating to certain restructuring and other expenses and gains on sales of stock, that the Company considers necessary for a fair presentation of the information when read in conjunction with the Consolidated Financial Statements and Notes thereto. The results of operations for any quarter are not necessarily indicative of the results to be expected for any future period.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nBACKGROUND\nThe Company was founded in 1981 to focus on the development and manufacture of electrically erasable programmable read only (\"EEPROM\") products and in 1982 began developing Ethernet data communication products. The Company recorded its first profitable year in fiscal 1987 and the growth continued in fiscal 1988 as both revenues and net income reached record levels. In addition, the Company's financial condition was strengthened when a public common stock offering was completed in May 1988. Fiscal 1989 results were adversely affected by weakening market conditions and production problems. In fiscal 1989, the Company adopted a strategy to have its products manufactured by outside foundries.\nDuring the second quarter of fiscal 1994, the Company sold its assets related to its EEPROM products (the \"EEPROM Asset Sale\") to Atmel Corporation (\"Atmel\"). Under the terms of the Asset Purchase Agreement dated February 7, 1994 between SEEQ and Atmel, Atmel acquired all rights in SEEQ's assets related to EEPROM products, including intellectual property, equipment, inventory and a portion of the accounts receivable. The purchase price for such assets consisted of 135,593 shares of Atmel's Common Stock and $481,632 in cash. In addition, Atmel assumed certain liabilities under equipment leases for equipment used in producing EEPROM products. Since this sale, the Company's business relates to data communication products.\nDuring the third quarter of fiscal 1994, SEEQ sold the 135,593 shares of Atmel Common Stock it received in the EEPROM Asset Sale for total proceeds of $6,693,000, reflecting a gain on the sale of $1,693,000. A significant portion of the proceeds from the stock sale was deposited in two escrow accounts subject to claims of indemnity by Atmel under the Asset Purchase Agreement. One escrow account, which contained $600,000, was subject to claims by Atmel with respect to the equipment, inventory and accounts receivable sold to Atmel in the EEPROM Asset Sale. Atmel asserted a claim for the full amount deposited in this escrow account. On January 30, 1995, the Company entered into an agreement with Atmel to settle Atmel's claim. Under the terms of the agreement, $250,000 was distributed to Atmel and the remaining $350,000 was distributed to the Company. All interest earned on the funds in such escrow account was distributed proportionately between SEEQ and Atmel. As a result, the Company recorded a $195,000 charge. In addition, the Company sold EEPROM inventory returned from distributors for approximately $82,000. The second escrow account, which initially contained $4,329,000 (recorded as other assets), is subject to any future claims that may be made by Atmel with respect to the EEPROM technology sold to Atmel in the EEPROM Asset Sale. During the first quarter of fiscal 1995, $300,000 was distributed to SEEQ from the escrow account, leaving $4,029,000 on deposit therein as of September 30, 1995 (excluding interest earned to date of $269,000). Atmel has notified SEEQ that, based on certain claims asserted by HMC, one of SEEQ's foundries and joint development partners, that SEEQ previously granted HMC certain license rights to the EEPROM technology, Atmel believes it may be entitled to assert a claim against this escrow account, although, Atmel has not done so to date. The funds in this escrow account will remain in escrow until February 1999, or until a determination is made that SEEQ is entitled to such funds under any release condition in the escrow agreement, or if Atmel makes a claim prior to February 1999 under such escrow, then until such claim is resolved by a court.\nIn connection with the EEPROM Asset Sale, Atmel acquired 3,614,701 shares of SEEQ's Common Stock pursuant to the Stock Purchase Agreement dated February 7, 1994, representing approximately 14% of SEEQ's outstanding shares of Common Stock as of such date. Such shares were purchased at a price of $1.25 per share, for a total purchase price of $4,518,376. The Company filed a registration statement for these shares that became effective with the Securities and Exchange Commission on March 24, 1995.\nIn connection with the EEPROM Asset Sale and the Company's decision in fiscal 1994 to discontinue its end-user Ethernet adapter board product line, the Company adopted a restructuring plan pursuant to which, among other things, certain business operations were discontinued, certain facilities were eliminated and certain employees were terminated.\nThe following table summarizes the activity under this restructuring plan for the year ended September 30, 1995 (in thousands):\nFACILITY LEASE, INVENTORY AND OTHER EQUIPMENT COSTS\nThe reversal in fiscal 1994 reflects an adjustment to a reserve recorded in prior fiscal years by the Company to cover estimated costs in connection with the termination of the Company's prior facility lease. During the second quarter of fiscal 1995, the Company entered into a final settlement of a lawsuit previously filed against the Company by GOCO Realty Fund I for rent and damages under a lease of certain premises previously occupied by the Company which the Company vacated in July 1992. The claims asserted in this lawsuit were subsequently assigned to Brazos Partners L.P. (\"Brazos\"). The terms of the settlement provided for the payment by the Company to Brazos of $37,500, the issuance by the Company to Brazos of 375,000 shares of its common stock, and the assignment by the Company of a $360,000 promissory note and the $75,000 security deposit on such premises which were both due to the Company. As a result of the settlement, all actions and related claims against the Company in this action and other related actions have been dismissed. In connection with the action and the proposed settlement thereof, the Company had previously recorded certain reserves covering, among other things, the proposed issuance of the shares of common stock. The market price of the Company's common stock increased during the second quarter of fiscal 1995, and, as a result, the Company recorded additional reserves of $122,000 to reflect the higher market price of the common stock at the time of the final settlement of the lawsuit. Upon settlement of this lawsuit, the restructuring reserves totaling approximately $637,000 were utilized, of which $37,500 represented the cash portion paid in the settlement. During fiscal 1995, the Company also sold equipment that had been fully reserved and settled certain associated lease obligations, resulting in a $133,000 reduction in the restructuring reserves.\nEEPROM ASSET SALE RESTRUCTURING\nIn connection with the EEPROM Asset Sale, the Company incurred certain restructuring costs or realized certain benefits during fiscal 1994 and 1995 as follows:\nEEPROM Asset Sale. On January 30, 1995 the Company and Atmel entered into a settlement agreement to settle Atmel's claims made against the $600,000 escrow previously established. Under the settlement agreement, $250,000 was distributed to Atmel and the remaining $350,000 was distributed to the Company. As a result, the Company recorded a $195,000 charge.\nExcess facilities. The Company determined that its current headquarters' office and manufacturing space was substantially in excess of the space necessary to operate the Company's continued business. Since the Company occupied these facilities under a lease with a remaining term of approximately eight years, the Company decided to sublease its facilities for the remaining term of the lease. In fiscal 1994, the Company recorded reserves representing the Company's estimate of the difference between the rent payable by the Company under the lease and the anticipated rent payable to the Company under a sublease. During the first quarter of fiscal 1995, the Company sublet the entire facility in which its headquarters and operations were located at a higher rental rate than previously estimated, and as a result in 1995, recorded an $818,000 reduction to its restructuring reserves. The Company also recorded $915,000 of facility lease payments, broker fees and relocation costs in connection with the sublease.\nSeverance. The Company substantially reduced its workforce as a result of the termination of 78 employees in the quarter ended March 31, 1994.\nDiscontinued Inventories. As a result of the EEPROM Asset Sale, the Company discontinued certain inventories; in fiscal 1995 the Company paid $99,000 to foundries for inventories.\nExcess property and leasehold improvements. In fiscal 1994 the Company wrote off fixtures and other property and leasehold improvements related to the assets sold that were no longer usable in the Company's continuing operations.\nOther costs. In fiscal 1994, the Company recorded other costs, including property tax obligations, obsolete computer systems and legal fees. In the fourth quarter of fiscal 1995, the Company settled its lawsuit against HMC Microelectronics Company (see Note 11 Litigation). For the fiscal year ended September 30, 1995, the Company recorded other costs of approximately $338,000, primarily reflecting legal fees and settlement costs in connection with the agreement with HMC. The Company paid $435,000 for settlement costs, outside foundries for memory product process development and lease payments for certain equipment related to EEPROM products.\nEND-USER ETHERNET ADAPTER BOARD PRODUCTS WRITE-OFF\nDuring the quarter ended March 31, 1994, the Company discontinued its end-user Ethernet adapter boards product line, and recorded restructuring costs as follows:\nDiscontinued inventories. The Company wrote off Ethernet adapter board product inventories that the Company discontinued.\nOther costs. In Fiscal 1994, the Company recorded other costs, including severance costs, component supplier termination charges and excess property and leasehold improvement write-offs. During fiscal 1995, the Company recorded as other costs a reserve of $39,000 reflecting the settlement of certain litigation relating to end-user Ethernet adapter board products. Offsetting this charge, the Company recorded a benefit of $91,000 from the collection of previously written-off accounts receivable and the reversal of excess warranty reserves.\nANNUAL RESULTS OF OPERATIONS\nFISCAL 1995 COMPARED TO FISCAL 1994\nThe Company's revenues in fiscal 1995 were $22,512,000, an increase of 5% from $21,480,000 in fiscal 1994. Since the EEPROM Asset Sale on February 7, 1994, the Company has derived its sales exclusively from the sale of data communication products. Consequently, there were no EEPROM sales for fiscal 1995 compared to EEPROM sales of $3,036,000 in fiscal 1994. Local area network (\"LAN\") integrated circuit product sales increased $4,315,000, or 30%, to $18,573,000 in fiscal 1995 as compared to fiscal 1994 due to a 65.1% increase in unit sales volumes, partially offset by a 21.4% decrease in average selling prices as a result of normal price erosion for certain mature products and a change in product mix. In fiscal 1995, the Company was notified by Apple Computer (\"Apple\") that the Company would receive no additional orders for the media attachment units (MAUs) that the Company had been manufacturing for Apple, following the second quarter of fiscal 1995. As a result, subsystem product sales decreased by $247,000, or 5.9% in fiscal 1995 as compared to fiscal 1994. The Company is actively marketing its LAN integrated circuits to Apple Computer for MAUs and other data communication products. During the fourth quarter of fiscal 1995, the Company began phasing-out one of its primary foundry suppliers. As a result, the Company experienced shortfalls in wafer deliveries and yields, which impacted fourth quarter revenues.\nGross margins increased to 34.4% compared to 27.2% in fiscal 1994. The increase in gross margin percentage in fiscal 1995 was largely the result of the discontinuance of EEPROM product sales in fiscal 1994, and the Company's emphasis on marketing its higher margin LAN integrated circuit products. During the fourth quarter of fiscal 1995, gross margin percentages were impacted on certain products for which the Company experienced shortfalls in wafer production from one of its foundries. Gross margins in future periods will be affected primarily by sales levels and product mix, average selling prices, wafer yields, the introduction of new products and improvements in manufacturing costs.\nResearch and development expenditures decreased from $3,278,000 in fiscal 1994 to $3,069,000 in fiscal 1995. As a percentage of sales, research and development expenditures decreased from 15.3% in fiscal 1994 to 13.6% in fiscal 1995 primarily as a result of increased revenues, termination of personnel, the elimination of engineering subcontracting and equipment expenses associated with EEPROM products from the EEPROM Asset Sale. The Company expects that the level of research and development spending will increase in absolute dollars in future periods as a result of increased development efforts on new LAN products and manufacturing cost reduction programs on existing products, but may vary as a percentage of sales.\nMarketing, general and administrative expenses decreased from $6,939,000 in fiscal 1994 to $3,827,000 in fiscal 1995, and decreased as a percentage of sales from 32.3% to 17.0% for the same periods, respectively. These decreases were attributable primarily to a decrease in payroll and selling and administrative expenses after the Company substantially reduced its workforce and terminated operations of sales offices no longer needed after the EEPROM Asset Sale. The Company anticipates that the level of marketing, general and administrative expenses will vary in future periods based on expected sales growth.\nInterest expense has resulted primarily from borrowings under the Company's credit facility and from equipment leases. Interest expense decreased slightly from $456,000 in fiscal 1994 to $431,000 in fiscal 1995 due to a decrease in equipment lease line financing as a result of terminated leases associated with EEPROM equipment sold after the EEPROM Asset Sale.\nInterest income increased from $187,000 in fiscal 1994 to $518,000 in fiscal 1995 due to an increase in interest earned on higher cash balances, due primarily to stock and warrant exercises and restricted cash and cash held in escrow invested in short-term investment instruments.\nDuring the third quarter of fiscal 1994, the Company sold 135,593 shares of common stock in Atmel Corporation it received in the EEPROM Asset Sale for total proceeds of $6,693,000, reflecting a gain on the sale of $1,693,000.\nFISCAL 1994 COMPARED TO FISCAL 1993\nThe Company's revenues in fiscal 1994 were $21,480,000, a reduction of 35% from $32,980,000 in fiscal 1993. This reduction primarily reflects the failure by one of its foundries to deliver to the Company sufficient quantities of wafers having acceptable yields and quality for EEPROM products during the first and second quarters of fiscal 1994 and the effect of the EEPROM Asset Sale on February 7, 1994, which resulted in a decrease in EEPROM product sales from $16,494,000 in fiscal 1993 to $3,036,000 in fiscal 1994. Local area network (\"LAN\") integrated circuit product sales increased $285,000, or 2.0%, to $14,258,000 in fiscal 1994 compared to fiscal 1993 due to a 21.3% increase in unit sales volumes, partially offset by a 15.6% decrease in average selling prices. LAN subsystem product sales increased $1,673,000, or 66.6%, to $4,186,000 in fiscal 1994 compared to fiscal 1993. The increase in LAN subsystem product sales in fiscal 1994 was primarily due to shipments of media attachment units (MAUs) to Apple Computer which began in March 1994. The increase in revenues attributable to sales of MAUs to Apple Computer was partially offset by a decrease in sales of Ethernet adapter board products as a result of the discontinuance of the Company's Ethernet adapter board product line in the second quarter of fiscal 1994. Sales of MAUs to Apple Computer represented 17.8% of the Company's revenues in fiscal 1994.\nGross margins decreased to 27.2% in fiscal 1994 compared to 33.9% in fiscal 1993. The decrease in gross margin percentage in fiscal 1994 was largely attributable to the loss of certain economies of scale as a result of lower production volumes for EEPROM products in the first and second quarters of fiscal 1994, primarily as a result of the low levels of supply and poor product cost. As a result of the EEPROM Asset Sale, the Company substantially reduced its workforce, reduced its facility requirements and eliminated its lower margin products.\nResearch and development expenditures for fiscal 1994 were $3,278,000 and were essentially unchanged compared to fiscal 1993 expenditures of $3,289,000. Lower payroll costs as a result of the termination of personnel associated with EEPROM products research and development during the second quarter of fiscal 1994 were offset by increased engineering materials, contracting and equipment expenses associated with the development of the Company's next generation of LAN integrated circuits. Research and development expenditures were 15.3% of revenues in fiscal 1994 compared to 10.0% of revenues in fiscal 1993, primarily reflecting the lower sales levels as a result of the EEPROM Asset Sale.\nMarketing, general and administrative expenses for fiscal 1994 decreased $888,000, or 11.3%, to $6,939,000 as compared to fiscal 1993. This decrease was attributable primarily to a decrease in payroll, reduction in marketing and selling commissions, product advertising and administrative expenses after the Company reduced its workforce and terminated operations of sales offices no longer needed after the EEPROM Asset Sale. These year-to-year expense reductions were partially offset by increases in litigation expenses, payments made to certain executive officers of the Company under the special loan forgiveness program, and reserves for future payments and associated costs under the officer loan forgiveness program covering the full amount of the notes to be forgiven. As a percentage of revenues, marketing, general and administrative expenses were 32.3% in fiscal 1994 compared to 23.7% in fiscal 1993, primarily reflecting lower sales levels of EEPROM products as a result of the EEPROM Asset Sale.\nInterest expense resulted primarily from borrowings under the Company's credit facility and from equipment leases. Interest expense in fiscal 1994 decreased $600,000 to $456,000 as compared to fiscal 1993 as a result of a reduction in lease payments, primarily attributable to the assignment of certain lease obligations to Atmel in the EEPROM Asset Sale.\nFACTORS AFFECTING FUTURE RESULTS\nThe semiconductor industry is highly cyclical. The industry is characterized by rapid technological change, fluctuations in end-user demand and price erosion. Accordingly, a particular company's operating results may be affected not only by industry-wide demand, but also by timely introduction of new products, market acceptance of competitive products, price competition and the distribution channels for its products. The Company's future operating results may also fluctuate as a result of other Company specific factors, such as price competition for mature products, growth of the Ethernet LAN segment of the electronics market and acceptance of the Company's newly introduced\nproducts for that market segment, access to production capacity at outside foundries, variations in manufacturing yields for its products and significant expenditures for new products and process development, and dependence on certain customer product shipment demands. With specific reference to customer product shipment demands, the Company was notified in fiscal 1995 by Apple Computer that the Company would receive no additional orders for the media attachment units (MAUs) that the Company had been manufacturing for Apple, following the second quarter of fiscal 1995. MAU product shipments represented 17% of the Company's revenues in fiscal 1995. Although the Company believes that it will be able to replace such sales with additional sales of the Company's existing and new products, there can be no assurance that the Company will be successful in doing so. Due to the foregoing and other factors, past results may not be indicative of future results.\nIn addition, the securities of many high-technology companies have historically been subject to extreme price and volume fluctuations. The Company may be subject to these same fluctuations which may adversely affect the market price of the common stock.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company has financed its operations and met its capital requirements through cash raised from operations, private and public placements of equity and debt securities, capital leases and bank lines of credit.\nManagement believes that existing sources of liquidity, anticipated cash flow from operations and borrowings under the Company's credit facility, will be adequate to satisfy its projected working capital expenditures through the end of fiscal 1996. However, there can be no assurance that the Company will have adequate resources to satisfy such requirements. It may become necessary for the Company to raise additional funds from debt and\/or equity financing. There can be no assurance that such funds will be available on terms acceptable to the Company, if at all.\nThe Company's cash and cash equivalents balance increased from $2,253,000 as of September 30, 1994 to $3,682,000 as of September 30, 1995, primarily as a result of proceeds from the issuance of common stock pursuant to the exercise of stock options and warrants, and the funds provided by the settlement with Atmel for claims made against an escrow account previously established in connection with the EEPROM Asset Sale. This increase was partially offset by the payment of one-time restructuring obligations, including real estate commissions incurred in the sublease of its previous headquarters building in Fremont, California, by paying for tenant improvements in its newly subleased headquarters building, by purchasing inventory in anticipation of higher levels of shipments, by an increase in accounts receivable and decrease in accounts payable.\nOperating Activities\nCash flows used for operating activities in fiscal 1995 were $1,854,000 compared to $1,923,000 in fiscal 1994. The decrease in cash flows used by operating activities in fiscal 1995 compared to fiscal 1994 was due primarily to the net profit in fiscal 1995 of $931,000 before a benefit credited against operating expenses of $399,000 representing a change in the estimates of its restructuring reserve associated with the assets sold in the EEPROM Asset Sale, compared to a net loss in fiscal 1994 of $4,638,000 before provisions for restructuring of $4,932,000 and before the effect of the gain on sales of stock of $1,693,000. Partially offsetting these favorable operating activities, other accrued liabilities decreased by $1,421,000 due primarily to payments against the restructuring costs related to the EEPROM Asset Sale. Also, the Company reduced accounts payable by $1,247,000.\nInvesting Activities\nCash flows used for investing activities in fiscal 1995 were $805,000, reflecting cash invested in property and equipment acquisitions of $851,000, partially offset by $46,000 of proceeds attributable to the disposal of equipment. Cash flows used for investing activities in fiscal 1994 were $3,296,000, reflecting cash invested in property and equipment acquisition of $394,000, partially offset by cash provided by proceeds on disposal of equipment of $98,000.\nDuring fiscal 1994, the Company used cash resources to reduce its effective short-term borrowings interest rate by borrowing the minimum required borrowings of $3,000,000 under a secured bank line of credit with CIT Group\/Credit Finance, Inc. (\"CIT\"), and investing the proceeds in a short-term certificate of deposits. The Company anticipates an increase in capital expenditures in future periods associated with test operations and research and development activities.\nFinancing Activities\nCash flows provided by financing activities in fiscal 1995 were $4,088,000. During fiscal 1995, the Company received $4,486,000 in proceeds from the issuance of its common stock, primarily from warrant and stock option exercises, partially offset by payments on capital lease obligations of $398,000. Cash flows provided by financing activities in fiscal 1994 were $6,698,000. During fiscal 1994, the Company received $4,917,000 in proceeds from the issuance and sale of its common stock to Atmel. Cash flows used to pay capital lease obligations in fiscal 1994 were $1,219,000, primarily as a result of the EEPROM Asset Sale, in which the Company terminated its equipment leases associated with equipment transferred to Atmel.\nIn November 1993, the Company entered into a two-year line of credit agreement, subject to renewal, with the CIT Group (\"CIT\"). Although the Company was not required to make use of the bank line of credit, during the second quarter of fiscal 1994 it used cash resources to reduce its effective short-term credit borrowings interest rate by borrowing the minimum required borrowings of $3,000,000 under a secured bank line of credit with CIT, and investing the proceeds in a short-term certificate of deposit. The revolving credit facility is secured by the assets of the Company, and requires the Company to maintain certain restrictive and financial covenants, including covenants requiring the Company to maintain working capital of $750,000 and a net worth of $3,000,000, and prohibiting the Company from incurring or agreeing to incur capital expenditures of in excess of $1,200,000 in any fiscal year. The Company is currently in compliance with such covenants. Interest on borrowings is payable at the lender's reference prime rate plus 2.25% per annum, with a minimum quarterly interest charge based on average borrowings of $3,000,000, and is payable monthly. Effective November 22, 1995, the Company renewed the credit facility with CIT for a two year term, subject to renewal thereafter. Under the terms of the new credit agreement, the minimum borrowing requirement has been reduced to $1,500,000 and is only applicable in the event the Company has a loan balance outstanding with CIT. Further, the credit agreement does not contain any restrictive or financial covenants. Interest on borrowings is payable at the lender's reference prime rate plus 2.0% per annum and is payable monthly.\nIMPACT OF CURRENCY AND INFLATION\nThe Company purchases its materials and services in U.S. dollars, and its foreign sales are primarily billed in U.S. dollars. Accordingly, the Company has not been subject to substantial currency exchange fluctuations. However, there can be no guarantee that this trend will continue. The effect of inflation on SEEQ's financial results have not been significant to date.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nSchedules not listed above have been omitted because they are not applicable or are not required or the information required to be set forth therein is included in the Financial Statements or notes thereto.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTO THE STOCKHOLDERS AND BOARD OF DIRECTORS OF SEEQ TECHNOLOGY INCORPORATED\nIn our opinion, the financial statements listed in the accompanying index present fairly, in all material respects, the financial position of SEEQ Technology Incorporated and its subsidiary at September 30, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended September 30, 1995, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.\nPRICE WATERHOUSE LLP\nSan Jose, California October 20, 1995, except for Note 12, which is as of December 14, 1995\nCONSOLIDATED BALANCE SHEETS\nSee accompanying notes to consolidated financial statements\nCONSOLIDATED STATEMENTS OF OPERATIONS\nSee accompanying notes to consolidated financial statements\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY - -------------------------------------------------------------------------------- Years ended September 30, 1995,1994 and 1993\nSee accompanying notes to consolidated financial statements\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nSee accompanying notes to consolidated financial statements\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1. THE COMPANY\nSEEQ Technology Incorporated (the \"Company\"), incorporated in Delaware, was formed on January 13, 1981 to engage in the development, production and sale of state-of-the-art, high technology semiconductor devices.\nFor purposes of presentation, the Company has indicated its fiscal year as ending on September 30; whereas, in fact, the Company operates on a 52\/53-week fiscal year ending on the last Sunday in September of each year. Fiscal 1993, 1994, and 1995 are 52-week years. Two customers accounted for approximately 17% and 16% of the Company's revenues in fiscal 1995 and two customers accounted for approximately 16% and 11% of revenues in fiscal 1994. No one customer accounted for 10% or more of revenues in fiscal 1993. Sales to foreign customers in fiscal years 1995, 1994 and 1993 represented 38%, 33% and 19%, respectively, of revenues during such years. During fiscal years 1995, 1994 and 1993, approximately $2.3 million, $3.4 million, $3.3 million respectively, represented sales to customers in Europe, and $6.2 million, $3.6 million, $2.9 million respectively, represented sales to customers in the Asian\/Pacific Rim region. Sales to other geographical regions during such years were not material.\nNOTE 2. SIGNIFICANT ACCOUNTING POLICIES\nBASIS OF PRESENTATION. The consolidated financial statements include the accounts of SEEQ Technology incorporated and its wholly owned subsidiary. Upon consolidation, all significant intercompany accounts and transactions are eliminated.\nINVENTORIES. Inventories are stated at the lower of cost or market. Cost is determined on a first-in, first-out basis.\nInventories consist of the following:\nPROPERTY AND EQUIPMENT. Property and equipment are stated at cost. Depreciation is computed using the straight-line method over the estimated useful lives of assets, generally five years. Depreciation of leasehold improvements is computed using the shorter of the remaining term of the leases or the estimated useful lives of the improvements. Depreciation for federal tax purposes is computed using accelerated methods.\nLICENSE AND ROYALTY INCOME RECOGNITION. Income resulting from the licensing of the Company's products to other manufacturers is recognized when the related contractual obligations are fulfilled and the related fees are billable. Royalty income is recognized upon the reported sale of products subject to royalties. License revenues and royalty income during fiscal years 1995, 1994 and 1993 were not material.\nSALES TO DISTRIBUTORS. The Company sells to certain domestic distributors under agreements allowing certain rights of return and price protection on unsold merchandise. Such sales are not recognized for financial reporting purposes until the merchandise is sold by the distributor, as reported by the distributor for its fiscal month end closest to that of the Company. Upon shipment of semiconductor devices by the Company, amounts billed to domestic distributors by the Company are included as accounts receivable; inventory is relieved; and the sale and estimated gross profit are deferred until all the conditions of sale are met. Semiconductor revenue from sales to international distributors is recognized at the time of shipment. The amount of inventory maintained at international distributors that is subject to returns and allowances is not material.\nCASH EQUIVALENTS AND SHORT-TERM INVESTMENTS. The Company considers all highly liquid investment instruments with a maturity of three months or less at the time of the purchase to be cash equivalents. Effective October 1, 1994, the Company adopted Statement of Financial Accounting Standards No. 115 \"Accounting for Certain Investments in Debt and Equity Securities\" (FAS 115). FAS 115 requires that, at acquisition, an enterprise shall classify debt and equity securities into one of three categories: held-to-maturity, available-\nfor-sale, or trading. The Company determined that certain investments in high grade commercial paper included in cash and cash equivalents and the escrow account relating to the EEPROM technology sold to Atmel in the EEPROM Asset Sale are available-for-sale and as such, any unrealized holding gains or losses will be excluded from earnings and reported net of the income tax effect in a separate component of stockholders' equity. Adoption of FAS 115 did not have a material effect on the Company's consolidated financial statements.\nINCOME TAXES. Deferred tax assets and liabilities are recognized for the expected tax consequences of temporary differences between the tax bases of assets and liabilities and the amounts reported for financial reporting purposes for all periods presented (See Note 9. Income Taxes).\nBONUS PLANS. The Company's employees earn bonuses for services rendered based upon the level of profitability achieved by the Company and the attainment of certain performance standards by the employee. Approximately $5,000, $20,000 and $150,000 in bonuses were earned and paid in fiscal 1995, 1994 and 1993, respectively.\nCONCENTRATION OF CREDIT RISK. Financial instruments which potentially subject the Company to concentration of credit risk consist of cash equivalents and accounts receivable. The Company invests primarily in money market accounts and high grade commercial paper.\nThe Company's accounts receivable are derived primarily from sales to customers located primarily in the U.S., Europe and the Asia\/Pacific Rim. The Company performs ongoing credit evaluations of its customers and generally does not require collateral.\nAt September 30, 1995, outstanding receivables from four customers accounted for 17%, 14%, 8% and 5% of the Company's accounts receivable. At September 30, 1994, outstanding receivables from four customers accounted for 21%, 11%, 7% and 6% of the Company's accounts receivable.\nNET INCOME (LOSS) PER SHARE. Primary and fully diluted net income per share for fiscal 1995 was determined using the treasury stock method. Primary income per share of common and common equivalent share is computed using the weighted average number of shares outstanding during the period, including dilutive stock options and warrants. Fully diluted income per common and common equivalent share reflects additional dilution related to stock options and warrants due to the use of the market price at the end of the period, when higher than the average price for the period.\nNet loss per share for fiscal 1994 and 1993 were computed using the weighted average number of common shares outstanding during the period. Common stock equivalents are not included because the effect is antidilutive.\nNOTE 3. SALE OF EEPROM ASSETS AND SEEQ COMMON STOCK TO ATMEL.\nPursuant to the Asset Purchase Agreement dated February 7, 1994 (the \"Asset Purchase Agreement\"), by and between SEEQ and Atmel Corporation (\"Atmel\"), Atmel purchased the assets of SEEQ related to its electrically erasable programmable read only memory (\"EEPROM\") products (the \"EEPROM Asset Sale\"). Under the terms of the Asset Purchase Agreement, Atmel acquired all of SEEQ's rights in assets related to SEEQ's EEPROM products, including intellectual property, equipment, inventory and a portion of the accounts receivable. The purchase price for such assets consisted of 135,593 shares of Atmel's common stock and $481,632 in cash. In addition, Atmel assumed certain liabilities under equipment leases for equipment used in producing EEPROM products.\nDuring the third quarter of fiscal 1994, SEEQ sold the 135,593 shares of Atmel common stock it received in the EEPROM Asset Sale for total proceeds of $6,693,000, reflecting a gain on the sale of $1,693,000. A significant portion of the proceeds from the stock sale was deposited in two escrow accounts subject to claims of indemnity by Atmel under the Asset Purchase Agreement. One escrow account, which contained $600,000 (recorded as other current assets at September 30, 1994), was subject to claims by Atmel with respect to the equipment, inventory and accounts receivable sold to Atmel in the EEPROM Asset Sale. Atmel asserted a claim for the full amount deposited in this escrow account. On January 30, 1995 the Company entered into an agreement with Atmel to settle Atmel's claim. Under the terms of this agreement, $250,000 was distributed to Atmel and the remaining $350,000 was distributed to the Company. All interest earned on the funds in such escrow account was distributed proportionately between SEEQ and Atmel. The second escrow account, which originally contained $4,329,000 (recorded as other assets), is subject to any future claims that may be made by Atmel with respect to the EEPROM technology sold to Atmel in the EEPROM Asset Sale. During the first quarter of fiscal 1995, $300,000 was\ndistributed to SEEQ from the second escrow account, leaving $4,298,000 on deposit therein as of September 30, 1995 (including interest earned to date of $269,000). Atmel has notified SEEQ that, based on certain claims asserted by Hualon Microelectronics Corporation (\"HMC\"), one of SEEQ's foundries and joint development partners, that SEEQ previously granted HMC certain license rights to the EEPROM technology, Atmel believes it may be entitled to assert a claim against this escrow account, although Atmel has not done so to date. The funds in this escrow account will remain in escrow until February 1999, or until a determination is made that SEEQ is entitled to such funds under any release condition in the escrow agreement, or if Atmel makes a claim prior to February 1999 under such escrow, then until such claim is resolved by a court.\nIn connection the EEPROM Asset Sale, Atmel acquired 3,614,701 shares of SEEQ's Common Stock pursuant to the Stock Purchase Agreement dated February 7, 1994, representing approximately 14% of SEEQ's outstanding shares of Common Stock as of such date. Such shares were purchased at a price of $1.25 per share, for a total purchase price of $4,518,376. The Company filed a registration statement for these shares that became effective with the Securities and Exchange Commission on March 24, 1995.\nThe following unaudited pro forma information reflects the results of operations for the years ended September 30, 1994 and 1993 as if the EEPROM Asset Sale had occurred as of October 1, 1992 after giving effect to certain adjustments, including reversal of the revenue and related costs of sales attributable to EEPROM products, reduction in research and development and marketing expenses associated with the development and marketing of EEPROM products and reduction in interest expense associated with leased equipment used in manufacturing EEPROM products. The pro forma information excludes the effect of the restructuring charges which were recorded in fiscal 1994, as a consequence of the sale of assets in the EEPROM Asset Sale, and the effect of the gain of sales of stock which was recorded in fiscal 1994. The average number of shares outstanding in fiscal 1994 and 1993 have been adjusted to reflect the effect of issuing shares of SEEQ's common stock to Atmel pursuant to the purchase agreement as if they had been outstanding for the entire periods. The pro forma results have been prepared for comparative purposes only and do not purport to be indicative of what operating results would have been had the acquisition taken place at October 1, 1992 or of operating results which may occur in the future.\nNOTE 4. RESTRUCTURINGS.\nIn connection with the closure of its manufacturing facility in fiscal 1992, the Company recorded an additional $2,449,000 restructuring charge in fiscal 1993. This charge was as a result of unsuccessful attempts by the Company to sell certain remaining fabrication equipment and a provision was made to write-off certain Company manufactured inventory which became non-saleable as a result of qualified products from the Company's foundry partners being produced. Additional reserves were also recorded due to certain pending litigation.\nIn connection with the EEPROM Asset Sale (SEE NOTE 3. SALE OF EEPROM ASSETS AND SEEQ COMMON STOCK TO ATMEL) and the Company's decision in fiscal 1994 to discontinue its end-user Ethernet adapter board product line, the Company adopted a restructuring plan, pursuant to which , among other things, certain business operations were discontinued, certain facilities were eliminated and certain employees were terminated. The restructuring reserves are included as part of other accrued liabilities and long term liabilities.\nThe following table summarizes the restructuring activity in fiscal 1994 and 1995 (in thousands):\nFACILITY LEASE, INVENTORY AND OTHER EQUIPMENT COSTS\nThe reversal in fiscal 1994 reflects an adjustment to a reserve recorded in prior fiscal years by the Company to cover estimated costs in connection with the termination of the Company's prior facility lease. During the second quarter of fiscal 1995, the Company entered into a final settlement of a lawsuit previously filed against the Company by GOCO Realty Fund I for rent and damages under a lease of certain premises previously occupied by the Company which the Company vacated in July 1992. The claims asserted in this lawsuit were subsequently assigned to Brazos Partners L.P. (\"Brazos\"). The terms of the settlement provided for the payment by the Company to Brazos of $37,500, the issuance by the Company to Brazos of 375,000 shares of its common stock, and the assignment by the Company of a $360,000 promissory note and the $75,000 security deposit on such premises which were both due to the Company. As a result of the settlement, all actions and related claims against the Company in this action and other related actions have been dismissed. In connection with the action and the proposed settlement thereof, the Company had previously recorded certain reserves covering, among other things, the proposed issuance of the shares of common stock. The market price of the Company's common stock increased during the second quarter of fiscal 1995, and, as a result, the Company recorded additional reserves of $122,000 to reflect the higher market price of the common stock at the time of the final settlement of the lawsuit. Upon settlement of this lawsuit, the restructuring reserves totaling approximately $637,000 were utilized, of which $37,500 represented the cash portion paid in the settlement. During fiscal 1995, the Company also sold equipment that had been fully reserved and settled certain associated lease obligations, resulting in a $133,000 reduction in the restructuring reserves.\nEEPROM ASSET SALE RESTRUCTURING\nIn connection with the EEPROM Asset Sale, the Company incurred certain restructuring costs or realized certain benefits during fiscal 1994 and 1995 as follows:\nEEPROM Asset Sale. On January 30, 1995 the Company and Atmel entered into a settlement agreement to settle Atmel's claims made against the $600,000 escrow previously established. Under the settlement agreement, $250,000 was distributed to Atmel and the remaining $350,000 was distributed to the Company. As a result, the Company recorded a $195,000 charge.\nExcess facilities. The Company determined that its current headquarters' office and manufacturing space was substantially in excess of the space necessary to operate the Company's continued business. Since the Company occupied these facilities under a lease with a remaining term of approximately eight years, the Company decided to sublease its facilities for the remaining term of the lease. In fiscal 1994, the Company recorded reserves representing the Company's estimate of the difference between the rent payable by the Company under the lease and the anticipated rent payable to the Company under a sublease. During the first quarter of fiscal 1995, the Company sublet the entire facility in which its headquarters and operations were located at a higher rental rate than previously estimated, and as a result in 1995, recorded an $818,000 reduction to its restructuring reserves. The Company also recorded $915,000 of facility lease payments, broker fees and relocation costs in connection with the sublease.\nSeverance. The Company substantially reduced its workforce as a result of the termination of 78 employees in the quarter ended March 31, 1994.\nDiscontinued Inventories. As a result of the EEPROM Asset Sale, the Company discontinued certain inventories; in fiscal 1995 the Company paid $99,000 to foundries for inventories.\nExcess property and leasehold improvements. In fiscal 1994 the Company wrote off fixtures and other property and leasehold improvements related to the assets sold that were no longer usable in the Company's continuing operations.\nOther costs. In fiscal 1994, the Company recorded other costs, including property tax obligations, obsolete computer systems and legal fees. In the fourth quarter of fiscal 1995, the Company settled its lawsuit against HMC Microelectronics Company (see Note 11 Litigation). For the fiscal year ended September 30, 1995, the Company recorded other costs of approximately $338,000, primarily reflecting legal fees and settlement costs in connection with the agreement with HMC. The Company paid $435,000 for settlement costs, outside foundries for memory product process development and lease payments for certain equipment related to EEPROM products.\nEND-USER ETHERNET ADAPTER BOARD PRODUCTS WRITE-OFF\nDuring the quarter ended March 31, 1994, the Company discontinued its end-user Ethernet adapter boards product line, and recorded restructuring costs as follows:\nDiscontinued inventories. The Company wrote off Ethernet adapter board product inventories that the Company discontinued.\nOther costs. In Fiscal 1994, the Company recorded other costs, including severance costs, component supplier termination charges and excess property and leasehold improvement write-offs. During fiscal 1995, the Company recorded as other costs a reserve of $39,000 reflecting the settlement of certain litigation relating to end-user Ethernet adapter board products. Offsetting this charge, the Company recorded a benefit of $91,000 from the collection of previously written-off accounts receivable and the reversal of excess warranty reserves.\nNOTE 5. STOCKHOLDERS' EQUITY\nWARRANTS. In fiscal 1991, as a partial consideration for a bank credit agreement, the Company issued a warrant exercisable for five years to purchase 150,000 shares of the Company's common stock at $1.56 per share; this warrant was exercised during fiscal 1995. In fiscal 1992, as consideration to extend the credit agreement for an additional year, the Company issued a warrant exercisable through August 1, 1995 to purchase 100,000 shares of the Company's common stock at $3.13 per share; this warrant was not exercised and therefore\nexpired in fiscal 1995. In fiscal 1992, in conjunction with the private placement of 700,000 shares of common stock, warrants to purchase a like number of shares were issued, exercisable for three years, to purchase shares of the Company's common stock at $2.75 per share. In addition, the placement agent was granted the right to purchase 70,000 shares of common stock at $2.00 per share together with a warrant to purchase an additional 70,000 shares of common stock at $2.75 per share. The warrants issued in conjunction with the private placement were repriced in fiscal 1993 to purchase the Company's common stock at $0.85 per share. During fiscal 1993 and 1994, 232,500 and 310,500 of these warrants were exercised, respectively. None of these warrants were exercised during fiscal 1995 and the remaining 227,000 warrants expired. In fiscal 1993, in conjunction with a foreign equity offering, warrants were issued to purchase 120,385 shares of common stock at $1.25 per share. During fiscal 1995, 84,270 of these warrants were exercised, leaving 36,115 warrants outstanding which expire on April 27, 1996. In the third quarter of fiscal 1993, as part of a public offering of 4.6 million shares of the Company's common stock, warrants to purchase an additional 2.3 million shares at $1.40 per share were issued. In addition, the selling agent was granted warrants to purchase 460,000 shares of common stock at $1.06 per share. During fiscal 1995, all of the 2.3 million warrants at $1.40 per share were exercised and 360,000 of the $1.06 per share warrants were exercised, leaving 100,000 of these warrants outstanding which expired on July 31, 1995. The value of these warrants was immaterial at the date of issuance for fiscal years 1993, 1992 and 1991.\nCONVERTIBLE PREFERRED STOCK. At September 30, 1995, 1,000,000 shares of preferred stock are authorized for issuance with no shares outstanding. Attributes of the preferred stock such as dividend rates, voting rights, and liquidation preferences, are subject to determination by the Company's Board of Directors upon issuance.\nCOMMON SHARES. The Company's amended articles of incorporation authorize the issuance of up to 40,000,000 common shares. The following table summarizes shares of common stock reserved for issuance as of September 30, 1995:\nSTOCK PURCHASE RIGHTS. In April 1995, the Company implemented a plan to protect stockholder's 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 Preferred Share Purchase Right (Right). Each Right entitles the holder, under certain circumstances, to purchase one one-hundredth of a share of Preferred Stock of the Company or its acquirer at a discounted price. The Rights are redeemable by the Company and expire in 2005.\nNOTE 6. EMPLOYEE STOCK PLANS\nPERIODIC PURCHASE PLAN. All employees who have met the minimum service period are eligible to participate in the Company's Periodic Purchase Plan. Employees may purchase shares subject to the Plan at a price not less than 85% of the lesser of the fair market value at the beginning or end of the offering period. The term of each offering period is six months. During fiscal 1995, 1994 and 1993, 15,000, 17,000 and 19,000 shares were issued at average purchase prices of $0.90, $1.01 and $0.85 per share, respectively. At September 30, 1995, 127,193 shares are available for issuance under the plan.\nSTOCK OPTION PLANS. During fiscal 1982, the Company adopted two stock option plans; an incentive plan for employees and a non-statutory plan for certain employees, directors, sales representatives, distributors and consultants. The plans were subsequently combined. Under the restated plan, as amended, a total of 6,360,000 shares of common stock have been reserved for issuance under the combined plan. Options are granted for a period not in excess of ten years from the date of grant. Terms for exercising options are determined by the Board of Directors. Options outstanding at September 30, 1995 become exercisable in cumulative increments proportionately over a four-year period from the date of grant, except that if termination occurs within six months from commencement date, no options are exercisable. Options are granted to purchase shares at prices not less than the fair market value at the date of grant. The plan expires in 2002.\nIn fiscal 1990, the Company adopted a non-statutory stock option plan for non-employee directors. A total of 200,000 shares of common stock were reserved for issuance under the plan. Options are automatically granted to eligible board members at the director's initial election or appointment and subsequent annual meetings commencing with the second annual meeting following the date of initial election or appointment. Options are exercisable after an initial six month waiting period following the date of grant at prices not less than the fair market value on the date of the grant. Options are subject to repurchase rights by the Company to the extent that they are not vested at the time of termination of Board membership.\nThe following table summarizes stock option activity under the stock option plans:\nNOTE 7. SHORT-TERM NOTE PAYABLE\nIn November 1993, the Company entered into a two-year line of credit agreement, subject to renewal, with the CIT Group (\"CIT\"). Although the Company was not required to make use of the bank line of credit, during the second quarter of fiscal 1994 it used cash resources to reduce its effective short-term credit borrowings interest rate by borrowing the minimum required borrowings of $3,000,000 under a secured bank line of credit with CIT, and investing the proceeds in a short-term certificate of deposit (restricted cash). The revolving credit facility is secured by the assets of the Company, and requires the Company to maintain certain restrictive and financial covenants, including covenants requiring the Company to maintain working capital of $750,000 and a net worth of $3,000,000, and prohibiting the Company from incurring or agreeing to incur capital expenditures of in excess of $1,200,000 in any fiscal year. The Company is currently in compliance with such covenants. Interest on borrowings is payable at the lender's reference prime rate plus 2.25% per annum, with a minimum quarterly interest charge based on average borrowings of $3,000,000, and is payable monthly. Effective November 22, 1995, the Company renewed the credit facility with CIT for a two year term, subject to renewal thereafter. Under the terms of the new credit agreement, the minimum borrowing requirement has been reduced to $1,500,000 and is only applicable in the event the Company has a loan balance outstanding with CIT. Thus the Company liquidated its restricted cash and repaid the note payable to bank in November 1995. Further, the credit agreement does not contain any restrictive or financial covenants. Interest on borrowings is payable at the lender's reference prime rate plus 2.0% per annum and is payable monthly.\nNOTE 8. LONG-TERM OBLIGATIONS AND COMMITMENTS\nLong-term obligations consisted of the following (in thousands):\nThe Company leases its facilities and certain manufacturing and office equipment under non-cancelable lease arrangements. The major facility lease expires in 2005 and provides for base rental rates which are increased at various times during the term of the lease and for a renewal option to extend the lease for an additional five-year period. The non-cancelable equipment leases are for terms of three to five years and generally provide for the lessor to retain the depreciation for income tax purposes. Most of the leases require the Company to pay property taxes, insurance and normal maintenance and repairs.\nLeases meeting certain specific criteria are accounted for as the acquisition of an asset and the incurrence of a liability (i.e., a capital lease). Assets recorded as property and equipment under capital leases were as follows:\nMinimum future lease payments (in thousands) for non-cancelable leases as of September 30, 1995 were as follows:\nRental expense under all operating leases was $1,206,000 for fiscal 1993, $1,056,000 for fiscal 1994 and $597,000 for fiscal 1995.\nNOTE 9. INCOME TAXES\nFor fiscal 1995, the Company recorded a provision of $14,000 for income taxes. The Company's provision was computed by applying the estimated annual tax rate to income taxes, taking into account net operating loss carryforwards and alternative minimum taxes. No provision for federal and state income taxes was recorded in fiscal 1994 nor 1993 as the Company incurred net operating losses. At September 30, 1995, the Company had net operating loss carryforwards of approximately $107,000,000 for federal income tax purposes, which may be utilized to reduce future taxable income through 2010. Under the Tax Reform act of 1986, the amounts of and the benefit from net operating losses that can be carried forward may be impaired or limited in certain circumstances. Events which may cause changes in the amount of net losses that the Company may utilize in any one year include, but are not limited to, a cumulative stock ownership change of more than 50% over a three year period.\nDeferred tax assets (liabilities) are comprised of the following (in thousands):\nThe Company has provided a full valuation allowance on the deferred tax asset because of the uncertainty regarding realizability.\nNOTE 10. DEVELOPMENT AND LICENSE AGREEMENTS\nIn July 1990, the Company entered into an eight year renewable manufacturing and technology agreement with Hualon Microelectronics Corporation (\"HMC\"). HMC provided foundry services to the Company through the second quarter of fiscal 1994. In fiscal 1994, as a result of the EEPROM Asset Sale and disputes with HMC, the Company discontinued its use of HMC's foundry services (see Note 11 Litigation.). In August 1995, the Company re-established its foundry and development relationship with HMC. The Company and HMC agreed to reactivate and modify their 1990 Foundry and Co-Development Agreement. Under the \"amended\" Agreement, HMC will manufacture wafers for certain of the Company's products through fiscal 1998. In connection with the transfer of production from another foundry to HMC, the Company has agreed to pay Non-recurring Engineering (\"NRE\") charges of $240,000. The Company paid approximately $40,000 of these NRE charges in fiscal 1995 and expects to pay the balance in fiscal 1996.\nIn fiscal 1992, the Company entered into a wafer fabrication agreement with International Microelectonic Products, Inc. (\"IMP\"). Under the agreement, IMP provided foundry services to the Company for the fabrication of Company designed semiconductor products. In August 1995, the Company and IMP agreed to phase out their long-term foundry arrangement by March 1996. The Company has begun the process of transferring production capability to other foundries.\nNOTE 11. LITIGATION\nOn March 30, 1994, the Company filed a lawsuit against HMC in which, among other things, the Company sought a declaration by the court that an alleged license agreement, pursuant to which HMC had allegedly been granted certain license rights to the EEPROM technology sold to Atmel (see Note 3), is invalid. In response to the Company's claims, HMC asserted affirmative defenses and counterclaims. On August 16, 1995, the Company and HMC entered into a Settlement Agreement, Release and Tolling Agreement. Under the terms of such Agreement, the Company agreed, among other things, that the claims asserted against HMC in respect of the alleged license agreement would be tolled for such time and on such terms as provided therein. As a result, the Company is not currently pursuing such claims. The Company is entitled to pursue such claims in the future, however, subject to the terms of the Settlement Agreement, Release and Tolling Agreement. In the event that the Company does not cause the alleged license agreement to be invalidated, Atmel may assert a claim against the Company under the Asset Purchase Agreement, including a claim for damages, if suffered by Atmel as a result of HMC's use of any of such technology, and, in the\nevent any such claim by Atmel is determined to be valid, Atmel may recover any such damages from the escrow described above. The Company believes that, in the event of any claim by Atmel, the amount of damages that may be payable by the Company upon a resolution thereof will not have a material adverse effect on the Company's cash flow, financial position or results of operations. However, there can be no assurance as to such matters. Under the terms of the settlement, the Company agreed to pay HMC $500,000 due in three consecutive monthly installments beginning in August 1995. The Company further agreed to issue to HMC 100,000 shares of SEEQ's common stock and reactivate and modify the 1990 Foundry and Co-Development Agreement (see Note 10. Development and License Agreements).\nDuring 1995, the Company settled a lawsuit previously filed against the Company by GOCO Realty Fund I \/ Brazos Partners LP (see note 4).\nIn addition, the Company is involved in certain other routine litigation in the ordinary course of its business. Based on the Company's limited review to date, management believes that the outcome of these legal proceedings will not have a material adverse effect on the Company's financial position or results of operations.\nNOTE 12. SUBSEQUENT EVENT\nOn November 28, 1995, Level One Communications Incorporated (\"Level One\") filed a complaint against the Company, in the United States District Court of Northern California, alleging patent infringement. In the complaint, Level One claims that the Company has used and sold products in violation of two of Level One's patents. Level One seeks immediate and permanent injunctive relief preventing the Company from making, using, or selling any devices that infringe such patents and unspecified damages. Management believes that the outcome of these legal proceedings will not have a material adverse effect on the Company's financial position or results of operations.\nPART III\nITEM 10.","section_9":"","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 information contained in the section entitled \"Election of Directors\" contained in the Proxy Statement.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe information required by this Item is incorporated by reference to the information contained in the section entitled \"Executive Compensation\" contained 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 by reference to the information contained in the section entitled \"Election of Directors - Share Ownership\" contained in the Proxy Statement.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe information required by this Item is incorporated by reference to the information contained in the section entitled \"Election of Directors\" contained in the Proxy Statement.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n1. Exhibits\n3.1 Certificate of Incorporation (incorporated herein by reference to Registrant's Registration Statement on Form S-1 (Registration No. 33-47985)).\n3.2 Bylaws (incorporated herein by reference to Registrant's Registration Statement on Form S-1 (Registration No. 33-47985)).\n4.1 Rights Agreement dated as of April 21, 1995 between the Company and American Stock Transfer and Trust Company, including exhibits thereto (incorporated herein by reference to Registrant's Form 8-A on May 2, 1995).\n10.1 Form of Indemnification Agreement with Directors and Officers (incorporated herein by reference to Registrant's Form 8-B filed on June 2, 1987).\n10.2 Executive Compensation Plans and Arrangements.\n10.2.1 Restated Periodic Purchase Plan, as amended (incorporated herein by reference to Registrant's Annual Report on Form 10-K for the fiscal year ended September 30, 1991).\n10.2.2 Notice of Periodic Purchase Plan Offerings (incorporated herein by reference to Registrant's Form S-8 Registration Statement (Registration No. 33-27419) filed on March 7, 1989.\n10.2.3 Restated 1982 Stock Option Plan, as amended (incorporated herein by reference to Registrant's Form S-8 Registration Statement (33-6544) filed on July 2, 1993.\n10.2.4 1989 Non-Employee Director Stock Option Plan (incorporated herein by reference to Registrant's Form S-8 Registration Statement (Registration No. 33-35838) filed on July 11, 1990).\n10.2.5 Kodiak Technology Incorporated 1989 Stock Option Plan, and related Stock Option and Stock Purchase Agreements (incorporated herein by reference to Registrant's Annual Report on Form 10-K for the fiscal year ended September 30, 1989).\n10.3 Build to Suit Lease dated as of October 15, 1982, as amended (\"1982 Lease\"), between the Company and David W Mariani Investment Partnership dba Mariani Financial Co. (incorporated herein by reference to Registrant's Annual Report on Form 10-K for the fiscal year ended September 30, 1986).\n10.4 Stock Purchase Agreement dated as of July 16, 1990 between the Company and HMC Microelectronics Corporation (incorporated herein by reference to Registrant's Quarterly Report on Form 10-Q for the period ended June 30, 1990).\n10.5 Technology Transfer and Foundry Agreement dated as of July 16, 1990 between the Company and HMC Microelectronics Corporation (subject to confidential treatment) (incorporated by reference to Registrant's Quarterly Report on Form 10-Q for the period ended June 30, 1990).\n10.5.1 Settlement Agreement, Release and Tolling Agreement dated as of August 16, 1995 by and between the Company and HMC Microelectronics Corporation (subject to confidential treatment).\n10.5.2 Amendment to Technology Transfer and Foundry Agreement dated August 16, 1995 by and between the Company and HMC Microelectronics Corporation (subject to confidential treatment).\n10.6 Business Loan Agreement with Silicon Valley Bank dated as of August 2, 1991 (incorporated herein by reference to Registrant's Annual Report on Form 10-K for the fiscal year ended September 30, 1991).\n10.7 Amendment to Business Loan Agreement with Silicon Valley Bank and warrant issued pursuant thereto (incorporated herein by reference to Registrant's Annual Report on Form 10-K for the fiscal year ended September 30, 1991).\n10.8 Warrant Purchase Agreement dated as of August 2, 1991 with Silicon Valley Bank and warrant issued pursuant thereto (incorporated herein by reference to registrant's Annual Report on Form 10-K for the fiscal year ended September 30, 1991.\n10.9 Foundry Agreement dated as of November 15, 1991 between the Company and International Microelectronics Products Inc. (subject to request for confidential treatment) (incorporated herein by reference to Registrant's Annual Report on Form 10-K for the fiscal year ended September 30, 1991).\n10.10 Loan and Security Agreement with CIT Group\/Credit Finance, Inc. dated November 22, 1993 (incorporated by reference herein to the Registrant's Annual Report on Form 10-K for the fiscal year ended September 30, 1993).\n10.10.1 Agreement to Renew and Amend Loan and Security Agreement dated November 22, 1995 between the Company and CIT Group\/Credit Finance, Inc.\n10.11 Warrant Agreement dated January 29, 1992 between the Company and certain stockholders (incorporated by reference herein to Registrant's Registration Statement on Form S-1 (Registration No. 33-64822)).\n10.12 Warrant Agreement dated April 27, 1993 between the Company and certain stockholders (incorporated by reference herein to Registrant's Registration Statement on Form S-1 (Registration No. 33-64822)).\n10.13 Form of Warrant issued by the Company to certain stockholders on July 30, 1993 (incorporated by reference herein to Registrant's Registration Statement on Form S-1 (Registration No. 33-64822)).\n10.14 Stock Purchase Agreement and Exhibits thereto dated January 10, 1992 between the Company and certain stockholders (incorporated by reference herein to Registrant's Registration Statement on Form S-1 (Registration No. 33-64822)).\n10.15 Asset Purchase Agreement dated February 7, 1994 between the Company and Atmel Corporation (incorporated by reference to the Company's Form 8-K dated February 7, 1994).\n10.16 Stock Purchase Agreement dated February 7, 1994 between the Company and Atmel Corporation (incorporated by reference to the Company's Form 8-K dated February 6, 1994).\n10.17 Escrow Agreement dated February 7, 1994 between the Company, Atmel Corporation and Wilson, Sonsini, Goodrich & Rosati, P.C. (incorporated by reference to the Company's Form 8-K dated February 7, 1994).\n10.18 Escrow Agreement dated April 14, 1994 between the Company, Atmel and Bank of America NT&SA (incorporated by reference to the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 1994).\n13.1 Registrant's Proxy Statement for the 1995 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission.\n21.1 The Company has one subsidiary: Talus Technology Incorporated, a California Corporation.\n23.1 Consent of Price Waterhouse LLP, Independent Accountants.\n24.1 Power of Attorney. Reference is made to the Signature Page.\n(a) Reports on Form 8-K. The Company filed no Current Reports on Form 8-K during the quarter ended September 30, 1995.\n27.1 Financial Data Schedules\nUndertakings\nFor purposes of complying with the amendments to the rules governing Form S-8 (effective July 13, 1990) under the Securities Act of 1933, the undersigned registrant hereby undertakes as follows:\nInsofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers or 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 1933 Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of the 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 on the Form S-8 identified below, 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 1933 Act and will be governed by the final adjudication of such issue.\nThe preceding undertaking shall be incorporated by reference into registrant's Registration Statement on Form S-8 Registration No.6554), filed July 2, 1993; registrant's Registration Statement on Form S-8 (Registration No. 33-35838), filed July 11, 1990; and registrant's Registration Statement on Form S-8 (Registration No. 33-27419), filed March 7, 1989.\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, thereto duly authorized.\nSEEQ TECHNOLOGY INCORPORATED\nBy \/s\/ Phillip J. Salsbury ------------------------------------- Phillip J. Salsbury Chief Executive Officer\nDated: December 18, 1995\nPOWER OF ATTORNEY\nKnow All Persons By These Presents, that each person whose signature appears below constitutes and appoints Phillip J. Salsbury and Robert O. Hersh, and each of them, as his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, for him and in his name, place, and stead, in any and all capacities, to sign any and all amendments to this report on Form 10K, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof:\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.\nSEEQ TECHNOLOGY INCORPORATED\nEXHIBIT 11\nSCHEDULE OF COMPUTATION OF EARNINGS PER SHARE (in thousands except per share amounts)\nSCHEDULE II\nSEEQ TECHNOLOGY INCORPORATED VALUATION AND QUALIFYING ACCOUNTS Years Ended September 30 (in thousands)\n- ----------------\n(1) Doubtful account write-offs and customer returns and price adjustments\n(S-1) SEEQ TECHNOLOGY INCORPORATED\nINDEX TO EXHIBITS","section_15":""}
{"filename":"930184_1995.txt","cik":"930184","year":"1995","section_1":"ITEM 1. BUSINESS\nINTRODUCTION\nOn November 1, 1994 the stockholders of ICN Pharmaceuticals, Inc. (\"ICN\"), SPI Pharmaceuticals, Inc. (\"SPI\"), Viratek, Inc. (\"Viratek\"), and ICN Biomedicals, Inc. (\"Biomedicals\") (collectively, the \"Predecessor Companies\") approved the Merger of the Predecessor Companies (\"the Merger\"). On November 10, 1994, SPI, ICN and Viratek merged into ICN Merger Corp., and Biomedicals merged into ICN Subsidiary Corp., a wholly-owned subsidiary of ICN Merger Corp. In conjunction with the Merger, ICN Merger Corp. was renamed ICN Pharmaceuticals, Inc. (\"New ICN\" or \"the Company\"). For accounting purposes, SPI is the acquiring company and as a result, the newly merged company reports the historical financial data of SPI in its financial results. Subsequent to the Merger, the results of the newly merged company include the combined operations of all Predecessor Companies.\nNew ICN is a multinational research based pharmaceutical company that develops, manufactures, distributes and sells pharmaceutical, nutritional, research and diagnostic products. The Company pursues a strategy of international expansion which includes (i) the research and development of proprietary products with the potential to be significant contributors to the Company's global operations; (ii) the penetration of major pharmaceutical markets by means of targeted acquisitions; and (iii) the expansion in these major markets through the development or acquisition of pharmaceutical products that meet the particular needs of each market.\nThe Company distributes and sells a broad range of prescription and over the counter (\"OTC\") pharmaceutical products in over 60 countries worldwide, primarily in North America, Latin America, Western Europe and Eastern Europe. These pharmaceutical products treat viral and bacterial infections, diseases of the skin, myasthenia gravis, cardiovascular disease, diabetes and psychiatric disorders. The Company's leading product is the broad spectrum antiviral agent ribavirin, which is marketed in the United States, Canada and most of Europe under the Virazole(R) trademark. Virazole(R) is currently approved for commercial sale in over 40 countries for one or more of a variety of viral infections, including respiratory syncytial virus (\"RSV\"), herpes simplex, influenza, chicken pox, hepatitis and HIV. In the United States, Virazole(R) is approved only for use in hospitalized infants and young children with severe lower respiratory infections due to RSV.\nThe Company believes it has substantial opportunities to realize growth from its internally developed compounds. These compounds are the result of significant investments in research and development activities related to nucleic acids conducted over three decades. During 1994, ICN submitted a New Drug Application (\"NDA\") to the Federal Drug Administration (\"FDA\") for Virazole(R) capsules as monotherapy in the treatment of chronic hepatitis C in the United States. In early 1995, the FDA confirmed that substantial additional drug development would be required for NDA approval. Similar conclusions were reached in other major world markets. However, the Company continues to believe that Virazole(R) has potential in the treatment of hepatitis C, and is taking all steps necessary to capitalize on its full potential.\nOn July 28, 1995, the Company entered into an Exclusive License and Supply Agreement (the \"Agreement\") and a Stock Purchase Agreement with a subsidiary of Schering-Plough Corporation (\"Schering\") to license the Company's proprietary anti-viral drug ribavirin as a treatment for chronic hepatitis C in combination with Schering's alpha interferon. The Agreement provided the Company an initial non-refundable payment by Schering of $23,000,000, and future royalty payments to the Company for marketing of the drug, including certain minimum royalty rates. Schering will have exclusive marketing rights for ribavirin for hepatitis C worldwide, except that the Company will retain the right to co-market in the countries of the European Economic Community. In addition, Schering will purchase up to $42,000,000 in common stock of the Company upon the achievement of certain regulatory milestones. Under the Agreement, Schering will be responsible for all clinical developments worldwide.\nThe Company believes it is positioned to expand its presence in the pharmaceutical markets in Eastern Europe. In 1991, a 75% interest was acquired in Galenika Pharmaceuticals, a large drug manufacturer and distributor in Yugoslavia. Galenika Pharmaceuticals was subsequently renamed ICN Galenika. This acquisition added new products and significantly expanded the sales volume of the Company. With the investment in Galenika Pharmaceuticals, the Company became one of the first Western pharmaceutical companies to establish a direct investment in Eastern Europe. ICN Galenika continues to be a significant part of the Company's operations although its sales and profitability have, at times, been substantially diminished owing principally to the imposition of sanctions on Yugoslavia by the United Nations (\"UN\"). However, in December 1995, the United Nations Security Council (\"UNSC\") adopted a resolution that suspended economic sanctions imposed on the Federal Republic of Yugoslavia since May of 1992. The suspension of economic sanctions will enable ICN Galenika to resume exporting certain of its product lines to Russia, other Eastern European markets, Africa, the Middle East and the Far East. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations - ICN Galenika\". Additionally, in pursuing its Eastern Europe expansion strategy, the Company acquired a 75% interest in Oktyabr, one of the largest pharmaceutical companies in the Russian Republic.\nIn addition to its pharmaceutical operations, the Company also develops, manufactures and sells a broad range of research chemical products, biomedical instrumentation, diagnostic reagents and radiation monitoring services. The Company markets these products internationally to major scientific, academic, health care and governmental institutions through catalog and direct mail marketing programs.\nBUSINESS SEGMENTS\nThe Company operates in two business segments: pharmaceutical and biomedical. For financial information about business segments, see Note 10 of Notes to Consolidated Financial Statements.\nPRODUCTS\nETHICAL DRUGS\nANTI-INFECTIVES: The Company sells approximately 70 antibacterial products, and sells its antiviral drug, ribavirin, under the tradename Virazole(R) in North America and most European countries. Ribavirin is sold as Vilona(R) and Virazid(R) in Latin America and Virazid(R) in Spain. References to the sale of Virazole(R) in this Form 10-K includes sales made under the trademarks Vilona(R) and Virazid(R). At the present time, the Company believes that there are fewer than ten antiviral agents marketed in the world. Antivirals are rare and more difficult to take through the regulatory approval process than antibacterials because of the nature of bacteria compared to viruses. Whereas bacteria live outside of cells, viruses live inside cells. Thus, while antibacterials can focus simply on killing bacteria, antivirals, ideally, must eliminate viruses without killing the host cell or adversely affecting the host organism.\nANTIVIRAL: Virazole(R) accounted for approximately 10%, 13% and 7% of the Company's net sales for the years ended December 31, 1995, 1994 and 1993, respectively. Virazole(R) is currently approved for sale in various pharmaceutical formulations in over 40 countries for the treatment of several different human viral diseases, including RSV, hepatitis, herpes, influenza, measles, chicken pox and HIV.\nIn the United States and Canada, Virazole(R) has only been approved for hospital use in aerosolized form to treat infants and young children who have severe lower respiratory infections caused by RSV. In the United States, RSV infection is sufficiently severe to require hospitalization of an estimated 100,000 children annually. Similar approvals for Virazole(R) for use in the treatment of RSV have been granted by governmental authorities in 22 other countries.\nIn treating RSV, Virazole(R) is administered by a small particle aerosolized generator (\"SPAG\"), a system that permits direct delivery of Virazole(R) to the lungs, the site of infection.\nA variety of small, independent clinical studies comparing the results of combining Virazole(R) capsules and interferon alpha 2b therapies versus interferon alone in the treatment of hepatitis C, demonstrated enhanced efficacy of the combination. Based upon these clinical findings, the Company has entered into an agreement with Schering whereby Schering will assume responsibility for worldwide clinical development and registration of oral ribavirin in combination with their product, INTRON-A(R), (interferon alpha 2b) for the treatment of hepatitis C. If these larger Phase III clinical trials confirm the findings of preliminary studies, the combination regime could provide the medical community with a valuable new option and potentially, become the standard therapy for the treatment of hepatitis C.\nANTIBACTERIALS: Antibacterials accounted for approximately 21%, 22% and 24% of the Company's net sales for the years ended December 31, 1995, 1994 and 1993, respectively. Most of the antibacterials sold by the Company (excluding ICN Galenika) are proprietary, whereas many of the antibacterial products manufactured and sold by ICN Galenika are licensed from other manufacturers including Roche Holding AG, Bristol-Meyers Squibb and Eli Lilly, principally under exclusive licenses for specific geographical areas, primarily Yugoslavia.\nOTHER ETHICAL DRUGS\nOther ethicals accounted for approximately 40%, 41% and 40% of net sales for the years ended December 31, 1995, 1994 and 1993, respectively. The Company manufactures and\/or markets a wide variety of other ethical pharmaceuticals, including analgesics, anticholinesterases, antirheumatics, cardiovasculars, dermatologicals, endocrine agents, gastrointestinals, hormonals and psychotropics. The Company manufactures and markets approximately 60 other dermatological products, primarily in North America and Eastern Europe. The Company markets three anticholinesterase product lines in North America under the trade names Mestinon(R), Prostigmin(R) and Tensilon(R). These products, manufactured by and licensed from Roche Holding AG, are used to treat myasthenia gravis, a progressive neuromuscular disorder, and in reversing the effects of certain muscle relaxants. Bensedin(R) is a tranquilizer manufactured by ICN Galenika and is used in the treatment of psychological and emotional disorders. The Company also sells insulin for the control of diabetes. Albumina(R) is sold in Spain and Mexico for use in emergency treatment of shock due to burns, trauma, operations and infections, and conditions where the restoration of blood volume is urgent.\nOTHER OVER THE COUNTER PRODUCTS\nOther OTC products accounted for approximately 17%, 18% and 21% of the Company's net sales for the years ended December 31, 1995, 1994 and 1993, respectively. Other OTC products encompass a broad range of ancillary products sold through the Company's existing distribution channels.\nRESEARCH CHEMICALS, DIAGNOSTIC AND OTHER BIOMEDICAL PRODUCTS\nResearch chemicals, diagnostic and other biomedical products accounted for approximately 12% of the Company's net sales for the year ended December 31, 1995.\nThe Company services life science researchers throughout the world through a catalog sales operation, direct sales and distributors. The Company's general catalog lists approximately 55,000 products which are used by medical, diagnostic and scientific researchers involved in the fields of molecular biology, cell biology, immunology, biochemistry, microbiology and other areas. A majority of these products are purchased from third party manufacturers and distributed globally by the Company. Over 750 new products were added to the catalog in 1995.\nThe ICN diagnostic product line includes reagents that are routinely used by physicians and medical laboratories to accurately and quickly diagnose hundreds of patient samples for a variety of disease conditions.\nACQUISITIONS\nThe Company has pursued a strategy of targeted expansion into regional markets which are considered to have significant potential for pharmaceutical and related products. This strategy has been implemented in large part through the acquisition of compatible businesses and product lines and the formation of strategic alliances and joint ventures in targeted markets. The Company intends to continue this strategy and to expand its manufacturing potential for Virazole(R).\nIn May 1995, the Company acquired from Becton-Dickinson (\"B-D\"), the radioimmunoassay product line along with the inventory and property located in Orangeburg, New York. These products, used for anemia and thyroid diagnostic testing by B-D, primarily were distributed in North America and Western Europe. The Company believes that significant opportunity exists to extend the distribution of these highly regarded products into Latin America, Asia, Eastern Europe and the Middle East, where the Company has already established distribution networks for diagnostics.\nIn December 1995, the Company purchased 40% of SeaLite Sciences, Inc. (\"SeaLite\") and has the option to purchase the remaining 60%. SeaLite has a patented diagnostics technology which can be used to produce extremely sensitive test kits which the Company believes are superior to existing tests. SeaLite has licensed the Company to produce these tests, the first of which is a thyroid test, so sensitive that it can be used as a replacement for a battery of existing tests. Four products are already cleared by the FDA and will be marketed beginning in 1996. The Company plans to increase its ownership in SeaLite to 100% at a future date.\nGALENIKA ACQUISITION: The Company believes it is positioned to expand its presence in the pharmaceutical markets in Eastern Europe. In 1991, a 75% interest was acquired in Galenika Pharmaceuticals, a large drug manufacturer and distributor in Yugoslavia. Galenika Pharmaceuticals was subsequently renamed ICN Galenika. This acquisition added new products and significantly expanded the sales volume of the Company. With the investment in Galenika Pharmaceuticals, the Company became one of the first Western pharmaceutical companies to establish a direct investment in Eastern Europe.\nUntil the imposition of UN sanctions in May 1992, ICN Galenika made a significant contribution to sales and net income. Approximately 20% of such sales were exports from Yugoslavia, primarily to Eastern Europe, the Middle East and certain Balkan nations. The imposition of sanctions, including the prohibition of exports, has had a negative effect on the operations and profitability of ICN Galenika. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations - - ICN Galenika\".\nOKTYABR ACQUISITION: During 1994 and 1993, the Company acquired a 41% interest in Oktyabr, a Russian pharmaceutical company. On July 21, 1995, the Company purchased an additional 34% interest in Oktyabr, raising the Company's ownership from 41% to 75%.\nFOREIGN OPERATIONS\nThe Company primarily operates in North America, Latin America (principally Mexico), Western Europe and Eastern Europe. For financial information about domestic and foreign operations and export sales, see Note 10 of Notes to Consolidated Financial Statements.\nForeign operations are subject to certain risks inherent in conducting business abroad, including possible nationalization or expropriation, price and exchange controls, limitations on foreign participation in local enterprises, health-care regulation and other restrictive governmental actions. Changes in the relative values of currencies take place from time to time and may materially affect the Company's results of operations. Their effects on the Company's future operations are not predictable. The current political and economic circumstances in Yugoslavia create certain risks particular to that country. Between May 1992 and December 1995, Yugoslavia had been operating under sanctions imposed by the UN which had severely limited the ability to import raw materials for manufacturing and had prohibited all exports. While the sanctions have been suspended, certain risks such as hyperinflation, currency devaluations, wage and price controls and potential government action could have a material adverse effect on the Company's results of operation. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Inflation and Changing Prices\".\nMARKETING AND CUSTOMERS\nThe Company has a worldwide marketing and sales staff of approximately 1,780 persons for its pharmaceutical products, including sales representatives in North America, Latin America, Western Europe and Eastern Europe, who call on physicians, pharmacists, distributors and other health care professionals. As part of its marketing program for pharmaceuticals, the Company also uses direct mailings, advertises in trade and medical periodicals, exhibits products at medical conventions, sponsors medical education symposia, and sells through distributors in countries where it does not have its own marketing staff.\nIn the United States, the Company currently promotes its pharmaceutical products through its own sales force to physicians. These products are distributed to drug stores and hospitals through wholesalers. In Latin America, including Mexico, the Company promotes to physicians and distributes products either directly or indirectly to hospitals and pharmacies. The Company's Spanish subsidiary promotes and sells pharmaceutical products through its own sales force to physicians, hospitals, retail outlets, pharmacies and wholesalers. In other Western European markets, sales forces are in the process of being established and distribution methods are in transition as ICN affiliates are established. In Canada, the Company has its own sales force and promotes and sells directly to physicians, hospitals, wholesalers, and large drug store chains.\nICN Galenika sells a broad range of pharmaceutical and other products in Yugoslavia through approximately 30 wholesalers, 6 sales offices and 85 sales representatives. In December 1995, the UNSC adopted a resolution that suspended economic sanctions imposed on the Federal Republic of Yugoslavia. The suspension of economic sanctions will enable ICN Galenika to resume exporting certain of its product lines to Russia, other Eastern European markets, Africa, the Middle East and the Far East.\nDuring 1995, approximately 81% of ICN Galenika's sales were to government sponsored entities of the Federal Republic of Yugoslavia. Future sales by ICN Galenika could be dependent on the ability of the Yugoslavian government to continue to subsidize purchases of pharmaceutical products.\nThe research chemical and diagnostic product lines are sold worldwide primarily through the Company's mail order catalogs, with additional sales being generated through affiliates and a network of distributors.\nRESEARCH AND DEVELOPMENT\nThe Company's research and development activities utilize the expertise accumulated by the Company and its predecessors in over 30 years of nucleic acids research. In addition, the Company develops innovative products targeted to address the specific needs of the Company's local markets.\nThe Company's predecessors include one of the first firms to engage in broad based nucleic acid research, enabling the Company to compile a library of over 5,000 nucleotide-based compounds. The Company's long-term research efforts are focused on development of therapeutics and diagnostics for diseases related to DNA and RNA, such as viral infections, cancer and skin diseases.\nThe Company currently has 330 employees devoted to Research and Development activities.\nLONG-TERM RESEARCH AND DEVELOPMENT\nThe Company's long-term research and development activities are targeted to the development of therapeutic and diagnostic agents for chronic viral diseases, cancer, diseases of the skin and hormonal therapy, and, as such, compliment the Company's current product lines and development efforts.\nOne important area of research is \"antisense\" technology. This approach seeks to block genetic material causing diseases such as cancer, viral infections and psoriasis by constructing longer sequences of nucleotides (oligonucleotides) that selectively bond to the disease-causing nucleic acid sequences. In this research, the Company makes use of its extensive library of nucleotide compounds. The Company is using similar technologies to develop diagnostic techniques used to screen for genetic diseases, viral infections and various forms of cancer.\nSHORT AND MEDIUM-TERM RESEARCH AND DEVELOPMENT\nThe Company's medium-term research and development efforts involve the preclinical and clinical testing of certain nucleotide compounds with broader market applications that have shown the most promise of successful commercialization. These compounds include:\nVIRAZOLE(R) (RIBAVIRIN): Virazole(R) is the only significant compound currently undergoing worldwide clinical development for the treatment of hepatitis C.\nA number of small, independent clinical studies in hepatitis C comparing the results of combining Virazole(R) capsules and interferon alpha 2b, versus interferon alone, demonstrated enhanced efficacy of the combination. Based upon these clinical findings, the Company has entered into an agreement with Schering whereby Schering will assume responsibility for worldwide clinical development and registration of oral ribavirin in combination with their product, INTRON-A(R), (interferon alpha 2b) for the treatment of hepatitis C and receive certain geographically exclusive marketing rights. If these large Phase III clinical trials confirm the findings of preliminary studies, the combination regime could provide the medical community with a valuable new option and potentially, become the standard therapy for the treatment of hepatitis C.\nClinical studies have been conducted with Virazole(R) in various formulations for treatment of several other viral diseases. Among diseases for which at least one governmental health regulatory agency (in countries other than the United States) has approved commercialization of Virazole(R) are herpes zoster, genital herpes, hemorrhagic fever with renal syndrome, lassa fever, measles, chicken pox, influenza and HIV. The Company has no immediate plans to initiate new clinical studies for any of these indications. The Company intends, where appropriate, to utilize the existing clinical data as a basis for future submissions to additional governmental health authorities to expand the use of Virazole(R).\nTIAZOLE(TM) (TIAZOFURIN): The Company has maintained an active research program centered on tiazofurin, which the Company is developing under the tradename Tiazole(TM) (a nucleotide chemically similar to Virazole(R)). Tiazole(TM) has been demonstrated to be an inhibitor of IMP-dehydrogenase, an enzyme whose presence in elevated concentrations is associated with a number of cancers. The Company is in the process of conducting Phase II\/III clinical studies with Tiazole(TM) as a treatment for blast crisis in chronic myelogenous leukemia. The Company is also conducting research into the effectiveness of Tiazole(TM) as an anti-cancer agent when used in conjunction with other basic anti-cancer compounds, such as taxol, in end-stage ovarian carcinoma.\nADENAZOLE(TM) (8-CL-C-AMP): This nucleotide, currently in preclinical research, has been shown to control cell proliferation and differentiation in certain cancers. Human trials have been conducted by independent investigators in Scotland and Italy. The Company is planning to begin preclinical studies for use of the drug in leukemia treatment and is exploring the drug's potential as a topical treatment for psoriasis, based on its ability to inhibit rapid cell proliferation.\nONCOZOLE(TM) (3-DEAZAGUANINE): Research on animals has shown this compound to be active against a range of solid tumors, including breast and colon tumors. The Company is engaged in preclinical research of Oncozole(TM) as a treatment for solid tumors.\nSELENAZOLE(TM) (SELENAZOFURIN): Selenazofurin, an anti-tumor nucleotide licensed from Brigham Young University, is related to tiazofurin. Preclinical studies suggest that selenazofurin combines synergistically with other well known agents against both leukemia and solid tumors.\nGROWTH HORMONE RELEASING FACTOR (GRF): In November 1994, the Company entered into a license agreement for the rights to develop and commercialize a group of compounds related to and including human GRF for the United States and other major pharmaceutical markets. Phase III clinical trials were initiated in 1995 to evaluate the efficacy and safety of GRF in treating growth retardation.\nThere can be no assurance with regard to the results of the Company's research and development efforts or the commercial success of any of its products under development.\nCOMPETITION\nThe Company operates in a highly competitive environment. The Company's competitors, many of whom have substantially greater capital resources and marketing capabilities and larger research and development staffs and facilities than the Company, are actively engaged in marketing products similar to those of the Company and in developing new products similar to those proposed to be developed and sold by the Company. Competitive factors vary by product line and customer and include service, product availability and performance, price and technical capabilities. The Company does business in an industry characterized by extensive and ongoing research efforts. Others may succeed in developing products that are more effective than those presently marketed or proposed for development by the Company. Progress by other researchers in areas similar to those explored by the Company may result in further competitive challenges.\nThe Company is aware of several ongoing research and development programs which are attempting to develop new prophylactic and therapeutic products for treatment of RSV. Although the Company will follow publicly disclosed developments in this field, on the basis of currently available data, it is unable to evaluate whether the\ntechnology being developed in these programs poses a threat to its current market position in the treatment of RSV or its revenue streams.\nIn the marketing segment relating to the treatment of chronic hepatitis C, the Company expects if Virazole(R) is approved either in combination or as a monotherapy, that it will experience competition from manufacturers who have or may introduce competing products.\nCompetitors of the Company's biomedical research product group include companies such as Sigma-Aldrich Corporation, Amersham International and New England Nuclear.\nORDER BACKLOG\nAs is customary in the pharmaceutical industry, all the Company's products are sold on an \"open order\" basis. Consequently, order backlog is not considered a significant factor.\nRAW MATERIALS\nThe Company manufactures pharmaceuticals at eight facilities. Those facilities are located in Bryan, Ohio; Mexico City, Mexico (at two locations); Montreal, Canada; Zoetermeer, The Netherlands; Barcelona, Spain; Belgrade, Yugoslavia and St. Petersburg, Russia. The Company believes it has sufficient manufacturing capacity to meet its needs for the foreseeable future. All of the manufacturing facilities, which require good manufacturing practices (\"GMP\") approval from the FDA or foreign agencies, have obtained such approval.\nIn Bryan, Ohio, the Company manufactures topical and oral dosages of several pharmaceutical products for the United States market. All of the Company's dermatology products are formulated, packaged and distributed from the Bryan, Ohio facility. The Bryan, Ohio facility also packages and distributes Virazole(R) on a worldwide basis.\nAt the two facilities in Mexico City, the Company manufactures a variety of pharmaceuticals in topical, oral and injectable dosage forms to serve the Latin America market. In Montreal, Canada, the Company manufactures Virazole(R) and SPAG units for the administration of Virazole(R) in the treatment of RSV, and other related medical devices. At that facility, the Company also manufactures a variety of topical and oral pharmaceuticals including a line of generics to serve the Canadian and United States markets. The Canadian facility also manufactures a full line of products using the controlled drug substance morphine for the management of pain in cancer and post- surgical states. In Spain, the Company manufactures and markets pharmaceuticals principally for distribution in Spain. In Yugoslavia, ICN Galenika manufactures over 450 pharmaceutical, veterinary, dental and other products in topical, oral and injectable forms. In Russia, the Company manufactures primarily pharmaceutical products in oral and injectable forms.\nThe Company subcontracts all of the manufacture of bulk ribavirin to third party suppliers. Most of the finishing and packaging of Virazole(R) is done by the Company and the balance by third party subcontractors. The capacities of these manufacturers are sufficient to meet the current demand for Virazole(R).\nManufacturing of the Company's biomedical products are chiefly carried out in three domestic facilities and one foreign facility: Irvine, California (radiochemicals), Orangeburg, New York (diagnostics and immunobiologicals), Huntsville, Alabama (diagnostic, microplate and liquid handling equipment) and Eschwege, Germany (chromatography products).\nIn general, raw materials used by the Company in the manufacture of all of its products are obtainable from multiple sources in the quantities desired.\nLICENSES, PATENTS AND TRADEMARKS (Proprietary Rights)\nThe Company may be dependent on the protection afforded by its patents relating to Virazole(R) and no assurance can be given as to the breadth or degree of protection which these patents will afford the Company. The Company has patent rights in the United States expiring in 1999 relating to the use of Virazole(R) to treat specified human viral diseases. If future development of Virazole(R) in combination with interferon is successful and approval granted in the United States, an additional award of exclusivity will be granted of up to three years from date of approval (Waxman-Hatch Act). The Company has patents in certain foreign countries covering use of Virazole(R) in the treatment of certain diseases, which expire at various times between 1996 and 2006. The Company has no, or limited, patent rights with respect to Virazole(R) and\/or its use in certain foreign countries where Virazole(R) is currently, or in the future may be, approved for commercial sale, including France, Germany and Great Britain. However, the Company will be granted a favorable review classification (Concertation Procedure) for Virazole(R) as a treatment for chronic hepatitis C in all European Union countries (including France, Germany and Great Britain). As a result, approval of the application of Virazole(R) for treatment of chronic hepatitis C (if such approval is granted) would, in the European Union, provide the Company up to ten years of marketing exclusivity, from the date of such approval of the application, against competitors' application to manufacture, market or sell generic substitutes of Virazole(R) for treatment of chronic hepatitis C. There can be no assurance that the loss of the Company's patent rights with respect to Virazole(R) upon expiration of the Company's patent rights in the United States, Europe and elsewhere will not result in competition from other drug manufacturers or will not otherwise have a significant adverse effect upon the business and operations of the Company. Marketing approvals in certain foreign countries provide an additional level of protection for products approved for sale in such countries. As a general policy, the Company expects to seek patents, where available, on inventions concerning novel drugs, techniques, processes or other products which it may develop or acquire in the future. However, there can be no assurance that any patents applied for will be granted, or that, if granted, they will have commercial value or as to the breadth or the degree of protection which these patents, if issued, will afford the Company. Patents for pharmaceutical compounds are not available in certain countries in which the Company markets its products.\nICN Galenika manufactures and sells three of its top-selling antibacterial products, Pentrexyl(R), Longaceph(R) and Palitrex(R) under licenses from Bristol-Myers Squibb, Roche Holding AG and Eli Lilly, respectively. See \"Products.\"\nMany of the names of the Company's products are registered trademarks in the United States, Yugoslavia, Mexico, Canada, Spain, The Netherlands and other countries. The Company anticipates that the names of future products will be registered as trademarks in the major markets in which it will operate. Other organizations may in the future apply for and be issued patents or own proprietary rights covering technology which may become useful to the Company's business. The extent to which the Company, at some future date, may need to obtain licenses from others is not known.\nGOVERNMENT REGULATION\nThe Company is subject to licensing and other regulatory control by the FDA, the Nuclear Regulatory Commission, other Federal and state agencies and comparable foreign governmental agencies.\nFDA approval must be obtained in the United States and approval must be obtained from comparable agencies in other countries prior to marketing or manufacturing new pharmaceutical products for use by humans. Obtaining FDA approval for new products and manufacturing processes can take a number of years and involve the expenditure of substantial resources. To obtain FDA approval for the commercial sale of a therapeutic agent, the potential product must undergo testing programs on animals, the data from which is used to file an Investigational New Drug Application with the FDA. In addition, there are three phases of human testing. Phase I: safety tests for human clinical experiments, generally in normal, healthy people; Phase II: expanded safety tests conducted in people who are sick with a particular\ndisease condition that the drug is designed to treat; and Phase III: greatly expanded clinical trials to determine the effectiveness of the drug at a particular dosage level in the affected patient population. The data from these tests is combined with data regarding chemistry, manufacturing, and animal toxicology and is then submitted in the form of an NDA to the FDA. The preparation of an NDA requires the expenditure of substantial funds and the commitment of substantial resources. The review by the FDA could take up to several years. If the FDA determines that the drug is safe and effective, the NDA is approved. No assurance can be given that authorization for the commercial sale by the Company of any new drugs or compounds for any application will be secured in the United States or any other country, or that, if such authorization is secured, those drugs or compounds will be commercially successful. The FDA in the United States and other regulatory agencies in other countries also periodically inspect manufacturing facilities.\nThe Company is subject to price control restrictions on its pharmaceutical products in the majority of countries in which it operates. To date, the Company has been affected by pricing adjustments in Spain and by the lag in allowed price increases in Yugoslavia and Mexico, which has created lower sales in U.S. dollars and reductions in gross profit. Future sales and gross profit could be materially affected if the Company is unable to obtain price increases commensurate with the levels of inflation.\nLITIGATION, GOVERNMENT INVESTIGATIONS AND OTHER MATTERS\nLITIGATION: The Predecessor Companies were parties to a number of lawsuits. As a result of the Merger, the Company has assumed all of the Predecessor Companies' liabilities with respect to such lawsuits. See \"Item 3. Legal Proceedings.\"\nPRODUCT LIABILITY: The Company could be exposed to possible claims for personal injury resulting from allegedly defective products. The Company generally self-insures against potential product liability exposure with respect to its marketed products, including Virazole(R). While to date no material claim for personal injury resulting from allegedly defective products, including Virazole(R), has been successfully maintained against any of the Predecessor Companies, a substantial claim, if successful, could have a material adverse effect on the Company.\nENVIRONMENTAL MATTERS: The Company has not experienced any material impact on its capital expenditures, earnings or competitive position as a result of compliance with any laws or regulations regarding the protection of the environment. The Company believes it is in compliance in all material respects with applicable laws relating to the protection of the environment.\nEMPLOYEES\nAs of December 31, 1995, the Company employed approximately 7,880 persons, an increase from 5,840 in 1994. The increase is due to acquiring the controlling interest of ICN Oktyabr in St. Petersburg, Russia and the decision to increase sales and marketing resources. At year-end, the Company employed 1,780 persons in sales and marketing, an increase from 1,509 in 1994. Additionally, at year-end, the Company employed 330 in research and development, 4,580 in production, and 1,190 in general and administrative matters. All of the employees employed by ICN Galenika, 245 of the employees of the Company's Mexican subsidiaries and 250 employees of the Company's Spanish subsidiary are covered by collective bargaining agreements, or similar such agreements. National labor laws in some foreign countries in which the Company has substantial operations, including Yugoslavia, Russia and Spain, govern the amount of wages and benefits paid to employees and establish severance and related provisions. The Company currently considers its relations with its employees to be satisfactory and has not experienced any work stoppage or serious labor problems.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe following are the principal facilities of the Company and its subsidiaries:\nDuring the third quarter of 1994, ICN Galenika commenced a construction and modernization program at its pharmaceutical complex outside Belgrade, Yugoslavia. This program includes the construction of two new pharmaceutical manufacturing plants (one to produce cephalosporins, which are broad spectrum penicillin resistant antibiotics, and the other to produce steroids and hormones) and the modernization of the existing facility. It is estimated that this program will have an aggregate cost of $136,000,000. ICN Galenika intends to fund their construction and modernization through existing funds and funds from local operations and locally funded debt.\nIn the opinion of the Company's management, all facilities occupied by the Company are adequate for present requirements, and the Company's current equipment is considered to be in good condition and suitable for the operations involved.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nLITIGATION\nSee Note 7 of Notes to Consolidated Financial Statements.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\nPART II\nITEM 5.","section_5":"ITEM 5.MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nNew ICN began trading its common stock on the New York Stock Exchange beginning November 14, 1994, the first trading day after the Merger was completed and New ICN common stock was approved for listing on the New York Stock Exchange (Symbol: ICN). Prior to the Merger, SPI common stock was first listed on NASDAQ (National Association of Securities Dealers Automated Quotation System) on October 7, 1983 and was subsequently listed on the American Stock Exchange on July 22, 1988.\nThe following table sets forth, from November 14, 1994, the high and low sales prices of the Company's common stock on the New York Stock Exchange. Prior to November 14, 1994, the table sets forth the high and low sales prices for SPI on the American Stock Exchange. During 1995, the Company issued quarterly stock distributions which totaled 5.6%. During 1994, SPI and the Company issued quarterly stock dividends and distributions which totaled 4.8%. The market prices set forth below have been retroactively adjusted for these dividends and distributions.\nAs of March 13, 1996, there were 7,947 holders of record of the Company's common stock.\nThe Board of Directors will continue to review the Company's dividend policy. The amount and timing of any future dividends will depend upon the profitability of the Company, the need to retain earnings for use in the development of the Company's business and other factors.\nSince 1993, and continuing throughout 1994 and 1995, the Company issued the majority of its annual dividend in the form of stock dividends. Beginning with the first quarter dividend of 1996, the Board of Directors elected to discontinue the issuances of stock dividends while increasing its quarterly cash dividend to 7.7 cents per quarter from 7 cents per quarter in 1995, an increase of 10%.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nOn November 1, 1994, the stockholders of ICN, SPI, Viratek and Biomedicals approved the Merger of the Predecessor Companies (\"the Merger\"). On November 10, 1994 (effective November 1, 1994), SPI, ICN and Viratek merged into ICN Merger Corp., and Biomedicals merged into ICN Subsidiary Corp., a wholly-owned subsidiary of ICN Merger Corp. In conjunction with the Merger, ICN Merger Corp. was renamed ICN Pharmaceuticals, Inc. (\"New ICN\" or \"the Company\"). The Merger was accounted for using the purchase method of accounting. Additionally, for accounting purposes, SPI was treated as the acquiring company and as a result, the Company has reported the historic financial data of SPI in its financial results and included the results of ICN, Viratek and Biomedicals from the effective date of the Merger, November 1, 1994.\nThe following table sets forth certain consolidated financial data for the five years ended December 31, 1995, 1994, 1993, 1992 and 1991. This information should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations and the financial statements included elsewhere in this Form 10-K (amounts in thousands, except per share information).\nITEM 7.","section_7":"ITEM 7.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nINTRODUCTION\nSince 1981 the ICN group of companies included a pharmaceuticals products company, SPI Pharmaceuticals, Inc. (\"SPI\"), a research products company, ICN Biomedicals, Inc. (\"Biomedicals\"), a research and development company, Viratek, Inc. (\"Viratek\"), and the parent company, ICN Pharmaceuticals, Inc. (\"ICN\") (collectively, the \"Predecessor Companies\"). Until November 1, 1994, the effective date of the Merger, ICN maintained a controlling interest in the subsidiary companies.\nOn November 10, 1994, SPI, ICN and Viratek merged into ICN Merger Corp., and Biomedicals merged into ICN Subsidiary Corp., a wholly- owned subsidiary of ICN Merger Corp. In conjunction with the Merger, ICN Merger Corp. was renamed ICN Pharmaceuticals, Inc. (\"New ICN\" or \"the Company\"). The Merger was accounted for using the purchase method of accounting. Additionally, for accounting purposes, SPI was treated as the acquiring company and as a result, the Company has reported the historical financial data of SPI in its financial results and the results of ICN, Viratek and Biomedicals have been included with the results of the Company since the effective date of the Merger.\nAs part of the Merger, the Company issued approximately 6,476,770 common shares valued on November 10, 1994 at $20.75 per share, which was the publicly traded price for SPI's common shares at that date. Accordingly, the purchase price, including direct acquisition costs of $3,654,000, has been allocated to the estimated fair value of the net assets, including amounts ascribed to purchased research and development costs for which no alternative use existed of $221,000,000 or $9.55 per share, which was written-off to operations immediately following the consummation of the Merger. Net income, excluding this one-time, non-cash write-off, was $37,419,000 or $1.62 per share in 1994.\nThe Merger resulted in the acquisition of a biomedical business with pre-merger annual sales of approximately $58,000,000, direct access to Viratek's research and development resources including its scientific expertise, substantial tax net operating loss carryforwards and the elimination of royalty payments to Viratek on the sales of Virazole(R).\nRESULTS OF OPERATIONS\nFor financial reporting purposes, the Company's operations are divided into two business segments, the Pharmaceutical segment and the Biomedical segment. Certain financial information for the two business segments is set forth below.\nThis discussion should be read in conjunction with the consolidated financial statements of the Company included elsewhere in this document. For additional financial information by business segment, see Note 10 of Notes to Consolidated Financial Statements.\nNET SALES: The increase in net sales of $88,745,000, or 25%, is primarily a result of higher sales at ICN Galenika. Net sales at ICN Galenika were $234,661,000 for the year ended December 31, 1995 compared to $172,124,000 for the same period last year. The increase in ICN Galenika sales of $62,537,000, or 36%, is primarily due to improved unit sales and favorable price increases for the year compared to 1994. ICN Galenika has also benefited from strong growth of antibiotics, where it holds a 65% market share in Yugoslavia.\nPharmaceutical net sales in 1995, excluding ICN Galenika, increased $26,208,000 compared to 1994, primarily due to increased sales in North America and Western Europe. North American sales rose to $109,505,000 in 1995 from $92,112,000 in 1994, an increase of 19%. Unit sales of virtually all pharmaceutical products increased in the United States in 1995. Sales of the Company's flagship product, Virazole(R), used in aerosol form to treat infants hospitalized with severe respiratory infection caused by respiratory syncytial virus (\"RSV\") and the only antiviral therapeutic for this infection, increased to $44,768,000 in 1995 from $35,868,000 in 1994, an increase of 25%. Prescription dermatologicals increased to $22,769,000 in 1995 from $18,437,000 in 1994, an increase of 24%.\nPharmaceutical net sales in Western Europe rose to $37,226,000 in 1995 from $28,949,000 in 1994. This increase in net sales of 29% is primarily a result of continued strong unit sales of Calcitonina (calcitonin) for osteoporosis and Huberdoxina(TM), an antibiotic in Spain. In addition, expanded resources were used to promote Virazole(R) sales in Western Europe for the 1995-1996 RSV season contributing to an increase in net sales of $2,151,000.\nThe Company's largest selling product, Virazole(R), accounts for approximately 10% of total Company sales and is sold principally in the United States for the treatment of RSV in young infants. RSV is a seasonal disease and overall sales of Virazole(R) from year to year are subject to the incidence and severity of the disease, which cannot be predicted with certainty. The incidence of RSV in the United States for the 1995-1996 season is not as prevalent as was experienced in the 1994-1995 season. The overall impact on 1996 earnings of the incidence of RSV in the 1995-1996 season is uncertain.\nThe increases in net pharmaceutical sales noted above were partially offset by lower sales in Latin America which were negatively impacted by inflation and the devaluation of the Mexican peso. Sales in Latin America decreased to $41,984,000 in 1995 from $56,393,000 in 1994, a decrease of 26%.\nThe biomedical business, acquired in the Merger, had net sales for 1995 of $61,339,000 or approximately 12% of total 1995 net sales. This represents an 8% increase over 1994 proforma net sales, assuming the Merger occurred on January 1, 1994, of $56,727,000, primarily due to the additional sales of diagnostic products acquired from Becton- Dickinson in 1995.\nNet pharmaceutical sales for 1994 declined to $357,821,000 compared to $403,957,000 in 1993. This decrease in net sales was primarily a result of lower sales at ICN Galenika. Net sales at ICN Galenika were $172,124,000 in 1994 compared to $239,832,000 in 1993, primarily due to the differences in exchange rates during 1994 compared to 1993 and the reluctance of the Yugoslavian government to allow sales price increases during 1994. The decrease in sales at ICN Galenika in 1994 is partially offset by sales increases of $21,572,000, or 13%, in the Company's operating units excluding ICN Galenika. The sales in these operations increased to $185,697,000 in 1994 compared to $164,125,000 in 1993. This increase is primarily due to increased Virazole(R) sales of $16,782,000 compared to 1993. Sales and operating results for 1994 were not adversely affected by the devaluation of the Mexican peso during December 1994. As a result of the Merger, the Company acquired a biomedical research products business that contributed $9,030,000 of sales to the 1994 operating results since November 1, 1994.\nGROSS PROFIT: Gross profit as a percentage of sales was 59% for 1995 compared to 50% for 1994. The increase in gross profit is primarily due to improved unit costs at ICN Galenika where gross profit margins increased to 50% in 1995 from 29% in 1994. During 1993, the unit cost of inventory had risen due to higher prices resulting from the economic conditions that existed in Yugoslavia. This higher priced inventory is reflected in cost of sales for 1994 and has been replaced with inventory having a lower unit cost in 1995, resulting from an improved economic environment in Yugoslavia and higher production levels. The gross profit margin in the Company's operating units, other than ICN Galenika, decreased to 67% in 1995 compared to 69% in 1994 due primarily to a full year impact of biomedical sales in 1995 compared to two months of biomedical sales in 1994. The biomedical business has gross profit margins of 56% compared to the pharmaceutical business gross profit margins, excluding ICN Galenika, of 71%.\nGross profit as a percentage of sales was 50% for 1994 compared to 48% in 1993. The increase in the gross profit margin is primarily due to increased sales of Virazole(R) in the United States, partially offset by decreases in the margins at ICN Galenika. Gross profit margin at ICN Galenika decreased to 29% in 1994 from 35% in 1993 primarily due to higher unit costs.\nSELLING, GENERAL AND ADMINISTRATIVE EXPENSES: Selling, general and administrative expenses as a percentage of sales were 38% in 1995 compared to 31% in 1994. This increase was primarily due to higher operating expenses at ICN Galenika resulting from inflationary pressures and the impact of a full year of biomedical operations in 1995 compared to two months of biomedical operations in 1994. The biomedical selling, general and administrative expenses as a percentage of sales is 46% compared to 29% for the pharmaceutical business.\nSelling, general and administrative expenses as a percentage of sales were 31% for 1994 compared to 33% for 1993. The decrease was primarily due to expense reductions at ICN Galenika resulting from a lower provision for bad debts, lower wages and the impact of differences in the exchange rates in 1994 compared to 1993.\nRESEARCH AND DEVELOPMENT COSTS: The increase in research and development costs, excluding the write-off of purchased research and development of $221,000,000, in 1995 compared to 1994 of $9,541,000 is primarily due to the acquisition of the Viratek research programs and increased spending at ICN Galenika. The decrease in research and development costs in 1994 compared to 1993 of $3,826,000 is primarily due to lower costs at ICN Galenika of $5,210,000 resulting from wage reductions for research and development personnel and differences in exchange rates. The 1994 decrease in research and development expense was partially offset by research and development expenses of $1,874,000 resulting from the Merger.\nTRANSLATION AND EXCHANGE (GAINS) LOSSES, NET: Foreign exchange (gains), net, in 1995 were $(9,484,000) compared to foreign exchange losses, net, of $191,000 in 1994. Foreign exchange (gains) at ICN Galenika were $(12,063,000) in 1995 related to exchange rate fluctuations of the dinar and a devaluation of the dinar on November 24, 1995 (See \"Management's Discussion and Analysis of Financial Condition and Results of Operation - ICN Galenika\") which was partially offset by exchange losses of $2,688,000 on the Company's foreign denominated debt. The increase in foreign exchange loss in 1994 compared to 1993 resulted from increased losses at ICN Galenika related to exchange rate fluctuations that occurred before the implementation of the stabilization program. The 1994 exchange losses at ICN Galenika were offset by foreign exchange gains related to certain of the Company's foreign denominated debt.\nINTEREST EXPENSE: The increase in interest expense in 1995 compared to 1994 of $13,572,000 is primarily due to interest expense on additional debt assumed in the Merger and the issuance of $115,000,000 Convertible Notes in November 1994, the proceeds of which were used to pay a portion of the debt assumed in the Merger. Additionally, the weighted average interest rate on short-term borrowings increased to 58% in 1995 compared to 9% in 1994. This increase reflects a hyperinflationary 66% average short-term borrowing rate at ICN Galenika in 1995 compared to a stabilized rate of 9.5% in 1994. The decrease in interest expense in 1994 compared to 1993 of $14,433,000 was primarily due to a decrease in interest expense of $15,840,000 at ICN Galenika. The economic stabilization program enacted by the Yugoslavian government early in 1994 resulted in lower interest rates in 1994 compared to 1993. This decrease in interest expense at ICN Galenika during 1994 was partially offset by increased interest expense in the United States resulting from the assumption of additional debt in connection with the Merger.\nINCOME TAXES: The Company's effective income tax rate was 3%, 6% and 20% for 1995, 1994 and 1993, respectively. In 1995, the Company benefited from a devaluation of ICN Galenika's tax liability balances, utilization of construction tax credits in Yugoslavia and the revaluation of the Company's deferred tax assets. The Company's effective tax rate of 6% in 1994 was significantly different than the expected United States statutory rate of 35% due to the write-off of purchased research and development related to the Merger for which there is no related tax benefit. The Company's effective rate of 20% in 1993 was significantly less than the United States statutory rate primarily due to the utilization of foreign and alternative minimum tax credits and other deferred tax benefits for which a valuation allowance existed at January 1, 1993.\nDuring 1995, the Company utilized $27,000,000 of acquired domestic net operating loss carryforwards (\"NOLs\") having a tax benefit of $9,400,000 for which a valuation allowance had been established as of the effective date of the Merger. The corresponding reduction in the valuation allowance of $9,400,000 resulted in a reduction of goodwill and intangibles acquired in connection with the Merger.\nIn addition to the utilization of the NOLs described above, the Company recognized a $27,000,000 tax benefit of an additional $76,000,000 of acquired NOLs and other deferred tax assets through a reduction in the Company's deferred tax asset valuation allowance. This reduction in the valuation allowance of $27,000,000 resulted in a $24,000,000 reduction in goodwill and intangibles acquired in connection with the Merger and a $3,000,000 reduction in deferred income tax expense. Realization of the deferred tax assets are dependent upon generating sufficient taxable income prior to expiration of the loss carryforwards. Although realization is not assured, management believes it is more likely than not that the remaining net deferred tax assets will be realized. The amount of the deferred tax assets considered realizable, however, could be reduced in the future if estimates of future taxable income during the carryforward period are reduced.\nCertain tax benefits that were acquired in the acquisition of ICN Galenika will expire in 1996. The expiration of these tax benefits will increase the effective tax rate for ICN Galenika. However, this increase may be partially offset by tax credits in connection with plant construction provided in Yugoslavia.\nLIQUIDITY AND CAPITAL RESOURCES\nLiquidity and Capital Resources\nCash provided by operating activities continues to be the Company's primary source of funds for its operating needs, capital expenditures and dividend payments. In 1995, cash provided by operating activities increased $36,769,000 to $79,326,000 primarily due to increased earnings before depreciation and minority interest and an advance payment from Schering-Plough of $23,000,000 related to the use of Virazole(R)for the treatment of hepatitis C, partially offset by cash payments used for the expansion of inventory levels at ICN Galenika of $23,336,000.\nOn July 28, 1995, the Company entered into an Exclusive License and Supply Agreement (the \"Agreement\") and a Stock Purchase Agreement with a subsidiary of Schering-Plough Corporation (\"Schering\") to license the Company's proprietary anti-viral drug ribavirin as a treatment for chronic hepatitis C in combination with Schering's alpha interferon. The Agreement provided the Company an initial non-refundable payment by Schering of $23,000,000, and future royalty payments to the Company for marketing of the drug, including certain minimum royalty rates. Schering will have exclusive marketing rights for ribavirin for the treatment of hepatitis C worldwide, except that the Company will retain the right to co-market in the countries of the European Economic Community. In addition, Schering will purchase up to $42,000,000 in common stock of the Company upon the achievement of certain regulatory milestones. Under the Agreement, Schering will be responsible for all clinical developments worldwide.\nThe $23,000,000 non-refundable payment has been recorded by the Company as prepaid royalty income of $10,000,000, a license fee of $8,000,000 and a liability to Schering for certain cost sharing agreements of $5,000,000. The prepaid royalty will be amortized to income based upon future sales of the product and the license fee will be amortized to income over the exclusive period of the Agreement, fifteen years.\nCash used in investing activities increased $35,635,000 to $47,025,000 due to the continuation of the plant expansion program at ICN Galenika. During 1994 and 1995, ICN Galenika has expended $51,000,000 toward an estimated $136,000,000 project that is expected to be completed in 1998. ICN Galenika intends to fund this program through existing funds and funds generated from local operations and locally funded debt.\nCash used in financing activities increased $47,599,000 to $50,518,000 reflecting principally the early retirement of the 12 7\/8% Sinking Fund Debentures of $34,160,000 and a reduction of notes payable, collateralized by marketable securities, of $8,103,000. In 1995, the Company sold common stock in the amount of $5,753,000 of which approximately $3,000,000 of the proceeds were utilized to purchase the radioimmunoassay product line from Becton-Dickinson and the remainder utilized for working capital purposes. The increase in 1995 distribution payments compared to 1994 is due primarily to a greater number of shares outstanding resulting from the Merger. During 1994, cash used in financing included cash payments to the parent company of $23,718,000 which did not recur in 1995, as a result of the Merger.\nPRODUCT LIABILITY: In December 1985, Management discontinued product liability insurance in the United States. While to date no material adverse claim for personal injury resulting from allegedly defective products has been successfully maintained against the Company, a substantial claim, if successful, could have a material adverse effect on the Company's liquidity and financial performance. See Note 7 of Notes to Consolidated Financial Statements.\nINVESTMENT IN RUSSIA: On July 21, 1995, the Company purchased an additional 34% interest in the Russian pharmaceutical company, Oktyabr, raising its ownership from 41% to 75%. In connection with the acquisition of the additional interest, the Company issued 225,807 shares of its common stock, valued at approximately $3,500,000, based upon the market price of the stock at the time the shares were issued, in exchange for the shares in Oktyabr. The acquisition is not material to the financial position or results of operations of the Company.\nDEMANDS ON WORKING CAPITAL: Management believes that funds generated from operations will be sufficient to meet its normal operating requirements during the coming year. If these funds prove to be insufficient, or if new acquisitions or other opportunities require the Company to raise capital, the Company may seek additional financing or issue preferred stock or additional common stock.\nThe Company is actively engaged in the identification of new businesses and products that complement the Company's existing product lines and markets. At December 31, 1995, the Company has several preliminary acquisition prospects that could require equity or debt financing during 1996.\nIn January, 1996, the Company sold approximately 400,000 shares of its common stock to a foreign bank for net proceeds of $6,000,000. The proceeds were used by the Company for the acquisition of Gly Derm, a Michigan based skin care company, and several smaller acquisitions.\nINFLATION AND CHANGING PRICES: Foreign operations are subject to certain risks inherent in conducting business abroad, including price and currency exchange controls, fluctuations in the relative values of currencies, political instability and restrictive governmental actions. Changes in the relative values of currencies occur from time to time and may, in certain instances, materially affect the Company's results of operations. The effect of these risks remains difficult to predict.\nThe Company is subject to foreign currency risk on its foreign denominated debt of $30,352,000, of which $28,956,000 is in Swiss francs, at December 31, 1995 and to devaluation losses on net monetary assets positions in Yugoslavia and Russia.\nThe effects of inflation are experienced by the Company through increases in the costs of labor, services and raw materials. While the Company attempts to raise selling prices in anticipation of inflation, adverse effects have been experienced in Yugoslavia and in Mexico as a result of price controls.\nThe Company is subject to price control restrictions on its pharmaceutical products in the majority of countries in which it operates. To date, the Company has been affected by the lag in allowed price increases in Yugoslavia and Mexico, which has created lower sales in U.S. dollars and reductions in gross profit. Future sales and gross profit could be materially affected if the Company is unable to obtain price increases commensurate with the levels of inflation.\nICN GALENIKA\nHYPERINFLATION AND DEVALUATION: ICN Galenika, a 75% owned subsidiary, operates in a highly inflationary economy and uses the dollar as the functional currency rather than the Yugoslavian dinar. Before the enactment of an economic stabilization program in January 1994, the rate of inflation in Yugoslavia was over 1 billion percent per year. The rate of inflation was dramatically reduced when, on January 24, 1994, the Yugoslavian government enacted a \"Stabilization Program\" designed to strengthen its currency. Throughout 1994, this program was successful in reducing inflation to approximately 5% per year, increasing the availability of hard currency, stabilizing the exchange rate of the dinar and improving the overall economy in Yugoslavia.\nThroughout 1995, the effectiveness of the stabilization program weakened and ICN Galenika began experiencing a decline in the availability of hard currency in Yugoslavia and inflation levels accelerated to an approximate annual rate of 90% by the end of the year.\nThrough the third quarter of 1995, the net monetary asset position of ICN Galenika had increased due to rising accounts receivable balances resulting from improved sales and the lengthening of the collection period of receivables resulting from the lack of availability of dinars in Yugoslavia. From a beginning balance of $25,442,000 at December 31, 1994, the net monetary asset position of ICN Galenika had risen to $52,366,000 at September 30, 1995. Upon devaluation of the dinar, a net monetary asset position will result in translation losses. Therefore, early in the fourth quarter of 1995, ICN Galenika took action to reduce its monetary exposure by shortening the payment terms on its receivables, reducing sales levels, accelerating the purchase of inventory and accelerating the purchase of building materials for its plant expansion. On November 24, 1995, the dinar devalued from a rate of 1.4 dinars per US $1 to a rate of 4.7 dinars per US $1. On this date, ICN Galenika had a net monetary liability position that resulted in a gain of $8,724,000. As of December 31, 1995, ICN Galenika had a net monetary asset position of $7,396,000 which would be subject to foreign exchange loss if a devaluation of the dinar were to occur.\nAs required by Generally Accepted Accounting Principles (\"GAAP\"), the Company translates ICN Galenika's financial results at the dividend payment rate established by the National Bank of Yugoslavia. To the extent that changes in this rate lag behind the level of inflation, sales and expenses will, at times, tend to be inflated. Future sales and expenses can substantially increase if the timing of future devaluations falls significantly behind the level of inflation. The future of the economic and political environment of Yugoslavia is uncertain and could deteriorate to the point that a severe impact on the financial position and results of operations of the Company could occur.\nSANCTIONS: A substantial majority of ICN Galenika's business is conducted in the Federal Republic of Yugoslavia (Serbia and Montenegro). In December 1995, the United Nations Security Council (\"UNSC\") adopted a resolution that suspended economic sanctions that had been imposed on the Federal Republic of Yugoslavia since May 1992.\nSanctions contributed to an overall deteriorating business environment in which ICN Galenika operated and denied ICN Galenika access to export sales which previously totaled approximately $30,000,000 per year. Sanctions also created restrictions on ICN Galenika's overseas investments and imposed administrative burdens in obtaining raw materials outside of Yugoslavia .\nThe Company believes the suspension of sanctions will provide a more favorable business environment in the future; however, the beneficial effects of the suspension will not take place immediately as the economy needs to adjust to new opportunities. If the peace process in the Balkans deteriorates there is a risk that sanctions could be reinstated.\nPRICE CONTROLS: ICN Galenika is subject to price controls in Yugoslavia. The size and frequency of government approved price increases is influenced by local inflation, devaluations, cost of imported raw materials and demand for ICN Galenika products. During 1995 and 1994, ICN Galenika received fewer price increases than in the past due to lower relative levels of inflation. As inflation increases, the size and frequency of price increases is expected to increase. During the third quarter of 1995, ICN Galenika received a 30% price increase on its pharmaceutical products. This was the first price increase the government had allowed since the start of the stabilization program. Subsequent to the devaluation on November 24, 1995, ICN Galenika received an 80% price increase on its pharmaceutical products. Price increases obtained by ICN Galenika are based on economic events preceding the price increase and not on expectations of ongoing inflation. This lag in allowed price increases creates downward pressure on the gross margins that ICN Galenika receives on its products. When necessary, ICN Galenika will limit sales of products that have poor margins until an acceptable price increase is received. The impact of an inability to obtain adequate price increases in the future could have an adverse impact on the Company as a result of declining gross profit margins or declining sales in an effort to maintain existing gross margin levels.\nFor additional information and expanded discussion regarding the impact of ICN Galenika, see Note 12 of Notes to Consolidated Financial Statements.\nNEW ACCOUNTING PRONOUNCEMENTS\nIn March 1995, the Financial Accounting Standards Board (\"FASB\") issued Statement of Financial Accounting Standards (\"SFAS\") No. 121 on accounting for the impairment of long lived assets. SFAS No. 121 requires the Company to review the carrying amounts of its long lived assets and certain identifiable intangible assets for impairment. If it is determined the carrying amount of the assets is not recoverable, the Company is required to recognize an impairment loss. The accounting standard will be implemented in the first quarter of 1996 and is not expected to result in a material loss.\nDuring October 1995, the FASB issued SFAS No. 123 on accounting for stock based employee compensation plans which must be implemented for fiscal years beginning on or after December 15, 1995. The Company will elect the disclosure only alternative of SFAS No. 123 beginning with its annual financial statements for the year ended December 31, 1996.\nQUARTERLY FINANCIAL DATA (UNAUDITED)\nFollowing is a summary of quarterly financial data for the years ended December 31, 1995 and 1994 (in thousands, except per share amounts):\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE DECEMBER 31, 1995\nReport of independent accountants....................................\nFinancial statements:\nConsolidated balance sheets at December 31, 1995 and 1994............ For the years ended December 31, 1995, 1994 and 1993:\nConsolidated statements of income.................................... Consolidated statements of stockholders' equity...................... Consolidated statements of cash flows................................ Notes to consolidated financial statements...........................\nSchedule supporting the consolidated financial statements for the years ended December 31, 1995, 1994 and 1993:\nII.-- Valuation and qualifying accounts..............................\nThe other schedules have not been submitted because they are not Applicable.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo ICN Pharmaceuticals, Inc.:\nWe have audited the consolidated financial statements and the financial statement schedule of ICN Pharmaceuticals, Inc. (a Delaware corporation, formerly SPI Pharmaceuticals, Inc.) and Subsidiaries listed in the index on page 26 of this Form 10-K. These financial statements and the financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and 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.\nThe Company had certain transactions, through, November 1, 1994, with previously Affiliated Corporations, as more fully described in Note 4. Whether the terms of these transactions would have been the same had they been between wholly unrelated parties cannot be determined.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of ICN Pharmaceuticals, Inc. and Subsidiaries as of December 31, 1995 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, 1995 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 consolidated financial statements taken as a whole, presents fairly, in all material respects, the information required to be included therein.\nCOOPERS & LYBRAND L.L.P. Los Angeles, California February 19, 1996\nICN PHARMACEUTICALS, INC. CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1995 AND 1994 (IN THOUSANDS, EXCEPT PER SHARE DATA)\nThe accompanying notes are an integral part of these consolidated statements.\nICN PHARMACEUTICALS, INC. CONSOLIDATED STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (IN THOUSANDS, EXCEPT PER SHARE DATA)\nThe accompanying notes are an integral part of these consolidated statements.\nThe accompanying notes are an integral part of these consolidated statements.\nICN PHARMACEUTICALS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (IN THOUSANDS)\nThe accompanying notes are an integral part of these consolidated statements.\nICN PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1995\n1.ORGANIZATION AND BACKGROUND:\nOn November 1, 1994, the stockholders of ICN Pharmaceuticals, Inc. (\"ICN\"), SPI Pharmaceuticals, Inc. (\"SPI\"), Viratek, Inc. (\"Viratek\"), and ICN Biomedicals, Inc. (\"Biomedicals\") (collectively, the \"Predecessor Companies\") approved the Merger of the Predecessor Companies, (\"the Merger\"). On November 10, 1994 (effective November 1, 1994), SPI, ICN and Viratek merged into ICN Merger Corp., and Biomedicals merged into ICN Subsidiary Corp., a wholly-owned subsidiary of ICN Merger Corp. In conjunction with the Merger, ICN Merger Corp. was renamed ICN Pharmaceuticals, Inc. (\"New ICN\" or \"the Company\").\nThe Merger was accounted for using the purchase method of accounting. Additionally, for accounting purposes, SPI was treated as the acquiring company and as a result, the Company has reported the historical financial data of SPI in its financial results and includes the results of ICN, Viratek and Biomedicals since the effective date of the Merger, November 1, 1994.\nSPI was incorporated on November 30, 1981, as a wholly-owned subsidiary of ICN and was 39%-owned by ICN prior to the Merger. Viratek and Biomedicals were 63%-owned and 69%-owned by ICN, respectively, prior to the Merger.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:\nPRINCIPLES OF CONSOLIDATION: The accompanying consolidated financial statements for 1995 reflect the first full year results of the Company. The consolidated financial statements for 1994 include the full year financial results of SPI and majority owned subsidiaries, which includes 75% ownership in ICN Galenika (See Note 12), and the financial results of ICN, Viratek and Biomedicals, from the effective date of the Merger. The consolidated financial statements for 1993 reflect the financial results of SPI. Investments in 20% through 50% owned affiliated companies are included under the equity method where the Company exercises significant influence over operating and financial affairs. The accompanying consolidated financial statements reflect the elimination of all significant intercompany account balances and transactions.\nCASH AND CASH EQUIVALENTS: Cash and cash equivalents at December 31, 1995 and 1994, includes $1,017,000 and $36,124,000, respectively, of certificates of deposit which have maturities of three months or less. For purposes of the statements of cash flows, the Company considers highly liquid investments purchased with a maturity of three months or less to be cash equivalents. The carrying amount of these assets approximates fair value due to the short-term maturity of these instruments.\nMARKETABLE SECURITIES: The Company has classified its investment in corporate bond securities, with maturities ranging from 1999 to 2003, as available-for-sale. The contractual maturity value of these corporate bond securities is approximately $26,700,000. The fair value of these corporate bond securities are determined based on quoted market prices. Changes in market values are reflected as unrealized gains and losses, calculated on the specific identification method, directly in stockholders' equity.\nDuring 1995, the Company sold $5,924,000 of corporate bond securities for a total of $6,380,000 including accrued interest resulting in a realized gain of $311,000. In January 1996, the Company sold $26,663,000 of corporate bond securities, plus accrued interest of $860,000, for a total of $27,812,000 resulting in a realized gain of $289,000.\nAt December 31, 1994, marketable securities had an aggregate fair value of $29,155,000.\nICN PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1995\nINVENTORIES: Inventories, which include material, direct labor and factory overhead, are stated at the lower of cost or market. Cost is determined on a first-in, first-out (\"FIFO\") basis.\nPROPERTY, PLANT AND EQUIPMENT: The Company primarily uses the straight-line method for depreciating property, plant and equipment over their estimated useful lives. Buildings and related improvements are depreciated from 7-50 years, machinery and equipment from 3 - 20 years, furniture and fixtures from 4-10 years and leasehold improvements are amortized over their useful lives, limited to the life of the lease.\nThe Company follows the policy of capitalizing expenditures that materially increase the lives of the related assets and charges maintenance and repairs to expense. Upon sale or retirement, the costs and related accumulated depreciation or amortization are eliminated from the respective accounts, and the resulting gain or loss is included in income.\nGOODWILL AND INTANGIBLES: The difference between the purchase price and the fair value of net assets acquired at the date of acquisition is included in the accompanying consolidated balance sheets as goodwill and intangibles. Goodwill and intangibles amortization periods are five years for single product line businesses acquired through November 30, 1986, and 10 to 23 years for certain businesses acquired in 1987, which have other intangibles (patents and trademarks), and whose values and lives can be reasonably estimated. The Company periodically evaluates the carrying value of goodwill and intangibles including the related amortization periods. The Company determines whether there has been impairment by comparing the anticipated undiscounted future operating income of the acquired entity or product line with the carrying value of the goodwill.\nAs a result of the Merger, the Company acquired certain intangible assets (primarily related to patents and customer lists) and goodwill, which were being amortized over 5 to 10 years, using the straight-line method. During 1995, the Company utilized acquired net operating loss carryforwards and reassessed the carrying value of its tax net operating loss carryforwards and other deferred tax assets acquired in the Merger which resulted in the elimination of intangibles and goodwill acquired in the Merger (See Note 5).\nNOTES PAYABLE: The Company classifies various borrowings with initial terms of one year or less as notes payable. The weighted average interest rate on short-term borrowings outstanding at December 31, 1995 and 1994 was 58% and 9%, respectively. This increase reflects a hyperinflationary 66% average short-term borrowing rate at ICN Galenika in 1995 compared to a stabilized rate of 9.5% in 1994.\nFOREIGN CURRENCY TRANSLATION: The assets and liabilities of the Company's foreign operations, except those in highly inflationary economies, are translated at the end of period exchange rates. Revenues and expenses are translated at the average exchange rates prevailing during the period. The effects of unrealized exchange rate fluctuations on translating foreign currency assets and liabilities into U.S. dollars are accumulated in stockholders' equity. The monetary assets and liabilities of foreign subsidiaries in highly inflationary economies are remeasured into U.S. dollars at the year end exchange rates and non-monetary assets and liabilities at historical rates. In accordance with Statement of Financial Accounting Standards (\"SFAS\") No. 52, \"Foreign Currency Translation\", the Company has included in earnings all foreign exchange gains and losses arising from foreign currency transactions and the effects of foreign exchange rate fluctuations on subsidiaries operating in highly inflationary economies. The recorded (gains) losses from foreign exchange translation and transactions for 1995, 1994 and 1993, were $(9,484,000), $191,000 and $(3,282,000), respectively.\nINCOME TAXES: In January 1993, the Company adopted SFAS No. 109, \"Accounting for Income Taxes\". SFAS No. 109 is an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequence 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 an enactment of changes in the tax law or rates. The adoption of SFAS No. 109 in 1993 did not result in a cumulative effect adjustment in the consolidated statements of income.\nUSE OF ESTIMATES: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenue and expenses during the reporting periods. Actual results could differ from those estimates.\nPER SHARE INFORMATION: Per share information is based on the weighted average number of common shares outstanding and the dilutive effect of common share equivalents. Common share equivalents represent shares issuable for outstanding options, on the assumption that the proceeds would be used to repurchase shares in the open market, and also the shares issuable related to certain of the Company's convertible debentures. Such convertible debentures are considered common stock equivalents if they meet certain criteria at the time of issuance and have a dilutive effect, if converted.\nDuring 1995, the Company issued quarterly stock distributions which totaled 5.6%. In 1994, SPI and the Company issued quarterly stock dividends and distributions which totaled 4.8%. In January 1993, SPI issued a 1992 fourth quarter stock dividend of 2%. During 1993, SPI issued additional stock dividends which totaled 6%. All share and per share amounts used in computing earnings per share have been restated to reflect these stock dividends and distributions.\nRECLASSIFICATIONS: Certain prior year items have been reclassified to conform with the current year presentation.\n3. ACQUISITION OF THE PREDECESSOR COMPANIES:\nOn November 10, 1994, SPI, ICN and Viratek merged into New ICN, and Biomedicals merged into ICN Subsidiary Corp., a wholly-owned subsidiary of New ICN. The Merger was accounted for using the purchase method of accounting. Additionally, for accounting purposes, SPI was treated as the acquiring company and as a result, the Company has reported the historical financial data of SPI in its financial results and the results of ICN, Viratek and Biomedicals have been included with the results of the Company since the effective date of the Merger, November 1, 1994.\nAs part of the Merger, the Company issued approximately 6,476,770 common shares valued on November 10, 1994 at $20.75 per share, which was the publicly traded price of SPI's common shares at that date. Accordingly, the purchase price, including direct acquisition costs of $3,654,000, has been allocated to the estimated fair value of the net assets, including amounts ascribed to purchased research and development costs which was charged to operations immediately following the consummation of the Merger.\nThe purchase price allocation, as of the effective date of the Merger, is summarized as follows (in thousands):\nThe Company obtained independent third party appraisals for the acquired in-process research and development costs and certain other intangible costs, primarily patents and trademarks. The $221,000,000 which represents the valuation of acquired in-process research and development for which no alternative use exists, has been charged to operations immediately upon consummation of the Merger in accordance with generally accepted accounting principles. In the fourth quarter of 1995, the purchase price allocation was finalized by recording a liability for a pre-acquisition contingency, as previously disclosed, in an amount that the Company considers adequate.\n4. RELATED PARTY TRANSACTIONS:\nGENERAL: Prior to the Merger, ICN controlled Biomedicals and Viratek through stock ownership and board representation and was affiliated with SPI. Certain officers of ICN occupied similar positions with SPI, Biomedicals, and Viratek and were affiliated with SPI. Prior to the Merger, ICN, SPI, Biomedicals, and Viratek engaged in certain transactions with each other.\nROYALTY AGREEMENTS: Effective December 1, 1990, SPI entered into a royalty agreement with Viratek whereby a royalty of 20% of all sales of Virazole(R) was paid to Viratek. Sales of Virazole(R), for purposes of determining royalties to Viratek, for 1994 and 1993 were $35,855,000 and $29,515,000, respectively, which generated royalties to Viratek for 1994 and 1993 of $7,171,000 and $5,903,000, respectively. As a result of the Merger, the Company is no longer required to pay future royalties on Virazole(R).\nThe Company, under an agreement, amended in 1993, between the Company and the employer of a director, is required to pay $20.00 for each new aerosol drug delivery device manufactured and a 2% royalty on all sales of Virazole(R) in aerosolized form. Such royalties for 1995, 1994 and 1993 were $905,000, $741,000 and $422,000, respectively.\nCOST ALLOCATIONS: Prior to the Merger, the affiliated corporations occupied ICN's facility in Costa Mesa, California. The accompanying consolidated statements of income include charges for rent from ICN of $230,000 for 1994 and $279,000 for 1993. In addition, the costs of common services such as maintenance, purchasing and personnel were incurred by SPI and allocated to ICN, Viratek and Biomedicals based on services utilized. The total of such costs were $2,207,000 for 1994 and $2,584,000 for 1993 of which $1,579,000 and $1,733,000 were allocated to affiliated corporations, respectively. It is management's belief that the methods used and amounts allocated for facility costs and common services were reasonable based upon the usage by the respective companies.\nOTHER: Following is a summary of transactions incurred prior to the Merger, as described above, between the Company and the former affiliated corporations for 1994 and 1993 (in thousands):\nThe average balances due to ICN were $6,326,000 and $26,439,000 for 1994 and 1993, respectively.\nIn July 1995, the Company loaned the Chief Operating Officer of the Company $93,000 for the exercise of stock options, which was repaid in March 1996.\n5. INCOME TAXES:\nPretax income (loss) from continuing operations before minority interest for the years ended December 31, consists of the following (in thousands):\nThe income tax provisions for the years ended December 31, consist of the following (in thousands):\nThe current federal tax provision has not been reduced for the tax benefit associated with the exercise of employee stock options of $1,300,000, $134,000, and $727,000 in 1995, 1994 and 1993, respectively, which were credited directly to additional capital.\nIn connection with the Merger, the Company acquired approximately $226,000,000 of net operating loss carryforwards (\"NOLs\"). Included in the total acquired NOLs are $191,000,000 of domestic NOLs and $35,000,000 of foreign NOLs. Internal Revenue Service Code Section 382 imposes an annual limitation on the availability of NOLs that can be used to reduce taxable income after certain substantial ownership changes of a corporation. Consequently, the Company's annual limitation on utilization of the acquired domestic NOLs is approximately $33,000,000 per year.\nIncluded in the total acquired NOLs is approximately $9,800,000 of domestic NOLs acquired by a subsidiary in a previous business combination. Under the terms of the acquisition agreement, 50% of the tax benefit from the utilization of these acquired NOLs in excess of $500,000 is payable to the former shareholders of which none were utilized in 1995. Under the terms of the acquisition agreement, utilization is determined on a with and without basis.\nIn accordance with SFAS No. 109, any realization of acquired tax benefits must be used to first, reduce goodwill, secondly, reduce acquired noncurrent intangible assets and lastly, reduce income tax expense. During 1995, the Company utilized $27,000,000 of acquired domestic NOLs having a tax benefit of $9,400,000 for which a valuation allowance had been established as of the effective date of the Merger. The corresponding reduction in the valuation allowance of $9,400,000 resulted in a reduction of goodwill and intangibles acquired in connection with the Merger.\nIn addition to the utilization of the NOLs described above, the Company recognized a $27,000,000 tax benefit of an additional $76,000,000 of acquired NOLs and other deferred tax assets through a reduction in the Company's deferred tax asset valuation allowance. This reduction in the valuation allowance of $27,000,000 resulted in a $24,000,000 reduction in goodwill and intangibles acquired in connection with the Merger and a $3,000,000 reduction in deferred income tax expense. Realization of the deferred tax assets is dependent upon generating sufficient taxable income prior to expiration of the loss carryforwards. Although realization is not assured, management believes it is more likely than not that the remaining net deferred tax assets will be realized. The amount of the deferred tax assets considered realizable, however, could be reduced in the future if estimates of future taxable income during the carryforward period are reduced.\nAt December 31, 1995, the Company's domestic NOLs were approximately $159,000,000. These domestic NOLs expire in varying amounts from 1996 to 2008.\nThe primary components of the Company's net deferred tax asset at December 31, 1995 and net deferred tax liability at December 31, 1994, are as follows (in thousands):\nThe Company's effective tax rate differs from the applicable U.S. statutory federal income tax rate due to the following:\nDuring 1995, no U.S. income or foreign withholding taxes were provided on the undistributed earnings of the Company's foreign subsidiaries with the exception of the Company's Panamanian subsidiary, Alpha Pharmaceuticals, since management intends to reinvest those undistributed earnings in the foreign operations. Included in consolidated retained earnings at December 31, 1995, is approximately $118,000,000 of accumulated earnings of foreign operations that would be subject to U.S. income or foreign withholding taxes, if and when repatriated.\nThe Company is under examination by the Internal Revenue Service for the tax years ended November 30, 1991 and 1990. Currently, the proposed adjustments, if upheld, would not result in a significant additional tax liability; however, they would result in a significant reduction in NOL's available to the Company in the future. During 1995, the Company settled audits for tax years 1989 and 1988 which resulted in a reduction in net operating loss carryforwards of $5,000,000 (pretax) and a corresponding decrease in the pretax valuation allowance.\n6. DEBT:\nOn November 17, 1994, the Company completed an underwritten public offering in the principal amount of $115,000,000 of 8.5% Subordinated Convertible Notes (the \"Convertible Notes\"), due in November 1999. These notes are convertible at the option of the holder either in whole or in part, at any time prior to maturity, into the Company's stock at a current conversion price of $22.117 per share, subject to adjustment in certain events. The Convertible Notes are also redeemable, in whole or in part, at the option of the Company at any time on or after November 15, 1997 at the specified redemption prices, plus accrued interest. The fair value of the Convertible Notes was approximately $127,650,000 at December 31, 1995.\nIn October 1986, Xr Capital Holding (\"Xr Capital\"), a trust established by ICN, completed an underwritten public offering in Switzerland of Swiss francs 100,000,000 principal amount of 5-5\/8% Swiss Franc Exchangeable Certificates (the \"Xr Certificates\") of which SFr. 66,510,000 remain outstanding at December 31, 1995. Currently and as a result of the Merger, the face value of the outstanding Xr Capital are convertible into 1,501,172 shares of the Company's common stock at the exchange price of $26.69 per share using a fixed exchange rate of SFr. 1.66 to U.S. $1.00. The net proceeds of the offering were used by Xr Capital to purchase from ICN 14 series of Swiss Franc Subordinated Bonds due 1988-2001 (the \"ICN-Swiss Franc Xr Bonds\") for approximately $27,944,000 and SFr. 45,700,000 principal amount of cumulative coupon 5.4% Italian Electrical Agency Bonds due 2001 for approximately $27,202,000. The Company has no obligation with respect to the payment of the face amount of the Xr Certificates since these are to be paid upon maturity by the Italian Bonds (except for payment of certain additional amounts, in the event of the imposition of U.S. withholding taxes on either the Xr Certificates or ICN Swiss Franc Xr Bonds, for redemption of the Xr Certificates in the event the Company exercises its optional right to redeem). The fair value of the ICN- Swiss Franc Xr Bonds was approximately $14,816,000 at December 31, 1995.\nIn 1987, Bio Capital Holding (\"Bio Capital\"), a trust established by ICN and Biomedicals, completed a public offering in Switzerland of SFr. 70,000,000 principal amount of 5-1\/2% Swiss Franc Exchangeable Certificates (\"Old Certificates\"). The Bio Capital debt is senior, uncollateralized indebtedness of the Company. At the option of the certificate holder, the Old Certificates are exchangeable into shares of the Company's common stock. Net proceeds were used by Bio Capital to purchase SFr. 70,000,000 face amount of zero coupon Swiss Franc Debt Notes due 2002 of the Kingdom of Denmark (the \"Danish Bonds\") for SFr. 33,772,000 and 15 series of zero coupon Swiss Franc Guaranteed Bonds of the Company (the \"Zero Coupon Guaranteed Bonds\") for SFr. 32,440,000 which are guaranteed by the Company. Each series of the Zero Coupon Guaranteed Bonds are in an aggregate principal amount of SFr. 3,850,000 maturing February of each year through 2002. The Company has no obligation with respect to the payment of the principal amount of the Old Certificates since they will be paid upon maturity by the Danish bonds. During 1990, Biomedicals offered to exchange, to all certificate holders, the Old Certificates for newly issued certificates (\"New Certificates\"), the terms of which remain the same except that 71 shares per SFr. 5,000 principal certificate can be exchanged at $47.15 using a fixed exchange rate of SFr. 1.49 to U.S. $1.00. Substantially all of the outstanding Old Certificates were exchanged for New Certificates (together referred to as \"Certificates\"). Currently, the face value of the outstanding Bio Capital (SFr. 39,615,000) are convertible into 552,992 shares of the Company's common stock at the exchange prices of $47.15 and $81.26 using fixed exchange rates of SFr. 1.49 and SFr. 1.54 to U.S. $1.00 for New and Old Certificates, respectively. The fair value of the Zero Coupon Guaranteed Bonds was approximately $9,751,000 at December 31, 1995.\nOn March 25, 1987, ICN completed an underwritten public offering in Switzerland of SFr. 60,000,000 principal amount of 3-1\/4% Subordinated Double Convertible Bonds due 1997 (\"Double Convertible Bonds\"). Currently, the outstanding Double Convertible Bonds totaling SFr. 4,952,000 are convertible into 68,369 shares of the Company's common stock at the exchange price of $47.34 per share using a fixed exchange rate of SFr. 1.53 to U.S. $1.00. The bondholders can convert the Bonds equally into both Ciba Geigy stock and common stock of the Company. In connection with this offering, the Company placed in escrow 15,000 shares of Ciba Geigy Ltd. common stock. As of December 31, 1995, 6,190 shares of Ciba Geigy stock were outstanding and are reflected in the consolidated balance sheet as other non current assets. The fair value of these bonds was approximately $5,215,000 at December 31, 1995. On March 8, 1996, the Company elected to redeem all outstanding 3-1\/4% Subordinated Double Convertible Bonds at par plus accrued interest to the redemption date, April 9, 1996.\nThe Company has the option to redeem the Zero Coupon-ECU Bonds, ICN- Swiss Franc Xr Bonds and Bio Certificates in the event that the market price of the Company's common stock meets certain conditions.\nThe Company has mortgage notes payable totaling $15,175,000, payable in U.S. dollars, Deutsche marks and Dutch guilders, collateralized by certain real property of the Company.\nAnnual aggregate maturities of long-term debt subsequent to December 31, 1995 are as follows (in thousands):\n1996 $ 7,650 1997 9,854 1998 13,522 1999 119,670 2000 4,895 Thereafter 6,252 ---------- Total $ 161,843 ==========\nThe fair value of the Company's debt is estimated based on quoted market prices for the same or similar issues or on the current rates offered to the Company for debt of the same remaining maturities. The carrying amount of all short-term and variable interest rate borrowings approximates fair value.\nSubsidiaries of the Company have short and long-term lines of credit aggregating $12,708,000 of which $2,215,000 was outstanding at December 31, 1995.\n7. COMMITMENTS AND CONTINGENCIES:\nLITIGATION\nThe Predecessor Companies were defendants in a number of lawsuits. As a result of the Merger, the Company has assumed all of the Predecessor Companies' liabilities with respect to such lawsuits.\nThrough May 1995, nineteen lawsuits were filed which named the Company, its Board of Directors, the Chairman and several other officers of the Company as defendants (the \"Defendants\"), all related to the Company's NDA for the use of Virazole(R) for the treatment of chronic hepatitis C (the \"Hepatitis C NDA\"). Eighteen of those lawsuits were consolidated into either the Consolidated Amended Class Action Complaint for Violations of Federal Securities Laws (the \"Securities Complaint\") or the Second Amended Consolidated Verified Derivative Complaint (the \"Derivative Complaint\"). One derivative lawsuit is still pending in Delaware (collectively, the \"1995 Actions\").\nIn general, it is alleged in the Securities Complaint that Defendants made various deceptive and untrue statements of material fact and omitted material facts regarding the Hepatitis C NDA in connection with: (i) the merger of the Company, SPI, Viratek and Biomedicals in November 1994 and the issuance of convertible debentures in connection therewith; and (ii) information provided to the public. Plaintiffs also allege that the Chairman of the Company traded on inside information relating to the Hepatitis C NDA. The Securities Complaint asserts claims for alleged violations of Sections 11 and 15 of the Securities Act of 1933, Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. Plaintiffs seek unspecified compensatory damages, pre- judgment and post-judgment interest and attorneys' fees and costs. Plaintiffs seek the certification of: (i) a class of persons who purchased ICN securities from November 10, 1994 through February 17, 1995; and (ii) a subclass consisting of persons who owned SPI and\/or Biomedicals common stock prior to the Merger. Defendants filed their answer to the Securities Complaint on January 8, 1996 and are actively engaged in the pre-trial discovery process.\nWith respect to the Derivative Complaint, plaintiffs assert claims against ICN's board (as it was composed in early 1995) and one officer for intentional breach of fiduciary duty, negligent breach of fiduciary duty, waste of corporate assets, constructive fraud, gross mismanagement, abuse of control, unjust enrichment and violation of California Corporations Code Section 25502.5, all in connection with the Hepatitis C NDA. Plaintiffs seek disgorgement, unspecified compensatory and punitive damages, attorneys' fees and costs and injunctive and equitable relief. Defendants have filed a motion to dismiss the Derivative Complaint and oral argument on that motion is scheduled for April 15, 1996. Defendants intend to vigorously defend these actions.\nFour lawsuits have been filed with respect to the Merger in the Court of Chancery in the State of Delaware (the \"1994 Actions\"). Three of these lawsuits were filed by stockholders of SPI and, in one lawsuit, of Viratek, against ICN, SPI, Viratek (in the one lawsuit) and certain directors and officers of ICN, SPI and\/or Viratek (including the Chairman) and purport to be class actions on behalf of all persons who held shares of SPI common stock and, in the one lawsuit, Viratek common stock. The fourth lawsuit was filed by a stockholder of Viratek against ICN, Viratek and certain directors and officers of ICN, SPI and Viratek (including the Chairman) and purports to be a class action on behalf of all persons who held shares of Viratek common stock. These suits allege that the consideration provided to the public stockholders of SPI and\/or Viratek (as applicable) in the Merger was unfair and inadequate, and that the defendants breached their fiduciary duties in approving the Merger and otherwise. The 1994 Actions have been dormant for the past year. The Company believes that these suits are without merit and intends to defend them vigorously.\nICN, SPI and Viratek and certain of their officers and directors (collectively, the \"ICN Defendants\") were named defendants in certain consolidated class actions pending in the United States District Court for the Southern District of New York entitled In re Paine Webber Securities Litigation (Case No. 86 Civ. 6776 (BMW)); In re ICN\/Viratek Securities Litigation (Case No. 87 Civ. 4296 (BMW)) (collectively the \"1987 Actions\"). In the Third Amended Complaint, plaintiffs allege that the ICN Defendants made, or aided and abetted Paine Webber, Inc. (\"Paine Webber\") in making, misrepresentations of material fact and omitted material facts concerning the business, financial condition and future prospects of ICN, Viratek and SPI in certain public announcements, Paine Webber research reports and filings with the Securities and Exchange Commission (\"SEC\"). The alleged misstatements and omissions primarily concern developments regarding Virazole(R), including the efficacy, safety and market for the drug. The plaintiffs allege that such misrepresentations and omissions violate Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder and constitute common law fraud and misrepresentation. On December 15, 1995, the ICN Defendants filed a motion to dismiss in part or for partial summary judgment, and in opposition to plaintiffs' motion to amend the Third Complaint. The Court has not yet ruled on the motion.\nFact discovery is complete and expert discovery is virtually complete. On January 3, 1996, the Court affirmed a report and recommendation certifying classes of purchasers of ICN, Viratek and SPI common stock for the period January 7, 1986 through April 15, 1987. Plaintiffs' damages expert, utilizing assumptions and methodologies that the ICN Defendants' damages experts find to be inappropriate under the circumstances, has testified that assuming that classes were certified for purchasers of ICN, Viratek and SPI common stock for the entire class periods and further assuming that all of the plaintiffs' allegations were proven, potential damages against ICN, Viratek and SPI would, in the aggregate, amount to $315,000,000. The ICN Defendants' four damages experts have testified that damages are zero. A trial date has been set for May 28, 1996.\nICN PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1995\nManagement believes that, having extensively reviewed the issues in the above referenced matters, there are strong defenses and the Company intends to defend the litigation vigorously. While the ultimate outcome of the 1987 Actions cannot be predicted with certainty, and an unfavorable outcome could have a material adverse effect on the Company, at this time management does not expect these matters will have a material adverse effect on the financial position and results of operations of the Company.\nIn January 1995, an action was commenced by a former employee against ICN, SPI, Viratek and the Chairman. The complaint asserts causes of action for sex discrimination and harassment, and for violations of the California Department of Fair Employment and Housing statute and a provision of the California Government Code. The complaint seeks injunctive relief and unspecified compensatory and punitive damages. A trial date has been set for September 9, 1996. The defendants intend to vigorously defend the suit.\nIn February 1992, an action was filed in California Superior Court for the County of Orange by Gencon Pharmaceuticals, Inc. (\"Gencon\") against ICN Canada Limited (\"ICN Canada\"), SPI, and ICN, alleging breach of contract and related claims arising out of a manufacturing contract between Gencon and ICN Canada. ICN and SPI were dismissed from the action in March 1993 based on SPI's agreement to guarantee any judgment against ICN Canada. Following trial in 1993, the judge granted judgment in favor of Gencon for breach of contract in the amount of approximately $2,100,000 plus interest, costs and attorneys' fees (which total approximately $650,000). ICN Canada filed its Notice of Appeal and Gencon filed a Notice of Cross-Appeal, seeking approximately $145,000 in additional claimed costs. Both the appeal and cross-appeal have been fully briefed and oral argument is scheduled for April 1996. The defendants intend to vigorously prosecute their appeal.\nOn April 5, 1993, ICN and Viratek filed suit against Rafi Khan (\"Khan\") in the United States District Court for the Southern District of New York. The complaint alleged, among other things, that Khan violated numerous provisions of the securities laws and breached his fiduciary duty to ICN and Viratek by attempting to effectuate a change in control of ICN while acting as an agent and fiduciary of ICN and Viratek. ICN and Viratek are seeking compensatory and punitive damages in the amount of $25,000,000. Khan has filed counterclaims, asserting causes of action for slander, interference with economic relations, a shareholders' derivative action for breach of fiduciary duties, violations of the federal securities laws and tortious interference with economic relations, and is seeking compensatory damages, interest and exemplary damages of $29,000,000. On November 4, 1994, ICN and Viratek moved to have a default judgment entered against Khan and to dismiss his counterclaims. The Company intends to vigorously defend the counterclaims.\nThe Company is a party to a number of other pending or threatened lawsuits arising out of, or incident to, its ordinary course of business. In the opinion of management, amounts accrued for awards, assessments or potential losses in connection with these matters and the matters referred to above, are adequate and the ultimate resolution will not have a material effect on the Company's consolidated financial position or results of operations.\nINVESTIGATIONS: Pursuant to an Order Directing Private Investigation and Designating Officers to Take Testimony, entitled In the Matter of ICN Pharmaceuticals, Inc., (P-177) (the \"Order\"), a private investigation is being conducted by the SEC with respect to certain matters pertaining to the status and disposition of the Hepatitis C NDA. As set forth in the Order, the investigation concerns whether, during the period June 1994 through February 1995, the Company, persons or entities associated with it and others, in the offer and sale or in connection with the purchase and sale of ICN common stock, engaged in possible violations of Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, by having possibly: (i) made false or misleading statements or omitted material facts with respect to the status and disposition of the Hepatitis C NDA; or (ii) purchased or sold ICN common stock while in possession of material, non-public information concerning the status and disposition of the Hepatitis C NDA; or (iii) conveyed material, non-public information concerning the status and disposition of the Hepatitis C NDA, to other persons who may have purchased or sold ICN stock. The Company is cooperating with the SEC in its investigation. To date, the Company has produced documents to the SEC pursuant to its request and the SEC has begun taking depositions of certain officers, directors, and employees of the Company.\nPRODUCT LIABILITY INSURANCE: The Company could be exposed to possible claims for personal injury resulting from allegedly defective products. While to date no material adverse claim for personal injury resulting from allegedly defective products has been successfully maintained against the Company, a substantial claim, if successful, could have a material adverse effect on the Company.\nLICENSE COMMITMENT: In November 1994, the Company entered into a license agreement for the rights to develop and commercialize a group of compounds related to and including human growth hormone releasing factor (\"GRF\"), for the United States and other major pharmaceutical markets. In connection with this agreement, the Company is obligated to pay, upon meeting certain milestones, an aggregate amount of $2,600,000. In addition, after such milestones are met, the Company is obligated to pay a royalty of 9%, subject to certain adjustments, based upon the net sales of GRF in certain territories.\nBENEFITS PLANS: The Company has a defined contribution plan that provides all U.S. employees the opportunity to defer a portion of their compensation for payout at a subsequent date. The Company can voluntarily make matching contributions on behalf of participating and eligible employees. The Company's expense related to such defined contribution plan was not material in 1995, 1994 and 1993.\nIn connection with the Merger, the Company assumed deferred compensation agreements with certain officers and certain key employees of the Predecessor Companies, with benefits commencing at death or retirement. As of December 31,1995, the present value of the deferred compensation benefits to be paid has been accrued in the amount of $2,924,000. Interest accrues on the outstanding balance at rates ranging from 9.5% to 12.6%. No new contributions are being made; however, interest continues to accrue on the present value of the benefits expected to be paid.\nOTHER: Milan Panic, the Company's Chairman of the Board, President and Chief Executive Officer, is employed under a contract expiring December 31, 1998 that provides for, among other things, certain health and retirement benefits. Mr. Panic, at his option, may provide consulting services upon his retirement for $120,000 per year for life, subject to annual cost-of-living adjustments from the base year of 1967. Including such cost-of-living adjustments, the annual cost of such consulting services is currently estimated to be in excess of $535,000. The consulting fee shall not at any time exceed the annual compensation as adjusted, paid to Mr. Panic. Upon Mr. Panic's retirement, the consulting fee shall not be subject to further cost of living adjustments.\nThe Company has Employment Agreements, assumed in connection with the Merger, with five key executives which contain \"change in control\" benefits. Upon a \"change in control\" of the Company as defined in the contract, the employee shall receive severance benefits equal to three times salary and other benefits.\n8. COMMON STOCK:\nPrior to Merger, each of the Predecessor Companies had their own stock option plans. Upon consummation of the Merger, New ICN assumed all options outstanding under the existing stock option plans. The existing stock option plans were exchanged for shares of New ICN. Each option of SPI common stock, ICN common stock, Viratek common stock and Biomedicals common stock was exchanged for 1.0, 0.512, 0.499 and 0.197 options of New ICN common stock, respectively.\nNew ICN assumed three, two and three Nonqualified Stock Option Plans from Biomedicals, ICN and Viratek, respectively, and two employee Incentive Stock Option Plans from each of Biomedicals, ICN and Viratek, respectively. Prior to the Merger, SPI had three Non Qualified Stock Option Plans, one of these Plans was reserved for certain officers of SPI, and two employee Incentive Stock Option Plans. At December 31, 1995, the number of options granted under plans that existed prior to the Merger were 5,159,000. Subsequent to the Merger, no new grants are being issued under these plans.\nAt the time of the Merger, the 1994 Stock Option Plan was adopted and is currently subject to stockholder approval. This plan provides for the granting of a maximum of 3,236,000 stock options. Under the plan each nonemployee director is granted 16,182 options on the day following the annual meeting of stockholders. Shares granted under this plan as of December 31, 1995 were 1,087,000, all of which are outstanding.\nUnder the terms of all stock option plans, the option price may not be less than the fair market value at the date of the grant and may not have a term exceeding 10 years. Option grants vest ratably over a four year period from the date of the grant. The options granted are reserved for issuance to officers, directors, key employees, scientific advisors and consultants.\nThe following table sets forth information relating to stock option plans during the years ended December 31, 1995, 1994 and 1993 (in thousands, except per share data):\nIn 1995, the Company issued quarterly stock distributions which totaled 5.6%. In 1994, the Company issued quarterly stock dividends and distributions which totaled 4.8%. In January 1993, SPI issued a 1992 fourth quarter stock dividend of 2%. During 1993, SPI issued additional quarterly stock dividends which totaled 6%. Accordingly, all relevant stock option data and per share data has been restated to reflect these dividends and distributions.\nIn January 1996, the Company sold approximately 400,000 shares of its common stock to a foreign bank for net proceeds of $6,000,000. The proceeds were used by the Company for the acquisition of Gly Derm, a Michigan based skin care company, and several smaller acquisitions.\nIn 1994, the Company issued common stock for certain bonuses accrued in 1993. The number of shares issued was based upon the fair value of the shares at the date of issuance and a fixed amount related to the bonuses paid.\nDuring the third quarter of 1994, ICN Galenika commenced a construction and modernization program at its pharmaceutical complex outside Belgrade, Yugoslavia. At December 31, 1995 and 1994, construction in progress primarily relates to costs incurred to date for these facilities and includes capitalized interest of $1,978,000 in 1995 and no amounts in 1994.\n(1) Includes a write-off of purchased research and development for which no alternative use exists of $221,000,000 as a result of the Merger.\nGEOGRAPHIC DATA\n(1) Includes a write-off of purchased research and development for which no alternative use exists of $221,000,000 as a result of the Merger.\nIn the fourth quarter of 1995 the purchase price allocation was finalized by recording a liability for a pre-acquisition contingency, as previously disclosed, in an amount that the Company considers adequate.\nThe following table sets forth the amounts of interest and income taxes paid during 1995, 1994 and 1993 (in thousands):\nICN GALENIKA SUMMARY STATEMENTS OF INCOME BEFORE PROVISION FOR INCOME TAXES AND MINORITY INTEREST FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (IN THOUSANDS)\n[FN] The credit to other accounts is primarily due to the impact of devaluations on the outstanding allowance for doubtful accounts. In highly inflationary countries such as Yugoslavia, a devaluation will result in a reduction of accounts receivable and a proportionate reduction in the accounts receivable allowance. The reduction of accounts receivable is recorded as a foreign currency translation loss and the reduction of the allowance is recorded as a translation gain. Shortly after a devaluation the level of accounts receivable will rise as a result of subsequent price increases. In conjunction with the rise in receivables, additions to the allowance for receivables will be made for existing doubtful accounts. This process will repeat itself for each devaluation that occurs during the year. The effect of this process results in a high level of bad debt expense that does not necessarily reflect credit risk or difficulties in collecting receivables.\nThese amounts relate to acquired net operating losses and reserves for inventory obsolescence as a result of the Merger (see Note 1 and 5 of the Notes to the Financial Statements).\nThe credit to other accounts represents the reduction of goodwill and intangibles assets for the utilization and reevaluation of the ultimate realization of acquired net operating losses and other deferred tax assets, as a result of the Merger, and the settlement of an IRS examination for 1989 and 1988 (see Note 5 of Notes to the Financial Statements).\nITEM 9.","section_9":"ITEM 9.CHANGES IN AND DISAGREEMENTS WITH AUDITORS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information required under this Item is incorporated by reference to the Company's definitive Proxy Statement to be filed in connection with the Company's 1995 annual meeting of stockholders. Reference is made to that portion of the Proxy Statement entitled \"Information Concerning Nominees and Directors.\" Information regarding the Company's executive officers is included in Part I of this Form 10-K under the caption \"Executive Officers of the Registrant.\"\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required under this Item is incorporated by reference to the Company's definitive Proxy Statement to be filed in connection with the Company's 1995 annual meeting of stockholders. Reference is made to that portion of the Proxy Statement entitled \"Executive Compensation and Related Matters.\"\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThat information required under this Item is incorporated by reference to the Company's definitive Proxy Statement to be filed in connection with the Company's 1995 annual meeting of stockholders. Reference is made to that portion of the Proxy Statement entitled \"Ownership of the Company's Securities.\"\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThat information required under this Item is incorporated by reference to the Company's definitive Proxy Statement to be filed in connection with the Company's 1995 annual meeting of stockholders. Reference is made to that portion of the Proxy Statement entitled \"Executive Compensation and Related Matters\" and \"Certain Transactions.\"\nPART IV ITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(A) 1. FINANCIAL STATEMENTS\nFinancial Statements of the Registrant are listed in the index to Consolidate Financial Statements and filed under Item 8, \"Financial Statements and Supplementary Data\", included elsewhere in the Form 10-K.\n2. FINANCIAL STATEMENT SCHEDULE\nFinancial Statement Schedule of the Registrant is listed in the index to Consolidated Financial Statements and filed under Item 8, \"Financial Statements and Supplementary Data,\" included elsewhere in this Form 10-K.\n3. EXHIBITS\n3.1. Certificate of Incorporation of Registrant, previously filed as Exhibit 3.1 to Registration Statement No. 2-84984 on Form S-1, which is incorporated herein by reference.\n3.2. Certificate of Amendment of Certificate of Incorporation, dated May 10, 1985, previously filed as Exhibit 3.2 to Registration Statement No. 2-99069, which is incorporated herein by reference.\n3.3. Certificate of Amendment of Certificate of Incorporation, dated December 24, 1986, previously filed as Exhibit 3.3 to annual report on Form 10-K for the year ended November 30, 1986, which is incorporated herein by reference.\n3.4. Bylaws of ICN, previously filed as Exhibit 3.2 to Registration Statement No. 2-84984 on Form S-1, which is incorporated herein by reference. Amendment of bylaws approved by stockholders on November 21, 1986, previously filed as Exhibit 3.4 to annual report on Form 10-K for the year ended November 30, 1986, which is incorporated herein by reference.\n10.1. 1982 Employee Incentive Stock Option Plan, previously filed as Exhibit 10.9 to Registration Statement No. 2-84984 on Form S-1, which is incorporated herein by reference.\n10.2. 1982 Non-Qualified Stock Option Plan, previously filed as Exhibit 10.10 to Registration Statement No. 2-84984 on Form S-1, which is incorporated herein by reference.\n10.3. Xr Capital Holding Trust Instrument between ICN Pharmaceuticals, Inc. and Ansbacher (C.I.) Limited dated as of September 17, 1986; Subscription Agreement between Ansbacher (C.I.) Limited, ICN Pharmaceuticals, Inc., SPI Pharmaceuticals, Inc., and Banque Gutzwiller, Kurz, Bungener S.A. and the other financial institutions named therein dated as of September 17, 1986; Bond Issue Agreement between ICN Pharmaceuticals, Inc. and Ansbacher (C.I.) Limited dated as of September 17, 1986; and Exchange Agency Agreement between ICN Pharmaceuticals, Inc., SPI Pharmaceuticals, Inc. Banque Gutzwiller, Kurz, Bungener S.A., and the other financial institutions named therein dated as of September 17, 1986, previously filed as Exhibit 10.24 to the Company's Annual Report on Form 10-K for the year ended November 30, 1986, which is incorporated herein by reference.\n10.4. Pro forma deed of sale of shares representing 100 percent of Capital Stock of Laboratorios Hubber, S.A. between ICN Pharmaceuticals, Holland B.V., Patrimonio Del Estado, an agency of the Spanish government, and Rumasa, S.A., previously filed as Exhibit 2.1 to Registrant's Current Report on Form 8-K dated February 18, 1987, previously filed as Exhibit 10.25 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992, which is incorporated herein by reference.\n10.5. Foundation Agreement between SPI Pharmaceuticals, Inc. and ICN Galenika dated November 22, 1990 previously filed as Exhibit 10.35 to the Company's Annual Report on Form 10-K for the year ended November 30, 1990, which is incorporated herein by reference.\n10.6. Closing Date Agreement between SPI Pharmaceuticals, Inc. and ICN Galenika dated April 26, 1991, previously filed as Exhibit 10.36 to the Company's Annual Report on Form 10-K for the year ended December 31, 1991, which is incorporated herein by reference.\n10.7. Amendment to Foundation Agreement between SPI Pharmaceuticals, Inc. and ICN Galenika dated December 31, 1991, previously filed as Exhibit 10.39 to the Company's Annual Report on Form 10-K for the year ended December 31, 1991, which is incorporated herein by reference.\n10.8. Additional Amendment to Foundation Agreement between SPI Pharmaceuticals, Inc. and ICN Galenika dated February 27, 1992, previously filed as Exhibit 10.40 to the Company's Annual Report on Form 10-K for the year ended December 31, 1991, which is incorporated herein by reference.\n10.9. Letter of Credit issued by SPI Pharmaceuticals, Inc. in favor of ICN Galenika previously filed as Exhibit 10.41 to the Company's Annual Report on Form 10-K for the year ended December 31, 1991, which is incorporated herein by reference.\n10.10 1992 Employee Incentive Stock Option Plan and Employee Incentive Stock Option Agreement Thereunder previously filed as Exhibit 10.42 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992, which is incorporated herein by reference.\n10.11 1992 Non-Qualified Stock Option Plan and Non- Qualified Stock Option Agreement Thereunder previously filed as Exhibit 10.43 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992, which is incorporated herein by reference.\n10.12 Leave of Absence and Reemployment Agreement between SPI Pharmaceuticals, Inc. and Milan Panic dated July 25, 1992, previously filed as Exhibit 10.44 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992, which is incorporated herein by reference.\n10.13 Application for Registration, Foundation Agreement, Joint Venture - ICN Oktyabr previously filed as Exhibit 10.46 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992, which is incorporated herein by reference.\n10.14 Charter of the Joint Stock Company - ICN Oktyabr, previously filed as Exhibit 10.47 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992, which is incorporated herein by reference.\n10.15 Supplemental Agreement to Subscription Agreement, dated October 14, 1994 between ICN Subsidiary Corp., ICN Merger Corp., DG Bank (Schweiz) AG and Bank Leu AG, previously filed as Exhibit 10.23 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994, which is incorporated herein by reference.\n10.16 Supplemental Agreement to Conversion Agency Agreement dated October 14, 1994 between ICN Merger Corp. and E. Gutzwiller & Cie, previously filed as Exhibit 10.24 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994, which is incorporated herein by reference.\n10.17 First Supplement To Indenture dated October 19, 1994 between ICN Pharmaceuticals, Inc., ICN Merger Corp. and Bank of America National Trust and Savings Association, previously filed as Exhibit 10.25 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994, which is incorporated herein by reference.\n10.18 Supplemental Agreement to Subscription Agreement dated October 14, 1994 between ICN Merger Corp. and Banque Parisbas S.A., previously filed as Exhibit 10.26 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994, which is incorporated herein by reference.\n10.19 First Supplement To Indenture dated October 14, 1994 between ICN Pharmaceuticals, Inc., ICN Merger Corp. and Citibank, N.A., previously filed as Exhibit 10.27 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994, which is incorporated herein by reference.\n10.20 Supplemental Agreement to Subscription Agreement dated October 14, 1994 between ICN Merger Corp. and Bank Leu AG, previously filed as Exhibit 10.28 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994, which is incorporated herein by reference.\n10.21 Second Supplement To Indenture dated October 14, 1994 between ICN Pharmaceuticals, Inc., ICN Merger Corp., and IBJ Schroder Bank and Trust Company, previously filed as Exhibit 10.29 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994, which is incorporated herein by reference.\n10.22 Supplemental Agreement to Bond Issue Agreement dated October 31, 1994 between ICN Pharmaceuticals, Inc, ICN Subsidiary Corp., ICN Merger Corp. and Ansbacher (Guernsey) Limited, previously filed as Exhibit 10.30 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994, which is incorporated herein by reference.\n10.23 Supplemental Agreement to the Bonds dated October 14, 1994 between ICN Merger Crop. and DG Bank, previously filed as Exhibit 10.31 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994, which is incorporated herein by reference.\n10.24 Supplemental Agreement to the Bond Issue Agreement dated October 31, 1994 between ICN Biomedicals, Inc, ICN Pharmaceuticals, Inc., ICN Subsidiary Corp., ICN Merger Crop. and Ansbacher (Guernsey) Limited, previously filed as Exhibit 10.32 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994, which is incorporated herein by reference.\n10.25 Supplemental Agreement to the Bonds dated October 31, 1994 between ICN Merger Crop. and DG Bank, previously filed as Exhibit 10.33 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994, which is incorporated herein by reference.\n10.26 Supplemental Agreement to the Bonds Issue Agreement dated October 31, 1994 between ICN Pharmaceuticals, Inc., ICN Merger Corp. and Ansbacher (Guernsey) Limited, previously filed as Exhibit 10.34 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994, which is incorporated herein by reference.\n10.27 Supplemental Agreement to the Bonds Issue Agreement dated October 31, 1994 between ICN Pharmaceuticals, Inc., ICN Merger Corp. and Ansbacher (Guernsey) Limited, previously filed as Exhibit 10.35 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994, which is incorporated herein by reference.\n10.28 Supplemental Agreement to the Bonds Issue Agreement dated October 31, 1994 between ICN Pharmaceuticals, Inc., ICN Merger Corp. and Ansbacher (Guernsey) Limited, previously filed as Exhibit 10.36 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994, which is incorporated herein by reference.\n10.29 Employment Contract between ICN Pharmaceuticals, Inc. and Milan Panic dated September 6, 1995.\n10.30 1994 Stock Option Plan\n11. Computation of Earnings per Share.\n21. Subsidiaries of the Registrant.\n23. Consent of Coopers & Lybrand L.L.P. Independent Auditors.\n27. Financial Data Schedule.\n(B) REPORTS ON FORM 8-K IN FOURTH QUARTER\nNone.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nICN PHARMACEUTICALS, INC.\nDate: March 30, 1996\nBy: \/s\/ Milan Panic ---------------------------------- Milan Panic, Chairman of the Board and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\n\/s\/ Milan Panic Date:March 28, 1996 - ------------------------------------------------- Milan Panic Chairman of the Board and Chief Executive Officer\n\/s\/ John E. Giordani Date:March 28, 1996 - ------------------------------------------------- John E. Giordani Executive Vice President, Chief Financial Officer and Corporate Controller\n\/s\/ Norman Barker, Jr. Date:March 28, 1996 - ------------------------------------------------- Norman Barker, Jr., Director\n\/s\/ Birch Bayh Date:March 28, 1996 - ------------------------------------------------- Senator Birch Bayh, Director\n\/s\/ Alan F. Charles Date:March 28, 1996 - ------------------------------------------------- Alan F. Charles, Director\n\/s\/ Roger Guillemin Date:March 28, 1996 - ------------------------------------------------- Roger Guillemin, M.D., Ph.D., Director\n\/s\/ Adam Jerney Date:March 28, 1996 - ------------------------------------------------- Adam Jerney, Executive Vice President, Director\nSIGNATURES - CONTINUED\n\/s\/ Dale M. Hanson Date:March 28, 1996 - ------------------------------------------------- Dale M. Hanson, Director\n\/s\/ Weldon B. Jolley Date:March 28, 1996 - ------------------------------------------------- Weldon B. Jolley, Ph. D., Director\n\/s\/ Jean-Francois Kurz Date:March 28, 1996 - ------------------------------------------------- Jean-Francois Kurz, Director\n\/s\/ Thomas Lenagh Date:March 28, 1996 - ------------------------------------------------- Thomas Lenagh, Director\n\/s\/ Charles T. Manatt Date:March 28, 1996 - ------------------------------------------------- Charles T. Manatt, Director\n\/s\/ Stephen Moses Date:March 28, 1996 - ------------------------------------------------- Stephen Moses, Director\n\/s\/ Michael Smith Date:March 28, 1996 - ------------------------------------------------- Michael Smith, Ph.D., Director\n\/s\/ Roberts A. Smith Date:March 28, 1996 - ------------------------------------------------- Roberts A. Smith, Ph.D., Director\n\/s\/ Richard W. Starr Date:March 28, 1996 - ------------------------------------------------- Richard W. Starr, Director\nEXHIBIT INDEX\nSequential Numbering Exhibit Page No. - -------- -----------\n10.29 Employment Contract between ICN Pharmaceuticals, Inc. and Milan Panic dated September 6, 1995.\n10.30 1994 Stock Option Plan\n11. Computation of Earnings Per Share\n21. Subsidiaries of the Registrant\n23. Consent of Coopers & Lybrand L.L.P. Independent Auditors\n27. Financial Data Schedule","section_15":""}
{"filename":"78239_1995.txt","cik":"78239","year":"1995","section_1":"Item 1. Business\nGeneral Overview\nPhillips-Van Heusen Corporation (the \"Company\") is a vertically integrated manufacturer, marketer and retailer of men's, women's and children's apparel and 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 include \"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.\nOn January 24, 1995, the Company signed a binding agreement to acquire the Apparel Group of Crystal Brands, Inc. (\"Crystal Brands\"). This transaction was completed on February 17, 1995, and in connection therewith, the Company acquired ownership of the \"Izod\", \"Gant\" and \"Salty Dog\" brand names. The Company believes this acquisition will enhance its strategy of marketing branded products both at wholesale and retail.\nOn January 24, 1995, the Company also entered into a licensing agreement to make and market \"Jantzen\" branded men's sweaters (the number-one selling sweater in the United States), sport shirts and related bottoms.\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. The Company's wholesale customers for branded and designer apparel include May Co., Federated, JCPenney, Macy's and Younkers. Wholesale customers for its private label shirts include JCPenney, Mervyn's, Lord & Taylor, Lands' End, Sears and Target, while wholesale customers for the Company's private label sweaters and golf apparel include Lands' End, JCPenney, Broadway Stores and Sears. The Company's customers for footwear include May Co., Dillard's, Macy's and Dayton Hudson. In fiscal 1994, 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 872 Company-owned stores operated in five different formats located primarily in manufacturers' outlet malls. At the end of fiscal 1994, these formats were Van Heusen, Geoffrey Beene, Bass, Cape Isle Knitters and Windsor Shirt. See \"Acquisition of the Apparel Group of Crystal Brands\" for a discussion regarding the acquisition of additional stores and the conversion plan for the Company's Cape Isle Knitters and Windsor Shirt stores.\nThe Company believes that its growth in recent years has been due in large part to its strategy of developing multiple channels of distribution for its merchandise. These channels include an increasing number of Company-owned outlet stores as well as the Company's 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. The Company also believes that the continued enhancement and expanded use of its inventory management and electronic data interchange systems and refinement of its promotional and advertising activities has resulted and will continue to result in further strengthening of its brand images, decreased risks of excess production and more efficient utilization of its production facilities and outside suppliers.\nAccording to research conducted by the NPD Consumer Purchase Panel, the Company's \"Van Heusen\" shirt brand is the best-selling dress shirt brand in the United States men's dress shirt market, and the Company's \"Geoffrey Beene\" shirt brand is the best-selling men's designer dress shirt in the United States. 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.\nIn addition to the Company's success with marketing dress shirts, the Company in recent years has extended its major brand product offerings to sportswear. With the acquisition of the \"Izod\", \"Gant\" and \"Salty Dog\" labels, and the license to manufacture and market \"Jantzen\" branded sweaters, sport shirts and bottoms, it is expected that sportswear will continue to increase as a percentage of the Company's sales.\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 wholesale customers.\nCritical to the Company's retailing 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 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 Company's stores 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 of its branded products which has enhanced the Company's ability to reach a broad array of consumers for its 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 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 wholesale product lines. For example, the Company now offers men's and women's sportswear and accessories in many of its Bass stores, has continued increasing the number of its stores offering Geoffrey Beene women's wear and plans to expand on its offering of Bass Kids apparel merchandise in 1995.\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\nforward 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 a 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.\nWrinkle-Free Dress Shirts\nDuring fiscal 1994, the Company began marketing wrinkle-free dress shirts to its wholesale customers and in its own retail stores. While increased advertising and higher production costs associated with introducing this product negatively impacted the Company's earnings in 1994, the Company believes these earnings pressures will be less severe in the future due to lower overall production costs. The Company believes that a niche market for non wrinkle-free dress shirts will exist, and, therefore, the Company plans to continue marketing both wrinkle-free and non wrinkle-free dress shirts for the foreseeable future.\nAcquisition of the Apparel Group of Crystal Brands\nOn February 17, 1995, the Company acquired the Apparel Group of Crystal Brands which added \"Izod\", \"Gant\" and \"Salty Dog\" to the Company's roster of highly regarded brands. The Company plans to market sportswear products under these labels both at wholesale and retail. \"Izod\" and \"Gant\" products are sold at many better department stores in the United States including Lord and Taylor, Macy's, Belk's, Dillard's and May Co. In connection with the acquisition, the Company acquired 88 outlet stores which market apparel under the various labels acquired from Crystal Brands. The Company plans to convert substantially all of these stores in fiscal 1995 to stores which will market apparel under either the \"Izod\" or \"Gant\" label, although several of the acquired stores will either be converted to other store formats which the Company operates, or will be closed. In addition, the Company plans to convert substantially all of its Cape Isle Knitters and Windsor Shirt private label retail stores into stores which will market apparel under the \"Izod\" and \"Gant\" labels, respectively. The Company believes that stores which sell products under a known brand name offer the Company higher profit margins, faster inventory turnover and greater opportunity to expand the product offerings in those stores.\nWholesale Distribution\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. For example, 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. The Company developed the \"Editions\" sub-brand under the \"Van Heusen\" label to cover the price point just above typical private label shirts. 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 fiscal 1994, the Company continued to expand usage of its electronic data interchange system. This quick response system 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 wholesale customers, at the same time as the Company has enhanced the image and increased the exposure of its products.\nApparel Business\nThe marketing of the Company's apparel products is currently conducted principally under the following labels: \"Van Heusen\", \"Geoffrey Beene\", \"Bass\", \"Jantzen\", \"Izod\", \"Gant\" and \"Salty Dog\". The Company also markets various private label apparel products. The Company manufactures dress shirts and sweaters in the Company's facilities in the United States, Puerto Rico and the Caribbean Basin. Additional dress shirts and sweaters, and all of the other sportswear and accessories which the Company markets, are sourced through contractors throughout the world, but primarily in the Far East.\nVan Heusen\n\"Van Heusen\" is the best-selling men's dress shirt brand in the United States, according to research conducted by the NPD Consumer Purchase Panel. In addition to the \"Van Heusen\" label, branded products are marketed under the sub-brands \"417\", \"Hennessy\", \"Players\", \"Over Easy\", \"Corporate Casual\", \"Winter-weights\" and \"Editions.\"\n\"Van Heusen\" branded dress and sport shirts are marketed at wholesale in the moderate to better price range to major department stores and men's specialty stores nationwide, including May Co., Frederick Atkins, JCPenney, Younkers and Mervyns.\nDuring fiscal 1994, the Company continued to expand its offering of Van Heusen \"Corporate Casual\" dress shirts. These shirts have a more casual appearance and have a softer feel than regular dress shirts. The trend in the United States to more casual work attire leads the Company to believe that the overall demand for casual work attire, or \"Friday Wear\", will continue to increase.\nIn addition, wholesale marketing of Van Heusen apparel includes knit sport shirts and sweaters, and golf apparel which is marketed under the \"Van Heusen Players\" label. Major customers include JCPenney and Broadway Stores.\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 Company'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.\nGeoffrey Beene\nThe Company markets dress shirts under the \"Geoffrey Beene\" label through a licensing agreement with that designer. The licensing agreement terminates\non December 31, 1996, but has renewal options which allow the Company to extend the agreement through December 31, 2011. \"Geoffrey Beene\" dress shirts are the best-selling men's designer dress shirts in the United States, according to NPD Consumer Purchase Panel research. Consistent with the increase in the demand for casual work attire, the Company has also expanded its marketing of Geoffrey Beene casual dress shirts. Geoffrey Beene shirts are sold in the upper moderate to better price range to major department stores and men's specialty stores nationwide, including Frederick Atkins, Federated, Macy's and May Co. During fiscal 1994, the Company also expanded on its fiscal 1993 introduction of \"Geoffrey Beene\" men's sweaters.\nGeoffrey 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 fiscal 1994, the Company increased the number of its stores offering \"Geoffrey Beene\" women's wear. Stores offering these products carry a full line of women's casual apparel bearing the designer's name. The Company plans to continue expanding the number of stores offering this product in the future.\nBass\nThe Company's marketing of apparel under the \"Bass\" label began in 1992 and has been continuously expanded since that time.\n\"Bass\" casual dress shirts, marketed at wholesale to major department stores including Federated, Macy's and Frederick Atkins, are sold in the upper moderate to better price range.\nUntil July 1992, the Company's Bass outlet stores had marketed only footwear. Since that time, the Company has introduced apparel and accessories consistent with the Bass \"lifestyle\" into many of its Bass stores. As a further extension of its \"Bass\" apparel products, the Company introduced a line of \"Bass Kids\" apparel merchandise in fiscal 1994. The Company plans to expand this product offering into more of its stores in fiscal 1995.\nJantzen\nOn January 24, 1995, the Company entered into a licensing agreement to make and market \"Jantzen\" branded men's sweaters, sport shirts (including golf apparel) and related bottoms. The licensing agreement expires January 31, 2000 but, under certain conditions, the Company may extend the agreement for an additional five years. \"Jantzen\" is the best-selling sweater in the United States according to NPD Consumer Purchase Panel research, and is sold in the moderate to better price range. Major customers for \"Jantzen\" branded apparel are department and specialty stores including Belk's, Mercantile, Steinbach's and Younkers. The Company believes that the licensing agreement further strengthens the Company's position as the leading sweater and golf apparel supplier in the United States.\nIzod\n\"Izod\" branded apparel products consist of men's and women's sportswear (including sweaters) and golf apparel. These products are marketed in the upper moderate to better price range to major retailers including JCPenney, May Co., Macy's and Lord and Taylor. In addition, golf apparel is marketed to golf pro shops and golf resort retail stores.\nThe Company's retail business offering Izod products will feature stores marketing men's and women's active inspired casual sportswear. Target customers will generally be brand loyalists who expect quality and fashion at reasonable prices. Stores in this format are expected to begin operating in the second half of fiscal 1995.\nGant\/Salty Dog\n\"Gant\" branded apparel consists of a collection of men's sportswear, including woven and knit tops and bottoms. The \"Gant\" brand represents a true American classic offering of men's sportswear designed for comfort and relaxed fit. \"Gant\" products are marketed in the better price range to major retailers including Dillards, Belk's, May Co., Macy's and Lord and Taylor. \"Salty Dog\", a sub-brand of \"Gant\", is used to market casual sportswear with a pre-washed, more casual appearance.\nThe Company's Gant outlet stores will offer fine quality knit and woven shirts, sweaters, pants and shorts, outerwear and accessories for men. The \"Gant\" line incorporates several quality sportswear \"lifestyles\". Included are rugged, spectator-active and Friday casual wear products, all of which maintain detailed construction and the highest quality fabrics. Stores in this format are expected to begin operating in the second half of fiscal 1995.\nPrivate Label Apparel\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. The 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. 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.\nThe Company markets at wholesale men's dress shirts under private labels to major national retail chains, department stores and catalog merchants, including JCPenney, Mervyns, Lord & Taylor, Lands' End, Sears and Marshalls. Private label sport shirts are marketed to major retailers including K-Mart, Wal-Mart, Target, Sears and JCPenney. Private label sweaters and golf apparel are marketed to traditional department and specialty stores, national retail chains and catalog merchants, including JCPenney, Broadway Stores, Sears and Lands' End. The Company also markets shirts to companies in service industries, including major airlines and food chains. The Company believes it is one of the largest marketers of private label shirts in the United States.\nThe Company currently markets private label apparel in two retail store formats: Windsor Shirt and Cape Isle Knitters. Windsor Shirt stores offer a full line of men's traditional and fashionable apparel, including dress shirts, neckwear, bottoms, sportswear, hosiery and accessories. 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. Both the Windsor Shirt and Cape Isle Knitters stores offer merchandise in the moderate to upper moderate price range. See \"Acquisition of the Apparel Group of Crystal Brands\" for a discussion of the Company's plan to convert its Windsor Shirt and Cape Isle Knitters stores.\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\nthe 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 dress shirt competitors include: Bidermann Industries (\"Arrow\" brand); Salant Corporation (\"Perry Ellis\" and \"John Henry\" brands); Warnaco (\"Hathaway\" brand); Smart Shirt (private label shirt division of Kellwood); Capital Mercury (private label shirts); and Oxford Industries (private label shirts). Some of the larger sportswear competitors include: Warnaco (\"Chaps\" brand); Nautica Enterprises (\"Nautica\" brand); and Tommy Hilfiger. For sweaters, the Company's brands compete for department store floor space with private label 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 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. During fiscal 1994, the Company also introduced a line of men's dress shoes. 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\" branded footwear with a 5.9% 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, Canada, South America and Asia.\nAll footwear carried in the Bass wholesale line is designed \"in-house.\" Additional styles which are sold only in the Company's Bass stores are designed both \"in-house\" and by third parties. The Company operates manufacturing facilities in the United States, Puerto Rico and the Dominican Republic. Additional footwear is sourced through manufacturers primarily located in the Far East and Brazil.\nCompany operated Bass stores located in manufacturers' outlet malls typically carry an assortment of \"Bass\" shoes, in the moderate to upper moderate price range, as well as complementary products not sold to wholesale customers. The Company also operates several \"image\" stores, located primarily in large upscale regional malls, typically offering a narrower assortment of \"Bass\" shoes than that carried in Bass 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.\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. 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 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 U.S. Shoe and Famous Footwear, compete on price and assortment.\nMerchandise Design, Manufacturing and Product Procurement\nThe 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. Apparel 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.\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 expanded use of its electronic data interchange 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, Brazil and throughout Central America, 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 in a manner designed 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, in part, to decreased domestic production. The Company monitors factors affecting textile production and\nimports and remains flexible in order to exploit advantages in obtaining materials from different suppliers and different geographic regions. Rawhide leather for \"Bass\" footwear 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.\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.\nTrademarks\nThe Company has the exclusive right to use the \"Gant\", Izod\" and \"Salty Dog\" names in most countries, the \"Van Heusen\" name in North, Central and South America as well as the Philippines, and the exclusive world-wide right to use \"Bass\" for footwear. The Company has registered or applied for registration of numerous 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 has various agreements under which it licenses the use of its brand names. The 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 source, 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 licenses the use of the \"Bass\" name for footwear in Hong Kong, Japan, Europe and Latin America, and for neckwear in the United States. The Company licenses the use of the \"Gant\" name for outerwear and dress furnishings in the United States. The Company licenses the use of the \"Izod\" name for infants, toddlers and childrens clothing, as well as \"big and tall\" apparel, in the United States, and for men's and women's sportswear in Canada. The Company plans to continue expanding its world-wide licensing efforts under the \"Gant\", \"Izod\", \"Salty Dog\" and other trademarks which were acquired from Crystal Brands.\nRetail Stores\nAs of January 29, 1995, the Company operated 872 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 \"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.\nIn connection with the Crystal Brands acquisition, the Company acquired 88 outlet stores which market apparel under the various labels acquired from Crystal Brands. The Company plans to convert substantially all of these stores in fiscal 1995 to stores which will market apparel under either the \"Izod\" or \"Gant\" label, although several of the acquired stores will either be converted to other store formats which the Company operates, or will be closed. In addition, the Company plans to convert substantially all of its Cape Isle Knitters and Windsor Shirt private label retail stores into stores which will market apparel under the \"Izod\" and \"Gant\" labels, respectively. The Company believes that stores which sell products under a known brand name offer the Company larger profit margins, faster inventory turnover and greater opportunity to expand the product offerings in those stores.\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, J. Crew, Jockey, Donna Karan, Sara Lee, 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 1990 and the number of stores operated at the end of each fiscal year:\nFiscal Fiscal Fiscal Fiscal Fiscal 1994 1993 1992 1991 1990\nStore openings:. . . . . . . . . . . . 139 126 116 126 166 (1) Store closings:. . . . . . . . . . . . 47 51 47 40 40 Total stores operated at year end: . . 872 780 705 636 550\n(1) Includes 46 Windsor Shirt stores acquired during fiscal 1990.\nThe Company plans to continue to expand the number of outlet stores which it operates. To continue this expansion, 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, in addition to the stores acquired from Crystal Brands, be the opening of multiple store formats in new malls. There are currently approximately 22 new malls scheduled to open in 1995 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\nAs of January 29, 1995, the Company employed approximately 10,000 persons on a full-time basis and approximately 3,800 persons on a part-time basis. Of the approximately 13,800 persons employed by the Company, 65% are employed in the apparel business, 32% are employed in the footwear business and 3% are corporate employees. Approximately 4% of the Company's total employees are represented for the purpose of collective bargaining by 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.\nItem 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 as of January 29, 1995:\nApparel Business\nSquare Feet of Floor Space (000's)\nOwned Leased Total\nManufacturing Facilities . . . . . . . . . . . . . . 333 277 610 Warehouses and Distribution Centers. . . . . . . . . 1,360 537 1,897 Administrative . . . . . . . . . . . . . . . . . . . 16 52 68 Retail Stores. . . . . . . . . . . . . . . . . . . . 4 1,995 1,999\n1,713 2,861 4,574\nFootwear Business Owned Leased Total\nManufacturing Facilities . . . . . . . . . . . . . . 274 115 389 Warehouses and Distribution Centers. . . . . . . . . 127 185 312 Administrative . . . . . . . . . . . . . . . . . . . 20 135 155 Retail Stores. . . . . . . . . . . . . . . . . . . . 9 1,388 1,397\n430 1,823 2,253\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 in part 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\nBruce J. Klatsky Chairman; President; Chief Executive Officer; Director 46 Irwin W. Winter Vice President, Finance; Chief Financial Officer; Director 61 Walter T. Rossi Chairman, PVH Retail Group 52 Allen E. Sirkin Chairman, PVH Wholesale Group 52 Mark Weber Vice President; Group President, The Sportswear Group 46\nMr. Bruce J. Klatsky has been employed by the Company in various capacities over the last 23 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 and Chairman of the Board of Directors in June of 1994.\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 23 years, has been Vice President of the Company since 1988 and was recently named Group President, The Sportswear Group.\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 1994 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 \"Eight Year Financial Summary\" in the 1994 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 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, which appear in the 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\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 13, 1995.\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 13, 1995.\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 13, 1995.\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 13, 1995.\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 29, 1995, January 30, 1994 and January 31, 1993 Consolidated Balance Sheets--January 29, 1995 and January 30, 1994 Consolidated Statements of Cash Flows--Years Ended January 29, 1995, January 30, 1994 and January 31, 1993 Consolidated Statements of Changes in Stockholders' Equity-- Years Ended January 29, 1995, January 30, 1994 and January 31, 1993 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 (incorporated by reference to Exhibit 3.4 to the Company's Annual Report on Form 10-K for the fiscal year ended January 30, 1993).\n3.5 Amendment to Certificate of Incorporation (incorporated by reference to Exhibit 3.5 to the Company's Annual Report on Form 10- K for the fiscal year ended January 30, 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 (incorporated by reference to Exhibit 4.5 to the Company's Annual Report on Form 10-K for the fiscal year ended January 30, 1994).\n4.6 First Amendment, dated as of February 13, 1995, to the Credit Agreement dated as of December 16, 1993.\n4.7 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).\n4.8 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).\n*10.1 1987 Stock Option Plan, including all amendments through March 30, 1993 (incorporated by reference to Exhibit 10.2 to the Company's Annual Report on Form 10-K for the fiscal year ended January 30, 1994).\n*10.2 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*10.3 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*10.4 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*10.5 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*10.6 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*10.7 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).\nExhibit Number\n*10.8 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).\n*10.9 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).\n10.10 Asset Sale Agreement, dated January 24, 1995, Among the Company and Crystal Brands, Inc., Crystal Apparel, Inc., Gant Corporation, Crystal Sales, Inc., Eagle Shirtmakers, Inc., and Crystal Brands (Hong Kong) Limited (incorporated by reference to Exhibit 1 to the Company's Report on Form 8-K dated March 6, 1995).\n*10.11 Agreement, dated as of April 28, 1993, between Bruce J. Klatsky, Lawrence S. Phillips and the Company.\n*10.12 Non-Incentive Stock Option Agreement, dated as of April 28, 1993, between the Company and Bruce J. Klatsky. Non-Incentive Stock Option Agreement, dated as of December 3, 1993, between the Company and Bruce J. Klatsky (reload of April 28, 1993 Non-Incentive Stock Option Agreement).\n*10.13 Amendment, dated December 6, 1993, to the Agreement, dated April 28, 1993, between Bruce J. Klatsky, Lawrence S. Phillips and the Company.\n*10.14 Consulting and non-competition agreement, dated February 14, 1995, between the Company and Lawrence S. Phillips.\n*10.15 Form of Restricted Stock Plan, effective as of April 18, 1995.\n11. Statement re: Computation of Earnings Per Share.\n13. Sections of the 1994 Annual Report to Stockholders for the fiscal year ended January 29, 1995 which are included in Parts I and II of this Form 10-K. These sections are Selected Quarterly Financial Data, Eight Year Financial Summary, Financial Review and the consolidated financial statements.\n21. Subsidiaries of the Company.\n23. Consent of Independent Auditors.\n27. Financial Data Schedule\n(b) Reports filed on Form 8-K filed during the fourth quarter of 1994:\nForm 8-K dated January 24, 1995\nItem 5. Other Item - The Company enters into a binding agreement to acquire the Apparel Group of Crystal Brands, Inc. subject to approval from a Federal Bankruptcy Court.\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 identified pursuant to Item 14(a) 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.\nPHILLIPS-VAN HEUSEN CORPORATION\nBy: Bruce J. Klatsky Bruce J. Klatsky Chairman, President, Chief Executive Officer and Director\nDate: April 19, 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\nBruce J. Klatsky Chairman, President, Chief Executive April 19, 1995 Bruce J. Klatsky Officer and Director (Principal Executive Officer)\nIrwin W. Winter Vice President, Finance and April 18, 1995 Irwin W. Winter Director (Principal Financial Officer)\nEmanuel Chirico Vice President and Controller April 20, 1995 Emanuel Chirico (Principal Accounting Officer)\nEdward H. Cohen Director April 18, 1995 Edward H. Cohen\nEstelle Ellis Director April 18, 1995 Estelle Ellis\nJoseph B. Fuller Director April 20, 1995 Joseph B. Fuller\nMaria Elena Lagomasino Director April 20, 1995 Maria Elena Lagomasino\nHarry N.S. Lee Director April 20, 1995 Harry N.S. Lee\nBruce Maggin Director April 20, 1995 Bruce Maggin\nEllis E. Meredith Director April 18, 1995 Ellis E. Meredith\nSteven L. Osterweis Director April 18, 1995 Steven L. Osterweis\nWilliam S. Scolnick Director April 20, 1995 William S. Scolnick\nPeter J. Solomon Director April 20, 1995 Peter J. Solomon\nFORM 10-K-ITEM 14(a)(2)\nPHILLIPS-VAN HEUSEN CORPORATION\nINDEX TO FINANCIAL STATEMENT SCHEDULES\nThe following consolidated financial statement schedule of Phillips-Van Heusen Corporation and subsidiaries is included herein:\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.\nSCHEDULE II\nPHILLIPS-VAN HEUSEN CORPORATION\nVALUATION AND QUALIFYING ACCOUNTS Year Ended January 29, 1995\nSCHEDULE II - (Continued)\nPHILLIPS-VAN HEUSEN CORPORATION\nVALUATION AND QUALIFYING ACCOUNTS Year Ended January 30, 1994\nSCHEDULE II - (Continued)\nPHILLIPS-VAN HEUSEN CORPORATION\nVALUATION AND QUALIFYING ACCOUNTS Year Ended January 31, 1993\nEXHIBIT 11\nPHILLIPS-VAN HEUSEN CORPORATION\nCOMPUTATION OF EARNINGS PER COMMON SHARE (In thousands, except per share amounts)\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\nPVH Retail Corp. Delaware\nWindsor Shirt Company Pennsylvania\nEXHIBIT 23\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 14, 1995, 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. 33-50751), Registration Statement (Form S-8 No. 33-59602), 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 14, 1995, 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 29, 1995.\nERNST & YOUNG LLP\nNew York, New York April 28, 1995","section_15":""}
{"filename":"71689_1995.txt","cik":"71689","year":"1995","section_1":"ITEM 1. BUSINESS.\nGENERAL - -------\nNew York Telephone Company (the \"Company\"), which was incorporated in 1896 under the laws of the State of New York, has its principal executive offices at 1095 Avenue of the Americas, New York, New York 10036 (telephone number (212) 395-2121) and provides telecommunications services in New York and a small portion of Connecticut (Greenwich and Byram only). The Company is a wholly-owned subsidiary of NYNEX Corporation (\"NYNEX\").\nEmpire City Subway Company (Limited) (\"Empire\"), a wholly-owned subsidiary of the Company, is primarily in the business of leasing underground conduit in Manhattan and the Bronx, primarily to companies in the telecommunications business. Approximately 92% of Empire's 1995 revenues was generated from the Company.\nIntrastate communications services are under the jurisdiction of state public utility commissions (see State Regulatory below), and interstate communications services are under the jurisdiction of the Federal Communications Commission (\"FCC\") (see Federal Regulatory below). In addition, state and federal regulators review various transactions between NYNEX affiliates.\nThe operations of NYNEX and its subsidiaries have been subject to the requirements of a consent decree known as the \"Modification of Final Judgment\" (\"MFJ\"), which arose out of an antitrust action brought by the United States Department of Justice against AT&T Corp. (\"AT&T\"). Pursuant to the MFJ, AT&T divested its 22 wholly-owned local exchange companies (\"LECs\"), including the Company and New England Telephone and Telegraph Company (\"New England Telephone\"), a wholly-owned subsidiary of NYNEX (collectively, the \"Telephone Companies\"), distributed them to seven regional holding companies (\"RHCs\"), and distributed the stock of the RHCs to AT&T's stockholders on January 1, 1984.\nThe Telecommunications Act of 1996 (the \"Act\") provides that any conduct or activity previously subject to the MFJ is now subject instead to the restrictions and obligations imposed by the Act (see Competition below).\nTELECOMMUNICATIONS SERVICES The Company provides primarily two types of telecommunications services, exchange telecommunications and exchange access, in New York State and a small portion of Connecticut.\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 telephone companies operating within such territory may provide telecommunications services. 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, private line voice\nand data services, Wide Area Telecommunications Service, long distance 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 telecommunications companies, primarily AT&T, and certain information providers that elect to subscribe to these services rather than perform such services themselves. In 1995, approximately 1% of the Company's operating revenues was derived from 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 now performed by the Company. The Company and AT&T are reviewing a proposed extension of the contract through December 31, 1996.\nThere are six LATAs that comprise the area served by the Company, and they are referred to as follows: the New York City Metropolitan Area (which includes Westchester, Rockland, Putnam, Nassau and Suffolk Counties in New York and Greenwich and Byram in Connecticut), Poughkeepsie, Albany-Glens Falls, Syracuse-Utica, Buffalo and Binghamton-Elmira.\nThe following table sets forth for the Company the approximate number of network access lines in service at the end of each year:\nIn Thousands -------------------------------------------------- 1995 1994 1993 1992 1991 ---- ---- ---- ---- ---- Network Access Lines in Service. . . . . . . 10,795 10,477 10,135 9,897 9,735\nThe territories served by the Company contain sizable areas and many localities in which local service is provided by nonaffiliated telephone companies. Rochester, Jamestown, Middletown, Webster and Henrietta, New York are the only cities with a population of more than 25,000 within the Telephone Companies' general operating area that are served by such nonaffiliated companies. On December 31, 1995, these nonaffiliated companies had approximately 1,183,000 network access lines in service.\nFor the year ending December 31, 1995, approximately 94% of the total operating revenues of the Company was derived from telecommunications services, of which one customer, AT&T, accounted for approximately 17%, primarily in network access and other revenues. The remaining approximately 6% of total operating revenues was from other sources, primarily licensing fees for telephone directories and inside wire related charges.\nCERTAIN AFFILIATED BUSINESS OPERATIONS - --------------------------------------\nTELESECTOR RESOURCES GROUP, INC Telesector Resources Group, Inc. (\"Telesector Resources\") is a wholly-owned subsidiary of the Telephone Companies. The Company has a 66 2\/3% ownership in\nTelesector Resources and shares voting rights equally with the other owner, New England Telephone.\nThe Telephone Companies have consolidated all or part of many regional service and support functions into Telesector Resources as part of the business restructuring (see Business Restructuring below). 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, accounting, finance, data processing and related services, 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 RHCs formed in connection with the AT&T divestiture owns an equal interest in Bell Communications Research, Inc. (\"Bellcore\"), which is held by Telesector Resources. 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. In 1995, it was announced that the seven RHC's, including NYNEX, have decided to pursue the disposition of Bellcore. A final decision regarding the disposition of their interests and the structure of such a transaction will be subject to obtaining satisfactory financial and other terms and necessary approvals.\nNYNEX INFORMATION RESOURCES COMPANY The Company has an agreement 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 use of the Company's name in soliciting directory advertising and in publishing and distributing directories. Since 1986, the Company and the New York State Public Service Commission (\"NYSPSC\") have been negotiating the terms of this agreement.\nBeginning in January 1991, Information Resources has made payments to the Company under an arrangement that in effect remits to the Company Information Resources' earnings related to publishing directories in New York in excess of a regulated return. In April 1992, the NYSPSC instituted a proceeding to investigate the directory publishing operations of the Company and its NYNEX affiliates. In December 1993, an administrative law judge of the NYSPSC issued a recommended decision that the Company's proposal not be accepted and that the Company, instead, assume the directory publishing function itself and\/or negotiate a modified agreement with Information Resources. In January 1994, the parties to the proceeding submitted their final briefs to the\nNYSPSC, which is to review the administrative law judge's recommendation and issue a final order. A final order has not been issued.\nBUSINESS RESTRUCTURING - ----------------------\nIn 1993, the Company recorded $992 million in pretax charges ($645 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 savings necessary for the Company to operate in an increasingly competitive environment (see Business Restructuring, Part II, Item 7).\nEXTRAORDINARY ITEM - ------------------\nThe Company discontinued the application of Statement of Financial Accounting Standards No. 71, \"Accounting for the Effects of Certain Types of Regulation\" (\"Statement No. 71\") in the second quarter of 1995. As a result, the Company recorded an extraordinary non-cash charge of approximately $627.8 million, net of income taxes of $414.2 million (see Extraordinary Item, Part II, Item 7).\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 exclude the equity component of allowance for funds used during construction prior to the discontinuance of Statement of Financial Accounting Standards No. 71, \"Accounting for the Effects of Certain Types of Regulation\" (see Extraordinary Item, Part II, Item 7), and additions under capital leases. Capital expenditures for 1991 through 1995 are set forth below:\nIn Millions -------------------------- 1995. . . . . . . . $1,436 1994. . . . . . . . $1,330 1993. . . . . . . . $1,342 1992. . . . . . . . $1,221 1991. . . . . . . . $1,354\nSTATE REGULATORY - ----------------\nSee discussion of State Regulatory in Part II, Item 7, which is incorporated herein by reference.\nNEW YORK In December 1995, MCI Telecommunications Corporation (\"MCI\") commenced a proceeding in the New York Supreme Court challenging the NYSPSC's reciprocal compensation scheme for interconnection between carriers. The Company intervened in the proceeding and filed an answer to MCI's petition in January 1996.\nPursuant to a 1993 NYSPSC order, the Company may retain a portion of 1993 earnings above an 11.7% return on equity, depending on its attainment of specified service quality criteria, with earnings above 12.7% return on equity to be held for the ratepayers' benefit. The Company has submitted a report to the NYSPSC showing 1993 earnings below 11.7%.\nFEDERAL REGULATORY - ------------------\nSee discussion of Federal Regulatory in Part II, Item 7, which is incorporated herein by reference.\nPRICE CAP PLAN Revised tariffs under the price cap rules reduced interstate access rates by approximately $90 million in the 1993-1994 tariff period and $9.4 million in the 1994-1995 tariff period. In August 1995, the Telephone Companies implemented the annual update to the price cap rates, which will result in a net reduction in interstate access rates of approximately $75.0 million by June 1996. The annual update included tariff revisions to recover approximately $21 million of exogenous costs resulting from the implementation of Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\". Collection of these revenues is subject to possible refund pending resolution of the FCC's Common Carrier Bureau investigation.\nIn 1995, the FCC announced interim changes in the price cap rules, under which each LEC will choose one of three productivity factor offsets to be used in setting its price cap index. LECs adopting the highest productivity factor will retain all interstate earnings. The two other options entail sharing of earnings and will allow a maximum interstate return on investment of either 14.25% or 12.75%.\nThe FCC also determined that the 3.3% productivity factor adopted in 1991 and used since then by most LECs, including the Telephone Companies, was understated. Accordingly, the FCC required each such LEC to make up front reductions to \"reinitialize\" its price cap index. The FCC also revised the criteria for including exogenous cost changes and, as a result, each LEC will be required to recalculate its price cap index on a prospective basis to exclude cost increases due to changes in the accounting treatment of other postemployment benefit expenses. Finally, the FCC gave the LECs additional pricing flexibility in certain service categories.\nOTHER FEDERAL In December 1995, MFS Communications (\"MFS\") filed a petition with the FCC for a declaratory ruling that LECs must provide central office collocation with respect to all interstate access services, upon bona fide request. In its petition, MFS cites the Telephone Companies for refusal to provide interconnection to certain services in central offices where MFS is collocated. The Telephone Companies filed comments in which they argued that the FCC's current rules do not require expanded interconnection to the services described in MFS' petition and that the relief sought by MFS would require the FCC to issue a new rule.\nIn October 1995, the U.S. Court of Appeals for the District of Columbia Circuit denied the Telephone Companies' petition for rehearing on its decision\nthat the FCC had understated the amount of damages to be paid in connection with overearnings complaints for the periods 1987-1988 and 1989-1990. In February 1996, the Telephone Companies joined other parties in petitioning the U.S. Supreme Court for review of the Court of Appeals decision. It is probable that the Telephone Companies will be required to pay damages plus interest, which were accrued in 1995. For the period 1987-1988, the amount for New York Telephone is approximately $5.4 million. For the period 1989-1990, New York Telephone will be required to pay approximately $9.7 million.\nIn March 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 had the effect of understating the Telephone Companies' revenue requirement; the net effect was 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. The Order required 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 index; and (3) require the Telephone Companies to improve their internal processes to bring them into compliance. The Telephone Companies filed responses in May and September 1995, demonstrating that forfeitures should not be imposed, that ratepayers were not harmed by the alleged violations, and that internal processes have already been improved.\nCOMPETITION - -----------\nFederal and state regulators have adopted policies favoring competition and have initiated various proceedings to further those policies. Those policies will be advanced by the enactment of the Telecommunications Act of 1996, which immediately opens the Company's local telecommunications markets to full competition. An increasing number of national and global companies with substantial capital and marketing resources are expected to enter many of the Company's local markets.\nMost of the services that the Company provides in its local telecommunications markets have been facing increasing competition for the past several years. The Company has responded by obtaining increased pricing flexibility under incentive regulation, introducing new services, and improving service quality. Increases in 1995 Private Line\/Special Access revenues, and the number of Centrex \"win-backs\" from PBX vendors indicate the Company's ability to respond effectively in its most competitive markets.\nCompetition for intraLATA toll revenues has intensified, beginning in 1994 with the increased marketing of \"dial-around\" programs by interexchange carriers. However, to date, the \"retail\" toll revenues the Company has lost to such programs are being offset in part by increased revenues from wholesale access charges. IntraLATA presubscription (\"ILP\") began in New York in late\n1995 and was completed in February 1996. Future wholesale pricing is the subject of pending regulatory proceedings.\nIn the highly competitive interstate access market, the Company received a waiver from the FCC in 1995, to de-average switched access rates in the metropolitan New York LATA and introduce a new fixed monthly charge paid directly by interexchange carriers. This has enabled the Company to charge prices that more accurately reflect the market conditions in its most competitive area.\nEMPLOYEE RELATIONS - ------------------\nThe Company and its subsidiary had approximately 34,100 employees at December 31, 1995. Approximately 30,900 employees are represented by unions, of which approximately 97% are represented by the Communications Workers of America (\"CWA\") and approximately 3% by the International Brotherhood of Electrical Workers (\"IBEW\"), both of which are affiliated with the AFL-CIO.\nIn 1994, agreements were ratified with the CWA and the IBEW to extend the collective bargaining agreements through August 8, 1998. The wage rates increased 4.0% in August 1994 and 1995 and will increase 3.5% and 3.0% in August 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 stock grant and other incentives to improve service quality.\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, 1995, the gross book value of telephone plant was $20.2 billion, consisting principally of telephone plant and equipment (87%). Other classifications include: land, land improvements and buildings (9%); furniture and other equipment (1%); and plant under construction and other (3%).\nSubstantially all of the Company's central office equipment is located in buildings owned by the Company and is 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. At December 31, 1995, the majority of the planned work centers were completed.\nSubstantially all of the Company's assets are subject to lien under the Company's Refunding Mortgage indenture. At December 31, 1995, the principal amount of Refunding Mortgage bonds outstanding was $1.1 billion.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThere were no proceedings reportable under Item 3.\nPART II\nITEM 6.","section_4":"","section_5":"","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nSee Management's Discussion and Analysis of Results of Operations for the effect of non-recurring items on 1995 results, and restructuring charges on 1995, 1994 and 1993 results of operations. Results of operations for 1991 include $317 million of pretax ($209 million after-tax) restructuring charges.\n* Excludes additions under capital lease obligations, and prior to the discontinuance of regulatory accounting principles, the equity component of allowance for funds used during construction.\nITEM 7.","section_7":"ITEM 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 - ---------------------- New York Telephone Company's (the \"Company\") 1993 results included pretax charges of approximately $992 million ($645 million after-tax) for business restructuring. 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 savings necessary for the Company to operate in an increasingly competitive environment.\nThe 1993 charges were comprised of: $557 million in employee termination costs to reduce the work force by approximately 9,000 employees by the end of 1996; $208 million of process re-engineering charges, primarily for systems redesign and work center consolidation; and $227 million for the Company's allocation of Telesector Resources Group, Inc. (\"Telesector Resources\") business restructuring charges.\n1995 AND 1994 ADDITIONAL CHARGES During 1994, the Company announced retirement incentives to provide a voluntary means of implementing substantially all of the planned work force reductions. The retirement incentives were to be offered at different times through 1996 according to local force requirements and were expected to generate additional charges over that period of time as employees elected to leave the business through retirement incentives rather than through the severance provisions of the 1993 force reduction plan. In 1995 and 1994, respectively, approximately 1,900 and 3,700 of the Company's employees accepted the incentive plan and $304.1 million ($197.6 million after-tax) and $523.4 million ($340.2 million after-tax), respectively, of incremental charges for the cost of retirement incentives were recorded for employees who left the Company, and for the Company's allocation from Telesector Resources for its retirement incentives. The reserves established in 1993 for severance have been and will continue to be transferred primarily to the pension liability on a per employee basis as a result of employees' accepting the retirement incentives. Much of the cost of the enhancements will be funded by NYNEX Corporation's (\"NYNEX\") pension plans.\nThe components of the additional pretax charges for 1995 were: $190.6 million for pension enhancements, $31.0 million for postretirement medical costs, and $82.5 million allocated to the Company from Telesector Resources for its retirement incentives and postretirement medical costs. The components of the additional pretax charges for 1994 were: $309.7 million for pension enhancements; $156.3 million for postretirement medical costs; and $57.4 million allocated to the Company from Telesector Resources for its retirement incentives and postretirement medical costs.\nEMPLOYEE REDUCTIONS The 1993 employee termination costs of $557 million were comprised of $287 million for employee severance payments (including salary, payroll taxes, and outplacement costs) and $270 million for postretirement medical costs\n(total after-tax charges were $362 million). These costs were for planned work force reductions of 1,500 management employees and 7,500 nonmanagement employees. At December 31, 1994, the actual number of employees who elected to leave through retirement incentives in 1994 and the expectation for 1995 and 1996 were as follows:\n1994 1995 1996 Total ------------------------------------------------ Management 1,300* 200 - 1,500 Nonmanagement 2,600 3,500 1,400 7,500 ------------------------------------------------ Total 3,900 3,700 1,400 9,000 ================================================\n* Includes 217 management employees who transferred from the Company to Telesector Resources and subsequently left in 1994 under the pension enhancements.\nCURRENT STATUS During 1995, it became evident that the number of management employees leaving under the retirement incentives would exceed the original estimate due to additional management staff reduction efforts. It was also determined that, due to volume of business growth, the expected reduction in the number of nonmanagement employees would be less and would not be fully realized until 1998. The actual number of employees who elected to leave through retirement incentives in 1995 were 810 management and 1,250 nonmanagement employees, which include 80 management and 70 nonmanagement employees who transferred from the Company to Telesector Resources and subsequently left under the pension enhancements.\nAt the present time, the Company expects the total number of employees who will elect to take the pension enhancements to be in the range of 9,000 to 9,600, consisting of approximately 2,700 management and 6,300 to 6,900 nonmanagement employees, depending on work volumes, needs of the business, and timing of the incentive offers.\nThe actual severance reserves utilized and the application of the postretirement medical liability established in 1993 during 1994 and 1995 are shown below:\n(Dollars In Millions) 1994 1995 Total ------------------------- Severance*# ----------- Management $113 $21 $134 Nonmanagement 22 20 42 ------------------------ Total $135 $41 $176 ========================\nPostretirement Medical# ----------------------- Management $ 46 $ 7 $ 53 Nonmanagement 36 29 65 ------------------------ Total $ 82 $36 $118 ========================\n* The severance utilization amounts in 1995 and 1994 are comprised of $32 and $107 million, respectively, of severance reserves transferred to the pension liability and $1 and $8 million, respectively, utilized for other retiree costs.\n# The severance and postretirement medical amounts above include $8 and $4 million, respectively, in 1995 and $20 and $8 million, respectively, in 1994 which was transferred to Telesector Resources for employees who transferred from the Company to Telesector Resources and subsequently left under the retirement incentives.\nAssuming that employees will continue to leave under the retirement incentives, it is expected that the remaining $111 million of severance reserves will be utilized and the remaining $152 million of the postretirement medical liability will be applied in the years 1996 through 1998.\nPROCESS RE-ENGINEERING Approximately $208 million of the 1993 charges ($135 million after-tax) consists of costs associated with re-engineering service delivery to customers, including operating the Company and New England Telephone and Telegraph Company (\"New England Telephone\") (collectively, the \"Telephone Companies\") as a single enterprise under the \"NYNEX\" brand. During the period 1994 through 1996, NYNEX is decentralizing the provision of residence and business customer service throughout the region, creating regional businesses to focus on unique markets, and centralizing numerous operations and support functions. At December 31, 1994, the actual 1994 utilization of reserves for process re-engineering and the revised expected utilization for 1995 and 1996 were as follows:\n(Dollars In Millions) 1994 1995 1996 Total --------------------------------------------- Systems redesign $ - $ 37 $ - $ 37 Work center consolidation 10 67 28 105 Branding 15 10 - 25 Relocation - 3 - 3 Training - 13 19 32 Re-engineering implementation 1 5 - 6 --------------------------------------------- Total $26 $135 $47 $208 =============================================\nSYSTEMS REDESIGN is the cost of developing new systems, processes and procedures to facilitate implementation of process re-engineering initiatives in order to realize operational efficiencies and enable the Company to reduce work force levels. These projects consist of radical changes in the applications and systems supporting business functions to be redesigned as part of the restructuring plan. All of 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. The business processes included in systems redesign are customer contact and customer operations.\nCUSTOMER CONTACT represents the direct interface with the customer to provide sales, billing inquiry and repair service scheduling on the first contact. CUSTOMER OPERATIONS focuses on network monitoring and surveillance, trouble testing, dispatch control, and proactive repair, with reliability as a critical 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 moving costs, lease termination costs (from the date premises are vacated), and other consolidation costs. BRANDING includes the costs to develop a single \"NYNEX\" brand identity associated with restructured business operations. RELOCATION costs are required to move personnel to different locations due to work center consolidations and include costs based on the Company's relocation guidelines and the provisions of collective bargaining agreements. TRAINING costs are for training\nnonmanagement employees on newly-designed, cross-functional job positions and re-engineered systems created as part of the restructuring plan, which will permit one employee to perform tasks formerly performed by several employees, and include tuition, out-of-pocket course development and administrative costs, facilities charges, and related travel and lodging. RE-ENGINEERING IMPLEMENTATION costs are incremental costs to complete re-engineering initiatives.\nCURRENT STATUS At December 31, 1995, the actual 1994 and 1995 utilization of reserves and revised expectation for 1996 are as follows:\n(Dollars In Millions) 1994 1995 1996 Total --------------------------------------------- Systems redesign $ - $ 68 $46 $114 Work center consolidation 10 35 17 62 Branding 15 4 1 20 Relocation - - 1 1 Training - 2 8 10 Re-engineering implementation 1 - - 1 --------------------------------------------- Total $26 $109 $73 $208 =============================================\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 and permit development of multi-tasking capabilities. A higher degree of complexity and additional functionality required by real-time, interactive systems contributed to the increase. During 1995, systems estimates increased due to the complexity and extensiveness of integration testing and quality assurance processes.\nThe actual 1994 and 1995 utilization and the revised expected utilization in 1996 of the systems redesign reserves, by business process, are as follows:\n(Dollars In Millions) 1994 1995 1996 Total --------------------------------------------- Customer contact $ - $49 $23 $ 72 Customer operations - 19 23 42 --------------------------------------------- Total $ - $68 $46 $114 =============================================\nWORK CENTER CONSOLIDATION was revised in 1994 for an increase in the number of work centers from what was originally planned based on union agreements. The revised estimate for 1996 is based on actual costs incurred to date and reflects the completion of the majority of the planned work centers. RELOCATION of employees was revised downward in 1994 due to the increase in the number of work centers and terms of the union agreements. At the end of 1995, the majority of the work centers are complete. TRAINING was delayed in 1994 due to the timing of the union agreements and the higher degree of complexity of systems redesign; total expected costs were decreased due to the planned use of more in-house training. Training was accomplished in 1995 through in-house, on-the-job, and multi-media training. RE-ENGINEERING IMPLEMENTATION is winding down and will be reported with the related projects in 1996.\nCOSTS ALLOCATED FROM TELESECTOR RESOURCES Approximately $227 million of restructuring charges ($148 million after-tax) was allocated to the Company from Telesector Resources, primarily related to\nits force reduction and re-engineering programs. The actual utilization of reserves in 1994 and 1995 and the expectation for 1996 are as follows:\n(Dollars In Millions) 1994 1995 1996 Total --------------------------------------------- Severance $ 71* $ - $ - $ 71 Postretirement medical costs 31 - - 31 Systems re-engineering 45 68 5 118 Re-engineering implementation 21 14 - 35 --------------------------------------------- Total $168 $82 $ 5 $255 =============================================\n* 1994 includes $28 million of severance amounts associated with the balance of the 1991 restructuring reserve at December 31, 1993.\nCOST SAVINGS Since the inception of process re-engineering and the special pension enhancement program in 1994, approximately 5,600 employees have accepted the retirement incentives. On an annualized basis, this will equate to an average reduction in wages and benefits of approximately $280 million. In addition, the Company's share of the annualized average reduction in wages and benefits attributable to employees of Telesector Resources leaving under retirement incentives will be approximately $110 million. Partially offsetting these cost savings will be the effects of wage and price inflation, growth in volume of business and higher costs attributable to service improvements.\nRESULTS OF OPERATIONS - --------------------- For the years ended December 31, 1995 and 1994, net (loss) income was $(1.8) billion and $345.0 million, respectively. Results for 1995 include: an after-tax extraordinary charge of $2.3 billion for the discontinuance of Statement of Financial Accounting Standards No. 71, \"Accounting for the Effects of Certain Types of Regulation\" (\"Statement No. 71\"); an after-tax charge of $197.6 million for pension enhancements for employees who elected to leave the Company under retirement incentives and for the Company's allocation from Telesector Resources for its pension enhancements; and non-recurring after-tax items of $160.6 million for accruals related to various self-insurance programs, regulatory contingencies, operating tax provisions, and revised benefit charges. Results for 1994 included an after-tax charge of $340.2 million for pension enhancements for employees who elected to leave the Company under retirement incentives and for the Company's allocation from Telesector Resources for its pension enhancements.\nOPERATING REVENUES for 1995 were $7.9 billion, an increase of $200.5 million, or 2.6%, over 1994. Adjusting for a change in presentation in 1995 of gross receipts tax, operating revenues increased 3.3% to $8.0 billion. Supporting the revenue growth was a 3.0% growth in access lines and an 8.3% increase in access usage over last year.\nOPERATING EXPENSES for 1995 were $6.9 billion, a decrease of $25.7 million, or .4%, from 1994. Included in this decrease (and as described below) were: pension enhancement charges in 1995 and 1994; non-recurring charges in 1995; and a change in presentation in 1995 of gross receipts tax. Adjusting for these items, operating expenses were $6.4 billion, an increase of $1.7 million over 1994.\nOPERATING REVENUES\nThe increase in operating revenues is comprised of the following:\n(In millions) ------------- Local service $ 51.2 Long distance - Network access 21.3 Other 128.0 ------ $200.5 ======\nLOCAL SERVICE REVENUES are earned from the provision of local exchange, local private line and local public network services. Increased demand of $97 million, driven by growth in access lines and sales of calling features, was partially offset by a $28 million decrease in rates attributable to an order by the New York State Public Service Commission (\"NYSPSC\") approving a performance-based regulatory plan (the \"Plan\") (see STATE REGULATORY) and an $8 million decrease attributable to potential customer billing claims.\nLONG DISTANCE REVENUES are earned from the provision of services beyond the local service area, but within the local access and transport area, and include public and private network switching. Long distance revenues did not change significantly in 1995. It should be noted that certain competitive losses in long distance revenues are mostly offset by increases in network access revenues.\nNETWORK ACCESS REVENUES are earned from the provision of exchange access services primarily to interexchange carriers. Network access revenues increased $76.5 million, or 3.4%, in 1995 excluding a $55.2 million decrease attributable to a change in the presentation of gross receipts tax collected by the Company on behalf of interexchange carriers. (In the third quarter of 1995, as a result of a change in tax law, the Company was no longer required to pay gross receipts tax to New York State on interstate access revenues. Prior to this change, these taxes were collected from interexchange carriers and remitted to the tax authority and were included in both operating revenues and operating expenses) (see OPERATING EXPENSES). Special access revenues increased $18 million primarily due to increased demand and an increase in interstate rates. Switched access revenues increased a net $58 million due to a $92 million increase in demand, partially offset by a $25 million reduction in interstate rates and a $7 million reduction in intrastate rates attributable to an NYSPSC order (see STATE REGULATORY).\nOTHER REVENUES are earned from the provision of products and services other than Local service, Long distance and Network access. The increase in other revenues is due to the following: (1) $109.2 million due to the cessation of \"setting aside\" revenues in the second quarter of 1995 as a result of an NYSPSC order approving the Plan, (2) $10 million due to the elimination of the deferral of intrastate revenues as a result of the discontinuance of regulatory accounting principles (see Note B), (3) $5 million from revenues earned under a service improvement plan implemented in 1994, (4) $5 million recognized in connection with intraLATA presubscription (\"ILP\") commitments that were met in 1995, and (5) $6 million related to the directory licensing agreement with NYNEX Information Resources Company. These increases were\npartially offset by a $12 million decrease in billing and collection revenues pursuant to a contract with AT&T Corp. (\"AT&T\").\nWith respect to (1) above, future quarters will no longer reflect the setting aside of revenues of $38 million per quarter experienced in 1994 and early 1995. At December 31, 1995, $188 million of revenues remains deferred ($161 million pursuant to the Plan and $27 million pursuant to the service improvement plan) and will be recognized as commitments are met or obligations are satisfied (see STATE REGULATORY).\nOPERATING EXPENSES\nOPERATING EXPENSES for 1995 were $6.9 billion, a decrease of $25.7 million, or .4%, from 1994. Included in this decrease were pension enhancement charges of $304.1 and $523.4 million in 1995 and 1994, respectively, and non-recurring charges in 1995 of $247.1 million for various self-insurance programs, a court decision on overearnings complaints for the periods 1987-1988 and 1989-1990, operating tax provisions and revised benefit charges. These charges reflect events that occurred in 1995 and additional information made available through revised estimates and analyses completed during 1995. In addition, there was a $55.2 million change in presentation in 1995 of gross receipts tax collected by the Company on behalf of interexchange carriers (see NETWORK ACCESS REVENUES). Adjusting for these items, operating expenses were $6.4 billion, an increase of $1.7 million over 1994.\nDEPRECIATION AND AMORTIZATION decreased $92.8 million principally due to: (1) $41 million due to the termination of amortization authorized by the NYSPSC, (2) $39 million due to an adjustment of plant balances as a result of the discontinuance of regulatory accounting principles (see Note B), (3) $15 million related to increased retirement of analog switching equipment partially offset by higher depreciation rates and fixed asset growth in other categories of plant, and (4) a net $2 million increase attributable to represcribed intrastate depreciation rates and a change in interstate depreciation rates in 1995 prior to the adoption of Statement of Financial Accounting Standards No. 101, \"Regulated Enterprises - Accounting for the Discontinuation of Application of FASB Statement No. 71\" (\"Statement No. 101\").\nTAXES OTHER THAN INCOME, which include gross receipts taxes, property taxes and other non-income based taxes, decreased $5.6 million. The decrease is principally due to a decrease in property taxes resulting from lower assessments of property value, partially offset by gross receipts taxes (primarily from a tax settlement).\nEMPLOYEE RELATED COSTS, which consist primarily of wages, payroll taxes, and employee benefits, decreased $58.4 million. Wages and payroll taxes decreased $28 million principally due to reductions in the Company's work force attributable to the Company's force reduction program and the transfers of employees to Telesector Resources associated with re-engineering service delivery to customers (see OTHER OPERATING EXPENSES), partially offset by salary and wage rate increases. Benefit expenses decreased $31 million. There was a $34 million decrease associated with revised charges for postemployment benefits (including revised estimates associated with workers compensation accruals) and a $23 million decrease resulting from the amortization of\ndeferred pension costs pursuant to an intrastate regulatory plan. These decreases were offset by an $18 million increase as a result of the 1994 deferral of postemployment benefits as ordered by the NYSPSC, a $7 million increase in pension expense attributable to changes in actuarial assumptions, and a $2 million increase attributable to revised charges for non-qualified pension plans.\nOTHER OPERATING EXPENSES, which consist primarily of contracted and centralized services, rent and other general and administrative costs, increased $158.5 million. There was a $247 million increase in charges from affiliated companies, primarily attributable to the transfer of functions to Telesector Resources, which includes charges for advertising, telemarketing and sales agent commissions, increases in Telesector Resources' contracted and centralized services and salary and wage rates, and the transfer of employees from the Company to Telesector Resources (see EMPLOYEE RELATED costs). In addition, there was a $29 million increase in the provision for uncollectibles. These increases were partially offset by a $96 million decrease in expenses primarily due to the transfer of functions to Telesector Resources (see EMPLOYEE RELATED COSTS) and to the Company's force reduction program, and a $16 million decrease in right-to-use fees resulting from decreased software deployment.\nOTHER INCOME - NET\nOTHER INCOME - NET increased $8.2 million, or 38.7%, due primarily to the Company's share of interest income on a federal income tax refund to AT&T for the tax years 1981-1983 and the elimination of the amortization of the intrastate portion of previously deferred refinancing costs in the second quarter of 1995 as a result of the discontinuance of regulatory accounting principles (see Note B).\nINTEREST EXPENSE\nINTEREST EXPENSE decreased $7.6 million, or 2.4%, from the same period last year. This decrease was due to the reversal in 1995 of $14 million of previously recorded interest on the revenue set aside as ordered by the NYSPSC (see STATE REGULATORY), partially offset by an increase in interest on funded debt as a result of the issuance of $600 million of long-term debt in February 1994.\nINCOME TAXES\nINCOME TAXES increased $86.5 million, attributable to an increase in pretax income, a decrease in amortization of investment tax credits, and the elimination of excess deferred tax reversals as a result of the discontinuance of regulatory accounting principles (see Note B).\nEXTRAORDINARY ITEM\nThe discontinued application of Statement No. 71 required the Company, for financial accounting purposes, to adjust the carrying amount of telephone plant and equipment and to eliminate non-plant regulatory assets and liabilities from the balance sheet. This change resulted in an after-tax\ncharge of $2.3 billion, consisting of $1.8 billion to adjust telephone plant and equipment and $0.5 billion to write off non-plant regulatory assets and liabilities. The Company now utilizes shorter asset lives for certain categories of telephone plant and equipment than those previously approved by regulators (see Note B).\nFINANCING\nAt December 31, 1995, the Company had $250 million of unissued, unsecured debt securities registered with the Securities and Exchange Commission.\nCOLLECTIVE BARGAINING AGREEMENTS - --------------------------------\nIn May 1994, agreements were ratified with the Communications Workers of America and the International Brotherhood of Electrical Workers in New York to extend the collective bargaining agreements through August 8, 1998. The wage rates increased 4.0% in August 1994 and 1995 and will increase 3.5% and 3.0% in August 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 stock grant and other incentives to improve service quality.\nREGULATORY ENVIRONMENT - ----------------------\nSTATE REGULATORY During 1995 the Company was able to replace rate of return regulation with a price regulation plan in New York. This state regulatory plan eliminates the Company's obligation to share earnings with customers, allows the Company greater flexibility to vary prices to meet competition, and imposes service quality performance measurements.\nINCENTIVE PLAN: In 1995, the NYSPSC approved with modifications a Plan that changes the manner in which the Company will be regulated by the NYSPSC over the next five to seven years. Prices are capped at current rates for \"basic\" services such as residence and business exchange access, residence and business local calling and LifeLine service, and price reduction commitments are established for a number of services, including toll and intraLATA carrier access services. Certain prices may be adjusted annually based on an inflation index and costs associated with NYSPSC mandates and other defined \"exogenous\" events. Depending on whether the Plan remains in effect for five or seven years, the Company's prices will have been decreased by an amount that, based on current volumes of business, would produce an aggregate revenue reduction over the term of the plan of $1.1 billion at the end of five years, or $1.9 billion at the end of seven years.\nThe Plan also establishes service quality targets with stringent rebate provisions if the Company is unable to meet some or all of the targets, and sets an accelerated schedule for the provision of ILP. The Company's compliance tariffs under the Plan became effective on a temporary basis as of September 1, 1995, and will remain temporary pending the NYSPSC Staff's review and investigation.\nThe NYSPSC has rejected various petitions that had been filed for reconsideration of the order approving the Plan and indicated that it had approved a Staff plan for monitoring the Company's compliance. In late 1995, MCI Telecommunications Corporation (\"MCI\") commenced a proceeding in the New York Supreme Court seeking to overturn the NYSPSC's orders with respect to the Plan. MCI challenges the lack of an earnings cap and asserts that the Company's rates should be further reduced annually by the amount of the $153 million set-aside.\nCOMPETITION II PROCEEDING: In 1995, the NYSPSC issued an order resolving certain issues in its proceeding on local exchange competition in New York State. The Company must provide White Pages directory listings at no charge to customers of competitive local exchange carriers (\"CLECs\"), but may negotiate fees with CLECs for delivery of the directories to their customers. The NYSPSC also established a reciprocal compensation scheme for the payment of access rates when the Company and CLECs terminate traffic on each other's networks. In general, the NYSPSC's plan permits \"full-service, facilities-based\" local exchange carriers to pay a lower rate than other carriers will be required to pay. The NYSPSC also determined that the Company must, upon request, provide services to interconnect CLECs that are collocated in the Company's central offices.\nThe NYSPSC also directed the Company to file tariffs to remove restrictions on the resale of residential services, effective February 1996, or to show cause why such restrictions should not be removed. In January 1996, following the Company's show-cause response requesting more time for implementation, the NYSPSC issued an order requiring implementation, with respect to both residential and business services, in October 1996.\nThe NYSPSC has issued orders resolving various procedural and operational issues related to ILP. The NYSPSC approved the Company's proposal to implement ILP for analog central offices as those switches are replaced by digital equipment. By the end of February 1996, the Company had implemented ILP in all of its digital switching systems.\nOTHER: In 1991, the NYSPSC authorized a $250 million increase in the Company's rates, of which $47.5 million annually remains subject to refund pending resolution of certain issues related to the Company's transactions with other NYNEX affiliates in 1984-1990. In 1995, the NYSPSC's independent consultant concluded its final report detailing findings and recommendations, and an NYSPSC administrative law judge issued a procedural ruling for future hearings and the filing of evidence. In January 1996, the Company filed notice with the NYSPSC of its intention to open settlement discussions in this case and requested an extension of the date for the filing of testimony.\nFEDERAL REGULATORY PRICE CAP PLAN: The Telephone Companies are subject to incentive regulation in the form of price caps. Price cap limits are subject to adjustment each year to reflect inflation, a productivity factor and certain other cost changes. In 1995, the Federal Communications Commission (\"FCC\") issued a Notice of Proposed Rulemaking regarding the productivity factor used by local exchange carriers (\"LECs\") in the FCC price cap formula. The Proposed Rulemaking will consider changes in the determination of the productivity factor, the recognition of exogenous costs, the extent of carrier sharing,\nand the formula for calculating the price cap index for certain services. The FCC expects to issue an order in time for the final changes to be reflected in LECs' rates as of July 1996. The FCC has also issued a Notice of Proposed Rulemaking to determine how the price cap rules should be modified to accommodate increasing levels of competition. The FCC asked for comments on a proposal by the Telephone Companies that earnings sharing be reduced or eliminated as an LEC implements measures to promote competition for local exchange services. The FCC has indicated that it intends to establish a rulemaking proceeding in 1996 to consider reform of the rules concerning the structure of access charges. This rulemaking proceeding would consider changes that might be necessary as competition increases in the local telephone market.\nOTHER FEDERAL Regulatory: In January 1996, the FCC issued a Notice of Proposed Rulemaking addressing the charges made for interconnection between LECs and wireless carriers. Currently, such charges are established by contracts under the jurisdiction of the state regulatory commissions. The FCC requested comment on its tentative conclusion to require, pending the completion of its Proposed Rulemaking, reciprocal \"bill-and-keep\" compensation arrangements under which the originating carrier would no longer pay the terminating carrier for access. Adoption of the proposed procedure would have a negative effect on the revenues of the LECs, including the Telephone Companies. The Telephone Companies plan to participate actively in the proceeding.\nDuring 1996, the FCC will conduct a number of rulemaking proceedings in order to implement the Telecommunications Legislation enacted in February 1996.\nITEM 8.","section_7A":"","section_8":"ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS.\nREPORT OF MANAGEMENT\nManagement of New York Telephone Company and its subsidiary (the \"Company\") has the responsibility for preparing the accompanying consolidated financial statements and for their integrity and objectivity. The consolidated financial statements were prepared in accordance with generally accepted accounting principles, which require Management to make estimates and assumptions that affect reported amounts. Actual results could differ from those estimates. In Management's opinion, the consolidated financial statements are fairly presented. Management also prepared the other information in this report and is responsible for its accuracy and consistency with the consolidated financial statements.\nThe consolidated 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 consolidated 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 York Telephone Company:\nWe have audited the consolidated financial statements and the consolidated financial statement schedule of New York Telephone Company and Subsidiary (the \"Company\") listed in Item 14(a)(1) and (2) of this Form 10-K. These consolidated financial statements and consolidated financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and consolidated financial statement schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 1995 and 1994, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles. In addition, in our opinion, the consolidated financial statement schedule referred to above, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information required to be included therein.\nAs discussed in Note B to the consolidated financial statements, in the second quarter of 1995, 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\". Additionally, as discussed in Note D to the consolidated financial statements, in the fourth quarter of 1993, the Company adopted Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits\", retroactive to January 1, 1993.\nCoopers & Lybrand L.L.P.\nNew York, New York February 5, 1996\nSee accompanying notes to consolidated financial statements.\nNEW YORK TELEPHONE COMPANY CONSOLIDATED BALANCE SHEETS --------------------------- DOLLARS IN MILLIONS\nDecember 31, ------------------------------- 1995 1994 ---- ---- ASSETS - ------ Current assets: Cash $ 39.9 $ 23.1 Receivables Trade (net of allowance of $154.7 and $133.6, respectively) 1,584.9 1,441.4 Affiliates 45.5 24.7 Other 29.2 18.3 Deferred charges 52.5 39.0 Deferred income taxes 44.1 105.1 Inventory 62.8 73.5 Prepaid expenses and other 82.4 57.2 --------- --------- Total current assets 1,941.3 1,782.3 --------- ---------\nTelephone plant - net 9,305.8 12,022.7\nDeferred charges and other 321.8 1,491.2 --------- --------- TOTAL ASSETS $11,568.9 $15,296.2 ========= =========\nSee accompanying notes to consolidated financial statements.\nNEW YORK TELEPHONE COMPANY CONSOLIDATED BALANCE SHEETS --------------------------- DOLLARS IN MILLIONS\nDecember 31, -------------------------- 1995 1994 ---- ---- LIABILITIES AND SHARE OWNER'S EQUITY - ------------------------------------\nCurrent liabilities: Accounts payable AT&T $ 203.6 $ 218.5 Affiliates 840.6 671.6 Compensated absences 151.7 155.1 Trade and other 908.1 951.2 Short-term debt 367.0 294.2 Dividends payable 180.5 181.2 Taxes accrued 29.8 72.9 Advance billing and customers' deposits 173.8 178.3 Interest accrued 67.2 74.7 --------- --------- Total current liabilities 2,922.3 2,797.7 --------- ---------\nLong-term debt 3,913.3 3,972.4 Deferred income taxes 102.1 1,611.3 Unamortized investment tax credits 130.9 212.5 Other long-term liabilities and deferred credits 2,027.5 1,896.9 --------- ---------- Total liabilities 9,096.1 10,490.8 --------- ---------\nCommitments and contingencies (Notes H, I, J, M and N)\nShare owner's equity: Common stock - one share, without par value (Note R) 1.0 4,103.2 Additional paid-in capital (Note R) 3,741.2 - Retained earnings\/(Accumulated deficit) (1,269.4) 702.2 --------- --------- Total share owner's equity 2,472.8 4,805.4 --------- ---------\nTOTAL LIABILITIES AND SHARE OWNER'S EQUITY $11,568.9 $15,296.2 ========= =========\nSee accompanying notes to consolidated financial statements.\nNEW YORK TELEPHONE COMPANY CONSOLIDATED STATEMENTS OF CASH FLOWS ------------------------------------- DOLLARS IN MILLIONS\nSee accompanying notes to consolidated financial statements.\nNEW YORK TELEPHONE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nA ACCOUNTING POLICIES -------------------\nNATURE OF OPERATIONS\nNew York Telephone Company and its wholly-owned subsidiary, Empire City Subway Company (Limited) (jointly referred to as the \"Company\"), primarily provide exchange telecommunications and exchange access services in substantially all of New York and a small portion of Connecticut. The Company is a wholly-owned subsidiary of NYNEX Corporation (\"NYNEX\"). Intrastate communications services are regulated by state public service commissions (\"state commissions\"), and interstate communications services are regulated by the Federal Communications Commission (\"FCC\").\nThe communications and media industry continues to experience fundamental changes at an ever-increasing pace. Telecommunications, information and entertainment services are converging in the market, driven by technology and released by landmark federal legislation that will remove historic regulatory barriers. These changes are likely to have a significant effect on the future financial performance of many companies in the industry. The Company cannot predict the effect of such competition on its business.\nNYNEX is implementing a major restructuring of its business, has entered into domestic strategic alliances, and is expanding globally in select international markets in order to respond to competition. In addition, NYNEX is pursuing reforms in telecommunications policy at both the state and federal levels. In February, the Telecommunications Act of 1996 was signed into law. This legislation will lead to the development of competition in local and long distance telephone service and cable television.\nBASIS OF PRESENTATION\nThe consolidated financial statements include the accounts of the Company and its subsidiary. The Company has a 66 2\/3% ownership interest in Telesector Resources Group, Inc. (\"Telesector Resources\") and shares voting rights equally with the other owner, New England Telephone and Telegraph Company (\"New England Telephone\"), which is a wholly-owned subsidiary of NYNEX. The Company uses the equity method of accounting for its investment in Telesector Resources.\nThe consolidated financial statements have been prepared in accordance with generally accepted accounting principles (\"GAAP\"). GAAP 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. The 1994 and 1993 consolidated financial statements have been reclassified to conform to the current year's format.\nIn the second quarter of 1995, the Company discontinued using GAAP applicable to regulated entities (see Note B).\nINVENTORY\nInventory, consisting of materials and supplies, is carried principally at average cost.\nTELEPHONE PLANT\nTelephone plant is stated at its original cost. When depreciable plant is disposed of, the carrying amount is charged to accumulated depreciation.\nAs a result of the implementation of Statement of Financial Accounting Standards No. 101, \"Regulated Enterprises-Accounting for the Discontinuation of Application of FASB Statement No. 71\" (\"Statement No. 101\"), in the second quarter of 1995, the Company began recording depreciation expense using shorter asset lives based on expectations as to the revenue-producing lives of the assets (see Note B), calculated on a straight-line basis. Previously, depreciation rates used by the Company were prescribed by the FCC and by the state commissions for interstate operations and for intrastate operations, respectively, and were calculated on a straight-line basis using the concept of \"remaining life\".\nCAPITALIZED INTEREST COST\nAs a result of the application of Statement No. 101, capitalized interest for the Company is recorded as a cost of telephone plant and equipment and a reduction of interest, in accordance with the provisions of Statement of Financial Accounting Standards No. 34, \"Capitalization of Interest Cost\" (\"Statement No. 34\"). Previously, regulatory authorities allowed the Company to capitalize interest, including an allowance on share owner's equity, as a cost of constructing certain plant and as income, included in Other income (expense) - - net. Such income was realized over the service life of the plant as the resulting higher depreciation expense was recovered through the rate-making process.\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.\nREFINANCING CHARGES\nAs a result of the application of Statement No. 101, the Company no longer defers call premiums and other charges associated with the redemption of long-term debt, and previously deferred refinancing costs were eliminated (see Note B). The intrastate portion of these costs had been deferred and amortized over periods stipulated by the state commissions. The interstate portion had been expensed as required by the FCC.\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.\nEffective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"Statement No. 109\"). Statement No. 109 requires 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.\nFor the Company, prior to the application of Statement No. 101, the treatment of excess deferred taxes resulting from the reduction of tax rates in prior years was subject to federal income tax and regulatory rules. Deferred income tax provisions of the Company were based on amounts recognized for rate-making purposes. The Company recognized a deferred tax liability and established 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. Statement of Financial Accounting Standards No. 71, \"Accounting for the Effects of Certain Types of Regulation\" (\"Statement No. 71\"), required the Company to reflect the additional deferred income taxes as regulatory assets to the extent that they would be recovered in the rate-making process. In accordance with the normalization provisions under federal tax law, the Company reversed excess deferred taxes relating to depreciation of regulated assets over the regulatory lives of those assets. For other excess deferred taxes, the state commissions generally allowed amortization of excess deferred taxes over the reversal period of the temporary difference giving rise to the deferred taxes. As a result of the application of Statement No. 101, income tax-related regulatory assets and liabilities were eliminated (see Note B).\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.\nB DISCONTINUANCE OF REGULATORY ACCOUNTING PRINCIPLES --------------------------------------------------\nIn the second quarter of 1995, the Company discontinued accounting for its operations in accordance with the provisions of Statement No. 71. As a result, the Company recorded an extraordinary non-cash charge of approximately $2.3 billion, net of income taxes of $1.2 billion.\nThe operations of the Company no longer met the criteria for application of Statement No. 71 due to a number of factors including: significant changes in regulation (achievement of price regulation rather than rate-of-return regulation in New York); an intensifying level of competition; and the increasingly rapid pace of technological change. Under Statement No. 71, the Company had accounted for the effects of rate actions by federal and state regulatory commissions by establishing certain regulatory assets and liabilities, including the depreciation of its telephone plant and equipment\nusing asset lives approved by regulators and the deferral of certain costs and obligations based on approvals received from regulators. The Company had continually assessed its position and the recoverability of its telecommunications assets with respect to Statement No. 71.\nTelephone plant and equipment was adjusted through an increase in accumulated depreciation, to reflect the difference between recorded depreciation and the amount of depreciation that would have been recorded had the Company not been subject to rate regulation. Gross plant was written off where fully depreciated, and non-plant regulatory assets and liabilities were eliminated from the balance sheet.\nThe after-tax extraordinary charge recorded consists of $1.8 billion for the adjustment to telephone plant and equipment and $0.5 billion for the write-off of non-plant regulatory assets and liabilities.\nThe net decrease of $2.8 billion to telephone plant and equipment was supported by a depreciation analysis, which identified inadequate depreciation reserve levels which the Company believes resulted principally from the cumulative under-depreciation of telephone plant and equipment as a result of the regulatory process. An impairment analysis was performed that did not identify any additional amounts not recoverable from future operations. ITC amortization was accelerated as a result of the reduction in asset lives of the associated telephone plant and equipment.\nThe major elements of the write-off of non-plant regulatory net assets were as follows:\n(In millions) Pretax After-tax\nCompensated absences $ 120.2 $ 78.1 Deferred pension costs 264.4 171.9 Refinancing costs 184.7 120.1 Deferred taxes - 53.7 Other 119.5 77.7 ------- ------- Total $ 688.8 $ 501.5 ======= =======\nWith the adoption of Statement No. 101, the Company now uses estimated asset lives for certain categories of telephone plant and equipment that are shorter than those approved by regulators. These shorter asset lives result from the Company's expectations as to the revenue-producing lives of the assets. A comparison of average asset lives before and after the discontinuance of\nStatement No. 71 for the most significantly affected categories of telephone plant and equipment is as follows:\nAverage lives (in years) ------------------------ Composite Regulator-Approved Economic Asset Lives Asset Lives ----------------------------------- Digital Switching 16 12 Circuit - Other 10 8 Aerial Metallic Cable 20 17 Underground Metallic Cable 25 15 Buried Metallic Cable 25 17 Fiber 25 20\nThe application of Statement No. 101 does not change the Company's accounting and reporting for regulatory purposes.\nC INCOME TAXES ------------\nThe components of Income tax expense (benefit) are as follows: - -------------------------------------------------------------------------------- Dollars in Millions 1995* 1994 1993** - -------------------------------------------------------------------------------- Federal: Current $426.6 $435.9 $352.5 Deferred - net (174.2) (268.0) (388.3) Deferred tax credits - net (29.5) (32.4) (37.4) ------ ------ ------ 222.9 135.5 (73.2)\nState and local 4.0 4.9 5.4 ------ ------ ------ Total $226.9 $140.4 $(67.8) ====== ====== ====== - --------------------------------------------------------------------------------\n* Does not include the deferred tax benefit of $1.2 billion associated with the Extraordinary item for the discontinuance of regulatory accounting principles.\n** Does not include the deferred tax benefit of $48.1 million associated with the Cumulative effect of change in accounting for postemployment benefits.\nA reconciliation between the federal income tax expense (benefit) computed at the statutory rate and the Company's effective tax expense (benefit) is as follows:\n- -------------------------------------------------------------------------------- Dollars In Millions 1995 1994 1993 - --------------------------------------------------------------------------------\nFederal income tax expense computed at the statutory rate $254.6 $169.9 $ 4.8\na. Amortization of investment tax credits (21.5) (32.4) (37.4)\nb. Amortization of excess deferred federal taxes due to change in the tax rates (5.2) (29.9) (38.7)\nc. Depreciation of certain taxes and payroll-related construction costs capitalized for financial statement purposes, but deducted for income tax purposes in prior years 2.9 13.1 14.8\nd. Federal income tax return adjustment for the difference between the accrued and actual tax expense .2 (0.4) (5.7)\ne. Allowance for funds used during construction, which is excluded from taxable income, net of applicable depreciation 8.9 6.7 6.6\nf. Other items - net (13.0) 13.4 (12.2) ------ ------ ------\nIncome tax expense (benefit) $226.9 $140.4 $(67.8) ====== ====== ====== - --------------------------------------------------------------------------------\nNot included above are gross receipts taxes the Company is subject to in lieu of a state income tax. Temporary differences for which deferred income taxes have not been provided by the Company are represented principally by \"c\" above. Upon the discontinuance of Statement No. 71 (see Note B), items \"b\" and \"c\" above have been eliminated.\nThe components of current and non-current deferred tax assets and liabilities at December 31, 1995 and 1994 are as follows:\n- -------------------------------------------------------------------------------- Dollars in Millions 1995 1994 - ------------------------------------------------------------------------------\nDeferred tax assets Employee benefits $ 663.7 $ 454.3 Restructuring charges 107.2 122.9 Unamortized ITC 44.3 114.7 Other 245.0 166.9 -------- -------- 1,060.2 858.8 -------- -------- Deferred tax liabilities Depreciation and amortization 966.1 2,062.0 Employee benefits 88.3 83.2 Other 63.8 219.8 -------- -------- 1,118.2 2,365.0 -------- -------- Net deferred tax liabilities $ 58.0 $1,506.2 ======== ======== - --------------------------------------------------------------------------------\nDuring 1995, income tax-related regulatory assets and liabilities were eliminated as a result of the discontinued application of Statement No. 71 (see Note B).\nAt December 31, 1994, the Company had recorded approximately $421.5 million in deferred charges and deferred taxes representing the cumulative amount of income taxes on temporary differences that were previously flowed through to ratepayers. This deferral had been increased for the tax effect of future revenue requirements and was amortized over the lives of the related depreciable assets concurrently with their recovery in rates.\nThe Company had recorded a regulatory liability at December 31, 1994 of approximately $293.2 million, in Other long-term liabilities and deferred credits and in Accounts payable - Trade and other. A substantial portion of the regulatory liability related to the 1986 reduction in the statutory federal income tax rate and unamortized ITC. This liability had been increased for the tax effect of future revenue requirements.\nD EMPLOYEE BENEFITS -----------------\nPENSIONS Substantially 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 for 1995, 1994 and 1993 was $152.4, $165.8 and $99.0 million, respectively. Deferral of pension cost was discontinued as of January 1, 1993, and the Company had implemented a plan to recover deferred pension costs through the rate-making process (see Postretirement Benefits Other Than Pensions below). The pension benefit for 1995, 1994 and 1993 includes the effect of plan amendments and changes in actuarial\nassumptions for the discount rate and future compensation levels. At December 31, 1995 and 1994, the Company recorded approximately $1.0 billion and $941.4 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, 1995 and 1994 include a discount rate of 7.25% and 8.50%, respectively, and an increase in future compensation levels of 4.1% and 4.5%, respectively, 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 1995, 1994 and 1993. The actuarial projections included herein anticipate plan improvements for active employees in the future.\nAs a result of planned work force reductions primarily through retirement incentives in 1995 and 1994, the Company incurred additional pension costs of $214.0 and $412.2 million, respectively. In 1995, this cost was comprised of a charge for special termination benefits of $290.2 million and a curtailment gain of $76.2 million, partially offset by 1993 severance reserves of $31.9 million which were transferred to the pension liability. In 1994, this cost was comprised of a charge for special termination benefits of $551.6 million and a curtailment gain of $139.4 million, partially offset by 1993 severance reserves of $106.7 million which were transferred to the pension liability.\nPOSTRETIREMENT BENEFITS OTHER THAN PENSIONS The 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. The Company participates in the NYNEX benefit plans, and the structure of the plans is such that certain disclosures required by Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (\"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 NYNEX's Annual Report for the year ended December 31, 1995.\nEffective January 1, 1993, the Company adopted Statement No. 106, which 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 1995, 1994 and 1993 for the Company was $295.7, $299.1 and $278.4 million, respectively.\nThe actuarial assumptions used to determine the 1995 and 1994 obligation for postretirement benefit plans under Statement No. 106 are as follows: discount rate of 7.25% and 8.50%, respectively; weighted average expected long-term\nrate of return on plan assets of 8.4% in both years; weighted average salary growth rate of 4.0% and 4.2%, respectively; medical cost trend rate of 11.6% and 12.6% in 1995 and 1994, respectively, grading down to 4.5% in 2008; and dental cost trend rate of 4.0% and 4.5% in 1995 and 1994, respectively, grading down to 3.0% in 2002.\nAs a result of planned work force reductions, the Company recorded an additional $270.5 million of postretirement benefit cost in 1993 accounted for as a curtailment. In 1995 and 1994, under work force reduction retirement incentives, the Company incurred additional postretirement benefit costs of $65.2 and $230.7 million, respectively. In 1995, this cost was comprised of a curtailment loss of $37.4 million and a charge for special termination benefits of $27.8 million, partially offset by $32.2 million accrued for in 1993. In 1994, this cost was comprised of a curtailment loss of $172.9 million and a charge for special termination benefits of $57.8 million, partially offset by $74.4 million accrued for in 1993.\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 excess pension 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 1995, 1994 and 1993. The assets in the VEBA Trusts consist primarily of equity and fixed income securities. Additional contributions to the VEBA Trusts are evaluated and determined by NYNEX management.\nREGULATORY TREATMENT With respect to interstate treatment, in 1994 the FCC's 1993 order denying exogenous treatment of additional costs recognized under Statement No. 106 was overturned in the court. Tariff revisions were filed by the Company and New England Telephone (collectively, the \"Telephone Companies\") with the FCC in 1994 to amend price cap indices to reflect additional exogenous costs recognized under Statement No. 106, including $42 million of costs already accrued, increased annual costs of $21 million and increased rates of $2.2 million. Commencing December 30, 1994, the Telephone Companies began collecting these revenues, subject to possible refund pending resolution of the FCC Common Carrier Bureau's investigation. The annual update to the price cap rates, effective August 1, 1995, included tariff revisions to recover approximately $21 million of exogenous costs resulting from the implementation of Statement No. 106.\nWith respect to intrastate treatment, in January 1994 the NYSPSC approved the Company's plan for regulatory accounting and rate-making treatment. The NYSPSC allowed the 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, providing for the amortization of existing deferred pension costs within a ten-year period, and eliminating the need for additional deferrals of Statement No. 106 and Statement No. 87 costs. The NYSPSC required the Company to write-off $75 million of previously deferred pension costs in 1993. In December 1994, the Company amortized $39 million of deferred pension costs according to this accounting plan. Upon the discontinuance of Statement No. 71, remaining deferred pension costs were eliminated (see Note B).\nPOSTEMPLOYMENT BENEFITS The 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 $137.4 million ($89.3 million after-tax) in 1993.\nE TELEPHONE PLANT - NET ---------------------\nThe components of telephone plant - net are as follows:\n- -------------------------------------------------------------------------------- December 31, - -------------------------------------------------------------------------------- Dollars in Millions 1995 1994 - -------------------------------------------------------------------------------- Buildings $ 1,835.9 $ 1,699.4 Telephone plant and equipment 17,475.1 17,597.2 Furniture and other equipment 137.7 129.2 Other 117.5 117.7 --------- --------- Total depreciable telephone plant 19,566.2 19,543.5 Less: accumulated depreciation 10,847.8 8,106.9 --------- --------- 8,718.4 11,436.6 Land 71.2 71.2 Plant under construction and other 516.2 514.9 --------- --------- Total Telephone plant - net $ 9,305.8 $12,022.7 ========= ========= - --------------------------------------------------------------------------------\nThe discontinued application of Statement No. 71 resulted in a net decrease to telephone plant and equipment of $2.8 billion, primarily through an increase in accumulated depreciation (see Note B).\nF LONG-TERM DEBT --------------\nInterest rates and maturities on long-term debt outstanding are as follows:\nIn 1997, $60.0 million of the Refunding Mortgage Bonds will mature. In 1998, $100 million of the Notes will mature.\nThe Company's Refunding Mortgage Bonds and the Company's Forty Year 7 7\/8% Debentures due June 15, 2017 are callable upon thirty days' notice, at the option of the Company, five years after the issue date. The Company's Forty Year 9 3\/8% Debentures due July 15, 2031, Thirty Year 7 5\/8% Debentures due February 1, 2023, Thirty-Two Year 7% Debentures due August 15, 2025 and Thirty Year 7 1\/4% Debentures due February 15, 2024 are callable upon thirty days' notice, at the option of the Company, ten years after the issue date. The Company's Thirty Year 6.7% Debentures due November 1, 2023 and Forty Year 7% Debentures due December 1, 2033 are callable upon thirty days' notice, at the option of the Company, twenty years after the issue date. The Company's Twelve Year 6 1\/2% Debentures due March 1, 2005, Twenty Year 7% Debentures due May 1, 2013, Twenty Year 7% Debentures due June 15, 2013 and Twenty-One Year 8 5\/8% Debentures due November 15, 2010 are not callable.\nSubstantially all of the Company's assets are subject to lien under the Company's Refunding Mortgage Bond indenture.\nOn February 28, 1994, the Company issued $450 million of its Thirty Year 7 1\/4% Debentures, due February 15, 2024, and $150 million of its Ten Year 6 1\/4% Notes, due February 15, 2004.\nAt December 31, 1995, the Company had $250 million of unissued, unsecured debt securities registered with the Securities and Exchange Commission.\nPursuant to the indentures for certain of its debentures, the Company has covenanted that it will not issue additional funded debt securities ranking equally with or prior to such debentures unless it has maintained an earnings coverage (excluding extraordinary items) of 1.75 for interest charges for a period of any 12 consecutive months out of the 15-month period prior to the date of the proposed issuance. As a result of the 1993 and 1994 business restructuring charges (see Note Q), beginning in March 1994, the Company did not meet the earnings coverage requirement. As of December 31, 1994 and 1995, the Company met the earnings coverage requirement.\nG SHORT-TERM DEBT ---------------\nInterest expense on advances from NYNEX was $17.0, $16.8 and $6.4 million in 1995, 1994 and 1993, respectively.\nH FINANCIAL COMMITMENTS ---------------------\nAs of December 31, 1995, the Company had deferred $188 million of revenues ($161 million under a NYSPSC-approved regulatory plan associated with commitments for fair competition, universal service, service quality and infrastructure improvements, and $27 million for a 1994 service improvement plan obligation). These revenues will be recognized as commitments are met or obligations are satisfied under the plans. If the Company is unable to meet certain of these commitments, the NYSPSC has the authority to require the Company to refund these revenues to customers.\nIn December 1995, Telesector Resources entered into purchase agreements with various suppliers to purchase, on behalf of the Telephone Companies, equipment and software to upgrade the network. The purchase agreements are over five years with a commitment of approximately $550 million.\nI LEASE COMMITMENTS -----------------\nThe Company leases certain facilities and equipment used in its operations. Rental expense was $90.6, $94.7, and $108.8 million for 1995, 1994 and 1993, respectively. At December 31, 1995, the minimum lease commitments under noncancelable leases for the periods shown are as follows:\n- -------------------------------------------------------------------------------- Dollars in Millions - -------------------------------------------------------------------------------- Operating Capital - -------------------------------------------------------------------------------- 1996 $ 26.5 $ 14.9 1997 23.1 11.1 1998 19.6 10.8 1999 16.9 10.8 2000 12.4 10.7 Thereafter 34.5 381.6 ------ ------ Total minimum lease payments $133.0 439.9 ====== Less: executory costs 10.2 ------ Net minimum lease payments 429.7 Less: interest 369.1 ------ Present value of net minimum lease payments $ 60.6 ====== - --------------------------------------------------------------------------------\nJ TRANSACTIONS WITH AT&T CORP. ----------------------------\nIn 1995, 1994 and 1993, AT&T Corp. (\"AT&T\") provided approximately 17%, 18% and 19%, 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.\nK TRANSACTIONS WITH AFFILIATES ----------------------------\nThe Company and other NYNEX subsidiaries receive corporate governance and ownership services such as securities administration, investor relations, certain tax, legal and accounting 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.\nNYNEX 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 1995, 1994 and 1993, the Company recorded allocated costs of $31.6, $17.9 and $138.9 million, respectively, in connection with these services. The Company also participates in compensation plans utilizing NYNEX stock.\nTelesector Resources performs marketing, accounting, finance, 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 1995, 1994 and 1993, the Company recorded charges from Telesector Resources of $1.1 billion, $889.6 million and $802.9 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 1995, 1994 and 1993 were approximately $320.1, $313.6 and $352.2 million, respectively. Telesector Resources acts as a purchasing agent for the Company for directly shipped materials and supplies. During 1995, 1994 and 1993, total agency purchases by Telesector Resources amounted to $76.2, $155.4 and $148.9 million, respectively. In addition, in 1995, 1994 and 1993, approximately $82.5, $57.4 and $227.3 million, respectively of restructuring charges ($53.7, $37.3 and $147.7 million after-tax) were allocated to the Company from Telesector Resources, primarily related to its force reduction and re-engineering programs. In 1995, the Company, New England Telephone and NYNEX transferred approximately 1,200, 930 and 170 employees, 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 1995, 1994 and 1993, the Company recorded charges of $54.7, $69.3 and $77.3 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 decrease and New England Telephone experienced an offsetting interstate rate increase. 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\nstructure. In 1993, the Company received transition payments of $55 million from New England Telephone. The transition plan was completed in 1993.\nThe Company has an agreement with NYNEX Information Resources Company (\"NIRC\") pursuant to which NIRC 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 1995, 1994 and 1993, licensing fees, included in Other revenues, amounted to $151.7, $142.4 and $129.4 million, respectively. Since 1991, NIRC has made payments to the Company of all of NIRC's earnings related to publishing directories in New York in excess of a regulated return. In 1992, the NYSPSC instituted a proceeding to investigate the directory publishing operations of the Company and its NYNEX affiliates. In 1993, an administrative law judge of the NYSPSC issued a recommended decision urging the Company to assume the directory publishing function itself and\/or negotiate a modified agreement with NIRC. In 1994, the parties to the proceeding submitted briefs to the NYSPSC.A final order has not been issued.\nL TAXES OTHER THAN INCOME -----------------------\nTaxes other than income consist of:\n- -------------------------------------------------------------------------------- Dollars in Millions 1995 1994 1993 - --------------------------------------------------------------------------------\nGross receipts $ 472.5 $ 450.5 $ 461.5 Property 263.2 274.9 299.0 Other 63.1 64.2 58.0 ------- ------- ------- Total $ 798.8 $ 789.6 $ 818.5 ======= ======= ======= - --------------------------------------------------------------------------------\nM REVENUES SUBJECT TO POSSIBLE REFUND -----------------------------------\nSeveral state and federal regulatory matters, including affiliate transaction issues in the Company's 1990 intrastate rate case ($188.0 million), may possibly require the refund of a portion of the revenues collected in the current and prior periods. As of December 31, 1995, the aggregate amount of such revenues that was estimated to be subject to possible refund was approximately $228.9 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.\nN LITIGATION AND OTHER CONTINGENCIES ----------------------------------\nVarious legal actions and regulatory proceedings are pending that may affect the Company. While counsel cannot give assurance as to the outcome of any of these matters, in the opinion of Management based on 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 but could have a material effect on annual operating results.\nO SUPPLEMENTAL CASH FLOW INFORMATION ----------------------------------\nThe following information is provided in accordance with Statement of Financial Accounting Standards No. 95, \"Statement of Cash Flows\": - -------------------------------------------------------------------------------- December 31, Dollars in Millions 1995 1994 1993 - --------------------------------------------------------------------------------\nIncome tax payments $481.5 $355.4 $507.7 Interest payments $293.5 $272.3 $303.9 Short-term debt classified as Long-term debt $ - $ - $588.6 - --------------------------------------------------------------------------------\nP FAIR VALUE OF FINANCIAL INSTRUMENTS -----------------------------------\nThe following table presents the carrying amounts and fair values of the Company's financial instruments at December 31, 1995 and 1994. Statement of Financial Accounting Standards No. 107, \"Disclosures about Fair Value of Financial Instruments,\" defines fair value as the amount at which the instrument could be exchanged in a current transaction between willing parties, other than a forced liquidation or sale.\n- -------------------------------------------------------------------------------- December 31, Dollars in Millions 1995 1994 - --------------------------------------------------------------------------------\nLong-term debt\nCarrying amount $3,858.7 $3,911.8 Fair value $3,972.5 $3,409.0 - --------------------------------------------------------------------------------\nQ BUSINESS RESTRUCTURING ----------------------\nIn 1995 and 1994, $304.1 and $523.4 million, respectively, of pretax pension enhancement charges were recorded. These charges were included in the Consolidated Statements of Income in Other expenses.\nIn the fourth quarter of 1993, approximately $992 million of pretax business restructuring charges was recorded, primarily related to efforts to redesign operations and work force reductions. These charges included: $557 million for severance and postretirement medical costs; $208 million for re-engineering service delivery; and $227 million of restructuring charges allocated to the Company from Telesector Resources. The restructuring charges were included in the Consolidated Statements of Income as follows: Maintenance and support - $198 million; Marketing and customer services - $129 million; and Other expense - $665 million.\nR SHARE OWNER'S EQUITY --------------------\nPursuant to the resolutions of the Board of Directors of the Company, adopted on June 21, 1995, the Common stock of the Company was reduced by approximately $4.1 billion and such amount was reallocated to Additional paid-in capital. The second and fourth quarter 1995 dividends of $180.5 million per quarter were declared from Additional paid-in capital. There were no dividends declared in the third quarter of 1995.\nSUPPLEMENTARY INFORMATION\nQuarterly Financial Information (Unaudited)\nResults for the first, second, third and fourth quarters of 1995 include $33.8, $115.2, $14.7 and $140.4 million, respectively, of pretax charges for pension enhancements, which were reflected in operating expenses. The after-tax effect of these charges was $22.0, $74.9, $9.5 and $91.2 million, respectively.\nResults for the second quarter of 1995 include the effects of the discontinuance of regulatory accounting principles, recorded as an extraordinary item (see Note B); and $162.0 million ($105.3 million after-tax) of special charges to meet various tax, benefit and legal obligations and contingencies, which was included in operating expenses. Results for the third quarter of 1995 include $85.1 million ($55.3 million after-tax) of special charges to meet tax and legal obligations and contingencies, which was included in operating expenses. Results for the fourth quarter of 1995 include a net $33.4 million of pretax credits in operating expenses ($22.0 million after-tax) primarily due to revised estimates associated with benefit accruals, and a $13.7 million ($8.9 million after-tax) reduction in Interest expense on the revenue set aside as ordered by the NYSPSC, partially offset by a $15.0 million ($9.7 million after-tax) charge in operating expenses for a gross receipts tax settlement.\nResults for the second, third and fourth quarters of 1994 include $394.9, $23.3 and $105.2 million, respectively, of pretax charges for pension enhancements, which were reflected in operating expenses. The after-tax effect of these charges was $256.7, $15.1 and $68.4 million, respectively.\nIn the third quarter of 1995, there was a change in the presentation of gross receipts taxes that were collected from customers. In the first two quarters of 1995, these taxes were included in operating revenues and expenses. In the\nlast two quarters, as a result of a tax law change, these taxes were no longer required to be collected.\nResults for the fourth quarter of 1994 include $24.7 million of pretax credits to pension and medical expense associated with plan amendments and favorable plan experience. The total pretax effect was included in operating expenses. The after-tax effect of these credits was an increase in net income of $16.1 million, of which $4.0 million was applicable to the fourth quarter.\nFor further discussion of these items, see Management's Discussion and Analysis of Results of Operations.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nDuring 1995 and 1994, the Company did not change its auditors.\nPART IV\nITEM 14.","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"ITEM 14. EXHIBITS, CONSOLIDATED FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K.\n(a) Documents filed as part of this Annual Report on Form 10-K. -----------------------------------------------------------\nPage(s) in this Annual Report on Form 10-K ----------------\n(1) Consolidated Financial Statements filed as part of this report are listed in the Table of Contents on page 3 and contained in Item 8 herein.\n(2) Consolidated Financial Statement Schedule. ------------------------------------------ The following consolidated financial statement schedule of the Registrant is included herein in response to Item 14:\nII - Valuation and Qualifying Accounts ....... 50\nConsolidated financial statement schedules other than that 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.\n(3) Exhibits. Exhibits on file with the Securities and Exchange --------- Commission (\"SEC\"), identified in parentheses below, are incorporated herein by reference as exhibits hereto.\nExhibit Number - ------- (3)a Certificate of Incorporation of New York Telephone Company (the \"Company\") as amended and restated December 2, 1987 (Exhibit No. (3)a to the Registrant's filing on Form SE dated March 24, 1988, File No.1-3435).\n(3)b By-laws of the Company as amended April 22, 1987 (Exhibit No. (3)b to the Registrant's filing on Form SE dated March 24, 1988, File No. 1-3435).\n(4) No instrument which defines the rights of holders of long-term debt of the Company and its subsidiary 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.\nExhibit Number - ------- (10)(ii)B Service Agreement concerning provision by Telesector Resources Group, Inc. to the 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. 1-3435).\n(12) Computation of Ratio of Earnings to Fixed Charges.\n(23) Consent of Independent Accountants.\n(24) Powers of attorney.\n(b) Reports on Form 8-K. --------------------\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nNEW YORK TELEPHONE COMPANY\nBy \/s\/Mel Meskin --------------------------------- Mel Meskin Vice President-Finance and Treasurer\nMarch 21, 1996\nPursuant to the requirements of the Securities Exchange Act 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:\nRichard. A. Jalkut* President and Chief Executive Officer\nPrincipal Financial Officer:\nMel Meskin Vice President-Finance and Treasurer\nPrincipal Accounting Officer:\nJohn W. Diercksen* Controller\nA Majority of Directors: Lilyan H. Affinito* *By \/s\/Mel Meskin Joseph A. Califano, Jr.* -------------------------------- Arnold J. Eckelman* (Mel Meskin, as attorney-in-fact, Thomas F. Gilbane, Jr.* and on his own behalf as Ronald A. Homer* Principal Financial Officer) Alice Stone Ilchman* March 21, 1996 Richard A. Jalkut* John F. X. Mannion* Jane E. Newman* Paul L. Snyder* Ira Stepanian* Frank J. Tasco*\n- ---------------------------\n(a) Includes amounts to establish a reserve for purchased accounts receivable.\n(b) Amounts written-off as uncollectible. Amounts previously written-off are credited directly to this account when recovered.\n(c) Amounts for 1993 have been reclassified to conform to the current year's format.","section_15":""}
{"filename":"717411_1995.txt","cik":"717411","year":"1995","section_1":"ITEM 1. BUSINESS - ------- --------\nGulf Southwest Bancorp, Inc. (\"Gulf Southwest\" or \"Company\") is a Texas bank holding company organized in 1982 under the Bank Holding Company Act of 1956, as amended (the \"Holding Company Act\"). Gulf Southwest maintains its principal offices at 4200 Westheimer, Suite 210, Houston, Texas 77027 (telephone: (713) 622-0042).\nAs of December 31, 1995, Gulf Southwest owned all of the outstanding capital stock of Gulf Southwest Nevada Bancorp, Inc. (\"Nevada Bancorp\"), a Nevada corporation and intermediate bank holding company (unless otherwise indicated, all references herein to Gulf Southwest include Nevada Bancorp). Nevada Bancorp owns 100.0% of the outstanding capital stock of Merchants Bank and First Bank Mainland, 99.47% of the outstanding capital stock of First Bank Pearland and 97.13% of Texas City Bank (hereinafter such banks may be referred to collectively as the \"Subsidiary Banks\" and individually as a \"Subsidiary Bank\"). Effective January 1, 1996, First Bank Mainland, First Bank Pearland and Texas City Bank were merged with and into Merchants Bank, which was the surviving bank. Gulf Southwest continued to own 100% of the outstanding capital stock of Merchants Bank. The banking facilities of the three merged banks will operate as branch facilities of Merchants Bank.\nGulf Southwest's principal activity is the ownership and management of the Subsidiary Banks. All Subsidiary Banks are state banks organized in the State of Texas. Each of the Subsidiary Banks offers a full range of banking services to its customers, including demand and time deposits and various types of commercial and consumer loans. The Subsidiary Banks draw substantially all of their deposits and a majority of their loans from the Galveston County\/Harris County area. In addition, Gulf Southwest has two wholly owned non-banking subsidiaries which conduct various aspects of its non-banking operations.\nAs a bank holding company, Gulf Southwest may own or control, directly or indirectly, one or more banks and furnish services to such banks. The banking activities of Gulf Southwest are conducted by the Subsidiary Banks. The officers and directors of the Subsidiary Banks direct its operations. The principal role of Gulf Southwest is to provide management assistance with respect to various aspects of the Subsidiary Banks' operations, including the areas of asset and liability management, business development, loan policies and procedures, capital planning, advertising, data processing, credit and loan administration, accounting, auditing, financial reporting and compliance with legal and governmental regulations.\nBANKING SERVICES - ----------------\nThe Subsidiary Banks offers a wide range of financial services to commercial, industrial, financial and individual customers, including short-term and medium-term loans, revolving credit arrangements, inventory and accounts receivable financing, equipment financing, real estate lending, Small Business Administration lending, letters of credit, installment and other consumer loans, savings accounts and various savings programs, including individual retirement accounts, and interest and non-interest-bearing checking accounts. Other services include federal tax depository, safe deposit and night depository services.\nOther than the Subsidiary Banks' charters to operate as a bank, the business of Gulf Southwest is not materially dependent upon any patent, trademark, license, franchise or concession. The business of Gulf Southwest is not seasonal.\nSUBSIDIARY BANKS - ----------------\nThe following table sets forth certain balance sheet and operating information at December 31, 1995, with respect to the Subsidiary Banks:\nSUBSIDIARY BANKS ----------------\n(IN THOUSANDS)\nFirst Bank Mainland, First Bank Pearland, Merchants Bank and Texas City Bank are state-chartered banking associations organized in 1947, 1976, 1970 and 1907, respectively. The services offered by the Subsidiary Banks are generally those offered by commercial banks of comparable size in their trade areas. The Subsidiary Banks do not engage in international operations or trust activities.\nEffective January 1, 1996, the Subsidiary Banks were merged with and into Merchants Bank. Currently, Merchants Bank's main office is at 999 North Shepherd, Houston, Texas with eleven branches located in Houston, and the surrounding communities.\nNON-BANKING ACTIVITIES - ----------------------\nG.S.W. Data Processing, Inc. (\"GSWDP\"), a Texas corporation, and Central Data Processing, Inc. (\"CDP\"), a Texas corporation, perform certain data processing services for the Subsidiary Banks. In addition, the Board of Governors of the Federal Reserve System (the \"Board\") has authorized GSWDP to furnish data processing services to banks in Texas which are not affiliated with Gulf Southwest. As of December 31, 1995, GSWDP was furnishing these services for one non-affiliated bank. As of December 31, 1995, Nevada Bancorp owned 100.0% of the outstanding capital stock of each of GSWDP and CDP.\nEffective January 31, 1996, the operations of GSWDP and CDP were acquired by Merchants Bank and the two subsidiaries were liquidated into Nevada Bancorp.\nSUBSIDIARY BANK HOLDING COMPANY - -------------------------------\nNevada Bancorp is a Nevada corporation organized in 1994, and is wholly owned by Gulf Southwest. The only activities of Nevada Bancorp relate to holding the stock of the Subsidiary Banks, CDP and GSWDP. Nevada Bancorp currently has no employees.\nEXPANSION - ---------\nACQUISITION OF TEXAS GULF COAST BANCORP, INC. On May 1,1995, Nevada Bancorp consummated its acquisition of Texas Gulf Coast Bancorp, Inc. (\"Texas Gulf\"). Texas Gulf was a holding company which owned 100% of the stock of First Bank Mainland in Lamarque, Texas and over 95% of the stock of each of Texas City Bank in Texas City, Texas and First Bank Pearland, Pearland, Texas. As of May 1, 1995, Texas Gulf had consolidated assets of approximately $203 million.\nBRANCH EXPANSION. On October 10,1995, an application to establish a branch facility at the corner of West Rittenhouse and Interstate 45 North in Houston, Texas was approved by the Texas Department of Banking and the Federal Deposit Insurance Corporation (\"FDIC\"). It is anticipated that the branch facility will commence operations in April, 1996.\nAn application to establish a branch facility at 5005 Woodway, Houston, Texas has been filed with the Texas Department of Banking and the FDIC. Approval was received in March, 1996, and operations at this branch facility are expected to commence in June, 1996.\nSUPERVISION AND REGULATION - --------------------------\nGULF SOUTHWEST. As a bank holding company, Gulf Southwest is subject to regulation by the Board and is required to file with the Board an annual report and to furnish such additional information as the Board may require pursuant to the Holding Company Act. The Board may conduct examinations of Gulf Southwest and each of its subsidiaries.\nGulf Southwest is required to obtain the prior approval of the Board for the acquisition of five percent or more of the voting shares or substantially all the assets of any bank or bank holding company. In considering proposed acquisitions, the Board considers the expected benefits to the public, including greater convenience, identifying and meeting the credit needs of the applicant's entire community, increased competition or gains in efficiency, weighed against the risks of possible adverse effects, such as undue concentration of resources, lessening or elimination of competition, conflicts of interest or unsound banking practices. After an application to acquire the voting shares of a state or national bank in Texas has been accepted for filing by the Board, a copy of such application must be submitted to the Texas Banking Commissioner (\"Commissioner\") pursuant to the Texas Banking Act of 1995, as amended (\"Act\"). Prior to September 29, 1995, no application to acquire shares of a bank located outside Texas could be approved by the Board unless such acquisition was expressly authorized by the statutes of the state where the bank whose shares or assets are to be acquired was located.\nBank holding companies are prohibited by law, except in certain instances prescribed by statute, from acquiring a direct or indirect interest in 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 activities other than those of banking, managing or controlling banks or providing service to its subsidiaries. Bank holding companies, however, may engage in, and may own shares of companies engaged in certain activities found by the Board to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. When an application concerning these activities is filed with the Board, a copy of such application also must be submitted to the Commissioner pursuant to the Act for a determination as to whether the application should be approved. The Commissioner is required to oppose the application if the proposed activities would be detrimental to the public's interest as the result of probable effects, such as undue concentration of resources, competition, conflicts of interest or unsound banking practices.\nUnder the Holding Company Act and the Board's regulations, 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. The Board possesses enforcement powers intended to prevent or eliminate practices of bank holding companies and their non-bank subsidiaries deemed to be unsafe and unsound or in violation of applicable laws.\nTHE INTERSTATE BANKING AND BRANCHING EFFICIENCY ACT OF 1994. On September 29, 1994, the Interstate Banking and Branching Efficiency Act of 1994 (\"IBBEA\") was enacted into law. The IBBEA authorizes adequately capitalized and adequately managed bank holding companies to acquire banks in any state beginning September 29, 1995 subject to certain restrictions. In addition, IBBEA authorizes interstate branching. Beginning June 1, 1997, a bank may merge with a bank located in another state so long as one or both of the states have not opted out of interstate branching. States may enact laws opting out of interstate branching anytime before June 1, 1997. States also may enact laws permitting (a) interstate branching before June 1, 1997, or (b) de novo branching. If a state opts out, no bank in any other state may establish a branch in that state, either through an acquisition or de novo. A bank whose home state opts out of interstate branching may not participate in any interstate branching. The State of Texas has elected to opt out of interstate branching.\nSUBSIDIARY BANKS. As Texas State Chartered Banks, the Subsidiary Banks are subject to regulation, supervision and periodic examination by the Texas Department of Banking. Effective January 1, 1996, First Bank Mainland, First Bank Pearland and Texas City Bank were merged with and into Merchants Bank. Because the resultant bank is not a member of the Federal Reserve System (i.e., a \"non-member bank\") and its' deposits are insured by the Federal Deposit Insurance Corporation (\"FDIC\") to the extent authorized by law, it is also subject to supervision and regulation, as well as examination by the FDIC. Various requirements of Federal and Texas law affect the operation of the Subsidiary Banks, including requirements relating to maintenance of reserves against deposits, restrictions on the nature and the amount of loans which may be made and the interest that may be charged thereon and restrictions relating to investments and other activities.\nCash revenues derived from dividends paid by the Subsidiary Banks represent the primary source of revenues for Gulf Southwest. Under the Act, a state bank may not reduce its capital and surplus through dividends without the prior written approval of the Commissioner. Dividends may be paid out of the undivided profits. At December 31, 1995, there was an aggregate amount of $25,424,000 available for the payment of dividends by the Subsidiary Banks under these restrictions. The payment of dividends is further subject to the authority of regulatory authorities to prohibit payment of dividends if such payment is determined to be an unsafe or unsound banking practice or if after making such distribution, the subsidiary bank would be considered \"undercapitalized\".\nFor further discussion of certain additional regulations affecting Gulf Southwest and the Subsidiary Banks, reference should be made to the \"Government Fiscal and Monetary Policies\" discussion below.\nENVIRONMENTAL ISSUES. Under the Comprehensive Environmental Response, Compensation and Liability Act (\"CERCLA\"), an owner or operator of a property where hazardous substances are located is potentially liable for hazardous waste cleanup costs. CERCLA specifically excludes from the definition of owner or operator \"a person, who without participating in the management of a vessel or facility, holds indicia of ownership primarily to protect his security interest in the vessel or facility.\" However, courts have reached differing conclusions as to what actions can be taken by a secured lender without such lender being deemed to be \"participating in the management\" of a property. Merchants Bank is not aware of any material liability to which it may be subject for hazardous waste clean-up costs. If a property is deemed to have a potential environmental problem, Merchants Bank will not foreclosure on the property until an environmental study has been performed.\nCOMPETITION - -----------\nThe activities in which the Subsidiary Banks engage are highly competitive. Each activity engaged in and geographic market served involves competition with other banks, as well as with non-banking financial institutions and non- financial enterprises. The Subsidiary Banks actively compete with other banks in their efforts to obtain deposits and make loans, in the scope of types of services offered, in interest rates paid on time deposits and charged on loans and in other aspects of banking. At December 31, 1995, the Subsidiary Banks had deposits of $434,073,000.\nIn addition to competing with other commercial banks within and outside their primary service area, the Subsidiary Banks compete with other financial institutions engaged in the business of making loans or accepting deposits, such as savings and loan associations, credit unions, industrial loan associations, insurance companies, small loan companies, finance companies, mortgage companies, real estate investment trusts, certain governmental agencies, credit card organizations and other enterprises. In recent years, competition for funds from securities brokers for money market accounts has intensified. Additional competition for deposits comes from government and private issues of debt obligations and other investment alternatives for depositors such as money market funds and mutual funds.\nCUSTOMERS. The Subsidiary Banks are not dependent upon any single customer or few customers; the loss of any one or more of which would have a materially adverse effect upon their business.\nGOVERNMENT FISCAL AND MONETARY POLICIES - ---------------------------------------\nThe commercial banking business is affected not only by general economic conditions but also by the fiscal and monetary policies of the Board. Changes in the discount rate on Federal Reserve borrowings, availability of borrowings at the Federal Reserve \"discount window\", open market operations, the imposition of any changes in reserve requirements against member banks' deposits and assets of foreign branches, the imposition of any changes in reserve requirements against certain borrowings by member banks and their affiliates, and the placing of limits on interest rates which member banks may pay on time and savings deposits are some of the instruments of fiscal and monetary policy available to the Board. Fiscal and monetary policies influence to a significant extent the overall growth of bank loans, investments and deposits and the interest rates charged on loans or paid on time and savings deposits. The nature of future monetary policies and the effect of such policies on the future business and earnings of Gulf Southwest and the Subsidiary Banks cannot be predicted.\nThe Board has cease and desist powers over bank holding companies, non- banking subsidiaries or any institution-affiliated party thereof to forestall activities which represent unsafe and unsound practices or constitute violations of law or regulations. The Board can also require affirmative actions to correct a violation or practice through the issuance of a cease and desist order. In certain instances, the Board is empowered to assess civil penalties against companies or individuals who violate the Holding Company Act or regulations or orders issued pursuant thereto in amounts up to $1,000,000 for each day's violation, to order termination of non-banking activities of non- banking subsidiaries and to order termination of ownership and control of a non- subsidiary bank by a bank holding company.\nSection 18(j) of the Federal Deposit Insurance Act makes applicable to state nonmember insured banks the provisions of Section 23A of the Federal Reserve Act among other statutes. Section 23A of the Federal Reserve Act and related statutes impose limits and collateralization requirements with respect to the amount of loans, extensions of credit, or investments or certain other transactions by member banks with their \"affiliates\", as well as limits on the amount of advances to third parties which are collateralized by the securities or obligations. Gulf Southwest is an \"affiliate\" of the Subsidiary Bank and, therefore, these restrictions are applicable to transactions by the Subsidiary Bank with Gulf Southwest. In addition, Section 23B of the Federal Reserve Act prohibits a bank that is an insured depository institution from engaging in certain transactions (including, for example, loans) with certain affiliates unless the transactions are substantially the same or at least as favorable to such bank or its subsidiaries, as those prevailing at the time for comparable transactions with or involving other nonaffiliated companies. In the absence of such comparable transactions, any transaction between a member bank and its affiliates must be on terms and under circumstances, including credit standards, that, in good faith, would be offered to or would apply to nonaffiliated companies. The Subsidiary Bank is also subject to certain prohibitions against tie-in arrangements in connection with extensions of credit and certain other transactions.\nThe Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (\"FIRREA\") contains important provisions affecting all federally insured financial institutions (\"banking organizations\") in such areas as anti-fraud and anti-abuse enforcement powers, each banking organization's performance and record in meeting community credit needs, and acquisitions of savings and loans institutions. For further discussion of these capital requirements, reference should be made to the \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Capital Management\" presentation beginning on page 23 of this report.\nIn 1991, the Federal Deposit Insurance Corporation Improvement Act of 1991 (\"FDICIA\") was enacted. The provisions of FDICIA include a plan to recapitalize the Bank Insurance Fund (\"BIF\") that is the source of deposit insurance coverage to FDIC-insured institutions, authority to ultimately fund such recapitalization plan through increased deposit insurance premiums, various supervisory reforms which will increase the frequency of on-site examinations by federal banking regulators, changes in the deposit insurance system, an array of new consumer lending requirements, and the adoption of the Truth in Savings Act. FDICIA also authorizes federal banking regulators to take prompt, corrective action against institutions which are under-capitalized, institute a risk-based assessment system for deposit insurance, and implement a series of operational and management-based standards and potential sanctions for violations of such standards. Under FDICIA, the FDIC is authorized to assess insurance premiums on a bank's deposits at a variable rate depending on the probability that the deposit insurance fund will incur a loss with respect to the bank. During 1995, the FDIC determined that the BIF was adequately funded and that banks which are adequately or well capitalized would not be assessed premiums for deposit insurance. Currently, Gulf Southwest and its Subsidiary Bank are deemed to be well capitalized.\nEFFECTS OF INTEREST RATES AND USURY LAWS. Texas usury laws limit the rate of interest that may be charged by the Subsidiary Bank. Certain federal laws provide a limited preemption of texas usury laws. The maximum rate of interest that the Subsidiary Bank may charge on business loans under Texas law varies between 18% per annum and (i) 28% per annum for business loans above $250,000 or (ii) 24% per annum for other loans. Texas' floating usury ceilings are tied to the 26-week united states treasury bill auction rate. A 1980 federal statute removed the interest ceiling under usury laws for loans by the Subsidiary Bank which are secured by first liens on residential real property.\nEMPLOYEES. Gulf Southwest and its subsidiaries had approximately 305 employees as of December 31, 1995. None of the employees are represented by any collective bargaining unit, and management believes it has excellent relations with its employees.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES - ------- ----------\nThe executive offices of Gulf Southwest are located at 4200 Westheimer, Suite 210, Houston, Texas 77027. Merchants Bank owns the 27,000 square foot branch facility located at 1111 Spencer Highway, South Houston, Texas, which consists of a two-story building and adjacent fourteen-window drive-in facility. The branch facilities located at 2051 West Main in League City, Texas and 3409 Spencer Highway, Pasadena, Texas are owned by Merchants Bank and consist of 13,000 and 4,400 square feet, respectively, of office and lobby space. The other banking quarters and drive-in facilities of Merchants Bank are leased.\nThe banking facilities of First Bank Mainland and First Bank Pearland are owned by the respective banks. First Bank Mainland has two bank lobbies and drive-in facilities located at 920 First Street, LaMarque, Texas and 2801 Main, Dickinson, Texas. First Bank Pearland's bank facilities are located at 3102 East Broadway and 2624 McHard in Pearland, Texas.\nTexas City Bank owns the banking and drive-in facilities located at 701 Sixth Street, North and 1110 25th Street, North in Texas City, Texas. The banking lobby located at 9300 Emmet Lowry Expressway in Texas City is a leased facility.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS - ------- -----------------\nNeither Gulf Southwest nor any of its subsidiaries is a party to any legal proceedings, which, in management's judgment, based upon opinions of legal counsel, would have a material adverse effect on the consolidated financial position of Gulf Southwest and its subsidiaries.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - ------- ---------------------------------------------------\nSince the annual shareholders' meeting held on May 16, 1995, no matters have been submitted to a vote of the shareholders of Gulf Southwest.\nPART II.\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND - ------- --------------------------------------------- RELATED SHAREHOLDER MATTERS ---------------------------\nThere is no established public trading market for shares of the Company's common stock, par value $1.00 per share (the \"Common Stock\"). The Board of Directors of Gulf Southwest has no present intention to arrange for the listing of the Common Stock on any stock exchange. Notwithstanding the foregoing, a limited market for the shares of the Common Stock exists, and such shares are traded on a sporadic basis. During 1995, 46,703 shares of the Common Stock were presented for transfer on the books of Gulf Southwest.\nThe following table sets forth the number of shares of the Common Stock presented for transfer on the books of Gulf Southwest for each quarterly period within the last two calendar years.\nBecause there is no public trading market for the Common Stock, the trading price is determined by private negotiations between the buyer and the seller.\nHOLDERS - -------\nAt March 1, 1996, the Common Stock was owned of record by approximately 960 shareholders. On such date, no shares of Gulf Southwest's preferred stock were issued and outstanding. The officers and directors of Gulf Southwest collectively owned 21.0% of the Common Stock as of such date.\nDIVIDENDS AND DIVIDEND POLICY - -----------------------------\nDIVIDEND POLICY. Holders of Common Stock are entitled to receive such dividends as are declared by gulf southwest's board of directors in accordance with Gulf Southwest's Dividend Policy. Factors which Gulf Southwest's Board of Directors consider prior to declaring a dividend include earnings, regulatory capital requirements, general business conditions and the capital needs of its subsidiaries, as well as other factors which the Board of Directors may deem relevant.\nDIVIDENDS FOR SUBSIDIARY BANKS. Since Gulf Southwest is a bank holding company, it is dependent upon receipt of dividends from its subsidiaries (primarily the Subsidiary Banks) for payment of dividends to shareholders. The payment of dividends by the Subsidiary Banks is limited by applicable banking laws.\nDIVIDEND HISTORY. Gulf Southwest paid quarterly cash dividends on the Common Stock from 1983 through December 31, 1986. Effective March 31, 1987, Gulf Southwest suspended the payment of dividends to holders of the Common Stock as a consequence of losses sustained from operations and a resulting desire to conserve capital. On December 14, 1993, Gulf Southwest's Board of Directors resumed the payment of cash dividends on the Common Stock by declaring a quarterly cash dividend of $.05 per share and a special cash dividend of $.05 per share. During 1994, regular quarterly dividends of $.05 per share of Common Stock were paid. On March 14, 1995, the Board of Directors declared a cash dividend of $.08 per share of Common Stock to shareholders of record on March 14, 1995, payable on March 28, 1995 and on June 15, 1995, payable on June 30, 1995. On September 26, 1995, the Board of Directors increased the quarterly cash dividend to $.10 per share of Common Stock, payable October 4, 1995 to shareholders of record on September 26, 1995. Concurrent with increased earnings, the Board of Directors increased the fourth quarter cash dividend to $.15 per share, payable on December 21, 1995 to shareholders of record on December 12, 1995.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA - ------- -----------------------\nSelected financial data presented below for the fiscal years ended December 31, 1995, 1995, 1993, 1992 and 1991 have been derived from the consolidated financial statements of the Company. The audited historical financial data for the fiscal years ended December 31, 1995, 1994 and 1993 are qualified in their entirety by, and should be read in conjunction with, the financial statements and the notes thereto included elsewhere herein.\nCONDENSED STATEMENTS OF EARNINGS - --------------------------------\nThe following is a comparison of Gulf Southwest's condensed statements of earnings for the most recent five-year period.\nCONDENSED AVERAGE BALANCE SHEETS - --------------------------------\nAlthough year-end statistics present general trends, the daily average balance sheets are more indicative of Gulf Southwest's levels of activity throughout the years indicated and less subject to day-to-day business activity fluctuations. The following schedule sets forth a comparison of the most recent five years' consolidated daily average balance sheets for Gulf Southwest.\n(1) The Company's financial statements for the fiscal year ended December 31,1995 reflect the acquisition of Texas Gulf, which occurred May 1, 1995. See note 2 to the Company's Consolidated financial statements.\n(2) For the years ended December 31, 1995, 1994, 1993, 1992 and 1991, interest income would have been $29,565,000, $17,156,000, $16,071,000, 16,688,000, and $18,960,000, respectively, and net interest income would have been $19,988,000, $12,360,000, $11,128,000, $10,790,000 and $9,912,000, respectively, if all such amounts were shown using a comparable fully taxable equivalent basis (using a tax rate of 34%).\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION - ------- ----------------------------------------------------------- AND RESULTS OF OPERATIONS -------------------------\nNet earnings increased 49.0% in 1995 to $5,907,000,as compared to $3,965,000 in 1994. The acquisition\/merger of Texas Gulf Coast Bancorp, Inc. represented $1,304,000 of the increase of $1,942,000. In 1995, earnings per common share were $3.44, as compared to $3.15 in 1994. Highlights of the major components that affected Gulf Southwest's net earnings are as follows:\nAverage assets grew $156.6 million, or 63.7% to $402.6 million, with average deposits totaling, $356.7 million, representing an increase of 61.5%.\nNon-performing assets - loans past due 90 days or more, non-accrual loans plus other real estate acquired - totaled $5.7 million, or 1.2% of total assets at December 31, 1995, as compared to 1.1% at December 31, 1994.\nNet interest income - the difference between total interest income on earning assets and total interest expense on deposits and borrowings - totaled $19.6 million for 1995, as compared to $12.2 million for 1994.\nNon-interest income - the fees charged for banking services - totaled $4.7 million for 1995, as compared to $3.2 million during 1994.\nNon-interest expense - carrying costs and losses incurred with the acquisition and sale of other real estate, employee compensation and other expenses, such as for occupancy, furniture and equipment, advertising, professional fees, deposit insurance premiums and supplies - totaled $15.9 million as compared to $10.4 million in 1994.\nIncome tax expense - the income tax provision on current year earnings - totaled $2.3 million in 1995, versus $1.0 million in 1994.\nIn the following sections, these and other major factors and trends affecting the components of income and expense are examined in depth. Information concerning assets and liabilities is subsequently provided so that an evaluation can be made of capitalization and liquidity as they may affect Gulf Southwest's future outlook. Balances of the banks acquired in 1995 are only included in the totals reported for 1995.\nNET INTEREST INCOME - -------------------\nNet interest income on a taxable equivalent basis for 1995 was $20.0 million, an increase of $7.6 million, or 61.3%, from $12.4 million in 1994. Net interest income for 1994 was $12.4 million, up $1.3 million, or 11.7%, from $11.1 million in 1993.\nDisregarding the acquisition of Texas Gulf Coast, net interest income increased $1.7 million, or 14.0%, for 1995 as compared to 1994. The improvement in net interest income for 1995 was primarily due to increases in average earning assets with higher average yields. The increase in average earning assets was the result of an increase of 3.8% in average deposits. The increase in 1994 was mainly due to the same factors, as well as the shift of non-earning assets to earning assets. Total interest expense increased $1.2 million in 1995 as compared to the 1994 decrease of $147 thousand. The 1995 increase was primarily due to an increase in interest bearing deposits with higher interest rates. The data used in the analysis of net interest income changes is derived from the daily average levels of interest-bearing assets and liabilities as well as from the rates earned and paid on these amounts. The following schedule gives a three-year history of Gulf Southwest's daily average interest-earning assets and interest-bearing liabilities. Net interest income is developed on a taxable equivalent basis because management of Gulf Southwest is of the opinion that such a presentation facilitates the analytical discussion of changes in the components of earnings. A history of the net interest margin on a taxable equivalent basis (using a federal income tax rate of 34%) is set forth below (in thousands), followed by detailed schedules of its components.\nSUMMARY OF EARNING ASSETS AND INTEREST-BEARING LIABILITIES (IN THOUSANDS)\nNote: Average balances are based upon daily balances. The interest on non- taxable securities has been calculated on a fully taxable equivalent basis- 34% tax basis. Non-accruing loans have been included in assets for these computations, thereby reducing yields on these investments.\nThe following rate\/volume variance has been allocated to the changes in rates. Non-accrual loans are included in the calculations made below. The interest on non-taxable investment income has been calculated on a fully taxable equivalent basis incorporating an effective tax rate of 34%.\nRATE\/VOLUME ANALYSIS CHANGES IN INTEREST INCOME AND INTEREST EXPENSE\n(IN THOUSANDS)\nLOAN PORTFOLIO - --------------\nThe following tables show the composition of the loan portfolio at the end of the last five years and the loan maturity distribution as of December 31, 1995 (dollars in thousands):\nLOAN PORTFOLIO COMPOSITION - --------------------------\nTotal loans increased 64.5% from December 31, 1994 to December 31, 1995. Commercial and industrial loans increased $16,058,000, or 56.2%, real estate related loans increased $44,079,000, or 50.3%, and installment loans increased $31,979,000, or 115.1%. Eliminating the loans acquired through the acquisition of Texas Gulf Coast, total loans increased $16,231,000, or 11.2%.\nThe composition of the loan portfolio at the end of the last three years is displayed in the following table:\nNon-accrual loans and past due loans (90 days or more) totaled $3,125,000 and $850,000, respectively at December 31, 1995, as compared to $1,215,000 and $128,000, respectively at December 31, 1994.\nPROVISION FOR CREDIT LOSSES - ---------------------------\nThe allowance for credit losses at December 31, 1995 was $2,411,000, representing 1.01% of outstanding loans. A year earlier, this ratio was 1.43%. The provision for credit losses charged against earnings was $135,000 in 1995, $50,000 in 1994, and $410,000 in 1993. For the year 1995, the Company had net losses totaling $525,000 as compared to net recoveries of $27,000 in 1994 and net losses of $149,000 in 1993. Included in the net losses of $525,000, loans totaling approximately $300,000 are expected to be recovered through litigation. During 1995, the net charge-off ratio to average loans was .26% as compared to a net recovery ratio to average loans of .02% in 1994 and a net charge-off of .12% in 1993.\nTo a very large extent, the Subsidiary Banks' loan portfolio remains secured and current re-appraisals of collateral value have been received and undertaken in an effort to further assess loss potential. Management has closely scrutinized its loss potential on its non-performing assets, as well as on the entire loan portfolio, and has, to the best of its knowledge and belief, reserved for losses accordingly.\nThe transactions occurring in the allowance for credit losses for the five years ended December 31, 1995, including a breakdown of net charge-offs by type of loan, are as follows:\nSUMMARY OF LOAN LOSS EXPERIENCE\n(IN THOUSANDS)\nManagement of the Subsidiary Banks continues to concentrate on identifying and addressing credit problems. Efforts have been undertaken and are ongoing to strengthen credit review policies and procedures. Intensive efforts are ongoing to ensure that any existing or identifiable developing problem loans receive the necessary effective attention. The Subsidiary Banks' procedures for reviewing the adequacy of their allowance for credit losses involve a review of lending policies and practices, the lending history of personnel involved in the lending process and the compliance by those personnel with the policies. Consideration also is given to (i) management's review of individual outstanding and proposed credits, (ii) the current size and composition of the loan portfolio, (iii) expectations of future economic conditions and their impact on particular industries and specific borrowers, (iv) the level and composition of non- performing loans, (v) evaluation of the underlying collateral for secured loans, (vi) historical loan loss and recovery experience and (vii) comments made during regular examinations or audits by banking regulators, the Subsidiary Banks' internal loan review staff and independent auditors.\nThe allocation of the Subsidiary Banks' allowance for credit losses by loan category for the five years ended December 31, 1995 is presented in the following table (dollars in thousands).\n* Less than $1,000\nNON-PERFORMING ASSETS - ---------------------\nAll loans which cause management to have doubt as to the borrower's ability to substantially comply with present loan repayment terms are included in the schedule of non-performing loans.\nNon-performing loans consist of loans on which interest is not being accrued; loans which are 90 days or more past due as to principal and\/or interest payment and not yet in a non-accruing status. The policy of the Subsidiary Banks is to continue to accrue interest on loans which are 90 days or more past due if periodic payments are being made on the loans. If a loan is classified as past due and payments then resume on the loan, it continues to be classified as past due until all past due amounts are paid. The Company had no material renegotiated or troubled debt restructuring loans during the years 1991 through 1995.\nThe following table discloses information regarding non-performing assets for each of the last five years (in thousands):\nThe Subsidiary Banks included in reported income for 1995, $61,858 of interest received on non-accrual loans. Had these loans paid interest at their original rates, the Subsidiary Banks would have reported $262,583 of interest on these non-accrual loans.\nNON-INTEREST INCOME - -------------------\nNon-interest income increased 43.8% in 1995 compared to an increase of 8.7% in 1994. Service charges on deposits, the largest component of non-interest income, increased by 47.6% in 1995 as compared to a decrease of 1.40% in 1994. Disregarding the acquisition of Texas Gulf Coast, non-interest income decreased by 10.3%\nThe components of other charges and fees consist of miscellaneous fees such as collection fees, credit card fees, safe deposit rentals, research fees, check printing income and wire transfer fees. These fees correlate to the level of transactions in each of the referenced categories. Other operating income increased $264,000, or 39.8%, from 1994 to 1995. The majority of the increase is attributable to the acquisition of the mortgage operation of Texas Gulf Coast. Income from the mortgage operation includes origination fees, as well as fees charged for servicing the underlying mortgages.\nThe following table sets forth by category the non-interest income and the percentage from the prior year for the most recent three years:\nNON-INTEREST EXPENSE - --------------------\nTotal non-interest expense increased by 52.8% for 1995 as compared to a decrease of 1.0% in 1994. All categories had significant increases due to the Texas Gulf Coast acquisition. Disregarding the acquisition, total non-interest expenses decreased $340,000, or 3.1%. Decreases in occupancy and furniture and equipment expenses ($139,000, or 8.3%), other real estate ($196,000, or 43.2%) and other operating expenses ($494,000, or 14.4%) were partially offset by an increase of $489,000 (10.1%) in salaries and benefits.\nThe following table sets forth by category the operating expenses and the percentage change from the prior year for the most recent three years:\nINCOME TAXES - ------------\nAt December 31,1995, the Company has for tax reporting purposes, $302,000 of alternative minimum tax credit carryforward. Footnote 10 to the financial statements on page 47 sets forth the components of the income tax provision and the amounts of deferred tax assets and liabilities of the Company.\nBALANCE SHEET MANAGEMENT - ------------------------\nDuring 1995, total average earning assets increased $139.9 million or 62.2%. Average loans increased $66.2 million, average investment securities increased $60.0 million and average short-term money market instruments increased $13.8 million (these investments include federal funds sold and interest bearing deposits in financial institutions and the Federal Home Loan Bank). The acquisition of Texas Gulf Coast accounts for approximately 75.2% of the increase in average earning assets.\nDuring 1994, total average earning assets increased $13.0 million or 6.1% from 1993. Average loans increased $11.5 million or 9.3% and average investment securities increased $7.8 million or 15.5%. These increases were partially funded by a decrease of $6.3 million or 19.9% in average short-term money market investments, which include federal funds sold and interest-bearing deposits in financial institutions. The remaining growth in average assets was funded by deposits and shareholders' equity, which expanded by an average balance of $7.9 million and $2.5 million, respectively.\nThe following table presents the Company's average balance sheet composition on a percentage basis:\nBALANCE SHEET COMPOSITION - PERCENTAGE OF TOTAL ASSETS - ------------------------------------------------------\nPERCENTAGE OF TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY - --------------------------------------------------------\nINVESTMENT SECURITIES - ---------------------\nThe book and market values of investment securities held by the Company as of dates indicated are summarized as follows (in thousands):\nOn January 1, 1994, all bank holding companies were required to adopt the Financial Accounting Standard Board (\"FASB\") Statement No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" FASB No. 115 requires institutions to divide their securities holdings among three categories: held- to-maturity, available-for-sale and trading securities. The accounting standard provides a different accounting treatment for each category.\nHeld-to-maturity securities are those debt securities which an institution has the positive intent and ability to hold to maturity. These debt securities are reported at amortized cost.\nTrading securities are those debt and equity securities that an institution buys and holds principally for the purpose of selling in the near term. Trading securities are reported at fair value, with unrealized changes in value reported directly in the income statement as a part of the institution's earnings.\nAvailable-for-sale securities are those debt securities which the institution does not have the positive intent and ability to hold to maturity, yet does not intend to trade actively as part of its trading account. Available-for-sale securities must be reported at fair value with any unrealized appreciation or depreciation in the value of these securities, net of tax effects, reported directly as a separate component of equity capital. Thus, unrealized changes in the value of these securities will have no effect on the reported earnings of the bank holding company.\nThe following table shows as of December 31, 1995, the distribution of maturities and the weighted average interest yields to maturity of the Company's investment securities (dollars in thousands).\nThe interest on non-taxable investment securities has been calculated on a fully taxable equivalent basis incorporating an effective tax rate of 34%.\nLIQUIDITY MANAGEMENT - --------------------\nLike any commercial bank, the liability structure of the Subsidiary Banks requires that they maintain an appropriate level of liquid resources to meet normal day-to-day fluctuations in deposit volume and to make new loans and investments as opportunities arise. Liquidity can be provided by either assets or liabilities. The liquidity of Gulf Southwest is provided primarily by dividends from the Subsidiary Banks and GSWDP, income tax benefits and interest on time deposits in financial institutions. Sources of liquidity for the Subsidiary Banks are principally provided by maturing loans, deposits, cash, short-term investments, time deposits in other financial institutions, federal funds sold and profits. At December 31, 1995, the Subsidiary Banks had $29,486,000 in cash, $51,704,000 in federal funds sold and interest bearing deposits with the Federal Home Loan Bank, $898,000 in time deposits with other financial institutions and a $150,719,000 investment securities portfolio in which the market value was $1,728,000 more than the carrying value. The loan- to-deposit ratio was 55.1% at December 31, 1995 compared to 63.9% at December 31, 1994.\nA financial service company's activities consist primarily of financing and investing activities. These activities result in large cash flows. Gulf Southwest's Consolidated Statement of Cash Flows on page 32 indicates the sources of these cash flows.\nCAPITAL COMMITMENTS - -------------------\nGulf Southwest believes that it has sufficient capital and financial resources to meet its current and anticipated capital commitments.\nDEPOSITS - --------\nThe most important source of the Subsidiary Bank's funds is deposits. The type of deposits that were in the Subsidiary Bank on a daily average basis and the related average rate paid during each of the last three years are broken down as follows (dollars in thousands):\nThe following table provides certain information regarding certificates of deposit issued by the Subsidiary Bank in amounts equal to or exceeding $100,000 at December 31, 1995 (dollars in thousands):\nINTEREST RATE SENSITIVITY - -------------------------\nThe objectives of monitoring and managing the interest rate risk position of the balance sheet are to contribute to earnings and to minimize the adverse changes in net interest income. The potential for earnings to be affected by changes in interest rates is inherent in a financial institution.\nInterest rate sensitivity is the relationship between changes in market interest rates and changes in net interest income due to the repricing characteristics of assets and liabilities. An asset sensitive position in a given period will result in more assets being subject to repricing; therefore, market interest rate changes will be reflected more quickly in asset rates. If interest rates decline, such a position will normally have an adverse effect on net interest income. Conversely, in a liability sensitive position, where liabilities reprice more quickly than assets in a given period, a decline in rates will benefit net interest income.\nOne way to analyze interest rate risk is to evaluate the balance of the interest sensitivity position. A mix of assets and liabilities that are roughly equal in volume and repricing represents a matched interest sensitivity position. Any excess of assets or liabilities results in an interest sensitivity gap. The purpose of this analysis is to be aware of the potential risk on future earnings resulting from the impact of possible future changes in interest rates on currently existing net asset or net liability positions. However, this type of analysis is as of a point-in-time; when in fact that position can quickly change as market conditions, customer needs, and management strategies change. Additionally, interest rate changes do not affect all categories of assets and liabilities equally or at the same time.\nThe following table presents the interest sensitivity position of the Company at December 31, 1995 (dollars in thousands):\nThe Company had a negative interest rate sensitive gap position in the 30-day period of $91.4 million. The cumulative rate sensitive gap position was a positive $19.3 million, which indicates that the Company may benefit from rising interest rates; conversely falling interest rates may have a negative impact upon the Company.\nCAPITAL MANAGEMENT - ------------------\nThe Board has adopted a system using the risk-based capital adequacy guidelines to evaluate the capital adequacy of bank holding companies. Under the risk- based capital guidelines, different categories of assets are assigned different risk weights, based generally on the perceived credit risk of the asset. These risk weights are multiplied by corresponding asset balances to determine a \"risk-weighted\" asset base. Certain off-balance sheet items, which previously were not expressly considered in capital adequacy computations, are added to the risk-weighted asset base by converting them to a balance sheet equivalent and assigning them to the appropriate risk weight.\nThe guidelines require that banking organizations achieve minimum ratios of total capital-to-risk-weighted assets of 8.0% (of which at least 4.0% should be in the form of certain \"Tier 1\" elements). Total capital is defined as the sum of \"Tier 1\" and \"Tier 2\" capital elements, with \"Tier 2\" being limited to 100 percent of \"Tier 1.\" For bank holding companies, \"Tier 1\" capital includes, with certain restrictions, common Shareholders' equity, perpetual preferred stock, and minority interests in consolidated subsidiaries. \"Tier 2\" capital includes, with certain limitations, certain forms of perpetual preferred stock, as well as maturing capital instruments and the reserve for possible credit losses.\nAt December 31, 1995, the Company's ratio of \"Tier 1\" and total capital to risk- weighted assets were approximately 18.85% and 19.79%, respectively. Both ratios significantly exceed regulatory minimums.\nThe following table summarizes the Company's Tier 1 and Total Capital (dollars in thousands):\nIn addition to the risk-based capital guidelines, the Board and the FDIC have adopted the use of a leverage ratio as an additional tool to evaluate the capital adequacy of banks and bank holding companies. The leverage ratio is defined to be a company's \"Tier 1\" capital divided by its adjusted total assets. The leverage ratio adopted by the federal banking agencies requires a ratio of 3.0% \"Tier 1\" capital to adjusted total assets for banks with a CAMEL rating of 1 or for bank holding companies with a BOPEC rating of 1. All other institutions will be expected to maintain at least a 100 to 200 basis point cushion, i.e., these institutions will be expected to maintain a leverage ratio of 4.0% to 5.0%. The Company's leverage ratio at December 31, 1995 was 9.92%, which also exceeds the regulatory minimum.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - ------- -------------------------------------------\n-----------------------------\nAll other schedules or supplementary data are omitted as the required information is inapplicable or the information is presented in the financial statements or related notes.\nHIDALGO, BANFILL, ZLOTNIK & KERMALI, P.C. C E R T I F I E D P U B L I C A C C O U N T A N T S (Originally Founded in 1949)\nBoard of Directors and Shareholders Gulf Southwest Bancorp, Inc. Houston, Texas\nINDEPENDENT AUDITORS' REPORT ----------------------------\nWe have audited the accompanying consolidated balance sheet of Gulf Southwest Bancorp, Inc. and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1995, and the balance sheet of Gulf Southwest Bancorp, Inc. (parent company only) as of December 31, 1995 and 1994, and the related statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1995. 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 Gulf Southwest Bancorp, Inc. and subsidiaries and the financial position of Gulf Southwest Bancorp, Inc. (parent company only) as of December 31, 1995 and 1994, and the respective results of their operations and their cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\nHidalgo, Banfill, Zlotnik & Kermali, P.C.\nHouston, Texas February 21, 1996\n3555 TIMMONS LANE, SUITE 460 - HOUSTON, TEXAS 77027 - (713) 963-8008\nGULF SOUTHWEST BANCORP, INC. AND SUBSIDIARIES ---------------------------------------------\nCONSOLIDATED BALANCE SHEET --------------------------\nASSETS ------\nSee notes to financial statements\nGULF SOUTHWEST BANCORP, INC. AND SUBSIDIARIES ---------------------------------------------\nCONSOLIDATED BALANCE SHEET --------------------------\nLIABILITIES AND STOCKHOLDERS' EQUITY ------------------------------------\nSee notes to financial statements.\nGULF SOUTHWEST BANCORP, INC. AND SUBSIDIARIES ---------------------------------------------\nCONSOLIDATED STATEMENT OF INCOME --------------------------------\nSee notes to financial statements.\nGULF SOUTHWEST BANCORP, INC. AND SUBSIDIARIES ----------------------------------------------\nCONSOLIDATED STATEMENT OF INCOME (CONTINUED) --------------------------------------------\nSee notes to financial statements.\nGULF SOUTHWEST BANCORP, INC. AND SUBSIDIARIES (CONSOLIDATED) ------------------------------------------------------------ AND --- GULF SOUTHWEST BANCORP, INC. (PARENT COMPANY ONLY) --------------------------------------------------\nSTATEMENT OF STOCKHOLDERS' EQUITY ---------------------------------\nSee notes to financial statements.\nGULF SOUTHWEST BANCORP, INC. AND SUBSIDIARIES ---------------------------------------------\nCONSOLIDATED STATEMENT OF CASH FLOWS ------------------------------------\nSee notes to financial statements.\nGULF SOUTHWEST BANCORP, INC. AND SUBSIDIARIES ----------------------------------------------\nCONSOLIDATED STATEMENT OF CASH FLOWS (CONTINUED) ------------------------------------------------\nSee notes to financial statements.\nGULF SOUTHWEST BANCORP, INC. AND SUBSIDIARIES ----------------------------------------------\nCONSOLIDATED STATEMENT OF CASH FLOWS (CONTINUED) ------------------------------------------------\nSee notes to financial statements.\nGULF SOUTHWEST BANCORP, INC. ---------------------------- (PARENT COMPANY ONLY) ----------------------\nBALANCE SHEET -------------\nASSETS ------\nSee notes to financial statements.\nGULF SOUTHWEST BANCORP, INC. ---------------------------- (PARENT COMPANY ONLY) ----------------------\nSTATEMENT OF INCOME -------------------\nSee notes to financial statements.\nGULF SOUTHWEST BANCORP, INC. ---------------------------- (PARENT COMPANY ONLY) ----------------------\nSTATEMENT OF CASH FLOWS -----------------------\nSee notes to financial statements.\nGULF SOUTHWEST BANCORP, INC. AND SUBSIDIARIES --------------------------------------------- AND --- GULF SOUTHWEST BANCORP, INC. (PARENT COMPANY ONLY) --------------------------------------------------\nNOTES TO FINANCIAL STATEMENTS -----------------------------\nNOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - ---------------------------------------------------\nThe accounting and reporting policies of Gulf Southwest Bancorp, Inc. (Company) and its subsidiaries conform to generally accepted accounting principles and practices within the banking industry which require the use of estimates by management in the preparation of financial statements.\nThe Company and its subsidiaries offer a full range of financial services to commercial, industrial, financial and individual customers in the greater Houston, Texas and surrounding area, including short-term and medium-term loans, revolving credit arrangements, inventory and accounts receivable financing, equipment financing, real estate lending, Small Business Administration lending, letters of credit, installment and other consumer loans, savings accounts and various savings programs, including individual retirement accounts, and interest and non-interest-bearing checking accounts. Other services include federal tax depository, safe deposit and night depository services. A summary of the more significant accounting policies follows:\nFINANCIAL STATEMENT PRESENTATION - --------------------------------\nThe consolidated financial statements include the accounts of the parent company and its wholly-owned subsidiary, Gulf Southwest Nevada Bancorp, Inc. and its wholly-owned subsidiaries Merchants Bank, First Bank Mainland, Central Data Processing, Inc. and G.S.W. Data Processing, Inc. and its majority owned subsidiaries Texas City Bank and First Bank Pearland. All significant intercompany accounts and transactions have been eliminated in consolidation. Investment in subsidiary is accounted for on the equity method of accounting in the Parent Company Only financial statements.\nINVESTMENT SECURITIES - ---------------------\nOn January 1, 1994, the Company adopted SFAS 115, which addresses the accounting for investments in debt and equity securities. Such securities are classified in three categories and accounted for as follows: debt securities that the Company has the intent and ability to hold to maturity are classified as held- to-maturity and are carried at amortized cost; debt and equity securities bought and held principally for the purpose of reselling, of which the Company has none, are classified as trading securities and are carried at fair value, with unrealized gains and losses included in income; debt or equity securities not classified as either held-to-maturity or trading securities are deemed available-for-sale and are carried at fair value, with unrealized gains and losses, net of applicable income taxes, reported as a separate component of stockholders' equity.\nInterest income on investment securities, including amortization of premiums and accretion of discounts, is recognized using the interest method. The specific identification method is used to determine realized gains and losses on sales of securities, which are reported in securities transactions.\nLOANS - -----\nLoans are stated at the principal amount outstanding, net of unearned income and the allowance for possible loan losses. Interest on commercial, real estate and other loans is accrued over the term of the loan based on the amount of principal outstanding except where serious doubt exists as to the collectibility of a loan, in which case the accrual of interest is discontinued. Interest income on installment loans is computed primarily on sum-of-the-months-digit method which, in the aggregate, does not differ materially from the interest method. Net loan origination and commitment fees are being deferred and amortized into income over the term of the loan as an adjustment of the yield.\nNonaccrual loans are those on which the accrual of interest has ceased. Loans are placed on nonaccrual status if in the opinion of management, principal or interest is not likely to be paid in accordance with the terms of the loan or when principal or interest is past due 90 days or more and collateral is insufficient to cover principal and interest. Interest accrued but not collected at the date a loan is placed on nonaccrual status is reversed against interest income. All cash receipts, whether\nGULF SOUTHWEST BANCORP, INC. AND SUBSIDIARIES --------------------------------------------- AND --- GULF SOUTHWEST BANCORP, INC. (PARENT COMPANY ONLY) --------------------------------------------------\nNOTES TO FINANCIAL STATEMENTS -----------------------------\nNOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) - ---------------------------------------------------------------\nLOANS (CONTINUED) - -----------------\ndesignated as principal or interest are used to reduce the carrying value of the loan when it is in the nonaccrual status. Loans are restored to accrual status when principal and interest payments are brought current and future payments in accordance with loan terms are reasonably assured.\nImpaired loans are carried at the fair value of the loan's collateral. Changes in these values are reflected as adjustments to the allowance for loan losses.\nALLOWANCE FOR POSSIBLE LOAN LOSSES - ----------------------------------\nThe allowance for possible loan losses is established by a charge to income as a provision for loan losses. Actual loan losses or recoveries are charged or credited directly to this allowance. The amount of the allowance is determined based upon evaluation of the loan portfolio, a review of past loan loss experience and management's judgment with respect to current and expected economic conditions and their potential impact on the loan portfolio.\nBANK PREMISES AND EQUIPMENT - ---------------------------\nBank premises and equipment are stated at cost less accumulated depreciation. Depreciation expense is computed on the straight-line method based upon the estimated useful lives of the assets. Amortization of leasehold improvements is based on the estimated useful lives of the improvements or the term of the respective lease, whichever is shorter. At the time of a retirement or sale, the related cost and accumulated depreciation are removed from the accounts, and any resulting gain or loss is recorded in income. Maintenance and repairs are charged to expense as incurred. Renewals and betterments, expenditures which generally increase the value of the property or extend its useful life, are capitalized.\nREAL ESTATE AND OTHER LOAN-RELATED ASSETS - -----------------------------------------\nReal estate and other loan-related assets are stated at the lower of cost or estimated fair value, less the estimated costs to sell. Any reduction from cost (loan value) to estimated fair value at the time of foreclosure is charged to the allowance for possible loan losses. Subsequent valuation adjustments are charged to current earnings through the provision for revaluation of real estate and other loan-related assets. Losses on dispositions are recognized in the period of occurrence while gains are not recognized until all criteria for income recognition have been met. Also, any income received or expense incurred during the period the assets are owned is recognized as income or expense during the period in which it is received or incurred and is included in other real estate expense.\nEXCESS OF COST OVER EQUITY IN NET ASSETS ACQUIRED - -------------------------------------------------\nThe fair value of the net assets acquired in transactions accounted for as purchases is recorded as an investment by the parent company. The excess of the cash or market value of the consideration given in the transaction over the fair value of the net assets acquired is recorded as the excess of cost over fair value of assets acquired, which is amortized into other operating expenses on a straight-line basis over a period of 15 to 40 years.\nGULF SOUTHWEST BANCORP, INC. AND SUBSIDIARIES --------------------------------------------- AND --- GULF SOUTHWEST BANCORP, INC. (PARENT COMPANY ONLY) --------------------------------------------------\nNOTES TO FINANCIAL STATEMENTS -----------------------------\nNOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) - ---------------------------------------------------------------\nINCOME TAXES - ------------\nThe Company and its subsidiaries file a consolidated Federal income tax return. The subsidiaries record income tax expense by applying the statutory tax rate to their income as adjusted for tax exempt interest and other temporary differences and remit the portion of Federal income taxes currently due to the parent company. The parent company records, as a tax benefit, the difference between total taxes reflected by the subsidiaries and the consolidated provision for income taxes. Deferred tax assets and liabilities are recognized for balance sheet basis differences for tax and financial reporting purposes. The deferred taxes represent future tax return consequences of those differences. Investment tax credits and alternative minimum tax credits are recognized as a reduction of Federal income taxes when such credits are utilized.\nEARNINGS PER SHARE - ------------------\nEarnings per share of common stock are computed by dividing earnings by the weighted average number of shares outstanding during the year.\nCASH AND CASH EQUIVALENTS - -------------------------\nFor purposes of reporting cash flows, cash and cash equivalents include cash and due from banks, interest bearing deposits with bank and federal funds sold. Generally, federal funds are purchased and sold for one-day periods.\nRECLASSIFICATIONS - -----------------\nCertain amounts in the 1994 and 1993 financial statements have been reclassified to conform with the 1995 presentation.\nNOTE 2 - ACQUISITION AND MERGERS - --------------------------------\nOn May 1, 1995, the Company through its wholly owned subsidiary Gulf Southwest Nevada Bancorp, Inc. acquired all of the outstanding common stock of Texas Gulf Coast Bancorp, Inc. by issuing 696,205 (with a fair value of $25.50 per share) shares of Gulf Southwest Bancorp, Inc. common stock plus cash of $52,231 for fractional and dissenter shares to effect the merger. The acquisition and merger was accounted for as a purchase transaction. The excess of cost of the acquired Company over the sum of the amounts assigned to identifiable assets acquired less liabilities assumed of $194,650 was recorded as excess of cost over the net equity in net assets acquired and is being amortized over 15 years.\nThe operations of Texas Gulf Coast Bancorp, Inc. since May 1, 1995 are included in the accompanying financial statements. If the Companies had been combined for all of 1995 and 1994 the results of operations would have been as follows:\nGULF SOUTHWEST BANCORP, INC. AND SUBSIDIARIES --------------------------------------------- AND --- GULF SOUTHWEST BANCORP, INC. (PARENT COMPANY ONLY) --------------------------------------------------\nNOTES TO FINANCIAL STATEMENTS -----------------------------\nNOTE 2 - ACQUISITION AND MERGERS (CONTINUED) - --------------------------------------------\nOn January 1, 1996, Gulf Southwest Nevada Bancorp, Inc. a wholly owned subsidiary of the Company merged all of its subsidiary Banks into its Merchants Bank subsidiary and the former subsidiary Banks became branches of Merchants Bank.\nEffective November 30, 1994, the Company contributed its investment in Merchants Bank and G.S.W. Data Processing, Inc., wholly owned subsidiaries to Gulf Southwest Nevada Bancorp, Inc., a newly formed, wholly owned, multi bank holding company subsidiary.\nNOTE 3 - RESERVE REQUIREMENTS - -----------------------------\nCash and due from banks of approximately $8,344,000 and $5,245,000 at December 31, 1995 and 1994, respectively, were maintained to satisfy regulatory reserve and other requirements.\nNOTE 4 - INVESTMENT SECURITIES - ------------------------------\nOn January 1, 1994, the Company adopted SFAS 115, which addresses the accounting for investments in debt and equity securities. See Note One for a further discussion with respect to SFAS 115.\nIn December of 1995 the Company reassessed the appropriateness of the classifications of investment securities in accordance with the Special Report on A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities. The Company transferred all U.S. Treasury and U.S. Government Agencies investment securities in the held-to- maturity classification to the available-for-sale classification. This transfer will enable the Company to more easily control their interest rate risks and liquidity as part of its overall asset\/liability management.\nU. S. Treasury securities at their amortized cost of $45,194,977 and U.S. Government Agencies securities at their amortized cost of $55,250,854 were transferred to the available-for-sale classification at their fair value of $45,129,601 and $56,058,300, respectively.\nHELD-TO-MATURITY INVESTMENT SECURITIES: - ---------------------------------------\nThe amortized cost and estimated fair value of held-to-maturity investment securities were as follows:\nGULF SOUTHWEST BANCORP, INC. AND SUBSIDIARIES --------------------------------------------- AND --- GULF SOUTHWEST BANCORP, INC. (PARENT COMPANY ONLY) --------------------------------------------------\nNOTES TO FINANCIAL STATEMENTS -----------------------------\nNOTE 4 - INVESTMENT SECURITIES (CONTINUED) - ------------------------------------------\nHELD-TO-MATURITY INVESTMENT SECURITIES (CONTINUED): - ---------------------------------------------------\nAVAILABLE-FOR-SALE INVESTMENT SECURITIES: - -----------------------------------------\nThe amortized cost and estimated fair value of available-for-sale investment securities were as follows:\nCash proceeds from the maturity of held-to-maturity investment securities during 1995, 1994 and 1993 were $19,036,859, $6,830,000 and $14,293,450, respectively. Cash proceeds from the maturity and sales of available-for-sale investment securities during 1995 and 1994 was $19,311,807 and $7,500,000, respectively. During 1995 the Company had a net loss of $40 on the call of held-to-maturity investment securities (gross gains of $53 and gross losses of $93.) The Company had no gross gains or losses from matured or sold held-to- maturity or available-for-sale securities during 1994. Net gains from investment securities matured or sold in 1993 amounted to $28,793 (gross gains of $61,419 and gross losses of $32,626).\nGULF SOUTHWEST BANCORP, INC. AND SUBSIDIARIES --------------------------------------------- AND --- GULF SOUTHWEST BANCORP, INC. (PARENT COMPANY ONLY) --------------------------------------------------\nNOTES TO FINANCIAL STATEMENTS -----------------------------\nNOTE 4 - INVESTMENT SECURITIES (CONTINUED) - ------------------------------------------\nAVAILABLE-FOR-SALE INVESTMENT SECURITIES: - -----------------------------------------\nThe amortized cost and estimated fair value of investment securities at December 31, 1995 by contractual maturity were as follows:\nInvestment securities with amortized costs of $74,309,085 and $6,220,306 at December 31, 1995 and 1994, were pledged to secure public deposits and for other purposes as required by law.\nNOTE 5 - LOANS - --------------\nThe loan portfolio was comprised of the following categories at December 31:\nGULF SOUTHWEST BANCORP, INC. AND SUBSIDIARIES --------------------------------------------- AND --- GULF SOUTHWEST BANCORP, INC. (PARENT COMPANY ONLY) --------------------------------------------------\nNOTES TO FINANCIAL STATEMENTS -----------------------------\nNOTE 5 - LOANS (CONTINUED) - --------------------------\nLoans on which interest was not being accrued and past due loans (90 days or more) amounted to $3,125,506 and $849,588, respectively at December 31, 1995, compared to $1,215,347 and $127,984, respectively at December 31, 1994.\nThe allowance for loan losses related to these loans was $226,208 and $111,938 in 1995 and 1994, respectively.\nInterest income lost on impaired loans and the average balance of impaired loans was as follows for the year ended December 31:\nSome of the directors and executive officers of the Company and its subsidiaries and their related parties are loan customers at the Company's subsidiary banks. In management's judgment, such borrowings were on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with others and do not involve other than normal risk of collectibility.\nAn analysis of loans to these parties, exclusive of loans to such persons that in the aggregate do not exceed $60,000, is as follows:\nTransactions in the allowance for possible loan losses were as follows:\nGULF SOUTHWEST BANCORP, INC. AND SUBSIDIARIES --------------------------------------------- AND --- GULF SOUTHWEST BANCORP, INC. (PARENT COMPANY ONLY) --------------------------------------------------\nNOTES TO FINANCIAL STATEMENTS -----------------------------\nNOTE 5 - LOANS (CONTINUED) - --------------------------\nThe Company adopted the Financial Accounting Standards Boards Financial Accounting Standard No. 114, Accounting by Creditors for Impairment of a Loan and No. 118, Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures on January 1, 1995. The adoption of these standards had no material effect on the Company's financial position or results of operations.\nNOTE 6 - BANK PREMISES AND EQUIPMENT - ------------------------------------\nBank premises and equipment were comprised of the following at December 31:\nDepreciation and amortization charged to operating expense was $814,045 in 1995, $506,385 in 1994, and $414,175 in 1993.\nNOTE 7 - INTEREST BEARING DEPOSITS - ----------------------------------\nInterest bearing deposits were comprised of the following categories at December 31:\nGULF SOUTHWEST BANCORP, INC. AND SUBSIDIARIES --------------------------------------------- AND --- GULF SOUTHWEST BANCORP, INC. (PARENT COMPANY ONLY) --------------------------------------------------\nNOTES TO FINANCIAL STATEMENTS -----------------------------\nNOTE 8 - BORROWINGS - -------------------\nThe Company had the following indebtedness at December 31, 1995:\nSubsidiaries - ------------\nIn January of 1996 the above borrowings were repaid.\nNOTE 9 - DIVIDENDS FROM SUBSIDIARIES - ------------------------------------\nSubstantially all of the retained earnings of the Company represent undistributed net income of subsidiaries. Dividends paid by the Company's subsidiary banks are subject to restrictions by certain regulatory agencies.\nGULF SOUTHWEST BANCORP, INC. AND SUBSIDIARIES --------------------------------------------- AND --- GULF SOUTHWEST BANCORP, INC. (PARENT COMPANY ONLY) --------------------------------------------------\nNOTES TO FINANCIAL STATEMENTS -----------------------------\nNOTE 10 - FEDERAL INCOME TAXES - ------------------------------\nThe Company adopted Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes, effective January 1, 1992. The cumulative adjustment resulted in a tax benefit of $2,469,500.\nDeferred income taxes result from differences between amounts of assets and liabilities as measured for income tax and financial reporting purposes. The significant components of Federal deferred tax assets and liabilities as of December 31, are as follows:\nThe consolidated provision for income taxes for the years ended December 31, consists of the following:\nThe income tax expense applicable to securities gains and losses for the years 1995, 1994 and 1993 was $(12), $(-0-) and $5,760, respectively.\nThe difference between the effective tax rate on consolidated income before income taxes and the statutory rate is attributed to the following:\nGULF SOUTHWEST BANCORP, INC. AND SUBSIDIARIES --------------------------------------------- AND --- GULF SOUTHWEST BANCORP, INC. (PARENT COMPANY ONLY) --------------------------------------------------\nNOTES TO FINANCIAL STATEMENTS -----------------------------\nNOTE 10 - FEDERAL INCOME TAXES (CONTINUED) - ------------------------------------------\nDeferred income taxes result from temporary differences between the carrying value of assets and liabilities for financial reporting and tax reporting purposes. The sources and related tax effects of these differences are as follows:\nAt December 31, 1995, the Company has, for tax reporting purposes, alternative minimum tax credits of approximately $301,700.\nNOTE 11 - COMMITMENTS AND CONTINGENCIES - ---------------------------------------\nIn the normal course of business, the Company's subsidiary banks are a party to financial instruments with off balance sheet risk 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 risk in excess of the amounts recognized in the consolidated balance sheet.\nThe Company's subsidiary banks use the same credit policies in making commitments as it does for on-balance sheet instruments. Collateral is required to support the off-balance sheet instruments when it is deemed necessary. Collateral held varies, but may include: deposits held in financial institutions, accounts receivable, inventory and property, plant and equipment.\nFinancial instruments whose contract amounts represent potential credit risk are as follows at December 31:\nGULF SOUTHWEST BANCORP, INC. AND SUBSIDIARIES --------------------------------------------- AND --- GULF SOUTHWEST BANCORP, INC. (PARENT COMPANY ONLY) --------------------------------------------------\nNOTES TO FINANCIAL STATEMENTS -----------------------------\nNOTE 11 - COMMITMENTS AND CONTINGENCIES (CONTINUED) - ---------------------------------------------------\nThe Company and subsidiaries have non-cancelable operating leases covering certain equipment and buildings. The following is a schedule of future minimum lease payments as of December 31, 1995:\nRent expense incurred under operating leases amounted to $519,882, $402,859 and $305,460 for the years ended December 31, 1995, 1994 and 1993, respectively.\nAt December 31, 1995, the Company's subsidiary banks had contracts for construction of new branch facilities and purchase of land and equipment of $1,400,150.\nVarious lawsuits are pending against the Company's subsidiary banks. Management, after reviewing these suits with legal counsel, considers that the aggregate liability, if any, would not have a material adverse effect on the Company's financial position.\nNOTE 12 - FLEXIBLE STOCK OPTION PLAN - ------------------------------------\nIn 1986, the Company adopted a Flexible Stock Option Plan, pursuant to which two hundred thousand (200,000) shares of the authorized, but unissued, or reacquired common stock were reserved for issuance. The plan provides for both incentive and nonstatutory stock options.\nOptions may be granted to any key employee, including officers and directors who are also employees, of the Company or of subsidiary corporations of the Company. Options granted under the plan generally become exercisable in installments of 25 percent per year beginning one year after the date of grant.\nThe exercise price of the stock options granted under the plan will be determined by the Board of Directors at the time of grant, and said exercise price must be at least equal to the fair market value of the common stock on the date of grant. The exercise price to any participant who owns stock possessing more than 10 percent of the total combined voting power of all classes of the stock of the Company, must be at least 110 percent of the fair market value of the common stock on the date of grant.\nThe maximum number of shares of common stock for which options may be granted to members of the Board of Directors under the plan is one hundred thousand (100,000) shares. No individual member of the Board of Directors may be granted options to purchase more than an aggregate of ten thousand (10,000) shares of common stock.\nAs of December 31, 1995 no options have been granted under the plan.\nGULF SOUTHWEST BANCORP, INC. AND SUBSIDIARIES --------------------------------------------- AND --- GULF SOUTHWEST BANCORP, INC. (PARENT COMPANY ONLY) --------------------------------------------------\nNOTES TO FINANCIAL STATEMENTS -----------------------------\nNOTE 13 - EMPLOYEE BENEFIT PLANS - --------------------------------\nThe Company has a noncontributory defined benefit pension plan covering substantially all full time employees. Benefits are based on an employee's years of service and compensation. The Company makes contributions to the plan annually based upon actuarial valuations. The plan assets are managed and invested by the trust division of a commercial bank. The plan assets are invested in several equity, bond and common trust investment funds managed by the trustee bank.\nThe Company's pension plan was adopted on September 1, 1994. The Texas Gulf Coast Bancorp, Inc. noncontributory defined benefit pension plan was merged with the Company's pension plan on December 31, 1995.\nUnrecognized prior service cost of the Company's pension plan is being amortized on a straight line basis over fifteen years.\nNet periodic pension cost for the pension plan was as follows for 1995:\nGULF SOUTHWEST BANCORP, INC. AND SUBSIDIARIES --------------------------------------------- AND --- GULF SOUTHWEST BANCORP, INC. (PARENT COMPANY ONLY) --------------------------------------------------\nNOTES TO FINANCIAL STATEMENTS -----------------------------\nNOTE 13 - EMPLOYEE BENEFIT PLANS (CONTINUED) - --------------------------------------------\nThe Company has a qualified employee benefit plan under section 401(k) of the Internal Revenue Code. Employees can contribute up to 15% of their compensation to the plan on a pretax basis subject to regulatory limits and the Company at its discretion can match up to 100 percent of 6 percent of the participant's compensation. The administrative cost of the plan is paid by the Company at no cost to the participants.\nNOTE 14 - ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS - -------------------------------------------------------\nThe following disclosure of the estimated fair value of financial instruments is made in accordance with the requirements of SFAS No. 107, Disclosure about Fair Value of Financial Instruments. The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is necessarily required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein 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.\nCash and cash equivalents - - For cash and due from banks, interest bearing deposits with bank, time deposits in financial institutions and federal funds sold, the carrying amount is a reasonable estimate of fair value.\nInvestment securities - - Investment securities fair value equals quoted market price, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities. See Note One for valuation methodologies used for investment securities.\nLoans - - The fair value of loans 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.\nDeposits - - The fair value of demand deposits, savings accounts and certain money market deposits is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities.\nBorrowings -- The fair value of borrowings is estimated based upon current market interest rates for Companies with like credit ratings and similar maturities.\nCommitments to extend credit and standby letters of credit - - The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counter parties. For fixed-rate commitments, fair value also considers the difference between current levels of interest rates and committed rates. The fair value of letters of credit is based on fees currently charged for similar letters of credit.\nGULF SOUTHWEST BANCORP, INC. AND SUBSIDIARIES --------------------------------------------- AND --- GULF SOUTHWEST BANCORP, INC. (PARENT COMPANY ONLY) --------------------------------------------------\nNOTES TO FINANCIAL STATEMENTS -----------------------------\nNOTE 14 - ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED) - -------------------------------------------------------------------\nThe estimated fair values of the Company's financial instruments are as follows:\nNOTE 15 - OTHER OPERATING EXPENSE - ---------------------------------\nOther operating expense for the years ended December 31, are as follows:\nITEM 9.","section_9":"ITEM 9. 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(Incorporated by reference to the section entitled \"Nominees for Election as Directors\" of Gulf Southwest's Proxy Statement for its 1996 annual meeting of shareholders.)\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION - -------- ----------------------\n(Incorporated by reference to the section entitled \"Executive Compensation\" of Gulf Southwest's Proxy Statement for its 1996 annual meeting of shareholders.)\nITEM 12.","section_12":"ITEM 12. SECURITY OWENRSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - -------- --------------------------------------------------------------\n(Incorporated by reference to the section entitled \"Ownership of Common Stock\" of Gulf Southwest's Proxy Statement for its 1996 annual meeting of shareholders.)\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - -------- ----------------------------------------------\n(Incorporated by reference to the section entitled \"Certain Relationships and Related Transactions\" of Gulf Southwest's Proxy Statement for its 1996 annual meeting of shareholders.)\nPART IV.\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON - -------- ------------------------------------------------------ FORM 8-K --------\n(A) LIST OF DOCUMENTS FILED AS PART OF THIS REPORT\n(1) Financial Statements See index to financial statements at Item 8 of this report. (2) Exhibits\n(B) REPORTS ON FORM 8-K.\nNo reports were filed.\nPursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nGULF SOUTHWEST BANCORP, INC.\nBY: \/s\/ J. W. Lander, Jr. -------------------- J. W. Lander, Jr. Chief Executive Officer\nDate: March 21, 1996\nPursuant to the requirement of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nSECURITIES AND EXCHANGE COMMISSION\nWASHINGTON, D.C. 20549\nEXHIBITS TO\nFORM 10-K\nANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF\nTHE SECURITIES EXCHANGE ACT OF 1934\nFOR THE FISCAL YEAR ENDED DECEMBER 31, 1995\nCOMMISSION FILE NUMBER 0-11033\nGULF SOUTHWEST BANCORP, INC.\n(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)\nINDEX TO EXHIBITS","section_15":""}
{"filename":"81025_1995.txt","cik":"81025","year":"1995","section_1":"Item 1. Business - - -----------------\nGeneral - - -------\nPublic Service Company of North Carolina, Incorporated (PSNC) is a public utility engaged primarily in selling and transporting natural gas to approximately 285,000 residential, commercial and industrial customers in North Carolina. It was organized as a North Carolina corporation in 1938, and its corporate office is located at 400 Cox Road, P. O. Box 1398, Gastonia, North Carolina 28053-1398, telephone (704) 864-6731.\nIn connection with its natural gas distribution business, PSNC promotes, sells and installs both new and replacement cooking, water heating, laundry, space heating, cooling and humidity control natural gas appliances and equipment. PSNC, through an unregulated subsidiary, provides conversion and maintenance services for natural gas-fueled vehicles (NGVs) in selected cities in and beyond its franchised territory. Through another unregulated subsidiary, PSNC is engaged in the marketing of natural gas to large commercial and industrial customers.\nDuring fiscal years 1995, 1994 and 1993, no single customer account contributed more than 2% of PSNC's total operating revenues.\nPSNC has no reportable industry segments. Revenues attributable to natural gas distribution, merchandise and jobbing, propane operations, exploration and development and gas marketing and other activities for each of the fiscal years in the three-year period ended September 30, 1995 were as follows (in thousands):\n1995 1994 1993 -------- -------- -------- Natural Gas Distribution(1) $247,893 $273,705 $279,989 Merchandise and Jobbing(2) 8,675 8,135 8,692 Propane Operations(3) - 9,090 9,662 Exploration & Development(3) (171) 1,547 535 Gas Marketing\/Other Activities(1) 8,827 7,654 157 -------- -------- -------- Total $265,224 $300,131 $299,035 ======== ======== ========\n- - ------------ (1) See \"Results of Operations\" on page 17 of this annual report. (2) Primarily the sale and installation of gas appliances. (3) Effective June 29, 1994, PSNC sold its propane operations to Empiregas, Inc. During June 1994, PSNC sold PSNC Production Corporation's exploration and development properties. Service Territory - - -------------------\nPSNC's 26-county franchised service territory includes Raleigh, Durham and the Research Triangle Park area in the northcentral portion of the state; this area accounts for approximately 60% of PSNC's customers and 51% of its throughput (total gas sales and transportation) in fiscal 1995. PSNC's central area includes the cities of Gastonia, Concord and Statesville which are located in the greater Charlotte metropolitan area; this area accounts for 28% of PSNC's customers and 33% of its throughput. PSNC's western area includes Asheville, Hendersonville and Brevard, and accounts for the remaining 12% of customers and 16% of throughput. PSNC's diversified industrial base in its service territory includes manufacturers of textiles, chemicals, ceramics and clay products, glass, automotive products, minerals, pharmaceuticals, plastics, metals, electronic equipment, furniture and a variety of food and tobacco products. PSNC's utility operations are regulated by the North Carolina Utilities Commission (NCUC).\nOver 2.3 million people reside in PSNC's franchised territory. During the past three fiscal years, PSNC has added approximately 36,300 new customers to its natural gas transmission and distribution systems. Of those customers, 32,700 were residential, 2,400 were commercial and 1,200 were industrial. The resulting 5% average annual growth rate is nearly three times the national industry average. PSNC's average annual customer growth rate since fiscal 1985 has been 5.3%. PSNC attributes this growth rate to two primary factors:\n- The continued expansion by PSNC of its transmission and distribution systems to enable it to reach new customers in its relatively unsaturated service territory. The population in PSNC's franchised territory has grown faster than the national average in recent years and PSNC estimates that it serves approximately one-third of that population.\n- The continued growth of the North Carolina economy, including areas within PSNC's service territory. Also, the State's relatively low unemployment rate has been below the national average in recent years.\nBusiness Strategy - - ------------------\nPSNC is expanding its transmission and distribution systems to deliver more natural gas throughout its service territory. Of its total construction expenditures of $61.1 million in fiscal 1995, $45.5 million in fiscal 1994, and $40.1 million in fiscal 1993, approximately $49.7 million, $39.1 million and $31.6 million, respectively, were expended on the construction of transmission and distribution pipelines. PSNC is focusing on the following marketing priorities:\n- Retaining existing customers by marketing the replacement of old appliances and equipment with new gas equipment.\n- Increasing demand for natural gas by marketing additional gas equipment to PSNC's existing customers.\n- Adding new customers either on its existing distribution system or by economical short distribution main extensions.\nIn addition, PSNC is evaluating the introduction of emerging gas technologies as a way to increase the long-term demand for natural gas. PSNC has identified the conversion of gasoline-fueled vehicles to NGVs as an opportunity to increase the demand for natural gas in the future. PSNC was the first local distribution company (LDC) in North Carolina to offer NGV conversions to the public and private sectors. PSNC also has identified natural gas cooling technology as an opportunity to increase the demand for natural gas and has begun marketing such technology. The implementation in 1992 of the Federal Energy Regulatory Commission (FERC) Orders 636, 636-A and 636-B created new off-system marketing opportunities for PSNC and its marketing affiliate.\nPSNC's internal focus has been to streamline its organizational structure and improve the performance of management and employees. In fiscal 1993, PSNC completed the process of streamlining the management of its operations and engineering departments by moving many operating decisions to the area offices. PSNC has also focused on increasing employee efficiency, improving its average number of customers per employee ratio over the last three years from 217 at September 30, 1992 to 247 at September 30, 1995.\nGas Supply - - ----------\nAs a result of FERC Orders 636, which restructured the interstate natural gas transportation industry, PSNC's gas purchasing practices have changed significantly during the past few years. Effective August 1, 1991, PSNC's primary pipeline supplier, Transcontinental Gas Pipe Line Corporation (Transco), became the first major pipeline to offer unbundled open-access transportation and storage services. The primary advantage is that PSNC now manages its gas supply, transportation and storage service requirements rather than utilizing a pipeline supplier whose service options are bundled together and then offered as a single city gate sales service. Unbundled open-access transportation and storage services, however, do shift the risk of ensuring an adequate supply of gas from the interstate pipelines to LDCs.\nThe FERC approved Transco's restructuring settlement effective November 1, 1993 and essentially preserved Transco's existing firm service settlement with PSNC. PSNC has not experienced any material adverse effect on its financial position or results of operations as a result of the Order. Further, management believes it will provide gas services marketing opportunities both on and off the existing pipeline system for PSNC and its subsidiaries which should provide an overall net benefit to PSNC.\nPSNC purchases for resale most of the natural gas that it delivers (throughput) to its customers. The balance of its throughput is natural gas purchased by certain large volume commercial and industrial customers directly from various producers and marketers. This gas is transported to these customers by PSNC at a rate which enables PSNC to earn a margin equivalent to that which it would have earned by selling the same quantity of gas to these customers. Quantities of transported gas represented approximately 38%, 26%, and 8% of PSNC's total volume throughput for fiscal 1995, 1994 and 1993, respectively.\nManagement believes that PSNC's gas supply portfolio will enable it to continue to provide secure service on a cost-competitive basis. This balance of security and cost control, along with flexibility to adapt to changing conditions, is achieved through a mix of long-term contractual obligations, coupled with short-term or spot market purchases. PSNC's utility gas purchasing practices are reviewed annually by the NCUC.\nThe following table summarizes the natural gas supply sources and transportation arrangements available to PSNC under contract with Transco and CNG Transmission Company (CNG). All amounts are shown in dekatherms (DT), a unit of heating value equal to one million British Thermal Units (BTU). PSNC's backhaul arrangement with CNG makes available additional daily capacity of 30,000 DT and is for a combination of storage and firm transportation. Natural gas purchased by PSNC from other sources is transported by Transco and CNG. Natural gas purchased directly from Transco accounted for 28% and 30%, respectively, of PSNC's supply in fiscal 1995 and 1994.\nDaily Contract Deliver- Annual Expiration Type of Contract ability Quantity Date - - -------------------------- -------- ---------- ---------- Firm Sales Service (1)(4) 41,928 15,303,720 3\/31\/96 Firm Sales Service (1) 41,928 15,303,720 3\/31\/01 Firm Transportation 164,151 59,915,115 1\/31\/12 Firm Transportation 5,175 1,888,875 10\/31\/07 Incremental Firm Transportation 2,264 826,360 3\/16\/98 Winter Firm Transportation (December 1 through February 28) 4,347 391,230 7\/31\/11 Southern Expansion Firm Transportation: November and March 35,397 December through February 39,330 5,698,917 10\/31\/05 Southeast Expansion Firm Transportation: Phase 1 6,064 2,213,360 11\/01\/14 Phase 2 (3) 20,759 7,577,035 11\/01\/15 Phase 3 (3) 17,804 6,498,460 11\/01\/15 CNG Firm Transportation 30,000 10,950,000 (2) - - ------------ (1) These are separate and concurrent contracts. (2) These represent multiple contracts which expire on dates ranging from 10\/31\/99 to 3\/31\/13. (3) Phase 2 was effective November 1, 1995; Phase 3 will be effective November 1, 1996. (4) PSNC intends to renew this contract for a one-year period ending 3\/31\/97. As discussed further in Note 2 to the financial statements, PSNC and a subsidiary of Piedmont Natural Gas Company, Inc. formed Cardinal Pipeline Company, LLC (Cardinal) in March 1994 to construct an intrastate transmission pipeline. The Cardinal pipeline was placed into service in December 1994 and provides additional daily capacity to PSNC's eastern service territory in and around the Durham and Raleigh areas. The NCUC granted an increase in annual revenues of $3,063,000 to recover PSNC's cost of the investment, effective January 26, 1995. In September 1995, PSNC, Piedmont, Transco, and North Carolina Natural Gas Corporation (NCNG) signed a letter of intent to form a limited liability company (LLC) to purchase and extend the Cardinal pipeline. As proposed, the pipeline will be extended 65 miles from Burlington to a point southeast of Raleigh and will add 140 million cubic feet per day of additional firm capacity. A definitive agreement was signed on December 6, 1995. The LLC plans to request appropriate regulatory authorization in the fall of 1996 to extend the existing pipeline, and subject to the approval of appropriate state and federal agencies, construction is scheduled to begin in early 1999. The facilities are expected to be in service on or before November 1, 1999.\nTo balance peak winter demands of residential and commercial customers with their much-reduced summer usage, PSNC uses underground natural gas storage services and liquefied natural gas (LNG) peaking facilities. During periods of reduced usage, PSNC purchases natural gas to replenish the LNG facilities owned by PSNC and used under contract storage services from its pipeline suppliers. The ability to maintain maximum delivery from these storage facilities for an extended period of time is limited. Information about PSNC's storage arrangements is shown in the following table.\nDaily Contract Deliver- Expiration Storage Facility ability Capacity Date - - ------------------------- -------- --------- ---------- CNG General Storage 11,669 696,000 3\/31\/13 Transco General Storage 33,218 1,923,485 3\/31\/13 Transco Washington Storage (1) 32,870 2,794,500 3\/31\/98 Transco LNG Storage 5,175 25,875 (3) Transco Eminence Storage 29,514 245,297 3\/31\/13 PSNC LNG Storage (2) 100,000 1,040,000 N\/A NCNG Peaking Supply 15,000 225,000 10\/31\/96 - - ------------ (1) No peak day delivery assured by contract. (2) Amounts shown represent maximum peak day capacity. (3) This contract has expired; however, its renewal is currently being negotiated with Transco. In the interim, this service is available to PSNC under the same terms and conditions contained in the expired agreement.\nAs discussed further in Note 2 to the financial statements, PSNC has signed a letter of intent with the Pine Needle LNG Company, LLC (Pine Needle), to add PSNC's subsidiary, PSNC Blue Ridge Corporation, as an owner of Pine Needle. Pine Needle, originally formed by subsidiaries of Transco and Piedmont, has sought approval from the FERC to construct, own and operate an LNG peak demand facility in North Carolina. A subsidiary of Transco will serve as the operator. PSNC Blue Ridge will own 17 percent of Pine Needle and PSNC will have the right to use 25 percent of the facility's gas storage capacity and withdrawal capabilities. The facility will be located near Transco's main transmission pipeline northwest of Greensboro and will have a storage capacity of four billion cubic feet with vaporization capability of 400 million cubic feet per day. A project application was submitted to the FERC in early November 1995 and, pending FERC approval, construction will begin in early 1997. Liquefaction is expected to begin in May 1999 in time for withdrawal service to begin in the 1999 winter heating season.\nCompetition - - -----------\nAlthough PSNC is the sole distributor of natural gas in its service area, it faces competition from suppliers of alternate fuels and other types of energy. Competition is strongest for sales to large volume commercial and industrial customers having alternate fuel capability but exists for all other customer classes as well.\nDuring fiscal 1995, approximately 40% of gas delivered by PSNC was delivered to large volume commercial and industrial customers having alternate fuel capability. The primary alternate fuels available to these customers are fuel oil and propane, and to a lesser extent coal and combustible wood products. The NCUC has approved a rate structure that allows PSNC to negotiate reduced rates in order to match the cost of alternate fuels to individual customers and recover the lost margin from other classes of customers. PSNC anticipates that the need to negotiate reduced rates with these customers will continue.\nElectricity is the primary competition to natural gas in the residential and commercial markets where the predominate uses of energy are for space heating, water heating and cooking. Currently, natural gas enjoys a competitive price advantage over electricity for these purposes, enabling PSNC in recent years to obtain a significant share of the new residential construction in its service area where natural gas is available.\nRegulation and Rates - - --------------------\nPSNC's natural gas transmission and distribution business is subject to regulation by the NCUC, including rates, issuance of securities, adequacy of service, safety standards, extension and abandonment of facilities, accounting and depreciation rates. The NCUC has seven commissioners appointed by the Governor of North Carolina for staggered eight-year terms. The NCUC granted PSNC's most recent general rate increase of $10,763,000 of additional annual revenues on October 7, 1994. The order allowed PSNC an opportunity to earn 11.87% on common equity and a 10.51% overall return on its net utility investment, as compared to 12.9% and 11.1% respectively, in its November 1991 rate order.\nPSNC's rates include a weather normalization adjustment mechanism (WNA). The WNA was initially approved in PSNC's general rate case order in November 1991 and is in effect for bills rendered during the period from November 1 through April 30 of each year. The WNA applies only to residential and small general service rates and affects only the non-gas portion of PSNC's rate. Sales to large-volume customers are not normalized because natural gas usage for such customers is significantly less weather-sensitive. The WNA increases tariff rates if weather is warmer than normal and decreases rates if weather is colder than normal. This prevents the under- or over-collection of non-gas costs due to variations in the quantity of natural gas delivered when weather deviates from normal. The WNA does not change the seasonality of PSNC's earnings and cash flow; however, it does reduce fluctuations caused by abnormal weather.\nPSNC also operates under two other rate provisions that serve to reduce fluctuations in PSNC's earnings. First, its Rider D rate mechanism allows PSNC to recover, in any manner authorized by the NCUC, margin losses on negotiated gas sales to large commercial and industrial customers with alternate fuel capability. The Rider D rate mechanism also allows PSNC to recover from customers all prudently incurred gas costs, including changes in natural gas prices. Second, PSNC operates with \"full margin\" transportation rates. These rates allow PSNC to earn the same margin on gas delivered to customers regardless of whether the gas is sold by PSNC to the customer or is only transported by PSNC.\nPSNC's rates are established using a base cost of gas approved by the NCUC which may be modified periodically due to changes in the market price of natural gas and changes in the rates charged by PSNC's pipeline suppliers. PSNC may file revised tariffs with the NCUC coincident with these changes or it may track the changes in its deferred accounts for subsequent rate consideration. The rules of the NCUC allow recovery of all prudently incurred gas costs. Also, the NCUC reviews PSNC's gas purchasing practices annually.\nIn April 1992, the NCUC adopted rules to implement a program of expansion permitted by an act passed by the North Carolina General Assembly in July 1991. This act permits the establishment of expansion funds to be used by each North Carolina LDC to expand natural gas service to areas which would otherwise not be economically feasible to serve. Separate funds have been established for use solely in each LDC's franchised service territory. Sources for expansion funds may be each LDC's respective supplier refunds, special surcharges or other sources permitted by the NCUC. Subject to the NCUC rules and availability of funds, the LDCs will be allowed to utilize the expansion funds to the extent necessary to make such projects feasible on a net present value basis. The balance of the funding for projects will be supplied by the LDC. Three counties in PSNC's franchised territory are currently unserved along with certain areas in other counties. On June 3, 1993, the NCUC entered an order creating an expansion fund for PSNC in the Office of the State Treasurer. PSNC has received approximately $19,580,000 of supplier refunds and interest earned thereon. The NCUC has approved an expansion project in McDowell County which will require funding from PSNC's expansion fund. The total estimated cost to complete this project is approximately $12.5 million, of which up to $8,193,500 can be used from the fund to finance the project. The project was initiated in December 1995 and is expected to be in service by December 1996. PSNC plans to initiate additional expansion projects in five other counties over an estimated five-year period, subject to approval by the NCUC.\nPSNC currently plans to file a general rate case with the NCUC in the spring of 1996. A general rate order from the NCUC is expected in the fall of 1996.\nFranchises - - ----------\nPSNC holds a certificate of public convenience and necessity granted by the NCUC to provide service in its 26-county service territory. Under North Carolina law, no company may construct or operate properties for the sale or distribution of natural gas without having obtained such a certificate, except that no certificate is required for construction in the ordinary course of business or for construction into territory contiguous to that already occupied by an LDC and not receiving similar service from another public utility.\nPSNC has nonexclusive franchises from 64 municipalities in which it delivers natural gas. The expiration dates of franchises having specific expiration provisions range from 1996 to 2029. The franchises contain no restrictions of a materially burdensome nature and are adequate for PSNC's business as presently, and as proposed to be, conducted. These franchises have been routinely renewed by the municipalities when they expire. The other communities served by PSNC have not required franchises.\nNon-utility Businesses - - ----------------------\nDuring fiscal 1995, PSNC continued its gas brokering activities through its subsidiary, PSNC Production Corporation. This rapidly expanding activity now serves over 200 accounts both on and off PSNC's system. Clean Energy Enterprises, Inc. (formerly Tar Heel Energy Corporation) also continued its activities in the refueling of natural gas vehicles and the conversion of gasoline-fueled vehicles to natural gas.\nEnvironmental Matters - - ---------------------\nPSNC is subject to regulation with regard to environmental matters by various federal, state and local authorities. PSNC owns or has owned portions of six sites in North Carolina on which manufactured gas plants (MGPs) were formerly operated and one site at which a manufactured gas holder was located. Evaluations have revealed that MGP residuals are present or suspected at each of the sites. PSNC has recorded a total liability of $3,705,000, which represents the minimum amount of the range of $3,705,000 to $50,145,000 expected for investigating and monitoring the extent of environmental degradation and of implementing remedial procedures. See Note 8 to the consolidated financial statements for further details regarding this and other environmental matters related to PSNC.\nEmployees - - ---------\nAt November 30, 1995, PSNC had 1,121 full-time employees compared with 1,130 at November 30, 1994. PSNC considers its relationship with its employees to be good and has never experienced a strike or work stoppage. PSNC has collective bargaining agreements with International Chemical Workers Union (ICWU) locals representing approximately 360 construction and service employees. In December 1993, these bargaining agreements were renewed for a three-year period.\nSeasonality - - -----------\nDue to the seasonal nature of PSNC's business, the first six months of its fiscal year are generally the most profitable. During fiscal 1995, the quarters ended December 31 and March 31 together accounted for approximately 75% and 77% of PSNC's natural gas sales revenues and volumes, respectively. The quarters ending June 30 and September 30 are generally PSNC's least profitable quarters due to decreased demand for natural gas related to lower space heating requirements.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nDate Elected Name and Age (1) Title (1) An Officer - - ----------------------- ------------------------------- ------------ Charles E. Zeigler, Jr. Chairman, President and 11\/01\/86 Age - 49 Chief Executive Officer John D. Grawe Senior Vice President - 10\/3\/94 Age - 47 Operations George F. Kast Senior Vice President - 8\/24\/87 Age - 49 Information Systems Jerry W. Richardson Senior Vice President - 2\/23\/82 Age - 50 Engineering Fred L. Schmidt Senior Vice President - 1\/04\/93 Age - 54 Human Resources Robert D. Voigt Senior Vice President - 9\/01\/81 Age - 44 Corporate Development and Chief Financial Officer Franklin H. Yoho Senior Vice President - 2\/01\/91 Age - 36 Marketing and Gas Supply Herbert B. Cox Vice President - 5\/01\/90 Age - 51 Operations Services J. Paul Douglas Vice President - 12\/21\/94 Age - 48 Corporate Counsel and Secretary Boyce C. Morrow, Jr. Vice President - 3\/01\/90 Age - 51 Governmental Relations Sharon D. Boone Controller and 3\/01\/95 Age - 42 Assistant Secretary Jack G. Mason Treasurer 3\/01\/95 Age - 38 - - -------------- (1) As of November 30, 1995.\nThe present terms of all officers extend to January 26, 1996, the date of the next annual meeting of shareholders and the annual meeting of the board of directors, or until their successors are elected and qualified.\nAll of the executive officers have served in executive positions with PSNC for the past five years with the exception of Fred L. Schmidt, Franklin H. Yoho, J. Paul Douglas, John D. Grawe, Sharon D. Boone and Jack G. Mason.\nFred L. Schmidt was employed by PSNC on January 4, 1993. Prior to joining PSNC, he was employed by RJR Nabisco, Incorporated in Winston- Salem, North Carolina as Director - Employee Relations, Compensation and Benefits, and Human Resources Information System.\nFranklin H. Yoho was employed by PSNC on January 9, 1989 and previously held the positions of Manager - Gas Supply and Transportation, Vice President - Gas Supply and Transportation, and Vice President - Corporate Development and Gas Supply. Prior to joining PSNC, he was employed by Columbia Gas System Service Corporation as Manager - Market Development.\nJ. Paul Douglas was employed by PSNC on December 21, 1994. Prior to joining PSNC, he was employed by Conoco, Inc. as counsel from March 1991 to December 1994, was a partner with the law firm of Katten, Muchin, Zavis and Dombroff from February 1990 to March 1991 and was a partner with the law firm of Grove, Jaskiewicz, Gilliam and Cobert from February 1984 to February 1990. In connection with a divorce proceeding, Mr. Douglas filed a bankruptcy petition in the United States Bankruptcy Court for the Southern District of Texas on June 18, 1991 and was discharged on October 11, 1991.\nJohn D. Grawe was employed by PSNC on October 3, 1994. Prior to joining PSNC, he was employed by Wisconsin Power and Light Company, most recently serving as Director of Gas Engineering and Operations.\nSharon D. Boone was employed by PSNC on November 15, 1982. During the past five years, prior to serving as Controller and Assistant Secretary, Ms. Boone held the positions of Manager - Plant Accounting and Tax Services, Manager - Corporate Accounting, and Director - Corporate Accounting.\nJack G. Mason was employed by PSNC on July 5, 1979. During the past five years, prior to serving as Treasurer, Mr. Mason held the positions of Assistant Treasurer and Assistant Controller, Assistant Treasurer, and Director - Financial Projects and Assistant Treasurer.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties - - -------------------\nPSNC owns 690 miles of transmission pipelines of 2 to 24 inches in diameter which connect its distribution systems with the Texas to New York pipeline transmission system of Transco. PSNC also owns 64 percent of the 37.5 miles of transmission pipeline associated with the Cardinal pipeline, as discussed more fully in Note 2 to the financial statements. Transco delivers natural gas to PSNC at various points on Transco's pipeline in North Carolina. Natural gas is distributed by PSNC through its 5,750 miles of distribution mains. These transmission pipelines and distribution mains are located primarily on rights-of-ways held under easement, license or permit on lands owned by others.\nPSNC's Energy Center, which consists of its LNG liquefaction, storage and vaporization facility, is located on a 70-acre tract of land in Cary, North Carolina.\nPSNC also owns 18 commercial office buildings, a measurement operations center, ten service center buildings, 16 service buildings, and an energy control building; PSNC leases six commercial office buildings for its own use. Two of the service buildings also house newly established training facilities. Another service building is jointly occupied by the NGV conversion facility.\nPSNC's gas utility plant is subject to the lien of the Indenture securing its outstanding first mortgage bonds. At September 30, 1995, PSNC had $3,680,000 of first mortgage bonds outstanding. PSNC retired these bonds effective December 1, 1995, and the lien will be released in December 1995 or early 1996.\nItem 3.","section_3":"Item 3. Legal Proceedings - - --------------------------\nAs more fully disclosed in Part I under \"Environmental Matters\" and in Part II in Note 8 to the financial statements, PSNC owns or has owned portions of sites at which manufactured gas plants were formerly operated and is cooperating with the North Carolina Department of Environment, Health and Natural Resources to investigate these sites.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders - - ------------------------------------------------------------\nNo matters were submitted to a vote of PSNC's security holders during the three months ended September 30, 1995.\nPART II -------\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Stock - - ------------------------------------------------- and Related Shareholder Matters -------------------------------\nEffective March 1, 1995 PSNC's common stock began trading on the New York Stock Exchange under the ticker symbol \"PGS\". PSNC's stock quotations are listed in most publications, including newspapers, as \"PubSvcNC\" or \"PubSNC\". Prior to March 1, 1995, PSNC was traded in the over-the-counter market and was included in the NASDAQ National Market System under the symbol \"PSNC.\" At November 30, 1995, there were approximately 11,600 holders of record of PSNC's common stock.\nThe table below presents the reported high and low common stock sale prices along with cash dividends declared per share for each quarter of fiscal 1995 and 1994.\nCash Quarter Dividends Ended High Low Declared ------- ------- ------- --------- Fiscal ------- Sep 30 $16 3\/4 $14 7\/8 $.2125 Jun 30 16 3\/4 14 3\/8 .2125 Mar 31 16 1\/2 14 .2050 Dec 31 15 1\/2 13 3\/4 .2050\nFiscal ------- Sep 30 15 3\/4 14 1\/4 .2050 Jun 30 15 3\/4 13 1\/2 .2050 Mar 31 17 3\/4 14 1\/2 .1975 Dec 31 18 1\/4 15 1\/2 .1975\nOn November 17, 1995 the Board of Directors declared a regular quarterly cash dividend on PSNC's common stock of 21.25 cents per share, payable on January 1, 1996 to shareholders of record on December 11, 1995. PSNC has paid regular quarterly cash dividends on its common stock since 1958, and has increased cash dividends paid to shareholders each calendar year since 1970.\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 ------------------------------------\nResults of Operations - - ---------------------\nNet Margin - - ----------\nFor the Fiscal Years Ended September 30, 1995 1994 1993 - - ---------------------------------------- -------- -------- -------- (Amounts in thousands except degree day and customer data)\nGross margin $130,828 $118,327 $112,105 Less - Franchise taxes 7,943 8,766 8,966 -------- -------- -------- Net margin $122,885 $109,561 $103,139 ======== ======== ========\nTotal volume throughput (DT): Residential 17,567 18,781 18,058 Commercial\/small industrial 11,855 12,450 11,945 Large commercial\/industrial 29,197 27,657 27,176 ------ ------ ------ 58,619 58,888 57,179 ====== ====== ======\nRaleigh\/Durham area degree days: Actual 2,954 3,389 3,462 Normal 3,341 3,341 3,341 Percent of normal 88% 101% 104%\nWeather normalization adjustment income (refund), net of franchise taxes $ 5,800 $ (138) $ (578)\nCustomers at end of period: Residential 246,877 234,957 223,004 Commercial\/small industrial 29,497 27,806 26,772 Large commercial\/industrial 389 376 377 ------- ------- ------- 276,763 263,139 250,153 ======= ======= =======\nTotal volume throughput and net margin, defined as operating revenues less cost of gas and franchise taxes, are more meaningful comparative statistics than gas sales volumes and operating revenues when analyzing PSNC's utility operating results. This is because certain large-volume customers purchase gas directly from gas producers or other gas suppliers and transport it through PSNC's pipeline system. PSNC's operating revenues and expenses do not include the commodity cost of this transported gas; however, PSNC earns a margin on the transported gas which is equivalent to the margin that PSNC would earn if it purchased and resold gas to these customers. Also, various temporary collection and refund mechanisms affect both operating revenues and cost of gas equally.\nFiscal 1995 - - -----------\n- - - Net margin increased by $13,324,000, or 12%, in fiscal 1995 as compared to fiscal 1994 primarily due to rate increases associated with the October 7, 1994 general rate case order and the approval of rates for the Cardinal pipeline effective January 26, 1995. Rate increases that affected PSNC's residential and commercial\/small industrial customers account for approximately $11,723,000 of the increase. The volumes of gas delivered to residential and commercial\/small industrial customer bases declined 6% and 5%, respectively, due to significantly warmer weather as compared to the prior fiscal year. This decrease was somewhat offset by increases in both customer bases of 5% and 6%, respectively. Net volume-related variances for these customers total approximately $2,956,000, including $5,938,000 related to the operation of the weather normalization adjustment (WNA) mechanism. The volumes of gas delivered to large commercial\/industrial customers rose 6% due to a 3% increase in the customer base and to higher operating levels by some of these customers. This volume increase resulted in additional net margin of approximately $1,346,000; however, the increase was offset by a price-related decline of approximately $1,539,000 due to both changes in the sales mix and the general rate case order, and a decline of $430,000 from the prior year in penalty billings for unauthorized gas usage. The twelve-month period also reflects a $732,000 refund ordered by the NCUC in the October 7, 1994 rate case order that related to income tax credits taken in prior periods.\nFiscal 1994 - - -----------\n- - - Net margin increased by $6,422,000 or 6% in fiscal 1994 as compared to fiscal 1993. This net increase includes the impact of the $1,225,000 write-off of Southern Expansion costs, as discussed in Note 2 to the financial statements, during fiscal 1993. A 5% increase in the residential and a 4% increase in the commercial\/small industrial customer bases, as compared to the previous year, generated increases in net margin of $2,937,000 and $1,141,000, respectively. The volumes of gas delivered to residential and commercial\/small industrial customers both increased 4% due to the increased customer bases. The WNA decreased net margin by $138,000 for fiscal 1994. Net margin for the large commercial\/industrial customer base increased $1,119,000. Total volumes delivered to large commercial\/industrial customers increased only 2% due to curtailments of interruptible customers during January 1994's record cold weather; however, volumes delivered to the general service segment of this customer base increased 14%. Fiscal 1993 - - -----------\n- - - Net margin increased by $846,000 or 1% in fiscal 1993 as compared to fiscal 1992. This net increase includes the negative impact of the $1,225,000 write-off of Southern Expansion costs. Net margin improved by approximately $1,425,000 and $219,000, respectively, due to the 4% increase in residential and the 3% increase in commercial\/small industrial customer bases as compared to the previous year. The increase of 12% and 8%, respectively, in the volumes of gas delivered to higher-margin, weather-sensitive residential and commercial\/small industrial customers was caused primarily by weather which was 9% colder than fiscal 1992 and 3% colder than normal. However, the resultant increase in net margin was reduced by the operation of the WNA mechanism which lowered net margin by $578,000. Although throughput to large commercial\/industrial customers declined 2% as compared to fiscal 1992, net margin for this customer base increased $427,000 due to higher unit margins attributable to a positive sales mix variance.\nOperating Expenses - - ------------------\nOther operating expenses increased 4% during fiscal 1995. This increase reflects higher salary expenses and the payroll reallocations implemented during November 1994 to standardize labor distributions. Also contributing to the increase were employee severance expenses related to departmental reorganizations, fees related to listing on the New York Stock Exchange, and expenses for outside consulting services related to information systems and employee benefits. These increases were partially offset by the reclassification of certain sales compensation expenses to merchandising and jobbing, and adjustments related to group life insurance and hospitalization insurance due to favorable experience realized by PSNC, along with the transfer of a large number of employees to a less costly health maintenance organization provider.\nThe 5% increase in other operating expenses during fiscal 1994 was primarily due to the October 1993 wage increases granted under the new performance-based pay system and rising health insurance costs. Also contributing to the increase were postretirement benefit expenses related to the adoption of Statement of Financial Accounting Standards (SFAS) No. 106 effective October 1, 1993.\nOther operating expenses increased 13% during fiscal 1993. The fiscal 1993 increase was due to increased expenses for wages, salaries, fringe benefits, outside consulting services and liability insurance. Outside consulting expenses largely reflect charges associated with the development and refinement of PSNC's strategic and operational plans, enhancement of its management practices, and improvements in microcomputer capabilities.\nMaintenance expenses decreased 8% in fiscal 1995 due to the $750,000 reversal of expenses related to the investigation of former manufactured gas plant (MGP) sites, originally recorded in fiscal 1992 (see Note 8 to the financial statements). Maintenance expenses decreased 5% in fiscal 1994 due to the absence of expenses relating to the overhauling of compressor equipment and maintenance of the LNG storage tank during fiscal 1993. The 7% decrease in fiscal 1993 primarily reflects the absence of the $750,000 accrual for environmental costs in fiscal 1992.\nDepreciation expense for all three fiscal years increased due to plant additions. Depreciation expense for fiscal 1995 also reflected higher depreciation rates approved in the October 1994 general rate case order. General taxes decreased during fiscal 1995 due to a reduction in franchise tax expense reflecting a decrease in revenues. General taxes increased during fiscal 1994 due to increased property tax expense due to an increase in taxable property and higher tax rates. The fiscal 1993 increase in general taxes was due to franchise tax expense reflecting increased revenues in fiscal 1993 over fiscal 1992.\nOther Income (Deductions) - - ------------------------\nOther income (deductions) decreased $4,350,000 during fiscal 1995 due mainly to proceeds received in fiscal 1994 for the sale of PSNC Propane and the absence of operating income from propane operations. Other income (deductions) also decreased due to a loss in merchandise and jobbing largely due to a reclassification of certain sales commission expenses to merchandise and jobbing from operation and maintenance in connection with the October 1994 general rate case order. Also contributing to the decrease was the fiscal 1994 reclassification of income from pipeline capacity sales from operating revenues to other income.\nOther income (deductions) increased $4,836,000 during fiscal 1994 mainly due to income from subsidiary operations and from merchandise and jobbing income. Income from subsidiary operations exceeded fiscal 1993 by $2,845,000 primarily due to the sale of the assets of PSNC Propane Corporation to Empiregas, Inc. of North Carolina. The sale resulted in an after-tax gain of $1,511,000, net of expenses related to terminating the operations, and to after-tax earnings of $810,000 related to gas marketing activities conducted by PSNC Production Corporation. Income from PSNC Propane's operations, net of tax and not including the gain from the asset sale, increased approximately $450,000 as compared to the same period during fiscal 1993. This increase was due to a decreased cost of propane and higher weather-related volumes of propane sold. The June 1994 sale of PSNC Production's remaining exploration and development properties resulted in an after-tax gain of $139,000. Merchandise and jobbing income for fiscal 1994 increased $1,341,000 over fiscal 1993. Although total unit sales decreased, the per unit margin increased due to price changes made in merchandising programs. The previously mentioned reclassification of income from pipeline capacity sales also contributed to the increase.\nIn fiscal 1993, other income increased $120,000 due mainly to increased earnings from subsidiary operations. Subsidiary earnings rose primarily due to increased propane gas sales reflecting weather during fiscal 1993 which was 9% colder than fiscal 1992. Increased subsidiary earnings were partially offset by a decrease in other interest income due to lower average balances in the deferred gas account for collections due from customers. Losses from merchandise operations were experienced during fiscal 1993 due to lower margins earned on appliance sales. Interest Deductions - - -------------------\nInterest deductions for fiscal 1995 and fiscal 1994 decreased 3% and 5%, respectively, due mainly to lower interest expense on declining balances in long-term debt. The declining balance in long-term debt is due to sinking fund payments and to the early redemption in May 1994 of the 9 7\/8% First Mortgage Bonds due 1995. These decreases were partially offset by increased interest expense due to higher rates on short-term debt related to financing of increased construction activities.\nInterest deductions for fiscal 1993 increased 3% as compared to fiscal 1992 due mainly to increased interest on long-term debt reflecting the issuance of an additional $32,000,000 of debentures in June 1992. This increase was partially offset by a decrease in other interest expense due to a declining balance in the deferred gas cost account for refunds due customers and a reduction in interest on short-term debt due to lower average bank loans outstanding and lower short-term interest rates.\nLiquidity and Capital Resources - - -------------------------------\nPSNC's primary capital needs are the funding of its continuing construction program and the seasonal funding of its stored gas inventories. PSNC uses short-term bank loans temporarily, together with internally generated funds, long-term debt and equity financing to fund its continuing construction program. PSNC has committed lines of credit with eight commercial banks which vary monthly depending upon seasonal requirements. For the twelve-month period beginning April 1, 1995, lines of credit with these banks range from a minimum of $22,000,000 to a winter- period maximum of $79,000,000. At September 30, 1995, committed lines of credit totaled $52,000,000. PSNC also has uncommitted annual lines of credit with three of these banks totaling $21,000,000. Lines of credit are evaluated periodically by management and renegotiated to accommodate anticipated short-term financing needs. Management believes these lines are currently adequate to finance construction expenditures, stored gas inventories and other corporate needs. At September 30, 1995 and 1994, PSNC's total short-term bank loans outstanding were $51,000,000 and $23,000,000, respectively.\nPSNC sold an additional 1,725,000 new shares of $1 par common stock through an underwritten public offering during May 1994. The proceeds, net of expenses, were $23,406,000. These proceeds were used to repay all outstanding short-term debt, to redeem the remaining $3,098,000 balance of the 9 7\/8% First Mortgage Bonds due 1995, and to finance a portion of fiscal 1994's construction expenditures. During both September 1995 and 1994, PSNC made additional payments on its 10% Senior Debentures due 2003 of $2,500,000, the maximum additional annual payment permitted pursuant to the terms of the debenture agreement.\nPSNC also generates equity capital through its dividend reinvestment, employee stock purchase and stock option plans. During fiscal 1995, 1994 and 1993, the dividend reinvestment plan generated $5,069,000, $5,020,000 and $4,952,000, respectively, of additional equity capital. The employee stock purchase plan generated $1,174,000, $1,255,000 and $1,043,000, respectively, of additional equity capital. The stock option plan generated net equity capital of $447,000, $861,000 and $416,000 for the respective three fiscal years.\nThe ratio of long-term debt to total capitalization at September 30, 1995 was 36.7% compared to 41.5% at September 30, 1994 and 50.2% at September 30, 1993. PSNC's goal is to maintain a capital structure with a ratio of long-term debt to total capitalization in the 40%-45% range with periodic moderate fluctuations.\nEffective December 1, 1995, PSNC anticipates redeeming the remaining $3,680,000 balance of its 8% Series I First Mortgage Bonds, due 1998, at a redemption price of 100.35%. PSNC will finance this redemption through the use of short-term bank debt. After this series of first mortgage bonds is retired, PSNC will close the original indenture and all supplemental indentures. PSNC currently plans to secure additional long-term debt financing to retire a portion of its then outstanding short-term bank debt in the first half of fiscal 1996. The type of financing and timing of the issuance have not been determined at this time.\nConstruction expenditures were $61,119,000, $45,469,000 and $40,127,000 for fiscal 1995, 1994 and 1993, respectively. The fiscal 1995 increase is due mainly to construction costs of $7,332,000 associated with the construction of the Cardinal Pipeline project, and approximately $4,000,000 associated with another transmission project. For fiscal 1996, PSNC's Board of Directors approved a budget of approximately $61,131,000 for PSNC's ongoing construction program.\nAs discussed more fully in Note 2 to the financial statements, PSNC and a subsidiary of Piedmont Natural Gas Company, Inc. (Piedmont) formed Cardinal Pipeline Company, LLC (Cardinal) in March 1994 to construct an intrastate transmission pipeline. The pipeline was placed into service in December 1994 and extends 37.5 miles to provide additional daily capacity to PSNC's eastern service territory in and around the Durham and Raleigh areas. In September 1995, Transcontinental Gas Pipe Line Corporation (Transco), PSNC, Piedmont, and North Carolina Natural Gas Corporation (NCNG) signed a letter of intent to form a limited liability company (LLC). After receiving North Carolina Utilities Commission (NCUC) approval, the LLC will purchase and extend the existing Cardinal pipeline by approximately 65 miles. The estimated cost of purchasing and extending the pipeline is $97 million. PSNC, through a subsidiary, will own approximately 33% of the new pipeline, and will contribute its net book investment in the existing pipeline plus additional capital of approximately $1 million.\nPine Needle LNG Company, LLC (Pine Needle), a limited liability company formed by subsidiaries of Transco and Piedmont, signed a letter of intent in September 1995 to add PSNC and NCNG as owners of Pine Needle. Pine Needle will own, build and operate a four billion cubic feet liquefied natural gas (LNG) storage facility near Transco's main line in northwest Guilford County. Pending approval by the Federal Energy Regulatory Commission, construction should begin in early 1997 at an estimated cost of $107 million. The facility is expected to be ready for operation by May 1999. PSNC, through its subsidiary PSNC Blue Ridge Corporation, will own 17% of the facility and PSNC will have the right to use 25% of the facility's gas storage capacity and withdrawal capabilities. At September\n30, 1995, PSNC's investment in Pine Needle totaled $708,000. PSNC will make additional capital contributions of approximately $8 million during the construction period.\nAs discussed more fully in Note 5 to the financial statements, PSNC and its subsidiaries sponsor a non-contributory defined benefit pension plan covering substantially all employees. Projected fiscal 1996 plan contributions total $2,855,000, which includes estimated quarterly contributions due for the 1996 plan year, in addition to the minimum contribution required for the 1995 plan year.\nRestricted cash and temporary investments and restricted supplier refunds are attributable to refunds of $19,580,000 received from PSNC's pipeline suppliers since fiscal 1992, including interest earned thereon of $1,163,000. The investment and use of these funds have been restricted by an order of the NCUC. These funds are to remain segregated from PSNC's general funds and may be used only for expansion of PSNC's facilities into unserved territories which would otherwise be uneconomical to serve. In an order dated June 3, 1993, the NCUC created an expansion fund for PSNC in the Office of the State Treasurer. Pursuant to the order, approximately $16,528,000 of the restricted funds have been deposited into the expansion fund. The NCUC has approved an expansion project in McDowell County to be funded from PSNC's expansion fund in an amount up to $8,193,500. The project was initiated in December 1995 and is expected to be in service by December 1996. PSNC has scheduled additional expansion projects in five other counties over a projected five-year period, subject to approval by the NCUC.\nNet accounts receivable decreased $3,044,000 as compared to September 1994. This decrease was due primarily to decreased revenues billed in September 1995 compared to September 1994.\nNet deferred gas costs fluctuate in response to the operation of PSNC's Rider D rate mechanism. This mechanism allows PSNC to recover margin losses on negotiated sales to large commercial and industrial customers with alternate fuel capability. It also allows PSNC to recover from customers all prudently incurred gas costs. On a monthly basis, any difference in amounts paid and collected from these costs is recorded for subsequent refund to or collection from PSNC's customers. Deferred gas costs at September 30, 1995 and September 30, 1994 primarily represent undercollections from customers of $3,692,000 and $734,000, respectively.\nOther assets increased $1,419,000 in fiscal 1995 primarily due to the recording of an additional $750,000 to a regulatory asset related to the investigation and remediation of MGP sites, which is discussed more fully later in this section. In addition, PSNC recorded a $376,000 transition obligation associated with the adoption of Statement of Financial Accounting Standards (SFAS) No. 112, \"Employers' Accounting for Postemployment Benefits,\" effective October 1, 1994. At September 30, 1995, the unamortized balance included in other assets totaled $250,000. Also contributing to the increase was the $708,000 investment in Pine Needle.\nAs discussed in Note 8 to the financial statements, PSNC owns or has owned portions of six sites in North Carolina on which MGPs were formerly operated and one site at which a manufactured gas holder was located. Evaluations of these sites have revealed that MGP residuals are present or suspected at each of the sites. The North Carolina Department of Environment, Health and Natural Resources (NCDEHNR) has recommended that no further action be taken with respect to one site. An environmental consulting firm retained by PSNC estimated that the minimum aggregate costs to investigate and monitor the extent of environmental degradation and to implement remedial procedures with respect to the remaining six sites may range from $3,705,000 to $50,145,000 over a 30-year period. PSNC is unable to determine the rate at which costs may be incurred over this time period. During October 1994, PSNC entered into an administrative order on consent with NCDEHNR to investigate the Durham, North Carolina site in accordance with standards and methods approved by NCDEHNR. At September 30, 1995, PSNC had recorded a total liability of the minimum amount of the range, or $3,705,000.\nIn the general rate order dated October 7, 1994, the NCUC allowed the recovery of incurred MGP costs of approximately $150,000 as a reasonable operating expense to be amortized over a three-year period and ordered PSNC to defer additional MGP costs for consideration in subsequent rate cases. The NCUC concluded that it is proper and in the public interest to allow recovery of prudently incurred clean-up costs from current ratepayers as reasonable operating expenses even though the MGP sites are not used and useful in providing gas service to current customers. However, the order does not allow recovery of carrying costs on deferred amounts. Management intends to request recovery of additional MGP clean-up costs, not recovered from other potentially responsible parties (PRPs), in future rate case filings and believes that all costs deemed by the NCUC to be prudently incurred will be recoverable in gas rates. PSNC is also in discussions with another PRP regarding potential cost-sharing arrangements for investigation and potential remediation costs at four of the sites. At this time, PSNC has not reached a definitive agreement regarding such arrangements.\nThe increase in accounts payable at September 30, 1995 as compared to the prior year reflects increased construction expenditures.\nThe decrease in accrued taxes at September 30, 1995 as compared to the prior year is primarily due to a decrease in accrued income taxes that includes an overpayment of approximately $2,100,000 for fiscal 1995.\nThe increase in cash dividends declared at September 30, 1995 as compared to the prior year is primarily due to the early payment of cash dividends of $1,073,000 during September 1994.\nThe increase in interim bank loans at September 30, 1995 as compared to September 30, 1994 is due to an increase in the level of construction expenditures. In addition, short-term indebtedness at September 30, 1994 decreased as compared to the prior year due to the use of a portion of the proceeds of the May 1994 stock sale to pay off all short-term indebtedness then outstanding.\nDeferred credits and other liabilities increased $2,230,000 due mainly to an increase of $4,136,000 related to net deferred taxes, an additional $1,006,000 recorded in fiscal 1995 for postretirement benefits, and the recording of the $376,000 transition obligation associated with the implementation of SFAS No. 112, \"Employers' Accounting for Postemployment Benefits,\" effective October 1, 1994. These increases were partially offset by a $440,000 decrease in insurance reserves and a $2,601,000 decrease in accrued pension cost due to pension contribution payments made during fiscal 1995. PSNC did not have to fund its pension plan during fiscal 1994 or fiscal 1993.\nEffects of Inflation - - --------------------\nThe margin charged to PSNC's firm gas customers may not be increased without a general rate case. Accordingly, in the absence of authorized rate increases and except for changes in the cost of gas sold, which are passed along to customers on a timely basis through various rate adjustment mechanisms, PSNC must look to performance improvement and higher gas sales volumes to offset inflationary increases in its cost of operations. Current rates only permit PSNC to recover its historical cost of utility plant and give no recognition to the replacement cost of these facilities. PSNC's last general rate case was filed March 9, 1994 and became effective October 7, 1994. Testimony and exhibits were filed with the NCUC on January 11, 1995 for an increase in annual revenues of approximately $3,000,000 to recover costs associated with PSNC's investment in the Cardinal Pipeline. A hearing was held on January 25, 1995 and new rates became effective on January 26, 1995. Management continually reviews operations and economic conditions to assess the need for filing for general rate relief. PSNC currently plans to file a general rate case with the NCUC in the spring of 1996. A general rate order from the NCUC is expected in the fall of 1996.\nEffects of SFAS Nos. 119, 121 and 123 - - -------------------------------------\nIn October 1994, the Financial Accounting Standards Board (FASB) issued its SFAS No. 119, \"Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments.\" PSNC currently uses derivatives primarily to reduce the level of price volatility of PSNC's gas supply. PSNC plans to adopt this standard on October 1, 1996. Due to its limited use of derivatives, PSNC does not expect the adoption of this statement to materially affect PSNC's financial position or results of operations.\nIn March 1995, the FASB issued its SFAS No. 121, \"Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of.\" This statement imposes stricter criteria for regulatory assets by requiring that such assets be probable of future recovery at each balance sheet date. PSNC plans to adopt this standard on October 1, 1996. Based on the current regulatory structure in which PSNC operates, PSNC does not expect the adoption of this statement to materially affect PSNC's financial position or results of operations.\nIn October 1995, the FASB issued its SFAS No. 123, \"Accounting for Awards of Stock-Based Compensation to Employees.\" This statement establishes financial accounting and reporting standards for stock-based employee compensation plans. PSNC will adopt this standard on October 1, 1996. The effect on PSNC's financial position and results of operations of adopting this standard is not known. Item 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data - - ----------------------------------------------------\nPublic Service Company of North Carolina, Incorporated and Subsidiaries\nConsolidated Statements of Capitalization\nSeptember 30, 1995 1994 - - ------------------------------------------ ------------ ------------\nCommon Equity: Common stock, $1 par, 30,000,000 shares authorized; shares outstanding 1995 - 18,689,346 and 1994 - 18,212,047 $ 18,689,346 $ 18,212,047 Capital in excess of par value 106,655,316 100,200,706 Retained earnings 48,027,708 42,142,636 ------------ ------------ 173,372,370 160,555,389 ------------ ------------ Long-term Debt: First mortgage bonds (An equivalent portion of gas utility plant pledged as collateral) - 8% Series I, due 1998 3,680,000 3,920,000\nSenior debentures (unsecured) - 8.65% due 2002 17,500,000 20,000,000 10% due 2003 15,000,000 20,000,000 10% due 2004 43,000,000 43,000,000 8.75% due 2012 32,000,000 32,000,000 ------------ ------------ 111,180,000 118,920,000 Less - Current maturities 10,480,000 5,240,000 ------------ ------------ 100,700,000 113,680,000 ------------ ------------ $274,072,370 $274,235,389 ============ ============\nPublic Service Company of North Carolina, Incorporated\nand Subsidiaries\nNotes to Consolidated Financial Statements\nFor the Fiscal Years Ended September 30, 1995, 1994 and 1993\n1. SIGNIFICANT ACCOUNTING POLICIES\nPrinciples of Consolidation and Segment Data ------------------------------------------- The consolidated financial statements include Public Service Company of North Carolina, Incorporated's (PSNC) wholly-owned subsidiaries, Clean Energy Enterprises, Inc. (previously Tar Heel Energy Corporation), PSNC Blue Ridge Corporation, PSNC Exploration Corporation, PSNC Production Corporation, PSNC Propane Corporation, and PSNC's interest in Cardinal Pipeline Company, LLC. All significant intercompany transactions have been eliminated in consolidation.\nPSNC and its subsidiaries operate in one dominant business segment, distribution of natural gas. PSNC, through an unregulated subsidiary, is engaged in the marketing of natural gas to large commercial and industrial customers. Through another unregulated subsidiary, PSNC provides conversion, maintenance and fueling services for natural gas vehicles in selected cities in and beyond its franchised territory. PSNC divested its remaining oil and gas properties during fiscal 1994, which ended PSNC's participation in exploration and development activities. Also during fiscal 1994, PSNC sold its propane subsidiary assets to Empiregas, Inc. of North Carolina.\nUtility Plant ------------- Utility plant is stated at the historical cost of construction. Included in historical cost are certain construction-related costs such as taxes, pensions and other fringe benefits, as well as the estimated cost of funds used during construction (AFUDC). PSNC capitalizes AFUDC on a pre-tax basis for both the cost of short-term debt and the allowed overall cost rate.\nDepreciation ------------ PSNC provides for depreciation on a straight-line basis by the application of specific rates to the various classes of depreciable property. These rates, which have been approved by the North Carolina Utilities Commission (NCUC), approximate on a composite basis 3.9%, 3.5% and 3.5% of the cost of depreciable property for fiscal 1995, 1994 and 1993, respectively.\nRevenues -------- Certain customers (primarily residential and commercial) are billed on a cycle basis while other customers are billed as of the end of each month. Revenues are recorded at the time of billing. The cost of gas delivered but unbilled is deferred and recognized in the period in which the related revenue is billed.\nIncome Taxes ------------ Beginning October 1, 1993, PSNC adopted Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes,\" issued by the Financial Accounting Standards Board (FASB). This statement requires the use of the liability method of accounting for income taxes. Under this method, the deferred tax liability represents the tax effect of temporary differences between the financial statement and tax bases of assets and liabilities and is measured using current tax rates. PSNC adopted SFAS No. 109 on a prospective basis without restating prior year amounts. As a result of implementation, PSNC increased its net regulatory liability by approximately $6,000,000 with a similar decrease in accumulated deferred income taxes.\nPSNC uses deferral accounting for investment tax credits, which amortizes the credits to income over the service life of related property.\nCash and Temporary Investments ----------------------------- For purposes of reporting cash flows, cash and temporary investments include cash on hand and investments of 45 days or less. Investments may include repurchase agreements, Treasury bills, federal agency securities, certificates of deposit and high-grade commercial paper.\nSince fiscal 1992, PSNC has received refunds from its pipeline suppliers for which the investment and use have been restricted by an order of the NCUC. Pursuant to the order, these funds are to remain segregated from PSNC's general funds and will be used for expansion of PSNC's facilities into unserved territories. These refunds, along with interest earned thereon, are periodically transferred to the Office of the State Treasurer. The balance not transferred is reported in restricted cash and temporary investments and restricted supplier refunds. The total amount transferred to the Office of the State Treasurer at September 30, 1995 is $16,528,000.\nDebt Expense ------------ PSNC amortizes issuance costs for its first mortgage bonds and debentures over the life of the related debt. In addition, PSNC is amortizing the redemption premium and the unamortized issuance costs on its previously refunded Series K First Mortgage Bonds over 15 years, in accordance with the treatment authorized by the NCUC.\nFair Value of Financial Instruments ----------------------------------- In December 1991, the FASB issued its SFAS No. 107, \"Disclosures about Fair Value of Financial Instruments.\" This standard requires disclosure of the fair value of financial instruments, both assets and liabilities, including those recorded and not recorded, for which it is practicable to estimate the fair value. The following methods and assumptions were used to comply with this standard.\nCash and temporary investments: The carrying value closely approximates fair value due to their short-term nature.\nLong-term debt: The fair value of these instruments are based on current market prices and yields for similar issues. Based on the current market value for similar issues, the fair market value of PSNC's long-term debt (including current maturities) at September 30, 1995 is $129,939,000 as compared to a carrying value of $111,180,000. Use of Estimates in the Preparation of Financial Statements ----------------------------------------------------------- The preparation of financial statements in conformity with generally accepted accounting principles requires management to make certain estimates and assumptions. These 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.\nReclassifications ----------------- Certain amounts included in the consolidated financial statements for fiscal 1994 and 1993 have been reclassified from their original presentation to conform with the current year's presentation.\n2. REGULATORY MATTERS\nIn PSNC's 1986 general rate case order, a rate mechanism (Rider D) was put into place. As currently approved by the NCUC, Rider D allows PSNC to record for recovery from its customers all prudently incurred gas costs on a monthly basis. Any difference in amounts paid and collected for these costs is deferred for subsequent refund to or collection from customers. Additionally, PSNC can recover its margin losses on negotiated gas sales to certain large commercial and industrial customers in any manner authorized by the NCUC. At September 30, 1995, the balance of net gas costs to be collected from customers pursuant to Rider D was approximately $3,913,000.\nIn PSNC's 1991 general rate case order, a weather normalization adjustment (WNA) mechanism was put into place. This mechanism allows PSNC to adjust its winter-period gas sales rates to certain customers to avoid undercollections or overcollections of its non- gas costs due to weather fluctuations.\nEffective November 1, 1990, PSNC obtained additional firm capacity from Transco's Southern Expansion project. The demand costs associated with this increased capacity were recorded as a reduction of refunds due customers in accordance with PSNC's interpretation of its tariffs as approved by the NCUC in Docket No. G-5, Sub 246. The Public Staff of the NCUC filed a petition with the NCUC claiming that these amounts were not recoverable from customers under tariffs and laws existing at the time, except through a general rate case. In an order dated April 5, 1991, the NCUC ordered that PSNC's prior treatment of these costs not be disturbed. The NCUC also ordered, prospectively, that these demand costs be collected through all rates on a provisional basis pending further order. In view of this NCUC order, PSNC deferred both the associated costs and the revenue for the period April 5, 1991 through October 31, 1991. In the November 1, 1991 general rate case order, the NCUC approved the prospective collection of these demand costs through all rates. On April 29, 1993, the Public Staff filed a motion with the NCUC requesting that PSNC be ordered to refund to its customers the revenues collected from April 5, 1991 through October 31, 1991. On July 27, 1993, the NCUC issued an order requiring the refund as proposed by the Public Staff. As a result of the order, PSNC charged to gas cost expenses during the fourth quarter of fiscal 1993 approximately $1,225,000 of related deferred gas costs and incurred approximately $199,000 of interest on the deferred revenue. PSNC has no additional exposure from this matter. On October 7, 1994 the NCUC issued an order in PSNC's general rate case filed in March 1994 granting additional annual revenues of $10,763,000 and rates of return of 10.51% and 11.87% on net utility investment and common equity, respectively. The order also approved the continuation of the previously mentioned WNA and Rider D rate mechanisms.\nPSNC and a subsidiary of Piedmont Natural Gas Company, Inc. (Piedmont) formed Cardinal Pipeline Company, LLC (Cardinal) in March 1994, to construct and operate a 24-inch natural gas pipeline. It was placed into service on December 31, 1994 and extends 37.5 miles from a connection with Transcontinental Gas Pipe Line Corporation (Transco) near Reidsville to Burlington, where it connects with existing pipelines of PSNC and Piedmont. An increase in annual revenues of $3,063,000 was granted by the NCUC to PSNC to recover the cost of the investment, effective January 26, 1995.\nIn September 1995, PSNC, Piedmont, Transco, and North Carolina Natural Gas Corporation (NCNG) signed a letter of intent to form a limited liability company (LLC) to purchase and extend the Cardinal pipeline. As proposed, the pipeline will be extended 65 miles from Burlington to a point southeast of Raleigh and will add 140 million cubic feet per day of additional firm capacity to North Carolina consumers. The purchase and extension will be project-financed at an estimated cost of $97 million. Through their respective subsidiaries, it is anticipated that PSNC will own approximately 33 percent, Piedmont will own approximately 17 percent, Transco will own approximately 45 percent, and NCNG will own approximately five percent of the LLC. PSNC, through a subsidiary, will contribute to the new LLC its net book investment in the existing pipeline plus additional capital of approximately $1 million. Following the execution of a definitive agreement and appropriate NCUC approval, the LLC plans to request appropriate regulatory authorization in the fall of 1996 for authorization to extend the existing pipeline. Subject to the approval of appropriate state and federal agencies, construction is scheduled to begin in early 1999. The facilities are expected to be in service on or before November 1, 1999.\nIn September 1995, PSNC signed a letter of intent with the Pine Needle LNG Company, LLC (Pine Needle), to add PSNC's subsidiary, PSNC Blue Ridge Corporation, as an owner of Pine Needle. Pine Needle, originally formed by subsidiaries of Transco and Piedmont, has sought approval from the FERC to construct, own and operate a liquefied natural gas (LNG) peak demand facility in North Carolina. A subsidiary of Transco will serve as the operator. PSNC Blue Ridge will own 17 percent of Pine Needle and PSNC will have the right to use 25 percent of the facility's gas storage capacity and withdrawal capabilities. The facility, estimated to cost $107 million, will be located near Transco's main line northwest of Greensboro and will have a storage capacity of four billion cubic feet with vaporization capability of 400 million cubic feet per day. Pine Needle plans to seek non-recourse project financing for the facility investment. A project application will be submitted to the FERC in early November 1995 and, pending FERC approval, construction will begin in early 1997. Liquefaction is expected to begin in May 1999 in time for withdrawal service to begin in the 1999 winter heating season. PSNC Blue Ridge will make capital contributions of approximately $8 million during the construction period, in addition to its initial investment of $708,000. 3. REDEEMABLE PREFERRED STOCK\nSeries Without Sinking Fund Requirements --------------------------------------- Effective January 1, 1993, PSNC redeemed all outstanding shares of its $25 par Cumulative Preferred Stock at $25.25 per share.\nThe amount and the number of shares redeemed during the year ended September 30, 1993 are shown below:\nRedemptions --------------------- Amount Shares ---------- ------ 5.75% Series $ 330,450 13,218\n6% Series $1,152,600 46,104 4. COMMON STOCK\nThe changes in common stock and capital in excess of par value for the three years ended September 30, 1995 were as follows:\nIn accordance with PSNC's 1992 Nonqualified Stock Option Plan, options to purchase an aggregate of up to 600,000 shares of PSNC's common stock can be granted to officers and key employees of PSNC annually beginning October 1, 1992. Options are granted at 90% of the fair market value determined on the date of the grant, are exercisable beginning two years from the date of the grant and expire five years from the date of the grant. An exception to the two-year exercise date is allowed upon the retirement, disability or death of a participant.\nOn January 4, 1993, PSNC effected a 3-for-2 common stock split in the form of a 50% common stock dividend. The following common stock options and shares have been restated.\nOptions granted, exercised and cancelled for the three years ended September 30, 1995 were as follows:\nOptions Exercise Price Outstanding Per Share ----------- -------------- September 30, 1992 273,399 Granted 120,000 $15.57 Exercised (54,468) $ 8.65 to $10.56 ------- September 30, 1993 338,931 Granted 120,000 $13.23 Exercised (98,928) $ 8.77 to $15.57 Cancelled (11,572) $ 8.77 to $15.57 ------- September 30, 1994 348,431 Granted 120,000 $12.86 Exercised (46,095) $10.56 to $15.57 Cancelled (1,479) $15.57 ------- September 30, 1995 420,857 =======\nPSNC also offers an Employee Stock Purchase Plan under which eligible employees may purchase PSNC's common stock through voluntary payroll deductions at a 10% discount from the fair market value as defined in the plan.\nAt September 30, 1995, there were 995,234 common shares reserved for issuance under PSNC's Automatic Dividend Reinvestment and Stock Purchase Plan, 253,052 total common shares reserved for granting under the 1992 Nonqualified Stock Option Plan and 461,623 common shares reserved under the Employee Stock Purchase Plan.\n5. PENSION AND POSTRETIREMENT PLANS\nPSNC and its subsidiaries sponsor a non-contributory defined benefit pension plan covering substantially all employees. The benefits are based on years of service and the employee's compensation during the five consecutive years of employment that will produce the highest average pay. Contributions to the plan are determined on an annual basis with the amount of such contributions being within the minimum required for funding standard account purposes and the maximum deductible for federal income tax purposes.\nNet pension cost in fiscal 1995, 1994 and 1993 consisted of the following components (amounts in thousands):\n1995 1994 1993 ------ ------ ------\nService cost $1,977 $2,026 $2,288 Interest cost 3,173 3,040 3,469 Actual return on assets (3,320) (814) (2,186) Net amortization 228 (2,244) (805) ------ ------ ------ Net pension cost $2,058 $2,008 $2,766 ====== ====== ======\nThe table below sets forth the amount recognized on PSNC's consolidated balance sheets at September 30, 1995 and 1994 (amounts in thousands):\n1995 1994 ------- ------- Actuarial present value of benefit obligations: Accumulated benefit obligation, including vested benefits in 1995 of $32,049 and 1994 of $27,317 $33,382 $28,477 ======= =======\nProjected benefit obligation $45,315 $42,054 Plan assets at fair value 37,011 34,321 ------- ------- Plan assets under projected benefit obligation 8,304 7,733 Unrecognized transition amount 2,849 3,160 Unrecognized net gain 7,074 10,507 Unrecognized prior service cost (5,296) (5,868) ------- ------- Accrued pension cost $12,931 $15,532 ======= ======= Actuarial assumptions:\nWeighted average discount rate 7% 8% Rate of increase in future compensation levels 3%-6.25% 4%-7.25% Weighted average expected long-term rate of return 8% 8%\nThe majority of plan assets is invested in obligations of the U.S. Treasury, corporate obligations and cash equivalents, with the balance primarily in common stocks. The fair value of PSNC's own common stock held by the plan at the respective 1995 and 1994 measurement dates was approximately $2,629,000 and $2,364,000.\nPSNC offers medical, life and dental insurance coverage to its qualified salaried and hourly retirees. Retirees are required to contribute for the cost of the coverage. PSNC's policy is to review the contributions required from retirees on an annual basis and to increase retiree contributions as necessary. Effective October 1, 1993, PSNC adopted SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" The standard provides for the accrual of the costs of retiree medical, life and dental insurance benefits over the working lifetime of the employees. Based on the actuarial valuation of October 1, 1993, the adoption of SFAS No. 106 resulted in a transition obligation of approximately $7,400,000. The following table reconciles the plan's funded status to the accrued benefit cost as of September 30, 1995 and 1994 (amounts in thousands):\n1995 1994 ------- ------- Fair value of plan assets $ - $ -\nAccumulated postretirement benefit obligation (APBO): Retirees and dependents $ 2,163 $ 1,676 Other fully eligible participants 1,651 1,567 Other active participants 4,466 4,377 ------- ------- 8,280 7,620 Unrecognized prior service cost - - Unrecognized net gain 721 769 Unrecognized transition obligation (6,639) (7,007) ------- ------- Accrued postretirement benefit cost $ 2,362 $ 1,382 ======= =======\nThe net periodic postretirement benefit cost for the twelve months ended September 30, 1995 and 1994 consists of the following components (amounts in thousands):\n1995 1994 ------ ------\nService cost $ 326 $ 366 Interest cost on APBO 599 533 Amortization of transition obligation 369 368 Amortization of unrecognized net gain (21) - ------ ------ Net periodic postretirement benefit cost $1,273 $1,267 ====== ======\nAs of the 1995 measurement date, the assumed health care cost trend rate used in determining the APBO was 10% in 1995, 9% in 1996, 8% in 1997, 7% in 1998, then decreasing .5% annually to an ultimate trend rate of 3.5% in 2005. A one-percentage point increase in the assumed health care cost trend rate would increase the APBO by approximately 12%. The service and interest cost components of the net periodic postretirement benefit cost would increase approximately 8%. The net periodic postretirement benefit cost was calculated using a discount rate of 8%. The APBO at the measurement date was determined using a discount rate of 7%.\nPSNC requested recovery of SFAS No. 106 expenses in its general rate case filed with the NCUC on March 9, 1994. In an order dated October 7, 1994, the NCUC granted recovery of these expenses on a prospective basis.\n6. SHORT-TERM BORROWING ARRANGEMENTS\nPSNC has committed lines of credit with eight commercial banks which vary monthly depending upon seasonal requirements. For the twelve-month period beginning April 1, 1995, total lines of credit with these banks range from a minimum of $22,000,000 to a winter- period maximum of $79,000,000. PSNC also has uncommitted annual lines of credit with three of these banks totaling $21,000,000. There are no restrictions on the withdrawal of cash balances maintained with these banks. The banks are compensated for the unused portion of the committed lines of credit through the payment of commitment fees. At September 30, 1995 and 1994, there were $51,000,000 and $23,000,000 of short-term loans outstanding, respectively.\nPSNC borrows funds on a short-term basis primarily for its construction program and for the seasonal financing of stored gas. The loans are generally arranged for periods of up to 90 days at rates below the prime rate. Bankers' acceptance loans are arranged for periods of up to 180 days at rates below the prime rate. At September 30, 1995 and 1994, there were no bankers' acceptance loans outstanding.\nCertain information related to short-term borrowings is as follows (dollars in thousands):\n1995 1994 ------- ------- At year end - Amount outstanding $51,000 $23,000 Weighted average rate 6.42% 5.24%\nDuring the year - Maximum amount outstanding $51,000 $49,000 Average daily amount outstanding $25,362 $24,064 Weighted average rate 6.10% 3.66%\nThe weighted average rate is determined by dividing the total short-term interest expense for the fiscal year by the average daily amount outstanding during the fiscal year.\n7. INCOME TAXES\nPSNC adopted SFAS No. 109 effective October 1, 1993 on a prospective basis. Income tax expense is shown on the consolidated statements of income within the captions listed below. Immediately following are the components of income tax expense (amounts in thousands):\nA reconciliation of the statutory federal income tax rate to the effective tax rate is as follows (dollars in thousands):\n1995 1994 1993 ------- ------- ------- Statutory federal income tax rate 35% 35% 34.75% Expected federal income tax expense at federal statutory rate $12,230 $10,541 $ 7,591 Less: State income tax benefit 962 757 600 Amortization of ITC 435 439 449 Tax on subsidiary income 141 1,096 99 Claim of right credit 19 29 470 Other (104) 189 56 ------- ------- ------- Federal income tax expense $10,777 $ 8,031 $ 5,917 ======= ======= =======\nThe components of the net deferred tax liabilities as of September 30, 1995 and 1994 are as follows (amounts in thousands):\n1995 1994 ------- -------- Deferred tax assets: Regulatory liabilities - income tax amounts $ 5,100 $ 5,156 Pension expense 3,903 4,675 Unamortized ITC 1,767 2,002 Exploration surcharge 334 335 Stock options 238 193 Other 1,760 1,407 -------- -------- $ 13,102 $ 13,768 -------- -------- Deferred tax liabilities: Depreciation and property related items $ 53,723 $ 50,167 Excess deferred taxes due to a change in the statutory rate 10,914 10,774 Regulatory assets - income tax amounts 701 756 Other 370 540 -------- -------- $ 65,708 $ 62,237 -------- -------- Net deferred tax liabilities $ 52,606 $ 48,469 ======== ========\nDuring fiscal 1993, deferred income taxes were provided for significant timing differences between revenues and expenses for tax and financial statement purposes. The source and deferred tax effect of these differences are summarized below (amounts in thousands):\n--------------- Federal State ------- ------- Deferred Income Tax Provision: Accelerated tax depreciation $ 2,731 $ 682 Accrued pension cost (691) (173) Tax deductions from exploration programs over book deductions 159 40 Accrued revenue taxable currently for income tax purposes 112 28 Effect of alternative minimum tax (144) - Other 168 (33) ------- ----- $ 2,335 $ 544 ======= =====\n8. ENVIRONMENTAL ISSUES\nPSNC owns or has owned portions of six sites in North Carolina on which manufactured gas plants (MGPs) were formerly operated and one site at which a manufactured gas holder was located. In 1992, PSNC retained an environmental consulting firm to perform an environmental survey of the sites, to plan investigative measures and to prepare cost estimates for investigative and remedial measures.\nOf the seven sites with which PSNC is involved, intrusive investigation (including drilling, sampling and analysis) has begun at only one site and the remaining sites have been evaluated using historical records and observations of current site conditions made during visits to the sites. These evaluations have revealed that MGP residuals are present or suspected at each of the sites. The North Carolina Department of Environment, Health and Natural Resources (NCDEHNR) has recommended that no further action be taken with respect to one site. In March and April 1994, the consulting firm estimated that the aggregate cost of investigating and monitoring the extent of environmental degradation and of implementing remedial procedures with respect to the remaining six sites may range from $3,705,000 to $50,145,000 over a 30-year period. PSNC is unable to determine the rate at which costs may be incurred over this time period. The estimated cost range has not been discounted to present value. The range includes costs of investigating and monitoring the sites at the low end of the range and investigating, monitoring and extensively remediating the sites at the high end of the range. PSNC's associated actual costs for these sites will depend on a number of factors, such as actual site conditions, third party claims and recoveries from other potentially responsible parties (PRPs). Another North Carolina public utility or its predecessors also operated the MGPs in Raleigh, Durham and Asheville and PSNC is in discussion with that utility regarding potential cost sharing arrangements for investigation and potential remediation costs of four of the sites. At this time, PSNC has not reached a definitive agreement regarding such arrangements.\nAt September 30, 1995, PSNC had recorded a total liability of the minimum amount of the range, or $3,705,000. Of this amount, $750,000 was accrued during the fiscal year ended September 30, 1992 in other current liabilities with a corresponding charge to maintenance expenses. In accordance with an order of the NCUC dated May 11, 1993, which authorizes deferral accounting, or the creation of a regulatory asset, for all costs associated with the investigation and remediation of MGP sites, PSNC recorded an additional liability and an associated regulatory asset of $2,955,000 during the second quarter of fiscal 1994 pending NCUC determination of the appropriate disposition of these costs in PSNC's general rate case filed March 9, 1994.\nIn the general rate order dated October 7, 1994, the NCUC allowed the recovery of incurred MGP costs of approximately $150,000 as a reasonable operating expense to be amortized over a three-year period and ordered PSNC to defer additional MGP costs for consideration in subsequent rate cases. The NCUC concluded that it is proper and in the public interest to allow recovery of prudently incurred clean-up costs from current ratepayers as reasonable operating expenses even though the MGP sites are not used and useful in providing gas service to current customers. However, the order does not allow recovery of carrying costs on deferred amounts. In October 1994, PSNC reversed the $750,000 accrual of MGP costs charged to maintenance expenses during fiscal 1992 and recorded an additional regulatory asset of $750,000, pursuant to the terms of the general rate order, to reflect estimated total remedial costs of $3,705,000. Management intends to request recovery of additional MGP clean-up costs not recovered from other PRPs in future rate case filings, and believes that all costs deemed by the NCUC to be prudently incurred will be recoverable in gas rates.\n9. LONG-TERM DEBT\nEffective December 1, 1995, PSNC anticipates redeeming the remaining $3,680,000 balance of its 8% Series I First Mortgage Bonds, due 1998, at a redemption price of 100.35%. PSNC will finance this redemption through the use of short-term bank debt. After this series of first mortgage bonds is retired, PSNC will close the original indenture and all supplemental indentures. PSNC currently plans to secure additional long-term debt financing to retire a portion of its then outstanding short-term bank debt in the first half of fiscal 1996. The type of financing and timing of the issuance have not been determined at this time.\nMaturities of long-term debt during each of the next five fiscal years will be as follows: 1996, $10,480,000; 1997, $9,300,000; 1998, $9,300,000; 1999, $9,300,000; and 2000, $11,800,000.\nUnder terms of the debt agreements, there are various provisions relating to the maintenance of certain financial ratios and conditions, the most significant of which could restrict payment of dividends. At September 30, 1995, PSNC is in compliance in all material respects with the requirements of its debt agreements.\n10. CONSTRUCTION PROGRAM\nThe construction program for fiscal 1996, as presently planned, provides for expenditures of $61,131,000.\n11. CONTINGENT LIABILITIES\nPSNC is party to certain legal actions. Although it is impossible to predict the outcome with certainty, based upon the opinions of legal counsel, management does not expect disposition of these matters to have a materially adverse effect on PSNC's financial position or results of operations.\n12. SUMMARY OF QUARTERLY FINANCIAL INFORMATION (UNAUDITED)\nThe following table presents certain financial information for each quarter during the fiscal years ended September 30, 1995 and 1994 (amounts in thousands, except per share data):\n-------------------------------------- Fourth Third Second First ------- ------- -------- ------- Operating revenues $26,718 $41,650 $112,690 $66,835\nGross margin 16,042 24,236 57,452 33,099\nOperating income (loss) (1,222) 3,595 21,849 9,838\nNet income (loss) (4,350) 605 18,503 6,663\nEarnings (loss) per share (.23) .03 1.00 .36\n-------------------------------------- Fourth Third Second First ------- ------- -------- ------- Operating revenues $30,858 $48,171 $123,234 $71,442\nGross margin 14,905 22,560 51,003 29,860\nOperating income (loss) (1,551) 3,344 19,014 7,849\nNet income (loss) (3,564) 1,669 16,856 5,016\nEarnings (loss) per share (1) (.20) .10 1.04 .31\n(1) The sum of the quarterly earnings (loss) per share amounts does not equal the annual earnings per share amount reflected in the consolidated statement of income due to the effect of changes in average common shares outstanding during the fiscal year. REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Shareholders and the Board of Directors of Public Service Company of North Carolina, Incorporated:\nWe have audited the accompanying consolidated balance sheets and statements of capitalization of Public Service Company of North Carolina, Incorporated (PSNC), a North Carolina corporation, and subsidiaries as of September 30, 1995 and 1994, and the related consolidated statements of income, retained earnings and cash flows for each of the three years in the period ended September 30, 1995. These financial statements are the responsibility of PSNC's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Public Service Company of North Carolina, Incorporated and subsidiaries as of September 30, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended September 30, 1995, in conformity with generally accepted accounting principles.\nAs explained in Note 1 and Note 5 to the financial statements, effective October 1, 1993, PSNC changed its method of accounting for income taxes and postretirement benefits other than pensions.\nArthur Andersen LLP\nCharlotte, North Carolina, November 2, 1995.\nMANAGEMENT'S RESPONSIBILITY FOR FINANCIAL STATEMENTS\nManagement is responsible for the preparation, presentation and integrity of the financial statements and other financial information in this report. The accompanying financial statements have been prepared in accordance with generally accepted accounting principles applicable to rate-regulated public utilities, including estimates and judgments made by management that were necessary to prepare the statements in accordance with such accounting principles, and are not misstated due to material fraud or error. To assure the integrity of the underlying financial records supporting the financial statements, management maintains a system of internal accounting controls sufficient to provide reasonable assurances that PSNC assets are properly accounted for, safeguarded and are utilized only in accordance with management's authorization. The concept of reasonable assurance recognizes that the costs of a system of internal controls should not exceed the related benefits derived from it.\nThe system of internal accounting controls is augmented by PSNC's internal audit department, which has unrestricted access to all levels of PSNC management. The internal audit department meets periodically, with and without the presence of management, with the Audit Committee of the Board of Directors to discuss, among other things, PSNC's system of internal accounting controls and the adequacy of the internal audit program. The Audit Committee is comprised of five directors who are not officers or employees of PSNC.\nThe Audit Committee also meets periodically with Arthur Andersen LLP, PSNC's independent public accountants, with and without the presence of management, to discuss the results of the annual audit of PSNC's financial statements and related data. The Audit Committee and Arthur Andersen LLP also discuss internal accounting control matters that come to the attention of Arthur Andersen LLP during the course of the audit.\ns\/Charles E. Zeigler, Jr. s\/Robert D. Voigt - - ------------------------- ------------------------- Charles E. Zeigler, Jr. Robert D. Voigt Chairman, President and Senior Vice President - Chief Executive Officer Corporate Development and Chief Financial Officer Supplementary Data ------------------\nThe information for this item is contained in Note 12 entitled \"SUMMARY OF QUARTERLY FINANCIAL INFORMATION (UNAUDITED)\" on page 43 of this 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 ------------------------------------------------------------ Directors ---------\nThe information for this item is set forth in the sections entitled \"Election of Directors\" and \"The Board of Directors and Committees of the Board - Compliance with Section 16(a)\" in PSNC's proxy statement dated December 20, 1995, relating to the January 26, 1996 annual meeting of shareholders, which section is incorporated herein by reference.\nExecutive Officers ------------------\nThe information for this item is set forth on page 13 of this annual report.\nItem 11.","section_11":"Item 11. Executive Compensation --------------------------------\nThe information for this item is set forth in the sections entitled \"Executive Compensation,\" \"Employee Retirement Plans,\" \"Performance Graph\" and \"The Board of Directors and Committees of the Board\" in PSNC's proxy statement dated December 20, 1995, relating to the January 26, 1996 annual meeting of shareholders, which section is incorporated herein by reference (specifically excluding disclosures in such sections relating to Items 402(k) and (l) of Regulation S-K). Item 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners --------------------------------------------------------- and Management --------------\nThe information for this item is set forth in the section entitled \"Common Stock Ownership By Directors and Executive Officers\" in PSNC's proxy statement dated December 20, 1995, relating to the January 26, 1996 annual meeting of shareholders, which section is incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions -------------------------------------------------------- The information for this item is set forth in the sections entitled \"Election of Directors\" and \"Compensation Committee Interlocks and Insider Participation\" in PSNC's proxy statement dated December 20, 1995, relating to the January 26, 1996 annual meeting of shareholders, 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 ------------------- Page ---- (a) 1. Financial statements -\nConsolidated Statements of Income for the Fiscal Years Ended September 30, 1995, 1994 and 1993 26 Consolidated Balance Sheets at September 30, 1995 and 1994 27 Consolidated Statements of Capitalization at September 30, 1995 and 1994 28 Consolidated Statements of Retained Earnings for the Fiscal Years Ended September 30, 1995, 1994 and 1993 28 Consolidated Statements of Cash Flows for the Fiscal Years Ended September 30, 1995, 1994 and 1993 29 Notes to Consolidated Financial Statements for the Fiscal Years Ended September 30, 1995, 1994 and 1993 30-43 Report of Independent Public Accountants 44 Management's Responsibility for Financial Statements 45\nPage ---- 2. Financial statement schedules -\nThe following financial statement schedules are included herein:\nSupplemental Schedules: Report of Independent Public Accountants 50 Schedule II - Reserves for the Fiscal Years Ended September 30, 1995, 1994 and 1993 51-53\nAll other financial statement schedules are omitted as not applicable, not required, or the required information is included in the consolidated financial statements and notes thereto.\n3. Exhibits -\nSee Exhibit Index on page 55 of this annual report.\n(b) Reports on Form 8-K -\nThere were no reports on Form 8-K filed during the three months ended September 30, 1995.\nCONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS -----------------------------------------\nAs independent public accountants, we hereby consent to the incorporation of our reports included in this Form 10-K, into PSNC's previously filed Registration Statements on Form S-3 (File Nos. 33-48911 and 33-52997) and Form S-8 (File Nos. 33-49153, 33-48908 and 33-27903).\nArthur Andersen LLP\nCharlotte, North Carolina, December 20, 1995. REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ----------------------------------------\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements of Public Service Company of North Carolina, Incorporated included in this Form 10-K, and have issued our report thereon dated November 2, 1995. Our report on the consolidated financial statements includes an explanatory paragraph with respect to changes in accounting for income taxes and postretirement benefits other than pensions as disclosed in Note 1 and Note 5 to the consolidated financial statements. Our audit was made for the purpose of forming an opinion on those statements taken as a whole. The schedules listed in the accompanying index are the responsibility of the Registrant'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 Charlotte, North Carolina, November 2, 1995.\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.\nPUBLIC SERVICE COMPANY OF NORTH CAROLINA, INCORPORATED ------------------------------- (Registrant)\nCharles E. Zeigler, Jr. ------------------------------- Charles E. Zeigler, Jr. Chairman, President and December 20, 1995 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 December 20, 1995.\nCharles E. Zeigler, Jr. Robert D. Voigt - - ---------------------------------- ----------------------------------- Charles E. Zeigler, Jr. Robert D. Voigt Chairman, President and Senior Vice President - Corporate Chief Executive Officer Corporate Development (Principal executive officer) and Chief Financial Officer (Principal financial and accounting officer)\nWilliam C. Burkhardt B. Frank Matthews, II - - ---------------------------------- ----------------------------------- William C. Burkhardt - Director B. Frank Matthews, II - Director\nWilliam A. V. Cecil William L. O'Brien, Jr. - - ---------------------------------- ----------------------------------- William A. V. Cecil - Director William L. O'Brien Jr. - Director\nBert Collins Plato P. Pearson, Jr. - - ---------------------------------- ----------------------------------- Bert Collins - Director Plato P. Pearson, Jr. - Director\nH. Max Craig, Jr. G. Smedes York - - ---------------------------------- ----------------------------------- H. Max Craig, Jr. - Director G. Smedes York - Director\nVan E. Eure Charles E. Zeigler, Sr. - - ---------------------------------- ----------------------------------- Van E. Eure - Director Charles E. Zeigler, Sr. - Director\nEXHIBIT INDEX ------------- The following documents are filed as a part of this annual report on Form 10-K for the fiscal year ended September 30, 1995. Those exhibits previously filed and incorporated herein by reference are identified below with an asterisk and with a reference to the previous filing.\nExhibit Number - - -------\n*3-A-4 - Amended and Restated Charter, dated February 1, 1991. (File No. 0-1218, 10-K--1992, Exhibit 3-A-4).\n*3-I - By-laws, as amended to date. (File No. 0-1218, 10-Q--March 31, 1994, Exhibit 3-I).\n*4-A - Debenture Purchase Agreement, dated as of June 15, 1987, for $25,000,000 of 8.65% Senior Debentures due August 31, 2002. (File No. 0-1218, 10-K--1987, Exhibit 4-A).\n*4-B - Debenture Purchase Agreement, dated as of September 15, 1988, for $25,000,000 of 10% Senior Debentures due October 1, 2003. (File No. 0-1218, 10-K--1988, Exhibit 4-B).\n*4-C - Debenture Purchase Agreement, dated as of December 5, 1989, for $43,000,000 of 10% Senior Debentures due December 1, 2004. (File No. 0-1218, 10-K--1989, Exhibit 4-C).\n*4-D - Debenture Purchase Agreement, dated as of June 25, 1992, for $32,000,000 of 8.75% Senior Debentures due June 30, 2012. (File No. 0-1218, 10-Q--June 30, 1992, Exhibit 4-D).\n*10-A-5 - Natural Gas Sales Agreement - TEMCO\/PSNC FT-1 between PSNC and Transco Energy Marketing Company dated January 1, 1989. (File No. 0-1218, 10-Q--March 31, 1989, Exhibit 19-A).\n*10-A-7 - Firm Seasonal Transportation Agreement dated June 29, 1990, between PSNC and Transcontinental Gas Pipe Line Corporation. (File No. 0-1218, 10-K--1990, Exhibit 10-A-7).\n*10-A-8 - Firm Sales Service Agreement under Rate Schedule FS, dated August 1, 1991, between PSNC and Transcontinental Gas Pipe Line Corporation. (File No. 0-1218, 10-Q--March 31, 1992, Exhibit 10-A-8).\n*10-A-9 - Firm Sales Service Agreement under Rate Schedule FS, dated August 1, 1991, between PSNC and Transcontinental Gas Pipe Line Corporation. (File No. 0-1218, 10-Q--March 31, 1992, Exhibit 10-A-9). Exhibit Number - - ------- *10-A-10 - Firm Sales Service Agreement under Rate Schedule FS, dated August 1, 1991, between PSNC and Transcontinental Gas Pipe Line Corporation. (File No. 0-1218, 10-Q--March 31, 1992, Exhibit 10-A-10).\n*10-A-11 - Firm Sales Service Agreement under Rate Schedule FS, dated August 1, 1991, between PSNC and Transcontinental Gas Pipe Line Corporation. (File No. 0-1218, 10-Q--March 31, 1992, Exhibit 10-A-11).\n*10-A-13 - Firm Transportation Service Agreement under Rate Schedule FT, dated August 1, 1991, between PSNC and Transcontinental Gas Pipe Line Corporation. (File No. 0-1218, 10-K--1992, Exhibit 10-A-13).\n*10-A-14 - Firm Transportation Service Agreement under Rate Schedule FT-NT, dated July 20, 1992, between PSNC and Transcontinental Gas Pipe Line Corporation. (File No. 0- 1218, 10-K--1992, Exhibit 10-A-14).\n*10-A-15 - Firm Transportation Service Agreement under Rate Schedule FT, dated February 1, 1992, between PSNC and Transcontinental Gas Pipe Line Corporation. (File No. 0- 1218, 10-K--1993, Exhibit 10-A-15).\n*10-A-16 - Firm Transportation Service Agreement under Rate Schedule FT-NN, dated October 8, 1993, between PSNC and CNG Transmission Corporation. (File No. 0-1218, 10-K--1993, Exhibit 10-A-16).\n*10-A-17 - Firm Transportation Service Agreement under Rate Schedule FT-NN-GSS, dated October 8, 1993, between PSNC and CNG Transmission Corporation. (File No. 0-1218, 10-K--1993, Exhibit 10-A-17).\n*10-A-18 - Firm Transportation Service Agreement under Rate Schedule FT-A, dated November 1, 1993, between PSNC and Tennessee Gas Pipeline Company. (File No. 0-1218, 10-K--1993, Exhibit 10- A-18).\n*10-A-19 - Firm Transportation Service Agreement under Rate Schedule FT-1, dated November 1, 1993, between PSNC and Texas Eastern Transmission Corporation. (File No. 0-1218, 10-K--1993, Exhibit 10-A-19).\n*10-A-20 - Firm Transportation Service Agreement under Rate Schedule FT, dated November 1, 1993, between PSNC and Texas Gas Transmission Corporation. (File No. 0-1218, 10-K--1993, Exhibit 10-A-20).\n*10-A-21 - Firm Transportation Service Agreement under Rate Schedule FT, dated October 1, 1993, between PSNC and Transcontinental Gas Pipe Line Corporation. (File No. 0-1218, 10-K--1993, Exhibit 10-A-21).\nExhibit Number - - ------- 10-A-22 - Firm Transportation Service Agreement under Rate Schedule FT, dated June 6, 1994, between PSNC and Transcontinental Gas Pipe Line Corporation.\n10-A-23 - Firm Transportation Service Agreement under Rate Schedule FT, dated April 30, 1995, between PSNC and Transcontinental Gas Pipe Line Corporation.\n*10-B-2 - General Storage Service Agreement under Rate Schedule GSS, dated May 2, 1972, between PSNC and Transcontinental Gas Pipe Line Corporation. (Registration No. 2-53708, Exhibit 5.4).\n*10-B-4 - Liquefied Natural Gas Storage Service Agreement under Rate Schedule LG-A, dated August 5, 1974, between PSNC and Transcontinental Gas Pipe Line Corporation. (Registration No. 2-53708, Exhibit 5.6).\n*10-B-5 - Eminence Storage Service Agreement under Rate Schedule ESS, dated November 1, 1993, and Amendment, dated December 1, 1993, between PSNC and Transcontinental Gas Pipe Line Corporation. (File No. 0-1218, 10-K--1993, Exhibit 10-B-5).\n*10-B-6 - Washington Storage Service Agreement under Rate Schedule WSS, dated August 1, 1991, between PSNC and Transcontinental Gas Pipe Line Corporation. (File No. 0-1218, 10-Q--March 31, 1994, Exhibit 10-B-6).\n*10-C-1 - 1987 Nonqualified Stock Option Plan. (Registration No. 33-17996, Exhibit 4.1).\n*10-C-2 - 1992 Nonqualified Stock Option Plan. (Registration No. 33- 48909, Exhibit 4).\n*10-D-3 - Construction, Operating and Management Agreement by and between Public Service Company of North Carolina, Inc. and Cardinal Pipeline Company, LLC, dated March 23, 1994. (File No. 0-12-18, 10-Q--March 31, 1994, Exhibit 10-D-3).\n11 - Statement re computation of per share earnings.\n*19 - Letter regarding change in method of accounting for the commodity cost of gas purchased and delivered to customers but not billed and recorded as revenue during the current period. (File No. 0-1218, 10-Q--March 31, 1981, Exhibit 19).\n22 - Subsidiaries of Registrant.\n24 - Consent of Independent Public Accountants. (Set forth on page 49 of this annual report).\n27 - Financial Data Schedule.\nExhibit Number - - ------- *28-C - Revised Item 21 of Part II to the Registration Statement on Form S-8, Registration No. 33-27903. (File No. 0-1218, 10- K--1990, Exhibit 28-C).","section_15":""}
{"filename":"19724_1995.txt","cik":"19724","year":"1995","section_1":"Item 1. Business\nGENERAL\nBell Atlantic - West Virginia, Inc. (the \"Company\") is incorporated under the laws of the State of West Virginia and has its principal offices at 1500 MacCorkle Avenue, S.E., Charleston, West Virginia 25314 (telephone number 304- 343-9911). The Company is a wholly owned subsidiary of Bell Atlantic Corporation (\"Bell Atlantic\"), which is one of the seven regional holding companies (\"RHCs\") formed in connection with the court-approved divestiture (the \"Divestiture\"), effective January 1, 1984, of those assets of American Telephone and Telegraph Company (\"AT&T\") related to exchange telecommunications, exchange access functions, printed directories and cellular mobile communications.\nThe Company presently serves a territory consisting of two complete Local Access and Transport Areas (\"LATAs\") and part of a third LATA. These LATAs are generally centered on a city or based on some other identifiable common geography and, with certain limited exceptions, each LATA marks the boundary within which the Company has historically been permitted to provide telephone service.\nThe Company currently provides two basic types of telecommunications services. First, the Company transports telecommunications traffic between subscribers located within the same LATA (\"intraLATA service\"), including both local and toll services. Local service includes the provision of local exchange (\"dial tone\"), local private line and public telephone services (including dial tone service for pay telephones owned by the Company and other pay telephone providers). Among other local services provided are Centrex (telephone company central office-based switched telephone service enabling the subscriber to make both intercom and outside calls) and a variety of special and custom calling services. Toll service includes message toll service (calling service beyond the local calling area) within LATA boundaries, and intraLATA Wide Area Toll Service (WATS)\/800 services (volume discount offerings for customers with highly concentrated demand). Second, the Company provides exchange access service, which links a subscriber's telephone or other equipment to the transmission facilities of interexchange carriers which, in turn, provide telecommunications service between LATAs (\"interLATA service\") to their customers. The Company also provides exchange access service to interexchange carriers which provide intrastate intraLATA long distance telecommunications service.\nLINE OF BUSINESS RESTRICTIONS AND THE TELECOMMUNICATIONS ACT OF 1996\nThe consent decree entitled \"Modification of Final Judgment\" (\"MFJ\") approved by the United States District Court for the District of Columbia (the \"D.C. District Court\") which, together with the Plan of Reorganization (\"Plan\") approved by the D.C. District Court, set forth the terms of Divestiture also established certain restrictions on the post-Divestiture activities of the RHCs, including Bell Atlantic and its subsidiaries. The MFJ's principal restrictions on post-Divestiture RHC activities included prohibitions on (i) providing interexchange telecommunications, and (ii) engaging in the manufacture of telecommunications equipment and customer premises equipment (\"CPE\").\nThe Telecommunications Act of 1996 (the \"Act\") became effective on February 8, 1996 and replaces the MFJ. In general, the Act includes provisions that would open the Company's local exchange markets to competition and would permit local exchange carriers, such as the Company, to provide interLATA services (long distance) and video programming and to engage in manufacturing. However, the ability of the Company to engage in businesses previously prohibited by the MFJ is largely dependent on satisfying certain conditions contained in the Act and regulations to be promulgated thereunder. For a brief discussion of certain provisions of the Act, see \"Management's Discussion and Analysis of Results of Operations - Factors That May Impact Future Results, Federal Legislation\" on pages 14 and 15.\nOPERATIONS\nDuring 1993, Bell Atlantic reorganized certain functions formerly performed by each of the seven Bell System operating companies (\"BOCs\") transferred to it pursuant to the Divestiture, including the Company (collectively, the \"Network Services Companies\"), into lines of business (\"LOBs\") organized across the Network Services Companies\nBell Atlantic - West Virginia, Inc.\naround specific market segments. The Network Services Companies, however, remain responsible within their respective service areas for the provision of telephone services, financial performance and regulatory matters. The LOBs are:\nThe Consumer Services LOB markets communications services to residential ----------------- customers within the service territories of the Network Services Companies, including the service territory of the Company.\nThe Carrier Services LOB markets (i) switched and special access to the ---------------- Company's local exchange network, and (ii) billing and collection services, including recording, rating, bill processing and bill rendering. The principal customers of this LOB are interexchange carriers; AT&T is the largest single customer. Other customers include business customers and government agencies with their own special access network connections, wireless companies and other local exchange carriers (\"LECs\") which resell network connections to their own customers.\nThe Small Business Services LOB markets communications and information ----------------------- services to small businesses (customers having up to 20 access lines).\nThe Large Business Services LOB markets communications and information ----------------------- services to large businesses (customers having more than 20 access lines). These services include voice switching\/processing services (e.g., dedicated private lines, custom Centrex, call management and voice messaging), end-user networking (e.g., credit and debit card transactions, and personal computer- based conferencing, including data and video), internetworking (establishing links between the geographically disparate networks of two or more companies or within the same company), network integration (integrating multiple geographically disparate networks into one system), network optimization (disaster avoidance, 911, intelligent vehicle highway systems), video services (distance learning, telemedicine, videoconferencing) and interactive multi-media applications services.\nThe Directory Services LOB manages the provision of (i) advertising and ------------------ marketing services to advertisers, and (ii) listing information (e.g., White Pages and Yellow Pages). These services are currently provided primarily through print media, but the Company expects that use of electronic formats will increase in the future. In addition, the Directory Services LOB manages the provision of photocomposition, database management and other related products and services to publishers.\nThe Public and Operator Services LOB markets pay telephone and operator ---------------------------- services in the service territories of the Network Services Companies to meet consumer needs for accessing public networks, locating and identifying network subscribers, providing calling assistance and arranging billing alternatives (e.g., calling card, collect and third party calls).\nThe Federal Systems LOB markets communications and information technology and --------------- services to departments, agencies and offices of the executive, judicial and legislative branches of the federal government.\nThe Network LOB manages the technologies, services and systems platforms ------- required by the other LOBs and the Network Services Companies, including the Company, to meet the needs of their respective customers, including switching, feature development and on-premises installation and maintenance services.\nFCC REGULATION AND INTERSTATE RATES\nThe Company is subject to the jurisdiction of the Federal Communications Commission (\"FCC\") with respect to interstate services and certain related matters. The FCC prescribes a uniform system of accounts for telephone companies, interstate depreciation rates and the principles and standard procedures used to separate plant investment, expenses, taxes and reserves between those applicable to interstate services under the jurisdiction of the FCC and those applicable to intrastate services under the jurisdiction of the respective state regulatory authorities (\"separations procedures\"). The FCC also prescribes procedures for allocating costs and revenues between regulated and unregulated activities.\nThe FCC has prescribed structures for exchange access tariffs to specify the charges (\"access charges\") for use and availability of the Company's facilities for the origination and termination of interstate interLATA service. In general, the tariff structures prescribed by the FCC provide that interstate costs which do not vary based on usage (\"non-traffic sensitive costs\") are recovered from subscribers through flat monthly charges (\"subscriber line charges\"), and from interexchange\nBell Atlantic - West Virginia, Inc.\ncarriers through usage-sensitive Carrier Common Line (\"CCL\") charges. Traffic- sensitive interstate costs are recovered from carriers through variable access charges based on several factors, primarily usage.\nPrice Caps\nThe price cap system, which became effective in 1991, (the \"Prior Price Cap Plan\") placed a cap on overall LEC prices for interstate access services which was modified annually, in inflation-adjusted terms, by a fixed percentage which was intended to reflect increases in productivity. The price cap level could also be adjusted to reflect \"exogenous\" changes, such as changes in FCC separations procedures or accounting rules. Under the Prior Price Cap Plan, the Company was required to share with customers in the form of prospective rate reductions a portion of its earnings above a certain authorized rate of return.\nIn March 1995, the FCC approved an Interim Price Cap Plan (\"Interim Plan\") for interstate access charges, which became effective on August 1, 1995, and replaced the Prior Price Cap Plan.\nUnder the Interim Plan, the Company's price cap index must be adjusted by an inflation index (GDP-PI), less a fixed percentage, either 4.0%, 4.7% or 5.3%, which is intended to reflect increases in productivity (\"Productivity Factor\"). Companies selecting the 4.0% or 4.7% Productivity Factor are required to reduce future prices and share a portion of their interstate return in excess of 12.25%. Companies selecting the 5.3% Productivity Factor are also required to reduce prices but are not required to share a portion of their future interstate earnings. The Interim Plan also provided for a reduction in the price cap index of 2.8% to adjust for what the FCC believes was an underestimate in its calculation of the Productivity Factor in prior years. The Interim Plan also eliminated the recovery of certain \"exogenous\" cost changes, including changes in accounting costs that the FCC believes have no economic consequences.\nIn May 1995, Bell Atlantic selected the 5.3% Productivity Factor for the August 1995 to June 1996 tariff period. The rates included in the May 1995 filing resulted in price decreases totaling approximately $16,100,000 on an annual basis. These price decreases included the scheduled expiration of a temporary rate increase of approximately $5,200,000 on an annualized basis that was in effect from March 17, 1995 through July 31, 1995 to recover prior years \"exogenous\" postemployment benefit costs. Approximately 80% of the remaining $10,900,000 reduction resulted from compliance with the Interim Plan. The remaining 20% represented reductions that the Company was required to make under the Prior Price Cap Plan.\nBell Atlantic appealed the Interim Price Cap Order to the Court of Appeals for the D.C. Circuit, and that case is currently pending.\nFCC Cost Allocation and Affiliate Transaction Rules\nFCC rules govern: (i) the allocation of costs between the regulated and unregulated activities of a communications common carrier and (ii) transactions between the regulated and unregulated affiliates of a communications common carrier.\nThe cost allocation rules apply to certain unregulated activities: activities that have never been regulated as communications common carrier offerings and activities that have been preemptively deregulated by the FCC. The costs of these activities are removed prior to the separations procedures process and are assigned to unregulated activities in the aggregate, not to specific services, for pricing purposes. Other activities must be accounted for as regulated activities, and their costs are subject to separations procedures.\nThe affiliate transaction rules govern the pricing of assets transferred to and services provided by affiliates. These rules generally require that assets be transferred between affiliates at \"market price\", if such price can be established through a tariff or a prevailing price actually charged to third parties. In the absence of a tariff or prevailing price, \"market price\" cannot be established, in which case (i) asset transfers from a regulated to an unregulated affiliate must be valued at the higher of cost or fair market value, and (ii) asset transfers from an unregulated to a regulated affiliate must be valued at the lower of cost or fair market value.\nThe FCC has not attempted to make its cost allocation or affiliate transaction rules preemptive. State regulatory authorities are free to use different cost allocation methods and affiliate transaction rules for intrastate ratemaking and to require carriers to keep separate allocation records.\nBell Atlantic - West Virginia, Inc.\nSTATE REGULATION AND COMPETITIVE ENVIRONMENT\nThe communications services of the Company are subject to regulation by the Public Service Commission of West Virginia (the \"PSC\") with respect to intrastate rates and services and certain other matters.\nIn December 1991, the PSC approved an \"Incentive Regulation Plan\". The Incentive Regulation Plan continued the major provisions of the prior plan, including pricing flexibility for competitive services and a freeze on rates for basic local exchange service. It also committed the Company to invest $450 million from 1991 through 1995 in West Virginia's telecommunications infrastructure.\nIn December 1994, the PSC issued an order extending the Incentive Regulation Plan for three years, with certain modifications. Basic rates remain frozen through January 15, 1998 and Touch-Tone charges will be eliminated over a three year period. The Company is committed to invest at least $375 million in its network over the five year period from 1995 through 1999.\nCOMPETITION\nGeneral\nRegulatory changes, as well as new technology, are continuing to expand the types of available communications services and equipment and the number of competitors offering such services. An increasing amount of this competition is from large companies which have substantial capital, technological and marketing resources. For a discussion of competition in the local exchange and intraLATA toll markets, see \"Management's Discussion and Analysis of Results of Operations - - Factors That May Impact Future Results\" on pages 14 and 15.\nAlternative Access\nA substantial portion of the Company's revenues from business and government customers is derived from a relatively small number of large, multiple-line subscribers.\nThe Company faces competition from alternative communications systems, constructed by large end users, interexchange carriers and alternative access vendors, which are capable of originating and\/or terminating calls without the use of the Company's plant.\nThe ability of such alternative access providers to compete with the Company has been enhanced by the FCC's orders requiring the Company to offer virtual collocated interconnection for special and switched access services.\nOther potential sources of competition are cable television systems, shared tenant services and other non-carrier systems which are capable of bypassing the Company's local plant, either partially or completely, through substitution of special access for switched access or through concentration of telecommunications traffic on fewer of the Company's lines.\nPersonal Communications Services\nRadio-based personal communications services (\"PCS\") also constitute potential sources of competition to the Company. PCS consists of wireless portable telephone services which would allow customers to make and receive telephone calls from any location using small handsets, and which could also be used for data transmission.\nDirectories\nThe Company continues to face significant competition from other providers of directories, as well as competition from other advertising media.\nBell Atlantic - West Virginia, Inc.\nPublic Telephone Services\nThe Company faces increasing competition in the provision of pay telephone services from other pay telephone service providers. In addition, the growth of wireless communications negatively impacts usage of public telephones.\nOperator Services\nAlternative operator services providers have entered into competition with the Company's operator services product line.\nCERTAIN CONTRACTS AND RELATIONSHIPS\nCertain planning, marketing, procurement, financial, legal, accounting, technical support and other management services are provided on behalf of the Company on a centralized basis by Bell Atlantic's wholly owned subsidiary, Bell Atlantic Network Services, Inc. (\"NSI\"). Bell Atlantic Network Funding Corporation provides short-term financing and cash management services to the Company.\nThe seven RHCs each own (directly or through subsidiaries) a one-seventh interest in Bell Communications Research, Inc. (\"Bellcore\"). Pursuant to the Plan, Bellcore furnishes the RHCs and their BOC subsidiaries with technical assistance such as network planning, engineering and software development, as well as various other consulting services that can be provided more effectively on a centralized basis. Bellcore is the central point of contact for coordinating the efforts of the RHCs in meeting the national security and emergency preparedness requirements of the federal government. It also helps to mobilize the combined resources of the RHCs in times of natural disasters.\nEMPLOYEES\nAs of December 31, 1995, the Company had approximately 1,800 employees. This workforce is augmented by employees of the centralized staff of NSI, who perform services for the Company on a contract basis.\nBell Atlantic - West Virginia, Inc.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nGENERAL\nThe principal properties of the Company do not lend themselves to simple description by character and location. The Company's investment in plant, property and equipment consisted of the following at December 31:\n\"Central office equipment\" consists of switching equipment, transmission equipment and related facilities. \"Cable, wiring and conduit\" consists primarily of aerial cable, underground cable, conduit and wiring. \"Land and buildings\" consists of land owned in fee and improvements thereto, principally central office buildings. \"Other equipment\" consists of public telephone terminal equipment and other terminal equipment, poles, furniture, office equipment, and vehicles and other work equipment. \"Other\" property consists primarily of plant under construction, capital leases and leasehold improvements.\nThe Company's customers are served by electronic switching systems that provide a wide variety of services. The Company's network has been in a transition from an analog to a digital network, which provides the capabilities to furnish advanced data transmission and information management services. At December 31, 1995, all existing access lines have been transitioned to digital capability.\nCAPITAL EXPENDITURES\nThe Company has been making and expects to continue to make significant capital expenditures to meet the demand for communications services and to further improve such services. Capital expenditures were approximately $100 million in 1993, $85 million in 1994 and $88 million in 1995. The total investment in plant, property and equipment was approximately $1.52 billion at December 31, 1993, $1.57 billion at December 31, 1994, and $1.63 billion at December 31, 1995, in each case after giving effect to retirements, but before deducting accumulated depreciation at such date.\nBell Atlantic - West Virginia, Inc.\nItem 3.","section_3":"Item 3. Legal Proceedings\nPre-Divestiture Contingent Liabilities and Litigation\nThe Plan provides for the recognition and payment by AT&T and the former BOCs (including the Company) of liabilities that are attributable to pre-Divestiture events but do not become certain until after Divestiture. These contingent liabilities relate principally to litigation and other claims with respect to the former Bell System's rates, taxes, contracts and torts (including business torts, such as alleged violations of the antitrust laws). Except to the extent that affected parties otherwise agree, contingent liabilities that are attributable to pre-Divestiture events are shared by AT&T and the BOCs in accordance with formulas prescribed by the Plan, whether or not an entity was a party to the proceeding and regardless of whether an entity was dismissed from the proceeding by virtue of settlement or otherwise. Each company's allocable share of liability under these formulas depends on several factors, including the type of contingent liability involved and each company's relative net investment as of the effective date of Divestiture. Under the formula generally applicable to most of the categories of these contingent liabilities, the Company's aggregate allocable share of liability is approximately 0.6%.\nAT&T and various of its subsidiaries and the BOCs (including, in some cases, the Company) have been and are parties to various types of litigation relating to pre-Divestiture events, including actions and proceedings involving environmental claims and allegations of violations of equal employment laws. Damages, if any, ultimately awarded in the remaining actions relating to pre- Divestiture events could have a financial impact on the Company whether or not the Company is a defendant since such damages will be treated as contingent liabilities and allocated in accordance with the allocation rules established by the Plan.\nEffective in 1994, the Company and the other Regional Holding Companies 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.\nWhile complete assurance cannot be given as to the outcome of any contingent liabilities or litigation, in the opinion of the Company's management, any monetary liability or financial impact to which the Company would be subject after final adjudication of all of the remaining potential or actual pre- Divestiture claims would not be material in amount to the financial position of the Company.\nBell Atlantic - West Virginia, Inc.\nPART I\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\n(Omitted pursuant to General Instruction J(2).)\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters\n(Inapplicable.)\nItem 6.","section_6":"Item 6. Selected Financial Data\n(Omitted pursuant to General Instruction J(2).)\nBell Atlantic - West Virginia, Inc.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Results of Operations (Abbreviated pursuant to General Instruction J(2).)\nThis discussion should be read in conjunction with the Financial Statements and Notes to Financial Statements included in the index set forth on page.\nRESULTS OF OPERATIONS - ---------------------\nThe Company reported net income of $81,247,000 in 1995, compared to net income of $7,643,000 in 1994.\nIn 1994, the Company recorded a pretax charge of $8,605,000, in accordance with Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits\" (Statement No. 112), to recognize the Company's proportionate share of benefit costs for the separation of employees who are entitled to benefits under preexisting Bell Atlantic separation pay plans. Results for 1994 also included a noncash, after-tax extraordinary charge of $76,616,000 in connection with the Company's decision to discontinue application of regulatory accounting principles required by Statement of Financial Accounting Standards No. 71, \"Accounting for the Effects of Certain Types of Regulation\" (see Note 2 to the Financial Statements).\nThese and other items affecting the comparison of operating results between 1995 and 1994 are discussed in the following sections.\nBell Atlantic - West Virginia, Inc.\nTRANSPORT SERVICES OPERATING STATISTICS - ---------------------------------------\nLOCAL SERVICE REVENUES\nDollars in Thousands Increase - ------------------------------------------------------------------------------- 1995 - 1994 $311 .1% - -------------------------------------------------------------------------------\nLocal service revenues are earned by the Company from the provision of local exchange, local private line and public telephone services.\nLocal service revenues increased primarily due to a 2.6% growth in network access lines in service. This increase was substantially offset by the completion, on December 31, 1994, of the phased elimination of Locality Rate Area charges, pursuant to the Company's Incentive Regulation Plan. The elimination of these charges reduced local service revenues by approximately $6,000,000 in 1995.\nNETWORK ACCESS REVENUES\nDollars in Thousands Increase - ------------------------------------------------------------------------------- 1995 - 1994 $738 .4% - -------------------------------------------------------------------------------\nNetwork access revenues are received from interexchange carriers (IXCs) for their use of the Company's local exchange facilities in providing long distance services to IXCs' customers and from end-user subscribers. Switched access service revenues are derived from usage-based charges paid by IXCs for access to the Company's network. Special access revenues arise from access charges paid by IXCs and end-users who have private networks. End-user access revenues are earned from local exchange carrier customers who pay for access to the network.\nNetwork access revenues increased principally due to higher customer demand for access services as reflected by growth of 6.8% in access minutes of use. Higher end-user revenues attributable to increases in access lines in service also contributed to the growth in network access revenues in 1995. Revenues in 1995 were positively impacted by a temporary rate increase that was in effect from March 17, 1995 through July 31, 1995 to recover prior years \"exogenous\" postemployment benefit costs.\nBell Atlantic - West Virginia, Inc.\nRevenue growth from volume increases was substantially offset by lower revenues from affiliated companies pursuant to an interstate revenue sharing agreement, and the effect of price reductions under the Federal Communications Commission's (FCC) Price Cap Plans.\nIn March 1995, the FCC adopted an order approving an Interim Price Cap Plan for interstate access charges, which replaced the prior Price Cap Plan. As required by the FCC's order, Bell Atlantic filed its Transmittal of Interstate Rates, which resulted in price decreases for the Company totaling approximately $16,100,000 on an annual basis, effective August 1, 1995. These price decreases included the scheduled expiration of a temporary rate increase of approximately $5,200,000 on an annualized basis that was in effect from March 17, 1995 through July 31, 1995 to recover prior years \"exogenous\" postemployment benefit costs. Also as part of the filing, Bell Atlantic selected a 5.3% Productivity Factor, which eliminates the requirement to share a portion of interstate overearnings related to the August 1995 to June 1996 tariff period.\nWhile the Company expects current volume growth trends to continue, the impact of the August 1, 1995 price decreases is expected to substantially offset volume-related growth during the first half of 1996, relative to 1995 network access revenues.\nTOLL SERVICE REVENUES\nDollars in Thousands (Decrease) - ------------------------------------------------------------------------------- 1995 - 1994 $(10,362) (13.9)% - -------------------------------------------------------------------------------\nToll service revenues are earned from calls made outside a customer's local calling area, but within the same service area boundaries of the Company, commonly referred to as Local Access and Transport Areas (LATAs). Other toll services include 800 services and Wide Area Telephone Service (WATS).\nThe reduction in toll service revenues was caused by a decline of 1.6% in toll message volumes and company-initiated price reductions. The decrease in toll messages was due primarily to increased competition for intraLATA toll and WATS services. Effective July 1, 1995, residential intrastate intraLATA toll rates were reduced by 18%, or $6,000,000 on an annual basis. The reduction in toll service revenues also reflects the impact of customers switching to lower priced optional calling plans offered by the Company.\nThe Company expects that competition for toll service revenues will continue in 1996. See \"Factors That May Impact Future Results\" below for a further discussion of toll service revenue issues.\nDIRECTORY PUBLISHING REVENUES\nDollars in Thousands Increase - ------------------------------------------------------------------------------- 1995 - 1994 $ 3,011 10.2% - -------------------------------------------------------------------------------\nDirectory publishing revenues are earned primarily from local advertising and marketing services provided to businesses in White and Yellow Pages directories. Other directory publishing services include database and foreign directory marketing.\nGrowth in directory publishing revenues was due to higher rates charged for these services, as well as growth in advertising volumes. Changes in billing procedures and lower customer claims and disconnects further boosted directory publishing revenues in 1995.\nBell Atlantic - West Virginia, Inc.\nOTHER ANCILLARY SERVICES REVENUES\nDollars in Thousands (Decrease) - ------------------------------------------------------------------------------- 1995 - 1994 $ (2,671) (17.9)% - -------------------------------------------------------------------------------\nOther ancillary services include billing and collection services provided to IXCs and facilities rental services provided to affiliates and non-affiliates.\nOther ancillary services revenues decreased principally due to lower facilities rental revenues from affiliates and a reduction in billing and collection services revenues as a result of the elimination of certain services from a contract with an IXC.\nVALUE-ADDED SERVICES REVENUES\nDollars in Thousands Increase - ------------------------------------------------------------------------------- 1995 - 1994 $ 1,354 2.9% - -------------------------------------------------------------------------------\nValue-added services represent a family of services which expand the utilization of the network. These services include recent products such as voice messaging services, Caller ID and Return Call as well as more mature products such as Centrex, Touch-Tone, and customer premises wiring and maintenance services.\nContinued growth in the network customer base (access lines) and higher demand by customers for certain value-added central office and voice messaging services offered by the Company, including the introduction of Caller ID Deluxe in the fourth quarter of 1994, increased value-added services revenues in 1995. Partially offsetting this revenue growth was a reduction in contract billing for certain advanced premises services for large business customers. Such premises services, which were primarily performed by the Company until May 1994, are now contracted with another affiliate of Bell Atlantic.\nEMPLOYEE COSTS\nDollars in Thousands (Decrease) - ------------------------------------------------------------------------------- 1995 - 1994 $(16,847) (12.6)% - -------------------------------------------------------------------------------\nEmployee costs consist of salaries, wages and other employee compensation, employee benefits and payroll taxes paid directly by the Company. Similar costs incurred by employees of Bell Atlantic Network Services, Inc. (NSI), who provide centralized services on a contract basis, are allocated to the Company and are included in other operating expenses.\nThe decrease in employee costs was principally due to the effects of lower workforce levels in 1995 and a third quarter 1994 charge of $7,010,000 to recognize benefit costs, in accordance with Statement No. 112, for the separation of employees who are entitled to benefits under preexisting Bell Atlantic separation pay plans. Benefit costs associated with the separation of employees of NSI were allocated to the Company and included in other operating expenses. Decreased overtime pay and a reduction in pension and postretirement benefit costs further reduced employee costs in 1995. These cost\nBell Atlantic - West Virginia, Inc.\nreductions were partially offset by annual salary and wage increases and the recognition of certain contract labor and separation pay costs in 1995 associated with the contract settlement with the Communications Workers of America (CWA).\nThe Company's contract with the CWA, representing approximately 2,300 employees, expired on August 5, 1995. In January 1996, a tentative three-year labor agreement was reached, which was subsequently ratified in February 1996. The agreement includes a 10.6% wage increase over the three-year contract period, a ratification bonus, improved pensions and benefits, and certain employment security provisions.\nDEPRECIATION AND AMORTIZATION\nDollars in Thousands Increase - ------------------------------------------------------------------------------- 1995 - 1994 $12,649 11.8% - -------------------------------------------------------------------------------\nDepreciation and amortization increased due to growth in depreciable telephone plant and higher depreciation rates. The composite depreciation rates were 7.6% in 1995 and 7.0% in 1994.\nOTHER OPERATING EXPENSES\nDollars in Thousands Increase - ------------------------------------------------------------------------------- 1995 - 1994 $5,362 2.8% - -------------------------------------------------------------------------------\nOther operating expenses consist primarily of contract services including centralized services expenses allocated from NSI, rent, network software costs, operating taxes other than income, provision for uncollectible accounts receivable and other costs.\nThe increase in other operating expenses was attributable to higher centralized services costs allocated from NSI, primarily as a result of additional costs incurred in that organization to enhance systems, consolidate work activities and market value-added services at Bell Atlantic's network services subsidiaries. Higher rent expense and network software costs also contributed to the increase in other operating expenses in 1995.\nThese increases were partially offset by lower costs for contracted labor and engineering services and the effect of a third quarter 1994 charge for the Company's allocated share of separation benefit costs associated with employees of NSI.\nOTHER INCOME AND (EXPENSE), NET\nDollars in Thousands Increase - ------------------------------------------------------------------------------- 1995 - 1994 $435 - -------------------------------------------------------------------------------\nThe change in other income and (expense), net was attributable to additional interest income related to a note receivable from an affiliate and short-term investments. Lower non-operating costs in 1995 also contributed to the change in other income and (expense), net. These increases were partially offset by the elimination of the allowance for funds used during construction.\nUpon the discontinued application of regulatory accounting principles, effective August 1, 1994, the Company began recognizing capitalized interest costs as a reduction of interest expense. Previously, the Company recorded an allowance for funds used during construction as an item of other income.\nBell Atlantic - West Virginia, Inc.\nINTEREST EXPENSE\nDollars in Thousands (Decrease) - ------------------------------------------------------------------------------- 1995 - 1994 $(895) (4.8)% - -------------------------------------------------------------------------------\nInterest expense decreased principally due to the recognition of increased capitalized interest costs, subsequent to the discontinued application of regulatory accounting principles, effective August 1, 1994.\nPROVISION FOR INCOME TAXES\nDollars in Thousands (Decrease) - ------------------------------------------------------------------------------- 1995 - 1994 $(4,441) (7.7)% - -------------------------------------------------------------------------------\nEFFECTIVE INCOME TAX RATES\nFor the Years Ended December 31 - ------------------------------------------------------------------------------- 1995 39.5% - ------------------------------------------------------------------------------- 1994 40.5% - -------------------------------------------------------------------------------\nThe Company's effective income tax rate was lower in 1995 principally due to a decrease in state deferred tax expense related to the discontinued application of regulatory accounting principles in August 1994.\nA reconciliation of the statutory federal income tax rate to the effective income tax rate for each period is provided in Note 9 to the Financial Statements.\nFACTORS THAT MAY IMPACT FUTURE RESULTS - --------------------------------------\nFEDERAL LEGISLATION\nThe Telecommunications Act of 1996 (the Act), which became effective on February 8, 1996, is the most comprehensive revision of the federal communications laws in over 60 years. In general, the Act includes provisions that would open the Company's local exchange markets to competition and would permit local exchange carriers, such as the Company, upon meeting certain conditions, to provide interLATA services (long distance) and video programming and to engage in manufacturing.\nWith regard to the rules governing competition in the interLATA market, the Act takes a two-fold approach. Effective February 8, 1996, Bell Atlantic is permitted to apply for approval to offer interLATA services outside of the geographic region in which it currently operates as a local exchange carrier. Bell Atlantic has announced its plans to offer such services in several states.\nSecondly, within Bell Atlantic's geographic region, each of the telephone subsidiaries, including the Company, must demonstrate to the FCC that it has satisfied certain requirements in order to be permitted to offer interLATA services within its jurisdiction. Among the requirements with which the Company must comply is a 14-point \"competitive checklist\" which is aimed at ensuring that competitors have the ability to connect to the Company's network. The Company must also demonstrate to the FCC that its entry into the interLATA market would be in the public interest.\nThe Act also imposes specific requirements on the Company that are intended to promote competition in the local exchange markets. These requirements include the duty to: (i) provide interconnection to any other carrier for the transmission and routing of telephone exchange service and exchange access at any technically feasible point; (ii) provide unbundled access to network elements at any technically feasible point; (iii) provide retail services for resale at wholesale prices; (iv) establish reciprocal compensation arrangements for the origination and termination of telecommunications and (v) provide physical collocation.\nBell Atlantic - West Virginia, Inc.\nNo definitive prediction can be made as to the specific impact of the Act on the business or financial condition of the Company. The financial impact on the Company will be dependent on several factors, including the timing, extent and success of competition in the Company's market and the timing, extent and success of the Company's pursuit of new business opportunities resulting from the Act.\nCOMPETITION\nIntraLATA Toll Services\nCompetition to offer intrastate intraLATA toll services is currently permitted in the Company's jurisdiction. Increased competition from IXCs has resulted in a decline in several components of the Company's toll services revenues.\nCurrently, intraLATA toll calls are completed by the Company unless the customer dials a five-digit access code. Presubscription for intraLATA toll services would enable customers to make intraLATA toll calls using the carrier of their choice without having to dial the five-digit access code.\nIn general, the Act prohibits a state from requiring presubscription or \"dialing parity\" until the earlier of such time as an operating telephone company in the state is authorized to provide long distance services within the state or three years from the effective date of the Act. This prohibition does not apply to a final order requiring an operating telephone company to implement presubscription that was issued on or prior to December 19, 1995.\nDuring 1995, the Public Service Commission of West Virginia (PSC) conducted proceedings to determine whether, and under what conditions, to authorize presubscription. In October 1995, the PSC issued an order directing the implementation of presubscription within eighteen months of that order. The Company has filed an appeal with the West Virginia Supreme Court. Implementation of presubscription for intraLATA toll services could have a material negative impact on toll service revenues, especially if the Company is not permitted contemporaneously to offer interLATA services.\nLocal Exchange Services\nThe ability to offer local exchange services has historically been subject to regulation by the PSC. The Act is expected to significantly increase the level of competition in the Company's local exchange market. However, increased competition in the local exchange market will facilitate FCC approval of the Company's entry into the interLATA markets.\nOther\nSee Item 1 - Description of Business, Competition on pages 4 and 5 for additional information on the Company's competitive environment.\nOTHER STATE REGULATORY MATTERS\nThe communications services of the Company are subject to regulation by the PSC with respect to intrastate rates and services and certain other matters.\nSee Item 1 - Description of Business, State Regulation on page 4 for a description of the Company's current regulatory plan.\nBell Atlantic - West Virginia, Inc.\nOTHER MATTERS - -------------\nEnvironmental Issues\nThe Company is subject to a number of environmental proceedings as a result of its operations and the shared liability provisions in the Plan of Reorganization related to the Modification of Final Judgment. Certain of these environmental matters relate to a Superfund site for which the Company has received a request for information. The Company is also responsible for the remediation of sites with underground fuel storage tanks and other expenses associated with environmental compliance.\nThe Company continually monitors its operations with respect to potential environmental issues, including changes in legally mandated standards and remediation technologies. The Company's recorded liabilities reflect those specific situations where remediation activities are currently deemed to be probable and where the cost of remediation is estimable. Management believes that the aggregate amount of any additional potential liability would not have a material effect on the Company's results of operations or financial condition.\nFINANCIAL CONDITION - -------------------\nManagement believes that the Company has adequate internal and external resources available to meet ongoing operating requirements, including network expansion and modernization, and payment of dividends. Management expects that presently foreseeable capital requirements will be financed primarily through internally generated funds. Additional long-term debt may be needed to fund development activities and to maintain the Company's capital structure within management's guidelines.\nAs of December 31, 1995, the Company had $69,600,000 of an unused line of credit with an affiliate, Bell Atlantic Network Funding Corporation. In addition, the Company had $50,000,000 remaining under a shelf registration statement filed with the Securities and Exchange Commission for the issuance of unsecured debt securities.\nThe Company's debt ratio was 47.7% at December 31, 1995, compared to 45.4% at December 31, 1994.\nOn February 1, 1996, the Company declared and paid a cash dividend in the amount of $14,000,000 to Bell Atlantic.\nBell Atlantic - West Virginia, Inc.\nPART II\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe information required by this Item is set forth on pages through .\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.\nNone.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\n(Omitted pursuant to General Instruction J(2).)\nItem 11.","section_11":"Item 11. Executive Compensation\n(Omitted pursuant to General Instruction J(2).)\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\n(Omitted pursuant to General Instruction J(2).)\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\n(Omitted pursuant to General Instruction J(2).)\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(a) The following documents are filed as a part of this report:\n(1) Financial Statements\nSee Index to Financial Statements and Financial Statement Schedule appearing on page.\n(2) Financial Statement Schedule\nSee Index to Financial Statements and Financial Statement Schedule appearing on page.\nBell Atlantic - West Virginia, Inc.\nPART IV\nItem 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K (Continued)\n(3) Exhibits\nExhibits identified in parentheses below, on file with the Securities and Exchange Commission (SEC), are incorporated herein by reference as exhibits hereto.\nExhibit Number (Referenced to Item 601 of Regulation S-K) ---------------------------------------------------------\n3a Certificate of Incorporation of the registrant as amended July 30, 1975 (Exhibit 3a to the registrant's Annual Report on Form 10-K for the year ended December 31, 1985, File No. 1-7150.)\n3a(i) Articles of Amendment dated August 29, 1990 (Exhibit 3a(i) to the registrant's Annual Report on Form 10-K for the year ended December 31, 1990, File No. 1-7150.)\n3a(ii) Articles of Amendment, dated January 6, 1994 and filed January 13, 1994. (Exhibit 3a(ii) to the registrant's Annual Report on Form 10-K for the year ended December 31, 1993, File No. 1-7150.)\n3b By-Laws of the registrant, as amended December 15, 1995.\n3b(i) Consent of Sole Stockholder of Bell Atlantic - West Virginia, Inc., dated December 15, 1995.\n4 No instrument which defines the rights of holders of long and intermediate term debt of the registrant is filed herewith pursuant to Regulation S-K, Item 601(b)(4)(iii)(A). Pursuant to this regulation, the registrant hereby agrees to furnish a copy of any such instrument to the SEC upon request.\n10a Agreement Concerning Contingent Liabilities, Tax Matters and Termination of Certain Agreements among AT&T, Bell Atlantic Corporation, the Bell Atlantic Corporation telephone subsidiaries, and certain other parties, dated as of November 1, 1983. (Exhibit 10a to Bell Atlantic Corporation Annual Report on Form 10-K for the year ended December 31, 1993, File No. 1-8606.)\n10b Agreement among Bell Atlantic Network Services, Inc. and the Bell Atlantic Corporation telephone subsidiaries, dated November 7, 1983. (Exhibit 10b to Bell Atlantic Corporation Annual Report on Form 10-K for the year ended December 31, 1993, File No. 1-8606.)\n23 Consent of Independent Accountants.\n24 Powers of Attorney.\n27 Financial Data Schedule.\n(b) Reports on Form 8-K:\nThere were no Current Reports on Form 8-K filed during the quarter ended December 31, 1995.\nBell Atlantic - West Virginia, Inc.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nBell Atlantic - West Virginia, Inc.\nBy \/s\/ Ritchie A. Ireland, II ----------------------------- Ritchie A. Ireland, II Principal Financial Officer and Controller\nMarch 27, 1996\nPursuant to the requirements of the Securities Exchange Act 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:\nDennis M. Bone President and Chief Executive Officer\nPrincipal Financial Officer:\nRitchie A. Ireland, II Principal Financial Officer and Controller\nBy \/s\/ Ritchie A. Ireland, II ---------------------------- Directors: Ritchie A. Ireland, II Dennis M. Bone (individually and as David B. Frost attorney-in-fact) Ritchie A. Ireland, II March 27, 1996\nBell Atlantic - West Virginia, Inc.\nINDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE\nFinancial statement schedules other than that listed above have been omitted because such schedules are not required or applicable.\nBell Atlantic - West Virginia, Inc.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo The Board of Directors and Shareowner of Bell Atlantic - West Virginia, Inc.\nWe have audited the financial statements and the financial statement schedule of Bell Atlantic - West Virginia, Inc. as listed in the index on page of this Form 10-K. The financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Bell Atlantic - West Virginia, Inc. as of December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles. In addition, in our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information required to be included therein.\nAs discussed in Notes 1 and 2 to the financial statements, the Company discontinued accounting for its operations in accordance with Statement of Financial Accounting Standards No. 71, \"Accounting for the Effects of Certain Types of Regulation,\" effective August 1, 1994. Also, as discussed in Notes 1, 8 and 9 to the financial statements, the Company changed its method of accounting for income taxes and postemployment benefits in 1993.\n\/s\/ COOPERS & LYBRAND L.L.P.\n2400 Eleven Penn Center Philadelphia, Pennsylvania February 5, 1996\nBell Atlantic - West Virginia, Inc.\nSTATEMENTS OF OPERATIONS AND REINVESTED EARNINGS (ACCUMULATED DEFICIT) FOR THE YEARS ENDED DECEMBER 31 (DOLLARS IN THOUSANDS)\nSee Notes to Financial Statements.\nBell Atlantic - West Virginia, Inc.\nBALANCE SHEETS (DOLLARS IN THOUSANDS)\nASSETS ------\nSee Notes to Financial Statements.\nBell Atlantic - West Virginia, Inc.\nBALANCE SHEETS (DOLLARS IN THOUSANDS)\nLIABILITIES AND SHAREOWNER'S INVESTMENT ---------------------------------------\nSee Notes to Financial Statements.\nBell Atlantic - West Virginia, Inc.\nSTATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31 (DOLLARS IN THOUSANDS)\nSee Notes to Financial Statements.\nBell Atlantic - West Virginia, Inc.\nNOTES TO FINANCIAL STATEMENTS\n1. DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nDESCRIPTION OF BUSINESS\nBell Atlantic - West Virginia, Inc. (the Company) is a wholly owned subsidiary of Bell Atlantic Corporation (Bell Atlantic). The Company provides two basic types of telecommunications services in a territory consisting of two complete Local Access and Transport Areas (LATAs) and part of a third LATA in the state of West Virginia. First, the Company transports telecommunications traffic between subscribers located within the same LATA (intraLATA service), including both local and toll services. Local service includes the provision of local exchange, local private line and public telephone services. Toll service includes message toll services and intraLATA Wide Area Toll Service\/800 services. Second, the Company provides exchange access service, which links a subscriber's telephone equipment to the facilities of an interexchange carrier (IXC) which, in turn, provides telecommunications service between LATAs (interLATA service) to their customers. The Company also provides exchange access service to IXCs which provide intrastate intraLATA long distance telecommunications service. Other services provided by the Company include directory publishing, customer premises wiring and maintenance, and billing and collection services.\nThe Telecommunications Act of 1996 is the most comprehensive revision of the federal communications laws in over 60 years. In general, the Telecommunications Act includes provisions that would open the Company's local exchange markets to competition and would permit local exchange carriers, such as the Company, upon meeting certain conditions, to provide interLATA services (long distance) and video programming and to engage in manufacturing.\nBASIS OF PRESENTATION\nEffective August 1, 1994, the Company discontinued accounting for its operations under the provisions of Statement of Financial Accounting Standards No. 71, \"Accounting for the Effects of Certain Types of Regulation\" (Statement No. 71) (see Note 2).\nUSE OF ESTIMATES\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of revenues, expenses, assets, and liabilities and disclosure of contingencies. Actual results could differ from those estimates.\nREVENUE RECOGNITION\nRevenues are recognized as earned on the accrual basis, which is generally when services are rendered based on the usage of the Company's local exchange network and facilities.\nCASH AND CASH EQUIVALENTS\nThe Company considers all highly liquid investments with a maturity of 90 days or less when purchased to be cash equivalents. Cash equivalents are stated at cost, which approximates market value.\nSHORT-TERM INVESTMENTS\nShort-term investments consist of investments that mature 91 days to 12 months from the date of purchase. Short-term investments are stated at cost, which approximates market value.\nMATERIAL AND SUPPLIES\nNew and reusable materials are carried in inventory, principally at average original cost, except that specific costs are used in the case of large individual items.\nBell Atlantic - West Virginia, Inc.\nPREPAID DIRECTORY\nCosts of directory production and advertising sales are principally deferred until the directory is published. Such costs are amortized to expense and the related advertising revenues are recognized over the average life of the directory, which is generally 12 months.\nPLANT AND DEPRECIATION\nThe Company's provision for depreciation is based principally on the composite group remaining life method of depreciation and straight-line composite rates. This method provides for the recovery of the remaining net investment in telephone plant, less anticipated net salvage value, over the remaining asset lives. The composite group method requires periodic revisions to depreciation rates based on a number of variables, including retirement estimates, survivor curves, salvage, and cost of removal.\nIn connection with the discontinued application of Statement No. 71, effective August 1, 1994, for financial reporting purposes, the Company began using estimated asset lives for certain categories of plant and equipment that were shorter than those approved by regulators prior to the discontinuance of Statement No. 71. The shorter lives result principally from the Company's expectation as to the revenue-producing lives of the assets.\nThe following asset lives were used in 1994 and 1995:\nWhen depreciable plant is replaced or retired, the amounts at which such plant has been carried in plant, property and equipment are removed from the respective accounts and charged to accumulated depreciation, and any gains or losses on disposition are amortized over the remaining asset lives of the remaining net investment in telephone plant.\nMAINTENANCE AND REPAIRS\nThe cost of maintenance and repairs, including the cost of replacing minor items not constituting substantial betterments, is charged to operating expense.\nCAPITALIZED INTEREST COST\nUpon the discontinued application of Statement No. 71, effective August 1, 1994, the Company began reporting capitalized interest as a cost of telephone plant and equipment and a reduction in interest expense, in accordance with the provisions of Statement of Financial Accounting Standards No. 34, \"Capitalization of Interest Cost.\"\nPrior to the discontinued application of Statement No. 71, the Company recorded an allowance for funds used during construction, which included both interest and equity return components, as a cost of plant and as an item of other income.\nEMPLOYEE BENEFITS\nPensions, Postretirement Benefits Other Than Pensions, and Postemployment Benefits\nSubstantially all employees of the Company are covered under multi-employer noncontributory defined benefit pension plans and postretirement health and life insurance benefit plans sponsored by Bell Atlantic and certain of its subsidiaries, including the Company.\nBell Atlantic - West Virginia, Inc.\nAmounts contributed to the Company's pension plans are actuarially determined, principally under the aggregate cost actuarial method, and are subject to applicable federal income tax regulations. Amounts contributed to 501(c)(9) trusts and 401(h) accounts under applicable federal income tax regulations to pay certain postretirement benefits are actuarially determined, principally under the aggregate cost actuarial method.\nThe Company also provides employees with postemployment benefits such as disability benefits, workers' compensation, and severance pay. Effective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits.\"\nINCOME TAXES\nBell Atlantic and its domestic subsidiaries, including the Company, file a consolidated federal income tax return.\nEffective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (Statement No. 109).\nThe consolidated amount of current and deferred tax expense is allocated by applying the provisions of Statement No. 109 to each subsidiary as if it were a separate taxpayer.\nThe Tax Reform Act of 1986 repealed the investment tax credit (ITC) as of January 1, 1986, subject to certain transitional rules. ITCs were deferred and are being amortized as a reduction to income tax expense over the estimated service lives of the related assets.\nRECLASSIFICATIONS\nCertain reclassifications of prior years' data have been made to conform to 1995 classifications.\n2. DISCONTINUATION OF REGULATORY ACCOUNTING PRINCIPLES\nIn the third quarter of 1994, the Company determined that it was no longer eligible for continued application of the accounting required by Statement of Financial Accounting Standards No. 71, \"Accounting for the Effects of Certain Types of Regulation\" (Statement No. 71). In connection with the decision to discontinue regulatory accounting principles under Statement No. 71, the Company recorded a noncash, extraordinary charge of $76,616,000, which is net of an income tax benefit of $43,792,000.\nThe Company's determination that it was no longer eligible for continued application of the accounting required by Statement No. 71 was based on the belief that the convergence of competition, technological change, actual and potential regulatory, legislative and judicial actions, and other factors were creating fully open and competitive markets. In such markets, the Company does not believe it can be assured that prices can be maintained at levels that will recover the net carrying amount of existing telephone plant and equipment, which has been depreciated over relatively long regulator-prescribed lives. In addition, changes from cost-based regulation to a form of incentive regulation contributed to the determination that the continued application of Statement No. 71 was inappropriate.\nA summary of the components of the after-tax charge recognized as a result of the discontinued application of Statement No. 71 follows:\nBell Atlantic - West Virginia, Inc.\nThe increase in the accumulated depreciation reserve was supported by both an impairment analysis, which identified estimated amounts not recoverable from future discounted cash flows, and a depreciation study, which identified inadequate depreciation reserve levels which the Company believes resulted principally from the cumulative underdepreciation of plant as a result of the regulatory process. Investment tax credit amortization was accelerated as a result of the reduction in remaining asset lives of the associated telephone plant and equipment.\nTax-related regulatory assets of $53,617,000 and tax-related regulatory liabilities of $43,243,000, which were established upon the adoption of Statement No. 109 and amortized as the related deferred taxes were recognized in the ratemaking process, were eliminated (see Note 9). The elimination of other regulatory assets and liabilities relates principally to deferred vacation pay costs, which were being amortized as they were recognized in the ratemaking process.\n3. PLANT, PROPERTY AND EQUIPMENT\nPlant, property and equipment, which is stated at cost, is summarized as follows at December 31:\nCertain prior year amounts previously included in Construction-in-progress have been reclassified to Other to conform to 1995 classifications.\n4. LEASES\nThe Company leases certain facilities and equipment for use in its operations under both capital and operating leases. Plant, property and equipment included capital leases of $65,000 and $99,000, and related accumulated amortization of $59,000 and $75,000 at December 31, 1995 and 1994, respectively. The Company incurred no initial capital lease obligations in 1995, 1994 and 1993.\nTotal rent expense amounted to $20,781,000 in 1995, $19,878,000 in 1994 and $23,207,000 in 1993. Of these amounts, $9,149,000, $9,593,000 and $10,332,000 in 1995, 1994 and 1993, respectively, were lease payments to affiliated companies.\nBell Atlantic - West Virginia, Inc.\nAt December 31, 1995, the aggregate minimum rental commitments under noncancelable leases for the periods shown are as follows:\n5. DEBT\nDEBT MATURING WITHIN ONE YEAR\nLong-term debt maturing within one year was $10,000 and $27,000 at December 31, 1995 and 1994, respectively.\nThe Company has a contractual agreement with an affiliated company, Bell Atlantic Network Funding Corporation (BANFC), for the provision of short-term financing and cash management services. BANFC issues commercial paper and secures bank loans to fund the working capital requirements of Bell Atlantic's network services subsidiaries, including the Company, and invests funds in temporary investments on their behalf. At December 31, 1995 and 1994, there was no outstanding Note payable balance with BANFC. At December 31, 1995, the Company had $69,600,000 of an unused line of credit with BANFC.\nLONG-TERM DEBT\nLong-term debt consists principally of debentures issued by the Company. Interest rates and maturities of the amounts outstanding are as follows at December 31:\nBell Atlantic - West Virginia, Inc.\nLong-term debt outstanding at December 31, 1995 includes $115,000,000 that is callable by the Company. The call prices of these debentures range from 102.5% to 100.0% of face value, depending upon the remaining term to maturity of the issue. In addition, $50,000,000 of long-term debt, bearing interest at 8.4%, will become redeemable only on October 15, 1996 at the option of the holders. The redemption price will be 100.0% of face value, plus accrued interest.\nThe Company recorded an extraordinary charge associated with the early extinguishment of debentures called by the Company of $1,456,000, net of an income tax benefit of $969,000 in 1993.\nAt December 31, 1995 the Company had $50,000,000 remaining under a shelf registration statement filed with the Securities and Exchange Commission.\n6. FINANCIAL INSTRUMENTS\nCONCENTRATIONS OF CREDIT RISK\nFinancial instruments that subject the Company to concentrations of credit risk consist primarily of trade receivables and a note receivable from affiliate.\nConcentrations of credit risk with respect to trade receivables other than those from AT&T are limited due to the large number of customers in the Company's customer base. For the years ended December 31, 1995, 1994 and 1993, revenues generated from services provided to AT&T, primarily network access and billing and collection, were $72,512,000, $78,455,000 and $79,506,000, respectively. At December 31, 1995 and 1994, Accounts receivable, net, included $3,910,000 and $6,382,000, respectively, from AT&T.\nFAIR VALUE OF FINANCIAL INSTRUMENTS\nThe following methods and assumptions were used to estimate the fair value of each class of financial instruments.\nNote Receivable from Affiliate (BANFC)\nThe carrying amount approximates fair value.\nDebt\nFair value is estimated based on the quoted market prices for the same or similar issues or on the net present value of the expected future cash flows using current interest rates.\nThe estimated fair values of the Company's financial instruments are as follows:\n* Debt includes Long-term debt and Debt maturing within one year, but excludes capital lease obligations and unamortized discount and premium.\nBell Atlantic - West Virginia, Inc.\n7. SHAREOWNER'S INVESTMENT\nThe Company has reclassified $36,417,000 previously reported for common stock to capital surplus to conform to the classification adopted at December 31, 1994.\nOn January 31, 1995, the Board of Directors of the Company approved a transfer in the amount of $40,000,000 from stated capital, as represented by the Company's one issued share of common stock without par value, to capital surplus.\nOn February 1, 1996, the Company declared and paid a cash dividend in the amount of $14,000,000 to Bell Atlantic.\n8. EMPLOYEE BENEFITS\nPENSION PLANS\nSubstantially all of the Company's management and associate employees are covered under multi-employer noncontributory defined benefit pension plans sponsored by Bell Atlantic and certain of its subsidiaries, including the Company. The pension benefit formula is based on a flat dollar amount per year of service according to job classification under the associate plan. The pension benefit formula for plans covering management employees in 1995 and prior years is based on a stated percentage of adjusted career average earnings. The Company's objective in funding these plans is to accumulate funds at a relatively stable level over participants' working lives so that benefits are fully funded at retirement. Plan assets consist principally of investments in domestic and foreign corporate equity securities, U.S. and foreign government and corporate debt securities, and real estate.\nEffective January 1, 1996, the plan covering management employees was converted to a cash balance plan. Under the cash balance plan, pension benefits are determined by a combination of compensation credits based on age and service and individual account-based interest credits. Each management employee's opening account balance is based on accrued pension benefits as of December 31, 1995, and converted to a lump-sum amount determined under the prior plan's\nBell Atlantic - West Virginia, Inc.\nprovisions. The lump-sum value is multiplied by a transition factor, based on age and service, to arrive at the opening balance.\nPension cost was $1,411,000, $4,569,000 and $3,886,000 for the years ended December 31, 1995, 1994 and 1993, respectively. The reduction in 1995 pension cost is principally due to an increase in the discount rate from 7.25% at December 31, 1993 to 8.25% at December 31, 1994, and plan changes.\nStatement of Financial Accounting Standards No. 87, \"Employers' Accounting for Pensions\" (Statement No. 87) requires a comparison of the actuarial present value of projected benefit obligations with the fair value of plan assets, the disclosure of the components of net periodic pension costs and a reconciliation of the funded status of the plans with amounts recorded on the balance sheets. The Company participates in multi-employer plans and therefore, such disclosures are not presented for the Company because the structure of the plans does not allow for the determination of this information on an individual participating company basis.\nThe significant assumptions used for the pension measurements were as follows at December 31:\nThe expected long-term rate of return on plan assets was 8.25% for 1995, 1994 and 1993.\nPension benefits for associate employees are subject to collective bargaining. Modifications in pension benefits have been bargained from time to time. Additionally, the Company has amended the benefit formula under pension plans maintained for its management employees. Substantive commitments for future amendments to the Company's pension plans have been reflected in determining the Company's pension cost. The actuarial assumptions used to determine pension cost are based on financial market interest rates, past experience, and management's best estimate of future benefit changes and economic conditions. Changes in these assumptions may impact future pension cost levels and benefit obligations.\nPOSTRETIREMENT BENEFITS OTHER THAN PENSIONS\nSubstantially all of the Company's management and associate employees are covered under postretirement health and life insurance benefit plans sponsored by Bell Atlantic and certain of its subsidiaries, including the Company. The determination of benefit cost for postretirement health benefit plans is based on comprehensive medical and dental benefit plan provisions. The postretirement life insurance benefit formula used in the determination of postretirement benefit cost is primarily based on annual basic pay at retirement. The Company funds the postretirement health and life insurance benefits of current and future retirees. Plan assets consist principally of investments in domestic and foreign corporate equity securities, and U.S. Government and corporate debt securities.\nPostretirement benefit cost was $7,798,000, $11,114,000 and $11,396,000 for the years ended December 31, 1995, 1994 and 1993, respectively. Postretirement benefit cost decreased in 1995 principally as a result of an increase in the discount rate from 7.25% at December 31, 1993 to 8.25% at December 31, 1994, and the effect of favorable plan experience.\nStatement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" (Statement No. 106) requires a comparison of the actuarial present value of projected postretirement benefit obligations with the fair value of plan assets, the disclosure of the components of net periodic postretirement benefit costs, a reconciliation of the funded status of the plan with amounts recorded on the balance sheets and the effect of a one-percentage-point increase in the assumed health care cost trend rates for each future year on net periodic postretirement benefit cost and the accumulated postretirement benefit obligation. The Company participates in multi-employer plans and therefore, such disclosures are not presented for the Company because the structure of the plans does not provide for the determination of this information on an individual participating company basis.\nBell Atlantic - West Virginia, Inc.\nAssumptions used in the actuarial computations for postretirement benefits are as follows at December 31:\nThe expected long-term rate of return on plan assets was 8.25% for 1995, 1994 and 1993.\nPostretirement benefits other than pensions for associate employees are subject to collective bargaining agreements and have been modified from time to time. The Company has also periodically modified benefits under plans maintained for its management employees. Substantive commitments for future amendments to the Company's postretirement benefit plans have been reflected in determining the Company's postretirement benefit cost. The actuarial assumptions used to determine postretirement benefit cost are based on financial market interest rates, past experience, and management's best estimate of future benefit changes and economic conditions. Changes in these assumptions may impact future postretirement benefit cost levels and benefit obligations.\nPOSTEMPLOYMENT BENEFITS\nEffective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits\" (Statement No. 112). The cumulative effect at January 1, 1993 of adopting Statement No. 112 reduced net income by $7,397,000, net of a deferred income tax benefit of $4,919,000.\nIn the third quarter of 1994, the Company recorded a pretax charge of $8,605,000 to recognize the Company's proportionate share of benefit costs for the separation of employees who are entitled to benefits under preexisting Bell Atlantic separation pay plans. The charge, which was actuarially determined, represents benefits earned through July 1, 1994 for employees who are expected to receive separation payments in the future.\nSAVINGS PLANS AND EMPLOYEE STOCK OWNERSHIP PLANS\nSubstantially all of the Company's employees are eligible to participate in savings plans established by Bell Atlantic to provide opportunities for eligible employees to save for retirement on a tax-deferred basis and encourage employees to acquire and maintain an equity interest in Bell Atlantic. Under these plans, a certain percentage of eligible employee contributions are matched with shares of Bell Atlantic common stock. Bell Atlantic funds the matching contribution through two leveraged employee stock ownership plans (ESOPs). Bell Atlantic accounts for its ESOPs in accordance with the accounting rules applicable to companies with ESOP trusts that held securities prior to December 15, 1989. The Company recognizes its proportionate share of total ESOP cost based on the Company's matching obligation attributable to participating Company employees. The Company recorded total ESOP cost of $2,757,000, $2,271,000, and $2,097,000, in 1995, 1994 and 1993, respectively.\nBell Atlantic - West Virginia, Inc.\n9. INCOME TAXES\nEffective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (Statement No. 109).\nAs of January 1, 1993, the Company recorded a charge to income of $173,000, representing the cumulative effect of adopting Statement No. 109, which has been reflected in the Provision for Income Taxes in the Statement of Operations and Reinvested Earnings (Accumulated Deficit).\nUpon adoption of Statement No. 109, the effects of required adjustments to deferred tax balances of the Company, which would be recognized in the future for regulatory purposes, were deferred on the balance sheet as regulatory assets and liabilities in accordance with Statement No. 71. At January 1, 1993, the Company recorded income tax-related regulatory assets totaling $43,899,000 in Other Assets and income tax-related regulatory liabilities totaling $48,460,000 in Deferred Credits and Other Liabilities - Other. During 1993, these regulatory assets were increased by $1,483,000 and regulatory liabilities were reduced by $4,379,000 for the effect of the federal income tax rate increase from 34% to 35%, effective January 1, 1993.\nThe income tax-related regulatory assets and liabilities were eliminated as a result of the discontinued application of Statement No. 71, effective August 1, 1994 (see Note 2).\nThe components of income tax expense are as follows:\nAs a result of the increase in the federal corporate income tax rate from 34% to 35%, effective January 1, 1993, the Company recorded a net charge to the tax provision of $212,000 in 1993.\nThe provision for income taxes varies from the amount computed by applying the statutory federal income tax rate to income before provision for income taxes. The difference is attributable to the following factors:\nBell Atlantic - West Virginia, Inc.\nSignificant components of deferred tax liabilities (assets) were as follows at December 31:\nTotal deferred tax assets include approximately $56,000,000 and $54,000,000 at December 31, 1995 and 1994, respectively, related to postretirement benefit costs recognized in accordance with Statement No. 106. This deferred tax asset will gradually be realized over the estimated lives of current retirees and employees.\n10. ADDITIONAL FINANCIAL INFORMATION\nInterest paid during the year includes $75,000 in 1995, $242,000 in 1994 and $847,000 in 1993 related to short-term financing services provided by Bell Atlantic Network Funding Corporation (see Note 5).\nBell Atlantic - West Virginia, Inc.\nAt December 31, 1995 and 1994, $6,318,000 and $4,167,000, respectively, of negative cash was classified as accounts payable.\nTotal advertising expense amounted to $3,226,000 in 1995, $3,357,000 in 1994 and $2,697,000 in 1993. Of these amounts, $2,788,000, $2,862,000 and $2,072,000 in 1995, 1994 and 1993, respectively, were advertising expenses allocated to the Company by Bell Atlantic Network Services, Inc. (NSI).\n11. TRANSACTIONS WITH AFFILIATES\nThe financial statements include transactions with NSI, Bell Atlantic Network Funding Corporation (BANFC), Bell Atlantic, and various other affiliates.\nThe Company has contractual arrangements with NSI for the provision of various centralized corporate, administrative, planning, financial and other services. These arrangements serve to fulfill the common needs of Bell Atlantic's operating telephone subsidiaries on a centralized basis. The Company's allocated share of NSI costs include costs billed by Bell Communications Research, Inc. (Bellcore), another affiliated company owned jointly by the seven regional holding companies.\nThe Company recognizes interest expense and income in connection with contractual arrangements with BANFC to provide short-term financing, investing and cash management services to the Company (see Note 5).\nOperating revenues include amounts from affiliates in connection with an interstate revenue sharing arrangement with Bell Atlantic's operating telephone subsidiaries. Operating revenues and expenses also include miscellaneous items of income and expense resulting from transactions with other affiliates, primarily rental of facilities and equipment. The Company also paid cash dividends and made distributions of capital surplus to its parent company, Bell Atlantic.\nTransactions with affiliates are summarized as follows:\nOutstanding balances with affiliates are reported on the Balance Sheets at December 31, 1995 and 1994 as Note receivable from affiliate, Accounts receivable - affiliates, and Accounts payable and accrued liabilities - affiliates.\nIn 1994, NSI operating expenses included $1,595,000, representing the Company's proportionate share of separation benefit costs for employees of NSI. Bellcore expenses in 1994 included reimbursements of $2,472,000 from other Bellcore owners in connection with their decision to participate in the Advanced Intelligent Network project. This\nBell Atlantic - West Virginia, Inc.\nproject previously had been supported entirely by Bell Atlantic's operating telephone subsidiaries, including the Company.\nIn 1993, the Company's reported charge for the cumulative effect of the change in accounting for postemployment benefits included $377,000, net of a deferred income tax benefit of $251,000, representing the Company's proportionate share of NSI's accrued cost of postemployment benefits at January 1, 1993.\n12. QUARTERLY FINANCIAL INFORMATION (unaudited)\n* The loss for the third quarter of 1994 includes an extraordinary charge of $76,616,000, net of an income tax benefit of $43,792,000, related to the discontinuation of regulatory accounting principles (see Note 2).\nBell Atlantic - West Virginia, Inc.\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (DOLLARS IN THOUSANDS)\n- ------------------------------------------\n(a) (i) Amounts previously written off which were credited directly to this account when recovered; and (ii) accruals charged to accounts payable for anticipated uncollectible charges on purchases of accounts receivable from others which were billed by the Company.\n(b) Amounts written off as uncollectible.\nEXHIBITS\nFILED WITH ANNUAL REPORT FORM 10-K\nUNDER THE SECURITIES EXCHANGE ACT OF 1934\nFOR THE FISCAL YEAR ENDED DECEMBER 31, 1995\nBell Atlantic - West Virginia, Inc.\nCOMMISSION FILE NUMBER 1-7150\nForm 10-K for 1995 File No. 1-7150 Page 1 of 1\nEXHIBIT INDEX\nExhibits identified in parentheses below, on file with the SEC, are incorporated herein by reference as exhibits hereto.\nExhibit Number (Referenced to Item 601 of Regulation S-K) ---------------------------------------------------------\n3a Certificate of Incorporation of the registrant as amended July 30, 1975. (Exhibit 3a to the registrant's Annual Report on Form 10-K for the year ended December 31, 1985, File No. 1-7150.)\n3a(i) Articles of Amendment dated August 29, 1990. (Exhibit 3a(i) to the registrant's Annual Report on Form 10-K for the year ended December 31, 1990, File No. 1-7150.)\n3a(ii) Articles of Amendment, dated January 6, 1994 and filed January 13, 1994. (Exhibit 3a(ii) to the registrant's Annual Report on Form 10-K for the year ended December 31, 1993, File No. 1- 7150.)\n3b By-Laws of the registrant, as amended December 15, 1995.\n3b(i) Consent of Sole Stockholder of Bell Atlantic-West Virginia, Inc., dated December 15, 1995.\n4 No instrument which defines the rights of holders of long and intermediate term debt of the registrant is filed herewith pursuant to Regulation S-K, Item 601(b)(4)(iii)(A). Pursuant to this regulation, the registrant hereby agrees to furnish a copy of any such instrument to the SEC upon request.\n10a Agreement Concerning Contingent Liabilities, Tax Matters and Termination of Certain Agreements among AT&T, Bell Atlantic Corporation, the Bell Atlantic Corporation telephone subsidiaries, and certain other parties, dated as of November 1, 1983. (Exhibit 10a to Bell Atlantic Corporation Annual Report on Form 10-K for the year ended December 31, 1993, File No. 1-8606.)\n10b Agreement among Bell Atlantic Network Services, Inc. and the Bell Atlantic Corporation telephone subsidiaries, dated November 7, 1983. (Exhibit 10b to Bell Atlantic Corporation Annual Report on Form 10-K for the year ended December 31, 1993, File No. 1-8606.)\n23 Consent of Independent Accountants.\n24 Powers of Attorney.\n27 Financial Data Schedule.","section_15":""}
{"filename":"809938_1995.txt","cik":"809938","year":"1995","section_1":"Item 1. Business\nLMR Land Company, Ltd. (\"Registrant\"), is a Tennessee limited partnership organized on December 22, 1986, pursuant to the provisions of the Tennessee Uniform Limited Partnership Act, Chapter 2, Title 61, Tennessee Code Annotated, as amended. The General Partner of Registrant is 222 LMR, Ltd.\nRegistrant's primary business is to acquire, own, and hold for investment certain undeveloped real properties located in Lebanon, Tennessee; Macon, Georgia; and Roanoke, Virginia (collectively, the \"Property\"). Registrant's investment objectives are preservation of investment capital and appreciation of the value of the Property due to development of the surrounding areas and the completion of improvements to the Properties prior to resale.\nFinancial Information About Segment\nThe Registrant's activity, investment in land, lies within the domestic United States and is within one industry segment. Therefore, financial data relating to the geographic area and industry segment is included in Item 6 - Selected Financial Data.\nNarrative Description of Business\nAt December 31, 1995, the Registrant is holding for investment approximately 50 acres of land in Lebanon, Tennessee (the \"Lebanon Property\") and 114 acres of land in Macon, Georgia (the \"Macon Property\").\nLebanon\nThe Lebanon Property consists of a 48 acre tract of land zoned for medium density residential and professional offices. The property is served by all public utilities. This type of zoning permits a wide variety of uses. The Lebanon Property is included in the Castle Heights Development and is contiguous to Property owned by an affiliate sharing a related General Partner. In 1994, the City of Lebanon agreed to extend a road through the Registrant's property. The road is expected to be complete by mid-year 1996.\nThe Lebanon Property continues to have minimal competition in the city. There has been some residential development on the outer edges of the city, but there is no other mixed-use development in the city. The affiliated Partnership contiguous to the Lebanon Property owns building and the land immediately around the buildings and therefore does not compete with the Registrant for undeveloped land sales.\nMacon\nThe Macon property consists of 114 acres at December 31, 1995. The property is located at the intersection of Eisenhower Parkway and Log Cabin Road southwest of downtown Macon. The property is zoned for retail, service center and service warehouse type uses. The property is served by municipal gas, electricity, water and sewer. No development has occurred on the Property. The Registrant has accepted a contract from a developer for all of the Macon property. The Registrant has received $100,000 in earnest money deposits as of December 31, 1995. The contract, for $50,000 an acre, is due to expire in March 1996 and the developer has asked for another extension. This contract is subject to contingencies. There can be no assurances that the contingencies will be met and the sale will close.\nThe Registrant has no employees. Program management services are being provided under a contractual agreement with Landmark Realty Services Corporation, an affiliate of the General Partner.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nAs of December 31, 1995, Registrant owned approximately 162 acres of undeveloped land. For further information concerning the Property, reference is made to the material in Item 1.\nItem 3.","section_3":"Item 3. Legal Proceedings\nRegistrant is not a party to, nor is any of Registrant's property the subject of, any material legal proceedings.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nThe security holders of Registrant did not vote on any matter during the fiscal year covered by this report.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Units of Limited Partnership Interest and Related Security Holder Matters\nThere is no established market for the Units and it is not anticipated that any will exist in the future. The Registrant commenced an offering to the public on April 1, 1987 of 7,500 Units of Limited Partnership Interests. The offering of $7,500,000 was fully subscribed and closed on June 8, 1987. As of February 29, 1996 there were 614 holders of record of the 7,500 Units of Limited Partnership Interests.\nThere were no cash distributions to the Limited Partners during 1995. There are no material restrictions upon Registrant's present or future ability to make distributions in accordance with the provisions of Registrant's Limited Partnership Agreement.\nItem 6.","section_6":"Item 6. Selected Financial Data\nFor the Year ended December 31,\n1995 1994 1993 1992 1991 Total Income $57,641 $76,055 $46,443 $269,614 $209,493 Net Earnings(Loss) (47,591) (32,783) (90,024) 128,165 67,286 Net Earnings(Loss) (6.35) (4.37) (12.00) 17.09 8.97 per unit Total Assets 4,499,958 4,501,627 4,504,976 5,445,499 6,533,028 Cash Distributions - - 120 160 30 per unit\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nResults of Operations\n1995 Sales\nThere were no sales during 1995. In May 1995, the Registrant received a $30,722 refund of excess construction escrow funds related to the 1993 sale of the Roanoke property. The deposit was recorded as miscellaneous income.\nThe Registrant accepted a contract for the entire Macon property in 1994 and continues to work with the developer on this contract. As of December 31, 1995, the Registrant had received a total of $100,000 in non- refundable earnest money for the Macon contract. There are several contingencies for this sales to close. There can be no assurance that the contingencies will be met and the sale will close. A contract for 14 acres of the Lebanon Property expired due to development plans not receiving required city government approval.\n1994 Sales\nDuring 1994, the Registrant sold approximately one acre of the Lebanon property for gross proceeds of $45,714. These proceeds were reserved to meet operating costs. The Registrant also received $18,000 in additional sale proceeds from the Kroger sale in 1993. This late receipt was the remaining balance in a construction escrow set up at the date of sale in 1993.\n1995 Versus 1994\nThere have been no significant changes in the Registrant's operations. The increase in interest income is due to higher cash balances.\n1994 Versus 1993\nThe change in sales is due to the difference in number of acres sold in 1994 and 1993. One acre was sold in 1994 for gross proceeds of $63,714 as compared to 22 acres in 1993 for gross proceeds of $1,515,372. The decline in property maintenance costs is due to the lack of development on the Lebanon Property and the minimal sales activity during the year. Property tax expense is lower due to a reduction in Lebanon taxes.\nFinancial Condition\nDevelopment\nDuring 1994, the City of Lebanon agreed to extend a road through the Registrant's Property. Although the city has agreed to fund the construction, the Registrant was asked to fund a $20,000 bond securing the contractor. The General Partner expects the return of these bond proceeds upon completion of the work. As of December 31, 1995, work had begun on this road and it is expected to be finished mid-year 1996.\nLiquidity & Capital Resources\nAs of December 31, 1995 the Registrant had a cash balance of $484,893. This level is expected to be sufficient to cover operating expenses for 1996. The receivable from an affiliated party totalling $40,628 at December 31, 1995 consists of shared development expenses incurred on the Lebanon property. The Registrant collected $1,848 of the receivable in 1995. The Registrant will collect this receivable in partial payments as the affiliate sells land.\nIn March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121 Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed of (Statement 121). It requires that long-lived assets that are to be disposed of be reported at the lower of carrying amount or fair value less costs to sell. If quoted prices are not available, the estimated fair value is determined using the best information available. After implementation, any material impairments must be recorded to reflect an excess of the carrying amount over the estimated fair value.\nStatement 121 is applicable for fiscal years beginning after December 15, 1995, and it will be implemented by the Registrant effective January 1, 1996. Implementation of Statement 121 is not expected to have a material impact on the financial statements of the Registrant.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe Financial Statements required by Item 8 are filed at the end of this Report.\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\nRegistrant does not have any directors or officers. 222 LMR, Ltd. is the General Partner. 222 Partners, Inc. is the general partner of the General Partner and as such has general responsibility and ultimate authority in matters affecting Registrant's business.\n222 Partners Inc.\n222 Partners, Inc. was formed in September, 1986, and serves as co-general partner for several other real estate investment limited partnerships. Steven D. Ezell is the president and sole shareholder of 222 Partners, Inc. The directors of 222 Partners, Inc. are W. Gerald Ezell, Steven D. Ezell and Michael A. Hartley. The directors of 222 Partners, Inc. are elected by the shareholder to serve one year or until their successors are elected and qualified. All officers are elected by the Board of Directors and serve until their successors are elected and qualified.\nThe officers and directors of 222 Partners, Inc. are as follows:\nW. Gerald Ezell\nW. Gerald Ezell, age 65, serves on the Board of Directors of 222 Partners, Inc. Mr. Ezell is also a general partner of affiliated limited partnerships which own various real estate properties. Until November, 1985, Mr. Ezell had been for over 20 years an agency manager for Fidelity Mutual Life Insurance Company and a registered securities principal of Capital Analysts Incorporated, a wholly owned subsidiary of Fidelity Mutual Life Insurance Company.\nSteven D. Ezell\nSteven D. Ezell, age 43, is the President and sole shareholder of 222 Partners, Inc. He has been an officer of 222 Partners, Inc. from September 17, 1986 through the current period. Mr. Ezell is President and 50% owner of Landmark Realty Services Corporation. He was for the prior four years involved in property acquisitions for Dean Witter Realty Inc. in New York City, most recently as Senior Vice President. Steven D. Ezell is the son of W. Gerald Ezell.\nMichael A. Hartley\nMichael A. Hartley, age 36, is Secretary\/Treasurer and a Vice President of 222 Partners, Inc. He has been an officer of 222 Partners, Inc. from September 17, 1986 through the current period. Mr. Hartley is Vice President and 50% owner of Landmark Realty Services Corporation. Prior to joining Landmark in 1986, Mr. Hartley was Vice President of Dean Witter Realty Inc., a New York-based real estate investment firm.\nItem 11.","section_11":"Item 11. Executive Compensation\nDuring 1995, Registrant was not required to and did not pay remuneration to any executives, partners of the General Partner or any affiliates, except as set forth in Item 13 of this report, \"Certain Relationships and Related Transactions.\"\nThe General Partner does participate in the profits, losses and distributions of the Registrant as set forth in the Partnership Agreement.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nAs of February 29, 1996, no person or \"group\" (as that term is used in Section 13(d)(3) of the Securities Exchange Act of 1934) was known by the Registrant to beneficially own more than five percent of the Units of Registrant.\nAs of the above date, the Registrant knew of no officers or directors of 222 Partners, Inc. that beneficially owned any of the Units of the Registrant.\nThere are no arrangements known by the Registrant, the operation of 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\nNo affiliated entities have, for the year ending December 31, 1995, earned or received compensation or payments for services from the Registrant in excess of $60,000. For a listing of miscellaneous transactions with affiliates which were less than $60,000 refer to Note 3 to Financial Statements in Item 8.\nThe Registrant has incurred costs on behalf of an affiliated partnership. The costs represent development work done on the Lebanon Property and the adjacent land owned by Castle Heights, Ltd, an affiliate. The costs are reflected in the Financial Statements of the Registrant as Accounts Receivable from Affiliate. See Item 8 - Financial Statements and Notes thereto for more information.\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 included herein:\nIndependent Auditors' Report\nFinancial Statements Balance Sheets Statements of Operations Statements of Partners' Equity Statements of Cash Flows Notes to Financial Statements\n(2) Financial Statement Schedule\nIndependent Auditors' Report on Schedule S-1\nSchedule XI- Real Estate and Accumulated Depreciation S-2\n(3) Exhibits\n3 Amended and Restated Certificate and Agreement of Limited Partnership, incorporated by reference to Exhibit A to the Prospectus of Registrant dated April 1, 1987 filed pursuant to Rule 424(b) of the Securities and Exchange Commission.\n22 Subsidiaries-Registrant has no subsidiaries.\n27 Financial Data Schedule\n(b) No reports on Form 8-K have been filed during the last quarter of 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.\nLMR LAND COMPANY, LTD.\nBy: 222 LMR, Ltd. General Partner\nBy: 222 Partners, Inc. General Partner\nDATE: March 30, 1996 By: \/s\/ Steven D. Ezell President and Director\nDATE: March 30, 1996 By: \/s\/ Michael A. Hartley Secretary\/Treasurer\nSIGNATURES (Cont'd.)\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nLMR LAND COMPANY, LTD.\nBy: 222 LMR, Ltd. General Partner\nBy: 222 Partners, Inc. General Partner\nDATE: March 30, 1996 By: \/s\/ Steven D. Ezell President and Director\nDATE: March 30, 1996 By: \/s\/ Michael A. Hartley Secretary\/Treasurer\nSupplemental Information to be Furnished with Reports filed Pursuant to Section 15(d) of the Act by Registrant Which Have Not Registered Securities Pursuant to Section 12 of the Act:\nNo annual report or proxy material has been sent to security holders.\nIndependent Auditors' Report\nThe Partners LMR Land Company, Ltd.:\nWe have audited the accompanying balance sheets of LMR Land Company, Ltd. (a limited partnership) as of December 31, 1995 and 1994, and the related statements of operations, partners' equity, and cash flows for each of the years in the three-year period ended December 31, 1995. 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 LMR Land Company, Ltd. at December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 1995, in conformity with generally accepted accounting principles.\nAs discussed in Note 6, the Partnership adopted in 1995 the provisions of Statement of Financial Accounting Standards No. 107, Disclosures about Fair Value of Financial Instruments.\nKPMG Peat Marwick LLP\nNashville, Tennessee January 19, 1996\nLMR LAND COMPANY, LTD. (A Limited Partnership)\nBalance Sheets\nDecember 31, 1995 and 1994\nAssets 1995 1994 ______ _____ ______\nCash and cash equivalents $ 484,893 484,714 Receivable from affiliate 40,628 42,476 (note 3) Land held for investment 3,974,437 3,974,437 (note 2) ________ ________ Total assets $4,499,958 4,501,627 ======== ========\nLiabilities and Partners' Equity\nLiabilities: Accounts payable (note 3) 15,078 13,949 Accrued property taxes 20,278 52,985 Deposits on land sale contracts (note 2) 100,000 22,500 ________ ________ Total liabilities 135,356 89,434\nPartners' equity 4,364,602 4,412,193 ________ ________ Commitments and contingencies (notes 2 and 3)\nTotal liabilities and partners' equity $4,499,958 4,501,627 ========= ========\nSee accompanying notes to financial statements.\nLMR LAND COMPANY, LTD. (A Limited Partnership)\nStatements of Operations\nYears ended December 31, 1995, 1994 and 1993\n1995 1994 1993\nIncome: Sales proceeds $ - 63,714 1,515,372 Cost of land sold - (12,785) (1,377,154) Selling expenses - (2,611) (98,753) ________ ________ _______ Gain on sale of land - 48,318 39,465\nInterest 26,669 17,737 6,728 Return of escrow funds 30,722 - - Miscellaneous income 250 - 250 Expired land purchase - 10,000 - option ________ ________ _______ Total income 57,641 76,055 46,443\nExpenses: Program management fees and property maintenance costs (note 3) 33,453 36,992 57,333 Property tax expense 51,899 53,459 63,353 Legal and accounting fees (note 3) 16,756 15,467 11,130 Other operating expenses 3,124 2,920 4,651 ________ ________ _______ Total expenses 105,232 108,838 136,467 ________ ________ _______ Net loss $(47,591) (32,783) (90,024) ======== ======== =======\nNet loss per unit $ (6.35) (4.37) (12.00) ======== ======== =======\nSee accompanying notes to financial statements.\nLMR LAND COMPANY, LTD. (A Limited Partnership)\nStatements of Partners' Equity\nYears ended December 31, 1995, 1994 and 1993\nLimited General partners partner Total ________ ________ _____\nPartners' equity, December 31, 1992 $5,434,517 483 5,435,000\nDistribution (900,000) - (900,000) (note 5) Net loss (90,024) - (90,024) ________ ____ ________ Partners' equity, December 31, 1993 4,444,493 483 4,444,976\nNet loss (32,783) - (32,783) ________ ____ ________ Partners' equity, December 31, 1994 4,411,710 483 4,412,193\nNet loss (47,591) - (47,591) ________ ____ ________ Partners' equity, December 31, 1995 $4,364,119 483 4,364,602 ======== ==== ========\nSee accompanying notes to financial statements.\nLMR LAND COMPANY, LTD. (A Limited Partnership)\nStatements of Cash Flows\nYears ended December 31, 1995, 1994 and 1993\n1995 1994 1993\nCash flows from operating activities: Net loss $(47,591) (32,783) (90,024) Adjustments to reconcile net (loss) earnings to net cash provided by operating activities: Decrease in receivable from affiliate 1,848 13,861 1,674 Cost of land improvements - (19,999) (138,000) Cost of land sold - 12,785 1,377,154 Increase in accounts payable 1,129 2,371 1,079 (Decrease) increase in accrued property taxes (32,707) 4,563 48,422 Increase in deposits on land sale contracts 77,500 22,500 - ________ ________ ________ Total adjustments 47,770 36,081 1,290,329 ________ ________ ________ Net cash provided by operating activities 179 3,298 1,200,305 ________ ________ ________ Cash flows from financing activities - cash distributions to limited partners - - (900,000) ________ ________ ________ Net increase in cash and cash equivalents 179 3,298 300,305\nCash and cash equivalents at beginning of year 484,714 481,416 181,111 ________ ________ ________ Cash and cash equivalents at end of year $ 484,893 484,714 481,416 ======== ======== ========\nSee accompanying notes to financial statements.\nLMR LAND COMPANY, LTD. (A Limited Partnership)\nNotes to Financial Statements\nDecember 31, 1995 and 1994\n(1) Summary of Significant Accounting Policies _______________________________________ (a) Organization ___________ LMR Land Company, Ltd. (the Partnership) is a Tennessee Limited Partnership organized on December 22, 1986, to acquire undeveloped land located in Roanoke, Virginia; Lebanon, Tennessee; and Macon, Georgia. The General Partner is 222 LMR, Ltd. The general partner of the General Partner is 222 Partners, Inc. (see note 4).\n(b) Income Taxes ____________ The Partnership prepares its financial statements and Federal income tax returns on the accrual method and includes only those assets, liabilities and results of operations which relate to the business of the Partnership. No provision has been or will be made in the financial statements for Federal and state income taxes, since such taxes are the personal responsibility of the partners.\n(c) Land Held For Investment _______________________ At various dates between April 27, 1987 and May 22, 1987, the Partnership acquired three tracts of undeveloped land representing approximately 210 acres. During 1989, the Partnership acquired additional tracts adjacent to the Macon, Georgia, property. During 1993, approximately 5 acres were received as partial consideration for the sale of property. Land held for investment is recorded at acquisition cost plus carrying costs. Insurance and property taxes are capitalized as carrying costs of the property during the development period. Insurance and property taxes are charged to expense once development of the property is substantially complete. Remaining acreage is approximately 164 acres at December 31, 1995 and 1994, which includes approximately 10 acres which are unsaleable attributable to roads, right of ways, and landscaping.\n(d) Partnership Allocations _____________________ Net earnings, losses, and cash flows of the Partnership are allocated among the limited partners and general partners, in accordance with the agreement of the limited partnership.\n(Continued)\nLMR LAND COMPANY, LTD. (A Limited Partnership)\nNotes to Financial Statements\n(e) Cash and Cash Equivalents ________________________ The Partnership considers all short- term investments with original maturities of three months or less to be cash equivalents.\nCash belonging to the Partnership is combined in an account with funds from other partnerships related to the general partner.\n(f) Estimates ________ Management of the Partnership has made estimates and assumptions to prepare these financial statements. Actual results could differ from those estimates.\n(2) Land Held for Investment _______________________ The components of land held for investment at December 31, 1995 and 1994 are as follows: 1995 1994\nLand $ 3,641,360 3,641,360 Land improvements 333,077 333,077 ________ ________ 3,974,437 3,974,437 ======== ======== Aggregate cost for federal income tax purposes for the land held for investment was $3,974,437 and $3,954,370 at December 31, 1995 and 1994, respectively.\nDuring 1994, the Partnership entered into a purchase and sale agreement for the sale of approximately 114 acres of the land in Macon, Georgia held for investment. The proposed sales price is $50,000 per acre or $5,700,000 in total. The closing of this transaction is subject to various terms and conditions.\n(3) Related Party Transactions ________________________ The General Partner and its affiliates have been actively involved in managing the property. Affiliates of the General Partner receive fees as consideration for performing certain services. Expenses incurred for these services during the years ended December 31, 1995, 1994 and 1993 are as follows:\n1995 1994 1993\nProgram management $14,000 14,000 14,000 fees Accounting fees 2,000 2,000 2,250 ===== ===== =====\n(Continued)\nLMR LAND COMPANY, LTD. (A Limited Partnership)\nNotes to Financial Statements\nThe receivable from affiliate totaling $40,628 at December 31, 1995 and $42,476 at December 31, 1994, consists of property development costs incurred at the Lebanon property that will be reimbursed as sales by the affiliate occur. Accounts payable totaling $10,499 at December 31, 1995 and 1994 was payable to an affiliate for commissions on the sale of property.\n(4) General Partner Bankruptcy ________________________ On February 25, 1991, W. Gerald Ezell, a former general partner of 222 LMR, Ltd., elected to file for reorganization under Chapter 11 of the United States Bankruptcy Code. This election is designed to allow Mr. Ezell to satisfy his personal creditors in an orderly manner. The filing has no impact on the legal standing of the Partnership.\nOn April 6, 1994, Mr. Ezell sold his general partnership interest in 222 LMR, Ltd. in accordance with bankruptcy court approved plan to liquidate his assets and satisfy his creditors. In accordance with the partnership agreement, Mr. Ezell's interest in 222 LMR, Ltd. was converted into a special limited partnership interest and his general partner responsibilities were transferred to 222 Partners, Inc., the remaining general partner. W. Gerald Ezell remains on the Board of 222 Partners, Inc.\n(5) Distributions ____________ For the year ended December 31, 1993, the Partnership made a distribution to its limited partners in the amount of $900,000 or $120 per unit. There were no distributions in 1995 or 1994.\n(6) Fair Value of Financial Statements ______________________________ At December 31, 1995, the Partnership had financial instruments including cash and cash equivalents of $484,893, receivable from affiliate of $40,628, and accrued liabilities of $135,356. The carrying amounts of these financial instruments approximate fair value because of the short maturity of such instruments.\nIndependent Auditors' Report ______________________________\nThe Partners LMR Land Company, Ltd.:\nUnder date of January 19, 1996, we reported on the balance sheets of LMR Land Company, Ltd. as of December 31, 1995 and 1994, and the related statements of operations, partners' equity, and cash flows for each of the years in the three-year period ended December 31, 1995. These financial statements and our report thereon are included elsewhere herein. In connection with our audits of the aforementioned financial statements, we have also audited the related financial statement schedule as listed in the accompanying index. This financial statement schedule is the responsibility of the Partnership's management. Our responsibility is to express an opinion on this financial statement schedule based on our audit.\nIn our opinion, such financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.\nKPMG Peat Marwick LLP\nNashville, Tennessee January 19, 1996\nS-1\nSchedule XI\nLMR LAND COMPANY, LTD. (A Limited Partnership)\nReal Estate and Accumulated Depreciation\nDecember 31, 1995\nInitial cost to Partnership\nBuilding and Description Encumbrances Land improvements\n164 acres of undeveloped land in Lebanon, Tennessee and $ - 6,201,635 - Macon, Georgia\n1995 1994 1993\n(1) Balance at beginning $3,974,437 3,967,223 5,206,377 of Period Additions during period: Other acquisitions 70,000 Improvements - 19,999 68,000 -------- -------- -------- - 19,999 138,000 -------- -------- -------- Deductions during period: Cost of real estate sold - 12,785 1,377,154\n-------- -------- -------- - 12,785 1,377,154 -------- -------- -------- Balance at end of period $3,974,437 3,974,437 3,967,233 ======== ======== ========\n(2) Aggregate cost for Federal income tax purposes $3,974,437 3,954,370 3,947,015 ======== ======== ========\nSee accompanying independent auditors' report. S-2\nSchedule XI\nLMR LAND COMPANY, LTD. (A Limited Partnership)\nReal Estate and Accumulated Depreciation\nDecember 31, 1995\nCost Gross capitalized subsequent amount at which carried to acquisition at close of period Building & Improve- Carrying improve- Description ments costs Land ments Total\n164 acres of undeveloped land in Lebanon, Tennessee 614,092 357,985 3,641,360 333,077 3,974,437 and Macon, Georgia\nSchedule XI\nLMR LAND COMPANY, LTD. (A Limited Partnership)\nReal Estate and Accumulated Depreciation\nDecember 31, 1995\nAccumulated Date of Date Description depreciation* construction acquired\n164 acres of undeveloped land in - - 4\/27\/87 Lebanon, Tennessee and Macon, Georgia 9\/8\/93\n*Life on which depreciation in latest income statement is computed is not applicable.(A Limited Partnership)\nExhibits filed pursuant to Item 14(a)(3):\nLMR LAND COMPANY, LTD. (A Tennessee Limited Partnership)\nExhibit Index\nExhibit\n3 Amended and Restated Certificate and Agreement of Limited Partnership, incorporated by reference to Exhibit A to the Prospectus of Registrant dated April 1, 1987 filed pursuant to Rule 424(b) of the Securities and Exchange Commission.\n22 Subsidiaries-Registrant has no subsidiaries.\n27 Financial Data Schedule","section_15":""}
{"filename":"64670_1995.txt","cik":"64670","year":"1995","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 technology 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 systems, mechanical and tissue heart valves, balloon and guiding catheters and stents used in angioplasty, implantable neurostimulation and drug delivery systems, and perfusion systems including blood oxygenators, centrifugal blood pumps, cannula products, and autotransfusion and blood monitoring systems.\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 (1993-1995) have been attributable to this single industry segment. The Company does business in more than 120 countries and reports on three business units -- Pacing, Other Cardiovascular, and Neurological and Other -- and three geographic areas -- the Americas, Europe\/Middle East\/Africa, and Asia\/Pacific.\nBUSINESS NARRATIVE. Medtronic's Pacing business unit is the company's largest operating unit, consisting of Bradycardia Pacing, which produces products for treating patients with slow or irregular heartbeats, and Tachyarrhythmia Management, which develops products for hearts with abnormally fast rhythms. The bradycardia pacing systems include pacemakers, leads and accessories. The pacemakers can be noninvasively programmed by the physician to adjust sensing, electrical pulse intensity, rate, duration and other characteristics, and can produce impulses to cause contractions in either the upper or lower heart chamber, or both, in appropriate relation to heart activity. In January 1995, the company commercially released the Thera(R) line of pacemakers in the U.S. Thera(R) is a flexible, technically advanced family of five new pacemakers for virtually every pacing application, a new specialized lead and the new Model 9790 programmer. This versatile programmer can be used interchangeably with all of the company's bradycardia pacemakers as well as with its Jewel(R) line of tachyarrhythmia management devices.\nMore than half of Medtronic's revenues are generated from the sale of implantable cardiac pacemaker systems for treatment of bradycardia. In addition to the \"Medtronic\" line of pacing products, the company also produces a separate line under the brand name \"Vitatron.\"\nThe Tachyarrhythmia Management business produces implantable devices and transvenous lead systems for treating ventricular tachyarrhythmias, which are abnormally fast, and sometimes fatal, heartbeats. The systems offer tiered therapy of pacing, cardioversion and defibrillation, and may be implanted without a thoracotomy, which reduces patient trauma, and hospitalization time and costs. The company's Jewel(R) line of devices, which were released in the U.S. in March 1995, are the smallest currently commercially available and are programmed with the Model 9790 pacing programmer. In fiscal 1995 the company also commercially released the Jewel(R) Active Can(tm) outside the United States. This system makes implantation possible with a single lead, resulting in faster, less costly implantation and quicker patient recovery. The Active Can(tm) device continues in clinical trials in the U.S. The company also produces the Atakr(R) radio frequency ablation system to neutralize heart muscle cells that cause tachyarrhythmias through a nonsurgical procedure. The Atakr(R) system consists of a closed-loop, temperature-controlled radio frequency generator with an array of steerable and non-steerable catheters.\nThe company's Pacing business unit accounted for 65.5% of Medtronic's net sales during the fiscal year ended April 30, 1995 (\"fiscal 1995\"), 67.2% of net sales in fiscal 1994 and 65.7% of net sales in fiscal 1993.\nThe company's Other Cardiovascular business unit consists of Cardiopulmonary, Blood Management, DLP, Heart Valves, and Interventional Vascular. Through a series of strategic acquisitions over the past decade, Medtronic now markets a complete line of blood-handling products. These include the Bio-Medicus Bio-Pump(R), the Maxima(R) oxygenator, Electromedics' autotransfusion equipment, a broad line of cannulae and hemostasis management equipment. These devices form a life-saving circuit by maintaining blood circulation, oxygen supply and body temperature while the patient is undergoing emergency treatment or open-heart surgery.\nThe company's Heart Valve business produces tissue and mechanical valve replacements for damaged or diseased heart valves. Two new tissue valves, the Mosaic(tm) stented valve and the Freestyle(R) non-stented aortic root, have improved antimineralization and durability and are currently in clinical trials outside the U.S. The company's Interventional Vascular business produces balloon and guiding catheters, stents and accessories used by physicians to open arteries obstructed by deposits of fatty plaque. In fiscal 1995, the company commercially released worldwide the Ascent(tm) guiding catheter, which provides the conduit and support of balloon catheters to reach the obstructed coronary artery, and two new balloon catheters, the Evergreen(tm) over-the-wire and the Falcon(tm). The Falcon(tm) is a \"rapid exchange\" style catheter which makes it possible for a single operator to perform the procedure, reducing the time required for an angioplasty procedure and minimizing the need for additional staff to assist the interventional cardiologist.\nThe company's Other Cardiovascular business unit accounted for 26.1% of net sales in fiscal 1995, and 23.6% and 22.9% of net sales, respectively, for fiscal 1994 and 1993.\nThe Neurological and Other business unit produces implantable systems for spinal cord stimulation and programmable drug delivery that are used in treating chronic intractable pain, tremor and spasticity. These include the SynchroMed(R) pump and the Itrel(R) II spinal cord stimulation system. The Mattrix(R) stimulator, which was commercially released in the U.S. in June 1995, is the first neurostimulation system that offers a dual stimulation mode for more effective pain management. The company is also collaborating with several biotechnology companies to develop therapies for neurodegenerative disorders such as Alzheimer's disease, Parkinson's disease, and amyotrophic lateral sclerosis or Lou Gehrig's disease. Compounds for treating these diseases, called neurotrophic factors, are still in development by these companies. Once they are proven to be safe and effective, Medtronic believes its drug delivery technology could be effective in administering these agents directly to their site of action in precise doses. The Neurological and Other business unit accounted for 8.4% of net sales for fiscal 1995, and 9.2% and 11.4% of net sales, respectively, for fiscal 1994 and 1993. The decrease in percentage of revenue is due to divested product lines during fiscal 1994 and 1995.\nGOVERNMENT REGULATION. The industry segment in which Medtronic competes involves development, production and sales of medical devices. In the United States, the Food and Drug Administration (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, order repair, replacement, or refund of such devices, 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 more stringent product regulation by the FDA. Rigorous regulatory action may be taken in response to deficiencies noted in inspections or to 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.\nThe U.S. Health Care Financing Administration, which determines Medicare reimbursement policy and practice, has changed its practice of reimbursing hospitals for procedures involving medical devices in clinical evaluation. This change in practice is causing hospitals to treat Medicare patients only with medical devices that have been cleared for commercial release by the FDA. This action has further limited the scope of clinical trials in the U.S., is forcing more clinical research to non-U.S. markets, and is increasing the cost and time required to complete clinical evaluations in the U.S.\nGovernment and private sector initiatives to limit the growth of health care costs, including price regulation and competitive pricing, are continuing in several countries in which the company does business, including the United States. These changes are causing the marketplace to put 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 this worldwide trend toward cost containment, the uncertainty as to the outcome of any proposed legislation or changes in the marketplace preclude the company from predicting the impact these changes may have on future operating results.\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. 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.\nThe Company operates in an industry susceptible to significant product liability claims. Product liability claims may be asserted against the company in the future relative to events not known to management at the present time. Management believes that the company's risk management practices, including insurance coverage, are reasonably adequate to protect against potential product liability losses.\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 93.6% of Medtronic's U.S. sales and approximately 64.8% of its sales from other countries in fiscal 1995. The remaining sales were made through independent distributors.\nRAW MATERIALS AND PRODUCTION. Medtronic generally has vertically integrated manufacturing operations, and makes its own lithium batteries, feedthroughs, integrated and hybrid circuits, microprocessors, and certain other components. Medtronic purchases many of the parts and materials used in manufacturing its components and products from external suppliers. Medtronic's single- and sole-sourced materials include biomaterials such as adhesives, polymers, elastomers and resins; certain integrated circuits and other electrical\/electronic components; power sources, battery anodes, pyrolytic carbon discs, pharmaceutical preparations such as Lioresal(R) (baclofen, USP) Intrathecal (registered trademark of CIBA-GEIGY Corporation), and computer and other peripheral equipment.\nCertain of the raw materials and components (e.g., silicone adhesives and polyurethanes) used in Medtronic products are available only from a sole U.S. supplier. 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, 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 companies 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.\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 characteristically has been rapid in the medical device industry, 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 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 have transvenous lead systems cleared for commercial sale in the U.S. Medtronic's Jewel(R) PCD(R) devices are commercially available with the company's Transvene(tm) leads in U.S. and non-U.S. markets. Approximately three other companies have devices in various stages of development and clinical evaluation.\nIn the coronary angioplasty market, which includes balloon and guiding catheters and implantable stents, there are numerous competitors worldwide. Medtronic believes that it is the leading manufacturer and supplier of guiding catheters worldwide. Medtronic and three other manufacturers account for most combined balloon and guiding catheter sales. In stents, Medtronic and two competitors account for most sales worldwide, with one competitor holding a dominant market position and numerous new competitors emerging.\nMedtronic is the second largest manufacturer and supplier of tissue heart valves and also of mechanical heart valves within and outside the U.S. A 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 is the leading manufacturer and supplier of blood oxygenators and centrifugal blood pumps worldwide.\nMedtronic is the market leader in cannula products. Medtronic and four competitors account for a significant portion of cannulae sales in the U.S.\nMedtronic 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 and drug delivery systems. Medtronic and two competitors account for most sales worldwide.\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 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 $191.4 million on research and development (11.0% of net sales) in fiscal 1995, $156.3 million (11.2% of net sales) in fiscal 1994 and $133.0 million (10.0%of net sales) in fiscal 1993. Such amounts have been applied toward improving existing products, expanding their applications, and developing new products. Medtronic's 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, spasticity 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 the blood\/device interface.\nMedtronic has not engaged in significant customer or government sponsored research.\nEMPLOYEES. On April 30, 1995, Medtronic and its subsidiaries employed 8,896 people on a regular, full-time basis and, including temporary and part-time employees, a total of 10,313 employees on a full-time equivalent basis.\nU.S. AND NON-U.S. OPERATIONS AND EXPORT SALES. Medtronic sells products in more than 120 countries in three geographic areas: the Americas, Europe\/Middle East\/Africa, and Asia\/Pacific. For financial reporting purposes, 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 1995 Annual Shareholder Report on page 49. U.S. export sales to unaffiliated customers comprised less than two percent of Medtronic's consolidated sales in each of fiscal 1995, 1994 and 1993.\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 of foreign currency fluctuations on net earnings. 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 52, 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 58, 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 47, has been Chief Operating Officer since January 1994 and has been a director since August 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 Products, at Abbott Laboratories from October 1989 to May 1992 and Divisional Vice President, Diagnostic Products, from May 1984 to October 1989. During his 14 years with Abbott, Mr. Collins served in various general management positions both in the United States and Europe.\nBOBBY I. GRIFFIN, age 58, 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 51, 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.\nJANET S. FIOLA, age 53, 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.\nPHILIP M. LAUGHLIN, age 47, joined the company as Senior Vice President and President, Cardiac Surgery, in July 1995. Prior to that he served with Clintec Nutrition Company (worldwide joint venture of Baxter International and Nestle Company in the field of clinical nutrition), as President, North America, from 1994 through July 1995 and as President, United States, from 1989 to 1993. From 1976 to 1989, he held numerous management positions at Baxter International, most recently as Vice President, Operations, Global Business Group.\nRONALD E. LUND, age 60, 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 served as Vice President and Associate General Counsel of The Pillsbury Company from 1984 to February 1989.\nJOHN A. MESLOW, age 56, 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.\nROBERT L. RYAN, age 52, 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.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nMedtronic'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. The company's total manufacturing and research space is approximately 1,653,000 square feet, of which 80% is owned by the company and the balance is leased.\nMedtronic also maintains sales and administrative offices inside the United States at 47 locations in 27 states and outside the United States at 96 locations in 24 countries. Most of these locations are leased. Medtronic 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\nNotes 11 and 12 to the consolidated financial statements appearing on pages 48 and 49 of Medtronic's 1995 Annual Shareholder Report are 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 MEDTRONIC'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS\nThe information in the sections entitled \"Price Range of Medtronic Stock\" and \"Investor Information\" on page 51 of Medtronic's 1995 Annual Shareholder Report is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe information for the years 1985 through 1995 on page 50 of Medtronic's 1995 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\nThe information on pages 33 through 37 of Medtronic's 1995 Annual Shareholder Report 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 independent accountants dated May 22, 1995, appearing on pages 38 through 49 of Medtronic's 1995 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\nNot applicable.\nPART III\nITEM 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 1995 Annual Shareholders' Meeting and on page 9 of such Proxy Statement regarding Section 16(a) reporting is incorporated herein by reference. See also \"Executive Officers of Medtronic\" on pages 5 and 6 hereof.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe sections entitled \"Election of Directors -- Director Compensation\" and \"Executive Compensation\" on pages 7 and 8, and 14 through 20, respectively, of Medtronic's Proxy Statement for its 1995 Annual Shareholders' Meeting are incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\n\"Shareholdings of Certain Owners and Management\" on page 9 of Medtronic's Proxy Statement for its 1995 Annual Shareholders' Meeting is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information on page 8 of Medtronic's Proxy Statement for its 1995 Annual Shareholders' Meeting, concerning services provided to the company by the Chairman of the Board and the Founder of the company in fiscal 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\nReport of Independent Accountants (incorporated herein by reference to page 38 of Medtronic's 1995 Annual Shareholder Report)\nStatement of Consolidated Earnings -- years ended April 30, 1995, 1994, and 1993 (incorporated herein by reference to page 39 of Medtronic's 1995 Annual Shareholder Report)\nConsolidated Balance Sheet -- April 30, 1995 and 1994 (incorporated herein by reference to page 40 of Medtronic's 1995 Annual Shareholder Report)\nStatement of Consolidated Cash Flow -- years ended April 30, 1995, 1994, and 1993 (incorporated herein by reference to page 41 of Medtronic's 1995 Annual Shareholder Report)\nNotes to Consolidated Financial Statements (incorporated herein by reference to pages 42 through 49 of Medtronic's 1995 Annual Shareholder Report)\n2. FINANCIAL STATEMENT SCHEDULES\nII Valuation and Qualifying Accounts -- years ended April 30, 1995, 1994, and 1993\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\n3.1 Medtronic Restated Articles of Incorporation, as amended to date (Exhibit 3.1).(g) 3.2 Medtronic Bylaws, as amended to date (Exhibit 3.2).(f) 4 Form of Rights Agreement dated as of June 27, 1991 between Medtronic and Norwest Bank Minnesota, National Association, including as Exhibit A thereto the form of Preferred Stock Purchase Right Certificate, incorporated by reference to Exhibit (1) of Medtronic's Form 8-A Registration Statement dated June 27, 1991 and filed with the Securities and Exchange Commission on June 28, 1991. *10.1 1994 Stock Award Plan (Appendix A).(b) *10.2 Management Incentive Plan (Appendix B).(b) *10.3 1979 Restricted Stock and Performance Share Award Plan, as amended to date (Exhibit 10.1).(d) *10.4 1979 Nonqualified Stock Option Plan, as amended (Exhibit A).(e) *10.5 Form of Employment Agreement for Medtronic executive officers. *10.6 1991 Restricted Stock Plan for Non-Employee Directors (Exhibit B).(e) *10.7 Capital Accumulation Plan Deferral Program (Exhibit 10.6).(d) *10.8 Postretirement Survivor Benefit Plan (Exhibit 10.7).(d) *10.9 Amendment effective October 1, 1993 to the Directors' Retirement Plan (Exhibit 10.9).(a) *10.10 Nonqualified Supplemental Benefit Plan (Exhibit 10.9).(d) *10.11 Management Incentive Plan Stock Option Replacement Program 11 Computation of Earnings Per Share. 13 Those portions of Medtronic's 1995 Annual Shareholder Report expressly incorporated by reference herein, which shall be deemed filed with the Commission. 21 List of Subsidiaries. 23 Consent and Report of Price Waterhouse (set forth on page 11 of this report). 24 Powers of Attorney. 27 Financial Data Schedule\n(a) Incorporated herein by reference to the cited exhibit in Medtronic's Annual Report on Form 10-K for the year ended April 30, 1994, filed with the Commission on July 27, 1994.\n(b) 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(c) 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(d) 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(e) 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(f) 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(g) 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*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, 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.\nMEDTRONIC, INC.\nDated: July 25, 1995\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.\nDated: July 25, 1995\nBY: \/S\/ WILLIAM W. GEORGE William W. George President and Chief Executive Officer Dated: July 25, 1995\nBY: \/S\/ ROBERT L. RYAN Robert L. Ryan Senior Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)\nF. CALEB BLODGETT ARTHUR D. COLLINS, JR. 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, 1995\nBY: \/S\/ RONALD E. LUND Ronald E. Lund Attorney-in-Fact\nREPORT 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 22, 1995 appearing on page 38 of the 1995 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 Schedule listed in Item 14(a) of this Form 10-K. In our opinion, this Financial Statement Schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.\nPRICE WATERHOUSE LLP\nMinneapolis, Minnesota May 22, 1995\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, 33-44230 and 33-55329) and Form S-4 (Registration No. 33-52751) of Medtronic, Inc. of our report dated May 22, 1995 appearing on page 38 of the 1995 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 Schedule as shown above.\nPRICE WATERHOUSE LLP\nMinneapolis, Minnesota July 25, 1995\nMEDTRONIC, INC. AND SUBSIDIARIES SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS (IN THOUSANDS OF DOLLARS)\n(a) Uncollectible accounts written off, less recoveries.\n(b) Reflects primarily the effects of foreign currency fluctuations.\n(c) Reflects the sale of all assets of the CardioCare division.\n(d) Reflects reclassification of assets retained in the sale of the Nortech division.\n(e) Includes both current and noncurrent amounts.\n(f) Claims settled, less reimbursement by insurance carrier\nCommission File Number 1-7707\nSECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549\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, 1995\n[LOGO]\nMedtronic, Inc. 7000 Central Avenue N.E. Minneapolis, Minnesota 55432 Telephone: 612\/574-4000\nEXHIBIT INDEX\n3.1 Medtronic Restated Articles of Incorporation, as amended to date (Exhibit 3.1).(g)\n3.2 Medtronic Bylaws, as amended to date (Exhibit 3.2).(f)\n4 Form of Rights Agreement dated as of June 27, 1991 between Medtronic and Norwest Bank Minnesota, National Association, including as Exhibit A thereto the form of Preferred Stock Purchase Right Certificate, incorporated by reference to Exhibit (1) of Medtronic's Form 8-A Registration Statement dated June 27, 1991 and filed with the Securities and Exchange Commission on June 28, 1991.\n10.1 1994 Stock Award Plan (Appendix A).(b)\n10.2 Management Incentive Plan (Appendix B).(b)\n10.3 1979 Restricted Stock and Performance Share Award Plan, as amended to date (Exhibit 10.1).(d)\n10.4 1979 Nonqualified Stock Option Plan, as amended (Exhibit A).(e)\n10.5 Form of Employment Agreement for Medtronic executive officers.\n10.6 1991 Restricted Stock Plan for Non-Employee Directors (Exhibit B).(e)\n10.7 Capital Accumulation Plan Deferral Program (Exhibit 10.6).(d)\n10.8 Postretirement Survivor Benefit Plan (Exhibit 10.7).(d)\n10.9 Amendment effective October 1, 1993 to the Directors' Retirement Plan (Exhibit 10.9).(a)\n10.10 Nonqualified Supplemental Benefit Plan (Exhibit 10.9).(d)\n10.11 Management Incentive Plan Stock Option Replacement Program\n11 Computation of Earnings Per Share.\n13 Those portions of Medtronic's 1995 Annual Shareholder Report expressly incorporated by reference herein, which shall be deemed filed with the Commission.\n21 List of Subsidiaries.\n23 Consent and Report of Price Waterhouse (set forth on page 11 of this report).\n24 Powers of Attorney.\n27 Financial Data Schedule\n_________________\n(a) Incorporated herein by reference to the cited exhibit in Medtronic's Annual Report on Form 10-K for the year ended April 30, 1994, filed with the Commission on July 27, 1994.\n(b) 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(c) 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(d) 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(e) 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(f) 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(g) 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.","section_15":""}
{"filename":"200138_1995.txt","cik":"200138","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"ITEM 2 PROPERTIES\nThe Company's principal banking subsidiary, CTC, operates banking facilities in 39 locations in Vermont. The offices of CTC are in good physical condition with modern equipment and facilities considered adequate to meet the banking needs of customers in the communities serviced.\nThe offices of the Company are located in the main office of the CTC, which occupied all of the five-floor Chittenden Building at Two Burlington Square in Burlington as of December 31, 1995. The Chittenden Building is owned by CTC.\nBWM operates banking facilities in 3 locations in Massachusetts. The offices of BWM are in good physical condition with modern equipment and facilities consid- ered adequate to meet thebanking needs of customers in the communities serviced.\nThe Company continues to conduct business out of properties owned or leased by FBT in the area of Worcester, Massachusetts. Reference is made to The Company's Registration Statement No. 33-64527 on Form S-4 under the Securities Act of 1933, filed in connection with the Company's acquisition of FBT.\nITEM 3","section_3":"ITEM 3 LEGAL PROCEEDINGS\nA number of legal claims against the Company arising in the normal course of business were outstanding at December 31, 1995. Management, after reviewing these claims with legal counsel, is of the opinion that these matters, when resolved, will not have a material effect on the consolidated financial statements.\nITEM 4","section_4":"ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matters.\nPART II\nITEM 5","section_5":"ITEM 5 MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nInformation regarding the market in which the Company's common stock is traded, and the quarterly high and low bid quotations for the Company's common stock during the past five years are included in the Company's 1995 Annual Report to Stockholders on page 57, and is attached hereto as Exhibit 13. The approximate number of stockholders at March 1, 1996 was 3,354. Note 8 of the Consolidated Financial Statements appearing on page 27 of the Company's 1995 Annual Report to Stockholders contains a discussion of restrictions on dividends and is attached hereto as Exhibit 13.\nITEM 6","section_6":"ITEM 6 SELECTED FINANCIAL DATA\nA five-year summary of selected consolidated financial data for the Company and its subsidiaries is included on page 39 of the Company's 1995 Annual Report to Stockholders and is attached hereto as Exhibit 13.\nThe Company consummated an acquisition of FBT on February 29, 1996. Reference is made to the Company's Registration Statement No. 33-64527 on Form S-4 under the Securities Act of 1933, filed in connection with the Company's acquisition of FBT, Worcester, Massachusetts.\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 included on pages 40 to 54 of the Company's 1995 Annual Report to Stockholders and is attached hereto as Exhibit 13.\nITEM 8","section_7A":"","section_8":"ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe following consolidated financial statements of the Company and its subsidiaries appear in the Company's 1995 Annual Report to Stockholders at the pages indicated and are attached hereto as Exhibit 13:\nReport of Independent Public Accountants Page 38\nConsolidated Balance Sheets at December 31, 1995 and 1994 Page 13\nConsolidated Statements of Income for the Years Ended December 31, 1995, 1994, and 1993 Page 14\nConsolidated Statements of Changes in Stockholders' Equity for the Years Ended December 31, 1995, 1994, and 1993 Page 15\nConsolidated Statements of Cash Flows for the Years Ended December 31, 1995, 1994, and 1993 Page 16\nNotes to Consolidated Financial Statements Pages 17-37\nITEM 9","section_9":"ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot Applicable\nPART III\nITEM 10","section_9A":"","section_9B":"","section_10":"ITEM 10 DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nInformation regarding the directors and director-nominees of the Registrant is included in the Company's definitive Proxy Statement for the 1996 Annual Meeting of Stockholders at pages 5-11, and is specifically incorporated herein by reference.\nAt December 31, 1995, the principal officers of the Company and its principal subsidiary, CTC, with their ages, positions, and years of appointment, were as follows:\nYEAR NAME AND AGE APPOINTED POSITIONS - --------------------------------------------------------------------------------\nBarbara W. Snelling, 68 1990 Chair of the Company\nPaul A. Perrault, 44 1990 President and Chief Executive Officer of the Company and Chittenden Trust\nLawrence W. DeShaw, 49 1990 Executive Vice President of the Company and Chittenden Trust\nJohn W. Kelly, 46 1990 Executive Vice President of the Company and Chittenden Trust\nNancy Rowden Brock, 39 1984 Treasurer of the Company and Senior Vice President, Chief Financial Officer, and Treasurer of Chittenden Trust\nF. Sheldon Prentice, 45 1985 Secretary of the Company and Senior Vice President, General Counsel, and Secretary of Chittenden Trust\nJohn P. Barnes, 40 1990 Senior Vice President of the Company and Chittenden Trust\nDanny H. O'Brien, 45 1990 Senior Vice President of the Company and Chittenden Trust\n- --------------------------------------------------------------------------------\nAll of the current officers have been principally employed in executive positions with CTC for more than five years.\nIn accordance with the provisions of the Company's By-Laws, the officers, with the exception of the Secretary, hold office at the pleasure of the Board of Directors. The Secretary is elected annually by the Board of Directors.\nITEM 11","section_11":"ITEM 11 EXECUTIVE COMPENSATION\nInformation regarding remuneration of the directors and officers of the Company is included in the Company's definitive Proxy Statement for the 1996 Annual Meeting of Stockholders at pages 11-19 and is specifically incorporated herein by reference.\nITEM 12","section_12":"ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation regarding the security ownership of directors and director-nominees of the Company, all directors and officers of the Company as a group, and certain beneficial owners of the Company's common stock, as of February 1, 1996, is included in the Company's definitive Proxy Statement for its 1996 Annual Meeting of Stockholders, at pages 4-10, and is specifically incorporated herein by reference.\nThere are no arrangements known to the registrant which may, at a subsequent date, result in a change of control of the registrant.\nITEM 13","section_13":"ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation regarding certain relationships and transactions between the Company and its Directors, Director-Nominees, Executive Officers, and family members of these individuals, is included in the Company's definitive Proxy Statement for its 1996 Annual Meeting of Stockholders at pages 10 and 21, and is specifically incorporated herein by reference.\nPART IV\nITEM 14","section_14":"ITEM 14 EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(l) FINANCIAL STATEMENTS\nThe following consolidated financial statements of the Company and its subsidiaries appear in the Company's 1995 Annual Report to Stockholders:\nReport of Independent Public Accountants Page 38\nConsolidated Balance Sheets at December 31, 1995 and 1994 Page 13\nConsolidated Statements of Income for the Years Ended December 31, 1995, 1994, and 1993 Page 14\nConsolidated Statements of Changes in Stockholders' Equity for the Years Ended December 31, 1995, 1994, and 1993 Page 15\nConsolidated Statements of Cash Flows for the Years Ended December 31, 1995, 1994, and 1993 Page 16\nNotes to Consolidated Financial Statements Pages 17-37\n(2) FINANCIAL STATEMENT SCHEDULES\nThere are no financial statement schedules required to be included in this report.\n(3) REPORTS ON FORM 8-K\nA report was filed by the Company on Form 8-K December 13, 1995 in connection with the Company's acquisition of FBT so as to file with the Securities and Exchange Commission certain paper reports that would be incorporated by reference into its Registration Statement on Form S-4.\n(4) EXHIBITS\nThe following are included as exhibits to this report:\n3. By-Laws of the Company, as amended, incorporated herein by reference to Exhibit 3 to the Company's Annual Report on Form 10-K for the year ended December 31, 1985.\n3.01 Amendment to the By-Laws of the Company, dated February 16, 1988, incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1987.\n3.02 Amendment to the By-Laws of the Company, dated January 17, 1990, incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1989.\n3.03 Amendment to the By-Laws of the Company, dated June 19, 1991, incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1991.\n3.04 Amendment to the By-Laws of the Company, dated November 15, 1995. CHANGED FROM: \"A director elected to fill a vacancy shall hold office until the next regular election of directors.\" CHANGED TO: \"A director elected to fill a vacancy shall hold office until the expiration of the term of the departed director who creates the vacancy.\"\n3.1 Articles of Association of the Company, as amended, incorporated herein by reference to the Proxy Statement for the 1994 Annual Meeting of Stockholders.\n4. Statement of the Company regarding its Dividend Reinvestment Plan is incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1993.\n10.1 Directors' Deferred Compensation Plan, dated April 1972, as amended January 1, 1992, incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1992.\n10.2 Pension Plan of CTC, attached to the Company's Annual Report on Form 10-K for the year ended December 31, 1994, as amended on March 15, 1995 and December 20, 1995 and attached to the Company's Annual Report on Form 10-K for the year ended December 31, 1995.\n10.3 Incentive Savings and Profit Sharing Plan, attached to the Company's Annual Report on Form 10-K for the year ended December 31, 1994, as amended on March 15, 1995 and attached to the Company's Annual Report on Form 10-K for the year ended December 31, 1995.\n10.4 The Company's Stock Option Plan, incorporated herein by reference to the Company's Proxy Statement in connection with the 1986 Annual Meeting of Stockholders.\n10.5 The Company's Stock Option Plan, incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1987.\n10.6 The Company's Restricted Stock Plan, incorporated herein by reference to the Company's Proxy Statement in connection with the 1986 Annual Meeting of Stockholders.\n10.7 Executive Management Incentive Compensation Plan, attached to the Company's Annual Report on Form 10-K for the year ended December 31, 1994 and is incorporated herein by reference.\n10.8 The Company's Stock Incentive Plan, dated January 1, 1993, incorporated herein by reference to the Company's Proxy Statement for the 1993 Annual Meeting of Stockholders.\n13. The Company's 1995 Annual Report to Stockholders.\n21. List of subsidiaries of the Registrant.\n23. Consent of Arthur Andersen LLP.\nEXHIBITS\nEXHIBIT 3.04 AMENDMENT TO THE BY-LAWS OF THE COMPANY\nEXHIBIT 10.2 AMENDMENT NUMBER ONE\nAMENDMENT NUMBER ONE TO THE PENSION PLAN FOR EMPLOYEES OF THE CHITTENDEN CORPORATION\n(As Amended and Restated Effective January 1, 1989)\nWHEREAS, Chittenden Corporation (the \"Principal Employer\") heretofore adopted the Pension Plan for Employees of The Chittenden Corporation (the \"Plan\"); and\nWHEREAS, Article X permits the Principal Employer to amend the Plan from time to time; and\nWHEREAS, the Principal Employer will acquire the Bank of Western Massachusetts (such date to be known as the \"Acquisition Date\"); and\nWHEREAS, the Principal Employer intends to maintain the qualified retirement plans of the Bank of Western Massachusetts on and after the Acquisition Date;\nNOW, THEREFORE, the Plan is hereby amended effective as of the Acquisition Date, as follows:\nSection 3.1, \"MEMBERSHIP\" shall be amended by adding the following paragraph (d) immediately after paragraph (c) thereof:\n\"(d) Notwithstanding the foregoing, each Employee who is employed by the Bank of Western Massachusetts shall not be eligible for membership hereunder.\"\nIN WITNESS WHEREOF, Chittenden Corporation has caused this amendment to be executed by its officer thereunto duly authorized and its corporate seal to be hereunto affixed as of the 15th day of March, 1995.\nCHITTENDEN CORPORATION\nBY: \/s\/ F. Sheldon Prentice, Esq. Secretary\nCORPORATE SEAL\nEXHIBIT 10.2 AMENDMENT NUMBER TWO\nBOARD OF DIRECTORS RESOLUTION AUTHORIZING THE ADOPTION OF AMENDMENT NUMBER TWO TO THE PENSION PLAN FOR EMPLOYEES OF THE CHITTENDEN CORPORATION (As Amended and Restated Effective January 1, 1989)\nWHEREAS, the Chittenden Corporation (the \"Principal Employer\") heretofore adopted the Pension Plan for Employees of the Chittenden Corporation (the \"Plan\"); and\nWHEREAS, Article X permits the Principal Employer to amend the Plan at any time by means of a resolution of the Board of Directors;\nWHEREAS, it is the desire of the Principal Employer to credit certain past service under the Plan;\nNOW, THEREFORE, the Plan is amended effective January 1, 1995, as follows:\n1. Section 3.3, ELIGIBILITY SERVICE, is amended by adding the following paragraph (f) to the end thereof:\n\"(f) Subject to the Break in Service provisions of Section 3.5, an Employee who terminates employment with the Employer and all Affiliated Companies on or after January 1, 1995, shall be credited with Eligibility Service in accordance with the provisions set forth in this Section 3.3 for periods of employment with the Employer or an Affiliated Company prior to December 1, 1976.\"\n2. Section 3.4, BENEFIT SERVICE, is amended by adding the following paragraph (g) to the end thereof:\n\"(g) Subject to the Break in Service provisions of Section 3.5, a Member who terminates employment with the Employer on or after January 1, 1995, shall receive Benefit Service in accordance with the provisions set forth in this Section 3.4 for periods of employment with the Employer prior to December 1, 1976.\"\nIN WITNESS WHEREOF, the Principal Employer has caused this instrument to be executed by its officer duly authorized and its corporate seal to be hereunto affixed as of the 20th day of December, 1995.\nCHITTENDEN CORPORATION BY: \/s\/ Paul A. Perrault\nATTEST:\n\/s\/ F. Sheldon Prentice\nCORPORATE SEAL\nEXHIBIT 10.2 AMENDMENT NUMBER THREE\nBOARD OF DIRECTORS RESOLUTION AUTHORIZING THE ADOPTION OF PROPOSED AMENDMENT NUMBER THREE TO THE PENSION PLAN FOR EMPLOYEES OF THE CHITTENDEN CORPORATION (As Amended and Restated Effective January 1, 1989)\nWHEREAS, Chittenden Corporation (the \"Principal Employer\") heretofore adopted the Pension Plan for Employees of The Chittenden Corporation (the \"Plan\"); and\nWHEREAS, Article X permits the Principal Employer to amend the Plan at any time by means of a resolution of the Board of Directors; and\nWHEREAS, the Internal Revenue Service (IRS) has requested that the Plan be amended in response to the Principal Employer's application for a letter of determination for the Plan;\nNOW, THEREFORE, the following proposed amendments shall be effective January 1, 1989, and shall be adopted by the Board upon approval of the IRS:\nSection 2.12, \"COMPENSATION\" shall be amended by deleting the last paragraph thereof and replacing it with the following:\n\"Effective for Plan Years beginning after December 31, 1988, Compensation taken in to account under the Plan shall not exceed $200,000 ($150,000 effective for Plan Years beginning after December 31, 1993) or such other amount as indexed pursuant to Sections 401(a)(17) and 415(d) of the Code. In any event, the Accrued Benefit of any Member determined in accordance with this provision shall not be less than the Accrued Benefit of such Member determined as of December 31, 1988, in accordance with the applicable provisions of the Plan as in effect on such date.\nIn determining the Compensation of an Employee for purposes of the Code Section 401(a)(17) limitation, the rules of Section 414(q)(6) of the Code shall apply; provided, however, that in applying such rules, the term \"family\" shall include only the spouse of the Employee and any lineal descendants of the Employee who have not attained age 19 before the close of the Plan Year.\nIf the Compensation of the Employee exceeds the Code Section 401(a)(17) limitation, then the Code Section 401(a)(17) limitation shall be prorated among the Compensation of the Employee and his family (as determined under this Section 2.12 prior to the application of the Code Section 401(a)(17) limitation) in proportion to each such individual's Compensation (as determined under the Section 2.12 prior to the application of the Code Section 401(a)(17) limitation).\"\nIN WITNESS WHEREOF, the Principal Employer has caused this instrument to be executed by is officer duly authorized and its corporate seal to be hereunto affixed as of the 20th day of December, 1995.\nCHITTENDEN CORPORATION\nBY: \/s\/ Paul A. Perrault\nATTEST:\n\/s\/ F. Sheldon Prentice\nCORPORATE SEAL\nEXHIBIT 10.3 AMENDMENT NUMBER ONE\nTHE CHITTENDEN CORPORATION INCENTIVE SAVINGS AND PROFIT SHARING PLAN\n(As Amended and Restated Effective January 1, 1989)\nWHEREAS, Chittenden Corporation (the \"Employer\") heretofore adopted the Chittenden Corporation Incentive Savings and Profit Sharing Plan (the \"Plan\"); and\nWHEREAS, Article XIII permits the Employer to amend the Plan from time to time; and\nWHEREAS, the Employer will acquire the Bank of Western Massachusetts (such date to be known as the \"Acquisition Date\"); and\nWHEREAS, the Employer intends to maintain the qualified retirement plans of the Bank of Western Massachusetts on and after the Acquisition Date;\nNOW THEREFORE, the Plan is hereby amended effective as of the Acquisition Date, as follows:\nSection 2.1, \"ELIGIBILITY TO PARTICIPATE\" shall be amended by adding the following paragraph immediately after paragraph (e) thereof:\n\"Notwithstanding the foregoing, each Employee who is employed by the Bank of Western Massachusetts shall not be considered an Eligible Employee hereunder.\"\nIN WITNESS WHEREOF, Chittenden Corporation has caused this amendment to be executed by its officer thereunto duly authorized and its corporate seal to be hereunto affixed as of the 15th day of March, 1995.\nCHITTENDEN CORPORATION\nBY: \/s\/ F. Sheldon Prentice, Esq. Secretary\nCORPORATE SEAL\nEXHIBIT 13 CHITTENDEN'S 1995 ANNUAL REPORT HAS BEEN FILED AS AN EXHIBIT ATTACHED HERETO\nEXHIBIT 21 LIST OF SUBSIDIARIES OF CHITTENDEN CORPORATION\nChittenden Trust Company, Vermont, d\/b\/a Chittenden Bank\nThe Bank of Western Massachusetts, Massachusetts\nChittenden Acquisition Bank, Massachusetts d\/b\/a Flagship Bank and Trust Company, is a Bank in formation to effectuate the acquisition of Flagship Bank and Trust Company.\nEXHIBIT 23 CONSENT LETTER ARTHUR ANDERSEN LLP\nCONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS\nAs independent public accountants, we hereby consent to the incorporation of our report dated January 16, 1996, included in Chittenden Corporation's Form 10-K for the year ended December 31, 1995, into the Company's previously filed Registration Statement File No. 33-1229.\ns\/ARTHUR ANDERSEN LLP Boston, Massachusetts March 25, 1996","section_15":""}
{"filename":"856250_1995.txt","cik":"856250","year":"1995","section_1":"ITEM 1. BUSINESS\nThe Company\nCraftmade International, Inc. (the \"Company\") was incorporated under the laws of the State of Texas on July 16, 1985 under the name of Mastercraft International, Inc. for the purpose of distributing ceiling fans, furniture, hardware and plumbing products. In January 1986, the Company limited its operations to the marketing and distribution of ceiling fans and related products and accessories. An arrangement with Fanthing Electrical Corp., (\"Fanthing\"), Taichung, Taiwan was completed in August 1986 for the manufacture of ceiling fans designed to the Company's specifications. The Company's ceiling fan product line consists of 23 series and 125 basic models of premium priced to lower priced ceiling fans, and represents approximately 65% of the Company's current product sales. The Company also markets 135 light kit models for attachment and use with the Company's ceiling fans or other ceiling fans, as well as parts and accessories for its ceiling fans and light kits. The Company purchases most of its light kits from Sunlit Industries (\"Sunlit\"), Taipei, Taiwan. The combination of design and functional features which characterize Craftmade ceiling fans have made them, in management's judgement, one of the most reliable, durable, energy efficient and cost effective ceiling fans in the marketplace. The Company's national sales organization, which consists of 29 independent sales representative groups employing approximately 52 sales representatives, markets the Company's products to in excess of 1,400 lighting showrooms and electrical wholesalers which sell primarily to the new home construction, remodeling and replacement markets. These markets are comprised principally of private residences and, to a lesser extent, offices, restaurants and certain public facilities.\nOn July 26, 1990, the Company formed Durocraft International, Inc. (\"Durocraft\") and completed an agreement and plan of merger with DMI Products, Inc. (\"DMI\"). Durocraft Design Manufacturing, a division of Durocraft, is a lamp manufacturer whose customer base includes major specialty retail chains. The merger has enabled the Company to expand its market share in the lighting industry. A division of Durocraft, Global Electronics, is a wholesaler of computer cable and accessories.\nOn December 27, 1991, the Company changed its state of incorporation from Texas to Delaware, at which time all of the Company's outstanding common stock was exchanged, share for share, for $.01 par value common stock.\nOn September 30, 1992, the Company formed C\/D\/R Incorporated located in Wilmington, Delaware for the purpose of holding all of the rights to the Company's trademarks. Management believes that these intangible assets have value and the Company will defend them as necessary.\nBackground\nPrior to the advent of air conditioning, ceiling fans were used in homes and other facilities to make hot weather tolerable by reducing air stratification. Developments in air conditioning technology and the pervasive use of central air conditioning and individual air conditioning units limited the market for ceiling fans until the mid 1970's, when high energy costs led to the rediscovery of ceiling fans primarily due to their potential for energy conservation. Additional benefits of utilizing ceiling fans during winter and less temperate periods to circulate warm air concentrated near ceilings down to floor level were also recognized at this time.\nThe Company estimates that annual unit sales of ceiling fans in the United States grew substantially in the 1970's and through 1983, and then declined and have stabilized since that time. Management believes that the principal factors underlying growth of unit sales between 1976 and 1983 were increased penetration of the residential household market, particularly in the northern and western sections of the United States (areas which historically have had a disproportionately low percentage of ceiling fan ownership), a continued shift to lower and medium priced ceiling fans, an increase in multiple fan ownership and replacement purchases. Management attributes the moderation of unit sales since 1983 to the initial saturation in the northern and western sections of the United States following limited usage prior to that time. The Company does not believe that industry unit sales of ceiling fans in the United States market will increase substantially in the foreseeable future. The Company will attempt to expand future sales of its ceiling fans by increasing its market share.\nProducts\nAll of the Company's ceiling fans are manufactured by Fanthing, and most of its light kits are purchased from Sunlit. Fanthing manufactures the ceiling fans based on specifications provided by the Company. The finished products are packaged and labelled by the manufacturer under the Company's trade name, Craftmade(R). Light kits used in conjunction with ceiling fans are similarly produced and packaged.\nCeiling Fans -- The Company's ceiling fan product line consists of 23 series and 125 basic models of ceiling fans for sales to the new construction, remodeling and replacement markets. Series are classified on the basis of cost, air movement and appearance. Craftmade fans are manufactured and assembled in a variety of colors, styles and finishes and can be used either in conjunction with or independent of Craftmade light kits. Series lines include Early American, Traditional and Modern High-Tech Decor and, depending on the size, finish and other features, range in price from the premium Presidential II, Crescent and High-Tech series to various low-end builder series. Suggested retail prices for the various Craftmade fans ranged at June 30, 1995 from $70.00 (builder series) to $780.00 (Cameo Series), which the Company believes are favorably priced relative to other mid-level and premium ceiling fans distributed by Hunter and Casablanca, yet represent comparable quality and performance characteristics.\nThe Company's ceiling fans come in five motor sizes, five blade sizes and 24 different decorative finishes. The range of styles and colors give consumers the ability to select ceiling fans for any style of house, interior decoration or living and working area, including outdoor patios. All Craftmade fans include a dual capacitor system to control motor starting and running; a 16-pole motor for greater efficiency and smoother performance; aluminum rotors die cast for cool running; two sealed heavy duty bearings which are permanently lubricated; balanced blades and blade arms to minimize vibration; blade arm gaskets for quieter performance; reversible switching for summer and winter energy saving; shipping blocks to maintain alignment in transit; and three-speed switches for high, medium, low and off. In management's judgement, although not specifically confirmed by any independent testing service, these features enable the Company's ceiling fans to perform efficiently, consistently and for extended periods. Management also believes that, in addition to these design features, the quality control program adhered to by Fanthing in the course of manufacturing contributes significantly to the quality and durability of the Craftmade fan. All Craftmade fans carry a limited warranty against defects in workmanship and materials covering the entire ceiling fan for one year and also provides a ten year warranty with respect to the motor contained in all fans except the Presidential I, Presidential II, Cameo, Crescent, Sergio and High-Tech Series, which carry a limited lifetime warranty. In addition, while the Company's agreement with Fanthing does not contain provisions relating to adjustments or returns as a result of product defect, Fanthing has previously extended the Company full credit for any product returns during the period of their working relationship.\nLight Kits -- The Company markets 135 models of light kits which may be utilized with the Company's ceiling fans or other ceiling fans. These kits, which consist of the glass shades and fitters, presently represent approximately 15% of the Company's product sales. As of June 30, 1995, suggested retail prices for the Company's light kits ranged from $16.50 to $250.00. Since the demand for the Company's Elegance Collection, which includes lead crystal and alabaster designer shades, has increased, the Company will continue its efforts to expand these premium lines.\nLamps -- The Company assembles and markets a variety of lamp styles for sale to certain major retail chains and catalog houses to be sold under private brand labels. In addition, the Company markets lamps under its own proprietary trade names. The lamps are assembled at the Company's facilities in Grand Prairie, Texas and consist of wood, solid brass, zinc coated, crystal, ceramic and porcelain table, floor and desk lamps as well as hanging lantern kits. At the present time, all of the Company's lamps are sold at retail prices ranging from $58 to $274. Sales of the Company's lamps account for approximately 15% of the Company's product sales.\nAccessories and Cable Components -- The Company also markets a variety of designer and standard wall controls to regulate the speed and intensity of ceiling fans and lighting fixtures and universal downrods for use with ceiling fans. In addition, following the acquisition of DMI Products, Inc. in July 1990, the Company also distributes various cable components, including connectors, switches and compatibles acquired from Far East manufacturers for use with computers and telephone board circuitry. Sales of such accessories and cable components presently account for approximately 5% of the Company's product sales.\nManufacturing\nThe Company's ceiling fans and most of its light kits and certain accessories are produced by Fanthing and Sunlit. The Company has had a working agreement with Fanthing since August 1986 to provide the Company with all of its ceiling fans and certain fan accessories. The Company selected Fanthing to manufacture the Craftmade fan based on its proven capability to produce and ship a wide variety of ceiling fans on a cost effective basis while at the same time maintaining excellent quality control in the manufacturing process. According to information made available to the Company, Fanthing was organized in 1981 and manufactures ceiling fans from a manufacturing facility consisting of in excess of 21,000 square feet in Taichung, Taiwan. The Company believes that a substantial part of Fanthing's revenues are derived from sales of ceiling fans to the Company. On December 7, 1989, the Company and Fanthing entered into a formal written agreement which is terminable on 180 days prior notice. The written agreement does not obligate Fanthing to produce and sell products to the Company in any specified quantity, nor does it obligate Fanthing to sell products to the Company at a fixed price. Fanthing is permitted under the arrangement to manufacture ceiling fans for other distribution provided such ceiling fans are not a replication of Craftmade's series or models. Fanthing also manufactures certain ceiling fan accessories, such as down rods, which are sold by the Company independently of its ceiling fans.\nFanthing has provided the Company with a $1,000,000 credit facility, pursuant to which Fanthing will manufacture and ship ceiling fans prior to receipt of payment from the Company. Accordingly, payment can be deferred until delivery of such products. At present levels, such credit facility is equivalent to approximately one month's supply of ceiling fans and represents a supplier commitment which, in the opinion of the Company, is unusual for the industry. Fanthing is not required to provide this credit facility under its agreement with the Company, and Fanthing may discontinue this arrangement at any time. The Company places orders with Fanthing in anticipation of normally recurring orders. In the ordinary course of business, orders are filled within 60 days which includes approximately 20 days for transport. All orders are in U.S. dollars. In the event of any fluctuation in exchange rates exceeding approximately 5%, any future orders\nplaced by the Company may be adjusted accordingly. Ceiling fans are shipped in container-size lots, generally consisting of 1,600 fan units. Delivery is made in Dallas, Texas upon presentment of documents by the Company's designated freight forwarder following payment for such containers at Fanthing's bank in Taiwan. While the Company believes the present arrangement for purchases and delivery has been generally satisfactory, the demand for Craftmade fans has periodically exceeded the Company's delivery capabilities.\nUnder a stock purchase agreement between the Company and Fancy Industrial, Inc. (\"Fancy\"), a Texas corporation and wholly-owned subsidiary of Fanthing, the Company, at its option, may repurchase 101,196 shares owned by Fancy Industrial, Inc. for an aggregate purchase price of $137,774. The Company has no intention of reacquiring any shares from Fancy at this time. The Company believes that its relationship with Fanthing and its ability to supply quality ceiling fans at competitive prices have been critical to the success of the Company. The Company believes its relationship with Fanthing to be excellent and foresees no reason, based on its association to date, for such relationship to deteriorate. If for any reason Fanthing were to discontinue its relationship with the Company in the future or should it be unable to continue to supply sufficient amounts of Craftmade products, the Company would be required to seek alternative sources of supply. There can be no assurance that any such alternative source of supply will produce products of comparable quality to those produced by Fanthing, or that any such source will sell products to the Company at prices and on terms as favorable as those presently applicable to purchases made by the Company from Fanthing.\nThe Company purchases most of its light kits from Sunlit which is located in Taipei, Taiwan. According to information made available to the Company, Sunlit was organized in January 1989 and occupies a manufacturing facility consisting of approximately 10,000 square feet. The Company believes that substantially all of Sunlit's revenues are derived from the sale of lighting kits to the Company. Light kit orders are placed independently of ceiling fan orders, but are also received in container-size lots generally consisting of up to 4,500 light kit units under payment and delivery arrangements similar to those for ceiling fans. The Company offers a variety of light kits in various finishes and colors, as well as a variety of fixtures designed for ceiling fans. The Company also offers a variety of glass selections for the various light fixtures, including blown glass, beveled glass and crystal. Fixtures and glass are shipped from Sunlit in the light kit containers. The Company's wall controls, timers and switches as well as certain of its ceiling fan blades, representing approximately 1% of the Company's product sales, are manufactured by companies based in the United States. The Company offers a variety of custom blade sets in various sizes and finishes, including unfinished oak, ash and other wood grains and in clear, mirror, gold mirror, black, smoke and antique white acrylic. The finished products are packaged and labeled under the Company's Craftmade brand name.\nThe Company assembles its lamps at its Grand Prairie facilities which includes the placement of the base, cap and shade together with the necessary wiring. Substantially all of the components are manufactured by domestic and foreign manufacturers located in Taiwan, China and Germany; however, the Company does undertake limited manufacturing of certain shade components. The Company purchases its components on a non-exclusive basis from such suppliers on either open account or through letters of credit, and no individual manufacturer accounts for in excess of 3% of such components.\nDistribution\nThe Company's products are marketed through in excess of 1,400 lighting showrooms and electrical wholesalers specializing in sales to the new home construction, remodeling and replacement markets. The Company's ceiling fans, light kits and accessory parts are distributed through 29 independent sales representative groups on a national basis (except for Alaska and\nHawaii). Each sales representative group is selected to represent the Company in a specific market area. The independent sales representative groups comprise a sales force for the Company's products of approximately 52 sales representatives. Sales representatives represent the Company exclusively in the sale of ceiling fans. Sales representatives are paid commissions on such sales. During the fiscal year ended June 30, 1995, no single lighting showroom or electrical wholesaler accounted for more than 2% of the Company's sales.\nSales representatives are carefully selected and continually evaluated in order to promote high level representation of the Company's products. Company personnel provide initial field training to new sales representatives covering features, styles, operation and other attributes of Craftmade products to enable representatives to more effectively market the Company's products. Additional training is provided at least annually, especially for new product series, at semi-annual trade shows held in Dallas, Texas and elsewhere. Management believes it has assembled a highly motivated and effective sales representative organization which has demonstrated a strong commitment to the Company and its products. Management further believes that the strength of its sales representative organization is primarily attributable to the quality and competitive pricing of the Company's products as well as the ongoing administrative and marketing support that the Company provides to its sales representatives.\nAs of June 30, 1995, of the Company's lamps sold to major retail chains and catalog houses to be distributed under private brand labels, approximately 83% were sold to Bombay Company. The balance of these lamp sales are made to various catalog houses and other retail chains including the Horchow Mail Order Catalog and Dr. Livingston. The Company also markets lamps under proprietary labels through lighting showrooms, furniture stores and mass merchandising and department stores.\nThe Company acts as a distributor for various overseas manufacturers of a range of cable components which account for approximately 4% of the Company's total product sales.\nMarketing\nThe Company relies primarily on the reputation of Craftmade ceiling fans and light kits for high quality and competitive prices and the efforts of its sales representative organization in order to promote the sales of the Company's products. The principal market for the Company's products is the new home construction, remodeling and replacement markets. The Company utilizes advertising in home lighting magazines, particularly in special editions devoted to ceiling fans and lighting fixtures, and broadly distributes its product catalog. The Company also promotes its ceiling fans and light kits at semi-annual trade shows in Dallas (January and July), and the Company maintains a showroom at the Dallas Trade Mart. The Company provides the same 10-year limited warranty on the fan motor for each series of its ceiling fans, and includes a one-year limited warranty against defects in workmanship and materials to cover the entire ceiling fan. The Company also provides a limited lifetime warranty on the Presidential series, High-Tech series, Sergio, Cameo and Crescent series ceiling fans. The Company believes these warranties, which are limited to its premium fan series, are highly attractive to dealers and consumers alike.\nProduct Expansion\nThe Company's proposed expansion of its light kit product line will include the development of new lighting fixture product lines to be marketed under the Craftmade name, including under cabinet lighting, bathroom and dressing room lighting, low voltage outside lighting and additional parts and accessories complementing its various product lines. The Company believes that such proposed new product lines will complement its light kit product line and that such product lines can be marketed through the same sales representatives, showrooms and electrical wholesalers\nwhich presently distribute the Company's ceiling fans and light kit products. The Company has commenced discussions with Sunlit and other manufacturers for the production of such new lighting fixture lines.\nBacklog\nAs substantially all of the Company's ceiling fan and lighting kit products are shipped to customers within 72 hours following receipt of orders, backlog is not material to the Company's operations. The Company at present is accepting orders for ceiling fans and light kits based on product availability. At June 30, 1995, Durocraft had approximately $2,300,000 in open lamp orders which are expected to be filled in the current fiscal year, compared with $2,700,000 in open lamp orders at June 30, 1994 which were filled during the year ended June 30, 1995. As a result, Durocraft is required to carry significant amounts of inventory to meet rapid delivery requirements of its customers.\nCompetition\nThe ceiling fan and lighting fixture market is highly competitive at all levels of operation. Some of the major companies in this industry include Casablanca, Hunter, Emerson Electric and Fasco. A number of other well established companies are also currently engaged in activities that compete directly with those of the Company. Some of the Company's competitors are better established, have longer operating histories, have substantially greater financial resources or have greater name recognition than the Company; however, the Company believes that the quality of its products, the strength of its marketing organization and the growing recognition of the Craftmade name will enable the Company to compete successfully in these highly competitive markets.\nIndependent Safety Testing\nAll of the ceiling fans, light kits and lamps sold by the Company in the United States are tested by UL, which is an independent non-profit corporation which tests certain products, including ceiling fans and lighting fixtures, for public safety. Under its agreement with UL, the Company voluntarily submits its products to UL, and UL tests the products for safety. If the product is acceptable, UL issues a listing report which provides a technical description of the product. UL provides the manufacturers with procedures to follow in manufacturing the products. Electrical products which are manufactured in accordance with the designated procedures display the UL listing mark, which is generally recognized by consumers as an indication of a safe product and which is often required by various governmental authorities to comply with local codes and ordinances. The contract between the Company and UL provides for automatic renewal unless either party cancels as a result of default or gives applicable prior notice.\nProduct Liability\nThe Company is engaged in a business which could expose it to possible claims for injury resulting from the failure of its products sold. While no material claims have been made against the Company since its inception and the Company maintains $10,000,000 in product liability insurance, there can be no assurance that claims will not arise in the future or that the coverage of such policy will be sufficient to pay such claims.\nPatents and Trademarks\nThe Company does not believe that patent protection is significant to most of the Company's\nproducts or current business operations. The Company holds a patent on its Cathedral Ceiling Adapter and the license on the patents for the Crescent Series fan and the Carousel light kit. The Company also holds certain other license agreements which is in the ordinary course of its business. Fanthing holds certain Taiwanese patents covering specific technology employed in Craftmade ceiling fans, but the Company does not believe that such patents are material to the production of Craftmade products. The Company's trademarks, Craftmade(R) and Durocraft(R), are registered with the United States Patent and Trademark office.\nEmployees\nAs of July 31, 1995, the Company employed a total of 98 full time employees, including four executive officers, nine managers, thirteen clerical and administrative personnel, ten marketing, twenty-eight warehouse and thirty-four production personnel. The Company's employees are not covered by any collective bargaining agreements, and the Company believes its employee relations are satisfactory.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's headquarters are located in Grand Prairie, Texas and consist of approximately 172,000 square feet of leased general office and warehouse space. The lease will expire in December 1995 and provides for monthly rental payments of $50,872. The Company believes that its present facilities will be sufficient for its purposes through the term of the lease. The Company also leases 1,656 square feet of permanent display facilities at the Dallas Trade Mart. The lease will expire in April 1998 and provides for monthly rental payments of approximately $2,993.\nThe Company has a contract to purchase a new facility that is to consist of approximately 378,000 square feet of general office and warehouse space and is currently under construction in Coppell, Texas at an estimated purchase price of $9,200,000. The Company anticipates that it will purchase this new facility and relocate its operations during December 1995 . The Company's management believes that this facility will be sufficient for its purposes for the foreseeable future. The Company has obtained a commitment from a financial institution to finance the Company's purchase of this facility at an interest rate of 8.125% for a term of twelve years.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThere are certain pending claims and matters incidental to normal business operations of the Company. Although the ultimate outcome of these claims is not presently known, in the opinion of management, it is unlikely that the resolution of any present claims will have a material impact on the financial condition of the Company.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNot applicable.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS\nSince the initial public offering of the Company's Common Stock at $3.50 per share on April 16, 1990, the Common Stock has been traded on NASDAQ under the symbol CRFT. On July 16, 1992, the Company was approved for inclusion in the National Market System of NASDAQ. At that time, the Company voluntarily delisted its common shares from the Boston Stock Exchange. Prior thereto, the Company's shares traded on a limited basis on that exchange. Prior to April 16, 1990, there was no public market for the Common Stock.\nThe following table sets forth for the periods indicated the high and low closing sales prices per share of Common Stock on the NASDAQ National Market System, as reported by NASDAQ.\nOn July 31, 1995, there were 157 holders of record of the Company's Common Stock.\nNorth American Transfer Company, 147 West Merrick Road, Freeport, New York 11520, is the Transfer Agent and Registrar for the Company's Common Stock.\nOn March 15, 1994, the Company's Board of Directors adopted a policy to pay $0.01 per share dividend on a quarter to quarter basis within the discretion of the Board out of the capital surplus or profits of the Company. The quarterly dividends may not exceed 40% of the Company's net profit before taxes as restricted by the Company's revolving line of credit. Pursuant to this policy, the Board has declared and paid a quarterly dividend for each quarter since March 31, 1994.\nCompany Common Stock Price Performance Graph\nThe following graph provides an indicator of and compares the percentage change of cumulative total shareholder return of the Company's Common Stock against the cumulative total return of the Russell 2000 Index and the NASDAQ Composite Index since the initial public\noffering of the Company's Common Stock on April 16, 1990. This graph assumes $100 was invested on April 16, 1990 in the Company's Common Stock, the Russell 2000 Index and the NASDAQ Composite Index. Both the Russell 2000 Index and the NASDAQ Composite Index exclude the Company.\nThe historical stock price performance of the Company's Common Stock shown on the graph above is not necessarily indicative of future stock performance.\nThe Company has compared its stock price performance with that of the Russell 2000 Index as it does not believe it can reasonably identify a peer group and no comparable published industry or line-of-business index is available. The Russell 2000 Index consists of companies with market capitalization similar to that of the Company; accordingly, the Company believes the Russell 2000 Index is the best available performance comparison.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe selected financial data in the tables below are for the five fiscal years ended June 30, 1995. The data should be read in conjunction with the financial statements and notes, which are included elsewhere herein. The amounts listed below are in thousands (except per share amounts).\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nYear Ended June 30, 1995 compared to June 30, 1994\nNet sales increased to $34,352,775 for the year ended June 30, 1995 from $32,130,223 for the year ended June 30, 1994, representing an increase of $2,222,552, or 6.9%. This increase in sales was primarily attributable to a 6.5% increase in sales from the Company's fan division as a result of the expansion of this division's customer base in excess of 10% and the continued success of new product introductions, despite the significant weakness in new home construction throughout the nation that affected the entire industry. This increase was supported by a 17% increase in lamp sales, primarily attributable to the addition of several new lamp styles to this division's major customer. The Company's increase in sales during fiscal 1995 was less than its historical levels of 15-20% primarily resulting from the downturn in new home construction. The Company is well positioned for sales growth at its historical levels should interest rates and consumer confidence stabilize, which would add strength to the resurgence of new home construction. Sales during fiscal 1995 to one of the lamp division's customers represented approximately 12% of the Company's fiscal 1995 consolidated sales. Recently, this customer has experienced a decline in sales which may adversely impact their level of purchases from the lamp division. However, the Company is focusing on broadening its customer base in the lamp division to minimize any negative impact this trend may have.\nGross profit increased to $12,380,599, or 36.0% of sales, for the year ended June 30, 1995, as compared to $11,728,649, or 36.5% of sales, for the year ended June 30, 1994. The Company experienced a decrease in its gross profit percentage primarily as a result of a 9% increase in costs of certain raw materials associated with the manufacture of its products, partially offset by a price increase to the Company's customers implemented during May 1995. As prices have stabilized for these raw materials and as the Company continues to introduce additional higher end products into the market gross margins have begun to improve. The Company's management anticipates that this trend will continue.\nTotal selling, general and administrative expenses increased $1,198,107 to $8,640,636, or 25.2% of sales, for the year ended June 30, 1995 from $7,442,529, or 23.2% of sales, for the year ended June 30, 1994. This increase was primarily attributable to (i) an increase in commissions and certain other costs directly correlated to the increase in sales and (ii) an increase in costs associated with the growth in the Company's workforce during the year ended June 30, 1995. The Company's management believes that the Company's current work force can adequately service the anticipated sales growth of the Company without incurring a proportionate increase in selling, general and administrative expenses. The Company's management also anticipates a decrease\nin certain costs associated with leasing a facility after the purchase and relocation of the Company's operations to the new facility, anticipated to be December 1995.\nNet interest expense increased $181,232 to $520,659 for the year ended June 30, 1995 from $339,427 for the year ended June 30, 1994. This increase was primarily the result of increases in the bank's prime lending rate, coupled with increases in indebtedness required to finance the Company's current growth and its stock repurchase program. The Company's management anticipates that interest expense in fiscal 1996 related to the line of credit may stabilize as interest rates settle and through the successful negotiation of the renewal of the Company's line of credit in November 1995. The Company also anticipates that total interest expense will increase in fiscal 1996 related to the financing of the new facility purchase.\nThe provision for income taxes decreased to $1,073,551, or 36.1% of income before income taxes for the year ended June 30, 1995 from $1,303,320, or 35.3% of income before income taxes, for the year ended June 30,1994.\nNet income decreased to $1,903,1175 or $.55 per share, for the year ended June 30, 1995 from $2,385,026, or $.69 per share, for the year ended June 30, 1994. This decrease was primarily the result of the decrease in the Company's gross profit percentage and increases in selling, general and administrative expenses.\nYear Ended June 30, 1994 compared to June 30, 1993\nNet sales increased to $32,130,223 for the year ended June 30, 1994 from $27,479,068 for the year ended June 30, 1993, representing an increase of $4,651,155, or 16.9%. This increase in sales was primarily attributable to a 24.5% increase in fan sales through the Company's continuing increase in market share, the success of new product introduction and the rise in housing starts. Improved fan sales were partially offset by an 11.1% decrease in lamp sales as the division adjusted to the loss of a major customer in 1992.\nGross profit increased to $11,728,649, or 36.5% of sales, for the year ended June 30, 1994, from $9,043,013, or 32.9% of sales, for the year ended June 30, 1993. This increase was primarily the result of a continuing growth in sales of the Company's higher end product line as consumers began to focus on the decorative as well as functional aspects of ceiling fans.\nTotal selling, general and administrative expenses increased $1,565,507 to $7,442,529, or 23.2% of sales, for the year ended June 30, 1994 from $5,877,022, or 21.4% of sales, for the year ended June 30, 1993. This increase was attributable to (i) an increase in freight expense related to a change in the Company's freight policy, (ii) an increase in commissions and certain other costs directly correlated to sales and (iii) an increase in costs associated with a 21% increase in the Company's work force.\nNet interest expense decreased $595 to $339,427 for the year ended June 30, 1994 from $340,022 for the year ended June 30, 1993. This decrease was primarily the result of reductions in the bank's prime lending rate throughout the year, partially offset by the Company's higher borrowing base over the prior year necessary to finance the Company's current growth.\nThe provision for income taxes increased to $1,303,320, or 35.3% of income before income taxes, for the year ended June 30, 1994 from $954,105, or 36.7% of income before income taxes, for the year ended June 30, 1993.\nNet income increased to $2,385,026, or $.69 per share, for the year ended June 30, 1994 from $1,646,137, or $.48 per share, for the year ended June 30, 1993. This increase was primarily the\nresult of the increase in sales and gross margins, partially offset by increases in selling, general and administrative expenses.\nYear Ended June 30, 1993 compared to June 30, 1992\nNet sales increased to $27,479,068 for the year ended June 30, 1993 from $22,750,227 for the year ended June 30, 1992, representing an increase of $4,728,841, or 20.8%. This increase in sales was primarily attributable to a nearly 10% increase in the Company's customer base, the success of several new products introduced by the Company this year, the continuing increase in market penetration by the ceiling fan division and a 65% increase in lamp division sales. These increases are particularly positive considering the unusually poor weather experienced during the second half of fiscal 1993 and the apparent wariness by consumers regarding the current political climate.\nGross profit increased from $7,555,244, or 33.2% of sales, for the year ended June 30, 1992 to $9,043,013, or 32.9% of sales, for the year ended June 30, 1993. The slight decrease in gross profit as a percentage of sales was a result of inefficiencies encountered in the lamp division during its higher than anticipated growth, but was partially offset by the continuing increase in gross profit as a percentage of sales in the ceiling fan division as demand for its higher end products increased.\nThe Company continued to demonstrate its ability to service increasing sales without proportionately increasing selling, general and administrative expenses. During fiscal 1993, the Company incurred an 11.3% increase, or $595,086, in its selling, general and administrative expenses over fiscal 1992 expenses of $5,281,936, or 23.2% of sales. This increase to $5,877,022, or 21.4% of sales, in fiscal 1993 was primarily attributable to (i) an increase in expenses related to the marketing of the Company's products, (ii) an increase in commissions related to the increase in sales, and (iii) an increase in salaries and related payroll costs corresponding with the increase in the Company's labor force.\nNet interest expense decreased from $410,791 or 1.8% of sales, for the year ended June 30, 1992 to $340,022, or 1.2% of sales, for the year ended June 30, 1993, representing a decrease of $70,769, or 17.2%. This decrease was primarily attributable to the decrease in the Company's interest rate on its line of credit through the reductions in the prime lending rate and the successful negotiation by management of a reduction in its borrowing rate, but was partially offset by the Company's higher borrowing base this year compared to last year.\nThe provision for income taxes increased from $558,203, or 34.5% of income before income taxes, for the year ended June 30, 1992 to $954,105, or 36.7% of income before income taxes, for the year ended June 30, 1993. The increase in the effective tax rate resulted primarily from the accrual of additional state taxes after the recent change in the state of Texas tax structure.\nNet income increased to $1,646,137, or $.48 per share, for the year ended June 30, 1993 from $1,060,064, or $.31 per share, for the year ended June 30, 1992, representing an increase of $586,073 or 55.3%. This increase in net income was a result of the increase in sales coupled with the decrease in overhead expenses as a percentage of sales and the decrease in interest expense, but was partially offset by an increase in the Company's effective tax rate.\nLiquidity and Capital Resources\nFiscal year ended June 30, 1995 -- The Company's cash increased $152,392, from $116,311 at June 30, 1994 to $268,703 at June 30, 1995. The Company's operating activities provided cash of $364,186, primarily from net income and decreases in accounts receivable of $452,062, offset by increases in inventory of $1,437,940 and prepaid assets of $678,046. The overall increase in\ninventory is primarily attributable to purchasing based on historical requirements to meet anticipated sales growth. As mentioned previously, the downturn in new home construction during the latter part of fiscal 1995 limited the Company's sales growth. It is management's belief that the Company is well positioned for sales growth with the resurgence in new home construction and the current levels of inventory will be sufficient to meet customer's demands.\nThe cash used by investing activities of $84,610 related to the purchase of warehouse equipment and general office furniture.\nCash used by financing activities of $127,184 was primarily the result of the repurchase of 192,000 of the Company's Common Stock at an aggregate cost of $1,757,318, coupled with dividends paid totalling $136,141, but partially offset by $1,755,000 in additional borrowings on the Company's line of credit.\nOn November 15, 1994, the Company's management negotiated an additional $2,000,000 on its existing line of credit increasing its line to $10,000,000. The Company's management believes that its current line of credit, combined with cash flow from operations, is adequate to fund the Company's current operating needs and its projected growth over the next twelve months.\nOn January 27, 1995, the Company's Board of Directors authorized the Company's management to initiate a stock repurchase program. Under the terms of this program, the Company, at its option, may purchase up to 200,000 shares of the Company's Common Stock. At June 30, 1995, the Company had purchased 192,000 shares at an aggregate cost of $1,757,318 related to this program.\nThe Company also has a contract to purchase a 378,000 square foot facility that is currently under construction, consisting of general office and warehouse space, at an estimated purchase price of $9,200,000. The Company anticipates that it will purchase this new facility and relocate its operations upon completion of this facility during December 1995. The Company has obtained a commitment from a financial institution to finance the purchase of this facility at an interest rate of 8.125% for a term of twelve years. During the fiscal year ended June 30, 1995, the Company made deposits of $503,500 in relation to the purchase of this facility, of which $384,000 is refundable upon the purchase of this facility. The Company's management believes that this facility will be sufficient for its purposes for the foreseeable future.\nFiscal year ended June 30, 1994 -- The Company's cash decreased $94,696, from $211,007 at June 30, 1993 to $116,311 at June 30, 1994. The Company used $559,427 in cash from operations. This use of cash was primarily due to increases in inventory of $1,220,873 and accounts receivable of $1,979,647, partially offset by net income and from certain expenses not requiring cash.\nThe cash used by investing activities of $283,093 related to the purchase of warehouse equipment, the upgrading of the Company's computer system and the addition of office space to accommodate the lamp division.\nCash provided by financing activities of $747,824 was primarily the result of $825,000 in additional borrowings on the Company's line of credit, partially offset by quarterly dividends of $68,921.\nFiscal year ended June 30, 1993 -- The Company's cash increased $117,510, from $93,497 at June 30, 1992 to $211,007 at June 30, 1993. The Company used $65,268 in cash from operations. This use of cash was primarily due to increases in inventory of $1,803,100, partially offset by increased profitability and from certain expenses not requiring cash.\nThe cash used by investing activities of $127,482 related to the purchase of lamp division\nequipment and general warehouse equipment and an upgrade of the Company's computer system.\nThe cash provided by financing activities of $310,260 was primarily the result of $550,000 in additional advances on the Company's line of credit, offset by the note payment of $250,000 made to a shareholder.\nAccounting Changes\nImpairment of Assets -- FAS 121\nIn March 1995, the Financial Accounting Standards Board issued FAS 121 on \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.\" This statement requires companies to investigate potential impairments of long-lived assets, certain identifiable intangibles, and associated goodwill on an exception basis, when there is evidence that events or changes in circumstances have made recovery of an asset's carrying value unlikely. The Company is required to adopt this statement by July 1, 1996; however, such adoption is not expected to have a material impact on the Company's results of operations or financial condition.\nInflation\nAlthough the Company experienced an increase in its product costs during fiscal year 1995 which resulted in lower margins, generally inflation has not had, and the Company does not expect it to have, a material impact upon operating results. However, there can be no assurance that the Company's business will not be affected by inflation in the future.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS\nThe financial statements and supplementary data are included under Item 14(a)(1) and (2) 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 information relating to the Company's directors and nominees for election as directors of the Company is incorporated herein by reference from the Company's Proxy Statement (herein so called) for its 1995 Annual Meeting of Shareholders, specifically the discussion under the heading \"Election of Directors.\" It is currently anticipated that the Proxy Statement will be publicly available and mailed to shareholders in September 1995.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe discussion under \"Remuneration of Directors and Officers and Certain Transactions\" in the Company's Proxy Statement is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe discussion under \"Voting and Principal Shareholders\" in the Company's Proxy Statement is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nNot applicable.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, 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 financial statements listed in the \"Index to Consolidated Financial Statements and Financial Statement Schedule\" described at.\n2. Financial Statement Schedule -- The financial statement schedule listed in the \"Index to Consolidated Financial Statements and Financial Statement Schedule\" described at.\n3. Exhibits -- Refer to (b) below.\n(b) 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 August 28, 1995.\nCraftmade International, Inc.\nBy: \/s\/ JAMES RIDINGS James Ridings, Chairman of the Board, President and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE\nFinancial statement schedules have been omitted since they are either not required, not applicable, or the required information is shown in the financial statements or related notes.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholders of Craftmade International, Inc.\nIn our opinion, the consolidated financial statements listed in the index appearing on page present fairly, in all material respects, the financial position of Craftmade International, Inc. and its wholly-owned subsidiaries (the \"Company\") at June 30, 1994 and 1995, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 1995, 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.\n\/s\/ PRICE WATERHOUSE LLP PRICE WATERHOUSE LLP\nFort Worth, Texas August 18, 1995\nCRAFTMADE INTERNATIONAL, INC. AND ITS SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF INCOME\nThe accompanying notes are an integral part of these consolidated financial statements.\nCRAFTMADE INTERNATIONAL, INC. AND ITS SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\nASSETS\nThe accompanying notes are an integral part of these consolidated financial statements.\nCRAFTMADE INTERNATIONAL, INC. AND ITS SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS (CONTINUED)\nLIABILITIES AND SHAREHOLDERS' EQUITY\nThe accompanying notes are an integral part of these consolidated financial statements.\nCRAFTMADE INTERNATIONAL, INC. AND ITS SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nThe accompanying notes are an integral part of these consolidated financial statements.\nCRAFTMADE INTERNATIONAL, INC. AND ITS SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)\nSupplemental disclosures of cash flow information:\nThe accompanying notes are an integral part of these consolidated financial statements.\nCRAFTMADE INTERNATIONAL, INC. AND ITS SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY\nFOR THE THREE YEARS ENDED JUNE 30, 1995\nThe accompanying notes are an integral part of these consolidated financial statements.\nCRAFTMADE INTERNATIONAL, INC.AND ITS SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1 - ORGANIZATION AND NATURE OF THE COMPANY\nORGANIZATION\nCraftmade International, Inc. (\"Craftmade\") was incorporated in the state of Texas in July 1985 under the name of Mastercraft International, Inc. In January 1987, Craftmade's Articles of Incorporation were amended to reflect Craftmade's current name. On July 26, 1990, Craftmade formed Durocraft International, Inc., a wholly-owned subsidiary of Craftmade International, Inc., and consummated an agreement and plan of merger with Durocraft International, Inc. and DMI Products, Inc., a lamp manufacturer based in Fort Worth. On December 27, 1991, Craftmade changed its state of incorporation from Texas to Delaware. On September 30, 1992, Craftmade formed C\/D\/R Incorporated, a wholly-owned subsidiary of Craftmade International, Inc., and transferred the rights of its trademarks to this subsidiary. Craftmade and Durocraft International are located in Grand Prairie, Texas. C\/D\/R Incorporated is located in Wilmington, Delaware.\nNATURE OF THE COMPANY\nCraftmade is a wholesaler\/distributor which provides customers with a complete selection of ceiling fans and light kits for ceiling fans. Craftmade currently sells and ships to customers nationwide from its Grand Prairie, Texas warehouse\/headquarters location through a network of independent sales representatives. Durocraft International, Inc. (\"Durocraft\") is a lamp manufacturer whose customer base includes major specialty chains. A division of Durocraft, Global Electronics, Inc., is a wholesaler of computer cable and accessories.\nNOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBASIS OF PRESENTATION - The consolidated financial statements of the Company include the accounts of Craftmade International, Inc. and its wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated.\nCONCENTRATION OF CREDIT RISK - Financial instruments which potentially subject the Company to concentrations of credit risk consist primarily of trade receivables. Substantially all of the Company's customers are lighting showrooms; however, credit risk is limited due to the Company's large number of customers and their dispersion across many different geographic locations. As of June 30, 1995, the Company had no significant concentration of credit risk.\nINVENTORIES - Inventories are stated at the lower of cost or market, with inventory cost determined using the first-in, first-out (FIFO) method. The cost of inventory includes freight-in and duties on imported goods.\nProperty and equipment - Property and equipment is recorded at cost. Depreciation is determined using the straight-line method over the estimated useful lives of the property and equipment, which range from three to seven years.\nMaintenance and repairs are charged to expense as incurred; renewals and betterments are charged to appropriate property or equipment accounts. Upon sale or retirement of depreciable assets, the cost and related accumulated depreciation is removed from the accounts, and the resulting gain or loss is included in the results of operations in the period of the sale or retirement.\nAdvertising Cost - The Company's advertising expenditures are expensed in the period the advertising first occurs. Advertising expense for the fiscal years ended June 30, 1993, 1994 and 1995 was $232,216, $266,236 and $279,126, respectively.\nGoodwill - Goodwill related to the Company's acquisition of DMI Products, Inc. in 1990 is being amortized using the straight-line method over 10 years. Accordingly, goodwill amortization has been recorded in the accompanying consolidated statements of income of $63,091, $40,344 and $55,644 for the years ended June 30, 1993, 1994 and 1995, respectively. Goodwill was also reduced by $47,948 upon the adoption of FAS 109 during the year ended June 30, 1994. See Note 4.\nIncome Taxes - In July 1993, the Company adopted Statement of Financial Accounting Standards No. 109 (FAS 109), Accounting for Income Taxes. The adoption of FAS 109 changes the Company's method of accounting for income taxes from the deferred method (APB 11) to an asset and liability approach. Previously the Company deferred the past 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 of temporary differences between the carrying amounts and the tax bases of other assets and liabilities. The adoption of FAS 109 had no material impact on the Company's results of operations for financial condition.\nImpairment of Assets - In March 1995, the Financial Accounting Standards Board issued FAS 121 on \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.\" This statement requires companies to investigate potential impairments of long-lived assets, certain identifiable intangibles, and associated goodwill on an exception basis, when there is evidence that events or changes in circumstances have made recovery of an asset's carrying value unlikely. The Company is required to adopt this statement by July 1, 1996; however, such adoption is not expected to have a material impact on the Company's results of operations or financial condition.\nEarnings per Common Share - Earnings per common share is based upon the weighted average number of shares of common stock and common stock equivalents outstanding during the periods.\nFor purposes of computing earnings per common share, stock options outstanding during each of the years in the three year period ended June 30, 1995 were treated as common stock equivalents using the treasury stock method. The aggregate number of shares added to weighted average shares as common stock equivalents at June 30, 1993, 1994 and 1995 were 73,842, 41,362 and 14,719, respectively.\nWeighted average number of shares including common stock equivalents, outstanding at June 30, 1993, 1994 and 1995 were, 3,453,567, 3,472,302 and 3,431,436, respectively.\nNOTE 3 - REVOLVING LINE OF CREDIT\nOn November 15, 1994, the Company negotiated an additional $2,000,000 availability on its existing line of credit, increasing its line to $10,000,000, bearing interest at the bank's prime lending rate\n(7.8125% at June 30, 1995). The line of credit is due on demand; however, if no demand is made, it is scheduled to mature November 15, 1995. This line of credit contains certain financial covenants, which include current ratio, consolidated tangible net worth, fixed charge coverage ratio, leverage ratio and capital expenditures, of which the Company is in compliance at June 30, 1995. In addition, this line of credit contains a restriction that the Company may not pay quarterly dividends in excess of 40% of the Company's net profit before taxes. This line of credit is secured by inventory, accounts receivable and equipment. Weighted average interest rate on borrowings outstanding at June 30, 1994 and 1995 was 7.25% and 7.8125%, respectively.\nNOTE 4 - INCOME TAXES\nComponents of the provision for income taxes for the years ended June 30, 1993, 1994 and 1995 consist of the following:\nDeferred taxes are provided for temporary differences between the financial reporting basis and the tax basis of the Company's assets and liabilities. The temporary differences that give rise to deferred tax assets and liabilities at June 30, 1993, 1994 and 1995 are as follows:\nThe differences between the Company's effective tax rate and the federal statutory rate of 34% for the years ended June 30, 1993, 1994 and 1995 are as follows:\nUpon adoption of FAS 109 for the fiscal year ended June 30, 1994, the Company recognized a deferred tax benefit of $47,948 representing the expected tax benefit of an unutilized net operating loss carryforward acquired in the purchase of the assets of DMI Products, Inc. in July 1990. The Company correspondingly reduced goodwill by this amount. A valuation allowance has not been established as the Company believes that it is more likely than not to realize this benefit before it expires in fiscal year 2005. During the year ended June 30, 1995, the Company utilized $20,098 of this deferred tax benefit.\nNOTE 5 - SHAREHOLDERS' EQUITY\nEMPLOYEE STOCK OPTION PLANS\nOn December 15, 1989, the Company granted to five key employees, including the President, options to purchase an aggregate of 200,000 shares of Common Stock of the Company at $.70 per share. Under the terms of the grant, the right to exercise such options vest as follows, provided such individuals remain in the employ of the Company:\nThe options are exercisable for a five-year period subsequent to vesting, except that following departure from the Company, exercisable options that have accrued must be exercised within three months of termination of employment. The right to exercise such options will immediately vest if in excess of 50% of the Company's shares of Common Stock are acquired by third parties resulting in a change of control of the Company or a majority of the Company's assets are sold in a transaction not in the ordinary course of the Company's business. The vesting schedule and exercise period related to such options is also accelerated in the event of death, disability or early retirement.\nOption activity during fiscal 1993, 1994 and 1995 is as follows:\nThe estimated fair value of the Common Stock underlying the options at date of grant was $1.75 per share. The difference between the appraised value and the aggregate exercise price of such shares is deemed future compensation to the recipients of such options. Accordingly, such compensation has been charged to operations through June 30, 1994. The Company has charged $42,928 to operations for the years ended June 30, 1993 and 1994, respectively, related to such options.\nOn December 31, 1992, the Company granted to two additional key employees options to purchase an aggregate of 30,000 shares of Common Stock of the Company at $6.56 per share, the average market value of Common Stock at date of grant. Under the terms of the grant, the right to exercise such options vest as follows, provided such individuals remain in the employ of the Company:\nThe options are exercisable for a five-year period subsequent to vesting, except that following departure from the Company, exercisable options that have accrued must be exercised within three months of termination of employment. The right to exercise such options will immediately vest if in excess of 50% of the Company's shares of Common Stock are acquired by third parties resulting in a change of control of the Company or a majority of the Company's assets are sold in a transaction not in the ordinary course of the Company's business. The vesting schedule and exercise period related to such options is also accelerated in the event of death, disability or early retirement.\nThere was no activity regarding these options during fiscal 1994 or 1995. At June 30, 1995, 30,000 options were exercisable.\nSTOCK REPURCHASE\nOn January 27, 1995, the Company's Board of Directors authorized the Company's management to repurchase up to 200,000 shares of the Company's outstanding Common Stock. During the year ended June 30, 1995, the Company acquired 192,000 shares of its Common Stock related to this repurchase program at an aggregate cost of $1,757,318. These repurchased shares are reflected as treasury stock at June 30, 1995 on the accompanying balance sheet.\nDividends\nOn March 15, 1994, the Company's Board of Directors adopted a policy to pay $0.01 per share dividend on a quarter to quarter basis within the discretion of the Board out of the capital surplus or profits of the Company. Pursuant to this policy, the Board has declared and paid a quarterly dividend since March 31, 1994.\nNOTE 6 - COMMITMENTS\nOPERATING LEASES\nThe Company leases various equipment and real estate under long-term, non-cancelable operating lease agreements which require future cash payments.\nThe required future cash payments relating to the Company's non-cancelable operating leases with terms in excess of one year are as follows:\nThe Company incurred rental expense under its operating lease agreements of $680,214, $647,154 and $682,600 for fiscal 1993, 1994 and 1995, respectively.\nFACILITIES\nThe Company has a contract to purchase a new facility that is to consist of approximately 378,000 square feet of general office and warehouse space at an estimated purchase price of $9,200,000. The Company anticipates that it will purchase the new facility and relocate its operations upon completion of this new facility, anticipated to be December 31, 1995. The Company has obtained a commitment from a financial institution to finance the purchase of this facility at an interest rate of 8.125% for a term of twelve years. During the fiscal year ended June 30, 1995, the Company made deposits of $503,500 in relation to the purchase of this facility, which is included in prepaid expenses at June 30, 1995 in the accompanying balance sheet. Of this amount, $384,000 is refundable upon the purchase of this facility.\nNOTE 7 - CONTINGENCIES\nThe Company is involved in certain legal matters. After taking into consideration the Company's insurance coverages and opinion of legal counsel, it is the opinion of management that none of these matters will have a materially adverse effect on the financial position of the Company.\nThe Company provides a limited warranty against workmanship or materials for its ceiling fans for one year and also provides a ten year warranty with respect to the motor contained in all fans except for certain high-end models which carry a limited lifetime warranty. Since inception of the Company's relationship with its major supplier of such fans, the supplier has extended the Company full credit for all product returns. Accordingly, no reserve for warranty has been accrued in the accompanying financial statements. Should the Company's relationship change in the future with respect to such supplier, the Company would be liable for any claims received during the warranty period. Based upon historical experience, management believes future claims resulting from defects in workmanship or materials are not significant to the Company's operations.\nNOTE 8 - 401(k) DEFINED CONTRIBUTION PLAN\nOn July 1, 1992, the Company established a qualified 401(k) defined contributions plan which\ncovers substantially all full-time employees who have met certain eligibility requirements. Employees are allowed to tax defer the lesser of 10% of their annual compensation or $8,994. The Company will match one-half of the participant's contributions up to 6% of their annual compensation. The Company's matching contribution for the year's ended June 30, 1993, 1994 and 1995 aggregated approximately $29,000, $31,000 and $42,000, respectively.\nNOTE 9 - MAJOR SUPPLIER, MAJOR CUSTOMER AND RELATED PARTY\nOn December 7, 1989, the Company and its major Supplier (the \"Supplier\") entered into a written agreement, terminable on 180 days prior notice, pursuant to which the Supplier has agreed to manufacture Craftmade ceiling fans for the Company. The Supplier is permitted under the arrangement to manufacture ceiling fans for other distribution provided such ceiling fans are not a replication of the Craftmade series or models.\nFans and accessories manufactured and sold to the Company by the Supplier account for approximately 75%, 86% and 90% of the Company's purchases in fiscal 1993, 1994 and 1995, respectively. As of June 30, 1994 and 1995, the Supplier owned 101,196 shares of the Company's Common Stock, representing less than 3% of outstanding Common Stock. The Company, at its option, may repurchase the shares for an aggregate purchase price of $137,774.\nSales during fiscal 1995 to one of Durocraft's customers aggregated $4,193,254. Sales to this customer represents approximately 12% of the Company's fiscal 1995 consolidated sales.\nEXHIBIT INDEX\nExhibit No. Description of Exhibit ----------- --------------------------------------------------------- 10(n) Lease agreement by and between Trammel Crow and Craftmade International, Inc.\n10(o) Revolving credit facility with NationsBank\n22 Subsidiaries of the Registrant\n27 Financial Data Schedule","section_15":""}
{"filename":"702402_1995.txt","cik":"702402","year":"1995","section_1":"ITEM 1. BUSINESS\nGeneral\nThe Dyco Oil and Gas Program 1981-1 Limited Partnership (the \"Program\") is a Minnesota limited partnership engaged in the production of oil and gas. The Program commenced operations on Febru- ary 7, 1981 with the primary financial objective of investing its limited partners' subscriptions in the drilling of oil and gas prospects and then distributing to its limited partners all available cash flow from the Program's on-going production operations. Dyco Petroleum Corporation (\"Dyco\") serves as the General Partner of the Program. See \"Item 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nWell Statistics\nThe following table sets forth the numbers of gross and net productive wells of the Program as of December 31, 1995.\nWell Statistics(1) As of December 31, 1995\nGross productive wells(2): Oil 1 Gas 18 -- Total 19\nNet productive wells(3): Oil .60 Gas 1.13 ---- Total 1.73\n- - ----------\n(1) The designation of a well as an oil well or gas well is made by Dyco based on the relative amount of oil and gas reserves for the well. Regardless of a well's oil or gas designation, it may produce oil, gas, or both oil and gas. (2) As used throughout this Annual Report, \"Gross Well\" refers to a well in which a working interest is owned. The number of gross wells is the total number of wells in which a working interest is owned. (3) As used throughout this Annual Report, \"Net Well\" refers to the sum of the fractional working interests owned in gross wells expressed as whole numbers and fractions thereof. For example, a 15% leasehold interest in a well represents one Gross Well, but 0.15 Net Well.\nDrilling Activities\nThe Program participated in no drilling activities for the year ended December 31, 1995.\nOil and Gas Production, Revenue, and Price History\nThe following table sets forth certain historical information concerning the oil (including condensates) and natural gas production, net of all royalties, overriding royalties, and other third party interests, of the Program, revenues attributable to such production, and certain price and cost information.\nNet Production Data\nYear Ended December 31, ---------------------------- 1995 1994 1993 -------- -------- --------\nProduction: Oil (Bbls)(1) 651 1,702 1,916 Gas (Mcf)(2) 173,930 173,376 249,577\nOil and gas sales: Oil $ 10,124 $ 23,109 $ 27,504 Gas 230,127 291,603 446,942 ------- ------- ------- Total $240,251 $314,712 $474,446 ======= ======= ======= Total direct operating expenses $118,744 $125,278 $103,871 ======= ======= ======= Direct operating expenses as a percentage of oil and gas sales 49.4% 39.8% 21.9%\nAverage sales price: Per barrel of oil $15.55 $13.58 $14.35 Per Mcf of gas 1.32 1.68 1.79\nDirect operating expenses per equivalent Mcf of gas(3) $ .67 $ .68 $ .40\n- - ----------\n(1) As used throughout this Annual Report, \"Bbls\" refers to barrels of 42 U.S. gallons and represents the basic unit for measuring the production of crude oil and condensate oil. (2) As used throughout this Annual Report, \"Mcf\" refers to volume of 1,000 cubic feet under prescribed conditions of pressure and temperature and represents the basic unit for measuring the production of natural gas. (3) Oil production is converted to gas equivalents at the rate of six Mcf per barrel, representing the estimated relative energy content of gas and oil, which rate is not necessarily indicative of the relationship of oil and gas prices. The respective prices of oil and gas are affected by market and other factors in addition to relative energy content.\nProved Reserves and Net Present Value\nThe following table sets forth the Program's estimated proved oil and gas reserves and net present value therefrom as of December 31, 1995. The schedule of quantities of proved oil and gas reserves was prepared by Dyco in accordance with the rules prescribed by the Securities and Exchange Commission (the \"SEC\"). As used throughout this Annual Report, \"proved reserves\" refers to those 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 oil and gas reservoirs under existing economic and operating conditions.\nNet present value represents estimated future gross cash flow from the production and sale of proved reserves, net of estimated oil and gas production costs (including production taxes, ad valorem taxes, and operating expenses), and estimated future development costs discounted at 10% per annum. Net present value attributable to the Program's proved reserves was calculated on the basis of current costs and prices at December 31, 1995. Such prices were not escalated except in certain circumstances where escalations were fixed and readily determinable in accordance with applicable contract provisions. The prices used by Dyco in calculating the net present value attributable to the Program's proved reserves do not necessarily reflect market prices for oil and gas production subsequent to December 31, 1995. Furthermore, gas prices at December 31, 1995 were\nhigher than the price used for determining the Program's net present value of proved reserves for the year ended December 31, 1994. There can be no assurance that the prices used in calculating the net present value of the Program's proved reserves at December 31, 1995 will actually be realized for such production.\nThe process of estimating oil and gas reserves is complex, requiring significant subjective decisions in the evaluation of available geological, engineering, and economic data for each reservoir. The data for a given reservoir may change substantially over time as a result of, among other things, additional development activity, production history, and viability of production under varying economic conditions; consequently, it is reasonably possible that material revisions to existing reserve estimates may occur in the near future. Although every reasonable effort has been made to ensure that the reserve estimates reported herein represent the most accurate assessment possible, the significance of the subjective decisions required and variances in available data for various reservoirs make these estimates generally less precise than other estimates presented in connection with financial statement disclosures.\nProved Reserves and Net Present Value From Proved Reserves As of December 31, 1995\nEstimated proved reserves: Natural gas (Mcf) 538,341 Oil and liquids (Bbls) 3,245\nNet present value (discounted at 10% per annum) $431,070\nNo estimates of the proved reserves of the Program comparable to those included herein have been included in reports to any federal agency other than the SEC. Additional information relating to the Program's proved reserves is contained in Note 5 to the Program's financial statements, included in Item 8 of this Annual Report.\nSignificant Properties\nAs of December 31, 1995 the Program's properties consisted of 19 gross (1.73 net) productive wells in which the Program owned a working interest. The Program owned a non-working interest in an additional 12 gross wells. Affiliates of the Program operate 8 (26%) of its total wells. As of December 31, 1995, the Program's net interests in its properties resulted in estimated total proved reserves of 538,341 Mcf of natural gas and 3,245 barrels of oil. Substantially all of the Program's reserves are located in the Anadarko Basin of western Oklahoma and the Texas panhandle, which is an established oil and gas producing basin. All of the Program's properties are located onshore in the continental United States.\nAs of December 31, 1995, the Program's properties in the Anadarko Basin consisted of 18 gross (1.13 net) wells in which the Program owned a working interest. The Program owned a non-working interest in an additional 12 gross wells. Affiliates of the Program operate 7 (23%) of its total wells in the Anadarko Basin. As of December 31, 1995, the Program's net interest in such wells resulted in estimated total proved reserves of approximately 465,734 Mcf of natural gas and approximately 1,040 barrels of crude oil, with a present value (discounted at 10% per annum) of estimated future net cash flow of approximately $354,054.\nTitle to Oil and Gas Properties\nManagement believes that the Program has satisfactory title to its oil and gas properties. Record title to substantially all of the Program's properties is held by Dyco as nominee.\nTitle to the Program's properties is subject to customary royalty, overriding royalty, carried, working, and other similar interests and contractual arrangements customary in the oil and gas industry, to liens for current taxes not yet due, and to other encumbrances. Management believes that such burdens do not materially detract from the value of such properties or from the Program's interest therein or materially interfere with their use in the operation of the Program's business.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nOn November 12, 1992 Larry and Leona Beck filed a lawsuit against Dyco and others in which the plaintiffs alleged damages to their land as a result of remediation operations conducted on the Paul King #1-7 well. (Beck v. Trigg Drilling Company, Inc., et al, C-92-227, District Court of Beckham County, Oklahoma). The Program had an approximate 5.7% interest in the Paul King #1-7 well at the time the lawsuit was filed. The lawsuit alleged claims based on negligence, private nuisance, public nuisance, trespass, unjust enrichment, constructive fraud, and permanent injunctive relief, all in amounts to be determined at trial. A trial was conducted in the matter on February 22, 1994 in which the jury entered a verdict in favor of the plaintiffs in the amount of approximately $5.5 million, consisting of approximately $2.75 million in actual damages and approximately $2.75 million in punitive damages. The Program's share of such verdict is approximately $155,000 in actual damages and approximately $31,000 in punitive damages. See Note 4 to the Program's financial statements included in Item 8 of this Annual Report. Dyco is presently appealing the matter.\nExcept for the foregoing, to the knowledge of the management of Dyco and the Program, neither Dyco, the Program, nor the Program's properties are subject to any litigation, the results of which would have a material effect on the Program's or Dyco's financial condition or operations.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF LIMITED PARTNERS\nThere were no matters submitted to a vote of the limited partners during 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S LIMITED PARTNERSHIP UNITS AND RELATED LIMITED PARTNER MATTERS\nThe Program does not have an established trading market for its units of limited partnership interest (\"Units\"). Pursuant to the terms of the Program's limited partnership agreement, Dyco, as General Partner, is obligated to annually offer a repurchase offer which is based on the estimated future net revenues from the Program's reserves and is calculated pursuant to the terms of the limited partnership agreement. Such repurchase offer is recalculated monthly in order to reflect cash distributions made to the limited partners and other extraordinary events. The following table sets forth, for the periods indicated, Dyco's repurchase offer per Unit and the amount of the\nProgram's cash distributions per Unit for the same period. For purposes of this Annual Report, a Unit represents an initial subscription of $5,000 to the Program.\nRepurchase Cash Price Distributions ---------- -------------\n1994: First Quarter $108 $ - Second Quarter 72 25 Third Quarter 72 - Fourth Quarter 72 -\n1995: First Quarter $ 72 - Second Quarter 72 - Third Quarter 44 - Fourth Quarter 44 -\n1996: First Quarter $ 44 (1)\n- - ----------\n(1) To be declared in March 1996.\nThe Program has 7,070 units outstanding and approximately 2,510 limited partners of record.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nResults of Operations\nGeneral -------\nThe following general discussion should be read in conjunction with the analysis of results of operations provided below. In management's view, it is not possible to predict accurately either the short-term or long-term prices for oil or gas. Specifically, due to the oversupply of natural gas in recent years, certain of the Program's gas producing properties have suffered, and continue to suffer during portions of the year, production curtailments and seasonal reductions in the prices paid by purchasers. Additional curtailments and seasonal or regional price reductions will adversely affect the operations and financial condition of the Program. Gas sales prices, which have generally declined significantly since the mid-1980s, increased during the fourth quarter of 1995. See \"Item 1. Business - Competition and Marketing.\" Actual future prices received by the Program will likely be different from (and may be lower than) the prices in effect on December 31, 1995. In many past years, year- end prices have tended to be higher, and in some cases significantly higher, than the yearly average price actually received by the Program for at least the year following the year-end valuation date. Management is unable to predict whether future gas prices will (i) stabilize, (ii) increase, or (iii) decrease. The amount of the Program's cash flow, however, is dependent on such future gas prices.\nYear Ended December 31, 1995 Compared to Year Ended December 31, 1994 -------------------------------------\nTotal oil and gas sales decreased 23.7% for the year ended December 31, 1995 as compared to the year ended December 31, 1994. This decrease resulted primarily from a decrease in the volumes of oil sold and a decrease in the average price of natural gas sold during the year December 31, 1995 as compared to the year ended December 31, 1994. Volumes of oil sold decreased 1,051 barrels, while volumes of natural gas sold remained relatively constant for the year ended December 31, 1995 as compared to the year ended December 31, 1994. The decrease in volumes of oil sold resulted primarily from diminished production on one well which was shut-in due to mechanical difficulties during a portion of the year ended December 31, 1995. Average natural gas prices decreased to $1.32 per Mcf for the year ended December 31, 1995 from $1.68 per Mcf for the year ended December 31, 1994, while average oil prices increased to $15.55 per barrel for the year ended December 31, 1995 from $13.58 per barrel for the year ended December 31, 1994.\nOil and gas production expenses (including lease operating expenses and production taxes) decreased 5.2% for the year ended December 31, 1995 as compared to the year ended December 31, 1994. This decrease resulted primarily from an accrual for certain legal contingencies during the year ended December 31, 1994, partially offset by a lease operating expense credit received from the operator of one of the Program's wells as a result of a clerical error during the year ended December 31, 1994. As a percentage of oil and gas sales, these expenses increased to 49.4% for the year ended December 31, 1995 from 39.8% for the year ended December 31, 1994. This percentage increase was primarily a result of the decrease in oil and gas sales discussed above.\nDepreciation, depletion, and amortization of oil and gas properties decreased $9,798 for the year ended December 31, 1995 as compared to the year ended December 31, 1994. This decrease was primarily a result of both an increase in the estimate of the Program's remaining natural gas reserves and the decrease in oil and gas sales discussed above, partially offset by recent additions to the amortizable full cost pool which were incurred in order to improve the ultimate recovery of oil and gas reserves. As a percentage of oil and gas sales, this expense increased to 18.2% for the year ended December 31, 1995 from 17.0% for the year ended December 31, 1994. This percentage increase resulted primarily from the decrease in the average price of natural gas sold during the year ended December 31, 1995 as compared to the year ended December 31, 1994.\nGeneral and administrative expenses increased by $7,631 for the year ended December 31, 1995 as compared to the year ended December 31, 1994. This increase resulted primarily from an increase in both professional fees and printing and postage expenses during the year ended December 31, 1995 as compared to the year ended December 31, 1994. As a percentage of oil and gas sales, these expenses increased to 29.5% for the year ended December 31, 1995 from 20.1% for the year ended December 31, 1994. This percentage increase was primarily a result of the dollar increase in general and administrative expenses as discussed above and the decrease in oil and gas sales discussed above.\nYear Ended December 31, 1994 Compared to Year Ended December 31, 1993 -------------------------------------\nTotal oil and gas sales decreased 33.7% for the year ended December 31, 1994 as compared to the year ended December 31, 1993. This decrease was primarily due to decreases in volumes and average prices of oil and natural gas sold. Volumes of oil and natural gas sold decreased 214 barrels and 76,201 Mcf for the year ended December 31, 1994 as compared to the year ended December 31, 1993. The decrease in volumes of natural gas sold was primarily a result of positive prior period volume adjustments on two wells during the year\nended December 31, 1993. Oil and natural gas prices decreased to averages of $13.58 per barrel and $1.68 per Mcf for the year ended December 31, 1994 from averages of $14.35 per barrel and $1.79 per Mcf for the year ended December 31, 1993.\nOil and gas production expenses (including lease operating expenses and production taxes) increased 20.6% for the year ended December 31, 1994 as compared to the year ended December 31, 1993. This increase was primarily a result of workover charges on two wells which were incurred in order to improve the recovery of reserves and an accrual for certain litigation costs in 1994, which was partially offset by a decrease in production taxes during 1994 related to the decrease in the volumes and average prices of oil and gas sold. As a percentage of oil and gas sales, these expenses increased to 39.8% for the year ended December 31, 1994 from 21.9% for the year ended December 31, 1993. This percentage increase was primarily a result of the decrease in volumes and average price of natural gas sold.\nDepreciation, depletion, and amortization of oil and gas properties decreased $16,066 for the year ended December 31, 1994 as compared to the year ended December 31, 1993. This dollar decrease was primarily due to the decrease in volumes of natural gas sold and upward reserve revisions, partially offset by lower year-end 1994 natural gas prices. As a percentage of oil and gas sales, this expense increased to 17.0% for the year ended December 31, 1994 from 14.7% for the year ended December 31, 1993. This percentage increase was primarily a result of the decrease in the volumes and average price of natural gas sold, partially offset by the dollar decrease in depreciation, depletion, and amortization expense as discussed above.\nGeneral and administrative expenses remained relatively constant for the year ended December 31, 1994 as compared to the year ended December 31, 1993. As a percentage of oil and gas sales, these expenses increased to 20.1% for the year ended December 31, 1994 from 13.5% for the year ended December 31, 1993. This percentage increase was primarily a result of the decrease in volumes and average price of natural gas sold.\nLiquidity and Capital Resources\nNet proceeds from operations less necessary operating capital are distributed to the limited partners on a quarterly basis. See \"Item 5. Market for the Registrant's Limited Partnership Units and Related Limited Partner Matters.\" The net proceeds from production are not reinvested in productive assets, except to the extent that producing wells are improved, or where methods are employed to permit more efficient recovery of reserves, thereby resulting in a positive economic impact. Assuming production levels for the year ended December 31, 1995, the Program's proved reserve quantities at December 31, 1995 would have a life of approximately 3.1 years for gas reserves and 5.0 years for oil reserves.\nThe Program's available capital from the limited partners' subscriptions has been spent on oil and gas drilling activities and there should be no further material capital resource commitments in the future. The Program has no debt commitments. Cash for operational purposes will be provided by current oil and gas production.\nThere can be no assurance as to the amount of the Program's future cash distributions. The Program's ability to make cash distributions depends primarily upon the level of available cash flow generated by the Program's operating activities, which will be affected (either positively or negatively) by many factors beyond the control of the Program, including the price of and demand for oil and natural gas and other market and economic conditions. Even if prices and costs remain stable, the amount of cash available for distributions will decline over time (as the volume of production from producing properties declines) since the Program is not replacing production through acquisitions of producing properties and drilling.\nInflation and Changing Prices\nPrices obtained for oil and gas production depend upon numerous factors, including the extent of domestic and foreign production, foreign imports of oil, market demand, domestic and foreign economic conditions in general, and governmental regulations and tax laws. The general level of inflation in the economy did not have a material effect on the operations of the Program in 1995. Oil and natural gas prices have fluctuated during recent years and generally have not followed the same pattern as inflation. See \"Item 2. Properties - Oil and Gas Production, Revenue, and Price History.\"\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nREPORT OF INDEPENDENT ACCOUNTANTS\nTO THE PARTNERS\nDYCO OIL AND GAS PROGRAM 1981-1 LIMITED PARTNERSHIP\nWe have audited the financial statements of the Dyco Oil and Gas Program 1981-1 Limited Partnership (a Minnesota limited partnership) as listed in Item 14(a) of this Form 10-K. These financial statements are the responsibility of the Program'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 dis- closures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as 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 Dyco Oil and Gas Program 1981-1 Limited Partnership at December 31, 1995 and 1994, and the results of its operations and cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\nCOOPERS & LYBRAND L.L.P.\nTulsa, Oklahoma February 6, 1996\nDYCO OIL AND GAS PROGRAM 1981-1 LIMITED PARTNERSHIP Balance Sheets December 31, 1995 and 1994\nASSETS 1995 1994 -------- --------\nCURRENT ASSETS: Cash and cash equivalents $ 86,202 $ 91,259 Accrued oil and gas sales, including $33,346 and $29,152 due from related parties 37,810 35,597 ------- ------- Total current assets $124,012 $126,856\nNET OIL AND GAS PROPERTIES, utilizing the full cost method 179,288 153,111\nDEFERRED CHARGE 31,560 43,842 ------- -------\n$334,860 $323,809 ======= =======\nLIABILITIES AND PARTNERS' CAPITAL\nCURRENT LIABILITIES: Accounts payable $ 25,822 $ 25,883 Gas imbalance payable 1,383 15,434 ------- ------- Total current liabilities $ 27,205 $ 41,317\nACCRUED LIABILITY 78,165 64,783\nCONTINGENCY (NOTE 4)\nPARTNERS' CAPITAL: General Partner, issued and outstanding, 70 Units 2,294 2,176 Limited Partners, issued and outstanding, 7,000 Units 227,196 215,533 ------- ------- Total Partners' capital $229,490 $217,709 ------- -------\n$334,860 $323,809 ======= =======\nThe accompanying notes are an integral part of these financial statements.\nDYCO OIL AND GAS PROGRAM 1981-1 LIMITED PARTNERSHIP Statements of Operations For the Years Ended December 31, 1995, 1994, and 1993\n1995 1994 1993 -------- -------- -------- REVENUES: Oil and gas sales, including $211,735, $310,817, and $435,795 of sales to related parties $240,251 $314,712 $474,446 Interest 4,886 3,253 2,728 ------- ------- ------- $245,137 $317,965 $477,174\nCOSTS AND EXPENSES: Lease operating $101,650 $102,115 $ 66,473 Production taxes 17,094 23,163 37,398 Depreciation, depletion, and amortization of oil and gas properties 43,661 53,459 69,525 General and administrative 70,951 63,320 64,161 ------- ------- ------- $233,356 $242,057 $237,557 ------- ------- ------- NET INCOME $ 11,781 $ 75,908 $239,617 ======= ======= ======= GENERAL PARTNER (1%) - NET INCOME $ 118 $ 759 $ 2,396 ======= ======= ======= LIMITED PARTNERS (99%) - NET INCOME $ 11,663 $ 75,149 $237,221 ======= ======= ======= NET INCOME per Unit $ 2 $ 11 $ 34 ======= ======= ======= UNITS OUTSTANDING 7,070 7,070 7,070 ======= ======= =======\nThe accompanying notes are an integral part of these financial statements.\nDYCO OIL AND GAS PROGRAM 1981-1 LIMITED PARTNERSHIP Statements of Partners' Capital For the Years Ended December 31, 1995, 1994, and 1993\nGeneral Limited Partner Partners Total -------- ---------- ----------\nBalances at December 31, 1992 $4,324 $428,110 $432,434 Cash distributions ( 3,535) ( 349,965) ( 353,500) Net income 2,396 237,221 239,617 ----- ------- -------\nBalances at December 31, 1993 $3,185 $315,366 $318,551 Cash distributions ( 1,768) ( 174,982) ( 176,750) Net income 759 75,149 75,908 ----- ------- -------\nBalances at December 31, 1994 $2,176 $215,533 $217,709 Net income 118 11,663 11,781 ----- ------- -------\nBalances at December 31, 1995 $2,294 $227,196 $229,490 ===== ======= =======\nThe accompanying notes are an integral part of these financial statements.\nDYCO OIL AND GAS PROGRAM 1981-1 LIMITED PARTNERSHIP Statements of Cash Flows For the Years Ended December 31, 1995, 1994, and 1993\n1995 1994 1993 ---------- ---------- ----------\nCASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 11,781 $ 75,908 $239,617 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation, depletion, and amortization of oil and gas properties 43,661 53,459 69,525 (Increase) decrease in accrued oil and gas sales ( 2,213) 20,261 69,238 (Increase) decrease in deferred charge 12,282 ( 43,842) - Increase (decrease) in accounts payable ( 61) 21,679 ( 654) Increase (decrease) in gas imbalance payable ( 14,051) 5,397 ( 17,221) Increase in accrued liability 13,382 51,454 13,329 ------- ------- ------- Net cash provided by operating activities $ 64,781 $184,316 $373,834 ------- ------- ------- CASH FLOWS FROM INVESTING ACTIVITIES: Additions to oil and gas properties ($ 69,838) ($ 191) ($ 691) Retirements of oil and gas properties - 196 4,554 ------- ------- ------- Net cash provided (used) by investing activities ($ 69,838) $ 5 $ 3,863 ------- ------- ------- CASH FLOWS FROM FINANCING ACTIVITIES: Cash distributions $ - ($176,750) ($353,500) ------- ------- ------- Net cash used by financing activities $ - ($176,750) ($353,500) ------- ------- ------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS ($ 5,057) $ 7,571 $ 24,197\nCASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 91,259 83,688 59,491 ------- ------- ------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 86,202 $ 91,259 $ 83,688 ======= ======= =======\nThe accompanying notes are an integral part of these financial statements.\nDYCO OIL AND GAS PROGRAM 1981-1 LIMITED PARTNERSHIP Notes to Financial Statements For the Years Ended December 31, 1995, 1994, and 1993\n1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nOrganization and Nature of Operations\nThe Dyco Oil and Gas Program 1981-1 Limited Partnership (the \"Program\"), a Minnesota limited partnership, commenced operations on February 7, 1981. Dyco Petroleum Corporation (\"Dyco\") is the General Partner of the Program. Affiliates of Dyco owned 2,570.76 (36.4%) of the Program's Units at December 31, 1995.\nThe Program's sole business is the development and production of oil and natural gas with a concentration on natural gas. Substantially all of the Program's natural gas reserves are being sold regionally in the \"spot market.\" Due to the highly competitive nature of the spot market, prices on the spot market are subject to wide seasonal and regional pricing fluctuations. In addition, such spot market sales are generally short-term in nature and are dependent upon the obtaining of transportation services provided by pipelines.\nCash and Cash Equivalents\nThe Program considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. Cash equivalents are not insured, which cause the Program to be subject to risk.\nCredit Risk\nAccrued oil and gas sales which are due from a variety of oil and natural gas purchasers subject the Program to a concentration of credit risk. Some of these purchasers are discussed in Note 3 - Major Customers.\nOil and Gas Properties\nOil and gas operations are accounted for using the full cost method of accounting. All productive and non-productive costs associated with the acquisition, exploration, and development of oil and gas reserves are capitalized. Capitalized costs are depleted on the gross revenue method using estimates of proved reserves. The full cost amortization rates per equivalent Mcf of gas produced during the years ended December 31, 1995, 1994, and 1993 were $0.25, $0.29, and $0.27, respectively. In the event the unamortized cost of oil and gas properties being amortized exceeds the full cost ceiling (as defined by the Securities and Exchange Commission) the excess is charged to expense in the year during which such excess occurs. In addition, the Securities and Exchange Commission rules provide that if prices decline subsequent to year end, any excess that results from these declines may also be charged to expense during the current year. Sales and abandonments of properties are accounted for as adjustments of capitalized costs with no gain or loss recognized, unless such adjustments would significantly alter the relationship between capitalized costs and proved oil and gas reserves.\nDeferred Charge\nDeferred Charge represents costs deferred for lease operating expenses incurred in connection with the Program's underproduced gas imbalance position. At December 31, 1995, cumulative total gas sales volumes for underproduced wells were less than the Program's pro-rata share of total gas production from these wells by 74,717 Mcf, resulting in prepaid lease operating expenses of $31,560. At December 31, 1994, cumulative total gas sales volumes for underproduced wells were less than the Program's pro- rata share of total gas production from these wells by 105,522 Mcf, resulting in prepaid lease operating expenses of $43,842.\nAccrued Liability\nThe Accrued Liability at December 31, 1995 and 1994 represents charges accrued for lease operating expenses incurred in connection with the Program's overproduced gas imbalance position. At December 31, 1995, cumulative total gas sales volumes for overproduced wells exceeded the Program's pro-rata share of total gas production from these wells by 185,049 Mcf, resulting in accrued lease operating expenses of $78,165. At December 31, 1994, cumulative total gas sales volumes for overproduced wells exceeded the Program's pro-rata share of total gas production from these wells by 156,028 Mcf, resulting in accrued lease operating expenses of $64,783.\nOil and Gas Sales and Gas Imbalance Payable\nThe Program's oil and condensate production is sold, title passed, and revenue recognized at or near the Program's wells under short-term purchase contracts at prevailing prices in accordance with arrangements which are customary in the oil industry. Sales of natural gas applicable to the Program's interest in producing oil and gas leases are recorded as income when the gas is metered and title transferred pursuant to the gas sales contracts covering the Program's interest in natural gas reserves. During such times as the Program's sales of gas exceed its pro rata ownership in a well, such sales are recorded as income unless total sales from the well have exceeded the Program's share of estimated total gas reserves underlying the property at which time such excess is recorded as a liability. At December 31, 1995, total sales exceeded the Program's share of estimated total gas reserves on one well by $1,383 (724 Mcf). At December 31, 1994 total sales exceeded the Program's share of estimated total gas reserves on five wells by $15,434 (10,571 Mcf). These amounts were recorded as gas imbalance payables at December 31, 1995 and 1994 in accordance with the sales method.\nUse of Estimates in Financial Statements\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Further, accrued oil and gas sales, the deferred charge, the gas imbalance payable, and the accrued liability all involve estimates which could materially differ from the actual amounts ultimately realized or incurred in the near term. Contingent liabilities from litigation (see Note 4) and oil and gas reserves (see Note 5) also involve significant estimates which could materially differ from the actual amounts ultimately realized.\nIncome Taxes\nIncome or loss for income tax purposes is includable in the income tax returns of the partners. Accordingly, no recognition has been given to income taxes in the accompanying financial statements.\n2. TRANSACTIONS WITH RELATED PARTIES\nUnder the terms of the Program's partnership agreement, Dyco is entitled to receive a reimbursement for all direct expenses and general and administrative, geological, and engineering expenses it incurs on behalf of the Program. During the years ended December 31, 1995, 1994, and 1993, such expenses totaled $70,951, $63,320, and $64,161, respectively, of which $50,052, $50,052, and $49,572, were paid to Dyco and its affiliates.\nAffiliates of the Program operate certain of the Program's properties. Their policy is to bill the Program for all customary charges and cost reimbursements associated with these activities, together with any compressor rentals, consulting, or other services provided.\nThe Program sells gas at market prices to Premier Gas Company (\"Premier\") and other similar gas marketing firms. Such firms may then resell such gas to third parties at market prices. Premier was an affiliate of the Program until December 6, 1995. During 1995, 1994, and 1993, these sales totaled $211,735, $310,817, and $435,795, respectively. At December 31, 1995 and 1994, accrued oil and gas sales included $33,346 and $29,152, respectively, due from Premier.\n3. MAJOR CUSTOMERS\nThe following purchaser individually accounted for more than 10% of the combined oil and gas sales (excluding the gas imbalance adjustment) of the Program for the years ended December 31, 1995, 1994, and 1993:\nPurchaser 1995 1994 1993 --------- ----- ----- -----\nPremier 88.1% 98.8% 91.9%\nIn the event of interruption of purchases by this significant customer or the cessation or material change in availability of open-access transportation by the Program's pipeline transporters, the Program may encounter difficulty in marketing its gas and in maintaining historic sales levels. Alternative purchasers or transporters may not be readily available.\n4. CONTINGENCY\nOn November 12, 1992, two individuals filed a lawsuit against Dyco and others in which the plaintiffs alleged damages to their land as a result of remediation operations conducted on one of the Program's wells located on an adjoining property. The lawsuit alleged claims based on negligence, private nuisance, public nuisance, trespass, unjust enrichment, constructive fraud, and permanent injunctive relief, all in amounts to be determined at trial. A trial was conducted in the matter on February 22, 1994 in which the jury entered a verdict in favor of the plaintiffs in the amount of approximately $5.5 million, consisting of approximately $2.75 million in actual damages and approximately $2.75 million in punitive damages. Dyco is presently appealing the matter. Included in these financial statements as of December 31, 1995 and 1994 is an accrual by the General Partner of $20,000 representing the Program's share of estimated ultimate damages resulting from this lawsuit.\n5. SUPPLEMENTAL OIL AND GAS INFORMATION\nThe following supplemental information regarding the oil and gas activities of the Program is presented pursuant to the disclosure requirements promulgated by the Securities and Exchange Commission.\nCapitalized Costs\nThe Program's capitalized costs and accumulated depreciation, depletion, amortization, and valuation allowance were as follows:\nDecember 31, ---------------------------- 1995 1994 ------------- -------------\nProved properties $41,186,027 $41,116,189\nUnproved properties, not subject to depreciation, depletion, and amortization - - ---------- ----------\n$41,186,027 $41,116,189\nLess accumulated depreciation, depletion, amortization, and valuation allowance ( 41,006,739) ( 40,963,078) ---------- ----------\nNet oil and gas properties $ 179,288 $ 153,111 ========== ==========\nCost Incurred\nCosts incurred by the Program in connection with its oil and gas property acquisition, exploration, and development activities were as follows:\nDecember 31, ----------------------- 1995 1994 1993 ------- ---- ----\nAcquisition of properties $ - $ - $ - Exploration costs - - - Development costs 69,838 191 691 ------ --- --- Total costs incurred $69,838 $191 $691 ====== === ===\nQuantities of Proved Oil and Gas Reserves - Unaudited\nThe process of estimating oil and gas reserves is complex, requiring significant subjective decisions in the evaluation of available geological, engineering, and economic data for each reservoir. The data for a given reservoir may change substantially over time as a result of, among other things, additional development activity, production history, and viability of production under varying economic conditions; con- sequently, it is reasonably possible that material revisions to existing reserve estimates may occur in the near future. Although every reasonable effort has been made to ensure that the reserve estimates reported herein represent the most accurate assessment possible, the significance of the subjective decisions required and variances in available data for various reservoirs make these estimates generally less precise than other estimates presented in connection with financial statement disclosures.\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 Program is a limited partnership and has no directors or executive officers. The following individuals are directors and executive officers of Dyco, the General Partner. The business address of such directors and executive officers is Two West Second Street, Tulsa, Oklahoma 74103.\nNAME AGE POSITION WITH DYCO ---------------- --- -------------------------------- C. Philip Tholen 47 Chief Executive Officer, Presi- dent, and Chairman of the Board of Directors\nDennis R. Neill 43 Senior Vice President and Director\nJack A. Canon 46 Senior Vice President - General Counsel and Director\nPatrick M. Hall 37 Senior Vice President - Controller\nAnnabel M. Jones 42 Secretary\nJudy F. Hughes 49 Treasurer\nThe directors will hold office until the next annual meeting of shareholders of Dyco and until their successors have been duly elected and qualified. All executive officers serve at the discretion of the Board of Directors.\nC. Philip Tholen - joined the Samson Companies in 1977 and has served as President, Chief Executive Officer, and Director of Dyco since June 18, 1991. Prior to joining the Samson Companies, he was an audit manager for Arthur Andersen & Co. in Tulsa where he specialized in oil and natural gas industry audits and contract audits. He holds a Bachelor of Science degree in accounting from the University of Tulsa and is a Certified Public Accountant. Mr. Tholen is also Executive Vice President, Chief Financial Officer, Treasurer, and Director of Samson Investment Company; President and Chairman of the Board of Directors of Samson Natural Gas Company, Geodyne Resources, Inc. and its subsidiaries, and Samson Resources Company; President of two Divisions of Samson Natural Gas Company, Samson Exploration Company and Samson Production Services Company; Senior Vice President, Treasurer, and Director of Samson Properties Incorporated; and Director of Circle L Drilling Company and Samson Industrial Corporation.\nDennis R. Neill - joined the Samson Companies in 1981 and was named Senior Vice President and Director of Dyco on June 18, 1991. Prior to joining the Samson Companies, he was associated with a Tulsa law firm, Conner and Winters, where his principal practice was in the securities area. He received a Bachelor of Arts degree in political science from Oklahoma State University and a Juris Doctorate degree from the University of Texas. Mr. Neill also serves as Senior Vice President, Chief Operating Officer, and Director of Samson Properties Incorporated; Senior Vice President of Samson Hydrocarbons Company; Senior Vice President and Director of Geodyne Resources, Inc. and its subsidiaries; and President and Chairman of the Board of Directors of Samson Securities Company.\nJack A. Canon - joined the Samson Companies in 1983 and has served as a Vice President and Director of Dyco since June 18, 1991. Prior to joining the Samson Companies, he served as a staff attorney for Terra Resources, Inc. and was associated with the Tulsa law firm of Dyer, Powers, Marsh, Turner and Armstrong. He received a Bachelor of Science degree in accounting from Quincy College and a Juris Doctorate degree from the University of Tulsa. Mr. Canon also serves as Secretary of Samson Investment Company; Director of Samson Natural Gas Company, Samson Properties Incorporated, Circle L Drilling Company, and Samson Securities Company; Senior Vice President - General Counsel of Samson Production Services Company, a Division of Samson Natural Gas Company, and Geodyne Resources, Inc. and its subsidiaries; and Vice President - General Counsel of Samson Industrial Corporation.\nPatrick M. Hall - joined the Samson Companies in 1983 and was named a Vice President of Dyco on June 18, 1991. Prior to joining the Samson Companies he was a senior accountant with Peat Marwick Main & Co. in Tulsa. He holds a Bachelor of Science degree in accounting from Oklahoma State University and is a Certified Public Accountant. Mr. Hall is also a Director of Samson Natural Gas Company and Geodyne Resources, Inc. and its subsidiaries; Senior Vice President - Controller and Director of Samson Properties Incorporated; and Senior Vice President - Controller of Samson Production Services Company, a Division of Samson Natural Gas Company.\nAnnabel M. Jones - joined the Samson Companies in 1982 and was named Secretary of Dyco on June 18, 1991. Prior to joining the Samson Companies she served as associate general counsel of the Oklahoma Securities Commission. She holds Bachelor of Arts in political science and Juris Doctorate degrees from the University of Oklahoma. Ms. Jones serves as Assistant General Counsel - Corporate Affairs for Samson Production Services Company, a Division of Samson Natural Gas Company, and is also Secretary of Samson Properties Incorporated, Samson Natural Gas Company, Geodyne Resources, Inc. and its subsidiaries, and Samson Industrial Corporation; Vice-President, Secretary, and Director of Samson Securities Company; and Assistant Secretary of Samson Investment Company.\nJudy F. Hughes - joined the Samson Companies in 1978 and was named Treasurer of Dyco on June 18, 1991. Prior to joining the Samson Companies, she performed treasury functions with Reading & Bates Corporation. She attended the University of Tulsa and also serves as Treasurer of Samson Natural Gas Company, Geodyne Resources, Inc. and its subsidiaries, and Samson Securities Company and Assistant Treasurer of Samson Investment Company and Samson Industrial Corporation.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe Program is a limited partnership and, therefore, has no officers or directors. The following table summarizes the amounts paid by the Program as compensation and reimbursements to Dyco and its affiliates for the three years ended December 31, 1995:\nCompensation\/Reimbursement to Dyco and its affiliates Three Years Ended December 31, 1995\nType of Compensation\/Reimbursement(1) Expense - - ------------------------------------- ------------------------- 1995 1994 1993 ------- ------- ------- Compensation: Operations $ (2) $ (2) $ (2) Gas Marketing $ (3) $ (3) $ (3)\nReimbursements: General and Administrative, Geological, and Engineering Expenses and Direct Expenses(4) $50,052 $50,052 $49,572\n- - ----------\n(1) The authority for all of such compensation and reimbursement is the limited partnership agreement of the Program. With respect to the Operations activities noted in the table, management believes that such compensation is equal to or less than that charged by unaffiliated persons in the same geographic areas and under the same conditions. (2) Affiliates of the Program serve as operator of a significant portion of the Program's wells. Dyco, as General Partner, contracts with such affiliates for services as operator of the wells. As operator, such affiliates are compensated at rates provided in the operating agreements in effect and charged to all parties to such agreement. The dollar amount of such compen- sation paid by the Program to such affiliates is impossible to quantify as of the date of this Annual Report. (3) Premier, an affiliate of the Program until December 6, 1995, purchased a portion of the Program's gas at market prices and resold such gas at market prices directly to end-users and local distribution companies. For the years ended December 31, 1995, 1994, and 1993, the Program sold $211,735, $310,817, and $435,795, respectively, of gas to Premier. (4) The Program reimburses Dyco and its affiliates for reasonable and necessary general and administrative, geological, and engineering expenses and direct expenses incurred in connection with their management and operation of the Program. The directors, officers, and employees of Dyco and its affiliates receive no direct remuneration from the Program for their services to the Program. See \"Salary Reimbursement Table\" below. The allocable general and administrative, geological, and engineering expenses are apportioned on a reasonable basis between the Program's business and all other oil and natural gas activities of Dyco and its affiliates, including Dyco's management and operation of affiliated oil and gas limited partnerships. The allocation to the Program of these costs is made by Dyco as General Partner.\nAs noted in the Compensation\/Reimbursement Table above, the directors, officers, and employees of Dyco and their affiliates receive no direct remuneration from the Program for their services. However, to the extent such services represent direct involvement with the Program, as opposed to general corporate functions, such persons' salaries are allocated to and reimbursed by the Program. Such allocation to the Program's general and administrative, geological, and engineering expenses of the salaries of directors, officers, and employees of Dyco and its affiliates is based on internal records maintained by Dyco and its affiliates, and represents investor relations, legal, accounting, data processing, management, and other functions directly attributable to the Program's operations. The following table indicates the approximate amount of general and administrative expense reimbursement attributable to the salaries of the directors, officers, and employees of Dyco and its affiliates for the three years ended December 31, 1995:\nIn addition to the compensation\/reimbursements noted above, during the three years ended December 31, 1995, the Samson Companies were in the business of supplying field and drilling equipment and services to affiliated and unaffiliated parties in the industry. Such companies may have provided equipment and services for wells in which the Program has an interest. These equipment and services were provided at prices or rates equal to or less than those normally charged in the same or comparable geographic area by unaffiliated persons or companies dealing at arm's length. The operators of these wells bill the Program for a portion of such costs based upon the Program's interest in the well.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following table provides information as to the beneficial ownership of the Program's Units as of December 31, 1995 by each beneficial owner of more than 5% of the issued and outstanding Units and by the directors, officers, and affiliates of Dyco. The address of each of such persons is Samson Plaza, Two West Second Street, Tulsa, Oklahoma 74103.\nNumber of Units Beneficially Owned (Percent Beneficial Owner of Outstanding) - - ----------------------------------------- -----------------\nSamson Properties Incorporated 2,570.76 (36.4%)\nAll directors, officers, and affiliates of Dyco as a group and Dyco (8 persons) 2,570.76 (36.4%)\nTo the best knowledge of the Program and Dyco, there were no officers, directors, or 5% owners who were delinquent filers of reports required under section 16 of the Securities Exchange Act of 1934.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nDyco and certain of its affiliates engage in oil and gas activities independently of the Program which result in conflicts of interest that cannot be totally eliminated. The allocation of acquisition and drilling opportunities and the nature of the compensation arrangements between the Program and Dyco also create potential conflicts of interest. Dyco and its affiliates own a significant amount of the Program's Units of limited partnership interest and therefore have an identity of interest with other limited partners with respect to the operations of the Program.\nIn order to attempt to assure limited liability for limited partners as well as an orderly conduct of business, management of the Program is exercised solely by Dyco. The partnership agreement of the Program grants Dyco broad discretionary authority with respect to the Program's participation in drilling prospects and expenditure and control of funds, including borrowings. These provisions are similar to those contained in prospectuses and partnership agreements for other public oil and gas partnerships. Broad discretion as to general management of the Program involves circumstances where Dyco has conflicts of interest and where it must allocate costs and expenses, or opportunities, among the Program and other competing interests.\nDyco does not devote all of its time, efforts, and personnel exclusively to the Program. Furthermore, the Program does not have any employees, but instead relies on the personnel of the Samson Companies. The Program thus competes with the Samson Companies (including other currently sponsored oil and gas programs) for the time and resources of such personnel. The Samson Companies devote such time and personnel to the management of the Program as are indicated by the circumstances and as are consistent with Dyco's fiduciary duties.\nAffiliates of the Program are solely responsible for the negotia- tion, administration, and enforcement of oil and gas sales agreements covering the Program's leasehold interests. Until December 6, 1995, Dyco had delegated the negotiation, administration, and enforcement of its oil and gas sales agreements to Premier. In addition to providing such administrative services, Premier purchased and resold gas directly to end-users and local distribution companies. Because affiliates of the Program who provide services to the Program have fiduciary or other duties to other members of the Samson Companies, contract amendments and negotiating positions taken by them in their effort to enforce contracts with purchasers may not necessarily repre- sent the positions that a Program would take if it were to administer its own contracts without involvement with other members of the Samson Companies. On the other hand, management believes that the Program's negotiating strength and contractual positions have been enhanced by virtue of its affiliation with the Samson Companies.\nFor a description of certain other relationships of and related transactions see \"Item 11. Executive Compensation.\"\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) Financial Statements and Schedules. The following financial statements and schedules for the Program as of December 31, 1995 and 1994 and for the years ended December 31, 1995, 1994, and 1993 are filed as part of this report.\n(1) Financial Statements: Report of Independent Accountants Balance Sheets Statements of Operations Statements of Partners' Capital Statements of Cash Flows Notes to Financial Statements\n(2) Financial Statement Schedules:\nNone.\nAll other schedules have been omitted since the required information is presented in the Financial Statements or is not applicable.\n(b) Reports on Form 8-K for the fourth quarter of 1995:\nNone.\n(c) Exhibits:\n4.1 Drilling Agreement dated February 11, 1981 for Dyco Oil and Gas Program 1981-1 by and between Dyco Oil and Gas Program 1981-1, Dyco Petroleum Corporation, and Jaye F. Dyer filed as Exhibit 4.1 to Annual Report on Form 10-K for the year ended December 31, 1991 on April 13, 1992 and is hereby incorporated herein.\n4.2 Form of Program Agreement for Dyco Oil and Gas Program 1981-1 by and between Dyco Petroleum Corporation and the Participants filed as Exhibit 4.2 to Annual Report on Form 10-K for the year ended December 31, 1991 on April 13, 1992 and is hereby incorporated herein.\n4.3 Amendment to Program Agreement for Dyco Oil and Gas Program 1981-1 dated February 9, 1989 filed as Exhibit 4.3 to Annual Report on Form 10-K for the year ended December 31, 1991 on April 13, 1992 and is hereby incorporated herein.\n4.4 Certificate of Limited Partnership, as amended for Dyco Oil and Gas Program 1981-1 Limited Partnership filed as Exhibit 4.4 to Annual Report on Form 10-K for the year ended December 31, 1991 on April 13, 1992 and is hereby incorporated herein.\n27.1 Financial Data Schedule containing summary financial information extracted from the Dyco Oil and Gas Program 1981-1 Limited Partnership's financial statements as of December 31, 1995 and for the year ended December 31, 1995.\nAll other Exhibits are omitted as inapplicable.\nSIGNATURES\nPursuant to the requirements of Sections 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly organized.\nDYCO OIL AND GAS PROGRAM 1981-1 LIMITED PARTNERSHIP\nBy: DYCO PETROLEUM CORPORATION General Partner February 15, 1996\nBy: \/s\/C. Philip Tholen ------------------------------ C. Philip Tholen 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 on the dates indicated.\nBy: \/s\/C. Philip Tholen Chief Executive Feb. 15, 1996 ------------------- Officer, President, C. Philip Tholen and Chairman of the Board (Principal Executive Officer)\n\/s\/Dennis R. Neill Senior Vice Feb. 15, 1996 ------------------- President and Dennis R. Neill Director\n\/s\/Jack A. Canon Senior Vice Feb. 15, 1996 ------------------- President - Jack A. Canon General Counsel and Director\n\/s\/Patrick M. Hall Senior Vice Feb. 15, 1996 ------------------- President - Patrick M. Hall Controller (Principal Accounting Officer)\n\/s\/Annabel M. Jones Secretary Feb. 15, 1996 ------------------- Annabel M. Jones\n\/s\/Judy F. Hughes Treasurer Feb. 15, 1996 ------------------- Judy F. Hughes\nINDEX TO EXHIBITS\nExhibit Number Description - - ------- -----------\n4.1 Drilling Agreement dated February 11, 1981 for Dyco Oil and Gas Program 1981-1 by and between Dyco Oil and Gas Program 1981-1, Dyco Petroleum Corporation, and Jaye F. Dyer filed as Exhibit 4.1 to Annual Report on Form 10-K for the year ended December 31, 1991 on April 13, 1992 and is hereby incorporated herein.\n4.2 Form of Program Agreement for Dyco Oil and Gas Program 1981- 1 by and between Dyco Petroleum Corporation and the Participants filed as Exhibit 4.2 to Annual Report on Form 10-K for the year ended December 31, 1991 on April 13, 1992 and is hereby incorporated herein.\n4.3 Amendment to Program Agreement for Dyco Oil and Gas Program 1981-1 dated February 9, 1989 filed as Exhibit 4.3 to Annual Report on Form 10-K for the year ended December 31, 1991 on April 13, 1992 and is hereby incorporated herein.\n4.4 Certificate of Limited Partnership, as amended for Dyco Oil and Gas Program 1981-1 Limited Partnership filed as Exhibit 4.4 to Annual Report on Form 10-K for the year ended December 31, 1991 on April 13, 1992 and is hereby incorporated herein.\n27.1 Financial Data Schedule containing summary financial information extracted from the Dyco Oil and Gas Program 1981-1 Limited Partnership's financial statements as of December 31, 1995 and for the year ended December 31, 1995.","section_15":""}
{"filename":"106532_1995.txt","cik":"106532","year":"1995","section_1":"Item 1. Business\nThe Company is a Wisconsin corporation incorporated in the year 1906 as Weyenberg Shoe Manufacturing Company. Effective April 25, 1990, the name of the corporation was changed to Weyco Group, Inc.\nThe Company and its subsidiaries engage in one line of business, the manufacture, purchase and distribution of men's footwear. The Company does not sell women's or children's shoes because these markets differ significantly from the men's market. The principal brands of shoes sold are \"Nunn Bush,\" \"Brass Boot,\" \"Stacy Adams,\" and \"Weyenberg\" and trademarks maintained by the Company on these names are important to the business. The Company's products consist of both mid-priced quality leather dress shoes which would be worn as a part of more formal and traditional attire and lower priced quality casual footwear of man-made materials or leather which would be appropriate for leisure or less formal occasions. The Company's footwear, and that of the industry in general, is available in a broad range of sizes and widths, primarily produced or purchased to meet the needs and desires of the American male population.\nThe Company assembles footwear at one manufacturing plant in Wisconsin. Shoe components, referred to as \"uppers,\" are purchased from outside sources, generally foreign, and turned into complete shoes by attaching the sole, either leather or man-made, applying appropriate \"finishes\" and packing the shoes into individual cartons, ready for sale. The Company purchases raw materials and shoe components from many suppliers and is not dependent on any one of them. The supply of these items is generally plentiful and there are no long-term purchase commitments. Over the past five years, production at the Company's plant has accounted for approximately 14% of the value of the Company's wholesale footwear sales.\nIn addition to the production of footwear at the Company's own manufacturing plants, complete shoes are also purchased from many sources worldwide, generally at U. S. dollar prices. These purchases account for the balance of the Company's wholesale footwear sales. In recent years, domestic production of men's shoes by the Company and the industry has declined, while imports to the United States have increased.\nThe Company's business is separated into two divisions - wholesale and retail. Wholesale sales constituted approximately 87% of total sales in 1995, 79% in 1994, and 68% in 1993. At wholesale, shoes are marketed nationwide through more than 8,000 shoe, clothing and department stores. The loss of any one or a few of these retail customers would not have a material adverse effect on the wholesale division sales. The Company employs traveling salesmen who sell the Company's products to the retail outlets. Shoes are shipped to these retailers primarily from warehouses maintained in Milwaukee and Beaver Dam, Wisconsin. Although there is no clearly identifiable seasonality in the men's footwear business, new styles are historically developed and shown twice each year, in spring and fall. In accordance with the industry practices, the Company is required to carry significant amounts of inventory to meet customer delivery requirements and periodically provides extended payment terms to customers.\nRetail sales constituted approximately 13% of total sales in 1995, 21% in 1994 and 32% in 1993. In the retail division there are 18 company-operated stores in principal cities of the United States and 13 leased departments in department stores throughout the country. The decrease in retail sales in recent years is a result of the termination of leased departments and company-operated stores. In 1995, 10 company-operated stores were closed due to unprofitable operations or unattractive lease renewal terms. In 1994, the Company closed 45 leased departments as a result of the termination of a lease agreement with a department store and 7 company-operated stores due to unprofitable operations or unattractive lease renewal terms. In 1993, the Company closed 71 leased shoe departments because of a restructuring at a lessor department store chain and closed 12 company-operated stores because of unprofitable operations or unattractive lease renewal terms. Sales in retail outlets are made directly to the consumer by company employees. In addition to the sale of the Company's brands of footwear in these retail outlets, other branded footwear and accessories are also sold in order to provide the consumer with as complete a selection as practically possible.\nIn dollar sales, the Company is about eighth largest among approximately 900 domestic men's shoe distributors. During 1995 it sold approximately 3% of the total men's non-rubber dress and casual shoes sold in the United States.\nPrice, quality and service are all important competitive factors in the shoe industry and the Company has been recognized as a leader in all of them. Although the Company engages in no specific research and development activities, new products and new processes are continually being tested by the Company and used where appropriate, in order to produce the best value for the consumer, consistent with reasonable price. Compliance with environmental regulations historically has not had, and is not expected to have, a material adverse effect on the Company's results of operations or cash flows.\nApproximately 525 persons are employed by the Company and its subsidiaries.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe following facilities are operated by the Company and its subsidiaries:\n(1) Not a material lease.\nAll of the above-named facilities are adequately equipped, well maintained and suitable for foreseeable needs. If all available manufacturing space were utilized and significant additional shoe making equipment were acquired, production could be increased about 25%.\nIn addition to the above-described manufacturing and warehouse facilities, the Company operates 18 retail stores and 13 leased departments throughout the United States under various rental agreements. See Note 9 to Consolidated Financial Statements and Item 1. Business above.\nItem 3.","section_3":"Item 3. Legal Proceedings\nOn December 6, 1993, a shareholder of the Company, on behalf of herself and all others similarly situated, filed an action in the Circuit Court of Milwaukee County, Wisconsin against the Company and certain of its officers in connection with the (then proposed) merger agreement subsequently signed by the Company under which the Company would have been acquired by a management group, including the principal shareholders of the Company, for $34.00 per share in cash. (Kahn v. Weyco Group, et. al, Case No. 93-CV-019022). Plaintiff alleged that the $34.00 per share price was grossly inadequate, that the Company's intrinsic value exceeded $60.00 per share, that the acquiring group controlled and dominated the Board of Directors, that the Special Committee of the Board of Directors failed to adequately explore all alternatives that might lead to maximizing shareholder values, that the merger agreement was not the result of arm's-length negotiations or an independent valuation of shares and that the defendants failed to have a disinterested third party negotiate on behalf of shareholders. Plaintiff sought an injunction, rescission, unspecified damages and fees and expenses. The defendants filed an answer denying all material allegations. Following the withdrawal of the proposed merger, the plaintiff amended the complaint in December 1994 to seek a declaration that the defendants, in proposing and pursuing the proposed merger, \"committed or aided and abetted a gross abuse of trust and have breached their fiduciary and other duties\" and also to seek to recover certain costs and expenses related to the action, \"including reasonable attorneys' and professional fees incurred with the solicitation of proxies.\" On June 2, 1995, the lawsuit was dismissed by the Circuit Court of Milwaukee County, Wisconsin. On September 25, 1995, the plaintiffs gave notice of their appeal to the Wisconsin Court of Appeals. The appeal was dismissed on December 29, 1995 and the Company is not aware of any further action by the plaintiff.\nThe Company has been identified as a potentially responsible party (\"PRP\") in two separate actions in connection with an alleged hazardous substance discharge in the State of Wisconsin. The Company is contesting these actions and denies liability in the matter. It is anticipated that the resolution of this matter will not have a material effect on the Consolidated Financial Statements of the Company.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNot Applicable\nExecutive Officers of the Registrant\nThomas W. Florsheim is the father of John W. Florsheim and Thomas W. Florsheim, Jr.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Shareholder Matters\nInformation required by this Item is set forth on page 11 of the Annual Report to Shareholders for the year ended December 31, 1995, and is incorporated herein by reference.\nItem 6.","section_6":"Item 6. Selected Financial Data\nInformation required by this Item is set forth on page 2 of the Annual Report to Shareholders for the year ended December 31, 1995, 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 required by this Item is set forth on page 12 of the Annual Report to Shareholders for the year ended December 31, 1995, and is incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nInformation required by this Item is set forth on pages 2 through 11 of the Annual Report to Shareholders for the year ended December 31, 1995, and 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\nInformation required by this Item is set forth on pages 1, 2 and 3 of the Company's proxy statement for the Annual Meeting of Shareholders to be held on April 23, 1996, and is incorporated herein by reference.\nItem 11.","section_11":"Item 11. Executive Compensation\nInformation required by this Item is set forth on pages 4, 5, 6 and 7 of the Company's proxy statement for the Annual Meeting of Shareholders to be held on April 23, 1996, and is incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners of Management\nInformation required by this Item is set forth on pages 1 and 2 of the Company's proxy statement for the Annual Meeting of Shareholders to be held on April 23, 1996, and is incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nInformation required by this Item is set forth on page 7 of the Company's proxy statement for the Annual Meeting of Shareholders to be held on April 23, 1996, and is incorporated herein by reference.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(a) The following documents are filed as a part of this report:\nItem 14. Exhibits, Financial Statement Schedules, and Report on Form 8-K (Continued)\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in Weyco Group, Inc.'s Annual Report to Shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated February 19, 1996. 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 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\nMilwaukee, Wisconsin, February 19, 1996\nItem 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K (Continued)\n3. Exhibits\nItem 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (Continued)\n3. Exhibits (Continued)\nSCHEDULE II\nWEYCO GROUP, INC.\nVALUATION AND QUALIFYING ACCOUNTS\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nWEYCO GROUP, INC. (Registrant)\nBy \/s\/ John Wittkowske March 25, 1996 -------------------------------------- -------------- John Wittkowske, Secretary\/Treasurer ______________ Power of Attorney\nKNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Thomas W. Florsheim, Robert Feitler, and John Wittkowske, and each of them, his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments to this report, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their substitutes, may lawfully do or cause to be done by virtue thereof. ______________\nPursuant to the requirements of the Securities Exchange Act of 1934, 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":"810830_1995.txt","cik":"810830","year":"1995","section_1":"Item 1 - Business.\nEmpire Banc Corporation (the \"Registrant\") was incorporated under the laws of the state of Delaware on February 6, 1987, for the purpose of becoming a bank holding company. The Empire National Bank of Traverse City (the \"Bank\"), is a wholly-owned subsidiary of the Registrant. On June 1, 1994 the Registrant changed its state of incorporation from Delaware to Michigan.\nThe Bank was established under the banking laws of the State of Michigan in 1912 in Empire, Michigan. In 1961 the Bank converted its charter from a state bank to a national banking association. The Bank's deposits are insured by the Bank Insurance Fund, administered by the Federal Deposit Insurance Corporation, and the Bank is regulated by the U.S. Comptroller of the Currency.\nIn December 1991, the Traverse City and Grayling, Michigan branches of Great Lakes Bancorp were purchased by the Bank. In exchange for assuming deposit liabilities, the Bank received loans, property, equipment and cash. The acquisition provided entry into the Grayling-Crawford County market, opportunity to consolidate branches and improve customer service in the Traverse City market and a source of core deposits for increased funding of loans and investments.\nThe Bank is engaged in the general commercial banking business, providing a full range of loan and deposit products. These Bank services include customary retail and commercial banking services, including checking and savings accounts, time deposits, interest-bearing transaction accounts, safe deposit facilities, trust services, real estate mortgage lending and direct and indirect consumer financing. It makes secured and unsecured commercial loans and also operates a trust department providing fiduciary, investment and other related trust services. The Bank has contracted with a full-service securities brokerage firm to make available a variety of investment products to the Bank's customers. This program operates from two of the Bank's principal branch offices.\nThe principal source of revenue for the Registrant is dividends upstreamed from the Bank. The Bank's principal source of revenue is interest and fees on loans. The sources of income for the three most recent years are as follows.\nThe Bank's primary market area is the northwestern portion of the lower peninsula of Michigan. The Bank is headquartered in Traverse City, Michigan, County of Grand Traverse. The Bank maintains offices in Grand Traverse, Leelanau, Kalkaska, and Crawford counties. The population of these counties combined is approximately 100,000. The Bank operates ten full service offices, provides drive-in convenience at seven locations and has automatic teller machines operating at ten locations. The Bank has no foreign operations.\nAs of December 31, 1995, the Bank employed approximately 177 full-time and 34 part-time employees.\nBanking is a highly competitive business. The Bank competes primarily with other financial institutions in its market areas for loans, deposits, and trust accounts. In its primary market, which includes the Grand Traverse, Kalkaska and Leelanau counties, the Bank maintains the second largest deposit base, or approximately 25 percent of the deposit market share. There are principally six banking institutions with offices is this area. Three of the competing banks with offices in this market are members of holding companies with substantially more assets than the Registrant.\nThe Bank is the only independent community bank in the Crawford County market. The Bank is the third largest in terms of deposits in the Crawford County market and competes with three financial institutions that are members of holding companies with substantially more assets than the Registrant.\nIn addition to these other banks, the Bank also competes for loans with savings and loan associations, credit unions, and certain large national retailers, and competes for deposits with investment firms and money market funds. In order to successfully compete, management has developed a sales and service culture, stresses and rewards excellent customer service and designs products to meet the needs of the customer. The Bank also utilizes its ability to sell loans in the secondary market.\nThe Bank makes mortgage, commercial and installment loans to customers primarily in northwestern lower Michigan. Fees may be charged for these services. Commitments to make loans and unused lines of credit outstanding are detailed in Note 16 of the Notes to Consolidated Financial Statements.\nHistorically, the Bank has predominantly sold its secondary market conforming residential mortgage loans. The mortgage loan portfolio serviced by the Bank for others, primarily the Federal Home Loan Mortgage Corporation, at December 31, 1995 totaled over $190 million. Mortgage banking activity is detailed in Note 6 of the Notes to Consolidated Financial Statements.\nThe Bank supports the growth of the service industry, with its year round resort and related businesses, manufacturing, the medical community, and many other activities important to growth in the greater Grand Traverse area. Designated as a Preferred Lender by the Small Business Administration (SBA), the Bank underwrites government guaranteed business loans, contributing to the economic growth in northern Michigan.\nThe Bank also arranges loan relationships with national and regional participating banks, increasing the amount of funds available for local businesses to grow. There are no material concentrations of credit to, nor have material portions of the Bank's deposits been received from, a single person, persons, industry or group.\nIn 1993, the Bank joined the Federal Home Loan Bank of Indianapolis, which generates an additional source of liquidity and long-term funds. Membership in the Federal Home Loan Bank also provides access to additional advantageous lending programs. The Community Investment Program makes advances to be used for funding community-oriented mortgage lending, and the Affordable Housing Program grants advances to fund lending for long- term low- and moderate-income owner occupied and affordable rental housing at subsidized interest rates.\nThe economy of the market areas of the Bank is affected by summer and winter tourism activities and, accordingly, the Bank experiences seasonal consumer and commercial deposit growth, with substantial growth increases from May to September. The Bank regularly assesses its ability to raise funds through the issuance of certificates of deposit in denominations of $100,000 or more in the local and regional market area and has established conservative guidelines for the total funding to be provided by these deposits. These deposits were less than three percent and four percent of total deposits at December 31, 1995 and 1994, respectively. The Bank also uses federal funds purchased from correspondent banks and the Federal Reserve Bank to respond to deposit fluctuations and temporary loan demands.\nAs of December 31, 1995, the Bank had no risks attendant to foreign sources. Compliance with federal, state and local statutes and\/or ordinances relating to the protection of the environment is not expected to have material effect upon the Bank's capital expenditures, earnings or competitive position.\nSUPERVISION AND REGULATION Banking is a highly regulated industry, with numerous federal and state laws and regulations governing the organization and operation of banks, bank holding companies, and their affiliates. As a bank holding company under the Bank Holding Company Act of 1956, the Registrant is regulated and examined by the Federal Reserve Board. This Act requires that the Registrant obtain prior Federal Reserve Board approval for bank and nonbank acquisitions and restricts the permissible activities of the Registrant. In addition, the Act formerly restricted the acquisition of shares of out-of-state banks unless such acquisition is specifically authorized by the laws of the state in which the bank to be acquired is located. Under the Reigle-Neal Interstate Banking and Branching Efficiency Act of 1994, this restriction was repealed effective September 29, 1995, and the Federal Reserve Board generally is authorized to approve bank acquisitions by out-of-state bank holding companies whether or not such acquisition is prohibited by state law.\nFederal law also regulates transactions between the Registrant and the Bank, including the amount and nature of loans or other extensions of credit. The Bank is also subject to regulation and examination by the Comptroller of the Currency.\nThe Comptroller of the Currency has established guidelines with respect to the maintenance of appropriate levels of capital for the Bank. The Federal Reserve Board has also established similar guidelines for the Registrant. Compliance with such standards can also limit the amount of dividends which the Bank can pay to the Registrant and the amount of dividends the Registrant can pay to its shareholders.\nThe banking industry is also affected by the monetary and fiscal policies of the federal government, including the Federal Reserve Board, which exerts considerable influence over the cost and availability of funds obtained for lending and investing.\nThe Federal Deposit Insurance Corporation Improvement Act of 1991 (\"FDICIA\") significantly affects the operation of banks and their relationship with federal regulatory agencies.\nUnder FDICIA, the FDIC has implemented a system of risk based premiums for deposit insurance pursuant to which the premiums paid by a depository institution are based on the probability that the applicable insurance fund will incur a loss in respect of such institution. Also under FDICIA federal regulatory agencies are developing comprehensive safety and soundness standards. FDICIA also prescribes various supervisory actions by federal regulatory agencies based on an insured institution's level of capital. These prescribed actions increase restrictions on and heighten regulatory scrutiny of the institution as its capital declines.\nProposals to change the laws and regulations governing the operations and taxation of banks, and companies which control banks and other financial institutions, are frequently raised in Congress. The likelihood of any major changes and the impact such changes might have on the Registrant are, however, impossible to predict.\nItem 2","section_1A":"","section_1B":"","section_2":"Item 2 - Properties. The executive offices of the Registrant and the Bank are maintained at the main office of the Bank, 1227 East Front St., Traverse City, Michigan. The Bank leases its main office and the following branch offices and automated teller machine facilities: Grand Traverse Mall Office, 3160 South Airport Rd, Traverse City, Michigan 49684; Kalkaska Office, 302 West Mile Road, Kalkaska, Michigan 49646; Acme Office, 3880 M-72 East, Acme, Michigan 49610; Woodmere Office, 859 Woodmere Avenue, Traverse City, Michigan 49686; Meijer Handy Teller ATM, 3955 South Memorial Highway, Traverse City, Michigan 49684. The leases expire at various times through the years 2011 and all include renewal periods. Net aggregate annual rentals for banking facilities in 1995 were $415,000.\nIn addition, the Bank owns and operates the following facilities none of which are encumbered: Northport Office, 122 Nagonaba, Northport, Michigan 49670; Leland Office, 111 North Main Street, Leland, Michigan 49654; Empire Office, 10210 Front Street, Empire, Michigan 49630; Cherryland Office, 1114 South Airport Road, Traverse City, Michigan 49686; Downtown Traverse City Office, 427 West Front St. Traverse City, Michigan 49684; Grayling Office, 2195 S. James St. Grayling, Michigan 49738.\nThe Bank operates drive-thru facilities at most of its office locations and has ten automatic teller machines for customer use in its market area.\nInformation about the executive officers of the Registrant is set forth below.\nItem 3","section_3":"Item 3 - Legal Proceedings. The Bank is routinely engaged in litigation, both as plaintiff and defendant, which is incident to its business. In certain proceedings, claims or counter-claims have been asserted against it. Management, after consultation with legal counsel, does not anticipate that the ultimate liability, if any, arising out of such litigation and threats of litigation will have a material effect on the financial statements of the Registrant.\nItem 4","section_4":"Item 4 - Submission of Matters to a Vote of Security Holders. No matters were submitted during the fourth quarter of fiscal 1995 to a vote of the Registrant's security holders.\nPART II Item 5","section_5":"Item 5 - Market for Registrant's Common Equity and Related Stockholder Matters. The common stock of Empire Banc Corporation is traded on the electronic bulletin board system of the National Association of Securities Dealers, symbol EMBM. The primary market is the State of Michigan. Principal market makers of common stock transactions are F.J. Morrisey & Co., First of Michigan Corp, Howe, Barnes & Co., McDonald & Co., Robert W. Baird & Co., Roney & Co. and Stifel Nicolaus & Co.\nQuarterly cash dividends were declared during 1995 and 1994 totaling $1.02 and $0.92 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. All of the prices are adjusted for the five-for-four stock split, effected in the form of a 25% stock dividend, paid in November, 1995.\nItem 6","section_6":"Item 6 - Selected Financial Data - Empire Banc Corporation\nItem 7","section_7":"Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations. Management's Discussion and Analysis is designed to provide shareholders of Empire Banc Corporation (the Corporation) with a more comprehensive review of the results of operations and financial position of the Corporation and its wholly-owned subsidiary, Empire National Bank (the Bank), than could be obtained from an examination of the consolidated financial statements alone. This discussion should be read in conjunction with the consolidated financial statements beginning on page 28 and the related footnotes.\nSummary of Earnings In 1995, the Corporation achieved record earnings of $4,146,000, an increase of $392,000, or 10.4 percent, over the $3,754,000 earned in 1994. In 1994, net income increased $347,000, or 10.2 percent, over the $3,407,000 earned in 1993.\nEarnings Per Share Earnings per share, computed on the average number of common shares and common equivalents outstanding during the year, increased 9.8 percent to $2.36, compared to the $2.15 earned in 1994 and $1.98 earned in 1993.\nReturn on Average Shareholders' Equity Return on average shareholders' equity measures how profitably the shareholders' invested capital is employed. Return on average equity was 14.8 percent for 1995 compared to 14.7 percent and 14.6 percent in 1994 and 1993, respectively.\nReturn on Average Assets Return on average assets, a key measure of bank profitability, was 1.18 percent in 1995 compared to 1.17 percent and 1.15 percent in 1994 and 1993, respectively.\nBook Value Per Share Book value per share of common stock increased 12.7 percent to $18.20 at December 31, 1995, compared to $16.15 and $15.09 at December 31, 1994 and 1993, respectively.\nSummary of Operating Results The following is a summary of the major components of the Corporation's consolidated operating results for the three years ended December 31:\nNet Interest Income\nNet interest income is the difference between interest and fees earned on earning assets (loans and investments) and the interest paid on deposits and other interest-bearing funds. It is the major component of earnings for a financial institution. For analytical purposes, the interest earned on investments and loans is measured and expressed on a fully taxable equivalent (FTE) basis. Tax-exempt interest income is increased to an amount comparable to interest subject to federal income taxes in order to properly evaluate the effective yields earned on earning assets. The tax equivalent adjustment is based on a federal income tax rate of 34 percent.\nNet interest income is influenced primarily by changes in the balance and mix of earning assets and interest-bearing liabilities, the proportion of earning assets that are funded by demand deposits and equity capital, and market interest rates. Some of these factors may be controlled to a certain extent by management.\nConditions beyond management's control may have a significant impact on changes in net interest income from one period to another. Examples of such external factors are Federal Reserve Board monetary policy, introduction of new deposit products by bank and non-bank financial competitors and the fiscal and debt management policies of the federal government.\nThe table on the following page details the key determinants of net interest income: the average daily balance sheet for each year - including the components of earning assets and supporting liabilities - the related interest income on an FTE basis and interest expense, as well as the average rates earned and paid on these assets and liabilities.\nNet Interest Income Average Balances, Interest Income\/Expense, Average Rates\nAn analysis of the changes in net interest income from period to period is presented in the following table. This analysis highlights the relative effect of the changes in interest income or expense due to changes in the average balances of earning assets and interest-bearing liabilities and changes in interest rates.\nAnalysis of Changes in Net Interest Income\nThe following table allocates net interest income on earning assets by the interest spread earned on assets funded by interest-bearing liabilities and the amount funded by non-interest-bearing liabilities and equity capital. The interest spread on earning assets funded by interest-bearing liabilities is the difference between the average rate earned on total earning assets and the average cost of interest-bearing liabilities. The interest spread on earning assets funded by non-interest-bearing liabilities and equity capital is the rate earned on earning assets.\nNet interest income (FTE) increased $1,576,000 or 11.3 percent, in 1995 as average earning assets increased $30.3 million, or 10.1 percent, and the net interest margin (net interest income as a percentage of average earning assets) increased 5 basis points. Earning assets funded with interest-bearing liabilities increased $24.1 million, or 9.6 percent, as the interest spread decreased 11 basis points, adding $670,000 in net interest income. Earning assets funded with non-interest-bearing liabilities and equity capital increased $6.2 million, or 12.9 percent, with an improved interest spread of 77 basis points, contributing $906,000 to the increase in net interest income.\nThe increase in average earning assets of $30.3 million was principally in loans, which increased $19.5 million or 8.5 percent, and the average rate on loans increased 75 basis points. Investment securities increased $7.0 million, or 10.7 percent, and the average rate increased 96 basis points. The primary funding for earning assets is interest-bearing deposits which increased $20.4 million, or 8.4 percent, and the average rate increased 81 basis points over 1994.\nIn 1994, net interest income increased $819,000, or 6.3 percent, due to increases in average earning assets of $24.9 million, or 9.1 percent, and the net interest margin decreased 12 basis points. The increase in earning assets funded with interest-bearing liabilities, at a decreased interest spread, accounted for $361,000 of the increase in net interest income. The increase in earning assets funded with non-interest-bearing liabilities, at a reduced interest spread, added $458,000 in net interest income.\nLoan Portfolio Management and Non-Performing Assets\nPortfolio Quality\nLoan portfolio quality, diversification of the portfolio and the monitoring of potential problem loans are the primary functions of loan portfolio management. The Bank adheres to internally established written loan policies and procedures. Management has established a loan review process which provides for frequent review of the loan portfolio in order to monitor loan portfolio quality and performance. In addition, management conducts a review of loan concentrations which could have an impact on the financial condition of the Bank. As of December 31, 1995, there were no industry concentrations in which the total loans to borrowers in one industry comprised 10 percent or more of total loans.\nLoans outstanding at year-end for the five years ended December 31, are shown in the following table according to the type of loan:\nMaturity and Rate Sensitivity of Selected Loans\nThe following table presents the remaining maturity of total loans outstanding (excluding residential real estate mortgage and consumer loans) at December 31, 1995, according to scheduled repayments of principal. The amounts due after one year are classified according to the sensitivity to changes in interest rates.\nNon-Performing Assets and Problem Loans\nThe following table is a summary of non-performing assets as of December 31:\nIn 1995, total non-performing assets decreased $172,000, or 8.9 percent, as other real estate owned increased $227,000 and non-performing loans decreased $399,000. In addition to loans classified as non-performing or 90 days past due, there were other loans totaling $3,213,000 at December 31, 1995, on which payments were current and management closely monitors the borrowers' ability to comply with payment terms. Effective January 1, 1995, the Corporation adopted Statement of Financial Accounting Standards No. 114, \"Accounting by Creditors for Impairment of a Loan\" (SFAS 114), as amended by Statement No. 118 (SFAS 118). Implementation of SFAS 114 and SFAS 118 did not have a material impact on the consolidated financial position and results of operations in 1995 as disclosed in Note 5, Loans, to the Consolidated Financial Statements. See Note 2, Significant Accounting Policies, to the Consolidated Financial Statements, for a description of SFAS 114 and SFAS 118.\nManagement regularly reviews the loan portfolio to identify loans for which there are concerns that the borrower will be unable to satisfy existing payment terms. Management reports monthly, to the Board of Directors, information regarding significant past-due and problem loans, non-accrual loans and other real estate owned. Non-performing assets are carried at estimated realizable values and the known losses of principal have been recognized. Management cannot predict which, if any, loans will eventually result in losses.\nIncluded in other assets is $1,041,000 of cash value of life insurance which has been classified non-accrual. The Trustee for the insurer\/debtor has signed an agreement in principle with a new insurer to assume these policies at full value. The definitive agreement is being drafted and the transfer to the new insurer is expected in 1996.\nThe accrual of interest is discontinued on a loan when management believes, after considering economic and business conditions and collection efforts, that collection of interest is doubtful. The gross interest income that would have been recorded in 1995 on the $867,000 of non-accrual loans amounted to $128,000 if the loans would have been current in accordance with their original terms and outstanding throughout the period. The amount of interest income included in net income on these loans amounted to $6,000.\nAll loans classified for regulatory purposes as loss, doubtful, substandard or special mention have been included in the above disclosures. There were no other interest bearing assets at December 31, 1995 that would be required to be disclosed as non-performing or potential problem loans.\nThere were no foreign loans outstanding at December 31, 1995.\nProvision for Loan Losses\nThe following table summarizes the provision for loan losses, net loan losses and the allowance for loan losses over the last three years:\nIn 1995, the decrease in the provision for loan losses of $51,000 was primarily due to a decrease in net loan charge-offs of $81,000. The ratio of net loan losses to average loans of 0.18 percent for 1995 and 0.23 percent for 1994 are substantially below historical industry norms. A sustained period of national and local economic growth has resulted in substantial growth in the loan portfolio. In 1995, the allowance for loan losses increased $300,000 and was 1.24 percent of loans at December 31, 1995. The allowance for loan losses was considered adequate by management and was 183 percent of non-performing assets at year-end compared to 151 percent at December 31, 1994.\nIn 1994, the $349,000 increase in the provision for loan losses was due to an increase in net loan charge-offs of $259,000, primarily indirect consumer loans, and growth in the loan portfolio of over 11 percent.\nSummary of Loan Loss Experience\nAdditional information relative to the allowance for possible loan losses is presented in the following table. This table summarizes loan balances at the end of each period and daily average balances, changes in the allowance for possible loan losses arising from loans charged off and recoveries on loans previously charged off by loan category, and additions to the allowance for possible loan losses through provisions charged to expense. Factors which influence management's judgement in determining the provision for loan losses each period include establishing specific loss allowances for selected loans (including large loans, non-accrual loans, and problem and delinquent loans) and consideration of historical loss information and local economic conditions.\nAllocation of the Allowance for Loan Losses\nThe allocation of the allowance for possible loan losses for the years ended December 31 is:\nNon-Interest Income Total non-interest income increased $174,000, or 3.6 percent, from 1994. Income from the origination, sales and servicing of mortgage loans decreased $71,000, or 6.2 percent. The higher level of interest rates in 1995 compared to 1994 substantially reduced mortgage activity in the industry and created a tightening of fees earned on new loans. Fees and gains on loans sold in 1995 were $589,000, a decrease of $123,000, or 17.3 percent, from 1994. Effective July 1, 1995 the Bank adopted Statement of Financial Accounting Standards No. 122, \"Accounting for Mortgage Servicing Rights\" (SFAS 122). This standard requires capitalizing the cost of mortgage servicing rights on loans sold. The capitalized cost of the mortgage servicing rights is amortized over the estimated period of servicing income. This standard also requires periodic evaluation of the capitalized servicing rights for impairment. The adoption of SFAS 122 increased gains on loans sold $154,000 in 1995. Servicing income on loans sold increased $52,000, or 12.1 percent, over 1994.\nTrust income increased $254,000, or 16.3 percent, in 1995, as funds under management increased $43 million, or 16.7 percent. Other service charges and fees increased 7.1 percent due to income earned from credit card fees and ATM fees.\nIn 1994, total non-interest income decreased $220,000, or 4.3 percent, due primarily to decreases in income from the origination, sales and servicing of mortgage loans of $637,000, or 35.8 percent, as fees and gains on loans sold decreased 50 percent, or $708,000, due to the substantially reduced new loan volume from the record levels of 1992 and 1993. Loan servicing\nincome increased $71,000, or 19.8 percent over 1993. Trust fees increased $181,000, or 13.1 percent, due to a 17.2 percent increase in assets under management. Other significant increases were in service charges and fees on deposit accounts of 5.2 percent; other service charges and fees of 6.9 percent; and other income of 58.7 percent due to increased fees earned through investment product sales by a third party vendor in the Bank's branches and gains on sales of other real estate owned.\nNon-Interest Expense In 1995, total non-interest expense increased $1,253,000, or 10.2 percent. Total personnel expense increased $1,079,000, or 15.9 percent, as benefit costs related to the 38 percent increase in the Corporation's stock price during the year increased $698,000 and the profit sharing incentive award paid to all employee partners increased $110,000, or 24.6 percent.\nOccupancy expense for 1995 increased $68,000, or 7.2 percent, due to increased lease and branch remodeling costs.\nOther operating expenses increased $59,000, or 1.6 percent, in 1995. FDIC insurance expense decreased $254,000, or 41.1 percent, due to the reduction in FDIC rates from $.23 per $100 of deposits to $.04, effective June 1, 1995. For 1996, the rate has been reduced to the statutory minimum of $2,000 per year for well-capitalized banks. The rate continues at $.23 for deposits purchased from savings associations.\nThe FDIC is proposing a one-time charge on all deposits purchased from savings associations and savings association deposits to bring the Savings Association Insurance Fund to the required level and reduce the premium rate to the level equivalent to the commercial banks' rate. Although legislation to implement the proposed one-time charge has not been enacted, management currently anticipates that any such charge would not have a significant impact on the Corporation's financial position or results of operations.\nLegal and professional fees increased $69,000, or 25.4 percent, and business taxes increased $54,000, or 17 percent. Other areas of expense increased due to increased activity levels in the overall growth of the Bank.\nIn 1994, total non-interest expense decreased $301,000, or 2.4 percent. Personnel expense decreased $121,000, or 1.8 percent, due to the $420,000, or 80.7 percent, decrease in benefit costs related to the change in the Corporation's stock price from year to year and the decrease in the profit sharing incentive award of $56,000, or 11.1 percent. Equipment expense increased 6.4 percent for investment in technology.\nOther operating expense declined $233,000, or 5.9 percent, in 1994. Legal and professional fees decreased $73,000, or 21.2 percent, and expenses associated with the sale of other real estate owned decreased $201,000, or 93 percent. Other areas of expense increased due to increased activity levels and overall growth of the Company.\nFederal Income Taxes Federal income tax expense for 1995 was $2,007,000 compared to $1,841,000 in 1994 and $1,600,000 in 1993 due to the increased profitability of the Corporation. The Corporation's effective tax rate has been substantially unchanged from 1993 through 1995 due to the consistency of statutory tax rates and the relative percentage of tax-exempt income.\nCapital Resources and Cash Dividends The foundation of a strong financial institution is a strong capital base. Shareholders' equity in 1995 increased $3.7 million, or 13.9 percent, to $30 million at year-end 1995. During 1994, total shareholders' equity increased $1.8 million, or 7.5 percent, over 1993. Shareholders' equity was 8.1 percent and 7.8 percent of total assets at December 31, 1995 and 1994, respectively.\nThe Federal bank regulatory agencies have established capital standards for financial institutions. The Corporation's capital ratios are all significantly above the guidelines for well-capitalized institutions, the highest capital standard. Note 19 to the consolidated financial statements details the Corporation's regulatory capital and the capital standards.\nTotal dividends in 1995 were $1,671,000, or $1.02 per share, compared to the $1,499,000, or $.92 per share in 1994, a 10.9 percent increase. The dividend payout ratio was 40 percent in 1995 and 1994, and 34 percent in 1993. A 25 percent stock dividend was paid in November of 1995. Cash dividends per share have increased at an average annual rate of 17.3 percent since 1990. Future dividends are declared at the discretion of the Board of Directors and may be determined by the financial performance, future prospects and capital requirements of the Corporation.\nThe Corporation's principal source of funds to pay cash dividends is the earnings of its subsidiary, the Bank. Consequently, cash dividends depend upon the earnings, capital needs, regulatory restraints and other factors affecting the Bank. Under current banking laws and regulations, during 1996 the Bank can distribute to the Corporation cash dividends in the amount of $4,831,000 plus 1996 net profits.\nThe Company maintains a five-year capital plan and utilizes a formal strategic planning process. Management and the Board continue to monitor long-term goals which include maintaining capital growth in relation to asset growth and the retention of earnings to fund growth while providing above-average returns to shareholders.\nInterest Rate Sensitivity and Liquidity Asset and liability management involves the development and implementation of strategies to maximize net interest income, minimize the vulnerability of earnings to major changes in interest rates and allow the Bank to profitably compete in all phases of the business cycle. This process is carried out through monthly meetings of senior officers representing lending, deposit-gathering, funds management and marketing functions.\nInterest rate risk arises when the maturity or repricing characteristics of assets differ significantly from the maturity or the repricing characteristics of liabilities. One of the goals of asset and liability management is to balance the various factors that create interest rate risk, thereby maintaining the interest rate risk of the Bank within acceptable levels.\nWhile controlling interest rate risk is an important objective, accommodating customer maturity and repricing preferences is an equally important objective. It is the function of asset and liability management to develop strategies to reconcile these objectives. Management has developed definitive policies and procedures to sell the current production of long-term residential mortgages in the secondary market to mitigate\ninterest rate risk. Long-term commercial loans are generally written with three- and five-year balloons and long-term fixed rate SBA guaranteed loans are sold in the secondary market.\nOne measure of interest rate risk is \"gap,\" which represents the cumulative difference between the amount of assets and liabilities maturing or repricing at various time intervals. In measuring the interest rate risk gap, management estimates loan repayments and early withdrawals of deposits and the interest sensitivity of assets and liabilities which do not mature or reprice. Because assets and liabilities do not reprice in the same manner as interest levels change, the gap should not be viewed as a sole indicator of how the net interest income of the Bank will be affected by changes in interest rates. The Bank continually monitors and has maintained within its policy a one-year rate sensitive asset-to- liability ratio (RSA-RSL) of between 0.8 and 1.2. The one year RSA-RSL ratio was 0.93 and 0.88 at December 31, 1995 and 1994, respectively.\nThe Bank measures the impact of changes in interest rates on net interest income through a comprehensive analysis of the Bank's interest rate sensitive assets and liabilities. This analysis takes into consideration the projected changes in market interest rates and alternative rate scenarios, the amount of change in the rate of individual interest rate sensitive assets and liabilities, changes in rate of growth and rate of prepayment of assets and liabilities and the effect of competition. Through this analysis, management is able to more realistically measure the projected effect on net interest income than by traditional gap analysis.\nThe period of 1993 through 1995 included periods of sustained significant interest rate decreases and increases as well as changes in the shape of the yield curve. The steady increase in net interest income demonstrates the effectiveness of these risk management techniques.\nLiquidity management for a commercial bank is closely related to asset and liability management. The goal of liquidity management is to maintain the availability of resources to fund withdrawals and other operating requirements. Monitoring maturities and future commitments and the use of short-term investments are integral parts of liquidity management.\nThe primary objective of the Bank's investment securities portfolio is to invest in securities of high quality that will provide a fair and reasonable return and will allow the Bank to maintain a sound liquidity position. Management of the portfolio is an integral part of liquidity and interest rate risk management. The Bank does not have complex or leveraged derivatives or structured notes in its portfolio.\nThe Corporation adopted on January 1, 1994, Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" (SFAS 115). The adoption of SFAS 115 requires management to designate as available for sale those securities which are intended to be used for interest rate risk management, liquidity needs and portfolio management.\nThe Board of Directors has established policies regarding the potential price fluctuation of the available for sale portfolio. At December 31, 1995, the available for sale portfolio had a net unrealized gain of $506,000 compared to a net unrealized loss of $774,000 at December 31, 1994. The price fluctuations experienced during 1994 and 1995 were primarily due to changes in market interest rates and were well within the policies established by the Board of Directors. Realization of any unrealized gain or loss will depend upon the future portfolio management, interest rate risk management and liquidity needs of the Bank. The regulatory agencies do not include the SFAS 115 adjustment in the calculation of regulatory capital. Please see Note 2, Significant Accounting Policies, for a description of SFAS 115.\nOther than securities guaranteed by the US Government or its agencies, the Bank held no investment securities from any one issuer that exceed ten percent of stockholders' equity at December 31, 1995.\nManagement believes that deposit growth through core deposits provides the primary funding for increases in loans and investment securities. Core deposits include demand deposits, savings and money market accounts and certificates of deposit of consumer and corporate customers. Core deposits represented 97 percent and 96 percent of total deposits at December 31, 1995 and 1994, respectively.\nManagement also regularly assesses the ability of the Bank to raise funds through the issuance of certificates of deposit in denominations of $100,000 or more in the local and regional market area and has established conservative guidelines for the total funding to be provided by these deposits. These deposits were less than 4 percent of total deposits at December 31, 1995 and 1994.\nManagement also believes that an integral part of liquidity management is the development of other sources of funding. It is management's policy to actively cultivate and maintain relationships with correspondent and other banks for sales of loans for liquidity, credit and interest rate risk management. Additionally, the Bank has established substantial federal funds lines with correspondent banks and may borrow from the Federal Reserve Bank.\nThe Bank is a member of the Federal Home Loan Bank of Indianapolis, which provides an additional source of liquidity and long-term funds to meet the borrowing needs of customers. Advances from the Federal Home Loan Bank of Indianapolis are secured through the pledge of investment securities or mortgage loans. Federal Home Loan Bank advances were $17 million and $8 million at December 31, 1995 and 1994, respectively. Management believes that with the combination of federal funds lines and borrowings from the Federal Reserve Bank and the Federal Home Loan Bank, the Bank has more than adequate resources available to meet liquidity needs and to provide for growth.\nSources and Uses of Funds Trends This table is an analysis of the changes in the average balances for the last two years:\nAnalysis of Changes in Average Balances\nTotal average earning assets increased $30.3 million, or 10.1 percent, in 1995. Total average loans increased $19.5 million, or 8.5 percent. The increase in average loans was primarily in mortgage loans, which increased $12.4 million, or 26.1 percent. Commercial loans increased $10.5 million, or 10.4 percent. Average consumer loans decreased $3.5 million, or 4.3 percent, as management reduced the emphasis on indirect lending and continues to concentrate on direct consumer lending. Average investment securities increased $7.0 million, or 10.7 percent.\nThe increase in average earning assets was funded by a $24.1 million, or 9.6 percent, increase in total average interest-bearing funds. Total average interest-bearing core deposits increased $21.5 million, or 9.2 percent. With increases in interest rates, consumers increased their investments in certificates of deposit, which grew $15.2 million, or 14.4 percent, in 1995 and money market accounts, which increased $10.2 million, or 16.1 percent. Total non-interest bearing funds invested in earning assets increased $6.2 million, or 12.9 percent. Average time certificates in denominations of $100,000 or more decreased $1.1 million and represented 3 percent of average total deposits in 1995, compared to 4 percent in 1994 and 2 percent in 1993, significantly below the levels of banks of comparable size. With the growth in average earning assets, deposit funding was augmented with Federal Home Loan Bank advances which increased $4.1 million, or 54.6 percent, in 1995.\nIn 1994, total average earning assets increased $24.9 million, or 9.1 percent. Total average loans increased $25.4 million, or 12.5 percent, due to increases in consumer loans of $11.6 million, or 16.9 percent, and commercial loans of $12.4 million, or 13.9 percent. Mortgage loans increased $2.4 million, or 5.4 percent. Average investment securities increased $1.3 million.\nThe increase in average earning assets in 1994 was funded by an $18.9 million, or 8.1 percent, increase in total average interest-bearing funds. Average interest-bearing core deposits increased $6.6 million, or 2.9 percent. Average time deposits in denominations of $100,000 or more increased $4.3 million in 1994. Total non-interest bearing funds invested in earning assets increased $6.0 million, or 14.4 percent. Federal Home Loan Bank advances averaged $7.5 million in 1994.\nItem 8","section_7A":"","section_8":"Item 8 - Financial Statements and Supplementary Data Consolidated Balance Sheet-Empire Banc Corporation\nConsolidated Statement of Income-Empire Banc Corporation\nConsolidated Statement of Cash Flows-Empire Banc Corporation\nConsolidated Statement of Cash Flows-Empire Banc Corporation (continued)\nConsolidated Statement of Changes in Shareholders' Equity- Empire Banc Corporation\nNotes to Consolidated Financial Statements\nNote 1 - Nature of Operations\nEmpire Banc Corporation, a one-bank holding company for Empire National Bank, is the largest independent bank holding company in northern Michigan. The Bank is engaged in the general commercial, retail and mortgage banking business, providing a full range of loan and deposit products. It also operates a trust department providing fiduciary, investment and other related services, and has contracted with a full-service brokerage firm to make available a variety of investment products to the Bank's customers.\nThe Bank is headquartered in Traverse City, Michigan, which is the retail, medical and financial hub for northern Michigan. The Bank's primary market area is the northwestern portion of northern Michigan.\nNote 2 - Significant Accounting Policies\nPrinciples of Consolidation - The consolidated financial statements include the accounts of Empire Banc Corporation (the Corporation) and its wholly- owned subsidiary, Empire National Bank (the Bank), after elimination of significant intercompany transactions and accounts.\nStatement of Cash Flows - Cash and cash equivalents includes cash on hand, demand deposits in other institutions, and federal funds sold. The Corporation reports net cash flows for customer loan transactions and deposit transactions and for deposits made with other financial institutions.\nSecurities - Effective January 1, 1994 the Corporation adopted Statement of Financial Accounting Standards No. 115 \"Accounting for Certain Investments in Debt and Equity Securities\" (SFAS 115). In adopting SFAS 115, certain securities have been identified as available for sale. Securities available for sale may be sold prior to maturity due to changes in interest rates, prepayment risks, yield and availability of alternative investments, liquidity needs, or other factors. Securities identified as available for sale are reported at their fair value and the net unrealized gain or loss is reported, net of related tax effect, as a separate component of shareholders' equity, until realized. In the event that a security available for sale is sold or called, the adjusted cost of the specific security is used to compute the applicable gain or loss. Securities held to maturity are those securities which management has the ability and positive intent to hold to maturity. Securities held to maturity are stated at amortized cost. Premiums and discounts are recognized in interest income using the interest method.\nAllowance for Loan Losses - The allowance for loan losses represents that amount which management estimates is adequate to provide for losses inherent in the loan portfolio. Management determines the adequacy of the allowance for loan losses by reviewing selected loans (including large loans, non-accrual loans and problem and delinquent loans) and establishes specific loss allowances on these loans. Historical loss information and local economic conditions are considered in establishing allowances on the remaining loan portfolio. The allowance is increased by provisions charged to expense and reduced by loan losses, net of recoveries.\nEffective January 1, 1995 the Corporation adopted Statement of Financial Accounting Standards No. 114 (SFAS 114), later amended by Statement No. 118 (SFAS 118), on accounting and disclosure by creditors for impairment of a loan. These standards require that impaired loans be measured based on the present value of expected cash flows discounted at each loans' effective interest rate or, as a practical expedient, at the loan's observable market price or the fair value of collateral if the loan is collateral dependent. Under this standard, loans considered to be impaired are reduced to the present value of expected future cash flows or to the fair value of collateral, by allocating a portion of the allowance for loan losses to such loans. If these allocations cause the allowance for loan losses to require increase, such increase is reported as an additional provision for loan losses. The impact of adopting these standards on the Corporation's financial condition and results of operations in 1995 is not material.\nSmaller-balance homogeneous loans include residential first mortgage loans secured by one-to-four family residences, residential construction loans, automobile, home equity and second mortgage loans and are collectively evaluated for impairment. Commercial loans and first mortgage loans secured by other properties are evaluated individually for impairment. Under the Corporation's loan evaluation system, loans rated substandard, doubtful and loss are considered impaired, since it is probable that such loans will be not be collected under their contractual terms. Loans, or portions thereof, are charged-off when deemed uncollectible. SFAS No. 114 and No. 118 disclosures for impaired loans are not expected to be materially different from non-accrual and renegotiated loan disclosures or non-performing asset and past-due disclosures.\nPremises and Equipment - Premises and equipment are depreciated over their estimated useful lives and are stated at cost less accumulated depreciation. The provision for depreciation is computed principally using the straight-line method. Leasehold improvements are amortized over the shorter of the respective lease term or the asset's useful life. Expenditures for normal repairs and maintenance are charged to operations as incurred.\nOther Real Estate - Other real estate is carried at the lower of cost or fair value less estimated costs to sell. Any reduction to fair value at the time of acquisition from a related loan is accounted for as a loan loss. Any subsequent reduction in fair value is charged to other non- interest expense. The costs incurred to carry other real estate are expensed as incurred.\nInterest and Fees on Loans - Interest on loans is accrued over the term of the loans based upon the principal outstanding. The accrual of interest is discontinued on a loan when management believes, after considering economic and business conditions and collection efforts, that the collection of interest is doubtful. Loans are generally moved to non- accrual status at 90 days or more past due. Under SFAS No. 114, as amended by SFAS No. 118, the carrying value of impaired loans is periodically adjusted to reflect cash payments, revised estimates of future cash flows, and increases in the present value of expected cash flows due to the passage of time. Cash payments representing interest income are reported as such. Other cash payments are reported as reductions in carrying value, while increases or decreases due to changes in estimates of future payments and due to the passage of time are reported as reductions or increases to bad debt expense.\nLoan origination and commitment fees and related costs are recognized over the life of the loan as an adjustment of yield. Fees on loans sold are recognized at the time of sale.\nLoan Servicing Rights - The Bank originates and purchases mortgage loans for sale to the secondary market, and sells the loans with servicing retained. Effective July 1, 1995 the Corporation adopted Statement of Financial Accounting Standards No. 122 (SFAS 122), \"Accounting for Mortgage Servicing Rights.\" For servicing retained, this Statement requires capitalizing the cost of mortgage servicing rights, regardless of whether those rights were acquired through purchase or origination activities. Prior to adoption of SFAS 122, only purchased loan servicing rights were capitalized.\nBeginning July 1, 1995, the total cost of mortgage loans originated with the intent to sell is allocated between the loan servicing right and the mortgage loan without servicing based on their relative fair values at the date of origination. The capitalized cost of loan servicing rights is amortized in proportion to, and over the period of, estimated net servicing revenue.\nMortgage servicing rights are periodically evaluated for impairment by stratifying them based on predominant risk characteristics of the underlying serviced loans. These risk characteristics include loan type (i.e., conventional or government insured, fixed or adjustable rate), term (i.e., 15 year or 30 year), and note rate. Impairment represents the excess of cost of an individual mortgage rights stratum over its fair value, and is recognized through a valuation allowance. Estimates of fair value include assumptions about prepayment, default and interest rates and other factors which are subject to change over time. Changes in these underlying assumptions could cause the fair value of mortgage servicing rights, and the related valuation allowance, to change significantly in the future.\nIncome Taxes - In 1993, the Corporation adopted Statement of Financial Accounting Standards 109, \"Accounting for Income Taxes,\" (SFAS 109). The Corporation records income tax expense based on the amount of taxes due on its return plus deferred taxes computed based on the expected future tax consequences of temporary differences between the carrying amounts and tax bases of assets and liabilities, using current tax rates. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized.\nThe Corporation and the Bank file a consolidated federal income tax return. Intercompany tax liabilities are settled as if each entity filed a separate return.\nUse of Estimates - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Areas were estimates are used in the accompanying financial statements include the allowance for loan losses, carrying value of mortgage servicing rights, fair values of financial instruments, the accrued liability associated with the defined benefit pension plan and supplemental retirement plan, the carrying value of impaired loans, deferred tax assets, the estimated life of loans and securities and the carrying value of other real estate. Estimates incorporated into the Corporation's financial statements which are more susceptible to change in the near term include the allowance for loan losses, carrying value of mortgage servicing rights, fair value of financial instruments, and the defined benefit pension plan and supplemental retirement plan liabilities. Actual results could differ from those estimates.\nEarnings Per Share - Earnings per share of common stock are computed by dividing net income by the weighted average number of common shares and common stock equivalents outstanding during the period. Common stock equivalents consist of common stock issuable under the assumed exercise of stock options granted under the Corporation's stock option plan, using the treasury stock method. All per share data presented in the consolidated financial statements is retroactively adjusted for all stock dividends and splits. The Corporation declared and issued a stock split effected in the form of a 25% stock dividend in November, 1995.\nIssued But Not Yet Adopted Accounting Standards - The Financial Accounting Standards Board has issued Statement of Financial Accounting Standards No. 121, \"Accounting for Impairment of Long-lived Assets and for Long-lived Assets to be Disposed Of\" (SFAS 121). The Statement requires that long- lived assets and certain identifiable intangibles held and used by an entity be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable, and establishes criteria for evaluating recoverability. The Statement also requires that long-lived assets and certain identifiable intangibles to be disposed of be reported at the lower of carrying amount or fair value less cost to sell, with certain exceptions. The Corporation will adopt SFAS No. 121 effective January 1, 1996. Management does not expect the Statement to have a material impact on the consolidated financial condition and results of operations of the Corporation.\nThe Financial Accounting Standards Board has issued Statement of Financial Accounting Standards No. 123, \"Accounting for Stock Based Compensation\" (SFAS 123). This Statement establishes a fair value based method of accounting for employee stock options and similar equity instruments, such as warrants, and encourages all companies to adopt this method of accounting for all of their employee stock compensation plans. However, the Statement allows companies to continue measuring compensation cost for such plans using accounting guidelines in place prior to SFAS 123. Companies that elect to remain with the former method of accounting must make pro forma disclosures of net income and earnings per share as if the fair value method provided for in SFAS 123 had been adopted. The accounting and disclosure requirements of the Statement are required for the Corporation for transactions entered into in fiscal years that begin after December 15, 1995.\nThe Corporation entered into no transactions in 1995 or 1994 for which the accounting treatment would differ between SFAS No. 123 and current accounting guidance or for which SFAS No. 123 would require pro forma disclosures. Further, the Corporation currently has no plans for transactions for which the fair value based method of accounting or disclosure, defined by SFAS No. 123, would apply. Accordingly, management does not expect the Statement to have material impact on the financial condition or results of the operations of the Corporation.\nReclassifications - Certain 1994 and 1993 amounts have been reclassified to conform with the 1995 presentation.\nNote 3 - Cash and Cash Equivalents\nThe Bank is required to maintain non-interest-bearing deposits (required reserve balances) with the Federal Reserve, based on a percentage of deposits. The required reserve balances at December 31, 1995 and 1994 were $3,976,000 and $3,691,000, respectively.\nNote 4 - Securities\nThe carrying amount of securities and their approximate fair values at December 31 were as follows:\nNote 4 - Securities (continued)\nThe carrying amount of securities and their approximate fair values at December 31 were as follows:\nSales of securities available for sale during 1995 resulted in gross realized losses of $5,000 and no realized gains. Sales of securities available for sale during 1994 resulted in gross realized gains of $11,000 and no realized losses. There were no sales of securities held to maturity during 1995 or 1994. During 1993 there were no sales of securities; realized gains and losses during this period resulted from called securities.\nPursuant to the FASB Special Report, \"A Guide to Implementation of Statement No. 115 on Accounting for Certain Investments in Debt and Equity Securities,\" securities with a carrying value of $2,853,000, fair value of $2,883,000 and unrealized gain of $30,000, were transferred at fair value to the available for sale classification on December 31, 1995, classifying all mortgage-backed securities as available for sale.\nThe scheduled maturities of securities available for sale and held to maturity at December 31, 1995 were as follows:\nNote 5 - Loans\nAccounting and disclosure regarding impaired loans, as required by Statement of Financial Accounting Standards No. 114 and amended by No. 118, \"Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures,\" became effective for the Corporation in 1995.\nThe average investment in impaired loans for the year ended December 31, 1995 is $1,919,000, with $98,000 interest income recognized, including $96,000 interest income recognized on a cash basis. At December 31, 1995 there is $1,429,000 outstanding in impaired loans, with $1,173,000 for which an allowance for credit losses is allocated, and $256,000 for which no allowance for loan losses is allocated. The portion of the allowance loan losses allocated to the impaired loan balance is $355,000 at December 31, 1995, although the entire allowance is available for charge-offs of any loans.\nLoans on which the accrual of interest was discontinued at December 31, 1995 amounted to $867,000 (including $777,000 that would be considered impaired under Statement No. 114). Non-accrual loans at December 31, 1994 amounted to $1,228,000. If the non-accrual loans had performed in accordance with their original terms, additional interest income would have been recorded in 1995, 1994 and 1993 of $122,000, $146,000 and $98,000, respectively.\nMarketable mortgage loans held for sale at December 31, 1995 and 1994, which are accounted for at the lower of aggregate cost or market, were $2,054,000 and $1,360,000, respectively.\nLoans with a book value of $12,762,000 at December 31, 1995 were pledged to secure Federal Home Loan Bank advances.\nNote 6 - Mortgage Banking\nNote 6 - Mortgage Banking (continued)\nNote 7 - Premises and Equipment\nNote 8 - Time Deposits\nIncluded within total time deposits are time deposit liabilities issued in denominations of $100,000 or more. At December 31, 1995 and 1994, these deposits amounted to $8,899,000 and $11,114,000, respectively. Interest expense on time deposits issued in denominations of $100,000 or more for 1995, 1994 and 1993 amounted to $589,000, $449,000 and $227,000, respectively. Maturities of time deposits of $100,000 or more outstanding at December 31, 1995 are summarized below:\nNote 9 - Federal Home Loan Bank Advances\nThe $5,000,000 floating rate advance due January 1999 carries a current interest rate of 7.65 percent, which is adjusted annually based on the one- year constant maturity treasury rate. This advance was prepaid on January 16, 1996. The fixed rate advances have no prepayment provisions. Prepayment of these notes would be subject to the credit policy of the Federal Home Loan Bank. Securities and mortgage loans have been pledged to fully collateralize these advances.\nNote 10 - Other Non-Interest Expense\nNote 11 - Federal Income Taxes\nNote 12 - Employee Benefit Plans\nThe Bank maintains an integrated employee benefit plan structure designed to provide basic retirement income for employees on a non-contributory basis, and to provide opportunities for employees to build additional retirement savings through tax-deferred voluntary contributions and participation in the Bank's success through stock ownership in the Corporation. A description of the individual plan components of this integrated structure follows.\nA non-contributory, defined benefit pension plan which covers substantially all full-time employees was established in 1991. The Bank's funding policy is to contribute annually the maximum amount that can be deducted for federal income tax purposes. Prior service cost is amortized on a straight-line basis. The plan assets consist of equity and fixed income securities at December 31, 1995. The following sets forth the plan's funded status and amounts included in the consolidated balance sheet at December 31, 1995 and 1994.\nNote 12 - Employee Benefit Plans (continued)\nThe weighted average discount rate used in determining the actuarial present value of the projected benefit obligation was 7 percent in 1995 and 8 percent and 7 percent in 1994 and 1993, respectively. The rate of increase in future compensation used was 4.5 percent in each period presented. As a result of the change in the discount rate for 1995, the accumulated benefit obligation and the projected benefit obligation have increased by $124,000 and $228,000, respectively. The expected long-term rate of return on assets was 9 percent for all periods presented. As a result of the change in the discount rate for 1994, the accumulated benefit obligation and the projected benefit obligation decreased by $111,000 and $204,000, respectively.\nIn 1991, the Bank established a supplemental retirement program for certain executive officers. This plan provides benefits which are integrated with certain of the Bank's other benefit plans.\nNote 12 - Employee Benefit Plans (continued)\nThe weighted average discount rate and rate of increase in future compensation used for the supplemental executive retirement plan in determining the actuarial present value of the projected benefit obligation were 7 percent and 5 percent, respectively in 1995, 8 percent and 6 percent, respectively in 1994 and 7 percent and 5 percent, respectively, in 1993. As a result of the change in the rates for 1995, the accumulated benefit obligation has increased $22,000 and the projected benefit obligation has decreased $46,000. As a result of the change in the rates for 1994, the accumulated benefit obligation decreased $24,000 and the projected benefit obligation increased $31,000.\nThe Bank has a profit sharing 401(k) plan covering substantially all of its full-time employees. Under this plan, participants may elect to defer up to 10 percent of their salaries and the Bank may match 50 percent of the employees' deferrals to a maximum of three percent. The Bank contributions for 1995, 1994 and 1993 amounted to $107,000, $103,000 and $90,000, respectively.\nThe Bank has an Employee Stock Ownership Plan (ESOP) covering substantially all of its full-time employees. At December 31, 1995 the plan had no indebtedness and held 226,643 shares of stock allocated and voted on by employees. The amount of the annual contribution to the ESOP is determined by the Board of Directors. The contributions for 1995, 1994, and 1993 amounted to $129,000, $123,000 and $115,000, respectively.\nThe Bank has agreements with certain officers to provide benefits upon death prior to retirement which are funded with life insurance contracts. The financial statement impact from these arrangements is not material.\nNote 13 - Long-Term Incentive Plan\nThe Corporation has a long-term incentive plan granting certain officers stock options and tandem stock appreciation rights. All options and rights under the plan have been granted. The right to exercise the stock options and related stock appreciation rights vest over a five year period and expire ten years and one day from the date of grant. As of December 31, 1995, 169,473 stock options and 81,299 stock appreciation rights were vested. The expense related to the tandem stock appreciation rights for 1995, 1994 and 1993 amounted to $798,000, $100,000 and $520,000, respectively. The following is a summary of stock options and rights, granted and exercised, for the years presented, restated for all stock dividends and splits.\nNote 14 - Related Party Transactions\nCertain directors and executive officers of the Corporation and the Bank (including family members, affiliates, and companies in which they are principal owners) had loans outstanding with the Bank in the ordinary course of business. A summary of the aggregate loans outstanding which exceeded $60,000 to these individuals follows:\nNote 15 - Restrictions on Subsidiary Retained Earnings\nRegulations issued by the Office of the Comptroller of the Currency limit the amount of dividends that the Bank may declare to the Corporation. The regulations specify the amount to be the sum of the current year's \"net profit\" and \"retained net profits\" for the previous two years, as defined in the regulations. The aggregate amount of cash dividends which may be paid to the Corporation by the Bank in 1996 approximates $4,831,000 plus current 1996 net profits.\nDividends paid to the Corporation by the Bank amounted to $1,700,000 in 1995, $1,564,000 in 1994 and $1,432,000 in 1993.\nNote 16 - Off-Balance Sheet Financial Instruments\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 make loans and unused lines of credit. The Bank's exposure to credit loss is the contractual amount of these instruments, assuming the amounts are fully advanced and collateral or other security is of no value. Collateral for loans and letters of credit is usually in the form of cash, inventory, securities or other real and personal property. The Bank's policy is to require suitable collateral to be provided prior to the disbursement of funds. The following is a summary of commitments as of December 31:\nAt December 31, 1995 and 1994, commitments to make loans included $5.8 million and $4.8 million, respectively, of primarily variable rate commercial loans. These commitments generally have fixed termination dates of 90 days or less and may require payment of a fee. Commitments to make loans also include primarily fixed rate mortgage loans of $11.3 million and $6.0 million at December 31, 1995 and 1994, respectively, which are intended for sale in the secondary market upon closing. Other commitments include variable rate mortgage loans of $4.5 million and $2.0 million at December 31, 1995 and 1994, respectively.\nNote 17 - Shareholder Rights Plan\nIn December 1990, the Corporation's Board of Directors adopted a Shareholder Rights Plan which is designed to protect shareholders against unsolicited attempts to acquire control of the Corporation in a manner that does not offer a fair price to all shareholders. The Corporation has reserved 500,000 shares of preferred stock for issuance as Series A Junior Participating Preferred Stock upon the exercise of certain preferred stock purchase rights issued to holders of and in tandem with shares of the common stock. The description and terms of the rights are set forth in a Rights Agreement dated December 19, 1990 between the Corporation and the Bank as Rights Agent.\nGenerally, in the event a person or group acquires or announces a tender offer which could result in ownership of 20 percent or more of the Corporation's common stock, and the acquiror engages in certain business transactions involving the Corporation as specified in the Rights Agreement, each right, other than those held by the acquiror, shall entitle the holder thereof to acquire common stock or other securities having a market value of twice the $50 per right exercise price.\nThe Corporation may redeem the rights at a price of one cent per right at anytime until 20 days after a 20 percent position has been acquired.\nNote 18 - Fair Value Disclosure\nThe following methods and assumptions were used by the Bank in estimating fair values of financial instruments as disclosed herein.\nShort-term financial instruments: For these instruments, the carrying value is deemed a reasonable estimate of fair value due to the relatively short period to maturity of the instruments. This approach applies to cash and cash equivalents and accrued interest receivable and payable. Securities held to maturity and available for sale: Fair values for securities is based on quoted market prices. Loans: Fair value for certain homogeneous categories of loans, such as some residential mortgages, is estimated using quoted market prices for similar loans, adjusted for differences in loan characteristics. The fair values of other types of loans are estimated by discounting future cash flows, including estimates of prepayments, using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Deposits: The fair value of demand deposits, savings accounts and certain money market deposits is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities. The value of long-term relationships with depositors is not taken into account in estimating the fair value disclosures. Short-term borrowings: The carrying amounts of federal funds purchased, and other short-term borrowings maturing within 90 days approximate their fair value. Federal Home Loan Bank advances: The fair values of the Bank's long-term debt are estimated using discounted cash flow analyses based on the Bank's current incremental borrowing rates for similar types of borrowing arrangements. Off-balance sheet instruments: Fair values for off-balance sheet lending commitments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties' credit standing.\nNote 18 - Fair Value Disclosure (continued)\nThe estimated fair values of the Corporation's financial instruments were as follows at December 31:\nNote 19 - Regulatory Capital\nThe Corporation and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. The regulations require the Corporation to meet specific capital adequacy guidelines that involve quantitative measures of the Corporation's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Corporation's capital classification is also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. To be considered adequately capitalized, as defined under the regulatory framework for prompt corrective action, the Corporation must maintain minimum tier 1 leverage, tier 1 risk-based and total risk-based ratios as set forth in the table below. As shown, the Corporation's capital ratios are significantly above the well-capitalized standards.\nNote 20 - Empire Banc Corporation (Parent Company Only) Condensed Financial Statements\nNote 20 - Empire Banc Corporation (Parent Company Only) Condensed Financial Statements (continued)\nIndependent Auditor's Report\nCROWE CHIZEK\nTo the Shareholders and Board of Directors Empire Banc Corporation Traverse City, Michigan\nWe have audited the accompanying consolidated balance sheet of Empire Banc Corporation as of December 31, 1995 and 1994 and the related consolidated statements of income, changes in shareholders' equity and cash flows for each of the three years in the period ended December 31, 1995. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Empire Banc Corporation as of December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\nAs discussed in Note 2 to the consolidated financial statements, the Corporation changed its methods of accounting for mortgage servicing rights and impaired loans in 1995, securities in 1994, and income taxes in 1993, all to conform to new accounting standards.\n\/s\/ Crowe, Chizek and Company LLP - --------------------------------- Crowe, Chizek and Company LLP\nGrand Rapids, Michigan January 18, 1996\nQuarterly Financial Data Empire Banc Corporation\nThe following is a summary of selected quarterly results of operations for the years ended December 31, 1995 and 1994.\nItem 9","section_9":"Item 9 - Changes in and disagreements with Accountants on Accounting and Financial Disclosure.\nNone\nPART III\nThe information called for by the items within this part is included in the Registrant's definitive Proxy Statement for the Annual Meeting of Shareholders to be held May 14, 1996, to be filed with the Commission, and is incorporated herein by reference, as follows:\nPART IV ITEM 14","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"ITEM 14 - Exhibits, Financial Statement Schedules, and Reports on Form 8-K\nSIGNATURES Pursuant 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, on March 20, 1996.\nEXHIBIT INDEX","section_15":""}
{"filename":"869391_1995.txt","cik":"869391","year":"1995","section_1":"Item 1. Business\nThe Sears Credit Account Master Trust I (the \"Trust\") was formed pursuant to the Pooling and Servicing Agreement dated as of November 18, 1992 (the \"Pooling and Servicing Agreement\") among Sears, Roebuck and Co. (\"Sears\") as Servicer, its wholly-owned subsidiary, Sears Receivables Financing Group, Inc. (\"SRFG\") as Seller, and Bank of America Illinois as trustee (the \"Trustee\"). The Trust's only business is to act as a passive conduit to permit investment in a pool of retail consumer receivables.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe property of the Trust includes a portfolio of receivables (the \"Receivables\") arising in selected accounts under open-end credit plans of Sears (the \"Accounts\") and all monies received in payment of the Receivables. At the time of the Trust's formation, Sears sold and contributed to SRFG, which in turn conveyed to the Trust, all Receivables existing under the Accounts as of the end of certain of Sears regular billing cycles ending in May and November, 1991 and all Receivables arising under the Accounts from time to time thereafter until the termination of the Trust. Information related to the performance of the Receivables during 1995 is set forth in the ANNUAL STATEMENT filed as Exhibit 21 to this Annual Report on Form 10-K.\nItem 3.","section_3":"Item 3. Legal Proceedings\nNone\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNone\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters\nInvestor Certificates are held and delivered in book-entry form through the facilities of The Depository Trust Company (\"DTC\"), a \"clearing agency\" registered pursuant to the provisions of Section 17A of the Securities Exchange Act of 1934, as amended. The sole definitive Investor Certificate is held by CEDE and Co., the nominee of DTC.\nItem 9.","section_6":"","section_7":"","section_7A":"","section_8":"","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone\nPART III\nItem 12.","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nAs of March 15, 1996, 100% of the Investor Certificates were held in the nominee name of CEDE and Co. for beneficial owners.\nSRFG, as of March 15, 1996, owned 100% of the Seller Certificate, which represented beneficial ownership of a residual interest in the assets of the Trust as provided in the Pooling and Servicing Agreement.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nNone\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(a) Exhibits:\n21. 1995 ANNUAL STATEMENT prepared by the Servicer.\n28. ANNUAL INDEPENDENT ACCOUNTANTS' REPORTS pursuant to Section 3.06 of the Pooling and Servicing Agreement.\n(a) Agreed Upon Pricedures Letter.\n(b) Annual Servicing Letter.\n(b) Reports on Form 8-K:\nCurrent reports on Form 8-K are filed on or before the Distribution Date each month (on, or the first business day after, the 15th of the month). The reports include as an exhibit, the MONTHLY INVESTOR CERTIFICATEHOLDERS' STATEMENT. Current Reports on Form 8-K were filed on October 16, 1995, November 15, 1995, and December 15, 1995.\nSIGNATURES\nPursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nSears Credit Account Master Trust I (Registrant)\nBy: Sears Receivables Financing Group, Inc. (Originator of the Trust)\nBy: Larry R. Raymond Vice President, Finance\nDated: March 28, 1996\nEXHIBIT INDEX\nExhibit No.\n21. 1995 ANNUAL STATEMENT prepared by the Servicer.\n28. ANNUAL INDEPENDENT ACCOUNTANTS' REPORTS pursuant to Section 3.06 of the Pooling and Servicing Agreement.\n(a) Agreed Upon Procedures Letter.\n(b) Annual Servicing Letter.\nSIGNATURES\nPursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nSears Credit Account Master Trust I (Registrant)\nBy: Sears Receivables Financing Group, Inc. (Originator of the Trust)\nBy: \/S\/Larry R. Raymond Larry R. Raymond Vice President, Finance\nDated: March 28, 1996","section_15":""}
{"filename":"720308_1995.txt","cik":"720308","year":"1995","section_1":"Item 1. Business.\nWellesley Lease Income Limited Partnership D (the \"Partnership\") is a limited partnership organized under the provisions of the Massachusetts Uniform Limited Partnership Act on May 6, 1983. As of December 31, 1995, the Partnership consisted of a General Partner and 2,659 Limited Partners owning 36,463 Units of Limited Partnership Interests of $500 each (the \"Units\"), except that employees of the Corporate General Partners of the General Partner and employees and securities representatives of its affiliates purchased 1,188 Units for a net price of $460 per Unit and the Partnership incurred no obligation to pay any sales commissions with respect to such sales. The Units were sold commencing September 2, 1983, pursuant to a Registration Statement on Form S-1 under the Securities Act of 1933. As set forth more fully at Item 10. Directors and Executive Officers of the Partnership. of this Report, the General Partner is Wellesley Leasing Partnership, and the General Partner has two Corporate General Partners (the \"Corporate General Partners\"): TLP Leasing Programs, Inc. (\"TLP\") and CIS Management Services Corporation (\"CISMS\"), both Massachusetts corporations.\nThe Partnership was organized to engage in the business of acquiring income-producing computer peripheral equipment for investment purposes, principally International Business Machines, Incorporated (\"IBM\") equipment. The Partnership's principal objectives are as follows:\n1. To acquire and lease equipment, primarily through operating leases, to generate income during its entire useful life;\n2. To provide quarterly distributions of cash to the Limited Partners from leasing revenues and from the proceeds of sales or other disposition of Partnership equipment; and\n3. To reinvest a portion of lease revenues and a substantial portion of cash from sales and refinancings in additional equipment during the first nine years of the Partnership's operations.\nThe Partnership was formed primarily for investment purposes and not as a \"tax shelter\".\nThe closing date of the Partnership was March 15, 1984, and aggregate equipment purchased through December 31, 1995 is $45,084,527. During August, 1995, the Partnership sold its equipment portfolio and terminated its lease operations. The Partnership will not be terminated until the net unsecured pre-petition claim against CIS has been settled and the remaining proceeds have been distributed to the Partners (see note 5 to the financial statements).\nOn January 9, 1996, TLP Holding LLC purchased all the common stock of TLP from CMI Holding Co. Under the new ownership, TLP will continue to operate in the same manner of business as described below.\nUnder the Partnership Agreement, the General Partner, Wellesley Leasing Partnership, is solely responsible for the operation of the Partnership and its equipment. As discussed above, the General Partner has two Corporate General Partners: TLP and CISMS. TLP was formed in December 1982 and is a wholly-owned subsidiary of CMI Holding Co. (\"Holding\"), the capital stock of which was acquired in August 1987 by Continental Information Systems Corporation (\"CISC\"), in Syracuse, New York (a New York Stock Exchange-listed corporation). Through this acquisition, CISC became the ultimate parent of TLP and CISMS. On July 20, 1993, Holding became a wholly-owned subsidiary of CIS Corporation (\"CIS\") pursuant to a court ordered settlement (see note 5 to the financial statements included in Item 8. Financial Statements and Supplementary Data). While Holding and its subsidiaries have retained their separate corporate identities since the acquisition, their operations (except those of TLP and the limited partnerships it manages) have been effectively integrated into those of CIS and its affiliates. These operations include buying, selling, financing, leasing and sub-leasing new and used computer equipment and their services include securing, financing, collecting rentals and supervising equipment maintenance and service. CISMS was formed in May 1983, and is a wholly-owned subsidiary of CMI Corporation (\"CMI\"), which is another wholly-owned subsidiary of Holding and an affiliate of TLP. CMI is engaged in equipment leasing, primarily involving computer equipment and aircraft.\nThe General Partnership Agreement between TLP and CISMS (the \"General Partnership Agreement\"), provides that CISMS will propose to the Partnership equipment acquisitions, leasing, financing and re-financing transactions and sale transactions, for approval by the Executive Committee and will oversee the operation, management and use of the Partnership's equipment and that TLP will oversee the marketing of the Units, all administrative functions of the Partnership and will supply substantially all of the General Partner's capital resources. All of the Partnership's equipment to date has been acquired and all dispositions of Partnership equipment have been made, through CISMS, using the personnel and resources of CMI, another Continental affiliate, both of which have emerged from protection under Chapter 11 of the United States Bankruptcy Code on December 21, 1994, and several outside equipment leasing brokers the General Partner believes would be most advantageous for the Partnership; see note 5 of Item 8. Financial Statements and Supplementary Data. of this report.\nThe Partnership's investment policy provides for the acquisition of diversified types of computer equipment and the leasing of such equipment to others on a short-term basis under operating leases. The Partnership generally purchases equipment for which a lease exists, or is entered into at the time of the Partnership's acquisition of the equipment. This equipment is recorded and depreciated at the Partnership cost (purchase price plus the acquisition fee). If at any time the General Partner deems the equipment to be obsolete or related maintenance and storage costs to be in excess of its fair market value, the equipment is scrapped or sold at the current fair market value, which ever is most advantageous for the Partnership.\nPursuant to its leasing policies, the General Partner performs a credit analysis of potential lessees to determine their creditworthiness. The General Partner leases all of its equipment to third parties by means of operating leases with fixed base lease rates. Rents are payable monthly or quarterly. Operating leases generally do not have terms greater than five years in duration and the aggregate noncancelable rental payments during the term of the lease (on a net present value basis), are not sufficient to permit the lessor to recover the purchase price of the equipment.\nAt the termination of the lease, the General Partner arranges for the equipment to be re-leased (either to the same lessee or a new lessee) if it determines that re-leasing is in the Partnership's best interests. Generally, equipment is re-leased at least once and possibly several times during the Partnership's life, unless it is determined that the equipment is not marketable and therefore may be sold. The General Partner provides, or arranges for the installation, removal, maintenance and modification of the Partnership's equipment. Also, the General Partner will purchase and maintain, or cause to be purchased and maintained, appropriate insurance coverage to protect the interests of the Partnership.\nDuring August, 1995, the Partnership sold its equipment portfolio and terminated its lease operations.\nThe Partnership's investments in computer peripheral equipment were subject to various risk factors. The principal business risk associated with ownership of the equipment is the inability to keep it fully leased at rentals which, after payment of operating expenses and debt service on Partnership borrowings, provide, together with any anticipated sales proceeds or salvage value, an acceptable rate of return. Other risk factors include:\n1. Technological and economic equipment obsolescence, physical deterioration, malfunction and risks attendant upon defaults by lessees and credit losses.\n2. Residual Values of Equipment. The Partnership's return on its investment in equipment will depend in part upon the continuing value of such equipment which in turn, depends upon, among other things: (1) the quality of the equipment; (2) the condition of the equipment; (3) the timing of the equipment's acquisition; (4) the cost of comparable new equipment; (5) the technological obsolescence of the equipment; (6) the General Partner's ability to forecast technological changes which may reduce the value of the equipment; and (7) market factors.\n3. Competition from Full Payout Lessors. In connection with operating leases, the Partnership will encounter considerable competition from those offering full payout leases, which are written for a longer term and a lower rate than the Partnership's operating leases.\n4. Competition from Manufacturers. Leases offered by the Partnership will compete with operating leases and full payout leases offered by equipment manufacturers in their own lease programs. In addition to attractive financial terms, manufacturers may also provide certain ancillary services which the Partnership cannot offer directly, such as maintenance service (including possible equipment substitution rights), warranty services and trade-in privileges.\n5. Other Competition. There are numerous other potential investors, including limited partnerships organized and managed similarly to the Partnership, seeking to purchase equipment subject to either operating leases or full payout leases, many of which will have greater financial resources than the Partnership and more experience than the General Partner. The Partnership will compete in the computer leasing marketplace with many non-manufacturing firms, including other equipment dealers, brokers and leasing companies, as well as with financial institutions.\n6. Changes in Marketing Policies. IBM's current marketing policy of offering accrual discounts (i.e., applying lease payments as a credit toward the purchase of equipment) and volume discounts enables certain customers to obtain IBM equipment at a cost lower than its fair market value. In the case of accrual discounts, lessees of IBM equipment who have earned a purchase credit toward that equipment can purchase the equipment from IBM and arrange a cost-effective sale and leaseback arrangement with CMI or the Partnership. The sale price to the Partnership will typically be less than the fair market value of the equipment. The Partnership may be able to participate in volume discounts through purchases arranged by lessees of CMI. The Partnership's lower equipment costs in turn should enable the Partnership to offer lower lease rates to customers and help offset the risk of early obsolescence. If IBM were to eliminate these policies, raise its prices, lower its lease rates, or become more active as a lessor, the Partnership might find it more difficult to compete successfully as a lessor of IBM equipment.\n7. Defaults by Lessees. Default by a lessee may cause equipment to be returned to the Partnership at a time when the General Partner may be unable to promptly arrange for its re-leasing (at the rental rate previously received or otherwise) or sale (with or without a loss), thus resulting in the loss of anticipated revenues and the inability to recover the Partnership's investment and repay related debt. Any related debt may be secured by the returned equipment and in some cases, by the Partnership's other equipment. If the debt is not paid in a timely manner, the lender may foreclose and assume ownership of all equipment securing the debt, resulting in economic loss and adverse tax consequences to the Partnership's partners.\n8. Changes in Technology. The General Partner intends to offer lease rates to the Partnership's lessees which take into account the risk of technological advances which may reduce the value of such equipment owned by the Partnership. However, the introduction of an entirely new technology could lead to a radical reduction in the fair market value of certain equipment and make such equipment difficult to re-lease.\nThe Partnership considers itself to be engaged in only one industry segment, the business of investing primarily in IBM computer peripheral equipment and the leasing of this equipment to major national corporations on an operating lease basis; therefore, industry segment information has not been provided.\nFor information regarding the settlements between the Partnership and the Liquidating Estate of CIS Corporation, et al, arising out of the emergence from bankruptcy of CIS and CMI, see Item 3. Legal Proceedings.\nDuring the fourth quarter of 1994, the General Partner announced its intentions of winding down the operations of the Partnership beginning in 1995. As of December 31, 1995, all of the assets have been sold with the exception of the unsecured pre-petition claim receivable. The sales proceeds generated from the sale of the assets were accumulated to settle all outstanding liabilities and make a distribution on November 28, 1995, prior to the sale of stock and receipt of the final Trustee settlement distribution. All future cash distributions have been halted until the remaining claim balance has been settled and any stock received, sold. At that time, a final distribution shall be made to the partners. The Partnership will not be terminated until the net unsecured pre-petition claim against CIS has been settled and the remaining proceeds have been distributed to the Partners.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nDuring August, 1995, the Partnership sold its equipment portfolio and terminated its lease operations.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nThere are no material pending legal proceedings that the Partnership is a party or of which any of its equipment or leases is the subject, except as described below and in note 5 to the financial statements herein in Item 8. Financial Statements and Supplementary Data.\nOn January 13, 1989 (the \"Petition Date\"), Continental, CIS, Holding, CMI and certain of its affiliates (collectively, the \"Debtors\"), voluntarily petitioned for relief under Chapter 11 of the United States Bankruptcy Code (\"Chapter 11\"), and thereafter continued in the management and operation of their businesses and property as Debtors In Possession until October 25, 1989, when the United States Bankruptcy Court (the \"Court\") confirmed the appointment of James P. Hassett as Chapter 11 trustee (the \"Trustee\") of the Debtors. Holding is the parent of TLP and CMI is the parent of CISMS. TLP and CISMS, neither of which filed under Chapter 11, are the two Corporate General Partners of Wellesley Leasing Partnership, the General Partner of the Partnership. Both before and after the Petition Date, CIS and CMI have acted as agents for the Partnership in selling, leasing and remarketing Partnership equipment. Holding became a wholly-owned subsidiary of CIS pursuant to a Court ordered settlement on July 20, 1993.\nOn January 9, 1996, TLP Holding LLC purchased all the common stock of TLP from Holding. Under the new ownership, it is expected that TLP will continue to operate in the same manner of business as it has in the past.\nAs of the Petition Date, there were a number of unsettled transactions between CIS and CMI and the Partnership and other affiliated partnerships (the Partnership and such other partnerships are herein collectively referred to as the \"Partnerships\"), including outstanding accounts receivable and accounts payable between each of the Partnerships and CIS and CMI and their affiliates, sales of equipment and related leases from CIS and CMI to each of the Partnerships for which not all documentation had been completed as of the Petition Date, and sales of equipment and related leases from which CIS had failed to remove prior third-party liens. In addition, accounts receivable and accounts payable continued to accrue and be paid between each of the Partnerships and CIS and CMI and their affiliates subsequent to the Petition Date.\nOn February 28, 1992, the Court granted an order implementing a settlement of the outstanding issues between each of the Partnerships and the Debtors. The settlement occurred on March 13, 1992. In the order the Court approved a set-off on a partnership-by-partnership basis of pre-petition amounts owed by each affected Debtor to each Partnership to the extent of pre-petition amounts owed by that Partnership to that Debtor. As a result of the set-off, the Partnership had a net unsecured pre-petition claim of $441,299 ($193,698 against CIS and $247,601 against CMI), as of December 31, 1993 which had been fully reserved.\nOn November 29, 1994, the Court confirmed the Trustee's proposed Joint Plan of Reorganization (\"the Plan\") dated October 4, 1994, and the Debtors emerged from Chapter 11 bankruptcy protection on December 21, 1994. In accordance with the Plan projections, 59% of each CIS claim would be paid in total, of which 44% would be cash and 15% would be common stock of the reorganized Continental Information Systems Corporation (\"CISC\"), based on a per share price of $4.29. Each of the CMI claims would be paid in full, of which 75% would be cash and 25% would be CISC common stock, as described above. Based on the Plan, the Partnership`s fully reserved unsecured pre-petition claim balance was reduced to $361,883.\nOn December 27, 1994, the Partnership received the first distribution from the Trustee (now trustee of the Liquidating Estate of CIS Corporation, et al) with respect to the net unsecured pre-petition claim described above. The distribution consisted of cash proceeds of $186,381 and 17,837 shares of common stock in CISC. On July 20, 1995, the Partnership received the second distribution which consisted of cash proceeds of $61,386 and 2,256 shares of common stock. The Partnership received the third distribution on October 20, 1995, comprised of cash proceeds of $1,216 and 775 shares of common stock. During the second quarter of 1995, the stock of CISC began trading, thereby providing an objective valuation method for establishing the cost basis of $2.50 per share, which approximated fair value at June 30, 1995. A charge off was made in 1995 in relation to the difference between the Trustee's original prescribed value of the CISC stock at $4.29 per share and the cost basis established by the Partnership. Following the Trustee's third distribution and the charge off made during the year, the Partnership has a remaining net unsecured pre-petition claim balance of $22,814 as of December 31, 1995. The General Partner anticipates that the Liquidating Estate will make future distributions on the remaining outstanding claim balance, although it is not possible at this time to determine when these distributions will be made (see note 6 to the 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.\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 Limited Partnership Interests in Units of $500 each. As of December 31, 1995, 36,463 Units had been sold to the public at a price of $500 per Unit (except for 1,188 Units which were sold for a net price of $460 per Unit to employees of the General Partners of the General Partner and employees and securities representatives of its affiliates).\nThere is no public market for the Units, and it is not anticipated that such a public market will develop.\n(b) Approximate Number of Security Holders\n(c) Dividend History and Restrictions\nDuring the fiscal period ended December 31, 1984, the Partnership completed its offering of 36,463 Units. Pursuant to Section 8 of the Limited Partnership Agreement, the Partnership's \"Distributable Cash From Operations\" for each year will be determined and then be distributed to the Partners. Upon reaching the end of its reinvestment period (the ninth anniversary of the Partnership's final closing date), the Partnership will also distribute to the Partners \"Distributable Cash From Sales or Refinancings\", if any. The Partnership distributed $683,681 to the Limited Partners in 1995, $729,260 in 1994 and $865,997 in 1993 and distributed $35,983 to the General Partner in 1995, $38,384 in 1994 and $45,580 in 1993. The cumulative cash distributions to the Limited Partners through December 31, 1995 are $23,921,188 as compared with the contributed Limited Partners' net capital of $16,259,064.\n\"Cash From Operations\" and \"Cash From Sales or Refinancing\" means the net cash provided by the Partnership's normal operations or as a result of any sales, refinancings or other dispositions of equipment, respectively, after the general expenses and current liabilities of the Partnership (other than the equipment management fee) are paid, as reduced by any reserves for working capital and contingent liabilities to the extent deemed reasonable by the General Partner, and as increased by any portion of such reserves then deemed by the General Partner not to be required for Partnership operations. \"Distributable Cash From Operations\" and \"Distributable Cash From Sales or Refinancings\" means Cash From Operations or Cash From Sales or Refinancings, respectively, reduced by amounts which the General Partner determines shall be reinvested (through the ninth anniversary of the Partnership's closing date) in additional Equipment and by payments of all accrued but unpaid equipment management fees.\nFor rendering services in connection with the normal operations of the Partnership, the Partnership will pay to the General Partner a Partnership management fee equal to 7% of the monthly rental billings collected.\nEach distribution of Distributable Cash From Operations and any Distributable Cash From Sales or Refinancings from gains of the Partnership shall be allocated 95% to the Limited Partners and 5% to the General Partner. Any losses from sales or refinancings of equipment shall be allocated 99% to the Limited Partners and 1% to the General Partner until \"Payout\" has occurred. \"Payout\" means the time when the aggregate amount of all distributions to the Limited Partners of Distributable Cash From Operations and of Distributable Cash From Sales or Refinancings equals the aggregate amount of the Limited Partners' original invested capital plus a cumulative 10% annual return (compounded daily) on their aggregate unreturned invested capital (calculated from the beginning of the first full fiscal quarter following the Partnership's closing date). The cumulative distribution to date is $656.04 per Unit and represents 61.55% of \"Payout\". After Payout has occurred, any Distributable Cash From Sales or Refinancings will be distributed 15% (plus an additional 1% for each 1% by which the total of all Limited Partners' original Capital Contributions actually paid or allocated to the Partnership's investment in equipment exceeds the greater of (i) 80% of the gross proceeds of the Partnership's offering of Units, reduced by 0.0625% for each 1% of leverage encumbering Partnership equipment, or (ii) 75% of the gross proceeds of such offering) to the General Partner, and the remainder to the Limited Partners. It is not anticipated that Payout will occur as of the liquidation of this Partnership.\nDistributable Cash, if any, will be distributed within 60 days after the completion of each of the first three fiscal quarters of each Partnership fiscal year and within 120 days after the completion of each fiscal year, beginning after the first full fiscal quarter following the Partnership's closing date. Each such distribution will be described in a statement sent to the Limited Partners. All future cash distributions have been halted until the remaining claim balance has been settled and all stock sold. At that time, a final distribution will be made to the Partners. In order to avoid unnecessary costs to the investors and promote the highest final distribution rate possible, there will be no future quarterly investor reports since there will be little activity in the Partnership. Instead, the December 31, 1995 Annual Report will be the last investor report issued.\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 read in conjunction with the financial statements and notes thereto, and Management's Discussion and Analysis of Financial Condition and Results of Operations, which are included in Items 8. and 7., respectively of this report.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nGeneral\nOn March 15, 1984, the Partnership completed its offering and received from the escrow account $18,183,980 representing 36,463 Units of Limited Partnership Interests. Of this amount, the Partnership received proceeds from the sale of 1,188 Units at a price net of sales commission for employees of the Corporate General Partners of the General Partner and employees and securities representatives of its affiliates, who are allowed to purchase Units for a net price of $460 per Unit.\nResults of Operations\nThe Partnership realized net income of $321,463, $556,967 and $373,736 for the years ended December 31, 1995, 1994 and 1993, respectively. Rental income decreased $432,182 or 67% and $419,751 or 39% in 1995 and 1994, respectively. The decrease in rental income each year is primarily due to lower rental rates generated on equipment lease extensions and remarketings resulting after the initial lease term expires and due to a decrease in the overall size of the equipment portfolio. Another factor resulting in the current year decrease is primarily due to the Partnership's sale of the equipment portfolio and the related leases during August 1995. Interest income decreased $25,305 and increased $24,772 for the years ended December 31, 1995, and 1994, respectively, as a result of the lower short-term investment balances held in 1995 versus higher short-term investment balances held in 1994. The recovery of net unsecured pre-petition claim of $114,773 and $186,381 for the years ended December 31, 1995 and 1994, respectively, was the result of the receipt of the Trustee's distributions on the fully reserved net unsecured pre-petition receivable(for further discussion refer to note 5 to the financial statements). The current year recovery relates to the receipt of the second and third Trustee's distributions comprised of cash and stock, along with the second quarter of 1995 establishment of the carrying value of the stock received in the December 27, 1994 distribution. Accordingly, the prior year recovery amount represents the cash portion of the Trustee's first distribution. The slight increase in net gain on sale of equipment between 1995 and 1994, is due to the current year sale of the entire equipment portfolio along with significant sales of equipment carrying lower net book values in 1994.\nTotal costs and expenses decreased 70% and 28% in 1995 and 1994, respectively, compared to prior periods. The decrease in costs and expenses is primarily a result of a decrease in depreciation expense, the current year reversal of provision for doubtful accounts and management fees. Depreciation expense decreased each year due to a large portion of the equipment portfolio becoming fully depreciated and the sale of the equipment. The entire equipment portfolio was sold in August of 1995 in preparation for the liquidation of the Partnership. Included in depreciation expense in 1994 is a provision for $20,000 to properly reflect the equipment portfolio's net realizable value. The reversal of provision for doubtful accounts of $28,777 is due to successful collection efforts on delinquent rents receivable. Management fees expense each year decreased in relation to the decline in rental income. The net loss on sale of marketable securities reflects the fourth quarter sale of stock that had been received from the Trustee. General and administrative expenses increased due to the establishment and satisfaction of outstanding liabilities as a result of the Partnership's liquidation. Another factor contributing to the increase is that salaries and expenses of the partnership accounting and reporting personnel, of the General Partner, which are reimbursable by the various partnerships under management are being allocated over a diminishing number of partnerships. The General Partner managed 15 partnerships in 1995, 19 partnerships in 1994 and 21 partnerships in 1993.\nThe Partnership had net income per Limited Partnership Unit of $6.82, $8.27 and $4.46 in 1995, 1994 and 1993, respectively. The allocation for the years ended December 31, 1995 and 1994 includes a cost recovery allocation of profit and loss among the General and Limited Partners which results in an allocation of net loss to the Limited Partners. This cost recovery allocation is required to maintain capital accounts consistent with the distribution provisions of the Partnership Agreement. In certain periods, the cost recovery of profit and loss may result in an allocation of net loss the Limited Partners in instances when the Partnership's operations were profitable for the period.\nLiquidity and Capital Resources\nDuring the fourth quarter of 1994, the General Partner announced its intentions of winding down the operations of the Partnership beginning in 1995. As of December 31, 1995, all of the assets have been sold with the exception of the unsecured pre-petition claim receivable. The sales proceeds generated from the sale of the assets were accumulated to settle all outstanding liabilities and make a final distribution on November 28, 1995, prior to the sale of stock and receipt of the final Trustee settlement distribution. All future cash distributions have been halted until the remaining claim balance has been settled and any stock received, sold. At that time, a final distribution shall be made to the partners. As discussed in note 6 Subsequent Events, the Partnership received the fourth distribution from the Trustee, with respect to the unsecured pre-petition claim. The distribution consisted of cash proceeds of $3,535. Following the Trustee's fourth distribution and an additional charge off made during 1995, the Partnership has a remaining net unsecured pre-petition claim of $19,279 as of January 19, 1996.\nThe Partnership's investing activities for the year resulted in the sale of its remaining equipment portfolio with a depreciated cost basis of $99,006, generating $204,038 in sales proceeds. During the fourth quarter, the Partnership sold 20,868 shares of CISC stock, having a cost basis of $52,170, generating net sales proceeds in the amount of $42,561.\nDuring 1995, the Partnership distributed a total of $18.75 per Limited Partnership Unit, of which $6.82 per Unit represents income and $11.93 per Unit represents a return of capital. As discussed above, the Partnership is awaiting the settlement of its outstanding net unsecured pre-petition claim balance in order to make the final distribution. The Partnership will not be terminated until the net unsecured pre-petition claim against CIS has been settled and the remaining proceeds have been distributed to the Partners (see note 5 to the financial statements). The effects of inflation have not been significant to the Partnership and are not expected to have a material impact in future periods.\nOn January 9, 1996, TLP Holding LLC purchased all the common stock of TLP from CMI Holding Co. Under the new ownership, it is expected that TLP will continue to operate in the same manner of business as it has in the past.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nIndependent Auditors' Report\nThe Partners of Wellesley Lease Income Limited Partnership D:\nWe have audited the accompanying balance sheets of Wellesley Lease Income Limited Partnership D (a Massachusetts Limited Partnership) as of December 31, 1995 and 1994, and the related statements of operations, partners' equity (deficit) and cash flows for each of the years in the three-year period ended December 31, 1995. In connection with our audits of the financial statements, we have also audited the accompanying financial statement schedule II for each of the years in the three-year period ended December 31, 1995. These financial statements and this financial statement schedule are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements and this 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 Wellesley Lease Income Limited Partnership D as of December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 1995, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.\nAs discussed in note 1, at December 31, 1995 the General Partner has sold all of the assets of the Partnership with the exception of the unsecured pre-petition claim, and has settled all outstanding liabilities. The Partnership will be terminated when this claim is settled and the proceeds have been distributed to the Partners.\nKPMG Peat Marwick LLP\nBoston, Massachusetts March 15, 1996\nWELLESLEY LEASE INCOME LIMITED PARTNERSHIP D (A Massachusetts Limited Partnership)\nBalance Sheets December 31, 1995 and 1994\nSee accompanying notes to financial statements.\nWELLESLEY LEASE INCOME LIMITED PARTNERSHIP D (A Massachusetts Limited Partnership)\nStatements of Operations For the Years Ended December 31, 1995, 1994 and 1993\nSee accompanying notes to financial statements.\nWELLESLEY LEASE INCOME LIMITED PARTNERSHIP D (A Massachusetts Limited Partnership)\nStatements of Partners' Equity (Deficit) For the Years Ended December 31, 1995, 1994 and 1993\nSee accompanying notes to financial statements.\nWELLESLEY LEASE INCOME LIMITED PARTNERSHIP D (A Massachusetts Limited Partnership)\nStatements of Cash Flows For the Years Ended December 31, 1995, 1994 and 1993\nSee accompanying notes to financial statements.\nWELLESLEY LEASE INCOME LIMITED PARTNERSHIP D (A Massachusetts Limited Partnership)\nNotes to Financial Statements December 31, 1995, 1994 and 1993\n(1) Organization and Partnership Matters\nThe Partnership was organized under the Massachusetts Uniform Limited Partnership Act on May 6, 1983. The Amended Agreement of Limited Partnership authorized the issuance of up to 36,413 Limited Partnership Units at a per unit gross price of $500 and up to 50 additional units to affiliates. The Partnership closed on March 15, 1984, with 36,463 units.\nThe General Partner has contributed $1,000 in respect of its General Partnership interest. In addition, the General Partner and its affiliates have acquired an additional $24,000 of Limited Partnership Units in accordance with the Amended Agreement of Limited Partnership.\nPursuant to the terms of the Amended Agreement of Limited Partnership, Distributable Cash From Operations and Profits for federal income tax and financial reporting purposes from normal operations and any Distributable Cash From Sales or Refinancings from gains of the Partnership shall be allocated 95% to the Limited Partners and 5% to the General Partner. Further, gains on sales of equipment occurring after the reinvestment period end shall be allocated first to eliminate negative capital accounts, if any, and second 95% to the Limited Partners and 5% to the General Partner until \"Payout\" has occurred. \"Payout\" means the time when the aggregate amount of all distributions to the Limited Partners of Distributable Cash From Operations and of Distributable Cash From Sales or Refinancings equals the aggregate amount of the Limited Partners' original invested capital plus a cumulative 10% annual return (compounded daily) on their aggregate unreturned invested capital (calculated from the beginning of the first full fiscal quarter following the Partnership's closing Date). Losses for federal income tax and financial reporting purposes from normal operations and any Distributable Cash From Sales or Refinancings from losses of the Partnership shall be allocated 99% to the Limited Partners and 1% to General Partner until Payout has occurred, and 85% to the Limited Partners and 15% to the General Partner thereafter. In addition, special cost recovery allocations may be required to reflect the differing initial capital contributions of the General Partner and the Limited Partners. The Partnership's books and records are in accordance with the terms of the Amended Agreement of Limited Partnership. The cumulative distributions to date are $656.04 per Unit and represent 61.55% of Payout. It is not anticipated that Payout will occur as of the liquidation of this Partnership.\nDuring the fourth quarter of 1994, the General Partner announced its intentions of winding down the operations of the Partnership beginning in 1995. As of December 31, 1995, all of the assets have been sold with the exception of the unsecured pre-petition claim receivable. The sales proceeds generated from the sale of the assets were accumulated to settle all outstanding liabilities and make a distribution on November 28, 1995, prior to the sale of stock and receipt of the final Trustee settlement distribution. All future cash distributions have been halted until the remaining claim balance has been settled and any stock received, sold. At that time, a final distribution shall be made to the partners. The Partnership will not be terminated until the net unsecured pre-petition claim against CIS has been settled and the remaining proceeds have been distributed to the Partners (see note 5 to the financial statements).\nWELLESLEY LEASE INCOME LIMITED PARTNERSHIP D (A Massachusetts Limited Partnership)\nNotes to Financial Statements\n(2) Significant Accounting Policies\nGeneral\nThe Partnership's records are maintained on the accrual basis of accounting so that revenues are recognized as earned and expenses are recognized as incurred. Assets and liabilities are those of the Partnership and do not include any assets and liabilities of the individual partners. 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.\nDepreciation on investment property purchased in 1987 and thereafter is provided using the double-declining balance method, generally over a five-year period. No salvage value is assumed. The Partnership's policy is to periodically review the estimated fair market value of its equipment to assess the recoverability of its undepreciated cost. In accordance with this policy, the Partnership records a charge to depreciation expense in instances when the net book value of equipment exceeds its net realizable value. Included in depreciation expense in 1994 is a provision for $20,000 to properly reflect the equipment portfolio's net realizable value. Routine maintenance and repairs are expensed as incurred. Major betterments and enhancements are capitalized and depreciated in accordance with the Partnership's depreciation policy.\nCash and Cash Equivalents\nThe Partnership considers cash and short-term investments with original maturities of three months or less to be cash and cash equivalents.\nAllowance for Doubtful Accounts\nThe financial statements include allowances for estimated losses on receivable balances. The allowances for doubtful accounts are based on past write off experience and an evaluation of potential uncollectible accounts within the current receivable balances. Receivable balances which are determined to be uncollectible are charged against the allowance and subsequent recoveries, if any, are credited to the allowance. At December 31, 1995 and 1994, the allowance for doubtful accounts included in rents receivable was $0 and $28,289, respectively, and $22,814 and $176,152, respectively, included in accounts receivable - affiliates, which related to the net unsecured pre-petition claim.\nIncome Taxes\nNo provision for federal income taxes has been made as the liability for such taxes is that of the Partners rather than that of the Partnership. Taxable income, as reported in Schedule K-1, Form 1065 \"Partner's Share of Income, Credits, Deductions, etc.\" was $92,129, $207,200 and $323,736, in 1995, 1994 and 1993, respectively (see note 4).\nReclassifications\nCertain prior year financial statement items have been reclassified to conform with the current year's financial statement presentation.\nWELLESLEY LEASE INCOME LIMITED PARTNERSHIP D (A Massachusetts Limited Partnership)\nNotes to Financial Statements\n(3) Related Party Transactions\nFees, commissions and other expenses paid or accrued by the Partnership to the General Partner or affiliates of the General Partner for the years ended December 31, 1995, 1994 and 1993 are as follows:\nUnder the terms of the Partnership Agreement, the General Partner is entitled to an equipment acquisition fee of 3% of the purchase price paid by the Partnership for the equipment. The General Partner is also entitled to a management fee equal to 7% of the monthly rental billings collected. Also, the Partnership reimburses the General Partner and its affiliates for certain expenses incurred by them in connection with the operation of the Partnership.\n(4) Reconciliation of Financial Statement Net Income to Taxable Income to Partners\nA reconciliation of financial statement net income to taxable income to partners is as follows for the years ended December 31, 1995, 1994 and 1993:\nLosses for federal tax purposes from normal operations are allocated 99% to the Limited Partners and 1% to the General Partner. Profits for federal tax purposes from normal operations are allocated 95% to the Limited Partners and 5% to the General Partner. In addition, special cost recovery allocations may be required to reflect the differing initial capital contribution of the General Partner and the Limited Partners.\nWELLESLEY LEASE INCOME LIMITED PARTNERSHIP D (A Massachusetts Limited Partnership)\nNotes to Financial Statements\n(5) Bankruptcy of Continental Information Systems Corporation\nOn January 13, 1989 (the \"Petition Date\"), Continental Information Systems Corporation (\"Continental\"), CIS Corporation (\"CIS\"), CMI Holding Co. (\"Holding\"), CMI Corporation (\"CMI\") and certain of its affiliates (collectively, the \"Debtors\"), voluntarily petitioned for relief under Chapter 11 of the United States Bankruptcy Code (\"Chapter 11\"), and thereafter continued in the management and operation of their businesses and property as Debtors In Possession until October 25, 1989, when the United States Bankruptcy Court (the \"Court\") confirmed the appointment of James P. Hassett as Chapter 11 trustee (the \"Trustee\") of the Debtors. Holding is the parent of TLP and CMI is the parent of CISMS. TLP and CISMS, neither of which filed under Chapter 11, are the two Corporate General Partners of Wellesley Leasing Partnership, the General Partner of the Partnership. Both before and after the Petition Date, CIS and CMI have acted as agents for the Partnership in selling, leasing and remarketing Partnership equipment. Holding became a wholly-owned subsidiary of CIS pursuant to a Court ordered settlement on July 20, 1993.\nAs of the Petition Date, there were a number of unsettled transactions between CIS and CMI and the Partnership and other affiliated partnerships (the Partnership and such other partnerships are herein collectively referred to as the \"Partnerships\"), including outstanding accounts receivable and accounts payable between each of the Partnerships and CIS and CMI and their affiliates, sales of equipment and related leases from CIS and CMI to each of the Partnerships for which not all documentation had been completed as of the Petition Date, and sales of equipment and related leases from which CIS had failed to remove prior third-party liens. In addition, accounts receivable and accounts payable continued to accrue and be paid between each of the Partnerships and CIS and CMI and their affiliates subsequent to the Petition Date.\nOn February 28, 1992, the Court granted an order implementing a settlement of the outstanding issues between each of the Partnerships and the Debtors. The settlement occurred on March 13, 1992. In the order the Court approved a set-off on a partnership-by-partnership basis of pre-petition amounts owed by each affected Debtor to each Partnership to the extent of pre-petition amounts owed by that Partnership to that Debtor. As a result of the set-off, the Partnership had a net unsecured pre-petition claim of $441,299 ($193,698 against CIS and $247,601 against CMI), as of December 31, 1993 which had been fully reserved.\nOn November 29, 1994, the Court confirmed the Trustee's proposed Joint Plan of Reorganization (\"the Plan\") dated October 4, 1994, and the Debtors emerged from Chapter 11 bankruptcy protection on December 21, 1994. In accordance with the Plan projections, 59% of each CIS claim would be paid in total, of which 44% would be cash and 15% would be common stock of the reorganized Continental Information Systems Corporation (\"CISC\"), based on a per share price of $4.29. Each of the CMI claims would be paid in full, of which 75% would be cash and 25% would be CISC common stock, as described above. Based on the Plan, the Partnership`s fully reserved unsecured pre-petition claim balance was reduced to $361,883.\nOn December 27, 1994, the Partnership received the first distribution from the Trustee (now Trustee of the Liquidating Estate of CIS Corporation, et al) with respect to the net unsecured pre-petition claim described above. The distribution consisted of cash proceeds of $186,381 and 17,837 shares of common stock in CISC. On July 20, 1995, the Partnership received the second distribution which consisted of cash proceeds of $61,386 and 2,256 shares of common stock. The Partnership received the third distribution on October 20, 1995, comprised of cash proceeds of $1,216 and 775 shares of common stock. During the second quarter of 1995, the stock of CISC began trading, thereby providing an objective valuation method for establishing the cost basis of $2.50 per share, which approximated fair value at June 30, 1995. A charge off was made in 1995 in relation to the difference between the Trustee's original prescribed value of the CISC stock at $4.29 per share and the cost basis established by the Partnership. Following the Trustee's third distribution and the charge off made during the year, the Partnership has a remaining net unsecured pre-petition claim balance of $22,814 as of December 31, 1995 (see note 6).\nWELLESLEY LEASE INCOME LIMITED PARTNERSHIP D (A Massachusetts Limited Partnership)\nNotes to Financial Statements\n(6) Subsequent Events\nOn January 19, 1996, the Partnership received the fourth distribution from the Trustee with respect to the net unsecured pre-petition claim. The distribution consisted of cash proceeds of $3,535. Following the Trustee's fourth distribution, the Partnership has a remaining net unsecured pre-petition claim balance of $19,279 as of January 19, 1996. The General Partner anticipates that the Liquidating Estate will make future distributions on the remaining outstanding claim balance, although it is not possible at this time to determine when these distributions will be made.\nOn January 9, 1996, TLP Holding LLC purchased all the common stock of TLP from Holding. Under the new ownership, it is expected that TLP will continue to operate in the same manner of business as it has in the past.\nWELLESLEY LEASE INCOME LIMITED PARTNERSHIP D (A Massachusetts Limited Partnership)\nSchedule II - Valuation and Qualifying Accounts and Reserves\nExhibit 11 WELLESLEY LEASE INCOME LIMITED PARTNERSHIP D (A Massachusetts Limited Partnership)\nComputation of Net Income per Limited Partnership Unit For the Years Ended December 31, 1995, 1994 and 1993\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Statement Disclosures.\nNone.\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\nThe Partnership has no Directors or Officers. As indicated in Item 1. of this report, the General Partner of the Partnership is Wellesley Leasing Partnership. Under the Partnership Agreement, the General Partner is solely responsible for the operation of the Partnership's properties, and the Limited Partners have no right to participate in the control of such operations. The General Partner has two Corporate General Partners: TLP and CISMS, both Massachusetts corporations. The names and ages of the Directors and Executive Officers of the Corporate General Partners are as follows:\n* Executive Committee Member\n(c) Identification of certain significant persons\nSee Item 10. (a-b)\n(d) Family relationship\nNo family relationship exists between any of the foregoing Directors or Officers.\n(e) Business experience\nArthur P. Beecher is President and Director of TLP. He is also President and Assistant Secretary of CISMS. Prior to joining TLP in October 1983, Mr. Beecher was an Officer of Computer Systems of America, Inc., in Boston, Massachusetts, most recently as Vice President, Finance and Administration since 1975. Mr. Beecher holds a B.S. from Boston University and is a Certified Public Accountant.\nThomas J. Prinzing is a Director of TLP and CISMS. On December 18, 1995, Mr. Prinzing was elected President, Chief Executive Officer and Director of Continental Information Systems Corporation (\"CISC\"). Mr. Prinzing is also the President of CIS Air Corporation, a position he has held since 1991. From 1984 to 1991 he was Senior Vice President and Chief Financial Officer of CIS. Mr. Prinzing has an Honors Bachelor of Commerce degree of the University of Windsor and is a Certified Public Accountant.\nFrank J. Corcoran is Director, Vice President, Treasurer and Clerk of TLP, and is also Vice President, Treasurer and Clerk of CISMS. Mr. Corcoran is Senior Vice President, Chief Financial Officer, Treasurer and Director of CIS and a Vice President and Treasurer of Holding. Prior to joining CIS in November 1994, he was with Unisys Finance Corporation, from 1985 to 1994, most recently as the Vice President and General Manager. Mr. Corcoran holds a B.S. from Wayne State University, a M.S. in Taxation from Walsh College and is a Certified Public Accountant.\n(f) Involvement in certain legal proceedings\nThe Partnership is not aware of any legal proceedings against any Director or Executive Officer of the Corporate General Partners which may be important for the evaluation of any such person's ability and integrity.\nItem 11.","section_11":"Item 11. Management Remuneration and Transactions.\n(a), (b), (c), (d), and (e): The Officers and Directors of the Corporate General Partners receive no current or proposed direct remuneration in such capacities, pursuant to any standard arrangements or otherwise, from the Partnership. In addition, the Partnership has not paid and does not propose to pay any options, warrants or rights to the Officers and Directors of the Corporate General Partners. There exists no remuneration plan or arrangement with any Officer or Director of the Corporate General Partners resulting from the resignation, retirement or any other termination. See note 3 to the financial statements included in Item 8. of this report for a description of the remuneration paid by the Partnership to the General Partner and its affiliates during 1995, 1994 and 1993.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Owners and Management.\nBy virtue of its organization as a limited partnership, the Partnership has no outstanding securities possessing traditional voting rights. However, as provided for in Section 13.2 of the Amended Agreement of Limited Partnership (subject to Section 13.3), a majority interest of the Limited Partners have voting rights with respect to:\n1. Amendment of the Limited Partnership Agreement;\n2. Termination of the Partnership;\n3. Removal of the General Partner; and\n4. Approval or disapproval of the sale of substantially all the assets of the Partnership.\nNo person or group is known by the General Partner to own beneficially more than 5% of the Partnership's outstanding Limited Partnership Units as of December 31, 1995.\nBy virtue of its organization as a limited partnership, the Partnership has no Officers or Directors. See also note 1 to the financial statements included in Item 8. and Item 10. of this report.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\n(a), (b), and (c): The General Partner of the Partnership is Wellesley Leasing Partnership, a Massachusetts general partnership which in turn has two Corporate General Partners: TLP and CISMS, both Massachusetts corporations. The Corporate General Partners' Directors and Executive Officers are identified in Item 10. of this report. The Partnership was not involved in any transaction involving any of these Directors or Officers or any member of the immediate family of these individuals, nor did any of these persons provide services to the Partnership for which they received direct or indirect remuneration. Similarly, there exists no business relationship between the Partnership and any of the Directors or Officers of the Corporate General Partners, nor were any of the individuals indebted to the Partnership.\nThe General Partner is responsible for acquiring, financing, leasing and selling equipment for the Partnership. CISMS proposes for the Partnership equipment acquisitions, leasing transactions, financing and refinancing transactions and sale transactions, for approval by the Executive Committee and oversees the operation, management and use of each Partnership's equipment. TLP oversaw the marketing of the Units and oversees all administrative functions of the Partnership and provides substantially all of the General Partner's capital resources. In consideration of such services and capital commitments, TLP receives 40%, and CISMS receives 60%, of all compensation received by the General Partner in connection with the formation and operation of the Partnership (including equipment management fees, acquisition fees, subordinated remarketing fees and the General Partner's share of Distributable Cash From Sales or Refinancings). The General Partner also was reimbursed in an amount equal to 3% of the gross proceeds of the Partnership's offerings for organizational and offering expenses; all such expenses in excess of that amount were borne by TLP. See note 3 to the financial statements included in Item 8. of this report for a description of payments made by the Partnership to the General Partner.\nFor information regarding the settlements between the Partnership and the Liquidating Estate of CIS Corporation, et al, arising out of the emergence from bankruptcy of CIS and CMI, see Item 3. Legal Proceedings.\nDuring the fourth quarter of 1994, the General Partner announced its intentions of winding down the operations of the Partnership beginning in 1995. As of December 31, 1995, all of the assets have been sold with the exception of the unsecured pre-petition claim receivable. The sales proceeds generated from the sale of the assets were accumulated to settle all outstanding liabilities and make a distribution on November 28, 1995, prior to the sale of stock and receipt of the final Trustee settlement distribution. All future cash distributions have been halted until the remaining claim balance has been settled and any stock received, sold. At that time, a final distribution shall be made to the partners.\nPart IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and 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.\nWELLESLEY LEASE INCOME LIMITED PARTNERSHIP D (Registrant)\nBy: Wellesley Leasing Partnership, its General Partner\nBy: TLP Leasing Programs, Inc., one of its Corporate General Partners\nDate: March 28, 1996\nBy: Arthur P. Beecher, President","section_15":""}
{"filename":"704386_1995.txt","cik":"704386","year":"1995","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.\nThis Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Actual results could differ materially from those projected in the forward-looking statements as a result of the risk factors set forth below and elsewhere in this Form 10-K.\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 computing, communications and consumer digital entertainment markets. VLSI targets a limited number of key Original Equipment Manufacturer (\"OEM\") customers who are leaders in their respective industries. See \"MARKETING AND CUSTOMERS\" below.\nThe Company has developed significant design expertise in its targeted markets by establishing a library of proprietary cells and highly integrated building blocks and uses that expertise 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 computing (high-end computing and desktop and portable personal computers) applications, wireless and networking communications applications and consumer digital entertainment systems.\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 29, 1995, approximately two-thirds of the Company's net revenues were derived from sales to its top 20 customers.\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), DSP, Ethernet, Fibre Channel, MPEGII and SSA.\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 -- VLSI PRODUCTS\nPRODUCTS AND SERVICES\nVLSI has organized its business around targeted market segments, establishing groups to address specific silicon markets. Each of the Company's silicon groups 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 Computing Products group designs, manufactures and markets devices for the computer market, including personal computer (\"PC\") applications and high-end computing applications such as graphics workstations and high-end storage. The Communications Products group designs, manufactures and markets devices for networking and wireless communications. The Consumer Digital Entertainment Products group designs, manufactures and markets devices for secure communications and home entertainment applications (such as interactive television and video game systems).\nThe key to the success of these business units 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.\nCompetition comes from a wide variety of large, established IC providers, including, but not limited to, AT&T, Intel, IBM, LSI Logic, Motorola, NEC, Texas Instruments (\"TI\") and Toshiba.\nCOMPUTING PRODUCTS\nThis group produces PC devices for Apple, its subcontractors and licensees as well as Apple-compatible peripheral suppliers worldwide and system-logic chip sets and peripheral components for personal computers based on X86 and competing personal computing architectures. The group also serves workstations (from entry-level through high-end graphic), servers, parallel processors, mass storage devices and peripherals. Apple and its licensees are provided with high-performance gate array and cell-based products, which are used in second-generation Power Macintosh(TM) systems, Apple's Powerbook(TM) computer line based on the Macintosh(R) platform and in a host of printer products. While the Company did not have significant silicon content in Apple's first generation Power Macintosh(TM) machines in 1994, VLSI has returned to historic levels of silicon content in second-generation Power Mac systems in 1995. See \"MARKETING AND CUSTOMERS\" below. See also \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Factors Affecting Future Results\" in Item 7 of Part II herein.\nThe PC chip set product line consists of highly-integrated core logic and peripheral input\/output devices for X86 systems. The group primarily targets a selected set of high-volume market leaders worldwide. VLSI's chip sets currently support Intel, Advanced Micro Devices and other competing microprocessors.\nDuring 1995, the dynamics of the X86 core logic chip set market changed dramatically with Intel, the dominant microprocessor supplier, gaining significant market share in core logic chip sets that work with its microprocessors, as well as motherboards that use the microprocessor and core logic chip sets. By the second half of 1995, Intel dominated the core logic chip set business and VLSI's design wins in this area dropped significantly. This drop is expected to result in a sharp decline in the Company's core logic chip set business in 1996. The Computing Products group is therefore shifting its focus away from standard core logic chip sets and redirecting its expertise to develop and produce custom products for X86 applications.\nSee \"COMPETITION\" herein and \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Factors Affecting Future Results\" in Item 7 of Part II hereof for recent 1996 developments that will likely reduce VLSI's current market share of the PC chip set market.\nSignificant high-end computing customers include AT&T, DEC, Silicon Graphics and Storage Technology.\nCOMMUNICATIONS PRODUCTS\nThis group serves wireless and network customers. Wireless solutions are provided for communications voice and data through the use of baseband signal processing technology developed to support various voice and data standards, the majority of which in 1995 were GSM solutions, and in 1996 are expected to include GSM, PHS, DECT and CDPD solutions. Standard products include GTI2000 (a GSM reference solution), Geode (a CDPD reference solution), RubyII (a communication processor) and Vocoder and Kernal (GSM basebands). The group supports major wireless telephone manufacturers, including Ericsson, Acer and Motorola. Additionally, solutions have been developed for other markets and standards. Wireless revenues are primarily generated in non-U.S. markets; sales to a single OEM, Ericsson, accounted for over 50% of 1995 and 1994 worldwide wireless revenues.\nNetwork solutions are provided for customers such as Alcatel, Cisco Systems, DSC Communications, NEC and Tellabs 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 complexity analog, digital and memory functions. Specific solutions for major customers include FSB cells for various networking standards, including ATM, T1, E1 and Sonet\/SDH.\nCONSUMER DIGITAL ENTERTAINMENT PRODUCTS\nThis group primarily targets high-volume entertainment-related markets including satellite and cable set-top box, digital video disk, cable modem, and electronic games as well as other miscellaneous industrial\napplications including manufacturing and robotics. The customer base for the group includes the Allen Bradley Division of Rockwell International, General Instruments, Pioneer, Sagem SAT, Sony and Thomson Consumer Electronic.\nAs these products become more sophisticated and interactive, security becomes a critical element of the product. In response to this critical need, VLSI has teamed its secure information technology with these consumer products. Secure information technologies in the form of data encryption strategies are another key area of focus for this group. VLSI also provides commercial applications of technologies developed for military applications, including Geo-Positioning Satellite systems and entertainment applications of graphics technology.\nMARKETING AND CUSTOMERS\nThe Company primarily uses a direct sales force and commissioned representatives to sell its silicon products and services. VLSI's silicon operations have 27 sales offices (19 in the United States, four in Europe, two in Japan and two in the Asia-Pacific region) as well as 19 Technology Centers (12 in the United States, four in Europe, two in Japan and one in the Asia-Pacific region). 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. The Technology Centers are staffed by system and integrated circuit designers.\nDuring each of the years 1995, 1994 and 1993, VLSI's top 20 customers represented approximately two-thirds of the Company's net revenues. Shipments to a single customer in the personal computer business, Apple, accounted for 11% of net revenues in 1995 and 19% in 1993, as compared to less than 10% in 1994. Shipments to Compaq accounted for 22% of net revenues in 1994, as compared to less than 10% in both 1995 and 1993. Due to the expected decline in the Company's X86 chip set business, the Company anticipates a shift in its top 20 customers in 1996 away from the high concentration of personal computer industry companies that was seen in 1995 and in prior years. 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 1995, 1994 and 1993 have shown sequential increases with total expenses of $89.7 million, $78.9 million and $66.4 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 in 1993 and 1994 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 regards purchased technology as a key component of product development. A few examples include ARM, DSP, Ethernet, Fibre Channel, MPEGII, SSA, power management, communications (including standards such as DECT, CT2, GSM and PHS), signal converters, forward error correction and digital signal processing, which represent key licensed technology. Research and development efforts are\nongoing to create products from those technologies and establish them as FSB's for use in ASIC products or for incorporation in ASSPs.\nThe Company's process technology development activities in 1995 concentrated on the successful development of a 0.35-micron CMOS process and on the development of software for the EDA market. R&D activities in the packaging area continue to 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 1995 in conjunction with the Company's strategic agreement with Hitachi include integration of 0.35-micron CMOS process and manufacturing methodologies.\nSee also \"EMPLOYEES\" below and \"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 needs.\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 1995 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 1995 wafer production utilized a 0.8-micron CMOS process; however, the production of wafers utilizing a 0.6-micron CMOS process increased to approximately 30% of total monthly wafer production by the end of the year.\nThe Company has three manufacturing locations. Its San Jose, California plant performs wafer fabrication, probe and final test activities. The Tempe, Arizona site contains design, probe and final test facilities. The San Antonio facility is primarily dedicated to wafer fabrication and includes four modules. Modules A, B and C have been fully facilitized, while VLSI currently anticipates facilitizing Module D during 1996. During 1995, the Company began the process of converting its San Antonio wafer fabrication facility from a predominantly 0.8-micron process to predominantly 0.6-micron and smaller processes. The conversion is expected to be completed in the first half of 1996. This will enable the Company to significantly increase its production capacity at the San Antonio facility in the fourth quarter of 1996 over the fourth quarter of 1995. These conversions, if successfully completed, will increase device volume production and lead to lower overall device costs.\nThe building housing the Company's San Jose wafer fabrication facility, which in 1995 accounted for approximately 45% of its total internal wafer production, was purchased by the Company during the first quarter of 1994. In late 1995, the conversion of the Class 10 San Jose facility from a 5-inch wafer process to a\n6-inch process was completed. This conversion is expected to 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 12-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. To the extent customers and markets served by the Company require advanced process technologies, there are no assurances that the Company will have sufficient demand to fully utilize the San Jose fabrication facility or have ultimate use for its capacity.\nIn addition to manufacturing in its own facilities, VLSI has wafer manufacturing arrangements with several 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 such as changes in government policies, transportation delays, increased tariffs, fluctuations in foreign exchange rates, and export and tax controls. Lengthy or recurring disruptions 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 50% of its final testing to third parties. The final tested circuits are then shipped to VLSI's customers or 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 and specialty gases 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. Competition in the X86 core logic chip set market, the Company's largest individual market segment, is especially intense and is subject to significant shifts in demand and severe pricing pressures. During the latter portion of 1995 and continuing into 1996, VLSI has experienced significant changes in customer behavior as Intel has become the predominant supplier of PC chip sets. As a result of this competition, VLSI expects significantly reduced market share and, to the extent VLSI elects to continue to compete in the X86 core logic market, expects to do so at reduced sales prices and gross margins.\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, Intel, IBM,\nLSI Logic, Motorola, NEC, TI and Toshiba. There is no assurance that the Company will be able to compete successfully in the future.\nCompetition is primarily based on 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 overall competitive strengths 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 \"EMPLOYEES\" below and \"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 focuses 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 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. COMPASS uses a number of different vendors' software tools to develop its own software tools and physical libraries. Vendor changes in those underlying tools in terms of features and functionality, interoperability, licensing and support can influence the focus of certain R&D projects and COMPASS' development strategies. The focus of COMPASS product development 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 established vendors, such as Cadence Design Systems, Mentor Graphics, Viewlogic Systems and Synopsys. COMPASS pursues cooperative relationships with certain of these 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, General Electric Corporation Ltd.'s Plessey Division, LG Semicon, Hitachi, Mitsubishi, NEC and Toshiba. Additionally, COMPASS libraries are supported by VLSI, Taiwan Semiconductor Manufactur-\ning 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' 20 sales offices (14 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 European distribution channels.\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.\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 29, 1995, the Company and its subsidiaries had approximately 3,000 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. In particular, the Company currently has numerous open positions, specifically in the engineering arena. Any lengthy delays in filling these positions will lead to delays in the introduction of various products currently being developed, as well as the research and development associated with potential new products.\nPATENTS AND LICENSES\nThe Company has filed a number of patent applications and currently holds various patents expiring from 2003 to 2012 covering inventions in areas including computer-aided engineering, semiconductor manufacturing and electronic circuitry. The Company expects to file additional patent applications from time to time, as appropriate. 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 three remaining defendants in a major patent infringement suit brought by TI and currently under appeal by TI (see \"Legal Proceedings\" in Item 3 of Part I herein).\nPeriodically, the Company is made aware that technology used by the Company in the manufacture of some or all of its products may infringe on product or process technology rights held by others. Resolution of whether the Company's manufacture of products has infringed on valid rights held by others may have a material adverse effect on the Company's financial position or results of operations, and may require material changes in production processes and products. IBM, Motorola and others have individually contacted the Company concerning its alleged use of intellectual property belonging to them. In addition, VLSI has also entered into 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. Certain of these agreements will require renewal in calendar 1996. The Company is unable to predict whether license agreements can be obtained or renewed on terms acceptable to the Company. Failure to obtain or renew such licenses could result in litigation and the attendant cost and diversion of resources associated therewith. An adverse decision on any such litigation or such material changes could have a material effect on the Company's financial position or results of operations.\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\".\nFINANCIAL INFORMATION BY BUSINESS SEGMENT AND GEOGRAPHIC DATA\nThis information is included in Note 9 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 and San Antonio facilities are located near residential areas, 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 material adverse effect on the Company's operating results.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company owns the buildings housing its three manufacturing facilities located in San Jose, California, Tempe, Arizona and San Antonio, Texas and recently acquired ownership of its previously leased headquarters buildings in San Jose. 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 19 Technology Centers (12 in the U. S., four in Europe, two in Japan and one in the Asia-Pacific region). The Company's other properties, including some comprising its San Jose campus, are occupied under operating leases that expire on various dates through October 2023 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 those San Jose and San Antonio facilities that it owns.\nThe Company's San Jose facility, which includes manufacturing, COMPASS, 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 primarily 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. During 1995, Module B was fully equipped and Module C was fully facilitized and minimally equipped, while Module D was partially facilitized.\nThe Tempe site contains the research and development resources supporting the PC chip set products for the Computing Products group, test facilities, marketing, sales and Technology Center functions.\nVLSI expanded into new leased facilities adjacent to its San Jose headquarters in each of the last three years ending in 1995. The Company anticipates that the lease of the additional space, along with an option obtained for additional space adjacent to its leased facilities in San Jose, will satisfy the Company's growth needs in the near term.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nTexas Instruments Litigation\nThe Company along with LSI Logic and Cypress Semiconductor (the Company and such other defendants are collectively referred to as the \"TI Defendants\") are named defendants in a lawsuit filed by TI in 1990 that claims alleged patent infringement.\nTI filed this patent infringement action against the TI Defendants in the United States District Court for the Northern District of Texas seeking damages for alleged past infringement of now expired U.S. Patent Nos. 4,043,027 and 3,716,764. A trial in April 1995 resulted in a May 1995 jury verdict against the Company in the amount of $19.4 million. While in the process of contesting the jury verdict, the Company recorded a charge to earnings of $19.4 million in the second quarter of 1995. In August 1995, the trial judge issued an order overturning and setting aside the jury verdict and conditionally granting a new trial on the matter in the event that his order is reversed on appeal. TI is pursuing an appeal of the trial judge's order in the United States Court of Appeals for the Federal Circuit and seeks a reversal of that order as well as enhanced damages, pre-judgment interest and attorneys' fees. The Company has not made any adjustments to the $19.4 million charge taken during the second quarter of 1995, pending resolution of this and related intellectual property matters. In the event that TI's appeal is successful and enhanced damages (which by statute may be as high as treble damages), pre-judgment interest and\/or attorney's fees are awarded, such a judgment could result in a material reduction in liquidity, as well as an additional adverse impact on the Company's reported results of operations.\nOther Patent Matters\nPeriodically, the Company is made aware that technology used by the Company in the manufacture of some or all of its products may infringe on product and process technology rights held by others. An adverse decision on infringement of patents may have a material adverse effect on the Company's financial position or results of operations and may require material changes in production processes or products. Where deemed advisable, the Company may seek or extend licenses or negotiate settlements. See \"Patents and Licenses\" in Item I of Part I herein.\nOther Litigation\nThe Company is currently a party to various other legal actions arising out of the normal course of business, none of which are 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 matters were submitted to a vote of the security holders of the Company during the fourth quarter of fiscal 1995, which ended December 29, 1995.\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 41, 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. Bernd U. Braune, age 40, was named Senior Vice President of Worldwide Sales and Marketing in November 1995. Mr. Braune joined the Company in June 1993 as General Manager and Vice President of European Operations. Prior to joining the Company, Mr. Braune was Managing Director for European operations of NCR Microelectronics, a computing company, from 1987 until 1991 and then Director\nof Marketing for NCR Central Europe as part of the Global Information Systems Group of AT&T, a computing company, until joining VLSI.\nMr. Donald L. Ciffone, Jr., age 40, was named Senior Vice President of VLSI Products in November 1995. Mr. Ciffone 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, a semiconductor manufacturer, in various capacities from 1978 until 1991, including as Director of Marketing, ASIC Division immediately prior to his departure.\nMr. Larry Grant, age 50, joined the Company in January 1996 as Vice President, General Counsel and Secretary. From 1985 until joining VLSI, Mr. Grant was Vice President and General Counsel to Micron Technology, Inc., a semiconductor manufacturer.\nMr. Gregory K. Hinckley, age 49, was named Senior Vice President in November 1995. Mr. Hinckley 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 and OEC Medical Systems, Inc.\nMr. Balakrishnan S. Iyer, age 39, 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 44, was named Group Vice President of the Computing Products Division in November 1995. Prior to that time, he was Vice President and General Manager of the Personal Computer Division from June 1994, and Vice President, Worldwide Sales and Technology Center Operations, from November 1992 until June 1994. 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 52, 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 Company's European operations. From December 1988 until March 1991, he was President of VLSI Technology Europe.\nThere are no family relationships among the Company's executive officers and directors.\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) The Company's Common Stock is traded on the Nasdaq National Market under the symbol VLSI. The prices per common share represent the highest and lowest closing prices for VLSI's Common Stock in the Nasdaq National Market during each quarter. On February 23, 1996, there were approximately 2,020 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.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA(1)\n- ---------------\n(1) Certain prior year amounts previously reported have been reclassified to conform to the 1995 presentation.\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.\nThe Company has never paid any cash dividends and is currently prohibited from doing so under the terms of its committed Credit Agreement. See Note 2 of Notes to Consolidated Financial Statements, which information is incorporated herein by reference to Item 8 of Part II hereof.\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 (\"MDA\") should be read in conjunction with the 1995 Consolidated Financial Statements and Notes thereto in Item 8","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY 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 29, 1995\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 29, 1995 and December 30, 1994 and the related consolidated statements of income, stockholders' equity and cash flows for each of the three fiscal years in the period ended December 29, 1995. 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 29, 1995 and December 30, 1994, and the consolidated results of its operations and its cash flows for each of the three fiscal years in the period ended December 29, 1995, 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\n-------------------------------------- ERNST & YOUNG LLP\nSan Jose, California January 16, 1996\nVLSI TECHNOLOGY, INC.\nCONSOLIDATED STATEMENTS OF INCOME\n(DOLLARS AND SHARES IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n- ---------------\n(1) See Note 8 for related party disclosures.\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- ---------------\n(1) See Note 8 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 29, 1995\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 years prior to 1994, the Company's fiscal year ended on the last Saturday in December. Fiscal years 1995, 1994 and 1993 ended December 29, 30 and 25, 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.\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 invests cash through high-credit-quality financial institutions. 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 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 semi-annual adjusted standard basis (which approximates average cost on a FIFO basis); market is based upon estimated net realizable value. The valuation of inventory at the lower of cost or market requires the use of estimates as to the amounts of current inventory that will be sold. These estimates are dependent on the Company's assessment of current and expected orders from its customers, given that orders, particularly of core logic and cellular handset chip sets, are subject to cancellation with limited advance notice prior to shipment. In most instances, inventory is reserved if the units in inventory exceed six months of estimated demand for that product. As a considerable portion of the Company's sales are to the personal computer and cellular handset markets, it is reasonably possible that the recoverability of VLSI's investment in inventory associated with these markets will change in the near term. No estimate can be made of a range of amounts of customer cancellations that would materially affect the consolidated financial statements.\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. The valuation of property, plant and equipment at depreciated cost requires use of estimates as to the estimated useful lives and salvage value of these assets. As the Company competes in an industry that relies on rapidly changing technology and manufacturing developments, the actual useful lives and salvage values may eventually prove to be lower than those estimated. No estimate can be made of a range of amounts of loss that are reasonably possible should actuals prove lower than estimated.\nREVENUES. Revenues from silicon product sales to customers are recognized upon shipment.\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 29, 1995\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. During 1995, the Company changed the functional currency of the majority of its larger foreign subsidiaries from the local subsidiary currency to U.S. dollar-based currency. 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 1995, 1994 and 1993. 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 29, 1995 relates to hedging foreign currency net asset and liability positions as well as purchase orders and consists of foreign exchange forward contracts to sell $25.8 million in foreign currency and buy $23.0 million in foreign currency. These contracts, which matured through January 1996, were with major international financial institutions resulting in a net gain of $0.8 million on the forward contracts hedging foreign currency net asset and liability positions and a $0.6 million deferred loss on the forward contracts hedging purchase orders. The deferred loss is to be included in the cost of the items to be acquired. 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 values.\nDebt (See Note 2) -- Quoted market prices of the Company's convertible debt 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 29, 1995 and December 30, 1994 are as follows:\nVLSI TECHNOLOGY, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) THREE YEARS ENDED DECEMBER 29, 1995\nThe fair value estimates presented are based on pertinent information available to management as of December 29, 1995 and December 30, 1994, 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.\nThe Company classifies liquid investments as available-for-sale or held-to-maturity at the time of purchase and reevaluates such designation as of each balance sheet date in accordance with the nature of the securities and the intent and investment goals of the Company. 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. Unrealized 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 liquid investments at December 29, 1995 are classified as available-for-sale securities. Such investments, which mature through June 1996, are categorized in the following table.\nVLSI TECHNOLOGY, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) THREE YEARS ENDED DECEMBER 29, 1995\nAll investments at December 30, 1994 were classified as available-for-sale securities. Such investments, which matured through April 1995, are categorized in the following table.\nThere were no gains or losses realized on sales of available-for-sale securities during 1995. Unrealized holding losses on available-for-sale securities included in stockholders' equity in 1995 and 1994 were immaterial.\nCAPITALIZED INTEREST. Of total interest expenditures in 1995 and 1994 of $12.3 million and $8.7 million, respectively, the Company capitalized $4.3 million and $0.4 million. Amounts subject to capitalization in prior years were not material.\nSTOCK-BASED COMPENSATION. The Company grants stock options for a fixed number of shares to employees with an exercise price equal to the fair value of the shares at the date of grant. The Company accounts for stock option grants in accordance with APB Opinion No. 25, \"Accounting for Stock Issued to Employees\" and, accordingly, recognizes no compensation expense for the stock option grants.\nNET INCOME PER SHARE. Net income 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 through late August 1995 a warrant held by Intel Corporation (\"Intel\"). Fully diluted earnings per share have not been presented, because the amounts are not materially different.\nUSE OF ESTIMATES. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.\nRECLASSIFICATIONS. Certain prior year amounts previously reported have been reclassified to conform to the 1995 presentation.\nNEW ACCOUNTING PRONOUNCEMENTS. The Company must adopt Statement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of\" (\"FAS 121\") and Statement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation\" (\"FAS 123\") with the commencement of fiscal 1996. Initial adoption of FAS 121 will not have a material effect on the Company's consolidated financial statements. The Company has elected to adopt the disclosure requirements of FAS 123 rather than the accounting requirements of FAS 123.\nVLSI TECHNOLOGY, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) THREE YEARS ENDED DECEMBER 29, 1995\n2. LONG-TERM DEBT\nTotal debt at December 29, 1995 and December 30, 1994 consists of the following:\nThe Company has a two-year committed Credit Agreement (the \"Credit Agreement\") with a syndicate of banks providing for borrowings of up to $52.5 million at various rates of interest that expires June 7, 1996. The Credit Agreement has various covenants that preclude the Company from, among other things, paying cash dividends and also places certain other limits on the Company. 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 29, 1995 and December 30, 1994, the Company had no outstanding borrowings on the Credit Agreement.\nInterest 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 equipment loans require adherence to certain financial covenants, one of which prohibits payment of cash dividends.\nIn July 1995, the Company called for redemption of the 7% Convertible Subordinated Debentures due 2012 (\"Debentures\"). Of the $57,500,000 in principal amount of Debentures, $57,364,000 were converted into 2,607,359 shares of the Company's Common Stock. The Debentures not converted, which amounted to $136,000, were redeemed by the Company at a price of $1,032.86 for each $1,000 in principal amount of Debentures redeemed. This resulted in the issuance of 6,181 shares of the Company's Common Stock under an underwritten call agreement that the Company had entered into with Bear, Stearns & Co. Inc. and Hambrecht & Quist LLC.\nIn September 1995, the Company completed the public offering of an aggregate of $172.5 million of 8.25% Convertible Subordinated Notes (\"Notes\") due 2005, for net proceeds of approximately $168 million. Interest on the Notes is payable on April 1 and October 1 of each year commencing April 1, 1996. The Notes are convertible into shares of VLSI Common Stock at any time on or before the close of business on the last trading day prior to maturity, unless previously redeemed, at a conversion price of $54.80 per share, subject to adjustment in certain events. The Notes are redeemable, in whole or in part, at the option of the Company, upon at least 15 days' notice, at any time on or after October 3, 1997, at redemption prices starting at 103.3% and at diminishing prices thereafter, plus accrued interest, except that the Notes may not be redeemed prior to October 3, 1999 unless the closing price of the Common Stock is at least 125% of the conversion price for at least 20 trading days within a period of 30 consecutive trading days ending on the fifth trading day prior to the notice of redemption. The Notes are unsecured and subordinated in right of payment in full to all existing and future Senior Debt of the Company (as defined). The Company expects from time to time to incur\nVLSI TECHNOLOGY, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) THREE YEARS ENDED DECEMBER 29, 1995\nindebtedness constituting Senior Debt. Additionally, the terms of the Company's existing Credit Agreement prohibit the Company from repaying any Notes prior to maturity.\nMaturities of debt are as follows: 1996 -- $7.6 million, 1997 -- $7.8 million, 1998 -- $7.9 million, 1999 -- $8.4 million, 2000 -- $9.0 million and thereafter (starting in 2001) -- $182.3 million.\n3. LEASES AND OTHER COMMITMENTS\nObligations under capital leases represent the present value of future minimum 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 $50.2 million and $54.6 million at December 29, 1995 and December 30, 1994, respectively.\nThe Company rents certain equipment and manufacturing and office facilities under operating lease agreements that 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.\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 29, 1995, are shown as follows:\nRental expense was approximately $10.2 million in 1995 ($9.0 million in 1994 and $11.3 million in 1993).\nOTHER COMMITMENTS. The Company has commitments for the purchase of equipment totaling approximately $157.2 million at December 29, 1995, as well as various other long-term committed contracts.\n4. LITIGATION AND CONTINGENCIES\nIn 1990, patent infringement claims were filed by Texas Instruments (\"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\nVLSI TECHNOLOGY, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) THREE YEARS ENDED DECEMBER 29, 1995\nAppeals, for the Federal Circuit, affirmed the ITC decision in 1993. The U.S. District Court proceedings resulted in a May 1995 jury verdict against the Company for damages of $19.4 million. Although the Company was in the process of contesting the verdict at the trial court level, the Company recorded a charge to earnings of $19.4 million in the second quarter of 1995. In August 1995, the trial judge issued an order overturning and setting aside the jury verdict and conditionally granting a new trial on the matter in the event that his order is reversed on appeal. TI has filed a notice of appeal and will seek a reversal of the trial judge's order as well as enhanced damages (which by statute may be as high as treble damages), pre-judgment interest and attorneys' fees. The Company intends to continue to vigorously defend itself against the TI claims throughout the appeals process. The Company has retained the $19.4 million charge taken during the second quarter of 1995, pending resolution of this and related intellectual property matters. The litigation charge is shown as a separate liability on the balance sheet, net of TI litigation expenditures incurred during 1995.\nWhile the final 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.\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.\n5. STOCKHOLDERS' EQUITY\nThe Company's amended certificate of incorporation authorizes 102,000,000 shares of Capital Stock for issuance, 100,000,000 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 99,000,000 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 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.\nIn June 1995, the Company completed the public offering of an aggregate of 3,450,000 shares of its Common Stock at a price to the public of $28.625 per share, for net proceeds to the Company of approximately $94 million.\nIn January 1996, the Board authorized the Company to repurchase shares of the Company's Common Stock on the open market or in privately negotiated transactions. The Board authorized the Company to re-issue those shares at a later date through certain of its employee stock plans and\/or to fund stock or asset acquisitions authorized by the Board. By the end of January 1996, the Company had repurchased 1.8 million shares at an average per share price of $15.10, and had not yet re-issued any of these shares.\nINTEL AGREEMENTS. In the third quarter of 1992, VLSI and Intel entered into two related agreements. On July 8, 1992, VLSI and Intel entered into a Technology and Manufacturing Agreement (\"Technology Agreement\"), and on August 25, 1992, pursuant to the Intel\/VLSI Stock and Warrant Purchase Agreement (\"Equity Agreement\") also entered into on July 8, 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. In addition, 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\nVLSI TECHNOLOGY, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) THREE YEARS ENDED DECEMBER 29, 1995\nefforts 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. In August 1995, Intel exercised its Warrant, resulting in net proceeds to the Company of approximately $31 million.\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.\nSTOCKHOLDERS' RIGHTS PLAN. In August 1992, the Board 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 outstanding 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 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 29, 1995, non-employee directors held options to purchase 115,000 shares of Common Stock at exercise prices ranging from $6.75 to $14.25 per share, of which 65,000 were exercisable. In addition, 160,000 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 9,000,000 shares authorized to be issued under this Plan, 6,816,094 shares have been issued through December 29, 1995.\nSTOCK OPTION PLANS. Employees and consultants may be granted options to purchase shares of VLSI's 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 29, 1995, 1,087,626 shares were available for grant under the 1992 Stock Plan. This Plan expires in 2002. The Board has authorized an increase of 5,000,000 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.\nVLSI TECHNOLOGY, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) THREE YEARS ENDED DECEMBER 29, 1995\nAdditional information relative to the Plans is as follows:\nDuring 1995, VLSI recorded a tax benefit related to options exercised under the Plans, resulting in a $10,250,000 increase in stockholders' equity ($1,200,000 in 1994 and $1,680,000 in 1993).\n6. EMPLOYEE BENEFIT PLANS\nThe Company accrued approximately $7.6 million, $5.0 million and $3.8 million in 1995, 1994 and 1993, 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 $1.4 million, $0.6 million and $0.5 million in 1995, 1994 and 1993, respectively.\n7. INCOME TAXES\nThe provision for taxes on income is as follows:\nPre-tax income from foreign operations was $9.6 million, $4.5 million and $1.2 million in 1995, 1994 and 1993, respectively.\nVLSI TECHNOLOGY, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) THREE YEARS ENDED DECEMBER 29, 1995\nThe provision for taxes reconciles with the amount computed by applying the U.S. statutory rate to income 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:\nIn accordance with Financial Accounting Standards No. 109, the Company has recorded net deferred tax assets totaling $30.0 million as of December 29, 1995 reflecting the benefit of credit and loss carryforwards, and other temporary differences. The credit and loss carryforwards expire in various years between 1998 and 2010. Realization of the benefits is dependent on generating sufficient U.S. taxable income prior to expiration of the carryforwards. Although realization is not assured, management believes it is more likely than not that all net deferred tax assets will be realized. The amount of the deferred tax assets considered realizable could be reduced in the near term if estimates of future taxable income during the carryforward period are reduced.\nVLSI TECHNOLOGY, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) THREE YEARS ENDED DECEMBER 29, 1995\nFor U.S. tax purposes, at December 29, 1995, VLSI had general business and alternative minimum tax credit carryforwards of approximately $9.9 million. Foreign subsidiaries have tax loss carryforwards of approximately $8.7 million. Such credit and loss carryforwards expire in various years beginning in 1998. 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. Certain foreign subsidiaries have accumulated earnings of $15.2 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.\n8. 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 $42.6 million, $27.6 million and $38.1 million in 1995, 1994 and 1993, 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 $4.3 million and $1.9 million in 1995 and 1994, respectively. Such company, which provides production, assembly and test services, is one of three primary suppliers that provide substantially all of the Company's assembly and test needs. Although the above company is not the only provider of these services and, as a related party, is not believed likely by management to precipitate a change in suppliers, a change in suppliers could cause manufacturing delays and a possible loss of sales, which would adversely affect operating results.\n9. 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 focuses its products for the computing, communications and consumer digital entertainment industries and distributes its products through worldwide direct sales, commissioned representatives and distributors.\nIn 1995 and 1993, Apple Computer, Inc. (\"Apple\") accounted for 11% and 19%, respectively, of net revenues. In 1994, Apple represented less than 10% of net revenues. In 1994, Compaq Computer Corporation accounted for 22% 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 29, 1995\nThe following is a summary of operations located within the indicated geographic areas for the three years ended December 29, 1995:\nU.S. export revenues, primarily to the Asia-Pacific region, were approximately $153.8 million, $162.1 million and $126.7 million in 1995, 1994 and 1993, 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 RELATIONSHIPS 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 index to financial statements and financial statement schedule (set forth in Item 8 of Part II of this Form 10-K) are filed within this Annual Report on Form 10-K.\n2. Financial Statement Schedule\nThe financial statement schedule listed in the Index to Consolidated Financial Statements and Financial Statement Schedule (set forth in Item 8 of Part II of this Form 10-K) 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 Reports on Form 8-K filed by the Company during the fourth quarter ended December 29, 1995.\n(c) Exhibits\n- ---------------\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 and 1986 Directors' Stock Option Plan of VLSI Technology, Inc. and in the related Prospectuses, of our report dated January 16, 1996, with respect to the consolidated financial statements and schedule of VLSI Technology, Inc. included in this Annual Report (Form 10-K) for the year ended December 29, 1995.\n\/s\/ ERNST & YOUNG LLP -------------------------------------- ERNST & YOUNG LLP\nSan Jose, California March 22, 1996\nVLSI TECHNOLOGY, INC.\nSCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS AND RESERVES (IN THOUSANDS)\n- ---------------\n(1) Deductions represent amounts written off against the allowance for doubtful accounts and customer returns.\n(2) Deductions represent amounts written off against the reserves.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the 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 ---------------------------------- Alfred J. Stein, Chairman of the Board, Chief Executive Officer and President\nDate: March 12, 1996\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, and each of them 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\n- ---------------\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":"789089_1995.txt","cik":"789089","year":"1995","section_1":"Item 1. Business\nGeneral\nThe Registrant, VMS National Properties Joint Venture (the \"Venture\"), of which the general partners are VMS National Residential Portfolio I (\"Partnership I\") and VMS National Residential Portfolio II (\"Partnership II\"), was formed in September, 1984. Collectively, Partnership I and Partnership II are referred to as the \"Partnerships\". The Partnerships are limited partnerships formed in September 1984, under the Uniform Limited Partnership Act of the State of Illinois. The Managing General Partner of each of the Partnerships is VMS Realty Investment, Ltd. (formerly VMS Realty Partners), an Illinois limited partnership. (Effective as of January 1, 1987, Chicago Wheaton Partners assigned its ownership interests in the Partnerships to VMS Realty Investment, Ltd.) Prudential-Bache Properties, Inc. is also a minority general partner of Partnership I.\nThe Venture originally acquired 51 residential apartment complexes located throughout the United States. At December 31, 1995, 32 of the Venture's properties had been foreclosed. The Venture continues to own and operate the remaining 19 residential apartment complexes it originally acquired. However, as provided by the Plan, the Venture filed notices of abandonment on 34 of the properties of which two remain and plans to continue to own and operate the remaining 17 retained properties. Three of the remaining 19 properties are encumbered by financing insured or held by the Department of Housing and Urban Development (\"HUD\"). HUD does not provide rent or interest subsidies in connection with such complexes nor does it restrict rental rates in such complexes from being at market rates. These properties are owned by 3 separate subpartnerships (\"Subpartnerships\"), of which the Venture owns a 99% equity interest. The remaining 1% interest is owned by VMS Realty Investment, Ltd.\nFrom the period October 26, 1984, through June 16, 1985, the Partnerships sold 912 Limited Partnership Interests at a price of $150,000 per Limited Partnership Interest for a total of $136,800,000. The Interests of each Partnership were offered in reliance upon exemptions from registration under the Securities Act of 1933, as amended (the \"ACT\"), and Regulation D thereunder.\nThe Venture is engaged solely in the business of real estate investment. A presentation of information about industry segments is not applicable and would not be material to an understanding of the Venture's business taken as a whole.\nAs a result of financial difficulties, VMS National Properties Joint Venture filed for Chapter 11 bankruptcy protection in the United States Bankruptcy Court in the Central District of California on February 22, 1991 (see Note 4 of the Notes to Combined Financial Statements). This voluntary filing encompassed the Venture's non-HUD properties only. In March 1993 the substance of the Venture's Plan of Reorganization was approved by the Bankruptcy Court and a Confirmation Order was entered (see \"Note 5\" of the Notes to Combined Financial Statements) and the Plan became effective on September 30, 1993.\nThe participation interest in the Venture of Partnership I and Partnership II is approximately 71% and 29%, respectively.\nThe Venture has no employees. The officers and employees of VMS Realty Partners and their affiliates performed all administrative and operational services, including all asset management functions, but excluding all property management functions, for the Venture's properties through September 30, 1993. Effective October 1, 1993, the Managing General Partner engaged Insignia Financial Group, Inc. (\"Insignia\") to provide asset management services to the Venture's retained complexes. Several nonaffiliated management companies had been retained by the Venture to manage, operate and maintain the Venture's HUD and non-HUD properties; however, they were replaced as the property manager by Insignia on all of the Venture's retained properties January 1, 1994.\nThe terms of transactions between the Venture and affiliates of the General Partners of the Venture are set forth in \"Item 13 Certain Relationships and Related Transactions.\"\nRecent Developments - VMS Realty Partners and Affiliates\nPast Liquidity Difficulties\nAs previously reported, VMS Realty Partners, an affiliate of VMS Realty Investment, Ltd. (\"VMSRIL\"), and certain of its affiliates had experienced severe liquidity problems. Because of VMS Realty Partners' inability to resolve the liquidity problems affecting it and its affiliates, VMS Realty Partners had generally suspended making payments relating to operating assets of it and its affiliates, other than payments generally necessary to maintain the operation of such assets and changed the business of VMS Realty Partners and its affiliates, eliminating the acquisition and development of real estate assets. However, VMSRIL and each of its affiliates that serve as general partners of the Syndicated Partnerships, as defined below, continued and are continuing to perform their responsibilities as general partners. On November 18, 1993, VMS Realty Partners assigned (without change in terms, including compensation) its asset management responsibilities for the Syndicated Partnerships, other than VMS National Properties Joint Venture, to Strategic Realty Advisers (\"SRA\"), a real estate company with primary emphasis on asset management and property management. SRA is wholly owned by Joel A. Stone, who is the sole shareholder of one of the corporate partners of VMSRIL. In the case of a number of the Syndicated Partnerships, including the Venture, SRA subsequently assigned such responsibilities to affiliates of Insignia Financial Group, Inc. (\"Insignia\"), a fully integrated real estate service organization. See \"Insignia and MAE.\" SRA has retained, and is performing, such asset management responsibilities for Syndicated Partnerships owning hotels. VMS Realty Partners had previously assigned its asset management responsibilities for VMS National Properties Joint Venture directly to affiliates of Insignia. See \"Insignia Transactions - Management.\" The \"Syndicated Partnerships\" are those partnerships, including the Venture, of which VMSRIL, one of the VMS Principal Entities (as defined below), or an affiliate thereof, is the managing general partner (or a general partner of a general partner) and as to which limited partnership interests were sold to investors through syndications.\nVMSRIL Agreement and CRA\nIn response to the above-described liquidity problems, on March 25, 1992, VMSRIL, the managing general partner of the Partnerships, and an affiliate of (i.e., under common control with) the VMS Principal Entities, as defined below, entered into an agreement (the \"VMSRIL Agreement\") with its single major creditor, European American Bank, and one of its affiliates, EURAM (collectively \"EAB\"), which held a lien on all of VMSRIL's assets.\nThe VMSRIL Agreement provided that for a 12-month period VMSRIL was prohibited from engaging in business activities or operations unrelated to the orderly liquidation of its existing assets, which liquidation was to be conducted consistent with its duties as the managing general partner of the Syndicated Partnerships. Notwithstanding the foregoing, the VMSRIL Agreement provided that VMSRIL was not prohibited from engaging in any activities with respect to the Syndicated Partnerships, including, but not limited to, the continuation of the Syndicated Partnerships' business operations.\nUnder the VMSRIL Agreement, in order to facilitate VMSRIL's operation of its assets in a manner intended to preserve and, if possible, enhance the value of such assets prior to their disposition, EAB granted VMSRIL a moratorium on enforcement of all indebtedness owed to EAB by VMSRIL. EAB agreed that, during the one year term of the VMSRIL Agreement (assuming no default by VMSRIL in the performance of its obligations under the VMSRIL Agreement), EAB would not take any action which would materially adversely affect the interests of VMSRIL, including, without limitation, demanding payment of indebtedness and filing a petition to institute an involuntary bankruptcy proceeding against VMSRIL.\nAlso in response to the above-described liquidity problems, on March 31, 1992, certain affiliates of VMSRIL, specifically VMS Realty Partners, Chicago Wheaton Partners, VMS Realty Investors, VMS Financial Services, VMS Financial Guarantee Limited Partnership and VMS Realty Guarantee Limited Partnership (the \"VMS Principal Entities\") entered into the VMS Creditor Repayment Agreement (the \"CRA\") with a number of parties including substantially all of the unsecured and undersecured creditors (other than trade creditors) of the VMS Principal Entities and certain of the unsecured or undersecured creditors (other than trade creditors) of their affiliates (collectively, the \"Creditors\"). Although VMSRIL is a party to the CRA, it is generally not considered a VMS Principal Entity thereunder.\nThe CRA was intended to achieve a purpose comparable to that described above for the VMSRIL Agreement. In consideration of the benefits received by the Creditors under the CRA, the Creditors granted the VMS Principal Entities a moratorium similar to that contained in the VMSRIL Agreement.\nDuring the respective terms of, and under certain circumstances specified in, the VMSRIL Agreement and the CRA, VMS Realty Partners and certain of its affiliates, including VMSRIL, were required to pay certain sums derived from their operations and asset dispositions to be applied to their restructured debts; these sums were paid by VMS Realty Partners and its affiliates, including VMSRIL, as and when required under the terms of those agreements.\nEffective November 17, 1993, the VMS Principal Entities entered into the Fifth Amendment to the CRA, dated as of October 25, 1993, pursuant to which each VMS Principal Entity (and not VMSRIL) has transferred certain of its assets in lieu of foreclosure (other than general partnership interests in Syndicated Partnerships and assets that the Creditors chose not to acquire, based on their view of the value of such assets and concerns about possible liability associated with them) to separate trusts beneficially owned by the Creditors of each of the respective transferring VMS Principal Entities, subject to the liens of the applicable Creditors, in consideration of, among other things, the granting of covenants not to sue by the respective Creditors (and their successors and assigns) with respect to each of the VMS Principal Entities' liability for the indebtedness owed such Creditors. Such transactions have amicably concluded the debtor\/creditor relationship between the VMS Principal Entities and the Creditors.\nPursuant to the CRA and the Fifth Amendment thereto, and as an inducement to the VMS Principal Entities to engage in the deed in lieu transactions described above, substantial cash consideration was paid by the Creditors to SRA as advanced payment for future services to be performed by SRA for the benefit of the VMS Principal Entities.\nDuring the summer of 1993, EAB introduced VMSRIL to Insignia, which was engaged in discussions with EAB concerning the possible acquisition by an Insignia affiliate of VMSRIL's debt to EAB and the assets securing that debt, and the granting by that Insignia affiliate of a covenant not to sue VMSRIL. This transaction has now occurred, effectively resolving VMSRIL's financial difficulties with its single major creditor. See \"Purchase of EAB and Creditor Assets and Granting of Covenants Not to Sue.\"\nSubsequently, Insignia entered into negotiations with VMSRIL that have resulted in the execution of the Insignia Letter of Intent and, thereafter, following consummation of certain transactions contemplated by the Insignia Letter of Intent, an agreement dated July 14, 1994 (\"Insignia Agreement\"), which terminated the Insignia Letter of Intent, and restructured certain of the then unconsummated transactions that had been contemplated by the Insignia Letter of Intent and provided for certain other agreements of the parties. See \"Insignia Transactions.\"\nInsignia Transactions\nManagement\nEffective November 16, 1993, the Insignia Letter of Intent was executed by VMSRIL and various of its affiliates, SRA, Insignia and a limited partnership (\"ISLP\").1 The Insignia Letter of Intent contemplated that VMSRIL and affiliates of VMSRIL serving as general partners of Syndicated Partnerships that do not own hotels (\"Non-Hotel Syndicated Partnership\") would withdraw as general partners and be replaced by MAERIL, Inc. (\"MAERIL\"), a single purpose affiliate of Metropolitan Asset Enhancement, L.P. (\"MAE\"). See \"Settlement Agreement Proxies.\" MAE is a limited partnership in which Insignia owns a 19.13% limited partnership interest and the general partner of which is a corporation owned by Andrew L. Farkas, the Chairman and Chief Executive Officer of Insignia.\nPursuant to the Insignia Agreement, MAERIL will become the substitute general partner of only the Selected Syndicated Partnerships,2 rather than all of the Non-Hotel Syndicated Partnerships as originally contemplated in the Insignia Letter of Intent. MAERIL has already become the substitute general partner of many of the Selected Syndicated Partnerships.\nThe Plan of Reorganization of the Venture requires that the consent of ContiTrade Service Corporation (\"ContiTrade\"), a creditor of the Venture, be obtained as a condition to the substitution of a new general partner, such consent not to be unreasonably withheld by ContiTrade. The parties are currently negotiating the terms of this consent, including a request by ContiTrade that Insignia and MAERIL acknowledge that ContiTrade has the right to consent to any future changes in control of the Venture, the Partnerships, MAERIL and Insignia. Pursuant to the terms of the Venture's secured loan obligations with respect to each of the Venture's properties, the substitution of MAERIL as general partner of the Venture also requires certain lender consents (including the FDIC and HUD), which have been requested but not received. The substitution of MAERIL, Inc. as the General Partner is expected and has been approved by the Bankruptcy Court and certain other creditors, but there is no assurance that the transaction will be consummated.\nEach property owned by the Venture as well as the other Selected Syndicated Partnerships, is subject to one or more secured project loans. The terms of each loan require lender consent for a change in (i) the general partner of the owner Non-Hotel Syndicated Partnership, (ii) such general partner's general partner or (iii) the general partner of any subpartnership which directly owns that particular property. Although VMSRIL has attempted to obtain such consents with respect to all such loans, it has been unsuccessful in obtaining any consents, and, in many cases, VMSRIL has not received any response to its request; however, none of the lenders have expressly rejected the proposed substitution.\nAlthough the Venture could contend that such consent was unreasonably withheld,\n1 An affiliate of MAE, as defined below, is the sole general partner in ISLP, and an Insignia affiliate holds the limited partnership interests.\n2 \"Selected Syndicated Partnerships\" means, collectively, the VMS National Realty Partners I, VMS National Realty Partners II, Boca Glades Associates, Ltd., Boca West Shopping Center Associates, Ltd., Four Quarters Habitat Apartments Associates, Ltd., Hearthwood Associates, Investors First-Staged Equity, L.P., Kendall Townhome Investors, Ltd., Lynnhaven Associates, Merrifields Apartments, Mount Regis Associates II, Pasadena Office Park Associates, Prudential-Bache VMS Realty Associates L.P. I, Scarlett Oaks Apartment Associates, Ltd., VMS Investors First- Staged Equity L.P. II, Woodlawn Associates and Yorktown Towers Associates.\nor that a lender's failure to respond should constitute an implied consent (or waiver of its right to consent), it is possible that one or more lenders might seek to declare a default and attempt to foreclose on their respective collateral if the transfer of general partnership interests to MAERIL were to proceed without such lender's express consent. The substitution of MAERIL as general partner of the Selected Syndicated Partnerships will transpire upon the occurrence of certain events (including receiving certain of the above consents) as specified in the Insignia Agreement.\nPursuant to the Insignia Letter of Intent, most of the Non-Hotel Syndicated Partnerships retained (to the extent permitted under applicable mortgages and other governing documents) Insignia affiliates to provide all management and asset management services to such Non-Hotel Syndicated Partnership for the maximum term permitted under the partnership agreement or other governing documents of such Non-Hotel Syndicated Partnerships. However, pursuant to the Insignia Agreement, Insignia terminated it and its affiliates' rights and obligations to provide management services to the following Syndicated Partnerships: Fort Lauderdale Office Park Associates, Garden City Plaza Associates, Ltd., Jacksonville\/Windsong Apartments Associates, Natick Village Apartment Associates, Oak Brook International Office Center Associates, Ramblewood Associates, 1600 Arch Investors Ltd., 1600 Arch Limited Partnership, Valley View Associates, Valley View Associates II, Village Green - Townhome Associates, Woodmere Associates, Ltd. In addition, an Insignia affiliate will not provide management services with respect to Kendall Mall which was formerly owned by VMS Investors First-Staged Equity L.P. II but was foreclosed upon after execution of the Insignia Letter of Intent.\nThe Insignia Letter of Intent had contemplated that the Insignia affiliate providing management services to the Syndicated Partnerships would retain SRA to assist it in the provision of such management services; however, pursuant to the Insignia Agreement, SRA has been retained to assist in the provision of management services only to the Venture and will not be retained to provide such services with respect to any of the other Syndicated Partnerships. In particular, Insignia, SRA, and the Venture have reached an agreement under which a subsidiary of Insignia is to become the asset manager of 17 apartment complexes owned by the Venture throughout the country, for a total fee to Insignia of $500,000 per year plus reimbursement of expenses of $200,000 per year. As a matter of comparison, the Bankruptcy Court allowed claims of a VMSRIL affiliate for $400,000 for asset management services for January 1993 through September 1993 (i.e., the date of the Venture's emergence from bankruptcy and on which Insignia assumed responsibility as the Venture's asset manager). The Venture has also entered into an agreement pursuant to which it has retained another subsidiary of Insignia to perform property management services (the \"Property Management Services Agreement\"). As consideration for its performance of property management services pursuant to the Property Management Services Agreement, the Insignia affiliate will receive a fee of 4% of collected revenues on each property. As a matter of comparison, the Venture's property management services prior to the effectiveness of the Property Management Services Agreement were performed by three different entities, none of which are affiliated with VMSRIL or Insignia. Harbour Realty Advisors, Inc. (\"Harbour\") provided property management services with respect to the Venture's non-HUD retained properties. For such services, Harbour received a fee of 4.0% of the rents actually collected per month on such properties. Republic Management Services, Inc. (\"Republic\") or FPI Management, Inc. (\"FPI\") managed all of the Venture's other properties. Republic received a management fee of 4% of effective gross income with respect to the properties it managed. The management agreements with FPI provided for management fee payments of 3.5% to 4.0% of effective gross income with respect to the properties it managed.\nAs required, the Venture obtained the consent of the FDIC, ContiTrade and HUD to its entry into the Property Management Services Agreement. ContiTrade's consent (the \"CT Consent\"), however, was conditioned upon an agreement by Insignia that no payment, compensation or thing of value will be conveyed by Insignia to any VMSRP Related Entity, including SRA, in connection with the payment of the property management fee by the Venture. Pursuant to the CT Consent, although Insignia is not permitted to pay SRA a percentage of the property management fees it earns with respect to the venture's property as contemplated by the Insignia Letter of Intent, Insignia was permitted to perform its other obligations under the Insignia Letter of Intent; furthermore, Insignia is authorized to pay SRA compensation for property management services actually performed by SRA in a reasonable amount for such services based upon what an unrelated third-party in the market place would receive for rendering similar services. See \"Insignia Transactions -- Compensation to VMSRIL Affiliate\".\nPurchase of EAB and Creditor Assets and Granting of Covenants not to Sue\nPursuant to the Insignia Letter of Intent, ISLP purchased for an aggregate price paid to EAB of $1,500,000 all of the debt of VMSRIL (the \"EAB Debt\") and of VMSRP to VMSRIL's single major creditor, EAB. Subsequently, VMSRIL conveyed to ISLP in a transfer in lieu of foreclosure, all of the assets (the \"EAB Assets\") securing the EAB Debt. The EAB Assets constituted all of the assets owned by VMSRIL other than its rights to act as general partner of the Syndicated Partnerships in which it is a general partner. In connection with this conveyance, ISLP has covenanted (i) not to sue VMSRIL with respect to the EAB Debt, (ii) to look exclusively to the EAB Assets for payment of the EAB Debt and (iii) to repay (but only out of the proceeds realized from the EAB Assets acquired by ISLP) loans made to VMSRIL, of which approximately $845,000 was outstanding as of November 16, 1993 (including principal and unpaid interest). These loans which were originally made to VMSRIL in 1992 by certain of its principals to provide VMSRIL sufficient funds to permit it to meet its obligations under the VMSRIL Agreement, were repaid in full by ISLP as of December 31, 1993.\nUpon exercise of an option granted SRA pursuant to the Insignia Letter of Intent, SRA acquired from Insignia, without payment of separate consideration, all of the EAB assets relating to the Syndicated Partnerships that own hotels. Furthermore, the Insignia Agreement contemplates, as did the Insignia Letter of Intent, that ISLP may seek to purchase certain assets (the \"Creditor Assets\") conveyed to creditors of VMSRP pursuant to the Fifth Amendment to the CRA. Following any such purchase, ISLP will (i) covenant not to sue VMSRP with respect to debts associated with the Creditor Assets, and (ii) agree to look exclusively to the beneficial interest of the applicable creditors in the Creditor Assets for payment of such debts.\nIndemnities Granted by Insignia\nPursuant to the Insignia Letter of Intent, Insignia granted an indemnity to each of the individual partners of each of the VMS Principal Entities and each of their partners (the \"Indemnified Partners\") with respect to the Non-Hotel Syndicated Partnerships, including the Venture. Insignia agreed to indemnify the Indemnified Partners for up to $500,000 of claims of creditors in connection with (i) consummation of the transactions contemplated by the Insignia Letter of Intent, (ii) the Indemnified Partners' roles as general partners of, and service providers to, the Non-Hotel Syndicated Partnerships, and (iii) the EAB and Creditor Assets. This indemnification obligation will be funded solely through a cash reserve (the \"Reserve\") established by Insignia. The Reserve has been funded with $333,333 and, pursuant to the Insignia Agreement, is to be funded with an additional $166,667 upon the offering by VMSRIL or its affiliates to cause the substitution of MAERIL for VMSRIL or such affiliate with respect to 60% of the Selected Syndicated Partnerships. In the event that the entire Reserve is not applied to the payment of Insignia indemnity obligations, all of the remaining funds in the Reserve will be paid over to SRA.\nPursuant to the Insignia Agreement, Insignia also will indemnify the Indemnified Partners against all claims in connection with certain prospective actions which may be taken by Insignia, MAE, and\/or MAERIL. The Reserve may not be used to pay Insignia's obligations with respect to this indemnity.\nCompensation to VMSRIL Affiliate\nThe Insignia Letter of Intent also provided for certain business relationships between Insignia (and its affiliates) and SRA. Pursuant to the Insignia Letter of Intent, SRA was to perform certain services (the \"Services\") for Insignia and its affiliates including:\n(i) assisting Insignia and its affiliates in minimizing their indemnity obligation under the Letter of Intent;\n(ii) maximizing the return on ISLP's investment in the EAB and Creditor Assets; and\n(iii) assisting (a) Insignia or its affiliates in connection with the management and asset management of properties owned by the Non-Hotel Syndicated Partnerships and (b) MAERIL or its affiliates in fulfillment of their obligations as substitute general partners.\nAs discussed below under the Insignia Agreement, SRA's right to provide the services and receive compensation therefore was bought-out by Insignia and SRA will not provide the services other than provision of asset management services to The Venture.\nFor its provision of the Services, SRA was to receive a variety of forms of compensation, including a right to acquire a 48.5% limited partnership interest in ISLP for nominal consideration. SRA exercised this right on May 24, 1994, but, pursuant to the Insignia Agreement, subsequently revoked such exercise, and relinquished such right. Prior to its exercise of this right, SRA also received 48.5% of all amounts realized from the EAB Assets and the other assets purchased by ISLP pursuant to the Insignia Letter of Intent, net of certain specified deductions; such right to receive such payments was not revived, however, following SRA's revocation of the exercise of its acquisition right. The payments to SRA prior to its exercise of its acquisition right totalled $17,135. As further consideration, to the extent Insignia became the property manager or asset manager for Non-Hotel Syndicated Partnerships and retained SRA to assist it, Insignia was to pay SRA the SRA Management Fee consisting of (a) 28% of the management and asset management fees paid to Insignia affiliates by the Non- Hotel Syndicated Partnerships and (b) 28% of all net income received by MAERIL (including all fees and distributions) as a result of its acting as general partner of the Non-Hotel Syndicated Partnerships. With certain exceptions, the obligations of Insignia pursuant to the Insignia Letter of Intent were to be secured.\nAlthough Insignia and MAE desired to have MAERIL substituted as the general partner of the Selected Syndicated Partnerships, Insignia, MAE and ISLP determined that they did not require SRA's management and related services on a long-term basis. Accordingly, the Insignia Agreement effects, among other things, a buyout by Insignia of SRA's rights to provide the Services and to receive the compensation therefore discussed above. Pursuant to the Insignia Agreement, SRA's right to provide the Services was terminated, except that SRA is required to assist Insignia in performing asset management services for the Venture but none of the other Syndicated Partnerships. Furthermore, Insignia and SRA acknowledged that they no longer contemplate seeking to maintain any future or ongoing mutual business relationships (although such relationships had been contemplated by the Insignia Letter of Intent). Additionally, SRA will be owed no further fees or obligations pursuant to the Insignia Letter of Intent or on account of services it has provided or will provide, but in lieu thereof will receive the following:\n(a) $500,000 on closing; (b) $100,000 on both of the first and second anniversaries of closing; (c) $226,250 each calendar quarter for 6 years commencing in the calendar quarter beginning in July of 1994; (d) 28% of all fees and other payments received by (i) Insignia or its affiliates for the provision of management services to Boca West Center Associates, ltd. and (ii) MAERIL in its capacity of substitute general partner of such Syndicated Partnership or otherwise related to such Syndicated Partnership; (e) the first $1.2 million of all net proceeds (\"Net Proceeds\") in excess of the Calculation Amount3 derived by Insignia or ISLP from the sale of Creditor Assets and EAB Assets; and (f) 50% of Net Proceeds in excess of the sum of (i) the Calculation Amount plus (ii) $1.2 million.\nThe payments pursuant to Clauses (a), (b), (e) and (f) of this paragraph are referred to herein as the \"Aggregate Payments.\" All of the obligations specified in clauses (a) through (f) will be secured by a security interest in Insignia's 48.5% limited partnership interest in ISLP and Insignia's economic rights (but not obligations) pursuant to each of the property and asset management agreements between Insignia or its affiliates and the Non-Hotel Syndicated Partnerships. In order to further secure payment of such obligations, Insignia and MAERIL agreed that at such time and from time to time as MAERIL becomes substitute general partner of a Selected Syndicated Partnership, at the election of SRA either (i) Insignia and\/or its affiliates owning 100% of the stock of MAERIL shall pledge such stock to SRA or (ii) MAERIL shall pledge to SRA 100% of its economic rights and entitlements of every kind and nature (but not obligations) as general partner of each of the Selected Syndicated Partnerships, including, but not limited to, rights to general partner distributions and fees.\nIn addition, pursuant to the Insignia Agreement, Insignia and its affiliates granted SRA a right of first refusal with respect to any proposed future sale by Insignia of EAB Assets and Creditor Assets to which Insignia or ISLP takes title by foreclosure, deed-in-lieu of foreclosure or otherwise.\nThe consideration to be received by SRA pursuant to the Insignia Agreement, however, is limited by the terms of the Plan of Reorganization of the Venture and the CT Consent. The Plan, as modified by subsequent orders4, provides that subject to the exceptions set forth in the next two sentences, none of Insignia, its affiliates, any VMSRP Related Party, any person who is a partner in or in control of Insignia, nor any affiliate of any of the foregoing, may receive, directly or indirectly, any payments or other compensation relating to the Venture or its business except with respect to asset management functions or payments on account of the Stout Claim pursuant to the Plan and VMSRP's prefiling and administrative claims against the Venture. The Plan further provides that no VMSRP Related Party is to receive compensation for services related to the Venture without the prior written consent of ContiTrade. However, the Plan does permit Insignia or any wholly-owned subsidiary of\n3 The Calculation Amount is equal to (x) $3.4 million plus (y) the aggregate cost of each of the Creditor Assets acquired by ISLP (including interest at a rate of 4% over Citibank's base rate from the date of acquisition of each of the respective Creditor Assets) plus (z) the sum of any amounts previously received by Insignia in repayment of its loan to ISLP to acquire the EAB Assets and the Creditor Assets, or by ISLP as proceeds of the sale, refinancing or disposition of any EAB Assets or Creditor Assets, which Insignia or ISLP has been required to disgorge by reason of a valid claim thereto asserted by an unaffiliated third party.\n4 The Plan was modified by the Order Re Documents to Be Delivered under Second Amended and Restated Plan of Reorganization and Approving Modification of Plan (the \"Modification Order\"), which was entered by the Bankruptcy Court on October 6, 1993. The Modification Order incorporates by reference the Revised Restructured Amended and Restated Asset Management Agreement with Insignia Financial Group, Inc. (the \"Insignia Asset Management Agreement\"), by and between the Venture and Insignia.\nInsignia to receive property management fees for management of the Venture's properties by Insignia or its subsidiary if Insignia or such subsidiary is approved pursuant to the Plan as a property manager and actually becomes a property manager of one or more of the Venture's properties. In addition, the Plan expressly authorizes Insignia to pay to VMSRP not more than 28% of Insignia's asset management fee and 28% of any fees Insignia receives for the provision of property management services to the Venture. In light of the foregoing restrictions and to permit SRA to provide property management services to Insignia with respect to the Venture's properties, SRA obtained ContiTrade's consent, pursuant to the CT Consent, to receive market rate compensation for property management services actually performed by SRA, and\/or such other compensation to which ContiTrade in the future may consent.\nSettlement Agreement Proxies\nUnder the terms of the Settlement Agreement (defined below), the holders of approximately 98% of the limited partnership interests in the Partnerships have given proxies to consent to an amendment of the partnership agreement of the Partnership permitting withdrawal of a general partner of the partnership and substitution of a replacement general partner if the withdrawing general partner reasonably determines that (x) the proposed withdrawal will not result in the reclassification of such Partnership as an association taxable as a corporation for Federal income tax purposes; and (y) any proposed substitute general partner has experience in real estate management and is reasonably capitalized to carry out its duties and obligations as general partner. Similar proxies have been used to facilitate the substitution of MAERIL as general partner in each of the Selected Syndicated Partnerships of which MAERIL has become the substitute general partner.\nDisposition of Properties\nCertain of the Syndicated Partnerships have entered into a contract to sell certain real estate assets. In addition, there are preliminary discussions and negotiations with third parties regarding the sale of assets owned by certain Syndicated Partnerships. There can be no assurance as to whether any such negotiations, letters of intent or contracts will result in the contemplated sales transactions. In addition, there can be no assurance as to the amount of net proceeds which may result from any one or all of such contemplated transactions. Since the CRA was entered into, Syndicated Partnerships have consummated a number of property dispositions involving sales, foreclosures, or deeds in lieu of foreclosure.\nIn the case of those Syndicated Partnerships, including the Partnerships, covered by the Settlement Agreement, the disposition of properties owned by said partnerships is subject to the review of the Oversight Committee (as such term is defined in the Settlement Agreement). To date, of approximately 13 proposed property dispositions submitted to the Oversight Committee for approval, only two have been challenged by a member of the Oversight Committee. A proposed sale of the property owned by Lynnhaven Associates was challenged by Equity Resources Group, a former member of the Oversight Committee as to only those Settling Limited Partnerships in which it is a limited partner, including Lynnhaven Associates. Judge Zagel of the United States District Court for the Northern District of Illinois approved the sale of the Lynnhaven property over the objection of Equity Resources Group, in accordance with the terms of the Settlement Agreement. Equity Resources Group then appealed Judge Zagel's decision, which was subsequently affirmed by the United States Court of Appeals for the Seventh Circuit. The Oversight Committee also objected to a proposed transaction in which the mortgage loan on two office buildings owned by Eaton Canyon Partners was to be restructured. As a result of the objection, the restructuring was abandoned and the properties were foreclosed.\nInspector General Audit\nThe Office of the Inspector General (OIG) for the Department of Housing and Urban Development (HUD) has completed an audit of the books and records of VMS Realty Management, Inc. relative to seven HUD projects which VMS Realty Management, Inc. managed from 1987 to 1991, the years which were the subject of the OIG audit. The OIG concluded that VMS Realty Management, Inc. did not comply with the terms and conditions for the HUD Regulatory Agreements and applicable HUD regulations and instructions relating to the financial and general management practices for six of the seven HUD projects reviewed. Specifically, the OIG audit concluded that VMS Realty Management, Inc. inappropriately disbursed $6,366,180 from the projects' funds for partnership expenses from 1987 to 1991 when the projects were in a non-surplus cash position or lacked adequate surplus cash for the payments as the term \"surplus cash\" is defined pursuant to the HUD Regulatory Agreements. $735,345 of the $6,366,180 which the OIG has concluded to have been inappropriately disbursed in payment of partnership obligations relates to projects in which the Venture is a partner. These inappropriate disbursements included payments for second mortgages, asset management fees, notes payable and other partnership expenses.\nThe OIG's Audit Report to HUD recommends that (1) the projects' owners reimburse $6,366,180 to the projects' accounts for the excess distributions and if the owners fail to comply, then HUD should initiate action for double damages remedy, (2) take action to debar VMS Realty Management, Inc. and the individuals which comprise it, and (3) require the appropriate HUD Regional\/Field Offices to conduct reviews of the 13 remaining HUD projects which VMS Realty Management, Inc. previously managed which were not the subject of the OIG audit.\nTwo of the six HUD projects which were the subject of the OIG audit have been settled with HUD. These two projects account for $1,854,657 of the entire $6,366,180 of inappropriate disbursements. Three of the remaining four HUD projects which were the subject of the OIG audit have surplus cash at December 31, 1995, in excess of the amounts which the OIG has concluded were inappropriately disbursed between 1987 and 1991, and HUD has tentatively agreed to accept a current financial statement verifying the surplus cash amounts in full settlement for these four projects. These three projects with sufficient current surplus cash represent $4,378,779 of the entire $6,366,180 inappropriate disbursements but do not include the HUD project owned by this venture. At the present time, no settlement has been reached between HUD and the projects' owners for the one other HUD project which the OIG has found to have made inappropriate disbursements. The maximum amount of this inappropriate disbursement totals $132,744, which relates to a project in which the Venture is a partner.\nInsignia and MAE\nInsignia is a publicly held fully integrated real estate service organization performing property management, asset management, investor services, partnership administration, mortgage banking, and real estate investment banking services for various ownership entities, including approximately 1,000 limited partnerships having approximately 400,000 limited partners. Based upon published industry surveys, Insignia is the largest manager of multifamily residential properties in the United States and is a significant manager of commercial property. Insignia commenced operations in December 1990 and since then has grown to provide property and\/or asset management services for over 2,400 properties, which include approximately 300,000 residential units and approximately 64,000,000 square feet of commercial space, located in over 500 cities in 48 states.\nA primary method of growth for Insignia has been by acquiring, directly or through related entities (principally MAE), controlling positions in general partners of real estate limited partnerships. Many of the sellers of such assets, and in some cases the partnerships which own the properties, were financially distressed, but the partnerships own properties that Insignia in most cases believes to be fundamentally sound. Following each acquisition, Insignia takes steps to enhance the value and stability of the acquired properties, including a thorough analysis of each property's operations, develops a detailed marketing strategy, and, when appropriate, develops a program for restructuring its indebtedness. Insignia or MAE has, where consistent with its fiduciary obligations to the property owner, caused the controlled entity to retain Insignia to provide property management and other services for the property, and will continue to do so in the future.\nInsignia's services include property management, providing all of the day-to-day services necessary to operate a property, whether residential or commercial; asset management, including long-term financial planning, monitoring and implementing capital improvement plans, and development and execution of refinancings and dispositions; maintenance and construction services; marketing and advertising; investor reporting and accounting, including preparation of quarterly reports and annual K-1 tax reporting forms for limited partners as well as regular reporting under the Securities Exchange Act of 1934 where applicable; investment banking, including assistance in workouts and restructurings, mergers and acquisitions, and debt and equity securitizations; and mortgage banking and real estate brokerage.\nIn addition, Insignia is the exclusive mortgage marketing advisor for Prudential Insurance Company of America's PruExpress program in the Southeast and Mid- Atlantic areas of the United States, originating loans typically in the $2,000,000 to $15,000,000 range for investment-grade income-producing real estate.\nInsignia's senior residential property management personnel have an average of over 15 years of experience in property management with a broad range of types of properties throughout the United States. Many of Insignia's most experienced managers joined Insignia in connection with certain of its acquisitions. Insignia believes that its management expertise and state-of-the-art computer and communications systems allow it to offer its customized services efficiently and at a cost to Insignia which permits it to be competitive with other real estate management service companies.\nInsignia and its affiliates have acquired control of or management rights to 29 significant portfolios of properties since 1990.\nInsignia was incorporated in Delaware in July 1990. Insignia's principal executive offices are located at One Insignia Financial Plaza, P.O. Box 1089, Greenville, South Carolina 29602, telephone number (864) 239-1000.\nOriginally, MAE was formed to be the principal vehicle for acquiring interests in real property that would be managed or serviced by Insignia. MAE, directly or through subsidiaries, holds general partnership interests in approximately 400 partnerships, all of which have retained Insignia as manager for all or certain aspects of their operations. MAE has no other material assets and has no material cash flow. MAE has various liabilities associated with prior acquisitions, certain of which have been guaranteed or are joint obligations with Insignia or one or more of its subsidiaries. MAE and Insignia have entered into an agreement governing the structuring of future acquisitions.\nInsignia holds a 19.13% limited partnership interest in MAE. Andrew L. Farkas, the Chairman of the Board and Chief Executive Officer of Insignia, owns the general partner of MAE, which has a 1% partnership interest. In addition, a 3% limited partnership interest in MAE is owned by five officers and one employee of Insignia. Although the general partner may not assign its interest in MAE without the consent of holders of a majority in interest of the limited partners' interests, there are no restrictions on Mr. Farkas' ability to sell such general partner. Insignia may not transfer its limited partnership interest in MAE without the consent of the general partner of MAE. The general partner has complete authority over the management of MAE and its assets, provided that, except in connection with acquisitions, the general partner may not cause MAE to sell all or a substantial portion of its assets without the consent of holders of a majority in interest of the limited partners' interests. The limited partners, including Insignia, have no other rights with regard to the business or operations of MAE.\nMAERIL is a Delaware corporation, formed in March 1994 for the purpose of serving as general partner of the Partnerships and certain of the other Syndicated Partnerships. MAE GP Corporation is the sole stockholder of MAERIL and MAE is the sole stockholder of MAE GP Corporation.\nOther Information\nOn October 21, 1993, an affiliate of Prudential-Bache Properties (\"PBP\"), Prudential Securities Incorporated (\"PSI\"), settled, without admitting or denying the allegations contained therein, civil and administrative proceedings with the Securities and Exchange Commission, the National Association of Securities Dealers, Inc., and various state regulators. These proceedings concerned, among other things, the sale by PSI of limited partnership interests, including interests of the Partnerships, during the period of 1980 through 1990. The settlement has no impact on the Partnerships themselves.\nRecent Developments - the Venture\nPETITION FOR RELIEF UNDER CHAPTER 11\nOn February 22, 1991, VMS National Properties Joint Venture filed for Chapter 11 bankruptcy protection in the United States Bankruptcy Court in the Central District of California. The initial filing included only the residential apartment complexes directly owned by VMS National Properties Joint Venture (entities included in the filing hereinafter referred to collectively as the Debtor) and excluded the 10 Subpartnerships, consisting of 10 residential apartment complexes encumbered by financing insured or held by the Department of Housing and Urban Development, and the investing limited partnerships, VMS National Residential Portfolio I and VMS National Residential Portfolio II (see \"Note 4\" of the Notes to Combined Financial Statements).\nThe Venture's Plan of Reorganization was confirmed by the Court in March 1993 and the Plan became effective September 30, 1993.\nThe primary aspects of the Venture's Second Amended and Restated Plan of Reorganization, which became effective September 30, 1993 (\"Effective Date\"), included the following:\na. The Venture retained 17 properties from the existing portfolio (the \"retained properties\"), and abandoned title of the remaining properties to the Federal Deposit Insurance Corporation (the \"FDIC\"). The retained properties consist of one HUD property and sixteen non-HUD properties.\nb. The Venture restructured the existing senior lien debt obligations on the retained properties (except for one of the retained properties which has a first mortgage lien insured by the Department of Housing and Urban Development and two of the retained properties which have senior liens formerly payable to the FDIC, as successor to Beverly Hills Mortgage Corporation, \"BH\") to provide for an interest rate of 8.75% per annum effective as of the first day of the month of the Effective Date with payments based on a 30 year amortization commencing on the first monthly payment due thereafter and a maturity date of January 15, 2000.\nThe senior lien collateralized by HUD on one of the retained properties was not modified, and the senior liens formerly held by the FDIC were modified to accrue at 9% per annum effective as of the first day of the month of the Effective Date with monthly payments of interest only made at 7% per annum commencing with the first monthly payment due thereafter on the FDIC value, as defined in \"c\" below.\nc. As it pertains to the existing BH junior mortgages on the retained properties, the FDIC reduced its claim on two of the properties to $300,000 per property evidenced by a non-interest bearing note scheduled to mature January 15, 2000, and has left in place liens for the full amount of its claims at the petition date for all other retained properties. Interest on the former FDIC loans for these retained properties accrue at 10% per annum on the FDIC value (total property value per the FDIC's June 1992 valuations less the property's senior lien indebtedness) commencing as of the first day of the month of the Effective Date and monthly payments of interest only at 7% per annum on the FDIC value will commence with the first monthly payment due thereafter. (The retained property governed by HUD Regulatory Agreements is to make payments of interest only following the approval by HUD of the Surplus Cash calculation.) On October 28, 1995, the FDIC sold all of the debt it held related to the retained properties to BlackRock Capital Finance, L.P. The debt amounts and terms were not modified.\nd. The Venture allocated $13,500,000 from the excess Limited Partner contributions (\"Partnership Cash\") to (1) satisfy unsecured prepetition creditor claims of approximately $6,000,000 including the nonaffiliated note payable to Security Pacific National Bank, trade creditors, and property taxes on the retained properties; (2) provide for allowed and unclassified administrative claims of approximately $1,700,000; and (3) reserve the balance of these funds of approximately $5,800,000 to make capital improvements at the retained properties. This capital improvement reserve was exhausted during 1995.\ne. The VMS\/Stout Joint Venture was granted an allowed claim in the amount of $49,534,819 for the Assignment and Long-Term Loan Arrangement Notes payable to them by the Venture (see \"Note 8\" of the Notes to Combined Financial Statements). Payments totalling $3,475,000 in conjunction with this allowed claim were made to the nonaffiliated members of the VMS\/Stout Joint Venture on October 7, 1993. The Venture also executed a $4,000,000 promissory note dated September 1, 1993, to ContiTrade Services Corporation (the ContiTrade Note) in connection with these allowed note claims. The ContiTrade Note represents a prioritization of payments to ContiTrade of the first $4,000,000 in repayments made under the existing Assignment and Long-Term Loan Arrangement Notes payable to the VMS\/Stout Joint Venture, and does not represent an additional $4,000,000 claim payable to ContiTrade. In addition to prioritizing ContiTrade's receipt of the first $4,000,000 in repayments on the old notes, the ContiTrade Note provides for 5% noncompounding interest on the outstanding principal balance calculated daily on the basis of a 360 day year. The ContiTrade Note is secured by a Deed of Trust, Assignment of Rents and Security Agreement on each of the Venture's retained properties, and provides ContiTrade with other approval rights as to the ongoing operations of the Venture's retained properties. The ContiTrade Note matures January 15, 2000.\nf. The Venture entered into a Revised Restructured Amended and Restated Asset Management Agreement (the Revised Asset Management Agreement) with Insignia. Effective October 1, 1993, Insignia took over the asset management of the Venture's retained properties and partnership functions. The Revised Asset Management Agreement provides for an annual compensation of $500,000 to be paid to Insignia in equal monthly installments. In addition, Insignia will receive reimbursement for all out-of-pocket costs incurred in connection with their services up to $200,000 per calendar year. These service fees are to be paid from the available operating cash flow of the Venture's retained complexes after the payment of operating expenses and priority reserve fundings for insurance, real estate and personal property taxes, senior mortgage payments, minimum interest payment requirements on the former FDIC mortgages, and any debt service and principal payments currently due on any liens or encumbrances senior to the ContiTrade Deeds of Trust. If insufficient operating cash flow exists after the funding of these items, the balance of Insignia's service fees may be paid from available partnership cash sources. Additionally, the service fee payable to Insignia will be reduced proportionately for each of the Venture's retained complexes which are sold or otherwise disposed of from time to time. The Venture engaged Insignia to commence property management of all of the Venture's retained complexes effective January 1, 1994.\nEXTRAORDINARY GAIN ON EXTINGUISHMENT OF DEBT\nThe Combined Statement of Operations for the years ended December 31, 1995, 1994, and 1993 includes the effects of the foreclosures of the following 5, 4, and 19 of the Venture's properties, respectively:\nAs a result of these foreclosures, the following liabilities and assets were written off: 1995 1994 1993\nMortgage Principal Payable $ 22,073,873 $ 23,319,976 $ 127,254,212 Accrued Interest Payable 25,636,250 16,489,517 50,563,155 Other (644,941) (368,417) (115,407) Investment in Properties (23,453,223) (22,857,797) (129,722,640) Accumulated depreciation 10,985,570 10,834,945 53,641,232 Extraordinary Gain $ 34,597,529 $ 27,418,224 $ 101,620,552\nAdditionally, as a result of the implementation of the Venture's Plan of Reorganization, certain liabilities compromised by the Plan were adjusted to the present value of amounts to be paid determined at appropriate current interest rates. As a result, the Venture realized a gain on extinguishment of debt on the retained complexes at December 31, 1993, as follows:\nFDIC mortgages $ 9,972,239 Accrued interest on FDIC mortgages 55,215,496 Notes payable 21,491,232 Other 2,893,882 89,572,849\nLess portion of gain deferred (54,052,737) Gain realized $ 35,520,112\nPursuant to the Plan, the mortgages held by the FDIC were modified effective September 30, 1993. For 15 of the 17 retained properties, the face value of the note was restated to the Agreed Valuation Amount. Under the terms of the restated notes, the FDIC may reinstate the full claim which was in place at the petition filing date upon the default of any note. The restated notes are cross-collateralized; however, they are not cross-defaulted. As a result, the Venture has deferred $54,052,737 of this extraordinary gain on extinguishment of debt. On October 28, 1995, the FDIC sold all of the debt it held related to the retained properties to BlackRock Capital Finance, L.P. The debt amounts and terms were not modified.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Description of Properties\nThe following table sets forth the Registrant's investments in properties:\nIn the opinion of the Managing General Partner, each of the properties is adequately covered by insurance.\nEach property above is encumbered by various debt. For additional information regarding the encumbrances and carrying value of the above properties, see accompanying Schedule of Properties and Schedule of Mortgages and \"Note 7\" of the combined financial statements.\n(a) Represents property to be retained pursuant to the Plan.\n(b) Represents property to be abandoned pursuant to the Plan.\nSchedule of Properties:\nDepreciation is computed using the following methods and estimated useful lives:\nSchedule of Mortgages:\nOn October 28, 1995, the FDIC sold all of the debt it held related to the retained properties to BlackRock Capital Finance, L.P. The debt amounts and terms were not modified.\nAverage annual rental rates per unit and occupancy for 1995 and 1994 for the retained properties: Average Annual Average Rental Rates Per Unit Occupancy Property 1995 1994 1995 1994\nBuena Vista Apartments $10,758 $10,456 96% 97% Casa de Monterey 7,690 7,470 92% 95% Crosswood Park 8,065 7,692 94% 92% Mt. View Apartments 9,197 8,958 92% 92% Pathfinder 9,899 9,634 94% 94% Scotchhollow 10,470 10,202 99% 97% The Bluffs 6,131 5,974 96% 96% Bellevue Towers 5,152 4,914 94% 96% Vista Village Apartments 5,854 5,715 82% 84% Chapelle Le Grande 7,380 7,182 96% 95% North Park Apartments 5,353 5,166 97% 97% Shadowood Apartments 5,779 5,708 94% 93% Towers of Westchester Park 10,013 9,810 97% 95% Terrace Gardens 7,535 7,120 96% 96% Carlisle Square 6,364 6,036 96% 98% Watergate Apartments 6,518 6,339 96% 97% Forest Ridge Apartments 6,486 6,094 94% 94%\nAs noted under \"Item 1. Description of Business,\" the real estate industry is highly competitive. All of the properties of the partnership are subject to competition from other residential apartment complexes in the area. The Managing General Partner believes that all of the properties are adequately insured. The multi-family residential properties' lease terms are for one year or less. No residential tenant leases 10% or more of the available rental space.\nReal estate taxes and rates in 1995 for each property were:\n1995 1995 Taxes Rate\nBuena Vista Apartments $ 62,268 1.15% Casa de Monterey 86,871 1.15% Crosswood Park 92,851 1.04% Mt. View Apartments 111,055 1.22% Pathfinder 207,531 1.50% Scotchollow 314,737 1.27% The Bluffs 61,657 2.33% Bellevue Towers 44,046 6.25% Vista Village Apartments 108,209 2.83% Chapelle Le Grande 55,819 13.14% North Park Apartments 131,252 12.44% Shadowood Apartments 28,900 11.31% Towers of Westchester Park 225,968 3.70% Terrace Gardens 87,813 2.81% Carlisle Square 29,573 3.54% Watergate Apartments 45,447 6.68% Forest Ridge Apartments 95,106 10.51%\nItem 3.","section_3":"Item 3. Legal Proceedings\nAs disclosed in the prior reports on Form 10-Q or Form 10-K (\"Prior Public Filings\"), the Joint Venture including the Joint Venturers, VMS-General Partner of the Joint Venturers, Subpartnerships, VMS Realty Partners, L.P., certain officers and directors of VMS Realty Partners, L.P. and certain other affiliates of the Venture are parties to certain pending legal proceedings (other than litigation matters covered by insurance policies). The adverse outcome of certain of the legal proceedings disclosed in this Report and the Prior Public Filings could have a materially adverse effect on the present and future operations of the Joint Venture.\nSummarized below are certain developments in legal proceedings filed against VMS Realty Partners, now known as VMS Realty Partners, L.P. and its affiliates which were disclosed in the Prior Public Filings. The inclusion in this Report of any legal proceeding or developments in any legal proceeding is not intended as a representation by the Joint Venture that such particular proceeding is material. For those actions summarized below in which the plaintiffs are seeking damages, the amount of damages being sought is an amount to be proven at trial unless otherwise specified. There can be no assurance as to the outcome of any of the legal proceedings summarized in this Report or in Prior Public Filings.\nA. VMS Limited Partnership Litigation\n1. Settlement of Consolidated Class Actions\nForty-three actions were filed by investors in various limited partnerships against VMS Realty Partners, now known as VMS Realty Partners, L.P. and certain entities and individuals related to VMS Realty Partners, now known as VMS Realty Partners, L.P.. Also named were certain selling agents, surety companies, appraisers, accountants, attorneys, and other parties that were involved in the syndication, sale, and management of the limited partnership interests and properties. Thirty-eight of these actions (i.e., all of the actions filed in federal court) were consolidated for pretrial and discovery purposes in the United States District Court for the Northern District of Illinois under the caption In Re VMS Limited Partnership Securities Litigation, No. 90 C 2412 (Judge James B. Zagel) (the \"Consolidated Actions\"). In addition, for settlement purposes, one action (the \"New Action\") was filed on behalf of all investors in approximately 100 non-publicly-traded VMS-sponsored syndicated limited partnerships against those defendants in the Consolidated Actions that had reached a Settlement Agreement with the class. The nature of these actions was described in the Prior Public Filings.\nAfter a final fairness hearing, on July 2, 1991, the United States District Court gave final approval to the Settlement Agreement. The order dismissed with prejudice all settling defendants from all of the Consolidated Actions and dismissed the New Action in full. No appeals were filed and the Settlement became effective on August 12, 1991. The terms of the Settlement Agreement were described in the Prior Public Filings.\nSubsequent to the effective date of the Settlement Agreement, the respective general partner of the various VMS sponsored syndicated limited partnerships has filed collection actions against the limited partners who remain in default in the payment of their installment promissory notes which were given to the limited partnership in consideration for the limited partner's partnership interest.\n2. CIGNA Claims\nOne of the non-settling defendants, CIGNA Securities, Inc. (\"CIGNA\"), has asserted claims against VMS Realty Partners, now known as VMS Realty Partners, L.P. and its affiliated entities for contribution and indemnification in cases in which CIGNA is a defendant.\nCIGNA subsequently entered into a class-action settlement agreement with a class of investors in the consolidated actions who had purchased their interest from CIGNA. As previously reported, on May 19, 1993, CIGNA and VMS executed a mutual release, effective when the CIGNA class-action settlement is effective. The Cigna class action settlement is now effective and, pursuant to the terms of the mutual release, CIGNA settling parties released the VMS released persons of and from all claims and liabilities relating to or arising out of the released claims in the VMS class-action settlement, including contractual claims for indemnification. In exchange, the VMS settling parties released the CIGNA released persons of and from all claims and liabilities relating to or arising out of the released claims in the VMS class-action settlement, including contractual claims for indemnification. However, the settling parties expressly reserved all common law and contractual claims for contribution and\/or indemnification arising out of or relating to claims brought by investors who opted out of both the VMS and CIGNA settlements, except to the extent such claims are barred by; (1) Section 4.02(A) of the VMS settlement agreement and the court's July 15, 1991, order approving the VMS class-action settlement agreement, or (2) Section 4.2(A) of the CIGNA class-action settlement agreement and any court order approving the CIGNA settlement agreement. In addition, now that the CIGNA class-action settlement agreement is effective, CIGNA's claims pending in the consolidated actions have been dismissed, except the Corkery action which is brought by opt-outs from both settlement agreements.\nPaul J. Corkery; Ronnie Rone; Max C. Jordan; F.J. Vollmer; Paula Boedeker; Norbert Braeuer; Dales Y. Foster; Billy J. Harris; Bob White; Gordon Flesch; Travis Barton, Jr.; Satish A. Dhaget; Varsha S. Dhaget; Alan J. Young; Dennis J. Cavanaugh; F. Jim Slater; Lois W. Rosebrook, Trustee; Sundaram V. Ramanan; Chitraleka Ramanan; Jeffrey A. Matz; Charles C. Voorhis III; Gerald C. Miller; Prince George's Orthopedic Associates, P.A.; John A. Martinez; Tom Rubattino; Susan Rubattino; Harold W. Stark and William C. Riedesel v. VMS Realty Partners; United States Fidelity and Guaranty Company; CIGNA Securities, Inc.; Boettcher & Company, Inc.; and A.G. Edwards & Sons, Inc., CA. No. Ca 4-90 087-E (U.S. District Court, N.D. Texas), filed February 5, 1990, removed to 90 C 3841, United States District Court for Northern District of Illinois, Eastern Division. CIGNA filed a Counterclaim against plaintiffs, Cross-Claims against VMS Realty Partners and A.G. Edwards & Sons, Inc., and a Third-Party Complaint against LaSalle\/Market Streets Associates, Ltd., Chicago Wheaton Partners, Peter Morris, Joel Stone, Robert Van Kampen, Residential Equities, Ltd., Van Kampen Stone, Inc., VMS Realty Management, Inc., VMS Realty, Inc., and VMS Mortgage Co. in this action. On July 12, 1993, the VMS' defendants filed a Motion to Dismiss and Memorandum in Support thereof. On December 21, 1995, the court dismissed Plaintiff's action against the VMS entities and Cigna Securities, Inc.\nB. Other Litigation\nMutual Benefit Life Insurance Co. v. PRM-Garden City Associates, Garden City Plaza Associates, First Texas Savings Association, People of the State of New York and John Doe #1 through John Doe #100, No. 9945-1990 (New York Sup. Court, Nassau County), filed April 30, 1990. This is an action to foreclose mortgages securing the payment of a loan made by plaintiff to Garden City Plaza Associates. Plaintiff declared due and owing the principal sum of $25,851,261.38, together with accrued interest of $470,988.73, and late charges of $42,813.28, totalling $26,305,004.39, together with interest from April 15, 1990. Mutual Benefit is the first mortgagee; First Texas Savings which has been taken over by the FDIC, is the second mortgagee. First Texas has asserted cross-claims against Morris, Van Kampen, Stone, and Merritt and seeks to foreclose on its second mortgage. On October 21, 1992, Garden City Plaza Associates filed for bankruptcy protection. On December 8, 1994, Garden City Plaza Associates' Plan of Reorganization was confirmed. The Plan of Reorganization provides for Garden City Plaza Associates to have until April 1, 1999, (absent a default) to sell or refinance the property.\nSan Jacinto Savings Association v. VMS Realty Partners; LaSalle\/Market Street Associates, Ltd.; Residential Equities, Ltd.; Van Kampen Stone, Inc.; Peter R. Morris; Joel A. Stone; Robert D. Van Kampen; Does 1 through 50, Case No. C 89-4398 JPV (California Sup. Court, San Francisco County), filed December 12, 1989. This is a foreclosure action brought by San Jacinto Savings Association, first mortgagee on the property known as the Phelan Building, San Francisco. The property was sold in a nonjudicial foreclosure sale and plaintiffs were pursuing a deficiency judgment alleged to be between $6-16 million. The action was remanded back to state court after removal to federal court. On March 17, 1992, the parties signed a settlement agreement pursuant to which VMS Realty Partners paid plaintiff $400,000 in exchange for a reduction in debt to $3,500,000. In connection with the settlement, plaintiff signed the VMS Realty Partners and Related Entities Creditor Repayment Agreement (\"CRA\"). San Jacinto Savings Association subsequently assigned its claim to Premier Financial Services.\nSheraton Holding, Inc. v. Park Centre Associates, f\/k\/a VMS Seventh Avenue Hotel Associates, Ingersoll-Rand Financial Corp., VMS Hotel Investment Trust, Omni Hotel Credit Corp., f\/k\/a\/ Dunfey Credit Corp., VMS Realty Partners, Marine Midland Bank, N.A., Bid Fire Systems, Inc., Mass Electric Construction Co., Mass Electric of New York, New York Plumbing & Heating Corp., Center 56 Associates, Basic Leasing Corp., EECO Inc., EECO Computer, Inc., RCA Corp., Ameritech Credit Corp., COMTEL Communications Corp., The City of New York, The People of the State of New York, and \"John Doe\" #1 through 500. This action has been dismissed.\nC. VMS National Properties and Subpartnerships Foreclosure Litigation\ni) The following foreclosure proceedings were filed against VMS National Properties and\/or its affiliates by lenders during the VMS National Properties bankruptcy proceedings:\nFederal Deposit Insurance Corporation in its Corporate capacity v. VMS National Properties, an Illinois joint venture, VMS National Properties V, VMS Realty Investment, Ltd., an Illinois limited partnership, Chicago Wheaton Partners, an Illinois general partnership, Case No. 92-5041-CBM (United States District Court, Central District of California), filed on August 24, 1992. On April 2, 1992, Beverly Hills Business Bank (\"BHBB\") sold and assigned to the FDIC in its Corporate capacity as Manager of the FSLIC Resolution Fund BHBB's right, title and interest in certain assets referred to as the \"VMS Portfolio\" which included, but was not limited to this loan. On August 19, 1992, VMS National Properties, by order of the bankruptcy court, abandoned its partnership interest in VMS National Properties V, which owned the Sierra Gardens Apartments. VMS National Properties V is alleged to have breached its obligation under the Note by virtue of, among other things, failure to make payments of principal and interest, and by the abandonment of the property. Stipulation for Appointment of Receiver was filed on August 31, 1992. A receiver was appointed on September 15, 1992.\nFederal Deposit Insurance Corporation in its Corporate capacity v. VMS National Properties, an Illinois joint venture, VMS National Properties X, VMS Realty Investment, Ltd., an Illinois limited partnership, Chicago Wheaton Partners, an Illinois general partnership, Case No. CV-F 92-5571-OWW (United States District Court, Eastern District of California), filed on or about August 24, 1992. On April 2, 1992, Beverly Hills Business Bank (\"BHBB\") sold and assigned to the FDIC in its Corporate capacity as Manager of the FSLIC Resolution Fund BHBB's right, title and interest in certain assets referred to as the \"VMS Portfolio\" which included, but was not limited to this loan. On August 19, 1992, VMS National Properties, by order of the bankruptcy court, abandoned its partnership interest in VMS National Properties X, which owned The Winery Apartments. VMS National Properties X is alleged to have breached its obligation under the Note by virtue of, among other things, failure to make payments of principal and interest, and by the abandonment of the property. Stipulation for Appointment of Receiver was filed on August 31, 1992. Receiver was appointed on September 16, 1992. A quit claim deed was executed as of March 27, 1995, from VMS National Properties X to Ecumenical Association for Housing. This action has been dismissed.\nFederal Deposit Insurance Corporation as manager of the Federal Savings and Loan Insurance Corporation Resolution Fund as assignee of BH Mortgage Corporation, a California corporation, v. Chicago Wheaton Partners, an Illinois general partnership, VMS National Properties, an Illinois partnership, VMS National Properties VI, a California general partnership, Case No. CIV S 93 861 EJG JFM (United States District Court, Eastern Division of California), filed on or about May 24, 1993. Complaint for Breach of Promissory Note and Security Agreement, Appointment of Rent Receiver; and Injunctive Relief. Receiver was appointed to Venetian Bridges on May 24, 1993. Properties were transferred to Venetian Bridges G.C. Operating Partnership, Venetian Bridges G.C.I Operating Partnership and Venetian Bridges G.C. II Operating Partnership. This action has been dismissed.\nFederal Deposit Insurance Corporation as manager of the Federal Savings and Loan Insurance Corporation Resolution Fund as assignee of BH Mortgage Corporation, a California corporation, v. Chicago Wheaton Partners, an Illinois general partnership, VMS National Properties, an Illinois partnership, VMS National Properties IV, a California general partnership, Case No. CIV S 93 933 EJG JFM (United States District Court, Eastern Division of California), filed on or about June 9, 1993. Property was transferred on February 6, 1996, to RJR Development, Inc. This action is in the process of being dismissed. Receiver was appointed to Pacific Hacienda on June 28, 1993.\nFederal Deposit Insurance Corporation, in its corporate capacity, as assignee of BH Mortgage Corporation, a California corporation, v. Chicago Wheaton Partners, an Illinois general partnership, VMS National Properties, an Illinois general partnership, VMS National Properties IX, a New York general partnership, Case No. 93 CV-1218FJS (United States District Court, Northern District of New York). FDIC and defendants seek an order appointing a Receiver to take possession of and manage Weatheridge Apartments. A receiver has not yet been appointed.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNone.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters\nThere is not a public market for the Limited Partnership Interests.\nAs of December 31, 1995, there were 823 holders of record of Partnership I and 332 holders of record of Partnership II.\nAs of December 31, 1995, there have been no cash distributions to the Limited Partners of either of the Partnerships. In accordance with the respective Agreements of Limited Partnership, there are no material restrictions on the Partnerships' ability to make cash distributions; future cash distributions are, however, subject to the order of distributions stipulated by the Venture's Plan of Reorganization. The source of future cash distributions is dependent upon cash generated by the Venture's properties and cash generated through the sale or refinancing of these properties.\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 Venture held unrestricted cash at December 31, 1995, of $1,983,932 which decreased $492,544 from December 31, 1994. This decrease was attributable to net cash provided by operating activities of $2,834,722, offset by net cash used in investing and financing activities of $2,414,765 and $912,501, respectively.\nThe decrease in net cash provided by operating activities for the year ended December 31, 1995, compared to the corresponding period of 1994 was due to increased payments of accounts payable and accrued expenses.\nNet cash used in investing activities decreased for the year ended December 31, 1995, compared to the corresponding period of 1994 as a result of fewer property improvements after the depletion of the capital reserve escrow established at the time of Reorganization.\nNet cash used in financing activities increased for the year ended December 31, 1995, compared to the year ended December 31, 1994, due to greater payments on mortgage notes, cash relinquished to lenders on foreclosed properties and reduced collections of subscription notes.\nIncome and expenses realized and incurred as a result of the Venture's Chapter 11 proceedings during the year ended December 31, 1993, consisted primarily of interest income on Treasury Bill investments and professional, legal, accounting, and other consulting expenses. Interest income of $377,823 was received on accumulated cash resulting from Chapter 11 proceedings, and $1,629,940 was paid for professional, consulting and other fees for the administration of Chapter 11 proceedings.\nAt December 31, 1992, the Venture had approximately $15,433,000 in excess limited partner contributions. Permitted uses of these excess limited partner contributions during 1993 were limited to 1) the funding of monthly Bankruptcy Court approved professional fees; 2) establishing a reserve of $5,960,000 to fund capital improvements on the retained complexes; 3) repayments of approximately $5,980,000 on various prepetition claims including notes payable, real estate taxes and amounts due trade creditors; 4) payments of $1,006,000 to the Managing General Partner for reimbursement of cash advances and asset management services; and 5) payments to the FDIC and ContiTrade for reimbursement of administrative costs incurred in connection with the bankruptcy case (see \"Note 5\" of the Notes to Combined Financial Statements). The Venture's Plan of Reorganization, which became effective on September 30, 1993, also restricts the permitted uses of the cash balances on hand at December 31, 1995.\nTotal capital contribution and interest amounts due from limited partners of Portfolio I and Portfolio II at December 31, 1995, approximated $1,105,375. A settlement agreement was entered into on March 28, 1991, by the Plaintiff class counsel on behalf of the class of limited partners in approximately 100 non- publicly traded VMS sponsored limited partnerships including VMS National Residential Portfolio I and II, VMS National Properties Joint Venture, and VMS Realty Partners and its affiliates and certain other defendants (see \"Note 6\" of the Notes to the Combined Financial Statements). The Settlement Agreement provided the settling Limited Partners with an option to refinance their defaulted subscription note principal and interest payments. Of the total number of limited partner units in Portfolio I and Portfolio II, only 10 limited partner units in Portfolio I and 5.666 limited partner units in Portfolio II opted out of the Settlement Agreement, and, accordingly, were ineligible to elect this refinancing option. Approximately 65% of the total capital and accrued interest amounts due from limited partners of Portfolio I and Portfolio II represented amounts due from limited partners who elected the refinancing option. All amounts remaining due from the limited partners are considered past due and their outstanding amount bears interest at the 18% default rate.\nA cash payment of $24,550,000 was paid into a settlement fund for the benefit of the settling class members of all settling limited partnerships on behalf of VMS and the other settling defendants. VMS National Residential Portfolio I and II and VMS National Properties Joint Venture was not obligated to fund any portion of this cash settlement. The settling class members in VMS National Residential Portfolio I and II were collectively allocated approximately $3,000,000 of the net settlement proceeds paid on behalf of the VMS Settling Defendants and Prudential-Bache Settling Defendants. A total of $390,875 in settlement funds was paid and applied towards delinquent amounts owed under the Investor Notes due VMS National Residential Portfolio I and II during February 1993.\nContinued operating losses and insufficient cash flows to meet all obligations of certain of the Venture's properties are expected to occur. The Managing General Partner is not obligated, and does not intend, to fund any such operating and cash flow deficits. However, the Venture's ability to continue as a going concern and to meet its obligations as they come due is solely dependent upon its ability to generate adequate cash flow from maintaining profitable operations on the retained properties or securing an infusion of capital. Management is involved in negotiations which would replace VMSRIL as the managing general partner and has entered into an agreement of intent with Insignia which contemplates that VMSRIL will withdraw as general partner and be replaced by an entity in which Insignia owns an interest. This change in ownership has been approved by the Bankruptcy Court and certain other creditors, but there is no assurance that the transaction will be consummated. Management believes that they will be successful in obtaining a replacement general partner and that the Venture will be able to continue operations as a going concern on that basis. However, the ultimate resolution of these financial difficulties and uncertainties cannot be determined at this time.\nResults of Operations\nTotal rental and other revenues of $27,874,143 for the year ended December 31, 1995, decreased compared to the year ended December 31, 1994, due to the foreclosure of 5 non-retained properties during 1995. Total rental and other revenues at December 31, 1994, decreased $11,776,513 or 28% from the year ended December 31, 1993, primarily due to the foreclosure of 9 properties from September 30, 1993, to December 31, 1994.\nOperating expenses for the year ended December 31, 1995, decreased $1,341,372 or 14.3% compared to operating expenses for the year ended December 31, 1994, due to the Venture losing 5 non-retained properties to foreclosure during 1995. Operating expenses decreased $3,583,491 or 27.6% for the year ended December 31, 1994, compared to 1993 due to the Venture owning fewer properties during 1994 as noted above. Additionally, general and administrative expenses, property management fees, depreciation, interest expense, and property taxes all decreased for the year ended December 31, 1994, compared to the year ended December 31, 1993, primarily due to the property foreclosures occurring between September 30, 1993, and December 31, 1994.\nGeneral and administrative expenses decreased $224,251 or 16.7% for the year ended December 31, 1995, compared to the year ended December 31, 1994, due to reductions in collection fees related to subscription note collections, legal fees, and other miscellaneous expenses. Maintenance expenses for the year ended December 31, 1995, decreased 23.2% or $1,203,573 compared to the corresponding period of 1994 primarily due to the depletion of the capital reserve escrow established by the Reorganization Plan in addition to the foreclosures of properties during 1995. Interest expense decreased $3,589,048 or 14.8% for the year ended December 31, 1995, compared to the year ended December 31, 1994. The decrease is largely attributable to the foreclosures of 5 properties during 1995.\nThe ordinary losses recognized for the write-downs of the carrying values of properties to their estimated fair values related to 5, 4 and 19 properties foreclosed upon during the years ended December 31, 1995, 1994 and 1993, respectively. The ordinary losses recognized were made pursuant to EITF Abstract Issue No. 91-2, \"Debtor's Accounting for Forfeiture of Real Estate Subject to a Nonrecourse Mortgage\" which prescribes that a \"two-step\" approach method be used to fairly present the economic transaction upon foreclosure events.\nThere were no net reorganization items for the years ended December 31, 1995 or 1994, as the reorganization was completed in 1993. The $1,892,261 recognized in 1993 was the result of extensive legal and consulting efforts related to the confirmation and implementation of the Venture's Plan of Reorganization.\nThe extraordinary gain on extinguishment of debt for the years ended December 31, 1995, 1994 and 1993 relates to the foreclosures of 5, 4 and 19 properties, respectively.\nThe loss on disposal of property for the years ended December 31, 1995 and 1994, resulted from the replacement of roofs for six and eight properties, respectively. The minority interest losses were reallocated to the Venture at the end of 1993 due to severe financial difficulties encountered by the interest.\nImpact of Recently Issued Accounting Statement\nOn February 22, 1991, the Venture filed for Chapter 11 bankruptcy protection (see \"Note 4\" of the Notes to Combined Financial Statements). The combined financial statements of the Venture during the bankruptcy proceedings (February 22, 1991 through September 30, 1993) reflect the financial reporting guidance prescribed by the AICPA Statement of Position 90-7, \"Financial Reporting by Entities in Reorganization Under the Bankruptcy Code\" (SOP 90-7).\nPursuant to SOP 90-7, interest on secured or undersecured debt is recognized to the extent of cash paid or to the extent that the value of the related collateral exceeds the sum of principal plus accrued interest, determined on a property by property basis. Interest on unsecured claims is recognized only to the extent paid. The Combined Statement of Operations includes the interest recognized by this method. Mortgage interest recorded was $33,257,576 less than the contractual amount for 1993. Notes payable and other interest expense recorded was $6,931,070 less than the contractual amount for 1993. Penalties on delinquent real estate taxes after February 22, 1991, and penalties on delinquent debt on the Venture's entities in bankruptcy are not accrued in the combined financial statements nor are they contractually disclosed.\nItems of income or expense that were realized or incurred as a result of the reorganization are included in the Combined Statement of Operations as reorganization items. During 1993, $377,823 of interest income was earned on accumulated cash resulting from Chapter 11 proceedings, and $1,629,940 was incurred for professional, consulting and other fees for the administration of Chapter 11 proceedings during 1993. Debt discounts (imputed interest) and deferred loan costs were written off as of February 22, 1991, in order to adjust the net debt balance to the amount allowed by the bankruptcy court as a claim against the Venture.\nIn March 1995, the FASB issued Statement No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of\" (Statement 121), which requires impairment losses to be recorded on long-lived assets used in operation when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less then the assets' carrying amount. Statement 121 also addresses the accounting for long-lived assets that are expected to be disposed of. The Venture will adopt Statement 121 in 1996; however, based on current circumstances, the Venture does not anticipate that Statement 121 will have any significant impact on the Ventures financial statements.\nInflation\nInflation has had an insignificant impact on the Venture's operations since inception in September 1984. Inflation, if present, should allow for future increases in rental rates to offset some of the impact of higher operating expenses and replacement costs. Furthermore, inflation generally does not impact contractually fixed long-term financing under which the real property investments were purchased.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nLIST OF COMBINED FINANCIAL STATEMENTS\nReport of Independent Auditors\nCombined Balance Sheets - Years ended December 31, 1995 and 1994\nCombined Statements of Operations - Years ended December 31, 1995, 1994 and 1993\nCombined Statements of Changes in Partners' Deficit - Years ended December 31, 1995, 1994 and 1993\nCombined Statements of Cash Flows - Years ended December 31, 1995, 1994 and 1993\nNotes to Combined Financial Statements\nReport of Ernst & Young LLP, Independent Auditors\nThe Partners VMS National Residential Portfolio I and VMS National Residential Portfolio II\nWe have audited the accompanying combined balance sheets of VMS National Residential Portfolio I (an Illinois Limited Partnership), VMS National Residential Portfolio II (an Illinois Limited Partnership) and VMS National Properties (an Illinois Partnership) and Subpartnerships (collectively the \"Venture\") as of December 31, 1995 and 1994, and the related combined statements of operations, changes in partners deficit and cash flows for each of the three years in the period ended December 31, 1995. These financial statements are the responsibility of the Venture'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 combined financial statements referred to above present fairly, in all material respects, the combined financial position of VMS National Residential Portfolio I, VMS National Residential Portfolio II and VMS National Properties and Subpartnerships at December 31, 1995 and 1994, and the combined results of their operations and their cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\nThe combined financial statements referred to above have been prepared assuming that the Venture will continue as a going concern. As more fully described in Note 1, the Venture has incurred recurring operating losses, has a partners' deficit, and is in default on certain debt. In addition, the General Partner and its affiliates have announced the existence of serious financial difficulties that may have an effect on the ability of the General Partner to function in that capacity and may adversely affect the financial condition of the Venture. These conditions raise substantial doubt about the Venture's ability to continue as a going concern. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability of assets or the amounts of liabilities that may result from the inability of the Venture to continue as a going concern.\n\/s\/ ERNST & YOUNG LLP\nGreenville, South Carolina February 26, 1996\nVMS NATIONAL RESIDENTIAL PORTFOLIO I VMS NATIONAL RESIDENTIAL PORTFOLIO II (Illinois limited partnerships) VMS NATIONAL PROPERTIES (an Illinois partnership) AND SUBPARTNERSHIPS\nVMS NATIONAL RESIDENTIAL PORTFOLIO I VMS NATIONAL RESIDENTIAL PORTFOLIO II (Illinois limited partnerships) VMS NATIONAL PROPERTIES (an Illinois partnership) AND SUBPARTNERSHIPS\nCOMBINED STATEMENTS OF OPERATIONS\nFOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nVMS NATIONAL RESIDENTIAL PORTFOLIO I VMS NATIONAL RESIDENTIAL PORTFOLIO II (Illinois limited partnerships) VMS NATIONAL PROPERTIES (an Illinois partnership) AND SUBPARTNERSHIPS COMBINED STATEMENTS OF OPERATIONS (Continued)\nFOR THE YEARS ENDED DECEMBER 31, 1995, 1994, AND 1993\nVMS NATIONAL RESIDENTIAL PORTFOLIO I VMS NATIONAL RESIDENTIAL PORTFOLIO II (Illinois limited partnerships) VMS NATIONAL PROPERTIES (an Illinois partnership) AND SUBPARTNERSHIPS\nCOMBINED STATEMENTS OF CASH FLOWS\nFOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nVMS NATIONAL RESIDENTIAL PORTFOLIO I VMS NATIONAL RESIDENTIAL PORTFOLIO II (Illinois limited partnerships)\nCOMBINED STATEMENTS OF CASH FLOWS (Continued)\nFOR THE YEARS ENDED DECEMBER 31, 1995, 1994, AND 1993\nVMS NATIONAL RESIDENTIAL PORTFOLIO I (an Illinois limited partnership) VMS NATIONAL RESIDENTIAL PORTFOLIO II (an Illinois limited partnership) VMS NATIONAL PROPERTIES (an Illinois partnership) AND SUBPARTNERSHIPS\nNOTES TO COMBINED FINANCIAL STATEMENTS\n1. GOING CONCERN\nThe combined financial statements have been prepared assuming that the VMS National Properties Joint Venture (the \"Venture\") will continue as a going concern. The combined financial statements do not include any adjustments that might result from the outcome of the uncertainties described below, however such uncertainties raise substantial doubt about the Venture's ability to continue as a going concern.\nThe Venture has incurred recurring operating losses, has a partners' deficit and is in default of certain debt agreements as described in \"Note 7\". Continued operating losses and insufficient cash flows to meet all obligations of certain of the Venture's properties are expected to occur. Historically, the General Partner and its affiliates had advanced funds to the Venture; however, the General Partner is not obligated, and does not intend, to fund any future deficits. During 1994, the General Partner and its affiliates assigned a portion of the unpaid advances to an affiliate of Insignia Financial Group, Inc., (\"Insignia\") (\"Notes 5 and 10\"). The General Partner is evaluating its options for the Venture should the Venture continue to suffer substantial losses from operations and cash deficiencies.\nIn addition, the General Partner and its affiliates have incurred serious financial difficulties that may affect the ability of the General Partner to function in that capacity. The administration and management of the Venture are dependent on the General Partner and its affiliates. Pursuant to an agreement dated July 14, 1994, a transaction is pending in which the current General Partner would be replaced by MAERIL, Inc., an affiliate of Insignia. The substitution of MAERIL, Inc. as the General Partner is expected and has been approved by the Bankruptcy Court and certain other creditors, but there is no assurance that the transaction will be consummated. The pending replacement of the General Partner in and of itself will not necessarily improve the financial condition of the Venture.\nThe combined financial statements do not include any adjustments relating to the recoverability of the recorded asset accounts or the amount of liabilities that might be necessary should the Venture be unable to continue as a going concern.\n2. ORGANIZATION\nThe Venture was formed as a general partnership pursuant to the Uniform Partnership Act of the State of Illinois and a joint venture agreement (the \"Venture Agreement\") dated September 27, 1984, between VMS National Residential Portfolio I (\"Portfolio I\") and VMS National Residential Portfolio II (\"Portfolio II\"). The General Partner of Portfolio I and Portfolio II is VMS Realty Investment, Ltd. (formerly VMS Realty Partners) an Illinois limited partnership. Prudential-Bache Properties, Inc. is also a minority general partner of Portfolio I. The Venture originally acquired 51 residential apartment properties located throughout the United States. Of these 51 properties, four were foreclosed prior to 1993. As more fully described in \"Note 4\", the Venture filed for Chapter 11 bankruptcy protection on February 22, 1991. The Venture's Second Amended and Restated Plan of Reorganization (the \"Plan\") became effective on September 30, 1993. Pursuant to the Plan, 19 of the Venture's properties were foreclosed in 1993, four properties were foreclosed in 1994, and an additional five properties were foreclosed in 1995. The Venture continues to own and operate 17 of the residential apartment complexes it originally acquired. In addition, as provided by the Plan, the Venture filed motions to abandon the two remaining non-retained HUD (as described below) properties (see \"Note 13\").\nThree of the remaining properties are encumbered by financings insured or held by the Department of Housing and Urban Development (\"HUD\"). These properties are owned by 3 separate subpartnerships (the \"Subpartnerships\"), of which the Venture owns a 99% interest. The remaining 1% interest is owned by VMS Realty Investment, Ltd. (Minority Interest). During 1993 cumulative losses of $640,144 previously allocated to the Minority Interest were reallocated to the Venture due to the severe financial difficulties encountered by the Minority Interest.\nThe VMS\/Stout Joint Venture (the \"VMS\/Stout Venture\") was formed pursuant to an agreement dated August 18, 1984, which was amended and restated on October 4, 1984. VMS Realty Partners has a 50% interest and affiliates of the Seller (as defined below) have a 50% interest in the VMS\/Stout Venture. The VMS\/Stout Venture, the J.D. Stout Company (\"Stout\") and certain affiliates of Stout entered into a contract of sale dated August 18, 1984, which was amended on October 4, 1984. The contract provided for the sale by Stout and other owners (collectively the \"Seller\") of the 51 residential apartment complexes to the VMS\/Stout Venture. The VMS\/Stout Venture assigned its interest as purchaser to the Venture. During 1987, Stout assigned its interest in the VMS\/Stout Joint Venture to ContiTrade Service Corporation (\"ContiTrade\"). On November 17, 1993, VMS Realty Partners assigned its interest in the VMS\/Stout Joint Venture to the Partners Liquidating Trust (see \"Note 8\").\nPursuant to the terms of the Joint Venture Agreement for the Venture and the respective Partnership Agreements for Portfolio I and Portfolio II, the Managing General Partner will manage Portfolio I, Portfolio II, VMS National Properties and each of the Venture's operating properties. The Limited Partners do not participate in or control the management of their respective partnership, except that certain events must be approved by the Limited Partners. These events include: (1) voluntary dissolution of either Portfolio I or Portfolio II, and (2) amending substantive provisions of either Partnership Agreement.\nThe operating profits and losses of VMS National Properties and the Venture's properties are allocated to Portfolio I and Portfolio II on a pro-rata, cumulative basis using the ratio of their respective Limited Partnership Interests issued and outstanding. The operating profits and losses of Portfolio I and Portfolio II are allocated 98% to the respective Limited Partners and 2% to the respective General Partners.\nOperating cash flow distributions for Portfolio I and Portfolio II will be made atthe discretion of the Managing General Partner subject to the order of distribution indicated in the Plan and approved by the Bankruptcy Court. Such distributions will be allocated first to the respective Limited Partners in an amount equal to 12% per year (on a noncumulative basis) of their contributed capital; then, to the General Partners, a subordinated incentive fee equal to 10.45% of remaining operating cash flow; and finally, of the balance to be distributed, 98% to the Limited Partners and 2% to the General Partners.\nDistributions of proceeds arising from the sale or refinancing of the Venture's properties will be allocated to Portfolio I and Portfolio II in proportion to their respective Venture interests subject to the order of distribution indicated in the Plan and approved by Bankruptcy Court. Distributions by Portfolio I and Portfolio II will then be allocated as follows: (1) first to the Limited Partners in an amount equal to their aggregate capital contributions; (2) then to the General Partners in an amount equal to their aggregate capital contributions; (3) then, among the Limited Partners, an amount equal to $62,000,000 multiplied by the respective percentage interest of Portfolio I or Portfolio II in the Venture; and (4) finally, of the balance, 76% to the Limited Partners and 24% to the General Partners.\nIn any event, there shall be allocated to the General Partners not less than 1% of profits or losses.\n3. ACCOUNTING POLICIES\n(a) The combined financial statements of the Venture for the period during the bankruptcy proceedings (February 22, 1991 to September 30, 1993) reflect the financial reporting guidance prescribed by the AICPA Statement of Position 90-7 (SOP 90-7), \"Financial Reporting by Entities in Reorganization Under the Bankruptcy Code\". In accordance with SOP 90-7,interest on secured or undersecured debt of the Venture's entities in bankruptcy was recognized to the extent of cash paid or to the extent that the value of the related collateral exceeded the sum of principal plus accrued interest, determined on a property by property basis. Interest on unsecured claims was recognized only to the extent paid. Effective September 30, 1993, the Venture resumed an accrual basis of interest recognition. Mortgage interest recorded for the three years ended December 31, 1993, was $33,257,576 less than the contractual amount. Interest on notes payable and other interest expense recorded for the same period was $6,931,070 less than the contractual amount. Penalties on delinquent real estate taxes after February 22, 1991, and penalties on delinquent debt on the Venture's entities that were in bankruptcy were not approved by the Bankruptcy Court as an allowed claim. Therefore, these penalties were neither accrued in the combined financial statements nor contractually disclosed.\nItems of income or expense that were realized or incurred as a result of the reorganization are included in the Combined Statements of Operations as reorganization items. During the year ended December 31, 1993, $377,823 in interest was earned on accumulated cash resulting from Chapter 11 proceedings and $1,629,940 was incurred for professional, consulting and other fees, for the administration of Chapter 11 proceedings. Debt discounts (imputed interest) and deferred loan costs related to the Venture's entities in bankruptcy were written off as of February 22, 1991, in order to adjust the net debt balance to the amount allowed by the bankruptcy court as a claim against the Venture.\nPursuant to the Plan which became effective on September 30, 1993, the Bankruptcy Court disallowed accrued contractual obligations of approximately $89,573,000 (see \"Note 11\") related to the retained complexes. Additionally, the assets and liabilities of the Venture's non- retained complexes (see \"Note 5\") have been segregated and presented as investment properties subject to abandonment and liabilities related to properties subject to abandonment on the Venture's Combined Balance Sheets (see \"Note 13\").\n(b) The accompanying combined financial statements include the accounts of Portfolio I, Portfolio II, the Venture and Subpartnerships (collectively, the \"Partnerships\"). Significant interpartnership accounts and transactions have been eliminated from these combined financial statements.\n(c) Depreciation is computed using the following methods and estimated useful lives:\n3. ACCOUNTING POLICIES - (continued)\n(d) The investment properties are stated at the lower of cost or estimated fair value. The Venture performs a valuation analysis of its property periodically. This analysis is performed to determine the estimated fair value of the properties. Estimated fair value is determined using net operating income of the properties capitalized at a rate deemed reasonable for the type of property adjusted for market conditions, physical condition of the properties and other factors to assess whether any permanent impairment in value has occurred.\nIn March 1995, the FASB issued Statement No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of\" (Statement 121), which requires impairment losses to be recorded on long-lived assets used in operation when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less then the assets' carrying amount. Statement 121 also addresses the accounting for long-lived assets that are expected to be disposed of. The Venture will adopt Statement 121 in 1996; however, based on current circumstances, the Venture does not anticipate that Statement 121 will have any significant impact on the Ventures financial statements.\n(e) The Venture generally leases its residential apartment units for twelve month terms or less.\n(f) The Venture expenses the costs of advertising as incurred. Advertising expense included in operating expenses was $428,100, 426,389 and $671,202 for the years ended December 31, 1995, 1994 and 1993, respectively.\n(g) The Venture considers all highly liquid investments with an original maturity of three months or less when purchased to be cash equivalents. Cash and cash equivalents are carried at cost which approximates fair value. At times cash balances exceed the insured limit as provided by the Federal Deposit Insurance Corporation.\n(h) The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.\n(i) In 1995, the Venture implemented Statement of Financial Accounting Standards No. 107, \"Disclosure about Fair Value of Financial Instruments,\" which requires disclosure of fair value information about financial instruments for which it is practicable to estimate that value. The carrying amount of the Venture's cash and cash equivalents approximates fair value due to short-term maturities. The Venture estimates the fair value of its fixed rate mortgages by discounted cash flow analysis, based on estimated borrowing rates currently available to the Venture (Note 7). The carrying amounts of variable-rate mortgages approximate fair value due to frequent re-pricing.\n(j) Certain reclassifications have been made to the 1994 and 1993 balances to conform to the 1995 presentation.\n(k) The Partnership requires security deposits from all apartment lessees for the duration of the lease. Deposits are refunded when the tenant vacates the apartment if there has been no damage to the unit.\n4. PETITION FOR RELIEF UNDER CHAPTER 11\nAs a result of severe liquidity difficulties and impending foreclosure proceedings, the Venture filed for Chapter 11 bankruptcy protection on February 22, 1991. The initial filing included only the residential apartment complexes directly owned by VMS National Properties Joint Venture and excluded the 10 Subpartnerships consisting of 10 residential apartment complexes encumbered by financing insured or held by HUD and the investing limited partnerships, Portfolio I and Portfolio II. Due to the partnership agreements existing between the Venture, Portfolio I and Portfolio II, which provide the Venture with exclusive rights to the limited partner investor contributions, the Venture's initial filing was amended to reflect the Venture's right to receive any excess limited partner investor contributions.\nThe Venture filed its proposed Plan of Reorganization and Disclosure Statement with the Bankruptcy Court on October 13, 1992. After several modifications to the Venture's proposed Plan, the \"Second Amended and Restated Plan of Reorganization\" (the \"Plan\") was approved by the Bankruptcy Court in March 1993 and became effective on September 30, 1993 (see \"Note 5\").\n5. PLAN OF REORGANIZATION\nThe primary aspects of the Venture's Plan, effective September 30, 1993, include the following:\na. The Venture retained 17 properties from the previously existing portfolio the \"retained properties\"). The retained properties consist of 16 non- HUD properties and one HUD property. The Venture filed motions to abandon the retained HUD properties held at Decmeber 31, 1993. Two of these non-retained properties remain at December 31, 1995.\nb. The senior mortgages on the Venture's non-HUD retained properties payable to lenders other than the FDIC were modified effective September 1, 1993. The modified senior mortgages provide for an interest rate of 8.75% per annum with payments based on a 30 year amortization commencing with the first payment due October 1, 1993, and mature on January 15, 2000. The modified senior loan balances consisted of principal and accrued interest balances due under the old mortgage terms at September 1, 1993, plus approved legal, late and other charges claimed by the senior lenders approximating $197,000 in the aggregate. There was no forgiveness of debt from the refinancing of mortgages payable to lenders other than the FDIC. The senior mortgage on the retained property which is insured by HUD was not modified.\n5. PLAN OF REORGANIZATION - (continued)\nThe senior liens formerly held by the FDIC on two of the Venture's non-HUD retained properties were modified effective September 1, 1993, to accrue interest at 9% with monthly payments commencing October 1, 1993 of interest only at 7% on the restated FDIC notes' \"Agreed Valuation Amount\" (defined in \"c\" below). Interest is calculated on the basis of a 360 day year and the actual number of days in each month. The difference between the 9% accrual rate and the 7% minimum pay rate (the \"FDIC Deferral\") shall accrue, but not be added to principal, and shall bear interest at the 9% note rate from and after the due date of each payment, compounded monthly. All unpaid principal and accrued interest is due in full on the January 15, 2000, maturity date. Approximately $3,774,000 in prepetition accrued unpaid interest was written off at September 30, 1993, to reduce the senior-lien FDIC liabilities recorded on the Venture's books to the Agreed Valuation Amounts. A portion of this gain was deferred (see \"Note 11\").\nc. The junior lien mortgages formerly held by the FDIC on the Venture's retained properties were modified effective September 1, 1993, and mature January 15, 2000. The FDIC reduced its claim on two of the non-HUD retained complexes to $300,000 per property evidenced by a non-interest bearing note. The FDIC left intact liens for the full amount of the original claims at the petition filing date for all other properties (including the two senior liens discussed in \"b\" above) in the event the Venture defaults on any of its obligations under the former restated FDIC notes. The former restated FDIC junior-lien notes provide for a 10% accrual rate with monthly payments commencing October 1, 1993, of interest only at 7% on the non-HUD restated FDIC notes' Agreed Valuation Amount. Pursuant to the Plan, the Agreed Valuation Amount represents the total property value per the FDIC's June 1992 valuations less the property's senior lien indebtedness at September 30, 1992. The retained property governed by HUD Regulatory Agreements will make payments of interest only at 7% each April 1st and October 1st, payable only from distributable surplus cash as provided by the HUD Regulatory Agreement and following the HUD's approval of semi-annual surplus cash calculations prepared each December 31st and June 30th. The Agreed Valuation Amount represents the total principal claim that will be repaid provided there are no defaults under the terms of the restated notes. Approximately $68,060,000 in prepetition principal and accrued unpaid interest was written off at September 30, 1993, to reduce the former FDIC junior lien liabilities recorded on the Venture's books to the Agreed Valuation Amounts. A portion of this gain was deferred (see \"Note 11\").\nd. The Venture distributed the following amounts in conjunction with the terms of the Plan:\n(1) A $5,960,000 reserve to fund capital improvements at the retained properties was established in 1993. This reserve was exhausted at December 31, 1995.\n(2) Approximately $5,980,000 in allowed prepetition claims, including the nonaffiliated Letter of Credit Note (see \"Note 8\"), amounts due trade creditors, and real and personal property taxes on the retained properties was disbursed in October 1993.\n(3) Payments totalling approximately $1,006,000 were authorized for immediate distribution to affiliates of the Managing General Partner for reimbursement of cash advances and asset management services provided to the Venture (see \"Note 10\").\n(4) Payments of $50,000 each to the FDIC and ContiTrade Services Corporation were made for reimbursement of administrative costs incurred in connection with the Venture's bankruptcy case.\ne. The VMS\/Stout Joint Venture was granted an allowed claim in the amount of $49,534,819 for the Assignment and Long-Term Loan Arrangement Notes payable to it by the Venture (see \"Note 8\"). Payments totalling $3,475,000 in conjunction with this allowed claim were made to the non- affiliated members of the VMS\/Stout Joint Venture on October 7, 1993. Of the remaining allowed claim, $4,000,000 is represented by a promissory note (the \"ContiTrade Note\") which bear interest at the rate of 5% per annum, while the remaining $42,059,819 is noninterest bearing. The ContiTrade Note is collateralized by a Deed of Trust, Assignment of Rents and Security Agreement on each of the Venture's retained properties, and provides ContiTrade with other approval rights as to the ongoing operations of the Venture's retained properties. The ContiTrade Note matures January 15, 2000.\nf. The Venture entered into a Revised Restructured Amended and Restated Asset Management Agreement (the Revised Asset Management Agreement) with Insignia. Effective October 1, 1993, Insignia took over the asset management of the Venture's retained properties and partnership functions. However, an affiliate of the Managing General Partner assisted in the asset management functions of the Venture's retained and nonretained properties through July 1994. This affiliate was compensated by Insignia at the rate of 28% of the asset management fees paid to Insignia by the Venture. (See \"Note 10\").\nThe Revised Asset Management Agreement provides for an annual compensation of $500,000 to be paid to Insignia in equal monthly installments. In addition, Insignia will receive reimbursement for all out-of-pocket costs incurred in connection with their services up to $200,000 per calendar year. Compensation to Insignia is to be paid from the available operating cash flow of the Venture's retained properties after the payment of operating expenses and fundings for insurance, real estate and personal property tax reserves, senior mortgage payments, minimum interest payment requirements on the former FDIC mortgages, and any debt service and principal payments currently due on any liens or encumbrances senior to the ContiTrade Deeds of Trust. If insufficient operating cash flow exists after the funding of these items, the balance of Insignia's compensation may be paid from available partnership cash sources. Additionally, the compensation payable to Insignia will be reduced proportionately for each of the Venture's retained properties which are sold or otherwise disposed of from time to time.\nThe Venture also engaged Insignia affiliates to commence property management of all of the Venture's retained properties effective January 1, 1994.\n6. SUBSCRIPTION NOTES AND ACCRUED INTEREST RECEIVABLE\nPortfolio I and Portfolio II executed promissory notes requiring cash contributions from the partners aggregating $136,800,000 to the capital of Portfolios I and II for 644 and 268 units, respectively. Of this amount, $134,919,694 was contributed in cash through December 31, 1995, and $910,074 was deemed uncollectible and written-off as of December 31, 1995. The following table represents the remaining Limited Partners' subscription notes principal balances and the related accrued interest receivable at December 31, 1995:\nPortfolio I Portfolio II\nSubscription notes receivable $586,445 $383,787 Accrued interest receivable 67,995 67,146 Total subscription notes and accrued interest receivable $654,440 $450,933\nAll amounts outstanding at December 31, 1995, are considered past due and bear interest at the default rate of 18%. The subscription notes receivable and the related interest are not recognized until collection is assured.\n7. MORTGAGE LOANS PAYABLE\nOn October 28, 1995, the FDIC sold all of the debt it held related to the retained properties to BlackRock Capital Finance, L.P. The debt amounts and terms were not modified.\nThe Managing General Partner believes that it is not appropriate to use the Venture's incremental borrowing rate for the debt as there is currently no market in which the Venture could obtain similar financing. Therefore, the Managing General Partner considers estimation of fair value to be impracticable.\n7. MORTGAGE LOANS PAYABLE - (continued)\nPrincipal payments on mortgage loans payable during the next five years are noted below. The 1996 amount includes the defaulted balances of $10,060,590 for the nonretained properties.\n1996 $ 10,368,301 1997 334,705 1998 364,078 1999 396,044 2000 115,704,911 Thereafter 3,859,069 $131,027,108\n8. NOTES PAYABLE\n(a) The Venture executed a $29,000,000 purchase money subordinated note (the \"Assignment Note\") payable to the VMS\/Stout Venture in exchange for the assignment by the VMS\/Stout Venture of its interest in the contract of sale to the Venture. The Assignment Note is collateralized by the pledge from Portfolio I and Portfolio II of their respective interests in the Venture.\nOn November 17, 1993, VMS Realty Partners assigned its 50% interest in the VMS Stout Joint Venture to the Partners Liquidating Trust which was established for the benefit of the former creditors of VMS Realty Partners and its affiliates. As a result of this assignment of interest, the Assignment Note and the Long- Term Loan Arrangement Fee Note (see below) are no longer classified as notes payable to related parties.\nThe stated rate of interest on the Assignment Note (prior to modification by the Plan) was 12% per annum (compounded semi-annually) with monthly payments of interest only at a rate of 6%. Monthly payments on this note were discontinued in May 1990, and the accrual of interest was discontinued after the February 22, 1991, petition filing date. Additionally, effective April 10, 1991, VMS Realty Partners waived its right to collect interest on its portion of the Assignment Note.\nPursuant to the Plan, the allowed claim for the Assignment note and related interest was $46,284,819; $3,475,000 of this amount was paid in October 1993 in accordance with the terms of the Plan. The Venture also executed a $4,000,000 promissory note payable dated September 1, 1993 to ContiTrade Services Corporation (ContiTrade note) which bears interest at 5% per annum. This note represents a prioritization of payment to ContiTrade and did not represent the assumption of any additional debt. The ContiTrade note matures on January 15, 2000, and is collateralized by a Deed of Trust, Assignment of Rents and Security Agreement on each of the Venture's retained complexes. Accrued interest on the ContiTrade note at December 31, 1995, is $466,667.\nThe remaining $42,809,819 of the Assignment Note is non-interest bearing and is payable only after payment of debt of higher priority, including mortgage notes due to senior lien holders and junior mortgages payable to the FDIC. Pursuant to SOP 90-7, the Assignment Note, the Long-Term Loan Arrangement Fee Note (as defined below) and related accrued interest were adjusted to the present value of amounts to be paid using an estimated current interest rate of 11.5%. Accordingly, the Venture recognized an extraordinary gain on extinguishment of debt of $21,491,232 in 1993. Interest expense is being recognized through the amortization of the discount which totaled $2,877,750, $2,566,524 and $597,033 in 1995, 1994 and 1993, respectively.\n(b) The Venture executed a $3,000,000 unsecured, nonrecourse promissory note, the \"Long-Term Loan Arrangement Fee Note\" payable to the VMS\/Stout Venture as consideration for arranging long-term financing.\nThe stated rate of interest on this note prior to modification by the Plan is 10% per annum, payable on a monthly basis. Monthly interest payments on this Note were discontinued in May 1990. Additionally, the accrual of interest on this Note was discontinued after the February 22, 1991, petition filing date.\nPursuant to the Plan, the entire $3,000,000 principal balance plus $250,000 in unpaid accrued interest was granted as an allowed claim. None of this balance bears interest, and the balance is payable only after debt of a higher priority, including senior and junior mortgage loans.\n8. NOTES PAYABLE - (continued)\n(c) The Venture executed a $3,190,000 nonrecourse promissory note payable to the Seller (\"Stout Note\") as additional consideration for the sale of the properties in 1984 which was collateralized by a letter of credit for $3,190,000.\nThe Venture discontinued scheduled monthly interest payments in May 1990 on the Stout Note. As a result, in July 1990 all three holders drew on the Letter of Credit for the principal note balances due. The drafts under the Letter of Credit bear interest at prime plus 5% and were due upon funding.\nThe accrual of interest on this Letter of Credit was discontinued after February 22, 1991.\nPursuant to the Plan, the entire amount of the allowed claim for the Letter of Credit, $3,504,874, was paid in full in October 1993.\n9. INCOME TAXES\nThe Partnership has received a ruling from the Internal Revenue Service that it will be classified as a partnership for Federal income tax purposes. Accordingly, no provision for income taxes is made in the combined financial statements of the Partnership. Taxable income or loss of the Partnership is reported in the income tax returns of its partners.\nThe following is a reconciliation of reported net income and Federal taxable income:\nThe following is a reconciliation between the partnership's reported amounts and Federal tax basis of net assets and liabilities at December 31, 1995:\nNet assets as reported $(147,213,520) Land and buildings 19,690,363 Accumulated depreciation (43,993,647) Syndication costs (17,649,849) Deferred gain 54,052,737 Loan costs 1,165,198 Other deferred costs 9,600,920 Other 2,060,396 Notes Payable 4,881,954 Subscription note receivable 2,112,632 Mortgage payable (51,995,377) Accounts payable - Affiliates 8,453,757\nNet assets - Federal tax basis $(158,834,436)\n10. TRANSACTIONS WITH AFFILIATES AND RELATED PARTIES\n(a) The Venture entered into agreements with affiliates of the Managing General Partner to provide asset management services at a fee equal to 1.5% (.5% to 1.5% for HUD properties) of monthly gross revenues. Subsequent to the February 22, 1991, bankruptcy filing, payment of these fees had been restricted by Bankruptcy Court approvals. Pursuant to the terms of the Venture's Plan, asset management fees of $1,734,100 for services rendered through September 30, 1993, were approved by the Bankruptcy Court as allowed claim payments. All affiliated asset management fees in excess of the allowed claim payments were written off as of September 30, 1993. Fees of $950,000 were approved for immediate payment and were paid in 1993. In addition, payments of $82,000 and $116,343 were made in 1995 and 1994, respectively. The remaining 585,757 prepetition portion of the allowed claim may be paid only from available partnership cash sources. Effective October 1, 1993, the Venture entered into an asset management agreement with Insignia in conjunction with the implementation of the Plan (see \"Note 5\").\nVarious nonaffiliated management companies have managed the properties since September 1991. Accordingly, no affiliated property management fees were incurred or paid in 1993; however, prepetition property management fees of $356,108 were approved by the Bankruptcy Court for payment to an affiliate. This allowed claim may be paid only from available partnership cash and remains unpaid at December 31, 1995.\n(b) Certain affiliates of the General Partners and the VMS\/Stout Venture may be entitled to receive various fees upon disposition of the properties. These fees will be paid from the disposition proceeds and are subordinated to the distributions required by the Plan. There were no property dispositions for which proceeds were received through December 31, 1995.\n(c) Prior to 1994, an affiliate of the Managing General Partner was reimbursed for accounting, due diligence, data processing, and other departmental costs, along with partnership travel, communication and certain overhead expenses of staff engaged in analysis and operation of Portfolio I, Portfolio II, the Venture and each of the Venture's operating properties.\n10. TRANSACTIONS WITH AFFILIATES AND RELATED PARTIES (continued)\nThese services were performed by Insignia in 1994 and 1995 (See \"Note 5\"). A portion of the 1994 reimbursements received by Insignia were assigned to an affiliate of the General Partner. The total reimbursable costs paid to an affiliate of the General Partner included on the Combined Statements of Operations for the years ended December 31, 1994 and 1993 amounted to $94,681 and $684,982, respectively. Payment of these reimbursable costs during the bankruptcy proceedings was restricted to $25,000 per month pursuant to court-approved cash collateral orders. No such payments were made in 1993, 1994 and 1995; however $754,957 in prepetition reimbursable costs was approved for payment as part of the Plan. This claim, which remains unpaid as of December 31, 1995, may be paid from partnership cash only. The remainder of reimbursable costs payable to affiliates not allowed by the Bankruptcy Court were written off as of September 30, 1993.\n(d) Under the terms of the Venture agreement, the Managing General Partner and its affiliates provided management and other services to the Venture through December 31, 1991. Pursuant to the Plan, a prepetition portion of fees totalling $583,333 was approved for payment from available partnership cash. No payments of these fees have been made during 1995, 1994 or 1993. The portion of these fees not allowed by the Bankruptcy Court were written off.\n(e) The Venture has engaged affiliates of Insignia to provide day-to-day management of the Venture's properties and to provide all partnership administrative functions under an agreement which provides for property management fees equal to 4% of revenues on each property and asset management fees of $500,000 for the Venture in total. For the period from October 1, 1993, through July 14, 1994, Insignia assigned a portion of these fees to an affiliate of the General Partner. Payments to this affiliate under this assignment were approximately $93,000 in 1994.\n11. EXTRAORDINARY GAIN ON EXTINGUISHMENT OF DEBT\nThe Combined Statements of Operations for the year ended December 31, 1995, 1994 and 1993 reflect the foreclosures of 5, 4, and 19 of the Venture's properties, respectively. As a result of these foreclosures, the following liabilities and assets were written off:\nAdditionally, as a result of the implementation of the Venture's Plan of Reorganization, certain liabilities compromised by the Plan were adjusted in 1993 to the present value of amounts to be paid determined at appropriate current interest rates. As a result, the Venture realized a gain in 1993 on extinguishment of debt on the retained properties as follows:\nFDIC mortgages $ 9,972,239\nAccrued interest on former FDIC mortgages 55,215,496\nNotes payable 21,491,232 Other 2,893,882 Extraordinary Gain 89,572,849 Less portion of gain deferred (54,052,737) Extraordinary gain realized $ 35,520,112\nPursuant to the Plan, the mortgages formerly held by the FDIC were modified effective September 30, 1993. For 15 of the 17 retained properties, the face value of the note was restated to the Agreed Valuation Amount (see \"Note 5\").Under the terms of the restated notes, the FDIC may reinstate the full claim which was in place at the petition filing date upon the default of any note. The restated notes are cross-collateralized; however, they are not cross- defaulted. As a result, the Venture deferred $54,052,737 of this extraordinary gain on extinguishment of debt and recognized an additional $35,520,112 in 1993. On October 28, 1995, the FDIC sold all of the debt it held related to the retained properties to BlackRock Capital Finance, L.P. The debt amounts and terms were not modified.\n12. CONTINGENCIES\nThe Venture and certain affiliates of the Venture, including the Managing General Partner and certain officers and directors of the Managing General Partner, are parties to certain legal proceedings pending at December 31, 1995. The legal proceedings in which the Venture is included relate primarily to the limited partners' investment in the Venture. The adverse outcome of any one or more legal proceedings against the Venture or any of its affiliates which provide financial support or services to the Venture could have a materially adverse effect on the present and future operations of the Venture. The eventual outcome of these matters cannot be determined at this time. Accordingly, no provision for any liability that may result has been made in the financial statements.\n13. INVESTMENT PROPERTIES SUBJECT TO ABANDONMENT\nThe Venture's investment in properties for which it obtained Bankruptcy Court approval to abandon, and to which it still held legal title for two of these properties at December 31, 1995, has been presented as \"Investment Properties Subject To Abandonment\" on the Venture's Combined Balance Sheets at December 31, 1995 and December 31, 1994. The extraordinary gain on the extinguishment of debt for all of these properties will exceed the ordinary loss from the write down of the net carrying values of these properties to their estimated fair market values. Therefore, no allowance or provision for the loss in asset value has been made in the Venture's Combined Statements of Operations for the year ended December 31, 1995. Five of these properties were foreclosed during 1995 (see \"Note 11\").\n14. HUD CONTINGENCIES\nThe Venture, VMS Realty Management, Inc. and HUD are engaged in discussions covering the appropriateness of certain Crosswood Park and Venetian Bridges Grand Canal I disbursements totalling approximately $602,601 and $132,744, respectively, made during the years 1987 through 1991. The parties are attempting to resolve this issue, but the ultimate outcome cannot presently be determined. The General Partner is vigorously defending its past actions and does not believe the eventual outcome of these discussions will have a material adverse effect on the operations of the Venture. Given the General Partner's beliefs and the uncertainty regarding the eventual resolution of the amounts in question, the responsible parties and their ability to make repayment if deemed necessary, no adjustment has been made to the Venture's combined financial statements concerning this matter. Two of the non-retained HUD projects were involved in similar discussions with HUD relating to $1,854,657 of inappropriate disbursements. These matters were settled during 1994 with no effect on the Venture.\n15. Investment Properties and Accumulated Depreciation\n(a) See description of Mortgage Loans Payable in \"Note 7\" of Notes to Combined Financial Statements. (b) The aggregate cost of land, building, personal property and improvements for financial reporting purposes differs from Federal income tax purposes by the imputed interest recorded at the various dates of acquisition. As a result of the Venture's reorganization and related debt modification, the aggregate cost for Federal income tax purposes of buildings and improvements was downwardly adjusted in 1993. The aggregate costs of the real estate for Federal income tax purposes at December 31, 1995 and 1994, is $175,133,297 and $207,598,281, respectively. The accumulated depreciation taken for Federal income tax purposes at December 31, 1995 and 1994, is $116,336,946 and $128,994,887, respectively.\n(c) Reconciliation of Real Estate\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 Managing General Partner of Partnership I and Partnership II at December 31, 1995, was VMS Realty Investment, Ltd., an Illinois General Partnership. Prudential-Bache Properties, Inc. was a minority General Partner of Partnership I at December 31, 1995.\nVMS Realty Investment, Ltd. is a limited partnership owned by Azel Realty Corporation (100% owned by Robert D. Van Kampen), PRM Realty Corporation (100% owned by Peter R. Morris), JAS Realty Corporation (100% owned by Joel A. Stone), Brewster Realty Inc. (which is controlled by Messrs. Van Kampen and Stone) and Residential Equities, Ltd. (which is 100% owned by Peter R. Morris) and XCC Investment Corporation (a Delaware Corporation).\nVMS Realty Partners (\"VMS\"), an affiliate of the General Partner, assisted the Managing General Partner in the management and control of the Venture's affairs through November 17, 1993, and Strategic Realty Advisors, Inc. (\"SRA\"), also an affiliate of the General Partner, replaced VMS in assisting the Managing General Partner effective November 18, 1993. VMS Realty Partners is an Illinois general partnership whose partners are Van Kampen\/Morris\/Stone, Inc. (100% owned by Robert D. Van Kampen, Peter R. Morris and Joel A. Stone), Residential Equities, Ltd. (100% owned by Mr. Morris), XCC Investment Corporation (a subsidiary of Xerox Credit Corporation) and Brewster Realty, Inc. (100% owned by Messrs. Van Kampen and Stone). A substantial number of the officers of VMS are also officers of entities affiliated with VMS. The principal executive officers of VMS are the following:\nJoel A. Stone ............. President and Chief Executive Officer and Member of the Executive Committee\nPeter R. Morris ........... Member of the Executive Committee\nRobert D. Van Kampen ...... Member of the Executive Committee\nStuart Ross ............... Member of the Executive Committee\nThe principal executive officers of SRA are the following:\nJoel A. Stone ............. President and Chief Executive Officer\nRichard A. Berman ........... Senior Vice President\/Secretary\nThomas A. Gatti ............. Senior Vice President\nJOEL A. STONE, age 51, is President and Chief Executive Officer of Strategic Realty Advisors, Inc., since November 1993. From the inception in 1981 of VMS Realty Partners, he held the positions of President and then Chief Executive Officer. Mr. Stone began his career as an Internal Revenue Agent and worked as a certified public accountant and an attorney specializing in taxation and real estate law. In 1972, Mr. Stone co-founded the certified public accounting firm formerly known as Moss, Stone and Gurdak. In 1979, Mr. Stone joined the Van Kampen group of companies, a privately held business engaged in investment banking and in real estate activities. He served as Senior Vice President of Van Kampen Merritt, Inc. until its sale to Xerox Corporation in 1984. An alumnus of DePaul University, Mr. Stone earned a Bachelor of Science degree in Accounting in 1966 and a Juris Doctorate in 1970. Mr. Stone is a member of the Illinois Bar and a certified public accountant.\nPETER R. MORRIS, age 46, is a member of the Executive Committee of VMS, and is one of the three individuals owning the entities that own VMS. From July 1970 to June 1973, Mr. Morris was employed by Continental Wingate Company, Inc., a firm engaged in the development of inner city housing projects, in the capacities of Vice President\/Finance, Director\/Consulting Division and Executive Assistant to the President. He has published a book and numerous articles relating to real estate development and syndication. Mr. Morris has been involved in the real estate and finance business with Messrs. Van Kampen and Stone since 1977. He received a Bachelor of Arts degree (summa cum laude) from Princeton University in 1971 and a Juris Doctorate (cum laude) from Harvard Law School in 1975.\nROBERT D. VAN KAMPEN, age 57, is a member of the Executive Committee of VMS and is one of the three individuals owning the entities that own VMS. Mr. Van Kampen has been involved in various facets of the municipal and corporate bond business for over 20 years. In 1967, he co-founded the company now known as Van Kampen Merritt, Inc., which specializes in municipal bonds and acts as a sponsor of unit investment trusts. The firm was sold to Xerox Corporation in January 1984. Mr. Van Kampen is a general partner of Van Kampen Enterprises. Mr. Van Kampen received his Bachelor of Science degree from Wheaton College in 1960.\nSTUART ROSS, age 59, is a member of the Executive Committee of VMS. He is an executive vice president of Xerox Corporation and chairman and chief executive officer of Xerox Financial Services, Inc., a wholly owned subsidiary. Mr. Ross joined Xerox in 1966 and has held a series of financial management positions. He assumed his current position in May 1990. Prior to Xerox, Mr. Ross was a financial representative for The Macmillan Publishing Company from 1963 to 1966, and a public accountant for Harris, Kerr, Forster & Company from 1958 to 1963. Mr. Ross is a director of Crum and Forster, Inc. and Ekco Group, Inc., and a trustee of the State University of New York at Purchase. He received a bachelor of science degree in accounting from New York University in 1958 and a master of business administrative degree from the City College of New York in 1966. Mr. Ross is a certified public accountant.\nRICHARD A. BERMAN, age 44, is a Senior Vice President and General Counsel of Strategic Realty Advisors, Inc. From 1986 through 1993, Mr. Berman was employed by VMS Realty Partners and was First Vice President and Corporate Counsel. Prior to joining VMS Realty Partners, Mr. Berman was a partner in the law firm of Gottlieb and Schwartz with his practice concentrated in corporate and real estate law. He received a Juris Doctorate from Northwestern University School of Law (Cumlaude, 1976) and a Bachelor of Arts degree from the University of Illinois (high honors, 1973). Mr. Berman is a member of the Illinois Bar.\nTHOMAS A. GATTI, age 39, is a Senior Vice President - Partnership Accounting of Strategic Realty Advisors, Inc., effective November 18, 1993. Prior to this time, Mr. Gatti was First Vice President - Partnership Accounting with VMS Realty Partners, where he was employed since January, 1982. Prior to joining VMS Realty Partners, he was with Coopers & Lybrand. Mr. Gatti received a Bachelor of Science in Accounting from DePaul University in 1978. Mr. Gatti is a Certified Public Accountant.\nPrudential-Bache Properties, Inc.\nPrudential-Bache Properties, Inc.(\"PBP\"), pursuant to the Partnership Agreement, does not participate in or exercise control over the affairs of the Partnership.\nThe directors and officers of PBP are as follows:\nJames M. Kelso.................. President, Chief Executive Officer, Chairman of the Board of Directors, and Director Barbara J. Brooks............... Vice President - Finance and Chief Financial Officer\nJAMES M. KELSO, age 40, is the President, Chief Executive Officer, Chairman of the Board of Directors and Director of PBP. He is a Senior Vice President of Prudential Securities Incorporated (\"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 numerous positions within PSI since 1983. Ms. Brooks is a certified public accountant.\nThere are no family relationships among any of the foregoing directors or executive officers. All of the foregoing directors and\/or officers have indefinite terms.\nLegal Proceedings\nSee \"Item 3, Legal proceedings\", for a discussion of legal proceedings during the past five years which may be material to an evaluation of the ability or integrity of any of the aforementioned directors or officers and VMS Realty Partners and its affiliates.\nItem 11.","section_11":"Item 11. Executive Compensation\nNone of the directors and officers of the General partner received any remuneration from the Partnership.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\n(a) Security ownership of certain beneficial owners.\nNo person owns of record or is known by the Partnerships to own beneficially more than 5% of the outstanding Interests of either of the Partnerships as of December 31, 1995.\n(b) Security ownership of management.\nNo partners of VMS Realty Investment, Ltd. or officers or directors of Prudential-Bache Properties, Inc., the general partners of the Partnerships, own any Limited Partnership Interests in the Partnerships.\nNo general partners, officers or directors of the General Partners of the Partnerships possess the right to acquire a beneficial ownership of Interests of either of the Partnerships.\n(c) Changes in Control.\nThe managing general partner of the Registrant is currently contemplating an agreement with Insignia Financial Group, Inc. (\"Insignia\") whereby an affiliate of Insignia would replace VMSRIL as the managing general partner of the Partnerships.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nSee \"Note 10\" of the Notes to Combined Financial Statements for information relating to transactions with affiliates.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(a) The following combined financial statements of the Registrant are included in Item 8:\nCombined Balance Sheets at December 31, 1995 and 1994.\nCombined Statements of Operations for the years ended December 31, 1995, 1994 and 1993.\nCombined Statements of Changes in Partners' Deficit for the years ended December 31, 1995, 1994 and 1993.\nCombined Statements of Cash Flows for the years ended December 31, 1995, 1994 and 1993.\nNotes to Combined Financial Statements\nSchedules, other than those listed, are omitted for the reason that they are inapplicable or equivalent information has been included elsewhere herein.\nThe following items are incorporated:\nPart V - Amended Restated Certificate and Agreement of:\nItem 1(b)(i) Limited Partnership of VMS National Residential Portfolio I.\nItem 1(b)(ii) Limited Partnership of VMS National Residential Portfolio II.\nItem 1(b)(iii) Joint Venture Agreement between VMS National Residential Portfolio I and VMS National Residential Portfolio II.\n(b) No reports on Form 8-K were filed during the quarter ended December 31, 1995.\n(c) 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.\nVMS NATIONAL PROPERTIES JOINT VENTURE (Registrant)\nVMS National Residential Portfolio I\nBy: VMS Realty Investment, Ltd. Managing General Partner\nBy: JAS Realty Corporation\nDate: March 29, 1996 By: \/s\/Joel A. Stone Joel A. Stone, President\nDate: March 29,1996 By: \/s\/Thomas A. Gatti Thomas A. Gatti Senior Vice President and Principal Accounting Officer\nVMS National Residential Portfolio II\nBy: VMS Realty Investment, Ltd. Managing General Partner\nBy: JAS Realty Corporation\nDate: March 29, 1996 By: \/s\/Joel A. Stone Joel A. Stone, President\nDate: March 29, 1996 By: \/s\/Thomas A. Gatti Thomas A. Gatti Senior Vice President 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.\n\/s\/Joel A. Stone President Joel A. Stone\nSenior Vice President and Thomas A. Gatti Principal Accounting Officer","section_15":""}
{"filename":"773326_1995.txt","cik":"773326","year":"1995","section_1":"ITEM 1. BUSINESS General\nForeland Corporation (the \"Company\") was organized in June 1985 to advance an exploration project in the Great Basin and Range geologic province in Nevada (the \"Great Basin\") that had been initiated by Gulf Oil Corporation (\"Gulf\"). Following its organization, the Company acquired rights to a geologic data base, assembled a management team with supporting consultants, obtained funding from a private placement and its initial public offering, and commenced the field geology phase of its exploration project.\nThe Company's field geology identified an oil source rock and porosity fairway in north and central Nevada in which the Company has concentrated its lease acquisition and exploration program. The Company has funded its exploratory drilling through arranging its own funding and obtaining funding from industry participants that agree to complete specified drilling or other exploration in order to earn an interest in an agreed area. Since 1986, the Company has identified a number of drilling targets in Pine Valley and other areas of Nevada and arranged Company and third-party funding for drilling a number of test wells.\nTo help fund future activities, in 1993 and 1994, the Company acquired nine shut-in wells in the Eagle Springs Field in Nevada. The Company then returned eight of these acquired wells to production and drilled a new water injection well. In August 1994, the Company entered into an agreement with Plains Petroleum Operating Company, which was acquired in August 1995 by Barrett Resources Corporation (together, \"Barrett\"), to fund further activities in the Eagle Springs Field. In September 1994, the Company and Barrett acquired an additional Eagle Springs lease with three previously producing wells, which have since been reworked and returned to production, and a shut-in water injection well. Pursuant to its agreement with the Company, Barrett provided $1,920,000 of $2,400,000 in well costs and thereafter, in January 1995, elected to continue to participate in the Company's Eagle Springs project, thereby earning a 40% working interest in the Company's Eagle Springs producing properties, subject to the right to make individual elections respecting participating in specific wells as they are proposed. As of March 31, 1996, the Company and Barrett have drilled and placed into production a total of eight new wells in the Eagle Springs Field, all of which are now in regular continuous production. The Company and Barrett plan to drill additional wells to test horizons productive in existing wells in a further effort to increase production.\nThe Company continues to increase and improve its geological and geophysical expertise respecting the Great Basin of Nevada through its own efforts and by obtaining data from third parties as part of joint exploration, property acquisition, or data sharing arrangements and from drilling and other field work in which the Company participates. In addition, all information is continuously reanalyzed as additional drilling data is gathered and as new computer modeling and other analytical tools become available to the industry. This has enabled the Company to increase substantially its understanding of the geology, location, potential, and other characteristics of the exploration process.\nNevada Exploration\nDuring the early 1980s, the Great Basin of Nevada emerged as a possible new frontier area for oil exploration. Conventional wisdom in the oil industry at the time held that certain geological indicators pointed to north and central Nevada as a possible repository of large (by continental United States standards) petroleum deposits. Several of the nation's largest exploration companies, including Exxon USA, Inc. (\"Exxon\"), Texaco, Inc., Gulf, Chevron USA, Inc. (\"Chevron\"), Mobil Exploration and Producing USA, Inc. (\"Mobil\"), and Amoco Corp. (\"Amoco\"), acquired substantial lease holdings and initiated exploration programs in eastern and central Nevada during the early years of the decade.\nBetween 1980 and 1983, Gulf conducted a detailed study of the hydrocarbon potential of north and central Nevada and other frontier exploration areas. The study, conducted by Gulf personnel and by outside consultants, generated a mass of raw data pertaining to the age and depositional history of potential oil-bearing formations. In 1983, Gulf became the target of a takeover attempt by Mesa Petroleum and subsequently was acquired by Chevron. In connection with that acquisition, a number of Gulf's exploration projects were terminated, including the study of Nevada.\nThe acquisition of Gulf by Chevron also led to the voluntary retirement of a number of Gulf employees. One such retiree was Dr. Grant Steele, who had been manager of geology for Gulf's central exploration group and was intimately involved with the study of the Great Basin of Nevada.\nPersonal and professional interest in the potential of the Great Basin of Nevada continued after his early retirement from Gulf in 1983. In 1985 Dr. Steele organized the Company and recruited Kenneth L. Ransom, who had served under Dr. Steele as a senior geologist with Gulf's central exploration group and who had also been deeply involved with Gulf's study of the Great Basin of Nevada.\nThe Company's goal is to secure a significant position in a potential new oil province. In order to implement this plan, the Company acquired rights to Gulf's data base, conducted additional geological survey work, acquired oil and gas lease holdings in north and central Nevada, and arranged for the exploration and development of its acreage. Virtually all of the Company's financial resources were committed from the outset to this goal.\nBusiness Strategy The Company has assembled a management and technical team of persons with specialized technical training and experience concentrated on Nevada oil exploration. In all, the Company's technical team has over 70 years of combined Nevada oil exploration experience with major oil companies such as Gulf, Mobil, and Chevron. The Company believes that the working experience of its executives in Nevada is a significant factor in the Company's exploration progress to date and in its ability to act as operator under exploration arrangements with other exploration firms such as Enserch Exploration, Inc. (\"Enserch\"), Berry Petroleum Company (\"Berry\"), Parker and Parsley Petroleum Company (successor-in-interest to Santa Fe Energy Resources, Inc.) (\"P&P\"), and Barrett. This team employs the following strategies in guiding the Company's Nevada exploration:\n. Take full advantage of the most advanced generally available scientific exploration tools and techniques such as 3-D and reprocessed seismic data to generate drilling prospects and select specific drilling locations. . Generate promising exploration prospects in areas in which the Company holds or believes that it can acquire a preemptive lease position and upgrade lease holdings based on further prospect evaluation. . Seek joint exploration agreements with other exploration firms active in Nevada to diversify the risk and to obtain additional scientific data and expertise, land, and funding. . To increase revenues by drilling in the Eagle Springs Field to develop proven reserves and to test horizons productive in existing wells. . Continually generate prospect concepts for the long-term exploration of the Great Basin.\nScience\nThe Company seeks to utilize the most advanced available scientific tools and techniques to evaluate the risk and exploration potential of specific prospects. The Company's oil exploration model for the Great Basin of Nevada was developed from a large data base collected, originally by Gulf and, since 1985, by the Company. As a result of the Company's own work as well as information sharing arrangements with others, the Company now has access to over 1,400 line miles of 2-D seismic data, much of it reprocessed with new analytical computer programs, newly acquired high resolution 3-D seismic surveys, and gravity data gathered by the Company as well as by Exxon, P&P, Mobil, Chevron, Enserch, and Berry. Data from 3-D seismic, gravity, reprocessed seismic surveys, and previous drilling are integrated as a guide to further exploration. The Company believes that it benefits from the long-term involvement of the Company's personnel in Nevada oil exploration and operations, which enhances the Company's ability to share data and expertise with industry participants.\nProspect Generation and Leasing\nThe Company's leasing program is coordinated with prospect generation and exploration results. As areas of interest are identified, the Company attempts to acquire leases or other exploration rights on what preliminarily appears to be the most promising prospect areas in order to establish a preemptive lease position prior to generating a specific drilling prospect. As specific prospect evaluation advances, the Company may seek leases on additional areas or relinquish leases on areas that appear less promising, thereby reducing lease holding costs. As a result, the Company has substantially increased the size of its gross acreage while, in management's opinion, improving the exploration potential of its leaseholdings.\nJoint Exploration\nThe Company regularly seeks joint exploration arrangements with other oil exploration firms active in Nevada to obtain access to additional scientific data and technical expertise, particularly relatively expensive geophysical data, including 3-D seismic. Joint exploration arrangements are sought with firms that have significant lease positions in the prospect area and that can bear a portion of the costs of specified further exploration. The Company also utilizes joint exploration arrangements to spread the risks of specific exploration, attempting to retain a larger interest by bearing a greater proportion of the related costs in those prospect areas in which management believes that the risks and reserve potential warrant such action. In situations in which management perceives a higher degree of risk or a smaller potential for the prospect, it seeks to retain a smaller interest and bear a smaller share of related costs.\nDrilling Near Existing Production\nFurther exploration drilling is required to delineate the extent of productive horizons in individual fields and complete development where warranted. In the Eagle Springs Field, the Company's geophysical and geological evaluation is ongoing to locate possible additional drilling locations to develop the undeveloped reserves and to test the horizons that are productive in the existing wells. The Company has surface facilities capable of handling additional production. The Company also intends to continue to drill exploration wells in the area of existing production in the Pine and Railroad Valleys to further evaluate reservoir extent and characteristics, increase production, and obtain data that might benefit the Company's overall exploration effort. The Company intends to pursue these drilling objectives in Pine Valley as well as specific prospects in Railroad Valley as involving somewhat lower risk than exploration testing in areas with relatively less drilling history or other exploration success to date.\nLong-Term Exploration\nManagement anticipates that it will take several years to explore fully the target areas selected by the Company in the Great Basin of Nevada, as is the case in many frontier areas of exploration, and believes that it is important to provide for an ongoing presence for the Company in Nevada exploration. In such a long term exploration effort, the results of early exploration serve as a guide for identifying new prospects so it is important, in management's view, to continually identify new prospect concepts and areas for possible future exploration while advancing existing prospects to the drilling stage.\nThrough 1996, the Company will focus its activities on drilling in the Eagle Springs Field to develop proved undeveloped reserves and to evaluate the horizons that are productive in existing wells and in several additional exploratory prospects in the Pine, Railroad, and Huntington Valleys and Toano Draw of Nevada. In addition, the Company will continue to review the exploration potential of certain acreage under its agreement with P&P, as discussed below, and continue its acquisition of 3-D seismic data and reanalysis of existing 2-D seismic data. The Company will also continue its evaluation of data to identify additional exploration targets, expand its lease holdings where warranted, and seek additional exploration arrangements with other industry participants.\nJoint Exploration Agreements\nEnserch\/Berry Operating Agreement\nEffective March 1993, the Company entered into an operating agreement with Enserch, Dallas, Texas, and Berry, Taft, California, independent oil exploration and production firms active in Nevada (collectively, \"Enserch\/Berry\"), to undertake a three-year, six-well joint exploration program on approximately 110,000 gross leased acres in Pine, Diamond, Little Smoky, and Antelope Valleys of northeastern Nevada. The Company is designated as the operator for the proposed drilling as well as other activities under the agreement. The Company and Enserch\/Berry each contributed approximately 50% of the gross acreage and will share, on the basis of the Company 50% and Enserch\/Berry 50%, in the costs of additional lease acquisition, geophysical exploration and drilling, and in the net revenues from oil produced.\nThe parties have identified four areas of mutual interest covering an aggregate of 500,000 acres, in which are located the 91,000 gross leased acres held during 1995. Through 1994, the parties drilled three test wells, one each in the Pine, Little Smoky, and Antelope Valleys, all three of which were dry holes that were plugged and abandoned. During 1995, the parties drilled the Hot Creek Wash test in Antelope Valley, and the Eldorado #15-1 test in Little Smoky Valley. Both tests were plugged and abandoned. The remaining well under the arrangement with Enserch\/Berry, the Pinon prospect in Pine Valley, is planned to be drilled during 1996, subject to obtaining required financing. (See \"Exploration Status.\")\nIn addition to the six required wells, during the term of the agreement any party has the right to propose additional wells to explore new prospects or develop discoveries. The joint exploration program continues to May 1, 1996, at which time the acreage in Diamond Valley contributed by Foreland to the joint arrangement is returned to Foreland. The balance of the acreage and the designated acreage surrounding wells that have then been drilled under the joint arrangement remain subject to the operating agreement. If the results of the initial exploration warrant and the parties agree to proceed with additional joint exploration, the proposed exploration of the area subject to this agreement may take several years to complete.\nRustler Prospect\nOn September 28, 1994, the Company entered into an agreement with Mobil under which the Company had the right to commence one test well on or before September 1, 1995, on the Rustler Prospect located in White Pine County, Nevada. The Company elected not to commence such well and has no further rights or obligations under the agreement. P&P Marketing and Exploration Agreement\nIn December 1992, the Company entered into a three year exploration agreement, subsequently extended to December 1, 1996, with P&P's predecessor-in- interest, appointing the Company the exclusive marketing representative for P&P's fee mineral interest in northern Nevada. The Company delineates exploration areas, defines prospects, and secures drilling partners utilizing the Company's and P&P's combined geological and geophysical data base. The Company has generated five drillable prospects affecting the P&P lands in the North Humboldt and Dixie Flats prospects in Huntington Valley and the Deadman Creek and Medicine Creek prospects in Toano Draw and the Pine Creek prospect in Pine Valley. If drilling is undertaken, the Company and P&P will each retain certain rights and interest in the drilling and development of identified prospects within the lands covered by the exploration agreement.\nUnder the terms of the exploration agreement, the Company has access to P&P's proprietary geological and geophysical data respecting the P&P properties and adjacent lands, with the express right to reprocess seismic data, utilizing improved analytical techniques and control data now available. If the Company elects to gather or to purchase additional geological or geophysical data for a mutually agreed exploration area, P&P is precluded from granting third parties exploration rights to such exploration area for one year. P&P has certain rights of access to the data developed by the Company on the P&P property.\nOn any drillings of P&P lands arranged by the Company, P&P and the Company will share in lease bonuses, the right to acquire a working interest by paying a portion of drilling and completion costs on any successful well, and overriding royalties, with the option to convert the overriding royalties to working interests in certain circumstances. The Company and P&P have a right of first refusal to participate in any drilling prospects generated by the other during the term of the exploration agreement.\nThe Company is required to release the remaining 434,000 acres subject to the P&P agreement by December 1996, when the agreement expires, subject to any specific acreage subject to leases, farmouts, or other arrangements reached under the agreement with the Company. The Company will review the P&P acreage with a view towards identifying the most promising prospects and reaching drilling arrangements by December 1996. Originally, the agreement required the Company to release the acreage by December 1995, but P&P and the Company agreed to extend the expiration date to permit further evaluation of the properties by the Company.\nAs a result of the Company's review of the P&P acreage, the Company identified an exploration target in the Deadman Creek area of Toana Draw based on the Company's review of available data regarding a test drilled by another operator in the mid 1980s that encountered favorable oil shows but was not completed for production. The Company has reentered this hole for testing and, if warranted, will attempt recompletion of the well using modern completion technologies. As a result of this reentry, the Company will earn a 100% working interest in 5,013 gross acres (4,261 net acres) under the P&P agreement, subject to P&P's 15% working interest in each well after the Company has recouped costs incurred.\nNorth Humboldt Prospect\nUnder the agreement with the Company discussed below, after the first three new Eagle Springs wells were placed into production in January 1995, Barrett exercised its right to earn an interest in the Company's acreage in an area of mutual interest in the North Humboldt prospect included in the P&P acreage. The Company and Barrett are undertaking a joint technical evaluation of the seismic data to select a drillsite. Upon the completion of any geophysical studies that the parties deem necessary and review of the data obtained, the parties will select a drillsite and proceed to drill, with Barrett bearing two-thirds of the cost of the initial well in each area to earn a one-half interest in the Company's acreage within the prospect area.\nHugoton\/Maxwell Agreement\nOn January 22, 1996, the Company entered into a revised agreement with Hugoton Energy Corporation and Maxwell Petroleum, Inc. (\"Hugoton\/Maxwell\"), respecting exploration of the Pine Creek prospect in Pine Valley, Nevada. Under this agreement, the Company and Hugoton\/Maxwell each agreed to assign to the other certain acreage to consolidate the Company's position in the prospect area; Hugoton\/Maxwell agreed to pay for a one-year extension of the leasehold assigned by it; the Company agreed to initiate a well on the federal acreage assigned, in order to obtain a two-year lease extension; and Hugoton\/Maxwell agreed to complete and pay for a 3-D seismic study in the area or pay the Company $75,000 as liquidated damages. If the Company does not initiate a test and obtain a two-year lease extension, Hugoton\/Maxwell is not required to complete the seismic study or pay damages. The total estimated dry hole cost for the Pine Creek test is $664,000, which the Company would seek to share on a 50-50 basis with other drilling participants if a drilling group can be formed. If a drilling group cannot be formed on terms acceptable to the Company, it may not drill the test.\nOther Exploration Arrangements\nThe Company is continuing to negotiate with other interested parties to fund further drilling on defined prospects in a number of locations in the Great Basin of Nevada. The ultimate goal of the Company is to arrange for the exploration and, if oil reservoirs are discovered, development of its holdings using the Company's own limited financing, to the extent available. In some instances, the Company may reach an agreement with other firms in which all participants contribute acreage and available scientific data and bear a portion of the costs of agreed drilling or other exploration, thereby earning a shared ownership in the contributed acreage and production, if any. The nature and extent of the Company's participation, share of costs, and interest retained in various arrangements are dependent on the acreage it has under lease in the target area, the amount of scientific information it has available as compared to the other participants, the relative financial strength of the participants, and the risks and rewards perceived by the various participants. These arrangements are very project specific and will vary from drilling prospect to drilling prospect.\nEagle Springs\nIn July 1993, the Company acquired an approximately 2,800 gross acre lease in Railroad Valley, Nevada, which included a portion of the Eagle Springs Field, with nine oil wells, then shut in, and one water injection well. In connection with the acquisition, the Company implemented certain in-field environmental remediation measures and resolved issues raised by various regulatory agencies and the claims of entities which asserted an ownership interest or had advanced funds or services to the field. In September 1994, the Company, with Barrett, acquired Kanowa's interest in a 240-acre lease on the remainder of the Eagle Springs Field with three wells with limited intermittent production and related equipment.\nWells drilled during the 1960s on the Eagle Springs property produced until late 1992 from depths of from 5,900 to 7,200 feet and had total cumulative production, as reported to the Nevada Department of Minerals, of 2,825,000 barrels of oil. The 14 wells drilled during development of the field between 1954 and 1965 reportedly had average per well daily production of approximately 150 barrels per day for the first year and approximately 100 barrels per day for the first three years of production. During the last 12 months that the wells acquired by the Company were in production, they produced an aggregate of approximately 120 barrels of oil per day.\nIn the year following acquisition of the Eagle Springs properties in July 1993, the Company completed substantial work and returned eight of the acquired wells in the Eagle Springs Field to production and drilled a water injection well. Under the agreement with Barrett discussed below, during 1994 and early 1995, the Company and Barrett drilled and placed into production three wells in the Eagle Springs Field. In January 1995, after these three wells were placed into production, Barrett elected to continue to participate in the Eagle Springs Field and in mid-1995, the Company and Barrett commenced the development drilling program in Eagle Springs based on the Company's own 3-D seismic study to develop additional production and evaluate at additional locations horizons that are productive in existing wells. The Company and Barrett have drilled and placed into production five additional wells of this program, for a total of eight new wells drilled by the Company and Barrett. According to the Company's year-end independent reserve report completed by Malkewicz Hueni Associates, Inc., Golden, Colorado, there are eight proved undeveloped drilling locations within the estimated perimeter of the Eagle Springs Field. A 3-D seismic survey has been completed on the field, and the 3-D seismic information continues to be evaluated and integrated with additional available drilling results as an ongoing guide for drilling. Initial evaluation of the 3-D seismic information provided the basis of the Company's decision to purchase Kanowa's interest in the 240-acre lease in the Eagle Springs field in September 1994. It is anticipated that the eight proved undeveloped locations identified in the reserve report will be scheduled to be drilled in 1996 and 1997, subject to available financing. As these locations are drilled, additional locations will be identified and evaluated for drilling in the Company's Eagle Springs program to the extent warranted by results as drilling progresses and the availability of required funding, and subject to unexpected delays, downtime, and similar unforeseen circumstances.\nWhen reworking the nine wells to return them to production, the Company also substantially renovated and upgraded surface facilities such as tank batteries, piping, separators, and other equipment in order to create substantial excess capacity of field production facilities available to service new wells and to reduce production costs. Increased production resulting from additional drilling would be sold under the Company's existing sales agreement and trucking arrangement.\nThe Company intends to evaluate engineering data from existing wells together with any additional wells that may be productive to determine whether a reduced well spacing from 20 acres to 10 acres, which is the spacing approved by regulatory authorities, may be economically beneficial. If the Company concludes that reduced well spacing would increase the financial return from the field, the total number of available well locations would be increased, which would correspondingly extend beyond 1997, the period during which the Eagle Springs Field could be developed. In addition, the Company has initiated a larger ongoing reservoir study of the Eagle Springs Field oriented toward development of a secondary or tertiary improved oil recovery project.\nFurther activities in the Eagle Springs Field are currently being conducted jointly with Barrett as discussed below.\nBarrett Agreement\nOn August 9, 1994, the Company entered into an agreement with Plains Petroleum Operating Company, which was acquired in August 1995 by Barrett Resources Corporation (together, \"Barrett\"), under which Barrett provided $1,920,000 of $2,400,000 in well costs to earn a 40% interest in the Company's Eagle Springs producing properties and obtained the right to participate in other specified Company exploration projects under agreed terms, including the North Humboldt prospect, as discussed above.\nUnder the agreement with Barrett, in September 1994, the Company and Barrett acquired for $225,000 in Company stock and cash an additional Eagle Springs lease on approximately 240 gross acres with three previously producing wells, then shut-in, and a shut-in water injection well. Of these wells, one was returned to production in 1994 and two were reworked and returned to production in July 1995. Two of the first new Eagle Springs wells drilled with Barrett are located on this acquired acreage.\nThe Company and Barrett drilled three new producing wells in the Eagle Springs Field in late 1994 and early 1995. In January 1995, after the first three new Eagle Springs wells were placed into production, Barrett elected to continue to participate in Eagle Springs, thereby earning a 40% working interest in the Company's Eagle Springs project, subject to the right to make individual elections respecting participating in future wells proposed by the Company. In mid-1995, the Company and Barrett commenced a multi-well drilling program on the proved nonproducing and proved undeveloped acreage in the field, to test at additional locations horizons that are productive in existing wells, and to increase proved reserves. The Company and Barrett are proceeding to prioritize the proved undeveloped locations as identified in the reserve report and anticipate those eight locations as additional wells to be drilled during 1996 and 1997. Barrett or Foreland may elect, on a well-by-well basis, to participate in the wells planned for 1996 and 1997 but has no obligation to participate in any well.\nBarrett also has elected to earn an interest in the Company's acreage in an area of mutual interest in the North Humboldt prospect, developed by the Company on P&P mineral interests under the Company's agreement with P&P. (See \"Joint Exploration Arrangements\" above.) Barrett has declined further participation in the Dixie Flats prospect in Huntington Valley. In January 1995, Barrett elected not to participate in the Pine Valley 3-D survey, indicating that the full study was too large for Barrett's revised exploration budget. Activities under the joint exploration arrangement with Barrett are conducted by the Company as operator, under the overall direction of a technical committee made up of representatives of both parties. In addition to joint exploration in each of the exploration areas under this agreement through 1998, the Company has granted to Barrett the right to participate in any other exploration prospects that the Company elects to offer to third parties.\nNorth Willow Creek and Tomera Ranch Discoveries\nNorth Willow Creek\nThe initial discovery well in this field, the North Willow Creek SPLC no. 1-27 well, drilled in 1987, discovered an oil bearing structure at a depth of from 5,818 to 6,358 feet. Two additional wells, the North Willow Creek no. 6-27 and no. 5-27 have been drilled, extending the productive area of the field. The Company continues to experience production difficulties and management has concluded that the wells are not producing to the potential indicated by initial tests and engineering and geologic evaluations. The Company continues to receive limited production from two wells in this field.\nTomera Ranch\nIn August 1987, the Tomera Ranch discovery well, the SPLC no. 1-5, drilled by another operator under a joint exploration arrangement with the Company, was completed for production in the Indian Wells formation at between 1,864 and 1,950 feet. This well subsequently produced intermittently in limited amounts. When this well was placed into production, the Company could not obtain access to a water disposal well necessary to continue production and was forced to shut in the well. In 1992, the Company converted the SPLC no. 1-5 well to a water disposal well and drilled an adjacent well, the SPLC no. 1-5R, as a replacement production well. In 1990, the no. 33-1 well was completed for production in the Tomera Ranch Field, but was not placed into production until the Company completed the water injection well at Tomera Ranch in 1992. Since then, the SPLC no. 1-5R and no. 33-1 Tomera Ranch wells have had limited sustained production. In December 1993, the Company acquired the working interest of the previous operator in the Tomera Ranch field, and since then has continued to evaluate the productive potential of the area. Both the North Willow Creek and Tomera Ranch wells hold acreage over productive zones that the Company believes can be produced at higher rates with additional evaluation and reworking, including chemical treatments, heat treatments, hydraulic fracturing treatments, and other alternative measures. There can be no assurance that such efforts will be successful or that the wells will produce in paying quantities. If such efforts are successful, the Company plans additional evaluation drilling as warranted. The Company's petroleum engineer is evaluating the North Willow Creek and Tomera Ranch Fields and is making recommendations for improvement of production.\nExploration Status\nPine Valley\nThe Company has participated in two wells in the Hay Ranch area. The first, the West Hay Ranch no. 12-1, was drilled by another operator and was subsequently plugged and abandoned. In 1993, after evaluating the results of the West Hay Ranch no. 12-1, the Company drilled the Hay Ranch no. 1-17. Oil shows were encountered over a 1,000 foot thick interval, and a drillstem test was performed on one of the lower zones. This test well has been temporarily abandoned, and additional testing, directional drilling, and deepening operations are all being considered for the future. The rock section with oil shows in the no. 1-17 well is not present in the no. 12-1 well, indicating a \"pinchout\" of those prospective horizons, a common geological phenomenon which is often associated with oil traps.\nThree exploratory test wells in which the Company participated were drilled in the northern part of Pine Valley within five miles of the Tomera Ranch Field. Each had varying degrees of oil shows. The most encouraging was the Tomera Ranch South no. 9-1, drilled by another operator in 1993. Promising oil shows were encountered in this test well, but attempts to log and test this hole were prevented by unstable hole conditions shallow in the well. The drilling results are being integrated with the geophysical data to guide further testing of this prospect. In December 1993, the Company increased its acreage position in this area by acquiring all of the previous operator's acreage in the Tomera Ranch area, including the previous operator's interest in the Tomera Ranch no. 33-1 well. The Company will now proceed with additional seismic exploration for use in positioning potential drilling sites.\nThe Company conducts exploration efforts in this area with Enserch\/Berry pursuant to the operating agreement entered into by the parties. With funding provided jointly by the Company and Enserch\/Berry, the Company acquired additional seismic data and defined two drilling prospects to be drilled in Pine Valley. In December 1994, the Trout Creek No. 26-1 exploratory well, the first well to be drilled in Pine Valley by the parties, was plugged and abandoned. The Pinon prospect in Pine Valley, the final well to be drilled under the Company's agreement with Enserch\/Berry, is planned to be drilled during 1996, subject to obtaining required financing.\nThe Company and Hugoton\/Maxwell are currently pursuing activities in the Pine Valley area pursuant to the revised agreement dated January 22, 1996, between the parties. Both parties contributed acreage under the agreement to consolidate the Company's position in the Pine Creek prospect. Hugoton\/Maxwell obtained a one-year extension of the leasehold assigned by it and has agreed to complete and pay for a 3-D seismic study in the area or pay the Company $75,000 as liquidated damages, provided that the Company initiates a test well and obtains a two-year lease extension. The Company has had the Pine Creek unit designated by the Bureau of Land Management and plans to drill this prospect in the latter part of the second quarter, subject to forming a drilling group on terms acceptable to the Company.\nLittle Smoky and Antelope Valley\nThe Company continues active exploration of these two valleys under the agreement with Enserch\/Berry. Substantial seismic surveys were completed late in 1993, leading to the drilling of two test wells. Although these tests were plugged and abandoned, these wells both added significantly to the Company's information in these two sparsely drilled yet promising prospect valleys. The Company and Enserch\/Berry drilled an additional test well in each of these valleys during 1995, the Hot Creek Wash no. 15-1 in Antelope Valley and the Eldorado #15-1 in Little Smoky Valley. Both were plugged and abandoned.\nNewark Valley\nThe Company is utilizing the extensive seismic information available to it through its agreement with Mobil for ongoing geological evaluation of this area. The two test wells in which the Company participated in this valley, the Buck Station and the Indian Springs prospects, encountered encouraging oil shows which were subsequently tested, but both tests were plugged and abandoned. The well information is being integrated with the seismic data to identify a potential \"up dip\" location to the Buck Station test for future drilling. On September 28, 1994, the Company entered into an agreement with Mobil under which it could drill one test well on or before September 1, 1995, on the Rustler Prospect located in White Pine County, Nevada, to earn an interest in such prospect area. The Company elected not to commence such well and has no further rights or obligations under the agreement.\nDeadman Creek\nThe Company has completed lease acquisition over its Deadman Creek prospect in the Toano Draw area of Elko County with the purchase of leases on approximately 10,000 acres, which supplement the approximately 12,300 acres previously acquired. This prospect was generated by the Company during 1994 and 1993. In November 1995, the Company reentered an existing hole drilled by a previous operator in the mid-1980s for testing to determine whether recompletion is warranted using modern completion technologies. The Company has opened additional zones and swabbing operations have recovered oil and drilling and testing fluids. Representative samples of the oil and mud recovered from the swabbing are being analyzed to determine the appropriate fluids to use for breaking down the perforations. This test is on P&P acreage covered by P&P's agreement with the Company.\nCompetition and Markets\nThe Company competes with numerous other firms and individuals in its activities. The Company's competitors include major oil companies and other independent operators, many of which have financial resources, staffs, and facilities substantially larger than those of the Company. Competition in the oil and gas industry is intense.\nThe Company faces intense competition in obtaining risk capital for test drilling within the Great Basin province. Management believes that competition for drilling funds from such sources is principally dependent on an analysis by the potential industry participant of the costs of drilling and related activities, the likelihood of discovering oil or other hydrocarbons in commercial quantities, and the potential size of oil reserves which geologic and engineering analyses indicate may eventually be established.\nThe Company believes that an important consideration in obtaining risk capital for drilling, new exploration rights, and joint exploration and development arrangements with other industry participants is the amount and quality of the Company's scientific data and exploration experience in Nevada. The Company also believes that it benefits from its use of reprocessed 2-D seismic and 3-D seismic data and its experience in correlating that data with the results of actual drilling.\nIn its efforts to obtain oil leases within the Great Basin, the Company encounters competition from lease speculators, independent oil firms, and major oil companies. The ability to acquire leases is generally determined by the amount of cash paid to acquire the lease, the royalty or other interest retained by the transferor, and the nature of any commitment to drill on the lease acreage. The Company seeks to acquire leases in those areas that have been identified through geological and geophysical data as having potential to produce oil in sufficient quantities to be economic.\nThe availability of a ready market for production and the prices obtained for production of oil depend on a number of factors beyond the Company's control, the effects of which cannot be predicted accurately. Such factors include the extent of domestic production and imports of oil; the competitive position of oil as a source of energy as compared to gas, coal, nuclear energy, hydroelectric power, and other energy forms; the refining capacity of prospective purchasers; transportation costs; the availability and capacity of pipelines and other means of transportation; and the effect of federal and state regulation on production, transportation, and sale of oil.\nGovernment Regulation\nThe exploration for and production of oil in the United States are subject to extensive regulation by both federal and state authorities. The following discussion concerning 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, and governmental orders to which operations of the Company may be subject.\nEnvironmental Regulations\nOperations of the Company are subject to numerous laws and regulations governing the discharge of materials into the environment, the remediation of environmental impacts, and other matters relating to environmental protection, which affect the Company's operations and costs. It is probable that state and federal environmental laws and regulations will become more stringent in the future. Proposed legislation to reauthorize the Federal Resource Conservation and Recovery Act would have reclassified a significantly greater portion of oil and gas production waste as \"hazardous waste.\" If this proposed legislation had been enacted, the stricter disposal requirements for hazardous wastes would have had a significant impact on the operating costs of the Company and the oil and gas industry in general, resulting in a significant number of wells becoming uneconomic. There can be no assurance that measures to further regulate the disposal of oil waste may not be adopted. Environmental laws and regulations are frequently changed so the Company is unable to predict the ultimate cost of compliance.\nIn connection with the acquisition of the Eagle Springs property, the Company performed limited environmental inquiries and agreed to undertake certain work to remediate a contaminated drilling pit at a former water injection well site. That work was completed in coordination with federal and state supervising agencies in early 1994 at a cost of $110,604. As a negotiated term of the acquisition of the Eagle Springs lease, the Company agreed to indemnify the secured creditor from which the Company acquired a portion of its property interests against claims for environmental liability. The Company does not believe that it has any material continuing financial obligation respecting remediation of environmental matters involving the Eagle Springs property. However, there can be no assurance that new remediation issues will not arise in the future.\nState and Local Regulation of Drilling and Production\nState regulatory authorities have established rules and regulations requiring permits for drilling, drilling bonds, and reports concerning operations. Such regulations also cover the location of wells, the method of drilling and casing wells, the surface use and restoration of well locations, and the plugging and abandoning of wells. Nevada also has statutes and regulations governing a number of environmental and conservation matters, including the unitization and pooling of oil properties and establishment of maximum rates of production from oil wells.\nFederal Leases\nThe Company conducts significant portions of its activities under federal oil and gas leases. These operations must be conducted in accordance with detailed federal regulations and orders which regulate, among other matters, drilling and operations on these leases and calculation and disbursement of royalty payments to the federal government.\nTitle to Properties\nSubstantially all of the Company's working interests are held pursuant to leases from third parties. The Company performs only a minimal title investigation before acquiring undeveloped properties, and a title opinion is typically obtained only prior to the commencement of drilling operations. The Company has obtained other documentary confirmation of title on its principal producing properties and believes that it has satisfactory title to such properties. The Company's properties are subject to customary royalty interests, liens for current taxes, and other common burdens which the Company believes do not materially interfere with the use of such properties and whose economic effect has been appropriately reflected in the Company's acquisition costs of such properties.\nOperational Hazards and Insurance\nThe Company's operations are subject to the usual hazards incident to the drilling for and the production of oil, such as blowouts, cratering, explosions, uncontrollable flows of oil or well fluids, fires, pollution, releases of toxic gas, and other environmental hazards and risks. These hazards can cause personal injury and loss of life, severe damage to and destruction of property and equipment, pollution or environmental damage, and suspension of operations.\nThe Company maintains insurance of various types to cover its operations. The Company has general liability insurance of $1 million per occurrence, with a $2 million aggregate limitation, including coverage for certain oil industry activities. Management believes that the Company's current insurance coverage is adequate; however, the Company's insurance does not cover every potential risk associated with the drilling and production of oil. In particular, coverage is not available for certain types of environmental hazards. The occurrence of a significant adverse event, the risks of which are not fully covered by insurance, could have a materially adverse effect on the Company. Moreover, no assurance can be given that adequate insurance will be available at reasonable rates or that the Company or the operators of wells in which the Company owns an interest will elect to maintain certain types or amounts of insurance.\nEmployees\nThe Company has 13 employees, including five executive officers (all of whom are also directors), four technical employees in addition to the executive officers, two field operations employees, and two administrative employees. (See \"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\")\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES The Company's principal oil and gas properties are located in Nevada.\nIn the oil and gas industry and as used herein, the word \"gross\" well or acre is a well or acre in which a working interest is owned; the number of gross wells is the total number of wells in which a working interest is owned. A \"net\" well or acre is deemed to exist when the sum of fractional ownership working interests in gross wells or acres equals one. The number of net wells or acres is the sum of the fractional working interests owned in gross wells or acres.\nProved Reserves\nThe following table sets forth the estimated oil reserves, net to the Company's interest, of oil and gas properties as of December 31. 1995, giving effect to Barrett' election on January 25, 1995, to continue to participate in the Eagle Springs Field and to receive a 40% working interest in the field effective August 1, 1994. The reserve information is based on the independent appraisal prepared by Malkewicz Hueni Associates, Inc., Golden, Colorado, and was calculated in accordance with the rules and regulations of the Securities and Exchange Commission. (See \"ITEM 1. BUSINESS.\")\nEstimated Future Net Revenues Estimated Discounted Reserve Category Oil (bbls) at 10% (1) - ------------------------- --------------- ----------------\nProved Developed Producing Eagle Springs 1,111,000 $3,918,600 North Willow Creek 17,100 50,200\nProved Developed Nonproducing Eagle Springs 47,400 123,200\nProved Undeveloped Eagle Springs 830,900 2,106,700 Total Proved 2,006,400 $6,198,700 =============== ==============\n(1)Neither prices nor costs have been escalated. (See \"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\") The discounted figures have been reduced by the Company's share of estimated development costs in the amount of $2,754,000.\nWells and Acreage\nShown below is a tabulation of the productive wells owned by the Company in Nevada as of December 31, 1995, which gives effect to Barrett's 40% working interest in the Eagle Springs field.\nProductive Oil Wells - -----------------------\nGross Net - ---------- ----------\n21.0 14.2\nSet forth below is information respecting the developed and undeveloped acreage owned by the Company in Nevada as of December 31, 1995, which gives effect to Barrett's 40% working interest in the Eagle Springs Field.\nDeveloped Acreage Undeveloped Acreage\nGross Net Gross Net\n4,120 2,728 209,480 154,024\nThe Company's leases in Eagle Springs (3,040 gross and 1,648 net acres), Tomera Ranch (680 gross and 680 net acres), and North Willow Creek (400 gross and 400 net acres) are held by production. The Company's undeveloped leases have various primary terms ranging from one to ten years. Management believes that the expiration of any individual or group of related undeveloped leasehold interests would not have a material adverse effect on the Company. Annual rentals on all undeveloped leases aggregate approximately $125,000. In addition to the above acreage, the Company has certain marketing and exploration rights to approximately 434,000 gross acres of P&P mineral interest in northern Nevada until December 1996.\nDrilling Activities\nSet forth below is a tabulation of wells completed in the period indicated in which the Company has participated and the results thereof for each of the periods indicated. Year Ended December 31, ---------------------------------\n1993 1994 1995 --------- ---------- ----------\nGro Net Gro Net Gro Net ss ss ss Exploratory: Dry................ 6 3.5 3 1.05 2.0 0.84 Oil................ -- -- -- -- -- -- Gas................ -- -- -- -- -- -- ---- ----- ----- ----- ---- ------\nTotals......... 6 3.5 3 1.05 2.0 0.84\nDevelopment: Dry................ -- -- -- -- -- -- Oil................ 1 1 3 1.8 5.0 3.0 Gas................ -- -- -- -- -- -- ---- ----- ----- ----- ---- ------\nTotals......... 1 1 3 1.8 5.0 3.0 ==== ===== ===== ===== ==== ======\nProduction and Sale of Oil\nThe following table summarizes certain information relating to the Company's net oil produced and sold from the Company's Nevada properties, after royalties, during the periods indicated.\nYear Ended December 31, ----------------------------\n1993(1) 1994(2) 1995(2)\nAverage net daily production of 16 121 236 oil (Bbls)\nAverage sales price of oil ($ $11.45 $10.80 $11.62 per Bbl)(3)\nAverage production cost ($ per $ 7.95 $ 8.09 $4.06 Bbl)(3)\n(1)Represents production from the Company's North Willow Creek and Tomera Ranch properties only. (2)Represents production from North Willow Creek, Tomera Ranch and Eagle Springs. (3)Includes lifting costs (electricity, fuel, water, disposal, repairs, maintenance, pumper, and similar items), and production taxes. The amount excludes costs related to completion of remediation of a contaminated drilling pit at a former water injection drillsite.\nProduction from Eagle Springs started in January 1994, and currently accounts for about 92% of the Company's oil production. This consists of oil produced and sold net to the Company's interest from the eleven wells the Company acquired, reworked, and returned to production commencing in early January 1994 plus the eight new wells subsequently drilled and placed into production, net of production royalties. However, certain of the wells have been shut-in from time to time, sometimes for several months. Other wells have been shut-in for shorter periods during particular months because of mechanical problems. Currently, one well is temporarily shut-in and not in production. The Company intends to undertake remedial work when its schedule permits, when appropriate rig and equipment are available in the area, and when funds are available.\nThe oil from the Eagle Springs and Pine Valley, Nevada, wells is sold to Crysen Refining, Inc., Salt Lake City, Utah, an unrelated purchaser, under agreements continuing through August 1996, and from month-to-month thereafter, unless terminated by either party, at a price equal to Amoco Oil Company's Wyoming per barrel sour crude oil posted price, adjusted for gravity and oil quality, less transportation of $3.05 or $2.90 per barrel, depending on the producing field, but in no case less than $9.50 per barrel after deduction of all charges. For example, during the month of January 1996, the Company received a net price of $12.36 per barrel, after deducting transportation charges. The sale of oil is subject to price adjustments, production curtailments, and similar provisions common in oil purchase contracts.\nProduction costs relating to Nevada production for 1993 include costs associated with various production testing measures on the Tomera Ranch and North Willow Creek wells and fixed costs allocable to a limited number of wells. The substantial increase in average daily production in 1994 and 1995 is attributable to returning the Eagle Springs wells to production and drilling additional wells during such periods. Production costs in 1994 were inordinately high per barrel of oil being produced due to start up costs associated with the revamped production facility and repairs to equipment that had been shut down without maintenance for over a year. In early 1994, the Company incurred additional costs of operating in winter due to energy costs for heating the oil and operating the wells using propane as its main fuel to generate power for the pumping units. Production costs in 1995 decreased dramatically due to higher production, improved production facilities, and utilization of more cost-efficient energy sources used in operations Overall operating costs are a combination of costs associated with each well and costs associated with operation of the entire field. As additional wells are added to the production system, the field operating costs will be spread among additional wells, lowering the impact of such costs on each well and per barrel produced. In addition, the Company has been changing to more cost effective energy sources for continuing production in a further effort to control costs. This consists principally of a large capacity boiler that the Company intends to eventually fuel by natural gas from the wells, which requires no propane fuel and, because its large capacity heats the oil to higher temperatures, will reduce costs for well treatment chemicals and increases production efficiencies. Because of the foregoing, the Company expects that production costs per barrel will continue to decrease as production increases sufficiently to obtain economics of scale and dilute the impact of fixed operating costs. In addition, operating costs may continue to vary materially due to the costs of ongoing treatment or reworking of existing wells and the impact of the other factors discussed above.\nThe Company has only minor gas production which is used in operations to reduce energy costs.\nTexas Interests\nThe Company's wholly owned subsidiary, Krutex Energy Corporation (\"Krutex\"), previously held an interest in approximately 125 producing shallow oil and gas wells in the West Salt Flat Field encompassing approximately 495 gross acres in Caldwell County, Texas. Pursuant to an April 1993 agreement with an unrelated third party operator (the \"Operator\"), the Operator received all revenues from production from the properties and bore all operating expenses through November 1, 1994. Prior to that date, the Operator had the right to earn 75% of Krutex's interest in the properties upon completing specified reworking of 16 wells located in the field. If the Operator timely completed the well reworking or established continuous production at a rate of at least 300 barrels per day by November 1, 1994, the Operator had the right to purchase Krutex's remaining interest at a price equivalent to Krutex's share of the proved developed oil and gas reserves estimated to be recoverable in 10 years, multiplied by 10 % of the price for west Texas crude oil for November 1994. On signing the agreement, the Operator agreed to pay Krutex $150,000 in monthly installments of $5,555. In October 1994, Krutex entered into a new agreement with the Operator under which it agreed to a cash payment of $50,000 to Krutex in lieu of the well reworking obligation referred to above to earn 75% of Krutex's working interest in the field. In addition, the Operator waived a payment of $12,500 by Krutex respecting the previous acquisition of certain third-party interests affecting the leases, and the Company waived the last two payments on the $150,000 note. Pursuant to the agreement, the Operator purchased Krutex's remaining 25% working interest for $25,000 in January 1995, so Krutex no longer has any interest in such Texas properties. The foregoing Texas properties are not included in the Company's principal oil and gas properties described in the tables above.\nOffices\nThe Company's principal executive offices located at 12596 West Bayaud, Suite 300, Lakewood, Colorado 80228-2019, are rented from an unrelated party under a lease expiring September 1, 1998, and requiring monthly payments of $3,553 plus certain common area charges. The Company also maintains a field operations office at 2561 South 560 West, Suite 200, Woods Cross, Utah 84087.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS The Company is not a party to any material legal proceeding, and none has been threatened by or, to the best of the Company's knowledge, against the Company.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of the shareholders during the fourth quarter of 1995.\nPART II ITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nThe Company's Common Stock is traded in the over-the-counter market and is quoted on Nasdaq under the symbol \"FORL.\" The following table sets forth the high and low closing bid quotations for the Company's Common Stock as quoted by Nasdaq for the periods indicated, based on interdealer bid quotations, without markup, markdown, commissions, or adjustments (which may not reflect actual transactions). Common Stock\nHigh Low\nFirst Quarter........... $3.50 $2.25 Second Quarter.......... $2.68 $2.06 Third Quarter........... $2.625 $2.25 Fourth Quarter.......... $3.188 $1.938\nFirst Quarter........... $2.125 $1.5625 Second Quarter.......... 2.50 1.375 Third Quarter .......... 2.4375 1.75 Fourth Quarter.......... 1.31 2.13\nOn April 11, 1996, the closing bid price of the Company's Common Stock on Nasdaq was approximately $1.25. The Company has approximately 2,000 Common Stock shareholders of record.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA The following selected financial data should be read in conjunction with the Consolidated Financial Statements of the Company and related notes included elsewhere in this Prospectus. The financial data as of December 31, 1995, 1994 and 1993, and for the years then ended have been derived from the Consolidated Financial Statements of the Company, which have been audited by Hein + Associates LLP, independent certified public accountants. The financial data as of December 31, 1992, and 1991, and for both of the years then ended, have been derived from the Consolidated Financial Statements of the Company for such periods, which were audited by another auditor. (See \"ITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION Overview\nSince its organization in June 1985, the Company has been engaged principally in oil exploration in the Great Basin and Range of Nevada, an area that management believes is one of the most promising unexplored onshore domestic areas with potential for the discovery of major oil reserves. In continuing to advance this exploration, the Company's strategy is to generate exploration prospects with the most recent generally available scientific techniques, expand and improve the Company's strategic land position, and establish arrangements with other oil exploration firms active in Nevada to obtain additional scientific data, leases, and funding.\nUntil 1994, the Company had only limited revenue, consisting of modest amounts of interest income earned on net proceeds from the sale of securities and revenue from producing properties, including properties held in Texas from which the Company received no material operating income after April 1993. In September 1994 the Texas properties were sold to an unrelated third party operator. In 1993 and 1994, the Company acquired twelve previously producing wells in Eagle Springs, including three acquired with Barrett, and has since reworked and returned to production eleven of such wells, drilled a new water injection well in the Eagle Springs Field, and has undertaken a multi-well drilling program with Barrett, as discussed below, in order to supplement the Company's other limited production from its Tomera Ranch and North Willow Creek oil discoveries. In August 1994, the Company entered into an agreement with Barrett under which Barrett provided $1,920,000 of $2,400,000 in well costs to earn a 40% interest in the Company's Eagle Springs producing properties and obtained the right to participate in one specified Company exploration project on agreed terms. Pursuant to such agreement, the Company and Barrett acquired an additional Eagle Springs lease on approximately 240 acres with three previously producing wells, which have since been reworked, and a shut-in water injection well and have drilled a total of eight new wells in Eagle Springs, all of which are now in regular continuous production. The Company plans to continue additional drilling in this field to place into production undeveloped reserves and to drill in additional locations to test horizons that are productive in existing wells.\nTo date, the Company has funded its exploration program principally from the sale of its equity securities. The Company also benefits from capital provided by oil industry participants for drilling and other exploration of certain oil prospects through joint arrangements typical in the oil industry.\nPlan of Operation\nEagle Springs Drilling\nThe Company's strategy in acquiring the Eagle Springs property was to increase revenue by returning existing wells to production and to identify additional drilling locations to evaluate the horizons that are productive in existing wells. Management believes that drilling in the Eagle Springs Field involves lower risk as compared to the Company's other exploration drilling in prospect areas with less drilling history and less available exploration data.\nThe Company has completed substantial work at Eagle Springs since its acquisition in July 1993, reworking eleven wells, including the three wells acquired and reworked with Barrett, to return them to production (subject to interruptions from time to time until further well treatment and other surface facilities could be completed), drilling a water injection well, and drilling and placing into production eight additional Eagle Springs wells with Barrett. Such activities include substantially renovating and upgrading surface facilities such as tank batteries, piping, separators, and other equipment so that field production facilities currently have excess capacity available to service new wells. Production from the Eagle Springs Field is sold under the Company's existing sales agreement and trucking arrangement to a refinery in Salt Lake City, Utah.\nOf the new wells drilled on the Eagle Springs Field, the Company and Barrett drilled three new producing wells in the Eagle Springs Field in late 1994 and early 1995. In January 1995, after the first three new Eagle Springs wells were placed into production, Barrett elected to continue to participate in Eagle Springs, thereby earning a 40% working interest in the Company's Eagle Springs project, subject to the right to make individual elections respecting participating in future wells proposed by the Company. In mid-1995, the Company and Barrett commenced a multi-well drilling program on the proved nonproducing and proved undeveloped acreage in the field, to test at additional locations horizons that are productive in existing wells, and to increase proved reserves. The Company and Barrett are proceeding to prioritize the proved undeveloped locations as identified in the reserve report and anticipate those eight locations as additional wells to be drilled during 1996 and 1997. Barrett or Foreland may elect, on a well-by-well basis, to participate in the wells planned for 1996 and 1997 but has no obligation to participate in any well.\nBased on its current drilling experience, the Company estimates that the Eagle Springs drilling will cost approximately $325,000 per gross well for a dry hole or $560,000 for a completed gross well, including related geophysical and geological evaluations, for estimated costs attributable to the Company's 60% share of the Eagle Springs drilling of from approximately $195,000 to $336,000 per well for a dry hole and a producing well, respectively. Therefore, the Company's share of the cost of the eight wells planned for 1996 and 1997 is estimated at approximately from $1,560,000, if all wells were dry holes, to $2,688,000 if all wells were completed for production.\nGeneral, Administrative, and Property Maintenance\nThe Company requires cash for general and administrative expenses, for maintaining its properties, and for other items that are required in order for the Company to continue, as distinguished from costs to advance its ongoing exploration program in Nevada. Based on estimates of the production rates and operating conditions during the first quarter of 1996, management believes that the Company currently requires cash from external sources of approximately $70,000 to $90,000 per quarter for ongoing fixed and recurring operating costs (which include general and administrative expenses, exploration consisting of an allocation of employee salaries and other overhead to the exploration function, and interest on outstanding debt), and approximately $32,000 to meet annual lease rental and other cost on its properties, which exceeds the Company's net revenue from oil production. Based on current production, after giving effect to reworking several existing Eagles Springs wells, to be accomplished during the second quarter of 1996, the Company estimates its second quarter oil revenue to be approximately $430,000, based on current oil prices, with average daily production net to the Company's interest of approximately 375 barrels of oil, giving effect to the fact that at any time some wells many not be in production. Related production costs are estimated at approximately $120,000, yielding estimated net production revenue of approximately $310,000 for the second quarter of 1996. (See \"ITEM 2. PROPERTIES: Production and Sale of Oil.) Therefore, the Company estimates that it will be able to meet fixed and recurring operating costs for the second quarter of 1996 and thereafter. However, there can be no assurance that the reworking of the Eagle Springs wells will result in increased production, that production levels will not decline, or that current prices for oil will not decline. Any improved operating margins resulting from increased production and reduced operating expenses as weather improves or price increases would benefit the Company. There can be no assurance that Eagle Springs development will result in material additional production or that the Company will be able to obtain funds from other sources, in which case the Company would be required to implement cost-cutting measures and curtail drilling and most other exploration activity in order to continue.\nExploration Program\nThe Company requires substantial amounts of capital to advance its oil exploration program, relying on funding provided through joint exploration arrangements with other firms and utilizing its own capital provided principally through the sale of securities and existing and anticipated revenues from the development of Eagle Springs. During 1995, the Company drilled the fourth and fifth exploratory tests under its agreement with Enserch\/Berry, both plugged and abandoned, incurring approximately $225,800 in drilling costs for the Hot Creek Wash test in Antelope Valley and approximately $153,200 in drilling costs for the Eldorado Federal # 15-1 exploratory well drilled in Little Smoky Valley.\nThe Company anticipates that it will continue its exploration program with up to six additional exploration tests during 1996, depending on the availability of required funds. The test in the Pinon Prospect in Pine Valley, with estimated total dry hole costs of $300,000, is planned for 1996, subject to available funding. The Company would be required to bear 50% of such costs. This would be the sixth well of the six well exploration program with Enserch\/Berry. The Company and Barrett may also drill one test at North Humboldt at an estimated dry hole cost of approximately $400,000 for a net cost to the Company of $133,000 under their joint exploration agreement. The Company has reentered an existing hole drilled by another operator in the Deadman Creek area of Toano Draw on lands covered by an exploration agreement with P&P. The hole was originally drilled in the mid 1980s and encountered favorable oil shows but was not completed for production. The Company is evaluating the hole to determine if it could be economically completed using modern completion techniques. If joint exploration arrangements can be reached with other industry participants and the Company's share of required funds is available, the Company may also attempt to drill a Dixie Flats test in Huntington Valley at an estimated dry hole cost of $400,000. In addition, the Company will be drilling the Pine Creek prospect in Pine Valley at a net estimated cost to the Company of $332,000 and the Ghost Ranch prospect in Railroad Valley at a net estimated cost to the Company of $261,000.\nThe Company also plans to continue its geophysical and geological data gathering and evaluation, property acquisition, and prospect evaluation, depending on the availability of funds, This includes continuing to process seismic data available to the Company, completing 3-D seismic studies of specific drilling prospects, and integrating seismic, gravity, and drilling data. In addition the Company may undertake joint geophysical data acquisition with others under arrangements in which each participant bears a share of the cost for specific surveys. The Company will continue its lease acquisition efforts in specific prospect areas and, as it generates drilling proposals, seek funding for drilling. Typically, new prospects that are generated are not drilled for several months or until the next drilling season or later.\nThe Company initiated its 1995 exploration program with the net proceeds of $1,376,718 received from the private placement of units consisting of preferred stock and common stock purchase warrants completed in September 1995 (and $329,250 received from the exercise of C Warrants in October 1995). In order to pay other liabilities incurred in connection with drilling, during February and March 1996, the Company sold 500 shares of preferred stock for net proceeds of $472,500. The Company is currently seeking and is dependent on the receipt of funds from the sale of debt or equity financing to fund its portion of the cost of the Eagle Springs drilling program and further exploration drilling, but there can be no assurance that the Company will be successful in obtaining such additional financing.\nIn seeking financing for proposed data gathering, land acquisition, or drilling or other exploration of specific prospect areas, the Company typically investigates both oil industry funding sources and the availability of capital through the sale of securities. In considering participation from industry sources, the Company assesses whether the potential industry participant can provide scientific data and lease or other exploration rights in the prospect area as well as required funding as compared to the dilution that may result to the interest of the Company by sharing in any reserves that may be discovered. In analyzing the availability of capital from the sale of securities, the Company considers conditions in the capital markets generally, the anticipated marketability of Company securities, and the dilution that may result to existing shareholders. In selecting between available financing alternatives, management seeks the source that management believes will result in lesser dilution and greater economic return to its shareholders.\nLiquidity and Capital Resources\nPrevious Periods\nHistorically the Company has obtained cash required for its other requirements from the sale of its equity securities. The Company's operations provided cash of $190,600 in 1995 when the Company reported a net loss of $2,275,600, which included $725,600 in expenses due to abandonments and impairments, and $852,600 for depreciation, depletion, and amortization. As of December 31, 1995, the Company's accumulated deficit was $19,212,300. Operations used $2,501,600 of cash in 1994, which included $1,847,200 in expenses due to abandonments and impairments, $434,500 for the loss on the sale of the Company's Texas oil and gas properties, and $329,500 for depreciation, depletion, and amortization. During 1995 investing activities used net cash of $1,814,300, principally due to $1,883,500 in additions to oil and gas properties. In 1994 investing activities used net cash of $1,182,500, principally due to additions to oil and gas properties resulting from the acquisition of additional lease rights from Kanowa in the Eagle Springs Field and additional Eagle Springs drilling, including the completion of a water injection well.\nAs noted above, cash required for both operating and investing activities was provided from financing activities during each of the past two fiscal years. In 1995, financing activities provided $1,560,400, provided by $1,561,400 from the issuance of equity securities. In 1994, financing activities provided $2,819,400, consisting primarily of a net of $2,537,600 from the issuance of equity securities and $400,000 in proceeds from new borrowing.\nIn addition to the above, the Company's oil and gas exploration and production activities were also advanced by approximately $2,233,000 and $2,345,000 provided during 1994 and 1995, respectively, by others under industry sharing arrangements related to specific drilling or other exploration.\nCurrent Position\/Future Requirements\nThe Company is dependent on the receipt of additional funds to repay certain drilling expenditures incurred during the fourth quarter of 1995 and to date during 1996 as well as to meet ongoing general and administrative expenses and other operating costs.\nThe Company requires cash for certain fixed and recurring operating costs in order for the Company to continue, as distinguished from drilling and related costs to advance its ongoing exploration program in Nevada that are either expensed as dry hole and abandonment costs in the case of an unsuccessful test or added to oil and gas properties if a producing well results. For example, during the fourth fiscal quarter ended December 31, 1995, the Company required cash for production operations ($105,800), exploration, consisting of an allocation of employee salaries and other overhead to the exploration function ($133,500), general and administrative ($139,100), and interest on outstanding debt requiring cash payment ($12,000), for an aggregate of approximately $390,400. (Most interest revenue and most interest expense relate to indebtedness to and from former and present officers and directors that do not require current cash expenditures.) During the fourth quarter, the Company received revenue of $298,400 from oil sales at an average of approximately 285 barrels per day, resulting in a cash shortfall for the quarter of $92,000.\nAverage daily net fourth quarter production increased to approximately 285 barrels per day, which is lower than anticipated. Due to delays in the Eagle Springs drilling and completion program, only three new Eagle Springs wells were placed in production during the fourth quarter. Such wells were not placed into production until the latter part of the fourth quarter. One additional well was placed in production in January 1996. Management believes that the Company's cash requirements, excluding drilling and related costs to advance the Company's ongoing development and exploration program in Nevada, will be met when certain Eagle Springs wells are recompleted in the second quarter of 1996, but there can be no assurance that production will increase in sufficient quantities or that oil prices will not fluctuate significantly.\nTo the extent that net production to the Company does not increase to a level sufficient to cover shortages of cash required for operations, the Company will be dependent on the sale of additional debt or equity securities, the exercise of outstanding options or warrants, or financing from other sources. There can be no assurance that Eagle Springs development will sustain sufficient additional production for the Company to be able to meet its requirements for recurring operating expenses or that the Company will be able to obtain funds from other sources, in which case the Company would be required to implement cost-cutting measures and curtail drilling and most other exploration activity in order to continue.\nBetween March and September 1995, the Company sold 507,667 units consisting of preferred stock and common stock purchase warrants at $3.00 for net proceeds of $1,376,719. During September 1995, the Company amended the exercise price of the C Warrants from $3.00 per share to $1.50 per share, and extended the expiration date from September 30, 1995 to October 10, 1995. The Company received, in October 1995, $329,250 in cash and notes receivable for the exercise of 219,500 C Warrants. In order to pay other liabilities incurred in connection with drilling, during February and March 1996, the Company sold 500 shares of preferred stock for net proceeds of $472,500 and is investigating the possibility of selling additional equity securities. The Company is current seeking and is dependent on the receipt of funds from the sale of debt or equity financing to fund its portion of the cost of the Eagle Springs drilling program and further exploration drilling, but there can be no assurance that the Company will be successful in obtaining such additional financing. There can be no assurance that the Company will be successful with any of its current financing activities\nOn April 30, 1994, the Company borrowed $400,000 from an unrelated third party, collateralized by oil and gas production and other personal property of the Company, to provide interim financing to advance the Company's drilling program in its Eagle Springs Field and to pay ongoing general and administrative expenses. The loan bears interest at 8.4% per annum, payable quarterly, and was originally due on April 30, 1995. In connection with this loan, the Company granted the lender options to purchase 200,000 shares of Common Stock at $2.00 per share at any time prior to the earlier of April 30, 1996, or 60 days subsequent to the repayment of the loan. In May 1995, the Company negotiated the extension of the due date of this loan to April 30, 1996. In connection with extending the loan payment date to April 30, 1996, the Company reduced the exercise price of the options previously granted to $1.50 and granted a new option to purchase 200,000 shares at $2.00 through the earlier of April 30, 1997, or 60 days subsequent to the repayment of the loan. The Company is currently investigating financing alternatives to repay the loan\nThe auditors' report on the financial statements of the Company as of December 31, 1995, contains a modification regarding the ability of the Company to continue as a going concern because of its limited working capital and revenue and continuing losses from operations. As of December 31, 1995, the Company had negative working capital of approximately $2,004,400 and had ongoing cash requirements for fixed and recurring operating expenses requiring cash expenditures, but excluding drilling and related expenditures, of approximately $92,000 greater than production revenue for the fourth quarter of 1995.\nThe Company will continue to seek cash proceeds from the exercise of outstanding options and warrants and from the sale of additional common stock, preferred stock, warrants, debt or other securities. In addition, the Company is exploring other sources of financing for ongoing costs as well as expanded activities and the possible purchase of additional production to increase the Company's production to increase the Company's financial security and stability as it continues its exploration. The purchase of producing properties would require substantial amounts of additional debt and equity financing. There can be no assurance that the Company can negotiate the acquisition of any properties or obtain any financing that may be required for such purchase. As in the past, the Company will rely largely on the sale of additional securities to meet its capital requirements.\nResults of Operations\n1994 and 1995\nFor the year ended December 31, 1995, oil sales increased $540,400 to $1,071,400 when compared to the fiscal year ended December 31, 1994, with sales from the Eagle Springs Field increasing $519,700 to $937,900 during such period. The revenues from the Company's other interests increased $20,700. Operating overhead revenue and well service revenue aggregately increased a net of $16,800 when compared to 1994, consisting of an increase of $33,000 in operating overhead revenue in 1995 due to the increased number of Eagle Springs wells drilled and placed into production during 1995 and a decrease of $16,100 in well service income during 1995 as compared to 1994 as a result of reduced fees earned for water disposal services. The increase of other income of $18,400 in 1995 as compared to 1994 was primarily a result of increases in value of new and used well equipment inventories used in the Company's drilling program. Interest income increased $63,000 in 1995 to $140,700, $76,600 of such increase attributable to interest earned on stock subscriptions receivable, while interest earned from excess cash investments decreased $14,900 in 1995 when compared to 1994.\nThe Company's oil and gas production expenses for 1995 decreased $33,300 to $424,400 when compared to 1994, attributable principally to reduction in operating expenses of the Eagle Springs Field of $34,700 in 1995 when compared to such expenses in 1994. These reductions were a result of increased efficiency and excess field operations capacity. During 1995, oil and gas exploration costs decreased $287,500. Components of oil and gas exploration costs in 1994 were Eagle Springs 3-D seismic program expenses of $207,500 and gravity and other surveys costing $16,000 for Dixie Flats, $16,300 for the North Humboldt prospect, and $57,600 for Toano Draw. The Company did not incur any similar expenses during 1995. Dry hole, abandonment, and impairment costs aggregately decreased $1,132,200 when compared to such expenses during 1994. Individually, dry hole expense decreased $70,500 when compared to 1994. Dry hole costs for 1995 were primarily from the Eldorado Federal #15-1 of $153,200, the Hot Creek Wash #15-1 of $225,800, and costs for the Trout Creek #26-1 well of $17,300. Impairment and abandonment of leases decreased $1,211,700 when compared to 1994. Major cost components during 1995 were abandonment of expired undeveloped leasehold costs of $23,000, impairment of undeveloped leases of $250,000 and impairment of well equipment inventory of $47,500, while the North Willow Creek nos. 1-27 and 5-27 and the Tomera Ranch wells were impaired in 1994 at $1,382,200. General and administrative expenses decreased $227,300 in 1995 to $775,300. Much of the reduction in general and administrative expenses were principally due to one time charges in 1994 that were not repeated in 1995 of $114,500 for relocation cost; and $129,200 as a reduction in securities offering costs that were required to be expensed because of delays in consummating the Company's financing, although in 1995 the Company did incur an increase of $70,000 in expenses related to financial public relations, information dissemination within the investment community (which management expects to decline) and a decrease in certain salaries and benefits of $27,900 when compared to 1994. Depreciation, depletion and amortization expenses increased $533,100 when compared to 1994. Such expenses attributable to the Eagle Springs Field increased $426,900, primarily due to new wells being brought into production with high initial production rates, while such expenses attributable to the Company's remaining properties increased $106,200 in 1995 when compared to 1994. Interest expense increased $39,600 in 1995 to $125,300, primarily due to a full year of interest and amortization of loan fees associated with the Company's $400,000 note payable, as opposed to nine months of interest and amortization of the same loan fees during 1994.\n1993 and 1994\nFor the year ended December 31, 1994, oil sales increased $401,200 to $477,000 as compared to 1993, with the Eagle Springs Field contributing approximately $418,200 of 1994 revenues as production from the Company's other fields declined. Well service revenue decreased $4,000 due primarily to reduced water disposal fees. Other income was approximately $35,600 higher in 1994 as compared to 1993 as a result of increased drilling and lease overhead fees charged to participants in Company drilling programs and lease operations.\nThe Company's oil and gas production expenses for 1994 increased $387,800 to $457,800 when compared to 1993, attributable principally to $346,500 in operating costs at Eagle Springs, which was placed into production in early 1994 and included one-time repair, maintenance and clean-up costs of $110,600. During 1994, oil and gas exploration costs increased $46,200, reflecting the Company's continuing active exploration program. Major components of 1994 exploration costs were an Eagle Spring 3-D seismic program expense of $207,500 and gravity and other seismic surveys of $16,000 for Dixie Flats, $16,300 for North Humboldt, and $57,600 for Toano Draw areas in Nevada contributed to the increase in exploration costs for 1994. Dry hole and abandonment cost increased by $468,200 due to the Company's exploration activities as well as specific abandonment expenses relating to wells initially drilled in previous years. Dry hole, abandonment, and impairment costs included charges to expense of $75,600 for the Indian Springs no. 22-A test that was plugged and abandoned, $31,800 for the Cedar Creek no. 2-1 dry hole, $87,900 for the Willow Springs no. 34-31 dry hole, and $268,800 for the Trout Creek no. 26-1 dry hole. Impairment expense increased due to the charge to expense of $703,900 for the North Willow Creek no. 1-27 test drilled in August 1993 that management concluded could not be placed into production. Additionally, during the fourth quarter of 1994 when it was determined that no reserves could be attributed to the North Willow Creek no. 1-27 or the Tomera Ranch wells, their undepleted capitalized costs of $564,400 and $103,900, respectively, were charged to impairment expense. General and administrative expenses for 1994 increased approximately $337,900 as compared to 1993. The major contributors to this increase were $222,600 associated with expenses written off for a canceled securities offering and the $84,200 cost on the guarantee of the selling price of N. Thomas Steele's residence. The Company recognized a $434,500 loss during 1994 related to the disposal of its remaining interest in certain Texas producing properties. In 1993, the Company reported a noncash compensation expense of $320,000 related to the grant of below market options. The Eagle Springs Field added approximately $154,000 of depletion expense in 1994, while depletion attributable to the North Willow Creek and the Tomera Ranch wells decreased $41,500 and $188,600, respectively, as compared to 1993. Interest expense declined $27,900, primarily due to the conversion of promissory notes to stock in September 1993 as compared to interest expense on the long term debt incurred in 1994.\nAccounting Treatment of Certain Capitalized Costs\nIncluded in oil and gas properties on the Company's balance sheets are costs of wells in progress. Such costs are capitalized until a decision is made to plug and abandon or, if the well is still being evaluated, until one year after reaching total depth, at which time such costs are charged to expense, even though the well may subsequently be placed into production. The Company also charges to expense the amount by which the total capitalized cost of proved oil and gas properties exceeds the total undiscounted net present value of related reserves. As a result of the foregoing policies, the Company expects that from time to time capitalized costs will be charged to expense based on management's evaluation of specific wells or properties or the disposition, through sales or conveyances of fractional interests in connection with industry sharing arrangements, of property interests for consideration in amounts that have the effect of reducing the Company's total undiscounted net present value of oil and gas reserves below the total capitalized cost of proved oil and gas properties. As part of the Company's evaluation of its oil and gas reserves in connection with the preparation of the Company's annual financial statements, the Company completes an engineering evaluation of its properties based on current engineering information, oil and gas prices, and production costs, which may result in material changes in the total undiscounted net present value of the Company's oil and gas reserves. The Company would be required to charge to expense the amount by which the total capitalized cost of proved oil and gas properties exceeds the amount of such undiscounted net present value of the Company's oil and gas reserves. (See \"ITEM 1. BUSINESS: Oil Properties.\")\nOperating Costs\nOperating costs relating to Nevada production from time to time include costs associated with various production testing measures on the Tomera Ranch and North Willow Creek wells and fixed costs allocable to a number of wells, including the Eagle Springs wells that were returned to production during 1994 and the new producing wells jointly drilled with Barrett. Production costs relating to the Eagle Springs Field have historically been higher than the normal industry standard per barrel of oil presently being produced due to start-up costs associated with the upgrading and expanding the production facility to facilitate additional production, and repairs to equipment that had been shut down without maintenance for over a year. During the first three months of 1995, the Company incurred additional costs of operating in winter due to energy costs for heating the oil, and operating the wells using propane as its main fuel to operate the pumping units. In early 1995, the Company completed field upgrades including a boiler system to heat the oil, a trace water disposal system to return produced water to the field water injection well as opposed to trucking the water to the disposal well.\nOverall operating costs are a combination of costs associated with each well and costs associated with operation of the entire field. As additional wells are added to the production system, the field operating costs will be spread among additional wells, lowering the impact of such costs on each well and per barrel produced. Because of the foregoing, the Company expects that production costs per barrel will continue to be high unless and until the amount of production increases sufficiently to obtain economies of scale and dilute the impact of high fixed operating costs. In addition, operating costs may continue to vary materially due to the costs of ongoing treatment or reworking of existing wells and other factors. Inflation\nThe Company's activities have not been, and in the near-term are not expected to be, materially affected by inflation or changing prices in general. The Company's oil exploration and production activities are generally affected by prevailing sales prices for oil, however, and material price declines may make wells with low rates of production uneconomical to operate. Because of the size of potential discoveries in Nevada, the Company does not expect that short term declines in oil prices would materially affect its exploration activities.\nAccounting Policy Changes\nThe Company's accounting policy is to compute depreciation and depletion expense for its proved oil and gas properties on a well-by-well basis, and to assess impairment on a Company-wide basis by comparing aggregate net capitalized costs related to proved properties to the aggregate undiscounted future cash flows related to such properties. At December 31, 1995, the Company recorded impairment to leases of undeveloped drilling properties of $250,000 and to well equipment inventory of $47,450. No impairment was necessary for net aggregate capitalized costs of proved properties.\nIn March 1995, the Financial Accounting Standards Board issued a new Statement titled \"Accounting for Impairment of Long-Lived Assets.\" This new standard is effective for years beginning after December 15, 1995, and would change the Company's method of determining impairment of proved oil and gas properties. Although the Company has not performed a detailed analysis of the impact of the new standard on the Company's financial statements, management estimates the application of the new standard would have increased the provision for impairment of oil and gas properties by approximately $450,000, as of December 31, 1995. The Company will adopt the new standard in the first quarter of fiscal 1996.\nIn October 1995, the Financial Accounting Standards Board issued a new statement titled \"Accounting for Stock-Based Compensation\" (SFAS 123). The new statement is effective for fiscal years beginning after December 15, 1995. SFAS 123 encourages, but does not require, companies to recognize compensation expense for grants of stock, stock options, and other equity instruments to employees based on fair value. Companies that do not adopt the fair value accounting rules must disclose the impact of adopting the new method in the notes to the financial statements. Transactions in equity instruments with non- employees for goods or services must be accounted for on the fair value method. For transactions with employees, the Company currently does not intend to adopt the fair value accounting under SFAS 123, and will be subject only to the related disclosure requirements.\nThe Company does not anticipate that any other currently adopted changes in accounting policies will have a material positive or negative effect on the Company.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The table of contents of the financial statements and supplementary data included in this report is contained in \"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.\"\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE The Company and its auditors have not disagreed on any items of accounting treatment or financial disclosure.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT Executive Officers and Directors\nThe following table sets forth the name, age, and position of each director and executive officer of the Company. Name Age Position - ----------------------- ------ --------------------------------\nDr. Grant Steele 71 Chairman and Director N. Thomas Steele 51 President and Director Kenneth L. Ransom 38 Vice-President, Exploration and Director Bruce C. Decker 44 Vice-President and Director Dennis J. Gustafson 48 Vice-President, Land and Director\nAll directors and executive officers of the Company serve for one year and until their respective successors are elected and qualified. Dr. Grant Steele is the uncle of N. Thomas Steele. There is no family relationship among any of the other officers and directors of the Company. Each of the officers is a full-time employee of the Company. The Company has entered into employment agreements with N. Thomas Steele, Kenneth L. Ransom, Bruce C. Decker, and Dennis J. Gustafson. See \"Employment Agreements\" below.\nDr. Grant Steele. Dr. Steele, the Company's co-founder and chairman, has been an executive officer and chairman of the Company since its organization in 1985. Prior to forming the Company, he was employed by Gulf Oil Corporation from 1953 to 1983. From 1973 to 1980, Dr. Steele was Chief Geologist\/U.S. for Gulf Oil. His knowledge of Nevada dates back to his Ph.D. work on the Pennsylvanian and Permian Systems of the eastern Great Basin. While with Gulf, he completed several studies, each spanning a number of years, in eastern Nevada. Dr. Steele graduated from the University of Utah, Salt Lake City, Utah, in 1949 with a bachelor of science degree and earned his doctorate in geology from the University of Washington in 1959. He is a certified professional geologist and an active member of the American Association of Petroleum Geologists, which awarded him a distinguished service award in 1984, the Houston Geological Society, and the Society of Economic Paleontologists and Mineralogists.\nN. Thomas Steele. Mr. Steele, co-founder and president, has been an officer and director of the Company since its organization in 1985. He was elected president in May 1993. Prior to joining the Company in 1985, he was the president of Magnum Resources, Inc., Ogden, Utah, which was engaged in mineral exploration in Nevada and Utah.\nKenneth L. Ransom. Mr. Ransom, has been vice-president of exploration and a director since the Company's founding in 1985. Mr. Ransom was senior geologist under Dr. Steele at Gulf Oil from 1981 to 1985, involved principally in its Nevada area study. He earned a bachelor of science degree in geological engineering from the Colorado School of Mines in 1979 and a master's degree in geological sciences from Brown University in 1981. Mr. Ransom is a member of the American Association of Petroleum Geologists and the Geological Society of America and has published numerous papers on Nevada exploration and geology.\n. Bruce Decker. Mr. Decker, has been an officer and director of the Company since 1991. Mr. Decker was an officer of Krutex Energy Corporation from 1983 through its acquisition by the Company in 1989. Mr. Decker received his bachelor's degree in finance and management from the University of Utah in 1973.\nDennis J. Gustafson. Mr. Gustafson received his bachelor's degree from Iowa State University in 1973, and has been active since then in the oil and gas industry. In 1973 he joined Mobil's Central Region Marketing and Refining Division and held various positions in their Marketing Department prior to joining Mobil's Exploration and Production Division in Denver as a landman in 1981, where he managed fee mineral interests, various acquisitions, and farmouts and farmins. As Mobil's land advisor for the Denver division, he directed Mobil's land activities in Nevada and negotiated Mobil's major Nevada development contract with the BLM, renegotiated the Mobil\/Chevron Nevada joint venture agreement, and managed the leasing of over 500,000 acres in Nevada. Mr. Gustafson left Mobil and joined the Company in 1993 as a director and executive officer.\nSignificant Employees\nJerry Hansen. Mr. Hansen, who joined the Company in 1986, is senior structural geologist for the Company with primary responsibility for generating and developing exploration proposals and drilling prospects for the Company. He has 12 years of oil and gas experience directed toward prospect generation and evaluation in the Powder River Basin, Gulf Coast, and primarily, in Nevada. He graduated with degrees in geology from the University of Colorado in 1973 and the University of Arizona in 1982. As senior structural geologist for the Company, Mr. Hansen's primary responsibility is in the generation and development of drillable prospects from inception to actual wellsite operations.\nCarl Schaftenaar. Mr. Schaftenaar, who joined the Company in 1993, has been a geophysicist and geologist in the oil industry for 12 years. He holds a bachelor's degree in geology from Hope College, Holland, Michigan, and a master of science degree in geophysics from Texas A&M University. Mr. Schaftenaar worked for Chevron USA on exploration and development projects in Nevada and the Rocky Mountain area from 1982 to 1992. As senior geophysicist, Mr. Schaftenaar is responsible for the acquisition and analysis of proprietary two- and three-dimension seismic programs of the Company.\nCompliance with Section 16(a) of the Exchange Act\nBased solely upon a review of forms 3, 4, and 5 and amendments thereto, furnished to the Company during or respecting its last fiscal year, no director, officer, beneficial owner of more than 10% of any class of equity securities of the Company or any other person known to be subject to Section 16 of the Exchange Act failed to file on a timely basis reports required by Section 16(a) of the Exchange Act for the last fiscal year, except that N. Thomas Steele and Grant Steele each failed to timely report a gift of shares of Common Stock during December 1995, and all directors failed to timely report the delivery of shares of stock held by them to the Company as payment for the September 1995 installment of their notes as discussed in \"Item 13. Certain Relationships and Related Transactions.\"\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nSummary Compensation\nThe following table sets forth the annual and long term compensation earned by, awarded to, or paid to the chief executive officer of the Company during the last fiscal year. None of the Company's other executive officers as of the end of the last fiscal year received total annual salary and bonuses in excess of $100,000 for all services rendered in all capacities to the Company and its subsidiaries. The Company provides to all of its full time employees, including executive officers and directors, health insurance and miscellaneous other benefits.\n(1)During 1994, the Company incurred a loss of $84,200 on its guarantee of a minimum sales price of $375,000 on Mr. Steele's former residence in connection with his move to Denver, Colorado, to become president and chief executive officer of the Company. (See \"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS: Relocation Agreement.\") (2)Consists of options to purchase 72,000 shares at $1.50 through May 1998 and stock appreciation rights with respect to appreciation on 45,000 shares of the Company's Common Stock above $4.56, the trading price of the Company's Common Stock on the date of grant on May 19, 1993. Such stock appreciation rights vest as to 15,000 shares on May 19, 1993, as to an additional 15,000 shares on May 19, 1994, and as to the remaining 15,000 shares on May 19, 1995. The terms of these stock appreciation rights were not determined in arm's length negotiations.\nOption\/SAR Grants in Last Fiscal Year\nThe chief executive officer was not granted any options or stock appreciation rights during the fiscal year ended December 31, 1995.\nAggregate Option\/SAR Exercises in Last Fiscal Year and Year End Option\/SAR Values\nThe following table sets forth information respecting the exercise of options and SARs during the fiscal year ended December 31, 1995, by the named executive officer of the Company and the fiscal year end values of unexercised options and SARs.\n(1)Includes stock appreciation rights with respect to appreciation on 45,000 shares of the Company's Common Stock above $4.56, the trading price of the Company's Common Stock on the date of grant on May 19, 1993. Such stock appreciation rights vested as to 15,000 shares on May 19, 1993, as to an additional 15,000 shares on May 19, 1994, and as to the remaining 15,000 shares on May 19, 1995. The terms of these stock appreciation rights were not determined in arm's length negotiations. (2)Based on the closing bid price for the Company's common stock of $1.5625 on December 31, 1995.\nDirector Compensation\nAs all of the Company's directors are also employees, the Company has not compensated and does not intend to compensate such individuals for their service as directors of the Company.\nEmployment Agreements\nThe Company entered into employment agreements dated May 19, 1993, with N. Thomas Steele, Kenneth L. Ransom, Bruce C. Decker, and Dennis J. Gustafson at annual salaries of $125,000, $119,000, $119,000, and $72,000 respectively, subject to reduction to $85,000, $77,760, $75,600, and $60,000 respectively, until the Company obtains net oil production levels of 500 barrels per day. Each such employment agreement is for a three-year term and is automatically extended on each anniversary date of the agreement for an additional three-year term. The employment agreements contain covenants not to compete for two years after termination of employment, restrictions on the disclosure of confidential information, provisions for reimbursement of expenses and payment of major medical insurance coverage, and an agreement of the Company to register securities of the Company held by such persons at the request of the employees. In addition, under the employment agreements, the Company agreed to award to each such officer stock appreciation rights to 45,000 shares of Common Stock, vesting 15,000 shares at the date of grant and 15,000 on each of the next two succeeding anniversary dates.\nLimitation of Liability and Indemnification\nThe articles of incorporation of the Company limit or eliminate the personal liability of directors for damages for breaches of their fiduciary duty, unless the director has engaged in intentional misconduct, fraud, or a knowing violation of law, or paid a dividend in violation of the Nevada Revised Statutes.\nThe Company's articles of incorporation and bylaws further provide for the indemnification of officers and directors for certain civil liabilities, including liabilities arising under the Securities Act. In the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth, as of April 15, 1996, the outstanding Common Stock of the Company owned of record or beneficially by each person who owned of record, or was known by the Company to own beneficially, more than 5% of the Company's 14,489,401 shares of Common Stock issued and outstanding, and the name and share holdings of each director and all of the executive officers and directors as a group:\n(1)Except as otherwise noted, shares are owned beneficially and of record, and such record shareholder has sole voting, investment, and dispositive power. The address of all such persons for purposes of this table is deemed to be the address of the Company. (2)Calculations of total percentages of shares outstanding for each individual assumes the exercise of options held by that individual to which the percentage relates. Percentages calculated for totals of all executive officers and directors as a group assume the exercise of all options held by the indicated group. (3)Represents 100,000 shares owned by Dr. Steele's wife's estate and 80,000 shares held by his Individual Retirement Account, over which Dr. Steele exercises sole investment, voting, and dispositive power. (4)Consists of options to acquire 100,000 shares of Common Stock at an exercise price of $1.50 per share at any time prior to December 1, 1996, and options to acquire 200,000 shares at an exercise price of $2.125 per share at any time prior to September 16, 1999. The options to acquire 100,000 shares at $1.50 per share contain a provision that, on exercise, the holder is granted a new option covering the number of shares for which the prior option was exercised, with the exercise price of the new option fixed at the then fair market value of the Common Stock. (5)Includes 7,000 shares of Common Stock and 6,250 shares of Common Stock issuable on conversion of outstanding preferred stock, such shares of common and preferred stock held by Mr. Steele's wife. (6)Consists of options to acquire 116,667 shares of Common Stock at an exercise price of $1.50 per share and 33,333 shares at an exercise price of $1.31 per share at any time prior to December 1, 1996, options to acquire 72,000 shares at $1.50 per share at any time prior to May 19, 1998, and options to acquire 200,000 shares at an exercise price of $2.125 per share at any time prior to September 16, 1999. The options to acquire 116,667 shares contain a provision that, on exercise, the holder is granted a new option covering the number of shares for which the prior option was exercised, with the exercise price of the new option fixed at the then fair market value of the Common Stock. (7)Consists of options to acquire 65,333 shares of Common Stock at an exercise price of $1.50 per share at any time prior to December 1, 1996, options to acquire 34,667 shares at $1.31 per share at any time prior to December 1, 1996, and options to acquire 200,000 shares at $2.125 per share at any time prior to September 16, 1999. The options to acquire 65,333 shares contain a provision that, on exercise, the holder is granted a new option covering the number of shares for which the prior option was exercised, with the exercise price of the new option fixed at the then fair market value of the Common Stock. (8)Consists of options to acquire 25,000 shares of Common Stock at $1.81 per share and options to acquire 25,000 shares at $3.38 per share, both expiring July 15, 1996, and options to acquire 25,000 shares at $2.125 per share expiring September 16, 1999. The options to acquire 25,000 shares at $3.38 per share contain a provision that, on exercise, the holder is granted a new option covering the number of shares for which the prior option was exercised, with the exercise price of the new option fixed at the then fair market value of the Common Stock. (9)Consists of shares owned by the individual retirement account of Mr. Gustafson, over which he exercises sole investment, voting and dispositive power. (10)Consists of options to acquire 25,000 shares of Common Stock at an exercise price of $2.125 per share at any time prior to September 16, 1999.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Salary Deferrals and Waivers\nBecause of shortages of cash and working capital suffered by the Company during recent periods, certain officers and directors of the Company agreed to defer or waive all or portions of their previous salaries. As of December 31, 1995, the Company owed $392,462 in deferred salaries (including $10,527 due N. Thomas Steele), which the officers and directors have agreed not to seek to collect until at least after January 1, 1996 unless such payment would not jeopardize the ability of the Company to continue, or the net amount received by such officers and directors is used to retire existing debt owed to the Company or to purchase stock from the Company on exercise of options so that the Company will have such amounts available for its ongoing cash requirements. The officers and directors to whom the deferred salaries are owed have advised the Company that they will not seek payment of such amounts if such payment would jeopardize the ability of the Company to continue or unless the net amount received, after paying applicable withholding taxes, was used to pay notes for stock purchased on the previous exercise of stock options or for the exercise of additional options now outstanding.\nOfficer, Director, and Employee Options\nOn September 16, 1994, outstanding options were exercised to purchase an aggregate of 650,000 shares of Common Stock as follows: Grant Steele, 200,000 shares at $1.50; N. Thomas Steele, 200,000 shares at $1.50; Kenneth L. Ransom, 200,000 shares at $1.50; Bruce C. Decker, 25,000 shares at $2.25; and Dennis J. Gustafson, 25,000 shares at $2.25. Pursuant to the terms of the options exercised, each optionee paid the purchase price of the options by the delivery of a promissory note payable in three equal, consecutive installments of principal plus interest on the unpaid balance at 7% per annum, payable annually commencing on the first anniversary of the exercise. The note installments are payable in cash or the delivery of Common Stock or other options valued at the trading price at the time of payment. In connection with the issuance of shares on the exercise of such options, Grant Steele, N. Thomas Steele, and Kenneth L. Ransom each returned 24,118 shares, for an aggregate of 72,354 shares, of Common Stock to satisfy withholding obligations of the Company, as provided for in the terms of the options exercised. On September 16, 1995, these individuals delivered to the Company shares of Common Stock , valued at $2.25 per share, the approximate price of the Company's common stock as quoted on Nasdaq as of such date, as payment of accrued interest and principal due on notes delivered by them to the Company as payment for the September 1995 installment of their notes as follows: N. Thomas Steele, 50,807 shares for $114,316; Grant Steele, 50,807 shares for $114,316; Kenneth L. Ransom, 50,807 shares for $114,316; Dennis Gustafson, 9,527 shares for $21,436; and Bruce C. Decker, 9,527 shares for $21,436. These transaction were not the result of arm's length negotiations.\nCertain Loans\nIn previous years, the Company loaned to Bruce C. Decker, an officer and director of the Company, and Robert Richins, a former officer and director, an aggregate of $160,005, secured by a pledge of the obligation of the Company to such persons for accrued but unpaid back salaries. Proceeds from these loans were used principally to purchase equity securities of the Company. As of December 31, 1995, the aggregate amount of principal and interest due the Company from such individuals was $247,470, and the aggregate amount of accrued but unpaid salaries, including interest, due by the Company to such persons was $258,638. The Company has not sought, nor will it seek, payment of the notes until back salaries owed these individuals are paid.\nRelocation Agreement\nIn May 1993, in connection with the relocation of N. Thomas Steele from Utah to Colorado in order to become president of the Company, the Company agreed, among other items, to guarantee the sales price of Mr. Steele's Utah home. In the third quarter of 1994, the Company sold the home and recognized a loss of approximately $84,200.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a)(1) Financial Statements. The following statements are included in --------------------\nthis report:\n(a)(2) Financial Statement Schedules. Schedules are omitted because of -----------------------------\nthe absence of conditions under which they are required or because the information is shown in the financial statements.\n(a)(3) Exhibits. The following exhibits are included as part of this --------\nreport\n(1)Incorporated by reference from the Company's registration statement on form S-2, SEC file number 33-42828. (2)Incorporated by reference from the Company's annual report on form 10-K for the fiscal year ended December 31, 1992. (3)Incorporated by reference from the Company's quarterly report on form 10-Q for the period ending March 31, 1993. (4)Incorporated by reference from the Company's registration statement on form S-1, SEC file number 33-19014. (5)Incorporated by reference from the Company's registration statement on form S-2, SEC file number 33-34970. (6)Incorporated by reference from the Company's annual report on form 10-K for the fiscal year ended December 31, 1991. (7)Incorporated by reference from the Company's annual report on form 10-K for the fiscal year ended December 31, 1993. (8)Incorporated by reference from the Company's registration statement on form S-1, SEC file number 33-81538. (9)Incorporated by reference from the Company's registration statement on form S-2, SEC file number 33-64756. (10) Incorporated by reference from the Company's registration statement on form S-2, , SEC file number 33-86076. (11) Incorporated by reference from the Company's quarterly report on form 10-Q for the period ending March 31, 1993. (12) Incorporated by reference from the Company's annual report on form 10-K for the fiscal year ended December 31, 1985. (13) Incorporated by reference from the Company's annual report on form 10-K for the fiscal year ended December 31, 1994.\n* Filed as an exhibit to this annual report on form 10-K. ** Identifies each management contract or compensatory plan or arrangement required to be filed as an exhibit. (b) Reports on Form 8-K.\nDuring the last quarter of the fiscal year ended December 31, 1995, the Company did not file any reports on form 8-K.\nSIGNATURES Pursuant to the requirements of section 13 or 15(d) of the Securities Exchange of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nFORELAND CORPORATION\nDated: April 15, 1996 By \/s\/ N. Thomas Steele ---------------------------\nN. Thomas Steele, President\nPursuant to the requirements of the Securities Exchange 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.\nDated: April 15, 1996 By \/s\/ N. Thomas Steele ---------------------------\nN. Thomas Steele, President and Director (Principal Executive Officer and Principal Financial Officer)\nDated: April 15, 1996 By \/s\/Grant Steele ---------------------------\nGrant Steele, Chairman and Director\nDated: April , 1996 By ----- ---------------------------- Kenneth L. Ransom, Vice President- Exploration and Director\nDated: April , 1996 By ----- ---------------------------- Bruce C. Decker, Vice-President and Director\nDated: April 15, 1996 By \/s\/ Dennis J. Gustafson ----------------------------\nDennis J. Gustafson, Vice President- Land and Director\nDated: April 15, 1996 By \/s\/Don W. Treece ----------------------------\nDon W. Treece, Controller (Principal Accounting Officer)\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS\nPAGE ----\nIndependent Auditor's Report.....................................F-2\nConsolidated Balance Sheets - As of December 31, 1994 and 1995...F-3\nConsolidated Statements of Operations - For the Years Ended December 31, 1993, 1994, and 1995.....................F-5\nConsolidated Statements of Stockholders' Equity - For the Years Ended December 31, 1993, 1994, and 1995.....................F-6\nConsolidated Statements of Cash Flows - For the Years Ended December 31, 1993, 1994, and 1995...........................F-8\nNotes to Consolidated Financial Statements......................F-10\nINDEPENDENT AUDITOR'S REPORT\nBoard of Directors Foreland Corporation Lakewood, Colorado\nWe have audited the accompanying consolidated balance sheets of Foreland Corporation and subsidiaries as of December 31, 1994 and 1995, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1995. 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.\nWe 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 Foreland Corporation and subsidiaries as of December 31, 1994 and 1995, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1995, 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, which contemplates the real- ization of assets and liquidation of liabilities in the normal course of business. As discussed in Note 2 to the financial statements, the Company has suffered losses from inception, and anticipates the need for additional cash to fund its operations. These conditions raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are also discussed in Note 2. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.\nHEIN + ASSOCIATES LLP\nDenver, Colorado April 12, 1996\nFORELAND CORPORATION AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\nDECEMBER 31, ------------\n1994 1995 --------- ---------\nASSETS ------\nCURRENT ASSETS: Cash and equivalents $ 93,715 $ 30,490 Accounts receivable, net of allowance of $9,000 in 1994 864,778 438,058 Inventory 168,699 81,382 Advances to officer and director 7,907 7,212 Prepaid expenses and other 1,472 2,586 ---------- ---------- Total current assets 1,136,571 559,728\nPROPERTY AND EQUIPMENT, at cost: Oil and gas properties, under the successful efforts method 5,133,538 6,874,635 Furniture, equipment, and vehicles 263,603 299,161 ---------- ---------- 5,397,141 7,173,796\nLess accumulated depreciation, depletion and amortization (1,500,648) (2,363,211) ---------- ----------\n3,896,493 4,810,585\nOTHER ASSETS 164,350 230,785 ---------- ----------\nTOTAL ASSETS $5,197,414 $5,601,098 ========== ==========\nSee accompanying notes to these consolidated financial statements.\nLIABILITIES AND STOCKHOLDERS' EQUITY ------------------------------------\nCURRENT LIABILITIES: Current maturities of long-term debt $ - $ 404,237 Accounts payable and accrued expenses 649,242 1,642,537 Officers' salaries payable 354,962 392,462 Oil and gas sales payable 84,738 125,899 ---------- ----------\nTotal current liabilities 1,088,942 2,565,135\nLONG-TERM DEBT, less current maturities 400,000 23,091\nCOMMITMENTS (Notes 2, 4 and 8)\nSTOCKHOLDERS' EQUITY: Preferred stock, $.001 par value, 5,000,000 shares authorized: 1991 Convertible Preferred Stock, 40,000 shares issued and outstanding, liquidation preference of $50,000 40 40 1994 Convertible Redeemable Preferred Stock, 1,242,210 and 433,686 shares issued and outstanding, respectively, liquidation preference of $2,484,420 and $867,372, respectively 1,242 434\n1995 Convertible Redeemable Preferred Stock, 1,015,334 shares issued and outstanding, liquidation preference of $1,523,001 - 1,015\nCommon stock, $.001 par value, 50,000,000 shares authorized; 13,587,852 and 14,489,401 shares issued and outstanding, respectively 13,588 14,489 Additional paid-in capital 21,887,629 23,301,858 Less note and stock subscriptions receivable (1,257,250) (1,092,622) Accumulated deficit (16,936,777)(19,212,342) ----------- ----------\nTotal stockholders' equity 3,708,472 3,012,872 ---------- ----------\nTOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $5,197,414 $5,601,098 ========== ==========\nSee accompanying notes to these consolidated financial statements.\nFORELAND CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF OPERATIONS\nFOR THE YEARS ENDED DECEMBER 31, --------------------------------\n1993 1994 1995 ----------- ----------- ----------\nREVENUE: Oil sales $ 75,748 $ 476,964 $1,017,401 Operator and well service revenue 21,589 54,880 71,722 Other income, net 907 11,147 26,753 ---------- ---------- ----------\nTotal revenue 98,244 542,991 1,115,876\nEXPENSES: Oil and gas production 69,970 457,782 424,445 Oil and gas exploration 860,214 906,371 618,895 Dry hole, abandonment, and 1,389,728 1,857,878 725,648 impairment costs General and administrative 655,985 1,002,662 775,300 Compensation - below market options 320,000 - - Depreciation, depletion, and amortization 356,676 329,502 862,563 ---------- ---------- ----------\nTotal expenses 3,652,573 4,554,195 3,406,851 ---------- ---------- ----------\nOPERATING LOSS (3,554,329) (4,011,204) (2,290,975)\nOTHER INCOME (EXPENSE): Interest income 89,636 77,693 140,688 Interest expense (113,561) (85,686) (125,278) Loss on sale of oil and gas properties - (434,521) - ---------- ---------- ----------\nNET LOSS ($3,578,254) ($4,453,718) ($2,275,565) ========== ========== ===========\nNET LOSS PER COMMON SHARE $ (.34) $ (.34) $ (.16) ============ ========= ===========\nWEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING 10,405,000 12,989,000 14,271,000 ========== ========== ==========\nSee accompanying notes to these consolidated financial statements.\nSee accompanying notes to these consolidated financial statements.\nFORELAND CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: ------------------------------------------\nNature of Operations - Foreland Corporation (Foreland) was incorporated in Nevada in 1985 to engage in oil exploration, development, and production. Activities to date have focused primarily in north-central Nevada.\nPrinciples of Consolidation - The consolidated financial statements include the accounts of Foreland and its wholly-owned subsidiaries, Krutex Energy Corporation (Krutex), and Eagle Springs LLC (Eagle Springs), collectively referred to as the Company. All significant intercompany transactions and balances have been eliminated in consolidation.\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.\nOil and Gas Properties - The Company follows the \"successful efforts\" method of accounting for oil and gas producing activities. Costs to acquire mineral interests in oil and gas properties, to drill and equip exploratory wells that find proved reserves, and to drill and equip development wells are capitalized. Costs to drill exploratory wells that do not find proved reserves, geological and geophysical costs, and costs of carrying and retaining unproved properties are expensed. Management estimates that the salvage value of lease and well equipment will approximately offset the future liability for plugging and abandonment of the related wells.\nThe Company determines impairment of proved oil and gas properties by comparing the net carrying value of all of the Company's proved properties to the undiscounted future net revenues for such properties. Impairment is recognized to the extent that the carrying value exceeds the undiscounted future net revenues. Also see Note 11.\nUnproved oil and gas properties are periodically assessed for impairment of value, and a loss is recognized at the time of impairment by providing an impairment allowance. Capitalized costs of producing oil and gas properties are depreciated and depleted by the unit-of-production method. Costs of exploratory wells in progress are capitalized and excluded from depletion until such time as proved reserves are established or impairment is determined, generally not longer than one year from completion of drilling.\nUpon the sale of an entire interest in an unproved property for cash, gain or loss on the sale is recognized, taking into consideration the amount of any recorded impairment if the property had been assessed individually. If a partial interest in an unproved property is sold, the amount received is treated as a reduction of the cost of the interest retained.\nOther Property and Equipment - Furniture, equipment, and vehicles are stated at cost. Depreciation is calculated using the straight-line method over the estimated useful lives (ranging from 3 to 10 years) of the respective assets. The cost of normal maintenance and repairs is charged to operating expenses as incurred. Material expenditures which increase the life of an asset are capitalized and depreciated over the estimated remaining useful life of the asset. The cost of properties sold, or otherwise disposed of, and the related accumulated depreciation or amortization are removed from the accounts, and any gains or losses are reflected in current operations.\nAccounting Estimates - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. The actual results could differ from those estimates.\nThe Company's financial statements are based on a number of significant estimates including the allowance for doubtful accounts, realizability of notes and common stock subscriptions receivable, impairment of unproved oil and gas properties, and oil reserve quantities which are the basis for the calculation of depreciation, depletion, and impairment of proved oil and gas properties. The Company's reserve estimates were determined by an independent petroleum engineering firm. However, management emphasizes that reserve estimates are inherently imprecise and that estimates of more recent discoveries are more imprecise than those for properties with long production histories. At December 31, 1995, approximately 44% of the Company's oil reserves are attributable to non-producing properties. Accordingly, the Company's estimates are expected to change as future information becomes available.\nAt least annually, the Company is required to evaluate the possible impairment of the carrying value of its proved oil and gas properties. This involves a comparison to the estimated future undiscounted cash flows, which is the primary basis for determining the related fair values for such properties. In addition to the uncertainties inherent in the reserve estimation process, this amount is affected by historical and projected prices for oil which has typically been volatile. It is reasonably possible that the Company's oil reserve estimates will materially change in the forthcoming year.\nAdditionally, at December 31, 1995, the Company has net capitalized costs of approximately $114,000 related to a well in progress. If this well is ultimately unsuccessful, these costs will be charged to operations.\nInventory - Inventory consists primarily of oil and gas production equipment and crude oil. Inventory is carried at the lower of cost or market, cost being determined generally under the average cost method of accounting, or where possible, by specific identification. The Company has classified $50,000 of used oil field equipment inventory as long-term (included with other assets), because based on current inventory usage and the type of equipment, it is not expected to be sold or placed in service within the next year.\nIncome Taxes - The Company accounts for income taxes on the liability method, whereby deferred tax assets and liabilities are recognized for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates.\nRevenue Recognition - The Company recognizes oil sales upon delivery to the purchaser. Revenues from operator and well service fees are recognized as the services are performed.\nNet Loss Per Share - The net loss per share calculation is based on the weighted average number of shares outstanding during each year. Convertible preferred stock, options, and warrants outstanding have been excluded from the calculation since the effect would be antidilutive.\nFinancial Instruments - Statement of Financial Accounting Standards No. 107 requires all entities to disclose the fair value of certain financial instruments in their financial statements. Accordingly, at December 31, 1995, management's best estimate is that the carrying amount of all financial instruments approximates fair value due to the short maturity of these instruments.\nReclassifications - Certain reclassifications have been made to the 1993 and 1994 financial statements to conform to the presentation in 1995. The reclassifications had no effect on the 1993 or 1994 net loss.\n2. BASIS OF PRESENTATION: ---------------------\nThe accompanying consolidated financial statements have been prepared on the going concern basis, which contemplates the realization of assets and liquidation of liabilities in the normal course of business. The Company has incurred cumulative losses of $19,212,342 since inception, and the ability of the Company to continue as a going concern is dependent on its ability to successfully develop its oil and gas properties and ultimately achieve profitable operations. Management's plans in this regard are set forth below.\nThe Company will continue to seek cash proceeds from the exercise of options and warrants currently outstanding and from the sale of additional common stock, preferred stock, warrants, or other securities for cash. If inadequate funds are received from security offerings, the Company will seek required operating capital through interim debt financing, the farmout of drilling prospects, the sale of leases, drilling prospects or exploration rights on specific prospects, the sale of geological and geophysical data gathered in Nevada by the Company since 1985, or through other means. The Company intends to fund its exploration drilling program by spreading the risk inherent in this type of drilling by entering into drilling partnerships with others. The Company is continuing negotiations with various other exploration firms to fund additional drilling in Nevada, but there is no assurance that arrangements can be reached on terms acceptable or favorable to the Company.\nThe Company believes these efforts along with increased revenues from oil and gas production will enable it to continue its operations in the forthcoming year.\n3. RELATED PARTY TRANSACTIONS: --------------------------\nThe Company owed $354,962 and $392,462 in salaries and interest to its officers and directors at December 31, 1994 and 1995, respectively.\nIn June 1991, the Company loaned an officer and director, and a former officer and director, an aggregate of $123,421, repayable with interest at the prime rate and collateralized by a pledge of the obligation of the Company to such persons for accrued but unpaid back salaries of approximately $156,720. A portion of the proceeds from these loans was used to purchase $100,000 in preferred stock and warrants. The notes were originally due in June 1992, but the Company has agreed not to seek payment of $247,470 (including additional advances and accrued interest) of the notes until back salaries owed these individuals (totaling $258,638 at December 31, 1995) are paid. At December 31,\n1995, $247,470, including accrued interest, was due under the notes (which are included as a reduction of stockholders' equity in the accompanying financial statements).\nIn May 1993, in connection with the Company's move to Denver, Colorado, the Company agreed to: (1) pay for all relocation expenses incurred by the president; (2) pay the president's mortgage payments and maintenance costs on his former residence; (3) grant the president options to purchase 72,000 shares of the Company's common stock at $1.50 per share; (4) guarantee a minimum sales price of $375,000 on his former residence; and (5) advance the president up to $175,000. In September 1994, the Company sold the residence and received approximately $290,000 net of selling costs and recognized a loss on the transaction of approximately $85,000. Additional relocation costs of approximately $29,000 were paid in 1994.\nSee Note 4 for other related party transactions.\n4. STOCKHOLDERS' EQUITY: --------------------\n1991 Offering - During November 1991, the Company received net proceeds of $1,971,100 from a public offering of 4,600 units. Each unit consisted of 270 shares of common stock, 270 A warrants to purchase common stock at $2.25 per share, and 270 B warrants to purchase common stock at $3.90 per share. The warrants were exercisable through October 30, 1994. Upon expiration of the B warrants, the Company issued 1,242,000 L warrants to replace the B warrants. The L warrants are exercisable to purchase common stock at $8.00 per share through December 31, 1996.\nThe L Warrants are subject to redemption by the Company at a price of $0.10 per L Warrant on 30 days' prior written notice if the closing bid price of the Common Stock of the Company, as quoted on NASDAQ, exceeds the L Warrant exercise price by at least 20% for 20 of 30 trading days during a period ending within 10 days of the notice of redemption. All L Warrants in any class must be redeemed if any L Warrant in that class is redeemed. L Warrants may be exercised during the 30 day period after notice of redemption has been given.\nIn conjunction with the 1991 Offering, the Company issued to the underwriter for $100, 400 underwriter unit warrants consisting of an aggregate of 108,000 Class A warrants, 108,000 Class B warrants, and 108,000 shares of common stock.\nThe underwriter's unit warrants were exercisable at $550 per each unit. In 1995, pursuant to their terms, the underwriter's unit warrants were adjusted so that they are now exercisable at $552 per unit and the 400 units purchasable on exercise now consist of an aggregate of 138,000 shares of common stock, 138,000 Class A Warrants and 138,000 Class B Warrants. The underwriter's unit warrants are exercisable through October 30, 1996. The A and B Warrants issuable on the exercise of the underwriter's unit warrants are not redeemable and are exercisable through October 30, 1995, at an exercise price of $2.25 and $3.90, respectively, to acquire one share of Common Stock for each A and B Warrant exercised.\nOn July 23, 1993, Foreland notified holders of its Class A warrants that Foreland would redeem the warrants at $.10 each if not exercised by October 1, 1993. During 1993, the holders of Class A warrants purchased 1,241,990 shares of common stock at $2.25 per share for total proceeds of $2,794,478.\n1991 Private Placement - During 1991, the Company sold 914,600 shares of convertible preferred stock in a private placement at $1.25 per share for net proceeds of $972,954. The purchasers of preferred stock also received two-year warrants (the 1991 warrants) to purchase an aggregate of 455,000 shares of common stock at $1.50 per share during the first year and $1.75 per share during the second year. The sales agent for the private placement received warrants to purchase an aggregate of 73,000 shares of common stock at $1.25 per share. At the election of the holder, each share of 1991 preferred stock may be converted into one share of common stock.\nThe holders of the 1991 warrants purchased 186,000 shares of common stock at $1.50 per share, and 10,000 shares of common stock at $1.75 per share for total proceeds of $296,500 during 1992 and 217,000 shares of common stock at $1.75 per share for a total of $379,750 during 1993.\nDuring 1992, 72,000 of the 73,000 underwriter warrants issued in connection with the 1991 preferred private placement were exercised at $1.25 per share for total proceeds of $90,000.\nThe holders of the 1991 convertible preferred stock elected to convert 450,000 and 34,600 shares into common stock in 1993 and 1994, respectively. No holders of the 1991 convertible preferred stock elected to convert their shares to common in 1995.\n1993 Private Placement - During May 1993, the Company completed a private placement totaling $3,500,000 for the sale of 700,000 units, each unit consisting of one share of 1993 Convertible Preferred Stock, par value $.001, and one X warrant, yielding net proceeds of approximately $3,126,542, after placement commissions and other costs of the offering. Subsequent to such offering, each share of 1993 preferred stock was convertd into two shares of the Company's common stock. Each X warrant entitled the holder to purchase, at any time through December 1, 1994 at an exercise price of $3.25 one share of the Company's common stock, and one Y warrant to purchase, for $4.00 per share, an additional share of common stock through December 15, 1995. Through December 1, 1994, holders of an aggregate of 3,000 X Warrants exercised such warrants and the Company isued 3,000 shares of common stock and 3,000 Y Warrants. The 697,000 X Warrants not exercised by December 1, 1994, were exercisable at $4.00 per share thereafter. The outstanding X and Y Warrants originally expired on December 15, 1995, but the Company extended the exercise period to March 14, 1996. During such period, no holders elected to exercise the outstanding X or Y Warrants.\nThe Company issued to the placement agent in this offering warrants to purchase 70,000 units, each unit consisting of one share of 1993 convertible preferred stock and one X warrant, such securities containing the same terms and conditions as those issued to investors.\n1994 Private Placement - In July of 1994, the Company issued 1,316,210 shares of 1994 Convertible Redeemable Preferred Stock and 658,105 C Warrants for net proceeds of $2,341,370. The preferred stock and warrants were sold as units at $4.00 per unit, such units consisting of two shares of preferred stock and one C Warrant. The Company issued to the placement agent in this offering warrants to purchase 65,811 units which are exercisable before July 8, 1999, at an exercise price of $4.40 per unit.\nAt the election of the holder, each share of preferred stock may be converted at any time after October 31, 1994, into one share of common stock. Holders of the 1994 Preferred Stock elected to convert 74,000 and 808,524 shares into common shares in 1994 and 1995, respectively. The 1994 preferred stock is redeemable at any time after March 31, 1996, at $4.00 per share at the Company's option, and has a liquidation preference of $2.00 per share.\nEach C Warrant originally entitled the holder to purchase, at any time between October 31, 1994, and July 1, 1995, for an exercise price of $3.00, one share of common stock During September 1995, the Company amended the exercise price of the Class C warrants from $3.00 per share to $1.50 per share, and extended the expiration date from September 30, 1995 to October 10, 1995. In October 1995, the Company received $191,749 in cash and a $137,500 note receivable for the exercise of 219,500 C warrants. The note receivable was recorded as a reduction in stockholders' equity.\n1995 Private Placement - Between March and September 1995, the Company completed the sale of 507,667 non-transferable units (the \"Units\") for $3.00 per unit. Each Unit consists of two shares of preferred stock designated as the 1995 Series Preferred Stock and one M warrant. At the election of the holder, each share of 1995 Preferred Stock may be converted into one share of common stock. The 1995 preferred stock has a liquidation preference of $1.50 per share. Each M warrant entitles the holder to purchase, at any time through December 31, 1998, for $4.00 one share of Common Stock. M Warrants not exercised by December 31, 1998 will expire. The M Warrants may be redeemed by the Company on at least 30 days' notice at a redemption price of $.10 per M Warrant if the average closing price for the Company's Common Stock is at least $6.00 per share for 20 consecutive trading days prior to the redemption notice, subject to certain other conditions. The Company has agreed to file a registration statement under the Securities Act of 1933 covering the resale of the Conversion Shares issuable on conversion of the 1995 Preferred Stock and the Warrant Shares issuable on the exercise of the M Warrants.\nOptions - In 1985, the Company granted to its founders, who were also directors and officers, options to purchase 1,100,000 shares of the Company's common stock at a purchase price of $1.50 per share. During 1989, the Board extended to June 15, 1992, the 1985 options held by the Company's current directors to purchase, in the aggregate, up to 1,050,000 shares of common stock. In addition, the 1985 options were revised to provide that upon exercise of any of the options to purchase 1,050,000 shares of common stock, the Company will grant new five-year options for an equal amount of shares at a new exercise price to be equal to the trading price for the Company's common stock as of the date of grant. In April 1991, the options were again extended through 1996 and the officers and directors waived their rights to 100,000 options. In 1991, options for 67,781 shares were exercised at $1.50 per share, and new options were granted for 67,781 shares at $1.31 per share through December 1996.\nDuring 1991, options to purchase 25,000 shares at $1.81 and 25,000 shares at $3.38 through July 15, 1996 were granted to an officer and director. Upon exercise of the 25,000 options at $3.38, new options for an equal number of shares at a new exercise price equal to the trading price of the Company's common stock at the date of grant will be issued.\nIn April 1994, options to purchase a total of 50,000 shares at $2.25 through April 1999 were granted to two officers and directors. Upon exercise of the options, new options for an equal number of shares at an exercise price equal to the trading price of the Company's common stock at the date of grant will be issued.\nDuring 1994, outstanding options, including the options granted in April 1994, were exercised to purchase Common Stock as follows: Grant Steele, 200,000 shares at $1.50; N. Thomas Steele, 200,000 shares at $1.50; Kenneth L. Ransom, 200,000 shares at $1.50; Bruce C. Decker, 25,000 shares at $2.25; and Dennis J. Gustafson, 25,000 shares at $2.25. Pursuant to the terms of the options exercised, each optionee paid the purchase price of the options by the delivery of a promissory note payable in three equal, consecutive installments of principal plus interest on the unpaid balance at 7% per annum, payable annually commencing on the first anniversary of the exercise. The note installments are payable in cash or the delivery of Common Stock or other options valued at the trading price at the time of payment. In connection with the issuance of shares on the exercise of such options, Grant Steele, N. Thomas Steele, and Kenneth L. Ransom each returned 24,118 shares, for an aggregate of 72,354 shares, of Common Stock to satisfy withholding obligations of the Company, as provided for in the terms of the options exercised. Also pursuant to the terms of the options exercised, the Company automatically granted new five year options to purchase Common Stock at $2.125, the market price for the Common Stock at the time of exercise, as follows: Grant Steele, 200,000 shares; N. Thomas Steele, 200,000 shares; Kenneth L. Ransom, 200,000 shares; Bruce C. Decker, 25,000 shares; and Dennis J. Gustafson 25,000 shares. The first payment for the above referenced notes became due in September 1995. Grant Steele, N. Thomas Steele, and Kenneth Ramson each returned 50,807 shares of Common Stock in satisfaction of the first installment of principal and interest on their $300,000 notes, while Bruce Decker and Dennis Gustafson each returned 9,527 shares in satisfaction of the first installment of principal and interest on their $56,250 notes.\nDuring 1994, the Company granted five-year options which allow several employees to purchase an aggregate of 105,000 shares of common stock at $3.00 per share. Options for 10,000 shares were immediately exercisable upon grant, 31,000 vested and became exercisable one year after grant, 32,000 vest and become exercisable after two years, and 32,000 vest and become exercisable after three years, provided that the employee in each case has been, within the preceding 30 days, an employee of the Company.\nIn 1994, the Company granted options to a non-affiliated person to purchase 30,000 shares of common stock at an exercise price of $3.00 per share through October 6, 1999.\nSARS - In 1993, the Company granted a total of 180,000 Stock Appreciation Rights (SARS) to officers. The SARS vest 1\/3 upon grant, 1\/3 on the first anniversary date of the grant, and 1\/3 on the second anniversary date of the grant. The SARS entitle the officers to receive cash, stock or a combination of\nboth in an amount equal to the amount by which the fair market value of the Company's common stock on the date the SARS are exercised exceeds $4.56 per share. The SARS expire in May 1998.\nIn 1994, the Company granted 45,000 SARS to an executive officer and director. The SARS entitle the officer to receive cash, stock, or a combination of both in an amount equal to the amount by which the fair market value of the Company's common stock on the date the SARS are exercised exceeds $2.50 per share. The SARS expire in June 1999.\nSummary - The following summarizes the options and warrants currently -------\noutstanding:\nEXPIRATION DATE COMMON SHARES ------------------ -----------------\nOptions (price per share): -------------------------\nOfficers and directors: Exercise price of $3.38 July 1996 25,000 Exercise price of $1.81 July 1996 25,000 Exercise price of $1.50 December 1996- 354,000 May 1998 Exercise price of $1.31 December 1996 68,000 Exercise price of $2.125 September 1999 650,000\nOthers: Exercise price of $2.50 April 1998 20,000 Exercise price of $1.50 April 1998 30,000 Exercise price of $3.00 October 1999 135,000 ---------\nTotal options 1,307,000 ---------\nWarrants (price per share): --------------------------\nExercise price of $4.00 March 1996 3,000 (Y warrants) Exercise price of $6.00-8.00 December 1996 1,242,000 (L warrants) Exercise price of $4.00 March 1996 697,000 (X warrants) Exercise price of $1.60 October 1996 138,000 (Placement Agent) Exercise price of $1.25 February 1996 1,000 (Underwriter) Exercise price of $1.50 April 1996 200,000 (CapitalPro) Exercise price of $2.00 April 1997 200,000 (CapitalPro) Exercise price of $4.00 December 1998 507,667 (M Warrants) Exercise price of $1.50 June 2000 100,000 (Investment Banker) ---------\nTotal warrants 3,088,667 ---------\nTotal options and warrants issued and outstanding 4,395,667 =========\nThe above table does not include 346,000 warrants to purchase common stock purchase warrants, underlying units currently outstanding, or any options issuable upon the exercise of existing options.\nThe Company has also issued 271,622 warrants to purchase preferred stock of prices ranging from $2.20 to $2.75.\n5. INCOME TAXES: ------------\nDeferred tax assets (liabilities) are comprised of the following at December 31, 1994 and 1995:\n1994 1995 ---------- ----------\nLong-term deferred tax assets (liabilities): Net operating loss carryforward $6,700,000 $7,300,000 Property and equipment basis (1,000,000) (1,300,000) differences Below-market stock options 100,000 100,000 --------- ---------\nNet deferred tax assets 5,800,000 6,100,000\nLess valuation allowance (5,800,000) (6,100,000) ---------- ----------\nNet deferred tax assets $ - $ - ======= =========\nThe Company has a net operating loss carryforward of approximately $19,700,000 for income tax purposes. A portion of these net operating loss carryforwards may be subject to reduction or limitation of use as a result of change in ownership or certain consolidated return filing regulations.\nThe loss carryforwards for income tax purposes expire as follows:\nYEAR OF EXPIRATION - -----------\n1999 $ 300,000 2000 100,000 2001 700,000 2002 1,600,000 2003 1,400,000 2004 1,000,000 2005 1,300,000 2006 1,900,000 2007 1,700,000 2008 4,300,000 2009 3,800,000 2010 1,600,000 ----------\n$19,700,000 ===========\n6. SIGNIFICANT CONCENTRATIONS: --------------------------\nSubstantially all of the Company's accounts receivable result from crude oil sales and joint interest billings to companies in the oil and gas industry. This concentration of customers and joint interest owners may impact the Company's overall credit risk, either positively or negatively, since these entities may be similarly affected by changes in economic or other conditions. In determining whether or not to require collateral from a customer or joint interest owner, the Company generally analyzes the entity's net worth, cash flows, earnings, and\/or credit ratings. Receivables are generally not collateralized; however, receivables from joint interest owners are subject to collection under operating agreements which generally provide lien rights. Historical credit losses incurred on trade receivables by the Company have been insignificant.\nThe Company's oil and gas properties are located in north-central Nevada where the net price realized for the Company's oil production is typically discounted due to gravity adjustments and transportation costs. Accordingly, in comparison to the net price received by oil producers in many other areas of the United States, the Company often realizes a lower net sales price. Additionally, the Company is vulnerable to a curtailment in drilling activity in order to realize the value of oil field inventories and related operating assets. Due to the remote location, the Company may be vulnerable to delays and shortages of equipment due to a relatively limited number of suppliers for certain goods and services.\nAt December 31, 1995, the Company had a receivable from a single oil purchaser for $225,000, which was collected in January 1996. This purchaser accounts for all of the Company's oil sales. Additionally, at December 31, 1994 and 1995, the Company had joint interest billings from a single customer of approximately $475,000 and $175,000, respectively.\n7. LONG-TERM DEBT: --------------\nLong-term debt at December 31, 1994 and 1995, consists of the following: 1994 1995 ======= ------\nNote payable to unrelated party. $400,000 $400,000\nOther installment notes. Interest at 13.4%, monthly principal and interest payments of approximately $639 through October 1999 when the remaining balance is due. The notes are collateralized by vehicles. - 27,328 -------- --------\nTotal long-term debt 400,000 427,328\nLess current maturities - (404,237) -------- -------- Total long-term debt, less current $400,000 $ 23,091 maturities -------- --------\nOn April 30, 1994, the Company borrowed $400,000 from an unrelated party to provide interim financing to proceed with the Company's drilling program in its Eagle Springs Field and to pay ongoing general and administrative expenses. In connection with the loan, the Company granted the lender warrants to purchase 200,000 shares of Common Stock at $2.00 per share at any time prior to the earlier of April 30, 1996 or 60 days subsequent to the repayment of the loan. The loan originally provided for interest at 8.4% per annum, payable quarterly, and was due on April 30, 1995.\nIn May 1995, the Company negotiated the extension of the due date of this loan to April 30, 1996, and in connection with such extension, the interest rate was increased to 10%, the Company reduced the exercise price of the warrants previously granted to $1.50 per share, and the Company granted new warrants to purchase 200,000 shares of Common Stock at $2.00 per share through the earlier of April 30, 1997, or 60 days subsequent to the repayment of the loan.\nBorrowings are collateralized by substantially all of the Company's property, equipment, receivables and inventory. The credit agreement contains certain covenants, including those that prohibit the Company from selling substantially all of its assets and incurring additional collateralized indebtedness in excess of $50,000. From time to time, certain vendors of the Company file mechanics liens against the Company's oil and gas properties in order to secure their claims. These liens are typically cleared in a relatively short period of time and management believes they are insignificant to the Company's financing activities.\nThe aggregate maturities of long-term debt are as follows:\nYear Ending December 31, - ------------\n1996 $404,237 1997 4,844 1998 5,538 1999 12,709 ------- $427,328 ========\n8. COMMITMENTS: -----------\nThe Company currently rents administrative office space and equipment under noncancelable leases. Total rental expenses incurred under operating leases amounted to $55,205, $64,717, and $67,382 for the years ended December 31, 1993, 1994, and 1995, respectively.\nThe total minimum rental commitment as of December 31, 1995 is as follows:\n1996 $ 57,061 1997 52,200 1998 29,393 -------- $138,654 ========\nIn 1995, the Company entered into a financial consulting agreement with Vantage Resource Group LLP (\"Vantage\") whereby the Company agreed to pay Vantage 3% of the gross proceeds from any debt or equity financing from any person directly or indirectly introduced to the Company by Vantage. The Company also agreed to pay Vantage 1% of the proceeds from any financing obtained from any other source. The Company agreed to pay these amounts during the term of the consulting agreement, which expires in June 1996, and for 12 months thereafter. The Company has issued 100,000 warrants exercisable at the lower of $1.50 or the average of the closing price of the common stock for the 20 business days preceding the exercise date. The warrants expire in June 2000. The Company has agreed to issue an additional 100,000 warrants in the event Vantage is successful in obtaining financing in excess of $1,000,000.\n9. OIL AND GAS PROPERTY CONVEYANCES: --------------------------------\nDuring 1994, the Company entered into an agreement with Barrett Resources Corporation (\"Barrett\") whereby Barrett agreed to pay 80% of the first $2,400,000, or as much as $1,920,000, of the costs to drill and, if practical, complete three oil wells in the Company's Eagle Springs field. In January 1995, Barrett elected to retroactively assign ownership of the Eagle Springs properties and leaseholds to the August 1, 1994 effective date of the agreement. The accompanying financial statements give effect to Barrett's election as of August 1, 1994, with no gain or loss recognized since this transaction represented a pooling of capital. After the initial $2,400,000 of expenditures, additional development costs are being shared 60% by the Company and 40% by Barrett.\nIn 1994, Krutex entered into an agreement with an unrelated third party operator under which the operator agreed to pay Krutex $50,000 to earn 75% of Krutex's working interest in the West Salt Flat Field. In addition, Krutex granted the operator an option to purchase Krutex's remaining 25% interest for $25,000 through February 2, 1995. This option was exercised in 1995 and the Company recognized a loss of $434,521 in 1994.\n10. SUBSEQUENT EVENTS: -----------------\nIn March 1996, the Company issued 500 shares of 6% convertible preferred stock for net proceeds of $472,500. From May 1996 through March 1998, at the election of the holder, each share may be converted into that number of shares\nof the common stock determined by dividing $1,000 plus all accrued but unpaid dividends on such a share by the lesser of (i) $1.50 or (ii) 75% of the average closing bid price of the common stock as reported by NASDAQ for the trading date immediately preceding the date of conversion.\nUnder certain conditions, this stock may be redeemed after April 1, 1997 at a price of 133% of the original issue price. The Company has agreed to register the resale of the common stock issuable on conversion in certain circumstances.\n11. IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS (UNAUDITED): ----------------------------------------------------------\nIn March 1995, the Financial Accounting Standards Board issued a new Statement titled \"Accounting for Impairment of Long-Lived Assets.\" This new standard is effective for years beginning after December 15, 1995 and will change the Company's method of determining impairment of proved oil and gas properties. Management estimates that the application of the new standard would have increased the provision for impairment of oil and gas properties by approximately $450,000 as of December 31, 1995. The Company plans to adopt the new standard in the first quarter of 1996.\nIn October 1995, the Financial Accounting Standards Board issued a new statement titled \"Accounting for Stock-Based Compensation\" (SFAS 123). The new statement is effective for fiscal years beginning after December 15, 1995. SFAS 123 encourages, but does not require, companies to recognize compensation expense for grants of stock, stock options, and other equity instruments to employees based on fair value. Companies that do not adopt the fair value accounting rules must disclose the impact of adopting the new method in the notes to the financial statements. Transactions in equity instruments with non- employees for goods or services must be accounted for on the fair value method. For transactions with employees, the Company currently does not intend to adopt the fair value accounting under SFAS 123, and will be subject only to the related disclosure requirements.\n12. DISCLOSURES ABOUT OIL AND GAS PRODUCING ACTIVITIES: --------------------------------------------------\nAll oil and gas operations of the Company and its subsidiaries are conducted in the United States. Capitalized costs relating to oil and gas producing activities are as follows:\nDECEMBER 31, --------------------\n1994 1995 ---------- ----------- Proved oil and gas producing properties $4,145,656 $6,292,331 Wells in progress 137,285 113,986 Unproved properties, net of allowance for impairment of $250,000 in 1995 850,597 468,318 --------- --------- 5,133,538 6,874,635 Accumulated depreciation, depletion and (1,361,802) (2,183,423) ---------- ---------- amortization $3,771,736 $4,691,212 ========== ==========\nCosts incurred in oil and gas producing activities, whether capitalized or expensed, during the three years ended December 31, 1993, 1994, and 1995 are as follows:\n1993 1994 1995 ---------- ---------- ----------\nAcquisition costs $ 843,871 $ 347,393 $ 46,597 ========= ========== =========\nExploration costs $2,249,942 $1,829,943 $1,024,008 ========== ========== ==========\nDevelopment costs $2,166,883 $1,232,606 $2,414,265 ========== ========== ==========\nEstimated Quantities of Proved Oil and Gas Reserves (Unaudited) - Proved oil ---------------------------------------------------------------\nand gas reserves are the estimated quantities of crude oil, 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 oil and gas reserves are those expected to be recovered through existing wells with existing equipment and operating methods. However, reserve information should not be construed as the current market value of the Company's oil and gas reserves or the costs that would be incurred to obtain equivalent reserves. Reserve calculations involve the estimation of future net recoverable reserves of oil and gas and the timing and amount of future net revenues to be received therefrom. These estimates are based on numerous factors, many of which are variable and uncertain. Accordingly, it is common for the actual production and revenues to vary from earlier estimates.\nAt December 31, 1995, over 40% of the Company's reserves are attributable to undeveloped properties which are scheduled to be drilled over the next two years at an estimated cost of approximately $2,750,000. As of December 31, 1995, the Company has minimal working capital and, therefore, may be unable to develop its reserves unless additional capital is raised, financing is obtained and\/or the property interests are sold. If the property interests are farmed out to fund development, the Company's revenue interest will decrease.\nReserve estimates for recently drilled wells and undeveloped properties are subject to substantial upward or downward revisions after drilling is completed and a production history obtained. Hence, reserve estimates and estimates of future net revenues from production may be subject to substantial revision from year to year. Reserve information presented herein is based on reports prepared by independent petroleum engineers for 1993 and 1995, and by a petroleum engineer who was employed by the Company for 1994.\nSet forth below is the unaudited summary of the changes in the net quantities of the Company's proved oil reserves (in barrels) as of December 31, 1993, 1994, and 1995:\n1993 1994 1995 --------- --------- --------\nProved reserves, beginning of 506,000 1,144,000 1,848,000 year Production (29,000) (38,000) (88,000) Purchase of reserves in place 627,000 308,000 - Discoveries, extensions and other additions - 994,000 724,000 Sale of reserves in place - (737,000) - Revisions of previous 40,000 177,000 (478,000) estimates --------- --------- --------\nProved reserves, end of year 1,144,000 1,848,000 2,006,000 ========= ========= =========\nProved developed reserves, end of 754,000 992,000 1,175,000 --------- --------- --------- year\nStandardized Measure of Discounted Future Net Cash Flows (Unaudited) --------------------------------------------------------------------\nStatement of Financial Accounting Standards No. 69 prescribes guidelines for computing a standardized measure of future net cash flows and changes therein relating to estimated proved reserves. The Company has followed these guidelines which are briefly discussed below.\nFuture cash inflows and future production and development costs are determined by applying year-end prices and costs to the estimated quantities of oil and gas to be produced. Estimated future income taxes are computed using current statutory income tax rates including consideration for estimated future statutory depletion and tax credits. The resulting future net cash flows are reduced to present value amounts by applying a 10% annual discount factor.\nThe assumptions used to compute the standardized measure are those prescribed by the Financial Accounting Standards Board and, as such, do not necessarily reflect the Company's expectations for actual revenues to be derived from those reserves nor their present worth. The limitations inherent in the reserve quantity estimation process, as discussed previously, are equally applicable to the standardized measure computations since these estimates are the basis for the valuation process.\nDECEMBER 31, -------------------------------\n1993 1994 1995 ---------- ----------- -----------\nFuture cash inflows $12,445,000 $21,178,000 $25,926,000 Future production costs (4,749,000) (7,439,000) (11,092,000) ) Future development costs (2,808,000) (2,352,000) (2,754,000) Future income tax expense - - - ---------- ---------- --------- Future net cash flows 4,888,000 11,387,000 12,080,000\n10% annual discount for estimated timing of cash flows (2,692,000) (6,276,000) (5,880,000) ---------- ---------- ----------\nStandardized measure of discounted future $2,196,000 $5,111,000 $6,200,000 of cash flows ---------- ---------- ----------\nThe following are the principal sources of change in the standardized measure of discounted future net cash flows for the years ended December 31, 1993, 1994, and 1995:\n1993 1994 1995 ---------- ----------- --------\nStandardized measure, beginning $1,215,000 $2,196,000 $5,111,000 of year Sales of oil and gas, net of (6,000) (19,000) (593,000) production costs Extensions, discoveries and - 4,165,000 4,122,000 other, net Purchase of reserves in place 3,136,000 1,364,000 - Sale of reserves in place - (1,118,000) - Net change due to revisions in 120,000 142,000 (2,565,000) quantity estimates Net change due to changes in (3,161,000) 346,000 (2,000) prices and production costs Net change in future development 472,000 (2,234,000) (384,000) costs Net change in income taxes 298,000 - - Accretion of discount 122,000 269,000 511,000 --------- --------- -------- Standardized measure, end of $2,196,000 $5,111,000 $6,200,000 year ---------- ---------- ----------","section_15":""}
{"filename":"82334_1995.txt","cik":"82334","year":"1995","section_1":"Item 1. Business\nGeneral\nThe Company was organized under the laws of Pennsylvania in 1833. It operated the Reading Railroad until April 1, 1976, when substantially all of the Company's railroad assets were conveyed to Consolidated Rail Corporation (\"Conrail\").\nIn 1993, the Company determined to focus its activities on the \"Beyond-the-Home\" segment of the entertainment industry, acquiring Theater Acquisitions of Puerto Rico, Inc. (\"TAPR\") for a cash purchase price of $22.7 million in mid-1994. At the time of acquisition, TAPR operated six motion picture exhibition theaters with a total of 36 screens in the Commonwealth of Puerto Rico. Renamed Cine Vista in 1994, the theater circuit currently consists of 44 screens in 7 locations with an additional 16 screens under development. Cine Vista is also in negotiations with respect to several additional theater locations.\nDuring 1995, the Company initiated theater development activities in Australia. In November 1995, the Company and Craig Corporation (\"Craig\"), the owner of approximately 49.3% of the Company's outstanding capital stock, formed Reading International Cinemas LLC (referred to herein together with its Australian subsidiaries as \"Reading International\"), a limited liability corporation owned equally by the Company and Craig to exploit opportunities in Australia. Reading International has acquired a 43 acre site in Melbourne, New South Wales and is currently seeking permits for the developments of a 24 screen multiplex cinema on this site. Reading International is also currently in negotiations with respect to several additional locations.\nThe Company also currently owns approximately 27 parcels of real estate located primarily in Pennsylvania and is a participant in two real estate joint ventures in center city Philadelphia.\nDescription of Business\nThe Company also has been liquidating certain of its assets since its emergence from bankruptcy in 1981. By late 1993, the various operating businesses owned by the Company had been sold.\nIn late 1993, following a review of investment opportunities in a number of industries, the Company determined to focus on acquiring or developing businesses in the \"Beyond-the-Home\" segment of the entertainment industry. The Company entered into two other development projects in the \"Beyond-the-Home\" segment of the entertainment industry in 1993 and early 1994: a joint venture project with Pacific Theatres (\"Pacific\") to develop multiplex cinemas in California and Hawaii (\"PRT\") and a project to develop a theme park based on the Wizard of Oz in Kansas (the \"Oz Project\"). Effective July 1, 1994, the Company acquired Cine Vista for a cash purchase price of $22.7 million, inclusive of $323,000 of acquisition expenses. Cine Vista operates 7 motion picture theaters in Puerto Rico. With the acquisition of Cine Vista, the development of internal operating capabilities, and the focusing of the Company's attention on foreign exhibition opportunities, the Company determined to terminate PRT and to make no additional financial commitments to the Oz Project. The Company continues to seek acquisitions and development opportunities in the \"Beyond-the-Home\" segment of the entertainment industry, but is currently emphasizing cinema exhibition opportunities. During 1995, the Company initiated theater development activities in Australia. In November 1995, the Company and Craig formed Reading International, a limited liability corporation owned equally by the Company and Craig, to exploit opportunities in Australia.\nThe Company's real estate activities include the sale or development of certain center city Philadelphia property, the sale of parcels outside center city and participation in two real estate joint ventures. Proceeds from the Company's real estate activities and sales of operating businesses, to the extent not needed to fund the Company's real estate operations, development and acquisition activities or to reduce indebtedness, have been held in readily marketable securities issued by the United States Treasury and federal agency securities, with the intent of preserving capital until needed in accordance with the Company's business plan to develop or acquire operating businesses. The Company attempts to avoid investment risk to the maximum extent practicable by holding\nfederal agency securities and United States Treasury obligations with maturities consistent with presently anticipated cash requirements.\nCine Vista\nCine Vista operates motion picture exhibition theaters in seven leased locations in Puerto Rico. Cine Vista currently has 16 screens under development in two locations, including a ten screen complex to replace an existing six screen facility. Cine Vista is also involved in negotiations for additional theater sites in Puerto Rico. While no assurances can be given, the Company anticipates a net increase of at least 12 screens over the next 24 months. Cine Vista continues to seek additional sites for the development of multiscreen movie theaters in Puerto Rico.\nAll of Cine Vista's theaters are modern multiscreen facilities.\nNumber of Existing Theaters Location Screens - - ----------------- -------- ------- Plaza de las Americas Mall San Juan 10 El Senorial Shopping Center San Juan 4 Cinema Centro Bayamon * 6 Plaza del Norte Shopping Center Hatillo 6 Mayaguez Mall 1 Hormigueros ** 6 Cayey Shopping Center Cayey 4 Plaza Palma Real Humacao 8\nUnder Development - - ----------------- Mayaguez Shopping Center Mayaguez 6 Mayaguez Mall 1 Hormigueros ** 10\n* San Juan metropolitan area ** Mayaguez metropolitan area\n1 Cine Vista is negotiating to demolish the building housing four of the existing six screens at the Mayaguez Mall and build a 10-plex on the site. After completion of the 10-plex, the remaining two screens at the Mayaguez Mall would be returned to the landlord.\nPuerto Rico is a self-governing Commonwealth of the United States with a population of approximately 3.8 million people. The Commonwealth exercises control over internal affairs similar to states; however, the relationship with the United States Federal Government is different than that of a state. Residents of Puerto Rico are citizens of the United States but do not vote in national elections and, with certain exceptions, do not pay federal income taxes. Income taxes are paid instead under a system established by the Commonwealth. In recent years there have been two major views concerning the future relationship with the United States Government, one favoring statehood and the other favoring continuation of commonwealth status. In 1993, Puerto Rico voters were asked in a plebiscite to express their preference for statehood (48.4%), commonwealth status (46.2%) or independence (4.4%). The United States mainland is Puerto Rico's largest trading partner.\nDuring the last four years, the Commonwealth has undergone significant retail shopping center development during which period the number of multiplex theaters has increased substantially. With approximately one screen per 24,000 of population, versus approximately one screen per 10,000 in the mainland United States, the Company\nbelieves that Cine Vista has an opportunity to expand its operations through the development of new multiplex theaters and improvement of its existing operations.\nCine Vista derives approximately 70% of its revenues from box office receipts. Ticket prices vary by location, and provide for reduced rates for senior citizens and children. Box office receipts are reported net of a 10% excise tax imposed by the Commonwealth. Show times and features are placed in advertisements in local newspapers with the costs of such advertisements paid by Cine Vista. Film distributors may supplementally advertise certain feature films with the costs generally paid by distributors.\nConcession sales account for approximately 25% of total revenues. Concession products primarily include popcorn, candy, and soda. Cine Vista has implemented training programs and incentive programs and experiments with product mix changes in order to increase the amount and frequency of concession purchases by theater patrons.\nScreen advertising revenues contribute approximately 4% of total revenues. Cine Vista has agreements with a major soft-drink bottler and an independent advertising production company to show advertisements on theater screens prior to feature film showings. Other sources of revenue include revenues from theater rentals for meetings, conferences, special film exhibitions and vending and video machine receipts or rentals.\nFilms are licensed under agreements with major film distributors and several local distributors specializing in films of special interest to the Commonwealth. Commonwealth regulations generally require that film exhibitors be provided with an opportunity to view films prior to submitting bids, that film distributors provide advance notice of films which will be provided to the market, and are generally designed to preclude anticompetitive practices. Films are licensed on a film-by-film, theater-by-theater basis. Generally, film payment terms provide for payment to film distributors under a percentage of gross box office receipts formula or an adjusted gross receipts formula. Under the gross receipts formula, the film distributor receives a specified percentage of the gross box office receipts. Ordinarily, the percentage will decline from a range of 60-70% in the first playweek to a low of 30% after 4-5 weeks. Under an adjusted gross receipts formula, the film distributor receives a specified percentage (usually 90%) of the box office receipts over the \"House Allowance,\" a negotiated allowance for theater expenses.\nCine Vista licenses film from substantially all of the major United States studios and is not dependent upon any one film distributor for all of its products. However, in the event the Company was unable to license film from a major studio, such lack of supply could have a material effect upon Cine Vista's business. Cine Vista believes that the popularity of the Puerto Rico exhibition market and the Commonwealth rules governing film licensing make such a situation unlikely. In 1995, films licensed from Cine Vista's 4 largest film suppliers accounted for approximately 65% of Cine Vista's box office revenues.\nCompetition - The Company believes there are approximately 30 first-run movie theaters in daily operation with approximately 156 screens in Puerto Rico. Based upon number of screens, box office revenues and number of theaters, Cine Vista is the second largest exhibitor in the Commonwealth. The three largest exhibitors are believed to account for over 98% of the box office revenues recorded in 1995 by theaters in daily operation. Competition among the theater exhibitors exists not only for theater patrons within certain geographic areas, but also for the licensing of films and the development of new theater sites. The number of sites suitable for multiplex cinema is limited. Competitors of Cine Vista are expected to open competitive theaters with approximately 30 screens during the next twelve months, certain of which are in locations competitive with those of Cine Vista's. It is likely that these new theaters will attract business that would otherwise have gone to theaters owned by Cine Vista.\nSeasonality - Most major films are released to coincide with the summer months, when schools are closed, or the winter holiday seasons. Accordingly, Cine Vista has historically recorded greater revenues and earnings during the second half of the calendar year.\nReading International LLC\nIn November 1995, the Company and Craig formed Reading International to develop and operate multiplex cinemas in Australia. Reading and Craig each committed to make an initial contribution of $5 million on an as needed basis for an aggregate initial capitalization of $10 million. The provisions of the agreement which governs the activities of Reading International provide, among other things, that each party will have preemptive rights with respect to the provision of future capital and rights of first refusal regarding any proposed disposition of the other's interest in Reading International.\nReading International has retained the services of several key executive employees resident in Australia to assist in the implementation of its plan to be a major participant in the Australian market for multiplex theaters. A site has been acquired in Melbourne, Australia, on which the Company intends to develop a 24 screen multiplex theater, subject to obtaining the necessary governmental land use entitlements and approvals. The contracts with respect to that site provide for a total purchase price of approximately $6.5 million. In addition, corporate joint venture agreements between Reading International and an existing owner and operator of cinemas in Australia are currently being negotiated with respect to the development and management of certain additional cinema sites. Reading International is also in negotiation with several developers and landlords with respect to other potential locations.\nOn March 29, 1996, the Company and Craig entered into a capital funding agreement (the \"Capital Funding Agreement\") with respect to Reading International pursuant to which they agreed to increase the capital committed by the Company and Craig to Reading International from $10 million to approximately $103 million through a combination of cash contributions and secured capital funding undertakings. Under the terms of the Capital Funding Agreement, the Company and Craig each agreed to immediately contribute to Reading International $12,500,000 in cash, for an aggregate $25,000,000. In addition, the Company and Craig have undertaken to contribute up to an additional $37,500,000 each, for an aggregate future commitment of $75,000,000 on an as needed basis. The commitments of the Company and Craig are secured by various assets of the two parties. The collateral pledged by Craig was reviewed by an independent committee of the Company's Board of Directors comprised of outside directors who are unaffiliated with Craig, and found to be adequate.\nAlthough the Company believes that there are significant opportunities for multiplex cinema development in Australia, several substantial and well capitalized competitors are already well established and active in this market. Accordingly, although Reading International believes that it has retained talented and experienced senior executives to lead its operations in Australia, no assurance can be given that Reading International will be able to successfully develop sites or to compete successfully in this market. Reading International activities in this market are currently entirely developmental in nature.\nOther Acquisition and Development Activities\nOn November 8, 1995, the Company, for a price of $1,285,000, acquired from a major bank a judgement encumbering, among other things, a controlling interest in a Company which owns a Manhattan multiplex theater. The judgement has been acquired as part of the Company's plan to acquire, in conjunction with Manhattan-based City Cinemas Corp. (\"City Cinemas\"), all or at least a controlling interest in this multiplex theater. James J. Cotter, Chairman of the Company, has an ownership interest in City Cinemas. The Company has also acquired options to obtain shares representing 5\/13ths of the voting power of the company owning the multiplex theater and to obtain certain other creditor claims against that company. No assurance can be given that the Company's plan to acquire the theater will ultimately prove successful.\nIn January 1994, the Company and an affiliate of Pacific formed PRT as a California general partnership in order to fund the development of new multiplex theaters to be built and managed by Pacific in California and Hawaii. In early 1995, the Company and Pacific dissolved PRT in order to permit the Company to focus on international theater exhibition opportunities and its expansion of Cine Vista.\nThe Company loaned Oz Resorts and Entertainment, Inc. (\"OREI\") a total of $795,000 in late 1993 and early 1994. The loans were made as part of a transaction intended to result in the acquisition by the Company of a controlling interest in OREI, which owns the rights to the Oz Project, a planned destination theme park, hotel and golf complex in Kansas City, Kansas. In May 1994, the Company entered into an agreement with OREI which provided the Company with a right, but no obligation, to participate in future debt or equity offerings by OREI. The Company elected to write off the $795,000 loan to OREI during 1994 due to the developmental nature of the project. As a result of the Company's acquisition of Cine Vista and its decision to explore international theater exhibition opportunities, the Company has determined not to enter into further financial commitments with respect to the Oz Project.\nReal Estate\nThe Company's real estate activities include the managed sale of certain of its real properties, the possible future development of certain center city Philadelphia properties and participation in two real estate joint ventures.\nThe Company owns property in the Market Street East area which is situated at the hub of center city Philadelphia. Company-owned holdings in Market Street East include several parcels leased to a parking lot operator near the site of the Pennsylvania Convention Center, which total approximately .67 acres. See \"Properties.\"\nIn addition to its properties in center city Philadelphia, the Company also owns a viaduct, a raised structure which was used to carry trains (the \"Viaduct\"), north of Vine Street to Fairmount Avenue and adjacent parcels which collectively total approximately 6.75 acres. The Company also owns approximately 23 parcels and other properties, including rights-of-way, located primarily in eastern Pennsylvania totaling approximately 425 acres. The Company is a participant in two real estate joint ventures, Parametric Garage Associates and S.R. Developers. See \"Properties.\"\nEmployees\nCine Vista employment is seasonal with the number of employees ranging from approximately 165 to 220 depending upon the time of the year. Approximately 15 projectionists are covered by a collective bargaining agreement which expires in May 1997. In late 1993, certain part-time employees voted to be represented by a collective bargaining unit. Approximately 80 employees would be covered by the collective bargaining agreement. To date, no agreement has been signed between the union representing the employees and Cine Vista.\nReading International employs eight people on a full-time or substantially full time basis. In addition to Cine Vista employees and Reading International employees, the Company has ten full-time employees and two part-time employees.\nClasses of Common Stock\nAs of December 31, 1995, the Company had available approximately $163 million in tax loss carryforwards. In order to preserve these carryforwards, the Company in 1989 in essence replaced its Common Stock with a new issue of Class A Common Stock. Substantially all of the Company's outstanding capital stock is now comprised of Class A Common Stock, which limits the ability of a holder thereof to acquire more than 4.75% of the Company's outstanding capital stock unless waived by the Board of Directors of the Company. The Board of Directors has waived certain restrictions on the transfer of Class A Common Stock in order to permit Craig to acquire up to approximately 49.9% of the Company's outstanding capital shares and an unrelated investment partnership to acquire up to 7%. Craig currently owns approximately 49.3% of the Company's outstanding capital shares and the investment partnership owns approximately 5.4%.\nSubsequent Event\nOn March 29, 1996 the (Company purchased from Craig 1,564,473 shares of the common stock, par value $.01 per share, of Citadel Holding Corporation (\"Citadel\" and the \"Citadel Common Stock\", respectively) for an aggregate purchase price of $3,324,505, representing slightly less than $2.125 per share. The closing price of Citadel Common Stock on the American Stock Exchange on March 28, 1996 was $2.25 per share. The Company paid Craig for the Citadel Common Stock with a five year, unsecured promissory note which provides for the payment of interest at a rate equal to the London Interbank Offered Rate (\"LIBOR\") plus 2.25%. The Company also acquired from Craig a one year option to acquire 1,329,114 shares of the 3% Cumulative Voting Convertible Preferred Stock, stated value $3.95 per share of Citadel (the \"Citadel Preferred Stock\") and an option to acquire a warrant to acquire 666,000 shares of Citadel Common Stock (the \"Warrant\").\nThe option to acquire the Citadel Preferred Stock (the \"Preferred Share Option\") will be exercisable commencing on the later to occur of July 1, 1996 or ten business days after the date of the next Citadel Annual Meeting of Stockholders. The Preferred Share Option is exercisable for a period of twelve months at an exercise price equal to the fair market value of the Citadel Preferred Stock as determined by an investment banking firm to be mutually agreed upon or, if the Company determines to proceed with a transaction or series of transactions pursuant to which the Company acquires sufficient additional shares of Citadel Common Stock to permit the consolidation of the Company and Citadel for Federal income tax purposes (an \"Acquisition Transaction\") the exercise price shall be in the amount and form of the price paid by the Company to an unrelated stockholder pursuant to such Acquisition Transaction. In all other cases the exercise price for the Preferred Share Option is payable by delivery by the Company of its promissory note having the same terms (including due date) of the note issued by the Company to acquire the Citadel Common Stock. The Company paid an option fee of $50,000 in cash upon acquisition of the Preferred Share Option, which will be credited against the Preferred Share Option exercise price if exercised. The Company may extend the exercise period for the Preferred Share Option for an additional 12 months by paying an additional option fee of $50,000 prior to expiration of the original 12-month option period, which additional $50,000 will also be credited against the option exercise price, if exercised.\nThe option to acquire the Warrant (the \"Warrant Option\") is exercisable if the Company determines to proceed with an Acquisition Transaction and remains exercisable for a period of twelve months, provided that any closing on the exercise of the Warrant Option is conditioned upon consummation of an Acquisition Transaction. No separate consideration was paid by the Company for the grant of the Warrant Option. The Warrant Option exercise price will be the price per share paid to an unrelated Citadel stockholder in an Acquisition Transaction less $3.00 (the exercise price of the Warrant); provided, however, that if Craig exercises the Warrant prior to exercise of the Warrant Option, the Warrant Option shall become an option to purchase the Citadel Common Stock issued on exercise of the Warrant for an option price equal to the full price paid to an unrelated Citadel stockholder in an Acquisition Transaction.\nIf the Company determines to proceed with an Acquisition Transaction, Craig has the right under the agreement to require the Company to purchase the Preferred Shares and the Warrant (or Common Stock issued on exercise of the Warrant) on the same terms as if the Company had exercised the Preferred Share Option and the Warrant Option.\nThe transaction was separately reviewed, negotiated and approved by a special committee composed of the independent directors of the Board of Directors.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nCenter City Philadelphia Properties\nThe Company's properties in center city Philadelphia, all of which are owned in fee, consist of several parcels of land aggregating approximately .67 acres located near or adjacent to the site of the Convention Center currently leased to a parking lot operator, the Viaduct north of Vine Street to Fairmount Avenue and adjacent parcels, comprising approximately 6.75 acres, and properties owned by partnerships in which the Company has interests. In 1993, the Company sold the Reading Terminal Headhouse, a vacant nine-story building located at 12th and Market Streets containing approximately 196,000 gross rentable square feet, and received gross proceeds of approximately $4.3 million. A center city Philadelphia parcel, totaling .28 acres, was sold in March 1994 generating gross proceeds of approximately $550,000.\nPartnership Properties\nS.R. Developers: A subsidiary of the Company is a general partner in S.R. Developers, a partnership which owns one property in center city Philadelphia.\nParametric Garage Associates: A subsidiary of the Company is a general partner in Parametric Garage Associates, a partnership which owns the 750-car Gallery II Parking Garage (the \"Garage\"). The Garage is adjacent to the Pennsylvania Convention Center Complex. The Company has primary responsibility for the leasing and management of 19,000 gross rentable square feet of retail space on the ground level of the Garage pursuant to a management agreement and provides certain other management services to the partnership.\nOther Domestic Real Estate\nWhen the Company's railroad assets were conveyed to Conrail, the Company retained fee ownership of approximately 650 parcels of real estate located throughout Pennsylvania, Delaware, and New Jersey. In addition, the Company retained portions of 52 abandoned rights-of-way with about 200 more parcels abutting these rights-of-way. Approximately 23 parcels and rights-of-way located outside of center city Philadelphia are still owned by the Company. The parcels consist primarily of vacant land and buildings, some of which are leased.\nCine Vista Properties\nAll of Cine Vista's real properties are leased. The seven theaters are leased pursuant to long-term leases with remaining terms and renewal options ranging from 12 to 38 years. Cine Vista has executed an additional theater lease, which lease term commences with occupancy, expected in late 1996. The landlord of one of Cine Vista's theaters has the right to terminate the lease relating to space presently housing two theaters, subject to six months' notice. All of Cine Vista's theater leases provide for the payment of minimum fixed rental payments and, in certain cases, may require additional payments based upon a percentage of theater revenues. Cine Vista also leases approximately 6,100 square feet of warehouse space and 2,200 square feet of office space.\nReading International Properties\nReading International maintains leased offices in Melbourne and Sydney, Australia pursuant to short term leases. The total space leased is approximately 2,300 square feet. In December 1995, Reading International acquired a site of approximately 43 acres in a suburban area outside of Melbourne. Reading International has also entered into a purchase agreement to acquire an additional six acres adjacent to the acquired site. Reading International intends to build a 24 screen multiplex theater on this site and is in the process of securing necessary permits to permit such development. No assurances can be given that the Company will be successful in this development effort. Reading International is also aggressively pursuing other locations in and about Sydney and\nMelbourne and elsewhere in Australia upon which it may develop theater operations. It has made several refundable deposits related to lease and purchase proposals.\nItem 3.","section_3":"Item 3. Legal Proceedings\nReading Railroad Employee Health Claims\nThe Company is a defendant in actions instituted in the United States District Court for the Eastern District of Pennsylvania or the [Pennsylvania State] Court of Common Pleas by or on behalf of persons who had been employed by the Reading Railroad prior to its reorganization under the federal bankruptcy laws in 1980. In general, these actions also name Conrail, which acquired substantially all of Reading's railroad assets in connection with the Company's reorganization, as a defendant. Approximately 115 plaintiffs seek damages under the Federal Employers Liability Act (\"FELA\") in varying amounts for illnesses or death allegedly caused by exposure to asbestos fibers while employed by the Reading Railroad and, in some cases, by Conrail. Approximately 122 plaintiffs in pending actions seek damages in varying amounts for alleged impaired hearing suffered while employed by the Reading Railroad prior to its reorganization and, in some cases, by Conrail. The underlying actions are proceeding to trial.\nThe eventual outcome of the above-described litigation cannot be predicted at this time, and the Company's liability, if any, cannot be accurately determined. However, during 1990, the Company and its insurance carriers entered into an agreement (the \"Settlement Agreement\") which provided the Company with reimbursement for prior payments made to claimants in certain personal injury actions and which provides for the Company to receive reimbursement of amounts expended in conjunction with the matters described above or, if the Company elects, to receive reimbursement from the parties to the Settlement Agreement prior to expenditures. Three participants in the insurance settlement are insolvent. Unreimbursed claims by these three carriers have totaled $61,000. The Company believes that it may be entitled to reimbursement of such amounts from the other parties to the Settlement Agreement and may file for an arbitration hearing on such matters. The Company believes that the amounts available under the Settlement Agreement are sufficient to prevent the above-described litigation from having a materially adverse effect on the financial position, results of operations, or liquidity of the Company.\nCine Vista\nA landlord of Cine Vista has alleged that Cine Vista underpaid rent by approximately $480,000 for the thirty month period ended December 31, 1995. The Company is contesting the landlord's claim and believes the claim to be without merit. If the landlord were to prevail in its assertion, the Company is indemnified by TALP for the amount due at June 30, 1994 ($180,000) and the Company believes it would be entitled to a reduction in the purchase price of TAPR relating not only to the 18 months ended December 31, 1995 but also relating to the 17 1\/2 future years under the lease. Such purchase price reduction would be funded, in part, from the proceeds of the TAPR purchase escrow.\nEnvironmental Litigation\nMcAdoo Site\nThe Company is one of approximately 63 private parties (the \"Settlors\") which in 1988 signed a consent decree (the \"1988 Consent Decree\") to perform a remedial action (the \"RA\") on a Superfund site located on land owned largely by the Company in McAdoo, Pennsylvania (\"McAdoo\"). Apart from future operation and maintenance (\"O&M\") expenses, the entire RA is complete. Under the 1988 Consent Decree, a portion of the costs the Settlors incurred to perform the RA before O&M is reimbursable from the Hazardous Substance Superfund (the \"Fund\"). In 1992, the Settlors submitted to the Fund a claim for reimbursement of such pre-O&M expenses (the \"Claim\").\nTo protect their right to seek contribution towards O&M from certain potentially responsible parties (\"PRPs\") who had refused to join in the 1988 Consent Decree (the \"Non-Settlors\"), the Settlors in 1992 attempted to intervene in the attempted settlement of the federal civil action which the United States had instituted against the Non-Settlors (the \"Non-Settlors Litigation\"). An agreement in principle to settle the Non-Settlors Litigation (the \"Tentative Settlement\") has now been reached and is being documented by the United States. The Company anticipates that the Settlors will approve the Tentative Settlement.\nUnder the Tentative Settlement, the Settlors would withdraw the Claim and instead recover most of the reimbursement sought thereby from funds which the Non-Settlors had deposited, before the Settlors attempted intervention, into a court registry to settle the Non-Settlors Litigation. The amount recovered by the Settlors from the court registry, along with an additional amount newly contributed by the Non-Settlors, would be dedicated to performing the remaining O&M at McAdoo and would also be used to perform certain additional ground water\nmonitoring sought by the United States. The Company has been advised that, in the likely event that the Tentative Settlement is finalized, it is unlikely that any additional amounts will be required to meet any of the Settlors' obligations under either the 1988 Consent Decree or the Tentative Settlement. Any amounts which might be so required would not be material.\nDouglassville Site\nReading Company (\"Reading\") and a wholly-owned subsidiary, Reading Transportation Company (\"RTC\"), have each been advised by the Environmental Protection Agency (\"EPA\") that they are PRPs under environmental laws including Federal Superfund legislation (\"Superfund\") for a site located in Douglassville, Pennsylvania. The EPA issued an Administrative Order under Superfund against 34 PRPs requiring, among other things, that the named parties be required to incinerate materials at the site pursuant to a June 30, 1989 Record of Decision (\"ROD\"). The ROD estimated that the incineration would cost approximately $53 million. Thirty-six PRPs were also named in a civil action brought by the United States which seeks to recover alleged costs incurred at the site by the United States of approximately $22 million. Reading and RTC have each been named in a third-party action instituted by the majority of the 36 PRPs sued by the United States. The actions instituted against the Company and approximately 300 PRPs seek to have the parties contribute to reimbursement for past costs and any costs associated with further remediation at the site.\nOn September 14, 1995, the federal district court judge who presided over Reading's reorganization ruled that all liability asserted against Reading relating to the site was discharged pursuant to the consummation order issued in conjunction with the Company's amended plan of reorganization on December 31, 1980. The United States Department of Justice and a named defendant in the above described Administrative Order have filed appeals of the decision. The judge's decision did not affect the potential liability of RTC for the site. RTC has no assets and therefore cannot fund a settlement or judgement relating to this matter and the Company believes that the potential liability of RTC, if any, is not in excess of $300,000. Based upon the appeal and possible alternate attempts by the PRPs to obtain Reading's participation in funding for the site as well as the existence of the other environmental matters set forth below, the Company has not reduced its provision for these matters, which totals $1.2 million.\nReading Terminal Train Shed Litigation\nIn 1991, the Company filed a lawsuit in the United States District Court for the Eastern District of Pennsylvania against the Southeastern Pennsylvania Transportation Authority (\"SEPTA\"), Conrail, the City of Philadelphia and other parties which sought to recover a portion of the approximately $9 million expended by the Company in conjunction with the cleanup of polychlorinated biphenyls (\"PCBs\") in the Reading Terminal Train Shed and a portion of the viaduct south of Vine Street. The action also sought a declaratory judgement as to future costs which could be incurred in cleaning up the remaining portions of the Viaduct. In January 1995, the parties agreed in principle to settle the claim for approximately $2.35 million which amount the Company anticipates receiving during 1996. The defendants have also agreed to pay an amount ranging from 52% to 55% of costs incurred by the Company, if any, relating to possible PCB contamination on the Viaduct.\nAtlantic City Site\nDuring 1995, the Company settled an action seeking the recovery of $3,800,000 of alleged environmental cleanup costs from five defendants under various provisions of New Jersey law for $235,000 which approximates the amount previously accrued by the Company to provide for its share of the liability.\nOther Environmental\nThe Company removed six underground storage tanks at a site owned by the Company in 1991 and in conjunction with such activities submitted an environmental assessment of the site to the Pennsylvania Department of Environmental Protection (\"DEP\"). DEP has advised the Company that no further action is required at the site. With the advance knowledge and consent of DEP, the Company extinguished a fire at a Company-owned site which\nhad been used as a landfill by the Reading Railroad. The Company neither anticipates nor faces any administrative action against it by DEP concerning the site.\nThe Company believes that the Viaduct may be contaminated by PCBs resulting from former railroad operations on that property conducted by or on behalf of the Reading Railroad, Conrail, the City of Philadelphia or SEPTA. The Company has advised the EPA of the potential contamination. The Company has not determined the scope or extent of any such PCB contamination. However, the Company has been advised by counsel that, given the lack of regulatory attention to the Viaduct in the eleven years which have elapsed since EPA was notified of the likelihood of contamination, it is unlikely that the Company will be required to decontaminate the Viaduct or incur costs related thereto. In the event that the Company was required to incur expenditures to remove PCB contamination on the Viaduct, under terms of the settlement described above, Conrail, the City of Philadelphia and SEPTA would be required to fund 52% to 55% of such costs.\nPrior to the Company's reorganization, the Company had extensive railroad and related operations. Such operations may have contributed to environmental contamination of properties now owned by the Company, previously sold or leased by the Company, or to which the Company, prior to its reorganization, sent waste. The ultimate extent of liabilities, if any, with respect to such matters, as well as the timing of cash disbursements, if any, cannot be determined. However, management is of the opinion, based on the information currently available to it, that while the ultimate liability resulting from such matters could have a material effect upon the results of operations in a given year, they will not have a material adverse effect upon the Company's financial position or liquidity.\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 ---- --- --------\nJames J. Cotter 57 Chairman of the Board of Directors\nS. Craig Tompkins 45 President and Director\nRobert F. Smerling 61 Chief Executive Officer, Domestic and Puerto Rico Cinema Operations, Reading Cinemas and Cine Vista\nJohn Rochester 52 Chief Executive Officer, Australian Cinemas Operations and Reading Australia Pty Ltd.\nJames A. Wunderle 43 Executive Vice President, Chief Operating Officer, Treasurer and Chief Financial Officer\nCharles S. Groshon 42 Vice President\nEileen M. Mahady 30 Controller\nMr. Cotter has been Chairman of the Board of Directors since December 1991, Chairman of the Company's Executive Committee since March 1993 and a director since September 1990. Mr. Cotter has been Chairman of the Board of Craig since 1988 and a director since 1985. Mr. Cotter has been a director and the Chairman of the Board of Citadel Holding Corporation (\"Citadel\") since 1991. From October 1991 to June 1993, Mr. Cotter also served as the acting Chairman of Citadel's wholly-owned subsidiary, Fidelity Federal Bank, FSB (\"Fidelity\"), and served as a director of Fidelity until December 1994. Mr. Cotter has been a director and Chief Executive Officer of Townhouse Cinemas Corporation (motion picture exhibition) since 1987, Executive Vice President and a director of The Decurion Corporation (motion picture exhibition) since 1969 and a director of Stater Bros. Holdings, Inc. (retail grocery chain) and its predecessors since 1987. From 1988 through January 1993, Mr. Cotter also served as the President and a director of Cecelia Packing Corporation (a citrus grower and packer), a company wholly owned by Mr. Cotter. Mr. Cotter is also a director and Executive Vice President of Pacific, a wholly-owned subsidiary of Decurion.\nMr. Tompkins has been President and a director of the Company since March 1994. Mr. Tompkins is also President and a director of Craig and has served in such positions since March 1, 1994. Prior thereto, Mr. Tompkins was a partner in the law firm of Gibson, Dunn & Crutcher for more than five years. Mr. Tompkins has been a director of Citadel since May 1994 and a director of G&L Realty Corp., a New York Stock Exchange listed REIT (Real Estate Investment Trust), since December 1994. He serves as the Vice Chairman of Reading Cinemas and Managing Director of Reading International.\nMr. Smerling has been President of Reading Cinemas, Inc. since November 1994. Mr. Smerling also serves as the President of Cine Vista and the Chief Executive Officer of Reading International. Mr. Smerling served as president of Loews Theater Management Corporation, a subsidiary of Sony Corporation, from May 1990 until November 1994. Mr. Smerling also serves as President and Chief Executive Officer of City Cinemas, a motion picture exhibitor located in New York City, New York. City Cinemas is an affiliate of James J. Cotter and has entered into an Executive Sharing Agreement with the Company with respect to the services of Mr. Smerling.\nMr. Rochester has been Chief Executive Officer of the Australian Cinemas Operations since November 1995. From 1990 through 1995, Mr. Rochester was the Managing Director of Television & Media Services Ltd.\n(formerly Hoyts Entertainment Ltd.). He also served in several other executive offices for that organization since 1987.\nMr. Wunderle has been Chief Operating Officer since February 1990 and Executive Vice President, Treasurer, and Chief Financial Officer since December 1988. He was Vice President of Finance, Chief Financial Officer and Treasurer from January 1987 to December 1988.\nMr. Groshon has been Vice President of the Company since December 1988. He was an internal auditor with the Company from August 1984 until December 1988, and a staff accountant prior thereto.\nMs. Mahady has been Controller of the Company since April 1990. Prior to joining the Company, she was a senior auditor with Ernst & Young. Ms. Mahady is a Certified Public Accountant.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters\nCommon Stock Summary\nThe following table sets forth the high and low prices of the Company's Class A Common Stock from January 1, 1994 through December 31, 1995, as reported on the National Market System of the National Association of Securities Dealers, Inc. (\"NASDAQ\"). The Company's Common Stock trades infrequently on the over-the-counter \"pink sheet\" market. Historical bid\/asked data is insufficient to provide high and low price information on the Company's Common Stock during 1994 and 1995. No cash dividends have been paid on either class of the Company's common stock during any of the periods indicated. Management does not intend to authorize the payment of dividends in the foreseeable future.\nQuarter 1st 2nd 3rd 4th - - ------- --- --- --- ---\nHigh 11 1\/2 11 1\/8 10 3\/16 9 1\/2 Low 9 5\/8 9 7\/8 9 8 1\/2\nQuarter 1st 2nd 3rd 4th - - ------- --- --- --- ---\nHigh 11 3\/4 10 1\/2 11 1\/8 11 1\/2 Low 9 7\/8 9 1\/2 9 3\/4 11\nOn March 28, 1996, the high, low, and closing prices of the Company's Class A Common Stock were $10.81, $10.63 and $10.63, respectively. On March 28, 1996, there were approximately 1,200 shareholders of record of the Company's Class A Common Stock and approximately 350 shareholders of record of the Company's Common Stock, which amounts do not include individual participants in security position listings.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe following table sets forth certain historical consolidated financial information for the Company. This table is based on, and should be read in conjunction with, the Consolidated Financial Statements included elsewhere herein and the related notes thereto.\n(in thousands, except per share information)\n(1) Results of operations of Cine Vista have been included since its acquisition effective July 1, 1994.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nResults of Operations\nDue to the nature of the Company's historical business activities, the Company's revenues and earnings have varied significantly reflecting the results of real estate and other asset sales. In addition, the operating results of Cine Vista are only included in the consolidated operating results of the Company since July 1, 1994 (see Note 2 to the Consolidated Financial Statements contained elsewhere herein and \"Item 1. Business\"). Accordingly, year-to-year comparisons of operating results will not be indicative of future financial results.\nRevenues:\nRevenues increased to $19,973,000 in 1995 from $10,990,000 in 1994 and $3,509,000 in 1993 due largely to the inclusion of $14,991,000 and $8,100,000 in revenue from Cine Vista for the year and six months ended December 31, 1995 and December 31, 1994, respectively. Cine Vista's business is seasonal and the second six months of the year have historically provided more than a proportionate share of annual revenue.\n\"Real estate\" revenues include gains and losses from real estate sales, rental income and real estate development activities. \"Real estate\" revenues decreased to $272,000 in 1995 from $697,000 in 1994 and $533,000 in 1993 due in part to fewer sales of the Company's remaining real estate parcels. Real estate revenues included $179,000 in 1994 representing the Company's share of fire insurance proceeds from the S.R. Developers joint venture and in 1993 included $294,000 relating to the Rutherford Industrial Center joint venture as well as a $151,000 loss from the sale of the Reading Terminal Headhouse (gross proceeds received from the sale totaled $4,300,000). The Company has approximately 23 parcels and rights-of-way located outside of center city Philadelphia, all of which are for sale, and several properties in center city Philadelphia which it may sell or develop. Other than the parcels located in center city Philadelphia, the size and location of the remaining properties limit their salability. Accordingly, the Company believes that future proceeds from sales of real estate will continue to decrease.\n\"Interest and dividends\" revenues in 1995 increased $301,000 to $2,435,000 from 1994 and decreased $338,000 from $2,773,000 in 1993. The increase in \"Interest and dividends\" revenue in 1995 versus 1994 was a result of higher interest yields on invested funds. The reduction between 1993 and 1994 was due to lower investable fund balances (due primarily to the $22,700,000 purchase of Cine Vista) and lower interest yields in 1994 versus 1993.\n\"Condemnation and other\" revenues increased to $2,341,000 in 1995 from $79,000 in 1994 and $203,000 in 1993. In 1995, these revenues included $1,146,000 in condemnation proceeds, $425,000 received by the Company in settlement of certain litigation, $319,000 received in settlement of two matters related to the Company's former railroad operations and $223,000 related to unclaimed reorganization debt-holders' obligations (See Note 13 to the Consolidated Financial Statements contained elsewhere herein).\nExpenses:\n\"Theater costs,\"\"Theater concession costs\" and substantially all of \"Depreciation and amortization\" expense reflect the direct theater costs of Cine Vista's operations since Cine Vista's acquisition, effective July 1, 1994.\n\"General and administrative\" expenses decreased $353,000 in 1995 from $4,553,000 in 1994 to $4,200,000 in 1995. In 1995, these expenses included $922,000 related to Cine Vista's operations for the twelve months ended December 31, 1995 versus $427,000 in such expenses for the six months ended December 31, 1994, both of which amounts are net of management fees paid to Reading Company by Cine Vista. The increase associated with the inclusion of Cine Visa's general and administrative expenses for a full year in 1995 was offset by a $795,000 charge in 1994 to fully reserve a loan to OREI (See Note 4 to the Consolidated Financial Statements contained elsewhere herein). \"General and administrative\" expenses increased $764,000 in 1994 from $3,789,000 in 1993 due primarily to the inclusion of the $795,000 loan provision described above and $427,000 in Cine Vista general and administrative expenses offset in part by a reduction in costs resulting from the 1993 sale of the Reading Terminal Headhouse.\n\"Equity loss from investment in Australian theater developments\" reflects the Company's 50% share of the initial general and administrative expenses in Australia and noncapitalized development expenditures relating to new theater site analysis and selection (See Note 5 to the Consolidated Financial Statements contained elsewhere herein). The Company does not anticipate material revenues from Reading International during the next 18 months and therefore anticipates continuing losses during such\nperiod as new theaters are developed and operations initiated. The investment in and operating results of Reading International are reported under the equity method.\nDuring 1994, the Company increased its \"Provision for environmental matters\" by $1,306,000, including $1,200,000 for the Douglassville Disposal Site based upon the advice of the Company's counsel, who estimated that the likely range of possible outcomes for the site was from $0 to $3,000,000, and an amount paid of $106,000 (See \"Item 3. Legal Proceedings\" and Note 10 to the Consolidated Financial Statements contained elsewhere herein). The Company recorded a provision for environmental matters of $241,000 in 1993 and paid environmental costs of $249,000, $133,000, and $676,000 during 1995, 1994 and 1993, respectively.\nThe \"Condemnation and other\" revenues of $2,341,000 comprised the Company's net income of $2,351,000 in 1995 versus a loss of $1,652,000 in 1994 and a loss before the cumulative effect of an accounting change of $520,000 in 1993. Cine Vista contributed approximately $1,271,000 and $900,000 in earnings for 1995 and the six months ended December 31, 1994, respectively.\nLiquidity and Capital Resources:\nThe Company's existing financial resources are sufficient to fund the Company's existing operations, obligations, acquisition plans and the present development plans of Cine Vista and Reading International. Reading International is actively seeking properties to develop in Australia and has acquired one site and has made deposits for several other real property purchases or leases. The Company is also negotiating to acquire a theater in Manhattan (See Note 4 to the Consolidated Financial Statements contained elsewhere herein). Cine Vista has two new theaters under development and is seeking additional theater sites in Puerto Rico. In order to assure that the Company has adequate liquidity to fund its current and planned activities the Company (i) arranged a line of credit for Cine Vista (described below) (ii) formed Reading International and entered into the Capital Funding Agreement (described below) and (iii) issued a promissory note in conjunction with its acquisition of the Citadel Common Stock (described below).\nIn November 1995, the Company and Craig formed Reading International in order to make available additional capital and liquidity to develop theater opportunities in Australia. On March 29, 1996, the Company and Craig entered into the Capital Funding Agreement with respect to Reading International pursuant to which they agreed to increase the capital committed by the Company and Craig to Reading International from $10 million to approximately $103 million through a combination of cash contributions and secured capital funding undertakings (See Note 16 to the Consolidated Financial Statements contained elsewhere herein). The Company and Craig each agreed to immediately contribute to Reading International $12,500,000 in cash and have undertaken to contribute up to an additional $37,500,000 on an as needed basis (the \"Funding Commitment\"). To secure the Funding Commitment, the Company pledged its interest in Cine Vista and government agency securities. The Company may substitute collateral for the Funding Commitment provided that the fair market value of the collateral substituted is equal to at least 125% of the Funding Commitment or, in the case of government or government agency securities, equal to 100% of the Funding Commitment. The Capital Funding Agreement allows the Company and Craig to be assured that each of the participants in Reading International has an adequate asset base to meet its Funding Commitment without requiring the parties to incur the expense associated with borrowing funds in advance of the need for funding. If the Company is successful in its negotiation to acquire the Manhattan theater described above, it anticipates utilizing the proceeds from the sale of a portion of its government agency securities to fund the purchase and substituting its interest in the acquired theater to secure its Capital Funding Commitment.\nCine Vista entered into a revolving credit agreement in December 1995 (the \"Credit Agreement\"). In accordance with the terms of the Credit Agreement, Cine Vista may borrow up to $15,000,000 to repay certain loans payable to a wholly-owned subsidiary of the Company and fund certain new theater development expenditures (See Note 14 to the Consolidated Financial Statements contained elsewhere herein). No amounts are presently outstanding under the Credit Agreement. The Company may use funds available under the Credit Agreement to fund non-Cine Vista theater development activities or other activities provided that a portion of such funds remain available under the Credit Agreement to fund certain Cine Vista development projects.\nOn March 29, 1996, the Company purchased from Craig 1,564,473 shares Citadel Common Stock for $3,324,505 (See Part I Subsequent Event and Note 17 to the Consolidated Financial Statements contained elsewhere herein). The Company paid Craig for the Citadel Common Stock with a five year unsecured promissory note which provides for the payment of interest at a rate equal to LIBOR plus 2.25%. The Company also acquired from Craig a one year option to acquire, at fair market value, as determined by an investment banker selected by the parties, 1,329,114 shares of the 3% Cumulative Voting Convertible Preferred Stock, stated value $3.95 per share of Citadel and an option to acquire a warrant to acquire 666,000 shares of Citadel Common Stock. If the Company elects to exercise the option to acquire the Citadel Preferred Stock, the Company may pay for the acquisition with the issuance of a note with the same terms as the note issued in payment of the Citadel Common Stock. Debt service on the note (or notes, if the Company acquires the Citadel Preferred Stock) will be paid from the Company's working capital.\nIn January 1995, the Company and several parties agreed to settle litigation whereby the Company sought to recover certain environmental cleanup costs previously expended by the Company on properties it formerly owned (See Note 16 to the Consolidated Financial Statements contained elsewhere herein). The agreement provides for the Company to receive payments totalling $2.35 million to recover these costs, which amount the Company anticipates receiving in 1996. The parties to the settlement also agreed to pay an amount ranging from 52% to 55% of certain future costs, if any, the Company may incur in cleaning environmental contamination on the Viaduct (See Note 10 to the Consolidated Financial Statements contained elsewhere herein and \"Legal Proceedings -- Reading Terminal Train Shed Litigation\").\nPrior to the Company's reorganization, the Company had extensive railroad and related operations. Such operations may have contributed to environmental contamination of properties now owned by the Company, previously sold by the Company, or to which the Company, prior to its reorganization, sent waste. The ultimate extent of liabilities, if any, with respect to such matters, as well as the timing of cash disbursements, if any, cannot be determined. However, management is of the opinion, based on the information currently known, that while the ultimate liability resulting from such matters could have a material effect upon the results of operations in a given year, they will not have a material adverse effect upon the Company's financial position or liquidity.\n1995:\n\"Unrestricted cash and cash equivalents\" together with \"Available-for-sale securities\" decreased $747,000 in 1995 from $44,936,000 in 1994 to $44,189,000 at December 31, 1995. Working capital decreased $717,000 from $43,383,000 at December 31, 1994 to $42,666,000 at December 31, 1995.\nWhile not necessarily indicative of its results of operations determined under generally accepted accounting principles. Cine Vista's operating cash flow (income before depreciation and amortization) of $2,625,000 contributed to the Company's liquid funds in 1995. Other principal sources of liquid funds in 1995 were $2,435,000 in \"Interest and dividends\" income, $2,341,000 in \"Condemnation and other\" proceeds from litigation (See Note 13 to the Consolidated Financial Statements contained elsewhere herein), a decrease of $664,000 in \"Insurance proceeds receivable\", a decrease of $208,000 in \"Restricted cash\" and $185,000 in proceeds from real estate joint venture investments.\nIn addition to operating expenses, principal uses of liquid funds in 1995 include a $1,040,000 increase in amounts \"Due from affiliate\" related to the Company's advance to Reading International on behalf of Craig for their share of certain capital contributions to the entity (See Note 5 to the Consolidated Financial Statements contained elsewhere herein) which amount was reimbursed by Craig to the Company in February 1996, $1,828,000 for the purchase of property, plant and equipment related primarily to Cine Vista's new eight screen multiplex theater which commenced operations during December 1995 (See Note 11 to the Consolidated Financial Statements contained elsewhere herein) and $1,285,000 for the purchase of a judgement encumbering certain cinema assets located in Manhattan (See Note 4 to the Consolidated Financial Statements contained elsewhere herein). Other uses of funds include $392,000 in payments of other liabilities and an increase of $529,000 in \"Amounts receivable.\"\n1994:\n\"Unrestricted cash and cash equivalents\" together with \"Available-for-sale securities\" decreased $21,378,000 in 1994 from $66,314,000 at December 31, 1993 to $44,936,000 at December 31, 1994 due primarily to the $22,700,000 purchase of Cine Vista. Working capital decreased accordingly. \"Available-for-sale securities\" consist of liquid treasury securities having maturities in excess of three months at the time of acquisition.\nWhile not necessarily indicative of its results of operations determined under generally accepted accounting principles, Cine Vista's operating cash flows (income before depreciation and amortization) of $1,573,000 for the period subsequent to July 1, 1994 (the acquisition effective date) contributed to the Company's liquid funds in 1994. Other principal sources of liquid funds were $2,114,000 in \"Interest and dividends\" income and receipt of $1,000,000 in full repayment of a loan made in 1993 to an officer of Reading Cinemas in accordance with the terms of his employment by the Company (see Note 12 to the Consolidated Financial Statements contained elsewhere herein).\nOther sources of liquid funds included $570,000 in proceeds from sales of real estate and a net increase of $829,000 in \"Accounts payable and accrued expenses,\" primarily due to Cine Vista operations subsequent to the purchase date. In addition to the purchase of Cine Vista, principal uses of liquid funds include a net increase of $654,000 in insurance proceeds receivable, a $470,000 loan to OREI, and a net decrease of $458,000 in other liabilities.\n1993:\nPrincipal sources of liquid funds in 1993 included $4,470,000 in proceeds from sales of real estate and \"Interest and dividends\" income of $2,773,000. In addition to operating expenses, principal uses of liquid funds included a reduction in accrued expenses and accounts payable of $660,000 which expenses related to the extinguishment of a fire on land owned by the Company in the fourth quarter of 1992. Principal uses of funds also included payment of $298,000 in accrued professional fees and the $1,000,000 loan to the officer of Reading Cinemas in accordance with the terms of his employment by the Company, which loan was repaid in 1994.\nEffects of Inflation\nThe Company does not believe that inflation has a material effect upon its existing operations.\nEffects of a Change in Accounting Principle\nThe Company adopted the Statement of Financial Accounting Standard (\"SFAS\") No. 109, \"Accounting for Income Taxes\" on January 1, 1994 without restating prior years' financial statements. The cumulative effect of $132,000 resulting from this change in accounting principle was recorded in the Consolidated Statement of Operations for the three months ended March 31, 1994. This amount is equivalent to the deferred tax asset recorded for the tax benefits which are more likely than not to be realized from the Company's net operating loss carryforwards.\nIn October 1995, the Financial Accounting Standards Board (\"FASB\") issued SFAS No. 123, \"Accounting for Stock-Based Compensation.\" SFAS No. 123, which must be adopted in 1996, establishes financial accounting and reporting standards for stock-based employee compensation plans, and establishes accounting standards for issuance of equity instruments to acquire goods and services from non-employees.\nIn March 1995, the FASB issued SFAS No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.\" SFAS No. 121, which must be adopted in 1996, establishes accounting standards for the, impairment, or disposal of long-lived assets, and certain intangible assets.\nThe Company does not expect that adoption of SFAS No. 121 and SFAS No. 123 will have a material effect on its consolidated financial position, consolidated statement of operations or liquidity.\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 through.\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, to the extent that it relates to directors of the Company, is incorporated by reference to the Company's proxy statement with respect to its 1996 Annual Meeting of Shareholders and, to the extent that it relates to executive officers, appears in Part I hereof.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe information required by this item is incorporated by reference to the Company's proxy statement with respect to its 1996 Annual Meeting of Shareholders.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThe information required by this item is incorporated by reference to the Company's proxy statement with respect to its 1996 Annual Meeting of Shareholders.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThe information required by this item is incorporated by reference to the Company's proxy statement with respect to its 1996 Annual Meeting of Shareholders.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(a)(1) Financial Statements\nAll other schedules for which provision is made in the applicable accounting regulations of the Commission are not required under the related instructions or are not applicable and therefore have been omitted.\n(a)(3) Exhibits\n2(a) Purchase Agreement dated July 8, 1994 by and among Theater Acquisitions, L.P., Theater Acquisitions of Puerto Rico, Inc., and Reading Company. (Incorporated by reference to Exhibit 2(a) to the Company's Form 10-Q for the period ended June 30, 1994.)\n2(b) Letter Agreement dated August 9, 1994 by and among Theater Acquisitions, L.P., Theater Acquisitions of Puerto Rico, Inc., and Reading Company. (Incorporated by reference to Exhibit 2(b) to the Company's Form 10-Q for the period ended June 30, 1994.)\n3.1 Articles of Incorporation of Registrant. (Incorporated by reference to Exhibit 3(A) in Registration Statement No. 2-87410, as amended.)\n3.2 Form of Amended and Restated Articles of Incorporation of Registrant. (Incorporated by reference to Exhibit 3(C) in Registration Statement No. 2-87410, as amended.)\n3.3 Copy of Amendment to Articles of Incorporation filed October 13, 1989. (Incorporated by reference to Exhibit 3.4 in registrant's annual report on Form 10-K for the year ended December 31, 1989.)\n3.4 Copy of Amendment to Articles of Incorporation filed October 13, 1989. (Incorporated by reference to Exhibit 3.5 in registrant's annual report on Form 10-K for the year ended December 31, 1989.)\n3.5 By-Laws of Registrant, as amended March 4, 1992. (Incorporated by reference to Exhibit 3.6 in registrant's annual report on Form 10-K for the year ended December 31, 1991.)\n3.6 By-Laws of Registrant, as amended February 26, 1993. (Incorporated by reference to Exhibit 3.6 in registrant's annual report on Form 10-K for the year ended December 31, 1993.)\n3.7 By-Laws of Registrant, as amended October 6, 1995.\n4.1 Instruments Defining the Rights of Security Holders. (Incorporated by reference to Exhibits 3.1 and 3.5 hereof and to Exhibit 4 in Registration Statement No. 2-87410, as amended.)\n10.1 Reading Company 1982 Non-Qualified Stock Option Plan, as Amended. (Incorporated by reference to Exhibit 4(b) to Registration Statement No. 2-83039, as amended).\n10.2 Reading Company 1982 Incentive Stock Option Plan, as Amended. (Incorporated by reference to Exhibit 4(a) to Registration Statement No. 2-83039, as amended.)\n10.3 Reading Company 1992 Non-Qualified Stock Option Plan. (Incorporated by reference to Exhibit 4(B) to Registration Statement No. 33-57222, as amended.)\n10.4 Executive Sharing Agreement by and between Reading Cinemas, Inc. and City Cinemas Corp. dated as of November 1, 1993. (Incorporated by reference to Exhibit 10.1 to registrant's annual report on Form 10-K for the year ended December 31, 1993).\n10.5 Lease Agreement between Plaza Las Americas, Inc. and Wometco de Puerto Rico, Inc. dated as of August 24, 1979, as amended. (Incorporated by reference to Exhibit 10.5 to registrant's annual report on Form 10-K for the year ended December 31, 1994).\n10.6 Lease Agreement between TJAC (Hatillo), S.E. and Theater Acquisitions of Puerto Rico, Inc. dated as of May 11, 1992. (Incorporated by reference to Exhibit 10.6 to registrant's annual report on Form 10-K for the year ended December 31, 1994).\n10.7 Agreement of Lease between Cinema Centro, S.E. and Theater Acquisitions of Puerto Rico, Inc. dated as of May 16, 1994. (Incorporated by reference to Exhibit 10.7 to registrant's annual report on Form 10-K for the year ended December 31, 1994).\n10.8 Memorandum of Understanding by and between Reading Company and Robert Kory dated May 19, 1994. (Incorporated by reference to Exhibit 10.8 to registrant's annual report on Form 10-K for the year ended December 31, 1994).\n10.9 Lease Agreement between Palma Real Associates, S.E. and Theater Acquisitions of Puerto Rico, Inc. dated as of July 13, 1994.\n10.10 The First Amendment dated May 10, 1995 between Palma Real Associates, S.E. and Reading Cinemas of Puerto Rico, Inc. (successor by merger to Theater Acquisitions of Puerto Rico, Inc.) to the Lease Agreement between Palma Real Associates, S.E. and Theater Acquisitions of Puerto Rico, Inc. dated as of July 13, 1994.\n10.11 Credit Agreement by and between Reading Cinemas of Puerto Rico, Inc., and Citibank, N.A., as administrative agent for the Lenders thereunder dated as of December 20, 1995.\n10.12 The First Amendment dated February 7, 1996 to the Credit Agreement by and between Reading Cinemas of Puerto Rico, Inc., and Citibank, N.A., as administrative agent for the Lenders thereunder dated as of December 20, 1995.\n10.13 Limited Liability Company Agreement of Reading International Cinemas LLC dated November 9, 1995.\n10.14 RC Revocable Trust Agreement between Reading Investment Company, Inc. and Craig Corporation and Craig Management, Inc. as trustee, dated November 9, 1995.\n10.15 Lease Agreement between Mayaguez Shopping Center, S.E. and Reading Cinemas of Puerto Rico, Inc. dated as of August 10, 1995.\n10.16 Contract of Sale of Real Estate between Brick & Pipe Industries LTD and Burgundy Two Pty LTD dated October 10, 1995.\n10.17 Contract of Sale of Real Estate between Royal Society for the Prevention of Cruelty to Animals (Victoria) Incorporated and Burgundy Two Pty LTD dated November 9, 1995.\n10.18 Stock Purchase and Sale Agreement dated as of March 30, 1996 by and between Reading Holdings, Inc. and Craig Corporation.\n10.19 Amended and Restated Capital Funding Agreement by and between Reading Investment Company, Inc., Craig Corporation, Craig Management Inc., and Reading International Cinemas LLC.\n21.1 Registrant's Subsidiaries.\n23.1 Consent of Independent Auditors - Ernst & Young LLP.\n(b) Reports on Form 8-K.\nNone\n(c) See item 14(a)(3) above.\n(d)(1) Not applicable.\n(d)(2) Not applicable.\n(d)(3) Not applicable.\n27. FINANCIAL DATA SCHEDULE\nReading Company and Subsidiaries Consolidated Balance Sheets (in thousands, except shares and per share amounts)\nDecember 31, - - -------------------------------------------------------------------------------- 1995 1994 - - -------------------------------------------------------------------------------- ASSETS\nCurrent Assets\nCash and cash equivalents $44,147 $9,413 Available-for-sale securities 42 35,523 Amounts receivable, less allowance of $291 in 1995 and $339 in 1994 624 280 Due from affiliate 1,040 0 Restricted cash 360 333 Inventories 112 86 Prepayments and other current assets 498 593 Due from insurance companies 87 751 Deferred tax asset 0 132 - - -------------------------------------------------------------------------------- Total current assets 46,910 47,111 - - -------------------------------------------------------------------------------- Other investments 1,771 438 Equity investment in Australian theater developments 640 0 Restricted cash 362 597 Real estate held for sale or development, less valuation allowance of $42 1,110 1,111 Property and equipment: Buildings 733 720 Capitalized premises lease 538 538 Leasehold improvements 5,095 3,560 Equipment 3,787 2,811 Construction-in-progress 236 103 ------ ------ 10,389 7,732 Less: Accumulated depreciation 1,176 726 ------ ------ 9,213 7,006 Intangible assets: Beneficial leases - net of accumulated amortization of $1,370 in 1995 and $455 in 1994 15,538 16,453 - - -------------------------------------------------------------------------------- 28,634 25,605 - - -------------------------------------------------------------------------------- $75,544 $72,716 ================================================================================\nSee Notes to Consolidated Financial Statements.\nReading Company and Subsidiaries Consolidated Balance Sheets (continued) (in thousands, except shares and per share amounts)\nDecember 31, - - -------------------------------------------------------------------------------- 1995 1994 - - -------------------------------------------------------------------------------- LIABILITIES AND SHAREHOLDERS' EQUITY\nCurrent Liabilities\nAccounts payable $2,279 $1,468 Accrued compensation 222 218 Accrued taxes and other 528 627 Film rent payable 299 359 Other liabilities 916 1,056 - - -------------------------------------------------------------------------------- Total current liabilities 4,244 3,728 - - --------------------------------------------------------------------------------\nCapitalized lease, less current portion 521 525 Other liabilities 2,067 2,377 - - -------------------------------------------------------------------------------- Total long term liabilities 2,588 2,902 - - --------------------------------------------------------------------------------\nCommitments and contingencies (See Note 10)\nShareholders' Equity\nPreferred stock, par value $1.00 per share: Authorized -- 5,000,000 shares Common stock, par value $.01 per share: Authorized -- 10,000,000 shares Issued 1995 -- 11,530 shares; 1994 -- 12,291 shares 1 1 Class A common stock, par value $.01 per share: Authorized -- 15,000,000 shares Issued 1995 -- 5,145,161 shares; 1994 -- 5,144,400 shares 51 51 Unrealized loss on available-for-sale securities 0 (286) Other capital 56,257 55,057 Retained earnings 15,035 13,884 Foreign currency translation adjustment (10) 0 Class A common stock in treasury, at cost: 1995 -- 183,397 shares; 1994 -- 183,250 shares (2,622) (2,621) - - -------------------------------------------------------------------------------- Total shareholders' equity 68,712 66,086 - - -------------------------------------------------------------------------------- $75,544 $72,716 ================================================================================\nSee Notes to Consolidated Financial Statements.\nReading Company and Subsidiaries Consolidated Statements of Operations (in thousands, except shares and per share amounts)\nYear Ended December 31, - - -------------------------------------------------------------------------------- 1995 1994 1993 - - -------------------------------------------------------------------------------- REVENUES: Theater: Admissions $10,356 $5,633 $0 Concessions 3,883 2,141 0 Advertising and other 686 306 0 Real estate 272 697 533 Interest and dividends 2,435 2,134 2,773 Condemnation and other 2,341 79 203 - - -------------------------------------------------------------------------------- 19,973 10,990 3,509 - - -------------------------------------------------------------------------------- EXPENSES: Theater costs 10,784 5,742 0 Theater concession costs 640 360 0 Depreciation and amortization 1,369 681 11 General and administrative 4,200 4,553 3,789 Provision for environmental matters 0 1,306 241 Equity loss from investment in Australian theater developments 390 0 0 - - -------------------------------------------------------------------------------- 17,383 12,642 4,041\nIncome (loss) before income taxes and cumulative effect of accounting change 2,590 (1,652) (532) Federal income tax (benefit) 239 0 (12) - - -------------------------------------------------------------------------------- Income (loss) before cumulative effect of accounting change 2,351 (1,652) (520) Cumulative effect of accounting change 0 0 132 - - -------------------------------------------------------------------------------- Net income (loss) $2,351 ($1,652) ($388) - - -------------------------------------------------------------------------------- Per share information: Income (loss) before cumulative effect of accounting change $0.47 ($0.33) ($0.11) Cumulative effect of accounting change 0.00 0.00 0.03 - - -------------------------------------------------------------------------------- Net income (loss) $0.47 ($0.33) ($0.08) ================================================================================\nAverage shares outstanding 4,973,369 4,973,548 4,973,649\nSee Notes to Consolidated Financial Statements.\nReading Company and Subsidiaries Consolidated Statements of Cash Flows (in thousands)\nYear Ended December 31, - - -------------------------------------------------------------------------------- 1995 1994 1993 - - -------------------------------------------------------------------------------- OPERATING ACTIVITIES\nNet income (loss) $2,351 ($1,652) ($388) Adjustments to reconcile net income (loss) to net cash provided from (used for) operating activities: Condemnation award (1,146) 0 0 Cumulative effect of accounting change 0 0 (132) Gain on real estate joint venture investments 0 (179) (294) Gain on sale of other real estate 0 (308) (32) Discharge of reorganization obligations (223) 0 0 Depreciation 453 226 12 Amortization 916 455 0 Deferred rent expense 165 82 0 Deferred income tax expense 132 0 0 Equity loss from investment in Australian theater developments 390 0 0 Provision for environmental matters 0 1,306 241 Valuation provision for loan to OREI 0 795 0 Changes in operating assets and liabilities: (Increase) decrease in amounts receivable (529) 89 (59) (Increase) decrease in inventories (26) 24 0 Decrease (increase) in prepaids and other current assets 95 (119) 70 Decrease (increase) in insurance proceeds receivable 664 (654) 125 Decrease (increase) in notes receivable due from officer of subsidiary 0 1,000 (1,000) (Decrease) increase in accounts payable and accrued expenses (119) 829 (1,107) Decrease in film rent payable (60) (65) 0 Decrease in other liabilities (392) (458) (132) Other, net (49) 4 23\n- - -------------------------------------------------------------------------------- Net cash provided from (used for) operating activities 2,622 1,375 (2,673) - - --------------------------------------------------------------------------------\nSee Notes to Consolidated Financial Statements.\nReading Company and Subsidiaries Consolidated Statements of Cash Flows (continued) (in thousands)\nSee Notes to Consolidated Financial Statements.\nReading Company and Subsidiaries Consolidated Statements of Shareholders' Equity Years ended December 31, 1995, 1994, 1993 (in thousands, except shares)\nSee Notes to Consolidated Financial Statements.\nReading Company and Subsidiaries\nNotes to Consolidated Financial Statements December 31, 1995 (amounts in tables in thousands, except shares and per share data)\nReading Company (the \"Company\") has operated motion picture exhibition theaters in leased locations in the Commonwealth of Puerto Rico since the acquisition of Theater Acquisitions of Puerto Rico, Inc. (\"TAPR\") in 1994. In November 1995, the Company and Craig Corporation (\"Craig\"), the owner of approximately 49.3% of the Company's capital stock, formed Reading International Cinemas LLC (\"Reading International\"), a limited liability company owned equally by the Company and Craig, which has initiated theater development activities in Australia. The Company's remaining real estate activities include the managed sale of certain of its real properties, the possible future development of certain center city Philadelphia properties and participation in two real estate joint ventures.\nNOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBasis of Consolidation: The consolidated financial statements of Reading Company and Subsidiaries (the \"Company\") include the accounts of Reading Company and its majority-owned subsidiaries. Significant intercompany transactions and accounts have been eliminated. TAPR was acquired as of July 1, 1994 and the results of TAPR have been consolidated with the Company's operating results since that date (See Note 2). On December 31, 1994, TAPR was merged into its parent corporation, Reading Cinemas of Puerto Rico, Inc. (\"RCPR\") with RCPR the successor corporation and the operating name changed to Cine Vista (unless otherwise required by the context, TAPR, RCPR and Cine Vista may be used interchangeably herein).\nIncome Taxes: The Company adopted Statement of Financial Accounting Standard (\"SFAS\") No. 109, \"Accounting for Income Taxes,\" on January 1, 1993, without restating prior years' financial statements. The cumulative effect resulting from this change in accounting principle was recorded in the Consolidated Statement of Operations for the year ended December 31, 1993. This amount is equivalent to the deferred tax asset recorded for the tax benefits which are more likely than not to be realized from the Company's net operating loss carryforwards. Under SFAS No. 109, an income tax provision is recorded in the statement of operations using the enacted income tax rates and the deferred asset is amortized in an amount equivalent to the tax provision as the tax benefits are realized.\nThe Company underwent a quasi-reorganization in 1981. The quasi-reorganization did not require restatement of any assets or liabilities or any other modification of capital accounts. The Company is required to make a transfer from \"Retained earnings\" to \"Other capital\" in the Consolidated Statement of Shareholders' Equity in an amount equal to the tax benefit resulting from utilization of federal net operating loss carryforwards which relate to periods prior to the quasi-reorganization.\nCash Equivalents: The Company considers all highly liquid investments with maturities of three months or less at the time of acquisition to be cash equivalents. Cash equivalents are stated at cost plus accrued interest, which approximates fair market value, and consist principally of federal agency securities and short-term money market instruments.\nAvailable-for-Sale Securities: The Company adopted SFAS No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" on January 1, 1994, without restating prior years' financial statements. Debt securities that a company does not have both the intent and ability to hold to maturity are to be classified as available-for-sale and carried at fair value with unrealized holding gains and losses, net of tax, reported as a separate component of shareholders' equity.\nManagement classifies treasury and federal agency securities held by the Company with maturities in excess of three months at the time of purchase as available-for-sale as such investments together with \"Cash and cash equivalents\" are expected to be used to fund expansion of theater operations, acquisition or other development activities.\nF - 7\nReading Company and Subsidiaries\nNotes to Consolidated Financial Statements December 31, 1995 (amounts in tables in thousands, except shares and per share data)\nThe amortized cost of securities available-for-sale is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization and the interest related to these securities are included in \"Interest and Dividends\" revenues. Any realized gains and losses and declines in value judged to be other-than-temporary on available-for-sale securities are included in earnings.\nUse of Estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nInventories: Inventories are comprised of confection goods used in Cine Vista's operations and are stated at the lower of cost (first-in, first-out method) or net realizable value.\nReal Estate Held for Sale or Development: Real estate held for sale or development is carried at the lower of cost, including related holding costs, or estimated net realizable value and is classified as a noncurrent asset due to the inherent difficulty in estimating the timing of future sales.\nProperty and Equipment: Property and equipment is carried at cost. Depreciation of buildings, capitalized premises lease, leasehold improvements and equipment is recorded on a straight-line basis over the estimated lives of the assets or, if the assets are leased, the remaining lease term (inclusive of options, if likely to be exercised), whichever is shorter. The estimated useful lives are generally as follows:\nBuilding and Improvements 40 years Equipment 15 years Furniture and Fixtures 7 years Leasehold Improvements 20 years\nIntangible Assets: Intangible assets are comprised of beneficial theater leases used in Cine Vista's operations. The amount of the TAPR purchase price ascribed to the beneficial leases was determined by an independent appraiser computing the present value of the excess of market rental rates over the rental rates in effect under TAPR's leases at the time of the Company's acquisition of TAPR and allocating such amount as a component of the purchase price of TAPR. The beneficial leases are amortized on a straight-line basis over the remaining term of the underlying leases, which approximates 19 years.\nTranslation of Non-U.S. Currency Amounts: The financial statements and transactions of Reading International's (See Note 5) Australian operations are maintained in their functional currency (Australian dollars) and translated into U.S. dollars in accordance with SFAS No. 52 \"Foreign Currency Translation.\" Assets and liabilities are translated at exchange rates in effect at the balance sheet date and shareholders' equity is translated at historical exchange rates. Revenues and expenses are translated at the average exchange rate for the period. Translation adjustments are reported as a separate component of shareholders' equity.\nIncome (Loss) Per Share: Income (loss) per share (Common Stock and Class A Common Stock) is calculated by dividing net income (loss) by the aggregate of the weighted average shares outstanding during the period and the dilutive effect, if any, of common stock equivalents that are outstanding.\nReclassifications: Certain amounts in previously issued financial statements have been reclassified to conform with the current presentation.\nF - 8\nReading Company and Subsidiaries\nNotes to Consolidated Financial Statements (continued) December 31, 1995 (amounts in tables in thousands, except shares and per share data)\nAccounting Changes: In October 1995, the Financial Accounting Standards Board (\"FASB\") issued SFAS No. 123, \"Accounting for Stack-Based Compensation.\" SFAS No. 123 must be adopted in 1996 and establishes financial accounting and reporting standards for stock-based employee compensation plans, and establishes accounting standards for issuance of equity instruments to acquire goods and services from non-employees.\nIn March 1995, the FASB issued SFAS No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.\" SFAS No. 121 must be adopted in 1996 establishes accounting standards for the impairment of long-lived assets, certain intangible assets and costs in excess of net assets related to those assets to be held and used and for long-lived assets and certain identifiable intangibles to be disposed of.\nThe Company does not expect that adoption of SFAS No. 121 and SFAS No. 123 will have a material effect on its consolidated financial statements.\nNOTE 2 -- ACQUISITIONS\nEffective July 1, 1993, the Company acquired TAPR from Theater Acquisitions, LP (\"TALP\") for an aggregate cash purchase price of approximately $22,700,000, inclusive of acquisition costs of $323,000. Cine Vista operates motion picture exhibition theaters in seven leased locations with a total of 44 screens in the Commonwealth of Puerto Rico. At the time of its acquisition, TAPR operated 36 screens in six leased locations. The acquisition was accounted for using the purchase method and TAPR's operating results since July 1, 1994 have been consolidated with the operating results of the Company.\nThe purchase price was subject to the satisfaction of certain contingencies in accordance with the provisions of a purchase agreement by and among TAPR, TALP and the Company dated July 1, 1994 (the \"Purchase Agreement\"). The landlord of one of Cine Vista's theaters has the right to terminate the lease relating to space presently housing two theaters, subject to six months' notice. Accordingly, $1 million of the purchase price was escrowed and was payable over 36 months provided the landlord did not cancel the lease during such period or assert other claims relating to the lease, in which case the escrow is available for set off. The landlord has asserted certain claims relating to the computation of the rent (See Note 10) and the Company and TALP therefore amended the terms under which the payments are made from the escrow. Under amended terms, payments of $30,000 are paid monthly to TALP. This escrow, which is invested in short term treasury securities, has been classified as \"Restricted cash.\" At December 31, 1995, $707,000 was due to TALP under this arrangement and has been classified as an \"Other liability.\"\nF - 9\nReading Company and Subsidiaries\nNotes to Consolidated Financial Statements (continued) December 31, 1995 (amounts in tables in thousands, except shares and per share data)\nThe pro forma consolidated operating results set forth below assume that the acquisition of TAPR was completed at the beginning of 1994 and include the impact of certain adjustments, including amortization of intangibles, depreciation and reductions in \"Interest and dividend\" income resulting from payment of the purchase price.\nYear Ended December 31,\n1994 1993 ------- --------\nRevenues $17,015 $ 15,628 ======= ========\nNet loss before cumulative effect of accounting change ($1,617) ($ 70) ======= ========\nPer Share:\nNet loss before cumulative effect of accounting change ($ 0.33) ($ .01) ======= ========\nNOTE 3 -- AVAILABLE-FOR-SALE SECURITIES\nThe net adjustment for unrealized holding losses on available-for-sale securities, included as a separate component of shareholders' equity, totaled $0 and $286,000 as of December 31, 1995 and 1994, respectively. As of December 31, 1994, the net adjustment consisted of an unrealized gain of $38,000, net of tax, recorded on January 1, 1994 as a result of the change in accounting method and an unrealized loss of $324,000, net of tax, recorded for the year ended December 31, 1994.\nAs of December 31, 1995, the amortized cost and estimated fair value of the \"Available-for-sale securities\" was $42,000. The contractual maturity of these securities as of December 31, 1995 was six months or less.\nAccrued interest as of December 31, 1994 was $478,000 and is included in \"Available-for-sale securities\" on the Consolidated Balance Sheet.\nNOTE 4 -- INVESTMENTS\nOn November 8, 1995, the Company acquired from a major bank for $1,285,000, a judgement encumbering, among other things, a controlling interest in a company which has as its principal asset a Manhattan multiplex theater. The judgement has been acquired as part of the Company's plan to acquire, in conjunction with Manhattan-based City Cinemas Corp. (\"City Cinemas\")(James J. Cotter, Chairman of the Company, has an ownership interest in City Cinemas), all of or at least a controlling interest in this theater. The Company also acquired options to purchase shares representing 5\/13ths of the voting power of the company that owns the multiplex theater and to obtain certain other creditor claims against that company. No assurance can be given that the Company's plan to acquire the theater will ultimately prove successful.\nManagement believes that the December 31, 1995 carrying amounts of this investment and the Company's other investments totalling $486,000 approximate their fair value.\nF - 10\nReading Company and Subsidiaries\nNotes to Consolidated Financial Statements (continued) December 31, 1995 (amounts in tables in thousands, except shares and per share data)\nNOTE 5 -- EQUITY INVESTMENT \/ ACQUISITION ACTIVITIES\nIn November 1995, the Company and Craig formed Reading International to develop and operate multiplex cinemas in Australia and other markets. A wholly owned subsidiary of Reading International has retained the services of several executive employees in Australia who provide services with respect to such Australian operations on a full time or substantially full time basis. Reading International is equally owned by the Company and Craig, each of which committed to make an initial contribution of $5 million, on an as needed basis, for an aggregate initial investment of $10 million. (See Note 17).\nThe Company accounts for its investment in Reading International and its foreign subsidiaries by the equity method. Summarized financial information for Reading International as of December 31, 1995 is as follows:\nCurrent assets $ 225 Noncurrent assets 4,534 ------ Total assets $4,759 ======\nCurrent liabilities 3,480 Shareholders' equity 1,279 ------ Total liabilities and shareholders' equity $4,759 ======\nReading International's net loss from its inception through December 31, 1995 was $781,000, consisting primarily of general and administrative expenses and development costs incurred with its theater development activities. The Company's equity loss from Reading International was $390,000, which is included in the Consolidated Statement of Operations.\nAs of December 31, 1995, advances and contributions amounting to approximately $2,080,000 have been made to the joint venture by Reading and Craig inclusive of $1,040,000 advanced on behalf of Craig classified as \"Due from affiliate\" on the Company's Consolidated Balance Sheet. This advance was repaid during the first quarter of 1996. These funds were used to finance capital expenditures and general and administrative expenses. Reading International's noncurrent assets at December 31, 1995 are comprised principally of $4,223,000 related to the purchase of land and development costs and $351,000 of refundable property deposits. The land purchase was made pursuant to a real estate purchase contract with the seller which provided for installment payments, including $3,144,000 due on December 20, 1996 which is included in current liabilities on Reading International's balance sheet at December 31, 1995. Reading International is also in negotiation with several developers and landlords with respect to other potential locations.\nIn the fourth quarter of 1995, the Company acquired from a major bank, for $1,285,000, a judgement encumbering among other things, a controlling interest in a company which has as its principal asset a Manhattan multiplex theater (See Note 4).\nNOTE 6 -- REAL ESTATE HELD FOR SALE OR DEVELOPMENT\nAs described in Note 1, \"Real estate held for sale or development\" is carried at the lower of cost or estimated net realizable value. The Company is exploring development and sale options for its center city Philadelphia properties which are adjacent to the Pennsylvania Convention Center site and is actively seeking buyers for its properties located outside center city Philadelphia.\nF - 11\nReading Company and Subsidiaries\nNotes to Consolidated Financial Statements (continued) December 31, 1995 (amounts in tables in thousands, except shares and per share data)\nNOTE 7 -- OTHER LIABILITIES\nOther liabilities consisted of the following at December 31:\n1995 1994 --------------- -------------- Reserve for guarantee obligations of SWS Industries, Inc. (See Note 10) $ 406 $ 555 Obligations related to past railroad operations and environmental issues (See Note 10) 1,251 1,489 Reorganization obligations 13 236 Cine Vista deferred purchase price (See Note 2) 707 917 Minimum rent obligations 247 82 Other 359 154 --------------- -------------- 2,983 3,433 Less estimated current portion (916) (1,056) --------------- -------------- $2,067 $ 2,377 =============== ==============\nThe reorganization obligations represent the Company's remaining liability to reorganization debt-holders. In accordance with the provisions of the Company's Plan of Reorganization, the Company was obligated to repay a portion of such indebtedness if certain debt-holders presented their claims for payment to the Company on or before December 24, 1995. In December 1995, the Company recorded $223,000 as \"Condemnation and other revenues\" in the Consolidated Statement of Operations equal to the total of the unclaimed amounts. These funds are presently available for use by the Company in accordance with the provisions of the Company's Plan of Reorganization.\nNOTE 8 -- STOCK OPTION PLANS\nThe Company has options outstanding under three Stock Option Plans, the 1982 Incentive Stock Option Plan, the 1982 Non-qualified Option Plan (collectively, the \"1982 Plans\") and the 1992 Non-qualified Stock Option Plan (the \"1992 Plan\"). Each plan was approved by shareholders in the year of adoption. No further grants may be made under the 1982 Plans and all options outstanding thereunder are currently exercisable at prices of $12.50 to $15.54 per share. All options granted under the 1982 Plans were at fair market value on the date of grant.\nThe 1992 Plan reserved 500,000 shares for grant and provides for one-third of options granted to be immediately exercisable, one-third exercisable on the first anniversary of the date of grant, and the final one-third exercisable upon the second anniversary date of the date of grant unless the Executive Committee of the Board of Directors (the \"Committee\"), in its discretion, decides otherwise. Options granted under the 1992 Plan shall not be for less than 100 percent of the fair market value on the date of grant and are eligible for exercise for a period of ten years from the date of grant and may contain certain other terms and conditions as determined by the Committee.\nF - 12\nReading Company and Subsidiaries\nNotes to Consolidated Financial Statements (continued) December 31, 1995 (amounts in tables in thousands, except shares and per share data)\nChanges in the number of shares subject to options under the plans are summarized as follows:\n1995 1994 1993 -------- -------- -------- 1982 Plans:\nOutstanding at beginning and end of period: 17,000 17,000 17,000 ======== ======== ========\n1992 Plan:\nOutstanding at beginning of period 357,732 357,732 325,232 Granted (at $14.00 per share) 40,000 Canceled (at $14.00 per share) (15,000) (7,500) -------- -------- -------- Outstanding at end of period 342,732 357,732 357,732 ======== ======== ======== Total Outstanding at December 31, 1995 ranging in price from $12.50 to $15.54 per share 359,732 Exercisable at December 31, 1995 324,982\nNOTE 9 -- INCOME TAXES AND CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING FOR INCOME TAXES\nAs described in Note 1, the Company adopted SFAS No. 109, \"Accounting for Income Taxes,\" on January 1, 1993, without restating prior years' financial statements. The cumulative effect of $132,000 ($.03 per share) resulting from this change in accounting principle was recorded in the Consolidated Statement of Operations. This amount is equivalent to the deferred tax asset recorded for the tax benefits which were determined by management to be more likely than not to be realized from the Company's net operating loss carryforwards. The Company recorded a $132,000 tax provision in the 1995 Consolidated Statement of Operations related to the realization of such tax benefits in that period.\nEffective December 31, 1981, after approval by its shareholders, the Company eliminated its accumulated deficit by a charge to \"Other capital.\" This quasi-reorganization did not require the restatement of any assets or liabilities or any other modification of capital accounts. Tax benefits realized from the carryforwards of pre-quasi-reorganization losses have been included in the determination of net income and then reclassified from \"Retained earnings\" to \"Other capital.\" Had such tax benefits been excluded from net income, the Company would have reported net income of $1,152,000 or $.23 per share for the twelve months ended December 31, 1995.\nF - 13\nReading Company and Subsidiaries\nNotes to Consolidated Financial Statements (continued) December 31, 1995 (amounts in tables in thousands, except shares and per share data)\nCarryforwards and temporary differences which give rise to the deferred tax asset at December 31, 1995 and 1994 are as follows:\n1995 1994 -------- -------- Net operating loss carryforwards $ 55,325 $ 56,695 Reserves 1,004 1,044 Other, net 242 108 -------- -------- Gross deferred asset 56,571 57,847 Valuation allowance (56,571) (57,715) -------- -------- Net deferred asset $ 0 $ 132 ======== ========\nBased on an analysis of the likelihood of realizing the Company's gross deferred tax asset (taking into consideration applicable statutory carryforward periods), the Company concluded that under SFAS No. 109, a valuation allowance for the entire amount was necessary.\nThe Company's federal tax net operating loss carryforwards expire as follows:\nYear Amount - - ------------------- ------------\n1996................... $123,097 1997................... 13 1998................... 2,096 1999................... 0 2000................... 26,915 2001................... 0 2002................... 7,382 2003................... 589 2004................... 0 2005................... 0 2006................... 0 2007................... 1,443 2008................... 1,155 2009................... 32 ------------ $162,722 ============\nThe Company is required to pay federal alternative minimum tax (\"AMT\") for 1995. AMT is calculated separately from the regular federal income tax and is based on a flat rate applied to a broader tax base. Amounts payable thereunder cannot be totally eliminated through the application of net operating loss carryforwards. The Company recorded AMT expense in 1995 of $87,000 and recorded no AMT expenses in 1994. The Company recorded an AMT benefit of $12,000 in 1993.\nF - 14\nReading Company and Subsidiaries\nNotes to Consolidated Financial Statements (continued) December 31, 1995 (amounts in tables in thousands, except shares and per share data)\nNOTE 10 -- COMMITMENTS AND CONTINGENCIES\nSWS Industries, Inc.\nThe Company sold a subsidiary, SWS Industries, Inc. (\"SWS\") in 1987. SWS subsequently filed for bankruptcy in 1988. Under the terms of the SWS sales agreement, the Company remained liable as guarantor on various performance bonds issued on behalf of SWS. The Company's liability under the performance bond guarantees has been reduced as the related contracts have been completed or settled. Completion activities will continue into 1996. Management believes the reserve at December 31, 1995 is adequate for the remaining obligations of the Company.\nCine Vista\nA landlord of Cine Vista has alleged that Cine Vista underpaid rent by approximately $480,000 for the thirty month period ended December 31, 1995. The Company is contesting the landlord's claim and believes the claim to be without merit. If the landlord were to prevail in its assertion, the Company is indemnified by TALP for the amount due at June 30, 1994 ($180,000) and the Company believes it would be entitled to a reduction in the purchase price of TAPR relating not only to the 18 months ended December 31, 1995 but also relating to the 17 1\/2 future years under the lease. Such purchase price reduction would be funded, in part, from the proceeds of the TAPR purchase escrow (See Note 2).\nHistorical Railroad Operations\nThe Company is a defendant in various personal injury legal actions relating to its railroad operations prior to reorganization and has insurance coverage relating to such actions. In accordance with the provisions of a 1990 settlement agreement (the \"Settlement Agreement\") with its insurance carriers, the Company receives quarterly reimbursement for certain personal injury legal actions. At December 31, 1995, $87,000 was reimbursable to the Company for amounts expended in defense and settlement of such actions. This amount has been classified as \"Due from insurance companies.\" Three participants in the insurance settlement are insolvent. Unreimbursed claims insured by these insolvent companies totaled $61,000 from 1992 through December 31, 1995. The Company believes that it may be entitled to reimbursement of such amounts from the other parties to the agreement and may request an arbitration hearing on such matters. Based upon the backlog of pending personal injury cases and the Company's experience in settling such cases, the Company has established a reserve of $146,000 reflecting the potential effect of such insolvencies on future insurance reimbursement if no recovery is received from either the insolvent carriers or the other parties to the Settlement Agreement. The reserve associated with such insolvencies may increase if additional claims are filed; however, the Company does not believe that such amount will be material.\nEnvironmental\nReading Company (\"Reading\") and a wholly-owned subsidiary, Reading Transportation Company (\"RTC\"), have each been advised by the Environmental Protection Agency (\"EPA\") that they are potentially responsible parties (\"PRPs\") under environmental laws including Federal Superfund legislation (\"Superfund\") for a site located in Douglassville, Pennsylvania. The EPA issued an Administrative Order under Superfund against 34 PRPs requiring, among other things, that the named parties be required to incinerate materials at the site pursuant to a June 30, 1989 Record of Decision (\"ROD\"). The ROD estimated that the incineration would cost approximately $53 million. Thirty-six PRPs were also named in a civil action brought by the United States Government which seeks to recover alleged costs incurred at the site by the United States of approximately $22 million. Reading and RTC have each been named in a third-party action instituted by the majority of the 36 PRPs sued by the United States. The actions instituted\nF - 15\nReading Company and Subsidiaries\nNotes to Consolidated Financial Statements (continued) December 31, 1995 (amounts in tables in thousands, except shares and per share data)\nagainst the Company and approximately 300 PRPs seek to have the parties contribute to reimbursement for past costs and any costs associated with further remediation at the site.\nDuring 1994, based upon the Company's and counsel's evaluation of possible outcomes in the matter, the Company increased its \"Provision for environmental matters\" by $1,200,000. On September 14, 1995, the federal district court judge who presided over Reading's reorganization ruled that all liability asserted against Reading relating to the site was discharged pursuant to the consummation order issued in conjunction with the Company's amended plan of reorganization on December 31, 1980. The United States Department of Justice and a named defendant in the above described Administrative Order have filed appeals of the decision. The judge's decision did not affect the potential liability of RTC for the site. RTC has no assets and therefore cannot fund a settlement or judgement relating to this matter and the Company believes that the potential liability of RTC, if any, is not in excess of $300,000. Based upon the appeal and possible alternate attempts by the PRPs to obtain Reading's participation in funding for the site as well as the existence of the other environmental matters set forth below, the Company has not reduced its \"Provision for environmental matters.\"\nThe Company is a party to a consent decree relating to a Superfund site located on land owned by the Company. Apart from future operation and maintenance expenses (\"O&M\"), remediation is complete. During 1994, the Company paid approximately $106,000 as its estimated share of ten years of O&M and charged such amount to \"Provisions for environmental matters\" expense. The Company believes that the amounts expended to date will be adequate to fund O&M at the site. If additional amounts are required, such amounts would not be material.\nDuring 1995, the Company settled an action seeking the recovery of $3,800,000 of alleged environmental cleanup costs from five defendants under various provisions of New Jersey law for $235,000, which approximates the amount previously accrued by the Company to provide for its share of the liability.\nThe Company believes that one of its properties, the Viaduct may be contaminated by polychlorinated biphenyls (\"PCBs\") resulting from former railroad operations on that property conducted by or on behalf of the Reading Railroad, Consolidated Rail Corporation (\"Conrail\"), the City of Philadelphia or the Southeastern Pennsylvania Transportation Authority (\"SEPTA\"). The Company has advised the Environmental Protection Agency of the potential contamination. The Company has not determined the scope and extent of any such PCB contamination. However, the Company has been advised by counsel that, given the lack of regulatory attention to the Viaduct in the eleven years which have elapsed since EPA was notified of the likelihood of contamination, it is unlikely that the Company will be required to decontaminate the Viaduct or incur costs related thereto. In the event that the Company is required to incur expenditures to remove PCB contamination from the Viaduct, under terms of a settlement of certain litigation (See Note 16), Conrail, the City of Philadelphia and SEPTA would be required to fund 52 to 55% of such costs.\nPrior to the Company's reorganization, the Company had extensive railroad and related operations. Such operations could have contributed to environmental contamination of properties now owned by the Company, previously sold or leased by the Company, or to which the Company, prior to its reorganization, sent waste. The ultimate extent of liabilities, if any, with respect to such matters, as well as the timing of cash disbursements, if any, cannot be determined. However, management is of the opinion that while the ultimate liability resulting from such matters could have a material effect upon the results of operations in a given year, they will not have a material adverse effect upon the Company's financial position or liquidity.\nF - 16\nReading Company and Subsidiaries\nNotes to Consolidated Financial Statements (continued) December 31, 1995 (amounts in tables in thousands, except shares and per share data)\nThe following is an analysis of the Company's accrual for environmental claims:\nBalance at January 1, 1993 $ 771 Provisions 241 Payments (676) ------ Balance at December 31, 1993 336\nProvisions 1,306 Payments (133) ------ Balance at December 31, 1994 1,509\nProvisions 0 Payments (248) ------ Balance at December 31, 1995 $1,261 ======\nNOTE 11 -- LEASE AGREEMENTS\nCine Vista conducts all of its operations in leased premises. The leases relate to motion picture theaters with remaining terms of approximately 6.5 to 27 years with certain leases containing options to extend the leases for up to an additional 30 years. The minimum remaining lease term, inclusive of any renewal options, for any of Cine Vista's theaters is approximately 17.5 years. Cine Vista also leases office, warehouse space and various equipment. Certain theater leases provide for contingent rentals based upon a specified percentage of theater revenues with a guaranteed minimum. Performance under one lease has been guaranteed by the Company. Substantially all of the leases require the payment of property taxes, insurance and other costs applicable to the property. The Company also leases office space and various equipment under noncancelable operating leases. With the exception of one capital lease, all leases are accounted for as operating leases.\nCine Vista determines annual base rent expense by amortizing total minimum lease obligations on a straight-line basis over the lease terms. Base rent expense under operating leases totaled $2,139,000, $1,097,000, and $75,000, in 1995, 1994, and 1993, respectively. In 1995 and 1994, contingent rental expense under the Cine Vista operating leases totaled $197,000 and $111,000, respectively.\nF - 17\nReading Company and Subsidiaries\nNotes to Consolidated Financial Statements December 31, 1995 (amounts in tables in thousands, except shares and per share data)\nFuture minimum lease payments, by year and in the aggregate, under noncancelable operating leases and the capital lease consist of the following at December 31, 1995:\nCapital Operating Lease Leases ----- ------\n1996 $95 $1,411 1997 95 1,328 1998 95 1,401 1999 95 1,413 2000 95 1,401 Thereafter 1,258 14,526 ----- ------ Total net minimum lease payments 1,733 $21,480 ======= Less amount representing interest (1,208) ------ Present value of net minimum lease payments under capital lease $ 525 ======\nIn May 1995, Cine Vista and a landlord amended a lease originally executed in July 1994 for a new eight-plex motion picture theater. The lease became effective and operations at the theater commenced in December 1995. Cine Vista was responsible for certain construction costs of the theater.\nIn June 1995, Cine Vista entered into a lease agreement for a new six-plex motion picture theater. The lease provides for a 20-year term with an average annual base rent of approximately $195,000 with options to extend the lease up to an additional 10 years. The lease will be effective after completion of construction of the new theater. Cine Vista is responsible for certain construction costs of the theater which are presently estimated to total $1.2 million. Completion of construction and commencement of theater operations is scheduled to occur in late 1996 or early 1997. The lease provides for contingent rentals based upon a specified percentage of theater revenues with a guaranteed minimum and requires the payment of property taxes, insurance and other costs applicable to the property.\nNOTE 12 -- RELATED PARTY TRANSACTIONS\nRobert F. Smerling serves as president of Cine Vista. In accordance with the terms of Mr. Smerling's employment, the Board of Directors authorized and extended a $1,000,000 loan to Mr. Smerling in December 1993. Principal relating to the fully secured loan, which accrued interest at the prime rate of interest plus one percent, was repaid by Mr. Smerling in April 1994.\nIn 1994 and 1995, the Company's Board of Directors voted to waive the transfer restrictions imposed by the provisions of the Company's Class A Common Stock to the extent necessary to permit James J. Cotter, Chairman of the Board of Directors of the Company and Craig to acquire additional shares of the Company's Class A Common Stock. The transfer provisions prohibit a party from acquiring more than 4.75% of the Company's outstanding capital stock without the permission of the Company's Board of Directors and are intended to assure the continuing availability of the Company's tax loss carryforwards by precluding a change in control which could limit the value of the carryforwards. Prior to granting the waiver of the restrictions, the Board of Directors had determined that acquisition of the shares by Mr. Cotter and Craig would not effect the continuing availability of the Company's tax loss carryforwards.\nF - 18\nReading Company and Subsidiaries\nNotes to Consolidated Financial Statements (continued) December 31, 1995 (amounts in tables in thousands, except shares and per share data)\nThe Company is presently negotiating to acquire a multiplex theater located in New York City (See Note 4). The theater will be owned jointly by City Cinemas, a Manhattan-based theater operator (or its affiliates) and the Company. It is anticipated that City Cinemas, owned in part by James J. Cotter, the Company's Chairman, will operate the theater pursuant to a management agreement. The terms of that management agreement have not yet been negotiated. Robert F. Smerling, President of Cine Vista, also serves as President of City Cinemas.\nNOTE 13 - CONDEMNATION AND OTHER INCOME\nDuring 1995, the Company and the Commonwealth of Pennsylvania Department of Transportation (\"PennDot\") agreed to settle certain litigation related to PennDot's 1985 condemnation of a bridge which connected sections of a right-of-way which was owned by the Company and located in center city Philadelphia. The Company received $1,146,000 in settlement of this claim during the fourth quarter of 1995 and the income related thereto has been recorded as \"Condemnation and other\" income in the Company's Consolidated Statement of Operations.\n\"Condemnation and other\" income also includes $425,000 received by the Company from ARAMARK in accordance with a litigation settlement which encompassed disputes relating to ARAMARK's tenancy in One Reading Center, a 32-story office tower in which the Company conveyed its interest in 1985. Additionally, $319,000 was received in settlement of two matters relating to the Company's former railroad operations and $223,000 relating to certain unclaimed reorganization obligations (See Note 7) were also included in \"Condemnation and other\" in the Company's Consolidated Statement of Operations.\nNOTE 14 -- LONG-TERM DEBT\nIn December 1995, Cine Vista entered into a $15 million eight year revolving credit agreement (the \"Credit Agreement\") with a bank. Under terms of the Credit Agreement, Cine Vista may borrow up to $15 million to repay Cine Vista acquisition loans, which loans are payable to a wholly-owned subsidiary of the Company (the \"Subsidiary Loans\"), and fund certain new theater development expenditures (the \"Development Expenditures\"). During the initial 30 months of the eight-year term, Cine Vista may borrow and repay amounts outstanding under the Credit Agreement. Amounts outstanding at the end of the 30 month period are payable in increasing quarterly installments over the balance of the loan term. At December 31, 1995, no amounts are outstanding under this agreement.\nAs security for the loan, Cine Vista has pledged substantially all of its assets. In addition, the stock of Cine Vista's parent company has been pledged as security for the loan. In conjunction with the loan, the Company has also agreed to subordinate to the lender its right to payment of the Subsidiary Loans as well as certain other fees payable by Cine Vista to the Company under certain circumstances. In addition, the Company has agreed to contribute funds to Cine Vista in the event that estimated unpaid Development Expenditures exceed the amount of funds available to Cine Vista under the Credit Agreement.\nThe provisions of the Credit Agreement require Cine Vista to maintain a minimal level of net worth and other financial ratios, restrict the payment of dividends and limit additional borrowings and capital expenditures. Borrowings under the Credit Agreement accrue interest at LIBOR (the London Interbank Offered Rate) plus 2.25%, the cost of Section 936 deposits (deposits held by lenders in Puerto Rico which are qualified under Section 936 of the Internal Revenue Code) to the lender (currently 4.91%) plus 2.25%, or the base rate plus 1\/2 of 1%, at Cine Vista's election. In accordance with the provisions of the Credit Agreement, Cine Vista is required to pay a commitment fee on the unused commitment equal to 1\/2 of 1%.\nF - 19\nReading Company and Subsidiaries\nNotes to Consolidated Financial Statements (continued) December 31, 1995 (amounts in tables in thousands, except shares and per share data)\nNOTE 15 -- QUARTERLY FINANCIAL INFORMATION (UNAUDITED)\nQuarterly financial information for 1995 and 1994 is summarized below:\n1995:\nThe operating results of Cine Vista are included in each quarter's financial information. The second quarter results include $425,000 received in settlement of certain litigation between the Company and ARAMARK (See Note 13) and $165,000 in expenses related to the review of theater acquisitions (See Note 4). The third quarter results include revenues of $1,146,000 in condemnation proceeds (See Note 13) as well as $319,000 received in settlement of two matters related to the Company's former railroad operations. Also included in the third quarter was a $290,000 equity loss from Reading International. The fourth quarter results include revenues of $223,000 related to unclaimed reorganization debt-holders' obligations (See Note 7) and a $100,000 equity loss from Reading International.\n1994:\nThe operating results of Cine Vista are included in the quarterly financial information after June 30. The third quarter results include $4,924,000 in theater revenues and $3,768,000 in theater cost of sales (inclusive of depreciation and amortization). Fourth quarter results include $3,177,000 in theater revenues and $3,000,000 in theater cost of sales (inclusive of depreciation and amortization). The second quarter results include a $265,000 gain on sale of real estate which was located in center city Philadelphia. Third quarter results also include a $1,305,000 provision for environmental matters and a $795,000 charge related to loans the Company made to OREI. Fourth quarter revenues include a gain of $179,000 from the S.R. joint venture.\nF - 20\nReading Company and Subsidiaries\nNotes to Consolidated Financial Statements (continued) December 31, 1995 (amounts in tables in thousands, except shares and per share data)\nNOTE 16 -- SUBSEQUENT EVENT I\nIn 1991, the Company filed a lawsuit against SEPTA, Conrail, the City of Philadelphia, and other parties which sought to recover costs expended by the Company in conjunction with the cleanup of PCBs in the Reading Terminal Train Shed and a portion of the viaduct south of Vine Street. In January 1996, the Company and several parties agreed to settle this litigation by providing for the Company to receive payments totaling $2.35 million which amount the Company anticipates receiving in 1996. The parties to the settlement also agreed to pay an amount ranging from 52% to 55% of certain future costs the Company may incur in cleaning environmental contamination on the Viaduct.\nNOTE 17--SUBSEQUENT EVENTS II\nOn March 29, 1996, the Company and Craig entered into a capital funding agreement (the \"Capital Funding Agreement\") with respect to Reading International pursuant to which they agreed to increase the capital committed by the Company and Craig to Reading International from $10 million to approximately $103 million through a combination of cash contributions and secured capital funding undertakings. Under the terms of the Capital Funding Agreement, the Company and Craig each agreed to immediately contribute to Reading International $12,500,000 in cash, for an aggregate $25,000,000. In addition, the Company and Craig have undertaken to contribute up to an additional $37,500,000 each, for an aggregate future commitment of $75,000,000 on an as needed basis. The commitments of the Company and Craig are secured by various assets of the two parties. The collateral pledged by Craig was reviewed by an independent committee of the Company's Board of Directors comprised of outside directors who are unaffiliated with Craig, and found to be adequate.\nOn March 29, 1996, the Company purchased from Craig 1,564,473 shares of the common stock of Citadel Holding Corporation (\"Citadel\" and the \"Citadel Common Stock\", respectively) for an aggregate purchase price of $3,324,505, representing slightly less than $2.125 per share. The closing price of Citadel Common Stock on the American Stock Exchange on March 28, 1996 was $2.25 per share. The Company paid Craig for the Citadel Common Stock with a five year unsecured promissory note which provides for the payment of interest at a rate equal to LIBOR plus 2.25%. The Company also acquired from Craig a one year option to acquire, at fair market value, as determined by an investment banker selected by the parties, 1,329,114 shares of the 3% Cumulative Voting Convertible Preferred Stock, stated value $3.95 per share of Citadel and an option to acquire a warrant to acquire 666,000 shares of Citadel Common Stock. The transaction was separately reviewed, negotiated and approved by an independent committee of the Company's Board of Directors comprised of outside directors who are unaffiliated with Craig, and found to be adequate.\nF - 21\nReport of Independent Auditors\nBoard of Directors and Shareholders Reading Company\nWe have audited the consolidated balance sheets of Reading Company and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1995. 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 Reading Company and subsidiaries at December 31, 1995 and 1994, and the consolidated results of their operations and their cash flows for each of three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.\nAs discussed in Note 1 to the consolidated financial statements, in 1993 the Company changed its method of accounting for income taxes.\nPhiladelphlia, Pennsylvania February 16, 1996, except Note 17, the date of which is March 29, 1996\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS\nREADING COMPANY AND SUBSIDIARIES (in thousands)\n(1) Uncollectible accounts written off and cash receipts. (2) Property sales.\nS-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 annual report to be signed on its behalf by the undersigned thereunto duly authorized.\nREADING COMPANY\nBy: \/s\/ S. Craig Tompkins ---------------------------------- S. Craig Tompkins, President\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated.\nSignature Title Date\n\/s\/ James J. Cotter - - ------------------------------------- James J. Cotter Chairman and Director 3\/28\/96 (Principal Executive Officer)\n\/s\/ S. Craig Tompkins - - ------------------------------------- S. Craig Tompkins President and Director 3\/28\/96\n\/s\/ James A. Wunderle - - ------------------------------------- James A. Wunderle Executive Vice President, 3\/28\/96 Chief Operating Officer and Treasurer (Principal Financial Officer)\n\/s\/ Eileen M. Mahady - - ------------------------------------- Eileen M. Mahady Controller 3\/28\/96 (Principal Accounting Officer)\n\/s\/ Edward L. Kane - - ------------------------------------- Edward L. Kane Director 3\/28\/96\n\/s\/ Gerard P. Laheney - - ------------------------------------- Gerard P. Laheney Director 3\/28\/96\n\/s\/ Ralph B. Perry III - - ------------------------------------- Ralph B. Perry III Director 3\/28\/96\n\/s\/ John W. Sullivan - - ------------------------------------- John W. Sullivan Director 3\/28\/96\n\/s\/ Albert J. Tahmoush - - ------------------------------------- Albert J. Tahmoush Director 3\/28\/96\nEXHIBIT INDEX\nExhibit Number Page - - ------ ----\n3.7 By-Laws of Registrant, as amended October 6, 1995.\n10.9 Lease Agreement between Palma Real Associates, S.E. and Theater Acquisitions of Puerto Rico, Inc. dated as of July 13, 1994.\n10.10 The First Amendment dated May 10, 1995 between Palma Real Associates, S.E. and Reading Cinemas of Puerto Rico, Inc. (successor by merger to Theater Acquisitions of Puerto Rico, Inc.) to the Lease Agreement between Palma Real Associates, S.E. and Theater Acquisitions of Puerto Rico, Inc. dated as of July 13, 1994.\n10.11 Credit Agreement by and between Reading Cinemas of Puerto Rico, Inc., and Citibank, N.A., as administrative agent for the Lenders thereunder dated as of December 20, 1995.\n10.12 The First Amendment dated February 7, 1996 to the Credit Agreement by and between Reading Cinemas of Puerto Rico, Inc., and Citibank, N.A., as administrative agent for the Lenders thereunder dated as of December 20, 1995.\n10.13 Limited Liability Company Agreement of Reading International Cinemas LLC dated November 9. 1995.\n10.14 RC Revocable Trust Agreement between Reading Investment Company, Inc. and Craig Corporation and Craig Management, Inc. as trustee, dated November 9. 1995.\n10.15 Lease Agreement between Mayaguez Shopping Center, S.E. and Reading Cinemas of Puerto Rico, Inc. dated as of August 10, 1995.\n10.16 Contract of Sale of Real Estate between Brick & Pipe Industries LTD and Burgundy Two Pty LTD dated October 10, 1995.\n10.17 Contract of Sale of Real Estate between Royal Society for the Prevention of Cruelty to Animals (Victoria) Incorporated and Burgundy Two Pty LTD dated November 9. 1995.\n10.18 Stock Purchase and Sale Agreement dated as of March 30, 1996 by and between Reading Holdings, Inc. and Craig Corporation.\n10.19 Amended and Restated Capital Funding Agreement by and between Reading Investment Company, Inc., Craig Corporation, Craig Management Inc., Craig Corporation and Reading International Cinemas LLC.\n21.1 Registrant's Subsidiaries.\n23.1 Consent of Independent Auditors - Ernst & Young LLP.\n27 Financial Data Schedule","section_15":""}
{"filename":"216729_1995.txt","cik":"216729","year":"1995","section_1":"Item 1. BUSINESS\nGENERAL\nTODAY'S BANCORP, INC. (the \"Parent\"), is a bank holding company incorporated under Delaware law in 1977. The Parent was originally named Northwest Illinois Bancorp, Inc. and changed its name to TODAY'S BANCORP, INC. effective January 1, 1995. The company includes: the parent company, TODAY'S BANCORP, INC.; its wholly-owned subsidiaries, TODAY'S BANK - East and TODAY'S BANK - West; its mortgage banking company, TODAY'S MORTGAGE SOURCE; and TODAY'S FINANCIAL SERVICES (collectively, the \"Company\").\nBanking constitutes the main business segment of the Company and there are no foreign operations. TODAY'S BANK - East is the largest subsidiary, and at December 31, 1995, accounted for approximately 73% of the consolidated assets of the Company.\nThe Banks are Illinois chartered commercial banks with trust powers, conducting full service domestic banking business at twelve locations throughout Northwestern Illinois.\nThe Freeport locations are one of the two primary banks of a total of three local banks in a city of 28,000 and compete locally for deposits and loans, generally county wide, within approximately a 50-mile radius of Freeport with several smaller banks, a number of savings and loan associations, credit unions and finance companies.\nThe Galena portfolio consists primarily of real estate mortgage and installment loans. Extensive historical restoration, coupled with the development of hotel, convention and resort facilities have made the Galena area a well known and widely visited tourist attraction and recreational center. The Galena Territory, which is situated six miles east of Galena, is a successful resort community and convention center. The Galena office has been instrumental in providing mortgage financing to this key component of the Galena economy as well as installment loans to its consumer base.\nThe Rockford offices are located in the Rockford Metro Area (consisting of Winnebago and Boone Counties). One Rockford branch is strategically located near downtown Rockford along one of the major thoroughfares feeding daily commuters into the business district. Another Rockford location established in early 1994, is located in the quickly growing East side market area. An additional Rockford location was opened in August, 1995 in the expanding northeast section of Rockford. This storefront location, in addition to our other Rockford locations, emphasizes a community banking orientation which concentrates on providing top quality service to customers.\nThe Pecatonica location is the only financial institution in the town of Pecatonica, a rural community of approximately 1,700 people. The Company also operates a facility and an ATM in the town of Winnebago, a community of approximately 2,200 people\nlocated nine miles southeast of Pecatonica. Consumer loans constitute the major portion of its loan portfolio.\nThe East Dubuque, Scales Mound and additional Galena locations were added in September, 1994 with the acquisition of Tri-State Bank & Trust Co. With this acquisition, the Company was able to expand its market share in the Northwestern Illinois area by moving into new communities.\nTODAY'S MORTGAGE SOURCE is based out of Rockford, Illinois. This subsidiary specializes in both retail and wholesale mortgage originations and currently is covering a two state area.\nTODAY'S FINANCIAL SERVICES was established in 1995 and includes the operations of trust, asset management, full service investment brokerage, insurance and other fee-based services.\nEmployee relations have been harmonious and include a competitively based employee benefit program. The Company had 230 full-time equivalent employees at year end.\nThe Banks each conduct a general banking business embracing most of the services, both consumer and commercial, which banks may lawfully provide, including the following principal services: the acceptance of deposits into demand, savings and time accounts and the servicing of such accounts; the establishment of IRA and Keogh accounts; commercial, industrial, consumer and real estate lending, including installment loans, student loans, farm loans, personal lines of credit and overdraft check protection; safe deposit operations; and an extensive variety of additional services tailored to the needs of individual customers, such as the acquisition of U.S. Treasury notes and bonds, the sale of travelers' checks, money orders and cashier's checks, direct deposit services, automatic transfer of funds between accounts, and other special services.\nLoans, both commercial and consumer, are provided on either a secured or unsecured basis to corporations, partnerships and individuals. Commercial lending covers such categories as business, industry, capital, agricultural, inventory and real estate, with the latter including residential properties.\nSUPERVISION AND REGULATION\nThe growth and earnings performance of the Company can be affected not only by management decisions and general economic conditions, but also by the policies of various governmental regulatory authorities including, but not limited to, the Board of Governors of the Federal Reserve System (the \"Federal Reserve Board\"), the Federal Deposit Insurance Corporation (\"FDIC\"), the Illinois Commissioner of Banks and Trust Companies (the \"Commissioner\"), the Internal Revenue Service and state taxing authorities. Financial institutions and their holding companies are extensively\nregulated under federal and state law. The effect of such statutes, regulations and policies can be significant, and cannot be predicted with a high degree of certainty.\nFederal and state laws and regulations generally applicable to financial institutions, such as the Company, regulate, among other things, the scope of business, investments, reserves against deposits, capital levels relative to operations, the nature and amount of collateral for loans, the establishment of branches, mergers, consolidations and dividends. This supervision and regulation is intended primarily for the protection of the FDIC's deposit insurance fund and the depositors, rather than the stockholders, of a financial institution.\nThe following references to material statutes and regulations affecting the Company are brief summaries thereof and do not purport to be complete, and are qualified in their entirety by reference to such statutes and regulations. Any change in applicable law or regulations may have a material effect on the business of the Company.\nThe Parent is a bank holding company within the meaning of the Bank Holding Company Act of 1956, as amended (the \"BHCA\"), and is registered as such with the Federal Reserve Board. As a bank holding company, it is required to file with the Federal Reserve Board annual reports and information regarding its business operations and those of its subsidiaries. It is subject to regulation and examination by the Federal Reserve Board.\nTODAY'S BANK - East and TODAY'S BANK - West are chartered under the Illinois Banking Act, as amended (the \"IBA\"), and are subject to the examination, supervision, reporting and enforcement requirements of the FDIC under the Federal Deposit Insurance Act, as amended, and the Commissioner under the IBA. The deposits of the Banks are insured by the Bank Insurance Fund of the FDIC to the extent permitted by law.\nTHE PARENT\nACQUISITIONS. The BHCA requires every bank holding company to obtain the prior approval of the Federal Reserve Board before merging with or consolidating into another bank holding company, acquiring substantially all the assets of any bank, or acquiring direct or indirect ownership or control of more than 5% of the voting shares of any bank.\nThe BHCA also prohibits a bank holding company, with certain exceptions, from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company which is not a bank, and from engaging in any business other than that of banking, managing and controlling banks or furnishing services to banks and their subsidiaries. With prior Federal Reserve Board approval, however, the Company may engage in, and may own shares of companies engaged in, certain businesses determined by the Federal Reserve Board to be so closely related to banking or managing or controlling banks as to be a proper incident thereto.\nINTERSTATE BANKING. Adequately capitalized and managed bank holding companies are permitted to acquire control of a bank in any state. States, however, may prohibit acquisitions of banks that have not been in existence for at least five years. Illinois bank holding companies are permitted to acquire banks and bank holding companies, and be acquired by bank holding companies, located in any state which authorizes such acquisitions under qualifications and conditions which are not unduly restrictive, as determined by the Commissioner, when compared to those imposed under Illinois law. The Federal Reserve Board is prohibited from approving an application if the applicant controls more than 10 percent of the total amount of deposits of insured depository institutions nationwide. In addition, interstate acquisitions would be subject to statewide concentration limits. The Federal Reserve Board would be prohibited from approving an application if, prior to consummation, the applicant controls any insured depository institution or branch in the home state of the target bank, and the applicant, following consummation would control 30 percent or more of the total amount of deposits of insured depository institutions in that state.\nThis legislation also provides that the provisions on concentration limits do not affect the authority of any state to limit the percentage of the total amount of deposits in the state which would be held or controlled by any bank or bank holding company to the extent the application of the limitation does not discriminate against out- of-state institutions. States may also waive the statewide concentration limit. The legislation authorizes the Federal Reserve Board to approve an application without regard to the 30 percent state-wide concentration limit, if the state allows a greater percentage of total deposits to be so controlled, or the acquisition is approved by the state bank regulator and the standard on which such approval is based does not have the effect of discriminating against out-of-state institutions.\nRecently enacted interstate branching legislation permits banks to merge across state lines, thereby creating a main bank in one state with branches in other states. Approval of interstate bank mergers will be subject to certain conditions: adequate capitalization; adequate management; CRA compliance; deposit concentration limits (as set forth above); and compliance with federal and state antitrust laws. An interstate merger transaction may involve the acquisition of a branch without the acquisition of the bank only if the law of the state in which the branch is located permits out-of-state banks to acquire a branch of a bank in that state without acquiring the bank. Following the consummation of an interstate transaction, the resulting bank may establish additional branches at any location where any bank involved in the transaction could have established a branch under applicable federal or state law, if such bank had not been a party to the merger transaction.\nInterstate branches will be required to comply with host state community reinvestment, consumer protection, fair lending, and intrastate branching laws, as if the branch were chartered by the host state. An exception is provided for national bank branches if federal law preempts the state requirements or if the OCC determines that the state law has a discriminatory effect on out-of-state banks. All other laws of the host state will apply to the branch to the same extent as if the branch were a bank, the main office of which is located in the host state.\nThe interstate branching by merger provisions will become effective on June 1, 1997, unless a state takes legislative action prior to that date. States may pass laws to either \"opt-in\" before June 1, 1997, or to \"opt-out\" by expressly prohibiting merger transactions involving out-of-state banks, provided the legislative action is taken before June 1, 1997.\nThe effects on the Company of such recent changes in interstate banking law cannot be accurately predicted, but it is likely that there will be increased competition from national and regional banking firms headquartered outside of Illinois that may have greater resources than the Company.\nCHANGE OF CONTROL. Federal law prohibits acquisition of \"control\" of a bank or bank holding company without prior written notice to certain federal bank regulators. \"Control\" is defined in certain cases as acquisition of as little as 10% of the outstanding shares. Furthermore, the Company cannot purchase its own stock where the gross consideration paid during the preceding twelve months will equal 10% or more of the Company's net worth without obtaining approval of the Federal Reserve Board.\nAny person, including associates and affiliates of and groups acting in concert with such person, who purchases 10% or more of the Common Stock of the Company, or thereafter acquires additional securities of the Company such that it owns more than 10% of the Common Stock of the Company, may be required to obtain approval of the Federal Reserve Board under the Change in Bank Control Act, and any corporation, partnership, trust or organized group that acquires a controlling interest in the Company may have to obtain approval of the Federal Reserve Board to become a bank holding company and thereafter be subject to regulation as such.\nSEC REGULATION. The Company's Common Stock is registered with the SEC under the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended. Consequently, the Company is subject to the information, proxy solicitation, insider trading and other restrictions and requirements of SEC under the Securities Exchange Act of 1934, and is required to file various reports with the SEC.\nTHE BANKS\nThe Banks are required to comply with various banking laws, including laws governing maximum rates of interest chargeable on certain types of loans, maximum credit that may be extended to any one borrower, restrictions on loans to bank insiders and affiliates and limitations on the type and amounts of securities in which banks may invest.\nExtensions of credit by the Banks are subject to a variety of federal laws and regulations, including truth-in-lending statutes, the Equal Credit Opportunity Act, the Real Estate Settlement Procedures Act and the Financial Institutions Regulatory and Interest Rate Control Act of 1978. In terms of permitted activities and services, the Banks are also affected by federal laws such as the Depository Institutions\nDeregulation and Monetary Control Act of 1980, the Garn-St. Germain Depository Institutions Act of 1982, the Competitive Equality Banking Act of 1987, the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (see \"FINANCIAL INSTITUTIONS REFORM, RECOVERY AND ENFORCEMENT ACT OF 1989,\" below) and the Federal Deposit Insurance Corporation Improvement Act of 1991 (see \"FEDERAL DEPOSIT INSURANCE CORPORATION ACT OF 1991,\" below).\nThe Banks are subject to certain restrictions under the Federal Reserve Act and the Federal Deposit Insurance Act on loans and other extensions of credit to the Company or to its subsidiaries, investments in the stock or other securities of the Company or its subsidiaries, or advances to any borrower collateralized by such stock or other securities.\nBanks located in Illinois are permitted to establish branches anywhere in Illinois without regard to the location of other banks' main offices or the number of branches maintained by the bank establishing the branch.\nEffective July 1, 1992, banks in Illinois that are commonly owned, directly or indirectly, by the same bank holding company, such as the Banks, may establish \"affiliate facilities.\" An affiliate facility may conduct the following transactions for another commonly owned bank if authorized by that bank: (1) receive deposits; (2) cash and issue checks, drafts and money order; (3) change money; and (4) receive payments on existing indebtedness.\nDIVIDENDS\nGENERAL. The Parent is a legal entity separate and distinct from the Banks. There are various state banking regulations which would limit the ability of the Banks to finance, pay dividends or otherwise supply funds to the Parent.\nTHE PARENT. The holders of the Parent's Common Stock are entitled to receive such dividends as are declared by the Board of Directors.\nThe Federal Reserve Board has issued a policy statement on the payment of cash dividends by bank holding companies. In the policy statement, the Federal Reserve Board expressed its view that a bank holding company experiencing earnings weaknesses should not pay cash dividends exceeding its net income or which could only be funded in ways that weakened the bank holding company's financial health, such as by borrowing.\nILLINOIS BANK RESTRICTIONS. Under the provisions of the IBA, dividends may not be declared by the state-chartered banks, (1) except out of the bank's net profits; and (2) unless the bank has transferred to surplus at least one-tenth of its net profits since the date of the declaration of the last preceding dividend, until the amount of its surplus is at least equal to its capital. Net profits under the IBA must be adjusted for losses and bad debts unless such debts are secured and in the process of collection. Additionally, the payment of dividends by a state-charted bank, whose deposits are insured by the\nBank Insurance Fund, is affected by the requirement to maintain minimum capital pursuant to the capital adequacy guidelines issued by the FDIC. The Banks exceeded the minimum capital requirements under FDIC guidelines as of December 31, 1995 (see \"CAPITAL REQUIREMENTS,\" below).\nCAPITAL REQUIREMENTS\nThe Federal Reserve Board and the FDIC have adopted risk-based capital guidelines to provide a framework for assessing the adequacy of the capital of banks and bank holding companies. These guidelines became effective on December 31, 1990, and were fully phased in on December 31, 1992. These guidelines apply to all banks and bank holding companies regardless of size and are used in the examination and supervisory process as well as in the analysis of applications to be acted upon by the regulatory authorities. These guidelines require banks and bank holding companies to maintain capital based upon the credit risk of their operations.\nThe risk-based capital guidelines are designed to require the maintenance of capital commensurate with both on and off-balance sheet credit risks. The minimum ratios established by the guidelines are based on capital, as defined, to total risk-weighted assets. Total risk-weighted assets are calculated by assigning each on-balance sheet asset and off-balance sheet item to one of four risk categories (depending on the nature of each item). The amount of the items in each category is then multiplied by the risk-weight assigned to that category (0%, 20%, 50% or 100%). Total risk-weighted assets equals the sum of the resulting amounts.\nThe risk-based capital guidelines require the Company and its Bank Subsidiaries to meet a minimum Tier 1 capital ratio of 4% and a total risk-based capital ratio of 8%. Tier 1 capital generally consists of (a) common stockholders' equity, (b) qualifying perpetual preferred stock and related surplus, subject to certain limitations specified by the appropriate regulatory authority, and (c) minority interests in the equity accounts of consolidated subsidiaries; less goodwill and any other intangible assets and investments in subsidiaries that the regulatory agencies determine should be deducted from Tier 1 capital. Tier 2 capital includes Tier 1 capital plus the allowed portion of the allowance for possible loan losses to risk-weighted assets.\nThe Federal Reserve Board and the FDIC have adopted an additional capital standard for banks and bank holding companies. Under this new standard, a 3% \"leverage\" ratio of Tier 1 capital to total assets is the minimum requirement for banking organizations that are deemed the strongest and most highly rated by its respective regulator. A higher minimum leverage ratio (4% to 5% or higher) is required of less highly rated banking organizations and of bank holding companies which propose to engage in expansionary business activities. The principal objective of the leverage ratio is to place a constraint on the maximum degree to which a bank holding company may leverage its equity capital base.\nAs of December 31, 1995, the Parent and the Banks exceeded all of the applicable capital requirements discussed above. As of December 31, 1995, the Banks also met\nthe criteria for classification as \"well capitalized\" institutions under the prompt corrective action rules and the deposit insurance premium rules promulgated under the Financial Deposit Insurance Corporation Improvement Act of 1991. Designation as a well capitalized institution under these regulations does not constitute a recommendation or endorsement of the Company and the Banks by federal bank regulators.\nThe following table presents the Company's capital ratios as of December 31, 1995:\n(1) Computed in accordance with current Federal Reserve Board guidelines. (2) Risk based capital and leverage ratios were initially effective December 31, 1990. (3) Under banking agency regulations, the minimum leverage ratio is 3.0% of adjusted total assets plus an additional amount of at least 100 to 200 basis points for all but the most highly rated.\nFINANCIAL INSTITUTION REFORM, RECOVERY AND ENFORCEMENT ACT OF 1989\nThe passage of the Financial Institution Reform, Recovery and Enforcement Act of 1989 (\"FIRREA\") resulted in significant changes in the enforcement powers of federal banking agencies, and more significantly, the manner in which the thrift industry is regulated. While FIRREA's primary purpose is to address public concern over the financial crisis of the thrift industry through the imposition of strict reforms on that industry, FIRREA grants bank holding companies more expansive rights of entry into \"the savings institution\" market through the acquisition of both healthy and failed savings institutions. Under the provisions of FIRREA, a bank holding company can expand its geographic market or increase its concentration in an existing market by acquiring a savings institution, but it cannot expand its product market by acquiring a savings institution.\nUnder 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 depository institution or (ii) any assistance provided by the FDIC to a commonly controlled FDIC-insured depository institution in danger of default (the \"Cross Guarantee\"). \"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 either that there is no reasonable prospect that the institution will be able to meet the demands of its depositors or pay its obligations in the absence of regulatory assistance, or that its capital has been depleted and there is no reasonable prospect that it will be\nreplenished in the absence of regulatory assistance. The Cross Guarantee thus enables the FDIC to assess a bank holding company's healthy Bank Insurance Fund members for the losses of any of such bank holding company's failed Bank Insurance Fund members. Cross Guarantee liabilities are generally superior in priority to obligations of the depository institution to its stockholders due solely to their status as stockholders and obligations to other affiliates.\nFEDERAL DEPOSIT INSURANCE CORPORATION IMPROVEMENT ACT OF 1991\nOn December 19, 1991, the Federal Deposit Insurance Corporation Improvement Act of 1991 (\"FDICIA\") was enacted into law. The regulatory framework of FDICIA represents a comprehensive and fundamentally changed approach to banking supervision. The new approach imposes relatively detailed standards and mandates the development of additional regulations governing nearly every aspect of the operation and management of banks, in addition to many aspects of bank holding companies. In addition to providing for the recapitalization of the Bank Insurance Fund, FDICIA contains, among other things: (i) truth-in-savings legislation that requires financial institutions to disclose terms, conditions, fees and yields on deposit accounts in a uniform manner; (ii) provisions that impose strict audit requirements and expand the role of the independent auditors of financial institutions; (iii) provisions that limit the powers of state-chartered banks to those of national banks unless the state-chartered bank meets minimum capital requirements and the FDIC finds that the activity to be engaged in by the state-chartered banks poses no significant risk to the Bank Insurance Fund; (v) provisions that require the expedited resolution of problem financial institutions; (vi) provisions that require regulatory agencies to develop a method for financial institutions to provide information concerning the estimated fair market value of assets and liabilities as supplemental disclosures to the financial statements filed with the regulatory agencies; (vii) provisions that require regulators to consider adopting capital requirements that account for interest rate risk; and (viii) provisions that require the regulatory agencies to adopt regulations that facilitate cross-industry transactions, and provide for the acquisition of banks by thrift institutions.\nDEPOSIT INSURANCE PREMIUMS. Pursuant to the requirements of FDICIA, the FDIC adopted regulations that assessed deposit insurance premiums based upon a bank's capital level and supervisory evaluation. Banks were placed into one of three categories (well capitalized, adequately capitalized and less than adequately capitalized) with each category divided into three subgroups (healthy, supervisory concern, and substantial supervisory concern) based upon supervisory evaluations. The risk-related premiums system contained gradations between insurance groups.\nA well-capitalized bank is one that has at least a 10% total risk- based capital ratio, a 6% Tier-1 risk-based capital ratio and a 5% Tier-1 leverage capital ratio. An adequately capitalized bank will have at least an 8% total risk-based capital ratio, a 4% Tier-1 risk-based capital ratio and a 4% Tier-1 leverage capital ratio. An undercapitalized bank will be one that does not meet either of the above definitions. These capital definitions are identical to those adopted by the FDIC for use in a\nseparate \"prompt corrective action\" regulation, except the premium rule excludes references in the other regulation to supervisory evaluations and directives.\nCurrently, TODAY'S BANK-East and TODAY'S BANK-West pay a minimum required assessment of $2,000 per bank.\nSUPERVISORY REFORMS. FDICIA contains several significant bank supervisory reforms including the establishment of a new regulatory system of \"prompt corrective action\" which links supervisory actions to bank capital levels. These categories include: well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. Bank regulators will apply increasingly stringent regulatory sanctions and restrictions to institutions if they fall into the latter three categories. These sanctions range, in order of severity, from being required to file and operate under a capital plan that is approved by the regulators, to restrictions on asset growth and interest rates paid, to the appointment of a receiver or a conservator for the institution. The FDIC has adopted regulations, effective December 19, 1992, that set forth capital definitions for purposes of taking \"prompt corrective action.\" These capital definitions are as follows:\n---------------------- (1) Tier I capital to total assets\n(2) 4% reduced to 3% for MACRO and CAMEL 1 rated institutions\n(3) Ratio of tangible capital to total assets\nAs of December 31, 1995, each of the Banks is considered to be a \"well capitalized\" institution under these guidelines.\nANNUAL AUDIT AND REPORTING REQUIREMENTS. FDICIA also requires annual on-site examinations by federal bank regulators for all depository institutions, with certain exceptions for those well-capitalized and managed institutions with assets less than $500 million, and imposes certain audit and accounting requirements on financial institutions. These requirements include annual independent audits, an independent accountant's attestation of management's report on the bank's internal control structure, and independent audit committees of outside auditors. These provisions are currently not applicable for the Company since none of the Banks have assets greater than $500 million.\nDEPOSIT INSURANCE. Deposit insurance changes promulgated by FDICIA will, among other things, impose new limits on brokered deposits based upon bank capital levels and on uninsured deposits that had previously received de facto protection under the \"too big to fail\".\nFDICIA would generally prohibit any institution that is not \"well capitalized\" from accepting brokered deposits. An institution is \"well capitalized\" if it has capital significantly in excess of regulatory minimums. An institution that is \"adequately capitalized,\" that is, that meets all applicable minimum capital requirements, could accept brokered deposits but only after obtaining a waiver from the FDIC. Any institution that is \"under capitalized,\" which is defined to include any institution that fails to meet any applicable minimum capital requirements, is prohibited from accepting brokered deposits.\nThe FDIC may terminate the deposit insurance of any insured depository institution if the FDIC determines, after a hearing, that the institution has engaged or is engaging in unsafe or unsound condition to continue operations or has violated any applicable law, regulation, order, or any condition imposed in writing by, or written agreement with, the FDIC. The FDIC may also suspend deposit insurance temporarily during the hearing process for a permanent termination of insurance if the institution has no tangible capital. Management of the Company is not aware of any activity or condition that could result in termination of the deposit insurance of any of the Banks.\nSUPERVISION AND REGULATION OF MORTGAGE BANKING OPERATIONS\nThe Company's mortgage banking business is subject to the rules and regulations of HUD, FHA, VA, FMHA and FNMA with respect to originating, processing, selling and servicing mortgage loans. Those rules and regulations, among other things, prohibit discrimination and establish underwriting guidelines which include provisions for inspections and appraisals, require credit reports on prospective borrowers, and fix maximum loan amounts. Moreover, lenders such as the Company are required annually to submit to FNMA, FHA and VA audited financial statements, and each regulatory entity has its own financial requirements. The Company's affairs are also subject to examination by the FRB, FNMA, FHA and VA at all times to assure compliance with the applicable regulations, policies and procedures. Mortgage origination activities are subject to, among others, the Equal Credit Opportunity Act, Federal Truth-in-Lending Act, Fair Credit Reporting Act and the Real Estate Settlement\nProcedures Act and the regulations promulgated thereunder which prohibit discrimination and require the disclosure of certain basic information to mortgagors concerning credit terms and settlement costs. Additionally, there are various state and local laws and regulations affecting the Company's operations as well as requirements promulgated by various private investors such as life insurance companies and others to whom loans have been sold.\nFEDERAL MONETARY POLICY\nThe businesses of the Banks are affected in important respects by the policies of monetary authorities, and particularly the Federal Reserve Board. The Federal Reserve Board attempts to regulate the national supply of bank credit in order to achieve, among other things, maximum employment and a stable price level. Among the instruments of monetary policy used by the Federal Reserve Board to implement these objectives are open market transactions in United States government securities, changes in the discount rate on member bank borrowings and changes in reserve requirements against member bank deposits. These means are used in varying combinations to influence overall growth of bank loans, investments, and deposits, and they may also affect interest rates charged on loans or paid for deposits.\nThe monetary policies of the Federal Reserve Board have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future. In view of changing conditions in the national economy, the money markets and the relationships of international currencies, as well as the effect of actions by monetary and fiscal authorities, including the Federal Reserve Board, no prediction can be made as to possible future changes in interest rates, deposit levels, loan demand, capital requirements, or the business and earnings of the Bank.\nSTATISTICAL DATA\nThe statistical data required by Industry Guide 3 under the Securities Exchange Act of 1934 is set forth on pages 15 through 26. This data should be read in conjunction with the financial statements and related notes and the discussion included in Management's Discussion and Analysis of Financial Condition and Results of Operations as set forth in the registrant's 1995 Annual Report to Shareholders and on pages 29 through 34 of the Annual Report, which is incorporated herein by reference.\nTODAY'S BANCORP, INC. DISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS' EQUITY INTEREST RATES AND INTEREST DIFFERENTIAL (Dollars in thousands, interest and average rates on taxable equivalent basis)\n(1) Net of unearned discount; average loan balances include loans on nonaccrual status. (2) Loan fees, which are immaterial in amount, are included in loan interest income. (3) Tax exempt interest shown is the fully taxable equivalent assuming a 34% rate. (4) Net interest margin is net interest income divided by average amounts of total earning assets.\nTODAY'S BANCORP, INC. CHANGES IN INTEREST EARNED AND INTEREST PAID\nThe following table describes changes in net interest income attributable to changes in the average volume of interest bearing assets and liabilities compared to changes in interest rates. Rate\/volume variances are allocated entirely to change due to volume.\n(1) Loan fees, which are immaterial in amount, are included in loan interest income.\n(2) Tax exempt interest shown is the fully taxable equivalent assuming a 34% income tax rate.\nTODAY'S BANCORP, INC.\nINVESTMENT PORTFOLIO\nThe following table sets forth certain information with respect to the book value of the investment portfolio. Securities available for sale and trading account securities are recorded at estimated fair value at December 31 and securities held to maturity are recorded at amortized cost. Amortized cost is the original cost adjusted for the amortization of premiums and accretion of discounts on the constant yield basis. The classifications shown below are in accordance with Statement of Financial Accounting Standard No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\", which the Company adopted on December 31, 1993.\nTODAY'S BANCORP, INC.\nINVESTMENT MATURITIES\nThe following table shows the maturities of investment securities, at amortized cost, at December 31, 1995, and the weighted average yields (for tax-exempt obligations on a fully taxable basis assuming a 34% tax rate) of such securities:\nThe maturity shown above for mortgage-backed securities was determined by the stated maturity on the investment.\nAt December 31, 1995, the Corporation held no securities of any one issuer with a book value exceeding 10% of capital.\nThe Company made a one-time transfer of securities from the held to maturity classification to the available for sale classification. See Footnote Three of the annual report for full disclosure.\nTODAY'S BANCORP, INC. LOAN PORTFOLIO - TYPES OF LOANS\nThe schedule below sets forth the amount of loans categorized by type for each of the last five years ended December 31.\n(1) Installment loans are shown net of unearned discount which was $154, $375, $748, $1,259, and $1,966 at December 31, 1995, 1994, 1993, 1992, and 1991 respectively.\nTODAY'S BANCORP, INC.\nLOAN PORTFOLIO\nLOAN MATURITIES AND SENSITIVITY TO CHANGES IN INTEREST RATES\nThe following schedule as of December 31, 1995, shows loan maturities and the amounts of those loans having fixed interest rates and those having adjustable or floating rates.\n(Dollars in thousands)\nTODAY'S BANCORP, INC. LOAN PORTFOLIO - RISK ELEMENTS\nThe following table provides information on trends in the Company's nonperforming loans since 1991:\n(Dollars in thousands)\nInterest income on nonaccruing loans for the year ended December 31, 1995 would have been approximately $ 79 if such loans had been current in accordance with their original terms and outstanding throughout the year or since origination. Interest recognized on these loans for the year ended December 31, 1995 totaled approximately $ 35.\nThe Company discontinues the accrual of interest income on any loan when, in the opinion of management, there is reasonable doubt as to the timely collectability of interest or principal. Nonaccrual loans are returned to an accrual status when, in the opinion of management, the financial position of the borrower indicates that there is no longer any reasonable doubt as to the timely payment of principal and interest.\nLoans, now current, where there are serious doubts as to the ability of the borrower to comply with the present loan repayment terms are immaterial.\nIncluded in the past due, renegotiated and nonaccrual loans are $495 of agricultural loans as of December 31, 1995.\nDuring 1995, the Company adopted FAS No. 114 and No. 118. See footnote Four of the Annual Report for full disclosure.\nTODAY'S BANCORP, INC. ANALYSIS OF ALLOWANCE FOR POSSIBLE LOAN LOSSES\nIn establishing the allowance for possible loan losses, management relies on its review of the loan portfolio to assess the risk characteristics and ascertain whether there are probable losses which must be provided for. Specific considerations in determining the adequacy of the allowance for possible loan losses are as follows:\n(1) Analytical reviews of loan loss experience in relation to outstanding loans and the existing level of the allowance for possible loan losses.\n(2) A continuing review of problem, nonperforming or other loans by senior management.\n(3) A rating of loans requiring continuing review in order to estimate future loss exposure.\n(4) Regular examinations and appraisals of the loan portfolio conducted by the internal audit and loan review staff, state and federal supervisory authorities and independent accountants.\n(5) Management's judgment with respect to current and expected economic conditions and their impact on the existing portfolio.\nTODAY'S BANCORP, INC. SUMMARY OF LOAN LOSS EXPERIENCE\nThe following table sets forth loans charged off and recovered by the type of loan and an analysis of the allowance for possible loan losses for each of the past five years. Management believes that the allowance for possible loan losses is adequate to absorb future losses in the portfolio.\nTODAY'S BANCORP, INC. ALLOCATION FOR THE ALLOWANCE FOR LOAN LOSSES\nThe following table sets forth the allocation of the allowance for possible loan losses by category as of December 31:\nTODAY'S BANCORP, INC. DEPOSITS\nThe following table sets forth the average deposits for the last three years. All deposits are in domestic bank offices; there are no foreign deposits.\nMaturities of time deposits and certificates of deposit of $100,000 or more as of December 31, 1995 are:\nRETURN ON EQUITY AND ASSETS\nTODAY'S BANCORP, INC. SHORT-TERM BORROWINGS\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nThe Company owns all of the following properties:\nTODAY'S BANCORP and its subsidiary, TODAY'S BANK-East, occupy approximately 65% of the floor space of 66,000 square feet, with the balance leased to outside tenants. Adjacent to this building is a two- level parking deck with parking for approximately 200 cars. Other TODAY'S BANK-East facilities owned include an additional Freeport location, a Rock City location, a Pecatonica location, a Winnebago location and two Rockford locations.\nThe additional facility in Freeport is located at 1705 South West Street. This facility is comprised of approximately 1,600 square feet and contains four drive-up teller installations.\nThe Rock City facility is located at 123 Main Street, Rock City, Illinois and is comprised of approximately 7,900 square feet and contains two drive-up teller installations.\nThe Pecatonica location has occupied its office at 430 West Main Street since March 30, 1981. The banking office consists of a modern structure of approximately 11,350 square feet. The main floor provides space for six tellers, seven private offices, a conference room, a board room, a safe deposit vault and four drive-up lanes. There is adequate parking located adjacent to the building.\nIn 1992, the Company began operations at an additional facility located at 585 S. Winnebago Rd. in Winnebago which comprises approximately 2,100 square feet and contains one drive-up teller installation.\nOne of the Rockford facilities is located at 850 North Church Street, Rockford, Illinois. The office building consists of a modern five- story structure encompassing approximately 22,000 square feet and contains three drive-up teller installations. The Bank owns two large lots, which are adjacent to its offices, that are used for tenant and employee parking for up to 150 cars. The Bank utilizes the first two floors of the office building, while the remaining three floors are leased.\nIn January 1994, the Company purchased an additional facility at 6833 Stalter Drive, Rockford, Illinois. The office building consists of a modern two-story structure encompassing approximately 22,000 square feet which was constructed in 1992. The Company uses approximately 12,700 square feet and the balance is leased to outside tenants. There is adequate parking located adjacent to the building.\nTODAY'S BANK-West has two locations in Galena, Illinois, a facility in East Dubuque, Illinois and a facility in Scales Mound, Illinois. TODAY'S BANK-West's main office is headquartered at 115 Perry Street in Galena. The office building consists of a two-story structure encompassing 12,500 square feet, which was constructed in 1969 and contains three drive-up teller installations. The Bank uses the main floor and a board room and conference room on the second floor. The remainder of the second floor is leased.\nThe other Galena facility is located at 953 Gear Street and is a modern one-story facility that was constructed in 1976. The building encompasses 2,000 square feet and has two drive-up teller installations. The lower level includes a large board room. The building is located in a newly developed retail area and has adequate parking available.\nThe facility in East Dubuque is located at 350 Wall Street on the edge of downtown East Dubuque. The one-story building encompasses 5,000 square feet and is currently being remodeled to more effectively meet the Company's needs. There are two drive-up teller installations attached to the building and the Company has its own parking lot next to the facility.\nThe Scales Mound facility is located at 311 North Railroad and encompasses 1,200 square feet. There are two drive-up facilities attached to the building.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThere are no material legal proceedings against the registrant or its subsidiaries.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS\nThe information required for this item is incorporated by reference from the Company's 1995 Annual Report to Shareholders on page 28, attached hereto as Exhibit 13a.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe information required for this item is incorporated by reference from the Company's 1995 Annual Report to Shareholders on page 34, attached hereto as Exhibit 13a.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe information required for this item is incorporated by reference from the Company's 1995 Annual Report to Shareholders on pages 29 through 34, attached hereto as Exhibit 13a.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe information for this item is incorporated by reference from the Company's 1995 Annual Report to Shareholders on pages 8 through 27, attached hereto as Exhibit 13a and page 83, attached hereto as Exhibit 13b.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThe information for this item is incorporated by reference from the Company's proxy statement, page 17, attached hereto as Exhibit 99(a).\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information required for this item is incorporated by reference from the Company's proxy statement, pages 2 through 5, attached hereto as Exhibit 99(a).\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required for this item is incorporated by reference from the Company's proxy statement, pages 6 and 7, attached hereto as Exhibit 99(a).\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required for this item is incorporated by reference from the Company's proxy statement, pages 13 through 15, attached hereto as Exhibit 99(a).\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required for this item is incorporated by reference from the Company's proxy statement, page 13, attached hereto as exhibit 99(a), and Note Four on page 18 of the Company's 1995 Annual Report to Shareholders, attached hereto as Exhibit 13a.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a)(1) INDEX TO FINANCIAL STATEMENTS\nThe following consolidated financial statements and related notes and Report of Independent Accountants are incorporated by reference from the 1995 Annual Report to Shareholders, attached hereto as Exhibit 13a and 13b. Annual Report Exhibit 13a Page No. ------------ -------------\nConsolidated Balance Sheets as of December 31, 1995 and 1994 8 Consolidated Statements of Income for the years ended December 31, 1995, 1994, and 1993 9 Consolidated Statements of Cash Flows for the years ended December 31, 1995, 1994, and 1993 10 Consolidated Statements of Changes in Capital for the years ended December 31, 1995, 1994, and 1993 11 Notes to Consolidated Financial Statements 12-26 Independent Auditors' Report for 1995 and 1994 27\nExhibit 13b ----------- Independent Auditors' Report for 1993 Page 83\n(a)(2) Schedules I and II thereon have been omitted since they are not applicable.\n(a)(3) Index to Exhibits ----------------- The following exhibits required by Item 601 of Regulation S-K are included along with this 10-K filing:\nRegulation S-K Item 601 No. ---------------------------\n(3) a. Certificate of Incorporation incorporated by reference to Exhibit (3)a. of registrant's Annual Report on Form 10-K for the year ended December 31, 1994 (File number 0-14511). b. By-laws incorporated by reference to Exhibit (3)a. of registrant's Annual Report on Form 10-K for the year ended December 31, 1994 (File number 0-14511). (4) a. Rights Agreement between registrant and Bank of America Illinois(Rights Agent) incorporated by reference to Exhibit 1 of registrant's registration statement on Form 8-A (file number 0- 14511) filed December 18, 1990. b. Amendment No. 1 to Rights Agreement between registrant and Bank of America Illinois(Rights Agent) incorporated by reference to Exhibit 4 of registrant's registration statement on Form 8-K (file number 0-14511) filed April 9, 1994.\nEXECUTIVE COMPENSATION PLANS\n(10) a. Incentive Plan for Management incorporated by reference to Exhibit 10(b) of registrant's registration statement on Form S-2 (No. 33-30213) filed July 28, 1989. b. Nonqualified Stock Option Plan incorporated by reference to exhibit 10(c) of registrant's Annual Report on Form 10-K for the year ended December 31, 1988 (File number 0-14511). c. Employment Agreements between registrant and Dan Heine and registrant and R. William Owen incorporated by reference to exhibit 10(d) of registrant's Annual Report on Form 10-K for the year ended December 31, 1988 (File number 0-14511). d. Indemnity Agreements between registrant and the Company's directors and executive officers incorporated by reference to exhibit 10(e) of registrant's Annual Report on Form 10-K for the year ended December 31, 1992 (File number 0-14511). e. Compensation Deferral Plan incorporated by reference to exhibit 10(f) of registrant's Annual Report on Form 10-K for the year ended December 31, 1992 (File number 0-14511). f. Severance Agreements between registrant and the Company's Senior Executive Officers filed herewith (see pages 34 through 39). (11) Computation of net income per share. See attached page 40. (13) a. Annual Report to Shareholders for the year ended December 31, 1995. Except to the extent specifically incorporated herein by said report, the annual report is furnished solely for the information of the Commission and is not to be deemed \"filed\" as part of this report. See attached pages 41 through 82. b. Independent Auditors' Report for 1993. See attached page 83. (21) Subsidiaries of the registrant. See attached page 84. (23) Consents of experts. See attached pages 85 through 86. (99) a. Other documents. (Proxy Statement) See attached pages 87 through 104. b. Other documents. (Form 11K) See attached pages 105 through 116.\n(b) REPORTS ON FORM 8-K\nThere were no Reports on Form 8-K filed the quarter ended December 31, 1995.\nREGULATION S-K ITEM 601 NO. (Note: Exhibits 2, 9, 12, 16, 18, 22, 24, 27, and 28 as requested by Regulation S-K, Item 601, have been omitted in this 10-K filing since the information requested is not required or not applicable.)\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.\nTODAY'S BANCORP, INC. --------------------- (Registrant)\nDATE: March 19, 1996 By \/s\/ Dan Heine ------------------- Dan Heine President and Chief Executive Officer\nBy \/s\/ R. William Owen ------------------- R. William Owen 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.\nThe following are all directors and all signed on March 19, 1996\n\/s\/ Allen E. Fehr \/s\/ Thomas A. Ferguson, Jr. ---------------------- --------------------------- Allen E. Fehr Thomas A. Ferguson, Jr.\n\/s\/ Frank E. Furst \/s\/ Craig D. Hartman ---------------------- --------------------------- Frank E. Furst Craig D. Hartman\n\/s\/ Dan Heine \/s\/ Edward D. Higgins ---------------------- --------------------------- Dan Heine Edward D. Higgins\n\/s\/ Raymond E. Johnson \/s\/ J. Michael Hillard ---------------------- --------------------------- Raymond E. Johnson J. Michael Hillard\n\/s\/ R. William Owen \/s\/ James C. Skyrms ---------------------- --------------------------- R. William Owen James C. Skyrms\n\/s\/ Ruth M. Smith ---------------------- Ruth M. Smith","section_15":""}
{"filename":"772372_1995.txt","cik":"772372","year":"1995","section_1":"Item 1. Description of Business\nExide Electronics Group, Inc. (\"Exide Electronics\" or the \"Company\") designs, manufactures, markets, and services a broad line of uninterruptible power systems (\"UPS\"), related equipment, and power management and facilities monitoring software. UPS products protect computers and other sensitive electronic equipment against electrical power distortions and interruptions by providing temporary backup power from batteries in the event of an outage. More sophisticated UPS products also provide additional protection by continuously cleaning and conditioning electrical power. The Company's broad range of UPS products include small systems for use with personal computers, workstations, client\/server platforms, local and wide area networks (\"LANs\" and \"WANs\"), and large standard or customized systems for use with mainframe computers, data centers, and similar applications. The Company's power management software products monitor, track, and communicate electrical power data and other related environmental events in an enterprise's power, network, and computer systems infrastructure that can threaten performance of information technology (\"IT\") systems, thereby giving network and facilities managers the ability to control their IT and power systems more effectively.\nGrowth in the UPS industry is being driven by the rapid proliferation of computers and related electronic systems in the manufacturing, financial services, utility, telecommunications, transportation, and other industries, all of which benefit from the protection offered by UPS products. The operations of such systems can be affected by a variety of distortions in electrical power, including under-voltages (\"sags\"), over-voltages (\"surges\") and transients (\"spikes\"). In many international markets, there is an acute need for constant conditioning of electrical power because of the poor quality of the public power supply which can cause temporary power reductions (\"brownouts\") and complete power interruptions (\"blackouts\"). Any of these power distortions can cause sensitive electronic equipment to malfunction or \"crash,\" increasing the likelihood of costly system downtime, information loss, or damage to equipment or software.\nThe majority of UPS products sold by the Company consist of on-line systems, which continuously clean and condition electric power in addition to providing a back-up power source. A typical on-line UPS product contains a rechargeable battery which stores energy to be used in the case of alternating current (\"AC\") input failure; a rectifier which converts incoming AC power to direct current (\"DC\"); an inverter which converts DC power from the rectifier or battery back to AC power suitable for the end-use application; a battery charger; surge suppressors and noise filters for protection from power fluctuations; and sensors, control circuits, and indicators to ensure that operations follow a proper sequence and provide status information to the user. The UPS unit continuously isolates the end-use equipment from voltage fluctuations, frequency variations, and electrical noise inherent in utility-supplied electrical power and, if this electrical power is interrupted, the UPS provides clean, stable back-up AC power. The back-up power lasts for a sufficient period of time (typically five to fifteen minutes) to permit an orderly shutdown of the affected equipment or continued operation pending the substitution of an auxiliary power source such as a generator or restoration of utility-supplied electrical power.\nIn recent years, the Company introduced various models of standby UPS products for power ranges up to 1.25 kilovolt amperes(1) to satisfy the power protection requirements of less critical applications. Standby systems, which generally are less expensive, monitor incoming power and switch to battery power in the event of power distortions or interruptions that exceed certain parameters, but do not continuously condition incoming power.\nThe Company's products and services and its product marketing, research and development, and manufacturing functions are organized into three business units: the Small Systems Group (\"SSG\") for all products below 50 kVA; the Large Systems Group (\"LSG\") for products of 50 kVA and above; and the Worldwide Services Group (\"WSG\") for all services provided by the Company. In the fourth quarter of fiscal 1995, the Company announced the formation of the Emerging Technologies Group (\"ETG\"). The Company formed this group to more aggressively position itself in newly emerging high-growth technology markets. Certain financial information relating to the Company's three principal business units is included in Management's Discussion and Analysis of Results of Operations and Financial Condition included under Part II, Item 7 of this Form 10-K.\nThe Company manufactures substantially all of its products at its manufacturing facilities in Raleigh and Wilmington, North Carolina and Dallas, Texas. The Company's large systems are generally sold through a direct salesforce, while the Company's small products are generally sold through Value-Added Resellers (\"VARs\"), Original Equipment Manufacturers (\"OEMs\") and distributors.\nThe Company's business began in 1962 as part of Electric Storage Battery, Inc., which was acquired in 1974 by Inco Limited (\"Inco\"). In 1982, Inco sold the business to the Company, which (although incorporated in Delaware in 1979) commenced operations at that time. The Company has three principal subsidiaries, Exide Electronics Corporation, Exide Electronics International Corp., and International Power Machines Corporation (\"IPM\"), all Delaware corporations, and various subsidiaries relating to its domestic and international operations. References to the Company herein also refer to the Company's subsidiaries, except where the context indicates otherwise. The Company's principal executive offices are located at 8609 Six Forks Road, Raleigh, North Carolina 27615, and its telephone number at that location is (919) 872-3020.\nDuring fiscal 1995, the Company acquired IPM, a manufacturer of UPS products headquartered in Dallas, Texas. IPM is compatible with the Company in terms of products and services provided and channels of distribution. In accordance with the merger agreement, the Company acquired all of the capital stock of IPM for approximately 1,510,000 newly registered shares of the Company's common stock. The acquisition was accounted for as a pooling-of-interests. Accordingly, the Selected Financial Data included in Part II, Item 6, Management's Discussion and Analysis of Results of Operations and Financial Condition included under Part II, Item 7, the consolidated financial statements and notes thereto included in Part II, Item 8, and the schedule and exhibits included in Part IV, Item 14 have been restated to reflect the merger with IPM for all periods presented.\n- ------------ (1) A kilovolt ampere (kVA) is a commonly-used unit of measure for electricity supplied using alternating current.\nIn August 1995, the Company completed the acquisition of Lectro Products, Inc. (\"Lectro\"). Lectro is a broadband industry leader specializing in power protection and other transmission enhancement devices for the cable television and telecommunications markets. While the results of Lectro did not have a material effect on the Company's results of operations for fiscal 1995, the acquisition gives the Company a significant position in powering the broadband communications market.\nPending Acquisition\nIn November 1995, the Company executed a definitive agreement to acquire Deltec Power Systems, Inc. and its subsidiaries (\"Deltec\") from Fiskars OY AB (\"Fiskars\") and an affiliated company, for a purchase price of approximately $195 million, subject to certain post-closing adjustments. Under the purchase agreement, Fiskars will receive approximately $157.5 million in cash and 1,875,000 shares of the Company's common stock valued at $37.5 million at a fixed price of $20 per share, in exchange for all of the issued and outstanding common stock of Deltec. Deltec has two principal operating subsidiaries: Deltec Electronic Corp., which is headquartered in San Diego, California; and FPS Power Systems, which is based near Helsinki, Finland. Deltec is one of the world's largest manufacturers and marketers of off-line and line-interactive small UPS systems. Off-line and line-interactive systems are generally smaller and less expensive than larger on-line systems, and are suitable for applications where system downtime may be less costly, such as personal or small business uses. The combination will strengthen the product line offerings of the Company and enhance its global service capabilities. It is expected that the acquisition will close during the first calendar quarter of 1996, after completion of due diligence reviews by the Company and attainment of all required governmental and other regulatory approvals.\nBusiness Strategy\nThe Company's business strategy, which it calls Strategic Power Management(TM), is to provide a full range of product and service solutions to satisfy the power management needs of its customers. Under this strategy, the Company's goal is to provide value to its customers by offering premium performance solutions at competitive prices, as compared to some industry participants who compete primarily on price but generally offer lower-performance products. Through strategic acquisitions, including IPM and Lectro, the Company has expanded its line of UPS products to include a wide range of off-line and on-line products operating across a broad spectrum of kVA power ratings and applications. These acquisitions have also enabled the Company to provide a broad line of service options, supported by a large staff of field service technicians; a large installed base of products that gives the Company extensive experience; a well-established research and development process executed by an experienced team of engineers; and a large and strategically located global distribution network. To further its strategic goals, the Company intends to implement the following business strategies:\nIncreasing presence in small systems segment. As a result of the continuing trend in the computer industry towards distributed processing and the proliferation of personal computers, workstations, client\/server platforms, networks, and other microprocessor-based electronic equipment, the market for smaller UPS systems has experienced significant growth. The Company is taking steps to increase its small systems business, such as frequent introduction of new products that incorporate new technologies, development of new distribution channels and marketing programs, providing new support services, and strategic acquisitions. Many of the technologies underlying small UPS products have been evolving rapidly, incorporating faster switching speeds and reductions in the number of discrete component parts. These new technologies improve reliability and allow reductions in product size, cost, and manufacturing time. The Company intends to introduce new models over the next several years with enhanced performance features based upon recent technological developments. Software that monitors and manages complex networks is becoming a critical success factor within the distributed client\/server marketplace, and the Company will continue to develop applications to meet this demand. The Company believes that these developments will enable the new models to address the needs of small systems users and will make its products more attractive to potential customers for small systems.\nExpanding international sales. The Company believes that the international market offers it significant growth potential due to the poor quality of electric power in many foreign countries. Accordingly, the Company continues to develop products designed specifically to meet the unique power protection needs of select international markets and establish joint ventures and other strategic partnerships to manufacture, design, sell, and service UPS products in new under-served markets. The Company believes that its global distribution and service networks, which were expanded through the acquisition of IPM, coupled with its broad line of high performance products, will position the Company to take a leading role in the international UPS market.\nExpanding its market share through segmentation. The Company intends to increase its market share in the rapidly growing worldwide UPS market by focusing its Strategic Power Management approach on specific industry segments. In addition to its historical segmentation of the market based on specific kVA ratings, the Company intends to manufacture and market power management products and solutions tailored to specific industries, including transportation, industrial process control, broadband cable television, and telecommunications.\nExpanding its WSG business. The Company's WSG is one of the leading service organizations in the global UPS market. The Company plans to increase its service revenues through the introduction of new service offerings that complement its Strategic Power Management focus, including offering support services for non-UPS power equipment such as generators, switchgear, breakers, and power distribution systems, as well as providing power quality analysis and remote systems monitoring. In addition, the Company is developing programs to provide service support for OEMs and the Federal government, which have historically provided their own service and product support but are increasingly looking to out source such services.\nRedefining its LSG focus. The Company believes that the market for large UPS products is relatively mature, and that the demand for such systems will not grow significantly over the next several years. Historically, large UPS systems were used to support the power requirements of large mainframe computers and data centers. With the movement away from mainframe systems towards smaller data centers and office environments, there has been a need for mid-range UPS systems operating in the 50kVA to 150kVA power range. To meet these changing needs, the Company has redesigned its product lines and introduced new combinations of large UPS products, ancillary equipment, and services. The Company is pursuing commercial applications for its LSG products in several markets including large medical facilities and industrial process control, as well as continuing to pursue sales of large systems to the Federal government.\nEstablishing a leading market position in emerging technologies. In response to rapid growth in a number of new technologies that use electrical power, the Company created ETG to aggressively seek out opportunities to develop new small system UPS products utilizing new technologies or serving new applications. ETG's initial efforts focus on low-end rectifiers and power supplies for the broadband cable television and telecommunications industries, product lines acquired as part of the acquisition of Lectro. The Company plans to utilize these product lines as a platform to enter the rapidly expanding wireless and personal communication services markets.\nUPS Market Trends\nOne of the most important trends over the last decade behind the expansion of the domestic demand for UPS products has been the focus by businesses on trimming costs, including costs associated with power outages and poor power quality. Businesses have become more aware of the dangers of transient surges and other utility line problems and their effect on sensitive electronic equipment. Moreover, businesses are more aware of losses caused by downed computers and lost data from surges, brownouts, and blackouts.\nA significant trend driving the growth of the UPS market, and the most important trend affecting the selection of UPS product type, is the migration from mainframe, mid-range and minicomputers to distributed computing. This trend has resulted in the proliferation of PCs, workstations, client\/server platforms, networks and other microprocessor-based equipment, leading to rapid growth for smaller UPS systems and more modest growth for larger systems. The shift to UPS products for LAN\/WAN file servers and PC\/workstations is expected to generate an increasing demand for lower cost UPS products. While computer systems are evolving from mainframes to file servers, the concept of computer rooms is undergoing a corresponding evolution to data centers that incorporate large numbers of servers in computer room settings. Accordingly, the Company is designing its LSG products for use with the new computer technology.\nAnother market trend involves increasing demand for UPS products in high-growth industries that are becoming more dependent on highly reliable computers and electronic systems. Industrial process control, telecommunications, and medical applications are expected to show future growth in both the large and small system UPS product markets.\nImprovements in the design of UPS products have led to declines in manufacturing costs, which have produced lower sales prices for UPS products. This trend has expanded the market for UPS products to applications where UPS solutions were previously cost-prohibitive.\nProducts\nThe Company offers a broad range of power protection and management systems for computers ranging from personal computers with power requirements starting at 0.2 kVA to the world's largest data centers with aggregate power requirements of thousands of kVA. The Company's product offerings consist primarily of the following product families:\nSmall Systems Small systems offer comprehensive power conditioning and power backup capabilities for personal computers, workstations, client\/server platforms, networks, and minicomputers, as well as other critical applications such as telecommunications, medical, and laboratory equipment. They are much smaller, lighter, and less expensive than large systems, and are generally easy to install and use. Small computers are especially vulnerable to power fluctuations, particularly in UNIX(R) and other sophisticated operating environments. The Company's sales of SSG products constituted approximately 38% of its total revenues in fiscal 1995.\nA number of the technologies underlying small UPS products have been evolving rapidly. These technologies have resulted in faster switching speeds, reductions in the number of discrete components, more sophisticated control architectures using microprocessors and microcontrollers, and enhanced communications capabilities that allow for transmission of data on a continuous basis concerning various parameters monitored by the UPS systems. These technologies have enabled small UPS products to be reduced in size and cost, manufactured in less time, and made more reliable. The Company's Powerware Plus products use the Company's proprietary advanced switching technology, which yields better isolation from damaging electrical noise, and application specific integrated circuit (\"ASICs\") control architecture.\nSeveral different models of small systems UPS products are currently offered, which differ principally in the amount of power that can be supplied, ranging from 0.25 kVA to 36 kVA. Each of the models offers various options relating to the length of time for which battery power can be supplied, the level of networking capability, and other features. Separate models have been developed for sales to international customers because of different standard voltages and frequencies in use in other countries and other technical factors.\nThe most notable of SSG's products is the Powerware Prestige line. Its technology and design give the Prestige relatively small dimensions and weight for its power ratings. The Prestige has a broad selection of software-configurable options, self-diagnostic capabilities, and tolerance of a wide input-voltage range that extends battery life. The Prestige is one of the first UPS products in its power range to incorporate all power components onto a printed circuit board, which improves quality and reliability while reducing costs. During fiscal 1994, the Prestige generated the highest level of first-year sales for an introductory product family in the Company's history. The Prestige continued as SSG's best selling product line in fiscal 1995. The Prestige is currently offered in nine models ranging from 650 VA to 6 kVA. This product line replaced the Powerware Personal and certain models of the Powerware Plus product lines.\nThe combination of small system UPS products and state-of-the-art network monitoring software has become a significant feature of the Company's SSG product line. The Company's proprietary power management software, OnliNet(TM), and related connectivity products can monitor power conditions, environmental events, and UPS performance, and initiate automatic shutdown of computers in a controlled sequence in the event of a prolonged power outage. OnliNet is compatible with most commercial operating systems.\nIn response to increased demand for low-end products, the Company offers five models of its ONE-UPS standby (\"off-line\") UPS products for use at lower power ranges (up to 1.25 kVA). Standby products generally offer less power protection than on-line products, but at a lower cost, so they are generally used for less critical applications. Historically, the Company has not offered line-interactive products, a hybrid UPS technology that typically falls between standby and on-line UPS products in terms of price and the degree of power protection provided. However, the Company has plans to introduce its first line-interactive products in fiscal 1996.\nLarge Systems The Company has produced large UPS products for over twenty years. The Company presently offers a number of models of its large UPS products, supporting power capacities from 50 kVA to 1,000 kVA in a single module. Single modules can be combined in systems for increased capacity and\/or redundancy. A majority of these large systems, including almost all systems for large mainframe computers and data centers, are customized by the Company's applications and product engineers to meet customers' specific requirements. The Company's sales of LSG products constituted approximately 31% of its total revenues in fiscal 1995.\nDuring the 1980s, the Company introduced the initial model of its Powerware Systems series of products as part of its strategy to develop a standard large system product line serving the needs of a broad range of computer applications. In fiscal 1994, the Company introduced the Powerware Plus 80, the first of a new generation of LSG products. The Powerware Plus 80 continued a migration of elements of the Company's advanced switching technology to higher power ranges. Its design provides quality and reliability enhancements as well as lighter weight, with excellent performance in non-linear load conditions and emergency generator operations (which typically supply erratic, low-quality electricity). The Powerware Systems and Powerware Plus products are designed to meet the power protection requirements of computer room and office environments and to operate with most combinations of central processing units, peripherals, and communication devices without significant customization. The Company also offers specialized products designed for medical imaging applications such as Magnetic Resonance Imaging and Computer-Assisted Tomography scanning equipment, transportation applications, including airlines and subways, and process control applications for manufacturing businesses.\nThe Company's largest UPS product line is the Series 3000, which is designed to meet the power protection requirements of large data centers, and is usually custom-engineered to meet customers' specific power protection needs. The Company's Series 3000 products are typically integrated with a significant amount of batteries, switchgear, and other ancillary equipment that the Company purchases from its suppliers. In addition, the Company's Hot-Tie(R) technology enables Series 3000 systems to be linked together to support very large power requirements and provide redundancy. The largest current installation is an 18,000 kVA parallel redundant series of systems for a major telecommunications company. As a result of the size of these systems and the inclusion of batteries, switchgear and other equipment, customized Series 3000 systems may exceed $1,000,000 per installation. In fiscal years 1995, 1994, and 1993, significant sales of Series 3000 systems and ancillary equipment were made to the Federal government in connection with the Federal Aviation Administration (\"FAA\") program described below under the caption \"Federal Government Contracts.\"\nThe Company acquired DataTrax Systems Corporation (\"DataTrax\") in fiscal 1993 to expand its ability to provide fully-integrated power management solutions. DataTrax gave the Company an innovative software product that monitors critical power, environmental, and security systems for customers with high systems-availability requirements. DataTrax products are designed to interface with other manufacturers' UPS products, air conditioners, generators, and other equipment. The Company believes that facilities monitoring products, such as those offered by DataTrax, have significant market growth potential.\nIPM products The acquisition of IPM in February 1995 provided the Company with a complementary product line. IPM has a broad line of on-line UPS products in power ranges from 600VA to 300kVA, including BalancedPower Plus, BalancedPower Advantage, and BalancedPower II. IPM's product line has enabled the Company to compete more effectively in the international markets, and provided the Company with an enhanced international presence, particularly in China. IPM also provided the Company with a stronger market presence in the transportation and telecommunications industries.\nEmerging technologies In August 1995, the Company formed ETG to aggressively enter and serve emerging markets for power protection and management systems, primarily the cable television and telecommunications industries. The acquisition of Lectro served as the catalyst for the formation of ETG, and provided the Company with new technology designed for use in harsh operating environments. These UPS products are currently sold primarily to the cable television industry. ETG also sells rectifiers and inverters to the rapidly expanding wireless and personal communication markets, as well as other segments of the telecommunications industry.\nNew products The Company plans to introduce additional new small systems products over the next several years, including enhanced products at the higher end of the power range for small to mid-range applications, a new generation of off-line products, and, in 1996, its first line-interactive product family. The Company also intends to introduce new models of existing products containing new features, such as more user-friendly software and expanded international language capabilities. Because of the rapid evolution of new technologies, SSG products are expected to have relatively shorter life cycles than LSG products. The market for large UPS products, however, is relatively mature, and the products have relatively long life cycles. The Company therefore expects to direct its improvement efforts at reducing cost, improving quality, reducing total cycle time, and incorporating new features, rather than redesigning entire LSG product lines. The Company also intends to introduce new combinations of large UPS products, ancillary equipment, and services. ETG expects to complete development of a new product to maximize the Company's position in the cable television industry. There can be no assurance that the Company will be able to develop these new products or that these products will achieve market acceptance.\nServices\nWSG offers a wide range of service programs, including preventive, corrective, and contract maintenance services offered under the PowerCare(R) name, and emergency services, training, and spare parts. Most of the Company's service revenues relate to large system UPS products, which often require a higher level of service, including post-sales applications support, systems implementation and integration, installation and startup support, and comprehensive maintenance services. The Company also provides, in connection with certain significant sales of large UPS products and ancillary equipment to the Federal government, site-specific engineering, construction, installation, systems implementation and integration, training, documentation, and overall program management services.\nThe Company has implemented a comprehensive global service strategy. The Company recently expanded its UPS product services to include battery monitoring services, site services, and services for OEMs, and expects to continue expanding its service business with high sustained rates of growth in maintenance contracts and battery monitoring services. In addition, the Company is developing programs to provide service support for OEMs and the Federal government, which historically have provided their own service and product support, but are increasingly seeking to out source services and support.\nRecent acquisitions have contributed to growth in the Company's service business. The Company is in the process of integrating IPM's service business, which expanded the Company's North American commercial service operating base by nearly 25%. The Company has also experienced international service growth as a result of the Company's acquisitions in 1994 of a company in the United Kingdom and two companies in Canada.\nServices in the United States are provided from service centers, which generally are located with sales offices, and individual field service engineers located throughout the country. The Company maintains inventories of spare parts at its service centers and sales offices. Telephone support is provided 24 hours per day. The Company also provides various factory and extended warranty services as part of the purchase of UPS products, and guarantees on-site support within 24 hours in the contiguous United States and 48 hours anywhere in the world. International services are provided through the Company's affiliates and distributors. The Company provides spare parts, training, and technical support for its international distributors in countries where the Company does not provide service support to ensure a consistent ability to provide worldwide customer service.\nSales and Distribution\nOrganizational Approach\nThe Company's principal sales efforts are organized geographically into two groups: the Americas Group, which covers the United States, Canada, and Latin America; and the International Group, which covers all other geographic areas. The Americas Group is further organized into five functional groups or areas: Commercial Sales, Partner Marketing, the Federal Systems Division, Canada, and Latin America. The International Group is divided into three geographic areas: Europe, Middle East, Africa; Japan; and the Far East. At the present time, the Company maintains separate distribution channels for IPM and Lectro products.\nThe Americas Group\nCommercial Sales The Company conducts its commercial sales using manufacturers' representatives, Value-Added Distributors (\"VADs\"), and a Corporate Accounts sales group. The Company works closely with its manufacturers' representatives and provides support to their marketing efforts through ongoing sales and product training programs, advertising and promotional campaigns, and participation in major trade shows. The Company has approximately 50 manufacturers' representative firms, which offer sales, technical service, and customer support to commercial accounts throughout the U.S. These manufacturers' representatives are the Company's primary sales channel for LSG systems, and have recently begun marketing the Company's SSG product lines as well. Commercial Sales also includes VADs, which are local or regional distributors who access the market directly to end users and on a resale basis by selling to VARs. The Company's Corporate Accounts sales group is responsible for coordinating direct sales efforts for all of its products to select major customers nationwide. Corporate Accounts may purchase products for their own use or for resale.\nPartner Marketing The Company's sales effort in Partner Marketing are conducted through OEMs, resellers, distributors, and VARs. The Company has OEM and reseller relationships with numerous companies, including IBM, AT&T, Digital Equipment Company, Data General and Unisys, some of which sell the Company's UPS products on a private-label basis. The Company's OEM\/reseller sales relate primarily to its SSG products. OEMs\/resellers market the Company's products separately, as part of a combined product offering with the OEMs' equipment, or through the OEMs' service organizations. The Company has also developed a network of distributors and VARs for the sale of SSG products. The Company supports the distributor effort with various VAR marketing programs, and expects to continue expanding its relationships with distributors and VARs.\nFederal Systems Division The Federal Systems Division coordinates the Company's selling efforts to military and civilian agencies of the Federal government and focuses the Company's efforts in order to maximize sales under government contracts. Historically, the majority of sales to the Federal government has consisted of LSG products and related services. Sales of SSG products are currently made to the Federal government through distributors, VARs, and systems integrators. The Company also offers certain of its UPS products in the 36 to 375 kVA range through a General Services Administration (\"GSA\") schedule. See the Federal Government Contracts section below for a discussion of sales to the Federal government and certain government contracts.\nCanada The Company's wholly-owned Canadian subsidiary distributes, services, and performs limited modification of its UPS products in Canada. The subsidiary uses manufacturers' representatives, VARs and direct sales for distribution.\nLatin America The Company maintains a sales office in Miami to support the Company's sales and marketing effort in Latin America, which are generally conducted by distributors and OEM's. The Company's network of distributors in Latin America are factory trained to provide service for all products sold. In December 1995, the Company announced plans to form a joint venture in Brazil to better serve this market.\nThe International Group\nThe International Group is organized into three geographic regions designed to maximize its participation in certain major international regions using approaches tailored to each geographic area based upon the market's size, growth potential, and local governmental requirements. International sales efforts are focused primarily on SSG products and services. The Company also has introduced several products to meet the specific voltage and frequency requirements of international customers.\nEurope, Middle East, and Africa The Company markets and sells its products and services in Europe through subsidiaries in France, the United Kingdom, and Germany. In European countries where the Company does not have a local affiliate, as well as in the Middle East and Africa, the Company markets and sells its UPS products through local distributors and manufacturers' representatives. The Company maintains a sales office in London to help support those sales.\nJapan In Japan, the Company has a joint venture with Japan Storage Battery Co., Ltd. (\"JSB\") that sells, markets, and distributes UPS products through a direct sales and service organization, as well as through distributors and VARs.\nFar East In Pacific Rim countries where the Company does not have a local affiliate, the Company markets and sells its UPS products through local distributors. The Company maintains sales offices in Singapore and Beijing, China to help support those sales. In December 1995, the Company announced plans to form a joint venture in India to better serve this market.\nIPM Distribution Channels\nThe Company continues to maintain most of IPM's distribution channels to market its IPM product lines. In North America, IPM markets its products primarily through independent manufacturers' representatives, OEM Resellers, national accounts, and directly to the Federal government. IPM sells its systems internationally primarily through distributors and manufacturers' representatives. Additionally, the Company is involved in direct sales activities from its Hong Kong office and in China, Germany, and Canada. Over time, the Company intends to integrate IPM's products into its sales and distribution organization.\nCustomers\nThe principal end users of the Company's products and services include a broad range of commercial users, from large multinational corporations to small businesses, and various military and civilian agencies of the Federal government. The Company's customer base has expanded significantly in recent years with the broadening of its product line, especially for small UPS products. The Company also has been increasing its customer base internationally; sales to international customers accounted for approximately 31%, 25%, and 22% of the Company's total revenues in fiscal years 1995, 1994, and 1993, respectively, and accounted for approximately 43%, 37%, and 33% of total commercial revenues for these periods. While the Federal government is the Company's largest single customer (see the caption \"Federal Government Contracts\" which follows), no single commercial customer accounted for 10% or more of the Company's total revenues in fiscal 1995.\nResearch and Development\nThe Company believes that it must continue developing new products and enhancing existing ones to maintain its position as an innovative leader in the power protection and management industry. The Company's research and development efforts with respect to SSG relate primarily to the incorporation of new technological developments, while efforts with respect to LSG are aimed at reducing cost and total cycle time and improving quality. The Company has also been expanding its product line to include specialized offerings for particular applications, such as medical, cable television, and telecommunications equipment, in addition to models that meet international voltage and frequency requirements. The Company has replaced most of its product line as well as expanding its product offerings over the last five years and is currently involved in the development of additional new products and further advances in its product line. In recent years, as software has become increasingly important in the design and operation of the Company's UPS products, the Company has expanded its software development capability to produce products that improve customers' ability to manage their information technology and power networks.\nThe Company believes that its relationships with suppliers of semiconductors, batteries, and other primary components give the Company access to emerging technologies and applications. The Company's relationships with OEMs also provide it with the opportunity to integrate power and user requirements of products under development by those OEMs into its research and development efforts.\nDuring fiscal 1995, 1994 and 1993, the Company spent approximately $9.9 million, $10.1 million, and $9.6 million, respectively, on research and development. The Company's research and development expenditures as a percentage of revenue were 2.5%, 2.8% and 3.0%, respectively, for fiscal 1995, 1994 and 1993. The Company expects that research and development expenditures will continue at substantially the same level in relation to sales for the foreseeable future as the Company takes advantage of synergies produced by its acquisitions of IPM and Lectro.\nManufacturing\nThe Company manufactures substantially all of its UPS products at three locations: Raleigh and Wilmington, North Carolina, and Dallas, Texas. In addition, the Company's international distributors and affiliates can customize products to the extent required for various international markets.\nMost of the Company's SSG systems are produced at a manufacturing facility near Wilmington, North Carolina, which became operational during fiscal 1991 and was expanded in fiscal 1995. IPM also manufactures a portion of its small systems product line at the Dallas, Texas plant. The Company's manufacturing operations for small systems consist primarily of product assembly, wiring harness fabrication, quality control, and product testing. The SSG manufacturing process involves production of high volumes of various models of products, which are significantly easier to assemble than LSG products because of standard production runs and fewer discrete components. The Company has historically out sourced production of some of its low-end products in Taiwan. Although the Company does not manufacture these products directly, they are built to the Company's design specifications.\nThe Company's LSG products are manufactured in Raleigh, North Carolina and Dallas, Texas. Manufacturing operations for large systems consist primarily of transformer fabrication, wiring harness fabrication, product assembly, painting, quality control, and product testing. LSG manufacturing involves production of lower volumes of products and requires a higher level of manufacturing expertise due to a higher number of components and, in many cases, the need for customization.\nAlthough the Company generally uses standard parts and components that are available from a variety of sources, certain electronic components currently are available only from single sources. While the Company has generally been able to obtain adequate supplies of these components, recently UPS manufacturers, including the Company, have experienced temporary shortages in some components, such as certain microprocessors, printed circuit boards and capacitors. These shortages affected the delivery schedule on some products and resulted in lower margins on some sales as the Company incurred higher costs in purchasing components from alternative sources. Generally, any inability to obtain supplies of sole-source components will temporarily disrupt production as alternatives are located or developed. In addition, the availability of certain specialized components used with large UPS products, such as switchgear, batteries and other ancillary equipment that are not inventoried by the Company, can affect the timing of delivery of the Company's integrated power protection systems, including its LSG products.\nIn October 1992, the Company, based upon an audit of its United States operations, was certified and recognized as a Registered Firm conforming to ISO 9001 quality criteria for the design, manufacture and servicing of its products. ISO 9001 certification is becoming increasingly important in the marketing and selling of products worldwide.\nBacklog\nThe Company's backlog as of September 30, 1995 was approximately $107 million as compared with $146 million as of September 30, 1994. Approximately $20 million of the backlog as of September 30, 1995 is not expected to be delivered within the next 12 months. Backlog reflects firm customer orders for products and services scheduled for shipment within 12 months, or firm, funded government orders. A significant portion of the backlog at September 30, 1995 is attributable to orders from the Federal government, particularly for the FAA modernization program. The FAA program is discussed below in the \"Federal Government Contracts\" section.\nThe level of backlog at any particular time is not necessarily indicative of future operating performance of the Company. Delivery schedules may be extended, particularly in the case of LSG products, and orders may be canceled at any time subject to certain cancellation penalties. In addition, since small systems generally can be shipped shortly after firm customer orders are received, backlog levels for SSG as of any particular date may reflect a temporary surge or lull in orders, and may not be indicative of business trends for subsequent periods.\nCompetition\nThe Company believes that it is one of three global companies providing a full range of UPS products and services worldwide. The Company competes with a large number of firms with respect to small UPS products, and believes that its principal competitors in the United States include American Power Conversion Corporation, the leading manufacturer and seller of small UPS products; a business unit of General Signal Corp.; and Trippe Manufacturing Company. Since recent growth in the UPS industry has been in small UPS products and since distribution channels for small UPS products are rapidly evolving, the Company believes that it is likely to face significant competition in the sale of small UPS products over the next several years.\nThe Company believes that its primary competitors in the large UPS product market include business units of Emerson Electric Co. and Groupe Schneider, S.A. Both of these companies are much larger than the Company and have greater financial and other resources. The Company believes that Federal government procurements will be highly competitive, such as the recent procurement process related to the new ALC contract discussed below under \"Federal Government Contracts.\"\nMany other companies compete successfully in certain countries or geographic regions and in individual UPS product or application niches. Some of the Company's competitors have greater financial and other resources than the Company. The Company believes that product reliability and quality, performance, service, support, and price are the most important factors with respect to sales of its UPS products. Marketing and brand recognition also play a role in competing for the sale of UPS products.\nFederal Government Contracts\nSales to the Federal government accounted for approximately 27%, 33%, and 35% of the Company's revenues for the fiscal years ended September 30, 1995, 1994, and 1993, respectively. A major portion of the Company's sales to the Federal government consists of large, customized UPS products and ancillary equipment under multi-year programs with complex manufacturing, system design, delivery, and installation schedules. In connection with these programs, the Company supplies significant services, including site-specific engineering, integration, systems implementation and startup, training, orientation, documentation, and program management. The Company also sells its products and services to the Federal government through its GSA schedule and frequently through miscellaneous competitively-awarded and sole-source procurement actions. Most of these contracts are subject to termination at the convenience of the government pursuant to the terms of the contracts.\nA significant portion of the Company's sales to the Federal government in recent years has been under a five-year contract with the Air Force Air Logistics Command (\"ALC\") awarded to the Company in May 1988 following a competitive procurement and, to a much lesser extent, under a five-year contract with the United States Navy awarded to the Company in June 1991 following a competitive procurement. In April 1992, the Company was awarded a second five-year contract with the United States Navy for a different range of UPS products.\nA significant portion of orders received by the Company under the ALC contract has been for the FAA Air Route Traffic Control Center Modernization Program. To date, the Company has received approximately $355 million in orders under this program, which relate to approximately 25 FAA locations. As of September 30, 1995, approximately $60 million of the Company's backlog relates to firm, funded orders received under this contract for the FAA. The period during which orders could be placed under this contract expired in May 1993. Expiration of the ALC contract does not affect orders received prior to expiration, and delivery on the remainder of such orders, which consist primarily of site implementation services for the FAA, is currently planned through fiscal 1997.\nIn June 1995, the Company was awarded a follow-on ALC contract. This is a three-year requirements contract, which permits extension of the ordering period for up to two additional one-year periods at the option of the Government. Actual revenues under this contract will depend on the specific purchases, if any, by the Air Force and other governmental agencies which can use the contract during the contract period. Following the award of the contract, certain competitors filed protests with the General Accounting Office (\"GAO\"). In December 1995, the GAO notified the Company that all of the protests had been dismissed, except the protest of the Air Force's evaluation of certain discounts offered by the Company in the contract. In sustaining this protest on the basis that it did, the GAO did not recommend termination of the contract or any other remedy adverse to the interests of the Company at this time. As a result, the Company retains the contract for the present and the Government can place orders under the contract. The GAO has, however, recommended that the Air Force amend a portion of the request for proposal that led to the contract award. The GAO further recommended that the Air Force allow the protesting companies and the Company to submit new proposals regarding such portion, and that the Air Force re-evaluate the award to the Company based upon these new proposals. The Company has not been advised by the Air Force whether it will contest or accept the GAO's recommendations. Similarly, the Air Force has not advised the Company of its plans regarding the issuance of additional orders under the contract, or an amended request for proposal. No assurances can be given that the Company ultimately will retain the contract.\nThe Company's government contracts require the Company to supply UPS products and services at the Company's contract prices. A principal benefit of these types of contracts is that military or civilian agencies may purchase products from the Company by procuring those products through the contracting agency. The Company's Federal Systems Division therefore seeks to identify applications useful to other Department of Defense and civilian agencies within the Federal government.\nThe Company's Federal government business is performed under firm fixed-price type contracts, time-and-materials type contracts, and at times a combination of both. Under firm fixed-price contracts, the Company agrees to deliver products and perform work for a fixed price. Accordingly, the Company realizes all of the benefit or detriment resulting from decreased or increased costs of performing under a firm fixed-price contract. Under time-and-materials contracts, the Company receives an agreed hourly rate for each employee working under the contract and is reimbursed for the cost of materials and certain administrative overhead.\nThe Company's compliance with government contract regulations is audited or reviewed from time to time by government auditors, who have the right to audit the Company's records and the records of its subcontractors during and after completion of contract performance. Under Federal government regulations, certain costs are not costs for which the government will reimburse the Company. Government auditors may recommend that certain charges be treated as unallowable and reimbursement be made to the government. In addition, as part of the Company's internal control practices, the Company performs regular internal reviews of its charges to the government. In connection with such reviews, the Company may make voluntary refunds to the government for certain unallowable or inadvertent charges, that are brought to the government's attention by the Company. The Company provides for estimated unallowable charges and voluntary refunds in its financial statements, and believes that its provisions are adequate as of September 30, 1995.\nThe Company recognizes that, in the current Federal government contracting environment, many other contractors are the subject of various investigations for breach of government contract rules and procedures. The Company is not aware of any such investigations relating to the Company. However, if the Company were charged with wrongdoing in connection with its Federal government contracts, the Company could be subject to civil and criminal damages and penalties, and could be suspended from bidding on or receiving awards of new Federal government contracts pending the completion of legal proceedings. Any Federal government contracts found to be tainted by illegality can be voided by the government and the contractor can be subject to fine or debarment from new Federal government contracts, and its export licenses could be terminated.\nIn addition to the right of the Federal government to terminate contracts, Federal government contracts are conditioned upon the continuing availability of budget appropriations. Funds are appropriated on a fiscal-year basis even though contract performance may take more than one year. Consequently, contracts usually are partially funded at the outset of multi-year programs; additional funds normally are committed to contracts by the procuring agency only as appropriations are made for future fiscal years.\nPatents, Licenses, and Trademarks\nThe Company currently holds various domestic and international patents (which expire at differing times from 2000 through 2011) and various patent applications are pending. Although the Company believes that the pending applications relate to patentable devices or concepts, there can be no assurance that patents will be issued or that any patent issued can be defended successfully. The Company's present policy is to pursue patents for products or processes that it believes are patentable, but there can be no assurance that any patents held by the Company will not be challenged or circumvented, or that\nsuch patent rights, once granted, will provide competitive advantages to the Company. Although the Company believes that obtaining patents wherever possible is in its best interests, it also believes that the legal protections afforded by such patents is of no greater importance in the UPS industry than such factors as rapid development cycles, technological expertise, marketing skill, and customer support. The Company does not believe that its patents or its patent applications are essential to the success of the Company.\nThe Company has a perpetual, exclusive, royalty-free license for the use of the name Exide as part of its corporate name and trade name for the manufacture, sale, and service of UPS products. The Company holds certain licenses required by Federal government agencies for the export from the United States of many of the Company's products.\nThe Company has numerous trademarks effective in the United States and in several foreign countries. Powerware(R), OnliNet(R), PowerVision(R), Hot-Tie(R), Strategic Power Management(R) and Cell Saver(R) are registered trademarks of the Company, and PowerCare(R) is a registered service mark. Applications for registered trademarks are pending for ONE-UPS(TM) and DataFrame(TM). Management considers its various trademarks to be valuable assets but believes that the loss of any one trademark would not have a material adverse effect on the Company's operations.\nEmployees\nAs of September 30, 1995, the Company employed approximately 1,700 persons. Approximately 650 are employed in manufacturing and the balance are in customer support, research and development, sales and marketing, and administration. In addition, the Company uses temporary personnel on an as-needed basis, which it believes affords operating flexibility. The Company believes that its continued success depends on its ability to attract and retain highly qualified personnel.\nNone of the Company`s employees is represented by a collective bargaining agreement The Company has not experienced any work stoppages and believes that its employee relations are good.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company's principal facilities are as follows:\nAll of the Company's principal facilities are occupied under long-term leases, except for the facility in Wilmington, North Carolina, which is owned. The Company also leases various sales and service offices worldwide. The Company believes that its facilities are adequate to meet its current requirements.\nItem 3.","section_3":"Item 3. Legal Proceedings\nIn January 1989, a case was filed by a former manufacturer's representative of the Company, alleging that the Company failed to pay commissions owed to him on certain sales. In April 1990, a jury awarded the plaintiff damages of approximately $14.9 million. The Company appealed the decision, and in September 1992, the appellate court reversed the judgment against the Company. In response to various motions filed by the plaintiff, a new trial was granted, and in March 1994, the jury in the new trial awarded damages of $3.75 million payable by the Company to the plaintiff. While the Company continued to believe that it should have no liability in this matter, it recorded a one time charge in the second quarter of fiscal 1994 of $5.0 million ($2.9 million after tax) for the jury verdict and costs of the trial.\nOn July 20, 1994, the Company announced that this litigation had been settled. Following agreement among the parties to settle, the court vacated the jury award of $3.75 million previously entered and determined that the vacated judgment cannot be used against the Company in the future. To avoid further litigation including post-trial motions and appeals, the Company settled the case by making payments to the plaintiff and his attorneys. The parties thereafter stipulated that the entire action was dismissed with prejudice. Since the total value of the settlement payments was less than the one-time charge for the jury verdict recorded by the Company in the second quarter of fiscal 1994, no further charges were necessary in this matter. By agreement with the plaintiff, the terms of the confidential settlement were not disclosed.\nIn May 1990, the Company was served with a complaint in the Delaware Court of Chancery and in May 1991, a related case was filed in Federal Court in New York. These complaints alleged, among other things, that the Company's description of the case involving the manufacturer's representative in its prospectus dated December 21, 1989 was false and misleading. In April 1995, the Company announced that it had settled both the Delaware and New York suits. The Delaware action had been dismissed once for failure to state a claim, but was reinstated following an appeal and was in the discovery process prior to the settlement. The Company recorded a pretax charge of $700,000 ($424,000 after tax) for the settlement of the two related lawsuits in the quarter ended March 31, 1995. Court approval of the settlement agreement, after notice to affected shareholders, was granted in August 1995. While the Company believed that neither suit had merit, it decided to settle as the suits were taking valuable corporate time and attention and would have involved significant legal costs to pursue further.\nThe Company is involved in various litigation proceedings incidental to its business. The defense of most of these matters is handled by the Company's insurance carriers. The Company believes that the outcome of such other pending litigation in the aggregate will not have a material adverse effect on its financial statements.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNo matters were submitted to the security holders during the fourth quarter of the fiscal year ended September 30, 1995.\nPART II\nItem 5.","section_5":"Item 5. Market For the Registrant's Common Equity and Related Shareholder Matters\nThe Company's common stock trades on the NASDAQ stock market under the symbol \"XUPS.\" The following table sets forth the range of high and low closing prices of the Company's common shares for the periods indicated:\n- -------------------- ------------------------- -------------------------- 1995 1994 - -------------------- ------------------------- -------------------------- - -------------------- ------------ ------------ ------------- ------------ High Low High Low - -------------------- ------------ ------------ ------------- ------------ First Quarter $21.50 $14.63 $23.50 $15.00 Second Quarter 20.00 15.75 20.75 15.25 Third Quarter 23.00 15.50 24.50 14.50 Fourth Quarter 25.25 18.75 25.75 19.25 - -------------------- ------------ ------------ ------------- ------------\nAs of December 22, 1995, there were approximately 4,000 shareholders based on the number of holders of record and an estimate of the number of individual participants represented by security position listings.\nAs discussed in Note 6 of the notes to consolidated financial statements included in this document at Item 8, the Company's existing credit facilities restrict payment of cash or property dividends if such payment would cause a default. The Company currently intends to retain all of its earnings for use in its business and, therefore, does not anticipate paying cash dividends on its common stock in the foreseeable future.\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\nThe following discussion provides an assessment of the consolidated results of operations and liquidity and capital resources of the Company and should be read in conjunction with the consolidated financial statements of the Company and the notes thereto included at Item 8","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nReport of Independent Public Accountants\nTo Exide Electronics Group, Inc.:\nWe have audited the accompanying consolidated balance sheet of Exide Electronics Group, Inc. (a Delaware corporation) and subsidiaries as of September 30, 1995 and 1994, and the related consolidated statements of operations, changes in common shareholders' equity and cash flows (restated for the pooling-of-interest transaction as discussed in Note 2) for each of the three years in the period ended September 30, 1995. These 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 financial statements referred to above present fairly, in all material respects, the financial position of Exide Electronics Group, Inc. and subsidiaries as of September 30, 1995 and 1994 and the results of their operations and their cash flows (restated for the pooling-of-interest transaction as discussed in Note 2) for each of the three years in the period ended September 30, 1995 in conformity with generally accepted accounting principles.\nAs explained in Note 12, in 1993 the Company changed its method of accounting for income taxes.\n\/s\/ARTHUR ANDERSEN LLP\nRaleigh, North Carolina, October 25, 1995(except with respect to the matters discussed in Note 16, as to which the date is December 13, 1995).\nExide Electronics Group, Inc. Consolidated Statement of Operations\nExide Electronics Group, Inc. Consolidated Balance Sheet\nExide Electronics Group, Inc. Consolidated Statement of Changes in Common Shareholders' Equity\nExide Electronics Group, Inc. Consolidated Statement of Cash Flows\nNotes To Consolidated Financial Statements\nNOTE 1: Significant Accounting Policies\nBasis of Presentation- The consolidated financial statements include the accounts of Exide Electronics Group, Inc. (the \"Company\") and its wholly-owned subsidiaries. The Company designs, manufactures, markets, and services a broad line of uninterruptible power systems (\"UPS\") products that protect computers and other sensitive electronic equipment against electrical power distortions and interruptions. The Company's products are used principally for financial, medical, industrial, telecommunications, military, and aerospace applications throughout the world. The Company's investment in a joint venture is accounted for using the equity method. All significant intercompany accounts and transactions have been eliminated in consolidation. Certain amounts in the prior years' financial statements have been reclassified to conform to the current year presentation. These reclassifications are not material.\nOn February 8, 1995, the Company completed the merger of International Power Machines Corporation (\"IPM\") with and into a newly formed subsidiary of the Company. The merger was structured as a tax-free exchange and was accounted for as a pooling-of-interests. Accordingly, the accompanying consolidated financial statements and related notes include the accounts and results of operations of IPM for all periods presented (see Note 2).\nRevenues- Revenues from product sales are recognized at the time of shipment to customers. Service revenues are recognized as services are performed. Maintenance contract revenues, net of directly associated costs, are deferred and recognized on a straight-line basis over the terms of the contracts. All revenues are shown net of provisions for customer returns and adjustments.\nAdvertising Costs- Advertising costs are reported in selling, general, and administrative expenses in the accompanying consolidated statement of operations and include costs of advertising, public relations, trade shows, direct mailings, customer seminars, and other activities designed to enhance demand for the Company's products. Advertising costs were $7,344,000 in 1995, $5,972,000 in 1994, and $4,356,000 in 1993. There are no capitalized advertising costs in the accompanying consolidated balance sheet.\nPer Share Data- Primary net income per common and equivalent share is computed using net income after preferred stock dividends and the weighted average number of shares of common stock and dilutive common stock equivalents. Fully diluted net income per share is similarly computed but includes the effect, when dilutive, of assumed conversion of the Company's convertible subordinated notes, and prior to its conversion, the Company's redeemable preferred stock (see Note 8).\nInventories- Inventories are stated at the lower of cost or market. Cost is determined by the last-in, first-out (\"LIFO\") method for certain domestic inventories and by the first-in, first-out (\"FIFO\") method for the remaining inventories.\nProperty, Plant, and Equipment- Property, plant, and equipment is stated at original cost. Depreciation and amortization is calculated using primarily the straight-line method for financial reporting purposes and primarily accelerated methods for tax purposes. For financial reporting purposes, equipment is depreciated over three to ten years and buildings are depreciated over thirty years. Leasehold improvements are amortized over the shorter of the useful life of the asset or the term of the lease.\nSoftware Development Costs- Costs of developing new software products and enhancements to existing software products are capitalized after technological feasibility is established. The costs of capitalized software are amortized over the estimated useful lives of the related products, generally one to five years. The accompanying consolidated balance sheet at September 30, 1995 and 1994 includes unamortized software development costs of $2,072,000 and $2,128,000, respectively. Related amortization expense was $1,035,000 in 1995, $683,000 in 1994, and $277,000 in 1993.\nGoodwill- Goodwill is amortized over periods ranging from ten to forty years.\nTranslation of Foreign Currencies- Certain of the Company's non-U.S. subsidiaries use their local currency as their functional currency. Their asset and liability accounts are translated into U.S. dollars at the exchange rates in effect at the balance sheet date, while revenues and expenses are translated using average exchange rates during the period. Translation adjustments are recorded directly to the cumulative translation adjustments component of common shareholders' equity and do not affect the results of operations. Losses on foreign currency transactions were $218,000 in 1995, $257,000 in 1994, and $221,000 in 1993.\nUse of Estimates- The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the reported amounts of revenues and expenses. Actual results may differ from those estimates.\nRecent Accounting Pronouncements- The Financial Accounting Standards Board recently issued SFAS No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed of.\" This statement requires long-lived assets to be evaluated for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Company will adopt SFAS No. 121 in fiscal 1996 and does not expect its provisions to have a material effect on the Company's consolidated results of operations.\nThe Financial Accounting Standards Board also recently issued SFAS No. 123, \"Accounting for Stock-Based Compensation.\" This statement introduces a fair-value based method of accounting for stock-based compensation. It encourages, but does not require, companies to recognize compensation expense for grants of stock, stock options, and other equity instruments to employees based on the new fair value accounting rules. However, if the Company chooses not to recognize compensation expense in accordance with the provisions of this statement, pro forma disclosures are required in the notes to consolidated financial statements. The Company will adopt the disclosure provisions of SFAS No. 123 by fiscal 1997.\nNOTE 2: Merger with IPM\nOn February 8, 1995, the Company completed the merger of IPM with and into a newly-formed subsidiary of the Company. IPM develops, manufactures, sells, and services UPS products, and is compatible with Exide Electronics in terms of the products and services provided and its channels of distribution. Under the terms of the agreement, the Company issued approximately 1,510,000 newly registered shares of Exide Electronics' common stock for all of the outstanding shares of IPM's common and preferred stock. The merger was structured as a tax-free exchange and was accounted for as a pooling-of-interests. Accordingly, the accompanying consolidated financial statements and related notes have been restated to include the accounts and results of operations of IPM for all periods presented.\nHistorically, IPM prepared its financial statements using a December 31 fiscal year end. As of September 30, 1994, IPM's fiscal year end has been changed to conform to Exide Electronics' September 30 year end. The consolidated statement of operations for the year ended September 30, 1994 combines Exide Electronics' historical consolidated statement of operations for the fiscal year ended September 30, 1994 with IPM's consolidated statement of operations for the year ended September 30, 1994. In accordance with the accounting rules prescribed or permitted for pooling-of-interests, the restated financial statements for the fiscal year ended September 30, 1993 combine the historical consolidated results of operations of Exide Electronics for the year then ended with IPM's historical consolidated results of operations for the calendar year ended December 31, 1993. As a result, IPM's operations for the quarter ended December 31, 1993 are included in the consolidated statements of income, changes in shareholders' equity, and cash flows for both of the fiscal years ended September 30, 1994 and 1993. IPM's revenues were $9,486,000 and net income was $688,000 for the quarter ended December 31, 1993.\nThe restated balance sheet as of September 30, 1994 combines Exide Electronics' historical consolidated balance sheet as of September 30, 1994 with IPM's consolidated balance sheet as of that date. The restated balance sheet as of September 30, 1993 combines Exide Electronics' historical consolidated balance sheet as of September 30, 1993 with IPM's consolidated historical balance sheet as of December 31, 1993. An adjustment to conform IPM's fiscal year is shown in the accompanying consolidated statement of changes in shareholders' equity. An adjustment is also shown in the accompanying consolidated statement of cash flows for the year ended September 30, 1994 to account for IPM's change in cash for the quarter ended December 31, 1993. Combined and separate results of Exide Electronics and IPM during the periods preceding the merger were as follows (in thousands):\nExide Electronics IPM Adjustments Combined ----------- -------- ----------- --------- Quarter ended December 31, 1994 Revenues $ 81,264 $10,802 $ - $ 92,066 Net income $ 1,746 $ 538 $ (35) $ 2,249\nYear ended September 30, 1994 Revenues $326,583 $37,400 $ - $363,983 Net income $ 7,731 $ 1,566 $(122) $ 9,175\nYear ended September 30, 1993 Revenues $281,949 $35,993 $ - $317,942 Net income $ 9,251 $ 1,814 $(233) $ 10,832\nThe combined financial results presented above and the accompanying consolidated financial statements include adjustments to conform the accounting methodology of IPM for reserving for excess and obsolete service inventories to the accounting methodology used by Exide Electronics. There were no intercompany transactions during the periods presented.\nIn connection with the merger, the Company recorded a nonrecurring charge of $5.5 million ($4.4 million after tax) in the second quarter of fiscal 1995. This charge included approximately $3.0 million for legal, accounting, financial advisory, and other costs. The Company also expensed approximately $2.5 million for the estimated costs of closing a duplicate operating facility and discontinuing certain duplicate product lines manufactured at that facility. As of September 30, 1995, all operations at the duplicate facility have ceased, and the Company has entered into negotiations to sell the remaining fixed assets at the facility. The Company is also in the process of disposing of excess inventories related to the duplicate product lines. Other than amounts sufficient to cover remaining lease payments on the duplicate facilities and disposal of excess inventory, there are no significant accrued costs related to the merger included in the consolidated balance sheet at September 30, 1995.\nNOTE 3: Accounts Receivable\nAccounts receivable consisted of the following (in thousands):\nSeptember 30, ----------------- 1995 1994 ------- ------- Accounts Receivable: Commercial $ 86,936 $ 73,913 United States government 21,105 33,947 ------ ------ 108,041 107,860 Less: Allowance for doubtful accounts, customer returns and adjustments 2,517 2,148 ----- ----- $105,524 $105,712 ======== ========\nAccounts receivable at September 30, 1995 and 1994 included unbilled receivables of $7,371,000 and $12,808,000, and retainage receivables of $1,452,000 and $755,500, respectively. Unbilled receivables relate primarily to one United States government contract with multiple installation sites and are generally billable in the month following contract performance. Retainage receivables generally relate to larger customer contracts and become payable at specified dates after installation and customer acceptance.\nCommercial accounts receivable are generally not concentrated in any geographic region or industry. Collateral is usually not required except for certain international transactions for which the Company requires letters of credit to secure payment.\nNOTE 4: Inventories\nInventories, which include materials, labor, and manufacturing overhead, consisted of the following (in thousands):\nSeptember 30, ----------------- 1995 1994 ------- ------- Raw materials and supplies $27,989 $20,149 Work in process 6,064 7,288 Finished goods 24,054 14,805 Service parts 14,783 13,287 ------- ------- $72,890 $55,529 ======= =======\nDomestic inventories of approximately $52,167,000 and $37,900,000 were valued using the LIFO method at September 30, 1995 and 1994, respectively. The LIFO value exceeded the FIFO value of these inventories by approximately $1,941,000 at September 30, 1995 and $693,000 at September 30, 1994. There was no liquidation of prior years' LIFO layers in 1995, and the effect of such liquidation in 1994 was not significant.\nNOTE 5: Short-Term Debt\nCertain of the Company's subsidiaries maintain various lines of credit. These lines, which had interest rates ranging from 7.25% to 8.50% at September 30, 1995, are primarily due on demand and are generally secured by guaranties of payment by the Company. Approximately $7,130,000 and $4,902,000 were outstanding under these facilities at September 30, 1995 and 1994, respectively. The remaining availability under these facilities at September 30, 1995 was approximately $6,900,000.\nThe weighted average interest rate incurred on the Company's short-term debt was 8.5% in 1995 and 8.1% in 1994. The short-term debt balance outstanding at September 30, 1995 approximated fair value for loans with similar terms.\nNOTE 6: Long-Term Debt and Convertible Subordinated Notes\nLong-term debt consisted of the following (in thousands):\nSeptember 30, ------------------ 1995 1994 ------- ------- Domestic bank credit facility $65,000 $39,700 Industrial revenue bonds - 4,600 Other long-term debt 783 - ------- ------- 65,783 44,300 Less current portion 525 900 ------- ------- $65,258 $43,400 ======= ======= Convertible subordinated notes $15,000 $15,000 ======= =======\nThe Company has a $145 million unsecured bank package comprised of a $95 million revolving credit facility (\"Facility A\") for working capital and general corporate purposes, which may include letters of credit, and a $50 million revolving credit facility (\"Facility B\") for financing certain acquisitions and refinancing specified existing obligations. Facility A includes a sublimit of $30 million which may be used in support of the Company's international subsidiaries.\nAmounts outstanding at September 30, 1995 under both facilities bear interest at either the agent bank's base rate or, at the Company's option, the LIBOR rate plus .60%. The weighted average interest rate on these facilities was 6.5% for the year ended September 30, 1995. The average daily unutilized commitment incurs a commitment fee of .20% per annum, and letters of credit bear a fee of .60% per annum. These rates and fees may be adjusted based on a senior debt to cash flow ratio, as defined. Balances outstanding on these facilities at September 30, 1995 and 1994 approximated their fair value. Amounts outstanding under Facility A are due and payable on September 30, 1997. Amounts outstanding under Facility B will convert to a term loan on September 30, 1996, with quarterly principal payments thereafter of 5% of the amount outstanding on conversion, with the remaining balance due September 30, 1999.\nThe credit agreement contains certain financial covenants, including a senior debt to cash flow ratio, a fixed charge coverage ratio, a leverage ratio, and a minimum net worth requirement. As of September 30, 1995, the Company was in compliance with all financial covenants, as amended. The agreement also imposes certain restrictions on mergers, acquisitions, investments in other companies and liquidations; additional senior indebtedness; disposition of assets; related party transactions; and prohibits payments of dividends on common stock if the Company would be in default before or after such dividend payment.\nIn fiscal 1990, Industrial Revenue Bonds (the \"IRBs\") in the aggregate amount of $9 million were issued to finance a portion of the cost of constructing a manufacturing facility near Wilmington, North Carolina. The average interest rate on the IRBs was 7.24%. On June 1, 1994, the Company executed a partial redemption in the amount of $2.6 million using the excess project funds held in trust. On December 1, 1994, the Company exercised its option to redeem the remaining bonds outstanding at a redemption price of 102%.\nIn September 1992, the Company sold $15 million of convertible subordinated notes (the \"Notes\"). The Notes bore interest at 8.375% per annum, payable semi-annually. The Notes were convertible into common stock of the Company at any time for an initial conversion price of $13.08 per share, subject to adjustment for certain events. On October 23, 1995, the holder of the Notes exercised its option to convert the Notes into 1,146,789 shares of the Company's common stock. The market value of the Notes if they had been converted into the Company's common stock was approximately $21.5 million and $24.9 million at September 30, 1995 and 1994, respectively.\nFuture maturities of long-term debt at September 30, 1995, giving effect to the October 1995 conversion of the Notes into the Company's common stock, were (in thousands):\n1996 $ 525 1997 53,469 1998 2,969 1999 8,769 2000 51 Thereafter - ------- $65,783 =======\nNOTE 7: Lease Commitments\nThe Company leases buildings, equipment and machinery under various operating leases. Future minimum payments at September 30, 1995 under noncancellable operating leases were (in thousands):\n1996 $ 6,410 1997 6,175 1998 5,249 1999 4,815 2000 3,909 Thereafter 19,265 ------- $45,823 =======\nRental expense related to operating leases was $8,109,000 in 1995, $7,780,000 in 1994, and $7,165,000 in 1993.\nNOTE 8: Redeemable Preferred Stock\nAuthorized preferred stock consists of 2,000,000 shares of $0.01 par value preferred stock, of which 6,000 shares have been designated as Series D Preferred Stock, 6,000 shares as Series E Preferred Stock, and 200,000 shares as Series F Junior Participating Preferred Stock.\nIn August 1991, the Company issued 5,000 shares of Series C Preferred Stock (\"the Series C shares\") at a purchase price of $1,000 per share. The Series C shares were convertible at the option of the holder into the Company's common stock at a conversion price per share of $9.5062. The holder exercised this option in August 1993 and converted the Series C shares into 525,972 shares of the Company's common stock. In February 1995, authorization for Series C Preferred Stock was removed from the Company's Certificate of Incorporation.\nIn July 1992, the Company issued to Japan Storage Battery Co., Ltd. (\"JSB\") 5,100 shares of the Company's Series D Preferred Stock (\"the Series D shares\") at a purchase price of $1,000 per share. JSB had the right to convert some or all of the Series D shares into the Company's common stock at a conversion price per share of $13.08, subject to adjustment upon the occurrence of certain events. In December 1992, JSB exercised an option to purchase 4,900 shares of Series E Preferred Stock (\"the Series E shares\") at a purchase price of $1,000 per share. The Series E shares were convertible at the option of JSB into the Company's common stock at a conversion price per share of $23.86, subject to adjustment upon the occurrence of certain events. On July 1, 1995, JSB exercised these options and converted all of the Series D and Series E shares into 595,273 shares of the Company's common stock.\nThe Company owns 50% of a joint venture with JSB for distribution of products in Japan. The carrying value of the Company's investment in the joint venture at September 30, 1995 was $399,000. Total sales to the joint venture by the Company were approximately $9.1 million in 1995, $4.1 million in 1994, and $3.6 million in 1993. Accounts receivable from the joint venture were approximately $2,806,000 and $938,000 at September 30, 1995 and 1994, respectively.\nNOTE 9: Common Shareholders' Equity\nAs of September 30, 1995, the Company had notes receivable of $5,520,000 (including accrued interest of $1,917,000) related to the sale of 537,852 shares of common stock to certain employees. The notes generally bear simple interest at prime and are payable ten years from the date of issuance or earlier upon sales of the shares or upon termination of employment. The market value of these notes receivable was approximately $4,956,000 and $5,120,000 at September 30, 1995 and 1994, respectively.\nIn November 1992, the Board of Directors adopted a shareholders' rights plan to deter coercive takeover tactics and to prevent a potential acquirer from gaining control of the Company without offering a fair price to all of the Company's shareholders. The Board declared a dividend distribution of one right for each share of common stock outstanding on or issued after December 7, 1992 (the \"Right\" or \"Rights\"). Each Right, when exercisable, entitles the registered holder to purchase from the Company one one-hundredth of a share of Series F Junior Participating Preferred Stock at a purchase price of $80 per one one-hundredth share, subject to certain adjustments. The Rights will become exercisable only upon the occurrence of a person or group acquiring beneficial ownership of 15% or more of the Company's then outstanding common stock, and will expire in December 2002 unless previously redeemed or exchanged by the Company.\nIn the event that a person becomes the beneficial owner of 15% or more of the Company's then outstanding shares of common stock, except pursuant to an offer for all outstanding shares of common stock which the outside directors determine to be fair to and otherwise in the best interests of the Company and its shareholders, each holder of a Right, other than the person triggering the Rights, will have the right to receive common stock (or in certain circumstances, cash, property or other securities of the Company) having a value equal to two times the exercise price of the Right. Similarly, if the Company is acquired in a merger or other similar business combination without the consent of the Company's Board of Directors, each holder of a Right, except the person triggering the Rights, will have the right to receive common stock of the acquiring Company having a value equal to two times the exercise price of the Right.\nIn November 1994, the Board of Directors authorized the repurchase of up to 5% of the Company's outstanding common stock. Purchases may be made from time to time as management considers appropriate. In October 1995, the Company repurchased approximately 131,000 shares of its common stock.\nNOTE 10: Stock and Benefit Plans\n1995 Employee Stock Option and Restricted Stock Plan- This plan provides for the grant to selected employees of up to 750,000 shares of the Company's common stock. The purchase price for stock options under this plan shall be no less than fair market value of the common stock at the date of grant.\n1995 Directors Plan- This plan provides for the grant of up to 150,000 shares of the Company's common stock. Each of the Company's non-employee directors receives an option to purchase 3,000 shares of common stock on the date of commencement of service as a director and annually thereafter for as long as the director remains on the board. The purchase price for stock options under this plan shall be no less than fair market value of the common stock at the date of grant.\n1989 Stock Option Plan- This plan provides for the grant to selected employees of options for up to 550,000 shares of the Company's common stock. The purchase price for stock options under this plan shall be no less than fair market value of the common stock at the date of grant.\nNon-Employee Directors Stock Option Plan- This plan provided for the grant of 87,500 shares of the Company's common stock. All options available under this plan have been granted. The purchase price for stock options granted under this plan was no less than the fair market value of the common stock at the date of grant.\nThe following table summarizes the activity under these plans:\nShares Exercise Available Options Price for Grant Outstanding Range --------- ---------- ---------- Balances at September 30, 1992 201,270 434,980 2.99-18.00 Granted (48,000) 48,000 15.00-20.13 Exercised - (23,375) 6.50-15.00 Forfeited 17,250 (17,250) 6.50-15.00 ------ ------- ----------- Balances at September 30, 1993 170,520 442,355 $2.99-$20.13 ------- ------- ----------- Granted (64,000) 64,000 16.13-23.50 Exercised - (49,059) 2.99-17.38 Forfeited 26,285 (26,285) 6.50-15.00 ------ ------- ------------ Balances at September 30, 1994 132,805 431,011 $6.50-$23.50 ------- ------- ------------ 1995 Director and Employee Plans 900,000 - - Granted (291,987) 291,987 16.38-16.75 Exercised - (42,590) 6.50-17.38 Forfeited 29,250 (29,250) 15.00-23.50 ------ ------- ------------ Balances at September 30, 1995 770,068 651,158 $6.50-$23.50 ======= ======= ============\nAs of September 30, 1995, outstanding options to purchase 342,404 common shares were exercisable. The majority of these options expire ten years after the grant date if not exercised.\nEmployee Stock Purchase Plan- This plan provides for the grant to employees of rights to purchase shares of the Company's common stock. Shares are purchased at the end of an offering period, with a purchase price for the shares equal to the lower of 85% of the fair market value of the common stock at the beginning or the end of the offering period. A maximum of 600,000 shares have been authorized under this plan, and through September 30, 1995, 234,242 shares have been issued under this plan. Under the current offering, which expires December 31, 1995, the offering price at the beginning of the offering period was $13.84.\nBenefit Plans- The Company and its subsidiaries have defined contribution plans that cover substantially all employees. The plans allow for the matching of voluntary employee contributions, and the Company may elect to make additional contributions at the discretion of the Board of Directors. Total expenses related to these plans were $1,917,000 in 1995, $2,303,000 in 1994, and $2,097,000 in 1993.\nNOTE 11: Geographic Operations\n(in thousands) 1995 1994 1993 ---- ---- ---- Revenues United States - Unaffiliated customers United States $ 268,289 $ 273,087 $ 248,452 Latin America 36,590 31,392 19,962 Far East 23,353 13,138 11,958 Other 452 8,669 6,986 Intercompany 37,338 22,030 18,171\nOutside the United States - Unaffiliated customers Europe 34,975 19,193 13,538 Canada 18,523 14,779 13,768 Other 8,796 3,725 3,278 Intercompany 6,541 3,360 2,341\nIntercompany eliminations (43,879) (25,390) (20,512) ------- ------- ------- Total revenues $ 390,978 $ 363,983 $ 317,942 ========= ========= ========= Income (loss) before income taxes and the cumulative effect of accounting change United States $ 9,035 $ 13,333 $ 17,560 Europe 2,097 (218) (2,630) Canada 419 120 1,068 Other 526 224 48 --- --- --- Total income before income taxes and the cumulative effect of accounting change $ 12,077 $ 13,459 $ 16,046 ========= ========= ========= Identifiable Assets United States $ 213,541 $ 190,515 $ 179,482 Europe 24,935 18,842 11,011 Canada 15,179 14,019 11,767 Other 2,796 1,300 973 ----- ----- --- Total assets $ 256,451 $ 224,676 $ 203,233 ========= ========= =========\nRevenues include sales to unaffiliated customers and the Company's joint venture (see Note 8). Intercompany sales are made at transfer prices intended to provide a profit for the purchasing entities after coverage of their selling, general and administrative expenses. Identifiable assets are those assets identified with operations in each geographic area.\nNOTE 12: Income Taxes\nAs of the beginning of fiscal 1993, the Company adopted Financial Accounting Standards Board Statement No. 109, \"Accounting for Income Taxes,\" which superseded Statement No. 96, the method of accounting for income taxes previously used by the Company. Statement No. 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 (\"NOLs\"). The Company elected to adopt Statement No. 109 using the prospective adoption method. Under this method, the Company recognized an increase in net income of $1.0 million in fiscal year 1993 for the cumulative effect of the change in accounting principle. The increase resulted from recording the net benefit of approximately $850,000 in net deferred tax assets for temporary differences and state income tax NOLs which could not previously be recognized under Statement No. 96, and approximately $150,000 for the net benefit of NOLs for certain of the Company's foreign subsidiaries.\nComponents of the tax provision are shown below (in thousands):\n1995 1994 1993 ---- ---- ---- Provision for (benefit from) income taxes: Federal Current $ 4,691 $ 4,784 $ 6,770 Deferred (731) (1,020) (1,736) ---- ------ ------ Total federal 3,960 3,764 5,034 ----- ----- ----- State Current 653 619 1,328 Deferred - (275) (363) ---- ---- ---- Total state 653 344 965 --- --- --- Foreign Current 269 228 420 Deferred (190) (52) (205) ---- --- ---- Total foreign 79 176 215 --- --- --- Total $ 4,692 $ 4,284 $ 6,214 ======= ======= =======\nDeferred income tax provision (benefit) has been provided for temporary differences resulting from the recognition of taxable income for tax and financial statement purposes. The provision (benefit) of the significant differences consisted of the following (in thousands):\n1995 1994 1993 ---- ---- ---- Deferred income, net $ (352) $(775) $(427) Provisions for uncollectible accounts (204) 365 (406) Inventory provisions (1,310) (208) (616) Foreign currency gains and losses (104) 5 (231) Depreciation 515 127 (46)\nThe effective income tax provision differs from the amount computed by applying the federal statutory rate of 35% to income before income taxes due to the following (in thousands):\n1995 1994 1993 ---- ---- ---- Income tax expense computed at the federal statutory rate $ 4,227 $ 4,710 $ 5,616 State taxes, net of federal tax benefit 424 253 648 Effect of permanent differences 1,413 442 132 Operating losses by foreign subsidiaries with no tax benefit 26 100 692 Benefit of Foreign Sales Corporation (315) (206) (189) Change in valuation allowance (995) (534) (603) Other (88) (481) (82) --- ---- --- Provision for income taxes $ 4,692 $ 4,284 $ 6,214 ------- ------- -------\nThe components of the Company's net deferred tax assets (liabilities) were as follows (in thousands):\nSeptember 30, 1995 1994 ---- ---- Current: Service revenue deferred for financial reporting purposes $ 4,842 $ 4,189 Non-deductible accruals 6,491 4,569 Accelerated expenses recognized for tax purposes (1,548) (1,366) Valuation allowance (867) (702) Other 754 842 --- --- 9,672 7,532 ----- -----\nNoncurrent: NOLs of foreign subsidiaries 1,234 2,215 Accelerated depreciation for tax purposes (1,979) (1,464) Accelerated expenses for tax purposes (955) (932) Valuation allowance (370) (1,731) Other 212 223 --- --- (1,858) (1,689) ------ ------ Net deferred tax assets $ 7,814 $ 5,843 ======= =======\nThe Company's foreign subsidiaries have tax NOLs of approximately $3.4 million, of which $1.3 million expires in fiscal 1998, and $2.1 million has no expiration date. If the NOLs are fully utilized at current statutory tax rates of the respective countries, the total asset is estimated to be approximately $1.2 million. Although the Company anticipates future operating income in these subsidiaries, because of prior operating losses in these subsidiaries, as well as general economic conditions, competition, and other factors beyond the Company's control, there can be no guarantee that these NOLs will be utilized. A valuation reserve has been established which reduces the deferred tax asset of the NOLs to an amount which the Company believes is more likely than not to be realized.\nThe Company has not provided for potential U.S. taxes on undistributed earnings of its foreign subsidiaries of approximately $7.6 million at September 30, 1995, as it does not currently intend to repatriate such earnings. Calculation of the potential unrecognized deferred tax liability related to these earnings is not practicable; however, credits for foreign income taxes already paid may partially offset potential U.S. income taxes.\nNOTE 13: Supplemental Cash Flow Information\nCash and cash equivalents consist of cash and short-term investments with original maturities of three months or less. Cash equivalents are carried at cost, which approximates market.\nCash flow disclosures, including non-cash investing and financing activities for the three years ended September 30, 1995, are as follows (in thousands):\n1995 1994 1993 ---- ---- ---- Income taxes paid $ 4,665 $9,616 $5,048 Interest paid 4,775 4,990 4,718 Liabilities assumed in exchange for certain assets in acquisitions of subsidiaries (see Note 14) 450 2,505 758 Conversion of preferred stock to common stock (see Note 8) 10,000 - 5,000 Issuance of common stock in the acquisition of a subsidiary (see Note 14) - 944 - Note receivable repaid with proceeds from treasury stock purchases 605 - -\nNote 14: Acquisitions\nDuring the fourth quarter of fiscal 1995, the Company acquired Lectro Products, Inc. (\"Lectro\"), a broadband industry leader specializing in power protection and other transmission enhancement devices for the converging cable television and telecommunications networks, for approximately $12.4 million plus the assumption of certain liabilities. The acquisition was accounted for using the purchase method of accounting. In connection with the acquisition, the Company recorded goodwill of approximately $10.2 million, which is being amortized over 20 years. The Company is evaluating the final purchase price allocation, which may impact currently recorded goodwill. Lectro's results of operations are included in the Company's results of operations beginning in July 1995. If Lectro had been consolidated at the beginning of the fiscal year, the effect on the Company's operations or financial condition would not have been significant.\nDuring the fourth quarter of fiscal 1994, the Company acquired two companies in Canada and one in the United Kingdom. These companies are involved in the sales and service of UPS products. The acquisitions were accounted for using the purchase method of accounting. Goodwill totaling approximately $4.0 million was recorded and is being amortized over periods ranging from ten to twenty years. The results of operations of these companies were included in the Company's consolidated financial statements at various dates beginning in the fourth quarter of fiscal 1994. If these companies had been consolidated at the beginning of fiscal 1994, the effect on the Company's operations or financial condition would not have been significant.\nDuring the fiscal year ended September 30, 1993, the Company completed the acquisition of DataTrax Systems Corporation (\"DataTrax\"). DataTrax is a developer of power, environmental, and security monitoring systems for computer rooms and other mission-critical applications, and is based in Colorado. The acquisition was accounted for using the purchase method of accounting. Goodwill of approximately $1.0 million was recorded and is being amortized over 15 years. The results of operations of DataTrax were included in the Company's consolidated financial statements beginning in September 1993. If DataTrax had been consolidated at the beginning of fiscal 1993, the effect on the Company's operations or financial condition would not have been significant.\nIn September 1995, the Company wrote off approximately $1.5 million ($813,000 after tax) of costs related to a proposed acquisition that was not consummated. Such costs were incurred during fiscal 1995, and consisted primarily of legal, accounting, and other financial advisory services.\nNote 15: Contingencies\nLitigation In January 1989, a case was filed by a former manufacturer's representative of the Company, alleging that the Company failed to pay commissions owed to him on certain sales. In April 1990, a jury awarded the plaintiff damages of approximately $14.9 million. The Company appealed the decision, and in September 1992, the appellate court reversed the judgment against the Company. In response to various motions filed by the plaintiff, a new trial was granted, and in March 1994, the jury in the new trial awarded damages of $3.75 million to the plaintiff. While the Company continued to believe that it should have no liability in this matter and announced its intention to appeal, it recorded a one-time charge in the second quarter of fiscal 1994 of $4,997,000 ($2,936,000 after tax) for the jury verdict and for the costs of the trial.\nIn July 1994, the Company announced that this litigation had been settled. Following agreement among the parties to settle, the court vacated the jury award of $3.75 million previously entered and determined that the vacated judgment cannot be used against the Company in the future. To avoid further litigation including post-trial motions and appeals, the Company settled the case by making payments to the plaintiff and his attorneys. The parties thereafter stipulated that the entire action was dismissed with prejudice. Since the total value of the settlement payments was less than the one-time charge for the jury verdict recorded by the Company in the second quarter of fiscal 1994, no further charges were necessary in this matter. By agreement with the plaintiff, the terms of the confidential settlement were not disclosed.\nIn May 1990, the Company was served with a complaint in the Delaware Court of Chancery and in May 1991, a related case was filed in Federal Court in New York. These complaints alleged, among other things, that the Company's description of the case involving the manufacturer's representative in its prospectus dated December 21, 1989 was false and misleading. In April 1995, the Company announced that it had settled both the Delaware and New York suits. The Delaware action had been dismissed once for failure to state a claim, but was reinstated following an appeal and was in the discovery process prior to the settlement. The Company recorded a charge of $700,000 ($424,000 after tax) for the settlement of the two related lawsuits in the quarter ended March 31, 1995. Court approval of the settlement agreement, after notice to affected shareholders, was granted in August 1995. While the Company believed that neither suit had merit, it decided to settle as the suits were taking valuable corporate time and attention and would have involved significant legal costs to pursue further.\nThe Company is involved in various litigation proceedings incidental to its business. The defense of most of these matters is handled by the Company's insurance carriers. The Company believes that the outcome of such other pending litigation in the aggregate will not have a material adverse effect on its financial statements.\nGovernment Contract Matters Sales to the United States Federal government accounted for approximately 27%, 33%, and 35% of total revenues for the years ended September 30, 1995, 1994, and 1993, respectively. The Company's Federal government business is currently performed under firm fixed-price type contracts and time-and-materials type contracts, and at times a combination of both contract types. The Company's compliance with government contract regulations is audited or reviewed from time to time by government auditors, who have the right to audit the Company's records and the records of its subcontractors during and after completion of contract performance. Under Federal government regulations, certain costs are not allowable as costs for which the government will reimburse the Company. Government auditors may recommend that certain charges be treated as unallowable and reimbursement be made to the government. The Company provides for estimated unallowable charges and voluntary refunds in its financial statements, and believes that its provisions are adequate as of September 30, 1995.\nDuring fiscal 1993, the Company engaged in discussions with the Federal government regarding contract interpretation matters relating to certain time-and-materials charges by the Company under its principal government contract. In August 1993, the Company reached an agreement with the Federal government under which these matters were resolved to the satisfaction of the Company. Under this agreement, there were no adjustments relating to the Company's past time-and-materials charges, and accordingly there was no effect on the Company's financial statements for prior periods relating to this matter. The agreement provided for adjustments to certain hourly labor rates and limited the recovery of certain general and administrative costs prospectively from August 1993.\nIn June 1995, the Company was awarded a follow-on ALC contract. This is a three-year requirements contract, which permits extension of the ordering period for up to two additional one-year periods at the option of the Government. Actual revenues under this contract will depend on the specific purchases, if any, by the Air Force and other governmental agencies which can use the contract during the contract period. Following the award of the contract, certain competitors filed protests with the General Accounting Office (\"GAO\"). In December 1995, the GAO notified the Company that all of the protests had been dismissed, except the protest of the Air Force's evaluation of certain discounts offered by the Company in the contract. In sustaining this protest on the basis that it did, the GAO did not recommend termination of the contract or any other remedy adverse to the interests of the Company at this time. As a result, the Company retains the contract for the present and the Government can place orders under the contract. The GAO has, however, recommended that the Air Force amend a portion of the request for proposal that led to the contract award. The GAO further recommended that the Air Force allow the protesting companies and the Company to submit new proposals regarding such portion, and that the Air Force re-evaluate the award to the Company based upon these new proposals. The Company has not been advised by the Air Force whether it will contest or accept the GAO's recommendations. Similarly, the Air Force has not advised the Company of its plans regarding the issuance of additional orders under the contract, or an amended request for proposal. No assurances can be given that the Company ultimately will retain the contract.\nNote 16: Subsequent Events\nIn November 1995, the Company executed a definitive agreement to acquire Deltec Power Systems, Inc. and its subsidiaries (\"Deltec\") from Fiskars OY AB (\"Fiskars\") and an affiliated company, for a purchase price of approximately $195 million, subject to certain post-closing adjustments. Under the purchase agreement, which will be accounted for as a purchase, Fiskars will receive approximately $157.5 million in cash and 1,875,000 shares of the Company's common stock valued at $37.5 million at a fixed price of $20 per share, in exchange for all of the issued and outstanding common stock of Deltec. Deltec had unaudited revenues of $86.9 million and net income of $1.8 million for the nine months ended September 30, 1995, and unaudited revenues of $97.2 million and net income of $2.2 million for the year ended December 31, 1994. Deltec has two principal operating subsidiaries: Deltec Electronic Corp., which is headquartered in San Diego, California; and FPS Power Systems, which is based near Helsinki, Finland. Deltec is one of the world's largest manufacturers and marketers of off-line and line-interactive small UPS systems. Off-line and line-interactive systems are smaller and less expensive than larger on-line systems, and are suitable for applications where system downtime may be less costly, such as personal or small business uses. The combination will strengthen the product line offerings of the Company and enhance its global service capabilities. It is expected that the acquisition will close during the first calendar quarter of 1996, and is subject to completion of due diligence reviews by the Company, and attainment of all required governmental and other regulatory approvals.\nIn December 1995, the Company received a commitment from several banks to establish a five-year senior bank package (the \"Facilities\") of up to $225 million comprised of a $75 million term loan (the \"Term Loan\") and a $150 million revolving credit facility (the \"Revolver\"). The Term Loan would be used for the Deltec acquisition and to refinance a portion of the Company's existing debt, while the Revolver would be used for working capital, letters of credit, and general corporate purposes. Amounts outstanding under the Facilities would be secured by substantially all the inventory and accounts receivable of the Company and would initially bear interest at LIBOR plus 200 basis points, or the bank's base rate plus 100 basis points, as defined. This commitment is subject to consummation of the Deltec acquisition by February 28, 1996, and issuance of at least $75 million of subordinated debt, or equivalent bridge financing.\nNOTE 17: Summarized Quarterly Financial Data\n(unaudited, in thousands except per share data)\nThe Company completed its merger with IPM during the second quarter of 1995. This merger has been accounted for as a pooling-of-interests, as discussed in Note 2. Accordingly, the results for all quarterly periods presented include the results of IPM. Per share amounts have been recalculated after adding the shares of Exide Electronics common stock issued to effect the merger to weighted average share amounts.\nIn connection with the merger, the Company recorded a nonrecurring charge of $5.5 million ($4.4 million after tax) in the second quarter of fiscal 1995. This charge included approximately $3.0 million for legal, accounting, financial advisory, and other costs related to the merger. The Company also expensed approximately $2.5 million for the estimated costs of closing a duplicate operating facility and discontinuing certain duplicate product lines manufactured at that facility.\nThe Company incurred additional nonrecurring charges in the second quarter of fiscal 1995 for litigation, and in the fourth quarter of fiscal 1995 for expenses related to a potential acquisition. The amount of these charges was $700,000, or $424,000 after tax (see Note 15), and $1,500,000, or $813,000 after tax (see Note 14), respectively.\nThe Company recorded a one-time litigation charge in the second quarter of fiscal 1994 of $4,997,000 ($2,936,000 after tax), which is described in Note 15.\nThe sum of quarterly per share amounts does not necessarily equal the annual net income per share due to the rounding effect of the weighted average common shares outstanding for the individual periods, and for the fully diluted calculation, to the inclusion of the dilutive effect of convertible securities.\nThe effective tax rate for the fourth quarter of fiscal 1995 was lower than the rate for the previous quarters in fiscal 1995. The lower rate reflected the use in the fourth quarter of foreign NOL's due to a different mix of foreign versus domestic taxable earnings for the full year than was anticipated in prior quarters.\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 hereunder relating to directors and executive officers of the Company is incorporated by reference herein from the Company's definitive proxy statement in connection with its Annual Meeting of Shareholders to be held on February 27, 1996, which proxy statement will be filed with the Securities and Exchange Commission not later than 120 days after the close of the Company's fiscal year ended September 30, 1995.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe information required hereunder relating to compensation of directors and executive officers and other transactions involving management is incorporated by reference herein from the Company's definitive proxy statement in connection with its Annual Meeting of Shareholders to be held on February 27, 1996, which proxy statement will be filed with the Securities and Exchange Commission not later than 120 days after the close of the Company's fiscal year ended September 30, 1995.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThe information required hereunder relating to security ownership of certain beneficial owners and management is incorporated by reference herein from the Company's definitive proxy statement in connection with its Annual Meeting of Shareholders to be held on February 27, 1996, which proxy statement will be filed with the Securities and Exchange Commission not later than 120 days after the close of the Company's fiscal year ended September 30, 1995.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThe information required hereunder relating to certain relationships and related transactions is incorporated by reference herein from the Company's definitive proxy statement in connection with its Annual Meeting of Shareholders to be held on February 27, 1996, which proxy statement will be filed with the Securities and Exchange Commission not later than 120 days after the close of the Company's fiscal year ended September 30, 1995.\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 Report of Independent Public Accountants Consolidated Statement of Operations for the three years ended September 30, 1995 Consolidated Balance Sheet as of September 30, 1995 and 1994 Consolidated Statement of Changes in Common Shareholders' Equity for the three years ended September 30, 1995 Consolidated Statement of Cash Flows for the three years ended September 30, 1995 Notes to Consolidated Financial Statements\n2. Financial Statement Schedules\nThe following consolidated financial statement schedule is included in Item 14(d): II -- Valuation and Qualifying Accounts\nSchedules other than those listed above have been omitted since they are either not required or the information required is included in the consolidated financial statements or the notes thereto.\n3. Exhibits\nExhibit Number Exhibit\n2(a) Agreement and Plan of Reorganization (\"the Reorganization Agreement\") among Exide Electronics, Exide Electronics Acquisition, Inc., and International Power Machines Corporation dated August 25, 1994, including the First Amendment to the Reorganization Agreement dated December 14, 1994 and the Second Amendment to the Reorganization Agreement dated January 4, 1995 (filed as Exhibit 2.1 to Exide Electronics' Registration Statement on Form S-4, File No. 33-88324, and incorporated by reference herein).\n2(b) Form of Certificate of Merger to be executed upon approval of the Merger by the stockholders of Exide Electronics and IPM (filed as Exhibit 2.2 to Exide Electronics' Registration Statement on Form S-4, File No. 33-88324, and incorporated by reference herein).\n2(c) Form of Affiliate Agreement to be executed in connection with the Reorganization Agreement (filed as Exhibit 2.3 to Exide Electronics' Registration Statement on Form S-4, File No. 33-88324, and incorporated by reference herein).\n2(d) Stock Purchase Agreement among Exide Electronics, Fiskars OY AB, and Fiskars Holdings, Inc., related to the purchase of Deltec Power Systems, Inc. (filed as Exhibit 10 to the Company's Current Report on Form 8-K, File No. 0-18106, for the event dated November 17, 1995, and incorporated by reference herein).\n3(a) Certificate of Incorporation of the Registrant, as amended (filed as Exhibit 3 to the Company's Quarterly Report on Form 10-Q, for the quarter ended March 31, 1995, and incorporated by reference herein).\n3(b) Article 11 of Exide Electronics' Certificate of Incorporation (filed as Exhibit 99b to Exide Electronics' Registration Statement on Form S-3, File No. 33-64818, and incorporated by reference herein).\n3(c) Certificate of Designation of Series D Preferred Stock (filed as Exhibit 4b to the Company's Current Report on Form 8-K, File No. 0-18106, for the event on July 10, 1992, and incorporated by reference herein).\n3(d) Certificate of Designation of Series E Preferred Stock (filed as Exhibit 3c to the Company's Annual Report on Form 10-K, File No. 0-18106, for the fiscal year ended September 30, 1992, and incorporated by reference herein).\n3(e) The Registrant's By-laws, as amended (filed as Exhibit 3b to the Company's Annual Report on Form 10-K, File No. 0-18106, for the fiscal year ended September 30, 1990, and incorporated by reference herein).\n3(f) Article 10 of Exide Electronics' Bylaws (filed as Exhibit 99c to Exide Electronics' Registration Statement on Form S-3, File No. 33-64818, and incorporated by reference herein).\n4(a) Rights Agreement dated as of November 25, 1992 by and between Exide Electronics Group, Inc. and First Union National Bank of North Carolina (filed as Exhibit 1 to the Company's Current Report on Form 8-K, File No. 0-18106, for the event on November 25, 1992, and incorporated by reference herein).\n4(b) Stockholder Agreement between Exide Electronics and Duquesne Enterprises, Inc., dated August 25, 1994, including amendments by a letter agreement dated December 14, 1994 and a letter agreement dated January 4, 1995 (filed as Exhibit 2.4 to Exide Electronics' Registration Statement on Form S-4, File No. 33-88324, and incorporated by reference herein).\n4(c) Stockholder Agreement between Exide Electronics and Shenkman Capital Management, Inc., dated August 25, 1994, including an Amendment Agreement dated December 14, 1994 and an Amendment Agreement dated January 4, 1995 (filed as Exhibit 2.5 to Exide Electronics' Registration Statement on Form S-4, File No. 33-88324, and incorporated by reference herein).\n4(d) Registration Rights Agreement between Exide Electronics Group, Inc. and Gilbert Stuart Goodchild, dated September 29, 1994 (filed as Exhibit 4.1 to Exide Electronics' Registration Statement on Form S-3, File No. 33-63969, and incorporated by reference herein).\n4(e) Registration Rights Agreement between Exide Electronics Group, Inc. and Carol Elizabeth Amans, dated September 29, 1994 (filed as Exhibit 4.2 to Exide Electronics' Registration Statement on Form S-3, File No. 33-63969, and incorporated by reference herein).\n4(f) Registration Rights Agreement between Exide Electronics Group, Inc. and Tony Peter Stuart Goodchild, dated September 29, 1994 (filed as Exhibit 4.3 to Exide Electronics' Registration Statement on Form S-3, File No. 33-63969, and incorporated by reference herein).\n4(g) Registration Rights Agreement by and among Exide Electronics, Duquesne and Shenkman Investment Partners L. P., dated as of January 5, 1995 (filed as Exhibit 4.7 to Exide Electronics' Registration Statement on Form S-3, File No. 33-88466, and incorporated by reference herein).\n4(h) Note Agreement by and among Massachusetts Mutual Life Insurance Company, MassMutual Corporate Investors, MassMutual Participation Investors, and Exide Electronics Group, Inc., dated September 2, 1992, relating to the 8.375% Guaranteed Convertible Subordinated Notes due June 30, 2000 (filed as Exhibit 4m to the Company's Annual Report on Form 10-K, File No. 0-18106, for the fiscal year ended September 30, 1992, and incorporated by reference herein).\n10(a)Lease Agreement, dated August 15, 1994 between E.L.E. Properties and Exide Electronics Corporation relating to Registrant's manufacturing facility in Raleigh, North Carolina (filed as Exhibit 10a to the Company's Annual Report on Form 10-K, File No. 0-18106, for the fiscal year ended September 30, 1994, and incorporated by reference herein).\n10(b)Lease Agreement, dated June 20, 1985, between Corporate Property Associates 5 and Exide Electronics Corporation and First Amendment thereto, relating to Registrant's engineering facility in Raleigh, North Carolina (filed as Exhibit 10c to Registration Statement No. 33-31872 on Form S-1 and incorporated by reference herein).\n10(c)Lease Agreement, dated May 12, 1994, between Forum Office Partners Three and Exide Electronics Group, Inc., relating to Registrant's corporate headquarters (filed as Exhibit 10 to the Company's Quarterly Report on Form 10-Q, File No. 0-18106, for the quarter ended March 31, 1994, and incorporated by reference herein).\n10(d)Contract, dated May 6, 1988, between the Directorate of Contracting and Manufacturing, Sacramento Air Logistics Center and Exide Electronics Corporation, and Amendment\/Modification Nos. P00001 through P00008 (filed as Exhibit 10c to Registration Statement No. 33-31872 on Form S-1 and incorporated by reference herein).\n10(e)Amendment\/Modification Nos. P00009 through P00012, between the Directorate of Contracting and Manufacturing, Sacramento Air Logistics Center and Exide Electronics Corporation (filed as Exhibits 10g-j to the Company's Annual Report on Form 10-K, File No. 0-18106, for the fiscal year ended September 30, 1990, and incorporated by reference herein).\n10(f)Amendment\/Modification Nos. P000013 through P000023 between the Directorate of Contracting and Manufacturing, Sacramento Air Logistics Center and Exide Electronics Corporation (filed as Exhibit 10h to the Company's Annual Report on Form 10-K, File No. 0-18106, for the fiscal year ended September 30, 1992, and incorporated by reference herein).\n10(g)Amendment\/Modification Nos. P000024 through P000028 between the Directorate of Contracting and Manufacturing, Sacramento Air Logistics Center and Exide Electronics Corporation (filed as Exhibit 10g to the Company's Annual Report on Form 10-K, File No. 0-18106, for the fiscal year ended September 30, 1993, and incorporated by reference herein).\n10(h)Amendment\/Modification No. P000029 between the Directorate of Contracting and Manufacturing, Sacramento Air Logistics Center and Exide Electronics Corporation.\n10(i)Contract dated June 20, 1991 between the United States Navy and Exide Electronics Corporation, and Modifications Nos. P00001 through P00003 (filed as Exhibit 10i to the Company's Annual Report on Form 10-K, File No. 0-18106, for the fiscal year ended September 30, 1992, and incorporated by reference herein).\n10(j)Modifications Nos. P00004 through P00005 to the contract dated June 20, 1991 between the United States Navy and Exide Electronics Corporation (filed as Exhibit 10a to the Company's Quarterly Report on Form 10-Q, File No. 0-18106, for the quarter ended June 30, 1994, and incorporated by reference herein).\n10(k)Modification No. P00006 to the contract dated June 20, 1991 between the United States Navy and Exide Electronics Corporation (filed as Exhibit 10k to the Company's Annual Report on Form 10-K, File No. 0-18106, for the fiscal year ended September 30, 1994, and incorporated by reference herein).\n10(l)Contract dated April 13, 1992 between the United States Navy and Exide Electronics Corporation, and Amendments Nos. 0001 through 0006 and Modification No. P00001 (filed as Exhibit 10j to the Company's Annual Report on Form 10-K, File No. 0-18106, for the fiscal year ended September 30, 1992, and incorporated by reference herein).\n10(m)Modifications Nos. P00002, P00003, P00006, and P00007 to the contract dated April 13, 1992 between the United States Navy and Exide Electronics Corporation (filed as Exhibit 10m to the Company's Annual Report on Form 10-K, File No. 0-18106, for the fiscal year ended September 30, 1994, and incorporated by reference herein).\n10(n)Modifications Nos. P00004 through P00005 to the contract dated April 13, 1992 between the United States Navy and Exide Electronics Corporation (filed as Exhibit 10b to the Company's Quarterly Report on Form 10-Q, File No. 0-18106, for the quarter ended June 30, 1994, and incorporated by reference herein).\n10(o)Loan Agreement among Exide Electronics Corporation, Exide Electronics International Corp., Exide Electronics Acquisition, Inc., First Union National Bank of North Carolina and BA Securities, Inc. as co-agents, and certain other lenders, dated September 30, 1994 (filed as Exhibit 10o to the Company's Annual Report on Form 10-K, File No. 0-18106, for the fiscal year ended September 30, 1994, and incorporated by reference herein).\n10(p)Agreement, dated as of July 1, 1982, between Exide Corporation and Exide Electronics Corporation relating to the use of the name Exide (filed as Exhibit 10f to Registration Statement No. 33-31872 on Form S-1 and incorporated by reference herein).\n10(q)Exide Electronics Group, Inc. 1989 Stock Option Plan (filed as Exhibit 10g to Registration Statement No. 33-31872 on Form S-1 and incorporated by reference herein).\n10(r)Employment Agreement, dated February 3, 1995, with Warren J. Johnson (filed as Exhibit 10 to to the Company's Quarterly Report on Form 10-Q, File No. 0-18106, for the quarter ended December 31, 1994, and incorporated by reference herein).\n10(s)Employment Agreement, dated September 30, 1989, with James A. Risher (filed as Exhibit 10o to the Company's Annual Report on Form 10-K, File No. 0-18106, for the fiscal year ended September 30, 1990, and incorporated by reference herein).\n10(t)Employment Agreement, dated March 15, 1990, with William J. Raddi (filed as Exhibit 10p to the Company's Annual Report on Form 10-K, File No. 0-18106, for the fiscal year ended September 30, 1990, and incorporated by reference herein).\n10(u)Severance Compensation Plan After Change of Control (filed as Exhibit 10o to Amendment No. 1 of Registration Statement No. 33-31872 on Form S-1 and incorporated by reference herein).\n10(v) Revised form of Stock Purchase Agreement for fiscal 1989 Common Stock sales to the Registrant's employees (filed as Exhibit 10l to Amendment No. 3 of Registration Statement No. 33-31872 on Form S-1 and incorporated by reference herein).\n10(w) 1989 Stock Option Plan, as amended on August 11, 1992 (filed as Exhibit 10t to the Company's Annual Report on Form 10-K, File No. 0-18106, for the fiscal year ended September 30, 1992, and incorporated by reference herein).\n10(x) Non-employee Directors' Stock Option Plan, as amended on August 11, 1992 (filed as Exhibit 10u to the Company's Annual Report on Form 10-K, File No. 0-18106, for the fiscal year ended September 30, 1992, and incorporated by reference herein).\n10(y) Contract, dated June 5, 1995, between the United States Air Force Sacramento Air Logistics Command and Exide Electronics Corporation (filed as Exhibit P to the Company's Quarterly Report on Form 10-Q, File No. 0-18106, for the quarter ended June 30, 1995, and incorporated by reference herein).\n10(z) Exide Electronics Group, Inc. 1995 Directors Stock Option Plan (filed as Appendix B to the Company's Proxy Statement dated January 30, 1995, issued in connection with the Company's Annual Meeting of Stockholders held on February 28, 1995, and incorporated by reference herein).\n10(aa) Exide Electronics Group, Inc. 1995 Employee Stock Option and Restricted Stock Plan (filed as Appendix A to the Company's Proxy Statement dated January 30, 1995, issued in connection with the Company's Annual Meeting of Stockholders held on February 28, 1995, and incorporated by reference herein).\n10(bb) Exide Electronics Corporation 401 (k) Retirement Benefit Plan Summary Plan Description (filed as Exhibit 4c to Registration Statement No. 33-64121 on Form S-8 and incorporated by reference herein).\n10(cc)Commercial Lease Agreement dated June 23, 1987 between Northgate V Business Park Associates and the registrant, as amended November 11, 1987, and as supplemented by Supplemental Lease Agreement dated December 9, 1992 (filed as Exhibit 10.1 to International Power Machines Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1992, and incorporated by reference herein).\n10(dd)Agreement dated February 20, 1987 between William L. Zang and the registrant (filed as Exhibit 10.10 to International Power Machines Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1992, and incorporated by reference herein).\n10(ee)Company Employee Capital Accumulation and Savings Plan (filed as Exhibit 10.12 to International Power Machines Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1992, and incorporated by reference herein).\n10(ff)Lease Agreement, dated June 8, 1995, between Banks D. Kerr and Exide Electronics Corporation relating to the registrant's offices in Raleigh, North Carolina.\n10(gg)Summary Description of 1995 Management Incentive Plan.\n11 Statement of Computation of Earnings Per Share.\n21 Subsidiaries of Exide Electronics Group, Inc.\n23 Consent of Arthur Andersen LLP.\n(b) Reports on Form 8-K:\nOn October 20, 1995, the Company filed a report on Form 8-K under Item 5, Other Events, related to the acquisition of International Power Machines Corporation, which was first reported on February 8, 1995. The IPM combination was accounted for as a pooling-of-interests. Accordingly, the Company filed management's discussion and analysis, audited consolidated financial statements, and the related notes as of and for the three year period ended September 30, 1994 restated to include the results of IPM for all periods presented.\nOn October 20, 1995, an additional Item 5 was reported under the same Form 8-K to report that the holders of the Company's 8.375% Guaranteed Convertible Subordinated Notes due June 30, 2000, in aggregate principal amount of $15,000,000 (\"the Notes\"), gave notice of their intent to convert the Notes into 1,146,789 shares of the Company's common stock on October 23, 1995.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULES\nTo Exide Electronics Group, Inc.\nWe have audited, in accordance with generally accepted auditing standards, the financial statements included in Exide Electronics Group, Inc.'s Form 10-K and have issued our report thereon dated October 25, 1995 (except with respect to the matters discussed in Note 16, as to which the date is December 13, 1995). Our audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. The information contained on 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.\n\/s\/ARTHUR ANDERSEN LLP\nRaleigh, North Carolina, October 25, 1995.\nSchedule II - Valuation and Qualifying Accounts\nAllowance for Doubtful Accounts and Customer Returns and Adjustments (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.\nEXIDE ELECTRONICS GROUP, INC.\nBY: \/s\/ JAMES A. RISHER\nJames A. Risher President and Chief Executive Officer Dated: December 29, 1995\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\n\/s\/ JAMES A. RISHER President, Chief Executive December 29, 1995 James A. Risher Officer, and Director (principal executive officer)\n\/s\/ MARTY R. KITTRELL Vice President, Chief December 29, 1995 Marty R. Kittrell Financial Officer, and Treasurer(principal financial and accounting officer)\n\/s\/ CONRAD A. PLIMPTON Chairman of the Board December 29, 1995 Conrad A. Plimpton and Director\n\/s\/ LANCE L. KNOX Vice-Chairman of the Board December 29, 1995 Lance L. Knox and Director\n\/s\/ WAYNE L. CLEVENGER Director December 29, 1995 Wayne L. Clevenger\n\/s\/ RON E. DOGGETT Director December 29, 1995 Ron E. Doggett\n\/s\/ JAMES E. FOWLER Director December 29, 1995 James E. Fowler\n\/s\/ DAVID J. MCLAUGHLIN Director December 29, 1995 David J. McLaughlin\n\/s\/ CHIAKI TANAKA Director December 29, 1995 Chiaki Tanaka\nExide Electronics Group, Inc.\nIndex to Exhibits to 1995 Annual Report on Form 10-K\nExhibit Number Exhibit\n10(h) Amendment\/Modification No. P000029 between the Directorate of Contracting and Manufacturing, Sacramento Air Logistics Center and Exide Electronics Corporation.\n10(ff) Lease Agreement, dated June 8, 1995, between Banks D. Kerr and Exide Electronics Corporation relating to the registrant's offices in Raleigh, North Carolina.\n10(gg) Summary Description of 1995 Management Incentive Plan.\n11 Statement of Computation of Earnings Per Share.\n21 Subsidiaries of Exide Electronics Group, Inc.\n23 Consent of Arthur Andersen LLP.","section_15":""}
{"filename":"850670_1995.txt","cik":"850670","year":"1995","section_1":"ITEM 1. BUSINESS\nTHE COMPANY\nWestcott Communications, Inc. was incorporated under the laws of the State of Texas in May, 1986. Unless the context requires otherwise, all references to the \"Company\" or \"Westcott Communications\" refer to Westcott Communications, Inc. and its subsidiaries. The Company's executive offices are located Galleria Tower II, 13th Floor, 13455 Noel Road, Dallas, Texas 75240. The Company's mailing address is 1303 Marsh Lane, Carrollton, Texas 75006, and its telephone number at that location is (214) 416-4100.\nThe Company educates, trains and informs individuals with common interests in selected markets by providing value-added products and services using appropriate communication technologies. By combining the talents and knowledge of industry experts with its creative programming, production, marketing and satellite communications expertise, the Company seeks to produce original, national network quality programming that meets the training, educational and informational needs of the Company's target markets while retaining the entertaining and visually stimulating character of consumer television and video. The Company currently delivers programming to the following markets: the government and public services market through the Law Enforcement Television Network (\"LETN\") and Fire & Emergency Television Network (\"FETN\") satellite networks, and American Heat, PULSE\/Emergency Medical Update and the Government Services Television Network (\"GSTN\") videotape subscription services; the automotive market through the Automotive Satellite Television Network (\"ASTN\") satellite network; the health care market through the Health & Sciences Television Network (\"HSTN\") and the Long Term Care Network (\"LTCN\") satellite networks, and the American Hospital Association (\"AHA\") and Westcott Healthcare Teleconference Group (\"WHTG\") video seminar operations; the corporate and professional market through the Professional Security Television Network (\"PSTN\"), CPA Report and Accounting and Financial Television Network (\"AFTN\") videotape subscription services, Excellence In Training Corporation (\"ETC\"), Industrial Training Systems Corporation (\"ITS\"), Tel-A-Train, Inc. (\"Tel-A- Train\") and Safety Watch (\"Safety Watch\") single tape sales, videotape library services, the Executive Education Network (\"EXEN\") interactive satellite network and the Interactive Distance Training Network (\"IDTN\") electronic classroom facilities; the primary and secondary education market through the TI-IN Network (\"TI-IN\") satellite network; and the financial services market through the Bankers Training and Consulting Company (\"BTCC\") videotape library service. The Company owns and operates all of its networks either as divisions or wholly owned subsidiaries, except GSTN which is operated as a limited liability partnership in which the Company is the managing partner and holds a 50% partnership interest.\nThe Company believes there are additional markets that are conducive to the use of private satellite, videotape, computer-based and interactive programming for their training and educational needs. The Company seeks to identify these potential new markets, develop programming tailored to serve those markets and deliver that programming through these and other multimedia technologies. In addition to the development and acquisition of new networks and services, the Company continually seeks to enhance the quality and variety of services offered by its existing networks. Company specialists work with various licensing organizations and industry leaders to develop programs and test formats acceptable for continuing professional education, accreditation, certification or other requirements of local, state and national boards.\nWorkers in both the private and public sectors face a continuing need for training and education. The demand for higher standards, stricter accreditation requirements and increased specialization cuts across professional lines, from firefighters to CPAs, and is driven by increasing levels of regulation, litigation and competition in all sectors of employment. These training and educational needs have traditionally been addressed through the use of relatively expensive in-house training departments and off-site seminars. These traditional training and educational methods have a limited ability to efficiently provide consistent, timely, high quality professional education programs due to the time and cost of designing, implementing and travel involved in such programs.\nElectronic communications media such as broadcast, cable television and video interactivity have created the opportunity to dramatically change the quality, cost and delivery of training and education services. In particular,\nsatellite and videotape technology permit the delivery of material to targeted audiences. Interactive capabilities increase the learning potential and retention of the information delivered and provide a more dynamic delivery environment. These technologies enable expert instructors to reach a larger audience, while providing economies of scale through a larger distribution base and greater consistency in training.\nThe Company believes that the ability of television to reach its full potential as a training, educational and informational vehicle is dependent on program content and production quality. The effectiveness of television as a communications medium results from its ability to create visually stimulating images that capture and hold the viewer's attention while conveying information. As production techniques used in national network television have become increasingly sophisticated, viewers have become accustomed to and expect state- of-the art productions. To be effective, instructional programming must provide viewers with information in a format that contains the same technical and programming qualities found in national network broadcast television.\nThe Company's business strategy is to provide quality, industry-specific training, education and information to address the needs of selected, well- defined markets. The Company's business, electronic classroom and government markets share the following characteristics: (I) an ongoing need to inform and train employees or provide continuing education for state accreditation or licensing requirements in a timely, convenient and consistent fashion; (ii) the availability of highly skilled trainers and educators whose services could previously reach only a small part of the work force; (iii) a large and widely dispersed work force sharing common concerns and interests; and (iv) an audience that can be segmented into one or more target audiences, each with homogeneous, well-defined training needs and objectives. The Company's education market has similar characteristics but is targeted toward primary and secondary teacher and student audiences. The Company's management team and selected experts have significant experience in and detailed knowledge of its selected markets, providing overall direction to the content of the Company's programming and to the Company's marketing efforts.\nThe Company's growth strategy focuses on three main elements: (I) the internal development of new networks and services in existing or additional markets; (ii) strategic acquisitions of networks and services in existing or additional markets; and (iii) the addition of new services through existing networks. The Company believes there are additional markets which share the characteristics of the Company's existing markets, making them conducive to the use of interactivity, private satellite, computer-based training and videotape programming for their training, educational and informational needs. The Company seeks to identify these potential markets, develop programming tailored to serve those markets and deliver that programming through appropriate multimedia technologies. The development and delivery of new networks and services increases the Company's efficiency through the use of existing production and delivery capabilities. This operating leverage is further enhanced by the creation of programming services in markets that overlap the Company's existing networks.\nPROGRAMMING\nThe Company's programming staff formats, writes and produces programs to meet the specific training, education or information needs of its learner audiences. The Company's producers specialize in transforming hands-on instruction in the classroom or seminar into focused, high-quality video presentations complete with syllabi, tests, and other appropriate collateral materials. Program formats vary from live, interactive classes delivered via satellite to carefully crafted videos, and interactive media - depending on the need and circumstances of the learners. All products are held to the highest standards for creativity, clarity and viewer enjoyment, matching or exceeding the quality found in more broad-based network broadcast television.\nProgram Design. The needs for individual programs are assessed by the Product Manager of each network, and built into an annual training and educational curriculum designed to satisfy continuing education and training requirements for each target audience. Then individual programs and series of programs are created by the producers to pre-set measurable objectives, often tested. Tests and other collateral material are supplied with the programs, either arriving with the videotape or delivered in a monthly mailing for satellite broadcasts.\nFormal Relationships. The Company built and maintained formal relationships with many industry associations, institutions, universities and other entities in 1995 which have been key to the Company's programming as well as\nmarketing efforts. These relationships include the International\/County Management Association, the National Association of Counties, Public Technology Inc, the FBI Academy, Drug Enforcement Administration, Police Officer Standards in Training Commission, Northwood University, the University of Cincinnati, the University of Dallas, International Fire Service Training Association, The American Medical Association, American Hospital Association, American Nurses Association, The Association of Rehabilitation Nurses, Pennsylvania State University, University of Texas Southwestern Medical Center, Continuing Education Coordinating Board for Emergency Medical Services, American Industrial Hygiene Association, International Association of Chiefs of Police, National Sheriff's Association, Bureau of Alcohol, Tobacco, and Firearms, National Association of State Boards of Accountancy, University of Cincinnati, Joint Commission on Accreditation of Healthcare Organizations, the Food and Drug Administration, Center for Disease Control, Annenberg Center at Eisenhower, Emergency Nurses Association, Oncology Nurses Association, Association of Women's Health Obstetrics and Neonatal Nurses, and Price Waterhouse. These groups participate in the Company's programming to various degrees, including participation on advisory committees, recommending topics and talent of interest to their respective industries, lending assistance in preparing program content, and in some cases, by providing entire courses for airing on the Company's networks. These relationships, as well as others, assist the Company in producing programming that features nationally recognized industry experts as well as widely recognized in-house trainers and consultants.\nProduction Processes. The Company's producers work in teams, in which primary responsibility is defined by market. These teams of writers and producers handle production schedules, contracts with presenters, outlines, synopses, field and studio production. Working closely with the programming teams are personnel in other departments, including Production, Print Graphics, Printing & Fulfillment, Videotape Distribution, Customer Service Center, Interactive Education Systems, Network Operations Control and Satellite Communications. In 1995, the Company streamlined the organizational structure between these groups to allow better quality, more direct contact and communication. This has fostered problem-solving and continuous improvement on a team-to-team level, improving efficiencies and shortening time frames for improvement.\nMARKETS\nThe Company currently offers services to the following markets: (i) government and public services; (ii) automotive; (iii) health care; (iv) corporate and professional; (v) financial services and (vi) education. The Company serves these markets primarily through the Company's satellite networks, videotape subscription, library services, and through IDTN and EXEN. The Company's operations have been conducted primarily within the continental United States. Sales outside the U.S. to date have not been material. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Overview\" for a listing of the Company's products and services by markets served.\nGOVERNMENT AND PUBLIC SERVICES\nMany states have implemented mandatory continuing education and accreditation or licensing requirements for their public safety personnel. The Company believes that this has resulted in a need for employee education and training in this market which, due to its size and diversity of locations, is particularly suited for private satellite and videotape training services.\nThe Company currently serves the law enforcement segment of the government and public services market through the LETN private satellite network. The Company also offers LETN on videotape services for law enforcement agencies with fewer than 15 officers. The fire and emergency medical services segment of this market is served through the Company's FETN private satellite network and American Heat and PULSE\/Emergency Medical Update videotape subscription services. The Company also serves elected and appointed local governmental officials through the GSTN videotape subscription service. The government and public services market accounted for approximately 21% of the Company's revenues for the year ended December 31, 1995.\nLaw Enforcement. LETN produces and delivers television programming via satellite and videotape to subscribing law enforcement agencies. The most recent development for training and documentation is the LETN workstation.\nThis computer-based training system allows for group or individual training, testing and documentation all in one convenient and efficient computer package. LETN provides a broad range of programming covering a variety of training areas designed to reach multiple target audiences within the law enforcement sector, including uniformed patrol officers, traffic officers, trainers, drug enforcement officers, investigators and detectives, law enforcement supervisors, managers and administrators, sheriffs and chiefs. These educational training areas include: officer safety techniques; civil liability issues; drug and vice operations; leadership training; community relations; patrol operations; criminal investigation; new technologies; lifestyle considerations; and other subjects relevant to law enforcement operations. LETN broadcasts 24 hours each weekday and the programming is repeated during the day in order to maximize availability to each shift of officers in each subscribing agency in all time zones.\nLETN's staff includes a number of former law enforcement officers, many of whom are involved in the development of the content and design of LETN programming and the selection of the program topics and ideas communicated to LETN by outside professionals and experts from throughout the law enforcement community.\nLETN programming generally fits one of the following categories: (i) \"Roll Call\" programming; (ii) in-service training; and (iii) law enforcement news and special forum programs.\nRoll Call programming is designed for viewing by officers during their pre- shift meetings. Roll Call programming consists primarily of short presentations designed to deliver training, news and information addressing such topics as officer safety, drug enforcement, legal briefs, community-oriented policing and patrol operations.\nIn-service training programming is designed to provide continuing education, including college credit and training programs for experienced officers. Typical in-service training consists of 25-minute segments featuring call-in question and answer segments, product reviews, documentaries, re- enactments and analyses of actual incidents and examinations of court cases affecting the law enforcement community. Video of police officers in the line of duty performing chases and handling disturbances, shootings and robberies in progress are frequently provided by agencies for broadcast.\nLETN news segments provide subscribers with coverage of national and regional developments of interest to the law enforcement community. In addition to regularly scheduled newscasts, LETN covers special events such as conventions, forums and seminars that may be of interest to subscribers.\nMany states requiring officers to obtain a minimum number of in-service training hours each year have approved LETN's programming for this purpose. Requirements for in-service training are generally set by peace officers standards and training commissions (\"POST\"). LETN regularly contacts all state POST organizations in an effort to keep them informed of LETN's programming and to insure continuing approval. LETN's Training Assistance Program (\"TAP\") provides individual officers with certificates of completion for a required number of hours of training. TAP is intended to help document LETN training and assist subscribing agencies in personnel development.\nMonthly subscription fees for LETN currently range from $228 to $628, depending upon the size of the agency, with an average satellite subscription fee at December 31, 1995 of $339. These fees include installation of all reception equipment, except television sets. Subscription fees for LETN's videotape service currently range from $228 to $628 per month, depending on frequency of delivery and level of programming requested. Fees for LETN's workstation product include a one-time installation fee of $985 and a current subscription price of $288 to $628, which includes the payment for the workstation hardware and software.\nThe market for LETN includes approximately 17,367 law enforcement agencies in the continental United States, as estimated by the Bureau of Justice Statistics, Office of Justice Programs, of the U.S. Department of Justice. This market includes approximately (i) 15,637 city, county and state departments; and (ii) 1,730 federal and special agencies, including ATF, Secret Service, Customs, IRS, FLETC, FBI, DEA, U.S. Marshals, and INS. As of December 31, 1995, approximately 1,900 law enforcement agencies subscribed to LETN.\nFire and Emergency Medical Services. FETN produces training programs for fire, rescue, medical, and industrial emergency response teams and delivers the information via satellite broadcast and videotape to subscribing volunteer and municipal agencies, industrial facilities, and military installations. FETN programming is designed to offer each\ndistinct audience within the fire and emergency service such as frontline firefighters, driver\/operators, emergency medical personnel, and chief\/command officers, with a program suited to their specific emergency response assignments. FETN broadcasts over 80 hours Monday through Friday and the programming is repeated during the day in order to maximize availability to individuals in all time zones.\nFETN programming changes weekly, and is staggered each day during the week to allow all shifts of paid personnel and all volunteer personnel ample time to view the programming at times convenient to their individual schedules. All programs are 25 to 30 minutes in length and most are accompanied by written training support materials.\nFETN programming is curriculum-based using standards developed by the National Fire Protection Association and training curriculums established by Fire Protection Publications, International Fire Service Training Association (IFSTA) of Oklahoma State University. Here are brief orientations of the seven curricula offered by FETN.\nFirefighter I Curriculum: The programs offered in this training curriculum are specifically designed to address the needs of entry-level or recruit firefighter candidates. The supporting documentation includes lesson objectives, a student lesson outline, and a student performance skills checklist for documentation of hands on training accomplishments.\nFirefighter II Curriculum: The programs offered in this training curriculum are advanced firefighter topic areas specifically designed to address the needs of in-service, experienced firefighters.\nFirst Line Supervisor Curriculum: The programs offered in the First Line Supervisor curriculum focus upon the training needs of a company officer at the lieutenant or captain rank.\nChief Officer's Forum Curriculum: The programs offered in FETN's Chief Officer's Forum curriculum address the needs of a chief executive officer. Weekly programming includes management, motivation, finance and budget, leadership, and firefighter health and fitness topics. One monthly feature reviews and recaps significant incidents occurring in the fire and emergency service field. Live, interactive teleconferences scheduled throughout the year make this curriculum our most dynamic and ever-changing offering to address current events, issues, and answers.\nEmergency Medical Curriculum: FETN's curriculum for emergency medical training presents all medical training needs from initial training in First Responder, Defibrillator, EMT, and Paramedic programs, through requirements for in-service medical continuing education credits required for medical certification. FETN's emergency medical training curriculum is approved by the Continuing Education Coordinating Board for Emergency Medical Services (CECBEMS), a nationally recognized accrediting body for continuing education activities in Emergency Medical Services.\nHazmat Curriculum: To assist all emergency responders in meeting mandatory compliance requirements for hazardous material response, FETN presents all nationally-recognized levels of hazardous materials response from the Awareness level to the Technician level.\nIndustrial Curriculum: The unique training needs of industrial-based facilities is addressed through the Industrial Curriculum. All performance requirements of NFPA #600, Standard on Industrial Fire Brigades are specifically addressed from the incipient-level fire brigade to the advanced-level industrial fire department.\nIn addition, FETN daily news programs provide subscribers with coverage of national and regional developments of interest to the fire and emergency services community. In addition to daily news broadcasts, FETN covers special events such as national conferences and learning symposiums that are of interest to subscribers.\n\"Fireground\" utilizes dramatic real-life video as a valuable training tool, when combined with lessons learned from the responders involved. The first Fireground of each month presents highlights and analysis of the past month's top news stories. The remaining shows of each month are in-depth case studies of actual incidents.\n\"E-MED\" is designed specifically for emergency medical technicians and paramedics. E-MED is designed and produced in affiliation with leading educators in the field, including the University of Texas Southwestern Medical Center at Dallas. This show utilizes scenarios to depict real-world situations.\n\"IFSTA\" is created in affiliation with the International Fire Service Training Association (IFSTA), part of the Fire Science Department at Oklahoma State University, and the creators of the highly respected IFSTA manuals used in fire departments worldwide. IFSTA programs, including \"Fire Company,\" \"Truck and River\" and \"Essentials,\" are based on IFSTA-validated materials and bear the IFSTA logo. IFSTA shows stress a demonstration-based, hands-on training approach.\nE-MED, Firefighter I and II, and IFSTA programs are complemented by worksheets containing objectives, lesson outlines and performance checklists or tests. For E-MED, viewers passing the tests can receive a certificate and continuing education units from educators such as University of Texas Southwestern Medical Center. Viewers of IFSTA programs who pass the tests furnished in connection with such programs are issued certificates from FETN and IFSTA to aid departments in tracking and validating training efforts to meet various national, state and local training criteria.\nFETN SCANTRON Test\/Evaluation forms are required for use by individuals who wish to receive emergency medical continuing education credit from FETN. Use of this form allows FETN to fulfill the requirements established by the Continuing Education Coordinating Board of Emergency Medical Services (CECBEMS) and University of Texas Southwestern Medical Center at Dallas. All participation is documented in the student's individual training transcript record. Participants achieving a score of 80% or higher receive University of Texas Southwestern Medical Center continuing education \"Certificates of Completion.\"\nDocumentation for FETN training is available through the FETN Academy. Utilizing an automated voice response phone system, fax, computer disk or modem, individuals and department training officials can register viewer participation in FETN programs and completion of tests, evaluations, or hands-on skills performance. Certificates of participation and quarterly training transcripts are available to FETN subscribers. The FETN Academy, in conjunction with the University of Cincinnati, offers Continuing Education Units which can be converted through the University's Open Learning Fire Service Program.\nThe Company also serves the fire service community with American Heat, a 90-minute monthly videotape subscription service. American Heat subscribers receive multiple case studies mixing actual video of the event with lessons learned by the responders involved. The videotape also includes trends in fire service in the \"Hot Topics\" and \"Fire File\" segments, college questions from the University of Cincinnati and basic firefighter skills training in the \"Survival Training\" segments. Collateral materials accompany each videotape in the form of the informational \"Heat Sheet.\"\nThe Company serves the emergency medical community with PULSE\/Emergency Medical Update, a 90-minute monthly videotape subscription service. PULSE\/Emergency Medical Update subscribers receive a case study footage of an incident of particular interest to emergency responders with lessons learned by responders involved. The tape also includes training in the form of segments such as \"PULSE Tips,\" and two full \"E-MED\" shows. Subscribers receive collateral material in the form of the informational \"PULSE Chart,\" and testing materials which help them become eligible for continuing education units from the University of Texas Southwestern Medical Center.\nMonthly subscription fees for FETN currently range from $228 to $928, depending on the population served by a subscriber, with an average satellite subscription fee of $277 at December 31, 1995. The subscription fee includes the installation of FETN programming and all related collateral material. The annual subscription fee for the American Heat videotape subscription service is $936. The annual subscription fee for PULSE\/Emergency Medical Update has been increased from $840 to $936 as subscriptions renewed in 1995.\nThe market for FETN and American Heat encompasses approximately 32,000 fire departments including local governments, colleges, vocational\/technical schools, hospitals and military bases in the United States and abroad. The market for PULSE\/Emergency Medical Update consists of fire and police departments, ambulance services and districts, hospitals, military installations and corporations with first-response capabilities. As of December 31, 1995,\nthere were approximately 1,010 subscribers to FETN, 1,930 subscribers to American Heat, 1,673 subscribers to PULSE\/Emergency Medical Update.\nGovernment Services. The Company, in partnership with International City\/County Management Association, National League of Cities, National Association of Countries, and Public Technology, Inc., provides for the news, training and informational needs of appointed and elected local government officials through the GSTN videotape subscription service.\nGSTN videotapes contain the following programs:\n\"GSTN\/Journal,\" a news and informational segment providing subscribers with coverage of new developments affecting local governments;\n\"Leadership Spotlights,\" a segment designed to assist top city and county officials better manage their organization;\n\"Human Factor,\" which provides training for all city employees on how to provide better service to their communities; and\n\"Money Watch,\" a program focusing on the financial management of local government.\nThe annual subscription fee for GSTN ranges from $1,560 to $2,160. The market for GSTN consists of approximately 13,000 city and county governments. As of December 31, 1995, GSTN had approximately 741 subscribers.\nAUTOMOTIVE\nThe Company serves the automotive industry primarily through the ASTN private satellite network. Approximately 11% of the Company's revenues for the year ended December 31, 1995, were attributable to the automotive market.\nAutomobile Dealers. ASTN produces and delivers television programming via satellite to subscribing automobile dealerships across the United States and Canada. ASTN programming targets the following audiences: (i) automobile sales departments; (ii) service department managers, technicians and other personnel; (iii) parts department managers and other personnel; (iv) dealership owners and managers; and (v) finance and insurance managers and other personnel. ASTN is currently on the air 40 hours per week, Monday through Friday.\nSubscribers receive original programming in three primary areas: (i) continuing education, training and motivation for sales, service, finance, insurance and parts departments of automobile dealerships; (ii) general management and financial planning for owners and other management personnel; and (iii) current automotive industry news and special events. All other dealership audiences are addressed with feature programs of approximately 25 minutes in length, separated by periodic five-minute news reports. The Company's news department produces the \"ASTN News,\" which features news of the automotive industry and coverage of special events. ASTN tape service customers receive 100 hours of training in areas of sales, management, and service operations each year.\nThe Company has established the \"ASTN Academy,\" a service that tracks and records the programs that members have watched. Members call the Academy toll- free number, enter requested information and the ASTN computers log the call, the member and the program and continually totals the member's viewing hours for credit toward participation certificates.\nThe Company, in conjunction with Northwood University of Midland, Michigan, also offers college level courses on ASTN. Successful completion of these courses combined with previous college credit or locally available courses will lead to an Associates of Arts degree in Automotive Sales Management.\nThe Company broadcasts ASTN through its own satellite transponder and through the GM Pulsat and Chrysler private satellite networks under agreements expiring October 1, 2000 and June 1, 1996, respectively. ASTN is\nreceived over those networks on equipment provided by GM Pulsat or Chrysler, as appropriate. The Company pays a GM Pulsat network access fee based on the number of dealers receiving ASTN over that network and directly markets ASTN to members of the GM Pulsat Network. Chrysler pays the Company a fee for ASTN based upon the number of dealers subscribing to ASTN through the Chrysler network and in turn markets ASTN to its network members at a subscription fee set by Chrysler. The Company is conducting discussions with Chrysler to extend the term of its Agreement. As of December 31, 1995, approximately 17% and 14% of all United States GM and Chrysler dealers, respectively, subscribed to ASTN through these agreements, which dealers represent approximately 59% and 27% respectively, of all ASTN subscribers.\nRetail subscription fees for ASTN currently range from $265 to $330 per month. Because of the Company's agreement with Chrysler described above, the average monthly fee received by the Company at December 31, 1995, was $261. The monthly ASTN subscription fee includes the installation of all equipment, excluding television sets, required to enable the subscriber to receive ASTN programming at sites other than GM or Chrysler dealerships.\nThe market for ASTN consists primarily of dealerships of new automobiles and trucks in the continental United States. According to Automotive News, as of January 1, 1996, there were approximately 22,288 new automobile dealership outlets in the United States. As of December 31, 1995, approximately 2,460 automobile dealers subscribed to ASTN.\nOther Activity. The Company also provides video production services for the marketing divisions of automobile manufacturers primarily in the Detroit area through Westcott Communications Michigan, Inc., a wholly owned subsidiary of the Company based in Detroit.\nHEALTH CARE\nThe Company serves the health care market through several private satellite networks. These health care networks represent approximately 20% of the Company's revenue for the year ending December 31, 1995.\nEffective January 13, 1992, the Company acquired all of the outstanding stock of Health & Sciences Network, Inc. which continued to broadcast as HSN until June, 1992. HSTN, a private satellite network, began broadcasting in June, 1992. HSTN provides a broad range of continuing education, training and information to nurses, physicians and allied health professionals and provides patient education. The current focus on health care reform as well as cost containment pressures and rapidly changing accreditation requirements combine to create a strong market for HSTN.\nIn December 1992, the Company attained the rights to produce and distribute a series of teleconferences for AHA. Marketing commenced January 1, 1993. The Company in conjunction with the American Hospital Association provides teleconferencing capabilities for the series, including the installation of satellite equipment to participating hospitals. Topics include patient record coding updates, hospital quality management, cost management and other areas relevant for administrative and management personnel. A number of teleconference series programs are available. Fees range from $4,400 for the full series of programs to $880 for a single program.\nWHTG produces both satellite and video conferences with the Association of Rehabilitation Nurses. These programs are customized to fit the needs of this discipline. The conferences are presented live from the television studio and allow participants to interact live via telephone with the program presenters. The price of an annual series is currently $2,000. WHTG also produces its own programs under the name AREN. AREN programs are designed for physical and occupational therapists and other allied health professionals. Subscribers to this series receive six to twelve new programs at an annual cost of $4,500. Each program is accompanied with extensive collateral materials. Continuing education credits are issued to program viewers in states requiring accreditation.\nWHTG also offers a management series to its subscribers at an annual cost of $4,500. This 12-part series entitled, \"Evolving Workplace,\" is directed toward common management needs. This series is designed to improve leadership, decision-making, strategy building and communication skills needed by management.\nOn April 1, 1993, LTCN began broadcasting training programming to healthcare professionals and support staff to long term care facilities around the country. LTCN has since gained national accreditation for training programs\ntargeted to administrators, nurses, physicians and dieticians, and effective January 1, 1994, began broadcasting 24 hours a day five days per week.\nIn December 1995, the Company entered into an agreement with the Joint Commission on Accreditation of Healthcare Organizations to establish the Joint Commission Satellite Network (\"JCSN\"). Under this three-year agreement, JCSN will produce ten 60 to 90 minute interactive video conferences each year. JCSN will communicate current information about Joint Commission Standards requirements, assist hospitals in preparing for surveys and review successful approaches to demonstrating standards compliance. The annual subscription fee for JCSN will be $4,500.\nHospitals. HSTN produces and delivers television programming via satellite to subscribing hospitals. HSTN's programming is designed to reach multiple target audiences within the hospital setting, including physicians, nurses, allied health professionals, executive managers and department heads, educators, in-service trainers, quality control managers, patients and the community. HSTN offers an MBA in Health Services Management from the University of Dallas, and a Bachelor of Science in Nursing from California State University at Fullerton. HSTN subscribers receive original programming in six primary areas: (i) accredited continuing education programming for health professionals; (ii) regulatory programs designed to meet Joint Commission for Accreditation of Healthcare Organizations (JCAHO) and Occupational Safety and Health Administration (OSHA) standards; (iii) in-service training for skills development and orientation, primarily for nurses; (iv) general management and financial planning for executive and other management personnel; (v) competency- based training for entry level personnel; and (vi) patient education programming. HSTN broadcasts 10 hours per day each weekday.\nHSTN programming includes the following:\n\"Management Dynamics\" provides key management strategies information for various levels of hospital managers. At the executive and trustee level, programming interprets major regulatory changes and provides guidance on reimbursement, strategic planning techniques and ethical issues. At the department manager level, this programming delivers current skills development tactics to increase productivity and profitability.\n\"Nurse's Station\" is designed for all types of nurses and consists of an hour of original programming each week. Each hour segment is divided into a 30- minute accredited continuing education program and two 15-minute in-service or \"how to\" training segments. The Company is an approved provider for nursing continuing education by the American Nurses Credentialing Center of the American Nurses Association.\n\"Hospital Operations\" focuses on comprehensive basic training for areas such as housekeeping, clerical, billing, food service, security and engineering.\n\"Healthline\" delivers patient education and community information for consumption by the lay public in such areas as parenting, stress management and illness prevention strategies.\n\"On Call\" features Category I continuing medical education for physicians.\nProfessional development programs provide accredited continuing education to integral operational sectors of the hospital, such as pharmacy, medical records, rehabilitation, dietary, clinical laboratory management and respiratory therapy.\n\"HSTN Specials\/Washington Report\" are special programs geared towards new services that hospitals may provide and\/or timely reports on the Washington based healthcare reform scene.\n\"HSTN News\" broadcasts information throughout the day on news events, topics and legislation impacting the health care industry.\nThe monthly subscription fee for HSTN currently ranges from $448 to $2,748, depending on the number of full-time equivalent employees, with a nominal charge for installation of satellite downlink equipment. The average satellite subscription fee at December 31, 1995, was $635.\nThe market for HSTN includes approximately 5,700 hospitals in the United States, as estimated by the American Hospital Association and SMG Marketing Group. As of December 31, 1995, approximately 1,030 facilities subscribed to HSTN.\nNursing Homes. LTCN produces and delivers programming via satellite to subscribing long-term care facilities. LTCN's programming is designed to reach multiple target audiences within the nursing home, including physicians, nurses, nurse's aides, management, the community and ancillary care and support staff. LTCN offers an MBA in Health Services Management from the University of Dallas, and a Bachelor of Science in Nursing from California State University at Fullerton.\nLTCN programming includes the following:\n\"Management Dynamics\" is designed for the unique challenges encountered by administrators of long-term care facilities. This programming addresses guidelines for interpreting and applying federal and state regulations unique to long-term care facilities and provides guidance on quality management and improvement.\n\"Nurse's Station\" is designed for nurses in the long-term care setting and consists of 30 minutes of original programming each week. These programs deliver \"how to\" care for the chronically ill and treatment of problems unique to the elderly. The Company is an approved provider of continuing education by the American Nurses Credentialing Center of the American Nurses Association.\n\"Fundamentals of Care\" is a series of 29 programs incorporating the basic mandatory curriculum for nurses aides. These programs assist the instructor in preparing students for the final nurse aide registry test.\n\"Back to Basics\" delivers federally mandated continuing education programming for the registered nurse's aide.\n\"On Call\" provides a continuing medical education series for physicians caring for the elderly and chronically ill, emphasizing physiology, disease process and pharmacology associated with geriatric patients.\n\"Community Connection\" delivers information to residents, their families and the community. The programming focuses on topics relating to residents of long-term care facilities as well as legal and emotional issues their families may encounter.\n\"Task Force\" focuses on basic training for such areas as housekeeping, security, food service, clerical and maintenance. Many of these programs are dubbed in Spanish to reach an even broader audience.\n\"LTCN News\" broadcasts information throughout the day on current events and legislation impacting the long-term care industry. In addition, special event programming will occasionally preempt regular broadcasts to bring live, interactive events to subscribers.\n\"Viewpoints\" provides accredited continuing education to integral operational sectors in long-term care facilities such as physical and respiratory therapists, lab technicians, nutritionists and social workers.\nThe market for LTCN includes approximately 16,000 long-term care facilities, as estimated by the Health Care Financing Administration. As of December 31, 1995, LTCN had approximately 1,045 subscribing facilities. The monthly subscription fee for LTCN currently ranges from $318 to $888, depending on the number of beds in long-term care facilities, with a nominal charge for installation of satellite downlink equipment.\nOther. IMN, a private satellite network, develops and implements continuing medical education programs for a host of medical specialties. IMN's primary operations are made up of PsychLINK network and the Family Medicine Television Network (\"FMTN\"). PsychLINK is a network of 247 psychiatric institutions linked together by satellite\ncommunications for the purpose of delivering continuing medical education programs to their medical staffs. PsychLINK programs are partially funded by educational grants provided by certain pharmaceutical companies. FMTN, a collaboration between IMN and the Association of Family Practice Residency Directors (\"AFPRD\"), provides continuing medical education to faculty, residents, and local community family physicians. All AFPRD members are invited to join FMTN.\nCORPORATE AND PROFESSIONAL\nThe Company serves the corporate and professional market through the PSTN videotape subscription service for private security departments of large corporations and private contract security providers, and the CPA Report and AFTN videotape subscription services for certified public accountants and for industry accounting and financial professionals. In addition, the Company serves small to large corporations through its ITS, Tel-A-Train and Safety Watch videotape and interactive computer software products which cover a broad range of technical, vocational, occupational health and safety topics. The Company also serves the corporate and professional market through Excellence In Training Corporation (ETC), a distributor of management, professional and career development videotape programs. The corporate and professional market accounted for approximately 31% of the Company's revenues for the year ended December 31, 1995.\nEffective June 2, 1993, the Company acquired all of the outstanding stock of Industrial Training Systems Corporation. The Company also acquired the assets of Tel-A-Train, Inc., effective December 1, 1993, and all of the outstanding stock of Excellence in Training Corporation on March 1, 1994. Safety Watch was a product acquired in the acquisition of Lockert Jackson and Associates on March 1, 1995.\nPrivate Security. PSTN produces and delivers security-related informational and educational programming via monthly videotapes for use by corporate, institutional and government security departments and private contract security providers. For an annual subscription fee, currently set at $1,860, subscribers receive approximately one hour of regularly scheduled programming each month, including \"ProForce,\" \"SecurityWorks\" and \"PSTN News.\"\nSecurityWorks provides in-service training and continuing education for security supervisors, educators and managers. Course materials that accompany ProForce allow viewers to measure and record training achievements. ProForce provides basic and in-service training for security officers and line supervisors and explores a wide range of subjects relating to protective force operations. PSTN News presents security-related news and special features of interest to security decision-makers and specialists, as well as information on security equipment and programs.\nWith a Training on Demand Catalog containing approximately 350 videotape programs, PSTN offers a Training on Demand service which makes security information and training programs available to subscribers through a lending library. Subscribers pay an annual fee for this service, determined by the number of programs they want on hand at a given time. In addition to its monthly videotape service and Training on Demand lending library service, PSTN began offering individual videotapes for sale in the fourth quarter of 1993.\nIn 1995, PSTN began producing and offering various special videotape series targeted at specific niches within the private security market. These series cover such topics as mall\/shopping center security, casino security, emergency room safety, as well as other specialized areas within this market. The average price for these series ranges from $1,120 to $2,995 depending on the topic selected.\nThe Company believes up to half of the approximately 10,000 contract security service companies and 50,000 corporate, institutional and government security departments may be viable prospects to subscribe to PSTN. There were approximately 775 subscribers to PSTN as of December 31, 1995.\nAccounting. The CPA Report delivers continuing professional educational programming via videotapes shipped at regular intervals for certified public accountants in private practice, as well as those in corporations and government agencies. For an annual subscription fee, currently ranging from $780 to $1,872, subscribers receive from 100 to 150 minutes of regularly scheduled continuing professional education programming each month. At December 31, 1995, the approximate average annual subscription fee for the CPA Report was $1,012. Topics include individual and\ncorporate tax; special topics on taxation; partnership and small business; estate planning; government accounting issues; pensions and employee benefits, and accounting and audit practices.\nThe CPA Report offers four different subscription packages, each designed for a specific audience and eligible for Continuing Professional Education (\"CPE\") credits. The \"CPE Master\" is a 2 1\/2 hour monthly (except March) program for CPAs with varying technical needs covering a broad range of topics. The \"Tax Specialist\" is a two-hour monthly (except March) program designed for tax professionals. The \"Government A & A Specialist\" is a two-hour quarterly program designed to meet the United States General Accounting Office Mandated CPE requirements for government employees. The \"CPE Manager\" is a two-hour monthly (except March) program designed for smaller firms, providing topics in taxation, accounting and auditing.\nAFTN delivers continuing professional education programming via videotapes shipped at monthly intervals for accounting and financial professionals and their staffs in corporations. For an annual subscription fee of $2,280, subscribers receive 120 minutes of regularly scheduled continuing professional education programming each month. AFTN provides a range of topics such as management reporting, internal audit, benefits, accounting, taxation and many more.\nIn June 1995, the Company introduced Accounting Television Satellite Network (\"ATSN\"). ATSN, in conjunction with various state accounting societies, produces live interactive seminars delivered via satellite to tax and accounting professionals. As of December 31, 1995, the average seminar fee per attendee was $135, and there were approximately 61 sites broadcasting ATSN.\nThe market for the CPA Report, AFTN and ATSN consists of approximately 160,000 certified public accountants engaged in private practice and 190,000 certified public accountants employed by corporations and government agencies. As of December 31, 1995, there were approximately 1,975 subscribers to the CPA Report and AFTN.\nSafety and Technical. ITS, Tel-A-Train and Safety Watch are three networks which provide authoritative training in the fields of health, safety, environmental and technical skills training. ITS is a leader in the safety industry for assisting companies in solving their most costly and troublesome problems - controlling rising worker's compensation cost; complying with government mandated health, safety and environmental training regulations; and reducing work-related injury and illnesses through effective training. Tel-A- Train is on the forefront of providing technical skills and safety training to both industry and vocational institutions. Safety Watch is nationally recognized for its training on safety awareness and accident prevention\/reduction. The market for ITS, Tel-A-Train and Safety Watch products includes approximately 150,000 petrochemical, manufacturing, general industry and vocational institutions. ITS and Tel-A-Train provide training through single tape sales for an average price of approximately $450 per tape. Safety Watch provides training through single tape sales and its videotape subscription service and has approximately 420 subscribers as of December 31, 1995.\nManagement. The Company serves the corporate market's need for programming relating to management, professional and career development and compliance with certain government regulations through videotape programs offered by ETC. ETC distributes more than 3,500 programs covering a variety of subjects ranging from management\/supervision to total quality and from employment law to customer service. ETC provides training through single tape sales for an average price of approximately $495 per tape.\nInteractive Distance Training Network. In addition to private satellite networks, videotape and computer-based training products the Company also provides distance learning to its corporate, professional and government markets through IDTN. IDTN, which currently provides services to major corporations creates, produces and delivers customized interactive programming for product announcements, sales and technical training and education, market research and a wide variety of seminar topics to IDTN clients, their employees and\/or customers.\nIDTN offers single and multiple day events seven days a week, 24 hours a day. IDTN participants interact live using one-way video and two-way audio and data response keypads. The price for a single day event is negotiated with each customer based on facility and technical expertise needed for the project. IDTN also provides services such as instructional design, production enhancement, course conversion and catering at additional charges.\nThe Company developed IDTN to meet the growing needs of customers who need to communicate effectively and frequently with large geographically dispersed groups of people. IDTN is available in 45 electronic classrooms across the United States. Each room has 24-36 seats in a classroom style setting.\nExecutive Education Network. The Executive Education Network (EXEN) produces, in association with major university business schools, live classroom seminars and courses, transmitted via encrypted satellite signals to classroom downlink sites on the premises of major corporations for the continuing education of managers and business executives.\nEXEN corporate sites consist of downlink equipment, television monitors, and personal keypads for use by participants. Courses are those which have been offered successfully by the participating institutions as on-campus executive or management education, and have been re-formatted for live distance learning. Site coordinators employed by the customer enroll and register students for the courses and download printed course materials, all via the Internet. Courses consist of three to ten sessions, and session broadcasts are two to three hours in length with high production values--with graphics, music and video examples. Instructors interact with students via One Touch keypads, which relay voice for two-way conversations between student and instructor and three-way conversations between two students and the instructor, plus data in the form of answers to multiple-choice questions, the results of which are displayed visually in a bar graph. Business schools give students who have logged on and interacted during the required number of sessions a certificate of completion. Course work is not accredited, but CEU's are available.\nParticipating schools include the Wharton School at the University of Pennsylvania, Southern Methodist University, Babson School of Executive Education, Carnegie Mellon University, The Pennsylvania State University, the University of Southern California, the University of North Carolina at Chapel Hill, Notre Dame University, the Center for Creative Leadership, the University of Massachusetts at Amherst and the University of Texas at Austin, and the Aspen Institute.\nFINANCIAL SERVICES\nThe Company serves the financial services market through BTCC. Approximately 6% of the Company's revenues for the year ended December 31, 1995 were attributable to the financial service market.\nBTCC provides instructional and marketing videotapes and interactive computer software to the financial services industry, primarily through its library subscription service. Library subscribers may select videotapes or computer diskettes from the Bankers Training library of approximately 250 titles. These tapes and computer applications cover topics such as commercial lending, consumer lending, mortgage lending, security and fraud, regulatory compliance, customer service and sales training.\nOn January 1, 1993, the Company acquired the assets of BancTraining Video Systems (\"BTVS\"). BTVS provides instructional videotapes for sale and rental to professionals in financial institutions. Programs are compliance oriented. Training topics include the Bank Secrecy Act, Consumer Protection Laws, Fair Lending Compliance, Real Estate Lending Laws and Comprehensive Teller Training. All BTVS programs are now offered through BTCC.\nOn August 1, 1995, the Company acquired Capital Training Company (\"CTC\"). CTC provides instructional and marketing videotapes and computer-based training products to the financial services market. Programs are sales, service and compliance oriented. All CTC programs are now offered through BTCC.\nBTCC offers a number of subscription choices based on the term and number of videotapes borrowed. Fees currently range from $185 per month for a three- year subscription with one tape out at a time to $11,500 per month for a one- year subscription with up to 500 tapes out at one time. Each subscription includes a workbook and leader's guide.\nThe potential market for BTCC products consists of approximately 28,000 financial institutions, including banks, savings and loans, and credit unions. As of December 31, 1995, there were 2,290 BTCC subscribers.\nEDUCATION\nThe Company entered the education market with its acquisition of the assets of TI-IN Network, Inc., in April 1993. TI-IN accounted for 12% of the Company's revenues for the year ended December 31, 1993. Actual revenues for TI-IN since the assets' acquisition accounted for 12% of the Company's revenues for the nine-month period ended December 31, 1993. TI-IN accounted for approximately 10% of the Companies revenues for the twelve-month period ended December 31, 1995.\nTI-IN currently broadcasts three channels of primarily live and interactive programming for students, teachers and administrators for approximately eight to ten hours per day. TI-IN is providing 20 accredited, live and interactive classes to high school students during the 1995-1996 school year. High school classes are broadcast on the hour for 50 minutes each weekday for 180 days in the school year, which runs from late August through late May. Full-year (two semester) classes for the 1995-1996 school year include:\n. Spanish I, II and III (two sessions of Spanish I) . Latin I and II . French I and II . German I and II . Japanese I and II . Anatomy and Physiology . Physics\/AP (Advanced Placement) Physics . Calculus\/AP Calculus\nOne semester classes for the 1995-1996 school year include:\n. Environmental Science . Marine Science . Sociology . Psychology\/AP Psychology . Astronomy . Ecology\nTI-IN also provides two 25-minute accredited high school classes which are pre-taped:\n. Creative Writing . Research Writing . Introduction to Business and Careers . Business Communications\nStudents enrolled in TI-IN high school classes have the opportunity to call their teachers during class, during the school day and during selected evening hours from home, all via toll-free telephone numbers. All classes are developed and presented by certified teachers.\nTI-IN provides nine 25-minute, pre-taped classes for elementary and middle schools during the 1995-1996 school year:\n. Beginning Spanish - Grades 2-3 (M, W & F) . Beginning Spanish - Grades 4-5 (M, W & F) . Continuing Spanish - Grades 3-4 (M, W & F) . Continuing Spanish - Grades 5-6 (M, W & F) . Elementary ESL (English as a Second Language) - Grades 1-2 (M, W & F) . Elementary ESL - Grades 3-5 (M, W & F) . The World Around Us - Grades K-1 (M, W & F) . Languages Around the World - Middle School (M - Th) . Science Counts\/Math & Science in Outer Space - Middle School (M - Th) . Science Counts - Grades 3-5 (M, W & F)\nIn addition to core curriculum classes, TI-IN programming includes student enrichment programs of varying length and frequency and college entrance exam test review courses for the Scholastic Aptitude Test and the American College Testing Exam, and has provided distance learning programs and services to limited populations of children of migrant worker families and incarcerated youth for the summer months and in the evenings.\nTI-IN also produces live and interactive staff development programming for teachers and school administrative personnel. Typically offered twice a week for two hours in the afternoons after the normal school day, this programming consists of nationally recognized experts speaking and answering questions on topics in the areas of administration, motivation, health, leadership, management, teaching and learning styles and strategies, and technology.\nFor the 1996-1997 school year, TI-IN plans to increase its programming with new courses in elementary, middle and high school. New elementary\/middle school courses planned include Introduction to Elementary Spanish for grades K-2, Elementary Spanish V and Science World for grades 6-8. Due to its increasing use, high school programming is being expanded to include block scheduling. TI- IN will offer Latin I, Latin II, Spanish I, Spanish II, Physics I and Physics II using the block format. This will allow the student to receive two years of a foreign language in one year, or it may be taken as a semester course. Marine Science has been expanded to include Aquatics Science. This course will now be offered as a full year course with saltwater covered in the fall and freshwater covered in the spring. The students may take Aquatic Science as a full year or semester course. Astronomy will now be offered both fall and spring semesters due to its popularity with the high schools.\nIn addition, TI-IN will offer Testing 101 during the 1996\/1997 school year as an unlimited enrollment course designed to give students additional practice for exit exams through extensive vocabulary development, reading analysis, and math reviews. Grad Chat, another unlimited enrollment course, will give high school students the opportunity to speak with colleges and technical schools from all over the United States regarding admissions, housing, financial aid and other issues related to choosing the best options following high school.\nTI-IN subscription fees for high schools range from approximately $2,500 to $5,500 per school depending on various factors. In addition to the subscription fee, enrollment fees for the full-year accredited high school classes are $580 per enrollment, and half those amounts for one-semester classes. TI-IN has approximately 6,000 enrollments in its high school classes for the 1995-1996 school year.\nFees for elementary\/middle school classes currently range from approximately $2,000 to $4,000, depending on the class selection desired. TI- IN's elementary and middle school classes are offered on an unlimited participation basis per school.\nThe market for TI-IN includes approximately 100,000 public and private kindergarten through 12th grade schools in the United States. As of December 31, 1995, approximately 1,186 high schools and 896 elementary and middle schools were subscribers to TI-IN.\nSALES AND MARKETING\nThe Company markets its networks primarily by telephone sales, supplemented by targeted media advertising and participation in trade shows. Sales efforts are directed at the management level or other appropriate contact, such as the directors of training with potential subscriber. The Company's telephone sales staff uses outbound telephone sales techniques to contact potential subscribers. After making an initial telephone contact, the Company sends a package of materials usually via overnight courier to each prospective subscriber. This package includes a videotape describing the network and the Company's services, a sample programming guide and appropriate subscription agreements. Each satellite network or videotape service has a distinct telephone sales force trained specifically for its market. The sales force for start-up satellite networks and videotape services is staffed in part by experienced members of the Company's existing sales forces.\nIn addition to its telephone sales staff, TI-IN currently employs four field sales representatives who live in various parts of the continental United States. These field representatives not only contact potential subscribers via the telephone, but they also personally visit the potential subscribers at their places of business.\nThe Company markets IDTN and EXEN primarily with account managers rather than telephone sales staff, due to the generally large financial commitments made by these customers. These account managers contact potential subscribers and personally visit the potential subscribers at their place of business, and provide ongoing support to the customer until the contract is fulfilled.\nIn regard to renewals of existing subscribers' contracts, the Company's networks utilize marketing personnel specifically dedicated to contacting these subscribers. These marketing employees attempt to obtain renewal contracts from the subscribers before the expiration of their existing contracts in order to avoid any break in satellite, teleconference or videotape service.\nMany of the Company's videotape networks facilitate the marketing of single tape sales by offering customers a preview tape for a limited period at little or no charge. Should the tape meet the customer's training needs, it is converted to a sale. If not, the customer is responsible for returning all materials by traceable carrier. Tapes and workbooks not returned are billed at the full catalog list price.\nA strong link is maintained between programming, marketing and customer service to ensure programming needs of subscribers are considered in all aspects of the Company's networks and videotape services.\nCUSTOMER SUPPORT CENTER\nThe Customer Service Center (\"CSC\") is one of several customer-driven divisions within the Company. It is operated under the philosophy that meeting the needs of the Company's existing and potential customers is the primary consideration in all decisions and practices. This group receives virtually all incoming calls to the networks which are not placed to a specific individual, and each Customer Service Representative is trained and empowered to handle a variety of customer questions and requests, on subjects as wide-ranging as technical assistance with satellite reception to information about upcoming programs or content experts. Calls to the CSC are measured and documented in terms of time-to-answer and time-to-abandon, and the staff works toward specific objectives in these and other areas. The CSC staff also acts as a liaison for the Company and all of its service departments.\nPRODUCTION AND DELIVERY\nProgramming for all satellite networks and videotape services is produced primarily at the Company's Carrollton, Texas facility with the exception of the TI-IN classes, which originate from the San Antonio production and uplink facility. The Company's production staff includes technical and creative personnel. The Company's Carrollton, Texas production facilities, constructed in the spring of 1988, include two 3,000 square foot studios, one 900 square foot news studio and the newest 500 square foot studio added in 1994 to accommodate interactive broadcast productions.\nThe Company believes that substantially all equipment integrated in these facilities represents current generation technology.\nPrograms for the Company's private satellite networks are delivered to downlink satellite reception equipment at each subscriber's location by satellite transmission. Each downlink is directed at the Galaxy VII satellite in order to receive the Company's broadcasts. Encrypted broadcasts may only be received by downlinks equipped with the appropriate decoder devices.\nSatellite Uplink Equipment. The Company owns and operates three Ku band uplinks, two at its facility in Carrollton, Texas, which uplink programming for LETN, ASTN, HSTN, LTCN, FETN, IDTN, EXEN, and ad-hoc teleconferences, and one located in San Antonio which uplinks TI-IN distance learning programming. Two uplinks are configured to transmit programming using Compressed Digital Video (CDV) technology.\nSatellite Signal. The Company has contracted with Hughes Communications Galaxy, Inc. (\"Hughes\") for satellite transponder capacity through January 1, 2002 on its Galaxy VII satellite for delivery of the programming signals of each satellite network throughout the continental United States and southern Canada. All daily programming is transmitted on Galaxy VII with the exception of some ad-hoc teleconferencing which occurs through the satellite most suitable to access the teleconference sites.\nIn the event that the satellite relaying the Company's programming were to become unavailable, use of another satellite would be necessary. The Company is not insured against losses which may occur if the Galaxy VII satellite were to become unavailable, but the Company's current contract with Hughes provides appropriate spacecraft redundancy to protect against risk within reason. Beyond this contractual obligation, the Company believes that sufficient satellite availability currently exists to meet its foreseeable needs. In the unlikely event that the Company would be forced to reposition the reception equipment of subscribers to another satellite, the Company would incur significant costs and a possible interruption in the Company's revenue stream.\nSatellite Downlink Equipment. The Company's satellite reception equipment package for its private satellite networks consists of an integrated receiver decoder (IRD), low noise block converter, dish and nonpenetrating roof mount. The Company does not supply the television sets used by subscribers to view the Company's programming. Except with respect to programming transmitted through the GM or Chrysler dealer networks, the Company generally supplies downlinks which are installed by independent contractors. The average cost to the Company for purchase and installation of a downlink capable of receiving encrypted broadcasts is approximately $2,600.\nIn addition to satellite reception equipment, the Company installs One Touch interactive keypads, a site controller, furniture and other related equipment at each of its IDTN classroom sites at an average additional cost of approximately $32,000. With the exception of furniture, which is provided by the customer, the Company also installs similar equipment at each of its EXEN sites at an average cost of approximately $11,000.\nEncryption. Encryption greatly reduces unauthorized reception of programming and permits programming to be customized for and directed to individual subscribers or groups of subscribers. All networks currently are encrypted using Compressed Digital Video (CDV), except ASTN which uses BMAC analog encryption.\nNEW TECHNOLOGY\nThe Company continues to commit to new technologies that improve customer service, add value to its products, improve the production processes, enhance its delivery mechanisms and lower operating costs.\nRecent commitments to DVC (DigitalVideo Cassette) technology will not only reduce the cost of TV acquisition equipment but will also improve the quality of video through the production process. It enables more decentralized production thereby tending to smooth out the demand for production resources.\nAfter spending several months testing digital production methods at its Carrollton facility, the Company is moving into digital video production in its subscription networks. Creating this type of production environment follows the\noverall strategic direction of decentralizing the process and empowering the producer. This paradigm shift puts the Company on the right platform to produce the training products of the future. It enables the producer to create all elements of video, audio, graphics, text and interactivity on one workstation with minimal hand-offs. Most importantly it allows the Carrollton production capacity to be put to its highest and best use in producing high revenue.\nThe Company is studying emerging delivery technology that will allow it to create and sell a product that has not been feasible in the past. The massive customization that is desirable in asynchronous, on-demand type products requires that the product not actually be assembled until it arrives at the point of participation. In this case the video, audio, text and interactivity are all integrated into one homogenous body of work. The Company will also be able to deliver more up to the minute information programming such as news. This technology employs scalable delivery which enables a scalable product offering allowing for a scalable marketing approach. It also facilitates massive customization creating products with broader market appeal. Usage at a desktop workstation allows all the advantages of newer computers to be leveraged in the provision of an on-line, cutting edge, education, information and training product. It also allows international sales without any special effort.\nOther appropriate technologies are being tested and evaluated to determine their applicability in the markets addressed by the Company such as DVD (Digital Versatile Disc) and new interactive response devices.\nCOMPETITION\nThe Company currently has no competitors delivering daily training programming to the Company's existing satellite markets through a private satellite network. GM and Chrysler have their own private satellite television networks, but the Company does not regard them as competitors because these manufacturers market ASTN in conjunction with their networks. Lambert Communications, Inc. (\"Lambert\") delivers a patient entertainment and a physician education product to approximately 160 hospitals, but due to differences in program focus and basis for revenues, the Company does not consider this to be a direct competitor to its HSTN training network. The Company does compete with a number of businesses and governmental agencies that provide videotape training material, consulting services and instruction at seminars, trade shows and conventions. In addition, in the law enforcement and fire and emergency areas, television programs are offered by certain agencies on an irregularly scheduled basis. It is possible that major automobile manufacturers, governmental agencies, television networks or other information service providers may attempt to compete with the Company's various networks.\nA number of companies have entered the private television market to serve particular business or professional groups, and many large business and governmental organizations have developed their own private networks. The Company believes the inherent barrier created by significant market penetration improves the Company's competitive posture. To the extent that networks are established by other companies in additional markets, the Company's opportunities for future expansion could be limited.\nEMPLOYEES\nAs of December 31, 1995, the Company employed 629 persons on a full-time basis, including 179 persons in its programming, production, news and engineering departments, 266 persons in its sales and marketing and 184 persons in its administrative, satellite communications, customer service, tape distribution, accounting and management information systems departments. In addition, the Company from time to time employs freelance labor to assist in the production of its programming.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nFACILITIES\nThe Company's primary production facilities occupy approximately 70,000 square feet in a leased building in Carrollton, Texas. These facilities are leased for a 10-year term that ends in June 1998. Of the total square footage of these facilities, approximately 60,000 square feet are used for office space and production and the remainder is used for set and supply storage. The Company leases approximately 50,000 square feet of additional office space in Dallas, Texas to accommodate its executive offices and the telemarketing force required for existing networks. These facilities are leased for a term that ends in June 1998. TI-IN has an agreement through August, 1996 with the Texas Education Service Center, Region 20 (\"Region 20\") in San Antonio, Texas, whereby TI-IN programming is developed using Region 20 teachers and facilities. The recently acquired ETC operations occupy approximately 13,130 square feet of leased office space in Des Moines, Iowa. These facilities are leased for a term that ends in October 1998. The Tel-A-Train operations occupy approximately 16,000 square feet of leased office space in Chattanooga, Tennessee. The Tel-A-Train facility is leased for a one year term, expiring March 31, 1996, with a one year renewal option. The BTCC operation is housed in a 6,732 square foot office space located in St. Louis. This facility is leased for a three-year term that ends October 31, 1998 with a six-month exit clause. In addition, the Company leases 50 classroom facilities throughout the United States for its IDTN and EXEN operations. These facilities range from approximately 1,000 to 2,000 square feet with lease terms that expire in two to four years. The Company believes that approximately 50,000 square feet of additional space will be required to facilitate the relocation of the Accounting, Management Information Services and Interactive Education Services departments along with the Fulfillment and Satellite Communications shipping operations. This move will free up needed space at the Carrollton facility for production purposes including use by IDTN clients. The Company is renegotiating its lease on the Carrollton facility in conjunction with the negotiation for the previously mentioned space. See Note 7 of Notes to Consolidated Financial Statements for further information regarding the Company's lease obligations.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nNot applicable\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNot applicable\nPART II.\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\n(a) The Company's Common Stock, $.01 par value, is traded on the NASDAQ National Market under the symbol WCTV. The ranges of high and low closing sales prices of Common Stock as reported on the NASDAQ composite tape of each fiscal quarter for the two most recent years, have been as follows:\n(b) As of March 15, 1996 there were approximately 5,000 shareholders of record or through nominee or street name accounts with brokers of the Company's Common Stock.\n(c) No cash dividends on Common Stock have been paid by the Company from its inception to the filing of this Report, nor does management have present plans for declaring any cash dividends. Payment of cash dividends on its Common Stock is prohibited by covenants in the Company's loan agreement.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nWESTCOTT COMMUNICATIONS, INC.\nSELECTED CONSOLIDATED FINANCIAL INFORMATION (IN THOUSANDS, EXCEPT PER SHARE DATA)\nThe following table sets forth certain selected consolidated financial data of the Company and should be read in connection with the more detailed Consolidated Financial Statements of the Company and the related notes thereto included in Part IV of this Form 10-K.\n\/(a)\/ See discussion and pro forma income statement data of acquisitions in Note 3 to Notes to Consolidated Financial Statements.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nOVERVIEW\nThe revenue growth of the Company depends on continued internal development of new networks and services in existing or additional markets, the addition of new products through existing networks, and strategic acquisitions. The Company's long-term planning anticipates, as in prior years, activity in all three areas. Internal growth will come from establishing additional networks such as LTCN, IDTN and EXEN. New product offerings are expected to include interactive products and other multimedia technologies such as CD\/ROM.\nThe Company's financial results are characterized by the recurring revenue derived from the subscriber bases of networks, the relatively high cost of producing, marketing and delivering high quality programming and the relatively low incremental cost of supplying that programming to additional subscribers. Internally developed networks typically incur marketing and programming costs in excess of revenues until the number of subscriptions reaches an incremental break-even level.\nThe Company installs downlink equipment at LETN, FETN, HSTN, LTCN, AHA, JCSN, WHTG, TI-IN and EXEN subscriber sites and at ASTN sites unless the subscriber is affiliated with GM or Chrysler, in which case the equipment is provided by those manufacturers. Typically, network installations are completed within 30 days after a subscription agreement is signed. As to each subscription for which the Company has the obligation to provide downlink equipment, the Company has an immediate cost, including both equipment and installation, of approximately $2,600. These costs are capitalized and depreciated over five years. Revenues from new satellite subscribers commence when downlink equipment is installed at the subscriber's site and the Company's signal is received. The subscription fee charged by the Company's satellite networks is based upon a number of factors, including the number of personnel at the subscriber location, the number of subscriber locations and the programming ordered. For an ASTN subscriber, the subscription fee is also dependent on whether a subscription is sold directly or through a manufacturer\/distributor arrangement. New satellite network subscriptions adversely impact profitability in the near term because sales commissions are expensed as new subscriptions are sold and installed.\nRevenues from the Company's videotape networks begin when the videotape products are shipped to the customer. All videotape subscription service fees are paid in advance except BTCC, which is typically billed monthly. Sales commissions for videotape services are expensed over the life of the related contract which is generally one to three years.\nThe Company also installs downlink equipment at IDTN and EXEN sites, along with other interactive equipment such as One Touch devices and computer hardware. Revenues for the Company's interactive multimedia networks commence as the live events occur in the case of IDTN; and when the first class of a course is offered in the case of EXEN. Fees charged to IDTN customers are based upon a base price for each single day event, with separate fees charged for providing additional services such as production enhancement, instructional design and catering. Fees charged to EXEN customers are based upon the number of participants enrolled in each course. Additionally, EXEN subscribers pay a monthly subscription fee and a one-time enrollment fee for the Company. Sales commissions for IDTN services are expensed as the live events occur, while commissions for EXEN are expensed over the life of the related contract which is generally one year.\nEven though the Company's networks have achieved sufficient penetration to establish a prominent presence in their respective fields, future revenue growth is dependent on staying abreast of specific industry needs and delivery of consistently high quality programming and timely information to its subscribers.\nThe following table contains information about products and services offered by the Company.\nLegend: S = Private Satellite V = Videotape T = Teleconferencing C = Computer Based Training W = Workstation I = Interactive Multimedia N\/A = Not Applicable\nRESULTS OF OPERATIONS\nCOMPARISON OF THE YEAR ENDED DECEMBER 31, 1995 TO THE YEAR ENDED DECEMBER 31, 1994:\nREVENUES. Revenues increased $8,093,481 or 9% primarily as a result of revenue growth in networks or products acquired or internally-developed since the first quarter of 1994, such as IDTN, LETN workstations, EXEN, and EMU. Also contributing to this increase was an increase in LTCN revenues. Revenues from the Company's six principal markets for the periods indicated were as follows:\nRevenues in the Government and Public Services market increased $1,702,071 or 9% due primarily to an increase in LETN workstation sales. Also contributing to this increase was an increase in revenues for EMU, which was acquired in the first quarter of 1995; and GSTN, which has experienced an increase in subscribers since its inception in mid-1993. The increase in revenues was partially offset by a decrease in revenues for LETN and FETN satellite and videotape subscriptions as a result of a decrease in subscribers over the same period last year.\nRevenues in the Automotive market decreased $198,119 or 2% due primarily to decreases in the number of subscribers for ASTN. WCMI experienced an increase in revenues resulting from several custom programming projects completed during 1995.\nRevenues in the Health Care market increased $299,765 or 2% primarily as a result of an increase in revenues for LTCN, an internally-developed network which began operations in April 1993. Partially offsetting this increase was a decrease in revenues for HSTN and AHA as a result of a decrease in subscribers for these networks over the same period last year. IMN also experienced a decrease in revenues from its PsychLINK network as a result of a decrease in available educational grants which fund its programming.\nRevenues in the Corporate and Professional market increased $5,898,887 or 24% primarily as a result of IDTN's electronic classrooms which began operations in the first quarter of 1994, and EXEN, which began operations during the fourth quarter of 1995. Also contributing to this increase was ATSN, an internally- developed network which was introduced during the second quarter of 1995; and Safety Watch, a product acquired from Lockert Jackson in the first quarter of 1995. Partially offsetting these increases were decreases in revenues for ITS and Tel-A-Train which management believes result from an industry-wide decline in safety training sales, and a decline in international sales as a result of the decline in economic conditions in Mexico.\nRevenues in the Financial Services market increased $603,795 or 10% due to an increase in subscription-based revenue for BTCC as a result of an increase in subscribers over the same period last year.\nRevenues in the Education market increased $68,361 or 1% due to revenues generated from a government grant received in the first quarter of 1995.\nPROGRAMMING AND PRODUCTION. Programming and production costs increased $2,080,821 or 11% primarily as a result of production costs associated with IDTN which began operations in early 1994. Programming and production costs for WCMI increased over the same period last year as an increased number of custom programming projects were completed during 1995. Also contributing to this increase was EXEN, which began operations in the fourth quarter of 1995; and TI- IN, which offered additional courses and provided additional programming under a government grant received during the first quarter of 1995. Partially offsetting these increases were decreases in programming and production costs for many of the Company's more mature satellite networks such as LETN, FETN, ASTN and HSTN, as a result of the more efficient use of production facilities and utilization of existing program inventory. IMN costs decreased because fewer teleconferences were produced.\nDELIVERY AND TRANSMISSION. The increase of $2,402,440 or 22% over the corresponding period last year is primarily due to an increase in transponder expense, resulting from an amendment in September, 1994 to the Company's long- term transponder lease which increased its satellite transponder capacity. From 1994 to 1995, the Company experienced an increase in the cost of goods sold attributable to the increase in LETN workstation sales, as well as an increase in delivery & transmission costs for IDTN, which began operations in early 1994. Also contributing to the overall increase was an increase in equipment cancellation expense as a result of decline in subscribers in some of the mature networks, and an increase in the proportion of service related activity as opposed to installation and CDV conversion activity over the same period last year.\nSALES AND MARKETING. Sales and marketing expenses decreased $1,577,482 or 7% primarily as a result of the closing of the ITS New Jersey sales office in late 1994. In addition, ITS experienced a decrease in commission expense as result of a decrease in sales from 1994 to 1995, and as a result of the implementation of a new sales commission plan adopted in late 1994. Also contributing to the decrease in overall sales and marketing expense was ASTN, LETN and FETN which experienced a reduction in commission expense resulting from a decrease in sales from 1994 to 1995. Sales and marketing costs for subscription networks tend to decrease as the networks mature since commissions on renewals are lower than those paid on original sales.\nSales personnel are compensated through commissions on new sales and renewals supplemented by a small base salary. Therefore, commission expense for the satellite networks in any reporting period will vary with the number of subscriptions and renewals sold during such reporting period. Commissions relating to the videotape, teleconference and interactive multimedia networks, however, are deferred and amortized over the life of the respective contract, which is generally a period of one to three years.\nGENERAL AND ADMINISTRATIVE. General and administrative expenses decreased $1,214,623 or 12% over the prior period. This category includes operating costs for the Company's travel agency, executive compensation, facilities and other expenses not directly attributed to the operation of the programming, production and sales and marketing departments. The decrease in expenses from 1994 to 1995 is primarily due to a decrease in bad debt expense, the sale of the travel agency in the fourth quarter of 1994 and a decrease in outside consulting expense for BTCC.\nDEPRECIATION AND AMORTIZATION. The $1,888,443 or 19% increase in depreciation and amortization expense over the same period last year is primarily attributable to depreciation increases for the installation of downlink and CDV equipment at customer receive sites for the Company's satellite networks. Production equipment, computer equipment and software, One-Touch equipment installed at TI-IN sites, equipment installed for IDTN electronic classrooms, and leasehold improvements necessary to accommodate the Company's overall growth also contributed to this increase in depreciation expense. Amortization increased over the same period last year primarily as a result of intangibles acquired in the acquisitions of ETC and Lockert Jackson since the first quarter of 1994.\nINTEREST. Interest expense decreased by $55,834 or 32% primarily as a result of the payment of $1,100,000 of long-term debt in December, 1994. Interest income increased $449,952 or 477% over the same period last year primarily as a result of the increase in temporary interest-bearing investments.\nTAXES. The provision for income taxes as a percentage of income before income taxes increased from 38% in 1994 to 40% in 1995. This increase resulted primarily from an increase in state income taxes, an increase in non-deductible goodwill and the application of graduated tax rates.\nCOMPARISON OF THE YEAR ENDED DECEMBER 31, 1994 TO THE YEAR ENDED DECEMBER 31, 1993:\nREVENUES. Revenues increased $20,443,261 or 30% primarily as a result of revenue growth in networks acquired or internally-developed since the first quarter of 1993. Because the Company now offers more diversified products and services than in past periods, including teleconferences, Training on Demand and other customer services, management believes that reporting revenues by markets served is becoming more indicative of the Company's performance. Revenues from the Company's six principal markets for the periods indicated were as follows:\nRevenues in the Government and Public Services market decreased $621,869 or 3% due primarily to decreases in the number of subscribers for LETN and FETN during 1994. Management believes these decreases stabilized to some extent by the end of 1994. This decrease in revenues was mitigated by an increase in revenues for GSTN, an internally-developed network which began operations in late 1993. American Heat and Pulse also experienced an increase in revenues from 1993 to 1994.\nRevenues in the Automotive market increased $192,737 or 2% due primarily to increases in the number of subscribers for ASTN.\nRevenues in the Health Care market increased $4,761,125 or 32% primarily as a result of an increase in revenues for LTCN, an internally-developed network which began operations in April 1993. An increase in the number of subscribers to Westcott Healthcare Teleconference programs, some of which were acquired during the first quarter of 1993, along with an increase in subscribers for HSTN also contributed to the revenue growth in this market.\nRevenues in the Corporate and Professional market increased $15,099,101 or 158% primarily as a result of the acquisitions of Tel-A-Train and ETC, in the fourth quarter of 1993 and the first quarter of 1994, respectively. Also contributing to this increase were IDTN's electronic classroom operation which began operations in the first quarter of 1994, and ITS, which was acquired during the second quarter of 1993.\nRevenues in the Financial Services market increased $173,210 or 3% as a direct result of revenue growth in BTCC.\nRevenues in the Education market increased $1,114,971 or 14% due to the introduction of elementary and middle school products and services, as well as the addition of new high school subscribers for the 1993-1994 school year.\nPROGRAMMING AND PRODUCTION. Programming and production costs increased $5,660,639 or 45% primarily as a result of production costs associated with IDTN which began operations in early 1994, product cost of ETC and Tel-A-Train acquired since the fourth quarter of 1993, costs attributable to additional collateral materials for new operations both acquired and internally developed since the first quarter of 1993. In addition, operating costs of the Interactive Education Service department increased as a result of more demand for test scoring and continuing education credit tracking.\nDELIVERY AND TRANSMISSION. The increase of $1,415,045 or 15% over the corresponding period last year is primarily due to videotape distribution costs associated with product delivery costs of Tel-A-Train and ITS, acquired in 1993; and ETC, acquired in the first quarter of 1994. BTCC also experienced an increase in videotape distribution costs as a result of the increase in the number of videotape subscribers. Offsetting these increases were decreases in videotape distribution costs for FETN, LETN and PSTN as a result of a decrease in the number of videotape subscribers in these networks. Also contributing to the overall increase in delivery and transmission costs was an increase in operating costs of the satellite communications department in order to accommodate the Company's overall growth.\nSALES AND MARKETING. Sales and marketing expenses increased $7,267,161 or 52% primarily as a result of the marketing of networks acquired or internally developed since the first quarter of 1993 such as Tel-A-Train, ETC, IDTN, ITS, ECI and GSTN. The marketing costs of BTCC also increased from 1993 to 1994 as a result of the amortization of deferred contract costs associated with contracts obtained in 1992 and 1993.\nSales personnel are compensated through full commissions on new sales, supplemented by significantly lower commissions for renewals and a small base salary. Therefore, commission expense for the satellite networks in any reporting period will vary with the number of subscriptions and renewals sold during such reporting period. Commissions relating to the videotape and teleconference networks, however, are deferred and amortized over the life of the respective contract, which is generally a period of one to three years.\nGENERAL AND ADMINISTRATIVE. General and administrative expenses decreased $768,073 or 7% over the prior period. This category includes operating costs for the Company's travel agency, executive compensation, facilities and other expenses not directly attributed to the operation of the programming, production and sales and marketing departments. The decrease in expenses from 1993 to 1994 is primarily due to networks acquired during 1993 such as BTVS, TI-IN and ECI; which experienced a reduction in expenses as they became fully integrated with the Company. Also contributing to this decrease was a reduction in operating costs for the travel agency. Partially offsetting these decreases was an increase in bad debt expense; an increase in administrative costs for ETC, which was acquired during 1994; and an overall increase in administrative operating costs in order to accommodate the Company's overall growth.\nDEPRECIATION AND AMORTIZATION. The $2,293,631 or 29% increase in depreciation and amortization expense over the same period last year is primarily attributable to depreciation increases for the installation of downlink and CDV equipment at LETN, FETN, HSTN, LTCN and TI-IN sites, as well as One-Touch equipment installed at TI-IN sites during 1994. Equipment installed for IDTN electronic classrooms, computer equipment and software, leasehold improvements and production equipment purchases necessary to accommodate the Company's overall growth also contributed to this increase in depreciation expense. Amortization of goodwill and other intangible assets added in connection with acquisitions made during 1993 and 1994 also increased during the comparison period.\nINTEREST. Interest expense decreased by $67,849 or 28% primarily as a result of the payment of $8,190,640 of long-term debt in June, 1993. Interest income remained relatively stable with a slight decrease of $68,000 or 42% over the same period last year primarily as a result of the decrease in temporary interest-bearing investments.\nTAXES. The provision for income taxes as a percentage of income before income taxes remained at 38% from 1993 to 1994.\nLIQUIDITY AND CAPITAL RESOURCES\nDuring 1995, the Company satisfied its liquidity needs principally from cash flow from operations. In addition, the Company has a credit facility under which the Company may borrow up to $18,000,000. No amounts have been drawn against this facility as of December 31, 1995. The facility, which has been extended through June 28, 1996, provides a sublimit of $1,000,000 for standby letters of credit. A commitment fee of one half of 1% of the unused credit line and an interest rate of prime, or if lower, an alternate CD rate plus 1 1\/2% will be charged. As of December 31, 1995, the Company had $14,267,208 in cash and cash equivalents.\nThe Company's credit facility contains various restrictive covenants which, among other things, prohibit the payment of cash dividends and require the Company to maintain certain financial and tangible net worth ratios. The facility is secured by studio equipment, downlink equipment, other equipment and fixtures, subsidiary stock and accounts receivable.\nDuring the year ended December 31, 1995, the Company generated approximately $20.6 million in cash from operations. Approximately $13.6 million in cash was used in investment activities, primarily in connection with the purchase of equipment, investments in program inventory and the acquisition of Lockert Jackson and Associates. The Company's financing activities during the year ended December 31, 1995 generated approximately $1.5 million, primarily from the issuance of Common Stock under the Company's employee stock purchase and option plans, which was partially offset by payments on short term and long term debt.\nThe Company has identified capital needs of approximately $8 million through 1996 primarily to fund additions to the production facility, additional purchases and installations of downlink equipment, computer hardware and software for the A\/S 400, purchases and installation of equipment for EXEN classroom sites, and investments in program inventory. As of December 31, 1995, the Company had operating lease commitments of $6,990,070, $6,628,508 and $5,949,778 in 1996, 1997 and 1998, respectively. The Company had no significant capital lease commitments.\nThe Company believes cash generated from operations, cash on hand, and funds available under the revolving line of credit will be sufficient to meet its budgeted capital and liquidity requirements through the foreseeable future.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe information required by this item begins on page.\nITEM 9.","section_9":"ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone\nPART III.\nThe information required by Part III is incorporated by reference to the Company's definitive proxy statement relating to its annual meeting of stockholders, which will be filed with the Securities and Exchange Commission within 120 days of the end of the 1995 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 10-K\n(a) The following documents are filed as part of this Report:\n1. FINANCIAL STATEMENTS - SEE INDEX TO CONSOLIDATED FINANCIAL STATEMENTS ON PAGE HEREOF.\n2. FINANCIAL STATEMENT SCHEDULES ARE REQUIRED TO BE FILED BY ITEM 8 AND PARAGRAPH (D) OF THIS ITEM 14\nSchedule II - Valuation and Qualifying Accounts\nAll other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted.\n3. EXHIBITS\n2.1 Agreement and Plan of Merger dated as of February 5, 1992, among USV Holdings, Inc., Gregory Earls, as Trustee under the Earls' Children Irrevocable Education Trust Agreement dated September 5, 1986, the Company, and ASTN, Inc.\/(5)\/\n2.2 Acquisition Agreement dated as of January 13, 1992, between ICF International, Inc. and HSN Acquisition, Inc.\/(5)\/\n2.3 Asset Purchase Agreement dated as of June 26, 1992, between Bankers Training and Consulting Company and the Company.\/(7)\/\n2.4 Purchase Agreement dated January 1, 1993 among the Company, BancTraining Video Systems, an Iowa general partnership, Financial Shares Corporation, an Illinois corporation, RWWR Corp., an Iowa corporation, Wes Ritchie & Co., George M. Morvis, Robert D. Williams and Weston R. Ritchie.\/(9)\/\n2.5 Plan and Agreement of Reorganization dated February 1, 1993 among the Company, Executive Communications, Inc., William H. Fueller, Thomas E. Rozzi, Thomas A. Rasmussen, Timothy H. Solomon, Richard M. Neustadt, William H. Stewart, Jr. and the Inside Stockholders.\/(9)\/\n2.6 Asset Purchase Agreement dated as of April 1, 1993 between the Company, TI-IN Acquisition Corp., a Texas corporation, TI-IN Network, Inc., a Texas corporation and Certain of Its Stockholders.\/(10)\/\n2.7 Agreement and Plan of Merger dated as of April 29, 1993 between the Company, ITS Acquisition Corp., a Texas corporation and Industrial Training Systems, Inc., a New Jersey corporation.\/(12)\/\n2.8 Plan and Agreement of Reorganization dated as of December 1, 1993 between the Company, Tel-A-Train, Inc., a Tennessee corporation and Automotive Satellite Television Network, Inc., a Delaware corporation.\/(12)\/\n2.9 Merger Agreement and Plan of Reorganization dated as of March 1, 1994 between Professional Security Television Network, Inc., a Delaware corporation, the Company and Excellence in Training Corporation, an Iowa corporation.\/(13)\/\n2.10 Stock Purchase Agreement between The Stockholders of Lockert Jackson and Associates, Inc. and Westcott Communications, Inc. dated March 1, 1995.\/(16)\/\n3(i) Articles of Incorporation of the Company, as amended.\/(14)\/\n3(ii) Bylaws of the Company, as amended.\/(14)\/\n4 Specimen of Common Stock certificate of the Company.\/(1)\/\n4.1 Rights Agreement, dated as of January 9, 1996, between the Company and KeyCorp Shareholder Services, Inc., as Rights Agent, which includes as Exhibit A the Form of Certificate of Designations of Series A Junior Preferred Stock of the Company, as Exhibit B the Form of Rights Certificate, and as Exhibit C the Summary of Rights to Purchase Shares of Preferred Stock of the Company.\/(17)\/\n10.1 Network Access Agreement by and between the Company and Electronic Data Systems Corporation, dated October 1, 1990 (confidential treatment has been granted with respect to certain financial terms of this agreement).\/(4)\/\n10.2 Lease of Premises at 1303 Marsh Lane, Carrollton, Texas, by and between the Company and Aetna Life Insurance Company, dated February 17, 1988.\/(1)\/\n10.3 Lease of Premises at Two Galleria Tower, 13455 Noel Road, Dallas, Texas 75240 dated April 15, 1992, as amended by First Amendment to Lease Agreement dated July 6, 1993.\/(14)\/\n10.4 Westcott Communications, Inc. Employee Stock Purchase Plan effective January 1, 1990.\/(1)\/\n10.5 Amendment No. 1 to the Westcott Communications, Inc. Employee Stock Purchase Plan.\/(14)\/\n10.6 Amendment No. 2 to the Westcott Communications, Inc. Employee Stock Purchase Plan.\/(14)\/\n10.7 Amendment No. 3 to the Westcott Communications, Inc. Employee Stock Purchase Plan.\/(14)\/\n10.8 Amendment No. 4 to the Westcott Communications, Inc. Employee Stock Purchase Plan.\/(14)\/\n10.9 1989 Stock Option Plan of Westcott Communications, Inc.\/(2)\/\n10.10 Amendment No. 1 to 1989 Stock Option Plan of Westcott Communications, Inc.\/(2)\/\n10.11 Amendment No. 2 to 1989 Stock Option Plan of Westcott Communications, Inc.\/(8)\/\n10.12 Amendment No. 3 to 1989 Stock Option Plan of Westcott Communications, Inc.\/(14)\/\n10.13 Amendment No. 4 to 1989 Stock Option Plan of Westcott Communications, Inc.\/(14)\/\n10.14 Amendment No. 5 to 1989 Stock Option Plan of Westcott Communications, Inc.\/(14)\/\n10.15 Amendment No. 6 to 1989 Stock Option Plan of Westcott Communications, Inc.\/(14)\/\n10.16 Amendment No. 7 to 1989 Stock Option Plan of Westcott Communications, Inc.\/(14)\/\n10.17 Westcott Communications, Inc. Nonemployee Stock Option Plan.\/(2)\/\n10.18 Amendment No. 1 to the Westcott Communications, Inc. Nonemployee Option Plan.\/(14)\/\n10.19 Amendment No. 2 to the Westcott Communications, Inc. Nonemployee Option Plan.\/(14)\/\n10.20 Transponder Lease Agreement dated as of May 1, 1991 scheduled to expire October 1, 1999 between the Company and Hughes Communications Galaxy, Inc.\/(8)\/\n10.21 Amended Transponder Lease Agreement dated as of February 24, 1993. \/(9)\/\n10.22 Amended Transponder Lease Agreement dated as of April 23, 1993 (confidential treatment has been requested with respect to certain financial terms of this agreement).\/(14)\/\n10.23 Amended and Restated Network Agreement dated as of May 31, 1991 between the Company and Chrysler Corporation.\/(9)\/\n10.24 Extension of Amended and Restated Network Agreement dated as of May 23, 1994 between the Company and Chrysler Corporation.\/(15)\/\n10.25 Lease Agreement dated as of January 13, 1992, between ICF Leasing Corporation, Inc. and Health & Sciences Network, Inc.\/(5)\/\n10.26 Non-Competition Agreement dated as of June 26, 1992, between Lawrence A. Darby and the Company.\/(8)\/\n10.27 Employment and Consulting Agreement dated as of June 26, 1992, between Lawrence A. Darby and the Company.\/(8)\/\n10.28 Employment and Settlement Agreement dated as of December 1, 1994 between the Company and Mr. William E. Smith.\/(15)\/\n10.29 Services Agreement dated December 17, 1992 between the Company and American Hospital Association.\/(9)\/\n10.30 Non-Competition Agreement dated as of February, 1993 between William H. Fueller and the Company.\/(14)\/\n10.31 Promissory Note dated as of April 1, 1993.\/(14)\/\n10.32 Second Amended and Restated Credit Agreement dated June 28, 1993 between the Company and Texas Commerce Bank, National Association.\/(11)\/\n11 Computation of Earnings Per Share.*\n22 Subsidiaries of the Company.*\n23.1 Consent of Ernst & Young LLP, Independent Auditors.*\n_________________\n* Exhibit filed herewith.\n\/(1)\/ Incorporated by reference from Registration Statement No. 33-28902 of the Company filed with the Securities and Exchange Commission.\n\/(2)\/ Incorporated by reference from the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 filed with the Securities and Exchange Commission.\n\/(3)\/ Incorporated by reference from the Company's Current Report on Form 8-K dated December 21, 1990 filed with the Securities and Exchange Commission.\n\/(4)\/ Incorporated by reference from the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990 filed with the Securities and Exchange Commission.\n\/(5)\/ Incorporated by reference to the corresponding exhibit to the Company's Current Report on Form 8-K dated February 5, 1992 filed with the Securities and Exchange Commission.\n\/(6)\/ Incorporated by reference from the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991 filed with the Securities and Exchange Commission.\n\/(7)\/ Incorporated by reference from the Company's Current Report on Form 8-K dated July 7, 1992, and filed with the Securities and Exchange Commission.\n\/(8)\/ Incorporated by reference from Registration Statement No. 33-50740 of the Company filed with the Securities and Exchange Commission.\n\/(9)\/ Incorporated by reference from the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1992 filed with the Securities and Exchange Commission\n\/(10)\/ Incorporated by reference from the Company's Current Report on Form 8-K dated April 19, 1993, and filed with the Securities and Exchange Commission.\n\/(11)\/ Incorporated by reference from the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 1993 filed with the Securities and Exchange Commission.\n\/(12)\/ Incorporated by reference from the Company's Current Report on Form 8-K dated January 12, 1994, and filed with the Securities and Exchange Commission.\n\/(13)\/ Incorporated by reference from the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 1994 filed with the Securities and Exchange Commission.\n\/(14)\/ Incorporated by reference from the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993 filed with the Securities and Exchange Commission.\n\/(15)\/ Incorporated by reference from the Company's Annual Report on Form 10-K for the fiscal ended December 31, 1994 filed with the Securities and Exchange Commission.\n\/(16)\/ Incorporated by reference from the Company's Annual Report on Form 10-Q for the fiscal quarter ended March 31, 1995 filed with the Securities and Exchange Commission.\n\/(17)\/ Incorporated by reference from the Company's Current Report on Form 8-K dated January 9, 1996, and filed with the Securities and Exchange and Commission.\n(b) Reports on Form 8-K:\nNone.\n(c) The Index of Exhibits and required Exhibits are included following the financial statement schedules.\n(d) The Index to Consolidated Financial Statements and Financial Statement Schedules is included 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 on the 25th day of March, 1996.\nWESTCOTT COMMUNICATIONS, INC.\nBy \/s\/ CARL WESTCOTT ------------------------------------------ Carl Westcott, 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 25th of March, 1996.\n\/s\/ CARL WESTCOTT - --------------------- Carl Westcott Chairman of the Board and Chief Executive Officer of the Company (Principal Executive Officer)\n\/s\/ JACK T. SMITH - --------------------- Jack T. Smith Director, President and Chief Operating Officer\n\/s\/ PHYLLIS FARRAGUT - --------------------- Phyllis Farragut Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)\n\/s\/ JEFFREY M. HELLER - --------------------- Jeffrey M. Heller Director\n\/s\/ GARY J. FERNANDES - --------------------- Gary J. Fernandes Director\n\/s\/ STANSFIELD TURNER - --------------------- Stansfield Turner Director\n\/s\/ KERN WILDENTHAL Director - --------------------- Kern Wildenthal\nWESTCOTT COMMUNICATIONS, INC.\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE\nREPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS\nTo the Shareholders WESTCOTT COMMUNICATIONS, INC.\nWe have audited the accompanying consolidated balance sheets of Westcott Communications, Inc. as of December 31, 1995 and 1994, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1995. 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 Westcott Communications, Inc. at December 31, 1995 and 1994, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.\nERNST & YOUNG LLP\nDallas, Texas February 16, 1996\nWESTCOTT COMMUNICATIONS, INC.\nCONSOLIDATED STATEMENTS OF OPERATIONS YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995\nSee accompanying notes.\nWESTCOTT COMMUNICATIONS, INC.\nCONSOLIDATED BALANCE SHEETS DECEMBER 31, 1994 AND 1995\nASSETS\nSee accompanying notes.\nWESTCOTT COMMUNICATIONS, INC.\nCONSOLIDATED BALANCE SHEETS (CONTINUED) DECEMBER 31, 1994 AND 1995\nLIABILITIES AND SHAREHOLDERS' EQUITY\nSee accompanying notes.\nWESTCOTT COMMUNICATIONS, INC.\nCONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995\nSee accompanying notes.\nWESTCOTT COMMUNICATIONS, INC.\nCONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995\nWESTCOTT COMMUNICATIONS, INC.\nCONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995\nNONCASH INVESTING ACTIVITY:\nIn 1993, the Company issued 973,445 shares of its Common Stock valued at approximately $15,210,500 and assumed liabilities of approximately $4,615,400 in connection with the acquisitions of BancTraining Video Systems, Executive Communications, Inc., TI-IN Network, Inc., Industrial Training Systems Corporation and Tel-A-Train, Inc. (See Note 3)\nIn March 1993, the Company acquired all 116,427 outstanding shares of its Preferred Stock held by EDS in exchange for a promissory note in the principal amount of $8,190,640. (See Note 11)\nIn March 1994, the Company issued 100,000 shares of its Common Stock valued at approximately $2,100,000 and assumed liabilities of approximately $979,000 in connection with the acquisition of Excellence in Training Corporation. (See Note 3)\nIn April 1995, the Company issued an additional 45,045 shares of its Common Stock valued at approximately $625,000 in connection with the acquisition of Excellence in Training Corporation. (See Note 3)\nThe Company recorded obligations for additional purchase price and non- competition agreements relating to 1993 and 1994 purchase business combinations totaling approximately $176,000 and $1,974,000 in 1993 and 1994, respectively.\nSee accompanying notes.\nWESTCOTT COMMUNICATIONS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1995\n1. DESCRIPTION OF COMPANY\nWestcott Communications, Inc., a Texas corporation (the \"Company\"), educates, trains and informs individuals with common interests in selected markets by providing value-added products and services using appropriate communication technologies. Markets that are currently served include government and public service, automotive, corporate and professional, healthcare, education, financial services and electronic classroom. The Company's operations have been conducted primarily within the continental United States, and sales outside the U.S. to date have not been material.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPrinciples of Consolidation - The consolidated financial statements include the accounts of the Company, its wholly owned subsidiaries and its 50% owned investee (Note 6). All significant intercompany transactions and balances have been eliminated.\nUse of Estimates - The preparation of consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.\nCash and Cash Equivalents - The Company considers all highly liquid investments with maturities of 90 days or less when purchased to be cash equivalents.\nRevenues - Subscription fees for satellite and videotape network services are recognized in the month services are rendered. IDTN customers are generally billed for services rendered upon completion of their broadcast. First time customers under a \"Proof of Concept\" contract may be billed one half of their fee when the contract is signed, with the remaining portion billed upon completion of the broadcast. Subscription fees for EXEN customers are billed in the month following the month of service. Fees for participation are generally billed in the month following the first class session of each course. Enrollment fees are billed upon contract signature.\nAccounts Receivable - Accounts receivable include subscription fees billed to satellite network subscribers one month in advance and videotape subscribers generally billed a year in advance or within one month of delivery of goods. The base contract fee for IDTN services are generally recognized in the month that the broadcast occurs. Additional revenues not covered by the base fee, such as those received for catering services, temporary viewing sites and additional production services, are recognized on the percentage-of-completion basis. The subscription fee for EXEN customers is recognized on a straight-line basis over the life of the related contract, which is generally one year. Revenue for participation fees in excess of this subscription fee are recognized in the month that the course begins. EXEN enrollment fees are recognized in the month the customer's enrollment is complete. Bad debt expense for the years ended December 31, 1993, 1994 and 1995 was approximately $1,111,000, $2,105,000 and $1,423,000, respectively. A portion of the amount in unearned revenue represents additional reserve for uncollectible accounts receivable to the extent the revenue has not been recognized.\nProgram Inventory - Program inventory represents the unamortized cost of programs produced for both the satellite and videotape networks. The cost of these programs has been calculated using the average cost method. The cost of satellite programs is expensed as airings occur in ratio to an estimated number of future showings of each program, and are allocated between current and noncurrent based on the estimated cost of programs to air in the following twelve months. The cost of videotape inventory is expensed on a straight-line basis over the estimated period of time that revenues from future sales are estimated to be generated, which is generally one to five years. The\nWESTCOTT COMMUNICATIONS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1995\namortization of satellite program inventory is dependent upon management's estimate of the number of future airings. Program inventory is reviewed periodically and revised downward if the usefulness of a program declines.\nGoodwill and Other Intangibles - Goodwill is generally amortized on a straight-line basis over a period of 15 years. Other intangible assets include noncompete agreements, trademarks and customer agreements which are amortized using the straight-line method over the lesser of the period of the agreement or the estimated useful lives which range from 3-7 years.\nInvestments - At December 31, 1994, investments consist primarily of equity securities. These securities are classified as trading securities and are stated at fair market value.\nEquipment Inventory - Equipment inventory represents uninstalled receive site equipment.\nDeferred Contract Costs - Certain costs incurred within the videotape networks to obtain sales contracts are deferred and amortized using the straight-line method over the period of time that revenues from these contracts are recognized, which generally ranges from 1-2 years. Such costs are included in other current assets in the accompanying financial statements. Amortization of deferred contract costs totaled approximately $1,344,000, $2,728,000 and $1,670,000 in 1993, 1994 and 1995, respectively, and is included in sales and marketing costs in the accompanying financial statements.\nCommission Expense - Commissions for obtaining satellite subscriber contracts are generally expensed in the month the contract is received, with the exception of TI-IN satellite subscriber contracts which are deferred and expensed over the life of the contract which is usually one school year. Commissions for obtaining EXEN and videotape contracts are deferred and expensed over the life of the related contract. IDTN commissions are expensed as the live events occur.\nUnearned Revenue - Unearned revenue represents amounts paid by or billed to customers (with payment due within 30 days) for services to be delivered in future periods. Unearned revenue is recognized as these services are delivered.\nDepreciation and Amortization - Depreciation of property and equipment is computed using the straight-line method over estimated useful lives which range from 3-8 years. Leasehold improvements are amortized over the shorter of the term of the related lease or their estimated useful lives.\nIncome Taxes - Deferred tax assets and liabilities are recorded based on the difference between the tax bases of assets and liabilities and their carrying amounts for financial reporting purposes. In addition, the current or deferred consequences of a transaction are measured by applying the provisions of enacted tax laws to determine the amount of taxes payable currently or in future years.\nStock-based Compensation - The Company has elected to follow Accounting Principles Board Opinion No. 25, \"Accounting for Stock Issued to Employees\" (APB 25) and related Interpretations in accounting for its employee stock options, rather than adopting the alternative fair value accounting provided for under FASB Statement No. 123, \"Accounting for Stock-Based Compensation\". Under APB 25, because the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized.\nRisk Concentration - Financial instruments which potentially subject the Company to concentrations of credit risk are short-term cash investments and accounts receivable. The Company places its short-term cash investments in\nWESTCOTT COMMUNICATIONS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1995\ngovernment securities and investment grade, short-term bank certificates of deposit. The Company sells subscription and production services to customers throughout the United States and Canada associated with the law enforcement, fire and emergency, healthcare, banking, professional security, corporate, education, accounting and automotive industries. The Company continuously evaluates the creditworthiness of its customers' financial condition and generally does not require collateral. The Company's allowance for doubtful accounts is based on current market conditions and losses on uncollectible accounts have consistently been within management's expectations.\nEarnings per share - Earnings per share amounts are computed by dividing net income available to common shareholders by the weighted average number of common and common equivalent shares outstanding.\nReclassifications - Certain prior year amounts have been reclassified to conform with the 1995 presentation.\n3. ACQUISITIONS\nEffective January 1, 1993, the Company acquired the assets of BancTraining Video Systems (\"BTVS\") in exchange for 135,000 shares of the Company's Common Stock valued at approximately $1,552,500 in a transaction accounted for under the pooling-of-interests method of accounting. BTVS produces and distributes video-based training material for the financial services industry.\nEffective February 1, 1993, the Company acquired certain assets of Executive Communications, Inc. (\"ECI\") in exchange for 40,000 shares of the Company's Common Stock valued at approximately $565,000 plus the assumption of approximately $1,106,000 of liabilities. ECI produces and distributes subscription-based training seminars via satellite and videotape for healthcare professionals. This acquisition was accounted for as a purchase, and accordingly, the net assets and results of operations of ECI are included in the Company's consolidated financial statements commencing February 1, 1993.\nEffective April 8, 1993, the Company acquired certain assets and liabilities of TI-IN Network, Inc. (\"TI-IN\") in exchange for 700,000 shares of the Company's Common Stock valued at approximately $11,025,000 in a transaction accounted for using the pooling-of-interests method of accounting. TI-IN provides live interactive courses via satellite, with two-way communication for students in Grades K through 12. TI-IN also provides in-service training and information for teachers and administrators.\nEffective June 2, 1993, the Company acquired all of the outstanding stock of Industrial Training Systems Corporation (\"ITS\") in exchange for approximately $2,998,000 and the assumption of approximately $531,400 of liabilities. In addition, the Company entered into an obligation for additional purchase price and noncompete agreements totaling approximately $595,000 which is payable through 1995. ITS develops, produces and markets instructional and training video products covering a broad range of occupational health, workplace safety and industry maintenance topics. ITS also provides custom video production and consulting services to satisfy specific training needs of individual companies and organizations. This acquisition was accounted for as a purchase, and accordingly, the net assets and results of operations of ITS are included in the Company's consolidated financial statements commencing June 2, 1993.\nEffective December 1, 1993, the Company acquired the assets of Tel-A-Train, Inc. (\"Tel-A-Train\") in exchange for 60,376 shares of the Company's Common Stock valued at approximately $1,268,000 plus the assumption of approximately $2,978,000 of liabilities. The Company issued an additional 38,069 shares of its Common Stock in payment of approximately $800,000 of these liabilities assumed. Tel-A-Train develops, produces and markets instructional and training video and interactive computer software products covering a broad range of technical, vocational and safety topics throughout the world. This acquisition was accounted for as a purchase, and accordingly,\nWESTCOTT COMMUNICATIONS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1995\nthe net assets and results of operations of Tel-A-Train are included in the Company's consolidated financial statements commencing December 1, 1993.\nEffective March 1, 1994, the Company acquired all of the outstanding stock of Excellence in Training Corporation (\"ETC\") in exchange for 100,000 shares of the Company's Common Stock valued at approximately $2,100,000 and the assumption of approximately $979,000 of liabilities. In addition, the Company entered into an obligation for additional purchase price and noncompete agreements which are payable through 1996. In April 1995, in accordance with the terms of the obligation for additional purchase price, the Company issued 45,045 additional shares of its Common Stock valued at approximately $625,000. ETC distributes instructional and training video products covering a broad range of business, management and human resource topics. ETC also produces and markets its own video products and provides custom video production and training services to satisfy specific training needs of individual companies and organizations. This acquisition was accounted for as a purchase, and accordingly, the net assets and results of operations of ETC are included in the Company's consolidated financial statements commencing March 1, 1994.\nEffective March 1, 1995, the Company acquired all of the outstanding stock of Lockert Jackson & Associates, Inc. (\"Lockert Jackson\") in exchange for a cash payment of $1,500,000 and the assumption of approximately $2,075,000 of liabilities. In addition, the Company made a one-time payment of $500,000 in return for five-year non-competition agreements, and will pay approximately $318,000 of additional purchase price over the next three years. Lockert Jackson is nationally recognized as a producer and distributor of \"Emergency Medical Update\" and \"Safety Watch,\" subscription based emergency medical and safety video training products. This acquisition was accounted for as a purchase, and accordingly, the net assets and results of operations of Lockert Jackson are included in the Company's financial statements commencing March 1, 1995.\nThe following pro forma income statement data reflects the pro forma consolidated results of operations of the Company, BTVS, ECI, ITS, Tel-A-Train, ETC and Lockert Jackson after giving effect to certain purchase related adjustments including amortization of goodwill, elimination of overhead allocation and related income tax effects. This pro forma summary does not necessarily reflect the results of operations as they would have been if the Company, BTVS, ECI, ITS, Tel-A-Train, ETC and Lockert Jackson had constituted a single entity during such period. The pro forma income statement data for the years ended December 31, 1993, 1994 and 1995 are presented as if the purchase acquisitions occurred on January 1 of the year preceding the year of acquisition.\n4. LONG-TERM OBLIGATIONS\nThe Company's long-term obligation at December 31, 1994 and 1995 consists of a note payable bearing interest at 7% and maturing through 1997.\nEffective June 28, 1993, the Company entered into a two-year revolving credit facility with its bank pursuant to which it may borrow up to $18,000,000. After the revolver term expires, outstanding amounts under this facility would be convertible into a four-year term loan. Effective June 28, 1995, this credit facility was extended for one year to\nWESTCOTT COMMUNICATIONS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1995\nJune 28, 1996. The facility provides a sublimit of $1,000,000 for standby letters of credit. A commitment fee of one-half of 1% of the unused credit line and an interest rate of prime, or if lower, an alternate CD rate plus 1 1\/2% will be charged.\nThe credit facility contains various restrictive covenants which, among other things, limit the payment of cash dividends and require the Company to maintain certain financial and tangible net worth ratios. The facility is secured by studio equipment, downlink equipment, other equipment and fixtures, subsidiary stock and accounts receivable. At December 31, 1995, there were no amounts borrowed under this facility.\n5. INCOME TAXES\nSignificant components of the provision for income taxes are as follows:\nThe differences between the statutory and effective tax rates on tax expense are as follows:\nWESTCOTT COMMUNICATIONS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1995\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 for the years ended December 31, 1994 and 1995 are as follows:\nDuring 1993, the Company acquired certain assets and liabilities of TI-IN Network, Inc. and BancTraining Video Systems including deferred tax assets of $3,134,615 and $438,229, respectively. These acquisitions were accounted for using the pooling-of-interests method of accounting, and as a result, the deferred tax assets were recorded through an addition to additional paid-in capital.\nAt December 31, 1995, the Company had a net operating loss carryforward of approximately $2,064,806. The net operating loss carryforward is subject to certain limitations under Section 382 of the Internal Revenue Code, and expires in 2009.\n6. INTEREST IN PARTNERSHIP\nEffective April 1993, the Company entered into a partnership agreement to form Government Services Television Network, L.L.P. (\"GSTN\"). The Company is the sole managing partner of GSTN and holds a 50% interest in the partnership, with the remaining 50% being held by the Public Parties Limited Partnership.\nThe Company believes that its 50% ownership interest in the partnership, coupled with its sole management authority, is sufficient to create a majority interest for purposes of applying SFAS No. 94. Therefore, the Company reports its investment in GSTN under the consolidation method.\nWESTCOTT COMMUNICATIONS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1995\n7. COMMITMENTS\nThe Company negotiated a long-term transponder lease commencing on September 1, 1991 and extending through January 16, 2002 to provide transmission services for ASTN, LETN, HSTN, LTCN and FETN. The terms of this operating lease agreement were renegotiated in 1993 to include services for TI-IN. In addition, occasional-use time is currently available to the Company under this agreement.\nDuring 1994, and in accordance with the terms of the transponder lease agreement, the Company expanded its satellite transponder capacity to provide transmission for IDTN, EXEN and other teleconferences, resulting in an increase in the minimum annual lease payments due under this agreement.\nThe Company is committed to certain operating leases for office and production space as well as satellite transponder capacity. The minimum annual lease payments due under these agreements are as follows:\nLease expense was $6,180,445, $7,125,579 and $7,151,288 for the years ended December 31, 1993, 1994 and 1995, respectively.\nThe Company's subsidiary, TI-IN Acquisition Corp. (\"TI-IN\"), has an agreement through August 1996 with the Texas Education Service Center, Region 20 (\"Region 20\") whereby TI-IN programming is developed using Region 20 teachers and facilities. The courses developed meet the standards established by the Texas Educational Agency. Region 20 secures teachers and develops administrative and instructional support procedures for transmitting of accredited programming by satellite and cable. The Company pays $110,094 monthly for these services, a fee which is renegotiated each September.\nWESTCOTT COMMUNICATIONS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1995\n8. STOCK OPTIONS\/EMPLOYEE STOCK PURCHASE PLAN\nA total of 3,000,000 shares of Common Stock are reserved for issuance under the 1989 Stock Option Plan (the \"Plan\"). All options are granted to officers and key employees of the Company at prices equal to the fair market value of the Company's Common Stock on the date of grant, and expire five years from the date of grant.\nInformation with respect to options granted is as follows:\nOf the 1,445,000 outstanding stock options, 491,250 were exercisable at December 31, 1995. Of the total 3,000,000 shares reserved for issuance under the Plan, 826,506 shares were available for future option grants at December 31, 1995.\nThe Company adopted a Nonemployee Stock Option Plan in January 1990 under which nonemployee directors and other persons rendering critical services to the Company may be granted stock options to purchase Common Stock. A total of 200,000 shares of Common Stock have been reserved for issuance under this plan. A total of 82,000 shares were outstanding at December 31, 1993 at an option exercise price of $2.44 to $12.63 per share. A total of 4,000 shares were granted in 1994 at $14.875 per share. A total of 6,000 shares were exercised in 1994 at $2.44 per share, and no options were cancelled. A total of 4,000 shares were granted in 1995 at $15.00 per share. A total of 16,000 shares were exercised in 1995 at $2.44 per share, and no options were cancelled.\nThe Company has also adopted an Employee Stock Purchase Plan (\"ESPP\") which allows Company employees meeting various service criteria, except certain officers and shareholders, to purchase shares of Common Stock through payroll deductions. A total of 27,696 shares were purchased in 1993 at a price per share of $11.16 to $18.23. A total of 33,572 shares were purchased in 1994 at a price per share of $9.72 to $19.55. During 1995, a total of 24,402 shares were purchased at a price per share of $11.95 to $13.02. At December 31, 1995, a total of 90,390 shares of Common Stock were reserved for future issuance under the ESPP.\nWESTCOTT COMMUNICATIONS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1995\n9. PUBLIC OFFERINGS\nOn May 27, 1993, the Company sold 1,571,500 shares of its Common Stock in an underwritten public offering. The Company received net proceeds from the sale of these shares of approximately $17,545,000 after deducting underwriting discounts, commissions and other offering expenses.\n10. DEFINED CONTRIBUTION PLAN\nIn January 1995, the Company adopted the Westcott Communications 401(k) Employee Savings Plan for the benefit of its employees. This qualified cash or deferred arrangement meets the requirements as set forth in Section 401(k) of the Internal Revenue Code, and as such, provides certain tax benefits to the participating employees.\nAll employees of the Company who are at least 21 years of age and who have worked for the Company for at least six months are eligible to participate in the Plan. Participating employees may contribute from 1% to 15% of their taxable wages as reported on Form W-2. As of December 31, 1995, the Company has made no matching contributions to the Plan on behalf of its employees. For the fiscal year ended December 31, 1995, the Company incurred approximately $4,000 in fees for administration of the Plan.\n11. RELATED PARTY TRANSACTIONS\nThe Company's Board of Directors includes two members of management of Electronic Data Systems Corporation (\"EDS\"). EDS is a subscriber to both the ASTN and EXEN networks. EDS paid the Company $5,393,926, $5,774,974 and $5,253,352 for subscription fees to ASTN in 1993, 1994 and 1995, respectively. During 1995, the Company received $296,717 for participation fees to EXEN.\nIn September 1992, the Company and EDS participated in a public offering in which EDS sold 2,304,500 shares and the Company sold 2,000,000 shares of Common Stock of the Company. In addition to the public offering, the Company and EDS entered into an Exchange Agreement whereby EDS exchanged its remaining 1,703,392 shares of Common Stock for 116,427 shares of a new series of Preferred Stock of the Company. This cumulative redeemable Preferred Stock had an aggregate initial liquidation value of $11,642,684 equal to the per share net proceeds of Common Stock received by the Company and EDS pursuant to the public offering, times the number of shares of Common Stock exchanged by EDS. This cumulative redeemable Preferred Stock had a dividend rate of 5 1\/2% per annum and was neither convertible nor mandatorily redeemable. This Preferred Stock had aggregate voting power equal to the 1,703,392 shares of Common Stock exchanged for the Preferred Stock. At January 1, 1993, the per share redemption value of the Preferred Stock was $100.50.\nEffective March 31, 1993, the Company entered into an agreement with EDS in which the Company acquired all of the outstanding shares of its Preferred Stock held by EDS. In payment for the Preferred Stock, the Company issued a promissory note to EDS in the principal amount of $8,190,640 payable within 180 days. Interest on the note accrued at the rate of 5 1\/2% per annum. The note was, at the Company's option, to be satisfied either in cash or by delivering shares of the Company's Common Stock which would be sufficient to pay the principal plus accrued interest at the date of delivery of the shares. On June 10, 1993, the Company paid cash in the amount of $8,278,235 in full satisfaction of the note and the accrued interest thereon.\nThe Company periodically leases a jet aircraft from a corporation wholly owned by its founder and Chief Executive Officer on terms the Company believes to be no less favorable to the Company than can be obtained for such service\nWESTCOTT COMMUNICATIONS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1995\nfrom unaffiliated parties. The Company paid $450,986, $283,591 and $149,783 in 1993, 1994, and 1995, respectively, for use of the jet aircraft and other related services.\n12. SUBSEQUENT EVENTS\nOn January 9, 1996, the Board of Directors of the Company declared a dividend of one preferred share purchase right (\"Right\") for each outstanding share of the Company's Common Stock. The dividend was payable to shareholders of record as of the close of business on January 22, 1996. Each Right entitles the registered holder to purchase one one-hundredth of a share of the Company's Series A Junior Participating Preferred Stock, par value $0.01 per share, at a price of $80.00 per one one-hundredth of a share of Preferred Stock, subject to adjustment. The Rights will be exercisable only if a person or group of persons acquires beneficial ownership of 20% or more of the Company's Common Stock or commences a tender or exchange offer upon consummation of which such person or group would beneficially own 20% or more of the Company's Common Stock. The Rights will expire on January 9, 2006. The Company will generally be entitled to redeem the Rights at $.01 per Right at any time until a 20% position has been acquired. The description and terms of the Rights are set forth in a Rights Agreement dated as of January 9, 1996, as the same may be amended from time to time, between the Company and KeyCorp Shareholder Services, Inc., as Rights Agent.\nWESTCOTT COMMUNICATIONS, INC.\nSELECTED QUARTERLY INFORMATION (UNAUDITED) (In thousands, except per share amounts)\nSCHEDULE II\nWESTCOTT COMMUNICATIONS, INC.\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995\nAmounts have been rounded to the nearest thousand.\nCONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS\nWe consent to the incorporation by reference in the Registration Statement (Form S-8 No. 33-31548) pertaining to the Westcott Communications, Inc. 1986 Stock Option Plan and the Westcott Communications, Inc. 1989 Stock Option Plan, the Registration Statement (Form S-8 No. 33-31549) pertaining to the Westcott Communications, Inc. Employee Stock Purchase Plan, the Registration Statement (Form S-8 No. 33-36395) pertaining to the Westcott Communications, Inc. Nonemployee Stock Option Plan, the \"shelf\" Registration Statement (Form S-3 No. 33-72672) of Westcott Communications, Inc. and the related Prospectus, and the Post-Effective Amendment to the \"shelf\" Registration Statement (Form S-3 No. 33- 62922) of Westcott Communications, Inc. and the related Prospectus, of our report dated February 16, 1996, with respect to the consolidated financial statements and schedule of Westcott Communications, Inc. included in the Annual Report (Form 10-K) for the year ended December 31, 1995.\nERNST & YOUNG LLP\nDallas, Texas March 25, 1996\nINDEX TO EXHIBITS\n10.4 Westcott Communications, Inc. Employee Stock Purchase Plan effective January 1, 1990.\/(1)\/\n10.5 Amendment No. 1 to the Westcott Communications, Inc. Employee Stock Purchase Plan.\/(14)\/\n10.6 Amendment No. 2 to the Westcott Communications, Inc. Employee Stock Purchase Plan.\/(14)\/\n10.7 Amendment No. 3 to the Westcott Communications, Inc. Employee Stock Purchase Plan.\/(14)\/\n10.8 Amendment No. 4 to the Westcott Communications, Inc. Employee Stock Purchase Plan.\/(14)\/\n10.9 1989 Stock Option Plan of Westcott Communications, Inc.\/(2)\/\n10.10 Amendment No. 1 to 1989 Stock Option Plan of Westcott Communications, Inc.\/(2)\/\n10.11 Amendment No. 2 to 1989 Stock Option Plan of Westcott Communications, Inc.\/(8)\/\n10.12 Amendment No. 3 to 1989 Stock Option Plan of Westcott Communications, Inc.\/(14)\/\n10.13 Amendment No. 4 to 1989 Stock Option Plan of Westcott Communications, Inc.\/(14)\/\n10.14 Amendment No. 5 to 1989 Stock Option Plan of Westcott Communications, Inc.\/(14)\/\n10.15 Amendment No. 6 to 1989 Stock Option Plan of Westcott Communications, Inc.\/(14)\/\n10.16 Amendment No. 7 to 1989 Stock Option Plan of Westcott Communications, Inc.\/(14)\/\n10.17 Westcott Communications, Inc. Nonemployee Stock Option Plan.\/(2)\/\n10.18 Amendment No. 1 to the Westcott Communications, Inc. Nonemployee Option Plan.\/(14)\/\n10.19 Amendment No. 2 to the Westcott Communications, Inc. Nonemployee Option Plan.\/(14)\/\n10.20 Transponder Lease Agreement dated as of May 1, 1991 scheduled to expire October 1, 1999 between the Company and Hughes Communications Galaxy, Inc.\/(8)\/\n10.21 Amended Transponder Lease Agreement dated as of February 24, 1993.\/(9)\/\n10.22 Amended Transponder Lease Agreement dated as of April 23, 1993 (confidential treatment has been requested with respect to certain financial terms of this agreement).\/(14)\/\n10.23 Amended and Restated Network Agreement dated as of May 31, 1991 between the Company and Chrysler Corporation.\/(9)\/\n10.24 Extension of Amended and Restated Network Agreement dated as of May 23, 1994 between the Company and Chrysler Corporation.*\n10.25 Lease Agreement dated as of January 13, 1992, between ICF Leasing Corporation, Inc. and Health & Sciences Network, Inc.\/(5)\/\n10.26 Non-Competition Agreement dated as of June 26, 1992, between Lawrence A. Darby and the Company.\/(8)\/\n10.27 Employment and Consulting Agreement dated as of June 26, 1992, between Lawrence A. Darby and the Company.\/(8)\/\n10.28 Employment and Settlement Agreement dated as of December 1, 1994 between the Company and Mr. William E. Smith.*\n10.29 Services Agreement dated December 17, 1992 between the Company and American Hospital Association.\/(9)\/\n10.30 Non-Competition Agreement dated as of February, 1993 between William H. Fueller and the Company.\/(14)\/\n10.31 Promissory Note dated as of April 1, 1993.\/(14)\/\n10.32 Second Amended and Restated Credit Agreement dated June 28, 1993 between the Company and Texas Commerce Bank, National Association.\/(11)\/\n11 Computation of Earnings Per Share.*\n22 Subsidiaries of the Company.*\n23.1 Consent of Ernst & Young LLP, Independent Auditors.*\n_________________\n* Exhibit filed herewith.\n\/(1)\/ Incorporated by reference from Registration Statement No. 33-28902 of the Company filed with the Securities and Exchange Commission.\n\/(2)\/ Incorporated by reference from the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 filed with the Securities and Exchange Commission.\n\/(3)\/ Incorporated by reference from the Company's Current Report on Form 8-K dated December 21, 1990 filed with the Securities and Exchange Commission.\n\/(4)\/ Incorporated by reference from the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990 filed with the Securities and Exchange Commission.\n\/(5)\/ Incorporated by reference to the corresponding exhibit to the Company's Current Report on Form 8-K dated February 5, 1992 filed with the Securities and Exchange Commission.\n\/(6)\/ Incorporated by reference from the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991 filed with the Securities and Exchange Commission.\n\/(7)\/ Incorporated by reference from the Company's Current Report on Form 8-K dated July 7, 1992, and filed with the Securities and Exchange Commission.\n\/(8)\/ Incorporated by reference from Registration Statement No. 33-50740 of the Company filed with the Securities and Exchange Commission.\n\/(9)\/ Incorporated by reference from the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1992 filed with the Securities and Exchange Commission\n\/(10)\/ Incorporated by reference from the Company's Current Report on Form 8-K dated April 19, 1993, and filed with the Securities and Exchange Commission.\n\/(11)\/ Incorporated by reference from the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 1993 filed with the Securities and Exchange Commission.\n\/(12)\/ Incorporated by reference from the Company's Current Report on Form 8-K dated January 12, 1994, and filed with the Securities and Exchange Commission.\n\/(13)\/ Incorporated by reference from the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 1994 filed with the Securities and Exchange Commission.\n\/(14)\/ Incorporated by reference from the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993 filed with the Securities and Exchange Commission.","section_15":""}
{"filename":"39743_1995.txt","cik":"39743","year":"1995","section_1":"ITEM 1. BUSINESS\nThe company was originally organized under the laws of Delaware, incorporated October 26,1970 as Halcyon Data Management Group, Inc. The Company had a public offering dated September 27, 1971.\nThe company name was changed to Quest International Equities, Inc. in 1974. The company merged with Era Oil Company, Inc. on December 16, 1983. The company also acquired Astrotek, Inc. during the same year. On November 27, 1990 the company name was changed to Agri-Quest Mining, Inc. On September 1, 1994 the company had a 100 to 1 reverse stock spilt. The company then merged with New Century Media, Ltd., a Nevada Corporation, who became the surviving entity in the merger. On February 17, 1995 the company entered into plan of reorganization to acquire the assets, business and capital stock of LBU, Inc. The plan was consummated on March 24, 1995 and the company changed its name to LBU, Inc. On August 7, 1995, the company had a 20 to 1 reverse spilt of its common stock; From inception to March 24, 1995, the company was involved in several business ventures which were not successful. The company had been dormant for periods of time and was dormant just prior to the acquisition of LBU, Inc.\nLBU, Inc. and its management had no relationship with any of the predecessor companies prior to its acquisition on March 24, 1995. At the present time, there are no members of management nor any directors of LBU, Inc. that have had any affiliation with any of the predecessor companies.\nGeneral. LBU, Inc. (the company) is a leading manufacturer of over ------- 300 styles of custom made fashionable and wearable bags. The company designs, manufactures, and distributes these high quality products to the retail, industrial, accessory and the promotional markets. LBU's largest area is the promotional\/premium markets where the company's extensive line of custom bags are purchased by consumer product and service companies, seeking to increase sales, and brand awareness.\nStrategy. The company business strategy is to continue to expand its --------- market share and increase sales in all divisions the company operates.\nThe major strengths or the company is its ability to take a corporation's image or their ideas and fully execute from design to finish a personalized, custom made promotional product program that will help increase their market share, brand awareness, customer loyalty and sales.\nThe company's full in house design, cutting, printing and sample making departments help set the company apart from its competitors who may rely on Asian or other overseas factories.\nThe company has the capability of providing a client within 48 hours a custom promotional product line. This gives the company a distinct competitive advantage since the average lead time in the industry for custom samples alone can take 2 - 6 weeks.\nEXPANSION - NEW MARKETS - -----------------------\nRETAIL. The creation of a new product line including Ironing Board ------ Cover and Pad Sets and its full laundry care program is in the works. This extensive new line will play a major role in the company's retail division. The company provides retailers such as Bed Bath and Beyond, Burlington Coat Factory, K-Mart Stores, Kroger, Nordstroms, Neiman Marcus, Rite Aid and Lechters with numerous products, such as water bottle bags, backpacks and laundry bags.\nACCESSORY. The accessory market consists of high end wearable Back --------- Packs, Totes, Gear Bags, Cosmetic Pouches, Water Bottle Holders, and many other stylish products. The products designed for this market are made from the latest fashionable materials and fabrics. These new high end products are a growing market for the company.\nINDUSTRIAL. The industrial division consists of heavy duty custom ---------- made bags for various OEM, industrial, and government applications. The company relies on extensive advertising through the Thomas Register, Industrial buying guides and trade shows to increase market share.\nPROMOTIONAL AND PRIVATE LABEL. The promotional and private label ----------------------------- markets should continue to account for a large percentage of the companies revenues. This market, into which the company has recently entered, accounts for approximately 50% if its business. Private label customers include Tommy Hilfiger, Jantzen Swimwear, Speedo, Mondi, Dockers and many others. Promotional customers include American Express, AT&T, Coca-Cola Dean Witter, Hitachi, Pepsi- Cola, Philips, General Electric, Ford Motor Company and the New York Yankees. Additionally, the company has license agreements with many colleges and universities throughout the United States.\nSALES AND MARKETING. The company sales originate through its in-house ------------------- salesmen, outside sales representatives, distributors, catalogs and trade shows. In addition the Company has developed its relationships with the Ad Specialty Market, which consists of over 6,000 independent distributors. All manufacturing is done in the United States.\nEMPLOYEES. The company employs 30 people at their headquarters and --------- manufacturing facility in Carlstadt, NJ\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe company leases 30,000 square feet, located at 310 Paterson Plank Road, Carlstadt, NJ. The executive offices, printing and part of the manufacturing facility are at this location.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nOn April 17, 1996 the registered agent of the Company was served with a complaint arising from the financial services contract entered into by the company on July, 24, 1995. The lawsuit was filed in the Eighth District Court, Las Vegas, Nevada. The plaintiff's are Glenneyre Capital Corporation, Pominandres Financial Corporation and HJS Financial Services, Inc. The suit alleges the Company committed breach of contract, and other causes of action against the plaintiffs in connection with the financial services contract and the securities issued the plaintiffs pursuant thereto. The Company believes the action it has taken is appropriate under the circumstances and intends to vigorously defend itself in the lawsuit. The initial complaint has been answered by the Company denying all allegations of any wrong doing.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE TO SECURITY HOLDERS\nNo matters were submitted to a vote of the company's shareholders during the fourth quarter of the fiscal year ending December 31, 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS.\nThe company has a single class of stock outstanding. It is designated as voting common stock with each share issued having a single vote. The company is authorized 50,000,000 shares at .001 par value shares. Issued and outstanding at December 31, 1995 are 1,310,834 shares.\nThe company has never declared a cash dividend on its common stock. It is not anticipated the company will declare a dividend in the foreseeable future.\nThe companies common stock is listed on the electronic bulletin board under the symbol LBUAA. Prior to the acquisition of LBU, Inc. on March 24, 1995, there was no quoted market for the company's stock. Subsequent to March 24, 1995 the common stock fluctuated from a low bid of $ .0938 to a high bid of $4.37 during 1995.\nAt December 31, 1995, the company had 1,310,834 shares of common stock outstanding. There were approximately 300 shareholders at December 31, 1995. During the fourth quarter, the company sold 83,334 shares if its voting common stock to investors for $125,000. In addition the company has disputed the proprietary of the issuance of certain shares under a financial consulting contract. Please refer to Part 1, Item 3, Legal Proceedings of this report for more detail.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe company acquired LBU, Inc. during the fiscal year. Prior to this combination, the aquiring company had been dormant for approximately two years, therefore its financial history is not relevant. LBU, Inc. (a Delaware Corporation) has conducted business since 1989 and their it's financial data for 1993 and 1994 are presented here for comparative purposes only.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe company was dormant for approximately two years prior to March 24, 1995 when it underwent a reorganization with LBU, Inc. through a reverse acquisition. The financial transactions for 1995 are applicable and presented as if the business combination occurred on January 1, 1995. Any comparative data for prior years is based on the activities of LBU, Inc. before the business combination occurred.\nThe company has a 41% increase in sales in 1995 over 1994 levels. The customized specialty promotional\/premium segment continues to account for and increasing percentage of sales.\nThe company manufactures its own product line under the LBU, Inc. label. It also manufactures a variety of customized bags which carry the brand name or corporate logo of the client wishing to increase its product or company awareness.\nThe company generates sales throughout the U.S. and abroad through outside sales reps and in house sales associates. The company exhibits its products at many leading trade shows throughout the U.S. and abroad.\nDuring 1995, the company moved its headquarters and manufacturing facilities to a 30,000 square foot complex in Carlstadt, New Jersey. This was necessary to meet the increased sales and production capacity as well as the future sales growth of the company.\nThe company factors its receivable to the CIT Group. The Company borrows against its receivables at a rate of 2% above the prime lending rate. Interest expense increased 86% from $29,742 in 1994 to $54,578 in 1995. This is due to the Company's increase in borrowings against factored receivables.\nLIQUIDITY AND CAPITAL RESOURCES\nThe sales growth, profits and its borrowing capacity has been hindered due to the current level of capital resources available in the Company. Until additional capital is invested in the Company, it will continue to incur high interest expense and large fluctuations in its liquidity. Company management is investigating various alternatives in attracting capital for the Company.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe audited financial statements of the company as of December 31, 1995 and the year then ended are attached to this report as Exhibit A and are incorporated herein by reference.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThe company changed auditors for the fiscal year ended December 31, 1995. This change was not due to any disagreement over accounting or financial disclosure.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY\nJeffrey Mayer is the founder of LBU, Inc. Formerly in various sales and marketing positions with Coca Cola and other companies. Mr. Mayer is responsible for the sales and marketing of the Company.\nFred King has been in a sales capacity with LBU, Inc. since 1994. He has experience in owning and operating retail establishments in the New York area. Mr. King is currently Director of Sales.\nMr. Robert Alpers resigned as a Director of the company during the fourth quarter of the year. His resignation was not due to any disagreement with the management of the company. Mr. Robert Alpers is currently National Sales Manager.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nJeffrey Mayer, President, is currently the sole corporate officer. Mr. Mayer devotes full time to the company and was compensated $100,000 during the year ended December 31, 1995.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following is a schedule of ownership of the company's common stock by officers, directors and holders of more then 5% of the issued and outstanding shares at December 31, 1995.\nOFFICERS AND DIRECTORS\nNAME POSITION SHARES % Jeffrey Mayer President\/Director 676,500 51.6 All Officers and Directors 676,500 51.6\nOTHER HOLDERS OF 5% OR MORE OF COMMON STOCK\nNAME SHARES % HJS Financial Services Inc. Glenneyre Equity Group, Ltd. Poimandres Financial Corporation 219 Broadway Suite 261 Laguna Beach, CA 92651 300,000 22.8\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 8K\nREPORTS ON FORM 8K\nMarch 24, 1996-Incorporated herein by reference\nAugust 8, 1996-Incorporated herein by reference\nFINANCIAL STATEMENTS AND SCHEDULES\nEXHIBIT\nReport of Independent Certified Public Accountants Balance Sheet, December 31, 1995 Statement of Income For the Year Ended December 31, 1995 the Year Ended December 31, 1995 Statement of changes in Stockholders' Equity For December 31, 1995 Statement of Cash Flows For the Year Ended Notes to the Financial Statements, December 31,\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the individual capacities and on the date indicated.\nDate_______________________\nLBU, Inc. (A Nevada Corporation)\nby\n_________________________ _______________________ Jeffrey Mayer Fred King President\/Director Director\nLBU, INC.\n(formerly NEW CENTURY MEDIA, LTD.)\nFINANCIAL STATEMENTS\n* * * *\nDECEMBER 31, 1995\n[LETTER OF NEIL DELLA TORRE & COMPANY APPEARS HERE]\nJuly 18, 1996\nTo The Board of Directors of LBU, Inc.\nIndependent Auditor's Report ----------------------------\nWe have audited the balance sheet of LBU, Inc., (a Nevada corporation) (formerly New Century Media, Ltd.) as of December 31, 1995, and the related statements of income, changes in stockholders' equity and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the 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 LBU, Inc., as of December 31, 1995, and the results of its operations, changes in stockholders' equity and cash flows for the years then ended in conformity with generally accepted accounting principles.\n\/s\/ Neil Della Tore & Company\nLBU, Inc. --------- (formerly New Century Media, Ltd.) ---------------------------------- Balance Sheet ------------- December 31, 1995 -----------------\nAssets ------\nLiabilities and Stockholders' Equity ------------------------------------\nThe accompanying notes are an integral part of these financial statements\n- 2 -\nLBU, Inc. --------- (formerly New Century Media, Ltd.) ---------------------------------- Statement of Income ------------------- For the year ending December 31, 1995 -------------------------------------\nThe accompanying notes are an integral part of these financial statements\n- 3 -\nLBU, Inc. --------- (formerly New Century Media, Ltd.) ---------------------------------- Statement of Changes in Stockholders' Equity -------------------------------------------- For the year ended December 31, 1995 ------------------------------------\nThe accompanying notes are an integral part of these financial statements\n- 4 -\nLBU, Inc. --------- (formerly New Century Media, Ltd.) ---------------------------------- Statement of Cash Flows ----------------------- For the year ending December 31, 1995 -------------------------------------\nSchedule of non-cash financing activities\nThe Company issued 300,000 shares of common stock valued at $540,000 for financial services. The financial services fees were charged to Additional Paid in Capital.\nIn connection with the recapitalization pursuant to a plan of reorganization 200,000 shares of common stock, with a net value of $157,647, were issued to acquire LBU, Inc.-Delaware in February 1995.\nThe accompanying notes are an integral part of these financial statements\n- 5 -\nLBU, Inc. --------- (formerly New Century Media, Ltd.) ---------------------------------- Notes to the Financial Statements --------------------------------- December 31, 1995 -----------------\nNote 1 - Organization And Significant Accounting Policies - ---------------------------------------------------------\nOrganization: LBU, Inc. (a Nevada corporation) (the \"Company\") previously known - ------------- as New Century Media Ltd. is a manufacturing marketing operation that specializes in the creation of innovative, fun and fashionable utility and wearable bags for the accessory industry, retail and promotional markets.\nIn February 1995, the Company entered into a plan of reorganization with LBU, Inc. (a Delaware corporation) (LBU-Delaware) whereby the shareholders of LBU- Delaware would obtain controlling interest of New Century Media, Ltd., in a transaction accounted for as a reverse acquisition. New Century Media, Ltd. ultimately changed its name to LBU, Inc. on March 31, 1995.\nInventories: Inventories are valued at the lower of cost or market, with cost - ------------ being determined by the first-in, first-out (FIFO) method.\nFixed Assets: Property and equipment are stated at cost. Depreciation of - ------------- furniture, fixtures and equipment is provided using the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized over the term of the lease on straight-line basis.\nCash and Cash Equivalents: For purposes of the statement 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.\nIncome Taxes: Income taxes are provided for the tax effects of transactions - ------------- reported in the financial statements and consist of taxes currently due plus deferred taxes related primarily to differences between the accelerated depreciation methods, the reserve method for bad debt and the uniform capitalization rules under IRS Code Section 263A for financial and income tax reporting. The deferred taxes represent the future tax return consequences of those differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled. Effective March 31, 1995, LBU- Delaware became a taxable entity due to the successful reorganization. Previously, its earnings and losses were included in the personal tax returns of the stockholders, and the Company did not record an income tax provision.\nEstimates: 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 period. Actual results could differ from those estimates.\nStockholders Equity: In August 1995, the Company declared a 20 for 1 reverse - -------------------- stock split on the then issued and outstanding common shares. All outstanding share amounts included in the accompanying financial statements have been retroactively adjusted to reflect the 20 for 1 reverse stock split. The result of this action reduced the previous 24,550,000 shares of common stock to 1,227,500 shares.\nIn July 1995, the Company entered into a financial services agreement with Glenneyre Capital Corp. (GCC), Poimandres Financial Corp. (PFC) and Bristol Media, Ltd. (BML) (a group of financial consultants). The agreement required GCC, PFC and BML to provide certain professional services relating to raising of capital to the Company in exchange for 300,000 shares of the Company's common stock. The agreement specified that such services were assigned a value of $60,000. However, the Company has recorded the issuance of the 300,000 shares based upon the then market value of its common stock, $540,000, resulting in a charge to additional paid in capital for the current period.\n- 6 -\nLBU, Inc. --------- (formerly New Century Media, Ltd.) ---------------------------------- Notes to the Financial Statements --------------------------------- December 31, 1995 -----------------\nNote 2 - Accounts Receivable And Factoring Arrangements - -------------------------------------------------------\nThe Company entered into a factoring arrangement with a factor whereby the factor will make advances to the Company on approved accounts receivable balances. Interest of 2% per annum above the prime rate will be charged on outstanding advances. The factor has a lien against all assigned receivables. In addition, the Company's president\/principal shareholder and his wife, who is also an officer of the Company, have personally guaranteed factor advances under this agreement.\nThe factor will also charge a commission of 1 1\/8% on the gross face amount of all accounts factored during each calendar month. The minimum commission on each invoice is $5.00. Further, a fee will be charged for each new customer, for any customer that has not had any activity with the factor for at least 18 months and other miscellaneous activity.\nIncluded in cash for the year ended December 31, 1995 is $42,350 in an interest bearing cash account held as additional collateral by the factor.\nThe components of accounts receivable are summarized as follows:\nNote 3 - Inventories - --------------------\nAs of December 31, inventories were as follows:\nNote 4 - Equipment And Leasehold Improvements - ---------------------------------------------\nEquipment and leasehold improvements are summarized as follows:\n- 7 -\nLBU, Inc. --------- (formerly New Century Media, Ltd.) ---------------------------------- Notes to the Financial Statements --------------------------------- December 31, 1995 -----------------\nNote 5 - Related Party Transactions - -----------------------------------\nDuring 1995, loans in the amount of $55,000 were repaid to related parties plus interest of approximately $6,500.\nNote 6 - Income Taxes - ---------------------\nThe provision for income taxes consists of the following components:\nAs discussed in Note 1, LBU-Delaware changed its tax status from nontaxable to taxable effective March 31, 1995. Accordingly, the deferred tax asset at the date that the termination election was filed of approximately $10,000 has been recorded through a credit to the deferred tax provision.\nNote 7 - Commitments and Contingencies - --------------------------------------\nIn August, 1993, LBU-Delaware entered into employment agreements with the president\/principal shareholder and his wife, who is also an officer of the Company. These agreements provide for payments of approximately $148,999 per year, and escalates periodically to approximately $163,000 per year, and run through 1996.\nThe Company entered into a ten year lease agreement for its new facilities in Carlstadt, New Jersey. The rent commencement date is July 1, 1995. At that time, the Company incurred incidental non-recurring costs due to the relocation of approximately $200,000. Rent paid during the year ended December 31, 1995 amounted to $99,105. The minimum future rental payments under the non- cancelable operating leases as of December 31, 1995 are:\nThe Company is currently involved in a dispute with Glenneyre Capital Corporation, Poimandres Financial Corporation and HJS Financial Services, Inc. (\"the Plaintiffs\"). The lawsuit stems from a financial service agreement dated July 24, 1995, between the plaintiff's and LBU, Inc.\n- 8 -\nLBU, Inc. --------- (formerly New Century Media, Inc.) ---------------------------------- Notes to the Financial Statements --------------------------------- December 31, 1995 -----------------\nNote 7 - Commitments and Contingencies (continued) - --------------------------------------------------\n300,000 shares of LBU, Inc's. restricted common stock were issued to the Plaintiffs in return for services in connection with the raising of capital. Currently, the restrictions on these shares are in dispute in addition to the actual services which LBU, Inc. claims were not performed. The shares were stopped by LBU, Inc. on November 19, 1995.\nAlthough legal counsel is unable to evaluate the likelihood of an unfavorable outcome or an estimate of the potential loss, the plaintiffs are requesting in excess of $10,000 for complaint damages, $60,000 in punitive damages determined by the fair market of their services at the time of the service agreement and an undeterminable amount of punitive damages.\nWith respect to the $60,000 claim for services to raise capital, such transaction would have no net effect on the Company's book equity.\nManagement believes these charges are without merit and that the outcome of the claim will not have a material impact on the Company's financial position. Nevertheless, due to uncertainties in the settlement process, it is at least reasonably possible that management's view of the outcome will change in the near term.\n- 9 -","section_15":""}
{"filename":"31224_1995.txt","cik":"31224","year":"1995","section_1":"Item 1. BUSINESS . . . . . .. . . . . . . . . . . . . . . . . .1 System Overview. . . . . . . . . . . . . . . . . . . . . . . .1 General - Core Electric Business . . . . . . . . . . . . . . .1 Electric Utility Industry Restructuring . . . . . . . . .4 General - EUA Cogenex. . . . . . . . . . . . . . . . . . . . .6 Construction . . . . . . . . . . . . . . . . . . . . . . . . .9 Construction Program - EUA. . . . . . . . . . . . . . . .9 Construction Program - Blackstone . . . . . . . . . . . 10 Construction Program - Eastern Edison . . . . . . . . . 10 Fuel for Generation. . . . . . . . . . . . . . . . . . . . . 10\nNuclear Power Issues . . . . . . . . . . . . . . . . . . . 13 General . . . . . . . . . . . . . . . . . . . . . . . 13 Decommissioning . . . . . . . . . . . . . . . . . . . . 14 Yankee Atomic . . . . . . . . . . . . . . . . . . . . . 14 Maine Yankee . . . . . . . . . . . . . . . . . . . . . 15 Recent NRC Actions . . . . . . . . . . . . . . . . . . 15\nPublic Utility Regulation. . . . . . . . . . . . . . . . . . 15\nRates . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 FERC Proceedings. . . . . . . . . . . . . . . . . . . . 18 Massachusetts Proceedings . . . . . . . . . . . . . . . 19 Rhode Island Proceedings. . . . . . . . . . . . . . . . 21\nEnvironmental Regulation . . . . . . . . . . . . . . . . . . 23 General . . . . . . . . . . . . . . . . . . . . . . . . 23 Electric and Magnetic Fields. . . . . . . . . . . . . . 24 Water Regulation. . . . . . . . . . . . . . . . . . . . 24 Air Regulation. . . . . . . . . . . . . . . . . . . . . 25\nEnvironmental Regulation of Nuclear Power. . . . . . . . . . 27\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nPower Supply\nMontaup supplies the EUA System with nearly 100% of its electric requirements. Newport became an all-requirements customer of Montaup on May 21, 1994. At the same time, Montaup assumed all of Newport's power contracts and began leasing all of Newport's generation facilities and a portion of Newport's transmission facilities. In 1995, the EUA System's wholly owned generating units referred to in the following table consisted of Montaup's jet- fueled peaking units (Somerset Jet 1 and Jet 2) and Somerset 6 which was converted from oil to coal burning in 1983, Blackstone's Pawtucket Hydro, which was repowered in 1985 and Newport's diesel peaking units (Jepson in Jamestown and Eldred in Portsmouth) which supply the EUA System with 8 MW and 8.25 MW, respectively. With the exception of Somerset's Jet 1 and Jet 2, Montaup has not significantly increased its wholly owned generating units since 1959. The EUA System has found it more economically beneficial to join with other utilities in the joint ownership of large generating units and in long-term purchase contracts, and to supplement these sources with short-term purchases as required. EUA believes that spreading the EUA System's sources of electricity among a number of plants should improve the reliability of its power supply and limit the financial exposure relating to construction and potentially prolonged outages of a generating unit. Current forecasts indicate that the combination of company owned generation, current long-term purchased power contracts, expected short-term power opportunities, and the System's C&LM programs, should meet EUA System capacity requirements through the year 2000.\nMontaup recovered approximately $12.8 million through rates in 1995 for its C&LM programs. C&LM is designed to (i) decrease existing energy demand and (ii) offset future load growth through conservation incentives, thereby minimizing future need for large capital investment in generating facilities.\nThe all-time peak EUA System demand was approximately 931 MW experienced on July 27, 1995.\nMontaup's participation in generating units of which it is not the sole owner takes various forms including stock (equity) ownership, joint ownership and purchase contracts. In most cases (other than short-term purchased power contracts) the purchaser is required to pay its share (i.e., the same percentage as the percentage of its entitlement to the output) of all of the costs of the generating unit (whether or not the unit is operating) including fixed costs, operating costs, costs of additional construction or modification, costs associated with condemnation, shutdown, retirement, or decommissioning of the unit, and certain transmission charges. Under its contracts with Maine Yankee, Connecticut Yankee Atomic Power Company, Vermont Yankee Nuclear Power Corporation and Yankee Atomic and, under its agreements relating to Phase II of the interconnection with Hydro-Quebec, Montaup may be called upon to provide additional capital and\/or other types of direct or indirect financial support. (See Item 1. BUSINESS -- Nuclear Power Issues \"Yankee Atomic\" and \"Maine Yankee.\")\nOther Property\nThe EUA System owns approximately 4,600 miles of transmission and distribution lines and approximately 85 substations located in the cities and towns served.\nBlackstone owns approximately 1,000 miles of transmission and distribution lines and approximately 23 substations located in the cities and towns served. Blackstone also owns 100% of a 1.2-MW hydroelectric generating plant located in Pawtucket, Rhode Island. See Note E of Notes to Financial Statements in Blackstone's 1995 Annual Report (Exhibit 13-1.01 filed herewith) regarding encumbrances.\nEastern Edison and Montaup own approximately 3,200 miles of transmission and distribution lines and approximately 48 substations located in the cities and towns served. See Note F of Notes to Consolidated Financial Statements in Eastern Edison's 1995 Annual Report (Exhibit 13-1.08 filed herewith) regarding encumbrances.\nIn addition to the above, the Retail Subsidiaries, Montaup, and EUA Service also own several buildings which house distribution, maintenance or general office personnel. See Note E of Notes to Consolidated Financial Statements contained in EUA's Annual Report to Shareholders for the year ended December 31, 1995, (Exhibit 13-1.03 filed herewith) regarding encumbrances.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nRate Proceeding\nSee descriptions of proceedings under Item 1, BUSINESS -- Rates.\nEnvironmental Proceedings\n1. In March 1985, Blackstone was notified by the DEQE, which is now the DEP, that it had been identified, along with other parties, as a potentially responsible party under Massachusetts law for a condition of soil and ground water contamination in Lowell, Massachusetts. The site in question was occupied by a scrap metal reclamation facility which received transformers and other electrical equipment from utility companies and others from the early 1960s until 1984. Among the contaminants apparently released at the site were PCBs. The potentially responsible parties (PRPs), including Blackstone, performed site studies and proposed a remedial action plan, which was approved by the DEQE several years ago. Since that time, the PRPs have negotiated over access, taxes and similar issues with the site owner and other parties. The remedial option selected but not yet completed is a process of solidification; however, a risk assessment that may now be required could lead the PRPs to choose capping as the remedial option. The cost of implementing either remedy could vary from $250,000 for capping to $600,000 for solidification. Blackstone is alleged to be the fifth ranked generator out of approximately twenty potentially responsible parties. However, Blackstone's estimated 2% share allocation is considerably less than the shares of the four largest contributors at the site. As a result, Blackstone expects to be offered a de minimis party buyout settlement from the major members of the site PRPs in the near future.\n2. On July 14, 1987, the Commonwealth of Massachusetts (the Commonwealth) on behalf of the DEP filed a cost recovery action pursuant to CERCLA and Mass. Gen. Laws Chapter 21E against Blackstone in the United States District Court for the District of Massachusetts (District Court). The Complaint seeks $2.2 million in costs incurred by DEP in the cleanup of an alleged coal gasification waste site at Mendon Road in Attleboro, Massachusetts. In October 1987, without admitting liability, Blackstone entered into an administrative Consent Order with DEP regarding the Mendon Road site and another alleged coal gasification site discovered by the DEP approximately 1\/4 mile away known as the Lawn\/Knoll site in Attleboro. Blackstone agreed to perform preliminary assessments at both sites in order to determine what remediation, if any, was necessary at the site. In 1988, Blackstone submitted Phase II testing results for the Lawn\/Knoll site to the DEP for review and approval, but Blackstone has not received a response or DEP authorization to proceed with further studies or remedial action. On May 26, 1993, the DEP requested Blackstone to submit additional Phase I testing for the Mendon Road site which was completed and sent to the DEP on December 20, 1993. Meanwhile, Blackstone has contested the DEP's cost recovery action, arguing, inter alia, that the waste removed from the Mendon Road site, ferric ferrocyanide (FFC), was not \"hazardous\" within the meaning of CERCLA or Mass. Gen. Laws Chapter 21E and the DEP's cleanup actions were inconsistent with the National Contingency Plan (NCP). On November 25, 1991, the District Court held that the waste was \"hazardous\" within the meaning of both statutes and on December 20, 1992, the District Court held Blackstone and a co-defendant, the Courtois Sand & Gravel Co. (Courtois) liable for an undetermined amount of cleanup costs. The District Court remanded the case to the DEP to supplement the administrative record with Blackstone's oral and written comments concerning the cleanup. On March 19, 1993, Blackstone made an oral presentation to the DEP and on April 19, 1993, Blackstone submitted written comments. On December 13, 1994, the District Court issued a judgment against Blackstone finding Blackstone liable to the Commonwealth for the full amount of response costs incurred by the Commonwealth in the cleanup of the Mendon Road site. The judgment also found Blackstone liable for interest and litigation expenses calculated to the date of judgment. The total liability at December 31, 1994 was approximately $5.9 million, including approximately $3.6 million in interest which has accumulated since 1985.\nOn January 20, 1995, Blackstone entered into an escrow agreement with the Commonwealth whereby Blackstone deposited $5.9 million with an escrow agent who transferred the funds into an interest bearing money market account. The distribution of the proceeds of the escrow account will be determined upon the final resolution of the judgment. No additional interest expense will accrue on the judgment amount.\nBlackstone filed a Notice of Appeal of the District Court's judgment and filed its brief with the United States Court of Appeals for the First Circuit (Circuit Court) on February 24, 1995. On October 6, 1995, the Circuit Court vacated the District Court's $5.9 million judgement. Rather than remand the case to the District Court for a trial on the issue of whether FFC is a hazardous substance, the Circuit Court exercised its primary jurisdictional powers to send the matter to the EPA for an administrative determination on the issue. If the EPA determines that FFC is not a hazardous substance, given the present posture of the case, Blackstone may not be liable to reimburse the Commonwealth for the Mendon Road cleanup costs.\nOn January 28, 1994, Blackstone filed a Complaint in the District Court seeking, among other relief, contribution and reimbursement from Stone & Webster Inc., of New York City and several of its affiliated companies (Stone & Webster), and Valley Gas Company of Cumberland, Rhode Island (Valley) for any damages incurred by Blackstone regarding the Mendon Road site. Blackstone's Complaint also seeks a declaratory judgment that Stone & Webster and Valley owned and\/or operated a coal gasification plant on Tidewater Street in Pawtucket (the Tidewater Plant) where the coal gasification waste allegedly was generated, and that they individually or collectively arranged for the disposal of such waste. The District Court has denied motions to dismiss the complaint filed by Stone & Webster and Valley in 1994. This proceeding was stayed in December 1995 pending final EPA determination as to whether FFC is a hazardous substance.\nBlackstone has notified certain liability insurers and has filed claims with respect to the Mendon Road site. Blackstone reached final settlement with one such insurer for coverage of legal costs related to this proceeding and in January 1996 received payment of approximately $1.2 million. Blackstone is actively pursuing coverage from other carriers.\n3. On October 28, 1986, RIDEM notified Blackstone that there may have been a release of hazardous material at the Tidewater Plant site in Pawtucket, Rhode Island. The site was placed on EPA's CERCLA list in 1987. The site includes the Tidewater Plant owned by Valley Gas Company (approximately 10 acres), the No. 1 Station owned by Blackstone (approximately 10 acres), and land formerly owned by Blackstone that was sold in 1968 to the City of Pawtucket (approximately 10 acres). RIDEM told Blackstone that the site contained cyanide-contaminated wastes and petroleum-contaminated soils due to tanks formerly located at the site. In December, 1990, after obtaining approval from RIDEM, Blackstone removed approximately 1,000 tons of soil from the site. On September 3, 1991, RIDEM initiated a site investigation which constitutes the second step in a site screening and assessment process established by the EPA to determine whether the site should be listed as a Superfund site. On February 3, 1993, RIDEM notified Blackstone that it required further assessment and evaluation of site conditions to determine if the site qualifies for review pursuant to the Hazardous Ranking System. The EPA is planning to review the site to determine whether a further investigation and a hazard ranking should be performed. As previously discussed in item 2 above, on January 28, 1994, Blackstone filed a complaint (previously mentioned in paragraph 2) in the District Court seeking, inter alia, a declaratory judgment that Stone & Webster and Valley are responsible for owning and\/or operating the Tidewater Plant and disposing and\/or arranging for the disposal of coal gasification wastes at the Tidewater Plant site. On September 12, 1995, RIDEM notified Blackstone and Valley of their responsibility regarding the release of hazardous substances at the Tidewater Plant site. RIDEM ordered Blackstone and Valley to conduct an environmental study of the Tidewater Plant site and adjoining lots. Blackstone and Valley have entered into an agreement to share the expenses of conducting the study and\/or retaining an environmental energy firm to conduct a Phase II site study.\n4. Montaup and EUA Service received a Notice of Responsibility on July 27, 1987, from the DEP for suspected hazardous material at a site owned by Montaup on Hortonville Road in Swansea, Massachusetts. EUA Service has contracted for and received an environmental site assessment for the property identifying the previous property owner as the party likely responsible for the deposit of suspected hazardous waste materials on the site. This assessment has been submitted to the DEP, identifying the previous property owner. Under the new Massachusetts Contingency Plan regulations, Montaup must take the initiative to complete investigative and remedial actions by August 1997. A site investigation was initiated in September 1995 as the first step in this process.\n5. During March-April 1990, Eastern Edison conducted a limited environmental investigation (Phase I study) of a portion of its Dupont Substation in Brockton, Massachusetts. During the investigation, Eastern Edison notified the DEP that it had encountered oils and PCBs. On May 3, 1990, the DEP notified Eastern Edison of its liability for releases of oil and\/or hazardous materials at the site, and requested a copy of the Phase I study. Following its review of the Phase I study on January 23, 1991, the DEP issued a Notice of Responsibility to Eastern Edison requiring a Phase II - Comprehensive Site Investigation. A scope of work for the Phase II study was submitted on April 12, 1991. In August 1994 a transition statement issued by DEP reclassifying the site from a Tier IA site to a Tier IB site was signed by Eastern Edison and submitted to DEP. That reclassification enables the site to be investigated and cleaned up under the guidance of a licensed site professional without DEP approval for each action taken. Cleanup activities were nearly completed at the site in 1995. The removal of storage tanks and excavation of PCB \"hot spots\" was accomplished. Backfilling and paving to cap areas of residual soil contamination are expected to commence in the spring of 1996. The total estimated cost of the cleanup including amounts already incurred, is anticipated to be approximately $550,000.\nBlackstone, Eastern Edison, Montaup and EUA Service are unable to predict the outcome of any of the foregoing environmental matters or to estimate the potential costs which may ultimately result. It is the policy of these companies in such cases to provide notice to liability insurers and to make claims. However, it is not possible at this time to predict whether liability, if any, will be assumed by, or can be enforced against, the insurance carrier in these matters. Under CERCLA, each responsible party can be held \"jointly and severally\" liable for clean-up costs. EUA or a subsidiary could thus be held fully liable for environmental damages for which they were only partially responsible. However, EUA might then be entitled to recover costs from other PRPs.\nAs of December 31, 1995, the EUA System has incurred costs of approximately $4.6 million (excluding the Mendon Road judgment) in connection with the foregoing environmental matters, substantially all of which relate to Blackstone. EUA estimates that additional expenditures (excluding the Mendon Road judgment) may be incurred through 1997 of up to $3.0 million of which approximately $2.5 and $0.5 million relate to Blackstone and Eastern Edison, respectively.\nAs a general matter, the EUA System will seek to recover costs relating to environmental proceedings in their rates. Blackstone is recovering in rates certain of its incurred costs over a five-year period. Montaup is currently recovering certain of its incurred costs in its rates. Estimated amounts after 1997 are not now determinable since site studies which are the basis of these estimates have not been completed. As a result of the recoverability in current rates and the uncertainty regarding both its estimated liability, as well as potential contributions from insurance carriers and other responsible parties, EUA does not believe that the ultimate impact of the environmental costs will be material to the financial position of the EUA System or to any individual subsidiary and thus, no loss provision is required at this time.\nEUA WestCoast L.P.\nEUA Cogenex, through its EUA WestCoast (WestCoast) L.P., had under development a cogeneration facility of approximately 1.5 MW. The cogeneration facility experienced numerous start-up delays and cost overruns. The host of the facility has taken the position that the energy services agreement between WestCoast and itself is terminated due to, among other things, failure to complete the project. WestCoast disagrees with the host's right to terminate, but has decided not to contest the host's purported termination.\nIn June 1993, WestCoast filed a lawsuit against the contractors responsible for the design and construction of the facility, as well as the surety which issued a performance bond guaranteeing construction. Certain defendants in that action have filed cross-complaints against WestCoast and EUA Cogenex, seeking, among other things, approximately $300,000 for payments withheld by WestCoast due to the contractor's deficient performance, contribution and indemnity. A contractor has also filed a cross-complaint against the host. Additionally, the host has filed a cross-complaint against Cogenex and the other parties in the litigation, seeking approximately $7 million in damages arising principally from lost economic advantage. EUA WestCoast filed its own cross complaint against the host affirmatively seeking damages. EUA WestCoast has secured defense from insurance carriers for the claims made by the host.\nEUA Cogenex intends to vigorously prosecute its claims against the contractors, surety and host, and defend itself against any cross-complaints. EUA Cogenex cannot predict the ultimate resolution of this matter. As a result of EUA Cogenex's decision to discontinue cogeneration operations effective as of July 1, 1995, EUA Cogenex has recorded a reserve for its total investment in this project which is included in the one-time after-tax charge to earnings of approximately $10.5 million.\nOther Proceedings\nIn December 1992, Montaup commenced a declaratory judgment action in which it sought to have the Massachusetts Superior Court determine its rights under the Power Purchase Agreement between it and Aquidneck Power Limited Partnership. In April 1995 Montaup filed a motion for summary judgement and in June 1995 the court granted Montaup's motion. In July, Aquidneck filed for appeal of the court's decision.\nMontaup, EUA and EUA Service intend to vigorously contest the appeal and continue to believe that Aquidneck's claims have no basis in law.\nOn June 30, 1987, the MDPU commenced a proceeding for the purpose of investigating Eastern Edison's power planning process after rejecting a proposed Purchased Capacity Adjustment Clause. One of the purposes of this proceeding is to investigate the prudency of Eastern Edison's all-requirements contract with Montaup. No procedural dates have been set nor has any other activity occurred in this docket. EUA cannot predict the outcome of this matter at this time.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS\nNone.\nEXECUTIVE OFFICERS OF EASTERN UTILITIES ASSOCIATES\nThe names, ages and positions of all of the executive officers of EUA as of March 18, 1996, are listed below along with their business experience during the past five years. Officers are elected annually by the Trustees at the meeting of Trustees next following the annual meeting of shareholders. The 1996 Annual Meeting of Shareholders is scheduled to be held on May 20, 1996. There are no family relationships among these officers, nor any arrangement or understanding between any officer and any other person pursuant to which the officer was selected. The executive officers also serve as officers\/or directors of various subsidiary companies.\nName, Age and Position Business Experience During Past 5 Years\nRichard M. Burns, 58 Comptroller since 1976, Assistant Secretary since Comptroller 1978, and Assistant Treasurer since April 1986. Chief Accounting Officer of EUA.\nJohn D. Carney, 51 Executive Vice President since April 1995; Executive Vice President President of Eastern Edison Company since January 1990; President of Blackstone since April 1995. Responsible for the day-to-day activities of The EUA System's retail electric operations.\nClifford J. Hebert, Jr., 48 Treasurer since April 1986. Secretary since May, Treasurer and 1995. Responsible for financial, treasury and Secretary corporate affairs of the EUA System.\nDonald G. Pardus, 55 Chairman since July 1990; Chief Executive Chairman of the Board, Officer since April 1989. Responsible for Chief Executive Officer the overall management of the EUA System. and Trustee\nRobert G. Powderly, 48 Executive Vice President since April 1992; Executive Vice President President of Newport Electric Corporation from March 1990 to April 1992. Responsible for purchasing, customer information services, information systems, human resources, marketing and rate activities of the EUA System.\nJohn R. Stevens, 55 President since July 1990; Chief Operating President, Chief Operating Officer since January 1990; Senior Executive Vice Officer and Trustee President from January 1990 to July, 1990. Responsible for retail operations and new ventures of the EUA System.\nExcept as described below, there have been no events under any bankruptcy act, no criminal proceedings and no judgments or injunctions material to the evaluation of the ability and integrity of any director or executive officer during the past five years.\nOn February 28, 1991, EUA Power (now Great Bay Power), filed a voluntary petition with the United States Bankruptcy Court for the District of New Hampshire for protection under Chapter 11 of the Federal Bankruptcy Code. EUA Power, a wholly owned subsidiary of EUA prior to February 5, 1993, the date it redeemed all of its equity securities held by EUA, was organized solely for the purpose of acquiring an interest in the Seabrook Project and selling in the wholesale market its share of electricity generated by the project. EUA has no ownership interest in Great Bay Power.\nMessrs. Burns, Hebert, Pardus and Stevens, were officers or directors of EUA Power since its formation in 1986, resigned their positions effective December 30, 1992, with the exception of Mr. Stevens who resigned as the sole officer and director of Great Bay Power on November 22, 1994.\nPART II\nItem 5.","section_5":"Item 5. MARKET FOR EUA'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe information set forth under the caption \"QUARTERLY FINANCIAL AND COMMON SHARE INFORMATION\" included in EUA's Annual Report to Shareholders for the year ended December 31, 1995 (Exhibit 13-1.03 filed herewith) is incorporated herein by reference.\nThe information required by this item for Blackstone and Eastern Edison is incorporated by reference to information contained under the like captioned sections of Blackstone's and Eastern Edison's 1995 Annual Reports (Exhibit 13- 1.01 and 13-1.08, respectively, filed herewith).\nAs of February 1, 1996 there were 12,161 EUA common shareholders of record.\nThe closing price of EUA's Common Shares as reported by the Wall Street Journal on March 18, 1996 was $21.125.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA\nThe information set forth under the caption \"SELECTED CONSOLIDATED FINANCIAL DATA\" included in EUA's Annual Report to Shareholders for the year ended December 31, 1995, (Exhibit 13-1.03 filed herewith) and the information set forth under the caption \"SELECTED FINANCIAL DATA\" included in the Annual Reports for the year ended December 31, 1995 for Blackstone and Eastern Edison (Exhibits 13-1.01 and 13-1.08, respectively, filed herewith) 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 incorporated herein by reference to pages 9 through 20 in the 1995 EUA Annual Report to Shareholders, pages 3 through 8 in the 1995 Blackstone Annual Report and pages 3 through 9 in the 1995 Eastern Edison Annual Report (Exhibits 13-1.03, 13-1.01 and 13-1.08 for EUA, Blackstone and Eastern Edison , respectively, filed herewith).\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 22 through 37 in the 1995 EUA Annual Report to Shareholders, page 2 and pages 10 through 27 in the 1995 Blackstone Annual Report and, page 2 and pages 12 through 31 in the 1995 Eastern Edison Annual Report (Exhibits 13-1.03, 13- 1.01 and 13-1.08 for EUA, Blackstone and Eastern Edison, respectively, filed herewith).\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 REGISTRANTS\nEASTERN UTILITIES ASSOCIATES\nThe information concerning trustees and executive officers set forth under the caption \"ELECTION OF TRUSTEES AND OWNERSHIP OF COMMON SHARES\" in EUA's definitive Proxy Statement to be mailed to shareholders in connection with the shareholders' annual meeting to be held on May 20, 1996, and filed with the SEC is incorporated herein by reference. See also \"EXECUTIVE OFFICERS OF EASTERN UTILITIES ASSOCIATES\" following Item 4 herein.\nBLACKSTONE AND EASTERN EDISON\nThe names, ages and positions of all of the directors and executive officers of Blackstone and Eastern Edison as of March 18, 1996 are listed below with their business experience during the past five years. The directors of Blackstone and the directors, Treasurer and Clerk of Eastern Edison are each elected to serve until the next annual stockholders' meeting. All other officers are elected to serve until the next meeting of directors following the annual stockholders' meeting. There is no family relationship between any of the directors or officers of Blackstone and Eastern Edison. Messrs. Pardus and Stevens are Trustees of EUA. Certain officers of Blackstone and Eastern Edison are, or at various times in the past have been, officers and\/or directors of the System Companies with which Blackstone and Eastern Edison have entered into contracts and had other business relations.\nName, Age and Position Business Experience During Past 5 Years\nRichard M. Burns, 58* Vice President, Assistant Treasurer and Assistant Vice President Clerk\/Assistant Secretary of Blackstone and Eastern Edison since April 1986.\nJohn D. Carney, 51* President and Director of Blackstone since April Director and President 1995; President and Director of Eastern Edison since January 1990.\nDavid H. Gulvin, 61 Senior Vice President of Blackstone and Eastern Senior Vice President Edison since April 1995; President of Blackstone from November 1989 to April 1995; Director of Blackstone since November 1989. Director of Eastern Edison since July 1995. Responsible for corporate communications, consumer services, marketing and rate activities.\nBarbara A. Hassan, 46 Vice President of Blackstone since April 1995; Vice President Vice President of Eastern Edison since January 1990. Responsible for the operation and maintenance of the transmission and distribution facilities.\nClifford J. Hebert, Jr., 48* Treasurer since April 1986 and Secretary\/Clerk Treasurer and since April 1995 of both Blackstone Secretary\/Clerk and Eastern Edison.\nMichael J. Hirsh, 41 Vice President of Blackstone since July 1991; Vice President Vice President of Eastern Edison since April 1995; Prior to that he was either a Director or Manager of the Engineering or Resource Planning Departments of EUA Service for more than five years. Responsible for all engineering and technical services.\nKevin A. Kirby, 45 Vice President of Blackstone and Eastern Edison Vice President since April, 1995; prior to that he was a Director of the Integrated Resource Management department of EUA Service for five years; responsible for the resource planning, power supply and contract administration activities of the EUA System.\nDonald G. Pardus, 55* Chairman of the Board since July 1989 and Director and Director since 1979 of both Blackstone and Chairman of the Board Eastern Edison.\nRobert G. Powderly, 48* Executive Vice President and Director since March Director and Executive 1992 of both Blackstone and Eastern Edison. Vice President\nJohn R. Stevens, 55* Vice Chairman of the Board since July 1989 and Director and Vice Director since July 1987 of both Blackstone and Chairman of the Board Eastern Edison.\n* Please refer to the material supplied under the caption \"EXECUTIVE OFFICERS OF EASTERN UTILITIES ASSOCIATES\" following Item 4 herein for other information regarding this officer.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION\nEastern Utilities Associates\nThe information concerning executive compensation set forth under the caption \"COMPENSATION AND OTHER TRANSACTIONS\" in EUA's definitive Proxy Statement to be mailed to shareholders in connection with the shareholders' annual meeting to be held on May 20, 1996 and filed with the SEC is incorporated herein by reference with the exception of the Report of the Compensation and Nominating Committee on Compensation of Executive Officers and accompanying Corporate Performance Graph that appears therein and which are specifically not incorporated herein by reference.\nBlackstone and Eastern Edison\nThe Chief Executive Officer and the four other most highly compensated executive officers of Blackstone and Eastern Edison hold the same or similar positions with EUA and are not paid directly by either Blackstone or Eastern Edison. The information required by this item is incorporated herein by reference to the material under the caption \"COMPENSATION AND OTHER TRANSACTIONS\" in the definitive Proxy Statement of EUA, dated March 27, 1996, with the exception of the Report of the Compensation and Nominating Committee on Compensation of Executive Officers and accompanying Corporate Performance Graph that appears therein and which are specifically not incorporated herein by reference.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\n(a) Security ownership of certain beneficial owners of Blackstone and Eastern Edison.\nAmount (number of Name and Address of shares) and Nature of Percent Title of Class Beneficial Owner Beneficial Ownership of Class\nCommon Stock Eastern Utilities Associates 2,891,357 of Eastern Edison* 100% One Liberty Square 184,062 of Blackstone* 100% Boston, Massachusetts _______________ *All shares, which are the only voting securities of Eastern Edison and Blackstone, are registered in the name of the beneficial owner.\n(b) Security ownership of certain beneficial owners of EUA and management of EUA, Blackstone and Eastern Edison.\nThe statements concerning security ownership of certain beneficial owners and management set forth under the caption \"ELECTION OF TRUSTEES AND OWNERSHIP OF COMMON SHARES\" in EUA's definitive Proxy Statement to be mailed to shareholders in connection with the shareholders' annual meeting to be held on May 20, 1996 and filed with the SEC are incorporated herein by reference.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nNone. PART IV\nItem 14.","section_14":"Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a)(1) Financial Statements\nThe response to this portion of Item 14 is set forth under Item 8.\n(a)(2) Financial Statement Schedules\nThe following additional consolidated financial statement schedules filed herewith for EUA and Blackstone should be considered in conjunction with the financial statements in the EUA's Annual Report to Shareholders and Blackstone's Annual Report for the year ended December 31, 1995 (Exhibit 13- 1.03 and 13-1.01, respectively, filed herewith):\n1. Financial Statement Schedules:\nEUA Schedule II - Valuation and Qualifying Accounts for the three years ended December 31, 1995.\nBlackstone Schedule II - Valuation and Qualifying Accounts for the three years ended December 31, 1995.\n(a)(3) Exhibits (*denotes filed herewith).\nArticles of Incorporation and By-Laws:\n-EUA-\n3-1.03 - Declaration of Trust of EUA, dated April 2, 1928, as amended (Exhibit A-3, File No. 70-3188; Exhibit 1 to EUA's 8-K Reports for April in each of the years 1957, 1962, 1966, 1968, 1972, and 1973, File No. 1-5366; Exhibit A-1 (a), Amendment No. 2 to Form U-1, File No. 70-5997; Exhibit 4-3, Registration No. 2-72589; Exhibit 1 to Certificate of Notification, File No. 70-6713; Exhibit 1 to Certificate of Notification, File No. 70-7084; Exhibit 3-2, Form 10-K of EUA or 1987, File No. 1-5366).\n- Eastern Edison -\n3-1.08 - Form of Restated and Amended Articles of Organization (filed as Exhibit B-1 to Form U5S of EUA for 1993).\nInstruments Defining the Rights of Shareholders, Including Indentures:\n- Eastern Edison -\n4-1.08 - Indenture of First Mortgage and Deed of Trust dated as of September 1, 1948 of Eastern Edison (Exhibit 4-1, Registration No. 2-77468), and twenty-six supplements thereto (Exhibit A, File No. 70-3015; Exhibit A-3, File No. 70-3371; Exhibit C to Certificate of Notification, File No. 70-3371; Exhibit D to Certificate of Notification, File No. 3619; Exhibit D to Certificate of Notification, File No. 70-3798; Exhibit F to Certificate of Notification, File No. 70-4164; Exhibit D to Certificate of Notification, File No. 70-4748; Exhibit C to Certificate of Notification, File No. 70-5195; Exhibit F to Certificate of Notification, File No. 70-5379; Exhibit C to Certificate of Notification, File No. 70-5719; Exhibit 5-24 Registration No. 2- 65785; Exhibit F to Certificate of Notification, File No. 70-6463; Exhibit C to Certificate of Notification, File No. 70-6608; Exhibit C to Certificate of Notification, File No. 70-6737; Exhibit F to Certificate of Notification, File No. 70-6851; Exhibit 4-31, Form 10-K of EUA for 1984, File No. 1-5366; Exhibit F to Certificate of Notification, File No. 70-7254; Exhibit C to Certificate of Notification, File No. 70-7373; Exhibit C to Certificate of Notification, File No. 70-7373; Exhibit C to Certificate of Notification, File No. 70-7373; Exhibit F to Certificate of Notification, File No. 20-7511; Exhibit 4-34, Form 10-K of Eastern Edison for 1990, File No. 0-8480; Exhibit 4- 24, Form 10-K of Eastern Edison for 1992, File No. 0-8480; Exhibit 4-35, Form 10-K of Eastern Edison for 1990, File No. 0-8480; Exhibit 4-36, Form 10-K of Eastern Edison for 1990, File No. 0- 8480; Exhibit C-33 to Form U5S of EUA for 1993; Exhibit C-34 to Form U5S of EUA for 1993; Exhibit 4-29.08, Form 10-K of Eastern Edison for 1994, File No. 0-8480).\n- Montaup -\n4-1.05 - Form of 8% Debenture Bonds due 2000 of Montaup (Exhibit 4-10, Registration No. 2-41488).\n4-2.05 - Form of 8-1\/4% Debenture Bonds due 2003 of Montaup (Exhibit B-3, Form U5S of EUA for year 1973).\n4-3.05 - Form of 14% Debenture Bonds due 2005 of Montaup (Exhibit 4-11, Registration No. 2-55990).\n4-4.05 - Form of 10% Debenture Bonds due 2008 of Montaup (Exhibit 5-3, Registration No. 2-65785).\n4-5.05 - Form of 16-1\/2% Debenture Bonds due 2010 of Montaup (Exhibit 4-11, Form 10-K of EUA for 1980, File No. 1-5366).\n4-6.05 - Form of 12-3\/8% Debenture Bonds due 2013 of Montaup (Exhibit 4-13, Form 10-K of EUA for 1983, File No. 1-5366).\n4-7.05 - Form of 10-1\/8% Debentures due 2008 of Montaup (Exhibit 4, Form 10-Q of Eastern Edison for quarter ended September 30, 1983, File No. 0-8480).\n4-8.05 - Form of 9% Debenture Bonds due 2020 of Montaup (Exhibit 4-10, Form 10-K of Eastern Edison for 1990, File No. 0-8480).\n4-9.05 - Form of 9 3\/8% Debenture Bonds due 2020 of Montaup (Exhibit 4-11, Form 10-K of Eastern Edison for 1990, File No. 0-8480).\n- Blackstone -\n4-1.01 - First Mortgage Indenture and Deed of Trust dated as of December 1, 1980 of Blackstone (Exhibit A, Form 8-K of EUA dated January 14, 1981, File No. 1-5366) and two supplements thereto (Exhibit 4-33, Form 10-K of EUA for 1989, File No. 1-5366; Exhibit 4-3, Form 10-K of BVE for 1990, File No. 0-2602).\n4-4.01 - Loan Agreement between Rhode Island Industrial Facilities Corporation and Blackstone dated as of December 1, 1984 (Exhibit 10-72, Form 10-K of EUA for 1984, File No. 1-5366).\n- EUA Service -\n4-1.07 - Note Purchase Agreement dated as of January 13, 1988 of Service (Exhibit 4-38, Form 10-K of EUA for 1987, File No. 1-5366).\n- EUA Cogenex -\n4-1.10 - Note Agreement dated as of June 28, 1990 of EUA Cogenex with the Prudential Insurance Company of America (Exhibit 4-46, Form 10-K of EUA for 1990, File No. 1-5366).\n4-2.10 - Note Agreement dated as of October 29, 1991 between EUA Cogenex and Prudential Insurance Company of America (Exhibit 4-55, Form 10-K of EUA for 1991, File No. 1-5366).\n4-3.10 - Note Purchase Agreement dated as of September 29, 1992 of EUA Cogenex and the Prudential Life Insurance Company of America (Exhibit 4-44, Form 10-K of EUA for 1992, File No. 1-5366).\n4-4.10 - Indenture dated September 1, 1993 between EUA Cogenex and the Bank of New York as Trustee (Exhibit 4-4.10, Form 10-K of EUA for 1993, File No. 1-5366).\n- Newport -\n4-1.14 - Indenture of First Mortgage dated as of June 1, 1954 of Newport, as supplemented on August 1, 1959, April 1, 1962, October 1, 1964, April 1, 1967, September 1, 1969, September 1, 1970, June 1, 1978, October 1, 1978, May 1, 1986, December 1, 1987 and November 1, 1989 (Exhibit 4-49, Form 10-K of EUA for 1990, File No. 1-5366).\n4-2.14 - United States Government Small Business Administration Loan to Newport entitled, \"Base Closing Economic Injury Loan\", signed May 30, 1975 and amended on October 6, 1983 (Exhibit 4-50, Form 10-K of EUA for 1990, File No. 1-5366).\n4-3.14 - Indenture of Second Mortgage dated as of September 1, 1982 of Newport, as supplemented on December 1, 1988 (Exhibit 4-51, Form 10-K of EUA for 1990, File No. 1-5366).\n4-4.14 - Loan Agreement between the Rhode Island Port Authority and Economic Development Corporation and Newport Electric Corporation dated as of January 6, 1994 (Exhibit 4-4.14, Form 10-K of EUA for 1993, File No. 1-5366).\n4-5.14 - Trust Indenture between the Rhode Island Authority and Economic Development Corporation and Newport Electric Corporation dated as of January 1, 1994 (Exhibit 4-5.14, Form 10-K of EUA for 1993, File No. 1-5366).\n4-6.14 - Letter of Credit and Reimbursement Agreement dated January 6, 1994 (Exhibit 4-6.14, Form 10-K of EUA for 1993, File No. 1-5366).\n- EUA Ocean State -\n4-1.12 - Note Purchase Agreement dated as of January 16, 1992 between EUA Ocean State Corporation and John Hancock Mutual Life Insurance Company (Exhibit 4-56, Form 10-K of EUA for 1991, File No. 1- 5366).\nMaterial Contracts:\n- EUA -\n10-1.03 - Employees' Retirement Plan of Eastern Utilities Associates and its Subsidiary Companies Trust Agreement as amended and restated, effective July 1, 1981 (Exhibit 10-1, Registration No. 2-80205).\n10-2.03 - Eastern Utilities Associates Employees' Savings Plan Trust Agreement (Exhibit 10-3, Form 10-K of EUA for 1992, File No. 1- 5366).\n10-3.03 - Eastern Utilities Associates Employees' Savings Plan as amended and restated effective January 1, 1989 (Exhibit 10-4, Form 10-K of EUA for 1992, File No. 1-5366).\n10-4.03 - Stock Purchase Agreement dated as of December 10, 1986, among Eastern Utilities Associates, Citizens Corporation and Citizens Energy Corporation (Exhibit 10-104, Form 10-K of EUA for 1986, File No. 1-5366).\n10-5.03 - Precedent Agreement dated as of November 29, 1989 between EUA and NECO Enterprises, Inc. (Exhibit B-4, Form U-1, File No. 70-7677).\n10-6.03 - Amendment to and Restatement of Stock Purchase Agreement dated as of February 1, 1990 between EUA, NECO Enterprises, Inc., Newport Electric Corporation and a special-purpose subsidiary of EUA for the acquisition by EUA of the stock of Newport Electric Corporation (Exhibit B-3, Form U-1, File No. 70-7677).\n10-7.03 - Letter of Assurance in connection with the Credit Agreement between Vermont Electric Transmission Company, Inc. and Bank of America National Trust and Savings Association dated July 19, 1983 (Exhibit 10-111, Form 10-K of EUA for 1990, File No. 1-5366).\n10-8.03 - Amended and Restated Equity Maintenance Agreement dated as of September 29, 1992 among EUA and The Prudential Insurance Company of America and Pruco Life Insurance Company (Exhibit 10-9, EUA 10- K for 1992, File No. 1-5366).\n10-9.03 - Guaranty, dated June 28, 1990 made by EUA in favor of The Prudential Life Insurance Company of America (Exhibit 10-10, EUA 10-K for 1992, File No. 1-5366).\n10-10.03 - Guaranty, dated January 16, 1992 made by EUA in favor of John Hancock Mutual Life Insurance Company (Exhibit 4-125, Form 10-K of EUA for 1991, File No. 1-5366).\n10-11.03 - Form of Service Contract between EUA Service Corporation and each of the other companies (including EUA) in the EUA System (Exhibit 13-1.03, Registration No. 2-55990).\n10-12.03 - Form of EUA Restricted Stock Plan effective July 17, 1989 (Exhibit 10-13, EUA Form 10-K for 1992, File No. 1-5366).\n10-13.03 - Eastern Utilities Associates Employees' Share Ownership Plan Trust Agreement (Exhibit 5, Form 10-K of EUA for 1977, File No. 1-5366).\n10-14.03* - Employees' Retirement Plan of Eastern Utilities Associates and Its Affiliated Companies as amended and restated effective January 1, 1989.\n10-15.03* - Eastern Utilities Associates Employees' Savings Plan as amended and restated effective January 1, 1989 (including amendments through January 1, 1992).\n10-16.03* - First Amendment to the Employees' Retirement Plan of Eastern Utilities Associates and Its Affiliated Companies dated December 21, 1994.\n10-17.03* - First Amendment to Eastern Utilities Associates Employees' Savings Plan and Its Affiliated Companies dated December 21, 1994.\n- Eastern Edison -\n10-1.08 - Trust Agreement dated as of July 1, 1993 between Massachusetts Industrial Finance Agency and Shawmut Bank, N.A. (filed as Exhibit 10-1.08 to Eastern Edison's Form 10-K for 1993, File No. 0-8480).\n10-2.08 - Loan Agreement dated as of July 1, 1993 between Massachusetts Industrial Finance Agency and Eastern Edison (filed as Exhibit 10- 2.08 to Eastern Edison's Form 10-K for 1993, File No. 0-8480).\n10-3.08 - Power Purchase Agreement entered into as of September 20, 1993 by and between Meridian Middleboro Limited Partnership and Eastern Edison Company (filed as Exhibit 10-3.08 to Eastern Edison's Form 10-K for 1993, File No. 0-8480).\n10-4.08 - Inducement Letter dated July 14, 1993 from Eastern Edison to the Massachusetts Industrial Finance Agency and Goldman, Sachs & Company and Citicorp Securities Markets, Inc. (filed as Exhibit 10-4.08 to Eastern Edison's Form 10-K for 1993, File No. 0-8480).\n- Montaup -\n10-1.05 - Montaup Contract, as amended (Exhibit 4-B, Registration No. 2- 14119; Exhibit 13-A1, Registration No. 2-14718; Exhibit 4-B-2, Registration No. 2-26509; Exhibit 4-B-3, Registration No. 2- 33061; Exhibits 13-3 and 13-4, Registration No. 2-48966; Exhibit B-2, Form U5S of EUA for year 1974 and Exhibit 5-40, Registration No. 2-62862).\n10-2.05 - Power Contract (composite copy) between Connecticut Yankee Atomic Power Company and Montaup dated July 1, 1964 as amended and supplemented March 1, 1978, August 22, 1980, and October 15, 1982 (Exhibit B-1, File No. 70-4245; Exhibit 20, Form 10-K of EUA for 1977, file No. 1-5366; Exhibit 10-52, Form 10-K for EUA for 1981, File No. 1-5366; Exhibit 10-67, Form 10-K for EUA for 1983, file No. 1-5366).\n10-3.05 - Capital Funds Agreement (composite copy) between Connecticut Yankee Atomic Power Company and Montaup dated September 1, 1964 (Exhibit B-2, File No. 70-4245).\n10-4.05 - Stockholder Agreement (composite copy) among Connecticut Yankee Atomic Power Company's Sponsors, including Montaup, dated July 1, 1964 (Exhibit B-4, File No. 70-4245).\n10-5.05 - Contract for sale of power to Montaup by Canal Electric Company dated December 1, 1965 (Exhibit 2D, File No. 0-688).\n10-6.05 - Capital Funds Agreement (composite copy) between Vermont Yankee Nuclear Power Corporation and Montaup dated as of February 1, 1968, and Amendment thereto dated as at March 12, 1968 (Exhibit B- 2, File No. 70-4611; Exhibit B-3, File No. 70-4611).\n10-7.05 - Form of Power Contract between Vermont Yankee Nuclear Power Corporation and Montaup dated as of February 1, 1968, as amended June 1, 1972, April 15, 1983, April 24, 1985, June 1, 1985, May 6, 1988 (2), June 15, 1989 and December 1, 1989 (Exhibit B-4, File No. 70-4591; Exhibit 13-21, Registration No. 2-46612; Exhibit 10- 63, Form 10-K of EUA for 1983, File No. 1-5366; Exhibit 10-74, Form 10-K of EUA for 1985, File No. 1-5366; Exhibit 10-78, Form 10-K of EUA for 1986, File No. 1-5366; Exhibits 10-97 and 10-98, Form 10-K of EUA for 1988, File No. 1-5366; Exhibit 10-95, Form 10-K of EUA for 1989, File No. 1-5366; Exhibit 10-80, Form 10-K of Eastern Edison for 1990, File No. 0-8480).\n10-8.05 - Sponsor Agreement (composite copy) among Vermont Yankee Nuclear Power Corporation's Sponsors, including Montaup, dated as of August 1, 1968 (Exhibit 4-0, Registration No. 2-33061).\n10-9.05 - Capital Funds Agreement (composite copy) between Maine Yankee and Montaup dated May 20, 1968 and as amended August 1, 1985 (Exhibit B-2, File No. 70-4658; Exhibit 10-78, Form 10-K of EUA for 1985, File No. 1-5366).\n10-10.05 - Power Contract (composite copy) between Maine Yankee Atomic and Montaup dated May 20, 1968, as amended December 19, 1983 and January 1, 1984 (Exhibit B-3, File No. 70-4658; Exhibit 10-64, Form 10-K of EUA for 1983, File No. 1-5366; Exhibit 10-66, Form 10-K of EUA for 1984, File No. 1-5366).\n10-11.05 - Stockholder Agreement (composite copy) among Maine Yankee Sponsors, including Montaup, dated May 20, 1968 (Exhibit B-4, File 70-4658).\n10-12.05 - Agreement (composite copy) among Vermont Yankee Nuclear Power Corporation's Sponsors, including Montaup, dated as of April 30, 1969 (Exhibit B-7, File No. 70-4435).\n10-13.05 - Form of Agreement among Maine Yankee Atomic Power Company's Sponsors dated as of May 20, 1969 (Exhibit B-5, File No. 70-4658).\n10-14.05 - Form of New England Power Pool Agreement dated as of September 1, 1971, as amended as of July 1, 1972, March 1, 1973, April 2, 1973, March 15, 1974, June 1, 1975, September 1, 1975, December 31, 1976, January 18, 1977, July 1, 1977, August 1, 1977, August 15, 1978, January 31, 1980, February 1, 1980, September 1, 1981, December 1, 1981, June 1, 1982, June 15, 1983, October 1, 1983, August 1, 1985, August 15, 1985, January 1, 1986, September 1, 1986, March 1, 1988, May 1, 1988, March 15, 1989 and October 1, 1990, (Exhibit 13-45, Registration No. 2-41488; Exhibit 13-38, Registration No. 2-46612; Exhibits 13-39 and 13-40, Registration No. 2-48966; Exhibit B-3, Form U5S of EUA for year 1974; Exhibit 13-35(a), Registration No. 2-54449; Exhibit 13-35, Registration No. 2-55990, Exhibits 5-69 and 5-70, Registration Exhibit 13- 35(a), Registration No. 2-54449; Exhibit 13-35, Registration No. 2-55990, Exhibits 5-69 and 5-70, Registration No. 2-58625; Exhibit 6, Form 10-K of EUA for 1977, File No. 1-5366; Exhibit 1, Form 10-K of EUA for 1979, File No. 1-5366; Exhibit No. 10-67, Registration No. 2-80205; Exhibit 10-65, Form 10-K of EUA for 1983, File No. 1-5366; Exhibit 10-66, Form 10-K of EUA for 1983, File No. 1-5366; Exhibits 10-75, 10-76, and 10-77, Form 10-K of EUA for 1985, File No. 1-5366; Exhibit 10-79, Form 10-K of EUA for 1986, File No. 1-5366; Exhibits 10-99 and 10-100, Form 10-K of EUA for 1988, File No. 1-5366; Exhibit 10-96, Form 10-K of EUA for 1989, File No. 1-5366; Exhibit 10-81, Form 10-K of Eastern Edison for 1990, File No. 0-8480).\n10-15.05 - Unit Participation Agreement between Maine Electric Power Company, Inc. and New Brunswick Electric Power Commission dated November 15, 1971 (Exhibit 13-43.1, Registration No. 2-44377).\n10-16.05 - Assignment Agreement dated March 20, 1972 between Maine Electric Power Company, Inc. and New Brunswick Electric Power Commission (Exhibit 13-43.3, Registration No. 2-44377).\n10-17.05 - Agreement between Montaup and Boston Edison Company dated August 1, 1972 and as amended January 1, 1985 for purchase of power from Pilgrim No. 1 nuclear unit at Plymouth, Massachusetts (Exhibit 13- 41, Registration No. 2-46612; Exhibit 10-67, Form 10-K of EUA for 1984, File No. 1-5366).\n10-18.05 - Agreement dated as of May 1, 1973 for Joint Ownership, Construction and Operation of New Hampshire Nuclear Units among Public Service Company of New Hampshire and other utilities including Montaup, as amended as of May 24, 1974, June 21, 1974, September 25, 1974, October 25, 1974, January 31, 1975, as supplemented by Letter Agreement dated April 27, 1978 and amended as of April 18, 1979 (two amendments), April 25, 1979, June 8, 1979, October 11, 1979, December 15, 1979, June 16, 1980, December 31, 1980, June 1, 1982, April 27, 1984, June 15, 1984, March 8, 1985, March 14, 1986, May 1, 1986, September 19, 1986, November 1987, January 13, 1989 and November 1, 1990. (Exhibit 13-57, Registration No. 2-48966; Exhibit B-6, Form U5S of EUA for year 1974; Exhibit 5-130, Registration No. 2-62862; Exhibit 5-70, Registration No. 2-65785; Exhibit 2, Form 10-K of EUA for 1979, File No. 1-5366; Exhibit 5-34, Registration No. 2-69052; Exhibit 20-1, Form 10-K of EUA for 1980, File No. 1-5366; Exhibit 10-69, Registration No. 2-80205; Exhibit 2, Form 10-Q of EUA for the Quarter Ended March 31, 1984, File No. 1-5366; Exhibit 3, Form 10-Q of EUA for the Quarter Ended June 30, 1984, File No. 1-5366; Exhibit 10-70, Form 10-K of EUA for 1985, File No. 1-5366; Exhibits 10-80 and 10-81, Form 10-K of EUA for 1986, File No. 1-5366; Exhibits 10-95 and 10-96, Form 10-K of EUA for 1987, File No. 1-5366; Exhibit 10-101, Form 10-K of EUA for 1988, File No. 1-5366; Exhibit 10-82, Form 10-K of Eastern Edison for 1990, File No. 0-8480).\n10-19.05 - Sharing Agreement dated as of September 1, 1973 among The Connecticut Light and Power Company and other utilities, including Montaup, concerning participation in a nuclear generating unit located in Connecticut (Millstone Unit No. 3), as amended and supplemented by Amendatory Agreement dated May 11, 1984 as amended as of April 1, 1986 (Exhibit B-17, Form U5S of EUA for year 1973; Exhibit B-8, as amended as of April 11, 1986, Form U5S of EUA for year 1974; Exhibit B-30, Form U5S of EUA for year 1976; Exhibit 10-68, Form 10-K of EUA for 1984, File No. 1-5366; Exhibit 10-82, Form 10-K of EUA for 1986, File No. 1-5366).\n10-20.05 - Agreement for Joint Ownership, Construction and Operation of William F. Wyman Unit No. 4 dated November 1, 1974 as amended June 30, 1975, August 16, 1976 and December 31, 1978 among Central Maine Power Company and other utilities including Montaup (Exhibit B-9, Form U5S of EUA for year 1974; Exhibit 13-58, Registration No. 2-55990; Exhibit 5-95, Registration No. 2-58625; Exhibit 5-40, Registration No. 2-69052).\n10-21.05 - Agreement for Joint Ownership dated as of October 27, 1970 between Canal Electric Company and Montaup (Exhibit 13-71, Registration No. 2-55990).\n10-22.05 - Agreement for use of Common Facilities by Canal Units I and II and for Allocation of Related Costs dated as of October 27, 1970 between Canal Electric Company and Montaup (Exhibit 13-72, Registration No. 2-55990).\n10-23.05 - Guarantee Agreement (composite copy) dated as of November 13, 1981 between The Connecticut Bank and Trust Company, as Trustee, and Montaup relating to debentures of Connecticut Yankee Atomic Power Company (Exhibit 10-61, Form 10-K of EUA for 1981, File No. 1-5366).\n10-24.05 - Guarantee Agreement dated as of November 5, 1981 between Bankers Trust Company, as Trustee of the Vernon Energy Trust, and Montaup relating to a nuclear fuel sales agreement and related transactions entered into by Vermont Yankee Nuclear Power Corporation (Exhibit 10-63, Form 10-K of EUA for 1981, File No. 1-5366).\n10-25.05 - Agreement for Seabrook Project Disbursing Agent, dated as of May 23, 1984, as amended March 8, 1985, May 20, 1985, June 18, 1985, January 1, 1986, November, 1987, August 1, 1989, and restated as of November 1, 1990, among the participants in the Seabrook nuclear generating project, including Montaup and Yankee Atomic Electric Company (Exhibit 2, Form 10-Q of EUA for the Quarter Ended June 30, 1984, File No. 1-5366; Exhibit 10-69, Form 10-K of EUA for 1985, File No. 1-5366; Exhibits 10-86, 10-87 and 10-88, Form 10-K of EUA for 1986, File No. 1-5366; Exhibit 10-97, Form 10-K of EUA for 1987, File No. 1-5366; Exhibit 10-105, Form 10-K of EUA for 1989, File No. 1-5366; Exhibit 10-84, Form 10-K of Eastern Edison for 1990, File No. 0-8480).\n10-26.05 - Guarantee Agreement dated as of August 1, 1985 among The Connecticut Bank and Trust Company, Connecticut Yankee Atomic Power Company and Montaup Electric Company relating to Revolving Credit Loans of Connecticut Yankee (Exhibit 10-85, Form 10-K of EUA for 1985, File No. 1-5366).\n10-27.05 - Equity Funding Agreement for New England Hydro-Transmission Corporation dated as of June 1, 1985, between New England Hydro- Transmission Corporation and several New England electric utilities, including Montaup as amended as of May 1, 1986 and September 1, 1987 (Exhibits 10-96 and 10-97, Form 10-K of EUA for 1986, File No. 1-5366; Exhibit 10-116, Form 10-K of EUA for 1987, File No. 1-5366).\n10-28.05 - Equity Funding Agreement for New England Hydro-Transmission Electric Company, Inc. dated as of June 1, 1985, between New England Hydro-Transmission Electric Company, Inc. and several New England electric utilities, including Montaup as amended as of May 1, 1986 and September 1, 1987 (Exhibits 10-98 and 10-99, Form 10-K of EUA for 1986, File No. 1-5366; Exhibit 10-117, Form 10-K of EUA for 1987, File No. 1-5366).\n10-29.05 - Unit Power Agreement for the Sale of Unit Capacity and Energy from Ocean State Power Project to Montaup Electric Company dated as of May 14, 1986 as amended as of August 27, 1986, September 27, 1988, October 21, 1988, July 21, 1989, February 7, 1990 and December 21, 1990 (Exhibits 10-101 and 10-102, Form 10-K of EUA for 1986, File No. 1-5366; Exhibits 10-106 and 10-107, Form 10-K of EUA for 1988, File No. 1-5366; Exhibit 10-106, Form 10-K of EUA for 1989, File No. 1-5366; Exhibits 10-86 and 10-87, Form 10-K of Eastern Edison for 1990, File No. 0-8480).\n10-30.05 - Power Purchase Agreement dated as of October 17, 1986, between Northeast Energy Associates and Montaup as amended as of June 28, 1989 (Exhibit 10-103, Form 10-K of EUA for 1986, File No. 1-5366; Exhibit 10-103, Form 10-K of EUA for 1989, File No. 1-5366).\n10-31.05 - Settlement Agreement dated as of January 13, 1989 among Montaup, EUA Power, certain past and present owners of the Seabrook Project and Yankee Atomic Electric Company (Exhibit 10-110, Form 10-K of EUA for 1988, File No. 1-5366).\n10-32.05 - Unit Power Agreement for the Sale of Second Unit Capacity and Energy from Ocean State Power Project to Montaup Electric Company dated as of September 28, 1988 as amended by an amendment dated July 21, 1989, and February 7, 1990 and a Supplemental Agreement dated July 21, 1989 (Exhibit 10-104, Form 10-K of EUA for 1989, File No. 1-5366; Exhibit No. 10-88, Form 10-K of Eastern Edison for 1990, File No. 0-8480).\n10-33.05 - Purchase Power Contract between Newport and Montaup dated July 23, 1963, as revised on March 23, 1983 (Exhibit 10-108, Form 10-K of EUA for 1990, File No. 1-5366).\n10-34.05 - Purchase Power Contract between Newport and Montaup for Contract Demand Service effective May 1, 1983, as amended on July 1, 1983, December 28, 1983 and November 1, 1984 (Exhibit 10-89, Form 10-K of Eastern Edison for 1990, File No. 0-8480 and Exhibit 10-109, Form 10-K of EUA for 1990, File No. 1-5366).\n10-35.05 - Power Contract (composite copy) between Yankee Atomic Electric Company and Montaup dated June 30, 1959 as revised April 1, 1975, as further amended October 1, 1980, April 1, 1985, May 6, 1988, June 26, 1989, July 1, 1989 and February 1, 1992 (Exhibit 10-6, Registration No. 2-72655; Exhibit 10-73, Form 10-K of EUA for 1985, File No. 1.5366; Exhibit 10-96, Form 10-K of EUA for 1988, File No. 1-5366; Exhibits 10-93 and 10-94, Form 10-K of EUA for 1989, File No. 1-5366; Exhibit 10-46 Form 10-K of Eastern Edison for 1992, File No. 0-8480).\n10-36.05 - Memorandum of understanding by and between Canal Electric Company and Montaup Electric Company dated September 23, 1993 (Exhibit 10- 39.05, Eastern Edison 10-K for 1993, File No. 0-8480).\n10-37.05 - Ancillary Agreement by and between Algonquin Gas Transmission Company, Canal Electric Company and Montaup Electric Company dated October 8, 1993. (Exhibit 10-40.05 of Eastern Edison 10-K for 1993, File No. 0-8480).\n*10-38.05 - Twenty-eighth Amendment to 10-14.05 dated September 15, 1992.\n*10-39.05 - Twenty-ninth Amendment to 10-14.05 dated May 1, 1993.\n*10-40.05 - Thirty-second Amendment to 10-14.05 dated September 1, 1995.\n- Blackstone -\n10-1.01 - Trust Indenture between Rhode Island Industrial Facilities Corporation and the Rhode Island Hospital Trust Company dated as of December 1, 1984 (Exhibit 10-73, Form 10-K of EUA for 1984, File No. 1-5366).\n10-2.01 - Remarketing Agreement between Rhode Island Hospital Trust Company, Citibank and Blackstone dated as of December 19, 1984 (Exhibit 10- 74, Form 10-K of EUA for 1984, File No. 1-5366).\n10-3.01 - Letter of Credit and Reimbursement Agreement between Blackstone Valley Electric Company and The Bank of New York dated as of January 21, 1993 (Exhibit 10-10, Form 10-K of Blackstone for 1992, File No. 0-2602).\n10-4.01 - Interconnection Agreement by and between Blackstone and Ocean State Power dated November 1, 1988, as amended and restated effective August 16, 1989 by and among Blackstone, Ocean State Power I and Ocean State Power II (Exhibit 10-100, Form 10-K of EUA for 1989, File No. 1-5366).\n10-5.01 - Power Purchase Agreement between Blackstone and Blackstone Hydro, Inc. dated as of January 8, 1989 and assignment to Montaup (Exhibits 10-101 and 10-102, Form 10-K of EUA for 1989, File No. 1-5366).\n- Newport -\n10-1.14 - Phase I Vermont Transmission Line Support Agreement dated as of December 1, 1981 and as amended as of June 1, 1982, November 1, 1982 and January 1, 1986 between Vermont Electric Transmission Company, Inc. and several New England utilities, including Montaup (Exhibit 10-65, Form 10-K of EUA for 1981, File No. 1-5366; Exhibit 10-72, Registration No. 2-80205; Exhibit 10-64, Form 10-K of EUA for 1982, File No. 1-5366; Exhibit 10-84. Form 10-K of EUA for 1986, File No. 1-5366).\n10-2.14 - Letter amendment dated August 4, 1983 reallocating the participating shares originally assigned to the Chicopee Municipal Lighting Plant and the Taunton Municipal Lighting Plant under the Phase I Vermont Transmission Line Support Agreement between Vermont Electric Transmission Company, Inc. and several New England electric utilities, including Newport, dated December 1, 1981, as amended on June 1, 1982 and November 1, 1982 (Exhibit 10- 110, Form 10-K of EUA for 1990, File No. 1-5366).\n10-3.14 - Phase I Terminal Facility Support Agreement dated December 1, 1981 and as amended as of June 1, 1982, November 1, 1982 and January 1, 1986 between New England Electric Transmission Corporation and several New England utilities, including Montaup (Exhibit 10-68, Form 10-K of EUA for 1981, File No. 1-5366; Exhibit 10-74, Registration No. 1-5366; Exhibit 10-68. Form 10-K of EUA for 1986, File No. 1-5366).\n10-4.14 - Letter amendment dated July 29, 1983 reallocating the participating shares originally assigned to the Chicopee Municipal Lighting Plant and the Taunton Municipal Lighting Plant under the Phase I Terminal Facility Support Agreement between New England Transmission Corporation and several New England electric utilities, including Newport, dated December 1, 1981, as amended on June 1, 1982 and November 1, 1982 (Exhibit 10-112, Form 10-K of EUA for 1990, File No. 1-5366).\n10-5.14 - Purchase Power Contract between Newport and City of Burlington Electric Department (life of the unit contract) for purchase of 15.24% of net capability of station output from Joseph C. McNeil Electric Generating Station located in Burlington, Vermont dated December 19, 1984 (Exhibit 10-115, Form 10-K of EUA for 1990, File No. 1-5366).\n10-6.14 - Firm Energy Contract between Hydro-Quebec and several New England electric utilities, including Newport, dated as of October 14, 1985 (Exhibit 10-116, Form 10-K of EUA for 1990, File No. 1-5366).\n10-7.14 - Unit Power Agreement for the Sale of Unit Capacity and Energy from Ocean State Power Project to Newport Electric Corporation dated May 14, 1986, as amended on August 20, 1986, July 12, 1988, September 23, 1988, October 21, 1988, July 21, 1989, February 7, 1990 and December 21, 1990 (Exhibit 10-117, Form 10-K for 1990, File No. 1-5366).\n10-8.14 - Unit Power Agreement for the Sale of Second Unit Capacity and Energy from Ocean State Power Project to Newport Electric Corporation dated July 12, 1988 as amended and supplemented September 23, 1988, July 21, 1989 and February 7, 1990 (Exhibit 10-118, Form 10-K for 1990, File No. 1-5366).\n10-9.14 - Agreement for Joint Ownership, Construction and Operation of William F. Wyman Unit No. 4 dated November 1, 1974 as amended June 30, 1975, August 16, 1976 and December 31, 1978 among Central Maine Power Company and other utilities including Newport (Exhibit B-9, Form U5S of EUA for year 1974; Exhibit 13-58, Registration No. 2-55990; Exhibit 5-95, Registration No. 2-58625; Exhibit 5-40, Registration No. 2-69052).\n- EUA Ocean State -\n10-1.12 - Ocean State Power Amended and Restated General Partnership Agreement among EUA Ocean State, Ocean State Power Company, TCPL Power Ltd., Narragansett Energy Resources Company and NECO Power, Inc. (collectively, the \"OSP Partners\") dated as of December 2, 1988, as amended March 27, 1989, December 31, 1990, November 12, 1992 and February 23, 1993 (Exhibit 10-107, Form 10-K of EUA for 1989; File No. 1-5366, Exhibits 10-3.12, 10-4.12 and 10-5.12, Form 10-K of EUA for 1994, File No. 1-5366).\n10-2.12 - Ocean State Power II Amended and Restated General Partnership Agreement among EUA Ocean State, JMC Ocean State Corporation, Makowski Power, Inc., TCPL Power Ltd., Narragansett Energy Resources Company and Newport Electric Power Corporation (collectively, the \"OSP II Partners\") dated as of September 29, 1989 (Exhibit 10-110, Form 10-K of EUA for 1989, File No. 1-5366).\nAnnual Reports to Shareholders:\n*13-1.03 - Annual Report to Shareholders of EUA for 1995, portions of which are incorporated by reference in this Annual Report on Form 10-K. Only the portions expressly so incorporated under PART II, Items 5, 6, 7 and 8 are to be deemed filed herewith.\n*13-1.01 - Annual Report to Shareholders of Blackstone for 1995, portions of which are incorporated by reference in this Annual Report on Form 10-K. Only the portions expressly so incorporated under PART II, Items 5, 6, 7 and 8 are to be deemed filed herewith.\n*13-1.08 - Annual Report to Shareholders of Eastern Edison for 1995, portions of which are incorporated by reference in this Annual Report on Form 10-K. Only the portions expressly so incorporated under PART II, Items 5, 6, 7 and 8 are to be deemed filed herewith.\nSubsidiaries of EUA:\n21-1.03 - Direct subsidiaries of Eastern Utilities Associates and the state of organization of each are: Blackstone Valley Electric Company (Rhode Island), Eastern Edison Company (Massachusetts), EUA Cogenex Corporation (Massachusetts), EUA Service Corporation (Massachusetts), EUA Ocean State Corporation (Rhode Island), EUA Energy Investment Corporation (Massachusetts) and Newport Electric Corporation (Rhode Island). Montaup Electric Company (Massachusetts) is a subsidiary of Eastern Edison Company. Each of the above subsidiaries does business under its indicated corporate name.\nConsent of Experts and Counsel:\n*23-1.03 - Consent of Independent Accountants.\n(b) Reports on Form 8-K.\nNone. 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.\nSignature Title Date\nEASTERN UTILITIES ASSOCIATES\nBy \/s\/Richard M. Burns Comptroller March 18, 1996 Richard M. Burns (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.\n\/s\/Donald G. Pardus Chairman and Chief Executive Officer Donald G. Pardus (Principal Executive Officer) and Trustee\n\/s\/John R. Stevens President and Chief Operating Officer John R. Stevens (Principal Financial Officer) and Trustee\n\/s\/Richard M. Burns Comptroller Richard M. Burns (Principal Accounting Officer)\n\/s\/Russell A. Boss Trustee Russell A. Boss\n\/s\/Paul J. Choquette, Jr. Trustee Paul J. Choquette, Jr. March 18, 1996 \/s\/Peter S. Damon Trustee Peter S. Damon\n\/s\/Peter B. Freeman Trustee Peter B. Freeman\n\/s\/Larry A. Leibenow Trustee Larry A. Liebenow\nTrustee Jacek Makowski\n\/s\/Wesley W. Marple, Jr. Trustee Wesley W. Marple, Jr.\n\/s\/Margaret M. Stapleton Trustee Margaret M. Stapleton\n\/s\/W. Nicholas Thorndike Trustee W. Nicholas Thorndike\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nSignature Title Date\nBLACKSTONE VALLEY ELECTRIC COMPANY\nBy\/s\/Richard M. Burns Vice President March 18, 1996 Richard M. Burns (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.\n\/s\/Donald G. Pardus Chairman of the Board and Donald G. Pardus Director (Principal Executive Officer)\n\/s\/John R. Stevens Vice Chairman and Director John R. Stevens (Principal Financial Officer)\n\/s\/Richard M. Burns Vice President Richard M. Burns (Principal Accounting Officer)\n\/s\/John D. Carney President and Director John D. Carney\n\/s\/David H. Gulvin Senior Vice President David H. Gulvin and Director March 18, 1996\n\/s\/Robert G. Powderly Executive Vice President and Robert G. Powderly Director\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nSignature Title Date\nEASTERN EDISON COMPANY\nMarch 18, 1996 By \/s\/Richard M. Burns Vice President Richard M. Burns (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.\n\/s\/Donald G. Pardus Chairman of the Board and Director (Principal Donald G. Pardus Executive Officer)\n\/s\/John R. Stevens Vice Chairman and Director John R. Stevens (Principal Financial Officer)\n\/s\/Richard M. Burns Vice President March 18, 1996 Richard M. Burns (Principal Accounting Officer)\n\/s\/John D. Carney President and Director John D. Carney\n\/s\/David H. Gulvin Senior Vice President David H. Gulvin and Director\n\/s\/Robert G. Powderly Executive Vice President and Robert G. Powderly Director\nEASTERN UTILITIES ASSOCIATES AND SUBSIDIARY COMPANIES\nItem 14(a)(2). Financial Statement Schedules","section_15":""}
{"filename":"67217_1995.txt","cik":"67217","year":"1995","section_1":"ITEM 1. BUSINESS\nTHE COMPANY\nMHI Group, Inc. (together with its subsidiaries, the \"Company\") was incorporated in Florida in 1968, and since 1987, has been engaged in the ownership and operation of funeral homes, cemeteries and crematories.\nAt April 30, 1995 the Company operated 16 funeral homes, five cemeteries and four crematories in the States of Florida and Colorado and are functionally defined by six regions or clusters. The Company entered the death care products and services business to capitalize on opportunities for consolidation in a highly fragmented industry, favorable demographic trends and historically stable business volumes and profitability of established operations in the industry. The Company believes it is a leader in the industry trend toward sales of prearranged death care products and services and has become a significant provider of funeral and cemetery products and services in the United States.\nThe Company has grown primarily through acquisitions and is focused upon expanding through further acquisitions. In fiscal year 1995, the Company acquired four funeral homes, two crematories and one cemetery. For information regarding acquisitions of funeral home and cemetery operations, see Note 4 to the Notes to Consolidated Financial Statements.\nOPERATIONS\nOperations include the Company's funeral homes, crematories, cemeteries and related businesses.\nThe Company's funeral homes offer a complete range of services including family consultation, the planning and arrangement of funeral services, the sale of caskets and related products, the removal and preparation of remains, the use of funeral home facilities for visitation and worship, the preparation of death certificates, transportation services and after-care services, such as support groups and self-help information.\nIn addition to traditional services, all of the Company's funeral homes offer cremation services. Consistent with the Company's clustering strategy, its four cremation facilities service five of the Company's six market areas. The Company's sixth operation uses independent cremation facilities located in its market. In addition to supporting its own operations, the Company also performs cremation services for third-party operations. Cremations are often combined with traditional funeral services and various types of memorialization, which are sold in packages prior to or at the time of need.\nThe Company's cemetery products and services include cemetery property (grave sites), lawn crypts, mausoleum spaces, internment niches, caskets, related vaults, markers, memorials and interment services. Cemetery operations generate revenues through pre-need and at-need sales, fees for interment services, marker and memorial installations, interest income from installment sales contracts and investment income from perpetual care trust funds and merchandise and service trust funds. A portion of the proceeds from certain cemetery sales is required by law to be paid into trust funds. Earning of perpetual care trust funds are used to maintain the cemeteries.\nPage 2 of 65\nDuring the fiscal year ended April 30, 1995, the Broward Operations accounted for approximately 75% of the Company's burials, 38% of the Company's funerals, 56% of the Company's revenues and 89% of the Company's earnings before interest, taxes, depreciation and amortization.\nA major focus of the Company's operations is the sale of prearranged funeral and cemetery products and services. The sale of a prearranged funeral service is a contractual right to a funeral service and other related services to be performed in the future. Prearranged funeral services are usually paid on an installment basis. The funds collected from prearranged funeral contracts are generally deposited into trust funds. Funds placed in trust for prearranged funerals may not be withdrawn until death or cancellation by the customer. The backlog of approximately 29,475 pre-need funeral services sold but not yet delivered at April 30, 1995 totaled $33,168,000 in deferred revenue. Prearranged funerals as a percentage of total funerals performed for the year ended April 30, 1995 were 44%.\nPre-need cemetery sales typically involve an installment sale contract covering an interment right in a Company cemetery and frequently includes caskets, related vaults, markers, and other merchandise or services. In the year ended April 30, 1995, approximately 90% of the Company's cemetery sales were on a pre-need basis. All or a portion of the proceeds from the sale of pre-need cemetery merchandise may be required to be paid into trust funds. See Note 1 of Notes to Consolidated Financial Statements for additional information regarding revenue recognition.\nEach funeral home and cemetery operation is managed by a local manager and each of the Company's funeral home and cemetery properties operates as a distinct profit center with annual operating budgets. Local managers have substantial autonomy with respect to the operation of the funeral home and cemetery and the manner in which services are conducted. The Company's 27 members of management and administrative staff, headquartered in Tallahassee, Florida, provide support functions to each of the Company's operations. These services include overall corporate planning and supervision, maintenance and monitoring of service quality, acquisition analysis, marketing and pricing strategy and coordination, as well as accounting services, investment trust management, budgeting, auditing, personnel and various other services.\nCOMPETITION\nAll of the Company's funeral home and cemetery operations are subject to extensive competition from both separately operated and combined local funeral homes and cemeteries in their respective markets. Market share for funeral homes is largely determined by reputation, location, tradition and heritage although the quality and condition of facilities and services, pricing and advertising also are important factors. The sale of pre-arranged funeral services has also become an increasingly important marketing tool for funeral homes to capture and influence market share. While the Company believes that cemetery and funeral home combinations such as the Broward Operations and the Pasco Operations have important competitive advantages, the Company believes that the high regard in which its operations are held in the communities in which they operate has been a significant factor in establishing and maintaining the favorable market positions of each operation.\nCemeteries receive the majority of their revenues from pre-need sales and, as such, pre-need sales efforts are important to obtain and maintain market share. Reputation, location, tradition, heritage and quality of maintenance of grounds also are important competitive factors.\nA significant area of competition for the Company is and will be acquisitions. There are several major publicly and privately owned companies that are aggressive buyers of funeral homes and cemeteries. Certain of those companies are larger and have greater financial resources than the Company. The Company believes that because of the large portion of the funeral and cemetery\nPage 3 of 65\nindustry that remains controlled by local family-owned firms, opportunities for growth through acquisitions continue to be significant. However, because of the competition for such acquisitions, prices paid for funeral homes and cemeteries have increased in recent years and may continue to do so. There can be no assurance that the Company will be able to make acquisitions on satisfactory terms and conditions.\nIn June of 1995, the Company engaged a financial advisor to provide investment banking services to the Company, including analysis of possible strategic investments in, or acquisitions of, the Company. While Company officials from time to time have discussed the possibility of such transactions with other industry participants, and expect to continue to do so, no such discussions have thus far resulted in any agreements or agreements in principle, nor has the Company altered its longstanding principal strategy of independence and growth through acquisitions.\nNET OPERATING LOSS CARRYFORWARD\nAs a result of losses incurred in connection with its operations prior to its entry into the funeral home and cemetery industry, the Company, as of April 30, 1995, had approximately $3,211,000 of net operating loss carryforwards for federal income tax purposes, $3,122,000 of which will expire over a period ending in 2002. Such losses may be applied to reduce the Company's future income tax liability. Under current tax law, a corporation's ability to carry forward its net operating loss following an \"ownership change\" is limited on an annual basis to an amount equal to the product of the fair market value of the corporation's outstanding stock (including qualifying preferred stock) immediately before the ownership change and the long-term tax-exempt interest rate, subject to certain adjustments for built-in gains of the corporation. The risk of change in a company's stock ownership is always present and may result from market purchases that are beyond the control of the company. As described in Note 14 of Notes to Consolidated Financial Statements, as of April 30, 1995, the risk of materially impairing the net operating loss carryforward has been significantly reduced.\nEMPLOYEES\nAs of April 30, 1995, the Company employed approximately 200 full-time persons, and 40 part time persons. Of these employees, approximately 78 persons are employed at the Broward Operations. As of April 30, 1995, there were 27 employees located at the Company's executive offices in Tallahassee, Florida, and all other employees are located in the Company's respective operating units. The Company has no union contracts and believes that its relationship with its employees is generally good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's executive offices are located at 3100 Capital Circle, NE, Tallahassee, Florida 32308, where the Company leases approximately 8,375 feet of office space. The term of the lease is for ten years ending in June 2002 with the Company having an option to renew the lease for two additional five year terms. Rent approximated $80,000 in fiscal year 1995. The building is leased from the Company's funeral service trust fund. See Note 17 to Notes to Consolidated Financial Statements.\nThe Company's dedicated cemetery properties located within the states of Florida and Colorado consist of approximately 151 acres, of which 83 acres have been developed.\nPage 4 of 65\nIn addition to its cemetery property, the Company owns 16 funeral chapels and administrative offices, four crematories and leases one funeral chapel and three sales offices. The Company considers its properties to be in excellent condition and adequate to satisfy business needs. The Company operated approximately 51 vehicles, all of which were owned at April 30, 1995.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is not currently involved in any material litigation nor, to management's knowledge, is any material litigation currently threatened against the Company, other than routine litigation arising in the ordinary course of business, most of which is expected to be covered by liability insurance. The Company carries insurance with coverages and coverage limits that it believes to be customary in the funeral home and cemetery industries. Although there can be no assurance that such insurance is sufficient to protect the Company against all contingencies, the Company believes that its insurance protection is reasonable in view of the nature and scope of the Company's operations.\nCHAPTER 11 REORGANIZATION\nOn December 3, 1984, the Company filed a petition for reorganization under provisions of Chapter 11 of the Bankruptcy Code. On April 15, 1986, the Court confirmed the Company's Plan of Reorganization which was approved by all classes of creditors and shareholders. However, the Court retained jurisdiction to take appropriate actions until all distributions had been made pursuant to the Plan and a final order terminating the Company's case had been entered. During fiscal year 1995, the Company extinguished all claims and the final decree was entered on March 16, 1995. See Note 11 of Notes to Consolidated Financial Statements for further information.\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 April 30, 1995.\nPage 5 of 65\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS\nCertain information required by this Item 5 is contained on Page 22 of the Company's 1995 Annual Report to Shareholders and is hereby incorporated herein by reference.\nThe Company's common stock is listed on the New York and Pacific Stock Exchanges.\nAs of June 26, 1995, there were approximately 3,386 holders of record of the Company's common stock.\nThere were no cash dividends paid on the Company's common stock for fiscal years ended April 30, 1995 or 1994. Significant restrictions apply to the Company's ability to pay such dividends. See Note 12 of Notes to Consolidated Financial Statements.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nSelected Financial Data on Page 4 of the Company's 1995 Annual Report to Shareholders is incorporated herein by reference.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe information required by this Item 7 is contained on Pages 5 to 8 of the Company's 1995 Annual Report to Shareholders and is hereby incorporated herein by this reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe consolidated financial statements included on Pages 9 to 21 of the Company's 1995 Annual Report to Shareholders is incorporated herein by reference.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPage 6 of 65\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation called for by Part III (Items 10, 11, 12 and 13) has been omitted as the Company intends to file with the Securities and Exchange Commission (the \"Commission\") not later than 120 days after the close of its fiscal year, a definitive Proxy Statement pursuant to General Instruction G of Form 10-K under the Securities Exchange Act of 1934. Such information will be set forth in such Proxy Statement under caption \"SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT,\" \"ELECTION OF DIRECTORS,\" \"EXECUTIVE COMPENSATION,\" \"COMPENSATION OF DIRECTORS,\" \"EMPLOYMENT CONTRACTS AND TERMINATION OF EMPLOYMENT AND CHANGE-IN-CONTROL ARRANGEMENTS,\" \"COMPENSATION AND STOCK OPTION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\" and \"CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS,\" 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) (1)-(2) Financial Statements and Schedules:\nThe financial statements and schedules listed in the accompanying Index to Consolidated Financial Statements at Page are filed as part of this report.\n(3) Exhibits:\nThe Exhibits listed on the accompanying Index to Exhibits at Pages E-1 through E-3 are filed as part of this report.\n(b) Reports on Form 8-K:\n(1) The Company did not file a Form 8-K in the fourth quarter of 1995.\nPage 7 of 65\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities and Exchange Act of 1934, the Registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nMHI GROUP, INC.\nDated: July 13, 1995 By: \/s\/ J.C. Ogier Mathewes ----------------- -------------------------------- J.C. Ogier Mathewes 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.\nPage 8 of 65\nINDEX TO EXHIBITS\nE-1\nPage 9 of 65\nE-2\nPage 10 of 65\n* Incorporated herein by reference.\n+ A management contract or compensatory plan or arrangement required to be filed pursuant to Item 14(c) of this report.\nE-3\nPage 11 of 65\nMHI GROUP, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS ITEM 14(A)(1) - (2)\nAll other schedules have been omitted because the required information is not applicable or is not present in amounts sufficient to require submission of the schedule or because the information required is included in the Consolidated Financial Statements, including the notes thereto.\nThe Consolidated Financial Statements listed in the above index, which are included in the 1995 Annual Report to Shareholders, are hereby incorporated by reference. With the exception of the information incorporated by reference into Items 5, 6, 7 and 8 of this Form 10-K, the 1995 Annual Report to Shareholders is not deemed filed as part of this Form 10-K report.\nThe report of Ernst & Young on the 1993 financial statements and financial statement schedules appears at Exhibit 13.1(a) and is incorporated herein by reference.\nPage 12 of 65\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS FINANCIAL STATEMENT SCHEDULES\nTo the Board of Directors of MHI Group, Inc.\nOur audits of the consolidated financial statements referred to in our report dated June 16, 1995 appearing on page 9 of the 1995 Annual Report to Shareholders of MHI Group, Inc. (which report and consolidated financial statements are incorporated by reference in this Annual Report on Form 10-K) also included an audit of the Financial Statement 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\nTampa, Florida June 16, 1995\nPage 13 of 65 Schedule VIII\nMHI GROUP, INC. AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS (000s OMITTED)\nPage 14 of 65","section_15":""}
{"filename":"790650_1995.txt","cik":"790650","year":"1995","section_1":"Item 1. Business\nGENERAL\nSouthern New England Telecommunications Corporation (\"Corporation\") was incorporated in 1986 under the laws of the State of Connecticut and has its principal executive offices at 227 Church Street, New Haven, Connecticut 06510 (telephone number (203) 771-5200). The Corporation is a holding company engaged through its subsidiaries in operations principally in Connecticut with expanded cellular services in Rhode Island and certain areas in Massachusetts. The Corporation has business units in the following telecommunications product groups: wireline; wireless; and information and entertainment. Wireline includes The Southern New England Telephone Company's telecommunications services; SNET America, Inc. (providing national and international long-distance services to Connecticut customers); and SNET Diversified Group, Inc. (providing premium telecommunications services and the selling and leasing of communications equipment to residential and business customers). Wireless includes SNET Cellular, Inc., SNET Mobility, Inc. and SNET Paging, Inc. (providing cellular (wholesale and retail), personal communications and paging resale services). Information and entertainment includes directory publishing, advertising and multimedia services. Non-telecommunications services include SNET Real Estate, Inc. (engaging in leasing commercial real estate) and the holding company (engaging in financial and strategic planning).\nWIRELINE\nThe Southern New England Telephone Company's Telecommunications Services\nThe Southern New England Telephone Company (\"Telephone Company\"), a local exchange carrier (\"LEC\"), was incorporated in 1882 under the laws of the State of Connecticut and is engaged in providing telecommunications services in Connecticut, most of which are subject to various degrees of rate regulation. These telecommunications services include: local and intrastate toll services; network access service, which links customers' premises to the facilities of other carriers; and other services such as digital transmission of data and transmission of radio and television programs, packet switched data network and private line services.\nIn 1995, approximately 70% of the Corporation's consolidated revenues and sales were derived from the Telephone Company's rate regulated telecommunications services. The remainder was derived principally from the Corporation's other subsidiaries, directory publishing operations, and activities associated with the provision of facilities and non-access services to interexchange carriers. About 71% of the operating revenues from rate regulated services were attributable to intrastate operations, with the remainder attributable to interstate access services.\nThe Telephone Company is subject to the jurisdiction of the Federal Communications Commission (\"FCC\") with respect to interstate rates, services, access charges and other matters, including the prescription of a uniform system of accounts. The FCC also prescribes the principles and procedures (referred to as \"separations procedures\") used to separate investments, revenues, expenses, taxes and reserves between the interstate and intrastate jurisdictions. In addition, the FCC has adopted accounting and cost allocation rules for the separation of costs of regulated from non-regulated telecommunications services for interstate ratemaking purposes. The Telephone Company's interstate services have been\nsubject to price cap regulation since January 1991. Price caps are a form of incentive regulation to limit prices and improve productivity. The price cap plan sets maximum limits on prices and requires LECs to share earnings in excess of authorized levels.\nThe Telephone Company, in providing telecommunications services in Connecticut, is subject to regulation by the Connecticut Department of Public Utility Control (\"DPUC\"), which has jurisdiction with respect to intrastate rates and services and other matters such as the approval of accounting procedures and the issuance of securities. The DPUC has adopted accounting and cost allocation rules for intrastate ratemaking purposes, similar to those adopted by the FCC, for the separation of costs of regulated from non-regulated activities. The Telephone Company's intrastate services have been subject to the traditional rate of return regulation. In 1996, the DPUC issued a decision that replaces traditional rate of return regulation with alternative (price based) regulation to be employed during the transition to full competition [see State Regulatory Initiatives].\nCompetition\nConnecticut's telecommunications industry continues to move toward a fully competitive marketplace brought about by legislative and regulatory initiatives during recent years. As a result of these initiatives, the Corporation is experiencing increased competition from interexchange carriers and competitive access providers with respect to the wireline's (Telephone Company's) existing services. Management supports bringing to customers the benefits of competition and affording all competitors the opportunity to compete fairly. As demand increases for telecommunications services in an increasingly competitive environment, the Corporation continues to seek growth opportunities beyond its traditional services.\nIn May 1994, the State of Connecticut Legislature enacted Public Act 94-83 (\"Act\"), providing a new regulatory framework for the Connecticut telecommunications industry. The Act, which took effect on July 1, 1994, represents a broad strategic response to the changes facing the telecommunications industry in Connecticut based on the premise that broader participation in the Connecticut telecommunications market will be more beneficial to the public than will broader regulation. The Act opens Connecticut telecommunications services to full competition, including local exchange service currently provided primarily by the Telephone Company, and encourages the DPUC to adopt alternative forms of regulation for telephone companies, including the Telephone Company.\nThe DPUC has conducted, and is conducting, a number of proceedings, in phases, to implement the Act. In the competitive phase, the DPUC addressed competition in the areas of: local exchange service; alternative operator services and customer owned coin operated telephone service; universal service and lifeline program policy issues; unbundling of LECs' local networks; and reclassification of LECs' products and services into non-competitive, emerging competitive and competitive categories. During the alternative regulation phase, the DPUC issued a decision replacing traditional rate of return regulation with alternative (price based) regulation to be employed during the transition to full competition. In addition, the alternative regulation phase involved a complete financial review of the Telephone Company and addressed cost of service, capital recovery and service standards [see State Regulatory Initiatives].\nThe Telephone Company's regulated services are subject to competition from companies and carriers, including competitive access providers, that construct and operate their own communications systems and networks, as well as from companies that resell the telecommunications systems and networks of underlying carriers. Over 85 telecommunications providers have received approval from the DPUC to\noffer \"10XXX\" or other competitive intrastate long-distance services. In addition, over 35 companies have filed for initial certificates of public convenience and necessity and are awaiting DPUC approval. The reduction in intrastate toll rates, and the increasingly competitive intrastate toll market continue to place significant downward pressure on intrastate toll revenues. Also contributing to lower intrastate toll revenues is the implementation of intrastate equal access for all dual preferred interexchange carrier (\"PIC\") capable switches by December 1, 1996. Although the DPUC ordered the Telephone Company to bear its proportionate share of the costs to deploy the dual PIC technology, the DPUC added the estimated 1996 average net toll revenue loss to the cost recovery formula. These costs will be recovered through an intrastate equal access rate element on the presubscribed lines of all carriers.\nSince the introduction of \"10XXX\" competition, major carriers have increased their marketing efforts in Connecticut to sell intrastate long-distance services to Connecticut customers. In response to competitors' efforts, the Telephone Company has undertaken a number of initiatives. The Telephone Company remains focused on providing excellent customer service and quality products and has made several changes to its product lines.\nThroughout 1995, the Telephone Company, with its affiliate, has enhanced several discount calling plans in its High Volume Discount Toll service offering and realigned its discount and rate structures to provide Connecticut customers with SNET All Distance[SM], a seamless toll service product line which includes a discount structure that combines intrastate, interstate and international calling. One such product, SNET All Distance Simple Solutions[SM], was made available to small business and residence customers beginning in September 1995. This easy-to- understand calling plan provides simple, competitive rates with a sliding discount based on calling volume.\nConcerning competition for local exchange service, seven telecommunications providers have been granted a certificate of public convenience and necessity for local service and one additional application is pending before the DPUC. The effect of increased competition on the Corporation's operating results cannot be predicted at this time. While some customers may purchase services from competitors, the Corporation expects that most competitors will utilize the Telephone Company's network and that increased network access revenues will offset a portion of local service revenues lost to competition. The Corporation's ability to compete continues to depend upon regulatory reform that will allow pricing flexibility to meet competition and provide a level playing field with similar regulation for similar services and with reduced regulation to reflect an emerging competitive marketplace. Local service competition began in early 1996.\nRegulatory Matters\nState Regulatory Initiatives\nIn March 1996, the DPUC issued a decision that replaces traditional rate of return regulation with alternative (price based) regulation to be employed during the transition to full competition. The decision contains the following major items: price cap regulation for non-competitive services; a five year monitoring period on financial results; and a price cap formula on services categorized as non-competitive (utilizing an inflation factor, a 5% productivity offset, a narrowly defined exogenous factor, a potential service quality adjustment and various pricing bands). In addition, basic local service rates for residence, business and coin are frozen until January 1, 1998, at which time the price cap formula becomes effective for these services. The decision also authorized a rate of return on the Telephone Company's common equity of 11.90% during the monitoring period. The impact of these changes on the Telephone Company's operating results will depend on the timing of classifying the various products and services into categories (non-competitive, emerging competitive and competitive) for pricing (banding)\nchanges. As of December 31, 1995, the Telephone Company's rate of return was below the 11.90% threshold.\nOn July 5, 1995, the Telephone Company filed a tariff with the DPUC to offer wholesale local service and certain related features. The service provides competitive local exchange carriers with an alternative to building facilities or constructing a ubiquitous network to meet their local service coverage obligations. On December 20, 1995, the DPUC, in a final decision, established interim rates for unbundled network elements and wholesale local service. The rates will remain in effect until the Telephone Company files revised cost studies during the second quarter of 1996.\nFederal Regulatory Initiatives\nOn February 1, 1996, the U.S. Congress passed legislation that created broad changes in telecommunications law and regulation nationwide. The primary thrust of this legislation opens local telecommunications markets to competition and allows the Regional Bell Operating Companies to provide long-distance services. In addition, the legislation permits telecommunications companies to enter the cable television business and eases cable regulation. The FCC is required to adopt terms and conditions to implement the legislation in the near term.\nThe majority of the federal legislation is consistent with legislation enacted by the State of Connecticut in 1994. Public Act 94-83 opened the Connecticut telecommunications market to competition, and the DPUC is nearing completion of the implementation proceedings. Certain provisions of the federal legislation relating to the prices the Telephone Company charges competitors for services could, however, have the effect of producing below cost prices, therefore necessitating the development of a significantly larger universal service fund than previously anticipated. If there are conflicts between state and federal law for LECs, including the Telephone Company, with less than 2% of the nationwide access lines, federal law prevails subject to a waiver and modification process included in the federal legislation. The DPUC may grant a waiver or modification of the federal law that is consistent with the public interest and avoids a significant adverse economic impact on users or a requirement that is unduly economically burdensome or technically infeasible.\nUnder price cap regulation, the FCC adopted an interim plan in 1995 for interstate access rates, requiring LECs to incorporate higher productivity targets into their rates. The interim plan requires LECs to choose from among three productivity factors: 4.0%, 4.7% or 5.3%. The selected factor is subtracted from inflation-based price increases allowed each year to account for increasing productivity. If either the 4.0% or 4.7% factor is chosen, LECs must share 50% of earnings above a 12.25% rate of return. In addition, all earnings above 13.25% and 16.25%, respectively, will be returned. If the 5.3% factor is chosen, all earnings can be retained without sharing. In addition, companies are required to reinitialize their price cap index (\"PCI\") on a one-time basis by reducing the PCI by 0.7% for each prior year in which they elected the 3.3% factor. The maximum PCI reduction over the four year price cap period would therefore be 2.8%. The Telephone Company has elected a 3.3% productivity factor each year since entering price cap regulation in 1991. Accordingly, the Telephone Company is required to reinitialize its PCI downward by 2.8%. The Telephone Company has joined a number of other LECs in filing an appeal with the D.C. Circuit Court of Appeals challenging the lawfulness of this interim plan. A decision on this appeal is expected in 1996.\nIn September 1995, the FCC released two further notices of proposed rulemaking that sought comment on changes to the established price cap plan including productivity measurements, sharing, common line formula, exogenous costs and necessary price cap rule changes to respond to a competitive environment for LECs. In response to the FCC, the Telephone Company commented that rule changes are required to\nallow price cap LECs to compete with alternate providers. The FCC is expected to adopt new price cap rules in 1996.\nThe Telephone Company's 1995 annual interstate access tariff filing under price cap regulation took effect August 1, 1995. The Telephone Company elected a 4.0% productivity factor and was allowed to earn up to a 12.25% interstate rate of return annually before any sharing is required. This filing, which was approved by the FCC, incorporated rate reductions of approximately $10 million in decreased interstate network access revenues for the period August 1, 1995 to June 30, 1996. Management expects this decrease to be partially offset by increased demand. As of December 31, 1995, the Telephone Company's interstate rate of return was below the 12.25% threshold.\nThe Telephone Company's 1994 annual interstate access tariff filing under price cap regulation took effect July 1, 1994. The Telephone Company elected a 3.3% productivity factor and was allowed to earn up to a 12.25% interstate rate of return annually before any sharing is required. This filing, which was approved by the FCC, incorporated rate reductions of approximately $7 million in decreased annual interstate network access revenues for the period July 1, 1994 to June 30, 1995. This decrease was offset by increased demand.\nThe Telephone Company will file its 1996 annual interstate access tariff on April 2, 1996 to become effective July 1, 1996. The filing will adjust interstate access rates for an experienced rate of inflation, the FCC's productivity target and exogenous cost changes, if any. The Telephone Company does not anticipate changing its 4.0% productivity factor election for the next tariff period.\nSince January 1, 1988, the Telephone Company has utilized an FCC approved, company-specific Cost Allocation Manual (\"CAM\"), which apportions costs between regulated and non-regulated activities, and describes transactions between the Telephone Company and its affiliates. In addition, the FCC requires larger LECs, including the Telephone Company, to undergo an annual independent audit to determine whether the LEC is in compliance with its approved CAM. The Telephone Company has received audit reports for 1988 through 1994 indicating it is in compliance with its CAM, and is currently undergoing an audit for the year 1995.\nCapital Expenditures\nThe network access lines provided by the Telephone Company to customers' premises can be interconnected with the access lines of other telephone companies in the United States and with telephone systems in most other countries. The following table sets forth, for the Telephone Company, the number of network access lines in service at the end of each year:\n1995 1994 1993 1992 1991 Network Access Lines in Service (thousands) 2,073 2,009 1,964 1,937 1,922\nThe Telephone Company has been making, and expects to continue to make, significant capital expenditures to meet the demand for regulated telecommunications services and to further improve such services [see discussion of I-SNET[SM] in Item 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe principal properties of the Corporation do not lend themselves to a detailed description by character and location. The majority of telecommunications property, plant and equipment of the Corporation is owned by the Telephone Company. Of the Corporation's investment in telecommunications property, plant and equipment at December 31, 1995, central office equipment represented 40%; connecting lines not on customers' premises, the majority of which are on or under public roads, highways or streets and the remainder on or under private property, represented 35%; land and buildings (occupied principally by central offices) represented 12%; telephone instruments and related wiring and equipment, including private branch exchanges, substantially all of which are on the premises of customers, represented 2%; and other, principally vehicles and general office equipment, represented 11%.\nSubstantially all of the central office equipment installations and administrative offices are located in Connecticut in buildings owned by the Telephone Company situated on land which it owns in fee. Many garages, service centers and some administrative offices are located in rented quarters.\nThe Corporation has a significant investment in the properties, facilities and equipment necessary to conduct its business with the overwhelming majority of this investment relating to telephone operations. Management believes that the Corporation's facilities and equipment are suitable and adequate for the business.\nThe buildout of I-SNET, a $4.5 billion investment over 15 years, is expected to be completed by 2009. I-SNET, a statewide telephony and information superhighway, is an advanced network capable of delivering voice, video and a full range of information and interactive multimedia services. I-SNET passed approximately 170,000 households by December 1995 and brought service to its first customer in October 1995. The Telephone Company expects I-SNET to pass approximately 230,000 households and provide telephony service on up to 80,000 lines by December 1996. The Telephone Company plans to support this investment primarily through increased productivity from the new technology deployed, ongoing cost-reduction initiatives and customer demand for the new services offered.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe Corporation and certain of its subsidiaries are involved in various claims and lawsuits that arise in the normal conduct of their business. In the opinion of management, upon advice of counsel, these claims will not have a material adverse effect on the financial position, operating results or cash flows of the Corporation or its subsidiaries.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNo matter was submitted to a vote of security holders in the fourth quarter of the fiscal year covered by this report.\nExecutive Officers of the Registrant (1) (as of February 29, 1996)\nExecutive Officer Name Age(2) Position Since\nDaniel J. Miglio 55 Chairman, President and Chief Executive Officer 1\/86 Jean M. LaVecchia 43 Senior Vice President- Organization Development 8\/94 Fred T. Page 49 Senior Vice President- Network Services 2\/96 Ronald M. Serrano 40 Senior Vice President-Communication, Information and Entertainment Group 1\/93 Donald R. Shassian 40 Senior Vice President and Chief Financial Officer 12\/93\n(1) Executive officers subject to Section 16 of the Securities Exchange Act of 1934. (2) As of December 31, 1995.\nMr. Miglio, Ms. LaVecchia and Mr. Page have held high level managerial positions with the Corporation or its subsidiaries for more than the past five years. Mr. Serrano was a Vice President of Mercer Management Consulting, Inc., (formerly Strategic Planning Associates) for more than five years prior to joining the Corporation. Mr. Shassian was a partner with Arthur Andersen & Co., independent accountants, for more than five years prior to joining the Corporation.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters\nThe common stock of the Corporation is listed on the New York and Pacific stock exchanges and the number of holders of record, computed on the basis of registered accounts, was 52,962 as of February 29, 1996. Information with respect to the quarterly high, low and closing sales price for the Corporation's common stock and quarterly cash dividends declared is included in the registrant's Annual Report to Shareholders on page 47 under the caption \"Market and Dividend Data\" and is incorporated herein by reference pursuant to General Instruction G(2).\nItems 6 through 8.\nInformation required under Items 6 through 8 is included in the registrant's combined Proxy Statement and 1995 Annual Report to Shareholders dated March 20, 1996 on pages 22 through 46 in their entirety and is incorporated herein by reference pursuant to General Instruction G(2).\nItem 9.","section_6":"","section_7":"","section_7A":"","section_8":"","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNo changes in or disagreements with accountants on any accounting or financial disclosure occurred during the period covered by this report.\nPART III\nItems 10 through 13.\nInformation required under Items 10 through 13 is included in the registrant's combined Proxy Statement and 1995 Annual Report to Shareholders dated March 20, 1996 on pages 1 (commencing under the caption \"Proxy Information\") through 5 and pages 8 through 11. Such information is incorporated herein by reference pursuant to General Instruction G(3).\nInformation regarding executive officers of the registrant required by Item 401(b) and (e) of Regulation S-K is included in Part I of this Annual Report on Form 10-K, following Item 4.\nPART IV\nItem 14.","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"Item 14. Exhibits, Financial Statement Schedule, and Reports on Form 8-K\n(a) Documents filed as part of the report: Page\n(1) Report on Consolidated Financial Statements *\nReport of Audit Committee *\nReport of Independent Accountants *\nConsolidated Financial Statements:\nConsolidated Statements of (Loss) Income - for the years ended December 31, 1995, 1994 and 1993 *\nConsolidated Balance Sheets - as of December 31, 1995 and 1994 *\nConsolidated Statements of Changes in Shareholders' Equity - for the years ended December 31, 1995, 1994 and 1993 *\nConsolidated Statements of Cash Flows - for the years ended December 31, 1995, 1994 and 1993 *\nNotes to Consolidated Financial Statements *\n(2) Consolidated Financial Statement Schedule for the year ended December 31, 1995\nReport of Independent Accountants 21\nII - Valuation and Qualifying Accounts 22\nSchedules other than those listed above have been omitted because the required information is contained in the financial statements and notes thereto, or because such schedules are not applicable.\n* Incorporated herein by reference to the appropriate portions of the registrant's combined Proxy Statement and 1995 Annual Report to Shareholders dated March 20, 1996 [see Part II].\n(3) Exhibits:\nExhibits identified in parentheses below, on file with the SEC, are incorporated herein by reference as exhibits hereto. Exhibits numbered 10(iii)(A)1 through 10(iii)(A)15 are management contracts or compensatory plans required to be filed as exhibits pursuant to Item 14 (c) of Form 10-K.\nExhibit Number\n3a Amended and Restated Certificate of Incorporation of the registrant as filed June 14, 1990 (Exhibit 3-A to Form SE dated 3\/15\/91, File No. 1-9157).\n3b By-Laws of the registrant as amended and restated through October 10, 1990 (Exhibit 3 to Form 8-K dated 10\/10\/90, File No. 1-9157).\n4a Rights Agreement dated February 11, 1987 between Southern New England Telecommunications Corporation and The State Street Bank and Trust Company, as Rights Agent (Exhibit 1 to Form SE dated 2\/13\/87-1, File No. 1-9157). Amendment No. 1 dated December 13, 1989 (Exhibit 4 to Form SE dated 12\/28\/89, File No. 1-9157). Amendment No. 2 dated October 10, 1990 (Exhibit 4 to Form SE dated 10\/12\/90, File No. 1-9157).\n4b Indenture dated December 13, 1993 between the registrant and Fleet National Bank of Connecticut, Trustee, issued in connection with the sale of $200,000,000 of 6 1\/8% Medium-Term Notes, Series C, due December 15, 2003 and $245,000,000 of 7 1\/4% Medium-Term Notes, Series C, due December 15, 2033 (Exhibit 4b to 1994 Form 10-K dated 3\/10\/95, File No. 1-9157).\n4c Indenture dated July 10, 1991 between the registrant and Fleet National Bank of Connecticut, Trustee, issued in connection with the sale of $100,000,000 of 6 1\/2% Medium-Term Notes, Series 2, due August 15, 2000 and $200,000,000 of 7% Medium-Term Notes, Series 2, due August 15, 2005.\n10(iii)(A)1 SNET Short Term Incentive Plan as amended February 8, 1995 (Exhibit 10(iii)(A)1 to 1994 Form 10-K dated 3\/10\/95, File No. 1-9157).\n10(iii)(A)2 SNET Long Term Incentive Plan as amended March 1, 1993 (Exhibit 10(iii)(A)2 to 1992 Form 10-K dated 3\/23\/93, File No. 1-9157).\n10(iii)(A)3 SNET Financial Counseling Program as amended January 1987 (Exhibit 10-D to Form SE dated 3\/23\/87-1, File No. 1-9157).\n10(iii)(A)4 Group Life Insurance Plan and Accidental Death and Dismemberment Benefits Plan for Outside Directors of SNET as amended July 1, 1986 (Exhibit 10-E to Form SE dated 3\/23\/87-1, File No. 1-9157).\n(3) Exhibits (continued):\nExhibit Number 10(iii)(A)5 SNET Pension Benefit Plan as amended November 1, 1991 (Exhibit 10-A to Form SE dated 3\/20\/92, File No. 1-9157). Amendment dated December 8, 1993 (Exhibit 10 (iii)(A)5 to 1993 Form 10-K dated 3\/23\/94, File No. 1-9157). Amendment dated February 8, 1995 (Exhibit 10(iii)(A)5 to 1994 Form 10-K dated 3\/10\/95, File No. 1-9157). Amendments effective December 13, 1995 and January 1, 1996 .\n10(iii)(A)6 SNET Management Pension Plan as amended March 31, 1995. Amendments effective December 20, 1995 through April 1, 1996.\n10(iii)(A)7 SNET Incentive Award Deferral Plan as amended March 1, 1993 (Exhibit 10(iii)(A)7 to 1992 Form 10-K dated 3\/23\/93, File No. 1-9157).\n10(iii)(A)8 SNET Mid-Career Pension Plan as amended November 1, 1991 (Exhibit 10-D to Form SE dated 3\/20\/92, File No. 1-9157). Amendment dated December 8, 1993 (Exhibit 10 (iii)(A)8 to 1993 Form 10-K dated 3\/23\/94, File No. 1-9157).\n10(iii)(A)9 SNET Deferred Compensation Plan for Non-Employee Directors as amended January 1, 1993 (Exhibit 10(iii)(A)9 to 1992 Form 10-K dated 3\/23\/93, File No. 1-9157).\n10(iii)(A)10 Change-in-Control Agreements (Exhibit 10-F to Form SE dated 3\/15\/91, File No. 1-9157).\n10(iii)(A)11 SNET 1986 Stock Option Plan as amended March 1, 1993 (Exhibit 10(iii)(A)11 to 1992 Form 10-K dated 3\/23\/93, File No. 1-9157).\n10(iii)(A)12 SNET Retirement and Disability Plan for Non- Employee Directors as amended April 14, 1993 (Exhibit 10(iii)(A)12 to 1993 Form 10-K dated 3\/23\/94, File No. 1-9157). Amendment dated January 1, 1994 (Exhibit 10(iii)(A)12 to 1994 Form 10-K dated 3\/10\/95, File No. . 1-9157).\n10(iii)(A)13 SNET Non-Employee Director Stock Plan effective January 1, 1994 (Exhibit 4.4 to Registration No. 33-51055, File No. 1-9157).\n10(iii)(A)14 Description of SNET Executive Retirement Savings Plan (Exhibit 10(iii)(A)14 to 1993 Form 10-K dated 3\/23\/94, File No. 1-9157).\n10(iii)(A)15 SNET 1995 Stock Incentive Plan (Exhibit 4.4 to Registration No. 33-64975, File No. 1-9157).\n(3) Exhibits (continued):\nExhibit Number\n12 Computation of Ratio of Earnings to Fixed Charges.\n13 Pages 22 through 47 of the registrant's combined Proxy Statement and 1995 Annual Report to Shareholders for the fiscal year ended December 31, 1995.\n21 Subsidiaries of the Corporation.\n23 Consent of Independent Accountants.\n24a Power of Attorney.\n24b Board of Directors' Resolution.\n27 Financial Data Schedule.\n99a Annual Report on Form 11-K for the plan year ended December 31, 1995 for the SNET Management Retirement Savings Plan will be filed as an amendment prior to June 30, 1996.\n99b Annual Report on Form 11-K for the plan year ended December 31, 1995 for the SNET Bargaining Unit Retirement Savings Plan will be filed as an amendment prior to June 30, 1996.\nThe Corporation will furnish, without charge, to a shareholder upon request a copy of the combined Proxy Statement and 1995 Annual Report to Shareholders, portions of which are incorporated by reference, and will furnish any other exhibit at cost.\n(b) Reports on Form 8-K:\nOn October 24, 1995, the Corporation and the Telephone Company filed, separately, reports on Form 8-K, dated October 23, 1995 announcing the Corporation's financial results for the third quarter of 1995.\nOn January 22, 1996, the Corporation and the Telephone Company filed, separately, reports on Form 8-K, dated January 22, 1996, announcing the Corporation's 1995 financial results including the fact that it discontinued the use of Statement of Financial Accounting Standards No. 71, \"Accounting for the Effects of Certain Types of Regulation.\"\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nSOUTHERN NEW ENGLAND TELECOMMUNICATIONS CORPORATION\nBy \/s\/ Donald R. Shassian Donald R. Shassian, Senior Vice President and Chief Financial Officer March 20, 1996\nPursuant to the requirements of the Securities Exchange Act 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:\nDaniel J. Miglio* Chairman, President, Chief Executive Officer and Director\nPRINCIPAL FINANCIAL AND ACCOUNTING OFFICER:\nDonald R. Shassian By \/s\/ Donald R. Shassian Senior Vice President and (Donald R. Shassian,as attorney- Chief Financial Officer in-fact and on his own behalf)\nDIRECTORS:\nWilliam F. Andrews* Richard H. Ayers* Zoe Baird* Robert L. Bennett* Barry M. Bloom* March 20, 1996 Frank J. Connor* William R. Fenoglio* Claire L. Gaudiani* James R. Greenfield* Ira D. Hall* Burton G. Malkiel* Frank R. O'Keefe, Jr.* * by power of attorney\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Shareholders of Southern New England Telecommunications Corporation:\nOur report on the consolidated financial statements of Southern New England Telecommunications Corporation has been incorporated by reference in this Form 10-K from the combined Proxy Statement and 1995 Annual Report to Shareholders of Southern New England Telecommunications Corporation on page 29 therein. In connection with our audits of such financial statements, we have also audited the related financial statement schedule for each of the three years in the period ended December 31, 1995 listed in Item 14 (a) (2) of this Form 10-K.\nIn our opinion, the financial statement schedule referred to above, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information required to be included therein.\nHartford, Connecticut COOPERS & LYBRAND L.L.P. January 22, 1996\nSOUTHERN NEW ENGLAND TELECOMMUNICATIONS CORPORATION\nSCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS (Dollars in Millions)\nCOLUMN A COLUMN B COLUMN C COLUMN D COLUMN E\nAdditions Balance at Balance at beginning Charged to Charged to end of Description of period expense other accounts Deductions period\nAllowance for Uncollectible Accounts Receivable:\nYear 1995 $29.8 $23.1 $3.6 (a) $22.3 (b) $34.2 Year 1994 27.9 20.7 7.5 (a) 26.3 (b) 29.8 Year 1993 23.5 28.4 4.9 (a) 28.9 (b) 27.9\nAllowance for Uncollectible Direct-Financing Lease Notes Receivable:\nYear 1995 $ 8.4 $ 1.4 $ - $ 0.1 (b) $ 9.7 Year 1994 11.7 1.7 - 5.0 (b) 8.4 Year 1993 8.2 15.6 - 12.1 (b) 11.7\nRestructuring Charge:\nYear 1995 $264.9 $ - $ - $187.9 (c) $ 77.0 Year 1994 355.0 - - 90.1 (c) 264.9 Year 1993 - 355.0 - - 355.0\n(a) Includes amounts previously written off that were credited directly to this account when recovered and miscellaneous amounts.\n(b) Includes amounts written off as uncollectible.\n(c) Includes non-cash amounts charged against the restructuring reserve of $98.8 in 1995 and $26.5 in 1994, primarily net pension and postretirement curtailment losses.\nExhibit Index\nExhibits identified in parentheses below, on file with the SEC, are incorporated herein by reference as exhibits hereto.\nExhibit Number\n3a Amended and Restated Certificate of Incorporation of the registrant as filed June 14, 1990 (Exhibit 3-A to Form SE dated 3\/15\/91, File No. 1-9157).\n3b By-Laws of the registrant as amended and restated through October 10, 1990 (Exhibit 3 to Form 8-K dated 10\/10\/90, File No. 1-9157).\n4a Rights Agreement dated February 11, 1987 between Southern New England Telecommunications Corporation and The State Street Bank and Trust Company, as Rights Agent (Exhibit 1 to Form SE dated 2\/13\/87-1, File No. 1-9157). Amendment No. 1 dated December 13, 1989 (Exhibit 4 to Form SE dated 12\/28\/89, File No. 1-9157). Amendment No. 2 dated October 10, 1990 (Exhibit 4 to Form SE dated 10\/12\/90, File No. 1-9157).\n4b Indenture dated December 13, 1993 between the registrant and Fleet National Bank of Connecticut, Trustee, issued in connection with the sale of $200,000,000 of 6 1\/8% Medium-Term Notes, Series C, due December 15, 2003 and $245,000,000 of 7 1\/4% Medium-Term Notes, Series C, due December 15, 2033 (Exhibit 4b to 1994 Form 10-K dated 3\/10\/95, File No. 1-9157).\n4c Indenture dated July 10, 1991 between the registrant and Fleet National Bank of Connecticut, Trustee, issued in connection with the sale of $100,000,000 of 6 1\/2% Medium-Term Notes, Series 2, due August 15, 2000 and $200,000,000 of 7% Medium-Term Notes, Series 2, due August 15, 2005.\n10(iii)(A)1 SNET Short Term Incentive Plan as amended February 8, 1995 (Exhibit 10(iii)(A)1 to 1994 Form 10-K dated 3\/10\/95, File No. 1-9157).\n10(iii)(A)2 SNET Long Term Incentive Plan as amended March 1, 1993 (Exhibit 10(iii)(A)2 to 1992 Form 10-K dated 3\/23\/93, File No. 1-9157).\n10(iii)(A)3 SNET Financial Counseling Program as amended January 1987 (Exhibit 10-D to Form SE dated 3\/23\/87-1, File No. 1-9157).\n10(iii)(A)4 Group Life Insurance Plan and Accidental Death and Dismemberment Benefits Plan for Outside Directors of SNET as amended July 1, 1986 (Exhibit 10-E to Form SE dated 3\/23\/87-1, File No. 1-9157).\n10(iii)(A)5 SNET Pension Benefit Plan as amended November 1, 1991 (Exhibit 10-A to Form SE dated 3\/20\/92, File No. 1-9157). Amendment dated December 8, 1993 (Exhibit 10 (iii)(A)5 to 1993 Form 10-K dated 3\/23\/94, File No. 1-9157). Amendment dated February 8, 1995 (Exhibit 10(iii)(A)5 to 1994 Form 10-K dated 3\/10\/95, File No. 1-9157). Amendments effective December 13, 1995 and January 1, 1996 .\n10(iii)(A)6 SNET Management Pension Plan as amended March 31, 1995. Amendments effective December 20, 1995 through April 1, 1996.\n10(iii)(A)7 SNET Incentive Award Deferral Plan as amended March 1, 1993 (Exhibit 10(iii)(A)7 to 1992 Form 10-K dated 3\/23\/93, File No. 1-9157).\n10(iii)(A)8 SNET Mid-Career Pension Plan as amended November 1, 1991 (Exhibit 10-D to Form SE dated 3\/20\/92, File No. 1-9157). Amendment dated December 8, 1993 (Exhibit 10 (iii)(A)8 to 1993 Form 10-K dated 3\/23\/94, File No. 1-9157).\n10(iii)(A)9 SNET Deferred Compensation Plan for Non-Employee Directors as amended January 1, 1993 (Exhibit 10(iii)(A)9 to 1992 Form 10-K dated 3\/23\/93, File No. 1-9157).\n10(iii)(A)10 Change-in-Control Agreements (Exhibit 10-F to Form SE dated 3\/15\/91, File No. 1-9157).\n10(iii)(A)11 SNET 1986 Stock Option Plan as amended March 1, 1993 (Exhibit 10(iii)(A)11 to 1992 Form 10-K dated 3\/23\/93, File No. 1-9157).\n10(iii)(A)12 SNET Retirement and Disability Plan for Non- Employee Directors as amended April 14, 1993 (Exhibit 10(iii)(A)12 to 1993 Form 10-K dated 3\/23\/94, File No. 1-9157). Amendment dated January 1, 1994 (Exhibit 10(iii)(A)12 to 1994 Form 10-K dated 3\/10\/95, File No. . 1-9157).\n10(iii)(A)13 SNET Non-Employee Director Stock Plan effective January 1, 1994 (Exhibit 4.4 to Registration No. 33-51055, File No. 1-9157).\n10(iii)(A)14 Description of SNET Executive Retirement Savings Plan (Exhibit 10(iii)(A)14 to 1993 Form 10-K dated 3\/23\/94, File No. 1-9157).\n10(iii)(A)15 SNET 1995 Stock Incentive Plan (Exhibit 4.4 to Registration No. 33-64975, File No. 1-9157).\n12 Computation of Ratio of Earnings to Fixed Charges.\n13 Pages 22 through 47 of the registrant's combined Proxy Statement and 1995 Annual Report to Shareholders for the fiscal year ended December 31, 1995.\n21 Subsidiaries of the Corporation.\n23 Consent of Independent Accountants.\n24a Power of Attorney.\n24b Board of Directors' Resolution.\n27 Financial Data Schedule.\n99a Annual Report on Form 11-K for the plan year ended December 31, 1995 for the SNET Management Retirement Savings Plan will be filed as an amendment prior to June 30, 1996.\n99b Annual Report on Form 11-K for the plan year ended December 31, 1995 for the SNET Bargaining Unit Retirement Savings Plan will be filed as an amendment prior to June 30, 1996.","section_15":""}
{"filename":"859119_1995.txt","cik":"859119","year":"1995","section_1":"Item 1. Business Background\nIllinois Central Corporation (the \"Company\"), was incorporated under the laws of Delaware on January 27, 1989. The Company, through its wholly-owned subsidiary, Illinois Central Railroad Company (the \"Railroad\") traces its origin to 1851, when the Railroad was incorporated as the nation's first land grant railroad. Today, the Railroad operates 2,700 miles of main line track between Chicago and the Gulf of Mexico, primarily carrying chemicals, coal and paper north, with coal, grain and milled grain products moving south along its lines. In addition to the Railroad, the Company's other direct subsidiary conducts railroad related financing operations.\nThe principal executive office of the Company is located at 455 North Cityfront Plaza Drive, Chicago, Illinois 60611-5504 and its telephone number is (312) 755-7500.\nThe 1992 Four-Year Growth Plan and Plan2000\nIn the fall of 1992, the Company announced a four-year growth plan designed to increase revenues $100 million to $647 million, reduce the operating ratio four percentage points to 66.7% and reduce interest expense $10 million to $34 million. By December 31, 1994, the Company had achieved the operating ratio and interest expense reduction goals. Therefore, in the spring of 1995, the Company developed and announced Plan2000. This new plan is designed to build on the success of the 1992 plan and position the Company for the next century. Plan2000 calls for (i) revenue to grow from the 1994 base of $594 million to $800 million by the end of 1999, (ii) the continued reduction of the operating ratio to below 60%, and (iii) a Long-Term Equity Enhancement Program of increased dividends and share repurchases.\nAs of December 31, 1995, following revenue increases of 3.1%, 5.2% and 8.4% in 1993, 1994 and 1995, respectively, revenue was 17.6% higher than 1992 and only $3 million below the original four year $100 million target. The 1995 revenue of $644 million is slightly ahead of the 1995 target specified in Plan2000. Contributing to the revenue growth since 1992 were gains in intermodal (57.7%), grain and grain mill (22.9%), and chemicals (14.4%), despite a decline in coal (.6%).\nSee \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Significant Developments.\"\nCommodities and Customers\nThe Railroad's customers are engaged in a wide variety of businesses and ship a number of different products that can be classified into commodity groups: chemicals, coal, grain, paper, grain mill and food products and other commodities. In 1995, two customers each accounted for approximately 6% of revenues (no other customer exceeded 5%) and the ten largest customers accounted for approximately 35% of revenues.\nIn 1995, approximately 71% of the Railroad's freight traffic originated on its own lines, of which approximately 22% was forwarded to other carriers. Approximately 16% of the Railroad's freight traffic was received from other carriers for final delivery by the Railroad, and the balance of approximately 13% represented bridge or through traffic.\nIn order to address more effectively the diversity of the Company's customer base, the Railroad's marketing department was re- organized in late 1995 into two major groups - Bulk and Consumer Products. The Bulk group is responsible for coal, chemicals and grain products. The Consumer group covers forest products, intermodal and metals. The formation of separate units enables a fully integrated sales and marketing effort. Specialization allows employees to anticipate and respond to customer needs more quickly, and to establish business relationships with new shippers. These new units work with current and prospective customers to develop customized shipping solutions. Management believes that this commitment to improved customer service will enhance relations with shippers.\nThe respective percentage contributions by principal commodity group to the Railroad's freight revenues and revenue ton miles during the past five years are set forth below:\nContributions to Total Freight Revenues by Commodity Group Commodity Group 1995 1994 1993 1992 1991 Chemicals 25.3 % 24.8% 25.0% 24.3% 24.5% Coal 14.0 15.2 12.8 15.3 15.0 Grain 14.4 10.2 14.0 12.2 11.7 Paper 12.9 12.2 12.4 12.1 11.2 Grain mill & food products 9.1 8.5 9.8 8.8 8.7 Intermodal 7.9 6.6 5.4 5.4 5.2 All other 16.4 22.5 20.6 21.9 23.7 Total 100.0% 100.0% 100.0% 100.0% 100.0%\nContribution to Revenue Ton Miles by Commodity Group\nCommodity Group 1995 1994 1993 1992 1991 Chemicals 14.6% 15.8% 15.9% 15.1% 16.0% Coal 20.8 24.0 15.1 18.2 17.0 Grain 26.8 20.0 27.9 27.3 27.7 Paper 9.0 9.8 9.6 9.0 8.4 Grain mill & food products 9.8 9.3 9.9 9.0 8.3 Intermodal 5.5 5.5 3.7 3.1 2.9 All other 13.5 15.6 17.9 18.3 19.7 Total 100.0% 100.0% 100.0% 100.0% 100.0%\nThe principal elements of these commodity groupings are as follows:\nChemicals A wide variety of chemicals and related products such as chlorine, caustic soda, potash, soda ash, vinyl chloride monomer, carbon dioxide, synthetic resins, alcohols, glycols, styrene monomer, plastics, sulfuric acid, muriatic acid, anhydrous ammonia, phosphates, mixed fertilizer compounds and carbon blacks.\nCoal Bituminous and metallurgical coal.\nGrain Corn, wheat, soybeans, sorghum, barley and oats.\nPaper Pulpboard, fiberboard, woodpulp, printing paper, newsprint and scrap or waste paper. Grain Mill & Food Products Products obtained by processing grain and other farm products such as feed, soybean meal, corn syrup, flour and middlings, animal packinghouse by-products (tallow), canned food, corn oil, soybean oil, vegetable oils, malt liquors, sugar and molasses.\nIntermodal A wide variety of products shipped either in containers or trailers on specially designed cars.\nOther Pulpwood and chips, lumber and other wood products; sand, gravel and stone, coke and petroleum products, metallic ores and other bulk commodities; primary and scrap metals, machinery and metal products, appliances, automobiles and parts, transportation equipment and farm machinery; glass and clay products, ordnance and explosives, rubber and plastic products, and general commodities.\nOperating Statistics\nSet forth below is certain information relating to the Railroad's freight traffic during the past five years:\n1995 1994 1993 1992 1991 Carloads (in thousands) 957 915 848 852 866 Freight train miles(in thousands)(1) 7,758 7,179 5,659 5,149 5,445 Revenue ton miles of freight traffic (in millions)(2) 24,635 21,160 20,334 18,734 19,357 Revenue tons per carload 74.7 76.3 79.1 76.6 79.0 Average length of haul(in miles) 328 286 293 284 286 Gross freight revenue per ton mile(3) $.025 $ .027 $ .027 $ .029 $ .028 Net freight ton miles per average route mile(in millions) 9.3 7.9 7.5 6.8 7.0 Gallons per ton mile(4) .00234 .00248 .00251 .00269 .00276 Active locomotives 333 328 322 331 361 Track resurfacing (miles) 1,360 1,397 1,293 1,465 940 Percent re- surfaced 32.2% 33.0% 29.8% 32.0% 19.6% Ties laid in replacement (including switch ties) 408,760 346,994 323,764 296,536 255,283 Slow order miles 209.76 275.79 152.32 135.42 194.62\n1 Freight train miles equals the total number of miles traveled by the Railroad's trains in the movement of freight. 2 Revenue ton miles of freight traffic equals the product of the weight in tons of freight carried for hire and the distance in miles between origin and destination. 3 Revenue per ton mile equals net freight revenue divided by revenue ton miles of freight traffic. 4 Gallons per ton mile equals the amount of fuel required to move one ton of freight one mile.\nThe following tables summarize operating expense-to-revenue ratios of the Company for each of the past five years, excluding the effect of the $8.9 million pretax special charge in 1992. The first table analyzes the various components of operating expenses based on the line items appearing on the income statements, whereas the second table is based on Surface Transportation Board (\"STB\") functional groupings.\nRatio 1995 1994 1993 1992 1991\nOperating (1) 64.2% 66.3% 68.2% 70.7% 73.5% Labor and fringe benefits 30.3 31.0 31.1 32.0 32.4 Leases and car hire 7.2 8.2 11.9 12.6 13.6 Diesel fuel 5.2 5.3 5.4 5.5 6.0 Materials and supplies 5.4 6.0 6.2 5.8 5.5 Depreciation and amortization 5.3 4.6 4.2 4.4 3.8 Casualty, insurance and losses 2.7 4.0 3.8 4.8 7.2 Other taxes 2.8 3.0 2.9 2.4 1.9 Other 5.3 4.2 2.7 3.2 3.1\n1995 1994 1993 1992 1991\nOperating (1) 64.2% 66.3% 68.2% 70.7% 73.5% Transportation(2) 28.0 28.9 29.6 31.6 34.8 Maintenance of way (3) 7.8 7.7 7.2 7.0 6.4 Maintenance of equipment (4) 18.9 19.2 20.7 22.5 23.9\n1 Operating ratio means the ratio of operating expenses before special charge over operating revenues. 2 Transportation ratio means the ratio of transportation expenses (such as expenses of operating, servicing, inspecting, weighing, assembling and switching trains) over operating revenues. 3 Maintenance of way ratio means the ratio of maintenance of way expenses (such as the expense of repairing, maintaining, leasing, depreciating and retiring right-of-way and trackage structures, buildings and facilities) over operating revenues. 4 Maintenance of equipment ratio means the ratio of maintenance of equipment expenses (such as the expense of repairing, maintaining, leasing, depreciating and retiring transportation and other operating equipment) over operating revenues.\nEmployees; Labor Relations\nRailroad industry personnel are covered by the Railroad Retirement System instead of Social Security. Employer contribution rates under the Railroad Retirement System are currently more than double those in other industries and may rise further because of the increasing proportion of retired employees receiving benefits relative to the shrinking number of working employees.\nLabor relations in the railroad industry is subject to extensive governmental regulation under the Railway Labor Act. Railroad employees are also covered by the Federal Employer's Liability Act (\"FELA\") rather than by state no-fault workmen's compensation systems. FELA is a fault-based system, with compensation for injuries determined by individual negotiation or litigation.\nApproximately 90% of all Railroad Employees are represented by a union. Prior to 1994, the Railroad had been a party to several national collective bargaining agreements which, until 1994, established the wages and benefits of its union workers. These agreements became subject to renegotiation beginning November 1, 1994, when bargaining notices were filed; however, cost of living allowance provisions and other terms in each agreement continue until new agreements are reached. Beginning in late 1994, the Railroad began negotiating separate distinct agreements with each of its eleven unions on a local basis. To date, eight unions, representing 42% of the Railroad's represented workforce, have ratified agreements which cover wages and work rule issues through 1999. During the term of these agreements wages will rise approximately 3%-4% per year on average. In reaching these agreements, approximately $1.2 million was paid in signing bonuses. It is too early to determine if separate agreements will be reached with the other crafts, although on November 10, 1995, a tentative agreement was reached with the United Transportation Union (\"UTU\"), subject to membership ratification. This agreement represented a significant change in the basis of paying operating employees, with an hourly wage system replacing a mileage-based system. On February 28, 1996, the Company was notified by the UTU that its members had rejected the agreement. As a result, no amounts have been reflected in the Consolidated Financial Statements associated with this agreement. The Company will seek the counsel of the National Mediation Board who facilitated the agreement in November. The following table shows the average annual employment levels of the Railroad:\n1995 1994 1993 1992 1991 Total employees 3,268 3,250 3,306 3,421 3,611\nA substantial portion of the decline from the 1992 level is the result of a separate agreement between the Railroad and the UTU, reached in November 1991. This agreement permits the Railroad to reduce the size of all crews on all trains operated. In accordance with this agreement, 158 crew members were severed at a cost of $9.6 million to date. The current crew size of approximately 2.74 is not expected to change significantly.\nManagement believes that over the next several years attrition and retirements will be the primary source of future declines in employment levels. Increases in employment levels, particularly in train operations, are possible in response to growth of business in accordance with Plan2000. See also, \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Significant Developments - CCP Holdings, Inc. Acquisition.\"\nRegulatory Matters; Freight Rates; Environmental Considerations\nThe Railroad is subject to significant governmental regulation by the STB and other federal, state and local regulatory authorities with respect to rates, service, safety and operations.\nThe jurisdiction of the STB encompasses, among other things,rates charged for certain transportation services, assumption of certain liabilities by railroads, mergers or the acquisition of control of one carrier by another carrier and extension or abandonment of rail lines or services.\nThe Federal Railroad Administration, the Occupational Safety and Health Administration and certain state transportation agencies have jurisdiction over railroad safety matters. These agencies prescribe and enforce regulations concerning car and locomotive safety equipment, track safety standards, employee work conditions and other operating practices.\nThe amount of Southern Illinois coal transported by the Railroad is expected to decline somewhat as the Clean Air Act is fully implemented. Much of the coal from mines in that area currently served by the Railroad will not meet the environmental standards of the Clean Air Act without blending with compliance coal or installation of air scrubbers at point of use. On the other hand, the Railroad expects to participate in additional movements of Western coal and Southern Illinois coal which does comply. Overall, management believes that implementation of the Clean Air Act is unlikely to have a material adverse effect on the results of the Company.\nThe Company is and will continue to be subject to extensive regulation under environmental laws and regulations concerning, among other things, discharges into the environment and the handling, storage, transportation and disposal of waste and hazardous materials. Inherent in the operations and real estate activities of the Company and other railroads is the risk of environmental liabilities. See Item 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nPhysical Plant and Equipment\nSystem. As of December 31, 1995, the Railroad's total system consisted of approximately 4,600 miles of track comprised of 2,700 miles of main line, 200 miles of secondary main line and 1,700 miles of passing, yard and switching track. The Railroad owns all of the track except for 190 miles operated by agreements over track owned by other railroads.\nTrack Structures. During the five years ended December 31, 1995, the Railroad has spent $394.5 million on track structure to construct and maintain its rail lines, as follows ($ in millions):\nCapital Expenditures Maintenance Total\n1995 $ 66.9 $ 33.5 $100.4 1994 63.2 29.1 92.3 1993 50.3 25.1 75.4 1992 46.4 23.0 69.4 1991 36.3 20.7 57.0\nTotal $263.1 $131.4 $394.5\nThese expenditures concentrated primarily on track roadway and bridge rehabilitation over the last four years. Approximately, 1,400 miles of road were resurfaced in each of the last three years. During 1994 and 1993, approximately $11.4 million was spent to complete the conversion of 198 miles of track, known as the Yazoo District, to a single track with centralized traffic control (\"CTC\"). In 1992 through 1994, a total of $11.4 million was spent to construct new or expanded intermodal facilities in Chicago and Memphis. Expenditures in 1991 benefited from the use of reclaimed rail, cross ties, ballast and other track materials from the second main line when the Railroad's double- track mainline was converted to a single-track mainline with CTC. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" for a discussion of future capital expenditures.\nFleet. The Company's fleet has undergone significant rationalization and modernization since 1985 when locomotives and cars were at their peak of 862 and 28,616, respectively. Over the last four years purchases of 59 used SD-40-2's and 20-new SD-70's have enabled the Railroad to replace older, lower horsepower and less efficient locomotives. The SD-70's, acquired in 1995, replaced 31 older smaller locomotives. These locomotives are owned by the Company's financing\/leasing subsidiaries and are leased to the Railroad.\nThese acquisitions were part of an equipment program implemented in 1993, to increase ownership of its equipment. The program includes lease conversions whereby equipment is acquired outright or leased under more favorable lease terms by the Company. To date, the conversion program has involved 118 locomotives and 4,228 freight cars. As a result of the new lease terms, $24.7 million of capital leases were recorded in 1994. Most of these leases contain fixed price options whereby the equipment can be acquired at or below fair market value at some point during the lease term.\nApproximately 1,800 of the Company's financing\/leasing subsidiaries cars acquired are leased to the Railroad as well. The remaining cars are leased to other non-affiliated companies. When those leases expire, the Railroad has first right of refusal to lease the equipment. As these cars are leased to the Railroad other leased equipment will be returned to the independent, third-party lessors or short-term car hire agreements will be terminated.\nThe third segment of the equipment program was a significant upgrade of the highway trailer fleet used in intermodal service. In 1992 all old leased trailers, approximately 880, were replaced with 800 newly built trailers. To further address expanded intermodal volume, another 100 trailers were added in 1994.\nDuring 1994 the Railroad repaired and reconditioned approximately 173 cars at a cost of $2.9 million. This equipment is being leased on a short-term basis to other carriers until the Railroad anticipates it will need the equipment for its expansion.\nThe following is the overall fleet at December 31:\nTotal Units: 1995 1994 1993 1992 1991 Locomotives (1) 397 417 468 449 470 Freight cars 15,872 16,498 16,634 15,877 16,381 Work equipment 654 625 745 902 881 Highway trailers 898 898 898 203 124\n1 Approximately 56 locomotives need repair before they can be returned to service. This equipment is repaired if needed on an ongoing basis or sold. The Railroad sold 40, 48, 23 and 66 surplus locomotives in 1995, 1994, 1993 and 1992, respectively. The active fleet is 333 as of December 31, 1995.\nThe components of the fleet by subsidiary and in total for 1995 and in total for 1994 are shown below:\nLeasing Subsid- iaries Railroad(3) 1995 1994 Description Total Owned(2) Leased Total Total Total\nLocomotives:\nMulti-purpose 79 215 18 233 312 325 Switching - 63 22 85 85 92 Total 79 278 40 318 397 417\nFreight Cars: Box (general service) 1,126 261 94 355 1,481 1,462 Box (special purpose) 384 2,577 50 2,627 3,011 3,101 Gondola - 910 518 1,428 1,428 1,362 Hopper (open top) 439 2,110 1,738 3,848 4,287 4,717 Hopper (covered) - 2,930 624 3,554 3,554 3,732 Flat - 239 466 705 705 780 Other - 1,167 239 1,406 1,406 1,344 Total 1,949 10,194 3,729 13,923 15,872 16,498 Work Equipment 654 - 654 654 625 Highway trailers - 898 898 898 898\n1 In addition, approximately 1,630 freight cars were being used by the Railroad under short-term car hire agreements. 2 Includes 59 locomotives and 1,722 freight cars under capital leases. 3 Excludes equipment listed under Leasing Subsidiaries.\nEnvironmental Conditions\nThe Railroad faces potential environmental cleanup costs associated with approximately 30 contaminated sites and various fueling facilities for which a total of $13 million has been reserved as of December 31, 1995. The most significant of those sites are described below.\nMobile, Alabama\nThe Railroad owned property in Mobile prior to 1976 upon which a lessee conducted creosoting operations. The Alabama Department of Environmental Management has determined that the soil and groundwater are contaminated with creosote, pentachlorophenol and possibly dioxins. The Railroad has been participating in joint cleanup efforts with the current owner and the Railroad's lessee. See Item 3.","section_3":"Item 3. Legal Proceedings\nState of Alabama, et al. v. Alabama Wood Treating Corporation, Inc., et al., S.D. Ala. No. 85-0642-C\nThe State of Alabama and Alabama State Docks (\"ASD\") filed suit in 1985 seeking damages for alleged pollution of land in Mobile, Alabama, stemming from creosoting operations over several decades. Defendants include the Railroad, which owned the land until 1976, Alabama Wood Treading Corporation, Inc., and Reilly Industries, Inc. (\"RII\"), which leased the land from the Railroad and conducted creosote operations on the site. In December 1976, the Railroad sold the premises to ASD. The complaint sought payment for the clean-up cost together with punitive and other damages.\nIn 1986, ASD, RII and the Railroad agreed to form a joint technical committee to clean the site, sharing equally the cost of clean-up, and in October 1986 the court stayed further proceedings in the suit. Under the agreement the joint technical committee has spent approximately $6.8 million and has been authorized to expend up to a total of $6.9 million. The Railroad has contributed $2.3 million. Further clean-up activities are anticipated.\nUnder the agreement, if any party disagrees with the amount determined by the joint technical committee to be expended or otherwise disagrees with any aspect of the clean-up, such party may decline further participation and recommence legal proceedings. However, amounts already contributed by any party will be credited against that party's eventual liability and may not be recovered from any other party.\nIn the Matter of Illinois Central Railroad Company, et al., Tennessee Division of Superfund No. 94-0187\nThe Tennessee Department of Environment and Conservation has issued a Remedial Order requiring cleanup by the Railroad and the current owners of a site in Jackson, Tennessee. The Railroad operated a rail yard and locomotive repair facility at the site. Trichloroethylene (\"TCE\") has been found in several municipal water wells near the site. TCE is a common component of solvents similar to those believed to have been used at the shop. In addition, concentrations of metals and organic chemicals have been identified on the surface of the site. The Railroad has commenced a remedial investigation and feasibility study of the site, and expects to cooperate with the agency and other PRP's to conduct any necessary clean-up activities.\nPeople of the State of Illinois v. Illinois Central Railroad No. 95 CH842 (Circuit Court of Cook County, Illinois)\nOn February 2, 1995, the State of Illinois filed a Complaint for Injunction and Civil Penalties against the Railroad relating to a release of diesel fuel from an underground pipeline at the Railroad's Markham Yard facility in East Hazel Crest, Illinois. The Complaint alleges that the Railroad violated State water pollution statutes by allowing diesel fuel to enter waters of the State and seeks an order compelling the Railroad to take necessary corrective actions at the site and to pay a civil penalty.\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 fourth quarter.\nItem 4A. Executive Officers of the Registrant\nThe executive officers of the Company are identified in the table below. Each executive officer of the Company currently holds an identical position with the Railroad. Executive officers of the Company and the Railroad serve at the pleasure of the respective Boards of Directors.\nName Age Position(s)\nGilbert H. Lamphere 43 Chairman of the Board of Directors E. Hunter Harrison 51 President and Chief Executive Officer, Director John D. McPherson 49 Senior Vice President - Operations Donald H. Skelton 52 Senior Vice President - Marketing and Sales James M. Harrell 43 Vice President - Human Resources David C. Kelly 51 Vice President - Maintenance Ronald A. Lane 45 Vice President and General Counsel and Secretary Dale W. Phillips 41 Vice President and Chief Financial Officer John V. Mulvaney 45 Controller\nBiographical Information\nThe following sets forth the periods during which the executive officers of the Company and the Railroad have served as such and a brief account of the business experience of such persons during the past five years.\nMr. Lamphere has been a director of the Corporation and the Railroad since 1989. He has been Chairman of the Board since 1993, and Chairman of the Executive Committee of the Board since 1990. Mr. Lamphere is Managing Director of the Fremont Group, a diversified investment company. He was Co-Chairman and Chief Executive Officer of The Noel Group, Inc. from 1991 until 1994 and was the Chairman and Chief Executive Officer of The Prospect Group, Inc. until 1994, for which he had served in various capacities since becoming a director in 1983.\nMr. Harrison was appointed President, Chief Executive Officer and a Director of the Company and the Railroad in February 1993. He joined the Company and the Railroad as Vice President and Chief Transportation Officer in 1989. In November 1991 he was appointed Senior Vice President - Transportation and was named Senior Vice President - Operations in July 1992.\nMr. McPherson joined the Company and the Railroad in July 1993. He was named Senior Vice President - Operations in 1994. He also serves as a Director of the Railroad. Prior to joining the Company and the Railroad, he held various positions with the Atchison, Topeka and Santa Fe Railway Company from 1966 to 1993, most recently as Assistant Vice President - Safety.\nMr. Skelton was elected Senior Vice President-Marketing and Sales of the Company and the Railroad in January 1996. In January 1996 he was elected a Director of the Railroad. He joined the Company and the Railroad as Vice President Marketing and Sales in October 1994. He was previously employed by Mark VII Transportation and as an independent consulting specialist in international transportation. From 1987 to 1993 he was employed by the Atchison, Topeka and Santa Fe Railway Company holding various executive positions including Vice President Marketing and Sales and Vice President International\/Domestic Customer Development.\nMr. Harrell joined the Company and the Railroad in his current position in 1992. He served as Director of Labor Relations for The Atchison, Topeka and Santa Fe Railway Company from 1989 to 1992.\nMr. Kelly joined the Company and the Railroad as Vice President and Chief Engineer in 1989. In January 1994, he was appointed Vice President - Maintenance.\nMr. Lane joined the Company and the Railroad as Vice President and General Counsel and Secretary in 1990. In April 1993 he was elected a Director of the Railroad.\nMr. Phillips was appointed to his present position in the Company and the Railroad in April 1990. He also serves as a Director of the Railroad. Mr. Phillips also serves as a director of Rail Association Insurance, Ltd.\nMr. Mulvaney joined the Company and the Railroad as Controller in June 1990.\nNo family relationship exists among the officers of the Company or the Railroad.\nOn December 31, 1995, Mr. Gerald F. Mohan, Senior Vice President-Marketing retired after over 35 years of service. He was replaced by Mr. Skelton.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters\nThe Common Stock is listed on the New York Stock Exchange, Inc. under the symbol \"IC.\"\nThe following table sets forth, for the periods indicated, (i) the high and low sale prices of the Common Stock as reported on the New York Stock Exchange Composite Tape and (ii) the per share amount of dividends paid. The following table has been restated to give effect to a 3-for-2 stock split declared in January 1996.\nStock Price Dividends High Low Per Share First Quarter $18.167 $15.750 $ .10 Second Quarter 20.083 16.917 .10 Third Quarter 21.833 17.750 .11 Fourth Quarter 24.000 19.500 .11\nFirst Quarter $25.750 $21.583 $ .14 Second Quarter 25.250 20.333 .14 Third Quarter 21.167 19.550 .14 Fourth Quarter 21.000 19.083 .14\nFirst Quarter $23.500 $20.500 $ .17 Second Quarter 23.750 21.833 .17 Third Quarter 28.000 23.000 .17 Fourth Quarter 28.667 24.500 .17\nFirst Quarter (through March 11, 1996) $26.417 $23.667 $ .19\nAs of March 11, 1996, there were approximately 25,000 stockholders based on estimates of beneficial ownership. The closing price of the Common Stock as reported on the New York Stock Exchange Composite Tape on March 11, 1996 was $39.125 per share.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe following table sets forth selected historical consolidated financial data of the Company for the five years ended December 31, 1995, all derived from the consolidated financial statements of the Company which were audited by Arthur Andersen LLP. This summary should be read in conjunction with the consolidated financial statements included elsewhere in this Report and the schedules and notes thereto.\nSELECTED CONSOLIDATED FINANCIAL INFORMATION ($ in millions, except share data) Years Ended December 31, 1995 1994 1993 1992 1991 Income Statement Data: Revenues $643.8 $593.9 $564.7 $547.4 $549.7 Operating expenses before special charge 413.3 393.6 385.2 387.0 404.1 Special charge - - - 8.9 - Operating income 230.5 200.3 179.5 151.5 145.6 Other income (expense), net (0.2) 1.0 1.7 2.0 5.7 Interest expense, net (29.5) (28.4) (33.1) (43.6) (55.1) Income before income taxes, extraordinary item and cumulative effect of changes in accounting principles 200.8 172.9 148.1 109.9 96.2 Provision for income taxes 71.0 59.0 56.4 37.4 30.8 Income before extra- ordinary item and cumulative effect of changes in accounting principles 129.8 113.9 91.7 72.5 65.4 Extraordinary item, net (11.4) - (23.4) - - Cumulative effect of changes in accounting principles - - (0.1) 23.4 - Net income $118.4 $113.9 $68.2 $95.9 65.4\nIncome per share (1): Before extraordinary item and accounting changes $ 2.06 $ 1.78 $ 1.43 $ 1.13 $ 1.09 Extraordinary item (0.18) - (0.36) - - Accounting changes - - - 0.37 - Net income per share $ 1.88 $ 1.78 $ 1.07 $ 1.50 $ 1.09\nWeighted average number of common shares out- standing (in thousands) (1) 62,885 64,089 64,020 63,900 59,745\nCash dividends declared per common share (1) $ .70 $ .59 $ .46 $ .33 -\nOperating ratio (2) 64.1% 66.3% 68.2% 70.7% 73.5%\nYears Ended December 31, 1995 1994 1993 1992 1991\nBalance Sheet Data: Total assets $1,404.2 $1,308.7 $1,258.7 $1,206.1 $1,183.5 Long-term debt 383.6 328.6 360.3 367.3 413.5 Stockholders' equity 470.1 454.1 377.4 338.8 260.3 Working capital (deficit) (76.1) (65.4) (32.4) (2.9) (3.4)\n1. Restated to give effect to a 3 for 2 stock split declared in January 1996, amount for the year 1991 also has been restated to give effect to a 3 for 2 stock split effective in February 1992. 2. Operating ratio is the ratio of operating expenses before special charge to operating revenue.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nSignificant Developments\n1992 Four-Year Growth Plan and Plan2000\nIn the fall of 1992, the Company announced a four-year growth plan designed to increase revenues $100 million to $647 million, reduce the operating ratio four percentage points to 66.7% and reduce interest expense $10 million to $34 million. By December 31, 1994, the Company had achieved the operating ratio and interest expense reduction goals. Therefore, in the spring of 1995, the Company developed and announced Plan2000. This new plan is designed to build on the success of the 1992 plan and position the Company for the next century. Plan2000 calls for (i) revenue to grow from the 1994 base of $594 million to $800 million by the end of 1999, (ii) the continued reduction of the operating ratio to below 60%, and (iii) a Long-Term Equity Enhancement Program of increased dividends and share repurchases.\nAs of December 31, 1995, following revenue increases of 3.1%, 5.2% and 8.4% in 1993, 1994 and 1995, respectively, revenue was 17.6% higher than 1992 and only $3.6 million below the original four year $100 million target. The 1995 revenue of $644 million is slightly ahead of the 1995 target specified in Plan2000. Contributing to the revenue growth since 1992 were gains in intermodal (57.7%), grain and grain mill (22.9%) and chemicals (14.4%), despite a decline in coal (.6%).\nPlan2000 was developed primarily as a management tool and is subject to factors and assumptions which could impact on its achievability. The most significant risks that could impact Plan2000 are its economic assumptions, the haulage agreement with the Southern Pacific Railroad (\"Southern Pacific\") and export grain demand. The plan assumes industrial production will rise, an average 2.8% in each year 1996 through 1999 with a soft landing of 2.4% in 1997. Historically, the Company's growth excluding coal and export grain, which are not affected by industrial production, has been 50% to 60% of industrial production. Plan2000 assumes the historical trend will continue. As to the Southern Pacific, intermodal haulage between Memphis and Chicago is expected to remain in excess of 30,000 units annually. However, the Southern Pacific and the Union Pacific Railroad have indicated that this business will be re-evaluated following their merger. Unlike the very low 1994 level and the unusually strong 1995 grain traffic levels, Plan2000 expects export grain traffic will be closer to the historical norm.\nLocal Union Agreements\nIn 1994 the Company began to negotiate separate distinct agreements with each of its eleven unions on a local basis effectively withdrawing from the traditional pattern of bargaining on a national basis with the other railroads. To date eight unions, representing 42% of the Railroad's union workforce, have ratified agreements which cover wages and work rule issues through 1999. These agreements provide wage increases of 3%-4% per year on average. Upon ratification, signing bonuses of $1.2 million were paid.\nIn November 1995, the Company and the United Transportation Union (\"UTU\") entered into a tentative agreement subject to membership ratification. This agreement represented a significant change in the basis of paying operating employees, with an hourly wage system replacing a mileage-based system. On February 28, 1996, the Company was notified by the UTU that its members had rejected the agreement. As a result, no amounts have been reflected in the Consolidated Financial Statements associated with this agreement. The Company will seek counsel of the National Mediation Board who facilitated the agreement in November.\nCCP Holdings, Inc. Acquisition\nOn January 17, 1996, the Company announced that it had entered into a definitive agreement to purchase all the stock of CCP Holdings, Inc., for approximately $125 million in cash, and the assumption of approximately $14 million in net debt and approximately $18 million of capitalized lease obligations. The Company expects to fund the acquisition using funds from its existing line of credit and the proceeds of public debt issued by the Railroad. The Railroad will transfer the funds to the Company via a combination of dividends and intercompany loans. The purchase will not close until required regulatory approval from the Surface Transportation Board is obtained, which is expected by no later than September 1996.\nThe Company will account for the transaction as a purchase. The total purchase price is subject to various potential adjustments for up to one year after the closing date.\nCCP Holdings, Inc., principal subsidiaries are the Chicago, Central and Pacific Railroad (CCP) and the Cedar River Railroad (CRR). These two railroads comprise a Class II freight system which operates 850 miles of road. CCP operates from Chicago west to Omaha, Nebraska, with connecting lines to Cedar Rapids and Sioux City, Iowa. CRR runs north from Waterloo, Iowa to Albert Lea, Minnesota. CCP Holdings, Inc.'s 1995 revenues were approximately $76 million, its operating ratio was approximately 70%, and its shareholders' equity was approximately $54 million at December 31, 1995.\nRailroad Industry Mergers\nDuring 1995, the merger of the Burlington Northern Railroad and the Sante Fe Railway and the merger of the Union Pacific Railroad and the Chicago and NorthWestern Railroad were completed and the intended acquisition of the Southern Pacific by the Union Pacific Railroad was announced. These consolidations have the potential to increase competition in the Railroad's service territory. To date, the impact on the Railroad's operation or financial results has not been material, but continued consolidations could limit the Railroad's access to shippers.\nStock Split\nOn January 25, 1996, the Board declared a 3-for-2 stock split in the form of a stock dividend to holders of record on February 14, 1996. New certificates will be issued March 14, 1996. Fractional shares will be settled in cash at a rate of $25.96 per share. When certificates are issued, the approximate 41.0 million shares outstanding will increase to approximately 61.4 million. All share counts, options outstanding, option prices and per share information presented in this annual report have been restated to reflect the 3-for-2 split as if it had occurred at the beginning of the earliest period presented.\nResults of Operations\nThe discussion below takes into account the financial condition and results of operations of the Company for the years presented in the consolidated financial statements.\n1995 Compared to 1994\nRevenues for 1995 increased from the prior year by $49.9 million or 8.4% to $643.8 million. The increase was a result of a 4.6% increase in carloadings coupled with a 2.1% increase in the average freight revenue per carload. In 1995, the Company experienced increased carloadings in intermodal (31.2%), grain and grain mill products (13.2%), paper (6.4%) and chemicals (4.1%), partially offset by decreased loadings in coal (11.9%).\nOperating expenses for 1995 increased $19.7 million or 5.0%. Labor and fuel expenses increased reflecting the increased loadings experienced in 1995 over 1994. Depreciation expense was higher in 1995 because of the Company's increased ownership of equipment. Other expenses, which include joint facilities, net and equipment related expenses, increased $9.3 million. Partially offsetting the increased expenses was a $2.1 million decrease in lease and carhire expense and decreased casualty, insurance and loss expense ($6.3 million) reflecting the Company's emphasis on safety and improved claims experience.\nOperating income for 1995 increased $30.2 million or 15.1% to $230.5 million for the reasons cited above.\nNet interest expense of $29.5 million for 1995 increased 3.9% compared to $28.4 million in 1994. Increased debt burden primarily associated with equipment additions and stock repurchases account for the increase in interest expense. Results for 1995, also reflect the issuance of lower coupon debt in connection with the prepayment of the Railroad's $160 million Senior Notes at face value, plus accrued interest and a prepayment penalty. The prepayment resulted in an extraordinary loss of $18.4 million, $11.4 million after tax. See \"-Liquidity and Capital Resources.\"\nNet income was further affected by a $4.3 million after tax gain on the resolution of prior period tax issues.\n1994 Compared to 1993\nRevenues for 1994 increased from the prior year by $29.2 million or 5.2% to $593.9 million. The increase was a result of a 7.9% increase in carloadings partially offset by a 3.7% decrease in the average freight revenue per carload. In 1994, the Company experienced increased carloadings in intermodal (53.0%), coal (22.6%), chemicals (3.6%) and paper (2.2%) partially offset by decreased loadings in grain (12.5%) and grain mill products (10.3%). The increase in intermodal carloadings highlighted the Company's emphasis and commitment in this area. For the year, carloadings increased over 67,000 to approximately 915,000 carloads.\nOperating expenses for 1994 increased $8.4 million or 2.2%. Labor and fuel expenses increased reflecting the increased loadings experienced in 1994 over 1993. Depreciation expense was higher in 1994 because of the Company's shift to ownership of equipment from leasing. Other expenses, which include property and franchise taxes, casualty and environmental accruals, joint facilities, net and equipment related expenses, increased $9.9 million. Partially offsetting the increased expenses was a $18.7 million decrease in lease and car hire expense which resulted from the Company's shift from leasing to owning, more effective turnaround of cars and lower export grain.\nOperating income increased $20.8 million or 11.6% to $200.3 million for the reasons described above.\nNet interest expense for 1994 decreased 14.2% ($4.7 million) to $28.4 million compared to $33.1 million in 1993. The sales of accounts receivable under a revolving agreement allowed the Railroad to utilize existing assets to obtain funds rather than issuing additional debt. The expense associated with this transaction is accounted for as Other Income (Expense), Net, not Interest Expense, Net, and when coupled with paydowns of other existing debt, produced the decrease in interest expense.\nNet income was further affected by two unusual transactions. The first was the terminated merger discussions with the Kansas City Southern Railroad Company which resulted in a $2.7 million pretax charge ($1.7 million after tax), and the second was a $5.0 million after tax gain on the favorable resolution of prior period tax issues.\nLiquidity and Capital Resources\nOperating Data ($ in millions): 1995 1994 1993 Cash flows provided by (used for): Operating activities $177.4 $205.5 $124.3 Investing activities (127.0) (80.4) (89.0) Financing activities (69.6) (111.6) (59.2) Net change in cash and temporary cash investments $ (19.2) $ 13.5 $ (23.9)\nCash from operating activities in 1995, 1994 and 1993 was primarily net income before depreciation, deferred taxes, extraordinary item and the cumulative effect of changes in accounting principles, and 1994 was also affected by the sales of accounts receivable. A significant source of cash in 1993 ($6.3 million) was the realization of settlement proceeds with numerous insurance carriers in connection with asbestos and hearing loss casualty claims. Most of the settlements were for prior claims but some cover future claims related to prior periods. As part of the settlements, the Railroad agreed to release the carriers from liability for future hearing loss claims. In 1995 and 1994, the Railroad received $1.1 million and $.5 million, respectively.\nAdditions to the property were as follows ($ in millions):\n1995 1994 1993\nCommunications and signals $ 10.7 $ 13.8 $ 5.6 Equipment-rolling stock 61.5 28.3 42.9 Track and bridges 47.0 44.7 36.6 Other 9.6 3.3 5.6 Total $128.8 $ 90.1 $90.7\nIn 1995, equipment purchases include $25.9 million for 20 new SD- 70 locomotives placed in service in the fourth quarter. In 1993, the Company purchased 21 used SD-40-2 locomotives and 1,522 freight cars. In 1994, Other includes $3.0 million for intermodal facility rehabilitation in Memphis. In 1995, 1994 and 1993 capital expenditures exceeded original estimates as several opportunities to acquire equipment were acted upon in accordance with the Company's strategy of owning more of its equipment. Property retirements and removals generated proceeds of $5.4 million, $8.2 million, and $5.3 million in 1995, 1994 and 1993, respectively.\nThe Company anticipates that capital expenditures for 1996 will be approximately $145 million of which $83 million of base expenditures will concentrate on track maintenance (i.e., renewal of track structures such as bridges) and freight car upgrades. Approximately $20 million will be incurred to expand the Company's intermodal facility in Chicago to service Canadian National Railway. Another $32 million will be spent to construct a bulk transfer facility along the Mississippi River in Louisiana. These expenditures are expected to be met from current operations or other available sources.\nThe aforementioned capital expenditures excludes the January 1996 announcement of the acquisition of CCP Holdings, Inc. for $125 million cash and assumption of debt and capital lease obligations. See \"-Significant Developments.\"\nSince 1990, a major financial goal has been to reduce leverage, expand funding sources, lower funding costs and obtain upgraded credit ratings from the debt rating services. Some of the steps taken have included replacing high-coupon public debt with private debt and public debt with lower interest rates, renegotiating existing bank credit agreements, obtaining separate unsecured credit lines for the Company and the Railroad, selling accounts receivables and initiating (in 1993) and expanding (in 1995) a commercial paper program.\nUnder the Railroad's commercial paper program a total of $150 million can be issued and outstanding at any one time. The program is supported by a $250 million Revolver with the Railroad's lending group (see below). At December 31, 1995, Standard & Poor's Corporation (\"S&P\"), Moody's Investor Services (\"Moody's\") and Fitch Investors Service (\"Fitch\") have rated the commercial paper A2, P2 and, respectively, and $57.0 million was outstanding. For the year the rates ranged from 5.90% to 6.60%. The Railroad views this program as a significant long-term funding source and intends to issue replacement notes as each existing issue matures. Therefore, commercial paper borrowings are classified as long-term. The Railroad's public debt is rated Baa2 by Moody's and BBB by S&P.\nIn 1994, the Railroad entered into a revolving agreement to sell undivided percentage interests in certain of its accounts receivable, with recourse, to a financial institution. The agreement, which expires in June 1998, allows for sales of accounts receivable up to a maximum of $50 million at any one time. The Railroad services the accounts receivable sold under the agreement and retains the same exposure to credit loss as existed prior to the sale. At December 31, 1995, the maximum had been sold pursuant to the agreement. Costs related to the agreement fluctuate with changes in prevailing interest rates. These costs, which are included in Other Income (Expense), Net, were $3.2 million for the year ended December 31, 1995.\nIn April 1995, the Railroad concluded negotiations with its bank lending group whereby the Railroad's Revolver was amended and restated, for the third time since becoming unsecured in September 1993, to a $250 million revolver expiring in 2000. Fees and borrowing spreads are predicated on the Railroad's long-term credit ratings. Currently, the annual facility fee is 17 basis points and borrowings under this agreement are at Eurodollar offered rate plus 32.5 basis points. This amended facility replaced the $150 million revolver due in 1999. The Revolver will be used primarily for backup for the Railroad's commercial paper program but can be used for general corporate purposes. The available amount is reduced by the outstanding amount of commercial paper borrowings and any letters of credit issued on behalf of the Railroad under the facility. No amounts have been drawn under the Revolver. At December 31, 1995, the $250 million was limited to $192.1 million because $57.0 million in commercial paper was outstanding and $.9 million in letters of credit had been issued.\nThe Company has $50 million 364-day floating-rate revolving loan agreement which charges a 17.5 basis point annual facility fee and LIBOR plus 40.5 basis points on any borrowings, and expires in August 1996. No amounts have been drawn upon during 1995. The Company's financing\/leasing subsidiaries have approximately $11.4 million in long-term borrowing agreements which were used to acquire a total of 61 locomotives during 1993 and 1991 and 1,522 freight cars in 1993.\nThe Company believes that its available cash, cash generated by its operations and cash available from the facilities described above will be sufficient to meet foreseeable liquidity requirements. Additionally, the Company believes it and its primary subsidiary the Railroad have access to the public debt market if needed.\nVarious borrowings of the Company's subsidiaries are governed by agreements which contain financial and operating covenants. All entities were in compliance with these covenant requirements at December 31, 1995, and management does not anticipate any difficulty in maintaining such compliance.\nCertain covenants of the Railroad's debt agreements require specific levels of tangible net worth but not a specific dividend restriction. The Railroad paid dividends to the Company of $107.7 million in 1995, $42.5 million in 1994 and $27.4 million in 1993. At December 31, 1995, the Railroad's tangible net worth exceeded the required level by approximately $71.9 million. In January 1996, the Railroad declared and paid a dividend of $12.0 million to the Company.\nIn 1995, the Railroad prepaid the holders of its $160 million Senior Notes at face value plus accrued interest and a prepayment penalty. The monies used to fund the prepayment were provided by commercial paper, the net proceeds of the $100 million 7.75% non- callable 10 year-notes due May 2005 and $40 million from existing lines of credit. The prepayment resulted in an extraordinary loss of $18.4 million, $11.4 million after-tax ($.18 per share). The line of credit borrowings were replaced with the proceeds of Medium-Term Notes (\"MTN\"). The MTN's expire as follows: $20 million (coupon 6.27%) in 1998, $30 million (coupon 6.83%) in 2000, and $50 million (coupon 6.98%) in 2007.\nIn 1993, a $23.4 million extraordinary loss, net of $12.6 million in tax benefits, was incurred in connection with the Railroad's tender offer for its $145 million 14 1\/8% Senior Subordinated Debentures (\"Debentures\") and the costs associated with calling the Debentures. In connection with the tender offer for the Debentures, the Railroad issued $100 million of 6.75% non-callable, 10-year notes due 2003 and irrevocably placed funds with a trustee to cover principal, a 6% premium and interest through the first call date of October 1, 1994, for the untendered Debentures.\nThe Railroad has entered into various diesel fuel collar agreements designed to mitigate significant changes in fuel prices. As a result, approximately 65% of the Railroad's short-term diesel fuel requirements through June 1996 and 17% for the period July 1996 through June 1997 are protected against significant price changes. See Note 7 of the Notes to Consolidated Financial Statements.\nThe Company has paid approximately $6 million, $6 million and $8 million in 1995, 1994, and 1993, respectively, for severance, lump sum signing awards and other costs associated with the various agreements signed in 1994, 1992 and 1991. The previously announced agreement with the United Transportation Union covering wages and work rule issues through 2000 failed to ratify. See \"- Significant Developments.\" As the Company continues to negotiate with its remaining operating unions on a local level, agreements may be reached that require significant lump sum payments. It is too early to determine if separate agreements will be reached but management believes available funding sources will be sufficient to meet any required payments.\nLong-Term Equity Enhancement Program\nThe Company paid its sixteenth consecutive quarterly cash dividend on January 9, 1996. The Board believes quarterly dividends are an integral part of its announced Long-Term Equity Enhancement Program designed to increase stockholder value through dividend payments and stock repurchases. Actual dividends are declared by the Board of Directors based on profitability, capital expenditure requirements, debt service and other factors. At December 31, 1995, the Railroad exceeded its tangible net worth covenant by $71.9 million.\nDuring 1995, the Company completed the $60 million stock repurchase program acquiring 2,475,000 shares in open market transactions. While intended to be an annual component of the Long-Term Equity Enhancement Program, the Board concluded that alternative funding needs, most notably the acquisition of CCP Holdings, Inc., the expansion of the intermodal facility in Chicago and the construction of a bulk transfer facility in Louisiana warranted the suspension of share repurchases for 1996. The Board intends to review the level of stock repurchase annually.\nEnvironmental Liabilities\nThe Company's operations are subject to comprehensive environmental regulation by federal, state and local authorities. Compliance with such regulation requires the Company to modify its operations and expend substantial manpower and financial resources.\nUnder the federal Comprehensive Environmental Response, Compensation and Liability Act of 1980 (\"Superfund\"), and similar state and federal laws, the Company is potentially liable for the cost of clean-up of various contaminated sites. The Company has been notified that it is a Potentially Responsible Party at sites ranging from those with hundreds of potentially responsible parties to sites at which the Company is primarily responsible. The Company generally participates in the clean-up at sites where other substantial parties share responsibility through cost-sharing arrangements, but under Superfund and other similar laws the Company can be held jointly and severally liable for all environmental costs associated with such sites.\nThe Company is aware of approximately 30 contaminated sites and various fueling facilities at which it is probably liable for some portion of the clean-up. The Company paid approximately $6.3 million in 1995 toward the investigation and remediation of those sites, and anticipates future expenditures of between $1 million and $2 million annually. Furthermore, recent amendments to the Clean Air Act require the Environmental Protection Agency to promulgate regulations restricting the level of pollutants in locomotive emissions which could impose significant retrofitting requirements, operational inefficiencies or capital expenditures in the future.\nFor all known sites of environmental contamination where Company loss or liability is probable, the Company has recorded an estimated liability at the time when a reasonable estimate of remediation cost and Company liability can first be determined. Adjustments to initial estimates are recorded as necessary based upon additional information developed in subsequent periods. Estimates of the Company`s potential financial exposure for environmental claims or incidents are necessarily imprecise because of the difficulty of determining in advance the nature and extent of contamination, the varying costs of alternative methods of remediation, the regulatory clean-up standards which will be applied, and the appropriate allocation of liability among multiple responsible parties. At December 31, 1995, the Company estimated the probable range of its estimated liability to be $13 million to $50 million, and in accordance with the provisions of SFAS No. 5 had a reserve of $13 million for environmental contingencies. This amount is not reduced for potential insurance recoveries or third- party contribution where the Company is primarily liable.\nThe risk of incurring environmental liability in connection with both past and current activities is inherent in railroad operations. Decades-old railroad housekeeping practices were not always consistent with contemporary standards, historically the Company leased substantial amounts of property to industrial tenants, and the Railroad continues to haul hazardous materials which are subject to occasional accidental release. Because the ultimate cost of known contaminated sites cannot be definitively established and because additional contaminated sites yet unknown may be discovered or future operations may result in accidental releases, no assurance can be given that the Company will not incur material environmental liabilities in the future. However, based on its assessments of the facts and circumstances now known, management believes that it has recorded adequate reserves for known liabilities and does not expect future environmental charges or expenditures to have a material adverse effect on the Company`s financial position, results of operations, cash flow or liquidity.\nRecent Accounting Pronouncements\nIn March 1995, the Financial Accounting Standards Board issued \"Statement of Financial Accounting Standards No. 121 - Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of\" (\"SFAS No. 121\"). SFAS No. 121 requires that long-lived assets and certain identifiable intangibles to be held or used by an entity be reviewed for impairment whenever events or changes in circumstances indicate the carrying amount may not be recoverable. The statement is effective for fiscal year beginning after December 15, 1995. The Company is reviewing this statement to determine its impact, if any. Early adoption is not anticipated.\nIn October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123 \"Accounting for Stock-Based Compensation\" (\"SFAS No. 123\"). SFAS No. 123 establishes a fair value based method of accounting for stock-based compensation plans. This statement applies to financial statements for fiscal years beginning after December 15, 1995, or for the fiscal year for which this Statement is initially adopted for recognizing compensation cost, which ever comes first. The Company is currently evaluating the impact, if any, this statement will have on its reported results.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nSee Index to Consolidated Financial Statements on page 32 of this Report.\nItem 9.","section_9":"Item 9. Changes in and Disagreement with Accountants in Accounting Financial Disclosures NONE\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nItem 11.","section_11":"Item 11. Executive Compensation\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThe information required by these items is incorporated by reference to the sections of the Company's definitive proxy statement for its 1996 Annual Meeting of Stockholders (which is expected to be filed with the Securities and Exchange Commission on or before March 19, 1996) entitled Nominees for Election as Class II Directors who would hold office until 1999, Class III Directors continuing in office until 1997, Class I Directors continuing in office until 1998, Committees of the Board of Directors, Compensation of Executive Officers and Directors, Ownership of Common Stock and Certain Transactions-Certain Transactions and General-Compliance with the Securities Exchange Act. However, the Compensation Committee Report and the Performance Graph are specifically not 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:\nSee Index to Consolidated Financial Statements on page 32 of this Report.\n2. Financial Statement Schedules:\nSee Index to Financial Statement Schedules on page of this Report.\n3. Exhibits:\nSee items marked with \"*\" on the Exhibit Index beginning on page E-1 of this Report. Items so marked identify management contracts or compensatory plans or arrangements as required by Item 14.\n(b) 1. Reports on Form 8-K:\nDuring the fourth quarter of 1995 the Registrant filed with the Securities and Exchange Commission the following reports on Form 8-K on the dates indicated to report the events described:\nNONE\n(c) Exhibits:\nThe response to this portion of Item 14 is submitted as a separate section of this Report. See Exhibit Index beginning on page E-1.\n(d) Financial Statement Schedules:\nThe response to this portion of Item 14 is submitted as a separate section of this Report.\nSIGNATURES\nPursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, there unto duly authorized.\nILLINOIS CENTRAL CORPORATION\nBy: \/s\/ DALE W. PHILLIPS Dale W. Phillips Vice President and Chief Financial Officer Date: March 11, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed by the following persons in the capacities and on the dates indicated.\nSignature Title(s) Date\n\/s\/ GILBERT H. LAMPHERE Chairman of the Board March 11, 1996 Gilbert H. Lamphere and Director\n\/s\/ E. HUNTER HARRISON President and Chief March 11, 1996 E. Hunter Harrison Executive Officer (principal executive officer), Director\n\/s\/ DALE W. PHILLIPS Vice President March 11, 1996 Dale W. Phillips and Chief Executive Officer (principal financial officer)\n\/s\/ JOHN V. MULVANEY Controller March 11, 1996 John V. Mulvaney (principal accounting officer)\n\/s\/ THOMAS A. BARRON Director March 11, 1996 Thomas A. Barron\n\/s\/ GEORGE D. GOULD Director March 11, 1996 George D. Gould\n\/s\/ WILLIAM B. JOHNSON Director March 11, 1996 William B. Johnson\n\/s\/ ALEXANDER P. LYNCH Director March 11, 1996 Alexander P. Lynch\n\/s\/ SAMUEL F. PRYOR, IV Director March 11, 1996 Samuel F. Pryor, IV\n\/s\/ F. JAY TAYLOR Director March 11, 1996 F. Jay Taylor\n\/s\/ JOHN V. TUNNEY Director March 11, 1996 John V. Tunney\n\/s\/ ALAN H. WASHKOWITZ Director March 11, 1996 Alan H. Washkowitz\nILLINOIS CENTRAL CORPORATION AND SUBSIDIARIES\nF O R M 10-K\nFINANCIAL STATEMENTS\nSUBMITTED IN RESPONSE TO ITEM 8\nILLINOIS CENTRAL CORPORATION AND SUBSIDIARIES\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS\nPage Report of Independent Public Accountants\nConsolidated Statements of Income for the three years ended December 31, 1995\nConsolidated Balance Sheets at December 31, 1995 and 1994\nConsolidated Statements of Cash Flows for the three years ended December 31, 1995\nConsolidated Statements of Stockholders' Equity and Retained Income for the three years ended December 31, 1995\nNotes to Consolidated Financial Statements for the three years ended December 31, 1995\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Board of Directors of Illinois Central Corporation:\nWe have audited the accompanying consolidated balance sheets of Illinois Central Corporation (a Delaware corporation) and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of income, cash flows and stockholders' equity and retained income for each of the three years in the period ended December 31, 1995. These financial statements and the schedules referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Illinois Central Corporation and subsidiaries as of December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995, 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 schedules listed in the index to financial statement schedules herein are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic financial statements. These schedules have been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\n\/s\/ ARTHUR ANDERSEN LLP ARTHUR ANDERSEN LLP\nChicago, Illinois January 25, 1996 (except with respect to the matter discussed in Note 18, as to which the date is February 29, 1996)\nILLINOIS CENTRAL CORPORATION AND SUBSIDIARIES Consolidated Statements of Income ($ in millions, except share data)\nYears Ended December 31,\n1995 1994 1993 Revenues $643.8 $593.9 $564.7 Operating expenses: Labor and fringe benefits 194.8 184.2 176.0 Leases and car hire 46.5 48.6 67.3 Diesel fuel 33.2 31.5 30.4 Materials and supplies 35.0 35.6 34.9 Depreciation and amortization 33.9 27.4 23.6 Casualty, insurance and losses 17.4 23.7 21.5 Other taxes 18.2 17.6 16.4 Other 34.3 25.0 15.1 Operating expenses 413.3 393.6 385.2 Operating income 230.5 200.3 179.5 Other income (expense), net (0.2) 1.0 1.7 Interest expense, net (29.5) (28.4) (33.1) Income before income taxes, extraordinary item and cumulative effect of changes in accounting principles 200.8 172.9 148.1 Provision for income taxes 71.0 59.0 56.4 Income before extraordinary item and cumulative effect of changes in accounting principles 129.8 113.9 91.7 Extraordinary item, net (11.4) - (23.4) Cumulative effect of changes in accounting principles - - (0.1) Net income $118.4 $113.9 $68.2\nIncome per share: Before extraordinary item and cumulative effect of changes in accounting principles $ 2.06 $ 1.78 $ 1.43 Extraordinary item, net (0.18) - (0.36) Cumulative effect of changes in accounting principles - - - Net income per share $ 1.88 $ 1.78 $ 1.07\nWeighted average number of shares of common stock and common stock equivalents outstanding 62,885,121 64,088,609 64,019,525\nThe following notes are an integral part of the consolidated financial statements.\nILLINOIS CENTRAL CORPORATION AND SUBSIDIARIES Consolidated Balance Sheets ($ in millions)\nASSETS December 31, 1995 December 31, 1994\nCurrent assets: Cash and temporary cash investments $ 5.0 $ 24.2 Receivables, net of allowance for doubtful accounts of $2.0 in 1995 and $2.1 in 1994 51.5 33.9 Materials and supplies, at average cost 14.9 15.7 Assets held for disposition 7.7 9.1 Deferred income taxes - current 19.1 21.8 Other current assets 2.6 3.3 Total current assets 100.8 108.0\nInvestments 13.6 13.5\nProperties: Transportation: Road and structures, including land 1,052.1 994.9 Equipment 225.6 165.6 Other, principally land 41.0 40.8 Total properties 1,318.7 1,201.3 Accumulated depreciation (44.0) (30.0) Net properties 1,274.7 1,171.3\nOther assets 15.1 15.9 Total assets $1,404.2 $1,308.7\nLIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Current maturities of long-term debt $ 12.4 $ 11.1 Accounts payable 56.6 54.5 Dividends payable 11.9 10.7 Income taxes payable 5.0 0.9 Casualty and freight claims 24.9 24.9 Employee compensation and vacations 16.9 16.5 Taxes other than income taxes 16.3 16.2 Accrued redundancy reserve 4.3 6.8 Other accrued expenses 28.6 31.8 Total current liabilities 176.9 173.4\nLong-term debt 383.6 328.6 Deferred income taxes 246.2 218.2 Other liabilities and reserves 127.4 134.4\nContingencies and commitments (Note 15)\nStockholders' equity: Common stock, par value $.001, authorized 100,000,000 shares, 64,284,846 shares issued and 61,425,231 shares outstanding 0.1 0.1 Additional paid-in capital 166.3 165.0 Retained income 368.2 293.0 Treasury stock (2,859,615 shares) (64.5) (4.0) Total stockholders' equity 470.1 454.1 Total liabilities and stockholders' equity $1,404.2 $1,308.7\nThe following notes are an integral part of the consolidated financial statements.\nILLINOIS CENTRAL CORPORATION AND SUBSIDIARIES Consolidated Statements of Cash Flows ($ in millions)\nYears Ended December 31, 1995 1994 1993\nCash flows from operating activities: Net income $118.4 $113.9 $68.2 Reconciliation of net income to net cash provided by (used for) operating activities: Extraordinary item, net 11.4 - 23.4 Cumulative effect of changes in accounting principles - - 0.1 Depreciation and amortization 33.9 27.4 23.6 Deferred income taxes 30.7 17.4 31.9 Equity in undistributed earnings of affiliates, net of dividends received (0.8) (0.4) (0.3) Net gains on sales of real estate (0.1) (2.0) (0.8) Cash changes in working capital (8.0) 54.3 (0.8) Changes in other assets (1.7) (4.4) (1.4) Changes in other liabilities and reserves (6.4) (0.2) (19.6) Net cash provided by operating activities 177.4 206.0 124.3\nCash flows from investing activities: Additions to properties (128.8) (90.1) (90.7) Proceeds from sales of real estate 2.5 3.8 1.5 Proceeds from equipment sales 2.9 4.4 3.8 Proceeds from sales of investments 0.8 2.7 (0.4) Other (4.4) (1.2) (3.2) Net cash (used for) investing activities (127.0) (80.4) (89.0)\nCash flows from financing activities: Proceeds from issuance of debt 250.0 134.7 330.8 Principal payments on debt (259.8) (184.6) (401.1) Net proceeds (payments) - Commercial Paper 42.0 (23.1) 38.1 Dividends paid (41.9) (35.7) (27.1) Stock repurchases (59.8) (0.7) - Proceeds from exercise of stock options and warrants 0.1 - 0.5 Purchase of subsidiary's common stock (0.2) (2.7) (0.4) Net cash (used for) financing activities (69.6) (112.1) (59.2) Changes in cash and temporary cash investments (19.2) 13.5 (23.9) Cash and temporary cash investments at beginning of year 24.2 10.7 34.6 Cash and temporary cash investments at end of year $5.0 $24.2 $10.7 Supplemental disclosure of cash flow information: Cash paid during the year for: Interest (net of amount capitalized) $32.1 $28.9 $38.4 Income taxes $31.0 $42.7 $10.9\nThe following notes are an integral part of the consolidated financial statements.\nILLINOIS CENTRAL CORPORATION AND SUBSIDIARIES Consolidated Statements of Stockholders' Equity and Retained Income\nShares (000's) Equity ($ in millions) Addition- Total al Stock- Common Common Paid-In Retained Treasury holders' Stock Stock Capital Income Stock Equity\nBalance December 31, 1992 64,011 $0.1 $160.8 $177.9 $ - $338.8\nIssuance of Common Stock: Exercise stock options 75 - 0.5 0.5 Restricted stock awards 37 - 2.8 2.8 Stock repurchased\/ forfeited (201) (3.3) (3.3) Dividends (29.6) (29.6) Net income 68.2 68.2\nBalance December 31, 1993 63,922 0.1 164.1 216.5 (3.3) 377.4\nIssuance of Common Stock: Exercise stock options 2 - - - Restricted stock awards 22 - 0.9 0.9 Stock repurchased\/ forfeited (31) (0.7) (0.7) Dividends (37.4) (37.4) Net income 113.9 113.9 Balance December 31, 1994 63,915 0.1 165.0 293.0 (4.0) 454.1\nIssuance of Common Stock: Exercise stock options 4 - - - Restricted stock awards - - 1.3 1.3 Stock repurchased \/forfeited (2,494) (60.5) (60.5) Dividends (43.2) (43.2) Net income 118.4 118.4 Balance December 31, 1995 61,425 $0.1 $166.3 $368.2 $(64.5) $470.1\nThe following notes are an integral part of the consolidated financial statements.\nILLINOIS CENTRAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. The Company\nIllinois Central Corporation (the \"Company\"), a holding company, was incorporated under the laws of Delaware. The Company, through its wholly- owned subsidiary, Illinois Central Railroad Company (the \"Railroad\"), is principally engaged in the rail freight transportation business. The Railroad operates 2,700 miles of main line track between Chicago and the Gulf of Mexico, primarily transporting chemicals, grain and milled grain, coal, paper and intermodal commodities. In addition to the Railroad, the Company's other direct subsidiary conducts financing operations for railroad equipment.\n2.Summary of Significant Accounting Policies\nPrinciples of Consolidation\nThe consolidated financial statements include the accounts of the Company and its subsidiaries. Significant investments in affiliated companies are accounted for by the equity method. Transactions between consolidated companies have been eliminated in the accompanying consolidated financial statements.\nProperties\nDepreciation is computed by the straight-line method and includes depreciation on properties under capital leases. The depreciation rates for the equipment owned by the Company's finance subsidiary are based on estimated useful life and anticipated salvage value. Lives used range from 18 to 20 years. At the Railroad, depreciation for track structure, other road property, and equipment is calculated using the composite method. In the case of routine retirements, removal cost less salvage recovery is charged to accumulated depreciation. Expenditures for maintenance and repairs are charged to operating expense.\nThe approximate ranges of annual depreciation rates for major property classifications of the Railroad are as follows:\nRoad properties 1% - 8% Transportation Equipment 1% - 7%\nPrior to 1996, the rates used by the Railroad were approved by the Interstate Commerce Commission (\"ICC\"). The Interstate Commerce Commission Termination Act of 1995, signed in December 1995, transfers certain responsibilities of the ICC, including economic and accounting analyses and authority to determine depreciation rates, to the Surface Transportation Board (\"STB\"), an independent agency of the Department of Transportation.\nRevenues\nRevenues are recognized based on services performed and include estimated amounts relating to movements in progress for which the settlement process is not complete. Estimated revenue amounts for movements in progress are not significant.\nIncome Taxes\nDeferred income taxes are accounted for on the asset and liability method by applying enacted statutory tax rates to differences between the financial statement carrying amounts and the tax bases of assets and liabilities. The resulting deferred tax liabilities and assets represent taxes to be paid or collected in the future when the related assets and liabilities are recovered and settled, respectively.\nCash and Temporary Cash Investments\nCash in excess of operating requirements is invested in certain funds having original maturities of three months or less. These investments are stated at cost, which approximates market value.\nIncome Per Share\nIncome per common share of the Company is based on the weighted average number of shares of common stock and common stock equivalents outstanding for the period. Dilution, which could result if all outstanding common stock equivalents were exercised, is not significant. See Note 13 regarding the January 1996 stock split.\nDerivative Financial Instruments\nThe Company has only limited involvement with derivative financial instruments and does not use them for trading purposes. Specifically, the Company has entered into various diesel fuel collar agreements with the objective of mitigating significant changes in fuel prices. Premiums paid for the purchase of these agreements are amortized to fuel expense over the terms of the agreements. Unamortized premiums are included in Other Assets in the Consolidated Balance Sheets. Amounts receivable or payable under the collar agreements are accrued as increases or decreases to Diesel Fuel Expense. See Note 7.\nCasualty Claims\nThe Company accrues for injury and damage claims based on actuarially determined estimates of the ultimate costs associated with asserted claims and claims incurred but not reported. As a result of significant improvements in safety performance and enhancements in claim and settlement approaches, the Company has experienced continuing reductions in its final claim settlement amounts. As a result, it is reasonably possible that future actuarial valuations will reflect additional improvements that could result in a reduction in the near term to casualty costs and related expenses.\nUse of Estimates\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nReclassifications\nCertain items relating to prior years have been reclassified to conform to the presentation in the current year.\n3. Stock Repurchase Program\nIn 1994, the Board of Directors adopted a plan to target approximately 75% to 150% of projected free cash flow after capital expenditures and dividends, subject to maintaining a target debt-to-capital ratio of not more than 45%, for the repurchase of Common Stock. The Board annually reviews the appropriate level of repurchases for the following year. For 1995 the Board authorized the purchase of $60 million of Common Stock. Such purchases under the program were funded by a special $60 million dividend from the Railroad which was declared in 1994 and paid in 1995. Through December 31, 1995, the Company spent an aggregate $60 million to acquire 2,475,000 shares of Common Stock (see Note 13) under the program. Further purchases are dependent on market conditions, the economy, cash needs and alternative investment opportunities. The Board has determined that the capital needs to fund the acquisition of CCP Holdings, Inc. (see Note 17),the expansion of the intermodal facility in Chicago and the construction of a bulk terminal facility in Louisiana preclude stock repurchases under the program for 1996.\n4. Extraordinary Items\nIn 1995, the Railroad prepaid the holders of its $160 million Senior Notes at face value plus accrued interest and a prepayment penalty. The prepayment resulted in an extraordinary loss of $18.4 million, $11.4 million after-tax. The loss resulted from the premium paid, the write-off of unamortized financing fees and costs associated with the prepayment. The monies used to fund the prepayment were provided by commercial paper, the net proceeds of the 7.75% Notes and $40 million from existing lines of credit. See Note 9.\nThe 1993 extraordinary loss resulted from the retirement of the Railroad's 14-1\/8% Senior Subordinated Debentures (the \"Debentures\") and refinancing the Permanent Facility. The loss was $23.4 million, net of tax benefits of $12.6 million. The loss resulted from the premium paid, the write-off of unamortized financing fees and debt discount and costs associated with calling the Debentures. The net proceeds of the 6.75% Notes, borrowings under the $180 million Revolving Credit Facility and other available cash were used to fund the retirement of the Debentures. See Note 9.\n5. Other Income (Expense), Net\nOther Income (Expense), Net consisted of the following ($ in millions):\nYears Ended December 31, 1995 1994 1993\nRental income, net $3.5 $ 3.3 $ 3.9 Net gains (losses) on sales of real estate (.1) 2.0 .8 Net gains (losses) on equipment sales - .2 (2.3) Equity in undistributed earnings of affiliates .9 .7 .5 Sales of accounts receivable(see Note 10) (3.2) (2.2) - Terminated merger discussions with Kansas City Southern - (2.7) - Other, net (1.3) (.3) (1.2) Other Income (Expense), Net $ (.2) $ 1.0 $ 1.7\n6. Supplemental Cash Flow Information\nCash changes in components of working capital, exclusive of Current Maturities of Long-Term Debt, included in the Consolidated Statements of Cash Flows were as follows ($ in millions):\nYears Ended December 31, 1995 1994 1993\nReceivables, net $(17.6) $46.3 $ (3.9) Materials and supplies .8 4.4 (1.4) Other current assets .7 .6 (1.5) Accounts payable 2.2 2.8 1.1 Income taxes payable 11.1 (1.3) 13.6 Accrued redundancy reserves (2.5) - (2.6) Other current liabilities (2.7) 1.5 (6.1) Cash Changes in Working Capital $ (8.0) $54.3 $ (.8)\nIncluded in changes in Other Liabilities and Reserves is approximately $6.3 million for the years ended December 31, 1993, reflecting the settlement of casualty claims with numerous insurance carriers.\nThe Railroad entered into capital leases of $7.1 million covering 328 freight cars in 1995, $24.7 million covering 65 locomotives and 1,623 freight cars in 1994, and $4.4 million covering 200 freight cars in 1993. See Note 8 for a recap of the present value of the minimum lease payments.\n7. Materials and Supplies\nMaterials and Supplies, valued using the average cost method, consist of track material, switches, car and locomotive parts and fuel.\nAs of December 31, 1995, the Railroad was party to four diesel fuel collar agreements under which the Company receives or makes monthly payments based on the monthly average near-by contract price for Heating Oil #2 traded on the New York Mercantile Exchange (the \"Contract Price\"), which was $.577 per gallon for December 1995. Under the agreements, the Railroad receives or makes monthly payments on notional amounts based on the excess or deficiency of the Contract Price over or under an amount averaging approximately $.59 or $.44 per gallon, respectively. As of December 31, 1995, the agreements cover notional quantities amounting to 3,000,000 gallons through June 1996 (approximately 65% of requirements). An agreement covering 800,000 gallons for the period July 1996 to June 1997 contains a put, whereby the issuer may increase the notional amount to 2,000,000 gallons per month at $.55 or $.43 per gallon, respectively. The put expires March 29, 1996.\n8. Leases\nAs of December 31, 1995, the Company leased 5,451 of its cars and 99 of its locomotives. These leases generally have original terms of 15 years and expire between 1996 and 2003. Under the terms of the majority of its leases, the Company has the right of first refusal to purchase, at the end of the lease term, certain cars and locomotives at or below fair market value. The Company also leases office facilities, computer equipment and vehicles.\nNet obligations under capital leases at December 31, 1995 and 1994, included in the Consolidated Balance Sheets were $23.2 million and $27.9 million, respectively.\nAt December 31, 1995, minimum rental payments under capital and operating leases that have initial or remaining noncancellable terms in excess of one year were as follows ($ in millions):\nCapital Operating Leases Leases\n1996 $14.2 $ 23.3 1997 3.0 18.2 1998 2.6 13.1 1999 2.6 11.8 2000 2.0 6.2 Thereafter 3.3 18.4 Total minimum lease payments 27.7 $ 91.0\nLess: Imputed interest 4.5 Present value of minimum payments $23.2\nTotal rent expense applicable to noncancellable operating leases amounted to $19.9 million in 1995, $38.1 million in 1994 and $44.9 million in 1993. Most of the leases provide that the Company pay taxes, maintenance, insurance and certain other operating expenses.\n9. Long-Term Debt and Interest Expense\nLong-Term Debt at December 31, consisted of the following ($ in millions):\n1995 1994 Equipment obligations, due annually to 2000, 6.11% to 9.254% $ 9.7 $ 31.0 Debentures and other debt, due 1996 to 2056, 4.5% to 10.89 10.2 10.5 Commercial Paper, at average interest rate 6.19% in 1995 and 4.72%in 1994 57.0 15.0 Notes, due 2003, 6.75% 100.0 100.0 Notes, due 2005, 7.75% 100.0 - Medium term notes, due 1998 to 2007, 6.27%-6.98% 100.0 - Senior Notes, 10.02% and 10.4% - 159.8 Capitalized leases (see Note 8) 12.8 18.5 Unamortized discount (6.1) (6.2)\nTotal Long-Term Debt $383.6 $328.6\nAt December 31, 1995, the aggregate annual maturities and sinking fund requirements for debt payments for 1996 through 2001 and thereafter were $12.4 million, $61.2 million, $24.0 million, $7.5 million, $32.1 million, $1.5 million and $263.4 million, respectively. The weighted- average interest rate for 1995 and 1994 on total debt excluding the effect of discounts, premiums and related amortization was 8.0% and 8.6%, respectively.\nIn 1995, the Railroad prepaid the holders of its $160 million Senior Notes at face value plus accrued interest and a prepayment penalty. The monies used to fund the prepayment were provided by commercial paper, the net proceeds of the $100 million 7.75% 10-year notes due May 2005 and $40 million from existing lines of credit. In connection with the prepayment, the Railroad amended and restated its revolver with its bank lending group (the \"Revolver\"). The Revolver was increased to $250 million and expires in the year 2000. The Railroad pays an annual fee of 17 basis points on the Revolver and the Eurodollar offered rates plus 32.5 basis points for any borrowings. The line of credit borrowings were replaced with the proceeds of Medium-Term Notes (\"MTN\"). The MTN's expire as follows: $20 million (coupon 6.27%) in 1998, $30 million (coupon 6.83%) in 2000 and $50 million (coupon 6.98%) in 2007.\nThe Railroad's commercial paper is rated A2 by S&P, P2 by Moody's and by Fitch and is supported by the Revolver. The Railroad views commercial paper as a significant long-term funding source and intends to issue replacement notes as maturities occur. Therefore, the $57.0 million outstanding at December 31, 1995, has been classified as long-term.\nThe Revolver may be used as backup for the commercial paper and for general corporate purposes. The available amount is reduced by the outstanding amount of commercial paper borrowings and any letters of credit issued on behalf of the Railroad under the facility. No amounts have been drawn under the Revolver. At December 31, 1995, the Revolver was limited to $192.1 million because $57.0 million in commercial paper was outstanding and $.9 million in letters of credit had been issued.\nThe Company has a $50 million 364-day floating-rate revolving loan agreement, which charges a 17.5 basis point annual facility fee and LIBOR plus 40.5 basis points on any borrowings, and expires in August 1996. No amounts have been drawn upon during 1995. The Company's financing\/leasing subsidiaries have approximately $11.4 million in long- term borrowing agreements which were used to acquire a total of 61 locomotives during 1993 and 1991. Such borrowings are secured by the locomotives which are leased to the Railroad and mature in 1999 and 2000.\nVarious borrowings of the Company's subsidiaries are governed by agreements which contain certain affirmative and negative covenants customary for facilities of this nature including restrictions on additional indebtedness, investments, guarantees, liens, distributions, sales and leasebacks, and sales of assets and capital stock. Some also require the Railroad to satisfy certain financial tests, including a leverage ratio, an earnings before interest and taxes to interest charges ratio, and minimum consolidated tangible net worth requirements. See Note 13.\nInterest Expense, Net consisted of the following ($ in millions):\nYears Ended December 31, 1995 1994 1993\nInterest expense $32.2 $31.2 $35.2 Less: Interest capitalized 1.3 1.4 .8 Interest income 1.4 1.4 1.3 Interest Expense, Net $29.5 $28.4 $33.1\n10. Sales of Accounts Receivable\nIn 1994, the Railroad entered into a revolving agreement to sell undivided percentage interests in certain of its accounts receivable, with recourse, to a financial institution. The agreement allows for sales of accounts receivable up to a maximum of $50 million at any one time. The Railroad services the accounts receivable sold under the agreement and retains the same exposure to credit loss as existed prior to the sale. During June 1995, the agreement was extended one year and now expires in June 1998. At December 31, 1995, the maximum had been sold pursuant to the agreement. Costs related to the agreement fluctuate with changes in prevailing interest rates. These costs, which are included in Other Income (Expense), Net, were $3.2 million and $2.2 million for 1995 and 1994, respectively.\n11. Benefit Plans\nAll employees of the Railroad are covered under the Railroad Retirement System instead of Social Security. Additionally, the Railroad provides various retirement plans, postemployment benefits and postretirement benefits.\nRetirement Plans. The Railroad has two qualified plans permitting participants to make \"pre-tax\" contributions of their salary up to Internal Revenue Code limitations and each contains a company match provision. The union plan, which started in mid-1995, allows union employees covered by local contracts to participate. The Railroad matches 25% of the first 4% of employee contributions. The management plan's matching provisions are 50% of the first 6% of salary deferral. The management plan also contains a separate defined contribution portion of 2% of each employee's salary. Expenses related to both plans were $1.1 million, $1.0 million, and $.9 million in 1995, 1994 and 1993, respectively. All Railroad contributions are fully vested upon contribution.\nThe Railroad also has a supplemental executive retirement plan (\"SERP\") which covers officers and certain other management employees. The SERP provides for a monthly benefit equal to 35% of a participant's final average compensation as defined in the plan. The monthly benefit is subject to offsets such as employer contributions to the 401(k) plan. The plan was adopted in 1994. The cost was not material in 1994 or 1995.\nThe Company's former Chairman, President and Chief Executive Officer is covered by a non-qualified, unfunded supplemental retirement benefit agreement which provides for a defined benefit payable annually, in the amount of $250,000 per year, until the year 2008.\nThe Company's non-employee directors are covered by a non-qualified, unfunded retirement plan which provides an annual payment equal to the annual retainer at the time of the director's retirement and is paid for the number of years the director served up to a maximum of ten years. The 1995 expense for the plan was $.9 million.\nSalary Deferral Plans. In addition to the 401(k) plan, all officers and certain other management employees may elect to defer up to 50% of base salary and 100% of annual bonus. Participant deferrals are fully vested and earn interest at a specified, variable rate. Approximately $.5 million and $.3 million were deferred in 1995 and 1994, respectively.\nBeginning in 1995 the Company's non-employee directors may also defer their annual retainer and meeting fees. All deferrals are 100% vested and earn interest at a specified, variable rate. Deferrals in 1995 were not material.\nUnfunded Plan. The Railroad has an unfunded plan whereby 10% of an officer's combined salary and bonus in excess of a wage offset factor ($102,000 in 1995) is accrued and earns interest. Amounts accrued are paid when the employee leaves the Company, normally at retirement. Expenses for this plan were $.4 million, $.3 million and $.2 million in 1995, 1994 and 1993, respectively.\nPostemployment Benefit Plans. The Company provides certain postemployment benefits such as long-term salary continuation and waiver of medical and life insurance co-payments while on long-term disability.\nPostretirement Plans. In addition to the Company's retirement plans, the Railroad has three benefit plans which provide some postretirement benefits to most former full-time salaried employees and selected former union-represented employees. The medical plan for salaried retirees is contributory, with retiree contributions adjusted annually if expected inflation rate exceeds 9.5%, and contains other cost sharing features such as deductibles and co-payments. The Company's contribution will be fixed at the 1999 year end rate for all subsequent years. Salaried retirees are covered by a life insurance plan which provides a nominal death benefit and is non-contributory. The medical plan for locomotive engineers who retired under a special early retirement program in 1987 provides non- contributory coverage until age 65. All benefits under this plan terminate in 1998. There are no plan assets and the Railroad funds these benefits as claims are paid.\nEffective January 1, 1993, the Railroad adopted the Statement of Financial Accounting Standards No. 106, \"Employer's Accounting for Postretirement Benefits Other than Pensions\" and the Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits.\" As a result of adopting these two standards, the Railroad recorded a decrease to Net Income of $84,000 (net of taxes of $46,000) as a cumulative effect of changes in accounting principles.\nThe accumulated postretirement benefit obligations (\"APBO\") of the postretirement plans were as follows ($ in millions):\nDecember 31, 1995 1994 Medical Life Total Total Accumulated postretirement benefit obligation: Retirees $14.2 $ 2.2 $16.4 $17.7 Fully eligible active plan participants .9 - .9 .6 Other active plan participants 3.4 - 3.4 3.3 Total APBO $18.5 $ 2.2 20.7 21.6\nUnrecognized net gain 18.4 18.9 Accrued liability for postretirement benefits $39.1 $40.5\nThe weighted-average discount rate used in determining the accumulated postretirement benefit obligation was 8.5% at December 31, 1994. As a result of the change in general interest rates in 1995 on high quality investment vehicles, the Company lowered the weighted-average discount rate to 7.25% as of December 31, 1995. The change in rates resulted in approximately $1.9 million actuarial loss. The actuarial gains and losses along with actual experience gains, primarily fewer claims and lower medical rate inflation, resulted in a total $18.4 million unrecognized net gain as of December 31, 1995. In accordance with SFAS No. 106, the excess gain is subject to $1.2 million annual amortization based on an amortization period of approximately 13 years.\nThe components of the net periodic postretirement benefits cost were as follows ($ in millions):\nYears Ending December 31, 1995 1994 Service costs $ .1 $ .2 Interest costs 1.7 2.4 Net amortization of excess gain (1.2) (.1) Net periodic postretirement benefit costs $ .6 $ 2.5\nThe weighted-average annual assumed rate of increase in the per capita cost of covered benefits (e.g., health care cost trend rate) for the medical plans is 12.0% for 1996 and is assumed to decrease gradually to 6.25% by 2002 and remain at that level thereafter. The health care cost trend rate assumption normally has a significant effect on the amounts reported; however, the plan limits annual inflation for the Railroad's portion of such costs to 9.5% each year and caps the Railroad's contribution at the actual 1999 level. Therefore, an increase in the assumed health care cost trend rates by one percentage point in each year would have no impact on the Company's accumulated postretirement benefit obligation for the medical plans as of December 31, 1995, or the aggregate of the service and interest cost components of net periodic postretirement benefit expense in future years.\n12. Provision for Income Taxes\nIn 1995 and 1994 tax benefits of $4.3 million and $5.0 million, respectively, were recorded to reflect the favorable resolution of prior- period tax issues. On August 10, 1993, the Omnibus Budget Reconciliation Act of 1993 became law and increased the maximum corporate federal income tax rate from 34% to 35% retroactive to January 1, 1993. This change required the Company to record additional deferred income tax expense of approximately $3.1 million in 1993 to reflect the new tax rate's impact on net deferred income tax liability as of January 1, 1993.\nThe Provision for Income Taxes for continuing operations consisted of the following ($ in millions):\nYears Ended December 31, 1995 1994 1993 Current income tax: Federal $35.8 $37.5 $23.6 State 4.5 4.1 .9 Deferred income taxes 30.7 17.4 31.9 Provision for Income Taxes $71.0 $59.0 $56.4\nThe effective income tax rates for the years ended December 31, 1995, 1994 and 1993, were 35%, 34% and 38%, respectively. See Note 4 for the tax benefits associated with the 1995 and 1993 extraordinary losses. In 1993, state income taxes benefited from the utilization of state net operating losses.\nThe items which gave rise to differences between the income taxes provided for continuing operations in the Consolidated Statements of Income and the income taxes computed at the statutory rate are summarized below ($ in millions):\nYears Ended December 31, 1995 1994 1993 Expected tax expense computed at statutory rate $70.3 35% $60.5 35% $51.8 35% Dividends received exclusion (.1) - (.9) - (.1 ) - Impact of OBRA 1993 rate change - - - - 3.1 2 State income taxes, net of Federal tax effect 5.4 2 3.6 2 .6 - Favorable resolution of prior period tax issues (4.3) (2) (5.0) (3) - - Other items, net ( .3) - .8 - 1.0 1 Provision for Income Taxes $71.0 35% $59.0 34% $56.4 38%\nTemporary differences between book and tax income arise because the tax effects of transactions are recorded in the year in which they enter into the determination of taxable income. As a result, the book provisions for taxes differ from the actual taxes reported on the income tax returns. The net results of such differences are included in Deferred Income Taxes in the Consolidated Balance Sheets.\nAt December 31, 1995, the Company for tax or financial reporting purposes, had no Federal net operating loss carryovers.\nDeferred Income Taxes consisted of the following ($ in millions):\nDecember 31, 1995 1994\nDeferred tax assets $ 80.5 $ 82.8 Less: Valuation allowance (1.8) (1.8) Deferred tax assets, net of valuation allowance 78.7 81.0 Deferred tax liabilities (305.8) (277.4) Deferred Income Taxes $(227.1) $(196.4)\nThe valuation allowance is comprised of the portion of state tax net operating loss carryforwards expected to expire before they are utilized and non-deductible expenses incurred with the previous merger of wholly- owned subsidiaries.\nMajor types of deferred tax assets are: reserves not yet deducted for tax purposes ($67.7 million) and safe harbor leases ($11.5 million). Major types of deferred tax liabilities are: accelerated depreciation ($276.1 million), land basis differences ($11.0 million) and debt marked to market ($2.0 million).\nThe Company and its subsidiaries have a tax sharing agreement whereby each subsidiary's federal income tax and state income tax liabilities are determined on a separate company income tax basis as if it were not a member of the Company's consolidated group, with no benefit for net operating losses or credit carryovers from prior years.\n13. Common Stock and Dividends\nThe Company is authorized to issue 100,000,000 shares of Common Stock, par value $.001. At December 31, 1995, there were 61,425,231 shares of Common Stock outstanding on a post split basis. Each holder of Common Stock is entitled to one vote per share in the election of directors and on all matters submitted to a vote of stockholders. Subject to the rights and preferences of redeemable preferred stock, if any, each share of Common Stock is entitled to receive dividends as may be declared by the Board of Directors out of funds legally available and to share ratably in all assets available for distribution to stockholders upon dissolution or liquidation. No holder of Common Stock has any preemptive right to subscribe for any securities of the Company. No shares of preferred stock were outstanding at December 31, 1995 and 1994.\nOn January 25, 1996, the Board of Directors declared a three-for-two stock split on Common Stock. The split will be effected in the form of a stock dividend and will be paid March 14, 1996. Approximately 21 million shares will be issued from declared but unissued shares. Fractional shares will be settled in cash. The effects of the stock split are presented herein as if it took place as of the earliest period shown. In 1992, the Board of Directors also authorized a three-for-two stock split on Common Stock.\nThe Board of Directors has a policy of quarterly dividends on the Common Stock of the Company. Future dividends may be dependent on the ability of the Railroad to pay dividends to the Company. The Railroad is no longer subject to specific dividend restrictions. Covenants of the Railroad's Revolver require specified levels of tangible net worth. At December 31, 1995, the Railroad exceeded its tangible net worth covenant by $71.9 million. In December 1994, the Railroad declared a special $60 million dividend, which was paid in 1995, in connection with the stock repurchase program. See Note 3.\nSee Note 14 for discussion of restricted stock awards in 1994 and 1993.\n14. Compensation and Stock Options\nLong-Term Incentive Plan. Under the Company's 1990 Long-Term Incentive Plan (the \"Long-Term Incentive Plan\") 1,556,250 shares of Common Stock are available for issuance upon the exercise of incentive options that may be awarded by the Compensation Committee to directors and selected salaried employees of the Company and its affiliates and to certain other individuals who possess the potential to contribute to the future success of the Company. The Compensation Committee also has the authority under the Long-Term Incentive Plan to award stock appreciation rights, restricted stock and restricted stock units, dividend equivalents and other stock-based awards, and to determine the consideration to be paid by the participant for any awards, any limits on transfer of awards, and, within certain limits, other terms of awards. In the case of options (other than options granted to directors who are not full-time employees of the Company (\"Outside Directors\"), as described below) granted under the Long-Term Incentive Plan, the Compensation Committee has the power to determine the exercise price of the option (which cannot be less than 50% of the fair market value on the date of grant of the shares subject to the option), the term of the option, the time and method of exercise and whether the options are intended to qualify as \"incentive stock options\" pursuant to Section 422A of the Internal Revenue Code. The Compensation Committee awarded stock options to employees under the Long-Term Incentive Plan for the first time in 1993. Awards, all at fair market value, vest ratably over four years and expire 10 years from date of grant.\nOutside Directors also participate in the Long-Term Incentive Plan. On the date of each Annual Meeting, each Outside Director who serves immediately prior to such date and who will continue to serve after such date (whether as a result of such director's re-election or by reason of the continuation of such director's term) is granted an option to purchase 2,250 shares of Common Stock. Options granted to Outside Directors entitle such persons to purchase Common Stock at the fair market value of such Common Stock on the date the option was granted. Options held by Outside Directors expire 10 years from the date of grant, or, if earlier, one year following termination of service as a director for any reason other than death or disability. Such options become exercisable in full six months after their date of grant.\nThe Company awarded 22,500 shares and 37,500 shares of restricted stock to eligible employees of the Railroad in 1994 and 1993, respectively. No cash payments are required by the individuals. Shares awarded under the plans may not be sold, transferred, or used as collateral by the holders until the shares awarded become free of the restrictions. Restrictions lapse over a four-year period. All shares still subject to restrictions will be forfeited and returned to the plan if the employee's relationship with the Railroad is terminated. A total of 4,125 shares, 150 shares and 20,250 shares were forfeited in 1995, 1994 and 1993, respectively. If the employee becomes disabled, or dies, or a change in control occurs during the vesting period, the restrictions lapse at that time. In connection with early retirements, 7,632 shares vested early in 1995. The compensation expense resulting from the award of restricted stock is valued at the closing market price of the Company's Common Stock on the date of the award, recorded as a reduction of Stockholders' Equity, and charged to expense evenly over the vesting period. Compensation expense was $1.2 million, $.9 million and $.8 million in 1995, 1994 and 1993, respectively.\nThe following table summarizes the shares available for award under the Long-Term Incentive Plan, after giving effect to the 3-for-2 stock split declared in January 1996, for the year ended December 31, 1995:\nShares available for award at beginning of year 2,076,150 Options exercised (4,500) Subtotal 2,071,650 Shares of restricted stock forfeited 4,125 Change in options outstanding during year (519,525) Shares available for award at end of year 1,556,250\nThe following table summarizes changes in shares under options after giving effect to the 3-for-2 stock split declared in January 1996, for the year ended December 31, 1995:\nOption Outside Price Range Directors Employees Total Per Share Outstanding options - beginning of year 283,500 780,000 1,063,500 $ 5.333 to $ 25.167\nOptions - Granted 20,250 523,425 543,675 22.917 to 23.167 - Exercised (4,500) - (4,500) 15.167 to 18.500 - Terminated - (19,650) (19,650) 20.833 to 23.167\nChange during the year 15,750 503,775 519,525 Outstanding options - end of year 299,250 1,283,775 1,583,025 5.333 to 25.167\nThe last date exercisable for options granted to Outside Directors is April 19, 2005, and March 16, 2005, for those granted to employees.\nStock Purchase Programs. The Company has two stock purchase programs. The regular program is open to all employees and permits employees to acquire Company common stock via payroll deductions. The other plan is the Discounted Stock Purchase Plan (\"Discounted Plan\"). Only management employees are eligible to participate in the Discounted Plan which provides for the investment of up to 15% of an eligible employee's salary in the common stock of the Company at a 15% discount. A participant must continue employment with the Company or its subsidiaries for two years to retain the 15% discount, and, during that period, the shares will be held by the plan's administrator. If the employee withdraws shares or directs the sale of shares within two years, the discount must be repaid in cash or relinquished shares. No such repayment is required in the event of death, retirement, disability or change of control of the Company. Cost associated with these programs have been immaterial to date.\n15. Contingencies, Commitments and Concentration of Risks\nThe Company has unconditionally guaranteed its finance subsidiary's $11.4 million obligations via a pledge of the stock of the finance subsidiary.\nThe Company is self-insured for the first $5 million of each loss. The Company carries $245 million of liability insurance per occurrence, subject to an annual cap of $345 million in the aggregate for all losses. This coverage is considered by the Company's management to be adequate in light of the Company's safety record and claims experience.\nAs of December 31, 1995, the Company had $.9 million of letters of credit outstanding as collateral primarily for surety bonds executed on behalf of the Company. Such letters of credit expire in 1996 and are automatically renewable for one year. The letters of credit reduced the maximum amount that could be borrowed under the Revolver. See Note 9.\nThe Company has guaranteed repayment of certain indebtedness of a jointly owned company aggregating $7.8 million. The Company's primary share is $1.0 million; the remainder is a primary obligation of other unrelated owner companies.\nThere are various regulatory proceedings, claims and litigation pending against the Company. While the ultimate amount of liability that may result cannot be determined, in the opinion of the Company's management, based on present information, adequate provisions for liabilities have been recorded. See \"Management's Discussion and Analysis - Liquidity and Capital Resources - Environmental Liabilities\" for a discussion of environmental matters.\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 for which it is practicable to estimate that value:\nCash and Temporary Cash Investments. The carrying amount approximates fair value because of the short maturity of those instruments. Investments in U.S. corporate demand notes of $1.4 million and $19.4 million included in Cash and Temporary Cash Investments as of December 31, 1995 and 1994, respectively, have been classified and accounted for as held to maturity securities.\nInvestments. The Company has investments of $8.2 million in 1995 and $8.8 million in 1994 for which there are no quoted market prices. These investments are in joint railroad facilities, railroad terminal associations, switching railroads and other transportation companies. For these investments, the carrying amount is a reasonable estimate of fair value. The Company's remaining investments ($5.4 million in 1995 and $4.7 million in 1994) are accounted for by the equity method.\nLong-Term Debt. The fair value of the Company's long-term debt is estimated based on the quoted market prices for the same or similar issues or on the current rates offered to the Company for debt of the same remaining maturities.\nDerivative Financial Instruments. The fair value of diesel fuel collar agreements is the estimated amount that the Company would receive or pay to terminate the agreements as of year end, taking into account the current credit worthiness of the agreement counterparties.\nThe estimated fair values of the Company's financial instruments are as follows ($ in millions):\nDecember 31, 1995 1994 Carrying Fair Carrying Fair Amount Value Amount Value\nCash and temporary cash investments $ 5.0 $ 5.0 $ 24.2 $ 24.8 Investments 8.2 8.2 8.8 8.8 Accounts payable (derivatives) - - (.1) (.4) Debt (396.0) (432.7) (339.7) (341.2)\n17. Subsequent Event - CCP Holdings, Inc. Acquisition\nOn January 17, 1996, the Company announced that it had entered into a definitive agreement to purchase all the stock of CCP Holdings, Inc., for approximately $125 million in cash, the assumption of approximately $14 million in net debt and approximately $18 million of capitalized lease obligations. The purchase will not close until required regulatory approval from the STB is obtained, which is expected by no later than September 1996.\nThe Company will account for the transaction as a purchase. The total purchase price is subject to various potential adjustments for up to one year after the closing date.\nCCP Holdings, Inc., principal subsidiaries are the Chicago, Central and Pacific Railroad (CCP) and the Cedar River Railroad (CRR). These two railroads comprise a Class II freight system which operates 850 miles of road. CCP operates from Chicago west to Omaha, Nebraska, with connecting lines to Cedar Rapids and Sioux City, Iowa. CRR runs north from Waterloo, Iowa to Albert Lea, Minnesota. CCP Holdings, Inc.'s 1995 revenues were approximately $76 million, its operating ratio was approximately 70%, and its shareholders' equity was approximately $54 million at December 31, 1995.\n18. Subsequent Event - UTU Agreement\nOn November 10, 1995, the Company announced a tentative agreement with the United Transportation Union (\"UTU\") providing for prospective wage and work rule changes and a one-time payment of $60,000 per trainman. On February 29, 1996, the Company was notified by the UTU that they had rejected the agreement. As a result, no amounts have been reflected in the Consolidated Financial Statements associated with the agreement. The Company will seek the counsel of the National Mediation Board who facilitated the agreement in November.\n19. Selected Quarterly Financial Data - (Unaudited) ($ in millions, except share data):\nFirst Second Third Fourth 1995 Quarter Quarter Quarter Quarter\nRevenues $167.5 $156.2 $161.0 $159.1 Operating income 62.5 55.9 53.1 59.0 Income before extraordinary item, net 34.3 29.6 29.2 36.7 Net income 34.3 18.2 29.2 36.7\nIncome per share: Before extra- ordinary item $ .54 $ .47 $ .47 $ .59 Extraordinary item - (.18) - - Net income per share $ .54 $ .29 $ .47 $ .59\nRevenues $ 147.5 $ 145.2 $ 146.7 $ 154.5 Operating income 50.6 45.2 45.9 58.6 Net income 27.7 24.8 25.9 35.5\nNet income per share $ .43 $ .39 $ .41 $ .55\nRevenues $142.7 $132.1 $ 147.4 $142.5 Operating income 46.4 38.3 46.4 48.4 Income before extraordinary item and cumulative effect of changes in accounting principles 24.0 19.9 21.5 26.3 Net income (loss) 23.9 (3.5) 21.5 26.3\nIncome per share: Before extra- ordinary item and cumulative effect $ .37 $ .31 $ .33 $ .41 Extra- ordinary item - (.36) - - Cumulative effect - - - - Net income (loss) per share $ .37 $ (.05) $ .33 $ .41\nPer share amounts have been restated to reflect the 3-for-2 stock split that was declared in January 1996.\nILLINOIS CENTRAL CORPORATION AND SUBSIDIARIES\nF O R M 10-K\nFINANCIAL STATEMENT SCHEDULES\nSUBMITTED IN RESPONSE TO ITEM 14(a)\nILLINOIS CENTRAL CORPORATION AND SUBSIDIARIES\nI N D E X T O FINANCIAL STATEMENT SCHEDULES SUBMITTED IN RESPONSE TO ITEM 14(a)\nSchedules for the three years ended December 31, 1995:\nI-Condensed financial information II-Valuation and qualifying accounts\nPursuant to Rule 5.04 of General Rules of Regulation S-X, all other schedules are omitted because they are not required or because the required information is set forth in the financial statements or related notes thereto.\nILLINOIS CENTRAL CORPORATION AND SUBSIDIARIES SCHEDULE I -- CONDENSED FINANCIAL INFORMATION Illinois Central Corporation--Parent Company Condensed Statements of Income ($ in millions, except share data)\nYears Ended December 31, 1995 1994 1993\nOperating expenses $0.7 $0.3 $0.2 Operating (loss) (0.7) (0.3) (0.2)\nOther income (expense), net (2.8) (3.7) (1.3) Interest income (expense), net (0.5) (0.1) - (Loss) before taxes and earnings of subsidiaries (4.0) (4.1) (1.5) Earnings of subsidiaries 120.9 116.5 69.1 Provision (benefit) for income taxes (1.5) (1.5) (0.6)\nNet income $118.4 $113.9 $68.2 Income per share $ 1.88 $ 1.78 $1.07\nWeighted average number of shares outstanding (thousands) 62,885.1 64,088.6 64,019.5\nThe Notes to Consolidated Financial Statements beginning on page are an integral part of this schedule.\nILLINOIS CENTRAL CORPORATION AND SUBSIDIARIES\nSCHEDULE I -- CONDENSED FINANCIAL INFORMATION Illinois Central Corporation--Parent Company Condensed Balance Sheets ($ in millions)\nDecember 31, 1995 1994 ASSETS Current assets: Cash and temporary cash investments $1.3 $11.0 Receivables 6.5 60.6 Other current assets - 0.1 Total current assets 7.8 71.7\nInvestments in subsidiaries 476.1 404.6\nLoan to affiliate 17.1 -\nDeferred income taxes 0.5 -\nOther assets 0.3 0.4 Total assets $501.8 $476.7\nLIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $16.8 $ 8.9 Dividends payable 11.9 10.6 Income taxes payable - 0.4 Total current liabilities 28.7 19.9\nDeferred income taxes - 1.1\nOther liabilities and reserves 3.0 1.6\nContingencies and commitments\nStockholders' equity: Common stock, par value $.001 authorized 100,000,000 shares: 64,284,846 shares issued and 61,425,231 shares outstanding 0.1 0.1 Additional paid-in capital 166.3 165.0 Retained income 368.2 293.0 Treasury stock (2,859,615 shares) (64.5) (4.0) Total stockholders' equity 470.1 454.1\nTotal liabilities and stockholders'equity $501.8 $476.7\nThe Notes to Consolidated Financial Statements beginning on page are an integral part of this schedule.\nILLINOIS CENTRAL CORPORATION AND SUBSIDIARIES\nSCHEDULE I -- CONDENSED FINANCIAL INFORMATION llinois Central Corporation--Parent Company Condensed Statements of Cash Flows ($ in millions)\nYears Ended December 31, 1995 1994 1993\nCash flows from operating activities: Net Income $118.4 $113.9 $68.2 Reconciliation of net income to net cash provided by (used for) operating activities: Deferred income taxes (1.5) 0.4 0.3 Earnings of subsidiaries (120.9) (116.5) (69.1) Cash changes in working capital: Receivables (4.1) 0.4 0.1 Other current assets 0.1 - (0.1) Accounts payable 7.9 2.6 2.2 Income taxes payable (0.4) 2.3 (0.7) Taxes other than income taxes - - (0.1) Changes in other assets 0.1 0.1 (0.5) Changes in other liabilities and reserves 2.2 0.2 1.1 Net cash provided by operating activities 1.8 3.4 1.4\nCash flows from investing activities: Loan to affiliate (17.1) - - Capital contribution to subsidiaries (0.4) (0.3) (9.9) Dividends received from subsidiaries 107.7 42.5 27.4 Net cash provided by investing activities 90.2 42.2 17.5\nCash flows from financing activities: Dividends paid (41.9) (35.7) (27.1) Stock repurchases (59.8) (0.2) - Proceeds from exercise of stock options and warrants - - 0.5 Net cash (used for) financing activities (101.7) (35.9) (26.6)\nChanges in cash and temporary cash investments (9.7) 9.7 (7.7) Cash and temporary cash investments at beginning of period 11.0 1.3 9.0 Cash and temporary cash investments at end of period $ 1.3 $11.0 $ 1.3\nSupplemental disclosure of cash flow information: Cash paid during the year for: Interest (net of amount capitalized) $ - $ - $ - Income taxes $ - $ - $ -\nThe Notes to Consolidated Financial Statements beginning on page are an integral part of this schedule.\nILLINOIS CENTRAL CORPORATION AND SUBSIDIARIES SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS ($ in millions)\nYear Ended December 31, 1995\nBalance At Additions Payments Balance Beginning Charges And At End Classification Of Year To Expense (Charges) Of Year\nAccrued redundancy reserve $ 38.2 $ 3.0 $ 7.3 $ 33.9 Casualty and other reserves 61.7 14.3 20.3 55.7 Environmental 13.3 5.3 5.7 12.9 Bad debt reserve 2.1 1.9 2.0 2.0 Taxes 1.8 - - 1.8 Total $117.1 $24.5 $35.3 $106.3\nYear Ended December 31, 1994\nAccrued redundancy reserve $ 43.6 $ 1.8 $ 7.2 $ 38.2 Casualty and other reserves 62.3 16.9 17.5 61.7 Environmental 11.9 4.4 3.0 13.3 Bad debt reserve 3.1 1.9 2.9 2.1 Taxes 2.2 - 0.4 1.8 Total $123.1 $25.0 $31.0 $117.1\nYear Ended December 31, 1993\nAccrued redundancy reserve $ 51.6 $ 1.8 $ 9.8 $ 43.6 Casualty and other reserves 67.4 18.8 23.9 62.3 Environmental 9.9 2.9 0.9 11.9 Bad debt reserve 2.6 2.0 1.5 3.1 Taxes 3.3 - 1.1 2.2 Total $134.8 $25.5 $37.2 $123.1\nILLINOIS CENTRAL CORPORATION AND SUBSIDIARIES EXHIBIT INDEX EXHIBIT NO. DESCRIPTION PAGE NO. 3.1 Articles of Incorporation of Illinois Central Railroad Company, as amended. (Incorporated by reference to Exhibit 3.1 to the Registration Statement of Illinois Central Railroad Company on Form S-1. (SEC File No. 33-29269))\n3.2 By-Laws of Illinois Central Railroad Company, as amended. (Incorporated by reference to Exhibit 3.2 to the Registration Statement of Illinois Central Railroad Company on Form S-1. (SEC File No. 33-29269))\n3.3 Restated Articles of Incorporation of Illinois Central Corporation. (Incorporated by reference to Exhibit 3.1 to the Current Report of the Illinois Central Corporation on Form 8-K dated July 29, 1994. (SEC File No. 1-10720))\n3.4 By-Laws of Illinois Central Corporation, as amended. (Incorporated by reference to Exhibit 3.4 to the Registration Statement of Illinois Central Corporation and Illinois Central Railroad Company on Form S-1. (SEC File Nos. 33-36321 and 33-36321-01))\n3.5 Certificate of Retirement of Illinois Central Corporation (Incorporated by reference to Exhibit 3.3 to the Registration Statement of Illinois Central Corporation and Illinois Central Railroad Company on Form S-1, as amended. (SEC File No. 33-40696 and Post-Effective Amendments to Registration Statement Nos. 33-36321 and 33-36321-01))\n3.6 Certificate of Elimination of Illinois Central Corporation. (Incorporated by reference to Exhibit 3.2 to the Quarterly Report of the Illinois Central Corporation on Form 10-Q for the three months ended September 30, 1991. (SEC File No. 1-10720))\n4.1 Form of 14-1\/8% Senior Subordinated Debenture Indenture dated as of September 15, 1989 (the \"Senior Subordinated Debenture Indenture\") between Illinois Central Railroad Company and United States Trust Company of New York, Trustee (including the form of 14-1\/8% Senior Subordinated Debenture included as Exhibit A therein). (Incorporated by reference to Exhibit 4.1 to the Registration Statement of Illinois Central Railroad Company on Form S-1, as amended. (SEC File No. 33-29269))\n4.2 Restated Articles of Incorporation of Illinois Central Corporation (included in Exhibit 3.3)\n4.3 Form of Pledge Agreement dated as of September 22, 1989, and amended and restated as of July 23, 1991, among Illinois Central Corporation and the Banks named therein that are or may become parties to the Amended and Restated Revolving Credit and Term Loan Agreement dated as of September 22, 1989, and amended and restated as of July 23, 1991, among the Illinois Central Railroad Company and the Banks named therein and the Senior Note Purchasers that are parties to the Note Purchase Agreement dated as of July 23, 1991. (Incorporated by reference to Exhibit 4.4 to the Quarterly Report of Illinois Central Corporation on Form 10-Q for the three months ended September 30, 1991. (SEC File No. 1-10720))\n4.4 Form of Note Purchase Agreement dated as of July 23, 1991, among Illinois Central Railroad Company, as issuer, and Illinois Central Corporation, as guarantor, for 10.02% Guaranteed Senior Secured Series A Notes due 1999 and for 10.4% Guaranteed Senior Secured Series B Notes due 2001 (including the Form of Series A Note and Series B Note included as Exhibits A-1 and A-2, respectively, therein). (Incorporated by reference to Exhibit 4.3 to the Quarterly Report of the Illinois Central Railroad Company on Form 10-Q for the three months ended September 30, 1991. (SEC File No. 1-7092))\n4.5 Form of the Loan and Security Agreement dated as of December 6, 1991, between IC Leasing Corporation I and Hitachi Credit America Corp. (including the Form of the Initial Funding Credit Note, the Form of the Refurbishing Credit Note, the Form of Assignment of Lease and Agreement, the Form of the Pledge Agreement between IC Financial Services Corporation and Hitachi Credit America Corp. and the Form of the Guaranty Agreement between Illinois Central Corporation and Hitachi Credit America Corp. included as Exhibits D, E, F, G and H, respectively, therein). (Incorporated by reference to Exhibit 4.9 to the Annual Report on Form 10-K for the year ended December 31, 1991, for the Illinois Central Corporation filed March 12, 1992. (SEC File No. 1-10720))\n4.6 Form of the Trust Agreement dated as of March 30, 1993, between IC Leasing Corporation II and Wilmington Trust Company. (Incorporated by reference to Exhibit 4.1 to the Current Report of Illinois Central Corporation on Form 8-K dated May 7, 1993. (SEC File No. 1-10720))\n4.7 Form of the Security Agreement and Mortgage dated as of March 30, 1993, between IC Leasing Trust II and UNUM Life Insurance Company of America (Including the Form of the Promissory Note between IC Leasing Trust II and UNUM Life Insurance Company of America included as Exhibit A, therein). (Incorporated by reference to Exhibit 4.2 to the Current Report of Illinois Central Corporation on Form 8-K dated May 7, 1993. (SEC File No. 1-10720))\n4.8 Assignment of Lease and Conveyance dated March 30, 1993, between IC Leasing Corporation II and IC Leasing Trust II. (Incorporated by reference to Exhibit 4.3 to the Current Report of Illinois Central Corporation on Form 8-K dated May 7, 1993. (SEC File No. 1-10720))\n4.9 Assignment of Lease and Conveyance dated March 30, 1993, between IC Leasing Trust II and UNUM Life Insurance Company of America. (Incorporated by reference to Exhibit 4.4 to the Current Report of Illinois Central Corporation on Form 8-K dated May 7, 1993. (SEC File No. 1-10720))\n4.10 Form of Commercial Paper Dealer Agreement between Illinois Central Railroad Company and Lehman Commercial Paper, Inc. dated as of November 19, 1993. (Incorporated by reference to Exhibit 4.10 to the Annual Report on Form 10-K for the year ended December 31, 1993 for Illinois Central Railroad Company filed March 16, 1994. (SEC File No. 1-7092))\n4.11 Form of Issuing and Paying Agency Agreement of the Illinois Central Railroad Company related to the Commercial Paper Program between Illinois Central Railroad Company and Bank America National Trust Company dated as of November 19, 1993, (including Exhibit A the Form of Certificated Commercial Paper Note included therein). (Incorporated by reference to Exhibit 4.11 to the Annual Report on Form 10-K for the year ended December 31, 1993 for Illinois Central Railroad Company filed March 16, 1994. (SEC File No. 1-7092))\n4.12 Form of Revolving Credit Agreement between Illinois Central Corporation and Bank of America National Trust and Saving Association Dated August 24, 1994. (Incorporated by reference to Exhibit 4.1 to the Quarterly Report of Illinois Central Corporation on Form 10-Q for the three months ended September 30, 1994. (SEC File No. 1-10720))\n4.13 Form of Revolving Credit and Term Loan Agreement between IC Leasing III and the First National Bank of Boston dated as of July 5, 1994. (Incorporated by reference to Exhibit 4.2 to the Quarterly Report of Illinois Central Corporation on Form 10-Q for the three months ended September 30, 1994. (SEC File No. 1-10720))\n4.14 Toronto Dominion Credit Agreement (Incorporated by reference to Exhibit 4.1 to the Quarterly Report of the Illinois Central Railroad Company on Form 10-Q for the three months ended March 31, 1994. (SEC File No. 1-7092))\n4.15 Form of Receivables Purchase Agreement dated as of March 29, 1994, between Illinois Central Railroad Company and Golden Gate Funding Corporation. (Incorporated by reference to Exhibit 4.2 to the Quarterly Report of the Illinois Central Railroad Company on Form 10-Q for the three months ended March 31, 1994. (SEC File No. 1-7092))\n4.16 Form of Railcar Management Agreement between Interrail and IC Leasing Corporation III dated December 3, 1993. (Incorporated by reference to Exhibit 4.1 to the Current Report of the Illinois Central Corporation on Form 8-K dated July 29, 1994. (SEC File No. 1-10720))\n4.17 Form of Note Purchase Agreement dated as of May 1, 1993, between Illinois Central Company and The First National Bank of Boston (Incorporated by reference to Exhibit 4.1 to the Registration Statement of Illinois Central Railroad Company on Form S-3. (SEC File No. 33-61410))\n4.18 Form of Second Amended and Restated Revolving Credit Agreement dated as of April 2, 1993, amended and restated as of October 27, 1993 and further amended and restated as of November 1, 1994, among Illinois Central Railroad Company and the Banks named therein (Incorporated by reference to Exhibit 4.14 to the Annual Report of Illinois Central Railroad Company on Form 10-K for the year ended December 31, 1994. (SEC File No. 1-7092))\n4.19 Form of Lease Agreement dated as of July 1, 1994, between IC Leasing Corporation III and Illinois Central Railroad Company. (Incorporated by reference to Exhibit 4.10 to the Annual Report on Form 10-K for the year ended December 31, 1994, for the Illinois Central Railroad Company. (SEC File No. 1-7092))\n4.20 Form of Lease Agreement dated as of July 1, 1994 between IC Leasing Corporation III and Waterloo Railway Company. (Incorporated by reference to Exhibit 4.11 to the Annual Report on Form 10-K for the year ended December 31, 1994, for the Illinois Central Railroad Company. (SEC File No. 1-7092))\n4.21 Form of Options Agreement dated as of July 1, 1994, between IC Leasing Corporation III and Illinois Central Railroad Company. (Incorporated by reference to Exhibit 4.12 to the Annual Report on Form 10-K for the year ended December 31, 1994, for the Illinois Central Railroad Company. (SEC File No. 1-7092))\n4.22 Form of Options Agreement dated as of July 1, 1994, between IC Leasing Corporation III and Illinois Central Railroad Company. (Incorporated by reference to Exhibit 4.13 to the Annual Report on form 10-K for the year ended December 31, 1994, for the Illinois Central Railroad Company. (SEC File No. 1-7092))\n4.23 Third Amended and Restated Revolving Credit Agreement between Illinois Central Railroad Company and the banks named therein dated as of April 2, 1993, amended and restated as of October 27, 1993, further amended and restated as of November 1, 1994 and further amended and restated as of April 28, 1995. (Incorporated by reference to Exhibit 4.1 to the quarterly report of Illinois Central Railroad Company in Form 10-Q for the three months ended June 30, 1995. (SEC File No. 1-7092))\n4.24 Form of Indenture dated as of April 1, 1995 between Illinois Central Railroad Company and The First National Bank of Boston. (Incorporated by reference to Exhibit 4.1 to Registration Statement on Form S-3 of Illinois Central Railroad Company dated April 12, 1995. (SEC File No. 33-58547))\n4.25 Form of Fixed Rate Medium-Term Note dated as of May 1, 1995 between Illinois Central Railroad Company and Lehman Brothers Inc., Salomon Brothers, Inc and Smith Barney Inc. (Incorporated by reference to Exhibit 4.1 to the Current Report of Illinois Central Railroad Company of Form 8-K dated May 2, 1995. (SEC File No. 1-7092))\n4.26 Form of Floating Rate Medium-Term Notes dated as of May 1, 1995 between Illinois Central Railroad Company and Lehman Brothers Inc, Salomon Brothers Inc and Smith Barney Inc. (Incorporated by reference to Exhibit 4.2 to the Current Report of Illinois Central Railroad Company on Form 8-K dated May 2, 1995. (SEC File No. 1-7092))\n10.1 * Form of supplemental retirement and savings plan. (Incorporated by reference to Exhibit 10C to the Registration Statement of Illinois Central Transportation Co. on Form 10 filed on October 7, 1988, as amended. (SEC File No. 1-10085))\n10.2 Form of indemnification agreement dated as of January 29, 1991, between Illinois Central Corporation and certain officers and directors. (Incorporated by reference to Exhibit 10.9 to the Annual Report on Form 10-K for the year ended December 31, 1990, for the Illinois Central Corporation filed on April 1, 1991. (SEC File No. 1-10720))\n10.3 * Form of IC 1990 Stock Purchase Plan. (Incorporated by reference to Exhibit 10.6 to the Registration Statement of Illinois Central Corporation on Form 10 filed on January 5, 1990, as amended. (SEC File No. 1-10720))\n10.4 * Form of IC Long-Term Incentive Option Plan. (Incorporated by reference to Exhibit 10.17 to the Registration Statement of Illinois Central Corporation and Illinois Central Railroad Company on Form S-1. (SEC File Nos. 33-36321 and 33-36321-01))\n10.5 * Amendments No. 1 and No. 2 to the IC Long-Term Incentive Plan. (Incorporated by reference to the Proxy Statement of Illinois Central Corporation in connection with its 1992 Annual Meeting of Stockholders. (SEC File No. 1-10720))\n10.6 Railroad Locomotive Lease Agreement between IC Leasing Corporation I and Illinois Central Railroad Company dated as of September 5, 1991. (Incorporated by reference to Exhibit 10.9 to the Annual Report on Form 10-K for the year ended December 31, 1991 for the Illinois Central Railroad Company filed March 12, 1992. (SEC File No. 1-7092))\n10.7 Railroad Locomotive Lease Agreement between IC Leasing Corporation II and Illinois Central Railroad Company dated as of January 14, 1993. (Incorporated by reference to Exhibit 10.6 to the Annual Report on Form 10-K for the year ended December 31, 1992, for the Illinois Central Railroad Company filed March 5, 1993. (SEC File No. 1-7092))\n10.8 * Form of Consulting and Non-Competition Agreement between Illinois Central Corporation and Edward L. Moyers dated as of February 18, 1993. (Incorporated by reference to Exhibit 10.10 to Annual Report on Form 10-K for the year ended December 31, 1992, for the Illinois Central Corporation filed March 5, 1993.(SEC File No. 1-10720))\n10.9 * Form of the Note Agreement between the Illinois Central Corporation and Edward L. Moyers dated February 18, 1993. (Incorporated by reference to Exhibit 10.11 to Annual Report on Form 10-K for the year ended December 31, 1992, for the Illinois Central Corporation filed March 5, 1993. (SEC File No. 1-10720))\n10.10 *Form of a Supplemental Retirement Benefit Agreement dated as of August 20, 1992 between Illinois Central Corporation and Edward L. Moyers. (Incorporated by reference to Exhibit 10.3 to the Quarterly Report of the Illinois Central Corporation on Form 10-Q for the three month ended September 30, 1992. (SEC File No. 1-10720))\n10.11 The Asset Sale Agreement between Allied Railcar Company and IC Leasing Corporation III dated December 3, 1993, (Incorporated by reference to Exhibit 10.13 to the Annual Report on Form 10-K for the year ended December 31, 1993 for the Illinois Central Corporation field March 16, 1994, including the Bill of Sale Agreement and Assumption of Liabilities included as Exhibits C and D, respectively, therein). (SEC File No. 1-10720))\n10.12 The Purchase Agreement between IC Leasing Corporation III and The First National Bank of Maryland dated December 29, 1993. (Incorporated by reference to Exhibit 10.15 to the Annual Report on Form 10-K for the Illinois Central Corporation filed March 16, 1994. (SEC File No. 1-10720))\n10.13* Form of the Illinois Central Railroad Company Executive Performance Compensation Program (Incorporated by reference to Exhibit 10.1 to the report on Form 8-K of the Illinois Central Railroad Company dated as of July 29, 1994. (SEC File No. 1-7092))\n10.14* Form of the Illinois Central Railroad Company Supplemental Executive Retirement Plan (Incorporated by reference to Exhibit 10.2 to the report on Form 8-K of the Illinois Central Railroad Company dated as of July 29, 1994. (SEC File No. 1-7092))\n10.15* Form of the Illinois Central Railroad Company Executive Deferred Compensation Plan (Incorporated by reference to Exhibit 10.3 to the report on Form 8-K of the Illinois Central Railroad Company dated as of July 29, 1994. (SEC File No. 1-7092))\n10.16* Form of Illinois Central Railroad Company Performance Compensation Program (Incorporated by reference to Exhibit 10.4 to the report on Form 8-K of the Illinois Central Railroad Company dated as of July 29, 1994. (SEC File No. 1-7092)\n10.17* Illinois Central Corporation Management Employee Discounted Stock Purchase Plan. (Incorporated by reference to Exhibit 10.7 to the report of Form 10-K of Illinois Central Corporation for the year ended December 31, 1995. (SEC File No. 1-10720)\n10.18 Form of Illinois Central Railroad Company Union Employees' Savings Plan. (Incorporated by reference to Registration Statement of Illinois Central Corporation on Form S-8 dated as of July 18, 1995. (SEC File No. 33-61095))\n11 Computation of Income Per Common Share (Included at E-10\n21 Subsidiaries of Registrant (Included at E-11\n23 Consent of Arthur Andersen LLP (A)\n27 Financial Data Schedule (A)\n* Used herein to identify management contracts or compensation plans or arrangements as required by Item 14 of Form 10-K.\n(A) Included herein but not reproduced.","section_15":""}
{"filename":"10488_1995.txt","cik":"10488","year":"1995","section_1":"ITEM 1. BUSINESS\nTHE COMPANY\nBay State Gas Company (\"Bay State\" or the \"Company\") was incorporated in 1974 as a Massachusetts corporation. However, Bay State's predecessor companies' operations began in 1847, and consecutive quarterly dividends have been paid by these entities or Bay State since 1853. The Company is primarily a gas distribution utility that provides local transportation service in the Brockton, Lawrence, and Springfield, Massachusetts areas. Additionally, the Company also offers additional energy products and services to its customers, including commodity sales of natural gas, and invests in energy ventures. Approximately 95% of all revenues are generated from providing local transportation and natural gas sales with 84% of these annual revenues coming from the Company's Massachusetts service area. Bay State has five subsidiaries within its corporate organization. Northern Utilities, Inc. (\"Northern\") is a gas distribution utility operating in the Portland and Lewiston areas in Maine and the Portsmouth area in New Hampshire. Granite State Gas Transmission, Inc. (\"Granite\") is an interstate gas transmission and supply company operating in the states of Maine, New Hampshire, Massachusetts, and Vermont. Granite has four wholly owned subsidiaries, Bay State Energy Development, Inc., which owns an equity interest in the MASSPOWER cogeneration partnership, Natural Gas Development Corp., a corporation established to invest in the Portland Natural Gas Transmission System (\"PNGTS\"), a proposed natural gas transmission pipeline in northern New England, Bay State Energy Enterprises, Inc., which owns a equity interest in KBC Energy Services, a partnership which markets natural gas supplies and energy-related services on a nonregulated basis to commercial and industrial end-users and Energy Asset Funding Inc., a corporation established to provide financing for energy-related equipment.\nNatural gas sales in New England are seasonal, and the Company's results of operations reflect this seasonality. Accordingly, results of operations are typically most favorable in the second quarter of the Company's fiscal year (three months ended March 31), with results of operations being next most favorable in the first quarter, while losses are commonly incurred in the third and fourth quarters. The quarterly operating results for 1995 and 1994 are described further in Note 9 of \"Notes to Consolidated Financial Statements,\" Part II, Item 8, FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe Company's customers generally are billed monthly on a cycle basis in therms. One therm equals 100,000 British thermal units (1 Btu), the heat content of approximately 100 cubic feet of gas. 1,000,000 Btu (1 MMBtu), or ten therms are the energy equivalent of approximately 1,000 cubic feet of natural gas or 7.14 gallons of home heating oil.\nLOCAL TRANSPORTATION MARKETS AND COMPETITION\nIn 1995, 97% of Bay State's customers purchased bundled local transportation and natural gas and the remaining 3% elected to purchase unbundled local transportation. The tables below show the net change in transportation customers and throughput volumes for the past three years.\nThe Company's principal competitors are unregulated fuel-oil retailers and regulated electric utilities. Increases in demand for natural gas are primarily driven by the rate of economic growth and new construction within the Company's service territories, and by the marketing and pricing of competing fuels.\nIn the residential market, the Company should continue to benefit from the New England region's market and growth potential. There are approximately 150,000 households along the Company's mains and additional homes located short distances from existing gas mains that use no gas at all. In addition, the Company anticipates additional growth from the estimated 44,000 existing residential nonheating customers. These are attractive markets for the Company and represent an opportunity to increase gas sales with little or no capital investment.\nFor commercial and industrial customers, environmental issues are an important issue in choosing an energy source. Since natural gas is the cleanest burning fossil fuel, using natural gas can assist companies in complying with the Clean Air Act and underground oil storage tank legislation.\nFinally, the Company markets gas to large users on a seasonal or interruptible basis. Approximately 59% of these interruptible volumes in 1995 were sold to five electric utilities for electric power generation. The remainder were sold to approximately 110 industrial customers equipped to burn either natural gas or fuel oil. Price is the key competitive factor in this market, and the Company pursues interruptible sales through a flexible pricing structure designed to remain competitive with other fuels. Substantially all net margins from interruptible sales are passed back to firm customers through cost of gas adjustment clauses (see \"Rates and Regulations\").\nNATURAL GAS SALES\nThe natural gas sales portion of the Company's bundled service does not currently provide a profit margin. However, as all but 85 of the Company's 287,000 local transportation customers purchase bundled transportation and natural gas, minimizing gas costs is an important part of the Company's business.\nThe Company's strategy of balancing gas purchase costs and security of supply is achieved by optimizing the mix and terms of natural gas contracts with the use of supplemental liquefied natural gas and propane to meet peak winter demand. The Company maintains a diversified gas supply portfolio of domestic and Canadian gas supply contracts with producers.\nCAPACITY REQUIREMENTS\nBay State has capacity contracts for the transmission of natural gas to its distribution system from the producing areas of North America. The Company currently transports natural gas from Canada through a converted oil pipeline leased from the Portland Pipe Line Corporation (\"PPLC\"). The PPLC lease currently extends to March 31, 1997. An agreement with PPLC to extend the lease through the 1997-1998 heating season is being sought. Short-term contingency plans have been developed for supplying customers in Maine and New Hampshire through the 1997-1998 heating season in the event that the lease is not extended. Long-term, two projects to replace the pipeline capacity provided by the PPLC lease are being pursued, a 2.0 million MMBtu liquefied natural gas storage facility in Wells, Maine, and PNGTS. For further discussion of these\nprojects see Note 8 of \"Notes to Consolidated Financial Statements,\" Part II, Item 8, FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nREGULATION AND RATES\nThe Company and its subsidiaries, are subject, where applicable, to regulation by the Massachusetts Department of Public Utilities (\"MADPU\"), the New Hampshire Public Utilities Commission (\"NHPUC\"), the Maine Public Utilities Commission (\"MPUC\") and the Federal Energy Regulatory Commission (\"FERC\") with respect to rates, adequacy of service, issuance of securities, accounting, and other matters.\nThe tariff schedules of the local distribution companies provide for declining block rates which result in reductions in the unit price as usage increases, and for seasonal rates that charge customers more per unit for gas purchased during the high-demand winter heating season and less per unit during summer months. These schedules also contain cost of gas adjustment (\"CGA\") clauses that permit the distribution companies to pass on to firm customers increases or decreases in recovered natural gas costs. Substantially all gas supplier refunds and profits from interruptible sales are returned to firm customers through the CGA clauses.\nAs a result of a third party fuel inventory financing program instituted by the Company in 1982, fuel inventory and the related administrative and carrying costs are also recovered through the CGA clauses. In addition, the MADPU allows recovery of the following through the CGA: 1) the working capital costs associated with purchased gas costs; 2) clean-up costs associated with waste materials from former gas manufacturing sites; and 3) costs associated with MDPU-approved energy conservation and load management programs.\nThe Company offers special contracts to large volume industrial customers in its Massachusetts service area and natural gas transportation service to industrial end-user customers in both its Massachusetts and New Hampshire jurisdictions. Contracts for such service are individually filed with and approved by the MADPU and NHPUC and are in effect for specified periods of time.\nThe following table provides the most recent rate activity of the Company by state and federal jurisdictions:\nFRANCHISES\nThe utility franchise rights of the Company are non-exclusive. Competition from other companies in the distribution of gas, however, is restricted without prior approval of the applicable local and state governmental agencies.\nThe laws of the Commonwealth of Massachusetts permit a municipality, by appropriate vote of its residents, to enter the gas business and purchase the facilities of the utility serving such municipality. If the utility is not willing to sell, the municipality may construct a plant or acquire one from another source. The Company is not aware of any municipality which intends to seek approval of such action.\nOTHER ENERGY PRODUCTS AND SERVICES\nFor a discussion of Other Energy Products and Services see \"Other Energy Products and Services\" in Part II, Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations.\nENERGY VENTURES\nFor a discussion of Income (Loss) from Investments in Energy Ventures, see \"Income (Loss) from Investments in Energy Ventures\" in Part II, Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations.\nEMPLOYEES\nThe Company employed 1,062 persons at September 30, 1995.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe names, ages, and positions of the principal executive officers of the Registrant as of November 15, 1995 are listed below along with their business experience during the past five years. All principal executive officers are elected annually by the Board of Directors at the Directors' first meeting following the annual meeting of shareholders. There are no family relationships among these officers, except as noted below, nor is there any arrangement or understanding between any officer and any other person pursuant to which the officer was selected.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company holds franchise rights to lay gas mains in the streets and public places of various service territories in Massachusetts, Maine, and New Hampshire.\nAs of September 30, 1995, the Company's system consisted of approximately 5,306 miles of distribution mains; 132 miles of transmission lines, with requisite accessory pumping and regulating stations; LNG liquefaction, vaporization and storage facilities; propane storage tanks; 259,185 services (small pipe connecting mains with piping on the customers' premises) and 287,213 meters installed on customers' premises.\nThe Company also leases a transmission line which is 166 miles in length running from the Canadian border through Vermont and New Hampshire and terminating in South Portland, Maine (see Item 1. Business, \"Capacity Requirements\").\nThe transmission and distribution system is for the most part located on or under public streets, alleys, avenues, and other public places or on private property not owned by the Company, with the permission or consent of the respective owners.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is working with federal and state environmental agencies to assess the extent and environmental impact of and appropriate remedial action for waste materials from former gas manufacturing sites (see Note 8 of \"Notes to the Consolidated Financial Statements,\" Part II, Item 8, Financial Statements and Supplementary Data).\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThere were no matters submitted during the fourth quarter of the fiscal year covered by this report to a vote of security holders through solicitation of proxies or otherwise.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe common stock of the Company is listed on both the New York Stock Exchange and the Boston Stock Exchange. The ticker symbol is \"BGC\" and common listings in the financial press include \"BayStGas\" and \"BaySGs.\" As of November 15, 1995, the Company had approximately 11,336 shareholders of record. The number of shareholders indicated does not reflect the number of persons or entities who hold their common stock in nominee name through various brokerage firms or other entities. Information regarding cash dividends declared on common stock is included in Note 9 of \"Notes to the Consolidated Financial Statements,\" Item 8, FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nListed below is the required selected financial data for the Company's last five fiscal years.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\nYear In Review\nDuring 1995, Bay State Gas Company (\"Bay State\" or the \"Company\") continued to respond to the changing energy industry while experiencing warmer than normal weather. During 1995, the weather was 11% warmer than the prior year and 6% warmer than normal within the Company's service territories. The following table displays the degree days for the past three years:\nBay State responded to the warmer weather by implementing several cost saving and service-related program improvements that not only minimized the impact of the weather on net income for 1995, but will also positively impact earnings in future years.\nNet income was $23.1 million in 1995 compared to $24.5 million in 1994, and earnings per share were $1.71. This compares to $1.85 one year ago. The common stock dividends declared in 1995 were $1.48 per share, 2.8% higher than the prior year. This was the twelfth consecutive year of increased common stock dividends, and it completes the 142nd year of consecutive quarterly dividends. The current annualized dividend is equivalent to $1.50 per share.\nLocal Transportation\nThe majority of Bay State's customers purchase bundled local transportation and natural gas. Some larger commercial and industrial customers have elected to purchase unbundled local transportation, requiring them to now manage their own gas purchasing, balancing, and storage functions.\nLocal transportation revenues decreased 3.6% from 1994 to 1995. This decrease in revenues was primarily attributable to the warmer weather experienced in the Company's service territories during 1995, which reduced transportation, or throughput, to firm customers. The 11% change in weather from year to year would have resulted in a $7.1 million decrease in transportation revenues. However, the Company added almost 6,500 customers in 1995, up from 4,800 and 5,800 in 1994 and 1993, respectively. This 2.3% growth in the customer base somewhat offset the negative impact of the weather on revenues.\nAdditionally, total system throughput increased from 77.8 million MMBtu in 1994 to 84.0 million MMBtu in 1995 as the Company utilized its capacity during the warmer weather by supplying additional volumes to interruptible customers. The profit margins from these customers are passed back to the Company's firm customers through reduced gas costs.\nNatural Gas Sales\nThe natural gas sales portion of the Company's bundled service does not currently provide a profit margin. However, as all but 85 of the Company's 287,000 local transportation customers purchase bundled local transportation and natural gas, minimizing gas costs is an important part of the Company's business.\nThe Company's strategy of balancing gas costs and security of supply is achieved by optimizing the mix and terms of natural gas contracts with the use of supplemental liquefied natural gas and propane to meet peak winter demand. The Company maintains a diversified gas supply portfolio of domestic and Canadian gas supply contracts with producers.\nThe Company's rates include cost of gas adjustment clauses (\"CGA\") pursuant to which natural gas purchase costs and other costs are recovered from customers. The following table details these costs:\nRecovered natural gas costs decreased by 15%, or $41.6 million, in 1995. This decrease was the result of a decline in purchase costs combined with decreases in supplemental fuel costs, demand-side management program (\"DSM\") costs, and transition costs. The decrease in purchase costs reflect a combination of the effect of the new competitive gas supply environment and the impact of the warm weather on demand. The decrease in supplemental fuel costs also reflect the warmer weather, as well as renegotiated contracts with supplemental fuel suppliers. DSM programs are aimed at motivating customers to use natural gas responsibly and, at the same time, cost the Company less than the incremental gas supply these customers would have used otherwise. As these programs have become fully implemented, their costs to customers have been reduced.\nThe Federal Energy Regulatory Commission (\"FERC\") is permitting gas pipeline companies, including those from which the Company purchases a significant portion of its natural gas supplies and storage services, to bill their customers for prudently incurred costs of transitioning into the deregulated environment. These costs significantly declined in 1995 and should continue to decline in the future. The Company has regulatory approval to recover these costs through the CGA.\nOther Energy Products and Services\nAs is the case with revenues generated from local transportation, propane revenues are also significantly impacted by the weather. However, in 1995, the Company was able to expand its propane business to compensate for the weather-related decrease in demand. Sales volumes for propane increased from 6.8 million gallons in 1994 to 7.4 million gallons in 1995.\nRevenues from equipment rentals and service increased by over 21% or $2.2 million in 1995 after increasing by 7% and 4% in 1994 and 1993, respectively. This significant increase in 1995 is primarily the result of moderate price increases and new service offerings combined with an increase in the number of units rented and serviced.\nOperating Expenses\nOperations expenses decreased by $3.9 million in 1995 after decreasing by $1.5 million in 1994 and increasing by $7.5 million in 1993. As the result of lower accounts receivable balances and improved collections from customers through special payment arrangements, bad debt expense was reduced by $2.5 million in 1995. The remaining decrease reflects other cost control measures.\nHigher plant balances, an outcome of customer growth, have resulted in continuing increases in depreciation expense. Taxes, other than income taxes, increased primarily due to higher property taxes. Annual increases in property tax rates and assessments, combined with the growth in plant, increased property taxes by $601,000, $808,000, and $821,000 in 1995, 1994, and 1993, respectively.\nIncome (Loss) from Investments in Energy Ventures\nBay State has operating results from two investments in energy ventures: MASSPOWER, a cogeneration facility, and KBC Energy Services (\"KBC\"), a partnership with Connecticut Natural Gas Corporation and Koch Gas Services Company, which markets natural gas supplies and energy-related services on a nonregulated basis to commercial and industrial end-users.\nInterest Expense and Dividend Requirements on Preferred Stock\nIn 1995, the Company incurred additional interest expense due to overcollections of recovered natural gas costs, a result of lower than forecasted wellhead costs, and higher than anticipated pipeline supplier refunds. Dividend requirements on preferred stock were relatively flat for the comparative periods.\nResults of Operations, 1994 and 1993\nNet income increased $1.7 million and $4.4 million in 1994 and 1993, respectively. In both years the Company experienced colder than normal weather and had a growing customer base. The 1993 net income increase also reflected the result of a rate increase in the Company's Massachusetts service area.\nOperating revenues for 1994 and 1993 increased by $50.9 million and $39.6 million, respectively. In both years, this growth was primarily due to customer additions, combined with an increase in the cost of gas and the colder weather. The increase in 1993 operating revenues also reflected the Massachusetts rate increase, which was effective in November 1992. Recovered natural gas costs increased 17.6% and 9.3% in 1994 and 1993, respectively. The 1994 increase was the result of higher combined purchase and transmission costs, and additional increases in supplemental fuel costs, DSM program costs, and transition costs while the 1993 increase was primarily the result of higher natural gas commodity prices both under long-term contracts and from the spot market. These costs represent a bundled product and transmission cost for most of 1993.\nOperations expenses decreased by $1.5 million in 1994, after increasing by $7.5 million in 1993. The decrease was the net result of the absence of costs related to the union work stoppages, which occurred in 1993, and higher bad debt expense related to the colder winter weather experienced in 1994. Also contributing to the decrease in 1994 operations expenses was the effect of an internal review of operations and corporate structure performed early in 1994. This review resulted in a flatter, more efficient organization requiring almost 5% fewer employees. The largest increases in operating expenses in 1993 were in employee benefits and outside services. The higher employee benefit expenses in 1993 included an increase in postretirement benefit costs, resulting from the implementation of Statement of Financial Accounting Standards No. 106, and the establishment of an accrual for an employee severance plan. Outside services included an abnormal level of costs related to the union work stoppages and regulatory restructuring costs.\nInterest expense increased $2.2 million in 1994 due to higher levels of long-term debt outstanding during the year, higher short-term debt rates, and a decrease in the debt portion of AFUDC. Total interest expense for 1993 was comparable to the prior year.\nLiquidity and Capital Resources\nNatural gas sales in New England are seasonal, and the Company's cash flows reflect this seasonality. Approximately 74% of annual revenues are generated during the heating season, which results in a high level of cash flow from operations from late winter through early summer. Short-term borrowings are typically highest in the fall and early winter as a result of completion of the annual construction program and seasonal\nworking capital requirements. The Company has been able to access the financial markets to meet its capital requirements and does not anticipate a change in its access to, or the availability of, capital in the coming year.\nCash flows from operations improved by $7.6 million in 1995 despite a decrease in net income primarily as the result of decreasing accounts receivable balances, increases in refunds due customers, and lower cash contributions to benefit plans. Refunds from upstream pipelines totaled approximately $15.8 million in 1995 as compared to $9.4 million in 1994. This amount will be refunded to customers in the near future, contributing to reduced gas prices. The Company made cash contributions to its benefit plans of $3.2 million, $15.3 million, and $15.0 million in 1995, 1994, and 1993, respectively.\nThe Company invests in property, plant, and equipment to improve and protect its distribution system, and to expand its system to meet customer demand. As a result of planned spending, capital expenditures for property, plant, and equipment increased $2.1 million in 1995. Capital expenditures for 1996 are estimated to be approximately $53.0 million.\nThe remaining increase in investing activities for 1995 relates to expenditures on energy ventures. These expenditures were $4.6 million, $1.0 million, and $4.8 million in 1995, 1994, and 1993, respectively. In 1993, a one-time equity investment was made in MASSPOWER of $4.2 million. Capital expenditures for energy ventures for 1996 are estimated to be approximately $6.3 million (see note 8).\nAs was the case in 1994, the 1995 decline in cash flows from financing activities reflects a reduction in debt issuances as a result of strong cash flows from operations. The Company has a shelf registration statement covering up to $125.0 million of senior unsecured debt securities, under which $65.0 million in notes has been issued as of September 30, 1995. The Company has access to $77.0 million in bank lines of credit. In early 1995, the Dividend Reinvestment Plan was converted to a market purchase plan, eliminating new equity issuances under this plan.\nThe Company is in the final stages of completing a sale and lease-back arrangement for equipment rental assets with a financing company, through which approximately $20.7 of additional capital will be made available. This, along with continuing strong operating cash flows, will enable the Company to fund its operating and investing activities without extensive long-term debt or equity issuances in 1996.\nImpact of Inflation\nThe rates charged to transportation customers may not be increased without formal proceedings before regulatory authorities. Accordingly, in the absence of authorized rate increases and except for changes in recovered gas costs, which are reflected in customer rates, the Company must look to performance improvements and higher sales volumes, particularly from highly profitable market segments, to offset inflationary increases in its costs of operations. Current rates only permit the Company to recover its historical cost of utility plant and give no recognition to the current cost of replacing facilities. Although no new material\nrate proceedings are currently planned, under the current regulatory process, management believes the cost of utility plant additions will be recognized in setting future rate levels.\nEnvironmental Issues\nThe Company continues to work with federal and state environmental agencies to assess the extent and environmental impact of waste materials that exist at or near former gas manufacturing sites located primarily in Massachusetts. The costs of such assessments and any related remediation determined to be necessary will be funded from traditional sources of capital and recovered from customers (see note 8).\nNew Accounting Standard\nIn March 1995, the Financial Accounting Standards Board (\"FASB\") issued Statement of Financial Accounting Standards No. 121 (\"SFAS 121\"), \"Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of.\" This statement, which is effective for years beginning after December 15, 1995, requires the Company to review long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Company does not expect that the adoption of this standard will have a material impact on the results of operations, financial condition, or cash flows of the Company.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\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.\nThe accompanying notes are an integral part of these statements.\nBAY STATE GAS COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 1995, 1994, AND 1993\nNOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION. The consolidated financial statements include the accounts of Bay State Gas Company and its wholly owned subsidiaries (the \"Company\"). All significant intercompany transactions and accounts have been eliminated. Certain information in the prior period financial statements has been reclassified to conform with the current period's presentation.\nREGULATION AND OPERATIONS. The Company is subject to regulation with respect to rates, accounting and other matters, where applicable, by the Massachusetts Department of Public Utilities (\"MADPU\"), the New Hampshire Public Utilities Commission, the Maine Public Utilities Commission, and the FERC. The Company's accounting policies conform to generally accepted accounting principles and reflect the effects of the ratemaking process in accordance with Statement of Financial Accounting Standards No. 71, \"Accounting for the Effects of Certain Types of Regulation.\"\nPLANT. Plant is stated at original cost and consists of utility plant and non-utility plant assets. The original cost of depreciable units of plant retired, together with the cost of removal, net of salvage, is charged to accumulated depreciation. The costs of maintenance, repairs, and replacements of minor items are charged to expense as incurred.\nDepreciation is provided for all classes of plant on a group straight-line basis in amounts equivalent to overall composite rates of 3.88% for 1995 and 1994 and 3.74% for 1993.\nALLOWANCE FOR FUNDS USED DURING CONSTRUCTION (AFUDC). AFUDC is the estimated cost of funds used for construction purposes. Such allowances are charged to plant and reported as other income (cost of equity funds) or a reduction of interest expense (cost of borrowed funds). AFUDC was $748,000, $457,000, and $2,028,000 for 1995, 1994, and 1993, respectively.\nINVESTMENTS. The Company accounts for its partnership investments by the equity method.\nCASH AND TEMPORARY CASH INVESTMENTS. The Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents.\nLOCAL TRANSPORTATION, NATURAL GAS SALES, AND DEFERRED GAS COSTS. Local transportation revenue and natural gas sales are based on the volume of gas transported or sold at billing rates authorized by regulatory authorities and include unbilled revenues for gas delivered, but not billed. The Company's rates include cost of gas adjustment clauses pursuant to which gas and certain other costs are recovered from customers. Any differences between gas costs incurred and amounts billed are deferred for recovery from or refund to customers in future periods. Also included in natural gas sales are sales to interruptible customers. Substantially all net margins from interruptible sales are used to reduce gas costs to customers through the cost of gas adjustment clauses.\nENVIRONMENTAL COSTS. In accordance with orders of regulatory authorities, the Company defers costs incurred to remediate environmental damage. Such costs are amortized to expense over periods of seven to 10 years as they are recovered from customers (see note 8).\nINCOME TAXES. On October 1, 1993, the Company adopted the asset and liability method of accounting for income taxes as required by Statement of Financial Accounting Standards No. 109 (\"SFAS 109\"), \"Accounting for Income Taxes.\" Pursuant to SFAS 109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the tax bases and the financial statement carrying amounts of existing assets and liabilities. Prior year financial statements reflect deferred income taxes for the tax effects of the timing differences between the recognition of revenue and expense for income tax purposes and financial reporting purposes (see note 2).\nInvestment tax credits related to plant additions prior to 1987 were deferred and are being amortized as reductions of income tax expense over the lives of the related assets.\nPENSION AND OTHER EMPLOYEE BENEFIT PLANS. The Company has noncontributory defined benefit pension plans covering substantially all employees. Benefits under the plans are generally based on years of service and the level of compensation during the final years of employment. Pension costs are recognized on the accrual method of accounting over the expected periods of employee service based on actuarial assumptions.\nStatements of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefit Plans Other than Pensions\" and No. 112, \"Employers' Accounting for Postemployment Benefits,\" were adopted on October 1, 1993, requiring the accrual method of accounting for the costs of postretirement and postemployment benefits. Other postretirement benefits consist of certain health and life insurance benefits for retired and active employees hired before September 30, 1990. Postemployment benefits consist of workers compensation claims, long-term disability payments, and medical coverage continuation payments. These costs were previously recognized when paid. They are now accrued over the expected periods of employee service based on actuarial assumptions (see note 7).\nEARNINGS PER SHARE. Earnings per common share have been computed by dividing earnings applicable to common stock by the weighted average number of shares of common stock outstanding during each year.\nNEW ACCOUNTING STANDARDS. Effective for fiscal years beginning after December 15, 1995, SFAS 121 will require a review of long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. It is expected that the adoption of this standard will not have a material impact on cash flows, financial condition, or the results of operations.\nNOTE 2. INCOME TAXES\nAt September 30, 1995 and 1994, unamortized deferred investment tax credits included in long-term deferred taxes amounted to $5.8 million and $6.2 million, respectively.\nAs discussed in note 1, a new method of accounting for income taxes was adopted as of October 1, 1993. The cumulative effect on the years prior to October 1, 1993 of adopting the new method of accounting for income taxes had no effect on net income because a regulatory asset of $9.6 million was recorded, reflecting future amounts due from customers for the effects of the temporary differences. The effect of the change on income tax expense for 1994 was not significant because amounts of income tax expense which differ from amounts calculated in accordance with currently effective rate orders for settlement with customers in future periods have been deferred.\nNOTE 3. CAPITALIZATION\nCOMMON STOCK. A Key Employee Stock Option Plan provided for the granting of options to key employees to purchase an aggregate of 1,050,000 shares of common stock. While it is anticipated that no further options will be granted under this plan, previously granted options may continue to be exercised through 2002.\nA Shareholder Rights Plan provides one right (\"Right\") to buy one share of common stock at a purchase price of $70 for each share of common stock issued and to be issued. The Rights expire on November 30, 1999 and only become exercisable, or separately transferable, 10 days after a person or group acquires, or announces an intention to acquire, beneficial ownership of 20% or more of the Company's common stock. The Rights are redeemable by the Board at a price of $.01 per Right, at any time prior to the acquisition by a person or a group of beneficial ownership of 20% or more of the Company's common stock. Once a person or group acquires more than 20% of the Company's common stock, however, the Rights may not be redeemed.\nAt September 30, 1995, there were 385,000 authorized but unissued shares of common stock reserved for the Dividend Reinvestment Plan (\"DRP\"). On December 1, 1994, the DRP was converted to a market based plan. It is anticipated that no further shares will be issued under this plan.\nCUMULATIVE PREFERRED STOCK AND LONG-TERM DEBT. The cumulative preferred stocks rank equally and are preferred over common stock in voluntary liquidation at the redemption price in effect at the time of such voluntary liquidation and in involuntary liquidation at the par value per share, in each case plus accrued dividends, except for the $3.80 Series, $50 par value, which has a voluntary liquidation value of $83 per share and a set involuntary liquidation value of $81.50 per share, plus accrued dividends.\nAs of September 30, 1995, long-term debt agreements contain no provisions restricting the payment of dividends on common stock. All debt is unsecured.\nAs of September 30, 1995 and 1994, $6.0 million and $18.0 million of long-term debt were outstanding under revolving credit agreements at weighted average interest rates of 6.23% and 5.36%, respectively.\nThe fair values of capital lease obligations are estimated using the present value of the minimum lease payments discounted at market rates. The fair values of long-term debt are estimated based on current rates offered to the Company for debt of the same remaining maturities. The carrying amounts for cash and temporary cash investments, accounts receivable, accounts payable, accrued liabilities, and short-term debt approximate their fair values due to the short-term nature of these instruments.\nNOTE 4. LEASES\nNoncancelable operating and capital leases have been entered into for the use of certain facilities and equipment. The operating lease agreements generally contain renewal options. The capital leases relate to liquefied natural gas storage facilities. Certain leases contain renewal and purchase options and escalation clauses.\nInterest included in capital lease payments was $253,000, $328,000, and $397,000 in 1995, 1994, and 1993, respectively.\nAt September 30, 1995, the Company had unsecured bank lines of credit aggregating $77.0 million for which it pays commitment fees, and access to an additional $30.0 million under the Fuel Purchase Agreements as described in note 6.\nNOTE 6. FUEL PURCHASE AGREEMENTS\nUp to $30.0 million can be raised through credit agreements (the \"Agreements\") underlying the Fuel Purchase Agreements with a corporation established to provide financing, through borrowing on a demand basis or selling supplemental gas inventories. Any inventories sold must be repurchased and any associated carrying costs paid when the gas is withdrawn from storage. All gas costs, carrying costs, and administrative charges are fully recoverable through the CGA approved in each state regulatory jurisdiction. The Agreements contain an expiration date of September 1998.\nNOTE 7. PENSION AND EMPLOYEE BENEFIT PLANS\nPlan assets are primarily invested in marketable pooled funds holding equity and corporate debt securities and in cash equivalents. Certain changes in items shown above are not recognized as they occur, but are systematically amortized over subsequent periods. Unrecognized amounts as of September 30, 1995 and 1994, are as follows:\nThe discount rate, rate of increase in future compensation levels, and expected long-term rate of return on plan assets used in determining the actuarial present value of the projected benefit obligation were 8.0%, 5.0%, and 9.0% for both 1995 and 1994. Net pension cost for 1995, 1994, and 1993 included the following components:\nPOSTRETIREMENT BENEFITS OTHER THAN PENSIONS. As described in note 1, the Company adopted the accrual method of accounting for postretirement benefit plans other than pensions in 1994. The change in the method of accounting had no significant impact in 1994 as regulatory authorities permit the Company to defer costs in excess of amounts recovered through rates for collection in future periods. The present value of the accumulated benefit obligation was $24.7 million and $28.2 million, at September 30, 1995 and 1994, respectively. The expense recognized was $2.7 million, $2.8 million, and $2.5 million for 1995, 1994, and 1993, respectively. The components of other postretirement benefit expense for 1995 and 1994 are as follows:\nPlan assets are held in voluntary employee benefit association (\"VEBA\") trusts and medical funds in the pension plans. VEBA assets are invested in common stocks, bonds, and cash equivalents.\nThe accumulated other postretirement benefit obligation was determined using an assumed discount rate of 8.0% and an expected long-term pre-tax rate of return on plan assets of 9.0% for both 1995 and 1994, and a health care cost trend rate of 9.0% and 11.0% in 1995 and 1994, respectively, decreasing to 6.0% by 1998. An annual 1% increase in the health care cost trend rate would increase the accumulated postretirement benefit obligation by $2.2 million and the cost for 1995 by $300,000.\nRETURN ON PREPAYMENTS OF OTHER POSTRETIREMENT BENEFITS. As permitted by regulatory authorities, noncash returns of $1,650,000, $857,000, and $286,000 for 1995, 1994, and 1993, respectively, have been recorded on amounts of prepayments associated with employee postretirement benefit plans other than pensions. Regulators permit the accrual of returns on these prepayments because the plan funding will significantly reduce future costs of the plans.\nPOSTEMPLOYMENT BENEFITS OTHER THAN PENSIONS. As described in note 1, the accrual method of accounting for postemployment benefit plans was adopted in 1994. The change in the method of accounting had no significant impact in 1994 as the Company deferred costs in excess of amounts recovered through rates for collection in future periods. The present value of the accumulated benefit obligation was $4.9 million and $4.1 million, at September 30, 1995 and 1994, respectively.\nEMPLOYEE SAVINGS PLAN. Employee Savings Plans (the \"ESP's\") provides eligible employees with an incentive to save and invest regularly. The ESP's are defined contribution plans, which allow eligible employees to defer a portion of their salaries to employee-funded pretax retirement savings accounts. Matching contributions to certain employee deferrals were $813,000, $784,000, and $601,000 in 1995, 1994, and 1993, respectively.\nNOTE 8. COMMITMENTS AND CONTINGENCIES\nCAPACITY REQUIREMENTS. The Company currently transports natural gas from Canada through a converted oil pipeline leased from the Portland Pipe Line Corporation (\"PPLC\"). The PPLC lease currently extends to March 31, 1997. An agreement with PPLC to extend the lease through the 1997-1998 heating season is being sought. Short-term contingency plans have been developed for supplying customers in Maine and New Hampshire through the 1997-1998 heating season in the event that the lease is not extended. Long-term, two projects to replace the pipeline capacity provided by the PPLC lease are being pursued, a 2.0 million MMBtu liquefied natural gas storage facility in Wells, Maine (\"Wells LNG\"), and the Portland Natural Gas Transmission System (\"PNGTS\").\nPNGTS is an interstate pipeline that will extend 250 miles from the US-Canadian border to the New Hampshire-Massachusetts border. By March 1, 1996, PNGTS plans to file an application with the FERC for approval to construct and operate the pipeline. The Company has entered into long-term agreements with PNGTS for service on the pipeline. Such agreements are subject to state regulatory review and approval in Massachusetts, Maine, and New Hampshire. In November 1994, the Company filed an application with the FERC for approval to construct and operate Wells LNG. The Company will file for approval from the public utility commissions of Maine and New Hampshire of its agreement for service from the LNG facility.\nRecovery of investments in PNGTS and Wells LNG is dependent upon, among other things, successful completion of the projects and the terms of required regulatory approvals. While their completion is subject to a number of factors beyond the Company's control, the Company believes that these projects will be successful. Both of these projects are scheduled to be completed and available for service by November 1998.\nDuring 1995, the Company made an initial investment of $50,000 in KBC and is committed to invest up to a total of $1.7 million. KBC began operations in 1995.\nLONG-TERM OBLIGATIONS. The Company has long-term contracts for the purchase, storage, and delivery of gas supplies. Certain of these contracts contain minimum purchase provisions which, in the opinion of management, are not in excess of the Company's requirements.\nENVIRONMENTAL ISSUES. Like other companies in the natural gas industry, the Company is party to governmental actions associated with former gas manufacturing sites. Management estimates that, exclusive of insurance recoveries, if any, expenditures to remediate and monitor known environmental sites will range from $3.9 million to $10.0 million. Accordingly, a $3.9 million liability, with an offsetting charge to a regulatory asset (see note 1), has been accrued. Environmental expenditures for 1995, 1994, and 1993 were $387,000, $129,000, and $620,000, respectively. Exclusive of amounts accrued for future expenditures, at September 30, 1995 and 1994, approximately $3.0 million of environmental expenditures had been deferred for future recovery from customers.\nREGULATORY MATTERS. On April 13, 1995, approval was received from the FERC for a $1.1 million increase in annual pipeline revenues effective November 1, 1994.\nAn overall revenue-neutral rate redesign has been filed with the MADPU. The goal of the rate redesign is to implement rates that more closely reflect the actual costs associated with serving different customers. New rates are expected to be effective early in calendar 1996.\nSignificant regulatory assets arising from the rate-making process associated with income taxes, employee benefits, and environmental response costs have been recorded. Based on its assessments of decisions by regulatory authorities, management believes that all regulatory assets will be settled at recorded amounts through specific provisions of current and future rate orders.\nLITIGATION. The Company is involved in various legal actions and claims arising in the normal course of business. Based on its current assessment of the facts of law, and consultations with outside counsel, management does not believe that the outcome of any action or claim will have a material effect upon the consolidated financial position, results of operations, or liquidity of the Company.\nNOTE 9. UNAUDITED QUARTERLY FINANCIAL DATA\nIn thousands except per share amounts.\nIn the opinion of management, quarterly financial data includes all adjustments, consisting only of normal recurring accruals, necessary for a fair representation of such information. Revenue and income amounts vary significantly due to seasonal weather conditions.\nREPORT OF MANAGEMENT\nThe management of Bay State Gas Company and its subsidiaries has the responsibility for preparing the accompanying financial statements. We believe the financial statements were prepared in conformity with generally accepted accounting principles. Management also prepared the other information in the annual report and is responsible for its accuracy and consistency with the financial statements.\nTo fulfill its responsibility, management maintains a system of internal control that has been designed to provide reasonable assurance as to the integrity and reliability of the financial statements and the safeguarding of Company assets.\nThe Company has established statements of corporate policy relating to conflict of interest and conduct of business and annually receives from appropriate employees confirmation of compliance with these policies.\nThe Company's financial statements have been audited by KPMG Peat Marwick LLP, independent certified public accountants. The independent accountants are elected by the Company's Directors and report any recommendations concerning the Company's system of internal control to the Audit Committee of the Board of Directors, which consists of three outside Directors. The Audit Committee meets periodically with management, internal auditors and KPMG Peat Marwick LLP, to review and monitor the Company's financial reporting, accounting practices, and business conduct.\nAlthough there are inherent limitations in any system of internal control, management believes that as of September 30, 1995, the Company's system of internal control was adequate to accomplish the objectives discussed herein.\nROGER A. YOUNG THOMAS W. SHERMAN Chief Executive Officer Chief Financial Officer\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Shareholders of BAY STATE GAS COMPANY\nWe have audited the accompanying consolidated balance sheets and statements of capitalization of Bay State Gas Company and subsidiaries as of September 30, 1995 and 1994, and the related consolidated statements of earnings, shareholders' equity and cash flows for each of the years in the three-year period ended September 30, 1995. 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 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 Bay State Gas Company and subsidiaries at September 30, 1995 and 1994, and the results of their operations and their cash flows for each of the years in the three-year period ended September 30, 1995 in conformity with generally accepted accounting principles.\nAs discussed in Notes 1, 2, and 7 to the consolidated financial statements, the Company changed its methods of accounting for income taxes, postemployment benefits and postretirement health and welfare benefits in 1994.\nKPMG PEAT MARWICK LLP\nBoston, Massachusetts October 24, 1995\nPART III\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nInformation regarding the Directors of the Registrant as set forth on pages 3 and 4 of the 1996 annual meeting proxy statement, dated December 7, 1995, is incorporated herein by reference. Information relating to the Executive Officers of the Registrant is contained in Part I, Item 1, Business.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation regarding compensation of the Registrant's executive officers as set forth on pages 7 through 15 of the 1996 annual meeting proxy statement, dated December 7, 1995, is incorporated herein by reference.\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 as set forth on pages 5 and 6 of the 1996 annual meeting proxy statement, dated December 7, 1995, is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation regarding certain relationships and related transactions as set forth on pages 4, 6, 7 and 15 of the 1996 annual meeting proxy statement, dated December 7, 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 THE REPORT:\n(1) The following financial statements are included herein under Part II, Item 8, FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nConsolidated Statements of Earnings for the Years ended September 30, 1995, 1994, and 1993 Consolidated Balance Sheets as of September 30, 1995 and 1994 Consolidated Statements of Capitalization as of September 30, 1995 and Consolidated Statements of Shareholders' Equity for the Years ended September 30, 1995, 1994, and 1993 Consolidated Statements of Cash Flows for the Years ended September 30, 1995, 1994, and 1993 Independent Auditors' Report\n(2) The following additional data should be read in conjunction with the financial statements included in Part II, Item 8, FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. Schedules not included herein have been omitted because they are not required or are not applicable, or the required information is shown in such financial statements or notes thereto.\n(3) Exhibits -- See Exhibit index on page 34.\n(B) REPORTS ON FORM 8-K:\nThe Company did not file a report on Form 8-K during the fourth quarter of fiscal 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.\nBAY STATE GAS COMPANY\n\/S\/ THOMAS W. SHERMAN By --------------------------------- THOMAS W. SHERMAN EXECUTIVE VICE PRESIDENT\nDate: December 1, 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\n(3) Articles of incorporation and by-laws:\n(4) Instruments defining the rights of security holders, including indentures:\nThe following is a listing of debt instruments defining the rights of security holders, including indentures and\/or note agreements for Bay State, Northern, and Granite. None of these instruments represent any securities in an amount authorized or outstanding which exceeds 10% of the total assets of the Company as of September 30, 1995. The Company will furnish the Securities and Exchange Commission with copies of any of the instruments listed below upon request.\nRevolving Credit Agreement between Northern and The First National Bank of Boston, to borrow up to $20,000,000, dated as of March 17, 1993, due March 17, 1997.\nIndenture between Bay State and The First National Bank of Boston, Trustee, dated as of April 1, 1991, for Senior Unsecured Debt Securities under which the following Notes have been issued under a Prospectus dated April 18, 1991:\n- $10,000,000 Principal Amount of 9.20% Notes due June 6, 2011 - $5,000,000 Principal Amount of 9.28% Notes due August 12, 2021 - $25,000,000 Principal Amount of 9.45% Notes due September 5, 2031 - $12,000,000 Principal Amount of 8.15% Notes due August 26, 2022 - $4,000,000 Principal Amount of 7.55% Notes due November 1, 2002 - $1,000,000 Principal Amount of 7.55% Notes due October 2, 2002 - $5,000,000 Principal Amount of 7.45% Notes due December 16, 2002 - $5,000,000 Principal Amount of 7.38% Notes due December 31, 2002 - $7,000,000 Principal Amount of 7.375% Notes due November 1, 2002 - $1,000,000 Principal Amount of 7.375% Notes due December 31, 2002 - $5,000,000 Principal Amount of 7.37% Notes due December 31, 2002 - $20,000,000 Principal Amount of 7.25% Notes due August 5, 2002\nIndenture between Bay State and The First National Bank of Boston, Trustee, dated as of April 1, 1991, for Senior Unsecured Debt Securities under which the following Notes have been issued under a Prospectus dated April 7, 1993:\n- $10,000,000 Principal Amount of 7.42% Notes due September 10, 2001 - $10,000,000 Principal Amount of 7.625% Notes due June 19, 2023 - $10,000,000 Principal Amount of 6.0% Notes due July 6, 2000 - $15,000,000 Principal Amount of 6.0% Notes due September 29, 2003 - $10,000,000 Principal Amount of 6.58% Notes due June 21, 2005 - $5,000,000 Principal Amount of 6.0% Notes due January 30, 2001 - $5,000,000 Principal Amount of 6.625% Notes due June 28, 2002\nNote Purchase Agreement between Northern and First Colony Life Insurance for the purchase and sale of $13,000,000 principal amount of 9.70% Notes dated as of January 1, 1992, due September 1, 2031.\nNote Purchase Agreement between Northern and the Mutual Life Insurance Company of New York for the purchase and sale of $10,000,000 principal amount of 6.93% Notes dated as of September 29, 1995, due September 27, 2010.\nNote Purchase Agreement between Northern and the Mutual Life Insurance Company of New York for the purchase and sale of $5,000,000 principal amount of 6.30% Notes dated as of September 29, 1995, due September 30, 1998.","section_15":""}
{"filename":"73354_1995.txt","cik":"73354","year":"1995","section_1":"ITEM 1. BUSINESS\nNursecare Health Centers, Inc. (the \"Company\") was organized in 1969 and for most of its existence provided skilled nursing, convalescent and rehabilitation care in the operation of two health care facilities. Virtually all of the Company's revenue for all years of its existence had been derived from these services.\nThe two facilities, Union Forge Nursing Home, Inc. and the Northwood Nursing and Convalescent Home, Inc. were separately incorporated and operated as wholly-owned subsidiaries of the Company. The Union Forge Nursing Home, Inc., located in Hunterton County, New Jersey, was sold in 1989. The Northwood Nursing and Convalescent Home, Inc. was sold in 1994.\nIn 1995, the Company formed the Pinnacle Healthcare Group, Inc., a wholly-owned subsidiary of the Company which provides long-term care consulting to long-term care facilities. This includes assistance in achieving regulatory compliance and providing the highest level of quality care through education and staff awareness. Constant new regulations in the long-term health care industry requires continuing education of staff and maintaining compliance with the ever changing regulations.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nCompany's headquarters are located in leased space of Three Station Square, Paoli, Pennsylvania, 19301. Registrant occupies approximately one thousand and forty-five (1,045) square feet on the second floor of this office building, which constitutes approximately fourteen percent (14%) of the rental space on that floor. The Registrant's lease runs for a one (1) year term from February 1995, to February, 1996. The annual rental for the year ending December 31, 1995, was $12,475.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nLICENSURE\nAll legal proceedings previously described in the Company's Reports to the Commission were settled before the end of the fiscal year ending December 31, 1995 with the exception of the following:\nNursecare Health Centers, Inc., et al. v. Realty-Vest Financial Corp., et al., Court of Common Pleas, Philadelphia County, June Term 1993, No. 1485. This action (the \"Nursecare Action\") was brought by the Company in the Philadelphia Court of Common Pleas for compensatory and punitive damages in excess of $50,000 arising from the allegedly inept, dishonest and fraudulent acts and omissions of certain former managers of a skilled care nursing home facility previously owned by Northwood from early 1990 through March 1993 and from certain defendants' breach of a contract for the sale of the Northwood facility. The Company alleges that the former managers physically damaged the Northwood facility, failed to submit properly documented claims for reimbursement for resident services to third-party payers, diverted Northwood funds for unauthorized uses, committed other acts of malfeasance that caused the Company financial loss and otherwise failed to fulfill their obligations under the contract for sale of the Northwood facility. The Company has sought damages for the defendants' breach of contract, breach of trust, breach of fiduciary duty, negligence, fraud, negligent misrepresentation, conversion, waste of premises, and under theories of individual liability of certain of the organizational defendants' officers and partners by virtue of their participation in the acts and omissions which injured the Company and piercing the corporate veil. The Company and the other plaintiffs also seek an award of their attorneys' fees and costs in an unspecified amount.\nThe defendants have asserted counterclaims against the Company (the \"Counterclaims\") and a third-party action against Northeastern Investment Company (\"Northeastern\") (the parent of Nursecare) and one of Nursecare's officers, James Hubbert, in his individual capacity (the \"Third-Party Action\"). Defendants allege in the Counterclaim that the Company, among others, breached a contract for the sale of the Northwood facility to them and committed various torts preventing the consummation of the sale of the Northwood facility and interfering with their management of the facility. In particular, the defendants allege in the Counterclaim that the Company committed fraud and negligently misrepresented material facts in connection with the attempt by Realty-Vest to purchase the Northwood facility beginning in 1989. The defendants further allege that these actions constitute a breach of the sales contract, and that the Company is liable to indemnify defendants for financial losses defendants allegedly incurred as a result of the Company's alleged actions. The defendants further allege that the Company, among others, tortuously converted Medicaid receivables and a reserve bank account for its own purposes. Defendants further allege that the Company, among others, tortuously interfered with their relationship with Northwood employees. The defendants seek compensatory and punitive damages in excess of $50,000 and an award of their attorneys' fees and costs in an unspecified amount.\nThe Nursecare Action still is in the discovery stages. The parties are in the process of conducting settlement negotiations. The parties tentatively have negotiated a settlement under which the defendants would pay the Company $280,000 plus interest over 20 months and provide certain other consideration under the terms of the proposed tentative settlement. Neither the Company nor any other entity or person named in the Counterclaim or the Third-Party Action would pay the defendants anything under the terms of the proposed settlement.\nIf settlement is not reached in the near future, the Company intends to prosecute this action vigorously. At this time, however, we are unable to express any opinion as to the likely outcome of this litigation.\nThe Company believes that all of the allegations against it and related persons and entities in the Counterclaim and the Third-Party Action are baseless and without merit and that the Company and all of the other persons and entities named in the Counterclaim and the Third-Party Actions have meritorious defenses to all such claims. If settlement is not reached in the near future, the Company intends to resist the Counterclaim and, to the extent that the Third-Party Action implicates the Company's interests, the Third-Party Action vigorously. At this time, however, we are unable to express any opinion as to the likely outcome of this litigation.\nThe Company previously tendered the defense of the Counterclaim to two of its insurers, the Continental Insurance Company (\"Continental\") and Pacific Employers Insurance Company (\"Pacific Employers\"). Continental has denied coverage, for which, among other acts and omissions, the Company has brought suit against Continental. See below. Pacific Employers has not yet determined whether it will provide the Company with a defense or indemnity.\nNorthwood Nursing and Convalescent Home, Inc. and Nursecare Health Centers, Inc. v. The Continental Insurance Co., U.S.D.C., E.D. Pa., C.A. No. 94-CV-6706. This action (the \"Coverage Action\") was brought by the Company against one of its insurance companies, Continental, in the United States District Court for the Eastern District of Pennsylvania. In this action, the Company seeks declaratory relief and damages in excess of $50,000. The Company alleges that Continental contracted to defend and indemnify the Company with regard to certain of the liabilities and losses that form the basis for their claims in the Nursecare Action (see above). The Company has alleged that Continental breached the insurance contract and Continental's obligations of good faith and fair dealing in its handling of the claims. The Company has alleged further that Continental is liable to the Company under Pennsylvania's bad faith insurance practices statute, under which the Company can recover punitive damages, attorneys' fees and enhanced interest.\nOn or about October 24, 1995, the Court entered a summary judgment in favor of Continental and against the Company. The Company filed an appeal of the Court's grant for the Third Circuit, captioned Northwood Nursing and Convalescent Home, Inc. and Nursecare, Inc. v. The Continental Insurance Co., U.S. Court of Appeals, 3rd Circuit, No. 95-2003 (the \"Appeal\").\nThe Company has reached a settlement with Continental under which Continental will pay the Company $10,000 and provide certain other consideration in exchange for the Company's withdrawal of the Appeal. Continental and the Company have filed a stipulation for the withdrawal of the Appeal in light of the settlement. The stipulation awaits Court approval.\nNursecare Health Centers, Inc. and Northwood Health, Inc. v. American Insurance Administrators a\/k\/a \"AIA\" and Donald R. Wert, individually and as President of American Insurance Administrators, Inc., Court of Common Pleas, Philadelphia Co., November Term 1994, No. 2112. This action was brought by the Company against the insurance agent (\"AIA\") which placed the Company's commercial coverage with Continental and Pacific Employers during the time period that the defendants in the Nursecare Action (see above) managed the nursing care facility previously owned by Northwood. The Complaint was filed in the Court of Common Pleas of Philadelphia County. The Company alleges that AIA and its principal, Donald Wert (\"Mr. Wert\"), failed to place insurance coverage adequate to insure the nursing home facility and negligently certified that AIA had placed adequate insurance coverage. The Company has brought claims against AIA and Mr. Wert for breach of contract, breach of fiduciary duty, negligent misrepresentation, fraud, professional negligence, and tortious interference with contractual relations. The Company seeks damages in excess of $50,000 and an award of its attorneys' fees and costs in an unspecified amount.\nThis action is in the pleading and discovery stages. The parties have negotiated a tentative settlement under which AIA, Mr. Wert and their insurance carrier, Utica Mutual Insurance Company, would pay the Company $41,250 and provide certain other consideration in exchange for a release.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SHAREHOLDERS\nA shareholders meeting took place on August 10, 1995 pursuant to notice. The only matter to be voted upon by the shareholders was the election of Directors for the following year. The Directors then in office were elected by a unanimous vote.PART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDERS MATTERS\n(a) Market. There is no active market for Registrant's Common Stock. The Company is aware that private sales between security holders occur from time to time by way of private negotiation. The Registrant is not involved in such transactions and the price established is between the individuals involved. The Company is aware that securities brokers from time to time will negotiate sales of the Company's stock. The Company does not participate in any such transactions, has not listed any of its shares on any securities exchange and does not know how or what prices are established. Otherwise, to the Company's knowledge, no stock exchange or brokerage firm makes a market in its securities although purchases and sales of its shares reportedly take place from time to time. As of December 31, 1995, the Company had 484 shareholders.\n(b) Dividends. The Registrant has never paid a cash, stock or property dividend. The Company's policy has been to reinvest its earnings.\nPART II\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\nPrior to November 30, 1994 the Company operated two nursing facilities with 210-bed capacity. Of the 210 beds, 148 were in Philadelphia, Pennsylvania (Northwood) and 62 beds were in Clinton Township, New Jersey (Union Forge). The Union forge was sold on February 7, 1990. From February, 1990 to November, 1994 only the Northwood was operational. On November 30, 1994 the Northwood was sold.\nThe Company has been wrapping up the affairs of the Northwood. There is no comparison of the revenue and income from discontinued operations of the Northwood and continuing operation. The continuing operations primarily exist of the 1995 start up on The Pinnacle Healthcare Group, Inc. The Company has been concentrating its efforts in the marketing and developing of this new venture. The Pinnacle Healthcare Group, Inc. is a long term care consulting firm dedicated to helping long term care facilities achieve regulatory compliance by providing the highest level of quality care through education and staff awareness.\nWe recognize that with the advent of new regulations, survey format and reimbursement methodology, keeping a facility's staff educated and up to date, while remaining in compliance, is a challenge. Therefore, we have developed a wide range of programs that will not only educate each facility's staff on how to identify problem areas, but will also give them the tools and training necessary to implement interventions which will maintain regulatory compliance and increase the facility's profit margin.\nNURSECARE HEALTH CENTERS, INCORPORATED AND SUBSIDIARIES YEARS ENDED DECEMBER 31, 1995, 1994, AND 1993\nNURSECARE HEALTH CENTERS, INCORPORATED AND SUBSIDIARIES\nPART II - ITEM 8.","section_7A":"","section_8":"","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThe Company's accountants, Zelenkofske & Axelrod & Co., Ltd., certified public accountants. During 1995 there was no change in the Company's accountants nor were there any disagreements with the accountants on accounting and financial disclosure.\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe Company has five (5) members of its Board of Directors who are listed below including Executive Offices held by each, if any. As noted in the table below, four (4) members of the Board have been serving in the capacity for twenty-three (23) years.\nPrincipal Director Shares Percent Officer Name Occupation Since Age Nursecare of Class - --------------------- -------------------- ----- --- --------- -------- James F. Hubbert President 1969 57 5,000 .9% Nursecare Health Centers, Inc.\nFrank H. Slattery CPA 1971 56 5,000 .9% Colucci & Slattery, P.C. Horsham, PA Secretary-Treasurer of Nursecare Health Centers, Inc. Since 1981 (and Treasurer Since 1979)\nHarry Wolfington Half-A-Car, Inc. 1971 58 5,000 .9% 308 Lancaster Avenue Wynnwood, PA\nJoseph Zoll President,. Co-Owner 1971 56 40,935 7.42% Associates For Research, Testing and Certifying Children and Adults Ascertaining Learning Potential of Disability Also, Marketing and Analysis Survey Firm\nF. Joseph Loeper, Jr. Pennsylvania 1990 52 -0- -0- State Senator Majority Leader Pennsylvania Senate\nITEM 11.","section_11":"ITEM 11. REMUNERATION OF MANAGEMENT\nNursecare Health Centers, Inc.. does not have any retirement benefits for its Officers or Directors. The table following indicated the aggregate cash and cash equivalent form of remuneration including salaries, Director fees, commissions and bonuses of all Officers of the Company in excess of Fifty Thousand Dollars ($50,000.00) each and all Officers and Directors of the Company as a group.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe first table following sets forth the names as of December 31, 1995, of persons owning of record, directly, indirectly or beneficially more than five percent (5%) of Nursecare Health Centers, Inc. Common Stock.\nThe second table following sets forth the amount of stock owned of record, beneficially, directly or indirectly, by the Directors and Officers of Nursecare Health Centers, Inc., as a group and individually as appropriate of Northeastern Investment Company, Inc. As of December 31, 1995, Northeastern Investment Company, Inc. had one (1) class of Common Stock outstanding and the total amount issued was one hundred seventy-three thousand five hundred seventy-six (173,576) shares.\nTitle of Class Amount of Beneficially Owned Percent of Class - -------------- ---------------------------- ---------------- Common Stock* 152,005 87.57 Percent\n*James F. Hubbert, President of Nursecare Health Centers, Inc. and Chairman of its Board of Directors, owns 140,000 shares of the above amount. This represents 80.66 percent of the outstanding shares. Northeastern Investment Company, Inc. has authorized Mr. Hubbert to vote its shares of Nursecare Health Centers, Inc., at the Annual Meeting.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONS AND RELATED TRANSACTIONS\nFrank H. Slattery, a director of the Company and a partner in a certified public accounting firm provided some accounting services for the Company during 1995. During the period covered in this report he had a 50% equity interest in the CPA firm.\nITEM 14.","section_14":"ITEM 14. EXHIBITS\nPreviously submitted Exhibits are incorporated herein by reference. They include the Articles of Incorporation of the Company, its bylaws, financial statements and material agreements concerning the sale of the Company's two nursing homes.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report of be signed on its behalf by the undersigned therefore duly authorized.\nNURSECARE HEALTH CENTERS, INC.\nDated: March 27, 1996 \/s\/James F. Hubbert 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 an in the capacities and on the dates indicated.\nDated: March 27, 1996 \/s\/James F. Hubbert President and Chairman of the Board (Principal Executive Officer)\nDated: March 27, 1996 \/s\/Frank H. Slattery Secretary, Treasurer and Director\nDated: March 27, 1996 \/s\/Harry Wolfington Director\nDated: March 27, 1996 \/s\/Joseph Zoll Director\nDated: March 27, 1996 \/s\/F. Joseph Loeper, Jr. Director\nFOOTNOTES\n1. Mr. Hubbert is also the President and Chairman of the Board of Northeastern Investment Company, Inc. and by reason thereof is beneficial owner of the shares held by Northeastern Investment company, Inc. (See ITEM 12.)\n2. 5,000 of the shares owned by Mr. Zoll and all shares owned by the other Directors were acquired pursuant to stock options exercised in January, 1987. No other stock options exist.\n3. Mr. Hubbert and Mr. Slattery are first cousins.\n4. The total percentage of shares owned by the Directors as a group of all outstanding shares of the Company is 10.4%. .\n5. The Company maintains life and health insurance for its Officers, as well as, a ,medical and dental protection plan for its President. The President also has use of the Company automobile. The Company reimburses its President for travel relating to Company business. Indirect remuneration includes all payments on account of these benefits.\n6. The Board of Directors met on eight (8) occasions in 1995. Of the figure included above, $44,000 was paid to Directors for meetings attended. $51,201 was paid to Colucci & Slattery, P.C. for accounting services. The Company's Assistant Secretary, Treasurer and Board Member Frank H. Slattery is a 50% partner in the firm.","section_15":""}
{"filename":"825167_1995.txt","cik":"825167","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL DESCRIPTION OF PARTNERSHIP\nSwift Energy Income Partners 1987-B, Ltd., a Texas limited partnership (the \"Partnership\" or the \"Registrant\"), is a partnership formed under a public serial limited partnership offering denominated Swift Energy Income Partners III (Registration Statement No. 33-11773 on Form S-1, originally declared effective March 19, 1987, and amended effective March 28, 1988, May 4, 1989 and May 1, 1990 [the \"Registration Statement\"]). The Partnership was formed effective July 23, 1987 under a Limited Partnership Agreement dated July 21, 1987. The initial 3,177 limited partners made capital contributions of $26,025,525.\nThe Partnership is principally engaged in the business of acquiring, developing and, when appropriate, disposing of working interests in proven oil and gas properties within the continental United States. The Partnership does not engage in exploratory drilling. Each working interest held by the Partnership entitles the Partnership to receive, in kind or in value, a share of the production of oil and gas from the producing property, and obligates the Partnership to participate in the operation of the property and to bear its proportionate share of all operating costs associated therewith. The Partnership typically holds less than the entire working interest in its producing properties.\nAt December 31, 1995, the Partnership had expended or committed to expend 100% of the limited partners' net commitments (I.E., limited partners' commitments available to the Partnership for property acquisitions after payment of organization fees and expenses) in the acquisition and development of producing properties, which properties are described under Item 2, \"Properties,\" below. The Partnership's revenues and profits are derived almost entirely from the sale of oil and gas produced from its properties and from the sale of acquired oil and gas properties, when the sale of such properties is economically preferable to continued operation.\nThe Partnership's business and affairs are conducted by its Managing General Partner, Swift Energy Company, a Texas corporation (\"Swift\"). The Partnership's Special General Partner, VJM Corporation, a California corporation (\"VJM\"), consults with and advises Swift as to certain financial matters. Swift is the designated operator of many of the properties in which the Partnership owns interests. The remaining properties are operated by industry operators designated by the owners of a majority of the working interest in each property.\nThe general manner in which the Partnership acquires producing properties and otherwise conducts its business is described in detail in the Registration Statement under \"Proposed Activities,\" which is incorporated herein by reference.\nCOMPETITION, MARKETS AND REGULATIONS\nCOMPETITION\nThe oil and gas industry is highly competitive in all its phases. The Partnership encounters strong competition from many other oil and gas producers, many of which possess substantial financial resources, in acquiring economically desirable Producing Properties.\nMARKETS\nThe amounts of and price obtainable for oil and gas production from Partnership Properties will be affected by market factors beyond the control of the Partnership. Such factors include the extent of domestic production, the level of imports of foreign oil and gas, the general level of market demand on a regional, national and worldwide basis, domestic and foreign economic conditions that determine levels of industrial production, political events in foreign oil-producing regions, and variations in governmental regulations and tax laws and the imposition of new governmental requirements upon the oil and gas industry. There can be no assurance that oil and gas prices will not decrease in the future, thereby decreasing net Revenues from Partnership Properties.\nI-1\nSWIFT ENERGY INCOME PARTNERS 1987-B, LTD.\nFrom time to time, there may exist a surplus of natural gas or oil supplies, the effect of which may be to reduce the amount of hydrocarbons that the Partnerships may produce and sell while such oversupply exists. In recent years, initial steps have been taken to provide additional gas transportation lines from Canada to the United States. If additional Canadian gas is brought to the United States market, it could create downward pressure on United States gas prices.\nREGULATIONS\nENVIRONMENTAL REGULATION\nThe federal government and various state and local governments have adopted laws and regulations regarding the control of contamination of the environment. These laws and regulations may require the acquisition of a permit by Operators before drilling commences, prohibit drilling activities on certain lands lying within wilderness areas or where pollution arises and impose substantial liabilities for pollution resulting from operations, particularly operations near or in onshore and offshore waters or on submerged lands. These laws and regulations may also increase the costs of routine drilling and operation of wells. Because these laws and regulations change frequently, the costs to the Partnership of compliance with existing and future environmental regulations cannot be predicted. However, the Managing Partner does not believe that the Partnership is affected in a significantly different manner by these regulations than are its competitors in the oil and gas industry.\nFEDERAL REGULATION OF NATURAL GAS\nThe transportation and sale of natural gas in interstate commerce is heavily regulated by agencies of the federal government. The following discussion is intended only as a summary of the principal statutes, regulations and orders that may affect the production and sale of natural gas from Partnership Properties. This summary should not be relied upon as a complete review of applicable natural gas regulatory provisions.\nPRICE CONTROLS - Prior to January 1, 1993, the sale of natural gas production was subject to regulation under the Natural Gas Act and the Natural Gas Policy Act of 1978 (\"NGPA\"). Under the Natural Gas Wellhead Decontrol Act of 1989, however, all price regulation under the NGPA and Natural Gas Act rate, certificate and abandonment requirements were phased out effective as of January 1, 1993.\nFERC ORDERS\nSeveral major regulatory changes have been implemented by the Federal Energy Regulatory Commission (\"FERC\") from 1985 to the present that affect the economics of natural gas production, transportation and sales. In addition, the FERC continues to promulgate revisions to various aspects of the rules and regulations affecting those segments of the natural gas industry that remain subject to the FERC's jurisdiction. In April 1992, the FERC issued Order No. 636 pertaining to pipeline restructuring. This rule requires interstate pipelines to unbundle transportation and sales services by separately stating the price of each service and by providing customers only the particular service desired, without regard to the source for purchase of the gas. The rule also requires pipelines to (i) provide nondiscriminatory \"no-notice\" service allowing firm commitment shippers to receive delivery of gas on demand up to certain limits without penalties, (ii) establish a basis for release and reallocation of firm upstream pipeline capacity, and (iii) provide non-discriminatory access to capacity by firm transportation shippers on a downstream pipeline. The rule requires interstate pipelines to use a straight fixed variable rate design. The rule imposes these same requirements upon storage facilities.\nI-2\nSWIFT ENERGY INCOME PARTNERS 1987-B, LTD.\nFERC Order No. 500 affects the transportation and marketability of natural gas. Traditionally, natural gas had been sold by producers to pipeline companies, which then resold the gas to end-users. FERC Order No. 500 altered this market structure by requiring interstate pipelines that transport gas for others to provide transportation service to producers, distributors and all other shippers of natural gas on a nondiscriminatory, \"first-come, first-served\" basis (open access transportation\"), so that producers and other shippers can sell natural gas directly to end-users. FERC Order No. 500 contains additional provisions intended to promote greater competition in natural gas markets.\nIt is not anticipated that the marketability of and price obtainable for natural gas production from Partnership Properties will be significantly affected by FERC Order No. 500. Gas produced from Partnership Properties normally will be sold to intermediaries who have entered into transportation arrangements with pipeline companies. These intermediaries will accumulate gas purchased from a number of producers and sell the gas to end-users through open access pipeline transportation.\nSTATE REGULATIONS\nProduction of any oil and gas from Partnership Properties will be affected to some degree by state regulations. Many states in which the Partnership will operate have statutory provisions regulating the production and sale of oil and gas, including provisions regarding deliverability. Such statutes, and the regulations promulgated in connection therewith, are generally intended to prevent waste of oil and gas and to protect correlative rights to produce oil and gas between owners of a common reservoir. Certain state regulatory authorities also regulate the amount of oil and gas produced by assigning allowable rates of production to each well or proration unit.\nFEDERAL LEASES\nSome of the Partnership's properties are located on federal oil and gas leases administered by various federal agencies, including the Bureau of Land Management. Various regulations and orders affect the terms of leases, exploration and development plans, methods of operation and related matters.\nEMPLOYEES\nThe Partnership has no employees. Swift, however, has a staff of geologists, geophysicists, petroleum engineers, landmen, and accounting personnel who administer the operations of Swift and the Partnership. As of December 31, 1995, Swift had 176 employees. Swift's administrative and overhead expenses attributable to the Partnership's operations are borne by the Partnership.\nI-3\nSWIFT ENERGY INCOME PARTNERS 1987-B, LTD.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nAs of December 31, 1995, the Partnership has acquired interests in producing oil and gas properties which are generally described below.\nPRINCIPAL OIL AND GAS PRODUCING PROPERTIES\nThe most valuable fields in the Partnership, based upon year-end engineering estimates of discounted future net revenues using constant pricing and costs, are described below.\n1. Approximately 18% of the Partnership's value is from the Giddings Field in Fayette and Burleson Counties, Texas (NRG acquisition). The wells produce from the Austin Chalk and Edwards zones.\n2. Approximately 18% of the Partnership's value is from the AWP Field in McMullen County, Texas (Bracken acquisition). The wells produce from the Olmos formation.\nThe remaining value in the Partnership is attributable to numerous properties none of which equals or exceeds 15 percent of the total Partnership value.\nTITLE TO PROPERTIES\nTitle to substantially all significant producing properties of the Partnership has been examined. The properties are subject to royalty, overriding royalty and other interests customary in the industry. The Managing General Partner does not believe any of these burdens materially detract from the value of the properties or will materially detract from the value of the properties or materially interfere with their use in the operation of the business of the Partnership.\nPRODUCTION AND SALES PRICE\nThe following table summarizes the sales volumes of the Partnership's net oil and gas production expressed in MCFs of oil. Equivalent MCFs are obtained by converting oil to gas on the basis of their relative energy content; one barrel equals 6,000 cubic feet of gas.\nI-4\nSWIFT ENERGY INCOME PARTNERS 1987-B, LTD.\nNET PROVED OIL AND GAS RESERVES\nPresented below are the estimates of the Partnership's proved reserves as of December 31, 1995, 1994 and 1993. All of the Partnership's proved reserves are located in the United States.\nRevisions of previous quantity estimates are related to upward or downward variations based on current engineering information for production rates, volumetrics and reservoir pressure. Additionally, changes in quantity estimates are the result of the increase or decrease in crude oil and natural gas prices at each year end which have the effect of adding or reducing proved reserves on marginal properties due to economic limitations.\nI-5\nSWIFT ENERGY INCOME PARTNERS 1987-B, LTD.\nThe following table summarizes by acquisition the Registrant's reserves and gross and net interests in producing oil and gas wells as of December 31, 1995:\nThere are numerous uncertainties inherent in estimating quantities of proved reserves and in projecting the future rates of production, timing and plan of development. Oil and gas reserve engineering must be recognized as a subjective process of estimating underground accumulations of oil and gas that cannot be measured in an exact way, and estimates of other engineers might differ from those above, audited by H. J. Gruy and Associates, Inc., an independent petroleum consulting firm. The accuracy of any reserve estimate is a function of the quality of available data and of engineering and geological interpretation and judgment. Results of drilling, testing and production subsequent to the date of the estimate may justify revision of such estimate, and, as a general rule, reserve estimates based upon volumetric analysis are inherently less reliable than those based on lengthy production history. Accordingly, reserve estimates are often different from the quantities of oil and gas that are ultimately recovered.\nI-6\nSWIFT ENERGY INCOME PARTNERS 1987-B, LTD.\nIn estimating the oil and natural gas reserves, the Registrant, in accordance with criteria prescribed by the Securities and Exchange Commission, has used prices received as of December 31, 1995 without escalation, except in those instances where fixed and determinable gas price escalations are covered by contracts, limited to the price the Partnership reasonably expects to receive. The Registrant does not believe that any favorable or adverse event causing a significant change in the estimated quantity of proved reserves has occurred between December 31, 1995 and the date of this report.\nFuture prices received for the sale of the Partnership's products may be higher or lower than the prices used in the evaluation described above; the operating costs relating to such production may also increase or decrease from existing levels. The estimates presented above are in accordance with rules adopted by the Securities and Exchange Commission.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Partnership is not aware of any material pending legal proceedings to which it 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\nNo matters were submitted to a vote of limited partners during the fourth quarter of the fiscal year covered by this report.\nI-7\nSWIFT ENERGY INCOME PARTNERS 1987-B, LTD.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET PRICE OF AND DISTRIBUTIONS ON THE REGISTRANT'S UNITS AND RELATED LIMITED PARTNER MATTERS\nMARKET INFORMATION\nUnits in the Partnership were initially sold at a price of $100 per Unit. Units are not traded on any exchange and there is no established public trading market for the Units. Swift is aware of negotiated transfers of Units between unrelated parties; however, these transfers have been limited and sporadic. Due to the nature of these transactions, Swift has no verifiable information regarding prices at which Units have been transferred.\nHOLDERS\nAs of December 31, 1995, there were 3,177 Limited Partners holding Units in the Partnership.\nDISTRIBUTIONS\nThe Partnership generally makes distributions to Limited Partners on a quarterly basis, subject to the restrictions set forth in the Limited Partnership Agreement. In the fiscal years ending December 31, 1994 and 1995, the Partnership distributed a total of $845,800 and $487,900, respectively, to holders of its Units. Cash distributions constitute net proceeds from sale of oil and gas production after payment of lease operating expenses and other partnership expenses. Some or all of such amounts or any proceeds the from sale of partnership properties could be deemed to constitute a return of investors' capital.\nOil and gas investments involve a high risk of loss, and no assurance can be given that any particular level of distributions to holders of Units can be achieved or maintained. Although it is anticipated that quarterly distributions will continue to be made through 1996, the Partnership's ability to make distributions could be diminished by any event adversely affecting the oil and gas properties in which the Partnership owns interests or the amount of revenues received by the Partnership therefrom.\nThe Partnership's Limited Partnership Agreement contains various provisions which might serve to delay, defer or prevent a change in control of the Partnership, such as the requirement of a vote of Limited Partners in order to sell all or substantially all of the Partnership's properties or the requirement of consent by the Managing General Partner to transfers of limited partnership interests.\nII-1\nSWIFT ENERGY INCOME PARTNERS 1987-B, LTD.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following selected financial data, prepared in accordance with generally accepted accounting principles as of December 31, 1995, 1994, 1993, 1992 and 1991, should be read in conjunction with the financial statements included in Item 8:\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nLIQUIDITY AND CAPITAL RESOURCES\nThe Partnership has expended all of the partners' net commitments available for property acquisitions (\"net commitments\") and development by acquiring producing oil and gas properties. The partnership invests primarily in proved producing properties with nominal levels of future costs of development for proven but undeveloped reserves. Significant purchases of additional reserves or extensive drilling activity are not anticipated. Oil and gas reserves are depleting assets and therefore often experience significant production declines each year from the date of acquisition through the end of the life of the property. The primary source of liquidity to the Partnership comes almost entirely from the income generated from the sale of oil and gas produced from ownership interests in oil and gas properties. This source of liquidity and the related results of operations will decline in future periods as the oil and gas produced from these properties also declines.\nSubject to 1996 market conditions remaining comparable with 1995, the Managing General Partner (\"MGP\") anticipates an increase in liquidity provided that certain development work scheduled in 1996 is completed successfully. The Partnership plans to spend in the next two years an estimated $495,000 for capital expenditures needed for this development work and the enhancement of proved oil and gas reserves. The MGP anticipates that the Partnership will have adequate liquidity from income from continuing operations to satisfy any future capital expenditure requirements. Funds generated from bank borrowings and proceeds from the sale of oil and gas properties will be used to supplement this effort if deemed necessary.\nRESULTS OF OPERATIONS\nOil and gas sales decreased 28 percent in 1995 vs. 1994. Production volumes decreased 21 percent due to a 21 percent gas production decrease and a 21 percent oil production decline. Since the Partnership's reserves are 75 percent gas, the decrease in gas production, due to accelerated production declines on mature wells, had a major impact on partnership performance. A decline in the 1995 gas prices of 18 percent or $.35\/MCF further contributed to the Partnership's decreased revenues. The average sales price per equivalent MCF decreased 9 percent in 1995.\nProduction cost per equivalent MCF increased 24 percent in 1995 compared to 1994; however, total production costs decreased 3 percent in 1995.\nAssociated depreciation expense decreased 20 percent in 1995 when compared to 1994. II-2\nSWIFT ENERGY INCOME PARTNERS 1987-B, LTD.\nOil and gas sales decreased 13 percent in 1994 vs. 1993. Production volumes decreased 11 percent due to a 15 percent gas production decrease. Since the partnership's reserves are 69 percent gas, the decrease in gas production, due to accelerated production declines on mature wells and production curtailments due to declining prices, had a significant impact on partnership performance. Declines in both 1994 gas and oil prices further contributed to the decreased revenues. The Partnership experienced a decline in gas prices of 3 percent or $.06\/MCF and a decline in oil prices of 8 percent or $1.24\/BBL. The average sales price per equivalent MCF decreased 3 percent in 1994.\nProduction cost per equivalent MCF decreased 9 percent in 1994 compared to 1993 and total production costs decreased 18 percent in 1994.\nAssociated depreciation expense decreased 10 percent in 1994 when compared to 1993.\nThe Partnership recorded an additional provision in depreciation, depletion and amortization in 1995 when the present value, discounted at ten percent, of estimated future net revenues from oil and gas properties, using the guidelines of the Securities and Exchange Commission, was below the fair market value paid for oil and gas properties resulting in a full cost ceiling impairment.\nDuring 1996, Partnership revenues and costs will be shared between the limited and general partners in a 90:10 ratio, based on the annualized rate of cash distributions by the Partnership during a certain period prior to December 31, 1995. Based on current oil and gas prices, current levels of oil and gas production and expected cash distributions during 1996, the MGP anticipates that the Partnership sharing ratio will continue to be 90:10.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nSee Part IV, Item 14(a) for index to financial statements.\nITEM 9.","section_9":"ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone. II-3\nSWIFT ENERGY INCOME PARTNERS 1987-B, LTD.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nAs a limited partnership, the Registrant has no directors or executive officers. The business and affairs of the Registrant are managed by Swift as Managing General Partner. Set forth below is certain information as of March 15, 1996 regarding the directors and executive officers of Swift.\nPOSITION(S) WITH NAME AGE SWIFT AND OTHER COMPANIES ---- --- -------------------------\nDIRECTORS --------- A. Earl Swift 62 President, Chief Executive Officer and Chairman of the Board\nVirgil N. Swift 67 Executive Vice President - Business Development, Vice Chairman of the Board\nG. Robert Evans 64 Director of Swift; Chairman of the Board, Material Sciences Corporation; Director, Consolidated Freightways, Inc., Fibreboard Corporation, Elco Industries, and Old Second Bancorp\nRaymond O. Loen 71 Director of Swift; President, R. O. Loen Company\nHenry C. Montgomery 60 Director of Swift; Chairman of the Board, Montgomery Financial Services Corporation; Director, Southwall Technology Corporation\nClyde W. Smith, Jr. 47 Director of Swift; President, Somerset Properties, Inc.\nHarold J. Withrow 68 Director of Swift\nEXECUTIVE OFFICERS ------------------ Terry E. Swift 40 Executive Vice President, Chief Operating Officer\nJohn R. Alden 50 Senior Vice President - Finance, Chief Financial Officer and Secretary\nBruce H. Vincent 48 Senior Vice President - Funds Management\nJames M. Kitterman 51 Senior Vice President - Operations\nAlton D. Heckaman, Jr. 38 Vice President - Finance and Controller\nIII-1\nSWIFT ENERGY INCOME PARTNERS 1987-B, LTD.\nFrom time to time, Swift as Managing General Partner of the Partnership purchases Units in the Partnership from investors who offer the Units pursuant to their right of presentment, which purchases are made pursuant to terms set out in the Partnership's original Limited Partnership Agreement. Due to the frequency and large number of these transactions, Swift reports these transactions under Section 16 of the Securities Exchange Act of 1934 on an annual rather than a monthly basis. In some cases such annual reporting may constitute a late filing of the required Section 16 reports under the applicable Section 16 rules.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nAs noted in Item 10, \"Directors and Executive Officers of the Registrant,\" above, the Partnership has no executive officers. The executive officers of Swift and VJM are not compensated by the Partnership.\nCertain fees and allowances contemplated by the Limited Partnership Agreement have been paid by the Partnership to Swift and VJM. See Note (4) in Notes To Financial Statements (Related-Party Transactions) for further discussion.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nNo single limited partner is known to the Partnership to be the beneficial owner of more than five percent of the Partnership's Units.\nSwift and VJM are not aware of any arrangement, the operation of which may at a subsequent date result in a change in control of the Partnership.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nAs noted in Item 10, \"Directors and Executive Officers of the Registrant,\" above, the Partnership has no executive officers or directors, and thus has not engaged in any transactions in which any such person had an interest. The Partnership is permitted to engage in certain transactions with Swift as Managing General Partner and VJM as Special General Partner, subject to extensive guidelines and restrictions described in the \"Conflicts of Interest\" section of the Amended Prospectus contained in the Registration Statement, which is incorporated herein by reference.\nSummarized below are the principal transactions that have occurred between the Partnership and Swift, VJM and their affiliates.\n1. The oil and gas properties acquired by the Partnership, as described in Item 2, \"Properties\" above, were typically acquired initially by Swift from the seller thereof and subsequently transferred to the Partnership. Such transfers were made by Swift at its Property Acquisition Costs (as defined in the Limited Partnership Agreement), less any amounts received from sale of production between the time of acquisition by Swift and the time of sale to the Partnership.\n2. Swift acts as operator for many of the wells in which the Partnership has acquired interests and has received compensation for such activities in accordance with standard industry operating agreements.\n3. The Partnership paid to Swift and VJM certain fees as contemplated by the Limited Partnership Agreement. See Note (4) in Notes To Financial Statements (Related-Party Transactions) for further discussion.\nIII-2\nSWIFT ENERGY INCOME PARTNERS 1987-B, LTD.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\na(1) FINANCIAL STATEMENTS PAGE NO. -------------------- -------- Report of independent Public Accountants IV-2\nBalance Sheets as of December 31, 1995 and 1994 IV-3\nStatements of Operations for the years ended December 31, 1995, 1994 and 1993 IV-4\nStatements of Partners' Capital for the years ended December 31, 1995, 1994 and 1993 IV-5\nStatements of Cash Flows for the years ended December 31, 1995, 1994 and 1993 IV-6\nNotes to Financial Statements IV-7\na(2) FINANCIAL STATEMENT SCHEDULES ----------------------------- All schedules required by the SEC are either inapplicable or the required information is included in the Financial Statements, the Notes thereto, or in other information included elsewhere in this report.\na(3) EXHIBITS -------- 3.1 Certificate of Limited Partnership of Swift Energy Income Partners 1987-B, Ltd. (including Limited Partnership Agreement of Swift Energy Income Partners 1987-B, Ltd., dated July 21, 1987), as filed July 23, 1987, with the Texas Secretary of State (excluding list of limited partners filed as part of Certificate.) (Form 10-K for year ended December 31, 1988, Exhibit 3.1).\n99.1 A copy of the following section of the Prospectus dated\nMarch 19, 1987, contained in Pre-Effective Amendment No. 1 to Registration Statement No. 33-11773 on Form S-1 for Swift Energy Income Partners III, as filed on March 19, 1987, which have been incorporated herein by reference: \"Proposed Activities\" (pp 30 - 36) and \"Conflicts of Interest\" (pp. 70 - 78). (Form 10-K for year ended December 31, 1989, Exhibit 28.1).\nb(1) REPORTS ON FORM 8-K ------------------- No reports on Form 8-K have been filed during the quarter ended December 31, 1995.\nIV-1\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo Swift Energy Income Partners 1987-B, Ltd.:\nWe have audited the accompanying balance sheets of Swift Energy Income Partners 1987-B, Ltd., (a Texas limited partnership) as of December 31, 1995 and 1994, and the related statements of operations, partners' capital and cash flows for the years ended December 31, 1995, 1994 and 1993. 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 Swift Energy Income Partners 1987-B, Ltd., as of December 31, 1995 and 1994, and the results of its operations and its cash flows for the years ended December 31, 1995, 1994 and 1993, in conformity with generally accepted accounting principles.\nARTHUR ANDERSEN LLP\nHouston, Texas February 19, 1996\nIV-2\nSWIFT ENERGY INCOME PARTNERS 1987-B, LTD. BALANCE SHEETS DECEMBER 31, 1995 AND 1994\nSEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.\nIV-3\nSWIFT ENERGY INCOME PARTNERS 1987-B, LTD. STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.\nIV-4\nSWIFT ENERGY INCOME PARTNERS 1987-B, LTD. STATEMENTS OF PARTNERS' CAPITAL FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.\nIV-5\nSWIFT ENERGY INCOME PARTNERS 1987-B, LTD. STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.\nIV-6\nSWIFT ENERGY INCOME PARTNERS 1987-B, LTD. NOTES TO FINANCIAL STATEMENTS\n(1) ORGANIZATION AND TERMS OF PARTNERSHIP AGREEMENT -\nSwift Energy Income Partners 1987-B, Ltd., a Texas limited partnership (the Partnership), was formed on July 23, 1987, for the purpose of purchasing and operating producing oil and gas properties within the continental United States. Swift Energy Company (\"Swift\"), a Texas corporation, and VJM Corporation (\"VJM\"), a California corporation, serve as Managing General Partner and Special General Partner of the Partnership, respectively. The general partners are required to contribute up to 1\/99th of limited partner net contributions. The 3,177 limited partners made total capital contributions of $26,025,525.\nProperty acquisition costs and the management fee are borne 99 percent by the limited partners and one percent by the general partners. Organization and syndication costs were borne solely by the limited partners.\nInitially, all continuing costs (including development costs, operating costs, general and administrative reimbursements and direct expenses) and revenues are allocated 90 percent to the limited partners and ten percent to the general partners. If prior to partnership payout, as defined, however, the cash distribution rate for a certain period equals or exceeds 17.5 percent, then for the following calendar year, these continuing costs and revenues will be allocated 85 percent to the limited partners and 15 percent to the general partners. After partnership payout, continuing costs and revenues will be shared 85 percent by the limited partners, and 15 percent by the general partners, even if the cash distribution rate is less than 17.5 percent. Payout had not occurred as of December 31, 1995.\n(2) SIGNIFICANT ACCOUNTING POLICIES -\nUSE OF ESTIMATES --\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from estimates.\nOIL AND GAS PROPERTIES --\nFor financial reporting purposes, the Partnership follows the \"full-cost\" method of accounting for oil and gas property costs. Under this method of accounting, all productive and nonproductive costs incurred in the acquisition and development of oil and gas reserves are capitalized. Such costs include lease acquisitions, geological and geophysical services, drilling, completion, equipment and certain general and administrative costs directly associated with acquisition and development activities. General and administrative costs related to production and general overhead are expensed as incurred. No general and administrative costs were capitalized during the years ended December 31, 1995, 1994 and 1993.\nFuture development, site restoration, dismantlement and abandonment costs, net of salvage values, are estimated on a property-by-property basis based on current economic conditions and are amortized to expense as the Partnership's capitalized oil and gas property costs are amortized.\nThe unamortized cost of oil and gas properties is limited to the \"ceiling limitation\", (calculated separately for the Partnership, limited partners, and general partners). The \"ceiling limitation\" is calculated on a quarterly basis and represents the estimated future net revenues from proved properties using current prices, discounted at ten percent, and the lower of cost or fair value of unproved properties. Proceeds from the sale or disposition of oil and gas properties are treated as a reduction of oil and gas property costs with no gains or losses being recognized except in significant transactions.\nIV-7\nSWIFT ENERGY INCOME PARTNERS 1987-B, LTD. NOTES TO FINANCIAL STATEMENTS (CONTINUED)\nThe Partnership computes the provision for depreciation, depletion and amortization of oil and gas properties on the units-of-production method. Under this method, the provision is calculated by multiplying the total unamortized cost of oil and gas properties, including future development, site restoration, dismantlement and abandonment costs, by an overall amortization rate that is determined by dividing the physical units of oil and gas produced during the period by the total estimated units of proved oil and gas reserves at the beginning of the period.\nThe calculation of the \"ceiling limitation\" and the provision for depreciation, depletion, and amortization is based on estimates of proved reserves. There are numerous uncertainties inherent in estimating quantities of proved reserves and in projecting the future rates of production, timing and plan of development. The accuracy of any reserve estimate is a function of the quality of available data and of engineering and geological interpretation and judgment. Results of drilling, testing and production subsequent to the date of the estimate may justify revision of such estimate. Accordingly, reserve estimates are often different from the quantities of oil and gas that are ultimately recovered.\nSTATEMENTS OF CASH FLOWS --\nHighly liquid debt instruments with an initial maturity of three months or less are considered to be cash equivalents.\n(3) OIL AND GAS CAPITALIZED COSTS -\nThe following table sets forth capital expenditures related to the Partnership's oil and gas operations:\nAll oil and gas property acquisitions are made by Swift on behalf of the Partnership. The costs of the properties include the purchase price plus any costs incurred by Swift in the evaluation and acquisition of properties.\nInterest expense, presented in the accompanying statements of operations, includes amortization of the discount recorded on gas imbalance liabilities assumed in property acquisitions ($30,391 in 1995, $28,053 in 1994 and $28,053 in 1993).\nDuring 1995, the Partnership's unamortized oil and gas property costs exceeded the quarterly calculations of the \"ceiling limitation\" resulting in an additional provision for depreciation, depletion and amortization of $773,758. In computing the Partnership's third quarter 1994 \"ceiling limitation\", the Partnership utilized the product prices in effect at the date of the filing of the Partnership's report on Form 10-Q. Utilizing these subsequent prices, no write down was required by the Partnership. The write down would have been $298,948 using product prices in effect at September 30, 1994.\nIV-8\nSWIFT ENERGY INCOME PARTNERS 1987-B, LTD. NOTES TO FINANCIAL STATEMENTS (CONTINUED)\nIn addition, the limited partners' share of unamortized oil and gas property costs exceeded their \"ceiling limitation\" in 1995 , resulting in a valuation allowance of $646,310. This amount is included in the income (loss) attributable to the limited partners shown in the statement of partners' capital together with a \"combining adjustment\" for the difference between the limited partners' valuation allowance and the Partnership's valuation allowance. The \"combining adjustment\" changes quarterly as the Partnership's total depreciation, depletion and amortization provision is more or less than the combined depreciation, depletion and amortization provision attributable to general and limited partners.\n(4) RELATED-PARTY TRANSACTIONS -\nAn affiliate of the Special General Partner, as Dealer Manager, received $650,638 for managing and overseeing the offering of limited partnership units.\nA one-time management fee of $650,638 was paid Swift in 1987 for services performed for the Partnership. During 1995, 1994 and 1993, the Partnership paid Swift $143,378, $207,186 and $243,681, respectively, as general and administrative overhead allowances.\n(5) NOTE PAYABLE TO A BANK -\nNote payable to a bank at December 31, 1995 and 1994 follows:\nAs provided by the Partnership Agreement, the note payable was obtained to fund development wells.\n(6) FEDERAL INCOME TAXES -\nThe Partnership is not a tax-paying entity. No provision is made in the accounts of the Partnership for federal or state income taxes, since such taxes are liabilities of the individual partners, and the amounts thereof depend upon their respective tax situations.\nIV-9\nSWIFT ENERGY INCOME PARTNERS 1987-B, LTD. NOTES TO FINANCIAL STATEMENTS (CONTINUED)\nThe tax returns and the amount of distributable Partnership income are subject to examination by the federal and state taxing authorities. If the Partnership's ordinary income for federal income tax purposes is ultimately changed by the taxing authorities, the tax liability of the limited partners could be changed accordingly. Ordinary income reported on the Partnership's federal return of income for the years ended December 31, 1995, 1994 and 1993 was $677,386, $1,076,658 and $1,165,078, respectively. The difference between ordinary income for federal income tax purposes reported by the Partnership and net income or loss reported herein primarily results from the exclusion of depletion (as described below) from ordinary income reported in the Partnership's federal return of income.\nFor federal income tax purposes, depletion with respect to production of oil and gas is computed separately by the partners and not by the Partnership. Since the amount of depletion on the production of oil and gas is not computed at the Partnership level, depletion is not included in the Partnership's income for federal income tax purposes but is charged directly to the partners' capital accounts to the extent of the cost of the leasehold interests, and thus is treated as a separate item on the partners' Schedule K-1. Depletion for federal income tax purposes may vary from that computed for financial reporting purposes in cases where a ceiling adjustment is recorded, as such amount is not recognized for tax purposes.\n(7) GAS IMBALANCES -\nThe gas imbalance receivable and deferred revenues represent imbalances assumed as part of property acquisitions. The imbalances are accounted for on the entitlements method, whereby the Partnership records its share of revenue, based on its entitled amount. Any amounts over or under the entitled amount are recorded as an increase or decrease to the gas imbalance receivable or deferred revenues as applicable.\n(8) VULNERABILITY DUE TO CERTAIN CONCENTRATIONS -\nThe Partnership's revenues are primarily the result of sales of its oil and natural gas production. Market prices of oil and natural gas may fluctuate and adversely affect operating results.\nThe Partnership extends credit to various companies in the oil and gas industry which results in a concentration of credit risk. This concentration of credit risk may be affected by changes in economic or other conditions and may accordingly impact the Partnership's overall credit risk. However, the Managing General Partner believes that the risk is mitigated by the size, reputation, and nature of the companies to which the Partnership extends credit. In addition, the Partnership generally does not require collateral or other security to support customer receivables.\n(9) FAIR VALUE OF FINANCIAL INSTRUMENTS -\nThe Partnership's financial instruments consist of cash and cash equivalents and short-term receivables and payables. The carrying amounts approximate fair value due to the highly liquid nature of the short-term instruments.\nIV-10\nSWIFT ENERGY INCOME PARTNERS 1987-B, LTD.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.\nSWIFT ENERGY INCOME PARTNERS 1987-B, LTD. (Registrant)\nBy: SWIFT ENERGY COMPANY General Partner\nDate: March 15, 1996 By: s\/b A. Earl Swift ----------------------- ---------------------------------- A. Earl Swift President\nDate: March 15, 1996 By: s\/b John R. Alden ----------------------- ---------------------------------- John R. Alden Principal Financial Officer\nDate: March 15, 1996 By: s\/b Alton D. Heckaman, Jr. ----------------------- ---------------------------------- Alton D. Heckaman, Jr. 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.\nSWIFT ENERGY INCOME PARTNERS 1987-B, LTD. (Registrant)\nBy: SWIFT ENERGY COMPANY General Partner\nDate: March 15, 1996 By: s\/b A. Earl Swift ----------------------- ---------------------------------- A. Earl Swift Director and Principal Executive Officer\nDate: March 15, 1996 By: s\/b Virgil N. Swift ----------------------- ---------------------------------- Virgil N. Swift Director and Executive Vice President - Business Development\nIV-11\nSWIFT ENERGY INCOME PARTNERS 1987-B, LTD.\nDate: March 15, 1996 By: s\/b G. Robert Evans ----------------------- ---------------------------------- G. Robert Evans Director\nDate: March 15, 1996 By: s\/b Raymond O. Loen ----------------------- ---------------------------------- Raymond O. Loen Director\nDate: March 15, 1996 By: s\/b Henry C. Montgomery ----------------------- ---------------------------------- Henry C. Montgomery Director\nDate: March 15, 1996 By: s\/b Clyde W. Smith, Jr. ----------------------- ---------------------------------- Clyde W. Smith, Jr. Director\nDate: March 15, 1996 By: s\/b Harold J. Withrow ----------------------- ---------------------------------- Harold J. Withrow Director\nIV-12","section_15":""}
{"filename":"851205_1995.txt","cik":"851205","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nCognex Corporation (\"Cognex\" or the \"Company,\" each of which term includes, unless the context indicates otherwise, Cognex Corporation and its subsidiaries) was incorporated in Massachusetts in 1981. Its principal executive offices are located at One Vision Drive, Natick, Massachusetts 01760 and its telephone number is (508) 650-3000.\nThe Company designs, develops, manufactures, and markets a family of machine vision systems - or computers that can \"see.\" Cognex machine vision systems, which consist of software and hardware designed specifically for industrial machine vision, are used to replace human vision in a wide range of manufacturing processes. When connected to a video camera, a Cognex machine vision system captures an image of each object in the manufacturing process and uses sophisticated image analysis software to extract information from that image. For example, a machine vision system can locate an object, read alphanumeric characters, measure dimensions, or detect flaws. Cognex machine vision systems are used in a variety of industries including the electronics, semiconductor, consumer products, automotive, pharmaceutical, and general manufacturing industries for applications in which human vision is inadequate due to fatigue, visual acuity or speed, or in instances where substantial cost savings are obtained through the reduction of direct labor and improved product quality.\nThe Company's business strategy is to develop and sell standard products - proprietary vision software together with vision hardware (vision engines) - which require minimal customization and support by the Company. The Company primarily markets to sophisticated customers such as original equipment manufacturers (OEMs) and system integrators who have the ability to configure their own vision solutions using the software tools and hardware platforms provided by the Company. The Company also markets \"easy-to-use\" machine vision systems to system integrators and end users (the \"factory floor\") which represents an expansion beyond its traditional OEM customer base. These machine vision systems designed for the factory floor marketplace provide an \"easy-to-use\" interface that allows system integrators and end users in a wide range of industries to implement vision solutions for the factory floor. This strategy has permitted the Company to focus its engineering resources on expanding its own product line and developing proprietary vision technology.\nThe strategy of selling standard products in high volume without extensive support by the Company requires a close match between the product's usability and functionality and the customer's capabilities and needs. The Company's traditional products are \"building blocks,\" both software and hardware, from which its customers can construct a vision solution. Although the Company's traditional products require that the customer have detailed expertise in computer porgramming, the customer need not have in-depth knowledge of image processing or image analysis since the Company's vision software products provide that expert knowledge in the form of subroutines. In addition, the Company believes that its \"easy-to-use\" products allow system integratores and end users without detailed experience in computer programming or knowledge of image processing or image analysis to construct a vision solution.\nThe Company's primary customers, OEMs in the electronics and semiconductor industries, are principally located in Japan and North America. Sales to international customers represented approximately 59%, 62%, and 60% of revenue in 1995, 1994, and 1993, respectively. The Company sells through a direct sales force, consisting of approximately 30 people at December 31, 1995, and through distributors to service its OEM and factory floor customers. In addition to its headquarters in Natick, Massachusetts, the Company has sales offices in the United States, Europe, and the Far East.\nRECENT DEVELOPMENTS\nIn February 1996, the Company acquired Isys Controls, Inc., an Alameda, California-based developer of ultra-high performance vision systems that automatically detect and classify surface flaws and defects on a variety of high value-added materials. In July 1995, the Company acquired Acumen, Inc., a Portland, Oregon-based developer of machine vision systems for semiconductor wafer identification. Information with respect to the acquisitions of Isys Controls Inc. and Acumen, Inc. may be found in the Notes to Consolidated Financial Statements, appearing on pages 31 and 32 of the Annual Report to Stockholders for the year ended December 31, 1995, which is Exhibit 13 hereto, and is incorporated herein by reference.\nThese acquisitions provide the company with an expansion beyond its traditional base of general-purpose machine vision systems. The potential market for machine vision is comprised of a number of market niches defined by application requirements, industry, and cost\/performance. The Company's business strategy includes selective expansion into other industrial machine vision applications. The recent acquisitions of Isys Controls, Inc. and Acumen, Inc. gives Cognex an immediate and strong presence in the niche markets for surface inspection and semiconductor wafer identification.\nINDUSTRY BACKGROUND\nA machine vision system is a computer-based image analysis machine which replaces human vision for tasks in which human vision is inadequate due to fatigue, visual acuity or speed, or in instances where substantial cost savings are obtained through the reduction of direct labor and improved product quality. Today, many types of manufacturing equipment require machine vision because of the increasing demands for speed and accuracy in manufacturing processes.\nA machine vision system consists of pattern recognition software and high-speed computer hardware which is specially designed to run the software in real-time. In most machine vision applications, a camera captures an image of the object to be inspected and sends that image to the machine vision computer. The machine vision system then uses the sophisticated software and special-purpose hardware to analyze the image of the object and derive some answer. Once the machine vision system has determined the answer, it can output these results to a monitor for review by the operator or it can use these results to control other equipment. Machine vision systems can provide four types of answers:\nMARKETS, CUSTOMERS, AND APPLICATIONS\nThe Company's current products are designed for factory automation because the Company believes that this market currently offers the greatest opportunity for selling standard products in high volume. Within the factory automation marketplace, the Company has historically focused primarily on those customers who must have machine vision because of the increasing complexity of their products or manufacturing methods.\nThe Company currently markets primarily to OEMs principally located in Japan and North America who supply automation equipment to the electronics and semiconductor industries. The value of automation is high in these industries because the products produced, such as semiconductor chips, hybrid circuits, and printed circuit boards, have high unit costs and are manufactured at speeds too fast for effective human intervention. In addition, the trend in these industries toward smaller devices with higher circuit densities and finer circuit paths require manufacturing and testing equipment capable of extremely accurate alignment and motion control which can only be achieved by using machine vision. Customers in these industries, moreover, employ knowledgeable engineers who are competent to work with computer-related equipment.\nThe Company's business strategy is to develop and sell standard products - proprietary vision software together with vision hardware (vision engines) - which require minimal customization and support by the Company. The Company primarily markets to sophisticated customers such as OEMs and system integrators who have the ability to configure their own vision solutions using the software tools and hardware platforms provided by the Company. The Company also markets \"easy-to-use\" machine vision systems to system integrators and end users which represents an expansion beyond its traditional OEM customer base. These machine vision systems designed for the factory floor marketplace provide an \"easy-to-use\" interface that allows system integrators and end users in a wide range of industries to implement vision solutions for the factory floor. This strategy has permitted the Company to focus its engineering resources on expanding its own product line and developing proprietary vision technology.\nIn addition to selling traditional machine vision systems to OEMs, the Company's products are also sold to system integrators and end users serving the consumer products, automotive, pharmaceutical, and general manufacturing industries. Current users of the Company's traditional products typically have extensive programming experience, therefore, programmable Cognex products are able to effectively meet their needs and requirements.\nThe strategy of selling standard products in high volume without extensive support by the Company requires a close match between the product's usability and functionality and the customer's capabilities and needs. The Company's traditional products are \"building blocks,\" both software and hardware, from which its customers can construct a vision solution. Although the Company's traditional products require that the customer have detailed expertise in computer programming, the customer need not have in-depth knowledge of image processing or image analysis since the Company's vision software products provide that expert knowledge in the form of subroutines. In addition, the Company believes that its \"easy-to-use\" products allow system integrators and end users without detailed experience in computer programming or knowledge of image processing or image analysis to construct a vision solution.\nTRADITIONAL MACHINE VISION PRODUCTS\nCognex machine vision systems are comprised of both machine vision software and machine vision hardware. The Company's products are \"building blocks\" of software and hardware that have been designed to give customers the flexibility to easily configure complete vision solutions without requiring extensive in-house expertise in image processing or image analysis. The Company offers a library of vision software tools, as well as a family of board-level vision hardware that ranges in performance and platform. The customer first chooses the most appropriate software tools from the vision software library and then selects the best vision hardware on which to run the software. All Cognex vision hardware is functionally and software compatible across product lines. Because of the Company's product strategy, its customers are given the flexibility to configure their own vision solutions to a broad range of complex vision problems without detailed support from the Company.\nWhen purchasing products from the Company, the customer pays for each vision engine as well as a license fee per engine for each software tool used in the vision solution. Because the Company's products are modular, the customer licenses only the software tools required and chooses the vision hardware with the price and performance that best meets the application's needs. The typical Cognex machine vision system, including software and hardware, ranges from $7,500 to $20,000 and the Company estimates that an aggregate of approximately 38,000 Cognex machine vision systems had been sold as of December 31, 1995.\nSOFTWARE PRODUCTS\nThe complete software package which is required to solve a customer's vision problem is built from three different levels of software provided by the Company: system software, image processing software, and image analysis software. A description of the three different levels of software is as follows:\nSystem Software. The system software level provides the utilities needed to program and operate the machine vision system. The system software includes software for acquiring, storing, and displaying images, as well as Cognex's proprietary incremental C compiler with a C run-time library, interface software for communicating with other devices, and software for controlling high-speed transmission of data into and out of the machine vision system.\nImage Processing Software. The image processing level contains software which manipulates images (usually before they are analyzed by subsequent image analysis routines). These tools can be used to simplify raw video images or alter images to increase processing speed and image storage capacity. Image processing can correct rotation, scale, and aspect ratio of an image in order to compensate for non-uniform optics, uncertainty in part positioning, or mechanical constraints that require awkward viewing angles. In addition, the image processing functions provide several methods for reducing the effects of video noise, such as averaging images together or spatially filtering a single image.\nImage Analysis Software. The image analysis level embodies the Company's most important and valuable technology. These software tools extract information from either raw or processed images and make decisions regarding items in those images. By providing this high level of software, the Company has made vision solutions available to a broader range of customers. Examples of image analysis software tools include Search for locating patterns, Golden Template Comparison (GTC) for locating defects, and Optical Character Recognition (OCR) for reading characters.\nBy writing simple C routines which interconnect various Cognex software modules from each of these three levels, the Company's customers \"build\" their own unique software solutions to address their particular vision problems. The Company also offers application-specific software products which are \"packaged\" software products designed to solve targeted problems without any customization by the Company or its customers. These software tools combine a series of system software, image processing software, and image analysis software tools to solve specific problems. For example, the Fiducial Finder tool locates fiducial, or alignment, marks on printed circuit boards and the PQI tool quickly and accurately inspects print produced by laser, pad, or offset printing equipment.\nHARDWARE PRODUCTS\nThe Company supplies a family of vision hardware with a wide range of price and performance levels. Customers select the Cognex vision hardware which best matches the requirements of each application. A description of the family of vision hardware products is as follows:\nStandard Machine Vision Platforms. The Company offers a variety of standard, programmable machine vision platforms on which to run the Cognex software tools. The Cognex 3000 Series, consisting of the 3100 and 3400, are proprietary, single-board machine vision systems that provide a range of performance levels for solving complex gauging, guidance, inspection, and identification tasks. The Cognex 4000 Series are a group of VMEbus-based, board-level machine vision systems that plug directly into a VME backplane. This family includes the low-end Cognex 4100 and 4200, as well as the high-end Cognex 4400. The Cognex 5000 Series are the first complete machine vision systems designed to plug into any ISA\/ATbus personal computer. All of these machine vision systems are software compatible, allowing customers to readily upgrade to higher performance systems or to change platforms as application needs change.\nApplication-Specific Hardware Products. The Company also offers a family of application-specific hardware products that are designed to solve specific tasks. The Cognex 1500 Simple Alignment System is an easy-to-use, low-cost machine vision system suitable for such tasks as aligning printed circuit boards prior to screen printing, drilling, or epoxy dispensing. The Cognex acuReader\/OCR is a machine vision system designed to read even the most degraded serial numbers from semiconductor wafers with near 100% accuracy. Both of these machine vision systems offer simple menu interfaces that allow customers to quickly and accurately configure the systems to solve tasks without the need for C programming.\nCustom Vision Chips. To boost the processing power of its boards, the Company has developed the VC-2 and VC-3 custom vision chips. These chips, which can be purchased with most of Cognex's standard machine vision platforms, provide the processing power of multiple boards or chip sets. The chips enhance the price\/performance of Cognex's products and currently provide a significant competitive advantage to the Company. The VC-2 chip performs image processing functions that are optimized for machine vision tasks which enables the Company's machine vision systems to address a new class of flaw and defect detection applications. The VC-3 chip is an application-specific integrated circuit designed to run image processing and image analysis algorithms at high speeds. In addition, the Company's Acumen division has developed a set of vision chips used for pattern recognition in the acuReader\/OCR.\nCHECKPOINT\nIn 1994, the Company introduced a new machine vision system known as Checkpoint. The Company markets Checkpoint to system integrators and end users which represents an expansion beyond its traditional OEM customer base. Checkpoint is designed for the factory floor marketplace and combines the Company's proven vision technology with a new and unique graphical user interface. The Company believes that Checkpoint allows system integrators and end users in a wide range of industries to design vision solutions for the factory floor, even if such engineers have little programming or machine vision experience. However, the deployment of Checkpoint on the factory floor requires the services of trained system integrators to mechanically and electrically integrate Checkpoint into manufacturing lines.\nA Checkpoint system includes pre-packaged existing software (system software, image processing software, and image analysis software), standard hardware (Checkpoint Model 400 and 800 vision processors), and Microsoft Windows-based application development software. Engineers using Checkpoint create a vision program based upon a personal computer (PC) running Checkpoint's Windows-based application builder. The PC communicates with the Checkpoint system over a serial line at development time. Then, at run-time, the system is deployed as a stand-alone unit on the factory floor utilizing a custom graphic operator interface created by the developer with Checkpoint.\nThe library of vision tools available with Checkpoint enables users to solve a wide range of inspection, gauging, and assembly verification problems. Checkpoint's gray-scale vision tools provide advanced object location and inspection technology and are accessed at development time via PC menus in a Microsoft Windows environment or vision system icons. Checkpoint's vision tools are supported by the Company's most powerful vision hardware platforms including Cognex's proprietary vision coprocessors.\nManufacturing engineers utilize pull-down menus and dialog boxes in Checkpoint's Windows graphic user interface to create customized vision applications. This \"point and click\" programming environment directs engineers to construct vision routines in a new way. A developer combines Checkpoint's high-level vision, I\/O, and operator interface tools with conventional programming elements such as English-language variables, expressions, and statements. This enables the developer to focus on tasks associated with solving the overall vision application, freeing the developer from the memorized detail and mechanical complexity of traditional machine vision system programming.\nSALES AND SERVICE\nThe Company's business strategy is to develop and sell standard products - proprietary vision software together with vision hardware (vision engines) - which require minimal customization and support by the Company. The Company primarily markets to sophisticated customers such as OEMs and system integrators who have the ability to use the Company's traditional products to configure their own vision solutions using the software tools and hardware platforms provided by the Company. The strategy of selling standard products in high volume without extensive support by the Company requires a close match between the product's usability and functionality and the customer's capabilities and needs.\nThe Company employs direct sales personnel for all accounts in North America and Japan, and sells through a direct sales force and through distributors in Europe and Southeast Asia. The Company's distributors do not have any rights of return and payment for products is due upon delivery. Distributors generally have non-exclusive distribution rights and there may be more than one distributor per territory.\nThe Company markets its products in North America through a direct sales force operating out of its Natick, Massachusetts headquarters, its Regional Technology Center in Mountain View, California, and its sales offices in Illinois, Minnesota, New Jersey, and Florida. The Company markets its products in Japan through a direct sales force operating out of its wholly-owned subsidiary, Cognex K.K. The Company also has sales offices in France, Germany, England, Italy, Singapore, and Korea where the Company sells through a direct sales force and through distributors. At December 31, 1995, the Company's direct sales and service force consisted of 80 professionals, including sales and application engineers. A significant portion of the Company's sales and service personnel have engineering or science degrees. Sales engineers call directly on targeted accounts and coordinate the activity of the application engineers. They focus on potential customers that represent potential volume purchases and long-term relationships. Opportunities that represent single unit sales or turnkey system requirements are qualified by the sales engineer and turned over to an independent system integrator or OEM that uses the Company's products.\nSales to international customers represented approximately 59%, 62%, and 60% of revenue in 1995, 1994, and 1993, respectively. One international customer based in Japan, Fuji America Corporation, accounted for approximately 16%, 20%, and 24% of revenue in 1995, 1994, and 1993, respectively. Information with respect to significant customers and export sales may be found in the Notes to the Consolidated Financial Statements, appearing on page 30 of the Annual Report to Stockholders for the year ended December 31, 1995, which is Exhibit 13 hereto, and is incorporated herein by reference. Although international sales may from time to time be subject to federal technology export regulations, the Company to date has not suffered delays or prohibitions in sales to any of its foreign customers.\nThe Company sells its products to customers that have entered or are expected to enter into volume discount contracts with the Company. These contracts are typically for one year and have associated delivery schedules. No orders are booked for delivery beyond six months.\nThe Company provides software update services and hardware maintenance on both a contract and a time and material basis. Software updates are provided via floppy disks and hardware maintenance is provided by exchanging printed circuit boards. Programming application services for projects can be contracted with the Company on a time and material basis only when doing so enhances the sale of the Company's standard products. Training courses are provided by the Company in Natick, Massachusetts; Mountain View, California; and Tokyo, Japan, as well as at the customer site when required. These courses provide the user with both lecture and laboratory sessions covering the use of Cognex products.\nRESEARCH, DEVELOPMENT AND ENGINEERING\nThe Company engages in research, development and engineering (\"R, D & E\") to enhance its existing products and to develop new products and functionality to meet market opportunities. The R, D & E organization consists of software engineering, research and development, hardware engineering, advanced products development, and custom products development. Software engineering is responsible for the development of image processing and image analysis tools, as well as the maintenance, quality assurance, and documentation of vision software products. The advanced end-user vision systems group, within the software group, develops Checkpoint. The research and development group focuses its energies on enhanced vision technology capabilities. Hardware engineering is responsible for the development of hardware products, primarily vision engines and vision chips. The advanced products development group is engaged in the development of the Placement Guidance Products and the VisionPro product line. The custom products development group is responsible for the development of application products used in wire bonders and other custom applications. The Company's Acumen division is responsible for the development of application-specific products for the semiconductor industry.\nAt December 31, 1995, the Company employed 104 professionals in R, D & E, most of whom are software developers. The Company's R, D & E expenses were approximately $13,190,000, $9,933,000, and $6,205,000 in 1995, 1994, and 1993, respectively.\nMANUFACTURING\nThe Company's current manufacturing process consists of final assembly, burn-in, final test, quality control, and shipment of systems and board-level products. Major components such as semiconductors, raw boards, and passive components are purchased by the Company and shipped to third parties for assembly and initial testing. Certain subassemblies are assembled in-house. Materials such as electronic components and sheet metal parts are purchased and stocked by the Company utilizing its own personnel. Some of the electronic components are tested and burned in before assembly. The Company puts together kits of components and supplies them to the third-party contractor for assembly. In some cases, components are stored and kitted by the supplier and sent directly to the third-party contractor. The third-party contractor assembles and performs initial testing of the product, using fixtures and programs owned by the Company, and returns the product to the Company for final assembly and test. The Company packages and ships its products to customers from its Natick, Massachusetts headquarters. Certain components purchased by the Company are presently available from a single source.\nIn 1995, the Company began the transition to a turnkey manufacturing operation whereby the majority of component purchasing, subassembly, final assembly, and testing is performed under agreement by a third-party contractor. The Company expects that the contractor will become the sole manufacturer of substantially all of the Company's products when the transition is complete in early 1997.\nCOMPETITION\nThe Company competes with other vendors of machine vision systems, the internal engineering efforts of the Company's current or prospective customers, and the manufacturers of image processing systems. Some or all of these competitors may have greater financial and other resources than the Company. In addition, certain application-specific machine vision products are being introduced as low-cost, software-only solutions by various companies and the Company does not currently have a significant product offering that effectively competes with respect to price against these new software-only systems. The Company considers itself to be one of the leading machine vision companies in the world. However, reliable estimates of the machine vision market and the number of competitors are almost nonexistent, primarily because of definitional confusion and a tendency toward double-counting of sales. The principal competitive factors affecting the choice of a machine vision system include product functionality and performance (e.g. speed, accuracy, and reliability) under \"real-world\" operating conditions, flexibility, programmability, and the availability of application support from the supplier. More recently, ease-of-use has become a competitive factor and product price has become a more significant factor with respect to the simpler guidance and gauging applications.\nBACKLOG\nAt December 31, 1995 the Company's backlog was approximately $27,655,000, compared to $16,827,000 at December 31, 1994. Backlog reflects purchase orders for products scheduled for shipment within six months. The level of backlog at any particular date is not necessarily indicative of the future operating performance of the Company. Delivery schedules may be extended and orders may be canceled at any time subject to certain cancellation penalties.\nPATENTS AND LICENSES\nSince the Company relies on the technical expertise, creativity, and know-how of its personnel, it utilizes patent, copyright, and trade secret protection to safeguard its competitive position. In addition, the Company makes use of non-disclosure agreements with customers, consultants, suppliers, and employees. The Company attempts to protect its intellectual property by restricting access to its proprietary information by a combination of technical and internal security measures. However, there can be no assurance that any of the above measures will be adequate to protect the proprietary technology of the Company.\nThe Company's software products are generally licensed to customers pursuant to a license agreement that restricts the use of the products to the customer's purposes on a designated Cognex machine vision engine. The Company has made portions of the source code available to certain customers and OEMs under very limited circumstances and for restricted uses. If source code is released to a customer or re-licenser, the customer or re-licenser is required by contract to maintain its confidentiality and, in general, to use the source code solely for internal purposes or for maintenance. Effective patent, copyright, and trade secret protection may be unavailable in certain foreign countries.\nSome users of the Company's products have received notice of patent infringement from Technivision Corporation and Jerome H. Lemelson alleging that their use of the Company's products infringe certain patents issued to Mr. Lemelson. Certain of these users have notified the Company that, in the event it is subsequently determined that their use of the Company's products infringes any of Mr. Lemelson's patents, they may seek indemnification from the Company for damages or expenses resulting from this matter. Certain of the users of the Company's products currently are engaged in litigation with Mr. Lemelson\/Technivision involving certain of these patents and the validity of these patents has been placed in issue. Although the Company has not been named in this litigation, it has entered into a joint defense agreement with a named party therein, which has recently entered into a settlement agreement with Mr. Lemelson for reasons unknown to the Company. The Company is not a party to that settlement and has no indemnification claims, nor obligations for such, with respect to the settlement. Certain products sold by the Company, as well as products of others, were identified in connection with this litigation as part of an allegedly infringing use.\nLitigation with respect to the Company's products at issue has been stayed for purposes of case management. Accordingly, any decision on the merits of this case regarding the Company's products is expected to be delayed at least until the litigation with respect to the products of others is settled or adjudicated. As a result, the Company's participation in this litigation may be required in the future. The Company may incur significant costs with respect to such participation or if it is required to indemnify any purchasers or users of the Company's products for damages or expenses resulting from the litigation.\nIn June 1995, a Magistrate Judge filed a recommendation that summary judgment be entered in favor of one of the Company's users engaged in litigation with Mr. Lemelson\/Technivision. If this recommendation is accepted by the applicable District Court, the summary judgment would entirely dispose of all the actions in favor of the user. Until further notice by the Court, action regarding this litigation is stayed. The Company cannot predict the outcome of this or any similar litigation which may arise in the future, or the effect of such litigation on the operating results of the Company. The Company does not believe its products infringe any valid and enforceable claims of Mr. Lemelson's patents.\nEMPLOYEES\nAt December 31, 1995, the Company employed 307 persons, including 119 in sales, marketing and support activities; 104 in research, development and engineering; 36 in manufacturing and quality assurance; and 48 in management, administration and finance. 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 good.\nITEM 2:","section_1A":"","section_1B":"","section_2":"ITEM 2: PROPERTIES\nIn 1994, the Company purchased and renovated a 100,000 square foot building located in Natick, Massachusetts. The Company's corporate headquarters, principal administrative, sales and marketing, research, development and engineering, manufacturing and quality assurance, and support personnel are located in this facility. In addition, the Company leases sales offices in the United States in California, Illinois, and Oregon, as well as in Japan, France, Germany, England, Italy, Singapore, and Korea.\nIn June 1995, the Company purchased an 83,000 square-foot office building adjacent to its corporate headquarters. The building is currently occupied with tenants who have lease commitments that expire at various dates through the year 2000. The Company will oversee these lease commitments until it is ready to take occupancy.\nITEM 3:","section_3":"ITEM 3: LEGAL PROCEEDINGS\nTo the Company's knowledge, there are no pending legal proceedings, other than as described in \"Business - Patents and Licenses,\" which are material to the Company to which it is a party or to which any of its property is subject. From time to time, however, the Company may be subject to various claims and lawsuits by customers and competitors arising in the normal course of business, including suits charging patent infringement.\nITEM 4:","section_4":"ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThere were no matters submitted during the fourth quarter of the year ended December 31, 1995 to a vote of security holders through solicitation of proxies or otherwise.\nITEM 4A: EXECUTIVE OFFICERS AND OTHER MEMBERS OF THE MANAGEMENT TEAM OF THE REGISTRANT\nThe following table sets forth the names, ages, and titles of the Company's executive officers at December 31, 1995:\nMr. Shillman, founder of the Company, has served as its President, Chief Executive Officer, and Chairman since its organization in 1981.\nMr. Alias joined the Company in 1991 as Executive Vice President of Sales and Marketing. From 1990 to 1991, he served as President of Gimeor SA, a manufacturer of CAD\/CAM software.\nMr. Rogers joined the Company in 1991 as Director of Finance and Administration and was appointed Vice President of Finance and Administration and Treasurer in 1993, Chief Financial Officer in 1994, and Executive Vice President of Finance and Administration in 1995. From 1989 to 1991, he served as Senior Manager of Financial Control and Analysis for the Waters Division of Millipore Corporation, a manufacturer of liquid chromatography equipment. Mr. Rogers is a certified public accountant.\nMr. Snyder joined the Company in 1991 as Executive Vice President of Operations. From 1981 to 1991, he held various positions within Prime Computer, including President and General Manager, Computer Systems Business Unit, Vice President Engineering, Vice President Systems Marketing and Development, and Vice President Software Development. The Computer Systems Business Unit of Prime Computer manufactures minicomputers and CAD\/CAM systems.\nExecutive officers are elected annually by the Board of Directors. There are no family relationships among the directors and the executive officers of the Company.\nOTHER MEMBERS OF THE MANAGEMENT TEAM\nMs. Matz and Messrs Nelson, Schatz, and Silver have been employed by the Company in their present or other capacities for no less than the past five years.\nMr. McGarry joined the Company in 1995 when the company he founded in 1991, Acumen, Inc., was acquired by Cognex. From 1991 to 1995, he served as President of Acumen, Inc., a developer of machine vision systems for semiconductor wafer identification.\nMr. Ohgusu joined the Company in 1992 as President of Cognex K.K., the Company's Japanese subsidiary. From 1989 to 1992, he served as President and CEO of Lonrho International Networks, Ltd., a manufacturer of computer diagnostic software.\nMr. Schalke joined the Company in 1991 as Vice President of Engineering. From 1988 to 1990, he served as Vice President and General Manager for the Small Systems product line of Concurrent Computer Corporation, a manufacturer of real-time computer systems.\nPART II\nITEM 5:","section_5":"ITEM 5: MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS\nCertain information with respect to this item may be found in the section captioned \"Selected Quarterly Financial Data,\" appearing on page 35, and the section captioned \"Company Information,\" appearing on page 36 of the Annual Report to Stockholders for the year ended December 31, 1995, which is Exhibit 13 hereto, and is incorporated herein by reference.\nThe Company has never declared or paid cash dividends on shares of common stock. The Company currently intends to retain all of its earnings to finance the development and expansion of its business and therefore does not intend to declare or pay cash dividends on its common stock in the foreseeable future. Any future declaration and payment of dividends will be subject to the discretion of the Board of Directors of the Company, will be subject to applicable law, and will depend upon the Company's results of operations, earnings, financial condition, contractual limitations, cash requirements, future prospects, and other factors deemed relevant by the Company's Board of Directors.\nITEM 6:","section_6":"ITEM 6: SELECTED FINANCIAL DATA\nInformation with respect to this item may be found in the section captioned \"Five-Year Summary of Selected Financial Data,\" appearing on page 34 of the Annual Report to Stockholders for the year ended December 31, 1995, which is Exhibit 13 hereto, 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 with respect to this item may be found in the section captioned \"Management's Discussion and Analysis of Financial Condition and Results of Operations,\" appearing on pages 12 through 16 of the Annual Report to Stockholders for the year ended December 31, 1995, which is Exhibit 13 hereto, and is incorporated herein by reference.\nITEM 8:","section_7A":"","section_8":"ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nInformation with respect to this item, which includes the consolidated financial statements and notes thereto, report of independent accountants, and supplementary data, may be found on pages 17 through 35 of the Annual Report to Stockholders for the year ended December 31, 1995, which is Exhibit 13 hereto, and is incorporated herein by reference.\nITEM 9:","section_9":"ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThere were no changes in or disagreements with accountants on accounting or financial disclosure during 1995 or 1994.\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 may be found in the section captioned \"Election of Directors,\" appearing in the definitive Proxy Statement for the Special Meeting in Lieu of the 1996 Annual Meeting of Stockholders to be held on April 23, 1996. Such information is incorporated herein by reference. Information with respect to Executive Officers of the Company may be found in the section captioned \"Executive Officers and Other Members of the Management Team of the Registrant\" in Part I of this Annual Report on Form 10-K.\nITEM 11:","section_11":"ITEM 11: EXECUTIVE COMPENSATION\nInformation with respect to this item may be found in the sections captioned \"Information Concerning the Board of Directors,\" \"Compensation\/Stock Option Committee Report on Executive Compensation,\" \"Comparison of Five Year Cumulative Total Returns Performance Graph for Cognex Corporation,\" and \"Executive Compensation,\" appearing in the definitive Proxy Statement for the Special Meeting in Lieu of the 1996 Annual Meeting of Stockholders to be held on April 23, 1996. Such information is incorporated herein by reference.\nITEM 12:","section_12":"ITEM 12: SECURITY OWNERSHIP AND CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation with respect to this item may be found in the sections captioned \"Principal Holders of Voting Securities\" and \"Security Ownership of Directors and Officers,\" appearing in the definitive Proxy Statement for the Special Meeting in Lieu of the 1996 Annual Meeting of Stockholders to be held on April 23, 1996. Such information 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 consolidated financial statements of Cognex Corporation and the report of independent accountants relating thereto are included in the Company's Annual Report to Stockholders for the year ended December 31, 1995, which is Exhibit 13 hereto, and is incorporated herein by reference:\nReport of Independent Accountants for the years ended December 31, 1995, 1994 and 1993\nConsolidated Statements of Income for the years ended December 31, 1995, 1994 and 1993\nConsolidated Balance Sheets at December 31, 1995 and 1994\nConsolidated Statements of Stockholders' Equity for the years ended December 31, 1995, 1994 and 1993\nConsolidated Statements of Cash Flows for the years ended December 31, 1995, 1994 and 1993\nNotes to Consolidated Financial Statements\n(2) Financial Statement Schedule\nIncluded at the end of this report are the following:\nReport of Independent Accountants on the Financial Statement Schedule\nSchedule II - 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.\n(3) Exhibits\nThe Exhibits filed as part of this Annual Report on Form 10-K are listed in the Exhibit Index on page 19, immediately preceding such Exhibits.\n(b) Reports on Form 8-K\nOn October 4, 1995, the Company filed a Current Report on Form 8-K for the acquisition of Acumen, Inc. as follows:\nItem 2. Acquisition or Disposition of Assets\nItem 7. Financial Statements and Exhibits\n(a) Financial Statements of Business Acquired\nReport of Independent Accountants\nStatements of Income for the three months ended June 30, 1995 (unaudited) and the twelve months ended March 25,\nBalance Sheets as of June 30, 1995 (unaudited) and March 25, 1995\nStatements of Stockholders' Equity for the three months ended June 30, 1995 (unaudited) and the twelve months ended March 25, 1995\nStatements of Cash Flows for the three months ended June 30, 1995 (unaudited) and the twelve months ended March 25, 1995\nNotes to Financial Statements\n(b) Pro Forma Financial Information\nIntroductory Information\nUnaudited Pro Forma Statement of Income for the six months ended July 2, 1995\nUnaudited Pro Forma Statement of Income for the twelve months ended December 31, 1994\nUnaudited Pro Forma Balance Sheet as of July 2, 1995\nNotes to Unaudited Pro Forma Financial Information\n(c) Exhibits\nExhibit 2 - Stock Purchase Agreement dated as of July 21, 1995 among Acumen, Inc., the Shareholders of Acumen Inc., and Cognex Corporation\nExhibit 27 - Financial Data Schedules (electronic filing 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.\nCognex Corporation\n\/s\/ Robert J. Shillman ----------------------------- Robert J. Shillman, President March 28, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, 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 ON THE FINANCIAL STATEMENT SCHEDULE\nTo the Board of Directors and Stockholders of Cognex Corporation:\nOur report on the consolidated financial statements of Cognex Corporation has been incorporated by reference in this Form 10-K from page 33 of the 1995 Annual Report to Stockholders of Cognex Corporation. In connection with our audits of such financial statements, we have also audited the related financial statement schedule for each of the three years in the period ended December 31, 1995 listed in Item 14(a) of this Form 10-K.\nIn our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.\nCOOPERS & LYBRAND L.L.P.\nBoston, Massachusetts January 26, 1996\nSCHEDULE II\nCOGNEX CORPORATION VALUATION AND QUALIFYING ACCOUNTS (Dollars in thousands)\n(A) Specific write-offs (B) Specific dispositions\nEXHIBIT INDEX\nEXHIBIT NUMBER - - --------------\n2A Stock Purchase Agreement dated as of July 21, 1995 among Acumen, Inc., the Shareholders of Acumen, Inc., and Cognex Corporation (incorporated by reference to Exhibit 2 to the Current Report on Form 8-K filed on October 4, 1995)\n2B Agreement and Plan of Merger dated as of February 29, 1996 among Cognex Corporation, Cognex Software Development, Inc., Isys Controls, Inc., and Richard Rombach (incorporated by reference to Exhibit 2 to the Current Report on Form 8-K filed on March 15, 1996)\n3A Articles of Organization of the Company effective January 8, 1981, as amended June 8, 1982, August 19, 1983, May 15, 1984, April 17, 1985, November 4, 1986, and January 21, 1987 (incorporated by reference to Exhibit 3A to the Registration Statement Form S-1 [Registration No. 33-29020]).\n3B Restated Articles of Organization of the Company effective June 28, 1989 (incorporated by reference to Exhibit 3C to the Registration Statement Form S-1 [Registration No. 33-29020]).\n3C By-laws of the Company as amended February 9, 1990 (filed as Exhibit 3C to the Company's Annual Report on Form 10-K for the year ended December 31, 1990).\n4 Specimen Certificate for Shares of Common Stock (incorporated by reference to Exhibit 4 to the Registration Statement Form S-1 [Registration No. 33-29020]).\n10A Cognex Corporation Employee Stock Purchase Plan (incorporated by reference to Exhibit 4A to Amendment No. 1 to the Registration Statement Form S-8 [Registration No. 33-32815]).\n10B Cognex Corporation 1984 Stock Option Plan, as amended (incorporated by reference to Exhibit 4B to Amendment No. 2 to the Registration Statement Form S-8 [Registration No. 33-31657]).\n10C Cognex Corporation 1992 Stock Option Plan (filed as Exhibit 10I to the Company's Annual Report on Form 10-K for the year ended December 31, 1992).\n10D Cognex Corporation 1993 Director's Stock Option Plan (filed as Exhibit 10J to the Company's Annual Report on Form 10-K for the year ended December 31, 1993).\n10E Cognex Corporation 1993 Employee Stock Option Plan (filed as Exhibit 10K to the Company's Annual Report on Form 10-K for the year ended December 31, 1993).\n10F Purchase and Sale Agreement with respect to the Natick Executive Park facility dated as of October 20, 1993 (filed as Exhibit 10L to the Company's Annual Report on Form 10-K for the year ended December 31, 1993).\n10G Purchase and Sale Agreement with respect to the Natick Executive Park facility dated as of June 30, 1995 *\n11 Statement re computation of per share earnings *\n13 Annual Report to Stockholders for the year ended December 31, 1995 (which is not deemed to be \"filed\" except to the extent that portions thereof are expressly incorporated by reference in this Annual Report on Form 10-K) *\n21 Subsidiaries of the registrant *\n23 Consent of Coopers & Lybrand L.L.P. *\n27 Financial Data Schedule *\n* Filed herewith","section_15":""}
{"filename":"796805_1995.txt","cik":"796805","year":"1995","section_1":"Item 1. Business - ----------------\nBalcor Equity Pension Investors-IV A Real Estate Limited Partnership (the \"Registrant\") is a limited partnership formed in 1986 under the laws of the State of Illinois. The Registrant raised $46,371,500 from sales of Limited Partnership Interests. The Registrant's operations consist exclusively of investment in and operation of income-producing real property, and all information included in this report relates to this industry segment.\nThe Registrant originally funded one acquisition loan and acquired two real property investments. The Registrant currently has two properties and an investment in joint venture with affiliates in its portfolio as of December 31, 1995 as described under \"Item 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties - ------------------\nAs of December 31, 1995, the Registrant owns the two properties described below:\nLocation Description of Property - -------- -----------------------\nEvanston, Illinois Evanston Plaza Shopping Center: a neighborhood shopping center containing approximately 170,000 square feet located on approximately 13 acres.\nDade County, Florida Gleneagles Apartments: a 292-unit apartment complex located on approximately 14 acres.\nThe Registrant also holds a minority interest in a joint venture with affiliates which owns the 45 West 45th Street Office Building in New York, New York. See Note 5 of Notes to Financial Statements for additional information.\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 1995.\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 1995.\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. For information regarding distributions, see Management's Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources, below.\nAs of December 31, 1995, the number of record holders of Limited Partnership Interests of the Registrant was 6,629.\nItem 6.","section_6":"Item 6. Selected Financial Data - -------------------------------\nYear ended December 31, ---------------------------------------------------------- 1995 1994 1993 1992 1991 ---------- ---------- ----------- ---------- ---------- Total income $5,191,721 $5,088,403 $ 4,556,554 $4,728,736 $4,603,781 Net income (loss) 905,702 1,144,130 339,089 698,621 (1,923,708) Net income (loss) per Limited Partnership Interest 3.82 5.14 .81 2.67 (11.28) Total assets 26,733,957 28,010,591 28,709,441 30,454,887 31,846,219 Distributions per taxable Limited Partnership Interest (A) 11.37 11.28 10.08 10.83 9.87 Distributions per tax-exempt Limited Partnership Interest (A) 9.76 10.09 10.53 10.00 10.00\n(A) No distributions of original capital were made in any of the last five years.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results - ------------------------------------------------------------------------------- of Operations - -------------\nOperations - ----------\nSummary of Operations - ---------------------\nDuring 1995 and 1993, Balcor Equity Pension Investors - IV A Real Estate Limited Partnership (the \"Partnership\") recognized its share of the decline in the fair value of the 45 West 45th Street Office Building. As a result, net\nincome decreased during 1995 as compared to 1994, and increased during 1994 as compared to 1993. Further discussion of the Partnership's operations is summarized below.\n1995 Compared to 1994 - --------------------- Interest income on short-term investments increased during 1995 compared to 1994 as a result of higher interest rates earned on short-term investments and higher average cash balances available for investment.\nProperty management fees, which are earned as a percentage of rental and service income collected, decreased during 1995 as compared to 1994 due to the timing of the collection of real estate tax reimbursements at the Evanston Plaza Shopping Center.\nParticipation in (loss) income of joint venture with affiliates represents the Partnership's share of the operations of the 45 West 45th Street Office Building. The Partnership recognized its share of a decline in the fair value of the 45 West 45th Street Office Building during 1995. As a result, the Partnership recognized participation in loss of joint venture with affiliates during 1995 as compared to participation in income during 1994.\n1994 Compared to 1993 - ---------------------\nDue to increased rental rates at the Gleneagles Apartments and Evanston Plaza Shopping Center, rental income increased during 1994 as compared to 1993.\nIncreased real estate tax and common area maintenance reimbursements from tenants at the Evanston Plaza Shopping Center resulted in higher service income during 1994 as compared to 1993. Property management fees, which are earned as a percentage of rental and service income collected, also increased for this period.\nAs a result of higher interest rates earned on short-term investments and higher average cash balances available for investment, interest income on short-term investments increased during 1994 as compared to 1993.\nDue to increased insurance and payroll costs at both the Gleneagles Apartments and Evanston Plaza Shopping Center, and increased expenditures for roof repairs, painting and appliances at the Gleneagles Apartments, property operating expenses increased during 1994 as compared to 1993.\nAs a result of higher accounting, legal and portfolio management fees, administrative expenses increased during 1994 as compared to 1993.\nThe Partnership recognized its share of a decline in the fair value of the 45 West 45th Street Office Building during 1993. As a result, the Partnership recognized participation in income of joint venture with affiliates during 1994 as compared to participation in loss during 1993.\nLiquidity and Capital Resources - -------------------------------\nThe cash position of the Partnership decreased as of December 31, 1995 as compared to December 31, 1994. Operating activities include cash flow from the operations of the Partnership's properties and short-term investments, which\nwere partially offset by the payment of administrative expenses. Investing activities consisted of net capital contributions to the joint venture with affiliates and financing activities consisted of distributions to the Partners.\nThe Partnership classifies the cash flow performance of its properties as either positive, a marginal deficit, or a significant deficit, each after consideration of debt service payments unless otherwise indicated. A deficit is considered significant if it exceeds $250,000 annually or 20% of the property's rental and service income. The Partnership defines cash flow generated from its properties as an amount equal to the property's revenue receipts less property related expenditures. During 1995 and 1994, the Gleneagles Apartments and Evanston Plaza Shopping Center generated positive cash flow. During 1995 and 1994, The 45 West 45th Street Office Building, in which the Partnership holds a minority joint venture interest with affiliates, also generated positive cash flow. Significant leasing costs were incurred in 1995 at the 45 West 45th Street Office Building to lease vacant space and renew existing tenant leases which were scheduled to expire. Had these non-recurring expenditures been included in classifying the cash flow performance, this property would have generated a significant cash flow deficit during 1995.\nAs of December 31, 1995, the Gleneagles Apartments and Evanston Plaza Shopping Center had occupancy rates of 100% and 96%, respectively, while the 45 West 45th Street Office Building had an occupancy rate of 86%. Many rental markets continue to remain extremely competitive; therefore, the General Partner's goals are to maintain high occupancy levels while increasing rents where possible and to monitor and control operating expenses and capital improvement requirements at the properties.\nThe General Partner believes that the market for multifamily housing properties has become increasingly favorable to sellers of these properties. As a result, the General Partner is exploring an acceleration of its strategy to sell the Partnership's residential properties. Additionally, the General Partner will explore the sale of its commercial properties over the next year if market conditions are favorable.\nThe Partnership and three affiliates (the \"Participants\") previously funded a $23,000,000 loan on the 45 West 45th Street Office Building. In February 1995, the Participants received title to the property through foreclosure. The Partnership owns a 15.22% joint venture interest in the property.\nThe Partnership made four distributions totaling $11.37 per Taxable Interest and $9.76 per Tax-exempt Interest during 1995 as compared to $11.28 per Taxable Interest and $10.09 per Tax-exempt Interest during 1994 and $10.08 per Taxable Interest and $10.53 per Tax-exempt Interest in 1993. See Statements of Partners' Capital for additional information. Average quarterly distributions to Limited Partners remained relatively unchanged during 1995 as compared to 1994 and 1993.\nIn January 1996, the Partnership paid a distribution of $419,733 ($2.29 per Taxable Interest and $2.26 per Tax-Exempt Interest) to the holders of Limited Partnership Interests representing the regular quarterly distribution of Cash Flow for the fourth quarter of 1995. Including the January 1996 distribution, Limited Partners have received cumulative distributions of $84.22 per $250 Taxable Interest, of which $83.97 represents Cash Flow from operations and $.25 represents a return of Original Capital, and $82.22 per $250 Tax-exempt Interest, of which $81.97 represents Cash Flow from operations and $.25 represents a return of Original Capital. In January 1996, the Partnership also\npaid $34,978 to the General Partner as its distributive share of the fourth quarter of 1995 distribution, and made a contribution to the Repurchase Fund in the amount of $11,659.\nIt should be noted that distributions to Taxable Limited Partners and Tax-exempt Limited Partners are computed by different formulas as set forth in the Prospectus; therefore, the amount of distributions to Taxable Limited Partners when compared to the amount of distributions to Tax-exempt Limited Partners will fluctuate from quarter to quarter. The General Partner expects that the cash flow from property operations should enable the Partnership to continue making quarterly distributions to Limited Partners. However, the level of future distributions will be dependent on the amount of cash flow generated from property operations, as to which there can be no assurances.\nDuring 1995, the General Partner used amounts placed in the Repurchase Fund to repurchase 414 Interests from Limited Partners at a cost of $70,752.\nIn 1995, the Financial Accounting Standards Board issued Statement No. 121 \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of\" which establishes accounting standards for impairment of long-lived assets and long-lived assets to be disposed of. This statement has been adopted by the Partnership as of January 1, 1995, and did not have a material impact on the financial position or results of operations of the Partnership.\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, 1995 December 31, 1994 ----------------------- ------------------------- Financial Tax Financial Tax Statements Returns Statements Returns ---------- ----------- ---------- -------\nTotal assets $26,733,957 $38,950,316 $28,010,591 $42,181,782 Partners' capital accounts (deficit): General Partner (116,554) 232,138 (109,380) 251,855 Limited Partners 25,605,915 37,473,570 26,736,406 40,725,852 Net income (loss): General Partner 197,170 184,627 191,630 204,184\nLimited Partners 708,532 (1,413,259) 952,500 1,125,994 Per Limited Part- nership Interest 3.82 (A) 5.14 (A)\n(A) The net loss is $6.90 per Tax-exempt Interest and $7.70 per Taxable Interest for 1995, and the net income is $5.94 per Tax-exempt Interest and $7.34 per Taxable Interest for 1994.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and - ----------------------------------------------------------------------- Financial Disclosure - --------------------\nOn September 14, 1995, the Partnership approved the engagement of Coopers & Lybrand L.L.P. as its independent auditors for the fiscal year ending December 31, 1995 to replace the firm of Ernst & Young LLP, who were dismissed as auditors of the Partnership effective September 14, 1995. The General Partner of the Partnership approved the change in auditors.\nThe reports of Ernst & Young LLP on the Partnership's financial statements for the past two fiscal years did not contain an adverse opinion or a disclaimer of opinion and were not qualified or modified as to uncertainty, audit scope, or accounting principles.\nIn connection with the audits of the Partnership's financial statements for each of the two fiscal years ended December 31, 1994, and in the subsequent interim period, there were no disagreements with Ernst & Young LLP on any matters of accounting principles or practices, financial statement disclosure, or auditing scope and procedures which, if not resolved to the satisfaction of Ernst & Young LLP would have caused Ernst & Young LLP to make reference to the matter in their report.\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 Equity Partners-IV, 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 Senior Vice President Alexander J. Darragh Senior Vice President Josette V. Goldberg Senior Vice President Alan G. Lieberman Senior Vice President, Chief Brian D. Parker Financial Officer, Treasurer and Assistant Secretary Senior Vice President John K. Powell, Jr.\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. He is also Senior Vice President of American Express Company and is responsible for its real estate operations worldwide. 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.\nAlexander J. Darragh (February 1955) joined Balcor in September 1988 and is responsible for due diligence analysis and real estate advisory services for Balcor and American Express Company. He also has supervisory responsibility for Balcor's environmental matters. Mr. Darragh received masters' degrees in Urban Geography from Queen's University and in Urban Planning from Northwestern University.\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 MIS functions. 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 Balcor's property sales and capital markets functions. Mr. Lieberman is a Certified Public Accountant.\nBrian D. Parker (June 1951) joined Balcor in March 1986 and, as Chief Financial Officer and Chief Accounting Officer, is responsible for Balcor's financial, legal and treasury functions. He is a Director of The Balcor Company. 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 portfolio and asset management matters relating to Balcor's partnerships. Mr. Powell also has supervisory responsibility for Balcor's risk management and investor services functions. He received a Master of Planning degree from the University of Virginia. Mr. Powell 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.\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 1995.\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 Balcor Equity Partners - IV, the General Partner. Certain of these officers receive compensation from The Balcor Company (but not from the Registrant) for services performed for various affiliated entities, which may include services performed for the Registrant. However, the General Partner believes that any such compensation attributable to services performed for the Registrant is immaterial to the Registrant. See Note 7 of Notes to Financial Statements for the information relating to transactions with affiliates.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management - -----------------------------------------------------------------------\n(a) The following entity is the sole Limited Partner which owns beneficially more than 5% of the outstanding Limited Partnership Interests of the Registrant:\nName and Amount and Address of Nature of Percent Beneficial Beneficial of Title of Class Owner Ownership Class -------------- ----------- ----------- ---------\nLimited Engineers Joint 12,780 6.89% Partnership Pension Fund Interests Interests Syracuse, New York\n(b) Balcor Equity Partners-IV 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 2,556 Interests 1.38% Partnership Interests\nRelatives and affiliates of the officers and partners of the General Partner do not own any 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 3 of Notes to Financial Statements for information relating to the Partnership Agreement and the allocation of distributions and profits and losses.\nSee Note 7 of Notes to Financial Statements for 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 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 of Balcor Equity Pension Investors-IV A Real Estate Limited Partnership, previously filed as Exhibit 3 to Amendment No. 1 dated November 28, 1986 to the Registrant's Registration Statement on Form S-11 (Registration No. 33-7133), is hereby incorporated herein by reference.\n(4) Form of Subscription Agreement set forth as Exhibit 4.1 to Amendment No. 1 to Registrant's Registration Statement on Form S-11 dated November 28, 1986 (Registration No. 33-7133) 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. 0-15648) are incorporated herein by reference.\n(16) Letter from Ernst & Young LLP dated September 19, 1995 regarding the change in the Registrant's certifying accountant previously filed as Exhibit 16 to the Registrant's Report on Form 8-K\/A dated October 27, 1995 (Commission File No. 0-15648) is hereby incorporated herein by reference.\n(27) Financial Data Schedule of the Registrant for 1995 is attached hereto.\n(b) Reports on Form 8-K: A Current Report on form 8-K\/A dated October 27, 1995, amending the Current Report on Form 8-K dated September 19, 1995 reporting a change in the Registrant's certifying public accountants, was filed (Commission File No. 0-15648).\n(c) Exhibits: See Item 14(a)(3) above.\n(d) Financial Statement Schedule: See Index to Financial Statements and Financial Statement Schedule attached hereto 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 EQUITY PENSION INVESTORS-IV A REAL ESTATE LIMITED PARTNERSHIP\nBy: \/s\/Brian D. Parker ------------------------------ Brian D. Parker Senior Vice President, and Chief Accounting and Financial Officer (Principal Accounting and Financial Officer) of Balcor Equity Partners-IV, the General Partner\nDate: March 28, 1996 ------------------\nPursuant to the requirements of the Securities Exchange Act of 1934, 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 Equity \/s\/Thomas E. Meador Partners-IV, the General Partner March 28, 1996 - -------------------- -------------- Thomas E. Meador Senior Vice President, and Chief Accounting and Financial Officer (Principal Accounting and Financial Officer) of Balcor Equity \/s\/Brian D. Parker Partners-IV, the General Partner March 28, 1996 - -------------------- -------------- Brian D. Parker\nINDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE\nReport of Independent Accountants\nReport of Independent Auditors\nFinancial Statements:\nBalance Sheets, December 31, 1995 and 1994\nStatements of Partners' Capital, for the years ended December 31, 1995, 1994 and 1993\nStatements of Income and Expenses, for the years ended December 31, 1995, 1994 and 1993\nStatements of Cash Flows, for the years ended December 31, 1995, 1994 and 1993\nNotes to Financial Statements\nFinancial Statement Schedule:\nIII - Real Estate and Accumulated Depreciation, as of December 31, 1995\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 Equity Pension Investors-IV A Real Estate Limited Partnership:\nWe have audited the accompanying balance sheet and the financial statement schedule of Balcor Equity Pension Investors-IV A Real Estate Limited Partnership (An Illinois Limited Partnership) as of December 31, 1995 and the related statements of partners' capital (deficit), income and expenses and cash flows for the year then ended. 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 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 Balcor Equity Pension Investors-IV A Real Estate Limited Partnership (An Illinois Limited Partnership) at December 31, 1995 and the results of its operations and its cash flows for the year then ended 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 20, 1996\nREPORT OF INDEPENDENT AUDITORS\nTo the Partners of Balcor Equity Pension Investors-IV A Real Estate Limited Partnership\nWe have audited the accompanying balance sheet of Balcor Equity Pension Investors-IV A Real Estate Limited Partnership (An Illinois Limited Partnership) as of December 31, 1994 and the related statements of partners' capital, income and expenses and cash flows for each of the two 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 Balcor Equity Pension Investors-IV A Real Estate Limited Partnership at December 31, 1994 and the results of its operations and its cash flows for each of the two years in the period ended December 31, 1994, in conformity with generally accepted accounting principles.\nERNST & YOUNG LLP\nChicago, Illinois March 20, 1995\nBALCOR EQUITY PENSION INVESTORS-IV A REAL ESTATE LIMITED PARTNERSHIP (An Illinois Limited Partnership)\nBALANCE SHEETS December 31, 1995 and 1994\nASSETS\n1995 1994 ------------- ------------- Cash and cash equivalents $ 3,389,826 $ 3,612,180 Accounts and accrued interest receivable 87,630 70,246 Prepaid expenses 35,931 Deferred expenses, net of accumulated amortization of $9,779 in 1995 and $4,191 in 1994 46,105 51,693 ------------- ------------- 3,559,492 3,734,119 ------------- ------------- Investment in real estate: Land 6,958,341 6,958,341 Buildings and improvements 24,248,600 24,248,600 ------------- ------------- 31,206,941 31,206,941 Less accumulated depreciation 9,171,989 8,363,940 ------------- ------------- Investment in real estate, net of accumulated depreciation 22,034,952 22,843,001 ------------- ------------- Investment in joint venture with affiliates 1,139,513 1,433,471 ------------- ------------- $ 26,733,957 $ 28,010,591 ============= =============\nLIABILITIES AND PARTNERS' CAPITAL\nAccounts payable $ 105,783 $ 44,724 Due to affiliates 16,286 54,646 Accrued liabilities, principally real estate taxes 1,034,351 1,176,087 Security deposits 88,176 108,108 ------------- ------------- Total liabilities 1,244,596 1,383,565 ------------- ------------- Limited Partners' capital (185,486 Interests issued and outstanding) 25,605,915 26,736,406 General Partner's deficit (116,554) (109,380) ------------- ------------- Total partners' capital 25,489,361 26,627,026 ------------- ------------- $ 26,733,957 $ 28,010,591 ============= =============\nThe accompanying notes are an integral part of the financial statements.\nBALCOR EQUITY PENSION INVESTORS-IV A REAL ESTATE LIMITED PARTNERSHIP (An Illinois Limited Partnership)\nSTATEMENTS OF PARTNERS' CAPITAL for the years ended December 31, 1995, 1994 and 1993\nPartners' Capital (Deficit) Accounts ------------- ------------- ------------- General Limited Total Partner Partners ------------- ------------- ------------- Balance at December 31, 1992 $ 29,408,145 $ (63,076) $ 29,471,221 Cash distributions to: Limited Partners (A) (1,945,152) (1,945,152) General Partner (216,128) (216,128) Net income for the year ended December 31, 1993 339,089 188,500 150,589 ------------- ------------- ------------- Balance at December 31, 1993 27,585,954 (90,704) 27,676,658 Cash distributions to: Limited Partners (A) (1,892,752) (1,892,752) General Partner (210,306) (210,306) Net income for the year ended December 31, 1994 1,144,130 191,630 952,500 ------------- ------------- ------------- Balance at December 31, 1994 26,627,026 (109,380) 26,736,406 Cash distributions to: Limited Partners (A) (1,839,023) (1,839,023) General Partner (204,344) (204,344) Net income for the year ended December 31, 1995 905,702 197,170 708,532 ------------- ------------- ------------- Balance at December 31, 1995 $ 25,489,361 $ (116,554) $ 25,605,915 ============= ============= =============\n(A) Summary of cash distributions paid per Interest:\n1995 1994 1993 ------------- ------------- ------------- Taxable - ----------------- First Quarter $ 3.24 $ 2.50 $ 2.57 Second Quarter 2.98 2.94 2.45 Third Quarter 2.86 3.08 2.56 Fourth Quarter 2.29 2.76 2.50\nTax-exempt - ----------------- First Quarter 2.50 2.59 2.50 Second Quarter 2.50 2.50 2.50 Third Quarter 2.50 2.50 2.50 Fourth Quarter 2.26 2.50 3.03\nThe accompanying notes are an integral part of the financial statements.\nBALCOR EQUITY PENSION INVESTORS-IV A REAL ESTATE LIMITED PARTNERSHIP (An Illinois Limited Partnership)\nSTATEMENTS OF INCOME AND EXPENSES for the years ended December 31, 1995, 1994 and 1993\n1995 1994 1993 ------------- ------------- ------------- Income: Rental $ 3,724,300 $ 3,677,124 $ 3,433,321 Service 1,288,507 1,278,641 1,034,957 Interest on short-term investments 178,914 132,638 88,276 ------------- ------------- ------------- Total income 5,191,721 5,088,403 4,556,554 ------------- ------------- -------------\nExpenses: Depreciation 808,049 808,049 808,049 Property operating 1,204,793 1,217,820 994,022 Real estate taxes 1,324,473 1,290,821 1,255,764 Property management fees 250,356 296,144 233,191 Administrative 326,279 350,877 292,533 ------------- ------------- ------------- Total expenses 3,913,950 3,963,711 3,583,559 ------------- ------------- ------------- Income before participation in (loss) income of joint venture with affiliates 1,277,771 1,124,692 972,995\nParticipation in (loss) income of joint venture with affiliates (372,069) 19,438 (633,906) ------------- ------------- ------------- Net income $ 905,702 $ 1,144,130 $ 339,089 ============= ============= ============= Net income allocated to General Partner $ 197,170 $ 191,630 $ 188,500 ============= ============= ============= Net income allocated to Limited Partners $ 708,532 $ 952,500 $ 150,589 ============= ============= ============= Net income per Limited Partnership Interest (185,486 issued and outstanding) $ 3.82 $ 5.14 $ 0.81 ============= ============= =============\nThe accompanying notes are an integral part of the financial statements.\nBALCOR EQUITY PENSION INVESTORS-IV A REAL ESTATE LIMITED PARTNERSHIP (An Illinois Limited Partnership)\nSTATEMENTS OF CASH FLOWS for the years ended December 31, 1995, 1994 and 1993\n1995 1994 1993 ------------- ------------- ------------- Operating activities: Net income $ 905,702 $ 1,144,130 $ 339,089 Adjustments to reconcile net income to net cash provided by operating activities: Participation in loss (income) of joint venture with affiliates 372,069 (19,438) 633,906 Depreciation of properties 808,049 808,049 808,049 Amortization of deferred expenses 5,588 4,191 Payment of deferred expenses (55,884) Net change in: Accounts and accrued interest receivable (17,384) 841,031 (82,785) Prepaid expenses (35,931) Accounts payable 61,059 5,580 (18,489) Due to affiliates (38,360) 22,213 4,378 Accrued liabilities (141,736) 239,914 72,360 Security deposits (19,932) (7,629) 18,496 ------------- ------------- ------------- Net cash provided by operating activities 1,899,124 2,982,157 1,775,004 ------------- ------------- ------------- Investing activities: Capital contribution to joint venture - affiliates (95,901) Distributions from joint venture - affiliates 17,790 275,720 ------------- ------------- Net cash used in or provided by investing activities (78,111) 275,720 ------------- ------------- Financing activities: Distributions to Limited Partners (1,839,023) (1,892,752) (1,945,152) Distributions to General Partner (204,344) (210,306) (216,128) ------------- ------------- ------------- Cash used in financing activities (2,043,367) (2,103,058) (2,161,280) ------------- ------------- ------------- Net change in cash and cash equivalents (222,354) 879,099 (110,556) Cash and cash equivalents at beginning of year 3,612,180 2,733,081 2,843,637 ------------- ------------- ------------- Cash and cash equivalents at end of year $ 3,389,826 $ 3,612,180 $ 2,733,081 ============= ============= =============\nThe accompanying notes are an integral part of the financial statements.\nBALCOR EQUITY PENSION INVESTORS-IV A REAL ESTATE LIMITED PARTNERSHIP (An Illinois Limited Partnership)\nNOTES TO FINANCIAL STATEMENTS\n1. Nature of the Partnership's Business:\nBalcor Equity Pension Investors-IV A Real Estate Limited Partnership (\"the Partnership\") is engaged principally in the operation of residential, commercial and retail real estate located in various markets within the United States.\n2. Accounting Policies:\n(a) The preparation of the financial statements in conformity with generally accepted accounting principles requires the General Partner 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 vary from those estimates.\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:\nBuildings and improvements 25 to 30 years Furniture and fixtures 5 years\nMaintenance and repairs are charged to expense when incurred. Expenditures for improvements are charged to the related asset account.\n(c) Effective January 1, 1995, the Partnership adopted Statement of Financial Accounting Standards No. 121 (SFAS 121), \"Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of\". Under SFAS 121, the Partnership records its investments in real estate at the lower of cost or fair value, and periodically assesses, but not less than on an annual basis, possible impairment to the value of its properties. The General Partner estimates the fair value of its properties by dividing the property's expected net operating income by a risk adjusted rate of return which considers economic and demographic conditions in the market. In the event the General Partner determines an impairment in value has occurred, and the carrying amount of the real estate asset will not be recovered, a provision is recorded to reduce the carrying basis of the property to its estimated fair value. The General Partner considers the method referred to above to result in a reasonable measurement of a property's fair value, unless other factors affecting the property's value indicate otherwise.\nLoan losses on mortgage notes receivable were charged to income when the General Partner believed the loan balance would not be recovered. The General Partner assesses the collectibility of each loan on a periodic basis through a review of the collateral property operations, the property value and the borrower's ability to repay the loan. Upon foreclosure, the loan balance was transferred to real estate, after the fair value of the property less costs of disposal were assessed. Upon the transfer to real estate, a new basis in the property was established consistent with Partnerships investment objectives to\nown income producing real property to be held for long-term appreciation, real estate acquired through foreclosure was recorded as investment in real estate.\n(d) Investment in joint venture with affiliates represents the Partnership's 15.22% interest, under the equity method of accounting, in a joint venture with affiliated partnerships. 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.\n(e) Deferred expenses consist of leasing commissions which are amortized over the life of each respective lease.\n(f) Revenue is recognized on an accrual basis in accordance with generally accepted accounting principles. Income from operating leases with significant abatements and\/or scheduled rent increases is recognized on a straight line basis over the respective lease term. Service income includes reimbursements from operating costs such as real estate taxes, maintenance and insurance and is recognized as revenue in the period the applicable costs are incurred.\n(g) The Financial Accounting Standard Board's Statement No. 107, \"Disclosures About Fair Value of Financial Instruments\", requires disclosure of fair value information about financial instruments for which it is practicable to estimate that value. Statement No. 107 does not apply to all balance sheet items and excludes certain financial instruments and all non-financial instruments such as real estate from its disclosure requirements.\n(h) Cash and cash equivalents include all unrestricted highly liquid investments with an original maturity of three months or less. Cash and cash equivalents are held or invested primarily in one type of commercial paper.\n(i) The Partnership is not liable for Federal income taxes and each Partner recognizes his proportionate share of the Partnership income or loss in his tax return; therefore, no provision for income taxes is made in the financial statements of the Partnership.\n(j) Several reclassifications have been made to the previously reported 1994 and 1993 financial statements to conform with the classifications used in 1995. These reclassifications have not changed the 1994 and 1993 results.\n3. Partnership Agreement:\nThe Partnership was organized on June 20, 1986; however, operations did not commence until 1987. The Partnership Agreement provides for Balcor Equity Partners-IV to be the General Partner and for the admission of Limited Partners through the sale of up to 1,000,000 Limited Partnership Interests at $250 per Interest, 185,486 of which were sold through December 14, 1987, the termination date of the offering.\nPursuant to the terms set forth in the Partnership Agreement, \"Operating Income from Real Properties\" of the Partnership will be allocated 10% to the General Partner and 90% to the Limited Partners; \"Operating Losses from Real Properties\" and certain other components will be allocated 1% to the General Partner and 99% to the Limited Partners; and \"Other 'Operating Income' or 'Operating Losses'\" will be allocated 10% to the General Partner and 90% to the Limited Partners.\nThe Partnership Agreement provides for different allocations of profits and losses and cash distributions to Limited Partners depending on whether the investor originally acquiring the Limited Partnership interest was a taxable or tax-exempt entity.\nNinety percent of Net Cash Receipts available for distribution will be distributed to Limited Partners. To the extent possible, Taxable Limited Partners will receive an allocation of such available Net Cash Receipts generated by the operation of the Partnership's two properties in the same manner as if their investment in the Partnership had been attributable solely to the properties. Taxable Limited Partners will commence sharing in such available Net Cash Receipts generated by the Partnership's investment in the 45 West 45th Street Office Building at such time as the Taxable Limited Partners' investment in the Partnership is not then solely attributable to the two properties (which time is anticipated to be upon the sale of both properties). The Tax-exempt Limited Partners will be allocated all other Net Cash Receipts to be allocated to the Limited Partners, consisting of (i) 100% of such available Net Cash Receipts generated by the investment in the 45 West 45th Street Office Building (until such time as both of the properties are sold, as described above) plus (ii) the Net Cash Receipts generated by the operation of the two properties, to the extent not allocated to the Taxable Limited Partners as described above. Of the remaining 10% of Net Cash Receipts, 7 1\/2% will be paid to the General Partner as its distributive share from Partnership operations and an additional 2 1\/2% will be paid to the General Partner for allocation to the Repurchase Fund, which may be utilized to repurchase Interests from Limited Partners pursuant to the terms set forth in the Partnership Agreement.\nAt the sole discretion of the General Partner and subject to certain limitations, amounts placed in the Repurchase Fund have become available to be used to repurchase Interests from existing Limited Partners. During 1995, the General Partner used amounts placed in the Repurchase Fund to repurchase 414 Interests from Limited Partners at a cost of $70,752. An amount not to exceed that originally allocated to the Repurchase Fund will be returned to the Partnership at liquidation if necessary to permit payment to the Limited Partners of their \"Original Capital\" plus any deficiency in their \"Liquidation Preference,\" as defined in the Partnership Agreement.\nSubject to the provisions of the Partnership Agreement, \"Net Cash Proceeds\" which are available for distribution will be distributed only to the Limited Partners until such time as the Limited Partners have received a return of their \"Original Capital\" and their \"Liquidation Preference\"; thereafter, the remaining \"Net Cash Proceeds\" will be distributed 90% to the Limited Partners and 10% to the General Partner. The General Partner's share shall be returned to the Partnership if necessary to permit payment to the Limited Partners of any deficiency in the return of their Original Capital and their Preferential Cumulative Distribution on Adjusted Original Capital of 10% per annum.\n4. Management Agreements:\nAs of December 31, 1995, both of the properties owned by the Partnership are under management agreements with a third-party management company. These management agreements provide for annual fees ranging from 3% to 6% of gross operating receipts for the commercial property and of 5% for the residential property.\n5. Investment in Joint Venture with Affiliates:\nIn 1995, the Partnership and three affiliates (the \"Participants\") acquired title to the 45 West 45th Street Office Building. The Partnership's investment had been reclassified from loan in substantive foreclosure to an investment in joint venture with affiliates, effective January 1993, because in the General Partner's opinion the borrower had effectively surrendered control of the property. Profits and losses, all capital contributions and distributions are allocated in accordance with the Participants' original funding percentages. The Partnership's sharing percentage is 15.22%. During 1995 and 1993, the Partnership recognized losses of $376,391 and $900,000, respectively, as its share of the reduction in the carrying value of the property. These amounts are included in the Partnership's participation in (loss) income of joint venture with affiliates. In addition, during 1995 and 1993, the Partnership received distributions from the joint venture totaling $17,790 and $275,720, respectively; and made contributions of $95,901 in 1995.\n6. Tax Accounting:\nThe Partnership keeps its books in accordance with the Internal Revenue Code, rules and regulations promulgated thereunder and existing interpretations thereof. The accompanying financial statements, which are prepared in accordance with generally accepted accounting principles, will differ from the tax returns due to the different treatment of various items as specified in the Internal Revenue Code. The net effect of these accounting differences is that the net income for 1995 in the financial statements is $2,134,334 greater than the tax loss the same period.\n7. Transactions with Affiliates:\nFees and expenses paid and payable by the Partnership to affiliates are:\nYear Ended Year Ended Year Ended 12\/31\/95 12\/31\/94 12\/31\/93 -------------- -------------- -------------- Paid Payable Paid Payable Paid Payable ------ ------- ------ ------- ------ -------\nMortgage servicing fees $ 1,484 None $ 8,750 $ 729 $ 8,750 $ 729 Property management fees None None 281,422 None 234,845 16,670 Reimbursement of expenses to the General Partner, at cost: Accounting 41,297 3,023 48,642 20,809 40,999 3,391 Data processing 14,275 1,034 26,543 5,752 29,295 6,725 Investor communica- tions 7,470 None 18,961 6,461 19,128 1,582 Legal 12,945 1,493 8,311 3,497 3,978 329 Portfolio management 73,979 10,736 27,917 12,020 25,055 2,072 Other 6,121 None 11,434 5,378 11,302 935\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, however, the General Partner is reimbursed\nfor expenses. The Partnership paid premiums to the deductible insurance program of $19,410, $26,864 and $17,378 for 1995, 1994 and 1993, respectively.\nAllegiance Realty Group, Inc., an affiliate of the General Partner, managed both of the Partnership's properties until the affiliate was sold to a third party in November 1994.\n8. Rentals under Operating Leases:\nThe Partnership receives rental income from the leasing of space at the Evanston Plaza Shopping Center 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, 1995 are approximately as follows:\n1996 $1,602,000 1997 1,526,000 1998 1,392,000 1999 1,442,000 2000 1,438,000 Thereafter 7,780,000 ----------- $15,180,000 ===========\nThese rentals include amounts relating to land leases which the Partnership entered into with certain tenants of the shopping center.\nMinimum 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 were not significant during 1995, 1994 and 1993. The Partnership is subject to the usual business risks regarding the collection of the rentals.\nApproximately 24% and 17% of the space at Evanston Plaza Shopping Center is leased to Office Depot and Frank's Nursery, respectively. Of the Partnership's total rental income recognized during 1995, 30% and 21% relates to Office Depot and Frank's Nursery, respectively. Office Depot's lease runs through September 2002, while Frank's Nursery's lease runs through August 2007.\n9. Fair Values of Financial Instruments:\nAs of December 31, 1995, the carrying amounts of cash and cash equivalents, accounts and accrued interest receivable and accounts payable approximate fair value.\n10. Subsequent Event:\nIn January 1996, the Partnership paid $419,733 to Limited Partners, representing the regular quarterly distribution of available Cash Flow of $2.29 per Taxable Interest and $2.26 per Tax-exempt Interest for the fourth quarter of 1995.\nBALCOR EQUITY PENSION INVESTORS-IV A REAL ESTATE LIMITED PARTNERSHIP (An Illinois Limited Partnership)\nBALCOR EQUITY PENSION INVESTORS-IV A REAL ESTATE LIMITED PARTNERSHIP (An Illinois Limited Partnership)\nBALCOR EQUITY PENSION INVESTORS-IV A REAL ESTATE LIMITED PARTNERSHIP (An Illinois Limited Partnership)\nNOTES TO SCHEDULE III\n(a) Consists of acquisition fees, legal fees, appraisal fees, title costs and other related professional fees.\n(b) The carrying basis of the Evanston Plaza Shopping Center was reduced due to a permanent impairment in the value of the property. In addition, any payments to and receipts from the seller under a master lease agreement were treated as adjustments to the basis of the property.\n(c) The aggregate cost of land for Federal income tax purposes is $7,487,141 and the aggregate cost of buildings and improvements for Federal income tax purposes is $26,441,518. The total of these assets is $33,928,659.\n(d) Reconciliation of Real Estate -----------------------------\n1995 1994 1993 ---------- ---------- ----------\nBalance at beginning of year $31,206,941 $31,206,941 $31,206,941\n----------- ----------- ----------- Balance at end of year $31,206,941 $31,206,941 $31,206,941 =========== =========== ===========\nReconciliation of Accumulated Depreciation ------------------------------------------\n1995 1994 1993 ---------- ---------- ----------\nBalance at beginning of year $8,363,940 $7,555,891 $6,747,842\nDepreciation expense for the year 808,049 808,049 808,049 ---------- ---------- ----------\nBalance at end of year $9,171,989 $8,363,940 $7,555,891 ========== ========== ==========\n(e) Depreciation expense is computed based upon the following estimated useful lives:\nBuildings and improvements 25 to 30 years Furniture and fixtures 5 years","section_15":""}
{"filename":"887309_1995.txt","cik":"887309","year":"1995","section_1":"ITEM 1. BUSINESS\nBackground. Control Data Systems, Inc. (\"Control Data\" or the \"Company\") is a global software and services company dedicated to helping large organizations develop the enterprise-wide communications systems required to create, transmit, access, and control business information. The Company focuses on the architecture, implementation, and lifetime support of electronic commerce, product design, and product information solutions. The Company provides productivity enhancing solutions for customers in government, financial services, telecommunications, and manufacturing.\nThe Company's software and services solutions include network design, installation, and maintenance; application design and deployment, particularly for electronic commerce projects; remote and on-site systems management and outsourcing; electronic mail integration; and for the discrete manufacturing industry, product data management (\"PDM\") systems, and computer-aided design (\"CAD\") products or systems. To provide its customers with leading-edge solutions the Company invests in four major areas:\no Development of software products associated with electronic commerce integration, PDM, and CAD.\no Training and development of its technical workforce.\no Sales and marketing of its products and services.\no Capital and operational expenditures for the fulfillment of managed services contracts (outsourcing contracts).\nThe Company also has a number of suppliers and partners providing a range of hardware and software platforms, complementary products and services, and sales and marketing activities.\nThe Company was established through Ceridian Corporation's (\"Ceridian\") transfer of its Computer Products business to the Company and Ceridian's subsequent distribution in July of 1992, of the Company's stock as a dividend to Ceridian's stockholders.\nThe Company's principal offices are located at 4201 Lexington Avenue North, Arden Hills, Minnesota 55126-6198.\nIndustry Background and Business Transition\nThe excitement over the information superhighway and other manifestations of Internet activity obscure the more significant forces at work below the surface of the emerging electronic marketplace. The introduction of inexpensive, easy-to-use browser technology is helping to popularize the medium, but this technology alone is not driving this trend. Global competitive forces, combined with continued technology breakthroughs in hardware, software, and telecommunications, are stimulating entrepreneurial interest in conducting business electronically - across both private and public networks - without the traditional limitations of time and space. While the individual technologies are important, equally crucial are the skills to align process and practices through enterprise networking and applications integration.\nFrom its history in the pioneering computer environments of the 1950's, the Company has applied its network integration skills across heterogeneous computing environments. In the early 1990's, the Company completed its transition away from the manufacture of proprietary mainframe computers to that of an open systems integration company. In 1994 the Company recorded a restructuring charge and goodwill write-off of $95.0 million. The restructuring charge and goodwill write-off included expenses for reducing the worldwide employee population, consolidating operations in selected locations, and revaluing certain intangible assets associated with prior acquisitions. In 1995, Control Data took further steps to focus its business for growth in the markets for our enterprise network integration software and services with the sale of certain of its international product fulfillment operations to AmeriData Technologies, Inc. (\"AmeriData\"). For additional information regarding the divestiture to AmeriData and the restructuring charges, see notes 3 and 18 of the Notes to Consolidated Financial Statements incorporated herein by reference to the Company's Annual Report to Stockholders for the fiscal year ended December 31, 1995 and the Company's Current Report on Form 8-K, dated September 13, 1995, as amended November 10, 1995.\nProducts and Services\nThe following table sets forth revenues for the Company's major product and service offerings for the periods indicated:\nSoftware and Services\nThe dramatic shift to networked computing environments has created a growing demand for technology infrastructures that provide a foundation for electronic commerce. In response to that demand, the Company has organized its delivery of services around the design, implementation and support of three types of technology infrastructures:\no Network Infrastructures. The most basic infrastructures are transport mechanisms that enable institutions to connect desktop users with sharable computing resources. These infrastructures reflect local area networks comprised of interconnected desktop computers and task-specific servers. However, as organizations expand the scope and complexity of their electronic processes beyond the confines of localized groups, their computing environments grow more complex.\no Messaging Infrastructures. At the next level, institutions require infrastructures capable of delivering information (most often in the form of electronic messages and their related attachments) to anyone who needs it regardless of where they are located. In enterprise environments, this often means the infrastructure has to enable users to exchange messages across dissimilar electronic mail domains. Beyond this, messaging infrastructures need to keep track of who's who within a dispersed environment, as well as record the business-related attributes associated with individual mail users.\no Information Infrastructures. As institutions perform more sophisticated work tasks electronically, their underlying infrastructures will be required to: 1) understand where given information resources reside within dispersed environments, 2) help authorized users access the information to which they are entitled, and 3) enable business applications to exchange information so these resources can be leveraged as reusable corporate assets.\nThe Company provides software solutions and services that support these infrastructure needs as companies in increasing numbers begin to execute more of their basic business processes electronically.\nSoftware\nMail*Hub. As its backbone messaging product, the Company offers Mail*Hub, an E-Mail integrator that links different mail systems on the same network using industry standard X.400 messaging and X.500 directory protocols. The X.500 directory gives customers a database for address, configuration, and routing information within their organization and to similar directories worldwide.\nAs a state of the art implementation of X.500 directory technology, Mail*Hub is the Company's leading network integration software product. It is packaged with services that include network analysis, configuration, installation, training, network monitoring, maintenance, and hotline support.\nCAD\/CAM\/CAE Application Software Products. The Company offers computer- aided design, manufacturing and engineering (\"CAD\/CAM\/CAE\") software applications packages that provide simultaneous engineering, or automated merging of engineering analysis, design, drafting, and manufacturing functions. This eliminates separate data entry operations, reducing the chance of errors and shortening the time to produce a product.\nThe Company's most important CAD\/CAM\/CAE offering is its Integrated Computer-aided Engineering and Manufacturing (\"ICEM\") series of CAD\/CAM\/CAE software modules for the manufacturing industry, specifically for automotive companies and their suppliers, airplane and aerospace companies and their suppliers, and machinery companies. ICEM software packages include surface modeling, computational fluid dynamics, surface milling, and solid modeling packages.\nOn January 1, 1993, the Company purchased 45% of the equity interest in ICEM Systems GmbH (\"ICEM Systems\") owned by Volkswagen AG (\"VW\"), which gave the Company a 95% equity interest in ICEM Systems. VW retained a 5% equity interest in ICEM Systems. On January 2, 1995, the Company purchased VW's 5% equity interest, making the Company 100% owner of ICEM Systems.\nProduct Data Management Software Products. The growing volume of complex and hard-to-manage information generated by CAD\/CAM\/CAE systems in manufacturing and engineering organizations has given rise to increasing demand for PDM software.\nThe Company's PDM software product is called Metaphase 2.1. Metaphase 2.1 is a collection of software tools and modules for managing the creation, manipulation, and transmission of information throughout a manufacturing or engineering organization to enable users to identify, locate, and manipulate information residing on personal computers, workstations, servers, minicomputers, and mainframes in a complex, heterogeneous system. As with the ICEM product line, Metaphase 2.1 emphasizes reducing the customer's development cycle by enabling different types of users, from designers to manufacturing experts, to share information and data.\nThe development activities for the Company's PDM product are conducted by Metaphase Technology, Inc. (\"Metaphase\"), an unconsolidated joint venture formed in August 1992 between the Company and Structural Dynamics Research Corporation (\"SDRC\"), in which each party holds a 50% ownership position. The Company offers the Metaphase software product in conjunction with its own professional services personnel to design, implement, and support PDM solutions.\nAdditionally, the Company resells software products from a wide range of third party standards-based suppliers, including Oracle, Informix, Sybase, OpenVision, 3Com, Wellfleet, Banyan, Novell, and Wingra.\nServices\nThe Company has a heritage of managing large programs requiring complex systems integration. Previously such projects centered on use of the Company's proprietary products. In the networked systems environment, the Company is increasingly involved in systems integration activities that require a diverse set of products and services procured from many suppliers. Integral to this business are the many professional services analysts whose knowledge and skills are required to assist in systems design and implementation.\nThe Company's integration services are designed to assist customers in the selection and creation of computer systems tailored to solve business- specific information management and networking problems or to automate system activities. In creating these customized systems, the Company incorporates selected hardware and software products it has developed or obtained from its suppliers.\nThe Company emphasizes the development of customized systems solutions using off-the-shelf open systems products. Focus is given on assisting customers with the information management problems caused by the proliferation of personal computers, workstations, servers, and other computers throughout an organization.\nClient\/Server Services. For customers that are downsizing or reengineering their computing systems through the application of client- server technology, the Company offers the following specialized services:\no Program management, design\/development of user interfaces, database design, solution connectivity, system administration, and the implementation of application functionality.\no Evaluation and implementation of operating environments required by the customer's application software. The Company offers experience in both enhanced and conventional versions of UNIX, desktop systems (MS-DOS, Microsoft Windows, and Windows NT), and high performance I\/O extensions.\no Evaluation and implementation of the most appropriate, cost effective computer hardware and software for a customer's client\/server environment. The Company offers a range of open systems platforms based on its marketing relationships with leading industry platform and peripheral suppliers, including Sun Microsystems, Inc. (\"Sun\"), Hewlett- Packard Company (\"Hewlett-Packard\"), and Silicon Graphics, Inc. (\"SGI\").\nNetworking Solutions. As computer users take advantage of downsized computer platforms, decentralized organizational processes, and open systems technology, their computing environment's basic networking structure must also be evaluated in terms of its capabilities, performance, and cost. When these changes take place, users often need to find new solutions for interconnecting dissimilar computer systems, finding cost- effective ways to manage complex networks on a daily basis, and improving the productivity of their business processes. The Company's networking experts provide solutions in the following areas:\no E-Mail Integration. The Company's Mail*Hub product allows disparate E- Mail systems from mainframes, PC's and workstation\/servers to communicate in a transparent manner.\no Directory Synchronization. The Company's X.500 technology enables the consolidation of e-mail directories and other basic organizational information in a central, updatable corporate repository.\no Security Services. The Company provides network analysis, penetration testing, security system design, and implementation.\no EDI Solutions. Standards based electronic data interchange (EDI) capabilities, enabling organizations to expedite their daily business processes.\no Network Integration Services. Requirements analysis, configuration design, installation, performance assessment, and ongoing maintenance.\no Enterprise Management Center. Remote management, monitoring, and troubleshooting support for computer networks and systems, worldwide, 24 hours a day, 7 days a week.\no Help Desk Hotline. Provides answers to questions on operating systems, networks, applications, and general computing problems. Engineers are trained to solve problems by phone or via dispatched on-site support.\nManaged Services. In 1995, the Company introduced a full range of managed network services, including a messaging and information exchange service it offered in conjunction with Sprint Corporation.\no Enterprise Networking. Remote monitoring and management of wide-area network hardware and software solutions that integrate local-area resources into enterprise networks.\no Sprint InfoXchange Enterprise\/Intercompany Messaging. Commercial service that offers business-ready features to clients that require enterprise and intercompany messaging, global directory services, and electronic commerce capabilities. Sprint markets the service, and provides the network connections required by clients. The Company provides the mail integration technology, integration expertise, and operations support.\no Enterprise Information Management. Administration, daily operation, maintenance, and support of client\/server solutions required to integrate locally managed data bases and other information resources into enterprise solutions.\nThe Company's integration services are carried out primarily by its professional services staff, which includes over 500 systems analysts serving customers worldwide from regional centers in the United States, Europe, and Asia. To meet the unique needs or preferences of customers in specific geographic markets, the Company selects the most suitable and cost effective hardware platforms currently available from marketing partners and third-party networking products, industry standard applications, and other local products such as microcomputers and terminals.\nRevenues from software and services were $174.1 million in 1995, $154.3 million in 1994, $140.3 million in 1993, representing 38.3%, 29.4%, and 31.1%, respectively of the Company's total revenues.\nMaintenance and Support\nThe Company provides hardware and software maintenance service for both CYBER and open systems products through engineers located throughout the United States and in many foreign countries. A central support organization provides technical planning and support, including a worldwide logistics operation for spare parts, a 24-hour hotline and an on-line diagnostic system accessible through CYBER mainframes.\nMaintenance and support revenues were $75.4 million in 1995, $92.8 million in 1994, and $113.8 million in 1993, representing 16.6%, 17.7%, and 25.2%, respectively of the Company's total revenues.\nHardware Products\nThe Company is differentiated from other integrators because it is not captive to a particular product set or technology. This objectivity allows it to work in a multivendor environment without bias. Beginning with its relationship with SGI in 1989, the Company began integrating UNIX based open system products into its customer solutions. Systems based on UNIX and Intel\/Microsoft technologies can support the industry's migration from centralized computing, which was dependent on mainframes, to a networked and distributed client-server environment, in which application processing and data are spread across many networked computing resources.\nTo expand the range of platform options available to its customers, in 1993 the Company signed remarketing agreements with Sun and Hewlett- Packard. As a Sun integrator, the Company remarkets Sun's complete line of workstations, servers, and software worldwide as a part of the Company's systems integration solutions for the commercial marketplace, particularly in the financial services, healthcare, telecommunications, and manufacturing markets. As a Hewlett-Packard integrator, the Company remarkets HP Apollo 9000 Series 700 workstations and HP 9000 Series 800 business server hardware and software, integrating the equipment and applications into solutions for customers in the aerospace, automotive, manufacturing, government, and commercial markets.\nRevenues from the sale and lease of hardware products were $205.3 million in 1995, $277.1 million in 1994, and $197.7 million in 1993, representing 45.1%, 52.9%, and 43.8%, respectively, of the Company's total revenues.\nSales\nWorldwide Business\nThe Company markets its products and services principally through its direct sales force located in the United States and 12 other countries. The Company's major international operations are in France, Germany, Korea, China, Taiwan, and the United Kingdom. In 1995, the Company sold seven of its international product distribution operations in Austria, Canada, Greece, Mexico, Norway, Portugal, and the United Kingdom to AmeriData.\nThe Company also markets its products and services through subsidiaries and distributors located in countries representing smaller markets. The Company believes that one of its strengths is its long-standing presence and name recognition in various foreign countries.\nRevenues from the Company's non-U.S. operations were approximately 69.2%, 71.5%, and 65.2%, of the Company's total revenues in 1995, 1994, and 1993, respectively. For further information regarding the Company's U.S. and international operations, see note 17 of the Notes to Consolidated Financial Statements incorporated herein by reference to the Company's Annual Report to Stockholders for the fiscal year ended December 31, 1995.\nThe Company's sales and support operations are organized into three regions (Americas, Europe, and Asia), each with its own marketing, sales and sales support professionals providing consulting and engineering services. Centralized technology support services are provided to the sales regions from the Company headquarters in Arden Hills, Minnesota. These resources are available to assist field organizations in understanding technology trends, formulate technology strategies, and provide pre-sales consulting and post-sales implementation expertise. The Company also provides essential system integration services including customer hot-line support, program\/project management, customized training systems, engineering analysis, and custom software development.\nCustomers\nThe Company's products and services are used in a wide variety of applications for customers in government, financial services, telecommunications, and manufacturing. The Company believes that its worldwide sales and support organization enables it to better understand the markets in which it competes, to focus its sales efforts effectively, and to develop long-term relationships with its customers.\nThe U.S. Government was the only customer of the Company accounting for more than 10% of total revenues in fiscal year 1995, 1994, or 1993. The Company estimates that contracts with the U.S. government represented approximately 13.6%, 12.0%, and 13.7% of total revenue in fiscal years 1995, 1994, and 1993, respectively. Generally, the Company's contracts with the U.S. Government contain provisions to the effect that they may be terminated at the convenience of the customer, and that in the event of such termination, the Company would be entitled to receive payment based on the cost incurred and the anticipated profit on the work completed prior to termination.\nResearch and Development\nThe Company's research and development efforts are primarily oriented toward electronic commerce, CAD\/CAM\/CAE products, PDM, and client\/server solutions. In 1994 the Company formed a new Electronic Commerce business unit dedicated to the development of products and services related to messaging and information infrastructures. Its flagship product in this arena is Mail*Hub, a UNIX-based integration toolkit that links disparate E- mail systems. Research and development efforts directed toward enhancing the Company's ICEM application software product line occur through the Company's ICEM Technologies division. Research and development activities for the Company's PDM software product have been transferred to Metaphase. Company-sponsored research and development expenses related to new products or services and the improvement of existing products totaled $9.7 million, $10.1 million, and $23.8 million, for 1995, 1994, and 1993, respectively.\nThe decrease in research and development expenses primarily relates to the Company's continuing business transition. This transition has enabled the Company to significantly reduce its research and development spending by acquiring and integrating products provided by other vendors and by pursuing customer funding for custom developed solutions.\nCompetition\nThe market for the Company's products and services is highly competitive and is characterized by rapid technological advances in both hardware and software development. These advances result in shorter product life cycles and enhanced product capabilities, typically at significantly better price and performance levels. At the same time, these advances have also created increased demand for the skills of knowledgeable systems integrators who can help customers make the best use of the available technology.\nCompetition in the systems integration market is intense and is based on a variety of factors including customer satisfaction, reputation, price, performance, product quality, software availability, connectivity, networking, compatibility with industry standards, marketing and distribution capability, customer support, name recognition, and financial strength. The Company competes throughout the world with numerous local, regional, national, and international systems integrators. Several of the Company's competitors have significantly greater financial and operational resources than the Company.\nBacklog\nThe backlog of the Company's orders believed to be firm is estimated to have been approximately $23 million as of December 31, 1995, most of which is expected to be reflected in revenues during 1996. At December 31, 1994, the backlog was approximately $76 million. These backlog amounts include the minimum noncancelable future lease revenue expected from contracts existing at those dates, which amounted to $3.0 million for 1995 and $14.7 million for 1994. The decrease in the 1995 backlog from 1994 is primarily due to the operations sold to AmeriData.\nNo backlog amount is determinable for a large portion of the Company's revenues, particularly for maintenance and other services, and the average time from order to installation of hardware products is shortening. In addition, customers may elect to accelerate or delay the delivery of products, and delivery of large orders may be spread over a period of time and may be subject to modification from time to time. Consequently, the Company believes that backlog information does not necessarily provide a meaningful indication of its future business volume.\nEnvironmental Matters\nIn connection with the Company's spin-off from Ceridian, Ceridian agreed to retain responsibility for and indemnify the Company against environmental liabilities relating to: 1) facilities formerly operated by the Computer Products business, 2) third-party disposal or treatment sites as to which Ceridian has been or is in the future identified as a potentially responsible party because of past operations of the Computer Products business at its former facilities, and 3) certain other known environmental matters related to past operations of the Computer Products business. These facilities and sites constitute all matters which, at the present time, are known to present potential environmental liabilities related to the operation of the Computer Products business. The Company has generally agreed to indemnify Ceridian against future environmental claims that relate to current and future facilities and operations of the Company.\nCompliance by the Company with federal, state, and local environmental protection laws during 1995 had no material effect upon capital expenditures, earnings or competitive position, and is expected to have none in the foreseeable future.\nPatents\nThe Company owns or is licensed under a number of patents which relate to some of its products. The Company believes that its business as a whole is not materially dependent upon any particular patent or license, or any particular group of patents or licenses. Instead, the Company believes that its success and growth are more dependent, among other things, on the quality of its services and products and its reputation with its customers.\nEmployees\nAs of December 31, 1995, the Company had approximately 1,800 full-time employees.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's corporate headquarters and U.S. field operations headquarters are located in Arden Hills, Minnesota. Facilities located elsewhere are primarily sales and service locations, and include significant office facilities in Atlanta, Georgia; Sunnyvale and Anaheim, California; Rockville, Maryland; Frankfurt, Germany; Copenhagen, Denmark; London, England; Paris, France; Delft, Netherlands; and Taipei, Taiwan.\nThe following table summarizes the usage and location of the Company's facilities as of January 1, 1996.\nNo facilities owned by the Company are subject to any major encumbrances. The Company believes that all of the facilities currently utilized in its ongoing business operations meet their intended purposes and are adequately maintained. As a result of the Company's continuing business transition, leased property decreased during fiscal 1995 by approximately 500,000 square feet, a reduction of 31.5%. The number of facilities also decreased from 140 at the end of 1994 to 90 at year end 1995, a net decrease of 50 locations. This substantial reduction was primarily attributable to the consolidation of locations in the U.S. field operations and the sale of certain international operations to AmeriData. Restructuring charges recorded in fiscal year ended December 31, 1994, included provisions of approximately $9.7 million for lease and other obligations related to excess facilities.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThere are no legal proceedings pending against or involving the Company which, in the opinion of management, will have a material adverse effect upon its consolidated financial position or results of operations.\nIn connection with the Company's spin-off from Ceridian, the Company has agreed to assume responsibility for, and indemnify Ceridian Corporation against, liability in connection with judicial and administrative claims and proceedings relating to the Computer Products business prior to August 1, 1992. It is anticipated that final disposition of some of these claims and proceedings may not occur for several years. Although occasional adverse decisions (or settlements) may occur, management believes that the final disposition of such 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 the Company's stockholders during the quarter ended December 31, 1995.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe executive officers of the Company are as follows:\nExecutive officers of the Company are elected by the Board of Directors and serve at the Board's discretion. There are no family relationships among any directors or executive officers of the Company.\nJames E. Ousley has been President and Chief Executive Officer of Control Data since August 1992. Mr. Ousley was President of Ceridian's Computer Products business from April 1989 to July 1992; Executive Vice President of Ceridian from February 1990 to July 31, 1992; Vice President, Marketing and Sales for Computer Products business from January 1989 to April 1989.\nJoseph F. Killoran has been Vice President and Chief Financial Officer of Control Data since February 1994. Mr. Killoran was Vice President and Controller of Control Data from August 1992 to January 1994; Vice President and Controller for Ceridian's Computer Products business from 1989 to July 31, 1992.\nRuth A. Rich has been Vice President, Human Resources and Administration of Control Data since August 1992. Ms. Rich was Vice President, Human Resources and Administration for Ceridian's Computer Products business from November 1990 to July 1992; and Vice President, Human Resources and Administration for Ceridian's Information Services Group from May 1986 to November 1990.\nDieter Porzel has been Vice President, Europe\/Middle East\/Africa Region of Control Data since February 1993. Mr. Porzel was Vice President, Central Europe Region for Control Data from August 1992 to January 1993; and Vice President, Central Europe Region of Ceridian's Computer Products business from 1987 to 1992.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\n\"Price Range of Common Stock,\" appearing on page 31 of the Company's 1995 Annual Report to Stockholders, is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\n\"Selected Consolidated Financial Data,\" appearing on inside cover page of the Company's 1995 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 OPERATION\n\"Management's Discussion and Analysis of Financial Condition and Results of Operations,\" appearing on pages 9 through 13 of the Company's 1995 Annual Report to Stockholders, is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe consolidated balance sheets of the Company and its subsidiaries as of December 31, 1995 and 1994, the related consolidated statements of operations, stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 1995, and the notes to consolidated financial statements, together with report therein of KPMG Peat Marwick LLP dated January 25, 1996, appearing on pages 8 through 31 of the Company's 1995 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\nIDENTIFICATION OF DIRECTORS\n\"Election of Directors\" in the Company's Proxy Statement for the 1996 Annual Meeting of Stockholders to be held on May 15, 1996 (hereinafter the \"Proxy Statement\") is incorporated herein by reference.\nIDENTIFICATION OF EXECUTIVE OFFICERS\nInformation regarding executive officers of the Company is contained in Part I of this Report on page 12 and is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\n\"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\n\"Stockholdings of Certain Owners and Management\" in the Proxy Statement is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\n\"Election of Directors-Certain Business Transactions\" in the Proxy Statement is incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\nFinancial Statements\nIncorporated by reference into Part II, Item 8 of this report.\nFinancial Statement Schedules\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.\nReports on Form 8-K\nA Form 8-K\/A No. 1 dated November 10, 1995, amending Form 8-K \"Date of Report: August 31, 1995\" was filed in the Registrant's fiscal quarter ended December 31, 1995 to (i) amend Item 2, Acquisition or Disposition of Assets, relating to the disposition of certain operations of the Registrant and (ii) file the following pro forma financial information under Item 7(b):\n1. Pro Forma Combined Statement of Operations for the 6 months ended June 30, 1995\n2. Pro Forma Combined Statement of Operations for the year ended December 31, 1994\n3. Pro Forma Combined Balance Sheet at June 30, 1995\nExhibits\n(Schedules to the foregoing exhibits have not been included but will be submitted supplementary to the Commission upon request)\n* - Incorporated by reference to other filing.\n(1) - Form 8 and Form 10 refer, respectively, to the Registrant's Form 8 Amendment No. 1 dated July 10, 1992 (the \"Form 8\") to its Registration Statement on Form 10 dated May 27, 1992 and declared effective July 16, 1992 (the \"Form 10\").\n(2) - Indicates a management contract or compensatory plan or arrangement required to be filed as an exhibit to Form 10-K.\n(Schedules to the foregoing exhibits have not been included but will be submitted supplementary to the Commission upon request)\n* - Incorporated by reference to other filing.\n(1) - Form 8 and Form 10 refer, respectively, to the Registrant's Form 8 Amendment No. 1 dated July 10, 1992 (the \"Form 8\") to its Registration Statement on Form 10 dated May 27, 1992 and declared effective July 16, 1992 (the \"Form 10\").\n(2) - Indicates a management contract or compensatory plan or arrangement required to be filed as an exhibit to Form 10-K.\nINDEPENDENT AUDITORS' REPORT ON FINANCIAL STATEMENT SCHEDULE\nThe Board of Directors and Stockholders of Control Data Systems, Inc.:\nUnder date of January 25, 1996, we reported on the consolidated balance sheets of Control Data Systems, Inc. and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 1995, as contained in the 1995 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 1995. In connection with our audits of the aforementioned consolidated financial statements, we also have audited the related financial statement schedule as listed in the accompanying index. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statement schedule based on our audits.\nIn our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.\n\/s\/ KPMG Peat Marwick LLP\nMinneapolis, Minnesota January 25, 1996\nSchedule VIII\nCONTROL DATA SYSTEMS, INC. Valuation and Qualifying Accounts\nAllowance for Doubtful 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.\nCONTROL DATA SYSTEMS, INC.\nBy: \/s\/ JAMES E. OUSLEY James E. Ousley President and Chief Executive Officer\nDated: March 22, 1996\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears above or below constitutes and appoints James E. Ousley and Joseph F. Killoran, or either of them, his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments to this Report, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, 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 attorneys-in-fact and agents, or their substitutes, may lawfully do or cause to be done by virtue hereof.\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nCONTROL DATA SYSTEMS, INC. EXHIBIT INDEX\n(Schedules to the foregoing exhibits have not been included but will be submitted supplementary to the Commission upon request)\n* - Incorporated by reference to other filing.\n(1) - Form 8 and Form 10 refer, respectively, to the Registrant's Form 8 Amendment No. 1 dated July 10, 1992 (the \"Form 8\") to its Registration Statement on Form 10 dated May 27, 1992 and declared effective July 16, 1992 (the \"Form 10\").\n(2) - Indicates a management contract or compensatory plan or arrangement required to be filed as an exhibit to Form 10-K.","section_15":""}
{"filename":"716822_1995.txt","cik":"716822","year":"1995","section_1":"Item 1. BUSINESS\nGeneral\nBoettcher Western Properties III Ltd. (the \"Partnership\") was organized in March 1983 as a Colorado limited partnership. The Partnership's primary business is to own and operate income-producing properties. At September 30, 1995, the Partnership owned and operated one multifamily apartment property located in Texas (\"La Risa Apartments\") and one shopping center located in California (\"Venetian Square Shopping Center\"), both of which are being held for sale (the \"Properties\"). The Properties are more fully described in Item 2","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nAt September 30, 1995, the Partnership owned and operated one multifamily apartment property and one shopping center, both of which are being held for sale, as more fully described below:\nName and Location General Character of Property\nLa Risa Apartments 33-building, 254-unit multifamily apartment property 800 Babock Road containing approximately 183,896 square feet of net San Antonio, Texas rentable area on approximately 9.7 acres of land.\nVenetian Square Shopping Center 3-building shopping center containing 4555 North Pershing Avenue approximately 117,107 square feet of net rentable Stockton, California area on approximately 9.2 acres of land.\nAs stated above, at September 30, 1995, the Partnership has classified both of the Properties as properties held for sale.\nFor information regarding the indebtedness to which each of the Properties is subject, see Notes 3 and 6 to the Financial Statements as contained in Item 8 of this report.\nOn June 6, 1994, the Partnership sold the land, related improvements and personal property of Los Compadres, La Paz and Maryland Villa Apartments (the \"Arizona Properties\") as described in more detail in Management's Discussion and Analysis of Financial Condition and Results of Operations as contained in Item 7 of this report and Note 2 to the Financial Statements as contained in Item 8 of this report.\nOn September 9, 1994, a foreclosure sale was held regarding the SouthCenter Plaza Shopping Center (\"SouthCenter Plaza\"), resulting in the loss of the Partnership's investment in SouthCenter Plaza, as more fully discussed in Note 2 to the Financial Statements as contained in Item 8 of this report.\nAverage and weighted average occupancies and weighted average effective rental rates generated by the Properties in fiscal 1995, 1994, and 1993 were as follows:\n(1) These rates are \"triple net\". In addition to this base rent, tenants pay their pro rata share of taxes, insurance and common area maintenance expenses at the property.\n(2) These rates are \"full service\". In addition to this base rent, tenants pay only their pro rata share of taxes, insurance and common area maintenance expenses at the property in excess of the expenses incurred at the property during the tenant's initial year of occupancy.\n(3) These computations give effect to the sale of the Arizona Properties on June 6, 1994.\n(4) Averages computed through date of foreclosure.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nThe Partnership is not a party to, nor are the Properties the subject of, any material pending legal proceedings.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF HOLDERS OF LIMITED PARTNERSHIP INTERESTS\nThere have been no matters submitted to a vote of holders of Limited Partnership Interests (the \"Units\") during the fiscal year which is covered by this report.\nPART II\nItem 5.","section_5":"Item 5. MARKET FOR THE REGISTRANT'S LIMITED PARTNERSHIP INTERESTS AND RELATED LIMITED PARTNER MATTERS\nAt September 30, 1995, 22,000 Units were outstanding and held by 2,220 limited partners.\nThe Units have limited transferability. There is no public market for the Units and it is not expected that any will develop. There are significant restrictions relating to the transferability of Units, including the requirement that the Managing General Partner consent to any transfer and to any transferee becoming a substituted limited partner, which consent may be granted or withheld at the sole discretion of the Managing General Partner. In addition, restrictions on transfers may be imposed by federal and state securities laws.\nOn June 22, 1994, a distribution of $2,750,000 ($125\/Unit) was made to limited partners from the net proceeds of the sale of the Arizona Properties. The Managing General Partner intends to apply cash flow generated from Partnership operations in fiscal 1996, if any, to maintain the Partnership's minimum required cash reserves, as necessary, including any additional reserves to cover potential remediation costs. Thereafter, the Partnership intends to pay amounts owed to the Managing General Partner and make distributions to the limited partners.\nThe Managing General Partner is attempting to sell the Partnership's remaining real estate investments in fiscal 1996. However, there can be no assurances that the Partnership will sell the Properties in 1996. The Managing General Partner believes that these sales will provide net proceeds to the Partnership after the payment of sales costs, closing costs and mortgages payable; however, the sales transactions may include both cash at closing and deferred payments to the Partnership. The ability of the Partnership to sell Venetian Square Shopping Center may be adversely affected by the potential remediation costs of the petroleum contamination at the property. The Partnership intends to apply net sales proceeds to establish and maintain the minimum required cash reserves, as necessary, including any additional reserves to cover potential remediation costs. Thereafter, the Partnership intends to pay amounts owed to the Managing General Partner and to make distributions to limited partners.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA\nBOETTCHER WESTERN PROPERTIES III LTD. SELECTED FINANCIAL DATA(a)\nAs of or For the Year Ended September 30,\n(a) The above selected financial data should be read in conjunction with the Financial Statements and related Notes as contained in Item 8 of this report.\n(b) Per Unit data is based upon the 22,000 weighted average Units outstanding during each fiscal year.\n(c) The Partnership is evaluating the remediation of petroleum contaminated soil and groundwater on a parcel of land adjacent to and part of the Venetian Square Shopping Center. The contamination resulted from a leaking underground storage tank which was part of a card-lock fueling station operated at Venetian Square Shopping Center from 1979 through 1990. The Partnership has spent approximately $405,000 to date in evaluating the remediation program. Amounts expended were primarily for the evaluation of the contamination in order to determine the method, cost and timing of required soil and groundwater remediation measures to be implemented in the future. Management is unable at this time to estimate the amount of additional remediation expense that may be incurred. Due to groundwater contamination, the Partnership may incur significant additional remediation costs. Accordingly, the Financial Statements contained in Item 8 of this report do not include any adjustments that reflect the results of the ultimate resolution of this uncertainty. For additional information, refer to Note 7 to the Financial Statements contained in Item 8 of this report.\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nResults of Operations 1995 as compared to 1994:\nSeptember 30, 1995 marked the close of the Partnership's twelfth year of operations. The Partnership continues to own and operate one multifamily apartment property located in Texas (La Risa Apartments) and one shopping center located in California (Venetian Square Shopping Center), both of which are being held for sale as of September 30, 1995.\nFor the fiscal year ended September 30, 1995, the Partnership generated total revenue of $2,508,536, and incurred total expenses of $2,655,431, resulting in an operating loss of $146,895. The Partnership's fiscal 1995 operating loss decreased $345,422 (70%) when compared with fiscal 1994. Due to the gain on sale of Los Compadres, La Paz and Maryland Villa Apartments (the \"Arizona Properties\"), the Partnership generated net earnings of $949,570 in fiscal 1994. Total revenue decreased, primarily rental and other income, and total expenses decreased in all categories, primarily due to the sale of the Arizona Properties. A summary of the Partnership's operations and period-to-period comparisons is presented below.\nWhen making period-to-period comparisons, the exclusion of the Arizona Properties and SouthCenter Plaza's operations from the prior fiscal year's results allows for a more meaningful analysis of the operations of the Partnership's remaining investments. For comparison purposes only, the Arizona Properties and SouthCenter Plaza's results of operations have been excluded from fiscal 1994 results of operations in the table below.\nBased upon the actual and pro forma amounts presented above, total revenue generated by the Partnership, excluding the Arizona Properties and SouthCenter Plaza, amounted to $2,508,536 in fiscal 1995, representing an increase of $15,761 (1%) compared with fiscal 1994. The Partnership's properties generated rental income of $2,145,948 in fiscal 1995, which represents a decrease of $8,055 when compared with fiscal 1994. La Risa Apartments achieved a weighted average occupancy of 94% and a weighted average effective rental rate per unit per month of $436, representing a decrease of 2% and an increase of $11, respectively, when compared with fiscal 1994. Rental income from Venetian Square Shopping Center decreased $37,803 (4%) in fiscal 1995 when compared with fiscal 1994. At Venetian Square Shopping Center, average occupancy decreased 4% in fiscal 1995 and the average effective rental rate decreased $.03 when compared with fiscal 1994. For additional information on the average occupancies and average effective rental rates for the Partnership's Properties, refer to the table provided in Item 2 as contained in this report. Other income increased $19,220 (27%) in fiscal 1995 when compared with fiscal 1994, primarily the result of increased interest earned by the\nPartnership.\nBased upon the actual and pro forma amounts provided above, total expenses, incurred by the Partnership amounted to $2,655,431 in fiscal 1995, a decrease of $158,270 (6%) when compared with fiscal 1994. The largest component of this decrease is the $113,308 (38%) decrease in fees and reimbursements to the managing general partner in fiscal 1995 when compared with fiscal 1994. This decrease is primarily the result of the elimination of the accrual of deferred acquisition fees related to the Arizona Properties in June, 1994. Property tax expense decreased $15,296 (6%) in fiscal 1995 when compared to fiscal 1994, primarily due to lower taxes assessed in 1995 on La Risa Apartments. Repairs and maintenance expense decreased $21,003 (7%) in fiscal 1995 when compared to fiscal 1994 mainly due to roof and parking lot repairs completed at Venetian Square Shopping Center in fiscal 1994. Environmental expense was $72,136 for fiscal 1995, an increase of $24,405 (51%) over fiscal 1994, representing costs associated with the continued evaluation of the soil and groundwater remediation at Venetian Square Shopping Center.\n1994 as compared to 1993:\nFor the fiscal year ended September 30, 1994, the Partnership generated total revenue of $4,521,349, and incurred total expenses of $5,013,666, resulting in an operating loss of $492,317. The Partnership's fiscal 1994 operating loss decreased $899,420 (65%) when compared with fiscal 1993. A gain on the sale of Arizona Properties, in the amount of $1,441,887, was recorded in the third quarter of fiscal 1994 as more fully discussed in Note 2 to the Financial Statements as contained in Item 8","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe following Financial Statements of the Partnership are included herein:\nIndependent Auditors' Report 17\nBalance Sheets - September 30, 1995 and 1994 18\nStatements of Operations - Years ended September 30, 1995, 1994 and 1993 19\nStatements of Partners' Capital (Deficit) - Years ended September 30, 1995, 1994 and 1993 20\nStatements of Cash Flows - Years ended September 30, 1995, 1994 and 1993 21\nNotes to Financial Statements 23\nINDEPENDENT AUDITORS' REPORT\nTHE PARTNERS BOETTCHER WESTERN PROPERTIES III LTD.:\nWe have audited the accompanying balance sheets of Boettcher Western Properties III Ltd. (a limited partnership) as of September 30, 1995 and 1994, and the related statements of operations, partners' capital (deficit), and cash flows for each of the years in the three-year period ended September 30, 1995. 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 Boettcher Western Properties III Ltd. as of September 30, 1995 and 1994, and the results of its operations and its cash flows for each of the years in the three-year period ended September 30, 1995, in conformity with generally accepted accounting principles.\nAs discussed more fully in Note 7 to the financial statements, management of the Partnership has determined that one of the Partnership's real estate properties has environmental contamination. Management is evaluating the extent of such contamination and the remediation of the property and has accrued certain remediation costs. However, management is currently unable to determine the full extent of the remediation measures and the related total cost. Accordingly, the financial statements do not include any additional adjustments, if any, relating to the ultimate outcome of this uncertainty.\nKPMG PEAT MARWICK LLP\nDenver, Colorado November 22, 1995\nBOETTCHER WESTERN PROPERTIES III LTD. (A Limited Partnership)\nBalance Sheets\nSeptember 30, 1995 and 1994\nSee accompanying notes to financial statements.\nBOETTCHER WESTERN PROPERTIES III LTD. (A Limited Partnership) Statements of Operations Years Ended September 30, 1995, 1994 and 1993\nSee accompanying notes to financial statements.\nBOETTCHER WESTERN PROPERTIES III LTD. (A Limited Partnership)\nStatements of Partners' Capital (Deficit)\nYears Ended September 30, 1995, 1994 and 1993\nSee accompanying notes to financial statements.\nBOETTCHER WESTERN PROPERTIES III LTD. (A Limited Partnership)\nStatements of Cash Flows\nYears Ended September 30, 1995, 1994 and 1993\n(continued)\nBOETTCHER WESTERN PROPERTIES III LTD. (A Limited Partnership)\nStatements of Cash Flows\nYears Ended September 30, 1995, 1994 and 1993\nSee accompanying notes to financial statements.\nBOETTCHER WESTERN PROPERTIES III LTD. (A Limited Partnership)\nNotes to Financial Statements\nSeptember 30, 1995, 1994 and 1993\n(1) Significant Accounting Principles\nOrganization and Allocation of Income and Losses Boettcher Western Properties III Ltd. (the Partnership) is a limited partnership formed on March 18, 1983 for the purpose of investing in improved and unimproved real property. Limited Partnership Interests (Units) were sold through a public offering and currently 22,000 Units at $1,000 per Unit are outstanding.\nThe managing general partner of the Partnership is Boettcher Properties, Ltd. (BPL), and the associate general partner is Boettcher 1983 Associates, Ltd.\nThe Partnership Agreement provides for the net operating income of the Partnership to be allocated as follows: (i) to the limited partners to the extent necessary to satisfy the 8% Current Distribution Preference, as defined (an amount equal to 8% of the daily average aggregate adjusted capital contributions of the limited partners) and (ii) 1% of the remainder to the General Partners and 99% to the limited partners. Net operating losses are allocated 1% to the General Partners and 99% to the limited partners.\nThe Partnership Agreement provides for net capital income from the sale or other disposition of Partnership properties to be allocated on a cumulative basis as follows: (i) 1% to the General Partner and 99% to the limited partners to the extent of depreciation deductions taken from the inception of the Partnership, (ii) to the limited partners to the extent necessary to satisfy the Net Proceeds Distribution Preference, as defined (an amount equal to the sum of limited partner capital contributions not yet returned and any unsatisfied 8% current Distribution Preference from prior periods) and (iii) 25% of the remainder to the General Partners and 75% to the limited partners. Net capital loss is allocated 1% to the General Partners and 99% to the limited partners.\nDeferred Leasing Costs Costs associated with the leasing of the Partnership's shopping center and office building are deferred and amortized over the life of the related leases. These costs are comprised of lease commissions and construction costs related to the buildout of tenant space.\nIncome Taxes No provision has been made for federal income taxes, as the taxable income (loss) is reported by the partners rather than the Partnership. The Partnership reports certain transactions differently for tax and financial statement purposes, primarily depreciation and debt discount.\nBOETTCHER WESTERN PROPERTIES III LTD. (A Limited Partnership)\nNotes to Financial Statements\nSeptember 30, 1995, 1994 and 1993\nA reconciliation of net earnings (loss) per the accompanying financial statements and Partnership's tax return is shown in the table below. Results of operations for the year ended September 30, 1995 as shown in the financial statements is actual. However, the Partnership's tax return for December 31, 1995 has not been prepared; therefore, the reconciling items for 1995 are estimates by management.\nReal Estate Investments Properties held for sale are recorded at the lower of cost or fair market value based upon independent appraised values.\nBuildings and improvements are depreciated using the straight-line method over an estimated useful life of 30 years. Equipment and furnishings are depreciated using the straight-line method over an estimated useful life of 5 years. Renewals and betterments are capitalized, and repairs and maintenance are charged to operations as incurred.\nBOETTCHER WESTERN PROPERTIES III LTD. (A Limited Partnership)\nNotes to Financial Statements\nSeptember 30, 1995, 1994 and 1993\n(1) Continued\nCash and Cash Equivalents For purposes of the Statement of Cash Flows, cash and cash equivalents include highly liquid debt instruments purchased with an original maturity of three months or less. Cash and cash equivalents are comprised of the following as of September 30:\nDebt Issuance Costs and Debt Discount Costs incurred in arranging financing, such as loan origination fees, commitment fees and extension fees, are deferred and amortized using the level-interest-yield method over the term of the related debt or the extension period.\nDebt discount is amortized to interest expense using the level-interest-yield method over the term of the related debt.\nReclassification\nCertain prior year amounts have been reclassified to conform with fiscal 1995 financial statement presentation.\n(2) Real Estate Investments\nMortgages assumed in connection with the acquisition of the Partnership's properties were discounted using an equivalent market rate of interest as of the date of acquisition. For financial statement purposes, the resulting discount is deducted from the original cost basis of the related real estate investment property, thereby resulting in a reduction of depreciation expense over the life of the assets.\nAs of September 30, 1995, the market value of the Partnership's properties held for sale exceeds cost, based upon independent appraised values or preliminary offers to purchase the properties.\nBOETTCHER WESTERN PROPERTIES III LTD. (A Limited Partnership)\nNotes to Financial Statements\nSeptember 30, 1995, 1994 and 1993\n(2) Continued\nThe cost of the Partnership's real estate investments and related accumulated depreciation, debt discount and allowance for loss are as follows:\nSeptember 30, 1995\nDisposition of Real Estate Investments\nSale of Arizona Properties On June 6, 1994, the Partnership sold the land, related improvements and personal property of Los Compadres, La Paz and Maryland Villa apartments (the Arizona Properties) for cash. The net proceeds to the Partnership, before proration of operating income and expenses related to the Arizona Properties, were as follows:\nBOETTCHER WESTERN PROPERTIES III LTD. (A Limited Partnership)\nNotes to Financial Statements\nSeptember 30, 1995, 1994 and 1993\nSouthCenter Plaza\nOn May 6, 1994, the Superior Court of Washington for King County issued an order granting the foreclosure of the mortgage secured by the SouthCenter Plaza property. A foreclosure sale was held on September 9, 1994, and the first mortgagor was the only bidder at the sale and became the owner of the property subject to a one-year redemption period. The sale resulted in the loss of the Partnership's investment in SouthCenter Plaza. The Partnership recorded a provision for loss on operating property in fiscal 1993 equal to the excess of the net book value of SouthCenter Plaza over the related mortgage payable as of September 30, 1993.\nBOETTCHER WESTERN PROPERTIES III LTD. (A Limited Partnership)\nNotes to Financial Statements\nSeptember 30, 1995, 1994 and 1993\n(3) Mortgages Payable\nMortgages payable at September 30 are secured by real estate investment properties and are comprised of the following:\nAll mortgages payable are secured solely by the respective properties and are nonrecourse to the Partnership.\n(a) Discount was based on market interest rate at the time of purchase of 12.5%. (b) The Partnership extended the mortgage payable to January 1, 1996. See note 6 for additional information. (c) Average rate of bond issue. (d) Paid semiannually in April and December. (e) The Partnership extended the mortgage payable to October 1, 1997. See note 6 for additional information.\nBOETTCHER WESTERN PROPERTIES III LTD. (A Limited Partnership)\nNotes to Financial Statements\nSeptember 30, 1995, 1994 and 1993\n(3) Continued\nAggregate maturities of principal payments for the five fiscal years ending September 30, 2000 and thereafter are as follows:\nFor additional discussion of the Partnership's mortgages payable refer to note 6.\n(4) Transactions with Related Parties\nBPL is the Managing Agent of the Partnership and is paid an annual fee for its services. The annual fee is comprised of a property management fee and a deferred acquisition fee. The property management fee is equal to 5% of gross receipts from the Properties, less management fees paid to others. The property management fee earned by BPL amounted to $15,734, $38,635 and $41,830 for the years ended September 30, 1995, 1994, and 1993, respectively. The deferred acquisition fee is an annual fee equal to the sum of 2% of average daily invested capital plus 1\/2 of 1% of average daily liquid capital, as defined. The deferred acquisition fee is payable for a maximum of 15 years and is limited in the aggregate to payments having a discounted value equal to 14% of gross limited partner capital contributions. Payments made over the 15-year period will be discounted at 10% per year from the date of payment to May 2, 1983 in determining whether the limit has been reached. Payments are limited in the aggregate to $3,080,000. Since inception, the total discounted deferred acquisition fee earned by the Managing General Partner is approximately $2,224,000. The annual deferred acquisition fee earned by BPL amounted to $140,364, $230,978 and $301,740 for the years ended September 30, 1995, 1994, and 1993, respectively.\nThe Partnership also reimburses BPL for its allocable share of salaries of nonmanagement and nonsupervisory personnel providing accounting, investor reporting and communications, and legal services to the Partnership and allowable expenses related to the maintenance and repair of data processing equipment used for or by the Partnership. The amount due to BPL for such reimbursements for the years ended September 30, 1995, 1994, and 1993 amounted to $30,795, $30,588 and $30,522, respectively.\nBOETTCHER WESTERN PROPERTIES III LTD. (A Limited Partnership)\nNotes to Financial Statements\nSeptember 30, 1995, 1994 and 1993\n(5) Future Rental Income Aggregate base rental income relating to long-term noncancellable leases for the Venetian Square Shopping Center for the five fiscal years ending September 30, 2000 and thereafter is as follows:\nCertain other leases related to the Partnership's multifamily apartment property are short term and cancelable upon notice by either party and, accordingly, are not included in the above amounts.\n(6) Liquidity and Debt Maturities\nThe Partnership is required under its Partnership Agreement to maintain cash reserves of not less than 3% of aggregate capital contributions for normal repairs, replacements, working capital and other contingencies. As of September 30, 1995, the Partnership had cash reserves of $836,140, while the required minimum amount was $660,000.\nDuring fiscal 1995, the payable to managing general partner increased $126,622 to a total of $1,527,391 as of September 30, 1995. This increase is the result of the accrual of fees and reimbursements earned by the Managing General Partner in fiscal 1995 and cash advances received from the Managing General Partner during fiscal 1995 totalling $92,977 and $33,645, respectively. The Managing General Partner intends to apply cash flow generated from Partnership operations in fiscal 1996, if any, to maintain the minimum required cash reserves, as necessary, including any additional reserves to cover remediation costs at Venetian Square Shopping Center. Thereafter, the Partnership intends to pay the Managing General Partner all unpaid cash advances made to the Partnership, all unpaid administrative reimbursements and all deferred fees earned by the Managing General Partner.\nThe Managing General Partner is attempting to sell the Partnership's remaining real estate investments in fiscal 1996. However, there can be no assurances that the Partnership will sell such Properties in 1996. As of September 30, 1995 and 1994, the remaining real estate investments are classified as properties held for sale. The Partnership has entered into listing agreements with unrelated real estate brokerage firms to act as exclusive selling agents for the properties. The Managing General Partner believes that both of these sales will provide net proceeds to the Partnership after the payment of sales costs, closing costs and mortgages payable; however, these sales transactions may include both cash at closing and deferred payments to the Partnership. The ability of the Partnership to sell Venetian Square Shopping Center may be adversely affected by the potential remediation costs of the petroleum contamination of the property. The Partnership\nBOETTCHER WESTERN PROPERTIES III LTD. (A Limited Partnership)\nNotes to Financial Statements\nSeptember 30, 1995, 1994 and 1993\nintends to apply net sales proceeds to maintain the Partnership's minimum required cash reserves, as necessary, including any additional reserves to cover potential remediation costs. Thereafter, the Partnership intends to pay amounts owed to the Managing General Partner and to make distributions to limited partners.\nDuring fiscal 1995 the Partnership entered into a loan extension agreement with MBL Life Assurance Corporation (\"MBL\") to extend the mortgage payable for La Risa Apartments through January 1, 1996 under similar terms and conditions as the original loan agreement. An additional extension of this loan would facilitate the Partnership's efforts to sell the property in 1996, with a portion of the sales proceeds being utilized to pay all principal and interest owed to MBL at that time. There can be no assurances that the Managing General Partner will be able to obtain such an extension. If the Partnership is unable to obtain an extension, the mortgage payable for La Risa Apartments will be due and payable on January 1, 1996. In this circumstance, if the Partnership does not pay off the mortgage, the Partnership will be in default, entitling MBL to exercise its available remedies, including foreclosure of the property.\nSubsequent to September 30, 1995, the Partnership entered into a letter agreement with Great West Life Assurance Company (Great West) to extend the maturity date of the first mortgage payable secured by Venetian Square Shopping Center to October 1, 1997. Under the agreement, the Partnership was obligated to pay a $20,000 fee, the interest rate was increased to 10.5% and the monthly payment was increased to $39,098 effective October 1, 1995.\nBOETTCHER WESTERN PROPERTIES III LTD. (A Limited Partnership)\nNotes to Financial Statements\nSeptember 30, 1995, 1994 and 1993\n(7) Environmental Contingency\nFrom approximately 1979 through 1990 a card-lock fueling station had been operated on a parcel of land adjacent to and a part of Venetian Square Shopping Center. In 1990, operation of the fueling station ceased, and in fiscal 1991 the Partnership determined that it would be permanently closed. In compliance with the California and San Joaquin County environmental regulatory requirements, the Partnership contracted with an environmental engineering firm to perform Phase I and Phase II environmental site assessments on this specific parcel of land. The results of those site assessments suggested that the site may contain petroleum contaminants. In fiscal 1992, the Partnership contracted for the excavation and removal of the three underground fuel storage tanks located on this parcel of land. Upon excavation and removal of those underground fuel storage tanks, leakage of petroleum contaminants was discovered through performance of soil and groundwater tests. The Partnership retained California legal counsel and contracted with an environmental engineering firm (EEF) to perform further site analysis and to determine the proximate cause and extent of any contaminants. In the first quarter of fiscal 1993, the Partnership received the Preliminary Site Assessment report (the PSA) from the EEF detailing the results of its Phase II soil and groundwater sampling and analysis, as well as the EEF's recommendation for further action. In working with the San Joaquin County Public Health Services\/Environmental Health Division (San Joaquin), the Partnership received approval to proceed with quarterly groundwater monitoring of the site for a term of one year which was completed as of December 31, 1993. An Evaluation of Remedial Alternatives For Petroleum Hydrocarbon Impacted Soil (the Report) was submitted to San Joaquin for further review and comments. San Joaquin notified the Partnership that the remedial alternative consisting primarily of soil vapor extraction complies with regulatory requirements and requested that the Partnership submit a work plan to the regulatory agency which will include the proposed actions and proposed schedule for implementation and operation of the soil vapor extraction system. However, the Partnership has been advised that groundwater contamination has also occurred and the Partnership is in the process of determining the method, cost and timing of required soil and groundwater remediation measures. The Partnership has spent approximately $405,000 to date in evaluating the remediation program. Management is unable at this time to estimate the full extent of additional expenses that may be incurred. Due to groundwater contamination, the Partnership may incur significant additional remediation costs. Accordingly, the accompanying financial statements do not include any adjustments that reflect the results of the ultimate resolution of this uncertainty.\nThe Partnership has contacted all previous and current insurance companies which have underwritten insurance coverages for Venetian Square. The Partnership intends to determine with these insurance companies the extent of the Partnership insurance coverage, if any, related to the environmental matters at Venetian Square. There can be no assurances that any insurance coverage will be available to the Partnership related to these matters.\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 with accountants on any matter of accounting principles or practices on 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 Partnership does not have directors or executive officers. The general partner of the Partnership's Managing General Partner and Associate General Partner is BPL Holdings, Inc. (BPL Holdings), a Delaware corporation. During fiscal 1995, the ultimate parent company of BPL Holdings (Kemper Securities Holdings, Inc.) experienced a change in ownership, whereby it became a wholly-owned subsidiary of EVEREN Capital Corporation and changed its name to EVEREN Securities Holdings, Inc. (ESHI). EVEREN Securities, Inc. is a wholly-owned subsidiary of ESHI. These changes have had no impact on the day-to-day operations of BPL Holdings. The following is a list of the directors and officers of BPL Holdings.\nPresent Position and Principal Occupation and Name and Age Affiliation During the Last 5 years or More\nJanet L. Reali Director, President and Principal Executive Officer Age: 44 of BPL Holdings,Inc. Ms. Reali was elected Executive Vice President and Secretary of EVEREN Capital Corporation in May 1995. Since December 1993 she has been Executive Vice President, Corporate Counsel and Corporate Secretary of EVEREN Securities, Inc. She was became a Director and the President of BPL Holdings, Inc. in May 1995. She was Senior Vice President and Associate General Counsel of EVEREN Securities, Inc. from July 1991 to December 1993. Before joining EVEREN Securities, Inc., she was a partner in the Chicago law firm of Keck, Mahin & Cate.\nStanley R. Fallis Director of BPL Holdings, Inc. Age: 54 Mr. Fallis graduated from the University of Idaho with a BS degree in accounting. Mr. Fallis also obtained an MBA degree from the University of Utah. Mr. Fallis is a Certified Public Accountant and practiced public accounting for six years. Mr. Fallis has been associated with Boettcher & Co. for 18 years and is currently Senior Executive Vice President and Chief Financial Officer as well as Director of Administration of EVEREN Securities, Inc.\nDaniel D. Williams Director and Vice President of BPL Holdings, Inc. Age: 44 Mr. Williams became a Director and Vice President of BPL Holdings, Inc. in May 1995. Mr. Williams was elected Senior Executive Vice\nPresident, Treasurer and Chief Financial Officer of EVEREN Capital Corporation in May 1995. Since April 1995 he has been Senior Executive Vice President and Chief Financial Officer of EVEREN Securities, Inc. From January 1994 to April 1995, Mr. Williams was Executive Vice President and Director of Finance and Administration and from January 1991 to January 1994 he was Senior Vice President and Director of Accounting of EVEREN Securities, Inc. Prior thereto, he was Executive Vice President, Treasurer and Chief Financial Officer of Boettcher & Co.\nKelly J. Stradinger Vice President and Secretary of BPL Holdings, Inc. Age: 36 Mr. Stradinger joined BPL in 1983 as Assistant Controller for the syndicated public real estate partnerships. Mr. Stradinger is currently in charge of asset management for all syndicated partnerships where BPL or an affiliate is the general partner. He is also a Vice President of EVEREN Securities, Inc., and Director of Leasing for the facilities management department. Mr. Stradinger graduated from Western Michigan University with a Bachelor of Business Administration in Accounting and successfully completed the Certified Public Accountant exam.\nThomas M. Mansheim Director and Treasurer of BPL Holdings, Inc. Age: 38 (Principal Financial and Accounting Officer of the Partnership) Mr. Mansheim joined BPL in 1984 and is currently a Senior Vice President with EVEREN Securities, Inc. He became a Director and the Treasurer of BPL Holdings, Inc. Mr. Mansheim is a Certified Public Accountant and from 1980 to 1984 was employed with KPMG Peat Marwick. Mr. Mansheim graduated from the University of Colorado with a Bachelor of Science degree in business administration.\nThere is no family relationship among the officers or directors of BPL Holdings or any of its affiliates.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION\nThe Partnership, as an entity, does not have any directors or executive officers. The information required by Item 402 of Regulation S-K relating to amounts owed by the Partnership to the Managing General Partner and its affiliates for services rendered during the fiscal year ended September 30, 1995 is presented below. Reference is also made to Note 4 to Financial Statements as contained in Item 8 of this report for a description of related parties.\nNo form of non-cash remuneration was paid by the Partnership. See Item 13 below with respect to a description of certain transactions of the General Partners and their affiliates with the Partnership.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nTo the knowledge of the Partnership, no person or group owns of record or beneficially more than 5% of the outstanding Units.\nThe Partnership has no directors or executive officers. To the knowledge of the Partnership, no directors or officers of the Managing General Partner or its affiliates own any Units.\nThere exists no arrangement, known to the Partnership, the operation of which may at a subsequent date result in a change in control of the Partnership.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe Partnership has no directors or executive officers. The information required by Item 404 of Regulation S-K is set forth in Item 11. Executive Compensation as contained in this report.\nThe Partnership has a Management Agreement with the Managing General Partner pursuant to which the Managing General Partner is responsible for performing the day-to-day investment and administrative operations of the Partnership and supervising the management and operation of the Partnership's properties. For such services and for services rendered in connection with the acquisition of the Partnership's properties, the Managing General Partner is entitled to receive annual fees comprised of a Deferred Acquisition Fee and a Property Management Fee as more fully discussed in Note 4 to the Financial Statements as contained in Item 8 of this report. The Managing General Partner earns such fees for services provided to the Partnership pursuant to the Management Agreement and not by reason of its Partnership interest. The Managing General Partner earned a Deferred Acquisition Fee of $140,364 and a Property Management Fee of $15,734 for the fiscal year ended September 30, 1995.\nPursuant to the Partnership Agreement, the Managing General Partner may be reimbursed by the Partnership for certain of its costs, including reimbursements for its allocable share of salaries of nonmanagement and nonsupervisory personnel providing accounting, investor reporting and communications and legal services to the Partnership, and the maintenance and repair of data processing equipment used for or by the Partnership. Pursuant to such provision, for services provided during the fiscal year ended September 30, 1995, the Managing General Partner is entitled to receive reimbursements aggregating $30,795.\nThe Partnership Agreement provides for the net operating income or loss of the Partnership to be allocated as follows: (i) to the limited partners to the extent necessary to satisfy the 8% Current Distribution Preference, as defined (an amount equal to 8% of the daily average aggregate adjusted capital contributions of the limited partners) and (ii) 1% of the remainder to the General Partners and 99% to the limited partners. Net operating losses are allocated 1% to the General Partners and 99% to the limited partners.\nThe Partnership Agreement provides for net capital income from the sale or other disposition of Partnership properties to be allocated on a cumulative basis as follows: (i) 1% to the General Partners and 99% to the limited partners to the extent of depreciation deductions taken from the inception of the partnership, (ii) to the limited partners to the extent necessary to satisfy the Net Proceeds Distribution Preference, as defined (an amount equal to the sum of limited partner capital contributions not yet returned and any unsatisfied 8% current Distribution Preference from prior periods) and (iii) 25% of the remainder to the General Partners and 75% to the limited partners. Net capital loss is allocated 1% to the General Partners and 99% to the limited partners.\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 Statement of the Partnership are included herein:\nIndependent Auditors' Report\nBalance Sheets - September 30, 1995 and 1994\nStatements of Operations - Years ended September 30, 1995, 1994 and 1993\nStatements of Partners' Capital (Deficit) - Years ended September 30, 1995, 1994 and 1993\nStatements of Cash Flows - Years ended September 30, 1995, 1994 and 1993\nNotes to Financial Statements\n(2) Financial Statement Schedule\nIndependent Auditor's Report\nSchedule III - Real Estate and Accumulated Depreciation - September 30, 1995\nSchedules, other than the one listed, are omitted for the reason that they are inapplicable or equivalent information has been included elsewhere herein.\n(b) Reports on Form 8-K\nNo reports on Form 8-K were filed by the Registrant during the last quarter of the fiscal year covered by this report.\n(c) Exhibits\nNumber Exhibit ------ ------- 4 Limited Partnership Agreement of Registrant(1)\n10.1 Management Agreement (1)\n10.2 La Risa Apartments Purchase and Sale Agreement (2)\n10.3 Venetian Square Shopping Center Purchase and Sale Agreement(2)\n10.4 Southcenter Office Building Purchase and Sale Agreement (2)\n10.5 La Paz Apartments Purchase and Sale Agreement(3)\n10.6 Maryland Villa Apartments Purchase and Sale Agreement (3)\n10.7 Los Compadres Apartments Purchase and Sale Agreement (3)\n10.8 Loan Extension Agreement for Los Compadres Apartments dated August 27, 1993 (5)\n10.9 Letter Agreement for Loan Extension for Los Compadres Apartments dated as of December 17, 1993 (5)\n10.10 Loan Extension Agreement for La Paz Apartments dated August 27, 1993 (5)\n10.11 Letter Agreement for Loan Extension for La Paz Apartments dated as of December 17, 1993 (5)\n10.12 Loan Extension Agreement for Maryland Villa Apartments dated August 27, 1993 (5)\n10.13 Letter Agreement for Loan Extension for Maryland Villa Apartments dated as of December 17, 1993 (5)\n10.14 Los Compadres Apartments Purchase and Sale Agreement dated January 11, 1994 (6)\n10.15 La Paz Apartments Purchase and Sale Agreement dated January 11, 1994 (6)\n10.16 Maryland Villa Apartments Purchase and Sale Agreement dated January 11, 1994 (6)\n10.17 First Amendment to Purchase and Sale Agreements for Los Compadres, La Paz and Maryland Villa Apartments dated February 18, 1994 (6)\n27 Financial Data Schedule\n(c) Exhibits (continued)\nNumber Exhibit ------ ------- 28.1 Complaint for Judicial Foreclosure of Mortgage Dated May 27, 1993 (4)\n28.2 Motion for Appointment of Receiver Dated May 27, 1993 (4)\n28.3 Objection to Order to Show Cause Dated June 3, 1993 (4)\n28.4 Order Appointing Receiver in Aid of Foreclosure Dated June 7, 1993(4)\n28.5 Motion for Order of Default, Order of Summary Judgement, and Entry of Judgement of Foreclosure of Mortgage Dated August 10, 1993(5)\n28.6 Second Extension and Modification Agreement dated December 28, 1994\n(1) Incorporated by reference to Exhibit No. 3.1 and Exhibit 10 to Amendment No. 2 to Form S-11 Registration Statement filed May 2, 1983 - File No. 2-82570.\n(2) Incorporated by reference to Registrant's Reports on Form 8-K dated October 18, 1983, December 9, 1983 and April 27, 1984, respectively.\n(3) Incorporated by reference to Registrant's Report on Form 8-K dated October 16, 1984.\n(4) Incorporated by reference to Registrant's Report on Form 8-K dated June 7, 1993.\n(5) Incorporated by reference to Registrant's Report on Form 10-K dated September 30, 1993.\n(6) Incorporated by reference to Registrant's Report on Form 8-K dated February 18, 1994.\n(7) Incorporated by reference to Registrant's Report on Form 10-Q dated February 13, 1995.\nINDEPENDENT AUDITORS' REPORT\nTHE PARTNERS BOETTCHER WESTERN PROPERTIES III LTD.:\nUnder date of November 22, 1995, we reported on the balance sheets of Boettcher Western Properties III Ltd. (a limited partnership) as of September 30, 1995 and 1994, and the related statements of operations, partners' capital (deficit), and cash flows for each of the years in the three-year period ended September 30, 1995, as contained in the Partnership's annual report on Form 10-K for the year 1995. In connection with our audits of the aforementioned financial statements, we also audited the related financial statement Schedule III - Real Estate and Accumulated Depreciation. This financial statement schedule is the responsibility of the Partnership's management. Our responsibility is to express an opinion on this financial statement schedule based on our audit.\nIn 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.\nThe audit report on the financial statements of Boettcher Western Properties III Ltd. referred to above contains an explanatory paragraph that states that management of the Partnership has determined that one of the Partnership's real estate properties has environmental contamination. Management is evaluating the extent of such contamination and the remediation of the property and has accrued certain remediation costs. However, management is currently unable to determine the full extent of the remediation measures and the related total cost. Accordingly, the financial statements do not include any additional adjustments, if any, relating to the ultimate outcome of this uncertainty.\nKPMG PEAT MARWICK LLP\nDenver, Colorado November 22, 1995\nBOETTCHER WESTERN PROPERTIES III, LTD. (A Limited Partnership) SCHEDULE III - Real Estate and Accumulated Depreciation September 30, 1995\nNotes: (a) La Risa and Venetian Square were purchased during the period ended September 30, 1984.\n(b) Net of debt discount.\n(c) Reconciliation of the total amount at which real estate was carried:\n(d) No item of real estate investment has been written down or reserved against.\n(e) The aggregate cost for Federal income tax purposes at September 30, 1995 is $16,346,743.\n(f) No intercompany profits are included in the total of column E.\nSee accompanying independent auditors' 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.\nBOETTCHER WESTERN PROPERTIES III LTD. (Registrant)\nBy: Boettcher Properties, Ltd., Managing General Partner\nBy: BPL Holdings, Inc., General Partner\nBy: \/s\/Thomas M. Mansheim --------------------- Treasurer\nDated: December 29, 1995\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons (constituting a majority of the Directors of the corporate general partner of the Registrant's Managing General Partner) on the 29th day of December, 1995 in the capacities indicated below.\nName Capacities\nJANET L. REALI Director and President of BPL Holdings, Inc.; Principal Executive Officer of the Partnership\nBy: \/s\/ Janet L. Reali Dated: December 29, 1995 ------------------------- Janet L. Reali\nDANIEL D. WILLIAMS Director and Vice President of BPL Holdings, Inc.\nBy: \/s\/ Daniel D. Williams Dated: December 29, 1995 ------------------------- Daniel D. Williams\nTHOMAS M. MANSHEIM Director and Treasurer of BPL Holdings, Inc.; Principal Financial and Accounting Officer of the Partnership\nBy: \/s\/ Thomas M. Mansheim Dated: December 29, 1995 ------------------------- Thomas M. Mansheim\nNo annual report or proxy material has been sent to the limited partners of the Partnership. An annual report will be sent to the limited partners subsequent to this filing and the Partnership will furnish copies of such report to the Commission when it is sent to the limited partners.","section_15":""}
{"filename":"27326_1995.txt","cik":"27326","year":"1995","section_1":"ITEM 1. BUSINESS\nGeneral\nDavis Water & Waste Industries, Inc. (the \"Company\" or the \"Registrant\") manufactures and markets products relating to the distribution of water and the treatment of water and wastewater. The Company markets a broad line of water distribution equipment and supplies, including underground pipe, pipe fittings, valves, fire hydrants, water meters and related equipment. The Company believes that it is the largest distributor of water distribution equipment and supplies in the Southeast based on annual revenues from sales of such products. The Company also designs, engineers, manufactures, sells and installs water and wastewater treatment and pumping equipment, and distributes certain process materials used to treat water and wastewater to comply with applicable health and water quality standards. The Company's products are sold from 33 distribution and sales facilities to more than 25,000 independent contractors, developers, industrial customers, municipalities and other government agencies, and private utilities located principally in the Southeastern, Southwestern, Midwestern and Western areas of the United States.\nThe Company was organized as a Georgia corporation in 1956 as the successor to a business which had operated since 1938. The Company has one wholly owned subsidiary, The Taulman Company (\"Taulman\"), which it acquired in August 1990. The Company discontinued substantially all of Taulman's operations in fiscal 1994. See \"Discontinuation of Taulman Operations\" below. As used herein, the term \"Company\" refers to Davis Water & Waste Industries, Inc., its divisions and its wholly-owned subsidiary, Taulman, unless otherwise indicated.\nBusiness Growth Strategy\nDuring the past ten years, the Company's operations have grown significantly through the acquisition of existing water distribution businesses and the opening of new water distribution warehouse locations in new geographic areas, through increased sales efforts in existing markets and through the introduction of new products. Since 1986, the Company has increased its total locations from 22 in eight states to 33 in twelve states and has increased its employee sales force from 75 to 91, an increase of 21%.\nIn 1986, the Company initiated a strategy of growth through selective acquisitions of compatible businesses in the same or related industries. Between 1986 and 1989, the Company acquired five water distribution businesses in the Western, Southwestern and Southeastern United States. These acquisitions enabled the Company to expand its water distribution operations in the California and Rocky Mountain markets and to strengthen its position in the Southeastern and Texas markets. All of these acquired companies were consolidated within the Davis Distribution Group division of the Company.\nManagement believes that these strategies have been successful for the Company and intends to continue to utilize these strategies when conditions in the Company's industry and in the general economy support such expansion. While the Company continuously analyzes opportunities for the acquisition of other businesses in the Company's industry or related industries, the Company currently has no agreements or understandings regarding any other acquisitions.\nDiscontinuation of Taulman Operations\nIn August 1990, the Company, through a wholly owned subsidiary, purchased certain assets and assumed certain liabilities of The Taulman Company, a privately held pollution control business headquartered in Atlanta, Georgia. Through May 1994, Taulman, through its Turbitrol Instrumentation and Controls division (\"Turbitrol\"), was engaged primarily in the design, manufacture and sale of process equipment and control systems used in municipal water and wastewater treatment facilities nationwide. Through its Taulman Composting Systems division, Taulman also marketed composting systems manufactured by others. In fiscal 1994, Turbitrol accounted for substantially all of Taulman's net sales, and the Taulman Composting Systems division was an immaterial component of Taulman's operation.\nIn fiscal 1994, the Company terminated the operations of Turbitrol due to continuing significant declines in sales and relatively high levels of selling, general and administrative expenses required to fulfill contractual obligations. Turbitrol ceased bidding on new contracts, terminated its sales force and will continue operations only for the next two years as necessary to complete its obligations under current contracts. In fiscal 1994 and 1993, Taulman's net sales were $15,871,000 and $24,739,000, respectively, which equalled 7.8%, and 13.0%, respectively, of the Company's net sales in such fiscal years. Taulman's pre-tax operating (losses) income for such fiscal years were ($2,903,000) and $18,000, respectively. The Taulman Composting Systems division began operating within the Company's Davis Process division in June 1994. See Note 2 of Notes to Consolidated Financial Statements contained in the Company's 1995 Annual Report, which Note is incorporated herein by reference. The 1995 Annual Report is filed as Exhibit 13 to this report.\nPrincipal Products\nThe Company markets a broad line of water distribution equipment and supplies purchased from independent manufacturers and suppliers, including underground pipe, pipe fittings, valves, fire hydrants, water meters and related equipment. The Company also designs, engineers, manufactures, sells and installs water and wastewater treatment and pumping equipment and related control systems, and distributes certain process materials used to treat water and wastewater to comply with applicable health and water quality standards. The following table sets forth the amount and percentage of net sales attributable to each of the Company's principal product classes for the periods indicated:\nWater Distribution Equipment and Supplies. Through the Distribution Group division, which operates under the Davis Meter & Supply, Taylor-Jett Co., Waterworks Equipment Company and McAllen Pipe & Supply Co. names, the Company markets water distribution equipment and supplies, including underground and fabricated pipe, pipe fittings, valves, fire hydrants, water meters, systems for storm drainage and wastewater collection, and related equipment used in the supply of water. The Company believes that it is the largest distributor of water distribution equipment and supplies in the Southeast based on annual revenues from sales of such products. The Company purchases more than 20,000 products from approximately 3,000 manufacturers and suppliers located principally in the Southern United States and markets and distributes these products through a network of 23 service center warehouses located in Arizona, California, Florida, Georgia, Nevada, North Carolina, Tennessee, Texas and Utah. Each service center warehouse services an area with a radius of from 50 miles to 150 miles depending on population density in the area. Purchasers of the Company's water distribution equipment and supplies consist principally of independent contractors, industrial customers, municipalities and other government agencies, and private utilities.\nAt each service center warehouse, the Company maintains an inventory of most of the water distribution equipment and supplies which it sells. The Company is able to fill and ship most orders from service center warehouse stock on the date the customer places an order. Equipment and supplies are transported to customers by Company owned or leased delivery vehicles or by common carriers. Frequently, however, orders are large enough for the Company to arrange shipment directly from the manufacturer or vendor in truckload quantities to the customer. Equipment and supplies which are not available at a particular service center warehouse may be ordered and shipped to a customer from another of the Company's service center warehouses. In addition, two large, centrally located service center warehouses function as support facilities for the surrounding service center warehouses, providing consolidated purchasing power, a large variety of normal inventory items and a complete inventory of special fittings and long lead-time inventory items.\nEach service center warehouse is under the direction of a district manager who is responsible for the purchasing, warehousing, selling and shipping of inventory items, the supervision of all service center warehouse and sales personnel, and the overall profitability of the service center warehouse. However, the Company operates a central, computerized inventory and customer billing system. A Company Executive Vice President is responsible for the overall management of the Distribution Group division. Major decisions affecting division policy, facilities or capital outlays are reviewed by the Company's executive officers.\nWater and Wastewater Treatment and Pumping Equipment and Control Systems. The Company's Davco division engineers, designs, manufactures, sells and installs water and wastewater treatment and pumping equipment used in the processing and handling of domestic and industrial water and wastewater. This equipment is used to process water and wastewater to comply with applicable health and water quality standards.\nThe water and wastewater treatment equipment manufactured by the Davco division is composed primarily of fabricated and coated steel treatment plants. This equipment is sold principally to commercial and residential land developers, industrial plants and municipalities. Most of such equipment is delivered to the job site, ready for erection. The fully prefabricated wastewater treatment systems are designed to process from 10,000 to 125,000 gallons of wastewater per day, thereby serving from 100 to 1,250 persons. The larger wastewater treatment plants process up to 10,000,000 gallons of wastewater per day and serve communities of up to 100,000 persons. The Davco division manufactures a variety of products for inclusion in these treatment plants, including denitrification filters, travelling bridge filters, solids contact clarifiers, clarifiers aeration systems and selector processes.\nThe Davco\\EMU division's water and wastewater pumping equipment consists of submersible pumps used in municipal, industrial and privately owned systems for pumping wastewater. These units are designed and built by the German company EMU Unterwasserpumpen GmbH both for underground and above ground installation and are used to pump wastewater to centrally located treatment or collection points or to maintain desired pressure in water distribution systems. The equipment is sold principally to general contractors for incorporation in utility systems being constructed for municipalities, industries, governmental agencies and private utilities.\nTaking advantage of its expertise in steel fabrication and erection, the Davco division provides specialty steel fabrication and on-site construction erection services to major contractors and industrial customers. These services relate principally to the fabrication and installation of steel components used in water and air pollution control equipment.\nThrough May 1994, the Turbitrol division of Taulman was engaged primarily in the design, manufacture, sale and servicing of instrumentation, control and telemetry systems primarily for municipal water and wastewater treatment facilities. These systems provided for the monitoring and storage of performance data and the computation of sophisticated control strategies required for water and wastewater treatment facilities. Turbitrol also manufactured a broad line of remote telemetry units used in the monitoring and control of potable water distribution systems and wastewater collection systems. In fiscal 1994, the Company terminated the operations of Turbitrol except to the extent necessary to complete its obligations under current contracts. Turbitrol has ceased bidding on new contracts and has terminated its sales force. See \" Discontinuation of Taulman Operations\" above and Note 2 of Notes to Consolidated Financial Statements.\nThe Company's Davis process division designs the control systems for, subcontracts the manufacture of and markets composting systems. These systems consist of a completely enclosed in-vessel process for the biological decomposition and stabilization of the organic sludge residue from wastewater treatment facilities. The sludge is converted to a stable, pathogen free and usable humus compost product. These composting systems are sold to municipal and industrial customers and are capable of processing compost in volumes ranging from less than one to several hundred dry tons per day.\nThe process embodied in these systems is a patented technology for which Taulman had the exclusive license to market in North America, and these systems were marketed by the Taulman Composting Systems division through May 1994. In the fourth quarter of fiscal 1994, the Company, in response to changing marketplace demands and the development by others of more economical methods for waste composting, elected to forego the exclusive North American marketing rights to the technology and to write- off the licensing agreement. See Note 2 of Notes to Consolidated Financial Statements and \"Discontinuation of Taulman Operations\" above. Beginning in June 1994, the operations of the Taulman Composting Systems division were assumed by the Company's Davis Process division.\nThe Company's water and wastewater treatment equipment and special fabrications are produced at the Company's manufacturing facilities. These products generally are designed, engineered and custom manufactured for a specific customer application. The process usually involves a consulting engineer who specifies the product for use in conjunction with a project, a contractor who purchases the product from the Company for installation on the project and an owner who is the end user of the product. The owner may be either a governmental body (such as a municipality, sewer district or state or federal agency) or a private entity (such as a developer, industrial manufacturer or motel or campground owner).\nIn connection with the water and wastewater treatment products manufactured by the Company, a time interval of 12 weeks generally is\nexperienced between the time of acceptance of the Company's bid and final approval of design and engineering specifications by customers, their engineers and any regulatory agencies. After such approval is granted, there is typically a further time interval of approximately 25 weeks, depending on the complexity and size of the units in question, between approval for construction and shipment and the installation of the completed products. The Company's water and waste water control systems and composting systems generally experience a time interval of between six months and two years from the time of bid acceptance to contract completion. In recognition of the substantial time interval between the submission of a bid by the Company and completion of the contract, the Company protects itself through contract clauses allowing for the renegotiation of the selling price or cancellation of the contract if specified time limits are not met.\nThe Company's specialty metal products and on-site erection services normally are sold to major contractors responsible for the entire construction or modification of the facility, and normally the construction period extends over a period of up to three years. As a result, the Company has contract provisions which provide for price escalations based on changes in published indices for material and labor and for progress payments for the equipment manufactured.\nOperations and management of the Davco division are the responsibility of a Company Vice President\/Division General Manager, while operations and management of Turbitrol are the responsibility of the President of Turbitrol. Major decisions affecting Davco or Turbitrol policy, facilities or capital outlays are reviewed by the Company's executive officers.\nProcess Materials and Services. The Company's Davis Process division supplies a product line of material used to control hydrogen sulfide, malodorous and toxic gas in wastewater collection systems, to treat water and wastewater to comply with applicable health and water quality standards and to condition sludge for disposal. The products also are used in certain areas to remove phosphorous from discharged waste. The raw material for this product line is shipped to the Company in solid or granular form and stored in the Company's facilities in California, Delaware, Florida, Georgia, Illinois, South Carolina and Texas. At these locations, other minor component materials are added and the resulting mixture is shipped to customers, which consist primarily of municipalities and private water and wastewater treatment facilities.\nThe Davis Process division has developed and patented a multistage air scrubber designed for the treatment and removal of odors. Davis Process sells, manufactures and installs these multistage air scrubbers. Services provided by Davis Process includes air scrubber maintenance, sludge management, odor surveys and analytical laboratory services specializing in water analysis.\nOperations and management of the Davis Process division are under the direction of a Vice President\/Division General Manager who is responsible for purchasing, warehousing, processing, marketing, distributing and selling the product lines. Major decisions affecting division policy, facilities or capital outlays are reviewed by the Company's executive officers.\nMarketing\nThe Company's water distribution equipment and supplies are marketed by approximately 67 Company-employed salesmen, each of whom operates from one of the 23 service center warehouses and reports to the service center district manager. Salesmen call directly on customers within their assigned territories and work with architects, engineers and government agencies to assist customers in determining their product needs. Salesmen are compensated by a base salary plus a commission based on a percentage of gross profits from their sales.\nThe Davco division's water and wastewater treatment and pumping equipment is marketed through a network of approximately 58 manufacturers' representative organizations and 5 Company-employed salesmen. The manufacturers' representatives are independent businessmen who are paid on a commission basis and have the exclusive right to sell the Company's products in a specified geographical area. The Company-employed salesmen are compensated by salary and incentives based on the volume and profitability of their sales. The manufacturers' representatives and Company-employed salesmen call on and work with consulting engineers and owners in an effort to have them specify the Company's products for use in a project. They also work with regulatory agencies to assure approval of the Company's products for the uses specified. They then attempt to make the sale through a negotiated price or a competitive bidding process. A general sales manager and a regional sales staff are responsible for the activities of the manufacturers' representatives, and the Company's home office sales support staff provides technical assistance and pricing information for the manufacturers' representatives and Company-employed salesmen.\nComposting systems are marketed by 14 Company-employed salesmen, each of whom operates from one of the 7 Davis Process locations and reports to the sales manager of the Davis Process division. Salesmen are compensated by a base salary plus a percentage of gross profits from their sales. These systems are sold principally to commercial and residential land developers, industrial plants and municipalities in a manner similar to sales of water and wastewater treatment and pumping equipment as described above.\nThe Company's specialty metal products and on-site erection services are marketed by a sales staff under the direction of a general sales manager. Sales staff personnel are compensated on a fixed salary plus an incentive based on the profitability of the sales of the product or by commissions. The sales staff calls on owners, contractors and engineers in an effort to have them specify and approve the Company's products for use in a project. They then attempt to make the sale either through a negotiated price or a competitive bidding process. A home office sales support staff provides technical assistance and pricing information for the field sales staff and in some instances quotes the price of the job directly to the customer.\nSales of the Company's process materials and services are made by 13 Company-employed salesmen who directly service California, Colorado, Delaware, Florida, Georgia, Kentucky, Massachusetts, Missouri, South Carolina, Texas, and Washington. Salesmen call directly on customers and consulting engineers, they are compensated with a base salary plus a percentage of gross profits from their sales.\nThe Company presently serves more than 25,000 customers. No customer accounts for more than 5% of sales annually. Information regarding the amount of net sales, operating income (loss) and assets attributable to each of the Company's principal geographic areas for each of the past three fiscal years, together with information regarding export sales for each of such years, is incorporated herein by reference to the tabular information set forth under the caption \"Review of Operations\" on page 4 of the Company's 1995 Annual Report.\nMarket Factors\nThe Company's sales of water distribution equipment and supplies are greatly affected by the amount of capital spending by the land development and housing construction industries, the amount of federal funding available for construction grants and the overall health of the economy, especially as these factors relate to interest rates and housing starts. Sales of the Company's water and wastewater treatment and pumping products, composting systems, specialty metal products and on-site erection services are dependent to a large extent upon the amount of capital spending by industry and governmental bodies. Sales of process materials products and services are dependent on operating expenditures of municipal and industrial water and wastewater treatment customers.\nIn addition, the enactment and enforcement of federal and state laws relating to water quality standards also may materially influence the level of sales of all of the Company's products. The Company's business therefore is linked to some extent to certain water quality control standards imposed by the Environmental Protection Agency (\"EPA\") under the Clean Water Act. The Clean Water Act and related EPA regulations establish comprehensive and, in some cases, stringent guidelines for the control of toxic pollutants. In addition, the government's financial commitment to assist with water pollution control and the civil and criminal enforcement penalties for violating water quality control standards also create a need for the Company's products. At the same time, other regulatory initiatives, combined with actual and potential cutbacks in legal requirements and funding for EPA, have the potential to reduce the future market for municipal and industrial water and wastewater treatment equipment. The net effect of these competing factors cannot be predicted.\nSources and Availability of Supplies\nPurchases of products for resale, raw materials and components are made from various unaffiliated manufacturers and vendors. In fiscal 1995, purchases from the Company's three largest suppliers accounted for approximately 10.9%, 5.3% and 4.5%, respectively, of total purchases made by the Company. The Company has not experienced, and does not anticipate, any shortages or other difficulties in obtaining any required materials.\nBacklog of Orders\nBacklogs for water treatment and pumping products result from the interval between the date of receipt by the Company of the purchase contract and the shipment, completion or on-site erection of the equipment. The backlog of firm orders for the Company's water and wastewater treatment and pumping products and control systems as of April 30, 1995 was approximately $17,000,000 as compared to approximately $25,000,000 at the same date in 1994. The Company anticipates that approximately $15,000,000 of its backlog as of April 30, 1995 will be shipped within twelve months thereafter. See \"Principal Products - Water and Wastewater Treatment and Pumping Equipment and Control Systems\" above. The decrease in the Company's backlog in fiscal 1995 when compared to fiscal 1994 was primarily due to the Company decision to terminate the operations of Turbitrol during fiscal 1994. See \" Discontinuation of Taulman Operations\" above and Note 2 of Notes to Consolidated Financial Statements.\nThere is no material backlog for water distribution equipment and supplies since these orders normally are shipped within one to ten days following receipt of an order. Process materials and services frequently are provided over a defined contract period as required by each contract.\nCompetitive Conditions\nIn connection with the marketing of water distribution equipment and supplies, the Company competes with a large number of independent wholesalers, other distribution chains similar to the Company and manufacturers who sell directly to customers. The principal methods of competition include product knowledge by the sales force, prompt delivery following receipt of an order, service and price. Due to the various sources and methods of competition and types of products sold by the Company, the Company knows of no reliable statistics upon which there might be based an estimate of the Company's relative competitive position in this market. However, the Company believes that it is the largest distributor of water distribution equipment and supplies in the Southeast based on annual revenues from sales of such products.\nThe Company encounters substantial competition in its markets for water and wastewater treatment and pumping equipment and control systems from several competitors which operate in the Company's major marketing areas. In addition, the Company competes with a substantial number of companies with regard to its specialty metal and process materials and services. The Company knows of no reliable statistics which might be used to estimate the Company's relative competitive position in these markets. No one competitor is considered dominant. The principal methods of competition in the markets for water and wastewater treatment and pumping equipment and control systems are price, timely product delivery, service and product knowledge.\nThe Company believes that in its markets, its capabilities meet or exceed the capabilities of its competitors.\nSeasonality\nThe Company typically experiences a seasonal downturn in the third fiscal quarter of each year. Harsh weather during the third fiscal quarter usually restricts construction activities in the Company's more northern and mountainous sales markets, thereby reducing the demand for the Company's products in these areas. This seasonality is normally reflected in reduced sales and earnings of the Company in the third quarter of the fiscal year. Certain portions of the Company's sales markets, notably South Georgia, Florida, Texas, Arizona, Nevada and Southern California, are not significantly affected by the seasonal change. See Note 10 of Notes to Consolidated Financial Statements contained in the Company's 1995 Annual Report, which Note is incorporated herein by reference.\nProduct Warranties and Insurance\nThe Company warrants the water and wastewater treatment and pumping equipment, control and composting systems and specialty metal equipment manufactured by it normally for a period of one year against defects in materials and workmanship. The Company does not warrant products purchased from other manufacturers beyond the warranty expressly provided by such manufacturer nor does the Company warrant its process materials.\nThe Company maintains product liability insurance with total coverage of $20,000,000 for any single occurrence relating to injury or damage to property. The Company, however, distributes and transports a process material which is classified by the Company's insurance carrier as a pollutant and therefore is excluded from insurance coverage. In addition, such material is designated by the EPA as a hazardous material. If released into drinking water sources in sufficient quantities, this product could be toxic. The product also may corrode metal products with which it comes into contact. The Company self-insures the risks associated with this product. The Company has distributed and transported this product for over twelve years, and no claims have been filed or governmental inquiries or actions commenced against the Company with respect to the product. Management\nbelieves the Company's insurance coverage is adequate for the other types of business which it conducts. No assurance can be given, however, that events will not occur which result in damage claims against the Company in excess of policy limits or outside the coverage maintained by the Company or which result in governmental actions or penalties against the Company. Such claims, actions or penalties could have a material adverse effect on the Company.\nProduct Development\nThe Company maintains a product development and enhancement program to modify and develop product lines and processes to meet the rapidly changing opportunities in its markets. Products developed by the Davis Process division include ALKA-PRO, a patented biological process control system for the effective and efficient control of biological treatment processes. Products developed by the Company's Davco division include a sequencing batch reactor for industrial wastes, the Gravisand traveling bridge filter for concrete tankage, the Denitrifilt denitrification filter for biological removal of total nitrogen and mechanical suspended solids removal, an oxidation ditch for municipalities, and the XtrakTor for aluminum sludge removal in water plants.\nThe Company spent approximately $230,600, $762,900 and $1,021,800 on its product development program in fiscal 1995, 1994 and 1993, respectively. The Company must incur a certain amount of product development costs to meet the rapidly changing advancements in technology. The Company has recently reduced the amount spent on product development due to management's increased effort to control cost.\nManagement believes that the goodwill associated with the tradenames of the Company's various divisions is of significant value to the Company but does not consider any of the Company's patents, trademarks, licenses, franchises or concessions to be of material importance to its business.\nEmployees\nOn June 30, 1995, the Company employed 669 persons, of which 36 were in executive and administrative positions, 91 were sales personnel, 36 were in engineering positions, 123 were office personnel and 383 were in production, warehousing and trucking positions. None of the Company's employees is subject to collective bargaining agreements. The Company believes that its relations with its employees are good. Environmental Compliance Matters\nThe Company does not anticipate that compliance by it with present provisions of federal, state and local statutes and regulations which regulate the protection of the environment will have any material effect upon the Company's capital expenditures, earnings or competitive position in the foreseeable future. The Company is not aware of any pending or anticipated governmental inquiry or action against the Company for noncompliance with environmental laws and regulations.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe principal executive offices of the Company are located in an 18,500 square-foot Company-owned building. The Company also owns a water and wastewater treatment manufacturing facility totaling 67,600 square feet adjacent to the Company's executive offices. All of these facilities are located on 28 acres of land in Thomasville, Georgia. The Company also owns or leases 23 water distribution and supplies warehouses, 1 submersible pump distribution warehouse and 7 process material warehouses in 12 states. Additionally, Taulman leases an executive and administrative office in the Atlanta, Georgia area which contain a total of 80,100 square feet of space. The Company believes that its facilities and equipment are in good condition and sufficient to meet the Company's present needs. The following table sets forth information with regard to the facilities operated by the Company and Taulman as of June 30, 1995.\nThe Company also owns or leases 36 transport tractors and 72 transport trailers used in the sale and distribution of its products.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThere are no pending legal proceedings to which the Company is a party or of which any of its property is the subject other than routine litigation incidental to business.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matter was submitted by the Company to a vote of its stockholders during the fiscal quarter ended April 30, 1995.\nITEM 4(A). EXECUTIVE OFFICERS OF THE COMPANY\nSet forth below, in accordance with General Instruction G(3) of Form 10-K and Instruction 3 to Item 401(b) of Regulation S-K, is certain information regarding the executive officers of the Company, including their ages as of April 30, 1995, their principal occupations (which have continued for at least the past five years unless otherwise noted), the calendar year in which each was elected and directorships held by them in certain other companies.\nR. DOYLE WHITE, age 64, has served as President of the Company since 1982, as Chief Executive Officer of the Company since 1986 and as Chairman of the Board of the Company since 1993. He also served from 1982 until June 1994 as Chief Operating Officer of the Company, and from 1978 until 1982, he served as Senior Vice President and a General Manager of the Company. Mr. White has served as a director of the Company since 1981.\nSTAN WHITE, age 53, has served as Secretary\/Treasurer of the Company since 1974.\nLARRY MAY, age 56, has served as Executive Vice President and Chief Operating Officer of the Company since June 1994. From 1992 until June 1994, he served as Senior Vice President of the Company. From 1988 until 1992, he served as Vice President of the Company's Distribution Group division.\nROBERT H. PLESS, JR., age 55, has served as Vice President and General Manager of the Company's Davco division since 1985. From 1982 until 1985, he served as General Manager of the Davco division.\nROBERT D. TATUM, age 39, has served as Vice President of the Company's Davis Process division since September 1993 and as General Manager of the Davis Process division since 1987.\nRobert D. Tatum is a nephew of H. Forbes Davis, Jasper C. Davis III and R.R. Davis, all of whom are directors of the Company. R. Doyle White and Stan White are not related.\nGenerally, the Company's executive officers are elected annually by the Board of Directors for a term of one year or until their successors are elected and qualified.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE COMPANY'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nInformation relating to the market for the Company's Common Stock and other matters relating to the holders thereof is set forth under the caption \"Stockholder Information\" and in Notes 4 and 10 of Notes to Consolidated Financial Statements in the Company's 1995 Annual Report. Such information is incorporated herein by reference. The 1995 Annual Report is filed as Exhibit 13 to this report.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nSelected financial data for the Company for each year of the ten-year period ended April 30, 1995 is set forth under the caption \"Selected Consolidated Financial Data\" in the Company's 1995 Annual Report. Such selected consolidated financial data are 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 results of operations and financial condition for the periods and at the dates covered by the consolidated financial statements set forth in the Company's 1995 Annual Report is set forth under the caption \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" in the Company's 1995 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 subsidiary and the related management letter and report of independent accountants, which are set forth on pages 14 through 29 of the Company's 1995 Annual Report, are incorporated herein by reference:\nConsolidated Statement of Operations for each of the three years in the period ended April 30, 1995\nConsolidated Balance Sheet at April 30, 1995 and April 30, 1994\nConsolidated Statement of Changes in Stockholders' Equity for each of the three years in the period ended April 30, 1995\nConsolidated Statement of Cash Flows for each of the three years in the period ended April 30, 1995\nNotes to Consolidated Financial Statements\nThe supplementary financial information required by Item 302 of Regulation S-K is set forth in Note 10 of Notes to Consolidated Financial Statements in the Company's 1995 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\nNo independent certified public accountant of the Company has resigned, indicated any intent to resign or been dismissed as the independent certified public accountant of the Company during the two fiscal years ended April 30, 1995 or subsequent thereto.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY\nInformation relating to the directors (including management's nominees for director) of the Company is set forth under the captions \"Proposal 1 - Election of Directors - Nominees\" and \"Proposal 1 - Election of Directors - Information Regarding Nominees and Incumbent Directors\" in the Company's Proxy Statement for its Annual Meeting of Stockholders to be held on September 8, 1995. Such information is incorporated herein by reference. Information relating to the executive officers of the Company is, pursuant to Instruction 3 of Item 401(b) of Regulation S-K and General Instruction G(3) of Form 10-K, set forth at Part I, Item 4(A) of this report under the caption \"Executive Officers of the Company.\" 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 under the caption \"Proposal 1 - Election of Directors - Compliance with Section 16(a) of the Securities Exchange Act of 1934\" in the above-referenced Proxy Statement. Such information is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation relating to management compensation is set forth under the captions \"Proposal 1 - Election of Directors - Director Compensation\" and \"Proposal 1 - Election of Directors - Executive Compensation\" in the Company's Proxy Statement referred to in Item 10 above. Such information is incorporated herein by reference, except for the information set forth in the subsections entitled \"Proposal 1-Election of Directors - Executive Compensation - Compensation Committee Report\" and \"Proposal 1 - Election of Directors - Stock Performance Graph\" which specifically is not so incorporated by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation regarding ownership of the Company's $0.01 par value Common Stock by certain persons is set forth under the captions \"Voting - Principal Stockholders\" and \"Proposal 1 - Election of Directors - Information Regarding Nominees and Incumbent Directors\" in the Company's Proxy Statement referred to in Item 10 above. Such information is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation regarding certain agreements and arrangements between the Company and certain of its directors is set forth under the caption \"Proposal 1 - Election of Directors - Director Compensation\" in the Company's Proxy Statement referred to in Item 10 above. Such information is incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) Documents Filed as Part of This Report.\n1. Financial Statements\nThe following consolidated financial statements and the related report of independent accountants and management responsibility letter, which are set forth on pages 14 through 29 of the Company's 1995 Annual Report, are incorporated by reference in Part II, Item 8 hereof:\nConsolidated Statement of Operations for each of the three years in the period ended April 30, 1995\nConsolidated Balance Sheet at April 30, 1995 and April 30, 1994\nConsolidated Statement of Changes in Stockholders' Equity for each of the three years in the period ended April 30, 1995\nConsolidated Statement of Cash Flows for each of the three years in the period ended April 30, 1995\nNotes to Consolidated Financial Statements\n2. Financial Statement Schedules\nThe following financial statement schedule and the report of independent accountants thereon is included in 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. See the Index to Financial Statement Schedules on page 26 hereof.\nReport of Independent Accountants on Financial Statement Schedules\nSchedule II Valuation and Qualifying Accounts for the Three Years Ended April 30, 1995\n3. Exhibits\nThe following exhibits are filed with or incorporated by reference in this report. Where such filing is made by incorporation by reference to previously filed registration statement or report, such registration statement or report is identified in parentheses. The Company will furnish any exhibit upon request to Stan White, Secretary-Treasurer, Davis Water & Waste Industries, Inc., 1820 Metcalf Avenue, Thomasville, Georgia 31792; telephone (912) 226-5733. There is a charge of $.50 per page to cover expenses for copying and mailing.\n(b) Reports on Form 8-K\nNo Current Reports on Form 8-K were filed during the fiscal quarter ended April 30, 1995.\n(c) See Item 14(a)(3) above.\n(d) See Item 14(a)(2) above.\n* All or portions of page 4, pages 6 through 29 and page 31 of the Company's 1995 Annual Report, as indicated in this report, are incorporated herein by reference. Other than as noted herein, the Company's 1995 Annual Report is furnished to the Commission solely for its information and is not deemed to be \"filed\" with the Commission or subject to the liabilities of Section 18 of the Securities Exchange Act of 1934.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the 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 July 27, 1995.\nDAVIS WATER & WASTE INDUSTRIES, Inc. (Registrant)\nBy:\/s\/ R. Doyle White R. Doyle White Chairman of the Board, President and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on July 27, 1995.\nSignature Title\n\/s\/ R. Doyle White Chairman of the Board, R. Doyle White President and Chief Executive Officer\n\/s\/ Stan White Secretary\/Treasurer, Principal Stan White Financial Officer and Principal Accounting Officer\n\/s\/ Joe E. Beverly* Director Joe E. Beverly\n\/s\/ O. Larry Comer* Director 0. Larry Comer\n\/s\/ Robert P. Crozer* Director Robert P. Crozer\n\/s\/ H. Forbes Davis* Director H. Forbes Davis\n\/s\/ Jasper C. Davis* Director Jasper C. Davis\n\/s\/ R. R. Davis* Vice Chairman of the Board R. R. Davis\n\/s\/ Thomas R. Pledger* Director Thomas R. Pledger\n*By: \/s\/ Stan White Stan White Attorney in Fact\nDAVIS WATER & WASTE INDUSTRIES, Inc.\nINDEX OF FINANCIAL STATEMENT SCHEDULES\nREPORT OF INDEPENDENT ACCOUNTANTS ON\nFINANCIAL STATEMENT SCHEDULES\nTo the Board of Directors of Davis Water & Waste Industries, Inc.\nOur audits of the consolidated financial statements referred to in our report dated June 16, 1995 included in the 1995 Annual Report to Stockholders of Davis Water & Waste Industries, Inc. (which report and consolidated financial statements are incorporated by reference in this Annual Report on Form 10-K) also included an audit of the Financial Statement Schedules listed in Item 14(a) of this Form 10-K. In our opinion, these Financial Statement Schedules present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.\nPRICE WATERHOUSE LLP\nAtlanta, Georgia June 16, 1995\n(A) Uncollectible accounts written off, net of recoveries.\nDAVIS WATER & WASTE INDUSTRIES. Inc.\nINDEX OF EXHIBITS\nThe following exhibits are filed as part of or incorporated by reference in this report. Where such filing is made by incorporation by reference to a previously filed registration statement or report, such registration statement or report is identified in parentheses.\n* All or portions of page 4, pages 6 through 29 and page 31 of the Company's 1995 Annual Report, as indicated in this report, are incorporated herein by reference. Other than as noted herein, the Company's 1995 Annual Report is furnished to the Commission solely for its information and is not deemed to be \"filed\" with the Commission or subject to the liabilities of Section 18 of the Securities Exchange Act of 1934.\nExhibit 10(u)\nCommitment Letter\nMay 4, 1995\nDAVIS WATER & WASTE INDUSTRIES, INC. Post Office Box 1419 Thomasville, Georgia 31799-1419\nAttention: Mr. Stan White, Treasurer and Secretary\nDear Stan:\nI am pleased to inform DAVIS WATER & WASTE INDUSTRIES, INC. (the \"Borrower\") that SUN BANK, NATIONAL ASSOCIATION (the \"Bank\") has approved (i) the renewal, modification and extension of the revolving line of credit loan (the \"Loan\") currently extended by the Bank to the Borrower pursuant to the terms of that certain Amended and Restated Loan Agreement by and between the Borrower and the Bank dated October 13, 1992 (the \"Loan Agreement\"; capitalized terms used but not defined herein shall have the meanings assigned thereto in the Loan Agreement unless the context requires otherwise) and (ii) the reduction of the maximum principal amount available for borrowing thereunder to $30,000,000.00, based upon and subject to the following terms and conditions:\nBORROWER: DAVIS WATER & WASTE INDUSTRIES, INC.\nLOAN AMOUNT:$30,000,000.00\nPURPOSE: To support short term working capital needs of the Borrower, including the purchase of inventory.\nGUARANTOR: None.\nTERMS: Revolving line of credit loan, expiring on the Maturity Date. Accrued interest only at the Interest Rate shall be payable (a) in the case of Prime Rate Based Advances, monthly, in arrears, and (b) in the case of LIBOR Rate Based Advances, at the expiration of the applicable interest period, but in no event less often than quarterly. The entire unpaid principal balance, together with accrued and unpaid interest, shall be due and payable in full on the Maturity Date. At no time shall the aggregate principal amount of advances outstanding in respect of the Loan exceed the lesser of (a) $30,000,000.00, or (b) the sum of (i) eighty percent (80%) of the value Inventory, valued at the lower of cost or market value.\nMATURITY DATE: The earlier of (a) April 30, 1997 (subject to annual review), (b) the occurrence of an Event of Default; or (c) such later date as the Bank, in its absolute discretion, may agree to in writing.\nEXTENSION OPTION: At the written request of the Borrower, which request shall be made not less than sixty (60) days prior to the first anniversary date, the Bank may, in its sole and absolute discretion, elect to extend the Loan for an additional twelve (12) month period.\nINTEREST RATE: Interest on any Advance made by the Bank in respect of the Loan shall be chosen by the Borrower from the following available options and shall fluctuate based upon the Borrowers' EBIT Ratio (\"EBIT\") and Total Liability to Tangible Net Worth Ratio (\"TL\/TNW\"), determined by the Bank quarterly, as follows:\nOption A (Prime Rate Based): Prime Rate plus or minus the indicated number of basis points\nOption B (LIBOR Rate Based): LIBOR plus the indicated number of basis points\nNotwithstanding the foregoing, however, until June 30, 1995, so long as no default has occurred in respect of the Loan, the interest rate on LIBOR Rate Based Advances shall be LIBOR plus 200 basis points (2.00%).\nLIBOR shall be available in 1 day, 1 month or 3 month options based on a 360 day year. Any interest due on the Loan shall be calculated on the basis of a year containing 360 days and shall be calculated for the actual number of days elapsed. The Borrower's EBIT Ratio and Total Liability to Tangible Net Worth Ratio shall be calculated by the Bank quarterly, on a rolling four (4) quarter basis based upon the Borrowers' quarterly financial statements, beginning with the Borrowers' statement for the period ending June 30, 1995, with any change in the applicable Interest Rate to be effective as of the first day of the second quarter following the date of the financial statements reflecting such change in the Borrowers' EBIT Ratio or Total Liability to Tangible Net Worth Ratio, as the case may be.\nPrime Rate shall be defined as the interest rate announced from time to time by Sun Banks, Inc. as the Prime Rate (which rate is only a benchmark, is purely discretionary, and is not necessarily the best or lowest rate charged borrowing customers of any subsidiary of Sun Banks, Inc.), adjusted daily with each change in the Prime Rate.\nLIBOR shall be defined as the interest rate per annum announced from time to time by Sun Banks, Inc. as its LIBOR rate for comparable interest periods, in effect on the Interest Rate Determination Date.\nRegardless of the above, the Interest Rate shall never exceed the maximum rate allowed, from time to time, by law.\nCOLLATERAL: Perfected first priority security interest in (a) all of the Borrower's now or hereafter existing or acquired Accounts and Inventory, (b) all property of the Borrower now or at any time hereafter in the possession of the Bank in any capacity whatsoever, including, but not limited to, any deposit balances, accounts, items, certificates of deposit or monies, and (c) Proceeds of the foregoing.\nThe Bank will release its lien on the Borrower's Accounts and Inventory when (a) the Borrower's Total Liability to Tangible Net Worth Ratio is less than 1.9:1 and (b) the Borrower's EBIT Ratio exceeds 3.5:1, as reflected in Borrower's audited fiscal year end financial statements for any fiscal year. At such time as the Bank releases its lien on such collateral, (a) the Borrower shall grant a \"negative pledge\" as to such collateral\nto the Bank and shall promptly execute any documents requested by the Bank to evidence such negative pledge and (b) the maximum Total Liability to Tangible Net Worth Ratio requirement shall be changed to 2.0:1.\nLOAN FEES: The Borrower shall pay to the Bank a non-usage fee in the amount of one-fourth of one percent (.25%) per annum, based on a 360 day year, on the average unfunded portion of the Loan, which fee shall be billed and payable quarterly in arrears. Such non-usage fee shall accrue until the Bank's obligation to fund Advances under the Loan is terminated and shall be calculated by determining the daily average of the unused portion of the Loan with respect to each calendar quarter, multiplied by the product derived from the following formula:\none-fourth of one percent (0.25%) of the average derived above divided by 360 and multiplied by the number of days in the applicable calendar quarter.\nCROSS-DEFAULT\/ CROSS- COLLATERAL: The Loan and the documentation executed in connection therewith shall be cross-defaulted and cross- collateralized with all other obligations of the Borrower to the Bank.\nBANK'S COUNSEL: Charles T. Brumback, Jr., Esq. Akerman, Senterfitt & Eidson, P.A. P. O. Box 231 255 South Orange Avenue 17th Floor, Citrus Center Orlando, Florida 32802 (407) 843-7860\nThe Loan shall continue to be governed by and subject to the Loan Agreement, which shall be amended by an amendment thereto corresponding with and containing the terms and understandings of this commitment letter.\nOur proposal to renew, modify and extend the Loan is contingent upon the satisfaction of the following conditions, which may be waived by the Bank in its sole discretion.\n1. Approval of Documents. The Borrower shall duly execute and\/or deliver such instruments, documents, certificates, opinions of the Borrower's counsel and assurances, and do such other acts and things as the Bank may reasonably request, to effect the purpose of the transactions described in this commitment letter. All proceedings, agreements, instruments, documents, and other matters relating to the renewal, modification and extension of the Loan, and all other transactions herein contemplated, shall be satisfactory to the Bank and the Bank's Counsel and shall be drafted by the Bank's Counsel.\n2. Financial Statements, etc. During the term of the Loan, the Borrower shall submit such audited financial statements, internally prepared financial statements, 10-K and 10-Q reports and other financial information as currently required pursuant to the Loan Agreement. In addition, the Borrower shall submit (a) a monthly borrowing base certificate, in form and content satisfactory to the Bank, and certified to the Bank by an authorized financial officer of the Borrower, (b) quarterly, within forty-five (45) days after the end of each quarter, an accounts receivable aging report in reasonable detail and in form and substance satisfactory to the Bank and certified to the Bank by an authorized financial officer of the Borrower and (c) with reasonable promptness, such other financial information as the Bank may request. The Borrower shall permit the Bank or its agents to visit its places of business to review and inspect its books and records and to make extracts therefrom, and to discuss the affairs, finances and\naccounts of the Borrower with its officers at all reasonable times as may be requested. In addition, the Borrower will permit representatives of the Bank's asset based lending group to audit and inspect the Accounts of the Borrower on a periodic basis, no less frequently than quarterly and the cost of such audits shall be paid by the Borrower.\n3. Financial Covenants. The Borrower will, during the term of the Loan, comply with the following financial covenants and ratios currently provided for in the Loan Agreement, which shall be amended as follows:\n(a) Total Liability to Tangible Net Worth Ratio. During the term of the Loan Agreement, the Borrowers' Total Liabilities to Tangible Net Worth Ratio shall not exceed (i) 2.5:1 until such time as the Bank releases its lien on the Accounts and Inventory of Borrower, and (ii) 2.0:1 thereafter, tested annually.\n(b) Minimum Tangible Net Worth. During the term of the Loan Agreement, the Borrowers' Tangible Net Worth shall be at least $24,500,000.00 through April 30, 1995, tested annually, which minimum requirement shall increase by thirty-three percent (33%) of the Borrower's net profit as at the conclusion of the Borrower's fiscal year-end each year thereafter during the term of the Loan.\n(d) Current Ratio. During the term of the Loan Agreement, the Borrowers' Current Ratio shall be equal to or greater than 1.15:1, tested quarterly.\n(e) EBIT Ratio. During the term of the Loan Agreement, the Borrowers' EBIT Ratio shall be at least 2.5:1, tested quarterly.\nThe Working Capital Ratio requirement and the Cash Flow Ratio requirement currently provided for in the Loan Agreement shall be deleted from the Loan Agreement.\n4. Other Liens; Security Interests; Indebtedness. Except as otherwise explicitly permitted by the terms of the Loan Agreement, the Borrower will not, during the term of the Loan, incur, create, assume or permit to exist any further indebtedness, including, without limitation, capitalized lease obligations, or create any other lien or security interest against any of its assets now in existence or hereafter existing or acquired, without the prior written consent of the Bank.\n5. Restriction on Capital Expenditures. Except as specifically permitted in the Loan Agreement, during the term of the Loan, the Borrower and\/or its Subsidiaries on a consolidated basis shall not, without the prior consent of Bank, make capital expenditures for fixed assets or stock acquired in an acquisition in excess of $2,500,000.00 in the aggregate.\n6. Insurance. The Borrower shall maintain such policies of liability insurance, hazard insurance (with fire, extended coverage, vandalism and mischief protection) and flood insurance as the Bank may request, issued by a company or companies licensed to do business in the State of Georgia and in such other location where the Borrower's assets are located or operated.\n7. Fees and Expenses. By acceptance of this commitment, the Borrower agrees to pay any out-of-pocket expenses incurred by the Bank in connection with the underwriting of or incidental to the Loan, including any and all applicable documentary stamp and intangible taxes, recording fees, lien and title search fees, and all fees and expenses of the Bank's Counsel, and in each instance whether or not the renewal, modification and extension of the Loan is closed or any proceeds disbursed thereunder.\n8. Financial Condition. There shall have been no adverse change in financial condition of the Borrower as reflected in their most recent respective audited fiscal year end statements at the time of closing.\nUnless extended by the Bank in writing, this commitment shall expire at the close of business on June ___, 1995. This commitment is not assignable. If the terms and conditions set forth herein are acceptable to you, please so indicate by having the enclosed duplicate copy executed and returned to me by June ___, 1995. Otherwise, this commitment shall become null and void.\nIt is with great pleasure that Sun Bank agrees to renew and extend the Loan. On behalf of Sun Bank's management, I would like to express our appreciation of the confidence which the Borrower and you have placed in Sun Bank. We look forward to the continuation of the mutually rewarding relationship established with the Borrower. If you have any questions, please do not hesitate to call me at (407) 237-6788 or (800)432-4760 extension 6788.\nI look forward to working with you on this matter.\nBest regards,\nH. Robert Neinken Service Vice President\ncc: Charles T. Brumback, Jr., Esq.\nAccepted and Agreed to this 15th day of June, 1995:\nBORROWER:\nDAVIS WATER & WASTE INDUSTRIES, INC.\nBy:_______________________________ Name: Stan White Title: Secretary\/Treasure (CORPORATE SEAL)\nExhibit 13\n1995 Annual Report\nABOUT OUR COMPANY\nDavis Water & Waste Industries, Inc. manufactures and markets products relating to the distribution of water and the treatment of water and wastewater. The Company markets a broad line of water distribution equipment and supplies, including underground pipe, pipe fittings, valves, fire hydrants, water meters and related equipment, and believes that it is the largest distributor of water distribution equipment and supplies in the Southeast, based on annual sales of such products. The Company also designs, engineers, manufactures, sells and installs water and wastewater treatment and pumping equipment. From humble beginnings, Davis has grown from a small regional company to become a New York Stock Exchange listed company with over 670 employees nationwide. Its mission is to meet the growing demand for clean water into the 21st Century.\nFinancial Highlights\nTO OUR STOCKHOLDERS:\nFiscal 1995 was a record year in both sales and net profit. Sales for fiscal 1995 were $215,649,362, up 6.4% from fiscal 1994. Net income was $3,448,227 as compared to a net loss of $5,340,258 for fiscal 1994. On a per share basis, net income was $1.06 as compared to net loss of $1.64 in fiscal 1994.\nThe Distribution Group's net sales for fiscal 1995 increased by $22,393,842, or 15.5% over fiscal 1994. The increased sales of the Distribution Group are attributed to the improvement in the economy and its positive effects on commercial and residential land development. The Distribution Group is currently in the process of opening two new locations, one in Florida and the other in the Atlanta area to capitalize on the improvement in the economy and the increased demand for the Company's products. Sales of the Water Treatment Group were down for fiscal 1995 compared to fiscal 1994 as a result of the shutdown of the Turbitrol Company, a division of The Taulman Company. However, the remaining operations in the Water Treatment Group recorded an increase in net sales for fiscal 1995 of $4,585,158, or 10.8%. The Water Treatment Group's backlog for fiscal 1995 has declined compared to fiscal 1994 levels due to the shutdown of Turbitrol, but increased bookings for the first two and a half months of fiscal 1996 indicate that the Water Treatment Group's backlog should return to a strong level by mid year.\nAs a result of the Company's improved performance during the first two quarters of fiscal 1995, the Board of Directors approved a semi-annual cash dividend of eight cents ($0.08) per share which was paid during the third quarter of fiscal 1995. Also, as a result of subsequent improvements in the Company's financial position, the Board of Directors approved a second semi-annual cash dividend in the amount of fourteen cents ($0.14) per share, which was paid on July 3, 1995 to shareholders of record on June 26, 1995. The payment of the two semi-annual cash dividends reflects our continuing strong operating results, our confidence in the future, and the Company's dedication to enhancing shareholder value.\nAll of us at Davis Water & Waste are proud of our record year in fiscal 1995 and excited about the new year. Management is optimistic that fiscal 1996 will be even better than fiscal 1995, and all current indications tend to confirm this. Housing starts are much improved and interest rates are not expected to increase, as indicated by the June 6, 1995 reduction announced by the Federal Reserve.\nManagement of your Company is dedicated to maximizing the return on stockholders' equity through outstanding service to our customers, efficient control of costs and margins, internal growth, and sensible acquisitions. Management extends sincere appreciation to our customers, our dedicated employees and our loyal stockholders for their support and contribution to the Company's success. We look forward with you to the continuing improvement in the Company's performance and financial results during fiscal 1996.\nR. Doyle White\nChairman of the Board, President and Chief Executive Officer\nREVIEW OF OPERATIONS\nThe Davis name has been associated with water for more than half a century. A family-owned Georgia business founded in 1938 to supply hardware for community waterworks was incorporated as Davis Water & Waste Industries, Inc. (the \"Company\" or \"Davis\") in 1956. The Company has subsequently expanded beyond its Southeast regional market to become a nationally-recognized supplier of water distribution products and water and wastewater treatment and pumping equipment. The Davis name was highlighted in 1987 when the Company listed its common stock on the New York Stock Exchange.\nAlthough the Company encountered a mild downturn in its net sales during fiscal 1992 and 1993, the Company has grown substantially since the early 1980's and reported record sales in fiscal 1995. This growth is attributable primarily to the implementation of an acquisition and expansion strategy during the mid - 1980's, which led to expansion into new markets and increased market share, and to the introduction of new water treatment products. The Company is cautiously optimistic that its performance in fiscal 1996 will reflect continued financial growth in conjunction with the continued improvements in the national economy.\nThe Company generates the major portion of its revenues from its tradi- tional business of marketing water distribution equipment and supplies, including underground pipe, pipe fittings, valves, fire hydrants and water meters. These products are purchased from numerous manufacturers for distribution through a network of 23 service center warehouses in 9 Southern and Western states. These products are sold principally to independent contractors, industrial customers, municipalities and other government agencies, and private utilities. The Company believes that it is the largest distributor of water distribution equipment and supplies in the Southeast, based on annual sales of such products.\nDavis also offers comprehensive, turnkey solutions to the growing public concern about water quality and wastewater treatment. The Company custom designs, manufactures and installs water and wastewater treatment equipment custom tailored for municipal and industrial use and distributes related materials that enable municipalities and industry to meet applicable health and water quality standards. Water treatment plants and wastewater systems that process up to five million gallons of water per day are among the large systems built by Davis at its Thomasville, Georgia facilities and sold throughout the United States by the Company's sales force and manufacturer's representatives. The Company also offers process materials that are used to control odor in municipal wastewater collection and treatment systems and other process materials that treat water and condition sludge for disposal. These products are distributed by the Company through its own sales force and manufacturer's representatives primarily to municipal and industrial customers.\nThe following table illustrates the contributions to the Company's annual sales, operating income (loss), and assets attributable to regions of the United States served by the Company. Export sales are included in \"Other.\"\nThe Company's export sales in fiscal 1995, 1994 and 1993 totaled $1,120,000, $1,776,000, and $5,003,000, respectively. Export sales consisted principally of water and wastewater treatment equipment and were made primarily in Canada, Mexico, and Puerto Rico.\nVarious divisions of the Company offer a wide variety of specialized products and services that contribute to the overall performance of the Company. A few examples of the specialized products and services provided by these divisions are noted below.\nWater Distribution Equipment and Supplies\nThe Distribution Group distributes a broad line of water distribution equipment and supplies. These products include underground pipe, pipe fittings, valves, fire hydrants, water meters and related products. The Distribution Group operates 23 Service Centers and handles more than 20,000 products from over 3,000 vendors. The Company's estimated 20,000 customers consist of municipal and other government agencies, private utilities, industrial companies, and independent contractors. The products are used by customers in their water distribution infrastructure systems for maintenance and repair, upgrading, and construction of new facilities.\nTo assist its customers' response to the increasing need to lower costs, the Distribution Group has instituted several technology initiatives, including:\nAn integrated management information system A part number interchange program An on-line order information system A job materials management system\nThese systems consist of microcomputers containing the Distribution Group's proprietary software installed at the customer's location. Using dial up capabilities to the nearest Distribution Group location, the customer is then connected by high speed telecommunication lines to the appropriate Distribution Group database. The customer has immediate access to information which assists the customer in reducing procurement costs.\nThe increased application of technology, along with a focused effort to better identify customer needs and provide solutions to reduce customers' total cost, is designed to increase the Company's value to the customer and thereby increase the Company's market share.\nThe Company believes that it is the only national distribution company focused entirely on water related infrastructure equipment and supplies.\nWater and Wastewater Treatment and Pumping Equipment\nThe Davis Industrial Waste Systems Group within the DAVCO division provides its industrial customers with a turnkey treatment system to assist in complying with the EPA requirement that contaminants be reduced in wastewater to approximately the strength of typical domestic sewage before it reaches a municipal treatment facility. Davis IWS also provides advanced and secondary treatment systems for direct and indirect discharges. In addition, construction management services, plant operations and maintenance, and treatability\/pilot studies are offered by Davis IWS.\nThe DAVCO division builds advanced wastewater treatment systems on site which are able to meet the most stringent environmental requirements, including biological nutrient removal systems. DAVCO also builds a tertiary wastewater treatment system, the discharge from which can be used in such applications as golf course irrigation, thereby reducing the demand for potable water.\nThe Davis-EMU Group within the DAVCO division sells submersible pumps, mixers and aerators designed and built by the German company EMU Unterwasserpumpen. This equipment is used to pump, mix and aerate wastewater. Davis-EMU is a major supplier of submersibles for large municipal projects in the United States.\nThe Davis Process division manufactures, distributes and supplies a variety of technology based products, equipment and services used in the treatment and processing of water and wastewater. The products include ODOPHOS, a solution used for nutrient and hydrogen sulfide removal in wastewater treatment systems; BIOXIDE, a patented biochemical process for the treatment and prevention of hydrogen sulfide in wastewater collection systems; POLYSTAGE scrubbers, a patented line of multistage scrubbers and biofilter systems used primarily for the treatment of contaminated air and vapors generated in collection and treatment systems; and ALKA-PRO, a patented biological process control system for the effective and efficient control of biological treatment processes. Additionally, the Davis Process division provides full service environmental and potable water laboratory analysis, product storage and feed systems, maintenance services and odor surveys.\nThe Davis Composting and Residuals Management Group designs, manufactures and markets equipment, processes and service for the treatment and beneficial reuse of water and wastewater residuals. The demand for these products and services has increased significantly in recent years in response to new Environmental Protection Agency regulations related to the processing and beneficial reuse of wastewater residuals. Davis has the largest installed base of residuals compost systems in North America. In addition to residuals compost systems, this group also supplies lime stabilization systems, residuals driers and residuals management services. This complete line of products and services enables Davis to provide our customers with the most efficient and effective solutions to their residual processing needs.\nSelected Consolidated Financial Data\nSelected Consolidated Financial Data\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nOverview\nDuring fiscal 1995, the Company reported a record year in both net sales and net income. The Company recorded net income of $3,448,000 or $1.06 per share for fiscal 1995 compared to a net loss of $5,340,000 or $1.64 per share for fiscal 1994 and net income of $653,000 or $ .20 per share for fiscal 1993. The Company's net sales for fiscal 1995 were $215,649,000, an increase of $13,028,000, or 6.4%, compared to fiscal 1994 net sales of $202,621,000. Fiscal 1994 net sales reflected a 6.1% improvement over fiscal 1993 net sales of $190,990,000. The improved results for fiscal 1995 compared to fiscal 1994 are due to improved performance by the Company's water distribution business, which reflects the improvement in the economy nationwide, and the shutdown of The Turbitrol Instrumentation and Controls of The Taulman Company (\"Taulman\") late in fiscal 1994. The results for fiscal 1994 compared to fiscal 1993 reflect the writedown of the Company's investment in Taulman to its realizable value and the establishment of a reserve for the shutdown of the Turbitrol division of Taulman. The adjustment for the write down and reserve resulted in an $8,895,000 pre-tax charge in fiscal 1994. Excluding the writedown and shutdown adjustment, the results for fiscal 1994 would have reflected net income of $499,000 before taxes.\nNet sales\nNet sales for fiscal 1995 increased 6.4% as compared to fiscal 1994, while fiscal 1994 net sales increased 6.1% as compared to fiscal 1993. Set forth below is sales information for the past three fiscal years regarding the Company's principal product classes:\nNet sales by the Company's water distribution business increased by 15.5% in fiscal 1995 as compared to fiscal 1994 and increased by 14.4% in fiscal 1994 when compared to fiscal 1993. The increase in net sales in each period is attributed to increased activity in the commercial and residential land development and construction markets as a result of the improvement in the national economy and the increased efforts by the Company's sales force to increase sales. This increased activity led to an increased demand for the Company's water distribution products, which resulted in both increased sales volume and generally higher per unit prices.\nNet sales by the Company's water and wastewater treatment business decreased by 16.1% in fiscal 1995 as compared to fiscal 1994 and decreased by 10.1% in fiscal 1994 as compared to fiscal 1993. The decrease in water and wastewater treatment sales for fiscal 1995 is a direct result of the Taulman shutdown in the fourth quarter of fiscal 1994. Operating results for fiscal 1995 exclude the operations of the Turbitrol division of Taulman. (See Note 2 of Notes to Consolidated Financial Statements.) Excluding the effects of the Taulman shutdown, net sales by the remainder of the water and wastewater treatment business increased by 10.8% in fiscal 1995 as compared to fiscal 1994. The increase in net sales was due to the improvement in the economy, which increased the volume of products sold. The decrease in water and wastewater treatment sales for fiscal 1994 as compared to fiscal 1993 is a direct result of reduced sales by Taulman in fiscal 1994.\nManagement is cautiously optimistic that sales of distribution products will increase in fiscal 1996 due to anticipated continued improvement in the economy, the land development and construction markets in particular, from lower long-term interest rates.\nCost of products sold\nThe gross profit margin (the difference between net sales and cost of products sold expressed as a percentage of net sales) was 14.8% for both fiscal 1995 and fiscal 1994 and was 16.5% for fiscal 1993. The gross profit margin for fiscal 1995 as compared to fiscal 1994 remained unchanged, although the gross profit margin for fiscal 1995 excluded the operating results of the Turbitrol division of Taulman.\nThe overall decrease in the margin for fiscal 1994 as compared to fiscal 1993 was attributable primarily to a decrease in Taulman's gross profit margin to 8.9% in fiscal 1994 from 24.9% in fiscal 1993. During fiscal 1993, the gross profit margin included the settlement of a claim by the Company against the former stockholders of Taulman which resulted in a $495,000 reduction in cost of products sold during fiscal 1993. This served to reimburse the Company for cost overruns on long-term contracts which the Company had previously recognized during fiscal 1991 and fiscal 1992. (See Note 8 of Notes to Consolidated Financial Statements.)\nSelling, general and administrative expenses\nWhen measured as a percentage of net sales, selling, general and adminis- trative expenses were 11.4%, 14.0%, and 15.7% for fiscal 1995, 1994 and 1993, respectively. The decrease in selling, general and administrative expense as a percentage of net sales for fiscal 1995 as compared to fiscal 1994 is attributed to the 6.4% increase in sales and a $3,978,000 decrease in expenses. The decrease in expenses is primarily due to the exclusion of the operating results of Taulman from the fiscal 1995 operating results and management's continuing efforts to reduce costs where possible.\nThe decreased selling, general and administrative expenses as a percentage of net sales for fiscal 1994 as compared to fiscal 1993 is due primarily to the high cost associated with relocating the Company's distribution centers to more profitable markets during fiscal 1993.\nInterest expense\nInterest expense increased by 6.6% in fiscal 1995 as compared to fiscal 1994 and decreased by 11.5% in fiscal 1994 as compared to fiscal 1993. The increase from fiscal 1994 to fiscal 1995 was due primarily to an increase in the average borrowing rate, despite a decline in the average amount of long-term and short-term debt. During fiscal 1995, the Company's average borrowing rate increased 160 basis points, or 25.4%, while average borrowings declined by $3,482,000, or 16.5%, when compared to fiscal 1994. The increase in the average borrowing rate was due to higher rates which were established in connection with a renegotiation of the Sun Bank revolving loan agreement during fiscal 1994. (See Note 4 of Notes to Consolidated Financial Statements). The decrease in average borrowings from fiscal 1995 to fiscal 1994 was a result of management's continued efforts to control inventories and improvements in average days to collect accounts receivable.\nThe 11.5% decrease in interest expense from fiscal 1993 to fiscal 1994 was due to a $5,372,000, or 20.2%, decline in average borrowings, despite an increase of 80 basis points, or 14.5%, in the Company's average borrowing rate. The reasons for the decline in average borrowings in fiscal 1994 were the same as in fiscal 1995.\nManagement believes that the Company's fiscal 1996 interest expense will decrease slightly from 1995 levels based on a reduction in the Company's average borrowing rate as a result of an amendment in June 1995 to the Company's revolving loan agreement with Sun Bank. (See Note 4 of Notes to\nConsolidated Financial Statements.)\nProvision (benefit) for income taxes\nThe effective income tax provision (benefit) rates for fiscal 1995, 1994 and 1993 were 40.6%, (36.4%) and 50.3%, respectively. The effective tax rate for fiscal 1995 was higher than the federal statutory rate due to the impact of state income taxes and an increase in the nondeductible portion of meals and entertainment expenses. The Omnibus Budget Reconciliation Act of 1993 (\"OBRA\"), which was enacted on August 10, 1993, raised the statutory corporate income rate from 34% on taxable income in excess of $10,000,000 and limited deductibility of meals and entertainment expenses. Based upon OBRA's enactment date, OBRA did not impact fiscal 1994 results of operations, but by limiting the deduction of meals and entertainment costs, OBRA increased income tax expense during fiscal 1995 by approximately $89,000, or $.03 per share.\nThe effective tax rate (benefit) for fiscal 1994 was higher than the federal statutory rate due to the additional state income tax benefit, which was somewhat offset by the nondeductible portion of meals and entertainment expenses. The effective rate for fiscal 1993 was higher than the federal statutory rate due to the nondeductible portion of meals and entertainment expenses.\nIn the second quarter of fiscal 1994, the Company agreed to a settlement with the Internal Revenue Service (\"IRS\") in connection with its examination of the Company's federal income tax returns for the four years ended April 30, 1992. The IRS adjustments related principally to the timing of recognition of certain expense items for tax purposes. The aggregate amount allocated to various identifiable intangible assets and their weighted average lives were not significantly changed. The effects of these adjustments did not materially impact the Company's results of operations or financial position.\nLIQUIDITY AND CAPITAL RESOURCES\nThe primary sources of liquidity for the Company are funds generated internally from operations and bank borrowings. Set forth below for the past three years is information regarding the sources and amounts of internally generated funds:\nWhen internally generated funds have been insufficient to support operations, capital expenditures and acquisitions, the Company has been able to borrow funds to meet its needs.\nAt April 30, 1995, the Company had $18,890,000 of available borrowing capacity under its revolving loan agreement with Sun Bank. These available funds, together with a cash balance of approximately $3,746,000, placed the\nCompany's potential cash availability at $22,636,000 as of April 30, 1995. As of June 15, 1995, the Company's available borrowing capacity under its Revolving Loan Agreement was reduced by $2,000,000. ( See Note 4 of Notes to Consolidated Financial Statements.) Management believes that the Company's internally generated funds and the amount available under the revolving term loan agreement are sufficient to support its activities for the foreseeable future. At the present time, the Company has no commitments for significant capital expenditures or acquisitions of other businesses.\nThe Company's working capital decreased in fiscal 1995 by $1,138,000 when compared to fiscal 1994. The decrease in working capital was due primarily to an increase in accounts payable of $2,921,000 offset by a decrease in inventories of $1,748,000. The Company's working capital decreased in fiscal 1994 by $2,051,000 when compared to fiscal 1993. This decrease in working capital was due primarily to an increase in accounts payable and other accrued liabilities totaling $9,231,000. The major component of the increase in other accrued liabilities was the $5,987,000 reserve established for the shutdown of the Turbitrol Division of Taulman. (See Note 2 of Notes to Consolidated Financial Statements). Set forth below is the Company's working capital position and certain liquidity comparisons at the dates indicated:\nThe two most significant tangible assets of the Company are accounts receivable and inventory. The Company measures the effectiveness of its accounts receivable management program by a calculation which estimates the number of days which it takes the Company to collect accounts receivable. For fiscal 1995, the Company's average number of days to collect its accounts receivable decreased 4.6 days as compared to fiscal 1994. The decrease in days outstanding in fiscal 1995 when compared to fiscal 1994 reflected in an increase in accounts receivable of only $637,000, or 1.6%, despite an increase in net sales of 6.4%. For fiscal 1994, the Company's average number of days to collect its accounts receivable decreased by 2.5 days as compared to fiscal 1993. The decrease in average days outstanding in fiscal 1994 when compared to fiscal 1993 is attributable to the $11,631,000 increase in sales with only a $1,058,000 increase in accounts receivable.\nThe Company measures the effectiveness of its inventory management program by a calculation which uses average quarterly inventory amounts to estimate the number of times inventory turns on an annual basis. For fiscal 1995, the Company's inventory turns increased by half a complete turn when compared to fiscal 1994 and by over one complete turn when compared to fiscal 1993. The increase is due to management's efforts to maintain a lower level of inventory while continuing to ensure adequate product availability.\nAverage long-term and short-term borrowings decreased by $3,482,000, or 16.5%, during fiscal 1995 when compared to fiscal 1994. This decrease is due to the profitability of the Company, management's efforts to improve collection of accounts receivable and the Company's computerized inventory program which enables the Company to better manage its inventory levels and its purchasing program. The Company's average borrowing rate increased 160 basis points during fiscal 1995 when compared to fiscal 1994 due to higher rates under the Sun Bank revolving loan agreement. (See Note 4 of Notes to Consolidated Financial Statements.) The table below sets forth average borrowing balances and the average interest rate over the past three fiscal years.\nThe payment of cash dividends is approved by the Board of Directors and depends, among other factors, on earnings, capital requirements, and the operating and financial condition of the Company. Additionally, under the terms of the Company's line of credit with Sun Bank, any cash dividend payment must be approved by Sun Bank. During the third quarter of fiscal 1992, as a result of losses sustained by the Company, the Board of Directors elected to forego the payment of cash dividends. Due to improved operating results during fiscal 1995, the Board of Directors, with the approval of Sun Bank, elected to pay a cash dividend of $0.08 per share during the third quarter of fiscal 1995 and, with the approval of Sun Bank, paid a second cash dividend of $0.14 per share in the first quarter of fiscal 1996.\nSEASONALITY\nThe Company typically experiences a seasonal downturn in the third fiscal quarter of each year. Harsh weather during the third fiscal quarter usually restricts construction activities in the Company's more northern and mountainous sales markets, thereby reducing the demand for the Company's products in these areas. This seasonality is normally reflected in reduced sales and earnings of the Company in the third quarter. Certain portions of the Company's sales markets, notably South Georgia, Florida, Texas, Arizona, Nevada and Southern California, are not significantly affected by the seasonal change. (See Note 10 of Notes to Consolidated Financial Statements.)\nIMPACT OF INFLATION\nInflationary pressures were moderate over most of the past three years. To date, the Company has been able to offset most cost increases through periodic price increases, labor efficiencies and higher productivity.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Stockholders of DAVIS WATER & WASTE INDUSTRIES, Inc.\nIn our opinion, the accompanying consolidated balance sheet and the related consolidated statements of operations, of changes in stockholders' equity and of cash flows present fairly, in all material respects, the financial position of DAVIS WATER & WASTE INDUSTRIES, Inc. and its subsidiary at April 30, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended April 30, 1995, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.\nAs discussed in Note 1 to the consolidated financial statements, the Company changed its method of accounting for income taxes in 1993.\nPrice Waterhouse LLP Atlanta, Georgia June 16, 1995\nMANAGEMENT'S RESPONSIBILITY FOR FINANCIAL STATEMENTS\nThe consolidated financial statements included in this report were prepared by the Company in conformity with generally accepted accounting principles. Management's best estimates and judgments were used where appropriate. Management is responsible for the integrity of the financial statements and for other financial information included in this report. The financial statements have been audited by the Company's independent accountants, Price Waterhouse LLP. As set forth in their report, their audit was conducted in accordance with generally accepted auditing standards and formed the basis for their opinion on the accompanying financial statements. They evaluated the system of internal accounting controls and performed such tests and other procedures as they deemed necessary to reach and express an opinion on the fairness of the financial statements.\nThe Company maintains a system of internal accounting controls which is designed to provide a reasonable assurance that assets are safeguarded and that the financial records reflect the authorized transactions of the Company. As a part of this process, the Company has an internal auditor who evaluates the adequacy and effectiveness of internal accounting controls.\nThe Audit Committee of the Board of Directors is composed of Directors who are neither officers nor employees of the Company. The Committee meets periodically with management, the internal auditor and the independent accountants to discuss auditing, internal accounting control and financial reporting matters. The internal auditor and the independent accountants have full and free access to meet with the Audit Committee, with and without management being present.\nR. Doyle White Stan White Chairman of the Board, Secretary\/Treasurer President and Chief and Chief Financial Officer Executive Officer\nConsolidated Statement of Operations\n(The accompanying notes are an integral part of these financial statements.)\nConsolidated Balance Sheet\n(The accompanying notes are an integral part of these financial statements.)\nConsolidated Statement of Changes in Stockholders' Equity\n(The accompanying notes are an integral part of these financial statements.)\nConsolidated Statement of Cash Flows\n(The accompanying notes are an integral part of these financial statements.)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - APRIL 30, 1995, 1994, and 1993\nNote 1 - Description of Business and Summary of Significant Accounting Policies:\nDESCRIPTION OF BUSINESS\nThe Company manufactures and markets products relating to the distribution and treatment of water.\nBASIS OF PRESENTATION\nThe accompanying financial statements include the accounts of the Company and its wholly-owned subsidiary, The Taulman Company. All significant intercompany balances and transactions have been eliminated in consolidation. Certain amounts in the prior year statements have been reclassified to conform to the current year presentation.\nACCOUNTS RECEIVABLE\nAccounts receivable at April 30, 1995 and 1994 include amounts under long- term contracts of approximately $4,060,000 and $8,503,000, respectively. Balances billed but not paid by customers pursuant to retainage provisions in long-term contracts will be due upon completion of the contracts and acceptance by the owner and aggregated approximately $2,216,000 and $2,735,000 at April 30, 1995 and 1994, respectively. Approximately $788,000 of these retention balances are expected to be collected during fiscal 1996, with the remainder to be collected during the following year.\nCONCENTRATION OF CREDIT RISK\nThe Company grants credit to its customers, who are primarily involved in the construction and real estate industries, including independent contractors, developers, municipalities and industrial customers. To secure its interest in trade accounts receivable, the Company obtains bonds or liens where considered prudent. The majority of the Company's sales are made to customers located in the Southeast. Other important markets include Texas, California and the Rocky Mountain states.\nINVENTORIES\nInventories are carried at the lower of cost (first-in, first-out) or market value.\nPROPERTY, PLANT AND EQUIPMENT\nFixed assets are stated at cost. Depreciation is calculated using principally the straight-line method over the estimated useful lives of the assets. Expenditures for additions and improvements are charged to property accounts; maintenance and repairs are charged to expense. Upon retirement or sale, the cost of the asset and related accumulated depreciation are removed from the accounts and any resulting gain or loss is included in income.\nThe approximate annual rates of depreciation are 4% to 14% for buildings and improvements, 14% to 20% for manufacturing equipment and 14% to 33 1\/3% for transportation and office equipment.\nINTANGIBLE ASSETS\nIntangible assets resulting from the acquisition of certain assets and liabilities of Taulman were being amortized on a straight line basis over their estimated useful lives ranging from one to 40 years. As a result of the shutdown or reorganization of Taulman, these intangibles were written off (see\nNote 2).\nTREASURY STOCK\nTreasury stock is carried at cost determined using the first-in, first-out method. Any excess of cost over proceeds from re-issuance of treasury stock is charged to retained earnings; any excess of proceeds over cost is credited to retained earnings to the extent of any prior charges and thereafter credited to capital in excess of par.\nREVENUE\nIncome from short-term contracts for the manufacture or installation of water and wastewater treatment and pumping equipment is recognized at time of shipment or when installation is completed, respectively. Income from long- term contracts for the manufacture of process equipment and control systems used in water and wastewater treatment facilities was recognized on the percentage-of-completion basis; however, revenues are no longer recognized in the Company's operations for these types of contracts due to the shutdown of Taulman. Income is recognized from the sale of water distribution equipment and supplies and process materials and supplies at the time of shipment. Commission income from the sale of products manufactured by others is recognized when the customer's order is shipped by the third party manufacturer.\nINCOME TAXES\nEffective May 1, 1992, the Company elected early adoption of SFAS No. 109, \"Accounting for Income Taxes\" (FAS 109). The adoption of FAS 109 changes the Company's method of accounting for income taxes from the deferred method (APB 11) to an asset and liability approach. Previously the Company deferred the past 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 of temporary differences between the carrying amounts and the tax basis of other assets and liabilities. The cumulative effect of this change in accounting principle was a $459,000 reduction in the Company's deferred tax liability. This reduction primarily represented the impact of adjusting deferred taxes to reflect the current federal tax rate of 34% as opposed to the higher tax rates that were in effect when the deferred taxes originated. The effect of the change on net income for fiscal 1993, exclusive of the cumulative effect of the change as of May 1, 1992, was immaterial.\nNET INCOME (LOSS) PER SHARE\nNet income (loss) per share is computed by dividing net income (loss) by the average number of common shares outstanding, increased by common equivalent shares determined using the treasury stock method.\nSTATEMENT OF CASH FLOWS\nCash equivalents are considered to be short term, highly liquid investments with original maturities of three months or less.\nSupplemental disclosure of cash flows follows:\nNote 2 - Provision for Taulman Shutdown and Related Intangible Assets:\nDuring the fourth quarter of fiscal 1994, the Company adopted a plan to shutdown or reorganize the operations of Taulman. Substantially all of Taulman's operations are contained within its Turbitrol Instrumentation and Control division; these operations are in the process of being shut down. Taulman Composting Systems, an immaterial component of Taulman, was combined with the Company's Process division. The pre-tax loss provision for these actions recorded in fiscal 1994 includes the write-off of intangible assets totalling $2,908,000 associated with Taulman and the accrual of $5,987,000 to provide for anticipated losses during the shutdown period. Accordingly, the results of operations of Taulman during fiscal 1995 were excluded from the results of operations of the Company.\nTaulman is engaged in the environmental pollution control business, primarily through the design, manufacture and sale of process equipment and control systems used in water and wastewater treatment facilities. Revenues and expenses on its long- term contracts are recognized on the percentage-of - completion basis. Taulman has ceased bidding on new contracts, has terminated its sales force and is working to complete its current obligations on long- term contracts during the next two years. The provision for losses during the shutdown period reflects declining revenues and relatively high levels of general and administrative costs necessary to complete the shutdown of these operations.\nDuring fiscal 1995, activity within the reserve for anticipated losses during the shutdown period is summarized as follows:\nThe adjustment to the reserve represents an increase in the reserve resulting from a revised estimate of the anticipated losses during the shutdown period. There have been no changes to the plan for shutting down Taulman since the adoption of the plan in the fourth quarter of fiscal 1994.\nThe Taulman shutdown represents the discontinuation of a product line. Therefore, Taulman's results of operations through the fourth quarter of fiscal 1994 have been included as components of continuing operations in the statement of operations for fiscal 1994 and fiscal 1993. Taulman's results of operations during fiscal 1995 and in future periods have been or will be charged against the reserve for anticipated losses during the shutdown period. Certain income, expense, asset and liability information with respect to Taulman for the three most recent fiscal years is as follows:\nAssets and liabilities at April 30, 1995 1994 and 1993 consisted primarily of accounts receivable, inventory, accounts payable, accrued expenses and intercompany debt.\nIntangible assets written off as a part of the shutdown included a technology licensing agreement of $1,321,000, noncompete agreements of $1,155,000 and goodwill of $432,000. The technology licensing agreement was written off because the Company, in response to changing marketplace demands, elected to forego its exclusive North American rights to this waste composting technology during the fourth quarter of fiscal 1994. Recently developed methods for waste composting are much more economical and substantially reduced the demand for the Company's licensed technology. The noncompete agreements and goodwill were written off because their value will not be recovered as a result of the shutdown.\nNote 3 - Inventories:\nInventories are summarized as follows:\nNote 4 - Notes Payable and Long-Term Debt:\nThe Company's line of credit with Sun Bank, National Association (\"SBNA\") provided a $32,000,000 revolving term loan as well as an annual $3,000,000 overline facility as of April 30, 1995. The loan agreement required the Company to maintain specified working capital, equity and earnings ratios in addition to minimum levels of tangible net worth. The loan agreement effectively curtailed the payment of cash dividends by specifying certain minimum levels of tangible net worth. Furthermore, the agreement required the Company to obtain SBNA's approval prior to payment of any cash dividends. The Company's accounts receivable and inventory served as collateral under the agreement. The Company was not in compliance with the working capital requirement as of April 30, 1995. On June 15, 1995, the Company and SBNA signed a commitment letter that extends the loan maturity through April 30, 1997, provides specific guidelines that the Company must meet to eliminate the security interest that SBNA has on the Company's accounts receivable and inventory, eliminates the working capital requirement with which the Company was not in compliance at April 30, 1995 and limits the amount that the Company may spend in connection with acquisitions to $2,500,000 per year during the term of the loan agreement without the prior consent of SBNA.\nAs of April 30, 1995, the interest on balances outstanding under the SBNA revolving term note was payable at SBNA's prime commercial rate. The Company pays a commitment fee equal to one-fourth of one percent per annum on the average daily unused portion of the revolving term note. The June 15, 1995 commitment letter allows the Company the option to change between the then current prime rate or the then current LIBOR rate plus two percent for advances under the revolving term loan.\nNotes payable and long-term debt consist of:\nAnnual maturities of long-term debt in each of the succeeding five years from April 30, 1995 are approximately $249; $13,323; $103; $0; and $0 respectively. Loans payable to insurance companies secured by cash surrender value in the amount of $1,361 do not have a stated maturity date.\nNote 5 - Pension 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 highest average compensation earned during any consecutive five- year period within the last ten years of employment, reduced by payments from Social Security. Pension cost is funded at amounts determined by management but not less than the minimum funding required by the Employee Retirement Income Security Act of 1974 (ERISA). At April 30, 1995, the assets of this Plan included cash equivalents and equity and fixed income mutual funds. Participants of certain acquired companies received service credit for vesting in the Plan upon date of acquisition or termination of any former benefit plans. The cost of these benefits will be amortized over 18 years, which is the average remaining service period of the participants.\nThe Company also has a supplemental defined benefit pension plan (the Supplemental Plan) covering all Company officers. The Supplemental Plan provides for annual disability benefits in amounts of 50% - 80% of base pay at the time of the disabling injury, to be paid to participants who become permanently disabled. This benefit will terminate at age 65. Additionally, the Supplemental Plan provides for retirement benefits to participants representing approximately 50% - 80% of base pay at the date of retirement, reduced by payments from Social Security. These retirement benefits will be paid over the expected lifetime of the participant. The Company has not funded the Supplemental Plan. This plan is not subject to ERISA funding requirements. The Company intends to fund the Supplemental Plan as benefits are paid.\nNote 6 - Income Taxes:\nThe components of the provision for income tax expense (benefit) are as follows:\nDeferred tax liabilities (assets) recorded under FAS 109 are comprised of the following at April 30, 1995 and 1994 :\nA reconciliation between the actual income tax expense (benefit) and the amount computed by applying the federal income tax rate (34.0%) in 1995, 1994 and in 1993 to pre- tax income from continuing operations follows:\nNote 7 - Stockholders' Equity:\nDuring the third quarter of fiscal 1995, the Board of Directors approved the Davis Water & Waste Industries, Inc. 1994 Employee Stock Option Plan (the \" Employees Plan\") and the Davis Water & Waste Industries, Inc. Directors Stock Option Plan (the \"Directors Plan\"). Both Plans are subject to approval by the stockholders of the Company at the 1995 Annual Meeting of Stockholders on September 8, 1995.\nUnder the Employees Plan and the Directors Plan (the \"Plans\"), options to acquire up to 250,000 and 75,000 shares of the Company's common stock, respectively, may be granted to employees and outside directors of the Company, respectively, by a committee of the Board of Directors. No options may be granted after ten years from the date of approval of the Plans by the Board. Options granted under the Plans vest evenly over five years and are exercisable for a period not exceeding ten years after the date of grant at a price equal to the quoted market value of the common stock as of the date of grant. Optionees may exercise the options by paying cash, exchanging Company stock having a quoted market value equal to or less than the exercise price, by instructing the Company to retain shares of stock upon the exercise of the option with a quoted market value equal to the exercise price as payment, or exchanging property or services as may be acceptable to the committee of the Board. The options are not transferrable except to the optionee's beneficiaries. The Plans may be amended or terminated at the discretion of the Board. Compensation expense is accrued for the Plans for options as earned by the optionees as the difference between the quoted market price at the period end and the option price multiplied by the number of options. Accrued compensation expense is adjusted for the changes in the quoted market value of the stock from period to period. At April 30, 1995, total compensation expense accrued for the Plans aggregated approximately $74,000.\nUnder the Employees Plan, the Board granted options to acquire 162,660 shares to certain Company officers at an option price of $7.75 per share, which was equal to the quoted market price for the shares of the Company's common stock at the date of grant. All such options were outstanding at April 30, 1995. No options were exercised, cancelled or expired during fiscal year 1995. At April 30, 1995, options for the purchase of 87,340 shares of common stock were available to be granted under the Employees Plan.\nUnder the Directors Plan, options to acquire 32,000 shares of common stock were granted to the outside directors of the Company at an option price of $7.75 per share, which was equal to the quoted market price for the shares of the Company's common stock at the date of grant. All such options were outstanding at April 30, 1995. No options were exercised, cancelled or expired during fiscal 1995. At April 30, 1995, options for the purchase of 43,000 shares of common stock were available to be granted under the Directors Plan.\nDuring fiscal 1989, the stockholders of the Company approved a qualified employee stock purchase plan (the\"1988 ESP Plan\"). During fiscal 1992, the stockholders of the Company approved an amendment to the 1988 ESP Plan increasing the shares of common stock reserved for issuance under this plan from 80,000 to 160,000 shares. Under the terms of the 1988 ESP Plan, all regular full time employees and officers of the Company may purchase common stock of the Company quarterly at 85% of the lower of market value on the offering date or the termination date of the offering period. The 1988 ESP Plan will terminate at such time as all shares made available under the plan have been issued. During fiscal 1995, 1994, and 1993, 13,616, 24,225 and 28,485 shares, respectively, were issued under the plan, and at April 30, 1995, 24,497 shares of common stock were reserved and available for issuance.\nDuring August 1988, a Long-Term Incentive Plan (the \"Incentive Plan\") was approved by the Company's stockholders. The Board of Directors had previously approved the Incentive Plan whereby certain key officers (the participants) would become eligible to receive performance shares provided the Company\nachieves specified financial goals over four year periods. Performance shares represent rights to receive common stock or, at the election of the participant, a combination of cash and common stock. Under this plan, participants were granted 55,642 performance shares during fiscal 1993. During fiscal 1995, 349 shares of common stock were distributed and payments of $2,967 were made to participants under the 1991-1994 Incentive Plan. During fiscal 1994 and fiscal 1995, the Board of Directors determined not to approve a Long-Term Incentive Plan for key officers but instead proposed the adoption of a stock option plan for the key employees of the Company (as discussed above).\nThe cost of the Incentive Plan is limited to twice the grant price at the grant date of the maximum number of performance shares issuable. The grant price is determined by the higher of the book value per share or the average of the closing price of the Company's common stock for a period prior to and following the public release of the preceding year's annual earnings. The grant price of the performance shares granted during fiscal 1993 was $8.30. The estimated costs of the Incentive Plan are charged to income over the applicable four year periods. During the fiscal years ended April 30, 1995, April 30, 1994 and April 30, 1993, no income or expense was recognized.\nThe Company purchases shares of its common stock to be held as treasury stock until needed for issuance through the Company's employee stock plans and directors and employees stock option plans discussed above.\nOn December 15, 1989, the Board of Directors of the Company adopted a Share Rights Plan and, in connection therewith, declared a dividend distribution of one Right for each outstanding share of the Company's common stock to stockholders of record at the close of business on January 8, 1990. The Company had 3,248,621 shares of its common stock outstanding at such date. The Share Rights Plan generally provides that 20 days following a public announcement that a person or a group of affiliated or associated persons have become owners of 10% or more of the Company's common stock (and have thus become an \"Acquiring Person\"), each Right will entitle the registered holder to purchase from the Company common stock at a purchase price per share equal to 20% of current market value. Any Rights beneficially owned by an Acquiring Person or any of the Acquiring Person's affiliates or associates are not exercisable. The number of shares that each holder of a Right will be entitled to receive upon exercise is equal to one share of common stock multiplied by a fraction, the numerator of which is the number of shares of common stock outstanding on the date of the first public announcement that a person has become an Acquiring Person (the \"Stock Acquisition Date\") and the denominator of which is the number of Rights outstanding on the Stock Acquisition Date that are not beneficially owned by the Acquiring Person or its affiliates or associates. Until such time as the Rights become exercisable, (a) the Rights will be evidenced by the common stock certificates and will be transferred with and only with such common stock certificates, (b) new common stock certificates issued after January 8, 1990 will contain a notation incorporating the Rights Agreement by reference and (c) the surrender for transfer of any certificates for common stock will also constitute the transfer of the Rights associated with the common stock represented by such certificate.\nOn June 16, 1995, the Board of Directors approved a cash dividend of fourteen cents ($0.14) per share, totalling $454,000, to all stockholders of record at the close of business on June 26, 1995. This dividend was paid on July 3, 1995.\nNote 8 - Commitments and Contingent Liabilities:\nThe Company leases certain warehouse facilities and equipment, principally trucking equipment, under operating leases. Certain leases provide for additional rental based on actual usage and many leases have renewal options. Under some leases the Company agrees to pay insurance costs and increases in property taxes. Total rent expense amounted to approximately $3,009,000 in\n1995, $3,141,000 in 1994, and $3,458,000 in 1993, of which $251,000, $250,000 and $254,000 was for truck rental based on mileage. The Company leases certain computer equipment and a front end loader under noncancelable capital lease agreements (see Note 4). The original capitalized cost of leases included in property and equipment was $318,000. As of April 30, 1995 the net book value of leased equipment totaled $304,808. Minimum lease and rental commitments under non-cancelable capital and operating leases in effect at April 30, 1995 are as follows:\nDuring fiscal 1993, the Company filed a claim against the former stockholders of Taulman. Through the claim, the Company, pursuant to certain indemnification provisions in the acquisition agreement, sought to be reim- bursed for losses incurred in connection with certain long-term contracts in existence at the date of acquisition. The claim was resolved during the second quarter of fiscal 1993 when the Company received $1,100,000 in cash in full settlement of such claim. Approximately $605,000 of the settlement was applied to establish the necessary reserves for the long-term contracts. The remaining $495,000 was recorded as a reduction of cost of products sold during the second quarter of fiscal 1993 because the Company had previously recognized the cost to complete these long-term contracts in earlier reporting periods.\nThe nature of the Company's business results in a certain amount of litigation. Accordingly, the Company is a party (as plaintiff and defendant) to a number of lawsuits incidental to its business, and in certain of such matters, claims have been asserted against the Company in substantial amounts. Management believes that the Company has meritorious defenses to these claims, and the Company, together with its insurance carriers, is vigorously defending these claims.\nNote 9 - Fair Value Of Financial Instruments\nCash, Cash Equivalents and Long-term Notes Receivable\nThe carrying amount reflected in the consolidated balance sheet approximates the fair value of cash, cash equivalents and long-term notes receivable.\nNotes Payable and Long-term Debt\nSubstantially all of the balance of notes payable and long-term debt is represented by a variable rate revolving term loan. Because this variable rate approximates a market rate of interest at year end, the carrying amount of notes payable and long-term debt approximates fair value.\nNote 10 - Quarterly Financial Data (unaudited)\nSummarized unaudited quarterly consolidated financial data is as follows:\nThe net income for the fourth quarter of fiscal 1995 includes an additional provision of $678,000 for management's revised estimate of the Taulman shutdown reserve. The net loss for the fourth quarter of fiscal 1994 was a result of a $2,908,000 write-down in the investment in Taulman to its realizable value and the establishment of a $5,987,000 shutdown reserve for Taulman. See Note 2.\nBOARD OF DIRECTORS\nJoe E. Beverly Vice Chairman of the Board of Synovus Financial Corp. of Columbus, Georgia\nO. Larry Comer Senior Partner of Comer Associates, an investment partnership, and Chairman of the Board of Caravelle Boats, Inc., a boat manufacturer\nRobert P. Crozer Vice Chairman of the Board of Flowers Industries, Inc., a diversified food products company\nH. Forbes Davis Retired executive officer of the Company\nJasper C. Davis III Retired executive officer of the Company\nR. R. Davis Vice Chairman of the Board of the Company\nThomas R. Pledger Chairman of the Board and Chief Executive Officer of Dycom Industries, Inc., a telecommunications and electrical services corporation\nR. Doyle White Chairman of the Board, President and Chief Executive Officer of the Company\nOFFICERS\nR. Doyle White Chairman of the Board, President and Chief Executive Officer of the Company\nLarry May Executive Vice President and Chief Operating Officer of the Company\nRobert H. Pless Vice President and General Manager - Davco Division\nRobert D. Tatum Vice President and General Manager - Process Division\nStan White Secretary-Treasurer and Chief Financial Officer\nSTOCKHOLDER INFORMATION\nCorporate Headquarters General Counsel Davis Water & Waste Industries, Inc. Alexander & Vann 1820 Metcalf Avenue 218 East Jackson Street Thomasville, Georgia 31792 Thomasville, Georgia 31792 (912) 226-5733\nFinancial Public Relations Independent Accountants Porter, LeVay & Rose, Inc. Price Waterhouse LLP 225 West 34th Street 50 Hurt Plaza Suite 1700 New York, New York 10001 Atlanta, Georgia 30303\nStock Prices and Cash Dividends Special Counsel The Company's Common Stock is listed Long, Aldridge & Norman on the New York Stock Exchange under One Peachtree Center, the symbol \"DWW.\" The table below Suite 5300 sets forth the high and low closing 303 Peachtree Street sales prices of the Common Stock and Atlanta, Georgia 30308 the cash dividends paid per share for each quarter during fiscal 1995 and fiscal 1994.\nAs of July 21, 1995, there were approximately 690 record holders of the Company's Common Stock. The total amount of dividends paid by the Company during each of the past ten fiscal years is set forth in Selected Consolidated Financial Data on page 6 and 7 of this report. Restrictions on the amount of dividends the Company may pay are described in Note 4 of Notes to Consolidated Financial Statements. Dividends are disbursed by Wachovia Bank of North Carolina, P.O. Box 3001, Winston-Salem, North Carolina 27102.\nTransfer Agent and Registrar Wachovia Bank of North Carolina Winston-Salem, North Carolina 27102 (800) 633-4236\nChanges of address, questions regarding lost certificates, requests for changes in registration and other general correspondence concerning stockholders' accounts should be directed to the Transfer Agent.\nAnnual Meeting The 1995 Annual Meeting of Stockholders of Davis Water & Waste Industries, Inc. will be held on Friday, September 8, 1995 at the Garden Center located at 1002 South Broad Street, Thomasville, Georgia 31792 at 11:00 A.M. Proxy materials and a notice of the meeting addressed to stockholders of record on July 21, 1995 are included in the mailing of this report. Stockholders are cordially invited to attend.\nForm 10-K A copy of the Company's Annual Report on Form 10-K for fiscal 1995 (without exhibits), as filed with the Securities and Exchange Commission, will be sent without charge to any stockholder who submits a written request to:\nMr. Stan White Secretary-Treasurer Davis Water & Waste Industries, Inc. 1820 Metcalf Avenue Thomasville, Georgia 31792\nDAVIS WATER & WASTE INDUSTRIES, Inc.\nList of Locations\nDAVIS METER & SUPPLY DAVIS PROCESS Sales Office\/Service Center Sales Office\/Warehouse Cape Coral, FL Laguna Nigel, CA Jacksonville, FL Wilmington, DE Ocala, FL Tallevast, FL Orlando, FL Canton, GA Pensacola, FL Granite City, IL Tallahassee, FL Florence, SC Tampa, FL Seguin, TX West Palm Beach, FL Kennesaw, GA DAVCO Savannah, GA Sales Office\/Manufacturing Asheville, NC Thomasville, GA Charlotte, NC Raleigh, NC EMU-SUBMERSIBLE PUMPS Knoxville, TN Sales Office\/Warehouse Nashville, TN Thomasville, GA\nTAYLOR-JETT COMPANY Sales Office\/Service Center South El Monte, CA\nWATERWORKS EQUIPMENT COMPANY Sales Office\/Service Center Bullhead City, AZ Las Vegas, NV Ogden, UT\nMcALLEN PIPE & SUPPLY COMPANY Sales Office\/Service Center Corpus Christi, TX Laredo, TX McAllen, TX San Antonio, TX\nABOUT THE LOGO ...\nThe Davis Water & Waste Industries, Inc. logo is the Theta sign. This Greek letter is identified as the universal symbol for ecology and has been adopted to signify our goal to meet the growing demand for clean water.\nExhibit 23\nConsent of Price Waterhouse to incorporation of accountant's reports into the Company's Registration Statement on Form S-8, No. 33-43032\nCONSENT OF INDEPENDENT ACCOUNTANTS\nWe hereby consent to the incorporation by reference in the Registration Statement on Form S-8 (No. 33-43032) of Davis Water & Waste Industries, Inc. of our report dated June 16, 1995 included in the Annual Report to Stockholders which is incorporated by reference of our report on the Financial Statement Schedules, included in this Form 10-K.\nPRICE WATERHOUSE LLP\nAtlanta, Georgia July 21, 1995\nExhibit 24\nPowers of Attorney\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned constitutes and appoints R. Doyle White and Stan White and each of them, his true and lawful attorneys-in-fact and agents, with full power of substitution, for him and in his name, place and stead, in any and all capacities, to sign the Annual Report on Form 10-K of Davis Water & Waste Industries, Inc. for the fiscal year ended April 30, 1995, and any and all amendments thereto, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission and the New York Stock Exchange, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.\nThis 27th day of July, 1995.\n\/s\/ Thomas R. Pledger Thomas R. Pledger\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned constitutes and appoints R. Doyle White and Stan White and each of them, his true and lawful attorneys-in-fact and agents, with full power of substitution, for him and in his name, place and stead, in any and all capacities, to sign the Annual Report on Form 10-K of Davis Water & Waste Industries, Inc. for the fiscal year ended April 30, 1995, and any and all amendments thereto, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission and the New York Stock Exchange, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys- in-fact and agents or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.\nThis 28th day of July, 1995.\n\/s\/ Robert P. Crozer Robert P. Crozer\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned constitutes and appoints R. Doyle White and Stan White and each of them, his true and lawful attorneys-in-fact and agents, with full power of substitution, for him and in his name, place and stead, in any and all capacities, to sign the Annual Report on Form 10-K of Davis Water & Waste Industries, Inc. for the fiscal year ended April 30, 1995, and any and all amendments thereto, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission and the New York Stock Exchange, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.\nThis 28th day of July, 1995.\n\/s\/ O. Larry Comer O. Larry Comer\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned constitutes and appoints R. Doyle White and Stan White and each of them, his true and lawful attorneys-in-fact and agents, with full power of substitution, for him and in his name, place and stead, in any and all capacities, to sign the Annual Report on Form 10-K of Davis Water & Waste Industries, Inc. for the fiscal year ended April 30, 1995, and any and all amendments thereto, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission and the New York Stock Exchange, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.\nThis 28th day of July, 1995.\n\/s\/ Joe E. Beverly Joe E. Beverly\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned constitutes and appoints R. Doyle White and Stan White and each of them, his true and lawful attorneys-in-fact and agents, with full power of substitution, for him and in his name, place and stead, in any and all capacities, to sign the Annual Report on Form 10-K of Davis Water & Waste Industries, Inc. for the fiscal year ended April 30, 1995, and any and all amendments thereto, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission and the New York Stock Exchange, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys- in-fact and agents or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.\nThis 27th day of July, 1995.\n\/s\/ H. Forbes Davis H. Forbes Davis\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned constitutes and appoints R. Doyle White and Stan White and each of them, his true and lawful attorneys-in-fact and agents, with full power of substitution, for him and in his name, place and stead, in any and all capacities, to sign the Annual Report on Form 10-K of Davis Water & Waste Industries, Inc. for the fiscal year ended April 30, 1995, and any and all amendments thereto, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission and the New York Stock Exchange, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys- in-fact and agents or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.\nThis 27th day of July, 1995.\n\/s\/ Jasper C. Davis Jasper C. Davis\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned constitutes and appoints R. Doyle White and Stan White and each of them, his true and lawful attorneys-in-fact and agents, with full power of substitution, for him and in his name, place and stead, in any and all capacities, to sign the Annual Report on Form 10-K of Davis Water & Waste Industries, Inc. for the fiscal year ended April 30, 1995, and any and all amendments thereto, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission and the New York Stock Exchange, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys- in-fact and agents or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.\nThis 26th day of July, 1995.\n\/s\/ R. R. Davis R. R. Davis","section_15":""}
{"filename":"320321_1995.txt","cik":"320321","year":"1995","section_1":"ITEM 1. BUSINESS\nSeagull Energy Corporation (the \"Company\" or \"Seagull\") is an independent energy company primarily engaged in natural gas exploration, development and production. The Company's operations are focused offshore Texas and Louisiana in the Gulf of Mexico and onshore in three principal geographic regions: (i) western Oklahoma and the Texas Panhandle; (ii) the Arklatex area in eastern Texas and northern Louisiana and the Arkoma Basin in eastern Oklahoma and western Arkansas; and (iii) western Canada. Seagull's two other business segments are also natural gas related: (i) pipeline and marketing which includes natural gas gathering, gas processing, gas marketing and pipeline engineering, design, construction and operation; and (ii) natural gas transmission and distribution in Alaska. In September 1995, the Company disposed of substantially all of its gas gathering and processing assets. The Company was incorporated in Texas in 1973 as a wholly owned subsidiary of Houston Oil & Minerals Corporation (\"HO&M\"). In March 1981, the Company became an independent entity as a result of the spin-off of its shares to the stockholders of HO&M. The \"Company\" or \"Seagull\" refers to Seagull and its consolidated subsidiaries, unless otherwise indicated or the context otherwise suggests.\nFor financial information relating to industry segments, see Note 15 of Notes to Consolidated Financial Statements of Seagull Energy Corporation and Subsidiaries. The Consolidated Financial Statements of Seagull Energy Corporation and Subsidiaries and the Notes related thereto (the \"Consolidated Financial Statements\") are included in the Company's 1995 Annual Report to Shareholders and as part of Exhibit 13 attached hereto. Prior to 1994, the Company derived no revenues and had no material assets outside the United States. See discussions below regarding the Company's interests in Canada and in production licenses acquired in United Kingdom waters.\nItems 1, 3 and 7 of this document include \"forward looking\" statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Although the Company believes that the expectations reflected in such forward looking statements are based upon reasonable assumptions, it can give no assurance that its expectations will be achieved. Important factors that could cause actual results to differ materially from the Company's expectations are disclosed in conjunction with the forward looking statements included herein (\"Cautionary Disclosures\"). Subsequent written and oral forward looking statements attributable to the Company or persons acting on its behalf are expressly qualified in their entirety by the Cautionary Disclosures.\nEXPLORATION AND PRODUCTION\nSeagull's exploration and production (\"E&P\") segment is the Company's primary growth area and is comprised of the following material direct and indirect wholly owned subsidiaries of the Company: Seagull Energy E&P Inc.; HO&M; Wacker Oil Inc.; Seagull Midcon Inc.; Seagull Mid-South Inc. and Seagull Energy Canada Ltd. (\"Seagull Canada\").\nThe Company's other exploration activities outside North America consist of several production licenses, awarded to two exploration groups which include Seagull, in United Kingdom waters. While the Company currently has no producing properties in the United Kingdom waters, two exploratory wells are scheduled to be drilled in 1996.\nSeagull's ongoing North American exploration program has been concentrated in the Gulf of Mexico, primarily in shallow waters off the central Texas Gulf Coast. The Company has in the past financed its gas and\noil exploration and development activities through internally generated funds and participation by industry partners on a prospect-by-prospect basis. The Company believes that its gas and oil exploration and development activities in the foreseeable future will be financed by internally generated funds. In 1996, the Company expects E&P capital expenditures to total approximately $122 million. Of this amount, about $47 million will be devoted to exploration, primarily in the Gulf of Mexico, $66 million to development and $9 million to leasehold acquisition. By comparison, 1995 capital expenditures for E&P activities totaled $76 million. Management believes that the Company's capital resources will be sufficient to finance current and forecasted operations.\nRevenues from the sale of gas and liquids production accounted for 62%, 64% and 60% of the Company's consolidated revenues for 1995, 1994 and 1993, respectively. As used in this Annual Report on Form 10-K, liquids means oil, condensate and natural gas liquids, unless otherwise indicated or the context otherwise suggests. Gas production in 1995 decreased from the prior year primarily as a result of voluntary curtailments by Seagull and natural production declines of the reserves. Production of gas and liquids for 1995 averaged 333.8 million cubic feet (\"MMcf\") per day (\"MMcf\/d\") and 4,268 barrels (\"Bbl\") per day (\"Bbl\/d\"), respectively, compared to 355.2 MMcf\/d and 5,063 Bbl\/d, respectively, in 1994.\nSeagull's principal gas and oil producing properties include the following:\n(*) The equivalent of one billion cubic feet (\"Bcfe\") of natural gas. Liquids are converted to gas at a ratio of one barrel of liquids per six Mcf (\"Mcf\" represents one thousand cubic feet) of gas, based on relative energy content.\nFor additional information relating to the Company's gas and oil reserves, based substantially upon reports of DeGolyer and MacNaughton (for the years ended December 31, 1995, 1994 and 1993), Netherland, Sewell & Associates, Inc. (for the years ended December 31, 1994 and 1993) and Ryder Scott Company (for the years ended December 31, 1994 and 1993), independent petroleum engineers (collectively the \"Engineers\"), see Note 7 of the Consolidated Financial Statements included in the Company's 1995 Annual Report to Shareholders and as part of Exhibit 13 attached hereto. The Engineers provided the estimates of \"proved developed and undeveloped reserves\" and \"proved developed reserves\" at the beginning and end of each of the three years included in Note 7. Under \"Standardized Measure of Discounted Future Net Cash Flows\" in Note 7, the Engineers provided all information except \"discounted income taxes\" and \"standardized measure of discounted future net cash flows\". All information in Note 7 not provided by the Engineers was supplied by the Company. As required, Seagull also files estimates of gas and oil reserve data with various governmental regulatory authorities and agencies. The basis for reporting reserves to these authorities and agencies, in some cases, may not be comparable. However, the difference in estimates does not exceed 5%.\nThe future results of this segment will be affected by the market prices of natural gas and liquids. The availability of a ready market for gas and liquids products in the future will depend on numerous factors beyond the control of the Company, including weather, production of other natural gas and liquids products, imports,\nmarketing of competitive fuels, proximity and capacity of gas and liquids pipelines and other transportation facilities, demand for storage refills, any oversupply or undersupply of gas and liquids products, the regulatory environment and other regional and political events, none of which can be predicted with certainty. As in the past, the Company expects to continue curtailing a portion of its gas production whenever prices are deemed to be below acceptable levels.\nGAS AND OIL DRILLING ACTIVITIES\nSeagull's gas and oil exploratory and developmental drilling activities are as follows for the periods indicated. Totals shown in each category include wells completed as productive wells and wells abandoned as dry holes. A well is considered productive for purposes of the following table if it justifies the installation of permanent equipment for the production of gas or oil. A well is deemed to be a dry hole if it is determined to be incapable of commercial production. The term \"gross wells\" means the total number of wells in which Seagull owns an interest, while the term \"net wells\" means the sum of the fractional working interests Seagull owns in gross wells.\nFrom January 1, 1996 through March 25, 1996, the Company drilled 14 gross (5.97 net) successful development wells in 15 attempts (6.97 net). As of late March, the Company had seven gross (3.26 net) exploratory wells and 18 gross (9.79 net) development wells in progress or being evaluated. As of the beginning of 1996, the Company had an inventory of approximately 100 exploratory prospects.\nPRODUCTION\nThe following table summarizes the Company's production, average sales prices and lifting costs for the periods indicated:\n(1) Thousands of barrels (\"Mbbl\"). (2) The equivalent of one thousand cubic feet (\"Mcfe\") and one million cubic feet (\"MMcfe\") of natural gas. (3) Average sales prices are before deduction of production, severance, and other taxes. (4) Lifting costs represent costs incurred to operate and maintain wells and related equipment and facilities. These costs include, among other things, repairs and maintenance, workover expenses, labor, materials, supplies, property taxes, insurance, severance taxes and transportation costs. (5) The Canadian properties were acquired on January 4, 1994 in connection with the purchase of Seagull Canada.\nThe following table sets forth information regarding the number of productive wells in which the Company held a working interest at December 31, 1995. Productive wells are either producing wells or wells capable of commercial production although currently shut-in. One or more completions in the same borehole are counted as one well.\n(*) Includes 333 gross (131.19 net) and 441 gross (282.20 net) gas wells with multiple completions for the United States and Canada, respectively.\nFor additional information relating to gas and oil producing activities, see Note 7 of the Consolidated Financial Statements included in the Company's 1995 Annual Report to Shareholders and as part of Exhibit 13 attached hereto.\nDEVELOPED AND UNDEVELOPED GAS AND OIL ACREAGE\nAs of December 31, 1995, the Company owned working interests in the following developed and undeveloped gas and oil acreage:\n(*) When describing acreage on drilling locations, the term \"net\" refers to the total acres on drilling locations in which the Company has a working interest, multiplied by the percentage working interest owned by the Company.\nAdditionally, as of December 31, 1995, the Company owned mineral and\/or royalty interests in 225,347 gross (32,129 net) developed and 327,302 gross (67,361 net) undeveloped gas and oil acres.\nCOMPETITION\nThe Company's competitors in gas and oil exploration, development, production and marketing include major oil companies, as well as numerous independent oil and gas companies, individuals and drilling programs. Some of these competitors have financial and personnel resources substantially in excess of those available to the Company and, therefore, the Company may be placed at a competitive disadvantage. The Company's success in discovering reserves will depend on its ability to select suitable prospects for future exploration in today's competitive environment.\nMARKETS\nThe Company utilizes a variety of commodity derivative contracts to achieve more predictable cash flows and to reduce its exposure to fluctuations in gas and oil prices for portions of its gas and oil production . As of March 26, 1996, the Company had entered into commodity derivative contracts for as much as 150,000 Mcf of natural gas per day. The Company's natural gas production is equal to approximately 360,000 Mcf per day. On a Mcfe basis, the Company's production as of March 26, 1996 was approximately 40% hedged. The terms of the Company's derivative contracts range from one to seven months. Of the total volume of production that has been hedged, over 80% has been hedged in a manner which only limits the Company's exposure to price decreases while allowing it to benefit from expected price increases. Seagull expects to continue to leave the majority of its own E&P production either unhedged or protected only from price decreases so that it can benefit from expected gas price strengthening. The Company accounts for its commodity derivative contracts as hedging activities and, accordingly, gains or losses are included in revenues when the commodities are produced. See Note 11 to the Company's Consolidated Financial Statements. The Company's production is sold in the spot market, as well as to local distribution companies, other marketing firms and end users under longer term contracts, typically with six-month to one-year terms.\nMost of the Company's natural gas is transported through gas gathering systems and gas pipelines which are not owned by the Company. Transportation space on such gathering systems and pipelines is occasionally limited and at times unavailable due to repairs or improvements being made to such facilities or due to such space being utilized by other gas shippers with priority transportation agreements. While the Company has not experienced any inability to market its natural gas, if transportation space is restricted or is unavailable, the Company's cash flow from the affected properties could be adversely affected.\nREGULATION\nThe availability of a ready market for natural gas and oil production depends upon numerous regulatory factors beyond the Company's control. These factors include regulation of natural gas and oil production, federal and state regulations governing environmental quality and pollution control and state limits on allowable rates of production by a well or proration unit. State and federal regulations generally are intended to prevent waste of natural gas and oil, protect rights to produce natural gas and oil between owners in a common reservoir, control the amount of natural gas and oil produced by assigning allowable rates of production and control contamination of the environment.\nRegulation of Natural Gas and Oil Exploration 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 permits for the drilling of wells, maintaining bonding requirements in order to drill or operate\nwells, and regulating the location of wells, the method of drilling and casing wells, the surface use and restoration of properties upon which wells are drilling and the plugging and abandonment of wells. The Company's operations are also subject to various conservation laws and regulations. These include the regulation of the size of drilling and spacing units or proration units and the density of wells which may be drilled and unitization or pooling of oil and gas properties. In this regard, some states allow the forced pooling or integration of tracts to facilitate exploration while other states rely on voluntary pooling of lands and leases. In addition, state conservation laws establish maximum rates of production requirements regarding the ratability of production. With respect to the establishment of maximum production rates from natural gas wells, certain producing states, in an attempt to limit production to market demand, have recently adopted (Texas and Oklahoma) or are considering adopting (Louisiana) measures that alter the methods previously used to prorate gas production from wells located in these states. For example, the new Texas rules provide for reliance on information filed monthly by well operators, in addition to historical production data for the well during comparable past periods, to arrive at an allowable. This is in contrast to historic reliance on forecasts of upcoming takes filed monthly by purchasers of natural gas in formulating allowables, a procedure which resulted in substantial excess allowables over volumes actually produced. The Company cannot predict whether other states will adopt similar or other procedures for prorating gas production. The effect of these regulations is to limit the amounts of natural gas and oil the Company's operator or the Company can produce from its wells, and to limit the number of wells or the locations at which the Company can drill. Legislation affecting the oil and gas industry also is under constant review for amendment or expansion. Generally, state-established allowables have been influenced by overall natural gas market supply and demand in the United States, as well as the specific \"nominations\" for natural gas from the parties who produce or purchase gas from the field and other factors deemed relevant by the agency. The Company cannot predict whether further changes will be made in how these states set allowables or what impact, if any, such further changes might have.\nNatural Gas Marketing and Transportation. Federal legislation and regulatory controls in the United States have historically affected the price of the natural gas produced by the Company and the manner in which such production is marketed. The transportation and sale for resale of natural gas in interstate commerce are regulated pursuant to the Natural Gas Act of 1938 (the \"NGA\"), the Natural Gas Policy Act of 1978 (the \"NGPA\") and the Federal Energy Regulatory Commission (the \"FERC\"). Although maximum selling prices of natural gas were formerly regulated, on July 26, 1989, the Natural Gas Wellhead Decontrol Act of 1989 (\"Decontrol Act\") was enacted, which terminated wellhead price controls on all domestic natural gas on January 1, 1993, amended the NGPA to remove completely by January 1, 1993 price and nonprice controls for all \"first sales\" of natural gas, which will include all sales by the Company of its own production; consequently, sales of the Company's natural gas currently may be made at market prices, subject to applicable contract provisions. The FERC's jurisdiction over natural gas transportation was unaffected by the Decontrol Act.\nThe FERC regulates interstate natural gas transportation rates and service conditions, which affect the marketing of natural gas produced by the Company, as well as the revenues received by the Company for sales of such natural gas. Since the latter part of 1985, the FERC has endeavored to make interstate natural gas transportation more accessible to gas buyers and sellers on an open and nondiscriminatory basis. The FERC's efforts have significantly altered the marketing and pricing of natural gas. Commencing in April 1992, the FERC issued Order Nos. 636, 636-A and 636-B (collectively, \"Order No. 636\"), which, among other things, require interstate pipelines to \"restructure\" to provide transportation separate or \"unbundled\" from the pipelines' sales of gas. Also, Order No. 636 requires pipelines to provide open-access transportation on a basis that is equal for all gas supplies. Order No. 636 has been implemented through negotiated settlements in individual pipeline service restructuring proceedings. In many instances, the result of the Order No. 636 and related initiatives has been to substantially reduce or bring to an end the interstate pipelines' traditional role as wholesalers of natural gas in favor of providing only storage and transportation services. The FERC has issued final orders in virtually all\npipeline restructuring proceedings, and commenced a series of reviews to determine whether refinements are required regarding individual pipeline implementations of Order No. 636.\nAlthough Order No. 636 does not regulate natural gas producers such as the Company, the FERC has stated that Order No. 636 is intended to foster increased competition within all phases of the natural gas industry. It is unclear what impact, if any, increased competition within the natural gas industry under Order No. 636 will have on the Company and its natural gas marketing efforts. In addition, numerous petitions seeking judicial review of Order No. 636 are pending. Numerous parties have also sought review of FERC orders implementing Order No. 636 on individual pipeline systems. Order No. 636 could be reversed in whole or in part as a result. Although Order No. 636, assuming it is upheld in its entirety in its current form, would provide the Company with additional market access and more fairly applied transportation service rates, terms and conditions, it could also subject the Company to more restrictive pipeline imbalance tolerances and greater penalties for violation of those tolerances. The Company does not believe, however, that it will be affected by any action taken with respect to Order No. 636 materially different than other natural gas producers and marketers with which it competes.\nAdditional proposals and proceedings that might affect the natural gas industry are considered from time to time by Congress, the FERC, state regulatory bodies and the courts. The Company cannot predict when or if any such proposals might become effective, or their effect, if any, on the Company's operations. The natural gas industry historically has been very heavily regulated; therefore, there is no assurance that the less stringent regulatory approach recently pursued by the FERC and Congress will continue indefinitely into the future. State regulation of gathering facilities generally includes various safety, environmental, and in some circumstances, nondiscriminatory take requirements, but does not generally entail rate regulation. Natural gas gathering has received greater regulatory scrutiny at both the state and federal levels as the pipeline restructuring under Order No. 636 continues. For example, Oklahoma enacted a prohibition against discriminatory gathering rates, and certain Texas regulatory officials have expressed interest in evaluating similar rules in Texas.\nOffshore Leasing. Certain operations the Company conducts are on federal oil and gas leases, which the Minerals Management Service (\"MMS\") administers. The MMS issues such leases through competitive bidding. These leases contain relative standardized terms and require compliance with detailed MMS regulations and orders pursuant to the Outer Continental Shelf Lands Act (\"OCSLA\") (which are subject to change by the MMS). For offshore operations, lessees must obtain MMS approval for exploration plans and development and production plans prior to the commencement of such operations. In addition to permits required from other agencies (such as the Coast Guard, the Army Corps of Engineers and the Environmental Protection Agency), lessees must obtain a permit from the MMS prior to the commencement of drilling. The MMS has promulgated regulations requiring offshore production facilities located on the Outer Continental Shelf (\"OCS\") to meet stringent engineering and construction specifications, and has recently proposed additional safety-related regulations concerning the design and operating procedures for OCS production platforms and pipelines. The MMS also has issued regulations to prohibit the flaring of liquid hydrocarbons and oil without prior authorization. Similarly, the MMS has promulgated other regulations governing the plugging and abandonment of wells located offshore and the removal of all production facilities. To cover the various obligations of lessees on the OCS, the MMS generally requires that lessees post substantial bonds or other acceptable assurances that such obligations will be met.\nIn addition, the MMS is conducting an inquiry into certain contract settlement agreements from which producers on MMS leases have received settlement proceeds that are royalty bearing and the extent to which producers have paid the appropriate royalties on those proceeds. The restructuring of oil and gas markets has resulted in a shifting of markets downstream from the wells. Deregulation has so altered the marketplace that lessors, including the MMS, are reevaluating the methods of valuation of gas for royalty purposes.\nIn Canada, exploration, production and development activities are governed by federal and provincial laws which subject operators to extensive controls and regulations. Exports of gas and oil across interprovincial borders or on pipelines which connect to United States pipelines are governed by the National Energy Board and each province has its own laws governing the operations of producers and protection of the environment.\nPIPELINE AND MARKETING\nPipeline and marketing operations include the marketing of Seagull's own and third-party gas, oil and natural gas liquids, as well as gas gathering and gas processing. Seagull is also involved in pipeline engineering, design, construction and operation. Revenue from the pipeline and marketing segment accounted for 9%, 10% and 11% of the Company's consolidated revenues for 1995, 1994 and 1993, respectively.\nOn September 25, 1995, the Company and three other sellers completed the sale of their disparate interests in 19 natural gas gathering systems and a gas processing plant. Together with the sale of another of Seagull's gas processing plants, the assets sold represent substantially all of the Company's gas gathering and gas processing assets.\nGAS MARKETING\nThe Company actively provides marketing services geared toward matching gas supplies available in the major producing areas with attractive markets available in the Midwest, Northeast, Mid-Atlantic, Appalachian and Texas\/Louisiana Gulf Coast areas. The matching process includes arranging transportation on a network of open-access pipelines on a firm or interruptible basis. Seagull contracts to provide natural gas and oil to various customers and aggregates supplies from various sources including third-party producers, marketing companies, pipelines, financial institutions and the Company's own production. In 1995, the Company initiated an active risk management program for both its own E&P production and third party activities, utilizing such derivative financial instruments as futures contracts, options and swaps. The primary objective of the risk management program is to help ensure more stable cash flow. However, Seagull expects to leave the majority of its own E&P production either unhedged or protected only from price decreases so that it can benefit from expected gas price strengthening. The risk management program is also an important part of the Company's third party marketing efforts, allowing the Company to convert a customer's requested price to a price structure that is consistent with the Company's overall pricing stragegy.\nMarketing profit margins are often small due to competition, and results can vary significantly from month to month. Large amounts of working capital are involved for relatively small net margins, which makes working capital management critical. The Company has policies and procedures in place that are designed to minimize any potential risk of loss from these transactions. These policies and procedures are reviewed and updated periodically by the Company's management.\nPIPELINE OPERATIONS AND CONSTRUCTION\nSeagull operates certain pipelines owned by other companies. In some cases the operating agreements provide for reimbursement of expenses incurred in connection with operations plus a profit margin. In other cases the Company receives a negotiated annual fee.\nThe Company also builds pipelines for other companies for which it receives construction fees that are fixed, cost-plus or a combination of both. In June 1995, Seagull was engaged to build an approximately 114-mile onshore pipeline. The project began in late 1995 and Seagull will operate the new pipeline upon\ncompletion. The Company recognized operating profit in 1994 and 1993 on another gas pipeline construction project, which was completed in the first quarter of 1994.\nCOMPETITION\nThe Company actively competes with numerous other companies for the construction and operation of short and medium length pipelines. The Company's competitors include oil companies, other pipeline companies, natural gas gatherers and petrochemical transporters, many of which have financial resources, staffs and facilities substantially larger than those of the Company. In addition, many of the Company's gas purchasers are also competitors or potential competitors in the sense that they have extensive pipeline-building capabilities and experience and generally operate large pipeline systems of their own. Seagull believes that its ability to compete will depend primarily on its ability to complete pipeline projects quickly and cost effectively, and to operate pipelines efficiently.\nThe Company's gas marketing activities are in competition with numerous other companies offering the same services. Some of these competitors are affiliates of companies with extensive pipeline systems that are used for transportation from producers to end-users. The Company believes its ability to compete depends upon building strong relationships with producers and end-users by consistently purchasing and supplying gas at competitive prices.\nALASKA TRANSMISSION AND DISTRIBUTION\nThe Company operates in Alaska through ENSTAR Natural Gas Company (\"ENG\"), a division of the Company, and Alaska Pipeline Company (\"APC\"), an Alaska corporation and a wholly owned subsidiary of the Company. ENG and APC are currently operated as a single business unit, ENSTAR Alaska (\"ENSTAR Alaska\"), and are regulated as a single operating unit by the Alaska Public Utilities Commission (the \"APUC\"). APC engages in the intrastate transmission of natural gas in South-Central Alaska. ENG engages in the distribution of natural gas in Anchorage and other nearby communities in Alaska and is APC's only customer. Revenues from the natural gas transmission and distribution segment accounted for 29%, 26% and 29% of the Company's consolidated revenues for 1995, 1994 and 1993, respectively.\nENSTAR Alaska's predecessor was formed in 1959 and began serving the Anchorage area with natural gas in 1961. Five years later, in 1966, the predecessor became one of the original entities that formed Alaska Interstate Company, a newly organized public company the shares of which were traded on the New York Stock Exchange. Alaska Interstate Company changed its name to ENSTAR Corporation in 1982.\nIn 1985, the Company purchased ENSTAR Alaska for $55 million in cash plus $10 million in the form of a seven-year unsecured, 10% subordinated note. At the time of the acquisition, APC had outstanding debt of approximately $65 million. The transaction received the final approval of the APUC in June 1985.\nGAS TRANSMISSION SYSTEM\nAPC owns and operates the only natural gas transmission lines in its service area that are operated for utility purposes. The pipeline transmission system is composed of approximately 277 miles of 12- to 20-inch diameter pipeline and approximately 71 miles of smaller diameter pipeline. The system's present design delivery capacity is approximately 410 MMcf\/d. The average throughput of the system in 1995, 1994 and 1993 was 122, 121 and 110 MMcf\/d, respectively.\nIn September 1995, APC entered into a 33-year agreement to lease a 60-mile, 8-inch diameter pipeline between Anchorage, Alaska and Whittier, Alaska. Conversion of the pipeline to natural gas is expected to be completed in 1996. The new pipeline is expected to account for nearly 1,000 new customers over the next two to three years.\nGAS DISTRIBUTION SYSTEM\nENG distributes natural gas through approximately 1,995 miles of gas mains to approximately 92,100 residential, commercial, industrial and electric power generation customers within the cities and environs of Anchorage, Eagle River, Palmer, Wasilla, Soldotna, Kenai and the Nikiski area of the Kenai Peninsula, Alaska. During the year ended December 31, 1995, ENG added approximately 33 miles of new gas distribution mains, installed 1,800 new service lines and added approximately 2,000 net customers. ENG anticipates relatively modest growth in its residential customer base and will install additional main and service lines to accommodate this growth.\nENG distributes gas to its customers under tariffs and contracts which provide for varying delivery priorities. ENG's business is seasonal with approximately 67% of its revenues earned in the first and fourth quarters of each year.\nIn 1995, purchase\/resale volumes represented 60% of ENG's throughput and 85% of ENG's operating margin. The remaining volumes are transported for power, industrial and large commercial customers for a transportation fee.\nENG's five largest customers are the Municipality of Anchorage; ARCO Alaska, Inc.; Aurora Gas, Inc.; the State of Alaska; and Unocal Corporation. Together, they account for about $8.6 million in annual operating margin and about 17.6 Bcf per year in volumes, which represent approximately 17% and 40%, respectively, of ENG totals.\nGAS SUPPLY\nIn May 1988, APC entered into a gas purchase contract (the \"Marathon Contract\") with Marathon Oil Company (\"Marathon\") providing for the delivery of approximately 450 Bcf of gas in the aggregate. The Marathon Contract is a \"requirements\" contract with no specified daily deliverability or annual take-or-pay quantities. APC has agreed to purchase and Marathon has agreed to deliver all of APC's gas requirements in excess of those provided for in other presently existing gas supply contracts, subject to certain exceptions, until the commitment has been exhausted and without limit as to time; however, Marathon's delivery obligations are subject to certain specified annual limitations after 2001. The contract has a base price of $1.55 per Mcf plus reimbursements for any severance taxes and other charges. The base price is subject to annual adjustment based on changes in the price of certain traded oil futures contracts. During 1995, the cost of gas purchased under the Marathon Contract averaged $1.74 per Mcf, including reimbursements for severance taxes. The Marathon Contract, as amended in 1991, has been approved by the APUC.\nEffective January 1, 1992, APC amended a gas purchase contract with Shell Oil Company and ARCO Alaska, Inc. (the \"Shell Contract\") to extend the term of the contract through the year 2009, modify the price, delivery and the deliverability provisions and provide procedures for reducing take-or-pay volumes for the effect of APC sales volumes that are displaced by gas sales made by others. The Shell Contract provides for the delivery of up to approximately 220 Bcf of gas. The amendments revised the price to a base price of $1.97 per Mcf plus reimbursements for any severance taxes and an annual adjustment based on changes in the price of certain traded oil futures contracts from the relevant base price. Certain portions of the gas purchased\nunder the amendments may be priced under a pricing term similar to the Marathon Contract. The 1995 price under the Shell Contract, after application of contractual adjustments, averaged $1.71 per Mcf, including reimbursements for severance taxes. The amendments provide for varying deliverability, before displaced gas sales adjustments, up to a maximum of 110 MMcf\/d through 1995, and take-or-pay quantities, before displaced gas sales adjustments, up to a maximum of 15 Bcf per year. The Shell Contract, as amended, has been approved by the APUC.\nCombined, the Marathon and Shell Contracts will supply all of ENSTAR Alaska's gas supply requirements through the year 2001. After that time supplies will still be available under the contracts in accordance with their terms, but the annual limitations contained in the Marathon Contract will take effect. As a result, after 2001, at least a portion of ENSTAR Alaska's requirements are expected to be satisfied outside the terms of the contracts, as currently in effect.\nBased on gas purchases during the twelve months ended December 31, 1995, which are not necessarily indicative of the volume of future purchases, gas reserves committed to APC under the Marathon and Shell Contracts would have a current reserve life index of approximately 15 years.\nENSTAR Alaska's average cost of gas sold in 1995, 1994 and 1993 was $1.75, $1.74 and $2.07 per Mcf, respectively. ENSTAR Alaska's average gas sales price in 1995, 1994 and 1993 was $3.41, $3.23 and $3.56 per Mcf, respectively.\nAs stated above, ENSTAR Alaska purchases all of its natural gas under long-term contracts in which the price is indexed to changes in the price of crude oil futures contracts. However, because ENSTAR Alaska's sales prices are adjusted to include the projected cost of its natural gas, there has been and is expected to be little or no impact on margins derived from ENSTAR Alaska's gas sales as a result of fluctuations in oil prices due to worldwide political events and changing market conditions.\nENSTAR Alaska has no material take-or-pay obligations and does not anticipate any such obligations in the foreseeable future.\nCOMPETITION\nENSTAR Alaska competes primarily with municipal and cooperative electric power distributors and with various suppliers of fuel oil and propane for the available energy market. There are also extensive coal reserves proximate to ENSTAR Alaska's operating area; however, such reserves are not presently being produced.\nDuring the last seven years, ENSTAR Alaska's natural gas volumes delivered on a purchase\/resale basis have declined. Beginning in 1989, several of its major customers began purchasing gas directly from gas producers or gas marketers. However, the APUC has approved tariffs allowing ENSTAR Alaska to transport these volumes for a transportation fee that approximates the margin that would have been earned had the customer remained a sales customer rather than becoming a transportation customer. Consequently, ENSTAR Alaska anticipates no adverse economic impact to result from these transportation arrangements.\nIf any other existing large customer of ENSTAR Alaska chooses to purchase gas directly from producers, ENSTAR Alaska would expect to collect a fee for transporting that gas equivalent to the margin earned on sales volumes for those customers because the large distance of remaining user facilities from producing fields would preclude the by-pass of ENSTAR Alaska's pipelines.\nENSTAR Alaska supplies natural gas to its customers at prices that at the present time economically preclude substitution of alternative fuels. Since the Shell Contract and the Marathon Contract include prices that fluctuate based on oil indices, a competitive margin favoring natural gas over oil-based energy sources is expected to continue. However, there is no assurance that the competitive advantage over other alternative fuels will not be reduced or eliminated by the development of new energy technology or by changes in the price of oil or refined products.\nREGULATION\nThe APUC has jurisdiction as to rates and charges for gas sales, construction of new facilities, extensions and abandonments of service and certain other matters. Rates are generally designed to permit the recovery of the cost of providing service, including purchased gas costs, and a return on investment in plant. APC and ENG are regulated by the APUC on a combined basis as though they were a single entity. Because ENSTAR Alaska's operations are wholly intrastate, ENSTAR Alaska is not subject to or affected by Order 636 or any other economic regulation by the FERC.\nAs a result of a proceeding filed in 1984, which was concluded in May 1986, the APUC granted ENSTAR Alaska an aggregate rate increase of 20.27% and authorized a regulatory rate of return on common equity of 15.65%. ENSTAR Alaska has no significant regulatory issues pending before the APUC. Since its inception in 1961, ENSTAR Alaska has participated in only three formal rate proceedings.\nCORPORATE\nREGULATION\nThe Company is a \"public utility company\" within the meaning of the Public Utility Holding Company Act of 1935, as amended (the \"1935 Act\"). Accordingly, if any \"company\" (as defined for purposes of the 1935 Act and therefore including so-called \"organized groups\") becomes the owner of 10% or more of the Company's outstanding voting stock, that company would be required to register as a \"holding company\" under the 1935 Act, in the absence of an exemption of the type described below. Section 9(a)(2) also requires a person (including both individuals and \"companies\") to obtain prior approval from the Securities and Exchange Commission (the \"SEC\") in connection with the acquisition of 5% or more of the outstanding voting stock of a public utility if that person is also the owner of 5% or more of the outstanding voting stock of another public utility.\nIn March 1991, the Company filed in good faith with the SEC an application pursuant to Section 2(a)(8) of the 1935 Act, seeking a determination that Seagull was not subject to regulation as a \"subsidiary company\" of FMR Corp. (the \"FMR Application\"), which was then the owner of 2,805,624 shares (approximately 12.5% at such time) (shares adjusted for a 2-for-1 stock split of all the issued shares of the Company's common stock (the \"Common Stock\"), effected June 4, 1993) of the outstanding Common Stock. Under the 1935 Act, a company is a \"subsidiary company\" of a \"holding company\" if the \"holding company\" owns 10% or more of the total voting power of the \"subsidiary company\", unless the SEC determines otherwise. Based upon the most recent information furnished to the Company by FMR Corp., FMR Corp. was the beneficial owner (albeit within the meaning of Section 13(d) of the Securities Exchange Act of 1934) of 568,800 shares, which is less than 2% of the Common Stock as of December 31, 1995. However, although FMR Corp.'s ownership and control, within the meaning of the 1935 Act, has fallen below 10% of the outstanding voting stock of the Company, the Company does not currently intend to withdraw the FMR Application.\nIn December 1993, Seagull filed in good faith with the SEC an additional application pursuant to Section 2(a)(8) of the 1935 Act, seeking a determination that the Company was not subject to regulation as a \"subsidiary company\" of AXA Assurances I. A. R. D. Mutuelle, AXA Assurances Vie Mutuelle, Alpha Assurances I. A. R. D. Mutuelle, Alpha Assurances Vie Mutuelle, Uni Europe Assurance Mutuelle and AXA (collectively, the \"Mutuelles AXA\") and The Equitable Companies Incorporated (\"Equitable\") and their respective affiliates (collectively, the \"Equitable Entities\"), (the \"Equitable Application\"). At such time, the Equitable Entities beneficially owned 4,495,600 shares (approximately 12.5%) of Common Stock. Based upon the most recent information furnished to the Company by the Equitable Entities, the Equitable Entities were the beneficial owners (albeit within the meaning of Section 13(d) of the Securities Exchange Act of 1934) of 1,403,000 shares, which represents approximately 4% of the Common Stock as of December 31, 1995. However, although the Equitable Entities' ownership and control has fallen below 10% of the outstanding voting stock of the Company, the Company does not currently intend to withdraw the Equitable Application.\nAccording to information provided by Wellington Management Company (\"WMC\"), WMC, in its capacity as investment adviser, may be deemed the beneficial owner of 3,712,200 shares (approximately 10%) of the Common Stock that are owned by numerous investment counseling clients, none of which is known to have such interest with respect to more than 5% of the class. WMC has shared voting power as to 2,405,000 shares and shared dispositive power as to 3,712,200 shares. Because WMC has shared voting power with respect to only 2,405,000 shares, and no voting power with respect to the remaining shares beneficially owned by WMC, it is deemed to own or control only these 2,405,000 shares (approximately 6.5%) for purposes of the 1935 Act.\nEven if FMR Corp. or the Equitable Entities held 10% or more of the outstanding voting stock of the Company, as a result of its good faith filing of the two applications, the Company currently would not be subject to any obligation, duty or liability imposed by the 1935 Act, unless and until the SEC enters an order denying or otherwise adversely disposing of the applications. To date, no such order has been issued. The Company believes that the FMR Application and the Equitable Application ultimately should be granted.\nENVIRONMENTAL MATTERS\nSeagull's operations are subject to federal, state and local laws and regulation governing the discharge of materials into the environment or otherwise relating to environmental protection. Numerous governmental departments issue rules and regulations to implement and enforce such laws which are often difficult and costly to comply with and which carry substantial penalties for failure to comply. These laws and regulations may require the acquisition of a permit before drilling commences, restrict the types, quantities and concentration of various substances that can be released into the environment in connection with drilling and production activities, limit or prohibit drilling activities on certain lands lying within wilderness, wetlands and other protected areas, and impose substantial liabilities for pollution resulting from the Company's operations. In addition, these laws, rules and regulations may restrict the rate of oil and natural gas production below the rate that would otherwise exist. State laws often require some form of remedial action to prevent pollution from former operations, such as pit closure and plugging abandoned wells.\nThe Comprehensive Environmental Response, Compensation and Liability Act (\"CERCLA\"), also known as the \"Superfund\" law, imposes liability, without regard to fault or the legality of the original conduct, on certain classes of persons who are considered to be responsible for the release of a \"hazardous substance\" into the environment. These persons include the owner or operator of the disposal site or sites where the release occurred and companies that disposed or arranged for the disposal of the hazardous substances. Under CERCLA, such persons may be subject to joint and several liability for the costs of cleaning up the hazardous\nsubstances that have been released into the environment, for damages to natural resources and for the costs of certain health studies. It is not uncommon for neighboring landowners and other third parties to file claims for personal injury and property damage allegedly caused by hazardous substances or other pollutants released into the environment.\nStricter standards in environmental legislation may be imposed on the oil and gas industry in the future. For instance, legislation has been proposed in Congress from time to time that would reclassify certain oil and natural gas exploration and production wastes as \"hazardous wastes\" and make the reclassified wastes subject to more stringent handling, disposal and clean-up requirements. If such legislation were to be enacted, it could have a significant impact on the operating costs of the Company, as well as the oil and gas industry in general. Furthermore, although petroleum, including crude oil and natural gas, is exempt from CERCLA, at least two courts have recently ruled that certain wastes associated with the production of crude oil may be classified as \"hazardous substances\" under CERCLA and thus such wastes may become subject to liability and regulation under CERCLA, as described above. State initiatives to further regulate the disposal of oil and natural gas wastes are also pending in certain states, and these various initiatives could have a similar impact on the Company. Compliance with environmental requirements generally could have a material adverse effect upon the capital expenditures, earnings or competitive position of the Company. Although the Company has not experienced any material adverse effect from compliance with environmental requirements, there is no assurance that this will continue in the future.\nThe Oil Pollution Act (the \"OPA\") requires persons responsible for \"offshore facilities\" to establish proof of financial responsibility to cover environmental cleanup and restoration costs likely to be incurred in connection with an oil spill. On August 25, 1993, the MMS published an advance notice of its intention to adopt a rule under the OPA that would define \"offshore facilities\" to include all oil and gas facilities that have the potential to affect \"waters of the United States.\" The term \"waters of the United States\" has been broadly defined to include not only the waters of the Gulf of Mexico but also inland waterbodies, including wetlands, playa lakes and intermittent streams. Since the Company has many oil and gas facilities that could affect \"waters of the United States,\" the Company would become subject to the financial responsibility rule if it is adopted as proposed. Under the proposed rule, financial responsibility could be established through insurance, guaranty, indemnity, surety bond, letter of credit, qualification as a self-insurer or a combination thereof. There is substantial opposition to the proposed rule throughout the oil and gas industry, and the MMS has informally indicated that it will not move forward with the adoption of the rule until Congress has had an opportunity to reconsider the financial responsibility requirements imposed under OPA. Absent Congressional action, the Company cannot predict the final form of any financial responsibility rule that may be adopted by the MMS under the OPA, but if the proposed rule were adopted no assurance can be given as to the Company's ability to comply with such rule or the costs of such compliance. On May 9, 1995, the U.S. House of Representatives passed a bill that would lower the financial responsibility requirements applicable to offshore facilities to $35 million (the current requirement under OCSLA). The bill allows the limit to be increased to $150 million if a formal risk assessment indicates the increase is warranted. It would also define \"offshore facility\" to include only OCS oil production, transportation and storage facilities, thus excluding inland or coastal oil and gas properties. A Senate bill that would provide the Coast Guard flexibility to establish liability limits that correspond to the facility's potential oil spill liability has been referred to the Senate Environmental and Public Works Committee. The Senate bill would reduce the scope of \"offshore facilities\" subject to this financial assurance requirement to those facilities seaward of the U.S. coastline that engaged in drilling for, producing or processing oil or that have the capacity to transport, store, transfer or handle more that 1,000 barrels of oil at a time. The Clinton Administration has indicated support for changes to the OPA financial responsibility requirements. Whether these legislative efforts will reduce the OPA financial responsibility requirements applicable to the Company cannot be determined at this time. In any event, the impact of any rule is not expected to be any more burdensome to the Company than it will be to other similarly situated companies involved in oil and gas exploration and production.\nOPA imposes a variety of additional requirements on \"responsible parties\" for oil and gas facilities or vessels related to the prevention of oil spills and liability for damages resulting from such spills in waters of the United States. The \"responsible party\" includes the owner or operator of an onshore facility or vessel or the lessee or permittee of the area in which an offshore facility is located. OPA assigns liability to each responsible party for oil spill removal costs and a variety of public and private damages from oil spills. While liability limits apply in some circumstances, a party cannot take advantage of liability limits if the spill is caused by gross negligence or willful misconduct or resulted from violation of a federal safety, construction or operating regulation. If a party fails to report a spill or to cooperate fully in the cleanup, liability limits likewise do not apply. OPA establishes a liability limit for offshore facilities of all removal costs plus $75 million. Few defenses exist to the liability for oil spills imposed by OPA. OPA also imposes other requirements on facility operators, such as the preparation of an oil spill contingency plan. Failure to comply with ongoing requirements or inadequate cooperation in a spill event may subject a responsible party to civil or criminal enforcement actions.\nIn addition, the OCSLA authorizes regulations relating to safety and environmental protection applicable to lessees and permittees operating in the OCS. Specific design and operation standards may apply to OCS vessels, rigs, platforms, vehicles and structures. Violations of lease conditions or regulations issued pursuant to OCSLA can result in substantial civil and criminal penalties, as well as potential court injunctions curtailing operations and the cancellation of leases. Such enforcement liabilities can result from either governmental or private prosecution.\nThe Federal Water Pollution Control Act (\"FWPCA\") imposes restrictions and strict controls regarding the discharge of pollutants to state and federal waters. The FWPCA provides for civil, criminal and administrative penalties for any unauthorized discharges of oil and other hazardous substances in reportable quantities and, along with the OPA, imposes substantial potential liability for the costs of removal, remediation and damages. State laws for the control of water pollution also provide varying civil, criminal and administrative penalties and liabilities in the case of a discharge of petroleum or its derivatives into state waters. Within the next few years, both state water discharge regulations and the federal permits are expected to prohibit the discharge of produced water and sand, and some other substances related to the oil and gas industry, to coastal waters. Although the costs to comply with zero discharge mandates under federal or state law may be significant, the entire industry will experience similar costs and the Company believes that these costs will not have a material adverse impact on the Company's financial conditions and operations. Some oil and gas exploration and production facilities are required to obtain permits for their storm water discharges. Costs may be associated with treatment of wastewater or developing storm water pollution prevention plans. Further, the Coastal Zone Management Act authorizes state implementation and development of programs of management measures for non-point source pollution to restore and protect coastal waters.\nMany states in which the Company operates have recently begun to regulate naturally occurring radioactive materials (\"NORM\") and NORM wastes that are generated in connection with oil and gas exploration and production activities. NORM wastes typically consist of very low-level radioactive substances that become concentrated in pipe scale and in production equipment. State regulations may require the testing of pipes and production equipment for the presence of NORM, the licensing of NORM-contaminated facilities and the careful handling and disposal of NORM wastes. The Company believes that the growing regulation of NORM will have a minimal effect on the Company's operations because the Company generates only a very small quantity of NORM on an annual basis.\nEMPLOYEES\nAs of March 1, 1996, the Company had 637 full time employees. In addition to the services of its full time employees, the Company employs, as needed, the services of consulting geologists, engineers, regulatory consultants, contract pumpers and certain other temporary employees.\nENSTAR Alaska operates under collective bargaining agreements with separate bargaining units for operating and clerical employees. These units represent approximately 70% of ENSTAR Alaska's work force. Contracts effective April 1, 1992 were negotiated that set wages and work relationships extending to April 1, 1995 for the clerical bargaining unit and until April 1, 1996 for the operating bargaining unit. ENSTAR Alaska is in the process of renegotiating a collective bargaining agreement with the clerical bargaining unit. The Company is not a party to any other collective bargaining agreements. The Company has never had a work stoppage.\nThe Company considers its relations with its employees to be satisfactory.\nEXECUTIVE OFFICERS OF THE COMPANY\nThe executive officers of the Company, each of whom has been elected to serve until his or her successor is elected and qualified, are as follows:\nThe business experience of each of the executive officers named above who has held the position(s) set forth opposite his or her name for less than five years, is as follows:\nMr. Elias joined the Company as Executive Vice President in April 1993 and was named Executive Vice President and Chief Operating Officer in January 1995. For the previous 30 years, he served in a variety of positions for Amoco Production Company and its parent, Amoco Corporation, most recently as Group Vice President of Worldwide Natural Gas for Amoco Production Company.\nMr. Shower joined the Company as Senior Vice President and Chief Financial Officer in March 1992 and was named Executive Vice President of the Company in December 1993. He served as Senior Vice President, Corporate Development for Albert Fisher, Inc. from 1991 to February 1992. From 1990 to 1991, he was Vice President and Chief Financial Officer with AmeriServ Food Company. From 1986 to 1990, he served as a Managing Director, Corporate Finance, for Lehman Brothers Inc., formerly Shearson Lehman Hutton Inc. Mr. Shower will retire as an executive officer and employee of the Company prior to the Annual Meeting of Shareholders on May 14, 1996.\nMr. Goodpasture joined the Company and has been an executive officer since 1981 and was named President of Seagull Pipeline Company in March 1990, and Senior Vice President, Pipelines and Marketing, in December 1992.\nMr. McConn was named Vice President, Exploration and Production of the Company in January 1990 and President of Seagull Energy E&P Inc. in March 1991. In December 1992, he was named Senior Vice President, Exploration and Production.\nMr. Bridges joined the Company as Corporate Controller in August 1990, and was named Vice President and Controller in December 1992.\nMs. Hartrick joined Seagull as Staff Counsel in 1987 and became Chief Counsel in 1989. She was named Chief Counsel and Vice President, Environmental Affairs in December 1992.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nIncorporated herein by reference to Item 1 of this Annual Report on Form 10-K.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nGulf Coast Vacuum Site. On March 19, 1993, Franks Petroleum, Inc. (\"Franks\") submitted a claim to Seagull Mid-South Inc., a subsidiary of the Company (\"Seagull Mid-South\"), for a portion of Franks' costs incurred in connection with the Gulf Coast Vacuum Services Superfund Site (the \"GCV Site\") in Vermilion Parish, Louisiana. The United States Environmental Protection Agency Region 6 (the \"EPA\") currently is seeking the cleanup of the GCV Site under the authority of the federal Comprehensive Environmental Response, Compensation and Liability Act (\"CERCLA\").\nFranks previously has been identified as a potentially responsible party (\"PRP\") at the GCV Site as a result of Franks' arrangements with the former operator of the GCV Site to transport wastes from various oil and gas leases owned or operated by Franks in trucks owned by the GCV Site operator. Franks' claim against Seagull Mid-South asserts that some of the wastes hauled by the GCV Site operator on behalf of Franks came from a gas well owned by Seagull Mid-South.\nOn February 9, 1993, the EPA also sent a notice to HO&M, a subsidiary of the Company, indicating that HO&M may be a PRP at the GCV Site. Based upon the Company's investigation of this claim, the Company believes that the basis for HO&M's alleged liability is a series of transactions between HO&M and the operator of the GCV Site that occurred during 1979 and 1980.\nThe EPA's cleanup cost estimate of the GCV Site is in the range of $17 million, although other unofficial estimates indicate the cost may be higher. Under certain circumstances, liability under CERCLA is joint and several, although parties whose liability is joint and several have contribution rights against each other under CERCLA. Nevertheless, if Seagull Mid-South and\/or HO&M is found to be a responsible party at the GCV Site, the Company believes that its liability is unlikely to be material to its financial condition, results of operations or cash flows because of the large number of potentially responsible parties at the GCV Site and the relative amount of contamination, if any, that may have been caused at the GCV Site by the disposal of wastes arising from the wells identified in the claims.\nMarco of Iota Superfund Site. In June 1995, the EPA advised HO&M that it had been identified as a PRP at the Marco of Iota Superfund Site (\"Iota Site\") located in Iota, Louisiana. The EPA is currently seeking the cleanup to the Iota Site under the authority of CERCLA. The EPA's cleanup cost estimate of the Iota Site is in the range of $5 million.\nBased on the information provided by the EPA, the basis for HO&M's alleged liability is a series of transactions between HO&M and the operator of the Iota Site that occurred during the early 1970s through the 1980's, long before Seagull acquired HO&M from Tenneco, Inc.\nIn January 1996, the Company entered into a deminimus settlement agreement with the EPA, which established a settlement payment of approximately $15,000. Pursuant to the provisions of the Stock Purchase Agreement dated as of October 24, 1988 between the Company and Tenneco, Inc., Tenneco has assumed the monetary liability for this matter.\nOther. The Company is a party to ongoing litigation in the normal course of business or other litigation with respect to which the Company is indemnified pursuant to various purchase agreements or other contractual arrangements. Management regularly analyzes current information and, as necessary, provides accruals for probable liabilities on the eventual disposition of these matters. While the outcome of lawsuits or other proceedings against the Company cannot be predicted with certainty, management believes that the effect on its financial condition, results of operations or cash flows, if any, will not 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 SHAREHOLDER MATTERS\nA. The Company's Common Stock (the \"Common Stock\") is traded on the New York Stock Exchange under the ticker symbol SGO. The high and low sales prices on the New York Stock Exchange Composite Tape for each quarterly period during the last two fiscal years were as follows:\nB. As of March 20, 1996, there were approximately 2,659 holders of record of Common Stock.\nC. Seagull has not declared any cash dividends on its Common Stock since it became a public entity in 1981. The decision to pay Common Stock dividends in the future will depend upon the Company's earnings and financial condition and such other factors as the Company's Board of Directors deems relevant. The Company's credit agreement (the \"Credit Agreement\") restricts the Company's declaration or payment of dividends on and repurchases of Common Stock unless each of the following tests have been met and after making such dividend payment such tests continue to be met: (i) aggregate dividend payments attributable to ENSTAR Alaska Stock must not exceed $20 million plus 100% of the net income of ENSTAR Alaska on a cumulative basis from January 1, 1994, (ii) aggregate dividend payments, other than those permitted under (i) above or on up to $150 million in preferred stock, must not exceed $20 million plus 33 1\/3% of the net income of the Company (excluding net income of ENSTAR Alaska) on a cumulative basis from January 1, 1994 plus 100% of the net income of ENSTAR Alaska on a cumulative basis for such period less any dividend payments allowed under (i) above, (iii) the aggregate amount of outstanding loans under the Credit Agreement, together with all other senior indebtedness of Seagull and its subsidiaries (excluding APC) then outstanding, must not exceed the Borrowing Base and (iv) no Default or Event of Default shall have occurred and be continuing. The foregoing restrictions do not apply to dividends payable solely in the form of additional shares of Common Stock or to dividends payable on up to $150 million of preferred stock. The capitalized terms used herein to describe the restrictions contained in the Credit Agreement have the meanings assigned to them in the Credit Agreement. Under the most restrictive of these tests, as of December 31, 1995, approximately $34.6 million was available for\npayment of dividends (other than the stock dividends described above) or repurchase of Common Stock. In addition, certain debt instruments of APC restrict the ability of APC to transfer funds to the Company in the form of cash dividends, loans or advances. For a description of such restrictions, reference is made to Note 9 of the Consolidated Financial Statements included in the Company's 1995 Annual Report to Shareholders and as part of Exhibit 13 attached hereto.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nIncorporated herein by reference to the Selected Financial Data included in the Company's 1995 Annual Report to Shareholders and as part of Exhibit 13 attached hereto.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nIncorporated herein by reference to Management's Discussion and Analysis of Financial Condition and Results of Operations included in the Company's 1995 Annual Report to Shareholders and as part of Exhibit 13 attached hereto.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nIncorporated herein by reference to the Consolidated Financial Statements and Supplementary Data included in the Company's 1995 Annual Report to Shareholders and as part of Exhibit 13 attached 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\nIncorporated herein by reference to \"Election of Directors\" included in the Proxy Statement for the Company's Annual Meeting of Shareholders to be held on May 14, 1996 (the \"Proxy Statement\"). See also \"Executive Officers of the Company\" included in Part I of this Annual Report on Form 10-K, which is incorporated by reference herein.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nIncorporated herein by reference to \"Election of Directors --Executive Compensation--Summary Compensation Table,\" \"--Compensation Arrangements,\" \"--Option Exercises and Fiscal Year-End Values,\" \"--Option Grants,\" \"--Executive Supplemental Retirement Plan,\" \"--ENSTAR Natural Gas Company Supplemental Executive Retirement Plan\" and \"--ENSTAR Natural Gas Company Retirement Plan\"; and \"Election of Directors-Compensation of Directors\" included in the Proxy Statement.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nIncorporated herein by reference to \"Principal Shareholders\" and \"Election of Directors--Security Ownership of Directors and Management\" included in the Proxy Statement.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nIncorporated herein by reference to \"Election of Directors--Certain Transactions\" included 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 following Consolidated Financial Statements and Independent Auditors' Report thereon are included in the Company's 1995 Annual Report to Shareholders and as part of Exhibit 13 attached hereto, and are incorporated herein by reference:\nConsolidated Financial Statements\nNotes to Consolidated Financial Statements\nIndependent Auditors' Report\n2. SCHEDULES:\nAll schedules have been omitted because the required information is insignificant or not applicable.\n____________________________ * Filed herewith. # Identifies management contracts and compensatory plans or arrangements.\n(B) REPORTS ON FORM 8-K\nThere were no Reports on Form 8-K filed during the three months ended December 31, 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.\nEXHIBIT INDEX\n____________________ * Filed herewith. # Identifies management contracts and compensatory plans or arrangements.","section_15":""}
{"filename":"216275_1995.txt","cik":"216275","year":"1995","section_1":"ITEM 1. BUSINESS\nGeneral\nThe Company, organized in 1969, is a leading manufacturer, distributor and international marketer of elevating work platforms. The Company also produces truck-mounted materials-handling equipment. The Company's products are used for high-reach applications, primarily in the construction, industrial, petrochemical, commercial and sports and entertainment industries.\nProducts\nElevating Work Platforms. Elevating work platforms are designed to permit workers to position themselves and their tools and materials easily and quickly in elevated work areas that otherwise might have to be reached by the erection of scaffolding, by the use of ladders, or through some other device. Elevating work platforms consist of self-propelled boom-type and scissor-type lifts and push-around lifts. These work platforms are mounted either at the end of a telescoping and\/or articulating boom or on top of a scissor-type lifting mechanism, which in turn are mounted on mobile, four-wheel chassis. The Company offers elevating work platforms powered by electric motors or gasoline, diesel, or propane engines. All of the Company's elevating work platforms are designed for stable operation in elevated positions and self-propelled models travel on grades of up to twenty-four degrees.\nBoom-type self-propelled elevating work platforms are especially useful for reaching over machinery and equipment that is mounted on floors and for reaching other elevated positions not easily approached by a vertical lifting device. The Company produces boom-type self-propelled elevating work platform models of various sizes with platform heights ranging up to 150 feet. The boom may be rotated up to 360 degrees in either direction, raised or lowered from vertical to below horizontal, and extended while the work platform remains horizontal and stable. Vehicles on which the booms are mounted may be maneuvered forward or backward and steered in any direction by the operator from the work platform. Boom-type models have standard-sized work platforms, which vary in size up to 3 by 8 feet, and the rated lift capacities range from 500 to 2,000 pounds. The distributor net price of the Company's standard models at July 31, 1995 ranged from approximately $18,200 to $325,000.\nScissor-type self-propelled elevating work platforms are designed to provide larger work areas, and generally to allow for heavier loads than boom-type lifts. Scissor-type lift vehicles may be maneuvered in a manner similar to boom-type models, but the platforms may be extended only vertically, except for an available option that extends the deck horizontally up to 6 feet. The scissor-type models have maximum elevation capabilities of up to 50 feet and various platform sizes up to 6 by 14 feet. The rated lift capacities range from 500 to 2,500 pounds. The distributor net price of the Company's standard models at July 31, 1995 ranged from approximately $9,000 to $47,400.\nIn 1992, the Company began manufacturing a line of push-around elevating work platforms used primarily in indoor maintenance applications. This line consists of a work platform attached to an aluminum mast that extends vertically, which in turn is mounted on a steel base. Available in various one and two-man models, these machines can be rolled in their retracted position through standard door openings and can be loaded by one person onto the bed of a pick-up truck. They have maximum elevation capabilities of up to 36 feet and rated lift capacities from 300 to 750 pounds. The distributor net price of the Company's standard models at July 31, 1995 ranged from approximately $3,600 to $8,600.\nMaterials-Handling Products. The Company's materials-handling products consist of boom truck cranes and trolley-type and articulating unloaders. The cranes and unloaders are mounted on various commercial truck chassis or trailers and are used primarily in construction and maintenance applications. Lifting capacities of the various models range up to 28 tons, and with the main boom and jib fully extended, tip heights range up to 170 feet. The distributor net price of the Company's standard models at July 31, 1995, excluding the vehicle on which they are mounted, ranged from approximately $18,200 to $88,100.\nThe Company has fourteen registered trademarks and thirty-seven patents and considers them to be beneficial in its business.\nMarketing\nThe Company's products are marketed internationally primarily through a network of independent distributors. The Company's distributors, operating from nearly four hundred locations, sell and rent the Company's products and provide service support. The Company also sells directly through its own marketing organizations to certain major accounts as well as to customers in parts of the world where independent distribution is either not available or not commercially feasible.\nThe Company supports the sales, service, and rental programs of its distributors with product advertising, cooperative promotional programs, major trade show participation, and distributor personnel training in both service and product attributes. The Company supplements domestic sales and service support to its international customers through its overseas facilities in the United Kingdom and Australia.\nThe Company maintains a national rental fleet of elevating work platforms. The purpose of this fleet is to assist the Company's distributors in servicing large, one-time projects and in meeting periods of unanticipated rental demand, and to make available more equipment to distributors with growing markets, but limited financial resources.\nProduct Development\nThe Company invests significantly in product development and diversification, including improvement of existing products and modification of existing products for special applications. Product development expenditures totaled $5,542,000, $4,373,000, and $3,385,000 for the fiscal years 1995, 1994 and 1993, respectively. New products introduced in the past two years accounted for approximately 24% percent of fiscal 1995 machine sales.\nCompetition\nIn selling its major products, the Company experiences two types of competition. The Company competes with more traditional means of accomplishing the tasks performed by elevating work platforms, such as ladders, scaffolding and other devices.\nThe Company believes that its elevating work platforms in many applications are safer, more versatile and more efficient, taking into account labor costs, than those traditional methods and that its elevating work platforms enjoy competitive advantages when the job calls for frequent movement from one location to another at the same site or when there is a need to return to the ground frequently for tools and materials.\nThe Company competes principally with nine elevating work platform manufacturers and three boom truck manufacturers and many manufacturers of unloader products. Some of the Company's competitors are parts of, or are affiliated with, companies which are larger and have greater financial resources than the Company. The Company believes that its product quality, customer service, experienced distribution network, national rental fleet and reputation for leadership in product improvement and development provide the Company with significant competitive advantages.\nExecutive Officers of the Registrant\nPositions with the Company Name Age (date of initial election)\t \t\t L. David Black 58 Chairman of the Board, President and Chief Executive Officer (1993); President and Chief Executive Officer (1991); prior to 1991, President and Chief Operating Officer (1990).\nCharles H. Diller, Jr. 50 Executive Vice President and Chief Financial Officer (1990).\nMichael Swartz 50 Senior Vice President - Marketing (1990).\nRao G. Bollimpalli 57 Senior Vice President - Engineering (1990).\nRaymond F. Treml 55 Senior Vice President - Manufacturing (1990).\nAll executive officers listed above are elected to hold office for one year or until their successors are elected and qualified, and have been employed in the capacities noted for more than five years, except as indicated. No family relationship exists among the above named executive officers.\nProduct Liability\nBecause the Company's products are used to elevate and move personnel and materials above the ground, use of the Company's products involves exposure to personal injury as well as property damage, particularly if operated carelessly or without proper maintenance.\nThe Company is a party to personal injury and property damage litigation arising out of incidents involving the use of its products. The Company's program for fiscal 1995 to insure against exposure to such litigation is comprised of a self-insurance retention of $5 million and catastrophic coverage of $10 million in excess of the retention. The Company has accrued as a reserve $8.4 million with respect to pending and potential claims for all years in which the Company is liable under its self-insurance retention. The number of product liability claims filed each year fluctuates significantly. The number of potential claims has been affected by the substantial growth in sales over the past two years which has dramatically increased machine population and number of users. This has exerted upward pressure on the number of claims, which the Company has countered through product design safety innovations. Product liability costs, based upon the Company's best estimate of anticipated losses, for years ended July 31, 1995, 1994 and 1993, approximated 1.4%, 2.6% and 2.8% of net sales, respectively.\nFor additional information relative to product liability insurance coverage and cost, see Item 3 Legal Proceedings.\nEmployees\nThe Company had 2,222 and 1,620 persons in its employ as of July 31, 1995 and 1994, respectively. The Company believes its employee relations are good, and it has experienced no work stoppages as a result of labor problems.\nForeign Operations\nThe Company manufactures its products in the U.S. for sales throughout the world. Sales to customers outside the U.S. were 18%, 16% and 26% of net sales for 1995, 1994 and 1993, respectively. Export sales were up substantially in dollar terms, but the percentage gain was only modest due to the continued strong growth of our domestic sales.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company has manufacturing plants and office space at five sites in Pennsylvania totaling 546,000 square feet and situated on 87 acres of land. Of this, 496,000 square feet are owned, with the remainder under long-term lease. The Company has several international sales offices under short-term operating leases.\nThe Company's McConnellsburg and Bedford, Pennsylvania facilities totalling $7.2 million in assets have been encumbered as security for Company long-term loans borrowings aggregating $2.2 million.\nThe Company's properties used in its operations are considered to be in good operating condition, well-maintained and suitable for their present purposes.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is a party to personal injury and property damage litigation arising out of incidents involving the use of its products. The Company's program for fiscal 1995 to insure against exposure to such litigation is comprised of a self-insurance retention of $5 million and catastrophic coverage of $10 million in excess of the retention. The Company contracts with an independent insurance firm to provide claims handling and adjustment services. The Company's estimates with respect to claims are based on internal evaluations of the merits of individual claims and the reserves assigned by the Company's independent insurance carrier. The methods of making such estimates and establishing the resulting accrued liability are reviewed continually, and any adjustments resulting therefrom are reflected in current earnings. Claims are paid over varying periods, which generally do not exceed five years. Accrued liabilities for future claims are not discounted.\nWith respect to all claims of which the Company is aware, accrued liabilities of $8.4 million and $8.0 million were established at July 31, 1995 and 1994, respectively. While the Company's ultimate liability may exceed or be less than the amounts accrued, the Company believes that it is unlikely that it would experience losses that are materially in excess of such reserve amounts. As of July 31, 1995 and 1994, there were no insurance recoverables or offset implications and there were no claims by the Company being contested by insurers.\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 SHAREHOLDER MATTERS\nThe Company's capital stock is traded on the NASDAQ National Market under the symbol JLGI. The table below sets forth the market prices and average shares traded daily for the past two fiscal years: Average Shares Price per Share Traded Daily Quarter 1995 1994 1995 1994 Ended High Low High Low October 31 $10 7\/16 $8 1\/2 $4 3\/4 $3 13\/16 54,763 31,673 January 31 $10 7\/16 $8 1\/2 $7 $4 5\/16 82,921 94,296 April 30 $10 3\/4 $8 1\/2 $8 3\/16 $6 1\/16 90,100 81,692 July 31 $18 1\/8 $9 5\/8 $9 1\/8 $6 1\/8 107,248 115,743\nThe Company's quarterly cash dividend rate is currently $.01 per share, or $.04 on an annual basis. The Board of Directors reinstated payment of the quarterly cash dividend in fiscal 1994, after it was suspended in November, 1991 due to the economic recession and its impact on the Company's results. The Board continually reviews the its dividend policy, but believes, at this time, that it is in the best interests of the Company to continue to reinvest the majority of its earnings into the growth of the business.\nAs of July 31, 1995, there were approximately 2,300 record holders of the Company's shares, including 1,300 employee holders. Record holders exclude participants in security position listings and other indirect shareholders.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThis summary should be read in conjunction with Management's Discussion and Analysis. All share and per share data have been adjusted for the two-for-one stock splits distributed in April and October, 1995.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe Company is a leading manufacturer, distributor and international and marketer of mobile elevating work platforms and truck-mounted material handling equipment used primarily in construction and industrial applications. Sales are made principally to independent equipment distributors that lease the Company's products and provide service support to equipment users. Equipment purchases by end-users, either directly from the Company or through distributors, comprise a significant, but smaller portion of sales.\nDemand for the Company's products tends to be cyclical, responding historically to varying levels of construction and industrial activity, principally in the United States and, to a lesser extent, in other industrialized nations. During recessionary conditions, demand for equipment held for rental typically declines more sharply than demand for equipment purchased by end-users. Other factors affecting demand include the availability and cost of financing for equipment purchases and the market availability of used equipment.\nDue to the cyclical demand, the Company's financial performance and cash flows tend to fluctuate. However, the Company continually strives to reduce operating costs and increase manufacturing efficiencies. The Company also considers the development and introduction of new and improved products and expansion into underserved geographic markets to be important factors in maintaining and strengthening its market position and reducing cyclical fluctuations in financial performance and cash flows.\nResults of Operations\nNet sales reached a new high in 1995, rising by 53% over 1994 and by 43% from 1993 to 1994. The growth in revenues for both years included increased demand across virtually all product classes. Continued strong North American demand for both 1995 and 1994, combined with improvement in the European market in 1995, generated the record sales. Foreign sales as a percent of total sales were 18%, 16% and 26% in 1995, 1994 and 1993, respectively. New products introduced over a two-year period contributed over 24% and 25% to sales in 1995 and 1994, respectively. Management does not believe that any single customer is material to the Company's business on an ongoing basis. The level of sales to a particular customer may vary significantly from year to year. In 1995 and 1994, sales to one customer amounted to 13% and 12% of net sales, respectively. In 1993, no single customer accounted for more than 10% of net sales.\nGross profit, as a percent of sales, was 24% for both 1995 and 1994. Lower manufacturing costs due to continued improvements in manufacturing processes, lower warranty and product liability costs, and higher selling prices offset increased material costs, a less profitable product mix and costs associated with outsourcing additional production as a result of the substantial increase in demand and capacity limitations. Gross profit increased to 24% in 1994 from 23% in 1993, primarily as a result of process cost reductions. This improvement was partially offset by increases in certain overhead expenses, higher personnel costs, changes in product mix and competitive pricing pressures.\nSelling, general and administrative expenses were $33.3 million, $27.1 million and $23.3 million, or as a percent of sales, 12%, 15% and 19% for 1995, 1994 and 1993, respectively. The dollar increase for both years included increased advertising, commissions and other personnel related expenses. In addition, research and development spending grew by 27% from 1994 to 1995 and 29% from 1993 to 1994 as the Company continued to invest in the development of new products. The expenditure increase from 1993 to 1994 also included an increase in the provision for doubtful accounts.\nThe effective income tax rate increased to 37% in 1995 compared to 35% and 30% in 1994 and 1993, respectively. The effective income tax rate for 1994 reflects the benefit of closing an overseas facility. The rate for 1993 includes a decrease in estimated taxes payable.\nFinancial Condition\nThe Company strengthened its financial position during 1995 through increased cash from operations and debt reduction. Cash generated from operating activities increased to $17.9 million in 1995, compared to $11.4 million in both 1994 and 1993. Working capital was $45.4 million and $32.4 million at July 31, 1995 and 1994, respectively. Capital expenditures increased substantially in both 1995 and 1994, as the Company continued to invest in property, plant and equipment needed to support business growth and improve productivity and quality. The ratio of debt to total capital at July 31, 1995, decreased to 4% from 14% at July 31, 1994, principally due to the repayment of debt with cash generated from operations. The increase from 10% at July 31, 1993, to 14% in 1994 was due to borrowed funds to purchase treasury shares.\nAt July 31, 1995, the Company had unused credit lines totaling $10 million and cash balances of $13 million. The Company considers these resources, coupled with cash expected to be generated by operations, adequate to meet its foreseeable funding needs, including $7 million budgeted for capital expenditures in fiscal 1996. In addition, the Company intends to relocate and expand its scissor lift manufacturing facility in 1996. Acquisition, relocation and refitting costs are estimated to be $9 million payable over twelve months. The Company intends to finance this project with borrowed capital.\nThe Company's exposure to product liability claims is discussed in the Commitments, Contingencies note to the consolidated financial statements. Future results of operations, financial condition and liquidity may be affected to the extent that the Company's ultimate liability with respect to product liability varies from current estimates.\nOutlook\nManagement expects fiscal year 1996 to be another strong year. Consensus economic forecasts predict no domestic recession in the near term, and forecasts for Western Europe and the Pacific Rim nations, except Japan, are generally optimistic. The existing markets for the Company's products, particularly elevating work platforms, continue to grow, although at a somewhat slower rate than a year ago. Rental fleet utilization remains strong in the United States and demand for used equipment exceeds its supply. The Company's backlog remains strong, and new products to be introduced during the third fiscal quarter, together with expanded international distribution, should spur demand. Management has targeted additional manufacturing cost reductions and a slight improvement in gross profit as a percentage of net sales. Capacity constraints and outsourcing requirements, particularly for scissor lift production, will be offsetting factors. This should be alleviated in fiscal 1997 once the new Bedford facility is fully operational. Product mix also affects gross margins and is difficult to forecast. The timing and terms of the proposed divestiture of the Material Handling Division are uncertain, but Management does not expect this transaction to have a material effect on the Company's results of operations in fiscal 1996.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe following consolidated financial statements of JLG Industries, Inc. and its subsidiaries, are included herein as indicated below:\nConsolidated Balance Sheets - July 31, 1995 and 1994\nConsolidated Statements of Income - Years Ended July 31, 1995, 1994 and 1993\nConsolidated Statements of Shareholders' Equity - Years Ended July 31, 1995, 1994 and 1993\nConsolidated Statements of Cash Flows - Years Ended July 31, 1995, 1994 and 1993\nNotes to the Consolidated Financial Statements - July 31, 1995\nReport of Independent Auditors\nJLG INDUSTRIES, INC. CONSOLIDATED BALANCE SHEETS (in thousands except per share data) \t\t\t\t\t\t\t \t \t July 31 1995 1994 ASSETS Current Assets Cash $12,973 $8,088 Accounts receivable, less allowance for doubtful accounts of $1,325 in 1995 and $965 in 1994 33,466 25,750 Inventories: Finished goods 7,630 4,968 Work in process 13,357 9,242 Raw materials 12,459 9,012 33,446 23,222 Future income tax benefits 4,219 3,531 Other current assets 464 1,871 Total Current Assets 84,568 62,462 Property, Plant and Equipment Land and improvements 3,038 2,033 Building and improvements 11,524 12,750 Machinery and equipment 29,290 22,924 43,852 37,707 Less allowance for depreciation 19,067 18,363 24,785 19,344 Equipment Held for Rental 5,052 4,190 Other Assets 5,303 5,638 $119,708 $91,634\nLIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities Current portion of long-term debt $243 $1,301 Accounts payable 20,028 14,770 Accrued expenses 18,893 14,011 Total Current Liabilities 39,164 30,082 Long-Term Debt 2,260 6,277 Other Liabilities and Deferred Credits 9,854 9,569 Shareholders' Equity Capital stock: Authorized shares: 17,081 at $.20 par value Issued and outstanding shares: 1995 - 14,275 shares; 1994 - 13,969 shares 2,855 2,939 Additional paid-in capital 10,121 10,861 Equity adjustment from translation (1,799) (1,899) Retained earnings 57,253 36,884 Treasury stock (3,079) Total Shareholders' Equity 68,430 45,706 $119,708 $91,634\nThe accompanying notes are an integral part of these financial statements.\nJLG INDUSTRIES, INC. CONSOLIDATED STATEMENTS OF INCOME (in thousands except per share data)\n\t\t\t\t\t\t\tFiscal Years Ended July 31 1995 1994 1993\nNet Sales $269,211 $176,443 $123,034\nCost of sales 203,258 134,289 94,794\nGross Profit 65,953 42,154 28,240\nSelling, general and administrative expenses 33,254 27,147 23,323\nIncome from Operations 32,699 15,007 4,917\nOther income (deductions): Interest expense (376) (380) (458) Miscellaneous, net 376 (24) 180\nIncome before Taxes 32,699 14,603 4,639\nIncome tax provision 11,941 5,067 1,410\nNet Income $20,758 $9,536 $3,229\nNet Income per Share $1.47 $.68 $.22\nThe accompanying notes are an integral part of these financial statements.\n\t\t\t\t\t\t The accompanying notes are an integral part of these statements\nCONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)\nYear Ended July 31, 1995 1994 1993 Operations Net income $20,758 $9,536 $3,229 Adjustments to reconcile net income to cash provided by operating activities:\t\t \t Depreciation 3,875 2,801 2,500 Provision for self-insured losses 408 2,292 1,425 Deferred income taxes (596) (1,233) 1,050 Changes in operating assets and liabilities:\t\t\t Accounts receivable (7,522) (4,686) (6,452) Inventories (9,867) (3,682) 4,628 Other current assets 1,412 21 156 Accounts payable 5,251 3,728 4,899 Accrued expenses 3,951 2,659 1,285 Changes in other assets and liabilities 279 (72) (1,304) Cash provided by operations 17,949 11,364 11,416 Investments Purchases of property, plant and equipment (11,035) (7,963) (3,780) Proceeds from sale of property, plant and equipment 2,417 201 210 Cash used for investments (8,618) (7,762) (3,570) Financing\t\t\t Repayment of long-term debt (5,081) (1,904) (7,980) Issuance of long-term debt 5,000 Payment of dividends (389) (352) Purchase of treasury stock (3,500) Stock issued for employee benefit plans 1,159 625 513 Cash used for financing (4,311) (131) (7,467) Currency Adjustments Effect of exchange rate changes on cash (135) (231) (471) Cash Net change in cash 4,885 3,240 (92) Beginning balance 8,088 4,848 4,940 Ending balance $12,973 $8,088 $4,848 \t\t\t \t\t\t The accompanying notes are an integral part of these statements.\nJLG INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands except per share data)\nSUMMARY OF SIGNIFICANT ACCOUNTING POLICES\nPrinciples of Consolidation and Statement Presentation The consolidated financial statements include the accounts of the Company and its subsidiaries. Significant intercompany accounts and transactions have been eliminated in consolidation.\nCash and Cash Equivalents The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents and classifies such amounts as cash.\nInventories Inventories are stated at the lower of cost or market. Cost is determined using the LIFO (last-in, first-out) method. Inventories at July 31, 1995 and 1994 would have been higher by $4,528 and $4,434, respectively, had the Company used FIFO cost, which approximates current cost, rather than LIFO cost for valuation of its inventories. In 1993, the liquidation of LIFO inventories decreased cost of sales and, therefore, increased income before taxes by $294.\nProperty, Plant and Equipment and Equipment Held for Rental Property, plant and equipment held for rental are stated at cost, net of accumulated depreciation. Depreciation is computed using the straight-line method, based on useful lives of 15 years for land improvements, 10 to 20 years for buildings and improvements, three to 10 years for machinery and equipment and three to seven years for equipment held for rental.\nIncome Taxes Deferred income tax assets and liabilities arise from differences between the tax basis of assets or liabilities and their reported amounts in the financial statements. Deferred tax balances are determined by using the tax rate expected to be in effect when the taxes are paid or refunds received.\nCapital Stock On February 23, 1995 and September 7, 1995, the Company declared two-for-one stock splits of the Company's then outstanding common stock. The splits were effected by stock dividends. All share and per share data included in this Annual Report have been restated to reflect the stock splits.\nProduct Development The Company incurred product development and other engineering expenses of $5,542, $4,373 and $3,385 in 1995, 1994 and 1993, respectively, which were charged to expense as incurred.\nTranslation of Foreign Currencies The translation of foreign currencies into U.S. dollars is performed for balance sheet accounts using current exchange rates in effect at the balance sheet date and for revenue and expense accounts using an average exchange rate for the period. The gains or losses resulting from translation are included in shareholders' equity.\nNet Income per Share Net income per share is based on the average number of shares of Common stock outstanding during each year. The effect of Common stock equivalents is immaterial to earnings per share.\nINCOME TAXES\nThe income tax provision consisted of the following for the years ended July 31:\n1995 1994 1993 Current: Federal $10,641 $5,373 $ 360 State 1,896 927 12,537 6,300 360 Deferred: Federal (483) (833) 954 State (113) (400) 96 (596) (1,233) 1,050 $11,941 $5,067 $1,410\nOn a net basis, the Company made income tax payments of $11,858 in 1995 and $5,700 in 1994 and received income tax refunds of $1,195 in 1993.\nThe difference between the U.S. federal statutory income tax rate and the Company's effective tax rate is as follows for the years ended July 31:\n1995 1994 1993 Statutory U.S. federal income tax rate 34% 34% 34% State tax provision, net of federal effect 4 4 6 Net tax effect of foreign operations (2) 3 Adjustments to reflect 1993 tax return as filed (9) Other (1) (1) (4) 37% 35% 30%\nComponents of deferred tax assets and liabilities were as follows at July 31:\n1995 1994 Future income tax benefits: Contingent liabilities provisions $3,811 $3,932 Employee benefits 1,154 970 Translation adjustments 918 1,166 Inventory valuation provisions 887 928 Other 1,360 563 8,130 7,559 Deferred tax liabilities: Depreciation and asset basis differences 925 597 Other 145 154 1,070 751 7,060 6,808 Less valuation allowance (234) (383) Net deferred tax assets $6,826 $6,425\nBANK CREDIT LINES AND LONG-TERM DEBT\nThe Company has available a $10 million unsecured bank revolving line of credit with a term of two years, renewable annually, and at an interest rate of prime or a spread over LIBOR. The facility further provides for borrowings using bankers acceptances at prevailing discount rates. The Company also has the option to convert outstanding borrowings under the facility to an amortizing term loan with a repayment period of up to five years, and at an interest rate based on the yield of U.S. Treasury securities with the same maturity. There were no amounts outstanding under this facility at July 31, 1995 and 1994.\nLong-term debt was as follows at July 31:\n1995 1994 Bank installment loans due $4,750 Industrial revenue bonds due in 1999 with interest at 7% $1,000 1,000 State agency mortgages due through 2004 with interest averaging 3.6% 662 760 Industrial revenue mortgages due through\t 2004 with interest at 5.5% 677 754 Other 164 314 2,503 7,578 Less current portion (243) (1,301) $2,260 $6,277\nThe bank revolving line of credit requires the maintenance of certain financial ratios. Borrowings aggregating $2.2 million under certain long-term loans are secured by $7.2 million in assets of the Company. Interest paid on all borrowings was $378, $461 and $511 in 1995, 1994, and 1993, respectively.\nThe aggregate amounts of long-term debt outstanding at July 31, 1995 which will become due in 1996 through 2000 are: $243, $246, $189, $1,142 and $143.\nEMPLOYEE BENEFIT PLANS\nThe Company's stock incentive plan has reserved 3,032 common shares that may be awarded to key employees in the form of options to purchase Common shares, restricted shares and limited appreciation rights. The option price is set by the Company's Board of Directors and, for all options currently outstanding, is the fair market value of the shares on their date of grant.\nThe directors stock option plan provides for annual grants to each outside director of a single option to purchase six thousand shares of Common stock, providing the Company earned a net profit, before extraordinary items, for the prior year. The option price shall be equal to the shares' fair market value on their date of grant. An aggregate of 702 shares of Common stock is authorized to be issued under the plan.\nOutstanding options and transactions involving the plans are summarized as follows:\n1995 1994 Outstanding options at the beginning of the year 620 525 Options granted ($3.37 to $16.89 per share) 76 114 Options cancelled ($1.31 to $8.81 per share) (4) (2) Options exercised ($1.31 to $8.81 per share) (55) (17) Outstanding options at the end of the year 637 620 Exercisable options at the end of the year ($1.31 to $8.81 per share) 175 89\nThe Company has two discretionary, defined-contribution retirement plans covering all its eligible U.S. employees. The Company's policy is to fund these pension costs as accrued. Plan assets are invested in money market funds, government securities, mutual funds and the Company's Common stock. The aggregate expense relating to these plans was $2,298, $1,888 and $1,025 in 1995, 1994 and 1993, respectively.\nACCRUED EXPENSES\nComponents of accrued expenses were as follows at July 31:\n\t 1995 \t1994 Salaries, wages and related taxes $ 6,609 $ 4,337 Income taxes 2,718 2,335 Contingent liabilities, current portion 2,378 1,965 Employee benefits 1,563 1,626 Other 5,625 3,748 $18,893 $14,011\nINDUSTRY AND EXPORT DATA\nThe Company operates in one dominant industry segment - the manufacturing and selling of mobile, hydraulically-operated equipment. The Company's customers are predominantly U.S. based equipment rental firms. Additionally, its receivables from these customers are generally not collateralized. In 1995 and 1994, sales to one customer amounted to 13% and 12% of net sales, respectively. For 1993, no single customer represented 10% or more of net sales. Sales to customers outside the U. S. were 18%, 16% and 26% of net sales for 1995, 1994 and 1993, respectively.\nCOMMITMENTS AND CONTINGENCIES\nThe Company is a party to personal injury and property damage litigation arising out of incidents involving the use of its products. The Company's insurance program for fiscal year 1995 is comprised of a self-insured retention of $5 million and catastrophic coverage of $20 million in excess of the retention. The Company contracts with an independent insurance firm to provide claims handling and adjustment services. The Company's estimates with respect to claims are based on internal evaluations of the merits of individual claims and the reserves assigned by the Company's independent insurance carrier. The methods of making such estimates and establishing the resulting accrued liability are reviewed continually, and any adjustments resulting therefrom are reflected in current earnings. Claims are paid over varying periods, which generally do not exceed five years. Accrued liabilities for future claims are not discounted.\nWith respect to all claims of which the Company is aware, accrued liabilities of $8.4 million and $8.0 million were established at July 31, 1995 and 1994, respectively. While the Company's ultimate liability may exceed or be less than the amounts accrued, the Company believes that it is unlikely that it would experience losses that are materially in excess of such reserve amounts. As of July 31, 1995 and 1994, there were no insurance recoverables or offset implications and there were no claims by the Company being contested by insurers.\nThe Company leases equipment under operating leases expiring in various years. These leases require the Company to pay all maintenance and general operating costs. Future minimum lease payments are: $1,068, $527, $472 and $59 in 1996 through 1999, respectively. Rental expense for all operating leases was $906, $955, and $763 in 1995, 1994 and 1993, respectively.\nUNAUDITED QUARTERLY FINANCIAL INFORMATION\nUnaudited financial information was as follows for the fiscal quarters within the years ended July 31:\nNet Net Income Net Sales Gross Profit Income per Share October 31 $ 53,724 $12,984 $ 3,863 $ .27 January 31 52,175 13,449 3,752 .27 April 30 75,809 18,082 6,089 .43 July 31 87,503 21,438 7,054 .50 $269,211 $65,953 $20,758 $1.47 October 31 $ 36,757 $ 8,629 $ 1,252 $ .09 January 31 34,172 7,765 1,095 .08 April 30 50,141 12,601 3,514 .25 July 31 55,373 13,159 3,675 .26 $176,443 $42,154 $ 9,536 $ .68\nGross profit for the first three quarters of fiscal 1994 has been restated from amounts previously reported by the Company in its interim financial statements. Restated amounts reflect the reclassification of certain costs between expense categories.\nREPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS\nTo The Board of Directors and Shareholders JLG Industries, Inc. McConnellsburg, Pennsylvania\nWe have audited the accompanying consolidated balance sheets of JLG Industries, Inc. as of July 31, 1995 and 1994, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended July 31, 1995. 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 JLG Industries, Inc. at July 31, 1995 and 1994, and the consolidated results of its operations and its cash flows for each of the three years in the period ended July 31, 1995 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 Baltimore, Maryland September 7, 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 information required by this Item 10 relating to identification of directors is incorporated herein by reference from pages 2 through 4 of the Company's Proxy Statement under the caption \"Election of Directors.\" Identification of officers is presented in Item 1 of this report under the caption \"Executive Officers of the Registrant.\"\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by this Item 11 relating to executive compensation is hereby incorporated by reference from pages 3 through 4, under the caption \"Board of Directors,\" and pages 5 through 11, under the caption \"Executive Compensation,\" of the Company's Proxy Statement.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required by this Item 12 relating to security ownership of certain beneficial owners and management is hereby incorporated by reference from pages 4 and 5 of the Company's Proxy Statement under the caption \"Voting Securities and Principal Holders.\" There is no required disclosure regarding change in control.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by this Item 12 relating to certain relationships and related transactions is hereby incorporated by reference from page 13 of the Company's Proxy Statement under the caption \"Certain Transactions.\"\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) (1) and (2) The following consolidated financial statements of the registrant and its subsidiaries are included in Item 8.\nConsolidated Balance Sheets - July 31, 1995 and 1994\nConsolidated Statements of Income - Years ended July 31, 1995, 1994 and\nConsolidated Statements of Shareholders' Equity - Years ended July 31, 1995, 1994 and 1993\nConsolidated Statements of Cash Flows - Years ended July 31, 1995, 1994 and 1993\nNotes to Consolidated Financial Statements - July 31, 1995\nThe following consolidated financial schedule of the registrant and its 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.\n(a) (3) Listing of Exhibits\nExhibit Number Exhibit\n3.1 Certificate of incorporation of JLG Industries, Inc., which appears as Exhibit 1 (a) to the Company's Form 10 Registration Statement (File No. 0-8454 -- filed April 22, 1977), is hereby incorporated by reference.\n3.2 Amendment to Section 5 of the Company's Articles of Incorporation effective as of September 15, 1995.\n3.3 By-Laws of JLG Industries, Inc., which appears as Exhibit 3 to the Company's Form 10-Q (File No. 0-8454 -- filed March 16, 1995), is hereby incorporated by reference.\n4.1 Trust Indenture between the Bedford County, Pennsylvania Industrial Development Authority and the Fulton County National Bank and Trust Company, as Trustee, which appears as Exhibit B5 to the Company's Form 10-K (File No. 0-8454 -- filed October 24, 1979), is hereby incorporated by reference.\n4.2 Installment Sale Agreement between Bedford County, Pennsylvania Industrial Development Authority and JLG Industries, Inc., which appears as Exhibit B6 to the Company's Form 10-K (File No. 0-8454 -- filed October 24, 1979), is hereby incorporated by reference.\n4.3 Agreement to disclosed upon request.\n10.1 Form of Deferred Compensation Benefit Agreement dated March 1, 1989 with certain retired key employees which appears as Exhibit 10.2 to the Company's 10-K (File No. 0-8454 -- filed October 18, 1989), is hereby incorporated by reference.\n10.2 Form of Deferred Compensation Benefit Agreement dated March 1, 1990 with certain key employees, which appears as Exhibit 10.4 to the Company's Form 10-K (File No. 0-8454 -- filed October 18, 1990), is hereby incorporated by reference.\n10.3 Form of Deferred Compensation Benefit Agreement dated August 15, 1990 between JLG Industries, Inc. and L. David Black, which appears as Exhibit 10.5 to the Company's Form 10-K (File No. 0-8454 -- filed October 18, 1990), is hereby incorporated by reference.\n10.4 Stock Redemption Agreement dated August 27, 1980, between JLG Industries, Inc. and Paul K. Shockey, which appears as Exhibit 25 to the Company's Form S-7 (Registration No. 2-69194 -- filed September 18, 1980), is hereby incorporated by reference.\n10.5 Directors' Deferred Compensation Plan date July 29, 1986, which appears as Exhibit 10.5 to the Company's Form 10-K (File No 0-8454 -- filed October 28, 1986), is hereby incorporated by reference.\n10.6 JLG Industries, Inc. Stock Incentive Plan dated May 23, 1991 which appears as Exhibit 10.10 to the Company's Form 10-K (File No. 0- 8454 -- filed October 27, 1992), is hereby incorporated by reference.\n10.7 Credit Agreement dated December 21, 1989 among JLG Industries, Inc., the First National Bank of Maryland, and Philadelphia National Bank, which appears as Exhibit 4.1 to the Company's 10-Q (File No. 0-8454 -- filed March 12, 1990), is hereby incorporated by reference.\n10.8 First Modification Agreement, dated January 29, 1990 to the Credit Agreement dated December 21, 1989 among JLG Industries, Inc., the First National Bank of Maryland, and Philadelphia National Bank, which appears as Exhibit 4.3 to the Company's 10-Q (File No. 0-8454 -- filed March 12, 1990), is hereby incorporated by reference.\n10.9 Second Modification Agreement, dated September 17, 1993 to the Credit Agreement dated December 21, 1989 among JLG Industries, Inc., the First National Bank of Maryland, and Philadelphia National Bank, which appears as Exhibit 10.12 to the Company's 10- K (File No. 0-8454 -- filed October 20, 1993), is hereby incorporated by reference.\n10.10 JLG Industries, Inc. Directors Stock Option Plan amended and restated as of September 7, 1995.\n22 Listing of subsidiaries.\n23 Consent of independent auditors\n(b) The Company was not required to file Form 8-K pursuant to requirements of such form in the fourth quarter of fiscal 1995.\n\tSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nJLG INDUSTRIES, INC. (Registrant)\nBy: \/s\/ L. David Black Date: October 19, 1995 L. David Black, Chairman of the Board, President and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities on the dates indicated.\nBy: \/s\/ Charles H. Diller, Jr. Date: October 19, 1995 Charles H. Diller, Jr., Executive Vice President, Chief Financial Officer and Director\nBy: \/s\/ George R. Kempton Date: October 19, 1995 George R. Kempton, Director\nBy: \/s\/ Gerald Palmer Date: October 19, 1995 Gerald Palmer, Director\nBy: \/s\/ Stephen Rabinowitz Date: October 19, 1995 Stephen Rabinowitz, Director\nBy: \/s\/ Paul Shockey Date: October 19, 1995 Paul Shockey, Secretary and Director\nBy: \/s\/ Charles O. Wood, III Date: October 19, 1995 \t\t Charles O. Wood, III, Director\n\t\nNote:\n(1)Amounts written off and transferred to other accounts in the current year.\n(2)Adjustment resulting from conversion of foreign currencies.","section_15":""}
{"filename":"945633_1995.txt","cik":"945633","year":"1995","section_1":"ITEM 1. BUSINESS\nEXPLANATORY NOTE\nTHIS INTEGRATED FORM 10-K IS FILED PURSUANT TO THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED, FOR EACH OF UNITED STATIONERS INC., A DELAWARE CORPORATION, AND ITS WHOLLY-OWNED SUBSIDIARY, UNITED STATIONERS SUPPLY CO., AN ILLINOIS CORPORATION (COLLECTIVELY, THE \"COMPANY\"). UNITED STATIONERS INC. IS A HOLDING COMPANY WITH NO OPERATIONS SEPARATE FROM ITS OPERATING SUBSIDIARY, UNITED STATIONERS SUPPLY CO. NO SEPARATE FINANCIAL INFORMATION FOR UNITED STATIONERS SUPPLY CO. HAS BEEN PROVIDED HEREIN BECAUSE MANAGEMENT FOR THE COMPANY BELIEVES SUCH INFORMATION WOULD NOT BE MEANINGFUL BECAUSE (I) UNITED STATIONERS SUPPLY CO. IS THE ONLY DIRECT SUBSIDIARY OF UNITED STATIONERS INC., WHICH HAS NO OPERATIONS OTHER THAN THOSE OF UNITED STATIONERS SUPPLY CO. AND (II) ALL ASSETS AND LIABILITIES OF UNITED STATIONERS INC. ARE RECORDED ON THE BOOKS OF UNITED STATIONERS SUPPLY CO. THERE IS NO MATERIAL DIFFERENCE BETWEEN UNITED STATIONERS INC. AND UNITED STATIONERS SUPPLY CO. FOR THE DISCLOSURE REQUIRED BY THE INSTRUCTIONS TO FORM 10-K AND THEREFORE, UNLESS OTHERWISE INDICATED, THE RESPONSES SET FORTH HEREIN APPLY TO EACH OF UNITED STATIONERS INC. AND UNITED STATIONERS SUPPLY CO.\nGENERAL\nOn March 30, 1995, pursuant to an Agreement and Plan of Merger, dated as of February 13, 1995 (the \"Merger Agreement\"), between Associated Holdings, Inc., a Delaware corporation (\"Associated\") and United Stationers Inc., a Delaware corporation (\"United\") and Associated's related Offer to Purchase dated February 21, 1995 (the \"Offer\"), Associated purchased 17,201,839 shares (NOT ADJUSTED FOR THE 100% STOCK DIVIDEND EFFECTIVE NOVEMBER 9, 1995) of Common Stock, $0.10 par value (the \"Shares\"), of United at a purchase price of $15.50 per share, or approximately $266.6 million, from United's stockholders (the \"Acquisition\"). On March 30, 1995, pursuant to the terms of the Merger Agreement, Associated was merged with and into United, with United surviving (the \"Merger\"), and immediately thereafter, Associated Stationers, Inc. (\"ASI\"), a Delaware corporation and wholly owned subsidiary of Associated was merged with and into United Stationers Supply Co. (\"USSC\"), an Illinois corporation and wholly owned subsidiary of United, with USSC surviving. Although United was the surviving corporation in the Merger, the transaction was treated as a reverse acquisition for accounting purposes with Associated as the acquiring corporation.\nExcept where the context clearly indicates otherwise, the term \"Company\" is used herein to refer to post-Merger United and the terms \"Associated\" and \"United\" are used hereinafter to refer to either the respective pre-Merger corporations or specific aspects of the post-Merger Company's business. United is the parent company of its direct wholly owned subsidiary, USSC. Except where the context clearly indicates otherwise including references to the capital structure of United Stationers Inc., the term \"Company\" hereinafter used includes United Stationers Inc. together with its subsidiary.\nThe Company is the largest general line business products wholesaler in the United States, with 1995 pro forma net sales of $2.2 billion. The Company sells its products through a single national distribution network to more than 12,000 resellers, who in turn sell directly to end users. Substantially all these products are distributed overnight through a computer-based network of warehouse facilities and truck fleets radiating from 43 distribution points.\nPRODUCTS\nThe Company markets a broad array of products, which include traditional office products; computers and related supplies, office furniture; and other products (including facilities management supplies). As part of the Company's business strategy to acquire incremental sales and increase market share through ancillary product offerings, the Company began to focus on niche product segments in 1991 and has expanded steadily upon this concept since then. The Company's product offerings, composed of more than 25,000 items, may be divided into four primary categories:\nTRADITIONAL OFFICE PRODUCTS. The Company's core business continues to be traditional office products, which includes both brand-name products and the Company's private brand products. Traditional office\nproducts include writing instruments, paper products, organizers and calendars and various office accessories. The Company's traditional office product offerings are quite deep, including, for example, more than 1,000 different stockkeeping units of ring binders and 800 types of file folders. Traditional office products constituted the majority of the Company's 1995 pro forma net sales.\nCOMPUTERS AND RELATED SUPPLIES. The Company sells computer supplies, peripherals and hardware with major brand names to computer resellers and office products dealers. Such office technology constituted approximately 27% of the Company's 1995 pro forma net sales.\nOFFICE FURNITURE. The Company's sale of office furniture such as leather chairs, wooden and steel desks and computer furniture has enabled it to become the nation's largest office furniture wholesaler, with the Company currently offering nearly 3,000 furniture items from 70 different manufacturers. Office furniture constituted approximately 15% of the Company's 1995 pro forma net sales. The Company's \"Pro-Image\" program enables resellers with no previous expertise to provide high-end furniture and office design services to end-users. The Company offers national delivery and product \"set-up\" capabilities to office products dealers as well as to attract new furniture dealers.\nOTHER PRODUCTS. The Company's newest product categories encompass the facilities management supplies market, which includes janitorial and sanitation supplies, specialty mailroom and warehouse items, kitchen and cafeteria items, first aid products and ergonomic products designed to enhance worker productivity, comfort and safety. Another one of the Company's niche markets is business presentation products, including audio visual equipment, flip charts and dry erase boards. Additionally, the Company offers its \"Signature Image\" program, which provides resellers with access into the advertising specialties market (such as imprinted and logo items).\nCUSTOMERS\nThe Company sells principally to resellers of office products, consisting primarily of commercial dealers and contract stationers, retail dealers, superstores, mail order companies and mass merchandisers. In addition, the Company sells to office furniture dealers, computer resellers and janitorial and sanitary supply distributors. No single reseller accounted for more than 5% of the Company's pro forma net sales in 1995.\nCommercial dealers and contract stationers are the most significant reseller channel for office products distribution and typically serve large businesses, institutions and government agencies. Through industry consolidation, the number of such dealers has decreased, with the remaining dealers getting larger. Net sales to these commercial dealers and contract stationers as a group are growing rapidly.\nThe number of retail dealers has been declining for some time as the result of individual retail dealers' inability to compete successfully with the growing number of superstores and, more recently, as a result of dealerships being acquired and brought under an umbrella of common ownership. However, many retail office products dealers have adapted to this highly competitive environment. Many retail dealers, commercial dealers and contract stationers have joined forces in marketing or buying groups in order to increase purchasing leverage. The Company believes it is the leading wholesale source for many of these groups, providing not only merchandise but also special programs that enable these dealers to take advantage of their combined strengths.\nWhile the Company maintains and builds its business with commercial dealers, contract stationers (including the contract stationer divisions of national office product superstores) and retail dealers, it has also initiated relationships with most major office products superstore chains. In addition, the Company supplies inventory and other fulfillment services to the retail operations of certain superstores, including their direct-to-business delivery programs.\nMARKETING AND CUSTOMER SUPPORT\nSubstantially all of the Company's 25,000 products are sold through its comprehensive office products catalogs and flyers. These materials include general line catalogs, promotional pieces and specialty catalogs for the office products, office furniture, facilities management supplies and other specialty markets. The Company produces numerous catalogs for placement with dealers' end- user customers, including the\nfollowing annual catalogs: General Line Catalog; Office Furniture Catalog featuring furniture and accessories; Universal Catalog promoting the Company's private-brand merchandise; Computer Products Catalog offering hardware, supplies, accessories and furniture; Workplace Solutions Catalog featuring janitorial, maintenance, food service, warehouse and mailroom supplies; Business Communications Catalog, featuring products and supplies used for meetings and presentations; and separate Legal and Healthcare Catalogs offering office products used within such professions. In addition, the Company produces the following quarterly promotional catalogs: Action 2000 and Office Saver, each featuring over 1,000 high-volume commodity items, and Computer Concepts, featuring computer supplies, peripherals, accessories and furniture. The Company also produces separate 8-page quarterly flyers covering general office supplies, office furniture and Universal-TM-products. Because commercial dealers, contract stationers and retail dealers typically distribute only one wholesaler's catalogs in order to streamline and concentrate order entry, the Company attempts to maximize the distribution of its catalogs by offering advertising credits to resellers, which can be used to offset the cost of catalogs.\nIn addition to marketing its products and services through the use of its catalogs, the Company employs a sales force of approximately 160 salespersons. The sales force is responsible for sales and service to resellers with which the Company has an existing relationship, as well as for establishing new relationships with additional resellers. The Company supplements the efforts of its sales force through telemarketing.\nThe Company concentrates its marketing efforts on providing value-added services to resellers. The Company distributes products that are generally available at similar prices from multiple sources, and most of its customers purchase their products from more than one source. As a result, the Company seeks to differentiate itself from its competitors through a broader product offering, a higher degree of product availability, a variety of high quality customer services and prompt distribution capabilities. In addition to emphasizing its broad product line, extensive inventory, computer integration and national distribution capabilities, the Company's marketing programs have relied upon two additional major components. First, the Company produces an extensive array of catalogs for commercial dealers, contract stationers and retail dealers that are usually custom imprinted with each reseller's name and sold to these resellers who, in turn, distribute the catalogs to their customers. Second, the Company provides its resellers with a variety of dealer support and marketing services, including business management systems, promotional programs and pricing services. These services are designed to aid the reseller in differentiating itself from its competitors by addressing the steps in the end-user's procurement process.\nTo assist its resellers with pricing, the Company offers a matrix pricing software program. Traditionally, many resellers have priced products on a discount from the manufacturer's suggested retail price, but recently pricing has shifted toward a net pricing approach, whereby the reseller sells certain products at significant discounts, assuming that it can recapture the discounts through the sale of other higher margin products. The Company's matrix pricing program provides resellers with a resource to assist them in identifying the optimum pricing mix between high and low margin items and, as a result, enables resellers to manage their gross margins.\nThe Company offers to its resellers a variety of electronic order entry systems and business management and marketing programs which enhance the resellers' ability to manage their businesses profitably. For instance, the Company maintains EDI systems that link the Company to selected resellers, and interactive order systems that link the Company to selected resellers and such resellers to the ultimate end-user. In addition, the Company's electronic order entry systems allow the reseller to seamlessly forward its customers' orders to the Company, resulting in the delivery of pre-sold products to the reseller or directly to its customers. The Company estimates that in 1995, approximately 90% of its orders were received electronically.\nDISTRIBUTION\nAt the time of the Merger, certain of the Company's 47 regional distribution centers were redundant and, accordingly, management determined to close eight of such facilities. To date, seven redundant facilities have been closed and one remaining facility is expected to be closed in early Spring of 1996. As a result, the Company has a network of 40 regional distribution centers (including the new distribution center in Pittsburgh, Pennsylvania) located in 36 metropolitan areas in 25 states, most of which will carry the Company's full line of inventory. In addition, the Company has achieved cost savings from the more efficient\npost-Merger operation of two distribution centers in each of four market areas, where the size of the Company's sales base requires multiple facilities.\nThe Company supplements its regional distribution centers with 25 local distribution points throughout the United States that serve as reshipment points for orders filled at the regional distribution centers. The Company utilizes more than 250 trucks, substantially all of which are contracted for by the Company, to enable direct delivery from the regional distribution centers and local distribution points to resellers.\nThe Company's distribution capabilities are augmented by its proprietary, computer-driven system. If a reseller places an order for an item that is out of stock at the Company location which usually serves the particular reseller, the Company's system will automatically search for the item at alternative distribution centers. If the item is available at an alternative location, the system will automatically forward the order to that alternate location, which will then coordinate shipping with the primary facility and, for the majority of resellers, provide a single on-time delivery. The system effectively provides the Company with added inventory support, which enables it to provide higher service levels to the reseller, to reduce back orders and to minimize time spent searching for merchandise substitutes, all of which contribute to the Company's high order fill rate and efficient levels of inventory balances.\nAnother service offered by the Company to resellers is its \"wrap and label\" program, which allows resellers the option to receive orders in accordance with the specifications of particular end-users. For example, when a reseller receives orders from a number of separate end-users, the Company groups and wraps the items separately by end-user so that the reseller need only deliver the package. The \"wrap and label\" program is attractive to resellers because it eliminates the need to break down case shipments and to repackage the orders before delivering them to the end-user.\nPURCHASING AND MERCHANDISING\nAs the largest national office products wholesaler in the United States, the Company has substantial purchasing power and can realize significant economies of scale. The Company obtains products from over 450 manufacturers, for many of whom the Company believes that it is a significant customer. In 1995 on a pro forma basis, no supplier accounted for more than 11% of the Company's aggregate purchases. As a centralized corporate function, the Company's merchandising department interviews and selects suppliers and products for inclusion in the catalogs. Selection is based upon end-user acceptance and demand for the product and the manufacturer's total service, price and product quality offering.\nCOMPETITION\nThe Company competes with office products manufacturers and with other national, regional and specialty wholesalers of office products, office furniture, computers and related items. Competition between the Company and manufacturers is based primarily upon net pricing, minimum order quantity and product availability. Although manufacturers may provide lower prices to resellers than the Company does, the Company's marketing and catalog programs, combined with speed of delivery and its ability to offer resellers a broad line of business products from multiple manufacturers on a \"one-stop shop\" basis and with lower minimum order quantities, are important factors in enabling the Company to compete effectively. See \"Marketing and Customer Support\" and \"Distribution.\" Manufacturers typically sell their products through a variety of distribution channels, including wholesalers and resellers.\nCompetition between the Company and other wholesalers is based primarily on net pricing to resellers, breadth of product lines, availability of products, speed of delivery to resellers, order fill rates and the quality of its marketing and other services. The Company believes it is competitive in each of these areas. Most wholesale distributors of office products conduct operations regionally and locally, sometimes with limited product lines such as writing instruments or computer products. Only one other national wholesaler carries a general line of office products.\nConsolidation has occurred in recent years throughout all levels of the office products industry. Consolidation of commercial dealers and contract stationers has resulted in an increased ability of those resellers to buy goods directly from manufacturers. In addition, over the last decade, office products\nsuperstores (which largely buy directly from manufacturers) have entered virtually every major metropolitan market.\nIncreased competition in the office products industry, together with increased advertising, has heightened price awareness among end-users. As a result, purchasers of commodity type office products have become extremely price sensitive, and therefore the Company has increased its efforts to market to resellers the continuing advantages of its competitive strengths (as compared to those of manufacturers and other wholesalers), such as marketing and catalog programs, speed of delivery, and the ability to offer resellers on a \"one-stop shop\" basis a broad line of business products from multiple manufacturers with lower minimum order quantities. In addition, such heightened price awareness has led to margin pressure on commodity office products. In the event that such trend continues, the Company's profit margins could be adversely affected.\nEMPLOYEES\nAt December 31, 1995, the Company employed approximately 4,800 persons.\nThe Company considers its relationships with its employees to be good. Approximately 900 of the shipping, warehouse and maintenance employees at certain of the Chicago, Detroit, Philadelphia, Baltimore, Los Angeles, Minneapolis and New York City facilities are covered by collective bargaining agreements. The agreements expire at various times during the next three years.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company considers its properties to be suitable and adequate for their intended uses. These properties consist of the following:\nEXECUTIVE OFFICES. The Company's office facility in Des Plaines, Illinois has approximately 135,800 square feet of office and storage space. In September 1993, approximately 47,000 square feet of office space located in Mt. Prospect, Illinois was leased by the Company. This lease expires in September of 1999 with an option to renew for two five-year terms.\nREGIONAL DISTRIBUTION CENTERS. The Company presently operates 41 distribution centers (including one which opened in Pittsburgh, Pennsylvania during the first quarter of 1996) in 25 states. These centers represent total square footage of approximately 7.1 million square feet, of which approximately 4.3 million is owned and the balance is leased. One center is scheduled to close by early Spring of 1996.\nLOCAL DISTRIBUTION POINTS. The Company also operates 25 local distribution points. Two are leased by the Company; the other local distribution points are operated through cross-docking arrangements with third party distribution companies.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is involved in legal proceedings arising in the ordinary course of its business. The Company is not involved in any legal proceeding that it believes will result, individually or in the aggregate, in a material adverse effect upon its financial condition or results of operations.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThere were no matters submitted to a vote of security holders through the solicitation of proxies in the fourth quarter of 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nQUARTERLY FINANCIAL DATA (IN THOUSANDS OF DOLLARS, EXCEPT SHARE DATA) (UNAUDITED)\nTHE COMPANY\/ASSOCIATED\n(1) Historical earnings per share amounts have been restated to reflect the share conversion resulting from the Merger and the 100% stock dividend, effective November 9, 1995. Earnings per share are net of preferred stock dividends.\n(2) Reflects the results of Associated only.\n(3) The extraordinary item reflects the write-off of financing costs and original issue discount relating to the retired debt which was being amortized over the life of the original debt.\n(4) As a result of changes in the number of common and common equivalent shares during the year, the sum of four quarters' earnings per share will not equal earnings per share for the total year.\nQUARTERLY STOCK PRICE DATA\nThe Common Stock is quoted through the Nasdaq National Market under the symbol \"USTR.\" The following table sets forth on a per share basis, for the periods indicated, the high and low sale prices per share for the Common Stock as reported by the Nasdaq National Market. All stock price information has been restated to reflect the 100% stock dividend effective November 9, 1995.\nHigh Low\nFirst Quarter * * Second Quarter * * Third Quarter * * Fourth Quarter * *\nFirst Quarter * * Second Quarter $ 9 5\/16 $ 8 9\/16 Third Quarter $15 1\/2 $ 8 11\/16 Fourth Quarter $27 3\/4 $13 3\/4\n* Due to the significant changes in the Company's capital structure resulting from the Merger, stock price information for periods prior to the Merger has not been included as it is not comparable to the stock price information since the Merger.\nOn February 27, 1996, there were approximately 1,082 holders of record of Common Stock.\nThe Company does not currently intend to pay any cash dividends on the Common Stock. Furthermore, as a holding company, the ability of the Company to pay dividends in the future is dependent upon the receipt of dividends or other payments from its operating subsidiary, USSC. The payment of dividends by USSC is subject to certain restrictions imposed by the Company's debt agreements. See Note 5 to the Consolidated Financial Statements of the Company included elsewhere herein.\nITEM 6.","section_6":"ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA\nSet forth below and on the following pages is selected historical consolidated financial data for the Company and its predecessors. Although United was the surviving corporation in the Merger, the Acquisition was treated as a reverse acquisition for accounting purposes, with Associated as the acquiring corporation. Therefore, the income statement and operating and other data for the year ended December 31, 1995 reflect the financial information of Associated only for the three months ended March 30, 1995, and the results of the Company for the nine months ended December 31, 1995. The balance sheet data at December 31, 1995 reflects the consolidated balances of the Company, including various Merger-related adjustments.\nTHE COMPANY \/ ASSOCIATED\nThe selected consolidated financial data of Associated's predecessor (the wholesale division of Boise Cascade Office Products Corporation \"BCOP\") set forth below for the fiscal year ended December 31, 1991 and for the one-month period ended January 31, 1992 (when Associated purchased the wholesale division of BCOP (the \"Associated Transaction\")) are derived from the unaudited financial statements of Associated's predecessor for such periods. Associated accounted for the Associated Transaction using the purchase method of accounting. There are material operational and accounting differences between Associated's predecessor and Associated resulting from the Associated Transaction. Accordingly, the historical financial data of Associated's predecessor may not be comparable in all material respects with data of Associated.\nThe selected consolidated financial data of Associated set forth below for the period from January 31, 1992 to December 31, 1992 and for the years ended December 31, 1993 and 1994 has been derived from the\nConsolidated Financial Statements of Associated which have been audited by Arthur Andersen LLP, independent public accountants. The Selected Consolidated Financial Data of the Company for the fiscal year ended December 31, 1995 (which for Income Statement and Operating and Other Data includes Associated only for the three months ended March 30, 1995 and the results of the Company for the nine months ended December 31, 1995) has been derived from the Consolidated Financial Statements of the Company which have been audited by Ernst & Young LLP, independent auditors. All Selected Consolidated Financial Data set forth below should be read in conjunction with, and is qualified in its entirety by, \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Historical Results of Operations of the Company\/Associated,\" \"Liquidity and Capital Resources of the Company\/Associated\" and the Consolidated Financial Statements of the Company included elsewhere in this Form 10-K.\n(1) The capital structure and accounting basis of the assets and liabilities of Associated's predecessor differ from those of Associated and the Company. Accordingly, certain financial information for periods before January 31, 1992 is not comparable to that for periods after January 31, 1992 and therefore is not presented in this table.\n(2) Associated's predecessor operated as a segment of a company which did not allocate income tax or interest expense to the predecessor. Accordingly, actual operating results for Associated's predecessor reflect only income from operations before interest expense and income taxes.\n(3) Derived from the unaudited financial statements of Associated's predecessor as of and for the year ended December 31, 1991.\n(4) Derived from the unaudited financial statements of Associated's predecessor for the one month ended January 31, 1992.\n(5) Includes a restructuring charge of $9.8 million for the year ended December 31, 1995.\n(6) EBITDA is defined as earnings before interest, taxes, depreciation and amortization and extraordinary item and is presented because it is commonly used by certain investors and analysts to analyze and compare companies on the basis of operating performance and to determine a company's ability to service and incur debt. EBITDA should not be considered in isolation from or as a substitute for net income, cash flows from operating activities or other consolidated income or cash flow statement data prepared in accordance with generally accepted accounting principles or as a measure of profitability or liquidity.\n(7) EBITDA margin represents EBITDA as a percentage of net sales.\n(8) EBITDA margin for the year ended December 31, 1995 would have been 5.2% if adjusted to exclude the restructuring charge.\n(9) Excludes amortization of deferred financing costs.\n(10) Total debt and capital leases include current maturities.\nUNITED\nThe selected consolidated financial data of United set forth below for the seven months ended March 30, 1995 (at which time United and Associated merged to create the Company) has been derived from the financial statements of United which have been audited by Ernst & Young LLP, independent auditors. The selected consolidated financial data at and for the seven-month period ended March 31, 1994 is unaudited and in the opinion of management reflects all adjustments considered necessary for a fair presentation of such data. The selected consolidated financial data of United for each of the fiscal years in the four-year period ended August 31, 1994 has been derived from the consolidated financial statements of United which have been audited by Arthur Andersen LLP, independent public accountants. All selected consolidated financial data set forth below should be read in conjunction with, and is qualified in its entirety by, \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Historical Results of Operations of United\" and \"Historical Liquidity and Capital Resources of United\" and the Consolidated Financial Statements of United, together with the related notes thereto, included elsewhere herein.\n(1) In connection with the Merger, United incurred approximately $27.8 million of Merger-related costs, consisting of severance payments under employment contracts ($9.6 million); insurance benefits under employment contracts ($7.4 million); legal, accounting and other professional services fees ($5.2 million); retirement of stock options ($3.0 million); and fees for letters of credit related to employment contracts and other costs ($2.6 million).\n(2) EBITDA is defined as earnings before interest, taxes, depreciation and amortization and is presented because it is commonly used by certain investors and analysts to analyze and compare companies on the basis of operating performance and to determine a company's ability to service and incur debt. EBITDA should not be considered in isolation from or as a substitute for net income, cash flows from operating activities or other consolidated income or cash flow statement data prepared in accordance with generally accepted accounting principles or as a measure of profitability or liquidity.\n(3) EBITDA margin represents EBITDA as a percentage of net sales.\n(4) Total debt and capital leases includes current maturities.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nOVERVIEW\nOn March 30, 1995, Associated merged with and into United. Although the Company was the surviving corporation in the Merger, the transaction was treated as a reverse acquisition for accounting purposes, with Associated as the acquiring corporation. Therefore, the results of operations for the year ended December 31, 1995 reflects the financial information of Associated only for the three months ended March 30, 1995 and the results of the Company for the nine months ended December 31, 1995. As a result of the Merger, the results of operations of the Company for the year ended December 31, 1995 are not comparable to those of previous periods.\nTo facilitate a meaningful comparison, the following supplemental discussion and analysis is based on certain components of the combined historical results of operations without any pro forma adjustments for Associated and United for the years ended December 31, 1993 and 1994 and on the pro forma results of operations for the Company for the year ended December 31, 1995. The pro forma and combined historical results of operations do not purport to be indicative of the results that would have been obtained had such transactions been completed for the periods presented or that may be obtained in the future. The following information should be read in conjunction with, and is qualified in its entirety by, the Consolidated Financial Statements of the Company and United, together with the related notes thereto, included elsewhere herein.\nGENERAL INFORMATION\nGROSS PROFIT MARGINS. Recently, a number of factors have adversely affected gross profit margins in the office products industry, including those of the Company. These factors reflect the increasingly competitive nature of the industry. Competitive pressures have increased due in part to the growth of large resellers such as national office products superstores that have heightened price awareness at the end-user level. The increasing price sensitivity of end-users has contributed to the decline in industrywide gross profit margins. These pressures are expected to continue in the future.\nThe Company's gross profit margins vary across product categories, so that material changes in its product mix can impact the Company's overall margin. For example, the gross profit margin on the Company's sales of commodity products, such as copier paper and laser printer toner-product categories that have grown over the past few years-tend to be lower than the gross profit margins on most other product categories. While the recent increases in sales of these types of products have adversely affected the Company's overall gross profit margin, they have contributed to higher operating income. The Company expects such sales to increase as a percentage of revenues in the future.\nRESTRUCTURING CHARGE. In the first quarter of 1995, the Company recorded a restructuring charge of $9.8 million ($5.9 million net of tax benefit of $3.9 million). The restructuring charge includes severance costs totaling $1.8 million. The Company's consolidation plan specifies that 330 distribution, sales and corporate positions, 180 of which relate to pre-Merger Associated, will be eliminated substantially within the one-year period following the Merger. As of December 31, 1995, approximately 90 former Associated employees had been terminated, with the related termination costs of approximately $1.0 million charged against the reserve. The restructuring charge also includes distribution center closing costs totaling $6.7 million and stockkeeping unit reduction costs totaling $1.3 million. The consolidation plan calls for the closing of eight redundant distribution centers, six of which relate to pre-Merger Associated facilities, and the elimination of overlapping inventory items from the Company's catalogs substantially within the one-year period following the Merger. Estimated distribution center closing costs include (i) the net occupancy costs of leased facilities after they are vacated until expiration of leases and (ii) the losses on the sale of owned facilities and the facilities' furniture, fixtures and equipment. Estimated stockkeeping unit reduction costs include losses on the sale of inventory items which have been discontinued solely as a result of the Acquisition. As of December 31, 1995, $0.4 million relating to distribution center closing costs had been charged against the reserve. See Note 4 to the Consolidated Financial Statements of the Company included elsewhere herein.\nEMPLOYEE STOCK OPTIONS. In September 1995, the Board of Directors approved, subject to stockholder approval, an amendment to the Company's employee stock option plan (the \"Plan\") that allows for the issuance of employee stock options to key management employees of the Company exercisable for up to approximately 2.2 million additional shares of Common Stock. The Plan was designed to build increased employee commitment through participation in the growth and performance of the Company. Subsequently, employee stock options exercisable for an aggregate of approximately 2.2 million shares of Common Stock were granted (subject to stockholder approval of the Plan amendment) to key management employees. Some of the employee stock options were granted at an exercise price below the then fair market value of the Common Stock. The exercise price of certain options is subject to increases on a quarterly basis beginning in 1996. The Company's stockholders will vote to approve such Plan amendment at the Company's annual meeting to be held in May 1996.\nThe employee stock options granted under the Plan do not vest to the employee until the occurrence of an event (a \"Vesting Event\") that causes the present non-public equity investors to have received at least a full return of their investment (at cost) in cash, fully tradable marketable securities or the equivalent. A Vesting Event will cause the Company to recognize compensation expense based upon the difference between the fair market value of the Common Stock and the exercise price of the employee stock options. Based upon a stock price of $22.75 and options outstanding as of January 31, 1996, the Company would recognize a nonrecurring noncash charge and related tax effect of $31.7 million in compensation expense ($19.0 million net of tax benefit of $12.7 million), if a Vesting Event were to occur. Each $1.00 change in the Common Stock price will result in an adjustment to such compensation expense of approximately $2.6 million ($1.6 million net of tax effect of $1.0 million).\nCHANGE IN ACCOUNTING METHOD. Effective January 1, 1995, Associated changed its method of accounting for the cost of inventory from the FIFO method to the LIFO method. Associated made this change in contemplation of its acquisition of United (accounted for as a reverse acquisition) so that its method would conform to that of United. Associated believed that in an inflationary environment the LIFO method provides a better matching of current costs and current revenues, and that earnings reported under the LIFO method are more easily compared to that of other companies in the wholesale industry where the LIFO method is common. In 1995, this change resulted in the reduction of pre-tax income of the Company of approximately $8.8 million ($5.3 million net of tax benefit of $3.5 million). See Note 3 to the Consolidated Financial Statements of the Company included elsewhere herein.\nPRO FORMA AND COMBINED RESULTS OF OPERATIONS\nThe following table of summary pro forma (see Note 4 to the Consolidated Financial Statements of the Company included elsewhere herein) and combined historical financial data is intended for informational purposes only and is not necessarily indicative of either financial position or results of operations in the future, or that would have occurred had the events described in the first paragraph under \"Overview\" occurred on January 1, 1995. The following information should be read in conjunction with, and is qualified in its entirety by, the historical Consolidated Financial Statements of the Company and its predecessors, including the related notes thereto, included elsewhere herein.\nThe following table also presents unaudited summary combined historical financial data for Associated and United for the years ended December 31, 1994 and 1993. This data has not been prepared in accordance with generally accepted accounting principles, which do not allow for the combination of financial data for entities that are not under common ownership. Nevertheless, management believes that this combined historical financial data, when read in conjunction with the separate historical financial statements of Associated and United prepared in accordance with generally accepted accounting principles and included elsewhere herein, may be helpful in understanding the past operations of the companies that were combined in the Merger. This combined historical financial data for 1994 and 1993 represents a combination of the historical financial data for Associated and United for the periods indicated without any pro forma adjustments, and is supplemental to the historical financial data of Associated and United included elsewhere herein.\nCOMPARISON OF PRO FORMA RESULTS FOR THE FISCAL YEAR ENDED DECEMBER 31, 1995 AND COMBINED RESULTS FOR THE FISCAL YEAR ENDED DECEMBER 31, 1994\nNET SALES. Net sales were $2,201.9 million for 1995, a 10.6% increase over net sales of $1,990.4 million in 1994. The increase in net sales is primarily the result of changes in unit volume rather than changes in prices. Sales grew in all geographic regions. In addition, the sales growth is also attributable to increases in the sales of computer-related products through the Company's MicroUnited Division.\nGROSS PROFIT. Gross profit as a percent of net sales decreased to 21.6% in 1995 from 22.0% in 1994. The lower gross profit margin reflects a shift in product mix and a larger LIFO charge due to Associated's change in its method of accounting for inventory from the FIFO method to the LIFO method. Also, gross profit was adversely affected by the higher sales of computer-related products and commodity items which typically carry lower gross profit margins.\nOPERATING EXPENSES. Operating expenses as a percent of net sales decreased to 17.9% in 1995 from 19.0% in 1994. The decrease in operating expenses as a percent of net sales was primarily due to increased operating efficiencies, improved productivity and increased economies of scale as a result of the higher sales base.\nINCOME FROM OPERATIONS. Income from operations as a percent of net sales was 3.7% in 1995 compared to 3.0% in 1994 due to the aforementioned reasons.\nCOMPARISON OF COMBINED RESULTS FOR THE FISCAL YEARS ENDED DECEMBER 31, 1994 AND 1993.\nNET SALES. Net sales were $1,990.4 million for 1994, a 3.4% increase over net sales of $1,925.4 million in 1993. The increase in net sales is primarily the result of changes in unit volume rather than changes in prices.\nGROSS PROFIT. Gross profit as a percent of net sales decreased to 22.0% in 1994 from 23.4% in 1993. The lower gross profit margin primarily reflects higher levels of rebates and volume allowances earned by the Company's customers as a result of ongoing consolidations. In addition, gross profit margin was affected by a LIFO charge (an increase to \"cost of goods sold\") of $2.1 million in 1994 versus LIFO income (a decrease to \"cost of goods sold\") of $5.0 million in 1993, and a shift in product mix.\nOPERATING EXPENSES. Operating expenses as a percent of net sales decreased to 19.0% in 1994 from 20.4% in 1993. The decrease is the result of streamlining the Company's work processes and reducing payroll and freight expense.\nINCOME FROM OPERATIONS. Income from operations as a percent of net sales was 3.0% in 1994 and 1993.\nHISTORICAL RESULTS OF OPERATIONS OF THE COMPANY\/ASSOCIATED\nCOMPARISON OF HISTORICAL FISCAL YEARS ENDED DECEMBER 31, 1995 AND 1994\nNET SALES. Net sales were $1,751.5 million for 1995 compared to $470.2 million in 1994. The increase is primarily the result of the Merger. Sales in 1995 include only nine months of United's sales.\nGROSS PROFIT. Gross profit as a percent of net sales decreased to 21.7% in 1995 from 24.0% in 1994. The lower gross profit margin reflects a shift in product mix, the Acquisition and the change in the method of accounting for inventory from the FIFO method to the LIFO method. See Note 3 to the Consolidated Financial Statements of the Company included elsewhere herein.\nOPERATING EXPENSES. Operating expenses as a percent of net sales decreased to 18.5% in 1995 from 20.2% in 1994. The actual results for 1995 include the impact of a restructuring charge of $9.8 million ($5.9 million net of tax benefit of $3.9 million) in the first quarter of 1995. Operating expenses before the restructuring charge were 17.9% in 1995. The decrease in operating expenses as a percent of net sales before the restructuring charge was primarily due to increased operating efficiencies and improved productivity, partially offset by Merger-related compensation expense relating to an increase in the value of employee stock options of approximately $1.5 million ($0.9 million net of tax benefit of $0.6 million).\nINCOME FROM OPERATIONS. Income from operations as a percent of net sales was 3.2% in 1995 (after the restructuring charge) compared to 3.8% in 1994. Before such restructuring charge, income from operations in 1995 was 3.8%.\nINTEREST EXPENSE. Interest expense as a percent of net sales was 2.5% in 1995 compared to 1.6% in 1994. The increase reflects additional debt needed to consummate the Acquisition and higher interest rates in 1995.\nINCOME BEFORE INCOME TAXES AND EXTRAORDINARY ITEM. Income before income taxes and extraordinary item as a percent of net sales was 0.7% in 1995 compared to 2.2% in 1994.\nINCOME BEFORE EXTRAORDINARY ITEM. Income before extraordinary item was $6.2 million in 1995 compared to $6.4 million in 1994. An extraordinary item, the loss on early retirement of debt related to the Merger of $2.4 million ($1.4 million net of tax benefit of $1.0 million), was recognized in the first quarter of 1995. Net income was $4.8 million in 1995 compared to $6.4 million in 1994. Excluding the extraordinary item, net income would have been $6.2 million.\nFOURTH QUARTER RESULTS. Certain interim expense and inventory estimates are recorded throughout the year relating to shrinkage, inflation and product mix. The results of the year-end close and physical inventory reflected a favorable adjustment with respect to such estimates, resulting in approximately $0.9 million of additional net income, which is reflected in the fourth quarter of 1995.\nCOMPARISON OF HISTORICAL FISCAL YEARS ENDED DECEMBER 31, 1994 AND 1993\nNET SALES. Net sales increased to $470.2 million in 1994 from $455.7 million in 1993, a 3.2% increase, primarily as a result of inclusion in 1994 of the full year of sales from Associated's new Baltimore distribution facility and increased unit sales volume to existing Associated customers as, in management's estimation, Associated's customers channeled more of their purchasing through Associated with the goal of reducing their internal inventory levels.\nGROSS PROFIT. Gross profit increased to $112.9 million in 1994 from $105.5 million in 1993, a 7.0% increase, primarily due to increased unit volume as well as Associated's lower net cost of goods sold, as a percentage of sales, resulting from increased allowances granted to Associated by its suppliers. Management of\nAssociated believes that increased vendor allowances were due to competition among Associated's vendors that resulted in increased purchasing leverage. The increase in gross profit also resulted in part from Associated's increased forward-buying efforts, as management better identified and utilized product pricing opportunities available in the marketplace. Gross profit increases were partially offset by increased allowances extended by Associated to its customers in response to increased competition.\nOPERATING EXPENSES. Operating expenses as a percent of net sales decreased to 20.2% in 1994 from 20.7% in 1993. The decrease in operating expenses as a percent of net sales was primarily due to productivity improvements and lower freight costs partially offset by lump-sum incentive awards earned in 1994 by employees and management based on Associated's level of profitability.\nINCOME FROM OPERATIONS. Income from operations increased to $18.1 million in 1994 from $11.0 million in 1993, a 65.1% increase, and as a percentage of net sales was 3.8% in 1994, compared with 2.4% in 1993, for the reasons stated above.\nINTEREST EXPENSE. Interest expense increased to $7.7 million in 1994 from $7.2 million in 1993, a 6.8% increase, as a result of an increase in the weighted average interest rate on outstanding debt in effect during the year from 7.75% in 1993 to 8.90% in 1994, which was offset in part by a reduction in average revolving debt balances to $39.6 million in 1994 from $46.9 million in 1993.\nINCOME BEFORE INCOME TAXES. Income before income taxes increased to $10.4 million in 1994 from $3.7 million in 1993, a 177.7% increase, for the reasons stated above.\nINCOME TAXES. Income taxes increased to $4.0 million in 1994 from $0.8 million in 1993, a $3.2 million increase. The effective tax rates for 1994 and 1993 were 38.4% and 20.9%, respectively. The increase in rate was due primarily to the effect of the change in the amount of tax valuation allowances.\nNET INCOME. Net income increased to $6.4 million in 1994 from $3.0 million in 1993, an increase of $3.4 million, or 116.2%. Net income as a percentage of net sales increased to 1.4% in 1994 from 0.6% in 1993 for the reasons stated above.\nHISTORICAL RESULTS OF OPERATIONS OF UNITED\nCOMPARISON OF THE SEVEN MONTHS ENDED MARCH 30, 1995 AND 1994\nNET SALES. Net sales were $980.6 million in the seven months ended March 30, 1995, a 12.5% increase from net sales of $871.6 million in the comparable period in 1994. The primary reason for the increase is growth in unit volume.\nGROSS PROFIT ON SALES. Gross profit as a percent of net sales was 21.1% for the seven months ended March 30, 1995, compared with 22.5% in the comparable period in 1994. This lower gross profit margin is primarily the result of a shift in the sale of computer related products that have lower gross profit margins and is consistent with the gross profit margins achieved in the latter half of United's fiscal year ended August 31, 1994.\nOPERATING EXPENSES. Operating expenses as a percent of net sales increased to 20.6% in the seven-month period ended March 30, 1995 from 19.6% in the comparable period in 1994. The increase is primarily attributable to $27.8 million ($18.5 million net of tax benefit of $9.3 million) of non-recurring Merger-related costs consisting of severance payments under employment contracts; insurance benefits under employment contracts; legal, accounting and other professional services fees; the repurchase of stock options; and fees for letters of credit related to employment contracts and other costs. Operating expenses as a percent of net sales prior to the Merger-related costs were 17.7% for the seven-month period ended March 30, 1995. This decline from the comparable period in 1994 is a result of savings in employee-related payroll and freight expenses.\nINCOME FROM OPERATIONS. Income from operations as a percent of net sales was 0.5% in the seven-month period ended March 30, 1995, compared with 2.9% in the comparable period in 1994. The decrease was attributable to the Merger-related costs discussed under \"Operating Expenses\" above. Income from operations as a percent of net sales was 3.3% in the seven-month period ended March 30, 1995, excluding the Merger-related costs.\nINTEREST EXPENSE. Interest expense was $7.6 million for the seven-month period ended March 30, 1995, compared with $6.1 million for the same period in 1994. The increase was due to higher interest expense from increased debt to meet working capital and other capital expenditure needs and higher interest rates on borrowings.\nINCOME (LOSS) BEFORE INCOME TAXES. Income (loss) before income taxes as a percent of net sales was a loss of 0.3% in the seven-month period ended March 30, 1995, compared to income of 2.3% in the comparable period of 1994. The decrease in income before income taxes was attributable to the factors stated above.\nINCOME TAXES. The effective tax rate for the seven-month period ended March 30, 1995 was (184.6%), compared with 41.5% for the seven-month period ended March 31, 1994. The increase is primarily due to non-deductible Merger-related costs and non-deductible amortization of goodwill.\nNET INCOME (LOSS). Net income (loss) was a loss of $7.2 million for the seven-month period ended March 30, 1995, compared with income of $11.5 million for the same period in 1994. The loss was primarily due to $27.8 million ($18.5 million net of tax benefit of $9.3 million) of non-recurring Merger-related costs discussed under \"Operating Expenses\" above. Net income (loss) per share was a loss of $0.39 in the seven-month period ended March 30, 1995, compared with income of $0.62 for the same period in 1994.\nCOMPARISON OF THE FISCAL YEARS ENDED AUGUST 31, 1994 AND 1993\nNET SALES. Net sales increased to $1,473.0 million in fiscal 1994 from $1,470.1 million in fiscal 1993, a 0.2% increase reflecting a slight increase in unit volume. Sales in the early part of fiscal 1994 were affected by a temporary drop in in-stock service levels and the discontinuing of nearly 12,000 items as a final step in the consolidation process of the SDC Acquisition in June 1992. Sales were also negatively impacted by the SDC Acquisition-related operational disruptions in the west and southwest regions. Sales grew in the fourth quarter by 3.4%, reversing the decline experienced in the prior two quarters.\nGROSS PROFIT ON SALES. Gross profit on sales decreased to $322.9 million in fiscal 1994 from $344.5 million in fiscal 1993, a 6.3% decrease, due principally to a decrease in gross profit margin. Gross profit margin decreased to 21.9% in fiscal 1994 from 23.4% in fiscal 1993. The decline primarily reflects higher levels of rebates and volume allowances earned by the Company's customers as a result of ongoing consolidations. Gross profit margins over the last half of fiscal 1994 were relatively stable reflecting the slowing pace of dealer consolidations. In addition, gross profit margin was affected by a LIFO charge (an increase to \"cost of sales\" of $2.2 million in fiscal 1994 versus LIFO income (a decrease to \"cost of sales\") of $4.7 million in fiscal 1993, and a shift in the sale of products to items that have lower gross margins.\nOPERATING EXPENSES. Operating expenses decreased to $286.6 million in fiscal 1994 from $298.4 million in fiscal 1993, a 4.0% decrease. Operating expenses as a percentage of net sales decreased to 19.4% in fiscal 1994 from 20.3% in fiscal 1993. The decrease is the result of streamlining United's work processes and reducing payroll and freight expense.\nINCOME FROM OPERATIONS. Income from operations decreased to $36.3 million in fiscal 1994 from $46.1 million in fiscal 1993, a 21.3% decrease, and as a percentage of net sales was 2.5% in fiscal 1994, compared with 3.1% in fiscal 1993, for the reasons stated above.\nINTEREST EXPENSE. Interest expense increased to $10.7 million in fiscal 1994 from $9.8 million in fiscal 1993, an 8.9% increase, primarily due to additional debt incurred to support working capital and other capital expenditures.\nINCOME BEFORE INCOME TAXES. Income before income taxes decreased to $26.0 million in fiscal 1994 from $36.9 million in fiscal 1993, a 29.4% decrease, for the reasons stated above.\nINCOME TAXES. Income taxes decreased to $10.3 million in fiscal 1994 from $15.5 million in fiscal 1993, a $5.3 million decrease. The effective tax rates for 1994 and 1993 were 39.6% and 42.1%, respectively. The decrease is primarily due to the liquidation of a foreign subsidiary and a decrease in the effective state income tax rate, offset by an increase in the non-deductible losses in United's foreign operation and the non-deductible amortization of goodwill.\nNET INCOME. Net income decreased to $15.7 million in 1994 from $21.4 million in 1993, a decrease of $5.7 million, or 26.3%. Net income as a percentage of net sales decreased to 1.1% in 1994 from 1.5% in 1993 for the reasons stated above.\nFOURTH QUARTER RESULTS. Certain interim expense and inventory estimates are recognized throughout the fiscal year relating to shrinkage, inflation and product mix. The results of the year-end close and physical inventory reflected a favorable adjustment with respect to such estimates, resulting in approximately $0.5 million of additional net income, which is reflected in the fourth quarter of fiscal 1994.\nLIQUIDITY AND CAPITAL RESOURCES OF THE COMPANY\/ASSOCIATED\nIn connection with the consummation of the Acquisition, Associated received an equity investment of $12.0 million and borrowed an aggregate of $416.5 million under the Credit Facilities (as defined below) and $130.0 million under a subordinated bridge facility (the \"Subordinated Bridge Facility\"). The proceeds of such investment and borrowings were used to (i) finance the purchase of shares of Common Stock pursuant to the Offer, (ii) refinance certain existing indebtedness of Associated (including all amounts outstanding under the Associated credit facilities in effect prior to the Merger) and indebtedness of the Company (including certain amounts outstanding under the United credit and overline facilities in effect prior to the Merger), (iii) repurchase United employee stock options and (iv) pay fees and expenses relating to the Acquisition.\nThe credit facilities under the Credit Agreement (the \"Credit Facilities\") consist of $200.0 million of term loan borrowings (the \"Term Loan Facilities\") and up to $325.0 million of revolving loan borrowings under the Revolving Credit Facility.\nOn May 3, 1995, USSC completed the issuance of $150.0 million of 12 3\/4% Senior Subordinated Notes due 2005 (the \"Notes\"). The net proceeds of the Notes (after an underwriter discount of $4.5 million) were used to repay the $130.0 million Subordinated Bridge Facility (together with $1.6 million in accrued and unpaid interest thereon), to repay a portion of the Term Loan Facilities and accrued interest thereon (totaling approximately $6.5 million), to pay a dividend to the Company to repurchase the Series B preferred stock and to pay certain expenses.\nThe Term Loan Facilities consist of a $125.0 million Tranche A term loan facility (the \"Tranche A Facility\") and a $75.0 million Tranche B term loan facility (the \"Tranche B Facility\"). Amounts outstanding under the Tranche A Facility are required to be repaid in 20 consecutive installments, the first four of which (each in the aggregate principal amount of $3.63 million) are due on the last day of each of the first four calendar quarters which commenced with the quarter ended June 30, 1995. Subsequent quarterly payments under the Tranche A Facility are each in the aggregate principal amount of $6.05 million for each of the eight consecutive calendar quarters commencing with the quarter ending June 30, 1996 and $7.26 million for each of the eight consecutive calendar quarters commencing with the quarter ending June 30, 1998. Amounts outstanding under the Tranche B Facility are required to be repaid in 28 consecutive quarterly installments, the first twenty of which (in the aggregate principal amount of $0.24 million each) are due on the last day of each of the first twenty calendar quarters which commenced with the quarter ended June 30, 1995. The remaining eight installments in the aggregate principal amount of $8.47 million each will be due on the last day of each calendar quarter commencing with the quarter ending June 30, 2000. The final installments under the Tranche A Facility and the Tranche B Facility will be payable on March 31, 2000 and March 31, 2002, respectively.\nThe Revolving Credit Facility is limited to the lesser of $325.0 million or a borrowing base equal to: 80% of Eligible Receivables (as defined); plus 50% of Eligible Inventory (as defined) (provided that no more than 60% or during certain periods 65%, of the Borrowing Base may be attributable to Eligible Inventory); plus the aggregate amount of cover for Letter of Credit Liabilities (as defined). The Revolving Credit Facility provides that, for each fiscal year commencing January 1, 1996, the Company must repay revolving loans so that for a period of 30 consecutive days in each fiscal year the aggregate revolving loans do not exceed $200.0 million. The Revolving Credit Facility matures on March 31, 2000. The Revolving Credit Facility was amended as of December 21, 1995 to increase the amount available thereunder from $300.0 million to an aggregate of $325.0 million. As of December 31, 1995, $87.4 million remained available for borrowing under the Revolving Credit Facility.\nThe Term Loan Facilities and the Revolving Credit Facility are secured by first priority pledges of the stock of USSC, all of the stock of the domestic direct and indirect subsidiaries of USSC, certain of the stock of all of the foreign direct and indirect subsidiaries of USSC and security interests in, and liens upon, all accounts\nreceivable, inventory, contract rights and other certain personal and certain real property of USSC and its domestic subsidiaries.\nThe Credit Agreement contains representations and warranties, affirmative and negative covenants and events of default customary for financings of this type. As of January 31, 1996, the Company was in compliance in all material respects with all covenants contained in the Credit Agreement.\nThe Credit Facilities permit capital expenditures for the Company of up to $12.0 million for its fiscal year ending December 31, 1996, plus $4.1 million of unused capital expenditures and approximately $3.0 million of unused excess cash flow (as defined) for the Company's fiscal year ended December 31, 1995. Capital expenditures will be financed from internally generated funds and available borrowings under the Credit Facilities. The Company expects gross capital expenditures to be approximately $10 to $12 million in 1996.\nManagement believes that the Company's cash on hand, anticipated funds generated from operations and available borrowings under the Credit Facilities, will be sufficient to meet the short-term (less than twelve months) and long-term operating and capital needs of the Company as well as to service its debt in accordance with its terms. There is, however, no assurance that this will be accomplished.\nOn July 28, 1995, the Company repurchased the Series B preferred stock. Quarterly dividends currently accrue on the Company's two outstanding series of preferred stock at the rate of 10.0% for Series A preferred stock and 9.0% for Series C preferred stock per annum (or, when dividends are not paid in cash, 13.0% for Series A preferred stock and 10.0% for Series C preferred stock), and may be paid in the form of additional shares of the respective series of preferred stock (except, in the case of the Series C preferred stock, for dividends payable after January 31, 1999).\nThe Company is a holding company and, as a result, the Company's primary source of funds is cash generated from operating activities of its operating subsidiary, USSC, and bank borrowings by USSC. The Credit Agreement and the indenture governing the Notes contain restrictions on the ability of USSC to transfer cash to the Company. Associated was a holding company and, as a result, Associated's primary source of funds was cash generated from operating activities of its operating subsidiary, ASI, and bank borrowings by ASI. The Associated credit agreement in effect prior to the Merger contained restrictions on the ability of ASI to transfer cash to Associated. The statements of cash flows for the Company for the periods indicated is summarized below:\nNet cash provided by operating activities for 1995 was $26.3 million. The increase in 1995 was due to the Acquisition. Net cash provided by operating activities for 1994 increased to $14.1 million from a use of cash of $12.1 million in 1993. This increase in 1994 was principally due to an increase in accounts payable, a lesser increase in inventory levels and an increase in net income. Associated used $12.1 million of cash in operations in 1993 relating to an increase in inventory in 1993 due to a full year of Associated's operations, additional inventory to support the acquisition of Lynn-Edwards Corporation, a privately held office products wholesaler based in Sacramento, California, and an overall increase in sales volume.\nNet cash used in investing activities in 1995 was $266.3 million, reflecting the Acquisition. Net cash used in investing activities in 1994 was $0.6 million, reflecting capital expenditures necessary to maintain existing assets. Net cash used in investing activities in 1993 was $3.3 million stemming mostly from capital expenditures in connection with the opening of the new Baltimore facility and those expenditures related to the acquisition of Lynn-Edwards Corporation.\nNet cash provided by financing activities in 1995 was $249.8 million, reflecting the additional debt needed to consummate the Acquisition. Net cash used in financing activities in 1994 was $12.7 million, which was attributable to the pay down of debt. Net cash provided by financing activities in 1993 was $8.1 million due to $11.5 million of borrowings and an equipment loan partially offset by scheduled principal payments of $3.4 million.\nLock-up agreements prohibiting the sale or other transfer of Common Stock by certain large stockholders of the Company are scheduled to expire on March 31, 1996. As a result, 1,344,000 shares of Common Stock issuable upon the exercise of certain warrants to purchase Common Stock of the Company may be immediately thereafter sold pursuant to an effective registration statement under the Securities Act of 1933, as amended, and the Company has agreed to register an additional 809,204 shares of Common Stock (including shares of Common Stock issuable upon conversion of the Company's Nonvoting Common Stock) as soon as practicable. Holders of approximately 6,583,349 shares of Common Stock are parties to a registration rights agreement whereby the Company must register such shares under the Securities Act of 1933, as amended, at the request of 20% in interest of the holders. Therefore, a large number of shares of Common Stock may be made available for sale in the public market by such stockholders at various times beginning March 31, 1996. The sale of a large block of such shares, and the availability of additional large blocks for sale, could have an adverse effect on the prevailing market price of the Common Stock.\nHISTORICAL LIQUIDITY AND CAPITAL RESOURCES OF UNITED\nUnited was a holding company and, as a result, United's primary source of funds was cash generated from operating activities of its operating subsidiary, USSC, and bank borrowings by USSC. United's statement of cash flows for the periods indicated is summarized below:\nOPERATING ACTIVITIES. The decrease in net cash used in operating activities from $55.8 million in the seven months ended March 31, 1994 to $47.5 million in the seven months ended March 30, 1995 was primarily due to increases in accounts payable and accrued liabilities partially offset by an increase to inventory. The decrease in net cash provided by operations from $36.0 million in fiscal 1993 to $8.1 million in fiscal 1994 was primarily attributable to a decrease in accounts payable and accrued liabilities as well as lower net income in 1994, partially offset by a decrease in accounts receivable and inventory.\nINVESTING ACTIVITIES. The increase in net cash used in investing activities from $4.3 million in the seven months ended March 31, 1994 to $7.8 million in the seven months ended March 30, 1995 was primarily due to the acquisition of property, plant and equipment. Net cash used in investing activities declined from $30.0 million in fiscal 1993 to $10.5 million in fiscal 1994, as a result of a commensurate decline in capital expenditures. The $30.0 million of capital expenditures in fiscal 1993 includes the purchase of $16.0 million of computer and related hardware. Net capital expenditures in fiscal 1994 and 1993 were $10.5 million and $30.0 million, respectively.\nFINANCING ACTIVITIES. The increase in net cash provided by financing activities from $62.5 million in the seven months ended March 31, 1994 to $62.9 million in the seven months ended March 30, 1995 was primarily due to increases in short-term debt partially offset by an increase in payments on long-term obligations. Net cash of $1.4 million was provided by financing activities in fiscal 1994 as compared to a net use of cash in financing activities in fiscal 1993 of $10.1 million.\nINFLATION AND CHANGING PRICES\nInflation during the last three years has not been a significant factor to operations. The Company's business is not generally governed by contracts that establish prices substantially in advance of the receipt of goods or services. As suppliers increase their prices for merchandise to the Company, the Company generally seeks to increase its prices to its customers. Significant deflation may, however, adversely affect the Company's profitability.\nSEASONALITY\nAlthough the Company's sales are generally relatively level throughout the year, the Company's sales vary to the extent of seasonal differences in the buying patterns of end-users who purchase office products. In particular, the Company's sales are generally higher than average during the months of January through March when many businesses begin operating under new annual budgets.\nThe Company experiences seasonality in terms of its working capital needs, with highest requirements in December through February reflecting a build up in inventory prior to and during the peak sales period. The Company believes that its current availability under the Revolving Credit Facility is sufficient to satisfy such seasonal capital needs for the foreseeable future.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nSet forth on the following pages are the financial statements of (i) the Company and (ii) pre-Merger United. Although United was the surviving corporation in the Merger, the Acquisition was treated as a reverse acquisition for accounting purposes, with Associated as the acquiring corporation. Therefore, the statements of income and cash flows for the year ended December 31, 1995 reflect the results of Associated only for the three months ended March 30, 1995, and the results of the Company for the nine months ended December 31, 1995. The financial statements of the Company for the years ended December 31, 1994 and 1993 reflect the financial position, results of operations and cash flows of Associated only. The financial statements of pre-Merger United are included because United is considered a significant predecessor for accounting purposes.\nREPORT OF INDEPENDENT AUDITORS\nTO THE STOCKHOLDERS AND BOARD OF DIRECTORS OF UNITED STATIONERS INC.\nWe have audited the accompanying consolidated balance sheet of United Stationers Inc. and Subsidiary as of December 31, 1995 and the related consolidated statements of income, changes in stockholders' equity and cash flows for the year then ended. Our audit also included the financial statement schedule for 1995 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 audit.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of United Stationers Inc. and Subsidiary at December 31, 1995 and the consolidated results of their operations and their cash flows for the year then ended in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule for 1995, 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 3 to the consolidated financial statements, in 1995, the Company changed its method of valuing inventory from the first-in, first-out (FIFO) method to the last-in, first-out (LIFO) method.\n\/s\/ERNST & YOUNG LLP\nChicago, Illinois January 29, 1996, except for Note 16, as to which the date is March 27, 1996\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTO THE BOARD OF DIRECTORS OF ASSOCIATED HOLDINGS, INC.\nWe have audited the accompanying consolidated balance sheets of ASSOCIATED HOLDINGS, INC. (a Delaware corporation) AND SUBSIDIARY as of December 31, 1994, and the related consolidated statements of income, stockholders' equity and cash flows for the years ended December 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 audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as 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 Associated Holdings, Inc. and subsidiary as of December 31, 1994, and the results of their operations and their cash flows for the years ended December 1994 and 1993, in conformity with generally accepted accounting principles.\nOur audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. 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.\n\/s\/ARTHUR ANDERSEN LLP\nChicago, Illinois January 23, 1995 (except with respect to the matters discussed in Note 1 as to which the date is February 13, 1995)\nUNITED STATIONERS INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF INCOME (dollars in thousands, except share data)\nTHE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ARE AN INTEGRAL PART OF THESE STATEMENTS.\nUNITED STATIONERS INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS (dollars in thousands)\nTHE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ARE AN INTEGRAL PART OF THESE STATEMENTS.\nUNITED STATIONERS INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS (dollars in thousands)\nTHE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ARE AN INTEGRAL PART OF THESE STATEMENTS.\nUNITED STATIONERS INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (dollars in thousands, except share data)\nTHE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ARE AN INTEGRAL PART OF THESE STATEMENTS.\nUNITED STATIONERS INC. AND SUBSIDIARY CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)\nTHE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ARE AN INTEGRAL PART OF THESE STATEMENTS.\nUNITED STATIONERS INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS IN THOUSANDS)\nTHE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ARE AN INTEGRAL PART OF THESE STATEMENTS.\nUNITED STATIONERS INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. BASIS OF PRESENTATION AND PURCHASE ACCOUNTING\nOn March 30, 1995, Associated Holdings, Inc. (\"Associated\") purchased 92.5% of the then outstanding shares of the common stock, $0.10 par value (\"Common Stock\") of United Stationers Inc. (\"United\") for approximately $266.6 million in the aggregate pursuant to a tender offer (the \"Offer\"). Immediately thereafter, Associated merged with and into United (the \"Merger\" and, collectively with the Offer, the \"Acquisition\"), and Associated Stationers, Inc. (\"ASI\"), a wholly owned subsidiary of Associated merged with and into United Stationers Supply Co. (\"USSC\"), a wholly owned subsidiary of United, with United and USSC continuing as the respective surviving corporations. United, as the surviving corporation following the Merger, is referred to herein as the \"Company.\" As a result of share conversions in the Merger, immediately after the Merger, (i) the former holders of common stock and common stock equivalents of Associated owned shares of Common Stock and warrants or options to purchase shares of Common Stock constituting in the aggregate approximately 80% of the shares of Common Stock on a fully diluted basis, and (ii) holders of pre-Merger United common stock owned in the aggregate approximately 20% of the shares of Common Stock on a fully diluted basis. Although United was the surviving corporation in the Merger, the transaction was treated as a reverse acquisition for accounting purposes with Associated as the acquiring corporation.\nThe financial information for the year ended December 31, 1995 includes Associated only for the three months ended March 30, 1995 and the results of the Company for the nine months ended December 31, 1995. Financial information prior to 1995 reflects that of Associated only. All common and common equivalent shares have been adjusted to reflect the 100% stock dividend effective November 9, 1995.\nThe Acquisition has been accounted for using the purchase method of accounting and, accordingly, the purchase price has been allocated to the assets purchased and the liabilities assumed based upon the estimated fair values at the date of acquisition with the excess of cost over fair value allocated to goodwill. The purchase price allocation to property, plant and equipment is amortized over the estimated useful lives ranging from 3 to 40 years. Goodwill is amortized over 40 years.\nThe total purchase price of United by Associated and its allocation to assets and liabilities acquired are as follows (dollars in thousands):\nPurchase price: Price of United shares purchased by Associated . . . . . . . . $266,629 Fair value of United shares not acquired in the Offer. . . . . 21,618 Transaction costs. . . . . . . . . . . . . . . . . . . . . . . 6,309 -------- Total purchase price. . . . . . . . . . . . . . . . . . . $294,556 -------- --------\nAllocation of purchase price: Current assets . . . . . . . . . . . . . . . . . . . . . . . . $542,993 Property, plant and equipment. . . . . . . . . . . . . . . . . 151,012 Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . 74,503 Other assets . . . . . . . . . . . . . . . . . . . . . . . . . 7,699 Liabilities assumed. . . . . . . . . . . . . . . . . . . . . . (481,651) -------- Total purchase price. . . . . . . . . . . . . . . . . . . $294,556 -------- --------\nImmediately following the Merger, the number of outstanding shares of Common Stock was 11,996,154 (or 13,947,440 on a fully diluted basis), of which (i) the former holders of Class A Common Stock, $0.01 par value, and Class B Common Stock, $0.01 par value, of Associated (collectively \"Associated Common Stock\") and warrants or options to purchase Associated Common Stock in the aggregate owned 9,206,666 shares constituting approximately 76.7% of the outstanding shares of Common Stock and outstanding warrants or options for 1,951,286 shares (collectively 80.0% on a fully diluted basis) and (ii) pre-Merger holders of shares of Common Stock (other than Associated-owned and\ntreasury shares) in the aggregate owned 2,789,488 shares of Common Stock constituting approximately 23.3% of the outstanding shares (or 20.0% on a fully diluted basis). As used in this paragraph, the term \"Common Stock\" includes shares of Nonvoting Common Stock, $0.01 par value, of the Company, which are immediately convertible into Voting Common Stock.\n2. ORGANIZATION\nThe Company is a national general line business products wholesaler. The Company stocks and distributes more than 25,000 items, including traditional office supplies, office furniture and desk accessories; computer supplies, peripherals and hardware, and facilities management supplies. The Company markets its products primarily through catalogs with a total annual circulation of more than 7.5 million copies. The Company markets and distributes products to a broad range of approximately 12,000 resellers, consisting primarily of office products dealers (including commercial, contract and retail), computer resellers, office furniture dealers, office products superstores, mail order companies and mass merchandisers. The Company's distribution capability is supported by a nationwide network of 40 (post-consolidation including the new Pittsburgh distribution center) strategically located and fully integrated distribution centers.\n3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the accounts of the Company. Investments in 20% to 50% owned companies are accounted for by the equity method. All significant intercompany accounts and transactions have been eliminated in consolidation.\nCertain prior year amounts have been reclassified to conform with current year presentations.\nREVENUE RECOGNITION\nSales and provisions for estimated sales returns and allowances are recorded at the time of shipment.\nCASH AND CASH EQUIVALENTS\nInvestments in low-risk instruments that have original maturities of three months or less are considered to be cash equivalents. Cash equivalents are stated at cost which approximates market value.\nINVENTORIES\nInventories constituting approximately 94% of total inventories at December 31, 1995 have been valued under the last-in, first-out (LIFO) method. Prior to 1995, all inventories were valued under the first-in, first-out (FIFO) method. Effective January 1, 1995, Associated changed its method of accounting for the cost of inventory from the FIFO method to the LIFO method. Associated made this change in contemplation of its acquisition of United (accounted for as a reverse acquisition) so that its method would conform to that of United. Associated believes that in an inflationary environment the LIFO method provides a better matching of current costs and current revenues and that earnings reported under the LIFO method are more easily compared to that of other companies in the wholesale industry where the LIFO method is common. This change resulted in a charge to pre-tax income of the Company of approximately $8.8 million ($5.3 million net of tax benefit of $3.5 million) or $0.37 per common and common equivalent share for the year ended December 31, 1995. The cumulative effect of this accounting change for years prior to 1995 is not determinable, nor are the pro forma effects of retroactive application of the LIFO method to prior years. Inventory valued under the FIFO and LIFO accounting methods are recorded at the lower of cost or market. If the lower of FIFO cost or market method of inventory accounting had been used by the Company for all inventories, merchandise inventories would have been approximately $8.8 million higher than reported at December 31, 1995.\nPROPERTY, PLANT AND EQUIPMENT\nDepreciation and amortization are determined by using the straight-line method over the estimated useful lives of the assets.\nThe estimated useful life assigned to fixtures and equipment is from two to ten years; the estimated useful life assigned to buildings does not exceed 40 years; leasehold improvements and assets under capital leases are amortized over the lesser of their useful lives or the term of the applicable lease.\nGOODWILL\nGoodwill represents the excess cost over the value of net assets of businesses acquired and is amortized on a straight-line basis over 40 years. The Company continually evaluates whether events or circumstances have occurred indicating that the remaining estimated useful life of goodwill may not be appropriate. When factors indicate that goodwill should be evaluated for possible impairment, the Company will use an estimate of undiscounted future operating income compared to the carrying value of goodwill to determine if a write-off is necessary. The cumulative amount of goodwill amortized at December 31, 1995 and 1994 is $1,953,000 and $295,000, respectively.\nSOFTWARE CAPITALIZATION\nThe Company capitalizes major internal and external systems development costs determined to have benefits for future periods. Amortization is recognized over the periods in which the benefits are realized, generally not to exceed three years. Systems development costs capitalized were $516,000, $780,000, and $767,000 in 1995, 1994 and 1993, respectively. Amortization expense was $2,298,000, $157,000 and $128,000 in 1995, 1994 and 1993, respectively.\nNET INCOME PER COMMON AND COMMON EQUIVALENT SHARE\nNet income per common and common equivalent share is based on net income after preferred stock dividend requirements. Net income per common and common equivalent share on a primary and fully diluted basis are computed using the weighted average number of shares outstanding adjusted for the effect of stock options and warrants considered to be dilutive common stock equivalents.\nUSE OF ESTIMATES\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the Consolidated Financial Statements and accompanying notes. Actual results could differ from these estimates.\nSTOCK OPTIONS\nThe Company accounts for stock options in accordance with APB Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES.\n4. BUSINESS COMBINATION AND RESTRUCTURING CHARGE\nThe following summarized unaudited pro forma operating data for the years ended December 31, 1995 and 1994 is presented giving effect to the Acquisition as if it had been consummated at the beginning of the respective periods and, therefore, reflects the results of United and Associated on a consolidated basis. These pro forma results have been prepared for comparative purposes only and do not purport to be indicative of the results of operations that actually would have resulted had the combination been in effect on the dates indicated, or which may result in the future. The pro forma results exclude one-time nonrecurring charges or credits directly attributable to the transaction (dollars in thousands, except share data):\nPro Forma Twelve Months -------------------------- Ended December 31, -------------------------- 1995 1994 ----------- ---------- Net sales $2,201,860 $1,990,363 Income before income taxes 22,737 4,237 Net income 13,063 2,581 Net income per primary and fully diluted common and common equivalent share $0.80 $0.07\nThe pro forma income statement adjustments consist of (i) increased depreciation expense resulting from the write-up of certain fixed assets to fair value, (ii) additional incremental goodwill amortization, (iii) additional incremental interest expense due to debt issued, net of debt retired, and (iv) reduction in preferred stock dividends due to the repurchase of the Series B preferred stock.\nIn the first quarter of 1995, the Company recorded a restructuring charge of $9.8 million ($5.9 million net of tax benefit of $3.9 million). The restructuring charge includes severance costs totaling $1.8 million. The consolidation plan specifies that 330 distribution, sales and corporate positions, 180 of which relate to pre-Merger Associated, will be eliminated substantially within a one-year period following the Merger. As of December 31, 1995, approximately 90 former Associated employees had been terminated, with related costs of approximately $1.0 million charged against the reserve. The restructuring charge also includes distribution center closing costs totaling $6.7 million and stockkeeping unit reduction costs totaling $1.3 million. The consolidation plan calls for the closing of eight redundant distribution centers, six of which relate to pre-Merger Associated facilities, and the elimination of overlapping inventory items from the Company's catalogs substantially within a one-year period following the Merger. Estimated distribution center closing costs include (i) the net occupancy costs of leased facilities after they are vacated until the expiration of the leases and (ii) the losses on the sale of owned facilities and the facilities' furniture, fixtures and equipment. Estimated stockkeeping unit reduction costs include losses on the sale of inventory items which have been discontinued solely as a result of the Acquisition and Merger. As of December 31, 1995, $0.4 million relating to distribution center closing costs have been charged against the reserve. The consolidation plan is scheduled to be substantially completed by March 31, 1996.\nThe historical results for 1995 include an extraordinary charge of approximately $2.4 million ($1.4 million net of tax benefit of $1.0 million) of financing costs and original issue discount relating to the debt retired. In addition, the historical results for 1995 include compensation expense relating to an increase in the value of employee stock options of approximately $1.5 million ($0.9 million net of tax benefit of $0.6 million) as a result of the Acquisition and Merger. The pro forma twelve months ended December 31, 1995 do not include the extraordinary write-off.\n5. LONG-TERM DEBT\nLong-term debt consists of the following amounts (dollars in thousands):\nThe prevailing prime interest rate at the end of 1995 and 1994 was 8.5%.\nIn connection with the Acquisition, Associated received an equity investment of $12.0 million and borrowed an aggregate of $416.5 million under the Credit Facilities and $130.0 million under the Subordinated Bridge Facility. The proceeds of these investments and borrowings were used to (i) finance the purchase of shares of United common stock pursuant to the Offer, (ii) refinance certain existing indebtedness of Associated (including all amounts outstanding under the existing old Associated credit facilities) and indebtedness of the Company (including certain amounts outstanding under United and USSC credit facilities), (iii) repurchase United employee stock options, and (iv) pay fees and expenses relating to the Acquisition.\nThe Credit Facilities as of December 31, 1995, consist of $200.0 million of term loan borrowings (\"Term Loan Facilities\") and up to $325.0 million of revolving loan borrowings (\"Revolving Credit Facility\"). The loans outstanding under the Term Loan Facilities and the Revolving Credit Facility bear interest, at the Company's option, equal to the prime rate plus 2.25% (if the Tranche B Facility) or 1.75% (if either the Tranche A Facility or the Revolving Credit Facility) or LIBOR plus 3.25% (if the Tranche B Facility) or 2.75% (if either the Tranche A or Revolving Credit Facility), based on one, two, three or six month periods.\nOn May 3, 1995, USSC completed the issuance of $150.0 million of 12 3\/4% Senior Subordinated Notes due 2005 (the \"Notes\"). The net proceeds of the Notes (after discount and fees of approximately $7.9 million) were used to pay certain expenses to repay the $130.0 million Subordinated Bridge Facility (together with $1.6 million in accrued and unpaid interest thereon), to repay a portion of the Tranche A and Tranche B term loans and accrued interest (totaling approximately $6.5 million), to repurchase all outstanding shares of the Company's Series B preferred stock and to provide working capital.\nThe Revolving Credit Facility is limited to the lesser of $325.0 million or a borrowing base equal to 80% of Eligible Receivables (as defined in the Credit Agreement); plus 50% of Eligible Inventory (as defined in the Credit Agreement) (provided that no more than 60% or during certain periods 65%, of the Borrowing Base may be attributable to Eligible Inventory); plus the aggregate amount of cover for Letter of Credit Liabilities (as defined). The Revolving Credit Facility provides that, for each fiscal year commencing January 1, 1996, the Company must repay revolving loans so that for a period of 30 consecutive days in each fiscal year the aggregate revolving loans do not exceed $200.0 million. The Revolving Credit Facility matures on March 31, 2000.\nThe Company is exposed to market risk for changes in interest rates. The Company may enter into interest rate protection agreements, including collar agreements, to reduce the impact of fluctuations in interest rates on a portion of its variable rate debt. Such agreements, generally require the Company to pay to or entitle the Company to receive from the other party the amount, if any, by which the Company's interest payments fluctuate beyond the rates specified in the agreements. The Company is subject to the credit risk that the other party may fail to perform under such agreements. The Company's allocated cost of such agreements is amortized to interest expense over the term of the agreements, and the unamortized cost is included in other assets. Payments received or made as a result of the agreements, if any, are recorded as an addition or a reduction of interest expense. At December 31, 1995, the Company had agreements which collar $200.0 million of the Company's borrowings under the Credit Facilities and expire in April 1998.\nThe agreement governing the Credit Facilities (the \"Credit Agreement\") contains representations and warranties, affirmative and negative covenants and events of default customary for financings of this type. Substantially all assets of the Company are pledged as collateral under the Credit Agreement and other long-term debt.\nThe right of the Company to participate in any distribution of earnings or assets of USSC is subject to the prior claims of the creditors of USSC. In addition, the Indenture and the Credit Agreement contain certain restrictive covenants, including covenants that restrict or prohibit USSC's ability to pay dividends and make other distributions to the Company.\nDebt maturities for the years subsequent to December 31, 1995, are as follows (dollars in thousands):\n------------------------------- Year Amount ------------------------------- 1996 $ 22,979 1997 27,630 1998 31,273 1999 34,172 2000 221,695 Later years 211,428 ------------------------------- $549,177 ------------------------------- -------------------------------\nOutstanding letters of credit totaled $56.0 million at December 31, 1995. The letters of credit were issued to support various activities of the Company.\n6. LEASES\nThe Company has entered into several non-cancelable long-term leases for property and equipment. Future minimum lease payments for non-cancelable leases in effect at December 31, 1995 having initial remaining terms of more than one year are as follows (dollars in thousands):\nOperating Leases ------------------------------------- Capital Lease Sublease Net Lease Year Lease Payments Income Payments - ---- -------- ------------------------------------- 1996 $1,181 $13,950 $372 $13,578 1997 1,479 11,085 199 10,886 1998 487 9,245 146 9,099 1999 - 7,502 61 7,441 2000 - 5,462 - 5,462 Later years - 18,801 - 18,801 - -------------------------------------- ----------------------------------- Total minimum lease payments 3,147 $66,045 $778 $65,267 ----------------------------------- Less amount representing interest 334 ----------------------------------- - -------------------------------------- Present value of net minimum lease payments (including current portion of $907) $2,813 - -------------------------------------- - --------------------------------------\nRental expense for all operating leases was approximately $14.2 million, $3.0 million and $2.7 million in 1995, 1994 and 1993, respectively.\n7. PENSION PLANS AND PROFIT SHARING PLANS\nPENSION PLANS\nIn connection with the Merger and Acquisition, the Company assumed the pension plans of United. Associated did not have a pension plan. Former Associated employees will enter the pension plan on July 1, 1996. At that time, the Company will have pension plans covering substantially all of its employees. Non-contributory plans covering non-union employees provide pension benefits that are based on years of credited service and a percentage of annual compensation. Non-contributory plans covering union members generally provide benefits of stated amounts based on years of service. The Company funds the plans in accordance with current tax laws.\nThe following table sets forth the plans' funded status at December 31, 1995 (dollars in thousands). This exhibit does not include the projected benefit obligation of $680,000 for the former Associated employees as of December 31, 1995.\n- ------------------------------------------------------------- Actuarial Present Value of Benefits Obligation Vested benefits $ 18,776 Non-vested benefits 1,996 --------- Accumulated benefits obligation 20,772 Effect of projected future compensation levels 2,861 --------- Projected benefits obligation 23,633 Plan assets at fair value 26,713 --------- Plan assets in excess of projected benefits obligation 3,080 Unrecognized net gain due to past experience different from assumptions (507) --------- Prepaid pension asset recognized in Consolidated Balance Sheet $ 2,573 --------- ---------\nThe plans' assets consist of debt securities, equity securities and government securities. Net periodic pension cost for 1995 for pension and supplemental benefits plans includes the following components (dollars in thousands): - ------------------------------------------------------------- Service cost-benefits earned during the period $ 1,142 Interest cost on projected benefits obligation 1,157 Actual return on assets (2,711) Net amortization and deferral 1,382 --------- Net periodic pension cost $ 970 --------- ---------\nThe projected benefit obligation for 1995 was determined using an assumed discount rate of 7.25%. In 1995, the assumed rate of compensation increase ranged from 0.0% to 5.5%. The expected long-term rate of return on assets used in determining net periodic pension cost was 7.5%.\nPROFIT SHARING PLANS\nIn connection with the Merger and Acquisition, the Company assumed the profit sharing plan of United; thus, the Company currently has two profit sharing plans which cover all salaried employees and certain hourly employees. The plans provide for annual contributions by the Company in an amount determined by the Board of Directors. The plans also permit employees to have contributions made as 401(k) salary deferrals on their behalf and to make after- tax voluntary contributions. The plans provide that the Company may match employee contributions as 401(k) salary deferrals. Company contributions for matching of employee contributions were approximately $0.6 million, $0.3 million and $0.4 million in 1995, 1994 and 1993, respectively.\n8. POSTRETIREMENT BENEFITS\nIn connection with the Merger, the Company assumed the postretirement plan of United on March 30, 1995. Associated did not have a postretirement plan. The plan is unfunded and provides health care benefits to substantially all retired non-union employees and their dependents. Eligibility requirements are based on the individual's age (minimum age of 55), years of service and hire date. The benefits are subject to retiree contributions, deductibles, co- payment provisions and other limitations.\nThe assumed health care average cost trend rate used in measuring the accumulated postretirement benefit obligation (\"APBO\") at December 31, 1995 was 11.0% and 3.0% in 1996 and beyond, respectively. Beginning in 1996, retirees will pay the difference between actual plan costs and the portion of costs paid by the Company which is limited to a cost trend rate of 3%. The assumed discount rate was 7.5%. A 1% increase in the health care cost trend rate would increase the APBO as of December 31, 1995 by approximately $396,000 and annual service cost and interest cost by approximately $46,000.\nThe cost of postretirement health care benefits for the year ended December 31, 1995 was as follows (dollars in thousands): - -------------------------------------------------------- Service cost $ 161 Interest on accumulated benefits obligation 109 -------- Net postretirement benefit cost $ 270 -------- --------\nThe following table sets forth the amounts recognized in the Company's Consolidated Balance Sheet as of December 31, 1995 (dollars in thousands):\n- -------------------------------------------------------- Retirees $ (762) Other fully eligible plan participants (697) Other active plan participants (1,362) -------- Total APBO (2,821) Unrecognized net loss 76 -------- Accrued postretirement benefit obligation $ (2,745) -------- -------- 9. STOCK PLAN INCENTIVES\nThe Management Stock Option Plan (the \"Plan\"), as amended, is administered by the Board of Directors, although the Plan provides that the Board of Directors of the Company may designate an option committee to administer the Plan. Options outstanding under the Plan as of the Merger date became exercisable for a number of Shares equal to the number of such Shares that would have been received in respect of such option if it had been exercised immediately prior to March 30, 1995 (the \"Effective Time\").\nIn September 1995, the Company's Board of Directors approved an amendment to the Plan, subject to stockholder approval, which provided for the issuance of options to key management employees of the Company exercisable for up to 2.2 million additional shares of its Common Stock. Subsequently, approximately 2.2 million options were granted to management employees subject to stockholder approval. Some of the options were granted at an option price below market value and the option price of certain options is subject to increases on a quarterly basis beginning in 1996.\nThe stock options granted under the Plan do not vest to the employee until the occurrence of an event (a \"Vesting Event\") that causes the present non- public equity investors to have received at least a full return of their investment (at cost) in cash, fully tradable marketable securities or the equivalent. A Vesting Event will cause the Company to recognize compensation expense based upon the difference between the fair market value of the Common Stock and the exercise price of the stock options. If a Vesting Event were to occur, based upon a stock price of $22.75, the Company would recognize a\nnonrecurring noncash charge and related tax effect of $31.7 million in compensation expense ($19.0 million net of tax benefit of $12.7 million). Each $1.00 change in the Common Stock price will result in an adjustment to such compensation expense of approximately $2.6 million ($1.6 million net of tax effect of $1.0 million).\nAn optionee under the Plan must pay the full option price upon exercise of an option (i) in cash, (ii) with the consent of the Board of Directors of the Company, by delivering shares of Common Stock already owned by such optionee (including shares to be received upon exercise of the option) and having a fair market value at least equal to the exercise price or (iii) in any combination of the foregoing. The Company may require the optionee to satisfy federal tax withholding obligations with respect to the exercise of options by (i) additional withholding from the employee's salary, (ii) requiring the optionee to pay in cash or (iii) reducing the number of shares of Common Stock to be issued (except in the case of incentive options).\nThe following table summarizes the transactions of the Plan for the last three years:\nAll share and per share data have been restated to reflect the 100% stock dividend effective November 9, 1995 and the conversion of Associated common stock as a result of the Merger.\nOn January 1, 1996, the Company granted, subject to stockholder approval, options exercisable for an aggregate of 240,000 shares of Common Stock at an exercise price of $12.50 per share (subject to quarterly increases) and 120,000 shares of Common Stock at a fixed exercise price of $5.12 per share. Further, the Company intends to grant options for an aggregate of 202,772 shares of Common Stock at an exercise price of $1.45 per share.\n10. REDEEMABLE PREFERRED STOCK\nAt December 31, 1995, the Company had 1,500,000 authorized shares of $0.01 par value preferred stock, of which 15,000 shares were designated as Series A preferred stock, 15,000 shares were designated as Series B preferred stock, 15,000 shares were designated as Series C preferred stock, and 1,455,000 shares remained undesignated. At December 31, 1994, the Company had 245,000 authorized shares of preferred stock (nonvoting), consisting of 15,000 shares of $0.01 par value Class A preferred stock, 15,000 shares of $0.01 par value Class B preferred stock, 15,000 shares of $0.01 par value Class C preferred stock and 200,000 shares of $0.01 par value additional preferred stock. All preferred stock issued at the date of inception was valued at the amount of cash paid or assets received for the stock at $1,000 per share. On July 28, 1995, the Company repurchased all 6,892 shares of Series B preferred stock issued and outstanding for $7.0 million, including accrued and unpaid dividends thereon. All outstanding shares of preferred stock are senior in preference to the Common Stock of the Company.\nSeries A preferred stock must be redeemed by the Company on July 31, 1999. Dividends are cumulative at a rate of 10% per annum, payable quarterly on April 30, July 31, October 31 and January 31. In the event that the Company does not pay dividends in cash, the dividend rate increases to 13% per annum and is payable in stock. Series B and C preferred stock are junior in relation to the Series A preferred stock. During each of the years ended December 31, 1995, 1994 and 1993, 649 shares of Series A preferred stock were accrued but not issued. As of December 31, 1995 and 1994, 2,437 and 1,788 shares of Series A preferred stock have been accrued as dividends but not issued.\nSeries C preferred stock is redeemable in four equal quarterly installments on April 30, 2001, July 31, 2001, October 31, 2001, and January 31, 2002. Dividends for both Series B and C are cumulative at a rate of 9% per annum. Dividends are payable quarterly on April 30, July 31, October 31 and January 31. In the event that the Company does not pay dividends in cash, the dividend rate increases to 10% per annum and is payable in stock. During the year ended December 31, 1995, noncash dividends were declared and issued for both Series B and C preferred stock in the amounts of 332 and 763 shares, respectively. In addition, during 1995 a cash dividend of approximately $254,000 was paid to Series C preferred stockholders in connection with the repurchase of Series B preferred stock. During the year ended December 31, 1994, noncash dividends were declared and issued for both Series B and C preferred stock in the amount of 617 and 926 shares, respectively. During the year ended December 31, 1993, noncash dividends were declared and issued for both Series B and C preferred stock in the amount of 559 and 838 shares, respectively.\nAll series of preferred stock may be redeemed at the option of the issuer at any time. All series of preferred stock have a redemption and liquidation value of $1,000 per share plus the aggregate of accrued and unpaid dividends on such shares to date. Required redemption of preferred stock for the five years following the year ended December 31, 1995 is $7.4 million in 1999 for the Series A preferred stock.\n11. REDEEMABLE WARRANTS\nThe Company had 1,430,468 and 1,311,091 warrants (\"Lender Warrants\") outstanding as of December 31, 1995 and 1994, respectively, which allow holders thereof to buy shares of Common Stock at an exercise price of $0.10 per share. Outstanding Lender Warrants as of December 31, 1995 were valued at $27.75 per warrant. During 1995, 117,954 warrants were exercised, 284,484 warrants were issued or accrued resulting from anti-dilution agreements and 47,153 were contributed back to the Company and terminated in connection with fees paid by the Company relating to the issuance of the Notes. Of the Lender Warrants outstanding as of December 31, 1994, 1,036,229 were valued at the date of inception at the negotiated amount of $0.97 per warrant while the remaining 274,862 warrants were valued at $1.58 per warrant. In addition, 129,725 additional Lender Warrants were accrued but not issued, as of December 31, 1994. These warrants were valued at $1.66 per warrant. The exercise period for Lender Warrants expires January 31, 2002.\nThe Lender Warrants contain certain put rights which allow the holders thereof to put the warrants to the Company commencing on February 10, 1996. The purchase price payable upon the exercise of the put rights is the greater of the then fair market value or equity value of the warrants, as defined, less the applicable exercise price of the warrants. Payment of the Lender Warrants can only occur after repayment of all debt outstanding under the Credit Agreement or with the consent of the lenders and\/or agent under the Credit Agreement.\n12. TRANSACTIONS WITH RELATED PARTIES\nThe Company has management advisory services agreements with three investor groups. These investor groups provide certain advisory services to the Company in connection with the Acquisition as defined below.\nPursuant to an agreement, Wingate Partners, L.P. (\"Wingate Partners\") had agreed to provide certain oversight and monitoring services to the Company in exchange for an annual fee of up to $725,000, payment (but not accrual) of which is subject to restrictions under the Credit Agreement related to certain Company performance criteria. At the Effective Time, the Company paid aggregate fees to Wingate Partners of $2.3 million for services rendered in connection with the Acquisition. Wingate Partners earned an aggregate of $603,000, $350,000 and $210,000 with respect to each of the fiscal years ended 1995, 1994 and 1993, respectively, for such oversight and monitoring services. Under the agreement, the Company is obligated to reimburse Wingate Partners for its out-of-pocket expenses and indemnify Wingate Partners and its affiliates from loss in connection with these services. The agreement expires on January 31, 2002, provided that the agreement continues in effect on a year to year basis thereafter unless terminated in writing by one of the parties at least 180 days before the expiration of the primary term or any subsequent yearly term.\nPursuant to an agreement, Cumberland Capital Corporation (\"Cumberland\") has agreed to provide certain oversight and monitoring services to the Company in exchange for (i) an annual fee of up to $137,500 payment (but not accrual) of which is subject to restrictions under the Credit Agreement related to certain Company performance criteria and (ii) previously issued shares of Associated Common Stock that converted in the Merger into 154,126 shares. Subject to certain exceptions, the issuance of such shares is subject to rescission if the agreement is terminated before January 31, 2002. At the Effective Time, the Company paid aggregate fees to Cumberland of $100,000 for services rendered in connection with the Acquisition. Pursuant to the agreement, Cumberland earned $129,000, $75,000 and $45,000 with respect to the fiscal years ended 1995, 1994 and 1993, respectively, for such oversight and monitoring services. The Company is also obligated to reimburse Cumberland for its out-of-pocket expenses and indemnify Cumberland and its affiliates from loss in connection with these services. The agreement expires on January 31, 2002, provided that the agreement continues in effect on a year to year basis thereafter unless terminated in writing by one of the parties at least 180 days before the expiration of the primary term for any subsequent yearly term.\nPursuant to an agreement, Good Capital Co., Inc. (\"Good Capital\") has agreed to provide certain oversight and monitoring services to the Company in exchange for (i) an annual fee of up to $137,500, payment (but not accrual) of which is subject to restrictions under the Credit Agreement related to certain Company performance criteria and (ii) previously issued shares of Associated Common Stock that converted in the Merger into 154,126 shares. Subject to certain exceptions, the issuance of such shares is subject to rescission if the agreement is terminated before January 31, 2002. At the Effective Time, the Company paid aggregate fees to Good Capital of $100,000 for services rendered in connection with the Acquisition. Pursuant to the agreement, Good Capital earned an aggregate $129,000, $75,000 and $45,000 in each of the fiscal years ended 1995, 1994 and 1993, respectively, for such oversight and monitoring services. The Company is also obligated to reimburse Good Capital for its out-of-pocket expenses and indemnify Good Capital and its affiliates from loss in connection with these services. The agreement expires on January 31, 2002, provided that the agreement continues in effect thereafter on a year to year basis unless terminated in writing by one of the parties at least 180 days before the expiration of the primary term or any subsequent yearly term.\n13. INCOME TAXES\nThe provision for (benefit from) income taxes consists of the following (dollars in thousands):\nYear Ended December 31, ------------------------ 1995 1994 1993 ------ ------ ------ Currently payable - Federal $4,172 $3,090 $ 227 State 1,119 903 554 ------ ------ ------ Total currently payable 5,291 3,993 781\nDeferred, net - Federal (142) 166 1,012 State (21) 24 148 Valuation allowance reduction - (190) (1,160) ------ ------ ------ Total deferred, net (163) - - ------ ------ ------ Provision for income taxes $5,128 $3,993 $ 781 ------ ------ ------ ------ ------ ------\nThe Company's effective income tax rates for the years ended December 31, 1995, 1994 and 1993 varied from the statutory Federal income tax rate as set forth in the following table (dollars in thousands):\nThe deferred tax assets and liabilities result from timing differences in the recognition of certain income and expense items for financial and tax accounting purposes. The sources of these differences and the related tax effects were as follows (dollars in thousands):\nAs a result of the Acquisition and Merger, the Company determined that the valuation allowance for deferred tax assets was no longer necessary and it has been eliminated.\nIn the Consolidated Balance Sheets, these deferred assets and deferred liabilities are classified as deferred tax assets or deferred income tax liabilities, based on the classification of the related asset or liability for financial reporting. A deferred tax liability or asset that is not related to an asset or liability for financial reporting, including deferred tax assets related to carryforwards, are classified according to the expected reversal date of the temporary difference.\n14. SUPPLEMENTAL CASH FLOW INFORMATION\nIn addition to the information provided in the Consolidated Statements of Cash Flows, the following are supplemental disclosures of cash flow information for the twelve months ended December 31, 1995, 1994 and 1993 (dollars in thousands):\n1995 1994 1993 ------- ------ ------ Cash paid during the year for: Interest $36,120 $6,588 $6,119 Income taxes 8,171 2,118 630\nThe following are supplemental disclosures of noncash investing and financing activities for the twelve months ended December 31, 1995, 1994 and 1993 (dollars in thousands):\n- On May 3, 1995, the Company issued stock valued at $2,406 in exchange for services related to the issuance of the Notes.\n- On March 30, 1995, the Company issued stock valued at $2,162 in exchange for services related to financing the Acquisition.\n- In 1994, Associated issued $9,000 of common stock to retire a $9,000 deferred obligation related to a transition services agreement.\n- In 1994, Associated accrued $244 for warrants which had an exercise price less than the fair market value of the common stock.\n- In 1994, Associated accrued $63 for common stock shares to be issued at less than fair market value.\n15. FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe estimated fair value of the Company's financial instruments are as follows (dollars in thousands):\nThe fair value of the Notes is based on quoted market prices. The fair value of the interest rate collar, estimated as a $3.9 million payable, is based on quotes from counterparties.\n16. CONTEMPLATED COMMON STOCK OFFERING\nThe Company has filed a preliminary registration statement with the Securities and Exchange Commission. The contemplated offering included both a primary component of 3.5 million shares and a secondary component of 3.5 million shares. Subsequently, the Board of Directors determined that the primary offering would be indefinitely postponed.\nUNITED STATIONERS INC. AND SUBSIDIARY SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS (IN THOUSANDS OF DOLLARS)\n(1) Reflects the results of Associated only for the three months ended March 30, 1995 and the Company for the nine months ended December 31, 1995.\n(2) Reflects the results of Associated only.\n(3) Reflects the liability assumed as a result of the Merger.\n(A) Accounts determined to be uncollectible and charged against reserves, net of collections on accounts previously written off.\n(B) Credit memos issued for sales returns.\nREPORT OF INDEPENDENT AUDITORS\nTO THE STOCKHOLDERS AND BOARD OF DIRECTORS OF UNITED STATIONERS INC.\nWe have audited the accompanying consolidated balance sheet of United Stationers Inc. and Subsidiary as of March 30, 1995 and the related consolidated statements of operations, changes in stockholders' investment and cash flows for the seven months then ended. Our audit also included the financial statement schedule as of March 30, 1995 and for the seven months then ended 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 audit.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of United Stationers Inc. and Subsidiary at March 30, 1995 and the consolidated results of their operations and their cash flows for the seven months 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.\n\/s\/ ERNST & YOUNG LLP\nChicago, Illinois June 27, 1995\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTO THE STOCKHOLDERS AND BOARD OF DIRECTORS OF UNITED STATIONERS INC.\nWe have audited the accompanying consolidated balance sheets of UNITED STATIONERS INC. (a Delaware Corporation) AND SUBSIDIARIES as of August 31, 1994 and 1993, and the related consolidated statement of operations, changes in stockholders' investment and cash flows for fiscal years ended August 31, 1994, 1993 and 1992. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of United Stationers Inc. and Subsidiaries as of August 31, 1994 and 1993, and the results of its operations and its cash flows for the fiscal years ended August 31, 1994, 1993 and 1992, in conformity with generally accepted accounting principles.\nOur audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. 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.\n\/s\/ Arthur Andersen LLP\nChicago, Illinois, October 6, 1994.\nUNITED STATIONERS INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS OF DOLLARS, EXCEPT SHARE DATA)\nThe accompanying notes to consolidated financial statements are an integral part of these statements.\nUNITED STATIONERS INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS (IN THOUSANDS OF DOLLARS, EXCEPT SHARE DATA)\n- -------------------------------------------------------------------------------- Aug. 31, MARCH 30, ----------------------- ASSETS 1995 1994 1993 - -------------------------------------------------------------------------------- CURRENT ASSETS:\nCash and cash equivalents $ 14,515 $ 6,920 $ 7,889\nAccounts receivable, less reserves for doubtful accounts of $4,775 in 1995, $4,010 in 1994 and $3,964 in 1993 188,672 187,565 188,396\nInventories 306,741 225,794 229,760\nDeferred income taxes and prepaid expenses 22,987 15,512 16,426\n- -------------------------------------------------------------------------------- Total current assets 532,915 435,791 442,471 - --------------------------------------------------------------------------------\nPROPERTY, PLANT AND EQUIPMENT, AT COST:\nLand and buildings 92,907 92,099 90,147\nFixtures and equipment 152,059 151,793 144,625\nLeasehold improvements 85 36 46\n- -------------------------------------------------------------------------------- Total property, plant and equipment 245,051 243,928 234,818\nLess - Accumulated depreciation and amortization 118,219 114,364 97,182 - --------------------------------------------------------------------------------\nNet property, plant and equipment 126,832 129,564 137,636 - --------------------------------------------------------------------------------\nGOODWILL, NET 41,719 42,369 43,484 - --------------------------------------------------------------------------------\nOTHER ASSETS 10,373 10,826 11,195 - --------------------------------------------------------------------------------\nTotal assets $711,839 $618,550 $634,786 - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------\nThe accompanying notes to consolidated financial statements are an integral part of these statements.\nUNITED STATIONERS INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS (IN THOUSANDS OF DOLLARS, EXCEPT SHARE DATA)\nThe accompanying notes to consolidated financial statements are an integral part of these statements.\nUNITED STATIONERS INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' INVESTMENT (IN THOUSANDS OF DOLLARS, EXCEPT SHARE DATA)\nThe accompanying notes to consolidated financial statements are an integral part of these statements.\nUNITED STATIONERS INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS OF DOLLARS)\nThe accompanying notes to consolidated financial statements are an integral part of these statements.\nUNITED STATIONERS INC. AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SUBSEQUENT EVENT\nOn March 30, 1995, Associated Holdings, Inc. (\"Associated\") purchased 92.5% of the then outstanding shares of the common stock, $0.10 par value (\"Common Stock\") of United Stationers Inc. (\"United\") for approximately $266.6 million in the aggregate pursuant to a tender offer (the \"Tender Offer\"). Immediately thereafter, Associated merged with and into United (the \"Merger\" and, collectively with the Tender Offer, the \"Acquisition\"), and Associated Stationers, Inc., a wholly-owned subsidiary of Associated (\"ASI\") merged with and into United Stationers Supply Co., a wholly-owned subsidiary of United (\"USSC\"), with United and USSC continuing as the respective surviving corporations. United, as the surviving corporation following the Merger, is referred to herein as the \"Company.\" As a result of share conversions in the Merger, immediately after the Merger, (i) the former holders of common stock and common stock equivalents of Associated owned shares of Common Stock and warrants or options to purchase shares of Common Stock constituting in the aggregate approximately 80% of the shares of Common Stock on a fully diluted basis, and (ii) holders of pre-Merger United common stock owned in the aggregate approximately 20% of the shares of Common Stock on a fully diluted basis. Although United was the surviving corporation in the Merger, the transaction was treated as a reverse acquisition for accounting purposes with Associated as the acquiring corporation.\nImmediately following the Merger, the number of outstanding Shares was 5,998,177 (or 6,973,720 on a fully diluted basis), of which (i) the former holders of Class A Common Stock, $0.01 par value, and Class B Common Stock, $0.01 par value, of Associated (\"Associated Common Stock\") and warrants or options to purchase Associated Common Stock in the aggregate owned 4,603,373 Shares constituting approximately 76.8% of the outstanding Shares and outstanding warrants or options for 975,603 Shares (collectively 80.0% on a fully diluted basis) and (ii) pre-Merger holders of Shares (other than Associated-owned Shares and treasury Shares) in the aggregate owned 1,394,744 Shares constituting approximately 23.2% of the outstanding Shares (or 20.0% on a fully diluted basis). As used in this paragraph, the term \"Shares\" includes shares of Nonvoting Common Stock, $0.01 par value, of the Company, which are immediately convertible into Shares for no additional consideration.\nTo finance the Offer, refinance existing debt of ASI, the Company and USSC, repurchase stock options and pay related fees and expenses, Associated, ASI, USSC and the Company entered into (i) new credit facilities (\"New Credit Facilities\") with a group of banks and financial institutions providing for term loan borrowings of $200.0 million and revolving loan borrowings of up to $300.0 million and (ii) a senior subordinated bridge loan facility in the aggregate principal amount of $130.0 million (the \"Subordinated Bridge Facility\"). In addition, simultaneously with the consummation of the Offer, Associated obtained $12.0 million from the sale of additional shares of Associated Common Stock, which proceeds were used to finance the purchase of a portion of the Shares pursuant to the Offer.\nOn May 3, 1995, USSC completed the issuance of $150.0 million of 12 3\/4% Senior Subordinated Notes (the \"Notes\") due 2005. The net proceeds of the Notes (after discount and fees of approximately $5.5 million) were used to pay certain expenses, to repay the $130.0 million Subordinated Bridge Facility (together with $1.6 million in accrued and unpaid interest thereon), to repay a portion of the Tranche A and Tranche B term loans (totaling approximately $6.5 million) and provide working capital. The Company expects to repurchase the Series B Preferred Stock, together with accrued and unpaid dividends thereon (approximately $7.0 million).\nThe New Credit Facilities contain certain financial covenants covering the Company and its subsidiaries on a consolidated basis, including, without limitation, covenants relating to tangible net worth, capitalization, fixed charge coverage, capital expenditures and payment of dividends by the Company.\nEffective for 1995, the Company changed its fiscal year from a year end of August 31 to December 31. The financial statements included herein represent the final financial statements of the Company through the date of the consummation of the Merger. Future financial statements of the Company will reflect Associated and its acquisition of the Company, and will be on the basis of a December 31 fiscal year end.\nAs part of the Merger, the Company incurred approximately $27.8 million of merger-related costs. The amount consisted of severance payments under employment contracts ($9.6 million); insurance benefits under employment contracts($7.4 million); legal, accounting and other professional services fees ($5.2 million); retirement of stock options ($3.0 million); and fees for letters of credit related to employment contracts and other costs ($2.6 million).\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the accounts of United Stationers Inc. and its wholly owned subsidiaries (\"the Company\"). Investments in 20% to 50% owned companies are accounted for by the equity method. All significant intercompany accounts and transactions have been eliminated in consolidation. Certain prior-year amounts have been reclassified to conform with current-year presentations.\nREVENUE RECOGNITION\nSales and provisions for estimated sales returns and allowances are recorded at the time of shipment.\nCASH AND CASH EQUIVALENTS\nInvestments in low-risk instruments which have an original maturity of three months or less are considered to be cash equivalents. Cash equivalents are stated at cost which approximates market value. The Company's cash equivalent policy conforms to the requirements of Financial Accounting Standard No. 95.\nINVENTORIES\nInventories constituting approximately 82% of total inventories at March 30, 1995, August 31, 1994 and August 31, 1993 have been valued under the last-in, first-out (LIFO) method with the remainder of the inventory valued under the first-in, first-out (FIFO) method. Inventory valued under the FIFO and LIFO accounting methods are recorded at the lower of cost or market. If the lower of FIFO cost or market method of inventory accounting had been used by the Company for all inventories, merchandise inventories would have been approximately $21,797,000, $18,854,000 and $16,679,000 higher than reported at March 30, 1995, August 31, 1994 and August 31, 1993, respectively.\nIn 1994, liquidations of certain LIFO inventories had the effect of increasing net earnings by $830,000 or $0.04 per share.\nDEPRECIATION AND AMORTIZATION\nDepreciation and amortization are determined by using the straight-line method over the estimated useful lives of the assets.\nThe estimated useful life assigned to fixtures and equipment is from two to 10 years; the estimated useful life assigned to buildings does not exceed 40 years; leasehold improvements and assets under capital leases are amortized over the lesser of their useful lives or the term of the applicable lease.\nGoodwill reflecting the excess of cost over the value of net assets of businesses acquired is being amortized on a straight-line basis over 40 years. The cumulative amount of goodwill amortized at March 30, 1995, August 31, 1994 and August 31, 1993 is $2,965,000, $2,315,000 and $1,200,000, respectively.\nSOFTWARE CAPITALIZATION\nThe Company capitalizes major internal and external systems development costs determined to have benefits for future periods. Amortization expense is recognized over the periods in which the benefits are realized, generally not to exceed three years. Systems development costs capitalized were $1,896,000,\n$2,166,000, $1,955,000 and $4,202,000 in 1995, 1994, 1993 and 1992, respectively. Amortization expense was $1,795,000, $2,376,000, $2,946,000 and $3,384,000 in 1995, 1994, 1993 and 1992, respectively.\nFAIR VALUE OF FINANCIAL INSTRUMENTS\nThe Company's financial instruments consist primarily of cash and cash equivalents, trade receivables, trade payables and debt instruments. The book value of cash and cash equivalents, trade receivables and trade payables are considered to be representative of their respective fair values.\nBorrowings under the Company's Reducing Revolving Credit and Term Loan Agreement are considered to be at fair market value. The Company had approximately $62.4 million, $62.7 million and $66.1 million of long-term debt (excluding borrowings under the Company's Reducing Revolving Credit and Term Loan Agreement) outstanding as of March 30, 1995, August 31, 1994, and August 31, 1993, respectively. The approximate fair value was $61.3 million, $59.8 million and $68.0 million as of March 30, 1995, August 31, 1994 and August 31, 1993, respectively. The fair value is based on the current rates offered to the Company for debt of similar maturities. The fair values on the long-term debt financial instruments are not necessarily indicative of the amounts that would be realized in a current market exchange and exclude any liquidation or origination costs.\nFOREIGN CURRENCY TRANSLATION\nAll assets and liabilities of the Company's foreign operations are translated at current exchange rates. Revenues and expenses are translated at average exchange rates for the year in accordance with Statement of Financial Accounting Standard No. 52. The amounts for all years presented were immaterial.\nEARNINGS PER SHARE\nEarnings per share and the effect on earnings per share of potentially dilutive stock options are computed by the treasury stock method. This computation takes into account the weighted average number of shares outstanding during each year, outstanding stock options and their exercise prices, and the market price of the stock throughout the year. The exercise of outstanding stock options would not result in a material dilution of earnings per share.\n3. BUSINESS COMBINATION AND RESTRUCTURING CHARGE\nOn June 24, 1992, the Company acquired all of the outstanding capital stock of SDC Distributing Corp., parent of Stationers Distributing Company, Inc. (\"SDC\"). The results of operations of SDC have been included in the Company's consolidated financial statements since June 25, 1992.\nThe following summarized unaudited pro forma results of operations for the years ended August 31, 1992 and 1991 assume the acquisition occurred at the beginning of the respective periods. These pro forma results have been prepared for comparative purposes only and do not purport to be indicative of the results of operations that actually would have resulted had the combination been in effect on the dates indicated, or which may result in the future.\n1992 1991 - ------------------------------------------------------------------------------- (in thousands of dollars, except share data) (unaudited)\nNet Sales.................. $1,445,900 $1,378,734 Net Income................. 20,444 14,070 Net Income per Share....... 1.10 0.76 - -------------------------------------------------------------------------------\nIn the fourth quarter of 1992, the Company recorded a $5.9 million pre-tax restructuring charge related to severance payments and closing of certain facilities associated with the acquisition.\n4. LONG-TERM DEBT\nLong-term debt consists of the following amounts (in thousands of dollars):\nThe prevailing prime interest rate at March 30, 1995, August 31, 1994 and August 31, 1993 was 9.0%, 7.8%, and 6.0%, respectively.\nThe Company has a $160.0 million Reducing Revolving Credit and Term Loan Agreement (\"Credit Agreement\") with a group of seven lenders (the \"Lenders\"). The Credit Agreement consists of a $130.0 million revolving credit facility (\"Revolver\") and a $30.0 million term loan (\"Term Loan\"). Proceeds are used to finance working capital requirements and capital expenditures of the Company.\nThe Revolver provides for revolving credit loans up to the amount of the commitment until August 31, 1997, at the Company's option. The initial $130.0 million commitment decreases to $83.6 million as of August 31, 1997 based on quarterly decreases which began in May 1994 as specified in the Credit Agreement. As of August 31, 1994, the Revolver commitment is $126.0 million. Under the terms of the Credit Agreement, the Company is required to pay a facility fee of 3\/16 of 1% of the total available Revolver. The Term Loan (as amended) matures on September 30, 1995 (or earlier upon certain subsequent offerings by the Company of debt or equity). The Term Loan can be prepaid without penalty. Interest on both loans is payable at varying rates provided for in the Credit Agreement.\nOn February 28, 1995, the Company entered into a $30.0 million line of credit with a major bank. This credit facility was entered into to meet seasonal requirements after the Revolver and Term Loan was fully utilized, and bore interest at agreed upon market rates. The Company had $6.0 million outstanding under this agreement immediately prior to the Merger. This agreement was terminated in connection with the Merger.\nThe Credit Agreement contains certain financial covenants covering the Company and its subsidiary on a consolidated basis, including, without limitation, covenants relating to the consolidated current ratio, tangible net worth, capitalization, fixed charge coverage, capital expenditures and payment of dividends by the Company.\nThe net book value of assets subject to secured mortgages and industrial development bonds as of March 30, 1995, August 31, 1994 and August 31, 1993 was $28,128,000, $28,610,000 and $28,962,000, respectively.\nMaturities of long-term debt (excluding amounts borrowed under the Credit Agreement), for the following periods as indicated, are as follows (in thousands of dollars):\n- ------------------------------------------------------------------------------- YEAR (EXCEPT 1995) AMOUNT - ------------------------------------------------------------------------------- Nine Months Ending December 31, 1995.................................. $ 6,125 1996.................................................................. 8,167 1997.................................................................. 8,218 1998.................................................................. 8,824 1999.................................................................. 6,129 Later years........................................................... 24,971 - ------------------------------------------------------------------------------- $62,434 - ------------------------------------------------------------------------------- - -------------------------------------------------------------------------------\nAs part of the Merger, approximately $180 million of debt at March 30, 1995 was refinanced. The refinanced debt consisted of various mortgages, the Edison, New Jersey industrial development bonds, the private placement loan, and the Term Loan and Revolver.\n5. PENSION PLANS AND POSTRETIREMENT BENEFITS\nThe Company has pension plans in effect for substantially all employees. Non-contributory plans covering non-union employees provide pension benefits that are based on years of credited service and a percentage of annual compensation. Non-contributory plans covering union members generally provide benefits of stated amounts based on years of service. The Company funds the plans in accordance with current tax laws.\nThe Company also has a non-contributory, non-qualified plan (\"Supplemental Benefit Plan\") in effect for certain executives. The Company has not funded this plan.\nPension expense in 1995, 1994, 1993 and 1992 was approximately $1,707,000, $1,755,000, $1,269,000 and $866,000, respectively.\nThe following table sets forth the plans' funded status at March 30, 1995, August 31, 1994 and August 31, 1993 (in thousands of dollars):\n(1) The Supplemental Benefit Plan was funded and paid out as a result of the merger.\nThe plans' assets consist of debt securities, equity securities and government securities. Net periodic pension cost for 1995, 1994, 1993 and 1992 for pension and supplemental benefits plans includes the following components (in thousands of dollars):\nThe projected benefit obligations for 1995, 1994, 1993 and 1992 were determined using an assumed discount rate of 7.5%, 7.5%, 7.25%, and 7.5%, respectively. In 1995, 1994, 1993, and 1992, the assumed rate of compensation increase ranged from 0% to 5.5%. The expected long-term rate of return on assets used in determining net periodic pension cost was 7.5%.\nThe Company provides an unfunded health care plan to substantially all retired non-union employees and their dependents. Eligibility requirements are based on the individual's age (minimum age of 55), years of service and hire date. The benefits are subject to retiree contributions, deductibles, co- payment provisions and other limitations.\nDuring the first quarter of 1994, the Company adopted Statement of Financial Accounting Standard No. 106 (SFAS 106), \"Employer's Accounting for Postretirement Benefits Other Than Pensions.\" SFAS 106 requires companies to accrue the expected cost of postretirement health care and life insurance benefits throughout the employee's active service period. Previously, postretirement health care costs were recognized as claims were paid. The Company elected to amortize the unfunded Accumulated Postretirement Benefit Obligation (APBO) over 20 years.\nThe assumed health care average cost trend rate used in measuring the APBO at March 30, 1995 was 11.0% in 1995 and 3% in 1996 and beyond. Beginning in 1996, retirees will pay the difference between actual plan costs and the portion of cost paid by the Company which is limited to a cost trend rate of 3%. The assumed discount rate was 7.75%. A 1% increase in the care cost trend rate would increase the APBO as of March 30, 1995 by approximately $339,000 and the sum of the 1995 annual service cost and interest cost by approximately $35,000.\nThe cost of postretirement health care benefits for the seven months ended March 30, 1995 and the year ended August 31, 1994 are as follows (in thousands of dollars):\n1995 1994 ---- ---- Service cost $109 $246 Interest on accumulated benefits obligation 106 146 Amortization of transition obligation 58 100 ---- ---- Net postretirement benefit cost $273 $492 ---- ---- ---- ----\nThe following table sets forth the amounts recognized in the Company's Balance Sheet at March 30, 1995 and August 31, 1994 (in thousands of dollars):\nMARCH 30, AUG. 31, 1995 1994 ------- ------- Retirees $ (781) $ (601) Other active plan participants (1,758) (1,634) ------- ------- Total APBO $(2,539) $(2,235) Unrecognized transition obligation 1,838 1,897 Unrecognized net (gain) 63 (76) ------- ------- Accrued postretirement benefit obligation $ (638) $ (414) ------- ------- ------- -------\nPrior to 1994, the cost of providing postretirement health care benefits, net of retiree contributions, was $46,777 in 1993 and $33,396 in 1992.\nThe Company has a qualified Profit Sharing Plan in which all salaried employees and certain hourly paid employees of the Company are eligible to participate upon completion of six consecutive months of employment. The Profit Sharing Plan provides for annual contributions by the Company in an amount determined by the Board of Directors. The Plan also permits employees to have contributions made as 401(k) salary deferrals on their behalf and to make after- tax voluntary contributions. The Plan provides that the Company may match employee contributions as 401(k) salary deferrals. Company contributions to the Plan for both profit sharing and matching of employee contributions were approximately $0.8 million in 1995, $0.5 million in 1994, $1.4 million in 1993 and $1.0 million in 1992.\n6. STOCK INCENTIVE PLANS\nAs a result of the change in control of the Company, the Company paid out approximately $3.0 million to option holders representing the difference between the tender offer price of the stock ($15.50 per share) and the option exercise price. The amount was included in merger-related costs in 1995.\nUnder the Directors' Stock Option Plan, the Company granted options for 7,500 shares at a price of $13.75 per share in 1995, 7,500 shares at a price of $15.25 per share in 1994 and 7,500 shares at a price of $19.25 per share in 1993. The Directors' Option Plan provides for the granting of options covering up to 100,000 shares of the Company's common stock, subject to anti-dilution adjustments. Options are exercisable at any time after they are granted, but for not more than ten years after the option's grant. As of the period ended 1995, 1994, and 1993, 0, 41,000 and 45,500 options, respectively, were outstanding at a price range of $8.75 to $22.13 per share.\nDuring fiscal 1995, options for a total of 100,000 shares at $10.50 were granted to certain officers. The grant was approved at the 1995 Annual Meeting held in January.\nUnder the Company's 1981 Stock Incentive Award Plan, options outstanding had an exercisable life of either five, six or ten years from the date of grant. The Company granted certain officers 15,000 and 16,700 shares of restricted stock in 1992 and 1991, respectively. There have been no restricted stock grants since 1992. The grants of restricted shares resulted in deferred compensation expense of $699,000 of which $16,000, $39,000, $132,000 and $185,000 was recognized in 1995, 1994, 1993 and 1992, respectively. The unrecognized portion of deferred compensation was $0, $16,000 and $55,000 as of March 30, 1995, August 31, 1994 and August 31, 1993, respectively. Under the terms of the grant, the stock does not vest to the employee until completion of three years of employment after the date of grant. The 1981 Stock Incentive Award Plan was terminated by the Company's Board of Directors on March 30, 1995.\nIn 1989, the Board of Directors terminated the 1985 Non-qualified Stock Option Plan so that no further stock options would be issued under this plan. The termination of the plan did not affect the options previously granted and outstanding. No option could have been exercised more than ten years after its grant.\nThe following table summarizes the transactions of the 1981 and 1985 Option Plans for 1995, 1994 and 1993.\n(1) As a result in change in control of the Company, the Company paid out to option holders the difference between the tender offer price of the stock ($15.50 per share) and the option exercise price. The total amount was included in merger-related costs in 1995.\n7. LEASES\nThe Company has entered into several non-cancelable long-term leases on property and equipment. Future minimum lease payments for non-cancelable leases in effect at March 30, 1995 having initial remaining terms of more than one year are as follows (in thousands of dollars):\nRental expense for all operating leases was approximately $7,731,000, $13,549,000, $14,917,000 and $11,546,000 in 1995, 1994, 1993 and 1992, respectively.\n8. INCOME TAXES\nThe Company accounts for income taxes in accordance with Statement of Financial Accounting Standard No. 109, \"Accounting for Income Taxes,\" which was adopted in 1992.\nThe Company does not intend to provide Federal income taxes on the undistributed earnings for its foreign subsidiaries. The Company's policy is to leave the income in the country of origin until such time as all Federal income tax due upon its distribution will be fully offset by foreign tax credits. As of March 30, 1995, neither foreign subsidiary had undistributed earnings.\nThe Company provides for income taxes at statutory rates based on income reported for financial statement purposes. A summary of income tax expense is shown below (in thousands of dollars):\nThe deferred tax assets and liabilities result from timing differences in the recognition of certain income and expense items for financial and tax accounting purposes. The sources of these differences and the related tax effects were as follows (in thousands of dollars):\nIn the consolidated balance sheets, these deferred assets and deferred liabilities are classified as deferred tax assets or deferred income tax liabilities, based on the classification of the related asset or liability for financial reporting. A deferred tax liability or asset that is not related to an asset or liability for financial reporting, including deferred tax assets related to carryforwards, are classified according to the expected reversal date of the temporary difference.\nNo valuation allowance was recorded in 1995 or 1994. A valuation allowance of $1,504,000 was recorded at August 31, 1993.\nThe table below records the differences between the statutory income tax rate and the Company's effective income tax rate:\nUNITED STATIONERS INC. AND SUBSIDIARY SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS (IN THOUSANDS OF DOLLARS)\n* Reflects the transition period of September 1, 1994 through March 30, 1995\n(A) Accounts determined to be uncollectible and charged against reserves, net of collections on accounts previously written off.\n(B) Credit memos issued for sales returns, rebates and allowances.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThe Registrant had no disagreements on accounting and financial disclosure of the type referred to in Item 304 of Regulation S-K.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS\nSet forth below is certain information with respect to those individuals who are currently serving as members of the Board of Directors or as executive officers of the Company on February 1, 1996:\nSet forth below is a description of the backgrounds of the directors and executive officers of the Company. There is no family relationship between any directors or executive officers of the Company. Officers of the Company are elected by the Board of Directors and hold office until their respective successors are duly elected and qualified.\nTHOMAS W. STURGESS became President and Chief Executive Officer of the Company on May 31, 1995 and Chairman of the Board of the Company upon consummation of the Merger. Prior to the Merger, Mr. Sturgess served as Chairman of the Board and Chief Executive Officer of Associated since January 1992 and had been Chairman of the Board and Chief Executive Officer of ASI since December 1994. Since 1987, Mr. Sturgess has served as a general partner of various Wingate entities, including the indirect general partner of each of Wingate Partners and Wingate II. Mr. Sturgess has not actively participated in the management of Wingate Partners or the Wingate entities since December 31, 1995. Mr. Sturgess currently serves as a non-executive Chairman of the Board of Redman Industries, Inc., a manufactured housing producer (\"Redman\"), as well as RBPI Holding Corporation, a manufacturer and distributor of aluminum and vinyl windows. He is a director of Loomis Armored Inc., a provider of armored car and related services (\"Loomis\"), and Century Products Company, a manufacturer and distributor of baby seats and other juvenile products (\"Century Products\").\nMICHAEL D. ROWSEY was elected to the Board of Directors upon consummation of the Merger and became Executive Vice President of the Company upon consummation of the Merger with primary responsibility for field operations. Prior to the Merger, Mr. Rowsey had been a director of Associated since 1992 and President and Chief Operating Officer of Associated since January 1992. From 1979 to January 1992, Mr. Rowsey served in various capacities with BCOP, most recently as the North Regional Manager.\nDANIEL H. BUSHELL became Executive Vice President and Chief Financial Officer of the Company upon consummation of the Merger. Mr. Bushell has served as Assistant Secretary of the Company since January 1996, and served as Secretary of the Company from June 1995 through such date. Mr. Bushell also served as Assistant Secretary of the Company from the consummation of the Merger until June 1995. Prior thereto, Mr. Bushell had been Chief Administrative and Chief Financial Officer of Associated and ASI since January 1992. From 1978 to January 1992, Mr. Bushell served in various capacities with ACE Hardware Corporation, most recently as Vice President of Finance.\nSTEVEN R. SCHWARZ became Executive Vice President of the Company upon consummation of the Merger with primary responsibility for marketing and merchandising. Prior thereto, he was Senior Vice President, Marketing of United since June 1992 and had previously been Senior Vice President, General Manager, MicroUnited since 1990 and Vice President, General Manager, MicroUnited since September 1989. He had held a staff position in the same capacity since February 1987.\nROBERT H. CORNELL became Vice President, Human Resources of the Company upon consummation of the Merger. Prior thereto, he was Vice President, Human Resources of United since February 1988, and since 1987 had been Vice President, Human Resources for USG Interiors Inc., a subsidiary of USG Corporation.\nOTIS H. HALLEEN became Vice President, Secretary and General Counsel of the Company as of January 30, 1996. Since November 1, 1995 he has served as Vice President, Secretary and General Counsel at USSC. From 1986 through March 1995 he had been Vice President, Secretary and General Counsel of United.\nJAMES A. PRIBEL became Treasurer of the Company upon consummation of the Merger. Prior thereto, he was Treasurer of United since 1992. Prior thereto he had been Assistant Treasurer of USSC since 1984 and had served in various positions since joining USSC in 1978.\nTED S. RZESZUTO became Vice President and Controller of the Company upon consummation of the Merger. Prior thereto, he was Vice President and Controller of United since 1987 and Controller of United since 1985 and prior thereto had served in various accounting positions since joining USSC in 1975.\nALBERT SHAW became Vice President, Operations of the Company shortly after consummation of the Merger. Prior thereto, he was Vice President, Midwest Region of USSC since March 1994. He had been a Vice President of USSC since 1992 and prior to that had served in various management positions since joining USSC in 1974.\nERGIN USKUP became Vice President, Management Information Systems and Chief Information Officer of the Company upon consummation of the Merger. Prior thereto, he was Vice President, Management Information Systems and Chief Information Officer of United since February 1994, and since 1987 had been Vice President, Corporate Information Services for Baxter International Inc., a global manufacturer and distributor of health care products.\nGARY G. MILLER was elected to the Board of Directors upon consummation of the Merger and became Assistant Secretary of the Company on June 27, 1995. Mr. Miller served as Vice President and Secretary of the Company from consummation of the Merger until June 27, 1995. Prior thereto, Mr. Miller had been a director of Associated since 1992 and Vice President and Secretary of Associated since January 1992. Mr. Miller also currently serves as President of Cumberland, a private investment firm which is located in Fort Worth, Texas. In addition, from 1977 to December 1993, Mr. Miller served as Executive Vice President, Chief Financial Officer and a director of AFG Industries, Inc., and its parent company, Clarity Holdings Corp. He is Chairman of the Board of both CFData Corp., a nationwide\nprovider of check collection and check verification services, and Fore Star Golf, Inc., which was formed in 1993 to own and operate golf course facilities.\nJAMES T. CALLIER, JR. was elected to the Board of Directors upon consummation of the Merger. Prior to the Merger, he had been a director of Associated since 1992. Mr. Callier is a general partner of Wingate Partners, and has served as President of Callier Consulting, Inc., an operating management firm, since 1985. Mr. Callier currently serves as Chairman of the Board of Century Products, as a director of Redman and Loomis and as an advisory director of Wingate II.\nDANIEL J. GOOD was elected to the Board of Directors upon consummation of the Merger. Prior to the Merger, he had been a director of Associated since 1992. Mr. Good is Chairman of Good Capital Co., Inc. (\"Good Capital\"), an investment firm in Lake Forest, Illinois. Until June 1995, Mr. Good was Vice Chairman of Golden Cat Corp., the largest producer of cat litter in the United States, and prior thereto he was Managing Director of Merchant Banking for Shearson Lehman Bros. and President of A.G. Becker Paribas, Inc. Mr. Good serves as a director of Supercuts, Inc.\nFREDERICK B. HEGI, JR. was elected to the Board of Directors upon consummation of the Merger. Prior to the Merger, he had been a director of Associated since 1992. Mr. Hegi is a general partner of various Wingate entities, including the indirect general partner of each of Wingate Partners and Wingate II. Since May 1982, Mr. Hegi has served as President of Valley View Capital Corporation, a private investment firm. Mr. Hegi also currently serves as Chairman of the Board of Loomis Holding Corporation, the parent corporation of Loomis, ITCO Holding Company, Inc., the parent corporation of ITCO Tire Company, Tahoka First Bancorp, Inc., a bank holding company, and Cedar Creek Bancshares, Inc., a bank holding company, and as a director of Century Products, Lone Star Technologies, Inc., a diversified company engaged in the manufacturing of steel pipe, Cattle Resources, Inc., a manufacturer of animal feeds and operator of commercial cattle feedlots and various funds managed by InterWest Partners.\nJEFFREY K. HEWSON was elected to the Board of Directors in 1991. Mr. Hewson served as President and Chief Executive Officer of the Company from consummation of the Merger until May 31, 1995. Prior thereto, he was President and Chief Operating Officer of United since April 1991. He had been Executive Vice President of United since March 1990. Prior to that, he had been President of ACCO International's U.S. Division since 1989 and President of its Canadian Division since 1987. ACCO International is a manufacturer of traditional office products and a subsidiary of American Brands, Inc., which is a global consumer products holding company. Mr. Hewson currently serves as President and Chief Executive Officer of Beckley-Cardy, distributor of supplies, furniture and equipment to the educational market.\nJAMES A. JOHNSON was elected to the Board of Directors upon consummation of the Merger. Prior to the Merger, he had been a director of Associated since 1992. Mr. Johnson is a general partner of various Wingate entities, including the indirect general partner of Wingate II. From 1980 until he joined Wingate Partners in 1990, Mr. Johnson served as a Principal of Booz-Allen & Hamilton, an international management consulting firm. Mr. Johnson currently serves as a director of Century Products.\nJOEL D. SPUNGIN has served as a member of the Board of Directors since 1972 and prior to the consummation of the Merger was Chairman of the Board of Directors and Chief Executive Officer of United since August 1988. From October 1989 until April 1991, he was also President of United. Prior to that, since March 1987, Mr. Spungin was Vice Chairman of the Board and Chief Executive Officer of United. Previously, since August 1981, Mr. Spungin was President and Chief Operating Officer of United. He also serves as a general partner of DMS Enterprises, L.P., a management advisory and investment partnership, and as a director of AAR Corp.\nMessrs. Sturgess, Rowsey, Miller, Callier, Good, Hegi and Johnson were elected to the Board of Directors pursuant to a voting trust.\nThe Charter provides that the Board of Directors shall be divided into three classes, each class as nearly equal in number as possible, and each term consisting of three years. The directors currently in each class are as follows: Class I (having terms expiring in 1996)--Messrs. Good, Johnson and Hewson; Class II (having terms expiring in 1997)--Messrs. Sturgess, Hegi and Rowsey; and Class III (having\nterms expiring in 1998)--Messrs. G. Miller, Callier and Spungin.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nIncorporated herein by reference, pursuant to General Instruction G(3) to Form 10-K, from the Registrant's definitive Proxy Statement for the Annual Meeting of Stockholders scheduled to be held on May 8, 1996, to be filed within 120 days after the end of the Registrant's fiscal year.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nIncorporated herein by reference, pursuant to General Instruction G(3) to Form 10-K, from the Registrant's definitive Proxy Statement for the Annual Meeting of Stockholders scheduled to be held on May 8, 1996, to be filed within 120 days after the end of the Registrant's fiscal year.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nIncorporated herein by reference, pursuant to General Instruction G(3) to Form 10-K, from the Registrant's definitive Proxy Statement for the Annual Meeting of Stockholders scheduled to be held on May 8, 1996, to be filed within 120 days after the end of the Registrant's fiscal year.\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K\n(A) The following financial statements, schedules and exhibits are filed as part of this report:\n(3) Exhibits (numbered in accordance with Item 601 of Regulation S-K)\nB) No reports on Form 8-K were filed by the Registrant during the last quarter.\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 Statement on Form S-8 No. 3332453 (filed December 6, 1989).\nInsofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the registrant pursuant to the foregoing provisions, or otherwise, the registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act of 1933 and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the 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 STATIONERS INC.\nBY: \/s\/Ted S. Rzeszuto -------------------------------------- Ted S. Rzeszuto Vice President and Controller (principal accounting officer) Dated: March 28, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, 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":"752290_1995.txt","cik":"752290","year":"1995","section_1":"Item 1. Business\nGeneral\nUnimar Company (the Company) was organized as a general partnership in 1984 under the Texas Uniform Partnership Act. The partners are LASMO (Ustar), Inc. (Ustar), a Delaware corporation and an indirect, wholly owned subsidiary of LASMO plc (LASMO), a public limited company organized under the laws of England, and Unistar, Inc. (Unistar), a Delaware corporation and a direct subsidiary of Union Texas Petroleum Holdings, Inc. (UTPH), a publicly-traded Delaware corporation.\nThe Company's sole business is its ownership of ENSTAR Corporation (ENSTAR) which, through its wholly-owned subsidiaries, Virginia International Company (INTERNATIONAL) and Virginia Indonesia Company (VICO), has a 23.125 percent working interest in, and is the operator of, a joint venture (the Joint Venture) for the exploration, development and production of oil and natural gas (gas) in East Kalimantan, Indonesia, under a production sharing contract (Production Sharing Contract or PSC) with Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (Pertamina), the state petroleum enterprise of the Republic of Indonesia. The majority of the revenue derived from the Joint Venture results from the sale of liquefied natural gas (LNG). Currently, the LNG is sold to utility and industrial companies in Japan, Taiwan and South Korea. See \"The Joint Venture\" below.\nEffective April 1, 1996, the principal executive offices of the Company will move to 1221 McKinney, Suite 700, Houston, Texas 77010-2015 and its telephone number will be (713) 754-6650. A Management Board consisting of six members, three appointed by each partner, exercises management, budgeting and financial control of the Company. As of December 31, 1995, VICO, in its capacity as the Joint Venture operator, had approximately 2,000 employees in the United States and Indonesia. The Company presently does not have any other employees. All aspects of the Company's business that are not associated with the management of the Joint Venture, such as operations, legal, accounting, tax and other management functions, are supplied either by VICO or employees of the partners in accordance with management agreements.\nThe Company can give no assurance as to the future trend of its business and earnings, or as to future events and developments that could affect the Company in particular or the oil industry in general. These include such matters as environmental quality control standards, new discoveries of hydrocarbons, and the demand for petroleum products. Furthermore, the Company's business could be materially affected by future events including price changes or controls, payment delays, increased expenditures, legislation and regulations affecting the Company's business, expropriation of assets, renegotiation of contracts with foreign governments, political instability, currency exchange and repatriation losses, taxes, litigation, the competitive environment, and international economic and political developments including actions of members of the Organization of Petroleum Exporting Countries (OPEC). See Item 7","section_1A":"","section_1B":"","section_2":"","section_3":"","section_4":"","section_5":"","section_6":"","section_7":"","section_7A":"","section_8":"","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures.\nSee Item 14(b).\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant.\nThe management, budgeting and financial control of the Company's interest in the Indonesian Joint Venture operations are exercised by a Management Board consisting of six members, three appointed by each partner. The following persons currently serve as members of the Company's Management Board:\nGEORGE W. BERKO (age 49) was appointed to the Company's Management Board in May 1992. In January 1996 he was appointed Controller of VICO. Since May 1992, he has served as the Partners' representative for Investor Relations, Treasurer and Chief Financial and Accounting Officer of ENSTAR, ENSTAR Indonesia, Inc., INTERNATIONAL, and certain of their subsidiaries, and has been LASMO America Ltd.'s Vice President - Unimar Accounting. From October 1990 until April 1992, he was Vice President, Controller of Ultramar Oil and Gas Limited, and prior to that time, he was a General Manager of American Ultramar Ltd. from December 1984.\nIAN D. BROWN (age 46) was appointed to the Company's Management Board in February 1993. He is also Director and Chairman of ENSTAR and certain of its affiliates. Since October 1995 he has been Director of Pakistan LNG Development for LASMO. From January 1994 to September 1995 he served as President and General Manager of LASMO Companies in Indonesia. In January 1993, he was appointed Director, Indonesian Joint Venture for LASMO plc and a member of the VICO Board. Since May 1986, he served as Commercial Manager for LASMO plc, and from February 1987, Managing Director, LASMO Trading Limited, the marketing, trading and transportation affiliates of the parent company.\nLARRY D. KALMBACH (age 44) was appointed to the Company's Management Board in February 1993. He is also a Director of ENSTAR and certain of its affiliates. Since February 1995 he has been Vice President and Chief Financial Officer of UTPH. Prior to that he held several executive and management positions with UTPH including Vice President - Finance from 1993 to 1995 and Vice President and Controller from 1986 to 1993.\nWILLIAM M. KRIPS (age 56) was appointed to the Company's Management Board in January 1987 and in May 1994 was appointed Chairman of the Management Board. He is also a Director of ENSTAR and certain of its affiliates. Since 1994, he has been Senior Vice President of UTPH. Prior to that time, he has served as Senior Vice President - Exploration & Production, Senior Vice President and General Manager - U. S. Exploration and Production, Senior Vice President and General Manager - Hydrocarbon Products Group and Vice President and General Manager - International Operations.\nARTHUR W. PEABODY, JR. (age 52) was appointed to the Company's Management Board in February 1992. He is also a Director of ENSTAR, ENSTAR Indonesia, Inc., International and VICO. Since May 1994, he has served as Senior Vice President of UTPH and has held several executive positions with UTPH including Senior Vice President - Exploration and Production, Senior Vice President and General Manager - Hydrocarbon Products Group, Vice President - Planning and Administration and Vice President - Acquisitions and Planning.\nRICHARD L. SMERNOFF (age 54) was appointed to the Company's Management Board in July 1995. He is also a Director of ENSTAR, ENSTAR Indonesia, Inc., INTERNATIONAL and VICO. Since March 1, 1994 he has served as Finance Director of LASMO. He has spent some fourteen years in senior finance positions in the oil and gas industry, most recently as Senior Vice President with Amerada Hess Corporation in the United States. Prior to joining the Company he was Chief Financial Officer of Datascope Corp.\nAs set forth above, control of the Company's operations is exercised by the Management Board. The Company, a Texas general partnership, does not have any Executive Officers.\nItem 11.","section_11":"Item 11. Executive Compensation.\nThe Company has no executive officers, and no members of the Management Board are paid directly by the Company. All members of the Management Board are full-time employees of UTPH or LASMO, or their respective subsidiaries, and do not receive from the Company any remuneration for their services to the Company. Moreover, the Company has no employees who are compensated for their services to the Company. VICO and its subsidiaries, have employees who are responsible for the daily operating activities of the Joint Venture and are compensated by the Joint Venture. See Item 13 below for information concerning the Company's reimbursement to LASMO for services rendered to the Company by one of LASMO's designees on the Management Board.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nThe Company is a Texas general partnership and as such has no voting securities apart from the general partnership interests owned by the partners. The table below reflects the beneficial ownership of 100 percent of the partnership interests in the Company as of March 15, 1996:\nName and Address of Amount Beneficially Title of Class Beneficial Owner Owned\nGeneral Partnership LASMO plc 50% Interest 100 Liverpool Street London EC2M 2BB England\nName and Address of Amount Beneficially Title of Class Beneficial Owner Owned\nGeneral Partnership Union Texas Petroleum 50% Interest Holdings, Inc. 1330 Post Oak Boulevard Houston, Texas 77252\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nThe partners of the Company provide management expertise, office space, and administrative, legal and professional services. For such services, a management fee of approximately $455 and $434 was charged in 1995 and 1994, respectively, including $147 ($109 in 1994) paid in respect of Mr. Berko's services.\nThe Company holds demand notes in the amount of $40 million from or generated by affiliates of each partner. These funds will be made available to the Company if additional working capital is required.\nAs operator of the Joint Venture, VICO conducts exploration and development activities within the PSC area. The cost of such activities is funded by the Joint Venture participants to VICO. In addition, VICO performs engineering, pipeline maintenance and human resource related services for the operator of the LNG Plant, P.T. Badak Natural Gas Liquefaction Company (P.T. Badak). For the year ended December 31, 1995 and 1994 VICO billed P.T. Badak $20.2 million and $21.8 million respectively for services rendered. Accounts receivable from P.T. Badak approximated $2.3 million at December 31, 1995 ($2.4 million 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 listed below are included as Part II, Item 8 hereof on the pages indicated:\nIndependent Auditors' Report 26\nReport of Independent Auditors 27\nConsolidated Balance Sheet, December 31, 1995 and 1994 28\nConsolidated Statement of Earnings, Years ended December 31, 1995, 1994 and 1993 29\nConsolidated Statement of Cash Flows, Years ended December 31, 1995, 1994 and 1993 30\nConsolidated Statement of Changes in Partners' Capital, Years ended December 31, 1995, 1994 and 1993 31\nNotes to Consolidated Financial Statements 32-45\nSupplemental Financial Information (unaudited) 46-52\nAll schedules are omitted as they are not applicable.\n(a)(3) The following documents are included as Exhibits to this Report. Unless it has been indicated that a document listed below is incorporated by reference herein, copies of the document have been filed herewith.\n(2)-1- Merger Agreement, dated May 22, 1984, and Amendment Agreements thereto, dated June 8, 1984 and June 12, 1984 (incorporated by reference to Annex A to the Prospectus\/Proxy Statement included in the Company's Registration Statement on Form S-14 (No. 2-93037)).*\n(2)-2- Agreement of Merger, dated as of August 28, 1984 (incorporated by reference to Annex B to the Prospectus\/Proxy Statement included in the Company's Registration Statement on Form S-14 (No. 2-93037)).*\n(2)-3- Divestiture Agreement, dated June 20, 1984 (filed as Exhibit 2.3 to the Company's Registration Statement on Form S-14 (No. 2-93037)).*\n(3)-1- Amended and Restated Agreement of General Partnership of Unimar Company dated September 11, 1990 between Unistar, Inc. and Ultrastar, Inc. (filed as Exhibit (3)-4- to the Company's 1990 Form 10-K (No. 18791)).*\n(4)-1- Form of Indenture between Unimar and Irving Trust Company, as Trustee (filed as Exhibit 4 to the Company's Registration Statement on Form S-14 (No. 2-93037)).*\n(4)-2- First Supplemental Indenture, dated as of October 31, 1986, to the Indenture between Unimar and Irving Trust Co., as Trustee (Exhibit (4)-1 above) (filed as Exhibit 10.114 to Union Texas Petroleum Holdings, Inc.'s Registration Statement on Form S-1 (No. 33- 16267)).*\n(10)-1- Joint Venture Agreement, dated August 8, 1968, among Roy M. Huffington, Inc., Virginia International Company, Austral Petroleum Gas Corporation, Golden Eagle Indonesia, Limited, and Union Texas Far East Corporation, as amended (filed as Exhibit 6.6 to Registration Statement No. 2-58834 of Alaska Interstate Company).*\n(10)-2- Agreement dated as of October 1, 1979, among the parties to the Joint Venture Agreement referred to in Exhibit (10)-1- above (filed as Exhibit 5.2 to Registration Statement No. 2-66661 of Alaska Interstate Company).*\n* Incorporated herein by reference.\n(10)-3- Amendment to the Operating Agreement dated April 1, 1990, between Roy M. Huffington, Inc., a Delaware corporation, Ultramar Indonesia Limited, a Bermuda corporation, Virginia Indonesia Company, a Delaware corporation, Virginia International Company, a Delaware corporation, Union Texas East Kalimantan Limited, a Bahamian corporation, and Universe Gas & Oil Company, Inc., a Liberian corporation. (filed as Exhibit (10)-3- to the Company's 1993 Form 10-K (No. 1-8791)).*\n(10)-4- Amended and Restated Production Sharing Contract dated April 23, 1990 (effective August 8, 1968 - August 7, 1998) by and between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (Pertamina) and Roy M. Huffington, Inc., Virginia International Company, Virginia Indonesia Company, Ultramar Indonesia Limited, Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc. and Huffington Corporation. (filed as Exhibit (10)-4- to the Company's 1993 Form 10-K (No. 1-8791)).*\n(10)-5- Production Sharing Contract dated April 23, 1990 (effective August 8, 1998 - August 7, 2018) between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (Pertamina) and Roy M. Huffington, Inc., Virginia International Company, Virginia Indonesia Company, Ultramar Indonesia Limited, Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc. and Huffington Corporation. (filed as Exhibit (10)- 5- to the Company's 1993 Form 10-K (No. 1-8791)).*\n(10)-6- Nilam Unit Agreement, effective as of January 1, 1980, to establish the manner in which the Joint Venture and Total will cooperate to develop the unitized area of the Nilam Field.\n(10)-7- Fourth Amended and Restated Implementation Procedures for Crude Oil Liftings, effective as of July 1, 1993, among Virginia Indonesia Company, LASMO Sanga Sanga Limited, Opicoil Houston, Inc., Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc. and Virginia International Company. (filed as Exhibit (10)-7- to the Company's 1994 Form 10-K (No. 1-8791)).*\n* Incorporated herein by reference.\n(10)-8- Amended and Restated 1973 LNG Sales Contract, dated as of the 1st day of January 1990, by and between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, as Seller, and Chubu Electric Power Co., Inc., The Kansai Electric Power Co., Inc., Kyushu Electric Power Co., Inc., Nippon Steel Corporation, Osaka Gas Co., Ltd. and Toho Gas Co., Ltd., as Buyers. (filed as Exhibit (10)-8- to the Company's 1993 Form 10-K (No. 1-8791)).*\n(10)-9- Amendment to the 1973 LNG Sales Contract dated as of the 3rd day of December, 1973, amended by Amendment No. 1 dated as of the 31st day of August, 1976, and amended and restated as of the 1st day of January, 1990 (\"1973 LNG Sales Contract\"), is entered into as of the 1st day of June, 1992, by and between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, a state enterprise of the Republic of Indonesia (Seller), on the one hand, and Kyushu Electric Power Co., Inc. (Kyushu Electric), Nippon Steel Corporation (Nippon Steel), and Toho Gas Co., Ltd. (Toho Gas), all corporations organized and existing under the laws of Japan, on the other hand. (filed as Exhibit (10)-9- to the Company's 1993 Form 10-K (No. 1-8791)).*\n(10)-10- Amended and Restated Supply Agreement (In Support of the Amended and Restated 1973 LNG Sales Contract) between Pertamina and Virginia Indonesia Company, LASMO Sanga Sanga Limited, Opicoil Houston, Inc., Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc., and Virginia International Company dated September 22, 1993, effective December 3, 1973. (filed as Exhibit (10)-10- to the Company's 1993 Form 10-K (No. 1-8791)).*\n(10)-11- Amended and Restated Badak LNG Sales Contract, dated as of the 1st day of January, 1990, by and between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, as Seller, and Chubu Electric Power Co., Inc., The Kansai Electric Power Co., Inc., Osaka Gas Co., Ltd. and Toho Gas Co., Ltd., as Buyers. (filed as Exhibit (10)-11- to the Company's 1993 Form 10-K (No. 1- 8791)).*\n(10)-12- Supply Agreement, dated as of April 14, 1981 between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (Pertamina) and the parties to the Joint Venture Agreement, including the Company. (filed as Exhibit (10)-12- to the Company's 1993 Form 10-K (No. 1- 8791)).*\n* Incorporated herein by reference.\n(10)-13- Seventh Supply Agreement for Excess Sales (Additional Fixed Quantities under Badak LNG Sales Contract as a Result of Contract Amendment and Restatement) between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara and Virginia Indonesia Company, Opicoil Houston, Inc., Ultramar Indonesia Limited, Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc. and Virginia International Company, dated September 28, 1992, but effective as of January 1, 1990. (filed as Exhibit (10)-13- to the Company's 1993 Form 10-K (No. 1-8791)).*\n(10)-14- Bontang II Trustee and Paying Agent Agreement Amended and Restated as of July 15, 1991 among Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, Virginia Indonesia Company, Virginia International Company, Union Texas East Kalimantan Limited, Ultramar Indonesia Limited, Opicoil Houston, Inc., Universe Gas & Oil Company, Inc., Total Indonesie, Unocal Indonesia, Ltd., Indonesia Petroleum, Ltd. and Continental Bank International. (filed as Exhibit (10)-14- to the Company's 1993 Form 10-K (No. 1-8791)).*\n(10)-15- Producers Agreement No. 2 dated as of June 9, 1987 by Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (Pertamina), Roy M. Huffington, Inc., Virginia International Company, Ultramar Indonesia Limited, Virginia Indonesia Company, Union Texas East Kalimantan Limited, Universe Tankships, Inc., Huffington Corporation in favor of The Industrial Bank of Japan Trust Company as Agent (filed as Exhibit (10)-30- to the Company's 1987 Form 10-K (No. 1-8791)).*\n(10)-16- Badak III LNG Sales Contract between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (Pertamina) as Seller and Chinese Petroleum Corporation as Buyer signed on March 19, 1987. (filed as Exhibit (10)- 16- to the Company's 1994 Form 10-K (No. 1-8791)).*\n(10)-17- Badak III LNG Sales Contract Supply Agreement, dated October 19, 1987 among Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (Pertamina) and the parties to the Joint Venture Agreement. (filed as Exhibit (10)-17- to the Company's 1993 Form 10-K (No. 1-8791)).*\n(10)-18- LNG Sales and Purchase Contract (Korea II) effective May 7, 1991 between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara and Korea Gas Corporation. (filed as Exhibit (10)-18- to the Company's 1993 Form 10-K (No. 1-8791)).*\n* Incorporated herein by reference.\n(10)-19- Schedule A to the LNG Sales and Purchase Contract (Korea II FOB) between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara and Korea Gas Corporation. (filed as Exhibit (10)-19- to the Company's 1993 Form 10-K (No. 1-8791)).*\n(10)-20- Bontang III Producers Agreement, dated February 9, 1988, among Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (Pertamina) and the parties to the Joint Venture Agreement. (filed as Exhibit (10)-20- to the Company's 1993 Form 10-K (No. 1-8791)).*\n(10)-21- Amendment No. 1 to Bontang III Producers Agreement dated as of May 31, 1988 among Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, Roy M. Huffington, Inc., Huffington Corporation, Virginia International Company, Virginia Indonesia Company, Ultramar Indonesia Limited, Union Texas East Kalimantan Limited, Universe Tankships, Inc., Total Indonesie, Unocal Indonesia, Ltd., Indonesia Petroleum, Ltd. and Train-E Finance Co., Ltd., as Tranche A Lender, The Industrial Bank of Japan Trust Company, as Agent and The Industrial Bank of Japan Trust Company on behalf of the Tranche B Lenders. (filed as Exhibit (10)-21- to the Company's 1993 Form 10-K (No. 1-8791)).*\n(10)-22- $316,000,000 Bontang III Loan Agreement dated February 9, 1988 among Continental Bank International as Trustee, Train-E Finance Co., Ltd. as Tranche A Lender and The Industrial Bank of Japan Trust Company as Agent. (filed as Exhibit (10)-23- to the Company's 1993 Form 10-K (No. 1-8791)).*\n(10)-23- Bontang III Trustee and Paying Agent Agreement, dated February 9, 1988, among Pertamina, Roy M. Huffington, Inc., Huffington Corporation, Virginia International Company, VICO, Ultrastar Indonesia Limited, Union Texas East Kalimantan Limited, Universe Tankships, Inc., Total Indonesia, Unocal Indonesia, Ltd., Indonesia Petroleum, Ltd. and Continental Bank International (filed as Exhibit 10.42 to the Union Texas Petroleum Holdings, Inc.'s 1991 Form 10-K (Commission File No. 1-9019)).*\n* Incorporated herein by reference.\n(10)-24- Amendment No. 1 to Bontang III Trustee and Paying Agent Agreement, dated as of December 11, 1992, among Pertamina, VICO, Virginia International Company, Ultramar Indonesia Limited, Union Texas East Kalimantan Limited, Opicoil Houston, Inc., Universe Gas & Oil Company, Inc., Total Indonesia, Unocal Indonesia Ltd., Indonesia Petroleum, Ltd. and Continental Bank International, as Bontang III Trustee (filed as Exhibit 10.83 to the Union Texas Petroleum Holdings, Inc.'s 1992 Form 10-K (Commission File No. 1-9019)).*\n(10)-25- Amended and Restated Debt Service Allocation Agreement dated February 9, 1988 among Perusahaan Pertambangan Minyak Dan Gas Bumi Negara and Roy M. Huffington, Inc., Virginia International Company, Ultramar Indonesia Limited, Virginia Indonesia Company, Union Texas East Kalimantan Limited, Universe Tankships, Inc., Huffington Corporation, Total Indonesie, Unocal Indonesia, Ltd. and Indonesia Petroleum, Ltd. (filed as Exhibit (10)- 26- to the Company's 1994 Form 10-K (No. 1-8791)).*\n(10)-26- Letter agreement between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara and Chinese Petroleum Corporation, dated December 1, 1989. (filed as Exhibit (10)-27- to the Company's 1993 Form 10-K (No. 1-8791)).*\n(10)-27- Badak IV LNG Sales Contract dated October 23, 1990 between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (Pertamina), as Seller and Osaka Gas Co., Ltd., Tokyo Gas Co., Ltd. and Toho Gas Co., Ltd., as Buyers. (filed as Exhibit (10)-29- to the Company's 1993 Form 10-K (No. 1-8791)).*\n(10)-28- LNG Sales Contract dated as of October 13, 1992 between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, as Seller and Hiroshima Gas Co., Ltd. and Nippon Gas Co., Ltd., as Buyers. (filed as Exhibit (10)-30- to the Company's 1993 Form 10-K (No. 1- 8791)).*\n(10)-29- LNG Sales Contract dated as of October 13, 1992 between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, as Seller and Osaka Gas Co., Ltd., as Buyer. (filed as Exhibit (10)-31- to the Company's 1993 Form 10-K (No. 1-8791)).*\n* Incorporated herein by reference.\n(10)-30- Supply Agreement for Natural Gas to Badak IV LNG Sales Contract dated August 12, 1991 between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, Virginia Indonesia Company, Opicoil Houston, Inc., Ultramar Indonesia Limited, Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc. and Virginia International Company. (filed as Exhibit (10)-32- to the Company's 1993 Form 10-K (No. 1-8791)).*\n(10)-31- Second Supply Agreement for Package IV Excess Sales (Osaka Gas Contract - Package IV Quantities) between Pertamina and Virginia Indonesia Company, LASMO Sanga Sanga Limited, Opicoil Houston, Inc., Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc., and Virginia International Company dated September 22, 1993, effective January 1, 1991. (filed as Exhibit (10)-33- to the Company's 1993 Form 10-K (No. 1-8791)).*\n(10)-32- Third Supply Agreement for Package IV Excess Sales (Toho Gas Contract - Package IV Quantities) between Pertamina and Virginia Indonesia Company, LASMO Sanga Sanga Limited, Opicoil Houston, Inc., Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc., and Virginia International Company dated September 28, effective January 1, 1991. (filed as Exhibit (10)-34- to the Company's 1993 Form 10-K (No. 1-8791)).*\n(10)-33- Eleventh Supply Agreement for Package IV Excess Sales (1973 Contract Build-Down Quantities) between Pertamina and Virginia Indonesia Company, LASMO Sanga Sanga Limited, Opicoil Houston, Inc., Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc., and Virginia International Company dated September 22, 1993, effective January 1, 1990. (filed as Exhibit (10)-35- to the Company's 1993 Form 10-K (No. 1-8791)).*\n(10)-34- Bontang IV Producers Agreement dated August 26, 1991 by Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, Virginia Indonesia Company, Opicoil Houston, Inc., Virginia International Company, Ultramar Indonesia Limited, Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc., Total Indonesie, Unocal Indonesia, Ltd. and Indonesia Petroleum, Ltd., in favor of The Chase Manhattan Bank, N.A. as Agent for the Lenders. (filed as Exhibit (10)-36- to the Company's 1993 Form 10-K (No. 1-8791)).*\n* Incorporated herein by reference.\n(10)-35- $750,000,000 Bontang IV Loan Agreement dated August 26, 1991 among Continental Bank International as Trustee under the Bontang IV Trustee and Paying Agent Agreement as Borrower, Chase Manhattan Asia Limited and The Mitsubishi Bank, Limited as Coordinators, the other banks and financial institutions named herein as Arrangers, Co- Arrangers, Lead Managers, Managers, Co-Managers and Lenders, The Chase Manhattan Bank, N.A. and the Mitsubishi Bank, Limited as Co-Agents and The Chase Manhattan Bank, N.A. as Agent. (filed as Exhibit (10)-37- to the Company's 1993 Form 10-K (No. 1- 8791)).*\n(10)-36- Bontang IV Trustee and Paying Agent Agreement dated August 26, 1991 among Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, Virginia Indonesia Company, Opicoil Houston, Inc., Virginia International Company, Ultramar Indonesia Limited, Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc., Total Indonesie, Unocal Indonesia, Ltd., Indonesia Petroleum, Ltd. and Continental Bank International. (filed as Exhibit (10)-38- to the Company's 1993 Form 10-K (No. 1-8791)).*\n(10)-37- Amended and Restated Bontang Processing Agreement dated February 9, 1988 among Perusahaan Pertambangan Minyak Dan Gas Bumi Negara and Roy M. Huffington, Inc., Huffington Corporation, Virginia International Company, Virginia Indonesia Company, Ultramar Indonesia Limited, Union Texas East Kalimantan Limited, Universe Tankships, Inc., Total Indonesie, Unocal Indonesia, Ltd., Indonesia Petroleum, Ltd. and P.T. Badak Natural Gas Liquefaction Company (filed as Exhibit (10)-39- to the Company's 1988 Form 10-K (No. 1-8791)).*\n(10)-38- Bontang LPG Sales and Purchase Contract between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, as Seller, and National Federation of Agricultural Co-Operative Associations (Zen-Noh), as Buyer, dated February 21, 1992. (filed as Exhibit (10)-42- to the Company's 1993 Form 10-K (No. 1-8791)).*\n(10)-39- Bontang LPG Sales and Purchase Contract between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, as Seller, and Japan Indonesia Oil Co., Ltd., as Buyer, dated February 20, 1992. (filed as Exhibit (10)-43- to the Company's 1993 Form 10-K (No. 1- 8791)).*\n* Incorporated herein by reference.\n(10)-40- Arun and Bontang LPG Sales and Purchase Contract between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (Pertamina) as Seller and Mitsubishi Corporation, Cosmo Oil Co., Ltd., Nippon Petroleum Gas Co., Ltd., Showa Shell Sekiyu K.K., Kyodo Oil Co., Ltd., Idemitsu Kosan Co., Ltd. and Mitsui Liquefied Gas Co., Ltd. as Buyers dated July 15, 1986. (filed as Exhibit (10)-42- to the Company's 1994 Form 10-K (No. 1-8791)).*\n(10)-41- Amendments to Arun and Bontang LPG Sales and Purchase Contract, dated October 5, 1994, between Pertamina, as Seller, and Mitsubishi Corporation, Cosmo Oil Co., Ltd., Nippon Petroleum Gas Co., Ltd., Showa Shell Sekiyu K.K., Japan Energy Corporation, Idemitsu Kosan Co., Ltd., and Mitsui Oil & Gas Co., Ltd., as Buyers. (filed as Exhibit 10.88 to the Union Texas Petroleum Holdings, Inc.'s 1994 Form 10- K (Commission File No. 1-9019)).*\n(10)-42- Bontang LPG Supply Agreement, dated November 17, 1987, between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (Pertamina) and the parties to the Joint Venture Agreement. (filed as Exhibit (10)-45- to the Company's 1993 Form 10-K (No. 1-8791)).*\n(10)-43- Advance Payment Agreement between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (Pertamina) and Arun Bontang Project Finance Co., Ltd., dated February 16, 1987 (filed as Exhibit (4)-15- to the Company's 1986 Form 10-K (No. 1-8791)).*\n(10)-44- Agreement and Plan of Reorganization of ENSTAR Corporation, dated December 22, 1989, by and among Unimar Company, Ultrastar, Inc., Unistar, Inc., ENSTAR Corporation, Newstar Inc., Union Texas Development Corporation, Union Texas Petroleum Corporation and Ultramar America Limited. (filed as Exhibit (10)-47- to the Company's 1993 Form 10-K (No. 1-8791)).*\n(10)-45- Amendment to Agreement and Plan of Reorganization of ENSTAR Corporation, dated May 1, 1990, by and among Unimar Company, Ultrastar, Inc., Unistar, Inc., ENSTAR Corporation, Ultramar Production Company, Union Texas Development Corporation, Union Texas Petroleum Corporation and Ultramar America Limited. (filed as Exhibit (10)-48- to the Company's 1993 Form 10-K (No. 1-8791)).*\n* Incorporated herein by reference.\n(10)-46- Addendum to Badak IV LNG Sales Contract Supply Agreement (effective October 23, 1990), dated January 31, 1994, by and between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (\"Pertamina\") and Virginia Indonesia Company (\"VICO\"), LASMO Sanga Sanga Limited, Opicoil Houston, Inc., Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc., and Virginia International Company. (filed as Exhibit (10)-48- to the Company's 1994 Form 10-K (No. 1-8791)).*\n(10)-47- Memorandum of Agreement for Purchase and Sale of LNG During 1995 - 1999 between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (\"Pertamina\") (\"Seller\") and Korea Gas Corporation (\"KGC\") (\"Buyer\") for the sale and purchase of certain quantities of LNG. (filed as Exhibit (10)-49- to the Company's 1994 Form 10-K (No. 1-8791)).*\n(10)-48- Second Amended and Restated 1973 LNG Sales Contract, dated as of August 3, 1995 between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (\"Pertamina\"), as Seller, and Chubu Electric Power Co., Inc., The Kansai Electric Power Co., Inc\/. Kyushu Electric Power Co., Inc., Nippon Steel Corporation, Osaka Gas Co., Ltd. and Toho Gas Co., Ltd., as the Buyers, with related letter agreement, dated August 3, 1995, between Seller and Buyers (filed as Exhibit 10.7 to the Union Texas Petroleum Holdings, Inc. Form 10-Q for quarter ended September 30, 1995 (Commission File No. 1-9019)).*\n(10)-49- Second Amended and Restated 1981 Badak LNG Sales Contract, dated as of August 3, 1995, between Pertamina, as Seller, and Chubu Electric Power Co., Inc., The Kansai Electric Power Co., Inc., Osaka Gas Co., Ltd. and Toho Gas Co., Ltd., as Buyers with related letter agreement, dated August 3, 1995, between Seller and Buyers. (filed as Exhibit 10.106 to the Union Texas Petroleum Holdings, Inc.'s 1995 Form 10-K (Commission File No. 1-9019)).*\n(10)-50- LNG Sales and Purchase Contract (Badak V) dated August 12, 1995, between Pertamina and Korea Gas Corporation. (filed as Exhibit 10.107 to the Union Texas Petroleum Holdings, Inc.'s 1995 Form 10-K (Commission File No. 1-9019)).*\n(10)-51- LNG Sales and Purchase Contract (Badak VI), dated October 25, 1995, between Pertamina and Chinese Petroleum Corporation. (filed as Exhibit 10.108 to the Union Texas Petroleum Holdings, Inc.'s 1995 Form 10-K (Commission File No. 1-9019)).*\n* Incorporated herein by reference.\n(10)-52- Allocation of Supply Entitlements between the Arun and Bontang Plants for LNG Sales (effective January 1, 1995).\n(10)-53- Memorandum of Understanding re: Supply Agreements and Package VI Sales dated and effective as of the 27th day of October, 1995, by and among Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (\"Pertamina\"); TOTAL Indonesie and Indonesia Petroleum, Ltd., (collectively referred to as the \"TOTAL Group\"); Virginia Indonesia Company, LASMO Sanga Sanga Limited, OPICOIL Houston, Inc., Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc., and Virginia International Company (collectively referred to as the \"VICO Group\"); Indonesia Petroleum, Ltd., in respect of its interest in a certain portion of the Attaka Unit (referred to as \"INPEX Attaka\"); and Unocal Indonesia Company (referred to as \"UNOCAL\") (the TOTAL Group, the VICO Group, INPEX Attaka, and UNOCAL each referred to as an \"East Kalimantan Contractor Group\" and collectively called the \"East Kalimantan Contractors\").\n(10)-54- Package V Supply Agreement for Natural Gas in Support of the 1973 LNG Sales Contract Extension, dated June 16, 1995, effective October 6, 1994, between Pertamina and Virginia Indonesia Company, LASMO Sanga Sanga Limited, OPICOIL Houston, Inc., Union Texas East Kalimantan Limited, Universe Gas and Oil Company, Inc. and Virginia International Company (filed as Exhibit 10.8 to the Union Texas Petroleum Holdings, Inc. Form 10-Q for the quarter ended September 30, 1995 (Commission File No. 1- 9010)).*\n(10)-55- Package V Supply Agreement (1995 - 1999 LNG Sales to Korea Gas Corp.) dated June 16, 1995, between Pertamina and Virginia Indonesia Company, LASMO Sanga Sanga Limited, Opicoil Houston, Inc., Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc. and Virginia International Company.\n(10)-56- Package V Supply Agreement (1998 - 1999 LNG Sales to Chinese Petroleum Corporation), dated as of June 16, 1995, between Pertamina and Virginia Indonesia Company, LASMO Sanga Sanga Limited, Opicoil Houston, Inc., Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc. and Virginia International Company.\n* Incorporated herein by reference.\n(10)-57- Tripartite Agreement Regarding Producer Contributions to Dwiputrai Costs, dated as of January 1, 1995, by and among Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (\"Pertamina\"); Mobil Oil Indonesia Inc. (\"Mobil\"); and Virginia Indonesia Company, Total Indonesie, and Unocal Indonesia Company, acting on behalf of themselves and all other LNG producers in the East Kalimantan Production Sharing Contracts (collectively, the \"East Kalimantan Producers\").\n(10)-58- Amendment No. 1 to Amended and Restated Badak Trustee and Paying Agent Agreement, dated as of July 1, 1995, among Continental Bank International, as Trustee, and the Producers (filed as Exhibit 10.4 to the Union Texas Petroleum Holdings, Inc. Form 10-Q for the quarter ended September 30, 1995 (Commission File No. 1-9019)).*\n(10)-59- Amendment No. 1 to Bontang III Loan Agreement, dated as of July 1, 1995, among Continental Bank International, as Trustee under the Bontang III Trustee and Paying Agent Agreement, Train-E Finance Co., Ltd., as Tranche A Lender, and The Industrial Bank of Japan Trust Company, as Agent on behalf of the Majority Tranche B Lenders (filed as Exhibit 10.6 to the Union Texas Petroleum Holdings., Inc. Form 10-Q for the quarter ended September 30, 1995 (Commission File No. 1-9019)).*\n(10)-60- Amendment No. 1 to Amended and Restated Bontang Excess Sales Trustee and Paying Agent Agreement, dated as of July 1, 1995, among Continental Bank International, as Trustee, and the Producers (filed as Exhibit 10.5 to the Union Texas Petroleum Holdings, Inc. Form 10-Q for the quarter ended September 30, 1995 (Commission File No. 1-9019)).*\n(10)-61- Bontang V Loan Agreement, dated as of July 1, 1995, among BankAmerica International, as Trustee under the Bontang V Trustee and Paying Agent Agreement, as Borrower, Bontang Train-G Project Finance Co., Ltd. (\"Tranche A Lender\"), the banks named therein as Tranche B Lenders, The Long-Term Credit Bank of Japan, Limited, New York Branch (\"Facility Agent\"), The Fuji Bank, Limited (\"Intercreditor Agent\"), Credit Lyonnais (\"Technical Agent\"), and Credit Lyonnais, The Fuji Bank, Limited and The Long-Term Credit Bank of Japan, Limited (collectively, the \"Arrangers\") (filed as Exhibit 10.1 to the Union Texas Petroleum Holdings, Inc. Form 10-Q for the quarter ended September 30, 1995 (Commission File No. 1-9019)).*\n* Incorporated herein by reference.\n(10)-62- Bontang V Producers Agreement, dated as of July 1, 1995, by Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, Virginia Indonesia Company, OPICOIL Houston, Inc., Virginia International Company, LASMO Sanga Sanga Limited, Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc., Total Indonesie, Unocal Indonesia Company and Indonesia Petroleum, Ltd. (collectively, the \"Producers\"), in favor of the Tranche A Lender, Facility Agent, Intercreditor Agent, Technical agent and Arrangers (filed as Exhibit 10.2 to the Union Texas Petroleum Holdings, Inc. Form 10-Q for the quarter ended September 30, 1995 (Commission File No. 1-9019)).*\n(10)-63- Bontang V Trustee and Paying Agent Agreement, dated as of July 1, 1995, among the Producers and BankAmerica International, as Trustee and Paying Agent (filed as Exhibit 10.3 to the Union Texas Petroleum Holdings, Inc. Form 10-Q for the quarter ended September 30, 1995 (Commission File No. 1- 9019)).*\n(10)-64- Bontang V Disbursement Trustee and Paying Agent Agreement dated as of July 1, 1995, by and among BankAmerica International, not in its individual capacity but solely as trustee and paying agent (in such capacity, the \"Bontang V Trustee\") under the Bontang V Trustee and Paying Agent Agreement dated as of July 1, 1995, as the same may be amended from time to time (the \"Bontang V Trust Agreement\"); and BankAmerica International, not in its individual capacity but solely as disbursement trustee and paying agent under this Agreement.\n(21)-1- List of Subsidiaries of the Company.\n(23)-1- Consent of KPMG Peat Marwick LLP.\n(23)-2- Consent of Ernst & Young LLP.\n(27)-1- Financial Data Schedule for the twelve months ended December 31, 1995.\n(b) Reports on Form 8-K\nThe Company filed a Form 8-K dated November 15, 1995 as required by SS 299.304 of Regulation S-K, disclosing changes in Registrant's Certifying Accountant.\n* Incorporated herein by reference.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nUNIMAR COMPANY\nMarch 19, 1996 By \/S\/ WILLIAM M. KRIPS William M. Krips Chairman of the Management Board\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated as of March 19, 1996.\nBy \/S\/ GEORGE W. BERKO By \/S\/ LARRY D. KALMBACH George W. Berko Larry D. Kalmbach Management Board Management Board (LASMO Representative) (UTPH Representative)\nBy \/S\/ IAN D. BROWN By \/S\/ WILLIAM M. KRIPS Ian D. Brown William M. Krips Management Board Chairman of the (LASMO Representative) Management Board (UTPH Representative)\nBy \/S\/ RICHARD L. SMERNOFF By \/S\/ ARTHUR W. PEABODY, JR. Richard L. Smernoff Arthur W. Peabody, Jr. Management Board Management Board (LASMO Representative) (UTPH Representative)\nINDEX TO EXHIBITS\nSequential Numbered Exhibit Number Page\nThe following documents are included as Exhibits to this Report. Unless it has been indicated that a document listed below is incorporated by reference herein, copies of the document have been filed herewith.\n(2)-1- Merger Agreement, dated May 22, 1984, and Amendment Agreements thereto, dated June 8, 1984 and June 12, 1984 (incorporated by reference to Annex A to the Prospectus\/Proxy Statement included in the Company's Registration Statement on Form S-14 (No. 2-93037)).*\n(2)-2- Agreement of Merger, dated as of August 28, 1984 (incorporated by reference to Annex B to the Prospectus\/Proxy Statement included in the Company's Registration Statement on Form S-14 (No. 2-93037)).*\n(2)-3- Divestiture Agreement, dated June 20, 1984 (filed as Exhibit 2.3 to the Company's Registration Statement on Form S-14 (No. 2-93037)).*\n(3)-1- Amended and Restated Agreement of General Partnership of Unimar Company dated September 11, 1990 between Unistar, Inc. and Ultrastar, Inc. (filed as Exhibit (3)-4- to the Company's 1990 Form 10-K (No. 18791)).*\n(4)-1- Form of Indenture between Unimar and Irving Trust Company, as Trustee (filed as Exhibit 4 to the Company's Registration Statement on Form S-14 (No. 2-93037)).*\n(4)-2- First Supplemental Indenture, dated as of October 31, 1986, to the Indenture between Unimar and Irving Trust Co., as Trustee (Exhibit (4)-1 above) (filed as Exhibit 10.114 to Union Texas Petroleum Holdings, Inc.'s Registration Statement on Form S-1 (No. 33-16267)).*\n(10)-1- Joint Venture Agreement, dated August 8, 1968, among Roy M. Huffington, Inc., Virginia International Company, Austral Petroleum Gas Corporation, Golden Eagle Indonesia, Limited, and Union Texas Far East Corporation, as amended (filed as Exhibit 6.6 to Registration Statement No. 2- 58834 of Alaska Interstate Company).*\n* Incorporated herein by reference.\n(10)-2- Agreement dated as of October 1, 1979, among the parties to the Joint Venture Agreement referred to in Exhibit (10)-1- above (filed as Exhibit 5.2 to Registration Statement No. 2-66661 of Alaska Interstate Company).*\n(10)-3- Amendment to the Operating Agreement dated April 1, 1990, between Roy M. Huffington, Inc., a Delaware corporation, Ultramar Indonesia Limited, a Bermuda corporation, Virginia Indonesia Company, a Delaware corporation, Virginia International Company, a Delaware corporation, Union Texas East Kalimantan Limited, a Bahamian corporation, and Universe Gas & Oil Company, Inc., a Liberian corporation. (filed as Exhibit (10)-3- to the Company's 1993 Form 10-K (No. 1-8791)).*\n(10)-4- Amended and Restated Production Sharing Contract dated April 23, 1990 (effective August 8, 1968 - August 7, 1998) by and between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (Pertamina) and Roy M. Huffington, Inc., Virginia International Company, Virginia Indonesia Company, Ultramar Indonesia Limited, Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc. and Huffington Corporation. (filed as Exhibit (10)-4- to the Company's 1993 Form 10-K (No. 1-8791)).*\n(10)-5- Production Sharing Contract dated April 23, 1990 (effective August 8, 1998 - August 7, 2018) between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (Pertamina) and Roy M. Huffington, Inc., Virginia International Company, Virginia Indonesia Company, Ultramar Indonesia Limited, Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc. and Huffington Corporation. (filed as Exhibit (10)-5- to the Company's 1993 Form 10-K (No. 1- 8791)).*\n(10)-6- Nilam Unit Agreement, effective as of January 1, 1980, to establish the manner in which the Joint Venture and Total will cooperate to develop the unitized area of the Nilam Field.\n(10)-7- Fourth Amended and Restated Implementation Procedures for Crude Oil Liftings, effective as of July 1, 1993, among Virginia Indonesia Company, LASMO Sanga Sanga Limited, Opicoil Houston, Inc., Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc. and Virginia International Company. (filed as Exhibit (10)-7- to the Company's 1994 Form 10-K (No. 1-8791)).*\n* Incorporated herein by reference.\n(10)-8- Amended and Restated 1973 LNG Sales Contract, dated as of the 1st day of January 1990, by and between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, as Seller, and Chubu Electric Power Co., Inc., The Kansai Electric Power Co., Inc., Kyushu Electric Power Co., Inc., Nippon Steel Corporation, Osaka Gas Co., Ltd. and Toho Gas Co., Ltd., as Buyers. (filed as Exhibit (10)-8- to the Company's 1993 Form 10-K (No. 1-8791)).*\n(10)-9- Amendment to the 1973 LNG Sales Contract dated as of the 3rd day of December, 1973, amended by Amendment No. 1 dated as of the 31st day of August, 1976, and amended and restated as of the 1st day of January, 1990 (\"1973 LNG Sales Contract\"), is entered into as of the 1st day of June, 1992, by and between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, a state enterprise of the Republic of Indonesia (Seller), on the one hand, and Kyushu Electric Power Co., Inc. (Kyushu Electric), Nippon Steel Corporation (Nippon Steel), and Toho Gas Co., Ltd. (Toho Gas), all corporations organized and existing under the laws of Japan, on the other hand. (filed as Exhibit (10)-9- to the Company's 1993 Form 10-K (No. 1-8791)).*\n(10)-10- Amended and Restated Supply Agreement (In Support of the Amended and Restated 1973 LNG Sales Contract) between Pertamina and Virginia Indonesia Company, LASMO Sanga Sanga Limited, Opicoil Houston, Inc., Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc., and Virginia International Company dated September 22, 1993, effective December 3, 1973. (filed as Exhibit (10)- 10- to the Company's 1993 Form 10-K (No. 1-8791)).*\n(10)-11- Amended and Restated Badak LNG Sales Contract, dated as of the 1st day of January, 1990, by and between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, as Seller, and Chubu Electric Power Co., Inc., The Kansai Electric Power Co., Inc., Osaka Gas Co., Ltd. and Toho Gas Co., Ltd., as Buyers. (filed as Exhibit (10)-11- to the Company's 1993 Form 10-K (No. 1-8791)).*\n(10)-12- Supply Agreement, dated as of April 14, 1981 between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (Pertamina) and the parties to the Joint Venture Agreement, including the Company. (filed as Exhibit (10)-12- to the Company's 1993 Form 10-K (No. 1-8791)).*\n* Incorporated herein by reference.\n(10)-13- Seventh Supply Agreement for Excess Sales (Additional Fixed Quantities under Badak LNG Sales Contract as a Result of Contract Amendment and Restatement) between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara and Virginia Indonesia Company, Opicoil Houston, Inc., Ultramar Indonesia Limited, Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc. and Virginia International Company, dated September 28, 1992, but effective as of January 1, 1990. (filed as Exhibit (10)-13- to the Company's 1993 Form 10-K (No. 1-8791)).*\n(10)-14- Bontang II Trustee and Paying Agent Agreement Amended and Restated as of July 15, 1991 among Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, Virginia Indonesia Company, Virginia International Company, Union Texas East Kalimantan Limited, Ultramar Indonesia Limited, Opicoil Houston, Inc., Universe Gas & Oil Company, Inc., Total Indonesie, Unocal Indonesia, Ltd., Indonesia Petroleum, Ltd. and Continental Bank International. (filed as Exhibit (10)-14- to the Company's 1993 Form 10-K (No. 1-8791)).*\n(10)-15- Producers Agreement No. 2 dated as of June 9, 1987 by Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (Pertamina), Roy M. Huffington, Inc., Virginia International Company, Ultramar Indonesia Limited, Virginia Indonesia Company, Union Texas East Kalimantan Limited, Universe Tankships, Inc., Huffington Corporation in favor of The Industrial Bank of Japan Trust Company as Agent (filed as Exhibit (10)-30- to the Company's 1987 Form 10-K (No. 1-8791)).*\n(10)-16- Badak III LNG Sales Contract between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (Pertamina) as Seller and Chinese Petroleum Corporation as Buyer signed on March 19, 1987. (filed as Exhibit (10)-16- to the Company's 1994 Form 10-K (No. 1- 8791)).*\n(10)-17- Badak III LNG Sales Contract Supply Agreement, dated October 19, 1987 among Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (Pertamina) and the parties to the Joint Venture Agreement. (filed as Exhibit (10)-17- to the Company's 1993 Form 10-K (No. 1-8791)).*\n(10)-18- LNG Sales and Purchase Contract (Korea II) effective May 7, 1991 between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara and Korea Gas Corporation. (filed as Exhibit (10)-18- to the Company's 1993 Form 10-K (No. 1-8791)).*\n* Incorporated herein by reference.\n(10)-19- Schedule A to the LNG Sales and Purchase Contract (Korea II FOB) between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara and Korea Gas Corporation. (filed as Exhibit (10)-19- to the Company's 1993 Form 10-K (No. 1-8791)).*\n(10)-20- Bontang III Producers Agreement, dated February 9, 1988, among Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (Pertamina) and the parties to the Joint Venture Agreement. (filed as Exhibit (10)-20- to the Company's 1993 Form 10-K (No. 1-8791)).*\n(10)-21- Amendment No. 1 to Bontang III Producers Agreement dated as of May 31, 1988 among Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, Roy M. Huffington, Inc., Huffington Corporation, Virginia International Company, Virginia Indonesia Company, Ultramar Indonesia Limited, Union Texas East Kalimantan Limited, Universe Tankships, Inc., Total Indonesie, Unocal Indonesia, Ltd., Indonesia Petroleum, Ltd. and Train-E Finance Co., Ltd., as Tranche A Lender, The Industrial Bank of Japan Trust Company, as Agent and The Industrial Bank of Japan Trust Company on behalf of the Tranche B Lenders. (filed as Exhibit (10)-21- to the Company's 1993 Form 10-K (No. 1-8791)).*\n(10)-22- $316,000,000 Bontang III Loan Agreement dated February 9, 1988 among Continental Bank International as Trustee, Train-E Finance Co., Ltd. as Tranche A Lender and The Industrial Bank of Japan Trust Company as Agent. (filed as Exhibit (10)-23- to the Company's 1993 Form 10-K (No. 1- 8791)).*\n(10)-23- Bontang III Trustee and Paying Agent Agreement, dated February 9, 1988, among Pertamina, Roy M. Huffington, Inc., Huffington Corporation, Virginia International Company, VICO, Ultrastar Indonesia Limited, Union Texas East Kalimantan Limited, Universe Tankships, Inc., Total Indonesia, Unocal Indonesia, Ltd., Indonesia Petroleum, Ltd. and Continental Bank International (filed as Exhibit 10.42 to the Union Texas Petroleum Holdings, Inc.'s 1991 Form 10-K (Commission File No. 1-9019)).*\n* Incorporated herein by reference.\n(10)-24- Amendment No. 1 to Bontang III Trustee and Paying Agent Agreement, dated as of December 11, 1992, among Pertamina, VICO, Virginia International Company, Ultramar Indonesia Limited, Union Texas East Kalimantan Limited, Opicoil Houston, Inc., Universe Gas & Oil Company, Inc., Total Indonesia, Unocal Indonesia Ltd., Indonesia Petroleum, Ltd. and Continental Bank International, as Bontang III Trustee (filed as Exhibit 10.83 to the Union Texas Petroleum Holdings, Inc.'s 1992 Form 10-K (Commission File No. 1-9019)).*\n(10)-25- Amended and Restated Debt Service Allocation Agreement dated February 9, 1988 among Perusahaan Pertambangan Minyak Dan Gas Bumi Negara and Roy M. Huffington, Inc., Virginia International Company, Ultramar Indonesia Limited, Virginia Indonesia Company, Union Texas East Kalimantan Limited, Universe Tankships, Inc., Huffington Corporation, Total Indonesie, Unocal Indonesia, Ltd. and Indonesia Petroleum, Ltd. (filed as Exhibit (10)- 26- to the Company's 1994 Form 10-K (No. 1-8791)).*\n(10)-26- Letter agreement between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara and Chinese Petroleum Corporation, dated December 1, 1989. (filed as Exhibit (10)-27- to the Company's 1993 Form 10-K (No. 1-8791)).*\n(10)-27- Badak IV LNG Sales Contract dated October 23, 1990 between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (Pertamina), as Seller and Osaka Gas Co., Ltd., Tokyo Gas Co., Ltd. and Toho Gas Co., Ltd., as Buyers. (filed as Exhibit (10)-29- to the Company's 1993 Form 10-K (No. 1-8791)).*\n(10)-28- LNG Sales Contract dated as of October 13, 1992 between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, as Seller and Hiroshima Gas Co., Ltd. and Nippon Gas Co., Ltd., as Buyers. (filed as Exhibit (10)-30- to the Company's 1993 Form 10-K (No. 1- 8791)).*\n(10)-29- LNG Sales Contract dated as of October 13, 1992 between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, as Seller and Osaka Gas Co., Ltd., as Buyer. (filed as Exhibit (10)-31- to the Company's 1993 Form 10-K (No. 1-8791)).*\n* Incorporated herein by reference.\n(10)-30- Supply Agreement for Natural Gas to Badak IV LNG Sales Contract dated August 12, 1991 between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, Virginia Indonesia Company, Opicoil Houston, Inc., Ultramar Indonesia Limited, Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc. and Virginia International Company. (filed as Exhibit (10)-32- to the Company's 1993 Form 10-K (No. 1-8791)).*\n(10)-31- Second Supply Agreement for Package IV Excess Sales (Osaka Gas Contract - Package IV Quantities) between Pertamina and Virginia Indonesia Company, LASMO Sanga Sanga Limited, Opicoil Houston, Inc., Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc., and Virginia International Company dated September 22, 1993, effective January 1, 1991. (filed as Exhibit (10)-33- to the Company's 1993 Form 10-K (No. 1-8791)).*\n(10)-32- Third Supply Agreement for Package IV Excess Sales (Toho Gas Contract - Package IV Quantities) between Pertamina and Virginia Indonesia Company, LASMO Sanga Sanga Limited, Opicoil Houston, Inc., Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc., and Virginia International Company dated September 28, effective January 1, 1991. (filed as Exhibit (10)-34- to the Company's 1993 Form 10-K (No. 1-8791)).*\n(10)-33- Eleventh Supply Agreement for Package IV Excess Sales (1973 Contract Build-Down Quantities) between Pertamina and Virginia Indonesia Company, LASMO Sanga Sanga Limited, Opicoil Houston, Inc., Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc., and Virginia International Company dated September 22, 1993, effective January 1, 1990. (filed as Exhibit (10)-35- to the Company's 1993 Form 10-K (No. 1-8791)).*\n(10)-34- Bontang IV Producers Agreement dated August 26, 1991 by Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, Virginia Indonesia Company, Opicoil Houston, Inc., Virginia International Company, Ultramar Indonesia Limited, Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc., Total Indonesie, Unocal Indonesia, Ltd. and Indonesia Petroleum, Ltd., in favor of The Chase Manhattan Bank, N.A. as Agent for the Lenders. (filed as Exhibit (10)-36- to the Company's 1993 Form 10-K (No. 1-8791)).*\n* Incorporated herein by reference.\n(10)-35- $750,000,000 Bontang IV Loan Agreement dated August 26, 1991 among Continental Bank International as Trustee under the Bontang IV Trustee and Paying Agent Agreement as Borrower, Chase Manhattan Asia Limited and The Mitsubishi Bank, Limited as Coordinators, the other banks and financial institutions named herein as Arrangers, Co- Arrangers, Lead Managers, Managers, Co-Managers and Lenders, The Chase Manhattan Bank, N.A. and the Mitsubishi Bank, Limited as Co-Agents and The Chase Manhattan Bank, N.A. as Agent. (filed as Exhibit (10)-37- to the Company's 1993 Form 10-K (No. 1- 8791)).*\n(10)-36- Bontang IV Trustee and Paying Agent Agreement dated August 26, 1991 among Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, Virginia Indonesia Company, Opicoil Houston, Inc., Virginia International Company, Ultramar Indonesia Limited, Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc., Total Indonesie, Unocal Indonesia, Ltd., Indonesia Petroleum, Ltd. and Continental Bank International. (filed as Exhibit (10)-38- to the Company's 1993 Form 10-K (No. 1- 8791)).*\n(10)-37- Amended and Restated Bontang Processing Agreement dated February 9, 1988 among Perusahaan Pertambangan Minyak Dan Gas Bumi Negara and Roy M. Huffington, Inc., Huffington Corporation, Virginia International Company, Virginia Indonesia Company, Ultramar Indonesia Limited, Union Texas East Kalimantan Limited, Universe Tankships, Inc., Total Indonesie, Unocal Indonesia, Ltd., Indonesia Petroleum, Ltd. and P.T. Badak Natural Gas Liquefaction Company (filed as Exhibit (10)-39- to the Company's 1988 Form 10-K (No. 1-8791)).*\n(10)-38- Bontang LPG Sales and Purchase Contract between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, as Seller, and National Federation of Agricultural Co-Operative Associations (Zen-Noh), as Buyer, dated February 21, 1992. (filed as Exhibit (10)-42- to the Company's 1993 Form 10-K (No. 1-8791)).*\n(10)-39- Bontang LPG Sales and Purchase Contract between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, as Seller, and Japan Indonesia Oil Co., Ltd., as Buyer, dated February 20, 1992. (filed as Exhibit (10)-43- to the Company's 1993 Form 10-K (No. 1- 8791)).*\n* Incorporated herein by reference.\n(10)-40- Arun and Bontang LPG Sales and Purchase Contract between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (Pertamina) as Seller and Mitsubishi Corporation, Cosmo Oil Co., Ltd., Nippon Petroleum Gas Co., Ltd., Showa Shell Sekiyu K.K., Kyodo Oil Co., Ltd., Idemitsu Kosan Co., Ltd. and Mitsui Liquefied Gas Co., Ltd. as Buyers dated July 15, 1986. (filed as Exhibit (10)-42- to the Company's 1994 Form 10-K (No. 1-8791)).*\n(10)-41- Amendments to Arun and Bontang LPG Sales and Purchase Contract, dated October 5, 1994, between Pertamina, as Seller, and Mitsubishi Corporation, Cosmo Oil Co., Ltd., Nippon Petroleum Gas Co., Ltd., Showa Shell Sekiyu K.K., Japan Energy Corporation, Idemitsu Kosan Co., Ltd., and Mitsui Oil & Gas Co., Ltd., as Buyers. (filed as Exhibit 10.88 to the Union Texas Petroleum Holdings, Inc.'s 1994 Form 10-K (Commission File No. 1-9019)).*\n(10)-42- Bontang LPG Supply Agreement, dated November 17, 1987, between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (Pertamina) and the parties to the Joint Venture Agreement. (filed as Exhibit (10)-45- to the Company's 1993 Form 10-K (No. 1-8791)).*\n(10)-43- Advance Payment Agreement between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (Pertamina) and Arun Bontang Project Finance Co., Ltd., dated February 16, 1987 (filed as Exhibit (4)-15- to the Company's 1986 Form 10-K (No. 1-8791)).*\n(10)-44- Agreement and Plan of Reorganization of ENSTAR Corporation, dated December 22, 1989, by and among Unimar Company, Ultrastar, Inc., Unistar, Inc., ENSTAR Corporation, Newstar Inc., Union Texas Development Corporation, Union Texas Petroleum Corporation and Ultramar America Limited. (filed as Exhibit (10)-47- to the Company's 1993 Form 10-K (No. 1-8791)).*\n(10)-45- Amendment to Agreement and Plan of Reorganization of ENSTAR Corporation, dated May 1, 1990, by and among Unimar Company, Ultrastar, Inc., Unistar, Inc., ENSTAR Corporation, Ultramar Production Company, Union Texas Development Corporation, Union Texas Petroleum Corporation and Ultramar America Limited. (filed as Exhibit (10)-48- to the Company's 1993 Form 10-K (No. 1-8791)).*\n* Incorporated herein by reference.\n(10)-46- Addendum to Badak IV LNG Sales Contract Supply Agreement (effective October 23, 1990), dated January 31, 1994, by and between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (\"Pertamina\") and Virginia Indonesia Company (\"VICO\"), LASMO Sanga Sanga Limited, Opicoil Houston, Inc., Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc., and Virginia International Company. (filed as Exhibit (10)-48- to the Company's 1994 Form 10-K (No. 1-8791)).*\n(10)-47- Memorandum of Agreement for Purchase and Sale of LNG During 1995 - 1999 between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (\"Pertamina\") (\"Seller\") and Korea Gas Corporation (\"KGC\") (\"Buyer\") for the sale and purchase of certain quantities of LNG. (filed as Exhibit (10)- 49- to the Company's 1994 Form 10-K (No. 1-8791)).*\n(10)-48- Second Amended and Restated 1973 LNG Sales Contract, dated as of August 3, 1995 between Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (\"Pertamina\"), as Seller, and Chubu Electric Power Co., Inc., The Kansai Electric Power Co., Inc\/. Kyushu Electric Power Co., Inc., Nippon Steel Corporation, Osaka Gas Co., Ltd. and Toho Gas Co., Ltd., as the Buyers, with related letter agreement, dated August 3, 1995, between Seller and Buyers (filed as Exhibit 10.7 to the Union Texas Petroleum Holdings, Inc. Form 10-Q for quarter ended September 30, 1995 (Commission File No. 1-9019)).*\n(10)-49- Second Amended and Restated 1981 Badak LNG Sales Contract, dated as of August 3, 1995, between Pertamina, as Seller, and Chubu Electric Power Co., Inc., The Kansai Electric Power Co., Inc., Osaka Gas Co., Ltd. and Toho Gas Co., Ltd., as Buyers with related letter agreement, dated August 3, 1995, between Seller and Buyers. (filed as Exhibit 10.106 to the Union Texas Petroleum Holdings, Inc.'s 1995 Form 10-K (Commission File No. 1- 9019)).*\n(10)-50- LNG Sales and Purchase Contract (Badak V) dated August 12, 1995, between Pertamina and Korea Gas Corporation. (filed as Exhibit 10.107 to the Union Texas Petroleum Holdings, Inc.'s 1995 Form 10-K (Commission File No. 1-9019)).*\n(10)-51- LNG Sales and Purchase Contract (Badak VI), dated October 25, 1995, between Pertamina and Chinese Petroleum Corporation. (filed as Exhibit 10.108 to the Union Texas Petroleum Holdings, Inc.'s 1995 Form 10-K (Commission File No. 1-9019)).*\n* Incorporated herein by reference.\n(10)-52- Allocation of Supply Entitlements between the Arun and Bontang Plants for LNG Sales (effective January 1, 1995).\n(10)-53- Memorandum of Understanding re: Supply Agreements and Package VI Sales dated and effective as of the 27th day of October, 1995, by and among Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (\"Pertamina\"); TOTAL Indonesie and Indonesia Petroleum, Ltd., (collectively referred to as the \"TOTAL Group\"); Virginia Indonesia Company, LASMO Sanga Sanga Limited, OPICOIL Houston, Inc., Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc., and Virginia International Company (collectively referred to as the \"VICO Group\"); Indonesia Petroleum, Ltd., in respect of its interest in a certain portion of the Attaka Unit (referred to as \"INPEX Attaka\"); and Unocal Indonesia Company (referred to as \"UNOCAL\") (the TOTAL Group, the VICO Group, INPEX Attaka, and UNOCAL each referred to as an \"East Kalimantan Contractor Group\" and collectively called the \"East Kalimantan Contractors\").\n(10)-54- Package V Supply Agreement for Natural Gas in Support of the 1973 LNG Sales Contract Extension, dated June 16, 1995, effective October 6, 1994, between Pertamina and Virginia Indonesia Company, LASMO Sanga Sanga Limited, OPICOIL Houston, Inc., Union Texas East Kalimantan Limited, Universe Gas and Oil Company, Inc. and Virginia International Company (filed as Exhibit 10.8 to the Union Texas Petroleum Holdings, Inc. Form 10-Q for the quarter ended September 30, 1995 (Commission File No. 1- 9010)).*\n(10)-55- Package V Supply Agreement (1995 - 1999 LNG Sales to Korea Gas Corp.) dated June 16, 1995, between Pertamina and Virginia Indonesia Company, LASMO Sanga Sanga Limited, Opicoil Houston, Inc., Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc. and Virginia International Company.\n(10)-56- Package V Supply Agreement (1998 - 1999 LNG Sales to Chinese Petroleum Corporation), dated as of June 16, 1995, between Pertamina and Virginia Indonesia Company, LASMO Sanga Sanga Limited, Opicoil Houston, Inc., Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc. and Virginia International Company.\n* Incorporated herein by reference.\n(10)-57- Tripartite Agreement Regarding Producer Contributions to Dwiputrai Costs, dated as of January 1, 1995, by and among Perusahaan Pertambangan Minyak Dan Gas Bumi Negara (\"Pertamina\"); Mobil Oil Indonesia Inc. (\"Mobil\"); and Virginia Indonesia Company, Total Indonesie, and Unocal Indonesia Company, acting on behalf of themselves and all other LNG producers in the East Kalimantan Production Sharing Contracts (collectively, the \"East Kalimantan Producers\").\n(10)-58- Amendment No. 1 to Amended and Restated Badak Trustee and Paying Agent Agreement, dated as of July 1, 1995, among Continental Bank International, as Trustee, and the Producers (filed as Exhibit 10.4 to the Union Texas Petroleum Holdings, Inc. Form 10-Q for the quarter ended September 30, 1995 (Commission File No. 1-9019)).*\n(10)-59- Amendment No. 1 to Bontang III Loan Agreement, dated as of July 1, 1995, among Continental Bank International, as Trustee under the Bontang III Trustee and Paying Agent Agreement, Train-E Finance Co., Ltd., as Tranche A Lender, and The Industrial Bank of Japan Trust Company, as Agent on behalf of the Majority Tranche B Lenders (filed as Exhibit 10.6 to the Union Texas Petroleum Holdings., Inc. Form 10-Q for the quarter ended September 30, 1995 (Commission File No. 1-9019)).*\n(10)-60- Amendment No. 1 to Amended and Restated Bontang Excess Sales Trustee and Paying Agent Agreement, dated as of July 1, 1995, among Continental Bank International, as Trustee, and the Producers (filed as Exhibit 10.5 to the Union Texas Petroleum Holdings, Inc. Form 10-Q for the quarter ended September 30, 1995 (Commission File No. 1-9019)).*\n(10)-61- Bontang V Loan Agreement, dated as of July 1, 1995, among BankAmerica International, as Trustee under the Bontang V Trustee and Paying Agent Agreement, as Borrower, Bontang Train-G Project Finance Co., Ltd. (\"Tranche A Lender\"), the banks named therein as Tranche B Lenders, The Long-Term Credit Bank of Japan, Limited, New York Branch (\"Facility Agent\"), The Fuji Bank, Limited (\"Intercreditor Agent\"), Credit Lyonnais (\"Technical Agent\"), and Credit Lyonnais, The Fuji Bank, Limited and The Long-Term Credit Bank of Japan, Limited (collectively, the \"Arrangers\") (filed as Exhibit 10.1 to the Union Texas Petroleum Holdings, Inc. Form 10-Q for the quarter ended September 30, 1995 (Commission File No. 1-9019)).*\n* Incorporated herein by reference.\n(10)-62- Bontang V Producers Agreement, dated as of July 1, 1995, by Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, Virginia Indonesia Company, OPICOIL Houston, Inc., Virginia International Company, LASMO Sanga Sanga Limited, Union Texas East Kalimantan Limited, Universe Gas & Oil Company, Inc., Total Indonesie, Unocal Indonesia Company and Indonesia Petroleum, Ltd. (collectively, the \"Producers\"), in favor of the Tranche A Lender, Facility Agent, Intercreditor Agent, Technical agent and Arrangers (filed as Exhibit 10.2 to the Union Texas Petroleum Holdings, Inc. Form 10-Q for the quarter ended September 30, 1995 (Commission File No. 1-9019)).*\n(10)-63- Bontang V Trustee and Paying Agent Agreement, dated as of July 1, 1995, among the Producers and BankAmerica International, as Trustee and Paying Agent (filed as Exhibit 10.3 to the Union Texas Petroleum Holdings, Inc. Form 10-Q for the quarter ended September 30, 1995 (Commission File No. 1- 9019)).*\n(10)-64- Bontang V Disbursement Trustee and Paying Agent Agreement dated as of July 1, 1995, by and among BankAmerica International, not in its individual capacity but solely as trustee and paying agent (in such capacity, the \"Bontang V Trustee\") under the Bontang V Trustee and Paying Agent Agreement dated as of July 1, 1995, as the same may be amended from time to time (the \"Bontang V Trust Agreement\"); and BankAmerica International, not in its individual capacity but solely as disbursement trustee and paying agent under this Agreement.\n(21)-1- List of Subsidiaries of the Company.\n(23)-1- Consent of KPMG Peat Marwick LLP.\n(23)-2- Consent of Ernst & Young LLP.\n(27)-1- Financial Data Schedule for the twelve months ended December 31, 1995.\n(b) Reports on Form 8-K\nThe Company filed a Form 8-K dated November 15, 1995 as required by SS 299.304 of Regulation S-K, disclosing changes in Registrant's Certifying Accountant.\n* Incorporated herein by reference.","section_15":""}
{"filename":"718418_1995.txt","cik":"718418","year":"1995","section_1":"ITEM 1. BUSINESS.\nThe Equity Income Fund, First Exchange Series - AT&T Shares (the \"Fund\") was formed in 1983 as a unit investment trust under New York law and in accordance with the Investment Company Act of 1940 by a trust indenture among Merrill Lynch, Pierce, Fenner & Smith Incorporated, Dean Witter Reynolds Inc., Prudential Securities, Incorporated and Smith Barney Inc. as Sponsors and The Bank of New York as Trustee.\nThe Fund was formed for the purpose of permitting an investor in common shares of the predivestiture American Telephone and Telegraph Company (\"AT&T\") to hold an investment in AT&T and the seven regional holding companies created pursuant to the AT&T Plan of Reorganization in the form of units of beneficial interest (the \"Units\") of the Fund, which consists solely of shares of AT&T common stock and those securities which are distributed to holders of such AT&T common stock pursuant to the reorganization. The Fund is not sponsored by, or affiliated with, AT&T or any of the regional holding companies.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Fund owns no physical properties.\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\nThe principal United States markets in which Units of the Fund are traded are the American Stock Exchange, Inc. and the Pacific Stock Exchange, Incorporated.\nThe following are the high and low sale prices of Units of the Fund during each quarter for the last two fiscal years in which the Units were traded on the American Stock Exchange, Inc., which was the principal exchange market for the Units:\n- 1 -\n(b) HOLDERS\nThere were 6407 record holders of Units of the Fund on the books of the Trustee on February 29, 1996. Eighty-three and seven tenths of a percent (83.70%) of such Units were held of record by Cede & Co., a nominee of the Depositary Trust Company, for certain of its participants on that date.\n(c) DIVIDENDS\nThe following are the cash distributions which were paid to holders of Units of the Fund during the last two fiscal years:\n- 2 -\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nSELECTED FINANCIAL DATA (in thousands except for outstanding Units and Per Unit Data)\n- 3 - ITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nThe Fund, as a non-managed unit investment trust, has no officers or directors. The Trustees and Sponsors of the Fund are named in Item 1.\nThe Fund had net investment income of $46.3 million and net realized and unrealized gain on investments of $406.5 million for the year 1995 as compared with net investment income of $49.7 million and net realized and unrealized loss on investments of $65.6 million for the year 1994 and net investment income of $50.3 million and net realized and unrealized gain on investments of $113.7 million for the year 1993.\nThe net increase in net assets resulting from operations for the year 1995 was $452.9 million as compared to a net decrease of $15.9 million for the year 1994 and a net increase of $164.1 million for the year 1993. The increase in net assets resulting from operations of $452.9 million for the year 1995 was substantially the result of realized and unrealized gain on investments. The net decrease in net assets resulting from operations of $15.9 for the year 1994 was the result of realized and unrealized loss on investments.\nCash distributions paid out per Unit during each year amounted to $2.77 for the year ending December 31, 1995 as compared to $2.73 for the year ending December 31, 1994 and $2.69 for the year ending December 31, 1993.\nIncome distributions accrued per Unit during each year amounted to $2.77 for the year ending December 31, 1995 as compared to $2.73 for the year ending December 31, 1994. The income distribution per Unit for the year ending December 31, 1993 was $2.69.\n- 4 - The per Unit net asset value was $88.47 at December 31, 1995, $64.30 at December 31, 1994 and $67.94 at December 31, 1993. The per Unit net asset value increased $24.17 from 1994 to 1995 and decreased $3.64 from 1993 to 1994.\nThere were 16,670,493 Units outstanding as of December 31, 1995, 17,701,839 Units outstanding as of December 31, 1994 and 18,514,279 Units outstanding as of December 31, 1993. There was a decrease of 1,031,346 Units during fiscal year 1995, a decrease of 812,440 Units during fiscal year 1994 and decrease of 378,731 Units during fiscal year 1993 as a result of redemptions.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nSee following pages 6 through 13.\n- 5 - INDEPENDENT ACCOUNTANTS' REPORT\nThe Sponsors, Trustee and Holders of The Equity Income Fund, First Exchange Series - AT&T Shares:\nWe have audited the accompanying statements of condition of The Equity Income Fund, First Exchange Series - AT&T Shares as of December 31, 1995 and 1994 and the related statements of operations and of changes in net assets for the years ended December 31, 1995, 1994 and 1993. 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. Securities owned at December 31, 1995 and 1994 were confirmed to us by The Bank of New York, the Trustee. 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.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of The Equity Income Fund, First Exchange Series - AT&T Shares at December 31, 1995 and 1994 and the results of its operations and changes in its net assets for the above-stated years in conformity with generally accepted accounting principles.\nDeloitte & Touche LLP\nFebruary 19, 1996 - 6 - THE EQUITY INCOME FUND, FIRST EXCHANGE SERIES - AT&T SHARES\nSTATEMENTS OF CONDITION\nSee Notes to Financial Statements.\n- 7 - THE EQUITY INCOME FUND, FIRST EXCHANGE SERIES - AT&T SHARES\nSTATEMENTS OF OPERATIONS\nSee Notes to Financial Statements.\n- 8 - THE EQUITY INCOME FUND, FIRST EXCHANGE SERIES - AT&T SHARES\nSTATEMENTS OF CHANGES IN NET ASSETS\nSee Notes to Financial Statements.\n- 9 - THE EQUITY INCOME FUND, FIRST EXCHANGE SERIES - AT&T SHARES\nNOTES TO FINANCIAL STATEMENTS\n1. SIGNIFICANT ACCOUNTING POLICIES\nThe Fund is registered under the Investment Company Act of 1940 as a Unit Investment Trust. A summary of the significant accounting policies, which are in conformity with generally accepted accounting principles, followed by the Fund in the preparation of its financial statements since July 7, 1983, its initial date of deposit, is as follows:\n(a) Securities are stated at market value based on the last sales price reported at the close of business on the New York Stock Exchange. Substantially all of the aggregate cost of securities represents the market value of the shares of common stock of American Telephone and Telegraph Company (AT&T) on the days the shares were exchanged for units of the Fund; such aggregate cost was subsequently allocated among the portfolio holdings in shares of AT&T and the seven regional holding companies following their divestiture by AT&T in accordance with its Plan of Reorganization. Realized gains or losses on sales of securities are determined using the identified cost basis.\n(b) The Fund is not subject to income taxes. Accordingly, no provision for such taxes is required.\n(c) Dividend income has been recognized on the ex-dividend date.\n2. MARKETABLE SECURITIES, AT DECEMBER 31, 1994:\n- 10 - THE EQUITY INCOME FUND, FIRST EXCHANGE SERIES - AT&T SHARES\nNOTES TO FINANCIAL STATEMENTS\nMARKETABLE SECURITIES, AT DECEMBER 31, 1995:\n3. DISTRIBUTIONS\nAny monthly distributions to Holders, who have not elected to participate in the Fund's Reinvestment Plan, are made on or about the first day of each month. The income distribution payable at December 31, 1994 and 1995 to holders of record at December 15, 1994 and December 15, 1995 was at the rate of $.22837 and $.23261 per unit, respectively.\n4. REINVESTMENT PLAN\nHolders could reinvest any distributions in the Fund prior to April 1, 1984, or in certain subsequent series of The Equity Income Fund after March 31, 1984, by executing an appropriate notice of election to participate in the Fund's Reinvestment Plan. The Sponsors (Merrill Lynch, Pierce, Fenner & Smith Inc., Dean Witter Reynolds Inc., Prudential Securities Inc. and Smith Barney Shearson, Inc.) may, in their sole discretion, cancel the Fund's Reinvestment Plan at any time.\n5. REDEMPTIONS\nHolders may request redemptions of units by presentation thereof to the Trustee, The Bank of New York. Redemptions of units are made in kind by the Trustee; fractional undivided interests are redeemed in cash. Under certain circumstances, Holders may request redemptions of units in cash. Units of the Fund are listed and traded on the American and Pacific Stock Exchanges.\n- 11 - THE EQUITY INCOME FUND, FIRST EXCHANGE SERIES - AT&T SHARES\nNOTES TO FINANCIAL STATEMENTS\n6. NET CAPITAL\n7. INCOME TAXES\nAll Fund items of income received, expenses paid, and realized gains and losses on securities sold are attributable to the Holders, on a pro rata basis, for Federal income tax purposes in accordance with the grantor trust rules of the United States Internal Revenue Code.\n8. QUARTERLY RESULTS OF OPERATIONS - UNAUDITED\nA summary of the Fund's 1994 and 1995 quarterly results of operations, in thousands of dollars, is as follows:\nYear Ended December 31, 1994\n- 12 - THE EQUITY INCOME FUND, FIRST EXCHANGE SERIES - AT&T SHARES\nNOTES TO FINANCIAL STATEMENTS\nYear Ended December 31, 1995\n- 13 - ITEM 9.","section_9":"ITEM 9. CHANGES IN AND 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.\nNone.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nNone.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nNone.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nNone.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\nPage ---- a. 1.1 - Statements of Condition as of December 31, 1994 and 1995 ......................... 7\n1.2 - Statements of Operations for the years ended December 31, 1993, December 31, 1994 and December 31, 1995 ................ 8\n1.3 - Statements of Changes in Net Assets for the years ended December 31, 1993, December 31, 1994 and December 31, 1995 ... 9\n2 - Financial schedules are not filed because of the absence of conditions under which they are required or because the required information, where material, is included in the financial statements or the footnotes thereto.\nb. None.\nc. 4.1 - Form of Trust Indenture (incorporated by reference to Exhibit 1.1 to the Registration Statement of The Equity\n- 14 - Income Fund, First Exchange Series - AT&T Shares, 1933 Act File No. 2-83192)\n4.1.1 - Form of Certificate of Amendment to Trust Indenture dated August 8, 1983 (incorporated by reference to Registration Statement on Form 8-A of The Equity Income Fund, First Exchange Series - AT&T Shares, 1934 Act File No. 1-8642)\n4.1.2 - Form of Standard Terms and Conditions of Trust effective January 1, 1983 (incorporated by reference to Exhibit 1.1.1 to the Registration Statement of The Equity Income Fund, First Exchange Series - AT&T Shares, 1933 Act File No. 2-83192)\n9. - None.\n11 - Computation of per Unit earnings (See Statement of Changes in Net Assets, Item 1.3, above)\n13.1 - Form 10-Q, for the quarter ended March 31, 1994, incorporated by reference to 1933 Act File No. 2-83192.\n13.2 - Form 10-Q, for the quarter ended June 30, 1994, incorporated by reference to 1933 Act File No. 2-83192.\n13.3 - Form 10-Q, for the quarter ended September 30, 1994, incorporated by reference to 1933 Act File No. 2-83192.\n13.4 - Form 10-K for the fiscal year ended December 31, 1994, incorporated by reference to 1933 Act File No. 2-83192.\n13.5 - Form 10-Q for the quarter ended March 31, 1995, incorporated by reference to 1933 Act File No. 2-83192.\n13.6 - Form 10-Q for the quarter ended June 30, 1995, incorporated by reference to 1933 Act File No. 2-83192.\n13.7 - Form 10-Q for the quarter ended September 30, 1995, incorporated by reference to 1933 Act File No. 2-83192.\n18. - None.\n21. - None.\n22. - None.\n- 15 - 23 - Consents (incorporated by reference to Registration Statement of The Equity Income Fund, First Exchange Series - AT&T Shares, 1933 Act File No. 2-83192).\n27. - Financial Data Schedule.\nd. None.\n- 16 - SIGNATURE\nPursuant to the requirements of the Securities Exchange Act of 1934, the Trustee of the Fund has duly caused this report to be signed on behalf of the Fund by the undersigned, thereunto duly authorized.\nThe Equity Income Fund, First Exchange Series - AT&T Shares\nThe Bank of New York, as Trustee\nDate: March 20, 1996 By: \/s\/ Christopher W. Peer --------------------------------- Christopher W. Peer Title: Assistant Vice President EXHIBIT INDEX -------------\nExhibit 27 Financial Data Schedule","section_15":""}
{"filename":"48039_1995.txt","cik":"48039","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIn July 1993, the DOJ, acting on behalf of the EPA, filed a complaint in the United States District Court for the District of New Mexico alleging that Navajo, beginning in September 1990 and continuing until the present, had violated and continues to violate RCRA and implementing regulations of the EPA by treating, storing and disposing of certain hazardous wastes without necessary authorization and without compliance with regulatory requirements. The complaint seeks a court order directing Navajo to comply with these regulatory standards and civil penalties for the alleged non-compliance. The Company believes that the parties are in the final stages of negotiations that should resolve the litigation. Based on these negotiations, the Company would close the existing evaporation ponds of its wastewater management system and implement an alternative wastewater treatment system. Any settlement with DOJ and EPA also is expected to involve payment of a civil penalty. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and Note 12 to the Consolidated Financial Statements.\nThe Company is a party to various other litigation and proceedings which it believes, based on advice of counsel, will not have a materially adverse impact on its financial condition or 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 Company's 1995 fiscal year.\nExecutive Officers of Registrant (per instruction 3 to Item 401(b) of Regulation S-K)\nThe executive officers of the Company as of October 20, 1995 are as follows:\nIn addition to the persons listed above, Kathryn Walker, age 45, was appointed Controller of Navajo Refining Company in August 1993; prior thereto she served from 1985 as Assistant Controller of Navajo.\nAll officers of the Company are elected annually to serve until their successors have been elected. Mr. Cella has occupied the additional office of Secretary since December 1994. Mr. Clifton previously served as Vice President, Economics, Engineering and Legal Affairs from 1988 to 1991. Mr. Knorr is also President of one of the partners of MRC and serves as the General Manager of MRC. Messrs. Blair, Knapp and White were elected to their respective positions in September 1994. Mr. Blair has served as Marketing Manager of Asphalt and LPG of Navajo since 1989 and previously held various marketing and supply positions. Mr. Knapp joined the Company in 1992 and served as Director of Corporate Development from 1992 to 1994. Mr. Knapp was Director of Corporate Planning for Northwest Airlines from 1991 to 1992, and prior to that was associated with the management consulting firm of Monitor Company from 1987 to 1991. Mr. White has served as Marketing Manager of Light Oils of Navajo since 1989 and previously held various marketing and supply positions.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDERS MATTERS\nThe Company's common stock is traded on the American Stock Exchange under the symbol \"HOC\". The following table sets forth the range of the daily high and low sales prices per share of common stock, dividends paid per share and the trading volume of common stock for the periods indicated:\nAs of July 31, 1995, the Company had approximately 2,000 stockholders of record.\nOn September 29, 1995, the Company's Board of Directors declared a regular quarterly dividend in the amount of $.10 per share payable on October 27, 1995. The Company intends to consider the declaration of a dividend on a quarterly basis, although there is no assurance as to future dividends since they are dependent upon future earnings, capital requirements and financial condition of the Company as well as other factors. The Senior Notes and Credit Agreement limit the payment of dividends. See Note 6 to the Consolidated Financial Statements.\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\n1995 Versus 1994\nNet income for the 1995 fiscal year was $18.1 million, including a $5.7 million accounting change in the first quarter of fiscal 1995, compared to $20.7 million in the prior year.\nRefining margins for the year were weak as crude oil costs increased at a greater rate than product prices. Margins at the Montana refinery were particularly poor in the first nine-month period of fiscal 1995 as compared to the prior year's period. The 11% increase in the Company's revenues for the year ended July 31, 1995 is attributable to a 6% increase in sales volume and higher selling prices. The prior year's sale volumes were reduced by a major maintenance turnaround at Navajo Refining Company's New Mexico facilities.\nEffective August 1, 1994, the Company changed its method of accounting for turnaround costs. Turnarounds consist of preventive maintenance on major processing units, as well as the shutdown and restart of units, and generally are scheduled at two to three year intervals. Previously, the Company estimated the costs of the next scheduled turnaround and ratably accrued the related expenses prior to the actual turnaround. To provide for a better matching of turnaround costs with revenues, the Company changed its accounting method for turnaround costs to one that results in the amortization of costs incurred over the period until the next scheduled turnaround. The amortization of turnaround costs is recorded in depreciation, depletion and amortization expense, whereas previously the expenses accrued prior to the turnaround were recorded in cost of sales as an operating expense. The increase in the current year in depreciation expense is primarily the result of this change in accounting. See Note 2 to the Consolidated Financial Statements for the effect of the accounting change.\n1994 Versus 1993\nNet income for the 1994 fiscal year ended July 31, 1994 was $20.7 million compared to $19.9 million before an accounting change in the prior fiscal year. A charge of $1.0 million relating to a change in the method to account for income taxes reduced net income to $19.0 million in fiscal 1993.\nWhile refinery margins for the 1994 fiscal year as a whole improved over the levels of the prior year, the margins were adversely impacted by poor refined product margins experienced by Navajo Refining Company in the year's fourth quarter, as product prices did not increase commensurately with a rise in crude oil costs. Montana Refining Company had a third consecutive record year in fiscal 1994, as favorable margins were sustained for the entire year. Most of the increase in profitability resulting from the Company's higher refinery margins was offset by the effect of a 3% reduction in sales volumes and the net effect of the other items described below. Net sales for the 1994 fiscal year were down 13% as the result of lower prices on product sales and the decrease in volumes. The reduction in sales volume for the year was caused primarily by a planned major maintenance turnaround of Navajo Refining Company's New Mexico facilities which occurred in the first months of fiscal 1994. A charge\nof $2.9 million was recorded in the fourth quarter of fiscal 1993 to reflect an increase in the estimate for the costs to be incurred in the turnaround, and an additional $1.5 million in excess of the revised accrual at July 31, 1993 was included as an expense in the second quarter of fiscal 1994. Further reducing income in fiscal 1994 were other operating expense increases and an increase in exploration expenses, including dry holes.\nIncome in fiscal 1993 was improved by $4 million relating to the settlement of litigation with a common carrier pipeline and was reduced by a $2 million charge relating to an action by the United States Department of Justice, acting on behalf of the Environmental Protection Agency (EPA). Both of these items are more fully discussed below.\n1993 Versus 1992\nNet income for the year ended July 31, 1993 was $19.9 million before an accounting change compared to $2.8 million in the prior year. The cumulative effect through the 1992 fiscal year of adopting Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\", which amends the accounting for income taxes from the deferral method to the liability method, was to decrease net income by $1.0 million, to $19.0 million for the year ended July 31, 1993. Other than the cumulative effect of the adjustment, the effect of the change on income for the year ended July 31, 1993 was not significant.\nNet income for the year ended July 31, 1993 improved substantially over the prior year due to improved refinery margins and higher sales volumes. Increased sales volumes of 23% and revenues of 24% over the prior year were the result of higher throughputs made possible by the refinery expansion completed in December 1991 and the alleviation of product pipeline distribution constraints in October 1992. Refinery margins and sales volumes for the 1993 fiscal year also may have been favorably affected by a temporary suspension of production during most of the year by a refinery in the Company's principal market area. Additionally contributing to 1993's performance was Montana Refining Company's second consecutive record year. Increases in fiscal 1993 in operating expenses, principally an increase made in the fourth quarter of $2.9 million in the estimate for a planned major maintenance turnaround scheduled for the fall of 1993, depreciation, depletion and amortization, primarily attributable to the refinery expansion, and general and administrative expense reduced profitability. Net income in the fourth quarter of the 1993 fiscal year was improved by pre-tax income of $4 million and reduced by a pre-tax charge of $2 million, both of which are described below.\nThe year ended July 31, 1993 included income of $4 million relating to a settlement of litigation with a common carrier pipeline company. As part of the settlement, trigger events were established which would require increases in the capacity of the pipeline the Company uses to access the Arizona markets.\nAs discussed in detail under Financial Condition below, the $2 million pre-tax charge relates to an enforcement action brought by the United States Department of Justice, acting on behalf of the EPA, which alleges that the Company's subsidiary, Navajo Refining Company, beginning in September 1990 and continuing until the present, violated and continues to violate the Resource Conservation and Recovery Act (RCRA) and implementing regulations of the EPA by treating, storing and disposing of certain hazardous wastes without required authorization and without compliance with regulatory requirements. The complaint seeks a court order directing Navajo to comply with these regulatory standards and civil penalties for the alleged non-compliance.\nNet income in the fourth quarter of fiscal 1992 was improved by the elimination, as a consequence of the Company's acquisition of the remaining interest in Montana Refining Company, of a $2.6 million liability for deferred taxes that had been reflected on the Company's financial statements.\nFINANCIAL CONDITION\nCash flows from operations during fiscal 1995 were greater than capital expenditures, debt payments and dividends paid, resulting in a net increase of cash and cash equivalents of $10.1 million. Working capital decreased during fiscal 1995 by $.5 million to $17.7 million at July 31, 1995. At July 31, 1995, the Company had $25 million of borrowing capacity under the Credit Agreement which can be used for short-term working capital needs. The Company believes that these sources of funds, together with future cash flows from operations and a new private placement and extension of debt currently being completed as described below, should provide sufficient resources, financial strength and flexibility for the Company to satisfy its liquidity needs, capital requirements, and debt service obligations and to permit the payment of dividends for the foreseeable future.\nNet cash provided by operating activities amounted to $34.2 million in fiscal 1995, compared to $27.7 million in fiscal 1994 and $38.7 million in fiscal 1993. The primary reason for the differences in cash provided from operations during the three years ended July 31, 1995 was changes in working capital accounts. Significant amounts of funds were required in fiscal 1994 to maintain working capital levels as compared to both the 1995 and 1993 fiscal year.\nCash flows used for investing activities totalled $57.8 million over the last three years, $15.2 million in 1995, $22.5 million in 1994 and $20.1 million in 1993, all for capital expenditures. In fiscal 1993 and 1994, most of the funds expended were for refinery projects including diesel desulfurization units at the Artesia, New Mexico facility and the Montana refinery in order to meet the October 1993 requirements for lower sulphur content in diesel fuel. The New Mexico unit was completed in August 1993 and the Montana unit was completed in December 1993.\nThe Company has adopted capital budgets totalling $44 million for fiscal 1996. The major components of this budget are projects at the Company's 60,000 barrel per day Navajo Refinery in Artesia, New Mexico. The projects entail both refinery upgrades to improve product yields and a joint venture to ship liquid petroleum gas (LPGs) to Mexico.\nThe Company believes its presently scheduled capital projects will improve product yields and enhance refining profitability. The first of these projects, a UOP Isomerization unit, will increase the refinery's internal octane generating capabilities and will result in improved light product yields. This unit is expected to be operational during the fourth quarter of fiscal 1996. In addition, the Company has determined to make certain state-of-the-art upgrades to its fluid catalytic cracking unit (FCC), which will improve FCC high value product yields. Engineering and equipment procurement for this project will proceed during fiscal 1996, with completion and realization of benefits occurring during fiscal 1997. The total estimated cost of these two projects is $12.5 million.\nThe Company's previously announced joint venture with Amoco and Mapco to transport LPGs to Mexico is in the final stages of negotiation with Pemex. Assuming successful completion of negotiations, a new 12\" pipeline would be constructed from the Navajo refinery in Artesia, New Mexico to El Paso, Texas, thereby allowing Navajo to realize reduced operating expenses at current throughput rates and position it, to expand capacity and ship greater volumes to its El Paso-origin markets, if such steps later prove advantageous. The new line would replace an 8\" pipeline currently used by Navajo which, in turn, would be transferred to the joint venture. The Company's total net cash investment in the project, including a 25% interest in the joint venture, is estimated to be $22 million.\nThe remainder of the approved budget will be for various refinery improvements, environmental and safety enhancements and approximately $2 million for exploration and production activities.\nCash flows used for financing activities amounted to $8.9 million in fiscal 1995, $8.5 million in fiscal 1994 and $13.4 million in fiscal 1993. Financing activities over the last three years included the renewals of the Company's Credit Agreement in July 1993 and July 1995 with a group of banks, which provides for a total facility of $100 million, the full amount of which may be used to support letters of credit and $25 million of which may be used for direct borrowings for short-term working capital needs. The Company had $10.5 million of borrowings outstanding under its Credit Agreement as of July 31, 1992, the full amount of which was paid off during fiscal 1993. The Company made principal payments of $5.6 million on the Senior Notes in June 1994 and 1995.\nIn October 1995, the Company negotiated with a group of insurance companies a new private placement of senior notes in the amount of $39 million and the extension of $21 million of existing Senior Notes for capital expenditures and for general corporate purposes. Closing of this transaction is expected in November 1995. The $39 million of new senior notes have a 10 year maturity, with equal annual principal payments of $5.6 million beginning at the end of the fourth year and will have an interest rate of 7.62%. The extension of $21 million of Series B Notes extends the final maturity from June 2001 to December 2005, with the first principal payment due changed from June 1996 to December 1999 and with an interest rate subsequent to the original maturity date of 7.82%. Both the new notes and the extension have terms and conditions similar to the existing Senior Notes. Maturities of long-term debt for the next five fiscal years upon closing of this transaction are as follows: 1996 -- $10,775,000; 1997 -- $10,775,000; 1998 -- $10,775,000; 1999 -- $5,175,000 and 2000 -- $13,746,000.\nSee Note 6 to the Consolidated Financial Statements for a summary of the Senior Notes and Credit Agreement.\nDiamond Shamrock, Inc., an independent refiner and marketer, is building a 420-mile, ten-inch refined products pipeline from its McKee refinery near Dumas, Texas to El Paso, the Company's largest market. Diamond Shamrock has announced that it expects to complete that pipeline, which will have an initial capacity of 25,000 BPD, in the fourth quarter of calendar 1995, and that it intends to use its pipeline to supply fuel to the El Paso, Arizona and northern Mexico markets. The Diamond Shamrock pipeline could substantially increase the supply of products in the Company's principal markets. In addition, in June 1995, an investor group announced that it is negotiating to purchase an existing crude oil pipeline running from West Texas to a refinery near Houston as part of the investor group's plan to reverse the line and extend it for use in transporting refined products from the Gulf Coast to El Paso.\nAt times in the past, the common carrier pipelines used by the Company to serve the Tucson and Phoenix markets have been operated at or near their capacity. In addition, the common carrier pipeline used by the Company to serve the Albuquerque market currently is operating at or near capacity. As a result, the volume of refined products that the Company and other shippers have been able to deliver to these markets at times has been limited. In general, there is no assurance that the Company will not experience future constraints on its ability to deliver its products through common carrier pipelines or that any existing constraints will not worsen. In particular, the flow of additional product into El Paso for shipment to Arizona, either as a result of the new Diamond Shamrock pipeline or otherwise, could result in the reoccurrence of such constraints.\nIn July 1993, the United States Department of Justice (DOJ), on behalf of the United States Environmental Protection Agency (EPA), filed a suit against the Company's subsidiary, Navajo Refining Company (Navajo) alleging that, beginning in September 1990 and continuing through the present, Navajo has violated and continues to violate the Resource Conservation and Recovery Act (RCRA) and implementing regulations of the EPA by treating, storing and disposing of certain hazardous wastes without compliance with regulatory requirements. The Company believes that the parties are in the final stages of negotiating a resolution of the litigation. If settled as anticipated, the Company would close the existing evaporation ponds of its wastewater management system at a cost believed to be substantially less than $1 million. The settlement also contemplates that the Company would implement one of several alternatives to the existing wastewater treatment system. Depending upon which approach were utilized, the Company could incur total costs of approximately $3 million over the next several years. The costs to implement an alternative wastewater treatment system would be capitalized and amortized over the future useful life of the resulting asset in accordance with generally accepted accounting principles. The settlement with the DOJ also is expected to involve the payment of a civil penalty of less than $2 million. In fiscal 1993, the Company recorded a $2 million reserve for the litigation.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nIndex to Consolidated Financial Statements\nREPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS\nThe Board of Directors and Stockholders of Holly Corporation\nWe have audited the accompanying consolidated balance sheet of Holly Corporation at July 31, 1995 and 1994, and the related consolidated statements of income, cash flows and stockholders' equity for each of the three years in the period ended July 31, 1995. 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 Holly Corporation at July 31, 1995 and 1994, and the consolidated results of its operations and its cash flows for each of the three years in the period ended July 31, 1995, in conformity with generally accepted accounting principles.\nERNST & YOUNG LLP\nDallas, Texas September 26, 1995\nHOLLY CORPORATION\nCONSOLIDATED BALANCE SHEET\nSee accompanying notes.\nHOLLY CORPORATION\nCONSOLIDATED STATEMENT OF INCOME\nSee accompanying notes.\nHOLLY CORPORATION\nCONSOLIDATED STATEMENT OF CASH FLOWS\nSee accompanying notes.\nHOLLY CORPORATION\nCONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY\n($ in thousands)\nSee accompanying notes.\nHOLLY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS July 31, 1995, 1994 and 1993\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION\nThe Company is principally engaged in the refining of petroleum products. Although the Company is also engaged in certain exploration and production activities, such activities do not represent a significant segment of the Company's assets or operations.\nThe consolidated financial statements include the accounts of the Company, its subsidiaries and Montana Refining Company, a Partnership (MRC).\nCASH EQUIVALENTS\nFor purposes of the statement 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.\nINVENTORIES\nInventories are stated at the lower of cost, using the last-in, first-out (LIFO) method for crude oil and refined products and the average cost method for materials and supplies, or market.\nREVENUE RECOGNITION\nSales and related cost of sales are recognized when products are shipped to customers and title passes. Sales are reported exclusive of excise taxes.\nDEPRECIATION\nDepreciation is provided by the straight-line method over the estimated useful lives of the assets, primarily 10 to 30 years for refining and pipeline facilities and 3 to 10 years for corporate and other assets.\nHOLLY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS July 31, 1995, 1994 and 1993\nOIL AND GAS EXPLORATION AND DEVELOPMENT\nThe Company accounts for the acquisition, exploration, development and production costs of its oil and gas activities using the successful efforts method of accounting. Lease acquisition costs are capitalized; undeveloped leases are written down when determined to be impaired and written off upon expiration or surrender. Geological and geophysical costs and delay rentals are expensed as incurred. Exploratory well costs are initially capitalized, but if the effort is unsuccessful, the costs are charged against earnings. Development costs, whether or not successful, are capitalized. Productive properties are stated at the lower of amortized cost or estimated realizable value of underlying proved oil and gas reserves. Depreciation, depletion and amortization of such properties is computed by the unit-of-production method. At July 31, 1995, the Company had not discovered a material amount of proven reserves.\nEARNINGS PER SHARE\nEarnings per share amounts are based upon the weighted average number of common shares outstanding during each period.\nFUTURES CONTRACTS\nThe Company enters into commodity futures contracts to hedge a portion of the price risk associated with crude oil and refined products. Gains or losses on contracts are recognized when the related inventory is sold or the hedged transaction is consummated.\n2. ACCOUNTING CHANGE\nEffective August 1, 1992, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes\", which amends the accounting for income taxes from the deferral method to the liability method. Under the liability method, deferred taxes are stated at the income tax rates currently in effect or scheduled to be implemented rather than at the tax rate in effect when the taxes were provided. The cumulative effect of this accounting change through the 1992 fiscal year was a $958,000 increase in the Company's deferred tax liability at August 1, 1992. This additional income tax expense was reflected as a reduction of $958,000 in net income in the first quarter of the 1993 fiscal year or $.12 per share. Excluding the provision for the cumulative effect upon adoption of the new standard, the effect of the change on net income was not material.\nHOLLY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS July 31, 1995, 1994 and 1993\nEffective August 1, 1994, the Company changed its method of accounting for turnaround costs. Turnarounds consist of preventive maintenance on major processing units as well as the shutdown and restart of all units, and generally are scheduled at two to three year intervals. Previously, the Company estimated the costs of the next scheduled turnaround and ratably accrued the related expenses prior to the actual turnaround. To provide for a better matching of turnaround costs with revenues, the Company changed its accounting method for turnaround costs to one that results in the amortization of costs incurred over the period until the next scheduled turnaround. The cumulative effect of this accounting change through the 1994 fiscal year was an increase in net income in the first quarter of the 1995 fiscal year of $5,703,000 (net of deferred taxes of $3,865,000), or $.69 per common share. Excluding the cumulative effect, the change increased net income for fiscal 1995 by $886,000 or $.11 per common share. If the accounting change for turnaround costs had been retroactively applied, pro forma net income and net income per common share would have been as follows:\n3. ACCOUNTS RECEIVABLE\nCrude oil resales accounts receivable principally represent the sell side of reciprocal crude oil buy\/sell exchange arrangements involved in supplying crude oil to the refineries, with an approximate like amount reflected in accounts payable. The net differential of these crude oil buy\/sell exchanges is reflected in cost of sales. The exchange differentials result principally from crude oil type and location differences.\nCredit losses are provided for in the financial statements and consistently have been minimal.\nHOLLY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS July 31, 1995, 1994 and 1993\n4. INVENTORIES\nThe excess of current cost over the LIFO value of inventory was $7,840,000 and $12,228,000 at July 31, 1995 and 1994, respectively.\n5. PROPERTIES, PLANTS AND EQUIPMENT\nRefining and pipeline facilities at July 31, 1995 and 1994 include $1,578,000 and $4,452,000, respectively, of construction in progress which was not being depreciated at those dates, pending completion of the construction projects.\n6. DEBT\nHOLLY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS July 31, 1995, 1994 and 1993\nSENIOR NOTES\nIn June 1991, the Company sold $80 million of Senior Notes to a group of insurance companies. The Senior Notes were issued in two Series and are unsecured. The Series A Notes are in the principal amount of $28 million, have a 7- year life, require equal annual principal payments of $5,600,000 beginning June 15, 1994 and bear interest at 9.72%. The Series B Notes are in the principal amount of $52 million, have a 10-year life, require equal annual principal payments of $8,667,000 beginning June 15, 1996 and bear interest at 10.16%. The note agreement imposes certain restrictive covenants, including limitations on liens, additional indebtedness, sale of assets, investments, business combinations and dividends, which collectively are less restrictive than the terms of the bank Credit Agreement.\nCREDIT AGREEMENT\nIn June 1995, the Company and certain of its subsidiaries amended its current bank Credit Agreement (Credit Agreement) extending the term for two additional years. The Credit Agreement provides a $100 million facility for letters of credit, or for direct borrowings of up to $25 million, with such borrowings being subject to an annual 20-day cleanup period. Interest on borrowings is based upon, at the Company's option, (i) the agent bank's prime rate plus 1\/2% per annum; (ii) various Eurodollar related rates; and (iii) various certificate of deposit related rates. A fee of 1% per annum is payable quarterly on the outstanding balance of all letters of credit, and a commitment fee of 3\/8 of 1% per annum is payable on the unused portion of the facility. The borrowing base for the facility consists of cash, cash equivalents, accounts receivable and inventory, all of which secure the facility. The Credit Agreement imposes certain restrictions, including: (i) a prohibition of other indebtedness in excess of $3 million with exceptions for, among other things, indebtedness under the Company's Senior Notes and certain nonrecourse debt; (ii) maintenance of certain levels of net worth, working capital and interest coverage; (iii) limitations on investments and dividends; and (iv) a prohibition of incursions on controlling ownership, material changes in senior management and business combinations with unaffiliated entities.\nAt July 31, 1995, the Company had outstanding letters of credit totalling $24,776,000 and no borrowings. The unused commitment under the Credit Agreement at July 31, 1995 was $75,224,000, of which up to $25,000,000 may be used for additional direct borrowings.\nThe average and maximum amounts outstanding and the effective average interest rate for borrowings under the Company's current and prior credit agreements were as follows:\nHOLLY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS July 31, 1995, 1994 and 1993\nThe Senior Notes and Credit Agreement restrict investments and distributions, including dividends, to an amount in the aggregate not to exceed 75% of cumulative consolidated net income (as defined). Under the most restrictive of these covenants, at July 31, 1995 approximately $26.6 million was available for the payment of dividends.\nMaturities of long-term debt for the next five fiscal years are as follows: 1996 -- $14,275,000; 1997 -- $14,275,000; 1998 -- $14,275,000; 1999 - -- $8,675,000 and 2000 -- $8,675,000.\nThe Company made interest payments of $8,183,000 in 1995, $8,744,000 in 1994 and $9,058,000 in 1993.\nBased on the borrowing rates that the Company believes would be available for replacement loans with similar terms and maturities of the debt of the Company now outstanding, the fair value of long-term debt including current maturities would be $73.2 million at July 31, 1995.\n7. INCOME TAXES\nEffective August 1, 1992, the Company adopted SFAS No. 109 to account for income taxes (see Note 2).\nThe statutory federal income tax rate applied to pre-tax book income reconciles to income tax expense as follows:\n(1) Blended rate, as federal income tax rate changed effective January 1, 1993.\nHOLLY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS July 31, 1995, 1994 and 1993\nOperations of the corporation that was the sole limited partner of MRC prior to the acquisition of such corporation by the Company (see Note 10) resulted in unused net operating loss carryforwards of approximately $7,000,000, which are expected to be available to the Company to a limited extent each year through 2006 based on the income of such corporation. As of July 31, 1995, approximately $6,000,000 of these net operating loss carryforwards remain available to offset future income. For financial reporting purposes, any benefit of these net operating loss carryforwards is being offset against any contingent future payments relating to the acquisition of such corporation.\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 amount used for income tax purposes. The Company's deferred income tax assets and liabilities as of July 31, 1995 and 1994 are as follows:\nHOLLY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS July 31, 1995, 1994 and 1993\nThe Company made income tax payments of $7,144,000 in 1995, $18,893,000 in 1994 and $5,138,000 in 1993.\nThe Company's federal income tax returns have been examined by the Internal Revenue Service through 1990.\n8. STOCKHOLDERS' EQUITY\nAt July 31, 1995 and 1994, no stock options were outstanding and 751,500 shares of common stock were reserved for issuance under the Company's stock option plan.\n9. EMPLOYEE BENEFIT PLANS\nPENSION PLANS\nThe Company has a non-contributory defined benefit retirement plan that covers substantially all employees. The Company's policy is to make contributions annually of not less than the minimum funding requirements of the Employee Retirement Income Security Act of 1974. Benefits are based on the employee's years of service and compensation.\nHOLLY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS July 31, 1995, 1994 and 1993\nPension expense includes the following components:\nThe following table sets forth the funded status of the plan and amounts recognized in the consolidated balance sheet:\nHOLLY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS July 31, 1995, 1994 and 1993\nThe principal actuarial assumptions were:\nPension costs are determined using the assumptions as of the beginning of the year. The funded status is determined using the assumptions as of the end of the year.\nApproximately 57% of plan assets is invested in equity securities and 43% is invested in fixed income securities and other instruments at July 31, 1995.\nThe Company has adopted a retirement restoration plan that provides for additional payments from the Company so that total retirement plan benefits for executives will be maintained at the levels provided in the Retirement Plan before the application of Internal Revenue Code limitations. During 1995, the Company accrued $237,000 in connection with this plan.\nEMPLOYEE STOCK OWNERSHIP PLAN\nIn December 1985, the Company established an Employee Stock Ownership Plan (ESOP). The ESOP is non-contributory and includes substantially all employees of the Company and its subsidiaries who meet certain length of service requirements and are not covered by a collective bargaining agreement.\nIn 1985, the ESOP borrowed from the Company the $4,102,000 needed to purchase 1,500,000 shares of the Company's common stock. The loan is repayable in ten annual installments of $410,000 (subject to certain adjustments) commencing August 1, 1986 and bears interest at 12% per annum. The Company is obligated to make annual contributions sufficient to enable the ESOP to repay the loan with interest. The unearned compensation of $4,102,000 was recorded as a reduction of stockholders' equity and is being reduced as payments are made. Interest income earned on the note due from the ESOP is offset against an equal amount contributed to the ESOP by the Company.\nHOLLY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS July 31, 1995, 1994 and 1993\n10. MONTANA REFINING COMPANY, A PARTNERSHIP\nThe Company acquired on July 31, 1992, the corporation that was the limited partner in MRC in connection with a settlement of litigation. The acquisition involved among other items contingent future payments of up to $189,000 per year over the period 1993 through 2005.\n11. OTHER INCOME\nThe 1993 fiscal year included income of $4,000,000 relating to a settlement with a common carrier pipeline concerning product pipeline distribution constraints.\n12. CONTINGENCIES\nIn July 1993, the United States Department of Justice (DOJ), on behalf of the United States Environmental Protection Agency (EPA), filed a suit against the Company's subsidiary, Navajo Refining Company (Navajo) alleging that, beginning in September 1990 and continuing through the present, Navajo has violated and continues to violate the Resource Conservation and Recovery Act (RCRA) and implementing regulations of the EPA by treating, storing and disposing of certain hazardous wastes without compliance with regulatory requirements. The Company believes that the parties are in the final stage of negotiating a resolution of the litigation. If settled as anticipated, the Company would close the existing evaporation ponds of its wastewater management system at a cost believed to be substantially less than $1 million. The settlement also contemplates that the Company would implement one of several alternatives to the existing wastewater treatment system. Depending upon which approach is utilized, the Company could incur total costs of approximately $3 million over the next several years. The costs to implement an alternative wastewater treatment system would be capitalized and amortized over the future useful life of the resulting asset in accordance with generally accepted accounting principles. The settlement with the DOJ also is expected to involve the payment of civil penalty of less than $2 million. In fiscal 1993, the Company recorded a $2 million reserve for the litigation.\nThe Company is a party to various other litigation and proceedings which it believes, based on advice of counsel, will not have a materially adverse impact on its financial condition or operations.\nHOLLY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS July 31, 1995, 1994 and 1993\n13. SIGNIFICANT CUSTOMERS\nVirtually all revenues were domestic revenues (including domestic sales for export to Mexico). Approximately $74,000,000 (12%) of the Company's revenues for fiscal 1995, $67,000,000 (12%) of revenues for fiscal 1994 and $65,000,000 (10%) for fiscal 1993 were from the sale of military jet fuel to the United States Government. Approximately $41,000,000 (7%) of the Company's revenues for fiscal 1995 and $58,000,000 (11%) of revenues for fiscal 1994 were from the sale of gasoline to an affiliate of PEMEX (the government-owned energy company of Mexico). In addition to the United States Government and PEMEX, another refiner, which is a purchaser of gasoline and diesel for resale to retail customers, accounted for approximately $75,000,000 (12%) of the Company's revenues in fiscal 1993. While a loss of, or reduction in amounts purchased by, major purchasers that resell to retail customers could have an adverse effect on the Company, the Company believes that the impact of such a loss on the Company's results of operations should be limited because the Company's sales volume with respect to products whose end-users are retail customers is more dependent on the general retail demand in the Company's primary markets than on sales to any specific customer.\nHOLLY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) July 31, 1995, 1994 and 1993\n14. QUARTERLY INFORMATION (UNAUDITED)\nHOLLY CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) July 31, 1995, 1994 and 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\nThe required information regarding the directors of the Company is incorporated herein by this reference to information set forth under the caption \"Election of Directors\" in the Company's Proxy Statement for its Annual Meeting of Stockholders to be held in December 1995 which will be filed within 120 days of July 31, 1995 (the \"Proxy Statement\").\nThe required information regarding the executive officers of the Company is included herein in Part I, Item 4.\nRequired information regarding compliance with Section 16(a) of the Securities Exchange Act of 1934 is incorporated herein by this reference to information set forth under the caption \"Compliance with Section 16(a) of the Securities Exchange Act of 1934\" in the Proxy Statement.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation regarding executive compensation is incorporated herein by this reference to information set forth under the captions \"Executive Compensation and Other Information\" and \"Compensation Committee Report on Executive Compensation\" in the Proxy Statement.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation regarding security ownership of certain beneficial owners and management is incorporated herein by this reference to information set forth under the captions \"Principal Stockholders\" and \"Election of Directors\" in the Proxy Statement.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation regarding certain relationships and related transactions is incorporated herein by this reference to information set forth under the caption \"Election of Directors\" in the Proxy Statement.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) Documents filed as part of this report\n(1) Index to Consolidated Financial Statements\n(2) Index to Consolidated Financial Statement Schedules\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 or notes thereto.\n(3) Exhibits\nSee Index to Exhibits on pages 44 to 48.\n(b) Reports on Form 8-K\nNo reports on Form 8-K were filed during the Company's fourth quarter that ended July 31, 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.\nHOLLY CORPORATION (Registrant)\n\/s\/ Lamar Norsworthy --------------------- Lamar Norsworthy Chairman of the Board, President and Chief Executive Officer\nDate: October 26, 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.\nHOLLY CORPORATION\nINDEX TO EXHIBITS\n(Exhibits are numbered to correspond to the exhibit table in Item 601 of Regulation S-K)","section_15":""}
{"filename":"766004_1995.txt","cik":"766004","year":"1995","section_1":"ITEM 1. BUSINESS\nSbarro, Inc., a New York corporation, was organized in 1977 and is the successor to a number of family food and restaurant businesses developed and operated by the Sbarro family. The Company has established wholly-owned subsidiaries to operate its restaurants in various geographic areas and to conduct its franchising business. As used in this report, the term \"Company\" refers to Sbarro, Inc. and its consolidated subsidiaries, unless the context indicates otherwise.\nGeneral\nThe Company and its subsidiaries develop and operate or franchise an international chain of family-style Italian restaurants under the \"Sbarro\", \"Sbarro The Italian Eatery\" and \"Cafe Sbarro\" names. Sbarro restaurants are family-oriented cafeteria-style restaurants featuring a menu of popular Italian food, including pizza with a variety of toppings, a selection of pasta dishes and other hot and cold Italian entrees, salads, sandwiches, cheesecake and other desserts.\nAs of December 31, 1995, there were 771 Sbarro restaurants, located in 47 states throughout the United States, as well as Australia, Belgium, Canada, Chile, the District of Columbia, France, Israel, Kuwait, Lebanon, the Philippines, Puerto Rico, Qatar, Saudi Arabia and the United Kingdom. At that date, the Company owned and operated 571 restaurants and franchised 200 restaurants. Most Sbarro restaurants are located in shopping malls. In addition, the Company and its franchisees have opened restaurants at downtown locations, on toll roads, and in strip shopping centers, sports arenas, hospitals, convention centers, universities and airports. In addition, kiosks have been introduced in certain selected markets. The Company continues to develop franchise opportunities in domestic and foreign markets.\nRestaurant Expansion\nThe Company has expanded significantly in recent years, growing from 457 restaurants at the beginning of 1991\nto 771 at the end of 1995. During 1995, 84 new Sbarro restaurants were opened, of which 44 were Company-owned and 40 were franchised. In addition, 40 Company-owned units and two franchised units were closed.\nDuring 1996, the Company plans to open approximately 80 - 90 restaurants, of which approximately 40 - 45 are expected to be Company-owned and the balance are expected to be franchised. The actual number of openings will depend on the Company's ability to locate appropriate sites, negotiate acceptable lease terms, obtain necessary local governmental permits, complete construction, and recruit and train restaurant management and hourly personnel.\nThe Company continues to expand the basic Sbarro concept outside of the shopping mall environment by opening Company and franchised restaurants on toll roads, in strip shopping centers, sports arenas, hospitals, convention centers, universities, airports and in transportation hubs. The Company and its franchisees also operate restaurants in downtown areas of major U. S. cities such as New York, Boston, Chicago and Philadelphia.\nThe following table indicates the number of Company-owned and franchised restaurants during each of the years from 1991 through 1995. Fiscal Year\n1995 1994 1993 1992 1991 Company-owned restaurants: Opened during period 44 53 59 58 63 Acquired from [sold to] franchisees during period - net - 2 7 [1] 2 Closed during period (*) [40] [3] [7] [13] [1] Open at end of period 571 567 515 456 412\nFranchised restaurants: Opened during period (**) 40 38 24 26 19 Purchased from [sold to] Company during period - net - [2] [7] 1 [2] Closed or terminated during period [2] [8] [14] [14] [8] Open at end of period 200 162 134 131 118\nAll restaurants: Opened during period 84 91 83 84 82 Closed or terminated during period [42] [11] [21] [27] [9] Open at end of period 771 729 649 587 530\n(*) In 1995, the Company closed 40 Company-owned restaurants. The costs associated with the closing of these restaurants was provided for in the 1995 financial statements. See Note A to \"Selected Financial Data\" in Item 6 of this Report and ``Management's Discussion and Analysis of Financial Condition and Results of Operations'' in Item 7 of this report.\n(**) In 1995, 1994, 1993 and 1992, Company franchisees opened one, two, two and five kiosk units, respectively. In addition, in 1994 the Company's franchisees closed one kiosk unit and one unit now operates as a food court. These kiosk units are in addition to the restaurants contained in the above table.\nConcept and Menu\nMost Sbarro restaurants are in enclosed shopping malls and are either \"in-line\" or \"food court\" locations. As of December 31, 1995, there were 241 \"in-line\" restaurants, which are self-contained restaurants usually occupying approximately 1,500-3,000 square feet, containing the space and furniture to seat approximately 60-120 people and employing 10-40 persons, including part-time personnel. At that date, there were also 524 \"food court\" restaurants, which are primarily located in areas of shopping malls designated exclusively for restaurant use and share a common dining area provided by the mall. These restaurants are generally smaller in size, occupy approximately 500-1,000 square feet, contain only enough space for kitchen and service areas, have a more limited menu than an \"in-line\" restaurant and employ 6-30 persons, including part-time personnel. A franchisee operates five free-standing units in the Middle East, two of which are in Saudi Arabia and two in Kuwait and one in Qatar. In addition, a franchisee operates a free-standing unit in Puerto Rico.\nThe Company's restaurants are generally open seven days a week serving lunch, dinner and, in limited locations, breakfasts, with hours conforming to the hours of the major department stores or other large retailers in the mall or trade area. Typically, mall restaurants are open to serve customers 10 to 12 hours a day, except on Sunday, when mall hours may be more limited. For Company-owned restaurants open a full year, average sales in 1995 and 1994 were $702,000 and $682,000, respectively, for \"in-line\" restaurants and $487,000 and $507,000, respectively, for \"food court\" restaurants.\nSbarro restaurants are family-oriented, featuring a menu of popular Italian food, including pizza with a variety of toppings, a selection of pasta dishes and other\nhot and cold Italian entrees, salads, sandwiches, cheesecake and other desserts. In addition to soft drinks, some of the larger restaurants serve beer and wine, although alcoholic beverage sales are not emphasized.\nFood is prepared according to special recipes developed by the Sbarro family. Emphasis is placed on serving generous portions of quality Italian-style food at modest prices. Entree selections, excluding pizza, generally range in price from $2.99 to $5.29. The Company believes that pizza, which is sold predominantly by the slice, and other pizza items account for approximately one- half of restaurant sales.\nSbarro restaurants offer quick, efficient, friendly cafeteria-style and buffet service designed to minimize customer waiting time and facilitate table turnover. The decor of a Sbarro restaurant incorporates a contemporary motif, with booth and table seating (for \"in- line\" restaurants), complemented by the feeling of a traditional Italian delicatessen, often with hanging replicas of cheeses, salamis, prosciutto hams and other Italian specialties.\nAll food products are prepared fresh daily in each restaurant. Pastries are purchased locally, and the Company's cheesecakes are prepared in its original kitchen located in Brooklyn, New York. Substantially all of the food ingredients and related restaurant supplies used by the restaurants are purchased from a national independent wholesale food distributor, while breads, produce, fresh dairy and certain meat products are purchased locally for each restaurant. The Company requires that the distributor adhere to established product specifications for all food products sold to its restaurants. The Company believes that there are other distributors who would be able to service the Company's needs and that satisfactory alternative sources of supply are generally available for all items regularly used in the restaurants.\nRestaurant Management\nEach Sbarro restaurant is managed by one General Manager and one or two Co-managers or Assistant Managers. Managers are required to participate in Company training sessions in restaurant management and operations prior to the assumption of their duties. In addition, each restaurant manager is required to comply with an extensive operations manual containing procedures for assuring uniformity of operations and consistent high quality of products.\nThe Company has a Restaurant Management Bonus Program which provides the management teams of Company-owned restaurants with the opportunity to receive cash bonuses based on a percentage of the operating profits of the restaurants and other performance related criteria.\nThe Company also employs 65 - 70 Area Directors, each of whom is typically responsible for the operations of 7 - 15 Company-owned restaurants in a given area. Before each new restaurant opening, the Company assigns an Area Director to coordinate opening procedures. Each Area Director reports to one of seven Regional Vice-Presidents. The Regional Vice-Presidents recruit, train and supervise the managerial and staff employees of all Company-owned restaurants. The Regional Vice-Presidents report to one of two Vice-Presidents of Operations. The Vice-Presidents of Operations coordinate the activities of the Regional Vice- Presidents assigned to their areas of responsibility and act as liaisons with the corporate office.\nFranchise Development\nThe Company continues to emphasize expansion through Company-owned units. In addition, increased growth in franchise operations is anticipated through the establishment of new restaurants by new franchisees and by existing franchisees capable of multi-unit operations. The Company relies principally upon its reputation and the strength of its existing restaurants to attract new franchisees.\nAs of December 31, 1995, the Company had 200 franchised restaurants operated by 65 franchisees in 28 states, Australia, Belgium, Canada, Chile, France, Israel, Kuwait, Lebanon, the Philippines, Puerto Rico, Qatar, Saudi Arabia and the United Kingdom.\nPrior to 1995, territorial agreements, which grant exclusive geographic development rights for a specified time period to franchisees, were entered into for Puerto Rico (including portions of the Caribbean Basin), the Netherlands, Luxembourg, Belgium, Northern France, Chile and Israel. In 1995, an additional Territorial Agreement was entered into for Korea and in early 1996 for Japan. The Company is in discussion regarding territorial agreements for Russia, the Bahamas, China, Hong Kong and South Africa.\nIn addition, the Company has agreements with Marriott Corporation and Concession Air Corporation covering the franchising in the United States of Sbarro units on certain toll roads and at certain airports and universities.\nIt also has a relationship with Forte PLC (formerly Trusthouse Forte) for the franchising of Sbarro units on motorways and at airports in the United Kingdom.\nThe Company is presently considering additional franchise opportunities in the United States and other countries.\nThe Company's basic franchise agreement generally requires payment of an initial license fee of $35,000 and requires continuing payments of fees of 5% - 7% of gross revenues (which includes total receipts from all sales less applicable sales taxes). Franchise agreements entered into prior to 1988 generally have an initial term of 15 years with the franchisee having a 5-year renewal option, provided that the agreement has not been previously terminated by either party for specified reasons. Since 1988, the Company has required the franchise agreements to be coterminous with the underlying lease, but generally not less than ten nor more than twenty years. Since 1990, the Company has granted a renewal option subject to certain conditions, including a remodel or image enhancement requirement. Franchise agreements granted under Territorial Agreements contain negotiated terms and conditions other than those contained in the Company's basic franchise agreement. The Company retains the right to terminate a franchisee for a variety of reasons, including insolvency or bankruptcy, failure to operate the restaurant according to standards, understatement of gross receipts, failure to pay fees, or material misrepresentation on an application for a franchise.\nNew Ventures\nDuring 1995, the Company entered into joint venture arrangements for the purpose of developing three potential new restaurant concepts. The first venture is developing a casual dining chain in a Rocky Mountain steakhouse motif. This venture, in which the Company has a 40% interest, presently operates two restaurants under the name Boulder Creek Steaks and Saloon, with a third restaurant under development. The second venture, in which the Company has a 70% interest, is developing a moderately priced, table service restaurant chain featuring an Italian Mediterranean menu under the name Bice Mediterranean Grille. Three restaurants in New York City and Long Island, New York are currently under development by this venture. The third venture is a family restaurant concept under the name Umberto's of New Hyde Park featuring pizza and other Italian-style foods with table and take-out service. The Company has an 80% interest in this venture, whose first unit is currently under development. The Company intends to\nuse 1996 to study the initial results of these three concepts for the purpose of evaluating their potential for future growth.\nEmployees\nAs of December 31, 1995, the Company employed approximately 7,700 persons, of whom approximately 2,600 were full-time field and restaurant personnel, 4,930 were part-time restaurant personnel and 170 were Headquarters Office personnel. None of the Company's employees are covered by collective bargaining agreements. The Company believes its employee relations are satisfactory.\nCompetition\nThe restaurant business is highly competitive with respect to price, service, location and food quality, and is often affected by changes in consumer tastes, economic conditions, population and traffic patterns. There is active competition for management personnel and attractive commercial shopping mall, center city and other locations suitable for restaurants. The Company competes in each market with locally-owned restaurants as well as with national and regional restaurant chains.\nTrademarks\nThe \"Sbarro\", \"Cafe Sbarro\", and \"Sbarro The Italian Eatery\" service marks are registered with the United States Patent and Trademark Office for terms presently expiring in 2004, 2001 and 2006, respectively. Registered service marks may continually be renewed for 10 year periods. The Company has also filed applications to register or has registered \"Sbarro\", \"Cafe Sbarro\" and \"Sbarro The Italian Eatery\" in several other countries. The Company believes that these marks continue to be materially important to the Company's business.\nGovernmental Regulation\nThe Company is subject to various Federal, state and local laws affecting its business. The restaurants of the Company and its franchisees are subject to a variety of regulatory provisions relating to wholesomeness of food, sanitation, health, safety and, in certain cases, licensing of the sale of alcoholic beverages.\nThe Company is also subject to a substantial number of state laws and regulations governing the offer and sale of franchises. Such laws impose registration and disclosure requirements on franchisors in the offer and sale\nof franchises and may also apply substantive standards to the relationship between franchisor and franchisee. The Company is also subject to Federal Trade Commission regulations governing disclosure requirements in the sale of franchises.\nThe Fair Labor Standards Act, governing such matters as minimum wage requirements, overtime, employment of minors and other working conditions, is applicable to the Company.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nAll Sbarro restaurants are operated in leased premises. As of December 31, 1995, the Company leased 601 restaurants, of which 30 were subleased to franchisees under terms which cover all obligations of the Company under the lease. The remaining franchisees directly lease their restaurant spaces. Most of the Company's restaurant leases provide for the payment of base rents plus real estate taxes, utilities, insurance, common area charges and certain other expenses, as well as contingent rents generally ranging from 6% to 10% of net restaurant sales in excess of stipulated amounts. Leases to which the Company was a party at December 31, 1995 have initial terms expiring as follows:\nYears Initial Lease Number of Company- Number of Franchised Terms Expire owned Restaurants Restaurants\n1996 16 4 1997 - 1999 134 10 2000 - 2004 321 16 2005 - 2013 100 -\nSince May 1986, the Company's Headquarters have been located in a two-story 20,000 square foot office building located in Commack, New York, which is subleased for a period of fifteen years from a partnership owned by certain shareholders of the Company at an annual base rental of $298,000 until April 1996, and $337,000 thereafter. In addition, the Company pays real estate taxes, utilities, insurance and certain other expenses for the facility.\nIn March 1994, the Company purchased a 100,000 square foot office building in Melville, New York, for $5,350,000. The Company is in the process of refurbishing the building at an estimated cost of approximately $7 million and intends to occupy a portion of the building in\nlate 1996 as its Corporate Headquarters and lease the remainder of the building.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nFrom time to time the Company is a party to certain claims and legal proceedings in the ordinary course of business. There are no pending claims or proceedings which, in the opinion of the Company, would 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\nNot applicable.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS\nEffective September 23, 1994, the Company's Common Stock was listed on the New York Stock Exchange (under the symbol ``SBA'') and its listing was withdrawn from the American Stock Exchange. The range of high and low sales prices on the New York Stock Exchange and the American Stock Exchange for the last two fiscal years is as follows:\n1995 1994\nQuarter High Low Quarter High Low Ended Ended\nApril 23 $27.88 $22.75 April 24 $29.50 $21.92 July 16 $26.00 $19.88 July 17 $25.83 $21.33 October 8 $25.00 $21.50 October 9 $25.63 $22.58 December 31 $23.25 $20.88 January 1 $26.00 $21.25\nAs of March 1, 1996 there were approximately 630 holders of record of the Company's Common Stock, exclusive of shareholders whose shares were held by brokerages, depositories and other institutional firms in \"street name\" for their customers.\nIn 1995 and 1994, the Company declared quarterly dividends of $.19 per share and $.16 per share, respectively, aggregating $.76 per share and $.64 per share for the respective years. On February 22, 1996, the Company's Board of Directors declared an increase in the quarterly dividend to $.23 per share, beginning with the quarterly cash dividend to be paid on April 3, 1996 to shareholders of record on March 19, 1996.\nAll share and per share data have been adjusted to give effect to a 3-for-2 stock split in the form of a 50% stock dividend distributed on September 22, 1994 to shareholders of record on September 9, 1994.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following Selected Financial Data should be read in conjunction with Management's Discussion and Analysis included in Item 7","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nResults of Operations\n1995 Compared to 1994\nRestaurant sales from Company-owned units increased 7.4% to $310,132,000 in 1995 from $288,808,000 in 1994. The increase resulted primarily from the higher number of units in operation during 1995, in addition to a .5% increase in comparable restaurant sales to $273,927,000 from $272,460,000 in 1994. In March 1995, the Company selectively increased menu prices which did not materially affect 1995 sales. Comparable unit sales are made up of sales at locations that were open during the entire current and prior fiscal year.\nFranchise related income increased 13.5% to $5,942,000 in 1995 from $5,234,000 in 1994. This increase resulted from higher royalties due to a larger number of franchise units in operation in the current year than in 1994 on relatively stable comparable unit sales, as well as an increase in the number of new franchise units resulting in higher initial franchise fees.\nInterest income increased to $3,081,000 in 1995 from $1,949,000 in 1994. This increase was primarily due to larger amounts of cash invested and higher investment yields on invested cash and marketable securities for the fiscal year.\nCost of food and paper products increased as a percentage of restaurant sales to 21.7% in 1995 from 21.4% in 1994. This increase was primarily due to higher prices of cheese and paper products in 1995.\nRestaurant operating expenses - payroll and other employee benefits increased to 25.3% of restaurant sales in 1995 from 24.5% of restaurant sales in 1994. This percentage increase is attributable to the higher cost of providing benefits to employees and a slower growth in comparable unit sales in 1995. Restaurant operating expenses - occupancy and other expenses increased to 27.2% of restaurant sales in 1995 from 26.4% of restaurant sales in 1994. This percentage increase was attributable to higher occupancy related charges and a slower growth in comparable unit sales in 1995.\nDepreciation and amortization increased to $23,630,000 in 1995 from $21,674,000 in 1994. The increase was the result of the number of additional Company-owned units in operation during 1995 over the number of units in operation during 1994.\nGeneral and administrative expenses were $16,089,000 in 1995 or 5.0% of revenues and $13,319,000 in 1994 or 4.5% of revenues. This increase was primarily due to increased costs associated with supervising and administering the additional restaurants in operations and adding management level personnel.\nIn 1995, a provision of $16,400,000 before tax ($10,168,000 or $0.50 per share after tax) was established for the closing of approximately 40 under-performing restaurants. These units produced sales of approximately $8 million in 1995 and pretax losses of approximately $3.2 million ($2 million or $0.10 per share after tax).\nThe effective income tax rate was 38.0% for 1995 and 1994.\n1994 Compared to 1993\nRestaurant sales from Company-owned units increased 11.4% to $288,808,000 in 1994 from $259,213,000 in 1993. The increase resulted primarily from sales at restaurants opened or acquired subsequent to January 3, 1993 in addition to a 3.1% increase in comparable restaurant sales to $250,280,000 in 1994 from $242,755,000 in 1993. There were no significant adjustments in menu prices that affected the comparison of the periods. Comparable restaurant sales are made up of sales at locations that were open during the entire 1994 and 1993 fiscal years.\nFranchise related income increased 10.0% to $5,234,000 in 1994 from $4,758,000 in 1993. This increase resulted primarily from an increase in royalties due to the larger number of franchise units in operation for the fiscal year. Comparable sales at franchise locations did not change significantly.\nInterest income increased to $1,949,000 in 1994 from $1,579,000 for 1993. This increase was primarily due to higher prevailing interest rates and an increase in invested cash and marketable securities for the fiscal year.\nCost of food and paper products, as a percentage of restaurant sales, were comparable for the reported fiscal years (21.4% for 1994 and 1993) reflecting similar raw ingredient prices in each year.\nRestaurant operating expenses - payroll and other employee benefits decreased to 24.5% of restaurant sales in 1994 from 24.9% of restaurant sales in 1993. This percentage decrease is primarily attributable to higher comparable unit sales in 1994, resulting in spreading the fixed portion of restaurant payroll over this larger sales base. Restaurant operating expenses - occupancy and other expenses remained relatively consistent in each year at 26.4% in 1994 and 26.3% in 1993.\nDepreciation and amortization increased to $21,674,000 in 1994 from $18,599,000 in 1993. The increase was the result of the number of additional Company-owned units in operation in 1994 and property and equipment expenditures, primarily in late 1993 and early 1994, related to the conversion of certain restaurants to the buffet concept.\nGeneral and administrative expenses were $13,319,000 in 1994 or 4.5% of revenues and $12,913,000 in 1993 or 4.9% of revenues. The dollar increase reflects the Company's addition of management (principally, field support) personnel during 1993 which permitted further expansion in 1994 of operating units and sales without further substantial addition to its administrative costs in 1994. The percentage decrease reflects the spreading of non-variable costs over a larger revenue base.\nThe effective income tax rate was 38.0% for 1994 and 39.6% for 1993. The 1994 percentage reflects lower state and local income taxes. Included in the 1993 rate is a non-recurring increase in the provision of $377,000 due to the increase in the Federal corporate income tax rate applied to the Company's deferred tax liabilities at year- end 1992.\nImpact of Inflation\nFood, labor, construction and equipment costs are the items most affected by inflation in the restaurant business. Although for the past several years inflation has not been a significant factor, there can be no assurance that this trend will continue.\nSeasonality\nThe Company's business is subject to seasonal fluctuations, the effects of weather and economic conditions. Earnings have been highest in its fourth fiscal quarter due primarily to increased volume in shopping malls during the holiday shopping season. Normally the fourth fiscal quarter accounts for approximately 40% of net income for the year. In 1995, the fourth fiscal quarter accounted for 42% of net income for the year (prior to the provision in 1995 for unit closings). The length of the holiday shopping period between Thanksgiving and Christmas and the number of weeks in the fourth quarter produce changes in the fourth quarter earnings relationship from year to year. (See also, ``Accounting Period''.)\nLiquidity and Capital Resources\nDuring 1995, operating activities contributed $54.6 million to cash flow resulting primarily from net income of $21.3 million, a non-cash expense of $23.6 million for depreciation and amortization and a $16.4 million provision for store closings, which were somewhat offset by a reduction in deferred income taxes of $5.2 million. During the year, the Company expended approximately $17.5 million for the acquisition of property and equipment related, primarily, to the opening of 44 Company-owned restaurants.\nThe Company anticipates that approximately 40 - 45 Company-owned and operated units will be opened during 1996 and that its capital expenditures (including approximately $7 million to renovate and equip the Company's new headquarters building) will approximate $25 million in 1996. The Company does not anticipate making material expenditures for remodeling of Company-owned restaurants during 1996. From time to time, the Company has the opportunity to contract for and secure price protection for certain of its raw ingredients. Such situations may require the advance outlay of funds for inventories of these items.\nAt December 31, 1995, the Company had cash, cash equivalents and marketable securities of approximately $103.5 million and its working capital was approximately $57.6 million.\nIn 1995, the Company declared quarterly dividends of $0.19 per share aggregating $0.76 per share (or $15.5 million) for the year. In February 1996, the Company's Board of Directors declared an increase in its quarterly dividend to $0.23 per share. The first such quarterly cash dividend will be paid on April 3, 1996 to shareholders of record on March 19, 1996.\nThe Company believes, based on current projections, that its liquid assets presently on hand, together with funds expected to be generated from operations, should be sufficient for its presently contemplated operations, dividends and the purchase of property and equipment for the opening of additional restaurant locations, as well as to renovate and equip the Company's new headquarters building. Accounting Period The Company's fiscal year ends on the Sunday nearest to December 31, with fiscal quarters of sixteen weeks in the first quarter and twelve weeks in each succeeding quarter (except in a 53 week year, which has a thirteen week fourth quarter, the next of which will be fiscal 1998). The Company's 1995, 1994 and 1993 fiscal years each contained 52 weeks. ITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Annexed hereto starting on Page. ITEM 9.","section_9":"ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None PART III PART III\nThe information called for by Part III (Items 10, 11, 12 and 13) of Form 10-K is incorporated herein by reference to such information which will be contained in the Company's definitive Proxy Statement to be used in connection with the Company's 1996 Annual Meeting.\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) and (a) (2) and (d) Financial Statements and Financial Statement Schedule\nFinancial Statements Page\nReport of Independent Public Accountants\nConsolidated Balance Sheets at December 31, 1995 and January 1, 1995\nConsolidated Statements of Income for each of the years in the three-year period ended December 31, 1995\nConsolidated Statements of Shareholders' Equity for each of the years in the three-year period ended December 31, 1995\nConsolidated Statements of Cash Flows for each of the years in the three-year period ended December 31, 1995\nNotes to Consolidated Financial Statements\nFinancial Statement Schedules\nReport of Independent Public Accountants on Schedule S-1\nII - Valuation and Qualifying Accounts S-2\n(b) Reports on Form 8-K\nThe only Reports on Form 8-K filed during the fourth quarter of the Company's fiscal year ended December 31, 1995 were reports dated December 13, 1995 and December 27, 1995 (dates of earliest events reported), each reporting under Item 5. Other events.\n(c) Exhibits:\n* 3.01(a) Restated Certificate of Incorporation of the Company as filed with the Department of State of the State of New York on March 29, 1985. (Exhibit 3.01 to the Company's Registration Statement on Form S-1, File No. 2-96807)\n(c) Exhibits (continued):\n* 3.01(b) Certificate of Amendment to the Company's Restated Certificate of Incorporation as filed with the Department of State of the State of New York on April 3, 1989. (Exhibit 3.01(b) to the Company's Annual Report on Form 10-K for the year ended January 1, 1989, File No. 1-8881)\n* 3.01(c) Certificate of Amendment to the Company's Restated Certificate of Incorporation as filed with the Department of State of the State of New York on May 31, 1989. (Exhibit 4.01 to the Company's Quarterly Report on Form 10-Q for the quarter ended April 23, 1989, File No. 1-8881)\n* 3.01(d) Certificate of Amendment to the Company's Restated Certificate of Incorporation as filed with the Department of State of the State of New York on June 1, 1990. (Exhibit 4.01 to the Company's Quarterly Report on Form 10-Q for the quarter ended April 22, 1990, File No. 1-8881)\n* 3.02 By-Laws of the Company, as amended. (Exhibit 4.02 to the Company's Quarterly Report on Form 10-Q for the quarter ended April 23, 1989, File No. 1-8881)\n*10.01 Commack, New York Corporate Headquarters Sublease. (Exhibit 10.04 to the Company's Registration Statement on Form S-1, File No. 2-96807)\n+ *10.02(a) 1985 Incentive Stock Option Plan, as amended. (Exhibit 4.01 to Post-Effective Amendment No. 1 to the Company's Registration Statement on Form S-8 File No. 33-4380)\n+ *10.02(b) 1991 Stock Incentive Plan, as amended. (Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended April 24, 1994, File No. 1-8881)\n+ *10.02(c) Form of Stock Option Agreement dated May 30, 1990 between the Company and each of Anthony Sbarro, Joseph Sbarro and Mario Sbarro, together with a schedule, pursuant to Instruction 2 to Item 601 of Regulation S-K,\n(c) Exhibits (continued):\nidentifying the details in which the actual agreements differ from the exhibit filed herewith. (Exhibit 10.02(c) to the Company's Annual Report on Form 10-K for the year ended December 30, 1990, File No. 1-8881)\n+ *10.02(d) 1993 Non-Employee Director Stock Option Plan. (Exhibit 10.02 (d) to the Company's Annual Report on Form 10-K for the year ended January 3, 1993, File No. 1-8881)\n+ *10.03 Consulting Agreement (including option) dated June 3, 1985 between the Company and Bernard Zimmerman & Company, Inc. (Exhibit 10.04 to the Company's Annual Report on Form 10-K for the year ended January 1, 1989, File No. 1-8881)\n+ *10.04 Form of Indemnification Agreement between the Company and each of its directors and officers. (Exhibit 10.04 to the Company's Annual Report on Form 10-K for the year ended December 31, 1989, File No. 1-8881)\n*22.01 List of subsidiaries. (Exhibit 22.01 to the Company's Annual Report on Form 10-K for the year ended January 2, 1994, File No. 1-8881)\n23.01 Consent of Arthur Andersen LLP.\n27.01 Financial Data Schedule.\n* Incorporated by reference to the document indicated.\n+ Management contract or compensatory plan.\nSIGNATURES\nPursuant to the requirements of Section 13 or\n15(d) of the Securities Exchange Act of 1934, the registrant\nhas duly caused this report to be signed on its behalf by\nthe undersigned, thereunto duly authorized on March 27,\n1996.\nSBARRO, INC.\nBy: \/s\/ Mario Sbarro Mario Sbarro, Chairman of the Board\nPursuant to the requirements of the Securities Exchange\nAct of 1934, this report has been signed below by the\nfollowing persons on behalf of the registrant and in the\ncapacities and on the dates indicated.\nSignature Title Date\n\/s\/ Mario Sbarro Chairman of the Board, March 27, 1996 Mario Sbarro (Principal Executive Officer) and Director\n\/s\/Robert S. Koebele Vice President-Finance March 27, 1996 Robert S. Koebele (Chief Financial and Accounting Officer)\n\/s\/Joseph Sbarro Director March 27, 1996 Joseph Sbarro\n\/s\/Anthony Sbarro Director March 27, 1996 Anthony Sbarro\n\/s\/Harold Kestenbaum Director March 27, 1996 Harold Kestenbaum\n\/s\/Richard A. Mandell Director March 27, 1996 Richard A. Mandell\nSignature Title Date\n\/s\/Paul A. Vatter Director March 27, 1996 Paul A. Vatter\n\/s\/Terry Vince Director March 27, 1996 Terry Vince\n\/s\/Bernard Zimmerman Director March 27, 1996 Bernard Zimmerman\nARTHUR ANDERSEN LLP\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Board of Directors and Shareholders of Sbarro, Inc.:\nWe have audited the accompanying consolidated balance sheets of Sbarro, Inc. (a New York corporation) and subsidiaries as of December 31, 1995 and January 1, 1995, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1995. 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 Sbarro, Inc. and subsidiaries as of December 31, 1995 and January 1, 1995, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\n\/s\/ Arthur Andersen LLP\nNew York, New York February 9, 1996\nSBARRO, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\nASSETS\n(In thousands) December 31, January 1, 1995 1995\nCurrent assets: Cash and cash equivalents $93,501 $42,362 Marketable securities 27,033\nReceivables: Franchisees 741 445 Other 1,863 2,270\n2,604 2,715\nInventories 2,763 2,792\nPrepaid expenses 1,754 1,570\nTotal current assets 100,622 76,472\nMarketable securities 10,000 11,585\nProperty and equipment, net (Note 3,9) 126,757 140,709\nOther assets: Deferred charges, net of accumulated amortization of $1,573,000 at December 31, 1995 and $1,548,000 at January 1, 1995 1,767 1,874 Other 3,584 1,411\n5,351 3,285\n$242,730 $232,051\n(continued)\nSBARRO, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS (CONTINUED)\nLIABILITIES AND SHAREHOLDERS' EQUITY\n(In thousands) December 31, January 1, 1995 1995\nCurrent liabilities: Accounts payable $7,399 $6,375 Accrued expenses (Note 4) 27,005 18,711 Dividend payable 3,865 3,253 Income taxes (Note 5) 4,708 4,862\nTotal current liabilities 42,977 33,201\nDeferred income taxes (Note 5) 14,087 19,270\nCommitments (Note 6)\nShareholders' equity (Note 8): Preferred stock, $1 par value; authorized 1,000,000 shares; none issued Common stock, $.01 par value; authorized 40,000,000 shares; issued and outstanding 20,345,483 shares at December 31, 1995 and 20,328,981 shares at January 1, 1995 203 203 Additional paid-in capital 30,330 30,066 Retained earnings 155,133 149,311 185,666 179,580\n$242,730 $232,051\nSee notes to consolidated financial statements\nSBARRO, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF INCOME\n(In thousands, except per share data)\nFor the Years Ended\nDecember 31, January 1, January 2, 1995 1995 1994 Revenues: Restaurant sales $310,132 $288,808 $259,213 Franchise related income 5,942 5,234 4,758 Interest income 3,081 1,949 1,579 Total revenues 319,155 295,991 265,550\nCosts and expenses: Cost of food and paper products 67,361 61,877 55,428 Restaurant operating expenses: Payroll and other employee benefits 78,342 70,849 64,653 Occupancy and other expenses 84,371 76,353 68,241 Depreciation and amortization 23,630 21,674 18,599 General and administrative 16,089 13,319 12,913 Provision for unit closings (Note 9) 16,400 Other income (1,359) (1,351) (1,244) Total costs and expenses 284,834 242,721 218,590\nIncome before income taxes and cumulative effect of change in method of accounting for income taxes 34,321 53,270 46,960 Income taxes (Note 5) 13,042 20,244 18,612 Income before cumulative effect of accounting change 21,279 33,026 28,348 Cumulative effect of change in method of accounting for income taxes (Note 5) 1,010\nNet income $21,279 $33,026 $29,358\n(continued)\n(Consolidated Statements of Income - Continued)\nPer share data: Earnings per common and common equivalent share before cumulative effect of change in method of accounting for income taxes $1.05 $1.63 $1.40 Cumulative effect of change in method of accounting for income taxes (Note 5) 0.05 Earnings per common and common equivalent share $1.05 $1.63 $1.45 Dividends declared $0.76 $0.64 $0.52\nWeighted average number of shares used in the computation 20,336,809 20,310,283 20,280,816\nSee notes to consolidated financial statements\nSBARRO, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY\n(In thousands, except share data)\nCommon stock Additional Number of paid-in Retained shares Amount capital earnings Total\nBalance at January 3, 1993 13,513,499 $135 $29,092 $110,747 $139,974\nExercise of stock options 17,662 523 523\nNet income 29,358 29,358\nDividends declared (10,818) (10,818)\nBalance at January 2, 1994 13,531,161 135 29,615 129,287 159,037\nExercise of stock options 24,124 519 519\n3-for-2 stock split 6,773,696 68 (68)\nNet income 33,026 33,026\nDividends declared (13,002) (13,002)\nBalance at January 1, 1995 20,328,981 203 30,066 149,311 179,580\nExercise of stock options 16,502 264 264\nNet income 21,279 21,279\nDividends declared (15,457) (15,457)\nBalance at December 31, 1995 20,345,483 $203 $30,330 $155,133 $185,666\nSee notes to consolidated financial statements\nSBARRO, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\n(In thousands)\nFor the Years Ended\nDecember 31, January 1, January 2, 1995 1995 1994 Operating activities:\nNet income $21,279 $33,026 $29,358 Adjustments to reconcile net income to net cash provided by operating activities: Cumulative effect of change in method of accounting for income taxes (1,010) Depreciation and amortization 23,630 21,674 18,599 Provision for deferred income taxes (5,183) 1,192 555 Provision for unit closings 16,400\nChanges in operating assets and liabilities: Decrease (increase) in receivables 58 (1,441) (290) Decrease (increase) in inventories 29 (257) (364) (Increase) decrease in prepaid expenses (292) (103) 66 Increase in deferred charges(1,400) (1,605) (1,551) Increase in other assets (2,425) (122) (254) Increase in accounts payable and accrued expenses 2,638 1,736 2,810 (Decrease) increase in income taxes payable (154) 301 173\nNet cash provided by operating activities 54,580 54,401 48,092\n(continued)\nSBARRO, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)\n(In thousands)\nFor the Years Ended\nDecember 31, January 1, January 2, 1995 1995 1994 Investing activities:\nProceeds from maturities of marketable securities 28,618 Proceeds from sales of marketable securities 526,192 23,298 Purchases of marketable securities (527,555) (60,553) Purchases of property and equipment (17,513) (32,058) (31,898) Proceeds from disposition of property and equipment 34 14 15\nNet cash provided by (used in) investing activities 11,139 (33,407) (69,138)\nFinancing activities:\nProceeds from exercise of stock options 264 519 523 Cash dividends paid (14,844) (12,456) (8,111)\nNet cash used in financing activities (14,580) (11,937) (7,588)\nIncrease (decrease) in cash and cash equivalents 51,139 9,057 (28,634) Cash and cash equivalents at beginning of year 42,362 33,305 61,939\nCash and cash equivalents at end of year $93,501 $42,362 $33,305\nSee notes to consolidated financial statements\nSBARRO, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. Summary of significant accounting policies:\nBasis of financial statement presentation:\nThe consolidated financial statements include the accounts of Sbarro, Inc. and its wholly-owned subsidiaries (the \"Company\"). All material intercompany accounts and transactions have been eliminated.\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that may affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.\nCash equivalents:\nAll highly liquid debt instruments with a maturity of three months or less at the time of purchase are considered to be cash equivalents.\nMarketable securities:\nThe Company classifies its investments in marketable securities as ``held to maturity''. These investments are stated at amortized cost, which approximates market, and are comprised primarily of direct obligations of the U.S. Government and its agencies. Securities classified as long term mature in 1997 and 1998.\nInventories:\nInventories, consisting primarily of food, beverages and paper supplies, are stated at cost which is determined by the first-in, first-out method.\nProperty and equipment and depreciation:\nProperty and equipment are stated at cost. Depreciation is provided for principally by the straight-line method over the estimated useful lives of the assets. Amortization of leasehold improvements is provided for by the straight-line method over the estimated useful lives of the assets or the lease term, whichever is shorter. One-half year of depreciation\nSBARRO, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n1. Summary of significant accounting policies (continued):\nProperty and equipment and depreciation (continued)\nand amortization is recorded in the year in which the restaurant commences operations.\nDeferred charges:\nCertain costs and expenses incurred which are directly related to new restaurant openings (primarily crew payroll costs and travel expenses incurred prior to opening) are deferred and amortized on a straight-line basis over a twenty-four month period. One-half year of amortization is recorded in the year in which the restaurant commences operations.\nDeferred income:\nDeferred income relates to vendor cash advances for allowances to be based on product usage.\nFranchise related income:\nInitial franchise fees are recorded as income as restaurants are opened by the franchisee and all services have been substantially performed by the Company. Development fees are amortized over the number of restaurant openings covered under each development agreement. Royalty and other fees from franchisees are accrued as earned. Revenues and expenses related to construction of franchised restaurants are recognized when contractual obligations are completed and the restaurants are opened.\nIncome taxes:\nThe Company files a consolidated federal income tax return. Deferred income taxes result primarily from differences between financial and tax reporting of depreciation and amortization.\nAccounting period:\nThe Company's fiscal year ends on the Sunday nearest to December 31, with fiscal quarters of sixteen weeks in the first quarter and twelve weeks in each succeeding quarter (except in a 53 week year, which has a thirteen week fourth quarter).\nSBARRO, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n1. Summary of significant accounting policies (continued):\nPer share data:\nEarnings per share is computed using the weighted average number of common shares outstanding and, where applicable, common equivalent shares issuable upon exercise of stock options calculated under the treasury stock method.\nAll share and per share data have been adjusted to give effect to a 3-for-2 stock split in the form of a 50% stock dividend distributed on September 22, 1994.\nImpact of recently issued accounting standards:\nIn March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (``SFAS'') No. 121, ``Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of''. The Company anticipates that SFAS 121, which is effective for the Company's 1996 fiscal year, will not have a material impact on the Company's results of operations and financial condition.\nSupplemental disclosures of cash flow information:\n(In thousands)\nFor the Years Ended\nDecember 31, January 1, January 2, 1995 1995 1994 Cash paid for:\nIncome taxes $18,880 $18,992 $17,386\n2. Description of business: The Company, its subsidiaries and franchisees develop and operate family oriented cafeteria style Italian restaurants under the ``Sbarro'', ``Sbarro the Italian Eatery'' and ``Cafe Sbarro'' names. The restaurants are located throughout the United States and overseas, principally, in shopping malls and other high traffic locations.\nSBARRO, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n2. Description of business (continued):\nThe following tabulates the number of units in operation as of the end of the indicated fiscal years:\nDecember 31, January 1, January 2, 1995 1995 1994\nCompany-owned 571 567 515 Franchised 200 162 134\n771 729 649\n3. Property and equipment:\n(In thousands)\nDecember 31, January 1, 1995 1995\nLeasehold improvements $142,341 $142,264 Furniture, fixtures and equipment 83,679 83,773 Construction-in-progress (*) 9,278 9,102 235,298 235,139\nLess accumulated depreciation and amortization 108,541 94,430\n$126,757 $140,709\n(*) Includes $6,351 in 1995 and $5,350 in 1994 related to the improvement and acquisition of the new corporate headquarters.\nSBARRO, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n4. Accrued expenses: (In thousands)\nDecember 31, 1995 January 1, 1995\nCompensation $4,905 $ 4,770 Payroll and sales taxes 4,196 3,545 Rent 6,330 5,938 Provision for store closings (Note 9) 6,767 - Other 4,807 4,458 $27,005 $18,711\n5. Income taxes: (In thousands) For the Years Ended\nDecember 31, January 1, January 2, 1995 1995 1994 Federal: Current $14,897 $15,606 $12,906 Deferred (4,158) 948 1,507 10,739 16,554 14,413\nState and local: Current 3,328 3,446 3,799 Deferred (1,025) 244 400 2,303 3,690 4,199 $13,042 $20,244 $18,612\nDeferred tax liabilities are comprised of the following: December 31, January 1, 1995 1995\nDepreciation and amortization $16,360 $19,293 Deferred charges 554 599 Other 102 106 Gross deferred tax liabilities 17,016 19,998\nAccrued liabilities (2,527) (504) Deferred income (336) (159) Other (66) (65) Gross deferred tax assets (2,929) (728) $14,087 $19,270\nSBARRO, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n5. Income taxes (continued):\nActual tax expense differs from ``expected'' tax expense (computed by applying the Federal corporate rate of 35% for the years ended December 31, 1995, January 1, 1995 and January 2, 1994) as follows:\n(In thousands) For the Years Ended\nDecember 31, January 1, January 2, 1995 1995 1994 Computed \"expected\" tax expense $12,012 $18,645 $16,436 Increase (reduction) in income taxes resulting from: State and local income taxes, net of Federal income tax benefit 1,497 2,399 2,715 Tax exempt interest income (311) (337) (296) Other, net (156) (463) (243) $13,042 $20,244 $18,612\nDeferred income taxes are provided for temporary differences between financial and tax reporting. These differences and the amount of the related deferred tax provision are as follows:\n(In thousands) For the Years Ended\nDecember 31, January 1, January 2, 1995 1995 1994\nDepreciation and amortization $(2,781) $1,210 $1,653 Accrued expenses (2,482) 104 309 Other 80 (122) 55 $(5,183) $1,192 $1,907\nSBARRO, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n5. Income taxes (continued):\nIn the first quarter of 1993, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes\", the effects of which have been reflected in the financial statements as a cumulative effect of a change in the method of accounting. SFAS 109 requires the Company to compute deferred income taxes based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. The adoption of this method of accounting, as required by SFAS 109, resulted in a $1,010,000 cumulative increase in earnings ($0.05 per share) and decrease in net deferred tax liabilities in 1993.\nIn accordance with SFAS 109, the retroactive increase in the Federal corporate income tax rate, enacted in the third quarter of 1993, has been reflected in the results for 1993. The effective rate for earnings subsequent to the rate increase was 38.9%. The new income tax rate resulted in an increase in the tax provision of approximately $500,000 (or $0.02 per share) and the new income tax rate applied to the Company's deferred tax liabilities at January 3, 1993 (which had previously been calculated using the old rate) resulted in a non-recurring increase in the tax provision of $377,000 (or $0.02 per share).\n6. Commitments:\nThe Company conducts all of its operations in leased facilities. Most of the Company's restaurant leases provide for the payment of base rents plus real estate taxes, utilities, insurance, common area charges and certain other expenses, as well as contingent rents generally ranging from 6% to 10% of net restaurant sales in excess of stipulated amounts.\nSBARRO, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n6. Commitments (continued):\nRental expense under operating leases, including common area charges, other expenses and additional amounts based on sales, are as follows:\n(In thousands) For the Years Ended\nDecember 31, January 1, January 2, 1995 1995 1994\nMinimum rentals $35,142 $31,146 $28,135 Contingent rentals 3,082 3,269 2,504 Common area charges 10,846 9,586 8,437 $49,070 $44,001 $39,076\nFuture minimum rental and other payments required under non-cancelable operating leases for Company-operated restaurants that were open on December 31, 1995 and the existing corporate office are as follows (in thousands):\nYears ending:\nDecember 29, 1996 $49,603 December 28, 1997 48,560 January 3, 1999 46,250 January 2, 2000 43,464 January 1, 2001 40,842 Later years 143,385 $372,104\nThe Company is the principal lessee under operating leases for certain franchised restaurants which are subleased to the individual franchisees. Franchisees pay rent and related expenses directly to the landlord. Future minimum rental payments required under these non-cancelable operating leases for franchised\nSBARRO, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n6. Commitments (continued):\nrestaurants as of December 31, 1995 are as follows (in thousands):\nYears ending:\nDecember 29, 1996 $1,492 December 28, 1997 1,303 January 3, 1999 1,177 January 2, 2000 1,006 January 1, 2001 788 Later years 1,280 $7,046\nAs of February 9, 1996, future minimum rental payments required under non-cancelable operating leases for restaurants which had not opened as of December 31, 1995 are as follows (in thousands):\nYears ending:\nDecember 29, 1996 $640 December 28, 1997 1,051 January 3, 1999 1,086 January 2, 2000 1,111 January 1, 2001 1,055 Later years 6,215 $11,158\nThe Company has entered into contracts aggregating $2,200,000 with respect to the construction of restaurants to be opened or renovated in 1996. Of such amount, $818,000 is included in construction-in- progress as of December 31, 1995.\nIn March 1994, the Company purchased a 100,000 square foot office building in Melville, New York, for $5,350,000. The Company is in the process of refurbishing the building at an estimated cost of approximately $7 million and intends to occupy a portion of the building as its Corporate Headquarters and lease the remainder of the building. (See Note 3).\nSBARRO, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n7. Transactions with related parties:\nIn May 1986, the Company entered into a fifteen year sublease with a partnership owned by certain shareholders of the Company for its Corporate Headquarters office building. In each of the years 1995, 1994 and 1993 the Company incurred rent expense for such building of $298,000. Pursuant to the sublease, the annual base rent increases to $337,000 beginning April 1996. Management believes that such rents are comparable to the rents that would be charged by an unaffiliated third party.\nA member of the Board of Directors acts as a consultant to the Company for which he received $96,000 in each of the years ended December 31, 1995 and January 1, 1995 and $65,400 in the year ended January 2, 1994.\n8. Stock options:\nIn 1991, the Company adopted its 1991 Stock Incentive Plan (the \"1991 Plan\") which replaced the Company's 1985 Incentive Stock Option Plan. No further options may be granted under the 1985 Plan. Under the 1991 Plan, the Company may grant, until February 2001, incentive stock options and non-qualified stock options alone or in tandem with stock appreciation rights (\"SARs\") to employees and consultants of the Company and its subsidiaries. An aggregate of 750,000 shares of common stock was originally subject to the 1991 Plan. In 1994, the Company's Board of Directors authorized and its shareholders approved an increase in the number of shares available under the 1991 Plan to 1,500,000 shares. Options and SARs may not be granted at exercise prices less than 100% of the fair market value of the Company's common stock on the date of grant. The Board of Directors' Committee administering the Plan is empowered to determine, within the limits of the 1991 Plan, the number of shares subject to each option and SAR, the exercise price, and the time period (which may not exceed ten years) and terms under which each may be exercised.\nSBARRO, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n8. Stock options (continued):\nChanges in options under these plans, expressed in number of shares, are as follows:\nFor the Years Ended December 31,January 1,January 2, 1995 1995 1994\nOptions outstanding, beginning of period 720,958 681,266 173,261\nGranted 15,000 128,500 569,250\nExercised (16,502) (32,306) (26,493)\nCanceled (69,244) (56,502) (34,752)\nOptions outstanding, end of period 650,212 720,958 681,266\nOptions exercisable, end of period 418,962 257,457 135,753 Exercise price per share for options outstanding, end of period $14.75-$28.75 $14.75-$28.75 $1.78-$28.75 Exercise price per share for options exercised during the period $14.75-$21.17 $1.78-$21.17 $16.25-$21.17\nAt December 31, 1995, there were 850,750 shares available for grant under the 1991 Plan.\nIn 1993, options were granted under the 1991 Plan to the Company's Chairman of the Board, President, Senior Executive Vice President and one non-employee director to purchase 120,000, 90,000, 75,000 and 37,500 shares, respectively, at $27.09 per share, the fair market value of the Company's common stock on the date of grant, for a period of 10 years from the date of grant. Such options remain unexercised.\nIn 1990, shareholder approved options were granted to the Company's Chairman of the Board, President and Senior Executive Vice President to purchase 150,000, 75,000 and 75,000 shares, respectively, at\nSBARRO, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n8. Stock options (continued):\n$20.67 per share, the fair market value of the Company's common stock on the date of grant, for a period of 10 years from the date of grant. Such options remain unexercised.\nOn February 16, 1993, the Company adopted the 1993 Non- Employee Director Stock Option Plan (\"1993 Plan\") covering an aggregate of 300,000 shares of common stock. Each non-employee director is to be granted an option to purchase 3,750 shares of common stock following each annual shareholders' meeting. Each option has a five year term and is exercisable in full commencing one year after grant at 100% of the fair market value of the Company's common stock on the date of grant. In 1995, 1994 and 1993, each of the six non- employee directors were granted options to purchase 3,750 shares at $21.50, $23.71 and $23.05 per share, respectively. No options granted under this plan have been exercised.\n9. Provision for unit closings:\nA provision for restaurant closings in the amount of $16,400,000 ($10,168,000 or $0.50 per share after tax) was established in 1995 for the closing of approximately 40 under-performing restaurants.\n10. Dividends:\nIn 1995 and 1994, the Company declared quarterly dividends of $0.19 per share and $0.16 per share, respectively, aggregating $0.76 per share and $0.64 per share for the respective years. In February 1996, the Company's Board of Directors declared an increase in the quarterly dividend to $0.23 per share, beginning with the quarterly cash dividend to be paid on April 3, 1996 to shareholders of record on March 19, 1996.\nSBARRO, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n11. Quarterly financial information (unaudited):\n(In thousands, except per share data)\nFirst Second Third Fourth Quarter Quarter Quarter Quarter\nFiscal year 1995\nRevenues $84,607 $68,764 $75,789 $89,995 Gross profit (a) 64,252 52,171 57,536 68,812 Net income 4,610 5,485 8,125 3,059 (b) Earnings per share $0.23 $0.27 $0.40 $0.15 (b)\nFiscal year 1994\nRevenues $77,411 $63,010 $69,776 $85,794 Gross profit (a) 59,071 48,208 53,365 66,287 Net income 6,169 5,838 8,061 12,958 Earnings per share $0.30 $0.29 $0.40 $0.64\n(a) Gross profit represents the difference between restaurant sales and the cost of food and paper products.\n(b) See Note 9.\nARTHUR ANDERSEN LLP\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nON SCHEDULE\nTo the Board of Directors and Shareholders of Sbarro, Inc.:\nWe have audited, in accordance with generally accepted auditing standards, the consolidated financial statements of Sbarro, Inc. and subsidiaries, included in this filing and have issued our report thereon dated February 9, 1996. Our audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The accompanying schedule 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 subjecctted to the auditing procedures applied in the audit of the bbaassic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relations to the basic financial statements taken as a whole.\n\/s\/ Arthur Andersen LLP\nNew York, New York February 9, 1996\nS-1\n(1) Write-off of fully amortized deferred charges (2) Included in other assets S-2\nEXHIBIT INDEX\nExhibit Number Description\n*3.01(a) Restated Certificate of Incorporation of the Company as file with the Department of State of the State of New York on March 29, 1985. (Exhibit 3.01 to the Company's Registration Statement on Form S-1, File No. 2-96807)\n*3.01(b) Certificate of Amendment to the Company's Restated Certificate of Incorporation as filed with the Department of State of the State of New York on April 3, 1989. (Exhibit 3.01(b) to the Company's Annual Report on Form 10-K for the year ended January 1, 1989, File No. 1-8881)\n*3.01(c) Certificate of Amendment to the Company's Restated Certificate of Incorporation as filed with the Department of State of the State of New York on May 31, 1989. (Exhibit 4.01 to the Company's Quarterly Report on Form 10-Q for the quarter ended April 23, 1989, File No. 1-8881)\n*3.01(d) Certificate of Amendment to the Company's Restate Certificate of Incorporation as filed with the Department of State of the State of New York on June 1, 1990. (Exhibit 4.01 to the Company's Quarterly Report on Form 10-Q for the quarter ended April 22, 1990, File No. 1-8881)\n*3.02 By-Laws of the Company, as amended. (Exhibit 4.02 to the Company's Quarterly Report on Form 10-Q for the quarter ended April 23, 1989, File No. 1-8881)\n*10.01 Commack, New York Corporate Headquarters Sublease. (Exhibit 10.04 to the Company's Registration Statement on Form S-1, File No. 2-96807)\n+ *10.02(a) 1985 Incentive Stock Option Plan, as amended. (Exhibit 4.01 to Post-Effective Amendment No.\n1 to the Company's Registration Statement on Form S-8 File No. 33-4380)\nExhibit Index (continued):\nExhibit Number\n+ *10.02(b) 1991 Stock Incentive Plan, as amended. (Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended April 24, 1994, File No. 1-8881)\n+ *10.02(c) Form of Stock Option Agreement dated May 30, 1990 between the Company and each of Anthony Sbarro, Joseph Sbarro and Mario Sbarro, together with a schedule, pursuant to Instruction 2 to Item 601 of Regulation S-K, identifying the details in which the actual agreements differ from the exhibit filed herewith. (Exhibit 10.02(c) to the Company's Annual Report on Form 10-K for the year ended December 30, 1990, File No. 1-8881)\n+ *10.02(d) 1993 Non-Employee Director Stock Option Plan. (Exhibit 10.02(d) to the Company's Annual Report on Form 10-K for the year ended January 3, 1993, File No. 1-8881)\n+ *10.03 Consulting Agreement (including option) dated June 3, 1985 between the Company and Bernard Zimmerman & Company, Inc. (Exhibit 10.04 to the Company's Annual Report on Form 10-K for the year ended January 1, 1989, File No. 1- 8881)\n+ *10.04 Form of Indemnification Agreement between the Company and each of its directors and officers. (Exhibit 10.04 to the Company's Annual Report on Form 10-K for the year ended December 31, 1989, File No. 1-8881)\n*22.01 List of subsidiaries. (Exhibit 22.01 to the Company's Annual Report on Form 10-K for the year ended January 2, 1994, File No. 1-8881)\n23.01 Consent of Arthur Andersen LLP.\n27.01 Financial Data Schedule.\n* Incorporated by reference to the document indicated.\n+ Management contract or compensatory plan.","section_15":""}
{"filename":"844843_1995.txt","cik":"844843","year":"1995","section_1":"Item 1. BUSINESS\nGeotek Communications, Inc. (the \"Company\" or the \"Registrant\"), through its subsidiaries, currently provides specialized mobile radio (\"SMR\") services in the United States, the United Kingdom and Germany. Since 1992, the Company has devoted substantial financial and management resources to the development of a low cost, high quality integrated digital voice and data wireless communications network known as GEONET(TM). The Company intends to deploy GEONET(TM) in a total of 36 markets by the end of 1997. The Company has acquired, and intends to continue acquiring, 900 MHz SMR licenses in cities throughout the United States and to make strategic acquisitions of spectrum and operating networks worldwide. The Company also intends to continue to develop technology, equipment and software which support its GEONET(TM) network. The Company also is engaged in the development, manufacture and marketing of communications products through its majority-owned subsidiary, Bogen Communications International, Inc. (\"BCI\"). The Company is a Delaware corporation whose principal executive offices are located at 20 Craig Road Montvale, New Jersey 07645 and its telephone number is (201) 930-9305.\nWireless Communications Activities\nOverview\nThe Company currently provides analog SMR services in the United Kingdom and Germany to approximately 72,600 subscribers. The Company started providing commercial digital voice communication services through GEONET(TM) in Philadelphia in January 1996, in Washington, D.C. and Baltimore in February 1996, and in New York City in March 1996. The Company intends to deploy GEONET(TM) in a number of other cities in the United States, including New York, Boston, Miami and Dallas by the Summer of 1996 and in over 35 markets by the end of 1997. Each market will consist of a major U.S. city and its surrounding area. In certain markets, the Company also intends to offer its services regionally.\nThe Company's strategy is to differentiate its services from those of other wireless communications providers. Specifically, the Company's strategy is to (i) target a niche market of small- to medium-sized mobile business users in metropolitan markets throughout the United States; (ii) provide meaningful product differentiation by offering a wide array of digital voice and data communications services through an integrated subscriber unit that has been specifically designed for its mobile business users; (iii) emphasize customer relationships through a strong dealer network and dedicated customer service representatives; and (iv) exploit the low cost advantages inherent in its proprietary FHMA(TM) technology.\nThe Company is currently offering commercial digital voice communications services to business users through GEONET(TM). These digital voice communications services will be expanded to enable users to access both their internal phone network and the general public switched network (the latter of which services is currently available). The Company expects to expand its service offerings to include data services, including messaging, data dispatch, automatic vehicle location and mobile data. Mobile data service offerings will permit such applications as credit card authorization, inventory management, automated order entry, access to electronic mailboxes, facsimile retrieval and transmission and interconnection to both a user's internal databases and to publicly available databases and networks. It is expected that all of such mobile data services will be offered by the Company later in 1996. GEONET(TM) will also permit advanced fleet management whereby businesses will be able to configure their mobile\nworkforces into, and conduct private conversations within, a number or combination of subfleets. Moreover, businesses will be able to select different communications capabilities for each subfleet, depending on each subfleet's particular needs.\nThe Company will make continuing hardware and software enhancements to GEONET(TM) during and after the system's commercial roll-out. For example, the Company must integrate the initial GEONET(TM) data applications, which are expected to be completed in the first half of 1996, with the initial GEONET(TM) voice applications. Subsequent applications also will need to be integrated with existing GEONET(TM) applications. There can be no assurance that the Company will be able to satisfactorily complete such modifications and\/or integration efforts, or that they will be able to be completed in a manner that enables the Company to offer its GEONET(TM) services on a profitable and timely basis.\nTo date, no other wireless service provider has been successful at providing the level of integrated voice and data services contemplated by the Company. Accordingly, in implementing GEONET(TM), the Company may encounter unforeseen technical issues. In addition, each of the Company's U.S. target markets is expected to present unique technical issues to the Company due to differences in geography and the level of local land development and construction. Technical difficulties in the operation and\/or performance of GEONET(TM) also may be experienced as additional subscribers are added to the system in a given market or as the coverage area in any market is increased. There can be no assurance that the Company will be able to adequately address any such issues in any given market or that such issues will be able to be addressed in a cost-effective manner.\nThe Company is targeting its services to small- to medium-sized business users in over 35 of the largest metropolitan markets throughout the United States. See \"- The GEONET(TM) Roll-out.\" The Company's efforts will be targeted at existing users of SMR, Private Mobile Radio (\"PMR\"), paging and cellular wireless services as well as businesses currently foregoing the use of wireless services to meet their communications needs. The Company believes that the specific communications needs of these businesses are not being met by existing wireless providers. The Company is targeting these markets in order to access a large potential subscriber base and to minimize its infrastructure costs per subscriber.\nThe Company intends to market its GEONET(TM) services in its target U.S. markets primarily through an indirect sales force compromised of dealers and agents, value-added resellers and joint marketing partners. The mix of distribution channels used in each target market will differ depending upon the individual characteristics of these markets. The Company's direct sales force will focus primarily on businesses that already are heavy users of mobile communications services. The Company will have its direct sales force target these customers because the sales cycle for these customers is expected to be longer and more interaction between the salesman and the potential customer is likely to be required to migrate these customers from their existing services to those provided by the Company. At present, the Company has a field sales force consisting of approximately 50 salespeople throughout the U.S. and intends to expand its direct sales force in each of its target markets as it rolls-out GEONET(TM). The Company will also market its services through dealers and agents that currently sell PMR, SMR, cellular and paging equipment and services to business users. To date, the Company has entered into agreements with over 70 dealers throughout the United States and is negotiating additional distributor agreements in its target markets. The Company also intends to utilize value-added resellers to market its services. Value-added resellers typically sell a variety of computing and communications solutions to business customers. The Company also intends to pursue marketing alliances with companies that sell complementary products and services to certain segments of the Company's targeted customer base.\nThe GEONET(TM) Roll-out\nThe Company presently expects to continue the roll-out of GEONETTM in accordance with the following schedule:\nCommencement of Operations* Markets\nAugust 1995 Philadelphia**\nDuring 1996 Baltimore** Miami Boston New York City** Orlando Dallas Tampa Houston Washington, D.C.** Jacksonville During 1997 Atlanta New Orleans Buffalo Norfolk Charlotte Phoenix Chicago Cincinnati Pittsburgh Denver Portland Greensboro Richmond Hartford Rochester Indianapolis Salt Lake City Kansas City San Antonio Memphis San Francisco Minneapolis St. Louis Nashville Seattle\n- ----------- * Markets are not in the order that services will be initiated in such markets. The rollout schedule is subject to change.\n** The Company started providing commercial services in Philadelphia in January 1996, in Washington, D.C. and Baltimore in February 1996 and New York in March 1996.\nThe key stages to the GEONET roll-out include:\nPropagation. Propagation analysis involves the identification, through software programs and engineering analysis, of the optimal areas in a target market for the placement of the GEONET(TM) base station and remote sites. The Company has substantially completed its propagation analysis for its first 11 target markets.\nProcurement of Site Leases and Permits. The Company must procure leases and permits for the sites at which the GEONET(TM) base stations and remote sites are to be located. The Company has engaged multiple site leasing organizations to assist the Company in the identification of potential site leases, the negotiation of leases and the acquisition of required local approvals. The acquisition of leases and required permits is typically a two to six month\nprocess, although delays may occur from time to time. To date, the Company has entered into leases and has received the necessary permits to install and operate its base stations in Philadelphia, Boston, Dallas, New York City, Washington, D.C.\/ Baltimore, Tampa, Orlando, Chicago, Jacksonville, Atlanta and Miami. As the Company increases its coverage area in each of these markets, it will need to procure additional site lease locations.\nThere are only a limited number of existing communications towers capable of providing the Company with optimal coverage area for its radio transmissions and that are capable of supporting the Company's transmission equipment. In the event the Company cannot obtain leases for existing towers, it may be required to purchase sites, obtain necessary permits and build such towers, a process which the Company estimates could take up to one year to complete for each tower. If the Company is required to build new towers, the roll-out of GEONET(TM) in one or more target markets could be delayed and be more costly than anticipated.\nBuild-out. Preparation of each base station, which includes ventilation and air conditioning, grounding and equipment installation, testing and optimization, is expected to last at least ten to twelve weeks. The Company has completed the initial build-out of GEONET(TM) in Philadelphia, Washington D.C.\/Baltimore, New York and has begun the initial build-out of GEONET(TM) in Boston, Miami, Orlando, Tampa, and Dallas. The Company intends to begin construction of GEONET(TM) in Jacksonville later in 1996. The Company expects to construct remote sites in these markets to increase its coverage. The Company intends to offer GEONET(TM) services in a over 35 markets by the end of 1997. The Company has entered into an agreement with IBM Corporation (\"IBM\") to manage the construction of the GEONET(TM) stations and the installation of FHMA equipment in the Company's U.S. target markets. The Company has also engaged, and intends to engage, other third party contractors to manage all or certain aspects of such construction or installation in certain of its U.S. target markets. A failure by IBM or such other contractors to properly manage the preparation and construction of the Company's base stations and remote sites could have a material adverse effect on the Company.\nSpectrum Acquisition. The Company controls in excess of 1,000 900 MHz channels in its U.S. target markets. The Company will require additional spectrum to add capacity and to service anticipated demand in certain of its target markets, including in certain of its 1996 target markets. The Company also requires additional spectrum to initiate services in certain of its 1997 target markets.\nCertain agreements pursuant to which the Company has the right to acquire spectrum are subject to regulatory approval. Although the Company believes that such approval will be forthcoming prior to its expected roll-out in each such market, there can be no assurance that such approvals will be received on a timely basis or at all.\nThe Company intends to acquire sufficient spectrum in each of its target markets in which it does not have sufficient spectrum to initiate service and to add additional capacity in certain of its other U.S. target markets. In December 1995, the Federal Communications Commission (the \"FCC\") commenced auctioning spectrum in each market in which the Company desires to acquire additional spectrum. Although the Company has bid on such spectrum to the extent it believes that such spectrum is needed, there can be no assurance that the Company will be the successful bidder for any radio spectrum auctioned by the FCC. In addition, the Company cannot predict the cost of obtaining licenses for additional spectrum since such costs are determined by factors beyond the Company's control, including but not limited to, the availability of licenses and the number of competitors seeking to acquire licenses in any particular market. Moreover, some of the spectrum available at auction in certain of the Company's 1996 and 1997 U.S. target markets is subject to a preferred right of usage by incumbent licensees. The Company, in limited circumstances, may choose to bid in the auction for licenses on a regional service area known as Market\nTrading Areas (\"MTA\") which may be subject to the right of prior use by a preferred licensee in cases where it believes it will be able to successfully gain access to such portions of the encumbered spectrum which are material to the Company. However, there can be no assurance that the Company will gain access to any such encumbered spectrum it may acquire. The failure to obtain such access may materially diminish the value of any spectrum so obtained by the Company. Although the Company believes that it will be able to acquire sufficient spectrum in each of its U.S. target markets, there can be no assurance that the Company will be able to make such acquisitions on commercially acceptable terms or at all. See \"- Government and Industry Regulation.\"\nThe successful and timely implementation of GEONET(TM) will depend upon a number of factors, including, but not limited to, the timely and cost-effective manufacture, construction and integration of the system infrastructure and software, the acquisition and control of additional radio spectrum, the procurement and preparation of base station and remote sites, the receipt of all necessary regulatory approvals, the establishment of effective sales and marketing organizations and distribution channels and the need for additional financing. The failure or delay with respect to any of these items could adversely affect the timing of the implementation of GEONET(TM) in one or more of the Company's target markets, which could have a material adverse effect on the Company. In this regard, the Company has experienced delays in the past with respect to its roll-out schedule related primarily to the development of its subscriber unit from a preproduction form to a full production unit. The Geotek subscriber units are currently being manufactured in their full production form and the Company does not expect to experience additional delays as a result of the production of its current subscriber units. However, there can be no assurance in this regard. The Company's roll-out schedule may be reviewed and revised from time to time in light of changing conditions.\nEach of the Company's target markets present unique technical issues due to differences in geography and the level of local land development and construction. Technical difficulties in the operation and\/or performance of GEONET(TM) also may be experienced as additional subscribers are added to the system in a given market or as the coverage area in any market is increased. There can be no assurance that the Company will be able to adequately address any such issues in any given market or that such issues will be able to be addressed in a cost-effective manner. Any failure by the Company to adequately address such issues or to address them in a cost-effective manner could have a material adverse effect on the Company.\nThe implementation of GEONET(TM) in all of the Company's target markets will require substantial additional funding. See item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.\"\nFHMA(TM) Technology\nThe Company will implement GEONET(TM) utilizing a relatively small number of high power transmission sites with a transmitter capable of covering an area of up to 30 miles. A base station containing the system computer and switching equipment will be located at or near one of the transmission sites in each market. Areas of high use or poor transmission quality will be served by a simple antenna relay and related equipment that improves signal quality to that area. The system's use of a relatively small number of high power sites and its ability to reuse frequencies will enable the Company to divide each cell coverage area into several sectors. In contrast, many other wireless service providers, including conventional cellular system and Enhanced Specialized Mobile Radio (\"ESMR\") operators, are required to build multiple overlapping \"cells,\" sometimes dozens or hundreds in a market, each with its own low power transmission station in order to reuse frequencies. The Company believes its use of a relatively small number of high power transmission sites will enable it to reduce the infrastructure cost required to service a market as compared to the multicell approach employed by other wireless service providers. The Company\nalso believes that its system design will allow it to initiate service in a given market at a lower cost and achieve profitability with fewer subscribers than other digital wireless communications providers. Moreover, the Company's ability to reuse frequencies will enable it to increase, at a relatively low cost, the capacity of GEONET(TM) as such capacity is needed by further sectorizing a coverage area or adding additional sites. The Company also believes that GEONET(TM) will be less expensive to operate than other multicell systems due to, among other things, lower costs for transmission lines and site leases.\nGEONET(TM) utilizes FHMA(TM), the Company's proprietary frequency hopping technology. FHMA(TM) integrates certain standard digital technology, such as TDMA, voice multiplexing and packet data transmission, with advanced error correction and frequency hopping techniques in a macrocell configuration. The Company believes that the utilization of FHMA(TM) will permit it to increase the capacity of its radio spectrum by more than 20 times traditional analog SMR capacity and to improve the quality and security of wireless communications over current analog systems.\nTDMA is a digital transmission technique currently utilized by digital cellular systems that allows each channel to carry several transmission signals at one time. FHMA(TM) employs \"three slot\" TDMA, which permits three transmission signals to be carried on each channel. The use of digital FHMA(TM) technology results in secure communications, an important attribute to many business users. FHMA(TM) also incorporates a voice multiplexing technique (digital speech interpolation) that is used by long distance carriers and borrows unused portions of a communications channel to increase capacity. The use of voice multiplexing should permit the Company to increase capacity by approximately 1.5 times the capacity of conventional analog systems and, when combined with 3.0 times TDMA, will result in capacity increases of up to 4.5 times the capacity of analog systems. In addition, FHMA(TM) utilizes a digital technology technique known as frequency hopping which enables frequency reuse in adjacent geographic areas. Typically, in wireless communications applications, it is not possible to reuse the same frequency in adjacent areas because of interference that generally results when two transmission signals share the same frequency. Frequency hopping technology permits the reuse of radio spectrum in adjacent sectors by breaking down a transmission signal into many small components and having each component \"hop\" from frequency to frequency in accordance with a predetermined sequence. Different frequency hopping sequence sets are used in adjacent areas to minimize interference. Finally, FHMA(TM) employs an advanced error correction feature which restores transmitted signals in the event of interference. The Company believes that its ability to sectorize coverage areas, when combined with 3.0 times TDMA and 1.5 times voice multiplexing, will enable it to increase the capacity of its available radio spectrum to more than 20 times traditional analog SMR capacity.\nSystem Hardware\nThe Company offers a subscriber unit with a large screen and prominently displayed function keys. For high-end users with a greater need for telephony services, the Company will offer a small screen subscriber unit that is similar in size and appearance to a mobile cellular telephone. The Company is developing a full line of accessories for each of its subscriber units, including push-to-talk and palm size handsets, speakers and microphones and magnetic strip readers. A standard serial port will permit the attachment of laptop computers, fax machines and other intelligent devices.\nPowerSpectrum Technology Ltd. (\"PST\"), a subsidiary of the Company, is responsible for the enhancement and manufacture of the base station and the validation systems. The Company procures all other components utilized in connection with GEONET(TM) from third parties. A number of these firms are located in Israel, the United Kingdom and the United States. These firms include PA Consulting Services Ltd. (commercial subscriber unit design), Digital Voice\nSystems, Inc. (vocoder), Tadiran Limited (switches), Orckit Communications Ltd. (system software design) and Analog Devices Inc. (ASIC chip set for the mobile subscriber unit).\nPST is also responsible for developing and engineering the radio component of the commercial subscriber unit for GEONET(TM) and integrating the subscriber unit with the remaining GEONET(TM) system hardware. This project is funded by the Company and involves a number of engineering and manufacturing firms including Mitsubishi Consumer Electronics America (\"Mitsubishi\"), Hughes Network Systems (\"Hughes\"), a unit of GM Hughes Electronics, Kenwood Corporation of Japan (\"Kenwood\"), PA Consulting Services, Ltd. and Orckit Communications Ltd. In particular, the Company has entered into an agreement with Mitsubishi pursuant to which Mitsubishi manufactures the Company's large screen vehicle-mounted subscriber units, has entered into an agreement with Hughes pursuant to which Hughes manufactures the Company's small screen vehicle-mounted subscriber units and will design, manufacture and deliver portable units starting in the fourth quarter of 1996 and has entered into an agreement with Kenwood to develop and manufacture second generation mobile subscriber units, with initial deliveries expected in the first half of 1997. There can be no assurance that such third parties will deliver such equipment on a timely basis or that the Company will be able to successfully integrate such components and hardware in a cost effective system on a timely basis, if at all. As discussed above, the Company has only a single manufacturing source for certain of the components of the GEONET(TM) system hardware, including the base stations and subscriber units. Although the Company believes that it can obtain all components necessary to build GEONET(TM) from other sources, delays may be encountered in the event of a component shortage because of the time it may take to identify substitute sources and manufacture substitute components. A failure by the Company to obtain hardware components on a timely basis or at satisfactory prices could adversely affect the ability of the Company to roll-out and market GEONET(TM), which could have a material adverse effect on the Company.\nInternational SMR Operations\nUnited Kingdom.\nOn July 2, 1993, the Company acquired all of the outstanding stock of National Band Three Ltd. (\"NB3\"). NB3 is the only national SMR equivalent service provider in the United Kingdom and controls approximately 70% of the domestic market for integrated dispatch voice and data wireless communications services, providing service to approximately 60,000 subscribers.\nNB3 targets its services at business users with mobile distribution or service fleets. NB3's major customers include providers of domestic and commercial maintenance services, haulers and couriers. The Company believes that NB3 will benefit from increased marketing efforts aimed at increasing its utilization by business users. The Company intends to take advantage of NB3's position as the only United Kingdom-SMR equivalent provider with a national license. The Company currently is focusing its marketing efforts in the United Kingdom on businesses utilizing their own private radio networks, emphasizing NB3's wide coverage area and voice and data capabilities. The Company believes that the same competitive pressures for improved field services that exist in the United States are present in the United Kingdom and should assist the Company in migrating private radio network users to NB3's network.\nThe NB3 network currently is an analog system that utilizes a series of overlapping cells in conjunction with large switching stations. The NB3 network currently consists of approximately 100 base stations and three switching\nstations. NB3 anticipates increasing the capacity of its analog system to approximately 75,000 subscribers from the current capacity of approximately 67,000 subscribers. The Company also is evaluating the possibility of establishing a nationwide digital network in the United Kingdom with either FHMA(TM) or a European digital standard. The Company believes that any conversion of the NB3 network to digital technology will entail significant cost. Digital technology, though, would significantly expand NB3's product offerings and may permit the Company to offer other wireless services to the general population.\nGermany.\nIn the Summer of 1994, the Company consummated the acquisitions of a non-controlling 49.0% equity interest in Preussag Bundelfunk GmbH (\"PBG\") and a non-controlling 49.9% equity interest in DBF Bundelfunk GmbH (\"DBF\"). During 1995, the Company acquired the remaining equity interests in PBG and DBF so that these entities are now wholly-owned subsidiaries of the Company. PBG and DBF provide analog trunked mobile radio service, which is equivalent to SMR service, to eight major regions in the northern part of Germany with a population of approximately 28 million people. This service is provided through a combined network known as \"RegioNet\" that currently provides dispatch, telephony and data communications services to approximately 12,500 subscribers. The Company intends to increase its subscriber base in Germany by expanding RegioNet, by adding new distribution channels and by creating differentiation from other networks by offering wireless applications and other products. The Company is also exploring possible startegic relationships to enhance its German operation.\nKorea\nThe Company and Anam Industrial Co., Ltd. (\"Anam\") have formed a joint venture, the purpose of which is to build an FHMA(TM) demonstration site for wireless service in Korea. The agreement pursuant to which the joint venture was established (the \"Joint Venture Agreement\") established of a new entity (\"Newco\") which in April 1996 expects to apply for a regional or national radio license in Korea and otherwise pursue the establishment of an FHMA(TM) based wireless communications system in Korea and in such other Asian countries as the Company and Anam may hereafter agree. According to the Ministry of Communications of Korea, a decision regarding the license application will be made in the summer of 1996. The Joint Venture Agreement is terminable by either the Company or Anam at any time. There can be no assurance that Newco will be granted licenses for sufficient radio spectrum to successfully develop an FHMA(TM) communications system in Korea or in any other jurisdiction or will otherwise be profitable or generate positive cash flow. The development of communications systems in Asia will be subject to many of the same risks inherent in the establishment of GEONET(TM) in the United States.\nOther Opportunities.\nThe Company intends to continue to seek opportunities to expand its position internationally. This expansion may take the form of acquiring ownership interests in trunked mobile radio licenses or the acquisition of SMR operators, or such other international opportunities as management may determine to be advantageous. The Company's ability to make investments is limited under certain circumstances by the terms of the indentures under which the Notes and the Company's 15% Senior Secured Discount Notes due 2005 were issued.\nCompetition\nThe Company expects to experience competition for each type of service it offers and intends to offer. Many of its current competitors presently offer generic services, such as dispatch, cellular telephony, paging or access to public data and electronic mail services. Cellular telephony companies are the dominant providers of wireless voice communications, although other SMR licensees offer a combination of dispatch (the traditional service provided by SMR licensees) and telephony over relatively discrete market areas. The Company expects to experience competition from both of these types of providers. The Company also expects to experience competition for traditional trunked mobile radio customers from operators utilizing frequencies in the 220MHZ, 800 MHz and 900 MHz bands. Data communications services also may provide competition for the data capabilities to be offered as part of the Company's integrated package. The Company also will experience competition from manufacturers of PMR equipment, which target existing private network operators and SMR customers and urge them to build or upgrade their own private networks rather than utilize SMR service providers. Many of these providers and manufacturers are larger, more established, have more experience in the telecommunications industry, have greater name recognition, have larger sales staffs and\/or have greater financial resources than the Company. The Company believes that its targeted business customers currently do not have access to the quality and array of services to be provided by the Company, and that such services will meaningfully differentiate the Company from other wireless providers.\nNEXTEL Communications, Inc. (\"NEXTEL\") has announced plans to construct a nationwide digital ESMR network and is offering services in several cities including many of the cities that the Company plans to enter. NEXTEL has also secured a significant number of 800 MHz SMR channels in several of the largest U.S. markets. Furthermore, several large SMR providers are positioning themselves to compete for wireless voice and data traffic and have announced plans to construct digital ESMR networks utilizing equipment manufactured primarily by Motorola. These providers include Nextel, Motorola, and Pittencrieff Communications. Moreover, recent regulatory changes may permit the Bell Operating Company's (\"BOCs\") to enter the Commercial Mobile Radio Service (\"CMRS\") marketplace. See \" - Governmental Regulation.\"\nThe Company also may face competition from technologies and services introduced in the future. In March 1995, the FCC completed auctions for wideband Personal Communications Services (\"PCS\") licenses on an MTA within the United States. The wideband PCS auction winners have already begun to provide service. In December 1995, the FCC commenced its auction of 493 broadband basic trading area PCS licenses. In addition, the FCC has also licensed national and regional narrowband PCS licenses. Additional narrowband PCS licenses on an MTA basis will be issued under government regulation in the future. Narrowband PCS service will be similar to paging services already offered and may compete with the Company's SMR proposed service. The FCC also intends to license additional spectrum for other wireless services. It is also possible that satellite technology ultimately could be developed to permit urban use equal to or superior to that available through SMR systems, which would result in increased competition for the Company's services. The commercialization or further development of any such technologies could have a material adverse effect on the Company.\nMany of the target customers for GEONET(TM) currently use other wireless communications services. In order to be successful, the Company will need to migrate a portion of its target customers from their existing services to those provided by the Company over GEONET(TM). The Company's ability to migrate its target customers over to its services will be highly dependent on the perceived utility of the Company's services to its target customers as compared to the services currently utilized by such customers. Because there currently is no integrated wireless communications network commercially available that is comparable to that expected to be offered by the Company over GEONET(TM), the extent of the demand for the Company's wireless communication services cannot be predicted with any degree of certainty. The demand for the Company's digital wireless communications services also could be affected by other matters beyond its control, such as the future cost of subscriber equipment, marketing and pricing strategies of competitors and general economic conditions.\nThe Company also expects to experience competition for radio spectrum from existing and future providers of wireless communications services and for communications tower space.\nThe Company also faces competition for its existing services and products. In the United Kingdom, NB3 competes for customers with regional SMR equivalent systems and from private radio networks. Additionally, NB3 competes for customers with cellular providers, PCS-like services, and wireless data. In Germany, DBF and PBG compete with two large regional operators of SMR equivalent systems. DBF and PBG also face competition from cellular networks, a PCS network and wireless data networks.\nThe Company also experiences competition for each of its products and services other than GEONET(TM) in the markets in which its sells such products and services. Such competition is expected to remain strong for the foreseeable future.\nGovernment and Industry Regulation\nThe construction, operation and acquisition of SMR systems in the United States is regulated by the FCC under the Communications Act of 1934, as amended (the \"Communications Act\"), and pursuant to the FCC's rules and policies adopted thereunder. The FCC previously granted five-year SMR licenses to the extent frequencies were available in a particular location. Licenses could be renewed for additional five-year terms upon demonstrating compliance with FCC regulations. In 1996, once new regulations adopted by the FCC in 1994 become fully effective, the license term for the Company's licenses will be ten years with an expectancy of renewal, provided that the Company complied with the FCC's service and operational requirements. For Market Trading Areas (\"MTA\") licenses which the Company is successful in acquiring through the ongoing 900 MHz spectrum auctions, the Company will be granted 10-year MTA licenses. In October 1992, the Company submitted a waiver request to the FCC in connection with certain rules and regulations covered under Part 90 of the FCC rules. Specifically, the Company requested an extension of the construction deadline for certain systems it has agreed to acquire so GEONET(TM) could be installed by 1997. On June 29, 1993, the FCC granted such waiver request extending the deadline for the construction and loading of the Company's 900 MHz SMR systems for a period of four years. This waiver allows the Company to maintain its SMR licenses until GEONET(TM) is implemented, as scheduled. In those markets where the Company successfully acquires an MTA license through the 900 MHz spectrum auctions, where the Company already has a Designated Frequency Area (\"DFA\") license on the same frequencies, the FCC's construction and operational rules for the MTA license will become applicable for both the existing DFA license and the MTA license, and the Company's waiver, for those frequencies, will become unnecessary. Although the Company's waiver is currently subject to a pending challenge by a third party before the FCC, the Company has vigorously opposed the challenge.\nUnder the Communications Act, SMR system providers were traditionally regulated as private carriers and, therefore, were subject to less regulation by both the FCC and individual states than were common carriers such as cellular telephone companies. However, the FCC has initiated and is likely to continue to initiate regulatory proceedings with wide-ranging implications for the wireless telecommunications industry. Most of the rule makings were initiated in response to congressional amendments to the Communications Act, as directed by the Omnibus Budget Reconciliation Act of 1993 (the \"Budget Act\"). Early this year, President Clinton signed into law the Telecommunications Act of 1996 (the \"Telecommunications Act\") which imposes sweeping reform of telecommunications policy. Although the majority of the Telecommunications Act's measures will directly impact large common carriers, cable and broadcast operators, and Internet service providers, many of the Telecommunications Act's provisions will have an effect upon the CMRS marketplace, and upon the Company. In particular, the Telecommunications Act may: (i) require CMRS providers to offer unblocked access to telephone toll services; (ii) require the Company to contribute to a Universal Service Fund; (iii) require local exchange (telephone) carriers (\"LECs\") to establish reciprocal compensation arrangements for CMRS providers for the origination and termination of calls; and (iv) require the Company to ensure that its equipment is accessible to disabled persons. All of the provisions of the Telecommunications Act which may have an effect upon the Company will be the subject of FCC rule making proceedings during the next 15 months. The FCC has been granted authority to forbear some of these requirements where appropriate. The primary intent of these recent amendments was to encourage competition among communications service providers and, thus, improve service to consumers. Accordingly, the most sweeping regulatory changes and legislative directives have been designed to ensure a level playing field among the Company and its competitors, although such impact could be materially adverse to the Company.\nCommercial Mobile Service Provider Regulation\nIn a series of rule makings, the FCC initiated or adopted, pursuant to congressional amendments to Sections 3(n) and 332 of the Communications Act, a mandated reclassification of mobile services. Specifically, the FCC reconfigured the mobile marketplace to include in the category of CMRS, any mobile service provider (including cellular and specialized mobile radio) which offers, for a profit, mobile service interconnected to the public switched network to a substantial portion of the public. This restructuring has been accomplished through a number of rule-making proceedings.\nIn its first decision effecting regulatory parity for CMRS providers, released January 5, 1994, the FCC adopted similar foreign ownership limitations under Section 310(b) of the Communications Act for CMRS providers that previously applied only to common carrier telephone service providers. Section 310(b) limits the percentage of foreign ownership and\/or participation in any entity holding an FCC license. As a result, the Company's ability to attract foreign investors will be limited by current FCC regulations. In a recent decision, however, the FCC revised its standards for regulating entry of foreign carriers and their affiliates into the U.S. market for international telecommunications services. The FCC will apply these revised standards in the application process for foreign entry, principally by taking into consideration whether \"effective competitive opportunities\" exist for U.S. carriers in the destination markets of foreign carriers seeking to enter the U.S. international services market. In addition, and of specific impact for the Company, the FCC determined that it will examine reciprocal foreign market competitive opportunities when considering additional waiver requests by CMRS providers to exceed foreign investment in excess of the existing 25% benchmark.\nOn March 7, 1994, the FCC released a decision which imposed the following regulatory modifications, which will generally take effect on August 10, 1996, relevant to the Company:\nAs a newly classified CMRS provider, the Company must comply with certain traditional common carrier obligations. Specifically, as of August 10, 1996, the Company (i) will be required to offer its services without discrimination, which could be construed as prohibiting the Company from withholding from one customer a customized service offering that it makes available to another customer; (ii) will be required to provide access to its services to other common carriers, and (iii) will be subject to the formal consumer complaint process.\nUnder past proceedings, the FCC determined that LECs must offer interconnection to CMRS providers on reasonable terms and conditions, and under the principle of mutual compensation. The FCC declined to impose direct interconnection obligations for CMRS-to-CMRS transmissions, but concluded that it would require CMRS providers to \"resell\" their services to another CMRS provider. In a recent rule making now pending, the FCC proposed specific limits with respect to prices, terms, and conditions of interconnection arrangements for LEC-CMRS interconnection, to ensure that CMRS providers are granted equal competitive footing with more established LEC service providers.\nIn a separate proceeding, the FCC proposed to amend its rules to permit broadband and narrowband CMRS providers to offer wireless local loop and related services. Specifically, the FCC proposed a definition of \"wireless local loop\" that is sufficiently broad to allow the provision, by CMRS providers such as the Company, of certain fixed services. The proposed definition of \"wireless local loop\" is \"the path between the subscriber and the first point of switching or aggregation of traffic.\" Such an expansion in available service offerings could be beneficial to the Company.\nThe FCC is also considering the adoption of rules that would require CMRS providers to offer enhanced emergency calling (\"E911\") access and features to mobile radio callers in three phases within five years after adoption of the rules. The FCC's current proposal, which is still pending, would require CMRS providers to ensure such features as calling party automatic number identification (\"ANI\"); 911 availability from any service initialized mobile radio handset; 911 access for speech and hearing-impaired callers; and call-back capability.\nOther Regulatory Matters\nManagement Agreements. On November 18, 1994, the FCC issued an order requiring CMRS providers subject to grandfathering protection that hold management agreements with FCC licensees to execute new revised management contracts for any managed stations by August 10, 1996. The FCC determined that the validity of a management agreement will be guided by the FCC's prohibition against the de facto transfer of control of the radio facilities from the licensee to the manager. It is the Company's belief that its existing management agreements comply with the FCC's policies by placing ultimate control over the maintenance and operation of any managed system with the licensee of the system. The Company will continue to monitor the FCC's positions on this issue, however, and holds a contractual right, contained in all of its management agreements, to modify any agreement in the event that it is determined that any are not in compliance with the FCC's rules.\nSignal Boosters. With respect to operations, the FCC recently considered permitting the routine use of one-way or two-way signal boosters for CMRS providers such as the Company. This matter remains pending before the FCC. In the event that the FCC permits the use of signal boosters, the Company could improve its service offerings by \"filling out\" its service footprints, particularly where terrain or geographic anomalies cause minor interference problems.\n900 MHz Auction. Most significantly, the FCC recently adopted rules that have had a sweeping effect on the licensing of 900 MHz SMR frequencies. The FCC imposed auction proceedings for the licensing of 20 10- channel blocks in each of the 51 MTA service areas in the 900 MHz bandwidth. Initiated in December 1995, the Company has been an active bidder in the 900 MHz spectrum auctions and could, if successful as a bidder at the close of auctions, be awarded MTA licenses in multiple markets. Although the MTA licenses will be separately licensed, the Company will be permitted to aggregate blocks of spectrum, subject only the 45 MHz spectrum cap for CMRS providers within three radio services, broadband PCS, SMR and cellular.\nWhere the Company is awarded an MTA license for frequencies of which it is the incumbent DFA licensee, the DFA license will be construed as included in the MTA license for purposes of build-out, operation and coverage. In those instances, the Company's waiver will no longer be necessary. In some markets, the Company may successfully bid on an MTA license where the incumbent DFA licensee is a third party. In those instances, the Company will be required to afford interference protection to the incumbent DFA licensee. In markets or with frequencies where the Company is the DFA licensee but not the successful MTA bidder, the Company's DFA license will retain all of its licensing and operational requirements, such as loading, in existence prior to the auction. The Company's waiver, in those instances, will remain in effect.\nWhere the Company is a successful MTA bidder, it must complete coverage of at least one third of the population of its service area within the first three years of its initial MTA license grant or in the alternative demonstrate substantial coverge of the MTA, and complete coverage of at least two thirds of the population within five years.\nThe FCC has granted type acceptance for the Company's network infrastructure equipment and subscriber units for commercial use.\nPatents and Technology Rights\nIn accordance with a joint venture agreement (the \"Power Spectrum Joint Venture Agreement\") between the Company and Rafael Armament Development Authority (\"Rafael\"), PST has the right to review the technology of Rafael provided to PST pursuant to the terms of the PowerSpectrum Joint Venture Agreement, and file, in Rafael's name, patent applications on any patentable technology already in existence at the time of the signing of such agreement. Pursuant to the PowerSpectrum Joint Venture Agreement, Rafael is also obligated to grant PST an exclusive royalty free license under any patent applications so granted, subject to an exclusion for military technology. PST has the right to file patent applications on any inventions made by PST based on, or connected to, the technology developed by PST after the date of the PowerSpectrum Joint Venture Agreement. Pursuant to these terms, a United States patent has been issued to Rafael.\nPST has filed several patent applications in Israel and intends to file patent applications in other countries including the United States.\nIn addition to those patent applications filed by PST, the Company also has filed patent applications in Israel and the United States based on technology developed by the Company. As of December 31, 1995, no patents had been issued to the Company or PST and there can be no assurance that a patent will issue from any pending or future patent applications or that if any are issued that any of them will have any commercial significance. The Company is aware of certain patents and patent applications held or filed by others which generally relate to the subject matter of the Company's activities. The Company believes that none of such patents or applications is likely to have a material adverse effect on the ability of the Company to utilize any technology currently intended to be utilized by the Company.\nThe Company protects its proprietary information by way of confidentiality and non-disclosure agreements with employees and third parties who may have access to such information. The Company continually reviews its technology developments in order to file patent applications and has filed patent applications with respect to certain aspects of its FHMA(TM) technology and GEONET(TM) in Israel and the United States and expects to file additional patent applications in Israel and the United States. Generally, the Company intends to file all patent applications in the United States and Israel and in such other countries as it deems appropriate. There can be no assurance that such applications will be granted. There can be no assurance that any patents issued will afford meaningful protection against competitors with similar technology or that any patents issued will not be challenged by third parties. There also can be no assurance that others will not independently develop similar technologies, duplicate the Company's technologies or design around the patented aspects of any technologies developed by the Company. Many patents and patent applications have been filed by third parties with respect to wireless communications technology. The Company does not believe that its technology infringes on the patent rights of third parties. However, there can be no assurance that certain aspects of the Company's technology will not be challenged by the holders of such patents or that the Company will not be required to license or otherwise acquire from third parties the right to use certain technology. The failure to overcome such challenges or obtain such licenses or rights could have a material adverse effect on the Company's operations.\nThe Company owns several trademarks, including GEONET(TM) and FHMA(TM), in the United States and certain other countries.\nThe Company's Research and Development expense related to the digital wireless communication system totaled $33.0 million in 1995 compared to $17.0 million in 1994 and $8.9 million in 1993 (exclusive of acquired research and development of $32.4 million in 1993).\nGMSI\nGMSI designs, manufactures, and sells various systems for the mobile data market. It has a dominant position in the market for data dispatch systems for taxicabs, limousines, and similar fleets, selling its systems in primarily North America, as well as, Europe and Australia.\nGMSI offers the Wireless Network Interface (\"WNI\") software package under license to interface to a variety of private and SMR radio networks. WNI licenses are available to UNIX, Windows and DOS machines. WNI provides software developers with a seamless interface to multiple networks and eliminates the complexities, cost and risk of implementing a mobile data solution with existing dispatch and management software.\nGMSI provides a variety of mobile data terminals and radio modems for courier and other applications. \"Status\" terminals report predetermined events such as on-site with a single keystroke on a labeled function key. A terminal with an alphanumeric keyboard is able to record information such as name of recipient. All terminals support customer designed forms, mag-swipe and bar-code data entry.\nCommunications Products Activities\nThe Company's communications products activities are conducted through Bogen Corporation (\"Bogen\") and Speech Design GmbH (\"Speech Design\"), which are subsidiaries of Bogen Communications, Inc. (\"BCI\"). The Company owns approximately 64% of the issued and outstanding capital stock of BCI. Bogen is a 99% owned subsidiary of BCI and Speech Design is a 68% owned subsidiary of BCI.\nBogen\nBogen develops, produces and sells telephone and telecommunications peripherals and sound and communications equipment through its wholly owned subsidiary, Bogen Communications, Inc. Since 1932, when originally founded, Bogen has been involved in the communications industry, concentrating its efforts on the development and sale of equipment for commercial, industrial, professional and institutional markets and applications.\nBogen's traditional line of products includes audio amplifiers and related sound equipment for professional, industrial and commercial system applications, such as telephone paging, intercommunications and administrative communications systems for schools, correctional facilities and other institutions.\nDuring 1991, Bogen introduced its first product in a line of telecommunications and telephone peripherals. The product is the MMT, a digital announcer with automatic microprocessor controlled tape download for \"on-hold\" applications. During 1992, Bogen introduced various products in the digital telephone peripherals area, including the Automated Attendant and the Digital Announcer. Bogen introduced, during 1993, the PCM\/ZPM, zone page modules for telephone paging. Although Bogen believes that the growth experienced in the last four years in this line of products may continue, there can be no assurance of such growth.\nIn September 1993, Bogen introduced the Friday Home Office Receptionist, a home-office digital receptionist with a built-in fax switch, call-forward capabilities, four incoming mailboxes and three outgoing message mailboxes. Additional products in this line were introduced in 1994 and 1995. In December 1995, Bogen's management decided to phase-out this product line during 1996.\nSales and Marketing\nAll of Bogen's products, with the exception of its office automation products, are sold primarily through distributors, dealers and contractors, often as complete systems designed to satisfy an end-user's specific sound and communications needs. The principal users of these products are industrial, professional and commercial concerns and institutions such as schools, nursing homes and correctional institutions. Bogen management believes that these user markets are all relatively stable markets in which Bogen enjoys name recognition.\nSales of Bogen's traditional products are made through a network of about 2,000 distributors, dealers and contractors located throughout the United States and Canada which purchase products directly from Bogen and then resell these products to dealers and\/or end-users.\nBogen considers its distribution network to be one of its most valuable assets. Bogen's products are generally marketed through a field sales organization and several independent sales representative entities under the direction of Bogen's internal sales force. Both the representatives and the field sales group are responsible for assigned territories. The representatives are compensated on a commission basis and the field sales personnel are compensated with salary and bonuses based on performance. Sales agreements are maintained with all of Bogen's independent sales representatives and engineered systems contractors. The sales representative agreements typically permit the sale of Bogen products by the representative in a specific territory. Each territory is assigned one or more sales representatives. Similarly, the engineered systems contractor agreements typically allow the contractor to purchase and install specific product lines in a designated territory. These agreements, which restrict the representative or contractor from dealing in a competitive line of products while representing Bogen, may be terminated by either party upon 30 days' notice.\nBogen maintains its principal warehouse and executive offices at its main location in Ramsey, New Jersey and it also maintains stock in the States of California and Washington at warehouses managed by certain of Bogen's independent sales representatives. Service for all of Bogen's products is provided by its service department.\nAlthough its sales are substantially to United States customers, Bogen also sells its products in Canada through a stocking representative that is headquartered in Ontario and has branch offices throughout Canada. Export sales to other foreign countries are handled in a similar fashion to sales within the United States, through distributors that purchase the products and sell them to an established account base overseas.\nPatents and Trademarks\n\"Bogen\" is a trademark of the Company registered in the United States and in certain foreign countries throughout the world, which expires in the United States in March 2000. Bogen has also obtained trademark registration for the trade name \"Multicom 2000\" utilized in connection with the engineered systems it markets, which expires in July 2001. Bogen has various pending patents related to its new products. There can be no assurance that any patents will ultimately be issued.\nSources of Material\nAll components and material used in the construction of Bogen's products are of standard commercial quality or better, and are readily available from overseas and United States suppliers. Bogen relies principally upon an established network of suppliers and subcontractors located in the Republic of South Korea, Taiwan, Israel and the United States. These suppliers and sub-contractors either produce sub-assemblies for use in the final assembly of a finished product, or produce the finished products themselves. Products are based on Bogen designs and are built in accordance with Bogen drawings and specifications.\nBogen's primary source of components and completed products is from manufacturers located in the Republic of South Korea. There can be no assurances that disruptions in supplies will not occur, or that such disruptions will not have a material adverse effect on Bogen.\nResearch and Development\nBogen's engineering department is responsible for research and development, production engineering and sales engineering. In 1995, Bogen incurred approximately $ 1.4 million in research and development expenditures, compared to $1.5 million in 1994 and $1.3 million in 1993.\nCompetition\nBased in large part on its relatively broad product base and multiple markets, Bogen believes that it has no significant direct competitor. Instead, competition varies from market to market and product to product. Bogen competes on the basis of several different factors, including name recognition, price, innovation and product quality. Such factors vary in relative importance depending on Bogen's product(s). Bogen's management has concentrated on markets in which it believes that Bogen could obtain at least a 10% market share, be one of the top two or three suppliers and\/or obtain substantial growth.\nIn the general line distributor customer market, Bogen's principal competition comes from University Sound, a United States manufacturer, and from several off-shore suppliers. Because these off-shore suppliers have not developed significant brand name recognition, no single one has become a major factor in this market. Because ready availability and accessibility is a primary consideration for retail customers, Radio Shack, with over several thousand retail outlets, is a significant competitor. Bogen's management anticipates no major competitive changes in this market in the foreseeable future.\nIn the view of Bogen's management, the Telco customer market has overall growth potential. Bogen's main competitor is Valcom Inc. which has been established in this market for several decades. Other competition comes primarily form several United States companies who have been losing market share over the past few years and from several companies attempting to enter the market. Bogen has increased its share of the Telco market in recent years.\nThe Engineered Sound customer market is a highly specialized market characterized by low unit volume\/high dollar sales which has deterred potential competition from off-shore manufacturers. Bogen's principal competition comes from Rauland Borg Corp. and Dukane Corporation, which, like Bogen, have been in\nthe market for several years and have well established name recognition and distribution channels. Rauland Borg Corp. is currently the acknowledged market leader.\nThe Commercial Sound customer market is characterized by intense competition, particularly from several overseas companies. Bogen's principal competitor is a Japanese company, TOA Electronics, Inc., which features broad, high quality product lines. Other competitors are comparatively small manufacturers that rely mainly on established account relationships.\nGovernment and Industry Regulation\nMany of Bogen's products require either certification by the Federal Communications Commission or Underwriter's Laboratory approval, or both. All current products of Bogen that require such approval have obtained them. Bogen's products must also comply with applicable local and state regulations to permit use by the end-user. Bogen makes all reasonable efforts to ensure that its products comply with such requirements.\nSpeech Design\nSpeech Design, located in Munich, Germany, develops, manufactures and markets telephone peripheral hardware utilizing digital voice processing technologies. The Company acquired a controlling interest in Speech Design in February 1993, with a goal of initially expanding sales of the Company's communications products into Germany, Europe's largest market, and to utilize Speech Design as a platform to penetrate other European markets.\nSpeech Design was engaged until 1992 primarily in selling peripheral equipment for cellular telephones over the analog network. With the advent of the European GSM digital standard and the related decline of prices of ancillary subscriber equipment, Speech Design's management decided to refocus its activities from the cellular market to the telephone peripherals. Management expects continued growth in sales of telephone peripherals, but there can be no assurance that such growth will be achieved.\nIn 1995, sales to five customers accounted for approximately 75% of Speech Design's sales. Such customers generally packaged Speech Design products with PBX equipment for sale to third parties.\nEmployees\nAs of December 31, 1995, the Company had approximately 450 full-time employees, of which approximately 300 were engaged in its wireless communications businesses and approximately 150 of which were engaged in its communications products businesses. The Company considers its relationship with its employees to be good.\nAs of December 31, 1995, approximately 90 employees of Rafael were engaged on a full-time basis in the development of the Company's FHMA(TM) digital system. Rafael's employees are represented by a labor union, and, from time to time, there have been labor disputes between Rafael and its employees which have resulted in slow-downs. To date, these slow-downs have not had a material effect upon the Company's business. There can be no assurance, however, that any future disputes will not have a material adverse effect on the development or introduction of GEONET(TM) services by the Company in its target markets.\nThe success of the Company will depend greatly upon the active participation and the experience of its management. The loss of the services of Yaron Eitan, the Company's President and Chief Executive Officer, could adversely affect the conduct of the Company's business. In addition, the successful implementation of the Company's business plan will depend, to a large extent, upon the ability of the Company's and its subsidiaries' engineers and scientific personnel to perfect and improve upon existing and proposed products. The loss of some or all of such personnel, or the inability of the Company to attract additional personnel, or the inability of such persons to enhance such systems or to continue product enhancements will directly inhibit the ability of the Company to sell its products and services and to operate in a timely or profitable manner.\nFinancial Information\nFinancial information about the Company's industry segments and the Company's foreign and domestic operations is disclosed in Footnote 16 to the Company's Consolidated Financial Statements. See \"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\"\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nSince July 2, 1993, the Company's principal place of business has been located at 20 Craig Road, Montvale, New Jersey. The Company rents 26,800 square feet of office space under several leases at a total rate of $500,000 per year, plus taxes and utilities. The lease expires between April 1996 and July 1999. The Company's Montvale facility functions both as its corporate headquarters and the general offices of the Company's U.S. wireless operation. The Company is considering relocating to a larger facility in the Montvale area.\nBogen subleases its facilities, located at 50 Spring Street, Ramsey, New Jersey from an unaffiliated third party. The sublease expires on December 31, 2000 and requires rental payments at a rate of approximately $700,000 per year for the remainder of the term.\nNB3 leases its principal place of business in Chelmsford, England, pursuant to a lease which expires in September 1999. This lease is subject to the Company's option to extend the lease for four successive five-year periods. Annual rental payments during the initial term of this lease are $310,000. Rental payments pursuant to each of the options are to be negotiated prior to the start of each five-year period. NB3 leases sites for its base stations from different parties under leases with various terms, amounts and conditions.\nSpeech Design leases its facilities in Munich, Germany pursuant to a lease which expires in 2005. Annual rental payments are approximately $240,000.\nGMSI leases its facilities in Ontario, Canada pursuant to a lease which expires in April 2005 Annual base rental payments over the remainder of the lease are approximately $140,000.\nIn connection with the roll-out of GEONET(TM), the Company expects to lease office space in each of the 35 target markets in which it intends to provide GEONET(TM) service. In addition to office space, the Company must secure leases for its transmission equipment at suitable locations in each of these cities. As of March 1996, the Company had leased office space in seven of its target markets. The aggregate annual rental payments pursuant to these leases are $375,000.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nIn June 1994, the Company filed a lawsuit in Dutch bankruptcy court against Harris Adacom Corporation B.V. (\"Harris\"), a Dutch corporation, to enforce its rights under a loan agreement between the parties. The Company is seeking repayment of a $3.5 million loan made to Harris in January 1994 in connection with a potential purchase transaction between the Company and Adacom Technologies Ltd. (\"ATL\"), an affiliate of Harris and an Israeli publicly-traded company. The loan was collateralized by stock owned by Harris in ATL. At the time of the loan, the collateral had a market value in excess of $10 million and the total market value of ATL was in excess of $100 million. The purchase transaction was not consummated. In May 1994, the market value of ATL dropped dramatically and ATL became insolvent, thereby reducing the value of the collateral to practically zero. At or about the same time, creditors placed Harris into bankruptcy proceedings in the Netherlands. The Company subsequently received information relating to the recoverability of the loan and management does not expect to recover the loan. The Company is aggressively pursuing its rights under the loan in Dutch bankruptcy court and is awaiting additional information on the assets and creditors of Harris. Based upon the information currently available to it, the Company cannot determine the amount, if any, that will ultimately be recovered and has established a reserve against the full amount of the loan.\nIn response to the Company's lawsuit, Harris and its subsidiaries filed a lawsuit against the Company in the courts of the State of Israel, requesting a declaratory judgment that the Company entered into a binding agreement for the purchase by the Company of a significant interest in certain wireless communication business assets owned by ATL and subsequently breached such agreement. The plaintiffs in such action have stated an intention to file a separate claim for monetary damages and have estimated their losses to be several million dollars. The Company believes that the claims in such action are without merit and are only an attempt to delay efforts to collect Harris' debt to the Company. The Company intends to defend such action vigorously.\nThe Company develops and utilizes technology for substantially all of the services and products it offers and intends to offer and has, from time to time, been the subject of infringement claims related thereto. It is often difficult to predict the outcome of such litigation and the amount of damages which may be awarded in these types of cases. The Company does not believe that any pending or threatened litigation related to the Company's technology or use thereof will have a material adverse effect on its financial position.\nThe Company is also, from time to time, party to litigation, which may or may not be covered by insurance, arising in the ordinary course of business. The Company does not believe the results of such litigation, even if the outcome were unfavorable to the Company, would have a material adverse effect on its financial position.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matters were submitted to a vote of the Company's stockholders during the fourth quarter of 1995.\nItem A. EXECUTIVE OFFICERS\nAs of the date hereof, the executive officers of the Company are:\nName Age Position ---- --- -------- Winston J. Churchill 55 Chairman of the Board and Director Yaron I. Eitan 39 President, Chief Executive Officer and Director Jonathan C. Crane 46 President & CEO - GEOTEK U.S. Operation George Calhoun 42 President - Wireless Communications Group and Director Yoram Bibring 38 Executive Vice President and Chief Operating Officer John Egidio 47 Senior Vice President, Operations Oliver Hilsenrath 37 Senior Vice President, Technology William A. Opet 38 Senior Vice President, Marketing and Sales Andrew Robb 52 Managing Director, European Operations Michael McCoy 43 Senior Vice President and Chief Financial Officer Michael Carus 30 Chief Accounting Officer and Corporate Controller Robert Vecsler 31 General Counsel and Secretary\nMr. Churchill has served as Chairman of the Board and as a director of the Company since 1991. Mr. Churchill is a principal of CIP Capital Management, Inc., a private investment firm formed in 1989. He has served as a principal of such firm since its inception. Prior to 1989, Mr. Churchill practiced law and served as Chairman of the Banking and Financial Institutions Department and the Finance Committee of Saul, Ewing, Remick & Saul, Philadelphia, PA.\nMr. Eitan has served as President, Chief Executive Officer and a director of the Company since March 1989. He is also Chairman of the Board of Bogen and a director of PST, GMSI and NB3, subsidiaries of the Company. Mr. Eitan served as a director of Patlex Corporation from 1985 until February 1989, during which time he served as President of Patlex from November 1987 to June 1988 and Executive Vice President of Patlex from July 1987 to November 1987 and from June 1988 to February 1989.\nMr. Crane joined the Company as President & CEO - GEOTEK U.S. Operations in October 1995. Prior to joining the Company, from January 1994 through January 1995, Mr. Crane was President & Chief Executive Officer of LightStream Corporation, a start-up ATM switch company. In January 1995, LightStream was purchased. From May 1985 through January 1994 Mr. Crane served in various executive capacities at MCI Telecommunications where he most recently served as Executive Vice President - Multinational Accounts.\nMr. Calhoun was appointed a director of the Company in July 1993 when he became President of the Company's wireless communications group. Mr. Calhoun joined the Company in June 1992 as President, Chief Operating Officer and a director of PST. He is also a director of NB3 and PST. Mr. Calhoun served in various positions with InterDigital Communications Corporation (formerly International Mobile Machines Corporation), a corporation co-founded by Mr. Calhoun and engaged in the development of digital radio technology, most recently as General Manager of the Intellectual Property Licensing Division, which position he held until June 1992.\nMr. Bibring joined the Company as Chief Financial Officer in February 1990, a position he held until September 1995. He has served as Executive Vice President and Chief Operating Officer of the Company since June 1993. He is also a director of Bogen. He served as Vice President of Aryt Optronics Industries, Ltd. (\"Aryt\") from December 1990 to April 1991. From November 1986 to January 1990, Mr. Bibring was a Senior Auditor at Shachak & Company, a public accounting firm in Israel.\nMr. Egidio became Senior Vice President of the Company in October 1993. From December 1991 to November 1992, he was President and Chief Executive Officer of Metagram America, Inc., a company engaged in the provision of alphanumeric messaging services. From February 1985 to April 1990, Mr. Egidio was President and Chief Executive Officer of MobileMedia Communications, Inc. (formerly Metromedia Paging), a subsidiary of Southwestern Bell engaged in wireless communications.\nMr. Hilsenrath has served as Senior Vice President of the Company since 1992. From August 1990 to September 1992, he was employed as Engineering Manager by the Aydin Vector Division of Aydin Corporation, a U.S. defense electronics and communications company. From 1983 to 1990, Mr. Hilsenrath was employed by the Communication Directorate of Rafael where he served as Chief Research and Development Engineer.\nMr. Opet was appointed Vice President of Marketing for the Company in April 1994 and has been Senior Vice President, Marketing and Sales since October 1994. From June 1990 to March 1994, he served as Vice President of Marketing for LIN Broadcasting (\"LIN\"), a 52% owned subsidiary of McCaw Cellular, where he worked extensively on the introduction of digital cellular systems. From May 1986 to June 1990, Mr. Opet was Vice President of Marketing and Sales for LIN's Philadelphia cellular operations.\nMr. Robb was appointed as Managing Director for the Company's European Operations in August, 1994. Previously, he had served as Managing Director of NB3 and one of its predecessor companies for more than five years. Prior to January 1987, Mr. Robb served as Sales Director of the Communications Group of Motorola in the United Kingdom for approximately four years.\nMr. McCoy has served as Senior Vice President and Chief Financial Officer of the Company since September 1995. From November 1994 through September 1995, Mr. McCoy was the Company's Vice President of the North East Region. Prior to joining the Company, from September 1992 through November 1994, Mr. McCoy was President of Greenlake Associates, Inc., a high technology consulting company. From November 1988 through September 1992, Mr. Mc Coy was a member of the Office of the Chairman and Senior Vice President of Business Development for LCI International, Inc., a facilities based long distance telecommunications company.\nMr. Carus has served as Chief Accounting Officer and Corporate Controller of the Company since June 1995. Mr. Carus is a Certified Public Accountant and, from August 1988 to June 1995, was a Business Assurance Manager in the communications team at Coopers & Lybrand L.L.P., a public accounting firm.\nMr. Vecsler was appointed General Counsel and Secretary of the Company in March 1996. From May 1995 through March 1996 he served as Corporate Counsel for the Company. Prior to joining the Company, from August 1994 until April 1995, Mr. Vecsler served as Assistant General Counsel at Enviro Source, Inc. From April 1993 until July 1994, he served as Counsel to Fletcher Asset Management, Inc. Mr. Vecsler practiced law at Kelly, Drye & Warren from September 1988 until March 1993.\nPART II\nItem 5.","section_5":"Item 5. MARKET PRICE FOR REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Company's Common Stock currently trades on the NASDAQ National Market under the symbol \"GOTK\" and on the Pacific Stock Exchange under the symbol \"GEO\".\nThe following tables set forth, for the quarters indicated, the high and low sales prices for the Company's Common Stock as reported on the NASDAQ National Market:\nYear Ended December 31, 1995 High Low\nFirst Quarter ........................ 9 3\/8 6 3\/4 Second Quarter ....................... 9 7\/8 7 1\/8 Third Quarter ........................ 10 7 1\/2 Fourth Quarter ....................... 9 1\/4 5 1\/2\nYear Ended December 31, 1994 High Low\nFirst Quarter ........................ 16 10 3\/8 Second Quarter ....................... 11 5\/8 7 1\/4 Third Quarter ........................ 12 1\/8 6 3\/8 Fourth Quarter ....................... 10 3\/4 7 1\/2\nAs of March 25, 1996, there were 56,774,000 record holders of the Common Stock.\nThe Company has not declared or paid any cash dividends on the Common Stock since commencing operations and is restricted from paying any dividends on the Common Stock due to debt covenant restrictions. At present, the Company is obligated to pay, for a five-year period following the issuance of its Series H preferred stock, cumulative dividends of $2,000,000 per year on the Series H preferred stock, in cash, and, for a five-year period following the issuance of its Series I preferred stock and Series K preferred stock, respectively, cumulative dividends equaling $700,000 per year on the Series I preferred stock and $700,000 per year on the Series K preferred stock, in cash or shares of Common Stock of the Company, before any cash dividends may be paid on the Common Stock. In addition, the Company is presently obligated to pay cumulative annual dividends of $750,000 per year on its Series L preferred stock, in cash or additional shares of Series L preferred stock, and cumulative annual dividends of $988,125 per year on its Series M preferred stock, in cash or shares of Common Stock, before any cash dividends may be paid on the Common Stock. At present, the Company is current in payment of all required dividends on its outstanding preferred stock.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA\n(In thousands, except per share data)\n(1) Historical numbers were restated for the acquisition in January 1994, through a merger, of 100% of Metro Net Systems Inc. The merger has been accounted for as a pooling of interests.\nThe Company did not pay a cash dividend on the Common Stock during any period indicated.\nThe difference in financial results among the years is influenced by the following acquisitions and dispositions. In April 1991, 87% of Bogen was acquired. In 1992 PowerSpectrum, Inc. was formed, the defense segment was discontinued and an additional 4% of Bogen was acquired. In 1993 NB3, Speech Design, GMSI and the remaining interest in PowerSpectrum, Inc. were acquired and Oram Electric Industries, Ltd., Oram Power Supplies 1990, Ltd. and Geopower were sold. In 1994, 49% interests in PBG and DBF and an 8% interest in Bogen were acquired. In 1995, the Company sold its interests in Special Design and Bogen to BCI in exchange for, among other things, a 64% interest in BCI, the remaining interests in PBG and DBF were acquired and the Company increased its interest in PST from 56% to 94%. See \"Item 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe following discussion should be read in conjunction with, and is qualified in its entirety by, the consolidated financial statements and the notes thereto included elsewhere in this report.\nResults of Operations\nGeneral\nOver the past four years, the Company has devoted and expects to continue to devote substantial financial and management resources to the development of a low cost, high quality integrated digital voice and data wireless communications network (\"GeoNet(TM)\"). Although Management believes GeoNet(TM) will have a positive effect on the Company's results of operations in the long term, it is expected to have a substantial negative effect on the Company's results of operations in the short term. The Company expects to incur substantial losses and have negative cash flow from operations for the foreseeable future, attributable primarily to the operating, sales, marketing, general and administrative expenses relating to the roll out of GeoNet(TM) as well as to a high investment in research and development related to its wireless communications activities. There can be no assurance that the Company will operate at profitable levels or have positive cash flow from operations.\nThe Company currently groups its operations primarily into three types of activities: wireless communications, communications products and corporate. The Company's wireless communications subsidiaries are currently engaged primarily in providing trunked mobile radio services in the United Kingdom and Germany utilizing analog equipment, developing and selling wireless data solutions, and implementing a digital wireless communications system for the United States that will provide integrated wireless communications services. The Company is presently in the process of commencing the rollout of GeoNet(TM). The Company started providing commercial services in Philadelphia in January 1996 and in February 1996 announced the initiation of commercial services on GeoNet TM in Washington, DC and Baltimore, MD and in March 1996, announced commercial service in New York. The Company intends to offer GeoNet TM in over 35 markets by the end of 1997.\nThe Company's communications products subsidiaries are primarily engaged in the development, manufacturing, and marketing of telephone peripherals and sound and communications equipment.\nSummary of Operations\n1995 Compared to 1994\nConsolidated revenues increased by 10% in 1995, principally due to subscriber growth of the National Band Three Network (\"NBTL\") in the United Kingdom.\nConsolidated operating expenses increased by 40.2% in 1995, principally due to increased research and development activities associated with the Company's digital wireless communication system and costs related to the rollout of GeoNet(TM).\nConsolidated losses increased by $44.8 million to $87.2 million in 1995.\nOn a consolidated basis, interest expense increased in 1995 principally due to the July 1995 issuance of Senior Secured Discount Notes which accrue interest at 15% as well as the accretion of the value of the warrants issued in connection with the Senior Secured Discount Notes. Interest income increased in 1995 due to greater cash and cash equivalents which resulted from the issuance of the Senior Secured Discount Notes. Amortization expense increased from $2.8 million in 1994 to $4.2 million in 1995 due to the Company's acquisitions of the German Networks.\n1994 Compared to 1993\nConsolidated revenues increased by 49% in 1994, principally due to the acquisition of NBTL in July 1993 and higher revenues from the communications products segment.\nConsolidated operating expenses increased by 4.9% in 1994, due to increased research and development activities associated with the Company's digital wireless communication system, costs related to the rollout of GeoNet(TM) and volume growth of the communications product segment.\nConsolidated losses from continuing operations decreased by $8.0 million to $42.2 million in 1994.\nOn a consolidated basis, interest expense increased in 1994 due to a higher level of debt outstanding during the year. Interest income increased in 1994 due to greater cash and cash equivalents and higher rates earned on invested funds. Amortization expense increased from $0.9 million in 1993 to $2.8 million in 1994 due to of the Company's 1993 and 1994 acquisitions.\nWireless Communications Activities\nThe tables below set forth certain information with respect to the results of operations of the Company's Wireless Communications Activities for the years ended December 31, 1995 and 1994. The North American column includes the U.S. Wireless Network as well as the Company's GMSI and MetroNet subsidiaries.\n1995 Compared to 1994\nFor the Year Ended December 31, 1995 (Dollars in Thousands)\nFor the Year Ended December 31,1994 (Dollars in Thousands)\nRevenues from wireless communications increased by $7.3 million or 29% for the year ended December 31, 1995. This increase is primarily due to the increase in the number of subscribers using the NBTL network (which totaled approximately 57,400 and 47,700 at December 31, 1995 and 1994, respectively) as well as, the inclusion of the DBF and PBG German Networks on the consolidated basis since July 1995 and December 1995, respectively, amounting to $0.7 million. Average revenue per subscriber on the NBTL network remained constant. Gross profit as a percent of revenues increased as NBTL's cost are primarily fixed thus, allowing subscriber growth to increase the gross profit percentage.\nResearch and development expenses (net of government grants) related to the digital wireless system and subscriber unit were $33.0 million for the year ended December 31, 1995. In 1995, the Company continued to receive grants from the Chief Scientist of the Ministry of Commerce and Industry of the Israeli Government (\"Chief Scientist\"). Such grants, which are recorded as a reduction of research and development expenses, totaled $5.9 million in 1995 ($4.1 million in 1994). Included in research and development expenses is a $5.6 million fourth quarter expense related to scope changes in the development of the digital wireless system. Additionally, research and development expense includes a $6.0 million fourth quarter charge related to payments for the development of the portable subscriber unit. Also included in research and development expense in 1995 is $2.0 million relating to shares of Common Stock issued to Rafael Development Corporation in consideration for a research and development project. The Company expects significant research and development expenses to continue in the future in connection with enhancements made to the system and subscriber unit.\nThe Company is presently in the process of commencing wireless service over its proprietary GeoNet(TM) network and accordingly continues to put in place its marketing, engineering, operations and administrative staff and systems. Marketing expenses increased by approximately $8.0 million or 90% due to the commencement of the marketing effort and increase in staff needed to execute the roll-out of GeoNetTM as well as volume growth in the German and NBTL networks. General and administrative expenses increased $2.2 million due to an increase in administrative staff to support GeoNetTM as well as volume growth in the German and NBTL networks.\nFor Wireless Communications Activities, equity in losses of less than 50% owned entities increased to $3.3 for the year ended December 31, 1995 from $1.9 million in 1994. The 1995 loss relates to the Company's investment in its German networks prior to the acquisitions of the remaining shares of these two networks. The Company began to fully consolidate these entities subsequent to the date of the acquisitions of the remaining interests. The 1994 loss relates to both of the German networks for six months. These networks have only recently begun operations and subscriber revenues do not cover operating expenses. It is expected that these networks will continue to generate losses in the near future. The number of subscribers on these networks as of December 31, 1995 was approximately 11,800.\nWireless activities generated a loss before net interest expense, amortization and depreciation of $55.2 million for the year ended December 31, 1995 compared to $30.0 million in 1994. This increase is primarily due to the increased research and development expense as well as costs related to the commencement of the roll-out of the digital wireless communication system for the U.S. network (including approximately $2.4 million relating to shares of common stock issued to Vanguard in consideration for management consulting services, which was $2.5 million in 1994).\nThe tables below set forth certain information with respect to the results of operations of the Company's Wireless Communication activities for the years ended December 31, 1994 and 1993. The North American column includes the U.S. Wireless Network as well as the Company's GMSI, Inc. and MetroNet subsidiaries.\nFor the Year Ended December 31, 1994 (Dollars in Thousands)\nFor the Year Ended December 31, 1993 (Dollars in Thousands)\nWireless Communications\n1994 Compared to 1993\nRevenues from wireless communications activities increased by $13.3 million, or 108%, in 1994, primarily due to the acquisitions of NBTL on July 1, 1993 (1994 revenues of NBTL were $19.8 million), and GMSI, Inc. (\"GMSI\") on May 1, 1993 (1994 revenues of GMSI were $3.5 million). The Company's 1993 results include the results of these subsidiaries from their date of acquisition forward, while the results for 1994 include the results of these subsidiaries for the entire year. On a pro forma basis year-to-year 1994 revenues of NBTL increased by 22%, while revenues of GMSI declined slightly. In addition, the average number of subscribers on the NBTL network increased by 29% in 1994. The increase was the result of an aggressive marketing program as well as through the acquisition of smaller regional networks. While average service revenue per subscriber on the Company's core customer base remained unchanged in 1994, the acquisition of the smaller regional networks, which charge lower tariffs, slightly reduced NBTL's average revenue per subscriber in 1994. U.S. analog wireless networks generated revenues of $2.5 million in 1994.\nOperating expenses decreased $4.6 million or 8.0% in 1994. In 1993, the Company had a $32.4 million non-cash charge related to the July 1993 acquisition of the minority ownership interest in PSI (the Company's U.S. wireless communications subsidiary). In exchange for all the shares of PSI that it did not already own, the Company issued common shares and options to acquire additional shares. The value of the consideration paid over the fair value of the net assets acquired ($32.4 million) has been attributed to the incomplete research and development project and was charged to expense at the time of the exchange. Excluding the non cash charge of $32.4 million, operating expenses increased by $27.7 million or 99%. Expenses at NBTL increased by $9.7 million in 1994, including $7.8 million for both the full year inclusion of NBTL, as well as network operating costs to service the larger subscriber base and approximately $1.9 million of additional marketing and general costs. Research and development expenses (net of grants) related to the digital wireless system and subscriber unit increased by $8.3 million or 94.0%. In 1994, the Company continued to receive grants from the Chief Scientist. Such grants, which are recorded as a reduction of research and development expenses totaled $4.0 million in 1994 and $2.8 million in 1993. Costs related to marketing,\nengineering, operations and administrative staff and systems totaled $14.8 million in 1994, an increase of $8.1 million over 1993.\nIn 1994, the Company acquired minority stakes in two wireless networks in Germany. The Company's 1994 loss related to these networks was $2.4 million.\nThe wireless activities generated a loss before net interest expense, amortization and depreciation of $30.0 million in 1994 compared to a loss of $48.0 million in 1993 due to the factors discussed above. Included in the 1994 loss were $17.0 million of research and development costs related to the digital wireless communications system and $14.8 million of rollout costs related to the U.S. network (including approximately $2.5 million relating to shares of common stock issued to Vanguard in consideration for management consulting services).\nCommunications Products Activities\nIn August 1995, the Company transferred its interests in Speech Design GmbH and Bogen Communications, Inc. to Bogen Communications International (\"BCI\") formerly, European Gateway Acquisition Corporation, in exchange for $7.0 million in cash, $3.0 million in convertible notes receivable, approximately 64% of BCI common shares and warrants to purchase 200,000 shares of BCI common stock at $5.50 per share. The Company will also be eligible to receive additional consideration if the future earnings of both Speech Design and Bogen through July 1997 attain certain levels. The Company continues to control and consolidate this entity.\nThe table below sets forth certain information with respect to the results of operations of BCI as consolidated by the Company for the years ended December 31, 1995, 1994 and 1993.\n(Dollars in Thousands) December 31\n1995 1994 1993 ---- ---- ---- Revenues $44,518 $46,074 $30,060 Gross profit 17,180 16,428 11,829 % of revenue 39% 36% 39% Research and Development 2,307 2,116 1,702 Marketing 9,960 8,913 6,374 General and Administration 5,962 3,342 2,374 Other income (236) Income before interest, tax, amortization & depreciation (813) 2,057 1,379 Amortization & depreciation 1,242 1,181 956 Interest expense, tax & minority interest 2,069 1,245 388 Net (loss) income $(4,124) $(369) 35\n1995 Compared to 1994\nRevenues from communications products activities for 1995 decreased by $1.6 million, or 3% to $44.5 million. The overall decrease in revenues is due to a decrease in the Office Automation System (\"OAS\") product line revenues of $7.8 million, offset by an increase in the core product line revenues by $6.2 million. In December 1995, due to continued losses, the management of Bogen decided to phase out the OAS product line.\nGross profit for 1995 increased $0.8 million and was equal to 39% of revenues, compared to 36% of revenues in 1994. The increase was entirely attributable to the core product line, in which the gross profit margin increased to 45% in 1995, from 40% in 1994, due primarily to change in product mix and higher average core sales prices. This was offset by the recording of a $1.5 million reserve for certain inventory in the OAS product line based on lower of cost or market.\nThe increase in marketing expense of $1.1 million and is due to marketing programs initiated by Bogen to stimulate sales in the OAS product line of business as well as, growth in the core product line.\nThe increase in general and administration expenses of $2.6 million is due primarily to costs to execute the aforementioned BCI transaction.\n1994 Compared to 1993\nRevenues from communications products activities in 1994 increased by $16.0 million, or 53%. Bogen increased its sales by $11.7 million, mainly due to the growth of its OAS product line. Speech Design's 1994 sales increased by $4.1 million, or 115%.\nCost of goods sold in 1994, amounted to $29.7 million or 64.3% of sales compared to $18.2 million or 60.6% of sales in 1993. This decrease in gross profit as a percentage of sales in 1994 reflects the change in product mix (the new products introduced by Bogen are typically sold at a lower margin than Bogen's traditional products), the sales to large customers and private label customers which enjoy volume discounts, and Bogen's reduction of the carrying value of certain inventories by $0.9 million. These factors were offset by the consistently higher margins on Speech Design's products.\nMarketing expenses in 1994 amounted to $8.9 million or 19.4% of sales, compared to $6.4 million or 21.2% of sales in 1993. This increase of $2.5 million is largely the result of higher revenue levels in general and higher distribution costs for Bogen's new products.\nGeneral and administrative expenses in 1994 were $3.3 million or 7.2% of sales, compared to $2.4 million or 7.9% of sales in 1993. This increase of $0.9 million in general and administrative expenses is directly related to the higher revenue levels at both Bogen and Speech Design.\nIncome before interest, depreciation, amortization, tax and minority interest from the Company's Communications Products activities amounted to $2.1 million in 1994 compared to $1.4 million in 1993.\nCorporate Group\nThe Corporate Group includes the Company's corporate headquarters and Geotest, Inc. subsidiary. The Company's Corporate Group generated a loss before net interest expense, amortization, depreciation and other charges of $7.2 million for 1995, compared to a loss of $5.9 million in 1994. The increase is primarily due to the general and administrative costs associated with the expansion of the corporate group. Revenues from corporate group subsidiaries were $2.8 million in 1995, compared to revenues of $1.2 million in 1994.\nThe Company's Corporate Group generated a loss before net interest expense, amortization, and other charges of $5.9 million in 1994, compared to a loss of $1.1 million in 1993. Revenues from corporate group subsidiaries were $1.2 million in 1994, compared to revenues of $6.6 million in 1993. The decrease in revenue is primarily caused by the disposal by the Company of Oram Electric Industries Ltd., Oram Power Supplies (1990) Ltd., and Geopower, Inc. In 1993 these entities generated a net loss of $0.3 million on revenues of $6.3 million. Operating losses at the Company's Geotest, Inc. subsidiary increased from $0.7 million in 1993 to $1.3 million in 1994. In addition, in 1994 the Company recorded a charge of $3.5 million as a reserve against a loan receivable.\nLiquidity and Capital Resources\nThe Company requires significant capital to implement its wireless communications strategy. In order to effect its strategy, the Company increased its debt borrowings and entered into a series of transactions, including the sale of debt and equity, mainly to strategic partners. At December 31, 1995, the Company had $61.4 million of cash and cash equivalents.\nThe Company's short term cash needs are primarily for capital expenditures related to the digital FHMATM system which GeoNet(TM) is deploying and the other costs of rolling out the U.S. network. One of the advantages of the Company's FHMATM system is its modularity, which allows the Company to execute a flexible roll-out plan requiring a relatively low investment in infrastructure in a given geographical area (compared to other wireless communications systems) which is sufficient to provide commercial service. Additionally, the Company expects to serve customers which require primarily local or regional coverage. Management believes therefore that the Company has additional flexibility in controlling its resources by accelerating or slowing down the rate at which various cities are rolled out without impacting the business results of its then operating city or regional networks in a material way.\nThe Company estimates that a minimum average investment of approximately $5 million is required to roll-out an average city. Additional expenditures will be required later if and when increased subscriber capacity or coverage is needed. In addition, the Company estimates that it will continue its present level of research and development expenses during the next 12 months in connection primarily with enhancements to the system and the subscriber unit and other related projects.\nIn March 1996, the Company issued $75 million Senior Subordinated Convertible Notes (\"Convertible Notes\"), due 2001. The Convertible Notes are convertible by the holders after one year from the date of issuance into common stock at a conversion price equal to the lower of (i) $9.50 per share and (ii) the weighted average market price of the share of Common Stock for ten trading day period immediately following the 90th day after issuance date of the Convertible Notes, but shall in no event be less than $8.25 per share. Interest on the Convertible Notes accrue at a rate of 12% per annum and will be payable semi-annually on each February 15 and August 15 commencing August 15, 1996. The Convertible Notes are unsecured senior subordinated obligations of the Company. The Convertible Notes can be converted at the option of the Company after 18 months if the closing price of the Company's common stock for 20 of the 30 trading days and for the five trading days before conversion is 160% of the conversion price.\nOn March 4, 1996, the Company and S-C Rig Investments - III, L.P. (\"S-C Rig\"), a significant stockholder of the Company, which is affiliated with George Soros, reached an agreement in principle pursuant to which S-C Rig will make a $40.0 million unsecured credit facility available to the Company. It is anticipated that all borrowings under the credit facility will accure interest at a rate of 10% per annum and will mature four years from the date of the final borrowing thereunder. It also is anticipated that the Company will be obligated to pay S-C Rig a fee equal to 3% of each borrowing under the credit facility at the time of such borrowing. Borrowings under the credit facility will constitute senior indebtedness of the Company. In connection with the establishment of the credit facility, it is anticipated that the Company will issue to S-C Rig a five-year warrant to purchase 4.2 million shares of Common Stock (subject to adjustment in certain circumstances) at an exercise price of $9.50 per share (subject to adjustment in certain circumstances). The transactions contemplated by the credit facility are subject to a number of conditions, including the negotiation and execution of definitive agreements and the authorization at the Company's next annual meeting of sufficient additional shares of Common Stock to permit the exercise in full of the warrant. There can be no assurances that the\nCompany will consummate the transactions contemplated by the agreement in principal on the terms described above, or at all.\nThe Company is planning to raise additional capital during the next 12 months to continue financing its current operating plan. The Company's long term capital needs include the planned roll-out of the U.S. network in 36 cities, the repayment of convertible debt and redeemable preferred stock (if such are not converted into equity), to finance international networks, and to make acquisitions of business in the field of telecommunications and of spectrum in the United States and internationally. The Company is currently pursuing various alternatives for raising capital including issuance of equity and debt securities, vendor financing, as well as a combination thereof, and other sources. There can be no assurance that the Company will be able to obtain any such financing on acceptable terms, or at all. The failure to obtain such financing may cause the Company to significantly alter its GeoNet TM rollout plan.\nThe following discussion of liquidity and capital resources, among other things, details the changes in the Company's financial and cash position during the year ended December 31, 1995.\nDuring 1995, cash and cash equivalents increased by $33.9 million to $61.4 million, while working capital increased by $22.1 million to $69.2 million as of December 31, 1995.\nCash utilized in connection with continuing operating activities for the year ended December 31, 1995, amounted to $42.1 million.\nCash outflows from investing activities, exclusive of decrease in temporary investments of $14.0 million, were $82.3 million. The Company expended $33.9 million on acquisitions of property, equipment $13.1 million on SMR licenses in the United States, and $6.4 million to purchase the remaining stock of one of the German subsidiaries offset by the receipt of $7.0 million in the BCI transactions.\nThe Company's financing activities provided cash of $143.3 million. In July 1995, the Company issued, in a private offering, $207.0 million aggregate principal amount at maturity of 15% Senior Secured Discount Notes due July 15, 2005 (\"the Notes\"). Gross proceeds of the Notes were approximately $100.0 million. The Notes were issued with 6,210,000 detachable warrants (\"the Warrants\"). Each Warrant entitles the holder to purchase one share of Company common stock at an exercise price of $9.90 per share. The Notes accrue interest until maturity at a rate of 15% per annum. Interest on the Notes are payable semi-annually, in cash, on July 15 and January 15, commencing January 15, 2001. The Notes include covenants that put restrictions on the Company primarily related to making certain investments and incurring additional debt. In August, in connection with the Notes, S-C Rig purchased approximately $21.0 million principal amount of additional units consisting of 15% Senior Secured Discount Notes due 2005 and 621,000 ten year warrants to purchase shares of Company common stock at $9.90 per share. Gross proceeds to the Company were approximately $10.0 million, bringing the total gross proceeds from the issuance of the Notes to $110.0 million. In addition, the Notes are collateralized by a pledge of the capital stock owned by the Company in NBTL, PowerSpectrum, Inc. and subsidiaries, MetroNet Systems, Inc., Geotek Communications GmbH and BCI.\nIn March 1995, the Company refinanced the $25.0 million of Senior Secured Notes, that were originally due in September 1995, with $36.0 million of newly issued Senior Secured Notes (\"Replacement Notes\"). At closing, the Company received net proceeds of $11.0 million and issued warrants to the purchaser to acquire 700,000 of the Company's common shares at $8.125 per share. The Replacement Notes are payable in three equal installments fifteen, twenty four and thirty six months after the closing. Interest at 14.75% is payable quarterly through the term of the Replacement Notes. In accordance with the Replacement Note agreement, the Replacement Notes are being converted into shares of the Company's common stock subject to daily limits and certain other restrictions, at 87.5% of the average trading price of the Company's common stock on the respective conversion dates. As of December 31, 1995, $8.0 million has been converted into 1,228,000 shares of common stock. As a result of the issuance of the aforementioned Replacement Notes in July 1995, the Company's indebtedness under the Replacement Notes was restructured in accordance with the terms thereof by the grant to the lenders of a security interest in a restricted cash account holding approximately $40.5 million and as of December 31, 1995, $30.9 million remains restricted. As conversion of the Replacement Notes occurs, a\nproportionate amount of the restricted cash becomes unrestricted. This amount is recorded on the balance sheet of the Company, as restricted cash, and is expected to satisfy the principal and total interest of the Replacement Notes. This security interest released the original collateral for the Replacement Notes.\nThe Company paid cash dividends totaling $4.1 million on its outstanding preferred stocks. Proceeds from the exercise of warrants and options totaled approximately $1.1 million in 1995.\nIn April 1995, the Company completed the previously announced sale of $10.0 million of Series K Cumulative Convertible Preferred shares to the Company's partner in a joint venture which is attempting to secure a license to provide wireless services in Korea. The shares pay a dividend of 7% per annum for 5 years, carry a conversion premium and can be redeemed by the Company in certain circumstances.\nIn May 1995, the Company sold 531,463 shares of its Series L Cumulative Convertible Preferred Stock (\"Series L Stock\"), to Toronto Dominion Investments, Inc. (\"TDI\") for an aggregate purchase price of $5.0 million. In connection with this transaction, in September 1995, Vanguard Cellular Systems, Inc. (\"Vanguard\"), a stockholder of the Company, purchased an additional 531,463 shares of Series L Stock for an aggregate purchase price of $5.0 million. The shares pay a dividend of 7.5% per annum, contain a conversion premium and can be redeemed by the Company in certain circumstances.\nIn connection with Vanguard's purchase of the Series L Stock, the parties agreed to modify the terms of certain options (the \"Options\") to purchase shares of the Company's common stock granted to Vanguard pursuant the Stock Purchase Agreement between the Company and Vanguard dated December 29, 1993. Pursuant to these modifications, the total number of shares of Common Stock subject to the Options was decreased from ten million shares to seven million shares. Of the remaining Options, Options to purchase two million shares of common Stock at $15.00 per share and two million shares of Common Stock at $16.00 per share expire September 1, 1996 ($16.00 per share options are subject to a March 1, 1997 extension under certain circumstances) and Options to purchase three million shares of Common Stock at $17.00 per share expire one year from the expiration of the $16.00 options. After giving effect to these modifications, Vanguard and TDI each hold one-half of the options exercisable at $15.00 per share, Vanguard holds six-sevenths of each of the Options exercisable at $16.00 and $17.00 per share, respectively and TDI holds one-seventh of each of the options exercisable at $16.00 and $17.00 per share, respectively.\nIn May 1995, the Company sold 1,162.5 shares of its Series M Cumulative Convertible Preferred Stock (\"Series M Stock\"), to a group of investors for an aggregate purchase price of $11,625,000. The shares pay a dividend of 8.5% per annum, contain a conversion premium and can be redeemed by the Company in certain circumstances.\nIn July 1995, the Company acquired the remaining 50.1% of the one of the German Networks that it did not own for DM 9.0 million (approximately $6.3 million) and in December 1995, the Company received regulatory approval for the transfer of the 51% of the other German Networks network it did not already own. In the near term these networks will require additional funding as subscriber revenue does not cover operating costs and capital needs. The Company is seeking outside sources of funding for the networks.\nIn October 1995, the Company sold 338,000 shares of common stock to Rafael Development Corporation for $3.0 million.\nIn November 1995, the Company exchanged certain MetroNet licenses with Nextel Communications, Inc. whereby the Company received 900 MHZ radio channels in seven major U.S. markets. The exchange was accounted for as a non-monetary transaction and no gain or loss was recognized.\nIn December 1995, the Company entered into an agreement with Hughes Network Systems (\"HNS\"), a unit of Hughes Electronics Corporation whereby HNS will extend a $24.5 million line of credit to the Company for a period of two years. This line of credit may be used to acquire additional 900 MHZ spectrum in the United States. The loans made under this agreement bear interest, payable\nquarterly, at a fixed rate of 12%. As of December 31, 1995, there were no borrowings under this line.\nThe debt agreements of the Company contain restrictions on the Company, affecting, among other things, the ability of the Company to incur indebtedness, make prepayments of certain indebtedness, pay common stock dividends and make certain investments.\nRecently Issued Accounting Pronouncements\nIn March 1995, the Financial Accounting Standards Board (\"FASB\") issued SFAS No. 121 \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of\" which is effective for fiscal years begining after December 31, 1995. The Company will adopt this standard in 1996 and is presently analyzing the impact of this new standard on its financial position and results of operations.\nIn October 1995, the FASB issued SFAS No. 123 \"Accounting for Stock-Based Compensation\" which is effective for fiscal years begining after December 15, 1995. The Company will adopt the disclosure provisions of this new standard in 1996. Therefore, this new standard will not have an effect on the Company's financial position and results of operations.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe remainder of this page is intentionally left blank. The Financial Statements of the Company begin on the following page.\nGEOTEK COMMUNICATIONS, INC. AND SUBSIDIARIES\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS\nPages\nFinancial Statements:\nGeotek Communications, Inc. and Subsidiaries\nReports of Independent Accountants -\nConsolidated Balance Sheets as of December 31, 1995 and 1994\nConsolidated Statements of Operations for the years ended December 31, 1995, 1994 and 1993 -\nConsolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 1995, 1994 and 1993 -\nConsolidated Statements of Cash Flows for the years ended December 31, 1995, 1994 and 1993 -\nNotes to Consolidated Financial Statements -\nSeparate Company Financial Statements for Subsidiaries whose Capital Stock is Pledged as Collateral.\nNational Band Three, Ltd. -\nBogen Communications International, Inc and Subsidiaries -\nItem 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone\nPART III\nThe information called for by Items 10, 11, 12 and 13 (except for the information regarding 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 SCHEDULE, AND REPORTS ON FORM 8-K\n(a)(1) Financial Statements\nSee \"Item 8. Financial Statements and Supplementary Data.\"\n(a)(2) Financial Statement Schedule\nSchedule II - Valuation and Qualifying Accounts\n(b) Reports on Form 8-K\nThe following Current Report on Form 8-K was filed by the Company during the fourth quarter of 1995:\nCurrent Report, dated December 21, 1995, reporting that a newly incorporated subsidiary of the Company, Geotek Financing Corporation, entered into a loan agreement with Hughes Network Systems, Inc. (\"HNS\") pursuant to which HNS is providing up to $24,500,000 of financing, in the form of a note bearing interest at a rate of 12% per annum, for use in connection with the future purchase of 900 MHz licenses from the FCC and from existing third party holders thereof.\n(c) Exhibits\nThe following exhibits are filed as part of this report (Exhibit numbers correspond to the exhibits required by Item 601 of Regulation S-K for an Annual Report on Form 10-K):\nExhibit No. -------\n3.1 Restated Certificate of Incorporation of the Company, as amended.(1)\n3.2 By-Laws of the Company, as amended through May 30, 1992.(2)\n4.1 Restated Certificate of Incorporation of the Company, as amended (incorporated from Exhibit 3.1 above).(1)\n4.2 By-Laws of the Company, as amended through May 30, 1992 (incorporated from Exhibit 3.2 above).(2)\n4.3 Certificate of Designation of Series H Participating Cumulative Convertible Preferred Stock.(3)\n4.4 Certificate of Designation of Series I Cumulative Convertible Preferred Stock.(1)\n4.5 Certificate of Designation of Series K Cumulative Convertible Preferred Stock. (4)\n4.6 Certificate of Designation of Series L Cumulative Convertible Preferred Stock. (5)\n4.7 Certificate of Designation of Series M Cumulative Convertible Preferred Stock. (5)\n** 4.8 1989 Employee Stock Option Plan, as amended, of the Company.(6)\n** 4.9 1994 Employee Stock Option Plan of the Company.(7)\n4.10 Certificate of Amendment of the Restated Certificate of Incorporation of the Company filed February 26, 1993.(8)\n4.11 Certificate of Amendment of the Restated Certificate of Incorporation of the Company filed February 16, 1994.(1)\n4.12 Note and Warrant Purchase Agreement, dated as of June 1, 1993, by and between the Company and SC-Geo L.P.(9)\n4.13 Form of 30-month Warrant Certificate granted to Investors in connection with Note and Warrant Purchase Agreement referenced in Exhibit 4.12, dated July 2, 1993.(9)\n4.14 Form of 60-month Warrant Certificate granted to Investors in connection with Note and Warrant Purchase Agreement referenced in Exhibit 4.12, dated July 2, 1993.(9)\n4.15 Form of 30-month Commitment Warrant Certificate granted to Investors in connection with Note and Warrant Purchase Agreement referenced in Exhibit 4.12, dated June 1, 1993.(9)\n4.16 Form of 60-month Commitment Warrant Certificate granted to Investors in connection with Note and Warrant Purchase Agreement referenced in Exhibit 4.12, dated June 1, 1993.(9)\n4.17 Senior Secured Note dated July 2, 1993 from the Company to The SC Fundamental Value Fund, L.P. for the aggregate principal amount of $8,592,000.(9)\n4.18 Senior Secured Note dated July 2, 1993 (together with the note referenced in Exhibit 4.17, above, the \"NBTL Notes\") from the Company to The SC Fundamental Value BVI Ltd. for the principal aggregate amount of $3,408,000.(9)\n4.19 Pledge Agreement, dated as of July 2, 1993, by and among the Company, The SC Fundamental Value Fund, L.P. [on behalf of itself] and SC Fundamental Value BVI, Ltd.(9)\n4.20 Note and Warrant Purchase Agreement, dated as of March 20, 1995, by and among the Company, The SC Fundamental Value Fund, L.P. and SC Fundamental Value BVI, LTD.(7)\n4.21 Warrant Certificate in connection with Note and Warrant Purchase Agreement referenced in Exhibit 4.20, dated March 30, 1995.(7)\n4.22 Warrant Certificate in connection with Note and Warrant Purchase Agreement referenced in Exhibit 4.20, dated March 30, 1995.(7)\n4.23 Senior Secured Convertible Note dated March 30, 1995 from the Company in connection with the Note and Warrant Purchase Agreement referenced in Exhibit 4.20.(7)\n4.24 Senior Secured Convertible Note dated March 30, 1995 from the Company in connection with the Note and Warrant Purchase Agreement referenced in Exhibit 4.20.(7)\n4.25 Pledge Agreement, dated as of March 30, 1995, by and among the Company, certain of its subsidiaries, and SC Fundamental Inc., as agent for, and on behalf of The SC Fundamental Value Fund, L.P. and SC Fundamental Value BVI, LTD.(7)\n4.26 Unit (Note and Warrant) Purchase Agreement, dated June 29, 1995, by and between the Company and Smith Barney Inc. (10)\n4.27 Indenture, dated as of June 30, 1995, between the Company and IBJ Schroder Bank & Trust Company, as trustee. (10)\n4.28 Notes Registration Rights Agreement, dated June 29, 1995, by and between the Company and Smith Barney Inc. (10)\n4.29 Pledge Agreement, dated as of July 6, 1995, by and between the Company and IBJ Schroder Bank & Trust Company, as collateral agent. (10)\n4.30 Share Transfer Agreement, dated July 6, 1995 between the Company and IBJ Schroder Bank & Trust Company, as collateral agent. (10)\n4.31 Charge Over Shares, dated July 6, 1995, between the Company and IBJ Schroder Bank & Trust Company, as collateral agent. (10)\n4.32 Warrant Agreement, dated as of June 30, 1995, by and between the Company and IBJ Schroder Bank & Trust Company, as warrant agent. (10)\n4.33 Warrant Share Registration Rights Agreement, dated July 6, 1995, between the Company and Smith Barney Inc. (10)\n4.34 Defeasance Security Agreement, dated as of July 6, 1995, by and among the Company and SC Fundamental Inc., as agent for and on behalf of the SC Fundamental Value Fund, L.P. and SC Fundamental Value BVI, Ltd. (10)\n4.35 Loan agreement dated as of December 21, 1995 between the Company and Hughes Network Systems, Inc. (11)\n4.36 Note Purchase Agreement, dated March 4, 1996, by and between the Company and Smith Barney Inc.(12)\n4.37 Indenture, dated as of March 5, 1996, between the Company and The Bank of New York, as trustee. (12)\n4.38 Registration Rights Agreement, dated March 5, 1996, between the Company and Smith Barney Inc. (12)\n10.1 Stockholders Voting Agreement, dated as of February 23, 1994, among the Company, Vanguard Cellular Systems, Inc., S-C Rig Investments-III, L.P., Evergreen Canada-Israel Investment & Co., Ltd., Yaron Eitan and Winston Churchill.(1)\n10.2 Asset Exchange Agreement, dated as of March 24, 1995, by and between the Company, Metro Net Systems, Inc., Nextel Communications, Inc. and certain Nextel subsidiaries. (7)\n10.3 FMHA Commercial Subscriber Unit Agreement dated as of June 8, 1994, between the Company and Mitsubishi Consumer Electronics America, Inc. (13)\n10.4 FMHA Portable Subscriber Unit Agreement dated as of May 19, 1995, between the Company and Hughes Network Systems, Inc. (13)\n* 12 Computation of Ratio of Earnings to Fixed Charges\n* 21 Subsidiaries of the Company.\n* 23.1 Consent of Coopers & Lybrand L.L.P.- Geotek Communications, Inc. Bogen Communications International, Inc.\n* 23.2 Consent of Shachak & Co. - PowerSpectrum Technology Ltd.\n23.3 Consent of Coopers & Lybrand - National Bank Three Limited\n* Filed herewith\n** Compensation Plan\n- ---------- (1) Incorporated by reference to the Exhibits to the Company's Annual Report on Form 10-K for the year ended December 31, 1993.\n(2) Incorporated by reference to the Exhibits to the Company's Registration Statement on Form S-3 (Registration No. 33-64117) filed with the Commission on November 9, 1995.\n(3) Incorporated by reference to the Exhibits to Amendment No. 1 to the Company's Registration Statement on Form S-3 (Registration No. 33-72820) filed with the Commission on January 25, 1994.\n(4) Incorporated by reference to the Exhibits to Amendment No. 1 to the Company's Registration Statement on Form S-3 (Registration No. 33-85296) filed with the Commission on May 26, 1995.\n(5) Incorporated by reference to the Exhibits to the Company's Current Report on Form 8-K dated May 26, 1995.\n(6) Incorporated by reference to the Exhibits to the Company's Registration Statement on Form S-3 (Registration No. 33-72820) filed with the Commission on December 10, 1993.\n(7) Incorporated by reference to the Exhibits to the Company's Annual Report on Form 10-K for the year ended December 31, 1994.\n(8) Incorporated by reference to the Exhibits to Post-Effective Amendment No. 2 to the Company's Registration Statement on Form S-1 (Registration No. 33-42185) filed with the Commission on August 27, 1993.\n(9) Incorporated by reference to the Exhibits to the Company's Current Report on Form 8-K\/A No. 1 filed with the Commission with respect to events whose earliest date was June 18, 1993.\n(10) Incorporated by reference to the Exhibits to the Company's Current Report on Form 8-K dated July 6, 1995.\n(11) Incorporated by reference to the Exhibits to the Company's current report on Form 8-K dated Decemebr 27, 1995.\n(12) Incorporated by reference to the Exhibits to the Company's Current Report on Form 8-K dated March 4, 1996.\n(13) Incorporated by reference to the Exhibits to the Company's current report on Form 8-K\/A dated June 26, 1995.\nGEOTEK COMMUNICATIONS, INC. SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS (In Thousands)\n(a) Uncollectible accounts written off, net of recoveries.\n(b) Write-off of obsolete inventory.\n(c) Assumed through acquisition.\n(d) Liability of deconsolidated and partially disposed entity.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nGEOTEK COMMUNICATIONS, INC.\nBy: \/s\/ Yaron I. Eitan ------------------ Yaron I. Eitan, Director, President and Chief Executive Officer\nDate: March 28, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed on March 28, 1996 by the following persons on behalf of the registrant in the capacities indicated.\n\/s\/ Winston Churchill Chairman of the Board - --------------------------- Winston Churchill\n\/s\/ Yaron I. Eitan Director, President and Chief Executive - --------------------------- Yaron I. Eitan Officer (Principal Executive Officer)\n\/s\/ Walter E. Auch Director - --------------------------- Walter E. Auch\n\/s\/ George Calhoun Director - --------------------------- George Calhoun\n\/s\/ Purnendu Chatterjee Director - --------------------------- Purnendu Chatterjee\n\/S\/ Haynes Griffin Director - --------------------------- Haynes Griffin\n\/s\/ Richard Krants Director - --------------------------- Richard Krants\n\/s\/ Richard T. Liebhaber Director - --------------------------- Richard T. Liebhaber\n\/s\/ Haim Rosen Director - --------------------------- Haim Rosen\n\/s\/ Kevin Sharer Director - --------------------------- Kevin Sharer\n\/s\/ William Spier Director - --------------------------- William Spier\n\/s\/ Michael McCoy Senior Vice President and Chief Financial - --------------------------- Michael McCoy Officer (Principal Financial Officer)\n\/s\/ Michael Carus Chief Accounting Officer and Corporate - --------------------------- Michael Carus Controller\nEXHIBIT INDEX ------------- Exhibit No. - -------\n12 Computation of Ratio of Earnings to Fixed Charges 23.1 Consent of Coopers & Lybrand L.L.P.- Geotek Communications, Inc. Bogen Communications International, Inc. 23.2 Consent of Shachak & Co. - PowerSpectrum Technology Ltd. 23.3 Consent of Coopers & Lybrand - National Band Three Limited\n[Coopers & Lybrand L.L.P. Letterhead]\nREPORT OF INDEPENDENT ACCOUNTANTS\n----------\nTo the Board of Directors and Shareholders of Geotek Communications, Inc.\nWe have audited the consolidated financial statements and the consolidated financial statement schedule of Geotek Communications, Inc. and Subsidiaries as listed in Item 14(a)(1) and (2) of this Form 10-K. The consolidated financial statements and the consolidated financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and the consolidated financial statement schedule based on our audits. We did not audit the financial statements of PowerSpectrum Technologies, Ltd., a consolidated research and development joint venture, which statements reflect losses from continuing operations of approximately 22%, 28%, and 34% of the corresponding consolidated totals in 1995, 1994 and 1993, respectively. These statements were audited by other auditors whose reports have been furnished to us, and our opinion, insofar as it relates to the amounts included for PowerSpectrum Technologies, Ltd. for 1995, 1994, and 1993 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 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, and the reports of other auditors, provide a reasonable basis for our opinion.\nIn our opinion, based on our audits and the reports of other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Geotek Communications, Inc. and Subsidiaries as of December 31, 1995 and 1994, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles. In addition, in our opinion, based on our audits and the reports of other auditors, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.\nCOOPERS & LYBRAND L.L.P.\nNew York, New York March 26, 1996\nF - 1\n[Shachak Peer Reznick & Co. Letterhead]\nAUDITORS' REPORT\nTo the shareholders of POWERSPECTRUM TECHNOLOGY LTD.\nWe have audited the accompanying balance sheets of POWERSPECTRUM TECHNOLOGY LTD. (hereinafter - \"the Company\") as of December 31, 1995 and 1994, and the statements of operation, changes in shareholders' equity and cash flows for the two years ended December 31, 1995 and for the fifteen month period ended December 31, 1993. These financial statements are the responsibility of the Company's Board of Directors and 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, including those prescribed under the Israeli Auditors' Regulations (Auditors' Mode of Performance), 1973. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by an error in the financial statements or by an irregularity therein. An audit includes examining, on a test basis 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 Company's Board of Directors and management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a fair basis for our opinion.\nThe financial statements referred to above have been prepared on the basis of historical cost, restated for the general purchasing power of the Israeli currency, in conformity with statements of the Institute of Certified Public Accountants in Israel. Condensed financial statements in nominal values, are presented in Note 18.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 1995 and 1994 and the results of operations, changes in shareholders' equity and its cash flows for the two years ended December 31, 1995 and for the fifteen month ended December 31, 1993, in conformity with generally accepted accounting principles in Israel which are essentially identical in all material matters to the accounting principles generally accepted in the U.S.\nPursuant to Section 211 of the Companies Ordinance (New Version) 1983, we state that we have obtained all the information and explanations we required and that our opinion on the abovementioned financial statements is given according to the best of our information and the explanations received by us and as shown by the books of the Company.\nWithout qualifying our opinion, we draw attention to Note 1B as to the Company being in the developing stage of certain applications of its products. The Company's ability to continue its operation is contingent upon funding by shareholders or others.\n\/s\/ SHACHAK PEER REZNICK & CO. Shachak Peer Reznick & Co. Certified Public Accountants (Israel)\nTel Aviv, March 26, 1996\nGEOTEK COMMUNICATIONS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS As of December 31, 1995 and 1994 (Dollars in thousands, except per share data)\n1995 1994 ASSETS --------- --------- Current assets: Cash and cash equivalents $ 61,428 $ 27,531 Temporary investments 7,945 21,960 Restricted cash 36,971 2,555 Accounts receivables trade, net of allowance for doubtful accounts of $1,487 in 1995 and $1,125 in 1994 14,028 11,371 Inventories 10,483 8,667 Deposits for spectrum licenses 11,500 Prepaid expenses and other assets 5,621 7,468 --------- ---------\nTotal current assets 147,976 79,552\nInvestments in affiliates 3,078 26,582 Property, plant and equipment, net 66,110 24,446 Intangible assets, net 68,181 46,099 Other assets 7,219 3,165 --------- --------- $ 292,564 $ 179,844 ========= =========\nLIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable - trade $ 17,948 $ 12,490 Accrued expenses and other 23,005 12,315 Notes payable, banks and other 8,285 5,641 Current maturities, long-term debt 29,577 2,056 --------- --------- Total current liabilities 78,815 32,502 --------- ---------\nLong-term debt 95,875 29,396 Other non current liabilities 1,217 198 Minority interest 395 392\nRedeemable preferred stock 40,000 40,000 Commitments and contingent liabilities\nShareholders' equity: Preferred stocks, $.01 par value: 11 Common stock, $.01 par value: Authorized 99,000,000 and 86,000,000 issued 55,251,000 and 50,869,000 shares respectively, outstanding 55,031,000 and 50,631,000 shares, respectively 553 509 Capital in excess of par value 272,456 186,651 Foreign currency translation adjustment 1,012 767 Accumulated deficit (196,384) (109,185) Treasury stock, at cost (238,000 common shares) (1,386) (1,386) --------- --------- 76,262 77,356 --------- --------- $ 292,564 $ 179,844 ========= =========\nSee notes to consolidated financial statements.\nF - 3\nGEOTEK COMMUNICATIONS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS for the years ended December 31, 1995, 1994 and 1993 (Dollars in thousands)\nSee notes to consolidated financial statements.\nF - 4\nGEOTEK COMMUNICATIONS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS, (Continued) for the years ended December 31, 1995, 1994 and 1993\n1995 1994 1993 ------ ------ ------ Weighted average number of common shares outstanding 52,329,000 49,687,000 35,579,000 ========== ========== ==========\nPer common share: Loss from continuing operations, after preferred dividends $(1.75) $(0.90) $(1.43) Discontinued operations: Gain on disposal 0.01 ------ ------ ------ Loss before extraordinary item and cumulative effect of accounting change (1.75) (0.90) (1.42) Extraordinary item - loss from early extinguishment of debt (0.07) Cumulative effect of change in fiscal year of subsidiary (0.03) ------ ------ ------\nNet loss applicable to common shares $(1.75) $( 0.90) $(1.52) ===== ====== =====\nSee notes to consolidated financial statements.\nF - 5\nGEOTEK COMMUNICATIONS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY as of and for the years ended December 31, 1995, 1994 and 1993 (In Thousands)\nSee notes to consolidated financial statements\nF - 6\nGEOTEK COMMUNICATIONS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY, Continued as of and for the years ended December 31, 1995, 1994 and 1993 (in Thousands)\nSee notes to consolidated financial statements.\nF - 7\nGEOTEK COMMUNICATIONS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS for the years ended December 31, 1995, 1994 and 1993 (Dollars in thousands)\n* Opening balance sheet adjusted to reflect cumulative effect of change in fiscal year of subsidiary.\nSee notes to consolidated financial statements.\nF - 8\nGEOTEK COMMUNICATIONS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS, Continued for the years ended December 31, 1995, 1994 and 1993 (Dollars in thousands)\n* Opening balance sheet adjusted to reflect cumulative effect of change in fiscal year of subsidiary.\nSee notes to consolidated financial statements.\nF - 9\nGEOTEK COMMUNICATIONS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS, Continued for the years ended December 31, 1995, 1994 and 1993 (Dollars in thousands)\nSee notes to consolidated financial statements.\nF - 10\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n----------\n1. Summary of Significant Accounting Policies:\nBasis of Presentation and Principles of Consolidation\nThe consolidated financial statements of Geotek Communications, Inc. (\"the Company\") include all wholly-owned, majority-owned and controlled subsidiaries. The Company accounts for 20%-50% owned entities by the equity method. All significant intercompany accounts and transactions have been eliminated. Certain amounts in the 1994 and 1993 financial statements and notes have been reclassified to conform to the 1995 presentation.\nUse of Estimates\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and revenues and expenses during the period reported. Actual results could differ from those estimates. Estimates are used for allowance for doubtful accounts, inventory reserve for the lower of cost or market, product warranty reserves, depreciation and amortization and the estimated lives of assets, including intangibles.\nRevenue Recognition\nCommercial manufacturing product revenues, net of expected sales returns, are recognized upon shipment. Revenues relating to contracts for the sale and installation of wireless dispatch systems are recognized using the percentage of completion method. Revenues for service income are recognized when services are provided. Deferred revenues are recognized when the customer is billed in advance and is recorded in income in the period to which the advance billing relates.\nInventories\nInventories are stated at the lower of cost (first-in, first-out method) or market.\nCash Equivalents\nCash equivalents are highly liquid debt instruments purchased with an original maturity of three months or less, and are considered to be cash equivalents for cash flow reporting purposes.\nTemporary Investments\nManagement determines the appropriate classification of its investments in debt securities with maturities of more than three months at the time of purchase and reevaluates such determination at each balance sheet date. Debt securities for which the Company has the intent and ability to hold to maturity are classified as held to maturity securities and reported at amortized cost. At December 31, 1995 and 1994, the Company did not have any investments in equity or debt securities that qualified as trading or available for sale.\nConcentration of Credit Risk and Off-Balance-Sheet Risks\nThe Company provides mobile radio services to commercial customers in the United States, the United Kingdom and Germany and designs, manufactures and distributes electronic communications equipment for commercial customers, under contractual arrangements. The Company performs ongoing credit evaluations of its commercial customers and generally does not require collateral. The Company maintains reserves for potential losses from these contractual arrangements. Credit risk with respect to accounts receivable is limited due to the large number of customers and their industry and geographic dispersion. The Company's Israeli subsidiaries are prohibited from making certain payments, including loans, to entities outside of Israel without the Bank of Israel's approval. The subsidiaries are permitted, however, to distribute dividends, reimburse expenses and make other specific payments.\nProperty, Plant and Equipment\nProperty, plant and equipment is stated at cost. Property, plant and equipment acquired through acquisition is recorded at the fair value at the date of acquisition. Depreciation and amortization are provided principally by the straight-line method over the estimated useful lives of the related assets which range between 3 to 10 years. Gains or losses arising from dispositions are recorded in operations.\nF - 11\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n----------\n1. Summary of Significant Accounting Policies: continued\nInterests costs incurred on borrowings during the construction of the network infrastructure for each market (until the assets are substantially complete and ready for use) are capitalized. Interest capitalized amounted to $0.5 million in 1995.\nIntangible Assets\nThe excess of cost over the fair value of net assets acquired is amortized on a straight-line basis over twenty to forty years. At each balance sheet date management assesses whether there has been an other than temporary impairment in the value of goodwill by comparing anticipated undiscounted future cash flows from operating activities with the carrying value of goodwill. The factors considered by management in performing this assessment include current operating results, trends and prospects as well as the effects of obsolescence, demand, competition and other economic factors. FCC and other private radio licenses are amortized over twenty years.\nForeign Currency Translation\nFor international operations, assets and liabilities are translated at year-end exchange rates and income statement items are translated at average exchange rates for the period. Resulting translation adjustments are recorded as a separate component of shareholders' equity.\nResearch and Development\nResearch and Development expenditures are expensed as incurred. All expenses relating to research and development ventures are recorded, net of grants, as research and development expense.\nTaxes on Income\nEffective January 1, 1993 the Company implemented SFAS No. 109, \"Accounting for Income Taxes\". This pronouncement changed the method of accounting for income taxes from the deferred method to the liability method, which includes a requirement for adjustment of deferred tax balances for tax rate changes.\nCumulative Effect on Prior Year of Changing Fiscal Year End of a Subsidiary\nIn 1993, the Company's PowerSpectrum, Inc. (\"PSI\") subsidiary changed its fiscal year end from September 30 to December 31. This change was made in anticipation of the merger, which occurred on July 30, 1993, of PSI into a wholly owned subsidiary of the Company (See Note 2). The operating results of PSI for the period October 1, 1992 to December 31, 1992 are included in the 1993 statement of operations as a cumulative effect on prior year of changing the fiscal year end of a subsidiary.\nLoss Per Common Share\nNet loss per common share is computed by dividing the net loss, after preferred dividend requirements, by the weighted average number of common shares outstanding during the year. Common stock equivalents are excluded since the effect would be anti-dilutive.\nRecently Issued Accounting Pronouncements\nIn March 1995, the Financial Accounting Standards Board (\"FASB\") issued SFAS No. 121 \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of\" which is effective for fiscal years beginning after December 31, 1995. The Company will adopt this standard in 1996 and is presently analyzing the impact of this new standard on its financial position and results of operations.\nIn October 1995, the FASB issued SFAS No. 123 \"Accounting for Stock-Based Compensation\" which is effective for fiscal years beginning after December 15, 1995. The Company will adopt the disclosure provisions of this new standard in 1996. Therefore, this new standard will not have an effect on the Company's financial position and results of operations.\nF - 12\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n----------\n2. Acquired, Discontinued and Disposed of Operations:\nWireless Networks in Germany\nThe Company acquired 49% of Preussag Bundelfunk GmbH (\"PBG\") in July 1994, for approximately $14.0 million in cash. The Company did not have a controlling interest in PBG and accounted for its investment under the equity method. Under the terms of its investment, the Company agreed to fund PBG after PBG's capital was exhausted and in 1995, the Company recorded 100% of PBG's losses as its share under the equity method. In December 1995, after regulatory approval for the transfer of the mobile radio licenses, the remaining 51% of PBG was transferred to the Company for no additional consideration and the Company began to consolidate the results of PBG in its financial statements. The Company has guaranteed the repayment of certain debt of PBG, due in 1999, to the seller, Preussag Mobilefunk GmbH (\"PMG\"), of DM 3.5 million plus interest (approximately $2.4 million). This guarantee has been collateralized by a letter of credit. The excess of the purchase price over the Company's share of the fair value of the net assets of PBG at the date of acquisition of $12.5 million has been accounted for as goodwill and is being amortized over 20 years.\nThe Company acquired 49.9% of DBF Bundelfunk GmbH & Co. (\"DBF\") in August 1994 for approximately $5.3 million in cash. In addition, the Company and the seller, Quante A.G., committed to contribute DM 5.0 million (approximately $3.2 million), of which DM 3.0 million (approximately $1.8 million) was contributed by the Company prior to December 31, 1994. The Company and Quante were granted call and put options, respectively, for the remaining 50.1% of DBF held by Quante. In March, 1995 Quante exercised its option to sell its 50.1% interest in DBF to the Company for DM 9.0 million (approximately $6.3 million) in cash. Prior to July 1995, the Company did not have a controlling interest in DBF and thus, accounted for its investment, and its funded share of the losses, under the equity method. Upon the purchase of the remaining 50.1% interest in DBF in July 1995, the Company began to consolidate the results of DBF in its financial statements. The excess of the purchase price over the Company's share of the fair value of the net assets of DBF at the date of acquisition of $10.1 million has been accounted for as goodwill and is being amortized over 20 years.\nCommunication Products\nIn August 1995, the Company transferred its interest in Speech Design GmbH and Bogen Communications, Inc. to Bogen Communications International (\"BCI\") (formerly, European Gateway Acquisition Corporation) in exchange for $7.0 million in cash, $3.0 million in convertible notes, approximately 64% of BCI's common shares and warrants to purchase 200,000 shares of BCI common stock. The Company will also be eligible to receive additional consideration if the future earnings of both companies through July 1997 attain certain levels. This transaction had no material recurring effect on the Company's results of operations and the Company continues to control and consolidate these entities. Included in general and administrative expenses are $1.5 million of costs to effect the transaction. The BCI warrant holders hold approximately 3,800,000 warrants to purchase one share of BCI common stock for between $5.00 to $5.50. These warrants are callable upon certain events. For services provided in connection with the transaction, a director of the Company acquired 19,500 shares in BCI.\nIn January 1994, the Company completed a tender offer, whereby its interest in Bogen Communications, Inc. increased from 91% to 99% in exchange for 233,442 shares of the Company's common stock. The shares have been valued at $3.4 million, which amount was recorded as additional goodwill.\nIn February 1993, the Company acquired a 67% interest in Speech Design GmbH, a Munich based developer, manufacturer and marketer of telephone peripherals in exchange for $900,000 in cash and notes and 553,000 of the Company's common shares. Goodwill created from this acquisition was $3.7 million, with $2.6 million remaining as of December 31, 1995.\nF - 13\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n----------\n2. Acquired, Discontinued and Disposed Operations: continued\nOther Acquisitions\nIn May 1993, the Company acquired a 66% interest in GMSI (formerly known as Gandalf Mobile Systems, Inc.) in consideration for Canadian $2.0 million (approximately $1.5 million) and the guarantee by the Company of Canadian $2.0 million in debt (due in 1998) to the seller. In April 1994, upon the exercise by GTI, GMSI's former parent company, of a put option granted at the acquisition date, the Company acquired GTI's remaining 10% interest in GMSI in consideration for 150,000 shares of the Company's common stock. The shares issued in April 1994 have been valued at $1.6 million, which amount has been recorded as additional goodwill.\nIn July 1993, the Company acquired all of the outstanding stock of National Band Three Ltd. (\"NBTL\"), the only national provider of private mobile radio services in Great Britain, for approximately $24.0 million in cash. The intangible asset created from this transaction was $8.1 million with $6.1 million remaining as of December 31, 1995.\nIn July 1993, the Company acquired the 38% of its US wireless subsidiary, PSI, that it did not already own, through a merger of PSI into a wholly-owned subsidiary of the Company (the \"Merger\"). In connection with the Merger, the Company issued approximately 5.1 million shares of common stock and options to acquire an additional 2.0 million shares of the Company's common stock. In 1992, PSI entered into a joint venture, PowerSpectrum Technologies, Ltd. (\"PST\"), with an Israeli government agency, Rafael Armament Development Authority (\"RDC\"). PST was formed to develop the Company's digital wireless communications system based upon the technology contributed to PST by Rafael. PSI held a 56% interest in PST. The excess of consideration paid over the fair value of the net assets acquired in the merger, of $32.4 million has been attributed to the incomplete research and development project and was charged to expense at the time of the Merger. In November 1995, the Company closed its September 1995 agreement with RDC, whereby RDC converted all the principal and interest issued to it by PST under convertible debentures into shares of PST representing its 38% interest in PST. Geotek issued to RDC 1.8 million shares of unregistered Company common stock in exchange for RDC's shares of PST. The unregistered shares were valued at approximately $8.6 million and $7.8 million was recorded as goodwill. RDC was granted an option to purchase up to 10% of PST in certain circumstances.\nPro Forma Information (unaudited)\nThe following table summarizes the unaudited consolidated pro forma results of operations, assuming the acquisitions had occurred at the beginning of each of the periods as follows (in thousands):\n1995 1994 1993* ---- ---- -----\nRevenue $ 82,781 $ 72,991 $ 58,190 Loss from continuing operations (89,428) (46,313) (56,107) Loss from continuing operations per share ($1.71) ($0.93) ($1.47)\n* Includes non cash charge of $32.4 million related to PSI merger.\nThe unaudited pro forma results of operations are not necessarily indicative of the actual results of operations that would have occurred had the acquisitions been made at the beginning of the period, or of results which may occur in the future.\nMerger and Exchange of Metro Net\nIn January 1994 the Company acquired, through a merger, all of the outstanding stock of Metro Net Systems, Inc. (\"MetroNet\") in consideration for the issuance of 3,112,500 common shares of the Company. The merger was accounted for as a pooling of interests and, accordingly, the Company's consolidated financial statements were restated for all periods prior to the acquisition to include the results of operations, financial position and cash flows of Metro Net. The effect of the merger on the results of operations in the period in which the pooling of interests occurred is immaterial. Metro Net is a provider of wide area SMR services in the New York City area.\nF - 14\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n----------\n2. Acquired, Discontinued and Disposed Operations: continued\nIn November 1995, the Company exchanged all of MetroNet's 800 MHz radio channels for the 900 MHz radio channels in seven major U.S. markets previously held by Nextel Communications Inc. The exchange of licenses was accounted for as a non monetary transaction and no gain or loss was recognized upon the transaction.\n3. Temporary Investments:\nTemporary Investments include $7.9 and $22.0 million of U.S. Government Agency securities at December 31, 1995 and 1994, respectively. The amortized cost of marketable securities at December 31, 1995 and 1994 approximates fair market value. All marketable debt securities are classified as held to maturity at December 31, 1995 and 1994 and mature within one year.\n4. Inventories:\nInventories as of December 31, 1994 and 1993 are as follows (in thousands):\n1995 1994 ------- ------- Raw materials $ 3,520 $ 2,030\nWork-in-process 2,344 781\nFinished goods 7,477 7,149 ------- ------- 13,341 9,960 Reserve for lower of cost or market 2,858 1,293 ------- ------- $10,483 $ 8,667 ======= =======\n5. Investments in Affiliates:\nIn 1995, the Company entered into a partnership in Korea the purpose of which is to build an FHMA(TM) demonstration site for wireless service. At December 31, 1995, the Company's investment in this partnership was $0.5 million. The Company entered into a joint venture in Korea which is attempting to secure a license to provide wireless service in Korea. At December 31, 1995, the Company's investment in the joint venture is $1.2 million. As part of the joint venture agreement, the Company has agreed to grant the joint venture partner 300,000 or 750,000 options to acquire Company Common Stock for $10.00 conditional on the joint venture obtaining a regional or national license in Korea, respectively.\nDuring 1994, the Company acquired minority non controlling equity interests in two wireless networks in Germany as described in Note 2. As of December 31, 1994 the carrying values of these equity basis investments was $14.9 million and $7.2 million in PBG and DBF, respectively.\nThe Company acquired, in August 1993, a 25% equity interest in Cumulous Communications Company (\"Cumulous\") for aggregate consideration of $1.5 million. Cumulous is a provider of SMR services in the San Joaquin Valley of California. The Company's investment exceeds its share of the underlying net assets of Cumulous by approximately $940,000 which amount is being amortized over 20 years. The carrying value of this investment as of December 31, 1995 and 1994 was $1.3 million.\nF - 15\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n----------\n5. Investments in Affiliates: continued\nThe gross revenues and net loss from operations for affiliated companies accounted for under the equity method were $3.1 million and $5.2 million, respectively, for the year ended December 31, 1994. The current assets, non-current assets, current liabilities, and non-current liabilities for such entities were $3.6 million, $15.3 million, $8.6 million and $3.7 million, respectively, as of December 31, 1994. All such amounts were not material in 1995.\n6. Property, Plant and Equipment and Capital Leases (in thousands):\n1995 1994 ------- ------- Property, Plant and Equipment Machinery and equipment $58,058 $29,064 Furniture and fixtures 7,481 1,891 Leasehold improvements 896 623 Construction in progress 25,846 724 ------- ------- 92,281 32,302 Capital Leases Equipment 5,364 Construction in progress 938 ------- 6,302 ------- ------- 98,583 32,302 Less: accumulated depreciation Property, Plant and Equipment 30,838 7,856 Capital Leases 1,635 ------- ------- 32,473 7,856 ------- ------- $66,110 $24,446 ======= =======\nDepreciation expense was $5,962, $4,666 and $1,914 in 1995, 1994, and 1993, respectively.\n7. Intangible Assets (in thousands):\n1995 1994 ------- ------- Excess of cost over fair value of net assets acquired $44,847 $21,462 FCC and other private mobile radio licenses acquired and related intangibles 29,143 27,479 Other 741 753 ------- ------- 74,731 49,694\nLess accumulated amortization 6,550 3,595 ------- -------\n$68,181 $46,099 ======= =======\nThe increase in the excess of cost over fair value of net assets acquired in 1995 is primarily attributable to the acquisitions of additional interests in the DBF and PBG Networks offset by a decrease in goodwill in Bogen from the sale of an interest in the Company's Bogen Communications, Inc. and Speech Design subsidiaries to BCI. Such sale was accounted for as a reverse acquisition in EGAC. The increase in FCC and other private mobile radio licenses is attributable to the cost of licenses acquired in the United States.\nF - 16\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n----------\n8. Notes Payable:\n1995 1994 ------ ------ Notes payable consists of the following (in thousands): $10.0 million line of credit, bank interest at prime plus 2.0% to 2.75% and 2.5% in 1995 and 1994, respectively (a) $3,670 $4,355 Line of credit, bank (b) 627 728 Line of credit, bank (c ) 647 558 Line of credit, bank (d) 3,341 ------ $8,285 $5,641 ====== ======\nPrime rate at December 31 8.50% 8.50%\n(a) This line of credit for up to $10.0 million was refinanced in August 1995 and is subject to available collateral (80% of accounts receivable and 50% of finished goods inventory of a subsidiary). Substantially all the assets of a subsidiary are pledged as collateral for the line, which also bears interest based on loan balance, has a two year term, and is guaranteed by the Company. As of December 31, 1995, the unutilized amount available under the line was $0.4 million.\n(b) The maximum amount available under this line of credit at December 31, 1995 is $2.7 million, including amounts outstanding under the long term portion. Interest rates vary between 6.5% and 9.5% depending on the length of time the funds will be used. As of December 31, 1995 the unutilized amount available under this line of credit was $1.9 million.\n(c) Interest on the line is payable at a rate of 6.75%.\n(d) This line of credit for $3.5 million is collateralized by $3.5 million restricted cash.\n9. Long-term Debt:\nF - 17\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n----------\n9. Long-term Debt: continued\n(a) In July 1995, the Company issued, in a private offering, $207.0 million aggregate principal amount at maturity of 15% Senior Secured Discount Notes due July 15, 2005 (\"the Discount Notes\"). Gross proceeds of the Discount Notes were approximately $100.0 million. The Discount Notes were issued with 6,210,000 detachable warrants (\"the Warrants\"). Each Warrant entitles the holder to purchase one share of Company common stock at an exercise price of $9.90 per share. The Warrants, which have been valued at $29.2 million, are recorded as a reduction of the Discount Notes and are being accredited over the ten year life of the Discount Notes.\nThe Discount Notes accrue interest until maturity at a rate of 15% per annum. Interest on the Discount Notes will be payable semi-annually, in cash, on July 15 and January 15, commencing January 15, 2001. The Discount Notes are collateralized by a pledge of substantially all subsidiary capital stock owned by the Company. Additionally, the Discount Notes are fully and unconditionally guaranteed, jointly and severally on a senior basis, by certain subsidiaries of the Company. The Discount Notes include covenants that put restrictions on the Company primarily related to making certain investments, incurring additional debt and paying dividends on common shares.\nIn August, in connection with the Discount Notes, investors affiliated with George Soros purchased approximately $21.0 million principal amount of additional units consisting of 15% Senior Secured Discount Notes due 2005 and 621,000 ten year warrants to purchase shares of Company common stock at $9.90 per share. The warrants, which have been valued at $2.9 million, are recorded as a reduction on the Discount Notes and are being accredited over the ten year life of the Discount Notes. Gross proceeds to the Company were approximately $10.0 million, bringing total gross proceeds from the issuance of the Notes to approximately $110.0 million. The Company has recorded in other assets approximately $4.3 million of deferred financing costs relating to this transaction which are being amortized, using the interest method, over the ten year life of the Discount Notes.\nIn November 1995, the Company registered the Discount Notes through an exchange offer, and the Warrants under the Securities Act of 1933, as amended.\n(b) In March 1995, the Company refinanced $25.0 million of Senior Secured Notes, that were originally due in September 1995, with $36.0 million of newly issued Senior Secured Notes (the \"Replacement Notes\"). At closing, the Company received net proceeds of $11.0 million and issued warrants to the purchaser to acquire 700,000 of the Company's common shares at $8.125 per share. The warrants have been valued at $1.8 million, which amount has been recorded as a discount on the Replacement Notes. The Replacement Notes are payable in three equal installments of $12 million, respectively, fifteen, twenty four and thirty six months after issuance. Interest at 14.75% is payable quarterly through the term of the Replacement Notes. In accordance with the Replacement Note agreement, the Replacement Notes are being converted into shares of the Company's common stock (conversion may occur beginning six months after the closing and end 18 months after closing) subject to daily limits and certain other restrictions, at 87.5% of the average trading price of the Company's common stock on the respective conversion dates. As of December 31, 1995, $8.0 million has been converted into 1,228,000 shares of common stock.\nConcurrently with the issuance of the Discount Notes (see a above), the Company's indebtedness under the $36 million Replacement Notes was restructured in accordance with the terms thereof by the grant to the lenders of a security interest in a restricted cash account holding approximately $40.5 million. As conversion of the Replacement Notes occurs, a proportionate amount of the restricted cash becomes unrestricted and as of December 31, 1995, $30.9 million cash remains restricted. This amount is separately stated on the balance sheet of the Company, as restricted cash, and is expected to satisfy the principal and total interest of the remaining unconverted Replacement Notes. This security interest has released the original collateral for the Replacement Notes.\n(c) These notes were assumed in connection with the purchase of certain SMR licenses in various cities in the US. Certain analog SMR equipment as well as revenues generated by the systems is pledged as collateral for the notes.\nF - 18\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n----------\n9. Long-Term Debt: continued\n(d) In accordance with the terms of this note, it was converted into a 38% ownership interest of PST.\nIn December, the Company and Hughes Network Systems (\"HNS\"), a unit of GM Hughes Electronics, the Company's strategic partner in the development of the Company's portable subscriber unit, entered into an agreement whereby HNS will extend the Company a two year, $24.5 million line of credit for the Company to acquire additional 900 MHZ spectrum in the United States. Loans made under the line of credit will bear interest at a fixed rate of 12% payable quarterly. As of December 31, 1995, there were no outstanding loans under this line of credit.\nMinimum annual principal repayments of long-term debt during the next five years and thereafter, are as follows:\nYear In Thousands ---- ------------ 1996 $ 29,577 1997 990 1998 2,936 1999 3,542 2000 596 Thereafter 229,025 -------\nTotal $ 266,666 ========\nIncluded in 1996 repayments, is the remaining unconverted portion of the Replacement Notes ($27,980) which are expected to be converted into common shares in 1996.\nThe Company's debt agreements contain covenants that restrict the Company's ability to pay dividends to common shareholders, make certain investments and incur debt.\nExtinguishment of Certain Debt\nIn July 1993, the Company issued a $12.0 million Senior Secured Note, (the \"Note\") in connection with the acquisition of National Band Three Ltd.\nIn December 1993, in separate but related transactions, the Note was retired and the purchaser of the Note exercised its rights to purchase 2.1 million common shares under warrants issued in connection with the Note and other warrants it held. In connection with the early extinguishment of debt the Company recorded a pre-tax extraordinary loss of $2.3 million resulting primarily from the unamortized discount on the Note as of the date of repayment.\n10. Income Taxes:\nEffective January 1, 1993, the Company adopted SFAS No. 109, \"Accounting for Income Taxes\". SFAS No. 109 requires recognition of deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax liabilities and assets are determined based on the difference between the financial statement 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 impact of adoption of this standard was immaterial.\nF - 19\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n----------\n10. Income Taxes: continued\nTaxes on income in 1995 and 1994 consists of taxes paid by a foreign subsidiary. The amounts presented includes $950,000 and $573,000 related to the 1995 and 1994 utilization of pre-acquisition net operating losses, respectively, by two subsidiaries which had full valuation allowances established at the time of the acquisitions by the Company and have been recorded in 1995 and 1994 as reductions to intangible assets.\nThe Company has domestic net operating loss (NOL) carryforwards for tax purposes of approximately $95.3 million and $36.2 million in 1995 and 1994, respectively, which expire between the years 2001 through 2010. Additionally, the Company has net deferred tax assets of approximately $4.6 million in 1995. The Company has established a valuation allowance offsetting the tax benefit as it is more likely than not that the tax benefit will not be realized. An effective tax rate reconciliation has not been provided as the Company had no domestic tax provision for the years ended December 31, 1995, 1994 and 1993.\nThe Company has domestic deferred tax assets of $ 38.9 million and $14.0 million in 1995 and 1994, respectively, related to the NOLs. In accordance with SFAS No. 109, the Company has established a valuation allowance offsetting the tax benefit of the NOL carryforwards as it is more likely than not that the tax benefit will not be realized.\nThe carryforwards are subject to certain limitations on their utilization and limitations as a result of various changes in control which have occurred.\nThe Company has not provided deferred U.S. income taxes on the undistributed earnings of foreign subsidiaries, which totaled $2.4 million at December 31, 1995 which the Company intends to permanently reinvest in their operations. The Company has foreign NOL carryforwards for tax purposes of approximately $18.8 million and $3.4 million in 1995 and 1994, respectively. The deferred tax asset related to those NOL carryforwards is approximately $9.4 million and $1.5 million, respectively. The Company has established a valuation allowance offsetting the tax benefit of the NOL carryforwards as it is more likely than not that the benefit will not be realized.\n11. Commitments and Contingent Liabilities:\nCapital Leases\nFuture minimum lease payments under capital leases at December 31, 1995 together with the present value of the minimum lease payments are:\nYear In Thousands ---- ------------ 1996 $ 941 1997 934 1998 1,141 1999 718 2000 718 Thereafter 1,424 ------\nTotal minimum payments 5,876 Amounts representing interest (1,292) Total present value of ------ minimum payments 4,584 Current portion 572 ------ Total long-term portion $ 4,012 ======\nF - 20\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n----------\n11. Commitments and Contingent Liabilities: continued\nOperating\nThe Company leases facilities under noncancellable operating leases, some of which include escalation clauses. Future minimum rental commitments under noncancellable operating leases are as follows:\nYear In Thousands ---- ------------ 1996 $9,732 1997 8,577 1998 8,220 1999 7,573 2000 4,013 Thereafter 6,626 ------ $ 44,741 ========\nRent expense was $7.4 million, $6.4 million and $2.1 million in 1995, 1994 and 1993, respectively.\nGovernment Participation in Research and Development Project\nThe Chief Scientist of the Israeli Ministry of Industry and Commerce (Chief Scientist) has agreed to fund certain eligible expenditures related to the development of the digital wireless communication system by PST. Funding received from the Chief Scientist is repayable without interest only from revenues generated by the product being developed. Such participation amounted to $5.9 million, $4.1 million and $2.7 million, for 1995, 1994 and 1993, respectively, and have been reported in the statement of operations as a reduction of research and development expenses.\nManufacturing Commitments\nThe Company has contracted with Mitsubishi Consumer Electronics of America to manufacture Commercial Subscriber Units on behalf of the Company.\nIn March 1995, the Company and HNS formed a strategic partnership to develop a series of subscriber terminals and equipment based on the Company's proprietary technology. Under the terms of the agreement, HNS and the Company will share equally the cost of developing the portable subscriber unit. As of December 31, 1995, the Company has expensed approximately $6.0 million paid to HNS under the terms of this development contract.\nGuarantees of Debt of Equity Investees\nThe Company has guaranteed the repayment of certain debt of PBG, due in 1999, to the former owner of PBG, in the amount of DM 3.5 million plus interest (approximately $2.4 million). A letter of credit has been issued as collateral for this obligation. Additionally, the Company has guaranteed certain debt of DBF to Quante, the former owner of DBF, in the amount of DM 5.0 (approximately $3.5 million). This amount is included as restricted cash.\nFCC Waiver\nThe Company has applied for and received a waiver by the FCC to construct and activate certain systems it has acquired. In the event the Company fails to construct or activate such systems in accordance with the dates set forth in the waiver, the Company could lose the waiver and lose all of the frequencies covered by such waiver to the extent the systems have not been constructed or activated.\nLitigation\nIn June 1994 the Company filed a lawsuit against Harris Adacom Corporation B.V. (\"Harris\"), a Dutch corporation, to enforce its rights under a loan agreement between the parties. The Company is seeking repayment of a $3.5 million loan made to Harris in January 1994 in connection with a potential purchase transaction between the Company and Adacom Technologies Ltd. (\"ATL\"), an affiliate of Harris and an Israeli publicly traded company. The loan was collateralized by stock owned by Harris in ATL. At the time of the loan, the collateral had a market value in excess of $10 million and the total market value of ATL was in excess of $100 million. The purchase transaction was not consummated. In May 1994 the market value of ATL\nF - 21\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n----------\n11. Commitments and Contingent Liabilities: continued\ndropped dramatically and ATL became insolvent, thereby reducing the value of the collateral to practically zero. At or about the same time, creditors placed Harris into bankruptcy proceedings in the Netherlands. The Company subsequently received limited information relating to the recoverability of the loan, and Management does not expect to recover the loan. The Company is aggressively pursuing its rights under the loan in Dutch bankruptcy court and is awaiting additional information on the assets and creditors of Harris. Based upon the information currently available, it cannot be determined what amount, if any, will ultimately be recovered; therefore, the Company has established a reserve against the full amount of the loan. Accordingly, the 1994 statement of operations includes, in other expenses, a charge of $3.5 million to establish this reserve.\nIn response to the Company's lawsuit, Harris and its subsidiaries filed a lawsuit against the Company in the courts of the State of Israel, requesting a declaratory judgment that the Company entered into a binding agreement for the purchase by the Company of a significant interest in certain wireless communication business assets owned by ATL and subsequently breached such agreement. The plaintiffs in such action have stated an intention to file a separate claim for monetary damages and have estimated their losses to be several million dollars. The Company believes none of plaintiffs' claims in such action have any merit and are only an attempt to delay efforts to collect Harris's debt to the Company. The Company intends to defend such action vigorously.\nThe Company is subject to various legal proceedings arising in the ordinary course of business. In the opinion of management, all such matters are without merit or are of such kind, or involve such amounts, as will not have a significant adverse effect on the financial position, results of operations or cash flows of the Company, if disposed of unfavorably.\n12. Redeemable Preferred Stock:\nIn December 1993, the Company issued to investors affiliated with George Soros, a related party, 444,445 shares of Series H Cumulative Redeemable Convertible Preferred Stock at a price of $90 per share. The shares bear a dividend for five years, at a rate of five percent per year, payable quarterly. The shares are redeemable, at stated value, on October 31, 2000 only if the Company's common stock has not closed at an average price of $18 for any 20 consecutive trading days after the third anniversary of the date of issuance of the preferred shares. In the event that the shares are redeemed, the Company may elect to pay the redemption price in shares of its common stock, provided that the common shares will have an aggregate market value equal to 150% of the redemption value of the Series H shares being redeemed. The shares are convertible into common shares at any time at a ratio (adjusted for splits) of ten common shares for each preferred share. The holders of the Series H shares are entitled to vote on all matters voted on by common shareholders as if the Series H shares were converted to common stock. The Company has paid dividends of $2.0 million in each of the years ended December 31, 1995 and 1994.\n13. Shareholders' Equity:\nPreferred Stocks\nIn May 1995, the Company sold 531,463 shares of its Series L Cumulative Convertible Preferred Stock (\"Series L Stock\"), to Toronto Dominion Investments, Inc. (\"TDI\") for an aggregate purchase price of $5.0 million. In connection with this transaction, Vanguard Cellular Systems, Inc. (\"Vanguard\"), a stockholder of the Company, purchased an additional 531,463 shares of Series L Stock on September 1, 1995 (the \"Transaction Date\") for aggregate purchase price of $5.0 million. The shares pay a dividend of 7.5% per annum, contain a Common Stock conversion premium and can be redeemed by the Company in certain circumstances. The Company has paid dividends of $351,000 during the year ended December 31, 1995.\nIn May 1995, the Company sold 1,162.5 shares of its Series M Cumulative Convertible Preferred Stock (\"Series M Stock\"), to a group of investors for an aggregate purchase price of $11,625,000. The shares pay a dividend of 8.5% per annum, contain a Common Stock conversion premium and can be redeemed by the Company in certain circumstances. The Company has paid dividends of $592,000 during the year ended December 31, 1995.\nF - 22\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n----------\n13. Shareholders' Equity: continued\nIn April 1995, the Company sold $10.0 million of Series K Cumulative Convertible Preferred Stock (\"Series K Stock\") to an affiliate of the Company's partner in a joint venture which is attempting to secure a license to provide wireless services in Korea. The shares pay a dividend of 7% per annum for 5 years, carry a Common Stock conversion premium and can be redeemed by the Company in certain circumstances. The Company has paid dividends of $489,000 during the year ended December 31, 1995.\nAt December 31, 1994, there were 15 shares of Series E Preferred Stock and 20 shares of Series I Preferred Stock issued and outstanding. In May 1995, the Series E Preferred shares were cancelled. At December 31, 1993, there were 345,000 of Series A Preferred Stock and 30 shares of Series E Preferred Stock issued and outstanding. In February 1994 all of the Series A Preferred shares then outstanding were converted into an equal number of common shares.\nIn December 1994, the Company issued a total of 20 shares of Series I Convertible Preferred Stock at a price of $500,000 per share or total consideration of $10.0 million to investors affiliated with George Soros (currently holders of 100% of the Company's Series H Cumulative Convertible Preferred Stock). The shares bear a dividend, payable quarterly in either cash or common shares, for five years at a rate of 7% per annum and carry a conversion premium. The Company has the option to retire the shares, in either cash or common shares if the price of the Company's common stock exceeds 150% of the conversion price for any 20 days within a period of 30 consecutive days. The Company has paid dividends of $700,000 during the year ended December 31, 1995.\nThe Series E Preferred Shares were issued to collateralize principal payments required by certain subordinated debt of which $150,000 was outstanding as of December 31, 1994 and each share is convertible into common shares with a market value of $10,000 based upon market price prior to conversion. Holders of Series E shares are entitled to vote only on matters affecting the Company's preferred stock.\nDuring 1993, 484,000 Series A and 42 Series G shares were converted into 1,323,000 common shares.\nThe Company's outstanding preferred shares earn cumulative annual dividends as follows: Series A (converted into common shares in 1994), $0.25 per share and Series G (converted into common shares in 1993 and 1992), $2,500 per share.\nCommon Stock\nIn February 1994 the Company sold 2.5 million shares of common stock to Vanguard Cellular Systems Inc. (\"Vanguard\") for a total of $30 million (before expenses of $750,000). See below for a description of the options issued to Vanguard.\nIn January 1993, the Company completed a private placement of 408,640 units, each consisting of nine common shares and three separate warrants to purchase one common share at an exercise price of $4.8125, expiring 18 months, 30 months and 42 months from issuance, respectively. Each unit was sold in consideration for $37.6876. Net proceeds to the Company amounted to approximately $14.4 million.\nIn order to finance a portion of the acquisition of National Band Three, the Company requested in June 1993 that warrant and option holders immediately exercise their right to purchase the Company's common stock. To induce the warrant and option holders to exercise early, the Company offered discounts from the original exercise price. The amount of the discount varied depending upon the expiration date of the warrant or option. The Company issued approximately 9,200,000 shares in connection with the exercise of options and warrants under this program. Net proceeds were approximately $23 million.\nF - 23\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n----------\n13. Shareholder's Equity: continued\nIncluded in the 5.1 million common shares issued in connection with the PSI Merger (Note 2) were approximately 424,000 shares issued to PST in exchange for the PSI shares then owned by PST. The number of shares issued was determined using the same ratio as for other PSI shareholders. The Company has recorded the value of its ultimate ownership interest in these shares as treasury stock. In 1993 the Company cancelled the 1.2 million shares that were held in treasury at December 31, 1992.\nWarrants and Options\nA summary of the warrants and options activity during the years ended December 31, 1995, 1994 and 1993 is as follows (shares in thousands):\nF - 24\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n----------\n13. Shareholder's Equity: continued\nAll options are vested upon issuance except those issued pursuant to the Employee \/ Director plan which are described below.\nEmployee\/Director Stock Option Plan\nThe Company has a non-qualified stock option plan (the \"Plan\") which permits the granting of options to employees and directors to purchase up to 2.75 million shares at not less than fair market value on the date of grant. The options generally vest over three years and expire 10 years from the date granted. Of the options granted pursuant to this plan, options to purchase 1.5 million shares and 1.2 million shares, respectively, were vested as of December 31, 1995 and 1994.\nVanguard Options\nIn connection with Vanguard's purchase of the Series L Preferred Stock, the parties agreed to modify the terms of certain options (the \"Options\") to purchase shares of the Company's common stock granted to Vanguard pursuant to the Stock Purchase Agreement between the Company and Vanguard dated December 29, 1993. Pursuant to these modifications, the total number of shares of Common Stock subject to the Options was decreased from ten million shares to seven million shares. Of the remaining Options, Options to purchase two million shares of common Stock at $15.00 per share and two million shares of Common Stock at $16.00 per share expire September 1, 1996 ($16.00 per share options are subject to a March 1, 1997 extension under certain circumstances) and Options to purchase three million shares of Common Stock at $17.00 per share expire one year from the expiration of the $16.00 options. After giving effect to these modifications, Vanguard and TDI each hold one-half of the options exercisable at $15.00 per share, Vanguard holds six-sevenths of each of the Options exercisable at $16.00 and $17.00 per share, respectively and TDI holds one-seventh of each of the options exercisable at $16.00 and $17.00 per share, respectively.\nLoan Warrants and Options\nIn connection with the issuance of the Discount Notes and the Replacement Notes, the Company issued approximately 6.8 million and 1.0 million warrants to purchase common stock, respectively.\nOther Warrants and Options\nIn exchange for services rendered, the Company granted options to purchase 213,000 shares of common stock during 1993. The exercise prices on these option range between $1.00 and $6.00 per share and the options expire five years from date of grant.\n14. Fair Value of Financial Instruments\nThe recorded amount of cash, cash equivalents, temporary investments and notes payable banks and other, approximates fair value due to the short term maturities of these assets and liabilities.\nInvestments in affiliates are accounted for by the equity method and pertain to equity investments in privately held companies for which fair values are not readily available. Management believes the fair values to be at least equal to carrying amounts. The asset and liability amounts recorded in the balance sheet (carrying amount) and the estimated fair values of financial instruments at December 31, consisted as follows (in thousands):\nF - 25\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n----------\n15. Certain Other Related Party Transactions:\nIn connection with the issuance of common shares and options to Vanguard in February 1994, the Company entered into a five-year management consulting agreement with Vanguard, pursuant to which Vanguard will provide operational and marketing support to the Company for an aggregate of 1.5 million shares of common stock. Such management consulting agreement will terminate upon Vanguard's failure to exercise any of the Vanguard Options. For the periods ended December 31, 1995 and 1994, Vanguard earned approximately 300,000 and 258,000 shares, respectively, pursuant to this agreement, which has been recorded at approximately $2.4 million and $2.5 million, respectively, and is included in marketing expenses.\nIn 1995 and 1994, the Company incurred expenses of $300,000, pursuant to its consulting agreement with the Soros Group, who are the holders of the Company's Series H redeemable Preferred Shares and Series I Convertible Preferred Shares.\nPST has entered into a subcontractor agreement with Rafael, the current holder of common shares, under which Rafael will partake in the development of the digital wireless communications system to be deployed by the Company in the U.S. Research and development expense for the years ended December 31, 1995, 1994 and 1993 includes approximately $12.5 million, $11.1 million and $7.0 million, respectively, for research performed by Rafael under this agreement. PST has also entered into agreements with Rafael under which Rafael will manufacture the infrastructure equipment to be used by PSI in its U.S. network. Through December 31, 1995 and 1994 the Company had placed firm orders for equipment and engineering totaling $22.6 million and $12.8 million, respectively and had made an advance payment (recorded in other current assets) of $1.2 million and $2.1 million to Rafael under these orders during the years ended December 31, 1995 and 1994, respectively.\nIn 1995, the Company issued 250,000 shares of common stock to Rafael in connection with the development of the digital wireless communications system. The shares have been valued at $2.0 million, which amount has been recorded in 1995 as research and development costs.\nIn October 1995, RDC converted all the principal and interest issued to it by PST under convertible debentures into shares of PST representing its 38% interest in PST. Geotek issued to Rafael 1.8 million shares of unregistered Company common stock in exchange for RDC's shares of PST. The Company valued the unregistered shares at $8.6 million and recorded the excess of the value of the shares over the fair value of the underlying assets of PST of $7.8 million as goodwill. As part of the arrangement, RDC was granted an option to purchase up to 10% of PST in certain circumstances. Additionally, in October 1995, Rafael purchased 338,000 shares of Company common stock for $3.0 million.\n16. Segment Information:\nThe Company's operations have been classified into three business segments: wireless communications, communications products and other. The wireless communications group is engaged in the development of a digital wireless communication system, preparation for the commercial rollout of its wireless communications network in the United States, principally through its PSI and PST subsidiaries, provision of mobile radio services in the United States (PSI and MetroNet), the United Kingdom (NBTL), Germany (PBG and DBF) and the development of certain mobile data applications (GMSI). The development of a digital wireless communication system is primarily taking place in Israel. GMSI is located in Canada and markets its products in Canada, the United States and the United Kingdom.\nThe wireless communications group is relying on certain key suppliers of manufacturing and engineering for the development and mass-production of GeoNet's subscriber units. In addition, the wireless communications group has only a single manufacturing source for certain of the components of the GeoNet system hardware which includes the base station. Although the wireless communications group believes it can obtain all components necessary to build GeoNet from other sources, delays may be encountered in the event of a component shortage because of the time it may take to identify substitute sources and manufacture substitute components. This could adversely affect the results of operations in any given period.\nMany of the target customers for GeoNet currently use other wireless communications services. In order to be successful, the Company will need to migrate a portion of its target customers from their existing services to those provided by the Company over GeoNet. The Company's ability to migrate its target customers over to its services will be highly dependent on the perceived utility of the Company's services to its target customers as compared to the services currently utilized by such customers. Because there currently is no integrated wireless communications network commercially available that is comparable to that expected to be offered by the Company over GeoNet, the extent of the demand for the Company's\nF - 26\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n----------\n16. Segment Information: continued\nwireless communications services cannot be predicted with any degree of certainty. The demand for the Company's digital wireless communications services also could be affected by other matters beyond its control, such as the future cost of subscriber equipment, marketing and pricing strategies of competitors and general economic conditions.\nThe communications products group is principally engaged in the development, manufacturing and marketing of telephone and facsimile peripheral products and commercial audio and paging equipment in the United States (Bogen) and Munich, Germany (Speech Design). The other segment primarily consists of subsidiaries engaged in the manufacturing and marketing of customized transformers and power supplies and other diversified operations. The Company disposed of its transformer and power supply operations in 1993.\nDuring 1995, the communications products group has decided to phase out of the Office Automation Services (\"OAS\") product line. The communications products group has taken a charge of $2.2 million related to this action of which $1.5 million relates to the writedown of its inventory to expected net realizable value. At December 31, 1995, the communications product group had $0.2 million of OAS inventory recorded in the financial statements.\nSales between geographic areas and industry segments are not material.\nInformation about the Company's segments in 1995, 1994 and 1993 follows (in thousands):\nF - 27\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n----------\n16. Segment Information: continued\n17. Subsequent Events:\nIn March 1996, the Company issued $75.0 million aggregate principal amount of its 12% Senior Subordinated Convertible Notes due 2001 (the \"Convertible Notes\"). Each Convertible Note is in the principal amount of $1,000, and beginning on March 5, 1997, will be convertible into shares of the Company's common stock, par value $0.1 per share (the \"Common Stock\"), at a conversion price equal to the lower of (i) $9.50 per share and (ii) the weighted average market price of the share of Common Stock for the ten trading day period immediately following the 90th day after the issuance date of the Convertible Notes, but shall in no event be less than $8.25 per share.\nCash interest on the Convertible Notes will accrue at the rate of 12% per annum and will be payable semiannually on each February 15 and August 15 commencing August 15, 1996. The Convertible Notes mature on February 15, 2001. In addition, the Company has the option to redeem the Convertible Notes, on or after February 15, 1999, in whole or in part, at a redemption price equal to 110% of the principal amount thereof, plus accrued and unpaid interest, if any, to the redemption date, for the 12 month period beginning February 15, 1999, and at a redemption price equal to 105% of the principal amount thereof, plus accrued and unpaid interest, if any, to the redemption date, on or after February 15, 2000. The Company also has the option, at any time on or after September 1, 1997, to require the conversion of all, but not less than all, of the then outstanding Convertible Notes into common stock at the conversion price then in effect if the closing price of the common stock for 20 of the 30 trading days and for the five trading days or exceeds 160% of the conversion price then in effect. The Convertible Notes are unsecured senior subordinated obligations\nF - 28\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n----------\n17. Subsequent Events: continued\nof the Company. In addition, the indenture contains certain covenants that, subject to certain exceptions, restrict the ability of the Company and its Subsidiaries to engage in mergers and acquisitions.\nPursuant to a registration rights agreement (the \"Registration Rights Agreement\"), the Company has agreed to file registration statements under the Securities Act of 1933, as amended (the \"Securities Act\") with respect to the resale of the Convertible Notes and the issuance, or to the extent the registration of such issuance is permitted by applicable law the resale, of the Common Stock issuable upon conversion of the Convertible Notes. If the Company fails to register the Convertible Notes or the shares of Common Stock issuable upon the conversion thereof or otherwise comply with the procedures set forth in the Registration Rights Agreement within the time periods prescribed by the Registration Rights Agreement, the Company will be subject to substantial monetary penalties.\nOne of the investors in the Convertible Notes is affiliated with a director of the Company.\nIn March 1996, the Company and S-C Rig Investments - III, L.P. (\"S-C Rig\"), a significant stockholder of the Company and investment group affiliated with George Soros, reached an agreement in principal pursuant to which S-C Rig will make a $40.0 million unsecured credit facility available to the Company. It is anticipated that all borrowings under the credit facility will be required to be made within two years from the establishment of the credit facility. The borrowings will accrue interest at a rate of 10% per annum and will mature four years from the date of the final borrowing thereunder. It also is anticipated the Company will be obligated to pay S-C Rig a fee equal to 3% of each borrowing under the credit facility at the time of such borrowing. Borrowings under the credit facility will constitute senior indebtedness of the Company. In connection with the establishment of the credit facility, it is anticipated that the Company will issue to S-C Rig a five year warrant to purchase 4.2 million shares of Common Stock (subject to adjustment in certain circumstances) at an exercise price of $9.50 per share (subject to adjustment in certain circumstances). The transactions contemplated by the credit facility are subject to a number of conditions, including the negotiation and execution of definitive agreements and the authorization at the Company's next annual meeting of sufficient additional shares of Common Stock to permit the exercise in full of the warrant. There can be no assurance that the Company will consummate the transactions contemplated by the agreement in principal on the terms described above, or at all.\n18. Condensed Consolidating Financial Information for Guarantors (\"Guarantor Information\"):\nIn July and August 1995, the Company issued, in a private offering, $227.7 million aggregate principal amount at maturity of 15% Senior Secured Discount Notes due July 15, 2005 (\"the Notes\"). Gross proceeds of the Notes was approximately $110.0 million. The Notes were issued with 6,831,000 detachable warrants (\"the Warrants\"). Each Warrant entitles the holder to purchase one share of Company common stock at an exercise price of $9.90 per share. The Warrants have been valued at approximately $32.1 million and have been recorded as a discount on the Notes. The Notes accrue interest until maturity at a rate of 15% per annum. Interest on the Notes will be payable semi-annually, in cash, on July 15 and January 15, commencing January 15, 2001.\nIn connection with the Note offering, PowerSpectrum, Inc. and its U.S. Domestic Subsidiaries as well as MetroNet Systems, Inc. (collectively referred to as the \"Guarantor Subsidiaries\") fully and unconditionally guarantee such Notes jointly and severally. The Guarantor Subsidiaries are wholly owned by the Company. In addition, the Notes are collateralized by a pledge of the capital stock owned by the Company in National Band Three Ltd., PowerSpectrum, Inc. and Subsidiaries, MetroNet Systems, Inc., Geotek Communications GmbH and BCI, the entity through which, effective August 1995, the Company owns its interests in Bogen Communications, Inc. and Speech Design GmbH.\nThe Guarantor Information of Geotek Communications, Inc. and Subsidiaries has been presented on pages through in order to present the Guarantor Subsidiaries pursuant to the Guarantor relationship. The Guarantor Information is presented as management does not believe that\nF - 29\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n----------\n18. Condensed Consolidating Financial Information for Guarantors (\"Guarantor Information\") continued\nseparate financial statements of the Guarantor Subsidiaries would be meaningful. This Guarantor Information should be read in conjunction with the Consolidated Financial Statements. The Notes include covenants that place restrictions on the Company primarily related to making certain investments, paying dividends and incurring additional debt.\nNotes to Guarantor Information:\nBasis of Presentation - To conform with the terms and conditions of the Notes, the Condensed Consolidating financial information of the Guarantor Subsidiaries are presented on the following basis:\n(1) Geotek Communications, Inc. -Investments in consolidated (Parent Company) subsidiaries are accounted for by the Parent Company on the cost basis for purposes of the Guarantor Information. Operating results of Subsidiaries are therefore not reflected in the Parent's investment accounts or earnings.\n(2) PSI -For purposes of the Guarantor (Guarantor) Information, PowerSpectrum, Inc. (\"PSI\") includes all U.S. wireless subsidiaries of PSI combined with MetroNet Systems, Inc. and ANSA Communications, Inc., both direct wholly owned subsidiaries of the Parent Company. For purposes of the Guarantor Information, PSI does not contain the consolidated financial statements of PST, a subsidiary of PSI, since PST is not a Guarantor Subsidiary. Such statements of PST are included with Non-Guarantor Subsidiaries. The assets and liabilities of PST are not material in relation to PSI.\n(3) Non-Guarantor -This includes the Company's Subsidiaries subsidiaries that are not Guarantor Subsidiaries.\n(4) Reclassification and -Certain reclassifications were Eliminations made to conform all of the Guarantor Information to the financial presentation of the Company's consolidated financial statements. The principal elimination entries eliminate investments in subsidiaries and intercompany balances and transactions.\nF - 30\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS ----------\n18. Condensed Consolidating Financial Information for Guarantors (\"Guarantor Information\") continued\nCONDENSED CONSOLIDATING BALANCE SHEET As of December 31. 1995 (Dollars in thousands, except per share amounts)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS ----------\n18. Condensed Consolidating Financial Information for Guarantors (\"Guarantor Information\") continued\nCONDENSED CONSOLIDATING BALANCE SHEET As of December 31, 1994 (Dollars in thousands, except per share amounts)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS ----------\n18. Condensed Consolidating Financial Information for Guarantors (\"Guarantor Information\") continued\nCONDENSED CONSOLIDATING STATEMENT OF OPERATIONS For the Year Ended December 31, 1995 (Dollars in thousands)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS ----------\n18. Condensed Consolidating Financial Information for Guarantors (\"Guarantor Information\") continued\nCONDENSED CONSOLIDATING STATEMENT OF OPERATIONS For the Year Ended December 31, 1994 (Dollars in thousands)\nF - 34\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS ----------\n18. Condensed Consolidating Financial Information for Guarantors (\"Guarantor Information\") continued\nCONDENSED CONSOLIDATING STATEMENT OF OPERATIONS For the Year ended December 31, 1993 (Dollars in thousands)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS ----------\n18. Condensed Consolidating Financial Information for Guarantors (\"Guarantor Information\") continued\nCONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS For the Year Ended December 31. 1995 (Dollars in thousands)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS ----------\n18. Condensed Consolidating Financial Information for Guarantors (\"Guarantor Information\") continued\nCONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS For the Year Ended December 31. 1995 (Dollars in thousands)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS ----------\n18. Condensed Consolidating Financial Information for Guarantors (\"Guarantor Information\") continued\nCONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS For the Year Ended December 31, 1994 (Dollars in thousands)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS ----------\n18. Condensed Consolidating Financial Information for Guarantors (\"Guarantor Information\") continued\nCONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS For the Year Ended December 31, 1993 (Dollars in thousands)\nRegistered no: 2672488\nNational Band Three Limited Annual report for the year ended 31 December 1995\nF - 40\nNational Band Three Limited\nAnnual report for the year ended 31 December 1995\nRegistered no: 2672488\nPages\nDirectors and advisers\nDirectors' report -\nReport of the auditors\nProfit and loss account\nBalance sheet\nCash flow statement\nNotes to the financial statements -\nF - 41\nNational Band Three Limited\nDirectors and advisers\nExecutive directors E J Watts S A Style R Conroy M Davey D Henson\nNon-executive directors Y Eitan - Chairman Y Bibring G Calhoun A D Robb\nSecretary and registered office S A Style Wren House Hedgerows Business Park Colchester Road Springfield CHELMSFORD Essex CM2 5PF\nRegistered Auditors Coopers & Lybrand 1 Embankment Place LONDON WC2N 6NN\nBankers National Westminster Bank Plc 21 Lombard Street LONDON EC3P 3AR\nF - 42\nNational Band Three Limited\nDirectors' report for the year ended 31 December 1995\nThe directors present their report and the audited financial statements for the year ended 31 December 1995.\nPrincipal activities\nThe profit and loss account for the period is set out on page 6.\nThe principal activities of the company are the expansion and operation of a national mobile communication system, under licences granted by the Department of Trade and Industry under the Telecommunications Act 1984 and the Wireless Telegraphy Act 1949.\nReview of business\nDuring the year the company continued to expand the capacity, coverage and facilities of the network. It has also invested in and strengthened its sales and marketing capability. This helped accelerate the growth in the subscriber base during the year and provided new products and services which will be the bedrock of future profitability. Both the level of business and the year end financial position were satisfactory, and the directors expect the level of activity to increase for the foreseeable future.\nDividends and transfers to reserves\nThe directors do not recommend the payment of a dividend. The profit for the period of (pound)1,605,000 (1994: loss (pound)508,000) has been taken to reserves.\nChanges in fixed assets\nThe movements in fixed assets during the year are set out in note 9 to the financial statements.\nF - 43\nNational Band Three Limited\nDirectors\nThe directors of the company during the year ended 31 December 1995 were:\nA D Robb P M Ratcliffe (resigned 6 December 1995) G M Calhoun Y Eitan Y Bibring S A Style E J Watts R Conroy D Henson (appointed 5 May 1995) M Davey (appointed 12 October 1995)\nDirectors' interests\nNone of the directors held any interest in the shares of the company at 31 December 1995 (1994: None).\nAt the year end the directors held options over the shares of National Band Three's parent company, Geotek Communications, Inc.\nStatement of directors' responsibilities\nThe directors are required by UK company law to prepare financial statements for each financial year that give a true and fair view of the state of affairs of the company and of the profit or loss of the company for that period.\nThe directors confirm that suitable accounting policies have been used and applied consistently and reasonable and prudent judgements and estimates have been made in the preparation of the financial statements for the year ended 31 December 1995. The directors also confirm that applicable accounting standards have been followed and that the financial statements have been prepared on the going concern basis.\nThe directors are responsible for keeping proper accounting records, for taking reasonable steps to safeguard the assets of the company and to prevent and detect fraud and other irregularities.\nF - 44\nNational Band Three Limited\nAuditors\nA resolution to reappoint the auditors, Coopers & Lybrand, will be proposed at the annual general meeting.\nBy order of the board\nS A Style Company Secretary 15 March 1996\nF - 45\nReport of the auditors to the members of National Band Three Limited\nWe have audited the balance sheets of National Band Three Limited as of 31 December 1995 and 1994 and the related statements of income, changes in shareholders' equity and cash flows for the years ended 31 December 1995 and 1994. The financial statements on pages to 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 auditing standards generally accepted in the United Kingdom which do not differ in any significant respects from auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of National Band Three Limited, as of 31 December 1995 and 1994 and the results of their operations and cash flows for the years ended 31 December 1995 and 1994 in conformity with generally accepted accounting principles in the United Kingdom.\nAccounting principles and financial statement presentation generally accepted in the United Kingdom vary in certain significant respects from accounting principles and financial statement presentation generally accepted in the United States. The application of these requirements would have affected the financial statement presentation and the determination of net income for the years ended 31 December 1995 and 1994 and of shareholders' equity as of 31 December 1995 and 1994, to the extent summarised in note 21 to the financial statements.\nCOOPERS & LYBRAND Coopers & Lybrand Chartered Accountants and Registered Auditors London 27 March 1996\nF - 46\nNational Band Three Limited\nProfit and loss account for the year ended 31 December 1995\nNotes 1995 1994 (pound '000) (pound '000)\nTurnover 2 15,835 12,887 Cost of sales (8,366) (8,524) ------- ------- Gross profit 7,469 4,363 Net operating expenses 3 (5,696) (4,707) ------- ------- Operating profit\/(loss) 1,773 (344) Interest receivable and similar income 98 75 Interest payable and similar charges 6 (266) (266) ------- ------- Profit\/(loss) on ordinary activities before taxation 7 1,605 (535) Tax on loss on ordinary activities 8 - 27 ------- ------- Retained profit\/(loss) for the financial year 16 1,605 (508) ======= =======\nAll figures in the profit and loss account relate to continuing operations.\nThere is no difference between the profit on ordinary activities before taxation and the profit for the year as stated above, and their historical cost equivalents.\nStatement of total recognised gains and losses\n1995 1994 (pound '000) (pound '000)\nProfit\/(loss) for the financial period 1,605 (508) Prior year adjustment - 26 ----- ----- Total gains\/(losses) recognised since last annual report 1,605 (482) ===== =====\nF - 47\nNational Band Three Limited\nBalance sheet at 31 December 1995\nNotes 1995 1994 (pound '000) (pound '000)\nFixed assets Tangible assets 9 11,889 11,702 ------- ------- Current assets Stocks 10 193 77 Debtors 11 3,322 3,105 Cash at bank and in hand 1,817 1,627 ------- ------- Total current assets 5,332 4,809\nCreditors: amounts falling due within one year 12 (9,727) (10,622) ------- ------- Net current liabilities (4,395) (5,813) ------- ------- Total assets less current liabilities 7,494 5,889 Provisions for liabilities and charges Deferred taxation 13 - - ------- ------- Net assets 7,494 5,889 ======= =======\nCapital and reserves Called up share capital 14 9,000 9,000 Share premium account 15 8,800 8,800 Goodwill reserve 15 (58) (107) Profit and loss account 15 (10,248) (11,804) ------- ------- Total shareholders' funds 16 7,494 5,889 ======= =======\nThe financial statements on pages to were approved by the board of directors on 15 March 1996 and were signed on its behalf by:\n\/s\/ E. J. Watts Director\nF - 48\nNational Band Three Limited\nCash flow statement for the year ended 31 December 1995\nNotes 1995 1994 (pound '000) (pound '000)\nNet cash inflow from operating activities 17 3,024 2,857 ------- ------- Returns on investments and servicing of finance Interest received 98 75 Interest paid (266) (266) ------- ------- Net cash outflow from returns on investments and servicing of finance (168) (191) ------- -------\nTaxation United Kingdom corporation tax paid - - ------- ------- Investment activities Purchase of goodwill - (25) Purchase of tangible fixed assets (2,801) (3,471) Sale of tangible fixed assets 135 66 ------- ------- Net cash outflow from investing activities (2,666) (3,430) ------- ------- Increase\/(decrease) in cash and cash equivalents 18 190 (764) ======= =======\nF - 49\nNational Band Three Limited\nNotes to the financial statements for the year ended 31 December 1995\n1 Principal accounting policies\nThe financial statements have been prepared in accordance with applicable Accounting Standards in the United Kingdom. A summary of the more important accounting policies, which have been applied consistently, is set out below.\nBasis of accounting\nThe financial statements are prepared in accordance with the historical cost convention.\nGoodwill\nGoodwill arising on the acquisition of businesses is written off directly to an unrealised goodwill reserve. It is amortised to the profit and loss account reserve over five years, the directors' estimate of its useful economic life.\nTangible fixed assets\nThe cost of tangible fixed assets is their purchase cost, together with any incidental expenses of acquisition.\nDepreciation is calculated so as to write off the cost of tangible fixed assets, less their estimated residual values, on a straight line basis over the expected useful economic lives of the assets concerned. The estimated useful lives used for this purpose are:\nShort term leasehold improvements Over the term of the lease Plant and machinery Between three and ten years Fixtures and fittings Between three and five years Motor vehicles Four years\nNo depreciation is charged on assets in the course of construction.\nStocks\nStocks are stated at the lower of cost and net realisable value. Provision is made where necessary for obsolete, slow moving and defective stocks.\nTurnover\nTurnover, which excludes value added tax, represents the invoiced value of goods and services supplied.\nF - 50\nNational Band Three Limited\nOperating leases\nCosts in respect of operating leases are charged on a straight line basis over the lease term.\nDeferred taxation\nProvision is made for deferred taxation, using the liability method, on all material timing differences to the extent that it is probable that a liability or asset will crystallise.\nPension costs\nThe company operates a \"money purchase\" pension scheme for the benefit of its employees.\nThe company provides no other post retirement benefits to its employees.\n2 Turnover\nTurnover consists entirely of sales in one class of business made in the United Kingdom.\n3 Net operating expenses\n1995 1994 (pound '000) (pound '000)\nSelling and distribution costs 3,544 2,656 Administrative expenses 2,152 2,051 ----- ----- 5,696 4,707 ===== =====\nF - 51\nNational Band Three Limited\n4 Directors' emoluments\n1995 1994 (pound' 000) (pound' 000)\nEmoluments (including pension contributions and benefits in kind) 481 256 === ===\nEmoluments (excluding pension contributions) include amounts paid to:\n1995 1994 pound pound\nThe chairman Nil Nil ====== ======\nThe highest paid director 121,306 78,164 ====== ======\nThe number of directors (including the chairman and the highest paid director) who received emoluments (excluding pension contributions) within the following ranges was:\n1995 1994 Number Number\npound 0 to pound 5,000 3 3 pound 5,001 to pound 10,000 - 2 pound 10,001 to pound 15,000 1 - pound 30,001 to pound 35,000 - 1 pound 40,001 to pound 45,000 1 - pound 45,001 to pound 50,000 - 1 pound 60,001 to pound 65,000 1 - pound 65,001 to pound 70,000 2 - pound 70,001 to pound 75,000 1 1 pound 75,001 to pound 80,000 - 1 pound 120,001 to pound 125,000 1 - === ===\nA provision of (pound) 95,000 has been established in these financial statements in respect of bonus payments which may be made to directors at the company's discretion. As these bonuses have not yet been approved, the above disclosures include no amounts in respect of bonuses for the year. However, bonus payments made in relation to the year ended 31 December 1994 are included above.\nF - 52\nNational Band Three Limited\n5 Employee information\nThe average weekly number of persons (including executive directors) employed by the company during the year was:\n1995 1994 Number Number\nBy activity Administration 26 22 Technical 43 45 Marketing 38 34 ----- ----- 107 101 ===== =====\n(pound '000) (pound '000)\nStaff costs (for the above persons) Wages and salaries 2,766 2,407 Social security costs 277 243 Other pension costs 154 104 ----- ----- 3,197 2,754 ===== =====\n6 Interest payable and similar charges\n1995 1994 (pound '000) (pound '000)\nInterest payable on sums owed to parent undertaking 266 266 === ===\n7 Profit\/(loss) on ordinary activities before taxation\n1995 1994 (pound '000) (pound '000)\nThe profit\/(loss) on ordinary activities before taxation is stated after charging\/(crediting): Depreciation 2,362 2,355 Auditors' remuneration 20 17 Auditors' remuneration for non-audit services 18 11 Rentals under operating leases on land and buildings 1,168 1,122 Hire of equipment under operating leases 1,358 1,578 Profit on disposal of fixed assets (58) (44) ====== ======\nF - 53\nNational Band Three Limited\n8 Tax on loss on ordinary activities\n1995 1994 (pound '000) (pound '000)\nUnited Kingdom corporation tax at 33% (1994: 33%) Deferred Nil 27 ===== =====\nNo charge arises for corporation tax in the year due to losses brought forward from previous years.\n9 Tangible fixed assets\nIncluded in the above are assets under construction to the value of (pound)235,000 (31 December 1994: (pound) 265,000) which did not incur depreciation during the year.\nThe adjustments relate to costs provided for and capitalised by the company in previous years which are not payable.\nF - 54\nNational Band Three Limited\n10 Stocks\n1995 1994 (pound '000) (pound '000)\nGoods for resale 193 77 === ===\n11 Debtors\n1995 1994 (pound '000) (pound '000) Amounts falling due within one year Trade debtors 1,955 2,022 Amounts owed by fellow subsidiary undertakings 155 - Other debtors 136 73 Prepayments and accrued income 1,076 1,010 ----- ----- 3,322 3,105 ===== =====\n12 Creditors: amounts falling due within one year\n1995 1994 (pound '000) (pound '000)\nTrade creditors 2,106 2,362 Amount owed to parent undertaking 4,432 4,432 Other taxes and social security 215 212 Accruals and deferred income 2,974 3,616 ----- ----- 9,727 10,622 ===== =====\nF - 55\nNational Band Three Limited\n13 Deferred taxation\nThe total liability to deferred taxation is as follows:\nNo provision has been made for deferred taxation on these financial statements as the above potential liability is covered by corporate tax losses carried forward.\n14 Called up share capital\n1995 1994 (pound '000) (pound '000) Authorised 12,000,000 ordinary shares of pound 1 each 12,000 12,000 ====== ====== Allotted, called up and fully paid 9,000,000 ordinary shares of pound 1 each 9,000 9,000 ====== ======\n15 Share premium account and reserves\nF - 56\nNational Band Three Limited\n16 Reconciliation of movements in shareholders' funds\n1995 1994 (pound '000) (pound '000)\nProfit\/(loss) for the financial year 1,605 (508) Goodwill written off - (25) ----- ----- Net movement in shareholders' funds 1,605 (533) Opening shareholders' funds 5,889 6,422 ----- ----- Closing shareholders' funds 7,494 5,889 ===== =====\n17 Reconciliation of operating profit\/(loss) to net cash inflow from operating activities\n1995 1994 (pound '000) (pound '000)\nOperating profit\/(loss) 1,773 (344) Profit on sale of tangible fixed assets (58) (44) Depreciation of tangible fixed assets 2,362 2,355 Amounts written off fixed assets 175 - Increase in stocks (116) (71) Increase in debtors (217) (490) (Decrease)\/increase in creditors (895) 1,451 ------ ------ Net cash inflow from operating activities 3,024 2,857 ====== ======\nF - 57\nNational Band Three Limited\n18 Cash and cash equivalents\n1995 1994 (pound '000) (pound '000)\nChanges in the period At 1 January 1995 1,627 2,391 Net cash inflow\/(outflow) 190 (764) ----- ----- At 31 December 1995 1,817 1,627 ===== =====\n1995 1994 (pound '000) (pound '000)\nAnalysis of balances Cash at bank and in hand 1,817 1,627 ===== =====\n19 Financial commitments\nCapital commitments 1995 1994 (pound '000) (pound '000)\nContracted for but not provided 1,490 1,242 ===== =====\nAuthorised but not yet contracted for Nil 18 ===== ====\nOperating lease commitments\nAt 31 December 1995 the company had annual commitments under non-cancellable operating leases, as follows:\nF - 58\nNational Band Three Limited\n20 Ultimate parent company\nThe directors regard Geotek Inc (formerly Geotek Industries, Inc), a company incorporated in the United States of America, as the ultimate parent company. Copies of the parent's consolidated financial statements may be obtained from The Secretary, Geotek Communications, Inc. 20 Craig Road, Montvale, New Jersey 07645, United States of America.\n21 Summary of differences between UK GAAP and US GAAP\nThese Financial Statements are prepared in British Pounds and presented in accordance with UK GAAP which differs in certain significant respects from US GAAP. These differences, which have a signigicant effect on consolidated net income and shareholders' equity, are discussed and quantified in a table of adjustments below. While this is not a comprehensive summary of all differences between UK GAAP and US GAAP, other differences are immaterial.\nSignificant differences between UK GAAP and US GAAP\n(a) Deferred income taxes\nUnder UK GAAP, deferred taxes are only provided on timing differences where it is considered probable that such taxes will become payable in the foreseeable future. Under SFAS No. 109, \"Accounting for Income Taxes\", US GAAP requires deferred taxes to be provided in full under the liability method. There is no net adjustment recorded to the deferred income tax accounts for them to comply with US GAAP. Taxes on income presented in 1995 reflects the utilization of a (pound)770,000 pre-acqusition net operating loss which had a full valuation allowance established at the time of acquisition by the Company. The utilization of this net operating loss has been recorded in 1995 as a reduction to intangible assets.\n(b) Goodwill\nUnder UK GAAP, the Company eliminates goodwill against reserves in the year in which it arises. US GAAP requires that goodwill is capitalized and amortized through the income statement over the estimated period of benefit. Additionally, under applicable rules of \"push-down accounting\" goodwill associated with the Parent Company's acquisition of the Company was \"pushed down\" onto the books of the Company at the time of the acquisition. The Parent Company's policy is to amortize goodwill on a straight line basis over 20 years. Amortization expense relating to goodwill was (pound)260,000 for December 31, 1995 and 1994. The carrying value of goodwill at December 31, 1995 after the adjustment for utilization of pre-acquisition net operating loss (see (a)) and amortization was (pound)4,000,000.\n(c) Statements of Cash Flows\nThe Company prepares its Consolidated Statements of Cash Flows under United Kingdom Financial Reporting Standard No. 1, \"Cash Flow Statements\" (\"FRS 1\"). Its objectives and principles are similar to those set out in the US Statement of Financial Accounting Standards No. 95, \"Statement of Cash Flows\" (\"SFAS 95\").\nF - 59\nNational Band Three Limited\nThe principal differences between the standards relate to classification. Under FRS 1, the Company presents its cash flows as (a) operating activities; (b) returns on investments and servicing of finance; (c) taxation; (d) investing acivities; and (e) financing activities. SFAS 95 requires only three categories of cash flow activity; (a) operating; (b) investing; and (c) financing. Cash flows from taxation and returns on investments and servicing of finance shown under FRS 1 would be included as operating activities SFAS 95.\nStatements of income\nThe following is a summary of significant items which reconcile the statements of income form that reported under UK GAAP to that which would be reported has US GAAP been applied.\nYear Ended Year Ended 31, December 31, December 1995 1994 (pound '000) (pound'000) --------------- ------------ Net income (loss) as shown in the financial statements (pound)1,605 (pound)(508) US GAAP adjustments: Amortization of goodwill (260) (260) Taxes on Income (770) -----\nNet income (loss) under US GAAP (pound) 575 (pound)(768) =========== ============\nShareholders' Funds\nThe following is a summary of the signigicant items which reconcile shareholders' funds from that reported under UK GAAP to that which would be reported had US GAAP been applied.\nAs of December 31, (pound '000) ----------------- 1995 1994 ---- ---- Shareholders' funds shown in the financial statements (pound)7,494 (pound)5,889 US GAAP adjustments: Goodwill 4,000 5,030 Deferred Income Tax -- -- --------- ---------\nShareholders' funds under US GAAP (pound)11,494 (pound)10,919 ============= =============\nF - 60\nBogen Communications Internatioal, Inc. and Subsidiaries\nF - 61\n[Letterhead of Coopers & Lybrand L.L.P.]\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Stockholders and Board of Directors of Bogen Communications International, Inc.:\nWe have audited the accompanying consolidated balance sheets of BOGEN COMMUNICATIONS INTERNATIONAL, INC. and SUBSIDIARIES (formerly European Gateway Acquisition Corp.) as of December 31, 1995 and 1994, and the related statements of operations, common stock subject to possible redemption and stockholders' equity and cash flows for each of the two years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Bogen Communications International, Inc. and Subsidiaries as of December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the two years then ended, in conformity with generally accepted accounting principles.\nCOOPERS & LYBRAND L.L.P.\nMarch 21, 1996 New York, New York.\nF - 62\n[Letterhead of Coopers & Lybrand L.L.P.]\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Stockholders and Board of Directors of Bogen Communications International, Inc.:\nWe have audited the accompanying consolidated statements of operations, common stock subject to possible redemption and stockholders' equity and cash flows of BOGEN COMMUNICATIONS INTERNATIONAL, INC. and SUBSIDIARIES (formerly European Gateway Acquisition Corp.) for the year ended December 31, 1993. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the results of operations and cash flows of Bogen Communications International, Inc. and Subsidiaries for the year ended December 31, 1993, in conformity with generally accepted accounting principles.\nCOOPERS & LYBRAND L.L.P.\nMarch 21, 1996 New York, New York.\nF - 63\nBOGEN COMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 1995 and 1994 (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AMOUNTS)\n1995 1994 -------- -------- ASSETS CURRENT ASSETS: Cash and cash equivalents $ 1,276 $ 148 Accounts receivable (less allowance for doubtful accounts of $424 and $365 at December 31, 1995 and 1994, respectively) 4,992 6,035 Inventory, net (Note 2) 6,922 8,158 Prepaid expenses and other current assets 1,042 1,294 -------- --------\nTOTAL CURRENT ASSETS 14,232 15,635 Property and equipment, net (Note 3) 2,191 2,024 Goodwill and intangible assets, net (Note 4) 14,706 15,055 Other assets 175 152 -------- -------- TOTAL ASSETS $ 31,304 $ 32,866 ======== ======== LIABILITIES CURRENT LIABILITIES: Amounts outstanding under revolving credit agreements (Note 5) $ 4,944 $ 5,635 Accounts payable, including cash overdrafts of $-0- and $238 at December 31, 1995 and 1994, respectively 2,861 3,645 Accrued expenses 3,610 2,029 Income taxes payable 1,353 89 Advances and notes payable to related parties (Note 6) 537 2,662 Current maturities of notes payable to non-related parties 174 573 -------- -------- TOTAL CURRENT LIABILITIES 13,479 14,633 Advances and notes payable to related parties (Note 6) 3,458 5,039 Notes payable to non-related parties (Note 6) -- 174 Other long term liabilities (Note 8) 674 649 Minority interest 550 547 -------- -------- TOTAL LIABILITIES 18,161 21,042 -------- -------- Commitments and contingencies (Note 8) Common stock - subject to possible redemption, 309,845 shares at redemption value -- 1,575 -------- -------- STOCKHOLDERS' EQUITY (Note 9) Common stock - $.001 par value; 50,000,000 shares authorized; 5,759,350 and 1,615,155 shares issued and outstanding at December 31, 1995 and 1994, respectively 6 2 Additional paid-in capital (Notes 9 and 10) 19,175 12,638 Accumulated deficit (6,185) (2,428) Cumulative currency translation adjustments 147 37 -------- -------- TOTAL STOCKHOLDERS' EQUITY 13,143 10,249 -------- -------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 31,304 $ 32,866 ======== ========\nAccompanying notes are an integral part of these financial statements\nF - 64\nBOGEN COMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 and 1993 (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AMOUNTS)\nPOST - PUSHDOWN PRE-PUSHDOWN 1995 1994 1993 ----------- ----------- -----------\nNet sales (Note 14: phase-out of OAS Product Line) $ 44,518 $ 45,922 $ 30,072\nCost of goods sold (including charges of $2,222, $1,273 and $115 to reduce certain inventory to market value for the years ending December 31, 1995, 1994 and 1993, respectively)(Note 14) 27,338 29,739 18,449 ----------- ----------- -----------\nGross profit (Note 14) 17,180 16,183 11,623\nOperating expenses: Research and development (Note 14) 2,307 1,999 1,696 Selling, general and administrative (Note 14) 15,067 12,555 9,140 Amortization of goodwill and intangible assets (Note 9) 443 424 18 ----------- ----------- -----------\nIncome (loss) from operations (637) 1,205 769\nOther (income) expenses: Other (income) (237) (39) -- Interest expense, net 587 498 342 Interest expense - related parties 619 696 427 Transaction costs 1,491 -- -- Minority interest of consolidated subsidiaries 184 326 37 ----------- ----------- -----------\n(Loss) before provision for income taxes (Note 14) (3,281) (276) (37)\nProvision for income taxes (Note 7) (1,262) (79) -- ----------- ----------- -----------\nNet (loss) $ (4,543) $ (355) $ (37) =========== =========== ===========\nNet (Loss) per common share: Net (Loss) $ (1.37) (0.18) $ (0.04) =========== =========== ===========\nWeighted Average number of common Shares Outstanding (Note 13) 3,311,668 1,925,000 865,506 =========== =========== ===========\nAccompanying notes are an integral part of these financial statements\nF - 65\nBOGEN COMMUNICATIONS INTERNATIONAL, INC. and SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN COMMON STOCK SUBJECT TO POSSIBLE REDEMPTION AND STOCKHOLDERS' EQUITY (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AMOUNTS)\nThe accompanying notes are an integral part of these financial statements\nF - 66\nBOGEN COMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (IN THOUSANDS OF DOLLARS)\nAccompanying notes are an integral part of these financial statements\nF - 67\nBOGEN COMMUNCATIONS INTERNATIONAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 and 1993 (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AMOUNTS)\nAccompanying notes are an integral part of these financial statements\nF - 68\nBOGEN COMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AMOUNTS)\n1. Summary of Significant Accounting Policies\nA. Principles of Consolidation\nThe consolidated financial statements of Bogen Communications International, Inc., formerly European Gateway Acquisition Corp. (the \"Company\"), include the accounts of Bogen Corporation, Inc. (\"Bogen\") and Speech Design GmbH (\"Speech Design\"). All significant intercompany balances and transactions have been eliminated in consolidation. Certain 1994 and 1993 balances have been reclassified to conform with the 1995 presentation.\nB. Nature of Operations\nThe Company's operations are conducted in one segment engaged in the development, manufacturing, and marketing of communication products. Product lines sold by the company are further described below:\nTelephone Products (\"Telco\")\nCommercial Audio Products (\"Commercial Sound\")\nIntercom\/Paging Equipment (\"Engineered Systems\")\nSmall Office\/Home Office Products(\"OAS\")\nC. Use of Estimates\nThe preparation of consolidated 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 periods. Actual results could differ from those estimates.\nD. Basis of Presentation\nOn August 21, 1995, the Company acquired a 99% interest in Bogen and a 67% interest in Speech Design. The Company paid Geotek Communications, Inc. (\"Geotek\") $7,000 in cash, a convertible promissory note in the aggregate principal amount of $3,000 and 3,700,000 shares of the Company's common stock and warrants to acquire 200,000 shares of common stock of the Company. As a result, Geotek acquired approximately 64% of the stock of the Company, thereby giving it a controlling interest in the Company. Geotek, in addition, forgave approximately $7,155 of intercompany indebtedness from Bogen as part of the transaction. Further, as contingent consideration, the Company could be liable to pay Geotek an amount up to $11,000, or receive up to $2,500 from Geotek, based upon the operating results of the Company during the two years after the transaction. For accounting purposes, the acquisition is being treated as a joint acquisition of the Company by Bogen and Speech Design, companies under the common control of Geotek. The transaction is considered a reverse acquisition with Geotek as the acquiror for accounting purposes. The historical financial statements reflect the combination of Bogen and Speech Design in a manner similar\nF - 69\nBOGEN COMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AMOUNTS)\nto a pooling-of-interests. Accordingly, the historical financial statements reflect the combined operations of Bogen and Speech Design.\nE. Transaction Costs\nThe Company incurred transaction costs of $1,491 in connection with the acquisition of Bogen and Speech Design which have been charged to non-operating expenses for the year ended December 31, 1995. These costs consist of non-recurring legal and other professional fees and other costs of the transaction amounting to $751 and a non-cash charge of $740 for the estimated fair value of 132,400 shares of common stock of the Company and warrants to purchase 60,000 shares of the Company's common stock at $5.25 per share, for services provided to the Company in connection with facilitating the acquisition of Bogen and Speech Design.\nF. Revenue Recognition\nProduct revenue, net of expected returns, is recognized upon shipment.\nG. Goodwill\nAs explained in Note 1D, the acquisition of Bogen and Speech Design is being accounted for as a reverse acquisition by Geotek. Accordingly, no goodwill will arise from the transaction described above as it is being accounted for on a historical cost basis.\nGoodwill represents the excess of cost over the fair value of net assets acquired. Goodwill also includes the effect of push-down accounting described below, by which Bogen recorded in its financial statements Geotek's goodwill associated with its purchase of Bogen. Goodwill is being amortized using the straight-line method over 40 years. At each balance sheet date, management assesses whether there has been a permanent impairment in the net carrying value of goodwill and the amount, if any, of such impairment by comparing anticipated undiscounted future cash flows from operating activities with the carrying value of goodwill. The factors considered by management in performing this assessment include current operating results, trends, the effect of obsolescence, demand, competition and certain other economic factors.\nThrough a series of transactions from 1991 through 1993, Geotek acquired for an aggregate consideration of approximately $8,400, 91% of Bogen. The purchase price included $1,500 in cash and short-term notes payable, the issuance of approximately 1,559,000 shares of Geotek's common stock and the conversion of $5,200 of Bogen's debt. In January 1994, Geotek completed a tender offer whereby its interest in Bogen increased from 91% to 99% in exchange for 230,300 shares of Geotek's common stock valued at approximately $3,300. Since Geotek acquired a greater than 95% interest in Bogen, pursuant to the rules of push-down accounting, the acquisition gave rise to a new basis of accounting and the goodwill related to Geotek's acquisition was \"pushed-down\" to the financial\nF - 70\nBOGEN COMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AMOUNTS)\nstatements of Bogen. Accordingly, Bogen recorded net goodwill in the amount of $14,300 million in the first quarter of 1994. The goodwill is being amortized over its then remaining life of approximately 38 years. The related amortization expense for the pushed down goodwill was approximately $376 for the years ended December 31, 1995 and 1994.\nThe consolidated financial statements as of and for the year ended December 31, 1993 were prepared using the Company's historical basis of accounting (Pre-Pushdown basis of accounting). The consolidated financial statements as of and for the years ended December 31, 1995 and 1994, were prepared under a new basis of accounting that reflects the additional goodwill pushed down from Geotek (Post-Pushdown basis of accounting). Comparability of operating results for the pre-pushdown and post-pushdown periods are affected by the additional amortization of goodwill.\nGoodwill in the amount of $739 represents the excess of cost over the fair value of net assets acquired by Speech Design related to the acquisition of its 67% owned subsidiary Satelco.\nH. Cash and Cash Equivalents\nCash includes cash on-hand and all highly-liquid debt instruments purchased with original maturities of three months or less. The Company has invested approximately $500 in a Certificate of Deposit in one bank at December 31, 1995.\nI. Inventories\nInventories are stated at the lower of cost (first-in, first-out method) or market. Reserves are established for valuation purposes or determined by management on a periodic basis, as required by conditions of obsolescence.\nJ. Property and Equipment\nProperty and equipment is recorded at cost. Depreciation is provided on a straight-line basis over the estimated useful life of the asset which generally ranges from three to ten years. Leasehold improvements are amortized ratably over their remaining lease terms, or estimated useful lives, if shorter.\nExpenditures for maintenance, repairs and renewals of minor items are charged to operations as incurred. Major renewals and improvements are capitalized. Upon disposition, the cost and related accumulated depreciation is removed from the accounts and the resulting gain or loss is reflected in operations for the period.\nK. Income Taxes\nThe Company follows Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (FAS 109). FAS 109 is an asset and liability\nF - 71\nBOGEN COMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AMOUNTS)\napproach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Company's financial statements or tax returns.\nL. Net Loss Per Share\nNet loss per common share is computed by dividing net loss by the weighted average number of shares of common stock outstanding. Common stock equivalents are excluded from the shares outstanding since the effect would be antidilutive.\nM. Credit Risk\nThe Company develops, produces, markets and sells commercial audio, electronic, paging, communications and other equipment. The Company performs on-going credit evaluations of its customers. The accounts receivable resulting from its sales transactions generally are not collateralized. The Company provides reserves for potential losses from these receivables.\nN. Translation of Foreign Currencies\nAssets and liabilities of the Company are translated from local currencies into U.S. dollars at the exchange rates in effect at the end of the period. Revenue and expense accounts are translated at average exchange rates prevailing during the period. Local currencies are considered to be the functional currencies of the Company and its subsidiaries. Translation adjustments that arise from translation of the Company and its subsidiaries' financial statements are accumulated in a separate component of shareholder's equity. Transaction gains and losses that arise from exchange rate changes on transactions denominated in a currency other than local currencies are included in income as incurred.\nIn the consolidated statements of cash flows, financing activities have been reflected at average rates for the years.\nO. Fair Value of Financial Instruments\nThe recorded amount of cash, cash equivalents, notes payable and advances, approximates fair value due to the short term maturities of these assets and liabilities.\nP. Recently Issued Accounting Pronoucements\nIn March 1995, the Financial Accounting Standards Board (\"FASB\") issued SFAS No. 121 \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of\" which is effective for fiscal years beginning after December 31, 1995. The Company will adopt this standard in 1996 and is presently analyzing the impact of this new standard on its financial position and results of operations.\nF - 72\nBOGEN COMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AMOUNTS)\nIn October 1995, the FASB issued SFAS No. 123 \"Accounting for Stock-Based Compensation\" which is effective for fiscal years beginning after December 15, 1995. The Company is still assessing the impact of implementing this new standard and can therefore not predict the effect on the Company's financial position and results of operations.\n2. Inventory\nInventory, at the lower of cost (first in, first out) or market, as of December 31, 1995 and 1994, is as follows:\n1995 1994 ------ ------ Raw materials and supplies $1,864 $1,985 Work in progress 1,155 758 Finished goods 3,903 5,415 ------ ------\nTOTAL $6,922 $8,158 ====== ======\nThe inventory balances are net of a reserve for inventory valuation and obsolescence of $2,552 and $1,267 at December 31, 1995 and 1994, respectively.\n3. Property and Equipment\nProperty and equipment at December 31, 1995 and 1994 is comprised of the following items:\n1995 1994 ------- -------\nMachinery, equipment and tooling $ 3,363 $ 2,735 Furniture and office equipment 1,485 1,367 Leasehold improvements 600 542 ------- ------- 5,448 4,644 Less: accumulated depreciation and amortization, net of disposals (3,257) (2,620) ------- -------\n$ 2,191 $ 2,024 ======= =======\nDepreciation and amortization expense was approximately $868, $574 and $428 for the years ended December 31, 1995, 1994 and 1993, respectively.\n4. Goodwill and Intangible Assets\nGoodwill and intangible assets consist of the following, at December 31, 1995 and 1994:\nF - 73\nBOGEN COMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AMOUNTS)\n1995 1994 -------- --------\nGoodwill $ 16,345 $ 16,345 Other intangibles 123 29 -------- --------\nTotal intangibles 16,468 16,374\nLess: accumulated amortization (1,762) (1,319) -------- --------\n$ 14,706 $ 15,055 ======== ========\nAmortization of goodwill and other intangibles was approximately $443, $424 and $18 for the years ended December 31, 1995, 1994 and 1993, respectively.\n5. Revolving Credit Agreeements\nIn August 1995, Bogen extended a $10,000 domestic revolving senior line of credit for a two year term expiring August 1997. The line is collateralized by substantially all the assets of Bogen and is guaranteed by Geotek. Advances bear interest at the rate of 2% to 2.75% over the lender's prime rate. At December 31, 1995, the lender's prime rate was 8.75%. Advances to Bogen are made based on a percentage of accounts receivable and inventory.\nAs of December 31, 1995 and 1994, Bogen had short term domestic borrowings outstanding under the line of credit of $3,670 and $4,350. The amounts available under the credit line based upon accounts receivable and inventory were $437 and $264 at December 31, 1995 and 1994, respectively. Under the terms of the line of credit, Bogen cannot, among other actions, declare or pay any dividends, return capital to its stockholders or redeem or repurchase any of its outstanding capital stock. Net assets of Bogen restricted under this agreement were $14,820 and $10,839 at December 31, 1995 and 1994, respectively.\nIn August 1995, in connection with the Company's acqusisition of Bogen and Speech Design, Geotek also agreed to provide Bogen with a working capital line of credit for two years in the aggregate principal amount of $2,000. Amounts drawn under the line bear interest at 1% per annum above the rate Bogen pays for its then largest credit facility. There were no borrowings under this facility at December 31, 1995.\nAt December 31, 1995 and 1994, Speech Design had short term lines of credit and overdraft facilities available of $3,453 and $1,863, respectively, of which short term borrowings amounted to $1,274 and $1,285, respectively. The amounts available under these credit lines were $2,179 and $578 at December 31, 1995 and 1994, respectively, with rates tied to short-term bank notes.\nTotal outstanding revolving lines of credit are summarized as follows at December 31:\nF - 74\nBOGEN COMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AMOUNTS)\n1995 1994 ------ ------ Domestic Lines of Credit Utilized $3,670 $4,350 Foreign Lines of Credit Utilized: Speech Design 627 728 Satelco 647 557 ------ ------\n$4,944 $5,635 ====== ======\n6. Long-Term Debt\nA: ADVANCES and NOTES PAYABLE TO RELATED PARTIES\nAdvances and notes payable to related parties at December 31, 1995 consist of the following:\n1995 1994 ------- -------\nAdvances from Geotek $ 138 $ 4,840 Notes Payable - Geotek (at prime rate + 1 1\/8%) -- 1,565 Notes Payable - Geotek (at prime rate) -- 333 Notes Payable - Geotek (at prime rate + 1%) 133 267 Notes Payable - Geotek 266 381 Loan to Related Party 317 315 Notes Payable - Geotek (at 13%) 3,141 -- ------- ------- Total 3,995 7,701 Less: Current Maturities (537) (2,662) ------- ------- $ 3,458 $ 5,039 ======= =======\nAdvances from Geotek\nThe $4,840 non-interest bearing advance from Geotek to Bogen was forgiven in connection with the acquisition of Bogen by the Company and was recorded as a contribution to equity on August 21, 1995 (the date of the acquisition). The remaining $138 consists of net current advances made subsequent to the acquisition.\nNotes Payable - Geotek (at prime rate + 1 1\/8%)\nThis $1,565 note was also forgiven in connection with the acquisition of Bogen by the Company and was recorded as a contribution to equity at the date of acquisition. Prior to conversion into equity, principal installments of $39 per quarter were made plus interest at the prime rate plus 1 1\/8%.\nF - 75\nBOGEN COMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AMOUNTS)\nNotes Payable - Geotek (at prime rate)\nThis $333 note was also forgiven in connection with the acquisition of Bogen by the Company and was recorded as a contribution to equity at the date of acquisition. Prior to conversion into equity, principal installments of $4 per month were made plus interest at the prime rate.\nNotes Payable - Geotek (at prime rate + 1%)\nThis note payable to Geotek from Speech Design is payable in quarterly installments of $33 plus interest at the prime rate plus 1%.\nNotes Payable - Geotek\nThis note payable to Geotek is from Satelco, a 67% owned subsidiary of Speech Design, and is payable in quarterly installments of $87 beginning in September, 1995 plus annual payments of interest at the Swiss prime rate plus 1%.\nLoan to Related Party\nThis $315 original note from the minority shareholders of Satelco is payable in quarterly installments of $31 plus interest at the Zurich Kantonal Bank rate with installments beginning February, 1995. The payments of this note have been suspended (with the approval of the noteholder) until such time as the Satelco subsidiary becomes profitable. Accordingly, this note payable has been classified as long-term.\nNotes Payable (by the Company) to Geotek\nThis note payable to Geotek from the Company was incurred at the date of acquisition for $3,000 plus interest payable quarterly in arrears at varying rates equal to the Company's current borrowing rate from CIT plus 2%. This note is due in February, 1997. These notes are convertible into Common Stock of the Company at any time under a conversion formula. These notes can be prepaid at any time which would void the conversion feature.\nB: NOTES PAYABLE TO NON-RELATED PARTIES\nNotes payable to non-related parties at December 31, 1995 consist of the following:\n1995 1994 ----- ----- Various Notes Payable (at prime rate) $ 60 $ 202 Notes Payable (with imputed interest 9%) -- 147 Notes Payable (with imputed interest at 9%) 37 177 Notes Payable (at 12% interest rate) 12 62 Notes Payable to Bank (at 8.5% interest rate) 65 159 ----- ----- Total 174 747 Less: Current Maturities (174) (573) ----- ----- $ -- $ 174 ===== =====\nVarious Notes Payable (at prime rate)\nPayable in monthly installments of $12 plus interest at the prime [ ] rate.\nF - 76\nBOGEN COMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AMOUNTS)\nNotes Payable (with imputed interest at 9%)\nPayable in monthly installments of $12 including imputed interest at 9%.\nNotes Payable (with imputed interest at 9%)\nPayable in annual installments of $150 including imputed interest at 9%.\nNotes Payable (at 12% interest rate)\nPayable in monthly installments of $4 plus interest at 12%.\nNotes Payable to Bank (at 8.5% interest rate)\nPayable by Speech Design in quarterly installments plus interest of 8.5%.\nPrincipal maturities of long-term debt over the next five years and thereafter are as follows:\nRelated Parties Other Total ------ ------ ------ 1996 $ 537 $ 174 $ 711 1997 3,141 -- 3,141 1998 -- -- -- 1999 -- -- -- 2000 -- -- -- Thereafter 317 -- 317 ------ ------ ------\n$3,995 $ 174 $4,169 ====== ====== ======\n7. Income Taxes\nThe Company's payable for income taxes consists of the following:\n1995 1994 ------ ------ Foreign: Speech Design $1,353 $ 89 ------ ------\nTOTAL INCOME TAXES PAYABLE $1,353 $ 89 ====== ======\nThe components of income tax expense (all foreign) are as follows for the years ended December 31:\n1995 1994 1993 ------ ------ ------\nCurrent income tax $1,257 $ 65 $ 0 Current corporation tax 5 14 0 ------ ------ ------\n$1,262 $ 79 $ -0- ====== ====== ======\nIncome tax expense for 1995 and 1994 differs from the amount computed by applying the U.S. federal statutory rates due to losses in the U.S. for which no benefit\nF - 77\nBOGEN COMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AMOUNTS)\nhas been provided offset by foreign taxable income at tax rates different than the U.S. federal statutory rate.\nThe Company had net operating loss (\"NOL\") carryforwards for U.S. tax purposes of approximately $6,746 as of December 31, 1995, which expire between the years 2004 through 2010. Under Section 382 of the Internal Revenue Code of 1986, as amended, the net operating loss carryforwards are subject to certain limitations on their utilization as a result of the changes in control of the Company in 1991 and 1995.\nThe components of deferred tax assets at December 31, 1995 and 1994, were approximately as follows:\n1995 1994 ------- ------- Deferred Tax Assets:\nNOL carryforwards $ 2,601 $ 1,886 Deferred rent 251 194 Inventory Reserves 972 642 Allowance for Doubtful Accounts 163 116 Other 844 294 ------- -------\nTOTAL DEFERRED TAX ASSETS 4,831 3,132\nLess, valuation allowance (4,831) (3,132) ------- -------\nNET DEFERRED TAX ASSETS $ -0- $ -0- ======= =======\nIn accordance with SFAS No. 109, the Company has established a valuation allowance of $4,831 and $3,132 for the years ended December 31, 1995 and 1994, respectively, offsetting the tax benefit of the deferred tax assets, principally the NOL carryforwards, to the extent the benefit is not expected to be realized.\n8. Commitments and Contingencies\nOperating Leases\nThe Company occupies its plant and office facilities and operates certain equipment under leases expiring at various dates through 2004. The facility lease contains an escalation clause and provides for payments of taxes and expenses over base rent. The facility lease also contains a five year renewal option.\nF - 78\nBOGEN COMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AMOUNTS)\nThe minimum annual rental commitments over the next five years under operating leases are as follows:\nYear Ending December 31, ------------ 1996 $ 1,127 1997 1,116 1998 1,039 1999 954 2000 872 Thereafter 807 ------ $5,915 ======\nBogen's facility lease includes scheduled rent increases over the lease term. Rent expense has been recorded on a straight-line basis and the related deferred rent obligation of $597 and $554 at December 31, 1995 and 1994, respectively, is classified as a long-term liability.\nRent expense charged to operations totaled approximately $1,055, $779 and $787 for the years ended December 31, 1995, 1994 and 1993, respectively.\nEmployment and Consulting Agreements\nIn March 1991, Bogen entered into an employment agreement with an officer which, among other things, provided for annual compensation of approximately $150 and a bonus equal to 5% of pre-tax earnings. In the first quarter of 1993, the officer resigned from the Company. As a result, in 1993, the Company recorded a charge of $50 for a severance payment pursuant to the termination agreement with such officer. This payment was made by Geotek on behalf of the Company and has been treated as a capital contribution in 1993. Other officers of the Company are employed pursuant to written agreements with Geotek and the Company.\nCommitments\nAt December 31, 1995, the Company had commitments to purchase merchandise from foreign vendors of $694 under documentary letters of credit and $133 under other sight documents. In addition, the Company has commitments to purchase from certain foreign vendors raw materials with a value of approximately $28. Pursuant to the sale of Aryt Optronics, Ltd. by Geotek in 1992, the Company obtained certain benefits and concessions from Reshef Technologies, Ltd. (\"Reshef\"), formerly a related company to Bogen. Such concessions and benefits would be lost by the Company if certain target purchases from Reshef were not met. Purchases made under this agreement complied with the target purchase requirements and approximated $3,612, $6,284 and $3,100 in 1995, 1994 and 1993, respectively. The\nF - 79\nBOGEN COMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AMOUNTS)\nconcessions and benefits from Reshef expired on December 31, 1995.\nLitigation\nOn April 13, 1995, a settlement of litigation was reached between AccessLine Technologies, Inc. (\"AccessLine\") and Bogen, that was effective January 1, 1995. Accessline had alleged patent infringement by Bogen's \"Friday\" product line and had sought unspecified damages from Bogen. The settlement resolved all current and future matters that may be brought by AccessLine with regard to this alleged patent infringement. Under the terms of the settlement, AccessLine granted a license to Bogen permitting Bogen to continue selling its \"Friday Home Office Receptionist\" line of products and other variations thereof on a worldwide basis. In return, the Company has agreed to pay AccessLine a royalty of 3% of net sales for applicable units sold after December 31, 1994. Applicable units would include current models of the \"Friday Home Office Receptionist\" and future new products that would be similar and meet the requirements of the agreement. The term of the license agreement is coincident with the expiration of patents applicable under the license agreement unless terminated sooner in accordance with the agreement. Under terms of this agreement, the Company has recorded royalty expense of $92 for the year ended December 31, 1995.\n9. Stockholder's Equity\nCommon Stock and Common Stock Subject to Possible Redemption\nThe following discussion summarizes the incorporation of the Company, the capitalization, and the requirements and privileges of the shareholders in the periods preceding the consummation of the acquisition of Bogen and Speech Design on August 21, 1995.\nThe Company was incorporated in Delaware on May 6, 1993 with the objective of acquiring a medium-sized operating business engaged in industrial manufacturing or industrial services and located in Germany, Switzerland or Austria (\"Business Combination\"). The Company's founding directors and advisors purchased 500,000 common shares, $.001 par value, for five hundred dollars during the three month period after incorporation. On September 30, 1993, 125,000 shares were returned to the Company by the founding shareholders and was retroactively reflected in the financial statements as a net issuance of 375,000 shares.\nOn October 15, 1993, the Company sold 1,550,000 units (\"Units\") in an initial public offering (\"Offering\") of the Company's common stock. Each unit consisted of one share of the Company's common stock, $.001 par value, and two Redeemable Common Stock Purchase Warrants (\"Warrants\"). Each Warrant entitled the holder to purchase, during the period commencing on the later of the consummation by the Company of its Business Combination or one year from the effective date of the Offering and ending seven years from the effective date of Offering, from the Company one share of common stock at an exercise price of $5.50. The Warrants are redeemable at a price of $.01 per Warrant upon 30 days notice any at time, only in the event that the last sale price of the common stock is at least $10.00 per share for 20 consecutive trading days ending on the third day prior to\nF - 80\nBOGEN COMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AMOUNTS)\ndate on which notice of redemption is given. The proceeds of the Offering were deposited in a trust fund to fund a Business Combination or liquidation of the Company.\nThe Company, after signing a definitive agreement for the acquisition of a Business Combination, submitted such transaction for stockholder approval. In the event that 20% or more of the shareholders excluding, for this purpose, those persons who were shareholders prior to the Offering, had voted against the Business Combination, the Business Combination would not have been consummated. For the first Business Combination consummated by the Company, all of the Company's shareholders prior to the Offering, including all of the officers, directors and advisors of the Company (\"Initial Shareholders\") agreed to vote their shares of common stock in accordance with the vote of the majority in interest of all other shareholders of the Company (\"Public Shareholders\") with respect to any Business Combination. After consummation of the Company's first Business Combination, these voting safeguards were no longer applicable.\nWhen the Business Combination was approved and consummated, any Public Shareholder who had voted against the Business Combination could have demanded that the Company redeem his shares. The per share redemption price equaled the amount in the Trust Fund, as of the record date for determination of shareholders entitled to vote on the Business Combination, divided by the number of shares held by Public Shareholders. Accordingly, Public Shareholders holding 19.99% of the aggregate number of shares owned by all Public Shareholders could have had their shares redeemed at the time of the Business Combination. The Company has classified the value of this redemption as common stock, subject to possible redemption, on its balance sheet at December 31, 1994 prior to the consumation of the Business Combination. Such Public Shareholders were entitled to receive their per share interest in the Trust Fund computed without regard to shares held by Initial Shareholders. On August 21, 1995, in connection with the Company's acquisition of Bogen and Speech Design, the Company reclassified the common stock subject to possible redemption to common stock. No shares of stock were redeemed as discussed above.\nThe Company's Certificate of Incorporation had provided for mandatory liquidation of the Company, without stockholder approval, in the event that the Company did not consummate a Business Combination.\nWarrants\nIn June 1993, 300,000 Warrants were issued to various individuals in consideration for providing the Company bridge financing until its offering in October 1993. As referred to above, the Company issued 3,100,000 Warrants to purchase its common stock in connection with the Offering.\nWarrants to purchase 200,000 shares of common stock were issued to Geotek in August 1995 in connection with the acquisition of Bogen and Speech Design. Another 60,000 Warrants were issued as consideration for providing certain financings and services provided to the Company to facilitate the Business Combination. At December 31, 1995, 3,660,000 Warrants were outstanding.\nF - 81\nBOGEN COMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AMOUNTS)\nOptions\nThree members of the Company's Board of Directors have been granted an option by the previous members of the Board of Directors to purchase from such persons, for nominal consideration, 337,500 of the 375,000 shares of the Company's common stock currently held by such persons.\nIn 1994, Bogen adopted an Employee Stock Option Plan (the \"Plan\"). Under the Plan, an aggregate of 3,000,000 shares may be issued to members of its Board of Directors, designated officers and employees and independent contractors or consultants who perform services for the Company. No option granted under the Plan is intended to be an incentive stock option within the meaning of section 442A(b) of the Internal Revenue Code of 1986 for income tax purposes. During 1994, 1,400,000 options were granted under this Plan at a price of $1.14 per share which approximates fair value. These options vest over a five (5) year period. During 1994, there were no options exercised or exercisable. During 1995, 325,000 options were granted, and 605,000 options were cancelled due to executives leaving the Company. At December 31, 1995, 180,000 options were exercisable.\nPrior to January 1, 1994, Bogen maintained a stock option plan which provided for the grant of up to 500,000 incentive and\/or non-qualified stock options to officers and key employees. No options were granted pursuant to this plan in 1993.\nPush-Down of Goodwill\nPursuant to Accounting Principles Board No. 16 \"Business Combinations\" (\"APB 16\"), the accumulated deficit of Bogen was required to be restated on the date of applying push-down accounting (see Note 2G, Goodwill). The restated accumulated deficit includes Geotek's recorded equity in the income and losses of Bogen since its original acquisition and all goodwill amortization recorded by Geotek relating to the acquisition of Bogen. Therefore, a reclassification of $8,524 was made from accumulated deficit to additional paid-in capital in January 1994.\nPreferred Stock\nThe Company is authorized to issue 1,000,000 shares of preferred stock with such designations, voting and other rights and preferences as may be determined from time to time by the Board of Directors.\nCommon Stock\nAt December 31, 1995 and 1994, 3,700,000 shares of common stock were reserved for issuance upon exercise of redeemable warrants.\n10. Related Party Transactions\nThe Company has issued 132,431 shares of its common stock for services received in connection with the acquisition of Bogen and Speech Design. Of these shares 19,565 were issued to a member of the Board of Directors of Geotek.\nF - 82\nBOGEN COMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AMOUNTS)\nDuring 1995, in conjuction with the acquisition of Bogen and Speech Design (see Note 1D above) Geotek forgave $7,155 in long-term debt due Geotek which was recorded as an increase in additional paid-in capital. As part of this acquisition, the Company issued $3,000 in convertible promissory notes to Geotek.\n11. Economic Dependency\nDuring the years ended December 31, 1995, 1994 and 1993, the Company purchased audio components of approximately $8,853, $14,016 and $7,460, respectively, from three suppliers located in the Republic of South Korea. Any future inability of any of these suppliers to provide the Company with a sufficient level of components may have a negative impact on the Company's operations.\nSales to one customer approximated $4,400 and accounted for more than 10% of the Company's net sales in 1995. Sales to a different customer approximated $7,100 and accounted for more than 10% of the Company's net sales in 1994.\nTwenty-two of Bogen's employees are subject to collective bargaining agreements which expire in mid-1997.\n12. Employee Benefit Plans\nBogen participates in multi-employer pension plans which cover all union employees. Contributions for the periods ended December 31, 1995, 1994 and 1993 were approximately $15, $18 and $19, respectively.\nEmployees of the Company are also eligible to participate in a defined contribution 401(K) plan sponsored by Geotek. The Company provides a matching contribution to a portion of funds contributed by employees that amounted to $82, $108, and $73 for the years ended December 31, 1995, 1994, and 1993, respectively.\n13. Segments\nThe Company's operations are conducted in one segment engaged in the development, manufacturing and marketing of communication products, such as telephone products, commercial audio, paging equipment, and small office home office products in the United States (Bogen) and Germany (Speech Design). Information about the Company for 1995, 1994, and 1993 has been presented geographically as follows:\n1995 1994 1993 ------- ------- ------- Geographic Segments: Revenues: United States $30,677 $37,745 $26,292 Foreign 13,841 8,177 3,780 ------- ------- ------- $44,518 $45,922 $30,072 ------- ------- -------\nF - 83\nBOGEN COMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AMOUNTS)\nOperating income (loss): United States $ (2,405) $ (18) $ 656 Foreign 1,768 1,223 113\nIncome (loss) from operations $ (637) $ 1,205 $ 769 -------- -------- --------\nIdentifiable assets: United States $ 24,425 $ 27,467 $ 12,263 Foreign 6,879 5,399 2,157 -------- -------- -------- $ 31,304 $ 32,866 $ 14,420 -------- -------- --------\n14. Phase-out of OAS Product Line\nIn December 1995, the Company's management made a decision to phase-out the OAS product line. This decision was made as a result of intense competitive pressure from competing companies. The Company expects to sell all remaining OAS inventory and complete the phase-out by the middle of 1996, with no material exit costs anticipated. The results of the OAS product line for the past three years are as follows:\nSelected Financial Information For The Years Ended December 31,\n1995 1994 1993 ------- ------- -------\nNet Sales $ 4,444 $12,252 $ 2,899\nCost of Goods Sold 4,932 9,431 1,765 ------- ------- -------\nGross Profit (Deficit) (488) 2,821 1,134\nEngineering, Selling & Marketing Expenses 4,026 3,773 1,849 ------- ------- -------\nOperating loss $(4,514) $ ( 952) $ (715) ------- ------- -------\n15. Fourth Quarter Adjustments\nCertain adjustments and provisions amounting to $1,500, primarily related to inventory valuation for the OAS product line, were recorded in the fourth quarter of 1995.\nF - 84","section_15":""}
{"filename":"88790_1995.txt","cik":"88790","year":"1995","section_1":"ITEM 1. Business\nSelas Corporation of America (together with its subsidiaries, unless the context otherwise requires, referred to herein as the (\"Company\")), was incorporated in Pennsylvania in 1930. The Company is a diversified firm with international operations and sales that engages in the design, development, engineering and manufacturing of a range of products. The Company, headquartered in Dresher, Pennsylvania with subsidiaries in Minnesota, Ohio, France, Germany and Italy, operates directly or through subsidiaries in three business segments.\nUnder the SelasTM name, the Company designs and manufactures specialized industrial heat processing systems and equipment for steel, glass and other manufacturers worldwide. The Company's subsidiary, Resistance Technology, Inc., designs and manufactures microminiature components and molded plastic parts primarily for the hearing instrument manufacturing industry worldwide. The Company's subsidiary, Deuer Manufacturing, Inc., manufactures spare tire holders and lifts and related products, primarily based on cable winch designs, for use principally as original equipment by the pick-up truck and minivan segment of the automotive industry.\nFinancial data relating to industry segments, geographical summary of assets and operations, export sales and major customers are set forth in Note 4 of the Company's consolidated financial statements.\nHEAT PROCESSING\nThe Company specializes in the controlled application of heat to achieve precise process and temperature control. The Company's principal heat processing equipment and systems are large custom-engineered furnaces and smaller standard-engineered systems, burners and combustion control equipment.\nCUSTOM-ENGINEERED FURNACES\nProducts and Industries Served. The Company designs specialized furnaces for use primarily in the steel and glass industries worldwide. The furnaces are engineered to subject a customer's products to carefully controlled heating and cooling processes in order to improve the physical characteristics of those products. Each furnace is custom-engineered by the Company to meet the customer's specific requirements. The Company believes that the SelasTM name, its reputation for quality and its leadership in the design and engineering of direct gas-fired heat processing furnaces are important factors in its business. The Company also offers gas-fired radiant tube and electric heating technology for heat processing furnaces.\nThe Company's custom-engineered systems for the steel industry include continuous annealing furnaces and continuous galvanizing furnaces. Continuous annealing furnaces are used to heat-treat semi-finished steel sheet and strip to soften it to improve the ductility of the steel, thereby making it suitable for use in the\nITEM 1. Business - (Continued)\nmanufacture of automobiles, appliances and other items. Continuous galvanizing furnaces consist of continuous annealing furnaces plus the components used to apply a zinc coating to steel strip to improve its resistance to corrosion.\nThe Company's furnaces for the glass industry are used for the tempering and bending of glass. The glass tempering process toughens glass plate through a controlled process of heating and cooling. Glass manufacturers use the Company's glass bending furnaces to heat and bend plate glass for automotive and architectural uses.\nFrom time to time, the Company also designs various other specialized furnaces for use by manufacturers in a variety of industries to suit particular process requirements. For example, over the years the Company has engineered large barrel line furnaces used for the continuous heat treatment of steel pipe, tube or bar.\nMarketing and Competition. The Company markets its custom-engineered furnaces on a global basis. Marketing personnel are located at the Company's offices in Dresher, Paris, Ratingen and Milan and at the offices of its 50%-owned affiliate, Nippon Selas Co., Ltd., in Tokyo. Over the years, the Company has installed custom-engineered systems throughout the world, in Europe, North America, South America, Asia, Australia and Africa. In a particular period, a single contract may account for a large percentage of sales, but the Company is not dependent on any custom-engineered systems customer on an ongoing basis.\nCompany engineering and marketing personnel maintain contact with potential major steel and glass customers to determine their needs for new furnaces, typically for expansion or new technology. The Company's furnaces have long useful lives, and replacement business is not a major factor in sales of custom-engineered systems.\nThe Company also markets its products and services through agents and licensees located in various parts of the world. Typically, the Company's license agreements provide that the licensee will act as the Company's sales agent in a particular territory, is granted a license to utilize the Company's heat processing technology in that territory, and is granted the right to utilize technical services provided by the Company. In exchange, the Company receives certain fees when the licensee sells the Company's products or services in the territory.\nOver the years, Japanese steel producers have aligned themselves in semi- exclusive relationships with furnace manufacturers. For a number of years, the Company has licensed direct fired furnace technology to NKK Corporation, the second largest steel producer in Japan.\nFurnaces for continuous galvanizing and annealing lines generally utilize either direct fired or radiant tube technology. The Company is the market leader for furnaces based on direct fired technology,\nITEM 1. Business - (Continued)\nand also sells furnaces of the radiant tube design utilized primarily by its competitors. Some of the Company's competitors are larger and have greater financial resources. Operations.\nThe Company's custom-engineered furnace business is conducted principally by its wholly-owned subsidiaries, Selas S.A. (Paris), Selas Waermetechnik GmbH (Ratingen) and Selas Italiana, S.r.L. (Milan). These subsidiaries currently employ approximately 88 persons, of whom 16 are administrative personnel and 72 are sales, engineering and operations personnel. A small number of engineering and marketing management personnel located at the Company's Dresher, Pennsylvania headquarters facility are also involved from time to time in the custom- engineered furnace business.\nOn large-scale projects, such as a continuous steel strip annealing or galvanizing line, the customer frequently contracts for the entire line on a turnkey basis with an engineering and construction firm specializing in line terminal equipment, and the Company acts as a subcontractor for the design, engineering, supply of material and installation of the furnace portion of the line, or, alternatively, as a subcontractor only for design and engineering. When the Company provides only design and engineering services, the prime contractor handles the fabrication and erection of the furnace. With the exception of certain proprietary parts, the Company does not manufacture the components used in such systems.\nThe Company's custom-engineered furnace business is historically cyclical in nature.\nSTANDARD-ENGINEERED SYSTEMS, BURNERS AND COMBUSTION CONTROL EQUIPMENT\nStandard-Engineered Systems. At its Dresher, Pennsylvania facility, the Company engineers and fabricates a variety of smaller furnaces and heat processing equipment. Although these systems are based on standard designs, the Company often adapts or re-engineers them to meet particular customer needs. These smaller systems are generally used by manufacturers in sophisticated applications for the heat treatment of finished and semi-finished parts.\nThe Company's standard-engineered systems include atmosphere- controlled furnaces for heat treating finished metal parts. Its continuous heat treating systems include not only the hardening and tempering furnaces central to the system, but also the ancillary loading, quenching and washing equipment.\nITEM 1. Business - (Continued)\nThe Company also manufacturers large non-atmosphere-controlled batch-type furnaces in a variety of designs. The Company's carbottom furnaces enable its customers to remove the furnace hearth, running on tracks similar to a railroad car, from the stationary furnace for loading and unloading. With its hood furnaces, the furnace itself can be lifted from the stationary hearth for loading and unloading. Carbottom and hood furnaces are used to heat treat large, usually semi-finished, metal parts of a variety of shapes and sizes. Clamshell furnaces designed by the Company open and close around steel rolls to produce a gradation of metal characteristics due to the differential heating of the steel roll. The Company's standard batch furnaces are supplied to customers with a need for the precise, accurately controlled application of heat to their products.\nThe Company's standard systems also include automatic brazing and soldering systems used in the assembly of radiators, air conditioner coils and electrical appliances. The precise application of heat in these systems improves a customer's product quality and uniformity while reducing production costs. The Company also produces the fuel mixing and monitoring systems, burners and product handling equipment necessary for these systems.\nThe Company also produces custom designed barrel furnaces used primarily to heat treat long metal parts, and also produces specialized glass lehrs for heating glass products.\nBurners and Combustion Control Equipment. The Company designs, manufactures and sells an array of original equipment and replacement gas-fired industrial burners for many applications. The Company is a producer of burners used in fluid processing furnaces serving the petrochemical industry. One type of fluid processing burner is capable of minimizing the emission of oxides of nitrogen as combustion products. As many jurisdictions reduce the permissable level of emissions of these compounds, the Company believes that the demand for \"low NOx\" burners will increase. The Company also produces burners suitable for creating a high temperature furnace environment desirable in steel and glass heat treating furnaces. The Company's burners accommodate a wide variety of fuel types, environmental constraints and customer production requirements.\nThe Company furnishes many industries with gas combustion control equipment sold both as component parts and as systems that have been custom-engineered to meet a particular customer's needs. This equipment is provided with the Company's original custom-engineered and standard heat treating equipment, as replacement or additional components for existing furnaces being refurbished or upgraded, and as original components for heat treating equipment manufactured by others. The components of the combustion control systems include mixing valves capable of mixing gas and air and controlling the air\/gas ratio, pressure and total flow of the mixed gases. The Company also produces its Qual-O-RimeterTM automated monitoring and control device used in conjunction with its mixing valves to maintain precise, uniform heat release and flame shape, despite fluctuations in fuel mix and quality, air temperature and humidity.\nITEM 1. Business - (Continued)\nAdditional combustion control products include Flo-ScopeTM flow meters, which measure the rate of flow of gases, and automatic fire checks and automatic blowouts, which arrest flame and pressure resulting from backfire from the burners into the pipe line.\nMarketing and Competition. The Company markets its standard-engineered systems products on a global basis through its sales and marketing personnel located in Dresher, and also sells these products through licensees and agents located in various parts of the world. Although the Company competes for orders for such products with many other manufacturers, some of which are larger and have greater financial resources, the Company believes that its reputation and its high standard for quality allow it to compete effectively with other manufacturers.\nOperations. At its Dresher facility, the Company employs approximately 70 persons, of whom 16 are executive and administrative personnel, 15 are sales and engineering personnel and 39 are personnel engaged in manufacturing. The hourly personnel are represented by a union, and the current union contract expires May 1, 1998. The Company considers its relations with its employees to be satisfactory.\nThe principal components used in the Company's heat processing equipment and other products are steel, special castings (including high-alloy materials), electrical and electronic controls and materials handling equipment. These items are available from a wide range of independent suppliers.\nResearch and Development. The Company conducts research and development activities at its Dresher facility to support its heat processing services and products. The Company's research efforts are designed to develop new products and technology as well as to improve existing products and technology. For example, the Company's research and development activities have led to the redesign and upgrade of its air- mixing valve process. The Company also conducts research on behalf of particular customers in connection with customers' unusual process needs. Research and development expenditures for heat processing aggregated $188,000, $194,000 and $251,000 in 1995, 1994 and 1993, respectively.\nIt is the Company's policy to apply for domestic and foreign patents on those inventions and improvements which it considers significant and which are likely to be incorporated in its products. It owns a number of United States and foreign patents and has a number of additional applications pending. It is licensed under patents owned by others and has granted licenses to others on a fee basis. The Company believes that, although these patents collectively are valuable, no one patent or group of patents is of material importance to its business as a whole.\nITEM 1. Business - (Continued)\nMICROMINIATURE COMPONENTS AND MOLDED PLASTICS\nResistance Technology, Inc. (\"RTI\"), a wholly-owned subsidiary whose outstanding capital stock the Company acquired on October 20, 1993, manufactures microminiature components and molded plastic parts primarily for the hearing instrument manufacturing industry worldwide.\nProducts and Industries Served. RTI is a leading manufacturer and supplier of microminiature electromechanical components to hearing instrument manufacturers. These components consist of volume controls, trimmer potentiometers and switches. RTI also manufactures hybrid amplifiers and integrated circuit components (\"hybrid amplifiers\"), along with faceplates for in-the-ear and in-the-canal hearing instruments. Components are offered in a variety of sizes, colors and capacities in order to accommodate a hearing manufacturer's individualized specifications. Sales to hearing instrument manufacturers represented approximately 91% of RTI's 1995 annual net sales.\nHearing instruments, which fit behind or in a person's ear to amplify and process sound for a hearing impaired person, generally are composed of four basic parts and several supplemental components for control or fitting purposes. The four basic parts are microphones, amplifier circuits, miniature receivers\/speakers and batteries. RTI's hybrid amplifiers are a type of amplifier circuit. Supplemental components include volume controls, trimmer potentiometers, which shape sound frequencies to respond to the particular nature of a person's hearing loss, and switches used to turn the instrument on and off and to go from telephone to normal speech modes. Faceplates and an ear shell molded to fit the user's ear often serve as a housing for hearing instruments.\nThe potential range of applications for RTI's molded plastic parts is broad. RTI has produced intravenous flow restrictors for a medical instruments manufacturer and cellular telephone battery sockets for a telecommunications equipment manufacturer. Sales to industries other than the hearing instrument industry represented approximately 9% of RTI's 1995 annual net sales.\nRTI manufactures its components on a short lead-time basis in order to supply \"just-in-time\" delivery to its customers. Due to the short lead- time, the Company does not include orders from RTI's customers in its published backlog figures.\nMarketing and Competition. RTI sells its hearing instrument components directly to domestic hearing instrument manufacturers through an internal sales force. Sales of molded plastic parts to industries other than hearing instrument manufacturers are made through independent sales representatives. In recent years, three companies have accounted for a substantial portion of the U.S.\nITEM 1. Business - (Continued)\nhearing instrument sales. In 1995, these three customers accounted for approximately 38% of RTI's net sales.\nInternationally, sales representatives employed by Resistance Technology, GmbH (\"RT, GmbH\"), a German company 80% of whose capital stock is owned by RTI, solicit sales from European hearing instrument manufacturers and facilitate sales with Japanese and Australian hearing instrument markets.\nRTI believes that it is the largest supplier worldwide of microminiature electromechanical components to hearing instrument manufacturers and that its full product line and automated manufacturing process allow it to compete effectively with other manufacturers with respect to these products.\nIn the market of hybrid amplifiers and molded plastic faceplates, RTI's primary competition is from the hearing instrument manufacturers themselves. The hearing instrument manufacturers produce a substantial portion of their internal needs for these components.\nOperations. RTI currently employs 280 people, of whom 28 are executive and administrative personnel and 252 are sales, engineering and operations personnel at RTI's two facilities near Minneapolis, Minnesota. A small number of sales personnel employed by RT, GmbH are located in Munich, Germany.\nAs a consumer products manufacturer, RTI is subject to claims for personal injuries allegedly caused by its products. While the Company maintains what it believes to be adequate insurance coverage, it retains a self-insured deductible under its liability insurance policies.\nResearch and Development. RTI conducts research and development activities primarily to improve its existing products and technology. RTI's research and development expenditures were $1,106,000, $896,000 and $125,000 in 1995, 1994 and 1993, respectively. The expense for 1993 represents the part of the year it was owned by the Company.\nRTI owns a number of United States patents which cover a number of product designs and processes. The Company believes that, although these patents collectively add some value to the Company, no one patent or group of patents is of material importance to its business as a whole.\nTIRE HOLDERS, LIFTS AND RELATED PRODUCTS\nDeuer Manufacturing, Inc. (\"Deuer\"), a wholly-owned subsidiary, manufactures tire holders, lifts, and other related products based principally on cable winch designs.\nProducts and Industries Served. Deuer is a leading supplier of spare tire holders used on light trucks and mini-vans manufactured by the major domestic automotive manufacturers. Deuer's spare tire holder holds the spare tire to the underbody of the vehicle by means of a steel cable running to the underside of the vehicle's frame. One end of the steel cable is attached to a hub placed through the\nITEM 1. Business - (Continued)\ncenter of the spare tire's rim, and the other end is attached to a hand- operated winch mounted at an accessible location on the vehicle. The spare tire holding system permits the spare tire to be stored in a remote location and to be easily removed without the need to crawl under the vehicle. During 1995, sales of spare tire holders accounted for approximately 87% of Deuer's net sales.\nDeuer also produces a variety of hand-operated hoist-pullers, using primarily a cable winch design, sold under the Mini-MuleTM brand name. These products, which retail from $30 to $60, are portable hand winches designed for a variety of uses, such as pulling objects, rigging loads and installing fencing. Deuer furnishes these hoist-pullers in a variety of sizes and capacities. It also manufactures accessories for use with the products, including slings, clamps, blocks and gantries.\nDeuer manufactures products on a short lead time basis in order to furnish \"just-in-time\" delivery to its automotive customers. Because of the substantial variances between manufacturers' estimated and actual requirements, the Company does not include blanket order commitments from automotive manufacturers in its published backlog figures.\nMarketing and Competition. Deuer sells its spare tire holders directly to domestic automotive manufacturers. Deuer's spare tire holders are sold to Chrysler Corporation, General Motors, Ford Motor Company and Mobile Home Manufactures. The design and quality of Deuer's spare tire holders have been recognized by its major customers. The Company sells its hoist-pullers through a network of distributors as well as directly to some large retail outlets.\nDeuer is one of several suppliers of spare tire holders to domestic mini- van and light truck manufacturers. Some of Deuer's competitors are larger and have greater financial resources. The Company believes that price and Deuer's reputation for quality and reliability of delivery are important factors in competition for business from the domestic automotive manufacturers. A number of other domestic and foreign manufacturers sell hoist-pullers to the retail market, and Deuer's share of this market is relatively small.\nOperations. At its Dayton facility, Deuer employs 17 executive and administrative personnel and approximately 136 manufacturing employees. Some of the manufacturing employees are represented by a union, and the current union contract expires in October 1998. Deuer considers its relations with its employees to be satisfactory.\nDeuer's principal raw material is coil rolled steel which is widely available. Deuer also conducts research and development activities which consist of the development of new products and technology and the modification of existing products. Deuer's research and development expenditures aggregated $171,000, $218,000 and $219,000 in 1995, 1994 and 1993, respectively.\nAs a consumer products manufacturer, Deuer is subject to claims for personal injuries allegedly caused by its products. While the\nITEM 1. Business - (Continued)\nCompany maintains what it believes to be adequate insurance coverage, it retains a self-insured deductible under its liability insurance policies.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. Properties\nThe Company owns the manufacturing facility in Dresher, Pennsylvania in which its standard-engineered systems, burners and combustion control equipment are produced. The Company's headquarters are located on the same 17 acre site. The 136,000 square foot Dresher facility has more space than is currently needed for the Company's operations and headquarters, and the Company is seeking to lease all or a portion of the excess office and manufacturing space to a suitable tenant. This property is subject to a mortgage. See note 8 of the Company's consolidated financial statements.\nRTI leases a 47,000 sq. ft. manufacturing facility in Arden Hills, Minnesota from a partnership consisting of three officers of RTI, one of whom, Mark S. Gorder, serves on the Company's Board of Directors. At this facility, RTI manufactures all of its products other than plastic component parts. The lease expires in October, 1996, but RTI has two consecutive 5-year renewal options. In addition, RTI owns, subject to a mortgage from a third party lender, a 20,000 sq. ft. building in Vadnais Heights, Minnesota at which RTI produces plastic component parts. (See notes 8 and 17 of the Company's consolidated financial statements.)\nDeuer owns its 82,000 square foot manufacturing facility located on 6.5 acres in Dayton, Ohio, where it produces its spare tire holders and hoist-pullers. The facility is furnished with a variety of steel fabrication equipment, including punch presses, drill presses, screw machines, grinders, borers, lathes and welders.\nDeuer owns and leases an additional 11,000 square feet of excess space to several tenants, principally for storage and office use. This and the above designated Deuer property are subject to a mortgage. See note 8 of the Company's consolidated financial statements.\nSelas S.A. owns the land and building which houses its engineering, sales and administrative operations in Gennevilliers, France (outside of Paris). The land under the building is owned by Selas S.A. and the property outside of the building is jointly owned by the building owners in the office complex. The building has 22,000 square feet. This property is subject to a mortgage. See note 8 of the Company's consolidated financial statements.Selas Italiana S.r.L., the Companys Italian subsidiary, and Selas Waermetechnik GmbH, the Company's German subsidiary, lease facilities in Milan, Italy and Ratingen, Germany, respectively. The Milan facilities, are comprised of engineering, sales and administrative offices, and the Ratingen facilities are used for sales, administrative and engineering activities and assembly of small furnaces and furnace components and each are on a year-to-year basis. Resistance Technology, GmbH, leases office space in Munich, Germany, on a year-to-year basis, for its sales personnel. Management expects to be able to extend these leases.\nITEM 3.","section_3":"ITEM 3. Legal Proceedings\nThe Company is a defendant along with a number of other parties in approximately 112 lawsuits as of December 31, 1995 (210 as of December 31, 1994) alleging that plaintiffs have or may have contracted asbestos- related diseases as a result of exposure to asbestos products or equipment containing asbestos sold by one or more named defendants. Due to the noninformative nature of the complaints, the Company does not know whether any of the complaints state valid claims against the Company. The Company is also one of approximately 500 defendants in a class action on behalf of approximately 2700 present or former employees of a Texas steel mill alleging that products supplied by the defendants created a poisonous atmosphere that caused unspecified physical harm. These cases are being defended by one or more of the Company's insurance carriers presently known to be \"at risk.\" Through October 1993, the legal costs of defense of the asbestos and steel mill cases were shared among the insurance carriers (92%) and the Company (8%). The lead insurance carrier settled a number of the cases in 1993 and requested that the Company pay a portion of the settlement amount. The Company declined to do so because no such payment is required by the express terms of the policies. The lead carrier then purported in October 1993 to abrogate the arrangement under which the defense costs had been shared, and the Company responded by tendering all of the cases to the lead carrier and demanding that the lead carrier honor its obligations under its policies to pay 100% of the costs of defense and 100% of all settlements and judgments up to the policy limits. The lead carrier has settled approximately 98 and 450 claims in 1995 and 1994, respectively with no request for the Company to participate in any settlement.\nIn 1995, a dispute arose under a contract between a customer and a subsidiary of the Company that was submitted to arbitration. The customer alleged that the subsidiary had breached the contract and that the customer was entitled to recision of the contract. The Company recorded revenue of approximately $1,400,000 under the contract in 1994 and had, as of December 31, 1995, a current billed receivable of $140,000 for the balance of the aggregate amount due under the contract. The subsidiary of the Company has contested the customer's claims in the arbitration proceeding.\nITEM 4.","section_4":"ITEM 4. Submission of Matters to a Vote of Security Holders\nNone\nITEM 4A. Executive Officers of the Company\nThe names, ages and offices (as of February 28, 1996) of the Company's officers were as follows:\nName Age Office\nStephen F. Ryan 60 President and Chief Executive Officer\nChristian Bailliart 47 Vice President and Chairman- Director Generale of Selas S.A.\nFrank J. Boyle 66 Vice President, Sales and Engineering\nJames C. Deuer 68 Vice President and President of Deuer Manufacturing, Inc.\nMark S. Gorder 49 Vice President and President of Resistance Technology, Inc.\nRobert W. Ross 47 Vice President, Chief Financial Officer, Treasurer and Secretary\nMr. Ryan joined the Company in May 1988, as President and Chief Executive Officer. Mr. Bailliart joined Selas S.A. in 1974 and in January 1, 1993 was promoted to Vice President of the Company and Chairman-Director Generale of Selas S.A. In 1989 he was promoted to Chairman-Director Generale of Selas S.A. from Vice President, Treasurer. Mr. Boyle joined the Company in 1961 and has held various management positions in research and development, applications engineering and sales. He was appointed Vice President-Sales and Engineering in July 1988. Mr. Deuer joined the Company as President of Deuer Manufacturing when it was acquired in May, 1986 and was promoted to Vice President of the Company and President of Deuer Manufacturing in December, 1990. From 1965 to 1986 he was President of Deuer Manufacturing. Mr. Gorder joined the Company October 20, 1993 when Resistance Technology, Inc. (RTI) was acquired. Prior to the acquisition, Mr. Gorder was President and one of the founders of RTI, which began operations in 1977. Mr. Gorder was promoted to Vice President of the Company and elected to the Board of Directors in 1996. Mr. Ross joined the Company in October 1990 as Vice President - Treasurer, was elected to Chief Financial Officer January 1, 1994 and Secretary February 21, 1995. From 1981 to 1990 he was with ALPO Pet Foods, a division of Grand Metropolitan PLC, as a Controller from 1981 and as Vice President, Controller from 1988.\nPART II\nITEM 5.","section_5":"ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters\nThe Company's common shares are listed on the American Stock Exchange. The high and low sale prices during each quarterly period during the past two years were as follows:\n1995 1994 Market Market Price Range Price Range QUARTER HIGH LOW HIGH LOW\nFirst 10 8-5\/8 15-5\/8 13 Second 9-3\/4 7-7\/8 13-3\/4 10-1\/2 Third 8-3\/4 7-3\/8 12-3\/8 10-3\/4 Fourth 9-7\/8 7-3\/16 11-1\/2 9-1\/2\nAt March 1, 1996, the Company had 589 shareholders of record.\nThe payment of any future dividends is subject to the discretion of the Board of Directors and is dependent on a number of factors, including the Company's capital requirements, financial condition, financial covenants and cash availability.\n1995 1994 1993\nDividends per share: First Quarter $.055 $.05 $.05 Second Quarter .055 .05 .05 Third Quarter .06 .05 .05 Fourth Quarter .06 .055 .05\nITEM 6.","section_6":"ITEM 6. Selected Financial Data\nCertain selected financial data is incorporated by reference to \"Selas Corporation of America Five-Year Summary of Operations\", page 4, and \"Other Financial Highlights\" (excluding graphs), page 5, of the Company's 1995 annual report to shareholders.\nITEM 7.","section_7":"ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nManagement's Discussion and Analysis is incorporated by reference to pages 6 through 8 of the Company's 1995 annual report to shareholders.\nITEM 8.","section_7A":"","section_8":"ITEM 8. Financial Statements and Supplementary Data\nThe Company's consolidated balance sheets as of December 31, 1995 and 1994, and the related consolidated statements of operations, cash flows and shareholders' equity for each of the three years in the period ended December 31, 1995, and the report of independent auditors thereon and the quarterly results of operations (unaudited) for the two year period ended December 31, 1995 are incorporated by reference to pages 9 to 30 of the Company's 1995 annual report to shareholders.\nITEM 9.","section_9":"ITEM 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure\nNone\nPART III\nThe information called for by Items 10, 11, 12 and 13 (except the information concerning executive officers included in Item 4A) is incorporated by reference to the Company's definitive proxy statement relating to its 1996 Annual Meeting which the Company filed on March 15, 1996. However, the portions of such proxy statement constituting the report of the Compensation Committee of the Board of Directors and the graph showing performance of the Company's common shares and certain share indices shall not be deemed to be incorporated herein or filed for purposes of the Securities Exchange Act of 1934.\nPART IV\nITEM 14.","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"ITEM 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\n(a) The following documents are filed as a part of this report:\n1. Financial Statements - The Company's consolidated financial statements, as described below, are incorporated by reference to pages 9 through 30 of the Company's 1995 annual report to shareholders.\nConsolidated Balance Sheet at December 31, 1995 and 1994.\nConsolidated Statements of Operations for the years ended December 31, 1995, 1994 and 1993.\nConsolidated Statements of Cash Flows for the years ended December 31, 1995, 1994 and 1993.\nConsolidated Statements of Shareholders' Equity for the years ended December 31, 1995, 1994 and 1993.\nNotes to Consolidated Financial Statements.\nReport of Independent Auditors.\nFinancial statements for 50% or less owned companies which are accounted for by the equity method have been omitted because they do not, considered individually or in the aggregate, constitute significant subsidiaries.\n2. Financial Statement Schedules Page Report of Independent Auditors on the Consoli- dated Financial Statements and Consolidated Financial Statement Schedules 19\nSchedule I - Condensed Financial Information of Registrant (Parent only) 20,21,22,23\nSchedule II - Valuation and Qualifying Accounts 24, 25\nAll other schedules are omitted because they are not applicable, or because the required information is included in the consolidated financial statements or notes thereto.\n3. Exhibits\n2. Stock Purchase and Sale Agreement dated September 27, 1993 by and among the Company, RTI and the shareholders of RTI. Exhibit 2 to the Company's report on Form 8-K filed on November 3, 1993 is hereby incorporated by reference.\nITEM 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K - (Continued)\n3A. The Company's Articles of Incorporation as amended May 18, 1984 and April 25, 1991. Exhibit 3A to the Company's report on Form 10-K for the year ended December 31, 1984 and Exhibit 3A1 to the Company's report on Form 10-K for the year ended December 31, 1991 are hereby incorporated herein by reference.\n3B. The Company's By-Laws as amended through January 8, 1996.\n4A. Credit Agreement dated October 20, 1993 by and among First Fidelity Bank, N.A., Pennsylvania, the Company, RTI and Deuer. Exhibit 4A to the Company's report on Form 10-K for the year ended December 31, 1993 is hereby incorporated by reference.\n4B. Term Note, dated October 20, 1993, of the Company in favor of First Fidelity Bank, N.A., Pennsylvania. Exhibit 4(b) to the Company's report on Form 8-K filed on November 3, 1993 is hereby incorporated by reference.\n4C. Amended Credit Agreement dated July 21, 1995 which amends the Credit Agreement dated October 20, 1993 by and among First Fidelity Bank, N.A., Pennsylvania, the Company, RTI and Deuer.\n4D. Amended and Restated Revolving Credit Note, dated July 21, 1995, of the Company in favor of First Fidelity Bank, N.A. Pennsylvania.\n4E. Amended and Restated Revolving Credit Note, dated July 21, 1995, of RTI in favor of First Fidelity Bank, N.A., Pennsylvania.\n4F. Amended and Restated Revolving Credit Note, dated July 21, 1995, of Deuer in favor of First Fidelity Bank, N.A., Pennsylvania.\n10A. Form of termination agreement between the Company and Messrs. Ryan, Boyle, Deuer and Ross. Exhibit 10A to the Company's report on Form 10-K for the year ended December 31, 1994 is hereby incorporated by reference.\n10B. 1985 Stock Option Plan, as amended. Exhibit 10C to the Company's Registration Statement on Form S-2 filed on June 15, 1990 (No. 33-35443) is hereby incorporated herein by reference.\n10C. Form of Stock Option Agreements granted under the 1985 Stock Option Plan. Exhibit 10D to the Company's Registration Statement on Form S-2 filed on June 15, 1990 (No. 33-35443) is hereby incorporated herein by reference.\n10D. Form of Amendments to Stock Option Agreements granted under the 1985 Stock Option Plan. Exhibit 10E to the Company's Registration Statement on Form S-2 filed on June 15, 1990 (No. 33-35443) is hereby incorporated herein by reference.\nITEM 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K - (Continued)\n10E. 1994 Stock Option Plan. Exhibit 10E to the Company's report on Form 10-K for the year ended December 31, 1993 is hereby incorporated by reference.\n10F. Form of Stock Option Agreements granted under the 1994 Stock Option Plan.\n10G. Agreement between Selas S.A., a wholly-owned subsidiary, and Europarc Gennevilliers dated May 16, 1991 relating to the purchase of land and building to house its operations in France, accompanied by an English translation. Exhibit 10E to the Company's report on Form 10-K for the year ended December 31, 1991 is hereby incorporated by reference.\n10H. Amended and Restated Executive Incentive Plan. Exhibit 10G to the Company's report on Form 10-K for the year ended December 31, 1994 is hereby incorporated by reference.\n10I. Supplemental Retirement Plan (amended and restated effective January 1, 1995).\n10J. Management Employment Agreement dated October 20, 1993 between Resistance Technology, Inc. and Mark S. Gorder.\n13. \"Selas Corporation of America Five-Year Summary of Operations\" contained on page 4 of the Company's 1995 annual report to shareholders; \"Other Financial Highlights\" (excluding graphs) contained on page 5 of the company's 1995 annual report to shareholders; \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" contained on pages 6-8 of the Company's 1995 annual report to shareholders; and the Company's consolidated financial statements, including the \"Notes to Consolidated Financial Statements\" and the \"Report of Independent Auditors\" contained on pages 9-30 of the Company's 1995 annual report to shareholders.\n21. List of significant subsidiaries of the Company.\n23. Consent of Independent Auditors.\n24. Powers of Attorney.\n99. Portions of the Company's definitive proxy statement for its 1996 Annual Meeting of shareholders responsive to Items 10, 11, 12 and 13 in Part III hereof, which was filed prior to March 15, 1996, are hereby incorporated herein by reference. However, the portions of such proxy statement constituting the report of the Compensation Committee of the Board of Directors and the graph showing performance of the Company's common shares and certain share indices shall not be deemed to be incorporated herein or filed for purposes of the Securities Exchange Act of 1934.\n(b) Reports on Form 8-K - There were no reports on Form 8K filed for the three months ended December 31, 1995.\nREPORT OF INDEPENDENT AUDITORS ON FINANCIAL STATEMENT SCHEDULES\nThe Board of Directors and Shareholders Selas Corporation of America:\nWe have audited the consolidated financial statements of Selas Corporation of America 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 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 Selas Corporation of America and subsidiaries as of December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1995, 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.\nPhiladelphia, Pennsylvania February 12, 1996\nSCHEDULE I\nSELAS CORPORATION OF AMERICA AND SUBSIDIARY COMPANIES\nCondensed Financial Information of Registrant Balance Sheets December 31, 1995 and 1994\nASSETS 1995 1994\nCurrent assets:\nCash $ 1,378,267 $ 4,318,953\nAccounts receivable (including $6,428,864 and $3,768,318 due from subsidiaries in 1995 and 1994, respectively, eliminated in con- solidation), less allowance for doubt- ful accounts of $10,000 in both years 10,191,115 5,266,608\nInventories, at cost 3,170,396 3,213,006\nPrepaid expenses and other current assets 850,367 955,180\nTotal current assets 15,590,145 13,753,747\nInvestment in wholly-owned subsidiaries 39,853,600 38,685,502\nProperty and equipment, at cost 5,594,309 5,403,914\nLess: accumulated depreciation (4,315,616) (4,152,988)\n1,278,693 1,250,926 Other assets and investment in unconsolidated affiliate 1,527,661 1,894,514\nTotal Assets $58,250,099 $55,584,689 =========== ===========\nSCHEDULE I\nSELAS CORPORATION OF AMERICA AND SUBSIDIARY COMPANIES\nCondensed Financial Information of Registrant Balance Sheets December 31, 1995 and 1994 LIABILITIES AND SHAREHOLDERS' EQUITY 1995 1994\nCurrent liabilities:\nNotes payable and current maturities of long term debt $ 1,900,000 $ 2,150,000\nAccounts payable (including $8,582,000 and $4,976,689 due to subsidiaries in 1995 and 1994, respectively, eliminated in consolidation) 9,224,558 5,891,721\nAccrued expenses 2,667,584 2,631,136\nTotal current liabilities 13,792,142 10,672,857\nLong-term debt 5,851,117 7,750,000\nOther postretirement benefit obligations 3,513,715 3,451,327\nDeferred income taxes 116,767 120,792\nPension plan obligation 320,184 491,800\nContingencies and commitments\nShareholders' equity\nCommon stock 3,702,426 3,697,426\nRetained earnings and other equity 31,335,685 29,782,424\nLess: 242,376 common shares held in treasury, at cost (381,937) (381,937)\nTotal shareholders' equity 34,656,174 33,097,913 Total Liabilities and Shareholders' Equity $58,250,099 $55,584,689 =========== ===========\nSee accompanying notes to the consolidated financial statements.\nSCHEDULE I\nSELAS CORPORATION OF AMERICA AND SUBSIDIARY COMPANIES CONDENSED FINANCIAL INFORMATION OF REGISTRANT STATEMENTS OF OPERATIONS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n1995 1994 1993\nSales - net $13,729,233 $ 8,889,438 $10,168,291\nAdd back: license fees and corporate charges paid by subsidiaries, eliminated in consolidation 720,192 992,930 1,042,831\n14,449,425 9,882,368 11,211,122\nCosts and expenses:\nCost of goods sold 8,289,761 5,638,307 7,765,096\nSelling, general and adminis- trative expenses 3,467,857 3,644,655 2,777,091\nRent and depreciation 337,845 305,321 307,705\n12,095,463 9,588,283 10,849,892\nIncome before income taxes and equity in net income of subsidiaries 2,353,962 294,085 361,230\nProvision for income taxes 927,328 20,614 12,356\nIncome before equity in net income of subsidiaries 1,426,634 273,471 348,874\nEquity in net income of subsidiaries 873,390 2,830,568 998,597\nNet income $ 2,300,024 $ 3,104,039 $ 1,347,471 =========== =========== ==========\nSee accompanying notes to the consolidated financial statements.\nSCHEDULE I\nSELAS CORPORATION OF AMERICA AND SUBSIDIARY COMPANIES\nCONDENSED FINANCIAL STATEMENTS OF THE REGISTRANT STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n1995 1994 1993\nOPERATING ACTIVITIES Net income $ 2,300,024 $ 3,104,039 $1,347,471 Adjustments to reconcile net income to net cash provided (used) by operating activities: Depreciation and amortization 201,806 186,666 187,224 Other adjustments (814,239) (2,954,973) (1,143,984) Net changes in operating assets and liabilities (1,495,030) 2,282,576 527,616\nNet cash provided by operating activities 192,561 2,618,308 918,327\nINVESTING ACTIVITIES Dividend from unconsolidated affiliate -- 34,538 93,669 Acquisition of subsidiary company -- (16,601)(19,004,852) Return of investment in subsidiary company -- -- 1,500,000 Purchase of property, plant and equipment (217,158) (99,331) (62,821) Proceeds of sale from property, plant and equipment 325 75 4,000\nNet cash (used) by investing activities (216,833) (81,319)(17,470,004)\nFINANCING ACTIVITIES Proceeds from borrowings used to acquire subsidiary -- 1,600,000 9,950,000 Proceeds from exercise of stock options 28,281 124,437 141,406 Repayments of short term borrowings -- (1,600,000) (200,000) Payment of dividends (795,812) (708,085) (645,060) Repayment of long term debt (2,148,883) (1,650,000) --\nNet cash provided (used) by financing activities (2,916,414) (2,233,648) 9,246,346 Increase (decrease) in cash and cash equivalents (2,940,686) 303,341 (7,305,331) Cash and cash equivalents, beginning of year 4,318,953 4,015,612 11,320,943\nCash and cash equivalents, end of year $ 1,378,267 $ 4,318,953 $ 4,015,612 =========== =========== =========== See accompanying notes to the consolidated financial statements.\nSCHEDULE II\nSELAS CORPORATION OF AMERICA AND SUBSIDIARY COMPANIES\nVALUATION AND QUALIFYING ACCOUNTS Years Ended December 31, 1995, 1994 and 1993\nColumn A Column B Column C Additions\nBalance at Charged to Beginning Costs and Classification of Period Expenses Other\nYear ended December 31, 1995: Reserve deducted in the balance sheet from the asset to which it applies: Allowance for doubtful accounts $ 513,045 $ 284,475 $ 36,136 (a) ========== ========== ========== Deferred tax asset valuation allowance $2,203,780 $ 412,646 $ 68,879 (a) ========== ========== ========== Reserve not shown elsewhere: Reserve for estimated future costs of service and guarantees $1,156,296 $ 119,903 $ 58,134 (a) ========== ========== ========== Year ended December 31, 1994: Reserves deducted in the balance sheet from the asset to which they apply: Allowance for doubtful accounts $ 468,308 $ 25,879 $ 38,639 (a) ========== ========== ========== Deferred tax asset valuation allowance $2,102,682 $ (2,933) $ 104,031 (a) ========== ========== ==========\nReserve not shown elsewhere: Reserve for estimated future costs of service and guarantees $ 774,652 $ 529,680 $ 44,821 (a) ========== ========== ========== Year ended December 31, 1993: Reserve deducted in the balance sheet from the asset to which they apply: Allowance for doubtful accounts $ 446,405 $ 13,183 $ 47,763 (a,d) ========== ========== =========\nDeferred tax asset valuation allowance $1,881,028 $ 305,263 $ (83,609) (a) ========== ========== ==========\nReserve not shown elsewhere: Reserve for estimated future costs of service and guarantees $1,020,910 $ 198,990 $ (29,526) (a) ========== ========== ==========\n(Continued)\nSCHEDULE II\nSELAS CORPORATION OF AMERICA AND SUBSIDIARY COMPANIES VALUATION AND QUALIFYING ACCOUNTS Years Ended December 31, 1995, 1994 and 1993\nColumn A Column D Column E\nBalance at End of Classification Deductions Period\nYear ended December 31, 1995: Reserve deducted in the balance sheet from the asset to which it applies: Allowance for doubtful accounts $ 41,407 (b) $ 792,249 ========== ========== Deferred tax asset valuation allowance $ -- $2,685,305 ========== ==========\nReserve not shown elsewhere: Reserve for estimated future costs of service and guarantees $ 489,546 (c) $ 844,787 ========== ========== Year ended December 31, 1994: Reserves deducted in the balance sheet from the asset to which they apply: Allowance for doubtful accounts $ 19,781 (b) $ 513,045 ========== ========== Deferred tax asset valuation allowance -- $2,203,780 ========== ========== Reserve not shown elsewhere: Reserve for estimated future costs of service and guarantees $ 192,857 (c) $1,156,296 ========== ========== Year ended December 31, 1993: Reserve deducted in the balance sheet from the asset to which they apply: Allowance for doubtful accounts $ 39,043 (b) $ 468,308 ========== ========== Deferred tax asset valuation allowance -- $2,102,682 ========== ========== Reserve not shown elsewhere: Reserve for estimated future costs of service and guarantees $ 415,722 (c) $ 774,652 ========== ==========\n(a) Represents difference between translation rates of foreign currency at beginning and end of year and average rate during year. (b) Uncollectible accounts charged off. (c) \"After job\" costs charged to reserve. (d) Represents increase resulting from acquisition of RTI.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nSELAS CORPORATION OF AMERICA (Registrant)\nBy: \/s\/ Robert W. Ross Robert W. Ross Vice President and Chief Financial Officer Dated: March 19, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons (including a majority of members of the Board of Directors) on behalf of the registrant and in the capacities and on the dates indicated.\n*By: \/s\/ Stephen F. Ryan Stephen F. Ryan Stephen F. Ryan Attorney-In-Fact President, Chief Executive March 19, 1996 Officer and Director March 19, 1996\n* \/s\/ Robert W. Ross John H. Austin, Jr. Robert W. Ross Director Vice President, Principal March 19, 1996 Financial and Accounting Officer March 19, 1996\n* Frederick L. Bissinger Director March 19, 1996\n* Roy C. Carriker Director March 19, 1996\n* Francis J. Dunleavy Director March 19, 1996\n* Mark S. Gorder Director March 19, 1996 * Ralph R. Whitney, Jr. Director March 19, 1996\nEXHIBIT INDEX\nEXHIBITS:\n3B. The Company's By-Laws as amended through January 8, 1996.\n4C. Amended Credit Agreement dated July 21, 1996 which amends the Credit Agreement dated October 20, 1993 by and among First Fidelity Bank, N.A., Pennsylvania, the Company, RTI and Deuer.\n4D. Amended and Restated Revolving Credit Note, dated July 21, 1995, of the Company in favor of First Fidelity Bank, N.A., Pennsylvania.\n4E. Amended and Restated Revolving Credit Note, dated July 21, 1995, of RTI in favor of First Fidelity Bank, N.A., Pennsylvania.\n4F. Amended and Restated Revolving Credit Note, dated July 21, 1995, of Deuer in favor of First Fidelity Bank, N.A., Pennsylvania.\n10F. Form of Stock Option Agreements granted under the 1994 Stock Option Plan.\n10I. Supplemental Retirement Plan (amended and restated effective January 1, 1995).\n10J. Management Employment Agreement dated October 20, 1993 between Resistance Technology, Inc. and Mark S. Gorder.\n21. List of significant subsidiaries of the Company.\n23. Consent of Independent Auditors.\n24. Powers of Attorney.\nEXHIBIT 3B\nAmended through 1\/8\/96\nBY-LAWS of\nSELAS CORPORATION OF AMERICA (A Pennsylvania Corporation)\nMEETINGS OF SHAREHOLDERS\nSection 1.01. Place of Meeting. Meetings of shareholders of the Corporation shall be held at such place, within the Commonwealth of Pennsylvania or elsewhere, as may be fixed by the Board of Directors. If the Board shall not fix a place for such meetings, they shall be held at the Offices of the Corporation in Dresher, Pennsylvania.\nSection 1.02. Annual Meeting. The Annual Meeting of Shareholders for the election of Directors and the transaction of any further business that may be brought before the meeting, shall, unless the Board of Directors shall fix some other hour or day therefore, be held at 2 o'clock p.m. on the last Tuesday in April of each year, if not a legal holiday under the laws of the Commonwealth of Pennsylvania, and, if a legal holiday, then on the next succeeding secular day not a legal holiday under the laws of said Commonwealth. If for any reason such meeting should not be held at the time fixed therefor, such election may be held at a subsequent meeting called for that purpose.\nSection 1.03. Notice of Meetings. Notice of every Annual Meeting of Shareholders shall be given by the Secretary.\nNotice of all meetings of shareholders shall be given to each shareholder of record entitled to vote at the meeting, at least ten days prior to the day named for the meeting, unless a greater period of notice is by law required in a particular case.\nSection 1.04. Organization. At every meeting of the shareholders, the President, or in his absence, a Vice President shall act as Chairman; and the Secretary, or in his absence, a person appointed by the Chairman, shall act as Secretary.\nSection 1.05. Voting. Except as otherwise specified herein or in the Articles or provided by law, all matters shall be decided by the vote of the holders of a majority of the outstanding shares entitled to vote, present in person or represented by proxy, at a meeting at which a quorum shall be present, though such a majority be less than a majority of all the shares entitled to vote thereon.\nIn each election for Directors, the candidates receiving the highest number of votes, up to the number of Directors to be elected in such election, shall be elected.\nII. DIRECTORS\nSection 2.01. Number, Classification, Term of Office and Removal of Directors.\n(a) The number of Directors of the Corporation shall be seven.\n(b) The Directors shall be classified with respect to the time for which they shall severally hold office. The Board of Directors shall be divided into three classes of Directors, as nearly equal in number of Directors as possible, to be known as Classes \"A\", \"B\", and \"C\". Class A Directors shall each be elected and hold office initially for one (1) year, or until the next annual election; Class B Directors shall be elected and hold office initially for two (2) years or until the second annual election; and Class C Directors shall each be elected and hold office initially for three (3) years, or until the third annual election. Each Director shall hold office for the term for which he is elected and until his successor shall have been elected and qualified. At each annual election, the successors to the class of Directors whose term shall expire in that year shall be elected to hold office for the term of three (3) years, so that the term of office of one class of Directors shall expire each year. If the number of Directors is changed, any newly-created directorships or any decrease in directorships shall be so apportioned among the classes so as to make all classes as nearly equal in number as possible. Any Director or the entire Board of Directors may be removed with or without cause only upon the affirmative vote of two-thirds (2\/3) of all of the shares outstanding and entitled to vote; provided that the Board of Directors shall retain the right conferred by Section 405B of the Pennsylvania Business Corporation Law, as amended from time to time, to declare vacant the office of a Director for the reasons specified therein.\nSection 2.02. Resignations. Any Director may resign at any time by giving written notice to the Board of Directors or to the Secretary. Such resignation shall take effect at the date of the receipt of such notice or at any later time specified therein; and, unless otherwise specified therein, the acceptance of such resignation shall not be necessary to make it effective.\nSection 2.03. Annual Meeting. Immediately after each annual election of Directors, the Board of Directors shall meet for the purpose of organization, election of Officers, and the transaction of other business, at the place where such election of Directors was held. Notice of such meeting need not be given. In the absence of a quorum at said meeting, the same may be held at any other time or place which shall be specified in a notice given as hereinafter provided for special meetings of the Board of Directors.\nSection 2.04. Regular Meetings. Regular meetings of the Board of Directors shall be held at such time and place as shall be designated from time to time by standing resolution of the Board. If the date fixed for any such regular meeting be a legal holiday under the laws of the State where such meeting is to be held, then the same shall be held on the next succeeding secular day not a legal holiday under the laws of said State, or at such other time as may be determined by resolution of the Board. At such meetings, the Directors may transact such business as may be brought before the meeting.\nSection 2.05. Special Meetings. Special meetings of the Board of Directors may be called by the President, by a Corporate Vice President, by the Secretary, or by two or more of the Directors, and shall be held at such time and place as shall be designated in the call for the meeting.\nSection 2.06. Notice of Meetings. Written notice of each special meeting shall be given, by or at the direction of the person or persons authorized to call such meeting, to each Director at least two days prior to the day named for the meeting.\nNotice of regular meetings need not be given.\nSection 2.07. Organization. At every meeting of the Board of Directors, a Chairman chosen by a majority of the Directors present, shall preside, and the Secretary, or in his absence, any person appointed by the presiding officer, shall act as Secretary.\nSection 2.08. Compensation of Directors. Each Director shall receive such compensation as from time to time may be fixed by the Board. Directors may also be reimbursed by the Corporation for all reasonable expenses incurred in traveling to and from the place of each meeting of the Board or any committee thereof.\nSection 2.09. Indemnification and Liability of Directors and Officers.\nA. Personal Liability of Directors. A director of the Corporation shall not be personally liable for monetary damages for any action taken, or any failure to take any action, as a director to the extent that under the terms of the Director's Liability Act, 42 Pa. Cons. Stat. Para. 8361 et seq., as modified by any Pennsylvania statute thereafter enacted, a director's liability for monetary damages may not be limited.\nB. Indemnification. The Corporation shall indemnify any person who was or is a party (other than a party plaintiff suing in his own behalf or in the right of the Corporation) or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding, including actions by or in the right of the Corporation, whether civil, criminal, administrative or investigative, by reason of the fact that such person is or was a director or officer of the Corporation, or is or was serving while a director or officer of the Corporation at the request of the Corporation as a director, officer, employee, agent fiduciary or other representative of another corporation, partnership, joint venture, trust, employee benefit plan or other enterprise, against expenses (including attorney's fees), judgements, fines, excise taxes and amounts paid in settlement actually and reasonably incurred by such person in connection with such action, suit or proceeding unless the act or failure to act giving rise to the claim for indemnification is determined by a court to have constituted willful misconduct or recklessness.\nC. Advancement of Expenses. Expenses actually and reasonably incurred by an officer or director of the Corporation in defending a civil or criminal action, suit or proceeding described in paragraph B shall be paid by the Corporation in advance of the final disposition of such action, suit or proceeding (regardless of the financial condition of such director or officer) upon receipt of an undertaking by or on behalf of such person to repay such amount if it shall ultimately be determined that the person is not entitled to be indemnified by the Corporation.\nD. Other Rights. The indemnification and advancement of expenses provided by or pursuant to this Section shall not be deemed exclusive of any other rights to which those seeking indemnification or advancement of expenses may be entitled under the Corporation's Articles of Incorporation, any insurance or other agreement, vote of shareholders or directors or otherwise, both as to actions in their official capacity and as to actions in another capacity while holding an office, and shall continue as to a person who has ceased to be a director or officer and shall inure to the benefit of the heirs, executors and administrators of such person.\nE. Insurance. The Corporation shall have the power to purchase and maintain insurance on behalf of any person who is or was a director, officer, employee or agent of the Corporation, or is or was serving at the request of the Corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust, employee benefit plan or other enterprise, against any liability asserted against and incurred by him in any such capacity, or arising out of his status as such, whether or not the Corporation would have the power to indemnify him against such liability under the provisions of these By-laws.\nF. Security Fund; Indemnity Agreements. By action by the Board of Directors (notwithstanding their interest in the transaction) the Corporation may create and fund a trust fund or fund of any nature, and may enter into agreements with its directors, officers, employees and agents for the purpose of securing or insuring in any manner its obligation to indemnify or advance expenses provided for in this Section.\nG. Modification. The duties of the Corporation to indemnify and to advance expenses to a director or officer provided in this Section shall be in the nature of a contract between the Corporation and each such director or officer, and no amendment or repeal of any provision of this Section, and no amendment or termination of any trust or other fund created pursuant to Paragraph F, shall alter, to the detriment of such director or officer, the right of such person to the advance of expenses or indemnification related to a claim based on an act or failure to act which took place prior to such amendment, repeal or termination.\nSection 2.10. Participation in Meetings. One or more directors may participate in a meeting of the Board or a committee of the Board by means of conference telephone or similar communications equipment by which all persons participating at the meeting can hear each other.\nIII. COMMITTEES\nSection 3.01. Executive Committee. The Board of Directors shall have authority to appoint an Executive Committee comprised of members of the Board of Directors. If such Executive Committee be appointed, it shall have such duties and responsibilities as shall be conferred upon it from time to time by the Board of Directors, including the right to act as to matters arising between meetings of the Board, except as to matters which, by law, require action by the Board. If so appointed, the Executive Committee shall report on its actions to the Board from time to time as appropriate or as may be requested by the Board.\nSection 3.02. Other Committees. The Board of Directors may at any time and from time to time, appoint such standing committees and\/or such special committees, consisting of Directors or others, to perform such duties and make such investigations and reports as the Board shall by resolution determine. Such committees shall determine their own organization and times and places of meeting, unless otherwise directed by such resolution.\nIV. OFFICERS\nSection 4.01. Number. The Officers of the Corporation shall be a President, a Secretary, a Treasurer and may include one or more Corporate Vice Presidents, and a Controller, and such other Officers and Assistant Officers as the Board of Directors may from time to time designate.\nSection 4.02. Qualifications. Any two or more offices may be held by the same person, except that the offices of President and Secretary or Assistant Secretary shall not be held by the same person. The Officers shall be natural persons of full age.\nSection 4.03. Election and Term of Office. The Officers of the Corporation shall be chosen by the Board of Directors at its Annual Meeting, but the Board may choose Officers or fill any vacancies among the Officers at any other meeting. Subject to earlier termination of office, each Officer shall hold office for one year and until his successor shall have been duly chosen and qualified.\nSection 4.04. Resignations. Any Officer may resign at any time by giving written notice to the Board of Directors, or to the President, or to the Secretary of the Corporation. Any such resignation shall take effect at the date of the receipt of such notice or at any later time specified therein; and unless otherwise specified therein, the acceptance of such resignation shall not be necessary to make it effective.\nSection 4.05. Duties.\n(a) The President. The President shall be the Chief Executive Officer of the Corporation and shall have general supervision over the business affairs of the Corporation, shall sign, or countersign, all share certificates, contracts or other instruments of the Corporation as authorized by the Board of Directors, except in cases where the signing and execution thereof shall be expressly designated by the Board to some other officer or agent of the Corporation; shall make reports to the Board of Directors and shareholders and shall perform such other duties as are incident to his office or are properly required of him by the Board of Directors.\n(b) The Vice Presidents. In the absence or disability of the President, any Corporate Vice President designated by the Board of Directors may perform all the duties of the President, and, when so acting, shall have all the powers and be subject to all the restrictions upon the President; provided, however, that no Corporate Vice President shall act as a member of, or as Chairman of, any special committee of which the President is a member, except when designated by the Board of Directors. The Corporate Vice Presidents shall perform such other duties as from time to time may be assigned to them by the Board of Directors or the President.\n(c) The Secretary. The Secretary shall record all the votes of the shareholders and of the Directors and the minutes of the meetings of the shareholders and of the Board of Directors in a book or books to be kept for that purpose; he shall see that notices of meetings of the Board and shareholders are given and that all records and reports are properly kept and filed by the Corporation as required by law; he shall be the custodian of the Seal of the Corporation, and shall see that it is affixed to all documents to be executed on behalf of the Corporation under its Seal; and, in general, he shall perform all duties incident to the office of the Secretary, and such other duties as may from time to time be assigned to him by the Board of Directors or the President.\n(d) Assistant Secretaries. In the absence or disability of the Secretary, or when so directed by the Secretary, any Assistant Secretary may perform all the duties of the Secretary, and, when so acting, shall have all the powers of and be subject to all the restrictions placed upon the Secretary. The Assistant Secretaries shall perform such other duties from time to time as may be assigned to them respectively by the Board of Directors, the President or the Secretary.\n(e) The Treasurer. The Treasurer shall have charge of all receipts and disbursement of the Corporation, and shall have or provide for the custody of its funds and securities; he shall have full authority to receive and give receipts for all money due and payable to the Corporation, and to endorse checks, drafts, warrants in its name and on its behalf and to give full discharge for the same; he shall deposit all funds of the Corporation, except such as may be required for current use, in such banks or other places of deposit as the Board of Directors may from time to time designate; and, in general, he shall perform all duties incident to the office of Treasurer and such other duties as may from time to time be assigned to him by the Board of Directors or the President.\n(f) Assistant Treasurers. In the absence or disability of the Treasurer, or when so directed by the Treasurer, any Assistant Treasurer may perform all the duties of the Treasurer, and, when so acting, shall have all the powers of and be subject to all the restrictions upon the Treasurer. The Assistant Treasurers shall perform such other duties as from time to time may be assigned to them respectively by the Board of Directors, the President or the Treasurer.\nSection 4.06. Compensation of Officers and Others. The compensation of all Officers shall be fixed from time to time by the Board of Directors, or by any committee or Officer authorized by the Board so to do. No Officer shall be precluded from receiving such compensation by reason of the fact that he is also a Director of the Corporation.\nAdditional compensation, fixed as above, may be paid to any Officers or employees for any year or years, based upon the success of the operations of the Corporation during such year.\nV. BORROWING, DEPOSITS, PROXIES, ETC.\nSection 5.01. Borrowing, etc. No Officer, agent or employee of the Corporation shall have any power or authority to borrow money on its behalf, to pledge its credit or to mortgage or pledge its real or personal property, except within the scope and to the extent of the authority delegated by resolution of the Board of Directors. Authority may be given by the Board for any of the above purposes and may be general or limited to specific instances.\nSection 5.02. Deposits. All funds of the Corporation shall be deposited from time to time to the credit of the Corporation in such banks, trust companies or other depositories as the Board of Directors may approve or designate, and all such funds shall be withdrawn only upon checks signed by such one or more Officers or employees as the Board shall from time to time determine.\nSection 5.03. Proxies. Unless otherwise ordered by the Board of Directors, any Officer of the Corporation may appoint an attorney or attorneys (who may be or include such Officer himself), 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 other securities are held by or for the Corporation, at meetings of the holders of the shares or other securities of such other corporation, or, in connection with the ownership of such shares or other securities, to consent in\nwriting to any action by 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 in the name of and on behalf of the Corporation and under its Seal such written proxies or other instruments as he may deem necessary or proper in the premises.\nSection 5.04. Non-Applicability of Certain Provisions of Law. The provisions of Subchapters E, G and H of Chapter 25 of the Pennsylvania Business Corporation Law of 1988, as amended, and any corresponding provisions of succeeding law shall not be applicable to the Corporation.\nVI. SHARE CERTIFICATES; TRANSFER\nSection 6.01. Share Certificates. To the extent permitted by law, share certificates shall be signed by the President, or a Corporate Vice President and by the Secretary or the Treasurer, or by an Assistant Secretary or Assistant Treasurer of the Corporation, but, to the extent permitted by law, such signatures may be facsimiles, engraved or printed.\nSection 6.02. Transfer of Shares. Transfer of share certificates and the shares represented thereby shall be made only on the books of the Corporation by the owner thereof or by his attorney thereunto authorized, by a power of attorney duly executed and filed with the Secretary or a Transfer Agent of the Corporation, and on surrender of the share certificates.\nSection 6.03. Transfer Agent and Registrar; Regulation. The Corporation may, if and whenever the Board of Directors so determines, maintain, in the Commonwealth of Pennsylvania, or any other State of the United States, one or more transfer offices or agencies, each in charge of a Transfer Agent designated by the Board, where the shares of the Corporation shall be transferable, and also one or more registry offices, each in charge of a Registrar designated by the Board, where such shares shall be registered; and no certificates for shares of the Corporation in respect of which a Transfer Agent and Registrar shall have been designated shall be valid unless countersigned by such Transfer Agent and registered by such Registrar. The Board may also make such additional rules and regulations as it may deem expedient concerning the issue, transfer, regulation and registration of share certificates.\nSection 6.04. Lost, Destroyed and Mutilated Certificates. The Board of Directors, by standing resolution or by resolutions with respect to particular cases, may authorize the issue of new share certificates in lieu of sharecertificates lost, destroyed, or mutilated, upon such terms and conditions as the Board may direct.\nVII. FINANCIAL REPORTS\nSection 7.01. The Directors of the Corporation shall not be required to cause to be sent to the shareholders an annual financial report under Section 318 of the Business Corporation Law of the Commonwealth of Pennsylvania; nor need any financial report which the Directors in their discretion may cause to be sent to the shareholders be required to be verified by a Certified Public Accountant. Any accountant or firm of accountants employed by the Corporation for any purpose may be or include a Director or full-time employee of the Corporation, and shall not be required to be elected by the shareholders of the Corporation.\nVIII. AMENDMENTS\nSection 8.01. Any or all of the provisions of these By-Laws whether contractual in nature or merely regulatory of the internal affairs of the Corporation, may be amended, altered, or repealed by the Board of Directors or by the shareholders entitled to vote thereon, at any regular or special meeting duly convened after notice to the Directors or shareholders, as the case may be, giving a summary of the proposed amendment, alteration, or repeal; provided, that any such proposal relating to Section 2.01(b) of these By-Laws must receive the affirmative vote of at least two thirds (2\/3) of all shares outstanding and entitled to vote and any proposal to change the two- thirds (2\/3) approval required by this Section must also receive the affirmative vote of at least two-thirds (2\/3) of all shares outstanding and entitled to vote.\nNo provision of these By-Laws shall vest any property right in any shareholder.\nEXHIBIT 4C\nAMENDMENT TO CREDIT AGREEMENT\nThis AMENDMENT TO CREDIT AGREEMENT (together with all amendments and modifications hereto, the \"Agreement\"), dated as of July ___, 1995, is by and among FIRST FIDELITY BANK, N.A., successor in interest by consolidation to FIRST FIDELITY BANK, N.A., PENNSYLVANIA, a national banking association with offices located at Broad and Walnut Streets, Philadelphia, PA 19109-1199 (the \"Bank\"), SELAS CORPORATION OF AMERICA, a Pennsylvania business corporation with offices located at 2034 Limekiln Pike, Dresher, PA 19025 (\"Selas\"), DEUER MANUFACTURING, INC., an Ohio business corporation with offices located at 2985 Springboro West, Dayton, OH 45439 (\"Deuer\"), and RESISTANCE TECHNOLOGY, INC., a Minnesota business corporation with offices located at 1260 Red Fox Road, Arden Hills, MN 55112 (\"RTI\", and together with Selas and Deuer, the \"Borrowers\").\nBACKGROUND\nA. The Bank and the Borrowers entered into that certain Credit Agreement, dated as of October 20, 1993 (together with all amendments and modifications thereto, the \"Loan Agreement\"), pursuant to which the Bank agreed to make available: (1) to Selas, among other things, a revolving credit facility in a maximum principal amount of $2,000,000; (2) to Deuer, a revolving credit facility in a maximum principal amount of $500,000; and (3) to RTI, a revolving credit facility in a maximum principal amount of $1,000,000 (the \"Loans\").\nB. In connection with the Loan Agreement and in order to evidence the Loans: (1) Selas executed and delivered to the Bank that certain Revolving Credit Note, dated as of October 20, 1993 (together with all amendments and modifications thereto, the \"Selas Note\"), by Selas in favor of the Bank in the principal amount of $2,000,000; (2) Deuer executed and delivered to the Bank that certain Revolving Credit Note, dated as of October 20, 1993 (together with all amendments and modifications thereto, the \"Deuer Note\"), by Deuer in favor of the Bank in the principal amount of $500,000; and (3) RTI executed and delivered to the Bank that certain Revolving Credit Note, dated as of October 20, 1993 (together with all amendments and modifications thereto, the \"RTI Note\", and together with the Selas Note and the Deuer Note, the \"Notes\"), by RTI in favor of the Bank in the principal amount of $1,000,000.\nC. The Loan Agreement, the Notes, and all of the documents, instruments and agreements executed and delivered in connection therewith, together with all amendments and modifications thereto, shall be referred to hereinafter as the \"Loan Documents\".\nD. The Bank and the Borrowers, pursuant to the terms hereof, wish to amend certain of the terms of the Loan Documents.\nNOW THEREFORE, incorporating the foregoing Background herein by reference and for other good and valuable consideration, the receipt and legal sufficiency of which is hereby acknowledged, and intending to be legally bound hereby, the parties agree as follows:\n1. DEFINED TERMS. Terms used herein which are capitalized but not defined herein shall have the meanings ascribed to such terms in the Loan Agreement. 2. AMENDMENTS.\n(a) Section 1.1 of the Loan Agreement is hereby amended by deleting the definition of the term \"Bank\" which appears therein and substituting therefore the following:\n\"Bank\" means First Fidelity Bank, N.A., a national banking association, and its successors and assigns.\n(b) Section 1.1 of the Loan Agreement is hereby amended by deleting the definition of the term \"Business Day\" which appears therein and substituting therefore the following:\n\"Business Day\" means a day of the year on which banks are not required or authorized to close in Philadelphia, PA and, if the applicable Business Day relates to any Eurodollar Loan, on which dealings are carried on in the London interbank market.\n(c) Section 1.1 of the Loan Agreement is hereby amended by deleting the definition of the term \"Deuer Revolving Credit Termination Date\" which appears therein and substituting therefore the following:\n\"Deuer Revolving Credit Termination Date\" means the earlier of (i) June 1, 1997 (as such date may be extended from time to time in accordance with Section 2.1(c)(ii) hereof) or (ii) the date on which the Deuer Revolving Credit Commitment is terminated pursuant to Section 2.7 or 9.2 hereof.\n(d) Section 1.1 of the Loan Agreement is hereby amended by deleting the definition of the term \"RTI Revolving Credit Termination Date\" which appears therein and substituting therefore the following:\n\"RTI Revolving Credit Termination Date\" means the earlier of (i) June 1, 1997 (as such date may be extended from time to time in accordance with Section 2.1(d)(ii)hereof) or (ii) the date on which the RTI Revolving Credit Commitment is terminated pursuant to Section 2.7 or 9.2 hereof.\n(e) Section 1.1 of the Loan Agreement is hereby amended by deleting the definition of the term \"Selas Revolving Credit Termination Date\" which appears therein and substituting therefore the following:\n\"Selas Revolving Credit Termination Date\" means the earlier of (i) June 1, 1997 (as such date may be extended from time to time in accordance with Section 2.1(b)(ii) hereof) or (ii) the date on which the Selas Revolving Credit Commitment is terminated pursuant to Section 2.7 or 9.2 hereof.\n(f) Section 1.1 of the Loan Agreement is hereby amended by adding the following defined terms which shall appear in alphabetical order:\n\"Applicable Margin\" means, with respect to each Eurodollar Loan, one and one-half percent (1.5%).\n\"Base Rate Loan\" means an Advance which bears interest as provided in Section 2.5(b)(i)(A).\n\"Conversion\", \"Convert\", and \"Converted\" each refer to a conversion of Advances of one Type into Advances of the other Type pursuant to Section 2.5(b)(ii).\n\"Eurocurrency Reserve Requirements\" means, for any day, the aggregate (without duplication) of the applicable rates (expressed as a decimal) of reserve requirements for the Bank (including, without limitation, basic, supplemental, marginal and emergency reserves), in effect on such day under Regulation D of the Board of Governors of the Federal Reserve System (or any successor) with respect to eurocurrency funding currently referred to as \"Eurocurrency liabilities\" in Regulation D.\n\"Eurodollar Base Rate\" means, with respect to each day during each Interest Period pertaining to a Eurodollar Loan, the rate per annum for deposits in United States dollars for a period equal to the relevant Interest Period which appears on the Telerate Page 3750 as of 11:00 a.m., London time, on the day that is two (2) Business Days prior to the commencement of such Interest Period. If such rate does not appear on the Telerate Page 3750, the rate to be utilized shall be the offered rate which appears, or if two or more such rates appear, the average (rounded up to the next higher 1\/16 of 1%) of the offered rates which appear on the Reuters Screen LIBO Page as of 11:00 a.m., London time, on the day that is two (2) Business Days prior to the commencement of such Interest Period.\n\"Eurodollar Loan\" means an Advance which bears interest as provided in Section 2.5(b)(i)(B).\n\"Eurodollar Rate\" means, with respect to each day during each Interest Period pertaining to a Eurodollar Loan, the rate determined in accordance with the following formula:\nEurodollar Base Rate 1.00 - Eurocurrency Reserve Requirements\n\"Interest Period\" means, with respect to any Eurodollar Loan:\n.0.0.0.1 initially, the period commencing on, as the case may be, the date of borrowing or Conversion with respect to such Eurodollar Loan and ending one, two, three, or six months thereafter as selected by the Borrower in its notice of borrowing as provided in Section 2.6 or its notice of conversion as provided in Section 2.5(b)(ii); and\n.0.0.0.2 thereafter, each period commencing on the last day of the next preceding Interest Period applicable to such Eurodollar Loan and ending one, two, three, or six months thereafter as selected by the Borrower by irrevocable notice to the Bank not less than three (3) Business Days prior to the last day of the then current Interest Period with respect to such Eurodollar Loan;\nprovided that the foregoing provisions relating to Interest Periods are subject to the following:\n.0.0.0.2.1 if any Interest Period pertaining to a Eurodollar Loan would otherwise end on a day which is not a Business Day, that Interest Period shall be extended to the next succeeding Business Day unless the result of such extension would be to carry such Interest Period into another calendar month in which event such Interest Period shall end on the immediately preceding Business Day;\n.0.0.0.2.2 any Interest Period pertaining to a Eurodollar Loan that begins on the last 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 end on the last Business Day of a calendar month; and\nthe Borrower may not select any Interest Period which ends after the Selas Revolving Credit Termination Date, the Deuer Revolving Credit Termination Date, or the RTI Revolving Credit Termination Date, as applicable.\n\"Reuters Screen LIBO Page\" means the display designated as page \"LIBO\" on the Reuter Monitor Money Rates Service (or such other page as may replace the LIBO page on that service for the purpose of displaying London interbank offered rates of major banks).\n\"Telerate Page 3750\" means the display designed as \"Page 3750\" on the Dow Jones Telerate Service (or such other page as may replace that page on that service for the purpose of displaying London interbank offered rates of major banks).\n\"Type\" means, when used in reference to an Advance, either a Base Rate Loan or a Eurodollar Rate Loan.\n(g) Section 2.3(d) of the Loan Agreement is hereby deleted in its entirety and replaced by the following:\n(d) RTI Revolving Credit Facility. Funds advanced under the RTI Revolving Credit Facility shall be used for working capital and general corporate purposes of RTI.\n(h) Section 2.5(b) of the Loan Agreement is hereby deleted in its entirety and replaced by the following:\n(b) Revolving Credit Facilities.\n(i)(A) Prior to an Event of Default, interest on each Base Rate Loan, if any, shall accrue at the Base Rate and shall be payable by the applicable Borrower monthly on the first day of each month, commencing the first day of the first month after such Advance and continuing until such Revolving Credit Commitment is terminated and the applicable Borrower's indebtedness thereunder is paid in full. (B) Prior to an Event of Default, interest on each Eurodollar Loan, if any, shall accrue at the Eurodollar Rate plus the Applicable Margin and shall be payable on the last day of the applicable Interest Period; provided that if such Interest Period has a duration of more than three months, interest shall be paid on the day which is three months after the first day of such Interest Period, and upon the termination of such Revolving Credit Commitment and the payment in full of the applicable Borrower's obligations thereunder. Interest will be calculated on the basis of a three hundred sixty (360) day year and the actual number of days elapsed.\n(ii) A Borrower may on any Business Day, upon notice given to the Bank not later than 12:00 noon on (A) the third Business Day prior to the date of the proposed Conversion into a Eurodollar Loan and (B) the first Business Day prior to the date of the proposed Conversion into a Base Rate Loan, and, in each case, subject to the provisions of Section 5.3, Convert all or any portion of an Advance from one Type to the other Type; provided, however, that any Conversion of Eurodollar Loans into Base Rate Loans shall be made only on the last day of an Interest Period for such Eurodollar Loan and any Conversion of a Base Rate Loan into a Eurodollar Loan shall be in an amount not less than the minimum amount specified in Section 2.6(a)(i). Each such notice of Conversion shall, within the restrictions specified above, specify (A) the date of such Conversion, (B) the particular Advances to be Converted, and (C) if such Conversion is into a Eurodollar Loan, the duration of the initial Interest Period for such Eurodollar Loan. Each notice of Conversion shall be irrevocable and binding upon the applicable Borrower.\n(iii) If a Borrower shall fail to select the duratin\nof any Interest period for any Eurodollar Loan in accordance with the provisions contained in the definition of \"Interest Period\" in Section 1.1 and Section 2.5(b)(ii), the Bank will forthwith so notify the applicable Borrower, whereupon each such Eurodollar Loan will automatically, on the last day of the then existing Interest Period therefor, Convert into a Base Rate Loan.\n(i) The initial paragraph of Section 2.6(a) of the Loan Agreement, which precedes Section 2.6(a)(i), (ii), and (iii), is hereby deleted in its entirety and replaced by the following:\n(a) A Borrower shall give the Bank written notice (which notice may be transmitted by telecopier, provided that the Bank receives an original executed Advance Request Form within 24 hours thereafter) not later than eleven o'clock (11:00) a.m. on the date of each requested Advance under its respective Revolving Credit Facility in the case of Base Rate Loans, and on the date which is three (3) Business Days prior to the date of each requested Advance under its respective Revolving Credit Facility in the case of Eurodollar Loans, in either case specifying the date, amount, Interest Period (if applicable), and purpose thereof. Such notice shall be in the form of the Advance Request Form attached hereto as\nExhibit A, shall be certified by the chief executive or chief financial or accounting officer (or the equivalent thereof) of the applicable Borrower and shall contain the following information and representations, which shall be deemed affirmed and true and correct as of the date of the requested Advance:\n(j) Section 2.8(b) of the Loan Agreement is hereby deleted in its entirety and replaced by the following:\n(b) Revolving Credit Commitment. Upon one (1) Business Day's prior written notice by a Borrower to the Bank, such Borrower may repay in whole or in part the aggregate amount outstanding under its Revolving Credit Facility at any time provided that: (i) such repayments prior to the applicable Revolving Credit Termination Date shall not reduce the applicable Revolving Credit Commitment and may be reborrowed and partial repayments after the Termination Date will be applied first to accrued interest and fees and then to outstanding Advances, (ii) any repayment shall be in an amount equal to or in excess of $50,000 and multiples of $50,000 in excess thereof, and (iii) if any prepayment of a Eurodollar Loan shall be made on a date which is not the last day of the Interest Period applicable to such Eurodollar Loan, the applicable Borrower shall also pay to the Bank any amount due to the Bank pursuant to Section 2.13 hereof.\n(k) Section 2.8(b) of the Loan Agreement is hereby amended by adding the following to the end of such Section:\nNotwithstanding the foregoing, the Borrowers shall not be permitted to prepay any Eurodollar Loan prior to the last day of the Interest Period applicable thereto.\n(l) Section 2 of the Loan Agreement is hereby amended by adding the following new Section 2.13:\n2.13 CHANGE IN CIRCUMSTANCES; COMPENSATION.\n(a) Basis for Determining Interest Rate Inadequate or Unfair. If on or prior to the first day of any Interest Period, with respect to any Eurodollar Loan:\n(i) the Bank determines that deposits in United States dollars (in the applicable amounts) are not being offered in the relevant market for such Interest Period, or\n(ii) the Bank determines that the Eurodollar Rate will not adequately and fairly reflect the cost to the Bank of funding such Eurodollar Loan for such Interest Period, then the Bank shall forthwith give notice thereof to the Borrowers, whereupon until the Bank notifies the Borrowers that the circumstances giving rise to such suspension no longer exist, the obligation of the Bank to make Eurodollar Loans shall be suspended. Unless a Borrower notifies the Bank at least two (2) Business Days before the date of any Advance of such Eurodollar Loans for which an Advance Request has previously been given that it elects not to borrow on such date, such Advance shall instead be made as a Base Rate Loan.\n(b) Illegality. If, after the date hereof, the adoption of any applicable law, rule or regulation, or any change therein, of any change in the interpretation or administration thereof by any governmental authority, central bank or comparable agency charged with the interpretation or administration thereof (any such agency being referred as an \"Authority\" and any such event being referred to as a \"Change of Law\"), or compliance by the Bank with any request or directive (whether or not having the force of law) of any Authority shall make it unlawful or impossible for the Bank to make, maintain, or fund Eurodollar Loans, the Bank shall forthwith give notice thereof to the Borrowers, whereupon until the Bank notifies the Borrowers that the circumstances giving rise to such suspension no longer exist, the obligation of the Bank to make Eurodollar Loans shall be suspended. If the Bank shall determine that it may not lawfully continue to maintain and fund any of its outstanding Eurodollar Loans to maturity and shall so specify in such notice, the Borrowers shall immediately prepay in full the then outstanding principal amount of each Eurodollar Loan, together with accrued interest thereon. Concurrently with prepaying each such Eurodollar Loan, the Borrowers shall borrow a Base Rate Loan in an equal principal amount from the Bank, and the Bank shall make such Base Rate Loan.\n(c) Increased Cost and Reduced Return.\n(i) If after the date hereof, a Change of Law or compliance by the Bank with any request or directive (whether or not having the force of law) of any Authority:\n(A) shall 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, but excluding any such requirement included in any applicable Eurocurrency Reserve Requirement) against assets of, deposits with, or for the account of, or credit extended by the Bank;\n(B) shall impose on the Bank or the London interbank market any other condition affecting the Eurodollar Loans, the Notes, or the Bank's obligation to make Eurodollar Loans;\nand the result of any of the foregoing is to increase the cost to the Bank of making or maintaining any Loan or to reduce the amount of any sum received or receivable by the Bank under this Agreement or under the Notes with respect thereto, by an amount deemed by the Bank to be material, then, within fifteen (15) days after demand by the Bank, the Borrowers shall pay to the Bank such additional amount or amounts as will compensate the Bank for such increased cost or reduction.\n(ii) If the Bank shall have determined that after the date hereof the adoption of any applicable law, rule, or regulation regarding capital adequacy, or any change therein or any change in the interpretation or administration thereof, or compliance by the Bank with any request or directive regarding capital adequacy (whether or not having the force of law) of any Authority, has or would have the affect of reducing the rate of return on the Bank's capital as a consequence of its obligations hereunder to a level below that which the Bank could have achieved but for such adoption, change or compliance (taking into consideration the Bank's policies with respect to capital adequacy) by an amount deemed by the Bank to be material, then from time to time, within fifteen (15) days after demand by the Bank, the Borrowers shall pay to the Bank such additional amount or amounts as will compensate the Bank for such reduction.\n(iii) The Bank will promptly notify the Borrowers of any event of which it has knowledge, occurring after the date hereof which will entitle the Bank to compensation pursuant to this Section and will designate a different lending office if such designation will avoid the need for, or reduce the amount of, such compensation, and will not, in the judgment of the Bank, be otherwise disadvantageous to the Bank. A certificate of the Bank claiming compensation under this Section setting forth the additional amount or amounts to be paid to it hereunder and containing in reasonable detail the calculations relevant thereto shall be conclusive in the absence of manifest error. In determining such amount, the Bank may use any reasonable averaging and attribution methods.\n(iv) The provisions of this Section shall be applicable with respect to the any participant, assignee, or other transferee, and any calculations required by such provisions shall be based upon the circumstances of such participant, assignee, or other transferee.\n(d) Base Rate Loans Substituted for Affected Eurodollar Loans. If: (i) the obligations of the Bank to make or maintain any Eurodollar Loan has been suspended pursuant to Section 2.13(b), or (ii) the Bank has demanded compensation under Section 2.13(c), and the Borrowers shall, by at least five (5) Business Days' prior notice to the Bank, have elected that the provisions of this Section shall apply to the Bank, then, unless and until the Bank notifies the Borrowers that the circumstances giving rise to such suspension or demand for compensation no longer apply:\n(A) all Loans which would otherwise be made by the Bank as Eurodollar Loans shall be made instead as Base Rate Loans, and\n(B) after each of its Eurodollar Loans has been repaid, all payments of principal which would otherwise be applied to repay such Eurodollar Loans shall be applied to repay its Base Rate Loans instead.\n(e) Compensation. Upon the request of the Bank, delivered to the Borrowers, the Borrowers shall pay to the Bank such amount or amounts as shall compensate the Bank for any loss, cost or expense incurred by the Bank as a result of: (i) any payment or prepayment of a Eurodollar Loan on a date other than the last day of an Interest Period for such Loan (whether as a result of prepayment, acceleration or otherwise); or\n(ii) any failure by a Borrower to borrow or Convert a Eurodollar Loan on the date specified in the applicable notice delivered pursuant to this Agreement; or\n(iii) a Borrower fails to make any prepayment after such Borrower has given notice thereof in accordance with the provisions of this Agreement\nsuch compensation to include, without limitation, an amount equal to the excess, if any, of (x) the amount of interest which would have accrued on the amount so paid or prepaid or not prepaid or borrowed for the period from the date of such payment, prepayment or failure to prepay or borrow to the last day of the then current Interest Period for such Eurodollar Loan (or, in the case of a failure to prepay or borrow, the Interest Period for such Eurodollar Loan which would have commenced on the date of such failure to prepay or borrow) at the applicable rate of interest for such Eurodollar Loan provided for herein over (y) the amount of interest (as reasonably determined by the Bank) the Bank would have paid on deposits in United States dollars of comparable amounts having terms comparable to such period placed with it by leading banks in the London interbank market.\n(m) Section 6.15 of the Loan Agreement is hereby deleted in its entirety and replaced by the following:\n6.15 Minimum Net Working Capital. Maintain, as of the last day of each fiscal quarter, Net Working Capital of not less than the following amounts for the following entities:\n(a) As to Selas, $1,800,000;\n(b) As to Deuer, $2,000,000; and\n(c) As to RTI, $3,500,000.\n(n) Section 6.20 of the Loan Agreement is hereby deleted in its entirety and replaced by the following:\n6.20 Net Worth. Maintain, as of the last day of each fiscal quarter, an aggregate Net Worth in amounts not less than those set forth for the following entities:\n(a) As to Selas, $18,000,000;\n(b) As to Deuer, $6,500,000; and\n(c) As to RTI, $23,000,000.\n3. CONDITIONS PRECEDENT. The effectiveness of this Agreement and the Bank's obligations hereunder are conditioned upon the satisfaction of the following conditions precedent:\n(a) The Borrowers shall have delivered to the Bank this Agreement duly executed by each of the Borrowers.\n(b) Selas shall have delivered to the Bank that certain Amended and Restated Revolving Credit Note, dated as of the date hereof, duly executed by Selas;\n(c) Deuer shall have delivered to the Bank that certain Amended and Restated Revolving Credit Note, dated as of the date hereof, duly executed by Deuer;\n(d) RTI shall have delivered to the Bank that certain Amended and Restated Revolving Credit Note, dated as of the date hereof, duly executed by RTI;\n(e) Selas shall have delivered that certain Reaffirmation of Guaranty and Suretyship Agreement, dated as of the date hereof, duly executed by Selas;\n(f) Selas shall have delivered that certain Reaffirmation of Security Agreement, dated as of the date hereof, duly executed by Selas;\n(g) Deuer shall have delivered that certain Reaffirmation of Security Agreement, dated as of the date hereof, duly executed by Deuer;\n(h) RTI shall have delivered that certain Reaffirmation of Security Agreement, dated as of the date hereof, duly executed by RTI;\n(i) Selas shall have delivered that certain Reaffirmation of Pledge Agreement, dated as of the date hereof, duly executed by Selas;\n(j) RTI shall have delivered that certain Reaffirmation of Patent and Trademark Security Agreement, dated as of the date hereof, duly executed by RTI;\n(k) Selas shall have delivered that certain Amendment to First Mortgage and Security Agreement, dated as of the date hereof, duly executed by Selas;\n(l) Deuer shall have delivered that certain Amendment to Open- End First Mortgage and Security Agreement, dated as of the date hereof, duly executed by Deuer;\n(m) All proceedings required to be taken by the Borrowers in connection with the transactions contemplated by this Agreement shall be satisfactory in form and substance to the Bank and its counsel, and the Bank shall have received all such counterpart originals or certified or other copies of such documents as the Bank may reasonably request;\n(n) The Borrowers shall have executed and delivered to the Bank such other documents, instruments and agreements as the Bank may reasonably request.\n4. REPRESENTATIONS AND WARRANTIES. In order to induce the Bank to enter into this Agreement, the Borrowers hereby represent and warrant to the Bank as follows:\n(a) The representations and warranties contained in the Loan Documents are true and correct on and as of the date of this Agreement and after giving effect hereto, no Event of Default will be in existence or will occur as a result of giving effect hereto.\n(b) The execution, delivery and performance of this Agreement will not violate any provision of any law or regulation or of any writ or decree of any court or governmental instrumentality, or any of the Borrowers' certificate or articles of incorporation, by-laws, or other similar organizational documents.\n(c) Each of the Borrowers has the power to execute, deliver and perform this Agreement and each of the documents, instruments and agreements to be executed and\/or delivered in connection herewith and has taken all necessary action to authorize the execution, delivery and performance of this Agreement and each of the documents, instruments and agreements executed and\/or delivered in connection herewith and the performance of the Loan Agreement as amended hereby.\n(d) The execution, delivery and performance of this Agreement and each of the documents, instruments and agreements to be executed and\/or delivered in connection herewith does not require the consent of any other party or the consent, license, approval or authorization of, or registration or declaration with, any governmental body, authority, bureau or agency and the Loan Documents, this Agreement and each of the documents, instruments and agreements executed and\/or delivered in connection herewith constitute legal, valid and binding obligations of each of the Borrowers, enforceable in accordance with their respective terms, subject to bankruptcy, insolvency, reorganization and other laws of general applicability relating to or affecting creditors' rights and except as enforcement may be subject to general equitable principles.\n5. REAFFIRMATION. Except as amended hereby, all of the terms, covenants and conditions of the Loan Agreement and each of the other Loan Documents (INCLUDING, BUT NOT LIMITED TO, PROVISIONS RELATING TO ANY AUTHORITY GRANTED TO THE BANK TO CONFESS JUDGMENT AGAINST THE BORROWERS, OR ANY OF THEM, AND ANY WAIVER OF THE RIGHT TO TRIAL BY JURY) are ratified, reaffirmed and confirmed and shall continue in full force and effect as therein written and are not intended to be re-enacted as of the above date, but rather to be effective as of the original date of such documents. Each of the Borrowers hereby reaffirms and ratifies all of the terms, covenants, and conditions contained in each of their respective guarantees and confirms that such guarantees are binding and enforceable against the parties thereto as if such guarantees had been executed as of the date hereof.\n6. BINDING EFFECT. This Agreement shall be binding upon and inure to the benefit of the Borrowers and the Bank and their respective heirs, executors, administrators, successors and assigns; provided, however, that the Borrowers may not assign any of their rights, nor delegate any of their obligations, under this Agreement without the prior written consent of the Bank and any purported assignment or delegation absent such consent shall be void. The Bank may at any time assign or otherwise transfer (by participation or otherwise) any or all of its rights, or delegate any or all of its obligations, hereunder.\n7. COUNTERPARTS; EFFECTIVENESS. This Agreement may be executed in any number of counterparts and by the different parties on separate counterparts. Each such counterpart shall be deemed to be an original, but all such counterparts shall together constitute one and the same agreement. This Agreement shall be deemed to have been executed and delivered when the Bank has received counterparts hereof executed by all parties listed on the signature page(s) hereto.\n8. AMENDMENT AND WAIVER. No amendment of this Agreement, and no waiver of any one or more of the provisions hereof shall be effective unless set forth in a writing and signed by the parties hereto.\n9. GOVERNING LAW. This Agreement shall be governed by and construed in accordance with the internal laws of the Commonwealth of Pennsylvania without reference to conflict of law principles.\n10. SEVERABILITY. Any provision of this Agreement that is held to be inoperative, unenforceable, voidable or invalid in any jurisdictin\nshall, as to that jurisdiction, be ineffective, unenforceable, void or invalid without affecting the remaining provisions in that or any other jurisdiction, and to this end the provisions of this Agreement are declared to be severable.\n11. JUDICIAL PROCEEDINGS. Each party to this Agreement agrees that any suit, action or proceeding, whether claim or counterclaim, brought or instituted by any party hereto or any successor or assign of any party, on or with respect to this Agreement, the documents, instruments and agreements executed in connection herewith, the Loan Documents or the dealings of the parties with respect hereto and thereto, shall be tried only by a court and not by a jury. EACH PARTY HEREBY KNOWINGLY, VOLUNTARILY AND INTENTIONALLY WAIVES ANY RIGHT TO A TRIAL BY JURY IN ANY SUCH SUIT, ACTION OR PROCEEDING. Further, each party waives any right it may have to claim or recover, in\nany such suit, action or proceeding, any special, exemplary, punitive or consequential damages or damages other than, or in addition to, actual damages. THE BORROWERS ACKNOWLEDGE AND AGREE THAT THIS SECTION IS A SPECIFIC AND MATERIAL ASPECT OF THIS AGREEMENT AND THAT THE BANK WOULD NOT ENTER INTO THIS AGREEMENT IF THE WAIVERS SET FORTH IN THIS SECTION WERE NOT A PART OF THIS AGREEMENT.\nIN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed and delivered as of the day and year first above written.\nATTEST: SELAS CORPORATION OF AMERICA\nBy:_________________ By:_____________________ Name: Name: Title: Title:\nATTEST: DEUER MANUFACTURING, INC.\nBy:_________________ By:_____________________ Name: Name: Title: Title:\nATTEST: RESISTANCE TECHNOLOGY, INC.\nBy:_________________ By:_____________________ Name: Name: Title: Title:\nFIRST FIDELITY BANK, N.A.\nBy:__________________________ Name: Title:\nEXHIBIT 4D\nAMENDED AND RESTATED REVOLVING CREDIT NOTE\n$2,000,000.00 July ____, 1995 Philadelphia, Pennsylvania FOR VALUE RECEIVED, the undersigned SELAS CORPORATION OF AMERICA, a Pennsylvania business corporation with offices at 2034 Limekiln Pike, Dresher, PA 19025 (the \"Borrower\"), promises to pay to the order of FIRST FIDELITY BANK, N.A., a national banking association (the \"Bank\"), with an office at Broad and Walnut Streets, Philadelphia, Pennsylvania 19109, on the Selas Revolving Credit Termination Date, the principal sum of Two Million and No\/100 Dollars ($2,000,000.00) or such lesser principal amount as is actually outstanding under the Revolving Credit Facility (as defined in the Credit Agreement defined below) on such date, and with interest on the unpaid principal balance hereof payable as set forth below. All such principal and interest shall be payable in lawful money of the United States of America in immediately available funds on a Business Day at the offices of the Bank set forth above.\nUntil maturity (whether by acceleration or otherwise), the outstanding principal balance hereunder shall bear interest at the rates and shall be payable at the times and in the manner set forth in the Credit Agreement. Subsequent to maturity, including after judgment, interest on the outstanding principal balance hereunder shall accrue at an annual rate which shall be two percent (2%) above the rate of interest otherwise payable hereunder.\nThis Amended and Restated Revolving Credit Note (herein, the \"Note\") arises out of a certain Credit Agreement, dated as of October 20, 1993 (together with all amendments and modifications thereto, the \"Credit Agreement\"), by and among Borrower, the Bank, DEUER MANUFACTURING, INC., an Ohio business corporation with offices located at 2985 Springboro West, Dayton, OH 45439 (\"Deuer\"), and RESISTANCE TECHNOLOGY, INC., a Minnesota business corporation with offices located at 1260 Red Fox Road, Arden Hills, MN 55112 (\"RTI\"). Capitalized terms used by not otherwise defined in this Note shall have the respective meanings given to such terms in the Credit Agreement. Reference is made to the Credit Agreement for a statement of the respective rights and obligations of the parties and the terms and conditions therein provided under which the principal hereof and accrued interest thereon, if any, may become immediately due and payable. The collateral specified in the applicable Collateral Security Documents shall secure the obligations of Borrower under this Note. Notwithstanding the face amount of this Note, Borrower's liability hereunder shall be limited at all times to the actual aggregate outstanding indebtedness to Bank (principal, interest and fees) under the Revolving Credit Facility, as established by Bank's books and records, which books and records shall be conclusive absent manifest error.\nThe occurrence of an Event of Default under the Credit Agreement constitutes an Event of Default under this Note and entitles Bank, in accordance with the Credit Agreement, to declare this Note immediately due and payable in full.\nBorrower hereby waives presentment, demand for payment, notice of dishonor or acceleration, protest and notice of protest, and any and all other notices or demands in connection with the delivery, acceptance, performance, default or enforcement of this Note, excepting any notice requirements set forth in the Credit Agreement.\nIn the event any interest rate applicable hereto is in excess of the highest rate allowable under applicable law, then the rate of such interest will be reduced to the highest rate not in excess of such maximum allowable interest and any excess previously paid by Borrower shall be deemed to have been applied against principal.\nBORROWER HEREBY AUTHORIZES AND EMPOWERS ANY ATTORNEY OR ATTORNEYS OR THE PROTHONOTARY OR CLERK OF ANY COURT OF THE COMMONWEALTH OF PENNSYLVANIA, OR ELSEWHERE, TO APPEAR FOR BORROWER AT ANY TIME FOLLOWING THE OCCURRENCE OF AN EVENT OF DEFAULT UNDER THE CREDIT AGREEMENT IN ANY SUCH COURT IN AN APPROPRIATE ACTION THERE OR ELSEWHERE BROUGHT OR TO BE BROUGHT AGAINST BORROWER BY THE BANK ON THIS NOTE, WITH OR WITHOUT DECLARATIONS FILED, AS OF ANY TERM OR TIME OF COURT THEREOF OR ELSEWHERE TO BE HELD AND THEREIN TO CONFESS OR ENTER JUDGMENT AGAINST BORROWER FOR ALL SUMS DUE BY BORROWER TO BANK UNDER THIS NOTE AND THE CREDIT AGREEMENT, TOGETHER WITH THE COST OF SUIT AND REASONABLE ATTORNEYS' FEES, AND FOR SO DOING THIS NOTE OR A COPY HEREOF VERIFIED BY AFFIDAVIT SHALL BE A SUFFICIENT WARRANT.\nBORROWER HEREBY KNOWINGLY, VOLUNTARILY, AND INTENTIONALLY WAIVES ANY RIGHTS IT MAY HAVE TO A TRIAL BY JURY IN RESPECT OF ANY LITIGATION HEREON OR ARISING OUT OF, UNDER OR IN CONNECTION WITH THIS NOTE OR THE CREDIT AGREEMENT OR THE MAKING OF THE LOANS OR ANY COURSE OF CONDUCT, COURSE OF DEALING, STATEMENTS (WHETHER VERBAL OR WRITTEN) OR ACTIONS OF BORROWER OR BANK OR ANY OF THEM. THIS PROVISION IS A MATERIAL INDUCEMENT FOR BANK'S ENTERING INTO THE CREDIT AGREEMENT.\nBORROWER ACKNOWLEDGES THAT IT HAS HAD THE ASSISTANCE OF COUNSEL IN THE REVIEW AND EXECUTION OF THIS NOTE AND FURTHER ACKNOWLEDGES THAT THE MEANING AND EFFECT OF THE CONFESSION OF JUDGMENT AND WAIVER OF JURY TRIAL HAVE BEEN FULLY EXPLAINED TO SUCH BORROWER BY SUCH COUNSEL.\nBorrower's liability under this Note shall include all fees and expenses provided in the Credit Agreement.\nThis Note shall be binding upon Borrower and its successors and assigns and shall inure to the benefit of the Bank and its successors and assigns and shall be governed as to validity, interpretation and effect by the laws of the Commonwealth of Pennsylvania.\nThis Note amends and restates in its entirety the terms of that certain Revolving Credit Note, dated as of October 20, 1993 (together with all amendments and modifications thereto, the \"Existing Note\"), by the Borrower in favor of the Bank. This Note is not intended to extinguish the Borrower's obligations under the Existing Note or constitute a novation thereof.\nIN WITNESS WHEREOF, the undersigned, by its duly authorized officer, has executed this Amended and Restated Revolving Credit Note the day and year first above written.\nATTEST: SELAS CORPORATION OF AMERICA\nBy:_____________________________ By:____________________________ Name: Name: Title: Title:\nEXHIBIT 4E AMENDED AND RESTATED REVOLVING CREDIT NOTE\n$1,000,000.00 July ____, 1995 Philadelphia, Pennsylvania\nFOR VALUE RECEIVED, the undersigned RESISTANCE TECHNOLOGY, INC., a Minnesota business corporation with offices located at 1260 Red Fox Road, Arden Hills, MN 55112 (the \"Borrower\"), promises to pay to the order of FIRST FIDELITY BANK, N.A., a national banking association (the \"Bank\"), with an office at Broad and Walnut Streets, Philadelphia, Pennsylvania 19109, on the RTI Revolving Credit Termination Date, the principal sum of One Million and No\/100 Dollars ($1,000,000.00) or such lesser principal amount as is actually outstanding under the Revolving Credit Facility (as defined in the Credit Agreement defined below) on such date, and with interest on the unpaid principal balance hereof payable as set forth below. All such principal and interest shall be payable in lawful money of the United States of America in immediately available funds on a Business Day at the offices of the Bank set forth above.\nUntil maturity (whether by acceleration or otherwise), the outstanding principal balance hereunder shall bear interest at the rates and shall be payable at the times and in the manner set forth in the Credit Agreement. Subsequent to maturity, including after judgment, interest on the outstanding principal balance hereunder shall accrue at an annual rate which shall be two percent (2%) above the rate of interest otherwise payable hereunder.\nThis Amended and Restated Revolving Credit Note (herein, the \"Note\") arises out of a certain Credit Agreement, dated as of October 20, 1993 (together with all amendments and modifications thereto, the \"Credit Agreement\"), by and among Borrower, the Bank, SELAS CORPORATION OF AMERICA, a Pennsylvania business corporation with offices located at 2034 Limekiln Pike, Dresher, PA 19025 (\"Selas\") and DEUER MANUFACTURING, INC., an Ohio business corporation with offices located at 2985 Springboro West, Dayton, OH 45439 (\"Deuer\"). Capitalized terms used by not otherwise defined in this Note shall have the respective meanings given to such terms in the Credit Agreement. Reference is made to the Credit Agreement for a statement of the respective rights and obligations of the parties and the terms and conditions therein provided under which the principal hereof and accrued interest thereon, if any, may become immediately due and payable. The collateral specified in the applicable Collateral Security Documents shall secure the obligations of Borrower under this Note. Notwithstanding the face amount of this Note, Borrower's liability hereunder shall be limited at all times to the actual aggregate outstanding indebtedness to Bank (principal, interest and fees) under the Revolving Credit Facility, as established byBank's books and records, which books and records shall be conclusive absent manifest error.\nThe occurrence of an Event of Default under the Credit Agreement constitutes an Event of Default under this Note and entitles Bank, in accordance with the Credit Agreement, to declare this Note immediately due and payable in full.\nBorrower hereby waives presentment, demand for payment, notice of dishonor or acceleration, protest and notice of protest, and any and all other notices or demands in connection with the delivery, acceptance, performance, default or enforcement of this Note, excepting any notice requirements set forth in the Credit Agreement.\nIn the event any interest rate applicable hereto is in excess of the highest rate allowable under applicable law, then the rate of such interest will be reduced to the highest rate not in excess of such maximum allowable interest and any excess previously paid by Borrower shall be deemed to have been applied against principal.\nBORROWER HEREBY AUTHORIZES AND EMPOWERS ANY ATTORNEY OR ATTORNEYS OR THE PROTHONOTARY OR CLERK OF ANY COURT OF THE COMMONWEALTH OF PENNSYLVANIA, OR ELSEWHERE, TO APPEAR FOR BORROWER AT ANY TIME FOLLOWING THE OCCURRENCE OF AN EVENT OF DEFAULT UNDER THE CREDIT AGREEMENT IN ANY SUCH COURT IN AN APPROPRIATE ACTION THERE OR ELSEWHERE BROUGHT OR TO BE BROUGHT AGAINST BORROWER BY THE BANK ON THIS NOTE, WITH OR WITHOUT DECLARATIONS FILED, AS OF ANY TERM OR TIME OF COURT THEREOF OR ELSEWHERE TO BE HELD AND THEREIN TO CONFESS OR ENTER JUDGMENT AGAINST BORROWER FOR ALL SUMS DUE BY BORROWER TO BANK UNDER THIS NOTE AND THE CREDIT AGREEMENT, TOGETHER WITH THE COST OF SUIT AND REASONABLE ATTORNEYS' FEES, AND FOR SO DOING THIS NOTE OR A COPY HEREOF VERIFIED BY AFFIDAVIT SHALL BE A SUFFICIENT WARRANT.\nBORROWER HEREBY KNOWINGLY, VOLUNTARILY, AND INTENTIONALLY WAIVES ANY RIGHTS IT MAY HAVE TO A TRIAL BY JURY IN RESPECT OF ANY LITIGATION HEREON OR ARISING OUT OF, UNDER OR IN CONNECTION WITH THIS NOTE OR THE CREDIT AGREEMENT OR THE MAKING OF THE LOANS OR ANY COURSE OF CONDUCT, COURSE OF DEALING, STATEMENTS (WHETHER VERBAL OR WRITTEN) OR ACTIONS OF BORROWER OR BANK OR ANY OF THEM. THIS PROVISION IS A MATERIAL INDUCEMENT FOR BANK'S ENTERING INTO THE CREDIT AGREEMENT.\nBORROWER ACKNOWLEDGES THAT IT HAS HAD THE ASSISTANCE OF COUNSEL IN THE REVIEW AND EXECUTION OF THIS NOTE AND FURTHER ACKNOWLEDGES THAT THE MEANING AND EFFECT OF THE CONFESSION OF JUDGMENT AND WAIVER OF JURY TRIAL HAVE BEEN FULLY EXPLAINED TO SUCH BORROWER BY SUCH COUNSEL.\nBorrower's liability under this Note shall include all fees and expenses provided in the Credit Agreement.\nThis Note shall be binding upon Borrower and its successors and assigns and shall inure to the benefit of the Bank and its successors and assigns and shall be governed as to validity, interpretation and effect by the laws of the Commonwealth of Pennsylvania.\nThis Note amends and restates in its entirety the terms of that certain Revolving Credit Note, dated as of October 20, 1993 (together with all amendments and modifications thereto, the \"Existing Note\"), by the Borrower in favor of the Bank. This Note is not intended to extinguish the Borrower's obligations under the Existing Note or constitute a novation thereof.\nIN WITNESS WHEREOF, the undersigned, by its duly authorized officer, has executed this Amended and Restated Revolving Credit Note the day and year first above written.\nATTEST RESISTANCE TECHNOLOGY, INC.\nBy:_____________________________ Name: Title:\nBy:____________________________ Name: Title:\nEXHIBIT 4F\nAMENDED AND RESTATED REVOLVING CREDIT NOTE\n$500,000.00 July ____, 1995 Philadelphia, Pennsylvania\nFOR VALUE RECEIVED, the undersigned DEUER MANUFACTURING, INC., an Ohio business corporation with offices located at 2985 Springboro West, Dayton, OH 45439 (the \"Borrower\"), promises to pay to the order of FIRST FIDELITY BANK, N.A., a national banking association (the \"Bank\"), with an office at Broad and Walnut Streets, Philadelphia, Pennsylvania 19109, on the Deuer Revolving Credit Termination Date, the principal sum of Five Hundred Thousand and No\/100 Dollars ($500,000.00) or such lesser principal amount as is actually outstanding under the Revolving Credit Facility (as defined in the Credit Agreement defined below) on such date, and with interest on the unpaid principal balance hereof payable as set forth below. All such principal and interest shall be payable in lawful money of the United States of America in immediately available funds on a Business Day at the offices of the Bank set forth above.\nUntil maturity (whether by acceleration or otherwise), the outstanding principal balance hereunder shall bear interest at the rates and shall be payable at the times and in the manner set forth in the Credit Agreement. Subsequent to maturity, including after judgment, interest on the outstanding principal balance hereunder shall accrue at an annual rate which shall be two percent (2%) above the rate of interest otherwise payable hereunder.\nThis Amended and Restated Revolving Credit Note (herein, the \"Note\") arises out of a certain Credit Agreement, dated as of October 20, 1993 (together with all amendments and modifications thereto, the \"Credit Agreement\"), by and among Borrower, the Bank, SELAS CORPORATION OF AMERICA, a Pennsylvania business corporation with offices located at 2034 Limekiln Pike, Dresher, PA 19025 (\"Selas\"), and RESISTANCE TECHNOLOGY, INC., a Minnesota business corporation with offices located at 1260 Red Fox Road, Arden Hills, MN 55112 (\"RTI\"). Capitalized terms used by not otherwise defined in this Note shall have the respective meanings given to such terms in the Credit Agreement. Reference is made to the Credit Agreement for a statement of the respective rights and obligations of the parties and the terms and conditions therein provided under which the principal hereof and accrued interest thereon, if any, may become immediately due and payable. The collateral specified in the applicable Collateral Security Documents shall secure the obligations of Borrower under this Note. Notwithstanding the face amount of this Note, Borrower's liability hereunder shall be limited at all times to the actual aggregate outstanding indebtedness to Bank (principal, interest and fees) under the Revolving Credit Facility, as established by Bank's books and records, which books and records shall be conclusive absent manifest error.\nThe occurrence of an Event of Default under the Credit Agreement constitutes an Event of Default under this Note and entitles Bank, in accordance with the Credit Agreement, to declare this Note immediately due and payable in full.\nBorrower hereby waives presentment, demand for payment, notice of dishonor or acceleration, protest and notice of protest, and any and all other notices or demands in connection with the delivery, acceptance, performance, default or enforcement of this Note, excepting any notice requirements set forth in the Credit Agreement.\nIn the event any interest rate applicable hereto is in excess of the highest rate allowable under applicable law, then the rate of such interest will be reduced to the highest rate not in excess of such maximum allowable interest and any excess previously paid by Borrower shall be deemed to have been applied against principal.\nBORROWER HEREBY AUTHORIZES AND EMPOWERS ANY ATTORNEY OR ATTORNEYS OR THE PROTHONOTARY OR CLERK OF ANY COURT OF THE COMMONWEALTH OF PENNSYLVANIA, OR ELSEWHERE, TO APPEAR FOR BORROWER AT ANY TIME FOLLOWING THE OCCURRENCE OF AN EVENT OF DEFAULT UNDER THE CREDIT AGREEMENT IN ANY SUCH COURT IN AN APPROPRIATE ACTION THERE OR ELSEWHERE BROUGHT OR TO BE BROUGHT AGAINST BORROWER BY THE BANK ON THIS NOTE, WITH OR WITHOUT DECLARATIONS FILED, AS OF ANY TERM OR TIME OF COURT THEREOF OR ELSEWHERE TO BE HELD AND THEREIN TO CONFESS OR ENTER JUDGMENT AGAINST BORROWER FOR ALL SUMS DUE BY BORROWER TO BANK UNDER THIS NOTE AND THE CREDIT AGREEMENT, TOGETHER WITH THE COST OF SUIT AND REASONABLE ATTORNEYS' FEES, AND FOR SO DOING THIS NOTE OR A COPY HEREOF VERIFIED BY AFFIDAVIT SHALL BE A SUFFICIENT WARRANT.\nBORROWER HEREBY KNOWINGLY, VOLUNTARILY, AND INTENTIONALLY WAIVES ANY RIGHTS IT MAY HAVE TO A TRIAL BY JURY IN RESPECT OF ANY LITIGATION HEREON OR ARISING OUT OF, UNDER OR IN CONNECTION WITH THIS NOTE OR THE CREDIT AGREEMENT OR THE MAKING OF THE LOANS OR ANY COURSE OF CONDUCT, COURSE OF DEALING, STATEMENTS (WHETHER VERBAL OR WRITTEN) OR ACTIONS OF BORROWER OR BANK OR ANY OF THEM. THIS PROVISION IS A MATERIAL INDUCEMENT FOR BANK'S ENTERING INTO THE CREDIT AGREEMENT.\nBORROWER ACKNOWLEDGES THAT IT HAS HAD THE ASSISTANCE OF COUNSEL IN THE REVIEW AND EXECUTION OF THIS NOTE AND FURTHER ACKNOWLEDGES THAT THE MEANING AND EFFECT OF THE CONFESSION OF JUDGMENT AND WAIVER OF JURY TRIAL HAVE BEEN FULLY EXPLAINED TO SUCH BORROWER BY SUCH COUNSEL.\nBorrower's liability under this Note shall include all fees and expenses provided in the Credit Agreement.\nThis Note shall be binding upon Borrower and its successors and assigns and shall inure to the benefit of the Bank and its successors and assigns and shall be governed as to validity, interpretation and effect by the laws of the Commonwealth of Pennsylvania.\nThis Note amends and restates in its entirety the terms of that certain Revolving Credit Note, dated as of October 20, 1993 (together with all amendments and modifications thereto, the \"Existing Note\"), by the Borrower in favor of the Bank. This Note is not intended to extinguish the Borrower's obligations under the Existing Note or constitute a novation thereof.\nIN WITNESS WHEREOF, the undersigned, by its duly authorized officer, has executed this Amended and Restated Revolving Credit Note the day and year first above written.\nATTEST: DEUER MANUFACTURING, INC.\nBy:_____________________________ By:____________________________ Name: Name: Title: Title:\nEXHIBIT 10F\n(FORM OF STOCK OPTION AGREEMENT UNDER SELAS 1994 STOCK OPTION PLAN)\n(Addressee)\nDear : I am pleased to inform you that on the Compensation Committee of the Company's Board of Directors granted you options to purchase Common Shares of the Company under the Company's 1994 Stock Option Plan (the \"Plan\"), at an exercise price of $ per share.\nUnder the Plan, the Company may grant either incentive stock options or non-qualified stock options. The options granted to you are intended to be (incentive stock options) (non-qualified stock options).\nThese options will become exercisable as follows:\nDate First Exercisable Number of Shares\nThe exercise price for your options shall be payable in cash or its equivalent.\nOnce options become exercisable, they will remain exercisable until they are exercised or until they terminate. Unless earlier terminated pursuant to the terms of the Plan, all options granted hereby shall terminate on . While the specific terms of the Plan will govern, generally upon termination of your employment for any reason the options will terminate to the extent of options that you could not have exercised on the date of such termination. Options that could have been exercised on the date of termination of employment for reasons other than death or disability may be exercised only prior to the earlier of three months following the date of termination of employment or the expiration date of such options. Options that could have been exercised on the date of termination of employment due to death or disability may be exercised only prior to the earlier of one year following the date of your death or such termination of employment or the expiration date of such options.\nFurther terms governing the options granted to you are set forth in the Plan, a copy of which is attached hereto and incorporated by reference herein.\nIf you wish to accept the grant of the options as provided above and in the Plan, please so indicate by signing and returning the enclosed copy of this letter, whereupon you and the Company shall be legally bound hereby under Pennsylvania law.\nVery truly yours,\nSELAS CORPORATION OF AMERICA\nBy: Robert W. Ross, Secretary\nAccepted and Agreed:\nEXHIBIT 10I\nSELAS CORPORATION OF AMERICA SUPPLEMENTAL RETIREMENT PLAN (AMENDED AND RESTATED EFFECTIVE JANUARY 1, 1995)\nDECEMBER 1995\nPAGE\nARTICLE I - NAME OF PLAN, FUNDING AND EFFECTIVE DATE 1 1.1 Name of Plan 1 1.2 Funding 1 1.3 Effective Date of Plan 1\nARTICLE II - DEFINITIONS 1 2.1 Incorporation of Definitions 1 2.2 Plan 1 2.3 Retirement Plan 1\nARTICLE III - AMOUNT OF BENEFITS 2 3.1 Pension Restoration Benefits 2 3.2 Benefits upon Reemployment 2\nARTICLE IV - VESTING 2\nARTICLE V - FORM OF BENEFIT AND DISTRIBUTION OF BENEFITS 2 5.1 No Election Made 2 5.2 Distribution Elections 3 5.3 Beneficiary Designation 3\nARTICLE VI - ADMINISTRATION 3 6.1 Plan Administrator 3 6.2 Responsibilities and Powers of the Plan Administrator 3 6.3 Claims for Benefits 4 6.4 Indemnification 4\nARTICLE VII - MISCELLANEOUS 4 7.1 Benefits Payable by Company 4 7.2 Amendment or Termination 4 7.3 Status of Employment 4 7.4 Inalienability of Benefits 5 7.5 Governing Law 5\nSELAS CORPORATION OF AMERICA SUPPLEMENTAL RETIREMENT PLAN\n(AMENDED AND RESTATED EFFECTIVE JANUARY 1, 1995)\nWHEREAS, SELAS CORPORATION OF AMERICA (the \"Company\") in 1994 adopted the SELAS CORPORATION OF AMERICA SUPPLEMENTAL RETIREMENT PLAN (the \"Plan\") to supplement the benefits provided to a select group of highly compensated or management employees under the SELAS CORPORATION OF AMERICA SALARIED RETIREMENT PLAN; and\nWHEREAS, the Company reserved the right to amend the Plan under Section 7.2 of the Plan; and\nWHEREAS, the Company desires to amend and restate the Plan, effective January 1, 1995, in order to make certain changes to the Plan;\nNOW, THEREFORE, effective January 1, 1995, the Company hereby amends and restates the SELAS CORPORATION OF AMERICA SUPPLEMENTAL RETIREMENT PLAN, as follows:\nARTICLE I\nNAME OF PLAN, FUNDING AND EFFECTIVE DATE\n.0.0.1 NAME OF PLAN. The plan as set forth herein shall be known as the \"SELAS CORPORATION OF AMERICA SUPPLEMENTAL RETIREMENT PLAN\" (the \"Plan\").\n.0.0.2 FUNDING. The Plan is designed to cover a select group of highly compensated or management employees, and shall be unfunded for tax purposes and for purposes of the exemptions from Title I of the Employee Retirement Income Security Act of 1974, as amended. All obligations of the Plan shall be paid from the general assets of the Company.\n.0.0.3 EFFECTIVE DATE OF PLAN. The effective date of the Plan is January 1, 1994.\nARTICLE II\nDEFINITIONS\n.0.0.4 INCORPORATION OF DEFINITIONS. All definitions used in the SELAS CORPORATION OF AMERICA SALARIED RETIREMENT PLAN (the \"Retirement Plan\") are hereby made a part of this Plan by reference. Any amendment of the definitions of the Retirement Plan shall be effective with respect to this Plan as of the effective date of the amendment to the Retirement Plan.\n.0.0.5 \"PLAN\" shall mean the SELAS CORPORATION OF AMERICA SUPPLEMENTAL RETIREMENT PLAN as set forth herein, and as amended from time to time.\n.0.0.6 \"RETIREMENT PLAN\" shall mean the SELAS CORPORATION OF AMERICA SALARIED RETIREMENT PLAN.\nARTICLE III\nAMOUNT OF BENEFITS\n.0.0.7 PENSION RESTORATION BENEFITS.\n.0.0.7.1 ELIGIBILITY. Each employee who is employed by the Company on or after January 1, 1994, and whose Accrued Benefit under the Retirement Plan is reduced as result of the compensation limitation imposed by section 401(a)(17) of the Internal Revenue Code of 1986, as amended (the \"Code\") on the Retirement Plan, in Plan Years after 1988, shall be entitled to Pension Restoration Benefits (\"PBR Benefits\") under this Plan.\n.0.0.7.2 AMOUNT. For each benefit payment made under the Retirement Plan, an employee entitled to PBR Benefits shall receive a PBR Benefit in an amount equal to the difference between (1) the amount such payment under the Retirement Plan would have been if, in Plan Years after 1988, the Compensation used in computing such employee's Accrued Benefit under the Retirement Plan had not been reduced as a result of section 401(a)(17) of the Code, and (2) the benefit payment the employee is entitled to under the terms of the Retirement Plan.\n.0.0.8 BENEFITS UPON REEMPLOYMENT. If a former employee is rehired by the Company after he begins to receive his PBR Benefits,\n.0.0.8.1 his PBR Benefits shall cease during such period of reemployment; and\n.0.0.8.2 the PBR Benefits payable after the employee's subsequent retirement or separation shall be the benefits computed in accordance with Section 3.1(b) at the date of the termination of his last period of reemployment.\nARTICLE IV\nVESTING\nAn employee shall become vested in his PBR Benefits under the Plan on the date his Accrued Benefit under the Retirement Plan becomes vested.\nARTICLE V\nFORM OF BENEFIT AND DISTRIBUTION OF BENEFITS\n.0.1 NO ELECTION MADE. If no effective election has been made under Section 5.2 before the later of the date the employee attains age 65 or separates from service with the Company, payment of benefits under the Plan shall be made to the employee in a lump sum distribution within 60 days following such date. If the employee dies before payment of benefits commences and the employee's Beneficiary has not made an effective election under Section 5.2 within 13 months of the employee's date of death, payment of benefits under the Plan shall be made to the employee's Beneficiary in a lump sum distribution within 60 days following the expiration of such 13-month period.\n.0.2 DISTRIBUTION ELECTIONS.\n(a) ELECTION BY EMPLOYEE. An employee shall be entitled to elect to have payment of benefits under this Plan commence in a form of payment that is available, and at a time which is permissible, under the Retirement Plan. However, no payment shall be made pursuant to such an election unless the election is made at least 30 days before the beginning of the taxable year in which payments to the employee are to commence under the election.\n(b) ELECTION BY BENEFICIARY. If an employee dies before payment commences, his Beneficiary shall be entitled to elect to commence payment of benefits under this Plan in a form of payment that is available, and at a time which is permissible, under the Retirement Plan. However, no payment shall be made pursuant to such an election unless the election is made at least 30 days before the beginning of the taxable year in which payments to the Beneficiary are to commence under the election.\n(c) SUBSEQUENT ELECTIONS. An employee or a Beneficiary may make an election under this Section 5.2 which shall supersede the previous election he made under this Section 5.2, provided that such a subsequent election is made at least 30 days before the beginning of the taxable year in which payments were to commence under the individual's previous election and the subsequent election otherwise meets the applicable requirements of this Section 5.2.\n(d) PROCEDURES FOR ELECTIONS. In addition to meeting the applicable requirements of this Section 5.2, an election under this Section 5.2 will only be effective if made in accordance with the procedures established by the Company.\n.0.3 BENEFICIARY DESIGNATION. An employee's designation of a Beneficiary under the Retirement Plan will also apply under this Plan.\nARTICLE VI\nADMINISTRATION\n.0.3.1 PLAN ADMINISTRATOR. The Company shall be the Plan Administrator and shall have responsibility to supervise the management and administration of this Plan.\n.0.3.2 RESPONSIBILITIES AND POWERS OF THE PLAN ADMINISTRATOR.\n.0.3.2.1 The Plan Administrator shall have the responsibility:\n.0.3.2.1.1 To administer the Plan in accordance with the terms hereof, and to exercise all powers specifically conferred upon the Plan Administrator hereby or necessary to carry out the provisions hereof.\n.0.3.2.1.2 To construe this Plan solely in its discretion, which construction shall be conclusive on all parties correct any defects, supply any omissions, and reconcile any inconsistencies to the extent necessary to effectuate the Plan.\n.0.3.2.1.3 To keep all records relating to the Plan and such other records as are necessary for proper operation of the Plan.\n.0.3.2.2 In carrying out its functions hereunder: .0.3.2.2.1 The Plan Administrator may adopt rules and regulations necessary for the administration of the Plan and which are consistent with the provisions hereof.\n.0.3.2.2.2 The Plan Administrator may authorize one or more of its employees, or other representatives, to act on its behalf.\n.0.3.2.2.3 The Plan Administrator shall have the right to hire, at the expense of the Company, such professional assistants and consultants as it, in its sole discretion, deems necessary or advisable, including, but not limited to, accountants, actuaries, consultants, counsel, and such clerical assistance as is necessary for proper discharge of its duties.\n.0.3.3 CLAIMS FOR BENEFITS. The Company will advise each employee of any PBR Benefits to which he is entitled under the Plan. If any employee believes that the Company has failed to advise him of any PBR Benefits to which he is entitled, or disputes the amount of his PBR Benefits he may file a written claim with the Human Resources Department. The claim and review procedure described in Section 10.5 of the Retirement Plan shall also apply to claims filed for benefits under this Plan.\n.0.3.4 INDEMNIFICATION. To the extent permitted by law, the Company shall indemnify employees properly appointed to perform Plan Administrator duties from all claims for liability, loss or damage (including payment of expenses in connection with defense against such claim) arising from any act or failure to act which constitutes a breach of such individual's responsibilities under any aspects of the law, unless such misconduct results from gross negligence or willful misconduct.\nARTICLE VII\nMISCELLANEOUS\n.0.3.5 BENEFITS PAYABLE BY COMPANY. Any benefits payable under this Plan shall constitute an unfunded obligation of the Company and this Plan constitutes a mere promise that the Company will make such PBR Benefit payments in the future. Payments shall be made, as due, from the general funds of the Company. The Company, at its option, may maintain one or more bookkeeping reserve accounts to reflect its obligations under the Plan and may make such investments as it may deem desirable to assist it in meeting such obligations. Any such investments shall be assets of the Company subject to the claims of its general creditors. No person eligible for benefits under this Plan shall have any right, title or interest in any such investments except as a general unsecured creditor of the Company.\n.0.3.6 AMENDMENT OR TERMINATION. The Company reserves the right, at any time and from time to time, pursuant to a written resolution of its Board of Directors, adopted at a duly held meeting of such Board or by unanimous written consent of such Board, to amend, modify, restate or terminate the Plan, provided, however, that no such action by the Company shall reduce an employee's PBR Benefits after the date of commencement of payment of such PBR Benefits.\n.0.3.7 STATUS OF EMPLOYMENT. Nothing herein contained shall be construed as conferring any rights upon any employee or other person for a continuation of employment nor shall it be construed as limiting in any way the right of the Company to discharge any employee or other person or to treat him without regard to the effect which such treatment might have upon him as a participant in the Plan. .0.3.8 INALIENABILITY OF BENEFITS. The right of any person to any benefit or payment under the Plan shall not be subject to voluntary or involuntary transfer, alienation or assignment, and, to the fullest extent permitted by law, shall not be subject to attachment, execution, garnishment, sequestration or other legal or equitable process. In the event a person who is receiving or is entitled to receive PBR Benefits attempts to assign, transfer or dispose of such right, or if an attempt is made to subject said right to such process, such assignment, transfer or disposition shall be null and void.\n.0.3.9 GOVERNING LAW. Except to the extent preempted by federal law, the provisions of the Plan will be construed according to the laws of the Commonwealth of Pennsylvania.\nIN WITNESS WHEREOF, SELAS CORPORATION OF AMERICA has caused this amended and restated Plan, effective as of January 1, 1995, to be executed this 8th day of December, 1995.\nSELAS CORPORATION OF AMERICA\nATTEST: \/s\/ Robert W. Ross, By: \/s\/ Stephen F. Ryan\nRobert W. Ross, Secretary Stephen F. Ryan President and Chief Executive Officer CORPORATE SEAL\nEXHIBIT 10J\nMANAGEMENT EMPLOYMENT AGREEMENT\nTHIS AGREEMENT is made effective the 20th day of October, 1993, by and between RESISTANCE TECHNOLOGY, INC., a Minnesota corporation (hereinafter \"RTI\"), and MARK S. GORDER, an individual resident of St. Paul, Minnesota (hereinafter, \"GORDER\").\nBACKGROUND\nGorder currently serves (and for the past several years Gorder has served) as the President and Chief Executive Officer of RTI and as a member of its Board of Directors. Gorder is a key employee of RTI and has been substantially involved with RTI's organization, operations and management and possesses trade secrets and other confidential information relating to RTI and its customers.\nRTI and the holders of all issued and outstanding shares of RTI have entered into a Stock Purchase and Sale Agreement with Selas Corporation of America, a Pennsylvania corporation (\"Selas\"), whereby Selas is acquiring on the date hereof all of the issued and outstanding shares of RTI. RTI and Selas recognize that Selas' substantial monetary investment in RTI, as well as the future business success of RTI, could be materially jeopardized and prejudiced if Gorder were not available to continue to serve RTI. Accordingly, RTI and Selas desire to assure the continued services and employment of Gorder for the period provided in this Agreement and to obtain the noncompetition and confidentiality protections provided for herein with respect to RTI's customers, relationships and trade secrets and other confidential information.\nGorder is willing to continue to serve RTI and to grant to RTI noncompetition and confidentiality protections as provided in this Agreement.\nNOW, THEREFORE, in consideration of the foregoing and the covenants and agreements hereinafter set forth, the parties hereto, intending to be legally bound, hereby agree as follows:\n.0.3.10 EMPLOYMENT AGREEMENT; TERM. RTI hereby hires and employs Gorder, and Gorder hereby accepts such engagement by RTI, for a term of five (5) years, commencing October 20, 1993, and ending October 20, 1998 (unless sooner terminated as hereinafter provided) and upon the terms and conditions contained in this Agreement.\n.0.3.11 COMPENSATION AND BENEFITS.\n.0.3.11.1 BASE SALARY. In consideration of all of Gorder's services to RTI, RTI shall pay Gorder, a base salary at a minimum rate of $160,706 per annum. Salary increases will be at the discretion of the Board of Directors of RTI, subject to the approval of the Compensation Committee of the Board of Directors of Selas (the \"Compensation Committee\"). Gorder's salary will be payable as earned in reasonable periodic installments in accordance with the regular practices of RTI in effect from time to time.\n.0.3.11.2 BONUSES. During the term of Gorder's employment hereunder, Gorder shall participate in such annual bonus or incentive compensation programs as may be adopted from time to time by the Board of Directors of RTI with the approval of the Compensation Committee, and Gorder shall be entitled to receive such annual bonus or incentive compensation as is provided for pursuant to the terms of such programs; provided, however, that with respect to the year ending December 31, 1993, Gorder shall receive a bonus in accordance with RTI's Annual Incentive Bonus Plan for 1993 as in effect on July 27, 1993.\n.0.3.11.3 FRINGE BENEFITS. Throughout the term of his employment, Gorder shall be entitled to participate in and receive the benefits of any health or medical insurance plan, life insurance plan, disability insurance plan, or other employee benefit plan made available to other officers of RTI [, provided that in any event Gorder shall be entitled to [six] weeks of vacation per year, with any unused vacation as of any year end to lapse]. In addition, Gorder shall be entitled to continue to have the use of an automobile similar to the automobile leased by RTI for his use as of July 27, 1993.\n.0.3.11.4 EXPENSES. RTI shall reimburse Gorder for all reasonable and ordinary direct expenses incurred by Gorder in conjunction with performing his duties hereunder, subject to expense guidelines established from time to time by the Board of Directors of RTI.\n.0.3.12 DUTIES. Gorder shall perform such senior executive responsibilities as shall from time to timebe assigned to him by the Board of Directors of RTI. He shall initially serve as President and Chief Executive Officer of RTI. Gorder shall devote his full time, knowledge, skill and efforts to the performance of his duties hereunder. Gorder shall not engage in any other business activity unless approved by the Board of Directors of RTI. Notwithstanding the foregoing, Gorder may passively invest his assets (other than in business entities which are in competition with RTI or Selas or any affiliate thereof) in such form or manner as will not require any material services on the part of Gorder in the operation of the affairs of such businesses in which such investments are made.\n.0.3.13 TERMINATION OF EMPLOYMENT. The term of Gorder's employment hereunder shall be terminated upon the occurrence of any of the events described below. In case of such termination, the date upon which Gorder ceases to be employed under this Agreement, after giving effect to any prior notice requirement set forth below, is hereinafter referred to as the \"Termination Date.\"\n.0.3.13.1 DEATH OR DISABILITY. This Agreement shall terminate upon the death or \"Disability\" (as defined below) of Gorder. If termination occurs for either such reason, Gorder (or his heirs, beneficiaries or estate) shall receive when due (i) all amounts payable under the provisions of Paragraph 2(a) hereof which have accrued through the Termination Date, and (ii) all bonus payments and benefits as are due in accordance with the terms of the benefit and bonus plans of RTI in effect on the date of his death or \"Disability\" referred to in Paragraph 2(b) and 2(c) hereof, and RTI shall have no further obligations hereunder to Gorder or to his heirs, beneficiaries or estate. As used herein, the terms \"Disability\" and \"Disabled\" shall mean Gorder's inability, as a result of physical or mental incapacity, to perform substantially his duties with RTI for a period of six (6) consecutive months. If there is any dispute as to whether Gorder is or was Disabled, such dispute shall be resolved by a licensed physician mutually agreeable to Gorder and RTI, or, if Gorder and RTI are unable to agree upon a physician within ten (10) days after notice from either to the other suggesting a physician, then a physician shall be designated by the then president of medical society for the county in which Gorder maintains his principal residence, upon request of either party. The cost of any such medical examination shall be borne by RTI.\n.0.3.13.2 CAUSE. RTI may, without liability, forthwith terminate Gorder's employment hereunder for \"Cause\" (as defined below) at any time, and thereafter the obligations of RTI hereunder shall cease and terminate except for (i) all amounts payable under the provisions of Paragraph 2(a) hereof which are accrued through the Termination Date and (ii) all bonus payments and benefits as are due in accordance with the terms of the benefit and bonus plans of RTI in effect on the Termination Date referred to in Paragraphs 2(b) and 2(c) hereof. For purposes of this Agreement, the term \"Cause\" shall mean (i) Gorder's continued failure to perform substantially his duties with RTI (other than any such failure resulting from his incapacity due to physical or mental illness), twenty (20) days after a demand for substantial performance is delivered to him by RTI which specifically identifies the manner in which RTI believes he has not substantially performed his duties, (ii) any willful act of misconduct by Gorder which is materially injurious to RTI or Selas, momentarily or otherwise, or (iii) a criminal conviction of Gorder for any act involving dishonesty, breach of trust or the commission of a felony. For purposes of this Subparagraph (b), no act, or failure to act, on Gorder's part will be considered \"willful\" unless done (or omitted to be done) by Gorder in bad faith and without reasonable belief that his act or omission was in the best interests of RTI.\n.0.3.13.3 TERMINATION WITHOUT CAUSE. RTI may terminate this Agreement at any time without Cause. If this Agreement is terminated by RTI for any reason other than for Cause or due to death or Disability of Gorder, then Gorder shall receive from RTI a lump sum payment equal to the present value (applying an 8% discount factor) of the amounts Gorder would have received pursuant to Paragraph 2(a) hereof assuming Gorder's then current annual base salary had continued to be paid, in equal monthly installments, during the remaining unexpired term of this Agreement. Upon such payment by RTI, RTI shall have no further obligations or liabilities hereunder.\n.0.3.14 NONCOMPETITION; CONFIDENTIAL INFORMATION.\n.0.3.14.1 For a period (the \"Relevant Period\") commencing on the date hereof and ending three years following the date Gorder ceases, for any reason, to be employed by RTI, except for the performance of his duties hereunder or as expressly consented to in writing by RTI and Selas, neither Gorder nor any Affiliate (as hereinafter defined) shall, directly or indirectly: (i) engage, anywhere in the Territory (as defined in subparagraph (c) below), in the manufacture, assembly, design, distribution or marketing of any product or equipment substantially similar to or in competition with any product or equipment which at any time during the period from the date hereof until the date Gorder ceases, for any reason, to be employed by RTI is manufactured, sold or distributed by RTI or any subsidiary of RTI (which jointly and severally are hereinafter referred to as the \"Group\") or any product or equipment which the Group develops during such period for future manufacture, sale or distribution; (ii) be or become a stockholder, partner, owner, officer, director or employee or agent of, or a consultant to or give financial or other assistance to, any person or entity considering engaging in any such activities or so engaged; (iii) seek in competition with the business of the Group to procure orders from or do business with any customer of the Group; (iv) solicit or contact with a view to the engagement or employment by any person or entity of any person who is an employee of the Group; or (v) seek to contract with or engage (in such a way as to adversely affect or interfere with the business of the Group as carried on at any time after the date hereof and on or prior to the date Gorder ceases, for any reason, to be employed by RTI) any person or entity who has been contracted with or engaged to manufacture, assemble, supply or deliver products, goods, materials or services to the Group; provided, however, that nothing herein shall prohibit Gorder and Affiliates from owning, as passive investors, such investments as are expressly permitted under Paragraph 3 hereof. The duration of Gorder's covenants set forth in this subparagraph shall be extended by a period of time equal to the number of days, if any, during which Gorder or any Affiliate is in violation of the provisions hereof.\n.0.3.14.2 From and after the date hereof, except in connection with the performance of his duties hereunder, neither Gorder nor any Affiliate shall, directly or indirectly: (i) use or procure the use of any name including the words Resistance Technology, Inc. or RTI or any derivative or colorable imitation thereof; or (ii) use in furtherance of any of their business affairs or disclose to any third party any trade secret, customer list, supplier list, financial data, pricing or marketing policy or plan or any other proprietary or confidential information relating to the Group or any of its products, services, customers or suppliers, so long as the same is not publicly known (other than by the act of Gorder or any Affiliate).\n.0.3.14.3 For the purposes of this Agreement, \"Territory\" means the world, and \"Affiliate\" means: (i) any corporation of which Gorder owns or otherwise possesses the power to direct the vote, directly or indirectly, of an amount of voting securities sufficient to elect a majority of the board of directors of such corporation, and (ii) any other person or entity controlled by Gorder. For the purposes of this definition of \"Affiliate,\" \"control\" means the power to direct the management and policies of a person or entity, directly or indirectly, whether through the ownership of voting securities, by contract or otherwise; provided that, any person or entity of which Gorder owns beneficially or of record, either directly or through one or more intermediaries, more than 20% of the ownership interests, shall be conclusively presumed to be an \"Affiliate.\"\n.0.3.14.4 Gorder acknowledges that damages alone shall not be an adequate remedy for any breach by Gorder or Affiliates of Gorder's covenants contained in this Paragraph 5 and accordingly expressly agrees that, in addition to any other remedies which RTI may have, RTI shall be entitled to injunctive relief in any court of competent jurisdiction for any breach or threatened breach of any such covenants by Gorder and\/or Affiliates. Nothing contained herein shall prevent or delay RTI from seeking, in any court of competent jurisdiction, specific performance or other equitable remedies in the event of any breach or intended breach by Gorder or Affiliates of any of their obligations hereunder.\n.0.3.14.5 Gorder acknowledges and agrees that (i) the market for nearly all of the products manufactured by RTI is worldwide, there being presently only one other company which manufactures many of RTI's products, and (ii) the covenants contained in this Agreement are fair and reasonable in light of the consideration paid hereunder and in order to protect Selas' investment in RTI, and the invalidity or unenforceability of any particular provision, or part of any provision, of this Paragraph 5 shall not affect the other provisions or parts hereof. If any provision of this Paragraph 5 is determined to be invalid or unenforceable by a court of competent jurisdiction by reason of the duration or geographical scope of the covenants contained therein, such duration or geographical scope, or both, shall be considered to be reduced to a duration or geographical scope to the extent necessary to cure such invalidity.\n.0.3.15 BENEFIT AND ASSIGNMENT. This Agreement shall be binding upon and inure to the benefit of RTI, its successors and assigns, Gorder and his heirs and legal representatives. This Agreement is not assignable by Gorder without the prior written consent of RTI. This Agreement is assignable by RTI only (i) with the prior written consent of Gorder, or (ii) to any person, firm or corporation which becomes a successor in interest (by purchase of its assets or stock, or by merger or otherwise) to RTI's business.\n.0.3.16 NOTICES. All notices required or permitted to be given under this Agreement shall be given in writing, and shall be sent by mail to the residence of Gorder then on file with RTI, and to the principal office of RTI.\n.0.3.17 CHOICE OF LAW. The provisions of this Agreement shall be interpreted and construed in accordance with the laws of the State of Minnesota.\n.0.3.18 HEADINGS AND CAPTIONS. The headings and captions of the paragraphs, sections and clauses of this Agreement are inserted for convenience of reference only and shall not constitute a part of this Agreement.\n.0.3.19 ENTIRE AGREEMENT. This Agreement and the Patent and Secrecy Agreement dated January 26, 1984 between RTI and Gorder, taken together, contain the entire understanding between RTI and Gorder concerning the subject matter hereof; and the provisions applicable thereto cannot be amended, altered, enlarged, supplemented, abridged, modified, extended or waived except in a writing duly signed by the party to be charged.\n.0.3.20 SEVERABILITY. The invalidity or unenforceability of any provisions of this Agreement or the application thereof to any person or circumstances shall not affect or impair the validity or enforceability of any other provision herein. Any provision in this Agreement that might otherwise be invalid or unenforceable because of contravention of any applicable law, statute or governmental regulation shall be deemed to be amended to the extent necessary to remove the cause of such invalidation or unenforceability and such provision, as so amended, shall remain in full force and effect.\n.0.3.21 COUNTERPARTS. This Agreement may be executed in two or more counterparts, each of which shall be deemed to be an original, but all of which shall constitute one and the same instrument.\nIN WITNESS WHEREOF, RTI and Gorder have executed this Agreement effective the date and year first above written.\nRESISTANCE TECHNOLOGY, INC. By:\/s\/ Thomas Giguere \/s\/ Mark S. Gorder\nIts Vice President for MARK S. GORDER Administration\nEXHIBIT 21\nSIGNIFICANT SUBSIDIARIES OF SELAS CORPORATION OF AMERICA\nSUBSIDIARY PLACE OF INCORPORATION\nDeuer Manufacturing, Inc. Ohio\nResistance Technology GmbH Germany Vertrieb von Elecktronikteilen\nResistance Technology, Inc. Minnesota\nSelas S.A. France\nSelas Italiana, S.A Italy\nSelas Waermetechnik, GmbH Germany\nEXHIBIT 23\nSELAS CORPORATION OF AMERICA\nEXHIBIT 23\nCONSENT OF INDEPENDENT AUDITORS\nThe Board of Directors Selas Corporation of America:\nWe consent to the incorporation by reference in the Registration Statement File No. 33-33712, on Form S-3, and the Registration Statement File No. 33-35802, on Form S-8, of Selas Corporation of America and subsidiaries of our report dated February 12, 1996 relating to the consolidated balance sheets of Selas Corporation of America and subsidiaries as of December 31, 1995 and 1994 and the related consolidated statements of operations, shareholders' equity, and cash flows and related financial statement schedules for each of the years in the three-year period ended December 31, 1995, which report appears in the December 31, 1995 annual report on Form 10-K of Selas Corporation of America.\nPhiladelphia, Pennsylvania March 25, 1996\nEXHIBIT 24\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS that the undersigned does hereby consent and appoint Stephen F. Ryan and Robert W. Ross, or either of them, his attorney to do any and all acts, including the execution of documents, which said attorneys, or either of them, may deem necessary or advisable to enable Selas Corporation of America (the \"Company\") to comply with the Securities Exchange Act of 1934, as amended, and the rules, regulations and requirements of the Securities and Exchange Commission, in connection with the filing under said Act of an annual report of the Company on Form 10-K for the year ended December 31, 1995, including the power and authority to sign in the name and on behalf of the undersigned, in any and all capacities in which the signature of the undersigned would be appropriate, such annual report and any and all amendments thereto and generally to do and perform all things necessary to be done in the premises as fully and effectually in all respects as the undersigned could do if personally present.\nIN WITNESS WHEREOF, the undersigned has hereunto set his hand and seal this 19th day of March, 1996.\n\/s\/ John H. Austin, Jr. John H. Austin, Jr.\n\/s\/ Frederick L. Bissinger Frederick L. Bissinger\n\/s\/ Roy C. Carriker Roy C. Carriker\n\/s\/ Francis J. Dunleavy Francis J. Dunleavy\n\/s\/ Mark S. Gorder Mark S. Gorder\n\/s\/ Ralph R. Whitney, Jr. Ralph R. Whitney, Jr.","section_15":""}
{"filename":"764156_1995.txt","cik":"764156","year":"1995","section_1":"Item 1. Business - ----------------- Item 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties - -------------------\nThe following discussion satisfies the reporting requirements of Items 1 and 2.\nDescription of Citizens -----------------------\nOrganizational History and Subsidiaries - ---------------------------------------\nCitizens Financial Corp., (\"Citizens\" or \"the Company\"), was organized as a Delaware business corporation on September 29, 1986, and its Certificate of Incorporation was filed with the Delaware Secretary of State on October 2, 1986. Citizens Financial Corp. was formed at the request of the Board of Directors of Citizens National Bank of Elkins, Randolph County, West Virginia, for the purpose of becoming a bank holding company within the meaning of applicable statutory and regulatory authority.\nCitizens National Bank, (\"the Bank\"), the sole subsidiary of Citizens Financial Corp., was organized on November 19, 1923 and has operated in Elkins, Randolph County, West Virginia, as a national banking association continuously since that time. On March 21, 1987, the stockholders of Citizens National Bank approved an Agreement and Plan of Reorganization whereby Citizens National Bank would become the wholly-owned subsidiary of Citizens Financial Corp. This reorganization became effective on April 30, 1987. To date, Citizens National Bank is the sole subsidiary of Citizens Financial Corp.\nEmployees - ---------\nAs of December 31, 1995 Citizens Financial Corp. had no employees. Citizens National Bank employed 71 full-time equivalent employees at that date. The Bank's employees are not represented by any union or other collective bargaining agreement and the Bank believes its employee relations are good.\nBusiness of Citizens and Citizens National Bank - -----------------------------------------------\nAs a bank holding company registered under the Bank Holding Company Act of 1956, as amended, Citizens' present business is the operation of its bank subsidiary. As of December 31, 1995 Citizens' consolidated assets approximated $126,350,000 and total shareholders' equity approximated $13,952,000.\nWhile Citizens has not and does not intend to become directly engaged in any other form of business it is permitted to engage in certain nonbanking activities which are closely related to banking under the provisions of the Bank Holding Company Act and the Federal Reserve Boards' Regulation Y. A list of such activities may be found on pages 47 through 49 of Citizens' Registration Statement on Form S-4 dated February 19, 1987 which is incorporated herein by reference.\nCitizens National Bank is a full-service commercial bank and, as such, engages in most types of business permitted by law or regulation. Among these services are the acceptance of time, demand and savings deposits\nincluding NOW accounts, regular savings accounts, money market deposit accounts, fixed-rate certificates of deposit and club accounts. In addition safe deposit box rentals, wire transfer services and 24-hour ATM services through a regional network known as MPACT are provided. MPACT is a participant in the nationwide Cirrus and Plus networks.\nThe Bank offers a full spectrum of lending services to its customers, including commercial loans and lines of credit, residential real estate loans, consumer installment loans and other personal loans. Loan terms, including interest rate, loan to value ratios, and maturities are tailored as much as possible to meet the needs of the borrower. Commercial loans are generally secured by various collateral, including commercial real estate, accounts receivable and business machinery and equipment. Residential real estate loans consist primarily of mortgages on the borrower's personal residence, and are typically secured by a first lien on the subject property. Consumer and personal loans are generally secured, often by first liens on automobiles, consumer goods or depository accounts. A special effort is made to keep loan products as flexible as possible within the guidelines of prudent banking practices in terms of interest rate risk and credit risk. Bank lending personnel adhere to established lending limits and authorities based on each individual's lending expertise and experience.\nWhen considering loan requests, the primary factors taken into consideration by the Bank are the cash flow and financial condition of the borrower, the value of the underlying collateral, if any, and the character and integrity of the borrower. These factors are evaluated in a number of ways including an analysis of financial statements, credit reviews and visits to the borrower's place of business.\nThe Bank also maintains a trust department which acts as trustee under wills, as executor and administrator of estates, as guardian for estates of minors and incompetents and serves in various corporate trust capacities.\nProperties - ----------\nThe services described above are offered from Citizens National Banks' main offices located at 213 Third Street, Elkins, West Virginia. In addition the Bank owns a drive-in facility directly across from its main offices on Third Street and it has owned and operated a full service branch bank in Parsons, West Virginia since 1984.\nIn February, 1992 an additional branch facility was opened in Beverly, West Virginia. This newest facility operates as a full service branch and provides drive-in and ATM service in addition to traditional lobby services.\nCitizens Financial Corp. does not own or lease any property. To date it has utilized the Bank's facilities and has not occupied more than a minimal amount of space. Citizens does not compensate the Bank in any way for such usage as it is deemed to be insignificant. Management believes the existing facilities are adequate to conduct the Company's and Bank's business.\nCompetition - -----------\nCitizens faces a high degree of competition for all of its services from local banks. Within its market area of Randolph and Tucker counties in West Virginia there exists 5 competing commercial banks operating numerous branches. As of June 30, 1995, the most resent date for which data are available, the Bank had deposits representing approximately 29.9% of total deposits for the five commercial banks serving its primary market area. Several in-market mergers involving local banks were completed in 1992 and\nthe introduction of a major regional competitor further consolidated the local banking industry in 1993. Such merger activity is not perceived as reducing competitive pressure. Rather it is believed to result in the establishment of stronger institutions and heightened competition.\nWest Virginia banks are allowed unlimited branch banking throughout the State. In addition, interstate acquisitions of and by West Virginia banks and bank holding companies are permissible on a reciprocal basis. West Virginia also allows reciprocal interstate acquisitions by thrift institutions. These conditions may serve to intensify future competition within Citizens' market.\nAs of September 30, 1995 there were 14 multi-bank holding companies and 33 one-bank holding companies in the State of West Virginia registered with the Federal Reserve System.\nSupervision and Regulation - --------------------------\nCitizens, as a bank holding company, is subject to the restrictions of the Bank Holding Company Act of 1956, as amended, and is registered pursuant to its provisions. As such, Citizens is subject to the reporting requirements of and examination by the Board of Governors of the Federal Reserve System (\"Board of Governors\").\nThe Bank Holding Company Act prohibits the acquisition by a bank holding company of direct or indirect ownership of more than five percent of the voting shares of any bank within the United States without prior approval of the Board of Governors. With certain exceptions, a bank holding company also 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, and from engaging directly or indirectly in business unrelated to the business of banking, or managing or controlling banks.\nAs a bank holding company doing business in West Virginia, Citizens is also subject to regulation and examination by the West Virginia Department of Banking and must submit annual reports to the Department. Further, any acquisition application which Citizens must submit to the Board of Governors must also be submitted to the West Virginia Banking Board for approval.\nOn September 29, 1994, the Bank Holding Company Act was amended by The Interstate Banking and Branch Efficiency Act of 1994 which authorizes interstate bank acquisition any where 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.\nCitizens National Bank, as a national banking association, is subject to supervision, examination and regulation by the Office of the Comptroller of the Currency. It is also a member of the Federal Reserve System, and as such is subject to applicable provisions of the Federal Reserve Act and regulations issued thereunder.\nThe deposits of the Bank are insured by the Federal Deposit Insurance Corporation (\"FDIC\") to the extent provided by law. Accordingly, the Bank is also subject to regulation by the FDIC.\nUnder the Community Reinvestment Act of 1977, the Comptroller of the Currency is required to assess the record of all financial institutions regulated by it to determine if such institutions meet the credit needs of\nthe community (including low-to-moderate income neighborhoods) served by them and to take this record into account in its evaluation of any application made by any such institution for, among other things, approval of a branch or other deposit facility, office relocation, or the merger with or acquisition of assets of another bank. The state of West Virginia has a similar statutory regulation.\nAs a subsidiary bank of a bank holding company, Citizens National Bank is subject to certain restrictions imposed by the Federal Reserve Act upon any extensions of credit to Citizens Financial Corp. or, if such existed, any of its other subsidiaries, on investments in the stock or other securities of that bank holding company or its subsidiaries, and on the taking of such stock or securities as collateral for loans to any borrower.\nItem 3.","section_3":"Item 3. Legal Proceedings - --------------------------\nAs of December 31, 1995 Citizens Financial Corp. was not involved in any material legal proceedings. The Bank is currently involved, in the normal course of business, in various legal proceedings. After consultation with legal counsel, management believes that all such litigation will be resolved without materially effecting on the financial position or results of operations. In addition, there are no material proceedings known to be threatened or contemplated against the Company or the Bank.\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 Citizens Financial Corp. during the fourth quarter of 1995.\nPart II - -------\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related - ---------------------------------------------------------- Stockholder Matters -------------------\nHistorically, the stock of Citizens Financial Corp. and, prior to its formation, the stock of Citizens National Bank, has traded only sporadically. The stock is not listed on any security exchange. However, effective November 4, 1991, Citizens established relationships with two regional brokerage firms in order to provide an efficient and orderly market for transactions involving its shares and to increase the shares' marketability. There are no further plans, understandings, arrangements or agreements to list the stock on any exchange at this time.\nCitizens has only one class of stock, that being common stock, and all voting rights are vested in its holders. The shareholders of Citizens are entitled to one vote for each share of common stock owned on all matters subject to a vote of shareholders. The Company has no plans to issue senior securities.\nAs of December 31, 1995 750,000 shares were issued including 66,212 held as treasury stock. The Company's outstanding shares are held by approximately 486 shareholders of record.\nThe following table presents the high and low market prices for Citizens' common stock for the periods indicated.\nThe prices listed above are based upon information available to Citizens' management and are believed to accurately represent the amount at which its stock was traded during the periods indicated. No attempt was made by management to ascertain the prices for every sale made during these periods.\nCitizens shareholders are entitled to receive dividends when and as declared by its Board of Directors. Dividends are typically paid quarterly. Aggregate dividends were $.70 per share in 1995 and $.60 per share in 1994. Dividends are paid out of funds legally available for the payment of dividends as set forth in the West Virginia Corporation Act.\nPayment of dividends by Citizens is dependent upon payment of dividends to it by the subsidiary bank. The ability of national banks to pay dividends is subject to certain limitations imposed by national banking laws - See Note 12 of the Notes to Consolidated Financial Statements found on page 41 of this report, for further discussion.\nItem 6.","section_6":"Item 6. Selected Financial Data - --------------------------------\nSelected financial data for the five years ended December 31, 1995 is presented in the following table. This summary should be read in conjunction with the consolidated financial statements and related notes included in Item 8 of this report.\nDistribution of Assets, Liabilities & Shareholders' Equity; Interest Rates and Interest Differential\n(1) Yields are expressed on a tax equivalent basis using a 34% tax rate.\n(2) For the purpose of these computations, nonaccruing loans are included in the amounts of average loans outstanding.\nRate Volume Analysis\nThe following table sets forth a summary on the changes in interest earned and interest expense detailing the amounts attributable to (i) changes in volume (change in the average volume times the prior year's average rate), (ii) changes in rate (change in the average rate times the prior year's average volume). The changes in rate\/volume (change in the average volume times the change in the average rate), has been allocated to the changes in volume and changes in rate in proportion to the relationship of the absolute dollar amounts of the change in each.\nSecurities Portfolio\nThe following table sets forth the amortized cost of securities as of the dates indicated.\nThe following table sets forth the maturities of securities as of December 31, 1995 and the weighted average yields of such securities (calculated on the basis of the amortized cost and effective yields weighted for the scheduled maturity of each security).\nThe portfolio contains no securities of any single issuer in which the aggregate amortized cost of such securities exceeds ten percent of shareholders' equity.\n(1) Tax-equivalent adjustments, using a rate of 34%, have been made in calculating yields on obligations of state and political subdivisions.\nLoan Portfolio - --------------\nTypes of Loans - --------------\nThe following table shows the distribution of loans by major category as of the dates indicated. All loans in the portfolio are domestic in nature.\nLoan Maturities and Interest Rate Sensitivity - ---------------------------------------------\nThe following table shows the maturity of loans (excluding real estate mortgages and installment loans) outstanding as of December 31, 1995. Also provided are the amounts due after one year classified as fixed rate and variable rate loans.\nRisk Elements - -------------\nNonperforming Loans - -------------------\nNonperforming loans consist of loans in nonaccrual status, loans which are past due 90 days or more and still accruing interest and restructured loans. The following table sets forth the amounts of such loans as of the dates indicated:\nLoans are generally placed on nonaccrual status when they are past due 90 days as to principal or interest unless they are both well secured and in the process of collection. The following table provides a summary of information pertaining to nonaccrual loans as of December 31, 1995:\nPotential Problem Loans - -----------------------\nAs of December 31, 1995, management is not aware of any potential problem loans other than those which are on nonaccrual status or are past due 90 days or more and still accruing interest.\nLoan Concentrations - -------------------\nInformation concerning loan concentrations is provided in Note 4 - Notes to Consolidated Financial Statements which may be found on page 33 of this report.\nSummary of Loan Loss Experience - -------------------------------\nThe following table summarizes loan loss experience for the two years ended December 31, 1995 and 1994.\n(1) The amount charged to operations and the related balance in the allowance for loan losses is based upon periodic evaluations of the loan portfolio by management. These evaluations consider several factors including, but not limited to, its analysis of overall loan quality, changes in the mix and size of the loan portfolio, previous loss experience, general economic conditions and information about specific borrowers.\nThe following table shows an allocation of the allowance for loan losses for the two years ended December 31, 1995 and 1994.\nDeposits - -------- The average daily amount of deposits and rates paid on such deposits are summarized for the periods indicated in the following table:\nThe following table summarizes maturities of time certificates of deposit, including individual retirement accounts, of $100,000 or more as of December 31, 1995. There were no other time deposits of $100,000 or more.\nReturn on Equity and Assets - ---------------------------\nThe following table shows consolidated operating and capital ratios for the periods indicated.\nShort-term Borrowing - --------------------\nInformation concerning the Company's short-term borrowing is presented in Note 10 - Notes to Consolidated Financial Statements which may be found on pages 39 and 40 of this report.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and - -------------------------------------------------------------------------- Results of Operations ---------------------\nThe following discussion and analysis presents the significant changes in financial condition and results of operations of Citizens Financial Corp., and its wholly-owned subsidiary Citizens National Bank of Elkins, for the periods covered by the audited financial statements contained in this report. This discussion and analysis should be read in conjunction with such financial statements and the accompanying notes thereto.\nEarnings Summary - ----------------\nNet income for the year 1995 was $1,626,000 or $2.36 per share. This compares to $1,110,000, or $1.60 per share, in 1994 and $1,140,000, or $1.65 per share, including a $116,000 one-time cumulative benefit from the adoption of Statement of Financial Accounting Standards No. 109 \"Accounting for Income Taxes\" in 1993. Return on average assets was 1.29% in 1995, .89% in 1994 and .91% in 1993. Returns on average equity were 12.07%, 8.78% and 9.52% in the three years respectively.\nThe primary factor contributing to the 46.5% earnings improvement in 1995 was a $589,000 increase in net interest income. Other factors include improved levels of noninterest income and a reduction in noninterest expense. While smaller, improvement in 1994's earnings before accounting changes of 8.4% was also mainly due to improved net interest income of $357,000. However, noninterest expenses increased $245,000 in 1994 which reduced the level of net earnings improvement. These and other factors relating to the results of operations are more fully addressed in the following sections of this report.\nNet Interest Income - -------------------\nNet interest income represents the primary component of Citizens' earnings. It is the difference between interest and fee income related to earning assets and interest expense incurred to carry interest bearing liabilities. Net interest income is impacted by changes in the volume and mix of interest earning assets and interest bearing liabilities, as well as by changing interest rates. In order to manage these changes, their impact on net interest income and the risks associated with them, the Company utilizes an ongoing asset\/liability management program. This program includes analysis of the Company's gap, earnings sensitivity to rate changes, and sources and uses of funds. A discussion of net interest income and the factors impacting it is presented below.\nNet interest income was $5,945,000 in 1995, $5,356,000 in 1994 and $4,999,000 in 1993. These year-to-year improvements of 11.0% in 1995 and 7.1% in 1994 each contributed significantly to the Company's improved earnings.\nOn a tax equivalent basis net interest income in 1995 increased $640,000 as a result of two primary factors: increased yields on the Bank's loan portfolio and increased loan volumes. The yield on this portfolio improved 101 basis points to 9.20% as adjustable rate mortgages repriced and consumer\nloans were added to the portfolio. This increase in yield had the effect of increasing interest income by $740,000. Higher loan volumes, including consumer and commercial loans, had the effect of increasing interest income an additional $588,000. The remaining interest earning assets, securities and federal funds sold, contributed less to income in 1995 than in 1994 as their volumes were reduced to fund loan growth. In total the yield on earning assets improved 80 basis points to 7.99% in 1995 while the average volume of earning assets increased $1,115,000 to $120,522,000.\nThe cost of interest bearing liabilities used to fund earning assets increased by $399,000 in 1995 but was more than offset by the $1,039,000 increase in tax equivalent interest income. The net impact of changes in the volume and mix of interest bearing liabilities was minimal adding just $30,000 to interest expense. Changing rates, particularly those of time deposits, caused a $369,000 increase in expense. Such changes caused the total cost of interest bearing liabilities to rise to 3.65% in 1995, a 43 basis point increase.\nOverall, the execution of strategies to increase loan levels and control funding costs in 1995 increased the Company's net interest margin 49 basis points from 4.57% to 5.06%.\nIn 1994 tax equivalent net interest income improved by $286,000 over 1993. The most significant factors in this improvement were a $1,523,000 increase in interest earning assets and a $1,125,000 reduction in interest sensitive liabilities. These two items combined to increase net interest income by $201,000. Meanwhile changes in interest rates had the effect of increasing net interest income another $85,000 as the savings from paying lower rates on deposits exceeded the reductions in interest income from earning assets. These changes produced a net interest margin of 4.57% in 1994, up 19 basis points from 4.38% in 1993.\nOther Income - ------------\nOther income includes all revenues which are not included in interest and fee income related to earning assets. Total other income has risen from $369,000 in 1993 to $418,000 in 1994 and to a record $476,000 in 1995. This positive trend reflects several items. First is management's effort, begun in 1994, to identify and recover costs through the imposition of reasonable service fees similar to those of the Bank's competitors. This effort has increased annual fee income from $172,000 in 1993 to $258,000 in 1995. Secondly, new services have helped raise the levels of fee income. In particular, 1995's introduction of a VISA card generated nearly $11,000 in merchant fees. Each of these factors are expected to provide continuing future benefit.\nOther income also benefitted in 1995 from the one-time sale of the Company's student loan portfolio. This sale, which involved approximately $2.5 million of student loans, generated a gain of $25,000.\nTrust income, which increased significantly in 1994, fell to more typical levels in 1995 as expected. The increase in 1994 was due to the settlement of several large estates. Finally, the Company has realized insignificant securities gains of $7,000 in 1995, $2,000 in 1994 and $5,000 in 1993. All of these gains were the result of securities being called at a premium over amortized cost. It remains the Company's policy not to engage in securities trading activity.\nOther Expenses - --------------\nOther expense includes all items of expense other than interest expense, the provision for loan losses, and income taxes. Other expense decreased $104,000, or 2.6%, in 1995 to $3,913,000. Total other expense was $4,016,000 and $3,772,000 on 1994 and 1993, respectively.\nThe 1995 reduction in other expense is attributable to a reduction of FDIC insurance premiums of $121,000. Absent this total other expense would have increased by $17,000, or less than .5%.\nThe largest component of other expense, salaries and benefits, remained nearly stable in 1995. Total salaries increased a modest 2.1%. Group insurance costs were reduced by $60,000 to $353,000 due mostly to engaging a new group medical administrator. This savings was offset however by the introduction of a deferred compensation plan for certain senior officers. This plan, which was implemented following a reduction in pension benefits, is designed to retain key management personnel by providing retirement benefits in exchange for continued service to the Bank and carried a cost of $61,000 in 1995. The Company also provides pension, 401(k) and postretirement life and health coverages to all qualifying full-time employees. See Note 9 of the accompanying financial statements for additional information regarding the Company's employee benefit plans.\nThe remaining components of other expense, including net occupancy expense, equipment expense, data processing, advertising, and other, totaled $1,806,000, up less than 1%, from $1,791,000 in 1994.\nThe increase in total other expense in 1994 of $245,000, or 6.5%, resulted from a $130,000 increase in salaries and benefits, including a $95,000 rise in group insurance costs, and a $41,000 increase in the category of other which primarily resulted from losses from a robbery of one of the Bank's branch facilities.\nIncome Taxes - ------------\nThe Company's provision for income taxes, which totaled $823,000 in 1995, $599,000 in 1994 and $482,000 in 1993, includes both federal and state income taxes. Also included in these amounts are deferred tax benefits of $21,000 in 1995 and $41,000 in 1994 and deferred tax expense of $8,000 in 1993. The increase in tax expense in 1995 is mainly due to the increase in pretax earnings. The effective tax rates for the years 1995, 1994 and 1993 were 33.6%, 35.1% and 32.0%, respectively.\nIn 1993, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (SFAS No. 109). As permitted under the provisions of SFAS No. 109, the cumulative effect of the accounting change on years prior to 1993, a benefit of $116,000, was included in 1993's earnings. Additional information regarding the Company's income taxes is contained in Note 8 of the consolidated financial statements.\nFinancial Condition - -------------------\nWhile total assets at December 31, 1995 of $126,350,000 are $2,423,000 over the prior year's total, average assets during the two years were nearly unchanged. Average assets during 1995 totaled $125,834,000, $470,000 in excess of 1994's $125,364,000. This reflects management's efforts to increase the loan to deposit ratio and net interest margin during 1995 while accepting the limits placed on deposit growth by a sluggish local economy. The execution of this strategy proved to be very successful as gross loans\nincreased $14.9 million during the year raising the loan to deposit ratio from 63.6% to 76.3% and the net interest margin 49 basis points to 5.06%. As explained previously, this was the primary contributor to the Company's earnings improvement in 1995.\nLoan Portfolio - --------------\nThe loan portfolio represents Citizens' largest earning asset. As noted earlier, management placed major emphasis on increasing loans in 1995 and was quite successful in doing so. The $14.9 million increase in total loans resulted primarily from growth in the consumer, commercial and mortgage portfolios.\nConsumer loans, including credit card loans, increased $7,213,000 or 62.0%. This increase primarily reflects a significant rise in indirect automobile lending. During the year the Bank availed itself of new opportunities to make such loans following the completion of a local highway which provided convenient access to auto dealers in nearby markets. Loans made under this program are subject to evaluation by the Bank's lending personnel and must satisfy the Bank's standard lending criteria prior to approval. Also effecting the consumer loan portfolio was the sale of $2.5 million of student loans in 1995. Proceeds from the sale of student loans were used to partly fund the increased automobile business resulting in higher yields and lower administrative cost.\nThe Bank's new Mountain Playground VISA card was introduced at the end of the first quarter and has performed better than expected. At December 31, 1995 total outstanding VISA card loans were $810,000. A total of 864 customers now carry this unique product with approved credit lines exceeding $3,344,000.\nAt $18,852,000 consumer loans now represent 22.5% of total loans, up from $16.9% at December 31, 1994.\nCommercial loans increased $4,144,000 or 60.4% in 1995 to $10,999,000. While some of this increase may also be traced to new lending relationships with automobile dealers in the form of floor plan financing, the Bank's success in meeting the credit needs of local lumber, oil, building and professional businesses also contributed to the growth. Management is pleased with this growth and believes that it adds considerably to the breadth of the Bank's loan portfolio and services.\nAlthough it increased by a lesser amount, $2,576,000 or 5.2%, mortgage lending continues to be the largest single loan portfolio held by the Bank. Totaling $52,020,000 this portfolio makes up 62.2% of total loans. The majority of the mortgage portfolio, over 69%, is comprised of loans secured by one to four family primary residence loans in the local area, where real estate values have historically remained stable.\nAdditional information on the composition of the loan portfolio, including concentrations of credit risk, may be found in Note 4 to the financial statements.\nWhile loan growth has been substantial, Citizens maintains underwriting and credit standards designed to maintain the quality of the loan portfolio. In addition, strategic goals limit the loan to deposit ratio to 80%. The Company also observes a policy requiring loans past due 90 or more days be placed on nonaccrual status unless the loans are adequately secured and in the process of collection. As of December 31, 1995 nonaccrual loans totaled $213,000 while loans past due 90 or more days which are still accruing\ninterest were $144,000. Together, these two items total $357,000 or .43% of gross loans. In comparison, the total at December 31, 1994 of $425,000 represented .62% of gross loans.\nManagement maintains the allowance for loan losses at a level it considers adequate to absorb potential loan losses based on its analysis of overall loan quality, changes in the mix and size of the loan portfolio, previous loss experience, general economic conditions, information about specific borrowers and other factors. At December 31, 1995 the allowance for loan losses was $1,036,000 or 1.24% of gross loans. This compares to $1,000,000, or 1.46%, a year ago.\nAs more fully explained in Notes 1 and 5 of the financial statements, the Company adopted Statements of Financial Accounting Standards Nos. 114 and 118 (SFAS Nos. 114 and 118) \"Accounting by Creditors for Impairment of a Loan\" and \"Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosure\", respectively. Under SFAS Nos. 114 and 118, certain impaired loans are required to be reported at the present value of expected future cash flows discounted using the loan's original effective interest rate or, alternatively, at the loan's observable market price, or at the fair value of the loan's collateral if the loan is collateral dependent. The adoption of SFAS Nos. 114 and 118 did not significantly impact the Company's financial position or results of operations during 1995.\nThe provision for loan losses is a charge to earnings which is made to maintain the allowance for loan losses at a sufficient level. This charge totaled $60,000 in 1995, $49,000 in 1994 and $90,000 in 1993. Net charge-offs continue to be low reflecting both the quality of the portfolio and management's effort to pursue all available avenues of recovery. Total net charge-offs were $24,000 in 1995, $92,000 in 1994 and $2,000 in 1993. Each of these totals represented less than .15% of average loans.\nAlthough the dollar amount of net charge-offs could increase in the coming months due to the increase in total loans outstanding, management believes the balance of the allowance for loan loss is adequate to provide for all reasonably foreseeable losses and is not aware of any trends, uncertainties or other information relating to the loan portfolio which it expects will materially impact future operating results, liquidity or capital resources.\nSecurities Portfolio and Federal Funds Sold - -------------------------------------------\nWith loan demand exceeding deposit growth in 1995 the securities portfolio was frequently used as a source of liquidity for the purpose of funding loans. Excluding the fair value adjustment for available for sale securities, the total portfolio decreased $15,190,000 in 1995, or 30.7%. This decrease was anticipated as strategies to increase the loan to deposit ratio and alter the earning asset mix were executed. Further significant reductions are not expected in 1996 as loan demand is expected to decline. Internal policies concerning the loan to deposit ratio and earning asset mix also serve to limit further securities reductions.\nThe Bank maintains a conservative philosophy with regard to its securities portfolio placing great importance on safety and liquidity. At year-end 1995 the portfolio was comprised of 29% U.S. Treasury securities, 24% U.S. agency securities, 8% mortgage backed securities issued by U.S. government agencies, 23% corporate debt securities, 14% municipal securities and 2% Federal Home Loan Bank stock and Federal Reserve Bank stock. The corporate debt securities carry a grade of A1 and an average remaining life of 0.63 years. The municipal securities carry a grade of A with a remaining\nlife of 4.31 years. In total the portfolio has a grade of AA. The remaining life, which is normally kept short, has been shortened even more by 1995's heavy loan demand to 1.65 years. The average yield on the portfolio is 5.76%.\nEffective January 1, 1994 the Company adopted Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" (SFAS No. 115). Under SFAS No. 115 securities are to be classified as held to maturity, available for sale, or trading. Through December 31, 1995 the Company has elected not to establish a trading portfolio and has no plans to do so in the foreseeable future.\nThe Bank classified its two equity securities as available for sale in 1994. During 1995, the Bank reassessed the classifications of its securities and transferred $3.2 million of securities from held to maturity to available for sale as permitted by the Financial Accounting Standards Board's Special Report \"A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities\". As of December 31, 1995 the available for sale portfolio was comprised of five debt securities in addition to the two equity securities. It carried an amortized cost of $5,743,000, 16.7% of the total portfolio, and had a fair value of $5,758,000. With $18.9 million of maturing securities in 1996 the Bank is in a good position to make further additions to the available for sale portfolio if it so chooses.\nIn times of excess funding Citizens may enter the federal funds sold market to maximize yields while maintaining the desired asset\/liability structure. Such investments were nonimal in 1995 as a result of the increased loan demand. On average, the Bank's federal funds sold balance was $677,000 in 1995 compared to $2,295,000 in 1994.\nDeposits and Other Funding Sources - ----------------------------------\nWhile Citizens attempts to control the rates offered on its deposit products through a consistent pricing policy, certain short-term exceptions to this did occur in 1995 in response to competitive pressures. These pressures have been mounting due to the increasing sophistication of customers, the general lack of local economic growth and the increasing levels of bank and nonbank competition. As a result, the rate paid on interest bearing liabilities rose in 1995 from 3.22% to 3.65%.\nIn total, the deposit portfolio averaged $109,211,000 in 1995 compared to $110,160,000 in 1994, a decrease of less than 1%, and $109,412,000 in 1993. Management believes this data reflects a stable core deposit base as well as the economic characteristics of the local market. Still, some changes were observed. Certificates of deposit rose throughout the year to $47,423,000 from $43,369,000 an increase of 9.3%. This primarily reflects a migration from savings accounts in response to the competitive pricing pressures noted earlier. Over the past two years savings accounts have fallen $4,829,000, a near reversal of 1993 when they grew $4,211,000 when certificate of deposit rates fell.\nHistorically, the Bank has borrowed only occasionally. The majority of the Bank's borrowings continue to be a floating rate repurchase agreement involving one local customer. From time to time the Bank may also require short-term funding which it typically satisfies with overnight borrowings. Such borrowings averaged $676,000 in 1995, nearly equaling its involvement in federal funds sold. Additional information on the Bank's borrowing activities is found in Note 10 to the financial statements.\nCapital Resources - -----------------\nWhile the Company seeks to maximize shareholder value by improving profits, such efforts are not undertaken without careful consideration of the attendant risks to both the preservation of shareholders' investments and depositors funds. Management believes that maintaining adequate levels of capital provides the best means to balancing these key demands. During 1995 shareholders' equity grew 7.5% to $13,952,000. This increase is the direct result of the Bank's record earnings and places capital at 11.04% of assets.\nThe Federal Reserve's risk-based capital guidelines provide another means of measuring the Bank's stability by weighting both on-balance-sheet and off- balance-sheet items based on their degree of risk. As of December 31, 1995 the Company's risk-based capital ratios were well in excess of the required minimums as shown in the following table.\nThe book value of the Company increased in 1995 to $20.40 per share from $18.75 as a result of net retained earnings. Although not heavily traded, the market value of the Company's stock traded in a range from $21.00 per share to $25.50 per share in 1995. This compares to 1994's range of $20.00 to $23.25 per share. Dividends also rose in 1995, the fourth straight annual increase, to $.70 per share from $.60. Each of these measures, book value, market value and dividends, are record highs for the Company.\nThe Company has no plans which would significantly alter either its capital structure or capital level.\nLiquidity and Interest Rate Sensitivity - ---------------------------------------\nThe objective of the Company's liquidity management program is to ensure the continuous availability of funds to meet the withdrawal demands of depositors and the credit needs of borrowers. The basis of Citizens' liquidity comes from the stability of its core deposits. Liquidity is also available through the available for sale securities portfolio, held to maturity securities due within one year, and short-term funds such as federal funds sold. At December 31, 1995 these sources totaled $27,709,000 or 21.9% of total assets. In addition, liquidity may be generated through loan repayments and over $23,000,000 of available borrowing arrangements with correspondent banks. Management believes the liquidity of the Bank is sufficient to satisfy all anticipated demands. Details on both the sources and uses of cash are presented in the Statements of Cash Flows contained in the financial statements.\nThe objective of the Company's interest rate sensitivity management program, also know as asset\/liability management, is to maximize net interest income while minimizing the risk of adverse effects from changing interest\nrates. This is done by controlling the mix and maturities of interest sensitive assets and liabilities. The Bank has established an asset\/liability committee for this purpose.\nOne common interest rate risk measure is the gap, or the difference between rate sensitive assets and rate sensitive liabilities. A positive gap occurs when rate sensitive assets exceed rate sensitive liabilities. This tends to be beneficial in rising interest rate environments. A negative gap refers to the opposite situation and tends to be beneficial in declining interest rate environments. The following table presents an analysis of the Company's interest rate sensitivity as measured by the gap at December 31, 1995. This information includes various assumptions and estimates regarding the maturity and prepayment patterns of certain instruments.\nThe preceding table reflects the Company's cumulative net interest sensitive position, or gap, as $(34,150,000) through three months, $(20,671,000) through six months and $13,556,000 through one year. Thus, the Bank has a positive one year gap of $13,556,000, or 11.19% of sensitive assets. This asset sensitive position suggests that should interest rates fall in the next year net interest income may be reduced while rising interest rates could have the opposite effect. The Company may reduce its degree of asset sensitivity by lengthening the repricing horizons of its assets, primarily by lengthening the maturities of its security portfolio, or by encouraging depositors to accept short-term deposit products. The large negative gap in the 0-90 day category is due to the placement of $47.6 million of savings, money market and checking plus deposits in this position. Interest rates on these deposits are determined by management and can be changed at any time. Management's ability to manage these rates in a beneficial manner has a significant impact on net interest income.\nIt should be noted that the gap analysis presented above is a static analysis as of December 31, 1995. As such, it does not consider variables such as future loan and deposit volumes, mixes or interest rates.\nImpact of Inflation - -------------------\nThe consolidated financial statements and related data included in this report were prepared in accordance with generally accepted accounting principles, which require the Company's financial position and results of operations to be measured in terms of historical dollars. Consequently, the relative value of money generally is not considered. Nearly all of the Company's assets and liabilities are monetary in nature and, as a result, interest rates and competition in the market area tend to have a more significant impact on the Company's performance than the effect of inflation.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data - ----------------------------------------------------\nFinancial statements required by this item are presented below:\nCITIZENS FINANCIAL CORP. AND SUBSIDIARY\nSee Notes to Consolidated Financial Statements\nCITIZENS FINANCIAL CORP. AND SUBSIDIARY\n(Continued)\nSee Notes to Consolidated Financial Statements\nCITIZENS FINANCIAL CORP. AND SUBSIDIARY\n(Continued)\nSee Notes to Consolidated Financial Statements\nCITIZENS FINANCIAL CORP. AND SUBSIDIARY\nSee Notes to Consolidated Financial Statements\nCITIZENS FINANCIAL CORP. AND SUBSIDIARY\nNotes to Consolidated Financial Statements\nNote 1. Significant accounting policies:\nThe accounting and reporting policies of Citizens Financial Corp. and its wholly owned subsidiary conform to generally accepted accounting principles and to general practices within the banking industry. 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. The following is a summary of the more significant accounting policies.\nPrinciples of consolidation: The accompanying consolidated financial statements include the accounts of Citizens Financial Corp. and its wholly owned subsidiary, Citizens National Bank. All significant intercompany accounts and transactions have been eliminated in consolidation.\nPresentation of cash flows: For purposes of reporting cash flows, cash and cash equivalents includes cash on hand, balances due from banks (including cash items in process of clearing) and Federal funds sold. Cash flows from demand deposits, NOW accounts and savings accounts are reported net since their original maturities are less than three months. Cash flows from loans and certificates of deposit and other time deposits are also reported net.\nSecurities: Effective January 1, 1994, the Company adopted Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" (SFAS No. 115). Under SFAS No. 115, securities are classified as \"held to maturity\", \"available for sale\" or \"trading\". The appropriate classification is determined at the time of purchase of each security and re-evaluated at each reporting date.\nSecurities held to maturity - Debt securities for which the Company has the --------------------------- positive intent and ability to hold to maturity are reported at cost, adjusted for amortization of premiums and accretion of discounts.\nSecurities available for sale - Securities not classified as \"held to ----------------------------- maturity\" or as \"trading\" are classified as \"available for sale\". Securities classified as \"available for sale\" are those securities the Company intends to hold for an indefinite period of time, but not necessarily to maturity. \"Available for sale\" securities are reported at fair value. Unrealized gains or losses, adjusted for applicable income taxes are reported as a separate component of shareholders' equity.\nTrading securities - There are no securities classified as \"trading\" in the ------------------ accompanying financial statements.\nRealized gains and losses on sales of securities are recognized on the specific identification method. Amortization of premiums and accretion of discounts are computed using the interest method.\nLoans and allowance for loan losses: Loans are stated at the amount of unpaid principal, reduced by unearned discount and an allowance for loan losses. Interest is recognized on an amortized basis.\nThe allowance for loan losses is maintained at a level considered adequate to provide for losses that can be reasonably anticipated. The allowance is increased by provisions charged to operating expense and reduced by net charge- offs. The subsidiary bank makes continuous credit reviews of the loan portfolio and considers current economic conditions, historical loan loss experience, review of specific problem loans and other factors in determining the adequacy of the allowance for loan losses. Loans are charged against the allowance for loan losses when management believes that the collectibility of the principal is unlikely.\nIn 1995, the Company adopted Statements of Financial Accounting Standards Nos. 114 and 118 (SFAS Nos. 114 and 118) \"Accounting by Creditors for Impairment of a Loan\" and \"Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosure\", respectively. Under SFAS Nos. 114 and 118, a loan is impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due in accordance with the contractual terms of the specific loan agreement. Impaired loans, other than certain large groups of smaller-balance homogeneous loans that are collectively evaluated for impairment, are required to be reported at the present value of expected future cash flows discounted using the loan's original effective interest rate or, alternatively, at the loan's observable market price, or at the fair value of the loan's collateral if the loan is collateral dependent. The method selected to measure impairment is made on a loan-by-loan basis, unless foreclosure is deemed to be probable, in which case the fair value of the collateral method is used. The implementation of SFAS Nos. 114 and 118 did not have a significant impact on the accompanying financial statements.\nInterest is accrued daily on impaired loans unless the loan is placed on non- accrual status. Impaired loans are placed on non-accrual status when the payments of principal and interest are in default for a period of 90 days, unless the loan is both well-secured and in the process of collection. Interest on non-accrual loans is recognized primarily using the cost-recovering method.\nLoan origination fees and certain direct loan origination costs are deferred and amortized as adjustments of the related loan yield over its contractual life.\nBank premises and equipment: Bank premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed primarily by the straight-line method over the estimated useful lives of the assets. Repairs and maintenance expenditures are charged to operating expense as incurred. Major improvements and additions to premises and equipment are capitalized.\nOther real estate: Other real estate consists of real estate held for resale which was acquired through foreclosure on loans secured by such real estate. At the time of acquisition, these properties are recorded at the lower of cost or appraised market value with any writedown being charged to the allowance for loan losses. Expenses incurred in connection with operating these properties are charged to operating expense. Gains and losses on the sales of these properties are credited or charged to operating income in the year of the transaction.\nSales of these properties which are financed by the subsidiary bank and meet the criteria of covered transactions remain classified as other real estate until such time as principal payments have been received to warrant classification as a real estate loan.\nOrganization costs: Organization costs are being amortized on a straight-line basis over a period of fifteen years. Unamortized organization costs totaled $195,483 at December 31, 1995.\nPension plan: The subsidiary bank has a defined benefit pension plan covering substantially all employees. Pension costs are actuarially determined and charged to expense.\nPostretirement benefits: The subsidiary bank provides certain health care and life insurance benefits for all retired employees that meet certain eligibility requirements. During 1993, the Company adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits other than Pensions\" (SFAS No. 106) to account for its share of the costs of those benefits. Under SFAS No. 106, the Company's share of the estimated costs that will be paid after retirement is generally being accrued by charges to expense over the employees' active service periods to the dates they are fully eligible for benefits, except that the Company's unfunded cost at January 1, 1993 is being accrued primarily on a straight-line basis through the year ending 2013.\nIncome taxes: During 1993, the Company adopted the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (SFAS No. 109), which changed the criteria for measuring the provisions for income taxes and recognizing deferred tax assets and liabilities. Deferred tax assets and liabilities are determined based on differences between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.\nValuation allowances are established when deemed necessary to reduce deferred tax assets to the amount expected to be realized.\nThe consolidated provision for income taxes includes Federal and state income taxes and is based on pretax income reported in the consolidated financial statements, adjusted for transactions that may never enter into the computation of income taxes payable.\nEarnings per share: Earnings per common share are computed based upon the weighted average shares outstanding. The weighted average shares outstanding were 687,598, 691,920 and 691,920 for the years ended December 31, 1995, 1994 and 1993, respectively.\nTrust department: Assets held in an agency or fiduciary capacity by the subsidiary bank's trust department are not assets of the Bank and are not included in the accompanying balance sheets. Trust department income is recognized on the cash basis in accordance with customary banking practice. Reporting such income on a cash basis rather than the accrual basis does not affect net income materially.\nNote 2. Cash Concentrations\nAt December 31, 1995, the subsidiary bank had a concentration totaling $3,075,518 with Mellon Bank, NA, which consisted of a due from bank balance and Federal funds sold. At December 31, 1994, the subsidiary bank had no such concentrations.\nNote 3. Securities\nIn connection with the adoption of SFAS No. 115, certain securities totaling $475,900 (at amortized cost) were classified as available for sale. The adoption of SFAS No. 115 had no impact on the Company's assets, shareholders' equity or net income.\nDuring 1995, concurrent with the adoption of the Special Report \"A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities\" issued by the Financial Accounting Standards Board, the Company reassessed the classifications of its securities and transferred securities with amortized cost of $3,210,789 and estimated fair value of $3,206,221 from the held to maturity category to the available for sale category. Accordingly, shareholders' equity was decreased $2,809, net of deferred income taxes of $1,759, to reflect the net unrealized holding loss on such securities. This reclassification did not have an impact on the accompanying statements of income.\nThe amortized cost, unrealized gains, unrealized losses and estimated fair values of securities at December 31, 1995 and 1994, are summarized as follows:\nThe maturities amortized cost and estimated fair values of the Company's securities at December 31, 1995 are summarized as follows:\nMortgage-backed securities having remaining contractual maturities ranging from 1 to 6 years have been allocated in the above maturity categories based on their anticipated average lives to maturity, which range from 1 to 2 years.\nThe proceeds from sales, calls and maturities of securities, including principal payments received on mortgage-backed securities and the related gross gains and losses realized are as follows:\nAt December 31, 1995 and 1994, securities carried at $6,523,349 and $5,157,985, respectively, with estimated fair values of $6,564,476 and $5,027,292, respectively, were pledged to secure public deposits, securities sold under agreements to repurchase, and for other purposes required or permitted by law.\nIncluded in corporate debt securities at December 31, 1995, are obligations of financial services industry companies with global operations with an approximate carrying value of $6,041,113 and an estimated fair value of $6,074,100.\nNote 4. Loans\nLoans are summarized as follows:\nIncluded in the above balance of net loans are nonaccrual loans amounting to $213,316 and $281,629 at December 31, 1995 and 1994, respectively. If interest on nonaccrual loans had been accrued, such income would have approximated $7,297, $41,725 and $0 for the years ended December 31, 1995, 1994 and 1993, respectively.\nIn the past, the subsidiary bank has made loans, in the normal course of business, to its directors, executive officers and their related interests, and will continue to make such loans in the future. At December 31, 1995 and 1994, outstanding loans of this nature totaled $3,950,576 and $2,415,857, respectively.\nThe following presents the activity with respect to related party loans aggregating $60,000 or more to directors, executive officers, and their related interests of Citizens Financial Corp. and subsidiary during the years ended December 31, 1995 and 1994:\nConcentrations of credit risk: The Company's subsidiary, Citizens National Bank, grants installment, commercial and residential loans to customers in Randolph County, West Virginia, and surrounding counties in striving to maintain a diversified loan portfolio.\nAs of December 31, 1995, Citizens National Bank had direct and indirect extensions of credit to automobile dealers totaling approximately $6,487,669. These loans consist of automobile floor plan loans, commercial loans generally secured by liens on the pledges of accounts receivable, inventories or personal guarantees and indirect installment loans with recourse against dealers to finance consumer purchases of automobiles. The Bank evaluates each such customer's credit worthiness on a case-by-case basis. The amount of collateral obtained is based upon management's credit evaluation.\nIn addition to the above, the Bank has direct extensions of credit to individuals and other entities for residences, vacation homes and condominiums in the ski areas surrounding Randolph County, West Virginia. These loans totaled approximately $3,802,484 at December 31, 1995, and consist of real estate installment contracts generally secured by liens on the property. The Bank evaluates each such customer's credit worthiness on a case-by-case basis.\nNote 5. Allowance for Loan Losses\nAn analysis of the allowance for loan losses for the years ended December 31, 1995, 1994 and 1993, is as follows:\nAs explained in Note 1, the Company adopted SFAS Nos. 114 and 118 in 1995. The Company's total recorded investment in impaired loans at December 31, 1995, approximated $105,523, for which the related allowance for loan losses determined in accordance with SFAS Nos. 114 and 118 approximated $0. The Company's average investment in such loans approximated $107,701 for the year ended December 31, 1995. All impaired loans at December 31, 1995, were collateral dependent, and accordingly, the fair value of the loan's collateral was used to measure the impairment of each.\nFor purposes of SFAS Nos. 114 and 118, the Company considers groups of smaller-balance, homogeneous loans to include: mortgage loans secured by residential property, other than those which significantly exceed the subsidiary bank's typical residential mortgage loan amount (currently those in excess of $100,000); small balance commercial loans (currently those less than $50,000); and installment and credit card loans to individuals, exclusive of those loans in excess of $50,000.\nFor the year ended December 31, 1995, the Company recognized approximately $8,847 in interest income on impaired loans. Using a cash basis-method of accounting, the Company would have recognized approximately the same amount of interest income on such loans.\nNote 6. Bank Premises and Equipment\nThe major categories of bank premises and equipment and accumulated depreciation at December 31, 1995 and 1994, are summarized as follows:\nDepreciation expense for the years ended December 31, 1995, 1994 and 1993, totaled $249,242, $249,860 and $246,978, respectively.\nNote 7. Deposits\nThe following is a summary of interest bearing deposits by type as of December 31, 1995 and 1994:\nInterest expense on deposits is summarized below:\nNote 8. Income Taxes\nThe components of applicable income tax expense (benefit) for the years ended December 31, 1995, 1994 and 1993, are as follows:\nDeferred income taxes reflect the impact of \"temporary differences\" between amounts of assets and liabilities for financial reporting purposes and such amounts as measured for tax purposes. Deferred tax assets and liabilities represent the future tax return consequences of temporary differences, which will either be taxable or deductible when the related assets and liabilities are recovered or settled.\nThe tax effects of temporary differences which give rise to the Company's deferred tax assets and liabilities as of December 31, 1995 and 1994, are as follows:\nA reconciliation between the amount of reported income tax expense and the amount computed by multiplying the statutory income tax rate by book pretax income for the years ended December 31, 1995, 1994 and 1993, is as follows:\nAs permitted under the provisions of SFAS 109, upon adoption, the cumulative effect of the accounting change on years prior to January 1, 1993 of $116,243 is included in net income for the year ended December 31, 1993.\nNote 9. Employee Benefit Plans\nPension Plan: Citizens National Bank has a defined benefit pension plan covering all employees who meet the eligibility requirements. To be eligible, an employee must be 21 years of age and have completed one year of continuous service. The plan provides benefits based on the participant's years of service and highest consecutive five year average annual earnings. During 1994, the Bank amended the Plan's benefit formula to reduce the level of future plan benefits and made the Plan, which had previously been contributory, non- contributory. The Bank's funding policy is to make the minimum annual contribution that is required by applicable regulations.\nThe components of the pension cost charged to expense for the years ended December 31, 1995, 1994 and 1993, consisted of the following:\nThe following table sets forth the plan's funded status as of December 31, 1995 and 1994, and the amount recognized in the accompanying balance sheets as of December 31, 1995 and 1994:\nAssumptions used by the Bank in the determination of pension plan information consisted of the following:\n401(k) Plan: The Bank established a 401(k) profit-sharing plan during 1994 for the benefit of all employees who have attained the age of 21 and completed one year of continuous service. Participating employees are eligible to contribute up to 10% of their annual compensation to the Plan. The Bank is eligible to make discretionary matching contributions in an amount up to 6% of each participant's annual compensation. In addition, the Bank is also eligible to make discretionary non-matching contributions to the Plan. Contributions made to the Plan by the Bank for the years ended December 31, 1995 and 1994, were $30,000 and $0, respectively.\nPostretirement Benefit Plans: Citizens National Bank sponsors a postretirement health care plan and a postretirement life insurance plan for all retired employees that meet certain eligibility requirements. Both plans are contributory with retiree contributions that are adjustable based on various factors, some of which are discretionary. The plans are unfunded. As discussed in Note 1, the Company changed its accounting policy with respect to these plans during 1993.\nNet periodic postretirement benefit cost included the following components for the years ended December 31, 1995 and 1994:\nThe following tables set forth the plans' funded status reconciled with the obligations recognized in the accompanying balance sheets at December 31, 1995 and 1994:\nThe weighted average discount rate used in estimating the accumulated postretirement benefit obligations of the health care plan and the life insurance plan at December 31, 1995 and 1994, was 7.00% and 8.00%, respectively.\nFor measurement purposes, the maximum monthly benefit of $100 payable per eligible retiree under the postretirement health care plan was assumed with no future increases. Accordingly, an assumed 1 percentage point annual increase in health care cost trend rates would not impact the health care plan's accumulated postretirement benefit obligation at December 31, 1995 or the aggregate of the service and interest cost components of the health care plan's net postretirement benefit cost for the year ended December 31, 1995.\nExecutive Supplemental Income Plan: During 1995, the Bank entered into a non- qualified supplemental income plan with certain senior officers which provides participating officers with an income benefit payable at retirement age or death. The liability accrued for the Executive Supplemental Income Plan at December 31, 1995, was $60,587 which is included in other liabilities. In addition, the Bank has purchased certain insurance contracts to fund the liabilities arising under this plan. At December 31, 1995, the cash surrender value of these insurance contracts was $63,667, respectively.\nNote 10. Other Borrowings\nShort-Term Borrowings: The Company's short-term borrowings consist of securities sold under an agreement to repurchase (repurchase agreement) involving one customer and advances under a line of credit with the Federal Home Loan Bank of Pittsburgh (FHLB). The repurchase agreement has a contractual term of 24 months expiring on June 30, 1997. Interest is paid on the agreement at 67.11% of the Wall Street Journal prime rate.\nAs a member of the FHLB, the subsidiary bank obtained a $12,598,600 line of credit under the FHLB's Flexline Program. Borrowings under this arrangement bear interest at the interest rate posted by the FHLB on the day of the borrowing and is subject to change daily. This line of credit is secured by a blanket lien on all unpledged and unencumbered assets of the Bank and expires January 2, 1997.\nThe following information is provided relative to these obligations:\nLong-Term Borrowings: The Company's long-term borrowings of $334,381 and $202,966 at December 31, 1995 and 1994, respectively, consisted of advances from the FHLB under its Affordable Housing Program. These borrowings, which at December 31, 1995 had an average fixed interest rate of 2.54% and mature in varying amounts through the year 2014, were used to finance the acquisition of loans issued by the Randolph County Housing Authority. A summary of the maturities of these borrowings for the next five years is as follows: $4,033 in 1996; $4,239 in 1997; $4,456 in 1998; $4,684 in 1999; $4,924 in 2000; and $312,045 due thereafter.\nNote 11. Commitments and Contingencies\nReserve Requirements: The subsidiary bank is required to maintain a reserve balance with the Federal Reserve Bank. At December 31, 1995, $906,000 was maintained in the reserve balance. The Bank does not earn interest on this balance.\nLitigation: The Company is involved in various legal actions arising in the ordinary course of business. In the opinion of counsel, the outcome of these matters will not have a significant adverse effect on the Company.\nFinancial Instruments With Off-Balance-Sheet Risk: The subsidiary 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. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The contract amounts of those instruments reflect the extent of involvement the Bank has in particular classes of financial instruments.\nThe Bank'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. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.\nCommitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The Bank evaluates each customer's credit worthiness 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. Collateral held varies but may include accounts receivable, inventory, equipment or real estate.\nStandby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans. These letters of credit are generally uncollateralized.\nNote 12. Restrictions on Subsidiary Dividends\nThe primary source of funds for the dividends paid by Citizens Financial Corp. is dividends received from its subsidiary, Citizens National Bank. Dividends paid by the subsidiary bank are subject to restrictions by banking regulations. The most restrictive provision requires approval by the Office of the Comptroller of the Currency if dividends declared in any year exceed the year's net income, as defined, plus the retained net profits of the two preceding years. During 1996, the net retained profits available for distribution to Citizens Financial Corp. as dividends without regulatory approval approximate $1,660,000, plus net income of the subsidiary bank for the interim periods through the date of declaration.\nNote 13. Fair Value of Financial Instruments\nThe following summarizes the methods and significant assumptions used by the Company in estimating its fair value disclosures for financial instruments.\nCash and due from banks: The carrying values of cash and due from banks approximate their estimated fair values.\nFederal funds sold: The carrying values of Federal funds sold approximate their estimated fair values.\nSecurities: Estimated fair values of securities are based on quoted market prices, where available. If quoted market prices are not available, estimated fair values are based on quoted market prices of comparable securities.\nLoans: The estimated fair values for loans are computed based on scheduled future cash flows of principal and interest, discounted at interest rates currently offered for loans with similar terms to borrowers of similar credit quality. No prepayments of principal are assumed.\nDeposits: The estimated fair values of demand deposits (i.e. noninterest bearing checking, NOW, Super NOW, money market and savings accounts) and other variable rate deposits approximate their carrying values. Fair values of fixed maturity deposits are estimated using a discounted cash flow methodology at rates currently offered for deposits with similar remaining maturities. Any intangible value of long-term relationships with depositors is not considered in estimating the fair values disclosed.\nShort-term borrowings: The carrying values of short-term borrowings approximate their estimated fair values.\nLong-term borrowings: The fair values of long-term borrowings are estimated by discounting scheduled future payments of principal and interest at current rates available on borrowings with similar terms.\nOff-balance sheet instruments: The fair values of commitments to extend credit and standby letters of credit are estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present credit standing of the counterparties. The amounts of fees currently charged on commitments and standby letters of credit are deemed insignificant, and therefore, the estimated fair values and carrying values are not shown below.\nThe carrying values and estimated fair values of the Company's financial instruments are summarized below:\nNote 14. Condensed Financial Statements of Parent Company\nInformation relative to the Parent Company's balance sheets at December 31, 1995 and 1994, and the related statements of income and cash flows for the years ended December 31, 1995, 1994 and 1993, are presented below.\nINDEPENDENT AUDITOR'S REPORT\nTo the Board of Directors Citizens Financial Corp. and Subsidiary Elkins, West Virginia\nWe have audited the accompanying consolidated balance sheets of Citizens Financial Corp. and its subsidiary as of December 31, 1995 and 1994, and the related statements of income, changes in shareholders' equity and cash flows for the years ended December 31, 1995, 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 audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as 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 Citizens Financial Corp. and its subsidiary as of December 31, 1995 and 1994, and the results of their operations and cash flows for the years ended December 31, 1995, 1994 and 1993, in conformity with generally accepted accounting principles.\nAs more fully described in Notes 1, 8 and 9 to the consolidated financial statements, the Company changed its methods of accounting for income taxes and postretirement benefits in 1993.\nARNETT & FOSTER\nCharleston, West Virginia January 19, 1996\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and - -------------------------------------------------------------------------- Financial Disclosure --------------------\nNo reportable items.\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 names of the nine persons who have served as directors of Citizens Financial Corp. for the year ended December 31, 1995, their ages and principal occupations, the length of their service to Citizens Financial Corp. and the expiration of their present term.\n(1) All of the above named directors, with the exception of Mr. Alday, have also served as directors of Citizens National Bank for the past five years on a continuous basis. Mr. Alday has not served Citizens National Bank in any official capacity.\n(2) Messrs. Armentrout, Fair, Harris and Williams have been nominated to stand for reelection to an additional 3 year term expiring in April, 1999.\nSet forth below are the executive officers of Citizens Financial Corp., their age, present position and relations that have existed with affiliates and others during the past five years.\nItem 11.","section_11":"Item 11. Executive Compensation - --------------------------------\nThe executive officers of Citizens Financial Corp. serve without compensation from the Company. They are, however, compensated by Citizens National Bank for serving as Bank officers with the exception of Messrs. Armentrout and Fair who are not employed by the Bank. The following table sets forth the compensation of the Company's CEO for the years 1995, 1994 and 1993. No executive officers received total annual salary and bonus exceeding $100,000.\n(1) Mr. Schoonover was appointed Company President & CEO effective April 16, 1994.\n(2) Mr. Thompson retired from the Company effective April 16, 1994.\n(3) The Bank's group life and health insurance program, which is paid for by the Bank, is made available to all full-time employees and does not discriminate in favor of directors or officers; however, in accordance with IRS Code Section 79, the cost of life insurance coverage for an individual in excess of $50,000 is added to the individual's earnings and is included in this figure. Also included\nin this figure is board fees earned.\n(4) The Bank's contributions to the pension plan, a defined benefit plan, are not and cannot be calculated separately for specific participants. No contributions were made by the Bank in the years presented. The Bank's executive supplemental income plan provides retirement benefits conditioned upon continued employment until retirement or the satisfaction of early retirement criteria. Participants are deemed to receive no compensation until such conditions are satisfied.\nNeither the Company or the Bank maintain any form of stock option, stock appreciation rights, or other long-term compensation plans. Directors of the registrant are compensated for meetings attended in the amount of $100 per meeting. Directors of the Bank receive $400 per meeting. Under normal circumstances, the Board of Citizens Financial Corp meets quarterly while the Citizens National Bank Board meets monthly. Directors who are members of the Bank's loan committee, which meets weekly, receive $300 per month. In addition, the chairman of Citizens Financial Corp. receives $1,100 per month for service in that capacity, while the senior vice-president of the Bank receives $750 monthly for his services. No employment contracts or change in control arrangements exist between the registrant, it's subsidiary and any executive officer.\nCompensation of the bank's executive officers, including its president, is determined by the personnel committee. The committee is comprised of five outside directors. Compensation levels are determined after consideration is given to net income objectives and cost of living factors. This process is consistent with that used to determine the compensation levels of all other employees. No specific criteria exist which relates executive compensation to corporate performance and executives receive no preferential consideration in the establishment of compensation.\nPension Benefits - ----------------\nCitizens Financial Corp., having no employees, has no retirement program, but Citizens National Bank has a pension program for its eligible employees. This pension plan is a qualified retirement plan and is available to all full- time employees, including officers, who meet the eligibility requirements. Directors do not participate in this plan. Pensions for all participants are based on five-year average final compensation. Annual compensation for the pension plan includes overtime pay and bonuses. Credits are received for each year of participation at the following rates: 1 percent of the first $9,600.00 of the 5-year average final compensation and 1.5 percent of such average final compensation in excess of $9,600.00, all multiplied by years of service up to a 25-year maximum.\nThe annual pension payable on retirement is the total of the pension credits for each year of service after age twenty-one and the completion of one year of service. The pension benefits are payable to participants on a monthly basis in the form of a joint and 50 percent survivor annuity for all married participants who do not elect otherwise, or in the form of a single life annuity for all other participants or survivors. Joint and 100 percent survivorship, single life annuity or 120 payments guaranteed are other optional forms of distribution. Contributions made to the pension plan are on an actuarial basis, with the plan year ending October 31. Pension benefits are not subject to a deduction for Social Security.\nAn amendment to the pension plan was adopted by the Citizens National Bank Board of Directors on July 20, 1988. This amendment modified the existing plan by the addition of two early retirement options. The options provide a change from actuarial method to straight 4 percent per year below normal retirement age, and retirement at age sixty-two with 30 years of service with no reduction in benefits. A subsequent amendment was adopted by the directors on October 31, 1994. This amendment changed the plan from a contributory plan to a noncontributory plan and reduced the credit formula from 1.5 percent of the first $9,600 of the 5-year average final compensation and 2 percent of such final average compensation in excess of $9,600 to the current 1 percent and 1.5 percent. Concurrent with this amendment the Bank established a 401(k) profit- sharing plan.\nThe following table represents the normal pension, beginning at age sixty- five based upon assumed final pay and years of credited services:\nThe estimated credited years of service for the executive officers of Citizens Financial Corp. in the pension plan of Citizens National Bank are as follows:\nYears of Credited Service* --------------------------\nRobert J. Schoonover 9 Thomas K. Derbyshire 4\n* Max L. Armentrout and Raymond L. Fair are not participants in the pension plan of Citizens National Bank.\n401-(k) Plan - ------------\nThe Bank established a 401-(k) profit-sharing plan during 1994 for the benefit of all employees who have attained the age of 21 and completed one year of continuous service. Participating employees are eligible to contribute up to 10% of their annual compensation to the plan. The Bank is eligible to make discretionary matching contributions in an amount up to 6% of each participants annual compensation. In addition, the Bank is also eligible to make discretionary non-matching contributions to the plan. During the year ended December 31, 1995, such discretionary non-matching contributions totaled $30,000. No contributions were made to the plan by the Bank for the year ended December 31, 1994.\nExecutive Supplemental Income Plan - ----------------------------------\nDuring 1995 the Bank entered into a non-qualified supplemental income plan with certain senior officers. This plan provides participating officers with retirement income benefits conditioned upon continued employment with the Bank until reaching the retirement age of 65 or the age of 62 with 30 years of service. Such benefits are payable to the participant, or their beneficiary, in 180 equal monthly installments. In the event the participant should die before attaining retirement age but after reaching age 55 with 15 years of service, or age 60, lump sum death benefits equal to the participants' deferred compensation amount are paid to the beneficiary. Should death occur prior to the above described conditions the death benefit is reduced by 50 percent. The liabilities arising under this plan are funded by certain insurance contracts purchased by the Bank.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management - ------------------------------------------------------------------------\nThe following table lists each shareholder who is the beneficial owner of more than 5% of the Company's common stock, the only class of stock outstanding, as of February 29, 1995.\nThe following table sets forth the amount and percentage of stock of Citizens Financial Corp. beneficially owned by each director and executive officer of the Company, and by all directors and executive officers as a group, as of February 29, 1995.\n(1) Mr. Alday's indirect ownership includes 17,500 shares owned by his wife and 13,400 shares which he votes for the Phil Williams Coal Company.\n(2) Mr. Armentrout's indirect ownership includes 3,700 shares owned by his wife and 375 shares owned by his daughter.\n(3) These 15,050 shares are owned by DeMotto Peerless Coal Company and are voted by Mr. DeMotto.\n(4) These 4,200 shares are owned by Mr. Fair's wife.\n(5) These 5,500 shares are jointly owned by Mr. Harris and his wife.\n(6) Mr. Kump's indirect ownership includes 8,500 shares owned by his mother, 750 shares owned by his wife and 1,505 held by his wife as custodian for their children.\n(7) These 100 shares are owned jointly by Mr. Schoonover and his wife.\n(8) Mr. Thompson's indirect ownership includes 13,580 shares which are jointly owned with his wife, 4,500 owned solely by his wife and 500 shares jointly owned by his wife and brother-in-law.\n(9) These 500 shares are owned by Mr. Williams' wife.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions - --------------------------------------------------------\nManagement personnel of Citizens Financial Corp. have had and expect to continue to have banking transactions with Citizens National Bank in the ordinary course of business. Extensions of credit to such persons are made in the ordinary course of business on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons. It is the opinion of management that these transactions do not involve more than a normal risk of collectibility or present other unfavorable features.\nDuring the year 1995, the highest aggregate indebtedness of all executive officers and directors of the holding company, its subsidiary, and their related interest was $3,783,000 or 27.11 percent of the equity capital of Citizens Financial Corp. As of December 31, 1995, there were unused lines of credit of $1,986,000, or 13.59 percent of the equity capital of Citizens Financial Corp. outstanding to these parties.\nNone of the directors, executive officers, 5 percent or more beneficial stockholders or their immediate family members have an interest or are involved in any transactions with Citizens Financial Corp. or Citizens National Bank in which the amount involved exceeds $60,000, or was not subject to the usual terms or conditions, or was not determined by competitive bids. Similarly, no director, executive officer or 5 percent or more beneficial stockholder has an equity interest in excess of 10 percent in a business or professional\nentity that has made payments to or received payments from Citizens Financial Corp. or Citizens National Bank in 1995 which exceeds 5 percent of either party's gross revenue.\nRaymond L. Fair is a director of Citizens Financial Corp. and also served as legal counsel to that corporation and to Citizens National Bank during 1995. Legal fees paid or payable to Mr. Fair by Citizens Financial Corp. and Citizens National Bank were approximately $1,500 for the year 1995.\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. All financial statements and financial statement schedules required to be filed by Item 8 of this Form or by Regulation S-X which are applicable to the registrant have been presented in the financial statements, notes thereto, in management's discussion and analysis of financial condition and results of operations or elsewhere where appropriate. (3) Listing of Exhibits - see Index to Exhibits on page 51.\n(b) Reports on Form 8-K - No reports on Form 8-K were filed during the fourth quarter of 1995.\n(c) Exhibits - see index to Exhibits on page 51 of this Form 10-K.\n(d) Consolidated Financial Statement Schedules - 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 or pertain to items as to which the required disclosures have been made elsewhere in the financial statements and notes thereto, and therefore have been omitted.\nItem 14(c) Index to Exhibits - -------------------------------------------\n(a) The computation of minimum standard capital ratios, which are shown on page 20 of this filing, was done as specified in applicable regulatory guidelines. All other ratios presented may be clearly determined from the material contained in this filing.\n(b) List of permitted nonbanking activities previously filed on pages 47-49 of Form S-4 Registration Statement of Citizens Financial Corp., SEC File No. 33-11423, dated February 19, 1987 is incorporated by reference into this filing.\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.\nCitizens Financial Corp.\nBy \/s\/ Robert J. Schoonover ----------------------------------------- Robert J. Schoonover President and Chief Executive Officer\nBy \/s\/ Thomas K. Derbyshire ----------------------------------------- Thomas K. Derbyshire Treasurer and Principal Financial Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated.\nSignature Title Date --------- ----- ----\n\/s\/ Max L. Armentrout Chairman of the Board 3\/19\/96 -------------------------- and Director ----------- Max L. Armentrout\nDirector -------------------------- ----------- Robert N. Alday\nDirector -------------------------- ----------- Virginia C. Chabut\n\/s\/ Carlo DeMotto Director 3\/19\/96 -------------------------- ----------- Carlo DeMotto\n\/s\/ Raymond L. Fair Director 3\/19\/96 -------------------------- ----------- Raymond L. Fair\n\/s\/ John F. Harris Director 3\/19\/96 -------------------------- ----------- John F. Harris\n\/s\/ Cyrus K. Kump Director 3\/21\/96 -------------------------- ----------- Cyrus K. Kump\n\/s\/ Emery Thompson, Jr. Director 3\/19\/96 -------------------------- ----------- Emery Thompson, Jr.\nDirector -------------------------- ----------- L. T. Williams\nSUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT TO SECTION 15 (d) OF THE ACT BY REGISTRANTS WHICH HAVE NOT REGISTERED SECURITIES\nPURSUANT TO SECTION 12 OF THE ACT ---------------------------------\nThe entire annual report and proxy materials mailed to the Company's stockholders will be furnished to the Commission for its information under separate cover, in paper format, upon submission to stockholders on or around March 25, 1996 .","section_15":""}
{"filename":"110074_1995.txt","cik":"110074","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nSubstantially all of the business of Systemed Inc. and its subsidiaries (\"Company\") is derived from acting as an integrated, full service pharmacy benefits manager serving corporations, insurers, and other benefit plan sponsors (\"Clients\") throughout the United States. The Company's benefit programs offer prescription drug benefits to approximately seven million eligible employees, retirees and dependents (\"Participants\") who receive funded benefits through their employers and other sponsors.\nThe Company is engaged, through its Newport Pharmaceuticals subsidiary located in Costa Rica, in the distribution of pharmaceutical products in Latin America, Mexico, South America and the Far East. This subsidiary represents approximately 2 percent of consolidated net operating revenues. It is anticipated that this business will be sold in the near future.\nIn March 1995, the Company entered into a definitive sales agreement whereby the Company's Ireland operation was sold to the principal managers of that operation. (See Note 10 of the Notes to Consolidated Financial Statements.)\nThe Company's principal executive office is located at 970 West 190th Street, Suite 400, Torrance, California, 90502, and its telephone number is (310) 538-5300.\nThe Private Litigation Reform Act of 1995 provides a \"safe harbor\" for forward looking statements. Certain information included in this Annual Report on Form 10-K is forward looking, such as information relating to competition, pricing, trends in the industry and potential for growth. Investors are cautioned that all forward looking statements involve risks and uncertainties, including but not limited to the ability to obtain new or retain existing accounts, the timely availability and acceptance of new products, the impact of competitive pricing and products and other risks detailed in the Annual Report and in the Company's other filings with the Securities and Exchange Commission.\nDescription of Pharmacy Benefits Management Business\nThe Company develops and administers client-specific pharmacy benefit programs (\"Programs\") on behalf of more than 900 clients throughout the United States. The Company's Programs are customized to meet the Clients' particular benefits strategy, combining a number of managed care features to cost effectively manage the Client's entire prescription benefits program. The Programs combine mail service pharmacy features such as therapeutic alternative programs, enhanced generic substitution and the convenience of home delivery, with the features of retail network pharmacy such as automated claims adjudication, real time electronic networking of retail pharmacies and card programs. Clients can choose a Program which incorporates on-line electronic claims processing, drug utilization review, and an electronic network linking more than 67 percent of the retail pharmacies in the U. S. to the Company, as well as features of a mail service pharmacy program. As an alternative, Clients can choose either a mail service pharmacy program or network claims processing program to combine with the Client's other existing prescription benefits.\nMail Service Pharmacy Programs\nThe Company's mail service pharmacy prescription benefit programs (\"Mail Service Programs\") are provided to Clients throughout the United States through the Company's dispensing operations located in Des Moines, Iowa. The Mail Service Programs offer the convenience of home delivery for maintenance, chronic care drugs at significant cost savings when compared to amounts paid under traditional prescription drug benefit plans which rely on retail pharmacies as the primary source for dispensing covered prescriptions. Through an emphasis on generic substitution and the use of less costly therapeutic alternatives, the Mail Service Programs can provide Clients with cost savings of 10 to 35 percent over traditional prescription benefit plans.\nParticipants who start in these Mail Service Programs mail in their prescription order requests, their prescriptions and a completed patient profile questionnaire which sets forth their known drug allergies and current medical condition. In most instances, the orders are accompanied by a co-payment, which is determined by the specific terms of each participant's Mail Service Program and can be a fixed dollar amount per prescription or may vary as a percentage of the total cost of the prescription.\nClients provide the Company with updates of eligible Participants on a regular basis. Upon receipt of the Participant's prescriptions and patient profile questionnaire, all pertinent information is entered into the Company's management information\nsystem to verify the Participant's eligibility, screen for any program restrictions and conduct a predispensing screening for allergies and drug interactions which may occur with the prescribed medication. If the Participant's patient profile questionnaire indicates potential drug interactions or allergic reactions, the Company's registered pharmacists, after review of the problem, will consult with the prescribing physician if necessary.\nThe Company's sophisticated management information system integrates the drug dispensing process with the prescription order entry function and assists the Company in monitoring the progress of the prescriptions through each stage of the dispensing process. Each filled prescription is inspected by the Company's registered pharmacists who verify it against the physician's written prescription and the prescription label. Required warning labels are affixed to the prescription container and appropriate patient counseling and reorder information is provided to the patient.\nServing the Cost Containment Needs of the Client\nThe Company's Mail Service Programs are designed to provide Clients with the ability to better understand and control their maintenance prescription drug benefit costs. Key features of the Mail Service Programs include:\no Customized Programs. Programs are customized to facilitate their integration into the Client's existing health care benefits plan and to meet the Client's particular benefits strategy. Incentives, such as reduced or eliminated co-payments, encourage maximum utilization of a Mail Service Program by eligible Participants. The Company's benefit professionals regularly review Mail Service Program design and utilization with each Client to evaluate opportunities for additional cost savings.\no Prescription Dispensing Policies. The Mail Service Programs emphasize the use of generic substitution and the use of therapeutic alternatives to increase cost savings. The Company's management information system alerts the Company's pharmacy staff to opportunities for generic and therapeutic substitution at the time prescriptions are dispensed. Higher order quantities reduce the number of repetitive dispensing and administrative fees typically charged at retail pharmacy alternatives.\no Management Reports. The Company's management information system provides Client benefits managers with monthly management reports setting forth Mail Service Program activity and costs. The reports also assist the Company's benefits professionals in identifying opportunities for further cost savings.\no Drug Utilization Review System. A computerized patient profile monitoring system allows the Company to conduct drug utilization review on prescription drugs dispensed under the Mail Service Programs to screen for potential abuse such as the duplication of medication from multiple physicians and excessive dosages.\no Refill Notification. A refill notification system automatically notifies prescribing physicians when Participants have used their last refill, reducing the need for unnecessary physician visits.\nProviding a Convenient Alternative to the Participant\nThe Company's Mail Service Programs also afford many benefits to Participants, who appreciate convenience, safety, and confidentiality. These benefits include:\no Home Delivery. The Company's Mail Service Programs offer the convenience of home delivery--which is especially advantageous to elderly or disabled Participants or those who live in rural areas who are unable to travel to a retail pharmacy for their drug purchases.\no Higher Order Limits. As compared with typical retail drug stores, the higher order limits offered by the Company's Mail Service Programs provide a larger drug supply on hand and reduce the number of refill requests otherwise necessary.\no Access to Confidential Professional Consultation. Participants are provided with convenient and confidential access to the professional advice of the Company's registered pharmacists through toll-free telephone lines. The Company's toll-free lines are also available to assist Participants requesting refills, seeking information on their individual prescriptions or making other inquiries about their Mail Service Program.\no Dispensing Standards. The Company's commitment to patient safety requires that each prescription be reviewed by registered pharmacists to ensure the accuracy and appropriateness of the prescription. Written guidance from drug manufacturers regarding the proper use of the medication is included with patient prescription orders.\no Patient Monitoring System. The Company's computerized patient monitoring system screens each new drug order against the patient's known drug sensitivities and allergies. The system allows the Company's staff pharmacists to analyze the patient's other known prescription medications for potentially harmful drug interactions. If, in the opinion of the screening pharmacist, a possibility exists of an adverse reaction from the medication prescribed, the pharmacist contacts the prescribing physician to discuss resolution of the problem.\no Refill Notification. The Company's Mail Service Programs include a refill notification feature which automatically notifies the prescribing physician when the last refill on a prescription has been dispensed and requests written refill authorization. This feature facilitates continuity in the supply of medication and eliminates the cost and inconvenience of unnecessary physician refill appointments.\no Alternate Delivery Arrangements. Participants may request that their prescriptions be delivered to alternate locations to coincide with travel, sabbatical or retirement plans. This feature is particularly appreciated by retirees who divide their time among several homes.\no Advantageous Claims Procedures. Participants in the Company's Mail Service Programs are not required to submit claim forms to their insurance provider prior to receiving a reimbursement for their prescription purchases. Unlike traditional indemnity health plans, a Participant in the Company's Mail Service Programs does not have to pay for the prescription at the time it is filled and then await reimbursement. Mail Service Programs may either require a small co-payment or no co-payment at the time of purchase, with the Client or a third-party payor paying the balance directly to the Company.\nDispensing Facilities:\nIn the fiscal year ended December 31, 1995, the Company filled approximately 1.7 million prescriptions at its dispensing facility located in Des Moines, Iowa. The facility, established in late 1992, features state-of-the-art automation technology to further enhance the Company's efficiency, quality control and customer responsiveness. The facility features a computer imaging system which stores and retrieves prescription orders to improve order accessibility and quality control, an automated robotic-enhanced dispensing system which utilizes Baker counting and dispensing units and bar coding to provide more accurate and efficient order filling, and an automated conveyor belt and shipping manifest system to increase the speed, accuracy and efficiency of order handling. In addition, the facility is equipped with a state-of-the-art automated voice response unit for use by patients desiring to make telephonic refill order requests. Continuing enhancements and expansion of the facility's management information system have been designed to further improve the order processing, inventory control, customer service and Client reporting functions.\nWhile the Company currently purchases most of its prescription drug inventory needs from a single major wholesaler, it believes that multiple sources exist for all of its inventory needs, and that the loss of its current primary supplier would not materially adversely impact its business. The Company considers its relationships with its suppliers to be excellent. The Company maintains an appropriate inventory of drugs to ensure the timely filling of most orders. In the infrequent case when the Company receives a prescription for a drug which it does not have in inventory, the Company generally can obtain the required item from a wholesaler within one or two business days.\nRetail Pharmacy Claims Processing Programs\nThe Company's retail pharmacy claims processing programs (\"Claims Programs\") are sponsor-specific benefit programs through which the Company processes and adjudicates paper and electronic prescription drug claims generated through a network of participating retail pharmacies. The pharmacy network includes more than 67 percent of the retail pharmacies in the United States, each of which contracts with the Company to provide prescription dispensing at contracted rates.\nThe Company's Claims Programs utilize point-of-sale electronic data transmission and automated claims adjudication to manage over $485 million in claims paid annually, covering over 3.5 million eligible Participants nationwide. Claims data is transmitted to the Company electronically from pharmacies, or by mail from beneficiaries, for adjudication and payment in accordance with the Client's particular plan design specifications.\nThe Claims Programs are designed to maximize the Client's control and cost savings opportunities by combining a number of managed care program features. The utilization control mechanisms and claims processing efficiencies of these Programs, as well as the price reductions the Company negotiates from retail pharmacies, reduce the benefit and administrative costs associated with providing retail pharmacy-based prescription drug benefits coverage. Claims Programs design features also encourage the dispensing of less expensive generic drugs and formulary products and incorporate a review of pharmaceutical therapy patterns. The Company estimates that the implementation of its Claims Programs reduces the Clients' cost of providing retail-based prescription drug benefits by 10 to 25 percent compared to coverage which does not include any cost containment features.\nThe Claims Programs are offered either on a stand-alone basis or are integrated into major medical plans. In addition, as discussed below, the Claims Programs are offered in conjunction with the Company's mail service pharmacy programs as an integral part of an integrated prescription benefits program. See \"Fully Integrated Pharmacy Benefits Programs\" below.\nDescription of the Retail Pharmacy Claims Processing Programs\nThe Company currently pays more than $485 million in net prescription drug claims annually from its 30,000 square foot operations center located in Independence, Ohio, a suburb of Cleveland. Under the Claims Programs, Clients provide the Company with periodically updated Participant eligibility data, which is integrated into the Company's management information system. The Company is then able to process prescription claims submitted either directly by eligible Participants by mail, or through the Company's nationwide network of retail pharmacies utilizing point-of-sale electronic data submission.\nUpon receipt of paper claim submissions, the claims are microfilmed for cost effective storage and retrieval and entered into the Company's management information system, which then accesses the Participant eligibility and Claims Programs design databases to determine the appropriate adjudication criteria to apply to the claims. Approximately 94 percent of claims submitted are fully adjudicated through system-based processing. The remaining claims are forwarded to various internal departments for special handling.\nOnce the Company's system determines the adjudication of the claim, reimbursement checks and an Explanation of Benefits form are generated and mailed to Participants. The Company strives to process 75 percent of all claims within five calendar days of receipt and the remaining claims within ten calendar days of their receipt, although during many periods of the year, the turnaround time is faster.\nThe process of electronic point-of-sale submissions through the Company's network of retail pharmacies is identical to the paper claims process described above, except that claims data is received electronically by the Company and processed automatically upon receipt by the Company's management information system. The retail pharmacy network can access the Company's processing system 24 hours a day, seven days a week.\nFor those Claims Programs which provide eligible Participants with a mail service pharmacy feature through a third party provider, the Company provides eligibility data directly to the mail service pharmacy, which then submits claims data to the Company.\nThe Company provides its Clients with regular management reports describing overall Claims Programs activity and utilization trends. The Company's account executives regularly analyze Client utilization data and make recommendations for additional opportunities for cost containment. In some cases, the Company produces management reports which are designed to highlight aberrant utilization patterns which may indicate that clinical intervention or fraud and abuse detection may be warranted. The Company's management reports include all Participant prescription drug utilization resulting from use of both the retail network and mail service pharmacies.\nThe Company's Claims Programs are structured to provide Clients with the ability to better understand and control the cost of their entire pharmaceutical benefits program. Features of the Company's Claims Programs include:\no Flexible Plan Design. Program designs are flexible to meet the Client's particular benefits strategy and cost containment objectives. The Claims Programs include incentives to encourage Participants to use the most cost effective retail network or mail service dispensing location and to purchase the least expensive drug available, including an emphasis on generic substitution. Claims Programs are regularly reviewed with Clients in order to target additional areas of savings.\no Comparison of Expected Results to Actual Activity. The Company regularly analyzes a Claims Program's projected savings associated with its plan design features, the use of the retail pharmacy network, and mail service pharmacy activity relative to the costs experienced by the Client. If deviations from savings expectations are evident, program modifications are recommended.\no Management Reports. The Company's database enables the Company to provide Clients with regular detailed management reports of claims activity and costs. The reports are designed to illustrate program results and opportunities for additional cost savings.\no Commitment to Service. Although the primary objective of the Company's Clients is to reduce pharmaceutical benefit costs, Clients also require the accurate and rapid processing of claims. The Company produces a variety of service level reports which provide Clients with an assessment of critical claims processing success indicators.\nFully Integrated Pharmacy Benefits Programs\nThe Company's fully integrated prescription pharmacy programs combine the cost savings and convenience of its mail service pharmacy programs with its retail network-based claims administration programs. With the programs, Clients can achieve cost savings of from 10 to 35 percent compared with traditional pharmacy benefit programs which lack managed care cost controls.\nThe integrated programs offer a variety of additional benefits which are designed to provide comprehensive plan design and maximize cost savings and control:\no Convenient, user-friendly programs with a single point of service and accountability to ensure rapid problem resolution.\no Coordination of dispensing data collection and analysis from all aspects of the benefits programs, whether generated from retail network pharmacies or the Company's mail service pharmacy. This ensures ready access to all information necessary to monitor program activity and develop further cost saving strategies without relying on the coordination among third party benefits providers.\no A drug utilization review system that detects potential adverse drug interactions, allergies, overuse and abuse in all areas of the prescription benefits system, whether the drugs are dispensed through mail service or through a retail network pharmacy.\no Prescription dispensing policies that encourage the use of less expensive, therapeutically equivalent generic or brand name drugs regardless of the dispensing location.\no Automated on-line administration of retail pharmacy prescription claims that emphasizes accurate claims review, rapid turn around time, informative utilization data and a reduction in manual review decisions.\no Regular and comprehensive management reports to provide the Client's benefits manager with an understanding of usage trends and costs for the entire pharmacy benefits program.\nThe Company believes that clients find that the Company's benefit programs afford many advantages over programs which use multiple pharmacy benefits providers. The fully integrated plan designs, comprehensive data collection and analysis, single point of service and accountability and improved cost controls achieved by the Company's programs yield maximum cost savings without sacrificing the quality of care. Through the programs, Clients can directly influence the prescription benefit habits of their beneficiaries while maintaining or improving therapeutic outcomes.\nClinical Products and Services\nThe Company has or is in the process of developing clinical products and services which can be incorporated into the mail service pharmacy or retail pharmacy claims processing activities in various forms. The Company's clinical products include Drug Formulary Management, Drug Utilization Evaluation, Therapeutic Alternatives, Shared Savings and Disease State Management programs. All of the clinical programs are aimed at controlling drug use through education and evaluation, with the goal of optimizing drug therapy.\nDrug Formulary Management programs consist of a list of drugs and a process that ensures appropriate drug use and cost effectiveness. The formulary is a continually revised compilation of pharmaceuticals which reflects the current clinical judgment of prescribers. The selection process is overseen by an expert panel of medical and pharmacological professionals, comprising a Pharmacy and Therapeutics Committee, which ensures that optimal medications are selected for patient care.\nDrug Utilization Evaluation is a review process that is conducted on a retrospective, concurrent and prospective basis to evaluate and analyze physician, pharmacist and patient prescription patterns and compliance. Systemed has enstablished a retrospective Drug Utilization Evaluation product that reviews pharmacy claims data and identifies areas where changes in drug treatment can therapeutically and financially benefit the patient and the payor.\nTherapeutic Alternative programs provide patients with the most appropriate and cost effective medication. It allows for the recommendation of a drug substitution where critical analysis has identified optimal alternatives for greater efficacy and cost effectiveness in the same therapeutic class or drug category as the originally prescribed medication. These programs are supported by Systemed's independence from drug manufacturers, which enables it to provide the best selection of pharmaceuticals from a wide range of drug companies.\nShared Savings programs encourage Systemed to implement drug utilization evaluation procedures that generate prescription cost savings, which are shared with the client.\nDisease State Management programs focus on effecting a positive, cost efficient outcome for specific disease entities. From a clinical perspective, this means achieving a quality outcome by proactively providing patient education and monitoring patient behavior. From a financial perspective, these programs decrease customers' overall health care costs by attempting to minimize additional physician and hospitalization expenses which could result from patient non-compliance.\nCustomers\nThe Company's Programs are presently provided to Clients comprised principally of medium sized and smaller corporations. The Company directs its marketing efforts principally to Clients whose current prescription drug benefits are supported by major medical insurance plans. The Company believes that it is this segment which is most likely to value the plan design consultative role and commitment to customer service and responsiveness which it strives to provide.\nThe Company enters into written agreements with its mail service pharmacy Clients, which can consist of either an employer corporation, its sponsoring insurer or another benefits administrator of the corporation's health benefits. The agreements may be subject to annual renewal and may be terminated by either party after a brief notification period. They do not preclude the Client from simultaneously using other mail service drug programs for the same Participants, although this is usually not done. The Company has agreements with two mail service clients that accounted for approximately 30 percent of the Company's revenues in 1995.\nIn 1995, the Company processed and paid more than $485 million in net prescription claims on behalf of administrators or plan sponsors covering over 3.5 million Participants nationwide. The Company enters into written agreements for claims processing services with either the employer corporation, its sponsoring insurer, or a medical benefits administrator of the plan sponsor's health benefits. The claims processing agreements generally cover one to three year terms and are normally subject to termination by either party following brief notification periods.\nMarketing & Sales\nThe Company's pharmacy benefit programs are marketed nationally through the Company's internal sales organization of experienced benefits professionals and a marketing support staff.\nA significant portion of new accounts are generated by marketing Programs through existing relationships with insurers, third party benefits administrators and other independent benefits consultants, who offer the Programs, sometimes on a commission basis, to their commercial customers as part of an overall benefits package. The remainder of new accounts are generated by direct solicitation of corporate accounts, usually through telemarketing, direct mail marketing, trade shows and referrals.\nRevenues of the Company depend upon the extent to which its Programs are utilized by the Clients' eligible Participants. Accordingly, the Company's benefits professionals work with Client benefit managers on an ongoing basis continually to assess utilization levels in the Programs and, where necessary, to incorporate additional incentives, sometimes in the form of more advantageous Program terms, to promote increased utilization among Participants.\nGovernment Regulation\nThere are extensive state and federal laws applicable to the dispensing of prescription drugs. Since sanctions may be imposed for violation of these laws, compliance is a significant operational requirement for the Company.\nIn general, the Company's mail service pharmacy operations are regulated by the laws of Iowa, where the Company maintains its dispensing facilities and where it is licensed as a pharmacy. Iowa has detailed laws governing a wide range of matters relating to the operation of pharmacies, and the Company believes that it is in substantial compliance with these laws. These laws are administered by the Iowa Board of Pharmacy, which is empowered to impose sanctions, including license revocation for non-compliance. The laws include, among others, provisions requiring pharmacies and pharmacists to be licensed, as well as provisions specifying who may write and dispense prescriptions, how prescriptions must be filled, what records must be maintained, and when generic drugs may be substituted.\nMost of the other states into which the Company mails pharmaceuticals also have laws governing the operation of pharmacies and the dispensing of prescription drugs in their states. In many cases, these laws include provisions which purport to regulate out-of-state mail service pharmacies that mail drugs into the state. The regulations are administered by an administrative body in each state (typically, a pharmacy board) which is empowered to impose sanctions, which may include license revocation for non-compliance. In those states where they exist, state laws regulating out-of-state pharmacies essentially can be divided into three categories: \"disclosure laws,\" \"licensing laws,\" and laws prohibiting the mail service delivery of pharmaceuticals.\nStates with disclosure laws generally require that out-of-state pharmacies register with the local board of pharmacy, follow certain procedures and make certain disclosures, but generally permit the mail service pharmacy to operate in accordance with the laws of the state in which the pharmacy operations are located.\nStates with licensing laws generally impose the same licensing requirements on out-of-state pharmacies as are applicable to in-state pharmacies. The Company understands that at least one state has adopted such laws by statute or regulation and that the pharmacy board staffs in at least one additional state interpret their licensing laws to cover out-of-state pharmacies. Should enforcement of any of these laws be attempted, however, the Company believes that these laws would be subject to challenge under the Commerce Clause of the United States Constitution, and the Company would consider formal action challenging the specific law or regulation where compliance with the law or regulation is unduly burdensome or impractical. In the event that licensing or disclosure laws are found to be enforceable against the Company notwithstanding any challenges on Constitutional grounds, the Company believes that it could substantially comply with these laws, although such compliance might, in some cases, be expensive and burdensome on its operations.\nIn addition to the above-described laws, which directly apply to the Company, a number of states have also enacted laws and regulations which purport to limit some of the financial incentives available to benefits plan sponsors that offer mail service pharmacy programs. This so-called \"freedom-of-choice\" legislation generally prohibits a benefits plan sponsor from requiring its Participants to purchase prescription drugs from a single source or from furnishing financial incentives to Participants to do so. The U. S. Department of Labor has opined that in some instances, freedom-of-choice laws applicable to self-funded sponsors are preempted by the Employee Retirement Income Security Act of 1974 (ERISA). The Attorney General in one state has reached a similar conclusion and raised additional constitutional issues. Finally, the Bureau of Competition of the Federal Trade Commission has stated that such legislation may reduce competition and raise prices to consumers, to the extent it impedes or prevents benefit plan sponsors from offering programs that take advantage of the economies of scale associated with single sourcing of pharmaceuticals from a mail service pharmacy.\nTo the Company's knowledge, there have been no formal administrative or judicial efforts to enforce any freedom-of-choice laws against the Company's Clients since the Company's acquisition of its mail service pharmacy business in 1987, and the Company believes that any future attempt to enforce these laws against self-funded Clients would be subject to challenge under the Supremacy Clause of the United States Constitution. However, the enforcement of such laws against Clients of the Company which are not self-funded could, to the extent that they limit the financial incentives available under the Company's Programs, render the Programs less desirable to those Clients and their Participants and thus adversely affect the Company's revenues.\nThe Company is aware that various national and state retail pharmacy associations and some boards of pharmacy are attempting to further promote laws and regulations designed to restrict the activities of mail service pharmacies. The Company attempts to monitor these regulatory issues and supports trade associations which lobby on the federal and state levels on behalf of the mail service pharmacy industry.\nIn addition to the above-described laws and regulations, there are federal statutes and regulations which establish standards for all pharmacies and pharmacists concerning the labeling, packaging, advertising, and adulteration of prescription drugs and the dispensing of \"controlled\" substances and prescription drugs. The Federal Trade Commission and the United States Postal Service regulations require mail order sellers to engage in truthful advertising, to stock a reasonable supply of drugs, fill mail orders within thirty days and, if that is impossible, to inform the consumer of his or her right to a refund. The Company believes that it is in substantial compliance with the above requirements. Further, the United States Postal Service has statutory authority to restrict the transmission through the mails of drugs and medicines to a degree that could have an adverse effect on the Company's mail service operations. To date, the United States Postal Service has not exercised this statutory authority.\nCompetition\nThe sector of the prescription drug benefit business in which the Company competes is highly competitive. The Company's principal competitors in this segment are other mail service pharmacy companies, including Merck\/Medco Caremark, Express Pharmacy Services, Value Health, and other prescription drug benefit providers\/processors, including PCS, Diversified Pharmaceutical Services, and a number of smaller companies. Many of these competitors have greater financial, marketing and other resources than the Company, and no assurance can be given that such competitors will not be able to design and offer programs or services which are different than those of the Company, or which are offered at lower price levels.\nThe Company competes for the business of both Clients and individual Participants. The principal competitive factors, with respect to Clients, are price and service levels, especially to the extent a prescription drug benefit provider's services yield lower health care costs for the Client, as well as the provider's reputation and industry contacts. These factors affect not only the industry's competition for new Clients, but also affect the ability of a pharmacy benefits provider to retain existing Clients.\nWith respect to Participants, the Company competes against other prescription drug benefit programs, retail drug stores, and to a lesser extent, with physician dispensing programs. The principal competitive factors relating to competition for Participants are price, convenience and service features. In this respect, the Company works closely with its Clients in an effort to provide incentives for increased utilization of the Programs by Participants.\nDuring the latter part of 1995, in competitive bid situations, the Company encountered certain changes in the market place. The Company began to experience a rise in large clients requesting that they participate to some extent in or retain drug purchase and market performance discounts. In addition, certain dominant pharmacy benefit management companies have been aggressively discounting their products and services to gain additional market share. These developments are consistent with current trends seen throughout the pharmacy benefit management industry and are expected to continue.\nRecent Events\nRecently, the Company was informed that certain Clients will not be renewing their contracts with the Company in 1996 due to competitive pricing, the effect of which will negatively impact future quarterly revenues by approximately $6 to $8 million for fiscal 1996. Further, it is anticipated that the pharmacy benefits management industry will continue to experience ongoing competitive pricing pressure. The Company regularly bids on customer accounts of various sizes, with its success ratio varying based upon a multitude of factors and market forces then in effect. The Company was recently informed that it was not awarded the business from a sizeable, potential account that would have commenced mid-1996. The Company continues to maintain its policy of pricing its bids at a profit, therefore electing not to buy certain accounts in the marketplace.\nInsurance\nThe dispensing of pharmaceutical and other products may subject the Company to claims for personal injuries, including those resulting from dispensing errors, package tampering and product defects. The Company carries the type of insurance customary in the industry, including general liability (which integrates product liability coverage) and professional liability insurance. The Company believes that its insurance protection is appropriate for its present business operations. Although wholesale and retail pharmacies in general have not, as yet, experienced any unusual or extraordinary difficulty in obtaining insurance at an affordable cost, there can be no assurance that the Company will be able to maintain its coverage in the future or, if it does, that the amount of such coverage would be sufficient to cover any potential claims.\nPharmaceuticals Distribution\nThe Company is engaged, through its Newport Pharmaceuticals subsidiary located in Costa Rica, in the distribution of pharmaceutical products in Latin America, Mexico, South America, and the Far East. This subsidiary generates approximately 2 percent of consolidated net operating revenues. It is anticipated that this business will be sold in the near future.\nIn December 1992, the Company announced its intent to sell Newport Synthesis, Ltd. (NSL), its pharmaceutical compound and fine chemical manufacturing operations located in Ireland. Accordingly, the Company's consolidated financial statements for the years ended December 1994 and 1993 reflect those operations as discontinued. In March 1995, the Company entered into a definitive sales agreement whereby the Company's Ireland operation was sold to the principal managers of that operation.\nThe international operations of the Company are subject to certain risks which are inherent in conducting business in foreign countries, including possible nationalization or expropriation, price and exchange controls, limitations on foreign participation in local enterprises and other restrictive governmental actions. The Company does not carry insurance against such risks. In addition, changes in the relative value of currencies occur from time to time and their effects may be materially favorable or unfavorable to the Company's financial results.\nEmployees\nAs of December 31, 1995, the Company had 574 full and part-time employees, consisting of 313 employees at its Des Moines, Iowa facility, 134 employees at its Independence, Ohio facility, 92 employees at the wholly-owned subsidiary in Costa Rica, 18 employees at its Torrance, California executive offices and 17 employees at its Illinois and Connecticut offices. In the opinion of management, the Company enjoys a good relationship with its employees and provides them with benefits which are competitive in the marketplace.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe principal operating properties of the Company are as follows:\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIn August of 1994, a shareholder of the Company filed a class action lawsuit in the Court of Chancery of the State of Delaware against the Company, certain of its officers and its Board of Directors. The suit alleged unfair dealing and breach of fiduciary duty arising from the adoption of an amendment to the Company's Bylaws and the adoption of a Stockholders' Rights Plan by the Company. The suit sought to order the defendants to carry out their fiduciary duties of cooperating fully with any group having a bona fide interest in the acquisition of the Company, to rescind the aforementioned amendment, enjoin the adoption of any future \"Poison Pill\" amendment and unspecified monetary damages, costs and attorneys fees. At fiscal year end, there had been no plaintiff activity regarding this suit and, on March 7, 1996, the court approved an agreement of the parties to dismiss this action without prejudice.\nIn December 1994, Biomed Healthcare, Inc., a Nevada corporation, filed a lawsuit in Los Angeles County Superior Court in the State of California against the Company and certain officers. The suit alleges breach of contract, fraud, breach of the covenant of good faith and unfair business practices. The suit was filed by a proposed purchaser of the Company's Irish and Costa Rican subsidiaries. The suit seeks damages in the alleged amount of $2,000,000, unspecified punitive damages, an injunction enjoining and prohibiting the Company to close, sell or materially encumber the Irish or Costa Rican subsidiaries. In early March 1995, the Company filed a Demurrer to the lawsuit. In response to such, the Court has ruled in favor of the Company as to several of the causes of action including the injunction against the closure, sale or encumbrance of the foreign subsidiaries. The Company and its legal counsel believe that it has meritorious defenses to the remaining causes of action and that the resultant liability, if any, should not have a material adverse effect on the financial position of the Company and its results of operations.\nIn November 1995, four retail pharmacies filed a complaint on behalf of all retail pharmacies in Georgia similarly situated in the Superior Court of Chatham County, state of Georgia against Blue Cross and Blue Shield of Georgia, Inc., and Systemed Pharmacy Inc., a subsidiary of the Company. The pharmacies allege that prescription discounts were improperly awarded to patients under a \"pharmacy discount program\". The suit sought equitable relief including a Temporary Restraining Order and an Injunction and alleges fraud, tortious interference with contractual relations and Georgia Racketeer Influenced and Corrupt Organization Act violations. The suit seeks punitive damages of $12 million and compensatory damages established at trial. In December 1995, the court denied the motion for a Temporary Restraining Order. The Company and its legal counsel believe it has meritorious defenses to this action and that the resultant liability, if any, should not have a material adverse effect on the financial position of the Company and its results of operations.\nIn addition, certain other claims, suits and complaints, which arise in the ordinary course of business, have been filed or are pending against the Company. Management believes that these matters, and the matters discussed above, are either adequately reserved for, covered by insurance, or would not have a material adverse effect on the financial position of the Company and its results of operations if disposed of unfavorably.\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 as follows. All officers serve at the discretion of the Board of Directors:\nSam Westover, 40, has served as President and Chief Executive Officer of the Company since August 1993, and as a Director of the Company since July 1992. From January 1993, until joining the Company, Mr. Westover served as Chief Financial Officer and Senior Vice President, Corporate Financial Services of Wellpoint Health Networks, the largest publicly traded managed health care company in the United States. Prior to joining Wellpoint, Mr. Westover served as Chief Financial Officer and Senior Vice President, Corporate Financial Services of Blue Cross of California, a position to which he was named in May 1990.\nPerry Cohen, 41, has served as President and Chief Operating Officer of INSURx, Inc. (now known as Systemed Pharmacy Inc.) from January to December 1994, as Senior Vice President of the Company's wholesale market unit since January 1995 and as Senior Vice President, Sales of Systemed Pharmacy Inc. from January 1996. Mr. Cohen served as Chief Operating Officer of Aetna Pharmacy Management from November 1990, until joining the Company, where he was responsible for Pharmacy Benefit Programs for the 13 million lives covered by Aetna Health Plans. From August 1984, to October 1990, Mr. Cohen served as Vice President, Pharmacy Services of MaxiCare Health Plans, Inc., a multi-regional health maintenance organization. Mr. Cohen is a past President of the Academy of Managed Care Pharmacy and a graduate of the University of the Pacific School of Pharmacy with a Doctor of Pharmacy degree.\nKenneth J. Kay, 40, has served as Senior Vice President, Finance and Administration, and Chief Financial Officer of the Company since July 1994. Previously Mr. Kay served, from 1990 until 1994, as Group Vice President and Senior Vice President-Finance and Administration at Ameron, Inc., a $450 million NYSE multi-national manufacturing company. From 1988 to 1990 he served as President, CEO and a member of the Board of Directors of Bishop Incorporated, a $15 million manufacturer and distributor of engineering design products and computer workstation systems. Mr. Kay is a Certified Public Accountant and holds an MBA in finance and marketing.\nRobert T. Nishimura, 55, has served as Senior Vice President, Chief Information Officer, of Systemed Pharmacy Inc. since September 1995. Previously, Mr. Nishimura was a Senior Network Design Consultant for Isuzu Motors of America from 1994 to September 1995 and Senior Technical Management Consultant with Taco Bell Corporation from 1993 to September 1995. From 1991 to 1993, Mr. Nishimura was Director of Management Information Systems at Knapp Communications Corporation. Mr. Nishimura was Vice President of Management Information Systems at First Interstate Bank from 1984 to 1991.\nJames J. Brehany, 41, has served as Vice President, Mail Service Operations, of Systemed Pharmacy Inc. since September 1995 and previously served as acting General Counsel of the Company from September 1994 to August 1995, and as Director, Pharmaceutical Purchasing from March 1994 to September 1994. Previously, Mr. Brehany was a Pharmacy Consultant for the California Physician Management Group from 1979 to 1994. Mr. Brehany was also a Pharmacy Manager for FHP, an HMO, from 1990 to 1994, and holds Doctor of Pharmacy and Juris Doctor degrees.\nPaul H. Hayase, 41, has served as Vice President, General Counsel and Human Resources, and Secretary since August 1995. From November 1993 to August 1995, Mr. Hayase was Senior Counsel at Ralphs Grocery Company. Mr. Hayase served as Senior Vice President, General Counsel at Knapp Communications Corporation from January 1985 to November 1993. Mr. Hayase has practiced law since 1980.\nDennis K. Tsuyuki, 43, has served as Vice President, Controller, since August 1994. Previously, Mr. Tsuyuki was Senior Vice President, Finance at Kennedy-Wilson Inc., a real estate broker and investment banking company from June 1994 to August 1994. From 1990 to April 1994, Mr. Tsuyuki was with Ameron, Inc. and served as Director of Information Systems.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nPrice Range of Common Stock\nThe Company's Common Stock is quoted on the NASDAQ National Market System under the symbol \"SYSM\". The following table sets forth the high and low sales prices of the Common Stock as reported on the NASDAQ National Market System for the calendar quarters and years indicated.\nOn February 29, 1996, there were 4,321 holders of record of the Company's Common Stock.\nDividend Policy\nThe Company has not paid cash dividends on its Common Stock, and management does not anticipate that it will do so in the foreseeable future. The present policy of the Board of Directors is to retain earnings to provide funds for use in the operation and expansion of the Company's businesses. The Indenture covering the Company's outstanding Notes currently restricts the payment of dividends. (See Note 5 of Notes to Consolidated Financial Statements.)\nThe Company's class of 8 percent Convertible Preferred Stock bears dividends at the rate of $0.80 per share per annum, payable annually to holders of record, and has full priority over the Company's Common Stock with respect to the payment of dividends. Dividends on the Preferred Stock are cumulative and are payable only from legally available assets, as and when declared by the Board of Directors. The Company has declared and paid dividends on all outstanding shares of its Preferred Stock for each of its fiscal years ended since April 30, 1982, and has accrued its Preferred Stock dividend requirement for the fiscal year ended December 31, 1995.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following table presents selected financial data of the Company and its subsidiaries as of and for each of the five years, as follows:\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nHealth Care Reform\nEmployers, insurers, and government payor programs are continuing to attempt to contain health care costs by limiting the price or reimbursement levels of medical products and services or establishing managed care programs to increase efficiency in medical care procurement and utilization. The Company believes it should benefit from the increasing use of managed care programs since it offers pharmacy benefits management services which are easily adaptable into a variety of managed care programs and provide efficiencies and cost savings in comparison to traditional indemnity health insurance programs where insureds obtain prescriptions from local pharmacies at retail prices. However, the announcement and progress of proposals to restructure the health care system by the Federal government, industry consolidation and restructurings resulting from actual and anticipated changes in the U.S. health care delivery system, and the investment community's reaction thereto, create an environment which could produce significant volatility in the trading and market price of the Company's Common Stock.\nResults of Operations\nThe following table summarizes, by segment, the operations of the Company for the periods indicated:\nThe following table sets forth certain financial data as a percentage of consolidated net operating revenues of the Company for the periods indicated:\nYear ended December 31, 1995 compared with 1994\nConsolidated net operating revenues for the year ended December 31, 1995 increased 7 percent or $10.4 million over the prior year. The Company's consolidated operating income for 1995 was $4,598,000, which exceeded the comparable 1994 amount by 26 percent. The Company had consolidated net income of $4,290,000 in 1995, reflecting an increase of over 39 percent in relation to last year's net income of $3,079,000.\nThe pharmacy benefits management revenue, which represents 98 percent of consolidated net operating revenues, increased 7 percent over the prior year. This increase was primarily generated from a rise in mail service pharmacy revenues of 7 percent due to an increase in prescriptions dispensed of 8 percent offset by a slight decline in the average revenue per prescription processed. This higher volume of prescriptions was the result of the addition of new Clients at the beginning of the year combined with increased utilization of mail service pharmacy benefits from existing accounts. The nominal decline in the average revenue per prescription was attributable to the impact of competitive pricing pressure and changes in product mix. Claims processing revenues for 1995 exceeded the prior year by 6 percent as a result of a 28 percent increase in the volume of claims offset by a reduction in the average revenue per transaction processed. This change in revenues occurred primarily as a result of a large portion of our customer base converting the majority of its eligible members to lower-cost electronic claims processing products versus traditional paper claims processing utilized in the past. Additionally, several accounts were repriced downward during the year.\nOther operating revenues reflect the sales from the Company's pharmaceutical distribution subsidiary, Newport Pharmaceuticals de Costa Rica. The Company believes its pharmacy benefits management segment offers greater revenue growth potential and anticipates disposing of this subsidiary in the near future.\nCost of sales as a percentage of consolidated net operating revenues for 1995 increased slightly in relation to the prior year. The current year's modest rise in the cost of sales percentage resulted mainly from one-time start up costs associated with implementation of the new proprietary prescription processing system and new automated dispensing technology at the Iowa mail service pharmacy in the fourth quarter. Additionally, administrative costs associated with the implementation of the therapeutic alternatives programs, an increase in branded drug costs and continued pricing pressure also contributed to the reduction in gross profit margin. The Company believes that its operations are performing at levels which are competitive with industry norms. The Company has met with moderate success in controlling its cost of sales through aggressive drug procurement strategies, which include higher purchase and market performance discounts, integration of operating activities, on-going process improvements at both the mail service pharmacy and claims processing operations and the Company's quality management program started earlier this year. Nevertheless, management anticipates that the pharmacy benefits management industry will continue to experience competitive pricing pressure consistent with what has been experienced over the last year, which could lead to an erosion of the gross profit margin in the future. Therefore, the Company intends to continue its on-going process improvement and quality management activities, pursue additional strategies for the reduction of drug costs, leverage its new automated dispensing technology and further invest in higher margin clinical and knowledge-based products, in order to offset the impact of competition on pricing for traditional product offerings.\nSelling, marketing and customer service expenses for the current year increased 32 percent over 1994. In the prior year, the Company benefited from lower costs attained by the restructuring of its selling, marketing and customer service activities in the first\nquarter. The initial aspects of this restructuring plan, which included staff reductions, consolidation of selected activities and relocation of certain functions, lowered selling, marketing and customer service costs below normal levels. As this restructuring activity progressed further into 1994, the Company began to upgrade staffing and facilities, and invest in new marketing and product literature and information systems development designed to capitalize on new marketing and customer service capabilities. In 1995, the Company continued to add to the new marketing and sales organizations, as well as further the development of advanced clinical and knowledge-based products for the healthcare marketplace, thus leading to higher overall costs for the selling, marketing and customer service functions.\nGeneral and administrative expenses for 1995 decreased 26 percent when compared to the prior year. The decline these expenses primarily reflects the Company's reorganization of certain management responsibilities at the beginning of 1995, which included the transfer of personnel from general and administrative positions to sales and operational roles, and substantial improvements made in accounts receivable management thereby reducing expenses associated with the collection of outstanding accounts. Additionally, the inclusion in the prior year's expenses of non-recurring investment advisory fees for implementation of the stockholder rights plan and corporate governance matters, also contributed to the favorable variance.\nInterest income increased $239,000 over the prior year due to the Company's higher level of invested cash. Interest expense and other non-operating expenses remained constant with the prior year amounts.\nThe 1995 provision for income taxes is comprised of amounts for state, federal and foreign taxes. The Company has significant net operating loss carryforwards available to offset future income tax liabilities. For the foreseeable future, the Company anticipates that the effective tax rates will be comprised primarily of state tax provisions.\nIn March 1995, the Company reached an agreement to sell NSL to the principal management of NSL for a nominal value. Additionally, the agreement requires NSL to repay its outstanding intercompany obligations of $2,710,000, which were converted to a promissory note payable in equal annual installments over 15 years with an additional balloon payment of $240,000 due in the fifth year if certain profit thresholds are achieved (See Note 10 of Notes to Consolidated Financial Statements).\nRecent Events\nRecently, the Company was informed that certain Clients will not be renewing their contracts with the Company in 1996 due to competitive pricing, the effect of which will negatively impact future quarterly revenues by approximately $6 to $8 million for fiscal 1996. Further, it is anticipated that the pharmacy benefits management industry will continue to experience ongoing competitive pricing pressure. The Company regularly bids on customer accounts of various sizes, with its success ratio varying based upon a multitude of factors and market forces then in effect. The Company was recently informed that it was not awarded the business from a sizeable, potential account that would have commenced mid-1996. The Company continues to maintain its policy of pricing its bids at a profit, therefore electing not to buy certain accounts in the marketplace.\nManagement has already taken steps in the first quarter of 1996 to appropriately size its overhead structure to match the newly expected volume of prescriptions, thus minimizing to the extent possible, the reduction in future profits from lower revenues. A restructuring charge to earnings of approximately $1.6 million will be taken in the first quarter of 1996 as a result of these organizational and facility changes.\nYear ended December 31, 1994 compared with 1993\nConsolidated net operating revenues for the year ended December 31, 1994 were $142 million, an increase of $7.7 million or 6 percent over 1993 revenues. The Company achieved consolidated operating income of $3.6 million for 1994, which surpassed the $5.1 million of consolidated operating losses incurred in the prior year. This 1993 loss included a one-time $4.9 million fourth quarter charge for restructuring and other non-recurring items. The Company's consolidated net income for 1994 was $3.1 million versus a consolidated net loss for 1993 of $5.7 million.\nThe pharmacy benefits management segment revenues, which comprised 98 percent of consolidated operating revenues, increased 6.2 percent over the prior year. The Company's 1994 mail service pharmacy revenues increased 6.8 percent from 1993 revenues due to the increased number of prescriptions dispensed (7 percent), which were partially offset by a nominal decline in the average revenue per prescription processed. The increase in the volume of prescriptions dispensed resulted from the addition of new customers and increased utilization by existing clients, while the small decline in average revenue per prescription was due to changes in the sales mix and competitive pricing pressure. Systemed Pharmacy's 1994 claims processing revenues were consistent with the prior year despite a transaction volume increase of 18 percent over the 1993 volume. This comparable revenue performance resulted as higher volume levels of transactions processed were offset by the impact of the repricing of a major account during the second quarter of 1993 and, to a lesser degree, a change in the mix of claims processed during the year.\nOther operating revenues represent sales from the Company's pharmaceutical distribution segment conducted through its subsidiary Newport Pharmaceuticals de Costa Rica (NPCR). The decrease in 1994 revenues for this segment reflected increased competition from products in NPCR's traditional markets, somewhat offset by NPCR's expansion into the distribution of additional product offerings in newer markets.\nCost of sales as a percent of consolidated net operating revenues decreased in 1994 to 82.7 percent from the comparable 1993 percentage of 87.8 percent. This decrease in the cost of sales percentage was due to significant operating efficiencies achieved during the year through on-going process improvement activities at the Company's mail service pharmacy operations, and the integration and streamlining of operating activities instituted within the claims processing business. Additionally, the implementation of aggressive drug purchasing strategies, which include purchase and market performance discounts, and enhanced formulary management led to further cost of sales reductions.\nSelling, marketing and customer service expenses increased 3.5 percent from the prior year. However, as a percentage of net operating revenues, these expenses remained constant. In early 1994, the Company benefited from lower costs attained by consolidation of functions and generally lower spending levels for these activities. As the year progressed, and as favorable projections for new business became more tangible, additional investments were made in staffing and facilities, and for marketing and product literature, and systems development which were designed to enhance client service and position the Company to capture new revenue opportunities.\nGeneral and administrative expenses for 1994 increased $4.0 million over 1993 as a result of monies spent for the enhancement of information systems, investments made in additional staffing to handle the anticipated growth in future revenues, increased legal costs for fulfilling regulatory compliance requirements, a higher allowance for potentially uncollectible accounts and non-recurring investment advisory fees incurred for implementation of the stockholder rights plan and other corporate governance matters.\nInterest income increased $204,000 over the prior year as a result of higher interest rates earned on the increased amount of invested cash. Interest expense for the same periods declined due to lower levels of debt outstanding. Other non-operating expense includes a modest amount of foreign currency exchange losses.\nThe Company's 1994 provision for income taxes increased $319,000 from the prior year. This increase was the result of the Company's attainment of profit for 1994 versus losses incurred last year. Federal and state income tax expenses were primarily offset by the utilization of net operating loss carryforwards. The Company continues to maintain significant net operating loss carryforwards which should offset future tax liabilities.\nLiquidity and Capital Resources\nAt the end of 1995, the Company had cash and cash equivalents of $13.2 million which is sufficient to meet its operating and other cash needs. The Company funds its operational and capital expenditure requirements through cash flow from operations and periodically receives cash through the exercise of stock options. Nevertheless, management is engaged in establishing new credit facility arrangements which are designed to meet the anticipated future growth requirements of the Company.\nThe Company's financial position remained solid throughout the year. Working capital at December 31, 1995 was $27.9 million, an increase of $1.3 million over the prior year amount. Included in the prior year working capital balance was $2 million of working capital from the Company's former Irish subsidiary, Newport Synthesis Ltd., which was sold in March 1995. Consequently, the actual rise in working capital for comparable year end balances was $3.3 million. This increase in working capital was mainly the result of higher cash and cash equivalents attained through improved accounts receivable management, and increased inventory at the mail service pharmacy attributable to the implementation of the new mail service pharmacy automated dispensing technology. Cash flow from operations in 1995 was $4.9 million, and was primarily comprised of cash provided by earnings and depreciation, collections of accounts receivable and the timing of accounts payable. The rise in accounts payable of $783,000 was attributable to increased levels of inventory maintained, as noted above.\nDuring 1995, the Company spent $5.5 million in capital expenditures, a 133 percent increase over the prior year, primarily to further automate and increase the capacity of the Company's mail service pharmacy in Iowa. In addition, other capital spending included advanced data processing equipment, and office furniture and equipment for core activities. Management believes that its facilities maintain sufficient capacity to accommodate significant growth. It is anticipated that capital expenditures in 1996 will return to levels consistent with prior years. As of December 31, 1995, the Company had no material commitments for capital expenditures.\nThe Company's cash requirements for 1996 are expected to be financed through internally generated cash flows.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nConsolidated financial statements of the Company at December 31, 1995, and 1994, and for the years ended December 31, 1995, 1994 and 1993, and the independent public accountants reports thereon as referenced in Item 14 herein, are incorporated herein by this reference.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThe change in selection of Independent Public Accountants which occurred in 1995 appears on Form 8-K, filed on March 31, 1995, and as amended on Form 8-K\/A, filed on April 13, 1995, reporting the change in registrants' certifying accounting firm, and is incorporated herein by reference.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nInformation regarding the directors of the Company and management's compliance with Section 16(a) of the Securities Exchange Act of 1934, as amended, appears under the sections \"Election of Directors\" and \"Compliance with Section 16(a) of the Securities Exchange Act of 1934\" in the Company's Proxy Statement to be filed within 120 days after December 31, 1995 with the Securities and Exchange Commission relating to the Company's Annual Meeting of Stockholders and is incorporated herein by reference thereto.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation regarding the compensation of the Company's executives appears under the section \"Executive Compensation\" in the Company's Proxy Statement to be filed within 120 days after December 31, 1995 with the Securities and Exchange Commission relating to the Company's Annual Meeting of Stockholders and is incorporated herein by reference thereto.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation regarding beneficial security ownership of the Company's equity securities appears under the section \"Security Ownership of Certain Beneficial Owners and Management\" in the Company's Proxy Statement to be filed within 120 days after December 31, 1995 with the Securities and Exchange Commission relating to the Company's Annual Meeting of Stockholders and is incorporated herein by reference thereto.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation regarding certain relationships and related transactions appears under the section \"Election of Directors\" and \"Executive Compensation\" in the Company's Proxy Statement to be filed within 120 days after December 31, 1995 with the Securities and Exchange Commission relating to the Company's Annual Meeting of Stockholders 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\n2. The following schedules for the years 1995, 1994 and 1993 are submitted herewith:\nAll other schedules not listed above are omitted because they either are not applicable, not required or because the required information is included in the Consolidated Financial Statements or the accompanying notes.\n3. Exhibits\n3.1 Certificate of Incorporation of the Company, as amended to date. (Incorporated herein by this reference to Exhibit 3.1 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1987.)\n3.2 Agreement and Plan of Merger between Newport Pharmaceuticals International, Inc. and Newport Pharmaceuticals International - Delaware, Inc. (Incorporated herein by this reference to Exhibit 2.1 of the Company's Current Report on Form 8-K dated April 15, 1987.)\n3.3 Certificate of Ownership and Merger merging Systemed Inc. into Newport Pharmaceuticals International, Inc. (Incorporated herein by this reference to Exhibit 3.3 of the Company's Registration Statement on Form S-2, Registration No. 33-43590.)\n3.4 Bylaws of Registrant, as amended. (Incorporated herein by this reference to Exhibit 3.4 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1992.)\n3.5 The Exhibits referenced in Exhibits 4.5, 4.6, 4.8 and 4.9 are incorporated herein by this reference.\n4.1 Indenture between Registrant and Trust Services of America dated September 30, 1987. (Incorporated herein by this reference to Exhibit 4.1 to the Company's Registration Statement on Form S-2, Registration No. 33-15748.)\n4.2 Supplemental Indenture dated February 1, 1988. (Incorporated herein by this reference to Exhibit 4.2 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1987.)\n4.3 Supplemental Indenture dated September 26, 1991. (Incorporated herein by this reference to Exhibit 4.3 to the Company's Registration Statement on Form S-2, Registration No. 33-43590.)\n4.4 Supplemental Indenture dated November 29, 1993. (Incorporated herein by this reference to Exhibit 4.4 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993.)\n4.5 Certificate of Designations, Preferences and Rights of Convertible Preferred Stock, as filed December 22, 1987, as amended. (Incorporated herein by this reference to Exhibit 4.3 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990.)\n4.6 Certificate of Correction to the Certificate of Designations, Preferences and Rights of Convertible Preferred Stock as filed February 4, 1991. (Incorporated herein by this reference to Exhibit 4.6 of the Company's Registration Statement on Form S-2, Registration No. 33-43590.)\n4.7 Form of Underwriter's Warrant Agreement. (Incorporated herein by this reference to Exhibit 4.7 of the Company's Registration Statement on Form S-2, Registration No. 33-43590.)\n4.8 Rights Agreement, dated as of August 17, 1994, between Systemed Inc. and the First National Bank of Boston, as Rights Agent. (Incorporated herein by this reference to Exhibit 1 to the Registration Statement on Form 8-A dated August 23, 1994.)\n4.9 Certificate of Designation, Preferences and Rights of Series C Junior Participating Preferred Stock, as filed August 24, 1994 is attached as Exhibit A to the Rights Agreement referenced in Exhibit 4.8 and is incorporated herein by this reference.\n10.1 Lease dated September 6, 1994 between Systemed Inc. and Nissan Real Estate Corporation U.S.A. with respect to the premises at 970 West 190th Street, Suite 400, Torrance, California. (Incorporated herein by this reference to Exhibit 10.1 of the Annual Report on Form 10-K for the Fiscal year ended December 31, 1994.)\n10.2 Employee Stock Option Plan -- 1987, as amended, and form of Stock Option Agreement. (Incorporated herein by this reference to Exhibit 10.6 of the Annual Report on Form 10-K for the fiscal year ended December 31, 1987.)\n10.3 Non-Qualified Stock Option Plan -- 1986 and form of Stock Option Agreement. ( Incorporated herein by this reference to Exhibit 10.7 of the Annual Report on Form 10-K for the fiscal year ended December 31, 1987.)\n10.4 Amendment to Employee Stock Option Plan -- 1987. ( Incorporated herein by this reference to Exhibit 10.14 of the Annual Report on Form 10-K for the fiscal year ended December 31, 1988.)\n10.5 Amendments to Non-Qualified Stock Option Plan -- 1986. (Incorporated herein by this reference to Exhibit 10.15 of the Annual Report on Form 10-K for the fiscal year ended December 31, 1988.)\n10.6 Amendments to Employee Stock Option Plan -- 1987. (Incorporated herein by this reference to Exhibit 10.6 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1992.)\n10.7 Amendments to Non-Qualified Stock Option Plan -- 1986. (Incorporated herein by this reference to Exhibit 10.7 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1992.)\n10.8 Stock Purchase Plan -- 1990. (Incorporated herein by this referenced to Exhibit 10.11 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990.)\n10.9 Credit Agreement and Guaranty dated September 4, 1991 by and among the Company, America's Pharmacy, Inc., The Daiwa Bank, Limited and Brenton Bank, National Association. (Incorporated herein by this reference to Exhibit 10.9 to the Company's Registration Statement on Form S-2, Registration No. 33-43590.)\n10.10 Lease dated February 28, 1992 between America's Pharmacy, Inc. and Mid-America Development Company with respect to premises at 6109 Willowmere Drive Parkway, Des Moines, Iowa. (Incorporated herein by this reference to Exhibit 10.11 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991.)\n10.11 Lease dated August 10, 1989 between INSURx, Inc. and Summit One, Ltd. with respect to premises at 4700 Rockside Road, Independence, Ohio. (Incorporated herein by this reference to Exhibit 10.11 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993.)\n10.12 Agreement and Plan of Reorganization dated June 30, 1992 between the Company, IIX Corp. and INSURx, Inc. (Incorporated herein by this reference to Exhibit 10.12 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1992.)\n10.13 1993 Non-Employee Director Stock Option Plan. (Incorporated herein by this reference to Exhibit 10.13 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993.)\n10.14 1993 Employee Stock Option Plan. (Incorporated herein by this reference to Exhibit 10.14 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993.)\n10.15 Amendment to Office Lease (Independence, Ohio facility), dated March 12, 1993. (Incorporated herein by this reference to Exhibit 10.15 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993.)\n10.16 Employment Letter dated August 10, 1993 with respect to Sam Westover. (Incorporated herein by this reference to Exhibit 10.16 to the Company's Annual Report on Form 10-K for the Fiscal year ended December 31, 1994.)\n10.17 Employment Letter dated December 23, 1993 with respect to Perry Cohen. (Incorporated herein by this reference to Exhibit 10.17 to the Company's Annual Report on Form 10-K for the Fiscal year ended December 31, 1994.)\n10.18 Employment Letter dated January 24, 1994 with respect to Mark P. Hanrahan. (Incorporated herein by this reference to Exhibit 10.18 to the Company's Annual Report on Form 10-K for the Fiscal year ended December 31, 1994.)\n10.19 Employment Letter dated July 1, 1994 with respect to Kenneth J. Kay. (Incorporated herein by this reference to Exhibit 10.19 to the Company's Annual Report on Form 10-K for the Fiscal year ended December 31, 1994.)\n10.20 Change of Control Severance Agreement dated September 29, 1995 between the Company and Sam Westover.*\n10.21 Change of Control Severance Agreement dated September 29, 1995 between the Company and Kenneth J. Kay.*\n10.22 Employment Agreement dated June 30, 1992, between Insurx, Inc. (now Systemed Pharmacy Inc.) and Michael J. Barone.*\n10.23 Employment Letter dated September 15, 1995 with respect to Robert T. Nishimura.*\n10.24 Employment Letter dated August 17, 1995 with respect to Jerry Brehany.*\n10.25 Employment Letter dated August 1, 1995 with respect to Paul H. Hayase.*\n10.26 Employment Letter dated July 22, 1994 with respect to Dennis K. Tsuyuki.*\n10.27 Separation Agreement and General Release dated February 16, 1996 between the Company and Mark P. Hanrahan.*\n10.28 Amendment Number One to 1993 Employee Stock Option Plan. (Incorporated herein by this Reference to the Company's Registration Statement on Form S-8, Registration No. 33-61865.)*\n11 Statement Regarding Computation of Earnings Per Share.*\n21 Subsidiaries of Registrant.*\n23.1 Consent of Independent Public Accountants.*\n23.2 Consent of Independent Auditors.*\n- ---------------\n* Filed herewith\nAll Exhibits incorporated by reference are filed under the Company's securities and Exchange commission file number 0-5118.\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.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the 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 1996.\nSYSTEMED INC.\nBy: \/s\/ Kenneth J. Kay ----------------------------------------- Kenneth J. Kay, Senior Vice President, Finance and Administration, and Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer)\nPursuant to the requirements of the Securities and Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated.\nReport of Independent Public Accountants\nTo the Stockholders and Board of Directors of Systemed Inc.:\nWe have audited the accompanying consolidated balance sheet of Systemed Inc. (a Delaware corporation) and its subsidiaries, as of December 31, 1995, and the related consolidated statements of operations, stockholders' equity, and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Systemed Inc. and its subsidiaries as of December 31, 1995, and the results of their operations and their cash flows for the year then ended in conformity with generally accepted accounting principles.\nOur audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. 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 regulations and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\nLos Angeles, California ARTHUR ANDERSEN LLP February 28, 1996\nReport of Independent Auditors\nBoard of Directors and Stockholders Systemed Inc.\nWe have audited the accompanying consolidated balance sheet of Systemed Inc. as of December 31, 1994, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the two years in the period ended December 31, 1994. Our audits also included the financial statement schedules listed in the Index at Item 14(a)(2), for years ended December 31, 1994 and 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 financial statements referred to above present fairly, in all material respects, the consolidated financial position of Systemed Inc. at December 31, 1994, and the consolidated results of its operations and its cash flows for each of the two 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.\nOrange County, California February 17, 1995 ERNST & YOUNG LLP except for Note 10, as to which the date is March 29, 1995\nCONSOLIDATED BALANCE SHEETS Systemed Inc.\nSee accompanying notes\nCONSOLIDATED STATEMENTS OF OPERATIONS Systemed Inc.\nSee accompanying notes\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSee accompanying notes\nCONSOLIDATED STATEMENTS OF CASH FLOWS Systemed Inc.\nSee accompanying notes\nSYSTEMED INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. Summary of significant accounting policies\nBusiness activity\nSystemed Inc. is a Delaware corporation with substantially all of its business derived from its activities in the pharmacy benefits management (PBM) industry, through its mail service pharmacy and retail pharmacy claims processing subsidiaries. In addition, approximately 2 percent of consolidated net operating revenues are generated by the distribution of pharmaceutical products through its subsidiary Newport Pharmaceuticals de Costa Rica (NPCR).\nBasis of presentation\nThe consolidated financial statements include the accounts of the Company and its domestic and foreign subsidiaries, all of which are wholly-owned. Significant intercompany accounts and transactions have been eliminated in consolidation. Certain prior years accounts have been reclassified to conform with the current year presentation.\nUse of estimates\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.\nFair value of financial instruments\nDuring 1995, the Company adopted Statement of Financial Accounting Standards No. 107, \"Disclosures about the Fair Value of Financial Instruments,\" which requires the disclosure of the estimated fair value of financial instruments. This statement defines fair value as the amount at which an instrument could be exchanged in a current transaction between willing parties, other than a forced liquidation. The Company's implementation of this pronouncement did not have a material impact on its financial position, as the fair value of such instruments approximated book value at December 31, 1995.\nRestructuring and other charges (Cash, cash equivalents, receivables, and debt)\nIn the fourth quarter of 1993, the Company recorded restructuring and other charges associated with implementing the Company's strategy to better serve its clients and more effectively compete in its primary business. The plan provided for the replacement of key management positions, upgrading the information systems, re-engineering of the mail service pharmacy prescription dispensing facility and de-emphasizing business activities outside the Company's primary operational focus. Adoption of the plan resulted in a restructuring charge of $4,900,000 which included estimated amounts for impairment of certain assets totaling $2,700,000, anticipated employee separation costs of $1,600,000 and other matters.\nA substantial portion of the restructuring activities were completed in 1994 and 1995. During 1995 and 1994, cash expenditures of $802,000 and $1,277,000, respectively, were charged against the reserve. The remaining balance in Accrued Restructuring and Other Charges represents employee separation costs and a reserve for the write down of the Company's carrying value of NPCR, both of which are expected to be completed in the near future.\nStatements of cash flows\nThe Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. The Company places its cash investments in certificates of deposit, money market account deposits and the highest rated commercial paper and U.S. Treasury securities.\nCash paid was as follows for the years ended December 31:\nThe exchange of Notes during 1995 and 1994 resulted in a transfer of long-term debt to capital of $20,000 and $172,000, respectively. The sale of NSL, during 1995, resulted in the conversion of NSL obligations of $2,710,000 to Other Assets (see Note 10).\nCredit risk\nFinancial instruments which potentially subject the Company to a concentration of credit risk principally consist of cash and cash equivalents and accounts receivable. The Company places its cash and cash equivalents with high credit quality financial institutions, corporations and securities backed by the United States government and limits the amount of credit exposure to any particular investment. Concentrations of credit risk with respect to trade receivables are limited due to the large number of customers comprising the Company's customer base and their economic and geographic diversification. In addition, the Company performs periodic credit evaluations of its customers and generally does not require collateral. The Company does not believe significant credit risk exists at December 31, 1995 with respect to its cash and cash equivalents or accounts receivable. The Company has agreements with two mail service clients that accounted for approximately 30, 27 and 23 percent of the Company's revenues in 1995, 1994 and 1993, respectively.\nForeign currency translation\nThe Company uses the U.S. dollar as the functional currency of its foreign subsidiary NPCR. Accordingly, the financial statements of NPCR are remeasured in terms of the U.S. dollar and resulting gains and losses are recognized in current operations. Losses included in the determination of net income (loss) for the years ended December 31, 1995, 1994 and 1993 were $111,000, $44,000 and $78,000, respectively.\nInventories\nInventories are stated at the lower of cost or market. Cost is determined principally using the first-in, first-out method. Cost for inventories of NPCR is determined using the last-in, first-out method (LIFO). LIFO costs were $1,091,000 at December 31, 1995 and $961,000 at December 31, 1994, and approximated current cost.\nPrepaid expenses and other\nPrepaid expenses and other consists primarily of deposits for the purchase of inventory of $2,500,000 at December 31, 1995 and 1994 and prepaid operating expenses.\nLong-lived assets\nThe Financial Accounting Standards Board (FASB) has issued Statement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed of,\" which the Company will implement in fiscal year 1996. This statement establishes accounting standards for the impairment of long-lived assets, certain identifiable intangibles, and goodwill related to those assets to be held and used, and for long-lived assets and certain identifiable intangibles to be disposed of. Management does not expect the implementation of this pronouncement to have a material impact on the financial position or results of operations of the Company.\nProperty, plant and equipment\nProperty, plant and equipment is stated at cost, net of accumulated depreciation and amortization which is computed using the straight-line method over estimated useful lives of 3 to 10 years for furniture, fixtures, equipment and software. Leasehold improvements are amortized over the shorter of their estimated useful lives or the terms of the leases.\nOther assets\nOther assets consists primarily of notes receivable related to the sale of NSL (see Note 10).\nGoodwill\nCost in excess of net assets acquired is amortized using the straight-line method over a period of 40 years. The Company periodically reviews whether events or circumstances have occurred or may occur that warrant a re-evaluation of the remaining useful life of goodwill or the recoverability of the remaining goodwill. When factors arise that would indicate that a review of goodwill is necessary, the Company assesses the future recoverability of such goodwill based upon a projection of related business' undiscounted net income and cash flow.\nDeferred offering costs\nCosts incurred in connection with the public offering of 10 percent Senior Secured Convertible Notes were capitalized in Other Assets and are being amortized over the term of the related debt on the bonds outstanding method.\nOther accrued liabilities\nOther accrued liabilities at December 31, included the following individual items greater than 5 percent:\nIncome taxes\nThe Company accounts for income taxes in accordance with Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes,\" which requires an asset and liability approach to financial accounting and reporting for income taxes.\nStock based compensation\nIn October 1995, the FASB issued Statement of Financial Accounting Standards No. 123 \"Accounting for Stock-Based Compensation.\" The company is required to adopt the new statement for 1996. The Company plans to adopt the statement through the disclosure method in 1996, accordingly, there will be no impact on the future reported results of operations or financial position.\nPer share data\nPer share data have been computed by dividing the net income or loss, after reduction for Preferred Stock dividend requirements in periods when assumed conversion of the Preferred Stock would have been antidilutive, by the weighted average number of common shares and equivalents outstanding during the period. Common Stock equivalents include dilutive stock options and warrants and the dilutive effects of Preferred Stock conversions. Fully diluted per share calculations are not presented in the financial statements because the assumed conversion of the convertible debt and any additional incremental issuance of stock options or warrants would be antidilutive.\n2. Inventories\nInventories at December 31 consisted of the following:\nFinished goods inventory included $4,574,000 and $2,067,000 of pharmaceutical drugs at the Company's mail service pharmacy at December 31, 1995 and 1994, respectively.\n3. Property, plant and equipment\nProperty, plant and equipment consisted of the following at December 31:\nEquipment and software at December 31, 1995 included $3,096,000 of construction in progress for the new pharmacy automation in Des Moines, Iowa, which will be depreciated beginning in 1996.\n4. Lines of credit\nAt December 31, 1995, the Company had foreign lines of credit with banks under which it may borrow up to $100,000 with interest at prime plus 4 percent and $150,000 at LIBOR plus 6 percent. Available credit under these lines was $250,000 at December 31, 1995.\n5. Long-term debt\nLong-term debt consisted of the following at December 31:\nThe 10% Senior Secured Convertible Notes (the \"Notes\") mature in September 2002, and are convertible into the Company's Common Stock at any time prior to maturity at the option of the holder, unless previously redeemed, at a conversion price subject to adjustment in certain circumstances. At December 31, 1995, the conversion price was $5.87 per share and 1,073,253 common shares have been reserved for issuance upon conversion.\nThe Notes are secured by certain assets of the Company and all of the capital stock of the Company's operating subsidiaries, but are effectively subordinate in right of payment to present and future creditors of such subsidiaries. Interest is payable semi-annually on September 15 and March 15. The debt agreement contains certain covenants and provisions that require the Company to: (a) limit dividends and distributions, (b) limit sales of assets, (c) limit capital transactions by subsidiaries, (d) limit charter amendments of subsidiaries, and (e) limit net intercompany subsidiary debt. At December 31, 1995, the Company was in compliance with these covenants.\nThe Notes are redeemable, in whole or in part, at the option of the Company, at various redemption prices which range from 105.4 percent in 1995 to 100.8 percent in 2001, together with accrued interest. Notwithstanding the above, redemption may be made, at par value plus accrued interest, at such time as the closing price of the Company's Common Stock has been at least 180 percent of the conversion price then in effect for a period of 30 consecutive trading days ending on the fifth trading day prior to the date of notice of redemption. The Note Indenture requires certain sinking fund payments such that substantial amounts of the Notes are retired prior to the scheduled 2002 maturity date. The first such sinking fund payment is scheduled for September 1997. Additional mandatory redemptions may be required if the Company's consolidated tangible net worth (as defined in the Indenture) on the last day of any two consecutive fiscal quarters is less than $6,500,000. At December 31, 1995, the Company's consolidated tangible net worth was $33,690,000.\nThe required aggregate principal maturities of the Notes for years ending subsequent to December 31, 1995 are as follows: 1996-$0; 1997-$268,000; 1998-$1,380,000; 1999-$1,380,000; 2000-$1,380,000 and thereafter $1,892,000.\n6. Stockholders' equity\nPreferred stock\nThe Company's 8 percent umulative Preferred Stock is convertible into 1.35 shares of Common Stock for each share of Preferred Stock and has full voting rights. Dividends are cumulative and accrue at $.80 per share, payable annually. Dividends were fully paid or accrued through December 31, 1995. This Preferred Stock has a liquidation preference of $10 per preferred share. During 1995, 2,000 shares of Preferred Stock were converted into 2,700 shares of Common Stock. The Company may at any time redeem, in amounts of at least $500,000, these preferred shares by paying $10 per share in cash plus accrued but unpaid dividends. The Company has reserved 217,789 shares of Common Stock for issuance upon conversion.\nCommon stock\nThe Company has a stock purchase plan which authorizes the sale of up to 500,000 shares of Common Stock, at prices per share not less than the fair market value at the date of sale, to qualified officers, directors and employees. At December 31, 1995, a total of 124,766 shares had been purchased under the plan and 375,234 shares of Common Stock has been reserved for future issuance.\nIn August 1994, the Company implemented a stockholder rights plan. Under the terms of the plan, the Company granted one right for each share of Common Stock outstanding on August 27, 1994. Each right allows the holder to purchase one unit, consisting initially of one share of a new class of preferred stock, for $35 per unit, subject to adjustment. The rights become exercisable in the event that a person or a group acquires beneficial ownership of 10 percent or more of the Company's Common Stock or commences a tender or exchange offer upon consummation of which such person or group would beneficially own 10 percent or more of the Company's Common Stock (except for a Board-approved tender or exchange offer for all of the Company's Common Stock). In connection with such an event, each right entitles the holder to purchase shares of the Company's Common Stock having a value of two times the right's exercise price. The rights expire on August 15, 2004.\nStock options and warrants\nThe Company's 1993 Employee Stock Option Plan authorizes the granting of options to qualified individuals, as defined in the option plan, to purchase, within a period of up to ten years from date of grant, up to 3,000,000 shares of Common Stock at prices per share equal to the fair market value on the date of grant. Options granted vest in such increments as the Board of Directors may determine.\nThe Company's 1993 Non-employee Director Stock Option Plan authorizes the granting of options to Non-employee Directors to purchase, within a period of five years from the date of grant, up to 300,000 shares of Common Stock at prices per share equal to the fair market value on the date of grant. All options granted under the plan vest at time of grant.\nIn 1993, the Company terminated the 1987 Employee Stock Option Plan and the 1986 Non-Qualified Stock Option Plan. Options granted prior to the termination of the plans remain outstanding according to the terms of those plans. At December 31, 1995 there were options for 408,000 and 156,250 shares outstanding under the plans, respectively.\nThe following summarizes transactions involving stock option plans during the years ended December 31, 1995, 1994 and 1993:\nAt December 31, 1995, options to purchase 1,472,575 shares were exercisable, at a weighted average price of $4.86 per share and options for 847,775 shares of Common Stock were available for future grant.\nAt December 31, 1995, the Company had warrants, which were issued at fair market value, outstanding and exercisable for the purchase of 168,750 shares of the Company's Common Stock at prices ranging from $4.00 to $6.60 per share. All warrants issued vest immediately and are exercisable for a period of up to five years. Activity in 1995 included the exercise of 515,000 warrants at prices ranging from $2.44 to $5.13 per share.\n7. Commitments and contingencies\nThe Company leases certain premises and equipment. Payments under several agreements were deferred during an initial specified period of the lease and, accordingly, amounts have been recorded as deferred lease payments. Some leases contain renewal options having substantially the same terms and conditions as the original lease. Substantially all of the leases require the Company to pay maintenance, insurance, taxes and certain other expenses in addition to the stated rentals.\nFuture minimum lease payments, by year and in the aggregate, for noncancelable operating leases with initial or remaining terms of one year or more consisted of the following at December 31, 1995:\nTotal rental expense for operating leases amounted to $1,749,000, $1,638,000 and $1,840,000 for the years ended December 31, 1995, 1994 and 1993, respectively. The Company accounts for rental payment concessions on a straight-line basis over the term of the respective lease.\nThe Company is involved in various legal proceedings incidental to the normal course of business. While it is not feasible to predict the outcome of such proceedings with certainty, management is of the opinion that their ultimate disposition will not have a material adverse effect on the Company's consolidated financial position or results of operations.\n8. Income taxes\nThe provision for income taxes consisted of the following for the years ended December 31:\nThe provision (benefit) for income taxes from continuing operations differs from that which would result from applying the U.S. statutory rate as follows:\nDeferred income taxes reflect the net tax effect 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 as of December 31, 1995 and 1994 are as follows:\nAt December 31, 1995, the Company had net operating loss carryovers for Federal income tax purposes totaling approximately $18,674,000 which expire at various dates beginning in 2000. The ultimate utilization of these carryovers is dependent upon future profitable operations of the respective entities.\nAt December 31, 1995, Systemed Inc. also had investment tax credit (\"ITC\") carryovers for Federal income tax purposes of approximately $60,000 which will be accounted for on the flow-through method, and other credit carryovers of approximately $180,000 which expire in various amounts through 2001 .\nFor financial reporting purposes, a valuation allowance has been recorded to offset the entire deferred tax asset related to these carryovers. When realized, future tax benefits from the carryovers of Systemed Inc. and Systemed Pharmacy Inc. (Ohio) will be applied to reduce income tax expense. Future tax benefit from the utilization of Systemed Pharmacy Inc. (Iowa) losses will be recognized as an adjustment to goodwill.\nProvisions of the 1986 Tax Reform Act could limit the use of loss carryovers and other tax attributes if changes in ownership of the Company aggregating more than 50 percent occur within any three-year period. The Company has not experienced a change in ownership for the three-year period ended December 31, 1995.\n9. Related party transactions\nIn 1995, 1994 and 1993, the Company incurred legal fees of approximately $12,000, $71,000 and $120,000 respectively, from a law firm which includes a partner who presently serves as a member of the Company's Board of Directors.\nPrior to his employment by the Company, a member of the Board of Directors and senior executive of the Company was employed at a company that has a significant contract with a subsidiary of the Company to manage and administer a prescription drug plan for its subscribers. Revenues under this contract for the processing of claims and other related services were $4,386,000, $4,266,000 and $5,104,000 in 1995, 1994, and 1993, respectively, of which $525,000, $1,004,000 and $358,000, was included in accounts receivable at December 31, 1995, 1994, and 1993, respectively.\n10. Sale of subsidiary\nIn March 1995, the Company sold its subsidiary, Newport Synthesis, Ltd (NSL), to the principal management of NSL for a nominal value. The agreement requires NSL to repay its outstanding intercompany obligations of $2,710,000, which were converted to a promissory note payable in equal annual installments of approximately $165,000 over 15 years, with interest at 8.1 percent, and a balloon payment of $240,000 plus interest due in the fifth year if certain profit thresholds are achieved. The principal amount of this promissory note is equivalent to the Company's net investment in NSL. Therefore, no additional provision for loss on disposal was required. Under the terms of the agreement, the Company retains Board representation rights at NSL until the note is paid in full. Due to the nature and structure of the transaction, generally accepted accounting principles dictate that it should be reflected in the financial statements as a transferred business and the net assets which constitute the note receivable have been classified in Other assets. Payments received on the note will be recorded as a reduction to the carrying value of the segregated assets.\nThe consolidated statements of operations exclude revenues and expenses, for all periods presented, of discontinued operations. Net operating revenues for NSL were $2,920,000 for the three month period ended March 31, 1995, and $6,812,000 and $6,201,000 for the years ended December 31, 1994 and 1993, respectively. Net income from discontinued operations was $651,000 for the three month period ended March 31, 1995, and $685,000 and $98,000 for the years ended December 31, 1994 and 1993, respectively. The Company deferred the income from discontinued operations as an addition to the Reserve for Estimated Loss on Disposal of Discontinued Operations.\nIn prior years the Company negotiated grants relating to NSL from the Industrial Development Agency (IDA) of the Republic of Ireland to be used for product development, employee training and the acquisition of property and equipment. Product development and employee training grants were recognized in income in the year in which the costs to which they related were incurred by NSL. Grants for the acquisition of property and equipment were deferred and recognized as income on the same basis as the related property and equipment was depreciated. The sale of NSL in March 1995, did not require the repayment of grants received.\n11. Subsequent event\nThe Company was informed that certain accounts would not be renewing their contracts for 1996 due to competitive pricing in the marketplace. The effect of this will negatively impact future quarterly revenues by approximately $6 to $8 million for fiscal year 1996. As a result, a restructuring charge to earnings of approximately $1.6 million will be taken in the first quarter of 1996. The restructuring charge will consist of employee separation and transition costs incurred in connection with organizational and facility changes.\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS SYSTEMED INC. (Amounts in thousands)\n- ---------------\n(1) Represents write off of accumulated amortization of trademarks charged against accrued restructuring and other items.\n(2) Net write off of receivables.\n(3) Represents the write off of accumulated amortization of goodwill associated with the Company's acquisition of DPS, in 1989, determined to have no future value.\n(4) Represents the effect of translating the account balance in accordance with Statement of Financial Accounting Standards No. 52, \"Foreign Currency Translation\".\n(5) Net write offs of receivables, a portion of which is included in restructuring and other charges.\n(6) Represents write off of receivables, and adjustments to the allowance for doubtful accounts due to improved collectibility.","section_15":""}
{"filename":"316793_1995.txt","cik":"316793","year":"1995","section_1":"ITEM 1. BUSINESS\nINTRODUCTION\nInternational Rectifier Corporation (\"IR\" or the \"Company\") is a major worldwide supplier of power semiconductors. Power semiconductors switch or condition electricity at relatively high voltage and current levels in products such as computers\/peripherals, automobiles, portable phones, and electronic lights.\nThe Company designs, manufactures and markets power semiconductors which are used for power conversion. In the same way that oil is refined to produce gasoline to power a car, electrical power is converted to operate equipment. This process of power conversion can be viewed in four stages: input rectification, control, switching, and output rectification. Input rectification conditions off-line electricity, typically rectifying alternating-current to direct-current. The control function measures incoming electricity and sends a signal to the switch. The switch chops the energy into small elements. Output rectification re-configures the elements into a form usable by electrically operated equipment.\nIR supplies products that perform each of the four basic functions in power conversion, and many circuits use more than one type of IR product. This allows IR to develop products that work together to optimize overall circuit performance, and enables the Company to capitalize more broadly on market- leading products.\nIR's products are used in all major market sectors. Applications for power semiconductors in automobiles include anti-lock braking and fuel injection systems, power accessories, and air bags. Computer\/peripheral applications include power supplies, disk drives, and printers. Office equipment applications include copiers and facsimile machines. Consumer electronics and lighting applications include home entertainment, household appliances and electronic lighting ballasts. Communications applications include portable phones, telephone networks and modems. Power semiconductors are also used widely in industrial applications such as motor-driven production lines, machine tools, fork lifts, and welders.\nBased on statistics published by the Semiconductor Industry Association (the \"SIA\"), the Company believes it is the leader in the power MOSFET (Metal Oxide Semiconductor Field Effect Transistor) segment with its trademarked HEXFET-Registered Trademark- power MOSFETs and IGBTs (Insulated Gate Bipolar Transistors). SIA data indicates that industry-wide sales of power MOSFETs were $1.5 billion in calendar 1994, an increase of 38% over 1993 levels, and that, over the past five years, power MOSFET sales have grown at an average rate of 28% per year.\nThe Company's major customers include industry leaders such as AT&T Technologies Inc., Conner Peripherals, Inc., General Motors Corp., Hewlett Packard Co., International Business Machines Corp., Matsushita Electronics Corporation, Sanken Electric Company, Ltd., Sony Corporation, Sporele and Siemens AG. In fiscal year 1995 the Company's sales by region were approximately 46% from North America, 28% from Europe, and 26% from Asia. IR has manufacturing facilities in North America, Europe, and Asia, and uses subcontract assembly in Asia.\nIR was founded as a California corporation in 1947 and reincorporated in Delaware in 1979. Its executive offices are located at 233 Kansas Street, El Segundo, California 90245 and its telephone number is (310) 322-3331.\nPOWER SEMICONDUCTOR INDUSTRY\nSemiconductors are silicon-based chips that conduct and block electricity. The semiconductor industry consists of integrated circuits (\"ICs\") and power semiconductors. ICs operate at low power levels and perform multiple functions to process and convey information in electronic signal form. IC capability is largely defined by circuit density, which increases as its features are miniaturized. The\napplications for ICs are generally concentrated in the computer industry and have been subject to frequent redesign, short product life cycles and rapid obsolescence. As a result, the demand for ICs has been highly cyclical.\nIn contrast to ICs, power semiconductors operate at higher power levels and perform a single function: they condition and control electricity to operate a power supply, control a motor, or light a lamp. Their capability is largely defined by the level of power that they can handle and their efficiency in converting raw electric current into a more useful form. The amount of electric current handled and the heat it generates limit the rate at which power semiconductors can be miniaturized.\nAdvances in power semiconductor performance and cost-per-function have been achieved through the use of MOS technology. MOS power transistors (power MOSFETs and IGBTs) have gained an increasing share of the power transistor market at the expense of bipolar transistors that also serve the switch function.\nMOS power transistors offer significant benefits over bipolar power transistors. They provide much greater switching speed, which allows the design of higher frequency, more compact circuits. They are activated by voltage rather than current, so they require less external circuitry. MOS transistors are more compatible with microprocessor controls. They offer more reliable long-term performance and are more rugged, so they can better withstand adverse operating conditions. Power MOSFETs and IGBTs compare favorably to bipolar power transistors on a price\/performance basis.\nAPPLICATIONS\nPower semiconductors are used in a broad spectrum of commercial and industrial applications, including many products with long life cycles. Because of their more gradual rate of technological change and the diversity of applications, the demand for power semiconductors is less cyclical than for ICs. Power semiconductor demand is driven by conversion to new technologies, the proliferation of new end-product applications, and growth in the end markets. The Company believes that markets driving future demand for power semiconductors include:\nPORTABLE ELECTRONICS. Advances in power semiconductors help extend battery life and reduce product size and weight in a variety of battery-operated products such as lap-top and notebook computers, personal digital organizers, cellular telephones, household appliances and hand tools.\nAUTOMOTIVE ELECTRONIC SYSTEMS. The concentration of solid state electronics in recent model year automobiles has increased rapidly, as safety and comfort features increase demands on the battery. Applications include anti-lock braking systems, air-bags, fuel injection systems, electric windows and adjustable mirrors and seats. Adoption of battery operated electric vehicles to reduce emissions would dramatically increase consumption of MOS transistors.\nELECTRONIC LIGHTING BALLASTS. Electronic lighting ballasts, which incorporate power MOSFETs and Power Integrated Circuits, significantly reduce the amount of energy consumed in lighting. Conversion to electronic ballasts has been driven by lower end-user operating costs and incentives from electric utilities to encourage energy efficiency.\nVARIABLE SPEED MOTORS. Variable-speed solid-state controls increase energy efficiency and performance in a broad range of industrial and appliance motors. In addition, clean air legislation is driving the conversion from traditional chlorofluorocarbons (\"CFCs\") to less toxic refrigerants which are also less efficient. Manufacturers of refrigerators and air conditioners can compensate for these less efficient chemicals by using more efficient variable-speed motors.\nPRODUCTS\nThe Company's products convert electrical power to make it more useable and efficient in performing work such as operating power supplies, controlling motors, and lighting lamps. The products' ability to minimize energy lost at each point in the power conversion process is central to\ntheir value. Important growth applications include such energy-sensitive products as electronic fluorescent lights, more energy efficient refrigeration and air conditioning equipment, and electric vehicles.\nThe Company's HEXFET power MOSFET products comprised about 66% of fiscal 1995 sales. IR also supplies IGBT transistors, High Voltage Control Integrated Circuits, high-performance diodes, and high power rectifiers and thyristors. The Company believes that this complete line of power conversion products represents a competitive advantage, enabling IR to provide customers with integrated solutions to their power conversion needs.\nSWITCHING PRODUCTS\nMOS TRANSISTORS. MOS transistors (power MOSFETs and IGBTs) serve the switch function in power conversion to provide an even, usable flow of power for electronic equipment.\nPOWER MOSFETS. Through its HEXFET product line, the Company is the world leader in power MOSFETs. The breadth and diversity of the market for these products help to stabilize demand.\nApplications for MOSFETs in automobiles include anti-lock braking and fuel injection systems, power accessories and air bags. Computer\/peripheral applications include power supplies, disk drives, and printers. Office equipment applications include copiers and facsimile machines. Consumer electronics applications include home entertainment, videocameras, household appliances, and power tools. Lighting applications include electronic lighting ballasts and compact fluorescent bulbs. Industrial applications include instrumentation and test equipment. Communications applications include telephone networks and modems. Government and aerospace applications include commercial and military satellites, communications equipment, command-and-control systems, and missiles.\nMarket acceptance and brand recognition of HEXFETs have benefited from the Company's emphasis on quality control and reliability, and the Company believes its standards to be among the most stringent in the industry. Cumulative and current data on long and short term product reliability is made available to customers quarterly.\nThe Company fabricates the large majority of its power MOSFET wafers at HEXFET America. Die from these wafers are assembled into packaged devices at HEXFET America, IR's facilities in England and Mexico, and subcontract facilities in Asia. See \"-- Manufacturing.\"\nIGBTS. IGBTs typically serve the switch function in power conversion applications that require higher current and voltage than power MOSFETs handle efficiently. IGBTs combine the ease of voltage-driven power MOSFET technology with the conduction efficiency of bipolar transistor technology. The performance and ruggedness of these devices enable them to replace bipolar transistors and thyristors in many high-voltage, high-current motor control and power conditioning applications. Energy-efficient, variable-speed motor controls are an emerging application, and the Company believes electric vehicles will require large quantities of IGBTs for each vehicle.\nThe Company's IGBT technology is closely related to its HEXFET technology, and the Company views them as complementary products. The Company believes that its patents on fundamental MOSFET technology also apply to IGBTs, and it is seeking further patent protection on its IGBT technology.\nCONTROL PRODUCTS\nHIGH VOLTAGE CONTROL ICS. These devices serve the control function of power conversion. They perform the functions of several discrete components. This integration allows IR's customers to simplify circuit design and assembly, improve reliability and reduce overall system size and cost. In sensing and responding to adverse operating conditions, High Voltage Control IC performance is superior to that of discrete components in a safety or diagnostic circuit. IR's High Voltage Control ICs draw on the Company's MOSFET technology and are designed to optimize the performance of both power MOSFETs and IGBTs. The Company believes that its power MOSFET patents also apply to a broad range of High Voltage Control ICs.\nHigh Voltage Control ICs are used in a wide variety of power supply, motor and lighting control applications. These include industrial motor controls, home appliance motor controls, solenoid drivers, welding equipment, telecom switchers, computer\/peripherals, instrumentation and test equipment, electronic lighting ballasts, and compact fluorescent light bulbs.\nINPUT RECTIFICATION PRODUCTS\nThe Company also manufactures a broad line of rectifiers, diodes and thyristors that serve the input rectification function of power conversion. These products condition power to make it more efficient and useable, principally in industrial end products that require power-handling capability from one amp to 5000 amps and from 20 volts to 5000 volts. Applications include motor and lighting controls, welding equipment, fork lifts, machine tools, induction heating, locomotives, motor-driven production lines, smelting equipment, and power supplies.\nOUTPUT RECTIFICATION PRODUCTS\nThe Company's Schottky diodes and Fast-Recovery diodes serve the output rectification function of power conversion. Output rectification reconfigures the elements into a form usable by electrically operated equipment. Schottky diodes are used with power MOSFETs in high-frequency applications such as computer\/peripherals. The Company's trademarked HEXFRED-Registered Trademark- Fast-Recovery diodes are used with IGBTs in higher-current, lower-frequency applications such as motor controls.\nMANUFACTURING\nSemiconductor manufacturing involves two phases of production: wafer fabrication and assembly (or packaging). Wafer fabrication is a sequence of process steps that expose silicon wafers to chemicals that change their electrical properties. The chemicals are applied in patterns that define cells or circuits within numerous individual devices (often termed \"die\" or \"chips\") on each wafer. Packaging or assembly is the sequence of production steps that divide the wafer into individual chips and enclose the chips in external structures (termed packages) that make them useable in a circuit. Power semiconductors generally use the process technology and equipment already proven in ICs manufacturing.\nThe Company has production facilities in California, England, Italy, Mexico and India. In addition, the Company has equipment at, or manufacturing supply agreements with, subcontractors located in the Philippines, Japan, Taiwan, Malaysia, and the United States.\nIR fabricates substantially all of its power MOSFET wafers at HEXFET America in Temecula, California. A wafer fabrication facility for IGBTs and other MOSFET devices as well as assembly operations for government and other advanced products are located in El Segundo, California. Facilities that assemble HEXFETs and other products are located in the United States and overseas, in Company-owned and subcontract facilities, in order to take advantage of low assembly costs and provide maximum customer service. In Tijuana, Mexico, the Company assembles MOSFET products, IGBTs and other modules. The Company's Oxted, England facility, which qualifies as a duty-free facility, assembles MOSFETs, IGBTs, Schottky and diodes. Since April 1, 1994 the Company has manufactured substantially all its high power rectifiers and thyristors at its Turin, Italy facility. The Company also has arrangements with third parties for product assembly in the Philippines, Malaysia, Taiwan, Japan and Mexico. In a duty-free zone in India, the Company has an assembly facility for rectifiers and thyristors.\nTo meet rising demand for power MOSFETs, the Company is expanding wafer fabrication at HEXFET America. The Company believes that the estimated $75 million expansion will increase its power MOSFET fabrication capacity by about 75% and is expected to support about $185 million in additional product shipments at full utilization.\nThe expansion will position IR to aggressively address the fastest growing segments of the power transistor market, high density MOSFETs and IGBTs. Next-generation devices designed for production in the new fabrication facility incorporate design and process advancements in the Company's proprietary HEXFET and IGBT technologies. A core process with shared elements for both products\nwill enable the facility to combine flexibility with efficient high-volume manufacturing techniques. The fabrication will be performed on six-inch wafers and will use a continuous-flow layout similar to the one already in use at HEXFET America. The expansion is on schedule and within budget at this time. The Company has completed substantially all equipment installation and has begun internal qualification and operator and technician training. Customer qualifications are expected to begin in September, and manufacturing is scheduled to begin to ramp up by the end of the calendar year.\nShortly after the close of the fiscal year, IR announced plans to transfer assembly lines from HEXFET America to its assembly facility in Tijuana, Mexico and to independent subcontractors. Designed to allow the California plant to focus on expansion of its benchmark wafer fabrication capability and to reduce the cost of assembling the Company's HEXFET-Registered Trademark- power MOSFET chips into finished devices, the move will affect only the assembly phase of manufacturing. The Company's 75 percent expansion of wafer fabrication capacity is unaffected by the move. The assembly lines will be moved out of the California plant over a 12 to 18 month period.\nMARKETING, SALES AND DISTRIBUTION\nThe Company markets its products through sales personnel, representatives, or distributors. The Company believes its ability to offer products that serve each of the four functions of power conversion enhances its competitive position in the overall power semiconductor market.\nIn fiscal year 1995 the Company's sales by region were approximately 46% from North America, 28% from Europe, and 26% from Asia. The Company's domestic direct sales force is organized in four sales zones. In Western Europe, the Company's products are sold through its own sales force as well as through sales agents and distributors. The Company's European sales and representative offices are in England, Italy, Sweden, France, Germany, Finland, Denmark, Russia, Poland, the Czech Republic, and Hungary. In Asia IR has sales and representative liaison offices in India, Japan, Singapore, China, Hong Kong, and Korea.\nBecause many applications require products from several product groups, the Company has organized its marketing efforts by market sector, rather than product type. These business management groups focus on several key commercial sectors and on government and aerospace business. In addition, the Company's staff of applications engineers provides customers with technical advice and support regarding the use of IR's products.\nCUSTOMERS\nIn most cases, the Company's devices are incorporated in larger systems manufactured by end product manufacturers. The Company's customers in the automotive segment include General Motors Corp., Ford, Delco, Siemens AG and Bosch. International Business Machines Corp., Hewlett Packard Co., Apple Computer Inc. and Compaq purchase the Company's products in the computer segment. Consumer electronics customers include Philips and Sony. Customers in the telecommunications segment include AT&T Technologies, Inc. and Nokia. The Company also sells its products to distributors including Arrow Electronics, Future Electronics, and Pioneer Electronics\/Pioneer Technology.\nBACKLOG\nAs of June 30, 1995, the Company's backlog of orders was $210.8 million compared to $121.8 million as of June 30, 1994. Backlog represents purchase orders which have been released for shipment and are scheduled to be shipped within the following 12 months. In accordance with industry practice, IR may in certain circumstances release customers from purchase orders without penalty. Increasingly, major customers are operating their businesses with shorter lead times and are placing orders on a periodic rather than an annual basis. Orders are cancelable and backlog is not necessarily indicative of sales for any future period.\nRESEARCH AND DEVELOPMENT\nThe Company is involved in ongoing research and development directed toward new processes, devices and packages as well as continued improvement of quality and reliability in existing products.\nIn fiscal years 1995, 1994 and 1993, the Company spent approximately $20.1 million, $16.4 million and $14.1 million, respectively, on research and development activities. In fiscal 1994, the Company introduced a variety of products designed to address growth opportunities identified by market sector: high-density, high-efficiency HEXFETs and surface-mount packages for portable electronics; High Voltage Control ICs for lighting and motor control applications; and IGBT devices for motor controls. IR's research and development program is focused on advancing and diversifying the HEXFET product line, expanding the related IGBT products, and developing High Voltage Control ICs and other power products that work in combination with HEXFETs and IGBTs to improve system performance. IR's research and development staff also works with the marketing staff to develop new products that address specific customer needs. Efforts are directed towards developing new processes that enable the Company to produce smaller, more efficient devices. Efforts are also directed at reducing assembly costs and developing new package designs and assembly processes.\nINTELLECTUAL PROPERTY\nThe Company has made significant investments in developing and protecting its intellectual property. Through successful enforcement of its patents, the Company has entered into a number of license agreements, generated royalty income and received substantial payments in settlement of litigation. The Company currently has 64 unexpired U.S. patents and 45 U.S. patents pending. Those patents fundamental to the Company's products expire between 2000 and 2010. In addition, the Company has 60 foreign patents and 73 foreign patents pending in a number of countries. The Company is also licensed to use certain patents owned by others. Under the terms of an agreement with Unitrode Corporation that terminates in March 2000, the Company pays Unitrode Corporation approximately 12% of the Company's net patent royalty income. The Company has several registered trademarks in the United States and abroad including trademarks for HEXFET. The Company believes that its proprietary technology and intellectual property contribute to its competitive advantage.\nSince the Company believes that its power MOSFET patents are broadly applicable, it is committed to enforcing its rights under those patents and is pursuing additional license agreements. The Company presently has royalty-bearing license agreements with 13 companies: CP Clare Corporation, Harris Corporation; Hitachi, Ltd.; Matsushita Electronics Corporation; Mitsubishi Electric Corporation; National Semiconductor Corporation; NEC Corporation; Nihon Inter Electronics Corporation; Sanken Electric Company, Ltd.; SGS-Thomson Microelectronics, Inc.; Siliconix incorporated; Toshiba Corporation; and Unitrode Corporation. In fiscal 1995, $9,743,000 of revenues were derived from such royalty-bearing license agreements.\nCertain of the company's fundamental power MOSFET patents have been subjected, and continue to be subjected, to reexamination in the United States Patent and Trademark Office (\"PTO\"). The patents subject to reexamination are fundamental to the Company's MOS transistors and their loss would allow competitors to use currently patented features of the Company's MOS transistor technology without liability for infringement of those patents. On the following dates, the PTO granted requests for reexamination of the following patents of the Company: November 13, 1992 and September 12, 1994 on patent 4,642,666; September 12, 1994 on patent 4,959,699; September 23, 1994 and June 28, 1995 on patent 5,008,725; January 17, 1995 on patent 5,130,767; June 5, 1995 on patent 5,191,396; and June 14,1995 on patent 4,593,302. On February 14, 1995, the PTO issued a reexamination certificate, confirming the patentability of the Company's U.S. patent 4,705,759.\nAlthough no assurance can be given as to the ultimate outcome of the Company's patent enforcement efforts, the PTO reexamination proceedings, or the success of the Company's patent licensing program, the Company believes that its patent portfolio will be the source of continuing royalty income.\nCOMPETITION\nThe Company encounters differing degrees of competition for its various products, depending upon the nature of the product and the particular market served. Generally, the semiconductor industry is highly competitive, and many of the Company's competitors are larger companies with\ngreater financial resources than IR. The Company believes that its breadth of product line and its ability to combine products that serve the different functions into one package distinguish it from its competitors. IR's products compete with products manufactured by others based on breadth of product line, quality, price, reliability, over-all performance of the products, delivery time to the customer, and service (including technical advice and support). The Company's competitors include Eupec, Harris Corporation, Hitachi Ltd., Motorola, Inc., NEC Corporation, Philips International B.V., Powerex, Inc., Samsung Semiconductor Inc., SGS-Thomson Microelectronics, Siemens AG, Siliconix incorporated, Toshiba Corporation and Westcode Semiconductors Ltd.\nENVIRONMENTAL MATTERS\nFederal, state and local laws and regulations impose various restrictions and controls on the discharge of certain materials, chemicals and gases used in semiconductor processing. The Company does not believe that compliance with such laws and regulations will have a material adverse effect on its financial position.\nThe Company and Rachelle Laboratories, Inc. (\"Rachelle\"), its former pharmaceutical subsidiary which discontinued operations in 1986, have been named among several hundred entities as potentially responsible parties (\"PRPs\") under the provisions of the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (\"CERCLA\"), in connection with the United States Environmental Protection Agency's (\"EPA\") investigation of the disposal of allegedly hazardous substances at a major superfund site in Monterey Park, California (the \"OII Site\"). Certain PRPs who settled certain claims with the EPA under consent decrees filed suit in Federal Court in May 1992 against a number of other PRPs, including the Company, for cost recovery and contribution under CERCLA. The lawsuit against the Company, relating to the first and second consent decrees, was settled in August 1993 for the sum of $40,000 to avoid protracted and expensive litigation. In June 1995, the Company was named among others as a party defendant in Federal Court apparently in connection with a third consent decree with respect to the OII Site. The Company recently received a letter (dated July 25, 1995) from the U.S. Department of Justice offering to settle claims against Rachelle relating to the first three elements of cleanup work at the OII Site for the sum of $4,953,148. (The final remedy assessment has not yet been made). The letter stated that if the offer is not accepted by September 1, 1995, enforcement action will follow. The Department of Justice letter is being evaluated. Claims have been made with the Company's insurers with respect to the OII Site matter; however, there can be no assurance that insurance coverage attaches to these claims. The Company does not believe that either it or Rachelle is responsible for the disposal at the OII Site of any material constituting hazardous substances under CERCLA. Although the ultimate resolution of this matter is unknown, the Company believes that it will not have a material adverse impact on its financial position.\nIn May 1993, the Company purchased property from its Employee Profit Sharing and Retirement Plan. It was determined that the property required clean-up of seepage from a storage tank, at an estimated additional cost of $525,000. The Company commenced the clean-up in fiscal year 1994, and through June 30, 1995 approximately $450,000 in clean-up costs have been incurred which will be capitalized as additional costs of the property.\nOn July 18, 1994, the Company received a letter from the State of Washington Department of Ecology (the \"Department\") notifying the Company of a proposed finding that the Company is a potentially liable person (\"PLP\") for alleged PCE contamination (also knows as perchloroethylene, tetrachloroethylene, and other names) of real property and groundwater in Yakima County, Washington. The letter alleges that the Company arranged for disposal or treatment of the PCE or arranged with a transporter for the disposal or treatment of the PCE in Yakima County. The Company replied by a letter dated August 11, 1994, stating that it has not contributed to PCE or other solvent contamination at the Yakima County site (resulting from sending carbon canisters for regeneration to a facility in the county) and that it should not be designated a PLP. On October 11, 1994, the Company received a letter from the Department notifying the Company of its finding that the Company is a PLP in the above matter. Initial information indicates that less than one percent of all contaminated carbon sent to the site by PLPs was contributed by the Company. What amount, if any, the Company may be asked to contribute to solve the groundwater problem is unknown.\nThe Company received a letter dated September 9, 1994, from the State of California Department of Toxic Substances Control stating that the Company may be a PRP for the deposit of hazardous substances at a facility in Whittier, California. The Company, in June 1995, agreed to join a group of other PRPs to remove contamination from the site. Although the final outcome is not known and depends on final clean-up costs and the allocation scheme, the group currently estimates a total clean-up cost of about $1.8 million to $2.5 million, of which about $6,000 to $9,000 might be requested to be borne by the Company.\nEMPLOYEES\nAs of June 30, 1995, the Company employed approximately 3,310 people, of whom approximately 2,190 are employed in North America, 1,070 in Western Europe and 50 in Asia. The Company is not a party to any collective bargaining agreements. The Company considers its relations with its employees to be good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's operations occupy a total of approximately 889,000 square feet, of which approximately 502,000 square feet are located within the United States. Of the worldwide total, approximately 268,000 square feet are leased and the balance is owned by the Company.\nIR's leases expire between 1995 and 2012. If the Company is unable to renew these leases upon expiration, it believes that it could find other suitable premises without any material adverse impact on its operations.\nThe Company's major facilities are in the following locations:\nThe Company believes that these facilities are adequate for its current and anticipated near term operating needs. IR estimates that it currently utilizes approximately 81.4% of its worldwide manufacturing capacity. To meet rising demand for power MOSFETs, the Company is expanding wafer fabrication at HEXFET America. Planned to be in production by the end of calendar 1995, the Company believes that the estimated $75 million expansion will increase the Company's wafer capacity in power MOSFETs by about 75%.\nThe Company has nine sales offices located throughout the United States, and other sales and technical support offices in Canada, France, Germany, Finland, Scandinavia, Russia, Czech Republic, Hungary, Hong Kong, Japan, China, Korea, Singapore, and India which operate in leased facilities.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company and SGS-Thomson Microelectronics, Inc. (\"SGS\") are engaged in various legal proceedings relating to their respective power MOSFET patents. SGS filed suit against the Company in June 1991 in Federal District Court in Texas, charging infringement of U.S. patent 4,553,314. On motion by the Company, the suit was transferred to the Federal District Court in Los Angeles, California, and thereafter SGS amended its complaint to charge infringement of U.S. patents\n4,495,513 and 4,712,127. SGS alleges, in substance, that the Company's power MOSFET, power IC and IGBT products infringe the '314 patent, that the Company's IGBT products infringe the '513 patent and that certain packages for the Company's products (including certain power MOSFET packages) infringe the '127 patent. The complaint, as amended, seeks unspecified actual damages (but no less than an unspecified reasonable royalty) and an injunction restraining further sales of such products. On February 1, 1993, the District Court dismissed SGS's claims for infringement of the '127 and '513 patents for lack of standing and on March 15, 1993, ruled that the SGS '314 patent is unenforceable due to inequitable conduct. SGS appealed these rulings, as well as the order transferring the case to California, to the Court of Appeals for the Federal Circuit. The Company cross-appealed a separate ruling by the District Court denying the Company's motion for summary judgment that the '314 patent is invalid. In July 1994, the Federal Circuit vacated the District Court's grants of summary judgment as to the '513, '127 and '314 patents and affirmed the District Court's denial of the Company's motion for summary judgment of invalidity of the '314 patent. The Federal Circuit ordered, however, that the case should proceed in California. A trial date of November 14, 1995 has been set for the '513 patent, but proceedings on the '314 and '127 patents are essentially stayed pending completion of reexamination of these patents in the PTO.\nIn separate proceedings before the same California District Court, the Company sought enforcement of a prior license agreement between the Company and SGS. The Court in July 1994, granted the Company's motions to enforce the license agreement with SGS, requiring SGS to pay additional past and prospective royalties under the Company's U.S. patents 4,959,699 and 4,642,666 on SGS's sales of power MOSFET, IGBT and power IC products. SGS appealed this decision to the Federal Circuit, which on May 10, 1995 affirmed the decision in favor of the Company. SGS subsequently made the required past royalty payment.\nThe Company has also filed a separate action in the same District Court against SGS and its Italian affiliate, SGS-Thomson Microelectronics, S.r.l., seeking an injunction against infringement of the Company's U.S. patents 5,008,725 and 5,130,767. This action has been essentially stayed pending completion of reexamination of these patents by the PTO.\nThe Company, its directors and certain officers have been named as defendants in three class action lawsuits filed in Federal Court in California. These suits seek unspecified but substantial compensatory and punitive damages for alleged intentional and negligent misrepresentations and violations of the federal securities laws. The complaints generally allege that the Company and the other defendants made materially false statements or omitted to state material facts in connection with the public offering of the Company's common stock completed in April 1991 and the redemption and conversion in June 1991 of the Company's 9% Convertible Subordinated Debentures Due 2010. They also allege that the Company's projections for growth in fiscal 1992 were materially misleading. Although the Company believes that the claims alleged in the suits are without merit, the ultimate outcome cannot be presently determined. A substantial judgment or settlement, if any, could have a material adverse effect on the Company's financial condition and results of operations. Two of these suits also name Kidder, Peabody & Co. Incorporated and Montgomery Securities as defendants. The Court has scheduled trial to begin in December 1995.\nNo provision for any liability that may result upon adjudication of these matters has been made in the consolidated financial statements.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF THE SECURITY HOLDERS\nNot applicable.\nADDITIONAL ITEM. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe executive officers and directors of IR are:\nEric Lidow is a founder of the Company, has been a director of the Company since its inception in 1947 and was Chief Executive Officer until March 6, 1995. Mr. Lidow continues as Chairman of the Board and also serves as Chairman of the Company's Executive Committee.\nAlexander Lidow, Ph.D., has been employed by the Company since 1977. He served as the Semiconductor Division's Vice President -- Research and Development since July 1979, was promoted to Semiconductor Division Executive Vice President -- Manufacturing and Technology in March 1985, and became the President of the Electronic Products Division in July 1989. In August 1992, Dr. Lidow was elected Executive Vice President of Operations. He was elected a director in September 1994 and Chief Executive Officer on March 6, 1995. Dr. Lidow is a son of Eric Lidow.\nDerek B. Lidow, Ph.D., has been employed by the Company since 1976. He served as the Semiconductor Division's Vice President -- Operations since March 1980, was promoted to Semiconductor Division Executive Vice President -- Marketing and Administration in March 1985, and became President of the Power Products Division in July 1989. In August 1992, Dr. Lidow was elected Executive Vice President and in July 1993 assumed responsibilities for worldwide sales and marketing. He was elected a director in September 1994 and Chief Executive Officer on March 6, 1995. Dr. Lidow is a son of Eric Lidow.\nRobert J. Mueller has been employed by the Company since November 1961. He served as Vice President of Marketing for the U.S. Semiconductor Division from 1963 until October 1969 when he was promoted to Corporate Vice President -- Foreign Operations. Mr. Mueller became Executive Vice President -- World Marketing and Foreign Operations in April 1978, Corporate Executive Vice President -- External Affairs and Worldwide Sales in July 1989, and in July 1993 became Executive Vice President -- External Affairs and Business Development. He was elected a director in 1990.\nMichael P. McGee has been employed by the Company since 1990. He joined the Company in July 1990 as Director of Corporate Accounting and was promoted to Corporate Controller in December 1990. Mr. McGee became Vice President, Controller and Principal Accounting Officer in 1991, and in 1993, became Vice President -- Chief Financial Officer. From 1985 to the time he joined the Company, Mr. McGee was a senior manager and audit manager at Ernst and Young.\nGeorge Krsek, Ph.D., was President of Houba, Inc. a pharmaceutical firm from 1975 to July 1994, and is currently President of Konec L.L.C., a management consulting company. He has been a director of the Company since 1979, and serves as Chairman of the Company's Audit Committee.\nJack O. Vance became the Managing Director of Management Research, a management consulting firm in November 1990. From 1960 through 1989 he was a director of McKinsey & Co., Inc., a management consulting firm. During the years 1973 through 1989 he was also the Managing Director of the firm's Los Angeles office. He has been a director of the Company since 1988 and also serves as\nChairman of the Company's Compensation and Stock Option Committee. He is also a director of Hillhaven Corporation, International Technology Corporation, Escorp, The Olson Company, University Restaurant Group, and FCG Enterprises, Inc.\nRochus E. Vogt, Ph.D., is the R. Stanton Avery Distinguished Service Professor and a Professor of Physics, California Institute of Technology, and acted as Provost from 1983 through 1987. He has been a director of the Company since 1984.\nDonald S. Burns has been Chairman, President and Chief Executive Officer of Prestige Holdings, Ltd., a property management and business consulting firm since 1978. Mr. Burns was elected a director of the Company in 1993. He is also a director of ESI Corporation, Hillhaven Corporation and International Technology Corporation.\nJames D. Plummer, Ph.D., has been the John M. Fluke Professor of Electrical Engineering, Stanford University since 1988 and Director of Stanford's Integrated Circuits Laboratory since 1984. Dr. Plummer was elected a director of the Company in September 1994.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANTS' COMMON EQUITY AND RELATED STOCKHOLDERS' MATTERS\nPRICE RANGE OF COMMON STOCK (IN DOLLARS)\nThe Company's Common Stock is traded on the New York Stock Exchange under the symbol \"IRF\".\nNo dividends have been recently declared or paid. The Company does not intend to pay cash dividends in the foreseeable future as all funds will be used to expand operations. Furthermore, under certain credit agreements, the Company is not permitted to pay any cash dividends.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe selected consolidated financial data as of June 30, 1995 and 1994 and for the fiscal years ended June 30, 1995, 1994 and 1993 are derived from the audited consolidated financial statements of the Company and should be read in conjunction with the audited consolidated financial statements and notes with respect thereto included herein. The selected consolidated financial data as of June 30, 1993, 1992 and 1991, and for the fiscal years ended June 30, 1992 and 1991 are derived from audited consolidated financial statements of the Company which are not included herein.\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 items included in selected financial data as a percentage of revenues.\n1995 COMPARED WITH 1994\nRevenues for fiscal 1995 increased 30.4% to $429.0 million from $328.9 million in the prior year. The Company's revenue increase reflected continued growing demand for the Company's power MOSFET and related devices which resulted in a 34% increase in revenues from these products. Revenues from the thyristor and rectifier product lines increased 17% from the prior period. Changes in foreign exchange rates positively impacted revenues by approximately $11.1 million. Revenues for fiscal 1995 also included $9.7 million of net patent royalties compared to $9.0 million in the prior period.\nGross profit was 35.2% of revenues ($150.8 million) in fiscal 1995 versus 33.1% of revenues ($108.9 million) in fiscal 1994. The increased margin reflected greater manufacturing volume and efficiencies and a greater contribution from new higher margin products.\nIn fiscal 1995, selling and administrative expense was 19.2% of revenues ($82.3 million) versus 21.0% of revenues ($69.0 million) in fiscal 1994. The decreased percentage reflects the Company's continued commitment to reducing operating expenses as a percentage of revenues.\nIn fiscal 1995, the Company's research and development expenditures increased $3.7 million to $20.1 million (4.7% of revenues) from $16.4 million (5.0% of revenues) in the prior period. The Company's research and development program was focused on the advancement and diversification of the HEXFET product line and expansion of the related IGBT products, the development of High Voltage Control ICs and power products that work in combination with HEXFETs and IGBTs to improve system performance.\nThe major components of other expense include a $1.0 million charge for the transfer of assembly operations to the Company's Mexican subsidiary, $0.3 million of severance costs, $0.3 million on the disposal of property, plant and equipment, $0.3 million of local taxes and $0.5 million in legal fees, offset by $0.3 million in foreign currency transaction gains and $1.8 million of net patent royalty revenues related to prior years.\nIn fiscal 1995, net interest expense decreased by $3.2 million from the prior year. The decrease was due to approximately $2.4 million in interest income earned in the current year on funds received\nfrom a November 1994 offering of the Company's common stock and an increase of $1.7 million of interest capitalized in the current year, partially offset by increased interest expense in the first half of the year on higher average debt balances over the prior year.\n1994 COMPARED WITH 1993\nThe Company operates on a fiscal calendar under which the twelve months ended July 3, 1994 consisted of 52 weeks compared to 53 weeks in the twelve months ended July 4, 1993.\nRevenues for fiscal 1994 increased 16.7% to $328.9 million from $281.7 million in the prior year. The Company's revenue increase reflected continued growing demand for the Company's power MOSFET and related devices which resulted in a 23.4% increase in revenues from these products. Offsetting this revenue increase was a 6.2% decrease in revenues from the Company's thyristor and rectifier product lines. This downturn reflected slow starting economies in key European markets in the first half, and the pruning of these mature product lines. Changes in foreign exchange rates negatively impacted revenues by approximately $2.0 million. Revenues for fiscal 1994 also included $9.0 million of net patent royalties compared to $9.5 million in the prior period.\nGross profit was 33.1% of revenues ($108.9 million) in fiscal 1994 versus 28.1% of revenues ($79.0 million) in fiscal 1993. The increased margin reflected IR's recovery from production constraints in fiscal 1993. In addition, greater MOSFET manufacturing volume and efficiencies resulted in lower per unit product costs and enabled the Company to balance output to market demand and return to a normal mix of original equipment manufacturers, distribution and higher margin spot market business.\nIn the fourth quarter of fiscal 1993 the Company extended the useful lives of certain assets. This change positively impacted gross profit by approximately $2.6 million (0.8% of revenues) during fiscal 1994.\nIn fiscal 1994, selling and administrative expense was 21.0% of revenues ($69.0 million) versus 22.2% of revenues ($62.6 million) in fiscal 1993. The decreased percentage reflects the Company's continued commitment to reducing operating expenses as a percentage of revenues.\nIn fiscal 1994, the Company's research and development expenditures increased $2.3 million to $16.4 million (5.0% of revenues) from $14.1 million (5.0% of revenues) in the prior period. The Company's research and development program was focused on the advancement and diversification of the HEXFET product line and expansion of the related IGBT products, the development of Control ICs and power products that work in combination with HEXFETs and IGBTs to improve system performance. Included in 1994 research and development expenses are the costs associated with an activity started in fiscal 1994, in Japan, where efforts are directed at reducing assembly costs and developing new assembly processes.\nThe major components of other expense include a $0.9 million charge for the consolidation of the Company's power products operations, $0.4 million of severance costs and $0.3 million on the disposal of property, plant and equipment, offset by $0.4 million in foreign currency transaction gains.\nSEASONALITY\nThe Company has experienced moderate seasonality in its business in recent years. On average over the past three years, the Company has reported approximately 47% of annual revenues in the first half and 53% in the second half of its fiscal year.\nLIQUIDITY AND CAPITAL RESOURCES\nAt June 30, 1995, the Company maintained cash and cash equivalent balances of $50.8 million and $3.0 million of short term investments. In addition, the Company had established $78.5 million of domestic and foreign revolving lines of credit, against which $17.3 million had been borrowed. Based on covenant and collateral limitations, the Company had $51.7 million available for borrowing against these lines at June 30, 1995. Additionally, the Company had at its disposal $25.0 million of unused\nbank term-loan facilities and $23.8 million of unused credit lines for capital equipment financing. At June 30, 1995, the Company had made purchase commitments for capital equipment of approximately $24.9 million.\nDuring fiscal 1996 the Company plans to spend approximately $75 million on capital expenditures for the continuing expansion of its global wafer fabrication and assembly capacity. The Company intends to fund these capital expenditure and working capital requirements through cash and cash equivalents on hand, anticipated cash flow from operations, and as needed, from funds available from revolving credit, term loan and equipment financing facilities. The Company may also consider the use of funds from other external sources, including, but not limited to, public or private offerings of debt or equity.\nAlthough the Company believes that the class action lawsuits brought against the Company and its Board of Directors (See \"Legal Proceedings\") are without merit, the ultimate outcome thereof cannot be presently determined. Accordingly, the Company has not made any provision for any liability, if any, that may result upon adjudication of these matters. For the possible effects of environmental matters on liquidity, see \"Business -- Environmental Matters\".\nFOREIGN CURRENCY TRANSACTIONS\nDue to the global nature of its operations, the Company is subject to the effect of international currency fluctuations. In fiscal year 1995, over 50% of the Company's revenues were derived from sales in foreign markets. In the years ended June 30, 1995, 1994 and 1993, foreign currency fluctuations did not significantly impact net income, the Company recognized net foreign currency transactions gains of $347,000, $376,000 and $129,000, respectively.\nThe Company may manage potential foreign currency exposure by entering into forward exchange contracts and options. These contracts are generally not speculative in nature as the resulting gains or losses generally offset any losses or gains on the underlying hedged transactions. Cash in excess of operating requirements is maintained in the United States.\nINCOME TAXES\nDue in part to the utilization of net operating loss carryforwards (\"NOLs\"), the Company's effective income tax rate in fiscal 1995 was approximately 17%. At June 30, 1995, the Company had fully utilized its NOL's for federal income tax purposes. The Company also has approximately $4.9 million of tax credits available to offset future U.S. taxes and approximately $1 million to offset future state taxes. When available tax credits are fully utilized, the Company will be subject to an estimated annual tax rate in the range of 35% to 40%.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE\nSchedules other than those listed above have been omitted since they are either not required, are not applicable, or the required information is shown in the consolidated financial statements or related notes.\nREPORT OF INDEPENDENT ACCOUNTANTS\nThe Stockholders and Board of Directors International Rectifier Corporation\nWe have audited the accompanying consolidated financial statements and the financial statement schedule of International Rectifier Corporation and Subsidiaries as of June 30, 1995 and 1994, and for the fiscal years ended June 30, 1995, 1994 and 1993 as listed on the index on page 16 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 International Rectifier Corporation and Subsidiaries at June 30, 1995 and 1994, and the consolidated results of their operations and their cash flows for the fiscal years ended June 30, 1995, 1994 and 1993, 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 Note 10 to the accompanying consolidated financial statements, three class action lawsuits have been filed against the Company and its Board of Directors (certain of whom are also officers). The ultimate outcome thereof cannot presently be determined. Accordingly, no provisions for any liability that may result upon adjudication of these matters has been made in the accompanying consolidated financial statements.\nCOOPERS & LYBRAND L.L.P. Los Angeles, California July 27, 1995\nINTERNATIONAL RECTIFIER CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF OPERATIONS (IN 000'S EXCEPT PER SHARE AMOUNTS)\nThe accompanying notes are an integral part of this statement.\nINTERNATIONAL RECTIFIER CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET (IN 000'S EXCEPT SHARE AMOUNTS)\nASSETS\nLIABILITIES AND STOCKHOLDERS' EQUITY\nThe accompanying notes are an integral part of this statement.\nINTERNATIONAL RECTIFIER CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (IN 000'S EXCEPT SHARE AMOUNTS)\nThe accompanying notes are an integral part of this statement.\nINTERNATIONAL RECTIFIER CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS (IN 000'S)\nThe accompanying notes are an integral part of this statement.\nINTERNATIONAL RECTIFIER CORPORATION AND SUBSIDIARIES 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 all its majority-owned subsidiaries which are located in Europe, Mexico, Canada, the Far East and South East Asia. All material intercompany transactions have been eliminated.\nFISCAL YEAR\nFiscal years 1995 and 1994 consist of 52 weeks ending July 2 and July 3, respectively. Fiscal year 1993 consists of 53 weeks ending July 4. For convenience, all references herein to fiscal years are to fiscal years ended June 30.\nREVENUE RECOGNITION\nThe Company recognizes revenues from product sales to all customers, including distributors, at the time of shipment.\nSHORT TERM INVESTMENTS\nThe Company's short term investments consist of investment grade money market instruments and government securities. All of the Company's investments have original maturities of less than one year. In accordance with the criteria established by Statement of Financial Accounting Standard No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\", all investments have been classified as \"available-for-sale\". The Company utilizes the specific identification method for determining the cost of the investments. At June 30, 1995 the cost of the investments approximates the market value.\nINVENTORIES\nInventories are stated at the lower of cost (principally first-in, first-out) or market. Inventories at June 30, 1995 and 1994 were comprised of the following (000's):\nPROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment is stated at cost. Upon retirement or other disposal, the asset cost and related accumulated depreciation are removed from the accounts and any gain or loss on disposition is included in income. Depreciation is provided on the straight-line method, based on the estimated useful lives of the assets, or the units of production method based upon the estimated output of\nINTERNATIONAL RECTIFIER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) the equipment. Depreciation expense for the fiscal years ended June 30, 1995, 1994, and 1993 was $21,819,000, $15,880,000, and $14,160,000, respectively. Property, plant and equipment at June 30, 1995 and 1994 was comprised of the following (000's):\nDepreciation of improvements to leased premises is provided on the straight-line method over the shorter of the remaining term of the lease or estimated useful lives of the improvements. Capital leases included in property, plant and equipment at June 30, 1995 and 1994 are as follows (000's):\nRepairs and maintenance costs are charged to expense. In the fiscal years ended June 30, 1995, 1994 and 1993, repairs and maintenance costs were $11,977,000, $8,144,000 and $7,721,000 respectively.\nFOREIGN CURRENCY TRANSLATION\nThe financial position and results of operations of the Company's foreign subsidiaries are measured using the local currency as the functional currency. Foreign assets and liabilities in the consolidated balance sheet have been translated at the rate of exchange on the balance sheet date. Revenues and expenses are translated at the average exchange rate for the year. Unrealized translation adjustments do not affect the results of operations and are reported as a separate component of stockholders' equity. In fiscal 1995, 1994 and 1993, the Company recognized foreign currency transaction gains of $347,000, $376,000, and $129,000, respectively.\nRESEARCH AND DEVELOPMENT\nResearch and development costs are expensed as incurred.\nINCOME TAXES\nDeferred income taxes are determined based on the difference between the financial reporting and tax bases of assets and liabilities using enacted rates in effect during the year in which the differences are expected to reverse. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Income tax expense is the tax payable for the period and the change during the period in deferred tax assets and liabilities.\nU.S. income taxes have not been provided on approximately $18,875,000 of undistributed earnings of foreign subsidiaries since management considers these earnings to be invested indefinitely or substantially offset by foreign tax credits.\nINTERNATIONAL RECTIFIER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) EARNINGS PER SHARE\nEarnings per share is computed by dividing earnings by the weighted average number of common and common stock equivalents outstanding. Stock options outstanding under stock option plans are considered common stock equivalents. Common stock equivalents for stock options of 243,056 and 112,700 were utilized in the computation of earnings per share in 1995 and 1994, respectively. No common stock equivalents for stock options were used in 1993 as the impact would have been anti-dilutive.\nINTANGIBLE ASSETS\nPatent costs are amortized using the straight-line method over the life of the related patent.\nSTATEMENT OF CASH FLOWS\nThe Company invests excess cash from operations in investment grade money market instruments. The Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents. Components in the changes in working capital are comprised of the following (000's):\nSupplemental disclosures of cash flow information (000's):\nIncluded in assets acquired through capital leases in 1994 is $7.2 million in existing operating leases that were renegotiated to capital leases.\nCONCENTRATION OF RISK\nThe Company places its temporary cash investments with high credit quality financial institutions. At times, such investments may be in excess of insured limits.\nThe Company performs periodic credit evaluations of its customers' financial condition and generally does not require collateral. Receivables on average are due in 60 days. Credit losses have consistently been within management's expectations.\nFINANCIAL INSTRUMENTS\nThe Company operates internationally, giving rise to exposure to market risks from changes in foreign exchange rates. The Company enters into forward foreign exchange contracts and foreign\nINTERNATIONAL RECTIFIER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) currency options to hedge certain foreign currency denominated receivables and payables from its foreign subsidiaries. The related gains and losses on these contracts are included in \"Other income (expense)\". The Company does not hold or issue financial instruments for trading purposes.\nForward foreign exchange contracts outstanding at June 30, 1995 had maturities of less than six months and were denominated in Japanese Yen and British Pound Sterling. Counterparties to the transactions were large financial institutions. At June 30, 1995, the Company had approximately $11.1 million outstanding in forward foreign exchange contracts and had no outstanding foreign currency options.\nRECLASSIFICATION\nCertain reclassifications have been made to previously reported amounts to conform with the current year presentation.\n2. LONG-TERM DEBT AND OTHER LOANS In February 1995, the Company modified its existing $25 million unsecured credit facility from Sanwa Bank California (\"Sanwa Facility\"). The modified facility was increased to $30 million, consisting of a $5 million revolving line of credit and a $25 million term loan facility. In March 1995, the Company increased its existing unsecured revolving line of credit with Wells Fargo Bank, N.A. (\"Wells Facility\") from $10 million to $25 million. In June 1995, the Company established an additional unsecured revolving line of credit of $10 million with Nationsbank of Texas, N.A. (\"Nationsbank Facility\"). Interest rates for loans under the Sanwa Facility and Wells Facility are at prime, or the banks cost of funds plus 1.00%, or LIBOR plus 1.00%, while the interest rates for loans under the Nationsbank Facility are at Prime or LIBOR plus 1.00% (at the Company's option). The Wells Facility and Sanwa Facility, which expire on October 31, 1996, and the Nationsbank Facility, which expires on June 14, 1996, contain the same financial covenants and ratios which affect the availability of funds, and prohibit the Company from paying cash dividends. At June 30, 1995, there were no outstanding borrowings under these three facilities.\nIn February 1995, as part of the modified credit facility with Sanwa Bank California, described above, the Company may draw down up to $25 million prior to December 31, 1995 on its $25 million unsecured term loan facility (\"Sanwa Term Facility\"). Interest rates for such loans are at prime, or LIBOR plus 1.00%, or the bank's fixed rate (at the Company's option). Principal repayments on loans under the Sanwa Term Facility are required to be made in equal quarterly installments from March 31, 1998 through December 31, 2001. This facility contains the same financial covenants and ratios as contained in the three unsecured revolving credit facilities mentioned above. At June 30, 1995, no borrowings were outstanding under this facility.\nThe Company also had an additional $38.5 million of revolving credit facilities at foreign locations. The interest rate on borrowings from these facilities ranged from 2.4% to 11.0% at June 30, 1995. Under the terms of the agreements, the availability of funds is impacted by various financial covenants and collateral requirements. At June 30, 1995, there was $17.3 million outstanding under these foreign credit facilities, and the weighted average interest rate was 5.9%. The weighted average interest rate for short term borrowings during fiscal year 1995 was also 5.9%.\nBased on covenant and collateral limitations under the above credit facilities, the Company had $51.7 million available for borrowing at June 30, 1995.\nINTERNATIONAL RECTIFIER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n2. LONG-TERM DEBT AND OTHER LOANS (CONTINUED) The following is a summary of the Company's long-term debt and other loans at June 30, 1995 and 1994 (000's):\nPrincipal payments on long-term debt are as follows: 1997 $8,216,000; 1998 $7,901,000; 1999 $4,405,000; 2000 $2,220,000; and $1,139,000 thereafter.\nIn accordance with Statement of Financial Accounting Standards No. 107 \"Disclosures About Fair Value of Financial Instruments,\" the fair values of the Company's long-term debt has been estimated based on current rates offered to the Company for debt of the same remaining maturities. The carrying amounts of the Company's loans approximate their fair values.\n3. CAPITAL STOCK The Company has an employee stock purchase plan. Under this plan employees are allowed to designate between two and ten percent of their base compensation to purchase shares of the Company's common stock at 85 percent of fair market value. In November 1993, the stock purchase plan was amended to cover an additional 1,000,000 shares. During fiscal 1995 and 1994, 74,032 and 69,065 shares were purchased at an aggregate purchase price of $915,000 and $723,000, respectively. Shares authorized under this plan that remained unissued were 980,971 and 1,055,003 at June 30, 1995 and 1994, respectively.\nThe Company has three stock option plans, the 1979, 1984, and 1992 Plans, as amended. Under these plans, options to purchase shares of the Company's common stock are issued to key employees as well as members of the Company's Board of Directors. Options are issued at 100% of the fair value of the Company's common stock at the date of grant and become exercisable in annual installments of 20%, beginning on the first anniversary date. The 1992 plan provides for the increase in options available for grant under the plan by 1 1\/2% of total common stock outstanding on January 1 of each year. On January 1, 1995, 1994 and 1993, 374,211, 304,503 and 300,061 options, respectively, were added to the plan. During fiscal year 1995, 8,150 shares expired under the 1979 and 1984 plans.\nINTERNATIONAL RECTIFIER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n3. CAPITAL STOCK (CONTINUED) A summary of the status of options under the 1992, 1984, and 1979 plans is as follows:\nThe following table summarizes the options exercisable:\nAdditional information relating to the 1992, 1984, and 1979 plans is as follows:\nINTERNATIONAL RECTIFIER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n4. GEOGRAPHIC SEGMENTS AND FOREIGN OPERATIONS The Company operates in one business segment. Transfers between geographic areas are made at prices reflecting market conditions. Revenues from unaffiliated customers is based on the location of the customer. Geographic segment information including sales and transfers between geographic areas is presented below:\nINTERNATIONAL RECTIFIER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n5. INCOME TAXES Effective July 1, 1993, the Company adopted the provisions of Statement of Financial Accounting Standards (\"SFAS\") No. 109, \"Accounting for Income Taxes\" which requires recognition of deferred tax assets and liabilities for temporary differences and net operating loss (\"NOL\") and tax credit carryforwards. Under SFAS No. 109, deferred income taxes are established based on enacted tax rates expected to be in effect when temporary differences are scheduled to reverse and NOL and tax credit carryforwards are expected to be utilized. Adoption of SFAS No. 109 did not have a material impact on the Company's financial position or results from operations. Prior year's financial statements have not been restated.\nThe major components of the net deferred tax asset (liability) as of June 30, 1995 and June 30, 1994 are as follows (000's):\nIncome (loss) before income taxes is as follows (000's):\nThe provision (benefit) for income taxes consists of (000's):\nINTERNATIONAL RECTIFIER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n5. INCOME TAXES (CONTINUED) Deferred taxes result primarily from temporary differences relating to depreciation, financial statement reserves, and state taxes.\nThe Company's effective tax rate on pretax income (loss) differs from the U.S. Federal Statutory tax rate as follows:\nDuring fiscal 1995, the Company fully utilized its $27.3 million of U.S. federal income tax net operating loss carryovers. The estimated tax benefit during fiscal 1995 from utilization of the net operating loss carryover was $9.7 million of which $2.3 million increased capital contributed in excess of par value of shares due to the exercise of stock options.\nAt June 30, 1995, the Company has approximately $2.0 million, $1.7 million, and $0.2 million, respectively, of investment, research and development, and foreign tax credit carryforwards available to reduce income taxes otherwise payable, which expire from 1996 to 2010. In addition, the Company has approximately $1.0 million of alternative minimum tax credits, which can be carried over indefinitely to offset regular tax liabilities to the extent of the alternative minimum tax, and a $1.0 million state tax credit which expires in 2002.\n6. PROFIT SHARING AND RETIREMENT PLANS The Company has established defined contribution plans for all eligible employees. The Profit Sharing and Retirement Plan provides for contributions by the Company in such amounts as the Board of Directors may annually determine. The Company has also established a voluntary Retirement Savings Plan (401K) to which the Company makes an annual contribution of up to $600 for each participating employee. Combined plan contributions totaled $1,027,000, $841,000, and $511,000 for fiscal years 1995, 1994, and 1993, respectively.\n7. ENVIRONMENTAL MATTERS Federal, state and local laws and regulations impose various restrictions and controls on the discharge of certain materials, chemicals and gases used in semiconductor processing. The Company does not believe that compliance with such laws and regulations will have a material adverse effect on its financial position.\nThe Company and Rachelle Laboratories, Inc. (\"Rachelle\"), its former pharmaceutical subsidiary which discontinued operations in 1986, have been named among several hundred entities as potentially responsible parties (\"PRPs\") under the provisions of the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (\"CERCLA\"), in connection with the United States Environmental Protection Agency's (\"EPA\") investigation of the disposal of allegedly hazardous substances at a major superfund site in Monterey Park, California (the \"OII Site\"). Certain PRPs who settled certain claims with the EPA under consent decrees filed suit in Federal Court in May 1992\nINTERNATIONAL RECTIFIER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n7. ENVIRONMENTAL MATTERS (CONTINUED) against a number of other PRPs, including the Company, for cost recovery and contribution under CERCLA. The lawsuit against the Company, relating to the first and second consent decrees, was settled in August 1993 for the sum of $40,000 to avoid protracted and expensive litigation. In June 1995, the Company was named among others as a party defendant in Federal Court apparently in connection with a third consent decree with respect to the OII Site. The Company recently received a letter (dated July 25, 1995) from the U.S. Department of Justice offering to settle claims against Rachelle relating to the first three elements of cleanup work at the OII Site for the sum of $4,953,148. (The final remedy assessment has not yet been made). The letter stated that if the offer is not accepted by September 1, 1995, enforcement action will follow. The Department of Justice letter is being evaluated. Claims have been made with the Company's insurers with respect to the OII Site matter; however, there can be no assurance that insurance coverage attaches to these claims. The Company does not believe that either it or Rachelle is responsible for the disposal at the OII Site of any material constituting hazardous substances under CERCLA. Although the ultimate resolution of this matter is unknown, the Company believes that it will not have a material adverse impact on its financial position.\nIn May 1993, the Company purchased property from its Employee Profit Sharing and Retirement Plan. It was determined that the property required clean-up of seepage from a storage tank, at an estimated additional cost of $525,000. The Company commenced the clean-up in fiscal year 1994 and through June 30, 1995 approximately $450,000 in clean-up costs have been incurred which will be capitalized as additional costs of the property.\nOn July 18, 1994, the Company received a letter from the State of Washington Department of Ecology (the \"Department\") notifying the Company of a proposed finding that the Company is a potentially liable person (\"PLP\") for alleged PCE contamination (also knows as perchloroethylene, tetrachloroethylene, and other names) of real property and groundwater in Yakima County, Washington. The letter alleges that the Company arranged for disposal or treatment of the PCE or arranged with a transporter for the disposal or treatment of the PCE in Yakima County. The Company replied by a letter dated August 11, 1994, stating that it has not contributed to PCE or other solvent contamination at the Yakima County site (resulting from sending carbon canisters for regeneration to a facility in the county) and that it should not be designated a PLP. On October 11, 1994, the Company received a letter from the Department notifying the Company of its finding that the Company is a PLP in the above matter. Initial information indicates that less than one percent of all contaminated carbon sent to the site by PLPs was contributed by the Company. What amount, if any, the Company may be asked to contribute to solve the groundwater problem is unknown.\nThe Company received a letter dated September 9, 1994, from the State of California Department of Toxic Substances Control stating that the Company may be a PRP for the deposit of hazardous substances at a facility in Whittier, California. The Company, in June 1995, agreed to join a group of other PRPs to remove contamination from the site. Although the final outcome is not known and depends on final clean-up costs and the allocation scheme, the group currently estimates a total clean-up cost of about $1.8 million to $2.5 million, of which about $6,000 to $9,000 might be requested to be borne by the Company.\nINTERNATIONAL RECTIFIER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n8. COMMITMENTS The future minimum lease commitments under non-cancelable capital and operating leases of equipment and real property at June 30, 1995 are as follows (000's):\nTotal rental expense on all operating leases charged to income was $7,965,000, $6,723,000, and $5,591,000 in fiscal years 1995, 1994 and 1993, respectively.\n9. INTELLECTUAL PROPERTY RIGHTS Certain of the Company's fundamental power MOSFET patents have been subjected, and continue to be subjected, to reexamination in the United States Patent and Trademark Office (\"PTO\"). The patents subject to reexamination are fundamental to the Company's MOS transistors and their loss would allow competitors to use currently patented features of the Company's MOS transistor technology without liability for infringement of those patents. On the following dates, the PTO granted requests for reexamination of the following patents of the Company: November 13, 1992 and September 12, 1994 on patent 4,642,666; September 12, 1994 on patent 4,959,699; September 23, 1994 and June 28, 1995 on patent 5,008,725; January 17, 1995 on patent 5,130,767; June 5, 1995 on patent 5,191,396; and June 14, 1995 on patent 4,593,302. On February 14, 1995, the PTO issued a reexamination certificate, confirming the patentability of the Company's U.S. patent 4,705,759.\n10. LITIGATION The Company and SGS-Thomson Microelectronics, Inc. (\"SGS\") are engaged in various legal proceedings relating to their respective power MOSFET patents. SGS filed suit against the Company in June 1991 in Federal District Court in Texas, charging infringement of U.S. patent 4,553,314. On motion by the Company, the suit was transferred to the Federal District Court in Los Angeles, California, and thereafter SGS amended its complaint to charge infringement of U.S. patents 4,495,513 and 4,712,127. SGS alleges, in substance, that the Company's power MOSFET, power IC and IGBT products infringe the '314 patent, that the Company's IGBT products infringe the '513 patent and that certain packages for the Company's products (including certain power MOSFET packages) infringe the '127 patent. The complaint, as amended, seeks unspecified actual damages (but no less than an unspecified reasonable royalty) and an injunction restraining further sales of such products. On February 1, 1993, the District Court dismissed SGS's claims for infringement of the '127 and '513 patents for lack of standing and on March 15, 1993, ruled that the SGS '314 patent is unenforceable due to inequitable conduct. SGS appealed these rulings, as well as the order transferring the case to California, to the Court of Appeals for the Federal Circuit. The Company cross-appealed a separate ruling by the District Court denying the Company's motion for summary judgment that the '314 patent is invalid. In July 1994, the Federal Circuit vacated the District Court's grants of summary judgment as to the '513, '127 and '314 patents and affirmed the District Court's denial of the Company's motion for summary judgment of invalidity of the '314 patent. The Federal\nINTERNATIONAL RECTIFIER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n10. LITIGATION (CONTINUED) Circuit ordered, however, that the case should proceed in California. A trial date of November 14, 1995 has been set for the '513 patent, but proceedings on the '314 and '127 patents are essentially stayed pending completion of reexamination of these patents in the PTO.\nIn separate proceedings before the same California District Court, the Company sought enforcement of a prior license agreement between the Company and SGS. The Court in July 1994, granted the Company's motions to enforce the license agreement with SGS, requiring SGS to pay additional past and prospective royalties under the Company's U.S. patents 4,959,699 and 4,642,666 on SGS's sales of power MOSFET, IGBT and power IC products. SGS appealed this decision to the Federal Circuit, which on May 10, 1995 affirmed the decision in favor of the Company. SGS subsequently made the required past royalty payment.\nThe Company has also filed a separate action in the same District Court against SGS and its Italian affiliate, SGS-Thomson Microelectronics, S.r.l., seeking an injunction against infringement of the Company's U.S. patents 5,008,725 and 5,130,767. This action has been essentially stayed pending completion of reexamination of these patents by the PTO.\nThe Company, its directors and certain officers have been named as defendants in three class action lawsuits filed in Federal Court in California. These suits seek unspecified but substantial compensatory and punitive damages for alleged intentional and negligent misrepresentations and violations of the federal securities laws. The complaints generally allege that the Company and the other defendants made materially false statements or omitted to state material facts in connection with the public offering of the company's common stock completed in April 1991 and the redemption and conversion in June 1991 of the Company's 9% Convertible Subordinated Debentures Due 2010. They also allege that the Company's projections for growth in fiscal 1992 were materially misleading. Although the Company believes that the claims alleged in the suits are without merit, the ultimate outcome cannot be presently determined. A substantial judgment or settlement, if any, could have a material adverse effect on the Company's financial condition and results of operations. Two of these suits also name Kidder, Peabody & Co. Incorporated and Montgomery Securities as defendants. The Court has scheduled trial to begin in December 1995.\nNo provision for any liability that may result upon adjudication of these matters has been made in the consolidated financial statements.\nThe Company is currently involved in litigation arising in the normal course of business. Management does not believe that the ultimate resolution of this litigation will have a material adverse impact on the financial position of the Company (also see Notes 7 and 9).\n11. EXECUTIVE AGREEMENT The Company entered into an executive agreement with Eric Lidow dated May 15, 1991 providing for his continued employment with the Company for a six year period as Chief Executive Officer and President or in such other position as the Board of Directors may determine. Mr. Lidow's salary at fiscal year end under this agreement was $632,500. Upon Mr. Lidow's retirement from the Company (or a change in control) he will receive annual payments (Founder's Pension) of 90% of his then current salary. The agreement was amended on April 12, 1995 to provide that upon retirement Mr. Lidow's pension would be based, in addition to his salary, on the average of the prior three years' cash bonuses, if any. The pension would further be adjusted annually to account for any increase in the Consumer Price Index. Upon Mr. Lidow's death, payments will be continued to his wife, if she survives\nINTERNATIONAL RECTIFIER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n11. EXECUTIVE AGREEMENT (CONTINUED) him, in an amount equal to two-thirds of his retirement benefits for the remainder of her life. Under the terms of the Founder's Pension, $1,068,000, $572,000, and $572,000, have been expensed in fiscal years 1995, 1994, and 1993, respectively.\n12. QUARTERLY FINANCIAL DATA (UNAUDITED) Summarized quarterly financial data is as follows (000's except per share data):\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone\nPART III\nFor information called for by Items 10, 11, 12 and 13, reference is made to the Registrant's definitive proxy statement for its Annual Meeting of Stockholders, to be held November 20, 1995, which will be filed with the Securities and Exchange Commission within 120 days after June 30, 1995, and which is incorporated herein by reference. Certain information concerning the Directors and Executive Officers of the Company is included in Part I. See \"Additional Item\" page 10.\nPART IV\nITEM 14.","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"ITEM 14. EXHIBITS AND FINANCIAL STATEMENT SCHEDULE\na. Financial Statements and Financial Statement Schedule being filed as part of this report are listed in the index on page 16.\nb. Exhibits filed as part of this report are listed on the Exhibit Index on page 35.\nEXHIBIT INDEX\nINCORPORATED BY REFERENCE:\nSUBMITTED HEREWITH: See page 16 for an index of Financial Statements and Schedules being 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 Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nINTERNATIONAL RECTIFIER CORPORATION (Registrant)\nBy MICHAEL P. MCGEE Date: 8\/24\/95 ------------------------------ ------------------------------ Michael P. McGee VICE PRESIDENT, CHIEF FINANCIAL OFFICER AND PRINCIPAL ACCOUNTING OFFICER\nEach person whose signature appears below hereby authorizes Michael P. McGee, as attorney-in-fact and agent, with full powers of substitution, to sign on his behalf, individually and in the capacities stated below, and to file any and all amendments to this Form 10-K, and other documents in connection therewith, with the Securities and Exchange Commission, granting to said attorney-in-fact and agent full power and authority to perform any other act on behalf of the undersigned required to be done in the premises.\nPursuant to the requirements of the Securities Exchange Act of 1934, 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 ------------------------------ ---------------------------------- ------------\nERIC LIDOW 8\/24\/95 ------------------------------ Chairman of the Board ------------ Eric Lidow\nALEXANDER LIDOW 8\/24\/95 ------------------------------ Director, Chief Executive Officer ------------ Alexander Lidow\nDEREK B. LIDOW 8\/24\/95 ------------------------------ Director, Chief Executive Officer ------------ Derek B. Lidow\nROBERT J. MUELLER 8\/24\/95 ------------------------------ Director, Executive Vice President ------------ Robert J. Mueller\nGEORGE KRSEK 8\/24\/95 ------------------------------ Director ------------ George Krsek\nJACK O. VANCE 8\/24\/95 ------------------------------ Director ------------ Jack O. Vance\n(Signatures continued on next page)\nSIGNATURES (CONTINUED)\nSIGNATURES TITLE DATE ------------------------------ ---------------------------------- ------------\nROCHUS E. VOGT 8\/24\/95 ------------------------------ Director ------------ Rochus E. Vogt\nDONALD S. BURNS 8\/24\/95 ------------------------------ Director ------------ Donald S. Burns\nJAMES D. PLUMMER 8\/24\/95 ------------------------------ Director ------------ James D. Plummer\nINTERNATIONAL RECTIFIER CORPORATION AND SUBSIDIARIES SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS AND RESERVES FOR THE FISCAL YEARS ENDED JUNE 30, 1995, 1994 AND 1993 (IN 000'S)","section_15":""}
{"filename":"41719_1995.txt","cik":"41719","year":"1995","section_1":"Item 1. Business.\nP.H. Glatfelter Company (together with its subsidiaries, the \"Company\" or the \"Registrant\"), a paper manufacturing company, began operations in Spring Grove, Pennsylvania in 1864 and was incorporated as a Pennsylvania corporation in 1905. On January 30, 1979 the Registrant acquired by merger Bergstrom Paper Company with paper mills located in Wisconsin and Ohio. The Ohio mill was sold on September 10, 1984. On May 7, 1987 the Registrant acquired all of the outstanding capital stock of Ecusta Corporation with a paper mill located in Pisgah Forest, North Carolina and other operations in North Dakota, Canada and Australia. Ecusta Corporation was merged into and became a division of the Registrant on June 30, 1987.\nThe Registrant's paper mills are located in Spring Grove, Pennsylvania, Pisgah Forest, North Carolina and Neenah, Wisconsin. It manufactures printing papers and tobacco and other specialty papers.\nThe Registrant sells its products throughout the United States and in a number of foreign countries. Net export sales in 1995, 1994 and 1993 were $54,961,000, $44,821,000 and $38,577,000, respectively.\nMost of the Registrant's printing paper products are directed at the uncoated free-sheet portion of the industry. The Registrant's printing paper products are used principally for the printing of case bound and quality paperback books, commercial and financial printing and envelope converting. Printing papers are manufactured in each of the Registrant's mills.\nIn 1995, sales of paper for book publishing and commercial printing generally were made through wholesale paper merchants, whereas sales of paper to financial printers and converters generally were made directly. During 1994, one of the Registrant's wholesale paper merchants, Central National-Gottesman Inc. (which buys paper through its division, Lindenmeyr Book Publishing) acquired substantially all of the assets of Perkins & Squier, another of the Registrant's wholesale paper merchants. As a result, during 1995 and 1994, Central National-Gottesman Inc. accounted for 14% and 13% of the Registrant's net sales, respectively.\nThe Registrant's tobacco and other specialty papers are used for cigarette manufacturing and other specialty uses such as the manufacture of playing cards, stamps, labels and surgical gowns. Sales of these papers are generally made directly to the converter of the paper. Tobacco papers are manufactured in the Pisgah Forest mill (hereinafter referred to as the \"Ecusta Division\" or \"Ecusta\"). Other specialty papers are manufactured in each of the Registrant's mills. A significant portion of the Pisgah Forest mill's sales are made to a limited number of major tobacco companies. The current legal and regulatory pressures on that industry could have an adverse effect on the future tobacco paper sales and profitability of the Pisgah Forest mill. Under such conditions, the Registrant would attempt to replace any lost sales and profitability with lightweight printing and other specialty papers.\nSet forth below is the amount (in thousands) and percentage of net sales contributed by each of the Registrant's two classes of similar products during each of the years ended December 31, 1995, 1994 and 1993.\nYear Ended December 31,\nIn October, 1992, Philip Morris Companies, Inc. informed the Registrant that, effective January 1, 1993, it would cease to make purchases from the Registrant for its domestic tobacco operations. Philip Morris had been one of Registrant's six domestic customers for tobacco paper products and sales to Philip Morris amounted to 7.5% of the Registrant's total sales in 1992. The Registrant succeeded in redirecting the lost Philip Morris product volume to printing paper customers in 1993 and to printing paper and the Registrant's remaining tobacco paper customers in 1994. Such sales to printing paper customers in 1993 and 1994 were not as profitable as sales to Philip Morris in 1992. Sales to the remaining tobacco paper customers in 1993 and 1994 were also less profitable than in 1992 due to increased competitive pressure and cost-cutting measures within the tobacco industry. These factors precluded the Registrant from offsetting significantly higher pulp costs in 1994 through tobacco paper price increases. As a result, the 1993 and 1994 profit performances of the Registrant's Ecusta Division were sharply below that of 1992. As described in Note 2 to the Consolidated Financial Statements and in Management's Discussion and Analysis of Financial Condition and Results of Operations, during the fourth quarter of 1994, the Registrant recognized a $208,949,000\nnoncash, pre-tax writedown of impaired assets, $198,189,000 of which related to the Ecusta Division.\nMarket conditions affecting the Registrant's tobacco papers improved during 1995. Although competition for domestic and foreign tobacco paper sales remained intense, this portion of the paper industry was buoyed by a lack of capacity increases. Domestic cigarette consumption was approximately the same in 1995 compared to 1994 while international cigarette consumption continued to grow. These favorable market conditions enabled Ecusta to sell more tobacco paper products in 1995, improve the product sales mix, and increase selling prices for many tobacco paper products. Favorable conditions are expected to continue during 1996.\nThe competitiveness of the markets in which the Registrant sells its products varies. There are numerous concerns in the United States manufacturing printing papers, and no one company holds a dominant position. Capacity in the uncoated free-sheet industry, which includes uncoated printing papers, is not expected to increase significantly for the next few years. In the tobacco papers business, while there is only one significant domestic competitor, there are numerous international competitors. Despite recent events described above, the Registrant remains a major tobacco papers supplier to the domestic tobacco products industry. If foreign production of tobacco products by U.S. companies increases significantly it may have an adverse effect on the Registrant's overall competitive position.\nService, product performance and technological advances are important competitive factors in all of the Registrant's businesses. The Registrant believes its reputation in these areas continues to be excellent.\nBacklogs are not significant in the Registrant's business.\nThe principal raw material used at the Spring Grove mill is pulpwood. In 1995, the Registrant acquired approximately 79% of its pulpwood from saw mills and independent logging contractors and 21% from Company-owned timberlands. Hardwood purchases constituted 51% of the pulpwood acquired and softwood the balance. Hardwoods are still abundant within a relatively short distance of the Registrant's Spring Grove mill, but the radius within which the Registrant has been acquiring hardwoods has increased modestly over prior years. Softwood is obtained primarily from Maryland, Delaware and Virginia. In order to protect its sources of pulpwood, the Registrant has actively promoted conservation and forest management among suppliers and woodland owners. In addition, its subsidiary, The Glatfelter Pulp Wood Company, has acquired, and is acquiring, woodlands, particularly softwood growing land, with the objective of having\nsufficient softwood growing on its lands to provide a significant portion of the Spring Grove mill's future softwood requirements. Wood chips produced from sawmill waste also accounted for a substantial amount of the Registrant's pulpwood purchases for the Spring Grove mill.\nThe Spring Grove pulp mill converts the pulpwood into wood pulp for use in its papermaking operations. In addition to the pulp it produces, the Spring Grove mill purchases market pulp from others. During the fourth quarter of 1994, the Registrant completed the pulp mill modernization project at the Spring Grove mill. This project, undertaken primarily for environmental reasons, resulted in an increase in total pulp production capacity at the mill.\nThe principal raw material used by the Neenah mill is high-grade recycled wastepaper. The quality of different types of high-grade wastepaper varies significantly depending on the amount of contamination. During 1994 and the first half of 1995, the start-up of various wastepaper deinking facilities increased the demand for the types of wastepaper, particularly higher quality high-grade wastepaper, used at the Neenah mill. As a result, wastepaper prices increased dramatically through the first half of 1995. Wastepaper prices decreased rapidly during the second half of 1995 and by the end of 1995 had returned to historical levels in part due to expanded collection systems which increased the supply of wastepaper. It is anticipated that there will be an adequate supply of wastepaper in the future.\nThe major raw materials used at the Ecusta Division mill are purchased wood pulp and processed flax straw, which is derived from linseed flax plants. Flax had become a less important raw material as a result of the loss of business of Philip Morris (referred to above), since it was the Registrant's major customer for flax-based products. Improved market conditions in 1995 enabled the Registrant to improve its sales mix, including an increase in flax-based paper sales. Flax-based paper sales are still below 1992 levels. The current supply of flax and wood pulp is sufficient for the present and anticipated future operations at the Ecusta Division. During 1995, the Registrant resumed the purchase of Canadian flax straw and the converting of such straw into processed flax straw.\nWood pulp consumed which was purchased from others comprised approximately 105,000 short tons or 22% of the total 1995 fiber requirements of the Registrant. The cost of market pulp increased significantly during the first nine months of 1995; however, the pulp market began showing signs of weakening during the fourth quarter of 1995 and prices have decreased significantly to date in 1996.\nThe Registrant's Spring Grove mill generates all of its steam requirements and is 100% self-sufficient in electrical\nenergy generation. It also produces excess electricity which is sold to the local power company under a long-term co-generation contract, which resulted in 1995 net energy sales of $9,455,000. Principal fuel sources used by the Registrant's Spring Grove mill are coal, spent chemicals, bark and wood waste, and oil which in 1995 were used to produce approximately 58%, 36%, 5% and 1%, respectively, of the total energy internally generated at the Spring Grove mill.\nThe Pisgah Forest mill generates all of its steam requirements and a majority of its electrical requirements (64% in 1995) and purchases electric power for the remainder. The principal fuel source used at the Pisgah Forest mill is coal (99.2% in 1995).\nThe Neenah mill generates all of its steam requirements and a portion of its electric power requirements (14% in 1995) and purchases the remainder of its electric power requirements. Gas was used to produce essentially all of the mill's internally generated energy during 1995.\nAt December 31, 1995, the Registrant had 2,926 active full-time employees.\nHourly employees at the Registrant's mills are represented by different locals of the United Paperworkers International Union, AFL-CIO. A labor agreement covering approximately 975 employees at the Pisgah Forest mill expires in October 1996. Under this agreement, wages increased 3% in 1995. A five-year labor agreement covering approximately 740 employees in Spring Grove was ratified in 1993 and expires in January 1998. Under this agreement, wages increased by 3% in 1995 and are to increase by 3% in each of 1996 and 1997. In January 1994, a five-year labor agreement covering approximately 320 employees in Neenah was ratified. Under this agreement, which expires in August 1997, wages increased 3% in 1995 and are to increase 3% in 1996.\nENVIRONMENTAL MATTERS\nThe Registrant is subject to numerous federal, state and foreign laws and rules and regulations thereunder with respect to solid waste disposal and the abatement of air and water pollution and noise. It has been the Registrant's experience over many years that directives with respect to the abatement of pollution have periodically been made increasingly stringent. During the past twenty years or more, the Registrant has taken a number of measures and spent substantial sums of money both for the installation of facilities and operating expenses in order to abate air, water and noise pollution and to alleviate the problem of disposal of solid waste. In spite of the measures it has already taken, the Registrant anticipates that environmental regulation of the Registrant's operations will\ncontinue to become more burdensome and that compliance therewith, when and if technologically feasible, will require additional capital expenditures and operating expenses. In addition, the Registrant may incur obligations to remove or mitigate any adverse effects on the environment resulting from its operations, including the restoration of natural resources, and liability for personal injury and damage to property, including natural resources. For further information with respect to such compliance, reference is made to Item 3 of this report.\nCompliance with government environmental regulations is a matter of high priority to the Registrant. In order to meet environmental requirements, the Registrant has undertaken certain projects, the most significant of which relates to the modernization of the Spring Grove pulpmill. The pulpmill modernization project, which began in 1990, was completed during the fourth quarter of 1994 for a total cost of $171,000,000 (exclusive of capitalized interest). Of this amount, $20,000,000 was expended through 1991, $48,000,000 in 1992, $71,000,000 in 1993 and $28,000,000 in 1994. The remaining $4,000,000 was paid in 1995. Since capital expenditures for pollution abatement generally do not increase the productivity or efficiency of the Registrant's mills, the Registrant's earnings have been and will be adversely affected to the extent that selling prices have not been and cannot be increased to offset additional incremental operating costs, including depreciation, resulting from such capital expenditures and to offset additional interest expense on the amounts expended for environmental purposes. Because other paper companies located in the United States are generally subject to the same environmental regulations, the Registrant does not believe that its competitive position in the U.S. paper industry will be materially adversely affected by its capital expenditures for, or operating costs of, pollution abatement facilities for its present mills, any other environmental related obligations it will incur or the limitations which environmental compliance may place on its operations.\nThe Wisconsin Department of Natural Resources (\"DNR\") is investigating the presence of polychlorinated biphenyls (\"PCBs\") in the lower Fox River on which the Registrant's Neenah mill is located. DNR has alleged that the Registrant's operations were a source of those PCBs. Among other areas, DNR's attention has been directed to a specific deposit of PCBs known as \"Deposit A\", which is near the Registrant's Neenah mill. DNR has not yet made any claim with respect to that deposit. The State of Wisconsin has notified another party that the State considers it to be potentially responsible with the Registrant for Deposit A. The Registrant performed the work necessary to upgrade DNR's initial study of the deposit to the usual technical standards of a remedial investigation\/feasibility study. Although DNR has not completed the remedy selection process for Deposit A, DNR has proposed a project to address Deposit A that DNR estimates will cost $14.6 million. At least one other\npreliminary cost estimate, which may not be comparable in scope, is significantly higher. Furthermore, DNR could propose projects to restore natural resources or otherwise to address the entire Fox River, the cost of which could exceed the available resources of the Registrant and other companies upon which most governmental attention has focused. The Registrant is engaged in discussions with the State of Wisconsin toward resolving any liability it may have to the state in connection with the Fox River, the outcome of which cannot be predicted.\nIn June 1994 the United States Fish and Wildlife Service (\"FWS\") notified the Registrant and four other parties that FWS considers them to be potentially responsible for natural resources damages arising from the presence of PCBs in the lower Fox River and the Bay of Green Bay pursuant to the Comprehensive Environmental Response, Compensation and Liability Act (\"CERCLA\" or \"Superfund\"). In February 1996, FWS provided notice to two additional parties that it considers them to be potentially responsible for natural resource damages. FWS indicated that it intended to commence a natural resources damages assessment (\"NRDA\"). The State of Wisconsin has declined the United States' invitation to participate in the NRDA as a co-trustee, and has repeatedly requested that the United States not undertake the NRDA because the NRDA and natural resource damage claims would disrupt a program of restoration activities under the auspices of the DNR through a public\/private group known as the Fox River Coalition. The Registrant is a member of the Fox River Coalition. The Menominee Indian Tribe has, however, indicated to FWS that it intends to participate in the NRDA as a co-trustee. In addition, the Menominee Tribe has commenced litigation in the United States District Court for the Western District of Wisconsin against the State to establish the tribe's usufructuary rights to natural resources, including the Fox River; the Registrant is not a party to that litigation. Further, the Oneida Indian Tribe has indicated to FWS that it may participate in the NRDA as a co-trustee. The Registrant is engaged in negotiations with FWS regarding the scope, nature and propriety of the NRDA and with DNR regarding the scope, nature and propriety of activities through the Fox River Coalition.\nThe amount and timing of future expenditures for environmental compliance, clean-up, remediation or personal injury or property damage liability cannot be ascertained with any certainty due, among other things, to the unknown extent and nature of any contamination, the extent and timing of any technological advances for pollution control, the remedial actions which may be required and the number and financial resources of any other responsible parties. The Registrant continues to evaluate its exposure and the level of its reserves. The Registrant's current assessment is that such expenditures are not likely to have a material adverse effect on its financial condition, results of operation or liquidity, but there can be no\nassurance that its reserves will be adequate or that such an effect will not occur at some future time.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nThe Registrant's executive offices are located in Spring Grove, Pennsylvania, 11 miles southwest of York. The Registrant's paper mills are located in Spring Grove, Pennsylvania, Pisgah Forest, North Carolina and Neenah, Wisconsin.\nThe Spring Grove facilities include seven uncoated paper machines with a daily capacity ranging from 11 to 298 tons and an aggregate annual capacity of about 296,000 tons of finished paper. The machines have been rebuilt and modernized from time to time. An off-machine coater gives the Registrant a potential annual production capacity for coated paper of approximately 48,000 tons. Since uncoated paper is used in producing coated paper, this does not represent an increase in the Spring Grove mill capacity. The pulpmill has a production capacity of approximately 625 tons of bleached pulp per day.\nThe Pisgah Forest facilities include twelve paper machines, stock preparation equipment, a modified kraft bleached flax pulpmill with thirteen rotary digesters, a precipitated calcium carbonate plant and a small recycled pulping operation. The annual light weight paper capacity is approximately 99,000 tons. Nine paper machines are essentially identical while the newer three machines have design variations specific for the products produced. Converting equipment includes winders, calendars, slitters, perforators and printing presses.\nThe Neenah facilities, consisting of a paper manufacturing mill, converting plant and offices, are located at two sites. The Neenah mill includes three paper machines, with an aggregate annual capacity of approximately 163,000 tons, a wastepaper processing and warehousing building, a wastepaper de-inking and bleaching plant, stock preparation equipment, power plant, water treatment and waste treatment plants and warehousing space. The converting plant contains a paper processing area and warehouse space.\nThe Glatfelter Pulp Wood Company, a subsidiary of the Registrant, owns and manages approximately 110,000 acres of land, most of which is timberland.\nThe Registrant owns substantially all of the properties used in its papermaking operations except for certain land leased from the City of Neenah under leases expiring in 2050, on which wastewater treatment and storage facilities and a parking lot are located. All of the Registrant's properties, other than those which are leased, are free from any major liens or encumbrances.\nThe Registrant considers that all of its buildings are in good structural condition and well maintained and its properties are suitable and adequate for present operations.\nItem 3.","section_3":"Item 3. Pending Legal Proceedings.\nThe Registrant does not believe that the environmental matters discussed below will have a material effect on its business or consolidated financial position.\nOn May 16, 1989, the Pennsylvania Environmental Hearing Board approved and entered an Amended Consent Adjudication between the Registrant and the Pennsylvania Department of Environmental Resources, now known as the Department of Environmental Protection (\"DEP\") in connection with the Registrant's permit to discharge effluent into the West Branch of the Codorus Creek. The Amended Consent Adjudication establishes limitations on in-stream color, and requires the Registrant to conduct certain studies and to submit certain reports regarding internal and external measures to control the discharge of color and certain other adverse byproducts of chlorine bleaching to the West Branch of the Codorus Creek.\nDuring 1990 and again in 1991, the Pennsylvania DEP proposed to reissue the Registrant's waste water discharge permit on terms with which the Registrant does not agree. The Registrant intends to contest those terms should they be included in the final permit. Among those terms is an unacceptable term concerning a suspected discharge of 2,3,7,8 tetrachlorodibenzo-p-dioxin (\"dioxin\"). At the behest of the United States Environmental Protection Agency (\"EPA\"), DEP has included the Registrant's Spring Grove mill on the list of dischargers submitted to and approved by EPA pursuant to Section 304(l) of the Clean Water Act. EPA has preliminarily approved that list because EPA suspects that the Spring Grove mill may discharge dioxin in concentrations of concern. The Registrant believes that the Spring Grove mill should not be included on the discharger list.\nThe Registrant has been identified by EPA and the Ohio Environmental Protection Agency as one of 34 potentially responsible parties (\"PRPs\") for the clean-up of the Cardington Road Landfill in Montgomery County,\nOhio. The Registrant has entered into a consent decree with the EPA, a small number of PRPs known as the Cardington Road Coalition (\"CRC\") and certain other PRPs pursuant to which the Registrant will contribute $85,000 in satisfaction of its liability to such parties for all past and future response costs at the Cardington Road Site. The consent decree will become effective upon entry by a federal district court. On March 25, 1994 the Registrant received notice that the court in Cardington Road Site Coalition v. Snyder Properties, Inc. (Case No. C-3-88-632 S.D. Ohio), a Superfund cost recovery action brought by the PRPs who implemented the remedial investigation, had authorized the filing of a complaint naming the Registrant as a third-party defendant in such action, but no complaint has been served. The consent decree provides the Registrant with protection from claims for contribution by PRPs who are not parties to the consent decree for response costs at the Cardington Road Site, and provides the Registrant with indemnification by the CRC for certain other claims. Such protection and indemnification may protect the Registrant from claims which may be asserted in the Snyder Properties action.\nThe Wisconsin DNR has reissued the Registrant's wastewater discharge permit for the Neenah mill on terms unacceptable to the Registrant. The Registrant has requested an adjudicatory hearing on the terms of that permit. The Wisconsin Paper Council is presently engaged in joint negotiation of some issues common to a number of permits issued at the same time to similar mills.\nThe State of Wisconsin commenced an action in 1995 against the Registrant seeking civil penalties and injunctive relief as the result of certain violations of the Neenah Mill's wastewater discharge permit. On February 5, 1996, the Registrant reached an agreement in principle to settle this matter for payment of approximately $130,000 in civil penalties, forfeitures, court costs and legal fees of the State. In addition, the Registrant has agreed to conduct an evaluation of its wastewater treatment plant and to pay stipulated forfeitures for certain further violations during the term of the evaluation.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nNot Applicable.\nExecutive Officers of the Registrant.\nOfficers are elected to serve at the pleasure of the Board of Directors. Except in the case of officers elected to fill a new position or a vacancy occurring at some other date, officers are elected at the annual meeting of the Board held immediately after the annual meeting of shareholders.\n- -------------------------\n(a) Unless otherwise indicated, the offices listed have been held for five or more years.\n(b) Mr. Glatfelter became Senior Vice President in September 1995. From May 1993 to September 1995, he was Vice President - General Manager, Glatfelter Paper Division. Prior to May 1993, he was General Manager, Glatfelter Paper Division.\n(c) Mr. Newcomer became Senior Vice President, Treasurer and Chief Financial Officer in September 1995. From April 1995 to September 1995, he was Vice President, Treasurer and Chief Financial Officer; he was Vice President and Treasurer from May 1993 to April 1995. Prior to May 1993, he was Assistant Comptroller.\n(d) Mr. Lawrence became Vice President - General Manager, Ecusta Paper Division on May 1993. Prior to May 1993, he was Director of Planning, Acquisitions and Governmental Affairs.\n(e) Mr. Miller became Vice President - Administration in September 1995. From August 1994 to September 1995, he was Director of Planning, Acquisitions and Governmental Affairs. He was Director, Marketing Services from May 1993 to August 1994; prior to May 1993, he was Director, Customer Services.\n(f) Mr. Smith became Comptroller in May 1993. Prior to May 1993, he was a Financial Analyst.\n(g) Mr. Wood became Secretary and Assistant Treasurer in September 1992. Prior to September 1992, he was Assistant Secretary and Assistant Treasurer.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters.\nCommon Stock Prices and Dividends Paid Information\nThe table below shows the high and low prices of the Company's common stock on the American Stock Exchange (Ticket Symbol \"GLT\") and the dividends paid per share for each quarter during the past two years.\nAs of December 31, 1995, the Company had 4,625 shareholders of record. A number of the shareholders of record are nominees.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nSeven-Year Summary of Selected Consolidated Financial Data\nYear Ended December 31 (in thousands except per share amounts)\n(a) After impact of an after tax charge for a writedown of impaired assets (unusual items) of $127,981,000 or $2.89 per share.\n(b) After impact of writedown of impaired assets (unusual items) of $208,949,000.\n(c) After impact of an after tax charge for rightsizing and restructuring (unusual items) of $8,430,000 or $.19 per share and the effect of an increased federal corporate income tax rate of $3,587,000 or $.08 per share.\n(d) Includes an increase of $61,062,000 resulting from the adoption of Statement of Financial Accounting Standards No. 109.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS P. H. GLATFELTER COMPANY AND SUBSIDIARIES\nOVERVIEW\nThe Company classifies it sales into two product groups: 1) printing papers; and 2) tobacco and other specialty papers. The Spring Grove, Pennsylvania and Neenah, Wisconsin mills produce printing and other specialty papers. The Pisgah Forest mill (hereinafter referred to as the Ecusta Division or \"Ecusta\") produces printing, tobacco and other specialty papers.\nMost of the Company's printing paper products are directed at the uncoated free-sheet portion of the industry. Strong demand for these papers into the third quarter of 1995 led to an increase in printing paper sales volume and prices. The demand for printing papers weakened towards the end of the third quarter and incoming orders remained low during the fourth quarter of 1995. It is generally believed that this decline was driven by abnormally high customer inventory levels. Prices for many of the Company's printing paper products declined marginally during this time. Sluggish conditions are expected to continue in this market during the first quarter of 1996. As customers deplete their inventories, the Company is cautiously optimistic that a steadier buying pattern will develop in the second quarter of 1996 and will remain for the balance of the year.\nMarket conditions affecting the Company's tobacco and other specialty papers products group improved during 1995. Although competition for domestic and foreign tobacco paper sales remained intense, this portion of the paper industry was buoyed by a lack of capacity increases. Domestic cigarette consumption was approximately the same in 1995 compared to 1994 while international cigarette consumption continued to grow. These favorable market conditions enabled Ecusta to sell more tobacco paper products in 1995, improve the product sales mix and increase selling prices for many tobacco paper products. Favorable conditions are expected to continue during 1996. A significant portion of Ecusta's sales, however, are made to a limited number of major tobacco companies. The current legal and regulatory pressures on that industry could have an adverse effect on the future tobacco paper sales and profitability of Ecusta. Under such conditions, the Company would attempt to replace any lost sales and profitability with lightweight printing and other specialty papers.\n1995 COMPARED TO 1994\nNet sales in 1995 increased $145,407,000, or 30.4%, over 1994. The Company's sales volume also increased in 1995 compared to 1994. Overall demand for the Company's products was very strong into the third quarter of 1995. The demand for printing papers weakened towards the end of the third quarter and incoming orders remained below normal levels during the fourth quarter of 1995. Strong market conditions resulted in significant price increases during the first nine months of 1995, tempered somewhat by a marginal decline during the fourth quarter of 1995.\nPrinting paper sales increased by $129,253,000, or 38.5%, in 1995 compared to 1994. The annual average net printing paper selling price increased 30.7% in 1995 from 1994 due to the significant increase in demand for printing papers as well as the Company's ability to offset increased raw material costs, particularly for market pulp, pulp substitutes and wastepaper. The increased demand for printing papers resulted in a 5.9% increase in sales volume in 1995 compared to 1994. Weakening demand resulted in some marginal price decreases during the fourth quarter of 1995. Despite these decreases, the average selling price during the fourth quarter of 1995 was 27.4% higher than the average selling price during the fourth quarter of 1994.\nNet tobacco and other specialty paper sales increased $16,154,000, or 11.3%, in 1995 compared to 1994. The Company had a 14.2% increase in tobacco paper sales volume in 1995 over 1994. An increase in worldwide demand for tobacco paper products in general and flax based tobacco papers specifically, and a lack of industry capacity increases allowed the Company to sell more tobacco paper volume and improve its sales mix. These factors also resulted in a slight increase in the average tobacco paper selling price in 1995 compared to 1994. Other specialty paper sales decreased by 3.5% in 1995 compared to 1994 as increased average selling prices were more than offset by a decrease in sales volume.\nIncreased sales volumes and selling prices led to a significant increase in operating profit in 1995 compared to 1994. Profit from operations, before unusual items, interest income and expense and taxes was $116,501,000 compared to $21,541,000 in 1994. The increase in average selling prices more than offset the increase in cost of products sold resulting in an increase in gross margin from 8.5% in 1994 to 22.7% in 1995. The cost of products sold on a per unit basis increased primarily as a result of higher costs for market pulp, pulp substitutes and wastepaper. These cost increases more than offset (i) the ability of the Company to spread its fixed manufacturing costs over more tons of products manufactured during 1995 compared to 1994, and (ii) the favorable impact of lower depreciation expense of approximately $10,000,000 during 1995 compared to 1994. Increased depreciation expense at the Spring Grove mill, due primarily to the completion of the pulpmill modernization project in the fourth quarter of 1994, was more than offset by a reduction in depreciation at Ecusta in 1995 of approximately $14,400,000 compared to 1994. The decrease in Ecusta's depreciation resulted from the writedown of the net assets of Ecusta in the fourth quarter of 1994.\nSelling, general and administrative expenses were $9,157,000 higher in 1995 than in 1994. This increase occurred primarily from higher profit sharing and incentive related expenses during 1995 compared to 1994. Selling, general and administrative expenses were 5.8% and 5.7% of net sales for 1995 and 1994, respectively.\nInterest on debt in 1995 increased $3,901,000 over 1994. The Company capitalized $3,066,000 of interest expense in 1994. No interest expense was capitalized during 1995. The increase in interest on debt was also due to a higher variable interest rate on the Company's interest rate swap\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS P. H. GLATFELTER COMPANY AND SUBSIDIARIES\nagreement which has a total notional principal amount of $50,000,000. Interest on short-term borrowings during 1995 was $50,000 less than in 1994. The Company had no short-term borrowings at the end of 1995.\nResults by Mill\nThe Spring Grove mill's profit from operations increased by $56,792,000 in 1995 compared to 1994. Net sales increased $78,426,000 in 1995 compared to 1994 due to a significant increase in sales volume and average selling price. Cost of sales increased primarily due to increased depreciation. Depreciation increased due to the completion of the pulpmill modernization project during the fourth quarter of 1994. This project, undertaken primarily for environmental reasons, resulted in an increase in total pulp production capacity at the mill. The corresponding reduction in volume of purchased market pulp resulted in increased profitability at Spring Grove during 1995.\nProfit from operations at the Neenah mill showed an increase of $9,298,000 in 1995 compared to 1994. Net sales increased $42,370,000 in 1995 due to a significant increase in sales volume and average selling price. Neenah's 1995 profit from operations was negatively impacted by a significant increase in the cost of wastepaper. Wastepaper costs decreased during the second half of 1995 and by the end of 1995 had returned to historical levels.\nProfit from operations at Ecusta increased $28,870,000 in 1995 compared to 1994. Net sales increased $24,611,000 in 1995, primarily due to an increase in average selling price due to an improved sales product mix and Ecusta's ability to offset increased raw material costs, particularly for market pulp. Ecusta's increase in raw material costs was more than offset through a combination of price increases and by a decrease of approximately $14,400,000 in depreciation costs, due to the writedown of the net assets of Ecusta in the fourth quarter of 1994. Ecusta's profitability was also significantly enhanced through comprehensive cost reduction efforts.\n1994 COMPARED TO 1993\nOverall demand for the Company's products increased significantly in the second half of 1994, particularly in the fourth quarter, which led to several price increases for certain printing paper grades. Net sales for the year increased $4,793,000 in 1994 over 1993. Net sales in the fourth quarter of 1994 were $19,539,000 higher than in the fourth quarter of 1993.\nPrinting paper sales decreased $5,646,000 or 1.7% in 1994 compared to 1993. The annual average net printing paper price decreased 1.3% in 1994 from 1993 due to the supply of uncoated free sheet papers exceeding demand during the first half of 1994. Significant increases in demand, particularly in the fourth quarter of 1994, led to price increases for certain printing paper grades. The average net selling price in the fourth quarter of 1994 was 8.6% higher than in the third quarter of 1994 and 4.0% higher than in the fourth quarter of 1993.\nNet tobacco and other specialty paper sales increased $10,439,000, or 7.9%, in 1994 compared to 1993. Other specialty paper sales increased 18.9% in 1994 over 1993 with a 16.4% increase in sales volume and a 2.2% increase in average net selling price. Increased competition and cost-cutting measures taken by Ecusta tobacco paper customers put severe pressure on tobacco paper prices. Aggressive pricing by the Company resulted in a 16.3% increase in tobacco paper sales volume in 1994 over 1993, primarily to export customers, but a 9.7% decrease in average net selling price.\nDespite the increase in sales, operating profits slipped significantly in 1994 from 1993. Profit from operations, before unusual items, accounting changes, interest income and expense and taxes was $21,541,000 compared to $48,563,000 in 1993, a 55.6% decrease. A decrease in average net selling price and increases in the cost of products sold caused a decrease in gross margin from 15.7% in 1993 to 8.5% in 1994. The cost of products sold increased as a result of higher costs for market pulp and wastepaper and higher depreciation costs, primarily as a result of the completion of the Spring Grove pulpmill modernization project. The Company's gross margin was also negatively impacted by unplanned mill downtime at the Spring Grove and Neenah mills during the first quarter of 1994 and above normal downtime at the Spring Grove mill during the third quarter of 1994 due to the complex integration of equipment required by the pulpmill modernization project.\nSelling, general and administrative expenses were $4,098,000 lower in 1994 than in 1993. This expected decrease occurred primarily in salaries, wages and other compensation expenses resulting from the Company's 1993 restructuring efforts. Profit sharing and incentive expenses were also lower in 1994 than in 1993 due to lower earnings.\nInterest on debt in 1994 increased $3,540,000 over 1993. This increase is due primarily to a full year of interest expense in 1994 related to the Company's March 1993 issuance of $150,000,000 principal amount of its 5 7\/8% Notes and an increase in interest expense related to short-term borrowings in 1994. In addition, during the third quarter of 1994, the Company ceased capitalizing interest on expenditures relating to the Spring Grove pulpmill modernization project, resulting in a significant increase in net interest expense.\nResults by Mill\nThe Company's Spring Grove mill showed a decline in its profits from operations of $5,856,000 in 1994 compared to 1993. Net sales were relatively flat in 1994 compared to 1993 as an overall improvement in average net selling price offset a slight decline in sales volume. The primary reason for the decline in profits from operations was an increase in depreciation expense resulting from the completion of the Spring Grove pulpmill modernization project.\nProfit from operations at the Neenah mill showed a decline of $6,322,000 in 1994 compared to 1993. Net sales increased $833,000 in 1994 as a 3.8% increase in volume more than\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS P. H. GLATFELTER COMPANY AND SUBSIDIARIES\noffset a 2.8% decrease in average net selling price. Neenah's profit from operations was negatively impacted by an increase in the cost of wastepaper, particularly in the fourth quarter of 1994.\nProfit from operations at Ecusta declined $14,844,000 in 1994 compared to 1993 resulting in an operating loss for the year. Net sales increased $3,737,000 in 1994 as an 8.0% increase in sales volume was offset somewhat by a 5.4% decrease in average net selling price. Ecusta's profit from operations was most negatively impacted by a sharp increase in the cost of purchased pulp and its inability to pass the increased costs onto its customers, particularly tobacco paper customers, due to severe competitive pressures.\n1994--UNUSUAL CHARGES\nDuring 1994, the Company closely monitored the Ecusta Division and continued its efforts to maximize utilization of Ecusta's assets by attempting to direct sales volume to its more profitable grades and by controlling costs. Despite these efforts, Ecusta experienced a 1994 operating loss before an unfavorable LIFO inventory charge, unusual items, interest expense and taxes of $4,921,000. Ecusta continued to be negatively impacted by the continuing trend of declining domestic tobacco consumption, a trend which was expected to continue. Increased competition for foreign tobacco paper sales also negatively impacted Ecusta's profitability.\nBased on 1994 Ecusta operating results, which indicated that market conditions were unlikely to improve significantly in the near future, the Company determined that its efforts to return Ecusta to an acceptable level of profitability would not be successful. As a result, the Company decided to evaluate other strategic alternatives. As part of its consideration of such alternatives, the Company solicited offers to buy the Ecusta Division during the fourth quarter of 1994. In January 1995, the Company rejected all offers which it received to buy the Ecusta Division because the offers were less than the Company's valuation of the net assets. Nevertheless, as a result of these offers, as well as the Company's revised valuation of the net assets of Ecusta, the Company concluded that the fair value of the net assets was less than the book value. Accordingly, during the fourth quarter of 1994, the net assets of Ecusta were written down to fair value, resulting in a $198,189,000 charge to pre-tax earnings. This writedown had no cash impact on the Company.\nThe Company concluded that asset impairment recognition was required as the revised projected undiscounted future cash flows of the Ecusta Division were less than the carrying value. In developing the revised projections, the Company considered 1994 actual results and the Company's conclusions concerning future market conditions and the resulting impact on prices. To determine the fair value of the Ecusta Division's net assets, the Company projected the present value of future cash flows using a 13% discount rate. The resulting fair value, which exceeded the offers received, was used to determine the amount of the writedown. The writedown of Ecusta's net assets reduced depreciation expense in 1995 by approximately $14,400,000 and will result in reduced depreciation in subsequent periods by declining amounts.\nDuring the fourth quarter of 1994, the Company also identified impaired assets at its Spring Grove and Neenah mills, resulting in a pre-tax charge of $10,760,000. This writedown primarily related to solid waste disposal assets, specifically, a sludge combustor at the Neenah mill and an unused landfill at the Spring Grove mill. During the fourth quarter of 1994, the Company identified more economical means, acceptable to the appropriate environmental agencies, by which to dispose of its solid waste at these locations and concluded that the significant additional expenditures necessary to make the assets operational were not prudent, resulting in unusable assets.\nFINANCIAL CONDITION\nLiquidity\nDuring 1995, the Company's cash and cash equivalents increased by $15,751,000. This increase in cash and cash equivalents was due to cash generated by operations of $115,751,000 which was largely offset by $32,493,000 for the funding of capital-related projects, the payment of $30,839,000 for dividends, the repayment of $24,100,000 of short-term bank borrowings and the purchase of $19,078,000 of common stock for the treasury.\nThe Company expects to meet all its near-term and long-term cash needs from a combination of internally generated funds, cash, cash equivalents, marketable securities and existing bank lines of credit.\nThe Company's interest rate risk is limited to its level of variable rate borrowings. In March 1993, the Company issued $150,000,000 principal amount of its 5 7\/8% Notes and immediately entered into an interest rate swap agreement having a total notional principal amount of $50,000,000. Under the agreement, the Company receives a fixed rate of 5 7\/8% and pays a floating rate (London Interbank Offered Rate (LIBOR) plus sixty basis points), as determined at six month intervals. The floating rate is 6.50625% for the six month period ending February 29, 1996. Although the Company can pay to terminate the swap agreement at any time, the Company intends to hold the swap agreement until its March 1, 1998 maturity. The cost to the Company to terminate the agreement fluctuates with prevailing market interest rates. As of December 31, 1995, the cost to terminate the swap agreement was approximately $200,000.\nCapital Resources\nDuring 1995, the Company expended $32,493,000 for capital projects including $6,716,000 relating to projects completed during 1994. Most of these expenditures were for maintenance-related capital; however, approximately $5,000,000 was expended for environmental capital projects and approximately $6,000,000 was expended for the Spring\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS P. H. GLATFELTER COMPANY AND SUBSIDIARIES\nGrove mill's pulpmill modernization project and turbine generator installation. These projects were both completed in the fourth quarter of 1994. Capital spending in 1996 is expected to increase as certain projects originally planned to begin in 1995 are now expected to commence during 1996.\nENVIRONMENTAL MATTERS\nThe Company is subject to loss contingencies resulting from regulation by various federal, state, local and foreign governmental authorities with respect to the environmental impact of air and water emissions and noise from its mills as well as its disposal of solid waste generated by its operations. In order to comply with environmental laws and regulations, the Company has incurred substantial capital and operating expenditures over the past several years. The Company anticipates that environmental regulation of the Company's operations will continue to become more burdensome and that capital expenditures will continue and operating expenditures will continue, and perhaps increase, in the future. In addition, the Company may incur obligations to remove or mitigate any adverse effects on the environment resulting from its operations, including the restoration of natural resources, and liability for personal injury and damage to property, including natural resources. Management's current assessment, after consultation with legal counsel, is that such expenditures are not likely to have a material adverse effect on the Company's financial condition, results of operations or liquidity, but there can be no assurance that its reserves will be adequate or that such an effect will not occur at some future time.\nEFFECTS OF CHANGING PRICES\nThe moderate levels of inflation during recent years have not had a material effect on the Company's net sales, revenues or income from operations. Although the replacement cost of assets increases during inflationary periods, earnings and adequate cash flow may be maintained through an increase in selling prices.\nStatements regarding the Registrant's expectations as to demand for its products in 1996 and certain other information presented in this Annual Report on Form 10-K constitute forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Although the Registrant believes that its expectations are based on reasonable assumptions within the bounds of its knowledge of its business and operations, there can be no assurance that actual results will not differ materially from its expectations. Factors which could cause actual results to differ from expectations include a significant change in economic growth, changes to paper production capacity, the gain or loss of significant customers, costs and availability of raw materials, changes in government policy or regulation and costs and other effects related to environmental matters.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nCONSOLIDATED STATEMENTS OF INCOME AND RETAINED EARNINGS P. H. GLATFELTER COMPANY AND SUBSIDIARIES\nFOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSee notes to consolidated financial statements.\nCONSOLIDATED BALANCE SHEETS P. H. GLATFELTER COMPANY AND SUBSIDIARIES\nDECEMBER 31, 1995 AND 1994\nSee notes to consolidated financial statements.\nCONSOLIDATED STATEMENTS OF CASH FLOWS P. H. GLATFELTER COMPANY AND SUBSIDIARIES\nFOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSee notes to consolidated financial statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS P. H. GLATFELTER COMPANY AND SUBSIDIARIES\nFOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\n(a) Nature of Operations and Principles of Consolidation P. H. Glatfelter Company and subsidiaries are principally manufacturers of printing papers and tobacco and other specialty papers. Headquartered in Spring Grove, Pennsylvania, the Company's paper mills are located in Spring Grove, Pisgah Forest, North Carolina and Neenah, Wisconsin. The Pisgah Forest mill is also known as the Ecusta Division. The Company's products are marketed in most parts of the United States and in many foreign countries, either through wholesale paper merchants, brokers and agents, or direct to customers. The accounts of the Company and its wholly-owned, significant subsidiaries are included in the consolidated financial statements. All intercompany transactions have been eliminated.\n(b) Income (Loss) per Common Share Net income (loss) per share of common stock is computed on the basis of the weighted average number of shares of common stock and common stock equivalents (Note 6) outstanding during each year.\nThe 1994 net loss per share of common stock of $2.67, as presented in the Consolidated Statements of Income and Retained Earnings, reflects the negative impact of the writedown of impaired assets (Note 2). The 1993 net income per share of common stock of $.37, as presented in the Consolidated Statements of Income and Retained Earnings, reflects the negative impact of adopting certain Statements of Financial Accounting Standards (Note 1(i)), rightsizing and restructuring charges (Note 3) and the increase in the federal corporate income tax rate from 34% to 35% (Note 9). The 1994 and 1993 net income per share of common stock, exclusive of these items, would have been $.22 and $.73, respectively. There were no such items recorded in 1995. A reconciliation of these amounts follows:\n(c) Cash and Cash Equivalents The Company considers all highly liquid financial instruments with effective maturities at date of purchase of three months or less to be cash equivalents.\n(d) Inventories Inventories are stated at the lower of cost or market. Raw materials and in-process and finished inventories are valued using the last-in, first-out (LIFO) method, and the supplies inventory is valued principally using the average cost method. Inventories at December 31 are summarized as follows:\nIf the Company had valued all inventories using the average cost method, inventories would have been $14,563,000 and $8,488,000 higher than reported at December 31, 1995 and 1994, respectively. During 1994, the Company liquidated certain LIFO inventories. The effect of the liquidation did not have a significant impact on net income. If the Company had valued all inventories using the average cost method in 1993, net income would not have been significantly different than that reported.\nAt December 31, 1995 and 1994, the value of the above inventories exceeded inventories for income tax purposes by approximately $23,000,000 and $24,200,000, respectively.\n(e) Plant, Equipment and Timberlands Depreciation is computed for financial reporting on the straight-line method over the estimated useful lives of the respective assets and for income taxes principally on accelerated methods over lives established by statute or Treasury Department procedures. Provision is made for deferred income taxes applicable to this difference.\nMaintenance and repairs are charged to income and major renewals and betterments are capitalized. At the time property is retired or sold, the cost and related reserve are eliminated and any resultant gain or loss is included in income.\nDepletion of the cost of timber is computed on a unit rate of usage by growing area based on estimated quantities of recoverable material.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS P. H. GLATFELTER COMPANY AND SUBSIDIARIES\nPlant, equipment and timberlands accounts are summarized as follows:\n(f) Investments in Debt and Equity Securities Effective January 1, 1994, the Company changed its method of accounting for investments in debt and equity securities to conform to Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" (\"SFAS No. 115\"). The adoption of this Standard did not have a material impact on the Company's Consolidated Balance Sheets or Consolidated Statements of Income and Retained Earnings.\nLong-term investments, which are due ratably over a 19-year period and are classified as held-to-maturity, are included in other assets in the Consolidated Balance Sheets at December 31, 1995 and 1994. The investments consist of approximately $13,200,000 and $16,000,000 in U. S. Treasury and government obligations at December 31, 1995 and 1994, respectively. The estimated fair market value of the investments in such securities approximated the amortized cost, and therefore, there were no significant unrealized holding gains or losses as of December 31, 1995 and 1994. Investments in equity securities of $111,000, classified as available-for-sale, are reported as marketable securities on the Consolidated Balance Sheets at December 31, 1995 and 1994. The fair market value for such securities approximates cost.\n(g) Income Tax Accounting Effective January 1, 1993, the Company changed its policy of accounting for income taxes to conform to Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS No. 109\") (Notes 1(i) and 9). The Company previously followed Accounting Principles Board Opinion No. 11, \"Accounting for Income Taxes\". Deferred taxes are provided for differences between amounts shown for financial reporting purposes and those included with tax return filings that will reverse in future periods.\n(h) Capitalized Interest The Company capitalizes interest incurred in connection with qualified additions to property. The Company capitalized $3,066,000 and $4,138,000 of interest in 1994 and 1993, respectively. The Company did not capitalize any interest in 1995.\n(i) Accounting Changes for Statements of Financial Accounting Standards Effective January 1, 1993, the Company adopted the provisions of Statements of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (\"SFAS No. 106\"), No. 112, \"Employers' Accounting for Postemployment Benefits\" (\"SFAS No. 112\"), and No. 109, \"Accounting for Income Taxes\" (\"SFAS No. 109\"). The cumulative effect of the accounting changes, net of tax charges (credits) due to the adoption of these Standards in 1993, was as follows:\nSFAS No. 106 requires recognition of the cost of retiree health and insurance benefits during an employee's active service. The cumulative effect, as of January 1, 1993, of the adoption of SFAS No. 106 was a one-time charge for postretirement health care costs of $20,900,000 which, after deferred income tax benefits of $8,050,000, resulted in a 1993 first quarter net charge of $12,850,000.\nThe Company had previously recognized the cost of postretirement benefits in the period benefits were paid. The effect of this change in accounting for the years ended December 31, 1995, 1994 and 1993, was an additional pre-tax expense of approximately $950,000, $300,000 and $770,000, respectively.\nSFAS No. 112 requires employers to recognize the obligation to provide postemployment benefits under certain conditions. Such benefits, relating primarily to disability-related benefits, were not previously recognized by the Company until paid. The cumulative effect as of January 1, 1993 of the adoption of SFAS No. 112 was a provision for accrued postemployment benefits of $3,201,000 which, after deferred income tax benefits of $1,234,000, resulted in a 1993 first quarter net charge of $1,967,000.\nSFAS No. 109 required a remeasurement of the Company's Ecusta Division acquisition which resulted in an increase in the fair value of the acquired assets and the establishment of a deferred income tax liability for the difference between the book and tax values of such assets. The adoption of SFAS No. 109 also resulted in a reversal of deferred income taxes provided during years when the effective income tax rates were higher than those currently in effect. The cumulative effect of these changes recorded in 1993 was an increase in plant and equipment of approximately $61,062,000; an increase in deferred income taxes of approximately $50,438,000; and a credit to operations as a cumulative effect of the change in method of accounting for income taxes of approximately $10,624,000.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS P. H. GLATFELTER COMPANY AND SUBSIDIARIES\n(j) Fair Market Value of Financial Instruments The amounts reported in the Consolidated Balance Sheets for cash and cash equivalents, marketable securities, trade receivables, other assets and long-term debt approximate fair value.\n(k) Asset Impairment Assets are reviewed for impairment on an annual basis in conjunction with the preparation of the annual budget or when a specific event indicates that the carrying value of an asset may not be recoverable. Recoverability is assessed based on estimates of future cash flows expected to result from the use and eventual disposition of the asset. If the sum of expected undiscounted cash flows is less than the carrying value of the asset, an impairment loss is recognized. The impairment loss is measured as the amount by which the carrying amount of the asset exceeds its fair value.\n(l) Statement of Financial Accounting Standards Pending Adoption In October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation\" (\"SFAS No. 123\"). SFAS No. 123 defines a fair value method of accounting for stock options and other equity instruments. Under the fair value method, compensation cost is measured at the grant date based on the fair value of the award and is recognized over the service period, which is usually the vesting period.\nUnder SFAS No. 123, the Company is permitted to continue to account for employee stock-based transactions under Accounting Principles Board Opinion No. 25, \"Accounting for Stock Issued to Employees\" (\"APB No. 25\"), but would be required to disclose in a note to the consolidated financial statements pro forma net income and income per share information as if the Company had applied the new method of accounting. SFAS No. 123 also requires increased disclosures for stock-based compensation arrangements regardless of the method chosen to measure and recognize compensation for employee stock-based arrangements.\nThe Company has determined that it will continue to account for such transactions under APB No. 25 and will provide the disclosures required by SFAS No. 123 during the year ending December 31, 1996.\n(m) Accounting Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires the use of management's estimates and assumptions. Management believes the estimates and assumptions used in the preparation of these consolidated financial statements are reasonable based upon currently available facts and known circumstances but recognizes that actual results may differ from those estimates and assumptions. Such differences, if any, are not expected to have a material impact on the Company's financial condition, results of operations or liquidity.\n2. WRITEDOWN OF IMPAIRED ASSETS (UNUSUAL ITEMS)\nDuring the fourth quarter of 1994, the Company recognized a noncash, pre-tax writedown of impaired assets of $208,949,000. Of this amount, $198,189,000 related to the pre-tax writedown of the Company's Ecusta Division to its fair value primarily due to writedowns related to property, plant and equipment of $189,441,000 and inventory of $6,406,000.\nThe Company concluded that asset impairment recognition was required as the revised projected undiscounted future cash flows of the Ecusta Division were less than the carrying value. In developing the revised projections, the Company considered 1994 actual results and the Company's conclusions concerning future market conditions and the resulting impact on prices. To determine the fair value of the Ecusta Division's net assets, the Company projected the present value of future cash flows using a 13% discount rate. The resulting fair value was used to determine the amount of the writedown.\nDuring the fourth quarter of 1994, the Company also identified impaired property and equipment at its Spring Grove, Pennsylvania and Neenah, Wisconsin mills, resulting in a pre-tax charge of $10,760,000. This writedown primarily related to solid waste disposal assets, specifically, a sludge combustor at the Neenah mill and an unused landfill at the Spring Grove mill. During the fourth quarter of 1994, the Company identified more economical means, acceptable to the appropriate environmental agencies, by which to dispose of its solid waste at these locations and concluded that the significant additional expenditures necessary to make the assets operational were not prudent, resulting in unusable assets.\nThe aggregate after tax impact of this writedown in 1994 was $127,981,000, or $2.89 per common share.\n3. RIGHTSIZING AND RESTRUCTURING (UNUSUAL ITEMS)\nDuring 1993, the Company incurred net unusual charges of $13,229,000 including rightsizing and restructuring costs of $16,363,000, partially offset by a gain of $1,492,000 on the disposal of its Ecusta Division's airplane and a credit of $1,642,000 resulting from the updating of estimates relating to SFAS No. 106, subsequent to its adoption on January 1, 1993. The charges primarily include provisions for the accelerated pension, stock awards and postretirement benefit costs of early retirements and other terminations in the second quarter of 1993 and other one-time net costs relating to the rightsizing and restructuring of the Company's operations. The rightsizing and restructuring, which was completed during 1993, resulted in the early retirement of 156 employees and a reduction in annual salaries, wages and benefits of approximately $7,500,000. The after tax impact of these charges was $8,430,000 or $.19 per common share.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS P. H. GLATFELTER COMPANY AND SUBSIDIARIES\n4. CAPITAL STOCK\nA summary of the number of shares of common stock outstanding follows:\nUnder the employee stock purchase plans, eligible hourly employees may acquire shares of the Company's common stock at its fair market value. Employees may contribute up to 10% of their compensation, as defined, and the Company may contribute, as specified in the plans, amounts up to 15% of the employee's contribution but not more than 3% of the employee's compensation, as defined. Effective October 1, 1995, the Company replaced the employee stock purchase plan for salaried employees with a 401(k) plan (Note 7).\nOn September 22, 1993, the Company's Board of Directors called for the redemption of all 3,147 outstanding shares of 4 5\/8% preferred stock. The preferred shares were redeemed on October 27, 1993 for $50.75 per share. The redeemed shares of preferred stock and all preferred stock shares held in treasury were canceled on October 27, 1993. The Company has 40,000 shares remaining of 4 5\/8% preferred stock authorized but not issued.\n5. CAPITAL IN EXCESS OF PAR VALUE\nA summary of changes in capital in excess of par value follows:\n6. KEY EMPLOYEE LONG-TERM INCENTIVE PLAN AND RESTRICTED COMMON STOCK AWARD PLAN\nOn April 22, 1992, the holders of common stock approved the 1992 Key Employee Long-Term Incentive Plan (\"1992 Plan\") which authorizes the issuance of up to 3,000,000 shares of the Company's common stock to eligible participants. The 1992 Plan provides for incentive stock options, non-qualified stock options, restricted stock awards, performance shares and performance units. The Company's 1988 Restricted Common Stock Award Plan (\"1988 Plan\") was simultaneously amended to provide that no further awards of common shares may be made thereunder.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS P. H. GLATFELTER COMPANY AND SUBSIDIARIES\nThe following summarizes the activity of non-qualified stock options granted to purchase an equivalent number of shares of common stock for the years ended December 31, 1993, 1994 and 1995:\nThere were 556,362 and 389,000 exercisable options as of December 31, 1995 and 1994, respectively. An additional 275,484 options became exercisable as of January 1, 1996. Options typically become exercisable for 25% of the shares of common stock issuable on exercise thereof, beginning January 1 of the year following the date of grant, assuming six months has passed, with options for an additional 25% of such shares becoming exercisable on January 1 of each of the next three years. Options not exercisable under this schedule are exercisable six months from the date of grant. All options expire on the earlier of termination of employment or ten years from the date of grant.\nThe exercise price represents the fair market value of the Company's common stock on the date of grant, or the average fair market value of the Company's common stock on the first day before and after the date of grant for which fair market value information was available if such information was not available on the date of grant. The exercise prices presented above are rounded to the nearest dollar.\nOn January 1, 1996, the Company granted to certain key employees non-qualified options to purchase an aggregate of 110,030 shares of common stock. Subject to certain conditions, these stock options are exercisable for 25% of such shares beginning on January 1, 1997 and an additional 25% of such shares beginning on January 1 of each of the next three years. The stock options, which expire on December 31, 2005, were granted at an exercise price of $17.16 per share, representing the average fair market value of the Company's common stock on Friday, December 29, 1995 and Tuesday, January 2, 1996.\nOn May 1, 1995 and January 1, 1996, the Company awarded 59,260 and 44,860 shares, respectively, subject to certain conditions, to certain key employees to be issued in whole or in part depending on the Company's degree of success in achieving certain financial performance goals during defined four-year performance periods. The May 1, 1995 and January 1, 1996 awards are for the performance periods ending December 31, 1998 and 1999, respectively, and if earned will be distributed the following year. Compensation expense is recognized over the performance period and is affected by the likelihood of achieving the performance goals and the fair value of the Company's common stock at the end of each reporting period. The Company expensed $186,000 related to these awards in 1995.\nDuring 1988 and 1991, 755,000 and 76,000 shares of common stock, respectively, were awarded under the 1988 Plan. Awarded shares are subject to forfeiture, in whole or in part, if the recipient ceases to be an employee within a specified period of time. Compensation expense equal to the fair market value of awarded shares on the award date is recognized over the period from the award date to the date the forfeiture provisions lapse. The Company may reduce the number of shares otherwise required to be delivered by an amount which would have a fair market value equal to the taxes withheld by the Company on delivery. The Company may also, at its sole discretion, elect to pay to the recipients in cash an amount equal to the fair market value of the shares that would otherwise be required to be delivered. In conjunction with the Company's rightsizing and restructuring in 1993 (Note 3), the vesting dates were accelerated to 1993 for 120,000 shares and to 1994 for 28,000 shares.\nOn March 1, 1994, under the 1988 Plan, in lieu of delivering 28,000 shares, the Company elected to pay in cash an amount equal to the fair market value of such shares. On May 2, 1994, 15,012 shares were delivered from treasury (after reduction of 8,988 shares for taxes). In 1993, the Company paid cash in lieu of delivering 271,000 shares. Shares awarded under the 1988 Plan cease to be subject to forfeiture as follows: 182,000 in 1996 and 20,000 in each of 1997, 1998 and 1999.\n7. RETIREMENT PLANS\nThe Company and its subsidiaries have trusteed, noncontributory defined benefit pension plans covering substantially all of their employees. The benefits are based, in the case of certain plans, on average salary and years of service and, in the case of other plans, on a fixed amount for each year of service. Plan provisions and funding met the requirements of the Employee Retirement Income Security Act of 1974. Pension income of $6,623,000, $6,082,000 and $4,205,000 was recognized in 1995, 1994 and 1993, respectively.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS P. H. GLATFELTER COMPANY AND SUBSIDIARIES\nAs discussed in Note 3, during 1993, the Company incurred rightsizing and restructuring costs, including provisions for the costs of termination benefits. In accordance with Statement of Financial Accounting Standards No. 88, \"Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits,\" the Company recognized a charge of $7,978,000 in 1993 related to early retirement termination benefits.\nThe following table sets forth the status of the Company's defined benefit pension plans at December 31, 1995 and 1994:\nNet pension income, excluding unusual charges, includes the following components:\nThe assumptions used in computing the information above were as follows:\nEffective October 1, 1995, the Company established a 401(k) plan for all salaried employees. Salaried employees may contribute up to 15% of their compensation to the plan, subject to certain restrictions. The Company will contribute up to 50% of the employee's contribution, but not more than 3% of the employee's compensation, as defined, in the form of shares of the Company's common stock into the Company stock fund maintained under the 401(k) plan. During 1995, the Company contributed shares of its common stock valued at $235,000 to the 401(k) plan.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS P. H. GLATFELTER COMPANY AND SUBSIDIARIES\n8. OTHER POSTRETIREMENT BENEFITS\nThe Company provides certain health care benefits to eligible retired employees. These benefits include a comprehensive medical plan for retirees prior to age 65 and fixed supplemental premium payments to retirees over age 65 to help defray the costs of Medicare. As discussed in Note 1(i), the Company adopted SFAS No. 106, effective January 1, 1993. The plan is not funded; claims are paid as incurred.\nThe following table sets forth the plan's status as of December 31:\nNet periodic postretirement benefit cost includes the following components:\nThe Company assumes an increase in the per capita cost of covered health benefits of 9% for 1996 decreasing ratably to 5.5% in 2000. The weighted average discount rates used in determining the accumulated postretirement benefit obligation were 7.5% in 1995, 8.0% in 1994 and 7.0% in 1993. If the health care cost trend rate increased by 1%, the accumulated postretirement benefit obligation as of December 31, 1995 would have been approximately $2,248,000 greater and the net periodic postretirement benefit cost would have been approximately $275,000 greater.\n9. INCOME TAXES\nIncome taxes are recognized for (a) the amount of taxes payable or refundable for the current year, and (b) deferred tax liabilities and assets for the future tax consequences of events that have been recognized in the Company's consolidated financial statements or tax returns. The effects of income taxes are measured based on effective tax law and rates.\nDuring 1993, federal tax legislation was enacted that significantly changed the income tax provisions for the Company. The principal provision of the law affecting the Company was an increase in the federal corporate income tax rate from 34% to 35%. Current payable and deferred tax liabilities were increased by $226,000 and $3,361,000, respectively, as a result of the law change. As a result, income tax expense from continuing operations for 1993 was increased by $3,587,000, causing a reduction in net income by the same amount and a reduction to earnings per share of $.08.\nThe Company has a federal alternative minimum tax credit carryforward of $5,090,000 which has no expiration period.\nThe following table sets forth the domestic and foreign components of pre-tax income (loss):\nThe income tax provision (credit) consists of the following:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS P. H. GLATFELTER COMPANY AND SUBSIDIARIES\nThe net deferred tax amounts reported on the Company's Consolidated Balance Sheets as of December 31 are as follows:\nThe following are components of the net deferred tax balances as of December 31:\nThe tax effects of temporary differences as of December 31 are as follows:\nA reconciliation between the provision (credit) for income taxes, computed by applying the statutory federal income tax rate of 35% to income (loss) before income taxes, and the actual provision (credit) for income taxes follows:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS P. H. GLATFELTER COMPANY AND SUBSIDIARIES\n10. COMMITMENTS AND CONTINGENCIES\nThe Company is subject to loss contingencies resulting from regulation by various federal, state, local and foreign governmental authorities with respect to the environmental impact of air and water emissions and noise from its mills as well as its disposal of solid waste generated by its operations. In order to comply with environmental laws and regulations, the Company has incurred substantial capital and operating expenditures over the past several years. The Company anticipates that environmental regulation of the Company's operations will continue to become more burdensome and that capital expenditures will continue and operating expenditures will continue, and perhaps increase, in the future. In addition, the Company may incur obligations to remove or mitigate any adverse effects on the environment resulting from its operations, including the restoration of natural resources, and liability for personal injury and damage to property, including natural resources. Because other paper companies located in the United States are generally subject to the same environmental regulations, the Company does not believe that its competitive position in the United States paper industry will be materially adversely affected by its capital expenditures for, or operating costs of, pollution abatement facilities for its present mills, any other environmental-related obligations it will incur or the limitations which environmental compliance may place on its operations.\nThe amount and timing of future expenditures for environmental compliance, clean up, remediation and personal injury and property damage liability cannot be ascertained with any certainty due, among other things, to the unknown extent and nature of any contamination, the extent and timing of any technological advances for pollution control, the remedial actions which may be required and the number and financial resources of any other responsible parties. The Company continues to evaluate its exposure and the level of its reserves. Management's current assessment, after consultation with legal counsel, is that such expenditures are not likely to have a material adverse effect on the Company's financial condition, results of operations or liquidity, but there can be no assurance that its reserves will be adequate or that such an effect will not occur at some future time.\nDuring 1995, the Company expended approximately $5,000,000 in environmental capital projects exclusive of approximately $4,000,000 in final payments related to the $171,000,000 Spring Grove pulp mill modernization project. The Company estimates that $3,000,000 and $8,000,000 will be expended for environmental capital projects in 1996 and 1997, respectively.\n11. LEGAL PROCEEDINGS\nThe Company is involved in various lawsuits. Although the ultimate outcome of these lawsuits cannot be predicted with certainty, the Company's management, after consultation with legal counsel, does not expect that such lawsuits will have a material adverse effect on the Company's financial position, results of operations or liquidity.\n12. SIGNIFICANT CUSTOMER AND FOREIGN SALES\nThe Company sells a significant portion of its printing and writing papers through wholesale paper merchants. During 1994, two of the Company's wholesale paper merchants merged into one company, and as a result, during 1995 and 1994, this customer accounted for 13.9% and 13.0% of the Company's net sales, respectively. Net sales in dollars to foreign customers were 8.8%, 9.4% and 8.1% of total net sales in 1995, 1994 and 1993, respectively.\n13. BORROWINGS\nThe Company has available lines of credit from two different banks aggregating $100,000,000 at interest rates approximating money market rates. The Company had no short-term borrowings as of December 31, 1995. Short-term borrowings were $24,100,000 as of December 31, 1994, at an average interest rate of 6.3%. The Company had average net short-term borrowings of $9,447,000 and $13,850,000 during 1995 and 1994, respectively, at an average interest rate of 6.2% and 5.2%, respectively. Maximum short-term borrowings during 1995 and 1994 were $29,400,000 and $36,900,000, respectively.\nIn March 1993, the Company issued $150,000,000 principal amount of its 5 7\/8% Notes. These Notes will mature on March 1, 1998 and may not be redeemed prior to maturity. Interest on the Notes is payable semiannually on March 1 and September 1. The Notes are unsecured obligations of the Company.\nIn March 1993, the Company entered into an interest rate swap agreement having a total notional principal amount of $50,000,000. Under the agreement, the Company receives a fixed rate of 5 7\/8% and pays a floating rate (London Interbank Offered Rated (LIBOR) plus sixty basis points), as determined at six month intervals. The floating rate is 6.50625% for the six month period ending February 29, 1996. The agreement converts a portion of the Company's debt obligation from a fixed rate to a floating rate basis. Under the agreement, the Company recognized net interest expense of $453,000 in 1995 and net interest income of $433,000 in 1994. These amounts are included in \"Interest on debt\" on the Company's Consolidated Statements of Income and Retained Earnings. The Company has pledged $3,600,000 of its other assets as security under the swap agreement. Although the Company can pay to terminate the swap agreement at any time, the Company intends to hold the swap agreement until its March 1, 1998 maturity. The cost to the Company to terminate the agreement fluctuates with prevailing market interest rates. As of December 31, 1995, the cost to terminate the swap agreement was approximately $200,000.\nThe Company has approximately $8,900,000 of letters of credit outstanding as of December 31, 1995. The Company bears the credit risk on this amount to the extent that the Company does not comply with the provisions of certain agreements. The letters of credit do not reduce the amount available under the Company's lines of credit.\nMANAGEMENT'S RESPONSIBILITY REPORT\nThe management of P. H. Glatfelter Company has prepared and is responsible for the Company's consolidated financial statements and other corroborating information contained herein. Management bears responsibility for the integrity of these statements which have been prepared in accordance with generally accepted accounting principles and include management's best judgments and estimates. All information in this annual report consistently reflects the data contained in the consolidated financial statements.\nThe Company maintains a system of internal controls designed to provide reasonable assurance that assets are safeguarded, transactions are executed and recorded in accordance with their authorizations, and financial records are maintained so as to permit the preparation of reliable financial statements. The system of internal controls is enhanced by written policies and procedures, an organizational structure providing appropriate segregation of duties, careful selection and training of qualified people, and periodic reviews performed by both its internal audit department and independent public auditors.\nThe Audit Committee of the Board of Directors, consisting exclusively of directors who are not Company employees, provides oversight of financial reporting. The Company's internal audit department and independent auditors meet with the Audit Committee on a periodic basis to discuss financial reporting and internal control issues and have completely free access to the Audit Committee.\n\/s\/ T. C. NORRIS - ---------------- T. C. Norris Chairman of the Board, President and Chief Executive Officer\n\/s\/ R. P. NEWCOMER - ------------------ R. P. Newcomer Senior Vice President, Treasurer and Chief Financial Officer\nINDEPENDENT AUDITORS' REPORT\nP. H. Glatfelter Company, Its Shareholders and Directors:\nWe have audited the accompanying consolidated balance sheets of P. H. Glatfelter Company and subsidiaries as of December 31, 1995 and 1994, 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, 1995. 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 P.H. Glatfelter Company and subsidiaries at December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles. Also, in our opinion, the financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.\nAs discussed in Note 1(i) to the consolidated financial statements, the Company changed its method of accounting for income taxes, postretirement benefits other than pensions and postemployment benefits as of January 1, 1993.\nDELOITTE & TOUCHE LLP Philadelphia, Pennsylvania February 2, 1996\nQUARTERLY FINANCIAL DATA\n(a) After impact of an after tax charge for a writedown of impaired assets (unusual items) of $127,981,000 or $2.89 per share.\nItem 9.","section_9":"Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.\nNot Applicable.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant.\n(a) Directors. The information with respect to directors required under this item is incorporated herein by\nreference to pages 2 through 3 of the Registrant's Proxy Statement dated March 15, 1996.\n(b) Executive Officers of the Registrant. The information with respect to the executive officers required under this item is set forth in Part I of this Report and incorporated by reference to pages 3 and 16 of the Registrant's Proxy Statement dated March 15, 1996.\nItem 11.","section_11":"Item 11. Executive Compensation.\nThe information required under this item is incorporated herein by reference to pages 5 through 13 of the Registrant's Proxy Statement dated March 15, 1996.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nThe information required under this item is incorporated herein by reference to pages 14 through 16 of the Registrant's Proxy Statement dated March 15, 1996.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nThe information required under this item is incorporated herein by reference to page 13 of the Registrant's Proxy Statement dated March 15, 1996.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.\n(a) 1. A. Financial Statements filed as part of this report:\nConsolidated Statements of Income and Retained Earnings for the Years Ended December 31, 1995, 1994 and 1993 Consolidated Balance Sheets, December 31, 1995 and 1994 Consolidated Statements of Cash Flows for the Years Ended December 31, 1995, 1994 and 1993 Notes to Consolidated Financial Statements for the Years Ended December 31, 1995, 1994 and\nB. Supplementary Data for each of the three years in the period ended December 31, 1995.\n2. Financial Statement Schedules (Consolidated):\nFor Each of the Three Years in the Period Ended December 31, 1995:\nII - Valuation and Qualifying Accounts\nSchedules other than those listed above are omitted because of the absence of conditions under which they are required or because the required information is included in the Notes to the Consolidated Financial Statements.\nIndividual financial statements of the Registrant are not presented inasmuch as the Registrant is primarily an operating company and its consolidated subsidiaries are wholly-owned.\n3. Executive Compensation Plans and Arrangements: see Exhibits 10(a) through 10(g), described below.\nExhibits:\nNumber Description of Documents\n(3)(a) Articles of Amendment dated April 27, 1977, including restated Articles of Incorporation (incorporated by reference to Exhibit 3(a) of Registrant's Annual Report on Form 10-K for the year ended December 31, 1993) as amended by Articles of Merger dated January 30, 1979 (incorporated by reference to Exhibit 3(a) of Registrant's Annual Report on Form 10-K for the year ended December 31, 1993); a Statement of Reduction of Authorized Shares dated May 12, 1980 (incorporated by reference to Exhibit 3(a) of Registrant's Annual Report on Form 10-K for the year ended December 31, 1993); a Statement of Reduction of Authorized Shares dated September 23, 1981 (incorporated by reference to Exhibit 3(a) of Registrant's Annual Report on Form 10-K for the year ended December 31, 1993); a Statement of Reduction of Authorized Shares dated August 2, 1982 (incorporated by reference to Exhibit 3(a) of Registrant's Annual Report on Form 10-K for the year ended December 31, 1993); a Statement of Reduction of Authorized Shares dated July 29, 1983 (incorporated by reference to Exhibit 3(a) of Registrant's Annual Report on Form 10-K for the year ended December 31, 1993); by Articles of Amendment dated April 25, 1984 (incorporated by reference to Exhibit 3(a) of Registrant's Annual Report on Form 10-K for the year\nended December 31, 1994); a Statement of Reduction of Authorized Shares dated October 15, 1984 (incorporated by reference to Exhibit (3)(b) of Registrant's Form 10-K for the year ended December 31, 1984); a Statement of Reduction of Authorized Shares dated December 24, 1985 (incorporated by reference to Exhibit (3)(b) of Registrant's Form 10-K for the year ended December 31, 1985); by Articles of Amendment dated April 23, 1986 (incorporated by reference to Exhibit (3) of Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 1986); a Statement of Reduction of Authorized Shares dated July 11, 1986 (incorporated by reference to Exhibit (3)(b) of Registrant's Form 10-K for the year ended December 31, 1986); a Statement of Reduction of Authorized Shares dated March 25, 1988 (incorporated by reference to Exhibit (3)(b) of Registrant's Form 10-K for the year ended December 31, 1987); a Statement of Reduction of Authorized Shares dated November 9, 1988 (incorporated by reference to Exhibit (3)(b) of Registrant's Form 10-K for the year ended December 31, 1988); a Statement of Reduction of Authorized Shares dated April 24, 1989 (incorporated by reference to Exhibit 3(b) of Registrant's Form 10-K for the year ended December 31, 1989); Articles of Amendment dated November 29, 1990 (incorporated by reference to Exhibit 3(b) of Registrant's Form 10-K for the year ended December 31, 1990); Articles of Amendment dated June 26, 1991 (incorporated by reference to Exhibit 3(b) of Registrant's Form 10-K for the year ended December 31, 1991); Articles of Amendment dated August 7, 1992 (incorporated by reference to Exhibit 3(b) of Registrant's Form 10-K for the year ended December 31, 1992); Articles of Amendment dated July 30, 1993 (incorporated by reference to Exhibit 3(b) of Registrant's Form 10-K for the year ended December 31, 1993); and Articles of Amendment dated January 26, 1994 (incorporated by reference to Exhibit 3(b) of Registrant's Form 10-K for the year ended December 31, 1993).\n(3)(b) Articles of Incorporation, as amended through January 26, 1994 (restated for the purpose of filing on EDGAR) (incorporated by reference to Exhibit 3(c) of Registrant's Form 10-K for the year ended December 31, 1993).\n(3)(c) By-Laws as amended through June 28, 1995.\n(4)(a) Indenture between P. H. Glatfelter Company and Wachovia Bank of Georgia, N.A. as Trustee dated as of January 15, 1993 (incorporated by reference to Exhibit 4(a) of Registrant's Form 10-K for the year ended December 31, 1993).\n(4)(b) Form of Note issued to Purchasers of 5 7\/8% Notes due March 1, 1998 (incorporated by reference to Exhibit 4(b) of Registrant's Form 10-K for the year ended December 31, 1992).\n(9) P. H. Glatfelter Family Shareholders' Voting Trust dated July 1, 1993 (incorporated by reference to Exhibit 1 of the Schedule 13D filed by P. H. Glatfelter Family Shareholders' Voting Trust dated July 1, 1993).\n(10)(a) P. H. Glatfelter Company Management Incentive Plan, adopted as of January 1, 1994, as amended and restated effective March 16, 1995 (incorporated by reference to Exhibit 10(a) of Registrant's Form 10-K for the year ended December 31, 1994).\n(10)(b) P. H. Glatfelter Company 1988 Restricted Common Stock Award Plan, as amended and restated June 24, 1992 (incorporated by reference to Exhibit (10)(c) of Registrant's Form 10-K for the year ended December 31, 1992).\n(10)(c) P. H. Glatfelter Company Supplemental Executive Retirement Plan, effective January 1, 1988, as amended and restated December 22, 1994 (incorporated by reference to Exhibit 10(c) of Registrant's Form 10-K for the year ended December 31, 1994).\n(10)(d) Deferral Benefit Pension Plan of Ecusta Division, effective May 22, 1986 (incorporated by reference to Exhibit (10)(ee) of Registrant's Form 10-K for the year ended December 31, 1987).\n(10)(e) Description of Executive Salary Continuation Plan (incorporated by reference to Exhibit (10)(g) of Registrant's Form 10-K for the year ended December 31, 1990).\n(10)(f) P. H. Glatfelter Company Plan of Supplemental Retirement Benefits for the Management Committee, as amended and restated effective June 28, 1989 (incorporated by reference to Exhibit (10)(h) of Registrant's Form 10-K for the year ended December 31, 1989).\n(10)(g) P.H. Glatfelter Company 1992 Key Employee Long-Term Incentive Plan, effective April 22, 1992 (incorporated by reference to Exhibit (10)(i) of Registrant's Form 10-K for the year ended December 31, 1992).\n(11) Computation of Earnings Per Share\n(21) Subsidiaries of the Registrant\n(23) Consent of Independent Certified Public Auditors\n(27) Financial Data Schedule\n(b) The Registrant filed the following report on Form 8-K during the quarter ended December 31, 1995:\nN O N E\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nP. H. GLATFELTER COMPANY (Registrant) March 15, 1996 By \/s\/ T. C. Norris ------------------------ T. C. Norris Chairman of the Board\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant in the capacities and on the dates indicated:\nP. H. GLATFELTER COMPANY AND SUBSIDIARIES\nFinancial Statement Schedule For Each of the Three Years in the Period Ended December 31, 1995 and Report of Independent Certified Public Accountants\nPrepared for Filing As Part of Annual Report (Form 10-K) to the Securities and Exchange Commission\nFINANCIAL STATEMENT SCHEDULE II\nThe provision for doubtful accounts included in administrative expense and the provision for sales discounts is deducted from sales. The related allowances are deducted from accounts receivable.\nEXHIBIT INDEX\nNumber\n(3)(a) Articles of Amendment dated April 27, 1977, including restated Articles of Incorporation (incorporated by reference to Exhibit 3(a) of Registrant's Annual Report on Form 10-K for the year ended December 31, 1993) as amended by Articles of Merger dated January 30, 1979 (incorporated by reference to Exhibit 3(a) of Registrant's Annual Report on Form 10-K for the year ended December 31, 1993); a Statement of Reduction of Authorized Shares dated May 12, 1980 (incorporated by reference to Exhibit 3(a) of Registrant's Annual Report on Form 10-K for the year ended December 31, 1993); a Statement of Reduction of Authorized Shares dated September 23, 1981 (incorporated by reference to Exhibit 3(a) of Registrant's Annual Report on Form 10-K for the year ended December 31, 1993); a Statement of Reduction of Authorized Shares dated August 2, 1982 (incorporated by reference to Exhibit 3(a) of Registrant's Annual Report on Form 10-K for the year ended December 31, 1993); a Statement of Reduction of Authorized Shares dated July 29, 1983 (incorporated by reference to Exhibit 3(a) of Registrant's Annual Report on Form 10-K for the year ended December 31, 1993); by Articles of Amendment dated April 25, 1984 (incorporated by reference to Exhibit 3(a) of Registrant's Annual Report on Form 10-K for the year ended December 31, 1994); a Statement of Reduction of Authorized Shares dated October 15, 1984 (incorporated by reference to Exhibit (3)(b) of Registrant's Form 10-K for the year ended December 31, 1984); a Statement of Reduction of Authorized Shares dated December 24, 1985 (incorporated by reference to Exhibit (3)(b) of Registrant's Form 10-K for the year ended December 31, 1985); by Articles of Amendment dated April 23, 1986 (incorporated by reference to Exhibit (3) of Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 1986); a Statement of Reduction of Authorized Shares dated July 11, 1986 (incorporated by reference to Exhibit (3)(b) of Registrant's Form 10-K for the year ended December 31, 1986); a Statement of Reduction of Authorized Shares dated March 25, 1988 (incorporated by reference to Exhibit (3)(b) of Registrant's Form 10-K for the year ended December 31, 1987); a Statement of Reduction of Authorized Shares dated November 9, 1988 (incorporated by reference to Exhibit (3)(b) of Registrant's Form 10-K for the year ended December 31, 1988); a Statement of Reduction of Authorized Shares dated April 24, 1989 (incorporated by reference to Exhibit 3(b) of Registrant's Form 10-K for the year ended December 31, 1989); Articles of Amendment dated November 29, 1990 (incorporated by reference to Exhibit 3(b) of Registrant's\nForm 10-K for the year ended December 31, 1990); Articles of Amendment dated June 26, 1991 (incorporated by reference to Exhibit 3(b) of Registrant's Form 10-K for the year ended December 31, 1991); Articles of Amendment dated August 7, 1992 (incorporated by reference to Exhibit 3(b) of Registrant's Form 10-K for the year ended December 31, 1992); Articles of Amendment dated July 30, 1993 (incorporated by reference to Exhibit 3(b) of Registrant's Form 10-K for the year ended December 31, 1993); and Articles of Amendment dated January 26, 1994 (incorporated by reference to Exhibit 3(b) of Registrant's Form 10-K for the year ended December 31, 1993).\n(3)(b) Articles of Incorporation, as amended through January 26, 1994 (restated for the purpose of filing on EDGAR) (incorporated by reference to Exhibit 3(c) of Registrant's Form 10-K for the year ended December 31, 1993).\n(3)(c) By-Laws as amended through June 28, 1995.\n(4)(a) Indenture between P. H. Glatfelter Company and Wachovia Bank of Georgia, N.A. as Trustee dated as of January 15, 1993 (incorporated by reference to Exhibit 4(a) of Registrant's Form 10-K for the year ended December 31, 1993).\n(4)(b) Form of Note issued to Purchasers of 5 7\/8% Notes due March 1, 1998 (incorporated by reference to Exhibit 4(b) of Registrant's Form 10-K for the year ended December 31, 1992).\n(9) P. H. Glatfelter Family Shareholders' Voting Trust dated July 1, 1993 (incorporated by reference to Exhibit 1 of the Schedule 13D filed by P. H. Glatfelter Family Shareholders' Voting Trust dated July 1, 1993).\n(10)(a) P. H. Glatfelter Company Management Incentive Plan, adopted as of January 1, 1994, as amended and restated effective March 16, 1995 (incorporated by reference to Exhibit (10)(a) of Registrant's Form 10-K for the year ended December 31, 1994).\n(10)(b) P. H. Glatfelter Company 1988 Restricted Common Stock Award Plan, as amended and restated June 24, 1992 (incorporated by reference to Exhibit (10)(c) of Registrant's Form 10-K for the year ended December 31, 1992).\n(10)(c) P. H. Glatfelter Company Supplemental Executive Retirement Plan, effective January 1, 1988, as amended and restated December 22, 1994 (incorporated by reference to Exhibit 10(c) of Registrant's Form 10-K for the year ended December 31, 1994).\n(10)(d) Deferral Benefit Pension Plan of Ecusta Division, effective May 22, 1986 (incorporated by reference to Exhibit (10)(ee) of Registrant's Form 10-K for the year ended December 31, 1987).\n(10)(e) Description of Executive Salary Continuation Plan (incorporated by reference to Exhibit (10)(g) of\nRegistrant's Form 10-K for the year ended December 31, 1990).\n(10)(f) P. H. Glatfelter Company Plan of Supplemental Retirement Benefits for the Management Committee, as amended and restated effective June 28, 1989 (incorporated by reference to Exhibit (10)(h) of Registrant's Form 10-K for the year ended December 31, 1989).\n(10)(g) P.H. Glatfelter Company 1992 Key Employee Long-Term Incentive Plan, effective April 22, 1992 (incorporated by reference to Exhibit (10)(i) of Registrant's Form 10-K for the year ended December 31, 1992).\n(11) Computation of Earnings Per Share\n(21) Subsidiaries of the Registrant\n(23) Consent of Independent Certified Public Auditors\n(27) Financial Data Schedule","section_15":""}
{"filename":"799721_1995.txt","cik":"799721","year":"1995","section_1":"ITEM 1. BUSINESS\nINTRODUCTION\nPXRE Corporation (\"PXRE\"), through its wholly-owned subsidiary PXRE Reinsurance Company (\"PXRE Reinsurance\"), provides treaty and facultative reinsurance to primary insurers and reinsurers (also known as ceding companies) on commercial and personal property risks, marine and aviation risks and certain casualty risks. Ceding companies purchase reinsurance principally to reduce their liability on individual risks, to protect themselves against catastrophic losses and to enhance their ratio of total net liabilities to capital and surplus. In consideration for providing reinsurance, PXRE receives a share of the premiums written by the ceding company. In certain instances, PXRE in turn purchases reinsurance protection from other reinsurers pursuant to retrocession agreements and surrenders to such reinsurers a portion of the premiums it receives from ceding companies. PXRE solicits its treaty and facultative reinsurance business from the worldwide brokerage market.\nPXRE also employs its property reinsurance underwriting expertise and generates management fee income by managing business for other insurers and reinsurers, either by retroceding some of its underwritten risks to participants through various retrocessional arrangements or, in one case, by managing the underwriting and other day-to-day operations of a publicly-owned reinsurance group. See \"Business--Management Agreement\" and \"--Retrocession Agreements\".\nPXRE was organized in July 1986 as a Delaware corporation by Phoenix Home Life Mutual Insurance Company (\"Phoenix Home Life\") to succeed, through PXRE Reinsurance, to the property and casualty reinsurance business carried on since 1982 by Phoenix General Insurance Company, formerly a wholly-owned subsidiary of Phoenix Home Life. As of March 20, 1996, Phoenix Home Life owned approximately 7.3% of the outstanding Common Stock of PXRE.\nThere are two principal types of reinsurance: facultative reinsurance and treaty reinsurance. In facultative reinsurance, the reinsurer separately underwrites each individual risk. In treaty reinsurance, the reinsurer and the ceding company negotiate a contractual arrangement which reinsures all or a portion of a specified type or category of risk. In the underwriting of treaty reinsurance, the reinsurer does not separately evaluate each individual\nrisk assumed, as it must in the underwriting of facultative reinsurance, and in general depends on the original underwriting decisions made by the ceding company.\nTreaty reinsurance can be written on either a pro rata or an excess of loss basis. In pro rata reinsurance, the reinsurer agrees, in return for a percentage of the premiums, to share in a proportional amount of the losses up to the limit, if any, of the reinsurance agreement. Premiums that the ceding company pays to the reinsurer are proportional to the premiums that the ceding company receives, and the reinsurer generally pays the ceding company a ceding commission to reimburse the ceding company for the expenses incurred in obtaining the business. In excess of loss treaty reinsurance, the reinsurer indemnifies the ceding company for a portion of the losses on underlying policies which exceed a specified loss retention amount up to an amount specified in the reinsurance agreement. Premiums paid by the ceding company for excess of loss coverage may not be directly proportional to the premiums on the underlying policies because the reinsurer does not assume a proportional share of the underlying risk.\nExcess of loss treaty reinsurance can, in turn, be written on a per risk or catastrophe basis. Per risk excess of loss reinsurance protects the ceding company against a loss resulting from a single risk or location. Catastrophe excess of loss reinsurance protects a ceding company from an accumulation of a large number of related losses resulting from a variety of risks which may occur in a given catastrophe, and hence is a highly volatile business.\nCORPORATE STRATEGY\nPXRE's strategy is to commit and withhold its underwriting capacity and to alter its mix of business at any given point in time to focus on business where management believes that above average underwriting results can be achieved, and to supplement its underwriting capacity and generate management fee income by managing business for other insurers and reinsurers.\nPXRE has been pursuing a strategy of focusing on catastrophe related coverages. Catastrophe related coverages include catastrophe coverage provided to ceding insurance companies and retrocessional catastrophe coverage provided to other reinsurers. This strategy has been designed to capitalize on the substantial improvements in pricing and other terms of these coverages which evolved following the high levels of catastrophic loss activity experienced by the worldwide reinsurance industry since 1987, but which have\nmoderated since the beginning of 1995. For 1995, catastrophe related coverages represented approximately 68% of PXRE's gross premiums written, as compared to 69% and 66% in 1994 and 1993, respectively.\nPXRE has also been diversifying its exposures and taking advantage of business opportunities in international reinsurance markets. For 1995, international reinsurance (principally the United Kingdom, Continental Europe, Australia and Asia) represented approximately 71% of gross written premiums, up from approximately 64% and 52% in 1994 and 1993, respectively. This business includes both reinsurance contracts protecting risks underwritten by United States ceding companies for the foreign operations of their United States insureds and reinsurance in which the reinsured is foreign-based. See Note 12 of Notes to Consolidated Financial Statements.\nPXRE's catastrophe retrocessional facilities and associated net exposures have fluctuated with PXRE's commitment and withholding of its underwriting capacity.\nBUSINESS WRITTEN\nSubstantially all of the reinsurance that PXRE currently writes is on property risks, both commercial and personal. (Although PXRE has written some casualty reinsurance in the past, it substantially reduced its writing of such reinsurance in 1986 and currently confines its casualty reinsurance activities to the marine and aviation business.) Catastrophe coverage by its nature protects both commercial and personal property risks since such coverage protects a ceding company from an accumulation of individual losses (commercial and personal) arising from a catastrophic event. The majority of PXRE's pro rata and risk excess business is written on commercial property risks.\nTreaty reinsurance represents the major portion of PXRE's reinsurance portfolio. PXRE typically participates in treaties with other reinsurers. PXRE occasionally will underwrite 100% of a treaty, but it usually underwrites a substantially smaller percentage. PXRE believes that underwriting treaty reinsurance on this basis potentially involves less risk in the long term than underwriting facultative reinsurance on the basis of an independent re-analysis of underwritten risks, due to the fact that the risks which generally are available for facultative reinsurance are usually more difficult to assess and often protect against more hazardous exposures than those available for treaty reinsurance. Emphasis on treaty reinsurance also\nallows PXRE to maintain a smaller staff than would be necessary to write the same volume of facultative reinsurance.\nPXRE's mix of business on a gross premiums written basis is set forth in the following table for the periods indicated:\nDISTRIBUTION OF GROSS PREMIUMS WRITTEN\nCatastrophe related coverages experienced substantial improvements in pricing and other terms following the high levels of catastrophic loss activity experienced by the international and domestic reinsurance markets since 1987. These improvements in the pricing of catastrophe related coverages have moderated since the beginning of 1995. In response, PXRE maintained the amount of its catastrophe related reinsurance at approximately 68% of gross premiums written for 1995 compared with approximately 69% and 66% in 1994 and 1993, respectively.\nIn late 1992, management decided to deemphasize pro rata and risk excess business because competition among reinsurers for such business and the levels of premium rates charged by primary insurers for property insurance had adversely impacted the profitability of such business. In addition, pro rata and risk excess business incurred substantial losses from Hurricane Andrew in 1992 reflecting the vulnerability of these lines of business to a major catastrophic event.\nPXRE has, in recent years, increased its writing of marine and aviation business. This business represented\napproximately 17% of PXRE's gross premiums written in 1995 and 1994, up from approximately 11% in 1993.\nFacultative reinsurance represented approximately 6% of PXRE's gross premiums written for 1995, up from 5% and 4% in 1994 and 1993, respectively.\nRETROCESSION AGREEMENTS\nThe following table sets forth certain information regarding the volume of premiums PXRE has ceded to other reinsurers pursuant to retrocession agreements for the periods indicated:\n- ---------------- (1) Consists of premiums written by PXRE and retroceded to Transnational Reinsurance Company as required by the management agreement to which such companies are parties. See \"Business--Management Agreement\".\nPXRE has been able to increase its underwriting commitments and to generate management fee income by retroceding some of its underwritten risks to other reinsurers through various retrocessional arrangements whereby it manages business for such participants. In 1995, PXRE was a party to two such arrangements. The first such arrangement, which is subject to renewal each January 1 and which has been renewed effective January 1, 1996, is referred to as the AMA. The AMA is a pool currently consisting of the following three reinsurance or insurance companies (the \"Pool\"), for which PXRE acts as reinsurance manager: Merrimack Mutual Fire Insurance Company, Pennsylvania Lumbermens Mutual Insurance Company and NRMA Insurance Limited. It is PXRE's policy that in order to join the Pool, companies must have a rating by A.M. Best Company, Inc. (\"A.M. Best\") of \"A-\" or better, other than foreign companies, most of which (including the foreign participant in the AMA) are not rated by A.M. Best, an independent insurance industry rating organization which rates insurance companies upon factors of concern to policyholders. Under the terms of the agreements governing the Pool, if a participating company's rating falls below \"A-\", it generally will be required to withdraw from the Pool in the following\nyear. Pursuant to the AMA arrangement, PXRE cedes 6% of its underwritten risks to the AMA, subject to a maximum liability per reinsurance program of approximately $600,000. PXRE receives, as reinsurance manager, a commission of 5% of premiums ceded as well as a contingent profit commission equal to a percentage of any ultimate underwriting profits in connection with the reinsurance ceded. The contingent profit commission is paid over a three year period and is subject to adjustment based on cumulative experience.\nThe second such retrocessional arrangement, which became effective on April 1, 1993, but for certain reinsurance ceded thereunder was retroactive to January 1, 1993, is with Trenwick America Reinsurance Corporation (\"Trenwick Group\"). This arrangement was renewed effective January 1, 1996. Pursuant to this arrangement, PXRE has undertaken to increase its commitments on its treaty reinsurance business and, in turn, Trenwick Group has undertaken to assume a 15% quota share of PXRE's new and renewal treaty business, subject to a maximum liability per reinsurance program of approximately $1,500,000. PXRE receives, as reinsurance manager, a management fee of 5% of premiums ceded as well as a contingent profit commission equal to a percentage of any ultimate underwriting profits in connection with the reinsurance ceded. The contingent profit commission is paid over a three-year period and is subject to adjustment based on cumulative experience. Trenwick Group is currently rated \"A+ (Superior)\" by A.M. Best.\nThe following table sets forth PXRE's earned commissions from retrocessionaires pursuant to its two managed business arrangements (not including Transnational) for the periods indicated:\n- ---------------- (1) Contingent profit commission is paid over a three year period and is subject to adjustment based on cumulative experience.\nEffective January 1, 1996, PXRE has entered into a retrocessional arrangement with Investors Reinsurance Ltd., a Barbados insurer (\"Investors Re\"), pursuant to which PXRE has agreed to offer to cede to Investors Re in each of the years 1996 through 2000 a quota share of PXRE's business. The quota share to be ceded to Investors Re in each such year will vary\nbased upon, among other things, the volume of business written by PXRE, subject to a minimum annual cession ($3 million in 1996). Pursuant to this arrangement, PXRE receives an override commission of 4.2% of premiums ceded as well as a profit commission equal to a percentage of the net profits in respect of the reinsurance ceded. Because Investors Re is not licensed in any jurisdiction in the United States, the retrocessional arrangement provides that a trust fund must be maintained and\/or letters of credit established by Investors Re for the benefit of PXRE to secure Investors Re's obligations.\nIn the past, PXRE has entered into other retrocessional arrangements providing catastrophic protection. In recent years, PXRE reduced, upon renewal, its own catastrophe retrocessional facilities and has borne the associated increase in net exposures. Although PXRE elected not to purchase any significant retrocessional coverage in 1995, recently the cost of catastrophe retrocessional facilities has declined, and PXRE has begun again selectively to purchase such coverages.\nPXRE has a committee consisting of its chief executive officer and senior underwriting executives responsible for the selection of reinsurers as managed business participants or as participating reinsurers in the catastrophe coverage protecting PXRE. Proposed reinsurers are evaluated at least annually based on consideration of a number of factors including the management, financial statements and the historical experience of the reinsurer. This procedure is followed whether or not a rating has been assigned to a proposed reinsurer by any rating organization. All reinsurers, whether obtained through direct contact or the use of reinsurance intermediaries, are subject to approval by PXRE.\nAt December 31, 1995, estimated losses recoverable (including incurred but not reported losses) from retrocessionaires (including Transnational Reinsurance Company) were $34,097,000 including $5,855,000 of paid loss recoverables. Since its inception, PXRE Reinsurance has had minimal amounts of uncollectible reinsurance. It may not be appropriate to extrapolate future experience from such historical experience. In the event that retrocessionaires are unable to meet their contractual obligations, PXRE Reinsurance would be liable for such defaulted amounts.\nMANAGEMENT AGREEMENT\nSince November 8, 1993, PXRE Reinsurance has been party to a management agreement (the \"Management Agreement\")\nwith Transnational Re Corporation (\"TREX\") and TREX's wholly-owned subsidiary, Transnational Reinsurance Company (\"Transnational\"). See \"Business--Other Operations\".\nUnder the Management Agreement, PXRE Reinsurance has responsibility for the day-to-day operations of TREX and Transnational, including all the reinsurance operations of Transnational. TREX and Transnational do not have any operating properties, systems or paid employees. Pursuant to the Management Agreement, PXRE Reinsurance provides all the operating facilities, systems, equipment and management and clerical employees required to conduct the businesses of TREX and Transnational.\nUnder the terms of the Management Agreement, Transnational shares in PXRE Reinsurance's \"new business\" (defined to mean reinsurance business from insurers and reinsurers which have not ceded reinsurance to PXRE Reinsurance during the twelve months preceding the date of the Management Agreement and, therefore, are not deemed current clients of PXRE Reinsurance) and \"additional business\" (defined to mean reinsurance for current clients of PXRE Reinsurance which does not replace existing coverage) classified as property retrocessional reinsurance business, marine and aviation retrocessional reinsurance or marine and aviation reinsurance and facultative excess of loss reinsurance. Transnational is entitled to share similarly in other property reinsurance business, if any, which PXRE Reinsurance may, from time to time, propose that Transnational underwrite and which Transnational's Board of Directors may approve.\nPXRE Reinsurance, with respect to the foregoing business, is required to endeavor to write for Transnational a line generally at least equal to PXRE Reinsurance's retained line (i.e., gross line net after pro rata cessions to third party companies under existing or substantially equivalent managed business retrocessional agreements), provided that the maximum amount written for Transnational may not exceed three times the amount retained by PXRE Reinsurance (i.e., 75% Transnational; 25% PXRE Reinsurance). In the event it is not practical or feasible to write reinsurance direct for Transnational, PXRE Reinsurance is required to use its best efforts to retrocede such amount of the line written by it so as to achieve the foregoing proportionate sharing formula, subject to the establishment of appropriate security in respect of Transnational's obligations thereunder. As a result, in 1995 PXRE wrote gross premiums written of $24,790,000 which were retroceded to Transnational.\n- 9 -\nWith respect to the renewal of policies written under the Management Agreement, Transnational is entitled to at least the same proportion of the combined lines of Transnational and PXRE Reinsurance as it had originally, subject to the foregoing limits.\nAlthough Transnational is not entitled to share in any business written by PXRE Reinsurance for current clients (as described above) or any renewals thereof, PXRE Reinsurance has agreed to endeavor to increase the amount of reinsurance written by it with respect to such current clients, which increase is considered \"additional business\" for the purposes of the Management Agreement, and is generally allocated first to Transnational to the extent required to obtain for Transnational a line at least equal to PXRE Reinsurance's net line.\nTransnational pays PXRE Reinsurance an annual basic management fee under the Management Agreement equal to 5% of gross premiums written (including reinstatement premiums less return premiums) of Transnational and its consolidated subsidiaries (if any) as reflected in Transnational's statutory quarterly and annual statements filed with state insurance authorities. In addition, PXRE Reinsurance is entitled to receive from TREX a contingent fee equal to 20% of \"net income\" (as defined) in excess of a 20% \"return on equity\" (as defined) of TREX for each year, or part thereof, that the Management Agreement remains effective (the first such year having commenced on January 1, 1994). TREX and Transnational also pay all expenses directly attributable to them, including a proportionate share of PXRE Reinsurance's rental expenses with respect to office space based on gross premiums written for the management year.\nThe Management Agreement has an initial term ending December 31, 1998 and is scheduled to renew automatically for successive three year terms unless either PXRE Reinsurance gives or TREX and Transnational give at least one year's advance written notice of non-renewal. The Management Agreement may be terminated by TREX and Transnational if Transnational's gross written premiums for a calendar year fall below specified levels. The Management Agreement may also be terminated upon events constituting a \"change of control\" (as defined in the Management Agreement) of TREX, Transnational or PXRE, material breaches of the Management Agreement by any party or if any party is subject to insolvency or similar proceedings. If the Management Agreement is terminated for any reason, PXRE Reinsurance is required, except in specified circumstances, to continue to provide reinsurance underwriting and\/or the other services and facilities contemplated by the Management Agreement, if\n- 10 -\nrequested by TREX and Transnational, for up to twelve months, to enable TREX and Transnational to locate facilities, equipment, personnel and management to continue their operations.\nPursuant to the Management Agreement, PXRE Reinsurance's liability to TREX and Transnational in respect thereof is limited to PXRE Reinsurance's willful misconduct or gross negligence, and TREX and Transnational have undertaken to hold PXRE Reinsurance and certain other specified persons and entities (collectively, \"PXRE Indemnitees\") harmless from any loss, claim, damage, liability or expense (collectively, \"losses\") resulting to such PXRE Indemnitees, based upon or related to the conduct by PXRE Reinsurance of TREX's and Transnational's business, except for losses caused by PXRE Reinsurance's willful misconduct or gross negligence in respect of which PXRE Reinsurance has agreed to indemnify TREX and Transnational. The Management Agreement provides that in no event, however, will PXRE Reinsurance be responsible for losses in respect of retrocessional and other reinsurance written by Transnational after the Offering. Nonetheless, business which is written on Transnational's behalf by PXRE Reinsurance and ceded to Transnational remains the primary liability of PXRE Reinsurance in the event that Transnational is unable to meet its contractual responsibilities.\nThe following table sets forth PXRE's earned management fees from Transnational (basic management fee) and TREX (contingent management fee) pursuant to the Management Agreement for the periods indicated:\n- ---------------- (1) The Management Agreement became effective on November 8, 1993.\n(2) The first management year for which a contingent management fee could become due was 1994.\n- 11 -\nLOSS LIABILITIES AND CLAIMS\nPXRE establishes losses and loss expense liabilities (to cover expenses related to settling claims, including legal and other fees) to provide for the ultimate cost of settlement and administration of claims for losses, including claims that have been reported to it by its reinsureds and claims for losses that have occurred but have not yet been reported to PXRE. Under United States generally accepted accounting principles (\"GAAP\"), PXRE is not permitted to establish loss reserves until an event which may give rise to a claim occurs.\nFor reported losses, PXRE first establishes liabilities when it receives notice of the claim. It is PXRE's general policy to establish liabilities for reported losses in an amount equal to the liability set by the reinsured. In certain instances, PXRE will conduct an investigation to determine if the amount established by the reinsured is appropriate or if it should be adjusted.\nFor incurred but not reported losses, a variety of methods have been developed in the insurance industry for use in determining such liabilities. In general, these methods involve the extrapolation of reported loss data to estimate ultimate losses. PXRE's loss calculation methods generally rely upon a projection of ultimate losses based upon the historical patterns of reported loss development. Additionally, PXRE makes provision through its liabilities for incurred but not reported losses for any identified deficiencies in the liabilities for reported losses set by its reinsureds.\n- 12 -\nThe following table provides a reconciliation of beginning and ending loss and loss expense liabilities under GAAP for the fiscal years ended December 31, 1995, 1994 and 1993. PXRE does not discount such liabilities; that is, it does not calculate them on a present value basis.\n- --------------- (1) The GAAP provision for losses and loss expenses includes net foreign currency exchange gains (losses) of $39,000, ($338,000) and ($205,000) for 1995, 1994 and 1993, respectively.\n(2) Effective January 1, 1993, PXRE adopted the Financial Accounting Standards Board's (\"FASB\") SFAS No. 113.\nThe following table presents the development of PXRE's GAAP balance sheet liability for losses and loss expenses for the period 1985 through 1995 for PXRE and its predecessor. The top line of the table shows the liabilities at the balance sheet date for each of the indicated years. This reflects the estimated amounts of losses and loss expenses for claims arising in that year and all prior years that are unpaid at the balance sheet date, including losses incurred but not yet reported to PXRE. The upper portion of the table shows the cumulative amounts subsequently paid as of successive years with respect to the liability. The lower portion of the table shows the reestimated amount of previously recorded liability 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 for individual years. A redundancy (deficiency) exists\n- 13 -\nwhen the reestimated liability at each December 31 is less (greater) than the prior liability estimate. The \"cumulative redundancy (deficiency)\" depicted in the table, for any particular calendar year, represents the aggregate change in the initial estimates over all subsequent calendar years.\nEach amount in the table below includes the effects of all changes in amounts for prior periods. For example, if a loss determined in 1988 to be $150,000 was first reserved in 1985 at $100,000, the $50,000 deficiency (actual loss minus original estimate) would be included in the cumulative redundancy (deficiency) in each of the years 1985-1987 shown below. This table does not present accident or policy year development data.\nLoss and loss expense liabilities for December 31, 1995, 1994, 1993, 1992 and 1991 are presented on a gross basis (excluding the effects of losses recoverable from retrocessionaires). Loss and loss expense liabilities for December 31, 1990 and prior periods are stated on a net basis (after deduction for losses recoverable from retrocessionaires) because gross incurred but not reported liability data were not developed by PXRE at any date prior to December 31, 1991 as it was not required for statutory reporting purposes. Furthermore, it is not practicable for PXRE currently to reconstruct this information.\n- 14 -\n- 15 -\nDuring 1995, PXRE incurred development from prior year losses amounting to $4,311,000 primarily as a result of Northridge earthquake activity. During 1994, PXRE incurred development from prior year losses amounting to $3,261,000 primarily as a result of marine pro rata losses and 1993 Midwest flood activity. During 1993, PXRE's management strengthened the liability for incurred but not reported losses occurring in prior years by $10,499,000, of which approximately $5,394,000 was the result of additional information received with respect to Hurricanes Andrew and Iniki and approximately $3,330,000 was the result of losses under a number of pro rata reinsurance treaties. During 1992, PXRE's management strengthened the liability for incurred but not reported losses occurring in prior years by $2,355,000 of which $2,036,000 was the result of additional information received with respect to losses under a number of pro rata reinsurance treaties. In 1991, PXRE's management strengthened the liability for losses and loss expenses occurring in prior years by $2,242,000, of which $1,196,000 was due to unfavorable development experienced on PXRE's marine and aviation reinsurance business. PXRE commenced writing marine and aviation reinsurance in 1988 and estimated the amounts of losses and loss expenses for claims on such business during 1988 and subsequent periods based on cumulative experience as of such time. As more information became available, prior estimates were revised. Approximately $740,000 of the balance of the liability strengthening in 1991 was attributable to changes in 1991 in the loss amounts applicable to catastrophes which occurred in 1989 and 1990, years impacted by high levels of catastrophe loss activity. Management of PXRE believes that the strengthening of reserves in fiscal years 1995, 1994, 1993, 1992 and 1991 is attributable to the factors described above and not to any material changes in reserving methods or assumptions. Management of PXRE further believes that the volatility in cumulative reserve redundancies (deficiencies) through 1988 demonstrated by the above table was attributable principally to the following: the lack of sufficient company-specific historical data in the early years of PXRE's operations (i.e., through 1985), significant changes in primary insurance rates commencing in 1985, and a favorable change in loss activity during the period 1986 through 1988.\nPXRE's management believes that its overall liability for losses and loss expenses at December 31, 1995, is adequate. In contrast to casualty losses, which frequently are slow to be reported and may be determined only through the lengthy, unpredictable process of litigation, property losses tend to be reported more promptly and usually are settled within a shorter time period. However, the estimation of losses for catastrophe reinsurers is inherently less reliable\nthan for reinsurers of risks which have an established historical pattern of losses. In addition, insured events which occur near the end of a reporting period, as well as, with respect to PXRE's retrocessional book of business, the significant delay in losses being reported to insurance carriers, reinsurers and finally retrocessionaires, require PXRE to make estimates of losses based on limited information from ceding companies and based on its own underwriting data. Because of the inherent uncertainty in the reserving process, as well as PXRE's writings of a small amount of casualty reinsurance, there is a risk that PXRE's liability for losses and loss expenses could prove to be inadequate in any year, with a consequent adverse impact on future earnings and stockholders' equity. Moreover, such risk could be exacerbated to the extent management of PXRE forgoes catastrophe retrocessional coverage. Also, conditions and trends that have affected reserve development in the past may not necessarily occur in the future. Accordingly, it would not be appropriate to extrapolate future redundancies or deficiencies based on the foregoing.\nINVESTMENTS\nPXRE's management has established general procedures and guidelines for its investment portfolio and oversees investment management carried out by Phoenix Duff & Phelps Corporation (\"Phoenix Duff & Phelps\"), a public majority-owned subsidiary of Phoenix Home Life. Although these investment guidelines stress conservation of principal, diversification of risk, and liquidity, investments are subject to market-wide risks and fluctuations, as well as to risk inherent in particular securities. As at December 31, 1995, PXRE's investment portfolio consisted primarily of fixed maturities and short-term investments. In 1994, PXRE's Board of Directors approved a resolution allowing PXRE to invest up to 15% of its consolidated net worth in equities. During 1995, PXRE invested $5,000,000 in equity securities. The investment policies and all investments of PXRE Reinsurance are approved by its Board of Directors.\nThe following table summarizes the investments of PXRE (at amortized cost) at December 31, 1995 and 1994:\n- 17 -\nANALYSIS OF INVESTMENTS\nIn 1995, PXRE sold its holdings of municipal bonds and reinvested the proceeds principally in Treasury securities.\nThe following table indicates the composition of PXRE's fixed maturity investments (at amortized cost), including short-term investments, by time to maturity at December 31, 1995 and 1994:\nCOMPOSITION OF INVESTMENTS BY MATURITY\n- ---------- (1) Based on stated maturity dates with no prepayment assumptions.\n- 18 -\nThe average market yield to maturity of PXRE's fixed maturities portfolio at December 31, 1995 and December 31, 1994 was 5.3% and 5.8%, respectively. At December 31, 1995, the fair value of PXRE's fixed maturities portfolio exceeded its amortized cost by $5,009,000. At December 31, 1994, the amortized cost of PXRE's fixed maturities portfolio exceeded its fair value by $7,878,000.\nThe following table indicates the composition of PXRE's fixed maturities portfolio (at amortized cost), excluding short-term investments, by rating at December 31, 1995 and 1994:\nCOMPOSITION OF FIXED MATURITIES PORTFOLIO BY RATING\n- ---------------- (1) Ratings as assigned by Moody's Investors Service, Inc. (\"Moody's\") and Standard & Poor's Corporation (\"S&P\"), respectively. Such ratings are generally assigned upon the issuance of the securities, subject to revision on the basis of ongoing evaluations.\nMARKETING\nIn the United States, PXRE currently reinsures both national and regional insurance and reinsurance companies headquartered mainly in the Northeast and Midwest. PXRE also provides reinsurance for international insurance and reinsurance companies principally headquartered in the United Kingdom, Continental Europe, Australia, and Asia.\nPXRE obtains most of its facultative business and substantially all of its treaty business through reinsurance intermediaries who represent reinsureds in negotiations for the purchase of reinsurance. None of the reinsurance intermediaries through which PXRE obtains business are authorized to arrange any business in the name of PXRE without\n- 19 -\nPXRE's approval. PXRE pays such intermediaries or brokers commissions based on the amount of premiums and type of business ceded. These payments constitute part of PXRE's total acquisition costs and are included in its underwriting expenses. PXRE generally pays a reinsurance brokerage fee of 10% on excess of loss business and between 1% and 2% on pro rata business, which rates are believed to be comparable to industry norms.\nApproximately 21.5% of gross premiums written in fiscal year 1995 were arranged through the worldwide branch offices of Guy Carpenter & Company, Inc., a subsidiary of Marsh & McLennan Companies, Inc. Approximately 12% of gross premiums written in fiscal year 1995 were arranged through Alexander Howden Reinsurance Brokers Ltd. The commissions paid by PXRE to these intermediaries are generally at the same rates as those paid to other intermediaries.\nCOMPETITION\nThe reinsurance industry is highly competitive and is undergoing a variety of challenging developments. The industry has in recent years moved toward greater consolidation as ceding companies have placed increased importance on size and financial strength in the selection of reinsurers. Additionally, reinsurers are tapping new markets and complementing their range of traditional reinsurance products with innovative new products which bring together capital markets and reinsurance experience. PXRE competes with numerous major international and domestic reinsurance and insurance companies. These competitors, many of which have substantially greater financial, marketing, and management resources than PXRE, include independent reinsurance companies, subsidiaries, or affiliates of established worldwide insurance companies, reinsurance departments of certain commercial insurance companies, and underwriting syndicates. PXRE also may face competition from new market entrants or from market participants that determine to devote greater amounts of capital to the types of business written by PXRE.\nAlthough PXRE obtains most of its facultative business and substantially all of its treaty business through reinsurance intermediaries or brokers, it competes indirectly with reinsurers who obtain business directly from primary insurers because PXRE's brokers must compete with direct reinsurers for business to be forwarded to PXRE. PXRE therefore competes both with reinsurers that obtain business directly from reinsureds and with reinsurers that obtain their business through intermediaries and brokers.\n- 20 -\nCompetition in the types of reinsurance business which PXRE underwrites is based on many factors, including the perceived overall financial strength of the reinsurers, premiums charged, other terms and conditions, A.M. Best rating, service offered, speed of service (including claims payment), and perceived technical ability and experience of staff. The number of jurisdictions in which a reinsurer is licensed or authorized to do business is also a factor. PXRE Reinsurance is licensed, accredited, or otherwise authorized or permitted to conduct reinsurance business in all states (except Arkansas, Hawaii, Kansas, Oklahoma, Vermont, and Washington) and the District of Columbia and Puerto Rico.\nIn the second quarter of 1995, A.M. Best affirmed PXRE Reinsurance's rating of \"A (Excellent)\". Management believes that this rating enhances the competitive position of PXRE Reinsurance. A.M. Best is an independent insurance rating organization whose ratings are based on an analysis of the financial condition and operating performance of an insurance or reinsurance company as they relate to the industry in general. These ratings represent an independent opinion of a company's financial strength and ability to meet its obligations to policyholders, although such ratings may not reflect the considerations applicable to an investment in an insurance or reinsurance company. A.M. Best reviews its ratings at least annually and there can be no assurance that this rating will be maintained in the future.\nOTHER OPERATIONS\nIn 1993, PXRE's management began exploring alternative business strategies to capitalize on perceived opportunities in the property retrocessional reinsurance markets, including the possibility of creating a property retrocessional reinsurance specialist company. Management believed that the additional capital needed for this purpose could be obtained by PXRE Reinsurance's subsidiary, Transnational, from third party investors. In this regard, PXRE incorporated TREX as a wholly-owned subsidiary in August 1993 and in November 1993, in connection with an initial public offering effected that month by TREX, caused PXRE Reinsurance to contribute all of the outstanding capital stock of Transnational to TREX. Upon completion of the TREX initial public offering, PXRE Reinsurance owned shares constituting approximately 21% of TREX's total issued and outstanding common stock and entitling PXRE Reinsurance to designate two of TREX's five directors. In addition, in connection with the TREX initial public offering, PXRE Reinsurance became party to the Management Agreement, whereby PXRE Reinsurance undertook, for a fee, to manage the businesses of TREX and Transnational, including the\n- 21 -\nreinsurance operations of Transnational. See \"Business-- Management Agreement\". Pursuant to the Management Agreement, Transnational now specializes principally in providing brokered property retrocessional reinsurance and marine and aviation retrocessional reinsurance in the United States and international markets. Prior to November 1993, Transnational, which was organized by PXRE in 1989 as a primary insurance unit, specialized in insuring property risks in the excess and surplus lines market but wrote only a nominal amount of business due to management's unfavorable evaluation of conditions in the excess and surplus lines market.\nIn March 1995, PXRE and TREX entered into a joint venture arrangement to trade in catastrophe futures and option contracts on the Chicago Board of Trade (the \"CBOT\"). PXRE and TREX have each committed $2.5 million to this venture. Although the joint venture has developed a number of trading strategies, the low level of activity in the CBOT market for catastrophe futures has kept trade volume to a minimum through December 31, 1995.\nIn 1995, PXRE established a wholly-owned London based subsidiary, PXRE Ltd., and is currently exploring ways to participate in the London marketplace.\nREGULATION\nPXRE and PXRE Reinsurance are subject to regulation under the insurance statutes of various states, including Connecticut, the domiciliary state of PXRE Reinsurance. The regulation and supervision to which PXRE Reinsurance is subject relate primarily to the standards of solvency that must be met and maintained, licensing requirements for reinsurers, the nature of and limitations on investments, restrictions on the size of risks which may be insured, deposits of securities for the benefit of a reinsured, methods of accounting, periodic examinations of the financial condition and affairs of reinsurers, the form and content of reports of financial condition required to be filed, and reserves for losses, and other purposes. In general, such regulation is for the protection of the reinsureds and, ultimately, their policyholders, rather than investors.\nIn addition, PXRE and PXRE Reinsurance are subject to regulation by state insurance authorities under the insurance statutes and insurance holding company statutes of various states, including Connecticut. These laws and regulations vary from state to state, but generally require an insurance holding company and insurers and reinsurers that are subsidiaries of an insurance holding company to register with\n- 22 -\nthe state regulatory authorities and to file with those authorities certain reports including information concerning their capital structure, ownership, financial condition, and general business operations. Moreover, PXRE Reinsurance may not enter into certain transactions, including certain reinsurance agreements, management agreements, and service contracts, with members of its insurance holding company system, unless PXRE Reinsurance has first notified the Connecticut Insurance Commissioner of its intention to enter into any such transaction and the Connecticut Insurance Commissioner has not disapproved of such transaction within the period specified by the Connecticut insurance statute. Among other things, such transactions are subject to the requirements that their terms be fair and reasonable, charges or fees for services performed be reasonable and the interests of policyholders not be adversely affected.\nState laws also require prior notice or regulatory agency approval of direct or indirect changes in control of an insurer, reinsurer, or its holding company, and of certain significant intercorporate transfers of assets within the holding company structure. An investor who acquires shares representing or convertible into more than 10% of the voting power of the securities of PXRE would become subject to at least some of such regulations, would be subject to approval by the Connecticut Insurance Commissioner prior to acquiring such shares, and would be required to file certain notices and reports with the Commissioner prior to such acquisition.\nThe principal sources of cash for the payment of operating expenses, debt service obligations, and dividends by PXRE are the receipt of dividends and net tax allocation payments from PXRE Reinsurance. Under the Connecticut insurance laws, the maximum amount of dividends or other distributions that PXRE Reinsurance may declare or pay to PXRE within any twelve-month period, without regulatory approval, is limited to the lesser of (a) earned surplus or (b) the greater of 10% of policyholder surplus at December 31 of the preceding year, or 100% of net income for the twelve month period ended December 31 of the preceding year, all determined in accordance with statutory accounting principles (\"SAP\"). Accordingly, the Connecticut insurance laws could limit the amount of dividends available for distribution by PXRE Reinsurance without prior regulatory approval, depending upon a variety of factors outside the control of PXRE, including the frequency and severity of catastrophe and other loss events and changes in the reinsurance market, in the insurance regulatory environment and in general economic conditions. As of December 31, 1995, PXRE Reinsurance had earned surplus of approximately $81,382,000, as defined, and policyholder surplus of $250,231,000 and its net income for\n- 23 -\n1995 was $37,996,000. The maximum amount of dividends or distributions that PXRE Reinsurance may declare and pay in 1996, without regulatory approval, is therefore $37,996,000. During 1995, $6,000,000 in dividends was approved and paid by PXRE Reinsurance to PXRE. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources.\"\nAdditionally, Connecticut adopted, effective September 28, 1994, regulations respecting certain minimum capital requirements, for property and casualty companies, based upon a model adopted by the National Association of Insurance Commissioners (the \"NAIC\"). The risk-based capital regulations provide for the use of a formula to measure statutory capital and surplus needs based on the risk characteristics of a company's products and investment portfolio to identify weakly capitalized companies. As at December 31, 1995, PXRE Reinsurance's surplus substantially exceeded its calculated risk-based capital.\nIn addition, from time to time various regulatory and legislative changes have been proposed in the insurance industry, some of which could have an effect on reinsurers. Among the proposals that have in the past been or are at present being considered are the possible introduction of federal regulation in addition to, or in lieu of, the current system of state regulation of insurers, the initiative to create a federally guaranteed disaster reinsurance pool prefunded by insurers, and proposals in various state legislatures (some of which proposals have been enacted) to conform portions of their insurance laws and regulations to various model acts adopted by the NAIC. The NAIC is an organization which assists state insurance supervisory officials in achieving insurance regulatory objectives, including the maintenance and improvement of state regulation. PXRE is unable to predict what effect, if any, the foregoing developments may have on its operations and financial condition in the future.\nThe NAIC's Insurance Regulatory Information System (\"IRIS\") was developed by a committee of state insurance regulators and is primarily intended to assist state insurance departments in executing their statutory mandates to oversee the financial condition of insurance companies operating in their respective states. IRIS identifies eleven industry ratios and specifies \"usual values\" for each ratio. Departure from the usual values on four or more of the ratios can lead to inquiries from individual state insurance commissioners as to certain aspects of an insurer's business. For the years ended December 31, 1995, 1994 and 1993, PXRE Reinsurance's results were within the usual values for each of the\n- 24 -\n11 ratios, except for one ratio in 1994 and three ratios in 1993. PXRE's management believes these ratios fell outside the usual range due largely to PXRE Reinsurance's expansion of net premiums written resulting from rate increases on new and renewal catastrophe related business and financing transactions which generated capital to support these writings.\nEMPLOYEES\nPXRE employs 49 full-time employees. None of PXRE's employees is represented by a labor union, and management considers its relationship with its employees to be excellent.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nPXRE leases a total of approximately 25,500 square feet of office space in Edison, New Jersey and Brussels, Belgium. The Edison, New Jersey lease, which covers approximately 24,000 square feet of office space, was signed in 1994 and is for a term of 15 years at a fixed annual rent of approximately $370,000 (inclusive of basic electricity) and additional rents on account of PXRE's proportionate share of increases in building operating expenses and property taxes over calendar year 1994. PXRE's lease of 21,000 square feet of office space in New York, New York expires in July 1996. PXRE plans to utilize this space until such expiration date.\nITEM 3.","section_3":"ITEM 3. PENDING LEGAL PROCEEDINGS\nPXRE 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 matters were submitted to a vote of security holders during the fourth quarter of PXRE's 1995 fiscal year.\n- 25 -\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nPXRE's Common Stock trades on The NASDAQ Stock Market under the symbol \"PXRE\". The following table sets forth for the periods indicated the high and low bid quotations for PXRE's Common Stock as reported by NASDAQ and cash dividends per share of Common Stock declared and subsequently paid:\nThese prices represent quotations by dealers and do not include markups, markdowns, or commissions, and do not necessarily represent actual transactions. As of March 20, 1996, there were 8,751,616 shares of the Common Stock issued and outstanding, which shares were held by approximately 135 shareholders of record and, based on PXRE's best information, in excess of 1,500 beneficial owners of the Common Stock. See Notes 10 and 11 of Notes to Consolidated Financial Statements for information with respect to shares reserved for issuance under employee benefit and stock option plans.\nBeginning in the fourth quarter of 1989, PXRE has each quarter declared and subsequently paid cash dividends on its Common Stock. The dividend rate, which initially was $0.05 per share, was increased in the fourth quarter of 1993 to $0.075 per share, in the fourth quarter of 1994 to $0.15 per share and in the fourth quarter of 1995 to $0.18 per share.\n- 26 -\nThe payment of dividends on the Common Stock is subject to the discretion of the Board of Directors which will consider, among other factors, PXRE's operating results, overall financial condition, capital requirements and general business conditions. There can be no assurance that dividends will be paid in the future.\nAs a holding company, PXRE is largely dependent upon dividends and net tax allocation payments from PXRE Reinsurance to pay dividends to PXRE's shareholders. PXRE Reinsurance is subject to state laws that restrict its ability to distribute dividends. In addition, certain covenants in the indenture governing PXRE's Senior Notes may restrict PXRE's ability to pay dividends. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources\" and \"Business--Regulation\" for further information concerning restrictions contained in the indenture governing PXRE's Senior Notes and under state insurance law.\n- 27 -\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\n- 28 -\n- -------------------- (1) Effective January 1, 1993, PXRE adopted the FASB's SFAS No. 113, \"Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts\". As a result of such adoption, PXRE effected a December 31, 1992 and 1991 balance sheet reclassification to assets of $53,314,969 and $25,369,685 of reinsurance recoverables on losses and loss expense liabilities and $5,529,292 and $3,395,276 of ceded unearned premiums in 1992 and 1991, respectively, both of which were previously deducted from liabilities. The adoption of SFAS No. 113 had no effect on PXRE's net income for the years ended December 31, 1993 or 1992.\n- 29 -\n(2) During the first quarter of 1993, PXRE completed an offering of 2,300,000 shares of common stock. The net proceeds of $46,942,000 (except for $5,000,000 which was retained by PXRE for general corporate purposes) were contributed to PXRE Reinsurance's surplus. During the third quarter of 1993, PXRE completed an offering of $75,000,000 principal amount of 9.75% Senior Notes due 2003. The net proceeds of $72,150,000 (except for approximately $3,938,000 which was used by PXRE to repay all amounts outstanding under and retire a term loan facility and $15,000,000 which was retained by PXRE to provide support for debt service on the Senior Notes) were contributed to PXRE Reinsurance's surplus.\n(3) The FASB's Emerging Issues Task Force (\"EITF\") reached a consensus on July 22, 1993 regarding Issue No. 93-6, \"Accounting for Multiple-Year Retrospectively-Rated Contracts by Ceding and Assuming Enterprises\". The EITF consensus requires that affected companies should accrue the lesser of termination penalties or the effect of prospective adjustments in rates or coverages triggered by the loss event in the period that a loss is recorded. The EITF mandate required adoption of this consensus no later than the third quarter of 1993. As described in Note 2 to PXRE's Consolidated Financial Statements for the year ended December 31, 1993, PXRE had certain retrocessional catastrophe coverage for its principal types of business. Certain of these contracts provided for terms of three or more years and had contractual adjustments regarding rates and\/or coverages when losses are recovered under these contracts. Although PXRE was provided with the opportunity to cancel some of these contracts without penalty, PXRE chose to continue the contracts to obtain the coverage provided thereunder. Accordingly, PXRE believed that the appropriate application of the EITF's consensus was to record in the third quarter of 1992 incremental premiums that resulted from Hurricane Andrew loss recoveries under these contracts. This change increased 1992 third quarter ceded earned premiums by $5,772,000, deferred income tax benefit by $1,962,000, net loss by $3,810,000 and loss per common share by $0.99. These adjustments were determined on the basis of losses estimated by PXRE at December 31, 1992. The financial statements for years prior to 1992 are not affected. Also, due to additional information received during the first six months of 1993 with respect to Hurricane Andrew losses, PXRE reported, in the second quarter of 1993, an additional $2,500,000 of ceded premium expenses through the application of the EITF consensus. The statutory capital and surplus of PXRE Reinsurance has not been adjusted.\n(4) Until the fourth quarter of 1993, Transnational Reinsurance was a wholly-owned subsidiary of PXRE Reinsurance. On November 1, 1993, a registration statement relating to an initial public offering (the \"Offering\") by TREX of 5,750,000 shares of Class A common stock at $20.00 per share was declared effective. In conjunction with the formation of TREX and registration of TREX's Class A common stock in the Offering, all of the outstanding capital stock of Transnational Reinsurance was contributed by PXRE Reinsurance to TREX in exchange for the issuance of 1,535,848 shares of TREX's Class B common stock which caused PXRE Reinsurance's holdings of TREX's Class B common stock (when combined with the 100 shares of Class B common stock contributed to PXRE Reinsurance by PXRE in connection with the closing of the Offering) to constitute approximately 21% of all of the outstanding common stock of TREX immediately after the Offering. TREX, through Transnational Reinsurance, now specializes principally in providing brokered property retrocessional reinsurance and marine and aviation retrocessional reinsurance in the United States and international markets pursuant to a Management Agreement with PXRE Reinsurance. As a result of this transaction, PXRE recorded a gain on sale in the fourth quarter of 1993 amounting to $10,564,000 on a pre-tax basis, representing the difference between PXRE Reinsurance's interest in the net assets of Transnational Reinsurance immediately after the Offering and the historical book value of its investment in Transnational Reinsurance. Subsequent to the Offering, PXRE accounts for its investment in TREX on the equity method.\n(5) The historical ratios of earnings to fixed charges were determined by dividing consolidated earnings by total fixed charges. For purposes of these computations (i) earnings consist of consolidated income before considering income taxes, fixed charges and minority interest and (ii) fixed charges consist of interest on indebtedness and that portion of rentals which is deemed by PXRE's management to be an appropriate interest factor. Earnings were inadequate to cover fixed charges by $7,615,000 for the year ended December 31, 1992. The historical ratios of earnings to combined fixed charges and preferred dividends were determined by dividing consolidated earnings by total fixed charges and preferred dividends. Earnings were inadequate to cover fixed charges and preferred dividends by $9,034,000 for the year ended December 31, 1992.\n(6) The loss, underwriting expense and combined ratios included under \"Other Operating Data\" have been derived from the audited consolidated statements of income of PXRE prepared in accordance with GAAP.\n(7) During 1995, all of the outstanding shares of Series A Preferred Stock were converted into shares of PXRE's Common Stock. To date, these convertible preferred shares were the principal reason for the difference between primary and fully diluted earnings per share.\n- 30 -\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nGENERAL\nPXRE provides reinsurance products and services to a domestic and international marketplace, with principal emphasis on commercial and personal property risks and marine and aviation risks, and with a particular focus on catastrophe related coverages.\nPXRE exercises discipline in committing and withholding its underwriting capacity and altering its mix of business to concentrate its underwriting capacity at any given point in time on those types of businesses where management believes that above average underwriting results can be achieved. PXRE has been pursuing a strategy of focusing on catastrophe related coverages in both the international and domestic markets. This strategy has been designed to capitalize on the substantial improvements in pricing and other terms of these coverages which evolved following the high levels of catastrophic loss activity, in terms of both frequency and severity of loss, experienced by the worldwide reinsurance industry since 1987, but which have moderated since the beginning of 1995. In the fourth quarter of 1992, PXRE decided to reduce significantly its writing of traditional pro rata and risk excess reinsurance business due to management's unfavorable evaluation of the condition of such business. Since that time, PXRE has also increased its writing of marine and aviation business.\nPXRE also generates management fee income by managing business for other insurers and reinsurers, either by accepting additional amounts of coverage on underwritten risks and retroceding such additional amounts to participants through various retrocessional arrangements or, in one case, by managing the underwriting and other day-to-day operations of a publicly-owned reinsurance group.\nAt December 31, 1995, PXRE was a party to two such retrocessional arrangements, one with a group of insurers and reinsurers referred to as the AMA, and one with Trenwick Group. Under these arrangements, both of which were renewed effective January 1, 1996, PXRE cedes some of its underwritten risks to the participants, subject to maximum aggregate liabilities per reinsurance program (approximately $600,000 in the case of the AMA and approximately $1,500,000 in the case of Trenwick Group). PXRE receives a management fee or commission of 5% of premiums ceded and a percentage of any ultimate underwriting profits in connection with the reinsurance ceded. Such percentage of ultimate underwriting\n- 31 -\nprofits is in each case paid over a three-year period and is subject to adjustment based on cumulative experience. Future management fee income is dependent upon the amount of business ceded to the participants and the profitability of that business.\nIn the past, PXRE has entered into other retrocessional arrangements providing catastrophic protection. In recent years, PXRE reduced, upon renewal, its own catastrophe retrocessional facilities and has borne the associated increase in net exposures. Although PXRE elected not to purchase any significant retrocessional coverage in 1995, as the cost of catastrophe retrocessional facilities declined, PXRE has begun again selectively to purchase such coverages.\nSince November 8, 1993, PXRE has been party to the Management Agreement under which PXRE has responsibility for the day-to-day operations of TREX and its subsidiary Transnational, including all the reinsurance operations of Transnational. TREX and Transnational do not have any operating properties, systems or paid employees. Pursuant to the Management Agreement, PXRE provides all the operating facilities, systems, equipment and management and clerical employees required to conduct the businesses of TREX and Transnational.\nUnder the terms of the Management Agreement, Transnational shares in certain specified business of PXRE that is classified as property retrocessional reinsurance business, marine and aviation retrocessional reinsurance or marine and aviation reinsurance and facultative reinsurance. Transnational is also entitled to share similarly in other property reinsurance business, if any, which PXRE may, from time-to-time, propose that Transnational underwrite and which Transnational's Board of Directors may approve.\nTransnational pays PXRE an annual basic management fee under the Management Agreement equal to 5% of gross premiums written (including reinstatement premiums less return premiums) of Transnational and its consolidated subsidiaries (if any) as reflected in Transnational's statutory quarterly and annual statements filed with state insurance authorities. In addition, PXRE is entitled to receive from TREX a contingent fee equal to 20% of \"net income\" (as defined) in excess of a 20% \"return on equity\" (as defined) of TREX for each year, or part thereof, that the Management Agreement remains effective (the first such year having commenced on January 1, 1994). TREX and Transnational also pay all expenses directly attributable to them, including a proportionate share of PXRE's rental expenses with respect to\n- 32 -\noffice space based on gross premiums written for the management year and time spent by officers and employees of PXRE in connection with the preparation of reports filed by TREX with the SEC and proxy materials and annual reports sent to TREX shareholders.\nThe Management Agreement has an initial term ending December 31, 1998, and is scheduled to renew for successive three-year terms unless either PXRE gives or TREX and Transnational give at least one year's advance written notice of non-renewal. The Management Agreement may be terminated by TREX and Transnational if Transnational's gross premiums written for a calendar year fall below specified levels.\nCERTAIN RISKS AND UNCERTAINTIES\nAs a reinsurer principally of property and catastrophe related coverages in both the international and domestic markets, PXRE's operating results in any given period depend to a large extent on the number and magnitude of natural and man-made catastrophes such as hurricanes, windstorms, floods, earthquakes, spells of severely cold weather, fires and explosions.\nThe estimation of losses for catastrophe reinsurers is inherently less reliable than for reinsurers of risks which have an established historical pattern of losses. In addition, insured events which occur near the end of a reporting period, as well as, with respect to PXRE's retrocessional book of business, the significant delay in losses being reported to insurance carriers, reinsurers and finally retrocessionaires, require PXRE to make estimates of losses based on limited information from ceding companies and based on its own underwriting data. Because of the uncertainty in the process of estimating its losses from insured events, there is a risk that PXRE's liabilities for losses and loss expenses could prove to be inadequate, with a consequent adverse impact on future earnings and stockholders' equity. Additionally, as a consequence of its emphasis on property reinsurance, PXRE may forgo potential investment income because property losses are typically settled within a short period of time.\nPXRE maintains only minimal catastrophe retrocessional coverage. In view of the increased underwritings of catastrophe related reinsurance and the net exposure being retained by PXRE, the occurrence of one or more major catastrophes in any given period (such as hurricanes Andrew and Iniki in 1992 and the Northridge earthquake in 1994) could have a material adverse impact on PXRE's results\n- 33 -\nof operations and financial condition and result in substantial liquidation of investments and outflows of cash as losses are paid.\nAs PXRE underwrites risks from a large number of insurers based on information generally supplied by reinsurance brokers, there is a risk of developing a concentration of exposure to loss in certain geographic areas prone to specific types of catastrophes. PXRE has developed systems and software tools to monitor and manage the accumulation of its exposure to such losses. Management has established guidelines for maximum tolerable losses from a single or multiple catastrophic event based on historical data, however no assurance can be given that these maximums will not be exceeded in some future catastrophe.\nPremiums on reinsurance business assumed are recorded as earned on a pro rata basis over the contract period based upon estimated subject premiums. Management must estimate the subject premiums associated with the treaties in order to determine the level of earned premiums for a reporting period. Such estimates are based on information from brokers which can be subject to change as new information becomes available. Because of the inherent uncertainty in this process there is the risk that premiums and related receivable balances may turn out to be higher or lower than reported.\nAlthough PXRE's investment guidelines stress conservation of principal, diversification of risk, and liquidity, investments are subject to market-wide risks and fluctuations, as well as to risk inherent in particular securities. Accordingly, the estimated fair value of PXRE's investments does not necessarily represent the amount which could be realized upon future sale particularly if PXRE were required to liquidate a substantial portion of its portfolio to fund catastrophic losses. In addition, PXRE's investment in and receivables from TREX amount to approximately $45,417,000 at December 31, 1995, which represent 11.5% of its total assets and 21.5% of its stockholders' equity.\nPremiums receivable and loss reserves include business denominated in currencies other than U.S. dollars. PXRE is exposed to the possibility of significant claims in currencies other than U.S. dollars. While PXRE holds positions denominated in foreign currencies to mitigate the effects of currency fluctuations on its results of operations, it does not hedge its currency exposures before a catastrophic event which may produce a claim.\n- 34 -\nPXRE Corporation (parent company) relies primarily on cash dividends and net tax allocation payments from its subsidiary PXRE Reinsurance to pay its operating expenses, to meet its debt service obligations and to pay common stock dividends to PXRE's stockholders. The payment of dividends by PXRE Reinsurance to PXRE Corporation is subject to limits imposed under the insurance laws and regulations of Connecticut, the state of incorporation and domicile of PXRE Reinsurance, as well as certain restrictions arising in connection with PXRE Corporation's outstanding indebtedness.\nIn the event the amount of dividends available, together with other sources of funds, are not sufficient to permit PXRE Corporation (parent company) to meet its debt service, other obligations and to pay cash dividends, it would be necessary to obtain the approval of the Connecticut Insurance Commissioner prior to PXRE Reinsurance's payment of additional dividends. If such approval were not obtained, PXRE Corporation (parent company) would have to adopt one or more alternatives, such as refinancing or restructuring its indebtedness or seeking additional equity. There can be no assurance that any of these strategies could be effected on satisfactory terms, if at all.\nThe reinsurance business is increasingly competitive and is undergoing a variety of challenging developments. The industry has in recent years moved toward greater consolidation as ceding companies have placed increased importance on size and financial strength in the selection of reinsurers. Additionally, reinsurers are tapping new markets and complementing their range of traditional reinsurance products with innovative new products which bring together capital markets and reinsurance experience. PXRE competes with numerous major international and domestic reinsurance and insurance companies, many of which have substantially greater financial, marketing and management resources than PXRE.\n- 35 -\nCOMPARISON OF 1995 AND 1994\nNet premiums written for the year ended December 31, 1995, decreased 10.0% to $97,636,000 from $108,518,000 for the corresponding period of 1994. Gross premiums written for 1995 decreased 13.5% to $155,380,000 from $179,684,000 for 1994. Net premiums earned for the year ended December 31, 1995, decreased 12.2% to $97,142,000 from $110,601,000 in the year-earlier period. Gross written, net written and net earned premium decreases for 1995 reflected PXRE's planned response to the continued trend of increased competition in the property catastrophe reinsurance market experienced since the end of 1994 and to recent loss activity in the aviation business. The increased level of competition continued to affect the 1996 annual renewals. During this period, PXRE experienced a reduction in premiums, based on current signed lines of approximately 19% from the 1995 renewal season which is primarily attributable to reductions in underwriting commitments and to a lesser extent rate reductions. In response to these pressures during 1995, PXRE continued to accept some price concessions when consistent with exposures, moved to layers of risk that are less affected by competitive pressures, or reduced commitments where warranted. Although the initial indications from renewals for 1996 are not necessarily representative of what premium levels may be for the full year, they do indicate that in 1996 premiums are likely to decline more than in 1995.\nPremiums ceded by PXRE to its managed business participants decreased 10.3% to $26,774,000 for 1995 compared with $29,842,000 for 1994. The decrease in premiums ceded to these programs was due to the decrease in the amount and percentage of gross premiums written by PXRE on behalf of the managed business participants. During 1995, pursuant to the Management Agreement, PXRE also ceded\n- 36 -\n$24,790,000 of premiums compared to $28,722,000 during the corresponding period of 1994 to Transnational in lieu of direct reinsurance writings by Transnational. Management fee income from all sources for 1995 decreased to $6,417,000 from $6,992,000 in 1994. The decrease reflected loss activity that resulted in decreased profitability of business managed for other companies.\nCeded premiums for catastrophe programs for 1995 decreased 47.8% from the comparable period of 1994 primarily because of the lower level of ceded reinstatement premiums resulting from the reduced level of loss activity in 1995 and management's decision to commute certain reinsurance coverages subsequent to the first quarter of 1994.\nThe underwriting results of a property and casualty insurer are discussed frequently by reference to its loss ratio, underwriting expense ratio and combined ratio. The loss ratio is the result of dividing losses and loss expenses incurred by net premiums earned. The underwriting expense ratio is the result of dividing underwriting expenses (reduced by management fees, if any) by net premiums written under SAP and net premiums earned under GAAP. The combined ratio is the sum of the loss ratio and the underwriting expense ratio. A combined ratio under 100% indicates underwriting profits and a combined ratio exceeding 100% indicates underwriting losses. The combined ratio does not reflect the effect of investment income on operating results. The ratios discussed below have been calculated on a GAAP basis.\nThe loss ratio was 35.7% for 1995 compared with 47.6% for 1994. The loss ratio for 1995 reflected incurred catastrophe losses of $28,439,000 gross and $20,073,000 net for 1995 and prior accident years as compared with $69,833,000 gross and $37,213,000 net for 1994 and prior accident years.\nSignificant catastrophe and risk losses affecting the year ended December 31, 1995 loss ratio are as follows:\n- 37 -\nSignificant events affecting the year ended December 31, 1994 loss ratio included the following:\nThe provision for losses and loss expenses includes the effect of foreign exchange movements on PXRE's liability for losses and loss expenses, resulting in a foreign currency exchange gain of $39,000 for 1995 compared to a loss of $338,000 for 1994.\nDuring 1995, PXRE experienced a deficiency of $4,311,000, net, for prior year losses and loss expenses primarily from the 1994 Northridge earthquake. The loss ratio for 1994 was unfavorably affected by increases to reserves of $3,261,000, net, for prior year losses and loss expenses.\nThe underwriting expense ratio was 18.6% for 1995, compared with 14.8% for 1994. The increase was substantially due to the effect of a provision for contingent commissions related to the low level of losses incurred. As a result of the above, the combined ratio was 54.3% for 1995, compared with 62.4% for 1994.\nOther operating expenses increased to $11,237,000 for 1995, from $8,365,000 in 1994. The operating expense increase for 1995 primarily reflects an increase of $1,653,000 related to changes in benefit plans, additional staff salaries, increased incentive compensation and other related benefits. Also contributing to the increases were additional costs of $216,000 under a new lease in Edison, New Jersey, and an increase in depreciation expense from the capital expenditures of $3,200,000 for PXRE's new facilities including additions to electronic data processing equipment. Included in other operating expenses were foreign currency exchange gains of $196,000 for 1995 compared to gains of $1,156,000 for 1994.\nInterest expense decreased to $7,143,000 in 1995, from $7,789,000 in 1994 due to repurchase of $5,300,000 par value of PXRE's 9.75% Senior Notes, at prices from 99.25 to 99.625 during the fourth quarter of 1994 and the repurchase of $1,925,000 par value of Senior Notes at prices ranging from\n- 38 -\n104.625 to 105.0 during the third quarter of 1995. The loss on repurchase was not material.\nNet investment income for 1995 increased 6.8% to $14,730,000 from $13,786,000 for 1994. The increase in net investment income was caused by a 5.0% increase in average investments for 1995 compared with the previous year, as well as an increase in PXRE's pre-tax investment yield to 5.9% for 1995 compared to 5.8% for 1994. Net realized investment gains for 1995 were $85,000 compared with net realized losses of $1,164,000 for 1994. PXRE recorded directly to equity a $9,759,000 after-tax unrealized increase in the value of its investment portfolio during 1995, resulting from the decline in interest rates since December 31, 1994.\nThe net effects of foreign currency exchange fluctuations were losses of $235,000 in 1995 and gains of $818,000 for 1994. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations-- Liquidity and Capital Resources\".\nNet income for the year ended December 31, 1995 includes $5,948,000 which represents PXRE's approximately 21.9% equity share of TREX's net earnings as compared with $4,141,000 representing PXRE's approximately 21.2% share of TREX's net earnings in 1994. The change in the equity in TREX's earnings reflects the higher level of TREX's net income and the change in PXRE's ownership. The change in PXRE's ownership of TREX resulted from the repurchase by TREX of 270,100 shares of its publicly owned Class A shares.\nFor the reasons discussed above, net income was $39,786,000 for the year ended December 31, 1995, compared to net income of $34,829,000 for the year ended December 31, 1994. Primary net income per common share was $4.74 for 1995 (after provision for cumulative dividends of $598,900 on the Series A Preferred Stock) compared to primary net income per common share of $4.89 for 1994 (after provision for cumulative dividends of $2,005,000 on the Series A Preferred Stock) based on average shares outstanding of 8,275,000 in 1995 and 6,710,000 in 1994. The change in the number of shares outstanding relates primarily to the conversion of all the remaining convertible preferred shares to common shares in May 1995. Fully diluted net income per common share was $4.48 for 1995 compared to $3.94 for 1994 based on average shares outstanding of 8,874,000 in 1995 and 8,847,000 in 1994.\n- 39 -\nCOMPARISON OF 1994 AND 1993\nNet premiums written for the year ended December 31, 1994 increased 40% to $108,518,000 from $77,506,000 for the corresponding period of 1993. Gross premiums written for the year 1994 increased 54% to $179,684,000 from $116,975,000 for the same period of 1993. The increase in net and gross premiums written resulted principally from increased participations on renewal business and new business written for new and existing reinsureds, the majority of which was catastrophe related. Premium growth also occurred in PXRE's marine, aviation, facultative and treaty risk excess reinsurance accounts. PXRE experienced reduced written premiums in pro rata in 1994 because of inadequate premium rates and terms caused by the continuing competition in these lines. Net premiums earned for 1994 increased 40% to $110,601,000 from $78,928,000 in 1993 because of the increase in net premiums written.\nPremiums ceded by PXRE to its managed business participants increased 28% to $29,842,000 (17% of gross premiums written) for 1994 compared with $23,387,000 (20% of gross premiums written) for 1993. The increase in gross premiums written ceded to these programs was due principally to the increase in the amount of premiums written by PXRE to accommodate the larger participation of Trenwick Group starting January 1, 1994. Pursuant to the Management Agreement, in 1994 PXRE also ceded $28,722,000 of premiums to Transnational in lieu of Transnational directly assuming reinsurance writings.\nManagement fee income for 1994 increased 121% to $6,992,000 from $3,158,000 in 1993. The increase was principally due to the increased amounts of business ceded to PXRE's managed business participants (Trenwick Group and the\n- 40 -\nAMA) and the business written for Transnational pursuant to the Management Agreement.\nCeded premiums for catastrophe programs were 18% lower compared to 1993, primarily because of management's decision not to renew certain retrocessional coverages in 1994. Other ceded premiums declined principally as a result of a reduction in facultative business and termination of a pro rata retrocession of that business.\nThe loss ratio was 47.6% for 1994 compared with 51.4% for 1993. The 1994 loss ratio reflected incurred catastrophe losses of $69,833,000 gross and $37,213,000 net for 1994 and prior accident years as compared with $29,265,000 gross and $16,017,000 net in 1993 for 1993 and prior accident years. Significant events affecting the 1994 loss ratio included the following:\nSignificant events affecting the same period of 1993 included the following:\nThe provision for losses and loss expenses includes the effect of foreign exchange movements on PXRE's liability for losses and loss expenses, resulting in a foreign currency exchange loss of $338,000 for 1994 compared to a loss of $205,000 in 1993.\nThe loss ratio for 1994 was unfavorably affected by increases to reserves of $3,261,000 net for prior years' losses and loss expenses which was principally attributable to\n- 41 -\nloss development on a number of marine pro rata reinsurance contracts and losses from the 1993 Midwest floods. During 1993, PXRE incurred losses and loss expenses of $10,499,000 net for prior years' losses and loss expenses, of which approximately $5,394,000 were due to additional information received with respect to hurricanes Andrew and Iniki, approximately $3,330,000 were the result of losses under a number of pro rata reinsurance treaties and the remainder were principally attributable to the other 1993 catastrophes.\nThe underwriting expense ratio was 14.8% for 1994 compared with 24.2% in 1993. The decrease was substantially due to the increase in net premiums earned, as well as a decrease in the amount of pro rata reinsurance written, which carries higher commissions than the excess of loss business which replaced it. As a result of the above, the combined ratio was 62.4% for 1994, compared with 75.6% for 1993.\nOther operating expenses decreased to $8,365,000 for 1994 from $8,917,000 for 1993 mainly because of foreign exchange gains in 1994 offset in part by an increase in salary related expenses and incentive compensation costs. Included in other operating expenses were foreign currency exchange gains of $1,156,000 for 1994 compared to losses of $397,000 for 1993.\nInterest expense increased to $7,789,000 in 1994 from $2,740,000 in 1993 reflecting the public offering in September 1993 of $75 million of 9.75% Senior Notes. In December 1994, PXRE Corporation (parent company) repurchased $5,300,000 par value of its Senior Notes at prices from 99.25 to 99.625.\nNet investment income for 1994 increased 72% to $13,786,000 from $8,011,000 for 1993. The increase in net investment income was caused by an increase in average investments for 1994 compared with the previous year, and in part by an increase in PXRE's pre-tax investment yield to 5.8% for 1994 compared with 5.0% for 1993. The increase in average investments reflects investment of the proceeds of the public offerings of 9.75% Senior Notes during the third quarter of 1993 (net proceeds of approximately $72,150,000) and of Common Stock during the first quarter of 1993 (net proceeds of approximately $46,942,000). The pre-tax yield increased principally because of investment and reinvestment of available funds at generally higher interest rates during 1994. Additionally, net investment income was increased by a retroactive adjustment of $1,603,000 to the amortization of premiums on Government National Mortgage Association mortgage-backed securities (\"GNMAs\") because of a significant slowing of prepayments on those securities. Net realized investment\n- 42 -\nlosses for 1994 were $1,164,000 compared with net realized losses of $1,526,000 for 1993. A gain of $10,564,000 in 1993 was attributable to the TREX initial public offering. The realized losses resulted from prepayments on mortgage-backed securities, principally GNMAs.\nThe net effect of foreign currency exchange fluctuations was a gain of $818,000 in 1994 and a loss of $602,000 in 1993. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources\".\nNet income for 1994 and 1993 included $4,141,000 and $84,000, respectively, which represented PXRE's approximately 21% equity share of TREX's net earnings.\nFor the reasons discussed above, net income was $34,829,000 for 1994 compared to $22,645,000 for 1993. Primary net income per common share increased to $4.89 for 1994 (after provision for cumulative dividends of $2,005,000 on the Series A Preferred Stock) compared to net income per common share of $3.34 for 1993 (after provision for cumulative dividends of $2,056,000 on the Series A Preferred Stock) based on average shares outstanding of 6,710,000 in 1994 and 6,170,000 in 1993. Fully diluted net income per common share increased to $3.94 for 1994 compared to $2.70 for 1993 based on average shares outstanding of 8,847,000 in 1994 and 8,380,000 in 1993.\nLIQUIDITY AND CAPITAL RESOURCES\nPXRE Corporation (parent company) relies primarily on cash dividends and net tax allocation payments from its subsidiary PXRE Reinsurance to pay its operating expenses and income taxes, to meet its debt service obligations and to pay dividends to PXRE stockholders. The payment of dividends by PXRE Reinsurance to PXRE Corporation is subject to limits imposed under the insurance laws and regulations of Connecticut, the state of incorporation and domicile of PXRE Reinsurance, as well as certain restrictions arising in connection with PXRE Corporation's Senior Notes discussed below. Connecticut insurance law provides that the maximum amount of dividends or other distributions that PXRE Reinsurance may declare or pay to PXRE Corporation within any twelve-month period, without regulatory approval, is limited to the lesser of (a) earned surplus or (b) the greater of 10% of policyholders' surplus at December 31 of the preceding year or 100% of net income for the twelve-month period ending December 31 of the preceding year, all determined in accordance with SAP. Accordingly, the\n- 43 -\nConnecticut insurance laws could limit the amount of dividends available for distribution by PXRE Reinsurance without prior regulatory approval, depending upon a variety of factors outside the control of PXRE, including the frequency and severity of catastrophe and other loss events and changes in the reinsurance market, in the insurance regulatory environment and in general economic conditions. As of December 31, 1995, PXRE Reinsurance had earned surplus of $81,382,000, as defined, and a policyholders' surplus of $250,231,000 and its net income for 1995 was $37,996,000. The maximum amount of dividends or distributions that PXRE Reinsurance may declare and pay in 1996, without regulatory approval, is therefore $37,996,000. During 1995, $6,000,000 in dividends was approved and paid by PXRE Reinsurance to PXRE Corporation.\nOther sources of funds available to PXRE Corporation (parent company) include investments retained by PXRE to provide support for debt service on its Senior Notes. Net tax allocation payments by PXRE Reinsurance are also expected to be a source of funds available to PXRE Corporation (parent company).\nIn the event the amount of dividends available, together with other sources of funds, are not sufficient to permit PXRE Corporation (parent company) to meet its debt service and other obligations and to pay cash dividends, it would be necessary to obtain the approval of the Connecticut Insurance Commissioner prior to PXRE Reinsurance's payment of additional dividends. If such approval were not obtained, PXRE (parent company) would have to adopt one or more alternatives, such as refinancing or restructuring its indebtedness or seeking additional equity. There can be no assurance that any of these strategies could be effected on satisfactory terms, if at all. In the event that PXRE Corporation (parent company) were unable to generate sufficient cash flow and were otherwise unable to obtain funds necessary to meet required payments of principal and interest on its indebtedness, PXRE Corporation (parent company) could be in default under the terms of the agreements governing such indebtedness. In the event of such default, the holders of such indebtedness could elect to declare all of the funds borrowed thereunder to be due and payable together with accrued and unpaid interest.\nIn August 1993, PXRE Corporation (parent company) completed a public offering of $75,000,000 principal amount of 9.75% Senior Notes due August 15, 2003. Interest is payable on the Senior Notes semi-annually. Interest expense, including amortization of debt offering costs, for 1995 in respect of the Senior Notes amounted to approximately\n- 44 -\n$7,143,000. Interest expense for 1996 will amount to approximately $6,869,000. On and after August 15, 1998, the Senior Notes may be redeemed at the option of PXRE, in whole or in part, at redemption prices (expressed as percentages of the principal amount), plus accrued and unpaid interest to the date fixed for redemption, of 103.656% at August 15, 1998, declining to 100% at August 15, 2001 and thereafter. The Indenture governing the Senior Notes contains covenants which, among other things, limit the ability of PXRE and its Restricted Subsidiaries (including PXRE Reinsurance): (a) to incur additional indebtedness (except for the incurrence of Permitted Indebtedness and the incurrence of other Indebtedness by PXRE in circumstances where no Default or Event of Default exists and the Consolidated Fixed Charge Coverage Ratio of PXRE would be greater than 2:1 after giving effect to the incurrence) and, in the case of the Restricted Subsidiaries, to issue preferred stock; (b) to pay dividends, repurchase stock and to make certain other Restricted Payments (other than, among other things, if no Default or Event of Default exists (x) Restricted Payments after August 31, 1993, not exceeding in the aggregate the sum of $3,000,000 plus 50% of Consolidated Net Income (or minus 100% of any loss) from such date (with certain adjustments), plus the amounts of certain equity proceeds and certain reductions in Investments in Unrestricted Subsidiaries, provided, that at the time of such Restricted Payment the Consolidated Fixed Charge Coverage Ratio is greater than 2.0, and (y) in addition to permitted Restricted Payments referred to in clause (x), the payment of cash dividends on Qualified Capital Stock after August 31, 1993 of up to an aggregate of $6,000,000, provided, that such dividends on Common Stock do not exceed $0.25 per share in any year); (c) to sell or permit the issuance of any stock of PXRE Reinsurance or any other Principal Insurance Subsidiary; (d) to sell or transfer other assets (other than for at least Fair Market Value and generally for not less than 75% in cash or Cash Equivalents); (e) to create liens upon the properties or assets of PXRE or its Restricted Subsidiaries; or (f) to engage in any business other than the insurance and reinsurance businesses and other businesses incidental and related thereto. The Indenture also provides that within 30 days after a Change of Control of PXRE, PXRE will offer to purchase all the Senior Notes then outstanding at a purchase price equal to 101% of the principal amount thereof, plus accrued and unpaid interest, if any, to the date of such purchase.\nIn the fourth quarter of 1994, PXRE's Board of Directors authorized the repurchase of up to $20 million principal amount of Senior Notes in any one calendar year at below par prices in negotiated or open market transactions. As of December 31, 1994, PXRE had repurchased $5,300,000\n- 45 -\nprincipal amount of its Senior Notes at an aggregate cost of $5,275,000. In April 1995, PXRE's Board of Directors authorized such Senior Note repurchases to be made at or above par prices. During the third quarter of 1995, PXRE Reinsurance Company purchased $1,925,000 principal amount of its parent company's Senior Notes at an aggregate cost of $2,016,000.\nPXRE Corporation (parent company) files federal income tax returns for itself and all of its direct or indirect domestic subsidiaries that satisfy the stock ownership requirements for consolidation for federal income tax purposes (collectively, the \"Subsidiaries\"). PXRE Corporation (parent company) is party to an Agreement Concerning Filing of Consolidated Federal Income Tax Returns (the \"Tax Allocation Agreement\") pursuant to which each Subsidiary makes tax payments to PXRE Corporation (parent company) in an amount equal to the federal income tax payment that would have been payable by such Subsidiary for such year if it had filed a separate income tax return for such year. PXRE Corporation (parent company) is required to provide for payment of the consolidated federal income tax liability for the entire group. If the aggregate amount of tax payments made in any tax year by a Subsidiary is less than (or greater than) the annual tax liability for such Subsidiary on a stand-alone basis for such year, such Subsidiary will be required to make up such deficiency (or receive a credit if payments exceed the separate return tax liability) to PXRE Corporation (parent company).\nThe primary sources of liquidity for PXRE Reinsurance are net cash flow from operating activities (including interest income from investments), the maturity or sale of investments, borrowings, capital contributions and advances from PXRE Corporation (parent company). Funds are applied primarily to the payment of claims, operating expenses, income taxes and to the purchase of fixed maturity and short-term investments. Premiums are typically received in advance of related claim payments. Net cash flow provided by operations was $32,412,000 during 1995, compared with net cash flow provided by operations of $30,988,000 and $35,792,000 during 1994 and 1993, respectively, due to the effects of timing of collection of receivables and reinsurance recoverables and payments of losses.\nPXRE's management has established general procedures and guidelines for its investment portfolio and oversees investment management carried out by Phoenix Duff & Phelps, a public majority-owned subsidiary of Phoenix Home Life. Although these investment guidelines stress conservation of principal, diversification of risk and liquidity, investments\n- 46 -\nare subject to market-wide risks and fluctuations, as well as to risk inherent in particular securities. As at December 31, 1995, PXRE's investment portfolio consisted primarily of fixed maturities and short-term investments. During the latter part of 1995, PXRE invested $5,000,000 in equities. The investment policies and all investments of PXRE are approved by its Board of Directors.\nOf PXRE's fixed maturities portfolio at December 31, 1995, 100% of the fair value was in obligations rated \"A1\" or \"A\" or better by Moody's or S&P, respectively, or in government or government-backed securities. Mortgage-backed securities (principally GNMAs) accounted for 22.6% of fixed maturities based on fair value at December 31, 1995. PXRE has no investments in real estate or commercial mortgage loans. The average market yield to maturity of PXRE's fixed maturities portfolio at December 31, 1995 and 1994 was 5.3% and 5.8%, respectively.\nFixed maturity investments are reported at fair value, with the net unrealized gain or loss, net of tax, reported as a separate component of stockholders' equity. PXRE recorded directly to equity a $9,759,000 after-tax unrealized increase in the value of its investment portfolio during 1995 reflecting a decrease in interest rates during the period. Short-term investments are carried at amortized cost which approximates fair value. PXRE's short-term investments, principally high grade commercial paper, were $41,722,000 at December 31, 1995 compared to $26,813,000 at December 31, 1994. The increase at December 31, 1995 was principally due to a planned buildup of short-term investments as PXRE approached the period of the year with a maximum probability of hurricane activity. Such level of short-term investments was not reduced as rapidly as usual in the latter part of the fourth quarter of 1995 after the period of maximum wind exposure. Cash flow requirements arising from the August 1995 hurricanes Marilyn and Luis required additional liquidity.\nIn November 1993, an initial public offering by TREX, a subsidiary of PXRE, of 5,750,000 shares of Class A Common Stock at $20 per share, was completed. In connection with this offering, PXRE contributed all of the capital stock of Transnational to TREX. TREX, through Transnational, now specializes principally in providing brokered property retrocessional reinsurance and marine and aviation retrocessional reinsurance in the United States and international markets pursuant to the Management Agreement with PXRE. PXRE owns approximately 21.9% of the total issued and outstanding common stock of TREX and is entitled to designate two of TREX's five directors.\n- 47 -\nDuring the fourth quarter of 1995, PXRE raised the quarterly dividend on its Common Stock from $0.15 per share to $0.18 per share. The increase in the dividend will result in an annual additional outlay of approximately $1,049,400.\nPXRE exercised its option to redeem PXRE's Series A Preferred Stock (and the related Depositary Shares) on May 1, 1995. At December 31, 1994, there were 10,009 shares of Series A Preferred Stock (1,000,900 Depositary Shares) outstanding. During the second quarter of 1995, all of the outstanding shares of Series A Preferred Stock were converted into shares of PXRE's Common Stock resulting in the issuance of approximately 1,760,000 shares of PXRE's Common Stock. Each Depositary Share had a conversion price of $12.29 per Depositary Share and was valued for conversion purposes at $25.00, resulting in approximately 2.0342 shares of Common Stock for each Depositary Share converted. As a result of this transaction, PXRE will save approximately $500,000 in dividend costs for the preferred shares each quarter. This will be offset by approximately $316,800 in additional common stock dividends on shares issued upon conversion. To date, these convertible preferred shares were the principal reason for the difference between primary and fully diluted earnings per share. Because of the conversion, that difference will be eliminated in future periods.\nBook value per share was $24.15 at December 31, 1995.\nIn April 1995, PXRE's Board of Directors authorized the repurchase of up to 700,000 shares of its common stock from time-to-time in open market or private block purchase transactions. From inception of this repurchase plan through March 1996, PXRE repurchased 25,000 of the 700,000 shares authorized at a cost of $625,000.\nIn March 1995, PXRE and TREX entered into a joint venture arrangement to trade in catastrophe futures and options contracts on the Chicago Board of Trade. PXRE and TREX have each committed $2.5 million to this venture. Although the joint venture has developed a number of trading strategies, the low level of activity in the CBOT market for catastrophe futures has kept trade volume to a minimum through December 31, 1995.\nPXRE may be subject to gains and losses resulting from currency fluctuations because substantially all of its investments are denominated in United States dollars, while some of its net liability exposure is in currencies other than U.S. dollars. PXRE holds, and expects to continue to hold, currency positions and has made, and expects to continue to\n- 48 -\nmake, investments denominated in foreign currencies to mitigate, in part, the effects of currency fluctuations on its results of operations. Currency holdings and investments denominated in foreign currencies do not constitute a material portion of PXRE's investment portfolio and, in the opinion of PXRE's management, are sufficiently liquid for its needs.\nAll amounts classified as reinsurance recoverable at December 31, 1995, are considered by management of PXRE to be collectible in all material respects.\nIn May 1994, PXRE signed a lease for approximately 24,000 square feet of office space in Edison, New Jersey, for a term of 15 years at a fixed annual rental of approximately $370,000. In conjunction with its relocation to that facility in April 1995, PXRE incurred capital expenditures of approximately $3,200,000 for construction costs and furniture and related electronic data processing equipment. The lease on PXRE's New York office space expires in July 1996. PXRE presently plans to continue utilization of the space until such expiration date.\nINCOME TAXES\nPXRE's effective tax rate for 1995, 1994 and 1993 was 31.4%, 31.1% and 32.7%, respectively, which differs from the statutory rate principally due to tax exempt income and state and local taxes. The change in the effective rate in 1995 reflects the higher relative proportion of underwriting activities compared to tax exempt municipal bond income.\n- 49 -\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe following financial statements are filed as part of this Form 10-K:\nITEM 9.","section_9":"ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNo disclosure hereunder is required as PXRE has not changed its accountants during the 24 months preceding December 31, 1995.\n- 50 -\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 is contained in PXRE's Proxy Statement, which information is incorporated herein by reference and which Proxy Statement will be filed within 120 days of the end of PXRE's 1995 fiscal year.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by this Item 11 is contained in PXRE's Proxy Statement, which information is incorporated herein by reference and which Proxy Statement will be filed within 120 days of the end of PXRE's 1995 fiscal year.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required by this Item 12 is contained in PXRE's Proxy Statement, which information is incorporated herein by reference and which Proxy Statement will be filed within 120 days of the end of PXRE's 1995 fiscal year.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by this Item 13 is contained in PXRE's Proxy Statement, which information is incorporated herein by reference and which Proxy Statement will be filed within 120 days of the end of PXRE's 1995 fiscal year.\n- 51 -\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) The following documents are filed as part of this Form 10-K:\n(1) Financial Statements\n(2) Financial Statements Schedules\n- 52 -\n(3) Exhibits\n(3) Certificate of Incorporation and By-laws of PXRE Corporation. The Restated Certificate of Incorporation and By-laws of PXRE Corporation were previously filed with PXRE's Registration Statement on Form S-1 dated August 29, 1986, as amended by Amendment No. 1 thereto dated February 19, 1987 and by Amendment No. 2 thereto dated March 25, 1987 (File No. 33-8406), as Exhibits 3.1 and 3.2 thereto, and are incorporated herein by reference. The Certificate of Designations designating the Series A Cumulative Convertible Preferred Stock of PXRE Corporation was previously filed with PXRE's Registration Statement on Form S-2 dated February 21, 1992, as amended by Amendment No. 1 thereto dated April 1, 1992 and by Amendment No. 2 thereto dated April 13, 1992 and by Amendment No. 3 thereto dated April 23, 1992 (File No. 33-45893) as Exhibit 4.5 thereto, and is incorporated herein by reference. A Certificate of Amendment dated May 20, 1993 to PXRE's Restated Certificate of Incorporation was previously filed with PXRE's Registration Statement on Forms S-8 and S-3 dated June 3, 1993 (File No. 33-63768) as Exhibit 4.3 thereto, and is incorporated herein by reference. A Certificate of Amendment dated May 19, 1994 to PXRE's Restated Certificate of Incorporation was previously filed as Exhibit 3 to the Annual Report on Form 10-K of PXRE for the fiscal year ended December 31, 1994 (File No. 0-15428), and is incorporated herein by reference. Article IV, Section 1 of the By-laws of PXRE Corporation, as amended on June 8, 1995, is attached hereto as Exhibit 3.\n(4) Instruments Defining the Rights of Security Holders. Trust Indenture dated as of August 31, 1993 between PXRE, as issuer, and The First National Bank of Boston, as trustee, relating to $75,000,000 principal amount of 9.75%\n- 53 -\nSenior Notes of PXRE due 2003 (Exhibit 4.1 to PXRE's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993 (File No. 0-15428), and incorporated herein by reference).\n(10) Material Contracts. The material contracts of PXRE are as follows:\n10.1 Lease dated January 29, 1986 between Phoenix General Insurance Company and 80 Maiden Lane Associates for office facilities located at 80 Maiden Lane, New York, New York (Exhibit 10.1 to PXRE's Form S-1 Registration Statement dated August 29, 1986, as amended by Amendment No. 1 thereto dated February 19, 1987 and by Amendment No. 2 thereto dated March 25, 1987 (File No. 33-8406), and incorporated herein by reference).\n10.2 Assignment and Assumption of Lease dated September 30, 1986 between Phoenix General Insurance Company and PXRE Reinsurance Company (Exhibit 10.2 to Amendment No. 1 dated February 19, 1987 to PXRE's Form S-1 Registration Statement dated August 29, 1986, as subsequently amended by Amendment No. 2 thereto dated March 25, 1987 (File No. 33-8406), and incorporated herein by reference).\n10.3 PXRE Reinsurance Company Management Agreement among PXRE Reinsurance and, among others, Merrimack Mutual Fire Insurance Company (\"Merrimack\"), Pennsylvania Lumbermens Mutual Insurance Company (\"Pennsylvania Lumbermens\"), and NRMA Insurance Limited (\"NRMA\") (Exhibit 10.1 to PXRE's Annual Report on Form 10-K for the fiscal year ended December 31, 1991 (File No. 0-15428), and incorporated herein by reference); letter dated November 28, 1990 from Pennsylvania Lumbermens confirming reduced participation (Exhibit 10.7 to PXRE's Form S-2 Registration Statement dated February 21, 1992, as amended by Amendment No. 1 thereto dated April 1, 1992 and by Amendment No. 2 thereto dated April 13, 1992 and by Amendment No. 3 thereto dated April 23, 1992 (File No. 33- 45893), and incorporated herein by reference); and forms of cover notes respecting January 1995 renewals by Merrimack, Pennsylvania Lumbermens and NRMA (Exhibit 10.3 to the Annual Report on Form 10-K of PXRE for the fiscal year ended December 31, 1994 (File No. 0-15428) and incorporated herein by reference).\n10.4 Tax Settlement Agreement dated June 21, 1991 between PXRE Corporation, PXRE Reinsurance Company and PM Holdings, Inc. (Exhibit 10.2 to the Annual Report on Form 10-K of PXRE for the fiscal year ended December 3, 1991 (File No. 0-15428), and incorporated herein by reference).\n- 54 -\n10.5 Investment Advisory Agreement between PXRE Reinsurance Company and Phoenix Investment Counsel, Inc., dated February 25, 1987 and effective as of January 1, 1987 (Exhibit 10.10 to Amendment No. 1 dated February 19, 1987 to PXRE's Form S-1 Registration Statement dated August 29, 1986, as subsequently amended by Amendment No. 2 thereto dated March 25, 1987 (File No. 33-8406), and incorporated herein by reference).\n10.6 Amendment to Investment Advisory Agreement between PXRE Reinsurance Company and Phoenix Investment Counsel, Inc., effective retroactively as of January 1, 1987 (Exhibit 10.3 to the Annual Report on Form 10-K of PXRE for the fiscal year ended December 31, 1991 (File No. 0-15428), and incorporated herein by reference).\n10.7 Amendment No. 2 to Investment Advisory Agreement between PXRE Reinsurance Company and Phoenix Investment Counsel, Inc. effective as of November 1, 1989. (Exhibit 10.4 to the Annual Report on Form 10-K of PXRE for the fiscal year ended December 31, 1991 (File No. 0-15428), and incorporated herein by reference).\n10.8 Amended and Restated Agreement Concerning Filing of Consolidated Federal Income Tax Returns dated as of August 23, 1993 between PXRE and PXRE Reinsurance (Exhibit 10.8 to the Annual Report on Form 10-K of PXRE for the fiscal year ended December 31, 1993 (File No. 0-15428), and incorporated herein by reference).\n10.9 Employee Stock Purchase Plan, as amended (Appendix A to PXRE's Proxy Statement dated April 23, 1993, and incorporated herein by reference).(M)\n10.10 Executive Long-Term Bonus Plan (Exhibit 10.6 to PXRE's Annual Report on Form 10-K for the fiscal year ended December 31, 1991 (File No. 0-15428), and incorporated herein by reference) and Amendment thereto made as of August 22, 1991 (Exhibit 10.14 to PXRE's Form S-2 Registration Statement dated February 21, 1992, as amended by Amendment No. 1 thereto dated April 1, 1992 and by Amendment No. 2 thereto dated April 13, 1992 and by Amendment No. 3 thereto dated April 23, 1992 (File No. 33-45893), and incorporated herein by reference).(M)\n- ---------------------\n(M) indicates a management contract or compensatory plan or arrangement in which the directors and\/or executive officers of PXRE participate.\n- 55 -\n10.11 Executive Severance Plan (Exhibit 10.1 to the Annual Report on Form 10-K of PXRE for the fiscal year ended December 31, 1989 (File No. 0-15428), and incorporated herein by reference).\n10.12 1988 Stock Option Plan, as amended (Exhibit A to the first Prospectus forming part of PXRE's Form S-8 and S-3 Registration Statement dated June 21, 1990 (File No. 33-35521), and incorporated herein by reference).(M)\n10.13 1987 Stock Option Plan, as amended (Appendix B to PXRE's Proxy Statement dated April 13, 1990, and incorporated herein by reference).(M)\n10.14 Non-Employee Director Deferred Stock Plan (Appendix A to PXRE's Proxy Statement dated April 12, 1991, and incorporated herein by reference).(M)\n10.15 Restated Employee Annual Incentive Bonus Plan, as amended (Appendix A to PXRE's Proxy Statement dated April 22, 1994, and incorporated herein by reference).(M)\n10.16 1992 Officer Incentive Plan, as amended (Appendix B to PXRE's Proxy Statement dated April 22, 1994 and incorporated herein by reference).(M)\n10.17 Quota Share Retrocessional Agreement between PXRE Reinsurance and Trenwick America Reinsurance Corporation (Exhibit 10.21 to the Annual Report on Form 10-K of PXRE for the fiscal year ended December 31, 1993 (File No. 0-15428), and incorporated herein by reference).\n10.18 Management Agreement dated as of November 8, 1993 among PXRE Reinsurance, Transnational Re Corporation and Transnational Reinsurance Company (Exhibit 10.22 to the Annual Report on Form 10-K of PXRE for the fiscal year ended December 31, 1993 (File No. 0-15428), and incorporated herein by reference).\n10.19 Aggregate Excess of Loss Reinsurance Agreement dated as of November 8, 1993 between PXRE Reinsurance, as reinsurer, and Transnational Reinsurance Company, as reinsured (Exhibit 10.23 to the Annual Report on Form 10-K of PXRE for the fiscal year ended December 31, 1993 (File No. 0-15428), and incorporated herein by reference).\n- ---------------------\n(M) indicates a management contract or compensatory plan or arrangement in which the directors and\/or executive officers of PXRE participate.\n- 56 -\n10.20 Registration Rights Agreement dated as of November 8, 1993 between PXRE Reinsurance and Transnational Re Corporation (Exhibit 10.24 to the Annual Report on Form 10-K of PXRE for the fiscal year ended December 31, 1993 (File No. 0-15428), and incorporated herein by reference).\n10.21 Amendment No. 1 dated December 1, 1994 to the Management Agreement dated as of November 8, 1993 between PXRE Reinsurance, Transnational Re Corporation and Transnational Reinsurance Company (Exhibit 10.21 to the Annual Report on Form 10-K of PXRE for the fiscal year ended December 31, 1994 (File No. 0-15428), and incorporated herein by reference).\n10.22 Addendum No. 2 dated November 10, 1994 to the PXRE Group Amended and Restated Agreement Concerning Filing of Consolidated Federal Income Tax Returns (Exhibit 10.22 to the Annual Report on Form 10-K of PXRE for the fiscal year ended December 31, 1994 (File No. 0-15428), and incorporated herein by reference).\n10.23 Amendment dated August 1994 to the Severance Plan for Certain Executives of PXRE Corporation (Exhibit 10.23 to the Annual Report on Form 10-K of PXRE for the fiscal year ended December 31, 1994 (File No. 0-15428), and incorporated herein by reference).(M)\n10.24 Lease dated May 9, 1994 between Thornall Associates and PXRE Corporation (Exhibit 10.24 to the Annual Report on Form 10-K of PXRE for the fiscal year ended December 31, 1994 (File No. 0-15428), and incorporated herein by reference).\n10.25 Director Stock Option Plan (Appendix A to PXRE's Proxy Statement dated May 3, 1995, and incorporated herein by reference).(M)\n10.26 Amendment No. 3 to Investment Advisory Agreement between PXRE Reinsurance Company and Phoenix Investment Counsel, Inc. (predecessor of Phoenix Duff & Phelps) effective June 1, 1995 (attached hereto as Exhibit 10.26).\n(11) Statement re computation of earnings per share (attached hereto as Exhibit 11).\n- ---------------------\n(M) indicates a management contract or compensatory plan or arrangement in which the directors and\/or executive officers of PXRE participate.\n- 57 -\n(12) Statement re computation of ratios (attached hereto as Exhibit 12).\n(21) List of Subsidiaries. During 1995, PXRE had three wholly-owned subsidiaries: PXRE Reinsurance Company, which is chartered in Connecticut as a property and casualty insurance and reinsurance company, PXRE Trading Corporation, a Delaware corporation and PXRE Limited, an English company. PXRE also has an approximately 21.9% interest in Transnational Re Corporation, a publicly-traded Delaware corporation and its wholly-owned subsidiaries. (See the discussion in this Form 10-K under the captions \"Business--Management Agreement\" and \"--Other Operations\" and \"Management's Discussion and Analysis of Financial Condition and Results of Operations\".)\n(23) Consents of Experts and Counsel. The consent of Price Waterhouse LLP, independent accountants to PXRE, is included as part of Item 14(a)(2) of this Form 10-K.\n(24) Power of Attorney. Copies of the powers of attorney executed by each of Robert W. Fiondella, Bernard Kelly, Wendy Luscombe, Edward P. Lyons, Philip R. McLoughlin, David W. Searfoss, Donald H. Trautlein and Wilson Wilde are attached hereto as Exhibit 24.\n(27) Financial Data Schedule. Exhibit 27 included in electronic filing only.\n(28) Information from reports furnished to state insurance regulatory authorities. Filed in paper under cover of Form SE.\n(b) Current Reports.\nNone.\n(c) See Item 14(a)(3) above.\n(d) See Item 14(a)(2) above.\n- ---------------------\n(M) indicates a management contract or compensatory plan or arrangement in which the directors and\/or executive officers of PXRE participate.\n- 58 -\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, PXRE Corporation has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nPXRE CORPORATION\nBy: \/s\/ Gerald L. Radke -------------------------------- Gerald L. Radke Its Chairman of the Board, President and Chief Executive Officer\nDate: March 29, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of PXRE Corporation and in the capacity and on the dates indicated:\nBy: \/s\/ Gerald L. Radke By: \/s\/ Sanford M. Kimmel _______________________________ __________________________ Gerald L. Radke Sanford M. Kimmel Its Chairman of the Board, Its Senior Vice President, President and Chief Treasurer and Chief Executive Officer Financial Officer (Principal Executive (Principal Financial Officer) and Director Officer and Principal Accounting Officer)\nDate: March 29, 1996 Date: March 29, 1996\nBy* By* _______________________________ __________________________ Robert W. Fiondella Bernard Kelly Director Director\nDate: March 29, 1996 Date: March 29, 1996\nBy* By* _______________________________ __________________________ Wendy Luscombe Edward Lyons Director Director\nDate: March 29, 1996 Date: March 29, 1996\n- 59 -\nBy* By* _______________________________ __________________________ Philip R. McLoughlin David W. Searfoss Director Director\nDate: March 29, 1996 Date: March 29, 1996\nBy* By* _______________________________ __________________________ Donald H. Trautlein Wilson Wilde Director Director\nDate: March 29, 1996 Date: March 29, 1996\n*By: \/s\/ Gerald L. Radke __________________________ Gerald L. Radke Attorney-in-Fact\n- 60 -\nREPORT OF INDEPENDENT ACCOUNTANTS\nTO THE BOARD OF DIRECTORS AND STOCKHOLDERS OF PXRE CORPORATION\nIn our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, of stockholders' equity and of cash flow present fairly, in all material respects, the financial position of PXRE Corporation and its subsidiaries at December 31, 1995 and 1994, and the results of their operations and their cash flow for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.\nPRICE WATERHOUSE LLP New York, New York February 15,1996\nPXRE Consolidated Balance Sheets Corporation\nThe accompanying notes are an integral part of these statements.\nPXRE Consolidated Statements of Income Corporation\nThe accompanying notes are an integral part of these statements.\nPXRE Consolidated Statements of Stockholders' Equity Corporation\nThe accompanying notes are an integral part of these statements.\nPXRE Consolidated Statements of Cash Flow Corporation\nThe accompanying notes are an integral part of these statements.\nPXRE Corporation Notes to Consolidated Financial Statements Years Ended December 31, 1995, 1994 and 1993\n1. Significant Accounting Policies\nBasis of Presentation and Consolidation\nThe accompanying consolidated financial statements have been prepared in conformity with generally accepted accounting principles. These statements reflect the consolidated operations of PXRE Corporation (formerly Phoenix Re Corporation) and its subsidiaries PXRE Reinsurance Company (formerly Phoenix Reinsurance Company) (\"PXRE Reinsurance\"), PXRE Trading Corporation (\"PXRE Trading\") and PXRE Ltd. (collectively referred to as \"PXRE\") and its subsidiary, Transnational Reinsurance Company (formerly Transnational Insurance Company) (\"Transnational Reinsurance\"), through October 31, 1993, the month preceding its contribution to Transnational Re Corporation (\"TREX\"). As described further in Note 9, after the closings of TREX's initial public offering on November 9 and 17, 1993, PXRE owned 21% of TREX which now owns 100% of Transnational Reinsurance Company. Activity from November 1, 1993 to November 9, 1993 was not material. All material transactions between the consolidated companies have been eliminated in preparing these consolidated financial statements.\nCertain reclassifications have been made for 1994 and 1993 to conform with the 1995 presentation.\nInvestment at Equity\nInvestments in affiliated companies (20% to 50% owned) are accounted for under the equity method.\nPremiums Assumed and Ceded\nPremiums on reinsurance business assumed are recorded as earned on a pro rata basis over the contract period based on estimated subject premiums. Adjustments based on actual subject premium are recorded once ascertained. The portion of premiums written relating to unexpired coverages at the end of the period is recorded as unearned premiums. Reinsurance premiums ceded are recorded as incurred on a pro rata basis over the contract period.\nDeferred Acquisition Costs\nAcquisition costs consist of commissions and brokerage expenses incurred in connection with contract issuance, net of acquisition costs ceded. These costs are deferred and amortized over the period in which the related premiums are earned. Deferred acquisition costs are reviewed periodically to determine that they do not exceed recoverable amounts after allowing for anticipated investment income. Amortization of acquisition costs amounted to $13,251,000, $15,026,000 and $13,339,000 in 1995, 1994 and 1993, respectively.\nManagement Fee\nManagement fees are recorded as earned under various arrangements whereby PXRE Reinsurance acts as underwriting manager for other insurers and reinsurers, including TREX (see Note 9). These fees are initially based on premium volume, but are adjusted through contingent profit commissions related to underwriting results measured over a period of years.\nLosses and Loss Expense Liabilities\nLiabilities for losses and loss expenses are established in amounts estimated to settle incurred losses. Losses and loss expense liabilities are based on individual case estimates provided for reported losses for known events and estimates of incurred but not reported losses. Losses and loss expense liabilities are necessarily based on estimates and the ultimate liabilities may vary from such estimates. Any adjustments to these estimates are reflected in income when known.\nReinsurance recoverable on paid losses and reinsurance recoverable on unpaid losses are reported as assets. Reinsurance recoverable on paid losses represents amounts recoverable from retrocessionaires at the end of the period for gross losses previously paid. Provisions are established for all reinsurance recoveries which are considered doubtful.\nInvestments\nFixed maturity investments and equity securities are considered available for sale and are reported at fair value. Unrealized losses, as a result of temporary changes in fair value during the period such investments are held, are reflected net of income taxes in stockholders' equity. Unrealized losses which are not temporary are charged to operations. Short-term investments, which have an original maturity of one year or less, are carried at amortized cost which approximates fair value. Realized gains or losses on disposition of investments are determined on the basis of specific identification. The amortization of premiums and accretion of discount for fixed maturity investments is computed utilizing the interest method. The effective yield under the interest method is adjusted for anticipated prepayments.\nIn March 1995, PXRE (through PXRE Trading) and TREX entered into a joint venture arrangement to trade in catastrophe futures and options contracts on the Chicago Board of Trade (\"CBOT\"). PXRE and TREX have each contributed $2.5 million to capitalize this venture. Although the joint venture has developed a number of trading strategies, the low level of activity in the CBOT market for catastrophe futures has kept trade volume to a minimum through December 31, 1995.\nLeasehold Improvements, Furniture and Equipment and Other Assets\nLeasehold improvements, furniture and equipment, included in other assets, are carried at depreciated cost. Depreciation and amortization are calculated principally on a straight-line method over 15 years. Acquired insurance licenses are carried at amortized cost.\nDebt Issuance Costs\nDebt issuance costs of $2,850,000 associated with the August 1993 issuance of Senior Notes are being amortized over the term of the related debt on a straight-line method. Such amortization expense amounted to $324,000, $456,000 and $95,000 in 1995, 1994 and 1993, respectively, including the pro rata charge of $59,000 and $171,000 relating to $1,925,000 and $5,300,000 of repurchased debt in 1995 and 1994, respectively.\nForeign Exchange\nForeign currency assets and liabilities are translated at the exchange rate in effect at the balance sheet date. Resulting gains and losses are reflected in income for the period.\nFederal Income Taxes\nDeferred tax assets and liabilities reflect the expected future tax consequences of temporary differences between carrying amounts and the tax bases of PXRE's assets and liabilities.\nEarnings Per Share\nPrimary earnings per share are determined by dividing net earnings (after deducting cumulative preferred stock dividends) by the weighted average number of shares outstanding of common stock and common stock equivalents. On a fully diluted basis, both net earnings and shares outstanding were adjusted to assume the conversion of convertible preferred stock from the date of issue, unless the effect of the assumed conversion was antidilutive.\nFair Value of Financial Instruments\nFair values of certain assets and liabilities are disclosed in the notes to the consolidated financial statements based on published market values, if available, or estimates based upon fair values of similar issues. Fair values are reported in Notes 4, 5 and 9.\n2. Business, Risks and Other Matters\nPXRE, through its wholly-owned subsidiary PXRE Reinsurance Company, provides treaty and facultative reinsurance to primary insurers and reinsurers on commercial and personal property risks, and marine and aviation risks. PXRE solicits its treaty and facultative reinsurance business from the worldwide reinsurance brokerage market, committing and withholding its underwriting capacity and altering its mix of business to focus on business where management believes that above average underwriting results can be achieved. To supplement its underwriting capacity and generate management fee income, PXRE manages business for other insurers and reinsurers through retrocessional agreements and management agreements. In recent years, PXRE has been pursuing a strategy of focusing on catastrophe related coverages and diversifying its exposures by writing a substantial amount of international reinsurance. See \"Certain Risks and Uncertainties\" in Management's Discussion and Analysis of Financial Condition and Results of Operations for further information regarding PXRE's business and risks affecting these consolidated financial statements.\n3. Underwriting Programs\nPremiums written and earned for the years ended December 31, 1995, 1994 and 1993 are as follows:\nSubstantially, all premiums written were assumed through reinsurance brokers or intermediaries. In 1995, 1994 and 1993, two, one and two reinsurance intermediaries, respectively, individually accounted for more than 10% of gross premiums written, and collectively accounted for approximately 34%, 21% and 35% of gross premiums written, respectively.\nUnder the terms of the management agreement described in Note 9, PXRE retroceded $24,790,000, $28,722,000 and $270,000 of premiums written to Transnational Reinsurance in 1995, 1994 and 1993, respectively.\nIn the past, PXRE has entered into retrocessional arrangements providing catastrophe protection. In recent years, PXRE reduced, upon renewal, its own catastrophe excess of loss retrocessional facilities (and associated premiums ceded) and has borne the associated increase in net exposures while pursuing various retrocessional arrangements whereby it manages business for participants. Although PXRE elected not to purchase any significant retrocessional coverage in 1995, as the cost of catastrophe retrocessional facilities declined, PXRE has begun again to selectively purchase such coverages. In the event that retrocessionaires are unable to meet their contractual obligations, PXRE would be liable for such defaulted amounts.\nThe components of reinsurance recoverable as stated on the December 31, 1995 and 1994 consolidated balance sheets are as follows:\nThe components of losses and loss expenses incurred as shown in the December 31, 1995, 1994 and 1993 consolidated statements of income are as follows:\nActivity in the losses and loss expense liability for the years ended December 31, 1995, 1994 and 1993 is summarized as follows:\nAs a result of changes in estimates of insured events in prior years, the net provision for losses and loss expenses increased by approximately $4,311,000 in 1995 primarily due to the Northridge earthquake; $3,261,000 in 1994 primarily due to marine pro rata experience and the 1993 Midwest floods and $10,499,000 in 1993 primarily due to hurricanes Andrew and Iniki.\n4. Investments\nThe amortized cost, gross unrealized gains, gross unrealized losses and estimated fair value of investments in fixed maturities and equity securities as of December 31, 1995 and 1994 are shown below.\nProceeds, gross realized gains, and gross realized losses from sales of fixed maturity investments before maturity date or securities that prepay were as follows:\nThere were no sales of equity securities during 1995.\nNet Investment Income\nThe components of net investment income were as follows:\nInvestment Expenses\nInvestment expenses primarily represent fees paid to Phoenix Duff & Phelps Corporation, a public majority-owned subsidiary of Phoenix Home Life Mutual Insurance Company which owned 7.3% of the outstanding common stock of PXRE at December 31, 1995.\nInvestment Maturity Distributions\nThe amortized cost and estimated fair value of fixed maturity investments at December 31, 1995 by contractual maturity date is shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.\nIn addition to fixed maturities, PXRE held $41,721,656 of short-term investments at December 31, 1995, comprised principally of high grade commercial paper with original maturities of one year or less.\nRestricted Assets\nUnder the terms of certain reinsurance agreements, irrevocable letters of credit in the amount of $734,895 were issued at December 31, 1995, in respect of reported loss reserves and unearned premiums. Investments with a par value of $1,500,000 have been pledged as collateral with issuing banks. In addition, securities with a par value of $5,122,000 at December 31, 1995 were on deposit with various state insurance departments in order to comply with insurance laws.\n5. Notes Payable and Credit Arrangements\nIn August 1993, PXRE completed a public offering of $75,000,000 of 9.75% Senior Notes due August 15, 2003. The balance outstanding at December 31, 1995 and 1994, amounting to $67,775,000 and $69,700,000, respectively, is carried at par which approximates fair market value. Interest is payable on the Senior Notes semi-annually commencing February 15, 1994. The notes are redeemable on or after August 15, 1998 at the option of PXRE, initially at 103.656%, declining to 100% at August 15, 2001 and thereafter, plus accrued and unpaid interest. The Indenture governing the Senior Notes contains certain covenants which, among other things, limit the ability of PXRE; (a) to incur certain additional indebtedness and, in the case of the Restricted Subsidiaries (as defined), to issue preferred stock; (b) to pay dividends, repurchase stock and to make certain other Restricted Payments (as defined); (c) to sell or transfer other assets; (d) to create liens; or (e) to engage in any business other than the insurance and reinsurance businesses and other businesses incidental and related thereto. In addition, the Indenture does not permit PXRE to sell or issue any stock of PXRE Reinsurance or any other Principal Insurance Subsidiary. The Indenture also provides that in the event of a Change of Control, PXRE will offer, within 30 days, to purchase all the Senior Notes then outstanding at a purchase price equal to 101% of the principal amount thereof, plus accrued and unpaid interest, if any.\nPXRE Reinsurance has an unsecured line of credit facility under which it can borrow up to $10,000,000 at the lending bank's base rate. At December 31, 1995, no amount was outstanding under this line of credit. No commitment fee was required for this facility.\nInterest and commitment fees paid, were $6,728,000, $7,354,000 and $310,000 for 1995, 1994 and 1993, respectively.\n6. Income Taxes\nThe components of the provision for income taxes for the years ended December 31, 1995, 1994 and 1993 are as follows:\nThe income tax provision for each of the years presented differs from the amounts determined by applying the applicable U.S. statutory federal income tax rate to pre-tax income as a result of the following:\nThe significant components of the net deferred tax provision (benefit) for the years ended December 31, 1995, 1994 and 1993 are as follows:\nThe significant components of the net deferred income tax asset (liability) are as follows:\n7. Leases and Rentals\nRental expenses for operating leases, principally with respect to office space and equipment, amounted to $1,190,000, $923,000 and $837,000 in 1995, 1994 and 1993, respectively.\nFuture net minimum rental payments under non-cancelable operating leases aggregate $5,843,000 as follows: 1996--$901,000; 1997--$513,000; 1998--$434,000; 1999--$406,000; 2000--$401,000; and thereafter $3,188,000.\n8. Stockholders' Equity and Dividend Restrictions\nStockholders' Equity\nAuthorized and issued common stock (1 cent par value) of PXRE consisted of 20,000,000 and 8,983,896 shares as of December 31, 1995.\nIn addition, at December 31, 1995, there were 500,000 shares of serial preferred stock (1 cent par value) authorized and none outstanding. The Board of Directors is authorized to determine the terms of each series of preferred stock which may be issued. During the second quarter of 1992, PXRE completed an offering of 1,059,800 depositary shares, each representing 1\/100 of a share of PXRE's Series A Cumulative Preferred Stock. Each depositary share paid dividends at an annual rate of 8% on its $25 per share liquidation value and was redeemable at the option of PXRE on or after May 1, 1995.\nPXRE exercised its option to redeem PXRE's Series A Preferred Stock (and the related Depositary Shares) on May 1, 1995. At December 31, 1994, there were 10,009 shares of Series A Preferred Stock (1,000,900 Depositary Shares) outstanding. During the second quarter of 1995, all of the outstanding shares of Series A Preferred Stock were converted into shares of PXRE's Common Stock, resulting in the issuance of approximately 1,760,000 shares of PXRE's Common Stock. Each Depositary Share had a conversion price of $12.29 per Depositary Share and was valued for conversion purposes at $25.00, resulting in approximately 2.0342 shares of Common Stock for each Depositary Share converted.\nDividend Restrictions\nThe Insurance Department of the State of Connecticut, in which PXRE Reinsurance is domiciled, recognizes as net income and surplus (stockholders' equity) those amounts determined in conformity with statutory accounting practices (\"SAP\") prescribed or permitted by the department, which differ in certain respects from generally accepted accounting principles. The amount of statutory capital and surplus of PXRE Reinsurance at December 31 and statutory net income for the periods then ended, as filed with insurance regulatory authorities are as follows:\nPXRE Reinsurance is subject to state regulatory restrictions which limit the maximum amount of annual dividends or other distributions, including loans or cash advances, available to stockholders without prior approval of the Insurance Commissioner of the State of Connecticut.\nAs of December 31, 1995, the maximum amount of dividends and other distributions which may be made by PXRE Reinsurance during 1996 without prior approval is limited to its 1995 statutory net income of approximately $37,996,000. Accordingly, the remaining amount of its capital and surplus is considered restricted.\nUnder the terms of the Senior Notes, dividends to PXRE stockholders in any year are limited as described in Note 5.\n9. Investment in TREX\nPublic Offering of Subsidiary\nOn November 1, 1993, a registration statement relating to an initial public offering (the \"Offering\") by TREX of 5,750,000 shares of Class A common stock at $20 per share was declared effective. In conjunction with the formation of TREX and registration of TREX's Class A common stock in the Offering, all of the outstanding capital stock of Transnational Reinsurance (formerly a 100% subsidiary of PXRE Reinsurance) was contributed by PXRE Reinsurance to TREX in exchange for the issuance of 1,535,848 shares of TREX's Class B common stock which caused PXRE Reinsurance's holdings of Class B common stock (when combined with the 100 shares of Class B common stock contributed to PXRE Reinsurance by PXRE in connection with the closing of the Offering) to constitute approximately 21% of all of the outstanding common stock of TREX immediately after the Offering. TREX now specializes in providing brokered property retrocessional reinsurance and marine and aviation retrocessional reinsurance in the United States and international markets pursuant to a management agreement with PXRE Reinsurance. As a result of this transaction, PXRE recorded a pre-tax gain on sale in the fourth quarter of 1993 amounting to $10,563,966 representing the difference between PXRE Reinsurance's interest in the net assets of Transnational Reinsurance immediately after the public offering and the historical book value of its investment in Transnational Reinsurance.\nThe investment in Class B common stock of TREX representing 21.9% of the outstanding Class A and B common stock of TREX is accounted for on the equity method of accounting. Fair value of PXRE's investment in TREX at December 31, 1995 and 1994, based on the closing price of the Class A stock as reported by the NASDAQ National Market System, was approximately $37,631,000 and $36,095,000, respectively.\nSummarized financial information for TREX at December 31, 1995 and 1994 and for the years then ended, respectively, is as follows:\nManagement Agreement\nUnder the Management Agreement between TREX, Transnational Reinsurance and PXRE Reinsurance, Transnational Reinsurance pays PXRE Reinsurance an annual basic management fee equal to 5% of Transnational Reinsurance's gross written premiums. In addition, PXRE Reinsurance will be entitled to receive from TREX a contingent fee equal to 20% of \"net income\" in excess of a 20% \"return on equity\" of TREX, as defined in the Management Agreement, for each year, or part thereof, that the Management Agreement remains effective, commencing January 1, 1994. TREX is required to reimburse PXRE for all expenses directly attributable to it.\nReinsurance Agreement\nIn connection with the closing of the Offering, Transnational Reinsurance and PXRE Reinsurance entered into a reinsurance agreement in order to protect Transnational Reinsurance from adverse loss development and uncollectible reinsurance relating to business written prior to the closing of the Offering. As of December 31, 1995, there have been no incurred losses under this agreement.\n10. Employee Benefits\nBenefit Plans\nEffective January 1, 1993, PXRE adopted a non-contributory defined benefit pension plan covering all employees with one year or more of service and who had attained age 21. Benefits are generally based on years of service and compensation. PXRE funds the plan in amounts not less than the minimum statutory funding requirement nor more than the maximum amount that can be deducted for Federal income tax purposes.\nPXRE also sponsors a supplemental executive retirement plan. This plan is nonqualified and provides certain key employees benefits in excess of normal pension benefits.\nPrior to January 1, 1993, PXRE's employees participated in a non-contributory defined contribution plan and a defined contribution savings and investment plan for employees with one year or more of service and who attained age 21.\nThe net pension expenses for the company-sponsored plans included the following components at December 31, based on a January 1, valuation date (the latest actuarial estimate):\nThe following table sets forth the funded status of the plans and amounts recognized in the consolidated balance sheets:\nThe assumptions used in computing the information above were as follows:\nEmployee Stock Purchase Plan\nPXRE maintains an Employee Stock Purchase Plan under which it has reserved 41,763 shares of its common stock for issuance to PXRE personnel. The price per share is the lesser of 85% of the fair market value at either the date granted or the date exercised. Under the plan 3,768, 3,388 and 3,833 shares of PXRE common stock were issued for total consideration of approximately $84,000, $74,000 and $62,000 in 1995, 1994 and 1993, respectively.\n11. Stock Options and Grants\nThe Financial Accounting Standards Board (\"FASB\") issued Statement of Financial Accounting Standards (\"SFAS\") No. 123 \"Accounting for Stock-Based Compensation\" effective for fiscal years beginning after December 15, 1995. This standard requires disclosure of fair value of all options issued to purchase PXRE stock. PXRE has not adopted SFAS No. 123 at December 31, 1995 and does not believe that the adoption of this standard will have an effect on the financial position of PXRE.\nDuring 1987, PXRE granted six officers options to purchase shares of common stock. All of these options are currently exercisable and expire on March 25, 1997. At December 31, 1995, 151,800 of these options had been exercised.\nPXRE adopted in 1988, a plan which provides for the grant of incentive stock options and non-qualified stock options to officers and key employees. Options granted under the 1988 Stock Option Plan have a term of 10 years and become exercisable in four equal annual installments. The exercise price for options granted pursuant to the plan must be equal to or exceed the fair market value of the common stock on the date the option is granted. At December 31, 1995, 234,925 options had been exercised under the 1988 Stock Option Plan. In 1992, the Board of Directors resolved to freeze the 1988 Stock Option Plan as of December 31, 1992, so that no further options could be granted thereafter under this plan.\nIn 1992, a Restated Employee Annual Incentive Bonus Plan was approved. Incentive compensation is based in part on return on equity compared to a target return on equity and in part on the discretion of the Restated Bonus Plan Committee. In 1995 and 1994, $1,757,000 and $1,343,000, respectively, was incurred under this plan. In addition, 30% of any bonus granted to certain levels of employees is paid in restricted shares of common stock. As of December 31, 1995, 34,000 restricted shares had been granted under this plan.\nIn 1992, PXRE adopted a 1992 Officer Incentive Plan which provides for the grant of incentive stock options, non-qualified stock options and awards of shares of common stock subject to certain restrictions. Options granted under the plan have a term of 10 years and generally become exercisable one year from the date of grant. The exercise price for the incentive stock options must be equal to or exceed the fair market value of the common stock on the date the option is granted. The exercise price for the non-qualified options may be less than, equal to, or greater than the fair market value of the common stock on the date of grant, but not less than 50% of such fair market value. As of December 31, 1995, 162,165 options and no shares of restricted stock had been granted under this plan.\nInformation regarding the above option plans is summarized below:\nTotal authorized common stock reserved for grants of stock options and restricted stock under the above plans is 885,746 shares. Total shares of 200,386 relate to stock options which are exercisable at December 31, 1995, at exercise prices between $8.00 and $25.00. All options become exercisable upon a change of control of PXRE as defined by the plans.\nIn 1990, PXRE adopted a non-employee Director Deferred Stock Plan granting 2,000 shares of its common stock to each non-employee Board member at the time specified in the plan. The 10,000 shares of stock granted to Board members who are not employees of PXRE or Phoenix Home Life will be issued to Board members at or after their retirement according to the option selected from those defined in the Plan. The 6,000 shares granted to Board members who are employees of Phoenix Home Life were issued on August 24, 1993. Increases and (decreases) to the obligations under the Plan amounted to $(25,000), $65,750 and $358,000 in 1995, 1994 and 1993, respectively.\nIn 1995, PXRE adopted a non-employee Director Stock Option Plan which provides for an annual grant of 8,000 options from 1995 to 2005 inclusive. Options granted under the plan have a term of 10 years from the date of grant and are exercisable in three equal annual installments commencing one year from the date of grant. The exercise price of the options is the fair market value on the date of grant. As of December 31, 1995, 8,000 options were granted and none were exercisable.\n12. Segment Information\nPXRE operates in one significant industry segment: property and casualty reinsurance. Domestic gross premiums written represent U.S. based risks written by U.S. based reinsureds. All other gross premiums written are considered international (principally the United Kingdom, Continental Europe, Australia and Asia).\nPXRE has offices in New Jersey and Brussels. The following table shows net premiums earned, operating profit and the aggregate carrying amount of identifiable assets by operational area:\n13. Quarterly Consolidated Results of Operations (Unaudited)\nThe following are unaudited quarterly results of operations on a consolidated basis for the years ended December 31, 1995 and 1994. Quarterly results necessarily rely heavily on estimates. This and certain other factors, such as catastrophic losses, call for caution in drawing specific conclusions from quarterly results. Due to changes in the number of average shares outstanding, quarterly earnings per share may not add to the total for the year.\nThe common stock price ranges are bid quotations as reported by the NASDAQ National Market System.\n(1) The losses and loss expenses incurred during the third and fourth quarters, reflect the release of approximately $3,055,000 and $750,000, respectively, of loss provisions recorded for the Kobe earthquake in the first quarter.\nSchedule II\nParent Company Information\nPXRE Corporation's summarized financial information (parent company only) is as follows:\nSchedule III\nPXRE CORPORATION AND SUBSIDIARY SUPPLEMENTARY INSURANCE INFORMATION\nSchedule VI\nPXRE CORPORATION AND SUBSIDIARY SUPPLEMENTAL INFORMATION CONCERNING PROPERTY -- CASUALTY INSURANCE OPERATIONS\nREPORT OF INDEPENDENT ACCOUNTANTS ON THE FINANCIAL STATEMENT SCHEDULES\nTo the Board of Directors of PXRE Corporation\nOur audits of the consolidated financial statements referred to in our report dated February 15, 1996 appearing on page of PXRE Corporation's Annual Report on Form 10-K for the year ended December 31, 1995, 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.\nPRICE WATERHOUSE LLP\nNew York, New York February 15, 1996\nCONSENT OF INDEPENDENT ACCOUNTANTS\nWe hereby consent to the incorporation by reference in the Prospectuses constituting part of the Registration Statements on Form S-8\/S-3 (Nos. 33-35521 and 33-63768) and Form S-8 (No. 33-82908) of PXRE Corporation of our report dated February 15, 1996 appearing on page of this Form 10-K. We also consent to the incorporation by reference of our report on the Financial Statement Schedules which appears above.\nPRICE WATERHOUSE LLP\nNew York, New York March 27, 1996\nINDEX TO EXHIBITS\n- ------------------------\n* Filed herewith.\n(M) Indicates a management contract or compensatory plan or arrangement in which the directors and\/or executive officers of PXRE participate.\n- ------------------------\n* Filed herewith.\n(M) Indicates a management contract or compensatory plan or arrangement in which the directors and\/or executive officers of PXRE participate.\n- 2 -\n- ------------------------\n* Filed herewith.\n(M) Indicates a management contract or compensatory plan or arrangement in which the directors and\/or executive officers of PXRE participate.\n- 3 -\n- ------------------------\n* Filed herewith.\n(M) Indicates a management contract or compensatory plan or arrangement in which the directors and\/or executive officers of PXRE participate.\n- 4 -\n- ------------------------\n* Filed herewith.\n(M) Indicates a management contract or compensatory plan or arrangement in which the directors and\/or executive officers of PXRE participate.\n- 5 -\n- ------------------------\n* Filed herewith.\n(M) Indicates a management contract or compensatory plan or arrangement in which the directors and\/or executive officers of PXRE participate.\n- 6 -\n- ------------------------\n* Filed herewith.\n(M) Indicates a management contract or compensatory plan or arrangement in which the directors and\/or executive officers of PXRE participate.\n- 7 -\n- ------------------------\n* Filed herewith.\n(M) Indicates a management contract or compensatory plan or arrangement in which the directors and\/or executive officers of PXRE participate.\n- 8 -\n- ------------------------\n* Filed herewith.\n** Filed in paper under cover of Form SE.\n(M) Indicates a management contract or compensatory plan or arrangement in which the directors and\/or executive officers of PXRE participate.\n- 9 -","section_15":""}
{"filename":"216540_1995.txt","cik":"216540","year":"1995","section_1":"Item 1. Business.\n(a) Business Development\nMedical Dynamics, Inc. and MedPacific Corporation, its wholly owned subsidiary (the \"Registrant\"), are engaged in the design, development, manufacture and marketing of medical video cameras and related surgical disposable products for a variety of medical specialties. The Registrant's principal products are small, color, medical video camera systems for use in medical diagnosis and surgical procedures. The Registrant has been manufacturing such cameras since August of 1981. The Registrant's principal executive offices and manufacturing facilities are at 99 Inverness Drive East, Englewood, Colorado, 80112. Its telephone number at that address is (303) 790- 2990.\nThe Registrant was incorporated under the laws of the State of Colorado on March 23, 1971, and began operations in 1973. During 1979, the Registrant began its involvement with medical video camera systems. Initial operations relating to such cameras consisted of the Registrant's purchase of completed cameras from their manufacturer and the retail sale of those products to the medical community. Exclusive marketing rights to a camera system manufactured by another company were acquired and the Registrant served as the distributor of that product until the arrangement was terminated in July of 1981. In August of 1981, the Registrant introduced its first medical video camera of which it was the manufacturer. Thereafter, additional cameras were acquired or developed by the Registrant.\nDuring the fiscal year ended September 30, 1995, the Registrant was not involved in any bankruptcy, receivership or similar proceeding nor did it engage in any material reclassification, merger or consolidation. During that period, the Registrant did not dispose of any material amounts of its assets other than in the ordinary course of its business, with the exception of patent licensing agreements, see note 3 to the financial statements.\nOn October 1, 1989, the Registrant acquired all of the outstanding shares of MedPacific Corporation from Viox Corporation in exchange for 195,000 shares of the Registrant's Common Stock. Included in this acquisition was a trademark and exclusive license to produce, market and distribute the Laser Doppler through March 1994. This investment was fully written-off in the fourth quarter of Fiscal 1992. See \"Model LD6000 Laser Doppler\" under (b)(1) of this Item 1.\nDuring fiscal 1995 the Registrant entered into a distribution agreement with Micro-Medical Devices, Inc. (MMD), of Castle Rock, Colorado. MMD is a corporation formed by and 100% wholly-owned by the Registrants Chairman. MMD manufactures and sells medical products to the Registrant. The distribution agreement signed with MMD will allow the Registrant more flexibility in matching inventory requirements and purchases with currently anticipated sales, thereby reducing inventory carrying costs. See item 12 - Certain Relationships and Related Transactions, \"Distribution Agreement.\"\n(b) Business of the Issuer\nThe Registrant's principal business is the design, development, manufacture and marketing of medical video cameras and related surgical disposable products for a variety of medical specialties. These products are used in surgical, diagnostic, research and teaching applications by physicians and other health care professionals.\nIn recent years, a variety of less invasive diagnostic and surgical techniques have been developed. Such techniques enable operations to be performed or observation to occur with minimal surgical incisions. Among the most common of such surgical techniques is the arthroscopic operation used by orthopedic surgeons. That surgical technique is made possible by means of a rigid endoscope known as an arthroscope. The arthroscope is a high quality optical instrument which is a tube approximately four millimeters in diameter. A light source is attached to the arthroscope and it is inserted through a small incision made in the patient's body. The surgeon is able to observe inside the joints through the lenses of the arthroscope and special surgical instruments are used to perform corrective surgery without open surgery. Arthroscopy has obtained widespread acceptance by orthopedic surgeons and is commonly used to remove damaged cartilage tissue which may result from athletic and other injuries. The use of the technique is less destructive of healthy tissue and thereby decreases the time necessary for healing of the damaged area and reduces the costs of hospitalization and rehabilitation.\nA much more common surgical technique involves the use of a rigid endoscope known as a laparoscope. The laparoscope is used in much the same way as the arthroscope, but is limited primarily to use in the abdominal area. The latest technique involves the use of the laparoscope to remove the gall bladder, a procedure commonly known as laparoscopic cholecystectomy. The laparoscope also is used to perform appendectomies, kidney removal and certain gynecologic procedures. The gynecologic usage accounts for the majority of all laparoscopic procedures at this time.\nThe Registrant's camera systems are utilized in conjunction with an arthroscope, laparoscope or other endoscope. They may also be connected with a microscope for use in microscopic surgery such as hand or eye surgery. The image which may be seen by the surgeon through the endoscope or microscope is viewed by the camera and transmitted to a television monitor. This use of a video camera provides an image which may be viewed by all persons in the operating room, diagnostic laboratory or classroom. The ability to observe the surgery permits the support staff to anticipate the needs of the surgeon and provides a mechanism which facilitates instruction of others. Additionally, the surgeon is provided with a television screen used to reduce intervals of viewing through the endoscope, thereby attenuating eye fatigue. The video camera may also be attached to peripheral equipment which enables the image to be recorded. The procedure and the patient may thereby be studied at a later time.\nAs of September 30, 1995 and 1994, the Registrant had approximately $60,400 and $98,600, respectively, in firm backlog orders for its products. Backlogs are not recorded in sales revenue until the order is shipped.\n(b)(1) Principal Products and Their Markets.\nModels 5960, 5970 and 5980 Cameras. The Registrant currently manufactures and markets a video camera which is designed for most endoscopic applications. Previously, differing light conditions for varying procedures required that different camera models be provided. The current camera models, the 5960, 5970 and 5980, contain a high performance video sensor which provides a brighter picture in lower light level environments than prior solid state cameras. In July 1990, the Model 5960 replaced the model 5940 in the United States. In October 1992, the Model 5970 replaced the Model 5960 in the United States. The Model 5980 utilizes a more advanced \"Digital\" base camera which provides enhanced visualization of the affected areas of the body without the aid of an automatic light source. These models are submersible for liquid sterilization, and have a detachable cable (facilitating replacement of the most frequently failing component).\nThe construction of the Registrant's camera is from standard video camera components which are purchased from major manufacturers of video cameras. The Registrant disassembles the components to enable its cameras to be separated into the camera head and power unit. The electronics are also adjusted as necessary. The Registrant adjusts the focal length of the camera to match the particular endoscope or microscope with which the camera will be used and makes other adjustments to each camera so that the camera will be suitable for use with the particular endoscope and in the particular application for which it is intended. The Registrant produces variations of the Model 5980 camera for use with European format video equipment and to meet specifications of original equipment manufacturer (\"OEM\") customers. These OEM customers market the cameras under their labeling. As a camera accessory, the Registrant offers a character generator whereby a keyboard is used to generate and display patient case data, including such items as date of procedure, patient name, physician, surgical procedure and elapsed procedure time.\nDuring the years ended September 30, 1995, and 1994 approximately 15 and 10, respectively, Model 5960, 5970, and 5980 cameras were sold by the Registrant at prices ranging from $1,600 to $8,075.\nThe Model 5990 Optical Catheter SystemTM. In June 1989 the Registrant introduced a new product in the micro-invasive surgery field, its 5990 Optical Catheter System. The Registrant developed this product from technology originally developed by the Chairman and licensed to the Registrant in response to the trend toward less invasive and less expensive diagnostic and surgical procedures which now are being performed in physicians' offices and outpatient clinics. The system was under development for three years and a prototype was introduced to the medical community during fiscal 1988. The Registrant is manufacturing the 5990 Optical CatheterTM System in its facility and commenced marketing in June 1989. During the fiscal years ended September 30, 1995, and 1994, 10 and 18 Model 5990 Optical Catheter systems were sold by the Registrant, netting sales of approximately $87,500, and $158,200 respectively.\nThe 5990 Optical Catheter System consists of a modular console containing a video camera, a light source, and a monitor. A flexible, small diameter endoscope utilizing the smallest, most flexible and versatile fiber optic image bundles available is attached to the console. This endoscope allows medical specialists to examine almost any area in the body with a puncture as small as that caused by a standard hypodermic needle.\nThe optical fibers contained in the endoscope transmit light from the console to the lens at the tip, and transmit the image from the lens to the camera in the console. The image is then displayed on the video monitor. The endoscopes which can be used with the console range from .5 millimeters up to 1.9 millimeters in diameter. Images produced by the 5990 Optical Catheter System can be preserved by use of recording and printing devices already marketed by the Registrant.\nThe 5990 Optical Catheter System in the future may be configured into a \"Smart\" Optical Catheter System by including additional diagnostic devices with the image sensor. The basic System includes only the image sensor as described in the foregoing paragraphs. The Registrant has developed or purchased additional components which can be inserted through the same catheter. These additional components can monitor and measure pressure, temperature, capillary blood flow, fluorescence and oxygen saturation levels to assist a physician in whatever procedure he or she may be performing on a patient. Although monitoring and measuring such functions is by no means a new concept, traditional methods use a separate piece of equipment which is not an integral part of the viewing system and which require an additional entry way into the body. In the 5990 System, because these additional devices can be inserted through the same catheter which is an integral part of the viewing system, the physician has the ability to view placement of the measuring devices to obtain optimum readings. The features of the Optical Catheter System which allow direct coupling of the diagnostic devices to the image sensors and which convert the light signals into usable diagnostic information are patented to the Registrant.\nThe Optical Catheter System is designed for use in every surgical and medical specialty. As noted, the optical catheter itself can be made very small in diameter (small enough to fit through a 20 gauge hypodermic needle) and can be made to any length. Lengths up to 180 inches have been made without loss of picture quality. The terminal end of optical catheter which contains one or more lenses can be made in any configuration including flexible, rigid and steerable, to suit any procedure required by the physician. Steerability of the terminal end can be in one direction, or in many directions. The Optical Catheter device therefore, is suitable for a wide variety of uses such as looking into joints, the ventricles of the brain, around the spinal cord, through the abdominal wall to look at structures within the peritoneum, or examining the fetus inside the uterus and peering into small diameter blood vessels.\nModels 6400, 6500 and 6600 Light Sources. The Registrant currently produces several light sources used in various procedures in conjunction with the model 1001.00, 5980 and 5500 cameras. The Registrant began production of the model 6500 light source during its 1990 fiscal year and began to market and produce the model 6600 light source during fiscal 1993. The Company began production of the model 6400 light source during fiscal 1995. All model numbers represent current lines used for Arthroscopy, Laparoscopy and various other endoscopic procedures and vary only in the amount and frequency of light emitted from each piece of equipment. The Registrant sold 39 and 26, new light source units during fiscal 1995 and 1994, respectively, netting sales of $137,100 and $99,100.\nAdair\/Veress NeedleTM. The Registrant has sold 1,402 and 1,044 units of a needle used to perforate the abdominal wall for fiscal years ended September 30, 1995 and 1994. Total sales of this product during fiscal 1995 and 1994 were approximately $26,700 and $28,400, respectively. The Medical Dynamics 5990 catheter and other manufacturers fiber scopes can be inserted through the needle, facilitating viewing of affected areas of the abdomen without an incision. The Registrant developed this needle in anticipation of its use in emergency rooms and for certain established laparoscopic procedures. The needle has FDA approval and is patented. See (b)(7) under this Item 1 below.\nPeripherals. The Registrant provides a variety of products designed for use in connection with its cameras. Because the Registrant's cameras are used with a variety of endoscopes and microscopes requiring varying light sources, optical couplers must be supplied to enable connection of the camera, light source and endoscope. These optical couplers are made by a supplier. The Registrant also provides the video monitors for use in connection with its cameras. These monitors are purchased from major electronics manufacturers and then disassembled and modified as needed for medical uses. Installation of medical grade cords, plugs, conductive castors, opto-isolation for control of current leakage and remote footswitching are a few of the modifications provided. Similarly, video cassette recorders of major manufacturers also are purchased by the Registrant, modified and resold for use in connection with its medical cameras.\nThe Registrant continues to market the video printer which it introduced in the fiscal year ended September 30, 1986 and the video floppy introduced during the fiscal year ended September 30, 1987. The video printer enables a video image to be stored on a photographic print while the video floppy unit records field-still pictures on a 2x2 still video floppy. During the fiscal years ended September 30, 1995 and 1994, the Registrant sold approximately 3 and 8 video printer units netting sales of $12,400 and $32,900, respectively. Additionally, 1 and 1 video floppy units were sold during the same periods generating net sales of $1,200 and $1,800, respectively. Sales of related video supplies totaled $34,842 and $71,220 for these same respective periods.\nCam-WrapTM. The Registrant markets a sterile camera cover (the Cam-Wrap) which permits the head and cable of soakable and non-soakable cameras (which cameras were previously manufactured and sold by the Registrant and others) to be draped for sterile requirements of operating rooms. The plastic camera cover is manufactured for the Registrant by a non-affiliated company. Approximately 21,400 and 23,100 units were sold in fiscal 1995 and 1994, respectively, for total sales of $202,500 and $217,500.\nBayne Pap BrushTM. During the fiscal year ended September 30, 1987, the Registrant started manufacturing and marketing a disposable product used to collect cells for Pap smears. The Bayne Pap Brush is constructed of DuPont nylon fibers that can be fitted to any position in or on the cervix. The Bayne Pap Brush collects 10 to 100 times more cells than traditional techniques which significantly decreases the number of false negative Pap smears. Dr. Dean Bayne, the developer of the Bayne Pap Brush, is a director and former employee of the Registrant. The Registrant sells a minimal amount of these brushes annually. Approximately 18,500 and 18,700 units were sold in fiscal 1995 and 1994, respectively, for total sales of $9,990 and $9,930. The Registrant discontinued the production and sale of this device during fiscal 1995 and is interested in licensing the patent and technology of this product to a third party experienced in the distribution, manufacturing and marketing of high volume disposable products. See \"Item 12 - Certain Relationships and Related Transactions.\"\nModel LD6000 Laser Doppler Blood Flow Monitor. The Laser Doppler is an apparatus enabling the measurement of capillary blood flow using coherent light. The unit can be used as a stand alone product or can be combined with the Registrant's Optical CatheterTM System to view and monitor (via laser light) the healing process of affected areas. The Registrant has not sold any units of the LD6000. The main use of the laser doppler will be to measure capillary blood flow of cancerous tissue after the application of certain photo-dynamic therapy drugs have been administered to the affected regions. These photosensitizers emit fluorescent properties which then can be useful in the localization of cancerous tissue. This device when married with the Registrant's Optical Catheter System is expected to form the basis for a Fluorescence Detection System\/Photodynamic Therapy System to be developed in the future, in conjunction with patents owned or licensed by the Registrant regarding the delivery of laser light through endoscopes.\nElectronic Video Laparoscope (EVL). The Model 5500 is a rigid endoscope that utilizes the latest in image processing without the need for multiple optical coupling lenses. The endoscope also eliminates the need for coupling and light source enhancement because it incorporates these features within the design. The Registrant introduced this product in October 1992 and commenced active marketing in April, 1993. During the fiscal years ended September 30, 1995 and 1994, the Registrant sold 35 and 28 units of the EVL control module, to both domestic and foreign markets generating net sales of $175,800 and $127,200. Total gross revenues for all EVL associated products, which includes ancillary scopes, umbilical cables, heads and control modules totalled $264,600 and $326,600 for the respective fiscal years.\nUnlike a conventional surgical camera system which utilizes a separate camera head and coupler that never enters the body, the EVL incorporates an image sensor chip at the tip of the laparoscope. As a result, the EVL, dubbed \"Chip on a Stick\", places the imaging chip in closer proximity to the anatomy being viewed, thereby creating a significantly higher resolution picture and increased illumination. With the elimination of the ancillary head and coupler, the Registrant has created a lighter weight device that requires only an optional focusing or magnification mechanism and eliminates the problem of fogging between the coupler and eyepiece. All of these features add up to a safer, more efficient device for use by surgeons.\nIn addition to the diagnostic versions of the EVL in 0 and 30 degree viewing angles, the Registrant received FDA approval in September, 1994 for the Operative Video LaparoscopeTM in both 3 and 5 millimeter working channels. These devices are believed to be a significant improvement over existing operative scopes on the market in that they allow the same bright, high resolution picture as the standard EVL, with additional capability to insert operative instruments or laser fibers through the working channels. Most competing operative scopes lack illumination and picture quality due to their less-than-optimal configuration. These devices have been added to the current product line.\nLap-WrapTM. In conjunction with the EVL, Medical Dynamics also markets the Lap-Wrap, a disposable sterile sheath and sleeve for the EVL and other manufacturers' brands of laparoscopes and camera systems. The product is part of the Company's line of higher-margin disposable accessories. The Lap-Wrap is a low cost alternative ($24 list) to current sterilization and disinfection techniques. It reduces repair costs on scopes and camera systems, and also eliminates the potential environmental and health hazards associated with exposure to chemical soaking solutions or ETO (gas) sterilization. During the fiscal years ending September 30, 1995 and 1994, 314 and 689 cases of Lap-Wrap were sold resulting in revenues of $49,100 and $117,500, respectively. Both the EVL and Lap-Wrap, which combine to form a patented device, have been licensed (See Licenses in Part I (b)(7)) to Medical Dynamics by the inventor and Chairman of the Registrant, Dr. Edwin L. Adair.\nUniversal Sterile Endoscopy SystemTM (USESTM). At the end of fiscal 1995 the Registrant introduced this new product. It consists of a non-soakable camera system that utilizes a proprietary \"closed system\" drape with each use. The advantages of this system over competitors models is the ability to have an absolutely sterile camera for every surgical case, at approximately one-third the price of competing models. Fiscal 1995 sales were minimal as the product is in the introductory stage. See item 12 - Certain Relationships and Related Transactions, \"Distribution Agreement.\"\nInventory. The Registrant is required to carry significant quantities of inventory to meet rapid delivery requirements of customers or to assure itself of a continuous allotment of goods from suppliers. The Registrant has continued to maintain its inventory of components on its Models 5500, 5960, 5970, and 5980 cameras; the 5990 Optical CatheterTM System, and various peripherals. Sufficient quantities of the Registrant's disposable product line such as Lap-Wrap and Cam-Wrap must also be maintained in anticipation of customer's future needs. The Registrant typically sells product on a net 30 day basis to all domestic customers and a net 60 to 90 day basis to foreign customers and distributors. With some exceptions, most foreign distributors post letters of credit to insure payment on orders. Inventory levels net of allowance for obsolescence for the fiscal years ended September 30, 1995 and 1994 were $948,500 and $984,300 respectively.\nWarranty. The Registrant's medical video cameras are warranted for a one- year period with respect to parts and labor required as a result of defects in material and workmanship. Cables and optical couplers are warranted to be free of defects for a period of 180 days. Defects or malfunctions are corrected by the Registrant at the Registrant's cost, if the applicable conditions to the warranty are satisfied. In the event warranty repairs cannot be effected within five days, the Registrant generally provides loaner cameras for customer use. Failures normally occur during the early life of the cameras, and repair expenses usually occur in the same year in which the camera is initially placed in service. The Registrant estimates future warranty costs and enters the estimated expenses into its results of operations based upon historical experience and revenues currently reported. The estimated warranty reserve at fiscal year end September 30, 1995 and 1994 was $25,000 and $50,000, respectively.\n(b)(2) Distribution Methods\nThe Registrant's video camera systems and disposable medical products are sold principally to physicians and hospitals. The Registrant has engaged in marketing and advertising of its products at professional seminars and specialty meetings, direct mail promotions, telemarketing, and through a sales representative network. During the years ended September 30, 1995 and 1994, the Registrant expended $258,800 and $254,200, respectively, on sales promotions, conventions and advertising expenses.\nThe Registrant has engaged approximately 18 organizations with approximately 38 field sales representatives to market its camera systems in the United States. Most major domestic sales territories are covered by the current sales representative network. The sales representatives enter into a one year agreement with the Registrant under which they receive commissions of 15% to 20% on video camera sales revenues, 10% to 15% on camera accessories and 10% to 20% on disposable product sales generated by them in exclusive marketing areas. All selling expenses are borne by the sales representative. The sales representative agreements prohibit each representative from purchasing or dealing in products of competitors of the Registrant. In addition to sales made in this manner, the Registrant also modifies some of its products to display the labeling of its customers. Those customers then sell the products directly to end-users.\nAs of the fiscal year ended September 30, 1995, the Registrant engaged approximately 12 agents to sell video cameras in areas outside the United States. The primary foreign territories where the Registrant has distributors are Japan, United Kingdom, Western Europe, Spain, and Latin America.\nDuring each of the past two fiscal years, sales of various models of video camera systems (including ancillary camera equipment) contributed more than 15% of the Registrant's total revenue. The percentages of the Registrant's revenues contributed by this product group during the fiscal years ended September 30, 1995 and 1994 were 36% and 40%, respectively.\n(b)(3) Status of New Products.\nThe Registrant has several products which are in various stages of development.\n3-D Electronic Video LaparoscopeTM (patent pending). Medical Dynamics has developed a prototype (not yet FDA approved), through its licensing agreement with the Registrant's Chairman, of this new technology, which combines two EVL systems within a single laparoscope to produce a three-dimensional view of the target area. In laparoscopic surgery, where surgeons are required to grasp and manipulate organs, vessels and tissue, the depth of field obtained through 3-D is superior to the \"flat field\" effect of two-dimensional camera systems. A commercial product is expected to be introduced within two years provided the market warrants such an introduction and FDA approval is received.\n(b)(4) Competition.\nWith regard to the Registrant's medical video cameras, the principal competitive factors to which it is subject are price, technological configuration, product performance, and product line diversification. Principal competitors in the United States include Circon\/ACMI Corporation, Stryker Corporation, Olympus, Wolf, and Karl Storz, each of which manufactures and sells some form of medical video system, and there are certain competitors overseas. The principal reasons why sales volumes remain volatile are fluctuating OEM revenue, the limited product line presently offered by the Registrant, a limited amount of capital available to promote the products through successful marketing efforts and distribution channels, and the continuing uncertainty surrounding the effects of a proposed national health care plan. Such limitations have proven detrimental to the ongoing operations of the Registrant to date. The industry has experienced a contraction of camera manufacturers over the past several years but the Registrant anticipates that other companies may enter into the manufacture and sale of small color video systems, thereby causing further competition in this field. The prices charged and warranties provided by the Registrant and competing manufacturers of surgical video camera systems are similar.\nThe Registrant's 5990 Optical Catheter SystemTM is protected by a number of patents licensed to the Registrant by it's Chairman, and to the Registrant's knowledge, no similar systems are presently being marketed. Both the 5990 Optical Catheter System and the 5500 EVL are subject to competition from the Registrants model 5980 camera and similar cameras manufactured by the Registrant's competitors, although the Registrant believes the 5990 is more suitable for office use than such other cameras.\n(b)(5) Availability of Raw Materials.\nFor a number of years, the Registrant had purchased cameras from Panasonic Industrial Company - Audio Video Systems Group (\"Panasonic\") exclusively. The Registrant now procures cameras from additional sources without sacrificing product or picture quality. Management believes the additional product resources, combined with current purchasing practices more in line with \"just- in-time\" inventory management, are beneficial to the Company. The Registrant has entered into an agreement with a United States manufacturer to supply the head cables used in its camera products and has negotiated a similar agreement with another United States manufacturer. If these sources of head cables were not available, the Registrant believes it would be materially affected, as other sources for these camera head cables may not be available to the Registrant.\n(b)(6) Principal Customers.\nThe Registrant had one customer who contributed 10% or more of gross revenues for fiscal year 1995. There were two such customers during fiscal year 1994. Gross billings to Rosot Enterprises of Locust Valley, New York during fiscal years 1995 and 1994 were $297,700 and $189,300 or 23.1% and 12.2% of Registrant revenues, respectively. Rosot Enterprises is an international distributing company which concentrates on Mexico, Central and South America. During fiscal year 1994 Shipments to Endosurgical Development Corporation (EDC) of Rolling Hills, California totaled $227,000 or 14.7% of the Registrants gross billings.\n(b)(7) Patents, Trademarks, etc.\nPatents. Although the Registrant does not own any patents relating to its Optical Catheter SystemTM, it holds an exclusive license on three patents related to this camera system. United States Patents No. 4,782,819, No. 4,736,733, and No. 4,754,328 expiring November 8, April 12, and June 28, 2005, respectively, relating to the Optical CatheterTM are owned by Dr. and Mrs. Adair and licensed on an exclusive basis to the Registrant. The terms of the license agreement are described under \"Licenses\" below. In addition, Dr. and Mrs. Adair have applied for several more patents on behalf of the Company relating to the 5990 Optical CatheterTM System, which applications are pending at the date of this filing.\nIn addition to the above referenced patents, the following patents are also licensed to the Registrant from the Chairman:\nThe Registrant has also licensed the rights on pending patents covering such technology and devices as \"Miniaturized Electronic Imaging Chips\", \"Imaging Tissue or Stone Removal Basket\", \"Steerable Sheath for use with Selected Removable Optical Catheter\", and \"Stereoscopic Endoscope\", among others.\nThe Bayne Pap BrushTM is subject to United States Patents No. 4,762,133, No. 4,754,764 and No. 4,873,992 expiring August 9, 2005 through October 17, 2006. Dr. Bayne, a director of the Registrant, assigned these patents to the Registrant and is entitled to receive a royalty of two percent of net sales of the product after recovery of certain expenses. No royalties have been accrued or paid to Dr. Bayne on this product.\nTrademarks. The Registrant is also the holder of United States Trademarks, registration numbers 1,299,413, 1,299,414, and 1,719,664 which relate to the name \"Medical Dynamics\", the corporate logo of the Registrant, and the Adair\/Veress Needle respectively. The trademarks are granted for a term of 20 years expiring October 8, 2004, and if still in use at that time may be renewed for successive 20-year periods by application. In addition, the Registrant claims rights in numerous unregistered trademarks which it uses in interstate commerce, and which are subject only to common law protection. Additionally, the Registrant holds trademark registration number 1,282,319 which relates to the name \"MedPacific Corporation\" and its corporate logo. This Trademark was renewed for a 20 year term in June 1990. The Registrant also has trademark applications pending on a variety of products including the EVL and Lap-WrapTM.\nLicenses. The Registrant entered into an exclusive revocable license agreement with Dr. Edwin Adair effective June 3, 1987, as amended, relating to use of certain technology invented and developed by Dr. Adair relating to certain malleable endoscopes, flexible optical catheters, the Adair\/VeressTM needle and complementary viewing systems for use in connection with detection, diagnosis and treatment of disease or injury in humans and animals. The Registrant used this technology to develop the 5990 Optical CatheterTM System, the Electronic Video Laparoscope (EVL), and the Lap-WrapTM. Dr. Adair is entitled to receive a royalty equal to the greater of two percent of net sales involving the licensed technology or a minimum annual royalty. Since inception and through September 30, 1995, $510,000 has been paid to Dr. Adair under this license agreement, and an additional $90,000 has been accrued. See Item 12, below for more information regarding license agreements.\n(b)(8) and (9) Government Regulation.\nThe United States Food and Drug Administration (the \"FDA\"), pursuant to the Medical Device Amendments of 1976 to the Food, Drug and Cosmetic Act (the \"Act\") and regulations promulgated thereunder, regulates the testing, manufacturing, packaging, distribution and marketing of medical devices in the United States, including the products manufactured by the Registrant.\nThe Act requires manufacturers of medical devices to register annually and, semi-annually, to list new devices being produced by the manufacturer for commercial distribution.\nThe Act also classifies medical devices and requires compliance with specific manufacturing and quality assurance standards. The FDA has published regulations defining good manufacturing practices to provide that each step of the manufacturing process for any device is controlled to maximize the probability that the finished product meets all quality and design specifications. The regulations also require that each manufacturer establish a quality assurance program by which the manufacturer monitors the manufacturing process and maintains records which show compliance with the FDA regulations and the manufacturer's written specifications and procedures relating to the devices.\nThe Registrant's facilities and records are subject to periodic unannounced inspections by the FDA for compliance with the applicable FDA regulations. The FDA may issue reports or citations where the manufacturer has failed to comply with all appropriate regulations and procedures. If the FDA finds a manufacturer not to be in such compliance, the FDA may prohibit a manufacturer from marketing the products for which the manufacturer is not in compliance, until such time as the manufacturer complies with the applicable FDA regulations with respect to those products. Compliance with the provisions of the Act and the FDA's regulations is time consuming and expensive due to the extensive record keeping required.\nDuring October, 1994, The Federal Food and Drug Administration performed a routine inspection of the Registrant's premises and issued a Form 483 \"Inspectional Observations\" itemizing certain deviations in the Registrant's sterilization procedures from that required in the FDA's regulations. The registrant has responded with a letter defending it's practices and to date has received no further response from the FDA. If the FDA continues to request the proposed changes after receipt of the company's response, the registrant will implement the requested changes. Management expects no negative product or financial ramifications from this action, although no assurances to that effect can be made.\n(b)(10) Research and Development.\nDuring the fiscal years ended September 30, 1995 and 1994, the Registrant spent approximately $228,100 and $142,500, respectively, on company-sponsored research and development activities. During those periods, there were no customer-sponsored research activities relating to new products, services, tech- niques or to the improvement of existing products, services or techniques.\n(b)(11) Compliance With Environmental Laws.\nThe Registrant is not materially affected by federal, state and local provisions which have been enacted or adopted regulating the discharge of materials into the environment or otherwise relating to the protection of the environment.\n(b)(12) Employees.\nAt September 30, 1995, the Registrant employed 18 persons, including 4 persons engaged in general administration, and 14 persons engaged in production, distribution, and customer service of the Registrant's products.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Description of Property.\nThe Registrant leases 18,358 square feet of space at 99 Inverness Drive East, Englewood, Colorado, where its principal executive offices are located and its business activities, including research, assembly, storage and customer service, are conducted. The Registrant has used the bulk of these facilities since 1981. A three-year extension to the lease expired December 31, 1995. This lease has been renewed for an additional three-year term, expiring on December 31, 1998. The current lease and all extensions obligate the Registrant to pay monthly rentals in the following amounts:\nThrough December 31, 1995 $11,075 January 1 - December 31, 1996 $12,315 January 1 - December 31, 1997 $13,080 January 1 - December 31, 1998 $13,845\nThe Registrant pays certain maintenance, insurance, common area and other expenses with respect to the property to the extent that the lessor's costs for such items exceed a specified amount. The Registrant also pays any increases in property taxes due to improvements on the property and pays for utilities.\nThe Registrant also rents temporary storage space in mini-warehouses located near its principal executive offices. During the fiscal year 1995 the average monthly cost amounted to $380.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nThere are no material pending legal proceedings or proceedings known to be contemplated by governmental authorities.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nThe Registrant has not submitted any matter to a vote of security holders during the fourth quarter of the fiscal year ended September 30, 1995.\nPART II\nItem 5.","section_5":"Item 5. Market for Common Equity and Related Stockholder Matters.\n(a) Market Information\nThe Registrant's $.001 par value common stock (the \"Common Stock\") is traded in the over-the-counter market and price quotations for the two years shown below were reported on the National Association of Securities Dealers Automated Quotation System (\"NASDAQ\") under the symbol \"MEDY\". The quotations shown below were compiled by the Registrant from Monthly Statistical Reports supplied by the NASD. All quotes represent inter-dealer quotations, without retail markup, mark-down or commission and may not necessarily represent actual transactions in the Common Stock:\n(b) Holders\nThe number of record holders of the Common Stock, as of September 30, 1995, was 13,604 not including an unknown number of beneficial holders in street name.\n(c) Dividends\n(c)(1) Payment of Dividends.\nThe Registrant has never paid a dividend with respect to its Common Stock and does not intend to pay such a dividend in the foreseeable future.\n(c)(2) Restrictions on the payment of dividends.\nThere are no contractual restrictions on the Company's present or future ability to pay dividends.\nItem 6.","section_6":"Item 6. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nLiquidity and Capital Resources. (September 30, 1995 as compared to September 30, 1994) During the fiscal year ended September 30, 1995, the Registrant's current ratio declined to 7.2 as compared to 10.1 at September 30, 1994. Net working capital decreased approximately $1,073,800, due primarily to the use of cash in operations and the resulting operating loss. Cash has been used primarily to fund the general operations of the Registrant including research and development, and to promote the sales and marketing of products.\nPrincipal changes in the components of net working capital for the twelve months ended September 30, 1995 consist of a decrease in accounts receivable of $66,200, a decrease in trade notes receivable of approximately $16,000, Micro-Medical Devices, Inc. cash advances of $110,000, a decrease in reported inventory levels by $35,800 (net of an increase in the obsolete inventory reserve of $100,000 and non-cash loaner equipment transfers of $15,700), net purchases and sales of short term investments with maturities of 60 days or less of $1,000,500, a reduction in prepaid expenses of $9,200, and a reduction in current liabilities by $7,800 to the current level of $354,300.\nDuring the twelve months ended September 30, 1995, the Registrant experienced a negative cash flow from operations of approximately $1,102,200 as compared to a negative cash flow from operations of approximately $937,200 during the comparable period of the prior fiscal year. The aggregate increase in cash used for operations during FY 1995 versus FY 1994 was a result of the following factors: Cash of $79,900 was used in FY 1995 to increase inventory levels of current products in anticipation of expected future sales, where during FY 1994 the Company reduced inventory by the amount of $226,300. Accounts payable, accrued expenses and product warranty costs were reduced during FY 1995 and FY 1994 requiring cash outlays of $7,800 and $278,200 respectively. Aggregate trade accounts and notes receivable cash collections reduced outstanding balances by $66,200 during FY 1995 versus a reduction of $267,500 during FY 1994.\nTo curtail operating losses, negative cash flow from operations and liquidity erosion further, management is continually reviewing all expense accounts to determine if any additional reductions in expenditures are possible. Purchasing procedures have also been implemented to minimize product cost and avoid excess inventory levels.\nDuring Fiscal 1995 the Registrant maintained workforce levels approximately the same as the levels of fiscal year 1994. Health insurance expense and property and casualty insurance expense were rebid at the end of fiscal 1994 in a successful effort to maintain equivalent coverage at significantly reduced expense. During fiscal 1995 the Registrant realized savings of approximately $19,400 in insurance expenses.\nA distribution agreement signed with Micro Medical Devices, Inc. will allow the Company more flexibility in matching inventory requirements and purchases with currently anticipated sales, thereby reducing inventory carrying costs. See item 12 - Certain Relationships and Related Transactions, \"Distribution Agreement.\"\nThe Company also entered into a revised license agreement with Dr. Edwin Adair in an effort to reduce patent maintenance costs and other associated costs. In addition, the Registrant prepaid royalties due to Dr. Adair for fiscal year 1996 by issuing an option to him in lieu of cash.\nWithout significant sales increases, the Registrant anticipates negative cash flow from operations for fiscal 1996 and beyond. The Registrant's future viability depends on its ability to generate cash to fund it's operations. In the short term, this was accomplished through equity placements during fiscal 1994, and in previous fiscal years through loans from the Registrant's Chairman. However, the Registrant's ability to fund its operations will be dependant upon achieving profitability and in generating a positive cash flow from operations. Unless the Registrant is able to increase sales revenues and maintain profitability, the Registrant may be facing significant working capital shortages beginning in fiscal year 1996. There can be no assurance that the Registrant will be able to achieve this goal as there are no new sales revenue sources at September 30, 1995. Should the Registrant be unable to meet future minimum royalty payments to the Registrant's Chairman beginning October 1, 1996, then under the terms of the licensing agreement the majority of patent rights under the agreement could revert back to the Registrant's Chairman, unless further compensatory arrangements are made. Possible compensation arrangements could include stock options in lieu of royalties or deferral of royalty payments, among others. No assurances can be given that these arrangements will be made. The majority of the Registrant's products use patents licensed to the Company by the Chairman. See item 12 - Certain Relationships and Related Transactions, \"Distribution Agreement.\"\nThe Registrant believes that its existing capital resources are sufficient for the current fiscal year, and the Registrant has planned no significant capital expenditures. The Registrant is not seeking additional debt or equity capital at this time. If, however, the Registrant does obtain additional capital (of which there can be no assurance), the Registrant will be able to allocate more resources to sales and marketing efforts (including negotiations with prospective OEM relationships), and research and development.\nResults of Operations. (September 30, 1995 as compared to September 30, 1994) As an aid to understanding the Registrant's operating results, the following table indicates the percentage relationships of principal revenue and expense items to total net sales included in the consolidated statements of operations for the years ended September 30, 1995, and 1994 and the percentage changes in those items for the same years.\nAdditionally, as an aid to understanding trends and factors of the Registrant, the following ratios describe historical summaries of liquidity, activity and profitability ratios for the years ended September 30, 1995 and 1994.\nRevenue. Revenue decreased $251,600, or 17.4% primarily as a result of a decrease in sales of the following product groups: catheters & accessories of $137,600, a decrease in general accessories of $15,800, and a decrease in cam wrap and lap wrap sales of $88,600. The continuing decrease in domestic, non OEM sales is primarily the result of the decrease in capital budget expenditures in hospitals and increased competition from other manufacturers of surgical cameras. The Registrant believes the capital equipment market will rebound somewhat in fiscal 1996 due to both the expansion of the office endoscopy market and the hospitals needing to replace outdated endoscopy equipment, but the Registrant is also taking steps to introduce products in the fiscal 1996 time frame that address the combined issues of cost and sterility that plague the capital tight hospital market, although no assurances of the success of that strategy can be given.\nOEM sales decreased during fiscal 1995 to $132,900 from $160,400 during fiscal year end 1994. This decrease is due primarily to reduced shipments to Endosurgical Development Company (EDC). The Registrant is attempting to replace the OEM revenue base lost during fiscal 1992 by expanding existing business with current OEM customers such as Endosurgical Development Corporation (EDC), and cultivating new relationships that are in the beginning stages of sales such as Origin Medsystems, Inc., a subsidiary of the Eli Lilly Company. As of the Registrants fiscal 1995 year end, backorders from these companies totaled approximately $63,400 consisting of orders from Origin Medsystems for Adair Veress needles. In the upcoming fiscal year the Registrant expects to expand revenues from all of these OEM customers as well as attempt to add others in the areas of general laparoscopy, arthroscopy, cardiovascular surgery, dental endoscopy, as well as add a national distributor for the Registrant's Lap-WrapTM and Coupler DrapeTM products, although no assurances can be given as to the success of these efforts.\nForeign market sales revenues decreased by $139,800, or 23.4% over fiscal 1994. The Registrant added two additional distributors in Pakistan and the Middle East and expects expansion of the foreign distribution network in fiscal 1996 along with an increase in revenues from this source, although no assurances can be given as to the success of those efforts.\nCost of Goods Sold. Cost of Goods Sold for the fiscal years ended 1995 and 1994 were $1,112,400 and $1,219,200 respectively, for a decrease of $106,800 or 8.8%. Cost of goods sold as a percent of revenue increased to 93.1% for fiscal 1994 from 84.2% in Fiscal 1994. The principal reason for the decrease in overall cost of goods sold is lower sales volumes, while the increase in cost of sales as a percentage of gross revenue is attributed to lower production volumes and charging excess manufacturing capacity to cost of goods sold. Varying sales mixes are an additional factor in the cost of sales percent increase. Underabsorbed overhead variances will continue to adversely affect cost of goods sold as a percentage of revenues during fiscal 1996 until such time that increases in sales and production volumes materialize.\nSelling, General & Administrative Expenses (S,G&A). S,G&A expenses for the fiscal years ended 1995 and 1994 were $1,364,400 and $1,539,200, respectively, for a decrease of $174,800 or 11.4%. The decrease is primarily due to the effectiveness of cost cutting measures instituted by management during fiscal years 1995 and 1994 and precipitated by lower sales and production volumes. The Registrant continues to reduce or eliminate expenses in all areas when practical including executive compensation, employee benefits, and travel & promotions. Subsequent to year end the Registrant amended its license agreement with its Chairman whereby he will forgo $120,000 in royalty payments for fiscal 1996 in exchange for options to purchase 120,000 shares of the Registrants common stock at $1.00 per share. No such waiver exists beyond fiscal 1996.\nResearch and Development Costs. Research and Development costs for the fiscal years ended 1995 and 1994 were $228,100 and $142,500, respectively, for an increase of $85,600 or 60.1%. The increase is primarily attributable to projects related to electrical compatibility conversions in the European market and the USESTM system. The USES system was transferred to Micro Medical Devices under the new distribution agreement. See item 12 - Certain Relationships and Related Transactions, \"Distribution Agreement.\" The Registrant will continue to fund Research and Development as it deems appropriate to maintain or gain a competitive advantage.\nEffect of Changing Prices and Inflation\nGenerally, inflation has not been a significant factor on the Registrant's operations.\nItem 7.","section_7":"Item 7. Financial Statements.\nThe following financial statements are filed as a part of this Form 10-KSB and are included immediately following the signature page.\nReport of Independent Certified Public Accountants\nBalance Sheet - September 30, 1995 and 1994\nStatements of Operations - Years ended September 30, 1995 and\nStatements of Stockholders' Equity - Years ended September 30, 1995 and 1994\nStatements of Cash Flows - Years ended September 30, 1995 and 1994\nNotes to Financial Statements\nItem 8.","section_7A":"","section_8":"Item 8. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.\nThe Company has not changed its principal independent accountant during the two most recent fiscal years. Thus, this item is not applicable.\nPART III\nItem 9.","section_9":"Item 9. Directors, Executive Officers, Promoters and Control Persons of the Company; Compliance With Section 16(a) of the Exchange Act.\n(a) Identification of Directors and Executive Officers.\nThe following table sets forth certain information regarding the directors and executive officers of the Registrant:\nName Age Position\nEdwin L. Adair, M.D. (1) 65 Chairman of the Board and Treasurer\nVan A. Horsley 43 Director, President, Chief Financial Officer and Chief Executive Officer\nPat Horsley Adair (1) 67 Director and Secretary\nI. Dean Bayne, M.D. 68 Director and Assistant Secretary\nLeroy Bilanich 45 Director\nJo Brehm 59 Vice President - Sales and Administration\n(1) Members of the Compensation Committee.\nNo arrangement exists between any of the above officers and directors pursuant to which any one of those persons was elected to such office or position.\nDirectors hold office until the next meeting of shareholders and until a successor is elected and qualified, or until their resignation. Executive officers are elected at annual meetings of the Board of Directors. Each such officer holds office for one year or until a successor has been duly elected and qualified or until death, resignation or removal.\nEdwin L. Adair, M.D. has been a director of the Registrant since June 30, 1971, Chairman of the Board since September 8, 1981 and Treasurer since March 27, 1973. From February 6, 1986 until July 13, 1990, Dr. Adair also served as Chief Executive Officer of the Registrant. Dr. Adair received B.S. and M.D. degrees from the University of Colorado in 1951 and 1955, respectively. He practiced medicine from 1956 until 1983 and is a board-certified urologist who discontinued the practice of medicine due to a physical disability resulting from an accident. Dr. Adair has published articles in medical journals and has taught at the University of Colorado School of Medicine. Dr. Adair is a member of the American Medical Association, American Board of Urology, the American Urological Society and the American College of Surgeons. The Registrant carried $1,100,000 of key man insurance on the life of Dr. Adair through the end of the current fiscal year, however, subsequent to the end of fiscal 1995 this amount was reduced to $100,000 as a cost cutting measure.\nVan A. Horsley has been a director, President and Chief Executive Officer of the Registrant since July 13, 1990. From March 1, 1990 until July 13, 1990, Mr. Horsley served as Chief Financial Officer. Mr. Horsley holds a B.S.B.A. degree in finance from the University of Denver and a graduate degree from the School of Banking at the University of Colorado. From 1974 to February 28, 1990, Mr. Horsley was employed in various capacities by Affiliated Denver National Bank in Denver, Colorado and from 1985 through February 28, 1990 served as executive vice president - head of lending.\nPat Horsley Adair has been a director and Secretary of the Registrant since September 8, 1981. Mrs. Adair attended McMurray College in Abilene, Texas, taking courses in English and business which did not lead to a degree. From June 1974 to July 1983, Mrs. Adair was employed by the Registrant as office manager. Since that time, Mrs. Adair has served as Corporate Secretary to the Registrant. From 1964 to 1975, Mrs. Adair served as executive director of the Arapahoe County Medical Society and from 1976 to 1980 she served as executive director of the Metro Denver Foundation for Medical Care, an organization which serves Arapahoe, Denver, Boulder, Jefferson and Adams counties, Colorado.\nI. Dean Bayne, M.D. has been a director of the Registrant since July 1987 and Assistant Secretary since October 1988. Dr. Bayne received B.S. and M.D. degrees from Louisiana State University in 1949 and 1953, respectively, and has been engaged in private medical practice since 1958. He attended Louisiana State University. Dr. Bayne was a resident in obstetrics at Herman Kiefer Hospital, Detroit, Michigan, and a resident in gynecology at Detroit Receiving Hospital, Detroit, Michigan. He is a member of the Board of Obstetrics and Gynecology and the American College of Obstetrics and Gynecology.\nLeroy Bilanich, Ed.D. has been a director of the Registrant since September 13, 1990. Dr. Bilanich has a B.S. in journalism and broadcasting from Pennsylvania State University, an M.A. in communication from the University of Colorado and has an Ed.D. in organizational behavior from Harvard University. Dr. Bilanich currently works as a consultant to large corporations in the area of organizational development and in the past has held various positions in the Human Resource Departments at Pfizer, Inc. from 1983 to March of 1988 and the Olin Corporation.\nJo Brehm is Vice President - Sales and Administration of the Registrant. She has been an employee of the Registrant since 1973. From December 1984 to September 1988, Mrs. Brehm served as Vice President of the Registrant. From September 1988 until July 1990, Mrs. Brehm served as President of the Registrant. In each position, Mrs. Brehm has performed various duties including management of customer service and order processing, as well as administration of the Registrant's office affairs, personnel relations and medical standard compliance activities. She also handles all OEM and foreign distributor relationships. In her present position, Mrs. Brehm continues to direct these activities as well as supervising the Registrant's general and administrative activities.\nNo director of the Company is a director of another company having securities registered under Section 12 of the Securities Exchange Act of 1934 or a company registered under the Investment Company Act of 1940.\n(b) Identification of Certain Significant Employees.\nThere are no significant employees who are not also directors or executive officers, described above.\n(c) Family relationships.\nDr. Edwin L. Adair and Pat Horsley Adair are married. Van A. Horsley is the son of Pat Horsley Adair. There are no other family relationships among the officers or directors.\n(d) Involvement in Certain Legal Proceedings.\nDuring the past five years, no director or officer of the Company has:\n(1) Filed or has had filed against him a petition under the federal bankruptcy laws or any state insolvency law, nor has a receiver, fiscal agent or similar officer been appointed by a court for the business or property of such person, or any partnership in which he was a general partner, or any corporation or business association of which he was an executive officer at or within two years before such filings;\n(2) Been convicted in a criminal proceeding or is a named subject of a pending criminal proceeding (excluding traffic violations and other minor offenses);\n(3) Been the subject of any order, judgment, or decree, not subsequently reversed, suspended or vacated, of any court of competent jurisdiction, permanently or temporarily enjoining such person from, or otherwise limiting his involvement in any type of business, securities or banking activities.\n(4) Been found by a court of competent jurisdiction in a civil action, the Securities and Exchange Commission or the Commodity Futures Trading Commission to have violated any federal or state securities or commodities law, which judgment has not been reversed, suspended, or vacated.\nCompliance with Section 16(a) of the Exchange Act\nSection 16(a) of the Securities Exchange Act of 1934 (the \"Exchange Act\") requires the Company's directors and officers and persons who own more than ten percent of the Company's equity securities, to file reports of ownership and changes in ownership with the Securities and Exchange Commission (the \"SEC\"). Directors, officers and greater than ten-percent shareholders are required by SEC regulation to furnish the Company with copies of all Section 16(a) reports filed.\nBased solely on its review of the copies of the reports it received from persons required to file, the Company believes that during the period from October 1, 1994 through September 30, 1995 all filing requirements applicable to its officers, directors and greater than ten-percent shareholders were complied with except as follows:\nVan Horsley, president of the Registrant, filed a form 4 reporting an event which occurred in June 1995 late. This report was filed in August 1995.\nJo Brehm, vice president of the Registrant, filed a form 4 reporting an event which occurred in June 1995 late. This report was filed in August 1995.\nDr. & Mrs. Edwin Adair, chairman and secretary of the Registrant, filed a form 4 reporting an event which occurred in June 1995 late. This report was filed in August 1995.\nI. Dean Bayne, director of the Registrant, filed a form 4 reporting an event which occurred in June 1995 late. This report was filed in August 1995.\nLeroy J. Bilanich, director of the Registrant, filed a form 4 reporting an event which occurred in June 1995 late. This report was filed in August 1995.\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Executive Compensation.\n(a) Summary Compensation Table\nThe following table sets forth information regarding compensation paid to the chief executive officer of the Registrant for the four years ending September 30, 1995. No other person who is currently an executive officer of the Registrant earned salary and bonus compensation exceeding $100,000 during any of those years.\n401(k) Plan. On January 1, 1990, the Registrant adopted an employee benefit plan under Internal Revenue Code Section 401(k). The 401(k) plan is a profit sharing plan under which both employees and the Registrant are entitled (at their own discretion) to contribute a portion of compensation and earnings, respectively, to investment funds to supplement employee retirement benefits. At September 30, 1995, the Registrant's matching contributions to the plan for the accounts of Van Horsley and Jo Brehm totalled approximately $427 and the matching contribution under the plan for the accounts of all executive officers as a group totalled $462. These amounts are included in column (i) of the Summary Compensation Table.\n(b) Stock Option Plans.\nOptions and Option Plans. Until April 10, 1988 the Registrant had two plans pursuant to which stock options could be granted to its directors and officers. These plans were the 1981 Non-Qualified Consultants' Plan and the 1981 Incentive Stock Option Plan (the \"Old Plans\"). On April 10, 1988, the Board of Directors canceled the Old Plans to the extent that shares reserved for issuance thereunder were not then under option, and adopted and authorized the 1988 Stock Option Plan (the \"1988 Plan\") and directed that management prepare the documents formally defining the plan. At that time the Board also authorized the issuance of certain options under the 1988 Plan. The Board formally approved the 1988 Plan on July 14, 1988 and the shareholders approved the 1988 Plan on September 28, 1988.\nAllocations of options under the Registrant's stock option plans are made by the Compensation Committee based on the duties, contributions and value of the services of the respective optionee. The Committee has the authority to determine to whom options were granted, the number of shares covered by each option, when each option was to be granted, date of initial ability to exercise, exercise price and certain other terms and to prescribe, interpret, amend and rescind rules and regulations relating to each plan. Any options canceled or not exercised within the option period became available for grants of new options under the plans. The Board also has the power to select committees consisting of not less than two members to administer each plan. The 1988 Plan contains the same provisions for administration as were contained in the Old Plans.\nUnder the 1988 Plan, the Registrant reserved an aggregate of 1,000,000 shares of its common stock for issuance to employees (including officers), consultants and directors of the Registrant or any subsidiary. The plan contains restrictions on the number of options granted to officers and directors, exercise price, maximum term and transferability. On May 14, 1991, the Registrant filed a registration statement under the Securities Act of 1933 on Form S-8 which registered the shares of common stock underlying options granted under the 1988 Plan. As such, shares issued upon exercise of outstanding options can be traded on the open market with limited restriction.\nAll of the options granted under the Old Plans and the 1988 Plan may be exercised through payment of the exercise price with shares of the Registrant's Common Stock or cash, or both. The ability to exercise options through surrendering shares of Common Stock enables holders of options to exercise the entire amount of an option by first exercising a small number of options, followed by successively larger option exercises which the optionee is able to effect by surrendering the increasing number of shares obtained thereby. For little or no initial cash payment, repeated exercises of options by surrendering stock having a market price in excess of the option exercise price, enable an optionee to provide sufficient consideration to the Registrant to exercise his entire stock option. The exercise of options might otherwise require substantial cash consideration. This procedure is often referred to as pyramiding.\nThe following table sets forth certain information regarding stock options granted by the Registrant to the Chief Executive Officer and no other executive officers received total annual salary and bonus in excess of $100,000 during 1995. No stock appreciation rights were granted.\nAggregated Option Exercises in Last Fiscal Year and Fiscal Year End Option Values.\nThe Following table sets forth information regarding stock options exercised by the chief executive officer and certain other officers or directors during the 1995 fiscal year as well as the year-end value of options being held by such persons on September 30, 1995: No Stock Appreciation Rights have been granted, or are held by, any such person:\n(c) The Registrant has no long term incentive compensation plans.\n(d) Other Compensation\nThere are no plans to pay bonuses or deferred compensation to employees of the Company.\nThe Company has adopted a medical insurance plan for its employees and provides life, disability, and other insurance plans for the benefit of its employees.\n(e) Compensation of Directors\nGeneral. The Registrant's directors are authorized to receive $200 for each directors' meeting attended by them. To date, the directors have waived their right to receive directors fees. In September 1990, certain directors were granted options under the 1988 Stock Option Plan. Dr. Bayne owns an incentive stock option to acquire 20,000 shares of common stock at $4.00 per share, expiring June 11, 2003. Leroy Bilanich owns an incentive stock option to acquire 20,000 shares of common stock at $1.50 per share, expiring June 11, 2003. The following options were granted during fiscal 1995 to board members: Dr. Bayne was granted an option to acquire 20,000 shares of common stock at $1.50 per share, expiring June 1, 2000 on June 2, 1995. Mr. Bilanich was granted an option to acquire 20,000 shares of common stock at $1.50 per share, expiring June 1, 2000 on June 2, 1995. Dr. Edwin Adair was granted an option to acquire 44,000 shares of common stock at $1.50 per share, expiring June 1, 2000 on June 2, 1995. Pat Horsley Adair was granted an option to acquire 23,600 shares of common stock at $1.50 per share, expiring June 1, 2000 on June 2, 1995.\nRoyalty Agreements. Dr. Adair and Dr. Bayne, directors of the Registrant, are each entitled to receive royalties equal to two percent of the net sales of products each assigned to the Company. No royalties have been accrued or paid to Dr. Bayne, however, $510,000 has been paid and $90,000 has been accrued to Dr. Adair. The Registrant is required to pay Dr. Adair minimum annual royalties of $120,000. Subsequent to the end of fiscal 1995, in an effort to help reduce negative cash flow during fiscal 1996, on December 1, 1995 Dr. Adair signed an agreement with the Registrant where he has accepted 120,000 common stock options priced at $1.00 per share in substitution for his customary cash royalty payment for the 1996 fiscal year. See Item 13 for further information regarding the royalty agreement, Certain Relationships and Related Transactions.\nIndemnification Agreements. The Registrant has entered into indemnification agreements with each of its directors and officers providing for indemnification of each such director by the Registrant to the full extent permitted by the Colorado Corporation Code. The agreements provide that in all circumstances in which a director or officer may receive indemnification by statute, such indemnity shall be provided.\nOfficer's Life Insurance and Split-Dollar Agreement. In August 1990, the Registrant purchased a $1,000,000 convertible term key-man life insurance policy on its Chairman. Additionally, in August 1990, the Registrant entered into a split-dollar life insurance agreement with an irrevocable trust established by the Chairman and Secretary of the Registrant. The Registrant had agreed to pay substantially all of the annual premiums on the $2,000,000 whole- life, second-to-die policy which had the insurance trust as the beneficiary. The split-dollar agreement specified that the Registrant would receive the greater of premiums paid or cash surrender value upon the second insured's death. However, should the Registrant decide not to pay the premium prior to the second insured's death, the Registrant would only collect premiums paid to the extent of the cash surrender value. As such, the Registrant had recorded the premiums paid in the accompanying consolidated balance sheets to the extent of cash surrender value. Subsequent to the end of fiscal 1995 the Registrant terminated both the above policies as a cost-cutting measure. The Registrant does however, currently maintain a $100,000 whole life key-man insurance policy on its Chairman which was acquired in 1985.\nThe Registrant has no other arrangements pursuant to which it compensates its directors for acting in their capacities as such.\n(g) The Registrant has no employment contracts with any executive officer. The Registrant has no compensatory arrangement which may result from a change-of-control of the Registrant or a change in any executive officers responsibilities.\n(h) No options were repriced during the fiscal year.\nItem 11.","section_11":"Item 11. Security Ownership of Certain Beneficial Owners and Management.\n(a) and (b) Security ownership of certain beneficial owners and management.\nAt September 30, 1995, the Registrant had only one class of outstanding voting securities, its Common Stock, $.001 par value. The following table sets forth information as of September 30, 1995 with respect to the ownership of the Company's Common Stock for all directors, individually, all officers and directors as a group, and all beneficial owners of more than five percent of the Common Stock. The following shareholders have sole voting and investment power with respect to the shares, unless it has been indicated otherwise.\n(1) As used in this section, the term beneficial ownership with respect to a security is defined by Rule 13d-3 under the Securities Exchange Act of 1934 as consisting of sole or shared voting power (including the power to vote or direct the vote) and\/or sole or shared investment power (including the power to dispose or direct the disposition) with respect to the security through any contract, arrangement, understanding, relationship or otherwise. Unless otherwise indicated, beneficial ownership is of record and consists of sole voting and investment power.\n(2) Includes 367,600 stock options issued to the Chairman of which all are presently exercisable. Does not include 120,000 options issued to Dr. Adair in December, 1995 in consideration for cancellation of fiscal 1996 royalty payments due him totaling $120,000.\n(3) Includes 174,638 shares under presently exercisable stock options.\n(4) Includes shares referenced in notes (2) through (3) and 74,800 additional shares and options held by one officer who is not a director, all of which are presently exercisable.\n(c) Changes in Control.\nThe Company knows of no arrangement, the operation of which may, at a subsequent date, result in change in control of the Company.\nItem 12.","section_12":"Item 12. Certain Relationships and Related Transactions.\n(a) and (b) Transactions With Management and Others.\nThe Registrant has engaged in certain transactions with members of its Board of Directors. In each case, the Board believed that the transaction was in the Registrant's best interests and the terms of the transaction were at least as fair to Registrant as could have been obtained from an independent person, and the transaction was approved by the disinterested directors. Registrant will continue to follow this procedure in approving any transactions with affiliated persons. No such transactions are contemplated at this time.\nLicense Agreement with Dr. Adair. The Registrant has entered into a license agreement, as further amended and explained below, effective June 3, 1987, with its Chairman relating to the use of certain technology invented and developed by him. Originally, the agreement licensed technology relating to certain malleable endoscopes, flexible optical catheters, the Adair\/VeressTM needle and complementing viewing systems for use in connection with detection, diagnosis and treatment of disease or injury in humans and animals. The Registrant used this technology to develop the Model 5990 Optical Catheter System.\nPursuant to an amendment, dated February 20, 1989, to the license agreement described in the preceding paragraph, the Registrant acquired the rights to certain technology including patent applications for technology related to the Registrant's (a) speculum camera which uses a small, video camera attached to a speculum for magnified viewing of the cervix as a diagnostic tool; and (b) camera with a sterilizable sheath (disposable), a molded or machined container used to hold the camera in place, and which utilizes a standard, off-the-shelf camera which is covered by a specialized sheath which provides proper alignment with endoscopes, sterility of the system and reduced cost to the hospital or other end-user.\nPursuant to an amendment dated June 22, 1989, to the license agreement described above, the Chairman agreed not to exercise his right of termination of the license if the Registrant used its best efforts to manufacture and market all products developed utilizing the technology included within the license. In exchange for the agreement not to exercise his right of termination, the Registrant agreed to pay the Chairman minimum annual royalties of $60,000, $80,000 and $100,000 for the years ended September 30, 1990, 1991 and 1992, respectively. Thereafter, the Registrant has agreed to pay the Chairman minimum annual royalties of $120,000. The license agreement does not specify a termination date. Through September 30, 1995, the Registrant has paid the Chairman $510,000 as specified under the agreement.\nPursuant to an amendment dated July 2, 1992, to the license agreement noted above, the Chairman agreed to add further developed technology along with patents and trademarks to the license agreement at no additional cost to the Registrant. This amendment added 23 technologies that had either patents pending or fully- issued patent coverage.\nPursuant to Amendment No. 4 dated October 8, 1992, to the license agreement noted above, the Chairman and Registrant agreed to continue the aforementioned royalty payments indefinitely and issue to the Chairman options to purchase an additional 300,000 shares of the Registrant's common stock at $4.00 per share. In exchange for the issuance of additional options and the continuation of the royalty payment stream, the Chairman agreed to contribute certain patent rights and technology (including some as yet to be issued patent rights) relating to rigid video endoscopes using advanced chip technology.\nThe amendment includes future technology relating to operative channel endoscopes, thoracic endoscopes, 3-D endoscopes and related disposable products. Specifically excluded from the license agreement is technology relating to flexible or steerable endoscopic devices.\nOther provisions included in this amendment include an option issued to the Chairman allowing him to require the Registrant to register the options granted pursuant to Amendment No. 4. The cost of registration will be borne by the Registrant. In addition, the Registrant agreed to sub-license technology to the Chairman relating to the use of laser light through flexible or steerable endoscopes on a non-exclusive basis.\nThe Registrant further agreed that, if within a three year period of the issuance of any patent included in the license agreement, as amended, the Registrant fails to commercialize such technology, the Chairman, upon written request, may terminate the license agreement on that specific patent. Furthermore, the Chairman has the right to terminate the license agreement on specific technologies upon acquisition by another person of 20% or more of the outstanding stock of the Registrant unless the acquiror provides notice in writing, within 30 days, of its intention to commercially exploit the specific technologies.\nThe Chairman is free to research and develop future technology and know-how at his own expense. Such as yet unnamed future technology is not a part of the aforementioned license agreement and the Registrant has no ownership rights to such technology. However, the Chairman has agreed to offer the Registrant a first right of refusal on such future technology prior to offering such technology to an unrelated third party. The first right of refusal shall be made in writing to the Registrant and remain open for a period of 60 days. During the development of this technology, the Registrant will allow the Chairman access to facilities, equipment and inventory of the Registrant at no cost provided the activities do not interfere with the ongoing business of the Registrant or result in an unreasonable expense to the Registrant.\nShould the Registrant accept the technology and know-how, such technology shall automatically be included within the license agreement, including all amendments. Furthermore, the Registrant shall be responsible to pay all future patent and development costs associated with the new technology. If the Registrant rejects the new technology, the Chairman is free to pursue third party alliances and has no further obligation to re-offer such technology to the Registrant. However, the Chairman may not use the facilities, equipment, inventory or other resources of the Registrant for any such further development of said technology.\nThe Registrant is free to terminate the license agreement, as amended, at any time and without penalty. The Chairman must give the Registrant 45 days prior written notice of his intent to terminate the license upon default by the Registrant of its obligations under the license agreement. Additionally, the license will terminate automatically immediately if (i) the Registrant files a voluntary case in bankruptcy or (ii) any order for relief against the Registrant shall be entered in an involuntary case in bankruptcy or (iii) the Registrant shall fail, or admit in writing an inability, to pay its debts as they mature.\nThe technology added to the license agreement over the years has increased MEDY's patent maintenance costs and management recently performed a review of the viability of certain of the technology based upon MEDY's current business and marketing plans. Management has determined that MEDY would not likely develop certain of the technology into saleable products because of the anticipated costs involved and the recent difficulties MEDY has had in obtaining approval of new devices from the federal Food and Drug Administration (\"FDA\"). As a result, management recommended, and the Board approved, the return of twelve items of technology to Dr. Adair. Medical had approximately $73,000 invested in this technology, and the maintenance costs for this technology which was not likely to be commercialized by MEDY in the near future were in excess of $20,000 per year. To conserve cash flow and to allow management to concentrate on MEDY's other products, the Board of Directors approved the return of this technology to Dr. Adair.\nAt the same time, the Board approved an amended and restated license agreement with Dr. Adair which consolidated the original license agreement and the four amendments thereto, and added an expanded right of first refusal. The principal amendments are:\nThe definition of \"Technology\" included within the license agreement was modified to more accurately describe the technology developed by Dr. Adair which is of continuing interest to MEDY: the Optical CatheterTM technology (including the fluorescence detection system); the Adair-Veress needleTM, the technology associated with the Electronic Video LaparoscopeTM, and Lap-WrapTM. The restated license agreement continues to specifically exclude from its terms technology relating to flexible or steerable endoscopic devices (other than the Optical Catheter). In the restated license agreement, MEDY continues to agree to sub-license technology to the Chairman relating to the use of laser light through flexible or steerable endoscopes on a non- exclusive basis.\nUnder the restated license agreement, Dr. Adair is specifically permitted to research and develop new technology and know-how at his own expense. Such technology and know-how will not be a part of the restated license agreement unless MEDY exercises its right of first refusal to acquire the new technology or know-how. Dr. Adair is obligated to offer all new technology which he may develop to MEDY's Board of Directors under the license agreement, subject only to reimbursement to him of costs he has in the development and patenting of the technology. Neither Dr. nor Mrs. Adair would participate in the Board's vote whether to accept the proffered technology. Should MEDY accept the technology and know-how, such technology shall automatically be included within the license agreement, including all amendments. Furthermore, MEDY shall be responsible to pay all future patent and development costs associated with the new technology. If MEDY rejects the new technology, the Chairman is free to pursue third party alliances and has no further obligation to re-offer such technology to MEDY.\nThe financial provisions of the license agreement were not modified in any material respect. The restated license agreement continues to provide for minimum royalties payable to Dr. Adair of $120,000 per year. The license agreement does not specify a termination date. Currently MEDY is accruing these royalties for future payment to Dr. Adair, without interest. These accrued royalties are collateral for a guarantee from Dr. Adair of a loan made by MEDY to an affiliated company, Micro-Medical Devices, Inc. (See further discussion under \"Distribution Agreement,\" below.) As noted above, Dr. Adair accepted 120,000 of the Registrants common stock options in lieu of the cash royalty payments due him for fiscal 1996.\nThe restated license agreement continues to provide that, if within a three year period of the issuance of any patent included in the license agreement, as amended, MEDY fails to commercialize such technology, Dr. Adair, upon written request, may terminate the license agreement on that specific patent. Furthermore, Dr. Adair has the right to terminate the license agreement on specific technologies upon acquisition by another person of 20% or more of the outstanding stock of the Registrant unless the acquirer provides notice in writing, within 30 days, of its intention to commercially exploit the specific technologies.\nAs noted, the restated license agreement contemplates that Dr. Adair will continue to develop new technology and know-how for his own account, subject to the right of first refusal. During the development of any new technology, MEDY will allow the Chairman access to facilities, equipment and inventory of the Registrant at no cost provided the activities do not interfere with the ongoing business of MEDY or result in unreasonable expense to MEDY. If, however, MEDY rejects the technology, Dr. Adair will not be entitled to use any of the equipment, facilities, or inventory of MEDY for further development.\nThe termination provisions were not changed materially in the restated license agreement. MEDY is free to terminate the license agreement, as amended, at any time and without penalty. Dr. Adair must give MEDY 45 days prior written notice of his intent to terminate the license upon default by MEDY of its obligations under the license agreement. Additionally, the license will terminate automatically immediately if (i) MEDY files a voluntary case in bankruptcy or (ii) any order for relief against MEDY shall be entered in an involuntary case in bankruptcy or (iii) MEDY shall fail, or admit in writing an inability, to pay its debts as they mature.\nDistribution Agreement.\nThe Registrant entered into a distribution agreement with Micro-Medical Devices, Inc. (\"MMD\"), a corporation wholly-owned by Dr. Adair during June of fiscal year 1995. The distribution agreement includes all products developed by Dr. Adair related to his Universal Sterile Endoscopy SystemTM (\"USES\"). MEDY had previously owned certain rights to this technology under the License Agreement but was required to return the technology to Dr. Adair due to MEDY's inability to commercialize the product within the required three year period. MEDY was unable to do so because of its lack of financial capability and its inability to obtain approval of products from the FDA. Dr. Adair, therefore, continued the research and development necessary to develop USES and the related products at his own expense, and through MMD, obtain FDA approval thereof.\nMMD has appointed MEDY as its exclusive worldwide distributor for the USES products through June 30, 2000. MMD also granted MEDY a right of first refusal to distribute any further products MMD may develop.\nPricing of the products has not yet been established, but MEDY will be free to resell products at any price it may determine. There are no minimum performance requirements under the distribution agreement, and MEDY need only purchase products it has already sold to third parties.\nAs a condition of the distribution agreement, however, MEDY agreed to loan MMD up to $120,000 pursuant to a promissory note signed by MMD. The note is collateralized by the amounts due Dr. Adair under the restated license agreement as the sole shareholder of MMD, and he has pledged all amounts due to him under the restated license agreement as collateral for this guarantee. MEDY is accruing these amounts payable to Dr. Adair without interest. MEDY is not obligated to advance any amounts to MMD except to the extent these amounts are fully collateralized by amounts due to Dr. Adair. The promissory note from MMD to MEDY bears interest at a rate of 1% over the current prime rate per annum. Furthermore, the distribution agreement provides that MEDY may credit 100% of the purchase price of any products from MMD under the distribution agreement against amounts due under the promissory note. As of September 30, 1995 MMD owed the Registrant $110,000 under the terms of the note, plus accrued interest. See note 3 to the financial statements.\nMMD also agreed to sublease space from MEDY for administration purposes at cost. The amount of space has not yet been defined, but the rental payment and reimbursement to MEDY for employees MMD may utilize are intended to compensate MEDY for all associated expenses, including rent on a per-square-foot basis.\nIn October 1987, I. Dean Bayne, M.D., a director, assigned his rights and interest in a then pending patent application related to the Bayne Pap BrushTM described in \"Item 1 - Business -Patents, Trademarks and Licenses.\" To reimburse him for his expenses in developing that product and as compensation for the assignment, the Registrant paid Dr. Bayne 10,000 shares of restricted common stock and will pay him a royalty for the duration of the patent equal to two percent of the net sales of the Bayne Pap BrushTM, less certain expenses. As of September 30, 1995, no royalties have been accrued or paid under this arrangement. See \"Item 1 - Business.\"\nThe Registrant employs two sons of Dr. Adair and one son of Pat Horsley Adair at annual salary rates of approximately $45,600, $45,600, and $105,000. During the most recently completed fiscal year those persons received no compensation from the registrant in addition to their salaries.\nExcept as otherwise stated above, since October 1, 1991, the Registrant has not been a party to any transaction involving in excess of $60,000, in which any director or executive officer, nominee for election as a director, security holder of record or beneficially of more than five percent of any class of the Registrant's securities, or any member of the immediate family of the foregoing had or will have a direct or indirect material interest.\nThe Registrant is not aware of any other relationship between nominees for election as directors or its directors and the Registrant that are similar in nature and scope to those relationships listed in this Item 12.\n(c) Parents of the Company\nNot applicable, inasmuch as there are no \"Parents\" of the Registrant.\n(d) Transactions with Promoters\nNot applicable, inasmuch as the Company was organized more than five years ago.\nItem 13.","section_13":"Item 13. Exhibits and Reports on Form 8-K.\n(a) Exhibits\nThe following isa complete list ofexhibits filed as partof this Annual Report on Form 10-KSB, which Exhibits are incorporated herein.\nExhibit Number Description\n3.1(k) Restated Articles of Incorporation (December 30, 1988)\n3.2(n) Bylaws, as amended\n10.1(m) Amendment Number Five to Lease Agreement - Englewood Office Space\n10.2(a) Stock Option Plan - Consultant's\n10.3 Omitted\n10.4(j) 1988 Stock Option Plan\n10.5 Omitted\n10.6(d) Sales Representative Agreement - Form\n10.7(e) International Distributor Agreement\n10.8(f) Indemnification Agreement - Edwin L. Adair, M.D.\n10.9(f) Indemnification Agreement - Pat Horsley Adair\n10.10(h) Indemnification Agreement - I. Dean Bayne\n10.11(a) Employee Confidentiality Agreement - Form\n10.12(b) Section 125 Cafeteria Plan\n10.13(h) Patent Assignment - Bayne Pap Brush\n10.14(o) Amended and restated License Agreement with Edwin L. Adair effective as of June 1, 1995\n10.15 Omitted\n10.19 Omitted\n10.20 Omitted\n10.21 Omitted\n10.22 Omitted\n10.23 Omitted\n10.24 Omitted\n10.25(n) 401(k) Plan\n10.26(b) Indemnification Agreement - Van A. Horsley\n10.27(b) Indemnification Agreement - Leroy A. Bilanich\n22.1 Subsidiaries of the Registrant: MedPacific Corporation, a Washington corporation\n24.1* Consent of McGladrey & Pullen, LLP\n* Filed herewith.\n(a) Incorporated by reference from Registration Statement on Form S-1, SEC File No. 2-82856.\n(b) Incorporated by reference from the Registrant's Form 10-K for the period ended September 30, 1991.\n(c) Omitted.\n(d) Incorporated by reference from the Registrant's Form 10-K for the year ended September 30, 1984.\n(e) Incorporated by reference from the Registrant's Form 8-K reporting an event of February 8, 1985.\n(f) Incorporated by reference from the Registrant's Form 10-K for the year ended September 30, 1986.\n(g) Omitted.\n(h) Incorporated by reference from the Registrant's Form 10-K for the fiscal year ended September 30, 1987.\n(i) Omitted.\n(j) Incorporated by reference from the Registrant's Form 8-K reporting an event of October 12, 1988.\n(k) Incorporated by reference from the Registrant's Form 10-Q for the quarter ended December 31, 1988.\n(l) Omitted.\n(m) Incorporated by reference from Amendment No. 1 to Registration Statement on Form S-1, Commission File No. 33-29497, filed with the Commission on July 26, 1989.\n(n) Incorporated by reference from the Registrant's Form 10-K for the fiscal year ended September 30, 1990.\n(o) Incorporated by reference from the Registrant's Form 10-QSB for the quarter ended June 30, 1995.\n(b) Reports on Form 8-K\nDuring the last quarter of the period covered by this Report the Company filed no reports on Form 8-K.\nSIGNATURES\nIn accordance with 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.\nMEDICAL DYNAMICS, INC.\nBy \/s\/ Van A. Horsley ------------------ Van A. Horsley, President\nDate: January 15, 1996\nIn accordance with 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.\nJanuary 15, 1996 \/s\/ Van A. Horsley ------------------- Van A. Horsley, Principal Executive Officer, Principal Financial Officer, and Director\nJanuary 15, 1996 \/s\/ Edwin L. Adair -------------------- Edwin L. Adair, M.D., Chairman of the Board and Director\nJanuary 15, 1996\nI. Dean Bayne, M.D., Director\nJanuary 15, 1996 \/s\/ Pat Horsley ---------------- Pat Horsley Adair, Director\nJanuary 15, 1996\nLeroy Bilanich, Director\nContents\nINDEPENDENT AUDITOR'S REPORT FINANCIAL STATEMENTS\nConsolidated balance sheets -\nConsolidated statements of operations\nConsolidated statements of stockholders' equity\nConsolidated statements of cash flows -\nNotes to consolidated financial statements -\nIndependent Auditor's Report\nBoard of Directors and Shareholders Medical Dynamics, Inc. and Subsidiary Englewood, Colorado\nWe have audited the accompanying consolidated balance sheets of Medical Dynamics, Inc. and its wholly-owned subsidiary, MedPacific Corporation (the Company) as of September 30, 1995 and 1994, and the related consolidated statements of operations, stockholders' equity and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Medical Dynamics, Inc. and Subsidiary as of September 30, 1995 and 1994, and the results of its operations and its cash flows for the years then ended, 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 6 to the financial statements, the Company has suffered recurring losses and negative cash flows from operations. This raises substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 6. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.\nMcGLADREY & PULLEN, LLP\nDenver, Colorado November 27, 1995, except for the fourth paragraph in Note 6, as to which the date is December 1, 1995\nSee Notes to Consolidated Financial Statements.\nSee Notes to Consolidated Financial Statements.\nSee Notes to Consolidated Financial Statements.\nMEDICAL DYNAMICS, INC. AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNote 1. Significant Accounting Policies\nNature of business:\nMedical Dynamics, Inc. and Subsidiary (the Company) are engaged in the design, development, manufacture and marketing of medical video cameras and related surgical disposable products for a variety of medical specialties. These products are sold directly to hospitals, health care professionals, wholesalers, and original equipment manufacturers throughout the United States and foreign markets. Sales are typically made on terms of net 90 days, though some extended terms are offered on foreign sales, to match terms normally offered in certain countries.\nPrinciples of consolidation:\nThe financial statements include the accounts of the Company and its wholly-owned subsidiary, MedPacific Corporation. All significant intercompany accounts and transactions have been eliminated.\nUse of estimates in the preparation of financial statements:\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures 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. The Company's significant estimates includes allowance for doubtful trade accounts receivables and an obsolete inventory reserve. These reserves are established based on review of accounts receivable and past debt history and a review of inventory usage, receptively.\nCash and cash equivalents:\nFor purposes of reporting the consolidated statements of cash flows, the Company includes all cash accounts, which are not subject to withdrawal restrictions or penalties, and all highly liquid debt instruments purchased with a maturity of three months or less as cash and cash equivalents on the accompanying consolidated balance sheets. Cash equivalents include a mutual fund backed by U.S. Government and Government Agency Securities.\nInvestments:\nInvestments, which consists of a certificate of deposit, and U.S. Government Securities at September 30, 1994, are carried at amortized cost, which approximates fair market value.\nInventories:\nInventories are stated at the lower of cost (first-in, first-out method) or market. All inventory is classified as a current asset although part of such inventory, because of current sales volume, is not anticipated to be utilized within one year.\nEquipment:\nEquipment is stated at cost. Depreciation and amortization is computed principally by the straight-line method over the following estimated useful lives:\nYears Loaner equipment 3 Machinery and equipment 3 - 10 Furniture and fixtures 3 - 10\nImprovements to leased property are amortized over the lesser of the life of the lease or life of the improvements.\nPatents and trademarks:\nPatents and trademarks are stated at cost and are amortized over their estimated economic lives up to ten years. In the event patents pending are not granted, the related costs will be charged to operations. The Company reviews its patents annually to determine potential impairment by comparing the carrying value of the intangible with expected future net cash flows related to the patent. An impairment loss would be recognized if the Company determined the carrying value exceeded the fair market value of the patent.\nWarranty accrual:\nThe Company provides a warranty against defects in materials and workmanship, generally for a period between one month and two years following the date of sale of the equipment. Estimated future costs of product warranties are charged to selling, general and administrative expenses.\nIncome (loss) per common share:\nFor the years ended September 30, 1995 and 1994 earnings per share are computed based upon 6,879,500 and 6,602,400, weighted average common shares outstanding for both primary and fully-diluted earnings per share. Shares issuable under common stock purchase warrants and common stock options were excluded from the computation of earnings per share because the effect was deemed to be anti-dilutive.\nIncome tax matters:\nDeferred 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 the effects of changes in tax laws and rates on the date of enactment.\nRevenue recognition:\nThe Company recognizes all revenue when it receives a valid purchase order and ships completed, finished products to a customer.\nOther operating revenue:\nOther operating revenue includes product service revenue of $41,300 and $59,800 for the years ended September 30, 1995 and 1994, respectively.\nNote 2. Inventories\nInventories consist of the following at September 30, 1995 and 1994:\nNote 3. Note Receivable - Officer and Related Party Transactions\nNote receivable - officer consists of a note due from an entity owned by the Company's Chairman (the Chairman). The note is due January 15, 1996 and bears interest at prime plus 1% (8.75% at September 30, 1995). The note is secured by all amounts due or which may become due to the Chairman under a license agreement with the Company (See Note 6).\nIn a related transaction, the Company transferred to the entity owned by the Chairman the licensed right to patents with a net book value of approximately $21,000. The patents had originally been obtained from the Chairman under the license agreement described above, and were transferred because the Company was unable to obtain FDA approval for products using the patents. The related entity has since obtained FDA approval and has entered into an exclusive agreement to have the Company distribute all products it manufactures. The agreement runs through June 30, 2000. The Company has purchased approximately $25,000 of products under the agreement at September 30, 1995, this amount was also included in accounts payable at September 30, 1995. There has been no significant sales of the products purchased under the agreement.\nNote 4. Common Stock (see also Note 6)\nStock option plan:\nThe Company has a stock option plan under which options to purchase common stock are granted generally at not less than the fair market value of the stock at the date of grant. The Board of Directors approved the plan on July 14, 1988 and a majority of the Company's stockholders approved the plan in October 1988. An aggregate of 1,000,000 shares were reserved for issuance pursuant to the terms of the plan. Activity in the stock option plan for the last two years is as follows:\nThe range of exercise prices of options exercised was $.85 to $3 in 1995 and 1994. During 1994 treasury stock was acquired in exchange for issuance of common stock pursuant to options exercised. At September 30, 1995, shares of common stock reserved for issuance under options totaled 133,100. Options available for future grant at September 30, 1995 totaled 83,100.\nThe Board has also agreed to issue options to purchase shares of the Company's common stock to certain employees as part of their compensation package. The option price on these options will be the market price on the date authorized. None of these options have been approved under a qualified plan by the stockholders and, as such, have certain holding period requirements and trading restrictions.\nDuring 1994, the Company sold 974,700 shares of its common stock for $2,602,800. The sale of the shares were made pursuant to a Regulation S placement. Under Regulation S, sales can only be made to qualified foreign investors, and must be held by the purchasers for a requisite period of time and meet other Regulation S requirements before they are able to sell the shares in the United States. The shares were sold at a discount of 37.5% to 40% of the closing bid price of an average of three days prior to the sale.\nNote 5. Income Taxes\nUnder the provisions of the Internal Revenue Code, the Company has available for federal income tax purposes, net operating loss and business tax credit carryforwards of approximately $14,500,000 and $188,000, respectively, which expire in varying amounts from 1996 through 2010.\nThe net operating loss and business tax credit carryforwards described above gives rise to a deferred tax asset of approximately $5,500,000. This asset is recorded net of a valuation allowance of the same amount, therefore no amounts are reflected in the accompanying balance sheet.\nThe actual provision for income taxes varied from the expected provision for income taxes (computed by applying the statutory U.S. Federal income tax rates to loss before taxes) due to the above carryforward and related valuation allowance.\nNote 6. Commitments and Contingencies\nThe Company has incurred continued substantial operating losses , negative cash flows from operations and has had trouble obtaining FDA approval on new products, the Company's future viability depends on its ability to increase sales and become profitable. To this end the Company will look for new OEM customers, increase marketing efforts on new products, explore distribution of products to new medical specialties, continue to expand in the foreign market place, and believes it will no longer have difficulty obtaining FDA approval on new products. However, there are no assurances that these efforts will result in a long-term increase in sales, profitability and cash flows, to allow for the long-term viability of the Company. The financial statements do not include any adjustment relating to the recoverability of recorded asset amounts, or the amounts of liabilities that might be necessary should the Company not be able to continue in existence, including the write-off of patents that would revert back to the Chairman under a licensing agreement.\nRecently, the cost of health care has risen significantly, and there have been proposals by legislators, regulators and third party health care payors to curtail these cost increases. Some proposals have involved limitations on the amount of reimbursement for specific surgical procedures. The Company is unable to predict the changes to be made in the reimbursement procedures utilized by third party health care payors. In addition, hospitals and other health care providers have become increasingly price competitive, and in some instances, put pressure on medical suppliers to lower their prices. As a result, the Company is unable to predict the financial impact of these factors.\nThe Company has various agreements to pay royalties to both a former officer and current directors of the Company. These royalties are based on the sales of specified products, some of which are no longer manufactured by the Company. In June, 1987, the Company entered into a license agreement with its then CEO and Chairman relating to the use of certain technology invented and developed by the Chairman. In connection with the agreement, the Company has agreed to pay royalties based on the greater of 2% of the sales of products which relate to this technology or the minimum annual royalties as described below. For the years ended September 30, 1995 and 1994 the Company accrued $120,000 in royalty expense of which $90,000 remained unpaid at each year end. The June, 1987 license agreement, as further amended, requires the Company to pay the Chairman minimum annual royalties of $120,000 for fiscal 1994 and beyond. The agreement does not specify the termination date, though both parties can terminate the agreement under certain circumstances. The Chairman can terminate the agreement with 45 days prior written notice upon default by the Company of its obligations under the agreement, and for specific technologies upon acquisition by another person of 20% or more of the outstanding stock of the Company unless, the acquior provides notice of its intention to commercially exploit the specific technologies. The agreement will terminate automatically if the Company is involved in a bankruptcy proceeding. In the circumstances described, the rights to be patents would revert back to the Chairman. Also under the agreement any patents not commercially developed by the Company in three years will revert back to the Chairman. During 1995, approximately $62,000 of patents were written off when the rights reverted back to the Chairman under this provision.\nOn December 1, 1995, the Chairman agreed to waive all payments due him under the above license agreement for the year ended September 30, 1996, in exchange for stock options to purchase 120,000 shares of common stock at $1 per share.\nOn October 8, 1992, the Company's Board of Directors issued options to purchase 300,000 shares of the Company's common stock at $4 per share to the Chairman in exchange for a license to develop and market certain patents rights and technology developed by the Chairman. The Company has agreed to register the options under certain circumstances. In connection therewith, the Board amended its 1987 license agreement and incorporated this technology in exchange for the options granted. The options can be exercised through October 2002. These options were not granted pursuant to a qualified plan and, as such, are subject to certain holding period requirements and trading restrictions. The commitments relating to the 1987 license agreement discussed in the previous paragraph were not changed by the above amendment.\nDuring fiscal 1995 and 1994, the Company granted stock options, totaling 216,200 and 100,000, respectively, at the then current market price, to certain officers, employees and sales representatives of the Company. The stock options were granted as part of their compensation package to certain officers and employees for both past and future service and as incentives to certain affiliates for future services to be performed. The Company may, in the future and at its discretion, decide to grant additional options to certain officers, employees and affiliates in lieu of compensation or services performed by those individuals or entities. These options are not pursuant to a qualified plan and, as such, will be subject to certain holding period requirements and trading restrictions. In all cases, options were granted at market prices in effect at the time of grant. At September 30, 1995, a total of 491,900 options have been granted, at an average price per option of $2.36. None of the options have been exercised. These option expire, beginning with 4,000 in the year ending September 30, 1997, 112,000 in 1998 and 375,900 in 2004.\nThe Company is committed to either compensating certain officers and employees at market rates or granting additional stock options as part of their compensation package. Under these circumstances, the Company and employee will mutually agree, on an annual basis, to the most beneficial compensation arrangement, subject to the employee or affiliate performing agreed upon future services.\nThe Company is regulated by the federal Food and Drug Administration (FDA). The Company cannot ensure that an adverse financial impact will not occur should the FDA find the Company's Good Manufacturing Practices are in non-compliance with current Federal regulations. If the FDA finds that a manufacturer is not in compliance, the manufacturer may be prohibited from marketing the products for which they are not in compliance, until such time as the manufacturer complies with the applicable FDA regulation. The Company has recently had difficulty obtaining FDA approval on new products due to past findings during FDA inspections. However, the Company does not expect problems in the future due to a change in FDA policy.\nThe Company conducts its operations from leased facilities and leases certain equipment. The terms of the facilities lease require the Company to pay all maintenance, utilities, property taxes and insurance. Rent expense has been recorded on a straight-line basis over the life of the lease. Following is a schedule of future minimum commitments under operating leases having an initial or remaining term of more than one year.\nYears Ending September 30, 1996 $152,000 1997 162,600 1998 171,100 ------- $485,700 =======\nTotal rent expense was $136,300 and $113,000 for the years ended September 30, 1995 and 1994, respectively.\nNote 7. Foreign Sales\nThe Company had export sales of $456,600 and $596,400 for the years ended September 30, 1995 and 1994, respectively. The sales are made in United States dollars.\nNote 8. Officers Life Insurance and Split-Dollar Agreement\nIn August, 1990, the Company purchased a $1,000,000 convertible term key-man life insurance policy on its Chairman. Subsequent to the end of the year, the Company terminated this plan due to cost cutting measures. The Company also has a $100,000 whole life key-man insurance policy on its Chairman which was acquired in 1985. The convertible term policy is renewable annually through year 2003.\nAdditionally, in August, 1990, the Company entered into a split-dollar life insurance agreement with an irrevocable trust established by the Chairman and Secretary of the Company. The Company has agreed to pay substantially all of the annual premiums on a $2,000,000 whole-life, second-to-die policy which has the insurance trust as the beneficiary. The split-dollar agreement specifies that the Company will receive the greater of premiums paid or cash surrender value upon the second insured's death. However, should the Company decide not to pay the premium prior to the second insured's death, the Company would only collect premiums paid to the extent of the cash surrender value. As such, the Company has recorded the premiums paid in the accompanying consolidated balance sheets to the extent of cash surrender value. At September 30, 1995 and 1994 $13,000 and $121,000 of cash surrender value was recorded, respectively. Subsequent to the end of the year, the Company terminated this plan due to cost cutting measures\nNote 9. Employee Benefit Plans\nEffective January 1, 1990, the Company adopted employee benefit plans under Internal Revenue Code Sections 401(k) and 125. The 401(k) plan is a profit sharing plan whereby both employees and the Company are entitled to contribute a portion of compensation and earnings, respectively, to investment funds to supplement employee retirement benefits. Under the IRS Section 125 cafeteria plan, employees may contribute to the cost of health care premiums with pre-tax dollars. Both plans were approved by the Board of Directors. The Company incurred $900 and $1,100 for the years ended in September 30, 1995 and 1994, respectively, in 401(k) benefit expense and $23,000 and $34,000 in Section 125 benefit expense for the years ended September 30, 1995 and 1994, respectively.\nNote 10. Major Customers\nSales to customers for 10% or more of revenues for the year ended September 30, 1995 and the related ending accounts receivable balance at September 30, 1995 are as follows:\n*had less than 10% of sales in 1995\nMedical Dynamics, Inc. Englewood, Colorado\nIn planning and performing our audit of the financial statements of Medical Dynamics, Inc. for the year ended September 30, 1995, we considered its internal control structure in order to determine our auditing procedures for the purpose of expressing our opinion on the financial statements and not to provide assurance on the internal control structure. However, we noted certain matters involving the internal control structure and its operation that we consider to be reportable conditions under standards established by the American Institute of Certified Public Accountants. Reportable conditions involve matters coming to our attention relating to significant deficiencies in the design or operation of the internal control structure that, in our judgment, could adversely affect the Company's ability to record, process, summarize, and report financial data consistent with the assertions of management in the financial statements.\nOne person performs virtually all of the accounting and financial duties. As a result, most of those aspects of internal control procedures which rely upon an adequate segregation of duties are, for all practical purposes, missing in your Company. We recognize that your Company may not be large enough to make the employment of additional persons for the purpose of segregating duties practicable from a financial standpoint, but we are required, under our professional responsibilities, to call the situation to your attention.\nThis report is intended solely for the information and use of the audit committee, management, and others within the Company.\nDenver, Colorado November 27, 1995","section_14":"","section_15":""}
{"filename":"775298_1995.txt","cik":"775298","year":"1995","section_1":"ITEM 1. BUSINESS.\nGENERAL DEVELOPMENT AND SCOPE OF BUSINESS\nSpaghetti Warehouse, Inc. (the \"Company\") was incorporated in Texas in June 1972 and operates as a holding company and conducts substantially all of its operations through its subsidiaries. Unless the context otherwise requires, all references herein to the Company include the Company and its subsidiaries. The Company's principal executive offices are located at 402 West I-30, Garland, Texas 75043. See Item 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company owns 27 and leases space for 10 of its presently operating Spaghetti Warehouse restaurants. One of the Company's owned restaurants is subject to a ground lease. When possible, the Company prefers to own rather than lease properties for its restaurants. The Company also owns its corporate office headquarters\/warehouse facilities, comprised of two buildings containing a combined total of approximately 30,000 square feet of space, which are situated on approximately 2.5 acres of land in Garland, Texas, a suburb of Dallas. None of the Company's properties are encumbered by mortgage indebtedness, except for a parking lot adjacent to the San Antonio restaurant. The Company believes that its corporate office\/warehouse facilities are adequate to meet its requirements through at least fiscal 1996 and that suitable additional space will be available, as needed, to accommodate further physical expansion of corporate operations.\nThe Company's restaurant leases, including renewal options, expire at various times from 2007 to 2027, and generally provide for minimum annual rentals and, in five cases, for payment of additional rent based on a percentage of restaurant sales. Five of the Company's leases provide for a preferential right of first refusal upon sale of the property. The Company is required to pay real estate taxes, insurance, maintenance expenses and utilities under substantially all of its leases. The Company depends on short-term leases for parking at nine of its 37 restaurants. There can be no assurance that adequate parking will continue to be available, or that the lack of such parking will not have an adverse impact on the operations of the respective restaurants.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nOn August 11, 1995, Elizabeth Bright and Thomas C. Bright III, the principal shareholders in Bright-Kaplan International Corporation (\"BK\"), filed a lawsuit against the Company in the Circuit Court of Hamilton County, Tennessee. BK is the owner of a Spaghetti Warehouse Franchise Restaurant located in Knoxville, Tennessee. Mr. & Mrs. Bright are claiming that the Company misrepresented and concealed numerous material facts in order to induce them to enter into a franchise agreement and that the Company engaged in deceptive trade practices. Mr. & Mrs. Bright are seeking damages in excess of $2.5 million and are seeking trebling of such damages under the Texas Deceptive Trade Practices Act. The Company intends to vigorously defend this lawsuit. In addition to this lawsuit, BK has submitted a claim against the Company to the American Arbitration Association based substantially on the same allegations contained in the lawsuit mentioned above. BK is seeking damages in excess of $6.6 million from this arbitration claim.\nThe Company is also involved in other routine litigation from time to time. Such other litigation in which the Company is currently involved is not material to the Company's consolidated financial condition or results of operations.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNo matter was submitted to a vote of the shareholders of the Company during the fourth quarter of the fiscal year ended July 2, 1995.\nPART 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 the New York Stock Exchange under the symbol \"SWH.\" Quotations of the Company's Common Stock began on the National Association of Securities Dealers' Automated Quotation System (\"NASDAQ\") National Market System on November 5, 1985. From August 15, 1989, to June 26, 1991, the Common Stock traded on the American Stock Exchange. On June 27, 1991, the Common Stock began trading on the New York Stock Exchange.\nThe following table sets forth the range of quarterly high and low closing sale prices on the New York Stock Exchange since July 5, 1993.\nAs of September 15, 1995, the Company estimates that there were approximately 3,900 beneficial owners of the Company's Common Stock, represented by approximately 658 holders of record.\nThe Company has never paid cash dividends. Management presently intends to retain any earnings for the operation and expansion of the Company's business and does not anticipate paying cash dividends in the foreseeable future. Any future determination as to the payment of dividends will depend upon results of operations, capital requirements, the financial condition of the Company and such other factors as the Board of Directors of the Company may consider.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe following table sets forth selected financial data regarding the Company's results of operations and financial position for, and as of the end of, each of the fiscal years in the five-year period ended July 2, 1995. The selected financial data under the captions \"Income Statement Data\" and \"Balance Sheet Data\" for periods prior to and including July 3, 1994, are derived from the Consolidated Financial Statements of the Company and its subsidiaries, which have been audited by KPMG Peat Marwick LLP, independent certified public accountants, and for periods subsequent to July 3, 1994, are derived from the Consolidated Financial Statements of the Company and its subsidiaries, which have been audited by Arthur Andersen LLP, independent public accountants. The Consolidated Financial Statements as of July 4, 1993, July 3, 1994, and July 2, 1995, and for each of the years in the three-year period ended July 2, 1995, and the independent auditors' reports thereon, are included elsewhere in this Report. The information below should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements and Notes thereto included elsewhere in this Report.\n____________________________________ Footnotes on following page.\n(1) Certain reclassifications have been made to various prior year balances in order to conform with current presentation. Specifically, net interest income (expense) have been reclassified below income from operations. In addition, all restaurant level overhead and marketing expenses previously classified as general and administrative expenses have been reclassified as operating expenses. Finally, all pre-opening costs, net of amounts amortized, and computer equipment inventory have been classified as non- current assets for financial statement purposes. (2) Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes, was adopted in fiscal 1993 and its provisions were applied retroactively to July 1, 1990. The results of operations for fiscal 1991 have been restated to retroactively record the cumulative effect of this change in accounting principle. See Note 1 of Notes to Consolidated Financial Statements. (3) See Note 1 (m) of Notes to Consolidated Financial Statements. (4) Dilution results from outstanding stock options granted to employees and directors, which totaled 542,324 in fiscal 1991; 560,265 in fiscal 1992; 601,706 in fiscal 1993; 728,896 in fiscal 1994; and 308,072 in 1995. (5) See \"Item 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nDIFFERENCE IN LENGTH OF FISCAL YEAR\nThe Company has historically reported on a fiscal year ending on the Saturday nearest July 1. Due to operational considerations, management adopted a Sunday period ending nearest July 1, commencing with the first month of fiscal 1993. Accordingly, the twelve-month period ending July 4, 1993 is comprised of 52 weeks and one day compared to fiscal 1994 and fiscal 1995 which are comprised of 52 weeks.\nRESULTS OF OPERATIONS\nThe following table presents, for the fiscal periods indicated, certain selected financial data as a percentage of total revenues.\n1995 COMPARED TO 1994\nREVENUES\nFiscal 1995 revenues increased $0.6 million, or 0.7%, over fiscal 1994 due to $4.2 million of incremental sales from the six restaurants opened after July 4, 1993. This increase was offset by a $3.6 million (5.2%) decline in sales of stores open for the full year in both fiscal 1994 and 1995 (\"same-stores\"). Average restaurant sales volumes for stores open as of the beginning of each fiscal year declined 6.1%, from $2.25 million in fiscal 1994 to $2.11 million in fiscal 1995.\nThe decline in same-store sales was the result of a 5.9% decrease in customer counts offset by a 0.7% increase in check averages. Same-store customer count comparisons were negatively affected by the rapid growth of competitors in the casual dining and Italian restaurant segments and to the normal decline in customer traffic for stores in their second and third years of operation. The increase in check averages was primarily the result of an expanded menu offering new appetizers, Caesar salads, pasta selections, and five new entrees. Some slight menu price adjustments made throughout the year also contributed modestly to the increase in check averages.\nCOSTS AND EXPENSES\nCost of Sales\nCost of sales as a percentage of total revenues increased slightly from 25.2% in fiscal 1994 to 25.4% in fiscal 1995. This 0.2% increase was the result of menu price reductions made in the fourth quarter of fiscal 1994 which continued throughout the first half of fiscal 1995. Additionally, temporary increases in various raw material costs including lettuce, pasta and tomato products also contributed to the increase in cost of sales in fiscal 1995. As the result of improved inventory controls and an increase in check averages during the second half of fiscal 1995, management anticipates that cost of sales as a percentage of total revenues will remain relatively flat in fiscal 1996.\nOperating Expenses\nOperating expenses as a percentage of total revenues increased 0.3%, from 56.4% in fiscal 1994 to 56.7% in fiscal 1995. This increase is primarily attributable to increased store management costs resulting from a new salary structure that was implemented in the fourth quarter of fiscal 1994 to enable the Company to be more competitive in attracting high-quality management personnel and to reduce management turnover. In addition to this increase in management costs, server labor, utility costs and property taxes were all higher in fiscal 1995. These increases were largely offset by reductions in cashier labor, group medical costs and workman's compensation insurance resulting from the implementation of various cost reduction initiatives in fiscal 1995.\nThe fixed nature of certain costs, relative to the decline in average restaurant sales volumes, also contributed to the increase in fiscal 1995 operating expenses as a percentage of total revenues. Operating expenses as a percentage of total revenues are not expected to return to levels achieved prior to fiscal 1994 until customer counts and same-store sales volumes show considerable improvement over current levels.\nGeneral and Administrative Expenses (G&A)\nG&A expenses as a percentage of total revenues increased from 6.9% in fiscal 1994 to 7.1% in fiscal 1995. This 0.2% increase was primarily the result of increased corporate labor costs. The increase in labor costs is attributable to positions in place in fiscal 1995 that were not in place for all of fiscal 1994, including President and Chief Executive Officer, Vice President of Operations, Vice President of Product Development and Purchasing, Health Benefits Coordinator, one additional Regional Director, and two additional information systems employees. These salary increases were largely offset by the reduction of 12 corporate level positions in the first quarter of fiscal 1995; however, the Company did not receive the full cost benefit of these reductions in fiscal 1995 due to severance packages paid to these former employees.\nIn addition to the increase in corporate labor costs, computer maintenance, management relocation costs and property taxes were all higher in fiscal 1995. These increases were offset by reductions in management training\nexpenses, recruitment expenses, donations and a loss on the write-off of certain previously incurred costs in searching for new locations no longer under consideration for Company-owned restaurant expansion.\nDepreciation and Amortization (D&A)\nD&A expenses as a percentage of total revenues decreased from 7.5% in fiscal 1994 to 6.6% in fiscal 1995. This 0.9% decrease was the result of a significant decrease in pre-opening expense amortization on new stores due to the reduction in the number of new stores opened by the Company. This decrease was partially offset by an increase in depreciation on Company information systems and by the relatively fixed nature of depreciation expense relative to the decline in average restaurant sales volumes.\nUnusual Charge\nThe Company recorded a $600,000 write-down of its one-third investment in F.P. Corporation PTY Ltd. and F.P. Restaurants PTY Ltd. (collectively \"Fasta Pasta\") in the fourth quarter of fiscal 1995. The write-down of the Company's investment in Fasta Pasta was the result of an alleged misappropriation of Fasta Pasta assets by the joint-venture's former managing director discovered during the fourth quarter of fiscal 1995. The Company is pursuing all possible remedies with this matter at this time; however, there can be no assurance that the Company will recover any of these charges.\nNET INTEREST EXPENSE\nNet interest expense increased from $0.9 million in fiscal 1994 to $1.2 million in fiscal 1995. This increase is attributable to an increase in the average debt outstanding under the Company's credit facilities and to increases in short-term borrowing rates on the Company's revolving credit facility during fiscal 1995. Management intends to incur additional long-term debt to the extent that future cash flow from operations is insufficient to cover planned expansion, capital expenditures and possible further repurchases of the Company's stock.\nINCOME TAXES\nThe Company's effective income tax rate decreased from 21.2% in fiscal 1994 to 15.8% in fiscal 1995. These tax rates were lower than statutory rates as a result of the use of the targeted jobs tax credit and the FICA tip credit. The 5.4% decrease in the effective tax rate over this period is due primarily to the increase in the benefit received from the targeted jobs tax credit and FICA tip credit relative to the decline in pre-tax income over the same period. The Company will continue to benefit from the use of the FICA tip credit in the future. However, the availability of the targeted jobs tax credit has not been assured as Congress has not reinstated this program since its expiration in December 1994.\n1994 COMPARED TO 1993\nREVENUES\nFiscal 1994 revenues increased $11.9 million, or 18.0%, over fiscal 1993 due to $7.7 million from the five new stores that opened in fiscal 1994, $7.6 million of incremental sales from seven restaurants that opened in fiscal 1993 and a $0.2 million increase in franchise income. These increases were offset by a $2.7 million (4.6%) decline in sales of stores open for the full year in both fiscal 1993 and 1994 (\"same stores\"), a decrease of $0.6 million due to closing of the South Bend restaurant in December of 1992 and a $0.2 million decrease in sales due to a one-day difference between fiscal 1993 and 1994. Average restaurant sales volumes, for stores open as of the beginning of each fiscal year, declined 8.7% from $2.46 million in fiscal 1993 to $2.25 million in fiscal 1994.\nThe decline in same-store sales was due to a 2.9% decrease in customer counts, mainly during the dinner period, and a 1.7% decline in check averages. Factors contributing to the decline in customer counts included the growth of competitors in the casual dining and Italian restaurant segments, periods of severe weather in the third quarter of fiscal 1994, and the normal decline in customer counts for stores in their second and third year of operation. The decline in check averages was primarily the result of menu price reductions made in the fourth quarter of fiscal 1994 and declining alcohol sales.\nCOSTS AND EXPENSES\nCost of Sales\nCost of sales as a percentage of revenues increased from 24.9% in fiscal 1993 to 25.2% in fiscal 1994. This increase was due to reduced menu prices in the fourth quarter of fiscal 1994, increased portion sizes on spaghetti entrees, the use of higher quality ingredients in selected items and increases in certain raw product costs.\nOperating Expenses\nOperating expenses as a percentage of revenues increased from 53.4% in fiscal 1993 to 56.4% in fiscal 1994. This increase was due primarily to increased employee and marketing expenses at the restaurants. In addition, repair and maintenance expenses, utility costs and property taxes were all significantly higher as a percentage of total revenues in fiscal 1994 due in part to the fixed nature of these costs relative to the decline in average restaurant sales volumes. The increase in employee costs was due to a new salary schedule for store managers implemented in the fourth quarter of fiscal 1994, an increase in claims paid by the Company's self-funded group medical plan and increased expenditures related to worker's compensation claims.\nGeneral and Administrative Expenses (G&A)\nG&A expenses, as a percentage of revenues, increased from 5.5% in fiscal 1993 to 6.9% in fiscal 1994. This increase resulted from a substantial increase in corporate employee costs due to the addition of six corporate positions, the reinstatement of bonus payments for corporate officers and to the occurrence of substantially higher management information system expenses.\nAlso contributing to the increase in fiscal 1994 G&A costs were severance packages paid in connection with the departure of several employees including the former President and Chief Executive Officer and former Chief Operating Officer, recruitment expenses related to the search for the Company's current President and Chief Executive Officer, write-off of certain previously incurred costs in searching for new locations no longer under consideration for Company- owned restaurant expansion, increased legal and accounting fees related to the Company's corporate reorganization, an increase in medical and worker's compensation insurance and a write-off of costs previously incurred in registering the Company's trademarks in foreign countries no longer under consideration for franchising expansion. The master franchise agreement with TGI Friday's for foreign countries and the development agreement with the Good Spaghetti Company in California were terminated in fiscal 1994 due to the lack of any probability of franchised restaurants being opened under these agreements.\nDepreciation and Amortization (D&A)\nD&A expenses, as a percentage of revenues, increased from 7.2% in fiscal 1993 to 7.5% in fiscal 1994. This increase was due primarily to depreciation incurred on the Company's new information system and to the relatively fixed nature of depreciation relative to the decline in average restaurant sales volumes. These increases were partially offset by a decrease in pre-opening expense amortization on new-stores resulting from a reduction in the number of new stores opened by the Company.\nLoss on Assets Scheduled For Divestiture\nIn fiscal 1993, the Company recorded a non-cash charge of $143,307 to write-down surplus real estate in Austin, Texas to its net realizable value as estimated by an independent appraiser at that time. The Company recorded an additional non-cash charge of $50,000 in fiscal 1994 to write-down the property based on indications of interest received by the Company from unrelated third parties at that time.\nLoss on Closed Restaurant\nDuring fiscal 1993, the Company recorded a charge of $358,671 as a result of closing a restaurant in South Bend, Indiana. This amount related primarily to the non-cash write-offs of certain property and equipment and unamortized pre- opening costs.\nNET INTEREST INCOME (EXPENSE)\nIn fiscal 1993, the Company recorded net interest income of $20,000. The Company incurred net interest expense of $904,000 in fiscal 1994 due to the $18.5 million of long-term debt incurred by the Company to fund its expansion and share repurchase program.\nINCOME TAXES\nThe Company's effective income tax rate decreased from 27.1% in fiscal 1993 to 21.2% in fiscal 1994. The fiscal 1993 rate was lower than statutory rates as a result of the use of targeted jobs tax credits and rehabilitation credits for the renovation of pre-1936 buildings. Beginning in fiscal 1994, the Company's expansion plans focused exclusively on the construction of new suburban buildings which are not eligible for rehabilitation tax credits; however, the effective tax rate decreased in fiscal 1994 due to a substantial increase in the targeted jobs tax credit relative to the decline in pre-tax net income and to the utilization of the FICA tip credit enacted by Congress at that time.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company's working capital deficit decreased from $3.2 million on July 3, 1994 to $2.6 million on July 2, 1995. This $0.6 million decrease is due to the timing of year-end payments of salaries and wages and to a reduction in accounts payable. The Company is currently operating with a working capital deficit, which is common in the restaurant industry, since restaurant companies do not normally require significant investment in either accounts receivable or inventory.\nNet cash provided by operating activities decreased from $9.6 million in fiscal 1994 to $6.1 million in fiscal 1995 primarily due to changes in certain components of working capital, including decreases in accrued payroll, accounts payable and deferred taxes and the decrease in net income.\nThe Company supplements cash provided by operations with long-term debt borrowed under its bank credit facilities. Long-term debt outstanding at July 2, 1995, consisted primarily of a $15.0 million fixed rate 10-year term loan and $0.5 million borrowed against the Company's floating rate revolving credit facility. The Company had an additional $14.2 million available under this revolving credit facility at July 2, 1995.\nIn fiscal 1994, the Company's Board of Directors authorized a program for the repurchase of up to 1,000,000 shares of the Company's common stock for investment purposes. As of July 2, 1995, the Company had repurchased 751,157 shares of common stock under this program. Further purchases with respect to this program are dependent upon various business and financial considerations.\nThe Company's capital expenditures decreased from $13.5 million in fiscal 1994 to $3.9 million in fiscal 1995 due to the reduction in the number of new stores opened by the Company. Fiscal 1995 expenditures consisted primarily of Bedford restaurant construction costs, purchases of new and replacement equipment and decor for the Company's existing restaurants, and costs associated with the replacement of point-of-sale (POS) equipment in 16 Company restaurants.\nIn fiscal 1996, the Company plans to increase seating capacity in various existing high-volume restaurants, complete replacement of POS equipment in seven additional restaurants, make construction and equipment modifications to an existing restaurant for a new concept currently under development and continue to make necessary replacements and upgrades to its existing restaurants and information systems. Total planned capital expenditures related to these fiscal 1996 projects is $4.5 million. Cash flow from operations, current cash balances\nand funds available under the Company's revolving credit facility are expected to be sufficient to fund planned capital expenditures and possible further repurchases of Company stock in fiscal 1996.\nEFFECT OF INFLATION\nManagement does not believe inflation has had a significant effect on the Company's operations during the past several years. The Company has historically been able to pass on increased costs through menu price increases; however, due to the competitive environment of the restaurant industry, there can be no assurance that the Company will be able to pass on such cost increases in the future.\nSEASONALITY\nThe Company's business is subject to seasonality with revenues generally being highest during the months of July and August and lowest during the months of September through January. This seasonality is due to the dining-out patterns of the Company's customers.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe Financial Statements and Supplementary Data are set forth herein commencing on page of this Report.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nAs previously disclosed in the Company's Form 8-K filed on November 1, 1994 with the Securities and Exchange Commission, on October 26, 1994, the Company dismissed KPMG Peat Marwick LLP as its independent public accountants and engaged Arthur Andersen LLP in place thereof.\nThe Company has had no disagreements with either independent accounting firm to report under this item.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nThe information required in response to this Item is incorporated herein by reference to the Company's proxy statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A, not later than 120 days after the end of the fiscal year covered by this report.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe information required in response to this Item is incorporated herein by reference to the Company's proxy statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A, not later than 120 days after the end of the fiscal year covered by this report.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe information required in response to this Item is incorporated herein by reference to the Company's proxy statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A, not later than 120 days after the end of the fiscal year covered by this report.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe information required in response to this Item is incorporated herein by reference to the Company's proxy statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A, not later than 120 days after the end of the fiscal year covered by this report.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(a) Documents filed as part of Report.\n1. Financial Statements: --------------------\nThe Financial Statements are listed in the index to Consolidated Financial Statements on page of this Report.\n2. Exhibits: --------\n3.1 - Second Amended and Restated Articles of Incorporation of the Company, as amended (incorporated by reference to Exhibit 3.1 of the Company's Form 10-Q for the quarter ended April 2, 1995, filed by the Company with the Securities and Exchange Commission).\n3.2 - Second Amended and Restated Bylaws of the Company, as amended (incorporated by reference to Exhibit 3.2 of the Company's Form 10-Q for the quarter ended January 1, 1995, filed by the Company with the Securities and Exchange Commission).\n4.1 - Rights Agreement, dated February 2, 1995 between the Company and Chemical Bank (incorporated by reference to Exhibit 1 of the Company's Registration Statement on Form 8-A, filed by the Company with the Securities and Exchange Commission on February 27, 1995).\n+ 10.1 - First Amended and Restated 1990 Spaghetti Warehouse, Inc. Incentive Stock Option Plan (incorporated by reference to Exhibit 4.3 of the Company's Registration Statement on Form S-8, registration no. 33-69024, filed by the Company with the Securities and Exchange Commission).\n+ 10.2 - 1991 Nonemployee Director Stock Option Plan (incorporated by reference to Exhibit 10.3 of the Company's Registration Statement on Form S-2, registration no. 33-40257, filed by the Company with the Securities and Exchange Commission).\n+ 10.3 - Stock Option of Spaghetti Warehouse, Inc., dated March 25, 1991, for Louis P. Neeb (incorporated by reference to Exhibit 10.23 of the Company's Registration Statement on Form S-2, registration no. 33-40257, filed by the Company with the Securities and Exchange Commission).\n+ 10.4 - Spaghetti Warehouse, Inc. 1992 Bonus Stock Option Plan (incorporated by reference to Exhibit 4.8 of the Company's Registration Statement on Form S-8, registration no. 33-69024, filed by the Company with the Securities and Exchange Commission).\n+ 10.5 - Letter dated April 2, 1991 relating to the Company's employment arrangement with Louis P. Neeb (incorporated by reference to Exhibit 10.26 of the Company's Registration Statement on Form S-2, registration no. 33-40257, filed by the Company with the Securities and Exchange Commission).\n+ 10.6 - Letter Agreement, dated as of August 23, 1993, relating to the Company's employment arrangement with H.G. Carrington, Jr. (incorporated by reference to Exhibit 10.6 of the Company's Annual Report on Form 10-K for the Fiscal Year Ended July 4, 1993).\n10.7 - Lease Agreement, dated June 13, 1977, between the Company and Oscar L. Thomas, Jr., relating to certain premises in Columbus, Ohio (incorporated by reference to Exhibit 10.5 of the Company's Registration Statement on Form S-1, registration no. 2-99832, filed by the Company with the Securities and Exchange Commission).\n10.8 - Lease Agreement, dated September 1, 1980 between the Company and Gagel Construction, Inc. (incorporated by reference to Exhibit 10.6 of the Company's Registration Statement on Form S-1, registration no. 2-99832, filed by the Company with the Securities and Exchange Commission).\n10.9 - Lease Agreement, dated November 18, 1981 between the Company and Samuel Geraldo, Trustee, as amended, relating to certain premises in Toledo, Ohio (incorporated by reference to Exhibit 10.6 of the Company's Registration Statement on Form S-1, registration no. 33-30676, filed by the Company with the Securities and Exchange Commission).\n10.10 - Lease Agreement, dated November 30, 1981, between the Company and Ybor Square, Ltd., relating to certain premises in Tampa, Florida (incorporated by reference to Exhibit 10.8 of the Company's Registration Statement on Form S-1, registration no. 2-99832, filed by the Company with the Securities and Exchange Commission).\n10.11 - Loan Agreement, dated as of December 1, 1981, between the Company and City of Toledo, Ohio (incorporated by reference to Exhibit 10.10 of the Company's Registration Statement on Form S-1, registration no. 2-99832, filed by the Company with the Securities and Exchange Commission).\n10.12 - Financing and Operating Agreement, dated September 2, 1982, among the Company, the City of Tampa, Florida, The Spaghetti Consultants of Florida, Inc., Ybor Square, Ltd. and Continental National Bank of Fort Worth, Texas (incorporated by reference to Exhibit 10.11 of the Company's Registration Statement on Form S-1, registration no. 2-99832, filed by the Company with the Securities and Exchange Commission).\n10.13 - Lease Agreement, dated April 1, 1987, between the Company and Memphis Center City Revenue Finance Corporation, relating to certain premises in Memphis, Tennessee (incorporated by reference to Exhibit 10.16 of the Company's Annual Report on Form 10-K for the Fiscal Year Ended July 4, 1987, filed by the Company with the Securities and Exchange Commission).\n10.14 - Lease, dated May 28, 1988, between the Company and Ward and Shirley Olander, relating to certain premises in Pittsburgh, Pennsylvania (incorporated by reference to Exhibit 10.18 of the Company's Registration Statement on Form S-1, registration no. 33-30676, filed by the Company with the Securities and Exchange Commission).\n10.15 - Lease Agreement, dated as of February 15, 1989, between the Company and North Clinton Associates, relating to certain premises in Syracuse, New York (incorporated by reference to Exhibit 10.21 of the Company's Registration Statement on Form S-1, registration no. 33-30676, filed by the Company with the Securities and Exchange Commission).\n10.16 - Deed of Trust, Security Agreement and Assignment of Rents, dated July 24, 1989, between the Company, as grantor, and Deposit Guaranty Bank, as beneficiary, and related promissory note (incorporated by reference to Exhibit 10.22 of the Company's Registration Statement on Form S-1, registration no. 33-30676, filed by the Company with the Securities and Exchange Commission).\n10.17 - Lease Agreement, dated May 29, 1990, between Spring- Ten Associates and the Company, as amended on July 18, 1990, October 26, 1990, and December 13, 1990, relating to certain premises in Philadelphia, Pennsylvania (incorporated by reference to Exhibit 10.24 of the Company's Registration Statement on Form S-2, registration no. 33-40257, filed by the Company with the Securities and Exchange Commission).\n10.18 - Lease Agreement, dated as of November 27, 1990, between the Company and The Foundry Associates, L.P., relating to certain premises in Providence, Rhode Island (incorporated by reference to Exhibit 10.25 of the Company's Registration Statement on Form S-2, registration no. 33-40257, filed by the Company with the Securities and Exchange Commission).\n10.19 - Contract for Sale of Real Estate, dated September 12, 1991, among the Company, Elie Guggenheim and Catherine Guggenheim (incorporated by reference to Exhibit 10.18 of the Company's Form 10-K for the fiscal year ended July 4, 1992, filed with the Securities and Exchange Commission).\n10.20 - Real Estate Term Note in original principal amount of $180,000, dated November 21, 1991, executed by the Company as maker, payable to the order of Elie Guggenheim and Catherine Guggenheim (incorporated by reference to Exhibit 10.19 of the Company's Form 10- K for the fiscal year ended July 4, 1992, filed with the Securities and Exchange Commission).\n10.21 - Lease Agreement, dated as of July 6, 1991, between the Company and Nautica Peninsula Land Limited Partnership, relating to certain premises in Cleveland, Ohio (incorporated by reference to Exhibit 10.21 of the Company's Annual Report on Form 10-K for the fiscal year ended July 4, 1993, filed with the Securities and Exchange Commission).\n10.22 - Lease Agreement, dated as of September 2, 1992, between the Company and Canal Place, Ltd., relating to certain premises in Akron, Ohio (incorporated by reference to Exhibit 10.22 of the Company's Annual Report on Form 10-K for the fiscal year ended July 4, 1993, filed with the Securities and Exchange Commission).\n10.23 - Form of Spaghetti Warehouse, Inc. Franchise Offering Circular (incorporated by reference to Exhibit 10.23 of the Company's Annual Report on Form 10-K for the fiscal year ended July 4, 1993, filed with the Securities and Exchange Commission).\n10.24 - Spaghetti Warehouse, Inc. Amended and Restated Master Development Agreement, dated as of February 10, 1993, between the Company and TGI Friday's, Inc. (incorporated by reference to Exhibit 10.24 of the Company's Annual Report on Form 10-K for the fiscal year ended July 4, 1993, filed with the Securities and Exchange Commission).\n10.25 - Amended and Restated Loan Agreement, dated as of November 1, 1993, among the Company, certain subsidiaries of the Company, Bank One Texas, N.A. and NationsBank of Texas, N.A., and Amendment No. 1 thereto, dated December 21, 1993 (incorporated by reference to Exhibit 10.25 of the Company's Annual Report on Form 10-K for the fiscal year ended July 3, 1994, filed with the Securities and Exchange Commission).\n10.26 - Stock Purchase Agreement, dated as of September 1, 1992, among Old Spaghetti Factory (Canada) Limited, Heather Buckley, Patti Hnatiw, Peter Buckley, Peter Hnatiw, 998757 Ontario Inc. and the Company (incorporated by reference to Exhibit 10.21 of the Company's Form 10-K for the fiscal year ended July 4, 1992, filed with the Securities and Exchange Commission).\n10.27 - Asset Purchase Agreement, dated as of September 1, 1992, among Esplanade Restaurants Ltd., Peter Hnatiw, SWEATAC Canada, Inc. and the Company (incorporated by reference to Exhibit 10.22 of the Company's Form 10-K for the fiscal year ended July 4, 1992, filed with the Securities and Exchange Commission).\n10.28 - Asset Purchase Agreement, dated as of September 1, 1992, among Old Spaghetti Factory (Western) Limited, Heather Buckley, Peter Buckley, SWEATAC Canada, Inc. and the Company (incorporated by reference to Exhibit 10.23 of the Company's Form 10-K for the fiscal year ended July 4, 1992, filed with the Securities and Exchange Commission).\n10.29 - Lease Agreement, dated as of August 11, 1993, between the Company and the State of Texas, relating to certain premises in Harris County, Texas, as amended by First Amendment to Lease Agreement effective October 25, 1993 and Second Amendment to Lease Agreement, undated (incorporated by reference to Exhibit 10.29 of the Company's Annual Report on Form 10-K for the fiscal year ended July 3, 1994, filed with the Securities and Exchange Commission).\n10.30 - Second Lease Addendum, dated as of July 29, 1994, by and between Patricia D. Thomas, Oscar L. Thomas III and Spaghetti Warehouse of Ohio, Inc., relating to\ncertain premises in Columbus, Ohio (incorporated by reference to Exhibit 10.30 of the Company's Annual Report on Form 10-K for the fiscal year ended July 3, 1994, filed with the Securities and Exchange Commission).\n+ 10.31 - Spaghetti Warehouse, Inc. Employee Stock Purchase Plan (incorporated by reference to Exhibit 10.31 of the Company's Annual Report on Form 10-K for the fiscal year ended July 3, 1994, filed with the Securities and Exchange Commission).\n+ 10.32 - Employment Agreement, dated as of June 25, 1994, by and between the Company and Phillip Ratner (incorporated by reference to Exhibit 10.32 of the Company's Annual Report on Form 10-K for the fiscal year ended July 3, 1994, filed with the Securities and Exchange Commission).\n10.33 - Shareholders Agreement, undated, among Competitive Foods Australia Limited, Tarlina PTY Limited, MCS (Australia) PTY Limited, SWH Antiques, Inc. and F.P. Corporation PTY Limited, with respect to Fasta Pasta (incorporated by reference to Exhibit 10.33 of the Company's Annual Report on Form 10-K for the fiscal year ended July 2, 1995, filed with the Securities and Exchange Commission).\n10.34 - Amendment No. 2, dated February 9, 1995 to the Amended and Restated Loan Agreement, dated as of November 1, 1993, June 7, 1993, among the Company, certain subsidiaries of the Company, Bank One Texas, N.A. and NationsBank of Texas, N.A., and Amendment No. 1 thereto, dated December 21, 1993 (incorporated by reference to Exhibit 10.34 of the Company's Form 10-Q for the quarter ended January 1, 1995, filed by the Company with the Securities and Exchange Commission).\n21.1 - Subsidiaries of the Company (incorporated by reference to Exhibit 21.1 of the Company's Annual Report on Form 10-K for the fiscal year ended July 3, 1994, filed with the Securities and Exchange Commission).\n* 23.1 - Consent of Arthur Andersen LLP\n* 23.2 - Consent of KPMG Peat Marwick LLP\n* 27.1 - Financial Data Schedule\n_______________ + Compensation plan, benefit plan or employment contract or arrangement. * Filed herewith. (b) Reports on Form 8-K\nThe Company did not file any report on Form 8-K during the last quarter of the period covered by this Report.\nSPAGHETTI WAREHOUSE, INC. AND SUBSIDIARIES\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ----------------------------------------\nThe Board of Directors Spaghetti Warehouse, Inc.:\nWe have audited the accompanying consolidated balance sheet of Spaghetti Warehouse, Inc. (a Texas Corporation) and subsidiaries as of July 2, 1995, and the related consolidated statements of income, stockholders' equity and cash flows of Spaghetti Warehouse, Inc. and subsidiaries for the year then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Spaghetti Warehouse, Inc. and subsidiaries as of July 2, 1995, and the consolidated results of operations and cash flows of Spaghetti Warehouse, Inc. and subsidiaries for the year then ended in conformity with generally accepted accounting principles.\nARTHUR ANDERSEN LLP\nDallas, Texas August 18, 1995\nINDEPENDENT AUDITORS' REPORT ----------------------------\nThe Board of Directors Spaghetti Warehouse, Inc.:\nWe have audited the accompanying consolidated balance sheet of Spaghetti Warehouse, Inc. and subsidiaries as of July 3, 1994, and the related consolidated statements of income, stockholders' equity and cash flows for each of the years in the two-year period ending July 3, 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 Spaghetti Warehouse, Inc. and subsidiaries as of July 3, 1994, and the results of their operations and their cash flows for each of the years in the two-year period ended July 3, 1994, in conformity with generally accepted accounting principles.\nKPMG Peat Marwick LLP\nDallas, Texas August 19, 1994\nSPAGHETTI WAREHOUSE, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\nJULY 3, 1994 AND JULY 2, 1995\nSee accompanying notes to consolidated financial statements.\nSPAGHETTI WAREHOUSE, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF INCOME\nYEARS ENDED JULY 4, 1993, JULY 3, 1994 AND JULY 2, 1995\nSee accompanying notes to consolidated financial statements.\nSPAGHETTI WAREHOUSE, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY\nSee accompanying notes to consolidated financial statements.\nSPAGHETTI WAREHOUSE, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nYEARS ENDED JULY 4, 1993, JULY 3, 1994 AND JULY 2, 1995\nSee accompanying notes to consolidated financial statements.\nSPAGHETTI WAREHOUSE, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (a) Principles of Consolidation\nThe consolidated financial statements include the accounts of Spaghetti Warehouse, Inc. and its wholly-owned subsidiaries (collectively, the Company). All significant intercompany balances and transactions have been eliminated in consolidation.\n(b) Fiscal Year\nThe Company's fiscal year ends on the Sunday nearest July 1.\n(c) Foreign Currency Translation\nThe accounts of the Company's operations in Canada are translated into United States dollars in accordance with Statement of Financial Accounting Standards No. 52. Assets and liabilities are translated at the rate of exchange on the balance sheet date. Income and expense items are translated at average monthly rates of exchange. Adjustments resulting from the translation are reported as a separate component of stockholders' equity.\n(d) Reclassifications\nCertain prior years' balances have been reclassified to conform with the current year presentation. These reclassifications had no effect on previously reported net income or stockholders' equity.\n(e) Cash Equivalents\nFor purposes of the consolidated statements of cash flows, the Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. The Company held cash equivalents of $360,075 and $651,857 at July 3, 1994 and July 2, 1995, respectively.\n(f) Accounts Receivable\nAccounts receivable primarily consist of credit card receivables and Canadian franchise royalty fees.\n(g) Inventories\nInventories, which primarily consist of food and beverages, are stated at the lower of cost (first-in, first-out method) or market.\n(h) Pre-opening Costs\nThe costs of hiring and training personnel, supplies and certain general and administrative costs relating to new restaurants are capitalized and amortized over the restaurant's first 12 months of operations.\nSPAGHETTI WAREHOUSE, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\n(i) Property and Equipment\nProperty and equipment are recorded at cost, including interest capitalized during the construction period. Total interest of $164,448, $95,104 and $18,340 was capitalized in fiscal years 1993, 1994 and 1995, respectively.\nBuildings, equipment, furniture and fixtures are depreciated using the straight-line method over the estimated useful lives of the related assets, which range from 3 to 40 years. Amortization of leasehold improvements is provided by the straight-line method over the lesser of the term of the lease, including renewal options, or the estimated useful lives of the assets, which range from 18 to 25 years.\n(j) Trademark and Franchise Rights\nThe costs of the Canadian operation's trademark (approximately $2,200,000) and franchise rights (approximately $1,700,000) are being amortized using the straight-line method over 40 years and 20 years, respectively.\nThe Company assesses the recoverability of these intangible assets by determining whether the amortization of the asset balance over its remaining life can be recovered through undiscounted future operating cash flows of the acquired operation. The amount of impairment, if any, is measured based on projected discounted future operating cash flows. The Company believes that no impairment or adjustment of estimated useful lives is warranted at July 2, 1995.\n(k) Income Taxes\nIn February 1992, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (Statement 109). Statement 109 requires a change from the deferred method of accounting for income taxes to the asset and liability method. 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 Statement 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.\nThe Company adopted Statement 109 in fiscal 1993 and all periods presented are in accordance with Statement 109.\n(l) Other Accrued Liabilities\nOther accrued liabilities consist of the following:\nSPAGHETTI WAREHOUSE, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\n(m) Net Income per Common Share\nBoth primary and fully diluted net income per common share are based on the weighted average number of shares outstanding during the year increased by common equivalent shares (primarily stock options) determined using the treasury stock method.\nThe weighted average numbers of shares outstanding for the primary and fully diluted net income per common share computations are as follows for fiscal years 1993, 1994, and 1995:\n(2) PROPERTY AND EQUIPMENT\nProperty and equipment consists of the following:\nIn fiscal 1992, the Company purchased the existing Austin location and ceased development of an alternate Austin location. In fiscal 1993 and 1994, the Company recognized a loss of $143,307 and $50,000, respectively, on the alternate location to reflect a reduction in the estimated value of the property to its expected recovery amount. The resulting current value of the alternate Austin location is reflected as an asset scheduled for divestiture in the accompanying consolidated balance sheets. In August 1995, a contract was entered into to sell the location for an amount exceeding the recorded net book value. Upon sale, the Company expects to recognize a net tax benefit of approximately $19,000.\n(3) TRADEMARKS AND FRANCHISE RIGHTS\nOn September 1, 1992, the Company acquired the common stock of Old Spaghetti Factory Canada, Ltd. and the assets of certain of its affiliates, including the trademark to the Old Spaghetti Factory concept in Canada and the franchise contracts and related royalty streams for five Old Spaghetti Factory restaurants in Canada. The acquisition was accounted for as a purchase. The cash purchase price of $3,900,000 was allocated primarily to the aforementioned trademark and franchise contract rights.\nSPAGHETTI WAREHOUSE, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\n(4) LONG-TERM DEBT\nLong-term debt consists of the following:\nOn June 7, 1993, the Company executed a new unsecured revolving credit and term loan agreement with two banks which enables the Company to borrow up to $30,000,000 in the aggregate. The Company may borrow $15,000,000 in revolving credit loans and an additional $15,000,000 in term loans. Revolving credit loans bear per annum interest at the Company's option of (a) the prime rate, (b) the certificate of deposit rate plus the Federal Deposit Insurance Corporation assessment rate plus 1.25% or (c) the LIBOR rate plus 1.50%. The Company incurs a commitment fee of 1\/4 of 1% per annum on the unused portion of the revolving credit facility, payable on a quarterly basis. The terms of the credit agreement require the Company to maintain certain minimum financial ratios.\nThe aggregate maturities of long-term debt at July 2, 1995 are as follows:\n(5) INCOME TAXES\nAs discussed in note 1, the Company adopted Statement 109 in fiscal 1993 and all periods presented are in accordance with Statement 109.\nSPAGHETTI WAREHOUSE, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nThe provision for income tax expense is summarized as follows for fiscal years 1993, 1994 and 1995:\nThe actual income tax expense differs from the \"expected\" income tax expense computed by applying the U.S. federal corporate tax rate to income before income tax expense as follows for fiscal years 1993, 1994 and 1995:\nThe tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities as of July 3, 1994 and July 2, 1995 are as follows:\nAs of July 2, 1995, the Company had approximately $3,642,000 of general business credit carryforwards for income tax purposes, which begin to expire in 2006. These carryforwards are comprised of targeted jobs tax credits, rehabilitation credits and FICA tip credits that were generated in all prior years, beginning in fiscal 1991. Based upon historical levels of earnings and considering the reversal of temporary differences resulting in future tax\nSPAGHETTI WAREHOUSE, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nliabilities, the Company believes it will more likely than not be able to realize the deferred tax assets recorded at July 2, 1995.\n(6) COMMON STOCK AND OPTIONS\n(a) Incentive Stock Option Plan\nThe Company has an Incentive Stock Option Plan (Plan) covering 946,275 shares of common stock. The Plan provides that options may be granted at option prices not less than the fair market value of its shares on the date of grant, or 110% of fair market value in the case of any employee holding in excess of 10% of the combined voting power of all classes of stock at the date of grant. The options currently outstanding are exercisable in installments of 10% to 100% per year.\nInformation with respect to options under the above plan follows (various options were repriced in fiscal 1994 and 1995 to the then current market price):\n(b) Other Plans\nIn March 1991, an officer of the Company was granted nonqualified stock options to purchase 165,000 shares of common stock at an option price per share of $14.58, the fair market value of the common stock on the date of grant. The options were generally exercisable in installments over a five-year period. During 1994, the officer left the Company and lost the rights to the stock options.\nThe Company's Board of Directors granted certain officers and directors of the Company nonqualified options to purchase 1,380 shares of common stock at an option price per share of $10.88 in fiscal 1993, 3,290 shares of common stock at an option price per share of $4.56 in fiscal 1994 and 862 and 5,335 shares of common stock at an option price of $3.25 and $2.81, respectively, in fiscal 1995 . The option prices were one-half of the fair market value of the common stock on the dates of grant. The options became exercisable six months subsequent to the dates of grant and, as such, all options granted are exercisable as of July 2, 1995. The options were granted as part of the officers' and directors' compensation and are recorded as compensation expense and additional paid-in capital\nSPAGHETTI WAREHOUSE, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nof $15,000 in fiscal 1993 and 1994, and $17,800 in fiscal 1995. As of July 2, 1995, there have been no exercises under this plan.\nCertain directors of the Company were granted nonqualified stock options to purchase an aggregate of 37,500 shares of common stock at option prices per share ranging from $9.88 to $21.75. The option prices were the fair market values of the common stock on the dates of grant. The options are exercisable in installments over a five-year period and 25,000 shares are exercisable as of July 2, 1995. As of July 2, 1995, there have been no exercises under this plan.\nOn August 23, 1993, the Company's Board of Directors approved an Employee Stock Purchase Plan (ESP Plan). The ESP Plan authorizes 250,000 shares of the Company's common stock to be purchased by employees of the Company through payroll deductions. The purchase price is the lesser of 85% of the fair market value of the stock on the first business day of the offering period or 85% of the fair market value of the shares on the last business day of the offering period. The ESP Plan, which consists of three one-year offering periods, became effective December 1, 1993 and will terminate on November 30, 1996. During the fiscal year ended July 2, 1995, a total of 28,713 shares were purchased by the employees of the Company under this plan.\n(7) COMMITMENT AND CONTINGENCIES\nThe Company leases certain restaurant facilities under operating leases expiring at various dates through 2027. These operating leases have renewal options for up to five successive five-year periods. The minimum rental commitments under all noncancelable operating leases as of July 2, 1995 are as follows:\nRental expense under operating leases was approximately $708,000, $660,000 and $750,000 for fiscal years 1993, 1994 and 1995, respectively.\nSubsequent to the balance sheet date, the company was notified that a claim had been submitted against the Company to the American Arbitration Association by Bright-Kaplan International Corporation, the owner of a Spaghetti Warehouse franchise in Knoxville, Tennessee, seeking damages in excess of $6.6 million. Additionally, Elizabeth Bright and Thomas C. Bright, III, the principal shareholders of Bright-Kaplan International Corporation, have filed a lawsuit against the Company, seeking damages in excess of $2.5 million, along with trebling of such damages under the Texas Deceptive Trade Practices Act. The Company believes the claims are without merit and intends to vigorously defend each claim. As of the balance sheet date, damages, if any, arising from such litigation are not estimable.\nThe Company is also a party to several legal proceedings arising in the ordinary course of business. After consultation with legal counsel and a review of available facts, management believes that damages, if any, arising from such litigation will not be material to the Company's financial position or results of operations.\nSPAGHETTI WAREHOUSE, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\n(8) UNUSUAL CHARGE\nDuring the fourth quarter of fiscal 1995, the Company recorded a write-down of its one-third investment in F.P. Corporation PTY Ltd. and FP Restaurants PTY Ltd. (collectively \"Fasta Pasta\"). The write-down was the result of an alleged misappropriation of Fasta Pasta assets by the joint-venture's former managing director. At July 2, 1995, the remaining net investment in Fasta Pasta of approximately $60,000 is reflected in other assets in the accompanying consolidated balance sheet.\n(9) RECONCILIATION OF NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES\nThe reconciliation of net income to net cash provided by operating activities for the years ended July 4, 1993, July 3, 1994 and July 2, 1995 follows:\nSPAGHETTI WAREHOUSE, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\n(10) QUARTERLY FINANCIAL DATA (UNAUDITED)\nUnaudited summarized quarterly financial data follows:\n(a) Gross profit is calculated as total revenues less cost of sales and operating expenses.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the 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 Garland, State of Texas, on September 26, 1995.\nSPAGHETTI WAREHOUSE, INC.\n\/s\/ Phillip Ratner ------------------------------------------ Phillip Ratner, 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\n_______________ + Compensation plan, benefit plan or employment contract or arrangement. * Filed herewith.","section_15":""}
{"filename":"733269_1995.txt","cik":"733269","year":"1995","section_1":"Item 1. Business\nGeneral\nThe Company's traditional business is the provision of data processing and related computer-based services and software products to direct marketing organizations and to the marketing departments of large corporations in the United States and the United Kingdom. Since its inception in 1969, the Company has evolved into what management believes, based upon its knowledge of the industry, is a leading provider of computer-based services to the direct marketing industry. The Company offers a broad range of services to direct marketers and to other businesses which utilize direct marketing techniques such as mail order, catalog sales and prospect generation. The Company assists its customers with the marketing process, from planning and project design, to list cleaning, list enhancement and list production, to database creation and management, to fulfillment and consumer response analysis.\nThe Company also offers outsourcing\/facilities management and information management services whereby the Company manages the data processing and information systems functions for its\ncustomers. Such customers and prospects include traditional direct marketing companies as well as companies which are not in the direct marketing industry. In addition, the Company provides software to the publishing industry. Management anticipates that the outsourcing\/facilities management services will continue to expand during the foreseeable future, and that such services will increasingly generate a greater percentage of the Company's revenue. See \"The Company's Products and Services,\" below.\nThe Company was incorporated in Delaware in 1983 and succeeded by merger to the business of Conway Communications Exchange, Inc., an Arkansas corporation incorporated in 1969 as Demographics, Inc., which thereafter changed its name to Conway Communications Exchange, Inc. Effective upon the 1983 merger, the Company operated as CCX Network, Inc. until 1988, when the name Acxiom Corporation was adopted. From 1986-1988, the Company acquired the following businesses: Southwark Computer Services, Ltd. (\"Southwark\"), a British corporation which offered data processing and computer based services in the United Kingdom, and Marketlead Services, Ltd. (\"Marketlead\"), a British corporation which provided promotional materials handling and fulfillment services in the United Kingdom (Southwark and Marketlead are now doing business as Acxiom U.K., Ltd.); BSA, Inc. (\"BSA\"), a New Jersey corporation which designed and marketed software systems for the catalog industry; and Modern Mailers, Inc., d\/b\/a Acxiom Mailing Services (\"AMS\"), a fully computerized direct mail business located in Philadelphia, Pennsylvania whose services included personalized printing and lettershop operations. The Company sold substantially all of the assets of AMS effective March 31, 1994. Likewise, the Company sold substantially all of the assets of BSA effective June 1, 1994. See \"The Company's Products and Services,\" below. The Company's headquarters and primary center of operations are located in Conway, Arkansas.\nThe Company's Products and Services\nTraditional List and Data Warehouse Services. The services described below have historically formed the core of the Company's business and will continue to be important to its operations:\nThe Company offers data processing and related services and software products to the direct marketing industry and to a variety of other businesses. With respect to the Company's traditional business, management believes, based upon its knowledge of the industry, that the Company is one of the leading suppliers of information services to the direct marketing industries in the United States and the United Kingdom, offering companies who use direct marketing access to extensive customer lists and databases of information, as well as providing a wide range of services that permit customers to precisely tailor their mailing lists in accordance with specifically targeted marketing plans.\nThe Company provides computer-based targeted marketing support for direct marketers, which support consists of planning and project design, list cleaning, list enhancement, list order fulfillment, database services and response analysis. Rather than focusing solely upon direct marketing programs designed to obtain new business prospects for its customers, the Company has begun to build marketing databases which enable its customers to focus upon their existing clientele. Such databases allow a marketer to analyze its customers' buying habits, and to narrowly target advertising campaigns to those customers who are most likely to respond. In addition, the Company offers integrated data processing software systems and enhancement services which provide its customers with rapid access to marketing information housed at the Company's Conway, Arkansas and Sunderland, England locations.\nAn integral aspect of the Company's traditional business is offering its customers access to extensive customer lists and databases of information. Rather than owning any of the approximately 25,000 lists to which its customers are granted access, the Company acts as a link between those who own or manage lists and those who buy or use lists for direct marketing purposes. The list owners could remove the lists from the Company's possession, and if a substantial number of lists were removed, a material adverse impact upon the Company's operations could result. However, management believes that any such actions are unlikely in that the value of the lists are enhanced through manipulation by the Company's software and through combination with other lists. Further, few list owners utilizing the Company's services in the past have removed their lists. Based upon its knowledge of the operations of its competitors and its customers, management believes that the Company has been entrusted with the largest aggregation of names, addresses and related data available to the direct marketing industry and to other businesses, in that it maintains and updates approximately 25,000 lists and 500 databases owned by others, totaling approximately 4.5 billion name and address records, all of which records are available to authorized customers.\nThrough a national data communications network in the United States, the Company provides decision support information for direct marketing organizations. Direct marketing programs require the analysis and segmentation of large amounts of data on past customers and known marketplace prospects to identify desired purchasing characteristics. From this information, specific targeted marketing strategies and personalized communications can be generated. The Company's primary vehicle for rapid delivery of these services is its data communications network (\"Network\") through which direct marketing customers receive authorized access to lists and databases housed at the Company's Conway, Arkansas location. Customers are connected to the Network through either Company-owned terminal devices furnished to the customer or through customer-owned equipment. The Network is composed of dedicated,\nleased data communication lines which link approximately 2,400 customer work stations and printers at 143 U.S. sites, computer-to- computer links to customers and communication to remote data centers located in the U.S. and U.K. connected to the Network's central computer in Conway. Management believes that the Company has one of the largest capacities for database management, mailing list processing and networking in the industry. Through the Network, lists may be interrogated and regrouped with marketing information selected by the customer, including geographic, demographic, psychographic and previous consumer response data, so as to create the desired universe of names. The customer can then create, select, merge and enhance the lists available to it for even more precise market segmentation, thus enabling each mailing program to be tailored for a carefully targeted sales audience. Upon a customer's request, mailing lists and labels of the composed universe of names can then be produced by the Company for the customer's use.\nIn addition to the traditional services described above, the Company also provides the services described below:\nOutsourcing\/Facilities Management Services; Information Management Services. For the past six years, the Company has provided \"outsourcing\" or \"facilities management\" services whereby the Company manages a customer's data center and\/or provides information systems functions, both on-site at the customer's location and remotely from the Company's Conway, Arkansas data center. In several of these instances, the Company has licensed certain of its software to its customers, and has involved certain of its customers as partial underwriters of and participants in its research and development efforts. The two largest customers of the Company in fiscal 1995 are in this category:\nUnder the Company's August 31, 1992 data center management agreement with Trans Union Corporation (\"Trans Union\"), one of the three largest credit bureaus in the U.S., the Company, through its subsidiary Acxiom Chicago Data Center, Inc., is managing Trans Union's data processing center in Chicago, Illinois, for annual fees of approximately $20 million for the existing base capacity, with revenues to be adjusted in the future for changes in Trans Union's capacity requirements. In August 1994, the Company and Trans Union agreed to extend the data center management agreement through August 2002, its full term of ten years. For additional discussion, this information appears in Note 10 of the Notes to Consolidated Financial Statements in the Company's Annual Report at pp. 43-44, which information is incorporated herein by reference. In addition, in December 1994 a marketing services agreement was executed between the Company and Trans Union's Marketing Services Division. Under the marketing services agreement, the Company will provide all of the data processing services for Trans Union's\nMarketing Services Division. When fully operational, annual revenues from the contract are expected to be approximately $20 million for the Company. Management anticipates aggregate revenues in excess of $175 million over the life of the contract.\nUnder a five-year information management agreement dated September 14, 1992 with Allstate Insurance Company (\"Allstate\"), the Company, through its subsidiary, Acxiom RM-Tools, Inc. (see discussion below) is managing the outside purchasing and internal processing of the consumer data Allstate uses for the underwriting of its lines of automobile insurance. These functions were previously handled through Allstate's twenty-eight (28) regional offices. The savings which result from Acxiom's management of this data are shared equally by Acxiom and Allstate. Under the agreement, the Company provides software systems and database management for Allstate to use in connection with new auto insurance policies across the United States. In addition, Allstate uses software systems developed by the Company to help evaluate auto policy renewals and to market various types of insurance to new and existing customers. Allstate has the right to obtain a non-transferable, non-exclusive license to Acxiom's core software utilized in processing Allstate's data, upon payment of Acxiom's standard software license fee. In January 1995 the Company and Allstate signed an agreement to make the Acxiom RM-ToolsSM software product, developed by the Company and Allstate, accessible for use by other personal lines property and casualty risk insurers. Through this software product, insurers will have access to an information package that includes motor vehicle registration, automatic claims history, driver information, financial stability information, vehicle verifications, property telephone inspections, property replacement costs and property claims history. It is expected that utilization of this product will streamline the underwriting process for these insurers, reduce their expenses and lower their data acquisition costs. Like the Trans Union agreement, the agreements with Allstate are in keeping with the Company's strategy to obtain long-term, large-volume contracts which generate predictable revenue. During the past fiscal year, Allstate accounted for approximately $53 million of the Company's total revenues.\nThrough its subsidiary, Acxiom RM-Tools, Inc. (\"Acxiom RM-T\"), the Company is pursuing contracts with other insurance companies whereby Acxiom RM-T would provide information management services to assist with the insurers' risk management, underwriting and marketing functions. In February 1994, Acxiom RM-T entered into a Software Development and Joint Sales Agreement with Fair, Isaac and Company, Incorporated (\"Fair Isaac\"), a leading developer of scoring technology for the insurance and credit industries. Together, the two companies plan to offer risk management information services to the insurance industry. In keeping with\nthis goal, Fair Isaac and Acxiom RM-T signed development partnership agreements during the last fiscal year with both the Hartford Fire Insurance Company, a member of the ITT Hartford Insurance Group (\"Hartford\"), and Lumbermens Mutual Casualty Company, a member of the Kemper National Insurance Companies (\"Kemper\"). Hartford and Kemper will participate directly in the development of the Acxiom RM-T\/Fair Isaac risk management products for the property and casualty insurance industry.\nIn May 1995, the Company entered into an agreement, effective April 1, 1995, with Automatic Data Processing (\"ADP\"). Pursuant to the agreement, ADP will outsource certain of its ADP Claims Solutions Group, Inc.'s data processing functions to the Company. These functions are currently performed in Ann Arbor, Michigan but will be transferred by the Company to its Conway, Arkansas facilities by July 1995. The term of the agreement is five (5) years, although ADP has the option to terminate the agreement at the end of the second year of the agreement, subject to a $210,000 penalty provision. When fully operational, annual revenues from the agreement are expected to generate approximately $2 million, with aggregate revenues in excess of $15 million over the life of the agreement.\nIt is the Company's intention to continue seeking outsourcing\/facilities management and information management agreements in the future. Because of the Company's skills and technology in the area of data processing, management believes that these types of agreements will be long-term benefits to the Company and will provide cost-effective data processing solutions for its customers. The services currently provided by the Company to such customers include data center management; information management; hardware installation and support; account management systems; installation, support and enhancement of software; customized software programming; and licensing of the Company's proprietary software.\nGS\/2000R Services. Subscription fulfillment data processing and software services have been offered by the company since 1989, when the Company entered into a data processing agreement and software license with Guideposts Associates, Inc. (\"Guideposts\"), one of the largest magazine publishers in the U.S. Pursuant to the agreement, the Company assumed management of Guideposts' data processing personnel, computer technology and operations. In addition, the Company acquired an exclusive license to develop and market Guideposts' proprietary magazine subscription fulfillment software (\"GS\/2000\"), a modular system that consolidates all aspects of subscription and book fulfillment and that supports the marketing, accounting and customer service functions necessary to a complete fulfillment operation. The Company has extensively developed GS\/2000 and has installed the software at three publishing companies. In addition, in 1994 the Company licensed GS\/2000 to the National Rifle Association for use in maintaining its membership records and continuity programs.\nIn 1991 the Company entered into a six-year agreement with Fulfillment Corporation of America (\"FCA\"), a recognized leader in the publishing fulfillment service industry. Pursuant to the agreement, FCA was to be the exclusive full-service provider of the Company's GS\/2000 system to U.S. magazine publishers. In addition, the Company was to outsource FCA's computer data processing functions by linking FCA to the Company's computer facilities and software systems in Conway, Arkansas. However, FCA was sold to Kable News Company, Inc. (\"Kable\") in January 1995, and it was decided by the Company and Kable to discontinue the relationship. As a result, the Company has no full-service distribution channel for the GS\/2000 product, an element that management believes was crucial to developing a competitive product. Consequently, the Company has determined that, rather than offer GS\/2000 as a generic solution for subscription fulfillment, the product can best be used as a custom access service for the Company's customers. The Company will continue to provide software support for its current GS\/2000 customers, but has discontinued its efforts to market GS\/2000 to new customers.\nInfoBase. In 1991, the Company entered into an eight-year partnership agreement with ADVO, Inc., a company which specializes in targeted direct mail products and services. Pursuant to the agreement, the Company and ADVO formed a partnership called InfoBase Services (\"InfoBase\") for the development of name-specific databases for use in direct marketing. InfoBase has two operating divisions: the original list enhancement operation created by the Company in 1987 and an operation which utilizes advanced optical scanning technology to extract data from directories and other printed materials (\"EDGE\"). In October 1994, the Company purchased ADVO's one-half interest in the partnership for $9 million. The Company also agreed to provide ADVO with service discounts over the next four years totaling, at a minimum, $2.6 million; provided, however, that if the service discounts do not total at least $2.6 million, the Company will pay the shortfall to ADVO in cash. For additional discussion, this information appears in Note 8 of the Notes to Consolidated Financial Statements in the Company's Annual Report at pp. 42-43, which information is incorporated herein by reference.\nThe primary business of InfoBase is the provision of list enhancement services to companies engaged in direct marketing to consumers. The household data which comprises the InfoBase IBConsumerSM database is owned by seven data contributors who permit InfoBase to access their data for the purpose of list enhancement, list analysis, segmentation modeling and merge\/purge screening. The type of data made available through InfoBase includes consumer names and addresses, as well as such demographic information as age, gender, approximate income brackets, occupation, marital status, the presence of children, and car and\nhome ownership. Management believes that the IBConsumer database is the most complete database of its kind in the United States, covering over 95% of all U.S. households.\nIn addition to its IBConsumer database, InfoBase has agreements with two companies, each of which have agreed to furnish information that can be used for the InfoBase business database, IBBusinessSM. The IBBusiness database is used by persons engaged in direct marketing to businesses.\nInfoBase has substantially completed the development of the EDGE file, which is a computerized listing of all U.S. telephone book white page information, and is marketing this file to potential users and resellers. To date, the EDGE file has been sold to six (6) users and resellers.\nU.K. Promotional Services. In addition to the data processing services offered by the Company in the U.K., the Company also provides comprehensive promotional materials handling and fulfillment services to its U.K. customers. Based upon its knowledge of the industry, management believes that it is one of the largest firms of its kind in the U.K. Among the services provided are promotional fulfillment, competition handling, in- bound telemarketing and response handling, lead monitoring, contract packing and mailing, and coupon redemption. Through the use of computerized tracking and monitoring systems, the Company is able to provide customers with current reports on the progress of their marketing campaigns and can furnish customers with information useful for promotion analysis and subsequent database campaigns. During the last fiscal year the Company mailed over 10,000,000 promotional items and custom-handled over 18,000,000 pieces of direct mail for over 30 U.K. customers. In addition, the Company handled over 250,000 telephone calls through its in-bound telemarketing and response handling service.\nCatalog Fulfillment Software Services. Effective June 1, 1994, the Company sold substantially all of the assets of BSA, Inc. (\"BSA\"), a subsidiary of the Company located in Ocean, New Jersey, to MorTech, Inc. (\"MorTech\"). Although management committed a substantial amount of software engineering resources to the development of BSA's proprietary catalog merchandise fulfillment software system marketed under the name \"Acxiom Acxess,\" a decision was made in fiscal 1994 to sell the assets of BSA. Management believed that the market potential for the sale of Acxess was significant; however, the performance of the subsidiary did not meet management's expectations. In addition, management is of the opinion that the catalog fulfillment software business is not within the range of the Company's core competencies: software systems development, data center management, and information management technology.\nAcxess was designed to facilitate the day-to-day operations of large mail order and catalog companies. Acxess also included accounting and inventory functions, as well as the ability to track marketing productivity. From 1992 to 1993, three Acxess sites were installed and a fourth site, installed in fiscal 1993, was subsequently de-installed upon mutual agreement of BSA and its customer, based upon the fact that Acxess did not meet the customer's needs. The Company is no longer involved in the day-to- day operations or support of the other three Acxess sites.\nConsequently, negotiations were held with various potential buyers, the result of which was the sale of certain U.S. assets of BSA to MorTech for $500,000. Charles D. Morgan, Jr., president of the Company, is the principal shareholder of MorTech. The proposed sale was evaluated by an independent committee of the Company's outside directors, which committee engaged a reputable investment valuation firm to render a fairness opinion regarding the proposed sale. Consummation of the sale was conditioned upon receipt of the investment valuation firm's fairness opinion, receipt of a favorable legal opinion from the Company's outside securities counsel, and a positive recommendation from the independent committee of outside directors. On May 16, 1994, the BSA operations in both the U.S. and the U.K. were significantly downsized. All BSA employees who were not hired by MorTech were laid off, and the BSA-U.K. operation was merged into Acxiom U.K.'s other operations. In addition, on October 20, 1994, the Company sold certain assets of BSA-U.K. to CPMS Limited, a U.K. company. For additional discussion, this information appears in Note 14 of the Notes to Consolidated Financial Statements in the Company's Annual Report at p. 46, which information is incorporated herein by reference.\nAcxiom Mailing Services. Effective March 31, 1994, the Company sold substantially all of the assets of its mailing services division (\"AMS\") located in Philadelphia, Pennsylvania to MorCom, Inc. For additional discussion, this information appears in Note 14 of the Notes to Consolidated Financial Statements in the Company's Annual Report at p. 46, which information is incorporated herein by reference. Management believed that the business of AMS was not within the range of the Company's core competencies.\nCustomers\nThe Company's customers include large U.S. and U.K. financial institutions, insurance companies, consumer credit organizations, seminar companies, communications companies, catalogers, retailers, television shopping networks, publishers, consumer goods manufacturers, membership and continuity\nassociations, and advertising agencies. Other customers include charities, list users (direct mailers and telemarketers), list owners (customers who generate and own their lists), and list managers and brokers (agents who manage lists and provide direct marketing consulting services). Having developed its expertise by servicing a traditional client base of companies which specialize in the direct marketing industry, the Company is finding increasing demand for its products and services within the marketing departments of large corporations as these companies turn to targeted marketing techniques to sell their goods and services. The Company is also experiencing a demand for its data processing and information management services by companies who are not in the direct marketing business. The Company's practice has been to extend payment terms to its customers for periods of up to sixty days and, accordingly, the Company uses operating capital to finance its accounts receivable. In fiscal 1995, the following customers accounted for 10% or more of the Company's total revenue: Trans Union Corporation (12.6%) and Allstate Insurance Company (26.4%).\nEmployees\nThe Company presently has approximately 1,850 employees.\nThe Direct Marketing Industry\nGeneral. The direct marketing industry is composed of businesses that use direct mail order and other methods of direct consumer contact to promote their products or services. Direct marketing service companies specialize in marketing consultation, list compilation and management, creative and lettershop services, data processing services and product fulfillment. Unlike traditional forms of advertising which are aimed at a broad audience through print or broadcast media, direct marketing involves targeted advertising sent directly to potential customers. Historically, direct marketing programs have had a positive response rate of approximately 1 to 3%. Consequently, direct marketers are heavily dependent upon specific market information and the application of statistics and computer modeling to assist them in predicting market behavior.\nThe products and services (see discussion above in \"The Company's Products and Services\") offered by the Company are designed to assist its customers to achieve a higher rate of return on their marketing investments by selectively targeting their marketing efforts to individuals who are most likely to respond.\nThe direct marketing industry has been negatively impacted during recent years by the U.S. economic recession and by postal rate increases. The most recent postal rate increase, which became effective in January 1995, and any future increases will, in the Company's opinion, force direct mailers to mail fewer pieces and to target their prospects more carefully. Through its software\nproducts and data processing services, the Company has the capability to assist its direct marketing customers to target their mailings to persons who are most likely to favorably respond, thereby meeting its customers' increasing need to market more effectively. The Company experienced no significant negative financial impact as a result of the most recent postal rate increase.\nConsumer Privacy and Legislative Concerns. There could be an adverse impact on the direct marketing industry due to an increase in public concern over consumer privacy issues. Senior management of the Company has taken a proactive role within the direct marketing industry to explore self-regulation alternatives in the privacy arena. Internally, the Company has formulated and distributed to each of its employees a written privacy policy which recognizes consumers' rights to control the dissemination of information about themselves. The privacy policy also states the Company's continuing commitment to strict data security systems, as well as the Company's support of the Direct Marketing Association's (\"DMA\") Mail and Telephone Preference Service programs, which permit consumers to \"opt-out\" of unrequested marketing solicitations. The Company has adopted a practice of purging its customers' lists of all names appearing on such DMA opt-out lists free of charge. Management is of the opinion that the measures which have been put in place, together with the Company's continuing efforts to stay informed and to take a leadership role in the area of privacy, will prevent the Company from being materially impacted by the growing consumer awareness of privacy issues.\nSenate and House of Representative bills have been introduced in the 104th Congress seeking to amend the Fair Credit Reporting Act (\"FCRA\"). The bills are similar to the versions that have been introduced in prior years but which have failed to be enacted into law. The primary effect of the bills is to provide consumers with easier access to their credit reports and to facilitate the correction of errors in their reports. The bills also address the issue of \"prescreening,\" a procedure utilized by many bankcard issuers and insurance companies in their direct marketing programs. Neither bill as presently drafted would have a material adverse effect upon the Company, which has traditionally provided prescreening services. It is, however, possible that some of the Company's customers could be negatively impacted by these bills, in that they place more administrative burdens upon consumer reporting agencies and upon merchants who report credit transactions to the consumer reporting agencies. In addition to the federal bills, there are numerous bills pending in various state legislatures. The stated purpose of the majority of these bills is to give consumers more control over how personal information concerning them is utilized in the marketplace. While the Company is not\nopposed to the stated purpose of such bills, it is possible that if certain of these bills are passed in their current form, the Company could be negatively impacted as a result. Management actively monitors legislation which could affect its business.\nCompetition\nTraditional Direct Marketing Industry Services. The Company experiences competition from other businesses in the list industry with respect to certain targeted marketing services, including merge\/purge, list enhancement, and database services. For many years, the Company was the only service firm in the United States offering a direct terminal access system by list users to multiple list databases. Certain competitors now offer a direct terminal access system to customers. While some direct competitors are divisions of larger corporations having greater financial, research and development, and\/or marketing resources than the Company, management believes that the Company's unique software enables it to effectively compete. Technological developments are expected to continue at a rapid pace in the field of direct marketing database management and market data collection, analysis and distribution.\nThe Company has traditionally relied heavily upon the use of mainframe hardware that is one generation old. While it expects to continue to do so in the future, it is nevertheless constantly seeking more cost-effective ways to deliver its services. During 1994, the Company introduced several new strategies into its processing environment: (1) one of the Company's core application systems products was re-engineered to run on a parallel processing architecture, thereby allowing the Company to significantly reduce its processing cycle time; (2) dedicated stand-alone mainframes have been applied as attached processors to the Company's computing enterprise, resulting in the ability to direct data processing capabilities to customer decision support systems at a significantly reduced cost; and (3) the Company installed a Local Area Network (\"LAN\") system and implemented extensive use of personal computers (\"PCs\") as front-end application workstations. The latter improvement provides a graphical user interface (\"GUI\") front-end use capability to all internal and customer applications, as well as the ability to institute a client\/server architecture within the Company's existing computing enterprise. As part of its client\/server strategy, the Company utilizes its object request broker (\"ORB\") technology, a messaging protocol which transparently links clients and servers located anywhere within the Company's Network. Management believes that through continued investment in research and development, the Company will be able to maintain or improve its present position in the marketplace. See \"Research\nand Development,\" below.\nOutsourcing\/Facilities Management Services; Information Management Services. The Company is aware of numerous other major businesses which offer outsourcing or facilities management services, and\/or information management services. Due to the recent emergence of this industry, and due to the fact that the market for such services remains largely untapped, the Company anticipates that the effects of competition will be minimal. With respect to software licensing, despite the existence of other vendors, the Company likewise anticipates minimal competitive effects due to the unique nature of the Company's software and the breadth of the potential marketplace.\nGS\/2000R Services. In the subscription fulfillment area, the Company has two major competitors who provide outsourcing services to the publishing industry. In addition, many publishing firms perform their fulfillment services in-house. Due to the Company's recent decision to curtail the marketing of its GS\/2000 software, the impact and the effects of competition upon the Company is negligible. See \"The Company's Products and Services,\" above.\nInfoBase. There are two other companies which compete with InfoBase's primary business of list enhancement services, and several other companies, including some of the companies who contribute their data to InfoBase, which compete with some of InfoBase's secondary lines of business. The Company is aware of no other business which offers an optical scanning technology service similar to InfoBase's. Management believes that InfoBase can effectively compete due to the leadership position which it has established in the industry thus far and due to its technical capabilities.\nU.K. Promotional Services. Various aspects of the Company's U.K. fulfillment business are performed by approximately fifteen other businesses in the U.K., certain of which offer other services as well. However, management knows of no other company which offers the complete range of services provided by the Company, and believes that it will be able to maintain and improve its present position in the industry by virtue of its continued technological developments and concentration on providing high quality customer service.\nResearch and Development\nIn fiscal 1995 approximately $8.1 million, representing approximately 4% of the Company's consolidated revenue, was spent on software and research and development, primarily involving the application and design of current technologies to further upgrade and improve its software systems. In fiscal 1994 and 1993, the Company spent $7.6 million and $7.5 million, respectively. Research and development projects which were begun in fiscal 1992 and continued through fiscal 1995 have resulted in a material upgrade and restructuring of the architecture of the Company's technology. Research and development costs incurred prior to\nestablishing the technological feasibility of products are charged to operations as incurred.\nEnvironment\nDue to the nature of the Company's business, the Company has experienced no material adverse effects based on its compliance with environmental regulations. In addition, no material expenditures have been made by the Company during the past two fiscal years and management does not expect the necessity of any material capital expenditures during the coming fiscal year for environmental control facilities.\nSeasonality\nAlthough some components of the Company's business have traditionally experienced a heavier volume of business during the third and fourth calendar quarters of each year, seasonal variances do not have a significant impact upon the Company's operations as a whole.\nForeign Operations\nThe information required hereunder appears in Note 12 of the Notes to Consolidated Financial Statements in the Company's Annual Report at p. 45, which information is incorporated herein by reference.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe following table sets forth the location, ownership and general use of the principal properties of the Company.\nLocation Held Use\nAcxiom Corporation: Conway, Arkansas Five facilities held Principal in fee; one facility executive secures a $4,475,000 offices; customer encumbrance service facilities and computer equipment space Acxiom Transportation Services, Inc.: Conway, Arkansas Lease Office space; warehouse\/hanger space\nAcxiom CDC, Inc.: Chicago, Illinois Lease Office and computer equipment space\nAcxiom U.K., Ltd.: (a) London, England Lease Office space; customer service facility (b) Sunderland, England Held in fee Office space; computer equipment and warehouse space\nThe Company's headquarters are located in Conway, Arkansas and consist of buildings housing the Company's principal executive offices and computer and data processing center. The Company also leases office and warehouse\/hanger space located at the Conway Municipal Airport.\nPursuant to its data center management agreement with Trans Union Corporation discussed above under Item 1, \"Outsourcing\/ Facilities Management Services; Information Management Services,\" the Company leases office and computer equipment space at Trans Union's corporate headquarters in Chicago, Illinois.\nThe Company's corporate and customer service operations in London, England are presently housed in two principal buildings, both of which are leased. The Company also owns a warehouse facility in Sunderland, England where fulfillment services and data processing operations are housed.\nIn addition to the foregoing, pursuant to the Guideposts data processing agreement, Guideposts provides office and computer equipment space for the Company's use at Guideposts' corporate headquarters in Carmel, New York. Furthermore, the Company leases a number of sales offices throughout the U.S: Washington, D.C.; Marietta, Georgia; Chicago, Illinois; Fairway, Kansas; Overland Park, Kansas; Iselin, New Jersey; New York, New York; Charlotte, North Carolina; Grapevine, Texas; McLean, Virginia; Richmond, Virginia; and Menomonee Falls, Wisconsin.\nIn addition, InfoBase leases office space in Jacksonville, Florida; Natick, Massachusetts; and New York, New York.\nThe Company also leases office space in Ocean, New Jersey which previously housed the BSA operation. See the discussion\nabove in Item 1 under \"Catalog Fulfillment Software Services.\" The Company intends to sublease the building for the remaining three years of the lease, and is in the process of seeking a suitable tenant.\nIn connection with the previous operation of its mailing services division, the Company owns a facility in Warminster, Pennsylvania, which it is presently leasing to a third party. See the discussion above in Item 1 under \"Acxiom Mailing Services.\"\nIn general, the offices, customer service and data processing facilities of the Company are in good condition. Management believes that its facilities, including the expansion of the Conway, Arkansas data center and construction of a new customer services building, both to be completed during fiscal year 1996 at the Conway location, are suitable and adequate to meet the presently anticipated needs of the Company. As such, management believes additional properties will not be required upon expansion of operations during fiscal 1996. A portion of the real property owned by the Company is pledged to secure notes payable. For additional discussion, this information appears in Notes 4 and 5 of the Notes to Consolidated Financial Statements in the Company's Annual Report at pp. 38-39, which information is incorporated herein by reference.\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 COMPANY\nThe Company's \"executive officers,\" as defined in Rule 16- a(1)(f) of the Securities Exchange Act of 1934, their title, age, and year of initial appointment as an executive officer and business experience for the past five years are listed below:\nYear Name Title Age Elected\nDon W. Barrett (a) Senior Vice President 55 1994\nJennifer T. Barrett (b) Senior Vice President 45 1979\nRobert S. Bloom (c) Chief Financial Officer 39 1992\nStephen H. Brighton (d) Senior Vice President 47 1993\nC. Alex Dietz (e) Senior Vice President 52 1983 and Chief Information Officer\nJerry C.D. Ellis (f) Senior Vice President 45 1991\nRodger S. Kline (g) Executive Vice 52 1975 President, Chief Operating Officer, Treasurer and Director\nCharles D. Morgan, Jr. Chief Executive 52 1972 (h) Officer, President and Chairman of the Board of Directors\nThomas B. Walker, Jr. Senior Vice President 46 1993 (i)\nJames T. Womble (j) Executive Vice 52 1975 President and Director\nPaul L. Zaffaroni Senior Vice President 48 1990 (k)\n------------------------------------\n(a) Mr. Barrett joined the Company in 1984 as Vice President. He was elected Sr. Vice President in 1993. Prior to joining the Company, he had worked for eighteen years for IBM Corporation, where he held various marketing management positions. Mr. Barrett holds a degree in mathematics from the University of Central Arkansas.\n(b) Mrs. Barrett joined the Company in 1974. She was elected Vice President in 1979 and was elected Sr. Vice President in 1993. Prior to joining the Company, she served as a data processing specialist for the State of Arkansas. Mrs. Barrett holds degrees in mathematics and computer science from the University of Texas.\n(c) Mr. Bloom joined the Company in 1992 as Chief Financial Officer. Prior to joining the Company, he was employed for six years with Wilson Sporting Goods Co. as Chief Financial Officer of its International Division. Prior to his employment with Wilson, Mr. Bloom was employed by Arthur Andersen & Co. for nine years, serving most recently as Manager. Mr. Bloom, a Certified Public Accountant, holds a degree in accounting from the University of Illinois.\n(d) Mr. Brighton joined the Company in 1989 as a director of sales and was subsequently named President and CEO of InfoBase Services in 1991, a position he held until October 1, 1993. At that time, he left InfoBase Services and he was elected Senior Vice President of the Company. Prior to joining the Company, he was employed for 13 years with IBM Corporation, serving most recently as Marketing Branch Manager. Mr. Brighton holds a degree in mechanical engineering from the U.S. Naval Academy, Annapolis, Maryland.\n(e) Mr. Dietz rejoined the Company in 1979. He first joined the Company in 1969 and served as a Vice President until 1975. Between 1975 and 1979 he was an officer of a commercial bank responsible for data processing matters. Following his return to the Company in 1979, Mr. Dietz was subsequently elected Vice President in 1983 and was named Chief Information Officer in 1991. In 1994 he was elected Senior Vice President. Mr. Dietz holds a degree in electrical engineering from Tulane University.\n(f) Mr. Ellis joined the Company in 1991 as Managing Director of the Company's U.K. operations. In 1994 he was elected Senior Vice President. Prior to 1991, Mr. Ellis was employed for 22 years with IBM, serving most recently as Assistant to the Chairman and Chief Executive Officer of IBM's U.K. operations. Prior to that, Mr. Ellis served as Branch Manager of the IBM U.K. Public Sector division.\n(g) Mr. Kline joined the Company in 1973. Since 1975 he has been Executive Vice President and a director. In 1988 he assumed the additional responsibilities of Treasurer and Chief Information Officer. In June 1991, Mr. Kline was named Chief Operating Officer, Executive Vice President and Treasurer. Prior to joining the Company, Mr. Kline was employed by IBM Corporation. Mr. Kline holds a degree in electrical engineering from the University of Arkansas.\n(h) Mr. Morgan joined the Company in 1972 and has served as Chief Executive Officer and Chairman of the Board of Directors since 1975. In 1991 he assumed the additional title of President. He was employed by IBM Corporation prior to joining the Company. Mr. Morgan holds a mechanical engineering degree from the University of Arkansas.\n(i) Mr. Walker joined the Company in 1990. In 1994 he was elected Senior Vice President. Prior to joining the Company he was employed by IBM for 18 years, most recently serving as Branch Marketing Support Manager. Mr. Walker holds a degree in industrial engineering from the University of Arkansas.\n(j) Mr. Womble joined the Company in 1974. In 1975 he was elected Vice President and a director. In 1982 he was elected\nExecutive Vice President. Prior to joining the Company, Mr. Womble was employed by IBM Corporation. Mr. Womble holds a degree in civil engineering from the University of Arkansas.\n(k) Mr. Zaffaroni joined the Company in 1990 as Vice President. In 1994 he was elected Senior Vice President. Prior to joining the Company he was employed by the IBM Corporation for 21 years, most recently serving as Regional Sales Manager for the Mid-America Area. Mr. Zaffaroni holds a degree in marketing from Youngstown State University.\nWith the exception of Mr. and Mrs. Barrett, who are married, there are no family relationships among any of the Company's executive officers and\/or directors.\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 appears on the inside facing of the back cover of the Company's Annual Report, which information is incorporated herein by reference.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe information required by this Item appears in the Company's Annual Report at p. 26, which information is incorporated herein by reference.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nThe information required by this Item appears in the Company's Annual Report at pp. 27-30, which information is incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe Financial Statements required by this Item appear in the Company's Annual Report at pp. 31-46, which information is incorporated herein by reference. The Financial Statement Schedule which constitutes the Supplementary Data required by this Item is attached hereto.\nItem 9.","section_9":"Item 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure\nNot applicable.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nPursuant to general instruction G(3) of the instructions to Form 10-K, information concerning the Company's executive officers is included under the caption \"Executive Officers of the Company\" at the end of Part I of this Report. The remaining information required by this Item appears under the caption \"Election of Directors\" in the Company's 1995 Proxy Statement at pp. 3-5, which information is incorporated herein by reference.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe information required by this Item appears under the heading \"Compensation of Directors and Executive Officers\" in the Company's 1995 Proxy Statement at pp. 9-13, which information is incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThe information required by this Item appears under the headings \"Principal Shareholders\" and \"Equity Ownership of Directors and Executive Officers\" in the Company's 1995 Proxy Statement at pp. 2-3, which information is incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Transactions\nThe information required by this Item appears under the heading \"Certain Transactions\" in the Company's 1995 Proxy Statement at pp. 15-16, 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\nThe following documents are filed as a part of this Report:\n1. Financial Statements.\nThe following consolidated financial statements of the registrant and its subsidiaries included on pages 31 through 46 of the Company's Annual Report and the Independent Auditors' Report on page 47 thereof are incorporated herein by reference. Page references are to page numbers in the Annual Report.\nPage\nConsolidated Balance Sheets as of March 31, 1995 and 1994 31\nConsolidated Statements of Earnings for the years ended March 31, 1995, 1994 and 1993 32\nConsolidated Statements of Cash Flows for the years ended March 31, 1995, 1994 and 1993 33\nConsolidated Statements of Stockholders' Equity for the years ended March 31, 1995, 1994 and 1993 34-35\nNotes to the Consolidated Financial Statements 36-46\nIndependent Auditors' Report 47\n2. Financial Statement Schedules.\nThe following additional information for the years 1995, 1994 and 1993 is submitted herewith and appears on the two pages immediately preceding the signature page of this Report on Form 10-K.\nIndependent Auditors' Report\nSchedule II - Valuation and Qualifying Accounts for the years ended March 31, 1995, 1994 and 1993\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 and Executive Compensation Plans.\nThe following exhibits are filed with this Report or are incorporated by reference to previously filed material.\nExhibit No.\n3(a) Amended and Restated Certificate of Incorporation\n3(b) Amended and Restated Bylaws (previously filed as Exhibit 3(b) to the Company's Annual Report on Form 10-K for the\nfiscal year ended March 31, 1991, Commission File No. 0- 13163, and incorporated herein by reference)\n10(a) Data Center Management Agreement dated July 27, 1992 between the Company and Trans Union Corporation (previously filed as Exhibit A to Schedule 13-D of Trans Union Corporation dated August 31, 1992, Commission File No. 5-36226, and incorporated herein by reference)\n10(b) Agreement for Professional Services dated November 23, 1992 between the Company and Allstate Insurance Company (previously filed as Exhibit 28 to Amendment No. 1 to the Company's Current Report on Form 8-K dated December 9, 1992, Commission File No. 0-13613, and incorporated herein by reference)\n10(c) Acxiom Corporation Deferred Compensation Plan (previously filed as Exhibit 10(b) to the Company's Annual Report on Form 10-K for the fiscal year ended March 31, 1990, Commission File No. 0-13163, and incorporated herein by reference)\n10(d) Amended and Restated Key Associate Stock Option Plan of Acxiom Corporation (previously filed as Exhibit 10(d) to the Company's Annual Report on Form 10-K for the fiscal year ended March 31, 1993, Commission File No. 0-13163, and incorporated herein by reference)\n10(e) Acxiom Corporation U.K. Share Option Scheme (previously filed as Exhibit 10(e) to the Company's Annual Report on Form 10-K for the fiscal year ended March 31, 1993, Commission File No. 0-13163, and incorporated herein by reference)\n10(f) Long-Term Executive Compensation Plan (previously filed as Exhibit 10(g) to the Company's Annual Report on Form 10-K for the fiscal year ended March 31, 1993, Commission File No. 0-13163, and incorporated herein by reference)\n10(g) Annual Executive Compensation Plan (1996)\n13 Portions of the Company's Annual Report\n21 Subsidiaries of the Company\n23 Consent of KPMG Peat Marwick LLP\n24 Powers of Attorney for Robert S. Bloom, Dr. Ann H. Die, William T. Dillard II, Harry L. Gambill, Rodger S. Kline, Charles D. Morgan, Jr., Robert A. Pritzker, Walter Smiley and James T. Womble\n27 Financial Data Schedule\nListed below are the executive compensation plans and arrangements currently in effect and which are required to be filed as exhibits to this Report:\n- Amended and Restated Key Associate Stock Option Plan of Acxiom Corporation - Acxiom Corporation U.K. Share Option Scheme - Long-Term Executive Compensation Plan - Acxiom Corporation Deferred Compensation Plan* - Annual Executive Compensation Plan (1996)\n---------------------------------\n* To date, only one grant has been made, in 1990.\n4. Reports on Form 8-K.\nNo reports on Form 8-K were filed by the Company during the last quarter of the fiscal year ended March 31, 1995.\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors Acxiom Corporation:\nUnder date of May 5, 1995, we reported on the consolidated balance sheets of Acxiom Corporation and subsidiaries as of March 31, 1995 and 1994, and the related consolidated statements of earnings, stockholders' equity and cash flows for each of the years in the three-year period ended March 31, 1995, as contained in the 1995 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 ended March 31, 1995. In connection with our audits of the aforementioned consolidated financial statements, we also have audited the related financial statement schedule as listed in the accompanying index. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement schedule based on our audits.\nIn our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.\n\/s\/ KPMG Peat Marwick LLP\nLittle Rock, Arkansas May 5,1995\nSchedule II\nACXIOM CORPORATION AND SUBSIDIARIES\nValuation and Qualifying Accounts\nYears ended March 31, 1995, 1994 and 1993\nAdditions Balance at charged Other Bad Bad Balance beginning to addi- debts debts at end of period costs and tions written recov- of expenses (note) off ered period 1995: Allowance for doubtful accounts and credits $1,086,000 1,656,000 178,000 803,000 26,000 2,143,000 ========= ========= ======= ======= ====== =========\n1994: Allowance for doubtful accounts and credits $1,049,000 970,000 - 945,000 12,OOO 1,086,000 ========= ======= ======= ======= ====== =========\n1993: Allowance for doubtful accounts and credits $1,485,000 367,000 - 824,000 21,000 1,049,000 ========= ======= ======= ======= ====== =========\nNote - Other additions in 1995 represent the valuation account acquired in InfoBase purchase.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nACXIOM CORPORATION\nDate: June 27, 1995 By:\/s\/ Catherine L. Hughes ------------------------------- Catherine L. Hughes Secretary and General 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.\nSignature\nRobert S. Bloom* Chief Financial Officer June 27, 1995 ----------------------- (Principle accounting Robert S. Bloom officer)\nDr. Ann H. Die* Director June 27, 1995 ----------------------- Dr. Ann H. Die\nWilliam T. Dillard II* Director June 27, 1995 ----------------------- William T. Dillard II\nHarry C. Gambill* Director June 27, 1995 ----------------------- Harry C. Gambill\nRodger S. Kline* Executive Vice President, June 27, 1995 ----------------------- Chief Operating Officer, Rodger S. Kline Treasurer and Director (Principle financial officer)\nCharles D. Morgan, Jr.* Chairman of the Board, June 27, 1995 ----------------------- Chief Executive Officer Charles D. Morgan, Jr. and President (Principle executive officer)\nRobert A. Pritzker* Director June 27, 1995 ----------------------- Robert A. Pritzker\nWalter V. Smiley* Director June 27, 1995 ----------------------- Walter V. Smiley\nJames T. Womble* Director June 27, 1995 ----------------------- James T. Womble\n*By: \/s\/ Catherine L. Hughes ---------------------------- Catherine L. Hughes Attorney-in-Fact\nEXHIBIT INDEX\nExhibits to Form 10-K\nExhibit No. Exhibit\n3(a) Amended and Restated Certificate of Incorporation\n3(b) Amended and Restated Bylaws (previously filed as Exhibit 3(b) to the Company's Annual Report on Form 10-K for the fiscal year ended March 31, 1991, Commission File No. 0-13163, and incorpo- rated herein by reference)\n10(a) Data Center Management Agreement dated July 27, 1992 between the Company and Trans Union Corpo- ration (previously filed as Exhibit A to Schedule 13-D of Trans Union Corporation dated August 31, 1992, Commission File No. 5-36226, and incorporated herein by reference)\n10(b) Agreement for Professional Services dated November 23, 1992 between the Company and Allstate Insurance Company (previously filed as Exhibit 28 to Amendment No. 1 to the Company's Current Report on Form 8-K dated December 9, 1992, Commission File No. 0-13613, and incorporated herein by reference)\n10(c) Acxiom Corporation Deferred Compensation Plan (previously filed as Exhibit 10(b) to the Com- pany's Annual Report on Form 10-K for the fiscal year ended March 31, 1990, Commission File No. 0-13163, and incorporated herein by reference)\n10(d) Amended and Restated Key Associate Stock Option Plan of Acxiom Corporation (previously filed as Exhibit 10(d) to the Company's Annual Report on Form 10-K for the fiscal year ended March 31, 1993, Commission File No. 0-13163, and incorpo- rated herein by reference)\n10(e) Acxiom Corporation U.K. Share Option Scheme (previously filed as Exhibit 10(e) to the Company's Annual Report on Form 10-K for the fiscal year ended March 31, 1993, Commission File No. 0-13163, and incorporated herein by reference)\n10(f) Long-Term Executive Compensation Plan (pre- viously filed as Exhibit 10(g) to the Company's\nAnnual Report on Form 10-K for the fiscal year ended March 31, 1993, Commission File No. 0-13163, and incorporated herein by reference)\n10(g) Annual Executive Compensation Plan (1996)\n13 Portions of the Company's Annual Report\n21 Subsidiaries of the Company\n23 Consent of KPMG Peat Marwick LLP\n24 Powers of Attorney for Robert S. Bloom, Dr. Ann H. Die, William T. Dillard II, Harry L. Gambill, Rodger S. Kline, Charles D. Morgan, Jr., Robert A. Pritzker, Walter Smiley and James T. Womble\n27 Financial Data Schedule\nEXHIBIT 3(a)\nAMENDED AND RESTATED CERTIFICATE OF INCORPORATION OF ACXIOM CORPORATION\nAcxiom Corporation (the \"Corporation), acting pursuant to Sections 245 and 242 of the General Corporation Law of the State of Delaware, hereby adopts the following Amended and Restated Certificate of Incorporation. The following Amended and Restated Certificate of Incorporation amends, restates, integrates, and supersedes, in its entirety, the Amended and Restated Certificate of Incorporation of Acxiom Corporation originally filed with the Delaware Secretary of State on August 10, 1993. The original Certificate of Incorporation was incorporated under the name of CCX NETWORK, INC. on September 28, 1983.\nFIRST: NAME. The name of the Corporation is:\nACXIOM CORPORATION\nSECOND: REGISTERED AGENT AND OFFICE. The address of the\nCorporation's registered office in the State of Delaware is Corporation Trust Center, 1209 Orange Street, Wilmington, Delaware 19801, in the County of Newcastle. The name of the Corporation's registered agent at such address is The Corporation Trust Company.\nTHIRD: PURPOSES. The purpose or purposes for which the Corporation is organized are:\n(a) To own, operate, sell, lease and otherwise deal in goods and services related to data processing, letter services, electronic computer operations, business machines, forms and procedures; to buy, rent, sell, lease and otherwise deal in computers.\n(b) To borrow money in such amount, for such times and upon such terms and conditions as is deemed wise and expedient; from time to time to draw, make, accept, endorse, discount, execute and issue promissory notes, drafts, bills of exchange, warrants, bonds, debentures and other negotiable and transferable instruments, and evidences, as well as to secure the same by mortgages, pledge, deed of trust, or otherwise.\n(c) To have one or more offices, to carry on all or any of its operations and business, and without restriction or limit as to amount to purchase or otherwise acquire, hold, own, mortgage, sell, lease, convey or otherwise dispose of real and personal property of every class and description.\n(d) To enter into, make and perform contracts of any and every kind with any person, firm, corporation, association, partnership or body politic.\n(e) To own, purchase, lease, or otherwise acquire lands and real estate, and to sell and develop lands and real estate, and to equip and operate buildings and structures of every kind and character for the manufacturing, storing and protection of goods and properties of every character and kind.\n(f) To conduct, promote or engage in any lawful act or activity for which corporations may be organized under the General Corporation Law of the State of Delaware.\nFOURTH: AUTHORIZED SHARES. The total number of shares of stock which the Corporation shall have authority to issue is:\nThirty million (30,000,000) shares of Common Stock, ten cents ($.10) Par Value per common share.\nOne million (1,000,000) shares of Preferred Stock, one dollar ($1.00) Par Value per preferred share. The Board of Directors of the Corporation is authorized to provide for the issuance of shares of Preferred Stock in series and to establish from time to time the number of shares to be included in each such series and to fix the designation, powers, preferences and rights of the shares of each such series and the qualifications, limitations and restrictions thereof.\nFIFTH: DURATION. The Corporation is to have perpetual existence.\nSIXTH: DIRECTORS.\n(a) Number, Election and Terms of Directors. The number of directors shall be not less than three (3) nor more than fifteen (15) persons. The exact number of directors of the Corporation shall be fixed from time to time by the Board of Directors. The directors shall be classified with respect to the time for which they severally hold office into three classes, as nearly equal in number as possible, one class to hold office initially for a term expiring at the annual meeting of stockholders to be held in 1991, another class to hold office initially for a term expiring at the annual meeting of stockholders to be held in 1992, and another class to hold office initially for a term expiring at the annual meeting of stockholders to be held in 1993, with the members of each class to hold office until their successors are elected and qualified. At each annual meeting of the stockholders of the Corporation, the successors to the class of directors whose term expires at that meeting shall be elected to hold office for a term expiring at the annual meeting of stockholders held in the third year following the year of their election. If the number of directors is changed, any increase or decrease shall be apportioned among the classes so as to maintain the number of directors in each class as nearly equal as possible, but in no case shall a decrease in the number of directors shorten the term of any incumbent director.\n(b) Manner of Election. Elections of directors need not be by written ballot unless the Bylaws of the Corporation shall so provide.\n(c) Stockholder Nomination of Director Candidates and Advance Notice of Matters to Be Brought Before an Annual Meeting. Advance notice of nominations by stockholders of persons for election to the Board of Directors and advance notice of matters to be brought before an annual meeting by shareholders shall be given in the manner provided in the Bylaws.\n(d) Newly Created Directorships and Vacancies. Newly created directorships resulting from any increase in the number of directors and any vacancies in the Board of Directors resulting from death, resignation, disqualification, removal or other cause shall be filled solely by the affirmative vote of a majority of the remaining directors then in office, even though less than a quorum of the Board of Directors. Any director elected in accordance with the proceeding sentence shall hold office for the remainder of the full term of the class of directors in which the new directorship was created or the vacancy occurred and until such director's successor shall have been elected and qualified. No decrease in the number of directors constituting the Board of Directors shall shorten the term of any incumbent director.\n(e) Removal of Directors. No director shall be removed from the Board of Directors by action of the stockholders of the Corporation during his appointed term other than for cause. For purposes hereof, cause shall mean final conviction of a felony, unsound mind, adjudication of bankruptcy, nonacceptance of office, or conduct prejudicial to the interest of the Corporation.\n(f) Scope. The provisions of this Article shall apply only to the holders of Common Stock. Accordingly, this Article shall in no way limit or restrict the authority of the Board of Directors to fix the designation, power, preferences and rights of shares of Preferred Stock and the qualifications, limitations and restrictions thereof.\nSEVENTH: MEETINGS OF HOLDERS OF COMMON STOCK AND ACTION BY HOLDERS OF COMMON STOCK WITHOUT A MEETING.\n(a) Place of Meetings. Meetings of holders of Common Stock may be held within or without the State of Delaware, as the Bylaws may provide.\n(b) Special Meetings. Special meetings of the holders of Common Stock may be called by such person or persons as may be authorized by the Bylaws.\n(c) Stockholder Action. Any action required or permitted by the General Corporation Law of the State of Delaware to be taken at a meeting of holders of Common Stock may be taken without a meeting if one or more written consents, setting forth the action so taken, shall be signed by all of the holders of Common Stock entitled to vote with respect to the subject matter thereof. The consents signed under this provision, taken together, shall have the same force and effect as a unanimous vote of the holders of Common Stock.\nEIGHTH: LOCATION OF BOOKS AND RECORDS. The books and records of the Corporation may be kept (subject to any provision contained\nin the statutes) outside the State of Delaware at such place or places as may be designated from time to time by the Board of Directors in the Bylaws of the Corporation.\nNINTH: BYLAWS. The Board of Directors shall have power to make, alter, amend and repeal the Bylaws, except so far as Bylaws adopted by the holders of Common Stock shall otherwise provide. Notwithstanding the foregoing, Bylaw provisions relating to informal action by holders of Common Stock without a meeting, nomination of director candidates by holders of Common Stock, notice of matters to be brought before an annual meeting by holders of Common Stock, the number, election and terms of directors elected by holders of Common Stock, the removal of directors elected by holders of Common Stock, the filling of vacancies on the Board of Directors created by an increase in the number of directors or by the death, resignation, removal or disqualification of directors elected by the holders of Common Stock, and the manner of calling and persons authorized to call special meetings of holders of Common Stock shall not be altered, amended or repealed, and no provisions inconsistent therewith shall be adopted, without (i) the approval of a majority of the Disinterested Directors, as defined in Article ELEVENTH hereof, or (ii) the affirmative vote of the holders of at least eighty percent (80%) of the votes entitled to be cast by the holders of Common Stock.\nTENTH: FAIR PRICE PROVISION.\n(a) Vote Required for Certain Business Combinations.\n1. Higher Vote for Certain Business Combinations. In addition to any affirmative vote required by law or this Amended and Restated Certificate of Incorporation, and except as otherwise expressly provided in Section (b) of this Article,\n(A) any merger or consolidation of the Corporation or any Subsidiary (as hereinafter defined) with (i) any Interested Stockholder (as hereinafter defined) or (ii) any other person (whether or not itself an Interested Stockholder) which is, or after such merger or consolidation would be, an Affiliate (as hereinafter defined) of an Interested Stockholder; or\n(B) any sale, lease, exchange, mortgage, pledge, transfer or other disposition (in one transaction or a series of transactions) to or with any Interested Stockholder or any Affiliate of any Interested Stockholder of any assets of the Corporation or any Subsidiary having an aggregate Fair Market Value of $10,000,000 or more; or\n(C) the issuance or transfer by the Corporation or any Subsidiary (in one transaction or a series of transactions) of any securities of the Corporation or any Subsidiary to any Interested\nStockholder or any Affiliate of any Interested Stockholder in exchange for cash, securities or other property (or a combination thereof) having an aggregate Fair Market Value of $10,000,000 or more; or\n(D) the adoption of any plan or proposal for the liquidation or dissolution of the Corporation proposed by or on behalf of any Interested Stockholder or any Affiliate of any Interested Stockholder; or\n(E) the adoption of any plan of share exchange between the Corporation or any Subsidiary with any Interested Stockholder or any other person which is, or after such share exchange would be, an Affiliate of any Interested Stockholder; or\n(F) any reclassification of securities (including any reverse stock split), or recapitalization of the Corporation, or any merger or consolidation of the Corporation with any of its Subsidiaries or any other transaction (whether or not with or into or otherwise involving an Interested Stockholder) which has the effect, directly or indirectly, of increasing the proportionate share of the outstanding shares of any class of Equity Security (as hereinafter defined) of the Corporation or any Subsidiary (as hereinafter defined) or the Corporation or any Subsidiary which is directly or indirectly owned by any Interested Stockholder or any Affiliate of any Interested Stockholder;\nshall require the affirmative vote of the holders of at least eighty percent (80%) of the votes entitled to be cast by the holders of Common Stock. Such affirmative vote shall be required notwithstanding the fact that no vote may be required, or that a lesser percentage may be specified, by law or in any agreement with any national securities exchange or otherwise.\n2. Definition of \"Business Combination\". The term \"Business Combination\" used in this Article shall mean any transaction which is referred to in any one or more of clauses (A) through (F) of Paragraph 1 of this Section (a).\n(b) When Higher Vote is Not Required. The provisions of Section (a) of this Article shall not be applicable to any particular Business Combination, and such Business Combination shall require only such affirmative vote as is required by law and\nany other provision of this Amended and Restated Certificate of Incorporation, if all of the conditions specified in either of the following paragraphs 1 and 2 are met:\n1. Approval by Disinterested Directors. The Business Combination shall have been approved by a majority of the Disinterested Directors (as hereinafter defined).\n2. Price and Procedure Requirements. All of the following conditions shall have been met:\n(A) The aggregate amount of the cash and the Fair Market Value (as hereinafter defined) as of the date of the consummation of the Business Combination of consideration other than cash to be received per share by holders of Common Stock in such Business Combination shall be at least equal to the higher of the following:\n(i) (if applicable) the highest per share price (including any brokerage commissions, transfer taxes and soliciting dealers' fees) paid by the Interested Stockholder for any shares of Common Stock acquired by it (a) within the two-year period immediately prior to the first public announcement of the terms of the proposed Business Combination (the \"Announcement Date\") or (b) in the transaction in which it became an Interested Stockholder, whichever is higher; and\n(ii) the Fair Market Value per share of Common Stock on the Announcement Date or on the date on which the Interested Stockholder became an Interested Stockholder (such latter date is referred to in this Article as the \"Determination Date\"), whichever is higher.\n(B) The aggregate amount of the cash and the Fair Market Value as of the date of the consummation of the Business Combination of consideration other than cash to be received per share by holders of shares of any other class of outstanding stock shall be at least equal to the highest of the following (it being intended that the requirements of this paragraph 2(B) shall be required to be met with respect to every class of outstanding stock, whether or not the Interested Stockholder has previously acquired any shares of a particular class of stock):\n(i) (if applicable) the highest per share price (including any brokerage commissions, transfer taxes and soliciting dealers' fees) paid by the Interested Stockholder for any shares of such class of stock acquired by it (a) within the two-year period immediately prior to the Announcement Date or (b) in the transaction in which it became an Interested Stockholder, whichever is higher;\n(ii) (if applicable) the highest preferential amount per share to which the holders of shares of such class of stock are entitled in the event of any voluntary liquidation, dissolution or winding up of the Corporation; and\n(iii) the Fair Market Value per share of such class of stock on the Announcement Date or on the Determination Date, whichever is higher.\n(C) The consideration to be received by holders of a particular class of outstanding stock (including Common Stock) shall be in cash or in the same form as the Interested Stockholder has previously paid for shares of such class of stock. If the Interested Stockholder has paid for shares of any class of stock with varying forms of consideration, the form of consideration for such class of stock shall be either cash or the form used to acquire the largest number of shares of such class of stock previously acquired by it. The price determined in accordance with paragraph 2(A) and 2(B) of this Section (b) shall be subject to appropriate adjustment in the event of any stock dividend, stock split, combination of shares or similar event.\n(D) After such Interested Stockholder has become an Interested Stockholder and prior to the consummation of such Business Combination: (i) except as approved by a majority of the Disinterested Directors, there shall have been no failure to declare and pay at the regular date therefor any full quarterly dividends (whether or not cumulative) on any outstanding stock having preference over the Common Stock as to dividends or upon liquidation; (ii) there shall have been (a) no\nreduction in the annual rate of dividends paid on the Common Stock (except as necessary to reflect any subdivision of the Common Stock), except as approved by a majority of the Disinterested Directors, and (b) an increase in such annual rate of dividends as necessary to reflect any reclassification (including any reverse stock split), recapitalization, reorganization or any similar transaction which has the effect of reducing the number of outstanding shares of the Common Stock, unless the failure so to increase such annual rate is approved by a majority of the Disinterested Directors; and (iii) such Interested Stockholder shall have not become the beneficial owner of any additional shares of Common Stock except as part of the transaction which results in such Interested Stockholder becoming an Interested Stockholder.\n(E) After such Interested Stockholder has become an Interested Stockholder, such Interested Stockholder shall not have received the benefit, directly or indirectly (except proportionately as a stockholder), of any loans, advances, guarantees, pledges or other financial assistance or any tax credits or other tax advantages provided by the Corporation or any Subsidiary whether in anticipation of or in connection with such Business Combination or otherwise.\n(F) A proxy or information statement describing the proposed Business Combination and complying with the requirements of the Securities Exchange Act of 1934, as amended, and the rules and regulations thereunder (or any subsequent provisions replacing such Act, rules or regulations) shall be mailed to public stockholders of the Corporation at least 30 days prior to the consummation of such Business Combination (whether or not such proxy or information statement is required to be mailed pursuant to such Act or subsequent provisions).\n(c) Certain Definitions. For the purpose of this Article:\n1. A \"person\" shall mean any individual, firm, corporation or other entity.\n2. \"Interested Stockholder\" shall mean any person (other than the Corporation or any Subsidiary) who or which:\n(A) is the beneficial owner, directly or indirectly, of 5% or more of the voting power of the outstanding Common Stock; or\n(B) is an Affiliate of the Corporation and at any time within the two-year period immediately prior to the date in question was the beneficial owner, directly or indirectly, of 5% or more of the voting power of the then outstanding Common Stock; or\n(C) is an assignee of or has otherwise succeeded to any shares of Common Stock which were at any time within the two-year period immediately prior to the date in question beneficially owned by any Interested Stockholder, if such assignment or succession shall have occurred in the course of a transaction or series of transactions not involving a public offering within the meaning of the Securities Act of 1933, as amended.\n3. A person shall be a \"beneficial owner\" of any Common Stock:\n(A) which such person or any of its Affiliates or Associates (as hereinafter defined) beneficially owns directly or indirectly; or\n(B) which such person or any of its Affiliates or Associates has (i) the right to acquire (whether such right is exercisable immediately or only after the passage of time), pursuant to any agreement, arrangement or understanding or upon the exercise of conversion rights, exchange rights, warrants or options, or otherwise, or (ii) the right to vote pursuant to any agreement, arrangement or understanding; or\n(C) which are beneficially owned, directly or indirectly, by any other person with which such person or any of its Affiliates or Associates has any agreement, arrangement or understanding for the purpose of acquiring, holding, voting or disposing of any shares of Common Stock.\n4. For the purpose of determining whether a person is an Interested Stockholder pursuant to paragraph 2 of this Section (c), the number of shares of Common Stock deemed to be outstanding shall include shares deemed owned through application of paragraph 3 of this Section (c) but shall not include any other shares of Common Stock which may be issuable pursuant to any agreement, arrangement or understanding, or upon exercise of conversion rights, warrants or options, or otherwise.\n5. \"Affiliate\" or \"Associate\" shall have the respective meanings ascribed to such terms in Rule 12b-2 of the General Rules and Regulations under the Securities Exchange Act of 1934, as in effect on January 1, 1990.\n6. \"Disinterested Director\" means any member of the Board of Directors who is unaffiliated with the Interested Stockholder and was a member of the Board of Directors prior to the time that the Interested Stockholder became an Interested Stockholder, and any successor of a Disinterested Director who is unaffiliated with the Interested Stockholder and is recommended to succeed a Disinterested Director by a majority of Disinterested Directors then on the Board of Directors.\n7. \"Equity Security\" shall have the meaning ascribed to such term in Section 3(A)(11) of the Securities Exchange Act of 1934, as in effect on January 1, 1990.\n8. \"Fair Market Value\" means: (A) in the case of stock, the highest closing sale price during the 30-day period immediately preceding the date in question of a share of such stock on the Composite Tape for New York Stock Exchange-Listed Stocks, or, if such stock is not quoted on the Composite Tape, on the New York Stock Exchange, or, if such stock is not listed on such Exchange, on the principal United States securities exchange registered under the Securities Exchange Act of 1934, as amended, on which such stock is listed, or, if such stock is not listed on any such exchange, the highest closing bid quotation with respect to a share of such stock during the 30-day period preceding the date in question on the National Association of Securities Dealers, Inc. Automated Quotations System or any system then in use, or if no such quotations are available, the fair market value on the date in question of a share of such stock as determined by a majority of the Disinterested Directors in good faith; and (B) in the case of property other than cash or stock, the fair market value of such property on the date in question as determined by a majority of the Disinterested Directors in good faith.\n9. \"Subsidiary\" means any corporation of which a majority of any class of Equity Security is owned,\ndirectly or indirectly, by the Corporation; provided, however, that for the purposes of the definition of Interested Stockholder set forth in paragraph 2 of this Section (c), the term \"Subsidiary\" shall mean only a corporation of which a majority of each class of Equity Security is owned, directly or indirectly, by the Corporation.\n10. In the event of any Business Combination in which the Corporation survives, the phrase \"consideration other than cash to be received\" as used in paragraphs 2(A) and (B) of section (b) of this Article EIGHTH shall include the shares of Common Stock and\/or the shares of any other class of outstanding stock retained by the holders of such shares.\n(d) Powers of the Board of Directors. A majority of the Directors shall have the power and duty to determine for the purposes of this Article, on the basis of information known to them after reasonable inquiry, (1) whether a person is an Interested Stockholder, (2) the number of shares of Common Stock beneficially owned by any person, (3) whether a person is an Affiliate or Associate of another, (4) whether the assets which are the subject of any Business Combination have, or the consideration to be received for the issuance or transfer of securities by the Corporation or any Subsidiary in any Business Combination has, an aggregate Fair Market Value of $10,000,000 or more. A majority of the Directors shall have the further power to interpret all of the terms and provisions of this Article.\n(e) No Effect on Fiduciary Obligations of Interested Shareholders. Nothing contained in this Article shall be construed to relieve any Interested Stockholder from any fiduciary obligation imposed by law.\nELEVENTH: STOCKHOLDER VOTE ON EXTRAORDINARY MATTERS. Any merger or consolidation of the Corporation with any other person, any sale, lease, exchange, mortgage, pledge, transfer or other disposition by the Corporation of its property or assets, and any dissolution or liquidation of the Corporation or revocation thereof that the General Corporation Law of the State of Delaware requires be approved by the holders of Common Stock must be approved by the affirmative vote of the holders of at least sixty-six and two-thirds percent (66 2\/3%) of the votes entitled to be cast by the holders of Common Stock.\nTWELFTH: LIMITATION OF DIRECTOR LIABILITY.\n(a) To the fullest extent permitted by the General Corporation Law of the State of Delaware, as the same exists or may\nhereafter be amended, a director of the Corporation shall not be liable to the Corporation or its stockholders for monetary damages for breach of fiduciary duty as a director.\n(b) Any repeal or modification of the foregoing paragraph by the stockholders of the Corporation shall not adversely affect any right or protection of a director of the Corporation existing at the time of such repeal or modification.\nTHIRTEENTH: INDEMNIFICATION OF DIRECTORS, OFFICERS AND EMPLOYEES. Any person who was or is a party or is threatened to be a party to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative (including any action or suit by or in the right of the Corporation to procure a judgment in its favor) by reason of the fact that he is or was a director, officer, employee or agent of the Corporation, or is or was serving at the request of the Corporation as a director, officer, employee or agent of another Corporation, partnership, joint venture, trust or other enterprise, shall be indemnified by the corporation, if, as and to the extent authorized by the laws of the State of Delaware, against expenses (including the attorneys' fees), judgments, fines and amounts paid in settlement, actually and reasonably incurred by him, in connection with the defense or settlement of such action, suit, investigation or proceeding. The indemnification expressly provided by statute in a specific case shall not be deemed exclusive of any other rights to which any person indemnified may be entitled under any lawful agreement, vote of stockholders or disinterested directors or otherwise, both as to action in his official capacity and as to action in another capacity while holding such office, and shall continue as to a person who has ceased to be a director, officer, employee or agent and shall inure to the benefit of the heirs, executors and administrators of such a person.\nFOURTEENTH: AMENDMENTS. From time to time any of the provisions of this Amended and Restated Certificate of Incorporation may be amended, altered or repealed, and other provisions authorized by the laws of the State of Delaware at the time in force may be added or inserted by the affirmative vote of the holders of at least a majority of the votes entitled to be cast by the holders of the outstanding stock of the Corporation entitled to vote thereon; provided, however, the affirmative vote of the holders of at least eighty percent (80%) of the votes entitled to be cast by the holders of Common Stock shall be required to alter, amend, repeal, or adopt any provision inconsistent with Articles SIXTH, SEVENTH, NINTH, TENTH and FOURTEENTH hereof.\nThe above Amended and Restated Certificate of Incorporation was adopted and approved by the Board of Directors of the Corporation on the 26th day of October, 1994 and by the stockholders of the Corporation, in the manner and by the vote prescribed by Section 242 of the General Corporation Law of the State of Delaware, this 15th day of December, 1994.\n\/s\/ Charles D. Morgan, Jr. -------------------------------- Charles D. Morgan, Jr., Chairman of the Board, CEO and President ATTEST:\n\/s\/ Catherine L. Hughes ------------------------------ Catherine L. Hughes, Secretary\nACKNOWLEDGMENT\nSTATE OF ARKANSAS ) ) ss. COUNTY OF FAULKNER )\nBE IT REMEMBERED that on this 15th day of December, 1994, personally came before me, a Notary Public for the State and county aforesaid, Charles D. Morgan, Jr., as Chairman, CEO and President and Catherine L. Hughes, as Secretary, respectively, of Acxiom Corporation, known to me personally to be such, and acknowledged the said Amended and Restated Certificate of Incorporation to be their act and deed and that the facts stated therein are true and correct.\nGIVEN under my hand and seal of office the day and year aforesaid.\n\/s\/ Kelley Rogers -------------------------------- Notary Public\nMy Commission Expires:\nJuly, 1996 ---------------------\nEXHIBIT 10(g)\nExecutive Annual Incentive Plan - Fiscal 1996\nFor purposes of the fiscal 1996 executive incentive plan, \"eligible associates\" will include those members of Acxiom's Executive Team (EOC members, corporate officers, business unit executives, business development executives and other non-officer executives).\nThe objective of the fiscal 1996 executive incentive plan is to design a compensation program which will reflect the executives' responsibility, provide compensation that is both equitable and competitive, and which will:\nAlign the executives' interests with shareholders'\/investors' interests;\nMotivate executives to achieve the highest level of performance;\nRetain key executives by linking executive compensation to company performance; and\nAttract the best executives through competitive, growth- oriented plans.\nTarget annual incentives for fiscal 1996 are based on a percentage of base salary as follows:\nEOC Members - 62.5% of base salary, representing 25% of total compensation\nCorporate Officers - 50% of base salary, representing 25% of total compensation\nBusiness Unit\/Development Executives and other Corporate Executives (non-officers) - 33% of base salary, representing 20% of total compensation\nPerformance measures will be determined on an annual basis, but will incorporate such measures as:\nCorporate Gate: . Earnings per share target must be made before the incentive plan is funded\nCorporate Goals: . Earnings per share . Economic Value Added (EVA)\nUnit Financial Goals: . Business Unit financial contribution\nCustomer Satisfaction and Associate Satisfaction\nEXHIBIT 13\n(This page and the following five (5) pages correspond to pages 27-30 of the Company's Annual Report.)\nSelected Financial Data\nYears Ended March 31, 1995 1994 1993 1992 1991\nEarnings Statement Data: Revenue $202,448 151,669 115,827 90,905 97,714 Net Earnings $ 12,405 8,397 6,230 2,143 3,843 Earnings per share $ .54 .38 .30 .11 .20 Average shares outstanding 22,943 21,840 20,768 19,056 19,548\nMarch 31, 1995 1994 1993 1992 1991\nBalance Sheet Data: Current assets $ 43,517 35,857 36,027 29,902 28,966 Current liabilities $ 24,964 12,895 14,938 12,474 13,687 Total assets $ 148,170 123,378 112,841 87,380 90,427 Long-term debt, excluding current installments $ 18,219 34,992 33,237 22,994 28,600 Redeemable common stock -- 7,692 7,222 -- -- Stockholders' equity $ 97,177 61,896 52,171 47,424 44,356\n(In thousands, except per share data. Per share data are restated to reflect two-for-one stock splits in both fiscal 1995 and 1993.)\nManagement's Discussion and Analysis of Financial Condition and Results of Operations\nResults of Operations In 1995, the Company recorded the highest annual revenues, net income and earnings per share in its history. The following table presents the revenue distribution by customer industry for each of the three years in the period ended March 31, 1995:\n1995 1994 1993\nInsurance 30% 16% 5% Financial Services 24 20 19 Direct Marketing 22 25 32 Information & Communication Services 16 16 15 Media\/Publishing 8 10 12 Other - 13 17 --- --- --- 100% 100% 100% === === ===\nConsolidated revenues were a record $202.4 million in 1995, a 33% increase from 1994 after increasing 31% from 1993 to 1994. Of the $50.8 million increase, $36.4 million related to the insurance industry attributable largely to the Allstate Insurance Company (\"Allstate\") data management agreement which increased $34.3 million during the year to $53.4 million. Financial services grew $18.3 million reflecting the strong activity in credit card marketing. Revenues in other industries increased $15.7 million. Partially offsetting these increases, other revenues decreased $20.1 million as a result of the disposal of Acxiom Mailing Services in the prior year and the disposal of certain assets of the U.S. and U.K. operations of BSA in the current year. Consolidated revenues grew $35.8 million from 1993 to 1994 which was attributable to revenue increases in the insurance segment (an $18.5 million increase) primarily related to ramping up the Allstate agreement signed in September, 1992, the financial services segment (an $8.3 million increase) resulting from strong credit card marketing activity and the information and communication segment (a $6.9 million increase) principally due to the Trans Union data center management agreement which was effective for only seven months in 1993. In 1995 and 1994, the Company had two customers who accounted for more than 10% of revenue. Allstate accounted for 26.4% and 12.6% in 1995 and 1994, respectively, and Trans Union Corporation (\"Trans Union\") accounted for 12.6% and 13.6% in 1995 and 1994, respectively. No customers accounted for more than 10% of revenue in 1993. Trans Union has elected to extend the data center management agreement from its initial term of 2\/ years to its full term of 10 years. The term of the Allstate agreement is five years. The Company does not have any reason to believe that either of these customers will not continue to do business with the Company.\nAcxiom U.K., the Company's remaining United Kingdom business unit, provides services to the United Kingdom market which are similar to the traditional direct marketing industry services the Company provides in the United States. In addition, Acxiom U.K. also provides promotional materials handling and fulfillment services to U.K. customers. These revenues were flat from 1994. Most of the Company's exposure to exchange rate fluctuation is due to translation gains and losses as there are no material transactions which cause exchange rate impact. The U.K. operation generally funds its own operations and capital expenditures, although the Company occasionally advances funds from the U.S. to the U.K. These advances are considered to be long-term investments, and any gain or loss resulting from changes in exchange rates as well as gains or losses resulting from translating the financial statements into U.S. dollars are accumulated in a separate component of stockholders' equity. There are no restrictions on transfers of funds from the U.K. As noted in footnote 12 to the consolidated financial statements, the Company's United Kingdom operations have sustained losses in each of the past three years. The losses in both 1995 and 1994 resulted from the BSA U.K. operation which sold catalog fulfillment software. This operation was sold in 1995. The remaining U.K. operations in London and Sunderland, England reported stronger results for the third successive year in 1995, with improvement in both profits and cash flow. The following table presents operating expenses for the three years in the period ended March 31, 1995 (in millions):\n1995 1994 1993 1994 to 1993 to 1995 1994 Salaries and benefits $ 67.3 $ 65.9 $ 57.8 +2% +14% Computer, communications and other equipment 28.3 27.3 22.6 +4 +21 Data costs 60.0 17.4 1.1 +245 +1482 Other operating costs and expenses 23.8 25.8 22.6 -8 +14 ----- ----- ----- --- ----\n$179.4 $136.4 $104.1 +32% +31% ===== ===== ===== === ====\nSalaries and benefits for 1994 to 1995 have increased 2% resulting from increased headcount associated with growth in the core U.S. operations largely offset by decreases in headcount resulting from the disposal of the units noted earlier. The 14% increase from 1993 to 1994 was largely attributable to growth in the U.S. business and the inclusion of Trans Union for a full year in 1994. Computer, communications and other equipment increased 4% from 1994 to 1995 primarily due to an increase in depreciation on computers for the core operations, again partially offset by the decrease in these costs for the units disposed of. The 21% increase from 1993 to 1994 relates to additional depreciation on computer equipment required to support the growth in the U.S. business combined with the impact of including the Trans Union facilities management agreement for the full year in fiscal 1994.\nData costs grew $42.6 million from 1994 to 1995 as a result of the growth in the Allstate revenue noted earlier combined with the data costs associated with InfoBase revenues. Effective October 1, 1994, the Company purchased the remaining 50% partnership interest in InfoBase not previously owned. Accordingly, InfoBase results are now consolidated with the Company's results. The $16.3 million increase in data costs from 1993 to 1994 reflects the ramp-up of the Allstate agreement which was signed in September, 1992. Other operating costs and expenses decreased 8% from 1994 to 1995 primarily due to the effect of the decrease in costs of hardware sales associated with BSA, which was sold in 1995. The 14% increase from 1993 to 1994 reflects higher cost of hardware sales in 1994 combined with higher expenses associated with the inclusion of Trans Union results for a full year in 1994 compared to seven months in 1993 as well as increased operating activities. Income from operations was a record $23.1 million, a 51% increase from 1994. Income from operations in 1994 increased 31% over 1993. The operating margin increased to 11.4% in 1995 from 10.1% in 1994 and 1993. Other expense of $3.0 million in 1995 increased 63% from 1994. The equity in operations for the InfoBase partnership in the first half of 1995 (prior to the purchase of the remaining half interest in the partnership) was a loss of $259,000 compared to income of $811,000 in 1994. In addition, amortization of the excess of costs over fair value of net assets acquired increased $246,000 in 1995 due to the InfoBase purchase. Other expense in 1995 also included $500,000 for the estimated cost of disposal of certain assets of the U.S. operation of BSA.\nInterest expense decreased 14% in 1995 compared to 1994, due to decreased levels of debt. Other expense in 1994 increased 20% over 1993 due to higher interest expense associated with increased levels of debt. The Company's effective tax rate was 38%, 37% and 39% for 1995, 1994 and 1993 respectively. In each year, the effective rate exceeded the statutory U.S. federal tax rate primarily because of state income taxes which were partially offset by research and development credits. The Company expects the effective tax rate to remain in the 37-39% range for the next fiscal year. Software and research and development spending was $8.1 million in 1995 compared to $7.6 million in 1994 and $7.5 million in 1993.\nCapital Resources and Liquidity Working capital at March 31, 1995 totaled $18.6 million compared to $23.0 million a year earlier. At March 31, 1995 the Company had available credit lines of $31.0 million of which none was outstanding. The Company's debt-to-capital (capital defined as long-term debt plus redeemable common stock plus stockholders' equity) was 16% at March 31, 1995 compared to 33% at March 31, 1994. Total stockholders' equity increased 57% from the prior year to $97.2 million at March 31, 1995. The increase included reclassifying the redeemable common stock to stockholders' equity, and the sale of stock during the year totaling $12.9 million.\nCash provided by operating activities was a record $36.9 million for 1995 compared to $24.6 million for 1994 and $14.0 million for 1993. In 1995, $27.1 million was used by investing activities and $7.2 million was used in financing activities. Investing activities in 1995 included the acquisition of the remaining 50% interest in the InfoBase partnership for $7.3 million (net of cash acquired) and capital expenditures of $24.4 million, compared to $27.3 million in 1994 and $28.8 million in 1993. Capital expenditures of $9.0 million, $15.9 million, and $16.0 million in 1995, 1994, and 1993 respectively, relate to assets acquired under the data center management agreement with Trans Union. Investing activities in 1995 also included proceeds of $5.7 million from sales of assets, primarily from the sale of substantially all the assets of Acxiom Mailing Services and the U.S. operations of BSA. Financing activities included payments on debt of $20.1 million, partially offset by sales of stock of $12.9 million. On August 31, 1994, the Company announced the extension of its data center management agreement with Trans Union Corporation which will carry the contract through August, 2002, its full term of ten years. As part of the extension agreement, Trans Union agreed to give up its right to cause the Company to repurchase the 960,000 shares of common stock then held by Trans Union. At the same time, the Company gave up its right to call the stock. Accordingly, the $7.9 million carrying value of the redeemable common stock has been transferred to stockholders' equity. The Company also announced on August 31, 1994, an agreement to sell Trans Union an additional 1,000,000 shares of newly issued common stock. This sale was completed during the third quarter, with the Company receiving sales proceeds of approximately $12 million. As noted in footnote 8 to the consolidated financial statements, the Company has purchased the remaining one-half interest in the InfoBase Services partnership owned by ADVO, Inc. The Company paid $9 million in cash, and also agreed to provide ADVO with service discounts over the next four years totaling at least $2.6 million. If the service discounts do not aggregate at least $2.6 million, the shortfall will be paid in cash. The Company is building a new 100,000 square foot customer service building on the main campus in Conway, Arkansas and is expanding its Conway data center to accommodate increasing data processing requirements. The data center expansion is expected to cost $4 million and will be completed in the first quarter of fiscal 1996. The new customer service facility is expected to cost $8 million and will be ready for occupancy in the third quarter of fiscal 1996. The Company plans to fund both projects through current operations and existing credit lines.\nWhile the Company does not have any other material contractual commitments for capital expenditures, additional investments in facilities and computer equipment will continue to be necessary to support the anticipated growth of the business. In addition, new outsourcing or facilities management contracts frequently require substantial up-front capital expenditures in order to acquire existing assets. Management believes that the combination of existing working capital, anticipated funds to be generated from future operations and the Company's available credit lines is sufficient to meet the Company's current operating needs as well as to fund the anticipated levels of capital expenditures. If additional funds are required, the Company would use existing credit lines to generate cash, followed by either additional borrowings to be secured by the Company's assets or the issuance of additional equity securities in either public or private offerings. Management believes that the Company has significant capacity to raise capital which could be used to support future growth.\nOther Information As discussed more fully in footnote 14 of the consolidated financial statements, the Company sold certain assets of its BSA subsidiary in 1995 and sold substantially all of the assets of its Acxiom Mailing Services subsidiary in 1994. Neither transaction had a significant financial impact. The impact on operations in future years is expected to be positive, as neither of these business units contributed positive earnings prior to their disposal. The Company has adopted a comprehensive privacy policy which includes recognition of consumers' rights to control the dissemination of information about themselves, the Company's commitment to strict data security to avoid unauthorized disclosures and support for programs which consumers can use to opt out of unrequested solicitations. The Company is taking the lead in exploring industry self-regulation that might preempt, or be used as a model for, any national policy mandated by Congress.\nSeasonality and Inflation Although the Company cannot accurately determine the amounts attributable thereto, the Company has been affected by inflation through increased costs of compensation and other operating expenses. Generally, the effects of inflation are offset by technological advances, economies of scale and other operational efficiencies. The Company has established a pricing policy for long-term contracts which provides for the effects of expected increases resulting from inflation. The Company's operations have not proven to be significantly seasonal, although the Company's traditional direct marketing operations experience slightly higher revenues in the Company's second and third quarters. In order to minimize the impact of these fluctuations, the Company continues to move towards long-term strategic partnerships with more predictable revenues.\n(This page and the following twenty-one (21) pages correspond to pages 31-47 of the Company's Annual Report.)\nConsolidated Balance Sheets March 31, 1995 and 1994\nAssets 1995 1994 Current assets: Cash and short-term cash investments $ 3,149,000 475,000 Trade accounts receivable, net 37,764,000 28,204,000 Refundable income taxes - 923,000 Other current assets (notes 7 and 14) 2,604,000 6,255,000 ---------- ---------- Total current assets 43,517,000 35,857,000 Property and equipment, net of accumulated depreciation and amortization (notes 3, 4 and 5) 67,419,000 59,697,000 Software, net of accumulated amortization of $6,601,000 in 1995 and $4,355,000 in 1994 (note 2) 9,693,000 5,113,000 Excess of cost over fair value of net assets acquired, net of accumulated amortization of $1,673,000 in 1995 and $1,260,000 in 1994 (note 8) 9,638,000 2,716,000 Investment in and advances to joint venture (note 8) - 3,974,000 Other assets (notes 10 and 14) 17,903,000 16,021,000 ----------- ----------- $ 148,170,000 123,378,000 =========== ===========\nLiabilities and Stockholders' Equity\nCurrent liabilities: Short-term notes payable (note 4) - 500,000 Current installments of long-term debt (note 4) 3,564,000 3,046,000 Trade accounts payable 8,342,000 3,006,000 Accrued expenses: Interest 522,000 609,000 Payroll and payroll related 5,280,000 2,073,000 Other 7,055,000 3,315,000 Advances from customers 162,000 346,000 Income taxes 39,000 - ---------- ---------- Total current liabilities 24,964,000 12,895,000 ---------- ---------- Long-term debt, excluding current installments (note 4) 18,219,000 34,992,000 Deferred income taxes (note 7) 7,138,000 5,734,000 Deferred revenue 672,000 169,000 Redeemable common stock (note 10) - 7,692,000 Stockholders' equity (notes 6 and 10): Preferred stock - - Common stock 2,308,000 2,097,000\nAdditional paid-in capital 46,493,000 24,624,000 Retained earnings 50,776,000 38,562,000 Foreign currency translation adjustment 7,000 (818,000) Treasury stock, at cost (2,407,000) (2,569,000) ---------- ---------- Total stockholders' equity 97,177,000 61,896,000 Commitments and contingencies (notes 4, 5, 8, 9, 10 and 13) ----------- ----------- $ 148,170,000 123,378,000 =========== ===========\nSee accompanying notes to consolidated financial statements.\nConsolidated Statements of Earnings Years ended March 31, 1995, 1994 and 1993\n1995 1994 1993\nRevenue (notes 8, 10 and 11) $ 202,448,000 151,669,000 115,827,000\nOperating costs and expenses: Salaries and benefits 67,287,000 65,924,000 57,796,000 Computer, communications and and other equipment 28,330,000 27,284,000 22,580,000 Data costs 59,963,000 17,356,000 1,103,000 Other operating costs and expenses 23,803,000 25,841,000 22,654,000 ----------- ----------- ----------- Total operating costs and expenses 179,383,000 136,405,000 104,133,000 ----------- ----------- ----------- Income from operations 23,065,000 15,264,000 11,694,000 ----------- ----------- ----------- Other income (expense): Interest expense (2,388,000) (2,770,000) (2,429,000) Other, net (note 8) (602,000) 939,000 903,000 ----------- ----------- ----------- (2,990,000) (1,831,000) (1,526,000) ----------- ----------- -----------\nEarnings before income taxes 20,075,000 13,433,000 10,168,000 Income taxes (note 7) 7,670,000 5,036,000 3,938,000 ----------- ----------- ----------- Net earnings $ 12,405,000 8,397,000 6,230,000 =========== =========== =========== Earnings per share $ .54 .38 .30 === === === Weighted average shares outstanding 22,943,000 21,840,000 20,768,000 =========== =========== ============\nSee accompanying notes to consolidated financial statements.\nConsolidated Statements of Cash Flows Years ended March 31, 1995, 1994 and 1993\n1995 1994 1993\nCash flows from operating activities: Net earnings $ 12,405,000 8,397,000 6,230,000 Non-cash operating activities: Depreciation and amortization 19,566,000 19,397,000 16,083,000 Loss (gain) on disposal of assets 114,000 44,000 (248,000) Equity in operations of joint venture (note 8) 259,000 (811,000) (511,000) Deferred taxes 319,000 1,492,000 1,215,000 Other, net 1,803,000 787,000 401,000 Changes in operating assets and liabilities: Accounts receivable (8,271,000) (5,661,000) (8,920,000) Other assets 60,000 2,282,000 (3,228,000) Accounts payable and other liabilities 10,692,000 (1,337,000) 2,969,000 ---------- ---------- ---------- Net cash provided by operating activities 36,947,000 24,590,000 13,991,000 ---------- ---------- ----------\nCash flows from investing activities: Sale of equipment and assets held for sale 87,000 118,000 1,522,000 Cash received on dispositions (note 14) 5,630,000 - - Development of software (1,084,000) (1,718,000) (764,000) Capital expenditures (24,417,000) (27,325,000) (28,787,000) Advances to joint venture - (616,000) (876,000) Net cash paid in acquisition of joint venture (7,290,000) - - Net cash included in disposition (note 14) - (1,471,000) - ---------- ---------- ---------- Net cash used by investing activities (27,074,000) (31,012,000) (28,905,000) ---------- ---------- ----------\nCash flows from financing activities: Proceeds from current and long-term debt - 5,442,000 10,774,000 Payments of current and long-term debt (20,147,000) (1,446,000) (1,283,000) Sale of common stock 12,948,000 1,441,000 2,523,000 Purchase of treasury stock - (20,000) (1,212,000) ---------- ---------- ----------\nNet cash provided (used) by financing activities (7,199,000) 5,417,000 10,802,000 ---------- ---------- ---------- Effect of exchange rate changes on cash - 1,000 (107,000) ---------- ---------- ---------- Net increase (decrease) in cash and short-term cash investments 2,674,000 (1,004,000) (4,219,000)\nCash and short-term cash investments at beginning of year 475,000 1,479,000 5,698,000 ---------- ---------- ---------- Cash and short-term cash investments at end of year $ 3,149,000 475,000 1,479,000 ========== ========== ========== Supplemental cash flow information: Noncash investing and financing activities: Capital lease obligations incurred $ 566,000 500,000 223,000 Noncash proceeds from disposition (note 14) - 12,672,000 - Redeemable common stock, warrants, and purchase liability issued in asset acquisition (note 10) 536,000 - 5,660,000 Cash paid during the year for: Interest 2,475,000 2,845,000 2,221,000 Income taxes 6,137,000 3,128,000 2,676,000 ========== ========== ==========\nSee accompanying notes to consolidated financial statements.\nConsolidated Statements of Stockholders' Equity Years ended March 31, 1995, 1994 and 1993\nCommon stock ------------------------ Additional Number of paid-in shares Amount capital\nBalances at March 31, 1992 19,768,980 $1,977,000 19,436,000 Sale of common stock 802,660 80,000 2,443,000 Issuance of common stock warrants (note 10) - - 135,000 Tax benefit of stock options exercised - - 701,000 Purchase of treasury stock - - - Issuance of treasury stock for employee awards - - - Accretion on redeemable common stock (note 10) - - - Translation adjustment - - - Net earnings - - - ---------- --------- ---------- Balances at March 31, 1993 20,571,640 2,057,000 22,715,000 Sale of common stock 400,424 40,000 1,401,000 Tax benefit of stock options exercised - - 483,000 Purchase of treasury stock - - - Issuance of treasury stock for employee awards - - 9,000 Issuance of treasury stock to retirement savings plan - - 16,000 Accretion on redeemable common stock (note 10) - - - Translation adjustment - - - Net earnings - - - ---------- --------- ---------- Balances at March 31, 1994 20,972,064 2,097,000 24,624,000 Sale of common stock (note 6) 1,144,227 115,000 12,833,000 Tax benefit of stock options exercised - - 252,000 Issuance of common stock warrants (note 10) - - 536,000 Issuance of treasury stock to retirement savings plan - - 461,000 Transfer redeemable common stock to stockholders' equity (note 10) 960,000 96,000 7,787,000 Accretion on redeemable common stock (note 10) - - - Translation adjustment - - - Net earnings - - - ---------- --------- ---------- Balances at March 31, 1995 23,076,291 $2,308,000 46,493,000 ========== ========== ==========\nSee accompanying notes to consolidated financial statements.\nConsolidated Statements of Stockholders' Equity Years ended March 31, 1995, 1994 and 1993\nForeign Total currency Treasury Stock stock- trans- holders' Retained lation Number of equity earnings adjustment shares Amount (note 6) Balances at March 31, 1992 26,592,000 792,000 (416,488) $(1,373,000) 47,424,000 Sale of common stock - - - - 2,523,000 Issuance of common stock warrants (note 10) - - - - 135,000 Tax benefit of stock options exercised - - - - 701,000 Purchase of treasury stock - - (296,908) (1,212,000) (1,212,000) Issuance of treasury stock for employee awards - - 4,948 17,000 17,000 Accretion on redeemable common stock (note 10) (2,187,000) - - - (2,187,000) Translation adjustment - (1,460,000) - - (1,460,000) Net earnings 6,230,000 - - - 6,230,000 ---------- --------- -------- --------- ---------- Balances at March 31, 1993 30,635,000 (668,000)(708,448) (2,568,000) 52,171,000 Sale of common stock - - - - 1,441,000 Tax benefit of stock options exercised - - - - 483,000 Purchase of treasury stock - - (2,156) (20,000) (20,000) Issuance of treasury stock for employee awards - - 1,700 6,000 15,000 Issuance of treasury stock to retirement savings plan - - 3,372 13,000 29,000 Accretion on redeemable common stock (note 10) (470,000) - - - (470,000) Translation adjustment - (150,000) - - (150,000) Net earnings 8,397,000 - - - 8,397,000 ---------- -------- ------- --------- ---------- Balances at March 31, 1994 38,562,000 (818,000)(705,532) (2,569,000) 61,896,000\nSale of common stock (note 6) - - - - 12,948,000 Tax benefit of stock options exercised - - - - 252,000 Issuance of common stock warrants (note 10) - - - - 536,000 Issuance of treasury stock to retirement savings plan - - 49,747 162,000 623,000 Transfer redeemable common stock to stockholders' equity (note 10) - - - - 7,883,000 Accretion on redeemable common stock (note 10) (191,000) - - - (191,000) Translation adjustment - 825,000 - - 825,000 Net earnings 12,405,000 - - - 12,405,000 ---------- -------- ------- --------- ---------- Balances at March 31, 1995 50,776,000 7,000 (655,785) $(2,407,000) 97,177,000 ========== ======= ======== ========== =========\nNotes to Consolidated Financial Statements March 31, 1995, 1994 and 1993\n(1) Summary of Significant Accounting Policies (a) Nature of Operations The Company provides information management technology and other related services, primarily for marketing applications. Operating units of the Company provide list processing services, data warehouse services, data and information products, and outsourcing and facilities management services in both the United States (U.S.) and United Kingdom (U.K.).\n(b) Consolidation Policy The consolidated financial statements include the accounts of Acxiom Corporation and its subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. Prior to October 1, 1994 the Company carried its 50% interest in InfoBase Services (\"InfoBase\") on the equity method (see note 8).\n(c) Revenue Recognition Revenues from the production of direct marketing lists are recognized when shipped. Revenues from data processing and outsourcing and facilities management services are recognized when the services are performed. Revenues from software licenses are recognized primarily when the software is installed or when the Company fulfills its obligations under the sales contract. The Company recognizes revenue from long-term contracts involving significant production, modification, or customization of software using the percentage-of-completion method, based on performance milestones specified in the contract where such milestones fairly reflect progress toward contract completion. In other instances, progress toward completion is based on individual contract costs incurred to date compared with total estimated contract costs. Revenues associated with the promotional fulfillment service are recog- nized based on usage of the service. Billed but unearned portions of revenues are reported as deferred revenues.\n(d) Accounts Receivable Financial instruments which potentially subject the Company to concentrations of credit risk consist primarily of trade receivables. All of the Company's receivables are from a large number of customers located throughout the U.S. and U.K. Accordingly, the Company's credit risk is affected by general economic conditions. Although the Company has several large individual customers, concentrations of credit risk are limited because of the diversity of the Company's customers. Trade accounts receivable are presented net of allowances for doubtful accounts and credits of $2,143,000 and $1,086,000 in 1995 and 1994, respectively.\n(e) Property and Equipment Property and equipment are stated at cost. Depreciation and amortization are calculated on the straight-line method over the estimated useful lives of the assets as follows:\nEstimated useful lives Buildings and improvements 5 - 30 years Office furniture and equipment 3 - 10 years\nData processing equipment 2 - 10 years\nGains or losses resulting from sales or retirements are recorded as incurred, at which time related costs and accumulated depreciation are removed from the accounts. Maintenance and repairs are charged to expense as incurred. Property held under capitalized lease arrangements is included in property and equipment, and the associated liabilities are included with long-term debt. Property and equipment taken out of service and held for sale is recorded at net realizable value and depreciation is ceased.\n(f) Software and Research and Development Costs Capitalized and purchased software costs are amortized on a straight-line basis over the remaining estimated economic life of the product, or the amortization that would be recorded by using the ratio of gross revenues for a product to total current and anticipated future gross revenues for that product, whichever is greater. Research and development costs incurred prior to establishing technological feasi- bility of software products are charged to operations as incurred.\n(g) Excess of Cost Over Fair Value of Net Assets Acquired The excess of acquisition costs over the fair values of net assets acquired in business combinations treated as purchase transactions (goodwill) are being amortized on a straight-line basis over 15 to 25 years from acquisition dates. The Company periodically evaluates the existence of goodwill impairment on the basis of whether the goodwill is fully recoverable from the projected, undiscounted net cash flows of the related business unit.\n(h) Income Taxes The Company and its domestic subsidiaries file a consolidated Federal income tax return. The Company's foreign subsidiaries file a combined income tax return in the United Kingdom. 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. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.\n(i) Foreign Currency Translation The balance sheets of the Company's foreign subsidiaries are translated at year-end rates of exchange, and the statements of earnings are translated at the weighted average exchange rate for the period. Gains or losses resulting from translating foreign currency financial statements are accumulated in a separate component of stockholders' equity.\n(j) Earnings Per Share Earnings per share computations are based upon the weighted average number of shares outstanding as adjusted for the two-for-one stock splits described in note 6. The weighted average number of shares outstanding includes redeemable common shares and the dilutive effect of stock\noptions and warrants which are considered common stock equivalents (see note 10).\n(k) Statement of Cash Flows For purposes of the statement of cash flows, the Company considers highly liquid, short-term investments with original maturities of three months or less when acquired to be cash equivalents.\n(2) Software and Research and Development Costs The Company recorded amortization expense related to internally developed and purchased computer software of $2,246,000, $1,232,000, and $1,240,000 in 1995, 1994 and 1993, respectively. Additionally, research and development costs of $7,020,000, $5,912,000, and $6,757,000 were charged to operations during 1995, 1994 and 1993, respectively.\n(3) Property and Equipment Property and equipment are summarized as follows: 1995 1994\nLand $ 1,214,000 1,208,000 Buildings and improvements 37,819,000 31,685,000 Office furniture and equipment 8,288,000 7,821,000 Data processing equipment 76,000,000 62,112,000 ----------- ----------- 123,321,000 102,826,000 Less accumulated depreciation and amortization 55,902,000 43,129,000 ----------- ----------- $ 67,419,000 59,697,000 =========== ===========\n(4) Long-Term Debt Long-term debt consists of the following: 1995 1994 9.75% Senior Notes, due May 1, 2000, payable in annual installments of $2,143,000 each May 1; interest is payable semiannually $ 12,857,000 15,000,000\nUnsecured revolving credit agreement - 15,713,000\n8.94% note payable due in monthly installments of principal and interest of $50,000 with remaining balance due June 30, 1997; collateralized by real estate 4,475,000 4,670,000\nOther notes and capital lease obligations payable (notes 5 and 8) 4,451,000 2,655,000\n---------- ---------- Total long-term debt 21,783,000 38,038,000\nLess current installments 3,564,000 3,046,000\n---------- ---------- Long-term debt, excluding current installments $ 18,219,000 34,992,000 ========== ==========\nThe unsecured credit agreement provides for revolving loans in amounts of up to $30,000,000. The terms of the credit agreement provide for interest at the prime rate (or, at the Company's option, at other alternative market rates). The agreement requires a commitment fee equal to 3\/16 of 1% on the average unused portion of the loan. The credit agreement expires on August 31, 1996. The Company also has another unsecured line of credit amounting to $1,000,000, of which none was outstanding at March 31, 1995. The other unsecured line expires in June 1995 and bears interest at prime minus 1\/2 of 1%.\nUnder the terms of certain of the above borrowings, the Company is required to maintain certain tangible net worth levels and working capital, debt to equity and debt service coverage ratios. The aggregate maturities of long-term debt for the five years ending March 31, 2000 are as follows: 1996, $3,564,000; 1997, $3,672,000; 1998, $7,549,000; 1999, $2,630,000; and 2000, $2,225,000.\n(5) Leases The Company leases data processing equipment, office furniture and equipment, land and office space under noncancellable operating leases and capital leases. Total property and accumulated amortization held under capital leases amount to $2,189,000 and $1,604,000, respectively, at March 31, 1995. Amortization of property held under capital leases is included in depreciation expense. Future minimum lease payments under noncancellable operating leases and capital leases as of March 31, 1995 are as follows:\nCapital Operating leases leases Year ending March 31: 1996 $ 176,000 1,720,000 1997 129,000 1,334,000 1998 126,000 948,000 1999 126,000 719,000 2000 84,000 699,000 Thereafter (through 2039) - 4,841,000 ------- ========= Total capital lease payments 641,000 Less amount representing interest (66,000) ------- Present value of minimum capital lease payments (note 4) 575,000 Less current installments of obligations under capital leases (134,000) ------- Obligations under capital leases, excluding current installments $ 441,000 =======\nTotal rental expense each year on operating leases was as follows: 1995 1994 1993 Gross rentals (note 8) $ 2,169,000 2,116,000 2,405,000\nSublease rentals 76,000 154,000 97,000 --------- --------- --------- $ 2,093,000 1,962,000 2,308,000 ========= ========= =========\n(6) Stockholders' Equity On November 4, 1992 the Company's Board of Directors declared a two-for- one stock split of its common stock, effected in the form of a stock dividend, which was distributed on November 30, 1992 to shareholders of record on November 16, 1992. On October 26, 1994 the Board of Directors declared an additional two-for-one stock split, effected in the form of a stock dividend, which was distributed on January 10, 1995 to shareholders of record on December 27, 1994. All share and per share data in the financial statements have been restated to give effect to the stock splits. Additionally, during the year ended March 31, 1995, the Company sold 1,000,000 shares of newly-issued common stock to Trans Union Corporation for approximately $12,000,000. The Company has 30,000,000 authorized shares of $.10 par value common stock and 1,000,000 shares of authorized but unissued $1.00 par value preferred stock. The Board of Directors of the Company may designate the relative rights and preferences of the preferred stock when and if issued. Such rights and preferences could include liquidation preferences, redemption rights, voting rights and dividends and the shares could be issued in multiple series with different rights and preferences. The Company currently has no plans for the issuance of any shares of preferred stock. The Company has for its U.S. employees a Key Employee Stock Option Plan (\"Plan\") for which 5,600,000 shares of the Company's common stock have been reserved. The Company has for its U.K. employees a U.K. Share Option Scheme (\"Scheme\") for which 2,800,000 shares of the Company's common stock have been reserved. These plans generally provide that the option price will be at least the fair market value at the time of the grant, except that the option price of nonqualified options granted under the Plan is determined by the Board of Directors. Any options granted under the plans must be exercised within 10 years after the date of the option. At March 31, 1995, 1,159,054 shares and 2,478,443 shares are available for future grants under the Plan and the Scheme, respectively.\nActivity in stock options was as follows:\nOptions Number of Number of price shares shares per share exercisable\nOutstanding at March 31, 1992 1,988,656 2.00 - 5.25 1,350,280 Granted 1,379,818 6.25 - 12.50 Exercised (743,600) 2.00 - 5.25 Terminated (93,900) 3.19 - 5.13 ---------- Outstanding at March 31, 1993 2,530,974 2.00 - 12.50 640,176 Granted 171,678 11.75 - 23.50\nExercised (348,816) 2.00 - 5.13 Terminated (53,608) 2.00 - 12.50 --------- Outstanding at March 31, 1994 2,300,228 2.75 - 23.50 514,422 Exercised (92,775) 2.83 - 12.50 Terminated (137,537) 2.83 - 23.50 --------- Outstanding at March 31, 1995 2,464,348 2.75 - 31.50 857,983 ========= ============= =======\nThe Company maintains an employee stock purchase plan which provides for the purchase of shares of common stock by employees through payroll deductions which may not exceed 10% of employee compensation. The price of the stock purchased under the plan is 85% of the market price as of the date the stock is purchased for the employee by the Trustee of the plan. There were 49,976, 51,606, and 59,060 shares purchased under the plan during the years ended March 31, 1995, 1994 and 1993, respectively.\n(7) Income Taxes Total income tax expense was allocated as follows:\n1995 1994 1993 Income from continuing operations $7,670,000 5,036,000 3,938,000\nStockholders' equity, for compensation expense for tax purposes in excess of amounts recognized for financial reporting purposes (252,000) (483,000) (701,000) --------- -------- -------- $7,418,000 4,553,000 3,237,000 ========= ========= =========\nIncome tax expense attributable to income from continuing operations consists of:\n1995 1994 1993 Current expense (benefit): Federal $ 5,953,000 2,841,000 2,199,000 Foreign - 72,000 (170,000) State 1,398,000 631,000 694,000 --------- --------- --------- 7,351,000 3,544,000 2,723,000 --------- --------- --------- Deferred expense (benefit): Federal 1,027,000 1,778,000 1,024,000 Foreign (408,000) (411,000) - State (300,000) 125,000 191,000 --------- --------- --------- 319,000 1,492,000 1,215,000 --------- ------------------ Total tax expense $ 7,670,000 5,036,000 3,938,000 ========= ========= =========\nThe actual income tax expense attributable to income from continuing operations differs from the expected tax expense (computed by applying the U.S. Federal corporate tax rate of 35% for 1995 and 1994 and 34% for 1993 to income before income taxes) as follows:\n1995 1994 1993 Computed expected tax expense $ 7,026,000 4,702,000 3,457,000 Increase (reduction) in income taxes resulting from: State income taxes, net of Federal income tax benefit 714,000 491,000 584,000 Research and development credits (315,000) (259,000) (135,000) Other 245,000 102,000 32,000 --------- --------- --------- $ 7,670,000 5,036,000 3,938,000 ========= ========= =========\nThe tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities at March 31, 1995 and 1994 are presented below.\n1995 1994 Deferred tax assets: Accrued expenses not deductible for tax purposes $ 1,209,000 253,000 Investment in InfoBase, principally due to differences in basis for tax and financial reporting purposes 112,000 202,000 United Kingdom net operating loss carryforward 738,000 392,000 Other 287,000 164,000 --------- --------- Total gross deferred tax assets 2,346,000 1,011,000 --------- ---------\nDeferred tax liabilities: Property and equipment, principally due to differences in depreciation (5,026,000) (3,693,000) Capitalized software and other costs expensed as incurred for tax purposes (2,703,000) (2,917,000) Installment sale gains for tax purposes (420,000) - --------- --------- Total gross deferred tax liabilities (8,149,000) (6,610,000) --------- --------- Net deferred tax liability $ (5,803,000) (5,599,000) ========= =========\nThe Company believes its substantial history of profitability and taxable income and its utilization of tax planning sufficiently supports the value of the deferred tax assets. Accordingly, the Company has not recorded a valuation allowance as all deferred tax assets are more likely\nthan not to be recovered. Included in other current assets are current deferred tax assets of $1,335,000 and $135,000 at March 31, 1995 and 1994, respectively.\n(8) Related Party Transactions The Company leases certain equipment from a business partially owned by an officer. Rent expense paid under this lease during the years ended March 31, 1995, 1994 and 1993 was approximately $247,000, $225,000 and $137,000, respectively. Additionally, the Company has guaranteed a loan executed by an officer and the business partially owned by the officer to purchase the leased equipment. The loan amount was approximately $1,450,000 at March 31, 1995. Effective October 1, 1994, the Company purchased the remaining one- half interest in the InfoBase partnership owned by ADVO, Inc. The purchase price consisted of $9,000,000 in cash and service discounts over the next four years, aggregating $2,560,000, which is included in long- term debt at March 31, 1995. If the service discounts do not aggregate at least $2,560,000 over the four-year period, the shortfall will be paid in cash.\nThe Company has accounted for the purchase of the partnership interest using the purchase method of accounting. The aggregate investment in the InfoBase partnership has been allocated as follows:\nCash paid $ 9,000,000 Less cash purchased 1,710,000 ---------- Net cash expenditure 7,290,000 Service discounts 2,560,000 Investment in and advances to joint venture prior to purchase 3,715,000 ---------- Total investment $ 13,565,000 ========== Software 5,797,000 Excess of cost over fair value of net assets acquired 7,049,000 Accounts receivable 2,612,000 Property and equipment 442,000 Deferred tax asset 115,000 Other assets 7,000 Accounts payable and other liabilities (2,457,000) ---------- Total investment $ 13,565,000 ==========\nThe amount of the purchase price allocated to software is being amortized over the estimated remaining economic life of the software products of 2 to 4 years. The excess of cost over fair value of net assets acquired is being amortized using the straight line method over its estimated economic life of 15 years. The following consolidated pro forma financial information (which includes adjustments to reflect the accounting bases recognized in recording the purchase and to eliminate the effects of transactions\nbetween the Company and InfoBase) shows the results of the Company's operations for the years ended March 31, 1995 and 1994 as though the purchase of InfoBase had occurred at the beginning of each period presented: 1995 1994\nRevenue $ 205,178,000 164,488,000 =========== =========== Net earnings 11,865,000 8,170,000 =========== =========== Earnings per share $ .52 .37 === ===\nThe operations of InfoBase are included in the Company's consolidated results of operations beginning October 1, 1994. Prior to that date, the Company's 50% equity in the operations of the joint venture was included in other income (expense). Included in revenue is $1,562,000, $2,236,000 and $2,197,000 from sales of services to InfoBase in 1995, 1994 and 1993, respectively. InfoBase also reimbursed the Company for processing, programming, and facility costs amounting to $2,585,000, $5,042,000, and $3,998,000 in 1995, 1994 and 1993, respectively. Commissions paid to InfoBase for list enhancement services totaled $4,395,000, $6,518,000 and $4,211,000 in 1995, 1994 and 1993, respectively. Included in other income (expense) is the Company's 50% share of the earnings (loss) of the partnership amounting to $(259,000), $811,000, and $511,000 in 1995, 1994 and 1993, respectively.\n(9) Retirement Plans The Company has a retirement savings plan which covers substantially all domestic employees. The Company matches 50% of the employee's salary deferred contributions up to 6% annually and may contribute amounts to the plan from the Company's earnings at the discretion of the Board of Directors. Company contributions amounted to approximately $653,000, $417,000 and $383,000 in 1995, 1994 and 1993, respectively.\n(10) Data Center Agreement Effective August 31, 1992, the Company entered into a data center management agreement with Trans Union Corporation (\"Trans Union\"). Under the agreement, the Company will manage Trans Union's data processing center for annual fees of approximately $20 million for the existing base capacity, with revenues to be adjusted in the future for changes in Trans Union's capacity requirements. Revenues for the years ended March 31, 1995, 1994 and 1993 were $25,552,000, $20,612,000 and $11,229,000, respectively. At closing, the Company acquired certain Trans Union data center assets for $6,698,000, consisting of $1,038,000 in cash, a purchase liability of $490,000 payable in two equal annual installments, 960,000 shares of newly-issued redeemable common stock valued at $5,035,000 and a warrant to purchase additional shares of common stock valued at $135,000. Trans Union had the right to cause the Company to repurchase the stock between years 2 1\/2 and 5 at the higher of $5.625 per share or fair market value. The stock was callable by the Company during the same period at $8.438 per share. The difference between the assigned value of the redeemable common stock and the estimated redemption value per share\nwas being accreted through charges to retained earnings. On August 31, 1994 the Company announced the extension of its data center management agreement with Trans Union. The extension will carry the contract through August 2002, its full term of 10 years. As part of the extension agreement, Trans Union agreed to give up its right to cause the Company to repurchase the 960,000 shares of common stock then held by Trans Union. At the same time, the Company gave up its right to call the stock. Accordingly, the $7,883,000 in carrying value of the redeemable common stock has been reclassified to stockholders' equity. The warrant, which expires on August 31, 2000, entitles Trans Union to acquire up to 2,000,000 additional shares of newly issued common stock. The exercise price for the warrant stock is $5.625 per share in years one through five of the agreement, $6.125 in year six, $6.625 in year seven and $7.125 in year eight. The first 500,000 shares became exercisable as of closing. The remaining 1,500,000 shares became exercisable upon Trans Union's election to extend the agreement. The value ($536,000) of the additional shares which became exercisable under the warrant has been credited to additional paid-in capital. Trans Union is precluded from exercising the warrant to the extent that the shares acquired thereunder would cause its percentage ownership of the Company's common stock acquired pursuant to the agreement to exceed 10% of the Company's then issued and outstanding common stock. Based on shares outstanding at March 31, 1995, Trans Union would be entitled to purchase approximately 1,425,000 total shares under the warrant agreement. In addition to the assets acquired, the Company has assumed certain other equipment leases, software licenses, and service agreement obligations of Trans Union. At March 31, 1995, the Company's remaining assumed obligations are $2,997,000 for the year ending March 31, 1996. As Trans Union elected to continue the agreement, the Company was required to pay Trans Union an additional cash payment of $752,000 which, together with the value of the warrant for additional shares which became exercisable at that time, is being amortized over the remaining term of the contract. Included in other assets on the consolidated balance sheet at March 31, 1995 and 1994 are unamortized contract costs in the amount of $3,759,000 and $2,370,000, respectively.\n(11) Major Customers In 1995 and 1994, the Company had two major customers who accounted for more than 10% of revenue. Trans Union Corporation accounted for revenue of $25,552,000 (12.6%) and $20,612,000 (13.6%) in 1995 and 1994, respectively, and Allstate Insurance Company accounted for revenue of $53,416,000 (26.4%) and $19,145,000 (12.6%) in 1995 and 1994, respectively. In 1993, the Company had no customers who accounted for more than 10% of revenue.\n(12) Foreign Operations The following table shows financial information by geographic area for the years 1995, 1994 and 1993.\nUnited United States Kingdom Consolidated\n1995: Revenue $ 187,879,000 14,569,000 202,448,000 Earnings (loss) before\nincome taxes 21,339,000 (1,264,000) 20,075,000 Net earnings (loss) 13,261,000 (856,000) 12,405,000 Total assets 138,180,000 9,990,000 148,170,000 Total tangible assets 131,367,000 7,165,000 138,532,000 Total liabilities (including deferred credits) 46,989,000 4,004,000 50,993,000 Total equity 91,191,000 5,986,000 97,177,000 =========== ========== ===========\n1994: Revenue 135,495,000 16,174,000 151,669,000 Earnings (loss) before income taxes 14,780,000 (1,347,000) 13,433,000 Net earnings (loss) 9,405,000 (1,008,000) 8,397,000 Total assets 113,169,000 10,209,000 123,378,000 Total tangible assets 113,169,000 7,493,000 120,662,000 Total liabilities (including deferred credits and redeemable common stock) 57,883,000 3,599,000 61,482,000 Total equity 55,286,000 6,610,000 61,896,000 ========== ========== ===========\n1993: Revenue 99,220,000 16,607,000 115,827,000 Earnings (loss) before income taxes 10,790,000 (622,000) 10,168,000 Net earnings (loss) 6,682,000 (452,000) 6,230,000 Total assets 101,988,000 10,853,000 112,841,000 Total tangible assets 101,988,000 7,929,000 109,917,000 Total liabilities (including deferred credits and redeemable common stock) 57,952,000 2,718,000 60,670,000 Total equity 44,036,000 8,135,000 52,171,000 =========== ========== ==========\n(13) Contingencies The Company is involved in various contingencies, claims and legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on the Company's consolidated financial position or its expected future consolidated results of operations.\n(14) Dispositions The Company sold substantially all assets of its mailing services operating unit, Acxiom Mailing Services (\"AMS\"), in exchange for the assumption of $3,045,000 in liabilities, $4,500,000 in cash, a $4,127,000 mortgage note receivable in monthly installments of $31,000, including interest at 6.5%, and due in full on May 19, 2001, and $1,000,000 of preferred stock issued by the buyer. The sale closed May 20, 1994 effective as of March 31, 1994. The preferred stock is redeemable on May 19, 2004 and pays quarterly dividends of 5% per annum. The $4,500,000 is shown as a receivable and included in other current assets at March 31, 1994. The note receivable and preferred stock are included in\nother assets. Additionally, the Company sold the buyer a non-exclusive, perpetual software license to use certain of the Company's database marketing and data processing software. The license fee of $1,550,000 is payable monthly over five years. Other assets includes license fee receivable of $895,000 and $1,550,000 at March 31, 1995 and 1994, respectively. The effect of these transactions on consolidated net earnings for the year ended March 31, 1994 was not significant. For the year ended March 31, 1994, AMS revenues were $14,257,000. Effective June 1, 1994, the Company sold for $500,000 certain U.S. assets of its BSA operating unit to an entity controlled by an officer and principal shareholder of the Company. The effect of this transaction on consolidated net earnings for the year ended March 31, 1995 was not significant.\n(15) Selected Quarterly Financial Data (Unaudited) The table below sets forth selected financial information for each quarter of the last two years:\n1st 2nd 3rd 4th quarter quarter quarter quarter\n1995: Revenue $ 46,881,000 47,853,000 52,742,000 54,972,000 Income from 3,712,000 5,354,000 7,437,000 6,562,000 operations Net earnings 1,516,000 2,793,000 4,121,000 3,975,000 Earnings per share $ .07 .12 .18 .17\n1994: Revenue 31,771,000 36,661,000 41,430,000 41,807,000 Income from 2,343,000 4,068,000 4,850,000 4,003,000 operations Net earnings 1,280,000 2,092,000 2,637,000 2,388,000 Earnings per share $ .06 .09 .12 .11\nIndependent Auditors' Report\nThe Board of Directors and Stockholders Acxiom Corporation:\nWe have audited the accompanying consolidated balance sheets of Acxiom Corporation and subsidiaries as of March 31, 1995 and 1994, and the related consolidated statements of earnings, stockholders' equity and cash flows for each of the years in the three-year period ended March 31, 1995. 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 financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Acxiom Corporation and subsidiaries as of March 31, 1995 and 1994, and the results of their operations and their cash flows for each of the years in the three-year period ended March 31, 1995, in conformity with generally accepted accounting principles.\n\/s\/KPMG Peat Marwick LLP\nLittle Rock, Arkansas May 5, 1995\n(This page corresponds to the inside facing of the back cover of the Company's Annual Report.)\nMarket Information\nPer share data is restated to reflect a stock split during fiscal 1995.\nStock Prices\nThe Company's Common Stock is traded on the national Market System of Nasdaq under the symbol \"ACXM.\" The following table sets forth for the periods indicated the high and low closing sale prices of the Common Stock.\nFiscal 1995 High Low Fiscal 1994 High Low\nFourth Quarter $18 $13 5\/8 Fourth Quarter $12 1\/8 $10 3\/8 Third Quarter 15 13 Third Quarter 12 1\/8 10 Second Quarter 14 1\/4 10 1\/4 Second Quarter 10 7\/8 8 1\/8 First Quarter 11 9 1\/4 First Quarter 9 3\/4 7 3\/8\nDuring the period beginning April 1, 1995, and ending May 15, 1995 the high closing sales per share for the Company's Common Stock as reported by Nasdaq was $18 \/ and the low closing sales price per share was $16. On May 15, 1995, the closing price per share was $17 \/.\nShareholders of Record\nThe approximate number of shareholders of record of the Company's Common Stock as of May 15, 1995 was 923.\nDividends\nThe Company has never paid cash dividends on its Common Stock. The Company presently intends to retain earnings to provide funds for its business operations and for the expansion of its business. Thus, it does not anticipate paying cash dividends in the foreseeable future.\nEXHIBIT 21\nSUBSIDIARIES OF THE COMPANY\nU.S. SUBSIDIARIES\nName Incorporated Doing Business As In\nAcxiom Chicago Data Center, Inc. Arkansas Acxiom CDC, Inc.\nAcxiom Children's Center, Inc. Arkansas Acxiom Children's Center, Inc.\nAcxiom Leasing Corporation Arkansas Acxiom Leasing Corporation\nAcxiom RM-Tools, Inc. Arkansas Acxiom RM-Tools, Inc.\nAcxiom Transportation Arkansas ATS; Conway Services, Inc. Aviation, Inc.\nU.K. SUBSIDIARIES\nName Incorporated Doing Business In As\nAcxiom U.K., Ltd. United Kingdom Acxiom U.K., Ltd.\nMarketlead Services, Ltd. United Kingdom N\/A (Agency company of Acxiom U.K., Ltd.)\nSouthwark Computer Services, Ltd. United Kingdom N\/A (Agency company of Acxiom U.K., Ltd.)\nEXHIBIT 23\nThe Board of Directors Acxiom Corporation:\nWe consent to incorporation by reference in the registration statements (No. 33-17115, No. 33-37609, No. 33-37610, No. 33-42351, No. 33-72310 and No. 33-72312 on Form S-8) of Acxiom Corporation of our report dated May 5, 1995, relating to the consolidated balance sheets of Acxiom Corporation and subsidiaries as of March 31, 1995 and 1994, and the related consolidated statements of earnings, stockholders' equity and cash flows for each of the years in the three-year period ended March 31, 1995 which is incorporated by reference in the March 31, 1995 annual report on Form 10-K of Acxiom Corporation. We also consent to incorporation by reference in the above-mentioned registration statements of our report dated May 5, 1995 relating to the consolidated financial statement schedule, which report appears in the March 31, 1995 annual report on Form 10-K of Acxiom Corporation.\n\/s\/ KPMG Peat Marwick LLP\nLittle Rock, Arkansas June 29,1995\nEXHIBIT 24\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned officer of Acxiom Corporation, a Delaware corporation (the \"Company\"), does hereby constitute and appoint Catherine L. Hughes as 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 his capacity as the principal accounting officer of the Company, to sign the Company's Annual Report on Form 10-K for the year ended March 31, 1995, together with any amendments thereto, and to file the same, together with any exhibits and all other documents related thereto, with the Securities and Exchange Commission, granting to said attorney-in-fact and agent, full power and authority to do and perform each and any act and thing requisite and necessary to be done in connection therewith, as fully to all intents and purposes as the undersigned might or could do in person, duly ratifying and confirming all that said attorney-in- fact and agent may lawfully do or cause to be done by virtue of the power herein granted.\nIN WITNESS WHEREOF, the undersigned has hereunto set his hand this date.\nSignature:\n\/s\/ Robert S. Bloom --------------------------- Robert S. Bloom\nACKNOWLEDGMENT\nSTATE OF ARKANSAS ) ) ss. COUNTY OF FAULKNER )\nI, the undersigned, a Notary Public in and for the County and State aforesaid, do hereby certify that Robert S. Bloom, personally known to me as the principal accounting officer of Acxiom Corporation, a Delaware corporation, subscribed to the foregoing instrument, appeared before me this day in person and acknowledged that he, being duly authorized, signed and delivered the said instrument for the uses and purposes therein set forth.\nGiven under my hand and notarial seal this 16th day of June, 1995.\n\/s\/ Barbara L. McMahan -------------------------------- Notary Public\nMy Commission Expires: January 8, 2000\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned director of Acxiom Corporation, a Delaware corporation (the \"Company\"), does hereby constitute and appoint Catherine L. Hughes and\/or Robert S. Bloom as her true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution for her and in her name, place and stead, in her capacity as a director of the Company, to sign the Company's Annual Report on Form 10-K for the year ended March 31, 1995, together with any amendments thereto, and to file the same, together with any exhibits and all other documents related thereto, with the Securities and Exchange Commission, granting to said attorneys-in-fact and agents, full power and authority to do and perform each and any act and thing requisite and necessary to be done in connection therewith, as fully to all intents and purposes as the undersigned might or could do in person, duly ratifying and confirming all that said attorneys-in-fact and agents may lawfully do or cause to be done by virtue of the power herein granted.\nIN WITNESS WHEREOF, the undersigned has hereunto set his hand this date.\nSignature:\n\/s\/ A. H. Die --------------------------- Dr. Ann H. Die\nACKNOWLEDGMENT\nSTATE OF ARKANSAS ) ) ss. COUNTY OF FAULKNER )\nI, the undersigned, a Notary Public in and for the County and State aforesaid, do hereby certify that Dr. Ann H. Die, personally known to me as a director of Acxiom Corporation, a Delaware corporation, subscribed to the foregoing instrument, appeared before me this day in person and acknowledged that she, being duly authorized, signed and delivered the said instrument for the uses and purposes therein set forth.\nGiven under my hand and notarial seal this 16th day of June, 1995.\n\/s\/ Sharon Tackett -------------------------------- Notary Public\nMy Commission Expires: April 3, 2000\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned director of Acxiom Corporation, a Delaware corporation (the \"Company\"), does hereby constitute and appoint Catherine L. Hughes and\/or Robert S. Bloom as his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution for him and in his name, place and stead, in his capacity as a director of the Company, to sign the Company's Annual Report on Form 10-K for the year ended March 31, 1995, together with any amendments thereto, and to file the same, together with any exhibits and all other documents related thereto, with the Securities and Exchange Commission, granting to said attorneys-in-fact and agents, full power and authority to do and perform each and any act and thing requisite and necessary to be done in connection therewith, as fully to all intents and purposes as the undersigned might or could do in person, duly ratifying and confirming all that said attorneys-in-fact and agents may lawfully do or cause to be done by virtue of the power herein granted.\nIN WITNESS WHEREOF, the undersigned has hereunto set his hand this date.\nSignature:\n\/s\/ William T. Dillard II -------------------------- William T. Dillard II\nACKNOWLEDGMENT\nSTATE OF ARKANSAS ) ) ss. COUNTY OF PULASKI )\nI, the undersigned, a Notary Public in and for the County and State aforesaid, do hereby certify that William T. Dillard II,\npersonally known to me as a director of Acxiom Corporation, a Delaware corporation, subscribed to the foregoing instrument, appeared before me this day in person and acknowledged that he, being duly authorized, signed and delivered the said instrument for the uses and purposes therein set forth.\nGiven under my hand and notarial seal this 19th day of June, 1995.\n\/s\/ Pat A. Albert -------------------------------- Notary Public\nMy Commission Expires: October 4, 2001\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned director of Acxiom Corporation, a Delaware corporation (the \"Company\"), does hereby constitute and appoint Catherine L. Hughes and\/or Robert S. Bloom as his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution for him and in his name, place and stead, in his capacity as a director of the Company, to sign the Company's Annual Report on Form 10-K for the year ended March 31, 1995, together with any amendments thereto, and to file the same, together with any exhibits and all other documents related thereto, with the Securities and Exchange Commission, granting to said attorneys-in-fact and agents, full power and authority to do and perform each and any act and thing requisite and necessary to be done in connection therewith, as fully to all intents and purposes as the undersigned might or could do in person, duly ratifying and confirming all that said attorneys-in-fact and agents may lawfully do or cause to be done by virtue of the power herein granted.\nIN WITNESS WHEREOF, the undersigned has hereunto set his hand this date.\nSignature:\n\/s\/ Harry C. Gambill -------------------------- Harry C. Gambill\nACKNOWLEDGMENT\nSTATE OF ILLINOIS ) ) ss. COUNTY OF COOK )\nI, the undersigned, a Notary Public in and for the County and State aforesaid, do hereby certify that Harry C. Gambill, personally known to me as a director of Acxiom Corporation, a Delaware corporation, subscribed to the foregoing instrument, appeared before me this day in person and acknowledged that he, being duly authorized, signed and delivered the said instrument for the uses and purposes therein set forth.\nGiven under my hand and notarial seal this 19th day of June, 1995.\n\/s\/ Jeanette M. Gazda -------------------------------- Notary Public\nMy Commission Expires: January 17, 1998\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned director and officer of Acxiom Corporation, a Delaware corporation (the \"Company\"), does hereby constitute and appoint Catherine L. Hughes and\/or Robert S. Bloom as his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution for him and in his name, place and stead, in his capacity as a director and principal financial officer of the Company, to sign the Company's Annual Report on Form 10-K for the year ended March 31, 1995, together with any amendments thereto, and to file the same, together with any exhibits and all other documents related thereto, with the Securities and Exchange Commission, granting to said attorneys-in-fact and agents, full power and authority to do and perform each and any act and thing requisite and necessary to be done in connection therewith, as fully to all intents and purposes as the undersigned might or could do in person, duly ratifying and confirming all that said attorneys-in-fact and agents may lawfully do or cause to be done by virtue of the power herein granted.\nIN WITNESS WHEREOF, the undersigned has hereunto set his hand this date.\nSignature:\n\/s\/ Rodger S. Kline -------------------------- Rodger S. Kline\nACKNOWLEDGMENT\nSTATE OF ARKANSAS ) ) ss. COUNTY OF FAULKNER )\nI, the undersigned, a Notary Public in and for the County and State aforesaid, do hereby certify that Rodger S. Kline, personally known to me as a director and the principal financial officer of Acxiom Corporation, a Delaware corporation, subscribed to the foregoing instrument, appeared before me this day in person and acknowledged that he, being duly authorized, signed and delivered the said instrument for the uses and purposes therein set forth.\nGiven under my hand and notarial seal this 16th day of June, 1995.\n\/s\/ Barbara L. McMahan -------------------------------- Notary Public\nMy Commission Expires: January 8, 2000\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned director and officer of Acxiom Corporation, a Delaware corporation (the \"Company\"), does hereby constitute and appoint Catherine L. Hughes and\/or Robert S. Bloom as his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution for him and in his name, place and stead, in his capacity as a director and principal executive officer of the Company, to sign the Company's Annual Report on Form 10-K for the year ended March 31, 1995, together with any amendments thereto, and to file the same, together with any exhibits and all other documents related thereto, with the Securities and Exchange Commission, granting to said attorneys-in-fact and agents, full power and authority to do and perform each and any act and thing requisite and necessary to be done in connection therewith, as fully to all intents and purposes as the undersigned might or could do in person, duly ratifying and confirming all that said attorneys-in-fact and agents may lawfully do or cause to be done by virtue of the power herein granted.\nIN WITNESS WHEREOF, the undersigned has hereunto set his hand this date.\nSignature:\n\/s\/ Charles D. Morgan, Jr. -------------------------- Charles D. Morgan, Jr.\nACKNOWLEDGMENT\nSTATE OF ARKANSAS ) ) ss. COUNTY OF FAULKNER )\nI, the undersigned, a Notary Public in and for the County and State aforesaid, do hereby certify that Charles D. Morgan, Jr., personally known to me as a director and the principal executive officer of Acxiom Corporation, a Delaware corporation, subscribed to the foregoing instrument, appeared before me this day in person and acknowledged that he, being duly authorized, signed and delivered the said instrument for the uses and purposes therein set forth.\nGiven under my hand and notarial seal this 15th day of June, 1995.\n\/s\/ Sharon Tackett -------------------------------- Notary Public\nMy Commission Expires: April 3, 2000\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned director of Acxiom Corporation, a Delaware corporation (the \"Company\"), does hereby constitute and appoint Catherine L. Hughes and\/or Robert S. Bloom as his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution for him and in his name, place and stead, in his capacity as a director of the Company, to sign the Company's Annual Report on Form 10-K for the year ended March 31, 1995, together with any amendments thereto, and to file the same, together with any exhibits and all other documents related thereto, with the Securities and Exchange Commission, granting to said attorneys-in-fact and agents, full power and authority to do and perform each and any act and thing requisite and necessary to be done in connection therewith, as fully to all intents and purposes as the undersigned might or could do in person, duly ratifying and confirming all that said attorneys-in-fact and agents may lawfully do or cause to be done by virtue of the power herein granted.\nIN WITNESS WHEREOF, the undersigned has hereunto set his hand this date.\nSignature:\n\/s\/ Robert A. Pritzker --------------------------- Robert A. Pritzker\nACKNOWLEDGMENT\nSTATE OF ILLINOIS ) ) ss. COUNTY OF COOK )\nI, the undersigned, a Notary Public in and for the County and State aforesaid, do hereby certify that Robert A. Pritzker, personally known to me as a director of Acxiom Corporation, a Delaware corporation, subscribed to the foregoing instrument, appeared before me this day in person and acknowledged that he, being duly authorized, signed and delivered the said instrument for the uses and purposes therein set forth.\nGiven under my hand and notarial seal this 19th day of June, 1995.\n\/s\/ Carol D'Ascenzo -------------------------------- Notary Public\nMy Commission Expires: December 1, 1996\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned director of Acxiom Corporation, a Delaware corporation (the \"Company\"), does hereby constitute and appoint Catherine L. Hughes and\/or Robert S. Bloom as his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution for him and in his name, place and stead, in his capacity as a director of the Company, to sign the Company's Annual Report on Form 10-K for the year ended March 31, 1995, together with any amendments thereto, and to file the same, together with any exhibits and all other documents related thereto, with the Securities and Exchange Commission, granting to said attorneys-in-fact and agent, full power and authority to do and perform each and any act and thing requisite and necessary to be done in connection therewith, as fully to all intents and purposes as the undersigned might or could do in person, duly ratifying and confirming all that said attorneys-in-fact and agents may lawfully do or cause to be done by virtue of the power herein granted.\nIN WITNESS WHEREOF, the undersigned has hereunto set his hand this date.\nSignature:\n\/s\/ Walter V. Smiley -------------------------- Walter V. Smiley\nACKNOWLEDGMENT\nSTATE OF ARKANSAS ) ) ss. COUNTY OF PULASKI )\nI, the undersigned, a Notary Public in and for the County and State aforesaid, do hereby certify that Walter V. Smiley, personally known to me as a director of Acxiom Corporation, a Delaware corporation, subscribed to the foregoing instrument, appeared before me this day in person and acknowledged that he, being duly authorized, signed and delivered the said instrument for the uses and purposes therein set forth.\nGiven under my hand and notarial seal this 14th day of June, 1995.\n\/s\/ Wendy Wilson -------------------------------- Notary Public\nMy Commission Expires: October 1, 2003\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned director and officer of Acxiom Corporation, a Delaware corporation (the \"Company\"), does hereby constitute and appoint Catherine L. Hughes and\/or Robert S. Bloom as his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution for him and in his name, place and stead, in his capacity as a director and officer of the Company, to sign the Company's Annual Report on Form 10-K for the year ended March 31, 1995, together with any amendments thereto, and to file the same, together with any exhibits and all other documents related thereto, with the Securities and Exchange Commission, granting to said attorneys-in- fact and agents, full power and authority to do and perform each and any act and thing requisite and necessary to be done in connection therewith, as fully to all intents and purposes as the undersigned might or could do in person, duly ratifying and confirming all that said attorneys-in-fact and agents may lawfully do or cause to be done by virtue of the power herein granted.\nIN WITNESS WHEREOF, the undersigned has hereunto set his hand this date.\nSignature:\n\/s\/ James T. Womble -------------------------- James T. Womble\nACKNOWLEDGMENT\nSTATE OF ARKANSAS ) ) ss. COUNTY OF FAULKNER )\nI, the undersigned, a Notary Public in and for the County and State aforesaid, do hereby certify that James T. Womble, personally known to me as a director and officer of Acxiom Corporation, a Delaware corporation, subscribed to the foregoing instrument, appeared before me this day in person and acknowledged that he, being duly authorized, signed and delivered the said instrument for the uses and purposes therein set forth.\nGiven under my hand and notarial seal this 15th day of June, 1995.\n\/s\/ Sharon Tackett\n-------------------------------- Notary Public\nMy Commission Expires: April 3, 2000","section_15":""}
{"filename":"794665_1995.txt","cik":"794665","year":"1995","section_1":"ITEM 1. BUSINESS - ------- --------\nThe registrant, First Capital Institutional Real Estate, Ltd. - 4 (the \"Partnership\"), is a limited partnership organized in 1986 under the Uniform Limited Partnership Act of the State of Illinois. The Partnership sold $59,302,500 in Limited Partnership Assignee Units (the \"Units\") to the public from November 1986 to May 1988, pursuant to a Registration Statement on Form S-11 filed with the Securities and Exchange Commission (Registration Statement No. 33-06149). Capitalized terms used in this report have the same meaning as those terms have in the Partnership's Registration Statement.\nThe business of the Partnership is to invest primarily in existing commercial income-producing real estate, such as shopping centers, warehouses and office buildings, and, to a lesser extent, in other types of commercial income- producing real estate. From January 1987 to March 1989, the Partnership made one real property investment and purchased 50% interests in three joint ventures and a 75% interest in one joint venture each with Affiliated partnerships. Two of the 50% joint ventures and the 75% joint venture were each formed for the purpose of acquiring a 100% interest in certain real property and one 50% joint venture was formed for the purpose of participating in a mortgage loan investment, which was recognized as of July 1, 1990 as being foreclosed in- substance and was recorded as two real property investments. All of the Partnership's joint ventures, prior to disposition, are operated under the common control of First Capital Financial Corporation (the \"General Partner\"). As of December 31, 1995, the Partnership, with its respective joint venture partner, dissolved the 50% joint venture which was originally formed for the purpose of participating in a mortgage loan investment, as a result of the sale and\/or disposition of the two real property investments.\nProperty management services for the Partnership's real estate investments are provided by Affiliates of the General Partner for fees calculated as a percentage of gross rents received from the properties.\nThe real estate business is highly competitive. The results of operations of the Partnership will depend upon the availability of suitable tenants, real estate market conditions and general economic conditions which may impact the success of these tenants. Properties owned by the Partnership frequently compete for tenants with similar properties owned by others.\nAs of March 1, 1996, there were eleven employees at the Partnership's properties for on-site property maintenance and administration.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES (a)(b) - ------- -----------------\nAs of December 31, 1995, the Partnership owned, directly or through a joint venture, the following four property interests, all of which were owned in fee simple.\nITEM 2. PROPERTIES (a)(b) - Continued - --------------------------------------\n(a) For a discussion of significant operating results and major capital expenditures planned for the Partnership's properties refer to Item 7.\n(b) For federal income tax purposes, the Partnership depreciates the portion of the acquisition costs of its properties allocable to real property (exclusive of land), and all improvements thereafter, over a useful life of 40 years utilizing the straight-line method. The Partnership's portion of real estate taxes for Carrollton Crossroads Shopping Center (\"Carrollton\"), Indian Ridge Plaza Shopping Center (\"Indian Ridge\"), Park Plaza Professional Building (\"Park Plaza\") and 3120 Southwest Freeway was $105,000, $243,400, $235,000 and $55,400, respectively, for the year ended December 31, 1995. In the opinion of the General Partner, the Partnership's properties are adequately insured and serviced by all necessary utilities.\n(c) Represents the total number of tenants as well as the number of tenants, in parenthesis, that individually occupy more than 10% of the net leasable square footage of the property.\n(d) The Partnership owns a 50% joint venture interest in this property.\n(e) The Partnership owns a 75% joint venture interest in this property.\nThe following table presents each of the Partnership's properties' occupancy rates as of December 31 for each of the last five years:\nThe amounts in the following table represent each of the Partnership's properties' average annual rental rate per square foot for each of the last five years ended December 31 and were computed by dividing each property's base rental revenues by its average occupied square footage:\nITEM 2. PROPERTIES - Continued - -------------------------------\nThe following table summarizes the principal provisions of the leases for each of the tenants which occupy ten percent or more of the rentable square footage at each of the Partnership's properties except 3120 Southwest Freeway which has no such tenants:\n(a) The Partnership's share of per annum base rents for each of the tenants listed above for each of the years between 1996 and the final twelve months for each of the above leases are no lesser or greater than the amounts listed in the above table.\n(b) Per annum base rents for 1996 are for the period January 1, 1996 through May 31, 1996 (the expiration date of the lease).\nITEM 2. PROPERTIES - Continued - ------- ----------------------\nThe amounts in the following table represent the Partnership's portion of leases in the year of expiration (assuming no lease renewals) through the year ended December 31, 2005:\n(a) Represents the Partnership's portion of base rents to be collected each year on expiring leases.\n(b) Represents the Partnership's portion of base rents to be collected each year on expiring leases as a percentage of the Partnership's portion of the total base rents to be collected on leases in effect as of December 31, 1995.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS - ------- -----------------\n(a & b) The Partnership and its properties were not a party to, nor the subject of, any material pending legal proceedings, nor were any such proceedings terminated during the quarter ended December 31, 1995. Ordinary routine litigation incidental to the business which is not deemed material was maintained during the quarter ended December 31, 1995.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - ------- ---------------------------------------------------\n(a,b,c & d) None.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S EQUITY AND RELATED SECURITY HOLDER MATTERS - ------- ----------------------------------------------------------------------\nThere has not been, nor is there expected to be, a public market for Units.\nAs of March 1, 1996, there were 4,825 Holders of Units.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA - ------- -----------------------\nITEM 6. SELECTED FINANCIAL DATA - Continued - ------- -----------------------------------\n(a) Net income (loss) allocated to Limited Partners for 1993 and 1992 included an extraordinary gain on extinguishment of debt.\n(b) Distributions to Limited Partners per Unit for the years ended December 31, 1994 and 1993 included Sale Proceeds of $2.74 and $1.42, respectively.\n(c) For the purposes of this table, return of capital represents either: the amount by which distributions, if any, exceed net income for each respective year or; total distributions, if any, in years when the Partnership incurs a net loss. Pursuant to the Partnership Agreement, Capital Investment is only reduced by distributions of Sale or Refinancing Proceeds. Accordingly, return of capital as used in the above table does not impact Capital Investment.\nThe following table includes a reconciliation of Cash Flow (as defined in the Partnership Agreement) to cash flow provided by operating activities as determined by generally accepted accounting principles (\"GAAP\"):\nITEM 6. SELECTED FINANCIAL DATA - Continued - ------- -----------------------------------\n(a) Cash Flow is defined in the Partnership Agreement as Partnership revenues earned from operations (excluding tenant deposits and proceeds from the sale, disposition or financing of any Partnership properties or the refinancing of any Partnership indebtedness) minus all expenses incurred (including Operating Expenses, payments of principal (other than balloon payments of principal out of offering proceeds) and interest on any Partnership indebtedness and interest on advances by the General Partner and any reserves of revenues from operations deemed reasonably necessary by the General Partner), except depreciation and amortization expenses and capital expenditures and lease acquisition expenditures. Cash Flow (as defined in the Partnership Agreement) shall include amounts distributed to Limited Partners from funds advanced to the Partnership by the General Partner and the General Partner's Partnership Management Fee.\nThe above selected financial data should be read in conjunction with the financial statements and the related notes appearing on pages A-1 through A-7 in this report and the supplemental schedule on pages A-8 and A-9.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The ordinary business of the Partnership is expected to pass through its life cycle in three phases: (i) the Offering of Units and Investment in Properties; (ii) the operation of properties and (iii) the sale or other disposition of properties.\nThe Partnership commenced the Offering of Units on November 5, 1986 and began operations on December 15, 1986, after achieving the required minimum subscription level. On May 4, 1988, the Offering was Terminated upon the sale of 593,025 Units. From January 1987 to March 1989, the Partnership made one real property investment and purchased 50% interests in three joint ventures and a 75% interest in one joint venture each with Affiliated partnership's. Two of the 50% joint ventures and the 75% joint venture were each formed for the purpose of acquiring a 100% interest in certain real property. The remaining 50% joint venture was formed for the purpose of participating in a mortgage loan investment, which was recognized as of July 1, 1990 as being foreclosed in-substance and was recorded as two real property investments; the Wellington North Office Complex (comprised of three office buildings, \"Wellington A, B and C\") and the North Valley Office Center (comprised of two office buildings collectively known as \"North Valley\").\nOne of the Partnership's objectives is to dispose of its properties when market conditions allow for the achievement of the maximum possible sales price. In 1992 the Partnership, in addition to being in the operation of properties phase, entered the disposition phase of its life cycle with the disposal of North Valley as a result of a conveyance of title to the mortgage holder in lieu of foreclosure. During the disposition phase of the Partnership's life cycle, comparisons of operating results are complicated due to the timing and effect of property sales and dispositions. Partnership operating results are generally expected to decline as real property interests are sold or disposed of since the Partnership no longer receives income generated from such real property interests. In addition, as of December 31, 1995, the Partnership, with its respective joint venture partner, have dissolved the 50% joint venture which was originally formed for the purpose of participating in a mortgage loan investment as a result of the sale and\/or disposition of the three buildings at Wellington.\nThe past year was disappointing for most retailers throughout the country. Gross margins and consequently profits were negatively impacted as retailers attempted to turn inventories. The prospects for expansion in 1996 are also minimal, if nonexistent. The poor sales performance of retailers has resulted in less demand for store space, further retailer consolidations and an increased number of bankruptcies. Factors utilized by prospective property purchasers such as higher capitalization and discount rates resulted in lower prices than previously seen in years. In addition, downward pressure on rent, upward pressure on tenant improvement costs and larger reserves for capital expenditures also negatively affected the pricing of retail assets. The Partnership's retail properties, which accounted for 56% of the Partnership's rental revenues for the year ended December 31, 1995, also experienced other issues which have affected the pricing of retail assets. During 1995, Indian Ridge Plaza Shopping Center (\"Indian Ridge\") was adversely affected by competition in its market area, together with the loss of an anchor tenant through bankruptcy. While this tenant is being replaced, the Partnership will incur tenant improvement costs related to this space and realize less rental revenue per square foot.\nThe Partnership's two office buildings accounted for the remaining 44% of the Partnership's rental revenues for the year ended December 31, 1995. Several factors have had an effect on operating performance and market values of these properties. While occupancy rates have generally continued to gradually improve, the age of the properties and increased competition from newer buildings with higher vacancy has caused rental rates to either decline or remain relatively stable in most instances. In addition, as further described in the Operations section below, the uncertainty surrounding the health care industry has had an adverse affect on the operating results of Park Plaza Professional Building (\"Park Plaza\").\nThe General Partner has historically reviewed significant factors regarding the Partnership's properties to determine that the properties are carried at lower of cost or market, and where appropriate has made value impairment adjustments. These factors include, but are not limited to: 1) recent and\/or budgeted operating performance; 2) research of market conditions; 3) economic trends affecting major tenants; 4) economic factors related to the region where the properties are located and 5) when available, recent property appraisals. As a result of the current year review, the Partnership has recorded (losses) for provisions for value impairment totaling $(2,400,000) for the year ended December 31, 1995. Of this amount, $(900,000) relates to one of the Partnership's retail properties and $(1,500,000) relates to the Partnership's two office buildings. For more details related to these provisions, see Note 7 of Notes to Financial Statements. The General Partner will continue to evaluate real estate market conditions affecting each of the Partnership's properties, in its efforts to maximize the realization of proceeds on their eventual disposition. The recording of the provisions for value impairment does not impact cash flows as defined by GAAP or Cash Flow (as defined in the Partnership Agreement).\nOPERATIONS The table below is a recap of certain operating results of each of the Partnership's properties for the years ended December 31, 1995, 1994 and 1993. The discussion following the table should be read in conjunction with the Financial Statements and Notes thereto appearing in this report.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED)\n(a) Excludes certain income and expense items which are either not directly related to individual property operating results such as interest income, interest expense and general and administrative expenses or are related to properties previously owned by the Partnership. (b) Property net income excludes losses from provisions for value impairment which were included in the Statement of Income and Expenses for the years ended December 31, 1995 and 1994 (see Note 7 of Notes to Financial Statements for additional information). (c) The joint venture which owned Wellington A, B and C, in which the Partnership had a 50% interest, disposed of Wellington A on March 17, 1993, sold Wellington B on March 23, 1993 and sold Wellington C on June 8, 1994. The property net incomes exclude the results from the sales and\/or disposition of these buildings, a portion of which was reported by the Partnership as a provision for value impairment in the Statement of Income and Expenses for the year ended December 31, 1992. The remaining portions of the net losses from these sales and\/or dispositions (including an extraordinary gain recognized in 1993 on the extinguishment of debt relating to Wellington A) were reported by the Partnership in the Statements of Income and Expenses as a loss on the sale or disposition of properties in the year of sale or disposition (see Note 6 of Notes to Financial Statements for additional information).\nCOMPARISON OF THE YEAR ENDED DECEMBER 31, 1995 TO THE YEAR ENDED DECEMBER 31, Net income (loss) for the year ended December 31, 1995 changed $(2,033,700) when compared to the year ended December 31, 1994. The effects of losses from provisions for value impairment in 1995 and 1994 and the net loss on the sale of a Partnership property in 1994 had significant impact on the comparison of net income (loss) for the years under comparison. As described above, the Partnership recorded (losses) from provisions for value impairment of $(2,400,000) during 1995. In addition, the Partnership recorded a (loss) from a provision for value impairment of $(500,000) during 1994 as well as a (loss) of $(48,900) on the sale of Wellington C. For further information, see the table above and the notes thereto as well as Notes 6 and 7 of Notes to Financial Statements.\nExcluding the effects on net income of the provisions for value impairment and the property sale, net income for the year ended December 31, 1995 decreased $182,600 when compared to the year ended December 31, 1994. The decrease was primarily due to a decrease in operating results of $296,200 and $87,400 at Indian Ridge and Park Plaza, respectively. Partially offsetting the decrease was: 1) an increase in interest income of $96,200 due to an increase in rates available on the Partnership's short-term investments as well as in the funds available for such investments; 2) an increase in operating results of $78,200 at Carrollton Crossroads Shopping Center (\"Carrollton\") and 3) a decrease in interest expense of $11,900 as a result of a lower average amount outstanding on the loan payable to the General Partner.\nFor purposes of the following comparative discussion, the operating results of Wellington C have been excluded.\nRental revenues for the year ended December 31, 1995 decreased $346,200, or 6%, when compared to the year ended December 31, 1994. The primary factor which contributed to the decrease in rental revenues was a lower average occupancy rate at Indian Ridge as a result of a major tenant vacating 45,000 square feet of space in July 1995 subsequent to filing for bankruptcy. This leasable square footage accounts for 24% of the total leasable square footage of the building. In addition, starting in December 1995, the other major tenant's lease at Indian Ridge began to pay percentage rent, in lieu of the required base rent, because of the major tenant vacancy. In total, rental revenues at Indian Ridge decreased $293,700 during 1995 when compared to 1994. Affiliates of the General Partner are actively marketing this space and are in negotiations with a prospective major tenant. When, and if, this space becomes occupied by this prospect, or any other prospective tenant, the major tenant currently paying percentage rent at the property will go back to paying the rental rates charged prior to the vacancy. Another contributing factor was the decrease in rental revenues of $116,100 at Park Plaza due to the uncertainties surrounding the health care industry. Over 95% of the leasable square footage at Park Plaza is currently leased to tenants in the health care industry. In order to maintain occupancy levels at Park Plaza, the Partnership in 1994 began to offer to new and renewing tenants reduced lease rates and the use of the current year as a base year for tenant expense reimbursements. Accordingly, rental revenues at Park Plaza have decreased due to the lower average effective rental rate charged to new and renewing tenants and lower tenant expense reimbursements. Rental revenues also decreased at Park Plaza due to a reduction in lease settlement fees received from tenants which in total were $21,300 greater in 1994 than in 1995 and a decrease in the recognition of security deposits as income in 1995. Other factors contributing to the decrease in rental revenues of the Partnership were: 1) the recovery of $22,800 in 1994 of certain tenant receivables which were previously written off as uncollectible at 3120 Southwest Freeway Office Building (\"3120 Southwest Freeway\"); 2) lower tenant expense reimbursements of $13,800 at Carrollton as a result of an underestimate of prior year reimbursements which were billed in 1994 and 3) a decrease in tenant expense reimbursements of $11,300 at 3120 Southwest Freeway due to lower operating expenses. Partially offsetting the decrease\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED) in rental revenues was an increase of $75,500 in percentage rental income at Carrollton resulting from higher tenant sales which determine the amount of percentage rents to be paid to the Partnership and an increase in the average effective base rental rate charged to new and renewing tenants at 3120 Southwest Freeway.\nReal estate tax expense increased $33,900 for the years under comparison primarily due to increases at Park Plaza and 3120 Southwest Freeway as a result of projected increases in assessed property valuations and tax rates and at Carrollton as a result of an underestimate of 1994 taxes which were paid in 1995. Partially offsetting the increase was lower real estate taxes at Indian Ridge due to an overestimate of 1994 real estate taxes paid in 1995.\nProperty operating expenses decreased $42,300 for the year ended December 31, 1995 when compared to the prior year primarily due to: 1) lower utility costs totaling $45,100 at 3120 Southwest Freeway and Park Plaza; 2) lower property management and leasing fees totaling $25,000 at Indian Ridge, Park Plaza and 3120 Southwest Freeway as a result of lower rental revenues at these properties which determines the amount of property management and leasing fees and 3) lower advertising and promotional fees of $16,900 at Indian Ridge. Partially offsetting the decrease in property operating expenses was: 1) an increase of $26,700 in professional service fees at Indian Ridge; 2) an increase totaling $12,500 in property office expenses primarily as a result of the purchase of new personal computers, printers and software at Park Plaza and 3120 Southwest Freeway and 3) higher security expenses at both Park Plaza and 3120 Southwest Freeway totaling $3,700.\nInsurance expense decreased $9,100 for the year ended December 31, 1995 when compared to the prior year. The decrease was primarily due to lower group rates on the Partnership's combined insurance coverage as a result of a minimal amount of claims made over the past several years.\nRepairs and maintenance expense decreased $5,200 for the year ended December 31, 1995 when compared to the year ended December 31, 1994. The decrease was primarily due to: 1) decreases of $22,900 and $8,900 in personnel costs at Park Plaza and Indian Ridge, respectively; 2) decreases of $9,000 and $6,100 at Indian Ridge and 3120 Southwest Freeway, respectively, for the cleaning, repairing and restriping of the parking lots; 3) the absence of the 1994 cost of $6,400 to paint the interior space of a major tenant at Carrollton and 4) lower snow removal costs of $5,100 at Indian Ridge in 1995. Partially offsetting the decrease was: 1) an increase of $30,100 in expenditures made at Indian Ridge in order to enhance the outside appearance of the building including painting, roof restoration and landscaping; 2) an increase of $6,200 and $6,000 at 3120 Southwest Freeway and Park Plaza, respectively, for the repair and maintenance of the heating, ventilating and air conditioning systems and 3) an increase of $10,000 at 3120 Southwest Freeway primarily as a result of some window maintenance and replacement.\nCOMPARISON OF THE YEAR ENDED DECEMBER 31, 1994 TO THE YEAR ENDED DECEMBER 31, Net income for the Partnership decreased $374,100 for the year ended December 31, 1994 when compared to the year ended December 31, 1993. The decrease was primarily due to a provision for value impairment of $500,000 recorded for the year ended December 31, 1994 for Park Plaza. Net income, exclusive of the provision for value impairment, increased $125,900 for the year ended December 31, 1994 when compared to the year ended December 31, 1993. The increase was primarily due to: 1) improved operating results totaling $185,400 at 3120 Southwest Freeway, Carrollton and Indian Ridge; 2) an increase in interest income of $85,400 due to an increase in rates and funds available on the Partnership's short-term investments and 3) lower general and administrative expenses of $48,500 primarily due to Indiana state sales taxes being assessed to the Partnership in 1993 for the tax years 1989, 1990 and 1992. Partially offsetting the increase was: 1) a decrease of $94,200 in operating results at Park Plaza; 2) decreased operations of $30,700 at Wellington as a result of the sale of the last office building at the property in June 1994 and 3) an increase in interest expense of $22,300 as a result of an increase in the average amount outstanding on the loan payable to the General Partner.\nFor purposes of the following comparative discussion, the operating results of Wellington A, B and C have been excluded.\nRental revenues for the year ended December 31, 1994 increased $178,300, or 3%, when compared to the year ended December 31, 1993. The increase in rental revenues was primarily due to: 1) the expansion of a major tenant's leasable square footage at Carrollton in May 1993 from 87,092 square feet to 124,128 square feet which represented a 14% increase in the total square footage of the property; 2) increases in the base rental rate charged to new and renewing tenants and in the average occupancy rate at 3120 Southwest Freeway and Indian Ridge; 3) an increase totaling $61,500 in tenant expense reimbursements at 3120 Southwest Freeway, Carrollton and Indian Ridge; 4) the collection of certain tenant receivables which were previously written off as uncollectible at 3120 Southwest Freeway as well as a decrease in the tenant receivables written off as uncollectible at Indian Ridge during 1995 as compared to 1994 and 5) an increase in the amount of lease settlement fees received at Park Plaza. Partially offsetting the increase was a decrease in tenant expense reimbursements and parking income as well as a lower average occupancy rate at Park Plaza.\nProperty operating expenses decreased $68,100 for the year ended December 31, 1994 when compared to the prior year primarily due to: 1) a decrease totaling $42,200 in professional service fees at all of the Partnership's properties; 2) a decrease of $18,600 in property management and leasing fees at Park Plaza; 3) a decrease of $16,400 in utility costs at Park Plaza and 4) a decrease of $10,000 and $4,800 in advertising and promotional costs at Park Plaza and 3120 Southwest Freeway, respectively. Partially offsetting the decrease was increased advertising and promotional costs at Indian Ridge and increased property management and leasing fees at 3120 Southwest Freeway.\nReal estate tax expense decreased $15,600 between the years under comparison primarily due to a decrease of $14,200 at 3120 Southwest Freeway as a result of the 1994 receipt of a 1993 refund and a decrease in the 1994 assessment, and a decrease of $12,500 at Carrollton as a result of an underestimate of 1992 real estate taxes which were paid in 1993. Partially offsetting the decrease was increases of $6,700 and $4,400 at Indian Ridge and Park Plaza, respectively, due to tax rate increases.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED) Depreciation and amortization expense increased $125,800 for the years under comparison. The increase was due to the fact that the periodic depreciation and amortization expense for depreciable and amortizable assets placed in service during 1994 exceeded the periodic depreciation and amortization expense for certain assets for which the depreciable and amortizable lives expired during 1994.\nRepairs and maintenance expense increased $7,200 for the year ended December 31, 1994 when compared to the prior year. The increase was primarily due to: 1) an increase in 1994 snow removal costs at Indian Ridge; 2) the painting of a major tenant's space at Carrollton, as previously discussed; 3) an increase in expenditures made at Indian Ridge in order to enhance the inside appearance of the building; 4) expenditures at 3120 Southwest Freeway to install a new fire alarm system and 5) expenditures to repair, maintain and restripe the parking lots at 3120 Southwest Freeway and Indian Ridge. Partially offsetting the increase was the extensive parking lot repairs at Carrollton during 1993.\nTo increase and\/or maintain occupancy levels at the Partnership's properties, the General Partner, through its Affiliated asset and property management groups, continues to take the following actions: 1) implementation of marketing programs, including hiring of third-party leasing agents or providing on-site leasing personnel, advertising, direct mail campaigns and development of building brochures; 2) early renewal of existing tenant leases and addressing any expansion needs these tenants may have; 3) promotion of local broker events and networking with local brokers; 4) networking with national level retailers; 5) cold-calling other businesses and tenants in the market area; and 6) providing rental concessions or competitively pricing rental rates depending on market conditions.\nThe rate of inflation has remained relatively stable during the years under comparison and has had a minimal impact on the operating results of the Partnership. The nature of various tenant lease clauses protects the Partnership, to some extent, from increases in the rate of inflation. Certain of the lease clauses provide for the following: (1) annual rent increases based on the Consumer Price Index or graduated rental increases; (2) percentage rentals at shopping centers, for which the Partnership receives as additional rent a percentage based on a tenant's sales over predetermined breakeven amounts and (3) total or partial tenant reimbursement of property operating expenses (e.g., common area maintenance, real estate taxes, etc.).\nLIQUIDITY AND CAPITAL RESOURCES A primary objective of the Partnership is to provide cash distributions to Partners from Partnership operations. Cash Flow (as defined in the Partnership Agreement) is generally not equal to Partnership net income or cash flows as defined by GAAP, since certain items are treated differently under the Partnership Agreement than under GAAP. The General Partner believes that to facilitate a clear understanding of the Partnership's operations, an analysis of Cash Flow (as defined in the Partnership Agreement) should be examined in conjunction with an analysis of net income or cash flow as defined by GAAP. The table in Item 6. Selected Financial Data of this report includes a reconciliation of Cash Flow (as defined in the Partnership Agreement) to cash flow provided by operating activities as defined by GAAP. Such amounts are not indicative of actual distributions to Partners and should not necessarily be considered as an alternative to the results disclosed in the Statements of Income and Expenses and Statements of Cash Flows.\nThe decrease in Cash Flow (as defined in the Partnership Agreement) of $269,500 for the year ended December 31, 1995 when compared to year ended December 31, 1994 was primarily due to the decrease in net income, exclusive of depreciation and amortization expense, the provisions for value impairment and the 1994 loss on the sale of Wellington C, partially offset by a decrease of $12,800 in the General Partner's Partnership Management Fee.\nThe increase in the Partnership's cash position as of December 31, 1995 when compared to December 31, 1994 was primarily the result of net cash provided by operating activities exceeding distributions paid to Partners and expenditures for capital and tenant improvements and leasing costs. Liquid assets of the Partnership as of December 31, 1995 were comprised of undistributed cash from operations retained for working capital purposes.\nNet cash provided by operating activities continues to be a primary source of funds to the Partnership. Net cash provided by operating activities decreased slightly from $3,147,200 for the year ended December 31, 1994 to $3,128,400 for the year ended December 31, 1995. The decrease was primarily due to decreases in cash provided by operating activities from Indian Ridge and Park Plaza as well as the absence of the 1994 operating activities from Wellington C, partially offset by increases in the cash provided by operating activities from Carrollton and 3120 Southwest Freeway as well as the increase in interest income, as previously discussed.\nNet cash (used for) provided by investing activities changed to $(412,600) for the year ended December 31, 1995 when compared to $1,761,300 for the year ended December 31, 1994. The change was primarily due to the sale proceeds received in 1994 from the sale of Wellington C. In addition, the Partnership maintains working capital reserves to pay for capital expenditures, such as building and tenant improvements and leasing costs. During the year ended December 31, 1995, the Partnership spent $412,600 for capital and tenant improvements and leasing costs and has budgeted to spend approximately $650,000 during the year ending December 31, 1996. This budgeted amount relates to anticipated capital and tenant improvements and leasing costs of approximately: 1) $375,000 at Park Plaza; 2) $100,000 at 3120 Southwest Freeway; 3) $100,000 at Indian Ridge and 4) $75,000 at Carrollton. The General Partner believes these improvements and leasing costs are necessary in order to increase and\/or maintain the occupancy levels in very competitive markets, maximize rental rates charged to new and renewing tenants and prepare the remaining properties for eventual disposition.\nNet cash (used for) financing activities changed from $(3,820,400) for the year ended December 31, 1994 to $(2,202,700) for the year ended December 31, 1995 primarily due to a decrease in the payment of cash distributions to Limited Partners as a result of the distribution in 1994 of Sale Proceeds from the sale of Wellington C.\nThe General Partner continues to take a conservative approach to projections of future rental income and to maintain higher levels of cash reserves due to anticipated capital and tenant improvements and leasing costs necessary to be made at the Partnership's properties during the next several years. As a result of this, cash continues to be retained to supplement working capital reserves. For the year\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED) ended December 31, 1995, Cash Flow (as defined in the Partnership Agreement) retained to supplement working capital reserves was $530,100.\nDistributions to Limited Partners for the quarter ended December 31, 1995 were declared in the amount of $1.05 per Unit. Cash distributions are made 60 days after the last day of each fiscal quarter. The amount of future distributions to Partners will ultimately be dependent upon the performance of the Partnership's investments as well as the General Partner's determination of the amount of cash necessary to supplement working capital reserves to meet future liquidity requirements of the Partnership. Accordingly, there can be no assurance as to the amount and\/or availability of cash for future distributions to Partners.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - ------- -------------------------------------------\nThe response to this item is submitted as a separate section of this report. See page A-1 \"Index of Financial Statements, Schedule and Exhibits.\"\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 Partnership has no directors. First Capital Financial Corporation (\"FCFC\") is the General Partner. The Directors of FCFC, as of March 29, 1996, are shown in the table below. Directors serve for one year or until their successors are elected. The next annual meeting of FCFC will be held in June 1996.\nName Office ---- ------ Samuel Zell........................................ Chairman of the Board Douglas Crocker II................................. Director Sheli Z. Rosenberg................................. Director Sanford Shkolnik................................... Director\nSamuel Zell, 54, has been a Director of the General Partner since 1983 (Chairman of the Board since December 1985) and is Chairman of the Board of Great American Management and Investment, Inc. (\"Great American\"). Mr. Zell is also Chairman of the Board of Equity Financial and Management Company (\"EFMC\") and Equity Group Investments, Inc. (\"EGI\"), and is a trustee and beneficiary of a general partner of Equity Holdings Limited, an Illinois Limited Partnership, a privately owned investment partnership. He is also Chairman of the Board of Directors of Anixter International Inc., Falcon Building Products, Inc. and American Classic Voyages Co. He is Chairman of the Board of Trustees of Equity Residential Properties Trust. He is a director of Quality Food Centers, Inc. and Sealy Corporation. He is Chairman of the Board of Directors and Chief Executive Officer of Capsure Holdings Corp. and Manufactured Home Communities, Inc. and Co-Chairman of the Board of Revco D.S., Inc. Mr. Zell was President of Madison Management Group, Inc. (\"Madison\") prior to October 4, 1991. Madison filed for protection under the Federal bankruptcy laws on November 8, 1991.\nDouglas Crocker II, 55, has been President and Chief Executive Officer since December 1992 and a Director since January 1993 of the General Partner. Mr. Crocker has been an Executive Vice President of EFMC since November 1992. Mr. Crocker has been President, Chief Executive Officer and trustee of Equity Residential Properties Trust since March 31, 1993. He was President of Republic Savings Bank, F.S.B. (\"Republic\") from 1989 to June, 1992 at which time the Resolution Trust Company took control of Republic. Mr. Crocker is a member of the Board of Directors of Horizon Group, Inc.\nSheli Z. Rosenberg, 54, was President and Chief Executive Officer of the General Partner from December 1990 to December 1992 and has been a Director of the General Partner since September 1983; was Executive Vice President and General Counsel for EFMC from October 1980 to November 1994; has been President and Chief Executive Officer of EFMC and EGI since November 1994; has been a Director of Great American since June 1984 and is a Director of various subsidiaries of Great American. She is also a Director of Anixter International Inc., Capsure Holdings Corp., American Classic Voyages Co., Falcon Building Products, Inc., Jacor Communications, Inc., Revco D.S., Inc., Sealy Corporation and CFI Industries, Inc. She was Chairman of the Board from January 1994 to September 1994; Co-Chairman of the Board from September 1994 until March 1995 of CFI Industries, Inc. She is also a trustee of Equity Residential Properties Trust. Ms. Rosenberg is a Principal of Rosenberg & Liebentritt, P.C., counsel to the Partnership, the General Partner and certain of their Affiliates. Ms. Rosenberg was Vice President of Madison prior to October 4, 1991. Madison filed for protection under the Federal bankruptcy\nITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - Continued - -------- --------------------------------------------------------------\n(a) DIRECTORS - (continued) -----------------------\nlaws on November 8, 1991. She has been Vice President of First Capital Benefit Administrators, Inc. (\"Benefit Administrators\") since July 22, 1987. Benefit Administrators filed for protection under the Federal bankruptcy laws on January 3, 1995.\nSanford Shkolnik, 57, has been a Director of the General Partner since December 1985. Mr. Shkolnik has been Executive Vice President of EFMC since 1976. He is Chairman of the Board and Chief Executive Officer of SC Management, Inc., which is general partner of Equity Properties and Development Limited Partnership, a nationally ranked shopping center management company.\n(b,c & e) EXECUTIVE OFFICERS ------------------\nThe Partnership does not have any executive officers. The executive officers of the General Partner as of March 29, 1996 are shown in the table. All officers are elected to serve for one year or until their successors are elected and qualified.\nName Office ---- ------ Douglas Crocker II................. President and Chief Executive Officer Arthur A. Greenberg................ Senior Vice President Norman M. Field.................... Vice President - Finance and Treasurer\nPRESIDENT AND CEO - See Table of Directors above.\nArthur A. Greenberg, 55, has been Senior Vice President of the General Partner since August 1986. Mr. Greenberg was Executive Vice President and Chief Financial Officer of Great American from December 1986 to March 1995. Mr. Greenberg also is an Executive Vice President of EFMC since 1971, and President of Greenberg & Pociask, Ltd. He is Senior Vice President since 1989 and Treasurer since 1990 of Capsure Holdings Corp. Mr. Greenberg is a Director of American Classic Voyages Co. and Chairman of the Board of Firstate Financial A Savings Bank. Mr. Greenberg was Vice President of Madison prior to October 4, 1991. Madison filed for protection under the Federal bankruptcy laws on November 8, 1991.\nNorman M. Field, 47, has been Vice President of Finance and Treasurer of the General Partner since February 1984, and also served as Vice President and Treasurer of Great American from July 1983 until March 1995. Mr. Field has been Treasurer of Benefit Administrators since July 22, 1987. He also served as Vice President of Madison until October 4, 1991. He was Chief Financial Officer of Equality Specialties, Inc. (\"Equality\"), a subsidiary of Great American, from August 1994 to April 1995. Equality was sold in April 1995.\n(d) FAMILY RELATIONSHIPS --------------------\nThere are no family relationships among any of the foregoing directors and officers.\n(f) INVOLVEMENT IN CERTAIN LEGAL PROCEEDINGS ----------------------------------------\nWith the exception of the bankruptcy matters disclosed under Items 10 (a), (b), (c) and (e), there are no involvements in certain legal proceedings among any of the foregoing directors and officers.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION - -------- ----------------------\n(a,b,c & d) As stated in Item 10, the Partnership has no officers or directors. Neither the General Partner, nor any director or officer of the General Partner, received any direct remuneration from the Partnership during the year ended December 31, 1995. However, the General Partner and its Affiliates do compensate its directors and officers. For additional information see Item 13 (a) Certain Relationships and Related Transactions.\n(e) None.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - -------- --------------------------------------------------------------\n(a) As of March 1, 1996, no person owned of record or was known by the Partnership to own beneficially more than 5% of the Partnership's 593,025 Units then outstanding.\n(b) The Partnership has no directors or executive officers. As of March 1, 1996, the executive officers and directors of the General Partner, as a group, did not own any Units.\n(c) None.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - -------- ----------------------------------------------\n(a) Certain Affiliates of the General Partner provide leasing, supervisory and property management services to the Partnership. Compensation for these property management services may not exceed 6% of the gross receipts from the property being managed where the General Partner or Affiliates provide leasing, re- leasing and leasing related services, or 3% of gross receipts where the General Partner or Affiliates do not perform leasing, re-leasing and leasing related services for a particular property. For the year ended December 31, 1995, these Affiliates were entitled to leasing, supervisory and property management fees of $326,400. In addition, other Affiliates of the General Partner were entitled to receive $100,900 for fees and reimbursements from the Partnership for insurance, personnel and other services. Compensation for these services are on terms which are fair, reasonable and no less favorable to the Partnership than reasonably could be obtained from unaffiliated persons. A total of $68,800 of these amounts was due to Affiliates as of December 31, 1995.\nAs of December 31, 1995, $40,200 was due to the General Partner for real estate commissions earned in connection with the disposition and sale of Partnership property. These commissions have been accrued but not paid. Under the terms of the Partnership Agreement, these commissions will not be paid until such time as the Limited Partners have received cumulative distributions of Sale or Financing Proceeds equal to 100% of their Original Capital Contribution, plus a cumulative return (including all Cash Flow which has been distributed to Limited Partners) of 6% simple interest per annum on their Capital Investment from the initial date of investment.\nIn accordance with the Partnership Agreement, as compensation for services rendered in managing the affairs of the Partnership, the General Partner shall be entitled to receive subsequent to May 4, 1988, the Termination of the Offering, a Partnership Management Fee payable annually within 60 days following the last day of each fiscal year, which shall be an amount equal to the lesser of (i) 0.5% of the net value of the Partnership's assets as of the end of such fiscal year reflected on the Certificate of Value furnished to the Limited Partners, plus, to the extent the Partnership Management Fee paid in any prior year was less than 0.5% of the net value of the Partnership's assets in such prior year, the amount of such deficit, or (ii) an amount equal to the difference between 10% of the Partnership's aggregate Cash Flow (as defined in the Partnership Agreement) for the period from the Commencement of Operations to the end of the fiscal year for which such Partnership Management Fee is payable, and the aggregate amount\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - Continued - -------- ----------------------------------------------------------\npreviously paid to the General Partner as a Partnership Management Fee. In addition, Sale Proceeds are distributed: first, 75% to all Limited Partners and 25% to the General Partner until the earlier of (i) receipt by Limited Partners of cumulative distributions of Sale Proceeds in an amount equal to 100% of their Original Capital Contribution, or (ii) receipt by the General Partner of cumulative distributions of Sale Proceeds sufficient to repay all outstanding advances to the Partnership from the General Partner; thereafter, to the General Partner, until all outstanding advances, if any, to the Partnership from the General Partner have been repaid; thereafter, to the Limited Partners, until they have received cumulative distributions of Sale Proceeds in an amount equal to 100% of their Original Capital Contribution, plus an amount (including Cash Flow (as defined in the Partnership Agreement)) equal to a cumulative return of 6% per annum simple interest on their Capital Investment from their investment date in the Partnership; thereafter, 85% to all Limited Partners; and 15% to the General Partner, provided, however, that no distribution of the General Partner's share of Sale Proceeds shall be made until Limited Partners have received the greater of (i) Sale Proceeds plus Cash Flow (as defined in the Partnership Agreement) previously received in excess of the Preferred Return equal to 125% of the Limited Partners' Original Capital Contribution, or (ii) Sale Proceeds plus all Cash Flow (as defined in the Partnership Agreement) previously received equal to their Original Capital Contribution plus a 10% per annum simple interest return on their Capital Investment from the date of investment.\nIn accordance with the Partnership Agreement, Net Profits (exclusive of Net Profits from the sale or disposition of Partnership properties) shall be allocated to the General Partner in an amount equal to the greater of 1% of such Net Profits or the Partnership Management Fee paid by the Partnership to the General Partner during such year, and the balance, if any, to the Limited Partners. Net Losses (exclusive of Net Losses from the sale, disposition or provision for value impairment of Partnership properties) are allocated 1% to the General Partner and 99% to the Limited Partners. Net Profits from the sale or disposition of a Partnership property are allocated: first, prior to giving effect to any distributions of Sale Proceeds from the transaction, to the General Partner and Limited Partners with negative balances in their Capital Accounts, pro rata in proportion to such respective negative balances, to the extent of the total of such negative balances; second, to each Limited Partner in an amount, if any, necessary to make the positive balance in its Capital Account equal to the Sale Proceeds to be distributed to such Limited Partner with respect to the sale or disposition of such property; third, to the General Partner in an amount, if any, necessary to make the positive balance in its Capital Account equal to the Sale Proceeds to be distributed to the General Partner with respect to the sale or disposition of such property; and fourth, the balance, if any, 15% to the General Partner and 85% to the Limited Partners. Net Losses from the sale, disposition or provision for value impairment of Partnership properties are allocated: first, after giving effect to any distributions of Sale Proceeds from the transaction to the General Partner and Limited Partners with positive balances in their Capital Accounts, pro rata in proportion to such respective positive balances, to the extent of the total amount of such positive balances; and second, the balance, if any, 1% to the General Partner and 99% to the Limited Partners. Notwithstanding anything to the contrary, there shall be allocated to the General Partner not less than 1% of all items of Partnership income, gain, loss, deduction and credit during the existence of the Partnership. For the year ended December 31, 1995, the General Partner was entitled to a Partnership Management Fee of $161,200 and allocated Net Profits of $137,200, which included a (loss) from provisions for value impairment of $(24,000).\nIn accordance with the Partnership Agreement, the General Partner made advances to the Partnership in cumulative amounts equal to the Acquisition Fees and the Partnership Management Fees which were paid to the General Partner or its Affiliates for distribution to the Limited Partners on a pro rata basis to the extent that Cash Flow (as defined in the Partnership Agreement) was less than sufficient to distribute cash in amounts equal to the Limited Partners' Preferred Return (7.5% per annum noncompounding cumulative return on the Limited Partners' Capital Investment); provided, however, that the maximum amount which shall be advanced to the Partnership by the General Partner for\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - Continued - -------- ----------------------------------------------------------\ndistribution to the Limited Partners shall be the amount of Acquisition Fees and Partnership Management Fees actually paid to the General Partner or its Affiliates. Amounts advanced shall bear interest at the rate of 8.5% per annum simple interest, payable monthly. Repayment of amounts advanced shall be made only from Cash Flow (as defined in the Partnership Agreement) if and to the extent it is more than sufficient to distribute cash to the Limited Partners in amounts equal to the Limited Partners' Preferred Return and from Sale Proceeds to the extent permitted by the Partnership Agreement. For the year ended December 31, 1995, the Partnership was required to pay $349,800 in interest on this loan payable. As of December 31, 1995 the outstanding loan payable and the interest expense due to the General Partner was $4,085,700 and $29,900, respectively.\n(b) Rosenberg & Liebentritt, P.C. (\"Rosenberg\"), serves as legal counsel to the Partnership, the General Partner and certain of their Affiliates. Sheli Z. Rosenberg, President and Chief Executive Officer of the General Partner from December 1990 to December 1992 and a director of the General Partner since December 1983, is a Principal of Rosenberg. For the year ended December 31, 1995, Rosenberg was entitled to $47,300 for legal fees from the Partnership. As of December 31, 1995, all fees due to Rosenberg have been paid. Compensation for these services are on terms which are fair, reasonable and no less favorable to the Partnership than reasonably could be obtained from unaffiliated persons.\n(c) No management person is indebted to the Partnership.\n(d) None.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K - -------- ----------------------------------------------------------------\n(a,c & d) See Index of Financial Statements, Schedule and Exhibits on page A-1 of Form 10-K.\n(b) Reports on Form 8-K:\nThere were no reports filed on Form 8-K for the quarter ended December 31, 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.\nFIRST CAPITAL INSTITUTIONAL REAL ESTATE, LTD. - 4\nBY: FIRST CAPITAL FINANCIAL CORPORATION GENERAL PARTNER\nDated: March 29, 1996 By: \/s\/ DOUGLAS CROCKER II ----------------- ----------------------------------------- DOUGLAS CROCKER II President and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\n\/s\/ SAMUEL ZELL March 29, 1996 Chairman of the Board - ---------------------------- -------------- and Director of the SAMUEL ZELL General Partner\n\/s\/ DOUGLAS CROCKER II March 29, 1996 President, Chief Executive - ---------------------------- -------------- Officer and Director of the DOUGLAS CROCKER II General Partner\n\/s\/ SHELI Z. ROSENBERG March 29, 1996 Director of the General - ---------------------------- -------------- Partner SHELI Z. ROSENBERG\n\/s\/ SANFORD SHKOLNIK March 29, 1996 Director of the General - ---------------------------- -------------- Partner SANFORD SHKOLNIK\n\/s\/ NORMAN M. FIELD March 29, 1996 Vice President - Finance - ---------------------------- -------------- and Treasurer NORMAN M. FIELD\nINDEX OF FINANCIAL STATEMENTS, SCHEDULE AND EXHIBITS\nFINANCIAL STATEMENTS FILED AS PART OF THIS REPORT\nPages -------------\nReport of Independent Auditors A - 2\nBalance Sheets as of December 31, 1995 and 1994 A - 3\nStatements of Partners' Capital for the Years Ended December 31, 1995, 1994, and 1993 A - 3\nStatements of Income and Expenses for the Years Ended December 31, 1995, 1994, and 1993 A - 4\nStatements of Cash Flows for the Years Ended December 31, 1995, 1994, and 1993 A - 4\nNotes to Financial Statements A - 5 to A - 7\nSCHEDULE FILED AS PART OF THIS REPORT\nIII - Real Estate and Accumulated Depreciation as of December 31, 1995 A - 8 and A - 9\nAll other schedules have been omitted as inapplicable, or for the reason that the required information is shown in the financial statements or notes thereto.\nEXHIBITS FILED AS PART OF THIS REPORT\nEXHIBITS (3 & 4) First Amended and Restated Certificate and Agreement of Limited Partnership as set forth on pages A-1 through A-32 of the Partnership's definitive Prospectus dated November 5, 1986 on Form S-11 Registration No. 33- 06149, filed pursuant to Rule 424(b), is incorporated herein by reference.\nEXHIBIT (13) Annual Report to Security Holders - ------------\nThe 1994 Annual Report to Limited Partners is being sent under separate cover, not as a filed document and not via EDGAR, for the information of the Commission.\nEXHIBIT (27) Financial Data Schedule - ------------\nA - 1\nREPORT OF INDEPENDENT AUDITORS\nPartners First Capital Institutional Real Estate, Ltd. - 4 Chicago, Illinois\nWe have audited the accompanying balance sheets of First Capital Institutional Real Estate, Ltd. - 4 as of December 31, 1995 and 1994, and the related statements of income and expenses, partners' capital and cash flows for each of the three years in the period ended December 31, 1995, and the schedule listed in the accompanying index. These financial statements and schedule are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of First Capital Institutional Real Estate, Ltd. - 4 at December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.\nErnst & Young LLP\nChicago, Illinois March 1, 1996\nA-2\nBALANCE SHEETS December 31, 1995 and 1994 (All dollars rounded to nearest 00s)\nSTATEMENTS OF PARTNERS' CAPITAL For the years ended December 31, 1995, 1994 and 1993 (All dollars rounded to nearest 00s)\nThe accompanying notes are an integral part of the financial statements. A-3\nSTATEMENTS OF INCOME AND EXPENSES For the years ended December 31, 1995, 1994 and 1993 (All dollars rounded to nearest 00s except per Unit amounts)\nSTATEMENTS OF CASH FLOWS For the years ended December 31, 1995, 1994 and 1993 (All dollars rounded to nearest 00s)\nThe accompanying notes are an integral part of the financial statements. A-4\nNOTES TO FINANCIAL STATEMENTS 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:\nDEFINITION OF SPECIAL TERMS: Capitalized terms used in this report have the same meaning as those terms have in the Partnership's Registration Statement filed with the Securities and Exchange Commission on Form S-11. Definitions of these terms are contained in Article III of the First Amended and Restated Certificate and Agreement of Limited Partnership, which is included in the Registration Statement and incorporated herein by reference.\nORGANIZATION: The Partnership was formed on May 20, 1986, by the filing of a Certificate and Agreement of Limited Partnership with the Recorder of Deeds of Cook County, Illinois, and commenced the Offering of Units on November 5, 1986. On December 15, 1986, the required minimum subscription level was reached and Partnership operations commenced. The Offering was Terminated on May 4, 1988 with 593,025 Units sold. The Partnership was formed to invest primarily in existing, improved, income-producing commercial real estate.\nThe Partnership Agreement provides that the Partnership will be dissolved on or before December 31, 2016. The Limited Partners, by a majority vote, may dissolve the Partnership at any time.\nACCOUNTING POLICIES: The financial statements have been prepared in accordance with generally accepted accounting principles. Under this method of accounting, revenues are recorded when earned and expenses are recorded when incurred.\nPreparation of the Partnership's 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.\nThe financial statements include the Partnership's 50% interest in two joint ventures and a 75% interest in another joint venture with Affiliated partnerships. These joint ventures were formed for the purpose of each acquiring a 100% interest in certain real property and are operated under the common control of the General Partner. In addition, the 1993 and 1994 financial statements included the Partnership's 50% interest in a joint venture with an Affiliated partnership. This joint venture was formed for the purpose of participating in a mortgage loan investment, which was subsequently foreclosed in-substance and recorded as two real property investments, and was operated under the common control of the General Partner prior to the sales and\/or disposition of the property investments in 1993 and 1994. Accordingly, the Partnership's pro rata share of the ventures' revenues, expenses, assets, liabilities and capital was included in the financial statements.\nThe Partnership is not liable for federal income taxes as the Partners recognize their proportionate share of the Partnership income or loss on their individual tax returns; therefore, no provision for income taxes is made in the financial statements of the Partnership. It is not practicable for the Partnership to determine the aggregate tax bases of the Limited Partners; therefore, the disclosure of the difference between the tax bases and the reported bases and the reported assets and liabilities of the Partnership would not be meaningful.\nCommercial rental properties are recorded at cost, net of any provisions for value impairment, and depreciated (exclusive of amounts allocated to land) on the straight-line method over their estimated useful lives. Lease acquisition fees are recorded at cost and amortized over the life of the lease. Repair and maintenance costs are expensed as incurred; expenditures for improvements are capitalized and depreciated over the estimated life of the improvements.\nThe General Partner periodically reviews significant factors regarding the properties to determine that the properties are carried at the lower of cost or fair market value. These factors include, but are not limited to, the General Partner's experience in the real estate industry, an evaluation of recent operating performance against expected results, economic trends or factors affecting major tenants or the regions in which the properties are located, and where available, information included in recent appraisals of properties.\nBased on this analysis, where it is anticipated that the carrying value of an investment property will not be recovered, the General Partner has deemed it appropriate to reduce the basis of the properties for financial reporting purposes to fair market value. Such fair market value is the General Partner's best estimate of the amounts expected to be realized were such properties sold as of the Balance Sheet date, based upon current information available. The ultimate realization may differ from these amounts. Provisions, where applicable, are reflected in the accompanying Statements of Income and Expenses in the year such evaluations have been made. For additional information see Note 7.\nProperty sales or dispositions are recorded when title transfers and sufficient consideration has been received by the Partnership. Upon disposition, the related costs and accumulated depreciation are removed from the respective accounts. Any gain or loss on sale or disposition is recognized in accordance with generally accepted accounting principles.\nCash equivalents are considered all highly liquid investments with an original maturity of three months or less when purchased.\nThe Partnership's financial statements include financial instruments, including receivables, trade liabilities and the loan payable to the General Partner. The fair value of financial instruments, including cash and cash equivalents, was not materially different from their carrying value at December 31, 1995 and 1994.\nCertain reclassifications have been made to the previously reported 1994 and 1993 statements in order to provide comparability with the 1995 statements. These reclassifications have no effect on net income (loss) or Partners' (deficit) capital.\n2. RELATED PARTY TRANSACTIONS:\nIn accordance with the Partnership Agreement, as compensation for services rendered in managing the affairs of the Partnership, the General Partner shall be entitled to receive subsequent to May 4, 1988, the Termination of the Offering, a Partnership Management Fee payable annually within 60 days following the last day of each fiscal year, which shall be an amount equal to the lesser of (i) 0.5% of the net value of the Partnership's assets as of the end of such fiscal year reflected on the Certificate of Value furnished to the Limited Partners, plus, to the extent the Partnership Management Fee paid in any prior year was less than 0.5% of the net value of the Partnership's assets in such prior year, the amount of such deficit, or (ii) an amount equal to the difference between 10% of the Partnership's aggregate Cash Flow (as defined in the Partnership Agreement) for the period from the Commencement of Operations to the end of the fiscal year for which such Partnership Management Fee is payable, and the aggregate amount previously paid to the General Partner as a Partnership Management Fee. In addition, Sale Proceeds are distributed: first, 75% to all Limited Partners and 25% to the General Partner until the earlier of (i) receipt by Limited Partners of cumulative distributions of Sale Proceeds in an amount equal to 100% of their Original Capital Contribution, or (ii) receipt by the General Partner of cumulative distributions of Sale Proceeds sufficient to repay all outstanding advances to the Partnership from the General Partner; thereafter, to the General Partner, until all outstanding advances, if any, to the Partnership from the General Partner have been repaid; thereafter, to the Limited Partners, until they have received cumulative distributions of Sale Proceeds in an amount equal to 100% of their Original Capital Contribution, plus an amount (including Cash Flow (as defined in the Partnership Agreement)) equal to a cumulative return of 6% per annum simple interest on their Capital Investment from their investment date in the Partnership; thereafter, 85% to all Limited Partners; and 15% to the General Partner, provided, however, that no distribution of the General Partner's share of Sale Proceeds shall be made until Limited Partners have received the greater of (i) Sale Proceeds plus Cash Flow (as defined in the Partnership Agreement) previously received in excess of the Preferred Return equal to 125% of the Limited Partners' Original Capital Contribution, or (ii) Sale Proceeds plus all Cash Flow (as defined in the Partnership Agreement) previously received equal to their Original Capital Contribution plus a 10% per annum simple interest return on their Capital Investment from the date of investment.\nA-5\nIn accordance with the Partnership Agreement, Net Profits (exclusive of Net Profits from the sale or disposition of Partnership properties) shall be allocated to the General Partner in an amount equal to the greater of 1% of such Net Profits or the Partnership Management Fee paid by the Partnership to the General Partner during such year, and the balance, if any, to the Limited Partners. Net Losses (exclusive of Net Losses from the sale, disposition or provision for value impairment of Partnership properties) are allocated 1% to the General Partner and 99% to the Limited Partners. Net Profits from the sale or disposition of a Partnership property are allocated: first, prior to giving effect to any distributions of Sale Proceeds from the transaction, to the General Partner and Limited Partners with negative balances in their Capital Accounts, pro rata in proportion to such respective negative balances, to the extent of the total of such negative balances; second, to each Limited Partner in an amount, if any, necessary to make the positive balance in its Capital Account equal to the Sale Proceeds to be distributed to such Limited Partner with respect to the sale or disposition of such property; third, to the General Partner in an amount, if any, necessary to make the positive balance in its Capital Account equal to the Sale Proceeds to be distributed to the General Partner with respect to the sale or disposition of such property; and fourth, the balance, if any, 15% to the General Partner and 85% to the Limited Partners. Net Losses from the sale, disposition or provision for value impairment of Partnership properties are allocated: first, after giving effect to any distributions of Sale Proceeds from the transaction to the General Partner and Limited Partners with positive balances in their Capital Accounts, pro rata in proportion to such respective positive balances, to the extent of the total amount of such positive balances; and second, the balance, if any, 1% to the General Partner and 99% to the Limited Partners. Notwithstanding anything to the contrary, there shall be allocated to the General Partner not less than 1% of all items of Partnership income, gain, loss, deduction and credit during the existence of the Partnership. For the year ended December 31, 1995, the General Partner was entitled to a Partnership Management Fee of $161,200 and allocated Net Profits of $137,200, which included a (loss) from provisions for value impairment of $(24,000). For the year ended December 31, 1994, the General Partner was entitled to a Partnership Management Fee of $174,000 and allocated Net Profits of $168,500, which included a (loss) from the sale of a Partnership property of $(500) and a (loss) from a provision for value impairment of $(5,000). For the year ended December 31, 1993, the General Partner was entitled to a Partnership Management Fee of $515,400 and allocated Net Profits of $515,700, which included (losses) on the sale and disposition of Partnership properties of $(14,300) and an extraordinary gain on extinguishment of debt of $14,600.\nIn accordance with the Partnership Agreement, the General Partner made advances to the Partnership in cumulative amounts equal to the Acquisition Fees and the Partnership Management Fees which were paid to the General Partner or its Affiliates for distribution to the Limited Partners on a pro rata basis to the extent that Cash Flow (as defined in the Partnership Agreement) was less than sufficient to distribute cash in amounts equal to the Limited Partners' Preferred Return (7.5% per annum noncompounding cumulative return on the Limited Partners' Capital Investment); provided, however, that the maximum amount which shall be advanced to the Partnership by the General Partner for distribution to the Limited Partners shall be the amount of Acquisition Fees and Partnership Management Fees actually paid to the General Partner or its Affiliates. Amounts advanced shall bear interest at the rate of 8.5% per annum simple interest, payable monthly. Repayment of amounts advanced shall be made only from Cash Flow (as defined in the Partnership Agreement) if and to the extent it is more than sufficient to distribute cash to the Limited Partners in amounts equal to the Limited Partners' Preferred Return and from Sale Proceeds to the extent permitted in the Partnership Agreement. As of December 31, 1995, the Partnership has drawn $4,085,700, which represents the total amount of the General Partner's current commitment.\nFees and reimbursements paid and payable by the Partnership to Affiliates were as follows:\n(a) As of December 31, 1995, $40,200 was due to the General Partner for real estate commissions earned in connection with the disposition of certain Partnership properties. These commissions have been accrued but not paid. Under the terms of the Partnership Agreement, these commissions will not be paid until such time as the Limited Partners have received cumulative distributions of Sale or Financing Proceeds equal to 100% of their Original Capital Contribution, plus a cumulative return (including all Cash Flow which has been distributed to Limited Partners) of 6% simple interest per annum on their Capital Investment from the initial date of investment.\nOn-site property management for the Partnership's properties is provided by Affiliates of the General Partner for fees ranging from 3% to 6% of gross rents received from the properties.\n3. RESTRICTED CERTIFICATES OF DEPOSIT:\nRestricted certificates of deposit include a negotiable certificate of deposit of $37,500, which has been pledged as collateral for security deposits to the Houston Lighting & Power Company, and $25,000, which has been pledged as collateral for security deposits to the Florida Lighting & Power Company.\n4. FUTURE MINIMUM RENTALS:\nThe Partnership's share of future minimum rental income due on noncancelable leases as of December 31, 1995 was as follows:\nA-6\nThe Partnership is subject to the usual business risks associated with the collection of the above-scheduled rentals. In addition to the amounts scheduled above, the Partnership expects to receive rental revenue from operating expense and real estate tax expense reimbursements and percentage rents. Percentage rents earned for the years ended December 31, 1995, 1994 and 1993 were $84,300, $7,500 and $6,400, respectively.\n5. INCOME TAX:\nThe Partnership utilizes the accrual basis of accounting for both income tax reporting and financial statement purposes. Financial statement results will differ from income tax results due to the use of differing depreciation lives and methods, the recognition of rents received in advance as taxable income and the Partnership's provisions for value impairment. The net effect of these accounting differences for the year ended December 31, 1995 was that the income for tax reporting purposes was greater than the net loss for financial statement purposes by $2,733,000. The aggregate cost of commercial rental properties for federal income tax purposes at December 31, 1995 was $46,223,400.\n6. PROPERTY SALES AND DISPOSITIONS:\nOn June 8, 1994, Farmington Hills Associates (\"FHA\"), the joint venture which owned North Valley Office Center and Wellington North Office Complex (\"Wellington A, B and C\"), in which the Partnership owned a 50% interest, sold Wellington C for the sale price of $4,500,000. The Partnership's share of selling expenses was $81,700. The Partnership's share of the net proceeds from this sale was $2,168,300. The Partnership recorded a total (loss) on the sale of this property of $(2,048,900) for financial statement purposes, of which $2,000,000 was recorded as of December 31, 1992 as a provision for value impairment. For tax reporting purposes, the Partnership reported a total (loss) in 1994 of $(1,915,700) on this sale.\nOn March 17, 1993, FHA disposed of Wellington A in conjunction with the mortgage holder, to a third party for a total sale price of $2,060,000. Of this amount, FHA remitted $1,910,000 to the mortgage holder (the Partnership's share of this amount was $955,000) which relieved the Partnership of its share of the obligation of $2,419,000 under the mortgage loan and any interest in the assets therein. This extinguishment of debt was considered a non-cash event for the purposes of the Statement of Cash Flows, and was not included in the Partnership's calculation of Cash Flow (as defined in the Partnership Agreement) for the year ended December 31, 1993. The Partnership incurred transaction costs of $63,500, including $10,600 of accrued expenses. The Partnership's share of the net proceeds from this transaction was $22,100. The Partnership recorded a (loss) on the disposition of this property of $(2,027,900) for financial statement purposes. This (loss) represented the net book value of this property and transaction costs incurred by the Partnership in excess of the sale price of the property. Due to an anticipated (loss) in connection with this disposition, the Partnership recorded $(765,000) as a provision for value impairment in 1992. Upon sale of the property in 1993, an additional (loss) of $(1,262,900) was recorded. In addition, the Partnership also recorded an extraordinary gain on extinguishment of debt in connection with the disposition of this property of $1,464,000 in its 1993 financial statements. This extraordinary gain on extinguishment of debt represented the excess property indebtedness over the amount remitted to the mortgage holder upon sale of the property. For tax reporting purposes the Partnership reported a total net (loss) of $(597,300) in 1993 on this disposition and extinguishment of debt.\nOn March 23, 1993, FHA sold Wellington B for a total sale price of $1,680,000. The Partnership's share of selling expenses were $64,600, including $45,900 of accrued expenses. The Partnership's share of the net proceeds from this sale was $821,300. The Partnership recorded a (loss) on the disposition of this property of $(463,600) for financial statement purposes. Due to the anticipated (loss) in connection with this sale, the Partnership recorded $(300,000) of the total (loss) as of December 31, 1992 as a provision for value impairment and the remaining portion of the (loss) in 1993. For tax reporting purposes the Partnership recorded a total (loss) of $(446,500) in 1993 on this sale.\nAll of the above sales and dispositions were all-cash transactions, with no further involvement on the part of the Partnership.\n7. PROVISIONS FOR VALUE IMPAIRMENT:\nDue to the depressed economic environment in the retail industry, regional factors affecting the Partnership's retail and office properties and other matters relating specifically to certain of the Partnership's properties, there is uncertainty as to the Partnership's ability to recover the net carrying value of certain of its properties during the remaining estimated holding periods. Accordingly, it was deemed appropriate to reduce the bases of such properties in the Partnership's financial statements during the years ended December 31, 1995 and 1994. The provisions for value impairment were considered non-cash events for the purposes of the Statements of Cash Flow and were not utilized in the determination of Cash Flow (as defined in the Partnership Agreement). The following is a summary of the provisions for value impairment reported by the Partnership for the years ended December 31, 1995 and 1994:\nThe provisions for value impairment were material fourth quarter adjustments pursuant to Accounting Principles Board Opinion No. 28, \"Interim Financial Reporting\". No other material adjustments were made in the fourth quarters.\nBeginning on January 1, 1996, the Partnership will adopt Financial Accounting Standards Board Statement No. 121 \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of\" (the \"Standard\"). The Standard established guidance for determining if the value of defined assets are impaired, and if so, how impairment losses should be measured and reported in the financial statements. The Standard is effective for fiscal years beginning after December 15, 1995. The Managing General Partner believes that, based on current circumstances, the adoption on January 1, 1996 of the Standard will not materially affect the Partnership's financial position or results of operations.\nA-7\nFIRST CAPITAL INSTITUTIONAL REAL ESTATE, LTD. - 4\nSCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION AS OF DECEMBER 31, 1995\nColumn B - Not Applicable\nSee accompanying notes on the following page.\nA-8\nFIRST CAPITAL INSTITUTIONAL REAL ESTATE, LTD. - 4\nNOTES TO SCHEDULE III\nNote 1. Consists of legal fees, appraisal fees, title costs and other related professional fees.\nNote 2. The following is a reconciliation of activity in columns E and F.\nNote 3. The aggregate cost for federal income tax purposes as of December 31, 1995 was $46,223,400.\nNote 4. Included provisions for value impairment. See Note 7 in Notes to Financial Statements for additional information.\nNote 5. Estimated useful life for building.\nNote 6. Estimated useful life for improvements.\nA-9","section_15":""}
{"filename":"717605_1995.txt","cik":"717605","year":"1995","section_1":"ITEM 1. BUSINESS.\nGENERAL DEVELOPMENT OF BUSINESS\nHexcel Corporation, founded in 1946, was incorporated in California in 1948, and reincorporated in Delaware in 1983. Hexcel Corporation and subsidiaries (herein referred to as \"Hexcel\" or the \"Company\") is an international developer and manufacturer of lightweight, high-performance composite materials, parts and structures for use in the commercial aerospace, space and defense, recreation and general industrial markets. The Company serves international markets through manufacturing and marketing facilities located in the United States and Europe, as well as sales offices in Asia, Australia and South America. The Company is also a partner in three joint ventures that manufacture and sell composite materials in the U.S. and Asia.\nACQUISITION OF THE CIBA COMPOSITES BUSINESS\nHexcel acquired the worldwide composites division of Ciba-Geigy Limited, a Swiss corporation (\"Ciba\"), and Ciba-Geigy Corporation, a New York corporation (\"CGC\"), including Ciba's and CGC's composite materials, parts and structures businesses (the \"Ciba Composites Business\"), on February 29, 1996. The Ciba Composites Business is engaged in the manufacture and marketing of composite materials, parts and structures for aerospace, recreation and general industrial markets. Product lines include fabrics, prepregs, adhesives, honeycomb core, sandwich panels and fabricated components, as well as structures and interiors primarily for the commercial and military aerospace markets.\nThe acquisition of the Ciba Composites Business was consummated pursuant to a Strategic Alliance Agreement dated as of September 29, 1995 among Ciba, CGC, and Hexcel, as amended (the \"Strategic Alliance Agreement\"). Under the Strategic Alliance Agreement, the Company acquired the assets (including the capital stock of certain of Ciba's non-U.S. subsidiaries) and assumed the liabilities of the Ciba Composites Business other than certain excluded assets and liabilities, in exchange for: (a) approximately 18.0 million newly issued shares of Hexcel common stock; (b) $25.0 million in cash; and (c) undertakings to deliver to Ciba and\/or one or more of its subsidiaries, following completion of certain post-closing adjustment procedures contemplated by the Strategic Alliance Agreement, senior subordinated notes in an aggregate principal amount of approximately $43.0 million, subject to certain adjustments (the \"Senior Subordinated Notes\"), and senior demand notes in a principal amount equal to the cash on hand at certain of Ciba's non-U.S. subsidiaries (the \"Senior Demand Notes\"). (The pro forma aggregate principal amount of the Senior Subordinated Notes as of December 31, 1995 was $27.4 million. See Note 3 to the Consolidated Financial Statements included in this Annual Report on Form 10-K.) Pursuant to the Strategic Alliance Agreement, certain assets of the Ciba Composites Business and certain assets of Ciba affiliates that will continue to act as distributors for the Ciba Composites Business will be acquired by the Company from time to time prior to February 28, 1997.\nIn connection with the acquisition of the Ciba Composites Business, Hexcel obtained a new three-year revolving credit facility of up to $175.0 million (the \"Senior Secured Credit Facility\") to: (a) fund the cash component of the purchase price; (b) refinance outstanding indebtedness under certain U.S. and European credit facilities; and (c) provide for the ongoing working capital and other financing requirements of the Company on a worldwide basis. Further discussion of the Senior Secured Credit\nFacility is included in \"Management Discussion and Analysis\" and in the Notes to the Consolidated Financial Statements included in this Annual Report on Form 10- K.\nManagement expects that significant costs will be incurred in connection with combining the operations of Hexcel and the Ciba Composites Business, including costs of eliminating excess manufacturing capacity and redundant administrative and research and development activities, as well as the various costs of consolidating the information systems and other business activities of the two companies. Some of the costs associated with combining the two businesses, including certain costs to eliminate redundant administrative and research and development activities, will be incurred during 1996. The anticipated resulting benefits are expected to be realized shortly thereafter. However, other costs, including many of the costs to eliminate excess manufacturing capacity, are expected to be incurred over a period of as much as three years. This is attributable, in part, to aerospace industry requirements to \"qualify\" specific equipment and manufacturing facilities for the manufacture of certain products. Based on the Company's experience with previous plant consolidations, these qualification requirements necessitate an approach to the consolidation of manufacturing facilities that will require two to three years to complete. Accordingly, the costs and anticipated future benefits of eliminating excess manufacturing capacity are long-term in nature.\nThe Board of Directors of Hexcel has not yet approved the plan for combining the operations of Hexcel and the Ciba Composites Business, but is expected to do so in the second quarter of 1996. Subject to the approval of the consolidation plan by the Board of Directors, management currently estimates that the cash costs of combining the two businesses could range from $35 million to $45 million, net of expected proceeds from asset sales which are expected to be received at the end of the consolidation process. (This range includes the estimated net cash cost to close the Anaheim manufacturing facility acquired as part of the Ciba Composites Business. The decision to close this facility was announced in the first quarter of 1996.) Management notes, however, that the actual cash costs of combining the two businesses could vary from current estimates due to the fact that the nature, timing and extent of certain consolidation activities is dependent on numerous factors.\nManagement expects to record one or more charges to earnings for the estimated costs of certain business consolidation activities. The estimated costs of specific consolidation activities will be accrued in accordance with generally accepted accounting principles as those activities are determined and announced. Although the aggregate amount of the resulting charges to earnings has not yet been determined, management currently estimates that the amount could range from $40 million to $50 million, including noncash charges. However, the actual aggregate amount of such charges could vary from current estimates.\nThe nature, timing and extent of consolidation activities will be determined, in part, by the factors described above and management's resulting evaluation of the probable economic and competitive benefits to be gained from specific consolidation activities. Management anticipates that the benefits to be realized from planned consolidation activities will be sufficient to justify the level of associated costs. However, some of the anticipated benefits are long-term in nature, and there can be no assurance that such benefits will actually be realized.\nFurther discussion of the acquisition of the Ciba Composites Business is included in \"Management Discussion and Analysis\" and in the Notes to the Consolidated Financial Statements included in this Annual Report on Form 10-K.\nBANKRUPTCY REORGANIZATION\nOn January 12, 1995, the United States Bankruptcy Court for the Northern District of California (the \"Bankruptcy Court\") entered an order dated January 10, 1995 confirming the First Amended Plan of Reorganization (the \"Reorganization Plan\") proposed by Hexcel and the Official Committee of Equity Security Holders (the \"Equity Committee\"). On February 9, 1995, the Reorganization Plan became effective and Hexcel emerged from the bankruptcy reorganization proceedings which had begun on December 6, 1993, when Hexcel filed a voluntary petition for relief under the provisions of Chapter 11 of the federal bankruptcy laws.\nFurther discussion of the Reorganization Plan and Hexcel's emergence from bankruptcy reorganization proceedings is included in \"Management Discussion and Analysis\" and in the Notes to the Consolidated Financial Statements included in this Annual Report on Form 10-K.\nINDUSTRY SEGMENT\nHexcel operates within a single industry segment: composite materials, parts and structures. The Company sells these materials, parts, and structures throughout the world. The net sales, income (loss) before income taxes, identifiable assets, capital expenditures, and depreciation and amortization for each geographic area for the past three years are included in Note 21 to the Consolidated Financial Statements included in this Annual Report on Form 10-K.\nBUSINESS\nAs discussed above, Hexcel acquired the Ciba Composites Business on February 29, 1996. Prior to the acquisition, the Company was organized around worldwide research, manufacturing, marketing and administrative functions with global responsibility for all of the Company's product groups. Those product groups, which have historically been manufactured and marketed primarily in the U.S. and Europe, were comprised of reinforcement fabrics, prepregs and adhesives, and honeycomb, including structural products made from honeycomb.\nIn connection with the acquisition of the Ciba Composites Business, Hexcel has been reorganized into strategic business units according to specific product groups and\/or geographic areas. The research, manufacturing and marketing activities of each of the strategic business units are supported by global administrative functions such as human resources, finance and information systems, legal affairs, and research and technology coordination. The acquisition of the Ciba Composites Business provides the Company with additional manufacturing and marketing capabilities in its reinforcement fabrics, prepregs and adhesives, and honeycomb product groups, in geographically complementary areas. In addition, the acquisition expands the Company's range of product offerings to include structural parts and interiors, primarily for the commercial and military aerospace markets.\nThe following is a description of Hexcel's new strategic business units, including their respective product groups and geographic areas, and the integrated manufacturing capabilities of the Company.\nFABRICS\nThe Fabrics business unit has worldwide responsibility for manufacturing and marketing reinforcement fabrics. The business unit operates manufacturing facilities in Les Avenieres, France; Lyon, France; and Seguin, Texas; and is responsible for Hexcel's participation in a joint venture with Owens-Corning Fiberglas Corporation.\nThe Fabrics business unit produces woven reinforcement fabrics, without resin impregnation, from the same fibers Hexcel uses in prepregs. These fibers include several types of fiberglass as well as carbon, aramid, Thorstrand - -Registered Trademark-, quartz, ceramic and other specialty reinforcements.\nReinforcement fabrics are sold for use in numerous applications. These include aerospace, marine, automotive and recreation applications, as well as ballistics protection, printed circuit boards, metal and fume filtration systems, insulation, window coverings, and civil engineering and other general industrial applications.\nIn addition, Hexcel owns a 50% interest in a joint venture with Owens- Corning Fiberglas Corporation. The Knytex joint venture, which was formed in June of 1993, sells multi-layer stitchbonded reinforcement fabrics which are stronger in all directions and generally lower cost than traditional woven fabrics. Knytex fabrics consist of multiple layers of reinforcement material, in varying orientations, which are stitched together to preserve the desired orientation of the various layers.\nHexcel's net sales of reinforcement fabrics were $119.1 million in 1995, $94.8 million in 1994 and $93.0 million in 1993. As a result of the acquisition of the Ciba Composites Business on February 29, 1996, net sales of reinforcement fabrics are expected to increase in 1996. The Ciba Composites Business had net sales of reinforcement fabrics totaling approximately $23 million in 1995.\nCOMPOSITE MATERIALS\nThe Composite Materials business unit, which is organized around U.S. and European markets, has worldwide responsibility for manufacturing and marketing prepregs, adhesives and honeycomb. The business unit operates manufacturing facilities in Welkenraedt, Belgium; Duxford and Swindon, England; Lyon, France; Casa Grande, Arizona; Anaheim, Dublin, and Livermore, California; and Lancaster, Ohio. (In the first quarter of 1996, Hexcel announced its decision to close the Anaheim facility and relocate certain production activities from Anaheim to other manufacturing sites.) Subject to the Company's acquisition of an Austrian subsidiary of Ciba as contemplated by the Strategic Alliance Agreement, the Composite Materials business unit will also operate a manufacturing facility in Linz, Austria. This business unit is also responsible for Hexcel's participation in a joint venture with Fyfe Associates Corporation.\nThe following is a description of the major product groups manufactured and marketed by the Composite Materials business unit.\nPREPREGS AND ADHESIVES\nPrepregs combine high performance reinforcement fibers with a resin matrix to form a composite material with exceptional structural properties not present in either of the constituent materials. Hexcel impregnates woven fabrics and non-woven fibers aligned in a single direction (unidirectional tape).\nThe Composite Materials business unit produces prepreg materials from a variety of reinforcements including S-2-Registered Trademark- and E-type fiberglass, carbon, aramid, quartz, ceramic, Thorstrand-Registered Trademark-, polyethylene and other specialty reinforcements. Hexcel offers a variety of resin matrices including bismaleimide, cyanates, epoxy, phenolic, polyester, polyimide and other specialty resins.\nPrepregs are sold to the commercial aerospace, space and defense, recreation and general industrial markets. Product applications include aircraft, mass transit and automotive components, as well as defense systems, military support equipment, athletic shoes, fishing rods, tennis rackets, golf clubs, surfboards, snow skis, snow boards and bicycles.\nAs a result of the acquisition of the Ciba Composites Business, Hexcel designs and markets a comprehensive range of Redux-Registered Trademark- film adhesives. These adhesives, which bond a wide range of composite, metallic, and honeycomb surfaces, are used in aerospace, automotive, marine and other applications.\nHONEYCOMB\nHoneycomb is a unique, lightweight, cellular structure composed of generally hexagonal cells nested together. The product is similar in appearance to a cross-sectional slice of a beehive. The hexagonal cell design gives honeycomb a high strength-to-weight ratio when used in \"sandwich\" form and a uniform resistance to crushing. These basic characteristics are combined with the physical properties of the material from which the honeycomb is made to meet various engineering requirements.\nThe Composite Materials business unit produces honeycomb from a number of metallic and non-metallic materials. Most metallic honeycomb is made from aluminum and is available in a selection of alloys, cell sizes and dimensions. Non-metallic honeycomb materials include fiberglass, carbon, thermoplastics, Nomex-Registered Trademark- (a non-flammable aramid paper), Kevlar-Registered Trademark- (an aramid fiber) and several other specialty materials.\nThe Composite Materials business unit sells honeycomb core material in standard block and sheet form. In this construction, sheets of aluminum, stainless steel, prepreg or other laminates are bonded with adhesives to each side of a slice of honeycomb core, creating a \"sandwich\" structure. Hexcel possesses autoclave and other advanced processing capabilities which enable the Company to manufacture complex bonded assembly parts.\nThe largest market for Hexcel's honeycomb products is the aerospace market. Non-aerospace honeycomb applications include high-speed trains and mass transit vehicles, automotive parts, energy absorption products, athletic shoe components, marine vessel compartments, portable shelters, business machine cabinets and other general industrial uses.\nHexcel also owns a 40% interest in a joint venture with Fyfe Associates Corporation. Hexcel-Fyfe, which was formed in October 1992, sells and applies high-strength architectural wrap for seismic retrofitting and strengthening of bridges, columns and other structures.\nHexcel's net sales of prepregs, adhesives and honeycomb (including machined and fabricated honeycomb parts), sold separately and together as complex bonded structures, were $231.1 million in 1995, $219.0 million in 1994 and $217.6 million in 1993. As a result of the acquisition of the Ciba\nComposites Business on February 29, 1996, net sales of prepregs, adhesives and honeycomb are expected to increase in 1996. The Ciba Composites Business had net sales of prepregs, adhesives and honeycomb totaling approximately $195 million in 1995.\nSPECIAL PROCESS\nThe Special Process business unit has worldwide responsibility for designing, manufacturing and marketing machined and fabricated honeycomb parts for use in commercial and military aerospace, automotive, and other applications. The business unit operates manufacturing facilities in Pottsville, Pennsylvania and Burlington, Washington, as well as special process activities in Hexcel's Welkenraedt, Belgium; Duxford and Swindon, England; Casa Grande, Arizona; and Bellingham, Washington facilities. The Special Process business unit adds value to standard honeycomb by contouring and machining it into complex shapes to meet customer specifications. Net sales of machined and fabricated honeycomb parts for 1995, 1994 and 1993 are included in the above sales totals for prepregs, adhesives and honeycomb.\nSTRUCTURES AND INTERIORS\nHexcel has acquired the structures and interiors businesses of the Ciba Composites Business, which operate under the Heath Tecna name. The Structures and Interiors business unit has worldwide responsibility for manufacturing and marketing structures and interiors, and operates manufacturing facilities in Brindisi, Italy; Bellingham, Washington; and Kent, Washington.\nThe structures operations of this business unit produce a wide variety of lightweight, composite structures primarily for aerospace use. Structures include such items as wing-to-body and flap track fairings, radomes, engine cowls and inlet ducts, wing panels and other aircraft components. Structural products are manufactured from advanced composite materials using such manufacturing processes as resin transfer molding, autoclave processing, multi- axis numerically controlled machining, press laminating, heat forming and other composite manufacturing techniques. These products are utilized primarily by commercial and military aircraft manufacturers. However, the Company has recently begun to pursue several industrial applications for structural products.\nThe interiors operations of this business unit design and produce innovative, light weight, high-strength composite interior systems for aircraft. Interior products include overhead stowage compartments and related interior components such as lavatories, sidewalls and ceilings for commercial jet and turboprop aircraft. These products are sold to airlines for replacement of existing interiors. In addition, stowage bins are provided for new production of Boeing 737 and 757 aircraft.\nHexcel did not sell structures or interiors in 1995, 1994 or 1993. The Ciba Composites Business, which was acquired on February 29, 1996, had net sales of structures and interiors totaling approximately $113 million in 1995.\nPACIFIC RIM\nThe Pacific Rim business unit is responsible for business development in the Asia-Pacific region. The business unit sells all Hexcel products within this region through distributors and sales offices in Pleasanton, California; Sydney, Australia; Taipei, Taiwan; and Tokyo, Japan. The Pacific Rim business unit is also responsible for the DIC-Hexcel joint venture, which was formed in 1990 with Dainippon Ink & Chemicals, Inc. for the production and sale of Nomex honeycomb, prepregs and decorative laminates for the Japanese market. The DIC- Hexcel joint venture operates a manufacturing facility in Komatsu, Japan.\nSales to the Asia-Pacific region, which are included in the above sales totals for the Fabrics and Composite Materials business units, were less than 10% of Hexcel's total sales in 1995, 1994 and 1993.\nINTEGRATED MANUFACTURING CAPABILITIES\nThe Fabrics business unit weaves the majority of the carbon, aramid and fiberglass fabrics used in the manufacture of honeycomb and prepreg products by the Composite Materials business unit. This integrated manufacturing capability provides Hexcel with competitive advantages in developing woven reinforcements to optimize the performance of certain of its Composite Materials products, and a greater ability to control the cost, quality and delivery of its woven fabric requirements.\nThe Special Process business unit utilizes honeycomb products manufactured by the Composite Materials business unit in the production of machined and fabricated honeycomb parts. Prior to the acquisition of the Ciba Composites Business, Hexcel was a supplier of honeycomb and prepreg products to the Heath Tecna structures and interiors businesses. Following the acquisition, the Company expects to continue to leverage its ability to supply Composite Materials to these businesses where it has, or can economically develop, qualified products that can be used in the fabrication of finished structural or interior components.\nManagement believes that the integrated manufacturing capabilities of Hexcel, combined with the breadth of its product lines, strengthen the Company's competitive position in the markets it serves and enhance its ability to develop new product forms for new product applications.\nRESEARCH AND TECHNOLOGY; PATENTS AND KNOW-HOW\nHexcel's Research and Technology function (\"R&T\") supports all of the Company's business units worldwide. R&T maintains expertise in chemical formulation and curatives, fabric forming and textile architectures, advanced composites structures, process engineering, analysis and testing of composite materials, computational design and prediction, and other scientific disciplines related to the Company's worldwide business base. Additionally, R&T performs a limited amount of contract research and development in the U.S. and Europe for strategically important customers in the areas of ceramics, higher temperature polymers, advanced textiles and composite structures manufacturing.\nEach strategic business unit maintains research and engineering staffs and facilities to support its business operations. Worldwide investment in research and technology is directed and coordinated by a committee consisting of the R&T managers within each of Hexcel's strategic business units. This committee is responsible for ensuring that research and technology investments are targeted towards maximizing the Company's long-term profitability and strengthening its competitive position in the marketplace. Additionally, the committee oversees the Company's portfolio of patents, technology licenses and other intellectual property.\nHexcel spent $7.6 million for research and technology in 1995, $8.2 million in 1994 and $8.0 million in 1993. These expenditures were expensed as incurred. Following the acquisition of the Ciba Composites Business, the Company expects to spend more than twice the 1995 level in 1996 on new product development, process engineering and technical services for the strategic business units.\nHexcel's products rely primarily on the Company's expertise in materials science, engineering and polymer chemistry. Consistent with market demand, the Company has been placing more emphasis on cost effective product design and agile manufacturing in recent years. Towards this end, the Company has entered into formal and informal partnerships, as well as licensing and teaming arrangements, with several customers, suppliers, external agencies and laboratories. Management believes that the Company possesses unique capabilities to design, develop and manufacture composite materials and structures. The Company owns and maintains in excess of 100 patents worldwide, has licensed many key technologies, and has granted technology licenses and patent rights to several third parties in connection with joint ventures and joint development programs. It is the Company's policy to actively enforce its proprietary rights. Management believes that the patents and know-how rights currently owned or licensed by the Company are adequate for the conduct of its business.\nRAW MATERIALS AND PRODUCTION ACTIVITIES\nHexcel purchases most of the raw materials used in production. Several key materials are available from relatively few sources, and in many cases the cost of product qualification makes it impractical to develop multiple sources of supply. The unavailability of these materials, which the Company does not anticipate, could have a material adverse effect on operations. The Company coordinates closely with key suppliers in an effort to avoid raw material shortages.\nHexcel's production activities are generally based on a combination of \"make to order\" and \"make to forecast\" production requirements. The Company's Special Process and Structures and Interiors businesses are almost entirely \"make to order\" operations.\nMARKETS AND CUSTOMERS\nHexcel's materials are sold for a broad range of uses. The following tables summarize net sales by market and by international operations for continuing operations for the five years ended December 31.\n(a) Net sales of international subsidiaries and U.S. exports, in millions.\nThe Boeing Company and Boeing subcontractors accounted for approximately 21% of Hexcel's 1995 sales. The loss of all or a significant portion of this business, which Hexcel does not anticipate, could\nhave a material adverse effect on sales and earnings. Sales to various U.S. government programs, including some of the sales to The Boeing Company and Boeing subcontractors noted above, were approximately 10% of sales in 1995.\nThe Boeing Company and Boeing subcontractors accounted for approximately 18% of the 1995 sales of the Ciba Composites Business, which was acquired by Hexcel on February 29, 1996.\nCOMMERCIAL AEROSPACE\nCommercial aerospace activity fluctuates in relation to two principal factors. First, the number of revenue passenger miles flown by the airlines affects the size of the airline fleets and generally follows the level of overall economic activity. A recent document, published by The Boeing Company, projects that revenue passenger miles will increase an average of 5.5% per year through the year 2000, with the Asian market having the highest growth rate. The second factor, which is less sensitive to the general economy, is the replacement and retrofit rates for existing aircraft. These rates, resulting mainly from obsolescence, are determined in part by Federal Aviation Administration regulations as well as public concern regarding aircraft age, safety and noise. These rates may also be affected by the desire of the various airlines for higher payloads and more fuel efficient aircraft, which in turn is influenced by the price of fuel.\nCommercial aircraft build rates, based on the estimated number of aircraft delivered, declined by more than 30% from 1992 to 1994. Commercial aircraft production appears to be gradually recovering from this period of decline. In 1995, the build rates for certain commercial aircraft began to increase, and published industry data indicates that 1995 commercial aircraft orders were double the 1994 level. Industry analysis indicates that the demand for aircraft is expected to grow through the turn of the century. Hexcel's commercial aerospace business volume is expected to increase in 1996 in part due to this general industry improvement and in part due to expected build rate increases for specific commercial aircraft. In addition to build rate increases, demands for improved aircraft performance have led to increased use of certain honeycomb and prepreg materials in aircraft, particularly in newer models. Despite this preference for high performance products, the Company must continuously demonstrate the cost benefits of its products for aerospace applications.\nSPACE AND DEFENSE\nHexcel's sales to space and defense markets increased slightly to $37.3 million in 1995 from $34.9 million in 1994. Sales in 1993 were $55.3 million. The 1995 growth was based primarily on increased volume associated with a few contracts. The current international and domestic political climate indicates that overall military spending will continue to decline in the foreseeable future. As a result, the Company believes that its participation in space and defense markets will shrink or remain relatively flat over the next several years.\nContracts to supply materials for military and some commercial projects contain provisions for termination at the convenience of the U.S. government or the buyer. In the case of such a termination, Hexcel is entitled to recover reasonable incurred cost plus a provision for profit on the incurred cost. The Company is subject to U.S. government cost accounting standards, which are applicable to companies with more than $25 million of government contract or subcontract awards each year.\nRECREATION, GENERAL INDUSTRIAL AND OTHER MARKETS\nHexcel's sales to recreation, general industrial and other markets were $153.9 million in 1995, or approximately 44% of total sales. This compares with $131.4 million in 1994 and $123.9 million in 1993. The Company has focused its participation in recreation and general industrial markets in areas where the application of composites technology offers significant benefits to the end user. As a result, the Company has focused on select opportunities where high performance is the key product criterion. Accordingly, future opportunities and growth depend primarily upon the success of the individual programs and industries in which the Company has elected to participate. Key industry sectors and applications in which the Company is involved include printed circuit boards, ballistics protection, certain recreation products (primarily athletic shoes, golf clubs, fishing rods, snow skis and snow boards), wind energy and marine products, and automotive, truck and mass transit components. The Company's participation in these markets is also dependent on the Company's willingness to fund application development and the available capacity of manufacturing facilities.\nFurther discussion of Hexcel's markets and customers is included in \"Management Discussion and Analysis\" included in this Annual Report on Form 10- K.\nSALES AND MARKETING\nA staff of salaried market managers, product managers and salespeople market Hexcel products directly to customers worldwide. The Company also uses independent distributors and manufacturer representatives for certain products, markets and regions. The Company's sales and marketing capabilities have been enhanced by the acquisition of the Ciba Composites Business, which possesses an existing sales and distribution network with offices in 19 countries throughout the world.\nBACKLOG\nThe backlog of orders for aerospace materials to be filled within 12 months was $88.3 million as of December 31, 1995, $65.6 million as of December 31, 1994 and $61.6 million as of December 31, 1993. A major portion of the backlog is cancelable without penalty.\nOrders for aerospace materials generally lag behind the award of orders for new aircraft by a considerable period. Thus, the level of new aircraft procurement normally will not have an impact on aerospace orders received by Hexcel for about one to three years, depending on the nature of the product, the manufacturer, and delivery schedules.\nBacklog for non-aerospace materials amounted to $33.5 million at December 31, 1995, compared with $40.7 million at December 31, 1994 and $29.1 million at December 31, 1993. Most of the non-aerospace backlog is expected to be filled within six months. Markets for Hexcel products outside of the aerospace industry are generally highly competitive requiring shorter lead times for delivery or stock for immediate sale.\nCOMPETITION\nIn the production and sale of its materials, Hexcel competes with numerous U.S. and international companies on a worldwide basis. The broad markets for the Company's products are highly competitive, and the Company has focused on both specific markets and specialty products within markets to obtain market share. In addition to competing directly with companies offering similar products, Hexcel materials compete with substitute structural materials such as structural foam, wood, metal, and concrete. Depending upon the material and markets, relevant competitive factors include price, delivery, service, quality and product performance. The acquisition of the Ciba Composites Business enhances the Company's competitive position by broadening the Company's product portfolio and strengthening the Company's position in certain geographic regions.\nENVIRONMENTAL MATTERS\nEnvironmental control regulations have not had a significant adverse effect on overall operations. A discussion of environmental matters is included in \"Item 3. Legal Proceedings.\" and in Note 19 to the Consolidated Financial Statements included in this Annual Report on Form 10-K.\nEMPLOYEES\nAs of December 31, 1995, Hexcel employed 2,127 full-time employees in its continuing operations, compared with 2,189 and 2,221 as of December 31, 1994 and 1993, respectively. Approximately 13% of these employees have union affiliations. Management believes that labor relations in the Company have been generally satisfactory.\nAs a result of the acquisition of the Ciba Composites Business on February 29, 1996, Hexcel added approximately 2,150 employees to its workforce, some of whom have union affiliations.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nHexcel owns manufacturing and sales offices located throughout the United States and in other countries as noted below. The corporate offices and principal corporate support activities for the Company are located in leased facilities in Pleasanton, California and Stamford, Connecticut. The central research and technology laboratories are located in Dublin, California.\nThe following table lists the manufacturing facilities of Hexcel by geographic location, approximate square footage, and principal products, including the facilities acquired in connection with the acquisition of the Ciba Composites Business. In the first quarter of 1996, the Company announced its decision to close the acquired Anaheim facility. Following the closure of this facility, and the completion of certain other consolidation activities and capital projects required to combine the operations of the Company and the Ciba Composites Business, management believes that the Company will possess production capacity appropriate for the conduct of its business. The following table does not include the manufacturing facilities operated by the Company's joint ventures.\nMANUFACTURING FACILITIES\nApproximate Facility Location Square Footage Principal Products - ----------------- -------------- ------------------ United States:\nSeguin, Texas 189,000 Reinforcement Fabrics Anaheim, California 300,000 Prepregs; Honeycomb; Adhesives Casa Grande, Arizona 320,000 Honeycomb; Special Process Honeycomb Lancaster, Ohio 35,000 Prepregs Livermore, California 141,000 Prepregs Burlington, Washington 58,000 Special Process Honeycomb Pottsville, Pennsylvania 104,000 Special Process Honeycomb Bellingham, Washington 185,000 Interiors; Special Process Honeycomb Kent, Washington 910,000 Interiors; Structures\nInternational:\nLes Avenieres, France 462,000 Reinforcement Fabrics; Prepregs Lyon, France 230,000 Reinforcement Fabrics; Prepregs Linz, Austria 187,000 Prepregs Welkenraedt, Belgium 223,000 Prepregs; Honeycomb; Special Process Honeycomb Duxford, England 380,000 Prepregs; Honeycomb; Adhesives Swindon, England 20,000 Special Process Honeycomb Brindisi, Italy 110,000 Structures\nHexcel leases the Swindon, England plant and the land on which the Burlington, Washington facility is located. The Company also leases portions of the Casa Grande, Arizona; Bellingham, Washington; Kent, Washington; Les Avenieres, France; and Welkenraedt, Belgium facilities.\nThe facilities of the Ciba Composites Business acquired on February 29, 1996 were: Anaheim, California; Bellingham, Washington; Kent, Washington; Lyon, France; Duxford, England; and Brindisi, Italy. The acquisition of the Linz, Austria facility did not occur on February 29, 1996, but is expected to\nbe completed in connection with the Company's acquisition of an Austrian subsidiary of Ciba in accordance with the Strategic Alliance Agreement. A portion of the Linz, Austria facility is leased.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nOn January 10, 1995, the Bankruptcy Court for the Northern District of California, Oakland Division, confirmed the First Amended Plan of Reorganization proposed by Hexcel and the Official Committee of Equity Security Holders dated as of November 7, 1994. The effective date of the Reorganization Plan was February 9, 1995. Further discussion of the Reorganization Plan and Hexcel's emergence from bankruptcy reorganization proceedings is included in \"Management Discussion and Analysis\" and in the Notes to the Consolidated Financial Statements included in this Annual Report on Form 10-K.\nIn December 1988, Lockheed employees working with epoxy resins and composites on classified programs filed suit against Lockheed and its suppliers (including Hexcel) claiming various injuries as a result of exposure to these products. Plaintiffs have filed for punitive damages which may be uninsured. The first trial of the cases of 15 pilot plaintiffs resulted in a mistrial and a retrial resulted in the entry of judgment in favor of the plaintiffs. The Company did not participate in the trial due to the automatic stay resulting from the Chapter 11 filing. Some of these claims were discharged as a result of the plaintiffs' failure to file claims in Hexcel's Chapter 11 case. As to the claims which have not been discharged, the Company has objected to them and intends to proceed with those objections within the Bankruptcy Court.\nHexcel \/ MCI, a business unit divested in 1991, performed brazing services in the manufacture of flexures under subcontract from Ormond which supplied the flexures to Thiokol. The flexures are used to support a rocket motor housing in a test stand during actual firing of the rocket. Several flexures cracked under the dead weight of a rocket motor prior to actual test firing, and Thiokol has sued Ormond and the Company for the costs of replacing all of the flexures purchased ($0.9 million) (Thiokol Corporation v. Ormond, Hexcel, et al.). The automatic stay in bankruptcy was lifted in April 1995 and the case was resumed in the state court in Utah. Discovery is ongoing. There is no insurance coverage available for an adverse court ruling or negotiated settlement.\nHexcel has been named as a potentially responsible party (\"PRP\") with respect to several hazardous waste disposal sites that it does not own or possess which are included on the Environmental Protection Agency's Superfund National Priority List and\/or various state equivalent lists. With respect to its exposure relating to these sites, the Company believes its responsibility to be de minimis. A total of 249 claims were filed in the Chapter 11 case with a face value of over $6.7 billion. These claims were, for the most part, duplicative as a result of the joint and several liability provisions of applicable laws and have been categorized into claims involving 19 sites. Claims involving 8 of the sites have been settled within the Chapter 11 case. The Company has been named a PRP with respect to 6 sites for which no claims were filed in the Chapter 11 case; as a result, the Company believes any further claims to be barred. The balance of the sites and their related claims have been passed through the bankruptcy. The Company's estimation of its exposure at these sites is de minimis.\nAlso, pursuant to the New Jersey Environmental Responsibility and Clean-Up Act, Hexcel signed an administrative consent order to pay for clean-up of a manufacturing facility it formerly operated in Lodi, New Jersey. Hexcel has reserved approximately $2.8 million to cover such remaining costs and believes that actual costs should not exceed the amount which has been reserved. Fine Organics Corporation, the current owner of the Lodi site and of Hexcel's former chemicals business operated on that site, has asserted\nthat the clean-up costs will be significantly in excess of that amount. The ultimate cost of remediation at the Lodi site will depend on developing circumstances.\nFine Organics Corporation filed a proof of claim and an adversary proceeding in the Bankruptcy Court. The court has disallowed a significant portion of the claim by denying Fine Organics claim for treble damages and certain contingent claims. The remaining claims are for prior clean-up costs incurred by Fine Organics and alleged contractual and tort damages relating to the original sale of the business and site to Fine Organics totaling approximately $3.2 million. This matter is proceeding in the Bankruptcy Court.\nHexcel, as a defense subcontractor, is subject to U.S. government audits and reviews of negotiations, performance, cost classifications, accounting and general practices relating to government contracts. The Defense Contract Audit Agency (\"DCAA\") reviews cost accounting and business practices of government contractors and subcontractors including the Company. The Company has been engaged in discussions on a number of cost accounting issues which could result in claims by the government. Some of these issues have already been resolved.\nAs part of these reviews, the DCAA has alleged that Hexcel improperly included certain land lease costs in its indirect rates at the Chandler, Arizona facility (the \"Chandler Land Lease\") and that, as a result, the Company's subcontracts had been overpriced in an amount of approximately $1.0 million. The Company has formally responded to the DCAA that it strongly disagrees with these allegations. In February 1996, the Company received a letter from the United States Attorney's Office, stating that it was considering filing an action against the Company for violation of the civil False Claims Act (\"FCA\") based upon the inclusion in the indirect rates of the Chandler Land Lease costs. While the Company does not agree that there was any violation of the FCA, if the U.S. government elects to pursue such an action and were it to prevail, it would be entitled to three times the actual damages claimed plus penalties of between $5,000 and $10,000 for each false claim; the number of alleged false claims could be significant.\nIn 1993, Hexcel became aware of an aluminum honeycomb sandwich panel delamination problem with panels produced by its wholly-owned Belgium subsidiary, Hexcel S.A., and installed in rail cars in France and Spain. Certain customers have alleged that Hexcel S.A. is responsible for the problem. The Company and its insurer continue to investigate these claims. The Company is also working with the customers to repair or replace panels when necessary, with certain costs to be allocated upon determination of responsibility for the delamination. While no lawsuit has been filed, two customers in France requested that a court appoint experts to investigate the claims; to date, the experts have not reported any conclusions. The Company's primary insurer for this matter has agreed to fund legal representation and to provide coverage of the claim to the extent of the policy limit for one year. The Company is investigating additional insurance coverage. Even if additional insurance coverage is not available, management believes that, based on available information, it is unlikely that these claims will have a material adverse effect on the consolidated financial position or results of operations of the Company.\nIn November, 1995, Hexcel was notified that Livermore Development Corporation (\"LDC\") was asserting a claim for damages arising from Hexcel's recent notification of its intent to exercise its option to purchase certain land in Livermore, California. LDC contends that the lease was a disguised partnership or joint venture agreement between Hexcel and LDC to develop the property for residential use. Hexcel disputes any such agreement and seeks to enforce its option to purchase under a written agreement. The parties are in ongoing negotiations to resolve this claim.\nIn September, 1995, Ciba was named as a potentially responsible party with respect to the removal of drums from a disposal site that it did not own or possess, known as the Omega Chemical Corporation (\"Omega Site\"). The Omega Site is a spent solvent recycling and treatment facility in Whittier, California. Ciba has previously notified the EPA that it intends to comply with the EPA's removal requirements and has paid its interim share of such removal costs to date. This responsibility was assumed by the Company as a result of its acquisition of the Ciba Composites Business, to the extent the Ciba waste delivered to the Omega site was from the operations of the Ciba Composites Business. This matter is under evaluation but is presently believed to be de minimis.\nIn addition to the foregoing, Hexcel is from time to time involved in other legal proceedings incidental to the conduct of its business. In addition, as a result of the acquisition of the Ciba Composites Business, the Company assumed certain liabilities, including certain legal proceedings incidental to the conduct of the Ciba Composites Business.\nManagement believes, based on available information, that it is unlikely these items, individually or in the aggregate, will have a material adverse effect on the consolidated 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.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nHexcel Common stock is traded on the New York and Pacific Stock Exchanges. The range of high and low sales prices of Hexcel common stock on the New York Stock Exchange Composite Tape is contained in Note 24 to the Consolidated Financial Statements included in this Annual Report on Form 10-K and is incorporated herein by reference.\nHexcel did not declare or pay any dividends in 1995, 1994 or 1993, and the payment of dividends is generally prohibited under the terms of certain of the Company's credit agreements. On March 15, 1996, there were 2,253 holders of record of Hexcel common stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe information required by Item 6 is contained on page 32 of this Annual Report on Form 10-K under \"Selected Financial Data\" and is incorporated herein by reference.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nThe information required by Item 7 is contained on pages 33 to 40 of this Annual Report on Form 10-K under \"Management Discussion and Analysis\" and is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe information required by Item 8 is contained on pages 44 to 81 of this Form 10-K under \"Consolidated Financial Statements and Supplementary Data\" and is incorporated herein by reference. The report of independent public accountants for the years ended December 31, 1995, 1994 and 1993 is contained on page 43 of this Annual Report on Form 10-K under \"Independent Auditors' 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.\n(a) Listed below are the directors of Hexcel as of March 21, 1996, the positions with the Company held by them and a brief description of each director's prior business experience.\nDIRECTOR POSITIONS WITH HEXCEL AND NAME AGE SINCE BUSINESS EXPERIENCE - ---- --- ---- -------------------- John J. Lee 59 1993 Chairman of the Board of Directors since February 1996; Chief Executive Officer since January 1994; Chairman and Chief Executive Officer from January 1994 to February 1995; Chairman and Co-Chief Executive Officer from July to December 1993; Director since May 1993. Mr. Lee is chairman of the Nominating Committee and a member of the Finance Committee of the Board of Directors. Mr. Lee has served as a director of XTRA Corporation, a transportation equipment leasing company, since 1990, and Chairman of the Board, President and Chief Executive Officer of Lee Development Corporation, a merchant banking company, since 1987. Mr. Lee has been a Trustee of Yale University and an advisor to The Clipper Group, a private investment partnership, since 1993. From July 1989 through April 1993, Mr. Lee served as Chairman of the Board and Chief Executive Officer of Seminole Corporation, a manufacturer and distributor of fertilizer. From April 1988 through April 1993, Mr. Lee served as a director of Tosco Corporation, a national refiner and marketer of petroleum products, and as President and Chief Operating Officer of Tosco from 1990 through April 1993. Mr. Lee is also a director of Aviva Petroleum Corporation and various privately-held corporations.\nDIRECTOR POSITIONS WITH HEXCEL AND NAME AGE SINCE BUSINESS EXPERIENCE - ---- --- ---- --------------------\nJuergen Habermeier 54 1996 President, Chief Operating Officer, and a member of the Board of Directors since February 1996. Dr. Habermeier is a member of the Technology Committee of the Board of Directors. Dr. Habermeier has served as the President of the Ciba Composites Business and as a Vice President of Ciba-Geigy Corporation since 1989. Since 1994, Dr. Habermeier has served on the Board of Directors of RHR International. He is a member of the Advisory Committee of the Polymer Composites Laboratory of the University of Washington.\nJohn M. D. Cheesmond 46 1996 Director (Chairman of the Executive Compensation Committee and a member of the Finance Committee). Mr. Cheesmond has served as Senior Vice President and Head of Regional Finance and Control of Ciba-Geigy Limited since 1994. From 1991 through 1993, Mr. Cheesmond served as Vice President - Planning, Information and Control at Ciba Vision Corporation.\nMarshall S. Geller 57 1994 Director (Chairman of the Audit Committee and a member of the Executive Compensation and Nominating Committees); Co-Chairman of the Board of Directors from February 1995 to February 1996. Mr. Geller has been Chairman, Chief Executive Officer and founding partner at Geller & Friend Capital Partners, Inc., a merchant banking firm, since November 1995. From 1990 to November 1995, Mr. Geller was Senior Managing Partner of Golenberg & Geller, Inc., a merchant banking firm. From 1988 to 1990, he was Vice Chairman of Gruntal & Company, an investment banking firm. From 1967 until 1988, he was a Senior Managing Director of Bear, Stearns & Co, Inc., an investment banking firm. Mr. Geller is currently a director of Ballantyne of Omaha, Inc., Dycam, Inc., Players International, Value Vision International, Inc., Styles on Video, Inc., and various privately-held corporations and charitable organizations.\nDIRECTOR POSITIONS WITH HEXCEL AND NAME AGE SINCE BUSINESS EXPERIENCE - ---- --- ---- -------------------- Peter A. Langerman 40 1995 Director (Chairman of the Finance Committee and a member of the Audit and Executive Compensation Committees); Co- Chairman of the Board of Directors from February 1995 to February 1996. Mr. Langerman is a director and the Executive Vice President of Mutual Series Fund Inc., a diversified open-end management investment company registered under the Investment Company Act of 1940 and a research analyst with Heine Securities Corporation, an investment advisor. Mr. Langerman has been the Executive Vice President of Mutual Series since 1988 and has been a research analyst at Heine Securities since 1986. Mr. Langerman is currently a director of Sunbeam Company, Inc. and various privately-held corporations.\nStanley Sherman 57 1996 Director (Member of the Finance and Executive Compensation Committees). Mr. Sherman has served as a director and Vice President - Finance and Information Services of Ciba-Geigy Corporation since 1991. From 1986 through 1991, Mr. Sherman served as Vice President - Corporate Planning of Ciba-Geigy Corporation. Mr. Sherman is currently a member of the Finance Committee of Ciba- Geigy Corporation.\nGeorge S. Springer 62 1993 Director (Chairman of the Technology Committee). Dr. Springer is Professor and Chairman of the Department of Aeronautics and Astronautics and, by courtesy, Professor of Mechanical Engineering and Professor of Civil Engineering, at Stanford University. Dr. Springer joined Stanford University's faculty in 1983.\nFrederick W. Stanske 37 1995 Director from August 1994 to February 1995, reappointed as a director in April 1995 (Member of the Audit Committee). Mr. Stanske is Vice President of Fisher Investments, Inc., an investment advisory firm.\nDIRECTOR POSITIONS WITH HEXCEL AND NAME AGE SINCE BUSINESS EXPERIENCE - ---- --- ---- -------------------- Joseph T. Sullivan 55 1996 Director (Member of the Nominating Committee). Dr. Sullivan has served as a director and Senior Vice President of Ciba-Geigy Corporation since 1986. Dr. Sullivan is currently a member of the Corporate Governance and Finance Committees of Ciba-Geigy Corporation.\nHermann Vodicka 53 1996 Director (Member of the Nominating and Technology Committees). Mr. Vodicka has served as President of the Polymers Division and a member of the Executive Committee of Ciba-Geigy Limited since 1993. Effective April 25, 1996, Mr. Vodicka will become Chairman of the Executive Committee of Ciba-Geigy Limited. Mr. Vodicka is currently the Chairman of the Board of METTLER-TOLEDO, a leading worldwide manufacturer of scales and balances and a wholly owned subsidiary of Ciba-Geigy Limited. From 1988 through 1993, Mr. Vodicka was President and Chief Executive Officer of METTLER-TOLEDO.\n(b) Listed below are the executive officers of Hexcel as of March 21, 1996, the positions held by them and a brief description of their business experience.\nDIRECTOR POSITIONS WITH HEXCEL AND NAME AGE SINCE BUSINESS EXPERIENCE - ---- --- ---- -------------------- John J. Lee 59 1993 See Item 10(a) above for a brief description of Mr. Lee's positions with Hexcel and his business experience.\nJuergen Habermeier 54 1996 See Item 10(a) above for a brief description of Dr. Habermeier's positions with Hexcel and his business experience.\nStephen C. Forsyth 40 1994 Senior Vice President of Finance and Administration since February 1996; Vice President of International Operations from October 1994 to February 1996; General Manager of Resins Business and Export Marketing from 1989 to 1994; other general management positions from 1980 to 1989. Mr. Forsyth joined Hexcel in 1980.\nRodney P. Jenks, Jr. 45 1994 Vice President, General Counsel and Secretary since March 1994. Prior to joining Hexcel in 1994, Mr. Jenks was a partner in the law firm of Wendel, Rosen, Black & Dean, where he continues to serve as counsel.\nDavid M. Wong 51 1996 Vice President of Corporate Affairs since February 1996; Director of Special Projects from July 1993 to February 1996; Corporate Controller and Chief Accounting Officer from 1983 to 1993; other general management positions from 1979 to 1993. Mr. Wong joined Hexcel in 1979.\nWilliam P. Meehan 60 1993 Vice President of Finance and Chief Financial Officer since September 1993, and Treasurer since April 1994. Prior to joining Hexcel in 1993, Mr. Meehan served as President and Chief Executive Officer of Thousand Trails and NACO, a membership campground and resort business, from 1990 through 1992. From 1986 through 1989, Mr. Meehan served as Vice President of Finance and Chief Financial Officer of Hadco Corporation.\nDIRECTOR POSITIONS WITH HEXCEL AND NAME AGE SINCE BUSINESS EXPERIENCE - ---- --- ---- -------------------- Wayne C. Pensky 40 1993 Corporate Controller and Chief Accounting Officer since July 1993. Prior to joining Hexcel in 1993, Mr. Pensky was a partner at Arthur Andersen & Co., where he was employed from 1979.\nMichael Carpenter 39 1996 Vice President of Structures and Interiors Business Unit, responsible for the structures business, since February 1996. Mr. Carpenter served as the Vice President of Structures in the Heath Tecna division of the Ciba Composites Business prior the acquisition. Mr. Carpenter has held various technical and managerial positions with Heath Tecna since 1983.\nWilliam Hunt 53 1996 President of the European Operations of the Composite Materials Business Unit since February 1996. Mr. Hunt served as the President of the EuroMaterials unit of the Ciba Composites Business from 1991 to February 1996, and as the Managing Director of Ciba-Geigy Plastics from 1990 to 1991. Prior to joining Ciba in 1990, Mr. Hunt held various other technical and managerial positions, including the position of Managing Director of Illford Limited (Photographic) Co.\nClaude Genin 60 1996 President of the Fabrics Business Unit since February 1996; Managing Director of Hexcel Lyon from 1977 to 1996. Hexcel Lyon was acquired by Hexcel in 1985.\nJames A. Koshak 52 1996 President of the U.S. Operations of the Composite Materials Business Unit since February 1996. Mr. Koshak served as Vice President of the Ciba Composites Business and General Manager of the U.S. Materials unit from 1993 to February 1996, and as Vice President of the Polymers Division and General Manager of Formulated Systems from 1988 to 1993. Mr. Koshak held various other technical and managerial positions with Ciba from 1974 to 1988.\nDIRECTOR POSITIONS WITH HEXCEL AND NAME AGE SINCE BUSINESS EXPERIENCE - ---- --- ---- -------------------- Thomas J. Lahey 55 1991 President of the Pacific Rim Business Unit since February 1996; Vice President of Worldwide Sales from April 1993 to February 1996; Vice President of Advanced Composites from 1992 to 1993; General Manager of Advanced Composites from 1991 to 1992; General Manager of Advanced Products from 1989 to 1991. Prior to joining Hexcel in 1989, Mr. Lahey held the position of Executive Assistant to the President of Kaman Aerospace Corporation in 1987 and 1988, and was a Vice President of Grumman Corporation from 1985 to 1987.\nRobert A. Petrisko 41 1993 Vice President of Research and Technology since September 1993; Manager of the Signature Technology Group at the Chandler facility and Director of Aerospace Technology from 1989 to 1993. Dr. Petrisko joined Hexcel in 1989, after serving as a Research Specialist with Dow Corning Corporation from 1985 to 1989.\nGary L. Sandercock 54 1989 President of the Special Process Business Unit since February 1996; Vice President of Manufacturing from April 1993 to February 1996; Vice President of Reinforcement Fabrics from 1989 to 1993; General Manager of the Trevarno Division from 1985 to 1989; other manufacturing and general management positions from 1967 to 1985. Mr. Sandercock joined Hexcel in 1967.\nDavid Tanonis 39 1996 Vice President of the Structures and Interiors Business Unit, responsible for the interiors business, since February 1996. Mr. Tanonis served as the Vice President of Interiors in the Heath Tecna division of the Ciba Composites Business prior to the acquisition. Mr. Tanonis has held various technical and managerial positions with Heath Tecna since he joined the division in 1987. Mr. Tanonis held various management positions with Polymer Engineering, Inc. from 1978 to 1987.\n(c) There are no family relationships among any of Hexcel's directors or executive officers.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe information required in Item 11 will be contained in Hexcel's definitive Proxy Statement for the 1996 Annual Meeting of Stockholders. Such information is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required in Item 12 will be contained in Hexcel's definitive Proxy Statement for the 1996 Annual Meeting of Stockholders. Such information is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe information required in Item 13 will be contained in Hexcel's definitive Proxy Statement for the 1996 Annual Meeting of Stockholders. 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.\na. FINANCIAL STATEMENTS\nThe consolidated financial statements of the Company, notes thereto, and independent auditors' report are listed on page 41 of this Annual Report on Form 10-K and are incorporated herein by reference.\nb. REPORTS ON FORM 8-K\nCurrent Report on Form 8-K dated as of October 13, 1995, relating to the proposed acquisition of the Ciba Composites Business.\nCurrent Report on Form 8-K dated as of March 15, 1996, relating to the consummation of the acquisition of the Ciba Composites Business.\nCurrent Report on Form 8-K\/A dated as of April 1, 1996, relating to the consummation of the acquisition of the Ciba Composites Business.\nc. EXHIBITS\nEXHIBIT NO. DESCRIPTION - ----------- -----------\n2.1 Strategic Alliance Agreement dated as of September 29, 1995 among the Company, Ciba and CGC (filed as Exhibit 10.1 to the Company's Current Report on Form 8-K dated as of October 13, 1995 and incorporated herein by reference).\n2.1(a) Amendment dated as of December 12, 1995 to the Strategic Alliance Agreement among the Company, Ciba and CGC (filed as Exhibit 2.1(a) to the Company's Current Report on Form 8-K dated as of March 15, 1996 and incorporated herein by reference).\n2.1(b) Letter Agreement dated as of February 28, 1996 among the Company, Ciba and CGC (filed as Exhibit 2.1(b) to the Company's Current Report on Form 8-K dated as of March 15, 1996 and incorporated herein by reference).\n2.1(c) Distribution Agreement dated as of February 29, 1996 among the Company, Brochier S.A., Composite Materials Limited, Salver S.r.l. and Ciba (filed as Exhibit 2.1(c) to the Company's Current Report on Form 8-K dated March 15, 1996 and incorporated herein by reference).\n2.2 First Amended Plan of Reorganization Proposed by the Debtor and the Official Committee of Equity Security Holders, dated as of November 7, 1994 (filed as Exhibit 2 to the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended October 2, 1994 and incorporated herein by reference).\n2.2(a) Order Confirming First Amended Plan of Reorganization Proposed by the Debtor and the Official Committee of Equity Security Holders, entered on January 12, 1995 by the\nEXHIBIT NO. DESCRIPTION - ----------- -----------\nUnited States Bankruptcy Court for the Northern District of California (filed as Exhibit 2.1 to the Company's Current Report on Form 8-K dated as of January 23, 1995 and incorporated herein by reference).\n2.2(b) Subscription Rights Plan (filed as Exhibit 4.1 to the Company's Current Report on Form 8-K dated as of February 9, 1995 and incorporated herein by reference).\n3.1 Certificate of Incorporation of the Company dated as of February 9, 1995 (filed as Exhibit 3.1 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 and incorporated herein by reference).\n3.1(a) Amendment dated as of February 21, 1996 to the Certificate of Incorporation of the Company (filed as Exhibit 3.1(a) to the Company's Registration Statement on Form S-8, Registration No. 333-1225, and incorporated herein by reference).\n3.2 Bylaws of the Company dated as of February 9, 1995 (filed as Exhibit 3.2 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 and incorporated herein by reference).\n3.2(a) Amendment dated as of February 29, 1996 to the Bylaws of the Company.\n4.1 Certificate of Incorporation of the Company dated as of February 9, 1995 (see Exhibit 3.1 above).\n4.1(a) Amendment dated as of February 29, 1996 to the Certificate of Incorporation of the Company (see Exhibit 3.1(a) above).\n4.2 Bylaws of the Company dated as of February 9, 1995 (see Exhibit 3.2 above).\n4.2(a) Amendment dated as of February 29, 1996 to the Bylaws of the Company (see Exhibit 3.2(a) above).\n4.3 Indenture dated as of October 1, 1988 between the Company and the Bank of California, N.A., as trustee (filed as Exhibit 4.10 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993 and incorporated herein by reference).\n4.4 Indenture dated as of February 29, 1996 between the Company and First Trust of California, National Association, as trustee (filed as Exhibit 4.1 to the Company's Current Report on Form 8-K dated as of March 15, 1996 and incorporated herein by reference).\n10.1 Credit Agreement dated as of February 8, 1995 among the Company, Citicorp USA, Inc., Heller Financial, Inc., Transamerica Business Credit Corporation and Citibank N.A. (filed as Exhibit 99.1 to the Company's Current Report on Form 8-K dated as of February 22, 1995 and incorporated herein by reference).\nEXHIBIT NO. DESCRIPTION - ----------- -----------\n10.2 Credit Agreement dated as of February 29, 1996 among the Company and certain subsidiaries of the Company, as borrowers, the lenders and issuing banks party thereto, Citibank, N.A., as U.S. administrative agent, Citibank International plc, as European administrative agent and Credit Suisse, as syndication agent (filed as Exhibit 99.1 to the Company's Current Report on Form 8- K dated as of March 15, 1996 and incorporated herein by reference).\n10.3 Restated and Amended Reimbursement Agreement dated as of February 1, 1995 between the Company and Banque Nationale de Paris (filed as Exhibit 99.2 to the Company's Current Report on Form 8-K dated as of February 22, 1995 and incorporated herein by reference).\n10.3(a) Second Restated and Amended Reimbursement Agreement dated as of February 29, 1996 between the Company and Banque Nationale de Paris.\n10.4 Asset Purchase Agreement dated as of November 3, 1994 between the Company and Northrop Grumman Corporation (filed as Exhibit 10 to the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended October 2, 1994 and incorporated herein by reference).\n10.5 Hexcel Corporation Incentive Stock Plan (filed as Exhibit 4.3 to the Company's Registration Statement on Form S-8, Registration No. 333-1225, and incorporated herein by reference).\n10.6 Long-Term Incentive Plan (filed as Exhibit 99.2 to the Company's Current Report on Form 8-K dated as of January 23, 1995 and incorporated herein by reference).\n10.7 1988 Management Stock Program (filed as Exhibit 28.1 to Post- Effective Amendment No. 1 to Form S-8, Registration No. 33-17025, and incorporated herein by reference).\n10.7(a) Amendments to 1988 Management Stock Program (filed as Exhibit 28.2 to the Company's Registration Statement on Form S-8, Registration No. 33-28445, and incorporated herein by reference).\n10.8 Form of 1988 Restricted Stock Agreement (filed as Exhibit 28.14 to Post-Effective Amendment No. 1 to the Company's Registration Statement on Form S-8, Registration No. 33-17025, and incorporated herein by reference).\n10.9 Form of 1988 Discounted Stock Option Agreement (filed as Exhibit 28.16 to Post-Effective Amendment No. 1 to the Company's Registration Statement on Form S-8, Registration No. 33-17025, and incorporated herein by reference).\n10.10 Form of 1988 Officers' Non-Qualified Stock Option Agreement (filed as Exhibit 28.9 to Post-Effective Amendment No. 1 to the Company's Registration Statement on Form S-8, Registration No. 33-17025, and incorporated herein by reference).\nEXHIBIT NO. DESCRIPTION - ----------- -----------\n10.11 Form of Executive Deferred Compensation Agreement (filed as Exhibit 10.10.B to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993 and incorporated herein by reference).\n10.12 Directors' Retirement Plan (filed as Exhibit 11.14 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1992 and incorporated herein by reference).\n10.13 Form of Option Agreement (Directors).\n10.14 Employment Agreement dated as of February 29, 1996 between the Company and John J. Lee.\n10.14(a) Employee Option Agreement dated as of February 29, 1996 between the Company and John J. Lee.\n10.14(b) Bankruptcy Court Option Agreement dated as of February 29, 1996 between the Company and John J. Lee.\n10.14(c) Performance Accelerated Restricted Stock Unit Agreement dated as of February 29, 1996 between the Company and John J. Lee.\n10.14(d) Short-Term Option Agreement dated as of February 29, 1996 between the Company and John J. Lee.\n10.14(e) Form of Reload Option Agreement between the Company and John J. Lee.\n10.15 Interim Employment Agreement and Consulting Agreement between the Company and John J. Lee (filed as Exhibit 10.4.E to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 and incorporated herein by reference).\n10.16 Interim Employment Agreement between the Company and William P. Meehan (filed as Exhibit 10.4.G to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 and incorporated herein by reference).\nEXHIBIT NO. DESCRIPTION - ----------- -----------\n10.17 Agreement between the Company and Gary L. Sandercock (filed as Exhibit 10.4.I to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 and incorporated herein by reference).\n10.18 Agreement between the Company and Thomas J. Lahey (filed as Exhibit 10.4.J to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 and incorporated herein by reference).\n10.19 Memorandum Agreement dated as of January 31, 1996 between the Company and Rodney P. Jenks, Jr.\n10.20 Letter Agreement dated as of February 1, 1995 between the Company and UniRock Management Corporation (filed as Exhibit 10.5 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 and incorporated herein by reference).\n10.20(a) Letter Agreement dated as of October 27, 1995 between the Company and UniRock Management Corporation.\n10.21 Governance Agreement dated as of February 29, 1996 between the Company and Ciba.\n10.22 Registration Rights Agreement dated as of February 29, 1996 between the Company and Ciba.\n10.23 Agreement Governing United States Employment Matters dated as of September 29, 1995 between the Company and CGC (filed as Exhibit D to Exhibit 10.1 to the Company's Current Report on Form 8-K dated as of October 13, 1995 and incorporated herein by reference).\n10.23(a) Amendment dated as of November 22, 1995 to the Agreement Governing United States Employment Matters between the Company and CGC.\n10.24 Employment Matters Agreement dated as of February 29, 1996 among Ciba-Geigy plc, Composite Materials Limited and the Company.\n11 Statement Regarding Computation of Per Share Earnings.\n21 Subsidiaries of Registrant.\n23 Independent Auditors' Consent -- Deloitte & Touche LLP\n27 Financial Data Schedule (electronic filing 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, IN THE CITY OF PLEASANTON, STATE OF CALIFORNIA.\nHEXCEL CORPORATION\nMARCH 21, 1996 By: \/s\/ JOHN J. LEE -------------------------------------- John J. Lee, Chief Executive Officer\nPURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.\nSIGNATURE TITLE DATE --------- ----- ----\n\/s\/ JOHN J. LEE Chairman of the March 21, 1996 - ----------------------- Board of Directors and (John J. Lee) Chief Executive Officer (PRINCIPAL EXECUTIVE OFFICER)\n\/s\/ WILLIAM P. MEEHAN Vice President and Chief March 21, 1996 - ----------------------- Financial Officer (William P. Meehan) (PRINCIPAL FINANCIAL OFFICER)\n\/s\/ WAYNE C. PENSKY Corporate Controller March 21, 1996 - ----------------------- (PRINCIPAL ACCOUNTING OFFICER) (Wayne C. Pensky)\n\/s\/ JOHN M. D. CHEESMOND Director March 21, 1996 - ------------------------ (John M. D. Cheesmond)\n\/s\/ MARSHALL S. GELLER Director March 21, 1996 - ----------------------- (Marshall S. Geller)\n\/s\/ JUERGEN HABERMEIER Director, President and March 21, 1996 - ----------------------- Chief Operating Officer (Juergen Habermeier)\n\/s\/ PETER A. LANGERMAN Director March 21, 1996 - ----------------------- (Peter A. Langerman)\nSIGNATURE TITLE DATE --------- ----- ----\n\/s\/ STANLEY SHERMAN Director March 21, 1996 - ----------------------- (Stanley Sherman)\n\/s\/ GEORGE S. SPRINGER Director March 21, 1996 - ----------------------- (George S. Springer)\n\/s\/ FREDERICK W. STANSKE Director March 21, 1996 - ------------------------ (Frederick W. Stanske)\n\/s\/ JOSEPH T. SULLIVAN Director March 21, 1996 - ----------------------- (Joseph T. Sullivan)\nDirector March 21, 1996 - ----------------------- (Hermann Vodicka)\nSELECTED FINANCIAL DATA\nThe following table summarizes selected financial data for continuing operations as of, and for, the five years ended December 31.\n(a) Primary and fully diluted net income (loss) per share for all five years were the same because the fully diluted computation was antidilutive.\nMANAGEMENT DISCUSSION AND ANALYSIS\nACQUISITION OF THE CIBA COMPOSITES BUSINESS\nHexcel acquired the Ciba Composites Business of Ciba-Geigy Limited and Ciba-Geigy Corporation on February 29, 1996. The Ciba Composites Business is engaged in the manufacture and marketing of composite materials, parts and structures for aerospace, recreation and general industrial markets. Product lines include fabrics, prepregs, adhesives, honeycomb core, sandwich panels and fabricated components, as well as structures and interiors primarily for the commercial and military aerospace markets.\nThe acquisition of the Ciba Composites Business was consummated pursuant to the Strategic Alliance Agreement. Under the Strategic Alliance Agreement, Hexcel acquired the assets (including the capital stock of certain of Ciba's non-U.S. subsidiaries) and assumed the liabilities of the Ciba Composites Business other than certain excluded assets and liabilities in exchange for: (a) approximately 18.0 million newly issued shares of Hexcel common stock; (b) $25.0 million in cash; and (c) undertakings to deliver to Ciba and\/or one or more of its subsidiaries, following completion of certain post-closing adjustment procedures contemplated by the Strategic Alliance Agreement, the Senior Subordinated Notes and the Senior Demand Notes. Pursuant to the Strategic Alliance Agreement, certain assets of the Ciba Composites Business and certain assets of Ciba affiliates that will continue to act as distributors for the Ciba Composites Business will be acquired by the Company from time to time prior to February 28, 1997.\nIn connection with the acquisition of the Ciba Composites Business, the Company obtained the Senior Secured Credit Facility to: (a) fund the cash component of the purchase price; (b) refinance outstanding indebtedness under certain U.S. and European credit facilities; and (c) provide for the ongoing working capital and other financing requirements of the Company, including consolidation activities, on a worldwide basis.\nFurther discussion of the acquisition of the Ciba Composites Business and the Senior Secured Credit Facility is included in \"Financial Condition and Liquidity\" below, as well as in \"Item 1. Business.\" and in the Notes to the Consolidated Financial Statements included in this Annual Report on Form 10-K.\nHexcel acquired the Ciba Composites Business on February 29, 1996. Accordingly, the Company's results of operations for 1995, 1994 and 1993 do not include the results of the Ciba Composites Business, and unless the context otherwise indicates, the following discussion and analysis relates solely to the operations of the Company prior to the acquisition of the Ciba Composites Business.\nBANKRUPTCY REORGANIZATION\nOn January 12, 1995, the Bankruptcy Court entered an order dated January 10, 1995 confirming the Reorganization Plan proposed by Hexcel and the Equity Committee. On February 9, 1995, the Reorganization Plan became effective and Hexcel emerged from the bankruptcy reorganization proceedings which had begun on December 6, 1993, when Hexcel filed a voluntary petition for relief under the provisions of Chapter 11 of the federal bankruptcy laws.\nThe Reorganization Plan which became effective on February 9, 1995 provided for: (a) the replacement of a debtor-in-possession credit facility with a new revolving credit facility (the \"Revolving Credit Facility\") of up to $45.0 million; (b) the creation of an amended reimbursement agreement with respect to the letters of credit in support of certain industrial development revenue bonds; (c) the completion of the first closing under a standby purchase commitment whereby Mutual Series Fund Inc. (\"Mutual Series\") purchased approximately 1.9 million shares of new common stock for $9.0 million and loaned Hexcel $41.0 million as an advance against the proceeds of a subscription rights offering for additional shares of new common stock; and (d) the reinstatement or payment in full, with interest, of all allowed claims, including prepetition accounts payable and notes payable.\nThe Revolving Credit Facility was replaced by the Senior Secured Credit Facility on February 29, 1996.\nThe subscription rights offering concluded on March 27, 1995, with the issuance of an additional 7.2 million shares of new common stock. The resulting cash proceeds of $33.1 million were used to reduce the outstanding balance of the loan from Mutual Series. The second closing under the standby purchase agreement was completed on April 6, 1995, with the issuance of an additional 1.6 million shares of new common stock to Mutual Series, the issuance of an additional 0.1 million shares of new common stock to John J. Lee, Hexcel's Chief Executive Officer, and the retirement of the remaining balance of the Mutual Series loan. Following the second closing under the standby purchase agreement on April 6, 1995, the Company had a total of 18.1 million shares of common stock issued and outstanding.\nOn February 9, 1995, Hexcel paid $78.1 million in prepetition claims and interest, and reinstated another $60.6 million in prepetition liabilities. The payment of claims and interest on February 9, 1995 was financed with: (a) cash proceeds of $26.7 million received in the first quarter of 1995 from the sale of the Company's Chandler, Arizona manufacturing facility and certain related assets and technology; (b) cash proceeds of $2.6 million received in the first quarter of 1995 from the sale of the Company's European resins business; (c) the $50.0 million in cash received from Mutual Series in connection with the standby purchase agreement; and (d) borrowings under the Revolving Credit Facility.\nFurther discussion of the Reorganization Plan, the Chandler and European resins transactions, and Hexcel's emergence from bankruptcy reorganization proceedings is included in the Notes to the Consolidated Financial Statements included in this Annual Report on Form 10-K.\nRESULTS OF OPERATIONS\nHexcel generated income from continuing operations of $3.2 million in 1995, or $0.20 per share. This compares with losses from continuing operations of $28.1 million in 1994 and $79.9 million in 1993. The Company earned net income of $2.7 million in 1995, or $0.17 per share. The Company incurred net losses of $30.0 million and $86.0 million in 1994 and 1993, respectively.\nOperating results for 1995 include other income of $0.8 million and bankruptcy reorganization expenses of $3.4 million. Other income relates primarily to additional monies received in connection with the sale of the Chandler, Arizona manufacturing facility and certain related assets and technology in 1994.\nOperating results for 1994 include other income of $4.9 million, which is largely comprised of $15.9 million in income related to the Chandler transaction, less an $8.0 million provision to reflect the\nestimated cost of restructuring a joint venture and a $2.9 million provision for bankruptcy claim adjustments. The 1994 loss from continuing operations also includes bankruptcy reorganization expenses of $20.2 million, as well as interest expenses for bankruptcy claims and exit financing of $2.5 million and a provision for the settlement of various tax audits of $1.8 million.\nOperating results for 1993 include restructuring charges of $46.6 million for a major expansion of the restructuring program begun in December 1992. The 1993 loss from continuing operations also includes other expenses of $12.8 million for the write-down of certain assets and increases in reserves for warranties and environmental matters on property previously owned. The impairment of assets was due primarily to the bankruptcy proceedings, changes in business conditions, and depressed real estate prices on property held for sale. In addition, Hexcel recorded a $10.9 million provision in 1993 to reflect the adverse impact of bankruptcy proceedings and substantial operating losses on the potential realization of deferred income tax benefits.\nLosses from discontinued operations totaled $0.5 million, $1.9 million and $10.6 million in 1995, 1994 and 1993, respectively. These losses reflect the results of the discontinued resins business, including provisions to write-down the net assets of this business by $2.8 million in 1994 and $6.0 million in 1993. The divestiture of the resins business was completed in October 1995. The 1993 losses from discontinued operations also reflect the results of the discontinued fine chemicals business, including a provision to write-down the net assets of this business by $2.8 million in 1993. The divestiture of the fine chemicals business was completed in January 1994.\nIn 1993, the Company recorded a one-time, cumulative benefit of $4.5 million from the adoption of a new accounting standard for income taxes.\nSALES\nNet sales for 1995 totaled $350.2 million, compared with 1994 net sales of $313.8 million and 1993 net sales of $310.6 million. The improvement in 1995 sales over 1994 and 1993 levels is attributable to increased sales of prepregs and reinforcement fabrics, partially offset by decreased sales of honeycomb. Sales of prepregs to commercial aerospace and general industrial markets were higher, as were sales of reinforcement fabrics for use in the recreation, electrical (printed circuit boards) and ballistics industries. In addition, Hexcel benefited from a significant military contract for prepregs, and improved sales of honeycomb to the commercial aerospace market. The overall decrease in honeycomb sales is attributable to the divestiture of the Chandler facility and the related reduction in military aerospace sales. The Chandler facility and certain related assets and technology were sold to the Northrop Grumman Corporation in December 1994.\nThe increase in sales from 1994 to 1995 reflects a modest increase in demand for certain products used in the commercial aerospace market, further penetration of selected recreation and general industrial markets, and continued improvement in the overall economic environment in both the U.S. and Europe. Changes in currency exchange rates were also a factor in the increase. During 1995, the U.S. dollar declined against most of the major European currencies, including the Belgian and French francs; accordingly, sales from Hexcel's primary international subsidiaries were increased when translated into U.S. dollars. Due to the highly competitive nature of most of the markets in which the Company competes, product price changes were not a significant factor in 1995 sales growth.\nU.S. sales were $179.5 million in 1995, compared with $171.5 million in 1994 and $185.2 million in 1993. The 1995 increase is primarily attributable to a significant military contract for prepregs and\nimproved sales of reinforcement fabrics to general industrial and other markets. The reduction in honeycomb sales attributable to the divestiture of the Chandler facility was partially offset by increased sales of honeycomb to commercial aerospace and other markets. The 1994 decrease in U.S. sales was mainly due to reduced sales of prepregs and honeycomb to commercial and military aerospace markets, partially negated by improved sales of prepregs to general industrial and other markets.\nInternational sales were $170.7 million in 1995, compared with $142.3 million in 1994 and $125.4 million in 1993. The 1995 and 1994 increases reflect higher sales of prepregs and reinforcement fabrics to recreation, electrical (printed circuit boards) and other industries, as well as increased sales of prepregs to certain European aerospace customers. A portion of each increase is also attributable to changes in currency exchange rates. The U.S. dollar declined relative to the Belgian and French francs in 1994 as well as in 1995.\nCOMMERCIAL AEROSPACE SALES\nWorldwide sales were $159.0 million in 1995, compared with $147.5 million in 1994 and $131.4 million in 1993. Sales of prepregs and honeycomb to the commercial aerospace market increased in 1995 as a result of modest improvements in the build rates for certain commercial aircraft, as well as increased sales of selected products. In addition, Hexcel benefited from the improved economic environment in Europe, which also contributed to the 1994 sales increase. Nonetheless, while sales of individual products such as graphite honeycomb and certain prepreg products have increased during the past two years in response to the production of new wide-bodied aircraft, the Company continues to face intense competition for many of the products it sells to the commercial aerospace market. As a result, there is significant price pressure on several of these products.\nSPACE AND DEFENSE SALES\nWorldwide sales were $37.3 million in 1995, compared with $34.9 million in 1994 and $55.3 million in 1993. The slight increase in 1995 sales is attributable to a significant military contract for prepregs, partially negated by a decline in honeycomb sales. The decline in honeycomb sales reflects the divestiture of the Chandler facility and the related reduction in military aerospace sales.\nThe reduction in space and defense sales from 1993 to 1994 continued a trend which began in 1988, when sales to this market exceeded $100 million, and reflects Hexcel's declining involvement in a major military aerospace program as well as the general decline in U.S. military spending.\nRECREATION, GENERAL INDUSTRIAL AND OTHER SALES\nWorldwide sales were $153.9 million in 1995, compared with $131.4 million in 1994 and $123.9 million in 1993. Sales of new products introduced within the past few years continued to grow, and Hexcel benefited from strong European demand for printed circuit boards. In addition, sales of lightweight, high- strength materials for use in athletic shoes, golf club shafts, energy absorption products, and certain automotive and mass transit components remained relatively strong. Continued growth in sales to recreation, general industrial and other markets has contributed to an increase of such sales as a percentage of the consolidated total from 34% in 1991 to 44% in 1995.\nGROSS MARGIN\nGross margin was $67.1 million, or 19.2% of sales, in 1995. This compares with gross margin of $48.4 million, or 15.4% of sales, in 1994 and $47.5 million, or 15.3% of sales, in 1993. The increase in 1995 gross margin over 1994 and 1993 levels reflects the impact of higher sales, as well as certain\nmanufacturing cost reductions. Cost reductions include the closure of the Graham, Texas plant, the sale of the Chandler facility and the consolidation of selected honeycomb production activities into Hexcel's site at Casa Grande, Arizona. Although these measures were initially undertaken in 1993 and 1994, the transfer of certain production processes from Graham and Chandler to Casa Grande was not completed until the middle of 1995. Consequently, the beneficial impact of these facility reductions and the consolidation of honeycomb production activities began to be realized during 1995.\nDue to the highly competitive nature of most of the markets in which Hexcel competes, product price changes were not a significant factor in the growth of 1995 gross margin.\nMARKETING, GENERAL AND ADMINISTRATIVE (M,G&A) EXPENSES\nM,G&A expenses were $49.3 million in 1995, compared with $45.8 million in 1994 and $52.5 million in 1993. The increase in M,G&A expenses during 1995 is largely attributable to higher selling expenses, certain costs incurred in connection with the acquisition of the Ciba Composites Business and changes in currency exchange rates. The decrease in M,G&A expenses during 1994 was mainly due to significant headcount reductions made during 1993 and the first quarter of 1994. These headcount reductions were achieved through a reorganization of sales, marketing and administrative functions to reduce redundancies and inefficiencies. M,G&A expenses include research and technology expenses of $7.6 million in 1995, $8.2 million in 1994 and $8.0 million in 1993.\nINTEREST EXPENSE\nInterest expense was $8.7 million in 1995, compared with $11.8 million in 1994 and $8.9 million in 1993. The 1994 total includes accrued interest on prepetition accounts payable as well as notes payable. The decline in interest expense from 1994 to 1995 reflects the absence of interest on bankruptcy claims after February 9, 1995, as well as the elimination of various debt obligations with proceeds from the subscription rights offering and the Chandler transaction. Hexcel also benefited from slightly lower interest rates on certain variable rate debt.\nThe increase in interest expense from 1993 to 1994 reflects the accrual of interest on bankruptcy claims beginning December 6, 1993, the cost of a debtor- in-possession credit facility and higher interest rates on certain variable rate obligations. These factors were only partially offset by reduced levels of borrowing by Hexcel's European subsidiaries.\nINCOME TAXES\nAs of December 31, 1995, the Company had net operating loss (\"NOL\") carryforwards for U.S. federal income tax purposes of approximately $65 million and net operating loss carryforwards for international income tax purposes of approximately $5 million. The U.S. NOL carryforwards, which are available to offset future taxable income, expire at various dates through the year 2010. As a result of the ownership changes which occurred in connection with the Reorganization Plan and the acquisition of the Ciba Composites Business, utilization of the U.S. NOL carryforwards is subject to certain annual limitations, as described in Note 16 to the Consolidated Financial Statements included in this Annual Report on Form 10-K.\nThe 1995 income tax provision of $3.3 million resulted primarily from state income taxes and taxable income for certain European subsidiaries. The 1994 and 1993 income tax provisions of $3.6 million and $6.0 million, respectively, were attributable to the same factors. In addition, the 1994 provision includes the impact of settling various tax audits. Hexcel fully reserved the income tax assets\ngenerated by the pre-tax losses of certain subsidiaries in 1995, 1994 and 1993, due to uncertainty as to the realization of those assets.\nFINANCIAL CONDITION AND LIQUIDITY\nFINANCIAL RESOURCES\nIn connection with the acquisition of the Ciba Composites Business on February 29, 1996, Hexcel obtained the Senior Secured Credit Facility. The Senior Secured Credit Facility is a three-year revolving credit facility of up to $175.0 million which is available to: (a) fund the $25.0 million cash component of the purchase price paid for the Ciba Composites Business; (b) refinance outstanding indebtedness under certain U.S. and European credit facilities; and (c) provide for the ongoing working capital and other financing requirements of the Company, including consolidation activities, on a worldwide basis. The Senior Secured Credit Facility replaces the Revolving Credit Facility which was obtained on February 9, 1995, in connection with Hexcel's Reorganization Plan, as well as certain European credit facilities.\nThe Senior Secured Credit Facility is secured by a pledge of stock of certain of Hexcel's subsidiaries, and is also guaranteed by the Company and certain of its subsidiaries. In addition, the Company is subject to various financial covenants and restrictions under the Senior Secured Credit Facility, including minimum levels of tangible net worth and fixed charge coverage, and maximum levels of debt to earnings before interest, taxes, depreciation and amortization. The Senior Secured Credit Facility also imposes certain restrictions on incurring additional indebtedness, and generally prohibits the Company from paying dividends or redeeming capital stock.\nIn addition to providing for typical events of default, including an event of default resulting from a \"change in control\" (as defined) of the Company, the Senior Secured Credit Facility provides that an event of default would occur if, under certain circumstances, Ciba: (a) ceases to hold, directly or indirectly through one or more wholly-owned subsidiaries, 100% of the outstanding principal amount of the Senior Subordinated Notes, or (b) ceases to beneficially own, directly or indirectly, at least 40% of Hexcel's voting stock. In light of the foregoing, the Company and Ciba entered into a Retention Agreement, dated as of February 29, 1996, pursuant to which Ciba agreed, subject to the limitations set forth therein, to: (a) hold directly or indirectly through one or more wholly- owned subsidiaries, 100% of the outstanding principal amount of the Senior Subordinated Notes, and (b) beneficially own, directly or indirectly, at least 40% of the Company's voting stock. Further discussion of the Senior Secured Credit Facility is included in the Notes to the Consolidated Financial Statements included in this Annual Report on Form 10-K.\nManagement believes that the Senior Secured Credit Facility provides Hexcel with more borrowing capacity and imposes less restrictive conditions than the credit facilities which it has replaced. Management expects that the financial resources of Hexcel, including the Senior Secured Credit Facility, will be sufficient to fund the Company's worldwide operations, including the operations of the Ciba Composites Business.\nCASH FLOWS\nUnaudited pro forma financial information as to the acquisition of the Ciba Composites Business, including the financing of this acquisition, is included in Note 3 to the Consolidated Financial Statements included in this Annual Report on Form 10-K.\nIncome from continuing operations before interest expense, bankruptcy reorganization expenses, income taxes, and depreciation and amortization (\"EBITDA\") was $30.2 million in 1995, but continuing operations used $3.0 million of cash. Approximately $23.0 million of the difference between EBITDA and net cash flow used by continuing operations is attributable to the payment of prepetition accounts payable and accrued liabilities that had been reinstated on February 9, 1995, and another $6.5 million is attributable to the payment of accrued restructuring costs. In addition, Hexcel incurred $8.7 million of interest expense, $3.4 million of bankruptcy reorganization expenses, and financed a $9.9 million increase in accounts receivable and inventories resulting from higher sales levels. However, the Company benefited from a $19.4 million increase in postpetition accounts payable and accrued liabilities, reflecting both higher production levels and a return to normal credit terms with most vendors.\nEBITDA was $21.7 million in 1994, and net cash provided by continuing operations was $1.1 million. Interest and bankruptcy reorganization expenses totaled $32.0 million, but these expenditures were largely offset by a comparable increase in accounts payable and accrued liabilities (including liabilities subject to disposition in bankruptcy reorganization). The increase in accounts payable and accrued liabilities was primarily attributable to the accrual of interest on prepetition obligations, adjustments to allowed claims, and a return to payment terms with some vendors. In addition, Hexcel paid approximately $10.1 million in restructuring costs and financed a $7.4 million increase in accounts receivable and inventories.\nEBITDA is presented for purposes of describing the significant components of Hexcel's cash flows from continuing operating activities, and is not presented as an alternative measure of those cash flows or of the Company's operating results as determined in accordance with generally accepted accounting principles.\nCAPITAL EXPENDITURES\nCapital expenditures were $12.1 million in 1995, compared with $8.4 million in 1994 and $6.3 million in 1993. The increase from 1994 and 1993 levels is due to purchases of equipment necessary to improve manufacturing processes, and to the deferral of expenditures during bankruptcy reorganization proceedings. Further increases in capital spending are expected in 1996, partially as a result of the acquisition of the Ciba Composites Business. The 1995 capital expenditures of the Ciba Composites Business were $13.2 million, and management expects that the Company's 1996 capital expenditures will exceed the $25.3 million spent in the aggregate by the Company and the Ciba Composites Business during 1995. Such expenditures will be financed with cash generated from operations and borrowings under the Senior Secured Credit Facility.\nRECENTLY ISSUED ACCOUNTING STANDARDS\nHexcel is required to adopt Statement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of\" (\"SFAS 121\"), in 1996. SFAS 121 requires that the recoverability of long-lived assets to be held or used, including intangible assets, be assessed when events or circumstances indicate that the value of those assets may be impaired. That assessment, determined by reference to the estimated undiscounted future cash flows resulting from the use of the assets, will be based on each group of assets within each of the Company's strategic business units. Management has not yet determined the impact, if any, that the adoption of SFAS 121 will have on the Company's consolidated financial position or results of operations.\nHexcel is required to adopt Statement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation\" (\"SFAS 123\"), in 1996. SFAS 123 establishes accounting and disclosure requirements using a fair value based method of accounting for stock based employee compensation plans. Under SFAS 123, the Company may either adopt the new fair value based accounting method or continue the intrinsic value based method and provide pro forma disclosures of net earnings and earnings per share as if the fair value method had been applied. The Company plans to adopt only the disclosure requirements of SFAS 123. Consequently, the adoption of SFAS 123 will have no effect on the Company's consolidated net earnings.\nCONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nFinancial statement schedules have been omitted because they are not applicable or the required information is included in the consolidated financial statements or notes thereto.\nMANAGEMENT RESPONSIBILITY FOR FINANCIAL STATEMENTS\nHexcel management has prepared and is responsible for the consolidated financial statements and the related financial data contained in this report. These financial statements, which include estimates, were prepared in accordance with generally accepted accounting principles. Management uses its best judgment to ensure that such statements reflect fairly the consolidated financial position, results of operations and cash flows of the Company.\nHexcel maintains accounting and other control systems which management believes provide reasonable assurance that financial records are reliable for purposes of preparing financial statements and that assets are safeguarded and accounted for properly. Underlying this concept of reasonable assurance is the premise that the cost of control should not exceed benefits derived from control.\nThe Audit Committee of the Board of Directors reviews and monitors the financial reports and accounting practices of Hexcel. These reports and practices are reviewed regularly by management and by the independent auditors, Deloitte & Touche LLP, in connection with the audit of the Company's financial statements. The Audit Committee, composed solely of outside directors, meets periodically, separately and jointly, with management and the independent auditors.\n\/s\/ JOHN J. LEE - ------------------------------ (John J. Lee) CHIEF EXECUTIVE OFFICER\n\/s\/ WILLIAM P. MEEHAN - ------------------------------ (William P. Meehan) CHIEF FINANCIAL OFFICER\n\/s\/ WAYNE C. PENSKY - ------------------------------ (Wayne C. Pensky) CHIEF ACCOUNTING OFFICER\nINDEPENDENT AUDITORS' REPORT\nTo the Board of Directors and Shareholders of Hexcel Corporation:\nWe have audited the accompanying consolidated balance sheets of Hexcel Corporation and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations, shareholders' equity (deficit) and cash flows for each of the three years in the period ended December 31, 1995. These financial statements are the responsibility of Hexcel'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 Hexcel Corporation and subsidiaries at December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles.\nAs discussed in Note 4 to the consolidated financial statements, on January 12, 1995, the U.S. Bankruptcy Court entered an order dated January 10, 1995 confirming Hexcel's plan of reorganization which became effective on February 9, 1995. The terms of the plan of reorganization are more fully described in Note 4.\nAs discussed in Notes 2 and 3 to the consolidated financial statements, on February 29, 1996, Hexcel acquired the Ciba Composites Business.\nAs discussed in Note 1 to the consolidated financial statements, Hexcel changed its method of accounting for income taxes effective January 1, 1993 to conform with Statement of Financial Accounting Standards No. 109.\n\/s\/ DELOITTE & TOUCHE LLP\nDELOITTE & TOUCHE LLP Oakland, California March 1, 1996\nTHE ACCOMPANING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.\nHEXCEL CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS\nTHE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.\nHEXCEL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS\nTHE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.\nHEXCEL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)\nTHE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.\nNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (IN THOUSANDS, EXCEPT PER SHARE DATA)\nNOTE 1 -- SIGNIFICANT ACCOUNTING POLICIES\nNATURE OF OPERATIONS AND BASIS OF ACCOUNTING\nThe consolidated financial statements include the accounts of Hexcel Corporation and subsidiaries (\"Hexcel\" or the \"Company\"), after elimination of intercompany transactions and accounts. Hexcel is an international developer and manufacturer of lightweight, high-performance composite materials, parts and structures for use in the commercial aerospace, space and defense, recreation and general industrial markets. The Company serves international markets through manufacturing and marketing facilities located in the United States and Europe, as well as sales offices in Asia, Australia and South America. The Company is also a partner in three joint ventures that manufacture and sell composite materials in the U.S. and Asia.\nAs discussed in Notes 2 and 3, Hexcel acquired the worldwide composites division of Ciba-Geigy Limited, a Swiss corporation (\"Ciba\"), and Ciba-Geigy Corporation, a New York corporation (\"CGC\"), including Ciba's and CGC's composite materials, parts and structures businesses (the \"Ciba Composites Business\"), on February 29, 1996. The Company acquired the Ciba Composites Business in exchange for: (a) approximately 18,022 newly issued shares of Hexcel common stock; (b) $25,000 in cash; and (c) undertakings to deliver to Ciba and\/or one or more of its subsidiaries, following completion of certain post- closing adjustment procedures, various senior subordinated notes and senior demand notes. In connection with the acquisition of the Ciba Composites Business, the Company obtained a new three-year revolving credit facility of up to $175,000 (the \"Senior Secured Credit Facility\") to: (a) fund the cash component of the purchase price; (b) refinance outstanding indebtedness under certain U.S. and European credit facilities; and (c) provide for the ongoing working capital and other financing requirements of the Company on a worldwide basis (see Note 10). The acquisition of the Ciba Composites Business and related financing activities occurred subsequent to December 31, 1995, and have not been reflected in the historical consolidated financial statements and accompanying notes presented herein.\nAs discussed in Note 4, Hexcel Corporation (a Delaware corporation) operated as a debtor-in-possession under the provisions of Chapter 11 of the federal bankruptcy laws from December 6, 1993 until February 9, 1995, when the First Amended Plan of Reorganization (the \"Reorganization Plan\") proposed by Hexcel and the Official Committee of Equity Security Holders (the \"Equity Committee\") became effective. Consequently, the consolidated financial statements as of December 31, 1994, and for each of the three years in the period ended December 31, 1995, have been prepared in accordance with Statement of Position 90-7, \"Financial Reporting by Entities in Reorganization Under the Bankruptcy Code,\" issued by the American Institute of Certified Public Accountants (\"SOP 90-7\").\nCASH AND EQUIVALENTS\nThe Company invests excess cash in investments with original maturities of less than three months. The investments consist of Eurodollar time deposits and are stated at cost, which approximates market value. The Company considers such investments to be cash equivalents for purposes of the statements of cash flows.\nACCOUNTS RECEIVABLE\nAccounts receivable were net of reserves for doubtful accounts of $2,603 and $1,249 as of December 31, 1995 and 1994, respectively.\nINVENTORIES\nInventories are valued at the lower of cost or market, with cost determined on a first-in, first-out basis.\nPROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment are recorded at cost. Repairs and maintenance are charged to expense as incurred; replacements and betterments are capitalized. Interest expense associated with major long-term construction projects is capitalized. No interest was capitalized in 1995 or 1994; $227 of interest was capitalized in 1993.\nThe Company depreciates property, plant and equipment over estimated useful lives. Accelerated and straight-line methods are used for financial statement purposes. The estimated useful lives range from 10 to 40 years for buildings and improvements and 3 to 20 years for machinery and equipment.\nCURRENCY TRANSLATION\nThe assets and liabilities of European subsidiaries are translated into U.S. dollars at year-end exchange rates, and revenues and expenses are translated at average exchange rates during the year. Cumulative currency translation adjustments are included in shareholders' equity. Realized gains and losses from currency exchange transactions were not material to the Company's consolidated results of operations in 1995, 1994 or 1993.\nRESEARCH AND TECHNOLOGY COSTS\nResearch and technology costs of $7,618 in 1995, $8,201 in 1994 and $7,971 in 1993 were expensed as incurred, and are included in \"marketing, general and administrative expenses\" in the consolidated statements of operations.\nACCOUNTING CHANGE\nEffective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS 109\") (see Note 16). The cumulative effect of this accounting change has been reflected in the consolidated statement of operations for the year ended December 31, 1993.\nEARNINGS PER SHARE\nNet income (loss) per share is computed by dividing net income (loss) by the weighted average number of common shares and dilutive common share equivalents (stock options) outstanding during each year. The computation on the fully diluted basis, which considers the exercise of stock options and the conversion of the convertible subordinated debentures, was antidilutive in 1995, 1994 and 1993.\nRECLASSIFICATIONS\nCertain prior year amounts in the consolidated financial statements and notes have been reclassified to conform to the 1995 presentation.\nESTIMATES AND ASSUMPTIONS\nThe consolidated financial statements and accompanying notes reflect numerous estimates and assumptions made by the management of Hexcel. These estimates and assumptions affect the reported amounts of assets and liabilities, the disclosures with respect to contingent assets and liabilities, and the reported amounts of revenues and expenses. Although management believes that the estimates and assumptions used in preparing the consolidated financial statements and accompanying notes are reasonable in light of known facts and circumstances, actual results could differ from the estimates used.\nRECENTLY ISSUED ACCOUNTING STANDARDS\nHexcel is required to adopt Statement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of\" (\"SFAS 121\"), in 1996. SFAS 121 requires that the recoverability of long-lived assets to be held or used, including intangible assets, be assessed when events or circumstances indicate that the value of those assets may be impaired. That assessment, determined by reference to the estimated undiscounted future cash flows resulting from the use of the assets, will be based on each group of assets within each of the Company's strategic business units. Management has not yet determined the impact, if any, that the adoption of SFAS 121 will have on the Company's consolidated financial position or results of operations.\nHexcel is required to adopt Statement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation\" (\"SFAS 123\"), in 1996. SFAS 123 establishes accounting and disclosure requirements using a fair value based method of accounting for stock based employee compensation plans. Under SFAS 123, the Company may either adopt the new fair value based accounting method or continue the intrinsic value based method and provide pro forma disclosures of net earnings and earnings per share as if the fair value method had been applied. The Company plans to adopt only the disclosure requirements of SFAS 123. Consequently, the adoption of SFAS 123 will have no effect on the Company's consolidated net earnings.\nNOTE 2 -- ACQUISITION OF THE CIBA COMPOSITES BUSINESS\nHexcel acquired the Ciba Composites Business of Ciba-Geigy Limited and Ciba-Geigy Corporation on February 29, 1996. The Ciba Composites Business is engaged in the manufacture and marketing of composite materials, parts and structures for aerospace, recreation and general industrial markets. Product lines include fabrics, prepregs, adhesives, honeycomb core, sandwich panels and fabricated components, as well as structures and interiors primarily for the commercial and military aerospace markets.\nThe acquisition of the Ciba Composites Business was consummated pursuant to a Strategic Alliance Agreement dated as of September 29, 1995 among Ciba, CGC, and Hexcel, as amended (the \"Strategic Alliance Agreement\"). Under the Strategic Alliance Agreement, the Company acquired the assets (including the capital stock of certain of Ciba's non-U.S. subsidiaries) and assumed the liabilities of the Ciba Composites Business other than certain excluded assets and liabilities in exchange for: (a) approximately 18,022 newly issued shares of Hexcel common stock; (b) $25,000 in cash; and (c) undertakings to deliver to Ciba and\/or one or more of its subsidiaries, following completion of certain post-closing adjustment procedures contemplated by the Strategic Alliance Agreement, senior subordinated notes in an aggregate principal amount of approximately $43,000, subject to certain adjustments (the \"Senior Subordinated Notes\"), and senior demand notes in a principal amount equal to the cash on hand at certain of Ciba's non-U.S. subsidiaries (the \"Senior Demand Notes\"). (The pro forma aggregate principal amount of the Senior Subordinated Notes as of December 31, 1995 was $27,400. See Note 3.) In connection with the acquisition of the Ciba Composites Business, the Company obtained the Senior Secured Credit Facility to: (a) fund the cash component of the purchase price; (b) refinance outstanding indebtedness under certain U.S. and European credit facilities; and (c) provide for the ongoing working capital and other financing requirements of the Company on a worldwide basis (see Note 10). The acquisition of the Ciba Composites Business and related financing activities occurred subsequent to December 31, 1995, and have not been reflected in the historical consolidated financial statements and accompanying notes presented herein.\nNOTE 3 -- ACQUISITION OF THE CIBA COMPOSITES BUSINESS: PRO FORMA FINANCIAL INFORMATION (UNAUDITED)\nThe following unaudited pro forma financial information combines the condensed balance sheets and statements of operations of Hexcel and the Ciba Composites Business after giving effect to the acquisition of the Ciba Composites Business by the Company. The unaudited pro forma condensed combined balance sheet as of December 31, 1995 gives effect to the acquisition as if it had occurred on December 31, 1995. The unaudited pro forma condensed combined statement of operations for the year ended December 31, 1995 gives effect to the acquisition as if it had occurred on January 1, 1995. The pro forma adjustments account for the acquisition as a purchase of the Ciba Composites Business by the Company, and are based upon the assumptions set forth in the accompanying disclosures.\nThe following unaudited pro forma financial information is not necessarily indicative of the financial position or operating results that would have occurred had the acquisition of the Ciba Composites Business been consummated on the dates indicated, nor is it necessarily indicative of future operating results or financial position. Management expects that significant costs will be incurred in connection with combining the operations of Hexcel and the Ciba Composites Business, including costs of eliminating excess manufacturing capacity and redundant administrative and research and development activities, as well as the various costs of consolidating the information systems and other business activities of the two companies. Some of the costs associated with combining the two businesses, including certain costs to eliminate redundant administrative and research and development activities, will be incurred during 1996. The anticipated resulting benefits are expected to be realized shortly thereafter. However, other costs, including many of the costs to eliminate excess manufacturing capacity, are expected to be incurred over a period of as much as three years. This is attributable, in part, to aerospace industry requirements to \"qualify\" specific equipment and manufacturing facilities for the manufacture of certain products. Based on the Company's experience with previous plant consolidations, these qualification requirements necessitate an approach to the consolidation of manufacturing facilities that will require two to three years to complete. Accordingly, the costs and anticipated future benefits of eliminating excess manufacturing capacity are long-term in nature.\nThe Board of Directors of Hexcel has not yet approved the plan for combining the operations of Hexcel and the Ciba Composites Business, but is expected to do so in the second quarter of 1996. Subject to the approval of the consolidation plan by the Board of Directors, management currently estimates that the cash costs of combining the two businesses could range from $35,000 to $45,000, net of expected proceeds from asset sales which are expected to be received at the end of the consolidation process. (This range includes the estimated net cash cost to close the Anaheim manufacturing facility of the Ciba Composites Business. The decision to close this facility was announced in the first quarter of 1996.) Management notes, however, that the actual cash costs of combining the two businesses could vary from current estimates due to the fact that the nature, timing and extent of certain consolidation activities is dependent on numerous factors.\nManagement expects to record one or more charges to earnings for the estimated costs of certain business consolidation activities. The estimated costs of specific consolidation activities will be accrued in accordance with generally accepted accounting principles as those activities are determined and announced. Although the aggregate amount of the resulting charges to earnings has not yet been determined, management currently estimates that the amount could range from $40,000 to $50,000, including noncash charges. However, the actual aggregate amount of such charges could vary from current estimates.\nThe cash expenditures necessary to combine the Ciba Composites Business with Hexcel are expected to occur over a period of as much as three years. The nature, timing and extent of these expenditures will be determined, in part, by management's evaluation of the probable economic and competitive benefits to\nbe gained from specific consolidation activities. Management anticipates that the benefits to be realized from planned consolidation activities will be sufficient to justify the level of associated costs. However, some of the anticipated benefits are long-term in nature, and there can be no assurance that such benefits will actually be realized. Accordingly, no effect has been given to the costs of combining the two businesses, or to the operating, financial and other benefits that may be realized from the combination, in the accompanying pro forma financial information.\nUNAUDITED PRO FORMA CONDENSED COMBINED BALANCE SHEET THE YEAR ENDED DECEMBER 31, 1995\nUNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS THE YEAR ENDED DECEMBER 31, 1995\nThe 1995 net loss for the Ciba Composites Business of $18,543 includes a fourth quarter net loss of $9,537. The fourth quarter net loss includes approximately $6,340 costs attibutable to write-downs of certain fixed and intangible assets, severance expenses, reserves for uncollectible receivables, and acquisition-related expenses.\nPURCHASE PRICE SUMMARY AND RELATED ALLOCATION\nThe purchase price paid by Hexcel for the Ciba Composites Business is comprised of the following components:\n18,022 shares of Hexcel common stock, valued at $8.00 per share (1) $ 144,200 Senior Subordinated Notes payable to Ciba in 2003 (2) 26,300 Cash paid to Ciba (3) 25,000 Estimated fees and expenses in connection with the acquisition (3) 7,600 - -------------------------------------------------------------------------------- Total purchase price $ 203,100 - --------------------------------------------------------------------------------\nThe allocation of the total purchase price to the net assets of the Ciba Composites Business is based upon the estimated fair values of the net assets acquired, and is summarized as follows:\nCash and equivalents (4) -- Accounts receivable (5) $ 53,285 Inventories (6) 58,792 Prepaid expenses (5) 3,938 Net property, plant & equipment (7) 110,877 Other assets, net (8) 1,000 Investments and other assets (5) 4,214 Current liabilities (9) (57,685) Other long-term liabilities, less current maturities (9) (19,221) Minority interest (10) -- Shareholders' equity (11) 3,600 Excess of purchase price over net assets acquired (12) 44,300 - -------------------------------------------------------------------------------- Total purchase price $ 203,100 - -------------------------------------------------------------------------------- (1) The aggregate value of the Hexcel common stock issued to Ciba is determined by multiplying the discounted market price per share by the number of shares issued. The market price per share is determined by reference to the prices at which Hexcel common stock was trading on the New York Stock Exchange during a reasonable period before and after December 12, 1995, the date upon which Hexcel and Ciba amended the aggregate amount of consideration to be paid by Hexcel for the Ciba Composites Business by agreeing to reduce the initial aggregate principal amount of the senior subordinated notes by $5,000. The market price is then discounted to reflect the illiquidity of the Hexcel common stock issued to Ciba caused by the size of Ciba's holding, the contractual restrictions on transferring such shares and, accordingly, limitations on the price Ciba could realize, the contractual limitation on the price per share Ciba could realize in certain types of transactions, the fact that such shares are \"restricted securities\" within the meaning of the Securities Act of 1933, and various other factors.\nFor purposes of valuing the Hexcel common stock issued to Ciba, a discounted market price of $8.00 per share is used. The discounted market price is based on a market price of $10.00 per share during a reasonable period before and after December 12, 1995, and a discount rate of 20%. The discounted market price of the shares issued is used in determining the total purchase price because the discounted market price of Hexcel common stock is more reliably measurable than the fair value of the assets acquired and the liabilities assumed.\n(2) Based on the formula included in the Strategic Alliance Agreement, the pro forma aggregate principal amount of the Senior Subordinated Notes as of December 31, 1995 is approximately\n$27,400. (Such amount is estimated as follows: $43,029 (a) increased by $9,000 for the price of acquiring a minority interest in an Austrian subsidiary of the Ciba Composites Business; (b) increased by $6,126 for the decline in the adjusted net working capital of Hexcel from July 2, 1995 to December 31, 1995; (c) decreased by $25,378 for the decline in the adjusted net working capital of the Ciba Composites Business from July 2, 1995 to December 31, 1995; and (d) decreased by $5,377 for certain net assets of the Ciba Composites Business retained by Ciba and other adjustments.) However, the actual aggregate principal amount of the Senior Subordinated Notes to be issued may be higher or lower, because the adjustments required under the Strategic Alliance Agreement to reflect changes in working capital and certain other items as of February 29, 1996 have not yet been determined.\nThe fair value of the Senior Subordinated Notes as of December 31, 1995 is estimated to be $26,300, which is $1,100 lower than the pro forma aggregate principal amount. The $1,100 discount reflects the absence of certain call protection provisions from the terms of the Senior Subordinated Notes and the difference between the stated interest rate on the Senior Subordinated Notes and the estimated market rate for debt obligations of comparable quality and maturity (see Note 10).\n(3) The cash paid to Ciba and certain estimated fees and expenses in connection with the acquisition of the Ciba Composites Business have been financed with the proceeds from the Senior Secured Credit Facility (see Note 10).\n(4) Under the terms of the Strategic Alliance Agreement, the cash and cash equivalents of the Ciba Composites Business, except for cash on hand at certain of Ciba's non-U.S. subsidiaries, are retained by Ciba. The cash on hand at certain of Ciba's non-U.S. subsidiaries was acquired in exchange for the Senior Demand Notes. The amount of acquired cash and the corresponding principal amount of the Senior Demand Notes, which Hexcel expects will be presented for payment shortly after issuance, are equal and offset each other. Accordingly, the acquisition of such cash and the issuance of the Senior Demand Notes has not been reflected in the unaudited pro forma condensed combined balance sheet.\n(5) The fair values of accounts receivable, prepaid expenses and investments and other assets acquired in the purchase of the Ciba Composites Business are estimated to equal respective net book values. Under the terms of the Strategic Alliance Agreement, a portion of the Ciba Composites Business' accounts receivable and prepaid expenses are retained by Ciba.\n(6) The fair value of inventories acquired in the purchase of the Ciba Composites Business is estimated to equal aggregate current sales value less estimated selling costs. Under the terms of the Strategic Alliance Agreement, a portion of the Ciba Composites Business' inventories is retained by Ciba.\n(7) The fair value of the property, plant and equipment acquired in the purchase of the Ciba Composites Business is estimated to be $45,000 lower than the respective net book value. The estimated fair value, which is based on a preliminary review of the production facilities and equipment of the Ciba Composites Business, reflects the fact that certain of these assets are expected to: (a) duplicate capabilities or productive capacities already possessed by Hexcel; or (b) be in excess of the combined company's needs. This estimate is subject to modification in connection with further analysis. In addition, under the terms of the Strategic Alliance Agreement, a portion of the Ciba Composites Business' property, plant and equipment is retained by Ciba.\n(8) The fair value assigned to other assets reflects the capitalization of estimated fees and expenses incurred to secure the Senior Secured Credit Facility in connection with the acquisition of the Ciba Composites Business.\n(9) The fair values of the current and long-term liabilities assumed by Hexcel in connection with the purchase of the Ciba Composites Business are estimated to equal the respective net book values. Under the terms of the Strategic Alliance Agreement, certain of the liabilities of the Ciba Composites Business are not assumed by Hexcel.\n(10) Prior to Hexcel's acquisition of the Ciba Composites Business, Ciba eliminated the minority interest in an Austrian subsidiary of the Ciba Composites Business (\"Danutec\") by purchasing that interest, subject to certain governmental approvals which were subsequently obtained. Accordingly, the estimated pro forma purchase price and purchase price allocation reflect the transfer of 100% of the capital stock of Danutec to the Company, and the minority interest in Danutec has been eliminated on a pro forma basis.\n(11) The estimated fees and expenses incurred in connection with issuing the Hexcel common stock to Ciba are deducted from shareholders' equity.\n(12) The excess of purchase price over net tangible assets acquired will be allocated to identifiable intangible assets and goodwill pursuant to an analysis and valuation of those assets in accordance with the provisions of Accounting Principles Board Opinion No. 16. Such analysis and valuation has not yet been performed. Accordingly, for purposes of the unaudited pro forma financial information, the excess of purchase price over net tangible assets acquired has been treated as a single intangible asset, with a 20- year life. While the values and estimated lives of various intangible assets resulting from the final purchase allocation will vary from these pro forma assumptions, management does not expect these variances to be material to the unaudited pro forma financial information contained herein.\nThe purchase price allocation does not reflect any liabilities for the costs of consolidating the business operations of the Ciba Composites Business and Hexcel. Those costs, as discussed above, are expected to be significant (see pages 51 and 52).\nPRO FORMA ADJUSTMENTS -- UNAUDITED PRO FORMA CONDENSED COMBINED BALANCE SHEET\n(a) Adjustment to eliminate the cash and cash equivalents of the Ciba Composites Business which are retained by Ciba $ (8,412) ---------------------------------------------------------------------------\n(b) Adjustment to eliminate accounts receivable of the Ciba Composites Business which are retained by Ciba, as well as trade account balances between the Ciba Composites Business and Hexcel $ (5,805) ---------------------------------------------------------------------------\n(c) Adjustment to eliminate inventories of the Ciba Composites Business which are retained by Ciba, and to record acquired inventories at estimated fair value $ (1,545) ---------------------------------------------------------------------------\n(d) Adjustment to eliminate prepaid expenses and other assets of the Ciba Composites Business which are retained by Ciba $ (6,019) ---------------------------------------------------------------------------\n(e) Adjustment to eliminate property, plant and equipment of the Ciba Composites Business which is retained by Ciba, and to record acquired property, plant and equipment at estimated fair value $ (45,487) ---------------------------------------------------------------------------\n(f) Adjustment to record the excess of purchase price over net assets acquired $ 44,300 ---------------------------------------------------------------------------\n(g) Adjustment to reflect the following:\nElimination of the intangible assets of the Ciba Composites Business $ (42,211) Capitalization and reclassification of certain fees and expenses incurred in connection with the acquisition (3,200) Write-off of capitalized debt issuance costs in connection with the extinguishment of certain existing debt obligations with proceeds from the Senior Secured Credit Facility (1,658) --------------------------------------------------------------------------- Net adjustment $ (47,069) ---------------------------------------------------------------------------\n(h) Adjustment to eliminate notes payable of the Ciba Composites Business which are not assumed by Hexcel $ (9,052) ---------------------------------------------------------------------------\n(i) Adjustment to eliminate current liabilities of the Ciba Composites Business which are not assumed by Hexcel, as well as trade balances between the the Ciba Composites Business and Hexcel $ (1,208) ---------------------------------------------------------------------------\n(j) Adjustment to reflect the issuance of the Senior Subordinated Notes payable to Ciba $ 26,300 ---------------------------------------------------------------------------\n(k) Adjustment to reflect the following:\nElimination of long-term liabilities of the Ciba Composites Business which are not assumed by Hexcel $ (9,502) Net borrowings under the Senior Secured Credit Facility to finance the cash payment to Ciba and certain fees and expenses incurred in connection with the acquisition 28,400 --------------------------------------------------------------------------- Net adjustment $ 18,898 ---------------------------------------------------------------------------\n(l) Adjustment to reflect the elimination of the minority interest in Danutec $ (6,968) ---------------------------------------------------------------------------\n(m) Adjustment to reflect the issuance of Hexcel common stock to Ciba, net of certain fees and expenses incurred in connection with issuing such stock $ 140,600 ---------------------------------------------------------------------------\n(n) Adjustment to reflect the write-off of capitalized debt issuance costs in connection with the extinguishment of certain existing debt obligations with proceeds from the Senior Secured Credit Facility $ (1,658) ---------------------------------------------------------------------------\n(o) Adjustment to eliminate Ciba's investment in the Ciba Composites Business $ (236,949) ---------------------------------------------------------------------------\nPRO FORMA ADJUSTMENTS -- UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS\n(p) Adjustment to eliminate sales between the Ciba Composites Business and Hexcel $ (3,207) ---------------------------------------------------------------------------\n(q) Adjustment to reflect the following: Elimination of cost of sales between the Ciba Composites Business and Hexcel $ 2,708 Reduction in depreciation costs resulting from the purchase price adjustment to the net property, plant and equipment of the Ciba Composites Business 4,152 ---------------------------------------------------------------------------\nNet adjustment $ 6,860 ---------------------------------------------------------------------------\n(r) Adjustment to reflect the following: Reduction in amortization expense and write-downs of intangible assets resulting from the elimination of the intangible assets of the Ciba Composites Business in connection with the purchase price allocation $ 6,930 Amortization of the excess of purchase price over net assets acquired (20 year amortization period) (2,215) Amortization of capitalized fees and expenses incurred in connection with securing the Senior Secured Credit Facility (3 year amortization period) (330) ---------------------------------------------------------------------------\nNet adjustment $ 4,385 ---------------------------------------------------------------------------\n(s) Adjustment to reflect the following: Elimination of interest expense on liabilities of the Ciba Composites Business which are not assumed by Hexcel $ 1,032 Net reduction in interest expense resulting from the refinancing of certain credit facilities with the Senior Secured Credit Facility 992 Estimated interest expense on the Senior Subordinated Notes payable to Ciba (2,893) --------------------------------------------------------------------------- Net adjustment $ (869) ---------------------------------------------------------------------------\n(t) On February 9, 1995, Hexcel emerged from bankruptcy reorganization proceedings which had begun on December 6, 1993. In connection with those proceedings, Hexcel incurred bankruptcy reorganization expenses of $3,361 during the year ended December 31, 1995. Although the resolution of certain bankruptcy-related issues, including the final settlement of disputed claims and professional fees, resulted in expenses being incurred after February 9, 1995, Hexcel has not incurred any significant bankruptcy- related expenses since October 1, 1995.\n(u) Adjustment to eliminate the minority interest in the operating results of the Ciba Composites Business $ 1,506 ---------------------------------------------------------------------------\n(v) The income tax consequences of the cumulative pro forma adjustments are estimated to be zero. This is due to the fact that the pro forma combined company incurred losses from continuing operations before income taxes for the year ended December 31, 1995, and no income tax benefits relating to these losses have been recognized. Furthermore, the pro forma combined company has sufficient net operating loss carryforwards for income tax purposes to substantially eliminate any tax liabilities arising from pro forma adjustments.\nNOTE 4 -- BANKRUPTCY REORGANIZATION\nOn January 12, 1995, the United States Bankruptcy Court for the Northern District of California (the \"Bankruptcy Court\") entered an order dated January 10, 1995 confirming the Reorganization Plan proposed by Hexcel and the Equity Committee. On February 9, 1995, the Reorganization Plan became effective and Hexcel emerged from the bankruptcy reorganization proceedings which had begun on December 6, 1993, when Hexcel filed a voluntary petition for relief under the provisions of Chapter 11 of the federal bankruptcy laws.\nThe Reorganization Plan which became effective on February 9, 1995 provided for: (a) the replacement of a debtor-in-possession credit facility with a new revolving credit facility (the \"Revolving Credit Facility\") of up to $45,000; (b) the creation of an amended reimbursement agreement with respect to the letters of credit in support of certain industrial development revenue bonds; (c) the completion of the first closing under a standby purchase commitment whereby Mutual Series Fund Inc. (\"Mutual Series\") purchased 1,946 shares of new common stock for $9,000 and loaned Hexcel $41,000 as an advance against the proceeds of a subscription rights offering for additional shares of new common stock; and (d) the reinstatement or payment in full, with interest, of all allowed claims, including prepetition accounts payable and notes payable.\nThe Revolving Credit Facility was replaced by the Senior Secured Credit Facility on February 29, 1996 (see Note 10).\nThe subscription rights offering concluded on March 27, 1995, with the issuance of an additional 7,156 shares of new common stock. The resulting cash proceeds of $33,098 were used to reduce the outstanding balance of the loan from Mutual Series. The second closing under the standby purchase agreement was completed on April 6, 1995, with the issuance of an additional 1,590 shares of new common stock to Mutual Series, the issuance of an additional 108 shares of new common stock to John J. Lee, Hexcel's Chief Executive Officer, and the retirement of the remaining balance of the Mutual Series loan. Following the second closing under the standby purchase agreement on April 6, 1995, the Company had a total of 18,101 shares of common stock issued and outstanding.\nThe Reorganization Plan provided for the reinstatement or payment in full, with interest, of all allowed claims, including prepetition accounts payable and notes payable. The total of all claims reinstated or paid, less the portion representing accrued interest for the period from January 1 to February 9, 1995, has been reflected as \"liabilities subject to disposition in bankruptcy reorganization\" in the consolidated balance sheet as of December 31, 1994. On February 9, 1995, Hexcel paid $78,144 in prepetition claims and interest, and reinstated another $60,575 in prepetition liabilities. Reinstated liabilities were reclassified from \"liabilities subject to disposition in bankruptcy reorganization\" to the appropriate liability captions of the consolidated balance sheet on February 9, 1995. The payment of claims and interest on February 9, 1995 was financed with: (a) cash proceeds of $26,694 received in the first quarter of 1995 from the sale of the Company's Chandler, Arizona manufacturing facility and certain related assets and technology (see Note 5); (b) cash proceeds of $2,602 received in the first quarter of 1995 from the sale of the Company's European resins business (see Note 5); (c) the $50,000 in cash received from Mutual Series in connection with the standby purchase agreement; and (d) borrowings under the Revolving Credit Facility.\nProfessional fees and other costs directly related to bankruptcy proceedings were expensed as incurred, and have been reflected in the consolidated statements of operations as \"bankruptcy reorganization expenses.\" Bankruptcy reorganization expenses have consisted primarily of professional fees paid to legal and financial advisors of Hexcel, the Equity Committee and the Official Committee of Unsecured Creditors. In addition, these expenses included incentives for employees to remain with the Company for the duration of bankruptcy proceedings and the write-off of previously capitalized costs\nrelated to the issuance of prepetition debt, as required by SOP 90-7. The resolution of certain bankruptcy-related issues, including the final settlement of disputed claims and professional fees, resulted in expenses being incurred after the effective date of the Reorganization Plan. However, the Company has not incurred any significant bankruptcy-related expenses since October 1, 1995.\nNOTE 5 -- RECEIVABLES FROM ASSET SALES\nSALE OF CHANDLER, ARIZONA MANUFACTURING FACILITY AND CERTAIN RELATED ASSETS AND TECHNOLOGY\nHexcel sold its Chandler, Arizona manufacturing facility and certain related assets and technology to Northrop Grumman Corporation (\"Northrop\") in the fourth quarter of 1994. In connection with the sale, the Company recognized other income of $15,900, which includes the effects of reversing $10,000 of a previously established restructuring reserve related to the Chandler facility and $5,900 which represents the excess of the sales price over the carrying value of the net assets sold. The transaction generated net cash proceeds of $28,988, of which $2,294 was received in 1994 and $26,694 was received in the first quarter of 1995. The net proceeds received in the first quarter of 1995 have been reflected in \"receivables from asset sales\" in the consolidated balance sheet as of December 31, 1994.\nUnder the terms of the Chandler transaction, Hexcel retained a royalty- free, non-exclusive license to use the technology sold in non-military applications and will receive royalties from Northrop on certain applications of that technology. In addition, the Company may receive up to an additional $2,300 pursuant to the terms of the transaction, when certain conditions are satisfied. Of this amount, $600 was received in the third quarter of 1995 and has been reflected in \"other income (expense), net\" in the 1995 consolidated statement of operations. An additional $1,560 was received in February 1996; the resulting income will be recognized in the first quarter of 1996.\nSALE OF RESINS BUSINESS\nOn December 29, 1994, Hexcel sold its European resins operations to Axson S.A., a French corporation, through the sale of all of the Company's shares in the capital stock of its European resins subsidiaries. The sale and related settlement transactions generated net cash proceeds of approximately $8,727, of which $6,125 was received in the fourth quarter of 1994 and $2,602 was received in the first quarter of 1995. The net proceeds received in the first quarter of 1995 have been reflected in \"receivables from asset sales\" in the consolidated balance sheet as of December 31, 1994.\nHexcel sold its U.S. resins operations to Fiber-Resin Corporation, a wholly-owned subsidiary of H.B. Fuller Company, on October 30, 1995. The estimated net proceeds from the sale approximated the net book value of the assets sold. The sale of the Company's U.S. resins operations completed the divestiture of the resins business, which has been accounted for as a discontinued operation in the consolidated financial statements for all periods presented (see Note 23).\nNOTE 6 -- INVENTORIES\nInvestments in joint ventures consist of a 50% equity interest in Knytex Company, L.L.C. (\"Knytex\"), which is jointly owned and operated with Owens- Corning Fiberglas Corporation, and a 40% equity interest in Hexcel-Fyfe, L.L.C. (\"Hexcel-Fyfe\"), which is jointly owned and operated with Fyfe Associates Corporation. The Company also owns an equity interest in DIC-Hexcel Limited, a joint venture with Dainippon Ink and Chemicals, Inc. (\"DIC\"), for which there was no recorded asset value as of December 31, 1995 or 1994 (see Note 9). Investments in joint ventures are accounted for by the equity method. Equity in the earnings of joint ventures were not material to the Company's consolidated results of operations in 1995, 1994 or 1993.\nKnytex was formed on June 30, 1993 when the Company sold 50% of its stitchbonded business to Owens-Corning and contributed the remaining 50% to the joint venture. The Company received proceeds of $4,500 and recognized a gain of $1,541 from the sale.\nDeferred business acquisition costs consists of certain transaction-related costs incurred in connection with the acquisition of the Ciba Composites Business through December 31, 1995. Such costs will be included in the allocation of the total purchase price to the net assets acquired as of the acquisition date, in accordance with the provisions of Accounting Principles Board Opinion No. 16.\nDebt financing costs are deferred and amortized over the life of the related debt. All debt financing costs as of December 31, 1995 relate to debt obligations that were extinguished on February 29, 1996 with proceeds from the Senior Secured Credit Facility. Accordingly, the unamortized balance of such costs will be written off by a charge to \"interest expense\" during the first quarter of 1996.\nNOTE 9 -- DIC-HEXCEL LIMITED\nThe Company owns an equity interest in DIC-Hexcel Limited, a joint venture with Dainippon Ink and Chemicals, Inc. (\"DIC\"). The joint venture was formed in 1990 for the production and sale of Nomex honeycomb, advanced composites and decorative laminates for the Japanese market. The joint venture owns and operates a manufacturing facility in Komatsu, Japan.\nUnder the terms of the original joint venture agreement, DIC agreed to guarantee all bank debt incurred by this venture. In turn, the Company provided an undertaking that in the event the joint venture went into liquidation the Company would reimburse DIC for 50% of all guaranteed bank loans, net of any proceeds from the sale of the venture's assets. During 1994, the economic viability of this joint venture became questionable, and the cost of product qualification efforts and the attendant lack of revenues were resulting in negative cash flows. During the third quarter of 1994, DIC proposed to liquidate the joint venture. The Company responded with a proposal to restructure the joint venture, subject to various conditions, which DIC agreed to consider. Under either proposal, the Company would retain responsibility for a portion of the joint venture's guaranteed bank debt. Accordingly, the Company recorded an $8,000 provision in the third quarter of 1994 to reflect the estimated cost of restructuring or liquidating DIC-Hexcel Limited. This provision has been included in \"other income (expenses), net\" in the 1994 consolidated statement of operations, and the corresponding liability has been included in \"liabilities subject to disposition in bankruptcy reorganization\" in the consolidated balance sheet as of December 31, 1994.\nOn February 20, 1995, Hexcel and DIC entered into an amendment to the original joint venture agreements which provided additional funding to permit DIC-Hexcel Limited to complete its product qualification efforts and limited the Company's potential liability for the venture's bank debt guaranteed by DIC to $9,000. Under the terms of the amendment, the Company and DIC each agreed to contribute $4,500 in cash to the venture, payable in installments of $1,438 in the first quarter of 1995 and $438 in each of the next seven quarters. It was agreed that such cash contributions by the Company would reduce pro-rata its potential liability of $9,000. The amendment also provided, after taking account to the transactions contemplated thereunder, for a reduction in the Company's equity interest in DIC-Hexcel Limited to approximately 42% with a corresponding increase in DIC's equity interest. After December 31, 1996, should demand be made under the loans made to DIC-Hexcel Limited guaranteed by DIC, the Company will be required to pay 50% of any amount DIC pays on account of its guarantees, up to a cumulative amount of $4,500. Furthermore, the Company and DIC agreed that they would discuss and review the prospects of the venture and its future financing during the second half of 1996. During this period both DIC and the Company each have the right to request the liquidation of DIC-Hexcel Limited. If such right is exercised, the Company will be required to make payment of the remaining contingent liability of up to $4,500. If such liquidation right is exercise by either party, it is not anticipated that payment would be required prior to January 1997.\nManagement believes that the $8,000 provision recorded in the third quarter of 1994 remains the best estimate of the Company's total probable liability under the amended joint venture agreement, based on the terms of that agreement and the projected future operating results of DIC-Hexcel Limited. The Company contributed $2,750 of cash to the joint venture during 1995, reducing the remaining probable liability to $5,250 as of December 31, 1995. Of this amount, $1,750 has been included in \"accrued liabilities\" and $3,500 has been included in \"deferred liabilities\" in the consolidated balance sheet as of December 31, 1995 (see Note 17).\nNOTE 10 -- NOTES PAYABLE\nNotes payable and capital lease obligations as of December 31, 1995 and 1994 were:\nSENIOR SECURED CREDIT FACILITY\nIn connection with the acquisition of the Ciba Composites Business, Hexcel obtained the Senior Secured Credit Facility on February 29, 1996. The Senior Secured Credit Facility is a three-year revolving credit facility of up to $175,000 which is available to: (a) fund the $25,000 cash component of the purchase price paid for the Ciba Composites Business; (b) refinance outstanding indebtedness under certain U.S. and European credit facilities; and (c) provide for the ongoing working capital and other financing requirements of the Company, including consolidation activities, on a worldwide basis. The Senior Secured Credit Facility replaces the Revolving Credit Facility which was obtained on February 9, 1995, in connection with Hexcel's Reorganization Plan, as well as certain European credit facilities.\nInterest on outstanding borrowings under the Senior Secured Credit Facility is computed at an annual rate of 0.4% in excess of the applicable London interbank rate or, at the option of Hexcel, the base rate of the administrative agent for the lenders. In addition, the Senior Secured Credit Facility is subject to a commitment fee of approximately 0.2% per annum on the unused portion of the facility and a letter of credit fee of up to 0.5% per annum on the outstanding face amount of letters of credit. The Company also paid one- time arrangement, syndication and closing fees totaling $869, as well as certain other costs and expenses related to the implementation of the Senior Secured Credit Facility.\nThe Senior Secured Credit Facility is secured by a pledge of stock of certain of Hexcel's subsidiaries, and is also guaranteed by the Company and certain of its subsidiaries. In addition, the Company is subject to various financial covenants and restrictions under the Senior Secured Credit Facility, including minimum levels of tangible net worth and fixed charge coverage, and maximum levels of debt to earnings before interest, taxes, depreciation and amortization. The Senior Secured Credit Facility also imposes certain restrictions on incurring additional indebtedness, and generally prohibits the Company from paying dividends or redeeming capital stock.\nIn addition to providing for typical events of default, including an event of default resulting from a \"change in control\" (as defined) of the Company, the Senior Secured Credit Facility provides that an event of default would occur if, under certain circumstances, Ciba: (a) ceases to hold, directly or indirectly through one or more wholly-owned subsidiaries, 100% of the outstanding principal amount of the Senior Subordinated Notes, or (b) ceases to beneficially own, directly or indirectly, at least 40% of Hexcel's voting stock. In light of the foregoing, the Company and Ciba entered into a Retention Agreement, dated as of February 29, 1996, pursuant to which Ciba agreed, subject to the limitations set forth therein, to: (a) hold directly or indirectly through one or more wholly- owned subsidiaries, 100% of the outstanding principal amount of the Senior Subordinated Notes, and (b) beneficially own, directly or indirectly, at least 40% of the Company's voting stock.\nREVOLVING CREDIT FACILITY\nThe Revolving Credit Facility, which replaced the Debtor-in-possession credit facility on February 9, 1995, was replaced by the Senior Secured Credit Facility on February 29, 1996.\nEUROPEAN CREDIT FACILITIES\nCertain European credit facilities were replaced by the Senior Secured Credit Facility on February 29, 1996.\nSENIOR SUBORDINATED NOTES PAYABLE TO CIBA-GEIGY\nIn connection with the acquisition of the Ciba Composites Business, Hexcel has undertaken to deliver to Ciba and\/or one or more of its subsidiaries the Senior Subordinated Notes. The Senior Subordinated Notes, which will be issued following the completion of certain post-closing adjustment procedures contemplated by the Strategic Alliance Agreement, will be general unsecured obligations of the Company in an aggregate principal amount of approximately $43,000, subject to certain adjustments. The actual aggregate principal amount of the Senior Subordinated Notes to be issued may be higher or lower than $43,000, because the adjustments required under the Strategic Alliance Agreement to reflect changes in working capital and certain other items as of February 29, 1996 have not yet been determined. (The pro forma aggregate principal amount of the Senior Subordinated Notes as of December 31, 1995 was $27,400, and the pro forma estimated fair value of the Senior Subordinated Notes on that date was $26,300. See Note 3.)\nThe Senior Subordinated Notes will bear interest for three years at a rate of 7.5% per annum, payable semiannually, from February 29, 1996. The interest rate will increase to 10.5% per annum on the third anniversary of the acquisition of the Ciba Composites Business, and by an additional 0.5% per year\nthereafter until the Senior Subordinated Notes mature in the year 2003. The payment of principal and interest on the Senior Subordinated Notes will be subordinate to the Senior Secured Credit Facility.\nThe Senior Subordinated Notes will be callable, in whole or in part, at the option of Hexcel at any time without penalty, and the Company will not be required to make mandatory redemption or sinking fund payments. Under certain circumstances, upon a \"change of control\" of the Company, as defined in the indenture governing the Senior Subordinated Notes, the holders of the Senior Subordinated Notes (except, under certain circumstances, Ciba) will have the right to cause the Company to repurchase all or any part of the Senior Subordinated Notes at a price equal to 101% of the principal amount to be repurchased plus accrued interest. Under such indenture, the Company will be subject to various restrictions, including restrictions on incurring additional indebtedness, paying dividends and redeeming capital stock.\n7% CONVERTIBLE SUBORDINATED DEBENTURES\nThe 7% convertible subordinated debentures were subject to disposition in bankruptcy reorganization, and were reinstated on February 9, 1995, pursuant to the Reorganization Plan. These debentures are redeemable by the Company under certain provisions, although any such redemption is restricted by the terms of the Senior Secured Credit Facility. Mandatory redemption is scheduled to begin in 2002 through annual sinking fund requirements. The debentures are convertible prior to maturity into common stock of the Company at $30.72 per share, subject to adjustment under certain conditions.\nOBLIGATIONS UNDER IDRB VARIABLE RATE DEMAND NOTES\nHexcel has various industrial development revenue bonds (\"IDRBs\") outstanding, guaranteed by bank letters of credit for fees of 0.5%. These IDRBs were subject to disposition in bankruptcy reorganization, and were reinstated on February 9, 1995, pursuant to the Reorganization Plan. The letters of credit which guarantee the IDRBs were also reinstated, in accordance with the terms of an amended reimbursement agreement (the \"Reimbursement Agreement\") with the issuing bank, and extended until December 31, 1998. The Reimbursement Agreement originally provided that, commencing April 1, 1995 and every three months thereafter for the duration of the agreement, the Company would either redeem $600 of the guaranteed IDRBs, obtain a $600 letter of credit in favor of the issuing bank, or deposit $600 into a sinking fund in which the issuing bank and\/or the trustees for the IDRBs will hold a first priority security interest. However, these provisions were eliminated by an amendment to the Reimbursement Agreement dated February 29, 1996. This amendment, which was agreed to by the issuing bank in connection with the Company's acquisition of the Ciba Composites Business, also eliminated certain financial covenants and other restrictions previously contained in the Reimbursement Agreement. The interest rates on the IDRBs are variable and averaged 6.2% in 1995, 3.9% in 1994 and 2.5% in 1993.\nOn November 1, 1994, Hexcel sold the property it owned in the City of Industry, California for $2,600, which approximated net book value. Under the terms of the sales agreement, the buyer paid the Company $260 in cash and assumed responsibility for $2,340 of the outstanding principal of a $4,900 IDRB related to the property. As of December 31, 1995, the outstanding balance of the IDRB had been reduced to $4,700, of which $2,160 was an assumed obligation of the buyer. The Company is contingently liable for that portion of the IDRB assumed by the buyer, in the event the buyer should default on assumed payment obligations.\nINSTALLMENTS DUE ON NOTES PAYABLE\nExcluding obligations extinguished with proceeds from the Senior Secured Credit Facility, installments due on long-term notes payable are $1,489 in 1996, $267 in 1997 and $38,966 in years after\nthe year 2000. The Senior Secured Credit Facility, which was used to refinance long-term debt obligations totaling $46,205 as of December 31, 1995, expires in 1999.\nAGGREGATE FAIR VALUE OF LONG-TERM DEBT\nManagement believes that the aggregate fair value of Hexcel's long-term debt, excluding the 7% convertible subordinated debentures, approximates the aggregate book value, as substantially all such debt is comprised of variable- rate obligations. However, there can be no assurance that the aggregate fair value of the Company's long-term debt will not materially vary from the aggregate book value. The fair value of the 7% convertible subordinated debentures is estimated on the basis of quoted market prices, although trading in the debentures is limited and may not reflect fair value. The estimated fair value of all of the outstanding debentures was $21,781 and $15,888 as of December 31, 1995 and 1994, respectively.\nINTEREST PAYMENTS\nInterest payments were $8,345 in 1995, $3,909 in 1994 and $8,802 in 1993. Hexcel was legally prohibited from paying interest on most prepetition debt obligations in 1994.\nNOTE 11 -- LEASING ARRANGEMENTS\nAssets, accumulated depreciation and related liability balances under capital leasing arrangements as of December 31, 1995 and 1994 were:\nCertain sales and administrative offices, data processing equipment, and manufacturing facilities are leased under operating leases. Rental expenses under operating leases were $2,871 in 1995, $3,675 in 1994 and $3,530 in 1993.\nFuture minimum lease payments as of December 31, 1995 were:\nTotal minimum capital lease payments include $2,332 of imputed interest.\nNOTE 12 -- ACCRUED RESTRUCTURING LIABILITIES\nIn December 1992, Hexcel initiated a worldwide restructuring program designed to improve facility utilization and determine the proper workforce requirements to support projected reduced levels of business in 1993 and beyond. The Company recorded a charge for this program of $23,000 in the fourth quarter of 1992.\nIn April 1993, Hexcel announced the closing of the Graham, Texas manufacturing facility and the consolidation of Graham operations into other plants. The estimated costs of this closure were included in the 1992 restructuring charge. The Graham closure was substantially completed in 1994.\nIn September 1993, Hexcel announced plans to significantly expand the restructuring program in response to the expected further decline in commercial and military aerospace markets. Accordingly, the Company recorded a charge of $44,000 in the third quarter of 1993. This expansion included deeper cuts in overhead and further consolidation of facilities in the United States and Europe. During the fourth quarter of 1993, an additional charge of $2,600 was recorded in connection with the expanded restructuring program. The 1993 and 1992 restructuring charges included approximately $34,000 of non-cash write- downs related to facility closures and the impairment of certain assets due to declining sales and the changed business environment.\nIn the fourth quarter of 1994, Hexcel sold the Chandler, Arizona manufacturing facility and certain related assets and technology (see Note 5). Together with the closure of the Graham facility, this completed the reduction in honeycomb production capacity contemplated by the expanded restructuring program. The Company transferred certain assets and production processes located at the Chandler facility, which were not included in the sale, to the Company's facility in Casa Grande, Arizona. The estimated costs associated with this transfer were included in the restructuring charge recorded in the third quarter of 1993.\nThe total of $69,600 in restructuring charges taken in 1992 and 1993 and the remaining balances of accrued restructuring charges as of December 31, 1995 and 1994 were:\nThe decrease in accrued restructuring liabilities during 1995 is primarily attributable to the consolidation of honeycomb manufacturing operations in connection with the disposal of the Chandler facility, as well as severance payments and implementation of a new management information system. The consolidation of honeycomb operations reflected in the 1992 and 1993 restructuring charges is substantially complete, while implementation of the information system will continue through 1996.\nNOTE 13 -- LIABILITIES SUBJECT TO DISPOSITION IN BANKRUPTCY REORGANIZATION\nLiabilities subject to disposition in bankruptcy reorganization as of December 31, 1994 were:\nThe Reorganization Plan provided for the reinstatement or payment in full, with interest, of all allowed claims, including prepetition accounts payable and notes payable. The total of all claims reinstated or paid, less the portion representing accrued interest for the period from January 1 to February 9, 1995, has been reflected as \"liabilities subject to disposition in bankruptcy reorganization\" in the consolidated balance sheet as of December 31, 1994.\nNOTE 14 -- RETIREMENT PLANS\nThe Company has various retirement and profit sharing plans covering substantially all U.S. employees and certain European employees. The net cost of these plans was $2,768 in 1995, $2,443 in 1994 and $2,330 in 1993.\nIn the United States, the Company maintains a defined contribution plan and a defined benefit pension plan. The defined contribution plan is available to substantially all U.S. employees, and is comprised of a 401(k) savings plan and a profit sharing plan. Under the 401(k) savings plan, the Company makes matching contributions equal to 50% of the contributions of the employees, not to exceed 3% of employee compensation. The defined benefit pension plan is a career average pension plan covering substantially all U.S. hourly employees. Effective January 1, 1996, participation in the defined benefit pension plan was extended to U.S. salaried employees as well. Benefits are based on years of service and the annual compensation of the employee, and the Company's funding policy is to contribute the minimum amount required by applicable regulations.\nThe Company also maintains a defined benefit pension plan for employees in the United Kingdom, and defined benefit retirement plans for certain senior executives and directors. The Company's European subsidiaries, except for those in the United Kingdom, participate in government retirement plans which cover all employees of those subsidiaries.\nContributions to the 401(k) savings plan were $1,290 for 1995, $1,039 for 1994 and $1,130 for 1993. There were no contributions to the profit sharing plan for 1995, 1994 or 1993. The net cost of the Company's defined benefit pension and retirement plans for the years ended December 31, 1995, 1994 and 1993 consisted of:\nAssumptions used in the accounting for these defined benefit and retirement plans were:\nThe funded status and amounts recognized for the defined benefit pension and retirement plans as of December 31, 1995 and 1994 were:\nNOTE 15 -- POSTRETIREMENT HEALTH CARE AND LIFE INSURANCE BENEFITS\nThe Company provides certain postretirement health care and life insurance benefits to eligible retirees. Substantially all U.S. employees hired on or before December 31, 1995 who retire on or after age 58 after rendering at least 15 years of service are eligible for benefits. Benefits consist of coverage of up to 50% of the annual cost of certain health insurance plans, as well as annual life insurance coverage equal to 65% of the final base pay of the retiree until the age of 70. Upon reaching 70 years of age, life insurance coverage is reduced.\nThe Company funds postretirement health care and life insurance benefit costs on a pay-as-you-go basis and, for 1995, 1994 and 1993, made benefit payments of $583, $423 and $576, respectively. Net defined postretirement benefit costs for the years ended December 31, 1995, 1994 and 1993 were:\nDefined postretirement benefit liabilities as of December 31, 1995 and 1994 were:\nTwo health care cost trend rates were used in measuring the accumulated postretirement benefit obligation. The assumed indemnity health care cost trend in 1996 was 11.0% for participants less than 65 years of age and 7.0% for participants 65 years of age and older, gradually declining to 6.0% for both age groups in the year 2001. The assumed HMO health care cost trend in 1996 was 8.0% for participants less than 65 years of age and 5.0% for participants 65 years of age and older, gradually declining to 6.0% and 5.0%, respectively, in the year 1998.\nThe weighted average discount rate used in determining the accumulated postretirement benefit obligation was 7.0% in 1995 and 8.0% in 1994. The rate of increase in compensation used in determining the obligation was 4.0% in both 1995 and 1994.\nIf the health care cost trend rate assumptions were increased by 1.0%, the accumulated postretirement benefit obligation as of December 31, 1995 would be increased by 3.6%. The effect of this change on the sum of the service cost and interest cost would be an increase of 3.0%.\nEffective January 1, 1996, Hexcel amended its postretirement benefit program to eliminate any benefits for employees hired after December 31, 1995 (other than certain former employees of the Ciba Composites Business hired on February 29, 1996), and to limit health care benefit coverage to selected health insurance plans for the majority of active employees hired on or before December 31, 1995. These amendments are expected to reduce the Company's accumulated postretirement benefit obligation by approximately $1,600, which will be recognized as a reduction in future benefit expense on a straight line basis over 14 years.\nNOTE 16 -- INCOME TAXES\nNET OPERATING LOSS CARRYFORWARDS\nAs of December 31, 1995, the Company had net operating loss (\"NOL\") carryforwards for U.S. federal income tax purposes of approximately $65,000 and net operating loss carryforwards for international income tax purposes of approximately $5,000. The U.S. NOL carryforwards, which are available to offset future taxable income, expire at various dates through the year 2010.\nAs a result of the ownership change which occurred in connection with the Reorganization Plan (see Note 4), a limitation on the utilization of NOL carryforwards in the U.S. was created. This utilization limitation, which applies to loss carryforwards generated prior to February 9, 1995, is estimated to be approximately $5,000 per year. As a result of the acquisition of the Ciba Composites Business (see Notes 2 and 3), a second successive limitation on the utilization of NOL carryforwards in the U.S. has been created. This utilization limitation, which applies to loss carryforwards generated between February 9, 1995 and February 29, 1996, is estimated to be approximately $12,000 per year. Under U.S. federal tax law, NOL carryforwards are utilized in the order of successive limitations. Consequently, the NOL carryforwards subject to the first annual limitation may be utilized to reduce future taxable income of up to $5,000 per year, and the NOL carryforwards subject to the second annual limitation may then be utilized to reduce future taxable income of up to $12,000 per year. The aggregate utilization of NOL carryforwards subject to both limitations may not exceed $12,000 annually.\nPROVISION FOR INCOME TAXES\nThe Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes,\" effective January 1, 1993. The cumulative effect of adopting SFAS 109 was the recognition of $4,500 of income, which was recorded in the first quarter of 1993. In connection with the adoption of SFAS 109, the Company established a valuation allowance of $4,693 against its deferred income tax assets.\nDuring 1993, substantial uncertainty developed as to the realization of Hexcel's deferred income tax assets. As a result, the Company increased the valuation allowance against its deferred income tax assets, reducing the recorded value of those assets to zero. The increase to the valuation allowance reflected the Company's assessment that the bankruptcy reorganization proceedings of Hexcel and substantial operating losses had jeopardized the realization of deferred income tax assets.\nIn 1994 and 1995, Hexcel continued to reserve for the income tax assets generated by the pre-tax losses of certain subsidiaries. As a result of settlements of various tax audits, state income taxes and taxable income for certain European subsidiaries, the Company recorded a provision for income taxes of $3,586 in 1994. As a result of state income taxes and taxable income for certain European subsidiaries, the Company recorded a provision for income taxes of $3,313 in 1995.\nIncome (loss) before income taxes and the tax provision for income taxes from continuing operations for the years ended December 31, 1995, 1994 and 1993 were:\nA reconciliation of the tax provision to the U.S. federal statutory income tax rate of 34% for the years ended December 31, 1995, 1994 and 1993 was:\nThe Company paid income taxes of $3,864 in 1995, $253 in 1994 and $203 in 1993. The Company has made no U.S. income tax provision for approximately $27,000 of undistributed earnings of international subsidiaries as of December 31, 1995. Such earnings are considered to be permanently reinvested. The additional U.S. income tax on these earnings, if repatriated, would be offset in part by foreign tax credits.\nDEFERRED INCOME TAXES\nDeferred income taxes result from temporary differences between the recognition of items for income tax purposes and financial reporting purposes. Principal temporary differences as of December 31, 1995 and 1994 were:\nNOTE 17 -- DEFERRED LIABILITIES\nDeferred liabilities as of December 31, 1995 and 1994 were:\nNOTE 18 -- SHAREHOLDERS' EQUITY AND INCENTIVE STOCK PLAN\nSHAREHOLDERS' EQUITY\nOn February 21, 1996, Hexcel's shareholders approved an amendment to the Company's Certificate of Incorporation increasing the number of authorized shares of Hexcel common stock from 40,000 to 100,000. On February 29, 1996, the Company issued 18,022 shares of Hexcel common stock to Ciba in connection with the acquisition of the Ciba Composites Business. As a result, Ciba owned 49.9% of the total number of shares of Hexcel common stock issued and outstanding as of that date.\nThere are 1,500 shares of Hexcel preferred stock authorized for issuance, but no such shares have been issued.\nHexcel did not declare or pay any dividends in 1995, 1994 or 1993. The Board of Directors suspended dividend payments beginning in 1993, and such payments are generally prohibited by the Senior Secured Credit Facility.\nINCENTIVE STOCK PLAN\nOn February 21, 1996, Hexcel's shareholders approved the Incentive Stock Plan. The Incentive Stock Plan authorizes an aggregate of 3,000 shares of Hexcel common stock for use by the Company in providing a variety of stock-based awards to eligible employees, officers, directors and consultants. The Incentive Stock Plan provides for grants of stock options, stock appreciation rights, restricted shares, and other stock-based awards.\nStock option data for the two years ended December 31, 1995 were:\nThe options granted during 1995 become exercisable in increments in 1996 and 1997. An additional 1,115 options primarily at exercise prices of $12.50 per share were granted on February 29 and March 1, 1996. Included in this total are 228 short-term options which expire 90 days after the grant date. The holders of the short-term options are entitled to receive two additional \"reload\" options for each short-term option exercised. Consequently, as many as 456 additional options could be granted during the 90 day period beginning March 1, 1996, in connection with the exercise of short-term options. Except for the short-term options, the options granted on February 29 and March 1, 1996 become exercisable in increments through 1999, and expire between 2001 and 2006.\nAs of December 31, 1995 and 1994, the Company had outstanding a total of 10 and 24 shares of restricted stock, respectively, which vest in increments through 1997. The holders of these shares are entitled to vote. An additional 269 shares of performance accelerated restricted stock (\"PARS\") were granted in March 1996. The PARS vest in increments through 2003, subject to accelerated vesting under certain circumstances.\nNOTE 19 -- CONTINGENCIES\nHexcel is involved in litigation, investigations and claims arising out of the conduct of its business, including those relating to government contracts, commercial transactions, and environmental, health and safety matters. The Company estimates its liabilities resulting from such matters based on a variety of factors, including outstanding legal claims and proposed settlements, assessments by internal and external counsel of pending or threatened litigation, and assessments by environmental engineers and consultants of potential environmental liabilities and remediation costs. Such estimates incorporate insignificant amounts for probable recoveries under applicable insurance policies but exclude counterclaims against other third parties. Such estimates are not discounted to reflect the time value of money due to the uncertainty in estimating the timing of the expenditures, which may extend over several years. Although it is impossible to determine the level of future expenditures for legal, environmental and related matters with any degree of certainty, it is management's opinion, based on available information, that it is unlikely that these matters, individually or in the aggregate, will have a material adverse effect on the consolidated financial position or results of operations of the Company.\nU.S. GOVERNMENT CLAIMS\nHexcel, as a defense subcontractor, is subject to U.S. government audits and reviews of negotiations, performance, cost classifications, accounting and general practices relating to government contracts. The Defense Contract Audit Agency (\"DCAA\") reviews cost accounting and business practices of government\ncontractors and subcontractors including the Company. The Company has been engaged in discussions on a number of cost accounting issues which could result in claims by the government. Some of these issues have already been resolved.\nAs part of these reviews, the DCAA has alleged that Hexcel improperly included certain land lease costs in its indirect rates at the Chandler, Arizona facility (the \"Chandler Land Lease\") and that, as a result, the Company's subcontracts had been overpriced in an amount of approximately $1,000. The Company has formally responded to the DCAA that it strongly disagrees with these allegations. In February 1996, the Company received a letter from the United States Attorney's Office, stating that it was considering filing an action against the Company for violation of the civil False Claims Act (\"FCA\") based upon the inclusion in the indirect rates of the Chandler Land Lease costs. While the Company does not agree that there was any violation of the FCA, if the U.S. government elects to pursue such an action and were it to prevail, it would be entitled to three times the actual damages claimed plus penalties of between $5 and $10 for each false claim; the number of alleged false claims could be significant.\nLEGAL CLAIMS AND PROCEEDINGS\nIn December 1988, Lockheed employees working with epoxy resins and composites on classified programs filed suit against Lockheed and its suppliers (including Hexcel) claiming various injuries as a result of exposure to these products. Plaintiffs have filed for punitive damages which may be uninsured. The first trial of the cases of 15 pilot plaintiffs resulted in a mistrial and a retrial resulted in the entry of judgment in favor of the plaintiffs. The Company did not participate in the trial due to the automatic stay resulting from the Chapter 11 filing. Some of these claims were discharged as a result of the plaintiffs' failure to file claims in Hexcel's Chapter 11 case. As to the claims which have not been discharged, the Company has objected to them and intends to proceed with those objections within the Bankruptcy Court.\nHexcel \/ MCI, a business unit divested in 1991, performed brazing services in the manufacture of flexures under subcontract from Ormond which supplied the flexures to Thiokol. The flexures are used to support a rocket motor housing in a test stand during actual firing of the rocket. Several flexures cracked under the dead weight of a rocket motor prior to actual test firing, and Thiokol has sued Ormond and the Company for the costs of replacing all of the flexures purchased ($900) (Thiokol Corporation v. Ormond, Hexcel, et al.). The automatic stay in bankruptcy was lifted in April 1995 and the case was resumed in the state court in Utah. Discovery is ongoing. There is no insurance coverage available for an adverse court ruling or negotiated settlement.\nIn November 1995, Hexcel was notified that Livermore Development Corporation (\"LDC\") was asserting a claim for damages arising from Hexcel's recent notification of its intent to exercise its option to purchase certain land in Livermore, California. LDC contends that the lease was a disguised partnership or joint venture agreement between Hexcel and LDC to develop the property for residential use. Hexcel disputes any such agreement and seeks to enforce its option to purchase under a written agreement. The parties are in ongoing negotiations to resolve this claim.\nAs the result of the acquisition of the Ciba Composites Business in February 1996, Hexcel assumed certain liabilities including certain legal proceedings.\nENVIRONMENTAL CLAIMS AND PROCEEDINGS\nHexcel has been named as a potentially responsible party (\"PRP\") with respect to several hazardous waste disposal sites that it does not own or possess which are included on the Environmental Protection Agency's Superfund National Priority List and\/or various state equivalent lists. With respect to its exposure relating to these sites, the Company believes its responsibility to be de minimis. A total of 249 claims were filed in the Chapter 11 case with a face value of over $6.7 billion. These claims were, for the most part, duplicative as a result of the joint and several liability provisions of applicable laws and have\nbeen categorized into claims involving 19 sites. Claims involving 8 of the sites have been settled within the Chapter 11 case. The Company has been named a PRP with respect to 6 sites for which no claims were filed in the Chapter 11 case; as a result, the Company believes any further claims to be barred. The balance of the sites and their related claims have been passed through the bankruptcy. The Company's estimation of its exposure at these sites is de minimis.\nAlso, pursuant to the New Jersey Environmental Responsibility and Clean-Up Act, Hexcel signed an administrative consent order to pay for clean-up of a manufacturing facility it formerly operated in Lodi, New Jersey. Hexcel has reserved approximately $2,800 to cover such remaining costs and believes that actual costs should not exceed the amount which has been reserved. Fine Organics Corporation, the current owner of the Lodi site and Hexcel's former chemicals business operated on that site, has asserted that the clean-up costs will be significantly in excess of that amount. The ultimate cost of remediation at the Lodi site will depend on developing circumstances.\nFine Organics Corporation filed a proof of claim and an adversary proceeding in the Bankruptcy Court. The court has disallowed a significant portion of the claim by denying Fine Organics claim for treble damages and certain contingent claims. The remaining claims are for prior clean-up costs incurred by Fine Organics and alleged contractual and tort damages relating to the original sale of the business and site to Fine Organics totaling approximately $3,200. This matter is proceeding in the Bankruptcy Court.\nIn September 1995, Ciba was named as a potentially responsible party with respect to the removal of drums from a disposal site that it did not own or possess, known as the Omega Chemical Corporation (\"Omega Site\"). The Omega Site is a spent solvent recycling and treatment facility in Whittier, California. Ciba has previously notified the EPA that it intends to comply with the EPA's removal requirements and has paid its interim share of such removal costs to date. This responsibility was assumed by the Company as a result of its acquisition of the Ciba Composites Business, to the extent the Ciba waste delivered to the Omega site was from the operations of the Ciba Composites Business. This matter is under evaluation but is presently believed to be de minimis.\nPRODUCT CLAIMS\nIn 1993, Hexcel became aware of an aluminum honeycomb sandwich panel delamination problem with panels produced by its wholly-owned Belgium subsidiary, Hexcel S.A., and installed in rail cars in France and Spain. Certain customers have alleged that Hexcel S.A. is responsible for the problem. The Company and its insurer continue to investigate these claims. The Company is also working with the customers to repair or replace panels when necessary, with certain costs to be allocated upon determination of responsibility for the delamination. While no lawsuit has been filed, two customers in France requested that a court appoint experts to investigate the claims; to date, the experts have not reported any conclusions. The Company's primary insurer for this matter has agreed to fund legal representation and to provide coverage of the claim to the extent of the policy limit for one year. The Company is investigating additional insurance coverage. Even if additional insurance coverage is not available, management believes that, based on available information, it is unlikely that these claims will have a material adverse effect on the consolidated financial position or results of operations of the Company.\nNOTE 20 -- RAW MATERIALS; SIGNIFICANT CUSTOMERS; MARKETS\nHexcel purchases most of the raw materials used in production. Several key materials are available from relatively few sources, and in many cases the cost of product qualification makes it impractical to develop multiple sources of supply. The unavailability of these materials, which the Company does not anticipate, could have a material adverse effect on sales and earnings.\nThe Boeing Company and Boeing subcontractors accounted for approximately 21% of 1995 sales, 22% of 1994 sales and 21% of 1993 sales. The loss of all or a significant portion of this business, which Hexcel does not anticipate, could have a material adverse effect on sales and earnings.\nNet sales by market for the years ended December 31, 1995, 1994 and 1993 were:\n- -------------------------------------------------------------------------------- 1995 1994 1993 - --------------------------------------------------------------------------------\nCommercial aerospace 45% 47% 42% Space and defense 11% 11% 18% Recreation, general industrial and other 44% 42% 40% - -------------------------------------------------------------------------------- Net sales 100% 100% 100% - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------\nNOTE 21 -- BUSINESS SEGMENT DATA\nThe Company operates within a single business segment: composite materials, parts and structures. The following table summarizes certain financial data for continuing operations by geographic area as of December 31, 1995, 1994, and 1993 and for the years then ended:\nInternational net sales consist of the net sales of international subsidiaries, sold primarily in Europe, and U.S. exports. U.S. exports were $18,902 in 1995, $14,008 in 1994 and $11,889 in 1993.\nTo compute income (loss) before income taxes, the Company allocated administrative expenses to International of $3,939 in 1995, $3,283 in 1994 and $2,894 in 1993.\nNOTE 22 -- OTHER INCOME AND EXPENSES, NET\nThe Company recognized $791 of other income in 1995, including $600 of income relating to the sale of the Chandler facility and related assets and technology (see Note 5).\nThe Company recognized $4,861 of other income in 1994, including $15,900 of income relating to the Chandler transaction (see Note 5), partially offset by an $8,000 provision for the estimated cost of restructuring or liquidating DIC- Hexcel Limited (see Note 9) and a $2,900 provision for bankruptcy claim adjustments. The provision for bankruptcy claim adjustments resulted from the reconciliation and settlement of certain claims as well as changes in the estimate of assumed liabilities.\nThe Company incurred $12,780 of other expenses in 1993, primarily as a result of write-downs of certain assets and increases in reserves for warranties and environmental matters on property previously owned. The impairment of assets was attributable to bankruptcy reorganization proceedings, changes in business conditions, and depressed real estate prices on property held for sale.\nNOTE 23 -- DISCONTINUED OPERATIONS\nThe divestiture of Hexcel's discontinued resins business was completed on October 30, 1995 (see Note 5). The Company recorded a $2,800 provision in 1994 to write down the net assets of the resins business to expected realizable value, following a $6,000 charge in 1993.\nThe divestiture of Hexcel's discontinued fine chemicals business was completed in 1994. The Company recorded a $2,800 provision in 1993 to write down the net assets of the fine chemicals business to expected realizable value.\nNet sales of discontinued operations for the years ended December 31, 1995, 1994 and 1993 were:\nNet assets of the discontinued resins business as of December 31, 1994 were:\nNOTE 24 -- QUARTERLY FINANCIAL DATA (UNAUDITED)\nQuarterly financial data for the years ended December 31, 1995 and 1994 were:\nDuring the third quarter of 1995, the Company recognized other income of $600 relating to the sale of the Chandler facility and related assets and technology (see Notes 5 and 22).\nDuring the third quarter of 1994, the Company recorded an $8,000 provision for the estimated cost of restructuring or liquidating DIC-Hexcel Limited (see Note 9), and a $2,800 provision to write down the net assets of the discontinued resins business to expected net realizable value (see Note 23).\nDuring the fourth quarter of 1994, the Company recognized other income of $15,900 relating to the Chandler transaction (see Notes 5 and 22). In addition, the Company recorded a total of approximately\n$10,800 in expenses for bankruptcy claim adjustments, additional interest on allowed claims, and the settlement of various tax audits.","section_15":""}
{"filename":"102037_1995.txt","cik":"102037","year":"1995","section_1":"ITEM 1. BUSINESS\nA. The Company\nUniversal Corporation (which together with its subsidiaries is referred to herein as \"Universal\" or the \"Company\") is the world's largest independent leaf tobacco merchant and has additional operations in agri-products and lumber and building products. Universal's tobacco operations have been the principal focus of the Company since its founding in 1918, and for the fiscal year ended June 30, 1995, such operations accounted for 70% of revenues and 75% of operating profits. Its agri-products and lumber and building products operations accounted for 14% and 16% of revenues and 9% and 16% of operating profits, respectively, during the same period. See Note 4 to Consolidated Financial Statements for additional business segment and geographical information.\nB. Description of Tobacco Business\nGeneral\nUniversal's tobacco business involves selecting, buying, shipping, processing,\npacking, storing and financing leaf tobacco in the United States and other tobacco growing countries for the account of, or for resale to, manufacturers of tobacco products throughout the world. Universal does not manufacture cigarettes or other consumer tobacco products. Most of its tobacco revenues are derived from sales of processed tobacco and from fees and commissions for specific services for its customers.\nTimely and efficient processing of leaf tobacco is a service of continuing importance to the Company's customers, the tobacco product manufacturers, as the quality of the Company's finished product substantially affects the cost and quality of the manufacturer's production. The Company's processing includes grading in the factories, blending, separation of leaf lamina from the stems and packing to precise moisture targets for proper aging. To accomplish these tasks according to exacting customer specifications requires considerable skill and significant investment in plants and machinery.\nThe Company's sales are predominantly flue-cured and burley tobaccos. Universal estimates that in fiscal 1995 it purchased or processed approximately 38% of the flue-cured and burley tobacco produced in the aggregate in the United States, Brazil, Zimbabwe and Malawi. In addition, Universal maintains a presence, and in certain cases a leading presence, in virtually all other tobacco growing regions in the world. Management believes that its leading position in the leaf tobacco industry is based on its broad market presence, its development of processing equipment and technologies, its solid financial position and its ability to meet customer demand through internal growth and selected acquisitions. During the past fiscal year the Company installed a state-of-the-art blending facility in one of its Italian factories as part of an ongoing effort to offer additional services to cigarette manufacturers.\nUniversal has a leading position in worldwide dark tobacco markets. Its operations are located in the major producing countries (i.e., the United States, the Dominican Republic, Indonesia and northern Brazil) and other smaller markets. These types of tobacco are typically used for cigars and smokeless tobacco products. After decades of sales volume declines, the cigar industry has experienced recent growth particularly in the premium segment of the market.\nAlthough consumption of tobacco products in the United States and certain industrialized countries has been declining, consumption in most developing countries has been rising. Moreover, as a result of the elimination of trade barriers in Far Eastern markets and the opening of markets in Eastern and Central Europe, a significant amount of the world's tobacco markets are open to free trade compared to ten years ago.\nReports and speculation with respect to the alleged harmful physical effects of cigarette smoking, restrictions on the use of tobacco products in public places and in advertising, and increases in sales and excise taxes have all had some adverse effect upon cigarette sales in the U.S. and in certain foreign countries. The U.S. Environmental Protection Agency has classified environmental tobacco smoke as a \"Group A\" (\"known human\") carcinogen, which action has been challenged in court by the Company and others. The U.S. Occupational Safety and Health Administration has proposed a standard on indoor air quality which if adopted would substantially limit smoking in the workplace. Federal legislation has been proposed to increase the excise tax on cigarettes, and the U.S. Food and Drug Administration (FDA) is proposing to regulate nicotine as a drug in an effort to deter smoking by minors. The FDA effort has been challenged in the courts. Numerous other legislative and regulatory anti-smoking measures have also been proposed at the federal, state and local levels. It is not possible to predict what, if any, governmental legislation or regulations will be adopted related to tobacco or smoking. However, if any or all of the foregoing were to be implemented, the Company's operating revenues and operating income could be adversely impacted in amounts which cannot be determined.\nLitigation seeking damages for health problems and nicotine addiction alleged to have resulted from the use of tobacco is pending against the leading United States manufacturers of consumer tobacco products. It is not possible to predict the outcome of such litigation or what effect adverse determinations against the manufacturers might have on the business of the Company.\nDomestic Tobacco Business\nUniversal is represented by its buyers on all significant tobacco markets in the United States, including flue-cured tobacco markets in Virginia, North Carolina, South Carolina, Georgia and Florida; Light air-cured (burley and Maryland) tobacco markets in Kentucky, Tennessee, Virginia, North Carolina and Maryland; air-cured tobacco markets in Kentucky and Virginia; dark fired and dark air-cured markets in Virginia, Tennessee and Kentucky; and cigar\/chewing tobacco markets in Connecticut, Pennsylvania and Wisconsin.\nIn the United States, flue-cured and burley tobacco is generally sold at public auction to the highest bidder. In addition, the price of such tobacco is supported under an industry-funded federal program that also restricts tobacco production through a quota system. The price support system has caused U.S. grown tobacco to be more expensive than most non-U.S. tobacco, resulting in a declining trend in exports. Industry leaders continue to explore options including program changes to improve the competitive position of U.S. leaf. Other factors affecting the competitive position of U.S. tobacco include improved methods of production and quality in the U.S. and in foreign countries. In 1994 and 1995, imports of foreign leaf declined in response to legislation enacted in 1993 which required that cigarettes manufactured in the U.S. contain at least 75% U.S. grown tobacco. In September 1995 this legislation was replaced with a somewhat less restrictive tariff rate quota system. To prevent a significant reduction in domestic production quotas, in December 1994 the domestic cigarette manufacturers agreed to purchase 700 million pounds of surplus flue-cured and burley tobacco from the stabilization cooperatives. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Results of Operations\".\nForeign Tobacco Business\nUniversal's business of selecting, buying, shipping, processing, packing, storing, financing, and selling tobacco is, in addition to its domestic operations, conducted in varying degrees in Argentina, Belgium, Brazil, Canada, the Commonwealth of Independent States (the former Soviet Union), Colombia, the Dominican Republic, Ecuador, France, Germany, Greece, Guatemala, Hong Kong, Hungary, India, Indonesia, Italy, Malawi, Mexico, the Netherlands, Paraguay, the People's Republic of China, the Philippines, Spain, Switzerland, Tanzania, Thailand, Turkey, Uganda, the United Kingdom, Zambia and Zimbabwe.\nIn a number of countries, including Brazil, Hungary, Italy and Mexico, Universal contracts directly with tobacco farmers, in some cases before harvest, and thereby takes the risk that the delivered quality and quantity will meet market requirements. The price may be set by negotiation with farmers' groups or with agencies of the local government. In some countries Universal also provides agronomy services and advances for seed, fertilizer and other supplies. Tobacco in Zimbabwe, Malawi and Canada, and to a certain extent in India, is purchased under a public auction system.\nThe Company has made substantial capital investments in Brazil and Africa and the profitability of the operations there can materially affect the operating results of the Company. The Company owns three tobacco leaf processing facilities in Brazil and five in Africa. See \"Properties.\"\nSales to foreign customers are made by Universal's sales force and through the use of commissioned agents. Most foreign customers are long-established firms or government monopolies.\nUniversal's foreign operations are subject to the usual international business risks, including unsettled political conditions, expropriation, import and export restrictions, exchange controls and currency fluctuations. During the tobacco season in many of the countries enumerated above, Universal has advanced substantial sums, has guaranteed local loans or has guaranteed lines of credit in substantial amounts for the purchase of tobacco. Most tobacco sales are denominated in U.S. dollars, thus limiting the Company's currency risk.\nRecent Developments and Trends\nFor recent developments and trends in the Company's tobacco business, see \"Management's Discussion and Analysis of Financial Condition and Results of Operations\".\nSeasonality\nThe purchasing and processing aspects of Universal's tobacco business are seasonal in nature. The United States flue-cured tobacco markets usually open the third week of July and last for approximately four months. The United States burley tobacco markets open in late November and last for approximately two and one-half months. Tobacco in Brazil is usually purchased from January through May. Other markets around the world last for similar periods, although at different times of the year, and this has resulted in less overall seasonality in the Company's business.\nUniversal normally operates its processing plants for approximately seven to nine months of the year. It purchases most of the tobacco which it redries and packs in the U.S. in the eight-month period, July through February. During this period, inventories of green tobacco, inventories of redried tobacco and trade accounts receivable normally reach peak levels in succession. Current liabilities, particularly short-term notes payable to banks, commercial paper and customer advances are a means of financing this expansion of current assets and normally reach their peaks in this period. At the end of the Company's fiscal year (June 30), these seasonal expansions in the United States are normally not reflected in the components of working capital. Seasonal expansions are reflected at that time, however, for Universal's operations in Brazil, Italy and Mexico.\nCustomers\nA material part of the Company's tobacco business is dependent upon a few customers, the loss of any one of whom would have an adverse effect on the Company. The Company has long-term contracts (which under certain circumstances may be amended or terminated) with a few of these customers, and, while there are no formal continuing contracts with the others, the Company has done business with each of its major customers for over 35 years. For the year ended June 30, 1995, tobacco sales to Philip Morris Companies, Inc. accounted for greater than 10% of consolidated revenues. See Note 12 to Consolidated Financial Statements. Five other customers accounted for approximately 14%.\nUniversal had orders from customers in excess of $278 million for its tobacco inventories at June 30, 1995. Based upon historical experience, it is expected that at least 90% of such orders will be delivered during the fiscal year ending June 30, 1996. Typically, delays in the delivery of orders result from changing customer requirements. Orders from customers at June 30, 1994, were in excess of $231 million, of which over 90% was delivered in the following fiscal year. The level of purchase commitments for tobacco fluctuates from period to period and is significant only to the extent that it reflects short-term changes in demand for redried tobacco.\nCompetitors\nCompetition among leaf tobacco merchants is based on the price charged for products and services as well as the firm's ability to meet customer specifications in the buying, processing, and financing of tobacco. Universal has many processing plants equipped with the latest technology and a world-wide buying organization of tobacco specialists which, management believes, give it a competitive edge. See \"Properties.\" Competition varies depending on the market or country involved. Normally, there are from five to seven buyers on each of the United States flue-cured and burley markets. The number of competitors in foreign markets varies from country to country, but there is competition in all areas to buy the available tobacco. The principal competitors in the industry that do not manufacture consumer tobacco products and that compete with the Company on the United States markets and on foreign markets are as follows: DiMon Incorporated, Export Leaf Tobacco Company, and Standard Commercial Corporation. Of the significant competitors in the United States that are not also manufacturers, Universal believes that it ranks first in total U.S. market share and also first in total worldwide market share.\nC. Description of Agri-Products Business\nThe Company's agri-products business involves the selecting, buying, shipping, processing, storing, financing, distribution, importing and exporting of a number of products including tea, rubber, sunflower seeds, nuts, dried fruit, canned meats, spices and seasonings. During the past fiscal year, the Company acquired a leading spice distribution company in Belgium and a small seed cleaner\/merchandiser in the Netherlands.\nThe emphasis of the Company's agri-products business is on value-adding activities and\/or trading of physical products in markets where a real function can be performed in the supply system from the countries of origin to the consuming industries. In a number of countries, longstanding sourcing arrangements for certain products or value-adding activities through modern processing facilities (tea, spices and sunflower seeds) contribute to the stability and profitability of the business. Traders are subject to strict trading limits to minimize speculative risks and allow effective management control. Seasonal effects on trading are limited.\nThe Company provides various products to numerous large and small customers in the food and food packaging industry and in the rubber and tire manufacturing industry. Generally, there are no formal continuing contracts with these customers, although business relationships may be longstanding. No single customer accounts for 10% or more of the Company's consolidated agri-products revenues.\nCompetition among suppliers in the agricultural products in which Universal deals is based on price as well as the ability to meet customer requirements in product quality, buying, processing, financing and delivery. The number of competitors in each market varies from country to country but there is competition for all products and markets in which the Company operates. Some of the main competitors are: Agway, Akbar Brothers, Andrew Weir Commodities, Burns Philip, Ennar, Cargill, Dahlgren, Global, EP Lambert Co., Finlay, Fuchs, Metallgeschellschaft\/SAFIC Alcan, Stassens, Symington, Universal Tea, UTT (Unilever) and Verstegen.\nFor recent developments and trends in the Company's agri-products business, see \"Management's Discussion and Analysis of Financial Condition and Results of Operations\".\nD. Description of Lumber and Building Products Business\nThe Company is engaged in the lumber and building products business in the Netherlands and Belgium. The majority of lumber products are sourced outside the Netherlands, principally in North America, Scandinavia, Eastern and Western Europe, and the Far East.\nThe lumber and building products business is seasonal to the extent that winter weather may temporarily interrupt the building industry which in turn affects this segment. The business is also subject to exchange risks and other normal market and operational risks associated with lumber operations centered in Europe including general economic conditions in the countries where the Company is located and related trends in the building and construction industries.\nThe Company's sales activities in this segment are conducted through three business units: regional sales, wholesale\/do-it-yourself (DIY) sales and industrial sales. The regional sales unit distributes and sells lumber and related building products through a network of regional outlets, mainly to the building and construction market. The wholesale\/DIY business unit supplies timber merchants and DIY chains with a wide range of panel products and doors. The industrial sales unit consists mainly of Heuvelman, a premier softwood distributor of value-added products to the construction industry. Both Heuvelman and a small timber processor in the south of Holland were acquired during the past fiscal year.\nThe Company carries inventories to meet customers' demands for rapid delivery. The level of inventories is based on a balance between providing service and continuity of supply to customers and achieving the highest possible turnover. The Company does not provide extended payment terms to its customers. No single customer accounts for 10% or more of the Company's consolidated lumber and building products revenues.\nThe Company's lumber and building products sales accounted for approximately 20% of the total market volume for the Netherlands, which is slightly above the market share of its largest competitor, Pont-Meyer N.V. Ten additional competitors account for approximately 20% to 30% of the market share and the balance is held by approximately 200 smaller competitors. The primary factors of competition are quality and price, product range and speed and reliability of logistic systems. The Company believes that its full geographical market coverage, its automated inventory control and billing system and its efficient logistics give it a competitive advantage in the Netherlands. The Company's share of the highly fragmented Belgium lumber and building products market is approximately 3%.\nFor recent developments and trends in the Company's lumber and building products business, see \"Management's Discussion and Analysis of Financial Condition and Results of Operations\".\nE. Employees\nThe Company employed approximately 30,000 employees throughout the world during the fiscal year ended June 30, 1995. This figure is estimated because many of the non-salaried personnel are seasonal employees.\nUniversal believes that in the United States approximately 1,300 of the non-salaried employees of its consolidated tobacco subsidiaries are represented by unions. Most of these are seasonal employees. The Company's labor relations have been good.\nF. Research and Development\nNo material amounts were expended for research and development during the fiscal years ended June 30, 1995, 1994, and 1993.\nG. Patents, etc.\nThe Company holds no material patents, licenses, franchises or concessions.\nH. Environmental Matters\nCompliance with Federal, state and local provisions regarding the discharge of materials into the environment, or otherwise relating to the protection of the environment, has not had, and is not anticipated to have, any material effect upon the capital expenditures, earnings or competitive position of the Company.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nUniversal owns the land and building located at Hamilton and Broad Streets in Richmond, Virginia, where it is headquartered. The building contains approximately 83,000 square feet of floor space. The Company also owns a smaller office building nearby which contains approximately 11,300 square feet of floor space.\nIn its domestic tobacco processing operations, Universal owns six large, modern, high volume plants which have the capacity to thresh, separate, quality grade and redry tobacco. Four of these plants are located in North Carolina (Wilson, Henderson, Rocky Mount and Smithfield), one plant is in Danville, Virginia, and one plant is in Lexington, Kentucky. The Henderson plant has a production capacity of over 140 million pounds of green tobacco and 500,000 square feet of floor space. The Wilson plant has approximately 500,000 square feet of floor space and a production capacity of over 130 million pounds of green tobacco. The remaining four plants each have a floor space of 300,000 to 400,000 square feet and an average annual production capacity of over 100 million pounds of green tobacco. Universal also owns a processing facility in Dinwiddie County, Virginia with 250,000 square feet of floor space.\nThe Company owns tobacco processing plants in the following foreign locations: a large processing plant in Canada; one large processing plant and one smaller plant in Malawi; three large processing plants in Italy; three plants in Zimbabwe; and plants in Hungary and Turkey. In Brazil, Universal owns three large plants one of which is for sale. Universal operates a plant in the Philippines. The Company's plant in Thailand has been closed and is for sale and a plant in Greece is for sale.\nThe facilities described above are engaged primarily in processing tobacco used by manufacturers in the production of cigarettes. In addition, Universal owns plants that process cigar\/chewing tobaccos in Lancaster, Pennsylvania; Kenbridge, Virginia; the Dominican Republic; Colombia; Indonesia; and Brazil. It operates sheet manufacturing plants in the Netherlands and in Germany.\nUniversal owns or leases extruder plants (baling operations), packaging stations and warehouse space in the tobacco-growing states and abroad. Large extruder plants are owned in Lumberton and Rocky Mount, North Carolina; Danville, Virginia; Greeneville, Tennessee; and Lexington and Bowling Green, Kentucky.\nThe processing and extruder plants are operated seasonally. The large processing plants usually are in operation from seven to nine months out of the year. A portion of Universal's tobacco inventory is stored in public storages. The following storages are owned:\n(a) Wilson, North Carolina - 12 storages covering 460,000 square feet;\n(b) Smithfield, North Carolina - 7 storages covering 240,000 square feet;\n(c) Henderson, North Carolina - 6 storages covering 178,500 square feet;\n(d) Rocky Mount, North Carolina - 3 storages covering 133,000 square feet;\n(e) Danville, Virginia - 4 storages covering 153,000 square feet;\n(f) Lexington, Kentucky - 5 storages covering 127,000 square feet; and\n(g) Kenbridge, Virginia - 7 storages covering 243,000 square feet.\nAdditional storage space is leased in Danville, Virginia; Lexington, Kentucky; and Smithfield, Henderson and Rocky Mount, North Carolina. Lancaster Leaf Tobacco Company of Pennsylvania, Inc. owns storage space with a capacity of 19,300 tons of tobacco and leases additional storage space. In other U.S. tobacco areas, Universal owns or leases storages on a smaller scale. In foreign areas storage space is owned or leased on a comparable scale.\nThe Company believes that the above-listed properties are maintained in good operating condition and are suitable and adequate for its purposes at current sales levels. Facilities owned are not subject to indebtedness except for those in Dinwiddie County and Kenbridge, Virginia, which are financed in part through governmental industrial development authorities.\nThe Company's agri-products subsidiaries own and operate a tea blending plant in the Netherlands, a tea warehouse and office in Sri Lanka, spice blending facilities in the Netherlands, a bean processing plant in Park Rapids, Minnesota, small grain processing facilities in Delaners, North Dakota and Zevenbergen, the Netherlands, and sunflower seed processing plants in Lubbock, Texas; Colby, Kansas; and Fargo, North Dakota. These latter two facilities are financed in part through governmental industrial development authorities. The Company has leased agri-products trading offices around the world, including locations in New York, London, Warsaw, Rotterdam, Belgium, Indonesia, Kenya and Malawi.\nThe lumber and building products division owns or leases 38 sales outlets in the Netherlands and six sales outlets in Belgium. It also has five storage and distribution warehouses, a softwood facility for large scale sawing, planing and fingerjointing, and a building components manufacturing facility, all in the Netherlands. Most of these locations are owned.\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\nDuring the quarter ended June 30, 1995, 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 SHAREHOLDER MATTERS\nDividend and market price information is as follows:\nThe Company expects the past trend of dividend payments to continue, subject, however, to its future earnings and financial condition. At June 30, 1995 there were 3,741 holders of record of the registrant's common stock which is traded on the New York Stock Exchange.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nFive-Year Comparison of Selected Financial Data For Years Ended June 30\nFiscal year 1995 includes a $15.6 million ($10.7 million net of tax) restructuring charge.\nFiscal year 1994 reflects the cumulative effect of the change in accounting principle ($29.4 million) resulting from the adoption of SFAS 106 \"Employer's Accounting for Postretirement Benefits Other Than Pensions\" as well as a $17.5 million ($11.8 million net of tax) restructuring charge.\nFiscal 1994 and prior years have been restated to reflect the consolidation of certain foreign susidiaries that had been accounted for under the cost or equity method of accounting.\nAmounts for 1991 have been reclassified to include the results of operations and financial position of Lawyers Title as discontinued operations as a result of a spinoff to shareholders.\nPer common share information reflects December 1991 two-for-one stock split.\nFiscal year 1991 reflects an extraordinary loss ($3.8 million) resulting from a provision for the uncollectability of a receivable from the Iraqi State Tobacco Monopoly as a result of the Persion Gulf war.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nLiquidity & Capital Resources\nDuring a year that reflected the continued impact of adverse market conditions, the Company maintained its financial strength and improved its operating efficiency. The restructuring plan announced in fiscal year 1994 has been implemented and a second program was approved in June 1995. As part of those programs, a number of facilities have been closed and operations have been rationalized.\nWorking capital declined by approximately $54 million to $265 million. Although this decline related primarily to short-term financing of acquisitions that occurred during the year, the Company also reduced its tobacco inventories and receivables. The level of uncommitted inventories was significantly reduced from the 1994 level.\nThe Company's capital needs are predominantly short term in nature and relate to working capital required for financing crop purchases. The working capital needs of the Company are seasonal within each geographical region. Generally, the peak need of domestic tobacco operations occurs in the second quarter of the fiscal year. Foreign tobacco operations tend to have higher requirements in the remainder of the year. The geographical dispersion and the timing of working capital needs permit the Company to predict its general level of cash requirements during the year. Each geographic area follows the cycle of buying, processing, and shipping of the tobacco crop. The timing of individual customer shipping requirements may change the level or the duration of crop financing. The working capital needs of individual agri-products operations fluctuate during the year, depending on the product, the country of origin, and the Company's inventory position; however, the total working capital requirements of agri-products during the year remain relatively stable due to offsetting seasonal patterns. Working capital needs of lumber and building products in Europe follow a pattern similar to that of the construction industry in which the third quarter of the fiscal year is typically sluggish. The Company finances its working capital needs with short-term lines of credit, exchange contracts for export prefinance, customer advances, and trade payables.\nInternational tobacco trade generally is conducted in U.S. dollars, thereby limiting foreign exchange risk to that which is related to product costs and overhead in the country in which tobacco is sourced. Because there are no forward foreign currency markets for the currencies of the major countries in which the Company purchases its tobacco, the Company manages its risk by matching the currency of funding for inventory purchases with the currency of the related sales and by minimizing the net investment in these countries. In addition, it is generally accepted practice in the tobacco processing industry that customers pay a market rate of interest for inventory purchased to their order; thus, changes in interest rates do not have a major impact on the Company's income and are not considered a source of significant risk.\nThe Company's agri-products and lumber operations, which are based in the United States and in the Netherlands, do business in a number of foreign countries. These operations enter into forward exchange contracts to hedge firm purchase and sales commitments in foreign currencies (principally Dutch guilders, U.S. dollars, pounds sterling, and Swedish kronas). The term of currency hedges is generally from one to six months.\nLong-term investments are reflected in \"Cash flows from investing activities.\" Over the last three years, total investment needs of $279 million were provided by cash flow from operating activities and the issuance of common stock in 1993 supplemented by long-term debt. Investments in fiscal year 1995 included the acquisition of the premier distributor of value-added softwood products in Holland as well as two smaller distributors in Belgium and Holland. In addition, the Company acquired a spice distribution company in Belgium and is negotiating a related joint venture that is expected to be the market leader in the Benelux area. These acquisitions required a net cash investment of $63 million in fiscal year 1995, which was funded primarily with previously existing credit lines.\nThe Company's capital expenditures are generally limited to those that add value to the customer, replace obsolete equipment, increase efficiency, or position the Company for future growth. During fiscal year 1995, Universal made substantial progress on the installation of a processing facility in China that is expected to be completed in late 1995. A state-of-the-art blending facility was installed in Italy and process improvements were completed in Hungary. In fiscal year 1994, a new processing line was added to the Company's facility in Malawi. Management believes that these operations represent significant opportunities for growth over the long term. At June 30, 1995, the Company had no material commitments for capital expenditures\nThe Company believes that its financial resources are adequate to support its capital needs. The Company and its subsidiaries currently have $1.5 billion in uncommitted lines of credit of which $900 million was available at June 30, 1995, to support future seasonal working capital needs in the United States and several foreign countries. In addition, the Company has $100 million in an unused committed facility under a revolving credit agreement. This facility is also available to support the future issuance of commercial paper. The Company's debt ratings are investment grade, and it has reduced the ratio of long-term debt to total capitalization to approximately 41%. Any excess cash flow from operations after dividends, capital expenditures, and long-term debt payments will be available to reduce short-term debt, or fund expansion.\nResults of Operations\nFiscal Year 1995 Compared to 1994\nIn fiscal year 1995, the Company began reporting its African operations on a consolidated basis. Previously, these operations were reported either on the cost or equity method. The change in reporting did not materially effect the results of operations, and all prior years have been restated to reflect this change.\nConsolidated revenues were up $232 million or 7.6% in fiscal year 1995 compared to 1994. Gross revenues in all three operating segments were up over the prior year, with lumber and building products accounting for over 60% of the consolidated increase. The improvement in lumber was due to a combination of increased sales, the inclusion of full year results of 1994 acquisitions and results of acquisitions in fiscal year 1995, and exchange rate differences. The total increase in revenues related to these acquisitions was almost $70 million. Domestic tobacco revenues were up $137 million because of an increase in sales and purchasing volume of about 16%. This improvement was due to the improved quality of the domestic crops as the Company purchased more tobacco for customers.\nTobacco operating profits were down 15.8% or $19 million compared to fiscal year 1994's results. Tobacco operating profits in fiscal year 1995 included $15.6 million of restructuring charges compared to $17.5 million in 1994. The lower results in fiscal year 1995 reflect the continued pressure on margins from the unbalanced supply and demand situation. At the end of fiscal year 1994, the worldwide leaf oversupply led to reduced prices and margins; shipments of discounted stocks from that oversupply continued well into fiscal year 1995. Although worldwide production declined in fiscal year 1995, the positive impact of an improved balance between supply and demand began to emerge later in the year and should benefit results in fiscal year 1996. In addition to the reduced margins on sales of foreign tobacco, the Company recorded a total of $10.7 million of tobacco inventory write-downs. Almost $7 million of the write-downs was related to Indonesian tobacco and the Company's decision to revise its operating approach to Eastern Europe in light of the economic instability of the area. Write-downs in 1994 were $27 million. Domestic tobacco's operating profits improved on increased volumes despite a significant drop in processing volume for the stabilization cooperatives. The volumes handled for the cooperatives in any one year are affected by domestic crop size, its price and quality, and market demand. Although tobacco results were disappointing in fiscal year 1995, the Company is confident that, with the implementation of its restructuring plans, it is well positioned for long-term growth.\nLumber and building products operating income for fiscal year 1995 was up 12.8% or $2.4 million largely due to the acquisition of Heuvelmann and a strong performance by the wholesale companies during the year. The acquisition, while not significant to consolidated operations, had a positive impact on this segment's results. Operating profits as a percentage of sales decreased from 5.1% in fiscal year 1994 to 4.1% in 1995 due to the adverse effects of a strike in the Dutch building industry, higher labor costs, and low prices for tropical plywood and hardwoods; however, improved volumes and acquired operations more than offset those factors. Agri-products operating income increased $2.7 to $11.9 million in fiscal year 1995. The majority of this increase was due to the discontinuation of coffee trading near the end of fiscal year 1994; that operation had recorded losses during the year. Trading activity in rubber showed improved results on the strength of higher prices. Tea results improved despite a flat market from continuing worldwide oversupply. In addition, improved earnings were reported in confectionery sunflower seeds.\nSelling, general and administrative expenses increased $18 million or 5.9% compared to 1994. Of the increase, $10 million was due to the acquisition of the Heuvelmann lumber operation in fiscal year 1995, and approximately $5.5 million of the increase related to provisions for customer obligations in Eastern Europe and other areas. Interest expense in fiscal year 1995 dropped almost $6 million compared to last year due to a combination of less crop financing in local currencies and reduced levels of inventory financing during the year.\nFiscal year 1995's income tax rate increased to 44.6% due to a combinations of factors. Full statutory benefits were not recognized on the restructuring charge or on the inventory write-downs and provisions related to Eastern Europe. In addition, the Company provided for limitations on the realization of foreign tax credits. The Company's consolidated income tax rate is affected by a number of factors, including but not limited to: the mix of domestic and foreign earnings, subsidiary local tax rates, the Company's policy regarding repatriation of foreign earnings, and its ability to utilize foreign tax credits. Historically, the Company has been able to fully credit foreign taxes paid against U.S. taxes on foreign earnings. Due to shifts in the mix of earnings and increases in foreign effective tax rates, the utilization of foreign tax credits may be limited in the future. The limitation would have the effect of increasing the Company's consolidated tax rate. However, the Company, through the implementation of a number of tax planning strategies, is taking steps to minimize the potential increase in its tax rate above the statutory rate.\nIn fiscal year 1995, the Company continued its effort to streamline operations by approving the 1995 restructuring plan pursuant to which it recorded a charge of $15.6 million. The plan is in addition to the rationalization and consolidation of operations approved in fiscal year 1994. The charge includes $7.2 million for the expected severance payments related to approximately 200 employees throughout the Company. The remainder of the charge was for the write-down of fixed assets in newly consolidated operations ($3.7 million), payments to terminate occupancy of leased facilities ($3 million), and other nonoperating restructuring costs ($1.7 million). Cash payments of $5 million had been made as of June 30, 1995, approximately half of which was for the termination of leases; the balance represented severance costs of 35 employees. When fully implemented by the end of fiscal year 1996, the plan is expected to yield annual savings approximating half the amount of the charge.\nFiscal Year 1994 Compared to 1993\nConsolidated revenues in fiscal year 1994 declined $29 million, less than 1% compared to 1993. The decline was mitigated by the inclusion of twelve months of Casalee's 1994 sales versus the six weeks included in fiscal year 1993. Tobacco revenues declined $66 million primarily due to the poor quality U.S. flue-cured crop and reduced worldwide demand for all growths. Lumber and building product revenues declined in fiscal year 1994 principally due to exchange rate differences. An increase of $53 million in agri-product revenues in fiscal year 1994 was attributable to increased nut and canned meat trading.\nTobacco operating profit of $121.8 million in fiscal year 1994 was net of a $17.5 million restructuring charge. Excluding the restructuring charge, tobacco operating profits were down $44 million or almost 25% compared to 1993. Included in fiscal year 1994 results were $27 million of inventory write-downs compared to approximately $14 million in fiscal year 1993. Tobacco operating results in fiscal year 1994 reflect a number of adverse factors in the United States, including a poor quality flue-cured crop and domestic content legislation, as well as market reactions to the expectation of an increased excise tax on cigarettes. In addition to these domestic issues, there was a worldwide glut of tobacco caused by reduced demand in the face of record crops. Total domestic tobacco purchases in fiscal year 1994 were down primarily due to lower purchases of the poor quality flue-cured crop. However, processing volumes were comparable to 1993 as reduced cigarette manufacturer orders were offset by significantly larger volumes of tobacco processed for the stabilization cooperatives. In addition to the adverse effects of the 1994 crop volumes, domestic tobacco results in fiscal year 1994 were down on a comparative basis to 1993 due to customer-mandated hold-over shipments recorded in the first quarter of fiscal year 1993. International tobacco profits for fiscal year 1994 were down principally due to the pressure on margins which reduced sales profits and resulted in significant inventory write-downs.\nLumber and building product operations reported higher operating results in fiscal year 1994 due to increased prices for hard and softwoods. Operating profits of the lumber and building products segment in fiscal year 1993 included a pre-tax gain of $3.8 million realized on the sale of the Company's flatboard finishing operation. Excluding the gain, lumber and building products operating profits increased almost 50% in 1994. Agri-product operating results were down approximately 15% in fiscal year 1994 compared to 1993. Improved results in nuts and sunflower seeds were more than offset by shortfalls in tea and coffee. Sunflower seed operations benefited from increased demand and a smaller crop, while tea operations were adversely affected by a weak market. Losses in coffee trading in fiscal year 1994 reflected the continuing volatility of those markets and led to the decision by the Company to terminate this business.\nSelling, general and administrative expenses increased $40 million as a result of the inclusion of Casalee's operations for the full fiscal year in 1994. This increase was slightly offset by declines in selling and shipping expenses on reduced volumes in fiscal year 1994. Interest expense in fiscal year 1994 increased $10 million due to increased inventory levels, longer holding periods, and increased levels of higher rate long-term financing. The Company's effective tax rate for fiscal year 1994 was 30.3% compared to 37.7% in 1993. The decrease in 1994 was due to a higher proportion of foreign earnings which were deemed permanently reinvested compared to 1993.\nIn June 1994, the Company recorded a $17.5 million restructuring charge which included approximately $16 million of severance provisions for approximately 700 of the Company's employees. The plan was implemented in fiscal year 1995 and funded with cash from operations. Savings from the 1994 plan are expected to approximate $19 million annually and relate primarily to reduced compensation.\nIn the first quarter of fiscal year 1994, the Company adopted SFAS 106 and elected to record a one-time charge of $29.4 million; subsequently, in the third quarter the Company amended its post-employment benefit plans. The effect of the amendment is expected to substantially offset the effect on earnings from SFAS 106. See Note 9 for more information.\nOther Information Regarding Trends and Management's Actions\nOver the last two years, the worldwide surplus of tobacco has had a significant impact on the industry and on the Company's results. During fiscal year 1995, a more balanced supply and demand relationship began to emerge. Worldwide production of flue-cured and burley tobaccos was estimated to be at least 20% below the fiscal year 1994 level, and much of the uncommitted inventory held by merchants at the end of fiscal year 1994 was sold in 1995, albeit at discounted prices. In December 1994, U.S. cigarette manufacturers and the stabilization cooperatives negotiated a buy-out of unsold U.S. stocks. Import restrictions under the U.S. domestic content law are slated to be replaced by tariff rate quotas, which should permit U.S. tobacco imports to recover somewhat from the very low levels attained in the past year. In addition, the threatened U.S. excise tax increase, which had depressed U.S. market expectations, did not materialize. Reduced world leaf production and the reduction of uncommitted inventories in the last year has improved the outlook for the merchant industry.\nOver the past few years, particularly in the United States, restrictions on cigarette smoking in public places and advertising have increase substantially, and the tobacco industry has been under unprecedented legislative and regulatory attack. Most recently the U.S. Food and Drug Administration (FDA) has proposed to regulate nicotine as a drug in an asserted effort to deter smoking by minors. The FDA effort has been challenged in the courts. Numerous other legislative and regulatory anti-smoking measures have also been proposed at the federal, state and local levels, and product liability litigation is pending against the leading U.S. manufacturers of tobacco products. It is not possible to predict what, if any, governmental legislation or regulations will be adopted related to tobacco or smoking, or the outcome of product liability litigation, and the effect thereof on consumption of tobacco products.\nCigarette consumption has been growing at a 1% annual rate worldwide, and a number of new or changing markets offer sourcing or sales opportunities for the Company, especially in Eastern Europe, China, the republics of the former Soviet Union, and developing countries in the Pacific Rim. China, where Universal is active, offers potential as the largest consumer of tobacco products in the world and as a source of low-priced filler style tobaccos for the export market. The republics of the former Soviet Union offer potentially large leaf markets as internal production has declined and demand has been artificially constrained by economic dislocation and lack of foreign exchange.\nA key trend in the tobacco industry has been consolidation among manufacturers and among merchants. This concentration should increase the need for better quality tobacco and improved processing which provides a good opportunity for the Company. However, it may also make demand for particular growths of tobacco less predictable.\nThe Company has a very large presence in the U.S. market where leaf has not been price competitive with the world market. If not corrected through tobacco program reforms and reduced support prices, this could result in a decline in U.S. production and marketings in the future. Management does not believe that a significant decline in the United States is imminent. The Company's operations are well placed to supply leaf from many sources in world markets, and the business is not capital intensive.\nIn its lumber and building products area, the Company has been leading a trend toward consolidation of a fragmented industry in Holland and has proved itself an attractive business partner in that environment.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nUniversal Corporation and Subsidiaries CONSOLIDATED STATEMENTS OF INCOME Years Ended June 30, 1995, 1994 and 1993\nSee accompanying notes.\nUniversal Corporation and Subsidiaries CONSOLIDATED BALANCE SHEETS June 30, 1995 and 1994\nSee accompanying notes.\nUniversal Corporation and Subsidiaries CONSOLIDATED BALANCE SHEETS June 30, 1995 and 1994\nUniversal Corporation and Subsidiaries CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended June 30, 1995, 1994 and 1993\nSee accompanying notes.\nUniversal Corporation and Subsidiaries CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY Years Ended June 30, 1995, 1994 and 1993\nSee accompanying notes.\nUniversal Corporation and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(All dollar amounts are in thousands, except as otherwise noted)\nNote 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPrinciples of Consolidation\nThe financial statements include the accounts of all controlled domestic and foreign subsidiaries. All material intercompany items and transactions have been eliminated. The fiscal years of foreign subsidiaries generally end March 31 or April 30 to facilitate timely reporting. The Company uses the equity method of accounting for its investments in affiliates which generally are owned less than 50%.\nEffective fiscal year 1995, the Company consolidated the results of affiliates located in Malawi and Zimbabwe into its financial statements. After changes in local governmental policies, the Company can now exercise greater control over operations including the remittance of dividends. Prior to fiscal 1995, affiliates located in Malawi were accounted for under the equity method and affiliates in Zimbabwe under the cost method. Financial data for all prior periods presented has been restated to reflect the consolidation. Before the effects of consolidation, consolidated net income for the years ended June 30 was as follows:\n1995 1994 1993\nNet income $23,768 $9,158 $80,242 Earnings per share $ .68 $ .26 $ 2.39\nCash and Cash Equivalents\nThe Company considers all highly liquid investments with a maturity of three months or less at the time of purchase to be cash equivalents.\nInventories\nInventories of tobacco and agri-products are valued at the lower of specific cost or market. In determining lower of cost or market for agri-products, an entire position, i.e., tea, including forward purchase and sales contracts, is considered. Net unrealized losses by position are charged to income. However, no recognition is given to net unrealized gains. All other inventories are valued principally at lower of average cost or market.\nReal Estate, Plant and Equipment\nDepreciation of plant and equipment is based upon historical cost and the estimated useful lives of the assets. Depreciation of property used in domestic tobacco operations is calculated using the declining balance method in the early years and the straight-line method thereafter. All other properties are generally depreciated using the straight-line method. Estimated useful lives of buildings range from fifteen to forty years and machinery and equipment range from three to ten years.\nGoodwill and Other Intangibles\nGoodwill and other intangibles include the excess of the purchase price of acquired companies over the net assets, covenants not to compete and pension intangibles. Goodwill and other intangibles are generally amortized using the straight-line method over periods not exceeding 40 years. Accumulated amortization at June 30, 1995, and 1994 was $19.6 and $11.3 million, respectively.\nIncome Taxes\nThe Company provides deferred income taxes on temporary differences arising from employee benefit accruals, depreciation, deferred compensation, and undistributed earnings of consolidated subsidiaries and unconsolidated affiliates not permanently reinvested. At June 30, 1995, the cumulative amount of undistributed earnings of consolidated subsidiaries on which no provision for U.S. income taxes had been made was $64.6 million.\nFair Values of Financial Instruments\nThe fair values of the Company's long-term obligations have been estimated using discounted cash flow analyses based on the Company's current incremental borrowing rates for similar types of borrowing arrangements.\nThe carrying amount of all other current assets and liabilities as reported in the balance sheet at June 30, 1995 and 1994, which qualify as financial instruments, approximates fair value.\nDerivative Financial Instruments\nDerivative financial instruments are used by the Company principally in the management of its foreign currency exposures. Realized and unrealized gains and losses on the Company's foreign currency contracts that are designated and effective as hedges are recognized in income in the same period as the foreign exchange gains and losses on the underlying transactions are recorded. The carrying amounts, including realized and unrealized gains and losses, of foreign currency derivatives are reflected under the same balance sheet captions as the hedged transactions. The Company does not enter into derivative financial instruments for trading purposes.\nPostretirement Benefits Other Than Pensions\nOn July 1, 1993, the Company adopted SFAS 106 \"Employers' Accounting for Postretirement Benefits Other Than Pensions\". The initial effect of adopting the statement was recorded in fiscal 1994 as a cumulative effect of a change in accounting principle. See Note 9.\nTranslation of Foreign Currencies\nThe financial statements of foreign subsidiaries where the local currency is the functional currency are translated into U.S. dollars using exchange rates in effect at period end for assets and liabilities and average exchange rates during each reporting period for results of operations. Adjustments resulting from translation of financial statements are reflected as a separate component of shareholders' equity.\nThe financial statements of foreign subsidiaries where the U.S dollar is the functional currency and which have certain transactions denominated in a local currency are remeasured as if the functional currency were the U.S. dollar. The remeasurement of local currencies into U.S. dollars creates translation adjustments which are included in net income. Exchange losses in 1995, 1994 and 1993 resulting from foreign currency transactions were $4.7, $3.7 and $1.0 million, respectively (including $2.6, $6.7 and $2.4 million resulting from foreign currency translation losses) and are included in the respective statements of income.\nReclassification\nAmounts in prior years' statements have been reclassified to be reported on a consistent basis with the current year's presentation.\nNote 2 - ACQUISITIONS\nOn February 12, 1993, the Company acquired substantially all of the tobacco operations of The Casalee Group SA (Casalee) through the purchase of all of Casalee's capital stock and certain of its subsidiaries at a cost of approximately $100 million. The acquisition has been accounted for by the purchase method of accounting. For financial reporting purposes, the accounts of Casalee are on a March 31 fiscal year basis, and are consolidated with the Company's June 30 fiscal year. Accordingly, the consolidated results of operations for the fiscal year ended June 30, 1993 include the results of Casalee from the acquisition date thru March 31, 1993. Unaudited pro forma consolidated results of operations for the year ended June 30, 1993 as though Casalee had been acquired at the beginning of the fiscal year, follow:\nGross revenues $3,290,355 Net income 53,333 Earnings per share* $ 1.50\n* Weighted average shares outstanding includes 2.7 million shares assumed to have been issued at the beginning of 1993.\nNote 3 - RESTRUCTURING\nIn the fourth quarter of fiscal years 1995 and 1994 , plans were developed to reduce the Company's worldwide cost structure including the consolidation of certain tobacco operations and a reduction in the number of employees. Fiscal 1995's consolidated statement of income includes an estimated $15.6 million pretax charge ($10.7 million net of tax benefits, or $.31 per share) related to the 1995 plan. This charge includes $7.2 million for the expected severance payments related to approximately 200 employees throughout the Company. The non-severance portion of the charge was for the write-down of fixed assets in operations consolidated ($3.7 million), payments to terminate occupancy of leased facilities ($3 million), and other nonoperating restructuring costs ($1.7 million). As of June 30, 1995, cash payments of $5 million had been made, approximately half of which was for the termination of leases and the balance to cover severance costs of 35 employees. In fiscal 1994 the Company had estimated and recorded a $17.5 million pre-tax restructuring charge. During fiscal 1995 the prior year's plan was implemented. Through June 30, 1995 the actual number of employees severed was almost equal to the 700 estimated. The total 1994 restructuring charge incurred was approximately $200 thousand less than the estimate last year and the difference is reported as a reduction of the restructuring amount in fiscal 1995.\nNote 4 - BUSINESS SEGMENT AND GEOGRAPHIC INFORMATION\nThe Company operates principally in three business segments:\nTobacco\nSelecting, buying, shipping, processing, packing, storing and financing leaf tobacco in the United States and other tobacco growing countries for the account of, or for resale to, manufacturers of tobacco products throughout the world.\nLumber and Building Products\nDistribution of lumber and building products to the building and construction market in Europe, primarily in Holland.\nAgri-Products\nTrading and processing tea and sunflower seeds and trading other products from the countries of origin to various customers in the consuming industries throughout the world.\nGenerally, sales between geographic areas are priced to generate a reasonable profit margin. Sales between business segments are insignificant.\nOperating profit is total revenue less operating expenses. In computing operating profit, none of the following items have been added or deducted: general corporate expenses, interest expense, income taxes and equity in net income of unconsolidated affiliates.\nIdentifiable assets are those of the Company that are identified with the operations in each industry group. Corporate assets are principally the fixed assets of the Company's administrative offices.\nU.S. Export Sales by Geographic Area\n1995 1994 1993\nEurope $266,682 $182,140 $302,733 Asia 179,737 203,197 168,075 Other Areas 51,962 27,321 33,895 $498,381 $412,658 $504,703\nThe fair value of the Company's long-term obligations was approximately $298 million at June 30, 1995 and $310 million at June 30, 1994. Certain notes are denominated in local currencies of foreign subsidiaries. Effective U.S. dollar interest rates vary based on exchange rate fluctuations.\nIn connection with the senior notes, the Company must meet certain financial covenants including maintainence of $300 million minimum shareholders' equity and restrictions on the issuance of long-term debt.\nOTHER INFORMATION:\nMaturities of long-term debt for the fiscal years succeeding June 30, 1995 are as follows: 1996-$31,476; 1997-$89,427; 1998-$23,413; 1999-$24,549; 2000-$20,988; 2001 and after-$126,571.\nNOTE 8 - PENSION PLANS\nThe Company and its subsidiaries have several defined benefit pension plans covering United States and foreign salaried employees and certain other employee groups. These plans provide retirement benefits based primarily on employee compensation and years of service. The Company's funding policy for domestic plans is to make contributions currently to the extent deductible under existing tax laws and regulations, subject to the full-funding limits of the Employee Retirement Income Security Act of 1974. Foreign plans are funded in accordance with local practices. Domestic and foreign plan assets consist primarily of fixed income securities and equity investments. Unamortized gains and losses and prior service costs are amortized equally over the average remaining service period of employees. Information regarding net pension cost and the funded status of domestic and foreign plans was as follows:\nSFAS 87 \"Employers' Accounting for Pensions,\" required the Company to recognize an additional minimum liability of $1.8 and $2.4 million for the unfunded accumulated benefit obligation in 1995 and 1994, respectively. An equal amount was recognized as an intangible asset in those years. Assumptions used in the computations were:\n\t 1995 1994\t1993 Discount rate: Domestic 8.00% 7.25%\t7.75% Foreign 7.00% 6.00%\t7.00%\nRate of increase in future compensation levels: Domestic 5.50% 5.50%\t6.00% Foreign 5.50% 4.50%\t5.00%\nExpected long-term rate of return on plan assets: Domestic 8.75% 8.75%\t8.50% Foreign\t 7.00% 7.00%\t7.00%\nNOTE 9 - POSTRETIREMENT BENEFITS\nThe Company provides postretirement health and life insurance benefits for eligible U.S. employees attaining specific age and service requirements. The health plan is funded by the Company as the costs of the benefits are incurred and contains cost-sharing features such as deductibles and coinsurance. The Company funds the life insurance plan with deposits to a retired life reserve account held by an insurance company. The Company has made changes to the plans that have reduced benefits in the past and reserves the right to amend or discontinue the plans at any time.\nEffective July 1, 1993, the Company adopted SFAS 106 \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" which requires that the estimated costs of these benefits be expensed over the employees' active service period rather than as paid. In accordance with SFAS 106, the Company elected to recognize the obligation as a one-time charge of approximately $29 million (net of $18 million in taxes) or $.83 per share during the first quarter of fiscal year 1994.\nEffective January 1, 1994, the Company amended the benefit plans for future retirees which reduced the Company's postretirement obligation by approximately $14 million (net of tax benefits). The amortization of this reduction is expected to substantially offset the net periodic postretirement benefit expense from SFAS 106 through fiscal year 2001.\nNet periodic postretirement benefit expense was as follows:\n\t\t 1995\t 1994 Service cost $ 857\t $1,288 Interest cost 2,517\t 3,255 Return on plan assets (219)\t (141) Net amortization and deferral (2,925)\t (1,527) Net periodic postretirement benefit expense $ 230\t $2,855\nPrior to fiscal year 1994, the Company recognized expense in the year the benefits were paid. In fiscal year 1993 approximately $1 million of expenses were recorded. The following table sets forth the components of the postretirement benefit obligation:\nJune 30 measurement date\t 1995\t 1994 Accumulated postretirement benefit obligation: Retirees $22,841\t $21,080 Fully eligible active plan participants 6,082\t 7,812 Other active plan participants 5,466\t 5,555 Accumulated postretirement benefit obligation 34,389\t 34,447 Fair value of plan assets 3,811\t 3,414 Accumulated postretirement benefit obligation in excess of plan assets 30,578\t 31,033 Unrecognized gain on plan amendment 19,060\t 22,119 Unrecognized net loss (1,631)\t (4,183) Accrued postretirement benefit cost $48,007\t $48,969\nThe accumulated postretirement benefit obligation was determined using an assumed annual health care cost trend rate of 13% for fiscal year 1995 and 12% for fiscal year 1996 and which is assumed to decrease gradually to 6.5% by fiscal year 2006. A one percentage point increase in the assumed health care cost trend rate would increase the accumulated benefit obligation by approximately $3.4 million and the aggregate of the service and interest cost components of net periodic postretirement benefit expense for the fiscal year by approximately $400 thousand.\nAssumptions used in the computations were:\n1995 1994\nDiscount rate 8.00% 7.25% Rate of increase in future compensation levels 5.50% 5.50% Expected long-term rate of return on plan assets 4.30% 4.30%\nNOTE 10 - SHARE PURCHASE RIGHTS PLAN\nIn 1989, the Company distributed as a dividend one preferred share purchase right for each outstanding share of common stock. As adjusted for the two-for-one split of the common stock effective December 16, 1991, each right entitles the shareholder to purchase one-half of one-hundredth of a share of Series A Junior Participating Preferred Stock (\"Preferred Stock\") at an exercise price of $110, subject to adjustment. The rights will become exercisable only if a person or group acquires or announces a tender offer for 20% or more of the Company's outstanding common stock. The Board of Directors may reduce this threshold percentage to 10%. If a person or group acquires the threshold percentage of common stock, each right will entitle the holder, other than the acquiring party, to buy shares of common stock or Preferred Stock having a market value of twice the exercise price. If the Company is acquired in a merger or other business combination, each right will entitle the holder, other than the acquiring person, to purchase securities of the surviving company having a market value equal to twice the exercise price of the rights. Following the acquisition by any person of more than the threshold percentage of the Company's outstanding common stock but less than 50% of such shares, the Company may exchange one share of common stock for each right (other than rights held by such person). Until the rights become exercisable, they may be redeemed by the Company at a price of one cent per right. The rights expire on February 13, 1999.\nNOTE 11 - EXECUTIVE STOCK PLAN\nUnder the Company's Executive Stock Plan (the Plan), executives, key employees, and directors may receive grants and\/or awards including common stock, restricted stock, options qualifying as incentive or non-qualified stock options and \"reload options\". Reload options allow a participant to exercise an option and receive new options by exchanging previously acquired common stock for the shares received from the exercise. One new option may be granted for each share exchanged with an exercise price equivalent to the market price at the date of exchange. Accordingly, the issuance of reload options does not result in a greater number of shares potentially outstanding than that reflected in the grant of the orginal option. Up to 2.0 million shares of the Company's common stock may be issued under the Plan. Pursuant to the Plan, non-qualified and reload options have been granted to executives and key employees at an option price equal to the fair market value of a share of common stock on the date of grant. In addition, restricted stock awards of 8,550 shares were issued in 1995.\nOptions granted under the Plan prior to December 5, 1991 became exercisable one year after date of grant except those granted on December 4, 1991 which became exercisable November 1, 1992. Options granted after December 4, 1991 are fully exercisable six months after the date of grant and qualify for reload options which are also fully exercisable six months after the date of the grant. All options expire ten years after date of grant.\nFurther information regarding options in the Plan for 1995, 1994 and 1993 is summarized as follows:\nFor the year ended:\t 1995\t 1994\t 1993\t Price Range Outstanding beginning of year 656,064 644,064\t 689,242 $11.06-28.00 Granted 717,999 12,000\t 116,805 21.50-28.00 Exercised (78,678)\t\t (141,032) 11.06-27.38 Canceled \t (20,951) 27.38-28.00 Outstanding end of year 1,295,385 656,064\t 644,064 11.06-28.00 Exercisable 1,235,886 650,064\t 588,231 11.06-28.00 Available for future grant 2,307,851 2,334,376\t1,633,746\nOf those available for future grant, 1,738,454, 1,097,929 and 385,299 for 1995, 1994 and 1993, respectively, are reload options.\nNOTE 12 - COMMITMENTS AND OTHER MATTERS\nA material part of the Company's tobacco business is dependent upon a few customers, the loss of any one of whom would have an adverse effect on the Company. For the years ended June 30, 1995, 1994 and 1993, one customer accounted for revenues of $1.1 billion, $900 million and $1.1 billion, respectively.\nThe Company provides guarantees for seasonal pre-export crop financing for some of its subsidiaries and unconsolidated affiliates. In addition, certain subsidiaries provide guarantees that ensure that Common Market subsidies and value-added taxes will be repaid if the crops are not exported or if the subsidies are not properly distributed to Common Market farmers. At June 30, 1995, total exposure under guarantees issued for banking facilities of unconsolidated affiliates was $27.8 million. Other commitments and contingent liabilities were approximately $59 million and relate principally to Common Market guarantees. The Company considers the possibility of loss on any of these guarantees to be remote.\nAs part of its financing of purchases of the Brazilian crop, the Company advances funds to its subsidiary under pre-export finance provisions of Brazilian law. When funds are held in Brazil before purchase of the crop, they are invested in U.S. dollar-indexed instruments issued by Brazilian banks. To reduce credit risk, investment limits are established with each bank according to the Company's evaluation of its credit standing. As of March 31, 1995, the date of consolidation of the Company's Brazilian subsidiaries, approximately $97 million was invested among eleven banks and is included in cash and cash equivalents in the Company's June 30, 1995 balance sheet. The carrying value of this investment approximates fair market value. As of June 30, 1995, all such funds had been fully recovered and utilized for crop purchases.\nThe Company's operating subsidiaries within each industry segment perform credit evaluations of customers' financial condition prior to the extension of credit. Generally, accounts and notes receivable are not secured with collateral and are due within 30 days. When collection terms are extended for longer periods, interest and carrying costs are usually recovered. Credit losses are provided for in the financial statements and such amounts have not been material except for the write-off of an account receivable from Iraq in fiscal year 1991. In the lumber and building product operations in Europe, it is traditional business practice to insure accounts and notes receivable against uncollectibility. At June 30, accounts and notes receivable by operating segment were as follows (in millions of dollars):\n1995 1994\nTobacco $225 $248 Lumber and Building Products 109 71 Agri-products 59 52 $393 $371\nNOTE 13 - DERIVATIVE FINANCIAL INSTRUMENTS\nThe Company's dominant business, tobacco, is generally conducted in U.S. dollars. However, the Company conducts its agri-products and lumber and building products businesses in various foreign currencies. As a result, it is subject to the transaction exposures that arise from foreign exchange rate movements between the dates that the foreign currency transactions are initiated and the date they are settled. To mitigate this risk where such derivative markets exist, the Company enters into forward exchange contracts, primarily in Dutch guilders, U.S. dollars, Swedish kronas, and pounds sterling, to hedge certain foreign currency transactions involving the purchase or sale of inventory in currencies other than the functional currency of the subsidiary. The terms of the agreements are for periods that are consistent with the terms of the underlying transactions, which are rarely longer than six months.\nAs of June 30, 1995, the Company through its subsidiaries had entered into foreign exchange contracts with a total notional value of approximately $57 million to hedge known transactions. The unrealized gains and losses were not material to the Company at June 30, 1995. All such transactions were conducted with financial institutions of good standing; however, the total credit exposure related to non-performance by those institutions is not material to the operations of the Company. At June 30, 1995, the carrying value of these derivative financial instruments approximates the fair market value.\nNOTE 14 - UNAUDITED QUARTERLY FINANCIAL DATA\nDue to the seasonal nature of the tobacco, lumber and building products, and agri-products businesses, it is always more meaningful to focus on cumulative rather than quarterly results.\nThe Company recorded $5.6 and $16.1 million in pre-tax writedowns of tobacco inventory and purchase commitments in the fourth quarter of 1995 and 1994, respectively. The third quarter of 1995 includes a $6.5 million writedown relating to Eastern European tobacco operations. The fourth quarter of 1995 and 1994 also included a pre-tax restructuring charge of $15.6 million and $17.5 million, respectively.\nREPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS\nThe Board of Directors and Shareholders Universal Corporation\nWe have audited the accompanying consolidated balance sheets of Universal Corporation and subsidiaries as of June 30, 1995 and 1994, and the related consolidated statements of income, changes in shareholders' equity, and cash flows for each of the three years in the period ended June 30, 1995. 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 accompanying principles used and significant estimates made by management, as 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 Universal Corporation and subsidiaries at June 30, 1995 and 1994, and the consolidated results of their operations and their cash flows for each of the three years in the period ended June 30, 1995, in conformity with generally accepted accounting principles.\nAs discussed in Note 1, the Company's consolidated financial statements for 1994 and 1993 have been restated to adopt the consolidation method of accounting for its African operations. As discussed in Note 9 to the consolidated financial statements, the Company changed its method of accounting for postretirement benefits other than pensions in fiscal year 1994.\n\/s\/ ERNST & YOUNG LLP Richmond, Virginia August 3, 1995\nREPORT OF MANAGEMENT\nTo the Shareholders of Universal Corporation\nThe consolidated financial statements of Universal Corporation have been prepared under the direction of management, which is responsible for their integrity and objectivity. The statements have been prepared in accordance with generally accepted accounting principles and, where appropriate, include amounts based on judgements of management.\nManagement is also responsible for maintaining an effective system of internal accounting controls designed to provide reasonable assurance that assets are safeguarded and that transactions are executed in accordance with management's authorization and properly recorded. This system is continually reviewed and is augmented by written policies and procedures, the careful selection and training of qualified personnel, and an internal audit program to monitor its effectiveness.\nErnst & Young LLP, independent auditors, are retained to audit our financial statements. Their audit provides an objective assessment of how well management discharged its responsibility for fairness in financial reporting.\nThe Audit Committee of the Board of Directors is composed solely of outside directors. The committee meets periodically with management, the internal auditors and the independent auditors to assure that each is properly discharging its responsibilities. Ernst & Young LLP and the internal auditors have full and free access to meet privately with the Audit Committee to discuss accounting controls, audit findings and financial reporting matters.\n\/s\/ HARTWELL H. ROPER\nHartwell H. Roper Vice President & Chief Financial Officer August 3, 1995\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nFor the three years ended June 30, 1995, there were no changes in and disagreements between the Company and its independent auditors on any matter of accounting principles, practices or financial statement disclosures.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nRefer to the caption, \"Election of Directors\" in the September 22, 1995 Proxy Statement which information is incorporated herein by reference.\nThere are no family relationships between any of the above officers.\nTerm of Office: All officers are elected until the next annual shareholders meeting or until their successors are elected.\nFootnotes:\n(1) H. H. Harrell was elected chairman and chief executive officer of Universal Leaf Tobacco Company, Incorporated (\"Universal Leaf\"), a subsidiary of the Company, in 1991. Prior to that he was president and chief executive officer of the Company and Universal Leaf.\n(2) A. B. King was elected president and chief operating officer of Universal Leaf in 1992. In 1991 he was president and prior to 1991 he was executive vice president of the Company and of Universal Leaf.\n(3) H. H. Roper was elected vice president of the Company in 1990. He has been executive vice president and chief financial officer of Universal Leaf since 1995 and prior to that he was senior vice president and chief financial officer.\n(4) W. L. Taylor was elected vice president of the Company in 1991. He joined Universal Leaf in 1990 as senior vice president and chief administrative officer and in 1995 was elected executive vice president and chief administrative officer.\n(5) K. M. L. Whelan joined the Company in 1992. She served as treasurer of the Company until October 1993. She was elected vice president and treasurer of Universal Leaf in 1992. Prior to joining the Company she was elected vice president of financial reporting in 1989 of James River Corporation.\n(6) J. H. Starkey, III was elected senior vice president of Universal Leaf in 1987.\n(7) R. J. Zalzneck was elected senior vice president of Universal Leaf in 1990.\n(8) J. M. White, III was elected vice president and general counsel of Universal Leaf in December 1987.\n(9) W. J. Coronado was elected vice president and controller of Universal Leaf in 1993. Prior to that he was controller of Universal Leaf.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nRefer to the caption, \"Executive Compensation,\" in the September 22, 1995 Proxy Statement which information is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nRefer to the caption, \"Stock Ownership,\" in the September 22, 1995 Proxy Statement which information is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nRefer to the caption, \"Certain Relationships,\" in the September 22, 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\n(a) (1) The following consolidated financial statements of Universal Corporation and Subsidiaries are included in Item 8:\nConsolidated Statements of Income for the years ended June 30, 1995, 1994 and 1993\nConsolidated Balance Sheets at June 30, 1995 and 1994\nConsolidated Statements of Cash Flows for the years ended June 30, 1995, 1994 and 1993\nConsolidated Statements of Changes in Shareholders' Equity for the years ended June 30, 1995, 1994 and 1993\nNotes to Consolidated Financial Statements for the years ended June 30, 1995, 1994 and 1993\nReport of Ernst & Young LLP, Independent Auditors\n(2) Financial Statement Schedules: None\n(3) List of Exhibits:\n3.1 Restated Articles of Incorporation (incorporated herein by reference to the Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 1990, File No. 1-652).\n3.2 Bylaws (incorporated herein by reference to the Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 1993, File No. 1-652).\n4.1 Indenture between the Registrant and Chemical Bank, as trustee (incorporated herein by reference to Registrant's Current Report on Form 8-K, dated February 25, 1991, File No. 1-652).\n4.2 Form of Fixed Rate Medium-Term Note, Series A (incorporated herein byreference to the Registrant's Current Report on Form 8-K, dated February 25,1991, File No. 1-652).\n4.3 Form of 9 1\/4% Note due February 15, 2001 (incorporated herein by reference to the Registrant's Current Report on Form 8-K, dated February 25, 1991, File No. 1-652).\n4.4 Rights Agreement, dated February 2, 1989, between the Registrant and Sovran Bank, N.A., as Rights Agent (incorporated herein by reference to the Registrant's Form 8-A Registration Statement, dated February 9, 1989, File No. 1-652).\n4.5 Amendment to Rights Agreement, dated May 2, 1991, between the Registrant and Sovran Bank, N.A., as Rights Agent (incorporated herein by reference to the Registrant's Form 8 Amendment No. 1, dated May 7, 1991, to Form 8-A Registration Statement, dated February 9, 1989, File No. 1-652).\n4.6 Amendment to Rights Agreement, dated July 17, 1992, between the Registrant, NationsBank, N.A., as Rights Agent, and Wachovia Bank of North Carolina, N.A., as Successor Rights Agent (incorporated herein by reference to the Registrant's Form 8 Amendment No. 2, dated July 17, 1992, to Form 8-A Registration Statement, dated February 9, 1989, File No. 1-652).\nThe Registrant, by signing this Report on Form 10-K, agrees to furnish the Securities and Exchange Commission, upon its request, a copy of any instrument which defines the rights of holders of long-term debt of the Registrant and its consolidated subsidiaries, and for any unconsolidated subsidiaries for which financial statements are required to be filed, which authorizes a total amount of securities not in excess of 10% of the total assets of the Registrant and its subsidiaries on a consolidated basis.\n10.1 Universal Corporation Restricted Stock Plan for Non-Employee Directors (incorporated herein by reference to the Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 1991, File No. 1-652).\n10.2 Universal Leaf Tobacco Company, Incorporated Supplemental Stock Purchase Plan, as amended June 24, 1991 (incorporated herein by reference to the Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 1991, File No. 1-652).\n10.3 Universal Corporation Management Performance Plan (incorporated herein by reference to the Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 1990, File No. 1-652).\n10.4 Universal Leaf Tobacco Company, Incorporated Management Performance Plan (incorporated herein by reference to the Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 1990, File No. 1-652).\n10.5 Universal Leaf Tobacco Company, Incorporated Executive Life Insurance Agreement (incorporated herein by reference to the Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 1994, File No. 1-652).\n10.6 Universal Leaf Tobacco Company, Incorporated Deferred Income Plan (incorporated herein by reference to the Registrant's Report on Form 8, dated February 8, 1991, File No. 1-652).\n10.7 Universal Leaf Tobacco Company, Incorporated Benefit Replacement Plan (incorporated herein by reference to the Registrant's Report on Form 8, dated February 8, 1991, File No. 1-652).\n10.8 Universal Leaf Tobacco Company, Incorporated Senior Executive Severance Plan (incorporated herein by reference to the Registrant's Report on Form 8, dated February 8, 1991, File No. 1-652).\n10.9 Universal Leaf Tobacco Company, Incorporated Supplemental Pension Plan (incorporated herein by reference to the Registrant's Report on Form 8, dated February 8, 1991, File No. 1-652).\n10.10 Universal Corporation 1989 Executive Stock Plan, as amended as of October 27, 1992 (incorporated herein by reference to the Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 1993, File No. 1-652).\n10.11 Universal Corporation 1991 Stock Option and Equity Accumulation Agreement (incorporated herein by reference to the Registrant's Quarterly Report on Form 10-Q for the quarter ended December 31, 1991, File No. 1-652).\n10.12 Amendment to Universal Corporation 1991 Stock Option and Equity Accumulation Agreement (incorporated herein by reference to the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 1992, File No. 1-652).\n10.13 Deli Universal, Inc. Management Performance Plan (incorporated herein by reference to the Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 1992, File No. 1-652).\n10.14 Universal Leaf Tobacco Company, Incorporated 1994 Deferred Income Plan (incorporated herein by reference to the Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 1994, File No. 1-652).\n10.15 Universal Corporation Outside Directors' 1994 Deferred Income Plan (incorporated herein by reference to the Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 1994, File No. 1-652).\n10.16 Universal Leaf Tobacco Company, Incorporated 1994 Benefit Replacement Plan (incorporated herein by reference to the Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 1994, File No. 1-652).\n10.17 Universal Corporation 1994 Stock Option and Accumulation Agreement (incorporated herein by reference to the Registrant's Quarterly Report on Form 10-Q for the quarter ended December 31, 1994, File No. 1-652).\n10.18 Universal Corporation 1994 Stock Option Plan for Non-Employee Directors (incorporated herein by reference to the Registrant's Quarterly Report on Form 10-Q for the quarter ended December 31, 1994, File No. 1-652).\n10.19 Universal Corporation Non-Employee Director Non-Qualified Stock Option Agreement (incorporated herein by reference to the Registrant's Quarterly Report on Form 10-Q for the quarter ended December 31, 1994, File No. 1-652).\n10.20 Amendment to the Universal Leaf Tobacco Company, Incorporated 1994 Deferred Income Plan effective June 1, 1995.*\n21 Subsidiaries of the Registrant.*\n23 Consent of Ernst & Young LLP.*\n27 Financial Data Schedule.*\n* Filed herewith.\n(b) Reports on Form 8-K\nForm 8-K filed on July 11, 1995. The form describes a press release announcing that earnings before a restructuring charge for the 1994\/1995 fiscal year are expected to slightly exceed earlier expectations. The press release also announced a plan of further restructuring measures designed to continue the process of consolidation and rationalization of operations and services in Company facilities around the world.\n(c) Exhibits\nThe exhibits listed in Item 14(a)(3) are filed as part of this annual report.\n(d) Financial Statement Schedules\nAll schedules are omitted since the required information is not present in amounts sufficient to require submission or because the information required is included in the consolidated financial statements and notes therein.\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.\n(REGISTRANT)\nSeptember 19, 1995 By \/s\/ Henry H. Harrell Henry H. Harrell\nChairman and Chief Executive Officer (Principal 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 the Registrant and in the capacities and on the dates indicated.\nChairman, Chief Executive \/s\/ Henry H. Harrell Officer and Director September 19, 1995 Henry H. Harrell (Principal Executive Officer)\n\/s\/ Allen B. King President, Chief Operating September 22, 1995 Allen B. King Officer and Director\n\/s\/ William W. Berry Director September 20, 1995 William W. Berry\n\/s\/ Wallace L. Chandler Director September 22, 1995 Wallace L. Chandler\n\/s\/ Richard G. Holder Director September 22, 1995 Richard G. Holder\n\/s\/ Hubert R. Stallard Director September 21, 1995 Hubert R. Stallard\n\/s\/ Thomas R. Towers Director September 22, 1995 Thomas R. Towers\n\/s\/ Hartwell H. Roper Vice President and September 19, 1995 Hartwell H. Roper Chief Financial Officer\n\/s\/ William J. Coronado Controller (Principal September 19, 1995 William J. Coronado Accounting Officer)","section_15":""}
{"filename":"805020_1995.txt","cik":"805020","year":"1995","section_1":"ITEM 1. BUSINESS.\nCOMPANY OVERVIEW\nSince its initial public offering in 1986, when it operated 208 convenience stores, the Company has expanded, primarily through three major acquisitions of groups of stores, including the acquisition of 141 stores from Getty Petroleum Corp. (\"Getty\") in December 1991. The Company currently operates 414 convenience stores in Pennsylvania, Virginia, New York, New Jersey, Delaware and Maryland, of which 300 sell gasoline. Following the acquisition of stores from Getty, the Company closed certain redundant and underperforming stores. Most of the stores are located in small towns and rural locations where costs of operations are generally lower than in urban areas. Most Company stores located in urban and suburban areas have been acquired and are generally leased on a long-term basis.\nThe size of the Company's stores ranges from approximately 1,200 to 3,300 square feet, with newly constructed stores having over 3,000 square feet. Typically, the stores offer a complete line of over 3,000 popular consumer items. In addition, the Company offers products designed to increase store traffic, such as branded fast foods as well as services, including lottery tickets, free check cashing and automated teller machines (\"ATMs\"). The Company allows store management to tailor the merchandise mix to fit the needs of that store's community. The Company believes that this results in customer loyalty and a more stable profit margin.\nThe following table shows the geographic distribution of the Company's stores as of September 30, 1995: Company- operated Franchise Total -------- --------- ----- Pennsylvania 290 30 320 Virginia 53 1 54 Western New York 24 24 Southern New Jersey 8 8 Delaware 5 5 Maryland 3 3 --- --- --- 375 39 414 === === ===\nThe Company commenced its convenience store operations in 1972 and was incorporated in Delaware in 1977. In 1986, the Company's shares were distributed in a tax-free spin-off to the holders of the stock of Unico Corporation, formerly the Company's parent. The Company's executive offices are located at 477 East Beaver Avenue, State College, Pennsylvania 16801-5690 and its phone number is (814) 234-6000.\nTHE CONVENIENCE STORE INDUSTRY\nThe convenience store industry is a retail service-oriented industry. It is distinguished from other retail businesses by its emphasis on location and\nconvenience and a commitment to customers who need to purchase items quickly at extended hours. Convenience stores feature a wide variety of items, including groceries, dairy products, tobacco products, beverages, prepared and self- service fast foods and health and beauty aids, and many sell gasoline on a self- service basis. Stores are generally designed with ample customer parking and quick checkout procedures to maximize convenience, as well as to encourage impulse buying of high margin items.\nThe convenience store industry is extremely fragmented. Industry sources report that there were 93,200 stores in the United States at the end of 1994, of which the six largest convenience store chains combined for about 9% of the total stores in operation. Currently, there are many external forces exerting considerable pressure on owners of independent and small convenience store chains. Two of the major forces include the need to comply with environmental regulations for underground storage tanks and the general weakness in the dairy industry. The large capital expenditures required to comply with environmental regulations are also affecting many operators of gasoline service stations. As a result of these forces, there has been and continues to be significant opportunities for consolidation in the industry.\nRecent competitive trends across many retail sectors are having a positive influence on the convenience store industry as it changes the typical convenience store's merchandise mix in reaction to market conditions and customer preferences. In addition, convenience stores compete not only with other convenience stores but now also with gasoline distributors which have converted to convenience stores. To compete for a broader customer base, convenience stores are adding prepared foods, new services and improving store layouts to attract new customers. Overall, industry sources report that convenience store industry sales rose 8.5% and 8.7% in 1993 and 1994, respectively, compared to a 6.3% and 7.8% increase in total U.S. retail sales for the same periods. As consumer preferences and government regulations put pressure on tobacco sales, convenience store operators are improving gasoline pumping facilities and installing branded fast-food outlets and ATMs. In addition, the convenience store industry has aggressively closed or remodeled under-performing stores. Over the last two years, the industry has either constructed, remodeled or closed about a third of the U.S. convenience store population.\nSTRATEGY\nManagement believes that the Company is uniquely positioned to take advantage of current trends in the convenience store industry. Its strategy is designed to (i) expand the number of store locations by acquiring chains of convenience stores and, on a limited basis, through internal growth and (ii) increase customer traffic, sales volume and profit margins. Key elements of the Company's strategy include the following:\nFOCUS ON RURAL AND SMALL-TOWN LOCATIONS. Most of the Company's stores are located in small towns and rural locations where costs of operations and levels of competition are generally lower than in urban and suburban markets. The Company's stores in these rural markets often serve as the community's \"general store\", providing the convenience of one-stop shopping for customers.\nAs a result, the Company is able to provide a wide range of services and products at favorable margins. In addition, there tends to be significantly less employee turnover at the Company's rural and small-town stores.\nMAINTAIN DISCIPLINED EXPANSION PROGRAM. The Company believes that there are many acquisition opportunities in its current and adjacent geographic market areas. The Company has had and continues to maintain an expansion program which has increased the number of convenience stores it operates through acquisitions of existing chains and construction of new stores. Potential acquisition candidates are carefully evaluated by the Company. In particular, before pursuing an acquisition, the Company takes into account whether an acquisition candidate is in compliance with applicable environmental laws and the level of capital expenditures required for environmental compliance and to bring the stores up to the Company's standards.\nINSTALL BRANDED FAST-FOOD UNITS. The Company has been actively adding fast-food units such as Burger King, Arby's and Blimpie to certain stores. The Company believes that the recognition associated with these names increases foot traffic and attracts new customers. In those stores that have added branded fast-food units, merchandise sales have increased approximately 20 to 25 percent, including fast-food sales, and margins have increased approximately four to five percent. To date, the Company is operating three Burger King units, five Arby's and 21 Blimpies. Of its current stores, approximately 200 have the potential to profitably support fast-food units. The Company plans to add 25 to 30 fast-food units per year in its existing and newly constructed stores.\nBUILD HIGH-VOLUME GASOLINE PUMPING STATIONS. The Company has been replacing its traditional gasoline pumping stations with state-of-the-art, multi-pump high-volume pumping stations, which include on-pump credit card readers. The new pumps are spaced farther apart and can dispense all grades of gasoline at a single pump, thereby enabling several customers to fuel their automobiles at the same time. Based on the Company's experience to date, the introduction of these pumping stations has resulted in more than 50 percent additional gallons of gasoline being sold per store. In addition, the increased number of gasoline customers served by these new high-volume pumping stations is expected to generate additional customer traffic and merchandise sales. The Company has installed twenty high-volume gasoline pumping stations to date and 140 of the Company's current stores have the necessary space for these new high- volume stations.\nADDITIONAL SERVICES. The Company offers various services at its stores, including the sale of lottery tickets, free check cashing and payment of utility bills. In addition, the Company has entered into an agreement to add ATMs to the Company's stores. The Company anticipates installing at least 155 ATMs to its stores by early 1997. The Company believes that the addition of these ATMs, like the addition of branded fast-food installations and high-volume gasoline pumping stations, will serve to increase merchandise and gasoline sales.\nMERCHANDISING AND MARKETING\nThe Company's merchandising and marketing programs are designed to promote convenience through store location, hours of operation, parking, customer service, product selection and checkout procedures. Store hours are intended to meet customer needs and the characteristics of the community in which each store is located. Approximately one-half of the Company's stores are open 24 hours per day, while the majority of the remaining stores are open from 6:00 a.m. to 12:00 midnight. To alleviate checkout congestion, many of the Company's products and services, such as certain prepared fast food, fountain beverages and gasoline, are sold on a self-service basis. Most Company stores provide parking for customers.\nUni-Marts has a separate merchandising and marketing department which develops and implements promotional and advertising programs, sometimes in conjunction with suppliers. Television, radio and newspaper advertisements are used to promote the Company's name and image. The Company maintains an employee training program for all employees which emphasizes the importance of service to customers and the development of merchandising and marketing skills for its store managers and store personnel.\nCONVENIENCE STORE MERCHANIDSE SALES. The Company's stores include dry grocery items, health and beauty aids, newspapers and magazines, lottery tickets, dairy products, candy, frozen foods, beverages, tobacco products, delicatessen foods, fountain drinks and hot coffee. In recent years, the Company has emphasized new merchandise sales such as prepared foods and branded fast foods to increase sales volume and customer traffic. In addition, the Company continues to add customer services, such as ATMs, check cashing, payment of utility bills and lottery ticket sales, all of which are designed to increase customer traffic. In addition, some stores offer a video rental program, as well as a variety of prepared and self-service fast foods, including freshly made sandwiches, hot dogs, pizza, chicken, freshly baked goods, frozen sandwiches, nachos and soups.\nAs part of the Company's strategy to increase branded fast foods, in fiscal year 1994, the Company entered into an agreement with Blimpie International (\"Blimpie\") to become an area developer (franchisor) for Blimpie Subs and Salads restaurants in Pennsylvania and western New York. During fiscal year 1995, the Company added Blimpie branded subs and salads installations at 13 of its stores. In addition, in fiscal year 1995, the Company added two Burger King and three Arby's installations. The Company intends to add more Blimpie, Burger King, and Arby's fast-food installations.\nCONVENIENCE STORE GASOLINE SALES. Convenience store operations and merchandise sales are enhanced by self-service gasoline facilities, which the Company plans to include in as many new locations as possible and to add to existing stores when feasible. Sales of gasoline products at the Company's stores are affected by wholesale and retail price volatility, competition and marketing decisions. At September 30, 1995, the Company had 300 locations offering unleaded gasoline, with 150 of these locations also offering kerosene. All are branded self-service units with 287 offering Getty gasoline pursuant to a petroleum supply agreement, and the balance offer other major brands.\nCOMPANY OPERATIONS\nSTORE MANAGEMENT. Each Company-operated store is managed by a store manager. Store managers are compensated by salary, as well as incentive compensation programs based on in-store sales volume and profitability. All Company stores are divided into groups of six to eleven stores by geographic area. Each group is managed by a store supervisor. A regional manager is responsible for a number of groups and their store supervisors. The regional managers report directly to the Director of Operations, who oversees the day-to- day operations of the stores. Managers, supervisors and regional managers are compensated through incentive programs which provide for quarterly bonuses based on increased profitability of the stores. The number of full-time and part-time employees per store depends on the sales volume of the store and its hours of operation.\nFRANCHISES. The Company has 39 franchised stores which operate under various franchise agreements. Under all franchise agreements, the franchisee pays a royalty, which varies depending upon the agreement and whether the Company or the franchisee owns the convenience food store equipment. The royalty is based on the store's merchandise sales volume.\nAs part of its services to 28 franchise locations, the Company provides accounting services, merchandising and advertising assistance, store layout and design guidance, supplier and product selection and ongoing operational assistance. These franchisees are required to use the same internal control systems that the Company uses for the stores it operates. The Company's financial statements include the sales and costs of sales of these 28 franchised stores. The Company does not provide these services for the 11 franchise locations formerly franchised by Getty. The Company has periodically closed franchised stores and does not intend to grant new franchises except in connection with new acquisitions or in other special circumstances.\nDISTRIBUTION AND SUPPLY\nAll 414 stores are serviced at least weekly by vendors. The Company does not distribute products to its stores itself. In order to minimize costs and facilitate deliveries, the Company utilizes a single wholesale distributor for most products, pursuant to a five-year supply agreement. The Company believes that it could easily replace this distributor with one or more distributors. Certain products, such as bakery items, dairy products, snacks, soft drinks, magazines and perishable products, are distributed by wholesale route salespeople. As part of the sale of its dairy operation, the Company entered into a 10-year supply agreement with the purchaser which provides for the Company's purchase of all dairy products sold at its Pennsylvania stores.\nIn connection with the 1991 acquisition of the Getty stores, the Company and Getty entered into a five-year gasoline supply agreement pursuant to which Getty supplies gasoline products to substantially all of the Company's convenience stores offering self-service gasoline. The Company is currently negotiating an extension of the petroleum supply agreement with Getty.\nMANAGEMENT CONTROLS AND INFORMATION SYSTEMS\nThe Company is developing an internal automation system which includes point-of- sale (\"POS\") scanning. The system is designed to improve the timeliness and accuracy of management information, reduce paperwork at the store level and enhance cash, pricing and inventory controls. As of September 30, 1995, installation of this new POS scanning system was complete in 14 stores, with plans to add approximately 35 more during fiscal year 1996.\nThe Company utilizes its current computer systems for inventory and accounting control, financial record-keeping and management reporting allowing management to monitor closely and evaluate store operations. The Company's computer systems are also programmed to identify variances from budgeted amounts by store on a monthly and year-to-date basis. In addition, profit and loss statements by store compare the current year's results for the month and year-to-date to the previous year's comparable periods.\nStore managers are responsible for placing orders for grocery, tobacco, frozen food and non-food items directly into the central computer system of the Company's wholesale supplier. The computer systems are programmed to compare current orders with historic order levels and to reject orders which appear to be incorrect. Orders and receiving reports are reviewed by store supervisors. Invoices are reviewed and compared to receiving reports by the Company's accounting personnel and are paid centrally.\nThe Company's inventory control system is designed to ensure that stores are adequately stocked, inventories are maintained at levels which minimize carrying costs and slow-moving items are identified. As part of the inventory control system, store management personnel conduct approximately 12 physical inventories at each store per year. The physical inventory, coupled with the computer systems, enables the Company to monitor each store's operating performance on a continuing basis. In addition, the Company's internal audit department conducts periodic inventories at a sampling of stores and reports the results to the Audit Committee of the Company's Board.\nThe Company believes that its automated accounting and inventory control systems provide the information required for management decisions and expense control.\nThe Company believes that its existing and planned systems and controls can accommodate significant expansion in the number of Company stores.\nCOMPETITION\nThe convenience store industry is highly competitive, fragmented and regionalized. It is characterized by a few large companies, some medium-sized companies, such as the Company, and many small independent companies. Several competitors are substantially larger and have greater resources than the Company. The Company's primary competitors include national chains such as A- Plus Mini-Markets and Seven-Eleven and regional chains such as Sheetz, WaWa,\nStop-N-Go, Convenient Food Mart, Turkey Hill, Coastal and Co\/Go. The Company also competes with other convenience stores, small supermarkets, grocery stores and major and independent gasoline distributors who have converted units to convenience stores.\nCompetition for gasoline sales is based on price and location. The Company competes primarily with self-service gasoline stations operated by independent dealers and major oil companies in addition to other convenience stores.\nENVIRONMENTAL COMPLIANCE AND REGULATION\nThe Company's gasoline operations are subject to federal, state and local environmental laws and regulations primarily relating to underground storage tanks. The United States Environmental Protection Agency (the \"EPA\") has established standards for owners and operators of underground storage tanks (\"USTs\") relating to, among other things: (i) maintaining leak detection systems; (ii) upgrading UST systems; (iii) implementing corrective action in response to releases; (iv) closing out-of-use USTs to prevent future releases; (v) maintaining appropriate records; and (vi) maintaining evidence of financial responsibility for corrective action and compensating third parties for bodily injury and property damage resulting from UST releases. All states in which the Company operates also have adopted these regulatory programs.\nUnder current federal and certain state regulatory programs, the Company is obligated to upgrade or replace all non-complying underground storage tanks it owns or operates to meet corrosion protection and overfill\/spill containment standards by 1998. The Company has evaluated each of its stores which sell gasoline to determine the type of expenditures required to comply with these and other requirements under the federal and state UST regulatory programs.\nManagement believes that the Company is currently in material compliance with all applicable federal and state laws and regulations. The Company has spent substantial amounts of money to upgrade all of its underground storage tanks to meet the applicable standards and requirements and intends to expend $2.8 million over the next three years to maintain compliance. The Company has adopted a program to ensure that new gasoline installations comply with federal and state regulations and that existing locations are upgraded if required under these regulations. For a discussion of the capital expenditures planned for environmental compliance, see \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nGOVERNMENTAL REGULATION\nIn addition to the laws and regulations referred to under \"Environmental Compliance and Regulation,\" certain aspects of the Company's business are governed by federal, state and local statutes. As a franchisor, the Company is also subject to federal and state laws governing franchising, which include, among other matters, the commencement and termination of franchises.\nManagement believes that the Company is currently in material compliance with all applicable federal and state laws and regulations.\nTRADEMARKS\nThe name \"UNI-MART\" and the Company's UNI-MART logo were registered with the U.S. Patent and Trademark Office as of May 31, 1983, and are owned by and licensed from Uni-Marts of America, Inc., a wholly owned subsidiary of the Company.\nEMPLOYEES\nAs of September 30, 1995, the Company had approximately 2,800 employees, approximately 1,250 of which were full-time. The Company believes that its employee relations are good. None of the Company's employees are covered by a collective bargaining agreement.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe following table sets forth certain information with respect to administrative and storage facilities owned or leased by the Company as of September 30, 1995: Type of Square Location Ownership Footage Use - -------- --------- ------- --- State College, PA Leased 25,200 Administrative offices\nState College, PA Owned 5,400 Administrative offices\nState College, PA Leased 2,800 State Gas & Oil offices and garages\nOak Hall, PA Leased 14,400 Storage facility\nPittsburgh, PA Leased 3,400 Regional office and storage facility\nWilliamsport, PA Leased 1,100 Regional office\nCamp Hill, PA Leased 3,700 Regional office and storage facility\nLancaster, PA Leased 3,000 Regional office and storage facility\nRoanoke, VA Leased 500 Storage facility\nThe Company's above-referenced leased administrative offices and storage facility in State College and Oak Hall, PA are leased from HFL Corporation. HFL Corporation is controlled by Henry D. Sahakian, the Company's Chairman of the Board and Chief Executive Officer, and his brother, Daniel D. Sahakian, a\nDirector of the Company. The State Gas & Oil division offices and garages are leased from Unico Corporation, which is also controlled by Henry D. Sahakian and Daniel D. Sahakian.\nOf the Company's 414 convenience store locations, 122 are owned by the Company, 12 are leased from affiliated parties and 280 are leased from unaffiliated parties. Most leases are for initial terms of five to ten years with renewal terms of five years available at the Company's option. Under most leases, the Company is responsible for the payment of insurance, taxes and maintenance. Of the leased locations, 11 are subleased to franchisees. Of the 280 stores leased from unaffiliated parties, 118 were leased from Getty in December 1991. These leases expire in December 1996. The Company is currently negotiating with Getty an extension of these leases. The Company also owns five gasoline service stations which are leased to unaffiliated operators. As of September 30, 1995, the Company had no stores under construction.\nThe Company's store leases expire as follows: Lease expiration date (1) Number of facilities ------------------------- -------------------- 1996 8 1997 124 1998 8 1999 3 2000 and later 149\n- -------------------- (1) Most of the Company's leases have one or more renewal options at an agreed upon rental or fair market rental at the end of their initial terms. The table assumes the exercise of these renewal options.\nThe Company has generally renewed its leases prior to their expiration. Where renewals have not been available or the Company otherwise determines to change location, the Company generally has been able to locate acceptable alternative facilities.\nThe lease for the Company's executive offices in State College, Pennsylvania expires in December 2000.\nManagement considers all properties currently in use, owned or leased, to be in good condition, well maintained and suitable for current operations.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThe Company is not a party to any pending material legal proceeding. The Company is self-insured.\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 on the American Stock Exchange under the symbol \"UNI.\" The transfer agent and registrar for shares of the Company's Common Stock is Chemical Mellon Shareholder Services, L.L.C., Ridgefield Park, New Jersey. As of December 1, 1995, the Company had 6,377,474 shares of its Common Stock outstanding.\nSet forth below is a table which shows the high and low sale prices as reflected on the American Stock Exchange and dividends paid on Common Stock for each quarter in the two most recent fiscal years.\nFIRST SECOND THIRD FOURTH QUARTER QUARTER QUARTER QUARTER ------- ------- ------- ------- - ---- Cash Dividends per share $.0275 $.0275 $.0275 $.0275\nPrice Range: High 6 5 7\/8 5 9\/16 8 Low 4 3\/4 5 1\/8 5 1\/4 5 3\/4\nFIRST SECOND THIRD FOURTH QUARTER QUARTER QUARTER QUARTER ------- ------- ------- ------- - ---- Cash Dividends per share $.0250 $.0250 $.0250 $.0250\nPrice Range: High 5 1\/2 6 1\/2 6 1\/4 6 Low 4 1\/2 5 3\/8 5 3\/8 4 7\/8\nEffective January 1995, the Company elected to increase the quarterly dividends on its Common Stock to the rate of $.0275 per share. However, there is no assurance of future dividends because they are at the discretion of the Company's Board of Directors and are dependent on future earnings, capital requirements and financial condition. In addition, certain debt agreements may restrict the Company's ability to declare and pay dividends on Common Stock. The amount of retained earnings available for such dividends at September 30, 1995 was $5,108,200.\nAt December 1, 1995, the Company had approximately 460 stockholders of record of Common Stock. The Company believes that approximately 43 percent of its Common Stock is held in street or nominee names.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nThe Company's revenues are derived primarily from sales of merchandise and gasoline at its 414 convenience stores. In recent years the sale of gasoline has become an increasingly significant part of the Company's revenues. Gasoline sales as a percentage of total revenues have increased from 38.5% in fiscal year 1993 to 40.5% in fiscal year 1994 to 43.9% in fiscal year 1995. Average gasoline sales per store, for stores open two full years, have increased from approximately $399,000 in fiscal year 1993 to approximately $433,000 in fiscal year 1994 to approximately $478,000 in fiscal year 1995, largely as a result of the increase in the selling price per gallon. While the Company expects to sell more gallons as it implements its strategy of adding high-volume gasoline pumpers, the price of gasoline can be volatile, and there can be no assurance that sales of an increased number of gallons will result in higher revenues.\nAverage merchandise sales per store, for stores open two full years, have increased from approximately $426,000 in year 1993 to approximately $441,000 in fiscal year 1994 and approximately $448,000 in fiscal year 1995. This merchandise sales growth trend is primarily the result of increased sales of branded fast-food items and the enhancement of in-store traffic building services, such as lottery tickets, money orders, utility bill collections and free check cashing. The Company intends to continue to add fast-food units to its stores as well as other services designed to enhance in-store traffic, including ATMs. Tobacco sales represented 25.7% and 26.5% of total merchandise sales in fiscal years 1994 and 1995, respectively. Over the last two fiscal years, the Company has experienced decreases in cigarettes sold. In addition, there has been volatility in selling prices as a result of competition among cigarette manufacturers. Since the Company expects this volatility to continue, it has sought increased sales of other merchandise to offset the uncertainty in cigarette sales.\nThe Company has grown primarily through acquisitions of groups of convenience stores. In fiscal year 1989, the Company acquired 65 stores from Handy Markets, Inc. and 23 stores from Foodcraft, Inc. In fiscal year 1992, the Company consummated an acquisition of 141 convenience stores from Getty. Following acquisitions, the Company consolidates by closing redundant or underperforming stores. As part of the Getty acquisition, the Company added 16 franchised stores, bringing to 50 the total number of franchised stores operated by the Company. Periodically, the Company has converted franchised stores to Company- operated locations. In general, the Company does not intend to expand the number of franchised stores it operates, except in connection with acquisitions or other special circumstances.\nIn connection with the Company's strategy to focus on expanding its convenience stores, the Company made a strategic decision to dispose of its dairy operation. In April 1994, it consummated the sale of the dairy operation for approximately $6.4 million. The cash proceeds of the sale were primarily used for capital expenditures, including remodeling, modernizing stores and adding branded fast-food units.\nConvenience stores selling gasoline have been heavily affected by environmental regulations principally concerning underground storage tanks, which require large capital expenditures in order to achieve compliance. In the late 1980s, the Company made significant expenditures to meet, and exceed, applicable standards. Management believes that the Company is currently in compliance with all applicable federal and state environmental laws and regulations and expects to make minimal expenditures in the future to maintain compliance. In addition, the Company has adopted a program to ensure that new gasoline installations comply with federal and state regulations.\nRESULTS OF OPERATIONS\nThe following table sets forth the percentage relationship of certain expense items to total revenues. Since the Company's franchise agreements for 28 of the Company's 39 franchise locations permit the Company to exercise complete control over the operations of these 28 franchised stores and the Company bears the attendant risks of ownership, the results of operations include sales and related cost of sales of stores operated by these franchisees. It should be noted that the primary factors influencing the percentage relationship of cost of sales to revenues are the volatility of gasoline prices and the proportional increase in the number of stores selling gasoline. On a percentage basis, the gross profit on gasoline sales is significantly less than the gross profit on merchandise sold in the convenience stores.\nYear Ended September 30, 1995 1994 1993 ------ ------ ------ Revenues: Merchandise sales 55.2% 55.5% 54.7% Gasoline sales 43.9 40.5 38.5 Dairy sales 0.0 3.2 6.0 Other income 0.9 0.8 0.8 ----- ----- ----- Total revenues 100.0 100.0 100.0 Cost of sales 73.4 73.4 73.6 ----- ----- ----- Gross profit: Merchandise (as a percentage of merchandise sales) 36.0 35.4 35.3 Gasoline (as a percentage of gasoline sales) 13.2 12.9 11.5 Dairy products (as a percentage of dairy sales) 0.0 29.8 31.4\nTotal gross profit 26.6 26.6 26.4\nCosts and expenses: Selling 19.7 20.2 19.9 General and administrative 2.1 2.0 2.0 Depreciation and amortization 1.7 1.7 2.0 Interest 1.0 1.0 1.2 ----- ----- ----- Total expenses 24.5 24.9 25.1 ----- ----- ----- Earnings before income taxes 2.1 1.7 1.3 Income taxes 0.8 0.6 0.4 ----- ----- ----- Net earnings 1.3% 1.1% 0.9% ===== ===== =====\nFISCAL YEAR 1995 COMPARED TO FISCAL YEAR 1994\nThe Company opened one new store during fiscal year 1995 and rebuilt two locations. The Company also closed six locations in fiscal year 1995, including three franchised locations. Total revenues were $327.0 million in fiscal year 1995 compared to $326.6 million in fiscal year 1994. Fiscal year 1994 revenues included $10.5 million of dairy sales which were not included in fiscal year 1995 since the Company's dairy operation was sold on April 1, 1994. Exclusive of dairy sales, total revenues increased 3.4% from fiscal year 1994 to fiscal year 1995.\nBecause the Company had fewer stores in operation, merchandise sales decreased by $987,000, or 0.5%, from $181.3 million in fiscal year 1994 to $180.3 million in fiscal year 1995. Merchandise sales at comparable stores increased 0.9%.\nGasoline sales increased $11.5 million, or 8.7%, from $132.2 million in fiscal year 1994 to $143.7 million in fiscal year 1995. The gasoline sales increase is due primarily to higher retail selling prices per gallon sold.\nGross profits on merchandise sales in fiscal year 1995 were $725,000 higher compared to fiscal year 1994 due to higher gross profit rates. As a percentage of merchandise revenues, gross profits increased from 35.4% in fiscal year 1994 to 36.0% in fiscal year 1995, primarily as a result of a differing mix of merchandise sold, which included higher-margin items such as branded fast food.\nGross profits on gasoline sales increased by $2.0 million, or 11.6%, in fiscal year 1995 compared to fiscal year 1994 as a result of an increase in gross profits per gallon sold at the Company's convenience stores, from $0.117 in fiscal year 1994 to $0.132 in fiscal year 1995, which resulted from favorable trends in wholesale gasoline price fluctuations. As a percentage of gasoline revenues, gross profits increased from 12.9% in fiscal year 1994 to 13.2% in fiscal year 1995.\nOther income, consisting primarily of rental income, promotional allowances and franchise royalties, increased from $2.6 million in fiscal year 1994 to $3.0 million in fiscal year 1995. The increase was primarily due to a higher level of promotional allowances, which offset decreases in other components of other income.\nTotal operational expenses attributable to the Company's dairy operation decreased from $2.6 million in fiscal year 1994 to no expense in fiscal year 1995. Excluding such expenses, selling expenses in fiscal 1995 of $64.4 million were $702,000, or 1.1%, higher than fiscal year 1994 selling expenses of $63.7 million. This increase is the result of increased convenience store expenses. General and administrative expense increased $453,000, or 7.0%, primarily due to increased employee compensation and incentive programs. Depreciation and amortization decreased by $127,000, or 2.2%, reflecting the expense reduction due to the April 1994 dairy sale offset by additional depreciation of convenience store capital improvements. Interest expense remained relatively level as lower borrowing levels were offset by higher interest rates.\nAs a result of the factors mentioned above, earnings before income taxes in fiscal year 1995 increased by $1.1 million, or 20.2%, from $5.5 million in fiscal year 1994 to $6.7 million in fiscal year 1995. Income taxes increased by $629,000 due to higher pre-tax income and a reduced level of tax credits. Net earnings grew by $489,000 from $3.7 million, or $0.54 per share, in fiscal year 1994 to $4.2 million, or $0.66 per share, in fiscal year 1995.\nFISCAL YEAR 1994 COMPARED TO FISCAL YEAR 1993\nThe Company opened three new stores during fiscal year 1994 and closed 30 underperforming stores, including two franchised locations. In addition, two franchised locations were converted to Company-operated stores, and one Company- operated store was converted to a franchised location. In addition, the Company sold its dairy operation if fiscal year 1994. Total non-dairy revenues in fiscal year 1994 were $316.1 million compared to $319.0 in fiscal year 1993, representing a decrease of $2.9 million, or 0.9%.\nDue to the Company's closing of underperforming stores in the consolidation following the Getty acquisition, merchandise sales declined by $4.2 million, or 2.3%, from $185.5 million in fiscal year 1993 to $181.3 million in fiscal year 1994. Merchandise sales at comparable stores remained essentially the same.\nTotal gasoline sales increased from $130.9 million in fiscal year 1993 to $132.2 million in fiscal year 1994, representing an increase of $1.3 million, or 1.0%, due to the sale of an additional 2.7 million gallons of gasoline at the Company's convenience stores.\nGross profits on merchandise sales declined by $1.3 million in fiscal year 1994 compared to 1993 due to lower sales volume resulting from the closing of underperforming stores in connection with consolidation of the Getty acquisition. As a percentage of revenues, gross profits on merchandise sales remained constant from fiscal year 1993 to fiscal year 1994.\nGasoline gross profits increased by $2.0 million, or 13.2%, in fiscal year 1994 due to the sale of additional gallons and an increase in gross profit per gallon sold at the Company's convenience stores, from $0.106 in fiscal year 1993 to $0.117 in fiscal year 1994, which resulted from favorable trends in wholesale gasoline price fluctuations. As a percentage of gasoline revenues, gross profits on gasoline sales increased from 11.5% in fiscal year 1993 to 12.9% in fiscal year 1994.\nTotal operational expenses attributable to the Company's dairy operation decreased from $5.0 million in fiscal year 1993 to $2.6 million in fiscal year 1994 due to the sale of such operation. Excluding such expenses, selling expenses increased $461,000, or 0.7%, from $63.2 million in fiscal year 1993 compared to $63.7 million in fiscal year 1994, reflecting increased selling expenses in the convenience store operation. General and administrative expenses declined by $427,000, or 6.2%, also due primarily to the sale of the dairy operation. Depreciation and amortization decreased by $1,006,000, or 15.1%, due to various factors including the sale of the dairy operation. Interest expense declined by $765,000, or 18.8%, as a result of lower borrowing levels.\nEarnings before income taxes in fiscal year 1994 of $5.5 million were higher than in fiscal year 1993 by $1.0 million, or 22.1%. Income taxes were $460,000 higher in fiscal year 1994 due to higher pre-tax income and an increased effective tax rate from increased state income taxes and reduced tax credits. Net earnings increased from $3.1 million, or $0.46 per share, in fiscal year 1993 to $3.7 million, or $0.54 per share, in fiscal year 1994.\nSEASONALITY AND QUARTERLY RESULTS\nThe Company's business has been subject to moderate seasonal influences with higher sales in the third and fourth fiscal quarters of each year, since customers tend to purchase more convenience items, such as ice, beverages and fast food, and more gasoline during the warmer months. Due to adverse weather conditions, merchandise sales for the second fiscal quarter have generally been lower than other quarters. However, because of price volatility, gasoline profit margins fluctuate significantly throughout the year.\nThe following table represents certain earnings data for the Company for the last eight fiscal quarters:\nLIQUIDITY AND CAPITAL RESOURCES\nNet cash provided by operating activities was $10.8 million for the year ended September 30, 1995, as compared to $9.1 million for fiscal year 1994. The increase was principally due to higher net income in 1995.\nNet cash used in investing activities was $8.3 million for fiscal year 1995 as compared to $1.0 million for fiscal year 1994. The Company used the proceeds of the sale of the dairy operation for remodeling, modernizing stores and adding branded fast-food units. Purchases of property, equipment and improvements, consisting primarily of remodeling existing stores and purchasing new land, were $8.6 million in fiscal year 1995 and $5.1 million in fiscal year 1994. Cash flows from investing activities in fiscal year 1994 included the sale of the dairy operation.\nNet cash used by financing activities was $3.7 million in fiscal year 1995 as compared to $9.4 million in fiscal year 1994, principally representing principal payments on debt and the purchase of treasury stock in fiscal year 1994.\nMost of the Company's sales are for cash and its inventory turns over rapidly. As a result, the Company's daily operations do not require large amounts of working capital. The Company has budgeted approximately $17 million in fiscal year 1996 for capital expenditures, including construction of new stores, and environmental compliance and anticipates debt and capital lease payments of approximately $3.4 million in fiscal year 1996. The Company believes that the cost of constructing a prototypical store is approximately $500,000, although additional costs to acquire land may vary considerably.\nOn December 26, 1995, the Company signed an agreement with its bank group to borrow $10 million on an interest-only basis for a period of three years. Proceeds from the loan will be used to complete major remodels, including adding branded fast-food units to existing stores, upgrading gasoline dispensing facilities to high-volume pumping units, and new store construction. In addition, the Company has available $14.8 million under existing credit agreements at September 30, 1995, including the $10.0 million loan. The Company anticipates that cash presently available and cash generated from operations will be sufficient to fulfill its cash requirements in fiscal year 1996 and for the foreseeable future.\nIMPACT OF INFLATION\nThe Company believes that inflation has not had a material effect on its results of operations in recent years. Generally, increases in the Company's cost of merchandise can be quickly reflected in higher prices of goods sold. However, upward movement of gasoline costs may have short-term negative effects on profit margins, since the Company's ability to raise gasoline prices can be limited by competition from other self-service gasoline outlets. In addition, fluctuation of gasoline prices can limit the ability of the Company to maintain stable gross margins.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nINDEPENDENT AUDITORS' REPORT ----------------------------\nThe Board of Directors and Stockholders Uni-Marts, Inc. State College, Pennsylvania\nWe have audited the accompanying consolidated balance sheets of Uni-Marts, Inc. and subsidiaries, (the \"Company\"), as of September 30, 1995 and 1994, and the related consolidated statements of earnings, stockholders' equity and cash flows for each of the three years in the period ended September 30, 1995. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Uni-Marts, Inc. and subsidiaries as of September 30, 1995 and 1994, and the results of their operations and their cash flows for each of three years in the period ended September 30, 1995, in conformity with generally accepted accounting principles.\n\/S\/ DELOITTE & TOUCHE LLP\nPhiladelphia, Pennsylvania October 23, 1995 (December 26, 1995, as to Note M)\nSee notes to consolidated financial statements\nSee notes to consolidated financial statements\nSee notes to consolidated financial statements\nSUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES:\nDuring fiscal 1994, the Company accepted $1,308,000 worth of the Company's Common Stock as repayment of a note receivable from an officer. (See Note G)\nSee notes to consolidated financial statements\nUNI-MARTS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED SEPTEMBER 30, 1995, 1994 AND 1993\nA. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: ------------------------------------------\nThe Company is an independent operator of convenience stores located in Pennsylvania, Virginia, New York, New Jersey, Delaware and Maryland.\n(1) Principles of Consolidation -- The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All material intercompany balances and transactions have been eliminated.\n(2) Marketable Equity Securities -- The Company adopted Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" (\"SFAS 115\") effective October 1, 1994. SFAS 115 requires the Company to account for debt and equity securities based on the classification into one of three categories: held-to-maturity, available-for-sale, or trading. Securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities.\nAll securities held by the Company are classified as trading. These securities are carried at their market value which was specifically identified using published quotes as of the last day of business on September 30, 1995. Unrealized holding losses for trading securities of $30,800, net of taxes of $18,500, are included in earnings.\n(3) Inventories -- The Company values its merchandise inventories at the lower of cost (first-in, first-out method) or market, as determined by the retail inventory method. Gasoline inventories are valued at the lower of cost (first-in, first-out method) or market.\n(4) Property, Equipment and Improvements -- Depreciation and amortization are calculated using the straight-line method over the useful lives of the related assets. Amortization of improvements to leased properties is based on the remaining terms of the leases or the estimated useful lives of such improvements, whichever is shorter.\nA. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED): ------------------------------------------------------\n(5) Intangible and Other Assets -- Intangible and other assets consist of the following:\nSeptember 30, 1995 1994 ----------- ----------- Goodwill $ 6,498,671 $ 6,498,671 Lease acquisition costs 1,639,505 1,674,483 Non-competition agreements 1,213,040 1,213,040 Other 1,694,767 1,647,520 ----------- ----------- 11,045,983 11,033,714 Less accumulated amortization 3,821,144 3,282,916 ----------- ----------- $ 7,224,839 $ 7,750,798 =========== ===========\nGoodwill represents the excess of costs over the fair value of net assets acquired in business combinations and is amortized on a straight-line basis over periods of 5 to 40 years. Lease acquisition costs are the bargain element of acquired leases and are being amortized on a straight-line basis over the related lease terms. Non-competition agreements are amortized over the terms of the particular agreements. It is the Company's policy to periodically review and evaluate the recoverability of the intangible assets by assessing current and future profitability and cash flows and to determine whether the amortization of the balances over their remaining lives can be recovered through expected future results and cash flows.\n(6) Self-Insurance Reserves -- The Company assumes the risks for general liability and workers' compensation insurance exposures up to certain loss thresholds set forth in separate insurance contracts. In fiscal 1994, the Company had assumed risks for health insurance exposures; however, on May 1, 1995, the Company entered into a commercial contract transferring the risks of its health insurance exposure to a third party. The Company has established self-insurance reserves for these risks using actuarial valuations provided by independent companies which are recorded on a present value basis. At September 30, 1995 and 1994, the Company had self-insurance reserves totaling $2,705,600 and $2,068,200, respectively.\n(7) Income Taxes -- The Company accounts for income taxes under the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes,\" (\"SFAS 109\"). SFAS 109 requires the Company to compute deferred taxes on the difference between the financial statement and tax basis of assets and liabilities using enacted rates.\nA. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED): ------------------------------------------------------\n(8) Operations -- The Company operates 414 convenience stores, 39 of which are operated by franchisees (46 in 1994 and 49 in 1993). During fiscal 1995, the results of operations include sales and costs of sales of 28 of these franchisees for which the Company exercises complete control and bears the attendant risks of ownership (33 in 1994 and 35 in 1993). Net sales of stores operated by these franchisees were $13,057,200 (1995), $14,163,600 (1994) and $15,286,800 (1993).\n(9) Earnings Per Share -- Earnings per share are calculated based on the weighted average number of shares of common stock outstanding. Common stock equivalents were not considered in the computation of earnings per share as the effect was not significant to the Company.\n(10) Reclassifications -- Certain reclassifications have been made to the 1994 and 1993 financial statements to conform to the classifications used in 1995.\nB. PROPERTY, EQUIPMENT AND IMPROVEMENTS - AT COST: ---------------------------------------------- Estimated September 30, Life in 1995 1994 Years ----------- ----------- ---------- Land $14,823,317 $13,162,045 Buildings 34,952,245 33,043,184 30-35 Machinery and equipment 34,823,917 31,347,942 3-20 Capitalized property and equipment leases 1,643,775 1,643,775 5-25 Leasehold improvements 10,575,655 9,715,947 1-20 Construction in progress 854,219 927,109 ----------- ----------- 97,673,128 89,840,002 Less accumulated depreci- ation and amortization 37,414,215 32,956,154 ----------- ----------- $60,258,913 $56,883,848 =========== ===========\nC. INTERIM CREDIT FACILITIES: -------------------------\nThe Company has a $13.5 million revolving credit agreement with a bank group at the bank's prime rate or a fixed rate option at the Company's election, with a maximum of $3.5 million available for issuance of letters of credit. The revolving credit facility is committed for a two-year period expiring February 28, 1997 or a later date as approved by the bank group. At September 30, 1995, borrowings of $6.0 million and letters of credit of $2.7 million were outstanding under the agreement.\nD. LONG-TERM DEBT: -------------- September 30, 1995 1994 ----------- ----------- Term Loan. Interest is paid at least quarterly. Principal on the note will be repaid in 16 quarterly installments beginning October 31, 1997. The interest rate was 8.125% at September 30, 1995. $16,741,488 $16,805,316\nSenior Notes of the Company. Interest is paid in semiannual installments at a blended rate of 10.500%. Principal on the notes will be repaid in seven semiannual installments. 10,636,735 13,703,402\nRevolving Credit Agreement. Interest is paid quarterly. At September 30, 1995, the interest rate was 8.750%. (See Note C) 6,000,000 6,000,000\nMortgage Loans Payable. Paid in monthly installments expiring in years 1997 through 2004 with interest ranging from the bank's prime rate to the bank's prime rate plus one-half percent. The blended interest rate was 9.064% at September 30, 1995. 2,262,297 2,460,328\nLoans Payable. Paid in monthly installments expiring in 2010. The interest rate was 9.000% at September 30, 1995. 248,674\nVarious Equipment Financing. Repaid in fiscal 1995. 3,235 ----------- ----------- 35,889,194 38,972,281 Less current maturities 3,272,958 6,851,260 ----------- ----------- $32,616,236 $32,121,021 =========== ===========\nThe mortgage loans are collateralized by $6,755,600 of property at cost.\nAggregate maturities of long-term debt during the next five years, including payments due in connection with the senior notes and the term loan are as follows: (See Note M)\nSeptember 30, 1996 $ 3,273,000 1997 10,138,700 1998 7,443,400 1999 6,071,100 2000 4,605,100 ----------- $31,531,300 ===========\nD. LONG-TERM DEBT (Continued): -------------------------- Certain of the Company's debt agreements contain covenants which provide for the maintenance of minimum working capital and net worth as well as limitations on future indebtedness, sales and leasebacks and dispositions of assets. These agreements may restrict the Company's ability to declare and pay dividends on common stock. The amount of retained earnings available for such dividends at September 30, 1995 was $5,108,200.\nE. COMMITMENTS AND CONTINGENCIES: -----------------------------\n(1) Leases - The Company leases its corporate headquarters, a majority of its store locations and certain equipment. Future minimum lease payments under capital leases and noncancellable operating leases with initial or remaining terms in excess of one year at September 30, 1995 are shown below. Some of the leases provide for additional rentals when sales exceed a specified amount and contain variable renewal options and escalation clauses. Rental income in connection with the sublease of certain properties is also provided. Such rental income was $1,075,700 in 1995, $1,086,900 in 1994, and $1,071,600 in 1993.\nSublease Capital Operating Rental Leases Leases Income ---------- ----------- ---------- 1996 $ 216,800 $10,070,800 $1,125,400 1997 196,400 5,073,700 550,200 1998 167,700 3,267,700 387,000 1999 132,100 2,110,200 173,400 2000 139,900 1,613,900 115,500 Thereafter 541,000 6,903,700 244,000 ---------- ----------- ---------- Total future minimum lease payments 1,393,900 $29,040,000 $2,595,500 Less amount representing =========== ========== interest 559,300 ---------- Present value of future payments 834,600 Less current obligations 108,100 ---------- $ 726,500 ==========\nRental expense under operating leases was as follows:\nYear Ended September 30, 1995 1994 1993 ----------- ----------- ----------- Minimum rentals $10,537,700 $10,503,400 $10,349,200 Contingent rentals 98,800 87,500 90,000 ----------- ----------- ----------- $10,636,500 $10,590,900 $10,439,200 =========== =========== ===========\nE. COMMITMENTS AND CONTINGENCIES (Continued): -----------------------------------------\n(2) Change of Control Agreements - The Company has change of control agreements with its four executive officers pursuant to which each executive officer will receive remuneration of 2.99 times his base compensation if his employment is terminated due to a change of control as defined in the agreements. Remuneration which might be payable under these agreements has not been accrued in the consolidated financial statements as a change of control has not occurred.\nF. INCOME TAXES: ------------\nThe provision for income taxes includes the following:\nYear Ended September 30, 1995 1994 1993 ---------- ---------- ---------- Current tax expense: Federal $2,572,100 $2,129,600 $2,276,600 State 290,100 358,900 255,400 ---------- ---------- ---------- 2,862,200 2,488,500 2,532,000 ---------- ---------- ---------- Deferred tax expense: Federal ( 213,900) ( 343,300) ( 800,400) State ( 142,100) ( 268,100) ( 314,600) ---------- ---------- ---------- ( 356,000) ( 611,400) ( 1,115,000) ---------- ---------- ---------- $2,506,200 $1,877,100 $1,417,000 ========== ========== ==========\nDeferred tax liabilities (assets) are comprised of the following at September 30: 1995 1994 1993 ---------- ---------- ---------- Depreciation $3,512,500 $3,460,800 $3,981,800 ---------- ---------- ---------- Gross deferred tax liabilities 3,512,500 3,460,800 3,981,800 ---------- ---------- ---------- Insurance reserves ( 1,120,100) ( 766,400) ( 590,000) Capital leases ( 119,600) ( 130,700) ( 158,400) Deferred compensation ( 211,900) ( 171,500) ( 135,700) Deferred income ( 91,600) ( 173,800) ( 261,700) Intangible assets ( 155,000) ( 132,300) Deferred tax payments ( 96,200) Other ( 100,900) ( 112,600) ( 251,100) ---------- ---------- ---------- Gross deferred tax assets ( 1,895,300) ( 1,487,300) ( 1,396,900) ---------- ---------- ---------- $1,617,200 $1,973,500 $2,584,900 ========== ========== ==========\nF. INCOME TAXES (Continued): ------------------------\nThe financial statements include noncurrent deferred tax liabilities of $2,876,400 and $2,806,800 in 1995 and 1994, respectively, and current deferred tax assets of $1,259,200 and $833,300, which are included in prepaid expenses and other. No valuation allowance is required because, based upon the weight of available evidence, it is more likely than not that all of the deferred tax assets will be realized.\nA reconciliation of the provision for income taxes to an amount determined by application of the statutory federal income tax rate follows:\nYear Ended September 30, 1995 1994 1993 ---------- ---------- ---------- Statutory rate $2,264,400 $1,884,400 $1,543,300 Increase (decrease) resulting from: Tax credits ( 82,500) ( 184,800) Nondeductible items 83,000 76,800 114,000 State taxes (net) 97,700 59,900 ( 39,100) Other (net) 61,100 ( 61,500) ( 16,400) ---------- ---------- ---------- Tax provision $2,506,200 $1,877,100 $1,417,000 ========== ========== ==========\nG. RELATED PARTY TRANSACTIONS: --------------------------\nOn September 2, 1994, the Company purchased 315,000 shares of its Common Stock from Henry D. Sahakian, Chairman of the Company's Board, at $5.25 per share. The closing price of the Company's Common Stock on the American Stock Exchange on that date was $5.375 per share. On this date, amounts due to the Company from Mr. Sahakian of $1,308,000 were paid.\nCertain directors and officers of the Company are also directors, officers and shareholders of Unico Corporation (\"Unico\"), formerly the Company's parent, and other affiliated companies. The following is a summary of significant transactions with these entities:\n(1) The Company leases seven stores and certain other locations from Unico and leases its corporate headquarters and five additional locations from affiliates of Unico. Aggregate rentals in connection with these leases were $700,300 (1995), $887,000 (1994) and $1,062,200 (1993).\n(2) The Company charges an affiliate of Unico for general and administrative services provided. Such charges amounted to $10,400 (1995), $9,900 (1994) and $8,500 (1993).\nThe Company received commissions from Coinfone Telecommunications, Inc. (\"CTI\") for coin-operated telephones installed at convenience store locations. The majority of the stock of CTI is beneficially owned or controlled by persons related to Henry D. Sahakian. Commissions received from CTI were $310,300 (1995), $241,400 (1994), and $62,500 (1993).\nG. RELATED PARTY TRANSACTIONS (Continued): --------------------------------------\nThe Company acquired property for $1,605,300 in 1995 by exercising a property option that was controlled by Whitehall Associates, a partnership in which the Company was a partner. Bruce K. Heim, a director of the Company, is also a partner in a partnership which controls 75% of Whitehall Associates. The Company also paid rents of $86,300 and $129,800 to Whitehall Associates in 1995 and 1994, respectively.\nH. RETIREMENT SAVINGS AND INCENTIVE PLAN: -------------------------------------\nThe Company has a contributory retirement savings plan covering all employees meeting minimum age and service requirements. The Company will match one-half of employee contributions up to 3% of the employee's compensation. Effective July 1, 1991, the Company's contributions are invested in the Company's Common Stock. The Board of Directors may elect to make additional contributions to be allocated among all eligible employees in accordance with provisions of the plan. The retirement savings plan expense, which is funded currently, was $111,100 (1995), $116,000 (1994) and $111,000 (1993).\nI. DEFERRED COMPENSATION PLAN AND PERFORMANCE UNIT PLAN: ----------------------------------------------------\nThe Company has a non-qualified unfunded deferred compensation plan which permits key executives to annually elect (via individual contracts) to defer a portion of their compensation until their retirement, death or disability. The Company makes a 50% matching contribution not exceeding $5,000. The deferred compensation expense was $27,000, $24,700 and $23,900 for the years ended September 30, 1995, 1994 and 1993, respectively.\nThe Company has recorded the assets and liabilities for the deferred compensation plan in the consolidated balance sheets because such assets and liabilities belong to the Company rather than to any plan or trust. Asset and matching liability of $568,000 and $406,400 at September 30, 1995 and 1994, respectively, include employee deferrals, accrued earnings and matching contributions by the Company.\nThe Company also has a Performance Unit Plan to provide long-term incentives to senior executives. Under the Performance Unit Plan, the amount of compensation is determined over the succeeding three-year period based upon performance of the Company as well as individual goals for the senior executives. Compensation expense recognized under this plan was $100,000 for the year ended September 30, 1995.\nJ. EQUITY COMPENSATION PLAN: ------------------------\nThe Company has reserved 775,491 shares of common stock which can be issued in accordance with the terms of the Company's Equity Compensation Plan, as amended (the \"Plan\").\nJ. EQUITY COMPENSATION PLAN (CONTINUED): ------------------------------------\nA committee of the Board of Directors has authority to administer the Plan, and the committee may grant qualified incentive stock options to employees of the Company, including officers, whether or not they are directors. The Plan also provides that all non-employee directors will receive annual non qualified stock option grants for 2,000 shares and grants of shares of common stock on the date of each annual meeting. The grants of stock will be equal in value to and in lieu of two-thirds of the non-employee directors' annual retainers. During fiscal 1995, 6,223 shares of common stock were granted to non-employee directors under the Plan.\nThe exercise price of all options granted under the Plan may not be less than the fair market value of the common stock on the date of grant and the maximum allowable term of each option is ten years. For qualified stock options granted to any person who holds more than 10% of the voting power of the outstanding stock, the exercise price may not be less than 110% of the fair market value and the maximum allowable term is five years.\nInformation regarding outstanding options is presented below. All options outstanding are exercisable except for options granted during the year ended September 30, 1995.\nOutstanding Options for Shares of Common Stock:\nOutstanding Options Price Per Share ------------------- --------------- Balance, October 1, 1992 427,829 $2.50 to $7.00 Granted 0 Exercised ( 10,000) $2.50 to $4.63 Canceled ( 7,600) $2.50 to $6.88 ------- Balance, September 30, 1993 410,229 $2.50 to $7.00 Granted 58,770 $5.38 to $5.91 Exercised ( 23,000) $2.50 to $3.50 Canceled ( 14,925) $3.50 to $7.00 ------- Balance, September 30, 1994 431,074 $2.50 to $6.36 Granted 73,000 $5.38 to $5.63 Exercised ( 40,165) $2.50 to $6.36 Canceled 0 ------- Balance, September 30, 1995 463,909 $2.50 to $6.36 ======= Exercisable at September 30, 1995 390,909 $2.50 to $6.36 ======= Balance of Shares Reserved for Grant at September 30, 1995 311,582 =======\nK. NON-QUALIFIED STOCK OPTIONS: ---------------------------\nThe Company made a one-time, special grant of non-qualified stock options to Henry D. Sahakian and Daniel D. Sahakian each to purchase 150,000 shares of common stock of the Company at a price of $4.50 per share in exchange for their relinquishment of effective voting control of the Company as a result of the elimination of the super-majority voting provisions of the Class B Common Stock. These non-qualified stock options are not related to the Company's Equity Compensation Plan. These stock options expire on February 25, 1998.\nL. SALE OF DAIRY OPERATION: -----------------------\nIn April 1994, the Company sold the net assets of its dairy operation for approximately $6,438,000 and received a cash payment of $5,788,000 and 105,906 shares of its common stock valued at $650,000. The sale resulted in a pre-tax loss of $245,000 which is included as a reduction of other income. The total effect of the sale on net earnings was a loss of $51,000.\nM. SUBSEQUENT EVENT: ----------------\nOn December 26, 1995, the Company signed an agreement with its bank group to borrow $10 million on an interest-only basis for a period of three years. Full amortization of the facility is required in fiscal 1999. Proceeds from the loan will be used to complete major remodels, including adding prepared fast-food installations to existing stores, upgrading gasoline dispensing facilities to high-volume units and new store construction.\nThis agreement has changed the composition of the Company's capital requirements. Aggregate maturities of long-term debt during the next five years, including payments due in connection with the senior notes and the term loans are as follows: (See Note D)\nSeptember 30, 1996 $ 3,273,000 1997 10,138,700 1998 7,443,400 1999 16,071,100 2000 4,605,100 ----------- $41,531,300 ===========\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNot Applicable\nPART III\nIn accordance with Instruction G(3), 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 September 30, 1995, the end of the fiscal year covered by this report.\nPART IV\nITEM 14.","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENTS AND REPORTS ON FORM 8-K.\n(A) Financial Statements\nThe Financial Statements listed below are filed as part of this Annual Report on Form 10-K.\nPAGE(S)\nReport of Deloitte & Touche LLP, Independent Auditors 23\nConsolidated Balance Sheets - September 30, 1995 and 1994 24-25\nConsolidated Statements of Earnings for the years ended September 30, 1995, 1994 and 1993 26\nConsolidated Statements of Stockholders' Equity for the years ended September 30, 1995, 1994 and 1993 27\nConsolidated Statements of Cash Flows for the years ended September 30, 1995, 1994 and 1993 28-29\nNotes to Consolidated Financial Statements 30-39\nSupplementary Financial Information - Selected Quarterly Financial Data (Unaudited) 40\n(B) Reports on Form 8-K\nUni-Marts, Inc. filed no reports on Form 8-K with the Securities and Exchange Commission during the last quarter of the fiscal year ended September 30, 1995.\n(C) Exhibits\n3.1 Amended and Restated Certificate of Incorporation of the Company (Filed as Exhibit 3.1 to the Company's Quarterly Report on Form 10-Q for the period ended March 30, 1995 and incorporated herein by reference thereto).\n3.2 By-Laws of the Company (Filed as Exhibit 3.2 to the Company's Quarterly Report on Form 10-Q for the period ended March 30, 1995 and incorporated herein by reference thereto).\n4.1 Form of the Company's Common Stock Certificate (Filed as Exhibit 4.3 to the Company's Quarterly Report on Form 10-Q for the period ended April 1, 1993 and incorporated herein by reference thereto).\n10.1 Uni-Marts, Inc. Amended and Restated Equity Compensation Plan (Filed as Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the period ended March 30, 1995 and incorporated herein by reference thereto).\n10.2 Uni-Marts, Inc. Stock Option Plan for Non-qualified Stock Options dated as of February 26, 1993 (Filed as exhibit 10-2 to the Annual Report of Uni-Marts, Inc. for the year ended September 30, 1993 and incorporated herein by reference thereto).\n10.3 Uni-Marts, Inc. Retirement Savings & Incentive Plan (Filed as Exhibit 4.2 to the Company's Registration Statement on Form S-8, File No. 33-9807 and incorporated herein by reference thereto).\n10.4 Composite Conformed Copy of Note Agreements dated August 28, 1989 between four insurance companies and Uni-Marts, Inc. (Filed as Exhibit 10.14 to the Annual Report of Uni-Marts, Inc. on Form 10-K for the year ended September 30, 1989 and incorporated herein by reference thereto).\n10.5 Credit Agreement between the Bank Group and Uni-Marts, Inc. dated as of March 1, 1993 (Filed as Exhibit 19 to the Company's Quarterly Report on Form 10-Q for the period ended April 1, 1993 and incorporated herein by reference thereto).\n10.5(a) Amendment No. 1 to Credit Agreement between the Bank Group and Uni-Marts, Inc. dated as of March 21, 1994 (Filed as Exhibit 10.5(a) to the Annual Report of Uni-Marts, Inc. on Form 10-K for the year ended September 30, 1994 and incorporated herein by reference thereto).\n10.5(b) Amendment No. 2 to Credit Agreement between the Bank Group and Uni-Marts, Inc. dated as of July 1, 1994 (Filed as Exhibit 10.5(b) to the Annual Report of Uni-Marts, Inc. on Form 10-K for the year ended September 30, 1994 and incorporated herein by reference thereto).\n10.5(c) Third Amendment to Credit Agreement between the Bank Group and Uni-Marts, Inc. dated as of October 26, 1994 (Filed as Exhibit 10.5(c) to the Annual Report of Uni-Marts, Inc. on Form 10-K for the year ended September 30, 1994 and incorporated herein by reference thereto).\n10.5(d) Amendment No. 4 to Credit Agreement between the Bank Group and Uni-Marts, Inc. dated as of March 27, 1995 (Filed as Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the period ended March 30, 1995 and incorporated herein by reference thereto).\n10.5(e) Amendment No. 5 to Credit Agreement between the Bank Group and Uni-Marts, Inc. dated as of December 26, 1995.\n10.6 Form of Indemnification Agreement between Uni-Marts, Inc. and each of its Directors (Filed as Exhibit A to the Company's Definitive Proxy Statement for the February 25, 1988 Annual Meeting of Stockholders filed on January 28, 1988 and incorporated herein by reference thereto).\n10.7 Uni-Marts, Inc. Deferred Compensation Plan (Filed as Exhibit 10.8 to the Annual Report of Uni-Marts, Inc. on Form 10-K for the year ended September 30, 1990 and incorporated herein by reference thereto).\n10.8 Uni-Marts, Inc. Annual Bonus Plan (Filed as Exhibit 10.8 to the Annual Report of Uni-Marts, Inc. on Form 10-K for the year ended September 30, 1994 and incorporated herein by reference thereto).\n10.9 Uni-Marts, Inc. Performance Unit Plan (Filed as Exhibit 10.9 to the Annual Report of Uni-Marts, Inc. on Form 10-K for the year ended September 30, 1994 and incorporated herein by reference thereto).\n10.10 Composite copy of Change in Control Agreements between Uni-Marts, Inc. and its executive officers (Filed as Exhibit 10.10 to the Annual Report of Uni-Marts, Inc. on Form 10-K for the year ended September 30, 1994 and incorporated herein by reference thereto).\n10.11 Agreement to Lease Properties and Sell Assets between Getty and the Company dated October 31, 1991 with amendment dated December 5, 1991 (Filed as Exhibit 2.1 to the Company's Current Report on Form 8-K dated December 20, 1991 and incorporated herein by reference thereto).\n10.12 Getty Petroleum Corp.\/Uni-Marts, Inc. Supply Agreement dated December 6, 1991 (Filed as Exhibit 28.1 to the Company's Current Report on Form 8-K dated December 20, 1991 and incorporated herein by reference thereto).\n11 Statement regarding computation of per share earnings.\n21 Subsidiary of the registrant.\n23 Consent of Deloitte & Touche LLP.\n27 Financial data schedule.\n99 Report on Form 11-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. UNI-MARTS, INC. (Registrant) By: \/S\/ HENRY D. SAHAKIAN ------------------------------ Henry D. Sahakian Chairman of the Board (Principal Executive Officer)\nBy: \/S\/ J. KIRK GALLAHER ------------------------------ J. Kirk Gallaher Executive Vice President and Chief Financial Officer (Principal Accounting Officer) (Principal Financial Officer)\nDATED: December 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 this registrant and in the capacities and on the date indicated: SIGNATURE TITLE DATE --------- ----- ---- \/S\/ HENRY D. SAHAKIAN Chairman of the Board December 29, 1995 - ----------------------------- Henry D. Sahakian \/S\/ CHARLES R. MARKHAM President and Director December 29, 1995 - ----------------------------- Charles R. Markham \/S\/ J. KIRK GALLAHER Executive Vice President December 29, 1995 - ----------------------------- and Director J. Kirk Gallaher \/S\/ G. DAVID GEARHART Director December 29, 1995 - ----------------------------- G. David Gearhart \/S\/ BRUCE K. HEIM Director December 29, 1995 - ----------------------------- Bruce K. Heim \/S\/ JEREMIAH A. KEATING Director December 29, 1995 - ----------------------------- Jeremiah A. Keating \/S\/ JOSEPH V. PATERNO Director December 29, 1995 - ----------------------------- Joseph V. Paterno \/S\/ CHARLES C. PEARSON, JR. Director December 29, 1995 - ----------------------------- Charles C. Pearson, Jr. \/S\/ DANIEL D. SAHAKIAN Director December 29, 1995 - ----------------------------- Daniel D. Sahakian \/S\/ MICHAEL J. SERVENTI Director December 29, 1995 - ----------------------------- Michael J. Serventi\nUNI-MARTS, INC. AND SUBSIDIARIES EXHIBIT INDEX\nNumber Description Page(s) - ------ ----------- ------- 10.5(e) Amendment No. 5 to Credit Agreement between the Bank Group and Uni-Marts, Inc. dated as of December 26, 1995. 46-61\n11 Statement regarding computation of per share earnings for the years ended September 30, 1995, 1994 and 1993. 62\n21 Subsidiary of the registrant 63\n23 Consent of Deloitte & Touche LLP 64\n27 Financial Data Schedule 65\n99 Report on Form 11-K 66-82","section_15":""}
{"filename":"890175_1995.txt","cik":"890175","year":"1995","section_1":"ITEM 1. BUSINESS. ------------------\nGeneral -------\nGreen Tree Financial Corporation (\"Green Tree\" or \"the Company\") is a diversified financial services company that originates conditional sales contracts for manufactured homes, home improvements, consumer products and equipment financing, and provides commercial financing to manufacturers and dealers. The Company's insurance agencies also market physical damage and term mortgage life insurance relating to the customers' contracts it services. Green Tree is the largest servicer of manufactured housing government insured or guaranteed contracts, and conventional manufactured housing contracts in the United States. Through its principal offices in Saint Paul, Minnesota and service centers throughout the United States, Green Tree serves all 50 states.\nThe Company finances both new and previously owned manufactured homes, and originates conventional contracts as well as contracts insured by the Department of Housing and Urban Development's Federal Housing Administration (\"FHA\") and contracts partially guaranteed by the Department of Veterans' Affairs (\"VA\"). The Company's home improvement loans are financed either on a conventional basis or insured through the FHA Title I program. Consumer and equipment finance products are financed using installment sales contracts. The Company provides financing for the purchase of motorcycles, marine products, pianos and organs, horse trailers, sport vehicles, small aircraft, tractor\/trailers and recreational vehicles.\nGreen Tree also provides inventory financing to dealers, manufacturers and distributors of various consumer and commercial products, and in 1996 began providing home equity and revolving credit financing.\nGreen Tree pools and securitizes substantially all of the contracts it originates, retaining the servicing on the contracts. Conventional manufactured housing contracts are pooled and such pools are structured into asset-backed securities which are sold in the public securities markets. Substantially all FHA and VA manufactured housing contracts are converted into pass-through certificates (\"GNMA certificates\") guaranteed by the Government National Mortgage Association (\"GNMA\"), a wholly owned corporate instrumentality of the United States within the Department of Housing and Urban Development. The GNMA certificates, which are secured by the FHA and VA contracts, are then sold in the secondary market. The Company also pools FHA-insured and conventional home improvement contracts, and consumer and equipment finance installment sales contracts, for sale in the secondary market. In servicing the contracts, the Company collects payments from the\nborrower and remits principal and interest payments to the holder of the contract or investor certificate secured by the contracts.\nThe Company was originally incorporated as Green Tree Acceptance, Inc. under the laws of the State of Minnesota in 1975. In 1992, the Company changed its name to Green Tree Financial Corporation and in 1995 reincorporated as Green Tree Financial Corporation under the laws of the State of Delaware. The Company's principal executive offices are located at 1100 Landmark Towers, 345 St. Peter Street, Saint Paul, Minnesota 55102- 1639, and its telephone number is (612) 293-3400. Unless the context otherwise requires, \"Green Tree\" or the \"Company\" means Green Tree Financial Corporation and its subsidiaries.\nPurchase and Origination of Contracts\nConditional sales contracts are the typical means of financing the purchase of manufactured homes (\"MH\"), consumer products (\"CP\")and equipment finance products(\"EF\") and can also be used to finance home improvements (\"HI\") to existing owner-occupied one- to- four family homes. A \"contract\" or \"conditional sales contract\" refers to an agreement evidencing a monetary obligation and providing security for the obligation. MH contracts grant the owner of the contract a security interest in the related manufactured home (and any other personal property described therein), and CP and EF contracts grant a security interest in the related consumer or equipment finance product. For secured HI contracts, a mortgage or deed of trust on the home to which the improvements relate serves as security for the payment obligation under the contract. Green Tree also offers unsecured HI contracts on certain loans of $15,000 or less.\nAll contracts that the Company originates directly or indirectly are written on forms provided or approved by the Company and are originated on an individually approved basis in accordance with Company underwriting guidelines.\nManufactured Housing\n\"Manufactured housing\" or a \"manufactured home\" is a structure, transportable in one or more sections, which is designed to be a dwelling with or without a permanent foundation. Since most manufactured homes are never moved once the home has reached the homesite, the wheels and axles are removable and have not been designed for continuous use. Manufactured housing does not include either modular housing (which typically involves more sections, greater assembly and a separate means of transporting the sections) or recreational vehicles (\"RV's\") (which are either self- propelled vehicles or units towed by passenger vehicles).\nConditional sales contracts for manufactured home purchases may be financed on a conventional basis, insured by the FHA or partially guaranteed by the VA. With respect to manufactured housing, the\nrelative volume of conventional, FHA and VA contracts originated by the Company depends on customer and dealer preferences as well as prevailing market conditions. Over the last five years, the percentage of FHA and VA contracts in the Company's manufactured home contract portfolio has ranged from 15% to 39%, and at December 31, 1995, such contracts constituted 15% of the Company's portfolio (of which approximately 95% were FHA contracts). The Company has developed more cost effective conventional manufactured housing lending programs and as a result, FHA and VA contracts represented less than 1% of the Company's manufactured housing originations during 1995. MH contracts are generally subject to minimum down payments of approximately 5% of the amount financed. The Company offers manufactured housing contract terms up to 30 years.\nThrough its regional service centers, the Company arranges to purchase MH contracts from MH dealers located throughout the United States. The Company's regional service center personnel contact dealers located in their region and explain the Company's available financing plans, terms, prevailing rates, and credit and financing policies. If the dealer wishes to utilize the Company's available customer financing, the dealer must make an application for dealer approval. Upon satisfactory results of the Company's investigation of the dealer's creditworthiness and general business reputation, the Company and the dealer execute a dealer agreement. The Company also originates manufactured housing installment loan agreements directly with customers. For the year ended December 31, 1995, the Company's manufactured housing contract originations consisted of 83% purchased from dealers, and 17% directly originated by the Company.\nThe dealer or the customer submits the customer's credit application and purchase order to a central or regional service center where Company personnel make an analysis of the creditworthiness of the proposed buyer. If the application meets the Company's guidelines and credit is approved, the Company generally purchases the contract after the manufactured home is delivered and set up and the customer has moved in.\nFor manufactured housing contracts, the Company uses a proprietary automated credit scoring system. It is a statistically based scoring system which quantifies information using variables obtained from customers' credit applications and credit reports. As of December 31, 1995, this credit scoring system has been used in making credit determinations on over two million applications. The Company believes the use of this proprietary credit scoring system has contributed to the reduction in the number of repossessions incurred as a percentage of the Company's servicing portfolio.\nIn 1995, new manufactured housing shipments rose to approximately 340,000 units, a 12% increase over 1994. The Company continues to benefit from this increase and believes that it is maintaining its\nmarket share of contracts for financing new manufactured homes. Competition to finance manufactured home purchases continues to be strong, and there can be no assurance that such competition will not intensify in the future. Significant decreases in consumer demand for manufactured housing, or significant increases in competition, could have an adverse effect on the Company's financial position and results of operations.\nHome Improvement\nThe types of home improvements financed by the Company include exterior renovations, including windows, siding and roofing; pools and spas; kitchen and bath remodeling; and room additions and garages. The Company may also, under certain limited conditions, extend additional credit beyond the purchase price of the home improvement for the purpose of debt consolidation.\nThrough its centralized loan processing operations in Saint Paul, Minnesota, the Company arranges to purchase certain contracts from HI contractors located throughout the United States. The Company's business development managers contact HI contractors and explain the Company's available financing plans, terms, prevailing rates and credit and financing policies. If the contractor wishes to utilize the Company's available customer financing, the contractor must make an application for contractor approval. The Company has a contractor approval process pursuant to which the financial condition, business experience and qualifications of the contractor are reviewed prior to his or her approval to sell contracts to the Company. The Company occasionally will originate directly a home improvement promissory note involving a home improvement transaction.\nThe level of growth in the Company's HI contract originations during the year ended December 31, 1995 results from significantly expanding the number of relationships with contractors, remodelers and dealers throughout the United States. This has provided the Company with an established and growing network through which to market its financing.\nThe Company finances both conventional HI contracts and HI contracts insured through the FHA Title I program. Such contracts are generally secured by first, second or, to a lesser extent, third mortgages on the improved real estate. The Company has also implemented an unsecured conventional HI lending program for certain customers which generally allows for loan amounts ranging from $2,500 to $15,000. Unsecured loans account for less than 20% of the home improvement portfolio.\nThe contractor submits the customer's credit application and construction contract to the Company's office where an analysis of the creditworthiness of the customer is made using a proprietary credit scoring system that was implemented by the Company in June\n1993. If it is determined that the application meets the Company's underwriting guidelines and applicable FHA regulations (for FHA-insured contracts) and the credit is approved, the Company generally purchases the contract from the contractor when the customer verifies satisfactory completion of the work.\nConsumer and Equipment Finance\nGreen Tree's consumer finance and equipment finance divisions finance the purchase of motorcycles; marine products (including boats, boat trailers and outboard motors); pianos and organs; horse trailers; sport vehicles (including snowmobiles, personal watercraft and all-terrain vehicles); tractor\/trailers; personal aircraft; and recreational vehicles.\nThe Company arranges to purchase certain contracts originated by dealers throughout the United States. The Company's personnel contact dealers and explain Green Tree's available financing plans, terms, prevailing rates and credit and financing policies. If the dealer wishes to utilize the Company's available customer financing, the dealer must make an application for approval.\nThe dealer submits the customer's credit application and purchase order to the Company's central service center where an analysis of the creditworthiness of the proposed buyer is made. If the application meets the Company's guidelines and credit is approved, the Company purchases the contract when the customer accepts delivery of the product.\nThe volume of contracts originated by the Company during the past five years and certain other information for each of those years, are indicated below:\n- ---------------- (a) Does not include $552,936,000 of conventional contracts purchased from the Resolution Trust Corporation (\"RTC\").\n(b) Does not include $66,980,000 of conventional contracts purchased from other originators.\nThe Company believes that, in addition to an individual analysis of each contract, it is important to achieve a geographic dispersion of contracts in order to reduce the impact of regional economic conditions on the overall performance of the Company's portfolio. Accordingly, the Company seeks to maintain a portfolio of contracts dispersed throughout the United States. At December 31, 1995, no state accounted for more than 10% of all contracts serviced by the Company.\nThe Company originates contracts through over 3,000 approved manufactured housing dealers, approximately 5,700 home improvement contractors and over 3,000 consumer product dealers. In 1995, no single MH dealer accounted for more than one percent of the total number of MH contracts originated by the Company. Likewise, no single contractor or dealer accounted for more than two percent of the total number of HI or CP contracts originated by the Company.\nCommercial Finance Division\nGreen Tree's Commercial Finance Division extends credit through its three regional lending centers under revolving credit agreements with dealers, manufacturers and distributors of various consumer and commercial products. \"Floorplan Receivables\" represent the financing of product inventory for retail dealers of a variety of consumer products. The products securing the Floorplan Receivables currently include manufactured housing, recreational vehicles and marine products. \"Asset-Based Receivables\" represent the financing of production and inventory by manufacturers, such revolving credit arrangements being secured by finished goods inventory, accounts receivable rising from the sale of such inventory, certain work- in-process, raw materials and component parts, as well as other assets of the borrower.\nThe Company will provide financing for products for a particular dealer, manufacturer or distributor (\"Dealer\"), in most instances, only if the Company has also entered into a floorplanning agreement with the manufacturer, distributor or other vendor of such product. A Dealer requesting the establishment of a credit line with Green Tree is required to submit an application and financial information.\nAdvances made for the purchase of inventory are most commonly arranged in the following manner: the Dealer will contact the manufacturer and place a purchase order for a shipment of inventory. If the manufacturer has been advised that Green Tree is the Dealer's inventory financing source, the manufacturer will contact Green Tree to obtain an approval number with respect to such purchase order. Upon such request, the Company will determine whether (i) the manufacturer is in compliance with its floorplan agreement, (ii) the Dealer is in compliance with its program with Green Tree and (iii) such purchase order is within the Dealer's credit limit. If all of such requirements are met, the Company will issue an approval number to the manufacturer. The manufacturer will then ship the inventory and directly submit its invoice for such purchase order to Green Tree for payment. Interest or finance charges normally begin to accrue on the Dealer's accounts as of the invoice date. The proceeds of the loan being made by the Company to the Dealer are paid directly to the manufacturer in satisfaction of the invoice price and are often funded a number of days subsequent to the invoice date depending upon the Company's arrangements with the manufacturer. Inventory inspections are performed to physically verify the collateral used to secure a Dealer's loan, check the condition of the inventory, account for any missing inventory and collect any funds due. Approximately two-thirds of Green Tree's MH dealers are participants in this program.\nAsset-Based Receivables arise from asset-based revolving credit facilities provided to certain manufacturers and distributors.\nThese facilities typically involve a revolving line of credit, for a contractually committed period of time, pursuant to which the borrower may draw the lesser of the maximum amount of such line of credit or a specifically negotiated loan availability amount, subject to the availability of adequate collateral. The loan availability amount is determined by multiplying an agreed upon advance rate against the value of certain types of assets. In these facilities, Green Tree will most typically lend against finished inventory and eligible accounts receivable arising from the sale of such inventory which are free and clear of other liens and otherwise in compliance with specified standards.\nPooling, Disposition and Related Sales Structures of Contracts, Net Interest Margin Certificates and Floorplan Receivables\nThe Company pools contracts for sale to investors, generally on a monthly basis. It is the Company's policy to sell substantially all of the contracts it originates or purchases. Conventional manufactured housing contracts are generally sold through asset-backed securities. FHA-insured and VA-guaranteed manufactured housing contracts are converted into GNMA certificates. The GNMA certificates, which are secured by the FHA and VA contracts, are then sold in the secondary market. The GNMA certificates provide for payment by the Company to registered holders of the certificates of monthly principal and interest, as well as the \"pass-through\" of any principal prepayments on the contracts. The Company also pools FHA-insured and conventional home improvement contracts for sale in the secondary market. Consumer product and equipment finance contracts have also been pooled for sale to investors through both public and private transactions. During 1994 and 1995, the Company also securitized a significant portion of its excess servicing rights receivable in the form of securitized Net Interest Margin Certificates (\"NIM Certificates\"), and in 1995 securitized a significant portion of its then outstanding floorplan receivables through a Master Trust structure.\nPrincipal and interest payments made by borrowers on the manufactured housing contracts securing each GNMA certificate are the source of funds for payments due on the GNMA certificates. The Company is required to advance its own funds in order to make timely payment of all amounts due on the GNMA certificates if, due to defaults or delinquencies on contracts, the payments received by the Company on the contracts securing such certificates are less than the amounts due on the certificates. If the Company was unable to make payments on the GNMA certificates as they became due, it would promptly notify GNMA and request GNMA to make such payments and, upon such notification and request, GNMA would make such payments directly to the registered holders of the certificates and would seek reimbursement from the Company, FHA or the VA as appropriate. The GNMA certificates are secured by manufactured housing contracts which are either FHA- insured or VA-guaranteed. For FHA manufactured housing contracts, the maximum\namount of insurance benefits paid by FHA is equal to approximately 90% of the net unpaid principal and uncollected interest earned to the date of default on the contract, subject to certain adjustments, less the greater of the actual net sales price or FHA appraisal of the home. The amounts reimbursable by FHA are further limited to an aggregate amount representing reserves FHA has established. These reserves, which approximated $106 million at December 31, 1995, are based on the Company's origination and loss experience. The Company is required to make scheduled premium payments to maintain the benefit of the reserve. If losses on FHA-insured contracts exceed the established reserve, the Company would not be reimbursed by FHA but would still be required to make payments on the GNMA certificates. For VA manufactured housing contracts, the maximum guarantee that may be issued is the lesser of: (1) the lesser of $20,000 or 40% of the principal amount of the contract, or (2) the maximum amount of guarantee entitlement available to the veteran (which may range from $20,000 to zero).\nConventional manufactured housing, home improvement, consumer and equipment finance contracts are pooled and sold by the Company through securitized asset sales which have been either single class or senior\/subordinated pass-through structures. Under certain securitized sales structures, corporate guarantees, bank letters of credit, surety bonds, cash deposits or other equivalent collateral have been provided by the Company as credit enhancements. Certain senior\/subordinated structures, such as those used during 1990, 1991 and 1992, retain a portion of the Company's excess servicing spread as additional credit enhancement or for accelerated principal repayments to subordinated certificateholders. The Company analyzes the cash flows unique to each transaction, as well as the marketability and earnings potential of such transactions when choosing the appropriate structure for each securitized loan sale. The structure of each securitized sale depends, to a great extent, on conditions of the fixed income markets at the time of sale as well as cost considerations and availability and effectiveness of the various enhancement methods. Customer principal and interest payments are deposited in separate bank accounts as received by the Company and are held for monthly distribution to the certificateholders.\nDuring 1994 and 1995 Green Tree sold a substantial portion of its excess servicing rights receivable, representing net cash flows retained from the securitization of its manufactured housing contracts, in the form of securitized NIM Certificates through public offerings. A subordinated interest in those certificates was retained by the Company. As a result of these transactions, certain net cash flows that formerly were retained by Green Tree are now passed through to investors with the exception of a 50 basis point servicing fee which Green Tree retains out of available monthly net cash flows. Payments on the subordinated interests retained do not commence until the senior certificateholders have been paid all principal and interest due them under the terms of\nthe transaction. Interest will continue to accrue to the balance of such subordinated certificates until payments commence.\nIn initially valuing its excess servicing rights receivable, the Company establishes an allowance for expected losses under the recourse provisions with investors\/owners and calculates that allowance on the basis of historical experience and management's best estimate of future credit losses likely to be incurred. If there is a default under a contract and liquidation of the underlying collateral on loans not sold as part of the NIM Certificate sales, any net losses are charged against the reserves that have been established. Losses in excess of those projected in the valuation of the NIM Certificates have the effect of reducing the value of the subordinate interest retained by Green Tree. The dollar amount of potential contractual recourse to the Company exceeds both the amount of projected losses factored into the subordinated certificate valuation and the amount established by the Company as an \"allowance for losses on contracts sold with recourse.\"\nDuring 1995 the Company formed a revolving Master Trust vehicle for purposes of selling its commercial finance receivables, and in December 1995 issued its first series of certificates through this trust totaling approximately $428 million. This first series of certificates has a two year life with an option to extend the term to three years at the Company's discretion, and was structured as a LIBOR-based floater backed by eligible commercial finance receivables, such receivables having been removed from the Company's balance sheet upon sale.\nEstimated losses relating to the Company's commercial finance receivables are recorded at the time the loans are made. Commercial finance receivables are shown net of the related allowance for losses and net of amounts securitized and sold on the balance sheet.\nInformation on the Company's securitized asset sales is as follows:\n(a) \"Contracts sold\" represents the face amount of the contracts sold but not necessarily settled during the same year.\n(b) Includes $533 million of contracts purchased from the RTC.\n(c) Includes $52 million of contracts purchased from other originators, but does not include $88 million of contracts sold pursuant to a joint venture agreement with Merrill Lynch Mortgage Capital, Inc.\n(d) Approximately $431 million of consumer products contracts were securitized and sold in January 1996.\nServicing\nThe Company services all of the contracts and commercial finance receivables that it originates or purchases from other originators, collecting loan payments, taxes and insurance payments, where applicable, and other payments from borrowers and remitting principal and interest payments to the holders of the asset-backed securities or of the GNMA certificates.\nThe following table shows the composition of the Company's servicing portfolio at December 31 for the years indicated on contracts it originated, excluding commercial finance receivables.\nDuring 1990 and 1991, the Company acquired servicing on manufactured housing contracts originated by other lenders. The Company has not since acquired servicing on manufactured housing contracts originated by other lenders, and does not expect to acquire such servicing in the near future. The Company has no loss risk on these contracts and charges a service fee based on principal outstanding. The following table shows the composition of this servicing portfolio at December 31 for the years indicated.\nAs of December 31, 1995 and 1994 the Company serviced $574,100,000 and $167,723,000, respectively, of commercial finance receivables. The Company currently has financing arrangements with approximately 2,000 dealers.\nDelinquency and Loss Experience\nA contract is considered delinquent by the Company if any payment of $25 or more is past due 30 days or more. Contracts for which the obligor is in bankruptcy are considered delinquent regardless of whether or not the borrower is current under a plan of bankruptcy. Delinquent contracts are subject to acceleration, and repossession\nor foreclosure of the underlying collateral. Losses associated with such actions are charged against applicable reserves upon disposition of the collateral.\nThe following table provides certain information with respect to the delinquency and loss experience of contracts the Company originated, excluding commercial finance receivables.\n(a) As a percentage of the total number of contracts serviced at period end (other than contracts already in repossession).\n(b) As a percentage of the average number of contracts serviced during the period.\n(c) As a percentage of the average principal amount of contracts serviced during the period. Annual net repossession losses represent the loss amount at the time the repossession is sold, and has not been reduced for amounts subsequently recovered from either customers or investors.\n(d) As a percentage of the total number of contracts serviced at period end.\nCommercial finance receivables due and unpaid aged over 60 days as of December 31, 1995 totaled .18%.\nInsurance\nThrough certain subsidiaries, the Company markets physical damage insurance on manufactured homes, certain consumer products and dealer lots which collateralize contracts and receivables serviced by the Company, and markets term mortgage life insurance to its MH and HI customers. In addition, the Company owns Green Tree Life Insurance Company, a life and disability reinsurance company which functions as a reinsurer for policies written by selected other insurers covering individuals whose contracts are serviced by the Company.\nThe following table provides certain information with respect to net written premiums (gross premiums on new or renewal policies issued less cancellations of previous policies) on policies written by the Company. The Company acts as an agent with respect to the\nsale of such policies and, in some cases, the Company also acts as reinsurer of such policies.\nRegulation\nThe Company's operations are subject to supervision by various state authorities (typically state mortgage lending, financial institutions, consumer credit and insurance authorities) that generally require that the Company be licensed to conduct its business. In many states, issuance of licenses is dependent upon a finding of public convenience, and of financial responsibility, character and fitness of the applicant. The Company is generally subject to state regulations, examinations and reporting requirements, and licenses are revocable for cause.\nContracts insured under the FHA Title I manufactured home and home improvement lending programs are subject to compliance with detailed federal regulations governing originations, servicing, and loss claim payments by the FHA to cover a portion of losses due to default and repossessions or foreclosures. Other governmental programs such as VA also contain similar detailed regulations governing loan origination and servicing responsibilities.\nThe Federal Consumer Credit Protection Act (\"FCCPA\") requires, among other things, a written disclosure showing the cost of credit to debtors when consumer credit contracts are executed. The Federal Equal Credit Opportunity Act requires certain disclosures to applicants for credit concerning information that is used as a basis for denial of credit and prohibits discrimination against applicants with respect to any aspect of a credit transaction on the basis of sex, race, color, religion, national origin, age, marital status, derivation of income from a public assistance program, or the good faith exercise of a right under the FCCPA, of which it is a part. By virtue of a Federal Trade Commission rule, consumer credit contracts must contain a provision that the holder of the contract is subject to all claims and defenses which the debtor could assert against the seller, but the debtor's recovery under such provisions cannot exceed the amount paid under the contract.\nThe Company is also required to comply with other federal disclosure laws for certain of its lending programs. The home equity lending program, the combination land-and-home program, the land-in-lieu program and the home improvement lending program are\nsubject to the Federal Real Estate Settlement and Procedures Act. In addition, the Company is subject to the reporting requirements of the Home Mortgage Disclosure Act for its manufactured home, purchase money mortgage and home improvement lending products.\nThe construction of manufactured housing is subject to compliance with governmental regulation. Changes in such regulations may occur from time to time and such changes may affect the cost of manufactured housing. The Company cannot predict whether any regulatory changes will occur or what impact such future changes would have on the manufactured housing industry.\nThe Company is subject to state usury laws. Generally, state law has been preempted by federal law with respect to certain manufactured home, mortgage lending and home improvement products, although certain states have enacted legislation superseding federal law. To be eligible for the federal preemption, the Company's contract form must comply with certain consumer protection provisions. The Company offers its products within the limitations set by the state usury laws and federal preemption of these laws.\nThe regulatory procedures discussed above are subject to changes by the regulatory authorities. There are no assurances that future regulatory changes will not occur. These regulatory changes could place additional burdens on the Company's programs.\nCompetition and Other Factors\nThe Company is affected by consumer demand for manufactured housing, home improvements, consumer products and its insurance products, as well as commercial demand for floorplan and asset-backed lending. Consumer and commercial demand, in turn, are partially influenced by regional trends, economic conditions and personal preferences. The Company competes primarily with banks, finance companies, savings and loan associations, and credit unions. Prevailing interest rates are typically affected by economic conditions. Changes in rates, however, generally do not inhibit the Company's ability to compete, although from time to time in particular geographic areas, local competition may choose to offer more favorable rates. The Company competes by offering superior service, prompt credit review, and a variety of financing programs.\nThe Company's business is generally subject to seasonal trends, reflecting the general pattern of sales of manufactured housing and site-built homes. Sales typically peak during the spring and summer seasons and decline to lower levels from mid-November through January.\nEmployees\nAs of December 31, 1995, the Company had 2,503 full-time and 308 part-time employees, and considers its employee relations to be satisfactory. None of the employees are represented by a union.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nAt December 31, 1995, the Company operated 50 manufactured housing regional service centers and three commercial finance business centers located in 35 states. Such offices are leased, typically for a term of three to five years, and range in size from 1,700 to 22,000 square feet. The Company also operates a central servicing center in Rapid City, South Dakota. The lease on this facility is for a term of five years with an option to purchase and consists of 100,000 square feet. The Company's home improvement and consumer products divisions lease their main office in Saint Paul, Minnesota. The lease is for a term of five years and consists of 122,000 square feet. (See Note I of Notes to Consolidated Financial Statements for annual rental obligations.) The Company owns the building which houses its equipment finance and insurance divisions and its corporate offices.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThe nature of the Company's business is such that it is routinely a party or subject to items of pending or threatened litigation. Although the ultimate outcome of certain of these matters cannot be predicted, management believes, based upon information currently available and the advice of counsel, that the resolution of these routine legal matters will not result in any material adverse effect on its consolidated 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 is traded on the New York and Pacific Stock Exchanges under the symbol \"GNT.\" The following table sets forth, for the periods indicated, the range of the high and low sale prices.\n1994 High Low ---- --------- ----------\nFirst quarter $14-1\/2 $10-27\/32 Second quarter 15-1\/4 10-3\/4 Third quarter 17-7\/16 12-3\/8 Fourth quarter 15-5\/16 12-1\/8\n1995 High Low ---- --------- ----------\nFirst quarter 20-1\/2 14-3\/8 Second quarter 23-5\/16 18-3\/4 Third quarter 31-7\/16 21-11\/16 Fourth quarter 32-3\/8 25\nThe above stock prices, as well as all other share and per share amounts referenced in this Annual Report on Form 10-K, have been restated to reflect the two-for-one stock splits effected in the form of stock dividends in June 1994 and October 1995.\nOn February 29, 1996, the Company had approximately 755 stockholders of record of its Common Stock including the nominee of The Depository Trust Company which held approximately 130,478,302 shares of Common Stock.\nThe Company has paid cash dividends since December 1986. The 1995 quarterly dividend rate for the first three quarters was $0.047 per share. In September 1995, the Board of Directors approved an increase in the quarterly dividend rate to $0.0625 per share effective December 1995. The payment of future dividends will depend on the Company's financial condition, prospects and such other factors as the Board of Directors may deem relevant. Under a letter of credit agreement, the Company is subject to restrictions limiting the payment of dividends and Common Stock repurchases. At December 31, 1995, such payments were limited to $25,046,000, which represents 50% of consolidated net earnings for the most recently concluded four fiscal quarter periods less dividends paid, repurchases of Common Stock and the retirement of Subordinated Indebtedness.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\n(a) Before extraordinary loss relating to the debt exchange in 1992.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS.\nIntroduction\nGreen Tree Financial Corporation is a diversified financial services company that originates conditional sales contracts for manufactured homes (\"MH\"), home improvements (\"HI\"), consumer products (\"CP\")and equipment financing (\"EF\"), and provides commercial financing to manufacturers and dealers. The Company's insurance agencies market physical damage and term mortgage life insurance relating to the customers' contracts it services. Green Tree also acts as servicer for manufactured housing contracts originated by other lenders.\nThe Company records \"net gains on contract sales\" at the time of sale of its contracts and defers service income, recognizing it as servicing is performed. Income from commercial financing is recognized as realized. Net gains on contract sales are an amount equal to the present value of the expected excess servicing rights receivable to be collected during the term of the contracts, plus or minus any premiums or discounts realized on the sale of the contracts and less any selling expenses. \"Excess servicing rights receivable\" represents cash expected to be received by the Company over the life of the contracts. The subordinated certificates retained by the Company from the securitized Net Interest Margin Certificate (\"NIM Certificate\") sales are shown net of projected losses and are included in excess servicing rights receivable. Excess servicing rights receivable, excluding the subordinated certificates, is calculated by aggregating the contractual payments to be received pursuant to the contracts and subtracting: (i) the estimated amount to be remitted to the investors\/owners of the contracts, (ii) the estimated amount that will not be collected as a result of prepayments, (iii) the estimated amount to be remitted for FHA insurance and other credit enhancement fees and (iv) the estimated amount that represents deferred service income. Deferred service income represents the amount that will be earned by the Company for servicing the contracts. Concurrently with recognizing such gains, the Company also records the present value of excess servicing rights as an asset on the Company's balance sheet. Excess servicing rights receivable is calculated using prepayment, default, and interest rate assumptions which the Company believes market participants would use for similar instruments,such assumptions being consistent, given portfolio composition, with those used in the public sales of the NIM Certificates. Excess servicing rights receivable has not been reduced for potential losses under recourse provisions of the sales. Such rights are subordinated to the rights of investors\/owners of the contracts. The Company believes that the excess servicing rights receivable recognized at the time of sale does not exceed the amount that would be received if it were sold in the marketplace.\nIn initially valuing its excess servicing rights receivable, the Company establishes an allowance for expected losses under the recourse provisions with investors\/owners of contracts or investor certificates and calculates that allowance on the basis of historical experience and management's best estimate of future credit losses likely to be incurred. The amount of this provision is reviewed quarterly and adjustments are made if actual experience or other factors indicate management's estimate of losses should be revised. While the Company retains a substantial amount of risk of default on the loan portfolios that it sells, such risk has been substantially reduced through the sales of the NIM Certificates. The Company believes that its allowance for losses on contracts sold with recourse is adequate and consistent with current economic conditions as well as historical default and loss experiences of the Company's entire loan portfolio. The allowance for losses on\ncontracts sold with recourse is shown separately as a liability. The allowance has been discounted using an interest rate equivalent to the risk-free market rate for securities with a duration consistent with the estimated timing of losses. The outstanding security balances of contracts at December 31, 1995 were $1,290,750,000 of GNMA certificates and $10,941,384,000 related to securitized transactions, including whole loan sales.\nThe Company records the amount to be remitted to the investors\/owners of the contracts or investor certificates for the activity related to the current month, payable the next month, as \"investor payable\" and it is shown separately as a liability on the Company's balance sheet.\nThe Company has provided the investors\/owners of pools of contracts with a variety of additional forms of credit enhancements on its securitized sales. These credit enhancements have included corporate guarantees, letters of credit and surety bonds that provide limited recourse to the Company, and letters of credit that, if drawn, are entitled to reimbursement only from the future excess cash flows of the underlying transactions. Furthermore, certain securitized sales structures use cash reserve funds and certain cash flows from the underlying pool of contracts as additional credit enhancement.\nThe carrying value of the subordinated interest in the NIM Certificates retained by the Company is determined using prepayment and default assumptions consistent with those used in determining the value of excess servicing rights receivable, giving consideration to differences in the composition of the contracts underlying those anticipated cash flows. The subordinated certificates are shown net of the effect of projected losses.\nPayments on the subordinated certificates will not be made until such time as the senior certificateholders have been paid all principal and interest due them under the terms of the transactions. As such, interest on the subordinated certificates will continue to accrue to the outstanding balance until payments commence. Green Tree collects a monthly servicing fee equal to 50 basis points on an annualized basis on the underlying contract balance to the extent that adequate funds are available based on cash flows provided by each underlying securitized sale.\nThe Company's expectations used in calculating its excess servicing rights receivable and allowance for losses on contracts sold with recourse, as well as the value of the subordinated interest in the NIM Certificates, are subject to volatility that could materially affect operating results. Prepayments resulting from obligor mobility, general and regional economic conditions, and prevailing interest rates, as well as actual losses incurred, may vary from the performance the Company projects. The Company recognizes the impact of adverse prepayment and loss experience by recording a\ncharge to current earnings. The Company reflects favorable portfolio experience prospectively as realized.\nResults of operations\nThe following table shows, for the periods indicated, the percentage relationships to income of certain income and expense items and the percentage changes in such items from period to period.\nNet gains on contract sales increased 47.7% and 63.0% for the years ended December 31, 1995 and 1994, respectively, as a result of increased dollar volume of contracts sold, longer average terms and in 1995, higher interest rate spreads on contracts sold. During 1995 and 1994, total contract sales increased $829,317,000 or 22.0% and $1,423,930,000, or 60.7%, respectively. In 1994, the increase in net gains on contract sales was partially offset by decreased interest rate spreads on contracts sold. The Company's net gains on contract sales in 1993 reflect higher interest rate spreads on contracts sold but were reduced by an increase in prepayment reserves as a result of higher than previously projected prepayment activity.\nPrevailing interest rates are typically affected by economic conditions. Changes in interest rates generally do not inhibit the Company's ability to compete, although from time to time, in particular geographic areas, local competition may be able to offer more favorable rates. Because of the size of the excess servicing spread (which enables the Company to absorb changes in interest\nrates) and the relatively short period of time between origination and sale of contracts, the Company's ability to sell contracts is generally not affected by gradual changes in interest rates, although the amount of earnings may be affected. Average excess servicing spreads were 3.8%, 3.1% and 3.8% for 1995, 1994 and 1993, respectively. Excess servicing spreads decreased during 1994 as the rates on the Company's sales of securitized loans increased faster than the rates on the contracts originated by the Company.\nThe increase in the provision for losses on contract sales of 65.9% in 1995 reflects the growth in total contract sales and the Company's increased provision for losses on contract sales as a percentage of contracts sold. This increased percentage is a result of increasing average contract terms and the changing mix of originations to a higher percentage of conventional contracts and to loans which have a lower down payment. The 74.3% increase in the provision for losses on contract sales during 1994 also reflects the Company's higher dollar volume of contracts sold during the year as well as the changing mix of originations to a significantly lower percentage of FHA and VA contracts. The Company feels that its credit underwriting standards and servicing procedures have served to stabilize its loss experience. A very important factor in the reduction of the Company's credit risk is the geographic dispersion of the portfolio. At December 31, 1995, no state accounted for more than 10% of all contracts serviced by the Company. The Company continually monitors its dispersion of contracts as economic downturns are often more severely felt in certain geographic areas than others.\nDuring 1994 and 1995 the Company sold a substantial portion of its excess servicing rights receivable, representing net cash flows retained from the securitization of its manufactured housing contracts, in the form of securitized NIM Certificates through public offerings. Green Tree Securitized Net Interest Margin Trusts 1994-A, 1994-B and 1995-A, sold certificates representing approximately 72% to 78% of the estimated present value of future excess servicing cash flows derived from the Company's sales of certain manufactured housing contracts between 1978 and 1995. The estimated present value of these future excess servicing cash flows was previously recorded on the Company's balance sheet as part of \"Excess servicing rights receivable\", \"Contracts, GNMA certificates and collateral\" and \"Allowance for losses on contracts sold with recourse\". The remaining interests retained by the Company, representing subordinated certificates, continue to be recorded as part of excess servicing rights receivable and are shown net of projected losses.\nThe manufactured housing market experienced a 12% increase in new home shipments during 1995 compared to 1994. The Company continues to benefit from this increase as its dollar volume of MH contract originations rose 29.9% during 1995 over 1994 to $4,159,836,000, and believes that it is maintaining its market share of contracts\nfor financing new manufactured homes. The Company's dollar volume of new manufactured housing contract originations rose 31.4% during 1995 over 1994. The dollar volume of previously owned MH contract originations also rose 43.7% year over year. Although small compared to total volume, the dollar volume of refinanced contracts decreased in 1995 compared to 1994. In addition to the increase in the number of new MH contracts originated by the Company, the average contract size has also increased due to a shift in the Company's manufactured home financing to more land-and-home contracts, price increases by the MH manufacturers, and new federal wind and thermal standards enacted in mid- to-late 1994.\nThe dollar volume of home improvement, consumer and equipment finance contract originations rose 95.5% during 1995 over 1994 to $1,098,139,000. The level of growth in these divisions results from significantly expanding the number of relationships with contractors, remodelers and dealers throughout the United States. This has provided the Company with an established and growing network through which to market its financing.\nInterest income is realized from contract inventory, commercial finance receivables, cash deposits, short-term investments, as well as amortization of the present value discount relating to excess servicing rights receivable. Interest income grew 58.0% during 1995 over 1994 primarily from increased earnings on the Company's commercial finance receivables. Amortization of the present value discount during 1995 increased in comparison to 1994 due to the growth of the Company's average excess servicing rights receivable. Contracts held for sale during the year was higher on average than during 1994 due to higher production levels, resulting in an increase in interest income. Interest income decreased 1.0% for the year ended December 31, 1994 compared to 1993. Interest income relating to the amortization of the present value discount during 1994 decreased compared to 1993 as a result of the NIM Certificate sales, offset partially by interest accrued on the subordinated certificates. Earnings on short-term investment activity relating to the cash generated by the NIM Certificate sales and an increase in average contracts held for sale due to substantially higher production levels during 1994 also partially offset that decrease. Contributing to the growth in interest income during 1993 was interest earned on the increased dollar amount of contracts held for sale and increased amortization of the present value discount on the Company's excess servicing rights receivable.\nThe increase in service income of 33.7% during 1995 and 28.3% during 1994 resulted from the 38.2% and 35.2% growth in the Company's average originated servicing portfolio during 1995 and 1994, respectively, but was offset by the decline in servicing income on contracts originated by others. The average unpaid principal balance of contracts being serviced for others during 1995 and 1994 decreased 21.0% and 22.1%, respectively. The Company expects this decline in outside servicing to continue in the future while overall servicing income should increase as its portfolio grows.\nCommissions and other income, which includes commissions earned on new insurance policies written and renewals on existing policies, as well as other income from late fees, grew during 1995, 1994 and 1993 primarily as a result of the increase in net written insurance premiums as the Company's contract originations and servicing portfolio continue to grow.\nInterest expense increased 37.7% during 1995 as a result of the Company maintaining a significantly higher level of borrowings to fund its loan originations and commercial finance portfolio during 1995 compared to 1994. Interest expense decreased 18.6% during 1994 compared to 1993. The Company maintained a lower level of borrowings to fund its loan originations during 1994, as compared with 1993, as a result of converting a substantial portion of its excess servicing rights receivable to cash through the NIM Certificate sales, as well as completing more frequent contract sales in 1994. This decreased level of borrowings is offset slightly by higher average interest rates throughout much of 1994. The Company's interest expense increased in 1993 as a result of the higher amount of average outstanding borrowings supporting the Company's increased contract inventory levels. The increase was, however, partially offset by lower average interest rates.\nGreen Tree's dollar amount of cost of servicing has increased over the past three years as its total average servicing portfolio during the years ended December 31, 1995, 1994 and 1993 grew 36.5%, 32.4% and 17.1%, respectively. The Company's cost of servicing as a percentage of contracts serviced has decreased over each of the past three years.\nGeneral and administrative expenses rose 67.1% and 38.1% during 1995 and 1994, respectively. The primary reason for these increases in both 1995 and 1994 relates to the compensation of the chief executive officer pursuant to the terms of an employment agreement, the majority of such expense being paid in stock. As a percentage of contract originations, however, general and administrative expenses have remained relatively constant over the past three years.\nDuring the third quarter of 1993, the Company took a one-time charge to earnings of $4,685,000 as a result of the August 1993 enactment of the new federal corporate income tax rate. The charge reflects the increase in the federal corporate income tax rate on the Company's deferred tax liability and increased the Company's effective tax rate during that year to 41.9%. The Company's effective tax rate during 1995 and 1994 was 38% and 40%, respectively.\nThe Company is affected by consumer demand for manufactured housing, home improvements, consumer products and its insurance products, as well as commercial demand for floorplan and asset-backed lending. Consumer and commercial demand, in turn, are partially influenced by regional trends, economic conditions and personal preferences. The Company can make no prediction about any particular geographic area in which it does business. These\nregional effects, however, are mitigated by the national geographic dispersion of its servicing portfolio.\nStatement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation,\" (FAS 123) was issued in October 1995 and requires that the impact of the fair value of employee stock-based compensation plans on net income and earnings per share be disclosed on a pro forma basis in a footnote to the consolidated financial statements for awards granted after December 15, 1994, if the accounting for such awards continues to be in accordance with Accounting Principles Board Opinion No. 25, \"Accounting for Stock Issued to Employees\" (APB 25). Alternatively, FAS 123 permits a company to record the fair value of employee stock-based compensation plans as a component of compensation expense in the statement of income as of the date of grant of awards related to such plans. Adoption of FAS 123 is required for fiscal years beginning after December 15, 1995. In adopting FAS 123, the Company plans to disclose the impact on net income and earnings per share on a pro forma basis in a footnote to the consolidated financial statements.\nInflation has not had a material effect on the Company's income or earnings over the past three fiscal years.\nCapital resources and liquidity\nThe Company's business requires continued access to the capital markets for the purchase, warehousing and sale of contracts. To satisfy these needs, the Company employs a variety of capital resources.\nHistorically, the most important liquidity source for the Company has been its ability to sell contracts in the secondary markets through loan securitizations and sales of GNMA certificates. Under certain securitized sales structures, corporate guarantees, bank letters of credit, surety bonds, cash deposits or other equivalent collateral have been provided by the Company as credit enhancements. Certain senior\/subordinated structures, such as those used during 1990, 1991 and 1992, retain a portion of the Company's excess servicing spread as additional credit enhancement or for accelerated principal repayments to subordinated certificateholders. The Company analyzes the cash flows unique to each transaction, as well as the marketability and earnings potential of such transactions when choosing the appropriate structure for each securitized loan sale. The structure of each securitized sale depends, to a great extent, on conditions of the fixed income markets at the time of sale as well as cost considerations and availability and effectiveness of the various enhancement methods. During 1995, the Company used a senior\/subordinated structure for each of its ten conventional manufactured home loan sales and enhanced a portion of the subordinated certificates sold with a corporate guarantee. The\nCompany's expertise and increased loan origination volume have allowed it to have multiple conventional manufactured home loan sales in a quarter which serves to reduce interest rate risk by shortening the holding period of the contracts. The Company's public home improvement sales in the first and third quarters of 1995 were each comprised of two trusts. The first trust, which included secured home improvement contracts, employed a senior\/subordinated structure with a limited corporate guarantee and the second trust, which included unsecured home improvement contracts, was a single class pass-through with a limited corporate guarantee. The Company's public home improvement sales in the second and fourth quarters of 1995 each employed a senior\/subordinated structure with a limited corporate guarantee.\nAnother liquidity source for the Company is its ability to sell portions of its excess servicing rights receivable in the form of securitized NIM Certificates. During 1994 the Company sold $600,400,000 of NIM Certificates and in August 1995 the Company completed another sale of $308,000,000 of NIM Certificates. These certificates represent approximately 72% to 78% of the estimated present value of future excess servicing cash flows derived from the Company's sales of certain manufactured housing contracts between 1978 and 1995. Net proceeds to the Company from these sales were used to reduce short-term borrowings supporting ongoing loan originations. The combined interest rate on the NIM Certificates sold and the market rate (based on market comparisons at the time of sale of the NIM Certificates) on the subordinated certificates retained by the Company was less than the discount rates the Company used to initially record the excess servicing rights receivable. Based on these market rates, the present value of the future excess servicing cash flows which exceeded the carrying value has been included in the Company's reserves related to its excess servicing rights receivables.\nServicing fees and net interest payments collected, which has been the Company's principal source of cash, increased during the year ended December 31, 1995 and decreased during 1994 as a result of the timing and size of the NIM Certificate sales, the proceeds of which are shown separately on the Company's statements of cash flows. Net interest payments collected on the transactions underlying the NIM Certificates, after certain deductions, are remitted directly to the senior certificateholders. Payments on the subordinated certificates will not commence until the senior certificateholders have been paid in full. For the year ended December 31, 1995 and 1994, servicing fees and net interest payments collected consist only of servicing fees collected on the NIM Certificates, plus servicing fees and net interest payments on all existing HI and CP securitizations, and all MH securitizations and GNMA pools in which the Company has not yet sold a portion of the related excess servicing rights. The increase in servicing fees and net interest payments collected during 1993 is a result of the increased amount of servicing spread collected due to the growth of the Company's servicing portfolio.\nNet principal payments collected have been positive in each of the last three years as a result of an increase in the contract principal payments collected by the Company as of the end of each year but not yet remitted to the investors\/owners of the contracts. These increases are a result of customer payoffs and the growth of the Company's servicing portfolio.\nInterest on contracts and GNMA certificates during 1994 includes interest the Company received on the NIM Certificates for the period they were held by the Company.\nInterest on cash, commercial finance receivables and investments grew significantly during 1995 primarily as a result of the increase in commercial finance receivables outstanding. During the first quarter of 1994, the Company began floorplan lending to provide financing to manufactured housing dealers for purposes of financing new manufactured home inventory. The Company merged this floorplan lending into its new commercial finance division in 1995 and sold a substantial portion of its portfolio in December 1995. This division provides inventory and asset-based financing for manufacturers and dealers in a variety of industries, including primarily manufactured housing and other products for which the Company is already providing retail financing. Average net commercial finance receivables outstanding for 1995 were $357 million compared to $35 million in 1994.\nDefeasance structures were used on the Company's securitized sales in the fourth quarter of 1990 and continued through the second quarter of 1992. The cash flows used to make these defeasance payments were sold as part of the NIM Certificate sale.\nRepossession losses net of recoveries decreased significantly in both 1995 and 1994 compared to 1993 as a result of the sale of the NIM Certificates. Repossession losses on contracts whose net cash flows were sold as part of these transactions (with the exception of the first five securitized sales completed by Green Tree in 1987 through the first quarter of 1988 as such losses were excluded from the 1994-A NIM Certificate sale) are not borne by the Company but, instead, reduce the amount of cash available to pay the senior certificateholders. To the extent that such losses should exceed projected levels, the impact would first be borne by Green Tree through charges to the valuation of its subordinated certificates, and thereafter by the holders of the certificates, not through charges to the allowance for losses on contracts sold. In the future, repossession losses net of recoveries will continue to include activity relating to all future securitizations and GNMA pools in which the Company does not sell or has not yet sold a portion of the related excess servicing rights, as well as losses on the first five MH securitizations.\nFHA insurance premiums paid also decreased significantly in 1995 and 1994 compared to 1993, as such payments which relate to\ncontracts in the NIM Certificate sales are made through cash flows on those transactions.\nDuring 1995, the Company repurchased 2,051,000 shares of its common stock for $53,913,000. These shares are currently held as treasury shares. Dividends paid by the Company increased 75.4% in 1995 compared to 1994 as the Company's 1995 quarterly average dividend rate increased 73.3% over the 1994 rate.\nNet cash from operating activities decreased in 1995 compared to 1994 as a result of the increased volume of contract purchases in 1995 as the Company prepared for its consumer product loan securitization in the first quarter of 1996. Net cash provided by operating activities during 1994 increased significantly over 1993, primarily as a result of the sale of NIM Certificates. Proceeds from the sale of contracts was greater than the purchase of contracts held for sale in 1994 as the Company, in that year, began public securitization of its HI loans primarily originated in the third and fourth quarters of 1993 in 1994. Net cash from operating activities was negative in 1993 due largely to the increase in dollar volume of contracts held for sale. This increase in contract inventory was a result of the Company's decision not to securitize any CP loans, or any HI loans after the second quarter, as well as increases in MH production. To a lesser extent, 1995, 1994 and 1993 cash flows from operating activities were also reduced by income taxes paid. The Company expects it will use its remaining net operating loss carryforward during 1996, and accordingly will be paying additional taxes on its taxable income thereafter.\nNet cash used for investing activities included, in 1995, leasehold improvements on its Rapid City servicing center and the purchase and upgrade of computer equipment as a result of the Company's growth; in 1994, the renovation of certain floors in its corporate office building and the buyout and upgrade of the Company's mainframe computer; and in 1993, the purchase of certain floors of the building where the Company's corporate offices are located.\nThe Company used cash from financing activities in 1995 as a result of the common stock repurchases, a 73.3% increase in the common stock dividend rate and the retirement of its senior subordinated debentures in June 1995. The Company also used cash from financing activities during 1994 as it repaid all of its borrowings on credit facilities and increased its common stock dividend rate 33.3% in May 1994. Net cash provided by financing activities was positive in 1993 as borrowings on credit facilities and proceeds from the issuance of common stock and debt exceeded debt repayments and dividends.\nThe Company has a $15,000,000 unsecured bank credit agreement for general operating purposes. In addition, the Company currently has $1.3 billion in master repurchase agreements with various\ninvestment banking firms for the purpose of financing its contract and commercial finance loan production. At December 31, 1995, the Company had $3,350,000 of borrowings outstanding under these agreements and had $1,221,150,000 available, subject to the availability of eligible collateral. The master repurchase agreements all provide for annual terms that are extended each quarter by mutual agreement of the parties for an additional annual term based upon receipt of updated quarterly financial information from the Company. The Company believes that these agreements will continue to be renewed.\nDuring April 1995, the Company began borrowing under its commercial paper program through which it is authorized to issue up to $500,000,000 in notes of varying terms (not to exceed 270 days) to meet its liquidity needs. This program is backed by the bank and master repurchase agreements referred to above. As of December 31, 1995, the Company had issued and outstanding $90,500,000 in notes under this program. Commercial paper is expected to be an ongoing source of liquidity for purposes of meeting the Company's funding needs between sales of its contract and commercial loan production.\nIn September 1993, the Company completed a 10,000,000 share common stock offering, and sold an additional 1,500,000 shares to cover over-allotments. The net proceeds of approximately $138,000,000 were used to finance the Company's continued growth in its manufactured home, home improvement and consumer products contract inventory, to temporarily reduce notes payable under the Company's borrowing agreements, and for other general corporate purposes.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nGREEN TREE FINANCIAL CORPORATION AND SUBSIDIARIES FINANCIAL STATEMENTS FURNISHED PURSUANT TO THE REQUIREMENTS OF FORM 10-K\nAND\nINDEPENDENT AUDITORS' REPORT -------------------------------------\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 --------------------------------------------\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Stockholders Green Tree Financial Corporation Saint Paul, Minnesota:\nWe have audited the accompanying consolidated balance sheets of Green Tree Financial Corporation and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 1995 and 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 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 Green Tree Financial Corporation and subsidiaries as of December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1995 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.\nMinneapolis, Minnesota January 30, 1996\nGREEN TREE FINANCIAL CORPORATION AND SUBSIDIARIES -------------------------------------------------\nCONSOLIDATED BALANCE SHEETS ---------------------------\nSee notes to consolidated financial statements.\nGREEN TREE FINANCIAL CORPORATION AND SUBSIDIARIES -------------------------------------------------- CONSOLIDATED STATEMENTS OF OPERATIONS -------------------------------------\nSee notes to consolidated financial statements.\nGREEN TREE FINANCIAL CORPORATION AND SUBSIDIARIES -------------------------------------------------\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY -----------------------------------------------\nSee notes to consolidated financial statements.\nGREEN TREE FINANCIAL CORPORATION AND SUBSIDIARIES -------------------------------------------------\nCONSOLIDATED STATEMENTS OF CASH FLOWS -------------------------------------\n(continued)\nGREEN TREE FINANCIAL CORPORATION AND SUBSIDIARIES ------------------------------------------------- CONSOLIDATED STATEMENTS OF CASH FLOWS ------------------------------------- (continued)\nSee notes to consolidated financial statements.\nGREEN TREE FINANCIAL CORPORATION AND SUBSIDIARIES -------------------------------------------------\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 --------------------------------------------\nA. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPrinciples of consolidation\nThe consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All material intercompany profits, transactions and balances have been eliminated.\nSecuritized asset sales\nThe Company originates directly, or indirectly through dealers, conditional sales contracts which are typically sold at or near par to investors. The Company retains the servicing rights and participation in certain cash flows from the loans. The present value of expected cash flows from this participation which exceeds normal servicing fees is recorded at the time of sale as \"excess servicing rights receivable.\" The excess servicing rights receivable is calculated using prepayment, default and interest rate assumptions which the Company believes market participants would use for similar instruments, such assumptions being consistent, given portfolio composition, with those used in the public sales of the NIM Certificates. The excess servicing rights receivable has not been reduced for potential losses under recourse provisions of the sales. The allowance for losses on contracts sold with recourse is shown separately as a liability on the Company's balance sheet. For contracts sold prior to October 1, 1992, the allowance is shown on a nondiscounted basis. For contracts sold after September 30, 1992, the allowance has been discounted using an interest rate equivalent to the risk-free market rate for securities with a duration consistent with the estimated timing of losses based on guidance issued by the Financial Accounting Standards Board's Emerging Issues Task Force (\"EITF\") in \"EITF Issue 92-2.\"\nIn determining expected cash flows, management considers economic conditions at the date of sale. In subsequent periods, these estimates are revised as necessary for any reductions in expected future cash flows arising from adverse prepayment and loss experience by recording a charge to current earnings. Favorable experience is recognized prospectively as realized.\nDuring 1995 and 1994, the Company sold portions of its excess servicing rights receivable to investors in the form of securitized NIM Certificates. The subordinated certificates retained by the\nCompany are included in excess servicing rights receivable at a value which is net of expected losses. No gain or loss was recorded as a result of these transactions, such certificates being valued in the market place using prepayment, default and interest rate assumptions generally consistent with those recorded by the Company.\nInterest payments received on the contracts, less interest payments paid to investors (including payments on the NIM Certificates), are reported on the consolidated statements of cash flows as \"servicing fees and net interest payments collected.\" Principal payments received on the contracts, less non- defeasance principal payments paid to investors, are reported as \"net principal payments collected\" on the consolidated statements of cash flows. Interest income and service income are recognized by systematically amortizing the present value discount and deferred service income, respectively.\nThe Company defers service income at an annual rate of 0.44% and discounts cash flows on its sales at the rate it believes a purchaser would require as a rate of return. The cash flows were discounted to present value using discount rates which averaged approximately 9.4% in 1995, 9.5% in 1994 and 9.3% in 1993. The Company has developed its assumptions based on experience with its own portfolio, available market data (including market estimates utilized in the sales of the NIM Certificates) and ongoing consultation with its investment bankers. The Company believes that the assumptions used in estimating cash flows are similar to those which would be used by an outside investor.\nThe Company's commercial finance receivables represent revolving credit arrangements with dealers for which a loss reserve is established at the time of origination. During 1995 a portion of these receivables was sold in the form of a revolving Master Trust. The portion of the loss reserve relating to the balances sold was reclassified as a liability, and no gain or loss was recorded at the time of sale. The Company's policy is to record income on these receivables only as realized.\nDepreciation\nProperty, furniture and fixtures are carried at cost and are depreciated over their estimated useful lives on a straight-line basis.\nDeferred debt expenses\nExpenses associated with the issuance of long-term debt are amortized on a straight-line basis over the term of the debt. Amortization was $362,000 in 1995, $390,000 in 1994 and $389,000 in 1993.\nEarnings per common and common equivalent share\nEarnings per common and common equivalent share are computed by dividing net earnings by the weighted average number of shares of Common Stock and Common Stock equivalents outstanding during each year. Common Stock equivalents consist of the dilutive effect of Common Stock which may be issued upon exercise of stock options. All share and per-share amounts have been restated to reflect the two-for-one stock splits the Company effected in June 1994 and October 1995. Earnings per share and fully diluted earnings per share are substantially the same.\nCash and cash equivalents\nFor purposes of the statements of cash flows, the Company considers all highly liquid temporary investments purchased with a maturity of three months or less to be cash equivalents. These temporary investments include United States Treasury Funds, A1\/P1 commercial paper or bank money market accounts. At December 31, 1995 and 1994, cash of approximately $239,617,000 and $164,901,000, respectively, was held in trust for subsequent payment to investors. In addition, cash of approximately $2,809,000 and $3,377,000 was restricted and held by the Company's subsidiaries pursuant to master repurchase agreements and government requirements at December 31, 1995 and 1994, respectively.\nOther investments\nOther investments consist of highly liquid investments with original maturities of more than three months. Other investments are held in United States Treasury Bills, United States Government and Agency Bonds, corporate bonds and certificates of deposit, and are stated at cost plus accrued interest, which approximates market value. At December 31, 1995 and 1994, investments of approximately $18,880,000 and $19,916,000, respectively, were held in trust for policy and claim reserves for the Company's insurance subsidiaries. In addition, investments of approximately $1,000,000 and $1,004,000 were restricted and held by the Company's subsidiaries pursuant to a master repurchase agreement at December 31, 1995 and 1994, respectively.\nAllowance for losses\nRecourse of investors against the Company is governed by the agreements between the investor and the Company (Note F). The allowance for losses on contracts sold with recourse represents the Company's best estimate of future credit losses likely to be incurred over the entire life of the contracts, pursuant to recourse provided to investors. Amounts representing losses on the contracts underlying the NIM Certificates are reflected in the carrying value of the subordinated certificates.\nB. RECEIVABLES\nExcess Servicing Rights Receivable\nExcess servicing rights receivable consists of net excess cash expected to be collected over the life of the contracts sold. During 1995 and 1994, portions of these net cash flows were sold to investors through securitized NIM Certificate sales in which the Company retained a subordinated interest. As of December 31 excess servicing rights receivable consisted of:\nDuring 1995 and 1994 the Company completed three sales of a substantial portion of its excess servicing rights receivable in the form of securitized NIM Certificates. Green Tree Securitized Net Interest Margin Trusts 1994-A, 1994-B and 1995-A, sold certificates representing approximately 72% to 78% of the estimated present value of future excess servicing cash flows derived from the Company's sales of certain manufactured housing contracts between 1978 and 1995. The remaining interests in the Net Interest\nMargin Trusts were retained by the Company as subordinated interests.\nThis subordinated interest will continue to accrue interest as no payments of principal or interest will be made until the senior certificateholders have been paid in full. The carrying value is analyzed quarterly to determine the impact, if any, of adverse prepayment or loss experience. However, the carrying value will continue to reflect the discount rates utilized at the time of sale.\nThe carrying value of excess servicing rights receivable is analyzed quarterly to determine the impact of prepayments, if any.\nDuring the years ended December 31, 1995, 1994 and 1993, the Company sold $12,236,000, $45,668,000 and $213,368,000, respectively, of GNMA guaranteed certificates secured by FHA-insured and VA-guaranteed contracts. At December 31, 1995 and 1994, the outstanding principal balance on GNMA certificates issued by the Company was $1,290,750,000 and $1,520,307,000, respectively.\nDuring the years ended December 31, 1995, 1994 and 1993, the Company sold $4,586,851,000, $3,724,102,000 and $2,132,472,000, respectively, of contracts in various securitized transactions, and during 1995 and 1994, the Company sold $308,000,000 and $600,400,000 of NIM Certificates, respectively. At December 31, 1995 and 1994, the outstanding principal balance on all conventional securitized and private investor sales was $10,941,384,000 and $7,534,340,000, respectively.\nCommercial Finance Receivables\nThe Company's commercial finance receivables represent revolving credit arrangements with dealers for which a loss reserve is established at the time of origination. As of December 31, 1995 and 1994 the outstanding principal balance on commercial finance receivables serviced by the Company was $574,100,000 and $167,723,000, respectively. During 1995 the Company sold $427,800,000 of these receivables in the form of a revolving Master Trust.\nC. CONTRACTS, GNMA CERTIFICATES AND COLLATERAL\nContracts, GNMA certificates and collateral consist of:\nCollateral in process of liquidation includes collateral related only to contracts which have not been included in the MH securitizations and GNMA pools underlying the NIM Certificate sales. Gross collateral in process of liquidation was $89,007,000 and $53,193,000 as of December 31, 1995 and 1994, respectively.\nThe aggregate method is used in determining the lower of cost or market value of contracts held for sale and contracts held as collateral. See fair value disclosure of financial instruments in Note H.\nPotential losses on the liquidation of the collateral are included in determining the allowance for losses on contracts sold with recourse (Notes F and H).\nIncluded in other accounts receivable as of December 31, 1994 was approximately $1,284,000 of GNMA certificates which were sold during 1994 for settlement in January 1995. These GNMA certificates along with contracts held for sale are used in full or in part as collateral on the Company's master repurchase agreements (Note E).\nD. PROPERTY, FURNITURE AND FIXTURES\nProperty, furniture and fixtures consist of:\nDepreciation expense for 1995, 1994 and 1993 was $10,956,000, $5,656,000 and $2,482,000, respectively.\nE. DEBT\nThe Company has a $15,000,000 unsecured bank credit agreement for general operating purposes. The agreement provides for interest at variable rates and certain fee provisions, the costs of which are included in interest expense. The credit agreement contains certain restrictive covenants which include maintaining minimum net worth (as defined in the agreement) and a debt to net worth ratio not to exceed 5 to 1. In addition, the Company currently has $1.3 billion in master repurchase agreements with various investment banking firms for the purpose of financing its contract and commercial finance loan production. At December 31, 1995, the\nCompany had $3,350,000 of borrowings outstanding under these agreements and had $1,221,150,000 available, subject to the availability of eligible collateral. The master repurchase agreements all provide for annual terms that are extended each quarter by mutual agreement of the parties for an additional annual term based upon receipt of updated quarterly financial information from the Company. The Company believes that, if it so desires, these agreements will continue to be renewed.\nDuring April 1995, the Company began borrowing under its commercial paper program through which it is authorized to issue up to $500,000,000 in notes of varying terms (not to exceed 270 days) to meet its liquidity needs. This program is backed by the bank and master repurchase agreements referred to above. As of December 31, 1995, the Company had issued and outstanding $90,500,000 in notes under this program.\nThe notes payable outstanding at December 31, 1995 bear interest at a weighted average rate of 6.15%.\nDebt is as follows:\nThe Company has on file a shelf registration to issue up to $250 million of senior notes with maturities in excess of nine months. The notes may bear interest at fixed or floating rates. The senior notes outstanding at December 31, 1995 and 1994 bear interest at a weighted average rate of 7.27% and have maturities ranging from 1998 to 2003. Interest on these notes is payable semi- annually.\nThe 10-1\/4% Senior Subordinated Notes due June 1, 2002 (the \"Notes\") were issued in connection with a debt exchange in April 1992. The effective interest rate on the Notes is 10.8%. The Company must maintain a net worth of $80,000,000 or will be required, through the operation of a sinking fund, to redeem $25,000,000 on such contingent sinking fund payment date. Interest is payable semi-annually.\nAt December 31, 1995, aggregate maturities of debt for the following five years are $23,000,000, payable as follows: $8,000,000 in 1998, $12,000,000 in 1999 and $3,000,000 in 2000.\nF. ALLOWANCE FOR LOSSES ON CONTRACTS SOLD WITH RECOURSE\nThe Company sells GNMA guaranteed certificates which are secured by FHA-insured and VA-guaranteed contracts. The majority of credit losses incurred on these contracts are covered by FHA insurance or VA guarantees with the remainder borne by the Company.\nIn initially valuing its excess servicing rights receivable, the Company establishes an allowance for expected losses under the recourse provisions with investors\/owners of contracts or investor certificates and calculates that allowance on the basis of historical experience and management's best estimate of future credit losses likely to be incurred. The amount of this provision is reviewed quarterly and adjustments are made if actual experience or other factors indicate management's estimate of losses should be revised. While the Company retains a substantial amount of risk of default on the loan portfolios that it sells, such risk has been substantially reduced through the sales of the NIM Certificates.\nThe Company has provided the investors\/owners of pools of contracts with a variety of additional forms of credit enhancements on its securitized sales. These credit enhancements have included corporate guarantees, letters of credit and surety bonds that provide limited recourse to the Company, and letters of credit that, if drawn, are entitled to reimbursement only from the future excess cash flows of the underlying transactions. Furthermore, certain securitized sales structures use cash reserve funds and certain cash flows from the underlying pool of contracts as the credit enhancement. At December 31, 1995 and 1994, the Company had bank letters of credit and surety bonds outstanding of $156,617,000 and $174,910,000, respectively. Cash deposits held in interest bearing accounts totaled $159,311,000 and $146,057,000, and contracts pledged aggregated $10,217,000 and $10,307,000 at December 31, 1995 and 1994, respectively, and are maintained as part of credit enhancement features under certain sales structures.\nAllowances are provided for the Company's best estimate of future credit losses likely to be incurred over the entire life of the contracts. Estimated losses are based on an analysis of the underlying loans and do not reflect the maximum recourse provided to investors. The following table presents an analysis of the allowance for losses on contracts sold with recourse for 1995, 1994 and 1993.\nG. STOCKHOLDERS' EQUITY\nCommon Stock\nIn May 1994 and September 1995, the Board of Directors declared two-for-one stock splits, in the form of stock dividends, payable on June 30, 1994 and October 15, 1995 to stockholders of record as of June 15, 1994 and September 30, 1995, respectively. All references in the consolidated financial statements and notes with regard to number of shares, stock options and related prices, and per-share amounts have been restated to give retroactive effect to the stock splits.\nIn February 1995, the Company's Board of Directors approved and authorized the repurchase of up to 7,000,000 shares of the Company's Common Stock from time to time in the open market or in private transactions.\nIn September 1993, the Company completed a 10,000,000 share Common Stock offering, and sold an additional 1,500,000 shares to cover over-allotments. The net proceeds of approximately $138,000,000 were used to finance the Company's continued growth in its manufactured home, home improvement and consumer products contract inventory, to temporarily reduce certain borrowings under the Company's bank warehousing agreement and master repurchase agreements and for other general corporate purposes.\nPreferred Stock\nThe Company's authorized shares of capital stock include 15,000,000 shares of stock designated as Preferred Stock. The Company had previously designated a series of Junior Preferred Stock in connection with its Stockholders Rights Plan (the \"Plan\"). As of October 31, 1995 the term of the Plan expired and the Company determined not to extend the term of the Plan. At December 31, 1995 there were no shares of Preferred Stock outstanding.\nRights\nIn October 1985, the Company issued one Preferred Stock purchase right for each share of Common Stock and amended the rights in August 1990 in connection with the Plan. As of October 31, 1995 the rights expired as the term of the Plan expired.\nStock option and stock bonus plans\nIn 1988, the Company's stockholders approved two stock option plans: an employee stock option plan and an outside director plan. In 1992, the Board of Directors approved a supplemental stock option plan for its outside directors and in 1995, the Company's stockholders approved an Employee Stock Incentive Plan.\nA summary of the stock option plans is as follows:\nOf the 6,256,532 options outstanding at December 31, 1995, 6,096,532 options related to the employee stock option plans, and 160,000 options related to the outside director plans. The director options and 2,575,532 shares of certain employee options were exercisable as of December 31, 1995. Options for 4,271,040 shares were available for future grant under these plans. The option price per share represents the market value of the Company's stock on the date of grant except for certain options granted in 1993 and 1995. The option price per share on 340,000 options granted in 1993 represents 50% of the market value of the Company's stock on the date of grant. The option price per share on 370,000 options granted in 1995 represents approximately 79% of the market value of the Company's stock on the date of grant.\nIn 1988, the Company's stockholders approved a key executive stock bonus plan. Shares issued under this plan are pursuant to an employment agreement and the stock is valued at $2.96875 per share which represents the closing market price of the stock on the date of the employment agreement. Total shares issued under this plan during 1995, 1994 and 1993 were 1,349,216, 886,428 and 481,240, respectively. As of December 31, 1995 there were 19,470,164 shares available for future issuance under this plan. This plan terminates December 31, 1998.\nThe Company's Board of Directors has reserved 12,406,252 shares for future issuance under all plans as of December 31, 1995.\nDividends\nDuring 1995, 1994 and 1993 the Company declared and paid dividends of $.20, $.12 and $.08 per share, respectively, on its Common Stock.\nUnder a letter of credit agreement, the Company is subject to restrictions limiting the payment of dividends and common stock repurchases. At December 31, 1995, such payments were limited to $25,046,000, which represents 50% of consolidated net earnings for the most recently concluded four fiscal quarter period less dividends paid, repurchases of Common Stock and the retirement of Subordinated Indebtedness.\nH. FAIR VALUE DISCLOSURE OF FINANCIAL INSTRUMENTS\nStatement of Financial Accounting Standards No. 107, \"Disclosures about Fair Value of Financial Instruments,\" requires that the Company disclose the estimated fair values of its financial instruments. Fair value estimates, methods and assumptions are set forth below for the Company's financial instruments.\nCash and cash equivalents, cash deposits and other investments\nThe carrying amount of cash and cash equivalents, cash deposits and other investments approximates fair value because they generally mature in 90 days or less and do not present unanticipated credit concerns.\nExcess servicing rights receivable\nExcess servicing rights receivable is calculated using prepayment, default and interest rate assumptions that the Company believes market participants would use for similar instruments at the time of sale. Projected performance is monitored on an ongoing basis. The initially established discount rate is fixed for the life of the transaction. As such, the fair value of excess servicing rights receivable primarily includes consideration of a current discount rate to be applied to the financial instrument as a whole.\nThe Company has consulted with investment bankers and obtained an estimate of a market discount rate. Utilizing this market discount rate, and such other assumptions as the Company believes market participants would use for similar instruments, the Company has estimated the fair value of its excess servicing rights receivable, excluding its subordinated interest in the NIM Certificates, to approximate its carrying value, shown net of the related allowance for losses which is disclosed separately as a liability on the balance sheet.\nThe carrying value of excess servicing relating to the subordinated interest retained in the NIM Certificates sold during 1994 and 1995 is calculated using prepayment and default assumptions which the Company believes market participants would use currently, but using the interest rate determined at the time of sale. For purposes of computing fair value, the Company consulted with its investment bankers and obtained an estimate of a market interest rate as of December 31, 1995. Using that rate, fair value exceeds carrying value\nfor this component of excess servicing rights receivable by $56,600,000.\nContracts held for sale and as collateral\nContracts held for sale and as collateral are generally recent originations which will be sold during the following quarter. The Company does not charge origination fees or points and, as such, its contracts have origination rates generally in excess of rates on the securities into which they will be pooled. Since these contracts have not been converted into securitized pools, the Company estimates the fair value to be the carrying amount plus the cost of origination.\nCommercial finance receivable\nCommercial finance receivable consists entirely of loans which reprice monthly, typically in accordance with the prime lending rate offered by banks. Given this repricing structure, the Company estimates the fair value of these receivables to approximate their carrying value.\nCollateral in process of liquidation\nCollateral in the process of liquidation is valued on an individual unit basis after inspection of such collateral. Shown net of the related allowance for losses on contracts sold with recourse, fair value approximates carrying value.\nOther contracts held\nPursuant to investor sale agreements, certain contracts are repurchased by the Company as a result of delinquency before they are repossessed, and are included in other contracts held. The loss has been estimated on an aggregate basis, and is included on the balance sheet in allowance for losses on contracts sold with recourse.\nNotes payable\nNotes payable consists of amounts payable under the Company's commercial paper program, bank line or repurchase agreements and, given its short-term nature, is at a rate which approximates market. As such, fair value approximates the carrying amount.\nSenior notes\nThe fair value of the Company's senior notes is estimated based on their quoted market price or on the current rates offered to the Company for debt of a similar maturity.\nSenior subordinated notes and debentures\nThe Company's senior subordinated notes and debentures are valued at quoted market prices.\nThe carrying amounts and estimated fair values of the Company's financial assets and liabilities are as follows:\nFair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. The estimates do not reflect any premium or discount that could result from offering for sale at one time the Company's entire holdings of a particular financial instrument. Fair value estimates are based on judgments regarding future loss and prepayment experience, current economic conditions, specific risk characteristics and other factors. 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 example, the Company has a regional branch network with significant dealer relationships and proprietary credit scoring systems, which contribute to the Company's ongoing profitability and neither of which is considered a financial instrument.\nI. COMMITMENTS AND CONTINGENCIES\nLease commitments\nAt December 31, 1995, aggregate minimum rental commitments under noncancelable leases having terms of more than one year were $18,087,000, payable $5,853,000 (1996), $5,498,000 (1997), $4,021,000 (1998), $1,765,000 (1999) and $950,000 (2000). Total rental expense for the years ended December 31, 1995, 1994 and 1993 was $6,101,000, $5,065,000 and $4,449,000, respectively. These leases are for office facilities and equipment, and many contain either clauses for cost of living increases and\/or options to renew or terminate the lease.\nLitigation\nThe nature of the Company's business is such that it is routinely a party or subject to items of pending or threatened litigation. Although the ultimate outcome of certain of these matters cannot be predicted, management believes, based upon information currently available and the advice of counsel, that the resolution of these routine legal matters will not result in any material adverse effect on its consolidated financial condition.\nJ. BENEFIT PLANS\nThe Company has a qualified noncontributory defined benefit pension plan covering substantially all of its employees over 21 years of age. The plan's benefits are based on years of service and the employee's compensation. The plan is funded annually based on the maximum amount that can be deducted for federal income tax purposes. The assets of the plan are primarily invested in common stock, corporate bonds and cash equivalents. As of December 31, 1995 and 1994, net assets available for plan benefits were $7,790,000 and $5,873,000, and the accumulated benefit obligation was $6,393,000 and $3,934,000, respectively. As of December 31, 1995 and 1994, the projected benefit obligation of the plan was $12,466,000 and $7,460,000, respectively. In addition, the Company maintains a nonqualified pension plan for certain key employees as designated by the Board of Directors. This plan is not currently funded and the projected benefit obligation at December 31, 1995 and 1994 was $13,023,000 and $9,711,000, respectively. Total pension expense for the plans in 1995, 1994 and 1993 was $3,091,000, $3,585,000 and $2,340,000, respectively.\nThe Company also has a 401(k) Retirement Savings Plan available to all eligible employees. To be eligible for the plan, the employee must be at least 21 years of age and have completed one year of employment at Green Tree during which the employee worked at least 1,000 hours. Eligible employees may contribute to the plan up to 10% of their earnings with a maximum of $9,240 for 1995 based on the Internal Revenue Service annual contribution limit. The\nCompany will match 50% of the employee contributions for an amount up to 6% of each employee's earnings. Contributions are invested at the direction of the employee in one or more funds. Company contributions vest after three years. Company contributions to the plan were $859,000, $713,000 and $575,000 in 1995, 1994 and 1993, respectively.\nK. INCOME TAXES\nIncome taxes consist of the following:\nDeferred income taxes are provided for temporary differences between pretax income for financial reporting purposes and taxable income. The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 1995 and 1994 are presented below.\nAt December 31, 1995, the Company has net operating loss carryforwards for federal income tax purposes of approximately $37,000,000 which are available to offset future federal taxable income and expire no earlier than 2003. No valuation allowance was required as of December 31, 1995 or 1994 since it is likely that\nthe deferred tax asset will be realized against future taxable income.\nA reconciliation of the statutory federal income tax rate to the Company's effective tax rate is as follows:\nQUARTERLY RESULTS OF OPERATIONS (unaudited) -------------------------------------------\nITEM 9.","section_9":"ITEM 9. DISAGREEMENTS 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. - -------------------------------------------------------------\nPursuant to General Instruction G(3), reference is made to the information contained in the Company's definitive proxy statement for its 1996 Annual Meeting of Stockholders which will be filed with the Securities and Exchange Commission on or before May 1, 1996.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION. - ---------------------------------\nPursuant to General Instruction G(3), reference is made to the information contained in the Company's definitive proxy statement for its 1996 Annual Meeting of Stockholders which will be filed with the Securities and Exchange Commission on or before May 1, 1996.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. - ------------------------------------------------------------------------\nPursuant to General Instruction G(3), reference is made to the information contained in the Company's definitive proxy statement for its 1996 Annual Meeting of Stockholders which will be filed with the Securities and Exchange Commission on or before May 1, 1996.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. - ---------------------------------------------------------\nReference is made to Note I of Notes to Consolidated Financial Statements contained in Item 8 hereof.\nPART IV -------\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(a)(l) Financial statements\nThe following consolidated financial statements of Green Tree Financial Corporation and subsidiaries are included in Part II, Item 8 of this report:\nPage(s) -------\nIndependent Auditors' Report 31 Consolidated Balance Sheets - December 31, 1995 and 1994 32 Consolidated Statements of Operations - years ended December 31, 1995, 1994 and 1993 33 Consolidated Statements of Stockholders' Equity - years ended December 31, 1995, 1994 and 1993 34 Consolidated Statements of Cash Flows - years ended December 31, 1995, 1994 and 1993 35-36 Notes to Consolidated Financial Statements 37-53\n(2) Financial statement schedules\nThe following consolidated financial statement schedule of Green Tree Financial Corporation and subsidiaries are included in Part IV of this report:\nSchedule II - Valuation and qualifying accounts 61\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 consolidated financial statements or notes thereto.\n(3) Exhibits\nExhibit No. -------\n3(a) Certificate of Incorporation of Green Tree Financial Corporation (incorporated by reference to the Company's Registration Statement on Form S-1; File No. 33-60869).\n3(b) Certificate of Merger of Incorporation of Green Tree Financial Corporation, as filed with the Delaware Secretary of State on June 30, 1995 (incorporated by reference to the Company's\nRegistration Statement on Form S-1; File No. 33-60869.)\n3(c) Bylaws of Green Tree Financial Corporation (incorporated by reference to Company's Registration Statement on Form S-1; File No. 33-60869).\n4(a) Indenture dated as of March 15, 1992 relating to $287,500,000 of 10 1\/4% Senior Subordinated Notes due June 1, 2002 (incorporated by reference to the Company's Registration Statement on Form S-4; File No. 33-42249).\n4(b) Indenture dated as of September 1, 1992 relating to $250,000,000 of Medium-Term Notes, Series A, Due Nine Months or More From Date of Issue (incorporated by reference to the Company's Registration Statement on Form S-3; File No. 33- 51804).\n10(a) Company's Key Executive Bonus Program (incorporated by reference to the Company's Registration Statement on Form S-l; File No. 2-82880).\n10(b) Employment Agreement, dated April 20, 1991 between the Company and Lawrence M. Coss (incorporated by reference to the Company's Registration Statement on Form S-4; File No. 33-42249).\n10(c) Green Tree Financial Corporation 1987 Stock Option Plan (incorporated by reference to the Company's Registration Statement on Form S-4; File No. 33-42249).\n10(d) Green Tree Financial Corporation Key Executive Stock Bonus Plan (incorporated by reference to the Company's Registration Statement on Form S-4; File No. 33-42249).\n10(e) Master Repurchase Agreement dated as of August 1, 1990 between Green Tree Finance Corp.-Three and Merrill Lynch Mortgage Capital Inc. (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1990; File No. 0-11652); as amended by Amendment to the Master Repurchase Agreement dated May 10, 1993 (incorporated by reference to the Company's Quarterly Report on Form 10-Q for the quarterly period ended March 31, 1994; File No. 0-11652); as amended by Amendment to the Master Repurchase\nAgreement dated August 8, 1995 (incorporated by reference to the Company's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1995; File No. 0-11652).\n10(f) Credit Agreement dated as of May 22, 1995 between Green Tree Financial Corporation and First Bank National Association (incorporated by reference to the Company's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1995; File No. 0-11652).\n10(g) Master Repurchase Agreement dated as of May 17, 1991 between Green Tree Finance Corp.-Four and First Boston Mortgage Capital Corp. (incorporated by reference to the Company's Registration Statement on Form S-4; File No. 33- 42249); as amended by Amendment to the Master Repurchase Agreement dated March 31, 1994 (incorporated by reference to the Company's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1994; File No. 0-11652).\n10(h) Insurance and Indemnity Agreement dated as of February 13, 1992 among Green Tree Financial Corporation, MaHCS Guaranty Corporation and Financial Security Assurance Inc. (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1991; File No. 0-11652); as amended by Amended and Restated Insurance and Indemnity Agreement dated March 11, 1994 (incorporated by reference to the Company's Quarterly Report on Form 10-Q for the quarterly period ended March 31, 1994; File No. 0- 11652).\n10(i) Master Repurchase Agreement dated as of October 15, 1992 between Green Tree Finance Corp.-Five and Lehman Commercial Paper, Inc. (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1992; File No. 0-11652); as amended by Amendment to the Master Repurchase Agreement dated June 30, 1995 (incorporated by reference to the Company's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1995; File No. 0-11652).\n10(j) 401(k) Plan Trust Agreement effective as of October 1, 1992 (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1992; File No. 0-11652).\n10(k) Green Tree Financial Corporation 1992 Supplemental Stock Option Plan (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1993; File No. 0-11652).\n10(l) Master Repurchase Agreement dated as of September 1, 1995 between Merrill Lynch Mortgage Capital, Inc. and Green Tree Financial Corporation (filed herewith).\n10(m) Master Repurchase Agreement dated as of November 9, 1995 between Salomon Brothers Holding Company and Green Tree Financial Corporation (filed herewith).\n10(n) Green Tree Financial Corporation 1995 Employee Stock Incentive Plan (filed herewith).\n11(a) Computation of Primary Earnings Per Share (filed herewith).\n11(b) Computation of Fully Diluted Earnings Per Share (filed herewith).\n12 Computation of Ratio of Earnings to Fixed Charges (filed herewith).\n21 Subsidiaries of the Registrant (filed herewith).\n23 Consent of KPMG Peat Marwick LLP (filed herewith).\n24 Powers of Attorney (filed herewith).\n27 Financial Data Schedule (filed herewith).\nPURSUANT TO ITEM 601(b)(4) OF REGULATION S-K, THERE HAS BEEN EXCLUDED FROM THE EXHIBITS FILED PURSUANT TO THIS REPORT, INSTRUMENTS DEFINING THE RIGHTS OF HOLDERS OF LONG-TERM DEBT OF THE COMPANY WHERE THE TOTAL AMOUNT OF THE SECURITIES AUTHORIZED UNDER SUCH INSTRUMENTS DOES NOT EXCEED TEN PERCENT OF THE TOTAL ASSETS OF THE COMPANY. THE COMPANY HEREBY AGREES TO FURNISH A COPY OF ANY SUCH INSTRUMENTS TO THE COMMISSION UPON REQUEST.\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, Green Tree Financial Corporation has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nGREEN TREE FINANCIAL CORPORATION\nBy: \/s\/Lawrence M. Coss By: \/s\/Robley D. Evans -------------------------- ---------------------------- Lawrence M. Coss Robley D. Evans Chairman and Chief Vice President and Executive Officer Controller (principal (principal executive financial and principal officer) accounting officer)\nDated: March 25, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, 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\/Lawrence M. Coss - --------------------------------- Lawrence M. Coss, Director March 25, 1996\n\/s\/Richard G. Evans - --------------------------------- Richard G. Evans, Director March 25, 1996\n\/s\/Robert D. Potts - --------------------------------- Robert D. Potts, Director March 25, 1996\nBy: \/s\/Joel H. Gottesman ------------------------- Joel H. Gottesman Attorney-in-Fact W. Max McGee, Director ) Dated: March 25, 1996 ) Tania A. Modic, Director ) ) Robert S. Nickoloff, Director )\nGREEN TREE FINANCIAL CORPORATION AND SUBSIDIARIES -------------------------------------------------\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS -----------------------------------------------\nNotes:\n(a) Reduced as a result of the NIM Certificate sales. (b) Amortization and discount. (c) Amounts charged off.\nGREEN TREE FINANCIAL CORPORATION\nSecurities and Exchange Commission\nForm 10-K (For the Fiscal Year Ended December 31, 1995)\nEXHIBIT INDEX\nExhibit No. Exhibit Page No. - ----------- ------- --------\n10(l) Master Repurchase Agreement dated as of September 1, 1995 between Merrill Lynch Mortgage Capital, Inc. and Green Tree Financial Corporation 63\n10(m) Master Repurchase Agreement dated as of November 9, 1995 between Salomon Brothers Holding Company and Green Tree Financial Corporation 103\n10(n) Green Tree Financial Corporation 1995 Employee Stock Incentive Plan 169\n11(a) Computation of Primary Earnings Per Share 181\n11(b) Computation of Fully Diluted Earnings Per Share 182\n12 Computation of Ratio of Earnings to Fixed Charges 183\n21 Subsidiaries of Registrant 184\n23 Consent of KPMG Peat Marwick LLP 186\n24 Powers of Attorney 187\n27 Financial Data Schedule 188","section_15":""}
{"filename":"795266_1995.txt","cik":"795266","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL The Company is a builder of single-family homes with domestic operations in six western states, and international operations in France, Canada and Mexico. The Company is the largest home builder in the western United States and among the largest builders in greater metropolitan Paris, France. The Company builds and markets innovatively designed homes, generally in medium-sized developments close to major metropolitan areas, that cater primarily to first-time home buyers. In France, the Company is also a developer of commercial projects and high-density residential properties, such as condominium and apartment complexes. The Company also provides mortgage banking services to its domestic home buyers through its wholly owned subsidiary, Kaufman and Broad Mortgage Company (\"KBMC\").\nThe Company's business originated in 1957 and was operated through various subsidiaries of SunAmerica Inc. (\"SunAmerica\"), previously known as Kaufman and Broad Inc. or Broad Inc., until 1986. At that time, SunAmerica transferred to the Company all of the outstanding stock of the subsidiaries then conducting SunAmerica's on-site housing businesses as well as the stock of KBMC. The Company shortly thereafter completed an initial public offering of its common stock, after which SunAmerica continued to own approximately 92.6% of the Company's outstanding common stock. In 1989, SunAmerica distributed substantially all of its holdings in the Company's common stock pro-rata to holders of SunAmerica's common stock. SunAmerica, through one of its wholly owned subsidiaries, continued to hold certain warrants to purchase shares of the Company's special common stock, which were subsequently either exercised by the subsidiary of SunAmerica or repurchased by the Company. No securities were held by SunAmerica or any of its subsidiaries as of December 1993.\nThe Company is a Delaware corporation and maintains its principal executive offices at 10990 Wilshire Boulevard, Los Angeles, California 90024. Its telephone number is (310) 231-4000. As used herein, the term \"Company\" refers to Kaufman and Broad Home Corporation and its subsidiaries, unless the context indicates otherwise.\nMARKETS The Company's three principal geographic markets are California, other United States (Nevada, Arizona, Colorado, New Mexico and Utah) and the greater metropolitan area of Paris, France. To a lesser extent, the Company builds single-family homes in Toronto, Canada. The Company delivered its first homes in California in 1963, France in 1970, Toronto in 1971, Nevada in 1993, Arizona and Colorado in 1994 and New Mexico and Utah in 1995. The Company expects to deliver its first homes in Dallas and San Antonio, Texas in 1996, as recent domestic expansion activities have included the purchase of land parcels in Dallas and the signing of a definitive agreement on January 22, 1996, to acquire San Antonio, Texas-based Rayco, Ltd. and certain affiliates. Rayco Ltd. is the largest single-family homebuilder in San Antonio. Although the Rayco, Ltd. transaction remains subject to certain conditions, completion of the acquisition is expected to occur on March 1, 1996. The Company also anticipates delivery of its first homes from its start-up housing operation in Mexico in 1996, as it has begun to generate a modest level of orders from its project near Mexico City.\nTo enhance its operating capabilities in regional submarkets, the Company conducted its domestic homebuilding business in 1995 through eleven divisional offices and two satellite offices in California and one divisional office in each of Nevada, Arizona, Colorado, New Mexico and Utah.\nCalifornia. During the 1980s, the Company benefited from the relative strength and growth of the California housing market. However, in five of the last six years, new housing permits issued in the state have declined. The California housing market was soft in 1995, with new housing permits issued decreasing approximately 12% in 1995 from 1994. While the Company had generally maintained a trend of increasing deliveries in California in spite of declines in housing permits issued, in 1995, for the first time in five years the Company's deliveries in California fell below prior year levels. The Company delivered 5,430 new homes in California in 1995, a decrease of approximately 13% from 1994. This decrease was due to severe weather conditions in California early in the year combined with the state's\ngenerally weak economy. In spite of the weak economic conditions in California, the Company has maintained approximately an eight percent share of the California housing market since 1993.\nIn Southern California, the Company concentrates its home building activity in Los Angeles, Kern, San Bernardino, Riverside, Orange and San Diego counties. In Northern California, the Company's activities are concentrated in the San Francisco Bay-San Jose, Monterey Bay, Sacramento, Central Valley and Fresno regions.\nMost of the communities developed by the Company consist of single-family detached homes primarily focused on the entry-level housing market. These homes ranged in size from 854 to 4,050 square feet in 1995 and sold at an average price of $176,800, well below the statewide new home average of $224,100, as a result of the Company's emphasis on the entry-level market. The Company's 1995 average selling price in California increased from the prior year reflecting a shift in mix to higher-priced homes and an increase in first-time move-up sales.\nOther United States. The prolonged economic downturn in California, the Company's largest market, has caused the Company to look for opportunities to expand its domestic operations outside the state. The Company began to implement its expansion strategy in 1993 with the opening of its Nevada division and since that time has developed a track record of profitable growth outside of California. The Company's operations outside of California accounted for approximately 25% of domestic home deliveries in 1995, a percentage which is expected to increase as these domestic divisions further establish and solidify their market positions.\nRecent developments in the Company's expansion strategy include its entry into Texas. The Company recently acquired land parcels in Dallas and has also signed a definitive agreement to acquire Rayco, Ltd. of San Antonio for approximately $110 million, comprised of $80 million cash and the assumption of $30 million of debt. Rayco, Ltd., San Antonio's largest single-family homebuilder, commanded a market share of approximately 45% in 1995. For the year ended December 31, 1995, Rayco, Ltd. delivered 2,585 homes, generating revenues of approximately $235 million. It is expected that the Rayco, Ltd. transaction will be completed on March 1, 1996. If this acquisition had been included in the Company's operations during the 1995 year, the Company's other United States deliveries would have represented approximately 45% of domestic deliveries in 1995.\nFrance. The French residential and commercial real estate markets, particularly within the greater metropolitan Paris region, where the Company's operations are concentrated, experienced substantial growth through the second half of the 1980s, as a strong economy and approaching European market unification fueled business expansion and individual home purchases. In the early 1990s, however, the French economy experienced a significant recession reflecting low consumer confidence, high unemployment and declines in both consumer and business investments in real estate. The French housing market continued to prove difficult in 1995 as turbulent economic conditions continued and home buyers deferred purchases until a key government support program was instituted in October 1995. Despite the current tenuous economic climate in France, the Company continues to believe that the greater Paris metropolitan area, which is the principal population, economic and government center of France, continues to offer long-term potential for growth in both the Company's residential and commercial operations.\nIn 1995, the Company's French operations had a break even year with housing deliveries decreasing approximately 16% to 574 units in 1995 from 1994, as the French economy remained weak and high unemployment continued during the economically disruptive election year. The French home building operations focused primarily on single-family detached and attached homes in 1995, ranging in size from 807 to 2,691 square feet with an average selling price of $203,700. The French commercial operation which has been engaged, directly and through joint ventures, in developing commercial office buildings in Paris for sale to institutional investors has become a smaller segment of the French operations in recent years. With the completion of large projects in prior years, the level of commercial operations has declined as the market absorbed existing commercial properties. Although commercial development revenues increased modestly in 1995, the Company does not expect a significant increase from these levels in 1996 as high vacancy rates are expected to persist in the French commercial market.\nThe Company's involvement in its most significant commercial project is as a member of a consortium, consisting of eight of France's largest financial institutions and three development firms, that was selected in 1992 to acquire and redevelop the former Paris headquarters of Esso, the French subsidiary of the Exxon Corporation, located in the prestigious La Defense quarter of metropolitan Paris. The Company, with a 7% interest in the project, is a minority partner in the joint venture and one of the three managing contractors for the redevelopment work for which it will receive a contractor's fee. Development of this project has been postponed as the consortium made the decision to await the recovery of the commercial market and the financial institutions study other alternatives. However, the Company has\nrecently entered into negotiations with the financial institutions whereby the Company would no longer be part of the consortium or have any involvement or obligations for the development of the project.\nCanada. In addition to its principal markets in the western United States and France, the Company operates a housing division in Toronto, Canada, which has been slowly winding down over the past few years. The Company has engaged in negotiations and expects to enter into a definitive agreement pursuant to which it will sell all of the issued and outstanding shares of Victoria Wood Development Corporation Inc., its Canadian subsidiary. If executed as anticipated, the share purchase and sale agreement will remain subject to the buyer's due diligence review and certain other conditions.\nMexico. In 1993, the Company determined that the projected growth in the Mexican economy and a shortage of housing in that country's major metropolitan areas would represent a unique opportunity for the Company, and on that basis established a new housing operation in Mexico City. However, recent economic events, particularly the continuing decline in value of the peso and the resulting economic recession, have seriously hampered the new home market in Mexico. These events have slowed an already complex regulatory process and heightened market uncertainties for new home sales. As a result, although the Company has opened a single-family home project near Mexico City and has begun to generate a modest number of orders for homes expected to be delivered in 1996, the Company remains cautious regarding its Mexican operations and continues to reassess its level of activity in Mexico and the desirability of expanding its market presence there.\nUnconsolidated Joint Ventures. The Company currently participates in the development, construction and sale of residential properties and commercial projects through a number of unconsolidated joint ventures. These include joint ventures in the Los Angeles, Paris and Toronto metropolitan areas.\nSelected Market Data. The following table sets forth, for each of the Company's markets, unit deliveries, average selling price of homes and total construction revenues for the years ended November 30, 1995, 1994 and 1993 (excluding the effect of unconsolidated joint ventures).\n- ------------\n(1) Total construction revenues include revenues from commercial and residential development activities and land sales.\n(2) Average selling prices and total construction revenues for France and Canada have been translated into U.S. dollars using weighted average exchange rates for each period.\nLOCAL EXPERTISE\nManagement believes that its business requires in-depth knowledge of local markets in order to acquire land in desirable locations and on favorable terms, to engage subcontractors, to plan communities keyed to local demand, to anticipate customer tastes in specific markets and to assess the regulatory environment. The Company's divisional structure is designed to utilize local market expertise. The Company has experienced management teams in each of its regional submarkets. Although the Company has centralized certain functions, such as marketing, materials purchasing and product development to benefit from economies of scale, local management continues to exercise considerable autonomy in identifying land acquisition opportunities, developing sales strategies, conducting production operations and controlling costs.\nIn France, the Company has assembled a management team which is highly experienced in the financing, development, construction and rehabilitation of commercial and high-density residential projects, as well as single-family housing. This expertise includes knowledge of local markets and the regulatory environment.\nINNOVATIVE DESIGN AND MARKETING STRATEGY\nThe Company believes that it has been and continues to be an innovator in the design of entry-level homes for the first-time buyer. The Company's in-house architectural services group, whose plans are protected by copyright, has been successful in creating distinctive design features that are not typically found in comparably priced homes. The Company is typically able to offer as standard features vaulted ceilings, kitchen islands, kitchens that open to family rooms, wall-to-wall carpeting and front-yard landscaping. To an even greater extent than in the past, the Company is emphasizing space-efficient functionality. One example of this is the broader use of the Company's unique L'Office(TM) computer workstation area. The L'Office(TM) (a combination of \"loft\" and \"office\") areas are designed to meet most families' home office needs without using up valuable bedroom or family room space. In France, the Company created a village concept through the elimination of front-yard walls and the extensive use of landscaping. It also introduced to the French market the American concept of a master bedroom suite, as well as walk-in closets, built-in kitchen cabinetry and two-car garages. The Company believes that in each of its residential markets, its value engineering enables it to offer appealing and well-designed homes without increasing construction costs.\nIn all of its residential markets, the sale of homes is carried out by the Company's in-house sales force. The Company markets its homes principally through the use of fully furnished and landscaped model homes which are decorated to emphasize the distinctive design features. The Company also markets its homes through various types of media, including newspaper advertisements, highway signs and direct mail. In addition, the Company extends its marketing programs beyond these traditional real estate avenues through the use of television advertising, off-site telemarketing, and large-scale promotions.\nSince 1985, the Company's California divisions have utilized an umbrella marketing concept, The California Series(R). This concept seeks to increase brand identification by incorporating certain common features in the marketing programs of its different development communities and by using \"California\" in the names of these communities. The Company has registered this trademark name and features The California Series(R) designs in its sales brochures and other promotional material.\nIn 1995, the Company introduced a television advertising campaign featuring its celebrity spokesperson, award-winning actor Tom Skerritt, to millions of potential homebuyers in the western United States. Skerritt is perhaps best known for his leading role in the CBS television series \"Picket Fences\" and movie roles in \"Top Gun\" and \"A River Runs Through It.\"\nCOMMUNITY DEVELOPMENT\nThe community development process generally consists of three phases: land acquisition; land development; and home construction and sale. The normal development cycle for a community has in the past ranged from six to 20 months in California and from 12 to 30 months in France. The development cycle varies depending on the extent of government approvals required, the size of the development, the site preparation necessary and marketing results.\nThe Company attempts to acquire finished lots within its pricing parameters, where available, enabling it to deliver completed homes shortly after acquisition. The total number of lots in the Company's domestic new home communities vary significantly but typically are comprised of 50 to 250 lots. These domestic developments usually include three different home designs, and in 1995 generally offered lot sizes ranging from 3,500 to 8,500 square feet. The Company, in prior years, has also acquired certain developments with total lots significantly in excess of 250 lots. Such developments are not consistent with the Company's current investment strategy. Strategies to reduce or eliminate such developments may be considered. In France, typical single-family developments are smaller, consisting of approximately 40 lots, with lot sizes generally ranging from 2,500 to 6,500 square feet.\nLand Acquisition and Development. The Company utilizes an in-house staff of land acquisition specialists at each division who carry out extensive site selection research and analysis in order to identify properties in desirable locations consistent with the Company's market strategy. In acquiring land, the Company considers such factors as: current market conditions, with an emphasis on the prices of comparable homes in the particular market; proximity to metropolitan areas; population, industrial and commercial growth patterns; estimated costs of completed lot development; customer preferences; and environmental matters. Senior corporate management controls the commitment of the Company's resources for land acquisition and utilizes a series of specific financial and budgetary controls in approving acquisition opportunities identified by division land acquisition personnel. During 1995, the Company implemented stricter standards for assessing all proposed land purchases based, in part, upon discounted after tax cash flow internal rate of return requirements. In addition, all operating divisions are measured for the first time based upon overall return on investment. Among other things, this focus will likely result in reductions in new land purchases and inventory investment in California during 1996 as a step toward improving the Company's overall return on equity over time. Cash flow available from reduced California investment will be used to fund the Company's expansion into other western states as well as reduce overall leverage as measured by the ratio of debt to total capital.\nThe following table shows the number of lots owned by the Company in various stages of development and under option contract in its principal markets as of November 30, 1995. The following table does not include acreage which has not yet been approved for subdivision into lots. This excluded acreage includes 1,089 acres owned in the United States and 223 acres owned in other areas.\nThe Company has focused its domestic efforts on acquiring finished or partially improved lots, usually under options which are exercised as the lots are needed. The purchase of finished lots generally allows the Company to begin delivery of finished homes within six months of the purchase of such lots and reduces the risks of unforeseen improvement costs and volatile market conditions. During the early 1990s, the Company made a number of advantageous purchases of finished lots in California, as many builders were unable to proceed with projects due to the tight restrictions on the availability of capital imposed by financial institutions. Although such opportunities were not as prevalent in the Company's domestic markets in 1995, the Company expects to continue this strategy into the immediate future to the extent such opportunities remain available.\nWhile the Company has significantly reduced the proportion of unentitled and unimproved land purchases, when all acquired property is considered, the Company has and expects to continue to purchase raw land under options which require little or no initial payments, or pursuant to purchase agreements in which the Company's obligations are contingent upon the Company being satisfied with the feasibility of developing and selling homes. During the option period of its acquisition agreements, the Company performs technical, environmental, engineering and entitlement feasibility studies and seeks to obtain necessary government approvals. The use of option arrangements allows the Company to evaluate and obtain regulatory approvals for a project, to reduce its financial commitments, including interest and other carrying costs, and to minimize land inventories. It also improves the Company's capacity to estimate costs accurately, an important element in planning communities and pricing homes. Generally, the Company purchases only amounts sufficient for its expected production needs and does not purchase land for speculative investment.\nIn France, as a result of the continued uncertainty in the French real estate market, the Company is employing a number of recession-conscious strategies, including a greater emphasis on the entry-level market segment and generally more restrictive policies regarding new land acquisition.\nHome Construction and Sale. Following the purchase of land and, if necessary, the completion of the entitlement process, the Company typically begins marketing the homes and constructing several model homes. The construction of production homes is generally contingent upon customer orders to minimize the costs and risks of standing inventory. Due to the Company's continued domestic expansion overall inventory levels increased in 1995.\nThe Company acts as the general contractor for its communities and hires subcontractors for all production. The use of subcontractors enables the Company to reduce its investment in direct labor costs, equipment and facilities. Where practical, the Company uses mass production techniques, construction on contiguous lots, and prepackaged, standardized components and materials to streamline the on-site production phase. During the early 1990s, the Company developed a system of national purchasing of certain building materials, appliances and other items to take advantage of economies of scale and to reduce costs. At all stages of production, the Company's own administrative and on-site supervisory personnel coordinate the activities of subcontractors and subject their work to quality and cost controls.\nThe Company generally prices its homes only after it has entered into contracts for the construction of such homes with subcontractors, an approach which improves its ability to estimate costs accurately.\nThe Company provides customers with a limited home warranty program operated by the personnel in each of its divisions to give customers prompt and efficient post-delivery service. The warranty program covers certain repairs which may be necessary following new home construction and covers structural integrity for a period of ten years. In the aggregate, the costs associated with the Company's warranty program are not material to its operations.\nCYCLICALITY\nThe Company's business, and the housing industry in general, are cyclical. The Company's operations and markets are affected by local and regional factors such as local economies, demographic demand for housing, population growth, property taxes and energy costs, and by national factors such as short and long-term interest rates, federal mortgage financing programs, federal income tax provisions and general economic trends. In addition homebuilders are subject to various risks including availability and cost of land, conditions of supply and demand in local markets, weather conditions, delays in construction schedules and the entitlement process. Net orders often vary on a seasonal basis, with the lowest sales activity typically occurring in the winter months.\nThe Company's 1995 financial results were particularly affected by certain factors, including but not limited to the weak economic conditions in California and France, severe weather conditions in California in early 1995 and a lack of urgency among potential homebuyers in many of the Company's markets.\nBACKLOG\nSales of the Company's homes are made pursuant to standard sales contracts, which generally require a customer deposit at the time of execution and an additional payment upon mortgage approval. The Company generally permits customers to cancel their obligations and obtain refunds of their deposits in the event mortgage financing is unobtainable within a specified period of time.\nBacklog consists of homes for which the Company has entered into a sales contract but which it has not yet delivered. Ending backlog represents the number of units in backlog from the previous period plus the number of net orders (sales made less cancellations) taken during the current period minus unit deliveries made during the current period. The backlog at any given time will be affected by cancellations which most commonly result from the inability of a prospective purchaser to obtain financing. Historically, the Company's cancellation rates have increased during difficult economic periods. In addition, as demonstrated by the table below, deliveries of new homes have typically increased from the first to the fourth quarter in any year. Accordingly, the Company usually experiences a relatively low backlog of orders at year end.\nThe following table sets forth net orders, unit deliveries and ending backlog relating to sales of homes and homes under contract for each quarter during the three-year period ended November 30, 1995.\nLAND AND RAW MATERIALS\nManagement believes that the Company's current supply of land is sufficient for its reasonably anticipated needs, and that it will be able to acquire land on acceptable terms for future housing developments. The principal raw materials used in the construction of homes are concrete and forest products. In addition, the Company uses a variety of other construction materials, including sheetrock and glass. The Company attempts to maintain efficient operations by utilizing standardized materials which are commercially available on competitive terms from a variety of sources. Since 1992, the Company has increasingly utilized centralized purchasing of certain building materials, appliances and fixtures, enabling it to benefit from large quantity purchase discounts for its domestic operations. The Company makes bulk purchases of such products at favorable prices from suppliers and instructs subcontractors to submit bids based on such prices.\nThe principal materials used in the construction of French commercial buildings are steel, concrete and glass.\nLAND SALES\nIn the normal course of its business, the Company sells land which can be sold at an advantageous price due to market conditions or does not meet its marketing needs. This property may consist of land zoned for commercial use which is part of a larger parcel being developed for single-family homes or in areas where the Company may consider its inventory to be excessive. The Company's decisions to maintain or decrease its land ownership position in certain markets may be impacted by the strength and number of competing developers entering particular markets at given points in time, the availability of land in markets served by the Company's housing divisions, and prevailing market conditions.\nCUSTOMER FINANCING -- KAUFMAN AND BROAD MORTGAGE COMPANY\nAt the Company's communities in the United States, on-site personnel facilitate sales by offering to arrange financing for prospective customers through KBMC. Management believes that the ability to offer customers financing on firm, competitive terms as a part of the sales process is an important factor in completing sales. The Company typically assists customers in arranging for guaranteed maximum interest rates at the time of sale even though delivery may take place in the future.\nKBMC's business consists of providing the Company's domestic customers with competitive financing and coordinating and expediting the loan origination transaction through the steps of loan application, loan approval and closing. KBMC has its headquarters in Los Angeles and operates branch offices in Anaheim, Dublin, Fremont, Fresno, Los\nAngeles, Modesto, Newport Beach, Palmdale, Sacramento, Salinas and San Diego, California; Las Vegas, Nevada; Phoenix, Arizona; Denver, Colorado; Albuquerque, New Mexico; and Salt Lake City, Utah.\nKBMC's principal sources of revenues are: (i) interest income earned on mortgage loans during the period they are held by KBMC prior to their sale to investors; (ii) net gains from the sale of loans; (iii) loan servicing fees; and (iv) revenues from the sale of the rights to service loans.\nKBMC is approved by the Government National Mortgage Association (\"GNMA\") as a seller-servicer of Federal Housing Administration (\"FHA\") and Veterans Administration (\"VA\") loans. A portion of the conventional loans originated by KBMC (i.e., loans other than those insured by FHA or guaranteed by VA) qualify for inclusion in loan guarantee programs sponsored by the Federal National Mortgage Association (\"FNMA\") or the Federal Home Loan Mortgage Corporation (\"FHLMC\"). KBMC arranges for fixed and adjustable rate, conventional, privately insured mortgages, FHA-insured or VA-guaranteed mortgages, and mortgages funded by revenue bond programs of states and municipalities. In fiscal 1995, approximately 44% of the mortgages originated for the Company's customers were conventional, (most of which conformed to FNMA and FHLMC guidelines) 36% were FHA-insured or VA-guaranteed, a portion of which are adjustable rate loans, 15% were funded by mortgage revenue bond programs and 5% were adjustable rate mortgages (\"ARMs\") primarily provided through commitments from institutional investors. The percentages set forth above change from year to year reflecting then-current fixed interest rates, introductory rates for ARMs, housing prices and other economic conditions. In 1995, KBMC originated loans for 80% of the Company's domestic home deliveries. Generally, KBMC receives an origination fee of approximately 1% of the principal amount of the loan.\nKBMC is a delegated underwriter under the FHA Direct Endorsement and VA Automatic programs in accordance with criteria established by such agencies. Additionally, KBMC has delegated underwriting authority from FNMA and FHLMC. As a delegated underwriter, KBMC may underwrite and close mortgage loans under programs sponsored by these agencies without their prior approval, which expedites the loan origination process.\nKBMC, like other mortgage bankers, customarily sells nearly all of the loans that it originates. Loans are sold either individually or in pools to GNMA, FNMA or FHLMC or against forward commitments to institutional investors, including banks and savings and loan associations.\nFor a small percentage of loans, and to the extent required for loans being held for sale to investors, KBMC services the mortgages that it originates. Servicing includes collecting and remitting loan payments, accounting for principal and interest, making inspections of mortgaged premises as required, monitoring delinquent mortgages and generally administering the loans.\nKBMC receives fees for servicing mortgage loans, generally ranging from .20% per annum to .50% per annum on the declining principal balances of the loans. KBMC typically sells servicing rights on a regular basis.\nThe Company also assists its customers in France by arranging financing through third party lenders, primarily major French banks with which the Company has established relationships. In some cases, French customers qualify for certain government-assisted, home financing programs. A second mortgage is usually handled through a government agency. A home buyer in France may also have a third mortgage provided through credit unions or other employee groups.\nEMPLOYEES\nThe Company employs a trained staff of land acquisition specialists, architects, planners, engineers, construction supervisors, marketing and sales personnel and finance and accounting personnel, supplemented as necessary by outside consultants, who guide the development of communities from their conception through the marketing and sale of completed homes.\nAt January 31, 1996, the Company had approximately 1,220 full-time employees in its operations, including approximately 130 in KBMC's operations.\nCOMPETITION AND OTHER FACTORS\nThe Company's business is highly competitive. It competes primarily on the basis of price, location, financing, design, reputation, quality and amenities with numerous housing producers ranging from regional and national firms to\nsmall builders. Resales of housing provide additional competition. In certain markets and at times when housing demand is high, the Company also competes with other builders to hire subcontractors.\nKBMC competes with other mortgage lenders, including mortgage bankers, savings and loan associations and other financial institutions, in the origination, sale and servicing of mortgage loans.\nIncreases in interest rates typically have a negative impact on the Company's operations in that such increases adversely affect the availability of home financing to, or qualification for such financing by, the Company's customers. Conversely, significant reductions in interest rates typically have a positive effect on the Company's operations.\nThe Company does not generally finance the development of its domestic communities with proceeds of loans specifically obtained for, or secured by, particular communities, i.e., project financing. Instead, financing of the Company's domestic operations has been primarily generated from results of operations, public debt and equity financing and borrowings under its $500 million unsecured revolving credit facility with a consortium of domestic and foreign banks. This revolving credit facility includes a $200 million sublimit for the Company's mortgage banking operations. Financing of its French operations has been primarily generated from results of operations and borrowings from its aggregate $140 million unsecured committed credit lines from a series of foreign banks. As a result of these diverse external sources of financing, the Company was not adversely affected by the tight credit conditions that much of the homebuilding industry experienced during the recent recession, both domestically and in France.\nREGULATION AND ENVIRONMENTAL MATTERS\nThe housing industry is subject to extensive and complex regulations. The Company and its subcontractors must comply with various federal, state and local laws, ordinances, rules and regulations concerning zoning, building design, construction and similar matters. The operations of the Company are affected by environmental laws and regulations, including regulations pertaining to availability of water, municipal sewage treatment capacity, land use, protection of endangered species, population density and preservation of the natural terrain and coastlines. These and other requirements could become more restrictive in the future, resulting in additional time and expense to obtain approvals for the development of communities.\nThe Company is also subject to regulations and restrictions by the governments of France, Canada and Mexico concerning investments in business operations in those countries by United States companies, none of which has to date had a material adverse effect on the Company's consolidated operations. The Company's foreign operations are subject to exchange rate fluctuations, which affect the Company's financial statements and the reporting of profits and payment of dividends from foreign subsidiaries, to restrictive foreign government regulations which may be in effect from time to time and to the terms of the Foreign Corrupt Practices Act with which it is the strict policy of the Company to comply. In addition, the Company has received dividends from its French and Canadian operations without burdensome restrictions, although tax considerations have limited the amount of such dividends.\nKBMC is subject to numerous federal, state and local laws, ordinances, rules and regulations concerning loans to purchasers of homes as well as Company eligibility for participation in programs of the VA, FHA, GNMA, FNMA and FHLMC.\nThe Company entered into a consent order with the Federal Trade Commission (\"FTC\") in 1979 pursuant to which the Company agreed to provide explicit warranties on the quality and workmanship of its new homes, follow certain guidelines in advertising and provide certain disclosures to any prospective purchaser who visits Company sales offices or model homes. In 1991, the Company reached a monetary settlement with the FTC, covering alleged violations of the Company's consent order. The FTC acknowledged that the Company did not admit any of the allegations and did not impose any additional requirements on the Company.\nThe Company currently has policies of using outside environmental specialists to investigate land considered for acquisition for environmental risks and requiring disclosure from land sellers of known environmental risks. Despite these activities, there can be no assurance that the Company will avoid material liabilities relating to the removal of toxic wastes, site restoration, monitoring or other environmental matters affecting properties currently or previously owned by the Company. Costs associated with the use of environmental consultants are not material to the Company's results of operations. No estimate of such potential liabilities can be made although the Company may, from time to time, purchase property which requires modest environmental clean-up costs after appropriate due diligence. In such instances,\nthe Company takes steps prior to acquisition to assure itself as to the precise scope of work required and costs associated with removal, site restoration and\/or monitoring, using detailed investigations by environmental consultants. To the extent such costs have occurred in the past, the Company believes it may be able to recover such costs from third parties, including, but not limited to, the generators of hazardous waste, land sellers or others in the prior chain of title and\/or insurers. Utilizing such policies, the Company anticipates that it is not likely that environmental clean-up costs will have a material effect on future results of operations or the Company's financial position. The Company has not been notified by any governmental agency of any claim that any of the properties owned or formerly owned by the Company are identified by the Environmental Protection Agency as being a \"Superfund\" clean-up site requiring clean-up costs, which could have a material effect on future results of operations or the Company's financial position.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's executive offices are in leased premises at 10990 Wilshire Boulevard, Los Angeles, California. The Company's housing operations are principally conducted from leased premises located in Anaheim, Bakersfield, Dublin, Fremont, Fresno, Los Angeles, Modesto, Newport Beach, Palmdale, Pleasanton, Sacramento, Salinas and San Diego, California; Las Vegas, Nevada; Phoenix, Arizona; Denver, Colorado; Albuquerque, New Mexico; Salt Lake City, Utah; Paris, France; Toronto, Canada; and Mexico City, Mexico.\nThe Company's mortgage banking subsidiaries lease executive offices in Los Angeles, California and branch offices in Anaheim, Dublin, Fremont, Fresno, Los Angeles, Modesto, Newport Beach, Palmdale, Sacramento, Salinas and San Diego, California; Las Vegas, Nevada; Phoenix, Arizona; Denver, Colorado; Albuquerque, New Mexico; and Salt Lake City, Utah.\nThe Company believes that such properties, including the equipment located therein, are suitable and adequate to meet the requirements of its businesses.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIn August 1992, homeowners from the Company's California Meadows community in Riverside County filed a lawsuit against the Company in Riverside County Superior Court seeking compensatory and punitive damages and alleging, among other things, defective construction, breach of warranty, negligence and fraud. The owners of approximately 115 homes are currently involved in the litigation. In February 1994, the Company filed cross-complaints against relevant subcontractors and certain other third parties. The Company believes that it has acted fairly and responsibly toward all homeowners at that community. Based upon its thorough investigation of the site, the Company believes that the most serious allegations in this lawsuit are substantially without merit and has contested such claims.\nThe Company is involved in other litigation incidental to its business. These cases are in various stages of development and, based on reports of counsel, it is management's opinion that provisions made for potential losses in the California Meadows and other matters are adequate and any further liabilities and costs arising out of currently pending litigation will not have a materially adverse effect upon 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 matters were submitted during the fourth quarter of 1995 to a vote of security holders, through the solicitation of proxies or otherwise.\nEXECUTIVE OFFICERS OF THE COMPANY\nThe following sets forth certain information regarding the executive officers of the Company as of January 31, 1996:\n- ---------------\n(1) All positions described were with the Company, unless otherwise indicated.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nAs of January 31, 1996, there were 2,186 holders of record of the Company's common stock.\nInformation as to the Company's quarterly stock prices is included on the inside back cover of the Company's 1995 Annual Report to Stockholders, which is included as part of Exhibit 13 and is incorporated in this Annual Report on Form 10-K.\nInformation as to the principal markets on which the Company's common stock is being traded and quarterly cash dividends is included on the inside back cover of the Company's 1995 Annual Report to Stockholders, which is included as part of Exhibit 13 and is incorporated in this Annual Report on Form 10-K.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe Five Year Summary of Kaufman and Broad Home Corporation and its consolidated subsidiaries for the five-year period ended November 30, 1995 is included on page 24 in the Company's 1995 Annual Report to Stockholders, which is included as part of Exhibit 13 and is incorporated in this Annual Report on Form 10-K. It should be read in conjunction with the consolidated financial statements included in the Company's 1995 Annual Report to Stockholders which are also included as part of Exhibit 13.\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 of Kaufman and Broad Home Corporation is included on pages 25 through 32 in the Company's 1995 Annual Report to Stockholders, which are included as part of Exhibit 13 and are incorporated in this Annual Report on Form 10-K.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe consolidated financial statements of Kaufman and Broad Home Corporation are included on pages 33 through 45 in the Company's 1995 Annual Report to Stockholders, which are included as part of Exhibit 13 and are incorporated in this Annual Report on Form 10-K. Reference is made to the Index to Financial Statements on page herein.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nThe Notice of 1996 Annual Meeting of Stockholders and Proxy Statement, filed pursuant to Regulation 14A under the Securities Exchange Act of 1934, incorporated by reference in this Annual Report on Form 10-K pursuant to General Instruction G(3) of Form 10-K, provides the information required under Part III (Items 10, 11, 12 and 13) except for the information regarding the executive officers of the Company, which is included in Part I on page 11 herein.\nPART IV\nITEM 14.","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"ITEM 14. FINANCIAL STATEMENTS, EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\nFINANCIAL STATEMENTS\nReference is made to the index set forth on page of this Annual Report on Form 10-K.\nEXHIBITS\nFINANCIAL STATEMENT SCHEDULES\nFinancial statement schedules have been omitted because they are not applicable or the required information is shown in the consolidated financial statements and notes thereto.\nREPORTS ON FORM 8-K\nNo reports on Form 8-K were filed during the fourth quarter of 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.\nKAUFMAN AND BROAD HOME CORPORATION\nBy: MICHAEL F. HENN ------------------------------------- Michael F. Henn Senior Vice President and Chief Financial Officer\nDated: February 22, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant in the capacities and on the dates indicated:\nKAUFMAN AND BROAD HOME CORPORATION AND CONSOLIDATED SUBSIDIARIES\nThe consolidated financial statements, together with the report thereon of Ernst & Young LLP, dated January 4, 1996, except as to Note 13, as to which the date is January 22, 1996, all appearing on pages 33 through 45 in the 1995 Annual Report to Stockholders, are incorporated in this Annual Report on Form 10-K between page and the List of Exhibits Filed. With the exception of the aforementioned information and the information incorporated in Items 5, 6 and 7, the 1995 Annual Report to Stockholders is not to be deemed filed as part of this Annual Report on Form 10-K.\nSeparate combined financial statements of the Company's unconsolidated joint venture activities have been omitted because, if considered in the aggregate, they would not constitute a significant subsidiary as defined by Rule 3-09 of Regulation S-X.\n------------------------\nThe following pages represent pages 24 through 45 and the inside back cover of the 1995 Annual Report to Stockholders of Kaufman and Broad Home Corporation, and include the Five Year Summary, Management's Discussion and Analysis of Financial Condition and Results of Operations, the Consolidated Financial Statements and related notes thereto, the Report of Independent Auditors, Stockholder Information and Quarterly Stock Prices. These pages were filed with the Securities and Exchange Commission as Exhibit 13 to this Annual Report on Form 10-K.\nSELECTED FINANCIAL INFORMATION\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\nOVERVIEW Revenues are generated from the Company's housing operations in the western United States, France and Canada; commercial development activities in France; and domestic mortgage banking operations. The Company's start-up housing operation in Mexico has yet to produce revenues. Operating results in 1995 were adversely affected by weak housing markets in California and France as well as severe weather conditions in California in early 1995. Beyond these markets, the Company continued its profitable expansion of domestic housing operations in five other western states. Divisions in New Mexico and Utah -- the Company's fourth and fifth entries into new U.S. markets in three years -- delivered their first homes in 1995, contributing to a 115.8% year-over-year increase in domestic housing deliveries from operations outside of California. During 1995, the Company continued strategic efforts to reduce overhead costs and improve operating efficiency. As a result, gross margin and selling, general and administrative expense ratios improved in each of the last three quarters of the year.\nTotal revenues increased to $1.40 billion in 1995, up 4.5% from $1.34 billion in 1994, which had increased 8.0% from revenues of $1.24 billion in 1993. The increase in 1995 reflected higher housing revenues, partially offset by a decline in revenues from land sales. In 1994, revenues rose due to higher housing revenues, partially offset by a significant decline in French commercial development revenues. Included in total revenues are mortgage banking revenues of $29.7 million in 1995, $28.7 million in 1994 and $38.1 million in 1993.\nNet income decreased 37.6% in 1995 to $29.1 million from $46.6 million in 1994, which had increased 16.6% from the prior year's $39.9 million. Net income fell in 1995 due to lower earnings from housing operations, as a decline in earnings from California operations, primarily stemming from continued weakness in the state's housing market, was only partially offset by an increase in earnings from domestic operations outside the state. In 1994, the improvement in net income reflected increased housing volume in the United States and improved results from French housing operations compared to the year earlier.\nEarnings per share decreased to $.73 in 1995, reflecting lower net income. Earnings per share increased to $1.16 in 1994 from $.96 in 1993 on higher earnings and a lower average number of shares outstanding. The Company's buyback of special common stock and warrants in December 1993 and its exchange and cancellation of the remaining shares of special common stock on various dates throughout 1994 reduced the number of shares outstanding for 1994.\nCONSTRUCTION\nREVENUES Construction revenues increased in 1995 to $1.37 billion from $1.31 billion in 1994, which had increased from $1.20 billion in 1993. The increase in 1995 primarily reflected higher domestic housing revenues, as a decline in California housing revenues was more than offset by increased housing revenues from other U.S. operations (including the Company's first deliveries in New Mexico and Utah). In 1994, revenues improved primarily due to increased domestic housing revenues, including initial contributions from the Company's then newly established divisions in Arizona and Colorado, partially offset by a reduction in French commercial revenues.\nHousing revenues totaled $1.33 billion in 1995, $1.26 billion in 1994 and $1.10 billion in 1993. The Company's 1995 increase in housing revenues reflected a 4.7% increase in the Company's average selling price as well as a modest increase in unit volume. In 1994, housing revenues increased on higher unit volume while the average selling price decreased slightly. California housing operations accounted for 72.3% of housing revenues in 1995, down from 82.0% in 1994, due to the Company's expansion into New Mexico and Utah during the year, combined with the maturation of the Nevada, Arizona and Colorado divisions and the still-stagnant economic conditions in California. California housing revenues were $959.8 million in 1995, down from $1.03 billion in 1994, while other U.S. housing revenues increased to $245.4 million in 1995 from $95.8 million in 1994. In 1994, the Company's California-generated revenues as a percentage of total housing revenues decreased from 85.4% in 1993 primarily due to the Company's diversification of its domestic housing business to Nevada, Arizona, and Colorado.\nHousing deliveries increased by 33 units to 7,857 units in 1995, exceeding the previous Company-wide record of 7,824 units set in 1994. Deliveries in the United States increased 2.2%, more than offsetting a 16.2% decline in French deliveries. The increase in domestic unit volume reflected continued expansion outside of California, with non-California deliveries increasing to 1,800 units in 1995 from 834 units in 1994, partially offset by a decline in deliveries from California's soft housing market. California deliveries, which decreased 13.0% to 5,430 units in 1995 from 6,238 units in 1994, were severely hampered by poor weather early in the year, the effects of which carried into the second quarter. French unit volume remained depressed by that country's adverse economic climate as well as the deferral of home purchases by many buyers anticipating new government incentive programs which did not take effect until October 1995.\nRESIDENTIAL QUARTERLY UNIT AND BACKLOG DATA\nHousing deliveries increased in 1994 from 6,764 units in 1993, with U.S. deliveries up 18.8% and French deliveries up 4.3%. The improvement in domestic unit volume reflected the Company's expansion in the western United States. In France, higher unit volume resulted from increased market demand for the Company's entry-level products in a modestly improved, but still weak French economy.\nThe Company's average new home price increased 4.7% to $168,900 in 1995 from $161,300 in 1994, which had decreased .5% from $162,100 in 1993. The 1995 increase was due to higher average selling prices in both the United States and France, reflecting a shift in product mix to higher priced, urban in-fill locations and first time move-up sales. In 1994, a modest decline in the average selling price was primarily due to a reduction in the Company's domestic average selling price.\nIn California, the Company's average selling price rose 6.6% to $176,800 in 1995 from $165,900 in 1994 which increased 1.7% from $163,100 in 1993. The increase in both years reflected a shift in mix toward higher-priced homes. Average selling prices in other U.S. markets were $136,300 in 1995, $114,900 in 1994 and $109,300 in 1993. These increases were the result of the Company's entry into new, higher-priced states in 1995 and 1994. Average selling prices in France have also fluctuated during the past two years with changes in product mix. The Company's average selling price in France increased to $203,700 in 1995 from $182,300 in 1994, which had decreased from $187,800 in 1993.\nRevenues from the development of commercial buildings, all of which are located in metropolitan Paris, totaled $20.5 million in 1995, $17.4 million in 1994 and $94.2 million in 1993. Although commercial development revenues increased modestly in 1995, the Company does not expect a significant increase from these levels in 1996 as high vacancy rates are expected to persist in the French commercial market. In 1994, the significant decrease in commercial revenues primarily reflected the Company's completion of large projects in prior years.\nLand sale revenues totaled $18.2 million in 1995, $27.2 million in 1994 and $8.0 million in 1993. Land sale revenues in these periods have fluctuated based on the Company's decisions to maintain or decrease its land ownership position in certain markets; the strength and number of competing developers entering particular markets at given points in time; the availability of land in markets served by the Company's housing divisions; and prevailing market conditions.\nOPERATING INCOME Operating income decreased by $22.8 million to $65.5 million in 1995 from $88.3 million in 1994. Operating income, net of minority interests in pretax income of consol-\nidated joint ventures, decreased by $22.5 million to $64.9 million in 1995 from $87.4 million in 1994. This decline reflected lower gross profits from commercial activities and land sales as well as an increase in selling, general and administrative expenses. Housing gross profits in 1995 were essentially flat compared to 1994 on slightly higher unit volume offset by a lower housing gross margin. Gross profits (excluding profits from land sales) in 1995 decreased by $8.5 million to $242.2 million from $250.7 million in 1994, largely due to lower gross profits from French commercial operations resulting from a lower commercial gross profit margin. As a percentage of related revenues, the Company's gross profit margin (excluding profits from land sales) was 18.0% in 1995, down from 19.6% in the prior year. The Company's housing gross margin decreased to 17.9% in 1995 from 19.0% in the prior year, primarily reflecting a lower gross margin in California. The lower gross margin from California operations stemmed from the severe and prolonged winter rain storms in early 1995 which reduced sales volumes and slowed production and from the large sales incentives which continued to be required throughout the year to stimulate buying activity in a generally stagnant market. Higher mortgage interest rates in early 1995 also depressed Company performance. Despite these obstacles, the Company's California housing gross margin showed steady improvement from the first through the fourth quarters of 1995 as a rising proportion of deliveries was generated from more recently opened higher-margin communities. Assuming market conditions in California do not deteriorate further, the Company expects its California gross margin to continue to improve in 1996 on a year-over-year basis as strategies to enhance profitability implemented during the course of 1995 are anticipated to have a favorable impact on operating results.\nCompany-wide profits from land sales decreased by $3.2 million to $5.3 million in 1995 from $8.5 million in 1994 with profit margins from these sales also down slightly.\nSelling, general and administrative expenses increased by $11.0 million in 1995. As a percentage of housing revenues, to which these expenses are most closely correlated, selling, general and administrative expenses increased to 13.7% in 1995 from 13.5% in 1994. Selling, general and administrative expenses rose mainly due to the continued expansion of the Company's domestic operations outside of California and increased financing incentives and sales commissions. These increases were partially offset by ongoing cost reduction programs which contributed to an improving expense ratio in each of the last three quarters of 1995. In the first quarter of 1995, selling, general and administrative expenses were 14.6% of housing revenues, gradually declining to 13.3% by the fourth quarter. With benefits of these cost-cutting initiatives anticipated to continue, and assuming market conditions in the Company's principal markets do not deteriorate further, the Company believes its 1996 selling, general and administrative expense ratio will be lower than the 1995 level.\nIn 1994, operating income increased slightly by $1.7 million to $88.3 million from $86.6 million in 1993. Operating income, net of minority interests, increased by $11.0 million to $87.4 million in 1994 from $76.5 million in 1993. This improvement reflected higher gross profits from housing sales and land sales, partially offset by higher selling, general and administrative expenses. Gross profits (excluding profits from land sales) rose by $22.6 million to $250.7 million in 1994 from $228.1 million in 1993, due to higher housing unit volume in the United States, partially offset by a decline in commercial development gross profits. As a percentage of related revenues, the Company's gross profit margin (excluding profits from land sales) was 19.6% in 1994, up from 19.1% a year earlier, on a higher residential gross margin and, to a lesser extent, a higher commercial gross margin. The Company's housing gross margin increased to 19.0% in 1994 from 18.4% in 1993 primarily reflecting gross margin improvement in France. The French housing gross margin improved in 1994 largely due to a lower land-cost basis and a modest strengthening of the French economy.\nCompany-wide profits from land sales increased to $8.5 million in 1994 from $1.1 million in 1993.\nSelling, general and administrative expenses increased by $28.4 million in 1994, as the Company expanded its operations in the western United States and commenced operations in Mexico. In addition, higher marketing and advertising costs and sales incentives were required in the latter half of 1994 to maintain sales momentum in the face of persistent mortgage rate increases triggered by actions of the Federal Reserve Board. These actions caused the average thirty-year fixed rate mortgage to increase by more than two percentage points during the year. In France, the Company continued to reduce selling, general and administrative expenses to levels commensurate with its significantly reduced commercial operations. Company-wide selling, general and administrative expenses as a percentage of housing revenues increased to 13.5% in 1994 from 13.0% in 1993.\nINTEREST INCOME AND EXPENSE Interest income, which is generated from mortgages receivable, principally from land sales, and from short-term investments, amounted to $2.1 million in 1995, $2.0 million in 1994 and $3.5 million in 1993. Interest income remained stable in 1995 compared to 1994 reflecting little change in the interest bearing average balances of short-\nterm investments and mortgages receivable. The reduction in interest income in 1994 from 1993 reflected lower average balances of short-term investments and mortgages receivable and the fluctuation in interest rates.\nInterest expense results principally from borrowings to finance land purchases, housing inventory, and other operating and capital needs. In 1995, interest expense, net of amounts capitalized, increased to $27.5 million from $17.8 million in 1994, reflecting higher average indebtedness, a higher overall effective borrowing rate than in 1994 and a lower percentage of interest capitalized. The Company's average debt level increased as inventory levels grew due to continued expansion. In addition, the Company's effective borrowing rate rose as a result of interest rate increases implemented by the Federal Reserve Board throughout 1994 and into early 1995. In 1994, interest expense, net of amounts capitalized, increased to $17.8 million from $16.8 million in the prior year, reflecting higher average indebtedness and a higher overall effective borrowing rate than in 1993. The average debt level rose as the Company increased inventory levels in conjunction with continued domestic expansion and executed the buyback of special common stock and warrants in December 1993.\nMINORITY INTERESTS IN PRETAX INCOME OF CONSOLIDATED JOINT VENTURES The Company conducts a portion of both its residential and commercial development activities through majority-owned partnerships, primarily in France, which are fully consolidated in the accompanying financial statements. As a result, operating income has been reduced by minority interests in the pretax income of these partnerships of $.6 million in 1995, $.9 million in 1994 and $10.2 million in 1993. Minority interests decreased both years on declining profit contributions from the Company's consolidated commercial development projects. Minority interests are expected to remain at low levels in 1996, consistent with the Company's reduced level of development activities in a generally depressed French commercial market.\nEQUITY IN PRETAX LOSS OF UNCONSOLIDATED JOINT VENTURES The Company's unconsolidated joint venture activities, located in the Los Angeles, Paris and Toronto metropolitan areas, posted combined revenues of $33.9 million in 1995, $82.7 million in 1994 and $6.4 million in 1993. Of these amounts, revenues from commercial activities in France accounted for $5.9 million in 1995, $34.0 million in 1994 and $2.6 million in 1993. These unconsolidated joint ventures generated combined pretax losses of $20.5 million in 1995, $35.7 million in 1994 and $30.8 million in 1993. The losses in 1995 and 1994 primarily consisted of selling, general, administrative and interest expenses from a single French multi-family residential project, as well as reserves taken in 1995 on a commercial development project. The loss in 1993 primarily resulted from selling, general, administrative and interest expenses incurred on a large project under construction prior to the recognition of related revenues. The Company's share of pretax losses from these joint ventures totaled $3.5 million in 1995, $3.7 million in 1994, and $6.3 million in 1993. These amounts have declined over the three year period due to the combined effect of changes in joint venture activity and the Company's proportionate share of related losses, as well as the amount and timing of management fees recognized.\nMORTGAGE BANKING\nINTEREST INCOME AND EXPENSE The Company's mortgage banking operations principally consist of providing financing to purchasers of homes sold by the Company's domestic housing operations through the origination of residential mortgages. The mortgage banking operations also realize revenues from the sale of such mortgages and related servicing rights to outside financial institutions. Prior to 1989, substantially all such mortgages were pledged for collateralized mortgage obligations. Accordingly, interest income is earned primarily from mortgage-backed securities held for long-term investment as collateral, while interest expense results mainly from the associated collateralized mortgage obligations.\nInterest income decreased to $15.6 million in 1995 from $17.0 million in 1994, and $24.2 million in 1993, while interest expense also declined to $14.8 million in 1995 from $17.2 million in 1994, and $25.1 million in 1993. These amounts decreased primarily due to the declining balances of outstanding mortgage-backed securities and related collateralized mortgage obligations, stemming from both regularly scheduled, monthly principal amortization and the prepayment of mortgage collateral. These balances, and the related interest income and expense, will continue to decline, as the Company's practice of participating in collateralized mortgage financings was discontinued in 1988 due to market conditions and tax law changes. Combined interest income and expense resulted in net interest income of $.8 million in 1995 and net interest expense of $.2 million in 1994 and $.9 million in 1993. These differences reflect variations in mortgage production mix; movements in short-term versus long-term interest rates; and the amount, timing and rates of return on interim reinvestments of monthly principal amortization and prepayments.\nOTHER MORTGAGE BANKING REVENUES Other mortgage banking revenues, which principally consist of gains on sales of mortgages and servicing rights and, to a lesser extent, mortgage servicing fees, totaled $14.1 million in 1995, $11.7 million in 1994 and\n$13.9 million in 1993. The increase in these revenues in 1995 reflected higher gains on the sales of mortgages and servicing rights due to a higher volume of mortgage originations -- resulting from higher housing unit volume in the United States -- and a more favorable mix of fixed to variable rate loans. In 1994, the decrease in other mortgage banking revenues primarily reflected lower gains on the sales of both servicing rights and mortgages.\nGENERAL AND ADMINISTRATIVE EXPENSES General and administrative expenses for mortgage banking operations amounted to $5.5 million in 1995 and 1994, and $5.4 million in 1993. Despite increased mortgage production volume in 1995, general and administrative expenses remained flat compared to 1994 levels due to the Company's successful cost containment efforts which extended to lending operations. General and administrative expenses increased in 1994 largely due to higher mortgage production levels, which rose in line with domestic unit deliveries, and the opening of new branches as part of the Company's domestic expansion.\nINCOME TAXES\nThe Company's income tax expense totaled $16.4 million in 1995, $27.3 million in 1994 and $24.4 million in 1993. These amounts represented effective income tax rates of approximately 36.1% in 1995, 37.0% in 1994 and 37.9% in 1993. The effective tax rate declined over the two-year period as a result of greater utilization of affordable housing investment credits. Pretax income for financial reporting purposes and taxable income for income tax purposes historically have differed primarily due to the impact of state income taxes, foreign tax rate differences, intercompany dividends and the use of affordable housing credits.\nIn 1993, the Company adopted the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\" The impact of the adoption on the Company's financial position and results of operations was not significant.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company assesses its liquidity in terms of its ability to generate cash to fund its operating and investing activities. Historically, the Company has funded its construction and mortgage banking activities with internally generated cash flows and external sources of debt and equity financing. In 1995, operating, investing and financing activities used net cash of $11.4 million; in 1994, these activities used net cash of $20.3 million.\nOperating activities in 1995 used $52.9 million, while 1994 operating activities used $111.1 million. The Company's uses of cash in 1995 included a net investment of $80.3 million in inventories (excluding $36.1 million of inventories acquired through seller financing), an increase of $14.7 million in receivables and $18.8 million of other operating uses. The use of cash was partially offset by earnings of $29.1 million, various noncash items deducted from net income and a $26.7 million increase in accounts payable, accrued expenses and other liabilities. Consistent with its continued domestic expansion, inventories increased, primarily in the United States, where they rose 11.6% to $901.4 million at November 30, 1995 from $807.5 million at year-end 1994.\nIn 1994, the use of operating cash included net investments of $137.6 million in inventories (excluding $27.1 million of inventories acquired through seller financing) and $26.3 million in payments to reduce accounts payable, accrued expenses and other liabilities. The use of cash was partially offset by earnings of $46.6 million and various noncash items deducted from net income. In 1994, inventories substantially increased, principally in the United States, rising to $807.5 million at November 30, 1994 from $633.0 million at year-end 1993, as the Company accelerated its domestic expansion, while sales rates slowed in the latter half of the year.\nCash provided by investing activities totaled $10.0 million in 1995 and $37.5 million in 1994, primarily from $13.8 million and $49.7 million, respectively, in proceeds from mortgage-backed securities paid off during the year within the mortgage banking operations. These proceeds were used largely to pay down the collateralized mortgage obligations for which the mortgage-backed securities had served as collateral.\nFinancing activities in 1995 and 1994 resulted in a net cash inflow of $31.5 million and $53.3 million, respectively. In 1995, cash was provided by $64.3 million in net proceeds from borrowings. These cash inflows were partially offset by payments on collateralized mortgage obligations of $13.3 million, the funds for which were provided by receipts on mortgage-backed securities; and $19.6 million of cash dividend payments. The Company's debt-to-capital ratio increased to 60.6% in 1995 from 58.3% in 1994 reflecting additional financing required for the higher level of inventories resulting from domestic expansion.\nFinancing activities in 1994 provided $211.0 million in net proceeds from borrowings, partially offset by the purchase of the Company's special common stock and warrants for $73.7 million; payments on collateralized mortgage obligations of $49.3 million, the funds for which were provided by receipts on mortgage-backed securities; and $19.6 million of cash dividend payments.\nIn order to simplify its capital structure, the Company commenced a tender offer in 1993 to purchase all of the 5.1\nmillion outstanding shares of its special common stock at a price of $19 per share. The offer expired on December 7, 1993 with 2.3 million shares tendered. In addition, on December 23, 1993, the Company purchased the remaining 2.4 million warrants to purchase shares of special common stock at a price equal to the tender offer price per share less the $6.96 per warrant exercise price. Subsequent to the expiration of the tender offer, the remaining 2.8 million outstanding shares of special common stock were exchanged by the Company at a ratio of .95 shares of common stock for each share of special common stock on various dates in 1994. There were no outstanding shares of special common stock at November 30, 1994. The purchase of special common stock and warrants was largely responsible for an increase in the Company's debt-to-capital ratio to 58.3% in 1994 from 41.4% in 1993.\nExternal sources of financing for the Company's construction activities include its domestic unsecured revolving credit facility, other domestic and foreign bank lines, third-party secured financings, and the public debt and equity markets. Substantial unused lines of credit remain available for the Company's future use, if required, and are centered mainly in its domestic unsecured revolving credit facility. Terms under this facility, as amended in November 1994, provide for a $500 million commitment with a $200 million sublimit for the Company's mortgage banking operations through December 31, 1997. As of November 30, 1995, there was $197.0 million available under the revolving credit facility for the Company's future use. In addition, under the Company's French unsecured financing agreements, $81.3 million was available in the aggregate at November 30, 1995. Depending upon available terms, the Company also finances certain land acquisitions with borrowings from land sellers and other third parties. At November 30, 1995, the Company had outstanding seller-financed notes payable of $43.7 million secured primarily by the underlying property which had a carrying value of $73.3 million.\nThe Company uses capital resources primarily for land purchases, land development and housing construction. The Company typically manages its investments in land by purchasing property under options and other types of conditional contracts whenever possible, and similarly controls its investment in housing inventories by carefully managing the timing of the production process. The Company's inventories are geographically diverse and primarily located in desirable areas within targeted growth markets principally oriented toward entry-level purchasers. In 1995, the Company focused on continued expansion of its domestic operations outside of California, while becoming more selective with regard to investment in California where the economy remains weak.\nDuring 1995, the Company implemented stricter standards for assessing all proposed land purchases based in part upon discounted after tax cash flow internal rate of return requirements. In addition, all operating divisions are measured for the first time based upon overall return on investment. Among other things, this focus will likely result in reductions in new land purchases and inventory investment in California during 1996 as a step toward improving the Company's overall return on equity over time. Cash flow available from reduced California investment will be used to fund the Company's expansion into other western states as well as reduce overall leverage as measured by the ratio of debt to total capital.\nThe principal sources of liquidity for the Company's mortgage banking operations are internally generated funds from the sales of mortgages and related servicing rights. Mortgages originated by the mortgage banking operations are generally sold in the secondary market within 60 days of origination. External sources of financing for these operations include a $200 million sublimit within the Company's $500 million revolving credit facility and a $120 million asset-backed commercial paper facility. The $200 million sublimit on the revolving credit facility is available to fund mortgage banking operations only to the extent that borrowings under the agreement for construction operations do not exceed $300 million.\nDebt service on the Company's collateralized mortgage obligations is funded by receipts from mortgage-backed securities. Such funds are expected to be adequate to meet future debt-payment schedules for the collateralized mortgage obligations and therefore these securities have virtually no impact on the capital resources and liquidity of the mortgage banking operations.\nThe Company believes it has adequate resources and sufficient credit line facilities to satisfy its current and reasonably anticipated future requirements for funds to acquire capital assets and land, to construct homes, to fund its mortgage banking operations, and to meet other needs of its business, both on a short and long-term basis.\nNEW ACCOUNTING PRONOUNCEMENT\nIn March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,\" which requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amount. This new pronouncement is effective for fiscal years beginning after December 15, 1995.\nThe Company plans to adopt the provisions of this pronouncement during 1996. The Company has not analyzed the impact of this pronouncement on the financial statements, although adoption may result in a non-cash charge to earnings which may have a material effect on the Company's financial position or results of operations.\nOUTLOOK\nThe Company's domestic operating results in 1995 reflected its ongoing expansion outside of California and included the Company's first housing deliveries from new divisions based in Albuquerque, New Mexico and Salt Lake City, Utah. Operations outside of California have generally produced successful results as evidenced by rapidly growing contributions from the Company's five non-California housing divisions. These operations produced 24.9% of domestic deliveries in 1995, up sharply from 11.8% in 1994. The Company expects to further expand and re-position its domestic operations in 1996 through more selective investment in California, where the housing market remains soft, as well as continued investment in other western states where the Company has developed a recent track record of profitable growth. Overall, the Company believes domestic operating results will improve in 1996 as its newer divisions develop market positions and existing operations further penetrate their markets. Nonetheless, significant challenges remain within the domestic operating environment. These include a continuing weak housing market in California, where approximately two-thirds of the Company's 1995 deliveries were generated, and a lack of urgency among potential home buyers in many of the Company's markets.\nThe Company is cautiously optimistic that economic conditions for housing in California will improve based on more favorable general economic and employment forecasts; however, in view of the last five years of adverse conditions, any California housing recovery will likely be slow to develop. In addition, the timing of any such improvements in California's new housing market remains uncertain. To better position itself domestically, particularly in California, the Company implemented a series of initiatives in 1995 designed to improve overall domestic profitability in 1996 and beyond. These initiatives, which were intended to improve gross margins and reduce overhead expenses, included a greater focus on maximizing rates of return in lieu of maximizing market share, more selective investment in land in California and greater emphasis on the sale of high-margin amenities. The Company also consolidated several divisions in California during 1995 and reduced staffing levels where appropriate. Other initiatives involved the continued simplification and standardization of home designs to lower construction costs, better regulation of quarterly production cycles and benchmarking of overhead costs. In general, the Company intends to maintain its rigorous pursuit of greater operating efficiencies, a leaner cost structure and an emphasis on return-on-investment concepts in assessing new investments. The initial results of these efforts were apparent in the Company's improving quarterly gross margins and expense ratios as the 1995 year progressed, trends which the Company believes will continue during 1996.\nThe French housing market proved difficult in 1995 as the economy was plagued by recession and high unemployment during an economically disruptive election year, while home buyers deferred purchases through much of the year in anticipation of a key government support program to assist home buyers introduced in October 1995. Although the general uncertainty surrounding the direction of the French economy continued into early 1996, the installation of a new French government in mid-1995 followed by the implementation of the new government program could improve the Company's housing sales volumes and housing profitability in Paris during 1996. French commercial activities are likely to remain at or below 1995 levels as the market continues to absorb existing properties in a period of high vacancy rates. Notwithstanding the possibilities of a more favorable economic climate, generally weak market conditions may persist in France throughout 1996 and the Company remains cautious in its business outlook.\nIn Mexico, where a start-up operation has yet to deliver its first homes, the Company continues to closely monitor the unsettled economic environment. The new home market in Mexico remains seriously hampered by the continuing decline in value of the peso and the economic recession this devaluation has created. These events have slowed an already complex regulatory process and heightened consumer concerns about new home purchases. In spite of these turbulent conditions, demand for housing in Mexico remains substantial and the Company has begun to generate a modest level of orders which it believes should result in 1996 deliveries. Nevertheless, the Company remains cautious regarding these operations and continues to reassess its level of activity in Mexico and the desirability of expanding its market presence there.\nThe Company continues to benefit in all of its operations from the strength of its capital position, which has allowed it to finance expansion, re-engineer product lines and diversify into strong new home building markets. The Company's strong capital position has also helped enable it to maintain overall profitability during troubled economic times in California and France, where the lingering effects of severe recessions continue\nto inhibit demand for affordable new housing. The Company believes it is particularly well-positioned to capitalize on any sustained improvement in the economies of California and France and has established strategies to help maximize future performance even under continued challenging economic conditions.\nAt November 30, 1995, the Company had outstanding sales contracts of 1,412 units in residential backlog, representing aggregate future revenues of approximately $243.8 million. Year-end 1995 backlog levels increased from the 1,016 units in residential backlog representing aggregate future revenues of $163.6 million at year-end 1994. Substantially all homes included in backlog are expected to be delivered during 1996. However, cancellations could occur, particularly if market conditions deteriorate or interest rates rise, thereby decreasing backlog and related future revenues.\nIn the United States, the Company's residential backlog at November 30, 1995 totaled 1,172 units, up 41.7% from 827 units at year-end 1994. This increase was primarily attributable to domestic operations outside of California. In California, residential unit backlog was essentially flat at 626 units compared to 628 units a year earlier, while non-California backlog rose 174.4% to 546 units at November 30, 1995 from 199 units at November 30, 1994. Net orders for non-California U.S. operations increased to 503 units in the fourth quarter of 1995, from 248 units in the year-earlier quarter. Net orders in California decreased 10.2% during the same period. Since year end, net order rates have improved sharply in California, up 17.7% in the first two months of 1996 compared to the same period of 1995. Total domestic net orders for the first two months of 1996 increased 25.8% versus the same period of 1995.\nIn France, the residential backlog at November 30, 1995 totaled 229 units, up 35.5% from 169 units at year-end 1994. Net orders in the fourth quarter of 1995 were comparable to the year-earlier period at 210 versus 215 units. For the year, however, net orders decreased 11.6% to 634 units from 717 units in 1994. In the first two months of 1996, net orders in France declined 35.2% compared to the same period a year ago. Given the decreased level of the Company's commercial development activities, the backlog associated with these operations declined to a value of approximately $10.8 million at November 30, 1995 from $31.1 million at year-end 1994.\nIn light of higher year-end backlog levels, improved recent domestic order trends and the maturation of the Company's non-California domestic divisions, the Company currently anticipates higher overall delivery volumes for full year 1996 when compared to full year 1995. Assuming stable or improving business conditions, interest rates and consumer confidence in its major markets, the Company believes an anticipated increase in delivery volumes coupled with the ongoing benefits of its strategic profitability and cost control initiatives will result in improved operating income and earnings per share in 1996 compared to 1995.\nPOTENTIAL ACQUISITION\nOn January 22, 1996, the Company entered into a definitive agreement to acquire San Antonio, Texas-based Rayco, Ltd. and certain affiliates for approximately $110 million, comprised of $80 million cash and the assumption of $30 million of debt. Rayco, Ltd., San Antonio's largest single-family homebuilder, currently commands approximately a 45% market share. For the year ended December 31, 1995, Rayco, Ltd. delivered 2,585 homes, generating revenues of approximately $235 million. Although the transaction remains subject to certain conditions, completion of this acquisition is expected to occur on March 1, 1996. If the acquisition is consummated as anticipated, the results of Rayco Ltd.'s operations will be included in the Company's consolidated financial statements from the date of acquisition, with the Company expecting the transaction to be accretive to earnings per share beginning in the second quarter. The acquisition of Rayco, Ltd. represents a major stride forward in the Company's expansion strategy -- Texas would be the Company's sixth non-California U.S. market. San Antonio is the ninth largest city in the United States and has ranked among the top ten cities in the nation in both job creation and economic growth for the past several years.\nIMPACT OF INFLATION\nThe Company's business is significantly affected by general economic conditions, particularly by the impact of inflation and the generally associated adverse effect on interest rates. Although inflation rates have been low in recent years, rising inflation would likely have a long-term impact on the Company's revenues and earning power by reducing demand for homes as a result of correspondingly higher interest rates. In periods of high inflation, the rising costs of land, construction, labor, interest and administrative expenses have often been recoverable through increased selling prices, although this has not always been possible because of high mortgage interest rates and competitive factors in the marketplace. In recent years, however, inflation has had no significant adverse impact on the Company, as cost increases have not exceeded the average rate of inflation.\nCONSOLIDATED STATEMENTS OF INCOME\nSee accompanying notes.\nCONSOLIDATED BALANCE SHEETS\nSee accompanying notes.\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY\nSee accompanying notes.\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nSee accompanying notes.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nOPERATIONS Kaufman and Broad Home Corporation (the Company) is a regional builder of single-family homes with domestic operations throughout the western United States, and international operations in France, Canada and Mexico. In France, the Company is also a developer of commercial and high-density residential projects. Through its mortgage banking subsidiary, Kaufman and Broad Mortgage Company, the Company provides mortgage banking services to its domestic home buyers.\nBASIS OF PRESENTATION The consolidated financial statements include the accounts of the Company and all significant majority-owned or controlled subsidiaries and joint ventures. All significant intercompany transactions have been eliminated. Investments in unconsolidated joint ventures in which the Company has less than a controlling interest are accounted for using the equity method.\nCASH AND CASH EQUIVALENTS The Company considers all highly liquid debt instruments and other short-term investments purchased with a maturity of three months or less to be cash equivalents.\nCONSTRUCTION OPERATIONS Inventories are stated at the lower of cost or estimated net realizable value for each parcel or subdivision. Estimated net realizable value is based upon the net sales proceeds anticipated in the normal course of business, less estimated costs to complete or improve the property to the condition used in determining the estimated selling price.\nHousing and other real estate sales are recognized when all conditions precedent to closing have been fulfilled. In France, sales of apartments, condominiums and commercial buildings to investors are recognized using the percentage of completion method which is generally based on costs incurred as a percentage of estimated total costs of individual projects. Revenues recognized in excess of amounts billed are classified as receivables. Amounts received from investors in excess of revenues recognized, if any, are classified as other liabilities.\nConstruction and land costs are comprised of direct and allocated costs including estimated future costs for warranties and amenities. Land, land improvements and other common costs are generally allocated equally to units within a parcel or subdivision. Land and land development costs generally include related interest and property taxes incurred until development is substantially completed or deliveries have begun within a subdivision.\nMORTGAGE BANKING OPERATIONS Principal and interest payments received on mortgage-backed securities are invested in short-term securities maturing on the next debt service date of the collateralized mortgage obligations for which the securities are held as collateral. Such payments are restricted to the payment of the debt service on the collateralized mortgage obligations.\nFirst mortgages and mortgage-backed securities consist of securities held for long-term investment and are valued at amortized cost. First mortgages held under commitment of sale are valued at the lower of aggregate cost or market. Market is principally based on public market quotations or outstanding commitments obtained from investors to purchase first mortgages receivable.\nINCOME TAXES In 1993, the Company adopted the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\" The impact of the adoption on the Company's financial position and results of operations was not significant.\nIncome taxes are provided for at rates applicable in the countries in which the income is earned. Provision is made currently for United States federal income taxes on earnings of foreign subsidiaries which are not expected to be reinvested indefinitely.\nEARNINGS PER SHARE The computation of earnings per share is based on the weighted average number of common shares, special common shares, equivalent Series B Convertible Preferred Shares and common share equivalents outstanding during each year. The Series B Convertible Preferred Shares are considered common stock due to their mandatory conversion into common stock, and the related dividends are not deducted from net income for purposes of calculating earnings per share. Common share equivalents include dilutive stock options and warrants using the treasury stock method. Earnings per share were based on the weighted average number of common shares, special common shares, equivalent Series B Convertible Preferred Shares and common share equivalents outstanding of 39,757,000 in 1995, 40,026,000 in 1994 and 41,547,000 in 1993.\nIf, for purposes of calculating earnings per share, the Series B Convertible Preferred Shares were excluded from the weighted average shares outstanding and the related dividends deducted from net income, the computation would have resulted in earnings per share of $.58 in 1995, $1.09 in 1994 and $.93 in 1993.\nRECENT ACCOUNTING PRONOUNCEMENTS In March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,\" which requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amount. The provisions of this statement are effective for fiscal years beginning after December 15, 1995. The Company has not assessed the impact on the financial statements. However, the future adoption of this statement may have a material effect on the Company's financial position or results of operations.\nRECLASSSIFICATIONS Certain amounts in the consolidated financial statements of prior years have been reclassified to conform to the 1995 presentation.\nNOTE 2. RECEIVABLES\nCONSTRUCTION Trade receivables amounted to $48,699,000 and $43,057,000 at November 30, 1995 and 1994, respectively. Included in these amounts are unbilled receivables due from investors on French apartment, condominium and commercial building sales accounted for using the percentage of completion method, totaling $8,478,000 at November 30, 1995 and $14,267,000 at November 30, 1994. The investors are contractually obligated to remit payments against their unbilled balances. Other receivables of $62,921,000 at November 30, 1995 and $71,864,000 at November 30, 1994 included mortgages receivable, escrow deposits and amounts due from municipalities and utility companies.\nAt November 30, 1995 and 1994, receivables were net of allowances for doubtful accounts of $3,034,000 and $3,269,000, respectively.\nMORTGAGE BANKING First mortgages and mortgage-backed securities consisted of loans of $7,187,000 at November 30, 1995 and $6,934,000 at November 30, 1994 and mortgage-backed securities of $90,485,000 and $103,289,000 at November 30, 1995 and 1994, respectively. The mortgage-backed securities serve as collateral for related collateralized mortgage obligations. The property covered by the mortgages underlying the mortgage-backed securities are single-family residences. Issuers of the mortgage-backed securities are the Government National Mortgage Association and Federal National Mortgage Association. The first mortgages and mortgage-backed securities bore interest at an average rate of 8-3\/5% and 8-7\/8% at November 30, 1995 and 1994, respectively (with rates ranging from 7% to 13% for both years).\nMortgages were net of discounts of $4,353,000 at November 30, 1995 and $6,243,000 at November 30, 1994. These discounts, which primarily represent loan origination discount points and acquisition price discounts, are deferred as an adjustment to the carrying value of the related first mortgages and mortgage-backed securities and amortized into interest income using the interest method.\nThe Company adopted the provisions of Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" effective December 1, 1994. In accordance with this pronouncement, the Company's mortgage-backed securities held for long-term investment have been classified as held-to-maturity and are stated at amortized cost, adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization is included in interest income. There was no impact on the Company's financial position or results of operations from the adoption of this pronouncement. The total gross unrealized gains and gross unrealized losses on the mortgage-backed securities were $6,175,000 and $0, respectively at November 30, 1995.\nNOTE 3. INVENTORIES\nInventories consist of the following:\nLand under development primarily consists of parcels on which 50% or less of estimated development costs have been incurred.\nThe impact of capitalizing interest costs on consolidated pretax income is as follows:\nNOTE 4. INVESTMENTS IN UNCONSOLIDATED JOINT VENTURES\nThe Company participates in a number of joint ventures in which it has less than a controlling interest. These joint ventures are based primarily in France and Canada and are engaged in the development, construction and sale of residential properties and commercial projects. Combined condensed financial information concerning the Company's unconsolidated joint venture activities follows:\nThe joint ventures finance land and inventory investments primarily through a variety of borrowing arrangements. The Company typically does not guarantee these financing arrangements.\nThe Company's share of pretax loss includes management fees earned from the unconsolidated joint ventures.\nNOTE 5. MORTGAGES AND NOTES PAYABLE\nCONSTRUCTION Mortgages and notes payable consist of the following (interest rates are as of November 30):\nTerms under the domestic unsecured revolving credit agreement with various banks dated December 24, 1992 and scheduled to expire in 1995 provided for a $350,000,000 commitment. On November 21, 1994, the agreement was amended, increasing the revolving credit facility to $500,000,000 with a $200,000,000 sublimit for the Company's mortgage banking operations. This facility has a three-year term expiring on December 31, 1997. As of November 30, 1995, the entire amount of the revolving credit facility was committed and $197,000,000 was available for the Company's future use. The agreement provides for interest on borrowings at either the applicable bank reference rate or the London Interbank Offered Rate plus an applicable spread and an annual commitment fee based on the unused portion of the commitment.\nUnder the terms of the revolving credit agreement, the Company is required, among other things, to maintain certain financial statement ratios and a minimum net worth and is subject to limitations on acquisitions, inventories, indebtedness, dividend payments and repurchases of stock. Under the conditions of the agreement, retained earnings of $71,554,000 were available for payment of cash dividends or stock repurchases at November 30, 1995.\nThe Company's French subsidiaries have lines of credit with various banks which totaled $140,339,000 at November 30, 1995 and have various committed expiration dates through December 1996. These lines of credit provide for interest on borrowings at either the French Federal Funds Rate or the Paris Interbank Offered Rate plus an applicable spread.\nThe weighted average interest rate on aggregate unsecured borrowings, excluding the senior and senior subordinated notes, was 6-9\/10% and 6-1\/2% at November 30, 1995 and 1994, respectively.\nOn August 11, 1992, the Company filed a registration statement with the Securities and Exchange Commission under which the Company could offer for sale from time to time up to $200,000,000 of unsecured debt securities. On September 8, 1992, the Company, pursuant to this registration statement, issued $100,000,000 of 10-3\/8% senior notes, due September 1, 1999, with interest payable semi-annually. The Company may redeem, in whole or in part, at any time on or after September 1, 1997, 100% of the principal amount of the notes.\nOn April 26, 1993, the Company issued $175,000,000 principal amount of 9-3\/8% senior subordinated notes at 99.202%. The notes are due May 1, 2003 with interest payable semi-annually. The notes represent unsecured obligations of the Company and are subordinated to all existing and future senior indebtedness of the Company. The Company may redeem the notes, in whole or in part, at any time on or after May 1, 2000 at 100% of their principal amount.\nThe 10-3\/8% senior notes and 9-3\/8% senior subordinated notes contain certain restrictive covenants that, among other things, limit the ability of the Company to incur additional indebtedness, pay dividends, make certain investments, create certain liens, engage in mergers, consolidations, or sales of assets, or engage in certain transactions with officers, directors and employees.\nPrincipal payments on senior and senior subordinated notes, mortgages, land contracts and other loans are due as follows: 1996, $33,025,000; 1997, $1,761,000; 1998, $1,067,000; 1999, $100,068,000; 2000, $158,000; and thereafter, $181,485,000.\nAssets (primarily inventories) having a carrying value of approximately $73,338,000 are pledged to collateralize mortgages, land contracts and other secured loans.\nMORTGAGE BANKING Notes payable include the following (interest rates are as of November 30):\nFirst mortgages receivable have historically been financed through a $230,000,000 collateralized revolving warehouse credit facility and a $120,000,000 asset-backed commercial paper facility (the Commercial Paper Facility). On November 21, 1994, the collateralized revolving warehouse credit facility was replaced with the amended revolving credit agreement which contains a $200,000,000 sublimit (the Revolving Warehouse Facility) for financing the mortgage banking operations. This Revolving Warehouse Facility provides for interest on borrowings at either the applicable bank reference rate or the Federal Funds rate plus an applicable spread and an annual commitment fee based on the unused portion of the commitment.\nThe Commercial Paper Facility expires on September 15, 1997 and provides for an annual commitment fee based on the unused portion of the commitment. Interest rates charged under the Commercial Paper Facility reflect those available in commercial paper markets plus an applicable spread on amounts borrowed.\nThere are no compensating balance requirements under either facility. These facilities are collateralized by first mortgages held under commitment of sale and are repayable from proceeds on the sales of first mortgages.\nThe terms of these facilities include financial covenants which, among other things, require the maintenance of certain financial statement ratios and a minimum tangible net worth and limit indebtedness of the mortgage banking operations (excluding indebtedness to the Company) to a maximum of $320,000,000. This maximum may be further limited as the $200,000,000 sublimit on the Revolving Warehouse Facility is available to fund mortgage banking operations only to the extent that borrowings under the amended revolving credit agreement for construction operations do not exceed $300,000,000.\nCollateralized mortgage obligations represent bonds issued to third parties which are collateralized by mortgage-backed\nsecurities with substantially the same terms. At November 30, 1995, the collateralized mortgage obligations bore interest at rates ranging from 8% to 12-1\/4% with stated principal maturities ranging from 3 to 30 years. Actual maturities are dependent on the rate at which the underlying mortgage-backed securities are repaid. No collateralized mortgage obligations have been issued since 1988.\nNOTE 6. FAIR VALUES OF FINANCIAL INSTRUMENTS\nStatement of Financial Accounting Standards No. 107, \"Disclosures about Fair Value of Financial Instruments,\" requires companies to disclose the estimated fair value of their financial instruments. The estimated fair value of financial instruments has been determined based on available market information and appropriate valuation methodologies. However, judgement is necessarily required in interpreting market data to develop the estimates of fair value. In that regard, the estimates presented herein are not necessarily indicative of the amounts that the Company could realize in a current market exchange.\nThe carrying values and fair values of the Company's financial instruments, except for those financial instruments for which the carrying values approximate fair values, are summarized as follows:\nThe Company used the following methods and assumptions in estimating fair values:\nCash and cash equivalents; borrowings under the domestic revolving credit facility, French lines of credit and Commercial Paper Facility; first mortgages and first mortgages held under commitment of sale and other receivables: The carrying amounts reported approximate fair values.\nSenior notes and senior subordinated notes: The fair values of the Company's senior notes and senior subordinated notes are estimated based on quoted market prices.\nMortgage-backed securities and collateralized mortgage obligations secured by mortgage-backed securities: The fair values of these financial instruments were based on quoted market prices for the same or similar issues.\nNOTE 7. COMMITMENTS AND CONTINGENCIES\nCommitments and contingencies include the usual obligations of housing producers for the completion of contracts and those incurred in the ordinary course of business. The Company is also involved in litigation incidental to its business, the disposition of which should have no material effect on the Company's financial position or results of operations.\nNOTE 8. STOCKHOLDERS' EQUITY\nPREFERRED STOCK On January 11, 1989, the Company adopted a Stockholder Rights Plan and declared a dividend distribution of one preferred share purchase right for each outstanding share of common stock. Under certain circumstances, each right entitles the holder to purchase 1\/100th of a share of a new Series A Participating Cumulative Preferred Stock at a price of $30.00, subject to certain antidilution provisions. The rights are not exercisable until the earlier to occur of (i) 10 days following a public announcement that a person or group has acquired 20% or more of the aggregate votes entitled from all shares of common stock and special common stock or (ii) 10 days following the commencement of a tender offer for 20% or more of the aggregate votes entitled from all shares of common stock and special common stock. In the event the Company is acquired in a merger or other business combination transaction, or 50% or more of the Company's assets or earning power is sold, each right will entitle its holder to receive, upon exercise, common stock of the acquiring company having a market value of twice the exercisable price of the right. At the option of the Company, the rights are redeemable prior to becoming exercisable at $.01 per right. Unless previously redeemed, the rights will expire on March 7, 1999. Until a right is exercised, the holder will have no rights as a stockholder of the Company, including the right to vote or receive dividends.\nIn 1993, the Company issued 6,500,000 depositary shares, each representing a one-fifth ownership interest in a share of Series B Mandatory Conversion Premium Dividend Preferred Stock (the Series B Convertible Preferred Shares). Dividends are cumulative and payable quarterly in arrears at an annual dividend rate of $1.52 per depositary share. On the\nmandatory conversion date of April 1, 1996, each of the outstanding depositary shares will convert, upon the automatic conversion of the Series B Convertible Preferred Shares, into one share of the Company's common stock, subject to adjustment in certain events. The Company may call any or all of the outstanding depositary shares prior to the mandatory conversion date at a call price initially equal to $27.12, declining to $23.66 by February 1, 1996, and equal to $23.46 thereafter, payable in shares of common stock having a market price equal to the applicable call price, plus an amount in cash equal to all accrued and unpaid dividends. The depositary shares are not convertible into common stock at the holders' option. The depositary shares were issued at $17.375 per share and have a liquidation preference price per depositary share equal to the issuance price.\nSPECIAL COMMON STOCK In connection with its restructuring in 1989, the Company issued warrants (the Warrants) to certain subsidiaries of SunAmerica Inc., the Company's former parent. The Warrants give the holder the right to purchase, at any time prior to March 1, 1999, up to 7,500,000 shares of special common stock at an exercise price of $6.96 per share. The rights of the special common stock are generally identical to the rights of the common stock except that the holder of special common stock is entitled to one-tenth of a vote per share on all matters to be voted on by stockholders.\nIn 1992, the Company issued in a public offering 5,123,000 shares of the special common stock in connection with the exercise of the Warrants. On November 8, 1993, the Company commenced a tender offer to purchase all of the outstanding shares of its special common stock at a price of $19 per share. The offer expired on December 7, 1993 with 2,331,785 shares of special common stock tendered. In addition, on December 23, 1993, the Company purchased the remaining 2,377,000 Warrants at a price equal to the tender offer price per share less the $6.96 per Warrant exercise price. The total consideration paid for these transactions was $73,677,000, including related costs.\nThe remaining 2,791,215 outstanding shares of special common stock were exchanged by the Company at a ratio of .95 shares of common stock for each share of special common stock on various dates throughout 1994.\nNOTE 9. EMPLOYEE BENEFIT AND STOCK PLANS\nBenefits are provided to most employees under the Company's 401(k) Savings Plan under which contributions by employees are partially matched by the Company. The aggregate cost of this plan to the Company was $1,795,000 in 1995, $1,734,000 in 1994 and $1,135,000 in 1993.\nThe Kaufman and Broad Home Corporation 1988 Employee Stock Plan (the 1988 Plan) provides that stock options, associated limited stock appreciation rights, restricted shares of common stock and stock units may be awarded to eligible individuals for periods of up to 15 years. The 1988 Plan replaced all existing employee stock plans.\nStock option transactions are summarized as follows:\nThe Company records proceeds from the exercise of stock options as additions to common stock and paid-in capital. The tax benefit, if any, is recorded as additional paid-in capital.\nIn 1991, the Board of Directors approved the issuance of restricted stock awards under the 1988 Plan of up to an aggregate 600,000 shares of common stock to certain officers and key employees. Restrictions lapse each year through May 10, 2005 on specified portions of the shares awarded to each participant so long as the participant has remained in the continuous employ of the Company. Restricted stock awards issued in 1991 totaled 575,000 shares with 48,000 and 110,000 of these shares being cancelled in 1995 and 1993, respectively.\nNOTE 10. INCOME TAXES\nThe components of pretax income are as follows:\nThe components of the provisions for income taxes are as follows:\nDeferred income taxes result from temporary differences in the financial and tax bases of assets and liabilities. Significant components of the Company's deferred tax liabilities and assets are as follows:\nNet operating loss carryforwards expire in 1999 and 2000. The Company expects that the entire deferred tax benefit of the tax loss carryforwards will be recognized in future periods.\nIncome taxes computed at the statutory United States federal income tax rate and income tax expense provided in the financial statements differ as follows:\nThe Company has commitments to invest $5,732,000 over three years in affordable housing partnerships which are scheduled to provide tax credits.\nThe Company had foreign tax credit carryforwards at November 30, 1995 of $5,421,000 for United States federal income tax purposes which expire in 1996 through 2000.\nThe undistributed earnings of foreign subsidiaries, which the Company plans to invest indefinitely and for which no United States federal income taxes have been provided, totaled $42,030,000 at November 30, 1995. If these earnings were currently distributed, the resulting withholding taxes payable would be $3,024,000.\nNOTE 11. GEOGRAPHICAL AND SEGMENT INFORMATION\nGeographical and segment information follows:\nA director of the Company served between 1981 and 1993 as chairman and chief executive officer of a French bank, which in 1989 formed a joint venture controlled by the Company. The joint venture acquired and subsequently sold, to a group of international investors, a commercial building in Paris, France, under a five-year redevelopment agreement, with the bank financing the acquisition and redevelopment of the property. The project, completed in 1993, generated commercial revenues of $63,141,000 in 1993, representing 5% of total revenues.\nNOTE 12. QUARTERLY RESULTS (UNAUDITED)\nQuarterly results for the years ended November 30, 1995 and 1994 follow:\nNOTE 13. SUBSEQUENT EVENT\nOn January 22, 1996, the Company entered into a definitive agreement to acquire Rayco, Ltd. and certain affiliates for approximately $110,000,000, comprised of $80,000,000 in cash and the assumption of $30,000,000 in debt. Rayco, Ltd., a regional builder of single-family homes in San Antonio, Texas, delivered 2,585 homes, generating revenues of approximately $235,000,000 for the year ended December 31, 1995. Although the transaction remains subject to certain conditions, completion of this acquisition is expected on March 1, 1996. If the acquisition is consummated as anticipated, the results of Rayco, Ltd.'s operations will be included in the Company's consolidated financial statements from the date of acquisition.\nREPORT OF INDEPENDENT AUDITORS\nTo the Board of Directors and Stockholders' of Kaufman and Broad Home Corporation\nWe have audited the accompanying consolidated balance sheets of Kaufman and Broad Home Corporation as of November 30, 1995 and 1994, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended November 30, 1995. 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 Kaufman and Broad Home Corporation at November 30, 1995 and 1994, and the consolidated results of its operations and its cash flows for each of the three years in the period ended November 30, 1995, in conformity with generally accepted accounting principles.\n\/s\/ ERNST & YOUNG LLP\nLos Angeles, California\nJanuary 4, 1996, except as to Note 13, as to which the date is January 22, 1996\nREPORT ON FINANCIAL STATEMENTS\nThe accompanying consolidated financial statements are the responsibility of management. The statements have been prepared in conformity with generally accepted accounting principles. Estimates and judgments of management based on its current knowledge of anticipated transactions and events are made to prepare the financial statements as required by generally accepted accounting principles. Management relies on internal accounting controls, among other things, to produce records suitable for the preparation of financial statements.\nThe responsibility of our external auditors for the financial statements is limited to their expressed opinion on the fairness of the consolidated financial statements taken as a whole. Their examination is performed in accordance with generally accepted auditing standards which include tests of our accounting records and internal accounting controls and evaluation of estimates and judgments used to prepare the financial statements. The Company employs a staff of internal auditors whose work includes evaluating and testing internal accounting controls.\nAn audit committee of outside members of the Board of Directors periodically meets with management, the external auditors and the internal auditors to evaluate the scope of auditing activities and review results. Both the external and internal auditors have the unrestricted opportunity to communicate privately with the audit committee.\n\/s\/ MICHAEL F. HENN\nMichael F. Henn Senior Vice President and Chief Financial Officer\nJanuary 4, 1996\nSTOCKHOLDER INFORMATION\n*Following the suspension of trading on the New York Stock Exchange on May 31, 1994, the special common stock was de-listed by the New York Stock Exchange and de-registered by the Securities and Exchange Commission on August 9, 1994. Subsequently, the Company completed the exchange for all remaining outstanding shares.\nDIVIDEND DATA\nKaufman and Broad Home Corporation paid a quarterly cash dividend of $.075 per common share in 1995 and 1994.\nANNUAL STOCKHOLDERS' MEETING\nThe annual stockholders' meeting will be held in the Dynasty Room at the Westwood Marquis Hotel in Los Angeles, California, at 9:00 a.m. on Thursday, March 28, 1996.\nSTOCK EXCHANGE LISTINGS\nThe common stock (ticker symbol: KBH) is listed on the New York Stock Exchange and is also traded on the Boston, Cincinnati, Midwest, Pacific and Philadelphia Exchanges.\nTRANSFER AGENT\nChemical Mellon Shareholder Services Los Angeles, California\nINDEPENDENT AUDITORS\nErnst & Young LLP Los Angeles, California\nFORM 10-K\nThe Company's Form 10-K filed with the Securities and Exchange Commission may be obtained without charge by writing to the Investor Relations Department, Kaufman and Broad Home Corporation.\nHEADQUARTERS\nKaufman and Broad Home Corporation 10990 Wilshire Boulevard Los Angeles, California 90024 (310) 231-4000 Fax (310) 231-4222\nLIST OF EXHIBITS FILED","section_15":""}
{"filename":"318140_1995.txt","cik":"318140","year":"1995","section_1":"ITEM 1. BUSINESS - ------- --------\nORGANIZATION - ------------\nMcNeil Real Estate Fund XI, Ltd. (the \"Partnership\") was organized June 2, 1980 as a limited partnership under the provisions of the California Uniform Limited Partnership Act. The general partner of the Partnership is McNeil Partners, L.P. (the \"General Partner\"), a Delaware limited partnership, an affiliate of Robert A. McNeil (\"McNeil\"). The Partnership is governed by an amended and restated partnership agreement of limited partnership dated August 6, 1991, as amended (the \"Amended Partnership Agreement\"). Prior to August 6, 1991, Pacific Investors Corporation (the prior \"Corporate General Partner\"), a wholly-owned subsidiary of Southmark Corporation (\"Southmark\"), and McNeil were the general partners of the Partnership, which was governed by an agreement of limited partnership dated June 2, 1980 (the \"Original Partnership Agreement\") as amended August 29, 1980. The principal place of business for the Partnership and for the General Partner is 13760 Noel Road, Suite 700, LB70, Dallas, Texas, 75240.\nOn September 18, 1980, a Registration Statement on Form S-11 was declared effective by the Securities and Exchange Commission whereby the Partnership offered for sale $80,000,000 of limited partnership units (\"Units\"). The Units represent equity interests in the Partnership and entitle the holders thereof to participate in certain allocations and distributions of the Partnership. The sale of Units closed on June 1, 1981, with 160,000 Units sold at $500 each, or gross proceeds of $80,000,000 to the Partnership. In addition, the original general partners purchased a total of 140 Units for $70,000. In 1993, 61 Units were relinquished. An additional 162 and 104 Units were relinquished in 1994 and 1995, respectively, leaving 159,813 Units outstanding as of December 31, 1995.\nSOUTHMARK BANKRUPTCY AND CHANGE IN GENERAL PARTNER - --------------------------------------------------\nOn July 14, 1989, Southmark filed a voluntary petition for reorganization under Chapter 11 of the U.S. Bankruptcy Code. Neither the Partnership, McNeil nor the Corporate General Partner were included in the filing. Southmark's reorganization plan became effective August 10, 1990. Under the plan, most of Southmark's assets, which included Southmark's interests in the Corporate General Partner, are being sold or liquidated for the benefit of creditors.\nIn accordance with Southmark's reorganization plan, Southmark, McNeil and various of their affiliates entered into an asset purchase agreement on October 12, 1990, providing for, among other things, the transfer of control to McNeil or his affiliates of 34 limited partnerships (including the Partnership) in the Southmark portfolio.\nOn February 14, 1991, pursuant to the asset purchase agreement as amended on that date: (a) an affiliate of McNeil purchased the Corporate General Partner's economic interest in the Partnership; (b) McNeil became the managing general partner of the Partnership pursuant to an agreement with the Corporate General Partner that delegated management authority to McNeil; (c) McNeil Real Estate Management, Inc. (\"McREMI\"), an affiliate of McNeil, acquired the assets relating to the property management and partnership administrative business of Southmark and its affiliates and commenced management of the Partnership's properties pursuant to an assignment of the existing property management agreements from the Southmark affiliates; and (d) the General Partner purchased the short-term, unsecured loan owing from the Partnership to a Southmark affiliate in the amount of $2,645,950. The unsecured loan has now been settled in full.\nOn August 6, 1991, the limited partners approved a restructuring proposal providing for (i) the replacement of the Corporate General Partner and McNeil with the General Partner; (ii) the adoption of the Amended Partnership Agreement, which substantially alters the provisions of the Original Partnership Agreement relating to, among other things, compensation, reimbursement of expenses, and voting rights; and (iii) the approval of a new property management agreement with McREMI, the Partnership's property manager.\nThe Amended Partnership Agreement provides for a Management Incentive Distribution (\"MID\") to replace all other forms of general partner compensation, other than property management fees and reimbursements of certain costs. Additional Units may be issued in connection with the payment of the MID pursuant to the Amended Partnership Agreement. See Item 8 - Note 2 - \"Transactions with Affiliates.\" For a discussion of the methodology for calculating and distributing the MID, see Item 13 - Certain Relationships and Related Transactions.\nSettlement of Claims:\nDuring 1990, the Partnership filed claims in the Southmark bankruptcy in the amount of $1,180,040. McNeil also filed claims on behalf of the Partnership in an indeterminate amount, some of which overlapped in whole or in part with claims filed by the Partnership. No claims were filed by McNeil or the Partnership on behalf of individual limited partners.\nIn July 1991, the United States Bankruptcy Court for the Northern District of Texas, Dallas Division, approved an agreement whereby the Partnership settled its claims against Southmark. Under the settlement agreement, an affiliate of McNeil agreed to waive on a dollar-for-dollar basis an amount equal to the settled claims against affiliate advances owed by the Partnership, which at June 30, 1991, were in excess of the amount of the claim. The reduction of affiliate advances resulted in an extraordinary gain on extinguishment of debt of $1,180,040 in 1991.\nCURRENT OPERATIONS - ------------------\nGeneral:\nThe Partnership is engaged in real estate activities, including the ownership, operation and management of residential real estate and other real estate related assets. At December 31, 1995, the Partnership owned eight income-producing properties as described in Item 2","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES - ------- ----------\nThe following table sets forth the real estate investment portfolio of the Partnership at December 31, 1995. The buildings and the land on which they are located are owned by the Partnership in fee, subject in each case to a first lien deed of trust as set forth more fully in Item 8 - Note 5 - \"Mortgage Notes Payable\". See also Item 8 - Note 4 - \"Real Estate Investments\" and Schedule III - - \"Real Estate Investments and Accumulated Depreciation.\" In the opinion of management, the properties are adequately covered by insurance.\n- ----------------------------------------- Total: Apartments - 2,511 units\n(1) Acacia Lakes Apartments is owned by Acacia Lakes Fund XI Limited Partnership which is wholly-owned by the Partnership.\n(2) Gentle Gale Apartments is owned by Gentle Gale Fund XI Limited Partnership which is wholly-owned by the Partnership.\n(3) Knollwood Apartments is owned by Knollwood Fund XI Associates which is wholly-owned by the Partnership and the General Partner.\n(4) The Park Apartments is owned by The Park Fund XI Associates which is wholly-owned by the Partnership and the General Partner.\n(5) Sun Valley Apartments is owned by Sun Valley Fund XI Associates which is wholly-owned by the Partnership and the General Partner.\n(6) Villa Del Rio Apartments is owned by Villa Del Rio Fund XI Limited Partnership which is wholly-owned by the Partnership.\n(7) The Village Apartments is owned by Village Fund XI Associates which is wholly-owned by the Partnership and the General Partner.\nThe following table sets forth the properties' occupancy rate and rent per square foot for each of the last five years:\nOccupancy rate represents all units leased divided by the total number of units of the property as of December 31 of the given year. Rent per square foot represents all revenue, except interest, derived from the property's operations divided by the leasable square footage of the property.\nCompetitive Conditions at Properties - ------------------------------------\nDue to a substantial investment of capital since 1992, Acacia Lakes has increased its rent per square foot by 44% over the last four years. Additionally, the property has maintained higher occupancy rates than the average market rate of 93%. Rental rates at Acacia Lakes are averaging $.62 per square foot, while many competitors are averaging $.66 per square foot.\nGentle Gale is located in Galveston, Texas, where the local economy is dependent upon the University of Texas Medical Branch and tourism. Over the last few years the economy has been sluggish and this has been reflected in the drop in the occupancy rates at the property. Gentle Gale is currently mirroring an average market rate of 88%. Gentle Gale competes with properties that are newer and offer better amenity packages. The property has been upgrading the units and offering rental discounts to remain competitive in the market.\nKnollwood finished 1995 just above the average market rate of 95%. The current rental rates per square foot are between $.52 and $.55 for Knollwood's townhouses and one and two bedroom apartments, while the market rate per square foot is between $.52 and $.54. Capital improvements are planned to improve the curb appeal and upgrade the apartments to take advantage of the strong market conditions.\nThe Park is the largest apartment community in Joplin, Missouri where the market's average occupancy rate is 90%. The local economy is expected to remain stable; however, during 1995, an additional 160 units were built which saturated the apartment market. The new units are entering the marketplace at $.44 per square foot while The Park is averaging $.52 per square foot. To remain competitive in the market, The Park has discounted rents.\nRock Creek is located in a strong rental market where the average occupancy rate is 95% and the rent per square foot averages $.72. Over the past few years the property has been upgrading the interiors of the units as well as improving the outside appearance with landscaping and a renovation of the clubhouse and office. These enhancements allowed the property to remain competitive with rental rates per square foot averaging $.66. An additional 3,300 units are scheduled to be built in the market during 1996. With the growth in employment, the market should absorb these additional units without any adverse effect to the property.\nStrong market conditions are beginning to stimulate new developments in the area surrounding Sun Valley. Currently, an additional 3,950 units are under construction with numerous other projects in the planning stages. These new units will have no adverse effect on the property. With the capital improvements made at the property over the last few years, the property has been able to stay competitive with the newer properties. Sun Valley finished 1995 above the market average occupancy rate of 96%.\nVilla Del Rio's occupancy rate has increased by 13% since 1991 and finished 1995 above the market average of 94%. The overall occupancy rate for Jacksonville has remained strong. The city experienced its highest level of new construction of apartment communities since 1986. Currently, 3,000 units are under construction with several other apartment communities in the planning stages. These new units will have no adverse effect on the property. Villa Del Rio's advantage over its competitors is design and layout of the property. All units are single story apartments and the property is spread over 25 acres.\nThe Village finished the year fully leased for the second year in a row. The area economy remains strong; and occupancy rates were at their highest in 5 years. The market rental rate per square foot and the rental rate at The Village is $.66. As a result of the strong economy, 5,500 units were absorbed during 1995. The Village should remain competitive in the marketplace.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS - ------- -----------------\n1) High River Limited Partnership v. McNeil Partners, L.P., McNeil Investors, Inc., McNeil Pacific Investors 1972, Ltd., McNeil Real Estate Fund V, Ltd., McNeil Real Estate Fund IX, Ltd., McNeil Real Estate Fund X, Ltd., McNeil Real Estate Fund XI, Ltd., McNeil Real Estate Fund XIV, Ltd., McNeil Real Estate Fund XV, Ltd., McNeil Real Estate Fund XX, L.P., McNeil Real Estate Fund XXIV, L.P., McNeil Real Estate Fund XXV, L.P., Robert A. McNeil and Carole J. McNeil (L95012) - High River (\"HR\") filed this action in the United States District Court for the Southern District of New York against McNeil Partners, L.P., McNeil Investors, Inc. and Mr. and Mrs. McNeil (as defined in this Section 1, collectively, the \"Defendants\") requesting, among other things, names and addresses of the limited partners in the partnerships referenced above (as defined in this Section 1, the \"Partnerships\"). The District Court issued a preliminary injunction against the Partnerships requiring them to commence mailing materials relating to the HR tender offer on August 14, 1995.\nOn August 18, 1995, the Defendants filed an Answer and Counterclaim. The Counterclaim principally asserts (1) the HR tender offers have been undertaken in violation of the federal securities laws, on the basis of material, non-public, and confidential information, and (2) that the HR offer documents omit and\/or misrepresent certain material information about the HR tender offers. The Counterclaim seeks a preliminary and permanent injunction against the continuation of the HR tender offers and, alternatively, ordering corrective disclosure with respect to allegedly false and misleading statements contained in the tender offer documents.\nThis action was dismissed without prejudice in November 1995.\n2) High River Limited Partnership v. McNeil Partners, L.P., McNeil Investors, Inc., McNeil Pacific Investors 1972, Ltd., McNeil Real Estate Fund V, Ltd., McNeil Real Estate Fund IX, Ltd., McNeil Real Estate Fund X, Ltd., McNeil Real Estate Fund XI, Ltd., McNeil Real Estate Fund XIV, Ltd., McNeil Real Estate Fund XV, Ltd., McNeil Real Estate Fund XX, L.P., McNeil Real Estate Fund XXIV, L.P., McNeil Real Estate Fund XXV, L.P., Robert A. McNeil and Carole J. McNeil - United States District Court for the Southern District of New York, (Case No. 95 Civ. 9488) (Second Action).\nOn November 7, 1995, High River filed a second complaint with the District Court which alleges, inter alia, that McNeil Partners, L.P.'s (the \"General Partner\") Schedule 14D-9 filed in connection with the High River tender offers was materially false and misleading, in violation of Sections 14(d) and 14(e) of the Securities Exchange Act of 1934, 15 U.S.C. Section 78n(d) and (e), and the SEC Regulations promulgated thereunder; and that High River further alleges that the General Partner has wrongfully refused to admit High River as a limited partner to the ten partnerships referenced above. Additionally, High River purports to assert claims derivatively on behalf of McNeil Real Estate Fund IX, Ltd., McNeil Real Estate Fund XI,\nLtd., McNeil Real Estate Fund XV, Ltd., McNeil Real Estate Fund XXIV, L.P. and McNeil Real Estate Fund XXV, L.P., for breach of contract and breach of fiduciary duty, asserting that the General Partner has charged these partnerships excessive fees. High River's complaint seeks, inter alia, preliminary injunctive relief requiring the General Partner to admit High River as a limited partner in each of the ten partnerships referenced above and to transfer the tendered units of interest in the partnerships to High River; an unspecified award of damages payable to High River and an additional unspecified award of damages payable to certain of the partnerships; an order that defendants must discharge their fiduciary duties and must account for all fees they have received from certain of the partnerships; and attorneys' fees.\nOn January 31, 1996, this action was dismissed without prejudice.\n3) Robert Lewis v. McNeil Partners, L.P., McNeil Investors, Inc., Robert A. McNeil et al - In the District Court of Dallas County, Texas, A-14th Judicial District, Cause No. 95-08535 (Class Action) - Plaintiff, Robert Lewis, is a limited partner with McNeil Pacific Investors Fund 1972, Ltd., McNeil Real Estate Fund X, Ltd. and McNeil Real Estate Fund XV, Ltd.\nPlaintiff brings this action on his own behalf and as a class action on behalf of the class of all limited partners of McNeil Pacific Investors Fund 1972, Ltd., McNeil Real Estate Fund V, Ltd., McNeil Real Estate Fund IX, Ltd., McNeil Real Estate Fund X, Ltd., McNeil Real Estate Fund XI, Ltd., McNeil Real Estate Fund XIV, Ltd., McNeil Real Estate Fund XV, Ltd., McNeil Real Estate Fund XX, L.P., McNeil Real Estate Fund XXIV, L.P. and McNeil Real Estate Fund XXV, Ltd. (as defined in this Section 3, the \"Partnerships\") as of August 4, 1995.\nPlaintiff alleges that McNeil Partners, L.P., McNeil Investors, Inc., Robert A. McNeil and other senior officers (as defined in this Section 3, collectively, the \"Defendants\") breached their fiduciary duties by, among other things, (1) failing to attempt to sell the properties owned by the Partnerships (as defined in this Section 3, the \"Properties\") and extending the lives of the Partnerships indefinitely, contrary to the Partnerships' business plans, (2) paying distributions to themselves and generating fees for their affiliates, (3) refusing to make significant distributions to the class members, despite the fact that the Partnerships have positive cash flows and substantial cash balances, and (4) failing to take steps to create an auction market for equity interests of the Partnerships, despite the fact that a third party bidder filed tender offers for approximately forty-five percent (45%) of the outstanding units of each of the Partnerships. Plaintiff also claims that Defendants have breached the partnership agreements of the Partnerships by failing to take steps to liquidate the Properties and by their alteration of the Partnerships' primary purposes, their acts in contravention of these agreements, and their use of the assets of the Partnerships for their own benefit instead of for the benefit of the Partnerships.\nThe Defendants deny that there is any merit to Plaintiff's allegations and intend to vigorously defend this action.\n4) James F. Schofield, Gerald C. Gillett and Donna S. Gillett v. McNeil Partners, L.P., McNeil Investors, Inc., McNeil Real Estate Management, Inc., Robert A. McNeil, Carole J. McNeil, McNeil Real Estate Fund V, Ltd., McNeil Real Estate Fund IX, Ltd., McNeil Real Estate Fund X, Ltd., McNeil Real Estate Fund XI, Ltd., McNeil Real Estate Fund XIV, Ltd., McNeil Real Estate Fund XV, Ltd., McNeil Real Estate Fund XX, L.P., McNeil Real Estate Fund XXIV, L.P., McNeil Real Estate Fund XXV, L.P. et al - Superior Court of the State of California for the County of Los Angeles, Case No. BC133799 (Class and Derivative Action Complaint) and United States District Court, Southern District of New York, Case No. 95CIV.6711 (Class and Derivative Action Complaint)\nThese are corporate\/securities class and derivative actions brought in state and federal court by limited partners of each of the nine (9) limited partnerships that are named as nominal defendants as listed above (as defined in this Section 4, the \"Partnerships\"). Plaintiffs allege that McNeil Investors, Inc., its affiliate McNeil Real Estate Management, Inc. and four (4) of their senior officers and\/or directors (as defined in this Section 4, collectively, the \"Defendants\") have breached their fiduciary duties. Specifically, Plaintiffs allege that Defendants have caused the Partnerships to enter into several wasteful transactions that have no business purpose or benefit to the Partnerships and which have rendered such units highly illiquid and artificially depressed the prices that are available for units on the limited resale market. Plaintiffs also allege that Defendants have engaged in a course of conduct to prevent the acquisition of units by Carl Icahn by disseminating false, misleading and inadequate information. Plaintiffs further allege that Defendants have acted to advance their own personal interests at the expense of the Partnerships' public unit holders by failing to sell Partnership properties and failing to make distributions to unitholders and, thereby, have breached the partnership agreements.\nThe Defendants deny that there is any merit to Plaintiff's allegations and intend to vigorously defend these actions.\n5) Alfred Napoletano v. McNeil Partners, L.P., McNeil Investors, Inc., Robert A. McNeil, Carole J. McNeil, McNeil Pacific Investors Fund 1972, Ltd., McNeil Real Estate Fund V, Ltd., McNeil Real Estate Fund IX, Ltd., McNeil Real Estate Fund X, Ltd., McNeil Real Estate Fund XI, Ltd., McNeil Real Estate Fund XIV, Ltd., McNeil Real Estate Fund XV, Ltd., McNeil Real Estate Fund XX, L.P., McNeil Real Estate Fund XXIV, L.P., McNeil Real Estate Fund XXV, L.P. - Superior Court of the State of California, County of Los Angeles, Case No. BC133849 (Class Action Complaint)\nPlaintiff brings this class action on behalf of a class of all persons and entities who are current owners of units and\/or are limited partners in one or more of the partnerships referenced above (as defined in this Section 5, the \"Partnerships\"). Plaintiff alleges that McNeil Partners, L.P., McNeil Investors, Inc., Robert A. McNeil and other senior officers (as defined in this Section 5, collectively, the \"Defendants\") have breached their fiduciary duties to the class members by, among other things, (1) taking steps to prevent the consummation of the High River tender offers, (2) failing to take steps to maximize unitholders' or limited partners' values, including failure to liquidate the properties owned by the Partnerships, (3) managing the Partnerships so as to extend indefinitely the present fee arrangements, and (4) paying itself and entities owned and controlled by the general partner excessive fees and reimbursements of general and administrative expenses.\nThe Defendants deny that there is any merit to Plaintiff's allegations and intend to vigorously defend this action.\n6) Warren Heller v. McNeil Partners, L.P., McNeil Investors, Inc., Robert A. McNeil, Carole J. McNeil, McNeil Pacific Investors Fund 1972, Ltd., McNeil Real Estate Fund V, Ltd., McNeil Real Estate Fund IX, Ltd., McNeil Real Estate Fund X, Ltd., McNeil Real Estate Fund XI, Ltd., McNeil Real Estate Fund XIV, Ltd., McNeil Real Estate Fund XV, Ltd., McNeil Real Estate Fund XX, L.P., McNeil Real Estate Fund XXIV, L.P., McNeil Real Estate Fund XXV, L.P. - Superior Court of the State of California, County of Los Angeles, Case No. BC133957 (Class Action Complaint)\nPlaintiff brings this class action on behalf of a class of all persons and entities who are current owners of units and\/or are limited partners in one or more of the partnerships referenced above (as defined in this Section 6, the \"Partnerships\"). Plaintiff alleges that McNeil Partners, L.P., McNeil Investors, Inc., Robert A. McNeil and other senior officers (as defined in this Section 6, collectively, the \"Defendants\") have breached their fiduciary duties to the class members by, among other things, (1) taking steps to prevent the consummation of the High River tender offers, (2) failing to take steps to maximize unitholders' or limited partners' values, including failure to liquidate the properties owned by the Partnerships, (3) managing the Partnerships so as to extend indefinitely the present fee arrangements, and (4) paying itself and entities owned and controlled by the general partner excessive fees and reimbursements of general and administrative expenses.\nThe Defendants deny that there is any merit to Plaintiff's allegations and intend to vigorously defend this action.\nFor a discussion of the Southmark bankruptcy, See Item 1 - Business - \"Southmark Bankruptcy and Change in General Partner.\"\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 UNITS OF LIMITED PARTNERSHIP AND - ------- ------------------------------------------------------------ RELATED SECURITY HOLDER MATTERS -------------------------------\n(A) There is no established public trading market for limited partnership units, nor is one expected to develop.\n(B) Title of Class Number of Record Unit Holders -------------- -----------------------------\nLimited partnership units 8,674 as of February 16, 1996\n(C) No distributions were made to the limited partners during 1995 or 1994, and none are anticipated for 1996. The Partnership accrued distributions of $871,503 and $769,448 for the benefit of the General Partner for the years ended December 31, 1995 and 1994, respectively. Total distributions of $2,449,555 remain unpaid at December 31, 1995. These distributions relate to the contingent portion of the MID pursuant to the Amended Partnership Agreement. See Item 8 - Note 2 - \"Transactions with Affiliates.\" See Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations for a discussion of distributions and the likelihood that they will be resumed to the limited partners.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA - ------- -----------------------\nThe following table sets forth a summary of certain financial data for the Partnership. This summary should be read in conjunction with the Partnership's financial statements and notes thereto appearing in Item 8.\nSee Item 7","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION - ------- ----------------------------------------------------------- AND RESULTS OF OPERATIONS -------------------------\nFINANCIAL CONDITION - -------------------\nThe Partnership was formed to acquire, operate and ultimately dispose of a portfolio of income-producing real properties. As of December 31, 1995, the Partnership owned eight apartment properties. All of the Partnership's properties are subject to mortgage notes.\nRESULTS OF OPERATIONS - ---------------------\n1995 compared to 1994\nRevenue:\nTotal Partnership revenues for 1995 increased by $1,026,400 or 8% as compared to 1994. Rental revenue and interest income increased $990,964 or 7% and $63,545 or 75%, respectively. In 1994, the Partnership recognized a gain on involuntary conversion of $28,109 as a result of a fire at Sun Valley in 1993.\nRental revenue for 1995 was $14,304,055 as compared to $13,313,091 for 1994. This increase of $990,964 is due to an increase in the rental rates at seven of the Partnership's eight properties and increases in the occupancy rates at three of the Partnership's properties. Of the three properties that experienced an increase in their occupancy rate, Rock Creek showed the largest increase of 5% from 94% at December 31, 1994 to 99% at December 31, 1995. This increase can be attributed to the capital improvements made at the property over the last two years.\nExpenses:\nTotal Partnership expenses increased by $525,335 or 4% for the year ended December 31, 1995 as compared to 1994.\nDepreciation expense increased $142,940 or 6% in 1995 as compared to 1994. This increase is due to capital improvements made at the properties. During 1995, the Partnership made $1,820,043 in capital improvements.\nProperty taxes decreased $98,679 or 11% in 1995 as compared to 1994. This is due to an decrease in the estimated tax liability at Gentle Gale, Knollwood, Rock Creek, Sun Valley and The Park.\nRepairs and maintenance increased by $128,072 or 8% in 1995 as compared to 1994. This increase can be attributed to increases in ground maintenance, exterminating, carpet cleaning and sheet rock repairs. Additionally, carpet replacements, which met the Partnership's criteria for capitalization based on the magnitude of replacements in 1994, were in part expensed for 1995.\nGeneral and administrative increased $242,009 or 160% in 1995 as compared to 1994. This increase was due to costs incurred by the Partnership in the third quarter of 1995 to evaluate and disseminate information regarding an unsolicited tender offer. See Item 8","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - ------- -------------------------------------------\nAll other schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Partners of McNeil Real Estate Fund XI, Ltd.:\nWe have audited the accompanying balance sheets of McNeil Real Estate Fund XI, Ltd. (a California limited partnership) as of December 31, 1995 and 1994, and the related statements of operations, partners' deficit and cash flows for each of the three years in the period ended December 31, 1995. These 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 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 McNeil Real Estate Fund XI, Ltd. as of December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\nOur audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule listed in the index to financial statements is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in our audits of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\n\/s\/ Arthur Andersen LLP\nDallas, Texas March 13, 1996\nMcNEIL REAL ESTATE FUND XI, LTD.\nBALANCE SHEETS\nSee accompanying notes to financial statements.\nMcNEIL REAL ESTATE FUND XI, LTD.\nSTATEMENTS OF OPERATIONS\nSee accompanying notes to financial statements.\nMcNEIL REAL ESTATE FUND XI, LTD.\nSTATEMENTS OF PARTNERS' DEFICIT\nFor the Years Ended December 31, 1995, 1994 and 1993\nSee accompanying notes to financial statements.\nMcNEIL REAL ESTATE FUND XI, LTD.\nSTATEMENTS OF CASH FLOWS\nIncrease (Decrease) in Cash and Cash Equivalents\nSee discussion of noncash investing and financing activities in Notes 6 and 7.\nSee accompanying notes to financial statements.\nMcNEIL REAL ESTATE FUND XI, LTD.\nSTATEMENTS OF CASH FLOWS\nReconciliation of Net Income (Loss) to Net Cash Provided by Operating Activities\nSee accompanying notes to financial statements.\nMcNEIL REAL ESTATE FUND XI, LTD.\nNOTES TO FINANCIAL STATEMENTS\nDecember 31, 1995\nNOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - --------------------------------------------------------------------\nOrganization - ------------\nMcNeil Real Estate Fund XI, Ltd. (the \"Partnership\") was organized June 2, 1980 as a limited partnership under the provisions of the California Uniform Limited Partnership Act. The general partner of the Partnership is McNeil Partners, L.P. (the \"General Partner\"), a Delaware limited partnership, an affiliate of Robert A. McNeil. The Partnership is governed by an amended and restated partnership agreement of limited partnership dated August 6, 1991, as amended (the \"Amended Partnership Agreement\"). The principal place of business for the Partnership and for the General Partner is 13760 Noel Road, Suite 700, LB70, Dallas, Texas, 75240.\nThe Partnership is engaged in real estate activities, including the ownership, operation and management of residential real estate and other real estate related assets. At December 31, 1995, the Partnership owned eight income-producing properties as described in Note 4 - Real Estate Investments.\nBasis of Presentation - ---------------------\nThe accompanying financial statements have been prepared in conformity with generally accepted accounting principles (\"GAAP\"). The preparation of financial statements in conformity with GAAP 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.\nThe Partnership's financial statements include the accounts of the following listed tier partnerships for the years ended December 31, 1995, 1994 and 1993. These single asset tier partnerships were formed to accommodate the refinancing of the respective property. The Partnership's and the General Partner's ownership interest in each tier partnership is detailed below. The Partnership retains effective control of each tier partnership. The General Partner's minority interest is not presented as it is either negative or immaterial.\n* The general partner of these partnerships is a corporation whose stock is 100% owned by the Partnership.\nReal Estate Investments - -----------------------\nReal estate investments are generally stated at the lower of cost or net realizable value. Real estate investments are monitored on an ongoing basis to determine if the property has sustained a permanent impairment in value. At such time, a write-down is recorded to reduce the basis of the property to its net realizable value. A permanent impairment is determined to have occurred when a decline in property value is considered to be other than temporary based upon management's expectations with respect to projected cash flows and prevailing economic conditions.\nImprovements and betterments are capitalized and expensed through depreciation charges. Repairs and maintenance are charged to operations as incurred.\nIn March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of.\" This statement requires that long-lived assets and certain identifiable intangibles to be held and used by an entity be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. This statement is effective for financial statements for fiscal years beginning after December 15, 1995. The Partnership has not adopted the principles of this statement within the accompanying financial statements; however, it is not anticipated that adoption will have a material effect on the carrying value of the Partnership's long-lived assets.\nDepreciation - ------------\nBuildings and improvements are depreciated using the straight-line method over the estimated useful lives of the assets, ranging from 3 to 40 years.\nCash and Cash Equivalents - -------------------------\nCash and cash equivalents include cash on hand and cash on deposit with financial institutions with original maturities of three months or less. Carrying amounts for cash and cash equivalents approximate fair value.\nEscrow Deposits - ---------------\nThe Partnership is required to maintain escrow accounts in accordance with the terms of various mortgage indebtedness agreements. These escrow accounts are controlled by the mortgagee and are used for payment of property taxes, hazard insurance, capital improvements and\/or property replacements. Carrying amounts for escrow deposits approximate fair value.\nDeferred Borrowing Costs - ------------------------\nLoan fees and other related costs incurred to obtain long-term financing on real property are capitalized and amortized using a method that approximates the effective interest method over the terms of the related mortgage notes payable. Amortization of deferred borrowing costs is included in interest expense on the Statements of Operations.\nDiscounts on Mortgage Notes Payable - -----------------------------------\nDiscounts on mortgage notes payable are being amortized over the remaining terms of the related mortgage notes using the effective interest method. Amortization of discounts on the mortgage notes payable is included in interest expense on the Statements of Operations.\nRental Revenue - --------------\nThe Partnership leases its residential properties under short-term operating leases. Lease terms generally are less than one year in duration. Rental revenue is recognized as earned.\nIncome Taxes - ------------\nNo provision for Federal income taxes is necessary in the financial statements of the Partnership because, as a partnership, it is not subject to Federal income tax, and the tax effect of its activities accrues to the partners.\nAllocation of Net Income and Net Loss - -------------------------------------\nThe Amended Partnership Agreement provides for net income of the Partnership for both financial statement and income tax reporting purposes to be allocated as indicated below. For allocation purposes, net income and net loss of the Partnership are determined prior to deductions for depreciation:\na) first, deductions for depreciation shall be allocated 5% to the General Partner and 95% to the limited partners;\nb) then, net income in an amount equal to the cumulative amount paid to the General Partner for the contingent portion of the Management Incentive Distribution (\"MID\"), for which no previous income allocations have been made, shall be allocated to the General Partner; provided, however, that if all or a portion of such payment consists of limited partnership units (\"Units\"), the amount of net income allocated shall be equal to the amount of cash the General Partner would have otherwise received; and\nc) then, any remaining net income shall be allocated to achieve the allocation of 5% to the General Partner and 95% to the limited partners.\nThe Amended Partnership Agreement provides that net losses, other than that arising from a sale or refinancing, shall be allocated 5% to the General Partner and 95% to the limited partners.\nNet losses arising from a sale or refinancing shall be allocated 1% to the General Partner and 99% to the limited partners.\nFederal income tax law provides that the allocation of loss to a partner will not be recognized unless the allocation is in accordance with a partner's interest in the partnership or the allocation has substantial economic effect. Internal Revenue Code Section 704(b) and accompanying Treasury Regulations establish criteria for allocations of Partnership deductions attributable to debt. The Partnership's tax allocations for 1995, 1994, and 1993 have been made in accordance with these provisions.\nDistributions - -------------\nPursuant to the Amended Partnership Agreement and at the discretion of the General Partner, distributions during each taxable year shall be made as follows:\n(a) first, to the General Partner, in an amount equal to the contingent portion of the MID; and\n(b) any remaining distributable cash, as defined, shall be distributed 100% to the limited partners.\nNo distributions were made to the limited partners in 1995, 1994 or 1993. The Partnership accrued distributions of $871,503, $769,448 and $625,529 for the benefit of the General Partner for the years ended December 31, 1995, 1994 and 1993, respectively. These distributions are the contingent MID pursuant to the Amended Partnership Agreement.\nNet Income (Loss) Per Limited Partnership Unit - ----------------------------------------------\nNet income (loss) per Unit is computed by dividing net income (loss) allocated to the limited partners by the number of Units outstanding. Per Unit information has been computed based on 159,813, 159,917 and 160,079 Units outstanding in 1995, 1994 and 1993, respectively.\nNOTE 2 - TRANSACTIONS WITH AFFILIATES - -------------------------------------\nThe Partnership pays property management fees equal to 5% of the gross rental receipts of the Partnership's properties to McNeil Real Estate Management, Inc. (\"McREMI\"), an affiliate of the General Partner, for providing property management and leasing services.\nThe Partnership reimburses McREMI for its costs, including overhead, of administering the Partnership's affairs.\nUnder terms of the Amended Partnership Agreement, the Partnership is paying the MID to the General Partner. The maximum MID is calculated as 1% of the tangible asset value of the Partnership. The maximum MID percentage decreases subsequent to 1999. Tangible asset value is determined by using the greater of (i) an amount calculated by applying a capitalization rate of 9% to the annualized net operating income of each property or (ii) a value of $10,000 per apartment unit for residential property to arrive at the property tangible asset value. The property tangible asset value is then added to the book value of all other assets excluding intangible items. Prior to July 1, 1993, the MID consisted of two components: (i) the fixed portion which was payable without respect to the net income of the Partnership and was equal to 25% of the maximum MID (the \"Fixed MID\") and (ii) a contingent portion which was payable only to the extent of the lesser of the Partnership's excess cash flow, as defined, or net operating income (the \"Entitlement Amount\") and was equal to up to 75% of the maximum MID (the \"Contingent MID\").\nEffective July 1, 1993, the General Partner amended the Amended Partnership Agreement as a settlement to a class action complaint. This amendment eliminates the Fixed MID and makes the entire MID payable to the extent of the Entitlement Amount. In all other respects the calculation and payment of the MID remain the same.\nFixed MID was payable in Units unless the Entitlement Amount exceeded the amount necessary to pay the Contingent MID, in which case, at the General Partner's option, the Fixed MID was paid in cash to the extent of such excess.\nContingent MID will be paid to the extent of the Entitlement Amount, and may be paid (i) in cash, unless there is insufficient cash to pay the distribution in which event any unpaid portion not taken in Units will be deferred and is payable, without interest, from the first available cash and\/or (ii) in Units. A maximum of 50% of the MID may be paid in Units. The number of Units issued in payment of the MID is based on the greater of $50 per Unit or the net tangible asset value per Unit, as defined. No Units were issued in payment of the MID in 1995, 1994 or 1993.\nDuring 1991, the Partnership amended its capitalization policy and began capitalizing certain costs of improvements and betterments which under policies of prior management had been expensed when incurred. The purpose of the amendment was to more properly recognize items which were capital in nature. The effect of the amendment standing alone was evaluated at the time the change was made and determined not to be material to the financial statements of the Partnership in 1991, nor was it expected to be material in any future year. However, the amendment can have a material effect on the calculation of the Entitlement Amount which determines the amount of Contingent MID earned and the amount of Fixed MID payable in cash. Capital improvements are excluded from cash flow, as defined. The majority of base period cash flow was measured under the previous capitalization policy, while incentive period cash flow is determined using the amended policy. Under the amended policy, more items are capitalized, and cash flow increases. The amendment of the capitalization policy did not materially affect the MID for 1995, 1994 or 1993 because the Entitlement Amount was sufficient to pay Contingent MID notwithstanding the amendment to the capitalization policy.\nAny amount of the MID that is paid to the General Partner in Units will be treated as if cash is distributed to the General Partner and is then contributed to the Partnership by the General Partner. The Fixed MID was treated as a fee payable to the General Partner by the Partnership for services rendered. The Contingent MID represents a return of equity to the General Partner for increasing cash flow, as defined, and accordingly is treated as a distribution.\nCompensation and reimbursements paid or accrued for the benefit of the General Partner or its affiliates are as follows:\nPayable to affiliates - General Partner at December 31, 1995 and 1994 consists primarily of reimbursable costs, unpaid property management fees and accrued but unpaid Contingent MID. These payables are due and payable from current operations.\nNOTE 3 - TAXABLE INCOME (LOSS) - ------------------------------\nMcNeil Real Estate Fund XI, Ltd. is a partnership and is not subject to Federal and state income taxes. Accordingly, no recognition has been given to income taxes in the accompanying financial statements of the Partnership since the income or loss of the Partnership is to be included in the tax returns of the individual partners. The tax returns of the Partnership are subject to examination by Federal and state taxing authorities. If such examinations result in adjustments to distributive shares of taxable income or loss, the tax liability of the partners could be adjusted accordingly.\nThe Partnership's net assets and liabilities for tax purposes were less than the net assets and liabilities for financial reporting purposes by $62,005 in 1995, $415,728 in 1994, and $371,525 in 1993.\nNOTE 4 - REAL ESTATE INVESTMENTS - --------------------------------\nThe basis and accumulated depreciation of the Partnership's real estate investments at December 31, 1995 and 1994 are set forth in the following tables:\nThe Partnership's real estate properties are encumbered by mortgage indebtedness as discussed in Note 5.\nNOTE 5 - MORTGAGE NOTES PAYABLE - -------------------------------\nThe following table sets forth the mortgage notes payable of the Partnership at December 31, 1995 and 1994. All mortgage notes are secured by real estate investments.\n(a) The debt is non-recourse to the Partnership.\n(b) Discounts are based on an effective interest rate of 8.62%.\n(c) Balloon payments on the mortgage notes are due as follows:\nScheduled principal maturities of the mortgage notes, before consideration of discounts of $203,606, are as follows:\nBased on borrowing rates currently available to the Partnership for mortgage loans with similar terms and average maturities, the fair value of notes payable was approximately $40,765,000 as of December 31, 1995.\nNOTE 6 - GAIN ON INVOLUNTARY CONVERSION - ---------------------------------------\nOn March 15, 1993, 8 units at Sun Valley were destroyed by fire causing $317,100 in damages. The Partnership received $277,145 in insurance reimbursements as of December 31, 1993, to cover the cost to repair Sun Valley. The property received an additional $28,109 in insurance reimbursements in 1994. Insurance reimbursements received in excess of the basis of the property damaged were recorded as a gain on involuntary conversion. The Partnership recorded a gain of $28,109 and $178,460 in 1994 and 1993, respectively.\nNOTE 7 - REFINANCING OF MORTGAGE NOTES PAYABLE - ----------------------------------------------\nOn November 23, 1993, the Partnership refinanced the mortgage note payable on Acacia Lakes. A summary of the proceeds from refinancing is as follows:\nThe Partnership deposited $183,751 into property taxes, insurance and replacement escrows and incurred loan costs of $376,292 relating to the refinancing. The Partnership also recognized an extraordinary loss on early extinguishment of debt on Acacia Lakes in the amount of $285,501, which is attributable to the unamortized discount on the retired mortgage.\nOn June 24, 1993, the General Partner refinanced a portfolio of properties via a Real Estate Mortgage Investment Conduit (\"REMIC\"). This REMIC consists of a pool of properties from various partnerships affiliated with McNeil. Gentle Gale and Villa Del Rio were included in the REMIC. The properties in the REMIC are not collateralized across the partnerships, but are cross-collateralized within the same partnership. The new mortgage loans bear an interest rate of 8.15%, which have been discounted to an effective rate of 8.62%, and mature in July 2003. Following is a summary of the cash proceeds relating to the refinancings:\nThe Partnership deposited $328,157 into separate escrow accounts for property taxes, insurance and replacement reserves and incurred loan costs of $487,233 relating to the refinancings. The Partnership recognized an extraordinary loss on early extinguishment of debt on Gentle Gale in the amount of $179,408, which is attributable to the unamortized discount and prepayment penalty relating to the retired mortgage. The Partnership also recognized an extraordinary loss on early extinguishment of debt on Villa Del Rio in the amount of $56,471, which is attributable to the prepayment penalty relating to the retired mortgage.\nNOTE 8 - LEGAL PROCEEDINGS - --------------------------\n1) High River Limited Partnership v. McNeil Partners, L.P., McNeil Investors, Inc., McNeil Pacific Investors 1972, Ltd., McNeil Real Estate Fund V, Ltd., McNeil Real Estate Fund IX, Ltd., McNeil Real Estate Fund X, Ltd., McNeil Real Estate Fund XI, Ltd., McNeil Real Estate Fund XIV, Ltd., McNeil Real Estate Fund XV, Ltd., McNeil Real Estate Fund XX, L.P., McNeil Real Estate Fund XXIV, L.P., McNeil Real Estate Fund XXV, L.P., Robert A. McNeil and Carole J. McNeil (L95012) - High River (\"HR\") filed this action in the United States District Court for the Southern District of New York against McNeil Partners, L.P., McNeil Investors, Inc. and Mr. and Mrs. McNeil (as defined in this Section 1, collectively, the \"Defendants\") requesting, among other things, names and addresses of the limited partners in the partnerships referenced above (as defined in this Section 1, the \"Partnerships\"). The District Court issued a preliminary injunction against the Partnerships requiring them to commence mailing materials relating to the HR tender offer on August 14, 1995.\nOn August 18, 1995, the Defendants filed an Answer and Counterclaim. The Counterclaim principally asserts (1) the HR tender offers have been undertaken in violation of the federal securities laws, on the basis of material, non-public, and confidential information, and (2) that the HR offer documents omit and\/or misrepresent certain material information about the HR tender offers. The Counterclaim seeks a preliminary and permanent injunction against the continuation of the HR tender offers and, alternatively, ordering corrective disclosure with respect to allegedly false and misleading statements contained in the tender offer documents.\nThis action was dismissed without prejudice in November 1995.\n2) High River Limited Partnership v. McNeil Partners, L.P., McNeil Investors, Inc., McNeil Pacific Investors 1972, Ltd., McNeil Real Estate Fund V, Ltd., McNeil Real Estate Fund IX, Ltd., McNeil Real Estate Fund X, Ltd., McNeil Real Estate Fund XI, Ltd., McNeil Real Estate Fund XIV, Ltd., McNeil Real Estate Fund XV, Ltd., McNeil Real Estate Fund XX, L.P., McNeil Real Estate Fund XXIV, L.P., McNeil Real Estate Fund XXV, L.P., Robert A. McNeil and Carole J. McNeil - United States District Court for the Southern District of New York, (Case No. 95 Civ. 9488) (Second Action).\nOn November 7, 1995, High River filed a second complaint with the District Court which alleges, inter alia, that McNeil Partners, L.P.'s (the \"General Partner\") Schedule 14D-9 filed in connection with the High River tender offers was materially false and misleading, in violation of Sections 14(d) and 14(e) of the Securities Exchange Act of 1934, 15 U.S.C. Section 78n(d) and (e), and the SEC Regulations promulgated thereunder; and that High River further alleges that the General Partner has wrongfully refused to admit High River as a limited partner to the ten partnerships referenced\nabove. Additionally, High River purports to assert claims derivatively on behalf of McNeil Real Estate Fund IX, Ltd., McNeil Real Estate Fund XI, Ltd., McNeil Real Estate Fund XV, Ltd., McNeil Real Estate Fund XXIV, L.P. and McNeil Real Estate Fund XXV, L.P., for breach of contract and breach of fiduciary duty, asserting that the General Partner has charged these partnerships excessive fees. High River's complaint seeks, inter alia, preliminary injunctive relief requiring the General Partner to admit High River as a limited partner in each of the ten partnerships referenced above and to transfer the tendered units of interest in the partnerships to High River; an unspecified award of damages payable to High River and an additional unspecified award of damages payable to certain of the partnerships; an order that defendants must discharge their fiduciary duties and must account for all fees they have received from certain of the partnerships; and attorneys' fees.\nOn January 31, 1996, this action was dismissed without prejudice.\n3) Robert Lewis v. McNeil Partners, L.P., McNeil Investors, Inc., Robert A. McNeil et al - In the District Court of Dallas County, Texas, A-14th Judicial District, Cause No. 95-08535 (Class Action) - Plaintiff, Robert Lewis, is a limited partner with McNeil Pacific Investors Fund 1972, Ltd., McNeil Real Estate Fund X, Ltd. and McNeil Real Estate Fund XV, Ltd.\nPlaintiff brings this action on his own behalf and as a class action on behalf of the class of all limited partners of McNeil Pacific Investors Fund 1972, Ltd., McNeil Real Estate Fund V, Ltd., McNeil Real Estate Fund IX, Ltd., McNeil Real Estate Fund X, Ltd., McNeil Real Estate Fund XI, Ltd., McNeil Real Estate Fund XIV, Ltd., McNeil Real Estate Fund XV, Ltd., McNeil Real Estate Fund XX, L.P., McNeil Real Estate Fund XXIV, L.P. and McNeil Real Estate Fund XXV, Ltd. (as defined in this Section 3, the \"Partnerships\") as of August 4, 1995.\nPlaintiff alleges that McNeil Partners, L.P., McNeil Investors, Inc., Robert A. McNeil and other senior officers (as defined in this Section 3, collectively, the \"Defendants\") breached their fiduciary duties by, among other things, (1) failing to attempt to sell the properties owned by the Partnerships (as defined in this Section 3, the \"Properties\") and extending the lives of the Partnerships indefinitely, contrary to the Partnerships' business plans, (2) paying distributions to themselves and generating fees for their affiliates, (3) refusing to make significant distributions to the class members, despite the fact that the Partnerships have positive cash flows and substantial cash balances, and (4) failing to take steps to create an auction market for equity interests of the Partnerships, despite the fact that a third party bidder filed tender offers for approximately forty-five percent (45%) of the outstanding units of each of the Partnerships. Plaintiff also claims that Defendants have breached the partnership agreements of the Partnerships by failing to take steps to liquidate the Properties and by their alteration of the Partnerships' primary purposes, their acts in contravention of these agreements, and their use of the assets of the Partnerships for their own benefit instead of for the benefit of the Partnerships.\nThe Defendants deny that there is any merit to Plaintiff's allegations and intend to vigorously defend this action.\n4) James F. Schofield, Gerald C. Gillett and Donna S. Gillett v. McNeil Partners, L.P., McNeil Investors, Inc., McNeil Real Estate Management, Inc., Robert A. McNeil, Carole J. McNeil, McNeil Real Estate Fund V, Ltd., McNeil Real Estate Fund IX, Ltd., McNeil Real Estate Fund X, Ltd., McNeil Real Estate Fund XI, Ltd., McNeil Real Estate Fund XIV, Ltd., McNeil Real Estate Fund XV, Ltd., McNeil Real Estate Fund XX, L.P., McNeil Real Estate Fund XXIV, L.P., McNeil Real Estate Fund XXV, L.P. et al - Superior Court of the State of California for the County of Los Angeles, Case No. BC133799 (Class and Derivative Action Complaint) and United States District Court, Southern District of New York, Case No. 95CIV.6711 (Class and Derivative Action Complaint)\nThese are corporate\/securities class and derivative actions brought in state and federal court by limited partners of each of the nine (9) limited partnerships that are named as nominal defendants as listed above (as defined in this Section 4, the \"Partnerships\"). Plaintiffs allege that McNeil Investors, Inc., its affiliate McNeil Real Estate Management, Inc. and four (4) of their senior officers and\/or directors (as defined in this Section 4, collectively, the \"Defendants\") have breached their fiduciary duties. Specifically, Plaintiffs allege that Defendants have caused the Partnerships to enter into several wasteful transactions that have no business purpose or benefit to the Partnerships and which have rendered such units highly illiquid and artificially depressed the prices that are available for units on the limited resale market. Plaintiffs also allege that Defendants have engaged in a course of conduct to prevent the acquisition of units by Carl Icahn by disseminating false, misleading and inadequate information. Plaintiffs further allege that Defendants have acted to advance their own personal interests at the expense of the Partnerships' public unit holders by failing to sell Partnership properties and failing to make distributions to unitholders and, thereby, have breached the partnership agreements.\nThe Defendants deny that there is any merit to Plaintiff's allegations and intend to vigorously defend these actions.\n5) Alfred Napoletano v. McNeil Partners, L.P., McNeil Investors, Inc., Robert A. McNeil, Carole J. McNeil, McNeil Pacific Investors Fund 1972, Ltd., McNeil Real Estate Fund V, Ltd., McNeil Real Estate Fund IX, Ltd., McNeil Real Estate Fund X, Ltd., McNeil Real Estate Fund XI, Ltd., McNeil Real Estate Fund XIV, Ltd., McNeil Real Estate Fund XV, Ltd., McNeil Real Estate Fund XX, L.P., McNeil Real Estate Fund XXIV, L.P., McNeil Real Estate Fund XXV, L.P. - Superior Court of the State of California, County of Los Angeles, Case No. BC133849 (Class Action Complaint)\nPlaintiff brings this class action on behalf of a class of all persons and entities who are current owners of units and\/or are limited partners in one or more of the partnerships referenced above (as defined in this Section 5, the \"Partnerships\"). Plaintiff alleges that McNeil Partners, L.P., McNeil Investors, Inc., Robert A. McNeil and other senior officers (as defined in this Section 5, collectively, the \"Defendants\") have breached their fiduciary duties to the class members by, among other things, (1) taking\nsteps to prevent the consummation of the High River tender offers, (2) failing to take steps to maximize unit holders' or limited partners' values, including failure to liquidate the properties owned by the Partnerships, (3) managing the Partnerships so as to extend indefinitely the present fee arrangements, and (4) paying itself and entities owned and controlled by the general partner excessive fees and reimbursements of general and administrative expenses.\nThe Defendants deny that there is any merit to Plaintiff's allegations and intend to vigorously defend this action.\n6) Warren Heller v. McNeil Partners, L.P., McNeil Investors, Inc., Robert A. McNeil, Carole J. McNeil, McNeil Pacific Investors Fund 1972, Ltd., McNeil Real Estate Fund V, Ltd., McNeil Real Estate Fund IX, Ltd., McNeil Real Estate Fund X, Ltd., McNeil Real Estate Fund XI, Ltd., McNeil Real Estate Fund XIV, Ltd., McNeil Real Estate Fund XV, Ltd., McNeil Real Estate Fund XX, L.P., McNeil Real Estate Fund XXIV, L.P., McNeil Real Estate Fund XXV, L.P. - Superior Court of the State of California, County of Los Angeles, Case No. BC133957 (Class Action Complaint)\nPlaintiff brings this class action on behalf of a class of all persons and entities who are current owners of units and\/or are limited partners in one or more of the partnerships referenced above (as defined in this Section 6, the \"Partnerships\"). Plaintiff alleges that McNeil Partners, L.P., McNeil Investors, Inc., Robert A. McNeil and other senior officers (as defined in this Section 6, collectively, the \"Defendants\") have breached their fiduciary duties to the class members by, among other things, (1) taking steps to prevent the consummation of the High River tender offers, (2) failing to take steps to maximize unitholders' or limited partners' values, including failure to liquidate the properties owned by the Partnerships, (3) managing the Partnerships so as to extend indefinitely the present fee arrangements, and (4) paying itself and entities owned and controlled by the general partner excessive fees and reimbursements of general and administrative expenses.\nThe Defendants deny that there is any merit to Plaintiff's allegations and intend to vigorously defend this action.\nNOTE 9 - SUBSEQUENT EVENT - -------------------------\nOn January 8, 1996, 23 units and a laundry facility, totaling 23,347 square feet at Knollwood Apartments were destroyed by fire causing approximately $865,000 in damages. Management believes the insurance reimbursements to cover the cost of repair will exceed the basis of the property damaged by approximately $705,000.\nMcNEIL REAL ESTATE FUND XI, LTD. SCHEDULE III REAL ESTATE INVESTMENTS AND ACCUMULATED DEPRECIATION December 31, 1995\n(b) The initial cost and encumbrances reflect the present value of future loan payments discounted, if appropriate, at a rate estimated to be the prevailing interest rate at the date of acquisition or refinancing.\nSee accompanying notes to Schedule III.\nMcNEIL REAL ESTATE FUND XI, LTD. SCHEDULE III REAL ESTATE INVESTMENTS AND ACCUMULATED DEPRECIATION December 31, 1995\n(a) For Federal income tax purposes, the properties are depreciated over lives ranging from 15-25 years using ACRS or MACRS methods. The aggregate cost of real estate investments for Federal income tax purposes was approximately $72,720,420 and accumulated depreciation was $58,365,830 December 31, 1995.\nSee accompanying notes to Schedule III.\nMcNEIL REAL ESTATE FUND XI, LTD. SCHEDULE III REAL ESTATE INVESTMENTS AND ACCUMULATED DEPRECIATION December 31, 1995\nSee accompanying notes to Schedule III.\nMcNEIL REAL ESTATE FUND XI, LTD.\nNotes to Schedule III\nReal Estate Investments and Accumulated Depreciation\nA summary of activity for the real estate investments and accumulated depreciation is as follows:\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING - ------- ----------------------------------------------------------- AND FINANCIAL DISCLOSURE ------------------------\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - -------- --------------------------------------------------\nNeither the Partnership nor the General Partner has any directors or executive officers. The names and ages of, as well as the positions held by, the officers and directors of McNeil Investors, Inc., the general partner of the General Partner, are as follows:\nEach director shall serve until his successor shall have been duly elected and qualified.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION - -------- ----------------------\nNo direct compensation was paid or payable by the Partnership to directors or officers (since it does not have any directors or officers) for the year ended December 31, 1995, nor was any direct compensation paid or payable by the Partnership to directors or officers of the general partner of the General Partner for the year ended December 31, 1995. The Partnership has no plans to pay any such remuneration to any directors or officers of the general partner of the General Partner in the future.\nSee Item 13 - Certain Relationships and Related Transactions for amounts of compensation and reimbursements paid by the Partnership to the General Partner and its affiliates.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - -------- --------------------------------------------------------------\n(A) Security ownership of certain beneficial owners.\nNo individual or group, as defined by Section 13(d)(3) of the Securities Exchange Act of 1934, known to the Partnership is the beneficial owner of more than 5 percent of the Partnership's Units, other than High River Limited Partnership, which owns 9,460 Units (approximately 5.9% of the outstanding Units) as of February 29, 1996. The business address for High River Limited Partnership is 100 South Bedford Road, Mount Kisco, New York 10549.\n(B) Security ownership of management.\nThe General Partner and the officers and directors of its general partner, collectively, own 313 Units which represent less than 1% of the outstanding Units.\n(C) Change in control.\nNone.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - -------- ----------------------------------------------\nUnder the terms of the Amended Partnership Agreement, the Partnership is paying the MID to the General Partner. The maximum MID is calculated as 1% of the tangible asset value of the Partnership. The maximum MID percentage decreases subsequent to 1999. Tangible asset value is determined by using the greater of (i) an amount calculated by applying a capitalization rate of 9% to the annualized net operating income of each property or (ii) a value of $10,000 per apartment unit for residential property to arrive at the property tangible asset value. The property tangible asset value is then added to the book value of all other assets excluding intangible items. Prior to July 1, 1993, the MID consisted of two components: (i) the fixed portion which was payable without respect to the net income of the Partnership and was equal to 25% of the maximum MID (the \"Fixed MID\") and (ii) a contingent portion which was payable only to the extent of the lesser of the Partnership's excess cash flow, as defined, or net operating income (the \"Entitlement Amount\") and was equal to up to 75% of the maximum MID (the \"Contingent MID\").\nEffective July 1, 1993, the General Partner amended the Amended Partnership Agreement as a settlement to a class action complaint. This amendment eliminates the Fixed MID portion and makes the entire MID payable to the extent of the Entitlement Amount. In all other respects, the calculation and payment of the MID remain the same.\nContingent MID will be paid to the extent of the Entitlement Amount, and may be paid (i) in cash, unless there is insufficient cash to pay the distribution in which event any unpaid portion not taken in Units will be deferred and is payable, without interest, from the first available cash and\/or (ii) in Units. A maximum of 50% of the MID may be paid in Units. The number of Units issued in payment of the MID is based on the greater of $50 per Unit or the net tangible asset value, as defined. For the year ended December 31, 1995, the Partnership accrued for the General Partner Contingent MID in the amount of $871,053.\nAny amount of the MID which is paid to the General Partner in Units will be treated as if cash is distributed to the General Partner and is then contributed to the Partnership by the General Partner. The Fixed MID was treated as a fee payable to the General Partner by the Partnership for services rendered. The Contingent MID represents a return of equity to the General Partner for increasing cash flow, as defined, and accordingly is treated as a distribution.\nThe Partnership pays property management fees equal to 5% of the gross rental receipts of the Partnership's properties to McREMI for providing property management and leasing services. Effective February 14, 1991, the Partnership began reimbursing McREMI for its costs, including overhead, of administering the Partnership's affairs. For the year ended December 31, 1995, the Partnership paid or accrued for McREMI $1,176,453 in property management fees and reimbursements.\nSee Item 1 - Business, Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations, and Item 8 - Note 2 - \"Transactions with Affiliates.\"\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K - -------- -----------------------------------------------------------------\nSee accompanying index to financial statements at Item 8.\n(B) Reports on Form 8-K. There were no reports on Form 8-K filed during the quarter ended December 31, 1995.\nMcNEIL REAL ESTATE FUND XI, LTD. A Limited Partnership\nSIGNATURE PAGE\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.","section_15":""}
{"filename":"721083_1995.txt","cik":"721083","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nSmith International, Inc. (\"Smith\" or the \"Company\") was incorporated in the State of California in January 1937 and reincorporated under Delaware law in May 1983. The Company is a leading worldwide supplier of products and services to the oil and gas drilling and production industry. Smith produces and markets drilling fluids and systems through its majority owned subsidiary, M-I Drilling Fluids L.L.C. (\"M-I Drilling Fluids\"). Smith also manufactures and markets technologically advanced drill bits through its Smith Tool and Smith Diamond Technology units, and manufactures and markets drilling and completion products and services through its Smith Drilling & Completions Unit. Approximately 97% of the Company's revenues are derived from the oil and gas drilling industry with the remainder related to the mining and industrial markets.\nThe Company's business units supply products and provide services to one industry segment, the petroleum services segment. The information regarding business segments and domestic and international operations appears in Note 12 of the Notes to Consolidated Financial Statements included elsewhere in this Form 10-K.\nRECENT ACQUISITIONS AND DIVESTITURES\nSale of Directional Drilling Business\nOn March 29, 1993, the Company sold its directional drilling systems and services (\"DDS\") business and certain of its subsidiaries and other affiliates to Halliburton Company (\"Halliburton\") for 6,857,000 shares of Halliburton common stock. In April 1993, the Halliburton common stock obtained in the transaction was sold for $247.7 million. The Company used a portion of these proceeds to repay certain debt of the Company. As a result of the DDS sale, the Company recorded income in 1993 from discontinued operations of $73.6 million, including the gain from the sale of the DDS business of $80.1 million. The gain included provisions for various fees, expenses and taxes related to the DDS transaction. The DDS operations had revenues of approximately $36.3 million and operating losses of $6.5 million for the first three months of 1993.\nAcquisitions of A-Z\/Grant and Lindsey Completion Systems\nOn December 22, 1993, the Company acquired the product line assets of A-Z\/Grant and Lindsey Completion Systems (\"A-Z\/Grant\" and \"Lindsey\") from MASX Energy Services Group, Inc. for $19.0 million in cash. The acquired A-Z\/Grant and Lindsey operations are leading providers of downhole tools, remedial services and liner hangers to the oil and gas industry. A-Z\/Grant and Lindsey reported unaudited revenues of $31.6 million in 1993. The acquisition was accounted for as a purchase effective December 22, 1993. The unaudited results of A-Z\/Grant and Lindsey from December 22, 1993 to December 31, 1993 were not significant to the operations of the Company.\nAcquisition of M-I Drilling Fluids\nEffective February 28, 1994, the Company acquired a 64% interest in M-I Drilling Fluids from Dresser Industries, Inc. (\"Dresser\") for $160.0 million. M-I Drilling Fluids was owned 64% by Dresser and 36% by Halliburton prior to the acquisition. M-I Drilling Fluids is a leading provider of environmentally sensitive drilling fluids and systems to the oil and gas drilling industry. The Company purchased the 64% interest using $80.0 million of its cash and financed the remaining portion of the purchase price with debt. M-I Drilling Fluids reported unaudited revenues of $458.0 million in 1994, and $405.8 million in 1993.\nAcquisition of Supradiamant, S.A.\nOn July 1, 1994, the Company acquired Supradiamant, S.A. (\"Supradiamant\") from Societe Industrielle de Combustible Nucleaire for approximately $6.3 million in cash. Supradiamant is a leading\nmanufacturer of ultrahard materials, polycrystalline diamonds and cubic boron nitride. This acquisition was accounted for as a purchase. Supradiamant reported unaudited revenues of $7.1 million in 1994 and $7.5 million in 1993.\nAcquisition of Baker Hughes Treatment Services\nEffective January 1, 1995, the Company's M-I Drilling Fluids Unit acquired Baker Hughes Treatment Services (\"BHTS\") from Baker-Hughes, Inc. for approximately $5.1 million in cash. BHTS is a leading supplier of waste minimization, product recovery services, water treatment, downhole injection and reserve pit remediation services to the oilfield industry. This acquisition was accounted for as a purchase. BHTS reported unaudited revenues of approximately $10.7 million and $9.8 million in 1994 and 1993, respectively.\nAcquisition of Fremont Chemical Company\nEffective June 23, 1995, M-I Drilling Fluids acquired Fremont Chemical Company (\"Fremont\") for approximately $2.7 million, of which $1.0 million was funded by borrowings under its revolving line of credit and $1.7 million was funded by the issuance of a 3-year note payable to the former owners of Fremont. Fremont is the largest supplier of completion fluids in the Rocky Mountain region of the United States. Fremont reported unaudited revenues of approximately $7.2 million in both 1994 and 1993.\nINDUSTRY OVERVIEW\nSubstantially all of the Company's products and services are used in the process of drilling oil and natural gas wells. Therefore, the level of drilling activity is a useful general indicator of the demand for the products and services of the Company at any given time. The level of drilling activity is determined by a variety of factors over which the Company has no control, including the current and anticipated market price of crude oil and natural gas, the production levels of the Organization of Petroleum Exporting Countries (\"OPEC\") and other oil and gas producers, the regional supply and demand for oil and natural gas, the level of worldwide economic activity and the long-term effect of worldwide energy conservation measures. The worldwide average active rig count decreased 3% from 1,769 in 1994 to 1,713 in 1995.\nManagement anticipates that total worldwide drilling activity in 1996 will increase slightly from 1995 activity levels. North American drilling activity is expected to increase approximately 2.0% primarily due to higher forecasted activity in the United States. Non-North American drilling activity is expected to increase approximately 4.0% primarily as a result of higher forecasted drilling activity in Latin America. Management believes that the Company is well positioned to benefit from the expected increase in oil and gas drilling activity.\nBUSINESS OPERATIONS\nM-I Drilling Fluids\nProducts and Services. Through the acquisition of M-I Drilling Fluids in February 1994, the Company provides drilling fluids systems, products, and technical services to end users engaged in drilling oil, natural gas, and geothermal wells worldwide. Drilling fluid products and systems are used to cool and lubricate the bit during drilling operations, contain formation pressures, keep rock cuttings in suspension to remove them from the hole, and maintain the stability of the wellbore. Technical services are provided to ensure that the products and systems are applied effectively to optimize drilling operations. These services include recommending products and systems during the well planning phase, testing drilling fluid properties and recommending adjustments during the drilling phase, and analyzing well results after the well is completed to improve the performance of wells to be drilled in the future.\nM-I Drilling Fluids offers water-based, oil-based, and synthetic-based drilling fluid systems. These are chemically complex systems, comprised of a number of products designed to ensure that the diverse functions of the fluid are met. Weighting agents, composed of high specific gravity materials such as barite and hematite are added to drilling fluid systems to increase their density. When drilling through pressurized zones, the\nadded weight creates hydrostatic pressures that hold back formation pressures and prevent an influx of fluids from the formation into the hole. Thickening agents, or viscosifiers, produce the viscosity needed to remove the cuttings from the bit and provide adequate gel strength to suspend the cuttings when circulation is interrupted. Bentonite, a naturally occurring clay, is the most widely used viscosifier. Polymers are used to control viscosity and gel strengths and for thinning a fluid that has become too thick from formation cuttings. Loss circulation materials, such as fibers, flakes, and shells, plug pores in the formation to prevent the loss of mud. Finally, specialty products are used in certain circumstances to complement the base products, acting to reduce torque and drag, free stuck pipe, and add or enhance temperature stability.\nOil-based drilling fluids are used to drill water-sensitive shales, to reduce torque and drag, and to drill in areas where stuck pipe is likely to occur. These systems are low viscosity systems that sharply increase rates of penetration in certain drilling areas of the world. Synthetic-based drilling fluids are used in similar drilling environments and often exceed the superior performance characteristics of oil-based drilling fluids.\nM-I Drilling Fluids' geothermal\/air drilling operations provides air drilling services to the geothermal, oil and gas drilling markets. These services include the rental of high-volume, high-pressure compressors and related equipment, along with expert technical support and fluid products associated with air drilling.\nThrough its Swaco operations, a complete line of solids control, pressure control, and rig instrumentation products are offered to the worldwide drilling market on both a sale and rental basis. Key products in the pressure control line include the D-Gasser and Super Choke which hold dominant market positions. The solids control product line of shakers, hydroclones, and centrifuges have been designed to offer operators the option to drill \"dry locations\", where drilling fluid waste is minimized and handled in an environmentally-safe manner. Swaco's rig instrumentation line features the SMART Data Acquisition System, an advanced monitoring system that measures, monitors and displays the drilling status of a well with high speed accuracy.\nWith the acquisition BHTS in January 1995, Swaco is the world's largest supplier of waste minimization and product recovery services to the oilfield industry. BHTS also expands Swaco's product line to include water treatment, downhole injection and reserve pit remediation services.\nCompetition. The major competitors in the worldwide drilling fluids industry are Baroid Drilling Fluids (a division of Dresser), Inteq (a division of Baker-Hughes, Inc.) and Dowell Drilling Fluids (a division of Schlumberger, Inc.). While these companies supply a majority of the market, the drilling fluids industry is highly competitive, with a significant number of smaller, locally-based competitors and foreign multinational drilling fluids suppliers as well as limited product producers that market their products without technical services.\nCompetition within the drilling fluids industry is primarily based on the performance of the system in meeting customers' drilling objectives, the quality and experience of the field engineers, pricing, locational or other operational advantages, well planning capabilities in the design of a drilling fluids program and the technical support of field engineers.\nSmith Tool\nProducts. The Company offers drill bits under the Smith Tool(TM) and Smith Mining(TM) product lines. This unit designs, manufactures and markets drill bits used in drilling oil and gas wells and mining applications. The Company offers drill bits under the Smith Tool(TM) and Smith Mining(TM) product lines. Drill bit sizes range from 3 1\/2 to 28 inches in diameter for the petroleum industry and from 2 15\/16 to 16 inches in diameter for the mining industry. Most bits manufactured by the Company are three-cone drill bits. The surfaces of the cones are comprised of different types of pointed structures that are referred to as \"cutting structures\" or \"teeth.\" The cutting structures are either an integral part of the steel cone with a hardmetal applied surface (referred to as \"milled tooth\") or made of an inserted material (referred to as \"insert\") which is usually tungsten carbide. In the last few years, there has been a significant increase in demand for drill bits in which the tungsten carbide insert is coated with polycrystalline diamond. The Company is the only manufacturer offering this product on a commercial basis.\nThe cutting structures in mining bits are principally tungsten carbide inserts (\"TCI\"). Mining bits are typically utilized for shallow drilling to place explosives for blasting in open pit mining operations. Other mining bits using both tungsten carbide and diamond enhanced inserts have been designed for use with air driven percussion tools and are known as hammer bits.\nCompetition. Besides the Company, Hughes Christensen (a division of Baker-Hughes, Inc.), Security\/DBS (a division of Dresser) and Reed\/Hycalog (a division of Camco International, Inc.) are the three major competitors in the petroleum drill bit business. While the Company and Hughes Christensen maintain the leading shares of worldwide revenues of three-cone drill bits, they compete with over 20 other competitors.\nCompetition for sales of petroleum drill bits is generally based on a number of factors, including performance, quality, reliability, service, price, technological advances and breadth of products. Competition for sales of mining drill bits generally is based on a number of factors, including price, performance and availability.\nSmith Drilling & Completions\nProducts and Services. The Smith Drilling & Completions business unit manufactures and markets product lines under the following names: Drilco\/Grant, A-Z\/Servco and Lindsey Completion Systems. In general, all product lines are manufactured, marketed, sold and maintained by the same management, operations and sales personnel operating out of 22 international locations and 19 U.S. locations. Houston, Texas is the sales, management, engineering, and manufacturing headquarters for this business unit.\nThe Drilco\/Grant product line includes rotating drilling heads, automatic connection torque monitoring and control systems, downhole drilling tools, tubular drill string components, drilling tool inspection products and services, and machine shop services. The rotating drilling heads are rented and sold to the end users primarily in air drilling areas and in underbalanced drilling areas. The downhole tools are sold or rented to the end users and include stabilizers to centralize the drill string and reamers to maintain a uniform hole diameter.\nThe tubular products, manufactured under the Drilco\/Grant product line, include drill collars to provide drilling weight to the bit, Hevi-Wate(TM) drill pipe to provide stress transition between drill collars and conventional drill pipe or to provide drilling weight to the bit in horizontal drilling, connecting subs to attach drill string members of differing diameters and connections and kellys to rotate the drill string on conventional drilling rigs.\nThe A-Z\/Servco product line includes downhole remedial, re-entry and fishing tools for use in connection with the drill string for specialized drilling and workover operations. This includes the patented Reamaster(TM) and Underream-While-Drilling System(TM) which allows two operations to be performed simultaneously. The product line also includes remedial, re-entry and fishing operations, including the patented Millmaster(TM) Performance Milling System and the patented Packstock(TM) and Anchorstock(TM) Performance Window Cutting System. These products provide a sidetrack or section milling operation to remove a section of casing permitting the well to be re-drilled using the existing casing slot. In addition, hole opening and underreaming services enlarge the wellbore to allow for annular area for proper cementing of the casing or for gravel pack displacement; packer milling to remove production packers; conventional milling to remove wellbore obstructions; mechanical, hydraulic, and explosive pipe cutting to remove casing during a well abandonment; and fishing services to remove wellbore obstructions during workover operations.\nThe Lindsey Completion Systems product line includes liner hangers, cementing products and tools, liner top packers and tie-back equipment, setting tools, plus the service personnel to supervise the running and setting of the necessary liner and completion products. These products are used prevalently in deep wells and in critical well completions because of the technological advantage.\nThe Company maintains field service centers which provide inspection and repair services of the Company's drill string components, customer-owned tubular goods and for the Company's rental tools and services. These field service centers also serve as the distribution points for all the Smith Drilling & Completions' products and are an important part of the Company's marketing efforts.\nCompetition. Competition in the drilling and completions sales, rentals, and services market is primarily based on performance, quality, reliability, service, price, response time, and, in some cases, breadth of products. Smith Drilling & Completions attributes its competitive position to its commitment to technological advancements that add value to the customer's programs plus the quality, performance, and service of its products and employees. The Company's major competitors in the drilling, remedial, re-entry and fishing services market are Weatherford Enterra, Inc., Baker Oil Tools (a division of Baker-Hughes, Inc.), and fragmented local companies. The main competitors in the completion markets are Baker Oil Tools and TIW.\nSmith Diamond Technology\nProducts. The Company also manufactures and markets shear bits featuring cutters made of polycrystalline diamond (\"PDC\") or natural diamonds. The Company manufactures PDC's and cubic boron nitride at its Megadiamond and Supradiamant subsidiary. These ultrahard materials are used in the Company's diamond drill bits and in other specialized cutting tools. Megadiamond developed and uses patented processes for applying diamonds to a curved surface with multiple transition layers. Smith is the only oilfield equipment manufacturer that develops, manufactures and markets its own synthetic diamond materials, which provides the Company a cost and technological advantage with respect to these products. In addition, the Company's in-house diamond research, engineering and manufacturing capabilities enhance the Company's ability to develop the application of diamond technology into Smith drill bits across other Smith product lines and into several non-energy cutting tool markets. Diamond enhanced products last longer and increase penetration rates, which decreases overall drilling costs in certain formations. The Company believes that its ability to develop specialized diamond inserts for specific applications will provide new business opportunities such as Diamond Enhanced Insert roller cone bits and Impax(TM) hammer bits as well as non-energy cutting tool markets.\nCompetition. The Company's major competitors in the petroleum shear bit business are Reed\/Hycalog (a division of Camco International, Inc.), Hughes Christensen (a division of Baker-Hughes, Inc.) and Security\/DBS (a division of Dresser).\nCompetition for sales of petroleum drill bits is generally based on a number of factors, including performance, quality, reliability, service, price, technological advances and breadth of products. The Company believes its quality and reliability as well as technological advances, such as the Diamond Enhanced Inserts, provide its products with a competitive advantage.\nINTERNATIONAL OPERATIONS\nSales to the international oil drilling markets are a key strategic focus of Smith management, and the Company markets its products and services through its subsidiaries, joint ventures and sales agents in virtually all petroleum producing areas of the world, including Canada, the North Sea\/Europe, the Middle East, Mexico, Central and South America, Asia\/Pacific and Africa. As a result, 59% of the Company's total revenues in 1995 were generated from sales in the international markets, compared to 57% in 1994. In 1995, approximately 74% of the Company's revenues were denominated in U.S. dollars.\nHistorically, international drilling activity has been less volatile than in the U.S. due to the relatively high costs of exploration and development programs which can only be undertaken by major oil companies, consortiums and national oil companies. These entities operate under longer term strategic priorities than do the independent drilling operators that are more common in the U.S. market.\nSALES AND DISTRIBUTION\nThe Company markets its products on a worldwide basis, employing Company sales personnel and independent sales agents. In addition, independent distributors and unconsolidated joint ventures market drilling fluid products in many locations. Sales efforts are also directed to end users in the drilling industry including independent drilling contractors, major and independent oil companies and national oil companies.\nThe Company's sales force is supported by field service centers worldwide. The Company considers that its worldwide sales position has been significantly enhanced by its field service centers presently maintained in every major oil and gas producing area. These field service centers serve as bases for the sales force and rental tool operations and also provide an opportunity to market a wider range of the Company's products than could be marketed by a sales office. The Company's field service centers are also important factors in maintaining good customer relations since they are designed primarily for repair and maintenance of drill string components and rental tools.\nMANUFACTURING\nThe Company's manufacturing operations, along with quality control support, are designed to ensure that all products and services marketed by the Company will meet standards of performance and reliability consistent with the Company's reputation in the industry.\nManagement estimates that the Company has available manufacturing facilities to accommodate a worldwide demand level equivalent to approximately 3,000 average active drilling rigs which compares to approximately 1,760 average active drilling rigs estimated for 1996. In addition, the Company has entered into license agreements and joint ventures with worldwide manufacturers in order to increase its production capacity for drill bits.\nRAW MATERIALS\nThrough its company-owned mines located in the U.S. and abroad, M-I Drilling Fluids has the capability to produce a large portion of its requirements for barite and bentonite. Significant barite reserves are located in Nevada and the United Kingdom. Bentonite is produced from ore deposits in Wyoming and Greece. Mining exploration activities continue worldwide to locate and evaluate ore bodies to ensure deposits are ready for production when market conditions dictate their entry. In addition to its own production, M-I Drilling Fluids purchases a majority of its worldwide barite requirements from international suppliers, mainly located in the People's Republic of China, India and Morocco.\nThe Company purchases a variety of raw materials for its Smith Tool, Smith Diamond Technology and Smith Drilling & Completions Units, including alloy and stainless steel bars, tungsten carbide inserts and forgings. Generally, the Company is not dependent on any single source of supply for any of its raw materials or purchased components. The Company currently purchases 80% of the tungsten carbide inserts used as cutting structures on drill bit cones, wear pads for stabilizers and hard surface materials for mills and reamers from one supplier pursuant to a supply agreement entered into in connection with the sale of a division by the Company to that supplier. In addition, the Company has also entered into a supply agreement to purchase 80% of its U.S. forging requirements from a single supplier. The Company believes that numerous alternative supply sources are available for all of such materials. The Company also produces PDC synthetic diamonds in Provo, Utah and Grenoble, France for utilization in various Company products as well as direct customer sales. The Company believes that it enjoys a competitive advantage in the manufacture of diamond drill bits because it is the only diamond drill bit manufacturer producing its own PDC.\nPRODUCT DEVELOPMENT, ENGINEERING AND PATENTS\nThe M-I Drilling Fluids Unit maintains an aggressive research and development effort, reflecting the market's demands for better performance in the more hostile drilling environments and heightened concern over protecting the environment where drilling occurs. Through its research facilities in Houston, Texas; Stavanger, Norway; Aberdeen, Scotland; and Bogota, Colombia; it provides basic research, testing, and technical support for its field engineers. Its environmental services group evaluates and monitors toxicity data and safe material handling procedures on all of its products, enabling the customer to design a drilling program that is environmentally responsible and safe.\nThe M-I Drilling Fluids Unit's focus on research and development has led to the development and introduction of several new drilling fluids products and systems, most notably, FLO-PRO(TM), the family of NOVA(TM) systems, KLA-GARD(TM), and DRIL-KLEEN(TM). The FLO-PRO(TM) system, a rheologically-engineered\nwater-based system designed to drill the productive interval of horizontal and highly-deviated wells, was introduced to the worldwide drilling and production market in 1994. The non-damaging character of a FLO-PRO(TM) system, coupled with its cuttings suspension and transport performance, results in reduced drilling and completion costs as well as maximum reservoir productivity. In 1995, the system found new markets in the U.S. Gulf Coast, Latin America, West Africa, and Europe, applications which extended the range and future potential of the fluid. In the summer of 1995, FLO-PRO(TM)'s contribution was formally recognized by the drilling industry when it was awarded Petroleum Engineer International's Special Meritorious Award for Engineering Innovation.\nThe NOVA(TM) family includes NOVADRIL(TM), NOVAPLUS(TM), and NOVALITE(TM), which together comprise M-I Drilling Fluids' olefin-based non-toxic invert emulsion drilling fluids systems. These systems offer many of the performance advantages of conventional oil mud systems but, because they are manmade olefins and contain no aromatics or other Clean Water Act priority pollutants, they avoid the environmental problems associated with using diesel oil. In May and June 1994, the NOVADRIL(TM) system set successive industry records for drilling performance, drilling over 7,400 and 8,400 feet, respectively, in a 24-hour interval. In 1995, NOVA(TM) systems have been successfully used in all sectors of the North Sea, Australasia, and the U.S. Gulf of Mexico, especially in the Gulf's emerging deepwater frontiers where drilling performance and environmental quality are paramount.\nKLA-GARD(TM) is a shale stabilizer that reduces the swelling of sensitive shales and drill cuttings exposed to water-based drilling fluids. By effectively controlling the thick gumbo shales present in many drilling locations, operators have been able to significantly reduce drilling time and reduce overall costs. The DRIL-KLEEN(TM) detergent is a concentrated, low-toxicity additive designed to prevent bit-and bottom-hole assembly (\"BHA\") balling in all water-based drilling fluids. Applied directly to the bit or BHA, the product forms a lubricating film which resists gumbo-balling and promotes higher rates of penetration in drilling operations.\nThe Smith Tool, Smith Drilling & Completions, and Smith Diamond Technology Units maintain product development and engineering departments in rock bit, diamond bit, downhole tool and liner hanger technology whose activities are directed to developing new products and processes, improving existing product lines and designing specialized products to meet customer requirements. Experimental work in metallurgy also comprises a significant portion of the work of these departments. For example, recent new product developments include: tungsten carbide insert and milled tooth Spinodal(TM) bearing roller cone bits, Diamond Enhanced Insert roller cone bits, steerable motor PDC and roller cone bits; Diamond Enhanced Stabilizers; the Smith Diamond Maxidrill(TM) products and Diamond Enhanced Impax(TM) hammer bits; the Servco Millmaster(TM) carbide cutting structure; and the Servco Superdome(TM) PDC underreamers and hole openers. In recent years, the Company has received special meritorious awards for engineering innovations sponsored by Petroleum Engineer International magazine. One such award was for the placement of PDC on curved surfaces for rock bit cutting structures, underreamers and hole openers while another was for the development of a new hardfacing material for use on milled tooth drill bits.\nDuring 1991, the Company developed FDS+ Milled Tooth Rock Bits for longer life at higher rates of penetration. The Company continuously attempts to improve the quality, performance and reliability of its products in order to maintain its competitive position in the industries it serves and to develop new tools and materials to meet the evolving market needs.\nThe Company also maintains a drill bit data base which records the performance of substantially all drill bits used in the U.S. over the last 10 years, including those manufactured by competitors. This database gives the Company the ability to monitor, among other things, drill bit failures and performance improvements with product development. Management believes this proprietary data base gives the Company a competitive advantage in the drill bit business.\nThe Company has historically maintained its research and engineering expenditures at a high level to enable it to maintain its technological and performance leadership and broaden its product lines. The Company's expenditures for research and engineering activities amounted to $21.4 million in 1995, $14.6 million in 1994 and $6.6 million in 1993. In 1995, research and engineering expenditures approximated 2.5% of revenues.\nAlthough the Company has over 650 patents and regards its patents and patent applications as important in the operation of its business, it does not believe that any significant portion of its business is materially dependent upon any single patent or group of patents or generally upon patent protection.\nEMPLOYEES\nAt December 31, 1995, the Company had approximately 4,700 full time employees throughout the world. Most of the Company's employees in the United States are not covered by collective bargaining agreements except certain domestic mining operations of M-I Drilling Fluids. The Company considers its labor relations to be satisfactory.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe principal facilities and properties utilized by the Company at December 31, 1995 are shown in the table below. All facilities and properties are owned by the Company with the exception of the Grenoble, France location.\nThe Company considers its mines and manufacturing and processing facilities to be in good condition and adequately maintained. Due to the downturn in business in recent years, the Company's manufacturing facilities operated below capacity throughout 1995 and are continuing to operate below capacity levels. A portion of the Houston, Texas facility is currently being held for sale by the Company.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nExecutive Life\nOn March 4, 1992, the Company was served with a complaint in the U.S. District Court in the Central District of California, entitled Lynn Martin, Secretary of the U.S. Dept. of Labor v. Smith International, Inc., et al., Case No. CV92-1196. In addition, seven of its employees or former employees (the \"Individual Defendants\") were also served. The complaint alleges violations of the Employee Retirement Income Security Act of 1974 (\"ERISA\") arising out of the Company's purchase of annuities from Executive Life Insurance Company (\"Executive Life\"), upon the termination of its Pension Plan in August 1985. On April 11, 1991, Executive Life was placed in conservatorship in California state court by the California Insurance Commissioner. Executive Life emerged from the conservatorship in 1993 as Aurora National Life Assurance Company, Inc. (\"Aurora\"). Under the rehabilitation plan as ordered by the Los Angeles Superior\nCourt judge, Aurora will honor in part Executive Life's past and continuing commitments under the annuities outstanding; however, a portion of these obligations will not be paid by Aurora (the \"Shortfall\").\nIn December 1994, the parties agreed in principle to a settlement. On April 12, 1995, the United States District Court for the Central District of California entered a Consent Order (\"Consent Order\"), which documented the principal settlement terms. The Individual Defendants were dismissed with prejudice. Pursuant to the Consent Order, the Company paid $4.07 million into an escrow account. A substantial portion of the $4.07 million settlement was paid by the Company's insurance carrier. The Company accrued its portion of the settlement of approximately $1.0 million in 1994.\nThe $4.07 million payment is still on deposit in the escrow account as the Department of Labor has not yet finalized the timing, amount or manner of the distributions from the escrow account to the Plan participants.\nSuperfund\nThe Sheridan Site. On March 31, 1987, the Sheridan Site Committee (the \"Committee\") filed a claim in the Company's Chapter 11 case on behalf of itself and 59 potentially responsible parties (\"PRPs\") at the Sheridan Disposal Services site in Hempstead, Texas, a National Priorities List (\"NPL\") site. The claim was based on the Company's alleged liability to the claimants for \"contribution and potential cost recovery for administrative and remedial work\" expenses incurred and to be incurred by them in connection with the Sheridan Disposal site.\nOn August 28, 1987, the Company reached a settlement with the Committee. The Committee agreed to withdraw its proof of claim. In return, the Company agreed to pay its allocable share of response costs incurred by the Committee, such share to be limited to the lesser of $3.0 million or 2.93% of actual response costs. The Company's obligations pursuant to the settlement agreement with the Committee were not discharged or affected by confirmation of the Company's plan of reorganization. Based upon an U.S. Environmental Protection Agency (\"EPA\") Record of Decision (\"ROD\"), total remediation costs are estimated, on a preliminary basis, to be approximately $28 million. On this basis, the Company's share would be $0.8 million. Remediation activities at the Sheridan Site have been suspended pending receipt of a consent decree relating to the settlement of this case. After it is resumed, the remediation, together with the related expenditures, will likely extend over several years.\nThe OII Site. Under the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (the \"Superfund Act\"), the EPA has been conducting various activities at the Operating Industries, Inc. (\"OII\") site, a disposal site on the NPL located in Monterey Park, California. The United States, on behalf of the EPA, filed a proof of claim in the Company's Chapter 11 case alleging that it had incurred approximately $8.0 million in response costs to date, and would continue to incur response costs in the future. Subsequently, the United States alleged that its costs had increased to over $10 million. On June 14, 1988, the United States District Court entered an order approving a Stipulation and Agreement to Compromise and Settle EPA's claim against the Company's estate (the \"OII Settlement Agreement\"). Under the OII Settlement Agreement, the claim of the United States was allowed as an amount (approximately $150,000) sufficient to entitle the EPA to a distribution pursuant to the Company's plan of reorganization. The Company further agreed to pay its allocable share of total future site response costs at the OII site, such share, however, to be limited to the lesser of $5.0 million or 0.65% of future site response costs.\nActual remediation of the OII Site is likely to extend for a number of years after a final remedy is selected for the site. The EPA issued an ROD with respect to the OII Site that estimates remediation costs of $300 million. At this time, the Company is unable to determine the amount it may ultimately have to contribute to the OII site pursuant to the OII settlement agreement. This amount will range from the approximately $150,000 that the Company has already paid to the $5.0 million at which the Company's liability is capped under the OII settlement agreement.\nThe Chemform Site. Chemform, Inc. (\"Chemform\"), a former wholly-owned subsidiary of the Company and, subsequently, the Company itself, operated a business and held a leasehold interest in property located in\nPompano Beach, Florida (the \"Chemform Site\") between May 14, 1976 and March 16, 1979, at which time the Company sold the Chemform business and assigned the lease.\nThe EPA placed the Chemform Site on the NPL on October 4, 1989. On September 22, 1992, the EPA issued the ROD for a portion of the Chemform Site. The ROD selected a \"No Action with Monitoring\" alternative, under which groundwater would be monitored quarterly for at least one year. Although the Company and two other PRPs have completed four quarters of groundwater monitoring, the Florida Department of Environmental Protection (\"Florida DEP\") has requested that additional monitoring be performed. The Company and two other PRPs are presently conducting discussions with the EPA and the Florida DEP regarding whether additional monitoring work will be required and, if so, what the scope of such work will be. The final scale of the monitoring work is not yet known. It is also not yet known whether any groundwater remediation work will thereafter be required.\nOn September 16, 1993, the EPA issued the ROD for the remainder of the Chemform Site, which addressed site-related soil contamination. The ROD determined that no further Superfund action was necessary to address Operable Unit Two at the site; however, the Florida DEP requested that additional soil be removed at the Chemform Site. The Company and the two other PRPs performed the soil removal requested under the oversight of the Florida DEP and has provided a Technical Memorandum summarizing this action to the EPA and the Florida DEP. The Company has not received any written response from either the EPA or the Florida DEP. As the EPA still retains jurisdiction over the Chemform Site, it is possible that additional issues may arise which would require further resolution. The Company believes that the EPA will demand reimbursement of certain oversight expenses that the EPA allegedly has incurred in administering the Chemform Site. The Company intends to scrutinize and, if necessary, vigorously contest any such claims made by the EPA.\nGeneral Environmental. At December 31, 1995, the recorded liability for estimated future clean-up costs for the sites discussed above as well as properties currently or previously owned or leased by the Company was $6.0 million. As additional information becomes available, the Company may be required to provide for additional environmental clean-up costs for Superfund sites and for properties currently or previously owned or leased by the Company. However, the Company believes that none of its clean-up obligations will result in liabilities having 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.\nITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT\n(a) The names and ages of all executive officers of the Company, all positions and offices with the Company presently held by each person named and their business experience during the last five years are stated below. Positions, unless otherwise specified, are with the Company.\n(b) All officers of the Company are elected annually by the Board of Directors at the meeting of the Board of Directors regularly held immediately following the annual meeting of shareholders. They hold office until their successors are elected and qualified.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS.\nThe Common Stock of the Company is traded on the New York Stock Exchange and the Pacific Stock Exchange. The following are the high and low sale prices for the Company's Common Stock as reported on the New York Stock Exchange Composite Tape for the periods indicated.\nOn March 11, 1996, the Company had approximately 4,688 Common Stock holders of record and the last reported closing price on the New York Stock Exchange Composite Tape was $21.75.\nThe Company has not paid dividends on its Common Stock since the first quarter of 1986. The determination of the amount of future cash dividends to be declared and paid on the Common Stock, if any, will depend upon the Company's financial condition, earnings and cash flow from operations, the level of its capital expenditures, its future business prospects and other factors that the Board of Directors deem relevant. In addition, the Company's debt agreements contain covenants restricting the payment of cash dividends to the Company's common stockholders based on net earnings and operating cash flow formulas as defined.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe Notes to Consolidated Financial Statements and Management's Discussion and Analysis of Financial Condition and Results of Operations included elsewhere in this Form 10-K should be read in order to understand factors such as accounting changes, business combinations, dispositions of business operations or other unusual items which may affect the comparability of the information shown above.\n(a) The 1991 results include $22.2 million of non-recurring charges related to the restructuring of the Company's worldwide operations in response to a decline in the U.S. drilling activity.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nGENERAL\nManagement's Discussion and Analysis of Financial Condition and Results of Operations is the Company's discussion of its financial performance and of significant trends which may impact the future performance of the Company. It should be read in conjunction with the Consolidated Financial Statements of the Company and the related notes thereto included elsewhere in this Form 10-K.\nThe Company manufactures and supplies a wide range of products and services to the worldwide oil and gas drilling and production and mining industries. The Company's revenues are derived from sales of drilling and completion fluid systems, solids control equipment, drill bits, downhole drilling tools and tubular drill string components and from providing drilling and completion services to the oil and gas industry.\nThe Company operates in the global oil and gas services market and is significantly impacted by changes in exploration and drilling activity in the major energy producing areas. Exploration and drilling activity is primarily influenced by the prices of oil and natural gas. In addition, exploration and drilling activity may be affected by political actions and uncertainties, environmental concerns, capital expenditure plans of customers and the overall level of global economic growth and activity.\nManagement anticipates that total worldwide drilling activity in 1996 will increase slightly from 1995 activity levels. North American drilling activity is expected to increase approximately 2.0% primarily due to higher forecasted activity in the United States. Non-North American drilling activity is expected to increase approximately 4.0% primarily as a result of higher forecasted drilling activity in Latin America. Management believes that the Company is well positioned to benefit from the expected increase in oil and gas drilling activity; however, there can be no assurance that the higher drilling activity will result in increased earnings for the Company.\nAfter management concluded that the sale of the Company's directional drilling systems and services (\"DDS\") business was in the best long term interest of the Company's shareholders, the DDS business was sold to Halliburton Company in March 1993. The proceeds of this sale have enabled the Company to strengthen its financial condition and pursue strategic growth objectives. The following operations have been acquired as part of the Company's strategic program which have strengthened the Company's product and service offerings and global presence: a 64% interest in M-I Drilling Fluids, a leading supplier of drilling fluid systems; Supradiamant, S.A., a leading manufacturer of diamond products; Baker Hughes Treatment Services (\"BHTS\"), a major supplier of waste minimization and product recovery services; and, Fremont Chemical Company, the largest supplier of completion fluids in the Rocky Mountain region of the United States. These acquisitions have been accounted for as purchase transactions and the results of the acquired operations have been included in the Consolidated Statements of Operations from the date of acquisition. These acquisitions complement the Company's existing core products forming a more complete package of expendable products to the oil and gas drilling and production industry.\nRESULTS OF OPERATIONS\nRevenues\nThe Company operates through four business units which market the products manufactured and provide services throughout the world. The following table sets forth the amounts and percentages of revenues by business unit and by area, as well as average rig count data (in thousands, except rig count information):\nM-I Drilling Fluids\nThe M-I Drilling Fluids operation, which was acquired in February, 1994, provides drilling fluids systems, solids control equipment, products and technical services to end users engaged in drilling oil, natural gas and geothermal wells worldwide. The consolidated revenues attributable to M-I Drilling Fluids increased $173.8 million or 45.4% from the prior year due primarily to the higher sales volume and the product mix of sales in Latin America, the United States and Germany. The remainder of the increase is related to the inclusion of a full year of revenues for M-I Drilling Fluids and the acquisitions of the BHTS and Fremont operations.\nSmith Tool\nThe Smith Tool business unit manufactures and sells three-cone drill bits used in the oil and gas drilling industry and in mining applications. Smith Tool revenues increased $12.2 million or 7.9% from $154.9 million in 1994 to $167.1 million in 1995 due primarily to higher sales volume and improved pricing in the United States and higher drilling activity in Latin America, Italy, and Germany. These increases were partially offset by reduced sales in Canada due to lower drilling activity. Smith Tool revenues increased $12.5 million or 8.8% from $142.4 million in 1993 to $154.9 million in 1994 due primarily to increased sales in Canada resulting from the increase in drilling activity and increased sales in Latin America and the United States.\nSmith Drilling & Completions\nThe Smith Drilling & Completions product group manufactures and markets downhole drilling tools and tubular drill string components and provides related drilling and completion services for drilling oil and gas wells. Drilling & Completions revenues increased $23.1 million or 25.1% from $92.1 million in 1994 to $115.2 million in 1995 due primarily to higher sales volumes resulting from increased activity in Latin\nAmerica and the North Sea. In addition, sales volumes increased in the United States, the Middle East and Canada. Drilling & Completions revenues increased $33.6 million or 57.4% from $58.5 million in 1993 to $92.1 million in 1994. The increase in revenues was primarily due to the acquisition of the A-Z\/Grant and Lindsey product lines and higher sales volume in North America and Colombia.\nSmith Diamond Technology\nIn 1995, the Company formed a new business unit, Smith Diamond Technology, which was previously a part of the Smith Tool operations. This business unit manufactures and markets shear bits featuring cutters made of polycrystalline diamond (\"PDC\") or natural diamonds at its Geodiamond division. Smith Diamond Technology also manufactures PDC's and cubic boron nitride at its Megadiamond and Supradiamant subsidiaries. These ultrahard materials are used in the business unit's diamond drill bits and in other specialized cutting tools. Smith Diamond Technology revenues increased $11.5 million or 47.3% from $24.3 million in 1994 to $35.8 million in 1995. The increase was primarily due to higher sales volumes in Latin America, the North Sea and the Middle East and the inclusion of a full year of revenues related to Supradiamant, which was acquired in July 1994. Smith Diamond Technology revenues increased $4.5 million or 22.7% from $19.8 million in 1993 to $24.3 million in 1994. The increase in revenues was primarily due to the acquisition of Supradiamant and increased volumes in the Far East and Brazil.\nFor the periods indicated, the following table summarizes the results of continuing operations of the Company and presents results as a percentage of total revenues of the continuing operations:\n1995 Versus 1994\nTotal revenues for 1995 increased $220.6 million or 33.7% from $653.9 million in 1994 to $874.5 million in 1995. The increase was primarily related to the additional revenues associated with the previously discussed business acquisitions and increased drilling activity in Latin America. The increase also reflected higher sales volume in the United States and Germany for M-I Drilling Fluids and Smith Tool. In addition, Smith Tool revenues increased in Italy. Smith Drilling & Completions revenues increased due primarily to higher volumes\nin the North Sea, the United States, the Middle East and Canada. The increase in Smith Diamond Technology was due to increased drilling activity in the North Sea and higher volumes in the Middle East.\nGross profit, computed as revenues less costs of revenues, increased $71.2 million or 32.2% from $221.3 million in 1994 to $292.5 million in 1995. The increase was due primarily to the aforementioned acquisitions. In addition, the increase in gross profit reflected higher international volumes due to the higher level of drilling activity and higher domestic sales.\nOperating expenses, consisting of selling expenses and general and administrative expenses, increased $45.1 million or 28.0% from the prior year; however, as a percentage of revenues, operating expenses decreased from 1994. The increase in absolute expenses is due primarily to increased variable costs related to the higher level of revenues and additional expenses associated with the recently acquired companies previously discussed. In addition, the increase in operating expenses reflects the establishment of the recently formed Smith Diamond Technology business unit and the expansion of M-I Drilling Fluids operations in Latin America.\nNet interest expense, which represents interest expense less interest income, increased $3.6 million from $8.6 million in 1994 to $12.2 million in 1995. The increase in net interest expense was due primarily to higher debt levels to fund working capital requirements, the acquisitions of M-I Drilling Fluids, BHTS and Fremont and to hedge certain foreign-denominated assets.\nThe effective tax rate for the year approximated 17.0% which is lower than the statutory rate and higher than the prior years' effective rate of 13.2%. The effective tax rate for the year was lower than the statutory rate due primarily to the utilization of U.S. net operating loss carryforwards. The effective rate was higher than the prior year's rate due primarily to the expiration of certain U.S. Alternative Minimum Tax net operating loss carryforwards.\nMinority interests represents the share of M-I Drilling Fluids' profits associated with the 36% minority interest as well as minority interests in investments in other joint ventures held by M-I Drilling Fluids. Minority interests increased $7.0 million from $8.8 million in 1994 to $15.8 million in 1995. The increase in minority interests was primarily due to the higher level of M-I Drilling Fluids' earnings.\n1994 Versus 1993\nTotal revenues for 1994 increased by $433.2 million from $220.7 million in 1993 to $653.9 million in 1994. The increase was primarily due to the acquisitions of M-I Drilling Fluids, A-Z\/Grant and Lindsey and Supradiamant. In addition, the revenue increase reflected the higher North American drilling activity, increased drill bit sales in Latin America and increased drilling and completion services volume in the United States and Colombia.\nGross profit, computed as revenues less cost of revenues, increased by $141.3 million from $80.0 million in 1993 to $221.3 million in 1994. The increase was due to the acquisitions of M-I Drilling Fluids, A-Z\/Grant and Lindsey and Supradiamant and higher volumes in Canada and the United States. In addition, the increase in gross profit reflected increased drill bit volumes in Latin America and lower drilling and completion services operating costs in Europe\/Africa.\nOperating expenses, comprised of selling expenses and general and administrative expenses, increased by $99.8 million from $61.4 million in 1993 to $161.2 million in 1994. The increase was due primarily to the additional expenses associated with the newly acquired companies and increased variable costs related to the higher level of revenues partially offset by lower legal expenses as a result of the settlement of the drill bit litigation suit in 1993. Operating expenses as a percentage of revenues decreased from 27.8% in 1993 to 24.7% in 1994.\nInterest expense increased by $4.0 million from $6.0 million in 1993 to $10.0 million in 1994 due primarily to the additional $80.0 million of debt incurred to acquire M-I Drilling Fluids and higher variable interest rates. Interest income decreased by $2.4 million from $3.8 million in 1993 to $1.4 million in 1994 as a\nresult of reduced short-term investments as these funds were used in the acquisition of A-Z\/Grant and Lindsey in December 1993 and M-I Drilling Fluids and Supradiamant in 1994.\nThe effective tax rate for 1994 approximated 13.2% which was lower than the statutory rate. The income tax provision increased approximately $6.3 million from the prior year due to increased profitability of the Company's foreign operations. The effective tax rate for the year was lower than the statutory rate due to the utilization of U.S. net operating loss carryforwards which was somewhat offset by foreign tax provisions in excess of the U.S. tax rate.\nMinority interest represents the share of M-I Drilling Fluids' profits associated with the 36% minority interest which was partially offset by credits associated with other minority interests from investments in other joint ventures held by M-I Drilling Fluids.\nLIQUIDITY AND CAPITAL RESOURCES\nGeneral\nThe Company's financial condition remained strong at December 31, 1995. Working capital at December 31, 1995 increased approximately $42.7 million, or 16.6%, from the comparative period in the prior year. In 1995, cash generated internally exceeded cash required to support the Company's operations resulting in a $6.7 million increase in cash from the prior year-end.\nThe Company invested approximately $25.1 million in net property, plant and equipment additions during the year. Capital expenditures for 1996 are expected to increase to approximately $34.4 million, which includes routine additions of equipment used to support the Company's operations as well as expenditures to increase the productivity and efficiency of certain operations. The Company believes funds generated from operations and amounts available under existing credit facilities will be sufficient to finance capital expenditures and other working capital needs of the existing operations for the foreseeable future.\nThe Company's primary internal source of liquidity is cash flow generated from operations. External sources of liquidity include debt and, if needed, equity financing. At December 31, 1995, the Company had a $65.0 million revolving line of credit with a bank group and approximately $22.0 million of international borrowing facilities with various foreign banks. The Company had approximately $32.2 million of funds available for borrowing under these facilities at December 31, 1995. Additionally, a revolving line of credit facility of $20.0 million, which was established for the use of the M-I Drilling Fluids operating group, had available borrowing capacity of $10.0 million at December 31, 1995.\nThe Company believes that it has sufficient existing manufacturing capacity to meet current demand for its products and services.\nThe Company has been named as a potentially responsible party in connection with three sites on the U.S. Environmental Protection Agency's National Priorities List. At December 31, 1995, the recorded liability for estimated future clean-up costs for Superfund sites as well as properties currently or previously owned or leased by the Company was $6.0 million. As additional information becomes available, the Company may be required to provide for additional environmental clean-up costs. However, the Company believes that none of its clean-up obligations will result in liabilities having a material adverse effect on the Company's consolidated financial position or results of operations. See Item 3. \"Legal Proceedings -- Superfund\" for further discussion.\nBecause of its substantial foreign operations, the Company is exposed to currency fluctuations and exchange risks. To mitigate the effect of fluctuations in exchange rates on foreign denominated balances, the Company utilizes a protective hedge program. The program is designed to hedge net balance sheet positions which expose the Company to exchange rate risk. To the extent possible, the Company matches assets and liabilities denominated in foreign currencies and uses hedging instruments to cover certain unmatched positions.\nInflation has not had a material effect on the Company in the last few years, and the effect is expected to be minor in the foreseeable future. In general, the Company has been able to offset most of the effects of inflation through productivity gains, cost reductions and price increases.\nOn December 11, 1995, M-I Drilling Fluids signed a letter of intent related to the acquisition of Anchor Drilling Fluids A.S., a Norwegian company. Management anticipates financing the Company's portion of the purchase price by utilizing approximately $70.0 million of borrowings under a new credit facilities agreement, which is currently being negotiated. Aside from the planned acquisition, management continues to evaluate opportunities to acquire products or businesses complimentary to the Company's operations. These acquisitions may involve the use of cash or, depending upon the size and terms of the acquisition, may require debt or equity financing.\nNEW ACCOUNTING PRONOUNCEMENTS\nThe Financial Accounting Standards Board (the \"FASB\") issued Statement of Financial Accounting Standards (\"SFAS\") No. 121 \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of\". This statement is effective for fiscal years beginning after December 15, 1995. Management does not believe that adoption of this pronouncement in 1996 will have a material impact on its financial statements.\nThe FASB also issued SFAS No. 123, \"Accounting for Stock Based Compensation\", effective for fiscal years beginning after December 15, 1995. This statement allows companies to choose to adopt the statement's new rules for accounting for employee stock-based compensation plans. For those companies who choose not to adopt the new rules, the statement requires disclosures as to what earnings and earnings per share would have been if the new rules have been adopted. Management intends to adopt the disclosure requirements of this statement in 1996.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo Smith International, Inc.:\nWe have audited the accompanying consolidated balance sheets of Smith International, Inc. (a Delaware corporation) and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1995. These consolidated financial statements and schedule referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Smith International, Inc. and subsidiaries as of December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\nOur audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule listed in the accompanying index of financial statements is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\nAs discussed in Note 1 to the Notes to Consolidated Financial Statements, the Company adopted, effective January 1, 1993, Statement of Financial Accounting Standards (\"SFAS\") No. 109 \"Accounting for Income Taxes\" and SFAS No. 106 \"Employers Accounting for Postretirement Benefits other than Pensions\".\nARTHUR ANDERSEN LLP\nHouston, Texas February 7, 1996\nSMITH INTERNATIONAL, INC.\nCONSOLIDATED STATEMENTS OF OPERATIONS\nThe accompanying notes are an integral part of these financial statements.\nSMITH INTERNATIONAL, INC.\nCONSOLIDATED BALANCE SHEETS\nASSETS\nThe accompanying notes are an integral part of these financial statements.\nSMITH INTERNATIONAL, INC.\nCONSOLIDATED BALANCE SHEETS\nLIABILITIES AND SHAREHOLDERS' EQUITY\nThe accompanying notes are an integral part of these financial statements.\nSMITH INTERNATIONAL, INC.\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nThe accompanying notes are an integral part of these financial statements.\nSMITH INTERNATIONAL, INC.\nCONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (IN THOUSANDS, EXCEPT SHARE AND WARRANT DATA)\nThe accompanying notes are an integral part of these financial statements.\nSMITH INTERNATIONAL, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (ALL DOLLAR AMOUNTS ARE EXPRESSED IN THOUSANDS, UNLESS OTHERWISE NOTED)\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBasis of Presentation\nSmith International, Inc. (the \"Company\") manufacturers a wide range of products and provides services to customers in the oil and gas drilling and production industry. The consolidated financial statements include the accounts of the Company and all of its wholly-owned and majority-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated. Investments in affiliates of at least a 20 percent interest but not more than a 50 percent interest are accounted for using the equity method; all other investments are carried at cost, which does not exceed the estimated net realizable value of such investments.\nSignificant Risks and Uncertainties\nPreparation 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, the disclosed amounts of contingent assets and liabilities and the reported amounts of revenues and expenses. Actual results could differ from those estimates.\nCash and Cash Equivalents\nFor purposes of the Consolidated Statements of Cash Flows, the Company considers all highly liquid financial instruments purchased with an original maturity of three months or less to be cash equivalents.\nFixed Assets\nFixed assets, consisting of rental equipment and property, plant and equipment, are stated at cost. The Company computes depreciation on fixed assets using principally the straight-line method. The estimated useful lives used in computing depreciation range from 30 to 40 years for buildings, 3 to 20 years for machinery and equipment, and 3 to 7 years for rental equipment. Leasehold improvements are amortized over the lives of the leases or the estimated useful lives of the improvements, whichever is shorter. For income tax purposes, accelerated methods of depreciation are used.\nCost of major renewals and betterments are capitalized as fixed assets. Expenditures for maintenance, repairs and minor improvements are charged to expense when incurred. When fixed assets are sold or retired, the remaining cost and related reserves are removed from the accounts and the resulting gain or loss is included in the results of operations.\nValuation of Inventories\nInventories are stated at the lower of cost or market. Cost is determined by the last-in, first-out (\"LIFO\") method for substantially all of the domestic inventories and by the first-in, first-out (\"FIFO\") method for all other inventories. Inventory costs consist of materials, labor and factory overhead.\nGoodwill\nGoodwill is amortized over 40 years using the straight-line method. The Company continually evaluates whether subsequent events or circumstances have occurred that indicate the remaining useful life of goodwill may warrant revision or that the remaining balance of goodwill may not be recoverable. Management believes that there have been no events or circumstances which warrant revision to the remaining useful life or which affect the recoverability of goodwill.\nSMITH INTERNATIONAL, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nTranslation of Foreign Currencies\nFor the majority of the Company's international operations, the functional currency is the United States dollar. As a result, the accounts of these international operations are translated to United States dollars as follows: cash, receivables and related allowances, current liabilities and long-term debt are translated at year-end exchange rates; income and expense accounts, except for cost of inventory sold and depreciation and amortization are translated at average exchange rates during the year and all other accounts are translated at historical rates. All translation adjustments resulting from the translation of these financial statements to United States dollars are charged or credited to income currently.\nFor the remaining international operations of the Company, the functional currency is the applicable local currencies. The accounts of these operations are translated to United States dollars as follows: all asset and liability accounts are translated at year-end exchange rates, and income and expense items are translated at the average exchange rates during the year. Cumulative translation adjustments resulting from the translation of the financial statements of these operations to United States dollars are recorded as a separate component of shareholders' equity.\nAll foreign currency transaction gains and losses are credited or charged to income currently.\nForeign Exchange Contracts\nFrom time to time, the Company enters into spot and forward contracts under foreign exchange lines as a hedge against accounts payable in foreign currencies. Market value gains and losses on such forward contracts are recognized on a monthly basis, and the resulting amounts offset foreign exchange gains or losses on the related accounts payable as payments are made.\nThe Company also purchases foreign exchange option contracts to hedge certain operating exposures. Premiums paid under these contracts are expensed over the life of the option contract. Gains arising on these options are recognized at the time the options are exercised.\nEnvironmental Obligations\nExpenditures for environmental obligations 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 remedial efforts are probable and the costs can be reasonably estimated.\nIncome Taxes\nThe Company accounts for income taxes in accordance with Statement of Financial Accounting Standards (\"SFAS\") No. 109 \"Accounting for Income Taxes\" which was adopted in the first quarter of 1993. This standard requires an asset and liability approach for financial accounting and income tax reporting based on enacted tax rates.\nRevenue Recognition\nThe Company's revenues are composed of product sales and rental, service and other revenues. The Company records product sales when the goods are sold to a customer. Rental, service and other revenues are recorded as the services are performed.\nSMITH INTERNATIONAL, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nMinority Interests\nThe Company records minority interests expense which primarily represents the portion of the earnings of M-I Drilling Fluids L.L.C. (\"M-I Drilling Fluids\") applicable to the 36 percent minority interest partner. In addition, minority interests includes income and expense associated with M-I Drilling Fluids' minority interest ownership position in other joint ventures.\nEarnings Per Common Share\nEarnings per common share are computed on the basis of the weighted average number of common shares and equivalent shares outstanding during each year after deducting preferred dividends in 1993. Earnings per common share assuming full dilution, is substantially the same as primary earnings per common share as presented for each of the years in the period ended December 31, 1995.\nIncome per common share from discontinued operations was $1.95 and the loss per common share attributable to the change in accounting principle was $(.03) for the year ended December 31, 1993.\nEmployee Benefits\nDuring the first quarter of 1993, the Company adopted SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\". This standard changed the criteria for recognizing the cost of postretirement benefits from the cash basis to the recognition of such benefits over the employee service periods. As a result of adopting this standard, the Company recorded the total outstanding liability related to such retiree benefits of $1.3 million as the cumulative effect of a change in accounting principle in the 1993 Consolidated Statements of Operations.\nThe provisions of SFAS No. 87, \"Employers' Accounting for Pensions\", require an additional minimum liability to be recognized for a defined benefit plan to the extent that the accumulated pension benefit obligation exceeds the fair value of pension plan assets and any accrued pension liabilities. An offsetting intangible asset is recorded in the amount of the additional minimum liability, not to exceed the amount of any unrecognized prior service costs and any unrecognized transition obligation. Amounts exceeding the unrecognized prior service costs and unrecognized transition obligation are reflected in other current liabilities in the Consolidated Balance Sheets.\nReclassifications\nCertain prior year amounts have been reclassified to conform to current year presentation.\n2. ACQUISITIONS AND DIVESTITURES\nAcquisition of M-I Drilling Fluids\nOn February 28, 1994, the Company acquired a 64 percent interest in M-I Drilling Fluids from Dresser Industries, Inc. (\"Dresser\") for $160.0 million. M-I Drilling Fluids, which was owned 64 percent by Dresser and 36 percent by Halliburton prior to the acquisition, is a leading provider of drilling fluids and systems to the oil and gas drilling industry. The Company purchased the 64 percent interest in the operations using $80.0 million of its cash and issuing a note payable to Dresser for $80.0 million (See Note 4). The acquisition was accounted for as a purchase and, accordingly, the purchase price has been allocated to the assets acquired based on estimated fair values at the date of acquisition. The purchase price allocation resulted in the Company recording approximately $37.3 million of goodwill in connection with the transaction. The acquired operations have been included in results of operations since the acquisition date.\nM-I Drilling Fluids reported unaudited revenues of $75.4 million for the two months ended February 28, 1994 and $405.8 million for the year ended December 31, 1993.\nSMITH INTERNATIONAL, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nOther Acquisitions\nThe Company has acquired certain other operations during the period presented. These acquisitions have generally been financed with cash. All of these acquisitions have been accounted for as purchases and, accordingly, the purchase price has been allocated to the assets acquired based on estimated fair values at the date of acquisition. The acquired operations have been included in results of operations since their respective acquisition dates.\nIn 1993 and 1994, the Company acquired the operations of A-Z\/Grant and Lindsey Completion Systems (\"A-Z\/Grant\" and \"Lindsey\") and Supradiamant, S.A. (\"Supradiamant\"). On December 22, 1993, the Company acquired the product line assets of A-Z\/Grant and Lindsey Completion Systems from MASX Energy Services Group, Inc. for $19.0 million. A-Z\/Grant and Lindsey are leading providers of downhole tools, remedial services and liner hangers to the oil and gas industry. On July 1, 1994, the Company acquired Supradiamant from Societe Industrielle de Combustible Nucleaire for approximately $6.3 million. Supradiamant is a leading manufacturer of ultrahard materials, polycrystalline diamonds and cubic boron nitride.\nDuring 1995, M-I Drilling Fluids acquired the operations of Baker Hughes Treatment Services (\"BHTS\") and Fremont Chemical Company (\"Fremont\"). The BHTS operations were acquired from Baker-Hughes, Inc. on January 1, 1995 in exchange for approximately $5.1 million. BHTS is a leading supplier of waste minimization, product recovery services, water treatment, downhole injection and reserve pit remediation services to the oilfield industry. The Fremont operations were acquired on June 23, 1995 for approximately $2.7 million. Fremont is a major supplier of completion fluids in the Rocky Mountain region of the United States.\nThe balances included in the 1995 Consolidated Balance Sheet related to the Fremont acquisition are based upon preliminary information and are subject to change when additional information concerning final asset and liability valuations is obtained. Material changes in the preliminary allocation are not anticipated by management.\nThe unaudited pro forma revenues and income from continuing operations for the years ended December 31, 1995 and 1994 assuming the acquisitions of M-I Drilling Fluids, Supradiamant, BHTS and Fremont had occurred on January 1, 1994 are as follows:\nSale of Directional Drilling Business\nOn March 29, 1993, the Company sold its Directional Drilling systems and services (\"DDS\") business and certain of its subsidiaries and other affiliates to Halliburton Company (\"Halliburton\") for 6,857,000 shares of Halliburton common stock. In April 1993, the Halliburton common stock was sold for $247.7 million. As a result, the Company recorded income from discontinued operations of $73.6 million including the gain from the sale of the DDS business of $80.1 million. The gain includes provisions for various fees, expenses and taxes related to the DDS sale.\nSMITH INTERNATIONAL, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nThe Consolidated Statements of Operations reported the net results of the DDS operations as income from discontinued operations. The DDS business reported revenues of $36.3 million in the first three months of 1993. In determining the income from discontinued operations, interest expense of $1.3 million in 1993 has been allocated to the discontinued DDS operations based on the ratio of the estimated net assets sold in relation to the sum of the Company's shareholders' equity and the aggregate of outstanding debt at the end of the period.\n3. INVENTORIES\nInventories consist of the following at December 31:\n4. DEBT\nThe following summarizes the Company's outstanding debt at December 31:\nPrincipal payments of long-term debt are as follows:\nSMITH INTERNATIONAL, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nThe Company has a $46.0 million term loan maturing April 1, 2001. The term loan bears interest at a rate of 9.83 percent. The Company was in compliance with all of its loan covenants under the various loan indentures at December 31, 1995 and 1994.\nIn March 1994, the Company refinanced the $80.0 million note payable to Dresser issued to purchase its investment in M-I Drilling Fluids with a $40.0 million term loan from two of its insurance company lenders and a $65.0 million revolving line of credit from a bank group. The term loan bears interest at a rate of 6.02 percent and is payable over a period ending in January 1998. The revolving line of credit expires in March 1997 and bears interest at a rate ranging from LIBOR + 5\/8 percent to LIBOR +1 1\/4 percent based upon the debt-to-total capitalization of the Company. The revolving line of credit carries a commitment fee of 3\/8 percent of the unutilized credit facility.\nIn June 1994, the Company established a $20.0 million revolving line of credit for M-I Drilling Fluids with its existing bank lenders. This revolving line of credit expires in May 1996 and bears interest at the rate of LIBOR + 5\/8 percent. At December 31, 1995, the borrowing capacity under this revolving line of credit approximated $10.0 million. The Company has guaranteed its proportional 64 percent interest of the revolving line of credit or approximately $12.8 million. This revolving line of credit carries a commitment fee of 1\/4 percent of the unutilized credit facility.\nCertain of the Company's foreign subsidiaries have short-term lines of credit with various foreign banks totaling approximately $22.0 million. At December 31, 1995, borrowings of $4.4 million were outstanding under these lines. The majority of these lines are unsecured.\nThe Company's indentures relating to its long-term debt contain covenants restricting the payment of cash dividends to the Company's common stockholders based on net earnings and operating cash flow formulas as defined. The Company has not paid dividends on its Common Stock since the first quarter of 1986. In addition to complying with the covenants of the indentures, the determination of the amount of future cash dividends to be declared and paid on the Common Stock, if any, will depend upon the Company's financial condition, earnings and cash flow from operations, the level of its capital expenditures, its future business prospects and other factors that the Board of Directors deem relevant.\nInterest paid during the years ended December 31, 1995, 1994 and 1993 amounted to $14.3 million, $7.0 million and $9.2 million, respectively.\n5. FINANCIAL INSTRUMENTS\nThe carrying values of cash and cash equivalents, receivables, accounts payable and short-term debt approximate the fair market values due to the short-term maturities of these instruments. Management believes that the carrying amount of long-term debt is not materially different from the fair value using rates currently available for debt of similar terms and maturity.\nThe Company is a party to financial instruments described below with off balance sheet risks which it utilizes in the normal course of business to manage its exposure to fluctuations in interest rates and foreign currency exchange rates.\nForeign Currency Forward Contracts and Options\nAt December 31, 1995, the Company had outstanding foreign exchange contracts as a hedge against foreign accounts totaling $22.8 million maturing at various dates during 1996. There were no significant unrecorded gains or losses on these contracts as of December 31, 1995. The Company has outstanding foreign currency option contracts of $7.9 million at December 31, 1995 which expire at various dates in 1996. The Company has no loss exposure under these contracts.\nSMITH INTERNATIONAL, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nInterest Rate Contracts\nIn July 1993, the Company entered into an interest rate swap agreement which expires on October 1, 1997 with a financial institution in order to balance the portfolio of fixed rate and floating rate instruments of the Company. Under this agreement, the Company receives a fixed rate of 4.86 percent and pays a floating rate based on 6 month LIBOR on $46.0 million in borrowings. During 1995, the Company entered into various interest rate swap agreements to offset the original agreement, thereby limiting any exposure to future interest rate fluctuations. The net effect of these swap agreements has resulted in a minimal gain to date. At December 31, 1995, the estimated costs which will be incurred over the remaining lives of the swap agreements approximated $1.0 million.\n6. INCOME TAXES\nThe income tax provision (benefit) relating to continuing operations are summarized as follows:\nDeferred taxes are principally attributable to timing differences related to depreciation expense and net operating loss (\"NOL\") and tax credit carryforwards. In 1995, 1994 and 1993, the Company reported the tax benefit of operating loss carryforwards as a reduction in the provision for income taxes in accordance with SFAS No. 109.\nSMITH INTERNATIONAL, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nThe income tax provision computed by applying the U.S. Federal statutory rate to income (loss) from continuing operations before income taxes and minority interests is reconciled to the actual tax provision as follows:\nThe components of the net deferred tax asset are as follows:\nSMITH INTERNATIONAL, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nThe net change in deferred taxes of $0.8 million is primarily attributed to the acquisition of M-I Drilling Fluids as discussed in Note 2.\nFor U.S. tax reporting purposes, the Company has cumulative NOL carryforwards in the amount of approximately $51.4 million. These losses were generated in 1987, 1988 and 1992 in the amounts of $6.9 million, $42.3 million and $2.2 million, respectively. Losses in 1987, 1988 and 1992 are available to reduce future U.S. taxable income that may be generated through the years 2002, 2003 and 2007, respectively. On certain changes in equity ownership of the Company, the ability to utilize NOL carryforwards becomes subject to limitation under Section 382 of the Internal Revenue Code of 1986, as amended. In the opinion of management, the application of Section 382 will not materially limit the availability of net tax loss carryforwards.\nAlso available to reduce future U.S. income taxes are unused alternative minimum tax credits of $5.0 million and investment and other business tax credits of $6.9 million. The investment tax credits expire as follows: $2.5 million in 1997, $1.6 million in 1998, $1.5 million in 1999, $1.1 million in 2000 and $0.2 million in 2001 through 2004. Income taxes paid during the years ended December 31, 1995, 1994 and 1993 amounted to $3.8 million, $7.0 million, and $0.9 million, respectively.\nThe Company's foreign subsidiaries currently have undistributed earnings of $16.2 million which if repatriated would be generally sheltered from U.S. tax by NOL carryforwards and various foreign tax credits.\n7. CAPITAL STOCK\nCommon stock warrants\nOn February 28, 1995, the Company's Class A Warrants and the Company's Class B Warrants expired in accordance with the terms of the respective warrant agreements. During 1995, prior to expiration, 143,449 Class A Warrants and 123 Class B Warrants were exercised and converted into 143,572 shares of the Company's Common Stock. The Company received approximately $1.2 million in connection with this exercise and conversion of these warrants. As of December 31, 1995, there were no Class A Warrants and Class B Warrants outstanding.\nDuring 1990, the Company issued 300,000 shares of common stock and 451,357 Class C warrants to an international subsidiary of the Company. These Class C Warrants were exercisable until February 28, 1995 at a price of $1.00 per share. The Company recorded these warrants at their estimated value at the date of issue of $16.125 per warrant. This transaction is reflected as treasury securities in the Consolidated Balance Sheets and Consolidated Statements of Shareholders' Equity at December 31, 1994. In 1994, the international subsidiary exchanged the 451,357 Class C Warrants with the parent to acquire the parent's 64 percent interest in the Canadian drilling fluids subsidiary.\nTreasury securities\nIn addition to the Class C warrants noted above, the Company held approximately 158,400 shares of common stock obtained under a stock repurchase program at the end of 1995, 1994 and 1993. These shares are reflected as treasury securities in the Consolidated Balance Sheets and Consolidated Statements of Shareholders' Equity. In June 1993, the Board of Directors approved a stock repurchase program whereby the Company was authorized to buy up to 3 million shares of its outstanding common stock. The program contemplates that the Company may, from time to time, purchase shares in the open market. The program is funded by the Company's cash balances, of which approximately $1.3 million was utilized for the share repurchases.\nSMITH INTERNATIONAL, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nPreferred Stock\nIn 1988, the Company authorized the issuance of 5,000,000 shares of 8.75 percent convertible preferred stock. The convertible preferred stock carried a cumulative annual dividend of 8.75 percent ($2.1875 per share based on a $25 value) was payable quarterly and was convertible into common stock at $8 per share, subject to certain antidilution adjustments.\nIn June 1993, the Company called the remaining shares of preferred stock for redemption in accordance with the terms of the Certificate of Designation with regard to the preferred stock. All holders of the preferred stock surrendered their shares for conversion into 2,496,250 shares of common stock of the Company. For purposes of the Consolidated Statements of Cash Flows, this conversion of preferred stock to common stock is a non-cash transaction, and therefore, is not reflected in the Consolidated Statements of Cash Flows for the year ended December 31, 1993. As of December 31, 1995 and 1994, there were no shares of the preferred stock outstanding.\n8. EMPLOYEE STOCK OPTIONS, RESTRICTED STOCK AWARDS AND STOCK APPRECIATION RIGHTS\nAs of December 31, 1995, the Company has outstanding stock options granted under two plans: the 1989 Long-Term Incentive Compensation Plan (\"1989 Plan\") and the 1982 Stock Option Plan (\"1982 Plan\"). Matters such as vesting periods and expiration of options are determined on a plan by plan or grant by grant, basis. The options, exercisable at various dates through December 2003, are conditioned upon continued employment.\nThe following is a summary of stock option activity for the years ended December 31, 1995, 1994 and 1993:\nOf the options outstanding at December 31, 1995, 494,889 options with exercise prices ranging from $2.48 to $14.73 were exercisable. At December 31, 1994, 428,291 options granted at prices ranging from $2.48 to $14.73 were exercisable.\nIn addition, as part of the 1989 Plan, the Company granted 82,540 Stock Appreciation Rights in 1991 at an exercisable price range of $10.52 - $14.73 and 80,775 Stock Appreciation Rights in 1990 at an exercisable price range of $12.56 - $16.09. At December 31, 1995, there were 8,594 of these rights outstanding. These rights vest over a four year period from date of grant, and are exercisable until February 2001. Upon exercise of the rights, appreciation is paid by distributing cash or shares at the option of the Company.\nSMITH INTERNATIONAL, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nAt December 31, 1995, there were 691,428 shares of common stock reserved under the 1989 Plan for the future granting of stock options, awarding of additional restricted stock options and\/or awarding of additional Stock Appreciation Rights. No further options may be granted under the 1982 Plan.\n9. EMPLOYEE BENEFITS\nPension Plans\nThe Company has pension plans in the U.S. and the United Kingdom. Benefit accruals under the Company's U.S. pension plan, which have been frozen since 1987, covered substantially all the U.S. employees of the Company at that date. Due to the freezing of domestic pension benefits and fully funding those benefits in 1987, a contribution was not necessary for 1995, 1994 or 1993. Most of the employees of M-I Drilling Fluids are not covered by any pension plans.\nThe following tables detail the components of pension expense for the three years ended December 31, 1995, the funded status of the plans and major assumptions used to determine these amounts:\nReconciliation of Funded Status of the Plan:\nThe Company has several other pension plans covering certain international employees as well as a pension plan covering directors. Pension expense, total accumulated plan benefits and net assets available for benefits for these plans were not material at December 31, 1995, 1994 or 1993.\nSMITH INTERNATIONAL, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nRetirement Plans\nThe Company established the Smith International, Inc. 401(k) Retirement Plan (the \"Plan\") for the benefit of all eligible employees. Employees may voluntarily contribute up to 12 percent of compensation, as defined, to the Plan. The Company makes retirement and, in certain cases, matching contributions to each participant's account under the Plan. The Company's retirement contributions range from 2 percent to 6 percent of each participant's qualified compensation. In addition, the Company may provide discretionary matching contributions to participants who are employed by the Company on December 31. The Company's contributions to the Plan totaled approximately $3.9 million, $4.4 million and $2.9 million in 1995, 1994 and 1993, respectively.\nM-I Drilling Fluids has an employee 401(k) savings plan (the \"M-I Plan\") under which participating employees may defer up to 12 percent of their compensation, as defined, to the M-I Plan. Under the M-I Plan, 100 percent of the first 1 1\/2 percent of participants' contributions are matched by M-I Drilling Fluids. In addition, M-I Drilling Fluids provides a 3 percent basic contribution to all eligible employees. M-I Drilling Fluids' contributions to the M-I Plan approximated $2.2 million in 1995 and $1.7 million in 1994.\nPostretirement Benefit Plans\nThe Company and its subsidiaries provide certain health care benefits for retired employees. Most of the employees who retire from the Company are eligible for these benefits. During the first quarter of 1993, the Company adopted SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" and recorded the total outstanding liability related to such retiree benefits of $1.3 million as the cumulative effect of a change in accounting principle in the Consolidated Statements of Operations.\nPrior to May 1, 1993, the Company had two retiree medical coverage plans. Effective May 1, 1993 the two plans were combined into one plan, the Smith International, Inc. Retiree Medical Plan. The plan provides postretirement medical benefits to retirees and their spouses. The retiree medical plan has an annual limitation (a \"cap\") on the dollar amount of the Company's portion of the cost of benefits incurred by retirees under the plan. The remaining cost of benefits in excess of the cap is the responsibility of the participants. The cap will be adjusted annually for inflation, which is currently assumed to be 4 percent.\nPrior to January 1, 1994 M-I Drilling Fluids had provided retiree medical coverage to its employees under the M-I Drilling Fluids Retiree Medical Plan. Eligibility for inclusion in that plan was closed as of January 1, 1994, to the majority of M-I Drilling Fluids' employees. The plan continues to provide post- retirement medical coverage to the eligible retirees and their dependents. M-I Drilling Fluids contributes to the cost of the benefits under this plan; however, these costs are reviewed annually for inflation, and limited to a maximum 5 percent increase in M-I Drilling Fluids' contribution per year. Any costs in excess of M-I Drilling Fluids' maximum contribution is the responsibility of the retiree or their dependents.\nSMITH INTERNATIONAL, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nThe following table sets forth the plans' unfunded status reconciled with the amount shown in the Company's Consolidated Balance Sheets at December 31:\nPostretirement benefit expense recognized in income from continuing operations for the three years ended December 31, 1995 is summarized as follows:\nThe health care cost trend rate assumption can have a significant effect on the amounts reported. For measurement purposes, an 10 percent, 11 percent and 12 percent annual rate of increase in the per capita cost of covered health care benefits was assumed for 1995, 1994 and 1993, respectively. The rate was assumed to gradually decrease to 7 percent for 1998 and to remain at that level thereafter. An increase of one percentage point in the health care cost trend rate would increase the accumulated postretirement benefit obligation and the aggregate of the service and interest cost components of the postretirement benefits expense by $1.1 million and $0.1 million, respectively.\nThe weighted-average discount rates used in determining the accumulated postretirement benefit obligation for 1995, 1994 and 1993 were 8.4 percent, 8.5-8.9 percent and 7.0 percent, respectively.\n10. STOCKHOLDERS' RIGHTS PLAN\nOn June 19, 1990, the Company adopted a Stockholder Rights Plan (\"the Rights Plan\"). The Rights Plan provides for a dividend distribution of one preferred stock purchase right (\"Right\") for each outstanding share of the Company's Common Stock, to shareholders of record at the close of business on June 29, 1990. The Rights Plan is designed to deter coercive takeover tactics and to prevent an acquirer from gaining control of the Company without offering a fair price to all of the Company's shareholders. The Rights will expire on June 19, 2000.\nEach Right entitles shareholders to buy one-hundredth of a newly issued share of Series A Junior Participating Preferred Stock of the Company at an exercise price of $50. The Rights are exercisable only if a person or group (a) acquires beneficial ownership of 20 percent or more of the Common Stock or (b) acquires beneficial ownership of 1 percent or more of the Company's Common Stock if such person or group is a 20 percent-or-more shareholder on the date when the Rights dividend distribution is declared or (c) commences a tender or exchange offer which upon consummation such person or group would beneficially\nSMITH INTERNATIONAL, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nown 20 percent or more of the Common Stock of the Company. However, the Rights will not become exercisable if Common Stock is acquired pursuant to an offer for all shares which a majority of the independent directors, excluding all officers of the Company, determine to be fair to and otherwise in the best interests of the Company and its shareholders.\nIf any person or group becomes the beneficial owner of 20 percent or more of the Company's Common Stock, or acquires 1 percent or more of the Common Stock if such person or group is a 20 percent-or-more shareholder on the date when the Rights dividend distribution is declared, other than (in either case) pursuant to an offer for all shares as described above, then each Right not owned by such person or group or certain related parties will entitle its holder to purchase, at the Right's then current exercise price, shares of the Company's Common Stock (or, in certain circumstances as determined by the Board, cash, other property, or other securities) having a value of twice the Right's exercise price. In addition, if, after any person becomes the beneficial owner of 20 percent or more of the Company's Common Stock, or acquires 1 percent or more of the Common Stock if such person is a 20 percent-or-more shareholder on the date when the Rights dividend distribution is declared, the Company is involved in the merger or other business combination transaction with another person in which its Common Stock is changed or converted, or sells 50 percent or more of its assets or earning power to another person, each Right will entitle its holder to purchase, at the Right's then current exercise price, shares of common stock of such other person having a value of twice the Right's exercise price.\nThe Company will generally be entitled to redeem the Rights at $.01 cents per Right at any time until the tenth business day (subject to extension) following public announcement that a person has become the beneficial owner of 20 percent or more of the Company's Common Stock, or acquires 1 percent or more of the Common Stock if a 20 percent-or-more shareholder on the date when the Rights dividend distribution is declared.\n11. QUARTERLY INFORMATION (UNAUDITED)\nIncluded in the results for 1995 are a full year of the operations of A-Z\/Grant and Lindsey, M-I Drilling Fluids, Supradiamant and BHTS, in addition to six months of operations of Fremont. For a further discussion of these acquisitions, see Note 2.\nSMITH INTERNATIONAL, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nIncluded in the results for 1994 are a full year of the operations of A-Z\/Grant and Lindsey, ten months of operations for M-I Drilling Fluids and six months of operations of Supradiamant. For a further discussion of these acquisitions, see Note 2.\n12. INDUSTRY SEGMENTS AND INTERNATIONAL OPERATIONS\nThe Company operates primarily in one industry segment, the petroleum services segment. The products and services of the petroleum services segment are primarily used in the drilling of oil and gas wells. No single customer represented in excess of 10 percent of total revenues during any of the years presented.\nThe following table presents financial information about foreign and domestic operations and export sales:\nGeneral corporate expenses and interest income and expense have been excluded from income from continuing operations before interest and taxes in the table above. Results of operations as reported in the accompanying consolidated financial statements include general corporate expenses of $10.4 million in 1995, $10.2 million in 1994 and $5.9 million in 1993.\nSMITH INTERNATIONAL, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nTransfers between geographic areas, which are eliminated upon consolidation, are excluded from the above presentation. These transfers are recorded by the Company and its subsidiaries based on their various intercompany pricing agreements. U.S. sales to affiliates amounted to $126.1 million, $85.2 million and $58.7 million in 1995, 1994 and 1993, respectively. International sales to affiliates approximated $58.2 million, $47.0 million and $23.1 million in 1995, 1994 and 1993, respectively.\nThe Company's revenues are derived principally from uncollateralized sales to customers in the oil and gas industry. This industry concentration has the potential to impact the Company's exposure to credit risk, either positively or negatively, because customers may be similarly affected by changes in economic or other conditions. The creditworthiness of this customer base is strong, and the Company has not experienced significant credit losses on such receivables.\n13. COMMITMENTS AND CONTINGENT LIABILITIES\nLeases\nThe Company has entered into operating and capital leases for certain of its facilities and equipment. At December 31, 1995 and 1994, machinery and equipment included $3.0 million and $3.2 million, respectively, of assets under capital lease for which accumulated amortization approximated $1.3 million and $1.1 million in 1995 and 1994, respectively. These capital leases are recorded in other current and other long-term liabilities in the accompanying Consolidated Balance Sheets.\nFuture minimum payments under all non-cancelable leases having initial terms of one year or more are as follows:\nLitigation\nThe Company is a defendant in various legal proceedings arising in the ordinary course of business. A description of certain of these proceedings follows.\nThe Company was named a defendant in an action entitled Lynn Martin, Secretary of the U.S. Dept. of Labor v. Smith International, Inc., et al., which alleged violations of the Employee Retirement Income Security Act of 1974 (\"ERISA\") arising out of the Company's purchase of Executive Life Insurance Company (\"Executive Life\") annuities. Executive Life was placed in conservatorship in 1991 by the California Insurance Commissioner and has since emerged from conservatorship as Aurora National Life Assurance Company, Inc. (\"Aurora\"). Aurora will honor in part Executive Life's past and continuing commitments under the annuities outstanding; however, a portion of these obligations will not be paid. In December 1994, the parties agreed in principle to a settlement. Pursuant to a consent order, the Company paid $4.07 million into an escrow account, the majority of which was paid by the Company's insurance carrier. The Company recognized its portion of the settlement of approximately $1.0 million in 1994. The settlement is still on deposit in the escrow account as the Department of Labor has not yet finalized the timing, amount or\nSMITH INTERNATIONAL, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nmanner of the distributions to the Plan participants. In the opinion of management, this matter will not have a material adverse effect on the Company's consolidated financial condition or results of operations.\nThe Company is involved in several actions relating to alleged liability in connection with the U.S. Environmental Protection Agency's (\"EPA\") National Priorities List (\"NPL\") sites:\nSheridan. On March 31, 1987, the Sheridan Site Committee (the \"Committee\") filed a claim on behalf of itself and 59 potentially responsible parties (\"PRPs\") at the Sheridan Disposal Services site in Hempstead, Texas, a NPL site. The claim was based on the Company's alleged liability to the claimants for \"contribution and potential cost recovery for administrative and remedial work\" expenses incurred and to be incurred by them in connection with the Sheridan Disposal site. On August 28, 1987, the Company reached a settlement and agreed to pay its allocable share of response costs incurred by the Committee, such share to be limited to the lesser of $3.0 million or 2.93 percent of actual response costs. Based upon an EPA Record of Decision (\"ROD\"), total remediation costs are estimated, on a preliminary basis, to be approximately $28 million. On this basis, the Company's share would be $0.8 million.\nOperating Industries. Under the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (the \"Superfund Act\"), the EPA has been conducting various activities at the Operating Industries, Inc. (\"OII\") site, a disposal site on the NPL located in Monterey Park, California. The United States, on behalf of the EPA, filed a proof of claim in the Company's Chapter 11 case alleging that it had incurred approximately $8.0 million in response costs to date, and would continue to incur response costs in the future. Subsequently, the United States alleged that its costs had increased to over $10 million. On June 14, 1988, the United States District Court entered an order approving a Stipulation and Agreement to Compromise and Settle EPA's claim against the Company's estate (the \"OII Settlement Agreement\"). Under the OII Settlement Agreement, the claim of the United States was allowed as an amount (approximately $150,000) sufficient to entitle the EPA to a distribution pursuant to the Company's plan of reorganization. The Company further agreed to pay its allocable share of total future site response costs at the OII site, such share, however, to be limited to the lesser of $5.0 million or 0.65 percent of future site response costs.\nActual remediation of the OII Site is likely to extend for a number of years after a final remedy is selected for the site. The EPA issued an ROD with respect to the OII Site that estimates remediation costs of $300 million. At this time, the Company is unable to determine the amount it may ultimately have to contribute to the OII site pursuant to the OII settlement agreement. This amount will range from the approximately $150,000 that the Company has already paid to the $5.0 million at which the Company's liability is capped under the OII Settlement Agreement.\nChemform. The Company operated a business and held a leasehold interest in property located in Pompano Beach, Florida (the \"Chemform Site\") between May 14, 1976 and March 16, 1979, at which time the Company sold the business and assigned the lease. The EPA placed the Chemform Site on the NPL on October 4, 1989. On September 22, 1992, the EPA issued the ROD for a portion of the Chemform Site. The ROD selected a \"No Action with Monitoring\" alternative, under which groundwater would be monitored quarterly for at least one year. Although the Company and two other PRPs have completed four quarters of groundwater monitoring, the Florida Department of Environmental Protection (\"Florida DEP\") has requested that additional monitoring be performed. The Company and two other PRPs are presently conducting discussions with the EPA and the Florida DEP regarding whether additional monitoring work will be required and, if so, what the scope of such work will be. The final scale of the monitoring work is not yet known. It is also not yet known whether any groundwater remediation work will thereafter be required.\nOn September 16, 1993, the EPA issued the ROD for the remainder of the Chemform Site, which addressed site-related soil contamination. The ROD determined that no further Superfund action was necessary to address Operable Unit Two at the site; however, the Florida DEP requested that additional soil be\nSMITH INTERNATIONAL, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nremoved at the Chemform Site. The Company and the two other PRPs performed the soil removal requested under the oversight of the Florida DEP and has provided a Technical Memorandum summarizing this action to the EPA and the Florida DEP. The Company has not received any written response from either the EPA or the Florida DEP. As the EPA still retains jurisdiction over the Chemform Site, it is possible that additional issues may arise which would require further resolution. The Company believes that the EPA will demand reimbursement of certain oversight expenses that the EPA allegedly has incurred in administering the Chemform Site. The Company intends to scrutinize and, if necessary, vigorously contest any such claims made by the EPA.\nAt December 31, 1995, the remaining recorded liability for estimated future clean-up costs for the sites discussed above as well as properties currently or previously owned or leased by the Company was $6.0 million. As additional information becomes available, the Company may be required to provide for additional environmental clean-up costs for Superfund sites and for properties currently or previously owned or leased by the Company. However, the Company believes that none of its clean-up obligations will result in liabilities having a material adverse effect on the Company's consolidated financial position or results of operations.\nLitigation Settlement. In 1993, the Company recorded a special charge of $19.9 million relating to the settlement of three civil actions which alleged violations of Section 1 of the Sherman Act. On August 27, 1993, without admitting any form of liability, the Company entered into an agreement with the plaintiffs to settle all claims against the Company. The litigation settlement appearing in the 1993 Consolidated Statements of Operations consists of the settlement cost of $16.8 million and estimated legal fees and other expenses.\n14. POTENTIAL ACQUISITION (UNAUDITED)\nOn December 11, 1995, M-I Drilling Fluids signed a letter of intent to acquire Anchor Drilling Fluids A.S., a Norwegian company, in a transaction which is expected to be accounted for as a purchase. Management anticipates financing the Company's portion of the purchase price by utilizing approximately $70.0 of borrowings under a new credit facilities agreement, which is currently being negotiated.\nThe transaction is subject to, among other conditions, execution of a Definitive Agreement and approval by various governmental entities in the United States and Norway. There are no assurances as to whether this transaction will be ultimately consummated.\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\nFor information concerning directors of the Registrant, see the information set forth following the caption \"ELECTION OF DIRECTORS\" in the Company's definitive proxy statement to be filed no later than 120 days after the end of the fiscal year covered by this Form 10-K (the \"Proxy Statement\"), which information is incorporated herein by reference. For information concerning executive officers of the Registrant, see ITEM 4A appearing in Part I of this Form 10-K.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information set forth following the caption \"EXECUTIVE COMPENSATION AND OTHER INFORMATION CONCERNING EXECUTIVE OFFICERS\" in the Company's Proxy Statement is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information set forth following the captions \"ELECTION OF DIRECTORS\" and \"SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS\" in the Company's Proxy Statement is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information set forth following the captions \"ELECTION OF DIRECTORS\" and \"EXECUTIVE COMPENSATION AND OTHER INFORMATION CONCERNING EXECUTIVE OFFICERS\" in the Company's Proxy Statement is incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(A) FINANCIAL STATEMENTS\nAll other schedules have been omitted since the required information is not present or not present in amounts sufficient to require submission of the schedule, or because the information required is included in the consolidated financial statements or notes thereto.\n(3) Exhibits and Index to Exhibits\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.\nSCHEDULE II\nSMITH INTERNATIONAL, INC.\nVALUATION AND QUALIFYING ACCOUNTS AND RESERVES (DOLLARS IN THOUSANDS)\n- ---------------\n(a) Amount represents accounts receivable reserves related to M-I Drilling Fluids, L.L.C. and Supradiamant upon purchase by the Company during the year ended December 31, 1994.\n(b) Amount represents the reclassification of certain reserves relating to long-term receivables to trade 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.\nSMITH INTERNATIONAL, INC.\nBy: \/s\/ DOUGLAS L. ROCK _____________________________ Douglas L. Rock Chief Executive Officer, President and Chief Operating Officer\nMarch 20, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities on the date indicated:\nINDEX TO EXHIBIT","section_15":""}
{"filename":"719529_1995.txt","cik":"719529","year":"1995","section_1":"ITEM 1. BUSINESS\nPRODUCTS\nImmunex Corporation (\"Immunex\" or the \"Company\") is a biopharmaceutical company that discovers and develops, manufactures and markets innovative therapeutic products for the treatment of cancer, infectious diseases and autoimmune disorders.\nImmunex is currently manufacturing and marketing LEUKINE-Registered Trademark- granulocyte-macrophage colony stimulating factor (\"GM-CSF\"), and marketing NOVANTRONE-Registered Trademark- (mitoxantrone) and five additional oncology products (the foregoing products other than LEUKINE, together with certain other products under development, are referred to herein as the \"Lederle Oncology Products\") in the United States. As a result of the 1993 merger (the \"Merger\") of Immunex and Lederle Oncology Corporation, a subsidiary of American Cyanamid Company (\"Cyanamid\") created for the purpose of merging Cyanamid's Lederle Laboratories North American oncology business (the \"Lederle Oncology Business\") with the biopharmaceutical business of Immunex, Immunex was assigned certain rights relating to the Lederle Oncology Products in the United States and Canada. Cyanamid currently owns approximately 54.3% of the outstanding common stock of Immunex, on a fully diluted basis. In November 1994, American Home Products Corporation (\"AHP\") acquired all of the common stock of Cyanamid. Prior to the acquisition of Cyanamid by AHP, Immunex and AHP entered into an agreement under which AHP agreed to protect Immunex's rights under its agreements with Cyanamid and be bound by Cyanamid's obligations under such agreements, including certain standstill restrictions agreed to by Cyanamid in connection with the Merger. As discussed below, AHP or various divisions or affiliates of AHP, including Wyeth-Ayerst Research, Wyeth-Ayerst Laboratories and Wyeth-Ayerst International, Inc., have assumed certain of the rights and obligations of Cyanamid under the various agreements that Immunex and Cyanamid entered into at the time of the Merger or thereafter. In the following discussion, \"AHP\" refers to AHP, or its various divisions or affiliates, including Cyanamid.\nImmunex, alone or with Wyeth-Ayerst Research, is testing five new proprietary biotechnology products in human clinical trials: soluble tumor necrosis factor receptor fusion protein (\"TNFR-Fc\"), PIXY321 (a patented colony stimulating factor fusion protein), soluble IL-1 receptor (\"IL-1R\"), soluble IL- 4 receptor (\"IL-4R\") and a humanized monoclonal antibody conjugate (\"CMA-676\"). Wyeth-Ayerst Research and Immunex are investigating certain other anticancer compounds on a preclinical basis, including a second humanized monoclonal antibody conjugate and chemical-based colony-stimulating factor (\"CSF\") inducers.\nPharmaceutical products under development are required to undergo several phases of testing before receiving approval for marketing. In the preclinical phase, a product is evaluated in animal models of human disease to enable preparation of an investigational new drug application (\"IND\"). There are three phases of clinical trials. In general, Phase I trials determine the safety of a proposed therapeutic for administration to patients; Phase II trials examine efficacy and dosing; and Phase III trials, which may be placebo-controlled, measure the efficacy of a proposed therapeutic in comparison to approved therapies. These trials generate the data required for regulatory approval to market products.\nData from human trials are submitted to the Food and Drug Administration (the \"FDA\") in a new drug application (\"NDA\") or a product license application (\"PLA\") and, with respect to products to be marketed in Canada, to the Canadian Health Protection Bureau (\"CHPB\") in a new drug submission (\"NDS\"). Data regarding manufacturing and bioequivalence of generic drug products are submitted to the FDA in an abbreviated NDA (\"ANDA\") and to the CHPB in an abbreviated NDS (\"A\/NDS\"). Preparing an NDA, PLA, NDS, ANDA or A\/NDS involves considerable data collection, verification and analysis.\nA summary of the Company's products is provided in the following tables. The information in the tables is provided solely for convenience of reference and is qualified in its entirety by the detailed discussion of each product and the related research and development activities following the tables.\nProducts for which Immunex owns marketing rights are described in the table below.\n_______________________________________\n(1) LEUKINE is approved in the United States for the clinical indications described in the foregoing table. Immunex has submitted amendments to its GM-CSF product license, seeking FDA approval for additional label indications for prophylaxis of chemotherapy-induced neutropenia in patients with solid tumors. In 1994, Immunex and AHP re-acquired all rights in GM-CSF previously held by Behringwerke AG (\"Behringwerke\"), a subsidiary of Hoechst AG (\"Hoechst\"). See \"Certain Relationships of Immunex - Relationship With Hoechst AG.\"\n(2) NOVANTRONE, THIOPLEX, methotrexate injectable, AMICAR and leucovorin calcium, are currently distributed in Canada by Wyeth-Ayerst International, Inc. pursuant to a distribution agreement with Immunex.\nCertain Immunex products are being developed for marketing by collaborators under various license agreements. These products, collaborators and clinical indications are set forth in the table below:\n- -------------------------------------\n(1) LEUKINE is approved in the United States for the clinical indications described in the foregoing tables. Immunex produces all sargramostim marketed in the United States and employed in clinical testing worldwide, and has agreed to supply AHP's requirements for marketing outside the United States.\n(2) Hoffmann-La Roche, Inc. and its parent, F. Hoffmann La Roche & Company, Limited Company of Basel, Switzerland (collectively, \"Roche\"), and Chiron are parties to certain IL-2 license and marketing agreements, pursuant to which Roche and a Chiron subsidiary, EuroCetus B.V., are co-promoting Chiron IL-2 (PROLEUKIN-Registered Trademark- IL-2) in several European countries. PROLEUKIN IL-2 was approved by the FDA for marketing in the United States in June 1992 and is being marketed by Cetus Oncology, a wholly owned subsidiary of Chiron. Under its agreements with Roche, Immunex is receiving royalties on sales of IL-2 products in Europe and the United States by Roche or Chiron.\nCYTOKINE PRODUCTS\nMost of the Company's biotechnology products are recombinant analogs of cytokines and cytokine receptors. Cytokines are protein messengers that coordinate the functions of immune cells (white blood cells) and certain other cells and tissues. Immune cells include: granulocytes, macrophages and eosinophils, all of which are scavenger cells specialized for uptake and disposal of foreign particles or infectious agents; B-cells, which produce antibodies to \"flag\" foreign particles or diseased cells for destruction; cytotoxic T-cells and natural killer cells, which recognize, contact and kill cancerous or virus-infected cells; and helper T-cells, which control and coordinate the function of other immune cells. Immunex has developed recombinant cytokine products capable of expanding and activating these immune cell populations, all of which must interact to provide a normal immune response. Immunex has also cloned and expressed genes encoding cytokine receptors. Using genetic engineering techniques, Immunex has produced soluble versions of cytokine receptors, including fusions of soluble receptors with fragments of human antibodies, that have been shown to be capable of suppressing immune responses by binding to and inactivating cytokines.\nLEUKINE (SARGRAMOSTIM, GM-CSF). GM-CSF stimulates the growth and differentiation of granulocytes and macrophages. In 1984, Immunex cloned and expressed a human GM-CSF gene, and subsequently designed an altered, or analog, form of the protein. This analog, which is exclusively manufactured by Immunex using recombinant yeast technology, has been designated \"sargramostim.\" Sargramostim possesses the biological activity of natural human GM-CSF but is a chemically distinct molecule. Immunex has been granted two U.S. patents and one European patent covering sargramostim. Certain competitors, however, have filed patent applications or have been issued patents relating to GM-CSF that could adversely affect the Company's ability to market LEUKINE. See \"Patents, Licenses and Trademarks.\"\nClinical testing has demonstrated that GM-CSF is effective in facilitating bone marrow transplant (\"BMT\") therapies currently used for the treatment of acute leukemia, lymphoma and Hodgkin's disease and in rescuing patients whose BMT grafts have failed. In March 1991, the FDA approved GM-CSF for facilitating BMT engraftment and in December 1991 approved GM-CSF for treatment of BMT graft failure. In March 1993, Immunex filed an amendment to the LEUKINE PLA to obtain FDA approval for an additional label indication for prophylaxis of chemotherapy-induced neutropenia. Since the 1993 filing, Immunex has supplemented the original filing with additional data as it became available. In April 1995, the FDA Biological Response Modifiers Committee declined to recommend approval of LEUKINE for the neutropenia indication. The Committee's decision not to recommend approval contravened a prior agreement between the FDA and Immunex regarding the acceptability of surrogate clinical endpoints (e.g., neutrophil recovery data) as primary endpoints for approval. In view of this and certain other issues concerning the Committee's decision making process, Immunex has continued to seek approval of this indication. Immunex has met with the FDA to discuss various approaches to approval of this indication and updated its amendment by filing supplemental data acquired from ongoing clinical studies. Thus, the PLA amendment for the neutropenia indication is still pending at the FDA. Although Immunex believes that this amendment to the LEUKINE PLA is approvable, no assurances can be given regarding the duration or outcome of the FDA review process.\nIn April 1994, Immunex filed a second amendment to its LEUKINE PLA to obtain approval of a label indication for acceleration of neutrophil recovery and reduction of mortality associated with treatment of patients with AML. This new indication was approved in September 1995. In late 1995, Immunex received marketing approval of additional label indications for allogeneic BMT and for PBPC mobilization and transplantation.\nIn 1994, Immunex began Phase II\/III clinical trials to investigate the efficacy of GM-CSF therapy for preventing infections in premature neonates and in surgery and trauma patients. A planned cohort analysis in the neonatal sepsis trial was completed in November 1995, which indicated that the infants receiving LEUKINE experienced significantly fewer infections. A Phase III study in this indication is continuing. In January 1995, Immunex filed a supplemental PLA with the FDA to obtain approval of a liquid formulation of LEUKINE, which Immunex plans to provide in 500 microgram and 1 milligram multi-dose vials. The liquid formulation will be more convenient to use and store than the current lyophilized formulation. The supplemental PLA is currently being reviewed by the FDA. Immunex has also developed a proprietary microsphere formulation for LEUKINE that may permit the drug to be administered in a single injection and slowly released into the body. This formulation may be useful as a vaccine adjuvant. In 1995, Immunex entered into a research and license agreement with Johns Hopkins University (JHU) to evaluate the utility of LEUKINE microspheres in conjunction with certain tumor vaccines being researched by JHU.\nPIXY321. In 1991, Immunex commenced clinical trials of a GM-CSF\/IL-3 fusion protein that stimulates the body's production of neutrophils and platelets. In Phase I\/II clinical studies conducted in the United States and Canada, PIXY321 has shown the ability to raise levels of neutrophils and platelets in patients receiving myelosuppressive chemotherapy. Immunex has been granted U.S. and European patents covering GM-CSF\/IL-3 fusion proteins and recombinant DNA technologies for producing such fusion proteins. Additional patents in other countries covering GM-CSF\/IL-3 fusion proteins have been granted or are pending. Certain competitors, however, have filed patent applications or have been issued patents relating to GM-CSF or IL-3 that could adversely affect the Company's ability to commercialize PIXY321. See \"Patents, Licenses and Trademarks.\"\nIn January 1992, Immunex and Bristol-Myers Squibb (\"BMS\") entered into a product exchange agreement (the \"BMS Agreement\") relating to the development and marketing of PIXY321 and certain other oncology products. The BMS Agreement was terminated by BMS in December 1993, resulting in the return of product rights to each party. Following the return of rights by BMS, Immunex licensed exclusive rights for PIXY321 to AHP in all territories except the U.S. and Canada. See \"Relationship with AHP and Cyanamid.\"\nIn October 1995, Immunex completed a preliminary analysis of a multicenter Phase III clinical study of PIXY321 in treating cancer patients receiving BMT for non-Hodgkin's lymphoma. The results showed that the product was safe and raised platelets and neutrophils as well as LEUKINE, the control drug used in the study. However, a statistically significant improvement over the control drug was not achieved. A Phase I study of PIXY321 following chemotherapy in pediatric solid tumor patients indicated improvements in recovery of blood cells of multiple lineages. A Phase III trial that compared PIXY321 to G-CSF in the setting of high-dose chemotherapy showed no increased benefit from PIXY321. In view of these results, Immunex and AHP are currently re-assessing whether further development of PIXY321 is warranted. There can be no assurances that any further development activities involving PIXY321 will be undertaken.\nINTERLEUKIN-2 (\"IL-2\"). IL-2 is a cytokine that controls the proliferation and activation of T cells. It can both augment normal immune function and help restore deficient immune responses. In 1983, Immunex entered into license agreements with Roche, pursuant to which Immunex is receiving royalties on worldwide sales of IL-2 products by Roche and its sublicensees, including Chiron. Chiron's PROLEUKIN-Registered Trademark- IL-2 was approved for treatment of metastatic renal cancers in several European countries in 1990 and 1991. In June 1992, the FDA approved the marketing of PROLEUKIN IL-2 for treating metastatic renal cancer patients who are asymptomatic or who are symptomatic but ambulatory. PROLEUKIN is a trademark of Chiron.\nIn February 1990, Immunex and Ajinomoto of Japan entered into certain agreements concerning IL-2 rights in Japan, Korea and Taiwan. Under these agreements, Immunex is entitled to royalties based on sales of IL-2 in such countries by Ajinomoto and its licensees.\nNEW CYTOKINES. Immunex scientists have cloned genes encoding several new cytokines that are now being characterized in preclinical studies.\nFLT3-L. In 1992, Immunex cloned cDNAs encoding a ligand for the Flt3 receptor (\"Flt3-L\"). Flt3-L binds to a receptor that is located on primitive hematopoietic cells, and has been shown to be capable of mobilizing PBPC in combination with other cytokines such as GM-CSF or G-CSF. Flt3-L is currently the subject of manufacturing scale-up and preclinical studies intended to assess the utility of this factor in augmenting harvest of PBPC and other hematopoietic precursors for transplantation following chemotherapy. Flt3-L has also been shown to be useful in culturing dendritic cells, specialized immune cells that are involved in the presentation of antigens to T-cells and therefore provide a new approach to developing vaccine adjuvants. Immunex plans to commence Phase I studies of Flt3-L as a PBPC mobilizer in 1996.\nINTERLEUKIN-15. In 1992, Immunex also cloned cDNAs encoding a cytokine now known as Interleukin-15 (\"IL-15\"), a T cell growth factor that mimics the effects of IL-2. IL-15 has also shown the ability to protect the intestinal epithelial cells in the mucosa from the harmful effects of chemotherapy or radiation. IL-15 was examined in preclinical studies in 1995, and such studies are anticipated to be continued in 1996.\nCD40-L. In 1992, Immunex cloned cDNAs encoding a ligand for the cell surface antigen CD40 (\"CD40-L\"). This ligand appears to be a required signal in the development of an antibody-based immune response. Thus, CD40-L may be useful as a vaccine adjuvant. In addition, soluble CD40-L has been shown to be useful in directly arresting the growth of certain B-cell lymphomas and epithelical cancers in laboratory experiments. Immunex intends to commence toxicology studies of CD40-L in 1996.\nOTHER NEW CYTOKINES: LERKS. Immunex has cloned and expressed cDNAs for a family of molecules known as \"ligands for eph-related protein kinases\" or \"LERKS,\" of which the ligands for Hek and Elk are members. These ligands and their receptors appear to be involved in cell-to-cell signaling that occurs in coordinating growth and differentiation of selected cell types. The ligand for the cell receptor Hek has shown the ability to stimulate neural cell growth. In 1995, Immunex granted an exclusive, royalty-bearing worldwide license for neurobiology uses under its LERK patent rights and technology to Genentech, Inc.\nRECEPTOR PRODUCTS\nCytokines act upon immune cells by binding to specific receptors. The binding of a cytokine to its receptor triggers a complex series of events within a responsive cell that transmits the cytokine's signal to that cell. This signal can stimulate cell division or production of antibodies, enzymes or other cytokines. In this way, circulating cytokines can control and coordinate the function of immune cells located throughout the body.\nUsing genetic engineering techniques, Immunex scientists have produced soluble versions of cytokine receptors. A soluble cytokine receptor retains the ability to bind to a specific cytokine, but lacks that portion of the natural receptor that is attached to a cell. This property enables the soluble cytokine receptor to circulate in the body after administration, where it can bind to and inactivate circulating cytokines, preventing interaction of the cytokines with immune cells and thereby neutralizing the development of an autoimmune or inflammatory response. In view of results obtained in certain preclinical and clinical studies, Immunex believes that soluble cytokine receptors may be effective as therapeutics to counteract autoimmune or inflammatory diseases.\nImmunex owns exclusive rights to IL-1R, IL-4R, IL-7 receptor (\"IL-7R\") and TNFR (together, the \"Receptor Products\") for the United States and Canada. Pursuant to a 1990 agreement, Immunex granted exclusive rights to Behringwerke for the Receptor Products for all countries except the United States and Canada. This grant was made in consideration of a grant by Behringwerke to Immunex of U.S. comarketing rights for GM-CSF and certain other CSF products. Immunex is entitled to royalties on future receptor product sales by Behringwerke. In July 1992, Immunex reacquired worldwide rights to TNFR from Behringwerke. See \"Relationship with Hoechst AG.\" At the effective time of the Merger, Immunex's rights to TNFR outside the United States and Canada were licensed to Cyanamid and are currently held by AHP. See \"Relationship with Cyanamid and AHP\".\nTNFR-FC. TNF is a cytokine produced by activated T cells and macrophages in the course of severe immune reactions, such as the body's response to severe bacterial infection (sepsis), rheumatoid arthritis, asthma, graft-versus host disease (\"GVHD\") and inflammatory bowel disease. Immunex has produced a soluble TNF receptor fusion protein (p80) that combines two TNF-binding domains derived from TNF receptor with a fragment of a human antibody molecule. This fusion protein (\"TNFR-Fc\") exhibits a long serum half-life and has been shown to be capable of rapidly lowering serum TNF levels. Immunex has received U.S. and European patents covering DNAs encoding p80 TNFR and certain related molecules, and is seeking additional patents covering TNFR-Fc fusions and methods of using TNFR proteins in treating certain diseases. However, other parties are seeking or have received patents that could interfere with the commercialization of TNFR-Fc by the Company or AHP. See \"Patents, Licenses and Trademarks.\"\nIn November 1995, Immunex completed analysis of a Phase II randomized, placebo-controlled, blinded clinical study of TNFR-Fc in patients with rheumatoid arthritis (\"RA\"), a progressively crippling disorder. Positive and statistically significant results in favor of treatment with TNFR-Fc were achieved with respect to multiple clinical endpoints. The Company and AHP intend to conduct additional Phase III studies of TNFR-Fc in this indication.\nThe Company has also investigated the use of TNFR-Fc in sepsis and in Crohn's disease (inflammatory bowel disease). In 1993, Immunex completed a Phase II dose-ranging, double-blind placebo-controlled trial of TNFR-Fc in treating patients with sepsis syndrome, a systemic inflammatory response to infection. Patients in the study were randomly assigned to receive either a placebo or TNFR-Fc at a low, medium or high dose level. The results of the study showed no difference between the mortality rate of patients treated with the lowest dose of TNFR-Fc and those treated with a placebo. Patients treated at higher doses had worse outcomes than the placebo group. On the basis of this study, development of TNFR-Fc as a treatment for sepsis has been terminated. A Phase II study of TNFR-Fc in Crohn's disease patients completed in 1995 indicated drug safety, but beneficial effects were not noted at the doses studied. Additional trials in the Crohn's disease indication are planned in order to evaluate alternate dosing regimens.\nIL-1R. IL-1R is a molecule that binds both IL-1 alpha and IL-1 beta. Overproduction or inappropriate production of IL-1 has been implicated in the development of autoimmune and inflammatory and allergic diseases such as diabetes, asthma, systemic lupus erythematosis and inflammatory bowel disease, and also in the development of septic shock. Immunex has produced genetically- engineered soluble IL-1 receptors of two types, designated Type I and Type II, and has conducted clinical studies of the Type I receptor. Based upon data obtained in preclinical and Phase I clinical studies, Immunex believes that IL-1R may be of therapeutic value in the treatment of a number of diseases and conditions, including allergy, asthma, chronic and acute myelogenous leukemia, organ transplant rejection, GVHD and inflammatory bowel disease. Immunex has been granted five U.S. patents covering mammalian Type I IL-1R DNAs and proteins, including soluble forms, and two U.S. patent covering Type II IL-1R DNAs and proteins. Immunex has also been granted two U.S. patents covering methods of using IL-1R to treat inflammation and allergy.\nThe Company conducted Phase I\/II clinical trials of Type I IL-1R in 1991 in allergy, rheumatoid arthritis, GVHD, experimental endotoxemia, and asthma patients. The studies have shown that the product was safe as administered. The Company is currently evaluating whether it should conduct additional trials itself or whether it should license its rights in IL-1R to another pharmaceutical company for further development of an IL-1R product.\nIL-4R. IL-4 is a cytokine that induces the proliferation of activated T cells and B cells. IL-4 enhances the ability of specific, activated T cells to kill tumor cells, or infected or transplanted tissue. In addition, IL-4 is responsible for promoting the production of specific types of antibodies, including the IgE antibody involved in allergic and asthmatic reactions. Immunex scientists have cloned genes encoding human and murine IL-4R and have genetically engineered and produced a soluble receptor which binds IL-4. Soluble IL-4R has been shown by Immunex and Behringwerke to inhibit IL-4 dependent immune responses in animal models. Based on these preclinical studies, Immunex believes that soluble IL-4R may be effective in the treatment of organ transplant rejection, GVHD, allergy, asthma and infectious diseases. Immunex filed an IND for IL-4R in May 1994. A Phase I\/II study of IL-4R in asthma has recently been completed. The Company is currently evaluating whether it should conduct additional trials itself or whether it should license its rights in IL-4R to another pharmaceutical company for further development of an IL-4R product.\nLEDERLE ONCOLOGY PRODUCTS\nEffective as of the Merger, Immunex acquired certain intellectual property rights, including marketing rights, in the United States and Canada relating to the Lederle Oncology Products, including the following current products: NOVANTRONE mitoxantrone, leucovorin calcium, thiotepa (including THIOPLEX), AMICAR aminocaproic acid and LEVOPROME methotrimeprazine. Immunex also acquired marketing rights in the United States and Canada to methotrexate injectable and to certain products that are the subject of pending regulatory filings completed by Cyanamid. These include etoposide, a generic anticancer product that is the subject of a pending Cyanamid ANDA, and ISOVORIN levoleucovorin. Wyeth-Ayerst Research and Immunex are also researching and developing certain new technologies for which Immunex has been assigned U.S. and Canadian rights, including humanized monoclonal antibody conjugates, a multidrug resistance reversal agent and an oral CSF inducer. In 1994, Immunex and Cyanamid ceased developing photodynamic therapy technologies and enloplatin. The rights acquired by Immunex as a result of the Merger include patents, know-how, trademarks, clinical and other supporting data, registrations and approvals from the FDA and the CHPB. Cyanamid also transferred to Immunex its United States oncology marketing and sales force.\nCyanamid did not transfer any manufacturing facilities, research assets, other tangible assets or other personnel to Immunex. At the effective time of the Merger (\"Effective Time\"), Immunex, Cyanamid and certain of its subsidiaries entered into agreements providing for, among other things, Immunex's contribution to and participation in oncology research by Cyanamid, the supply and toll manufacturing of the Lederle Oncology Products by Cyanamid and Lederle Parenterals, Inc. (\"LPI\") and Cyanamid's provision of certain other services to Immunex. See \"Relationship with AHP and Cyanamid.\"\nNOVANTRONE. NOVANTRONE is currently approved for the initial therapy of ANLL in the United States, and for ANLL, advanced breast cancer, non-Hodgkin's lymphoma and hepatoma in Canada. NOVANTRONE is an anthracenedione similar in chemical structure to anthracyclines (doxorubicin and idarubicin), yet lacking an amino sugar component that is thought to contribute to the cardiotoxicity characteristic of anthracyclines. NOVANTRONE has a more favorable nonhematological toxicity profile than anthracyclines; while NOVANTRONE'S use may result in toxicities similar to those commonly occurring with other chemotherapeutic agents (nausea, vomiting, alopecia, mucositis and cardiotoxicity), these can be less frequent and less severe with NOVANTRONE than with competing anthracycline products. A composition of matter patent covering mitoxantrone has been assigned to Immunex. This patent expires in August 1997. However, Immunex owns a U.S. patent, which does not expire until 2006, covering the use of NOVANTRONE in the treatment of various cancers.\nLEUCOVORIN CALCIUM. Leucovorin is a racemic mixture of the dextro- and levo- isomers of leucovorin used in methotrexate rescue therapy and in modulation of 5-FU drug therapy in advanced colorectal cancer. Immunex sells both liquid and tablet formulations of leucovorin. Leucovorin has no significant patent protection and has significant generic competition. See \"Competition.\" A liquid formulation of leucovorin is being developed.\nTHIOTEPA AND THIOPLEX. Thiotepa is a cytotoxic agent approved for the palliative treatment of a wide variety of tumor types, including adenocarcinomas of the breast and ovary, superficial papillary bladder cancers and other lymphomas such as lymphosarcomas and Hodgkin's disease, and for the control of intracavity effusions secondary to localized or diffuse neoplastic disease of serosal cavities. Immunex owns manufacturing process patents for thiotepa in the United States and Canada that expire in 2007. Following FDA approval of an NDA for THIOPLEX in December 1994, Immunex is now selling and distributing this lyophilized formulation of thiotepa in the United States. THIOPLEX is more stable and has a longer shelf life than thiotepa. THIOPLEX is marketed in Canada by Wyeth-Ayerst International under a distributorship agreement with Immunex.\nMETHOTREXATE INJECTABLE. Methotrexate injectable is an antimetabolite used in the treatment of certain neoplastic diseases. Methotrexate injectable has no significant patent protection and has significant generic competition. Immunex distributes methotrexate injectable in the United States pursuant to a distribution agreement with Cyanamid.\nAMICAR AMINOCAPROIC ACID. AMICAR is a fibrinolysis-inhibitory agent useful in enhancing hemostasis when fibrinolysis contributes to bleeding, which is sometimes associated with neoplastic diseases. AMICAR is not subject to any material patent protection.\nLEVOPROME METHOTRIMEPRAZINE. LEVOPROME is a potent injectable analgesic that is indicated for the relief of pain of moderate to marked degree of severity in nonambulatory patients. LEVOPROME is not subject to any material patent protection.\nETOPOSIDE INJECTION. In conjunction with Elkins-Sinn, an AHP affiliate, the Company is seeking approval of an ANDA for etoposide injection. Etoposide is a semisynthetic derivative of podophyllotocin used in the treatment of testicular and small cell lung cancers.\nPRODUCT LINE EXTENSIONS\nNOVANTRONE MITOXANTRONE. Immunex and Wyeth-Ayerst Research are sponsoring Phase I and Phase II clinical trials using high dosage NOVANTRONE alone and in combination with other oncology agents in lung, ovarian, breast and prostate cancers. One of the protocols being tested involves use of NOVANTRONE in combination with paclitaxel in breast cancer patients. If successful, these trials could be expanded and continued to provide the basis for a supplemental NDA to obtain approval of labeling for new indications.\nIn May 1995, the Company and its clinical collaborators announced the completion of a Phase III study of NOVANTRONE in patients with advanced prostate cancer. When used in combination with steroids, NOVANTRONE therapy had a significant impact upon pain reduction and quality of life in patients with hormone-resistant prostate cancer. Patients receiving NOVANTRONE experienced marked reduction in pain. The drug was well-tolerated, with little or no nausea or vomiting, and was associated with improvement in various indicators of quality of life. A second Phase III study of NOVANTRONE in this indication is scheduled to be completed in 1996. The Company plans to file a supplemental NDA to obtain approval to market NOVANTRONE for this indication.\nLEUCOVORIN CALCIUM. Immunex and Wyeth-Ayerst Research are sponsoring Phase II clinical trials of leucovorin for use as 5-FU drug modulation therapy in the treatment of breast, head and neck cancers. In addition, clinical trials of leucovorin for such therapy in the treatment of advanced colorectal cancer are nearing completion by third parties. Data from such research may be submitted to the FDA by Immunex for the foregoing indications. There can be no assurance that the clinical trial data will be such that Immunex will deem the evidence adequate to support a supplemental NDA or that, if it does, the FDA will approve the NDA or will approve it within a time sufficient to permit commercial success.\nISOVORIN LEVOLEUCOVORIN. As only the levoleucovorin isomer is active therapeutically, Cyanamid developed and clinically tested a purified, nonracemic formulation of leucovorin calcium: ISOVORIN levoleucovorin. If approved, ISOVORIN is expected to be eligible for exclusivity under the Drug Price Competition and Patent Term Restoration Act of 1984 (the \"Waxman-Hatch Legislation\") for three or five years subsequent to any U.S. approval and under the Orphan Drug Act in the methotrexate rescue indication for seven years subsequent to any U.S. approval. ISOVORIN is also covered by a compound patent and a process patent held by third parties and licensed to Cyanamid, each of which expires in 2005. An NDA for ISOVORIN approval for use in a methotrexate rescue indication in osteosarcoma was filed in the United States in 1990. There can be no assurance that the clinical data will be such that the FDA will approve the NDA or will approve it within a time sufficient to permit commercial success. Wyeth-Ayerst Research and Immunex are also currently sponsoring Phase II and Phase III clinical trials investigating ISOVORIN'S benefits in the 5-FU modulation indication in colorectal, breast, head and neck cancer therapies.\nLEDERLE ONCOLOGY PRODUCTS UNDER DEVELOPMENT\nHUMANIZED MONOCLONAL ANTIBODY CONJUGATES. The successful clinical development of mouse monoclonal antibody-based therapies has been limited due to a human anti-mouse antibody (\"HAMA\") response. Wyeth-Ayerst Research is involved in collaborative research and development with Celltech Limited to develop a series of humanized monoclonal antibody drug conjugates that include a proprietary calicheamicin antitumor drug previously developed by Cyanamid. In these conjugates, the mouse amino acid sequences in the antibody portion have been largely replaced by human amino acid sequences. It is hoped that because humanized monoclonal antibodies contain a reduced number of mouse amino acid sequences, they will be less immunogenic and not trigger a HAMA response. Two lead calicheamicin monoclonal conjugates are expected to be introduced into clinical trials. The first, CMA-676, was introduced into a Phase I clinical trial in AML patients in 1995. As with all experimental drugs in preliminary human clinical trials, there can be no assurance that CMA-676 or other monoclonal antibody conjugates will prove safe or effective in any clinical indication.\nPRECLINICAL RESEARCH\nWyeth-Ayerst Research is also investigating, primarily on a preclinical basis, several other compounds, including agents to combat resistance of tumor cells to chemotherapeutic drugs and chemical-based CSF inducers to reverse bone marrow depression, a common side effect of anti-cancer products. No assurance can be given that any of these compounds will show sufficient safety to enable commencement of clinical trials or that such trials will show the safety or efficacy required to gain the regulatory approvals necessary for marketing. Any commercial products successfully developed from these research projects would be marketed in the oncology field in the United States and Canada by Immunex. See \"Relationship with AHP and Cyanamid.\"\nPACLITAXEL. Paclitaxel is a chemotherapeutic agent that is extracted from the bark of the Pacific yew tree. BMS currently markets paclitaxel for treatment of metastatic breast and ovarian cancers in the United States and Canada under the trademark TAXOL. At present, BMS is the holder of marketing exclusivity for paclitaxel in the United States under the Waxman-Hatch Legislation. The term of this exclusivity expires in December 1997. In 1994, Cyanamid entered into exclusive supply and research agreements with Hauser Chemical Research, Inc. (\"Hauser\") under which Hauser will supply Cyanamid and its affiliates with their requirements for paclitaxel for development and marketing worldwide. Cyanamid and Hauser will also collaborate in the development and testing of new taxane derivatives related to paclitaxel. At the same time that Cyanamid entered into the research and supply agreements with Hauser, Immunex and Cyanamid entered into a taxane agreement under which Cyanamid and Immunex will collaborate in conducting clinical trials and obtaining regulatory approval of paclitaxel in their respective territories, and Cyanamid will manufacture and supply product to Immunex for sale in the United States and Canada. Immunex and AHP will equally share the costs of research and supply under the Hauser agreements. Currently, Wyeth-Ayerst International and Immunex are collaborating in the development of paclitaxel for introduction into the markets for which each holds marketing rights. In 1995, Immunex completed the filing of an A\/NDS for paclitaxel in Canada.\nRELATIONSHIP WITH AHP AND CYANAMID\nAt a special meeting of stockholders held June 1, 1993, the stockholders of predecessor Immunex Corporation (\"Predecessor\") approved and adopted an Amended and Restated Agreement and Plan of Merger dated as of December 15, 1992 (the \"Merger Agreement\") among Predecessor, Cyanamid, LPI and Lederle Oncology Corporation, a wholly owned subsidiary of Cyanamid (\"Merger Subsidiary\"). Pursuant to the Merger Agreement, Predecessor was merged with and into Merger Subsidiary in accordance with the General Corporation Law of the State of Delaware, with the Merger Subsidiary as the surviving corporation. In 1994, the Company re-incorporated in the state of Washington. Prior to the Merger, Cyanamid and LPI contributed to Merger Subsidiary certain assets and contractual obligations of the Lederle Oncology Business, together with $350 million in cash.\nAs a result of the Merger, the separate corporate existence of Predecessor ceased, and the assets and liabilities of Predecessor and Merger Subsidiary became the assets and liabilities of a new corporation that was renamed \"Immunex Corporation.\" Each share of Predecessor Common Stock outstanding immediately prior to the effective time of the Merger (\"Effective Time\") was converted into the right to receive $21 in cash (the \"Cash Consideration\"), and one share of common stock of the surviving corporation (the \"Stock Consideration\" and, together with the Cash Consideration, the \"Merger Consideration\"). A substantial portion of the $350 million contributed to Merger Subsidiary by Cyanamid was used to pay the Cash Consideration.\nThe common stock of Merger Subsidiary outstanding immediately prior to the Effective Time, all of which was held by Cyanamid and LPI, was converted into that number of shares of the Company's Common Stock equal to 53.5% of the total number of shares of Common Stock outstanding immediately following the Effective Time on a fully diluted basis. No appraisal rights were perfected. By acquiring all of the common stock of Cyanamid in late 1994, American Home Products became the effective owner of the shares of the Company's common stock held by Cyanamid.\nSimultaneously with entering into the Merger Agreement, Predecessor, Cyanamid and Merger Subsidiary entered into an Amended and Restated Governance Agreement (\"Governance Agreement\"), which sets forth, among other things, certain agreements of the parties relating to (i) the corporate governance of Immunex, including the composition of its Board of Directors (the \"Immunex Board\"), (ii) rights of Cyanamid to purchase additional shares of Immunex Common Stock from Immunex upon the occurrence of certain events, (iii) future acquisitions and dispositions of Immunex securities by Cyanamid, (iv) the right of members of the Immunex Board designated by Cyanamid to approve certain corporate actions of Immunex, (v) the requirement that a supermajority of the members of the Immunex Board approve certain corporate actions of Immunex, and (vi) payments to be made by Cyanamid to Immunex in the event that products of the Lederle Oncology Business and certain other products of Immunex do not achieve net sales targets. AHP has agreed to protect Immunex's rights under the agreement and be bound by certain standstill restrictions set forth there-in.\nThe specified net sales targets for the Lederle Oncology Business are as follows: $120,600,000 in 1993 (reduced proportionately to reflect the portion of the year Immunex sold products of the Lederle Oncology Business), $154,600,000 in 1994, $168,600,000 in 1995, $190,500,000 in 1996 and $216,500,000 in 1997. In the event that the expected revenues are not achieved for any year, AHP will be obligated to make certain payments. In no event will AHP's payment obligations exceed $56,000,000 for 1996 and $60,000,000 for 1997.\nPursuant to the Merger Agreement, Cyanamid, Immunex and certain of their respective subsidiaries entered into certain agreements (collectively, the \"Related Agreements\"). The Related Agreements include a Research and Development Agreement relating to ongoing cooperation in research and development and the parties' commercialization of products resulting from such efforts. Pursuant to this agreement, Immunex and Cyanamid established a collaboration committee to supervise and coordinate oncology research and development activities. This committee is now comprised of representatives of Wyeth-Ayerst Research and Immunex. Immunex is providing financial support for the oncology research and development program conducted by Wyeth-Ayerst Research. This agreement and another Related Agreement together provide for the commercialization of new oncology products by Immunex in the United States and Canada, and by AHP elsewhere. To the extent Immunex develops products or technology other than new oncology products and determines not to market such products or technology itself, Immunex has agreed to offer to AHP exclusive marketing rights to any such products or technology before offering any marketing rights to third parties. Other Related Agreements provide for, among other matters, the supply and toll manufacture by Cyanamid or its subsidiaries for Immunex or its subsidiaries of the oncology products of the Lederle Oncology Business, the licensing by Cyanamid or its subsidiaries to Immunex of the LEDERLE and other trademarks for use on Immunex products, and various other implementing licenses and distribution agreements. The Related Agreements, together with the Governance Agreement, establish the framework for the ongoing relationship between Immunex and AHP.\nOn November 1, 1995, AHP presented Immunex with an offer to acquire the remaining shares of Immunex stock not held by AHP for $14.50 per share. The Company's Board of Directors formed a Special Committee to consider the offer, comprising all directors other than the directors that AHP is entitled to designate pursuant to the Governance Agreement. The Special Committee retained Alex. Brown & Sons, Incorporated, as the Special Committee's financial advisor. After considering the offer and the recommendations of its financial and legal advisors, the Special Committee informed AHP that it had decided to reject AHP's offer as being inadequate.\nIn December 1995, AHP and Immunex entered into certain research and license agreements under which Immunex granted AHP exclusive worldwide rights to develop compounds that inhibit an enzyme known as TNF-alpha converting enzyme, or TACE. TACE is involved in the processing of cell-bound TNF to provide circulating TNF. There is evidence that inhibiting this enzyme may be beneficial in treating inflammatory diseases and conditions such as RA. Under the agreements, AHP will screen compounds using recombinant TACE provided by Immunex. Immunex will receive license fees, research payments, commercial development milestones and royalties on any compounds that are commercialized by AHP.\nRELATIONSHIP WITH HOECHST AG\nPursuant to a 1984 research and license agreement that has been amended periodically, Immunex and Hoechst, through its subsidiary Behringwerke, have conducted an international collaborative research effort focusing on CSFs. Under the agreement, Immunex granted exclusive worldwide license rights to Behringwerke to develop, manufacture and market CSF products in consideration for technology transfer payments, research support payments, and royalties on sales of licensed products. Immunex and Behringwerke, together with Behringwerke's U.S. affiliate, Hoechst-Roussel Pharmaceuticals, Inc., (\"HRPI\") collaborated in the clinical development of GM-CSF (sargramostim) in the United States. In 1989, Immunex acquired co-marketing rights to sargramostim in the United States and from March 1991 to April 1993, Immunex and HRPI co-marketed sargramostim in the United States. Immunex acquired HRPI's United States rights in April 1993. Behringwerke applied for European approvals to market sargramostim for bone marrow transplant indications, and initiated Phase III clinical trials in Europe for treatment of prophylaxis of neutropenia resulting from radiotherapy or chemotherapy. However, due to a blocking patent owned by Sandoz, Behringwerke elected not to attempt to commercialize GM-CSF in Europe. See \"Patents, Licenses and Trademarks.\" Immunex reacquired worldwide rights to sargramostim from Behringwerke in 1994, and licensed the rights previously held by Behringwerke to AHP. Immunex has agreed to supply AHP's requirements for marketing outside the United States. Immunex also assumed responsibility for financing the completion of certain European trials begun by Behringwerke, in order to acquire data useful in obtaining registration of the product in other countries. In 1990, Immunex also granted Behringwerke exclusive license rights to the Receptor Products for development and marketing outside the United States and Canada. Pursuant to a 1992 agreement between Behringwerke and Immunex, Immunex reacquired Behringwerke's worldwide rights to TNFR, which it has licensed to AHP. Immunex is entitled to certain payments and royalties on sales of the other Receptor Products licensed to Behringwerke or its sublicensees.\nRELATIONSHIP WITH TARGETED GENETICS CORPORATION\nTargeted Genetics Corporation (\"Targeted Genetics\") was formed by Immunex in 1989 to develop proprietary human gene therapy treatments for acquired and inherited diseases. Targeted Genetics focuses on cytotoxic T lymphocytes as a therapy for infectious diseases and cancer; in vitro delivery of genes to non- dividing cells, such as lung cells; and modification of peripheral blood stem cells in order to correct genetic blood disorders. Immunex currently holds an equity interest in Targeted Genetics. Immunex granted a worldwide, exclusive field of use license to Targeted Genetics for certain Immunex technology applicable to gene therapy. In exchange, Targeted Genetics issued shares of stock to Immunex and agreed to license to Immunex new technology developed by Targeted Genetics in the area of cytokines. In addition, Targeted Genetics granted Immunex a right of first offer with respect to non-cytokine technology if Targeted Genetics intends to pursue a license agreement with a third party.\nMARKETING AND DISTRIBUTION\nImmunex sells its products through a specialized oncology-based sales force that consists of approximately 101 sales representatives and sales managers. The Company sells its products both to pharmaceutical wholesalers and end users such as oncology clinics, hospitals and pharmacies. Orders are received and processed by the Company through a centralized customer service and sales support group. Shipping, warehousing and certain data processing services are provided on a fee basis by an outside contractor.\nCOMPETITION\nCompetition in researching, developing, manufacturing and marketing biopharmaceuticals and other oncology products is intense. Immunex is marketing a group of cancer products and simultaneously developing an extensive portfolio of cytokines, cytokine receptors and other immunological therapeutic products. There are other companies, including established pharmaceutical and biotechnology companies, that are researching, developing and marketing products, based on related or competing technologies, that will compete with products being developed by Immunex. Most of the cancer products marketed by Immunex have established competitors. Significant competitors in the field of oncology include BMS and Amgen Inc. (\"Amgen\"). These competitors, in certain cases, have substantially greater capital resources, greater marketing experience, and larger research and development staffs and manufacturing facilities than Immunex.\nSeveral companies are marketing or developing products that compete or are expected to compete with LEUKINE. One such company, Amgen, has been marketing its competing G-CSF product since early 1991 and has achieved a majority share of the U.S. market for CSFs.\nImmunex and other pharmaceutical firms compete primarily in performing research and clinical testing, acquiring patents, developing efficient manufacturing processes, securing regulatory approvals and marketing the resulting products to physicians. Immunex believes that its strategic focus on immunology has resulted in expertise that can be applied to reduce development times, create innovative and cost-saving research techniques, optimize product quality, and discover new products and applications. Immunex possesses manufacturing facilities to produce recombinant protein products using microbial or mammalian cell culture technologies. Professional clinical, legal, regulatory affairs, marketing and sales staffs have been developed to enhance the Company's scientific resources. Immunex possesses a specialized, well- trained oncology sales force and comprehensive professional services, including continuing medical educational programs, publications, literature searches and treatment information. These professional services are important because, historically, new anticancer drugs have provided incremental treatment advances, but few outright cures. Therefore, physicians rely heavily on peer-reviewed clinical data in making treatment decisions.\nCompetition in the sale of generic pharmaceutical products is intense due to the entry of multiple sources for each product after expiration of patents and exclusivity grants previously covering such products. Manufacturers of generic products compete aggressively, primarily on the basis of price. Immunex currently faces aggressive generic competition from numerous suppliers on methotrexate injectable and leucovorin calcium, resulting in lower prices and lower sales. Thiotepa may be subject to generic competition in the future.\nSUPPLY\nIn general, the raw materials that AHP requires to manufacture the Lederle Oncology Products are readily available. AHP directly manufactures leucovorin, THIOPLEX and mitoxantrone. Heinrich Mack Nachf KG (\"HMN\"), a German company, currently supplies AHP with all of its requirements of methotrexate. Methotrexate is purchased pursuant to a supply agreement which commenced in July 1992. The agreement has a minimum term of ten years, with termination requiring four years' prior notice. Substantially all the raw materials used to manufacture Immunex's recombinant protein products are available from multiple sources.\nGOVERNMENT REGULATION\nThe manufacturing and marketing of pharmaceutical products in the United States requires the approval of the FDA under the Food, Drug and Cosmetic Act. Similar approvals by comparable agencies are required in foreign countries. The FDA has established mandatory procedures and safety standards which apply to the clinical testing, manufacture and marketing of pharmaceutical and biotechnology products. Obtaining FDA approval for a new therapeutic product may take several years and involve expenditure of substantial resources.\nThe Company's operations are also subject to regulation under, among others, the Occupational Safety and Health Act, the Environmental Protection Act, the Nuclear Energy and Radiation Control Act, the Toxic Substances Control Act, the Conservation and Recovery Act, the Comprehensive Environmental Response, Compensation, and Liability Act, and Title III of the Superfund Amendments and Reauthorization Act (Community Right-to-Know and Emergency Response Act).\nPATENTS, LICENSES AND TRADEMARKS\nImmunex has filed applications for U.S. and foreign patents covering numerous aspects of its technology. The Company has been granted and maintains 76 U.S. and 258 foreign patents, and currently has 88 patent applications pending in the United States Patent and Trademark Office (the \"USPTO\") and 211 applications pending abroad. There can be no assurance that any of its pending or future applications will result in issued patents. The Company also relies upon trade secrets, unpatented proprietary know-how and continuing technological innovation to develop and maintain its competitive position. There can be no assurance that others will not acquire or independently develop the same or similar technology, or that the Company's issued patents will not be circumvented, invalidated or rendered obsolete by new technology.\nIt is the Company's policy to respect the valid patent rights of others. Immunex has obtained licenses from various parties covering certain recombinant DNA technologies it employs to make its products. The Company, however, may need to acquire additional licenses in the future if its processes are changed or if patents are awarded to others which cover current processes. The Company is not aware of the need for any such additional licenses. Competitors of Immunex, including established pharmaceutical and biotechnology companies, are seeking to obtain patents covering technologies which Immunex may need to manufacture or market its products. Competitors of Immunex have obtained or are seeking patents which, if issued or granted, may have a bearing upon the Company's ability to successfully commercialize GM-CSF, PIXY321 and TNFR-Fc.\nImmunex has been issued three U.S. patents covering an altered, or analog, form of GM-CSF, that is marketed by the Company under the LEUKINE trademark. Immunex and several competitors, however, filed patent applications in 1984 disclosing the isolation of mouse and human GM-CSF DNAs. Two such applications that were filed before Immunex's application included claims which, if such patents were issued, would be infringed by Immunex's process for making LEUKINE. A GM-CSF interference proceeding in the United States directed to human GM-CSF DNAs was declared in July 1990, involving competing U.S. patent applications filed by or licensed to Immunex, Sandoz AG (\"Sandoz\"), Research Corporation, Schering-Plough, Inc. and Biogen, Inc. As of February 1995, all parties to the intereference except Immunex and Sandoz had been eliminated from future participation in the priority determination. Proceedings in the interference were suspended during 1995 to permit the parties to negotiate a settlement of the interference, and Sandoz and Immunex have discussed the terms of a proposed settlement. If a settlement cannot be reached and Sandoz were to prevail in the interference, litigation may result if Sandoz elects to enforce any resulting GM-CSF patents in the U.S. Sandoz has been granted patents in Europe and certain other countries covering recombinant GM-CSF technologies that blocks the Company or its licensees from commercializing GM-CSF in such countries. Genetics Institute, Inc. owns certain U.S. patents covering recombinant DNA and protein technologies related to human IL-3. Because PIXY321 is a fusion protein consisting of analog protein sequences possessing biological activity human GM-CSF and human IL-3, Sandoz or Genetics Institute may claim that the Company's making, using or selling of PIXY321 constitutes infringement of such patents. The outcome of any litigation involving such patents cannot be predicted. If Immunex were blocked from manufacturing or selling LEUKINE in the United States or a license could not be obtained upon commercially reasonable terms, the Company would be materially and adversely affected.\nThe TNFR-Fc product being developed by Immunex is a fusion protein consisting of a dimer of two subunits, each of which comprises a TNF receptor domain derived from a TNF receptor known as \"p80,\" fused to a segment derived from a human antibody molecule known as an \"Fc domain.\" Immunex believes that it was the first to isolate a recombinant DNA encoding p80 TNFR and also the first to express the protein using recombinant DNA technology. In March 1995, the Company was granted a U.S. patent covering DNAs encoding p80 TNFR and was granted a European patent in December 1995. Two other companies, however, BASF and Yeda Research & Development Co. (\"Yeda\"), filed patent applications relating to TNFR proteins shortly prior to the time Immunex filed its patent applications concerning TNFR DNAs. No patents have been issued to Yeda in the U.S., but two patents have been granted to Yeda by the European patent office that relate to TNFR proteins. These patents are the subject of pending opposition proceedings. Hoffmann-La Roche, Inc. (\"Roche\") and Synergen Corporation (\"Synergen\") filed patent applications directed to p80 TNFR DNAs after the date the Company filed its application. No patents have been issued to Roche or Synergen. BASF has been issued a U.S. patent with claims covering certain TNFR proteins that differ in both structure and function from the fusion protein being tested by Immunex. If BASF, Roche, Synergen or Yeda were able to assert TNFR patents to cover the Company's TNFR-Fc product, the Company's or AHP's commercialization of their TNFR-Fc product would be impeded in any territories in which such patents were in force. In addition, a U.S. patent was obtained by the Board of Regents of the University of Texas System that contains claims relating to TNFR-Fc fusions. However, the Company's TNFR applications disclosing such fusions, as well as other applications that were filed by other companies after the Company's application but more than one year prior to the filing date of the Texas patent, were not considered by the USPTO in its decision to grant a patent to the Texas applicants. In view of such prior disclosures and publications, the Company is of the opinion that the relevant claims of the Texas patent are invalid. Zymogenetics, Inc. and Genentech have been issued U.S. patents having claims directed to various fusion proteins comprising Fc domains, and have also filed corresponding European applications which have not yet been granted. The Company is reviewing the claims of these patents in view of prior art disclosures of Fc fusion proteins and other technical issues of patent law to ascertain whether the claims of the Zymogenetics or Genentech patents can be validly asserted to cover the Company's TNFR-Fc product.\nNOVANTRONE is a proprietary product that is covered by several U.S. and Canadian patents. The last of such patents expires in 2006. Although Immunex has rights to patents and pending patent applications with respect to levoleucovorin in the United States and Canada, the protection afforded by these patents and patent applications does not provide Immunex with patent exclusivity for levoleucovorin. AHP holds a manufacturing process patent on thiotepa in the United States and Canada. Although methotrexate is the subject of certain patents held by AHP, the protection afforded by such patents is not material.\nWyeth-Ayerst Research and Immunex are pursuing several collaborative preclinical research areas to discover or develop other new oncology products. AHP and Immunex intend to pursue all protection of all forms of intellectual property, including, but not limited to, patents, trade secrets, Orphan Drug exclusivity, and benefits of the Waxman-Hatch legislation, for all inventions, discoveries and developments in these areas of research.\nUnder its agreements with licensors of certain patents, Immunex is obligated to pay process royalties on sales of products produced using certain basic recombinant DNA processes and related technologies. Certain licenses, for example the Cohen-Boyer license covering basic recombinant DNA processes, may be material to the Company; however, the terms of such licenses extend for the life of the patents licensed and are subject to cancellation by the licensor only upon default or bankruptcy by Immunex. In addition, Immunex has agreed to pay Behringwerke product royalties based on sales of LEUKINE, PIXY321 and TNFR-Fc. Both the process royalties and the product royalties currently payable by the Company are commensurate in percentage rate to those paid by other companies developing biotechnology products and are not expected to exceed, in the aggregate, 10% of net sales. The Company, however, may need to enter into additional license agreements with other companies concerning LEUKINE, PIXY321 or TNFR-Fc which may require payment of additional product royalties. There can be no assurance that such license agreements will be available or that the total royalties payable under such agreements will not adversely affect the Company's results of operations with respect to such products.\nCyanamid has license arrangements with the University of Strathclyde and with Eprova AG with respect to levoleucovorin. Cyanamid entered into a Collaborative Research and Development Agreement with Celltech Limited (\"Celltech\") concerning the humanized monoclonal antibodies that Wyeth-Ayerst Research and Immunex are currently developing.\nThe U.S. and Canadian trademarks for NOVANTRONE, ISOVORIN and THIOPLEX have been assigned to Immunex. In addition, the LEDERLE trademark in the U.S. and Canada, and two other trademarks owned and currently used in Canada by Wyeth- Ayerst International have been licensed to Immunex for use in connection with current and future oncology products. AHP has the right to terminate the Lederle trademark licenses in the event that its ownership of Immunex common stock was to decrease below 50%.\nPROPERTIES\nIn 1986, Immunex purchased for $1.2 million the master lease for the Immunex Building in Seattle, Washington where its primary laboratory and initial manufacturing facilities are located. Immunex currently occupies all but a small percentage of this building. Immunex also leases space in an adjacent office building that is used for office and administrative purposes. Immunex's facilities in these two buildings occupy a total of 160,000 square feet. In 1993, the Company signed a lease for 37,000 square feet of additional office space in a building located near its headquarters. The total of current rental payments under these leases is approximately $2.8 million per year. The master lease for the Immunex Building extended through August 1995 and was renewed through August 2000, with three five-year renewal options. The master lease calls for rental increases at three-year intervals through 1995 and at five-year intervals through the renewal periods. An amendment to the master lease in 1994 reduced the rent with no increases through August of 2000. The lease for the adjacent office building expires in August 2000 and has three five-year renewal options at market value.\nIn 1988, Immunex began operating a 10,000 square foot fermentation and pharmaceutical manufacturing facility located in the Immunex Building for the production of recombinant protein therapeutics. This facility is designed to comply with FDA Good Manufacturing Practices, and Immunex has received an establishment license for this facility as a part of the PLA approval applicable to GM-CSF. This facility can produce sufficient quantities of recombinant cytokines using yeast and bacterial fermentation technologies to support clinical testing, and in addition can produce commercially significant quantities of GM-CSF. In October 1992, Immunex completed the construction of a manufacturing and development center in Bothell, Washington which includes a large-scale microbial manufacturing facility and a separate mammalian cell-based protein manufacturing facility. These facilities have been used to produce TNFR-Fc for clinical trials as well as PIXY321. In 1995, both the microbial manufacturing facility and the mammalian cell facility were used to conduct contract manufacturing for other companies.\nThe Company is currently exploring several alternatives in order to meet its long-term facility needs. The Company also owns approximately 20 acres of undeveloped land adjacent to its manufacturing and development center in Bothell, Washington. Immunex has entered into a purchase and sale agreement with the Port of Seattle concerning the purchase of a 29 acre parcel of land located in Seattle, Washington, known as Terminal 88. Pursuant to the terms of the agreement, Immunex will not be committed to complete the purchase until it has approved the results of complete due diligence review of the property and obtained a master use permit (\"MUP\") and other governmental authorizations needed to enable the property to be developed and used in accordance with the Company's plans. In 1995, the Company filed an application to the City of Seattle to obtain the MUP required to develop the site. In February 1996, the Port of Seattle submitted a environmental impact statement (\"EIS\") to the City of Seattle. If the MUP is granted and funding for transportation improvements is secured by the City of Seattle, the Company must decide whether to close purchase of the site in the first six months of 1996.\nPERSONNEL\nAs of December 31, 1995, Immunex and its wholly owned subsidiaries employed a total of 770 persons, of whom 77 hold doctoral degrees, 362 were engaged in research and development, 132 in manufacturing and 134 in sales and marketing. Each employee has entered into a confidentiality agreement which contains provisions requiring disclosure of ideas, developments, discoveries or inventions conceived during employment, and assignment to the Company of all proprietary rights to such matters.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nSee Properties above, under Item 1.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nImmunex is currently a party to a GM-CSF patent interference that may affect products it is developing or has developed, including GM-CSF and PIXY321. In addition, an interference may be declared that may affect TNFR-Fc. No assurance can be given as to the outcome of these interferences. Immunex may be materially and adversely affected by a negative outcome of any of these interferences. See Item 1. \"Patents, Licenses and Trademarks.\"\nCISTRON LITIGATION. In September 1993, Immunex filed a complaint seeking a declaratory judgment and injunctive relief against Cistron Biotechnology, Inc. (\"Cistron\") in the U.S. District Court for the Western District of Washington in Seattle. On the same day, Cistron filed suit against Immunex in the U.S. District Court for the District of New Jersey. The New Jersey action was transferred to the Western District of Washington and Immunex agreed to dismiss the original Washington action. Immunex has asserted its claim in the original action as a counterclaim in the transferred action. The case is now pending as CISTRON BIOTECHNOLOGY, INC. V. IMMUNEX CORPORATION. Cistron asserts that in 1984 Immunex misappropriated information regarding interleukin-1-beta (\"IL-1B\") and that such information was used by Immunex in patent applications relating to IL-1B. Cistron's complaint seeks a declaratory judgment that scientists associated with Cistron should be named co-inventors of Immunex's patents, and seeks damages for misappropriation of trade secrets by Immunex and conversion of Cistron's property interest in certain patents and patent applications. In its counterclaims Immunex seeks declaratory judgment that it did not misappropriate any trade secrets of Cistron and seeks entry of an order enjoining Cistron from engaging in unfair competition by claiming rights in Immunex's patents or patent applications and by claiming misappropriation of trade secrets. In December 1994, the court granted Cistron's motion to amend its complaint to add a new claim against Immunex for alleged violation of The Racketeer Influenced and Corrupt Organizations (\"RICO\") Act. Cistron also filed a suit against three former officers of Immunex, alleging that they misappropriated trade secrets and committed fraud and RICO violations arising from the same facts. The court consolidated the pending Immunex litigation with the action against the individual defendants. Claims against one former officer have been dismissed. Cistron seeks recovery of unspecified actual, punitive and exemplary damages, as well as costs and attorney's fees.\nIn December 1994, the court also granted Immunex's motion to amend its answer and counterclaims to add a new claim against Cistron for a declaration of non-infringement, invalidity, and unenforceability of Patent No. 4,766,069. This declaratory judgment claim was withdrawn by Immunex after Cistron filed declarations agreeing not to sue Immunex for patent infringement.\nIn October 1995, Immunex filed motions for summary judgment seeking a ruling that Cistron lost any trade secret protection in 1984, and that all of Cistron's claims should be dismissed for statute of limitations or laches reasons. In November 1995, Cistron moved to amend its complaints to add claims of breach of contract, breach of confidential relationship, and unfair competition. Cistron's motion to amend its complaint was granted, and Immunex's motions were denied, by the court in January 1996. Thus, resolution of the issues raised by the motions has been reserved for trial. Discovery in the case is substantially complete and trial is scheduled to begin on April 23, 1996.\nAHP LITIGATION. On or about November 2, 1995, a purported class action lawsuit brought on behalf of all of the shareholders of Immunex was filed in the Superior Court of the State of Washington for King County, titled BARISH V. FRITZKY ET AL. The defendants are the Company and certain of its officers and directors as well as AHP. The action arises from the unsolicited offer by AHP to acquire for cash the 45.7% ownership of the Company which AHP does not already own. The complaint alleges that the proposed AHP transaction is unfair and harmful to the Company's minority shareholders. The complaint seeks injunctive relief against consummation of the proposed AHP transaction. On November 13, 1995, the Special Committee of the Board of Directors of the Company advised AHP that it rejected the proposed buy-out offer because it concluded that the price offered of $14.50 per share was inadequate. Since the public announcement of that communication, there has been no activity in the pending case.\nImmunex is not a party to any other material 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 Company's security holders during the fourth quarter of its fiscal year ended December 31, 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET PRICE OF THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nThe Company's common stock is traded on the Nasdaq National Market under the symbol IMNX.\nThe following table sets forth for each period indicated the high and low sales prices for the Company's common stock as reported on the Nasdaq National Market.\n1995 1994 ---------------- ---------------- HIGH LOW HIGH LOW ------ ------ ------ ------\n1st Quarter 18 1\/2 13 3\/4 19 3\/4 13 3\/4\n2nd Quarter 18 9 3\/4 15 11 1\/2\n3rd Quarter 17 12 1\/4 16 1\/2 10 3\/4\n4th Quarter 17 3\/4 11 3\/4 18 1\/4 11 1\/2\nThere were 1,651 holders of record of the Company's common stock as of December 31, 1995. A significant number of beneficial owners of the Company's common stock hold their shares in street name.\nThe Company has not paid any cash dividends since its inception. The Company currently does not intend to pay any cash dividends in the foreseeable future, but intends to retain all earnings, if any, for use in its business operations.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\nOn June 1, 1993, the Company was merged with and into Lederle Oncology Corporation, a wholly owned subsidiary of American Cyanamid Company. See Item 7, \"Management's Discussion and Analysis of Financial Condition\" and the notes to the consolidated financial statements for a description of the merger. The selected financial data as of and for the years ended December 31, 1995 and 1994 and the period June 2, 1993 to December 31, 1993, are those of the Company subsequent to the merger. The selected financial data for the period January 1, 1993 to June 1, 1993 and as of and for the years ended December 31, 1991 and 1992 are those of the Company prior to the merger.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nORGANIZATION\nOn June 1, 1993, Immunex Corporation (the \"Predecessor\") was merged into Lederle Oncology Corporation (\"LOC\"), a wholly owned subsidiary of American Cyanamid Company (\"Cyanamid\"). Prior to the merger, Cyanamid contributed to LOC, among other things, the rights to certain oncology products in the United States and Canada (\"Lederle Oncology Products\") and $350 million in cash. As a result of the 1993 merger (\"Merger\"), the assets and liabilities of the Predecessor and LOC became the assets and liabilities of a new entity which was named Immunex Corporation (the \"Company\" or the \"Successor\"). Holder's of the Predecessor's common stock received cash consideration of $21 per share and one share of common stock of the Successor. A substantial portion of the $350 million contributed by Cyanamid was used to pay the cash consideration of $21 per share. Cyanamid received that number of shares of Successor common stock equal to 53.5 percent of the Successor's common stock outstanding immediately following the effective time of the Merger. In addition, pursuant to the Merger, the Successor and Cyanamid entered into certain agreements relating to cooperation in research and development activities and the support of manufacturing and supply of the Lederle Oncology Products.\nIn November 1994, all of the outstanding shares of common stock of Cyanamid were acquired by American Home Products Corporation (\"AHP\"). Prior to the acquisition of Cyanamid by AHP, the Company and AHP entered into an agreement under which AHP agreed to protect the Company's rights under its agreements with Cyanamid. AHP and certain of its divisions or affiliates have assumed certain of the rights and obligations of Cyanamid under the various agreements that the Successor and Cyanamid entered into at the time of the Merger or thereafter. As a result of AHP's acquisition of Cyanamid, AHP now holds a majority interest in the Successor. All references to AHP include AHP and its various affiliates, divisions and subsidiaries, including Cyanamid.\nThe consolidated financial statements for the five months ended June 1, 1993 are those of the Predecessor. The consolidated financial statements for the seven months ended December 31, 1993 and as of and for the years ended December 31, 1994 and 1995 are those of the Successor. For comparison to operating results in 1995 and 1994, operating results of the Predecessor for the five months ended June 1, 1993 have been combined with operating results of the Successor for the seven months ended December 31, 1993, unless more meaningful comparisons could be made by distinguishing between these periods.\nRESULTS OF OPERATIONS\nOVERVIEW\nFollowing the Merger, revenues of the Company increased due to the addition of the Lederle Oncology Products to the Predecessor's product line. However, the revenues generated from the sales of the Lederle Oncology Products were not sufficient to offset the operating expense levels of the Company. In December 1993, Bristol-Myers Squibb Company (\"BMS\") terminated a product exchange agreement with the Company which resulted in the return of marketing rights for certain products to BMS (the \"BMS Products\") in early 1994. The loss of the revenue from the BMS products, combined with the increased operating costs and funding requirements of the Successor organization, resulted in continued operating losses in 1994. In response to these developments, the Company initiated several expense reduction programs including a reorganization of the sales force, elimination of certain non-essential programs and staffing reductions across the organization. These expense control measures resulted in a substantial reduction of operating expenses and improved operating results during the last six months of 1994.\nDuring 1995, the Company's financial performance improved steadily throughout the year. For the year ended December 31, 1995, the Company incurred a net loss of $11.3 million, a reduction of 66 percent compared to the $33.1 million net loss incurred for the year ended December 31, 1994. The improvement is attributable to a continued focus on controlling operating expenditures and an increase in operating revenues. The Company has increased operating revenues in 1995 through a combination of increased product sales, performance of contract manufacturing services and license fees relating to early stage research collaborative agreements.\nREVENUES\nProduct sales increased moderately in 1995 to $137.6 million compared to $135.8 million in 1994 and $119.1 million in 1993. Improvement in product sales during 1995 is due primarily to growth in sales of NOVANTRONE-Registered Trademark- (mitoxantrone) and the launch in February 1995 of THIOPLEX-Registered Trademark- (thiotepa for injection). The increase in product sales in 1994, as compared to 1993, resulted from the addition of the Lederle Oncology Products to the Successor's product line following the Merger in June 1993.\nNet sales of NOVANTRONE totaled $43.0 million, $39.1 million and $37.2 million in 1995, 1994 and 1993, respectively. The steady increase in NOVANTRONE sales is attributable to increased sales volume combined with price increases initiated in 1994 and 1995. In February 1995, the Company launched THIOPLEX, which is more stable and has a longer shelf life than thiotepa. Following the product launch and marketing campaign, net sales of THIOPLEX\/thiotepa increased to $20.7 million in 1995, compared to net sales of thiotepa in 1994 and 1993 of $15.4 million and $14.0 million, respectively. Declining sales volumes and selling prices resulting from generic competition caused net sales of leucovorin calcium to decrease to $18.4 million and $19.1 million in 1994 and 1995, respectively, from $25.4 million in 1993. Sales of the other Lederle Oncology Products have increased slightly during both 1994 and 1995.\nNet sales of LEUKINE-Registered Trademark- (sargramostim) totaled $41.4 million, $45.6 million and $42.1 million in 1995, 1994 and 1993, respectively. Between the second quarter of 1993 and the first quarter of 1995, sales of LEUKINE did not fluctuate significantly from quarter to quarter. However, in early 1995, LEUKINE's unit volume temporarily declined from its historical sales levels due to what is believed to be certain distribution programs initiated by a competitor. Sales rebounded in the third quarter and returned to historically normal levels in the fourth quarter of 1995. The Company's primary strategy for increasing market share is to expand LEUKINE's approved label indications. In late 1995, the Company received Food and Drug Administration (\"FDA\") approval to market LEUKINE for treatment of acute myelogenous leukemia, allogeneic bone marrow transplantation and for mobilizing and post transplantion support of peripheral blood progenitor cells. Although the Company has initiated marketing campaigns using the expanded label approvals, it is uncertain what the impact, if any, the expanded label approvals will have on future sales of LEUKINE. In addition, the Company is seeking an expanded label indication for treatment of chemotherapy-induced neutropenia in solid tumors. In April 1995, the FDA advisory committee declined recommendation of LEUKINE in this indication. The Company subsequently met with the FDA to discuss approaches for approval of LEUKINE for treatment of chemotherapy-induced neutropenia and has updated its amendment by filing supplemental data acquired from ongoing clinical studies. There can be no assurance that the Company will receive approval of this expanded label indication.\nNet LEUKINE revenues could be adversely affected by the resolution of certain patent and contractual matters. No U.S. patents have been issued with respect to GM-CSF, but the Company is a party to a patent interference proceeding directed at establishing which of the parties to the proceeding was first to invent recombinant DNA technologies for producing GM-CSF. If a patent were to be granted to the other party, the Company might be required to pay royalties with respect to future sales of LEUKINE.\nIn 1992, the Predecessor and BMS entered into a product exchange agreement whereby the Predecessor received the U.S. marketing rights to the BMS Products in exchange for the foreign marketing rights to PIXY321. In December 1993, BMS exercised its option to terminate the agreement and the licenses to each party's products were returned. As a result, the Company ceased marketing the BMS Products in early 1994. The BMS Products generated revenues of $2.7 million and $25.5 million in the years ended December 31, 1994 and 1993, respectively.\nRoyalty and contract revenue increased to $19.0 million in 1995 compared to $8.5 million and $3.8 million in 1994 and 1993, respectively. In 1995, the Company commenced a program of utilizing the available capacity at its manufacturing development center to perform contract manufacturing services for certain customers. Revenue recognized from performing these services totaled $6.4 million in 1995. No related revenue was recognized during the 1994 and 1993 periods. The amount of revenue from these services will fluctuate from period to period depending on the available capacity at the manufacturing development center and the demand for these services. The Company also recognized revenue in 1995 under certain collaborative research agreements. In December 1995, the Company entered into research and license agreements with AHP covering tumor necrosis factor alpha converting enzymes (\"TACE\"), whereby AHP was licensed exclusive worldwide rights to TACE technology. The Company received a license fee of $2.0 million upon signing of the agreement and will receive quarterly payments of $1.0 million beginning in 1996. The TACE agreement includes milestone payments and royalties on future product sales. Pursuant to a research and development agreement between the Company and AHP, the Company is also receiving quarterly payments of $1.0 million from AHP to support the development of tumor necrosis factor receptor (\"TNFR\"). The payments began in 1994 and will continue through 1997 unless AHP elects to discontinue support of TNFR, in which case rights to TNFR outside North America will revert to the Company. The Company earns royalties on sales of the Lederle Oncology Products by AHP outside of North America and generates royalty income under technology license agreements with other entities. Royalties earned in 1995, 1994 and 1993 totaled $5.8 million, $4.4 million and $2.5 million, respectively.\nOPERATING EXPENSES\nCost of product sales, as a percentage of product sales, decreased to 18 percent for the year ended December 31, 1995 compared to 21 percent and 27 percent for the years ended December 31, 1994 and 1993, respectively. The decrease in cost of product sales as a percentage of product sales during 1995 is primarily attributable to the February 1995 launch of THIOPLEX, which has a lower production cost than thiotepa, combined with a favorable change in the mix of product sales to include a higher percentage of the Company's products with relatively lower production costs. In addition, the Company has reduced its trademark royalty obligations on the sale of the Lederle Oncology Products which bear the Lederle trademark. In 1994, the Company began the process of discontinuing use of the Lederle trademark. As of the end of 1995 nearly all of the former Lederle Oncology Products were sold using the Immunex trademark. Royalties incurred under this agreement decreased to $0.3 million in 1995 compared to $1.7 million and $0.9 million for the year ended December 31, 1994 and the period June 2, 1993 to December 31, 1993, respectively. The cost of product sales percentage decreased in 1994 from the seven-month period ended December 31, 1993 due to cessation of the BMS Product sales in early 1994. The cost of the BMS Products was approximately 40 percent of net sales in 1993. Cost of product sales, as a percentage of product sales, will fluctuate moderately from period to period, reflecting any change in the mix of product sales. Significant fluctuations are not expected to occur unless the mix of product sales changes substantially or if substantial period costs are incurred at any of the manufacturing facilities utilized by the Company.\nResearch and development expense increased to $83.5 million in 1995 compared to $77.6 million and $72.5 million in 1994 and 1993, respectively. Research and development expense fluctuates from period to period depending on the number of products under development and the progress those products make towards commercialization. The focus of the Company's manufacturing activities also impacts research and development expense from period to period. The costs to produce products for resale are capitalized to inventory whereas the cost of producing clinical materials and performing contract manufacturing services are expensed to research and development. Research and development expense has increased in each successive period due to the progression of commercial drug candidates into clinical trials and increased medical development efforts in pursuit of expanded label indications for existing commercial products. In addition, the use of the Company's manufacturing resources for the production of clinical material and performance of contract manufacturing services increased in 1995, as compared to 1994. Manufacturing costs expensed to research and development increased in 1994, as compared to 1993, following construction and validation of the manufacturing development center in April 1993.\nFollowing the Merger, the Company began making payments to fund a portion of AHP's oncology research and development programs. Payments under this agreement totaled $15.8 million, $15.3 million and $17.8 million in 1995, 1994, and the seven-month period ended December 31, 1993, respectively. Under the terms of the research and development agreement with AHP, the Company's funding obligation is forecasted to increase to $26.1 million in 1996. Funding of other external research collaborations increased to $3.7 million in 1995 compared to $1.1 million and $0.3 million in 1994 and 1993, respectively.\nSelling, general and administrative expense declined in 1995 to $59.3 million from $67.7 million and $62.1 million in 1994 and 1993, respectively. The decrease in selling, general and administrative expenditures in 1995 resulted primarily from continuation of certain expense reduction and cost control measures implemented in 1994. These activities included reorganizing and reducing the size of the sales force, scaling back or eliminating certain non- essential programs and reducing staff in other areas of the organization. In connection with the staffing reductions, a charge of $1.7 million was made to selling, general and administrative expense to cover severance and termination benefits in the third quarter of 1994. In addition, in 1995, the Company eliminated, or brought in-house, virtually all of the services provided by AHP under a transitional services agreement entered into at the time of the Merger. Costs incurred under this agreement totaled $1.0 million, $6.8 million and $5.9 million in 1995, 1994 and 1993, respectively. These cost reductions have, to a certain extent, been offset by transition costs and ongoing support costs associated with bringing these services in-house. The reductions in selling, general and administrative expense realized in 1995 have also been partially offset by increased legal defense costs related to litigation between the Company and Cistron Biotechnology, Inc. (\"Cistron\"). The Company has incurred costs totaling approximately $3.7 million in defense of this lawsuit in 1995 compared to $1.2 million in 1994. Trial is currently scheduled for April 1996 and these costs are expected to continue until such time that the litigation is resolved. Additional expenses were incurred in selling, general and administrative expense in the fourth quarter of 1995 following AHP's unsolicited offer to acquire the remaining shares of the Company which it does not already own. The Company incurred expenses totaling approximately $2.2 million related to the adoption of certain employee retention programs and costs associated with investment banking, legal and increased board fees. Additional costs will be incurred in 1996 related to AHP's offer.\nThe increase in selling, general and administrative expenses in 1994, as compared to 1993, was due primarily to the addition of the LOC sales organization for a full twelve month period, expanded sales and marketing programs to encompass the Lederle Oncology Products and administrative costs to support the Successor organization. In addition, the Company began incurring increased legal fees associated with the Cistron litigation, as noted above. These increased costs were partially offset by the cessation of certain costs to market and support the BMS Products which the Company ceased marketing early in 1994.\nThe Merger resulted in three one-time charges to operations. The Merger was accounted for using the purchase method, under which the purchase price is allocated to assets and liabilities acquired based on fair values. In accordance with generally accepted accounting principles, all of the purchase price allocated to in-process research and development, totaling $346.4 million, was expensed by the Company in June 1993. In connection with the Merger, holders of employee stock options of the Predecessor were given the right to exercise their options on a cashless basis, whereby employees tendered a portion of the shares subject to option to satisfy the exercise price. This resulted in a charge to the Predecessor's compensation expense in May 1993 of $25.6 million. The Predecessor incurred other Merger-related expenses during the five months ended June 1, 1993, totaling $14.8 million.\nOTHER INCOME (EXPENSE)\nFollowing the receipt of $35.8 million from AHP in March 1995, as settlement of the 1994 revenue shortfall obligation, the Company paid the $34.0 million outstanding balance on its loan with AHP and made the final $10.6 million payment on its construction loan. No additional borrowings were made during the year. These developments, combined with significant improvements in cash generated from operations, led to a moderate increase in interest income in 1995. In addition, interest expense decreased to $1.1 million in 1995 compared to $2.5 million in 1994. Interest expense in 1994 increased from the 1993 level due to an increase in borrowings under the AHP loan agreement from $10.0 million at December 31, 1993 to $34.0 million at December 31, 1994.\nOther income (expense) in 1995 consists primarily of the Company's loss related to its equity investment in Targeted Genetics Corporation (\"TGC\"). For the years ended December 31, 1995 and 1994 and the seven-month period June 2, 1993 to December 31, 1993, the Company recorded losses of $0.5 million, $1.0 million and $0.9 million, respectively, related to its equity investment in TGC. Future losses, if any, are dependent upon TGC's use of its existing cash reserves and the timing and ability of TGC to generate additional capital. In no circumstance will future losses exceed the carrying value of the Company's investment in TGC, which, at December 31, 1995 was $2.4 million. In December 1993, BMS terminated a product exchange agreement with the Company. The Company had recorded a reserve of $5.4 million related to the potential that additional consideration would be payable to BMS to retain the exclusive rights to the BMS Products. This non-cash provision was reversed to other income following notification of termination of the agreement. This addition to other income was offset by a charge of $4.5 million in December 1993 related to the settlement of a class action lawsuit.\nThe Company's provision for income tax consists of the tax obligation of the Company's operations in Puerto Rico and income taxes incurred in the states in which the Company sells its products. In order to reduce current taxes, in 1994, the Company dissolved two of its subsidiaries, including the Puerto Rico corporation. As a result, the provision for income taxes decreased to $0.2 million for the year ended December 31, 1995, compared to $2.0 million and $1.1 million for the year ended December 31, 1994 and the period June 2, 1993 to December 31, 1993, respectively. At December 31, 1995, the Company had a net operating tax loss carryforward of approximately $200 million. The provision for income taxes is not expected to be significant in 1996.\nLIQUIDITY AND CAPITAL RESOURCES\nCash, cash equivalents and securities available-for-sale totaled $20.4 million and $24.7 million at December 31, 1995 and 1994, respectively. Reflecting the Company's improved financial performance, operating activities generated cash of $11.4 million in 1995, compared to cash used in operating activities of $15.7 million in 1994. The cash generated in 1995 was used primarily for capital expenditures and repayment of a construction loan.\nDuring the year ended December 31, 1995, the Company invested $5.2 million in plant and equipment. The Company is currently evaluating certain property in the vicinity of its corporate headquarters for possible development and relocation of its corporate offices and research facilities. The development of this property would allow for the potential future expansion of its research facilities and would support long-term growth of the organization. The Company has an option on the property and has performed initial environmental impact and other site studies. In addition to certain remaining purchase contingencies, management is evaluating the timing and feasibility of this project in the Company's current operating environment. If the Company moves forward with this project in 1996, expenditures for land and related closing costs would be approximately $15 million. Exclusive of the campus development project, expenditures for furniture and equipment are expected to remain at levels consistent with 1995. Additionally, in accordance with a 1992 settlement agreement with Hoechst Roussel Pharmaceutical, Inc. (\"HRPI\"), a payment of $2.0 million will be made to HRPI if the Company receives an expanded label indication for LEUKINE for treatment of chemotherapy-induced neutropenia.\nThe Company used cash of $9.9 million in financing activities during 1995. In March 1995, the Company received $35.8 million from AHP as settlement of its 1994 revenue shortfall obligation. These funds were used to pay the outstanding balance on the AHP loan of $34.0 million. In addition, the Company made the final $10.6 million payment on its construction loan and used $1.0 million for payment of lease debt and other long-term obligations. The loan agreement with AHP, under which there were no borrowings at December 31, 1995, expires in March 1996. The Company has not entered into any discussions at this time to extend the loan agreement and it is uncertain if other sources of short-term financing could be secured. Under the terms of the Amended and Restated Governance Agreement, portions of which were assumed by AHP, AHP will make annual payments to the Company if revenues from the Lederle Oncology Products do not achieve certain sales levels through 1997. The maximum amount payable with respect to 1996 and 1997 are $56.0 million and $60.0 million, respectively. At December 31, 1995, the Company had a receivable from AHP of $45.3 million, which was received in March 1996. Other financing activities are not expected to be significant in 1996.\nThe positive cash flow gains comparable to those in 1995 may not be achieved in 1996 due to increases in payments that may be due under the research and development agreement with AHP. The Company will rely on cash generated from operations and, if necessary, the revenue shortfall obligation payments under the Governance Agreement to meet its near-term cash needs. The ability to meet its cash needs beyond 1997 are largely dependent on the Company's ability to expand the revenue base of its existing products and to realize value from its research and development pipeline.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nPage in FORM 10-K\nConsolidated Balance Sheets at December 31, 1995 and 1994. 24\nConsolidated Statements of Operations for the years ended December 31, 1995 and 1994 and the periods June 2, 1993 to December 31, 1993 and January 1, 1993 to June 1, 1993. 25\nConsolidated Statements of Shareholders' Equity for the years ended December 31, 1995 and 1994 and the periods June 2, 1993 to December 31, 1993 and January 1, 1993 to June 1, 1993. 26\nConsolidated Statements of Cash Flows for the years ended December 31, 1995 and 1994 and the periods June 2, 1993 to December 31, 1993 and January 1, 1993 to June 1, 1993. 27\nNotes to Consolidated Financial Statements for the years ended December 31, 1995 and 1994 and the periods June 2, 1993 to December 31, 1993 and January 1, 1993 to June 1, 1993. 28 - 39\nReport of Ernst and Young LLP, Independent Auditors. 40\nIMMUNEX CORPORATION CONSOLIDATED BALANCE SHEETS (In thousands, except share data)\nSee accompanying notes.\nIMMUNEX CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share amounts)\nSee accompanying notes.\nIMMUNEX CORPORATION CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (In thousands, except share data)\nSee accompanying notes.\nIMMUNEX CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)\nSee accompanying notes.\nIMMUNEX CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1. ORGANIZATION AND BASIS OF PRESENTATION\nImmunex Corporation (the \"Company\") is a biotechnology company that discovers, develops, manufactures and markets human therapeutic products to treat cancer, infectious diseases and autoimmune disorders.\nThe Company operates in a highly regulated and competitive environment. The manufacturing and marketing of pharmaceutical products requires approval from and is subject to ongoing oversight by the Food and Drug Administration in the United States and by comparable agencies in other countries. Obtaining approval for a new therapeutic product is never certain and may take several years and involve expenditure of substantial resources. Competition in researching, developing and marketing pharmaceutical products is intense. Any of the technologies covering the Company's existing products or products under development could become obsolete or diminished in value by discoveries and developments of other organizations.\nThe Company's market for pharmaceutical products is the United States, Canada and Puerto Rico. The Company has arrangements with Wyeth-Ayerst Canada, Inc. and Wyeth-Ayerst Laboratories Puerto Rico, Inc. for distribution and sale of its pharmaceutical products in Canada and Puerto Rico, respectively. Products are sold primarily to wholesalers, oncology distributors, clinics and hospitals in the United States.\nThe financial statements are prepared in conformity with generally accepted accounting principles which require management estimates and assumptions that, to a certain extent, affect the amounts reported on the balance sheet and disclosure of contingent liabilities at the financial statement date and the amounts of revenues and expenses reported during the reporting period. Actual results could differ from those estimates.\nOn June 1, 1993, the shareholders of Immunex Corporation (the \"Predecessor\") approved the Amended and Restated Agreement and Plan of Merger dated as of December 15, 1992 between the Predecessor, American Cyanamid Company (\"Cyanamid\"), Lederle Parenterals Inc., (\"LPI\") a wholly owned subsidiary of Cyanamid, and Lederle Oncology Corporation, a wholly owned subsidiary of Cyanamid (\"Merger Subsidiary\"). Pursuant to this agreement, among other things, the Predecessor was merged (the \"Merger\") with and into Merger Subsidiary (see Note 11). The surviving corporation was named Immunex Corporation, referred to herein as the \"Successor.\"\nPrior to the Merger, Cyanamid and LPI contributed to Merger Subsidiary, among other things, the rights to certain oncology products in the United States and Canada, referred to herein as the \"Lederle Oncology Products,\" and $350 million. Each share of common stock of the Predecessor outstanding immediately prior to the effective time of the Merger (\"Effective Time\") was converted pursuant to the Merger into the right to receive $21 in cash consideration and one share of common stock of the Successor; and the common stock of Merger Subsidiary outstanding immediately prior to the Effective Time, all of which was held by Cyanamid and LPI, was converted pursuant to the Merger into that number of shares of Successor common stock equal to 53.5% of the total number of shares of Successor common stock outstanding immediately following the Effective Time, on a fully diluted basis. A substantial portion of the $350 million contributed by Cyanamid to Merger Subsidiary was used to pay the cash consideration to Predecessor shareholders.\nIn November 1994, all of the outstanding shares of common stock of Cyanamid were acquired by American Home Products Corporation (\"AHP\"). Prior to the merger of Cyanamid and AHP, the Company and AHP entered into an agreement under which AHP agreed to protect the Company's rights under its agreements with Cyanamid. AHP and certain of its divisions or affiliates have assumed the rights and obligations of Cyanamid under the various agreements that the Successor and Cyanamid entered into at the time of the Merger or thereafter. As a result, AHP now holds a majority interest in the Successor. All references to AHP include AHP and its various affiliates, divisions and subsidiaries, including Cyanamid.\nThe consolidated financial statements for the period January 1, 1993 to June 1, 1993 are those of the Predecessor. The consolidated financial statements as of December 31, 1995, 1994 and 1993 and for the period June 2, 1993 to December 31, 1993 are those of the Successor.\nIMMUNEX CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.\nCASH EQUIVALENTS\nCash equivalents consist principally of deposits in money market accounts available on demand or securities with purchased maturities of 90 days or less.\nSECURITIES AVAILABLE-FOR-SALE\nEffective January 1, 1994, the Successor adopted Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities. Statement No. 115 requires the classification of certain investments in debt and equity securities as either held-to-maturity securities, trading securities or available-for-sale securities. The Successor's investments are considered available-for-sale, and such securities are stated at fair value, with the unrealized gains and losses included in accumulated deficit on the Successor's balance sheet. Cost of securities is calculated using the specific-identification method. Securities available-for-sale at December 31, 1994 consist primarily of U.S. Government securities, all of which mature within three years.\nINVENTORIES\nInventories are stated at the lower of cost, using a weighted-average method, or market. The components of inventories at December 31, 1995 and 1994 are as follows (in thousands):\nDEPRECIATION AND AMORTIZATION\nDepreciation of buildings, equipment and capital leases is calculated using the straight-line method over the estimated useful lives of the related assets which range from 3 to 31.5 years. Leasehold improvements are amortized on a straight- line basis over the lesser of the estimated useful life or the term of the lease. The costs of acquiring leasehold interests are amortized over the remaining term of the lease.\nPROPERTY HELD FOR FUTURE DEVELOPMENT\nThe Company owns certain properties intended for the possible future expansion of its manufacturing facilities which are recorded at cost.\nINVESTMENT IN AFFILIATE\nThe Company owns a 21% equity interest in Targeted Genetics Corporation (\"TGC\"), a biotechnology company engaged in developing human gene therapy products for the treatment of acquired and inherited diseases. The Company records its share of the net losses of TGC to the extent its cash investment exceeds its interest in the net tangible assets of TGC. Losses of $514,000, $974,000 and $886,000 were recorded for the years ended December 31, 1995 and 1994 and the period June 2, 1993 to December 31, 1993, respectively. No losses were recorded for the period January 1, 1993 to June 1, 1993. The market value of the Successor's investment in TGC at December 31, 1995 is $14,699,000.\nIMMUNEX CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED\nGOODWILL AND OTHER INTANGIBLE ASSETS\nGoodwill recorded pursuant to the Merger is being amortized using the straight- line method over a 10-year period. Accumulated amortization at December 31, 1995 and 1994 totaled $5,271,000 and $3,208,000, respectively.\nIntangible product rights recorded pursuant to the Merger are amortized using the straight-line method over their estimated useful lives ranging from 11 to 15 years. Accumulated amortization at December 31, 1995 and 1994 totaled $2,006,000 and $1,230,000, respectively.\nThe Company seeks patent protection on processes and products in various countries. Patent application costs are capitalized and amortized over their estimated useful lives, not exceeding 17 years, on a straight-line basis from the date the related patents are issued. Accumulated amortization at December 31, 1995 and 1994 totaled $210,000 and $194,000, respectively.\nREVENUES\nProduct sales are recognized when product is shipped. The Company performs ongoing credit evaluations of its customers and does not require collateral. Product sales are recorded net of reserves for estimated chargebacks, returns, discounts, Medicaid rebates and administrative fees. The Company maintains reserves at a level which management believes is sufficient to cover estimated future requirements. Allowances for discounts, returns and bad debts, which are netted against accounts receivable, totaled $6,276,000 and $6,536,000 at December 31, 1995 and 1994, respectively. Reserves for chargebacks, Medicaid rebates and administrative fees are included in accounts payable and totaled $9,303,000 and $5,822,000 at December 31, 1995 and 1994, respectively.\nRevenues received under royalty, licensing and contract manufacturing agreements are recognized based on the terms of the underlying contractual agreements. Expenses related to the performance of contract manufacturing are included in research and development expense.\nNET LOSS PER COMMON SHARE\nNet loss per common share is calculated by dividing net loss by the weighted average number of common shares.\nIMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS\nIn March 1995, the FASB issued Statement No. 121,\"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,\" which requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amount. The Company will adopt Statement No. 121 in the first quarter of 1996, as allowed for in the statement, and based on current circumstances, does not believe the effect of adoption will be material.\nIn October 1995, the FASB issued Statement No. 123, \"Accounting for Stock-Based Compensation,\" which requires stock-based compensation expense to be measured using either the intrinsic-value method as prescribed by Accounting Principles Board Opinion (\"APB\") No. 25 or the fair-value method described in Statement No. 123. Companies choosing the intrinsic-value method will be required to disclose the pro-forma impact of the fair-value method on net income and earnings per share. The Company will adopt Statement No. 123 in the first quarter of 1996, as allowed for in the statement, using the intrinsic-value method of APB Opinion No. 25.; there will be no effect of adopting the Statement on the Company's financial position and results of operations.\nIMMUNEX CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 3. PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment, at cost, consist of the following at December 31, 1995 and 1994 (in thousands):\nEquipment, principally laboratory and office equipment, includes $1,001,000 and $3,542,000 at December 31, 1995 and 1994, respectively, under capitalized lease arrangements. Related accumulated amortization was $856,000 and $2,953,000 at December 31, 1995 and 1994, respectively. The leases contain purchase options at the end of the lease terms.\nNOTE 4. LONG-TERM DEBT AND OTHER OBLIGATIONS\nLong-term debt and other obligations consist of the following at December 31, 1995 and 1994 (in thousands):\nIn connection with the Merger, termination benefits were awarded to a former Chief Executive Officer who retired from the Predecessor. Benefits are payable over approximately 20 years in varying amounts and have been discounted using a rate of 7%.\nScheduled annual maturities of other obligations in 1997 and the three subsequent years are as follows: $539,000, $713,000, $886,000 and $1,067,000, respectively.\nInterest paid on all borrowings was $1,226,000, $2,515,000, $1,021,000, and $159,000 for the years ended December 31, 1995 and 1994, the period June 2, 1993 to December 31, 1993 and the period January 1, 1993 to June 1, 1993, respectively.\nNOTE 5. FAIR VALUES OF FINANCIAL INSTRUMENTS\nAt December 31, 1995 and 1994, the Company had several categories of financial instruments. With the exception of the deferred state sales tax, the balance sheet carrying value for all categories of financial instruments approximate fair value at December 31, 1995 and December 31, 1994. The fair value of the deferred state sales tax on the Company's manufacturing facility was estimated by discounting the future cash flows using the Company's current estimated incremental borrowing rate for similar types of borrowing arrangements. At December 31, 1995 and 1994, the fair value of the deferred state sales tax was $2,685,000 and $2,423,000, respectively, compared to a balance sheet carrying value of $3,442,000.\nIMMUNEX CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 6. SHAREHOLDERS' EQUITY\nSTOCK OPTIONS\nPrior to the Merger, Merger Subsidiary adopted the 1993 Stock Option Plan (the \"Plan\") which provides for the issuance of incentive and non-qualified stock options to employees and officers. There have been 6,225,000 shares of common stock reserved for the plan. Options are granted by a committee of the Successor's Board of Directors. Under policy of the Successor, options are not granted at less than the fair market value of the Successor's common stock at the date of grant. Each outstanding option has a term of ten years from the date of grant and, depending on the option, becomes exercisable at a rate of 20% or 33% per year beginning one year from the date of grant.\nInformation with respect to the Plan follows (in thousands, except per share amounts):\nGUARANTY PAYMENTS RECEIVABLE FROM AHP\nUnder the terms of the Amended and Restated Governance Agreement, AHP has agreed to make certain payments or contribute products to the Successor if revenues from the Lederle Oncology Products do not achieve certain levels (\"Expected Revenues\") through December 31, 1997. The revenue shortfall obligation is limited to a maximum amount in each year (\"Maximum Guaranty Obligation\"). Such payments are treated as additional contributions to the capital of the Successor.\nAHP's Maximum Guaranty Obligation and the Expected Revenues for the years ending December 31, 1996 and December 31, 1997 are as follows (in thousands):\nMaximum Guaranty Expected Year Ending December 31, Obligation Revenues - ------------------------ ---------- --------- 1996 $ 56,000 $ 190,500 1997 60,000 216,500\nThe Successor recorded a receivable from AHP of $45,288,000 and $35,768,000 for the revenue shortfall related to the Lederle Oncology Products for the years ended December 31, 1995 and 1994, respectively.\nIMMUNEX CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 7. INCOME TAXES\nThe Successor's deferred tax assets consist primarily of the benefit to be derived from unused net operating tax loss carryforwards of approximately $200 million and carryforwards of approximately $11.5 million for research and experimental credits at December 31, 1995. The carryforwards expire from 1996 through 2010. Net operating tax loss carryforwards and research and experimental credits of $113,000 and $6,000, respectively, expired in 1995. Due to the uncertainty regarding the Successor's ability to generate taxable income in the future to realize the benefit from its net deferred tax assets at December 31, 1995 and 1994, a valuation allowance of $79.3 million and $75.2 million, respectively, has been recognized for financial reporting purposes to offset the excess of the Successor's deferred tax assets over its deferred tax liabilities. This represents an increase in the valuation allowance of $4.1 million and $17.0 million for the years ended December 31, 1995 and 1994, respectively. In the event the Successor is able to utilize its net operating tax loss carryforwards, the carryforwards would be used to first reduce the unamortized balance of goodwill, followed by the unamortized balance of intangible product rights and, lastly, federal income tax expense.\nThe significant components of the Successor's deferred tax assets and liabilities at December 31, 1995 and 1994 are as follows (in thousands):\nThe provision for income taxes consist of the following (in thousands):\nThe entire provision for the period is current. Income taxes paid during the years ended December 31, 1995 and 1994 totaled $1,289,000 and $1,347,000, respectively. No income taxes were paid during the period June 2, 1993 to December 31, 1993. For the period January 1, 1993 to June 1, 1993, the Predecessor was in a net operating loss position for domestic federal income tax purposes and was not subject to foreign income taxes.\nIMMUNEX CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 7. INCOME TAXES, CONTINUED\nReconciliation of the U.S. federal tax rate to the Successor's effective tax rate is as follows:\nNOTE 8. EMPLOYEE BENEFITS As a retirement vehicle, the Successor has a defined contribution plan covering all full-time salaried employees. The plan is a salary deferral arrangement pursuant to Internal Revenue Code section 401(k) and is subject to the provisions of the Employee Retirement Income Security Act of 1974 (\"ERISA\"). The Successor matches 100% of the first 2% of an employee's deferred salary and 50% of the next 4% of an employee's deferred salary. Employees with five or more years of service receive a match of 100% of the first 2% of deferred salary and 75% of the next 4% of deferred salary. The matching contributions to the plan were $1,370,000, $1,656,000, $773,000 and $408,000 for the years ended December 31, 1995 and 1994, the period from June 2, 1993 to December 31, 1993 and the period from January 1, 1993 to June 31, 1993, respectively.\nNOTE 9. RELATED PARTY TRANSACTIONS On June 1, 1993, the Predecessor merged with a subsidiary of Cyanamid. In November 1994, all of the outstanding shares of common stock of Cyanamid were acquired by AHP. AHP, its subsidiaries and affiliates have assumed the rights and obligations of Cyanamid under various agreements entered into at the time of the Merger or thereafter. Significant transactions under these agreements are summarized below.\nGOVERNANCE AGREEMENT\nUnder the terms of the governance agreement, AHP is required to make certain payments or contribute products to the Successor if revenues from the Lederle Oncology Products do not achieve certain established levels through December 31, 1997 (see Note 6). At December 31, 1995 and December 31, 1994, the Successor had recorded a receivable from AHP of $45,288,000 and $35,768,000 related to the revenue shortfall for the years ended December 31, 1995 and 1994, respectively.\nIMMUNEX CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 9. RELATED PARTY TRANSACTIONS, CONTINUED\nRESEARCH AND DEVELOPMENT AGREEMENT\nThe Successor and AHP are parties to a research and development agreement under which the parties cooperate to research, develop and commercialize new products. Under the terms of the research and development agreement, the Successor is required to support AHP's worldwide oncology research and development programs by paying certain amounts to AHP. In return, the Successor receives the North American rights to any products resulting from AHP's research programs in oncology. For the years ended December 31, 1995 and 1994 and the period June 2, 1993 to December 31, 1993, the Successor paid $15,800,000, $15,300,000 and $17,799,000, respectively, to AHP under the research and development agreement, which represented it's entire 1995, 1994 and 1993 obligations. For the years 1996 and 1997, the Successor's forcasted funding obligations under the research and development agreement are $26,100,000 and $38,300,000, respectively, which represents 37.5% and 50% of AHP's forecasted oncology research and development budget for each respective year. For years after 1997, the Successor is obligated to contribute 50% of the cost of AHP's oncology research and development programs. In order to retain the international rights to TNFR , AHP is required to pay the Successor $4,000,000 per year through 1997. AHP's entire 1995 and 1994 TNFR obligations were received during each respective year.\nONCOLOGY PRODUCT LICENSE AGREEMENT\nThe Successor and AHP are parties to an oncology product license agreement under which AHP has an exclusive license to manufacture in North America certain oncology products for ultimate sale by AHP and its sub-licensees outside North America. The Successor earns a royalty equal to 5% of the net sales of the oncology products sold under this agreement. The Successor recognized revenue under this agreement of $2,546,000, $2,571,000 and $650,000 for the years ended December 31, 1995 and 1994 and the period June 2, 1993 to December 31, 1993, respectively. At December 31, 1995 and 1994, $800,000 was due from AHP.\nNEW ONCOLOGY PRODUCT LICENSE AGREEMENT\nThe Successor and AHP have entered into a new oncology product license agreement under which AHP has a co-exclusive license to make, have made, use and sell outside North America new oncology products resulting from the research and development efforts of the Successor (\"New Oncology Products\"). AHP is required to pay a royalty equal to 5% of the net sales of the New Oncology Products sold under this agreement. In the event that a New Oncology Product is to be manufactured by the Successor for AHP or by AHP for the Successor, the manufacturing party will supply such product at a price that will reimburse the manufacturing party for its manufacturing, process development and overhead costs allocable to such product, plus a reasonable profit. The Successor recognized revenue under this agreement of $651,000 and $327,000 for the years ended December 31, 1995 and 1994, respectively, of which $61,000 and $327,000 was receivable at December 31, 1995 and 1994, respectively. Under the terms of a subsequent related agreement, the Successor incurred costs of $2,434,000 for the year ended December 31, 1995 of which $1,472,000 was payable at December 31, 1995.\nTACE AGREEMENTS\nIn December 1995, the Successor licensed exclusive worldwide rights to tumor necrosis factor alpha converting enzyme (\"TACE\") technology to AHP. The Successor received a license fee of $2.0 million upon signing of the agreement and will receive quarterly payments of $1.0 million beginning in 1996. The TACE agreements also include milestone payments and royalties on future product sales. Under the agreements, AHP will be responsible for developing inhibitors of TACE.\nSUPPLY AGREEMENT, TOLL MANUFACTURING AGREEMENT AND METHOTREXATE DISTRIBUTORSHIP AGREEMENT\nThe Successor and AHP are parties to a supply agreement and toll manufacturing agreement under which AHP manufactures and supplies the reasonable commercial requirements of certain oncology products at a price equal to 125% of AHP's or its subsidiaries' manufacturing costs. The Successor and AHP also have a methotrexate distributorship agreement whereby AHP agreed to supply methotrexate at certain established prices which are adjusted annually. The Successor and its subsidiaries purchased $9,536,000 and $10,062,000 of inventory from AHP and its subsidiaries under these agreements during the years ended December 31, 1995 and 1994, of which $976,000 and $1,426,000 was payable at December 31, 1995 and 1994, respectively. In addition, AHP billed the Successor $659,000 and $677,000 for other expenses for the years ended December 31, 1995 and 1994, respectively, of which the entire 1995 amount was paid during the year and $83,000 was payable at December 31, 1994.\nIMMUNEX CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 9. RELATED PARTY TRANSACTIONS, CONTINUED\nDISTRIBUTORSHIP AGREEMENT FOR CANADA\nThe Successor and Wyeth-Ayerst Canada, Inc. (\"Wyeth-Ayerst Canada\"), a wholly owned subsidiary of AHP, are parties to a distributorship agreement under which Wyeth-Ayerst Canada distributes certain oncology products in Canada. The Successor supplies the oncology products to Wyeth-Ayerst Canada at certain established prices which are subject to annual adjustment. The Successor sold $1,631,000, $1,894,000 and $1,642,000 of inventory to Wyeth-Ayerst Canada during the years ended December 31, 1995 and 1994 and the period from June 2, 1993 to December 31, 1993, respectively, of which $801,000 and $265,000 was receivable at December 31, 1995 and 1994, respectively.\nTRADEMARK LICENSE AGREEMENT\nThe Successor and AHP are parties to a trademark license agreement under which the Successor received the right to use certain trademarks relating to oncology products. The Successor incurs a royalty of 2% of net sales of the products sold under these trademarks. The royalty incurred by the Successor for the years ended December 31, 1995 and 1994 and the period from June 2, 1993 to December 31, 1993 totaled $267,000, $1,702,000 and $889,000, respectively, of which $52,000 and $509,000 was payable at December 31, 1995 and 1994, respectively.\nUNITED STATES SERVICES AGREEMENT\nThe Successor and AHP are parties to a transitionary services agreement under which AHP agreed to provide certain services, including, among other things, marketing, customer service, distribution, and credit and collections related to the Lederle Oncology Products. The Successor incurred costs under this agreement totaling $968,000, $6,759,000 and $5,937,000 for the years ended December 31, 1995 and 1994 and the period from June 2, 1993 to December 31, 1993, respectively, of which $7,000 and $563,000 was payable at December 31, 1995 and 1994, respectively. In 1994 and 1993, AHP also incurred certain additional expenses not included in the service fees for which the Successor agreed to directly reimburse AHP. These expenses totaled $893,000 and $1,341,000 for the year ended December 31, 1994 and the period from June 2, 1993 to December 31, 1993, of which $1,705,000 was payable at December 31, 1994. The Successor has terminated nearly all of the services provided under this agreement. Accordingly, future costs will not be significant.\nLOAN AGREEMENT\nThe Successor has a loan agreement with a subsidiary of AHP whereby the subsidiary agreed to provide to the Successor a $50 million line of credit, which expires March 31, 1996. At December 31, 1994, the Successor had borrowed $34,000,000 under the agreement. The Successor repaid the $34,000,000 in March 1995 and no additional borrowings were made during the year. Interest accrues at LIBOR plus 1% and is payable upon maturity of individual borrowings under the loan. For the years ended December 31, 1995 and 1994 and the period from June 2, 1993 to December 31, 1993, the Successor recorded interest expense of $510,000, $1,143,000 and $50,000 related to the loan, respectively. No interest was owed at December 31, 1995 and $39,000 was payable at December 31, 1994.\nIMMUNEX CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 10. COMMITMENTS AND CONTINGENCIES\nThe Successor leases office and laboratory facilities under certain noncancelable operating leases which expire through August 2000. These leases provide the Successor with options to renew the leases at fair market rentals through August 2015. A summary of minimum rental commitments under noncancelable operating and capital leases at December 31, 1995 follows (in thousands):\nRental expense on operating leases was $2,704,000, $2,572,000, $1,122,000 and $1,001,000 for the years ended December 31, 1995 and 1994, the period from June 2, 1993 to December 31, 1993 and the period from January 1, 1993 to June 1, 1993, respectively.\nFollowing AHPs' unsolicited offer in November 1995 to acquire for cash the 45.7% ownership interest of Immunex which AHP does not already own, a class action lawsuit was filed on behalf of the shareholders of Immunex in the Superior Court of Washington for King County. The complaint alleges that the proposed AHP transaction is unfair and harmful to the minority shareholders of Immunex and seeks injunctive relief against consummation of the proposed AHP transaction. A special committee of Immunex's Board of Directors subsequently advised AHP that it rejected the proposed buy-out offer because it concluded that the price offered of $14.50 per share was inadequate. Since that announcement, there has been no activity in the pending case. The suit is not expected to have a material adverse impact on the financial condition or results of operations of the Company.\nIn September 1993, Cistron Biotechnology, Inc. (\"Cistron\") filed suit against Immunex asserting that Immunex had misappropriated information regarding Interleukin-1 beta (\"IL-1 beta\") and that such information was used by Immunex in patent applications relating to IL-1 beta. Immunex filed a countersuit seeking a declaratory judgment and injunctive relief against Cistron asserting that it did not misappropriate any trade secrets of Cistron. Cistron has subsequently amended its complaint to include violation of the Racketeer Influenced and Corruption Organization's (\"RICO\") Act and also filed suit against three former officers of Immunex, alleging that they misappropriated trade secrets and committed fraud and RICO violations arising from the same facts. Claims against one of the former officers have been dismissed. Immunex has also amended its counterclaim for a declaration of non-infringement, invalidity and unenforceability of Patent No. 4,766,069. This counterclaim was withdrawn by Immunex following Cistron's agreement not to sue Immunex for patent infringement. Cistron moved to amend its complaint in November 1995 to include breach of contract, breach of confidential relationship and unfair competition. Cistron is seeking unspecified actual, punitive and exemplary damages and costs and attorney's fees. Trial is scheduled to begin in April 1996. The Company has and intends to continue to vigorously defend the allegations of the suit. Based on the available information, management of the Company does not expect the suit to have a material adverse impact on the financial condition or results of operations of the Company.\nIMMUNEX CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 10. COMMITMENTS AND CONTINGENCIES, CONTINUED\nThe outcomes of certain unresolved patent situations could have a material adverse impact on the Successor's future product sales. The Successor is a party to a patent interference proceeding directed to human GM-CSF DNAs. If a patent were to be granted to one of the other parties to the proceeding, the Successor might be sued for patent infringement in a lawsuit seeking damages, royalties, or an injunction barring the Successor from making, using or selling LEUKINE-Registered Trademark- (Sargramostim). PIXY321 is a protein under development that is designed to combine the effects of GM-CSF and Interleukin-3 (\"IL-3\") in a single molecule. A competitor holds patents covering recombinant DNA technologies related to IL-3. This competitor, or a competitor holding a GM-CSF DNA patent, could claim that PIXY321 infringes either or both such patents. The outcome of these unresolved patent situations is uncertain; however, management of the Company does not expect these patent interferences to have a material adverse impact on the financial condition or results of operations of the Company.\nIn accordance with a 1992 settlement agreement with Hoechst Roussel Pharmaceuticals, Inc. (\"HRPI\"), a payment of $2.0 million will be made to HRPI if the Successor receives an expanded label indication for LEUKINE for treatment of chemotherapy-induced neutropenia.\nThe Successor has certain agreements to fund third-party research. Commitments under these agreements are estimated at $3.1 million and $1.6 million in 1996 and 1997, respectively. Funding under one agreement beyond 1997 is dependent upon several factors.\nVarious license agreements exist which require the Successor to pay royalties based on a percentage of sales of products manufactured using licensed technology or sold under license. Expenses incurred under these agreements are included in cost of product sales and totaled $5,844,000, $6,194,000, $3,307,000, and $1,751,000 for the years ended December 31, 1995 and 1994, the period June 2, 1993 to December 31, 1993 and the period January 1, 1993 to June 1, 1993, respectively. Certain of these agreements contain minimum annual royalty provisions which range from $10,000 to $3,750,000 per year in 1996 and 1997 and from $10,000 to $3,500,000 in 1998 and beyond.\nNOTE 11. BUSINESS COMBINATION\nThe Merger, described in Note 1, was accounted for by the Successor using the purchase method of accounting. Accordingly, assets and liabilities acquired from the Predecessor were recorded at historical cost adjusted by the amount of excess purchase price (53.5% of the excess of the aggregated market value of the Predecessor's common stock outstanding at the Effective Time, on a fully diluted basis, over the shareholders' equity of the Predecessor). Excess purchase price was allocated to the Predecessor's assets and liabilities acquired based on estimated fair market values at the Effective Time.\nThe allocation of excess purchase price was as follows (in thousands):\nExcess purchase price allocated to in-process research and development was expensed by the Successor, as required under generally accepted accounting principles, which resulted in a significant non-cash charge against earnings of $346.4 million for the period June 2, 1993 to December 31, 1993.\nIMMUNEX CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 12. BRISTOL-MYERS SQUIBB AGREEMENT\nThe Predecessor and Bristol-Myers Squibb Company (\"BMS\") entered into a product exchange agreement in 1992. Pursuant to the agreement, the Predecessor licensed exclusive foreign marketing rights to PIXY321, to BMS in exchange for exclusive U.S. marketing rights to HYDREA and RUBEX (collectively, \"the BMS Products\").\nIn December 1993, BMS terminated the product exchange agreement which resulted in the return of each party's product rights in January 1994. The Successor had recorded a non-cash charge to cost of sales related to the potential that additional consideration would be payable to BMS to retain the exclusive rights to the BMS Products. The charge totaled $1.6 million and $1.1 million for the periods June 2, 1993 to December 31, 1993 and January 1, 1993 to June 1, 1993, respectively. Upon termination of the agreement in December 1993, the reserve, totaling $5.4 million, was reversed and included in other income.\nNOTE 13. RECEPTECH CORPORATION\nIn 1989, Receptech was formed to accelerate the development of soluble cytokine receptor products licensed to Receptech by the Predecessor. At the time of the Receptech units offering, in exchange for warrants to purchase 2,290,000 shares of the Predecessor's common stock, the Predecessor received an option to purchase all of the outstanding shares of Receptech common stock at specified prices. In December 1992, the Predecessor exercised its option to purchase all outstanding shares of Receptech common stock. Payment of $26 per share was made to Receptech Shareholders in February 1993 for a total cost to the Predecessor of $59,774,000.\nReport of Ernst and Young LLP, Independent Auditors\nBoard of Directors Immunex Corporation\nWe have audited the accompanying consolidated balance sheets of Immunex Corporation (Successor, see Note 1) as of December 31, 1995 and 1994, and the related consolidated statements of operations, shareholders' equity, and cash flows for the years then ended and the period June 2, 1993 through December 31, 1993, and the related consolidated statements of operations, shareholders' equity, and cash flows of Immunex Corporation (Predecessor, see Note 1) for the period January 1, 1993 through June 1, 1993. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Immunex Corporation (Successor) as of December 31, 1995 and 1994, and the consolidated results of its operations and its cash flows for the years then ended and for the period June 2, 1993 through December 31, 1993, and the consolidated results of operations and cash flows of Immunex Corporation (Predecessor) for the period January 1, 1993 through June 1, 1993, in conformity with generally accepted accounting principles. Also, in our opinion the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nErnst & Young, LLP\nSeattle, Washington January 19, 1996\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 from the section labeled \"Election of Directors\" and \"Executive Officers\" in the Company's definitive Proxy Statement for the annual meeting to be held on April 25, 1996.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by this item is incorporated by reference from the section labeled \"Executive Compensation\" in the Company's definitive Proxy Statement for the annual meeting to be held on April 25, 1996.\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 sections labeled \"Principal Holders of Voting Securities\" in the Company's definitive Proxy Statement for the annual meeting to be held on April 25, 1996.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by this item is incorporated by reference from the sections labeled \"Relationship with American Home Products Corporation and American Cyanamid\" in the Company's definitive Proxy Statement for the annual meeting to be held on April 25, 1996.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) The following documents are filed as part of this Form 10-K:\n1. FINANCIAL STATEMENTS. The following Financial Statements are included in Part II, Item 8:\nPage in Form 10-K ---------\nConsolidated Balance Sheets at December 31, 1995 and 1994. 24\nConsolidated Statements of Operations for the years ended December 31, 1995 and 1994 and the periods June 2, 1993 to December 31, 1993 and January 1, 1993 to June 1, 1993. 25\nConsolidated Statements of Shareholders' Equity for the years ended December 31, 1995 and 1994 and the periods June 2, 1993 to December 31, 1993 and January 1, 1993 to June 1, 1993. 26\nConsolidated Statements of Cash Flows for the years ended December 31, 1995 and 1994 and the periods June 2, 1993 to December 31, 1993 and January 1, 1993 to June 1, 1993. 27\nNotes to Consolidated Financial Statements for the years ended December 31, 1995 and 1994 and the periods June 2, 1993 to December 31, 1993 and January 1, 1993 to June 1, 1993. 28-39\nReport of Ernst and Young LLP, Independent Auditors. 40\n2. FINANCIAL STATEMENT SCHEDULE. The following schedule supporting the foregoing Financial Statements for the years ended December 31, 1995 and 1994 and the periods June 2, 1993 to December 31, 1993 and January 1, 1993 to June 1, 1993 is filed as part of this Form 10-K:\nPage in Form 10-K --------- II - Valuation and Qualifying Accounts 46\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 Number Description ------ ----------- 3.1 Certificate of Incorporation, as filed with the Secretary of State of Washington on April 14, 1994. (Exhibit 3.1) (G)\n3.2 Amended and Restated Bylaws. (Exhibit 3.4) (C)\n10.1 Real Estate Purchase and Sale Agreement by and between Cornerstone-Columbia Development Company (\"CCDC\") and the Company dated November 12, 1986; Master Lease, dated as of August 20, 1981 between OTR, an Ohio General Partnership, and CCDC; Assignment of Master Lease between CCDC and the Company dated December 17, 1986; Consent to Assignment of Master Lease from OTR to CCDC, the Company and Weyerhaeuser Real Estate Company, dated December 8, 1986. (Exhibit 10.22) (A)\n10.2 Amendment to Master Lease dated May 1, 1994, between the Company and Watumull Enterprises, LTD. (Exhibit 10.2) (G)\n10.3 Amended and Restated Lease Agreement dated December 21, 1994, between the Company and the Central Life Assurance Company. (Exhibit 10.3) (G)\n**10.4 Amended and Restated Agreement and Plan of Merger, dated as of December 15, 1992, among the Company, American Cyanamid Company, Lederle Parenterals, Inc. and Lederle Oncology Corporation. (Exhibit 2.1) (C)\n10.5 Amended and Restated Governance Agreement, dated as of December 15, 1992, among the Company, American Cyanamid Company and Lederle Oncology Corporation. (Exhibit 2.2) (C)\n10.6 Settlement Agreement, dated as of July 22, 1992, among the Company, Hoechst-Roussel Pharmaceuticals Inc. and Behringwerke AG. (Exhibit 10.13) (B)\n10.7 Research and Development Agreement between the Company and American Cyanamid Company Dated June 1, 1993. (Exhibit 10.1) (D)\n*10.8 Oncology Product License Agreement between the Company and American Cyanamid Company dated as of June 1, 1993. (Exhibit 10.2) (D)\n10.9 Immunex New Oncology Product License Agreement between the Company and American Cyanamid Company dated as of June 1, 1993. (Exhibit 10.3) (D)\n10.10 United States Service Agreement between the Company and American Cyanamid Company dated as of June 1, 1993. (Exhibit 10.4) (D)\n*10.11 United States Royalty-Bearing Trademark License Agreement between the Company and American Cyanamid Company dated as of June 1, 1993. (Exhibit 10.5) (D)\n10.12 Toll Manufacturing Agreement between Immunex Carolina Corporation, a wholly owned subsidiary of the Company, and Lederle Parenterals, Inc. dated as of June 1, 1993. (Exhibit 10.6) (D)\n*10.13 Supply Agreement between the Company and American Cyanamid Company dated as of June 1, 1993. (Exhibit 10.7) (D)\n*10.14 Separation Agreement between the Company and Stephen A. Duzan dated as of May 26, 1993. (Exhibit 10.8) (D)\n**10.15 Loan Agreement between the Company and Cyanamid Agricultural de Puerto Rico, Inc. dated as of September 30, 1993. (Exhibit 10.21) (E)\n10.16 Director Stock Option Plan (Exhibit 4.1) (F)\n10.17 Second Amendment to Loan Agreement between the Company and Cyanamid Agriculture de Puerto Rico, Inc. dated as of November 18, 1994. (Exhibit 10.23) (G)\n10.18 Agreement between the Company and American Home Products dated as of September 23, 1994. (Exhibit 10.24) (G)\n10.19 Amended and Restated 1993 Stock Option Plan. (Exhibit 4.1) (H)\n10.20 Form of Employment Agreement, together with schedule of actual agreements. 47-57\n21.1 Subsidiaries of the Registrant. 58\n23.1 Consent of Independent Auditors. 59\n24.1 Power of Attorney. 60\n27.1 Financial Data Schedule. 61\n____________________________________\n* Confidential treatment granted as to certain portions.\n** Executive compensation plan or arrangement.\n(A) Incorporated by reference to designated exhibit included with the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1986.\n(B) Incorporated by reference to designated exhibit included with the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1992.\n(C) Incorporated by reference to designated exhibit included in the Registration Statement on Form S-4 (SEC File No. 33-60254) filed by Lederle Oncology Corporation March 18, 1993.\n(D) Incorporated by reference to designated exhibit included with the Company Current Report on Form 8-K dated June 4, 1993.\n(E) Incorporated by reference to designated exhibit included with the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993.\n(F) Incorporated by reference to designated exhibit included in the Registration Statement on Form S-8 (SEC File No. 33-78694) filed by Immunex Corporation on May 6, 1994.\n(G) Incorporated by reference to designated exhibit included with the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994.\n(H) Incorporated by reference to designated exhibit included in the Registration Statement on Form S-8 (SEC File No. 33-59061) filed by Immunex Corporation on May 3, 1995.\n(b) REPORTS ON FORM 8-K.\nNot applicable.\nSIGNATURES\nPursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the registrant has duly caused this Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nIMMUNEX CORPORATION REGISTRANT\nBy: \/s\/ Douglas G. Southern March 13, 1996 ------------------------------------ Douglas G. Southern Senior Vice President, Treasurer and Chief Financial Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated:\n\/s\/ Edward V. Fritzky March 13, 1996 --------------------------------------------------- Edward V. Fritzky Chief Executive Officer, Chairman of the Board and Director (Principal Executive Officer)\n\/s\/ Michael L. Kranda March 13, 1996 --------------------------------------------------- President, Chief Operating Officer and Director\n\/s\/ Douglas G. Southern March 13, 1996 --------------------------------------------------- Douglas G. Southern Senior Vice President, Treasurer and Chief Financial Officer (Principal Financial and Accounting Officer)\nJoseph J. Carr* March 13, 1996 --------------------------------------------------- Joseph J. Carr Director\nKirby L. Cramer* March 13, 1996 --------------------------------------------------- Kirby L. Cramer Director\nSteven Gillis* March 13, 1996 --------------------------------------------------- Steven Gillis Director\nRichard L. Jackson* March 13, 1996 --------------------------------------------------- Richard L. Jackson Director\nJohn E. Lyons* March 13, 1996 --------------------------------------------------- John E. Lyons Director\n*By: \/s\/ Douglas G. Southern March 13, 1996 -------------------------------------- Douglas G. Southern Attorney-in-Fact\nSCHEDULE II IMMUNEX CORPORATION\nVALUATION AND QUALIFYING ACCOUNTS The periods January 1, 1993 to June 1, 1993 and June 2, 1993 to December 31, 1993, and the years ended December 31, 1994 and 1995 (in thousands)","section_15":""}
{"filename":"713275_1995.txt","cik":"713275","year":"1995","section_1":"ITEM 1. BUSINESS\nINTRODUCTION\nPharmos Corporation (the \"Company\") is an emerging pharmaceutical company engaged in the discovery, design, development and commercialization of pharmaceuticals to meet significant therapeutic needs in major markets. The Company is developing pharmaceuticals in various fields including: site specific drugs for ophthalmic indications, neuroprotective agents targeted at specific brain receptors for the treatment of central nervous system (CNS) disorders, systemic drugs designed to avoid CNS related side effects, and emulsion-based products for topical and systemic applications. The Company submitted to the U.S. Food and Drug Administration (\"FDA\") a new drug application (\"NDA\") for the treatment of ocular inflammation and allergy on March 30, 1995 and signed an agreement with Bausch & Lomb Pharmaceuticals Inc. (\"Bausch & Lomb\") regarding the marketing of this product in the U.S. on June 30, 1995. In addition, the Company has two other ophthalmic products in Phase II clinical trials, a CNS product aimed at treating stroke, head trauma and cardiac arrest which has been studied in a Phase I clinical trial, and an anti-cancer project in a preclinical stage.\nSTRATEGY\nThe Company's business objective is the design of novel drugs with safety superiority initially targeted to ophthalmic, neurological and other disorders. The Company expects to enter into collaborative relationships with established pharmaceutical companies to bring its products to market.\nPRODUCTS AND TECHNOLOGY\nThe Company is developing pharmaceuticals which are designed to address unmet needs in the market place and exhibit superior efficacy and safety profiles over competing products. Many current ophthalmic drugs have significant side effects, such as elevation of intraocular pressure (\"IOP\"), or have inconvenient dosing regimens which can significantly reduce their use. For many neurological indications, there are no effective drug therapies available.\nThe Company is applying its experience in drug design and its novel drug delivery technology in developing products directed at several fields including: site specific drugs for ophthalmic indications, neuroprotective compounds targeted at specific CNS receptors associated with neurological indications, and systemic drugs designed to avoid CNS side effects and to have an excellent peripheral safety profile. The Company is also using proprietary lipid-based technologies, primarily submicron emulsions, to achieve better delivery routes.\nSITE SPECIFIC DRUGS FOR OPHTHALMIC INDICATIONS ----------------------------------------------\nLOTEMAX AND LINE EXTENSIONS\nLotemaxTM is the trade name of a drug product in a form of eye drop suspension in which the active compound is Loteprednol Etabonate (\"LE\"). The product is a unique steroid, designed to act in the eye and cure inflammatory and allergic conditions, and then, as predicted, be deactivated to an inactive metabolite once it reaches systemic circulation. This pharmacological profile results in improved safety by preventing the side effects related to exposure to systemic steroids. In the eye, the most unwanted side effect of steroids is the elevation of IOP, which is sight-threatening. While glucocorticoids, for lack of an alternative, are regularly used for severe inflammatory conditions of the eye, milder conditions such as allergies are preferentially treated with less potent non-steroidal agents. LotemaxTM has demonstrated a superior safety profile without compromising efficacy.\nAn NDA for LotemaxTM for general ocular inflammatory indications (\"class labeling\") was submitted to the FDA in March 1995. A low dose LE for specific allergic conditions (\"LEA\") has completed Phase III clinical studies and a combination of LE with the antibiotic tobramycin (\"LET\") for the treatment of inflammatory and ineffective indications such as post-cataract surgery is in a preclinical development stage. In December 1995, because of the clinical importance of uveitis, a severe form of eye inflammation, the Company, in conjunction with Bausch & Lomb, opted to accelerate a previously planned uveitis clinical trial to provide the FDA with additional information fully supporting the broad class labeling claims sought in the NDA. The study began in early 1996 and is expected to be completed by mid 1996. Contingent upon receiving approval of the NDA, the Company anticipates a late 1996 product launch.\nOn June 30, 1995, the Company entered into an agreement with Bausch & Lomb to market the product in the U.S., to purchase the \"drug substance\" from the Company, to manufacture the \"drug product\" and to assist the Company in developing the product and line extensions. In 1995, the Company also signed an agreement with SIPSY Chemical Corporation for exclusive manufacturing of LE for sale to the Company.\nADAPROLOL MALEATE\nAdaprolol Maleate is a beta blocker for the treatment of glaucoma, designed, like LotemaxTM, as a \"soft drug,\" with a predictable metabolic disposition in the systemic circulation. Systemic side effects of beta blockers include cardiovascular and pulmonary complications due to the presence of beta adrenergic receptors in the heart and lung. These complications limit the use of beta blockers in the elderly, cardiac patients and asthmatics.\nAdaprolol Maleate is in Phase II clinical trials. A completed Phase II study with 60 patients (with a control group treated with Timolol) has shown that Adaprolol Maleate significantly reduces IOP in glaucoma patients by an average 18% with no deleterious effect on mean arterial blood pressure unlike in the Timolol-treated patients. Presently, the Company is attempting to identify a strategic partner to assist in the continued development of Adaprolol Maleate.\nNEUROPROTECTIVE AGENTS: DEXANABINOL AND ANALOGS ------------------------------------------------\nDEXANABINOL (HU-211)\nDexanabinol is a synthetic cannabinoid designed to avoid the psychotropic and sedative spectrum of canabimimetic agents, while retaining their beneficial properties as anti-emetics, analgesics and anti-glaucoma agents.\nIt is now well established that the psychotropic effects of cannabinoids are mediated via stereo selective (-) preferring receptors. Dexanabinol is a (+) optical isomer and does not interact with cannabinoid receptors. It does, nevertheless, retain anti-emetic and anti-glaucoma properties. More importantly, it is also a stereo selective, non-competitive antagonist of the glutamate NMDA receptor channel, activation of which is believed to play a key role in secondary neuronal damage due to head trauma, stroke and cardiac arrest. The molecule also has free radical scavenging properties, and anti-inflammatory properties (including inhibition of TNF- production). Both of these latter mechanisms are important for neuroprotection. Therefore, dexanabinol emerges as a unique modality for neuroprotection, combining three relevant mechanisms of action in a single molecule.\nWhile trauma and stroke are the highest priority indications for dexanabinol, this drug also has potential in chronic neuroprotection associated with other diseases such as glaucoma and Parkinson's and Alzheimer's diseases, as well as various inflammatory conditions. Development of dexanabinol for these indications is being explored at the preclinical level.\nA Phase I study of rising dose tolerance in healthy volunteers (30 subjects) has shown dexanabinol to be safe at doses up to and including the expected therapeutic doses. Specifically, there were no hallucinations, sedation or blood pressure changes of the type reported with other glutamate antagonists. The Company plans on beginning Phase II studies in 1996.\nDRUG DESIGN FOR ELIMINATION OF CNS SIDE EFFECTS -----------------------------------------------\nTAMOXIFEN METHIODIDE\nTamoxifen Methiodide is an analog of Tamoxifen, which is a widely used drug in the treatment of breast cancer. Several diseases not involving brain pathology are currently treated with drugs that produce mild to dose-limiting CNS side effects. For instance, tamoxifen, which is used to treat breast cancer patients and has been suggested for use as a prophylactic agent in healthy women at risk of developing the disease, causes hot flashes and may be associated with cognitive and affective deficits as well. Additionally, corticosteroids, used to treat chronic inflammatory and auto-immune diseases, cause psychotic reactions in some patients and have been shown to cause selective neuronal death in animals. Neuropathic pain could be treated by certain systemic anesthetics, but the resulting CNS side effects make such therapy unsafe. These side effects could be addressed by designing drugs with limited passage to the brain through the blood brain barrier (BBB).\nIn the light of this concept, several analogs of tamoxifen and lidocaine with poor CNS uptake have been synthesized and tested in several animal models. Tamoxifen Methiodide, a permanently charged tamoxifen derivative, was tested in animals (nude mice) inoculated with human breast cancer cells. Treatment resulted in rapid arrest of growth followed by tumor regression. Growth arrest was also observed in estrogen-independent tumors. The rate and magnitude of response was higher than that seen with tamoxifen itself. The compound retains the anti-osteoporotic effects of tamoxifen in bone but is considerably less active than tamoxifen as auterotrophic agent, demonstrating an improved therapeutic profile as compared to the parent compound. Permanently charged lidocaine analogs suppress electrophysiological activities typical to neuropathic pain in vivo, similar to that achieved with the parent compound.\nEMULSION-BASED DRUG DELIVERY SYSTEMS ------------------------------------\nPILOCARPINE-SME\nPilocarpine-SME is an eye drop formulation of generic Pilocarpine in a submicron emulsion (\"SME\") for the treatment of glaucoma. The development of ocular drug delivery systems that extend corneal residence time, reduce irritation and deliver lipophilic drugs to the eye, addresses many of the major problems of topical eye preparations. In general, lipophilic drugs are difficult to deliver systematically. The Company's SME technology, consisting of oily droplets in an aqueous medium, was developed to meet these needs. Further, the Company's second generation EmulsomeTM technology, which combines features of oil-in-water emulsion and liposomal technologies, has demonstrated increased drug loading capacity and drug availability, without the use of synthetic surfactants.\nOphthalmic drugs, including Pilocarpine, Indomethacin, and Adaprolol Maleate, were successfully formulated using the Company's proprietary SME technology, and have demonstrated advantages over standard formulations in terms of reduced irritation and increased bioavailability in animal models as well as in Phase I and certain Phase II clinical trials. Pilocarpine-SME given twice a day in a Phase II trial for glaucoma was as effective as the four times a day regimen required with generic pilocarpine, with fewer side effects and an improved degree of comfort and safety. Similarly, a Phase II trial of Adaprolol-SME demonstrated safety, efficacy and lower ocular irritation compared to an aqueous formulation. Presently, the Company is attempting to identify a strategic partner to assist in the continued development of Pilocarpine-SME.\nCOMPETITION\nThe pharmaceutical industry is highly competitive, and research relating to drug delivery and formulation technologies is developing rapidly. The Company competes with a number of pharmaceutical companies which have financial, technical and marketing resources significantly greater than those of the Company. Some companies with established positions in the pharmaceutical industry may be better equipped than the Company to develop and market products in the markets the Company is seeking to enter. A significant amount of pharmaceutical research is also being carried out at universities and other not- for-profit research organizations. These institutions are becoming increasingly aware of the commercial value of their findings and are becoming more active in seeking patent protection and licensing arrangements to collect royalties\nfor the use of technology they have developed. These institutions may also market competitive commercial products on their own or through joint ventures and will compete with the Company in recruiting highly qualified scientific personnel.\nThe Company is pursuing areas of product development in which there is a potential for extensive technological innovation. The Company's competitors may succeed in developing products that are more effective than those of the Company. Rapid technological change or developments by others may result in the Company's potential products becoming obsolete or non-competitive.\nCOLLABORATIVE RELATIONSHIPS\nThe Company's commercial strategy includes the development of products in collaboration with established pharmaceutical companies and institutions. Collaborative partners may provide financial resources, research and manufacturing capabilities and marketing infrastructure to aid in the commercialization of the Company's products in development and potential future products. Depending on the availability of financial, marketing and scientific resources, among other factors, the Company may license its technology or products to others and retain profit sharing, royalty, manufacturing, co- marketing, co-promotion or similar rights. Any such arrangements could limit the Company's flexibility in pursuing alternatives for the commercialization of its products. There can be no assurance that the Company will establish any collaborative arrangements or that, if established, such relationship will be successful.\nBausch & Lomb. On June 30, 1995, the Company signed a definitive agreement ------------- with Bausch & Lomb to manufacture and market LotemaxTM, the Company's lead product, in the United States. The agreement also covers LotemaxTM line extension products currently being developed by the Company.\nUnder the agreement, Bausch & Lomb will purchase the active drug substance from the Company and has provided the Company $4 million in cash advances. An additional $2 million is subject to reaching certain development milestones in the LotemaxTM line extension products. Bausch & Lomb will also collaborate in the development of such additional products by making available amounts up to 50% of their Phase III clinical trial costs. The Company will retain certain conditional co-marketing rights to all of the products covered by the marketing agreement.\nPATENTS, PROPRIETARY RIGHTS AND LICENSES\nPATENTS AND PROPRIETARY RIGHTS ------------------------------\nProprietary protection generally has been important in the pharmaceutical industry, and the commercial success of products incorporating the Company's technologies may depend, in part, upon the ability to obtain strong patent protection.\nSome of the technologies underlying the Company's potential products were invented or are owned by various third parties, including various universities and Dr. Nicholas Bodor. The Company is the licensee of these technologies under patents held by the applicable owner through\nlicenses which generally remain in effect for the life of the applicable patent. The Company generally maintains, at its expense, U.S. and foreign patent rights with respect to both the licensed and its own technology and files and\/or prosecutes the relevant patent applications in the U.S. and foreign countries. The Company also relies upon trade secrets, know-how, continuing technological innovations and licensing opportunities to develop its competitive position. The Company's policy is to protect its technology by, among other things, filing, or requiring the applicable licensor to file, patent applications for technology that it considers important to the development of its business. The Company intends to file additional patent applications, when appropriate, relating to its technology, improvements to its technology and to specific products it develops. There can be no assurance that any additional patents will be issued, or if issued, that they will be of commercial benefit to the Company. In addition, it is impossible to anticipate the breadth or degree of protection that any such patents will afford.\nThe patent positions of pharmaceutical firms, including the Company, are uncertain and involve complex factual questions. In addition, the coverage claimed in a patent application can be significantly reduced before or after the patent is issued. Consequently, the Company does not know whether any of the pending patent applications underlying the licensed technology will result in the issuance of patents or, if any patents are issued, whether they will provide significant proprietary protection or will be circumvented or invalidated. Since patent applications in the U.S. are maintained in secrecy until patents issue and since publication of discoveries in the scientific or patent literature often lag behind actual discoveries, the Company cannot be certain that it or its licensors, as the case may be, were the first creators of inventions covered by pending and issued patents or that it or its licensors, as the case may be, were the first to file patent applications for such inventions. Moreover, the Company may have to participate in interference proceedings declared by the U.S. Patent and Trademark Office to determine priority of invention, which could result in substantial cost to the Company, even if the eventual outcome is favorable to the Company. There can be no assurance that the patents relating to the licensed technology, if issued, will be upheld by a court of competent jurisdiction or that a competitor's product will be found to infringe such patents.\nOther pharmaceutical and drug delivery companies and research and academic institutions may have filed patent applications or received patents in the Company's fields. If patents are issued to other companies that contain competitive or conflicting claims and such claims are ultimately determined to be valid, there can be no assurance that the Company would be able to obtain licenses to these patents at a reasonable cost or be able to develop or obtain alternative technology.\nThe Company also relies upon trade secret protection for its confidential and proprietary information. There can be no assurance that others will not independently develop substantially equivalent proprietary information and techniques or otherwise gain access to the Company's trade secrets.\nIt is the Company's policy to require its employees, consultants, outside scientific collaborators and sponsored researchers and other advisors to execute confidentiality agreements upon the commitment of employment or consulting or advisory relationships with the Company. These agreements generally provide that all confidential information developed or made known to the individual during the course of the individual's relationship with the Company is to be kept\nconfidential and not disclosed to third parties except in specific circumstances. In the case of employees and certain consultants, the agreements provide that all inventions conceived by the individual in the course of their employment or consulting relationship shall be the exclusive property of the Company. There can be no assurance, however, that these agreements will provide meaningful protection or adequate remedies for the Company's trade secrets in the event of unauthorized use or disclosure of such information. The Company's patents and licenses underlying its potential products described herein are summarized below.\nSITE-SPECIFIC DRUGS. In the general category of site-specific drugs which ------------------- are active mainly in the eye and have limited systemic side effects, the Company has licensed several patents from Dr. Nicholas Bodor. The earliest patents date from 1984 and the most recent from 1993. Some of these patents cover LotemaxTM, the ophthalmic anti-inflammatory product, and Adaprolol Maleate, for treatment of glaucoma.\nNEUROPROTECTIVE AGENTS. The Company has licensed from the Hebrew ---------------------- University, which is the academic affiliation of the inventor, Dr. Raphael Mechoulam, patents covering novel compounds which have demonstrated certain beneficial neuropharmacological activity while appearing to be devoid of most of the deleterious effects usually associated with this class of compounds. This group of patents has been designed to protect this family of compounds and their uses devised by the Company and the inventors. The earliest patent applications resulted in patents issued in 1989, and the most recent patents date from 1994. These patents cover Dexanabinol, which is under development for the treatment of glaucoma, head trauma, cardiac arrest, and stroke. The Company has received notice of allowance for another of its U.S. patent applications relating to certain uses of analogs of this compound. Three additional U.S. patent applications are pending.\nTAMOXIFEN METHIODIDE. The Company has filed patent applications in the -------------------- U.S. and Israel, and has an international application, to protect pharmaceutical compositions of Tamoxifen Methiodide and other charged derivatives of anti- estrogens. These charged derivatives are superior to the parent compounds in that they are devoid of CNS side effects and show an overall improved pharmacological profile.\nEMULSION-BASED DRUG DELIVERY SYSTEMS. In the general category of SubMicron ------------------------------------ Emulsion (SME) technology, the Company licensed two patent applications from the Hebrew University of Jerusalem (\"Hebrew University\") and has separately filed six patent applications which are at different stages of prosecution. These patents and patent applications have been devised to protect a group of formulation technologies devised by the Company and the inventors as they relate to pharmaceutical and medicinal products. The earliest patent filings for SME technology date from 1986 and the most recent, from 1994. These patents cover Pilocarpine-SME, which is being developed to treat glaucoma.\nLICENSES --------\nThe Company's license agreements generally require the Company, as licensee, to pay royalties on sale of products developed from the licensed technologies, and fees on revenues the Company receives for sublicenses, where applicable. The royalty rates defined in the licenses are customary and usual in the pharmaceuticals industry. The royalties will be payable for periods up\nto fifteen years from the date of certain specified events, including the date of the first sale of such products, or the date from which the first registered patent from the developed technologies is in force, or the year following the date in which FDA approval has been received for a developed product. Certain of the license agreements also require annual payments through 2012.\nGOVERNMENT REGULATION\nThe Company's activities and products are significantly regulated by a number of governmental entities, especially the FDA, in the U.S. and by comparable authorities in other countries. These entities regulate, among other things, research and development activities and the testing, manufacture, safety, effectiveness, labeling, storage, record keeping, approval, advertising, promotion, distribution and sale of the Company's potential products. Product development and approval within this regulatory framework takes a number of years and involves the expenditure of substantial resources. Many products that appear promising initially ultimately do not reach the market because they are found to be unsafe (perhaps too toxic) or to lack effectiveness, as demonstrated by testing required by government regulation during the development process. In addition, there can be no assurance that this regulatory framework will not change or that additional regulation will not arise at any stage of the Company's product development that may preclude or otherwise adversely affect approval, delay an application or require additional expenditures by the Company. Moreover, even if approval is obtained, failure to comply with present or future regulatory requirements, or new information adversely reflecting on the safety or effectiveness of the approved drug, can lead to FDA withdrawal of approval to market the product.\nThe regulatory process required to be completed by the FDA before a new drug delivery system may be marketed in the U.S. depends significantly on whether the drug (which will be delivered by the drug delivery system in question) has existing approval for use and in what dosage form. If the drug is a new chemical entity that has not been approved, then the process includes (I) preclinical laboratory and animal tests, (ii) an IND application which has become effective, (iii) adequate and well-controlled human clinical trials to establish the safety and effectiveness of the drug for its intended indication and (iv) FDA approval of a pertinent NDA. If the drug has been previously approved, then the approval process is similar, except that certain toxicity tests normally required for the IND application may not be necessary. Even with previously approved drugs, additional toxicity testing may be required when the delivery form is substantially changed, or when a company does not have access to the raw data from the prior preclinical studies.\nThe activities required before a pharmaceutical product may be marketed in the U.S. begin with preclinical testing. Preclinical tests include laboratory evaluation of product chemistry and other end points and animal studies to assess the potential safety and efficacy of the product as formulated. The conduct of preclinical studies is regulated by the FDA under a series of regulations called the Good Laboratory Practice regulations. Violations of these regulations can, in some cases, lead to invalidation of the data from these studies, requiring such studies to be replicated.\nThe entire body of preclinical development work necessary to administer investigational drugs to volunteers or patients is summarized in an Investigative New Drug (\"IND\") application to the FDA. FDA regulations provide that human clinical trials may begin thirty days following the submission and receipt of an IND application, unless the FDA advises otherwise or requests\nadditional information, clarification or additional time to review the IND application; it is generally considered good practice to obtain affirmative FDA response before commencing trials. There is no assurance that the submission of an IND application will eventually allow a company to commence clinical trials. Once trials have commenced, the FDA may stop the trials, or particular types or parts of trials, by placing a \"clinical hold\" on such trials because of concerns about, for example, safety of the product being tested or the adequacy of the trial design. Such holds can cause substantial delay and in some cases may require abandonment of a product.\nClinical testing involves the administration of the drug to healthy volunteers or to patients under the supervision of a qualified principal investigator, usually a physician pursuant to an FDA-reviewed protocol. Each clinical study is conducted under the auspices of independent Institutional Review Boards (\"IRBs\") at the institutions at which the study will be conducted. An IRB will consider, among other things, ethical factors, the safety of human subjects and the possible liability of the institution.\nPhase I clinical studies are commonly performed in 20 to 40 healthy human subjects or, more rarely, in selected patients with the targeted disease or disorder. Their goal is to establish initial data about tolerance and safety of the drug in humans. Also, the first data regarding the absorption, distribution, metabolism, and excretion of the drug in humans are established.\nIn Phase II human clinical studies, preliminary evidence is sought regarding the pharmacological effects of the drug and the desired therapeutic efficacy in limited studies with small numbers of selected patients (50 to 200). Efforts are made to evaluate the effects of various dosages and to establish an optimal dosage level schedule and validate clinical efficacy endpoints to be used in Phase III trials. Additional safety data are also gathered from these studies.\nPhase III clinical studies consist of expanded, large scale studies of patients (200 to several thousand) with the target disease or disorder, to obtain definitive statistical evidence of the effectiveness and safety of the proposed product and dosing regimen. These studies may also include separate investigations of the effects in subpopulations of patients, such as the elderly.\nAt the same time that the human clinical program is being performed, additional non-clinical (i.e., animal) studies are also being conducted. Expensive, long duration (12-18 months) toxicity and carcinogenicity studies are done to demonstrate the safety of drug administration for the extended period of time required for effective therapy. Also, a variety of laboratory, animal, and initial human studies may be performed to establish manufacturing methods for the drug, as well as stable, effective dosage forms.\nThe results of product development, preclinical studies and clinical studies and other information are submitted to the FDA in an NDA to seek approval for the marketing and interstate commercial shipment of the drug. With the NDA, a company must pay the FDA a user fee in of approximately $200,000. Companies with less than 500 employees and no revenues from products are eligible for an exception. This exception was granted to the Company in connection with the NDA for LotemaxTM and reduces the fee to $100,000, which is payable 12 months after the NDA is filed by the FDA. The FDA may refuse to file or deny an NDA if applicable regulatory requirements, such as compliance with Current Good Clinical Practice (\"cGCP\") requirements, are\nnot satisfied or may require additional clinical testing. Even if such data are submitted, the FDA may ultimately decide that the NDA does not satisfy the requirements for approval. If the FDA does ultimately approve the product, it may require, among other things, post-marketing testing, including potentially expensive Phase IV studies, and surveillance to monitor the safety and effectiveness of the drug. In addition, the FDA may in some circumstances impose restrictions on the use of the drug that may be difficult and expensive to administer, and almost always seeks to require prior approval of promotional materials. Product approvals may be withdrawn if compliance with regulatory requirements is not maintained or if problems occur after the product reaches the market. After a product is approved for a given indication in an NDA, subsequent new indications or dosages for the same product are reviewed by the FDA via the filing and upon receipt of a Supplemental NDA (\"sNDA\") submission as well as payment of another user fee. The sNDA is more focused than the NDA and deals primarily with safety and effectiveness data related to the new indication or dosage, and labeling information for the sNDA indication or dosage. Finally, the FDA requires reporting of certain information, e.g., adverse experience reports, that becomes known to a manufacturer of an approved drug.\nEach domestic drug product manufacturing establishment must be registered with, and approved by, the FDA and must pay the FDA a registration fee and annual fee. In addition, each such establishment must inform the FDA of every drug product it has in commercial distribution and keep such list updated. Establishments handling controlled substances must be licensed and are inspected by the U.S. Drug Enforcement Agency (\"DEA\"). The Company has a current DEA license appropriate for handling the substances it uses in its facilities. Domestic establishments are also subject to inspection by the FDA for compliance with Current Good Manufacturing Practice (\"cGMP\") regulations after an NDA has been filed and thereafter, at least biennially. The labeling, advertising and promotion of drug products also must be in compliance with pertinent FDA regulatory requirements. Failure to comply with applicable requirements relating to production, distribution or promotion of a drug product can lead to FDA demands that production and shipment cease, and, in some cases, that product be recalled, or to enforcement actions that can include seizures, injunctions and criminal prosecution.\nTo develop and market its potential products abroad, the Company is also subject to numerous and varying foreign regulatory requirements, implemented by foreign health authorities, governing, among other things, the design and conduct of human clinical trials, pricing and marketing. The approval procedure varies among countries and can involve additional testing, and the time required to obtain approval may differ from that required to obtain FDA approval. At present, foreign marketing authorizations are applied for at a national level, although within the European Union (\"EU\") certain registration procedures are available to companies wishing to market a product in more than one EU member country. If a regulatory authority is satisfied that adequate evidence of safety, quality and efficacy has been presented, marketing authorization is almost always granted. The foreign regulatory approval process includes all of the risks associated with obtaining FDA approval set forth above. Approval by the FDA does not ensure approval by other countries.\nVarious aspects of the Company's business and operations are also regulated by a number of other governmental agencies including the DEA, U.S. Department of Agriculture, Environmental Protection Agency and Occupational Safety and Health Administration as well as by other federal,\nstate and local authorities. In addition, any future international sales would be regulated by numerous foreign authorities.\nThe Company's ability to commercialize its products successfully may depend in part on the extent to which reimbursement for the cost of such products and related treatments will be available from government health administration authorities, private health insurers and other organizations. Third-party payors are increasingly challenging the price of medical products and services. Significant uncertainty exists as to the reimbursement status of newly approved health care products, and there can be no assurance that adequate third-party coverage will be available to enable the Company or any of its future licensees to maintain price levels sufficient to realize an appropriate return on its investment in product development.\nCORPORATE HISTORY\nPharmos Corporation (the \"Company\"), a Nevada corporation, formerly known as Pharmatec, Inc., was incorporated under the laws of the State of Nevada on December 20, 1982. On October 29, 1992, the Company completed a merger (the \"Merger\") with Pharmos Corporation, a privately held New York corporation (\"Old Pharmos\"), and on October 30, 1992 exercised an option to acquire all of the outstanding shares of Xenon Vision, Inc., a privately held Delaware corporation (\"Xenon\"). Prior to the Merger, Old Pharmos was a biopharmaceutical company with proprietary drug delivery and formulation technologies, one of which involved an initial application of ophthalmic drugs, and another of which involved research pharmaceuticals with neuroprotective properties being developed for applications such as stroke and head trauma. Prior to the Merger, the Company was a publicly-held company primarily engaged in the development and testing of a chemical delivery system which has been shown in animal studies to permit the passage of drugs across the blood-brain barrier. Prior to its acquisition, Xenon was a research-based pharmaceutical company developing several patented products for the ophthalmic field. In April 1995, the Company acquired Oculon Corporation (\"Oculon\") a privately-held development stage company with anti- cataract technologies and net assets of approximately $3.5 million, consisting substantially of cash and cash equivalents.\nHUMAN RESOURCES\nAs of March 1, 1996, the Company had 46 full time employees, 19 in the U.S. and 27 in Israel, of whom approximately 18 hold doctorate or medical degrees.\nThe Company's employees are not covered by a collective bargaining agreement. The Company has never experienced employment-related work stoppages and considers its employee relations to be excellent.\nPUBLIC FUNDING AND GRANTS\nThe Company's subsidiary, Pharmos Ltd., has received certain funding from the Chief Scientist of the Israel Ministry of Industry and Trade (the \"Chief Scientist\") for research and development of SME technology for injection and nutrition as well as for research relating to\npilocarpine, dexamethasone and ophthalmic formulations for dry eyes. The Company has received approximately $1,400,000 under such agreements through December 31, 1995. Funding is repayable on the basis of royalties from the sale of products developed as a result of the research activities conducted with such funds. The obligation to pay royalties is limited to the amount of such funding received, linked to the exchange rate of the U.S. dollar and the New Israeli Shekel. Additionally, funding by the Chief Scientist places certain legal restrictions on the transfer of know-how and the manufacture of resulting products outside of Israel. See \"Conditions in Israel.\"\nIn November 1992, the Company was awarded a grant of approximately $750,000 from the Israel-U.S. Binational Industrial Research and Development Foundation to develop LotemaxTM. The agreement terminated in April 1995. The Company has received the entire amount allowed under the grant as of December 31, 1995. Funding is repayable on the basis of royalties from the sale of products developed as a result of the research activities conducted with such funds. The obligation to pay royalties is limited to 150% of the amount of such funding received.\nCONDITIONS IN ISRAEL\nThe Company conducts significant operations in Israel through its subsidiary, Pharmos Ltd., and therefore is affected by the political, economic and military conditions to which that country is subject.\nPharmos Ltd. has received certain funding from the Chief Scientist with respect to its SubMicron Emulsion Technology and with respect to its new chemical entity, Dexanabinol. The proclaimed purpose of the legislation under which such funding is provided is to develop local industry, improve the state balance of trade and to create new jobs in Israel. Such funding prohibits the transfer or license of know-how and the manufacture of resulting products outside of Israel, without the permission of the Chief Scientist. Although it is the Company's belief that the Chief Scientist does not unreasonably withhold this permission if the request is based upon commercially justified circumstances and any royalty obligations to the Chief Scientist are sufficiently assured, there can be no assurance that such consent, if requested, would be granted upon terms satisfactory to the Company or granted at all.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company is headquartered in Alachua, Florida and leases facilities used in the operation of its research, development, pilot manufacturing and administrative activities in Alachua, Florida and Rehovot, Israel. These facilities have been improved to meet the special requirements necessary for the operation of the Company's research and development activities. In the opinion of the management these facilities are sufficient to meet the current and anticipated future requirements of the Company. In addition management believes that it has sufficient ability to renew its present leases related to these facilities or obtain suitable replacement facilities.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIn September 1994, a class action was commenced in the United States District Court for the Southern District of New York against David Blech (\"Blech\"), D. Blech & Co. (\"Blech & Co.\"), Bear Stearns & Co., Inc. and certain other Defendants alleging that Defendants conspired to manipulate and inflate the prices of the securities of a number of publicly traded biotechnology companies in which Blech and Blech & Co. allegedly had a controlling interest for an alleged class period from July 1, 1991 through September 21, 1994.\nOn March 28, 1995, an Amended Consolidated Class Action Complaint, entitled In re Blech Securities Litigation, 94 Civ. 7696 (RWS) (S.D.N.Y.) (\"Amended --------------------- Complaint\") was filed, in which action the Company was named as an additional co-Defendant. The Amended Complaint names as Defendants, Blech, Blech & Co., Bear Stearns & Co., Inc. and numerous other Defendants, including eleven publicly traded biotechnology companies, one of which is the Company (the \"Defendants\"). The Amended Complaint asserts the same basic claims as the original complaint. The Amended Complaint seeks certification as a class action and requests unspecified damages against Defendants in connection with the alleged unlawful manipulation of the stock market prices of twenty-four different biotechnology companies.\nThe Company believes that the claims against it have no factual or legal basis, and filed in June 1995 a motion to dismiss the claims asserted against it. In the Company's motion to dismiss, the Company maintained, inter alia, ----- ---- that the Amended Complaint did not contain any specific or legally cognizable allegations of fraudulent conduct on the part of the Company, and that the named Plaintiffs (none of whom are alleged to have purchased or sold common stock of the Company) lacked standing to assert any claims against the Company.\nThe Company's motion to dismiss (along with motions to dismiss by numerous other Defendants) was argued and submitted before United States District Court Judge Robert W. Sweet, the Federal Judge assigned the case on November 9, 1995. The Federal Judge took the motions under submission at the conclusion of oral argument on November 9, 1995, and a decision has not yet been rendered by the Court.\nOn October 27, 1995, the Company commenced an action in Supreme Court, New York County (the \"State Court\"), against Dr. Nicholas Bodor, a former director of the Company, seeking to enjoin Dr. Bodor from taking any steps to terminate or interfere with the Company's rights under its License Agreement with Dr. Bodor relating to LotemaxTM. Dr. Bodor claims that the advances against future revenues of LotemaxTM recently received by the Company under its Marketing Agreement with Bausch & Lomb are an up front licensing fee of which Dr. Bodor is entitled to receive a portion and that the failure to pay would constitute grounds for his terminating the License Agreement. Dr. Bodor also claims that the Marketing Agreement is actually a sublicense entitling Dr. Bodor to additional royalties under his License Agreement. In such event, Dr. Bodor would be entitled to receive a portion of the Company's advances from Bausch & Lomb as well as a higher royalty percentage from the Company on future sales of LotemaxTM.\nThe Company strongly disagrees with Dr. Bodor's characterization of the Bausch & Lomb Marketing Agreement and believes his interpretation is incorrect and has no merit. To prevent Dr. Bodor from wrongfully terminating the License Agreement, the Company commenced the action to protect its rights under both the License Agreement and the Marketing Agreement.\nIn a Memorandum Decision obtained by the Company in February 1996, the Court ruled in favor of the Company on both motions, granting the Company's motion for a preliminary injunction and denying Dr. Bodor's motion to dismiss. The Court instructed the parties to submit a proposed order implementing the terms of the Court's Memorandum Decision and affidavits regarding an appropriate undertaking (bond) by the Company pending a final determination of the action.\nIn late November 1995, Dr. Bodor commenced an action against the Company in the state court in Florida seeking a declaratory judgement and money damages. An amended complaint in the Florida action was recently served on the Company. The Company will vigorously defend the Florida action.\nIn March 1996, the Company reached a settlement with Yissum Research Development Company of the Hebrew University of Jerusalem (\"Yissum'), licensor to the Company's Israel subsidiary, Pharmos Ltd., of the SME technology. Such settlement provides the Company with an exclusive license to utilize new technology developed by Yissum in connection with the Company's SME technologies.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nAt its Annual Meeting held on October 31, 1995, the stockholders of the Company elected the following persons as directors of the Company to hold office until the next annual meeting of the stockholders and until their successors are duly elected and qualified: Haim Aviv, Stephen C. Knight, David Schlachet, Marvin P. Loeb, E. Andrews Grinstead, III and William C. Hulley. Each of these individuals received 16,523,399 votes for and 84,328 votes withheld.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nFrom October 20, 1993 until January 26, 1995, the Company's Common Stock was traded on the NASDAQ National Market System under the symbol \"PARS\", and prior thereto was traded on the Nasdaq SmallCap Market. Prior to the Merger, the Common Stock was quoted under the symbol \"PHTC\". The Company's Common Stock was moved to the Nasdaq SmallCap Market, effective January 27, 1995, as a result of the Company's non-compliance with certain Nasdaq corporate governance requirements. The following table sets forth the range of high and low bid prices for the Common Stock as reported on the NASDAQ National Market System and the Nasdaq SmallCap Market during the periods indicated.\nYear ended December 31, 1995 HIGH LOW ---------------------------- ------ ------\n1st Quarter................. $ 1.37 $ .50 2nd Quarter................. 2.75 .62 3rd Quarter................. 3.19 1.50 4th Quarter................. 2.56 1.22\nYear ended December 31, 1994 HIGH LOW ---------------------------- ------ ------\n1st Quarter................. $7.88 $6.50 2nd Quarter................ 6.63 4.50 3rd Quarter................. 5.00 1.25 4th Quarter................. 2.00 1.06\nThe foregoing represent inter-dealer prices, without retail mark-up, mark- down or commission, and may not necessarily represent actual transactions.\nOn March 22, 1996, there were 533 record holders of the Common Stock of the Company and approximately 4,127 beneficial owners of the Common Stock of the Company, based upon the number of shares of Common Stock held in \"street name\".\nThe Company has paid no dividends and does not expect to pay cash dividends in the foreseeable future. The Company is not under any contractual restriction as to its present or future ability to pay dividends. The Company currently intends to retain any future earnings to finance the growth and development of its business.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\n*Restated to reflect the transfer of assets among entities under common control in a manner similar to a pooling of interests.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe Company has generated limited revenues from product sales and is dependent upon external financing, interest income, and research and development contracts to pursue its intended business activities. The Company has not been profitable since inception and has incurred a cumulative net loss of $54,024,741 through December 31, 1995. Losses have resulted principally from costs incurred in research activities aimed at identifying and developing the Company's product candidates, clinical research studies, merger and acquisition costs, the write- off of purchased research and development, and general and administrative expenses. The Company expects to incur additional operating losses over the next several years as the Company's research and development and clinical trials programs continue. The Company's ability to achieve profitability is dependent on its ability to develop and obtain regulatory approvals for its products, to enter into agreements for product development and commercialization with strategic corporate partners and to develop the capacity to manufacture and sell its products, and to secure additional financing. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.\"\nRESULTS OF OPERATIONS\nYears Ended December 31, 1995 and 1994\nTotal revenues increased by $67,185 from $7,815 in 1994 to $75,000 in 1995. This increase resulted from a fee the Company received as a result of sublicensing certain technologies which were not being actively developed by the Company. Revenues in 1994 related to sales of fine chemicals. The Company phased out the selling of specialty chemicals and no such revenues were received in 1995.\nTotal operating expenses decreased by $4,782,795, or 37%, from $13,036,461 in 1994 to $8,253,666 in 1995 primarily due to decreases in research and development expenses, patent expenses and general and administrative expenses.\nResearch and development expenses decreased by $2,931,323, or 37%, primarily due to clinical trials of the Company's lead product Lotemax(TM) being substantially completed in 1994; the Company submitted a New Drug Application (\"NDA\") for this product with the Federal Drug Administration (\"FDA\") in March 1995. Late in 1995, the Company began clinical trial testing on one of its Lotemax line extension products and such trials are expected to continue into 1997.\nPatent expenses decreased by $461,596, or 49%, in 1995. This decrease reflects a return to more normalized levels of patent expenses as 1994 was impacted by costs of defending patent challenges related to technologies licensed by the Company. In addition patent expenses in 1994 were impacted by costs associated with improving the Company's patent coverage for its lead product Lotemax(TM) and its Dexinabinol and Tamoxifen Methiodide compounds.\nGeneral and administrative expenses decreased by $1,503,343, or 41%, in 1995 primarily reflecting the impact of the cost savings which resulted from the Company's decisions in late 1994 and early 1995 to eliminate staff and relocate its corporate headquarters from New York to Alachua, Florida. In 1994 the Company recognized costs of approximately $360,000 related to this restructuring primarily related to severance and relocation expenses.\nNet interest income in 1995 of $82,581 represented an increase of 13% compared to 1994, and was comprised of interest income of $209,584 offset by interest expense of $127,003. Interest income in 1995 increased by $62,654, or 42%, compared to 1994 and resulted from the Company's higher level of investible funds in 1995. Interest expense in 1995 increased by $53,270, or 72% compared to 1994 and resulted from interest expense on the convertible debentures issued by the Company in February 1995 and converted into Common Stock by July 1995.\nThe net loss for 1995 of $8,096,085 reflected a decrease of $4,859,214, or 38%, from the net loss of $12,955,299 for 1994. The decrease in operating expenses described above accounted for substantially all of this decrease.\nYears Ended December 31, 1994 and 1993\nTotal revenues decreased by $74,085, or 90%, from $81,900 in 1993 to $7,815 in 1994. The Company is phasing out the sale of specialty chemicals and has already phased out specialized research contracts conducted for outside parties in favor of developing patented, proprietary pharmaceuticals.\nTotal 1994 operating expenses increased by $3,442,370, or 36%, from $9,594,091 in 1993 to $13,036,461 in 1994 primarily due to increases in research and development and Phase III clinical trials for the Company's lead compound, LotemaxTM.\nResearch and development expenses increased by $2,233,806, or 39%, from $5,753,349 in 1993 to $7,987,155 in 1994, as the number of research personnel, research expenses, and clinical trial programs expanded. Patent expenses increased by $360,818, or 62%, from $581,637 in 1993 to $942,455 in 1994. This is primarily due to the advancement of product development and reimbursements to the University of Florida for patent expenses incurred under the terms of the Company's license agreement.\nGeneral and administrative expenses increased by $776,225, or 27%, from $2,908,083 in 1993 to $3,684,308 in 1994. These increases were caused primarily by the expansion of staff in the first half of 1994, and the subsequent restructuring costs, including severance expenses of $253,500, incurred in the second half of 1994. In addition, during 1994 the Company had been working to raise funds through various financing, which were unsuccessful. The related costs of these financing, such as travel, printing, legal and accounting fees, are a component of the increase in general and administrative expenses.\nNet interest income of $73,197 for 1994 was comprised of interest income of $146,930 offset by interest expense of $73,733. Net interest income of $111,866 for 1993 was comprised of interest income of $166,459 and interest expense of $54,593. The decrease in interest income from 1993 to 1994 of $19,529, or 12%, results from smaller balances of funds and the general decline in interest rates in 1994. The increase in interest expense of $19,140, or 35%, between 1993 and 1994 primarily reflects costs related to financing activity in the form of a loan and a line or credit obtained by the Company's Israeli subsidiary, Pharmos Ltd.\nThe net loss for 1994 of $12,955,299 reflected an increase of $3,556,604, or 38%, from the net loss of $9,398,695 for 1993. The increase of research and development, and general and administrative expenses detailed above account for the majority of the increase in net loss.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company currently has no sources of recurring revenues and has incurred operating losses since its inception and has financed its operations with public and private offerings of securities, a marketing agreement with Bausch & Lomb, research contracts, license fees, royalties and sales, and interest income.\nThe Company had working capital of $6.4 million, including cash and cash equivalents of $7.4 million as of December 31, 1995. Management believes that existing cash and cash equivalents combined with additional cash inflows from investment income, grants and advances pursuant to the Marketing Agreement described below, will be sufficient to support operations through the first quarter of 1997. Management believes that additional funding will be required to fund operations until, if ever, profitable operations can be achieved. Therefore, the Company is continuing to actively pursue various funding options, including additional equity offerings, commercial and other borrowings, strategic corporate alliances and business combination transactions, the establishment of product related research and development limited partnerships, or a combination of these methods for obtaining the additional financing that would be required to continue the research and development necessary to complete the development of its products and bring them to commercial markets.\nDuring 1995, the Company raised additional equity of $12,481,426 through the issuance of 14,517,309 shares of common stock. A portion of these funds, $201,258 net of short term deposits securing such borrowings, were used to pay off short term bank debt and the remaining funds were available to fund ongoing operations of the Company. In addition, during 1995, the Company signed a definitive marketing agreement (the \"Marketing Agreement\") with Bausch & Lomb to market Lotemax(TM), the Company's lead product, on an exclusive basis in the United States. Under the Marketing Agreement, Bausch & Lomb will purchase the active drug substance from the Company and provide the Company with $4 million in cash advances through March 1996. An additional $2 million in advances may be made subject to reaching certain development milestones in the Lotemax(TM) line extension products. Bausch & Lomb will also collaborate in the development of such additional products by making available amounts up to 50% of the Phase III clinical trial costs.\nAs of the date hereof, the Company has received $4,000,000 in advances against future sales to Bausch & Lomb of the active drug substance (needed to manufacture the drug). Bausch & Lomb will\nbe entitled to credits against such future purchases of the drug substance based on the advances and future advances until the advances have been recouped. The Company may be obligated to repay such advances if it is unable to supply Bausch & Lomb with certain specified quantities of the active drug substance.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe information called for by this Item 8 is included following the \"Index to Financial Statements\" contained in 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 directors, officers and key employees of the Company are as follows:\nName Age Position - ---- --- --------\nHaim Aviv, Ph.D. 55 Chairman, Chief Executive Officer, Acting President, Chief Scientist and Director\nMarvin P. Loeb 69 Director\nE. Andrews Grinstead, III 50 Director\nStephen C. Knight, M.D. 36 Director\nDavid Schlachet 50 Director\nWilliam C. Hulley 38 Director\nGad Riesenfeld, Ph.D. 52 Executive Vice President, Chief Operating Officer\nS. Colin Neill 49 Acting Vice President\/Finance, Chief Financial Officer, Treasurer and Secretary John F. Howes, Ph.D. 53 Vice President\/Clinical Affairs\nAnat Biegon, Ph.D. 42 Vice President\/Research and Development\nHaim Aviv, Ph.D., is Chairman, Chief Executive Officer, Acting President, Chief Scientist and a Director of the Company and co-founded in 1990, Pharmos Corporation, a New York corporation (\"Old Pharmos\"), which merged into the Company on October 29, 1992 (the \"Merger\"). Dr. Aviv also served as Chairman, Chief Executive Officer, Chief Scientist and a Director of Old Pharmos prior to the Merger. Dr. Aviv was the co-founder in 1980 of Bio-Technology General Corp. (\"BTG\"), a publicly-traded company engaged in the development of products using recombinant DNA, its General Manager and Chief Scientist from 1980 to 1985, and a Director and Senior Scientific Consultant until August 1993. Prior to that time, Dr. Aviv was a professor of molecular biology at the Weizmann Institute of Science. Dr. Aviv is the principal stockholder of Avitek Ltd., a stockholder of the Company. Dr. Aviv is Chairman of the Board and\nholds over 5% of the common stock of Peptor, Ltd., an Israeli corporation engaged in the research and development of drugs based on peptides. Dr. Aviv is also a Director, officer and\/or significant stockholder of several privately- held Israeli pharmaceutical and venture capital companies.\nMarvin P. Loeb, a Director, was Chairman of the Board of the Company (then known as Pharmatec, Inc.) from December 1982 through October 1992. He has been Chairman of Trimedyne, Inc. (and its subsidiaries), a publicly-held company engaged in the manufacture of lasers, optical fibers and laser delivery systems, since April 1981; a Director of Gynex Pharmaceuticals, Inc., from April 1986 until its merger with and into Biotechnology General Corporation in 1993, a publicly-held company engaged in the development and commercialization of pharmaceutical products; a Director of Petrogen, Inc., an inactive, privately- held company engaged in the genetic engineering of bacteria for cleanup of oil waste and toxic waste, from April 1987 to April 1992 (Chairman from November 1980 to December 1982 and from July 1983 to April 1987); Chairman of Automedix Sciences, Inc., an inactive, publicly-held company engaged in the development of products for treating cancer and other diseases, since September 1980; Chairman of Cardiomedics, Inc., a privately-held, development stage company engaged in the development of heart assist devices, from May 1986; Chairman of Xtramedics, Inc. (now Athena Medical Corporation), a publicly-held company developing a feminine hygiene product, from November 1986 to February 1994, and a Director from November 1986 until May 1994; Chairman of Ultramedics, Inc., an inactive, privately-held company developing blood treatment products, since November 1988; and President and Director of Marvin P. Loeb & Co. since 1965, and Master Health Services, Inc. since 1972, both of which are family-held companies engaged in licensing of inventions and financial consulting.\nE. Andrews Grinstead, III, a Director of the Company since 1991, is Chairman and Chief Executive Officer of Hybridon, Inc., a publicly-held biotechnology company. Mr. Grinstead joined Hybridon in 1991. From 1987 to October 1990, he was Managing Director and group head of the life sciences group at PaineWebber, Inc. From 1986 to 1987, Mr. Grinstead was Managing Director and group head of the life sciences group at Drexel Burnham Lambert. From 1984 to 1986, he was a Vice President at Kidder, Peabody & Co., Inc., where he developed the life sciences corporate finance specialty group. Prior to his seven years on Wall Street, Mr. Grinstead served in a variety of operational and executive positions with Eli Lilly & Company, most recently as general manager of Venezuelan Pharmaceutical, Animal Health and Agricultural Chemical Operations. Since 1991, Mr. Grinstead has served as a Director of EcoScience Corporation, a development-stage company engaged in the development of biopesticides. Since 1994, Mr. Grinstead has served as a member of the Board of Trustees for the Albert B. Sabine Vaccine Foundation, a 501(c)(3) charitable foundation dedicated to disease prevention. Mr. Grinstead was appointed to the President's Council of the National Academy of Sciences and the Institute of Medicine in 1992.\nStephen C. Knight, M.D., a Director of the Company since November 10, 1994, is a Senior Consultant in the Process Industries section of the North American Management Consulting Directorate at Arthur D. Little, Inc. Dr. Knight recently returned from a two-year assignment in the Arthur D. Little office in Brussels, Belgium. During the past five years, he has been involved\nin a variety of corporate and research and development strategic planning, technology assessment, and merger and acquisition studies in the pharmaceutical, biotechnology, health care information, medical equipment and diagnostic industries. Prior to joining Arthur D. Little, Dr. Knight worked as a consultant at APM, Inc. Dr. Knight has performed medical research at the National Institutes of Health, AT&T Bell Laboratories, and Yale and Columbia Universities.\nDavid Schlachet, a Director of the Company since December 15, 1994, is Vice President of Finance and Administration at the Weizmann Institute of Science in Rehovot, Israel, a position he has held since 1990. Mr. Schlachet is responsible for the Institute's administration and financial activities, including personnel, budget and finance, funding, investments, acquisitions and collaboration with the industrial and business communities. From 1989 to 1990, Mr. Schlachet was President and Chief Executive Officer of YEDA Research and Development Co. Ltd., a marketing and licensing company at the Weizmann Institute of Science. Mr. Schlachet is a Director of Taya Investment Company Ltd., an Israeli publicly-held investment company.\nWilliam C. Hulley, a Director of the Company since April 11, 1995, is Vice President and General Partner of Adams Capital Management, a venture capital management firm. Mr. Hulley co-founded Adams Capital Management in January 1995. From 1989 until January 1995, Mr. Hulley was employed by Fostin Capital Corp, a venture capital management where he served as a General Partner of Fostin Capital Partners beginning in 1993. Prior to 1989, Mr. Hulley held engineering and marketing management positions in several high technology companies, most recently with Carnegie Group Inc. Mr. Hulley is a director of On Technology and several privately held companies.\nGad Riesenfeld, Ph.D., was named Chief Operating Officer in March 1995 and has served as Executive Vice President since December 1994. He had been the Vice President of Corporate Development and General Manager of Florida Operations since October 1992 and was employed by Pharmos Ltd. from March 1992 until the Merger. Prior thereto, he was engaged in free-lance consulting relating to the commercialization of intellectual property, primarily in the pharmaceutical and medical fields. From March 1990 through May 1991 Dr. Riesenfeld was a Managing Director of Kamapharm Ltd., a private company specializing in human blood products. Prior thereto, from May 1986, he was Managing Director of Galisar Ltd., a private company involved in extracorporeal blood therapy.\nS. Colin Neill became Acting Vice President\/Finance, Secretary, Treasurer and Chief Financial Officer of the Company at the end of March 1995. Mr. Neill is a certified public accountant and worked at Price Waterhouse, the Company's auditor, for eight years. Prior to joining the Company, Mr. Neill worked as a financial consultant. From October 1992 until December 1993, Mr. Neill was Vice President - Finance of BTR Inc., a British diversified manufacturing company. From January 1991 to October 1992, he worked as a financial consultant. From 1986 through January 1991, Mr. Neill served as Vice President - Financial Services of BOC Group, Inc., a British industrial gases and health care company.\nJohn F. Howes, Ph.D., was named Vice President of Clinical Affairs in December 1994. He had been Senior Director of Clinical Affairs from the Merger in 1992 until his recent\nappointment as a Vice President. From 1988 until the Merger, Dr. Howes served as Vice President for Development at Xenon Vision, Inc.\nAnat Biegon, Ph.D., was named Vice President of Research and Development in December 1994. Dr. Biegon became head of Research and Development for the Company in 1994. From 1992 to 1994, Dr. Biegon was a director in Pharmos Ltd.'s Department of Pharmacology. From 1991 to 1992, she was a Staff Physiologist at the University of California at Berkeley's Lawrence Berkeley Laboratory, Division of Research Medicine and Radiation Biophysics. From 1990 to 1991, Dr. Biegon was a Research Associate Professor in the Department of Psychiatry at New York University Medical Center. From 1988 to 1990, she was an Associate Professor in the Department of Neurobiology at the Weizmann Institute of Science.\nSECTION 16 FILINGS\nThe following individuals did not file reports on Form 4 regarding certain transactions during the fiscal year ended December 31, 1995:\nHaim Aviv - re-pricing of options and grant of options in October; Gad Riesenfeld - re-pricing of options and grant of options in October; E. Andrews Grinstead III - re-pricing of options and grant of options in October; Marvin Loeb - re-pricing of options and grant of options in October; Colin Neill - sale of shares and grant of warrants in October; John Howes -re-pricing of options and grant of options in October; Anat Biegon - re-pricing of options and grant of options in October; William Hulley - grant of options in October; Stephen Knight - grant of options in October; David Schlachet - grant of options in October; (Form 5's were filed for the above-named individuals, except Ms. Biegon, in February 1995).\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe following table summarizes the total compensation of the Chief Executive Officer of the Company for 1995 and the two previous years, as well as all other executive officers of the Company who received compensation in excess of $100,000 for 1995. Stock options have been adjusted for the Reverse Share Split.\nSUMMARY COMPENSATION TABLE\n- --------------- 1) Consists of car allowance\n2) Consists of housing allowance ($15,300) contributions to insurance premiums ($13,500), and car allowance.\n3) Consists of non-employee compensation\n4) These amounts represent the value of 94,115 shares of Old Pharmos common stock (equal to 18,000 shares of Common Stock, as adjusted) issued in 1990, subject to forfeiture in the amount of 75%, 50%, 25% and 0%, respectively, on each anniversary of grant until four years after grant. (No dividends have been paid to date on these shares). The market value of these 18,000 equivalent shares as of December 31, 1995 was $26,438.\n5) Consists of warrant to purchase 10,000 shares of common stock at $1.88 per share expiring on 10\/31\/2001\nThe following tables set forth information with respect to the named executive officers concerning the grant, repricing and exercise of options during the last fiscal year and unexercised options held as of the end of the fiscal year.\nOPTION GRANTS FOR THE YEAR ENDED DECEMBER 31, 1995:\n(1) represents previously issued options canceled and regranted in 1995\nAGGREGATED OPTION EXERCISES FOR THE YEAR ENDED DECEMBER 31, 1995 AND OPTION VALUES AS OF DECEMBER 31, 1995:\n(1) Based upon closing price on December 31, 1995 as reported on the Nasdaq SmallCap Market and the exercise price per option.\nTEN YEAR OPTION REPRICINGS\nREPORT ON REPRICING OF OPTIONS\nThe Compensation\/Stock Option Committee of the Board of Directors ( the \"Committee\") establishes the general compensation policies of the Company, establishes the compensation plans and specific compensation levels for executive officers, and administers the 1992 Incentive and Non-Qualified Stock Option Plan as well as the Company's other Stock Option Plans. The Committee is composed of two independent, non-employee Directors.\nThe Committee believes that the chief executive officer's (\"CEO\") compensation and the compensation of other officers of the Company should be heavily influenced by Company performance. Stock options are granted to the CEO and other executives, primarily based upon the executive's ability to influence the Company's long term growth. In addition, the Committee considers factors such as relative Company performance, the individual's past performance and future potential in establishing the compensation levels and stock option awards.\nDuring 1995 the Committee considered the fact that the exercise price for existing stock options for executive officers, employees, current directors and consultants of the Company granted in prior years had become considerably in excess of market prices for the Company's Common Stock and that as a result such options did not provide the holders with the desired incentive of linking their long term compensation with the performance goals of the Company's stockholders. This consideration along with the Committee's consideration of the performance of the executive officers during a very critical period of the Company's history, including: the filing of the NDA for the Company's leading product candidate Lotemax(TM), the signing of the Marketing Agreement with Bausch & Lomb, the progress made by the Company with other new compounds, and the improved cash and equity positions of the Company as a result of equity offerings and the implementation of cost savings, lead to the Committee's recommendation that\npreviously issued options be canceled and reissued at exercise prices closer to the market value of the Company's Common Stock.\nAs a result in October 1995, the Committee and Board approved the cancellation and reissuance of certain previously issued options held by current executives, employees, directors and consultants of the Company at an exercise price of $2.50 per share. Such price represented a 29% premium over the market price of the Company's Common Stock as of the date of the grant. The options regranted subject to the 1992 Plan are subject to an exercise schedule which provides that none of the regranted options may be exercised until one year from the date of the grant, October 31, 1995. See \"Stock Option Plans\" included herein for a further discussion of the Company's Stock Option Plans.\nSTOCK OPTION PLANS\nIt is currently the Company's policy that all full time key employees be considered annually for the possible grant of stock options, depending upon employee performance. The criteria for the awards are experience, uniqueness of contribution to the Company and level of performance shown during the year. Stock options are intended to improve loyalty to the Company and help make each employee aware of the importance of the business success of the Company. The amount and exercise price of all options discussed herein have been adjusted for the Reverse Share Split.\nAs of December 31, 1995, the Company has 994,378 options to purchase shares of the Company's Common Stock outstanding under various option plans, 282,626 of which were issued under no established plan. During 1995 the Company granted options to purchase 300,000 shares of its Common Stock to employees under a plan established in 1992 and granted options to purchase 70,000 shares of its common stock under no established plan to Directors of the Company. In addition, during 1995 the Company's Board elected to reprice certain options issued prior to 1995 under the various option plans and as a result 561,118 previously issued options were canceled and regranted. A summary of the various established stock option plans is as follows:\n1983, 1984, 1986, 1988 Plans. The Company (then known as Pharmatec, Inc.) ---------------------------- established Incentive Stock Option Plans in 1983, 1984, 1986 and 1988) for officers and employees. There are currently no options outstanding under these plans and it is anticipated that future grants of stock options will not be made from these plans.\n1991 Plan. Old Pharmos established a stock option plan in 1991. There --------- are currently 11,476 options outstanding under this plan and it is anticipated that future grants of stock options will not be made from this plan.\n1992 Plan. The 1992 Plan is administered by a committee appointed by the --------- Board of Directors (the \"Committee\"), consisting of Messrs. Marvin P. Loeb and E. Andrews Grinstead, III. The Committee will designate the persons to receive options, the number of shares subject to the options and the terms of the options, including the option price and the duration of each option, subject to certain limitations.\nThe maximum number of shares of the Company's Common Stock available for issuance under the 1992 Plan is 750,000 shares, subject to adjustment in the event of stock splits, stock dividends, mergers, consolidations and the like. Common Stock subject to options granted under the 1992 Plan that expire or terminate will again be available for options to be issued under the 1992 Plan. As of December 31, 1995, there were options to purchase 700,266 shares of the Company's Common Stock outstanding under this plan. Options to purchase 300,000 shares were granted on October 31, 1995 at an exercise price of $1.94 per share and options to purchase 400,266 shares previously outstanding and having an average exercise price of $6.50 were canceled and reissued with an exercise price of $2.50 per share. Each option granted outstanding under the 1992 plan as of December 31, 1995 expires on October 31, 2005.\nThe price at which shares of the Company's Common Stock may be purchased upon exercise of an incentive stock option must be at least 100% of the fair market value of the Company's Common Stock on the date the option is granted (or at least 110% of fair market value in the case of a 10% Holder).\nThe aggregate fair market value (determined at the time the option is granted) of the Company's Common Stock with respect to which incentive stock options are exercisable for the first time in any calendar year by an optionee under the 1992 Plan, or any other plan of the Company or a subsidiary, shall not exceed $100,000. The Committee will fix the time or times when, and the extent to which, an option is exercisable, provided that no option will be exercisable earlier than one year or later than ten years after the date of grant (or five years in the case of a 10% Holder). The option price is payable in cash or by check. However, the Board of Directors may grant a loan to an employee, pursuant to the loan provision of the 1992 Plan, for the purpose of exercising an option or may permit the option price to be paid in shares of the Company's Common Stock at the then current fair market value, as defined in the 1992 Plan.\nNo option may be exercised unless the holder has been an employee or consultant of the Company or a subsidiary for six months from the date of grant. Upon termination of an optionee's employment or consultancy, all options held by such optionee will terminate, except that any option that was exercisable on the date employment or consultancy terminated may, to the extent then exercisable, be exercised within three months thereafter (or one year thereafter if the termination is the result of permanent and total disability of the holder). If an optionee dies while he or she is an employee or a consultant or during such three month period, the option may be exercised within one year after death by the decedent's estate or his legatees or distributees, but only to the extent exercisable at the time of death.\nThe Board of Directors may amend, suspend or discontinue the 1992 Plan, but it must obtain stockholder approval to (I) increase the number of shares subject to the 1992 Plan, (ii) change the designation of the class of persons eligible to receive options, (iii) decrease the price at which options may be granted, except that the Board may, without stockholder approval, accept the surrender of outstanding options and authorize the granting of new options in substitution therefor specifying a lower exercise price that is not less than the fair market value of the Company's Common Stock on the date the new option is granted, (iv) remove the administration of the 1992 Plan from the Committee, (v) render any member of the Committee eligible to receive an option,\nother than options granted pursuant to formula, under the 1992 Plan while serving thereon, or (vi) amend the 1992 Plan in such a manner that options issued under it intended to be incentive stock options fail to meet the requirements of Incentive Stock Options as defined in Section 422 of the Code.\nEMPLOYMENT\/CONSULTING CONTRACTS\/DIRECTORS' COMPENSATION\nHaim Aviv, Ph.D. In addition to serving as Chairman of the Board and Chief ---------------- Executive Officer of the Company, Dr. Aviv has provided consulting services under a consulting agreement with an initial three-year term ended May 3, 1993. The term automatically renews for additional one-year periods unless either the Company or Dr. Aviv terminates the agreement at least 90 days prior to a scheduled expiration date. The agreement has been renewed on an annual basis and presently expires on May 3, 1997. Dr. Aviv is entitled to severance pay equal to 25% of his salary in the event of termination or non-renewal without cause. Under the agreement, Dr. Aviv is required to render certain consulting services to the Company and in consideration therefore, Dr. Aviv is entitled to receive $170,000 per year, subject to yearly increases and review.\nThe Company's subsidiary, Pharmos Ltd., employs Dr. Aviv as its Chief Executive Officer under an employment agreement with Dr. Aviv pursuant to which Dr. Aviv receives $30,000 per year, subject to yearly increases and review. Dr. Aviv is required to devote at least 50% of his business time and attention to the business of Pharmos, Ltd. and to serve on its Board of Directors. Dr. Aviv was issued at par value effective as of the time of his engagement, the equivalent of 18,000 shares of Common Stock, subject to a four year divesting program; all shares under this agreement are fully vested.\nGad Riesenfeld, Ph.D. In October 1992, Old Pharmos entered into a one-year --------------------- employment agreement with Dr. Riesenfeld, which is automatically renewable for successive one-year terms unless either party gives three months prior notice of non-renewal. Under the Agreement, Dr. Riesenfeld devotes his full time to serving as Executive Vice President of the Company. Dr. Riesenfeld's annual gross salary is $150,000.\nDirectors' Compensation. In 1995, Directors did not receive cash ----------------------- compensation for service on the Board or for attending Board meetings. Non employee members of the Board received options to purchase shares of the Company's Common Stock at an exercise price of $1.94 per share. Such options expire on October 31, 2001. These options become exercisable in three equal installments on October 31, 1996, 1997, and 1998. The number of shares to be acquired under such options as granted to each Director is as follows: Messrs. Loeb and Grinstead 20,000 each, Messrs. Knight, Hulley, and Schlachet 10,000 each. During 1995, the Board canceled and reissued options previously issued to current Directors. The following table reflects the impact of such cancellation and reissuance.\nLength of Original Number Option of Market term Securities Price of Exercise Remaining Underlying Stock at Price at Net at Date Options Time of Time of Exercise of Name Date Repriced Repricing Repricing Price Repricing ---- ---- -------- --------- --------- ----- --------- Marvin P. 10\/31\/95 30,000 $1.94 $6.50 $2.50 4.5 years Loeb\nE. Andrews 10\/31\/95 80,000 $1.94 $6.50 $2.50 4.5 years Grinstead 10\/31\/95 5,738 $1.94 $5.23 $2.50 5.5 years III\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following table sets forth certain information with respect to the beneficial ownership of the Company's Common Stock as of March 1, 1996, by (I) each person who was known by the Company to own beneficially more than 5% of any class of the Company's Common Stock, (ii) each of the Company's Directors, and (iii) all current Directors and executive officers of the Company as a group. Except as otherwise noted, each person listed below has sole voting and dispositive power with respect to the shares listed next to such person's name.\nAmount Name and Address of of Beneficial Percentage Beneficial Ownership Ownership of Total (1) - -------------------- -------------- ------------\nGrace Brothers Ltd.(2) 1,923,077 6.6% 1000 W. Diversey Parkway Suite 233 Chicago, IL 60614\nHaim Aviv, Ph.D.(3) 833,805 2.9% c\/o Pharmos Ltd. Kiryat Weizmann Rehovot, Israel\nMarvin P. Loeb(4) 300,271 * Trimedyne, Inc. 2810 Barranca Road Irvine, CA 92714\nE. Andrews Grinstead, III(5) 75,738 * Hybridon, Inc. One Innovation Drive Worcester, MA 01605\nStephen C. Knight, M.D. -0- -0- Arthur D. Little, Incorporated Acorn Park Cambridge, MA 02140\nDavid Schlachet -0- -0- Weizmann Institute of Science Rehovot, Israel\nWilliam C Hulley(6) 16,161 -0- Adams Capital Management, Inc. Sewickley, PA 15143\nAll Directors and 1,225,975 9.2% Executive Officers as a group (9 persons)(7)\n- ---------------- * Indicates ownership of less than 1%.\n(1) Based on 29,205,683 shares of Common Stock outstanding, plus each individual's currently exercisable, or exercisable within 60 days, warrants and\/or options. Assumes that no other individual will exercise any warrants and\/or options.\n(2) Information determined according to a Schedule 13G filed with the Securities and Exchange Commission.\n(3) Includes 276,153 shares of Common Stock held in the name of Avitek Ltd., of which Dr. Aviv is the Chairman of the Board of Directors and the principal stockholder, and, as such, shares the right to vote and dispose of such shares. Also includes currently exercisable options to purchase 39,376 shares of Common Stock.\n(4) Held jointly with his wife. Also includes currently exercisable options to purchase 20,000 shares of Common Stock. Does not include shares held by his adult children, his grandchildren or a trust for the benefit of his grandchildren.\n(5) Consists of currently exercisable options to purchase Common Stock.\n(6) Consists of shares of Common stock held by Croesus Biotech Investments L.P., a limited partnership of which Mr. Hulley is a general partner.\n(7) Based on the number of shares of Common Stock outstanding, plus 135,114 currently exercisable warrants and\/or options held by the Directors and executive officers.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nIn February 1995, the Company completed the sale of $1,270,000 principal amount convertible debentures bearing an interest rate of 10% per annum in a private placement transaction. Such debentures were convertible into shares of the Company's Common Stock at $.52 per share. A member of the Company's Board of Directors, Marvin P. Loeb, purchased $70,000 of such debentures and upon conversion of such debentures received 134,616 shares of Common Stock. In addition the Company paid this director $3,920 in interest related to these debentures. Another investor in these debentures, Grace Brothers, Ltd., was a holder of over 5% of the Company's common stock at the time of this transaction. This investor purchased $1,000,000 of such debentures and upon conversion received 1,923,077 shares of Common Stock. In addition the Company paid this investor $49,167 in interest related to these debentures.\nIn connection with an agreement between the Company and Mr. Dachowitz, who served as Vice President - Finance and Chief Financial Officer through March 1995, during 1995 the Company made a severance payment of $75,000 to Mr. Dachowitz on the date he terminated his employment with the Company.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(A) FINANCIAL STATEMENTS AND EXHIBITS\n(1) FINANCIAL STATEMENTS --------------------\nReport of Independent Accountants\nConsolidated Balance Sheets at December 31, 1995 and 1994\nConsolidated Statements of Operations for the years ended December 31, 1995, 1994 and 1993\nConsolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 1995, 1994 and 1993\nConsolidated Statements of Cash Flows for the years ended December 31, 1995, 1994 and 1993\nNotes to Consolidated Financial Statements\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; EXECUTIVE COMPENSATION PLANS --------------------------------------\nEXHIBITS - --------\n2 PLAN OF ACQUISITION, REORGANIZATION, ARRANGEMENT, LIQUIDATION OR SUCCESSION\n2(a) Agreement and Plan of Merger dated as of March 28, 1995 between Pharmos Corporation, PMC Merger Corporation and Oculon Corporation (Incorporated by reference to the Company's Current Report on Form 8-K, dated April 11, 1995, as amended).\n3 ARTICLES OF INCORPORATION AND BY-LAWS\n3(a) Restated Articles of Incorporation (Incorporated by reference to Appendix E to the Joint Proxy Statement\/Prospectus included in the Form S-4\nRegistration Statement of the Company dated September 28, 1992 (No. 33-52398) (the \"Joint Proxy Statement\/Prospectus\").\n3(b) Certificate of Amendment of Restated Articles of Incorporation (Incorporated by reference to Annual Report on Form 10-K for the year ended December 31, 1994).\n3(c) Amended and Restated By-Laws (Incorporated by reference to Form S-1 Registration Statement of the Company dated June 30, 1994 (No. 33-80916)).\n4 INSTRUMENTS DEFINING THE RIGHTS OF SECURITY HOLDERS, INCLUDING INDENTURES\n4(a) 1983 Incentive Stock Option Plan (The Company's 1984 and 1986 Plans are identical in all respects except as to the number of shares subject to option) (Incorporated by reference to Form S-18 Registration Statement of the Company dated June 7, 1983 (2-84298-C)).\n4(b) Amendment of 1983, 1984 and 1986 Incentive Stock Option Plans (Incorporated by reference to Annual Report on Form 10-K for the year ended December 31, 1988).\n4(c) 1988 Incentive Stock Option Plan (Incorporated by reference to Annual Report on Form 10-K for the year ended December 31, 1988).\n4(d) Pharmos Corporation 1991 Incentive Stock Option Plan (Incorporated by reference to Annual Report on Form 10-K for the year ended December 31, 1992).\n4(e) 1992 Incentive and Non-Qualified Stock Option Plan (Annexed as Appendix F to the Joint Proxy Statement\/Prospectus).\n4(f) Form of Class A Warrant to purchase (x) shares of Common Stock and (y) Class B Warrants (Incorporated by reference to Annual Report on Form 10-K for the year ended December 31, 1991).\n4(g) Form of Class B Warrant to purchase shares of Common Stock (Incorporated by reference to Annual Report on Form 10-K for the year ended December 31, 1991).\n4(h) Unit Purchase Option Agreement dated February 18, 1992 between the Company and David Blech (Incorporated by reference to Annual Report on Form 10-K for the year ended December 31, 1991).\n4(i) Form of Warrant to purchase Common Stock at an exercise price of $1.31 per share (pre-reverse split) (Incorporated by reference to Form S-3 Registration Statement of the Company dated September 14, 1993 (33-68762)).\n4(j) Form of Placement Agent's Warrant Agreement, dated August 13, 1993, to purchase shares of Common Stock (Incorporated by reference to Form S-3 Registration Statement of the Company dated September 14, 1993 (33-68762)).\n4(k) Registration Agreement dated as of January 18, 1994 by and among the Company, David Blech and Lake Charitable Remainder Trust (Incorporated by reference to Form S-3 Registration Statement of the Company dated January 28, 1993 (33-74638)).\n4(l) Form of Stock Purchase Agreement dated as of September 2, 1994 between the Company and the Purchaser (Incorporated by reference to Form S-1 Registration Statement of the Company dated June 30, 1994 [No. 33-80916], Amendment No. 2).\n4(m) Form of Warrant Agreement dated September 2, 1994 to purchase 42,000 shares of Common Stock (Incorporated by reference to Form S-1 Registration Statement of the Company dated June 30, 1994 [No. 33-80916], Amendment No. 2).\n4(n) Form of Common Stock Purchase Agreement dated as of October 4, 1994 between the Company and the Purchasers (Incorporated by reference to Form S-3 Registration Statement of the Company dated November 25, 1994 [No. 33-86720]).\n4(o) Warrant Agreement dated October 4, 1994 between the Company and Judson Cooper (Incorporated by reference to Form S-3 Registration Statement of the Company dated November 25, 1994 [No. 33-86720]).\n4(p) Form of Convertible Debenture Purchase Agreement dated as of February 7, 1995 between the Company and the Investors (Incorporated by reference to Annual Report on Form 10-K for the year ended December 31, 1994).\n4(q) Warrant Agreement dated February 7, 1995 between the Company and Judson Cooper (Incorporated by reference to Annual Report on Form 10-K for the year ended December 31, 1994).\n4(r) Form of Employee Warrant Agreement, dated April 11, 1995, between the Company and Oculon Corporation (Incorporated by reference to the Company's Current Report on Form 8-K, dated April 11, 1995, as amended).\n4(s) Form of Penalty Warrant Agreement, dated April 11, 1995, between the Company and Oculon Corporation (Incorporated by reference to the Company's Current Report on Form 8-K, dated April 11, 1995, as amended).\n4(t) Form of Unit Purchase Agreement dated as of September 14, 1995 between the Company and the Investors (Incorporated by reference to the Company's Current Report on Form 8-K, dated September 14, 1995).\n4(u) Form of Warrant Agreement dated as of September 14, 1995 between the Company and the Investors (Incorporated by reference to the Company's Current Report on Form 8-K, dated September 14, 1995).\n4(v) Form of Warrant Agreement dated as of April 30, 1995 between the Company and Charles Stolper (Incorporated by reference to Form S- 3 Registration Statement of the Company dated November 14, 1995, as amended [No. 33-64289]).\n4(w) Form of Warrant Agreement dated as of April 30, 1995 between the Company and Janssen\/Meyers Associates, L.P. (Incorporated by reference to Form S-3 Registration Statement of the Company dated November 14, 1995, as amended [No. 33-64289]).\n4(x) Form of Warrant Agreement dated as of October 31, 1995 between the Company and S. Colin Neill (Incorporated by reference to Form S-3 Registration Statement of the Company dated November 14, 1995, as amended [No. 33-64289]).\n10 MATERIAL CONTRACTS\n10(a) License Agreement dated as of March 14, 1989 between National Technical Information Service (NTIS), U.S. Department of Commerce and the Company (Incorporated by reference to Annual Report on Form 10-K for year ended December 31, 1989).\n10(b) Common Stock and Warrant Purchase Agreement, dated November 5, 1991, between the Company and David Blech (Incorporated by reference to Annual Report on Form 10-K for year ended December 31, 1991).\n10(c) Private Placement Agreement, dated November 5, 1991, between the Company and David Blech and D. Blech & Company, Incorporated (Incorporated by reference to Annual Report on Form 10-K for year ended December 31, 1991).\n10(d) Stock Option Agreement, dated March 20, 1992, between the Company, Pharmos Corporation, Xenon Vision, Inc. and the security holders of Xenon Vision, Inc. (Incorporated by reference to Annual Report on Form 10-K for year ended December 31, 1991).\n10(e) Agreement and Plan of Merger, dated May 13, 1992, as amended, by and among the Company, Pharmatec Merger Corporation and Pharmos Corporation (composite copy as amended to date) (Incorporated by reference to the Joint Proxy Statement\/Registration Statement).\n10(f) Registration Rights Agreement dated October 30, 1992 between the Company and the security holders of Xenon Vision, Inc. (Incorporated by reference to the Joint Proxy Statement\/ Registration Statement).\n10(g) Agreement between Avitek Ltd. (\"Avitek\") and Yissum Research Development Company of the Hebrew University of Jerusalem (\"Yissum\") dated November 20, 1986 (Incorporated by reference to Annual Report on Form 10-K, as amended by Form 10-K\/A, for year ended December 31, 1992).1\n10(g)(1) Supplement to Agreement (Incorporated by reference to Annual Report on Form 10-K, as amended by Form 10-K\/A, for year ended December 31, 1992).1\n10(g)(2) Hebrew language original executed version of Agreement (Incorporated by reference to Annual Report on Form 10-K, as amended by Form 10-K\/A, for year ended December 31, 1992).1\n10(h) Agreement between Avitek and Yissum dated January 25, 1987 (Incorporated by reference to Annual Report on Form 10-K, as amended by Form 10-K\/A, for year ended December 31, 1992).1\n10(h)(1) Schedules and Appendixes to Agreement (Incorporated by reference to Annual Report on Form 10-K, as amended by Form 10-K\/A, for year ended December 31, 1992).1\n10(h)(2) Hebrew language original executed version of Agreement (Incorporated by reference to Annual Report on Form 10- K, as amended by Form 10-K\/A, for year ended December 31, 1992).1\n10(i) Research, Development and License Agreement between Pharmos Ltd., Pharmos Corporation (\"Old Pharmos\") and Yissum dated February 5, 1991 (Incorporated by reference to Annual Report on Form 10-K, as amended by Form 10-K\/A, for year ended December 31, 1992).1\n(10)(i)(1) Schedules and Appendixes to Agreement (Incorporated by reference to Annual Report on Form 10-K, as amended by Form 10-K\/A, for year ended December 31, 1992).1\n10(j) Pharmos Ltd. Employment Agreement with Haim Aviv (\"Aviv\") dated as of May 2, 1990 and Old Pharmos Consulting Agreement with Aviv dated as of May 2, 1990, as amended by letter from Old Pharmos to Aviv dated June 27, 1990 and Unanimous Written Consent of the Board of Directors of Old Pharmos dated March 17, 1992 (Incorporated by reference to Annual Report on Form 10-K, as amended by Form 10-K\/A, for year ended December 31, 1992).\n10(k) Letter from Old Pharmos to D. Blech & Co. Incorporated (\"D. Blech & Co.\") dated June 27, 1991 re: consulting services (Incorporated by reference to Annual Report on Form 10-K, as amended by Form 10-K\/A, for year ended December 31, 1992).\n10(l) Old Pharmos Employment Agreement with Stephen Streber dated as of July 1, 1992 (Incorporated by reference to Annual Report on Form 10-K, as amended by Form 10-K\/A, for year ended December 31, 1992).\n10(m) Letter dated July 27, 1992 from Old Pharmos to Henry Dachowitz re employment (Incorporated by reference to Annual Report on Form 10-K, as amended by Form 10-K\/A, for year ended December 31, 1992).\n10(n) Personal Employment Agreement dated October 1, 1992 between Old Pharmos and Gad Riesenfeld (Incorporated by reference to Annual Report on Form 10-K, as amended by Form 10-K\/A, for year ended December 31, 1992).\n10(o) Lease Agreement dated as of November 1, 1992 between Talquin Development Company and the Company (Incorporated by reference to Annual Report on Form 10-K, as amended by Form 10-K\/A, for year ended December 31, 1992).\n10(p) Form of Purchase Agreement dated as of August 13, 1993 by and among the Registrant and the Investors listed on Exhibit A thereto (Incorporated by reference to Form S-3 Registration Statement of the Company dated September 29, 1993 [33-68762]).\n10(q) Amended and Restated License Agreement with Research Component dated July 1, 1993 between University of Florida Research Foundation, Inc. and the Company (Incorporated by reference to Annual Report on Form 10-K, as amended by Form 10-K\/A, for year ended December 31, 1993).1\n10(r) License Agreement dated as of April 2, 1993 between the Company and Dr. Nicholas Bodor (Incorporated by reference to Annual Report on Form 10-K, as amended by Form 10-K\/A, for year ended December 31, 1993).1\n10(s) Consulting Agreement dated as of January 1, 1993 between the Company and Dr. Nicholas Bodor (Incorporated by reference to Annual Report on Form 10-K, as amended by Form 10-K\/A, for year ended December 31, 1993).1\n10(t) Agreement and Release dated as of November 11, 1994 between the Company and Stephen R. Streber (Incorporated by reference to Annual Report on Form 10-K for the year ended December 31, 1994).\n10(u) Employment Agreement dated as of November 11, 1994 between the Company and Henry M. Dachowitz (Incorporated by reference to Annual Report on Form 10-K for the year ended December 31, 1994).\n10(v) Marketing Agreement, dated as of June 30, 1995, between the Company and Bausch & Lomb Pharmaceuticals, Inc. (Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the quarter ending June 30, 1995).1\n10(w) Processing Agreement, dated as of June 30, 1995, between the Company and Bausch & Lomb Pharmaceuticals, Inc. (Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the quarter ending June 30, 1995).1\n21 SUBSIDIARIES OF THE REGISTRANT\n21(a) Subsidiaries of the Registrant.\nXenon Vision - Incoporated under the laws of Delaware Pharmos Limited - Incorporated under the laws of Israel Oculon Corporation - Incorporated under the laws of Delaware\n- ---------------- 1 Confidential information is omitted and identified by a * and filed separately with the SEC.\nEXECUTIVE COMPENSATION PLANS AND ARRANGEMENTS\n1983 Incentive Stock Option Plan (The Company's 1984 and 1986 Plans are identical in all respects except as to the number of shares subject to option) (Incorporated by reference to Exhibit 4(a) to Annual Report on Form 10-K for the year ended December 31, 1988).\nAmendment of 1983, 1984 and 1986 Incentive Stock Option Plans (Incorporated by reference to Exhibit 4(b) to Annual Report on Form 10-K for the year ended December 31, 1988).\n1988 Incentive Stock Option Plan (Incorporated by reference to Exhibit 4(C) to Annual Report on Form 10-K for the year ended December 31, 1988).\nPharmos Corporation 1991 Incentive Stock Option Plan (Incorporated by reference to Exhibit 4(e) to Annual Report on Form 10-K for the year ended December 31, 1992).\n1992 Incentive and Non-Qualified Stock Option Plan (Annexed as Appendix F to the Joint Proxy Statement\/Prospectus).\nPharmos Ltd. Employment Agreement with Haim Aviv (\"Aviv\") dated as of May 2, 1990 and Old Pharmos Consulting Agreement with Aviv dated as of May 2, 1990, as amended by letter from Old Pharmos to Aviv dated June 27, 1990 and Unanimous Written Consent of the Board of Directors of Old Pharmos dated March 17, 1992 (Incorporated by reference to Exhibit 10(t) to Annual Report on Form 10-K, as amended by Form 10-K\/A, for year ended December 31, 1992).\nOld Pharmos Employment Agreement with Stephen Streber dated as of July 1, 1992 (Incorporated by reference to Exhibit 10(x) to Annual Report on Form 10-K, as amended by Form 10-K\/A, for year ended December 31, 1992).\nLetter dated July 27, 1992 from Old Pharmos to Henry Dachowitz re employment (Incorporated by reference to Exhibit 10(y) to Annual Report on Form 10-K, as amended by Form 10-K\/A, for year ended December 31, 1992).\nPersonal Employment Agreement dated October 1, 1992 between Old Pharmos and Gad Riesenfeld (Incorporated by reference to Exhibit 10(z) to Annual Report on Form 10-K, as amended by Form 10-K\/A, for year ended December 31, 1992).\nAgreement and Release dated as of November 11, 1994 between the Company and Stephen R. Streber (Exhibit 10(u) hereto).\nEmployment Agreement dated as of November 11, 1994 between the Company and Henry M. Dachowitz (Exhibit 10(t) hereto).\n(B) REPORTS ON FORM 8-K\nSince October 1, 1995 the Company has filed the following reports on Form 8-K\n1. The Company's Current Report on Form 8-K, dated February 15, 1996, filed pursuant to Section 13 of the Exchange Act.\n2. The Company's Current Report on Form 8-K, dated October 27, 1995, as amended, filed pursuant to Section 13 of the Exchange Act.\n(C) EXHIBITS\nSee Item 14(a)(3) above\n(D) FINANCIAL STATEMENT SCHEDULES\nSee Item 14(a)(2) above\nSIGNATURES ----------\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nPHARMOS CORPORATION\nBy:\/s\/ HAIM AVIV ---------------------------------- Dr. Haim Aviv, Chairman of the Board and Chief Executive Officer (Principal Executive Officer)\nDate: March 28, 1996\nPursuant to the requirements of the Securities Exchange Act of 1934, 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\/ S. COLIN NEILL Acting Vice President\/Finance March 28, 1996 - ------------------ S. Colin Neill and Administration, Acting Chief Financial Officer, Acting Secretary and Acting Treasurer (Principal Financial and Accounting Officer)\n\/s\/ MARVIN P. LOEB Director March 28, 1996 - ---------------------- Marvin P. Loeb\n\/s\/ E. ANDREWS GRINSTEAD III Director March 28, 1996 - ---------------------------- E. Andrews Grinstead III\n\/s\/ STEPHEN C. KNIGHT Director March 28, 1996 - --------------------- Stephen C. Knight\n\/s\/ DAVID SCHLACHET Director March 28, 1996 - ------------------- David Schlachet\n\/s\/ WILLIAM C. HULLEY Director March 28, 1996 - ------------------------- William C. Hulley\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholders of Pharmos Corporation\nIn our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, of shareholders' equity and of cash flows present fairly, in all material respects, the financial position of Pharmos Corporation and its subsidiaries at December 31, 1995 and 1994 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995, 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 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.\nThe accompanying financial statements have been prepared assuming that the Company will continue as a going concern. The Company has suffered recurring losses from operations and, at December 31, 1995, has an accumulated deficit of $54,024,741 that raise substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are described in Note 2. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.\n\/s\/ Price Waterhouse LLP\nPRICE WATERHOUSE LLP New York, New York March 26, 1996\nPHARMOS CORPORATION\nThe accompanying notes are an integral part of these consolidated financial statements.\nThe accompanying notes are an integral part of these consolidated financial statements.\nPHARMOS CORPORATION\nThe accompanying notes are an integral part of these consolidated financial statements.\nPHARMOS CORPORATION\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nThe accompanying notes are an integral part of these consolidated financial statements.\nPharmos Corporation\nNotes to Consolidated Financial Statements December 31, 1995, 1994 and 1993 - ------------------------------------------\n1. The Company\nPharmos Corporation (the \"Company\") is a bio-pharmaceutical company incorporated under the laws of the state of Nevada and is engaged in the design and development of novel pharmaceutical products in various fields including: site specific drugs for ophthalmic indications, neuroprotective agents for treatment of central nervous system (\"CNS\") disorders, systemic drugs designed to avoid CNS related side effects, and emulsion based products for topical and systemic applications. The Company uses a variety of patented and proprietary technologies to improve the efficacy and\/or safety of drugs. The Company's compounds are in various stages of development, from preclinical to advanced clinical trials and in March 1995, the Company completed the submission of its first New Drug Application (\"NDA\") with the U.S. Food & Drug Administration ('FDA\"). In conjunction with its development efforts, the Company has also undertaken research and development contracts in the past and has sold fine chemicals to the pharmaceutical research community. The Company conducts operations in Alachua, Florida and through its wholly-owned subsidiary, Pharmos, Ltd., in Rehovot Israel.\n2. Liquidity and Business Risks\nThe Company currently has no sources of recurring revenues and has incurred operating losses since its inception. At December 31, 1995, the Company has an accumulated deficit of $54,024,741. Such losses have resulted principally from costs incurred in research and development and from general and administrative expenses associated with the Company's operations. The Company expects that operating losses will continue for at least the next few years as product development, clinical testing and other operations continue. The Company currently funds its operations principally through the use of cash obtained from third party financing. Management believes that existing cash and cash equivalents of $7.4 million as of December 31, 1995, combined with anticipated cash inflows from investment income, grants and advances pursuant to the Marketing Agreement (See Note 4), will be sufficient to support operations through the first quarter of 1997. The Company is continuing to actively pursue various funding options, including equity offerings, commercial and other borrowings, strategic corporate alliances and business combination transactions, the establishment of product related research and development limited partnerships, or a combination of these methods for obtaining the additional financing that would be required to continue the research and development necessary to complete the development of its products and bring them to commercial markets.\nAs described in Note 1, in March 1995, the Company submitted its first NDA. It is reasonably possible that FDA approval for this product candidate will not be granted on a timely basis or at all. Any delay in obtaining or failure to obtain such approval would materially and adversely affect the marketing of the Company's drug candidate and the Company's business, financial position and results of operations.\nPharmos Corporation\nNotes to Consolidated Financial Statements December 31, 1995, 1994 and 1993 - ------------------------------------------\n3. Significant Accounting Policies\nBasis of Consolidation The accompanying financial statements include all wholly owned subsidiaries. Intercompany transactions are eliminated in consolidation.\nAccounting estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that effect 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 reported period. Actual results could differ from those estimates.\nCash and cash equivalents The Company invests its excess cash in U.S. Treasury securities and debt instruments of financial institutions and corporations with strong credit ratings. The Company has established guidelines relative to diversification and maturity that maintain safety and liquidity. Investments having original maturities of three months or less and are classified as cash equivalents.\nRevenue recognition Revenue for contracted research and development services is recognized as performed. Revenue from these contracts is recognized as costs are incurred (as defined in the contract), generally direct labor and supplies plus agreed overhead rates. Any advance payments on contracts are deferred until the related services are performed. License fees and royalties are recognized when earned in accordance with the underlying agreements. Sales revenue is recognized upon shipment of goods.\nFixed assets Fixed assets are recorded at cost. Maintenance and repairs are expensed as incurred. Property, furniture and equipment are depreciated on a straight- line basis over their estimated useful lives which range from three to fourteen years. Leasehold improvements are amortized on a straight-line basis over the shorter of the lease term or the estimated lives of the related assets.\nIntangible assets Intangible assets represent the Company's rights to develop and commercialize certain products derived from certain licensed technologies. The assets are being amortized over fifteen years. As of December 31, 1995 and 1994, accumulated amortization was $655,470 and $608,946, respectively. In 1995 the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121 (SFAS 121) \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of\". SFAS 121 requires that assets to be held and used be reviewed for impairment whenever events or changes indicate that the carrying amount of the asset in question may not be recoverable. In accordance with this statement, and as a result of the current period operating loss combined with a\nPharmos Corporation\nNotes to Consolidated Financial Statements December 31, 1995, 1994 and 1993 - ------------------------------------------\nhistory of operating losses, management assessed whether or not the Company's intangible assets were recoverable. As of December 31, 1995, management estimates that the net future cash inflows expected to result from the commercial exploitation of the licensed technologies will exceed the carrying amount and accordingly, no impairment loss was recognized.\nOn a periodic basis, the Company will assess whether there are conditions present that indicate an impairment of long lived assets and long lived assets to be disposed of. In the event such an impairment is present, management will consider the undiscounted cash flows from such assets to qualify the amount of such impairment and the loss to be recorded.\nAmortization expense amounted to approximately $46,000 in each of the years ended December 31, 1995, 1994 and 1993.\nResearch and development costs All research and development costs are expensed when incurred. The Company has accounted for reimbursements of research and development expenses received with respect to the royalty participation agreements described in Note 7 as a reduction of research and development expense.\nIncome taxes Income taxes are provided for on a liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss carry forwards 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 the effects of changes in tax laws and rates on the date of enactment.\nPostemployment benefits Effective January 1, 1994, the Company adopted Statement of Financial Accounting Standards No. 112, 'Employers' Accounting for Postemployment Benefits' (\"SFAS 112\"). The implementation of SFAS 112 did not have a significant impact on the Company's financial position or results of operations.\nForeign exchange The Company's foreign operations are principally conducted in U.S. dollars. Any transactions or balances in currencies other than U.S. dollars are remeasured and any resultant gains and losses are included in the determination of current period income and loss.\nTreasury stock Shares of common stock held in treasury are accounted for at par value with any difference between cost and par included in paid-in capital in excess of par value.\nPharmos Corporation\nNotes to Consolidated Financial Statements December 31, 1995, 1994 and 1993 - ------------------------------------------\nLoss per share Loss per share is calculated based on the weighted average number of common shares and convertible Class B common shares outstanding during the period. Options and warrants outstanding are excluded from the calculations because their impact would be antidilutive.\nRestatement for reverse stock split On October 18, 1993, the Company announced a reverse stock split on a 1- for-4 basis of all common and Class B convertible common shares. Additionally, the reverse stock split provided for a corresponding reduction in the number of shares of authorized preferred, common and Class B convertible common shares.\nAll common and Class B convertible common shares, warrants, options and related per share data, except for the par value per share, reflected in the accompanying financial statements and notes thereto, have been presented as if the reverse stock split in October 1993 on a 1-for-4 basis and reduction in the number of shares of authorized shares had occurred as of the beginning of the earliest year presented.\nNew accounting principle In October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123 \"Accounting for Stock-based Compensation\", which the Company will adopt in 1996. The Company intends to adopt this statement through disclosure in the notes to the financial statements.\nReclassifications Certain amounts for 1994 and 1993 have been reclassified to conform with the presentation in 1995 to maintain comparability. Such reclassifications did not have an impact on the Company's shareholders' equity.\n4. Collaborative Agreement\nOn June 30, 1995, the Company signed a marketing agreement (the \"Marketing Agreement\") with Bausch & Lomb Pharmaceuticals, Inc. (\"Bausch & Lomb\") to market Lotemax(TM), the Company's lead product candidate, on an exclusive basis in the United States. As described in Notes 1 and 2, this product candidate is pending FDA approval. The Marketing Agreement also includes Lotemax(TM) line extension products currently being developed by the Company. Under the Marketing Agreement, Bausch & Lomb will purchase the active drug substance (Loteprednol Etabonate) from the Company and provide the Company with $4 million in cash advances through March 1996. An additional $2 million advances may be made subject to reaching certain development milestones in the Lotemax(TM) line extension products. Bausch & Lomb will also collaborate in the development of such additional products by making available amounts up to 50% of the Phase III clinical trial costs. The Company has retained certain conditional co-marketing rights to all of the products covered by the Marketing Agreement.\nPharmos Corporation\nNotes to Consolidated Financial Statements December 31, 1995, 1994 and 1993 - ------------------------------------------\nAs of December 31, 1995, the Company has received $1,877,141 in advances against future sales to Bausch & Lomb of the active drug substance (needed to manufacture the drug). Bausch & Lomb will be entitled to credits against such future purchases of the drug substance based on the advances and future advances until the advances have been recouped. The Company may be obligated to repay such advances if it is unable to supply Bausch & Lomb with certain specified quantities of the active drug substance. Advances received through December 31, 1995 are reflected as a long term liability in the accompanying balance sheet as, in the opinion of management, no recoupment of such advances is expected to occur in 1996.\n5. The Acquisition of Oculon Corporation\nIn April 1995, the Company acquired Oculon Corporation (\"Oculon\"), a privately-held drug development stage company with anti-cataract technologies. The acquisition was primarily intended to provide a source of working capital for the Company, the operations of Oculon were discontinued and technologies licensed by Oculon were assigned to the licensor. Under an agreement with the licensor, the Company has no future responsibilities related to the maintenance of patents or payment of license fees related to these technologies. In the event certain of these technologies produce future royalty revenues, the Company would receive a proportional share of such royalties.\nUnder the terms of the acquisition agreement, the Company issued 6,000,000 shares of its common stock to the holders of Oculon's Series III Senior Preferred Stock. The shares of all other holders of Oculon capital stock were canceled. In addition, the Company issued ten year warrants to purchase 500,000 shares of the Company's common stock at an exercise price of $2.75 per share to certain holders of Oculon stock options. The acquisition agreement also provides that additional consideration of up to 600,000 shares may be issuable if the Company fails to meet certain milestones relating to further development or commercialization of the technology and products acquired from Oculon.\nAt the time of the acquisition, Oculon had net assets with a fair value of $3,555,812, including cash and cash equivalents of $4,218,669. The transaction was accounted for as an acquisition of net assets. Accordingly, the shares of stock and warrants issued have been recorded at the fair value of the net assets received less transaction costs of $483,386.\nPharmos Corporation\nNotes to Consolidated Financial Statements December 31, 1995, 1994 and 1993 - ------------------------------------------\n6. Fixed Assets\nFixed assets consist of the following: December 31, 1995 1994 Laboratory, pilot plant and other equipment $1,600,611 $1,715,352 Office furniture and fixtures 233,230 326,569 Vans 51,378 51,378 Computer equipment 109,544 66,948 Leasehold improvements 567,738 596,066 ---------- ---------- 2,562,501 2,756,313 Less - Accumulated depreciation and amortization (1,707,045) (1,497,378) ---------------------------- $ 855,456 $1,258,93 ========= =========\nDepreciation and amortization of fixed assets amounted to $489,486, $389,261 and $304,498 in 1995, 1994 and 1993, respectively.\n7. Government Grants for Research and Development\nThe Company has entered into agreements with U.S. federal agencies and the State of Israel which provide for grants for research and development relating to certain projects. Amounts earned pursuant to these agreements have been reflected as a reduction of research and development expense. Such reductions amounted to $331,546, $900,298, and $1,014,403 during 1995, 1994 and 1993, respectively.\nThe grant agreements generally provide for reimbursement of a percentage of allowable research and development costs, to a specified maximum, undertaken in the Company's research facilities. The grants are to be repaid on the basis of royalties from the sale of products developed as a result of the research activities carried out with the grant funds. As of December 31, 1995, the total amounts received under grants which contain repayment provisions amounted to $2,189,120. Potential repayment liability for royalties related to these grants amounted to $2,564,120. Agreements with certain agencies of the State of Israel place certain legal restrictions on the transfer of technology and manufacture of resulting products outside Israel.\nPharmos Corporation\nNotes to Consolidated Financial Statements December 31, 1995, 1994 and 1993 - ------------------------------------------\n8. Licensing Arrangements\nThe Company is both a licensor and licensee of certain research technologies.\nAs a licensor, the Company has entered into various agreements under which the rights to certain of its technologies are licensed to others. The Company is to be compensated by receipt of its share of defined future product sales or royalties earned by the licensee. These agreements have provided for funding of research, either in whole or in part by the licensee.\nAs a licensee, the Company has various license agreements with certain U.S. federal agencies and the State of Israel, certain universities, and a former director who had been a vice president of the Company, wherein the Company has acquired exclusive or coexclusive rights to develop and commercialize certain research technologies. These agreements, which include agreements related to Lotemax(TM) (the Company's lead product candidate), generally require the Company to pay royalties on sale of products developed from the licensed technologies and fees on revenues from sublicenses, where applicable. The royalty rates, as defined in the respective license agreements, are customary and usual in the pharmaceutical industry. The royalties will be payable for periods up to fifteen years from the date of certain specified events, including the date of the first sale of such products, or the date from which the first registered patent from the developed technologies is in force, or the year following the date in which U.S. Food and Drug Administration approval has been received for a developed product. No amounts have been recorded as a liability with respect to these contingent royalties as of December 31, 1995, as none of the specified events have occurred. In addition, certain of the license agreements require annual payments for periods extending through 2012. License fee expense amounted to approximately $355,000, $455,000 and $270,000 during 1995, 1994 and 1993 respectively. As of December 31, 1995, aggregate minimum annual payments under such agreements range from $103,500 to $132,500 per year.\nAs discussed in Note 12, the Company is involved in disputes with certain of its licensors.\n9. Shareholders' Equity, Warrants, Stock Options and Certain Related Party and Other Financing Transactions\n1993 transactions On August 13, 1993, the Company completed a private offering (the \" 1993 Private Placement\") of 1,666,668 shares of common stock at $6.00 per share. The proceeds of the 1993 Private Placement, net of costs, were $8,934,401. In connection with this offering the Company issued 161,667 warrants to purchase an equivalent number of shares of the Company's common stock to placement agents who assisted in this transaction. Such warrants had an exercise price of $7.50 per share and expire in August 1998. The sole shareholder and chief executive officer of one placement agent was David\nPharmos Corporation\nNotes to Consolidated Financial Statements December 31, 1995, 1994 and 1993 - ------------------------------------------\nBlech. Mr. Blech served as a director of the Company until February 1994. This placement agent earned commissions of $734,500 and also received 134,167 of the warrants described above.\nIn connection with the 1993 Private Placement, Lake Charitable Remainder Trust, of which David Blech is the income beneficiary, agreed to cancel 1,800,000 of its $5.00 and $7.00 per share warrants in exchange for 875,000 newly issued shares of the Company's common stock. This transaction was completed in December 1993.\nOn October 20, 1993, the Company qualified and began listing its common shares on the National Market System of the NASDAQ, ticker symbol PARS.\nDuring 1993, the Company paid $155,950 in consulting fees to D. Blech and Company for services rendered. Additionally, the Company paid $50,000 in consulting fees to one director and $202,692 in consulting and licensing fees to another director during 1993 under the terms of certain consulting and license agreements.\nThe Company leased corporate office space in New York through May 15, 1993 from D. Blech & Company on a month to month basis at a rate at $6,000 per month.\n1994 transactions The Company issued an aggregate of 5,086,665 unregistered shares of common stock in two private placement transactions on September 2 and October 4, 1994 (the \"1994 Private Placement Transactions\"). The proceeds from the 1994 Private Placement Transactions were $5,300,100, net of issuance costs of $317,400. In connection with the 1994 Private Placement Transactions, the Company also issued to the finders an aggregate of 242,000 warrants to purchase an equivalent number of shares of the Company's common stock. 42,000 of such warrants had an exercise price of $3.50 per share and expire in September 1999. 200,000 of such warrants had an exercise price of $.90 per share, and expire in October 1999.\nDuring 1994, the Company paid $100,000 and recorded an additional liability of $53,192, which was paid in 1995, in consulting fees to D. Blech & Company. Additionally, the Company made payments of $182,934 to a former director of the Company (who served as a director through March 1994) for consulting and licensing fees; an additional $100,000 due to this former director was included in accrued expenses at December 31, 1994 and was paid in 1995. A second former director of the Company (who served as a director through October 1994) was paid $50,000 for consulting services.\nDuring the first quarter of 1994, the Company exchanged all convertible Class B stock for an equal amount of shares of the Company's common stock. There was no impact on shareholder's equity as a result of this exchange.\nPharmos Corporation\nNotes to Consolidated Financial Statements December 31, 1995, 1994 and 1993 - ------------------------------------------\n1995 transactions On January 18, 1995, the Company's stockholders authorized an amendment to the Company's Restated Articles of Incorporation which provided for an increase in the number of shares of authorized common stock from 20 million shares to 50 million shares, and the elimination of the Class B convertible common stock.\nIn January 1995, the Company sought a waiver from Nasdaq of a rule requiring shareholder approval or prior notification of the October 1994 Private Placement Transaction, a transaction involving the issuance of 20% or more of the Common Stock outstanding at below market prices. The Nasdaq Listing Qualifications Committee rejected the Company's request, and determined that the Company's Common Stock had to be moved from the Nasdaq National Market and listed on the Nasdaq SmallCap Market, effective January 27, 1995, as a result of the Company's non-compliance with Nasdaq corporate governance requirements.\nIn February 1995, the Company completed the sale of $1,270,000 principal amount convertible debentures in a private placement transaction to several accredited investors, including a large institutional shareholder. A member of the Company's Board of Directors purchased $70,000 of such debentures. During 1995, all of the debentures were converted into 2,442,309 shares of the Company's common stock at an exchange price of $.52 per share. In connection with this transaction the Company issued warrants to purchase 150,000 shares of common stock at an exercise price of $.52 per share. During 1995, warrants to purchase 75,000 shares were exercised and the remaining 75,000 were exercised in January 1996.\nIn connection with the acquisition of Oculon (see Note 5), the Company issued 6,000,000 shares of its common stock and warrants to purchase 500,000 shares of common stock.\nOn September 14, 1995, the Company completed a private offering of 6,000,000 units at $1.50 per unit. The proceeds of the private offering, net of costs of $900,000, were $8,100,000. Each unit consisted of 1 share of the Company's common stock and one warrant to purchase 0.075 of one share of common stock (450,000 shares). In addition the Company issued warrants to purchase 450,000 of common stock to the two finders who assisted in this transaction. Both groups of warrants have an exercise price of $1.80 per share and may be exercised commencing September 14, 1996 and expire on September 14, 2000.\nDuring 1995, the Company issued warrants to consultants who assisted the Company on various business and financial matters as follows: warrants to purchase 10,000 shares at an exercise price of $1.88 per share, which expire on October 31, 2001; warrants to purchase 10,000 shares of the Company's common stock at an exercise price of $.78 per share, which expire on April 10, 2005; warrants to purchase 75,000 shares, 25,000 each of which have an exercise price of $.75, $1.00 and $1.50 per share, respectively, and may be exercised beginning May 1, 1996 and expire on April 30, 2000. The Company recognized compensation expense of $48,000 related to warrants in 1995.\nPharmos Corporation\nNotes to Consolidated Financial Statements December 31, 1995, 1994 and 1993 - ------------------------------------------\nMany of the warrants issued in connection with various equity financings and related transactions during 1991 through 1995 contain anti-dilution provisions requiring adjustment if at a latter date, securities are issued at prices below the respective warrant's exercise price. The following table summarizes the shares issuable upon exercise of warrants outstanding at December 31, 1995 as adjusted for the events which have triggered anti- dilution provisions contained in the respective warrant agreements:\nShares Issuable Upon Exercise Issuance Date Expiration Date Exercise Price ------------- --------------- -------- -----\nNovember 1991 November 1996 223,342 $5.24\nNovember 1991 March 1998 236,540 2.29 March 1998 267,971 2.83\nMarch 1998 331,328 1.66\nAugust 1993 August 1998 398,852 3.04\nSeptember 1994 September 1999 61,766 2.38 October 1994 October 1999 222,222 .81\nFebruary 1995 February 2000 75,000 .52\nApril 1995 April 2005 556,680 2.47\nApril 2005 10,000 .78 April 2000 25,000 .75\nApril 2000 25,000 1.00\nApril 2000 25,000 1.50\nSeptember 1995 September 2000 900,000 1.80 October 1995 October 2001 10,000 1.88 -------\nTotal shares and average exercise price 3,368,701 $2.29 ========= =====\nPharmos Corporation\nNotes to Consolidated Financial Statements December 31, 1995, 1994 and 1993 - ------------------------------------------\nStock Option Plans The Company's shareholders have approved incentive stock option plans for officers and employees. Options granted are generally exercisable over a specified period, not less than one year from the date of grant, and generally expire ten years from the date of grant. The following table summarizes activity in approved incentive stock options:\nShares Average Under Exercise Option Price ------ -----\nOptions Outstanding at December 31, 1992 93,883 $ 6.47\nExercised (10,500) 10.50 ------- Options Outstanding at December 31, 1993 83,383 5.97\nGranted 389,439 6.50\nExpired (38,832) 7.02 ------- Options outstanding at December 31, 1994 433,990 6.35\nGranted 300,000 1.94\nExpired (181,804) 6.12 Canceled (252,186) 6.66\nReissued 252,186 2.50 -------\nOptions outstanding at December 31, 1995 552,186 2.19 ======= ====\nOptions exercisable at December 31, 1995 - - ======= =====\nPharmos Corporation\nNotes to Consolidated Financial Statements December 31, 1995, 1994 and 1993 - ------------------------------------------\nThe Company's Board of Directors approved nonqualified stock options for key employees, directors and certain non-employee consultants. The following table summarizes activity in Board-approved nonqualified stock options:\nShares Average Under Exercise Option Price ------ -----\nOptions Outstanding at 229,868 $10.79 December 31, 1992\nGranted 63,254 7.29 Exercised (36,875) 15.30 -------\nOptions Outstanding at 256,247 8.24 December 31, 1993\nGranted 407,160 6.50\nExpired (28,251) 10.50 -------\nOptions outstanding at 635,156 7.02 December 31, 1994\nGranted 70,000 1.94 Expired (262,964) 7.44\nCanceled (308,932) 6.49\nReissued 308,932 2.50 -------\nOptions outstanding at 442,192 3.10 ======= ===== December 31, 1995\nOptions exercisable at 168,577 $4.18 ======= ===== December 31, 1995\nPharmos Corporation\nNotes to Consolidated Financial Statements December 31, 1995, 1994 and 1993 - ------------------------------------------\n10. Loans Payable\nThe Company's Israeli subsidiary, Pharmos Limited, obtained short term financing in 1994 in the form of a short term loan and a line of credit facility from one of its banks. Such agreements provide for interest payable monthly at an annualized rate of LIBOR plus 1.5%. Borrowings under such agreement amounted to $401,953 at December 31, 1994 and were repaid in full in November 1995. As of December 31, 1995, Pharmos Limited had an unutilized line of credit of $100,000 denominated in New Israeli Shekels.\nThe Company has a note payable outstanding relating to the refurbishment of the Florida facility. The note is payable in monthly installments of $7,500 including interest at 8%, the final payment is due in June 1996. As of December 31, 1995, the outstanding obligation amounted to $ 39,133 and is recorded as a current liability in the accompanying balance sheet.\nThe Company's subsidiary, Oculon Corporation ( Note 5 ) has a note payable related to leasehold improvements to a research facility (Note 12). The note is payable in monthly installments of $6,281 including interest at the prime rate plus 1% ( 8.5% at December 31, 1995) the final payment is due in September 1999. As of December 31, 1995 the outstanding balance of such note was $236,199 of which $54,551 has been classified as a current liability in the accompanying balance sheet.\nMinimum annual principal repayments of long term debt by year are as follows: 1996-$93,684, 1997- $60,355 , 1998 -$66,701 , 1999-$54,592.\n11. Income Taxes\nNo provision for income taxes was recorded for the three years ended December 31, 1995 due to net operating losses incurred. Net operating loss carry forwards for U.S. tax purposes of approximately $47,500,000 expire from 2000 through 2010.\nThe Company's gross deferred tax assets of $19,387,000 and $16,297,000 at December 31, 1995 and 1994, respectively, represent primarily the tax effect of both the net operating loss carry forwards and deferred research and development costs and, research and development tax credit carry forwards. As a result of previous business combinations and changes in stock ownership, substantially all of these net operating loss and credit carry forwards are subject to substantial restriction with regard to annual utilization. A full valuation allowance has been established with regard to the gross deferred tax assets.\nPharmos Corporation\nNotes to Consolidated Financial Statements December 31, 1995, 1994 and 1993 - ------------------------------------------\n12. Commitments and Contingencies\nLegal proceedings On October 27, 1995, the Company commenced an action in Supreme Court, New York County (the \"Court\"), against Dr. Nicholas Bodor, a former director of the Company, seeking to enjoin Dr. Bodor from taking any steps to terminate or interfere with the Company's rights under an agreement (the \"License Agreement\") with Dr. Bodor relating to LotemaxTM. Dr. Bodor claims that the advances against future revenues of LotemaxTM received by the Company under its Marketing Agreement with Bausch & Lomb are an up front licensing fee of which Dr. Bodor is entitled to receive a portion and that the failure to pay would constitute grounds for terminating the License Agreement. Dr. Bodor also claims that the Marketing Agreement is actually a sublicense entitling Dr. Bodor to additional royalties under his License Agreement and in response has commenced a separate action seeking judicial clarification of these issues. If successful in all aspects of the litigation, Dr. Bodor could possibly receive approximately $750,000 based on advances received by the Company as of December 31, 1995, and a similar amount based on advances received by the Company in 1996, as well as a higher royalty percentage on sales of LotemaxTM.\nThe Company strongly disagrees with Dr. Bodor's characterization of the Marketing Agreement and believes his interpretation is incorrect and has no merit. To prevent Dr. Bodor from wrongfully terminating the License Agreement, the Company commenced the action to protect its rights under both the License Agreement and the Marketing Agreement.\nIn a Memorandum Decision obtained by the Company in February 1996, the Court ruled in favor of the Company on both motions, granting the Company's motion for a preliminary injunction and denying Dr. Bodor's motion to dismiss. The Court instructed the parties to submit a proposed order implementing the terms of the Court's Memorandum Decision and affidavits regarding an appropriate undertaking (bond) by the Company pending a final determination of the action. Although the Company intends to vigorously defend its position related to this matter and believes its position is correct in this dispute and that it will prevail, an adverse determination or resolution of this dispute could have a material adverse effect on the Company's financial position and results of operations.\nIn March 1995, the Company was named as an additional co-defendant in an amended complaint filed in a pending purported class action suit against David Blech, D. Blech & Co. and a number of other defendants, including eleven publicly traded biotechnology companies. The complaint seeks damages for alleged unlawful manipulation of the stock market prices of the named biotechnology companies. The Company believes that the claims against it have no factual or legal basis and are without merit and has filed a motion to dismiss the claims asserted against it. The Company's motion to dismiss (along with motions to dismiss by numerous other Defendants) was argued and submitted before United States District Court on November 9, 1995 and a decision has not yet been rendered by the Court. Management believes that the ultimate outcome will not have a significant impact on the Company's financial position or results of operations.\nPharmos Corporation\nNotes to Consolidated Financial Statements December 31, 1995, 1994 and 1993 - ------------------------------------------\nManagement has reviewed with counsel all other actions and proceedings pending against or involving the Company. Although the ultimate outcome of such actions and proceedings cannot be predicted with certainty at this time, management believes that losses, if any, in excess of amounts accrued resulting from those actions will not have a significant impact on the Company's financial position or results of operations.\nLeases The Company leases research and office facilities in Israel and Florida which are used in operation of the Company's research and administration activities. The Florida facility which serves as a research and development facility as well as the corporate headquarters is leased under an agreement which expires in November 1996 and can be renewed at the Company's option for two additional one year periods. The research and development facility in Israel is leased under an agreement which expires in May 1998 but may be terminated at the Company's option in May 1997.\nThe Company also has a long term lease on office facilities in New York, which previously served as the Company's executive headquarters, which expires in March 2000. In conjunction with relocating its corporate headquarters, the Company entered into a non-cancelable sublease agreement for this facility. Such sublease expires in March 2000. The anticipated shortfall between future lease payments to be made by the Company and income to be received under the sublease amounts to $36,000 and has been reflected as a liability in the accompanying balance sheet at December 31, 1995.\nOculon Corporation leased office and research facilities in Cambridge, Massachusetts and Seattle, Washington under long term lease agreements which expire in July and October 1999, respectively. The Company has entered into subleases for these facilities. The sublease for the Seattle facility is non-cancelable and expires in October 1999. There is no difference between the anticipated minimum payments to be made under the lease agreement and the minimum sublease income to be received under the sublease agreement. The Cambridge facility is subleased under a non- cancelable agreement which expires on December 31, 1996. Minimum sublease income to be received under the non-cancelable sublease amounts to $241,000. Minimum future payments under the lease agreement for the Cambridge facility amount to $815,000. Management expects that in the normal course of business that the sublease which expires in December 1996 will be replaced by a new sublease. The Company has recorded a liability based upon management's estimate of the amount by which future payments to be made under the lease agreement are expected to exceed contractual and estimated future sublease income. As of December 31, 1995, such estimated liability amounted to $185,000, of which $90,000 is reflected as a current liability. It is possible that the Company will not be successful in obtaining a new sublease after December 1996, or if successful, that such rental income will be insufficient to cover the Company's minimum rental payments. If the Company is not successful, additional provisions will be required.\nAll of the leases and subleases described above call for base rentals, payment of certain building maintenance costs (where applicable) and future increases based on the consumer price indices.\nPharmos Corporation\nNotes to Consolidated Financial Statements December 31, 1995, 1994 and 1993 - ------------------------------------------\nAt December 31, 1995 the future minimum lease commitments and sublease rental receivables with respect to non-cancelable operating leases with terms in excess of one year are as follows:\nLease Sublease Commitments Rentals ----------- -------\n1996 $1,017,626 590,600\n1997 777,726 373,517 1998 777,726 373,517\n1999 387,323 315,269\n2000 35,131 35,131 ---------- -------\n$2,995,532 $1,688,034 ========== ==========\nRent expense during 1995, 1994 and 1993 amounted to $542,885, $488,136, and $316,602, respectively. Rent expense in 1995 is net of $88,698 of sublease income.\nIn connection with the sublease of the Seattle facility the Company's subsidiary Oculon Corporation leases certain leasehold improvements to a third party under a sublease agreement. As of December 31, 1995, the present value of such payments of $206,407 is reflected in the accompanying balance as $146,100 in other assets and the current portion of $60,307 in prepaid expenses and other current assets. Future payments to be received under this leasehold improvements sublease are as follows: $81,318 each in 1996, 1997 and 1998 and $64,387 in 1999.\nManufacturing agreement The Company has a five year agreement with a foreign company to manufacture bulk quantities of the drug product which will be used in Lotemax(TM), the Company's lead product. As of December 31, 1995, the Company has a non- cancellable commitment to purchase approximately $750,000 in 1996, payable in a foreign currency. In the event the Company does not receive approval from the FDA or other countries to market its Lotemax(TM) or line extension products, the active drug substance required to be purchased pursuant to this commitment could have little or no value to the Company.\nConsulting contracts and employment agreements In the normal course of business, the Company enters into annual employment and consulting contracts with various employees and consultants.\nPharmos Corporation\nNotes to Consolidated Financial Statements December 31, 1995, 1994 and 1993 - ------------------------------------------\nDividend restrictions Dividends may be paid by the Company's subsidiary, Pharmos Limited, only out of retained earnings as determined for Israeli statutory purposes. There are no retained earnings in Israel available for distribution as dividends as of December 31, 1995, 1994 or 1993. The Company does not intend to pay a cash dividend in the foreseeable future.\n15. Employee Benefit Plan The Company has a 401-k defined contribution profit-sharing plan covering certain employees. Contributions to the plan are based on salary reductions by the participants, matching employer contributions as determined by the Company, and allowable discretionary contributions, as determined by the Company's Board of Directors, subject to certain limitations. Contributions by the Company to the plan amounted to $10,731, $16,890 and $6,559 in 1995, 1994 and 1993 respectively.\n16. Estimated Fair Value of Financial Instruments The estimated fair value of financial instruments has been determined based upon available market information and appropriate valuation methodologies. However, considerable judgement 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 might 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.\nThe carrying amounts of cash and cash equivalents, accounts payable and accrued expenses are reasonable estimates of their fair values. The estimated fair value of investment in sublease is not materially different from its carrying value for financial statement purposes at December 31, 1995. In making this determination the Company used interest rates based upon the credit worthiness of the sublessor. Due to the uncertainty of the timing of future product sales it is not practical to estimate the fair value of advances against future sales which have a carrying value $1,877,141 at December 31, 1995.","section_15":""}
{"filename":"99802_1995.txt","cik":"99802","year":"1995","section_1":"Item 1. Business.\nGeneral\nTrion, Inc. (the \"Company\" or \"Trion\") was incorporated in 1946 in the Commonwealth of Pennsylvania and is principally engaged in the design, manufacture, sale and distribution of equipment to improve indoor air quality (\"IAQ\"). On August 1, 1995 the Company acquired Envirco Corporation (\"Envirco\"), a manufacturer and distributor of ultra-clean air systems and components located in Albuquerque, New Mexico.\nProducts and Markets\nThe Company's industry segments are Engineered Products, Consumer Products and European Operations. European Operations consists of sales and distribution primarily in Europe of both engineered and consumer IAQ products manufactured at Trion's two U.S. facilities.\nEngineered Products. The Engineered Products group designs, manufactures and sells indoor air quality and dust collection equipment and systems primarily designed for industrial, residential, commercial and specialty uses. These products are used in a wide variety of industries including microelectronics, residential, metal working, pharmaceuticals, medical, commercial buildings, general manufacturing and ships and submarines. Products range from custom-engineered systems that remove large volumes of airborne contaminants caused by industrial processes to self-contained air cleaners used to capture tobacco smoke, dust and pollen in environments such as enclosed work areas, restaurants and homes.\nThrough its recently acquired Envirco subsidiary, the Company utilizes high efficiency particulate arrestance (\"HEPA\") and ultra low particulate arrestance (\"ULPA\") technologies in applications including cleanrooms in the semiconductor and microelectronics industries and systems to provide hospitals with clean environments for surgery rooms, cancer research, patient isolation and sterile medication preparation. The Company's products include the patented MAC-10 used in cleanroom applications and Hospi-Gard , a portable filtration unit used in medical applications.\nThe Company also manufacturers equipment to electrostatically distribute microthin films of lubricants, corrosion inhibitors and other protective coatings to metal strips on high speed lines.\nConsumer Products. The Company's Consumer Products group manufactures and markets appliance air cleaners, including both tabletop and free standing console units. Trion's appliance units historically have been marketed principally to retailers and others on a private label basis. In recent years, the Company has begun to market products under Trion brand names.\nTechnologies\nIn its air cleaning products, the Company utilizes what it believes to be the industry's broadest range of technologies to collect airborne contaminants.\n- HEPA filtration utilizes laminar flow filtration which ensures even and constant airflow and has 99.97% efficiency on .3 micron size particles. ULPA filtration functions similarly and has 99.999% efficiency on .12 micron size particles. These processes provide the level of airborne contamination control essential for applications requiring ultra-clean air, such as cleanrooms and hospital and laboratory settings.\n- Electrostatic precipitators are high efficiency electronic air filters. In an electrostatic precipitator, air passes through an ionizing section where airborne particles are electrically charged by ions in an electrostatic field. The charged particles then enter a collecting cell where the particles are repelled from charged plates and collected on grounded plates within the cell. This process is highly effective at capturing submicron particulate, including particulate found in tobacco smoke, dust, pollen, welding smoke and oil mists from machining operations.\n- In a media filtration system, air passes through media filters that trap airborne particles. Some of these filters, like cartridge collectors, can collect submicron particulate, such as welding smoke, as well as larger particulate. Other filters, like bag collectors, are useful for larger particulate such as that generated in machining and welding processes. In some systems, air passes through a prefilter where large particles are collected and then pass through a second or third media filter where smaller particles are collected.\nRaw Materials and Purchased Components\nRaw materials and components used by the Company in the manufacturing process are either readily available from a number of suppliers or are manufactured by the Company from raw materials that have such availability.\nAluminum and steel represent principal raw materials in the Company's products and prices continued to rise significantly during 1995. Prices for aluminum and steel can be subject to wide fluctuation and the Company's products cannot always be priced to take into account such fluctuations, especially in the short term. Other significant materials used by the Company include motors, blowers, injection molded plastics, filter paper, media filters, packaging materials and various electrical components. In aggregate, the cost of materials in 1995 increased slightly ahead of the consumer price index. The Company anticipates similar cost increases during\n1996. The Company intends to take actions, including price increases and cost containment measures, to help mitigate the impact of such increases.\nSales and Distribution\nEngineered Products are sold in North America to end users, contractors and distributors directly as well as through manufacturers' representatives and the Company's own sales force. Consumer Products are sold directly to retailers, distributors and other companies for ultimate sale to consumers through retail outlets.\nTrion sells appliance air cleaners on a recurring basis to Sears, Roebuck and Co. within Consumer Products. This customer represented approximately 14% of consolidated sales in 1995 and the loss of the account could have an adverse effect on the Company.\nThe Company's indoor air quality products are sold throughout the world. Through Trion Limited, a wholly-owned subsidiary, the Company has a marketing and distribution office in Andover, England, servicing primarily the European market directly and through distributors and representatives. The Company's products are also sold in other countries outside Europe through distributors and representatives, principally in the Pacific Rim.\nCompetition\nWhile the Company is a principal competitor in most of its markets, the indoor air quality industry is highly competitive. In Engineered Products, the Company and its major competitors, Honeywell, Inc., White-Rodgers, a division of Emmerson Electric, Research Products, United Air Specialists, Inc., American Air Filter Co., Inc., Torit, a division of Donaldson Co., Inc., Farr Company, and Flanders Filters, Inc., account for the predominant share of the market in the lines in which they compete. In Consumer Products, while appliance air cleaners are sold by a large number of companies, Honeywell, Inc., Bionaire, Inc. and Trion together have the predominant share of the market. Of the three, Trion is the only manufacturer of electronic appliance air cleaners. Principal competitors outside the United States include some of these companies as well as foreign competitors. Competition in the Company's market segment is primarily on the basis of price, product technology, product quality and customer service; with a majority of the Company's business obtained through competitive bidding. Some of the Company's competitors have assets and\/or sales substantially in excess of the Company.\nPatents and Trademarks\nThe Company holds a number of patents that relate to the design and use of its products, some of which it considers significant to the overall conduct of the Company's business. No patents which the Company considers significant will expire within the next five years.\nThe Company owns several trademarks that it considers important in the marketing of its products and believes that its rights in these trademarks are adequately protected and of unlimited duration.\nResearch and Development\nThe Company's ongoing research and development program involves creating new products and redesigning existing products to reduce manufacturing costs and to increase product efficiencies. During 1995, 1994 and 1993, the Company spent approximately $771,000, $531,000 and $515,000, respectively, on research and development activities.\nEmployees\nAs of December 31, 1995, the Company employed approximately 439 persons worldwide. The Company's employees are not represented by a union. The Company believes its employee relations are satisfactory.\nBacklog\nThe backlog of unfilled orders at December 31, 1995 was $9,301,000 compared to $4,023,000 at the prior year-end. Substantially all of this backlog is scheduled for shipment during 1996.\nRisks\nAs a cautionary note to investors, statements made in this Annual Report on Form 10-K which are not historical are forward - looking statements that involve risks and uncertainties. There are several important factors that could cause actual results to differ materially from those anticipated. Such factors include, but are not limited to, those set forth below.\nAcquisition Strategy\nThe Company has initiated an acquisition program as part of its strategic plan. The Company's acquisition strategy entails the potential risk inherent in assessing the value, strengths, weaknesses, contingent and other liabilities and potential profitability of acquisition candidates and in integrating the operations of acquired companies. There can be no assurance that suitable acquisition opportunities will be available, that the Company will have access to the capital required to finance potential acquisitions, that the Company will continue to acquire businesses or that any business acquired will be integrated successfully or prove profitable.\nPotential Fluctuations in Operating Results\nThe Company can experience fluctuations in operating results, both on a quarterly and annual basis, caused by various factors, including general economic conditions and the factors discussed below under \"Cyclicality\". Fluctuations in the Company's operating results, particularly quarter-to- quarter, are also affected in certain of its markets by the timing of customer orders, the pattern of customer purchasing cycles and the resulting changes in product mix.\nFluctuations in Raw Material Costs\nAluminum and steel represent principal raw materials in the Company's air cleaning products. Prices for both products can be subject to wide fluctuation and the Company's products cannot always be priced to take into account such fluctuations, especially in the short term. See \"Business - Raw Materials and Purchased Components\" for a more detailed discussion of raw materials used in the Company's business.\nCyclicality\nA significant percentage of the Company's sales of residential wholehouse air cleaners is dependent upon new residential construction, which is a cyclical industry. In addition, the Company has substantial sales of products for cleanroom applications to the microelectronics industry, which can be cyclical. Sales of Engineered Products in general are also tied to capital spending levels.\nCompetition\nWhile the Company is a principal competitor in most of its markets, the indoor air quality industry is highly competitive. Competition is primarily on the basis of price, product quality, product technology and customer service, with a majority of the Company's business obtained through competitive bidding. See \"Business - Competition\" for a more detailed discussion of competition in the Company's markets.\nIntellectual Property\nThe Company's success is dependent in part on its ability to protect proprietary technology contained in certain of its products. While Trion's critical technologies are patented, there can be no assurance that this will prove sufficient to deter misappropriation of those technologies or independent third-party development of rival technologies, which would have an adverse effect on the Company's sales. The defense and prosecution of patent suits are both costly and time-consuming, even if the outcome is favorable to the Company. In foreign countries, the expenses associated with such proceedings can be prohibitive. In addition, there is an inherent unpredictability in obtaining and enforcing patents in foreign countries.\nReliance on Key Personnel\nThe Company's operations are dependent on the continued efforts of senior management, in particular Steven L. Schneider, its President and Chief Executive Officer. Should any of the senior managers be unable to continue in their present roles, the Company's prospects could be adversely affected.\nPotential Regulatory Risks\nThe Company's business and products may be significantly influenced by the constantly changing body of environmental laws and regulations, which require that certain environmental standards be met and impose liability for the failure to comply with such standards. While the Company endeavors at both of its facilities to assure compliance with\nenvironmental laws and regulations, future changes in such standards could have an adverse effect on the Company. In addition, to some extent, changes in the liabilities and risks imposed by the environmental laws on the Company's customers could impact demand for certain of the Company's products or impose greater liabilities and risks on the Company, which could also have an adverse effect on the Company's business.\nInternational Transactions\nThe Company has sold and expects it will continue to sell products in areas outside the United States. Such transactions entail the risks associated with conducting business internationally, including the risk of currency fluctuations, slower payment of invoices and possible social, political and economic instability.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nThe Company owns a 263,000 square foot modern brick facility on 27 acres in Sanford, North Carolina which houses the Company's corporate headquarters as well as manufacturing, engineering, sales and distribution operations. This property plus equipment are pledged to secure industrial revenue bonds totaling $3,200,000 at December 31, 1995. The bonds mature on November 1, 2011. The carrying value of assets pledged to secure these bonds was approximately $3,700,000 at December 31, 1995. In addition, the Company leases a 45,000 square foot facility in Albuquerque, New Mexico which houses Envirco and which expires in 1998.\nForeign properties consist of a 53,000 square foot facility located in Andover, England owned by the Company.\nThe Company's facilities in Sanford and Andover, while suitable for their intended uses, have excess capacity for current needs. The facility in Albuquerque is approaching full capacity. The facility in Andover, England remains for sale.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nNeither the Company nor its subsidiaries are party to any material pending legal proceedings nor is any of their property subject to such proceedings.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nNot applicable.\nItem 4.(a) Executive Officers of the Registrant.\nPositions and Name Age Office Held Steven L. Schneider (1) 52 President, Chief Executive Officer\nBrian H. Boender (2) 46 Vice President - Sales and Marketing\nCharles A. Haynes (3) 47 Vice President - Engineering\nCalvin J. Monsma (4) 44 Vice President and Chief Financial Officer\nJ. Gary Waters (5) 50 Vice President - Operations\nOn March 31, 1993 the Company and Mr. Schneider entered into an employment agreement which was subsequently amended and restated on July 28, 1995 (the \"Agreement\") providing for his employment as President and Chief Executive Officer for a three-year term commencing on May 24, 1993. A more complete discussion regarding the Agreement may be found under the caption \"Compensation Agreements\" on page 11 of the annual Proxy Statement dated March 13, 1996 and is incorporated herein by reference. All other executive officers serve at the discretion of the Board.\n(1) Mr. Schneider joined the Company on May 24, 1993. For a period of more than five years prior to joining the Company, Mr. Schneider served as Group President of Tomkins Industries U.S.A., a subsidiary of Tomkins PLC, a diversified manufacturing company.\n(2) Prior to joining the Company on July 19, 1993, Mr. Boender was Vice President-International for White-Rodgers (Division of Emerson Electric Co.), a leading manufacturer in the HVAC industry, from May 1992 until July 1993 and Vice President-Sales and Marketing from 1989 until 1992. Prior to joining White-Rodgers, Mr. Boender was Vice President-Marketing for Warner Electric, a worldwide manufacturer of industrial electromechanical and electronic products.\n(3) Prior to joining the Company on July 6, 1994, Mr. Haynes was Engineering Director of Heating Products for NORDYNE, a leading manufacturer of HVAC products for modular housing and residential applications from August 1992 until June 1994. Prior to joining NORDYNE, for a period of more than three years, Mr. Haynes was the Engineering Program Manager for New Product Development at United Technologies Corporation's Allied Products Division of Carrier Air Conditioning and was responsible for the design and development of various indoor air quality and electric heat products.\n(4) Prior to joining the Company on July 11, 1994, Mr. Monsma was employed by Concurrent Computer Corporation, a leading provider of high-performance real- time computer systems, serving as Director of Finance for worldwide sales and international operations until he joined the Company.\n(5) Mr. Waters was promoted to Vice President - Operations on September 1, 1994. Prior to that, he had served the Company as Vice President and Controller since 1989.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.\nMARKET AND DIVIDEND INFORMATION\nThe Company's common stock trades on the Nasdaq National Market under the symbol: \"TRON\". There were 1,015 shareholders of record on January 16, 1996. There were no dividends declared in 1994. High and low closing sales prices by quarter for the last two years and dividends declared in 1995 were:\n1995 Market Price Dividends 1994 Market Price Quarter Ended High Low Declared High Low\nMarch 31. . . . . . . . $6.25 $4.62 $0.02 $6.50 $4.75 June 30 . . . . . . . . $6.25 $5.12 $0.02 $7.13 $5.50 September 30. . . . . . $6.62 $5.38 $0.02 $6.13 $4.63 December 31 . . . . . . $6.25 $4.88 $0.02 $5.88 $4.63\nItem 6.","section_6":"Item 6. Selected Financial Data.\nFINANCIAL AND PERFORMANCE HIGHLIGHTS (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.\nResults of Operations On August 1, 1995, the Company acquired the Envirco Corporation in Albuquerque, New Mexico (\"Envirco\") and the financial statements include the activity for Envirco during the five months of August through December, 1995.\nNet sales for the year 1995 were $43,695,000, a significant improvement over the prior year's $34,077,000 and the $34,568,000 reported in 1993. The substantial increase in the current year was primarily due to Envirco. North American base business sales increased 6% in 1995 after remaining stable in 1994 as compared to 1993. Sales by our consolidated European operations declined 4% in 1995 from 1994 following an 8% decrease in 1994 from 1993 mainly due to the decline in business posted by our German subsidiary, subsequently closed at the end of 1994.\nIn terms of product mix, Engineered Products sales continue to reflect management's emphasis on growing the Company's share of this market. Due primarily to the acquisition of Envirco, Engineered Products revenues climbed by 54% in 1995 over 1994 after a slight increase in 1994 from 1993. Consumer Products showed signs of improvement during 1995 due to the introduction of a new appliance product and returned to 1993 levels. Going forward, management expects the Engineered Products component of the business to continue to grow faster than Consumer Products which faces mounting pressure from larger, foreign based manufacturers, although the Company continues to invest resources to protect and cultivate this important segment.\nConsolidated gross profit as a percentage of sales was 37.1% in 1995 which compares to 37.8% and 37.0% in 1994 and 1993, respectively. During 1995, the prices for raw materials such as aluminum, steel, plastics and packaging increased thereby placing pressures on margins. Partially offsetting these increases were the Company's Value Analysis and profit improvement programs as well as advances and changes to our manufacturing processes.\nOperating expenses as a percentage of sales were 27.9% in 1995 in comparison to 29.4% and 29.8% in 1994 and 1993, respectively. This reduction is attributable to the synergies developed by the acquisition of Envirco, controls on spending and the aforementioned profit improvement programs implemented by the Company. The Company continues to invest sales, marketing, and research and development resources in those areas within the organization having strategic significance. 1994 operating expenses included a onetime charge of $125,000 for the closure of the German subsidiary and the consolidation of European operations.\nInterest expense during 1995 was $434,000 as compared to $171,000 in 1994 and $156,000 in 1993. This increase is due to the borrowing of $6,800,000 for the Envirco acquisition.\nIncome taxes were $1,335,000, $1,012,000, and $838,000 in 1995, 1994 and 1993, respectively. The majority of taxable income during these periods was earned in the United Sates and was subject to taxation. In 1995 the Company also redeemed 1.55 million British Pounds Sterling of share capital from the Trion Limited subsidiary in the United Kingdom causing income for the current year to be taxable. Going forward, Trion Limited continues to be eligible for favorable tax treatment due to losses in prior years. These operating losses may be carried forward indefinitely.\nNet income for the year ended 1995 increased by $455,000, or 26% over 1994. The $2,234,000 of reportable net income in 1995 compares to $1,779,000 in 1994\nand $1,578,000 in 1993. Earnings per share continued to rise, with 1995 resulting in $0.35 per share as compared to $0.28 per share in 1994 and $0.25 per share in 1993. The 1994 figure included the onetime charge for the consolidation of European operations, reducing earnings by $0.03 per share. The overall positive trend is a direct result of the Company's focus on growth, internally and through acquisitions, as well as continuing efforts to control production costs and operating expenses.\nLiquidity and Sources of Capital\nCash flow from operations was sufficient to fund working capital requirements and core business capital expenditures during the most recent period. The cash balance on hand decreased by 88% in 1995 to $497,000 from $4,149,000 in 1994 due to the purchase of the Envirco operation. In addition to the Company's own funds, supplemental bank borrowings of $6,800,000 were required to settle the Envirco acquisition. Working capital increased to $15,780,000 in 1995 compared to $14,286,000 in 1994, representing a 10% improvement. The ratio of current assets to current liabilities in 1995 was 3.3 to 1 compared to 5.0 to 1 a year ago.\nCurrently, the Company has an unsecured line of credit in the amount of $18,000,000 with Wachovia Bank of North Carolina, N.A. which is deemed sufficient to fund future operating requirements. Anticipated acquisition financing requirements may require the Company to seek additional sources of credit. These funds would be used primarily for financing activities associated with future growth opportunities through additional acquisitions. The Company has no commitments with respect to any additional acquisitions at this time. Additionally, in 1995 the Company refinanced the $3,200,000 remaining on the 1984 tax exempt, variable rate industrial revenue bonds (requiring principal payments to be made annually through 2004) with tax exempt, adjustable mode industrial development revenue refunding bonds (requiring no principal payments until the year 2011).\nImpact of Recently Issued Accounting Standards\nIn March 1995, the FASB issued Statement No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, which requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amount. Statement 121 also addresses the accounting for long-lived assets that are expected to be disposed of. The Company will adopt Statement 121 in the first quarter of 1996 and, based on current circumstances, does not believe the effect of adoption will be material.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nThe consolidated financial statements and the report of independent auditors are set forth below. Information required by Item 302, \"Supplementary Data,\" is set forth in Note J of the Notes to Consolidated Financial Statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE A - ACCOUNTING POLICIES\nPrinciples of Consolidation: The financial statements include the accounts of the Company's subsidiaries, all of which are wholly owned. All significant intercompany transactions have been eliminated.\nUse of Estimates: The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.\nTranslation of Foreign Currencies: Assets and liabilities of foreign subsidiaries are translated using year-end exchange rates and revenues and expenses are translated using exchange rates prevailing during the year. Unrealized currency translation adjustments are recorded as a component of shareholders' equity and are not included in income until realized.\nOperations: The Company is principally engaged in the design, manufacture and sale of equipment to improve the quality of indoor air in the consumer, residential, commercial and industrial markets, and equipment to electrostatically distribute micro-thin films of lubricants, corrosion inhibitors and other protective coatings to metal strips on high speed process lines.\nInventories: Inventories are stated at the lower of cost or market. Cost is determined by the last-in, first-out method for domestic raw materials and by the first-in, first-out method for all other inventories. Obsolete or slow moving inventory is written off or written down when it is determined that the carrying value of the particular item exceeds realizable value.\nProperty, Plant and Equipment: Property, plant and equipment are carried at cost. Depreciation is computed by the straight-line method.\nIntangible Assets: The carrying value of intangible assets are reviewed if the facts and circumstances indicate impairment of their carrying value. Any impairment in the carrying value of such intangibles is recorded when identified.\nPension and Savings Plans: The Company has one noncontributory defined benefit pension plan and two defined contribution profit sharing plans covering eligible employees. (See Note I)\nNet Sales: The Company recognizes a sale when title passes to the customer - usually the date of shipment. New equipment returned by customers is charged to sales when received by the Company.\nResearch and Development Expenses: Included in selling, administration and engineering expenses is $771,000, $531,000 and $515,000 for research and development in the years 1995, 1994 and 1993, respectively. It is a policy of the Company to expense research and development costs in the year incurred.\nWarranty Expenses: The Company has a warranty reserve which has been established at a percentage of cost of sales. This percentage, which is subject to regular review, is based on the history of warranty expenses incurred.\nNet Income Per Share: Net income per share of common stock is computed by dividing net income by the weighted average number of shares of common stock outstanding during the year (6,429,396 in 1995, 6,381,229 in 1994 and 6,313,799 in 1993). Outstanding stock options are not considered in computing earnings per share as the effect would not be material.\nStatement of Cash Flows: For purposes of this statement, the Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.\nIncome Taxes: Income taxes are accounted for under the provisions of FASB Statement No. 109 (SFAS 109). (See Note F).\nStock Based Compensation: The Company grants stock options for a fixed number of shares to employees with an exercise price equal to the fair value of the shares at the date of grant. The Company accounts for stock option grants in accordance with APB Opinion No. 25, Accounting for Stock Issued to Employees, and, accordingly, recognizes no compensation expense for the stock option grants.\nReclassification: Certain amounts in 1994 and 1993 have been reclassified to conform to present classifications. These reclassifications have no effect on previously reported shareholders' equity or financial results.\nImpact of Recently Issued Accounting Standards: In March 1995, the FASB issued Statement No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, which requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amount. Statement 121 also addresses the accounting for long-lived assets that are expected to be disposed of. The Company will adopt Statement 121 in the first quarter of 1996 and, based on current circumstances, does not believe the effect of adoption will be material.\nNOTE B - ACQUISITION\nOn August 1, 1995 the Company acquired all of the outstanding common stock of Envirco Corporation, a manufacturer and distributor of ultra-clean air systems and components located in Albuquerque, New Mexico for cash consideration of approximately $7,986,000. The Company incurred costs of approximately $516,000; consisting principally of a finders fee, accounting and legal\nexpenses. The acquisition was financed through a combination of cash on hand and borrowings of $6,800,000. The details of the credit facility are discussed in Note D.\nIn a related transaction, the Company and\/or Envirco Corporation entered into employment agreements and\/or non-compete agreements with five key employees of the Envirco Corporation. These agreements have terms which vary from two to five years, maintain salary levels previously in effect, and, in certain circumstances based upon company performance, provide incentive payments and options to purchase the Company's common stock at $6.00 per share.\nThe Envirco acquisition was accounted for using the purchase method, with the assets and liabilities of the business recorded at their estimated fair value at the acquisition date. The excess of total acquisition cost over the fair value of the net assets acquired was classified as goodwill and is being amortized on a straight line basis over 20 years. The results of operations of Envirco are included in these consolidated statements of income as of the date of the acquisition.\nIf Envirco had been acquired at the beginning of 1995 and 1994, the unaudited pro forma summary of consolidated results of operations would have been reported as: net sales of $51,438,000 and $45,620,000; net income of $2,331,000 and $1,879,000; and net income per share of $0.36 and $0.29, respectively. These pro forma results do not purport to be indicative of the results that would have actually been attained, or that will be attained in the future.\nNOTE C - INVENTORIES (in thousands) 1995 1994 Raw materials. . . . . . . . . . . . . . . . . $4,757 $2,147 Work in process and finished products. . . . . 3,998 3,443 $8,755 $5,590\nIf the first-in, first-out method of accounting for cost had been used for domestic raw materials, inventories would have been approximately $355,000 and $251,000 more at December 31, 1995 and 1994, respectively.\nNOTE D - LINE OF CREDIT\nThe Company has a master credit facility in the United States which allows the Company to borrow up to $18,000,000 at the London Interbank Offering Rate of interest plus 1.3%. This master credit facility expires in September, 1998. This facility replaced the previous $3,000,000 line of credit which was at the prime rate of interest less 0.25%.\nNOTE E - LONG-TERM DEBT\nIn September 1995, the Company obtained a master credit facility for $18,000,000. The structure of the master credit facility includes an $8,000,000 thirty six (36) month revolving line of credit and a $10,000,000 sixty (60) month declining balance term loan.\nIn addition, as part of the purchase and sale agreement associated with the acquisition of Envirco Corporation, the Company obtained an escrow note for $458,000; due in October of 1997 and bearing interest at the fixed rate of 6%.\nIn November 1995, the Company refunded the entire $3,200,000 balance of the 1984 industrial revenue bonds; bearing interest based upon a percentage of prime, 68.5% or a 5.99% interest rate at the time, and requiring principal payments to be made annually through 2004. The entire amount was refinanced with industrial development revenue refunding bonds, due in November of 2011; bearing interest, inclusive of fees for the letter of credit, remarketing, and other financing charges, of approximately 5.5% and requiring no principal payments until maturity. The bonds are secured by the facility, including real property and equipment.\nNOTE F - INCOME TAXES\nThe liability method is used in accounting for income taxes as prescribed by SFAS 109. 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.\nIncome before income taxes consisted of the following: (in thousands) 1995 1994 1993 Domestic . . . . . . . $3,475 $2,705 $2,028 Foreign . . . . . . . . 94 86 388 $3,569 $2,791 $2,416\nIncome tax payments were $994,000 in 1995, $1,211,000 in 1994 and $586,000 in 1993.\nAt December 31, 1995, the Company had operating loss carryforwards of $3,119,000 in England that are available indefinitely to offset future taxable income of that subsidiary. For financial reporting purposes, a valuation allowance has been recognized to offset the deferred tax assets related to the carryforward.\nNOTE G - STOCK OPTIONS\nAt December 31, 1995, the Company had two incentive stock option plans in effect - the \"1985 Plan\" and the \"1995 Plan\". Under terms of both plans options to purchase shares of common stock have been granted to officers and other key executives at prices not less than the fair market value of the stock on the date of grant. Options may be granted for a term of up to ten years at the discretion of the Board of Directors. At December 31, 1995, there were no shares available for future grants under the 1985 Plan and 277,000 shares available under the 1995 Plan.\nIn addition, a non-qualified stock option for 100,000 common shares was granted in 1991 at $2.00 per share under terms of an employment agreement. The market value on the date of grant was $3.13 and the difference of $1.13 per share was charged to expense during 1991 and 1992. In 1993, 66,666 of these shares were exercised with the remaining 33,334 shares exercised in 1994. During 1993, non-qualified stock options were granted for 100,000 shares at $2.50 per share, 75,000 shares at $3.00 per share and 70,000 at $3.13 per share. The market value on the date of grant of 175,000 shares was $3.75 and the market value on the date of grant of 70,000 shares was $4.38. The options for 175,000 shares were granted for a period of five years. Vesting of 100,000 of these shares is 25% per year commencing in May 1993, and 75,000 of these shares vest at 33 1\/3% per year commencing May 1994. In 1995, 43,300 of the $2.50 per share options were exercised. The options for 70,000 shares are for a period of ten years and were vested immediately. The difference between grant prices and market prices at the date of grant are charged to expense over the respective vesting periods.\nAll incentive stock options and the 1991 non-qualified stock option were granted for a period of five years and may be exercised for one-third of the shares in each year following the date of grant.\nNOTE I - PENSION AND SAVINGS PLANS\nThe Company maintains a noncontributory defined benefit retirement plan for substantially all Sanford employees. Benefits are based on earnings and years of service. The Company's funding policy is to contribute annually the amount required by the Employee Retirement Income Security Act. Assets of the Plan are managed by a trustee and invested in marketable securities, bonds and money market instruments. Based on actuarial studies as of January 1 of each year, the contribution required was $191,000 for 1995, $0 for 1994 and $0 for 1993.\nA weighted average discount rate of 7.0% in 1995, 1994 and in 1993 and a rate of increase in future compensation levels of 5.5% in 1995, 1994 and 1993, were used in determining the actuarial present value of the projected benefit obligation. The expected long-term rate of return on plan assets was 8.0% for 1995, 1994 and 1993.\nThe Company also maintains defined contribution profit sharing plans as described in Section 401(k) of the Internal Revenue Code of 1986. Participants may elect to defer from 2% to 18% of their total cash compensation. The maximum deferral allowed for income tax purposes was $9,240 in 1995 and 1994. There are also other limitations placed upon highly compensated employees, as defined in the plans.\nThe Company may make discretionary matching contributions. During 1995 and 1994, the Company contributed $79,000 and $74,000, respectively, representing 25% of the employee's deferral up to a maximum of 1.25% of total cash compensation.\nAmounts deferred, including Company matching contributions, are invested by a trustee in a variety of investment options as directed by the participant.\nNOTE J - SUMMARY OF QUARTERLY FINANCIAL DATA (UNAUDITED)\nNOTE K - FINANCIAL INSTRUMENTS\nFinancial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash investments and trade accounts receivable. The Company maintains cash and cash equivalents with various financial institutions. Concentrations of credit risk with respect to trade accounts receivable are limited due to the large number of entities comprising the Company's customer base. However, as of December 31, 1995, the Company's receivable from one customer was $1,927,000. The carrying amount reported in the balance sheet for cash and cash equivalents, accounts receivable, accounts payable and long-term debt approximate their fair values.\nNOTE L - INDUSTRY SEGMENT INFORMATION\nThe Company's operations are classified in three general industry segments: Engineered Products; Consumer Products and European Operations.\nEngineered Products include air cleaning products manufactured for commercial, industrial and marine applications, air cleaning equipment manufactured for permanent installation in residential air handling systems, and equipment designed to electrostatically distribute micro-thin films of lubricants, corrosion inhibitors and other protective coatings to metal strips on high speed process lines.\nConsumer Products include portable room-size units, small appliance models and equipment and components sold to other suppliers of air cleaners.\nTrion Limited (and Trion GmbH in 1994) functions in Europe as a sales and distribution operation. The U.S. manufacturing operation provides products for resale. Trion GmbH ceased operations at the end of 1994.\nNet sales by segment include only sales to unaffiliated customers as reported in the Company's consolidated income statement. Segment income from operations is net sales less cost of products sold and certain operating expenses. In computing income from operations, other income, general corporate expenses, domestic interest expense and taxes on income have been excluded.\nThe Company's manufacturing facilities serve all segments; therefore, specific identification of all property, plant and equipment and inventory is not practicable. These assets and related depreciation were allocated to segments based on estimates. General corporate assets were principally cash and cash equivalents, office equipment and engineering equipment.\nNet sales of the Company in 1995 include approximately $1,466,000 of direct and indirect sales to the United States Government ($1,277,000 in 1994 and $1,043,000 in 1993). These sales are included in the Engineered Products group. Sales to a significant customer in the Consumer Products group were $6,288,000 in 1995; $5,967,000 in 1994 and $7,702,000 in 1993.\nNOTE L - INDUSTRY SEGMENT INFORMATION - (continued)\nREPORT OF INDEPENDENT AUDITORS\nShareholders and Board of Directors Trion, Inc. Sanford, North Carolina\nWe have audited the accompanying consolidated balance sheets of Trion, Inc. and subsidiaries as of December 31, 1995 and 1994, 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, 1995. 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 Trion, Inc. and subsidiaries at December 31, 1995 and 1994, and the consolidated results of their operations and cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.\nErnst & Young LLP\nRaleigh, North Carolina January 31, 1996\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.\nElection of Directors on pages 4 through 6 and Security Ownership on page 7 of the annual Proxy Statement dated March 13, 1996 are incorporated herein by reference.\nSee Part I, pages Item 4.(a) of this report for the required information on executive officers.\nSection 16 of the Exchange Act requires the Company's directors and executive officers to file reports with the Securities and Exchange Commission indicating their holdings of and transactions in the Company's equity securities and to provide copies of such reports to the Company. To the Company's knowledge, except for James E. Heins, who inadvertently filed one Form 4 one day late for one purchase transaction, insiders of the Company complied with all filing requirements.\nItem 11.","section_11":"Item 11. Executive Compensation.\nExecutive Compensation on pages 8 through 13 (excluding the information under the subheading \"Compensation Committee Report on Executive Compensation\" on pages 12 and 13), Service Agreement on page 15 and information concerning Director's compensation on page 6 of the annual Proxy Statement dated March 13, 1996 is incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nSecurity Ownership on page 7 and information concerning Director's ownership on pages 4 through 6 of the annual Proxy Statement dated March 13, 1996 are incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nService Agreement on page 15 of the annual Proxy Statement dated March 13, 1996 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) and (2)- The following consolidated financial statements of Trion, Inc. and subsidiaries, included in the annual report of the Company to its shareholders for the year ended December 31, 1995 are included in Item 8 beginning on page 12 hereof:\nConsolidated Balance Sheets -- December 31, 1995 and 1994.\nConsolidated Statements of Income and Retained Earnings -- years ended December 31, 1995, 1994 and 1993.\nConsolidated Statements of Cash Flows -- years ended December 31, 1995, 1994 and 1993.\nNotes to Consolidated Financial Statements -- December 31, 1995.\nParent company financial statements are not included because restricted net assets of subsidiaries after intercompany eliminations are less than 25% of consolidated net assets.\nItem 14. (a) (3) - See Index to Exhibits beginning on page 30 hereof.\nItem 14. (b) - There were no reports on Form 8-K filed by the Registrant during the last quarter of the period covered by this report.\nItem 14. (d) - The following consolidated financial statement schedule of Trion, Inc. and subsidiaries is included on page 29 hereof:\nSchedule II - Valuation and Qualifying Accounts and Reserves\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 not applicable and therefore have been omitted.\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.\nTRION, INC.\nBy: \/s\/ Steven L. Schneider 3\/22\/96 Steven L. Schneider, Date President and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below be the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\n\/s\/ Steven L. Schneider 3\/22\/96 \/s\/ Seddon Goode, Jr. 3\/22\/96 Steven L. Schneider, Date Seddon Goode, Jr., Date President, Chief Executive Director Officer and Director (Principal Executive Officer)\n\/s\/ Calvin J. Monsma 3\/22\/96 \/s\/ James E. Heins 3\/22\/96 Calvin J. Monsma, Date James E. Heins, Date Vice President and Director Chief Financial Officer (Principal Financial and Accounting Officer)\n\/s\/ Hugh E. Carr 3\/22\/96 \/s\/ Grant R. Meyers 3\/22\/96 Hugh E. Carr, Date Grant R. Meyers, Date Director Director\n\/s\/ Edwin V. Clarke, Jr. 3\/22\/96 \/s\/ Samuel J. Wornom III 3\/22\/96 Edwin V. Clarke, Jr., Date Samuel J. Wornom III, Date Director Director\n\/s\/ Joseph W. Deering 3\/22\/96 Joseph W. Deering, Date Director\nINDEX TO EXHIBITS\nThe following Exhibits to this report are filed herewith or, if marked with an asterisk (*), are incorporated herein by reference:\nExhibit Number Description of Exhibits 3.1 Articles of Incorporation (incorporated herein by reference to Exhibit 3.1 to Form 10-K for the year ended December 31, 1985, file number 0-3108). (*)\n3.2 Bylaws (incorporated herein by reference to Exhibit 3.2 to Form 10-K for the year ended December 31, 1994, file number 0-3108). (*)\n4.1 $18,000,000 Credit Agreement dated September 8, 1995.\n10.1 1996 Management Incentive Plan as adopted in December 1995. (**)\n10.2 1985 Trion, Inc. Incentive Stock Option Plan as adopted and approved by shareholders on April 16, 1985 (incorporated herein by reference to Exhibit A to Proxy Statement dated April 16, 1985, file number 0-3108). (*) (**)\n10.3 Form of option for the 1985 Trion, Inc. Incentive Stock Option Plan (incorporated herein by reference to Exhibit 10.4 to Form 10-K for the year ended December 31, 1986, file number 0-3108). (*) (**)\n10.4 Trion Savings Plus Plan, effective January 1, 1987 as approved in November 1986 (incorporated herein by reference to Exhibit 10.5 to Form 10-K for the year ended December 31, 1986, file number 0-3108). (*) (**)\n10.5 Loan Agreement dated August 1, 1984 between The Lee County Industrial Facilities and Pollution Control Financing Authority and Trion, Inc. (incorporated herein by reference to Exhibit 10.1 to Form 10-Q for the quarter ended September 30, 1984, file number 0-3108). (*)\n10.6 Note dated September 11, 1984 from Trion, Inc. to The Lee County Industrial Facilities and Pollution Control Financing Authority (incorporated herein by reference to Exhibit 10.2 to Form 10-Q for the quarter ended September 30, 1984, file number 0-3108). (*)\n10.7 Guaranty and Purchase Agreement dated as of August 1, 1984 from Trion, Inc. to Wachovia Bank and Trust Company, N.A. (incorporated herein by reference to Exhibit 10.3 to Form 10-Q for the quarter ended September 30, 1984, file number 0-3108). (*)\n10.8 Stock Option Agreement between Edwin V. Clarke, Jr. and Trion, Inc. dated September 17, 1993 (incorporated herein by reference to Exhibit 10.1 to form 10-Q for the quarter ended September 30, 1993, file number 0-3108) (*) (**)\nINDEX TO EXHIBITS (continued)\n10.9 Stock Option Agreement between Samuel J. Wornom III and Trion, Inc. dated September 21, 1993 (incorporated herein by reference to Exhibit 10.2 to form 10-Q for the quarter ended September 30, 1993, file number 0-3108). (*) (**)\n10.10 Stock Option Agreement between Steven L. Schneider and Trion, Inc. dated March 31, 1993 (incorporated herein by reference to Exhibit 10.2 to form 10-Q for the quarter ended June 30, 1993, file number 0-3108). (*) (**)\n10.11 Service Agreement dated October 30, 1992 between Trion, Inc. and Hugh E. Carr, a director of Trion, Inc. (incorporated herein by reference to Exhibit 10.8 to Form 10-K for the year ended December 31, 1992, file number 0-3108). (*) (**)\n10.12 Employment Agreement between Steven L. Schneider and Trion, Inc. dated March 31, 1993 (incorporated herein by reference to Exhibit 10.1 to Form 10-Q for the quarter ended June 30, 1993, file number 0-3108). (*) (**)\n10.13 Trion, Inc. 1995 Stock Incentive Plan (incorporated herein by reference to the Registrant's Registration Statement No.033-59095 on Form S-8 dated May 4, 1995). (*) (**)\n10.14 Form of option for the Trion, Inc. 1995 Stock Incentive Plan. (**)\n10.15 First Amendment to Stock Option Agreement between Steven L. Schneider and Trion, Inc. dated July 28, 1995. (**)\n10.16 Amended and Restated Employment Agreement between Steven L. Schneider and Trion, Inc. dated July 28, 1995. (**)\n10.17 Trion, Inc. 1995 Non-Employee Director Stock Plan (incorporated herein by reference to the Registrant's Registration Statement No.033-58561 on Form S-8 dated April 12, 1995). (*) (**)\n21.1 Subsidiaries of the Registrant.\n23.1 Consent of Independent Auditors.\n27 Financial Data Schedule.\n(**) Management Contract or Compensatory Plan.","section_15":""}
{"filename":"80418_1995.txt","cik":"80418","year":"1995","section_1":"Item 1. BUSINESS\nVestro Natural Foods Inc. (\"Company\") is engaged in the operation of niche or specialty food the companies and products. The Company is currently focused in the area of Natural Food Products.\nThe Company, a Delaware corporation, was originally incorporated in New York on June 13, 1947 under the name of Project Fabrication Corporation. The Company assumed the name Vestro Foods Inc., adopting its present name in 1994, and began its program of acquiring specialty food companies during 1987 as a result of an equity infusion of $3,420,000 (later increased to $5,000,000) by a group of institutional investors.\nOn February 5, 1988, effective January 1, 1988, Westbrae Natural Foods, Inc. (\"Westbrae\"), a California corporation, merged with and into a wholly owned subsidiary of the Company. Westbrae marketed soy beverages, condiments, pasta, and Japanese products. This subsidiary was the first in the Company's Natural Foods core.\nEffective September 29, 1989, the Company acquired 100% of the Common Stock of Little Bear Organic Foods, Inc. (\"Little Bear\") a national marketer of organic snack foods such as corn chips, salsas, popcorn, taco and tostada shells and refried beans under the trade names Little Bear and Bearitos, to the natural foods industry.\nOn December 27, 1989, the Company completed a private placement of $9,575,000 of a new issue of 10% Exchangeable Convertible Preferred Stock (\"10% Stock\") to an investment group principally comprised of institutional investors.\nEffective December 18, 1992, substantially all of the assets of the Company's Fine Baked Products operations, Heidi's Pastry, Inc. and Jan Holzmeister Cheesecake, Ltd., were sold to HK Acquisition Corp., a subsidiary of Heritage Kitchens Specialty Foods, Inc. Heidi's was acquired in August, 1987 while Jan Holzmeister had been acquired effective May 1, 1990. See Management's Discussion and Analysis of Financial Condition and Results of Operations located elsewhere in this report. Reference is also made to Form 8-K dated December 18, 1992 which is incorporated herein by reference.\nOn January 10, 1994 an Exchange Agreement was executed providing for the exchange of the Company's outstanding Series A Convertible Preferred Stock (\"Series A Stock\") and 10% Exchangeable Convertible Preferred Stock for 3,899,570 (after the reverse split described below) shares of the Company's Common Stock and $1,500,000 of Subordinated Notes. In addition, $2,872,000 principal amount of Subordinated Notes were issued to the holders of the Company's 10% Stock. See Management's Discussion and Analysis of Financial Condition and Results of Operation. Reference is also made to Form 8-K dated January 10, 1994 which is incorporated herein by reference.\nOn January 21, 1994, the Company's shareholders approved an amendment to the Company's Certificate of Incorporation to effect a reverse split of the Company's Common Stock on the basis of one new share for each ten shares issued and outstanding.\nNATURAL FOODS\nWestbrae Natural Foods, Inc. and Little Bear Organic Foods Inc. are the Company's subsidiaries operating in the Natural Foods industry.\nWestbrae markets an extensive line of natural food products, including soy and rice beverages, cookies, potato chips, pasta, condiments, tahini, ramen soups, soy sauce and rice cakes. Westbrae's products are sold nationally through specialty food distributors, which in turn sell to retail natural food stores, specialty food stores and mass market food stores. Westbrae's products are marketed under the names Westbrae Natural, WestSoy and Ci'Bella.\nLittle Bear has been a leader in the natural foods industry in the use of organic products, i.e. those grown without the use of chemical fertilizers or pesticides. Little Bear's product lines consist of snack foods (blue, yellow and white corn tortilla chips, popcorn, pretzels, baked chips, corn chips, cheddar puffs, and licorice) and canned products (canned whole beans, refried beans, soups, chili, baked beans, bean dip, salsa). Little Bear's products are marketed under the trade names Little Bear and Bearitos.\nThe Company believes there is significant potential in the expansion of Little Bear's organic product lines as well as new Westbrae products which are organic. Little Bear and Westbrae operate in the same marketplace and sell their products through the same distribution channels for sale nationally by natural foods, specialty food and mass market retail stores.\nIn January, 1992, the Company consolidated the operations of Westbrae and Little Bear. The product lines continue to be sold under each label, but the sales, distribution and administration functions are performed by a unified operating staff.\nThe Company has historically been a leader in its industry in the formulation and introduction of new products. These introductions have provided the impetus to the Company's growth.\nIn September, 1989, Westbrae introduced a line of potato chips made from 100% organically grown potatoes and oil. The potato chips are now available in salted, no salt, barbecue, sour cream ranch and ripple varieties.\nIn March, 1990, Westbrae introduced Westsoy Lite, a reduced fat (1%) soy beverage in three flavors, cocoa, vanilla, and plain. This\nproduct line was unique in the natural foods industry and has produced significant sales for the Company.\nIn September, 1991, Westbrae introduced Westsoy Plus, a fortified (with vitamins and calcium) soy beverage in three flavors. This product line is considered unique and has experienced encouraging sales volume.\nIn 1992, Westbrae and Little Bear introduced items that fit into the growing trend to \"low fat\" food products. Westbrae added a line of five Lite Malteds to its soy beverage offerings. Little Bear brought out baked chips (with no fat from oil) in three varieties and a Lite version of its Cheddar Puffs.\nIn 1993, Westbrae and Little Bear continued their high level of product introductions with an emphasis on \"fat free\" and \"low fat\" products. Most significantly, a new soy drink, which is both lowfat and popularly priced, and a product line of eight flavors of fat free soups were introduced.\nIn 1994, Westbrae introduced a rice drink as an addition to its non dairy beverage line, as well as a nonfat soy beverage. At the end of the year a line of reduced fat cookies in ten flavors was introduced. These cookies were very well received in the market place and produced over $2.5 million of net sales in their first year.\nIn 1995, the Company introduced corn chips in four varieties, the first in the natural foods industry. To reinforce its commitment to lowfat and nonfat products, the Company reformulated its soups, caramel corn and baked chips to improve their taste while retaining their healthy characteristics\nApproximately 10% of Westbrae's products are currently imported through one trading company in Japan. Westbrae is subject to the risks of currency price fluctuations on these products. During certain times of the year certain items with long lead delivery times must be purchased in advance and inventoried to ensure available product at reasonable prices.\nThe Company uses copackers to process products to the Company's specifications. In some product lines the Company uses only one source. In the past the Company has been able to change copackers without a significant disruption of its business. However, the loss of copacker could cause a temporary lapse in the Company's supply chain of those products resulting in reduced revenue in that product line until a replacement is found.\nWestbrae and Little Bear compete with several producers of natural food products on a national basis. The principal factors of competition are believed to be the formulation of natural and organic products and consumer confidence in the nutritional content\nof the ingredients. The Company believes it prices its products competitively and a well recognized and trusted name in its marketplace.\nSales to four customers amounted to $4,860,000 (17%), $3,674,000 (13%), $3,170,000 (11%) and $3,016,000 (10%), respectively, of consolidated net sales in 1995. Sales are not seasonal and the Company does not normally have a material backlog.\nThe Company currently employs 36 people.\nThe Company owns the right to certain trademarks, tradenames, and service marks used in its business.\nThe Company maintains ongoing product development programs relating to new food products which it considers important to the growth of its business.\nOperations are supervised by various federal, state and local regulatory agencies, including the U. S. Department of Agriculture, U. S. Food and Drug Administration, California Food and Agricultural Department, California Air Resources and Solid Waste Management Boards, California Industrial Relations Department, Air Pollution Control Board, Building Inspectors Office and Bureau of Weights and Measures. The Company believes that it substantially complies with pertinent environmental regulations and does not contemplate any significant expenditures for environmental control facilities in the foreseeable future.\nFINE BAKED PRODUCTS\nHeidi's Pastry, Inc. and Jan Holzmeister Cheesecake, Ltd. were the subsidiaries of the Company which operated the Company's Fine Baked Products core. Heidi's and Jan Holzmeister manufactured and marketed frozen gourmet cakes sold primarily to hotels and restaurants. Effective December 18 1992, substantially all of the assets of the Fine Baked Products core were sold to an unaffiliated firm.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nVestro Natural Foods Inc., Westbrae and Little Bear currently lease 9,600 square feet of office space in Carson, California. The lease for this property runs to September 30, 1997 with a short term cancellation clause. In addition, the Company currently rents 38,000 square feet of warehouse space in the same building for the storage and shipping of their inventory. The Company believes that this arrangement should be adequate to meet its needs for the foreseeable future, although it is exploring alternative facility locations. Westbrae and Little Bear also utilize public warehouses as well as the facilities of co- packers to inventory and distribute their products.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS None.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTER 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 is traded in the over-the-counter market and quoted on NASDAQ under the symbol VEST. The following table sets forth high and low bid quotations (adjusted for the 1 for 10 reverse split) for the quarters commencing January 1, 1994 through December 31, 1995. These bids represent quotations between market makers without adjustments for markups or markdowns as reported by the National Quotation Bureau Inc. These prices may not represent actual transactions.\n1994 High Bid Low Bid ---------------- -------- -------\nFirst Quarter 3-1\/8 2-1\/4 Second Quarter 3-7\/8 2-1\/2 Third Quarter 2-7\/8 2-1\/4 Fourth Quarter 2-3\/8 1-3\/4\n1995 High Bid Low Bid ---------------- -------- -------\nFirst Quarter 1-7\/8 1-3\/8 Second Quarter 1-5\/8 1-1\/2 Third Quarter 2-1\/8 1-5\/8 Fourth Quarter 1-3\/4 1-3\/8\nThe Company had approximately 800 holders of record of its Common Stock as of February 28, 1996.\nThe Company has not paid any dividends on its Common Stock during the past two fiscal years and does not anticipate paying a dividend this fiscal year.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA\nNo dividends were declared on the Company's Common stock during any of the above periods.\nCumulative preferred dividends of $1,048,000, for each of the years ended December 31, 1993, 1992, and 1991, not paid or declared are deducted from net income (loss) applicable to common shareholders in the period in which they are earned.\nIn 1992, results were affected by the sale of substantially all the assets of Heidi's Pastry, Inc. and Jan Holzmelster Cheesecake, Ltd.\nSelected Financial Data should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements of the Company located elsewhere in this Report.\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nLIQUIDITY AND CAPITAL RESOURCES\nAt January 1, 1994, the Company entered into a credit agreement with a bank to provide up to $4,000,000 of financing based upon certain percentages of the Company's accounts receivable and inventory. Under the terms of the agreement, the Company had $2,400,000 of borrowing capacity at December 31, 1995. At December 31, 1995 there was $100,000 of borrowing outstanding under this facility. This agreement expires on April 15, 1996. The bank has made a proposal to renew the agreement.\nThe Company's Senior Subordinated Notes A, totalling $2,872,000, are payable, interest and principal, monthly through May 15, 1998. $549,000 of principal was paid in 1995 with principal payments of $675,000 due in 1996. Senior Subordinated Notes B, totalling $1,500,000, are payable, interest only, quarterly through May 15, 1998. Principal payments will then be made quarterly through November 15, 1999. Interest on both series is payable at 8% per annum. Payments of interest or principal on the Senior Subordinated Notes B are subject to a limitation that the total principal and interest paid on both series in any fiscal quarter cannot exceed 30% of net income. During 1995, the Board of Directors determined that, due to the Company's cash balances, interest on Subordinated Notes B would be paid.\nDuring the year 1995, the Company experienced negative cash flow of $1,297,000. In addition to the principal payments of debt, this was largely caused by increased accounts receivable and inventory levels necessary to meet the increased sales level. In addition increased inventory was required for new products introduced during the year.\nDuring 1995, the Company collected $167,000 of principal on the note receivable from HK Acquisition Corp. This was the final payment from the sale of the Company's Fine Baked Products operations.\nThe Company anticipates that cash flow from operations together with its current cash balance and the availability under its credit line should be sufficient to support its operating needs for at least the current fiscal year.\nINFLATION\nIn general, the impact of inflation on the Company's operations has not been and is not expected to be significant. The Company has been able to make selected price increases which have more than offset the effects of rising costs.\nRESULTS OF OPERATIONS\n1995 COMPARED TO 1994\nNet sales for the year ended December 31, 1995 were $28,840,000 an increase of 16% over net sales of $24,892,000 in the prior year. A major contribution to the increased level was the introduction of Chocolate Chip Classic and Cookie Jar Classic reduced fat cookies. These cookies, in ten flavors, accounted for over $2.5 million of net sales in 1995. The Company's nondairy beverages also experienced a significant increase of 19% over 1994.\nGross profit of the Company was $10,462,000 or 36.3% of sales for the year ended December 31, 1995 compared to $8,833,000 or 35.5% of sales in 1994. Margins on the Company's non dairy beverages improved somewhat from 1994, offsetting increased costs of Japanese products due to the weakened dollar early in the year.\nSelling, general and administrative expenses were $9,676,000 or 33.6% of sales for the year ended December 31, 1995 compared to $8,168,000 or 32.8% of sales in 1994. The increase was due largely to marketing expenses incurred to promote the Company's products. In 1995 the Company began its first consumer magazine advertising program with placements in seven healthy lifestyle magazines. In addition, the Company sponsored a promotion in conjunction with Dr. Earl Mindell's book \"The Soy Miracle.\" The Company provided displays to most natural food stores in the country and gave the book to consumers who purchased the Company's soy beverages.\nThe Company had net interest expense of $259,000 in 1995 compared to net interest expense of $257,000 in the prior year. The Company had other income (net) of $89,000 in 1995 compared to $148,000 in 1994. In both years, this arose largely from an adjustment to the valuation reserve recorded against the receivable from the purchaser of the Company's Fine Baked Products operations, $83,000 in 1995 and $256,000 in 1994.\nThe Company recorded income tax expense of $14,000, which represents alternative minimum tax, in the year ended December 31, 1995 while there was $18,000 of income tax expense for the year ended December 31, 1994.\nAs a result of the above items, the Company recorded net income of $602,000 for the year ended December 31, 1995. In the year ended December 31,1994, the Company had net income of $538,000.\n1994 COMPARED TO 1993\nNet sales for the year ended December 31, 1994 were $24,892,000 compared to $26,065,000 in the prior year. During the second half of 1994, the Company encountered severe shortages in meeting customer orders. During this period, the Company redesigned most of\nits labels to meet new FDA standards as well as a graphic redesign of its two largest product lines. Because of high demand at packaging suppliers, the Company was unable to time the receipt of new packaging with the exhaustion of the old. In addition, capacity restrictions at a major copacker limited the Company's ability to obtain products. During the second half of 1994, the Company experienced out of stocks in the amount of 11.4% of net sales, about three times the prior rate. In addition, the Company's efforts in redesigning labels, obtaining packaging and filling \"out of stocks\" limited its ability to pursue product sales and to introduce new products to the extent it normally does.\nGross profit of the Company was $8,833,000 or 35.5% of sales for the year ended December 31, 1994 compared to $8,824,000 or 33.9% of sales in 1993. During 1994, the Company took a charge of $237,000 (1.0% of net sales) for estimated losses on the sale of certain slow moving inventory and contingencies related to several discontinued products.\nSelling, general and administrative expenses were $8,168,000 or 32.8% of sales for the year ended December 31, 1994 compared to $7,123,000 or 27.3% of sales in 1993. The increase was due largely to higher levels of promotional allowances, by 2.4% of net sales, as well as to the addition of several salespeople in the Eastern and Southeastern regions of the country and increased marketing personnel. In addition, the Company recorded a charge of $182,000 related to the settlement of the former Chief Executive Officer's Stock Purchase Agreement and the costs of recruitment of a successor.\nThe Company had net interest expense of $257,000 in 1994 compared to net interest expense of $113,000 in the prior year. The interest expense in 1994 was a result of the issuance of 8% interest bearing Subordinated Notes to the former holders of the Company's 10% Stock in partial exchange for the stock. The Company had other income (net) of $148,000 in 1994 compared to ($14,000) in 1993. During 1994, the Company recorded $256,000 of income from an adjustment to the valuation reserve recorded against the receivable from the purchaser of the Company's Fine Baked Products operations.\nThe Company recorded income tax expense of $18,000, which represents alternative minimum tax, in the year ended December 31, 1994 while there was $39,000 of income tax expense for the year ended December 31, 1993.\nAs a result of the above items, the Company recorded net income of $538,000 for the year ended December 31, 1994. In the year ended December 31, 1993, the Company had net income of $1,535,000.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe financial statements and financial statement schedules required by Item 8 of this report are set forth on pages 15 through 27.\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. EXECUTIVE OFFICERS OF THE COMPANY\nListed below are the executive officers of the Company. All officers serve at the pleasure of the Board of Directors. There are no family relationships among any officers or directors of the Company.\nName Age Position ---- --- --------\nRobert J. Cresci 52 Chairman of the Board\nB. Allen Lay 61 President and Chief Executive Officer\nStephen Schorr 50 Vice President, Finance, Secretary, Treasurer and Chief Financial Officer.\nMr. Cresci has been a Managing Director of Pecks Management Partners Ltd., an investment management firm, since September 1990. Mr. Cresci currently serves on the boards of Bridgeport Machines, Inc., Serv-Tech, Inc., EIS International, Inc., Sepracor, Inc., Elements, Inc., Garnet Resources Corporation, HarCor Energy, Inc., Meris Laboratories, Inc. and several private companies.\nMr. Lay was elected President and Chief Executive Officer of the Company on January 12, 1995. Mr. Lay has been a Director of the Company since 1987. Mr. Lay has served as a General Partner of Southern California Ventures, a venture capital firm, since May, 1983. He is a director of PairGain Technologies (OTC), Physical Optics Corp., Kofax Imaging, ViaSat Inc. and Medclone Inc. Mr. Lay was Chairman and C.E.O. of Meridian Data Inc. from July, 1993 to December, 1994.\nMr. Schorr joined the Company in July, 1988 as Vice President, Finance. He is an Officer and Director of each of the Company's subsidiaries. From December, 1982 through June, 1988, he held the positions of Vice President, Finance and Corporate Controller of Linear Corporation, a manufacturer of electronic components.\nSIGNIFICANT EMPLOYEES\nAndrew Jacobson, 35, is President of Westbrae and Little Bear. From 1985- 1992, Mr. Jacobson was employed by Tree of Life Inc. a major national natural products distributor, in several executive capacities culminating as Director of Sales of Tree of Life West prior to joining Westbrae and Little Bear in November, 1992. Mr. Jacobson is a member of the Board of Directors of the National Nutritional Foods Association.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION\nItem 12.","section_12":"Item 12. SHARE OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nExcept for information regarding the Company's executive officers (See Item 10), the information called for by Items 10 through 13 is incorporated in this Report by reference to the definitive Information Statement for the Company's 1996 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 following documents are filed as part of this report.\n1. FINANCIAL STATEMENTS\nThe following Consolidated Financial Statements of Vestro Natural Foods Inc. and subsidiary companies are incorporated by reference in Part II, Item 8:\nPages -------\nREPORT OF INDEPENDENT ACCOUNTANTS..... 14\nCONSOLIDATED BALANCE SHEET DECEMBER 31, 1995 and 1994.......... 15\nCONSOLIDATED INCOME STATEMENT FOR THE YEARS ENDED DECEMBER 31, 1995, 1994, and 1993................ 16\nCONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1995, 1994, and 1993... 17\nCONSOLIDATED STATEMENT OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994, and 1993...................... 18\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS........................... 19-27\n2. FINANCIAL STATEMENT SCHEDULES\nAll financial statements schedules are omitted because they are not applicable, or because the information required is either immaterial or included in the Consolidated Financial Statements and notes thereto.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholders of Vestro Natural Foods Inc.\nIn our opinion, the consolidated financial statements listed in the index appearing under Item 14(a)(1) on page 13 present fairly, in all material respects, the financial position of Vestro Natural Foods Inc. and its subsidiaries at December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995, 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.\n\/s\/ Price Waterhouse LLP\nPRICE WATERHOUSE LLP Costa Mesa, California March 26, 1996\nVESTRO NATURAL FOODS INC.\nCONSOLIDATED BALANCE SHEET - -------------------------------------------------------------------------\nSee accompanying notes to consolidated financial statements.\nVESTRO NATURAL FOODS INC.\nCONSOLIDATED INCOME STATEMENT - --------------------------------------------------------------------------------\nSee accompanying notes to consolidated financial statements.\nVESTRO NATURAL FOODS INC.\nCONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY - -------------------------------------------------------------------------------\nSee accompanying notes to consolidated financial statements.\nVESTRO NATURAL FOODS INC.\nCONSOLIDATED STATEMENT OF CASH FLOWS - -------------------------------------------------------------------------------\nSee accompanying notes to consolidated financial statements.\nVESTRO NATURAL FOODS INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1995, 1994 AND 1993 - --------------------------------------------------------------------------------\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nDESCRIPTION OF BUSINESS Vestro Natural Foods Inc., a Delaware corporation, is engaged in the acquisition, ownership and operation of specialty food businesses. Its products are sold under the tradenames Westbrae, Westsoy, Little Bear, Bearitos and CiBella.\nBASIS OF PRESENTATION The consolidated financial statements include the accounts of Vestro Natural Foods Inc. and its subsidiaries (the Company), all of which are wholly-owned. All significant intercompany accounts and transactions have been eliminated in consolidation.\nUSE OF ESTIMATES IN PREPARATION OF FINANCIAL STATEMENTS 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 respective reporting periods. Actual results could differ from those estimates.\nFAIR VALUE OF FINANCIAL INSTRUMENTS The Company values financial instruments as required by Statement of Financial Accounting Standards No. 107, \"Disclosure about Fair Values of Financial Instruments\" (SFAS 107). The carrying amounts of cash and cash equivalents, accounts and other receivables, accounts payable, accrued liabilities and debt approximate fair value.\nCASH AND CASH EQUIVALENTS The Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents for purposes of the consolidated statement of cash flows.\nCONCENTRATIONS OF CREDIT RISK Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of trade receivables. The credit risk exists because the Company's sales are concentrated to a relatively small number of customers within the natural foods industry. The Company maintains reserves for potential credit losses and such losses have been within management's expectations.\nINVENTORIES Inventories are valued at the lower of cost or market, cost being determined on a first-in, first-out basis. At December 31, 1995 and 1994, inventories consist of:\n1995 1994\nFinished goods $ 2,541,000 $ 2,311,000 Raw materials and supplies 369,000 236,000 ----------- -----------\n$ 2,910,000 $ 2,547,000 ----------- ----------- ----------- -----------\nVESTRO NATURAL FOODS INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1995, 1994 AND 1993 - --------------------------------------------------------------------------------\nPROPERTIES Properties are stated at cost less accumulated depreciation. Machinery and equipment are depreciated using a straight-line basis over the estimated useful life of the asset ranging from five to seven years. Leasehold improvements are amortized on a straight-line basis over the lesser of the useful lives or the term of the lease.\nINTANGIBLE ASSETS The excess of the cost over the fair value of net assets of purchased businesses (goodwill) is amortized on a straight-line basis, generally over 40 years. The Company evaluates whether there has been any impairment of goodwill based upon management's estimate of future net income, on an undiscounted basis, over the remaining useful life of goodwill.\nINCOME TAXES Effective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\" Under the liability method specified by SFAS No. 109, the deferred tax liability is determined based on the difference between the financial statement and tax bases of assets and liabilities as measured by the enacted tax rates which will be in effect when these differences reverse. Deferred tax expense is the result of changes in the liability for deferred taxes. The adoption did not have a material effect on the financial statements.\nEARNINGS PER SHARE Earnings per share are based upon the weighted average number of common shares and common stock equivalents outstanding. Assumed exercise of contingent shares, convertible preferred stock, outstanding warrants and options have been considered in the computation of per share data to the extent they are dilutive. Cumulative preferred dividends including those not paid or declared ($1,048,000 for the year ended December 31, 1993) are deducted from net income applicable to common shareholders in the period in which they are earned. The weighted average number of shares used in the calculation of earnings per share for the three years ended December 31, 1995 are 6,067,376, 6,260,130 and 1,739,072, respectively.\nRECLASSIFICATIONS Certain reclassifications have been made to the 1993 and 1994 statements to conform to the 1995 presentation.\n2. BUSINESS DIVESTITURES\nDIVESTITURE OF THE NET ASSETS OF HEIDI'S PASTRY, INC. AND JAN HOLZMEISTER CHEESECAKE, LTD. Effective December 18, 1992, the Company sold substantially all of the assets of Heidi's Pastry, Inc., a bakery and wholesale distributor of gourmet pastries, and Jan Holzmeister Cheesecake, Ltd., a producer of cheesecakes. The sales price included $4,200,000 in cash, a note receivable valued at $411,000, and the assumption of certain related liabilities and obligations. A cash payment for the remaining balance of the note receivable was received during 1995.\nVESTRO NATURAL FOODS INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1995, 1994 AND 1993 - --------------------------------------------------------------------------------\n3. DEBT OBLIGATIONS\nREVOLVING LINE OF CREDIT In April 1994, the Company executed a revolving credit agreement with a financial institution. The terms of the credit agreement provide: (1) borrowings up to 80% of eligible accounts receivable plus 30% of eligible inventory (up to $1,000,000) less all outstanding commercial and standby letters of credit; (2) a maximum outstanding credit balance of $4,000,000; (3) interest rate at the bank's prime rate; (4) a requirement to maintain a non-interest bearing deposit of $200,000 or pay a fee calculated at the prime rate plus 3% on the difference between the average daily deposit and the $200,000 requirement; and (5) a term expiring April 30, 1996.\nUpon execution of the agreement, the Company paid a loan fee of $40,000. In addition, the Company was required to reimburse such expenses as filing, recording and search fees, appraisal fees, title report fees, legal and audit fees. These expenses were not significant for the years ended December 1995 and 1994. Outstanding borrowings under the revolving credit agreement were $100,000 at December 31, 1995.\nThe revolving line of credit is secured by substantially all of the Company's assets. The agreement contains various covenants which restrict the Company from incurring additional indebtedness and require the Company to maintain certain financial ratios.\nNOTES PAYABLE In connection with the exchange agreement (see Note 5) with the holders of the Company's 10% convertible exchangeable preferred stock, the Company issued $4,372,000 in notes payable bearing interest at 8% per annum. The Senior Subordinated Notes A (Notes A) were issued in consideration of the dividends in arrears at the time of the agreement, which amounted to approximately $2,872,000. Principal and interest on Notes A are due monthly through May 15, 1998. The Senior Subordinated Notes B (Notes B) total $1,500,000. Interest on Notes B is payable monthly through May 15, 1998, subject to the limitation that the total principal and interest paid under both Notes A and B does not exceed 30% of net income. Any interest payments that are deferred due to this provision are payable in the next quarter that such provision will permit. Principal payments on Notes B are due quarterly beginning August 15, 1998 through 1999. The aggregate principal maturities of Notes A and B and various other notes payable in the aggregate amount of $38,000 are payable as follows:\nYEAR ENDED DECEMBER 31, 1996 $675,000 1997 869,000 1998 908,000 1999 988,000\nThe agreement also contains various covenants which restrict the Company from incurring additional indebtedness and property liens without the consent of the holders of a majority of the notes payable.\nVESTRO NATURAL FOODS INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1995, 1994 AND 1993 - --------------------------------------------------------------------------------\n4. INCOME TAXES\nThe income tax provision for the years ended December 31, 1995 and 1994 consists of:\nThe differences between the tax provision calculated based on the statutory and effective tax rates for the year ended December 31, 1995 and 1994 are as follows:\nDeferred tax assets (liabilities) comprise the following:\nVESTRO NATURAL FOODS INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1995, 1994 AND 1993 - -------------------------------------------------------------------------------\nThe Company has net operating loss carryforwards for federal and state income tax purposes of approximately $4,740,000 and $173,000, respectively, which expire in varying amounts through 2009. The amount of net operating loss deductions available to the Company to offset future taxable income may be limited due to certain income tax regulations related to a change in ownership of the Company.\n5. CAPITAL STOCK\nOn January 21, 1994, the shareholders approved an amendment to the Company's certificate of incorporation reducing the authorized common shares to 30,000,000 and authorized a one-for-ten reverse stock split. A total of 14,924,729 shares of common stock were retired in connection with the split. The stated par value of each share was not changed from $.01. A total of $149,000 was reclassified from the Company's common stock account to additional paid-in capital account, representing the par value of the shares retired. All references in the financial statements to average number of shares outstanding, per share amounts and stock option plan data have been restated to reflect the split.\nOn January 10, 1994, the Company consummated an exchange agreement with the holders of the Series A convertible preferred stock whereby all shares were retired and dividends in arrears eliminated in exchange for $21,000 in cash and 534,800 shares of the Company's common stock. At the time of the exchange, dividends in arrears amounted to $297,000.\nOn January 10, 1994, the Company consummated an exchange agreement with the holders of the 10% convertible exchangeable preferred stock whereby all shares were retired and dividends in arrears eliminated in exchange for $73,000 in cash, 3,364,770 shares of the Company's common stock, and notes payable in the amount of $4,372,000 (see Note 3). At the time of the exchange, dividends in arrears amounted to $2,872,000.\n6. INCENTIVE COMPENSATION AND STOCK PURCHASE AND OPTION PLANS\nIn 1995, the Company granted nonqualified stock options to purchase 120,000 shares of the Company's common stock to an officer of the Company. Of the options, 60,000 were granted at an exercise price of $1.63 per share and the remaining 60,000 were granted at $1.88 per share. The options were granted at market value of the Company's common stock and as such no compensation expense was recorded. These options were 100% exercisable upon issuance.\nVESTRO NATURAL FOODS INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1995, 1994 AND 1993 - --------------------------------------------------------------------------------\nIn 1995, the Company granted nonqualified stock options to purchase 160,000 shares of the Company's common stock at an exercise price of $1.88 per share to the Directors of the Company. The options were granted at market value of the Company's common stock and as such no compensation expense was recorded. The options vest over a three-year period with up to two years credit given to individual Directors for prior service. As of December 31, 1995, 80,000 of these options are exercisable.\nEffective January 1, 1994, the Company adopted a 401(k) Savings Plan covering substantially all employees. Monthly contributions to the Savings Plan are made by the Company based upon the employee's contributions to the plan. The Company contributed $26,000 to the Savings Plan during each of the years ended December 31, 1995 and 1994.\nIn 1994, the Company entered into a bonus arrangement with two key executive officers. In connection with the arrangement, the officers participate in an incentive compensation plan which provides a bonus based on pre-tax earnings in excess of predetermined targets. The incentive compensation bonus was $7,000 for the year ended December 31, 1994. This arrangement expired on December 31, 1994.\nOn January 10, 1994, the Company consummated a stock purchase plan under which 659,750 shares of the Company's common stock were issued to an executive officer for total consideration of $850,000, consisting of $66,000 in cash and a $784,000 note receivable, bearing interest at 5.75%, due December 31, 1997. The purchase plan provides the Company with the right to repurchase shares in the event that the officer's employment is terminated prior to a five-year vesting period. Following the officer's resignation in January 1995, the Company was entitled to repurchase 395,850 shares with a corresponding reduction in the amount of the note receivable due from the former officer. The Company entered into a severance agreement with the former officer which entitled the officer to purchase an additional 131,950 shares with a note receivable. The Company recorded the repurchased shares and the severance agreement in the financial statements as of December 31, 1994. The Company also recognized earned compensation expense of $198,000 during the year ended December 31, 1994, representing the difference between the sale price and the fair market value of these shares as of the date of the stock purchase plan and of the severance agreement. Nonqualified stock options to purchase 494,812 shares of the Company's common stock were also forfeited upon the former officer's resignation.\nIn 1993, the Company granted nonqualified stock options to purchase 329,875 shares of the Company's common stock at an exercise price of $1.29 per share to an officer of the Company's subsidiary. In connection with the nonqualified stock options granted below the fair market value of the Company's common stock at the date of grant, the Company will amortize $194,000 to compensation expense over a five-year vesting period. Amortization recorded to compensation expense was $52,000 and $40,000 for the years ended December 31, 1995 and 1994, respectively.\nVESTRO NATURAL FOODS INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1995, 1994 AND 1993 - --------------------------------------------------------------------------------\nThe Company adopted a stock option plan in 1988 under which employees may be granted options to purchase up to 150,000 shares of the Company's common stock at prices not less than the fair market value of the common stock on the date of grant. Stock options may be granted under the plan through 1998. As of December 31, 1995, 149,500 options are outstanding under this plan, 21,000 of which are currently exercisable.\nThe Company adopted a nonqualified stock option plan in 1987 under which certain employees and directors may be granted options to purchase up to 270,000 shares of the Company's common stock at prices not less than the fair market value of common stock on the date of grant. Stock options may be granted under the plan through 1997. As of December 31, 1995, there are no options outstanding under this plan.\nThe following table sets forth the options granted, forfeited and exercised during the three years ended December 31, 1995 and their respective exercise price ranges:\nAll options granted are for a five-year period. Except as noted above, options granted to officers and employees are not generally exercisable for a period of one year after date of grant and thereafter become exercisable at 25% per year.\nAt December 31, 1995 the Company has reserved 759,375 shares of common stock for the exercise of outstanding stock options.\n7. RELATED PARTY TRANSACTIONS\nThe Company leases certain office and warehouse space in Carson, California from a partnership which includes a Director of the Company. Total rent expense paid to the partnership was $196,000, $161,000 and $147,000 for the years ended December 31, 1995, 1994 and 1993, respectively.\nVESTRO NATURAL FOODS INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1995, 1994 AND 1993 - --------------------------------------------------------------------------------\n8. SALES TO MAJOR CUSTOMERS\nIn 1995 sales to four customers accounted for $4,860,000, $3,674,000, $3,170,000 and $3,016,000 or approximately 17%, 13%, 11% and 11% of total revenue, respectively. In 1994 sales to three customers accounted for $3,650,000, $3,625,000 and $2,592,000 or approximately 15%, 15% and 10% of total revenue, respectively. In 1993 sales to two customers accounted for $3,803,000 and $3,172,000 or approximately 15% and 12% of total revenue, respectively.\n9. COMMITMENTS AND CONTINGENCIES\nLEASES As of December 31, 1995, the Company and its subsidiaries are obligated under various agreements to lease facilities and equipment. Future minimum rentals under noncancellable operating leases are as follows:\nOPERATING YEAR ENDING DECEMBER 31, LEASES\n1996 $ 201,000 1997 152,000 1998 3,000 --------- Total $ 356,000 --------- ---------\nRental expense related to operating leases amounted to $207,000, $228,000 and $194,000 for the years ended December 31, 1995, 1994 and 1993, respectively.\nLEGAL PROCEEDINGS Management has received information furnished by legal counsel on the current status of all outstanding legal proceedings and the development of these matters to date. Based upon this review, it is the opinion of management that adequate provision has been made for all reasonably estimable costs and that the ultimate aggregate liability, if any, should not materially affect the Company's financial position or results of operations.\nVESTRO NATURAL FOODS INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1995, 1994 AND 1993 - --------------------------------------------------------------------------------\n10. ACCRUED LIABILITIES\nAccrued liabilities consist of the following:\n1995 1994\nRelocation costs $ 100,000 $ 140,000 Salaries and related benefits 69,000 65,000 Employee bonuses 78,000 7,000 Other 260,000 432,000 --------- --------- $ 507,000 $ 644,000 --------- --------- --------- ---------\n11. CONSOLIDATED STATEMENT OF CASH FLOWS - SUPPLEMENTAL DISCLOSURES\nSUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:\nInterest paid during 1995, 1994 and 1993 amounted to $268,000, $257,000 and $113,000, respectively.\nCash paid for income taxes during 1995, 1994 and 1993 amounted to $8,000, $8,000 and $14,000, respectively.\nSUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES:\nYEAR ENDED DECEMBER 31, 1994\nNotes payable exchanged in retirement of preferred stock and dividends in arrears $ 4,372,000 ----------- -----------\nNote receivable recorded in connection with stock purchase plan, net of reduction for shares repurchased $ 444,000 ----------- -----------\n3. EXHIBITS\n(b) No reports on Form 8-K were filed during the last quarter of the fiscal year.\n(c) (3.1) CERTIFICATE OF DESIGNATION, VOTING POWERS, PREFERENCES AND RIGHT OF THE SERIES OF THE PREFERRED STOCK OF VESTRO NATURAL FOODS INC. TO BE DESIGNATED SERIES A CONVERTIBLE PREFERRED STOCK EFFECTIVE JANUARY 28, 1988. Incorporated by reference to the Registrant's Form 8-K filed on February 19, 1988.\n(3.2) CERTIFICATE OF INCORPORATION, DATED APRIL 1, 1987. Incorporated by reference to the Registrant's Information Statement filed on May 26, 1987.\n(3.3) BY-LAWS. Incorporated by reference to the Registrant's Form 8-B Report filed on July 16, 1987.\n(4.1) STOCK PURCHASE AGREEMENT BY AND AMONG EQUITABLE LIFE ASSURANCE SOCIETY OF THE UNITED STATES, STATE EMPLOYEE'S RETIREMENT FUND OF THE STATE OF DELAWARE, ICI AMERICAN HOLDINGS INC., THRESHOLD FUND II, L.P., SCOTTISH INVESTMENT TRUST REVERE FUND, AMONG OTHERS AND VESTRO NATURAL FOODS, INC. Incorporated by reference to the Registrant's Form 8-K dated December 27, 1989.\n(4.2) CERTIFICATE OF DESIGNATION OF 10% CONVERTIBLE EXCHANGEABLE PREFERRED STOCK OF VESTRO NATURAL FOODS, INC. Incorporated by reference to the Registrant's Form 8-K dated December 27, 1989.\n(4.3) REGISTRATION RIGHTS AGREEMENT BY AND AMONG EQUITABLE LIFE ASSURANCE SOCIETY OF THE UNITED STATES, STATE EMPLOYEES' RETIREMENT FUND OF THE STATE OF DELAWARE, ICI AMERICAN HOLDINGS INC., THRESHOLD FUND II, L.P., SCOTTISH INVESTMENT TRUST,\nREVERE FUND, AMONG OTHERS AND VESTRO NATURAL FOODS INC. Incorporated by reference to the Registrant's Form 8-K dated December 27, 1989.\n(4.4) EXCHANGE AGREEMENT; dated as of October 28, 1993, among the holders of the Company's Preferred Stock and Vestro Natural Foods Inc. Incorporated by reference to the Registrant's Form 8- K dated January 10, 1994.\n(4.5) FORM OF SENIOR SUBORDINATED NOTE A Incorporated by reference to the Registrant's Form 8-K dated January 10, 1994.\n(4.6) FORM OF SENIOR SUBORDINATED NOTE B Incorporated by reference to the Registrant's Form 8-K dated January 10, 1994.\n(10.1) 1988 STOCK OPTION PLAN OF VESTRO NATURAL FOODS INC. DATED MAY 23, 1988. Incorporated by reference to the Registrant's Form 10-Q for the quarter ending June 30, 1988, Item 6.\n(10.2) MANAGEMENT AGREEMENT BETWEEN VESTRO NATURAL FOODS INC., AND ALANE CORPORATION DATED DECEMBER 15, 1989. Incorporated by reference to the Registrant's Form 10-K for the year ended December 31, 1989.\n(10.3) AGREEMENT AND PLAN OF MERGER EFFECTIVE MAY 1, 1990, BY AND BETWEEN JAN HOLZMEISTER CHEESECAKE, LTD., VESTRO NATURAL FOODS INC. AND JHC ACQUISITION CORPORATION. Incorporated by reference to the Registrant's Form 10-Q for the quarter ending June 30, 1990, Item 6.\n(10.4) AGREEMENT RESPECTING MERGER EFFECTIVE MAY 1, 1990 BY AND BETWEEN JAN HOLZMEISTER CHEESECAKE, LTD., VESTRO NATURAL FOODS INC. AND JHC ACQUISITION CORPORATION. Incorporated by reference to the Registrant's Form 10-Q for the\nquarter ending June 30, 1990, Item 6.\n(10.5) EMPLOYMENT AGREEMENT DATED MAY 15, 1990, BETWEEN JHC ACQUISITION CORPORATION AND ROBERT KLEIN. Incorporated by reference to the Registrant's Form 10-Q for the quarter ending June 30, 1990, Item 6.\n(10.6) CONSULTING AGREEMENT DATED MAY 15, 1990 BY AND AMONG ROBERT KLEIN, JAN HOLZMEISTER CHEESECAKE, LTD. AND JHC ACQUISITION CORPORATION. Incorporated by reference to the Registrant's Form 10-Q for the quarter ending June 30, 1990, Item 6.\n(10.7) WARRANTS TO PURCHASE 400,000 SHARES OF COMMON STOCK DATED MAY 23, 1990, ISSUED TO THE STOCKHOLDERS OF JAN HOLZMEISTER CHEESECAKE, LTD. Incorporated by reference to the Registrant's Form 10-Q for the quarter ending June 30, 1990, Item 6.\n(10.8) CONSULTING AGREEMENT BETWEEN VESTRO NATURAL FOODS INC., ALANE CORPORATION AND ALFRED STROGOFF dated March 31, 1992. Incorporated by reference to the Company's Form 10K dated December 31, 1992.\n(10.9) ASSET PURCHASE AGREEMENT EFFECTIVE DECEMBER 18, 1992 BY AND AMONG VESTRO NATURAL FOODS INC., HEIDI'S PASTRY INC., JAN HOLZMEISTER CHEESECAKE LTD. AND HK ACQUISITION CORPORATION. Incorporated by reference to the Company's Form 8-K dated December 18, 1992.\n(10.10) SETTLEMENT CONTRACT AND RELEASE BETWEEN JENNIFER MUELLER, VESTRO ACQUISITION CORPORATION, VESTRO NATURAL FOODS INC. AND LITTLE BEAR ORGANIC FOODS, INC. effective December 31, 1992. Incorporated by reference to the Company's Form 10K dated December 31, 1992.\n(10.11) STOCK PURCHASE AGREEMENT, AS OF JULY 29, 1993 BY AND BETWEEN VESTRO NATURAL\nFOODS INC. AND ALLAN DALFEN. Incorporated by reference to the Company's Form 10K dated December 31, 1993.\n(10.12) STOCK OPTION AGREEMENT AS OF JULY 29, 1993 BY AND BETWEEN VESTRO NATURAL FOODS INC. AND ALLAN DALFEN. Incorporated by reference to the Company's Form 10K dated December 31, 1993.\n(10.13) STOCK OPTION AGREEMENT AS OF JULY 29, 1993 BY AND BETWEEN VESTRO NATURAL FOODS INC. AND ANDREW JACOBSON. Incorporated by reference to the Company's Form 10K dated December 31, 1993.\n(10.14) SEVERANCE AND SETTLEMENT AGREEMENT DATED AS OF FEBRUARY 28, 1995 BETWEEN VESTRO NATURAL FOODS INC. AND ALLAN DALFEN.\n(11) Computation of Earnings per Share\n(22) Subsidiaries of the Registrant\n(27) Financial Data Schedule\n(28.1) PROMISSORY NOTE DATED DECEMBER 18, 1992, OF HK ACQUISITION CORPORATION Incorporated by reference to the Company's Form 8-K dated December 18, 1992.\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.\nVESTRO NATURAL FOODS INC.\nDated: March 28, 1996 By: \/s\/ B. Allen Lay -------------- ---------------------- B. Allen Lay Principal Executive Officer and Director\nDated: March 28, 1996 By: \/s\/ Stephen Schorr -------------- ---------------------- Stephen Schorr Vice President Finance\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:\nDated: March 28, 1996 By: \/s\/ Jay J. Miller --------------------------- Jay J. Miller Director\nDated: March 28, 1996 By: \/s\/ Stephen Monticelli --------------------------- Stephen Monticelli Director\nDated: March 28, 1996 By: \/s\/ Noel Perry --------------------------- Noel Perry Director\nDated: March 28, 1996 By: \/s\/ Henry W. Poett III --------------------------- Henry W. Poett III Director\nEXHIBIT INDEX\nEXHIBIT DESCRIPTION PAGE NO. - ------- ----------------------------------------- ---------------\n11 Computation of Earnings per Share 35\n22 Subsidiaries of the Registrant 36\n27 Financial Data Schedule 37","section_15":""}
{"filename":"831378_1995.txt","cik":"831378","year":"1995","section_1":"Item 1. Organization and Business\nCondor West Corporation (\"The Company\"), a Nevada corporation organized in October 1987 for the purpose of implementing an initial distribution of its stock and thereafter to seek operating businesses as potential candidates for acquisition or other forms of combination. The Company has no operating history. No representation is made, nor is any intended, that the Company will be able to acquire one or more operating businesses or, if any acquisitions are made, that any operations will be profitable.\nOn May 7, 1990, 650,000 shares, constituting 52% of the Company's 1,250,000 outstanding shares of Common Stock, were acquired by Dr. Everett Renger and Carl D. Nation. Concurrent therewith, the Company's existing officers and directors resigned and were replaced by:\nDr. Everett Renger, Chairman of the Board Carl D. Nation, President and Director Steven R. Paige, Director Terrance Rasmussen, Vice President, Treasurer and Director Patrick D. West, Executive Vice President David A. Christman, Secretary\n(See Item 10, Directors and Executive Officers of the Registrant.)\nThe newly-elected Board of Directors, in 1994, authorized the issuance of 541,766 shares of the Company's previously unissued Common Stock in exchange for all of the outstanding shares of Super Brakes, Inc., a corporation owned 50\/50 by Messrs. Renger and Nation. Super Brakes, Inc. is a company in the organizational stage and its activities to date have consisted solely of the development of a business plan for the financing and establishment of a chain of Company owned retail brake and installation outlets. As Super Brakes, Inc. had no significant assets or operations at that time, the shares issued to Messrs. Renger and Nation were recorded at a nominal amount representing their aggregate par value of $542, of which $10 was capitalized as the cost of the investment, and the remaining $532 was deemed to be for services rendered and was expensed.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nNone\nItem 3.","section_3":"Item 3. Legal Proceedings\nThere are no material legal proceedings pending in which Registrant is named a party.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nThere were no matters submitted to a vote of the Registrant's security holders during the fourth quarter of the fiscal period covered by this report.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters\nThere is no active market for the Company's shares.\nItem 6.","section_6":"Item 6. Selected Financial Data\nFiscal Years Ended May 31,\n1995 1994 1993 1992 1991 -------- --------- --------- --------- -------- Total assets $202,915 $ -0- $ -0- $8,903 $17,807\nLong term debt 200,000 -0- -0- -0- -0-\nPreferred stock -0- -0- -0- -0- -0-\nNet revenue -0- -0- -0- -0- -0-\nNet loss (26,266) -0- (8,903) (8,904) (9,553)\nLoss per share (.01) (.00) (.01) (.01) (.01)\nDuring the five year period ended May 31, 1995 there were no changes in accounting methods.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nThe Company has had limited funds for the last several years, however, in April, May and June, 1995, the Company received $300,000 in loans from a Director\/Stockholder (see item 13) to provide the working capital to commence active operations beginning in June, 1995. During the fiscal year ended May 31, 1996, the Company issued 540,000 shares of stock to the Director in full payment of the notes, plus accrued interest of $4,068\nThe Company will continue to seek long-term capital through future offerings of equity and\/or long-term financing from investors or financial institutions.\nManagement does not anticipate that the Company's continuing capital requirements in the near term will exceed its ability to obtain resources and believes that the timing of such requirements as are foreseeable will be such that the funds will be available on a basis sufficient to satisfy them in a timely manner. Management may increase or reduce working capital at such times as it, in its sole discretion, deems appropriate. The Company may also establish, increase or decrease its reserves in addition to its working capital, at the discretion of Management. The Company's reserves will generally be available to satisfy working capital or operating expense needs of the Company and will also be available to pay any excess third party costs or expenses incurred by the Company in connection with its administration.\nRESULTS OF OPERATIONS\nThe Company has had no operations in the past three years, however, the Company began seeking in May, 1995 an established business that could be acquired in a leveraged buy-out to provide an operating entity to begin the Super Brakes operations. See the discussion regarding changes in amounts previously reported for the year ended May 31, 1995, below under Item 9.\nItem 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nEffective January 1, 1995, the Company's prior auditors, O'Neal and White, P.C., merged their audit practice into the firm of C. Williams & Associates, P.C. of Houston, Texas. During the preceding two fiscal years ending May 31, 1994 and through January 1, 1995, the Company had no disagreements with O'Neal and White, P.C. on any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedure. In February, 1996, the Texas State Board of Public Accountancy revoked the license of Charles R. Williams, the principal of C. Williams & Associates, and the SEC required the Company to have its May 31, 1995 financial statements re-audited. As a result, it retained the firm of Bateman, Blomstrom & Co. as auditors, who conducted the re-audit as of May 31, 1995. As a result of the re-audit, the Company restated certain accounting items, including the following: (1) the investment in Super Brakes, Inc. was restated at a value of $10, from the previous $542; (2) shares issued to officers and directors for services in creating a business plan for Super Brakes were originally capitalized as organization expenses of $18,192, but were charged to expense as a result of the re-audit; (3) 7,541,680 shares of the Company's stock, originally issued to two of its officers in connection with the Super Brakes business plan development, were re-contributed back to the Company in October, 1995, and the return was retroactively recorded at May 31, 1995. As a result of the adjustments from the re-audit, the Company's stockholders' equity was decreased from $20,242 to ($13,516), and net loss was restated from ($3,935) to ($26,266).\nPART III\nItem 10. Directors and Executive Officers of the Registrant\nThe following person are the directors and (where indicated) executive officers of the Company and have served in their respective positions since the indicated dates:\nDr. Everett Renger (1) 53 Co-Chairman Carl D. Nation (1) 61 Co-Chairman Wade D. Althen (2) 53 President, CEO David A. Christman (2) 53 Vice President of Finance, Treasurer, CFO Steven R. Paige (1) 34 Vice President of Operations, COO Terrance L. Rasmussen (1) 34 Vice President, Secretary Dennis L. Swenson (3) 44 Vice President, Human Resources John A. Murdock III (3) 51 Dr. Felix F. Banchs (3) 56\n(1) Joined Company on May 7, 1990 (2) Joined Company on August 4, 1993 (3) Joined Company on May 12, 1995\nDr. Everett Renger has been a practicing orthodontist in Houston, Texas since 1973. He received both a Bachelor of Science and a Doctor of Dental Science degrees from Baylor University and a Master of Science (orthodontics) from the University of Texas Dental School. Dr. Renger is a member of the American Association of Orthodontists, Southwest Society of Orthodontists,\nAmerican Dental Association, Texas Dental Association, Houston District Dental Society, Baylor Dental Alumni Association and the University of Texas orthodontic Alumni Association. He is currently serving on the Peer Review Committee of the Houston District Dental Society and is President of Wilson Radiographic Centers of Houston.\nMr. Carl D. Nation founded Super Brakes, Inc. in 1981. He, along with Dr. Renger, acquired controlling interest in the Company in 1990 in order to provide a public vehicle to facilitate growth in the automotive after-market field. Mr. Nation has been a self-employed financial consultant in the Fort Worth, Texas area for the past fifteen years representing several major industries, including precious metals, banks municipalities and various government and private businesses. Effective June 1, 1995, Mr. Nation became a full time employee of the company. Mr. Nation has held a prior position as Vice President and General Manager of Insurers of America, representing Lloyds of America. Mr. Nation completed an executive management program that consisted of six months manufacturing, shipping and receiving, inventory control and sales management. Upon completion he served as marketing director for the Northeastern United States for Kelsey-Hayes Company, a major manufacturer of disc brakes. He managed sales personnel, opened new distribution channels, organized sales and product clinics through automotive, manufacturing, warehousing, national accounts, mass merchants, municipalities and state governments. He then became the district manager of the New England district for Monroe Auto Equipment Company, a manufacturer of shock absorbers. While with Monroe, he directed the sales force, marketing products through national accounts, mass merchants, automotive distribution centers, jobbers and dealers. He also organized and instructed approximately fifty product and sales clinics annually. His responsibilities included administration, sales training and new distribution and arranging credit through financial institutions for new customers. Before that, he was the marketing director of nine northeastern states for Belden Corporation, a manufacturer of electrical wire and cable. He held a prior position as the operations department manager for Hartford National Bank. Mr. Nation was honorably discharged from the United States Marine Corps.\nMr. Wade D. Althen began functioning as the President\/CEO of the Company on a full time basis effective June 1, 1995. During April and May of 1995 he served as Licensed Manager of Employment World, Inc. in North Little Rock, Arkansas. From May 1992 to March 1995 he was employed by National Education Centers, Inc. a subsidiary of National Education Corporation (a NYSE company). His positions with National Education Corporation included Business Instructor in Economics, Accounting and Computer Science and Co-Chair of the Business Department from May 1992 to June 1993. From July 1993 to June 1994 he was Education Director in charge of: curriculum; hiring, scheduling and training instructional staff; budgeting; attrition of student body; and filing Accreditation reports. These positions were all at the Little Rock, Arkansas campus. In June 1994 Mr. Althen was appointed Director and President of the Fort Worth, Texas campus until his resignation in March 1995. From February 1987 to May 1992 he was a self-employed Certified Public Accountant and financial consultant in North Little Rock, Arkansas. He has provided executive level management for eighteen of the last twenty-one years including four years as Chief Executive of a commercial bank, one year as Chief Executive Officer of a publicly traded petroleum company and two years as managing partner of a CPA firm. Mr. Althen has prepared and provided oversight of preparation of budgets in many industries. In the banking industry, he planned for significant growth by utilizing financial and human resources to enable a seventy year old bank to double in size within four years. In the petroleum industry,\nhe established and executed a plan that made a publicly traded company that was in reorganization viable as an acquisition candidate. He is experienced with preparation of initial registrations of public corporations and Securities and Exchange Commission reports. He has conducted audits for many types of industries and submitted financial statements to clients and regulatory agencies. He also has experience with statements required by the Federal Deposit Insurance Corporation and other banking agencies. In 1970, Mr. Althen obtained his Bachelor of Science Degree in Accounting from Arkansas State University and received one year of post graduate training from the Stonier Graduate School of Banking at Rutgers University. He has been a Certified Public Accountant since 1972.\nMr. David A. Christman has been a Senior Financial Analyst with Intellicap Limited since November 1994 working with the Ministry of Finance of the State of Kuwait to develop and administer the government's Counter-Trade Offset Program. His duties include working with supply contractors. He contributed to the design of the program's guidelines and designed and implemented the Financial Performance Model of evaluating the feasibility and acceptability of business plans submitted by the contractors. He also developed a training program and teaches finance to the Kuwaiti staff. From January 1991 to November 1994 he was the principal in David A. Christman & Associates, an independent financial and management consulting firm in Dallas, Texas. He work consisted of installing management accounting systems, job cost reporting systems, standard cost accounting systems and other phases of financial management procedures and policies. He also helped with restructuring organizations, wrote job descriptions, designed and installed incentive plans and employee evaluation procedures. He provided management training, wrote employee handbooks and installed management by objectives (MBO) programs. From February 1988 to January 1991 he served as a management consultant with George S. May International Company where his duties included all aspects of financial and organizational management consulting as well as computer installation. Mr. Christman holds a Bachelor of Science in Business Administration Degree with a Major in Accounting from Rochester Institute of Technology in New York and has completed a post-graduate program in finance and statistics.\nMr. Steven R. Paige graduated from the University of New York at Albany in 1984 with a Bachelor of Science degree in Business Administration which he achieved while enlisted in the U.S. Air Force. Upon completion of his enlistment and degree requirements, Mr. Paige worked for a major television station in Denver, Colorado as an account executive. In 1986 he joined one of Denver's most prominent advertising agencies. Within two years, Mr. Paige was personally responsible for doubling the firm's gross revenues by acquiring three national accounts, and was promoted to Executive Vice President. His new responsibilities included personnel development, full creative and buying authority, and future business development. In 1988 he left the agency and formed his own marketing company, The Paige Group, which pursued new areas of marketing, advertising and finance for clients. From March 1989 to June 1990, Mr. Paige was Sales Manager for Mike Naughton Ford Company with full responsibility for hiring and training of sales personnel as well as total responsibility for movement of inventory including advertising, marketing and promotional activities. Through his implementation of creative marketing and sales techniques, he was instrumental in bringing the dealership from a seventh place rating to a number one rating in a little over a year. From June 1990 to December 1991, Mr. Paige was General Manager of Metro Toyota with overall responsibility of the dealership including inventory control, budgeting, sales performance, service and maintenance operations and total income performance.\nFrom January 1992 to May 1995, he was Sales Manager and General Manager of Don Massey Cadillac (a member of the largest Cadillac group in the world) with total responsibility as dealer-operator including procurement of all major inventory. Again, with his implementation of marketing and sales techniques, he brought the dealership from a number six rating to a number one rating in less than six months. Mr. Paige has been associated with Condor West Corporation and with Mr. Carl D. Nation, Co-Chairman for more than five years. Effective June 1, 1995 he became a full-time employee of the Company.\nMr. Terrance L. Rasmussen has been employed in a management position with Hilti Corporation since 1990. His responsibilities include inventory control and internal auditing. Prior to that he was employed by A & A Plate Service, Inc. and Sears, Roebuck and Company in computerized accounting systems. Additional areas of experience accounts payable, accounts receivable, payroll and tax consulting. Mr. Rasmussen has also analyzed company operations for purposes of recommending changes for improvement, and potential companies for take-over based on profitability potential. Major projects included areas of real estate, manufacturing and agriculture. Mr. Rasmussen is licensed by NASD and was an account executive for a national brokerage firm where he developed corporate and individual accounts. He provided guidance to clients, determined investment objectives and developed solid portfolios according to the objectives using stocks, bonds, and mutual funds. He received a Bachelors degree in business, management and finance from Iowa State university in Ames, Iowa, and attended the Metropolitan State University in Minneapolis, Minnesota where he obtained a degree in accounting. Mr. Rasmussen is also a CPA.\nJohn A. Murdock III is the founder of JAM Consulting Service, Inc. and principal stockholder, chief executive officer and founder of Power By Nature, Inc. Mr. Murdock served more than 20 years in the United States Air Force where he obtained extensive training in management and operations. As Weapons Superintendent, he was responsible for more than 250 airmen and worked world wide in areas of Europe, Asia and the Middle East. Mr. Murdock's decorations include the Distinguished Flying Cross (with four oak leaf clusters), the Airman's Medal of Valor, the Air Medal (with 18 oak leaf clusters), the Vietnamese Cross of Gallantry (with Bronze Star, Palm Leaf and 3 oak leaf clusters), and the Good Conduct Medal (with 7 oak leaf clusters). After retiring from the United State Air Force, Mr. Murdock used his experience to be an advisor for the Armament and Mobility Officers for the Royal Saudi Air Force. He worked directly with foreign country representatives as a Logistics Engineer for Foreign Military Sales. This included the sale of aircraft and other defense systems. Currently, he is an agent for the leasing of Deeds of Assignments of United States Treasuries. These are used to aid in the funding of projects, and require highest contacts in banking and business. Mr. Murdock Obtained a B.S. Degree from Troy State Unviersity, a Masters in Business Administration in Personnel Administration from Chapman College, and a Doctor of Laws degree from Louisiana Baptist University.\nDennis L. Swenson possesses more than 25 years of human resource and administrative management experience with Fortune 500 and smaller corporations. From January 1991 to present he has been Vice President Human Resources and Administration for PharmAssist, Inc. as well as owner of DLS Associates, a Human Resources consulting firm. From January 1987 to January 1991 he was Director of Compensation and Benefits for FoxMeyer Corporation and from May 1969 to December 1986 he was Manager of Employee Benefits for Burlington Northern Railroad Company. While at FoxMeyer Corporation he established the Human Resource\nDepartment serving more than 4,500 employees as well as developing and staffing the Customer Service Department for a $45 billion wholly owned subsidiary. While employed with Burlington Norther, Inc., Mr. Swenson managed and administered all labor relations functions, including negotiation of the benefits program covering 48,000 employees. Through design and administrative modifications, he was responsible for cost reductions of nearly $5 million annually. !n 1990, he served as acquisition consultant to Computer Land Corporation when they acquired the $750 million Nynex Business Information Systems. He has extensive experience in conducting audits to assure sound and feasible business practices based upon corporate liability and profit margin.\nDr. Felix F. Banchs has served as Mexico Project Manager\/Nationally Certified Financial Counselor for the National Foundation for Consumer Credit, Fort Worth, Texas from 1992 to present where his responsibilities include the development, implementation and supervision of debt management and financial programs for the USA, Puerto Rico and Mexico. From 1990 to 1992 he was Director of Training for Centro de Amistad, Dallas, Texas where he developed and supervised vocational training programs. From 1977 to 1990, Dr. Banchs was Vice President for Administration and Dean of Business Administration for Boricua College in New York. His responsilbilities included the development of the business administration curriculum and management of three campuses. During his tenure, both faculty and student population increased by 500%. In addition, Dr. Banchs has held executive positions with Shell Oil Co., Baxter- Travenol Laboratories and Colgate-Palmolive. Dr. Banchs graduated Magna Cum Laude with a BBA in Management from Catholic University of Puerto Rico, Cum Laude with a Masters in Business Administration in Marketing Management from St. John's University, New York and earned a PhD in Business Administration and Economics from Columbia University, New York. Dr. Banchs is listed in AWho's Who in Finance and Industry in America and is a veteran of the United States Air Force.\nItem 11. Management remuneration\nThrough May 31, 1995, the Company's officers have not received any compensation in connection with their activities on behalf of the Company. However, the Company's officers will be reimbursed for any reasonable business expenses incurred in connection with their activities on its behalf. In the event of a change of control in the Company, the present shareholders may derive a benefit through the sale of their shares. Effective June 1, 1995, Messrs. Nations, Althen and Paige became full-time employees of the Company as it commenced attempts to implement its business plan to activate Super Brakes. Their level of compensation in the future will be determined based on the Company's level of operations.\nItem 12. Security Ownership of Certain Beneficial Owners and Management\nOfficers and Directors, and persons beneficially owning more than 5% of the 21,541,148 shares of common stock outstanding at May 31, 1995 were as follows:\nName Officer Director Shares Percent\nDr. Everett Renger Yes Yes 9,095,840 (1) 42.2% Carl D. Nation Yes Yes 9,095.840 (1) 42.2 Wade D. Althen Yes Yes 1,000,000 4.6 Steven R. Paige Yes Yes 1,000,000 4.6 Terrance L. Yes Yes 300,000 1.4 Rasmussen David A. Christman Yes Yes 200,000 0.9 All officers and directors as 20,691,680 96.1 a group\n(1) Subsequent to May 31, 1995, on October 10, 1995, Messrs Renger and Nation each returned 3,770,840 shares to the Company as an anti-dilutionary measure. The return of these shares has been retroactively recorded as of May 31, 1995.\nItem 13. Certain Relationships and Related Transactions\nSee Item 1, _Organization and Business_, for discussion of the acquisition of all the outstanding stock of Super Brakes, Inc. from Dr. Renger and Mr. Nation. On April 28, 1995, May 30, 1995, and June 22, 1995, John A. Murdock, III, a Director, loaned the Company $100,000 on each occasion, or a total of $300,000. The notes bore interest at 15% and were due and payable two years after date. Under the terms of the notes, Mr. Murdock had the option to convert each note into 130,000 shares of common stock of the Company. However, on June 30, 1995, the notes and accrued interest of $4,068 were converted into 540,000 shares of stock at the rate of $0.563 per share.\nPART IV\nItem 14. Exhibits, Financial Statements, Schedules, and Reports of Form 8-K\nCONDOR WEST CORPORATION (A development stage enterprise) May 31, 1995 - -------------------------------------------------------------------------------\nDescription Page - ------------------------------------------------------- ----------\nReports of Independent Certified Public Accountants\nBalance sheets as of May 31, 1995 and 1994\nStatements of loss for the periods ended May 31, 1995, 1994 and 1993\nStatements of stockholders' equity for the years ended May 31, 1995, 1994 and 1993\nStatements of cash flows for the periods ended May 31, 1995, 1994 and 1993\nNotes to financial statements\nBateman, Blomstrom & Co. Certified Public Accountants\n9301 Southwest Freeway, Suite 100 Houston, Texas 7074-1593 (713) 552-9800 (713) 771-4385 FAX (713) 771-5553\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nTo The Board of Directors and Stockholders Condor West Corporation Greenwood Village, Colorado\nWe have audited the accompanying balance sheet of Condor West Corporation (a development stage enterprise) as of May 31, 1995, and the related statements of loss, stockholders' equity, and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and the 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 Condor West Corporation (a development stage enterprise) as of May 31, 1995, and the results of its operations and its cash flows for the year then ended in conformity with generally accepted accounting principles.\n\/s\/Bateman, Blomstrom & Co.\nBATEMAN, BLOMSTROM & CO.\nHouston, Texas December 5, 1996\nMember INTERNATIONAL ASSOCIATION OF PRACTISING ACCOUNTANTS Offices in Principal Cities Around The World\nO'NEAL AND WHITE, P.C. Certified Public Accountants 17350 Tomball Parkway, Suite 300 Houston, Texas 77064 (713) 890-2554\nINDEPENDENT AUDITOR'S REPORT\nThe firm of O'Neal and June 5, 1994 White, P.C. has discontinued the practice of public accounting and no Board of Directors and Shareholders longer provides audit and Condor West Corporation accounting services. This Houston, Texas document is a copy of the latest signed and dated audit report issued by O'Neal and White.\nWe have audited the accompanying balance sheet of Condor West Corporation as of May 31, 1994 and 1993, and the related statements of operations, shareholders' equity, and cash flows for the three years ended May 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 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 the 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 Condor West Corporation (a development stage enterprise) as of May 31, 1994 and 1993, and the results of its operations and its cash flows for the three years ended May 31, 1994 in conformity with generally accepted accounting principles.\nO'NEAL AND WHITE, P.C. CERTIFIED PUBLIC ACCOUNTANTS\nCONDOR WEST CORPORATION (A development stage enterprise) Balance Sheets May 31, 1995 and 1994 - -------------------------------------------------------------------------------\n1995 1994 ----------- ---------- ASSETS Current assets: Cash $202,905 $ - ----------- ---------- Total current assets 202,905 - ----------- ----------\nOther assets 10 - ----------- ---------- Total assets $202,915 $ - =========== ==========\nLIABILITIES Current liabilities: Accrued interest $ 1,397 $ - Accounts payable, related party 15,034 - ----------- ---------- Total current liabilities 16,431 - ----------- ----------\nNoncurrent liabilities: Notes payable, related party 200,000 - ----------- ---------- Total liabilities 216,431 - ----------- ----------\nCommitments and contingencies - -\nSTOCKHOLDERS' EQUITY (DEFICIT) Common stock, par value $.001 per share, 35,000,000 shares authorized, 13,999,468 and 1,249,468 shares issued and outstanding 14,000 1,250 Capital in excess of par value 53,200 53,200 Deficit accumulated during the development stage (80,716) (54,450) ----------- ---------- Total stockholders' equity (deficit) (13,516) - ----------- ---------- Total liabilities and stockholders' equity $202,915 $ - =========== ==========\nThe accompanying notes are an integral part of these statements.\nCONDOR WEST CORPORATION (A development stage enterprise) Statements of Loss For The Periods Ended May 31, 1995, 1994 and 1993 - -------------------------------------------------------------------------------\nCumulative October 8, Through May 31, Years ended May 31, 1995 1995 1994 1993 ----------- --------- ---------- ---------\nRevenues $191 $ - $ - $ - ----------- --------- ---------- ---------\nExpenses: Depreciation and amortization 40,186 - - 8,903 Salaries and fees for services 19,589 19,589 - - Other general and administrative 19,735 5,280 - - ----------- ---------- ---------- --------- Total expenses 79,510 24,869 - 8,903 ----------- ---------- ---------- --------- Income (loss) from (79,319) (24,869) - (8,903) operations\nOther income (expenses): Interest (1,397) (1,397) - - ----------- --------- ---------- ---------\nNet (loss) $(80,716) $(26,266) $ - $(8,903) =========== ========= ========== =========\nNet loss per common share $(0.004) $ - $(0.007) ========= =========== =========\nWeighted average number of shares outstanding 7,572,071 1,249,468 1,249,468 ========== =========== =========\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.\nCONDOR WEST CORPORATION (A development stage enterprise) Notes To Financial Statements May 31, 1995, 1994 and 1993 - -------------------------------------------------------------------------------\nNote 1 - Organization and summary of significant accounting policies: Following is a summary of the Company's organization and significant accounting policies:\nOrganization and nature of business - Condor West Corporation (the Company) is a Nevada corporation, incorporated on October 8, 1987, engaged in organizational activities, raising capital, and investigating business opportunities, currently in the retail automotive services field. Accordingly, the Company has no business operations and does not intend to engage in an active business until it acquires or combines with an operating enterprise.\nTo date, the Company's activities have been limited to its formation, the initial registration of its securities, and the identification and screening of potential business acquisitions. In its current development stage, management anticipates incurring substantial additional losses as it investigates business opportunities.\nBasis of presentation - The accounting and reporting policies of the Company conform to generally accepted accounting principles applicable to development stage enterprises.\nUses of estimates - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period. Actual results could differ from those estimates. The Company's periodic filings with the Securities and Exchange Commission include, where applicable, disclosures of estimates, assumptions, uncertainties and concentrations in products and markets which could affect the financial statements and future operations of the Company.\nCash and cash equivalents - For purposes of the statement of cash flows, the Company considers all cash in banks, money market funds, and certificates of deposit with a maturity of less than one year to be cash equivalents.\nFederal income taxes - Deferred income taxes are reported for timing differences between items of income or expense reported in the financial statements and those reported for income tax purposes in accordance with Statement of Financial Accounting Standards number 109 Accounting for Income Taxes, which requires the use of the asset\/liability method of accounting for income taxes. Deferred income taxes and tax benefits 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 for tax loss and 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. The\nCONDOR WEST CORPORATION (A development stage enterprise) Notes To Financial Statements May 31, 1995, 1994 and 1993 - -------------------------------------------------------------------------------\nCompany provides deferred taxes for the estimated future tax effects attributable to temporary differences and carryforwards when realization is more likely than not.\nNet income per share of common stock - Net income per share of common stock is computed by dividing net income by the weighed average number of shares of common stock outstanding during the period, after giving retroactive effect to stock splits, if any.\nNote 2 - Issuance of stock: Since its inception, the Company has issued shares of its common stock as follows:\nPrice Per Date Description Shares Share Amount - -------------------------------------------------------------------------------- Transactions prior to current year: 10\/8\/87 Shares issued for cash 750,000 $.0275 $20,625 5\/31\/90 Shares issued in exchange for debt 499,468 .0677 33,825 ----------- -------- Subtotal 1,249,468 54,450 ----------- --------\nTransactions during current year: 12\/1\/94 Shares issued to officers and directors for services 20,281,680 .001 20,282 Less, shares subsequently returned (7,541,680) .001 (7,542) ----------- -------- Net shares issued for services 12,740,000 12,740\n12\/1\/94 Shares issued to acquire all of the outstanding stock of Super Brakes, Inc. 10,000 .001 10 ----------- -------- Subtotal 12,750,000 12,750 ----------- -------- 5\/31\/95 Total outstanding 13,999,468 $67,200 =========== ========\nDuring the year ended May 31, 1995, the Company began the formulation of a business plan to enter the retail automotive service field. In that connection, 20,281,680 shares of common stock (including 531,666 shares described in the following paragraph) were issued to 8 officers and directors for their services in connection with the proposed business, including the development of a business plan. Subsequently, on October 10, 1995, two of the officers returned 7,541,680 of these shares to the Company for cancellation as an adjustment in the value of the services rendered. The return of shares has been retroactively recorded as of December 1, 1994. Shares issued were recorded at par value, which approximates fair value of the services rendered, and were charged to expense as incurred.\nAlso on December 1, 1994, the Company issued 541,666 shares to its Chairman and Co-chairman\nCONDOR WEST CORPORATION (A development stage enterprise) Notes To Financial Statements May 31, 1995, 1994 and 1993 - -------------------------------------------------------------------------------\nin exchange for all the outstanding stock of Super Brakes, Inc. Super Brakes was an inactive corporation with no assets, liabilities or operations that was formed to engage in the proposed retail automotive services business. Of the total shares issued, 10,000 shares (or $10) were capitalized as the investment cost, and the remaining 531,666 (or $532) were deemed to have been issued for services and were charged to expense. Subsequent to May 31, 1995, on May 18, 1996, the Super Brakes investment was sold back to the Co-chairman for $10. The investment is included among other assets on the accompanying balance sheet.\nNote 3 - Notes payable, related party: The Company is indebted on two promissory notes payable to a Director dated April 28, 1995, and May 30, 1995 in the amount of $100,000 each. The notes are due two years after date, bear interest at 15%, and are unsecured. On June 22, 1995, the Director loaned an additional $100,000 to the Company on similar terms.\nOn June 30, 1995, the three loans, plus accrued interest of $4,068, were exchanged for 540,000 shares of common stock at the rate of $0.563 per share.\nNote 4 - Federal income tax: No provision for currently refundable Federal income tax has been made in the accompanying statements of loss as no recoverable taxes were paid previously. Similarly, no deferred tax asset attributable to the net operating loss carryforward has been recognized, as it is not likely to be realized. At May 31, 1995, the Company had unused net operating loss carryovers which may be used to offset future taxable income and which expire as follows:\nExpires May 31, Amount - ------------------------------------------- ----------- 2004 $16,233 2005 10,857 2006 9,553 2007 8,904 2008 8,903 2009 - 2010 26,266 ----------- Total net operating loss carryover $80,716 ===========\nNote 5 - Commitments: The Company is obligated on two operating leases for automobiles requiring monthly payments of $1,342, and expiring in May 1998 and October 1998. Aggregate commitments under these leases at May 31, 1995 were as follows:\nCONDOR WEST CORPORATION (A development stage enterprise) Notes To Financial Statements May 31, 1995, 1994 and 1993 - -------------------------------------------------------------------------------\nYear ended May 31, Amount - ---------------------------------------- ----------- 1996 $16,101 1997 15,363 1998 3,625\nIn May, 1995, the Company also entered into a lease for office space on a month-to-month lease requiring monthly rentals of $1,250 per month. The total amount charged to operations under operating leases during the year ended May 31, 1995 was $1,342.\nIn December 1995, the auto lease obligations were assumed by two officers of the Company and the related vehicles were retained by them.\nNote 6 - Accounts payable, related party: An officer of the Company has advanced funds to or paid expenses for the Company aggregating $15,035 at May 31, 1995. These amounts were repaid by the Company subsequent to May 31, 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.\nCONDOR WEST CORPORATION\nDated 2-6-97 By \/s\/Dr. Everett Renger ----------------- -------------------------- Dr. Everett Renger Co-Chairman of the Board\nDated 2-14-97 By \/s\/Carl D. Nation ----------------- -------------------------- Carl D. Nation Co-Chairman of the Board\nDated 2-7-97 By \/s\/Wade D. Althen ----------------- -------------------------- Wade D. Althen, President, CEO and Directorr\nDated 2-10-97 By \/s\/Steven R. Paige ----------------- -------------------------- Steven R. Paige, Executive Vice President, COO, and Director\nDated 2-11-97 By \/s\/David A. Christman ----------------- -------------------------- David A. Christman, Treasurer, CFO and Director\nDated 2-11-97 By \/s\/Terrance Rasmussen ----------------- -------------------------- Terrance Rasmussen, Secretary and Director\nDated 2-14-97 By \/s\/John A. Murdock ----------------- -------------------------- John A. Murdock, III, Director\nDated 2-14-97 By \/s\/Felix F. Banchs ----------------- -------------------------- Dr. Felix F. Banchs, Director\nDated 2-14-97 By \/s\/Dennis L. Swenson ----------------- -------------------------- Dennis L. Swenson, Vice President of Human Relations 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:\nDated 2-17-97 \/s\/Dr. Everett Renger ---------------- ----------------------------- Dr. Everett Renger Co-Chairman of the Board","section_7A":"","section_8":"","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nEffective January 1, 1995, the Company's prior auditors, O'Neal and White, P.C., merged their audit practice into the firm of C. Williams & Associates, P.C. of Houston, Texas. During the preceding two fiscal years ending May 31, 1994 and through January 1, 1995, the Company had no disagreements with O'Neal and White, P.C. on any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedure. In February, 1996, the Texas State Board of Public Accountancy revoked the license of Charles R. Williams, the principal of C. Williams & Associates, and the SEC required the Company to have its May 31, 1995 financial statements re-audited. As a result, it retained the firm of Bateman, Blomstrom & Co. as auditors, who conducted the re-audit as of May 31, 1995. As a result of the re-audit, the Company restated certain accounting items, including the following: (1) the investment in Super Brakes, Inc. was restated at a value of $10, from the previous $542; (2) shares issued to officers and directors for services in creating a business plan for Super Brakes were originally capitalized as organization expenses of $18,192, but were charged to expense as a result of the re-audit; (3) 7,541,680 shares of the Company's stock, originally issued to two of its officers in connection with the Super Brakes business plan development, were re-contributed back to the Company in October, 1995, and the return was retroactively recorded at May 31, 1995. As a result of the adjustments from the re-audit, the Company's stockholders' equity was decreased from $20,242 to ($13,516), and net loss was restated from ($3,935) to ($26,266).\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nThe following person are the directors and (where indicated) executive officers of the Company and have served in their respective positions since the indicated dates:\nDr. Everett Renger (1) 53 Co-Chairman Carl D. Nation (1) 61 Co-Chairman Wade D. Althen (2) 53 President, CEO David A. Christman (2) 53 Vice President of Finance, Treasurer, CFO Steven R. Paige (1) 34 Vice President of Operations, COO Terrance L. Rasmussen (1) 34 Vice President, Secretary Dennis L. Swenson (3) 44 Vice President, Human Resources John A. Murdock III (3) 51 Dr. Felix F. Banchs (3) 56\n(1) Joined Company on May 7, 1990 (2) Joined Company on August 4, 1993 (3) Joined Company on May 12, 1995\nDr. Everett Renger has been a practicing orthodontist in Houston, Texas since 1973. He received both a Bachelor of Science and a Doctor of Dental Science degrees from Baylor University and a Master of Science (orthodontics) from the University of Texas Dental School. Dr. Renger is a member of the American Association of Orthodontists, Southwest Society of Orthodontists,\nAmerican Dental Association, Texas Dental Association, Houston District Dental Society, Baylor Dental Alumni Association and the University of Texas orthodontic Alumni Association. He is currently serving on the Peer Review Committee of the Houston District Dental Society and is President of Wilson Radiographic Centers of Houston.\nMr. Carl D. Nation founded Super Brakes, Inc. in 1981. He, along with Dr. Renger, acquired controlling interest in the Company in 1990 in order to provide a public vehicle to facilitate growth in the automotive after-market field. Mr. Nation has been a self-employed financial consultant in the Fort Worth, Texas area for the past fifteen years representing several major industries, including precious metals, banks municipalities and various government and private businesses. Effective June 1, 1995, Mr. Nation became a full time employee of the company. Mr. Nation has held a prior position as Vice President and General Manager of Insurers of America, representing Lloyds of America. Mr. Nation completed an executive management program that consisted of six months manufacturing, shipping and receiving, inventory control and sales management. Upon completion he served as marketing director for the Northeastern United States for Kelsey-Hayes Company, a major manufacturer of disc brakes. He managed sales personnel, opened new distribution channels, organized sales and product clinics through automotive, manufacturing, warehousing, national accounts, mass merchants, municipalities and state governments. He then became the district manager of the New England district for Monroe Auto Equipment Company, a manufacturer of shock absorbers. While with Monroe, he directed the sales force, marketing products through national accounts, mass merchants, automotive distribution centers, jobbers and dealers. He also organized and instructed approximately fifty product and sales clinics annually. His responsibilities included administration, sales training and new distribution and arranging credit through financial institutions for new customers. Before that, he was the marketing director of nine northeastern states for Belden Corporation, a manufacturer of electrical wire and cable. He held a prior position as the operations department manager for Hartford National Bank. Mr. Nation was honorably discharged from the United States Marine Corps.\nMr. Wade D. Althen began functioning as the President\/CEO of the Company on a full time basis effective June 1, 1995. During April and May of 1995 he served as Licensed Manager of Employment World, Inc. in North Little Rock, Arkansas. From May 1992 to March 1995 he was employed by National Education Centers, Inc. a subsidiary of National Education Corporation (a NYSE company). His positions with National Education Corporation included Business Instructor in Economics, Accounting and Computer Science and Co-Chair of the Business Department from May 1992 to June 1993. From July 1993 to June 1994 he was Education Director in charge of: curriculum; hiring, scheduling and training instructional staff; budgeting; attrition of student body; and filing Accreditation reports. These positions were all at the Little Rock, Arkansas campus. In June 1994 Mr. Althen was appointed Director and President of the Fort Worth, Texas campus until his resignation in March 1995. From February 1987 to May 1992 he was a self-employed Certified Public Accountant and financial consultant in North Little Rock, Arkansas. He has provided executive level management for eighteen of the last twenty-one years including four years as Chief Executive of a commercial bank, one year as Chief Executive Officer of a publicly traded petroleum company and two years as managing partner of a CPA firm. Mr. Althen has prepared and provided oversight of preparation of budgets in many industries. In the banking industry, he planned for significant growth by utilizing financial and human resources to enable a seventy year old bank to double in size within four years. In the petroleum industry,\nhe established and executed a plan that made a publicly traded company that was in reorganization viable as an acquisition candidate. He is experienced with preparation of initial registrations of public corporations and Securities and Exchange Commission reports. He has conducted audits for many types of industries and submitted financial statements to clients and regulatory agencies. He also has experience with statements required by the Federal Deposit Insurance Corporation and other banking agencies. In 1970, Mr. Althen obtained his Bachelor of Science Degree in Accounting from Arkansas State University and received one year of post graduate training from the Stonier Graduate School of Banking at Rutgers University. He has been a Certified Public Accountant since 1972.\nMr. David A. Christman has been a Senior Financial Analyst with Intellicap Limited since November 1994 working with the Ministry of Finance of the State of Kuwait to develop and administer the government's Counter-Trade Offset Program. His duties include working with supply contractors. He contributed to the design of the program's guidelines and designed and implemented the Financial Performance Model of evaluating the feasibility and acceptability of business plans submitted by the contractors. He also developed a training program and teaches finance to the Kuwaiti staff. From January 1991 to November 1994 he was the principal in David A. Christman & Associates, an independent financial and management consulting firm in Dallas, Texas. He work consisted of installing management accounting systems, job cost reporting systems, standard cost accounting systems and other phases of financial management procedures and policies. He also helped with restructuring organizations, wrote job descriptions, designed and installed incentive plans and employee evaluation procedures. He provided management training, wrote employee handbooks and installed management by objectives (MBO) programs. From February 1988 to January 1991 he served as a management consultant with George S. May International Company where his duties included all aspects of financial and organizational management consulting as well as computer installation. Mr. Christman holds a Bachelor of Science in Business Administration Degree with a Major in Accounting from Rochester Institute of Technology in New York and has completed a post-graduate program in finance and statistics.\nMr. Steven R. Paige graduated from the University of New York at Albany in 1984 with a Bachelor of Science degree in Business Administration which he achieved while enlisted in the U.S. Air Force. Upon completion of his enlistment and degree requirements, Mr. Paige worked for a major television station in Denver, Colorado as an account executive. In 1986 he joined one of Denver's most prominent advertising agencies. Within two years, Mr. Paige was personally responsible for doubling the firm's gross revenues by acquiring three national accounts, and was promoted to Executive Vice President. His new responsibilities included personnel development, full creative and buying authority, and future business development. In 1988 he left the agency and formed his own marketing company, The Paige Group, which pursued new areas of marketing, advertising and finance for clients. From March 1989 to June 1990, Mr. Paige was Sales Manager for Mike Naughton Ford Company with full responsibility for hiring and training of sales personnel as well as total responsibility for movement of inventory including advertising, marketing and promotional activities. Through his implementation of creative marketing and sales techniques, he was instrumental in bringing the dealership from a seventh place rating to a number one rating in a little over a year. From June 1990 to December 1991, Mr. Paige was General Manager of Metro Toyota with overall responsibility of the dealership including inventory control, budgeting, sales performance, service and maintenance operations and total income performance.\nFrom January 1992 to May 1995, he was Sales Manager and General Manager of Don Massey Cadillac (a member of the largest Cadillac group in the world) with total responsibility as dealer-operator including procurement of all major inventory. Again, with his implementation of marketing and sales techniques, he brought the dealership from a number six rating to a number one rating in less than six months. Mr. Paige has been associated with Condor West Corporation and with Mr. Carl D. Nation, Co-Chairman for more than five years. Effective June 1, 1995 he became a full-time employee of the Company.\nMr. Terrance L. Rasmussen has been employed in a management position with Hilti Corporation since 1990. His responsibilities include inventory control and internal auditing. Prior to that he was employed by A & A Plate Service, Inc. and Sears, Roebuck and Company in computerized accounting systems. Additional areas of experience accounts payable, accounts receivable, payroll and tax consulting. Mr. Rasmussen has also analyzed company operations for purposes of recommending changes for improvement, and potential companies for take-over based on profitability potential. Major projects included areas of real estate, manufacturing and agriculture. Mr. Rasmussen is licensed by NASD and was an account executive for a national brokerage firm where he developed corporate and individual accounts. He provided guidance to clients, determined investment objectives and developed solid portfolios according to the objectives using stocks, bonds, and mutual funds. He received a Bachelors degree in business, management and finance from Iowa State university in Ames, Iowa, and attended the Metropolitan State University in Minneapolis, Minnesota where he obtained a degree in accounting. Mr. Rasmussen is also a CPA.\nJohn A. Murdock III is the founder of JAM Consulting Service, Inc. and principal stockholder, chief executive officer and founder of Power By Nature, Inc. Mr. Murdock served more than 20 years in the United States Air Force where he obtained extensive training in management and operations. As Weapons Superintendent, he was responsible for more than 250 airmen and worked world wide in areas of Europe, Asia and the Middle East. Mr. Murdock's decorations include the Distinguished Flying Cross (with four oak leaf clusters), the Airman's Medal of Valor, the Air Medal (with 18 oak leaf clusters), the Vietnamese Cross of Gallantry (with Bronze Star, Palm Leaf and 3 oak leaf clusters), and the Good Conduct Medal (with 7 oak leaf clusters). After retiring from the United State Air Force, Mr. Murdock used his experience to be an advisor for the Armament and Mobility Officers for the Royal Saudi Air Force. He worked directly with foreign country representatives as a Logistics Engineer for Foreign Military Sales. This included the sale of aircraft and other defense systems. Currently, he is an agent for the leasing of Deeds of Assignments of United States Treasuries. These are used to aid in the funding of projects, and require highest contacts in banking and business. Mr. Murdock Obtained a B.S. Degree from Troy State Unviersity, a Masters in Business Administration in Personnel Administration from Chapman College, and a Doctor of Laws degree from Louisiana Baptist University.\nDennis L. Swenson possesses more than 25 years of human resource and administrative management experience with Fortune 500 and smaller corporations. From January 1991 to present he has been Vice President Human Resources and Administration for PharmAssist, Inc. as well as owner of DLS Associates, a Human Resources consulting firm. From January 1987 to January 1991 he was Director of Compensation and Benefits for FoxMeyer Corporation and from May 1969 to December 1986 he was Manager of Employee Benefits for Burlington Northern Railroad Company. While at FoxMeyer Corporation he established the Human Resource\nDepartment serving more than 4,500 employees as well as developing and staffing the Customer Service Department for a $45 billion wholly owned subsidiary. While employed with Burlington Norther, Inc., Mr. Swenson managed and administered all labor relations functions, including negotiation of the benefits program covering 48,000 employees. Through design and administrative modifications, he was responsible for cost reductions of nearly $5 million annually. !n 1990, he served as acquisition consultant to Computer Land Corporation when they acquired the $750 million Nynex Business Information Systems. He has extensive experience in conducting audits to assure sound and feasible business practices based upon corporate liability and profit margin.\nDr. Felix F. Banchs has served as Mexico Project Manager\/Nationally Certified Financial Counselor for the National Foundation for Consumer Credit, Fort Worth, Texas from 1992 to present where his responsibilities include the development, implementation and supervision of debt management and financial programs for the USA, Puerto Rico and Mexico. From 1990 to 1992 he was Director of Training for Centro de Amistad, Dallas, Texas where he developed and supervised vocational training programs. From 1977 to 1990, Dr. Banchs was Vice President for Administration and Dean of Business Administration for Boricua College in New York. His responsilbilities included the development of the business administration curriculum and management of three campuses. During his tenure, both faculty and student population increased by 500%. In addition, Dr. Banchs has held executive positions with Shell Oil Co., Baxter- Travenol Laboratories and Colgate-Palmolive. Dr. Banchs graduated Magna Cum Laude with a BBA in Management from Catholic University of Puerto Rico, Cum Laude with a Masters in Business Administration in Marketing Management from St. John's University, New York and earned a PhD in Business Administration and Economics from Columbia University, New York. Dr. Banchs is listed in AWho's Who in Finance and Industry in America and is a veteran of the United States Air Force.\nItem 11.","section_11":"Item 11. Management remuneration\nThrough May 31, 1995, the Company's officers have not received any compensation in connection with their activities on behalf of the Company. However, the Company's officers will be reimbursed for any reasonable business expenses incurred in connection with their activities on its behalf. In the event of a change of control in the Company, the present shareholders may derive a benefit through the sale of their shares. Effective June 1, 1995, Messrs. Nations, Althen and Paige became full-time employees of the Company as it commenced attempts to implement its business plan to activate Super Brakes. Their level of compensation in the future will be determined based on the Company's level of operations.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nOfficers and Directors, and persons beneficially owning more than 5% of the 21,541,148 shares of common stock outstanding at May 31, 1995 were as follows:\nName Officer Director Shares Percent\nDr. Everett Renger Yes Yes 9,095,840 (1) 42.2% Carl D. Nation Yes Yes 9,095.840 (1) 42.2 Wade D. Althen Yes Yes 1,000,000 4.6 Steven R. Paige Yes Yes 1,000,000 4.6 Terrance L. Yes Yes 300,000 1.4 Rasmussen David A. Christman Yes Yes 200,000 0.9 All officers and directors as 20,691,680 96.1 a group\n(1) Subsequent to May 31, 1995, on October 10, 1995, Messrs Renger and Nation each returned 3,770,840 shares to the Company as an anti-dilutionary measure. The return of these shares has been retroactively recorded as of May 31, 1995.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nSee Item 1, _Organization and Business_, for discussion of the acquisition of all the outstanding stock of Super Brakes, Inc. from Dr. Renger and Mr. Nation. On April 28, 1995, May 30, 1995, and June 22, 1995, John A. Murdock, III, a Director, loaned the Company $100,000 on each occasion, or a total of $300,000. The notes bore interest at 15% and were due and payable two years after date. Under the terms of the notes, Mr. Murdock had the option to convert each note into 130,000 shares of common stock of the Company. However, on June 30, 1995, the notes and accrued interest of $4,068 were converted into 540,000 shares of stock at the rate of $0.563 per share.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statements, Schedules, and Reports of Form 8-K\nCONDOR WEST CORPORATION (A development stage enterprise) May 31, 1995 - -------------------------------------------------------------------------------\nDescription Page - ------------------------------------------------------- ----------\nReports of Independent Certified Public Accountants\nBalance sheets as of May 31, 1995 and 1994\nStatements of loss for the periods ended May 31, 1995, 1994 and 1993\nStatements of stockholders' equity for the years ended May 31, 1995, 1994 and 1993\nStatements of cash flows for the periods ended May 31, 1995, 1994 and 1993\nNotes to financial statements\nBateman, Blomstrom & Co. Certified Public Accountants\n9301 Southwest Freeway, Suite 100 Houston, Texas 7074-1593 (713) 552-9800 (713) 771-4385 FAX (713) 771-5553\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nTo The Board of Directors and Stockholders Condor West Corporation Greenwood Village, Colorado\nWe have audited the accompanying balance sheet of Condor West Corporation (a development stage enterprise) as of May 31, 1995, and the related statements of loss, stockholders' equity, and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and the 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 Condor West Corporation (a development stage enterprise) as of May 31, 1995, and the results of its operations and its cash flows for the year then ended in conformity with generally accepted accounting principles.\n\/s\/Bateman, Blomstrom & Co.\nBATEMAN, BLOMSTROM & CO.\nHouston, Texas December 5, 1996\nMember INTERNATIONAL ASSOCIATION OF PRACTISING ACCOUNTANTS Offices in Principal Cities Around The World\nO'NEAL AND WHITE, P.C. Certified Public Accountants 17350 Tomball Parkway, Suite 300 Houston, Texas 77064 (713) 890-2554\nINDEPENDENT AUDITOR'S REPORT\nThe firm of O'Neal and June 5, 1994 White, P.C. has discontinued the practice of public accounting and no Board of Directors and Shareholders longer provides audit and Condor West Corporation accounting services. This Houston, Texas document is a copy of the latest signed and dated audit report issued by O'Neal and White.\nWe have audited the accompanying balance sheet of Condor West Corporation as of May 31, 1994 and 1993, and the related statements of operations, shareholders' equity, and cash flows for the three years ended May 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 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 the 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 Condor West Corporation (a development stage enterprise) as of May 31, 1994 and 1993, and the results of its operations and its cash flows for the three years ended May 31, 1994 in conformity with generally accepted accounting principles.\nO'NEAL AND WHITE, P.C. CERTIFIED PUBLIC ACCOUNTANTS\nCONDOR WEST CORPORATION (A development stage enterprise) Balance Sheets May 31, 1995 and 1994 - -------------------------------------------------------------------------------\n1995 1994 ----------- ---------- ASSETS Current assets: Cash $202,905 $ - ----------- ---------- Total current assets 202,905 - ----------- ----------\nOther assets 10 - ----------- ---------- Total assets $202,915 $ - =========== ==========\nLIABILITIES Current liabilities: Accrued interest $ 1,397 $ - Accounts payable, related party 15,034 - ----------- ---------- Total current liabilities 16,431 - ----------- ----------\nNoncurrent liabilities: Notes payable, related party 200,000 - ----------- ---------- Total liabilities 216,431 - ----------- ----------\nCommitments and contingencies - -\nSTOCKHOLDERS' EQUITY (DEFICIT) Common stock, par value $.001 per share, 35,000,000 shares authorized, 13,999,468 and 1,249,468 shares issued and outstanding 14,000 1,250 Capital in excess of par value 53,200 53,200 Deficit accumulated during the development stage (80,716) (54,450) ----------- ---------- Total stockholders' equity (deficit) (13,516) - ----------- ---------- Total liabilities and stockholders' equity $202,915 $ - =========== ==========\nThe accompanying notes are an integral part of these statements.\nCONDOR WEST CORPORATION (A development stage enterprise) Statements of Loss For The Periods Ended May 31, 1995, 1994 and 1993 - -------------------------------------------------------------------------------\nCumulative October 8, Through May 31, Years ended May 31, 1995 1995 1994 1993 ----------- --------- ---------- ---------\nRevenues $191 $ - $ - $ - ----------- --------- ---------- ---------\nExpenses: Depreciation and amortization 40,186 - - 8,903 Salaries and fees for services 19,589 19,589 - - Other general and administrative 19,735 5,280 - - ----------- ---------- ---------- --------- Total expenses 79,510 24,869 - 8,903 ----------- ---------- ---------- --------- Income (loss) from (79,319) (24,869) - (8,903) operations\nOther income (expenses): Interest (1,397) (1,397) - - ----------- --------- ---------- ---------\nNet (loss) $(80,716) $(26,266) $ - $(8,903) =========== ========= ========== =========\nNet loss per common share $(0.004) $ - $(0.007) ========= =========== =========\nWeighted average number of shares outstanding 7,572,071 1,249,468 1,249,468 ========== =========== =========\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.\nCONDOR WEST CORPORATION (A development stage enterprise) Notes To Financial Statements May 31, 1995, 1994 and 1993 - -------------------------------------------------------------------------------\nNote 1 - Organization and summary of significant accounting policies: Following is a summary of the Company's organization and significant accounting policies:\nOrganization and nature of business - Condor West Corporation (the Company) is a Nevada corporation, incorporated on October 8, 1987, engaged in organizational activities, raising capital, and investigating business opportunities, currently in the retail automotive services field. Accordingly, the Company has no business operations and does not intend to engage in an active business until it acquires or combines with an operating enterprise.\nTo date, the Company's activities have been limited to its formation, the initial registration of its securities, and the identification and screening of potential business acquisitions. In its current development stage, management anticipates incurring substantial additional losses as it investigates business opportunities.\nBasis of presentation - The accounting and reporting policies of the Company conform to generally accepted accounting principles applicable to development stage enterprises.\nUses of estimates - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period. Actual results could differ from those estimates. The Company's periodic filings with the Securities and Exchange Commission include, where applicable, disclosures of estimates, assumptions, uncertainties and concentrations in products and markets which could affect the financial statements and future operations of the Company.\nCash and cash equivalents - For purposes of the statement of cash flows, the Company considers all cash in banks, money market funds, and certificates of deposit with a maturity of less than one year to be cash equivalents.\nFederal income taxes - Deferred income taxes are reported for timing differences between items of income or expense reported in the financial statements and those reported for income tax purposes in accordance with Statement of Financial Accounting Standards number 109 Accounting for Income Taxes, which requires the use of the asset\/liability method of accounting for income taxes. Deferred income taxes and tax benefits 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 for tax loss and 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. The\nCONDOR WEST CORPORATION (A development stage enterprise) Notes To Financial Statements May 31, 1995, 1994 and 1993 - -------------------------------------------------------------------------------\nCompany provides deferred taxes for the estimated future tax effects attributable to temporary differences and carryforwards when realization is more likely than not.\nNet income per share of common stock - Net income per share of common stock is computed by dividing net income by the weighed average number of shares of common stock outstanding during the period, after giving retroactive effect to stock splits, if any.\nNote 2 - Issuance of stock: Since its inception, the Company has issued shares of its common stock as follows:\nPrice Per Date Description Shares Share Amount - -------------------------------------------------------------------------------- Transactions prior to current year: 10\/8\/87 Shares issued for cash 750,000 $.0275 $20,625 5\/31\/90 Shares issued in exchange for debt 499,468 .0677 33,825 ----------- -------- Subtotal 1,249,468 54,450 ----------- --------\nTransactions during current year: 12\/1\/94 Shares issued to officers and directors for services 20,281,680 .001 20,282 Less, shares subsequently returned (7,541,680) .001 (7,542) ----------- -------- Net shares issued for services 12,740,000 12,740\n12\/1\/94 Shares issued to acquire all of the outstanding stock of Super Brakes, Inc. 10,000 .001 10 ----------- -------- Subtotal 12,750,000 12,750 ----------- -------- 5\/31\/95 Total outstanding 13,999,468 $67,200 =========== ========\nDuring the year ended May 31, 1995, the Company began the formulation of a business plan to enter the retail automotive service field. In that connection, 20,281,680 shares of common stock (including 531,666 shares described in the following paragraph) were issued to 8 officers and directors for their services in connection with the proposed business, including the development of a business plan. Subsequently, on October 10, 1995, two of the officers returned 7,541,680 of these shares to the Company for cancellation as an adjustment in the value of the services rendered. The return of shares has been retroactively recorded as of December 1, 1994. Shares issued were recorded at par value, which approximates fair value of the services rendered, and were charged to expense as incurred.\nAlso on December 1, 1994, the Company issued 541,666 shares to its Chairman and Co-chairman\nCONDOR WEST CORPORATION (A development stage enterprise) Notes To Financial Statements May 31, 1995, 1994 and 1993 - -------------------------------------------------------------------------------\nin exchange for all the outstanding stock of Super Brakes, Inc. Super Brakes was an inactive corporation with no assets, liabilities or operations that was formed to engage in the proposed retail automotive services business. Of the total shares issued, 10,000 shares (or $10) were capitalized as the investment cost, and the remaining 531,666 (or $532) were deemed to have been issued for services and were charged to expense. Subsequent to May 31, 1995, on May 18, 1996, the Super Brakes investment was sold back to the Co-chairman for $10. The investment is included among other assets on the accompanying balance sheet.\nNote 3 - Notes payable, related party: The Company is indebted on two promissory notes payable to a Director dated April 28, 1995, and May 30, 1995 in the amount of $100,000 each. The notes are due two years after date, bear interest at 15%, and are unsecured. On June 22, 1995, the Director loaned an additional $100,000 to the Company on similar terms.\nOn June 30, 1995, the three loans, plus accrued interest of $4,068, were exchanged for 540,000 shares of common stock at the rate of $0.563 per share.\nNote 4 - Federal income tax: No provision for currently refundable Federal income tax has been made in the accompanying statements of loss as no recoverable taxes were paid previously. Similarly, no deferred tax asset attributable to the net operating loss carryforward has been recognized, as it is not likely to be realized. At May 31, 1995, the Company had unused net operating loss carryovers which may be used to offset future taxable income and which expire as follows:\nExpires May 31, Amount - ------------------------------------------- ----------- 2004 $16,233 2005 10,857 2006 9,553 2007 8,904 2008 8,903 2009 - 2010 26,266 ----------- Total net operating loss carryover $80,716 ===========\nNote 5 - Commitments: The Company is obligated on two operating leases for automobiles requiring monthly payments of $1,342, and expiring in May 1998 and October 1998. Aggregate commitments under these leases at May 31, 1995 were as follows:\nCONDOR WEST CORPORATION (A development stage enterprise) Notes To Financial Statements May 31, 1995, 1994 and 1993 - -------------------------------------------------------------------------------\nYear ended May 31, Amount - ---------------------------------------- ----------- 1996 $16,101 1997 15,363 1998 3,625\nIn May, 1995, the Company also entered into a lease for office space on a month-to-month lease requiring monthly rentals of $1,250 per month. The total amount charged to operations under operating leases during the year ended May 31, 1995 was $1,342.\nIn December 1995, the auto lease obligations were assumed by two officers of the Company and the related vehicles were retained by them.\nNote 6 - Accounts payable, related party: An officer of the Company has advanced funds to or paid expenses for the Company aggregating $15,035 at May 31, 1995. These amounts were repaid by the Company subsequent to May 31, 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.\nCONDOR WEST CORPORATION\nDated 2-6-97 By \/s\/Dr. Everett Renger ----------------- -------------------------- Dr. Everett Renger Co-Chairman of the Board\nDated 2-14-97 By \/s\/Carl D. Nation ----------------- -------------------------- Carl D. Nation Co-Chairman of the Board\nDated 2-7-97 By \/s\/Wade D. Althen ----------------- -------------------------- Wade D. Althen, President, CEO and Directorr\nDated 2-10-97 By \/s\/Steven R. Paige ----------------- -------------------------- Steven R. Paige, Executive Vice President, COO, and Director\nDated 2-11-97 By \/s\/David A. Christman ----------------- -------------------------- David A. Christman, Treasurer, CFO and Director\nDated 2-11-97 By \/s\/Terrance Rasmussen ----------------- -------------------------- Terrance Rasmussen, Secretary and Director\nDated 2-14-97 By \/s\/John A. Murdock ----------------- -------------------------- John A. Murdock, III, Director\nDated 2-14-97 By \/s\/Felix F. Banchs ----------------- -------------------------- Dr. Felix F. Banchs, Director\nDated 2-14-97 By \/s\/Dennis L. Swenson ----------------- -------------------------- Dennis L. Swenson, Vice President of Human Relations 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:\nDated 2-17-97 \/s\/Dr. Everett Renger ---------------- ----------------------------- Dr. Everett Renger Co-Chairman of the Board","section_15":""}
{"filename":"846581_1995.txt","cik":"846581","year":"1995","section_1":"ITEM 1. BUSINESS\nThe Prudential Variable Contract Real Property Account (the \"Real Property Account\"), the Registrant, was established on November 20, 1986 by The Prudential Insurance Company of America (\"The Prudential\"), as a separate investment account, pursuant to New Jersey law. 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 The Prudential.\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, Pruco Life Insurance Company, 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 five tenants at December 31, 1995.\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, 1995 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 100% occupied by seven tenants at December 31, 1995.\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 increased by $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 296,584 square feet of rentable space. At December 31, 1995 it was 99% occupied by 32 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, 1995 it was 95% leased to 12 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, 1995, the property was 98% 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 92% occupied by 52 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 IN JACKSONVILLE, FLORIDA 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 100% occupied at December 31, 1995.\nAPARTMENT COMPLEX IN RALEIGH, NORTH CAROLINA Dunhill Trace consists of fourteen two and three story apartment buildings, containing a total of 250 units. It was acquired upon completion of construction in June, 1995. The property, located on a 16.2 acre site in northwest, downtown Raleigh, North Carolina, was 95% occupied at December 31,\nOFFICE FACILITY IN NASHVILLE, TENNESSEE Westpark is a 97,000 square foot office center located in Brentwood, Tennessee, a suburb of Nashville. The property was constructed in 1982. The partnership purchased this property in October 1995. At December 31, 1995 the building was 98.6% leased.\nOFFICE FACILITY IN OAKBROOK TERRACE, ILLINOIS Oakbrook Terrace Corporate Center is a 123,000 square foot building located in in a western suburb of Chicago, Illinois. The Partnership purchased this property in December 1995. At December 31, 1995 the property was 99.5% leased.\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, 1996, there were approximately 64,601 Contract owners of record investing in the Real Property Account.\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 The Prudential 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 American, Pruco Life Insurance Company and Pruco Life Insurance Company of New Jersey.\n(a) Liquidity and Capital Resources\nAt December 31, 1995, the Partnership's liquid assets consisting of cash and cash equivalents and marketable securities totaled $24,755,420. This is a decrease of $24,162,016 from liquid assets at December 31, 1994 of $48,917,436. The decrease is due primarily to the acquisition of an apartment complex at a total cost of $15,758,700 and two office centers at a total cost of $21,015,643 as discussed below. This was partially offset by cash received from operations of the Partnership's properties and interest income received from short-term investments.\nThe Partnership has established a $10 million annually renewable revolving line of credit with First Fidelity Bank National Association to be drawn upon as needed for potential liquidity needs. The line of credit had never been drawn upon. Management did not anticipate any future needs for this credit facility and decided to terminate the line of credit as of October 31, 1995. The Prudential has 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 $52.2 million as of December 31, 1995.\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, 1995, 12.6% of the Partnership's assets consisted of cash and cash equivalents and marketable securities.\nDuring 1995, the partners withdrew $3.0 million. Withdrawals may be made during 1996 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, 1995, and currently, the Partnership has adequate liquidity. Management anticipates that ongoing cash flow from operations will satisfy the Partnership's needs over the next twelve months and the foreseeable future.\nThe Partnership acquired properties totaling $36,774,343 in 1995. The properties acquired were an apartment complex in Raleigh, NC on June 30, 1995 at a total cost of $15,758,700, an office building in Nashville, TN on October 4, 1995 for $8,385,450 and an office center in Oakbrook Terrace, IL on December 28, 1995 for $12,630,193. These acquisitions were funded entirely by cash held by the Partnership.\nDuring 1995 the Partnership expended $1,050,197 in capital expenditures, of which approximately $831,200 were for tenant alterations and leasing commissions. Approximately $327,000 in tenant\nimprovements and leasing commissions was spent at the Azusa, CA warehouse related to the lease signed by Best Buy. This is the final installment of such costs related to this tenant. At the Morristown, N.J. office center approximately $193,000 was expended, primarily related to the lease signed by Kodak in the first quarter of 1995. Of the $83,000 that was spent at the Pomona, CA warehouse, approximately $60,000 related to an expansion by Ashley Furniture and $23,000 related to a new tenant, Pac Rosa Enterprises. At the Roswell, GA shopping center these tenant improvements and leasing commissions totaled $78,000 of which approximately $66,000 was attributable to leases signed by Capezio's ($49,000) and Accentrics ($17,000). Approximately $104,000 was expended at the Flint, MI office property primarily related to an expansion for Olsten Kimberly ($66,500) and the lease signed for Combs (37,500). Approximately $46,200 was expended for tenant improvements at the Nashville office center.\nOther major capital expenditures in 1995 included approximately $62,300 for access gates at the Atlanta, GA apartments, and $32,530 for floor repairs and sewer repair at the Bolingbrook, IL warehouse. At the Morristown Office Center, approximately $37,000 was spent for HVAC upgrades, a new transformer and fire sprinklers. The Farmington Hills, MI apartments spent approximately $35,000 for an irrigation system upgrade and installation of new carpets and linoleum. Approximately $38,000 in costs related to the foreclosure of the Flint property in 1994 were paid in 1995.\nProjected capital expenditures for 1996 total approximately $1,811,000. Of this, approximately $1,549,000 consists of leasing commission and tenant alterations. The largest of these is $352,000 which is budgeted for the Morristown Office Center. The property expects to pay approximately $120,000 in costs associated with the Spectrum Financial expansion and projections include leasing the remaining vacancies at the property. At the Lisle, IL office building the Partnership projects leasing commissions of $324,000 resulting from efforts to renew the tenant prior to the November, 1997 expiration of its lease. In addition, tenant improvements and commissions are projected at $161,966 for the Pomona warehouse, $185,000 at the Azusa warehouse, $207,000 at the Roswell shopping center, $140,000 at the Flint office park and $66,000 at the Unit Distribution warehouses. The Partnership expects to expend another approximately $47,000 on smaller leasing commissions on other various properties. Except for the Spectrum Financial 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 1996 include $63,000 for fencing, entrance gates and upgrades to the exercise room at the Atlanta apartments: $90,000 for the installation of separate water meters at the Pomona warehouse: $35,000 for window replacements and a boiler study at Morristown; $27,000 for a landscaping upgrade, new signage and carport roof replacement at Farmington Hills and $38,000 to replace exterior entrance doors and landscaping upgrades at the Flint property. Approximately $75,000 was budgeted for smaller projects among the various properties.\nThe Partnership intends to exercise its option to purchase the land on which the Pomona warehouse is located for $4,000,000. The Partnership will exercise the option prior to its expiration in November, 1997.\nThe Partnership has entered into a commitment to sell the warehouse located in Azusa, California at an estimated sales price of $15,250,000. This transaction is expected to be consummated in April, 1996. In addition, the Partnership has entered into negotiations to sell the office park in Flint for an estimated $6,300,000 in the second quarter of 1996. The proceeds of both sales may be invested at a later date if suitable properties are identified.\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, 1995, 1994 and 1993.\n1995 vs 1994\nThe Partnership's net investment income for 1995 was $14,720,271, an increase of $1,872,072 (14.6%) from net investment income for 1994 of $12,848,199. The increase was primarily the result of higher interest income from short-term investments ($1,089,471) and net income from property operations ($1,058,039) partially offset by lower interest income on mortgage loans ($105,694).\nIncome from property operations, including income from interest in properties, was $15,081,290 for 1995. Income from interest in properties relates to the Partnership's 50% co-investment in several warehouses (the Unit warehouses). This is an increase of $1,058,039 (7.5%) from $14,023,251 for 1994. This was due primarily to increased rent from properties (approximately $3,482,785). The increase was offset by lower income from interest in properties due to the sale for the seven Unit warehouses in October, 1994 (approximately $1,717,000), higher real estate taxes (approximately $145,000), property administrative expenses (approximately $399,000), and property operating expenses (approximately $163,000).\nRent from properties for 1995 increased by $3,482,785 (21.3%) to $19,827,044 from $16,344,259 for 1994. A large portion of this was the result of properties that were acquired during 1995. This revenue totaled approximately $1,466,000. Revenue provided by the apartments in Raleigh was $1,111,744, the office building in Nashville, $331,165 and the office building in Oakbrook Terrace, $23,587. Rental income at the Flint office park increased by approximately $662,600 in 1995. This was primarily due to the acquisition of this property through foreclosure in July, 1994. As a result, only six months of operating results are included in 1994 as compared to a full year in 1995. Increased occupancy in 1995 resulted in an additional $906,000 in rental revenue for the Azusa and Morristown buildings as well as the Partnership's two other apartment properties. Rental income at the Bolingbrook warehouse increased about $82,000 in 1995 as a result of the expiration of a free rent period granted to the tenant in the first quarter of 1994. Revenue at the Pomona warehouse was almost $221,000 higher due to increased occupancy and higher expense recoveries.\nThese additional revenues were partially offset by the net effect of approximately $15,000, due to lower percentage rent in 1995 from the Roswell, GA shopping center, offset by higher rental income and expense recoveries.\nIncome from the Unit Warehouses decreased $1,717,021 (72.9%) from $2,355,204 for 1994 to $638,183 for 1995. The Partnership sold its investments in seven of these warehouses in 1994. Of the four remaining warehouses, income increased by approximately $83,000 due to higher occupancy at one of the warehouses.\nAdministrative expenses on the statement of operations includes both those related to property operations and the administration of the Partnership. Property administrative expenses for 1995 were $1,575,663. This is $399,265 (33.9%) higher than the $1,176,398 for 1994. Most of the increase was the result of the inclusion of the Flint, Raleigh and Nashville properties, (almost $270,000), higher insurance premiums ($72,000) primarily at the two California properties and in increase in bad debt expense ($63,000). The increase in bad debt expense arose from the 1994 application of a security deposit to amounts owed by that tenant which reduced 1994 bad debt expense by approximately $33,000. Professional fees also increased approximately $45,000 in 1995 due to the utilization of real estate tax consultants to assist with the appeal values at several of the properties. The appeal generated\nsignificant tax savings as noted below. Advertising and promotional expenses were lower at several of the properties which offset the increased administrative expenses by about $40,000.\nProperty operating expenses for 1995 were $1,870,183 compared to $1,707,039 for 1994, an increase of $163,144 (9.6%). The increase was primarily due to the inclusion of approximately $217,336 in operating expenses related to the Raleigh and Nashville properties. The Flint property had an increase of $73,600 when comparing the full year 1995 to the last six months of 1994. In addition there were higher repairs and maintenance at the Farmington Hills apartments of approximately $18,500. These increases were reduced by lower expenses at the Azusa warehouse related to the painting of building exteriors in 1994 ($88,500), at Pomona due to lower repairs and maintenance ($24,500), and lower repairs and maintenance, security and utilities at Roswell ($35,000).\nReal estate taxes for 1995 were $1,938,090, a net increase of $145,315 (8.1%) from $1,792,775 for 1994. Approximately $244,000 of the increases was due to the inclusion of the Flint office buildings, where $101,000 of 1994 taxes were reflected in 1995 activity. The acquisition of the Raleigh apartments and the Nashville office center also contributed to this increase. At the Roswell shopping center, real estate taxes had a net increase of $31,500. These increases were offset by approximately $153,000 in decreases achieved as the result of appealing the assessed values at the Azusa, Pomona, Morristown and Farmington Hills properties. Real estate taxes at the net lease properties in Bolingbrook and Lisle also increased nearly $22,000.\nThere was no interest income from mortgage loans in 1995. This was due to the maturing of the Lincoln, NE loan in May 1994 and the 1994 default of the mortgagor on the Flint loan. Interest income from short-term investments increased $1,089,471 (69.3%) from $1,571,394 for 1994 to $2,660,865 for 1995. This was the result of increased amounts invested and higher interest rates in 1995. The Partnership had retained increased cash balances in anticipation of acquiring properties in 1995.\nAdministrative expenses related to the Partnership totaled $219,429 for 1995. This is a reduction of $17,895 (7.5%) from $237,324 for 1994. The decrease resulted primarily from lower professional fees for 1995.\nThe investment management fee for 1995 was $2,341,878. This is $54,062 (2.4%) higher than the fee for 1994 of $2,287,816. The fee is computed as 1.25% of gross daily assets. During 1995, gross assets were slightly higher than the prior year due to cash flow retained by the Partnership and increased market values of the real estate investments.\nMarket values of invested assets: 1995 vs 1994\nDuring 1995, the Partnership recognized an unrealized gain of $661,623 on its real estate investments. This represents 0.5% of the investments' December 31, 1994 value. The apartments experienced the largest increase, approximately $2,700,000. The warehouses increased by about $421,000. The office building properties experienced an unrealized loss of approximately $1,933,000 and the retail property, an unrealized loss of about $528,000.\nThe Partnership's luxury garden apartments in Raleigh had an unrealized gain of nearly $1,441,300. The property has benefited from very strong leasing demand (occupancy at December 31, 1995 was 95%) and is performing at a higher level than anticipated. The Farmington Hills and Atlanta apartments experienced unrealized gains of $626,143 (4.6% of its year-end 1994 value) and $634,165 (5.3% of its year-end 1994 value), respectively. These increases were primarily the result of higher rental rates, occupancy and tenant retention than previously projected for these properties.\nThe warehouses experienced an unrealized gain of about $421,000 during 1995. The Pomona property had the largest unrealized gain, $684,153 (4.2% of its year-end 1994 value). This was the result of two leases that were signed which brought the occupancy to 100%. The market values of the four Unit warehouses in which the Partnership owns a 50% interest at the end of 1995 increased $49,134 (.9% of their December 31, 1994 value).\nThe warehouse in Bolingbrook experienced an unrealized gain of $357,563 (5.1% of the property's December 31, 1994 value). This was due to lower estimates of operating expenditures.\nThe increases in the market values of these warehouses were partially offset by a decrease of $669,928 (4.3% of the property's December 31, 1994 value) in the market value of the Azusa warehouse. The decrease in market value was partially attributable to less optimistic assumptions of expense growth, future rental rates and leasing activity as current leases expire, based on the property's competitive position in the local market.\nThe office buildings experienced an unrealized loss of approximately $1,933,000. The Flint property value decreased $1,314,060 (17.1% of its December 31, 1994 value). This was caused by reduced expectations of future rental rate increases and tenant renewals due to increased competition from new construction in the Flint market. The Lisle office building decreased in value by $400,000 (3.3% of the property's December 31, 1994 value) and the Morristown property also decreased in value by $473,993 (4.8% of its December 31, 1994 value). The Lisle property's decrease in value reflects the possibility that the current tenant, R.R. Donnelley, may not 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 increases in the discount rates, reflecting the soft market conditions in the local areas and the expectations that potential buyers are requiring higher returns on such investments. The decreases in value at the office buildings were partially offset by an increase of $254,871 at the Nashville building. The increase represented 3% of its acquisition cost. The rise in value reflects the expectations of continued high occupancy and the potential for higher rental rates in the future.\nThe Partnership's sole retail property, King's Market Shopping Center in Roswell, GA, experienced an unrealized loss of $527,726 (1.6% of its December 31, 1994 value). This was due to increased competition in the local market due to the construction of a competing shopping center which is expected to exert downward pressure on rental rates.\nProperty leasing activity\nOccupancy at the Partnership's properties at December 31, 1995 is generally higher than at December 31, 1994. The Partnership acquired two office properties in 1995. Westpark, an office building in suburban Nashville, TN has 96,880 rentable square feet. At December 31, 1995 the property was 98.6% leased. There is one lease expiring in 1996 for 6,257 square feet. We expect to renew this tenant in that space. The Partnership is actively marketing the available vacancy of 1,350 square feet. Oakbrook Terrace is located in Oakbrook, Illinois. The property is 99.5% leased and there are no expirations in 1996.\nOccupancy at Pomona increased from 83% at December 31, 1994 to 100% at the end of 1995. During the second quarter of 1995, two leases were signed which brought occupancy to 100%. Pac Rosa Enterprises signed a three year lease covering 33,400 square feet (6% of the property). The tenant took occupancy July 1, 1995. The second was a 55,000 square foot expansion by Ashley Furniture (10% of the property). The lease expires concurrent with their existing lease in 2003. There are two leases which expire in 1996. Inter City Products occupies 33,300 square feet (6% of the property) and their lease\nexpires in January, however they will continue to occupy the space on a month to month basis. The Partnership does not expect them to renew and efforts are underway to market the space. Structural Composite's lease expires in November. This tenant occupies 56,450 square feet (11% of the property) and we expect them to renew although no agreement has been reached.\nThe Unit warehouses were 100% occupied at December 31, 1995 compared to 92% at the end of December, 1994. The Biaggi Brothers signed a two year lease covering 90,000 square feet at one of the Unit warehouses (18% of the four buildings) effective February 1, 1995. This brought the occupancy at the four buildings to 100%. Associated Unit Companies renewed their lease for two years at a rental rate approximately 10% greater than that on the expiring lease. The lease covers 102,000 square feet (20% of the four Unit warehouses). The Unit warehouses have two leases expiring in 1996 covering 198,240 square feet. The Partnership is currently in negotiations with Angelo Brothers to exercise their option to renew the lease in their current space of 84,000 square feet (17% of the four warehouses). The Partnership expects this tenant to renew the lease prior to its expiration in April, 1996. GATX's lease expires in May, 1996. Presently, they occupy 114,240 square feet. The Partnership is discussing renewal terms with this tenant, but we do not believe they will renew. Management is marketing the space to others and does not expect a significant down time to re-lease the space.\nThe warehouse in Bolingbrook continues to be fully occupied by Gillette under a lease expiring in 2000.\nThe Morristown office building was 94.8% occupied at December 31, 1995 a slight increase of 2% from December, 1994. During 1995, Kodak renewed its lease covering 6,600 square feet (8% of the property). The new lease expires on February 28, 2003. During the fourth quarter of 1994, a 2,100 square foot expansion was executed with Smith Barney, effective January 16, 1995. The lease expires in 1997. Chase Home Mortgage's lease expired on December 31, 1995. Their lease was extended through March 31, 1996. The Partnership does not expect them to renew their lease. Mutual of Omaha's lease expires in March, 1996. They currently occupy 5,769 square feet (7% of the property). Discussions are being held with this tenant and we do not expect them to renew their lease in 1996. Spectrum signed a new lease and moved into a larger space that will increase their square footage from 2,350 to 3,765 or 4% of the property. The Partnership is also discussing expansions with other tenants in the property and actively marketing the available space. No other leases are scheduled to expire in 1996.\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. Discussions are being held with this tenant in an attempt to secure an early renewal. The tenant is also evaluating alternatives at other properties.\nKing's Market Shopping Center in Roswell, GA was 99% leased at December 31, 1995 as it was at the end of 1994. Two new tenants signed leases totaling 5,450 square feet (2% of the center) in 1995. Roswell Pet Supply renewed their lease in the fourth quarter of 1995 for 4,100 square feet (2%) of the center. Four tenant's totaling 7,864 square feet (5% of the property) expire in 1996. Two tenants occupying 2,882 square feet (1% of the property) are expected to renew. The Partnership is discussing potential renewal terms with the current tenants. The Men's Wearhouse (3,982 square feet or 2% of the property) is expected to vacate at the expiration of its lease in May, 1996. Kid's Mart vacated in January, 1996 and will not be renewing. Parties Galore vacated in December, 1995. They had occupied 6,100 square feet (2% of the property). The Partnership is marketing these spaces and expects to lease them in 1996. Leases covering the major tenants at the shopping center, Home Depot, CompUSA and A&P, are not scheduled to expire until after 2003. Marshalls, Inc. was acquired by TJX Companies, Inc., in 1995. Marshalls' lease covers 25,000 square feet (8.4% of the property), and expires on January 31, 1999. There is some uncertainty regarding their continued tenancy, and TJX Companies, Inc., is currently evaluating the Marshalls' locations to determine how these stores will fit into their future strategy.\nAs of December 31, 1995, the Partnership's residential properties located in Atlanta, GA and Farmington Hills, MI were 97% and 98% leased, respectively. Occupancy ranged from 96% to 98% during 1995. At December 31, 1994, these properties were 98% leased. The luxury garden apartments in Raleigh, NC were acquired in June, 1995. This property was approximately 95% leased at December 31, 1995. Market rental rates are expected to increase slightly in 1996 in the residential markets in which the Partnership's apartments are located. Occupancy at these properties are expected to remain strong over the upcoming year.\n1994 vs 1993\nThe Partnership's net investment income for 1994 was $12,848,199, an increase of $193,568 (1.5%) from the 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 rest 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 several warehouses (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 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 slightly 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.\nThe 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 recognized an unrealized gain of $2,576,828 on its real estate investments. Of this, $1,502,226 represents the 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 result of increases 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 condition 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 release 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 complexes 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 to capital expenditures at the property during 1994 which did not result in a corresponding increase in the shopping center's value and 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.\nThe 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.\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 THE PRUDENTIAL\nDIRECTORS OF THE PRUDENTIAL\nFRANKLIN E. AGNEW, Director since 1994 (current term expires April, 2000). Member, Finance Committee; Member, Committee on Dividends. Business Consultant since 1987. Mr. Agnew is also a director of Bausch & Lomb and John Wiley & Sons Inc. Age 61.\nFREDERICK K. BECKER, Director since 1994 (current term expires April, 1999). Member, Auditing Committee; Member, Committee on Business Ethics. President, Wilentz, Goldman and Spitzer (law firm) since 1989. Age 60.\nWILLIAM W. BOESCHENSTEIN, Director since 1982 (current term expires April, 1997). Chairman, Executive Committee; Member, Auditing Committee. Retired since 1990. Mr. Boeschenstein is also a director of FMC Corporation. Age 70.\nLISLE C. CARTER, JR., Director since 1987 (current term expires April, 1997). Chairman, Committee on Nominations; Member, Executive Committee; Member, Finance Committee. Retired since 1991. Senior Vice President and General Counsel, United Way of America from 1988 to 1991. Age 70.\nJAMES G. CULLEN, Director since 1994 (current term expires April, 2001). Member, Compensation Committee; Member, Committee on Business Ethics. President, Bell Atlantic Corporation since 1993. President New Jersey Bell from 1989-1993. Mr. Cullen is also a director of First Fidelity Bancorporation and Johnson & Johnson. Age 53.\nCAROLYNE K. DAVIS, Director since 1989 (current term expires April, 1997). Member, Compensation Committee; Member, Finance Committee; Member, Committee on Business Ethics. Health Care Advisor, Ernst & Young since 1985. Dr. Davis is also a director of Merck & Co. Inc., Beckman Instruments, Inc., Pharmaceutical Marketing Services, Inc. and Science Applications International Corp. Age 64.\nROGER A. ENRICO, Director since 1994 (current term expires April, 1998). Member, Committee on Nominations; Member, Compensation Committee. Vice Chairman, Pepsi Co. Inc. since 1993. Chairman and CEO, Pepsi Co. Worldwide Food, from 1991 to 1993. President and CEO Pepsi Co. Worldwide Beverage from 1986-1991. Mr. Enrico is also a director of Dayton Hudson Corp., PepsiCo Inc., and A.H. Bello Corp. Age 51.\nALLAN D. GILMOUR, Director since 1995 (current term expires April, 1999). Member, Finance Committee; Former Vice Chairman, Ford Motor Company. Mr. Gilmour is also a director of Whirlpool Corporation, U.S. West Inc., and The Dow Chemical Company. Age 61\nWILLIAM H. GRAY III, Director since 1991 (current term expires April, 1996). Member, Finance Committee; Member, Committee on Nominations. President and Chief Executive Officer, United Negro College Fund, Inc. since 1991. Appointed special advisor to Haiti by President Bill Clinton, May 1994. Mr. Gray served in Congress from 1979 to 1991. Mr. Gray is also a director of Warner-Lambert Co., Chase Manhattan Corp., Municipal Bond Investors Assurance Corp., Westinghouse Electric Corp., Union Pacific Corp, Lotus Development Corp. and Rockwell International Corp. Age 54.\nJON F. HANSON, Director since 1991 (current term expires April, 1997). Member, Committee on Dividends; Member, Finance Committee. Chairman, Hampshire Management Company since 1976. Mr. Hanson is also a director of United Water Resources. Age 59.\nCONSTANCE J. HORNER, Director since 1994 (current term expires April, 1998). Member, Committee on Nominations; Member, Auditing Committee. Guest Scholar, The Brookings Institution since 1993. Assistant to the President and Director of Presidential Personnel, U.S. Government, 1991-1992. Deputy Secretary, Department of Health and Human Services from 1989 to 1991. Ms. Horner is also a director of Pfizer, Inc and Ingersoll-Rand Company. Age 54.\nALLEN F. JACOBSON, Director since 1992 (current term expires April, 1998). Member, Auditing Committee; Member, Compensation Committee. Retired since 1991. Chairman of the Board and Chief Executive Officer, Minnesota Mining & Manufacturing Co. from 1986 to 1991. Mr. Jacobson is also a director of Abott Laboratories, Deluxe Corp., Northern States Power Co., Silicon Graphics, Inc., Valmont Industries, 3M, Mobil Corporation, U.S. West, Inc., Sara Lee Corporation and Potlatch Corporation. Age 69.\nGARNETT L. KEITH, JR., Director since 1984 (current term expires April, 1999). Vice Chairman of Prudential since 1984. Mr Keith is also a director of Super Valu Stores, Inc., AEA Investors, Inc., and Pan-Holding, Societe Anonyme. Age 60.\nBURTON G. MALKIEL, Director since 1978 (current term expires April, 1998). Chairman, Finance Committee; Member, Committee on Nominations; Member, Executive Committee. Chemical Bank Chairman's Professor of Economics, Princeton University, since 1988. Dr. Malkiel is also a director of The Jeffrey Co., Vanguard Group, Inc., Amdahl Corp., Baker Fentress & Co. and Southern New England Telecommunications Co. Age 63.\nJOHN R. OPEL, Director since 1984 (current term expires April, 1996). Chairman, Committee on Dividends; Member, Compensation Committee; Member, Executive Committee; Member, Finance Committee. Retired Chairman, International Business Machines Corporation since 1986; Chairman of the Executive Committee, IBM, from 1986 to 1993. Mr. Opel is also a director of AEA Investors, Inc. Age 71.\nARTHUR F. RYAN, Chairman of the Board, President and Chief Executive Officer of Prudential since 1994. President and Chief Operating Officer, Chase Manhattan Corp. from 1990 to 1994, with Chase since 1972. Age 53.\nCHARLES R. SITTER, Director since 1995 (current term expires April, 1999). Member, Committee on Dividends. President and Director of Exxon Corporation since 1993. Age 65.\nDONALD L. STAHELI, Director since 1995 (current term expires April, 1999). Member, Compensation Committee. Chairman and Chief Executive Officer of Continental Grain Company since 1994. Prior to 1994, Mr. Staheli was Chairman of Continental Grain Company. Age 64.\nRICHARD M. THOMSON, Director since 1976 (current term expires April, 1996). Chairman, Compensation Committee; Member, Committee on Nominations; Member, Executive Committee. Chairman of the Board and Chief Executive Officer, The Toronto-Dominion Bank since 1978. Mr. Thomson is also a director of National Retail Credit Services Limited, Inc., Eaton's of Canada, Ltd., INCO, Ltd., The Thomson Corp., S.C. Johnson and Son, Inc., TEC Leaseholds Limited, Thomglen Corporation, and The Toronto-Dominion Bank. Age 62.\nP. ROY VAGELOS, M.D., Director since 1989 (current term expires April, 1997). Chairman, Auditing Committee; Member, Committee on Dividends; Member, Executive Committee. Chairman, Regeneron Pharmaceuticals since 1995. Chairman, President and Chief Executive Officer, Merck & Co., Inc. from 1986 to 1994. Dr. Vagelos is also a director of Pepsi Co., Inc., Regeneron Pharmaceuticals, McDonnell Douglas Corporation, and Estee Lauder Companies. Age 66.\nSTANLEY C. VAN NESS, Director since 1990 (current term expires April, 1996). Chairman, Committee on Business Ethics; Member, Auditing Committee; Member, Executive Committee. Attorney, Picco Mack Herbert Kennedy Jaffe Perella and Yoskin (law firm) since 1990. Mr. Van Ness is also a director of Jersey Central Power\n& Light Company. Age 62.\nPAUL A. VOLCKER, Director since 1988 (current term expires April, 1996). Member, Committee on Dividends; Member, Committee on Nominations. Chief Executive Officer, James D. Wolfensohn, Inc. Since 1995. Chairman, James D. Wolfensohn, Inc. since 1988. Chairman, J. Rothschild, Wolfensohn & Co. since 1992. Mr. Volcker is also a director of Fuji-Wolfensohn International, Nestle, S.A., American Stock Exchange, Municipal Bond Investors Assurance Corporation, J. Rothschild\/Wolfensohn and Company, and UAL Corporation. Age 68.\nJOSEPH H. WILLIAMS, Director since 1994 (current term expires April, 1998). Member, Committee on Dividends; Member, Auditing Committee. Chairman of the Board, The Williams Companies since 1994. Chairman and Chief Executive Officer, The Williams Companies 1979-1993. Mr. Williams is also a director of Flint Industries, The Orvis Company, and The Williams Companies, Inc. Age 62.\nEXECUTIVE OFFICERS OF THE PRUDENTIAL\nARTHUR F. RYAN, Chairman, Chief Executive Officer, and President since 1994; 1990-1994, President and Chief Operating Officer, Chase Manhattan Corp. Age 53\nGARNETT L. KEITH, JR., Vice Chairman since 1984. Age 60.\nE. MICHAEL CAULFIELD, Chief Executive Officer, Money Management Group since 1995; 1992-1995, Senior Vice President; 1989-1992, Managing Director. Age 49.\nMARK B. GRIER, Executive Vice President and CFO, Individual Insurance Group since 1995; 1995-1984, Executive Vice President, Chase Manhattan Bank. Age 43\nEUGENE B. HEIMBERG, President and Chief Investment Officer, Prudential Investment Company since 1995; Senior Vice President since 1987. Age 62.\nWILLIAM P. LINK, President and Chief Executive Officer, Prudential Health Care Group since 1995; 1990-1995, Executive Vice President, Prudential. Age 48.\nJOHN V. SCICUTELLA, Operations and Systems Executive Officer since 1995; 1970- 1995, Executive Vice President, The Chase Manhattan Bank. Age 46.\nERIC A. SIMONSON, President, Private Asset Management Group since 1995; 1992- 1994, President, Prudential Investment Advisory Company, Ltd.; 1990-1992, Chairman, Prudential Capital Corporation. Age 50.\nWILLIAM F. YELVERTON, Chief Executive Officer, Individual Insurance Group since 1995; 1990-1995, Chief Executive Officer, New York Life Worldwide. Age 54.\nMARTIN A. BERKOWITZ, Senior Vice President and Comptroller since 1995; 1991- 1995, Senior Vice President and CFO, Prudential Investment Company. Age 47.\nWILLIAM M. BETHKE, President, Capital Markets Group since 1995; Senior Vice President since 1986. Age 48.\nSTEPHEN R. BRASWELL, Senior Vice President and Chief Ethics Officer, Enterprise Ethics Office since 1995; Senior Vice President since 1983. Age 56.\nROBERT M. CHMELY, President, Guaranteed Products and Retirement Administration since 1995; Senior Vice President since 1988. Age 60.\nWILLIAM D. FRIEL, Senior Vice President and Chief Information Officer since 1995; 1993-1995, Senior Vice President; 1988-1992, Vice-President. Age 56.\nJAMES R. GILLEN, Senior Vice President and General Counsel since 1984. Age 58.\nBRUCE J. GOODMAN, Chief Executive Officer, Prudential Service Company since 1995; 1993-1995, Senior Vice President; 1992-1993, Senior Vice President, Metropolitan Life; 1977-1991, Vice President, Metropolitan Life. Age 54.\nSAMUEL H. HAVENS, President, Prudential Health Care since 1995; 1989-1995, Senior Vice President. Age 52.\nIRA J. KLEINMAN, Chief Marketing and Product Development Officer, Individual Insurance Group since 1995; 1992-1995, Senior Vice President; 1978-1992, Vice President. Age 48.\nDONALD C. MANN, Senior Vice President, Human Resources since 1995; 1990-1995, Senior Vive President. Age 53.\nPRISCILLA A. MYERS, Senior Vice President and Auditor since 1995; 1989-1995, Vice President and Auditor, Prudential. Age 46.\nRICHARD O. PAINTER, President, Prudential Insurance & Financial Services since 1995; 1989-1995, Senior Vice President, New York Life Insurance Company Age 47.\nI. EDWARD PRICE, Senior Vice President and Actuary, Individual Insurance Group since 1995; 1993-1995, Senior Vice President; 1990-1993, Senior Vice President and Company Actuary. Age 53.\nKIYOFUMI SAKAGUCHI, President, Prudential International Insurance since 1995; 1994-1995, Chairman and CEO, Prudential Life Insurance Ltd., Japan; 1991-1994, President and CEO, Prudential International Insurance. Age 52.\nGREGORY W. SCOTT, Chief Financial Officer, Prudential Health Care Group since 1995; 1993-1995, Executive Vice President and CFO, Prudential Securities Inc. Age 42.\nSUSAN L. BLOUNT, Vice President and Secretary since 1995; 1989-1995, Assistant General Counsel, PRSC. Age 38.\nC. EDWARD CHAPLIN, Vice President and Treasurer since 1995; 1983-1995, Vice President and Assistant Treasurer. Age 39.\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, 1995 was $2,341,878.\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, 1995 was $219,429.\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 $6,133,157. 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, through August 1995 at the Bolingbrook, IL warehouse, through October 1994 at the Atlanta, GA, Desoto, TX, Fort Worth, TX, Shreveport, LA, Bedford Park, IL, and Normal, IL warehouses, and through August 1993 at the Pomona and Azuza warehouses. The property management fees earned by PREMISYS during 1995 were $31,360.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 10-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\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 year of 1995..\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, 1995. 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 Charter of The Prudential Insurance Company of America, filed as Exhibit 1.A.(6)(a) to Post-Effective Amendment No. 2 to Form S-6, Registration Statement No. 33-19999, filed March 2, 1989, and incorporated herein by reference.\n3.2 Amended By-Laws of The Prudential Insurance Company of America, filed as Exhibit 1.A.(6)(b) to Post-Effective Amendment No. 4 to Form S-6, Registration Statement No. 33-19999, filed March 2, 1990, and incorporated herein by reference.\n3.3 Resolution of the Board of Directors establishing The Prudential Variable Contract Real Property Account, filed as Exhibit (3C) to Form S-1, Registration Statement No. 33-20083, filed February 10, 1988, and incorporated herein by reference.\n4.1 Revised Individual Variable Annuity Contract filed as Exhibit A(4)(w) to Post-Effective Amendment No. 8 to Form N-4, Registration Statement No. 2-80897, filed October 23, 1986, and incorporated herein by reference.\n4.2 Discovery Plus Contract, filed as Exhibit (4)(a) to Form N-4, Registration Statement No. 33-25434, filed November 8, 1988, and incorporated herein by reference.\n4.3 Custom VAL (previously named Adjustable Premium VAL) Life Insurance Contracts with fixed death benefit, filed as Exhibit 1.A.(5) to Form S-6, Registration Statement No. 33-25372, filed November 4, 1988, and incorporated herein by reference.\n4.4 Custom VAL (previously named Adjustable Premium VAL) Life Insurance Contracts with variable death benefit, filed as Exhibit 1.A.(5) to Form S-6, Registration Statement No. 33-25372, filed November 4, 1988, and incorporated herein by reference.\n4.5 Variable Appreciable Life Insurance Contracts with fixed death benefit, filed as Exhibit 1.A.(5) to Pre-Effective Amendment No. 1 to Form S-6, Registration Statement No. 33-20000, filed June 15, 1988, and incorporated herein by reference.\n4.6 Variable Appreciable Life Insurance Contracts with variable death benefit, filed as Exhibit 1.A.(5) to Pre-Effective Amendment No. 1 to Form S-6, Registration Statement No. 33-20000, filed June 15, 1988, 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 Pre-Effective Amendment No. 1 to Form S-1, Registration Statement No. 33-20083, 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 Pre-Effective Amendment No. 1 to Form S-1, Registration Statement No. 33-20083, 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. Powers of Attorney: F. Agnew, F. Becker, W. Boeschenstein, L. Carter, Jr., J. Cullen, C. Davis, R. Enrico, A. Gilmour, W. Gray, III, J. Hanson, C. Horner, A. Jacobson, G. Keith, Jr., B. Malkiel, J. Opel, A. Ryan, C. Sitter, D. Staheli, R. Thomson, P. Vagelos, S. Van Ness, P. Volcker, and J. Williams, filed as Exhibit 9 to Post-Effective Amendment No. 15 to Form S-6, Registration Statement No. 33-20000, filed May 1, 1995, 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.\nTHE PRUDENTIAL INSURANCE COMPANY OF AMERICA in respect of The Prudential Variable Contract Real Property Account ------------------------------------------------------ (Registrant)\nDate: March 19, 1996 By: \/s\/ Esther H. Milnes ----------------- ------------------------ Esther H. Milnes Vice President\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nSignature Title Date - --------- ----- ----\n* Chairman of the Board and March 18, 1996 ------------------------ Chief Executive Officer Arthur F. Ryan\n\/s\/ Stephen P. Tooley Chief Accounting Officer March 18, 1996 - ------------------------- Stephen P. Tooley\n* Director March 18, 1996 ------------------------ Franklin E. Agnew\n* Director March 18, 1996 ------------------------ Frederic K. Becker\nBy: * \/s\/ Thomas J. Loftus --------------------- Thomas J. Loftus (Attorney-in-Fact)\nSignature Title Date - --------- ----- ----\n* Director March 18, 1996 ------------------------ William W. Boeschenstein\n* Director March 18, 1996 ------------------------ Lisle C. Carter, Jr.\n* Director March 18, 1996 ------------------------ James G. Cullen\n* Director March 18, 1996 ------------------------ Carolyne K. Davis\n* Director March 18, 1996 ------------------------ Roger A. Enrico\n* Director March 18, 1996 ------------------------ Allan D. Gilmour\n* Director March 18, 1996 ------------------------ William H. Gray, III\n* Director March 18, 1996 ------------------------ Jon F. Hanson\n* Director March 18, 1996 ------------------------ Constance J. Horner\n* Director March 18, 1996 ------------------------ Allen F. Jacobson\n* Director March 18, 1996 ------------------------ Garnett L. Keith, Jr.\n* Director March 18, 1996 ------------------------ Burton J. Malkiel\nBy: * \/s\/ Thomas J. Loftus --------------------- Thomas J. Loftus (Attorney-in-Fact)\nSignature Title Date - --------- ----- ----\n* Director March 18, 1996 ------------------------ John R. Opel\n* Director March 18, 1996 ------------------------ Charles R. Sitter\n* Director March 18, 1996 ------------------------ Donald L. Staheli\n* Director March 18, 1996 ------------------------ Richard M. Thomson\n* Director March 18, 1996 ------------------------ P. Roy Vagelos, M.D.\n* Director March 18, 1996 ------------------------ Stanley C. Van Ness\n* Director March 18, 1996 ------------------------ Paul A. Volcker\n* Director March 18, 1996 ------------------------ Joseph H. Williams\nBy: * \/s\/ Thomas J. Loftus --------------------- Thomas J. Loftus (Attorney-in-Fact)\nTHE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY ACCOUNT (Registrant)\nINDEX\nPage ----\nA. THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY ACCOUNT\nIndependent Auditors' Report\nFinancial Statements:\nStatements of Net Assets - December 31, 1995 and 1994\nStatements of Operations - Years Ended December 31, 1995, 1994 and 1993\nStatements of Changes in Net Assets - Years Ended December 31, 1995, 1994 and 1993\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, 1995 and 1994\nStatements of Operations - Years Ended December 31, 1995, 1994 and 1993\nStatements of Changes in Net Assets - Years Ended December 31, 1995, 1994 and 1993\nStatements of Cash Flows - Years Ended December 31, 1995, 1994 and 1993\nSchedule of Investments - December 31, 1995 and 1994\nNotes to Financial Statements\nTHE PRUDENTIAL 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\nAll other schedules are omitted because they are not applicable, or because the required information is included in the financial statements or notes thereto.\n[Deloitte & Touche LLP letterhead]\nINDEPENDENT AUDITORS' REPORT\nTo the Contract Owners of The Prudential Variable Contract Real Property Account Newark, New Jersey\nWe have audited the accompanying statements of net assets of The Prudential Variable Contract Real Property Account (\"Real Property Account\") as of December 31, 1995 and 1994, and the related statements of operations and changes in net assets for each of the three years in the period ended December 31, 1995. 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 amount and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, 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 Account as of December 31, 1995 and 1994, and the results of its operations and the changes in net assets for each of the three years in the period ended December 31, 1995 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, 1995 and 1994, as discussed in Note 1 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.\n\/s\/ Deloitte & Touche LLP\nMarch 1, 1996\nFINANCIAL STATEMENTS OF THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY ACCOUNT\nSTATEMENTS OF NET ASSETS\nSTATEMENTS OF OPERATIONS\nSEE NOTES TO FINANCIAL STATEMENTS ON PAGES THROUGH.\nFINANCIAL STATEMENTS OF THE PRUDENTIAL 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 THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY ACCOUNT For Years Ended December 31, 1995, 1994 and 1993\nNOTE 1: GENERAL\nThe Prudential Variable Contract Real Property Account (the \"Real Property Account\") was established on November 20, 1986 by resolution of the Board of Directors of The Prudential Insurance Company of America (\"The Prudential\"), as a separate investment account pursuant to New Jersey law. The assets of the Real Property Account are segregated from The Prudential's other assets. The Real Property Account is used to fund benefits under certain variable life insurance and variable annuity contracts issued by The Prudential. On April 29, 1988, The Prudential contributed $100,000 to commence operations of the Real Property Account.\nThe assets of the Real Property Account are invested in The Prudential Variable Contract Real Property Partnership (the \"Partnership\"). The Partnership is a general partnership organized under New Jersey law on April 29, 1988, through agreement among The Prudential, Pruco Life Insurance Company, 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. On April 29, 1988, the Real Property Account initially contributed $100,000 to the 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. BASIS OF ACCOUNTING\nThe financial statements are prepared on a current value basis due to the fact that 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).\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, 1995 and 1994 the Real Property Account's interest in the Partnership, based on current value equity was 45.4% or 5,465,515 shares and 44.6% or 5,465,515 shares, respectively.\nC. INCOME RECOGNITION\nThe Real Property Account recognizes its proportionate share of the Partnership's net investment income on a daily basis, as 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 The Prudential's separate accounts investing in the Real Property Account:\n- -------------------------------------------------------------------------------- Variable Appreciable Account - Contracts with face amounts of less than $100,000 0.90% - Contracts with face amounts of $100,000 or more 0.60% Individual Variable Contract Account 1.20% - --------------------------------------------------------------------------------\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 The Prudential, 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 The Prudential. Under the Internal Revenue Code, all ordinary income and capital gains allocated to the Contract owners are not taxable to The Prudential. 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: 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 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 commitment is reduced by $10 million for every $100 million in current value net assets of the Partnership. The amount available under this commitment as of December 31, 1995 is approximately $52.2 million.\nNOTE 6: NET REALIZED LOSS ON INVESTMENT\nThe Net Realized Loss on Investment reflected on the Statement of Operations represents the Real Property Account'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, 1995 financial statements.\n[Deloitte & Touche LLP letterhead]\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 including the schedules of investments, of the Prudential Variable Contract Real Property Partnership as of December 31, 1995 and 1994, 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, 1995 (collectively referred to as the financial statements). 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, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995 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.\nInvestments in properties and interest in properties are stated at current value at December 31, 1995 and 1994, as discussed in Note 1 to the financial statements. Determination of current value involves subjective judgment because the actual market value of real estate can be determined only by negotiation between the parties in a sales transaction.\n\/s\/ Deloitte & Touche LLP\nMarch 1, 1996\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\nSCHEDULE OF INVESTMENTS\n(a) Includes land under capital lease of $3,412,636 representing the present value of minimum future lease payments at the inception of the lease.\nTHE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP\nSCHEDULE OF INVESTMENTS\nTHE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP\nSCHEDULE OF INVESTMENTS\nNOTES TO FINANCIAL STATEMENTS OF THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP For Years Ended December 31, 1995, 1994, 1993\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 Insurance Company of America, Pruco Life Insurance Company and Pruco Life Insurance Company 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. The real estate valuations are reviewed internally at least every three months and adjusted if there has been any significant changes and circumstances related to the real estate since the most recent independent appraisal.\nThe Chief Appraiser of the Prudential Comptroller's Department Valuation Unit (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 real estate valuations are reviewed quarterly by the Valuation Unit 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 real estate as of a specific date. Current value has been defined as the most probable price for which the appraised real estate 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 real estate 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 real estate in the market. In the reconciliation of these three approaches, the one most heavily relied upon is the one generally recognized for the type of real estate in the market.\nB: 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.\nC: Cash Equivalents - The Partnership considers all highly liquid investments with an original maturity of three months or less when purchased to be cash equivalents. Cash equivalents are carried at market value.\nD: Marketable Securities - Marketable securities are highly liquid investments with maturities of more than three months when purchased and are carried at market value.\nE: 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 $193,288,982 at December 31, 1995 and $148,001,027 at December 31, 1994.\nF: Basis of Accounting - The financial statements are prepared on a current value basis due to the fact that the unit values under Contracts participating in the Partnership are determined using the current value basis of investments (see General Note).\nG: Management Use of Estimates in the Financial Statements - 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 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.\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 . In 1995, the annual ground lease payment increased $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. The Partnership intends to exercise its option\nto purchase the Ground Lease prior to its expiration. Future minimum ground lease payments under capital lease at December 31, 1995 are as follows:\n1996 $ 376,450 Thereafter 4,062,742 ---------- Total minimum ground lease payments 4,439,192 Less amount representing interest 556,771 ---------- Present value of minimum ground lease payments $3,882,421 ---------- ----------\nNote 3: Investment In Mortgage Loans\nAt December 31, 1993, the Partnership had an investment in two mortgage loans with a current value totaling $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, 1995 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, 1995, 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.\nYear Ending December 31, ------------ 1996 $14,170,889 1997 11,474,949 1998 8,926,646 1999 7,766,592 2000 6,837,373 Thereafter 19,199,780 ----------- Total $68,376,229 ----------- -----------\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, 1995, 1994 and 1993 management fees incurred by the Partnership were $2,341,878, $2,287,816, and $2,269,206, respectively.\nThe Partnership also reimburses The Prudential for certain administrative services rendered by The Prudential. The amounts incurred for the years ended December 31, 1995, 1994 and 1993 were $123,919; $95,015; and $119,467, 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, 1995 , these properties had total assets of $10,316,275 and liabilities of $33,802. For the year ended December 31, 1995 the Unit warehouses had revenues of $1,601,012 and expenses of $715,797.\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, through August 1995 at the Bolingbrook, IL warehouse, through October 1994 at the Atlanta, GA, Desoto, TX, Fort Worth, TX, Shreveport, LA, Bedford Park, IL, and Normal, IL warehouses, and through August 1993 at the Pomona and Azuza warehouses. The property management fees earned by PREMISYS for the years ended December 31, 1995, 1994, and 1993 were $31,360, $92,382, and $89,684, respectively.\nNote 6: Line Of Credit\nThe Partnership had established a $10 million annually renewable unsecured revolving line of credit with First Fidelity Bank, N.A., which could have been drawn upon as needed for potential liquidity needs. The annual cost of maintaining the line of credit was 0.1875% of the total line of credit. Since no drawdowns had occurred and management did not anticipate the need to draw upon this resource in the future, the line of credit was discontinued as of October 31, 1995.\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 commitment is reduced by $10 million for every $100 million in current value net assets of the Partnership. The amount available under this commitment for property purchases as of December 31, 1995 is approximately $52.2 million.\nNote 8: Net Realized Loss on Investments\nOn October 7, 1994, the Partnership sold its 50% ownership interest in the two warehouse\/distribution buildings located in Atlanta, GA and the ones 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: Foreclosure on Mortgage Loan\nOn 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 2, 1995.\nNote 10: Per Share Information (For a share outstanding throughout the year.)\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.","section_15":""}
{"filename":"88000_1995.txt","cik":"88000","year":"1995","section_1":"ITEM 1. BUSINESS. - -------------------\nPortions of the 1995 Annual Report to shareholders of Scott's Liquid Gold-Inc. (the \"Company\" or \"Registrant\") are attached to this Report as Exhibit 13 and are called in this Report the \"Annual Report\". The information set forth under the headings \"Description of Business,\" \"Products and Services,\" and \"Management Discussion and Analysis of Financial Condition and Results of Operations\" of the Annual Report hereby is incorporated by reference into this Report.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES. - ---------------------\nThe information set forth under \"Description of Business - Properties\" and \"Management Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources\" of the Annual Report hereby is incorporated by reference into this Report.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS. - ----------------------------\nThe information set forth under \"Description of Business - Legal Proceedings\" and \"Management Discussion and Analysis of Financial Condition and Results of Operations - Other\" of the Annual Report hereby is incorporated by reference into this Report. The lawsuit by the United States Department of Justice at the request of the United States Army, as described therein, is United States of America v. Scott's Liquid Gold-Inc., in the United States - ----------------------------------------------------\nDistrict Court for the District of Colorado and was instituted on September 8, 1994.\nThe lawsuits against private label producers, as described in the Report, are the following: Neoteric Cosmetics, Inc. v. Evron Industries, Inc., in the --------------------------------------------------\nUnited States District Court for the District of Colorado, which was instituted on January 30, 1996; and Neoteric Cosmetics, Inc. v. Perrigo Co. and Cumberland- -------------------------------------------------------\nSwan, Inc., in the United States District Court for the District of - ----------\nMassachusetts, which was instituted on July 18, 1995.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. - -------------------------------------------------------------\nNot applicable.\nPART II - -------\nITEM 5, MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. - --------------------------------------------------------------------------------\nThe information set forth under \"Corporate Data\" and \"Market Information\" of the Annual Report hereby is incorporated by reference into this Report.\nAs of March 11, 1996, the Company had approximately 1,400 shareholders of record.\nThe high and low prices of Scott's Liquid Gold-Inc. common stock as traded on the New York Stock Exchange for the 1995 year were as follows:\nITEM 6.","section_5":"","section_6":"ITEM 6. SELECTED FINANCIAL DATA. - ----------------------------------\nThe information set forth under \"Selected Financial Data\" of the Annual Report hereby is incorporated by reference into this Report.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND - ------\nRESULTS OF OPERATIONS.\nThe information set forth under \"Management Discussion and Analysis of Financial Condition and Results of Operations\" of the Annual Report hereby is incorporated by reference into this Report.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. - -------- The information set forth under \"Consolidated Financial Statements,\" \"Notes to Consolidated Financial Statements,\" \"Report of Independent Public Accountants\" and \"Selected Financial Data - Selected Quarterly Financial Data\" of the Annual Report hereby is incorporated by reference into this Report.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND - ------------------------------------------------------------------------\nFINANCIAL DISCLOSURE. - ---------------------\nNot applicable.\nPART III - --------\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. - -------------------------------------------------------------\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION. - ---------------------------------\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. - -------------------------------------------------------------------------\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. - ---------------------------------------------------------\nFor Part III, the information set forth in the Company's definitive Proxy Statement for the Company's Annual Meeting of Shareholders to be held on May 1, 1996, hereby is incorporated by reference into 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:\nConsolidated Statements of Income - Years ended December 31, 1995, 1994 and 1993\nConsolidated Balance Sheets - December 31, 1995 and 1994\nConsolidated Statements of Cash Flows - Years ended December 31, 1995, 1994 and 1993\nConsolidated Statements of Shareholders' Equity - Years ended December 31, 1995, 1994 and 1993\nNotes to Consolidated Financial Statements\nReport of Independent Public Accountants\n(2) Financial Statement Schedules:\nII - Valuation and Qualifying Accounts - Years ended December 31, 1995, 1994 and 1993\nInasmuch as Registrant is primarily a holding company and all subsidiaries are wholly-owned, only consolidated statements are being filed. 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 included in the financial statements or notes to the financial statements.\n(b) Reports on Form 8-K:\nNot applicable.\n(c) Exhibits:\nDOCUMENT -------- EXHIBIT NO. - -------\n3.1 Articles of Incorporation, as amended and restated through May 4, 1988, incorporated by reference to Exhibit 3.1 of Annual Report on Amended Form 10-K for the year ended December 31, 1993. 3.2 Bylaws, as amended through February 27, 1996. 4.1 Indenture of Trust (including form of First Mortgage Bond Due 2001) dated July 1, 1994 between Registrant and Norwest Bank Colorado, N.A. as Trustee, incorporated by reference to Exhibit 4.1 of the Company's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1994. 4.2 Combination Deed of Trust, Security Agreement and Fixture Financing Statement, dated July 29, 1994, between the Company, as Grantor, the Public Trustee for the City and County of Denver, Colorado, and Norwest Bank Colorado, N.A. as Beneficiary, incorporated by reference to Exhibit 4.2 of the Company's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1994. 10.1* Scott's Liquid Gold-Inc. Fourth Amended Health and Accident Plan effective January 1, 1995, incorporated by reference to Exhibit 10.1 of Annual Report on Form 10-K for the year ended December 31, 1994. 10.2* Amended Key Executive Disability Plan--Scott's Liquid Gold-Inc., incorporated by reference to Exhibit 10.2 of Annual Report on Form 10-K for the year ended December 31, 1992. 10.3* Scott's Liquid Gold-Inc. Restricted Stock Plan effective July 22, 1987, incorporated by reference to Exhibit 10.3 of Annual Report on Amended Form 10-K for the year ended December 31, 1993. 10.4* 1996 Key Executive Bonus Plan.\n10.5* Indemnification Agreements dated May 6, 1987 between the Registrant and Jerome J. Goldstein, Mark E. Goldstein, Carolyn J. Anderson, and Barry Shepard, incorporated by reference to Exhibit 10.5 of Annual Report on Amended Form 10-K for the year ended December 31, 1993. An Indemnification Agreement dated October 4, 1990 between the Registrant and Michael J. Sheets, incorporated by reference to Exhibit 10.5 of Annual Report on Form 10-K for the year ended December 31, 1990. An Indemnification Agreement dated December 23, 1991 between the Registrant and Dennis H. Field, and two separate Indemnification Agreements dated January 17, 1992 between the Registrant and Michael J. Sheets and Dennis H. Field, incorporated by reference to Exhibit 10.5 of Annual Report on Form 10-K for the year ended December 31, 1992. Indemnification Agreement dated February 23, 1993 between the Registrant and James F. Keane, incorporated by reference to Exhibit 10.5 of Quarterly Report on Form 10-Q for the three months ended March 31, 1993. 10.6* Scott's Liquid Gold-Inc. Employee Stock Ownership Plan and Trust Agreement, effective January 1, 1989, and First and Second Amendments thereto, incorporated by reference to Exhibit 10.6 of Annual Report on Form 10- K for the year ended December 31, 1994. 10.7* 1986 Incentive Stock Option Plan and First Amendment thereto, incorporated by reference to Exhibit 4.4 of the Company's Registration Statement No. 33-63254 on Form S-8, filed with the Commission on May 25, 1993. 10.8* Scott's Liquid Gold-Inc. 1993 Stock Option Plan for Outside Directors, incorporated by reference to Exhibit 4.7 of the Company's Registration Statement No. 33-63254 on Form S-8, filed with the Commission on May 25, 1993. 10.9 Compliance Order on Consent, executed by the Colorado Department of Health on March 5, 1990, originally filed with the Commission on Form 10-K for the year ended December 31, 1989, and incorporated by reference to Exhibit 10.9 of Annual Report on Form 10-K for the year ended December 31, 1994. 13 Portions of 1995 Annual Report to Security Holders. 21 List of Subsidiaries, incorporated by reference to Exhibit 21 of Annual Report on Form 10-K for the year ended December 31, 1994. 23 Consent of Arthur Andersen LLP. 24 Powers of Attorney. 27 Financial Data Schedule.\n*Management contract or compensatory plan or arrangement\n(1) Uncollectible accounts written off, net of recoveries.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Board of Directors and Shareholders of Scott's Liquid Gold-Inc.:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements of Scott's Liquid Gold- Inc. and subsidiaries' annual report to shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated January 15, 1996. Our audit was made for the purpose of forming an opinion on those statements taken as a whole. The schedule listed in the index of financial statements 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.\n\/s\/ Arthur Andersen LLP\nDenver, Colorado January 15, 1996\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.\nDate: March 28, 1996.\nSCOTT'S LIQUID GOLD-INC. a Colorado corporation\nBy: \/s\/ Barry Shepard --------------------------------------- Barry Shepard, as an Attorney-in-Fact for Mark E. Goldstein, President Principal Executive Officer\nBy: \/s\/ Barry Shepard --------------------------------------- Barry Shepard, Treasurer Principal Financial Officer\nBy: \/s\/ Jeffry B. Johnson --------------------------------------- Jeffry B. Johnson, Controller\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons of the Registrant and in the capacities and on the dates indicated:\nDate Name and Title Signature - ---- -------------- ---------\nMarch 28, 1996 Carolyn J. Anderson, ) Director ) ) March 28, 1996 Mark E. Goldstein, ) Director ) ) March 28, 1996 Jerome J. Goldstein, ) \/s\/ Barry Shepard Director ) ------------------------- ) Barry Shepard, for ) himself and as Attorney- ) in-Fact for the named ) directors who March 28, 1996 Dennis H. Field, ) together constitute all of Director ) the members of ) Registrant's Board of ) Directors March 28, 1996 Michael J. Sheets, ) Director )\nEXHIBIT INDEX -------------\nEXHIBIT DOCUMENT NO. -------- - ----\n3.1 Articles of Incorporation, as amended and restated through May 4, 1988, incorporated by reference to Exhibit 3.1 of Annual Report on Amended Form 10-K for the year ended December 31, 1993. 3.2 Bylaws, as amended through February 27, 1996. 4.1 Indenture of Trust (including form of First Mortgage Bond Due 2001) dated July 1, 1994 between Registrant and Norwest Bank Colorado, N.A. as Trustee, incorporated by reference to Exhibit 4.1 of the Company's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1994. 4.2 Combination Deed of Trust, Security Agreement and Fixture Financing Statement, dated July 29, 1994, between the Company, as Grantor, the Public Trustee for the City and County of Denver, Colorado, and Norwest Bank Colorado, N.A. as Beneficiary, incorporated by reference to Exhibit 4.2 of the Company's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1994. 10.1* Scott's Liquid Gold-Inc. Fourth Amended Health and Accident Plan effective January 1, 1995, incorporated by reference to Exhibit 10.1 of Annual Report on Form 10-K for the year ended December 31, 1994. 10.2* Amended Key Executive Disability Plan--Scott's Liquid Gold-Inc., incorporated by reference to Exhibit 10.2 of Annual Report on Form 10-K for the year ended December 31, 1992. 10.3* Scott's Liquid Gold-Inc. Restricted Stock Plan effective July 22, 1987, incorporated by reference to Exhibit 10.3 of Annual Report on Amended Form 10-K for the year ended December 31, 1993. 10.4* 1996 Key Executive Bonus Plan. 10.5* Indemnification Agreements dated May 6, 1987 between the Registrant and Jerome J. Goldstein, Mark E. Goldstein, Carolyn J. Anderson, and Barry Shepard, incorporated by reference to Exhibit 10.5 of Annual Report on Amended Form 10-K for the year ended December 31, 1993. An Indemnification Agreement dated October 4, 1990 between the Registrant and Michael J. Sheets, incorporated by reference to Exhibit 10.5 of Annual Report on Form 10-K for the year ended December 31, 1990. An Indemnification Agreement dated December 23, 1991 between the Registrant and Dennis H. Field, and two separate Indemnification Agreements dated January 17, 1992 between the Registrant and Michael J. Sheets and Dennis H. Field, incorporated by reference to Exhibit 10.5 of Annual Report on Form 10-K for the year ended December 31, 1992. Indemnification Agreement dated February 23, 1993 between the Registrant and James F. Keane, incorporated by reference to Exhibit 10.5 of Quarterly Report on Form 10-Q for the three months ended March 31, 1993. 10.6* Scott's Liquid Gold-Inc. Employee Stock Ownership Plan and Trust Agreement, effective January 1, 1989, and First and Second Amendments thereto, incorporated by reference to Exhibit 10.6 of Annual Report on Form 10-K for the year ended December 31, 1994. 10.7* 1986 Incentive Stock Option Plan and First Amendment thereto, incorporated by reference to Exhibit 4.4 of the Company's Registration Statement No. 33-63254 on Form S-8, filed with the Commission on May 25, 1993. 10.8* Scott's Liquid Gold-Inc. 1993 Stock Option Plan for Outside Directors, incorporated by reference to Exhibit 4.7 of the Company's Registration Statement No. 33-63254 on Form S-8, filed with the Commission on May 25, 1993. 10.9 Compliance Order on Consent, executed by the Colorado Department of Health on March 5, 1990, originally filed with the Commission on Form 10-K for the year ended December 31, 1989, and incorporated by reference to Exhibit 10.10 of Annual Report on Form 10-K for the year ended December 31, 1994. 13 Portions of 1995 Annual Report to Security Holders. 21 List of Subsidiaries, incorporated by reference to Exhibit 21 of Annual Report on Form 10-K for the year ended December 31, 1994. 23 Consent of Arthur Andersen LLP. 24 Powers of Attorney. 27 Financial Data Schedule\n*Management contract or compensatory plan or arrangement","section_15":""}
{"filename":"715988_1995.txt","cik":"715988","year":"1995","section_1":"Item 1. Business.\nBrauvin Real Estate Fund L.P. 3 (the \"Partnership\") is a Delaware limited partnership formed in July 1983 whose business has been devoted exclusively to acquiring, operating, holding for investment and disposing of existing office buildings, shopping centers and industrial and retail commercial buildings of a general purpose nature, all in larger metropolitan areas.\nThe General Partners originally intended to dispose of the Partnership's properties approximately five to eight years after acquisition of each property, with a view toward liquidation of the Partnership. Due to real estate market conditions and economic trends the General Partners instead believed it to be in the best interest of the Parternship to retain the properties until such time as the General Partners deemed it appropriate to dispose of the Partnership's properties. The General Partners have now determined that it is in the best interest of the Partnership to liquidate the Partnership. Accordingly, efforts are currently underway to sell or otherwise liquidate the remaining Partnership assets. There can, however, be no assurance that the General Partners will achieve their goal of liquidating the Partnership during 1996. However, since the limited partnership agreement (the \"Agreement\") provides that the Partnership shall terminate December 31, 2007, unless sooner terminated, the General Partners shall in no event dispose of the properties after that date.\nDuring 1984, the Partnership had acquired three properties, one of which was conveyed to the first mortgage holder in 1989. In June 1995 an additional property was conveyed to the first mortgage holder. The remaining property consisted of three office buildings, one of which was sold in May 1995. The Partnership will not purchase any additional properties.\nThe Partnership is currently operating the two remaining office buildings which are being managed by Brauvin Management Company. The focus of property management activities has been improvement in the economic performance of the properties with the goal of maximizing value to the Partnership upon disposition.\nThe Partnership has no employees.\nThe Partnership utilized its proceeds available for investment for the acquisition of properties. In seeking disposition opportunities,\nthe Partnership is competing with many established and experienced firms, as well as individuals and entities who own properties similar to those owned by the Partnership. The Partnership, therefore, expects keen competition in connection with the sale of its properties.\nThe Partnership, by virtue of its ownership of real estate, is subject to federal and state laws and regulations covering various environmental issues. Management of the Partnership retains the services of third parties who hold themselves out to be experts in the field to assess a wide range of environmental issues and conduct tests for environmental contamination. Management believes that all real estate owned by the Partnership is in full compliance with applicable environmental laws and regulations.\nMarket Conditions\/Competition\nThe Partnership faces active competition in all aspects of its business and must compete with entities which own properties similar in type to those owned by the Partnership. Competition exists in such areas as attracting and retaining creditworthy tenants, financing capital improvements and eventually selling properties. Many of the factors affecting the ability of the Partnership to compete such as, softened markets caused by an oversupply of similar rental facilities, declining performance in the economy in which a property is located, population shifts, reduced availability of permanent mortgage funds, and changes in zoning laws or changes in patterns of the needs of users, are beyond the General Partners' control. The marketability of the properties may also be affected by prevailing interest rates and existing tax laws. As a result, the Partnership has retained ownership of its properties for periods longer than anticipated at acquisition; in addition, it may refinance, sell or otherwise dispose of certain properties at times or on terms and conditions that are less advantageous than would otherwise be the case if such unfavorable economic or market conditions did not exist.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nThe following is a discussion of the rental properties owned and operated by the Partnership. The Partnership purchased three properties during 1984 and has not purchased any additional properties. On December 26, 1989, the Partnership conveyed Kensington Tower back to the first mortgage lender, Travelers Insurance Company. In 1995, the Partnership conveyed the Country Club Plaza back to the first mortgage lender, Finova Capital Corporation. The Partnership also sold one of the three Bear Canyon office buildings in 1995.\nAs of December 31, 1995, the Partnership owned the property described below:\nLocation Description of Property Albuquerque, NM Two Office Buildings\nBear Canyon Professional Buildings (\"Bear Canyon\")\nOn November 16, 1984, the Partnership acquired three, two-story office buildings with approximately 63,000 square feet of space, collectively known as the Bear Canyon Professional Buildings, located in Albuquerque, New Mexico. The Partnership paid approximately $4,700,000 for these properties consisting of $1,600,000 in cash and the issuance of an all-inclusive note to the seller in the amount of approximately $3,100,000. This all-inclusive wrap note accrued interest at the rate of 12.375% to 12.025% per annum compounded annually over the term of the all-inclusive note, which was to mature at the time of the sale of Bear Canyon. The holder of the note was to receive 25% of the property's cash flow after debt service and was to provide a 9% guaranteed return to the Partnership on its investment in Bear Canyon.\nAs a result of legal proceedings instituted by the Partnership against the seller, a settlement agreement was reached whereby the Partnership is no longer obligated to the seller under the terms of the all-inclusive wrap note and is now obligated directly to the underlying lenders. Furthermore, the seller is no longer entitled to share in any portion of Operating Cash Flow or sale proceeds derived from Bear Canyon.\nOn May 26, 1995, the Partnership sold the Bear Canyon Office Building II to an unaffiliated third party for approximately $920,000. The net sales proceeds to the Partnership were approximately $377,000 which were used to fund operating expenses.\nOn October 1, 1992, the Partnership signed a loan modification agreement with the lender of Bear Canyon Office Building I (the \"Bear Canyon I\"). The modification reduced the interest rate from 10.875% to 8.875%, effective July 1, 1992, and reduced the monthly payments to interest only payments. The unpaid interest on the loan as of July 1, 1992 was added to the principal of the note. Additional payments of 50% of annual cash flow, if any, commencing in the fourth quarter of 1992 and calculated quarterly as of December 31, March 31, June 30 and September 30 shall be applied to the principal of the note.\nOn April 20, 1995 the Partnership received a further modification from the lender extending the maturity date from May 1, 1995 to May 1, 1996. The modification increased the interest rate from 8.875% to 10%. Interest is payable monthly and additional payments of 50% of annual cash flow, if any, calculated quarterly as of December 31, March 31, June 30 and September 30 shall be applied to the principal of the note.\nThe Bear Canyon I building is currently under contract for sale to an unaffiliated third party for $625,000. The Partnership will consider reverting the property to the first mortgage lender during 1996 if the property cannot be sold to an unaffiliated third party. As of December 31, 1994, the carrying amount of the affected real estate pledged as collateral was written down to the related outstanding debt of $414,730 and the resulting loss of $344,452 was included in the adjustment to liquidation basis in the statement of changes in net liabilities in liquidation.\nThe Partnership modified the mortgage on Bear Canyon Office Building III during the third quarter of 1990 (the \"First Loan Modification\"). The First Loan Modification reduced the interest pay rate on the mortgage from 13.50% to 6.0% for the period from September 1989 to August 1990 and the interest pay rate was reduced from 13.50% to 9.75% for the period from September 1990 to August 1991. The difference between the pay rate and the initial rate of 13.5% was to be deferred, but was forgiven pursuant to the Second Loan Modification (defined below). Bear Canyon Office Building III continued to operate at a cash flow deficit after the First Loan Modification. In November 1991, the Partnership reached an agreement with the lender to further modify the terms of the mortgage loan in a manner which the Partnership believed would allow the property to operate at a break-even or positive cash flow level (the \"Second Loan Modification\"). Pursuant to the terms of the Second Loan Modification, the annual interest rate was reduced from 13.5% to 3% effective December 1, 1990. The Partnership would make monthly payments of interest, plus principal payments based upon a: (i) 30 year amortization schedule plus 100% of net cash flow through June 1, 1992; (ii) 25 year amortization schedule plus 100% of net cash flow from July 1, 1992 through June 1, 1993; and (iii) 15 year amortization schedule plus 50% of net cash flow from July 1, 1993 through July 1, 1997, the extended maturity date. The deferred interest which began accruing in September 1989 and the interest thereon has been forgiven and was not added to the principal amount of the loan as had been agreed upon pursuant to the First Loan Modification. Due to the\nSecond Loan Modification, the Partnership recognized a non-cash gain on forgiveness of deferred interest of $154,129 in 1991.\nThe lender has the option to accelerate the loan maturity on July 1, of each year if the property is not: (i) in good condition and repair; (ii) occupied at a rate that is equal to the prevailing occupancy rate for similar properties in the same locale; and (iii) leased at rental rates which are at least 90% of the prevailing rate for similar properties in the same locale. In the opinion of the General Partners, the property currently meets these standards. The Partnership established an escrow account with the mortgage servicing agent in which the Partnership deposited approximately $21,000 to be used to perform certain repairs and improvements to the property. These escrowed funds were fully utilized. As a condition to the Second Loan Modification, the Partnership has brought the loan current based on the modified terms. At the time the Partnership acquired the property it acquired the property subject to this mortgage and note. In order to complete the Second Loan Modification, the Partnership was required to assume the obligations and duties of the mortgage and note on a non-recourse basis.\nThe Bear Canyon III building is currently under contract for sale to an unaffiliated third party for $1,800,000. The Partnership will consider reverting the property to the first mortgage lender during 1996 if the property cannot be sold to an unaffiliated third party. As of December 31, 1994, the carrying amount of the affected real estate pledged as collateral was written down to the related outstanding debt of $1,461,925 and the resulting loss of $345,933 was included in the adjustment to liquidation basis in the statement of changes in net liabilities in liquidation.\nThe occupancy rate and average annual base rental per square foot at December 31 for the last five years are as follows(all three Bear Canyon office buildings are presented for the years ended December 31, 1994, 1993, 1992 and 1991): 1995 1994 1993 1992 1991\nOccupancy Rate 95% 97% 98% 80% 68% Average Annual Base Rental Per Square Foot $11.22 $10.26 $8.63 $9.18 $11.16\nBear Canyon I and III have one tenant who individually occupies ten percent or more of the net rentable square feet. The following is a summary of the tenant rent roll at December 31, 1995:\nSquare Annual Expiration Renewal Tenant Feet Rent Date Options Real Estate Center 6,757 74,327 3\/31\/96 No Others 37,371 420,698 Various Various Vacant 2,122 -- -- -- 46,250 $495,025\nRisks of Ownership\nThe possibility exists that the tenants of the Partnership's properties may be unable to fulfill their obligations pursuant to the terms of the leases, including making base rent payments to the Partnership. Such defaults by one or more of the tenants could have an adverse effect on the financial position of the Partnership. Furthermore, the Partnership may be unable to replace these tenants due to conditions in the market area and competition in the areas in which the properties are situated at the time any vacancies occur. Additionally, there are costs to the Partnership when replacing tenants such as leasing commissions and tenant improvements.\nIn the opinion of the General Partner, the Partnership has provided for adequate insurance coverage of its real estate investment properties.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nOn July 22, 1994, a complaint was filed with the Second Judicial District Court, in the county of Bernalillo, in the state of New Mexico, against the Partnership and Brauvin Real Estate Fund L.P. 4 (\"BREF 4\"), (the \"Defendants\"). United of Omaha Life Insurance Company (the \"Plaintiff\") alleges that the Defendants failed and refused to make payments when due and are in default under the Modification Agreements, secured by the Bear Canyon III property and a property in BREF 4, dated November 13, 1991. The Plaintiff declared due and owing, from the Partnership only, the principal sum of $1,510,300, together with accrued interest of $594,954, and non payment of cash flow payments in the amount of $25,930, totaling $2,131,184 together with interest from July 22, 1994. On September 6, 1994, the Partnership filed an answer and counterclaim. The\ncounterclaim alleges breach of contract and breach of the duty of good faith and dealing.\nOn July 18, 1995, the Plaintiff and Defendants agreed to dismiss all legal actions against each other. Furthermore, the parties agreed that the Partnership would make an additional payment of approximately $13,600 to reduce the principal balance of the loan, which it did on May 1, 1995. On August 10, 1995, in compliance with the agreement, an Order of Dismissal was entered in the Second Judicial District Court of the State of New Mexico.\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 Limited Partnership Interests and Related Security Holder Matters.\nAt December 31, 1995, there were approximately 631 Limited Partners in the Partnership. There is no established public trading market for Units and it is not anticipated that there will be a public market for Units. Bid prices quoted by \"partnership exchanges\" vary widely and are not considered a reliable indication of market value. Neither the Partnership nor Brauvin Realty Partners, Inc. (the \"Corporate General Partner\") will redeem or repurchase outstanding Units.\nPursuant to the terms of the Agreement, there are restrictions on the ability of the Limited Partners to transfer their Units. In all cases, the General Partners must consent to any transfer.\nThe Partnership suspended quarterly distributions to investors in May 1988 (beginning with the quarter ended March 31, 1988) due to cash flow shortages. As of December 31, 1995, cash distributions to Limited Partners have totaled $1,371,640.\nBRAUVIN REAL ESTATE FUND L.P.3 (a Delaware limited partnership) (Going Concern Basis)\nItem 6.","section_6":"Item 6. Selected Financial Data.\nFor the Six Months ended June 30, (Unaudited) 1994 1993 Selected Income Statement Data:\nTotal Income: $ 523,204 $ 476,085\nExtraordinary Item: Gain on extinguishment of debt -- 292,615\nNet Income (Loss) (175,393) 150,692\nNet Income (Loss) Per Limited Partnership Unit $ (22.47) $ 19.30\nSelected Balance Sheet Data:\nTotal Assets 7,066,809 7,400,754\nMortgages Payable $4,673,184 $4,784,137\nBRAUVIN REAL ESTATE FUND L.P.3 (a Delaware limited partnership) (Going Concern Basis)\nItem 6. Selected Financial Data - Continued\nYears Ended December 31,\n1993 1992 1991\nSelected Income Statement Data:\nTotal Income $ 925,522 $903,511 $915,290\nExtraordinary Items Gain on extinguishment of debt 292,172 -- 154,129\nNet Income (Loss) 26,784 (222,606) (19,117)\nNet Income (Loss) Per Limited Partnership Unit $ 3.43 $ (28.51) $ (2.45)\nSelected Balance Sheet Data:\nTotal Assets 7,153,861 7,400,754 7,502,795\nMortgages Payable $4,730,197 $5,148,403 $5,209,684\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nLiquidity and Capital Resources\nThe Partnership commenced an offering to the public on April 28, 1983 of 12,000 Units. A total of $7,729,000 was raised from the sale of Units. Of the properties held by the Partnership during 1995, the Partnership owned Country Club Plaza, which it acquired in 1984, and the Bear Canyon Professional Buildings (\"Bear Canyon\"), which it acquired in 1984. The Partnership conveyed Kensington Tower Building, in which it had acquired an 80% interest in 1984 and the remaining 20% interest in 1989, back to the first mortgage holder on December 26, 1989. The Partnership conveyed the Country Club Plaza back to the first mortgage holder on June 13, 1995. The Partnership sold one of the three Bear Canyon properties in May 1995 to an unaffiliated party for approximately $920,000.\nThe Partnership continues to operate at a cash flow deficit due to market conditions at the Bear Canyon properties and the payment of certain Partnership overhead items. The Partnership, not having the resources to continue to fund these deficits, requested loan modifications from the lenders in order to operate its properties at a break-even cash flow or better. The Partnership has been able to obtain loan modifications from the lenders of Bear Canyon I and Bear Canyon III. Bear Canyon I and III continue to generate a slight negative cash flow.\nAs a result of continued inadequate cash flow to service the Partnership's debts caused by its inability to increase tenant rental rates and\/or attract new tenants at the Partnership's remaining properties, the General Partners have decided to cease operations and liquidate all of the Partnership's assets as quickly as possible. The Partnership shall endeavor to sell all of its real estate holdings or negotiate an uncontested foreclosure of the properties to the lenders.\nThe partnership agreement (the \"Agreement\") provides that distributions of Operating Cash Flow, as defined in the Agreement, shall be distributed 99% to the Limited Partners and 1% to the General Partners. The receipt by the General Partners of such 1% of Operating Cash Flow is subordinate to receipt by the Limited Partners of Operating Cash Flow equal to a 9% per annum, cumulative, non-compounded return on Adjusted Investment, as such term is defined in the Agreement (the \"Preferential Distribution\"). In the event the full Preferential Distribution is not made in any year (herein referred to as a\n\"Preferential Distribution Deficiency\") and Operating Cash Flow is available in following years in excess of the Preferential Distribution for said year, then the Limited Partners shall be paid such excess Operating Cash Flow until they have been paid any unpaid Preferential Distribution Deficiency from prior years.\nThe Partnership has also entered into a contract to sell Bear Canyon I to an unaffiliated third party for approximately $625,000 with a closing anticipated for early 1996. The sale is subject to a \"due diligence\" review by the purchaser and a financing contingency. Accordingly, there can be no assurance that the sale will close.\nThe Partnership has entered into a contract to sell Bear Canyon III to an unaffiliated third party for approximately $1,800,000 with a closing anticipated for early 1996. The sale is subject to a \"due diligence\" review by the purchaser and a financing contingency. Accordingly, there can be no assurance that the sale will close.\nAs of December 31, 1995, the carrying amount of the Bear Canyon properties real estate pledged as collateral was $1,876,655 and the related outstanding debt was $1,749,375. In accordance with the liquidation basis of accounting, a provision for loss of $878,099 has been reflected in the 1994 financial statements.\nNet Sale Proceeds, as defined in the Agreement, received by the Partnership shall be distributed as follows: (a) first, to the Limited Partners until such time as the Limited Partners have been paid an amount equal to the amount of their Adjusted Investment; (b) second, to the Limited Partners until such time as the Limited Partners have been paid an amount equal to any unpaid Preferential Distribution Deficiency; and (c) third, 85% of any remaining Net Sale Proceeds to the Limited Partners, and the remaining 15% of the Net Sale Proceeds to the General Partners. At December 31, 1995, the Preferential Distribution Deficiency equaled $7,091,358.\nThe General Partners are doubtful that at the time the Partnership's properties are sold, Net Sale Proceeds will be sufficient to repay the Limited Partners an amount equal to a portion of their Adjusted Investment or certain portions of the unpaid Preferential Distribution Deficiency.\nFinancial Condition\nAs a result of the General Partners' decision to cease operations and liquidate the Partnership, the Partnership began using the liquidation basis of accounting as of July 1, 1994 and has stated its financial statements to reflect management's belief as to the approximate fair value of the Partnership's assets and its estimated liquidation costs. As of December 31, 1995, the total estimated value of the Partnership's assets was $1,934,115 and its liabilities were $2,032,875. The Partnership's assets as of December 31, 1995 consist of the two Bear Canyon office buildings. Based on the fair value of these properties and other assets, it is doubtful that any net liquidation proceeds will be available to distribute to Limited Partners.\nResults of Operations\nThe Partnership's revenue and expenses are affected primarily by the operations of the properties. Management of the Partnership has elected and may continue to renegotiate the terms of the mortgage loans (collateralized by the Partnership's properties) which frequently results in a reduction of interest expense over its remaining term to maturity or it may elect to dispose of assets that are non-performing in order to produce cash flow sufficient to support the total operations of the Partnership. Management evaluates the Partnership's properties to determine their long-term viability on an on-going basis.\nVarious factors, all beyond the control of the Partnership and its General Partner, converged to cause severe economic hardships on real estate owners which had not been experienced in more than fifty years. These conditions which have pervaded the real estate industry since the late 1980's to the current time have been referred to optimistically as a recession and realistically as a depression. Some of the factors which contributed to the current condition of the real estate industry include:\nDevelopment during the 1980's out paced demand for both office and retail space causing higher vacancy rates in many markets.\nPassage of the Tax Reform Act of 1986 reduced or eliminated most tax benefits associated with ownership\/investment in real estate forcing real estate to compete for capital based solely on a recession impacted cash flow.\nThe savings and loan crisis resulted in the creation of the Resolution Trust Corp. (RTC). The RTC sponsored auctions of large blocks of properties at significant discounts. This allowed the new\nowners to drop asking rentals markedly resulting in significantly lower market rents.\nRecessionary economic conditions combined with competitive forces caused many U.S. companies to reduce employment levels thus adversly impacting the demand for office space. This reduction in employment also resulted in reduced retail sales further depressing the demand for retail space.\nThese conditions have adversely impacted the Partnership's property economics. Rental and occupancy rates have improved at the remaining properties; however, they remain below where they were when the properties were acquired.\nIn certain instances and under limited circumstances, management of the Partnership has entered into negotiations with lenders for the purpose of restructuring the terms of loans so as to provide for debt service levels that could be supported by operations of the properties. In such instances, the terms of the restructuring agreement provided the lender with the potential for recovering forgone economic benefits at the time the property is sold or refinanced. When negotiations are unsuccessful, management of the Partnership considers the possibility of reverting the properties to the first mortgage lender. Foreclosure proceedings may require six to 24 months to conclude.\nAn affiliate of the Partnership and the General Partners is assigned responsibility for day-to-day management of the properties. The affiliate receives a management fee which cannot exceed 6% of gross revenues generated by the properties. Management fee rates are determined by the extent of services provided by the affiliate versus services that may be provided by third parties, i.e., independent leasing agents. In all instances, fees paid by the Partnership to the property management affiliate are, in the General Partner's opinion, comparable to fees that would be paid to independent third parties.\nThe General Partners conduct an in-depth assessment of each property's physical condition as well as a demographic analysis to assess opportunities for increasing occupancy and rental rates and decreasing operating costs. In all instances, decisions concerning restructuring of loan terms, reversions and subsequent operation of the property are made with the intent of maximizing the potential proceeds to the Partnership and, therefore, return of investment and income thereon to Limited Partners.\nResults of Operations - December 31, 1995 Compared to December 31,\nResults of operations prior to the $24,319 gain on the sale of Bear Canyon II and the $381,550 adjustment to the estimated losses through date of liquidation, for the year ended December 31, 1995 reflected net income of $68,229 compared to a net loss of $111,180 for the year ended December 31, 1994, an increase in net income of $179,409.\nTotal revenue generated for the year ended December 31, 1995 was $746,617 compared to $996,044 in 1994, a decrease of $249,427. The decrease in revenue was the result of the Partnership owning Country Club Plaza and all three Bear Canyon office buildings for the entire year of 1994. In May 1995, Country Club Plaza was foreclosed by the first mortgage lender, and Bear Canyon Office Building II was sold to an unaffiliated third party.\nTotal expenses incurred for the year ended December 31, 1995 were $678,388 compared to $1,111,224 in 1994, a decrease of $432,836. The decrease in expenses was mainly the result of the Partnership owning fewer properties due to the May 1995 foreclosure of Country Club Plaza and the sale of Bear Canyon II.\nResults of Operations - December 31, 1994 Compared to December 31, 1993\nPursuant to its liquidation basis of accounting, the Partnership accrued $2,135,197 as of July 1, 1994 to provide for operating expenses during its liquidation and adjust assets and liabilities to estimated net realizable value or settlement amounts, respectively. Net income was reduced by this amount for the period July 1, 1994 to December 31, 1994. The Partnership's write down of its assets to net realizable value pursuant to the liquidation basis of accounting resulted in a $1,971,197 reduction of net income for the period July 1, 1994 to December 31, 1994. The remaining liquidation expenses consisted of\n$100,000 in professional fees and $64,000 in property operating losses.\nResults of operations prior to adjustment to liquidation basis, for the year ended December 31, 1994 reflected a net loss of $111,180 compared to a net loss of $26,784 for the year ended December 31, 1993, an increase of $84,396.\nTotal revenue generated for the year ended December 31, 1994 was $996,044 compared to $925,522 in 1993, an increase of $70,522. The increase in revenue was due to an increase in occupancy at the Bear Canyon properties. The Partnership operated four rental properties in\n1994 which were acquired in 1984. The Partnership did not purchase any additional properties in 1994.\nTotal expenses incurred prior to the adjustment to liquidation basis, for the year ended December 31, 1994 were $1,111,224 compared to $1,190,910 in 1993, a decrease of $79,686. The decrease in expenses was mainly due to a decrease in depreciation expense as a result of the liquidation basis of accounting which reduced the properties to their net realizable value.\nResults of Operations - June 30, 1994 compared to June 30, 1993 (unaudited)\nResults of operations for the six months ended June 30, 1994 reflected a net loss of $175,393 compared to a net income of $150,692 for the six months ended June 30, 1993, a decrease of approximately $326,000. The decrease in net income was due to the Partnership recognizing a non-cash gain of approximately $292,000 which resulted from the forgiveness of debt on the Country Club loan modification finalized in 1993. Also contributing to the decrease in net income was an increase in legal fees of approximately $90,500 associated with litigation.\nTotal revenue generated for the six months ended June 30, 1994 was $523,204 compared to $476,085 in 1993, an increase of approximately $47,100. The increase in revenue was due to an increase in other income resulting from an increase in tenant reimbursement billings for the second quarter of 1994 as compared to the second quarter of 1993 which reflects a tenant reimbursement billings adjustment for the year ended 1992. The decrease in income was due to lower rental income during the second quarter of 1994 as a result of lower occupancy at the Partnership's properties.\nTotal expenses incurred for the six months ended June 30, 1994 were $698,597 compared to $618,008 in 1993, an increase of approximately $80,600. The increase in expenses was primarily due to an increase in legal fees of approximately $90,500 associated with litigation. Partially offsetting this increase was a decrease in general and administrative expenses such as bad debt and audit expense.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nSee index to Financial Statements and Schedule on Page of this Annual Report on Form 10-K for financial statements and financial statement schedule, where applicable.\nThe supplemental financial information specified in Item 302 of Regulation S-K is not applicable.\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 Partnership.\nThe General Partners of the Partnership are: Brauvin Realty Partners, Inc., a Delaware corporation Mr. Jerome J. Brault, individually Mr. Cezar M. Froelich, individually\nBrauvin Realty Partners, Inc. (the \"Corporate General Partner\"), was formed under the laws of the State of Delaware in December 1982, with its issued and outstanding shares being owned by The A.G.E Realty Corporation (50%), ChiCorp., Inc., the holding company of The Chicago Corporation (5%) and Messrs. Jerome J. Brault (beneficially) (22-1\/2%) and Cezar M. Froelich (22-1\/2%).\nMr. Jerome J. Brault. . . . . . . . .Chairman of the Board of Directors and President\nMr. Robert J. Herleth . . . . . . . .Vice President and Director\nMr. James L. Brault . . . . . . . . .Vice President and Secretary\nMr. David W. Mesker . . . . . . . . .Director\nMr. Thomas J. Coorsh. . . . . . . . .Chief Financial Officer and Treasurer\nThe business experience during the past five years of the General Partners and officers and directors of the Corporate General Partner are as follows:\nMr. Jerome J. Brault (age 62) is Director, Chairman of the Board and President of Brauvin Properties, Inc., Brauvin Realty Properties, Inc., Brauvin Realty Partners, Inc., Brauvin Ventures, Inc., Brauvin Associates, Inc., Brauvin 6, Inc., Brauvin Advisory Services, Inc., Brauvin Securities Inc. and Brauvin Restaurant Properties, Inc. He is Director, President, Chairman of the Board, Chief Executive Officer and Secretary of Brauvin Realty Services, Inc., Brauvin Management Company and Brauvin Financial, Inc. He is President and Director of Brauvin, Inc. He is also Director, President, Chairman of the Board and Chief Executive Officer of Brauvin Chili's Inc., Brauvin Realty Advisors, Inc., Brauvin Realty Advisors II, Inc., Brauvin Realty Advisors III,\nInc., Brauvin Realty Advisors IV, Inc., Brauvin Realty Advisors V, LLC, and Brauvin Net Lease V, Inc. as well as an individual general partner in seven other affiliated public limited partnerships. Prior to Mr. Brault's affiliation with the Brauvin organization, he was the Chief Operating Officer of Burton J. Vincent, Chesley & Company, a New York Stock Exchange member firm. He is the father of James L. Brault, officer of certain affiliated Brauvin entities.\nMr. Cezar M. Froelich (age 50) is a principal with the Chicago law firm of Shefsky Froelich & Devine Ltd., which acts as counsel to the General Partners, the Partnership and certain of their affiliates. His practice has been primarily in the fields of securities and real estate and he has acted as legal counsel to various public and private real estate limited partnerships, mortgage pools and real estate investment trusts. Mr. Froelich is an individual general partner in seven other affiliated public limited partnerships and a shareholder in Brauvin Management Company and Brauvin Financial Inc. Mr. Froelich resigned as a director of the corporate general partner in December 1994.\nMr. James L. Brault (age 35) is a Vice President and Secretary of Brauvin Chili's, Inc., Brauvin Properties, Inc., Brauvin Realty Properties, Inc., Brauvin Realty Partners, Inc., Brauvin Ventures, Inc., Brauvin 6, Inc., Brauvin Realty Advisors, Inc., Brauvin Realty Advisors II, Inc., Brauvin Realty Advisors III, Inc., Brauvin Associates Inc., Brauvin Inc., Brauvin Securities, Inc. and Brauvin Restaurant Properties, Inc. He is Executive Vice President and Secretary of Brauvin Advisory Services, Inc. He is also Executive Vice President, Secretary and Director of Brauvin Realty Advisors IV, Inc. and Brauvin Realty Advisors V, LLC., and Brauvin Net Lease V, Inc.. Additionally, he is the Executive Vice President and Assistant Secretary of Brauvin Management Company and Brauvin Financial, Inc., as well as a Director of Brauvin Financial, Inc. Prior to joining the Brauvin organization in May 1989, he was a Vice President of the Commercial Loan Division of the First National Bank of Chicago, based in their Washington, D.C. office. Mr. Brault joined the First National Bank of Chicago in 1983 and his responsibilities included the origination and management of commercial real estate loans, as well as the direct management of a loan portfolio in excess of $150,000,000. Mr. Brault received a B.A. in Economics from Williams College and an M.B.A. in Finance and Investments from George Washington University in 1983 and 1987, respectively. Mr. Brault is a son of Mr. Jerome J. Brault, the managing general partner of the Partnership.\nMr. Robert J. Herleth (age 43) is a Vice President and Director of Brauvin Properties, Inc., Brauvin Realty Properties, Inc., Brauvin Realty Partners, Inc., Brauvin Ventures, Inc., and Brauvin 6, Inc. He joined A.G. Edwards and Sons, Inc. in 1980 and presently serves as a Vice President of A.G.E. Realty Corp. Mr. Herleth is also a director and officer of Gull-AGE Capital Group and its subsidiaries.\nMr. David W. Mesker (age 64) is a Director of Brauvin Properties, Inc., Brauvin Realty Properties, Inc., Brauvin Realty Partners, Inc., Brauvin Ventures, Inc. and Brauvin 6, Inc. Mr. Mesker is presently a Senior Vice President of A.G. Edwards & Sons, Inc. and a Director and officer of Gull-AGE Capital Group and its subsidiaries.\nMr. Thomas J. Coorsh (age 46) is the Treasurer and Chief Financial Officer of Brauvin Chili's, Inc., Brauvin Properties, Inc., Brauvin Realty Properties, Inc., Brauvin Realty Partners, Inc., Brauvin Ventures, Inc., Brauvin 6, Inc., Brauvin Realty Advisors, Inc., Brauvin Realty Advisors II, Inc., Brauvin Realty Advisors III, Inc., Brauvin Realty Advisors IV, Inc., Brauvin Realty Advisors V, LLC., Brauvin Net Lease V, Inc., Brauvin Management Company, Brauvin Financial, Inc., Brauvin Securities, Inc., Brauvin Inc., Brauvin Associates, Inc., Brauvin Advisory Services, Inc. and Brauvin Restaurant Properties, Inc. He is responsible for the overall financial management of Brauvin Management Company, Brauvin Financial, Inc. and related partnerships. He is responsible for partnership accounting and financial reporting to regulatory agencies. From May 1992 until joining Brauvin in November of 1993, Mr. Coorsh was self-employed as a business consultant. Between 1990 and 1992, Mr. Coorsh was the senior vice president of finance and chief accounting officer for Lexington Homes, a large Illinois home builder. In 1990 Mr. Coorsh left The Balcor Company, a major real estate syndicator, property manager and lender to join Lexington Homes. Mr. Coorsh began work at The Balcor Company in 1985 and his most recent position was first vice president - finance. Mr. Coorsh's responsibilities at Balcor included property management accounting and finance, treasury, and financial and strategic planning. Before joining Balcor, Mr. Coorsh held financial positions with several large, public corporations headquartered in the Chicago metropolitan area. Mr Coorsh received a B.S. degree in Industrial Management from Purdue University, in 1971, and an M.B.A. in Finance and Accounting from the University of Chicago, in 1975 and is a Certified Public Accountant.\nItem 11.","section_11":"Item 11. Executive Compensation.\n(a & b) The Partnership is required to pay certain fees, make distributions and allocate a share of the profits and losses of the Partnership to the Corporate General Partner or their affiliates as described under the caption \"Compensation Table\" on pages 9 to 11 of the Partnership's Prospectus, as supplemented, and the sections of the Agreement entitled \"Distributions of Operating Cash Flow,\" \"Allocation of Profits, Losses and Deductions,\" \"Distribution of Net Sale or Refinancing Proceeds\" and \"Compensation of General Partners and Their Affiliates\" on pages A-8 to A-15 of the Agreement attached as Exhibit A to the Partnership's Prospectus.\nThe relationship of the Corporate General Partner (and its directors and officers) to its affiliates is set forth above in Item 10. Reference is also made to Item 8, Note 3 for a description of such distributions and allocations.\nThe General Partners received a share of the Partnership's losses for 1995, 1994 and 1993. An affiliate of the General Partners received Acquisition Fees as such term is defined in the Agreement, in connection with the real property investments acquired by the Partnership in 1985 in the aggregate sum of $927,480 when the real property purchases were made.\nAn affiliate of the Partnership may be reimbursed for its direct expenses relating to the administration of the Partnership.\n(c, d, e & f) Not applicable.\n(g) The Partnership has no employees and pays no employee or director compensation.\n(h & i) Not applicable.\n(j) Compensation Committee Interlocks and Insider Participation. Since the Partnership had no employees, it did not have a compensation committee and is not responsible for the payment of any compensation.\n(k) Not applicable.\n(l) Not applicable.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\n(a) No person or group is known by the Partnership to own beneficially more than 5% of the outstanding Units of the Partnership.\n(b) The officers and directors of the Corporate General Partner do not own, individually or as a group, any Units.\nNo officer or director of the Corporate General Partner possesses a right to acquire beneficial ownership of Units. The General Partners of the Partnership will share in the profits, losses and distributions of the Partnership as outlined in Item 11, \"Executive Compensation\".\n(c) The Partnership is not aware of any arrangements, the operations of which may result in a change of control of the Partnership.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\n(a & b) The Partnership is entitled to engage in various transactions involving affiliates of the Corporate General Partner, as described in the sections of the Partnership's Prospectus, entitled \"Compensation Table\" and \"Conflicts of Interest\" at pages 9 to 13, as supplemented, and the section of the Articles entitled \"Rights, Duties and Obligations of General Partners\" at pages A-13 to A-16. The relationship of the Corporate General Partner to its affiliates is set forth in Item 10. Cezar M. Froelich is an individual general partner of the Partnership and is also a principal of the law firm of Shefsky, Froelich & Devine, Ltd., which firm acts as securities and real estate counsel to the Partnership.\n(c) No management persons are indebted to the Partnership.\n(d) There have been no significant transactions with promoters.\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) (2) Financial Statements and Schedules indicated in Part II, Item 8 \"Financial Statements and Supplementary Data\" of Form 10-K.\n(3) Exhibits required by the Security Exchange Commission Regulation S-K Item 601.\n(27) Financial Statement Disclcosure\nThe following exhibits are incorporated by reference to the Registrant's Registration Statement (File No. 2-82289) on Form S-11 filed under the Securities Act of 1933:\nExhibit No. Description\n3.(a) Articles of Limited Partnership\n3.(b) Articles of Incorporation of Brauvin Realty Partners, Inc.\n3.(c) By-Laws of Brauvin Realty Partners, Inc.\n3.(d) Certificate of Limited Partnership of the Partnership\n10.(a) Escrow Agreement\n(b) The Partnership was not required to file any report on Form 8-K during the fourth quarter of 1995.\n(c) An annual report for the fiscal year 1995 will be sent to the Limited Partners subsequent to this filing and the Partnership will furnish copies of such report to the Securities and Exchange Commission at that time.\n(d) Not applicable.\nThe following exhibits are incorporated by reference to the Registrant's 1994 Form 10-K:\n(10)(b)(1)Management Agreement\n(28) Pages 9-13 and A-8 to A-16 of the Partnership's Prospectus, as supplemented, and the Articles dated April 28, 1983.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.\nBRAUVIN REAL ESTATE FUND L.P. 3\nBY: Brauvin Realty Partners, Inc. Corporate General Partner\nBy: \/s\/ Jerome J. Brault Jerome J. Brault Chairman of the Board of Directors and President\nBy: \/s\/ Robert J. Herleth Robert J. Herleth Vice President and Director\nBy: \/s\/ James L. Brault James L. Brault Vice President and Secretary\nBy: \/s\/ David W. Mesker David W. Mesker Director\nBy: \/s\/ Thomas J. Coorsh Thomas J. Coorsh Chief Financial Officer and Treasurer\nINDIVIDUAL GENERAL PARTNERS\n\/s\/ Jerome J. Brault Jerome J. Brault\n\/s\/ Cezar M. Froelich DATED: March 29, 1996 Cezar M. Froelich\nPage\nReport of Independent Auditors. . . . . . . . . . . . . . .F-2\nStatements of Net Liabilities in Liquidation, December 31, 1995 and December 31, 1994 (Liquidation Basis). . . . . .F-4\nStatement of Changes in Net Liabilities in Liquidation, for the year ended December 31, 1995 and the period from July 1 to December 31, 1994(Liquidation Basis) . . . . .F-5\nStatements of Operations for the period January 1, 1994 to June 30, 1994 and the year ended December 31, 1993 (Going Concern Basis) . . . . . . . . . . . . . . . . . .F-6\nStatements of Partners' Capital for the period January 1, 1994 to June 30, 1994 and the year ended December 31, 1993 (Going Concern Basis) . . . . . . . . . . . . . . .F-7\nStatements of Cash Flows for the period January 1, 1994 to June 30, 1994 and the year ended December 31, 1993 (Going Concern Basis). . . . . . . . . . . . . . . . . .F-8\nNotes to Financial Statements . . . . . . . . . . . . . . .F-9\nSchedules are omitted for the reason that they are inappropriate or equivalent information has been included elsewhere herein.\nTo the Partners of Brauvin Real Estate Fund L.P. 3\nWe have audited the statements of net liabilities in liquidation of Brauvin Real Estate Fund L.P. 3 as of December 31, 1995 and 1994, and the related statements of changes in net liabilities in liquidation for the year ended December 31, 1995 and for the period from July 1, 1994 to December 31, 1994 (prepared on a liquidation basis). In addition, we have audited the related statements of operations, partners' capital, and cash flows for the period from January 1, 1994 to June 30, 1994 and the year ended December 31, 1993 (prepared on a going concern basis). 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 provided a reasonable basis for our opinion.\nAs described in Notes 1 and 2 to the financial statements, the Partnership decided to cease operations and changed its basis of accounting for periods subsequent to June 30, 1994 from the going concern basis to a liquidation basis. Accordingly, as of December 31, 1995 and 1994, the carrying value of the assets are presented at estimated realizable amounts and all liabilities are presented at estimated settlement amounts.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the statements of net liabilities in liquidation at December 31, 1995 and 1994 of Brauvin Real Estate Fund L.P. 3 and the changes in its net liabilities in liquidation for the year ended December 31, 1995 and for the period from July 1, 1994 to December 31, 1994 (prepared on a liquidation basis) and the results of its operations and its cash flows for the period from January 1, 1994 to June 30, 1994 and the year ended December 31, 1993 (prepared on a going concern basis), in conformity with generally accepted accounting principles applied on the bases of accounting described in Notes 1 and 2 to the financial statements.\n\/s\/ ERNST & YOUNG, LLP\nChicago, Illinois March 9, 1996\nSTATEMENTS OF NET LIABILITIES IN LIQUIDATION - (Liquidation Basis)\nDecember 31, December 31, 1995 1994 ASSETS\nCash $ 28,032 $ 65,468 Tenant receivables 13,395 17,475 Other assets 16,033 16,454 Real estate held for sale 1,876,655 4,974,040\nTotal Assets $1,934,115 $5,073,437\nLIABILITIES\nAccounts payable and other accrued expenses $ 29,901 $ 42,213 Due to affiliates: Management fees and reimburseables 230,662 433,015 Legal fees -- 141,156 Security deposits 22,937 40,152 Note payable -- 125,000 Mortgages payable 1,749,375 4,608,211 Estimated losses through date of liquidation -- 164,000\nTotal Liabilities 2,032,875 5,553,747\nNet liabilities in liquidation $ 98,760 $ 480,310\nSee accompanying notes.\nSTATEMENT OF CHANGES IN NET LIABILITIES IN LIQUIDATION For the year ended December 31, 1995 and the period from July 1 to December 31, 1994 (Liquidation Basis)\nNet liabilities in liquidation at July 1, 1994 (Going Concern Basis) $1,594,674\nAdjustment to liquidation basis (2,074,984)\nNet liabilities in liquidation at December 31, 1994 (480,310)\nAdjustments to provision of estimated losses through date of liquidation 381,550\nNet liabilities in liquidation at December 31, 1995 $ (98,760)\nSee accompanying notes\nSTATEMENTS OF OPERATIONS For the period January 1, 1994 to June 30, 1994 and for the year ended December 31, 1993 (Going Concern Basis)\nFor the Period Year Ended January 1, 1994 to December 31, June 30, 1994 1993 INCOME: Rental $ 479,404 $ 904,372 Interest 77 1,027 Other 43,723 20,123 Total Income 523,204 925,522\nEXPENSES: Interest 211,533 416,862 Depreciation 110,927 232,995 Real estate taxes 45,157 84,838 Repairs and maintenance 44,090 75,410 Other property operating 121,418 217,006 General and administrative 165,472 163,799 Total Expenses 698,597 1,190,910\nLoss before Extraordinary Item (175,393) (265,388)\nExtraordinary Item- Gain on extinguishment of debt -- 292,172\nNet Income (Loss) $(175,393) $ 26,784\nNet Income (Loss) allocated to: Limited Partners $(173,639) $ 26,516 General Partners (1,754) 268 $(175,393) $ 26,784\nINCOME (LOSS) PER LIMITED PARTNERSHIP INTEREST BEFORE EXTRAORDINARY ITEM (7,729 units) $ (22.47) $ (34.00)\nNET INCOME (LOSS) PER LIMITED PARTNERSHIP INTEREST (7,729 units) $ (22.47) $ 3.43\nSee accompanying notes.\nSTATEMENTS OF PARTNERS' CAPITAL For the period January 1, 1994 to June 30, 1994 and for the year ended December 31, 1993 (Going Concern Basis)\nLimited General Partners Partners (7,729 Units) Total\nBALANCE at January 1, 1993 $(36,487) $1,779,770 $1,743,283\nNet income 268 26,516 26,784\nBALANCE at December 31, 1993 (36,219) 1,806,286 1,770,067\nNet loss (1,754) (173,639) (175,393)\nBALANCE at June 30, 1994 $(37,973) $1,632,647 $1,594,674\nSee accompanying notes.\nSTATEMENTS OF CASH FLOWS For the period January 1, 1994 to June 30, 1994 and for the year ended December 31, 1993 (Going Concern Basis)\nFor the Period Year Ended January 1, to December 31, June 30, 1994 1993 Cash Flow from Operating Activities: Net (loss) income $(175,393) $ 26,784 Adjustment to reconcile net (loss) income to net cash provided by operating activities: Depreciation 110,927 292,701 Bad debt expense -- 19,577 Extraordinary gain on extinguish debt -- (292,172) Changes in operating assets and liabilities: (Increase) decrease in tenant receivables, net (32,778) 22,311 Decrease (increase) in other assets 42,558 (24,908) Increase in due to affiliates 161,548 150,055 Decrease in accounts payable and other accrued expenses (22,750) (124,876) Increase (decrease) in security deposits 6,556 (5,650) Total adjustments 266,061 37,038 Net cash provided by operating activities 90,668 63,822\nCash Flow from Investing Activities: Capital expenditures (33,655) (45,869) Cash used by investing activities (33,655) (45,869)\nCash Flow from Financing Activities: Repayment of mortgages (57,013) (142,953) Proceeds from note payable -- 125,000 Net cash used by financing activities (57,013) (17,953) Net increase in cash -- -- Cash at beginning of period -- -- Cash at end of period $ -- $ --\nSee accompanying notes.\nNOTES TO FINANCIAL STATEMENTS\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:\nBasis of Presentation:\nEffective July 1, 1994, the General Partners decided to cease operations and liquidate all of the Partnership's assets in an orderly manner. It is the Partnership's intention to sell all of its real estate holdings or negotiate an uncontested foreclosure of the properties to the lenders.\nAs a result of the General Partners' decision to cease operations, and in accordance with generally accepted accounting principles, the Partnership's financial statements for periods subsequent to June 30, 1994 have been prepared on a liquidation basis. Accordingly, at December 31, 1995 and 1994, the carrying value of the assets was presented at estimated realizable amounts and all liabilities were presented at estimated settlement amounts, including estimated costs associated with carrying out the liquidation. Preparation of the financial statements on a liquidation basis requires significant assumptions by management, including assumptions regarding the amounts that creditors would agree to accept in settlement of obligations due them, the estimate of liquidation costs to be incurred and the resolution of contingent liabilities, including tax liabilities, resulting from the liquidation. There may be differences between the assumptions and the actual results because events and circumstances frequently do not occur as expected.\nIncome Taxes:\nThe Partnership is not subject to the payment of federal or state income taxes because components of its income and expenses flow through directly to its investors.\nNOTES TO FINANCIAL STATEMENTS - (CONTINUED)\nFor tax purposes, the net carrying value of the real estate for the Partnership is $994,612.\nProperty:\nAs of December 31, 1995, the Partnership owns one property consisting of two office buildings located in Albuquerque, New Mexico.\nPrior to conversion from the going concern basis to the liquidation basis of accounting,the Partnership's rental properties were stated at cost, adjusted for acquisition costs and unstated interest and included leasing commissions and tenant improvements. Depreciation and amortization were recorded on a straight-line basis over the economic lives of the properties, which approximated 30 years and the terms of the tenant's leases, respectively. The Partnership made periodic assessments concerning possible permanent impairment to the value of all the properties. In the event that the Partnership determined that impairment in value had occurred, the carrying basis of the property was reduced to its estimated fair value.\nIn accordance with the liquidation basis of accounting, the carrying value of property is stated at estimated realizable amounts. Accordingly, there are no provisions for depreciation or amortization.\nThe Partnership's properties are subject to liens under first mortgages (See Note 4).\n(2) ADJUSTMENT TO LIQUIDATION BASIS\nEffective July 1, 1994, in accordance with the liquidation basis of accounting, assets were adjusted to estimated net realizable value and liabilities were adjusted to estimated settlement amounts,\nNOTES TO FINANCIAL STATEMENTS - (CONTINUED)\nincluding estimated costs associated with carrying out the liquidation. The net adjustment required to convert from the going concern (historical cost) basis to the liquidation basis of accounting was a decrease in assets of $2,074,984 which is included in the December 31, 1994 statement of changes in net liabilities in liquidation. During 1994, significant changes in the carrying value of assets and liabilities are summarized as follows:\nDecrease in real estate to net realizable value $1,971,197\nProvision for estimated losses through date of liquidation 164,000\nEstimated adjustments to other assets and liabilities (60,213) $2,074,984\n(3) PARTNERSHIP AGREEMENT:\nThe partnership agreement (the \"Agreement\") provides that distributions of Operating Cash Flow, as defined in the Agreement, shall be distributed 99% to the Limited Partners and 1% to the General Partners. The receipt by the General Partners of such 1% of Operating Cash Flow shall be subordinated to the receipt by the Limited Partners of Operating Cash Flow equal to a 9% per annum, cumulative, non-compounded return on Adjusted Investment, as such term is defined in the Agreement (the \"Preferential Distribution\"). In the event the full Preferential Distribution is not made in any year (herein referred to as a \"Preferential Distribution Deficiency\") and Operating Cash Flow is available in following years in excess of the Preferential Distribution for said year, then the Limited Partners shall be paid such excess Operating Cash Flow until they have been paid any unpaid Preferential Distribution Deficiency from prior years. Net Sale Proceeds, as defined in the Agreement, received by the Partnership shall be distributed as follows: (a) first, to the Limited Partners until such time as the Limited\nNOTES TO FINANCIAL STATEMENTS - (CONTINUED)\nPartners have been paid an amount equal to the amount of their Adjusted Investment; (b) second, to the Limited Partners until such time as the Limited Partners have been paid an amount equal to any unpaid Preferential Distribution Deficiency; and (c) third, 85% of any remaining Net Sale Proceeds to the Limited Partners, and the remaining 15% of the Net Sale Proceeds to the General Partners. Net profits and losses from operations of the Partnership for each fiscal year of the Partnership shall be allocated 99% to the Limited Partners and 1% to the General Partners. The Preferential Distribution Deficiency equaled $7,091,358 and $6,395,748 at December 31, 1995 and 1994, respectively.\n(4) MORTGAGES AND NOTE PAYABLE:\nMortgages and note payable at December 31, 1995 and 1994 consist of the following: First Mortgages Interest Date 1995 1994 Rate Due\nCountry Club Plaza(c) $ -- $2,257,385 12.22% 8\/94 Bear Canyon Office Buildings I(b) 399,960 414,730 10.00% 5\/96 II(d) -- 474,171 9.96% 10\/06 III(a) 1,349,415 1,461,925 3.00% 7\/97 $1,749,375 $4,608,211\nNote Payable Interest Date 1995 1994 Rate Due\nCountry Club Plaza (c) $ -- $ 125,000 -- --\n(a) The terms of the mortgage loan on Bear Canyon Office Building III were modified for the first time in the third quarter of 1990 and for the second time in the third quarter of 1991. The second loan modification requires that the Partnership make monthly payments of principal and interest based upon a (i) 25-year\nNOTES TO FINANCIAL STATEMENTS - (CONTINUED)\namortization schedule plus 100% of net cash flow from July 1, 1992 through June 1, 1993 and (ii)a 15-year amortization schedule plus 50% of net cash flow from July 1, 1993 through July 1, 1997, the extended maturity date. The Lender has the option to accelerate the loan maturity on July 1 of each year if the property is not: (i) in good condition and repair; (ii) occupied at a rate that is equal to the prevailing occupancy rate for similar properties in the same locale; and (iii) leased at rental rates which are at least 90% of the prevailing rate for similar properties in the same locale.\nThe Bear Canyon III building is currently under contract for sale. The Partnership will consider reverting the property to the first mortgage lender during 1996 if the property cannot be sold to an unaffiliated third party. As of December 31, 1995 and 1994, the carrying amount of the affected real estate pledged as collateral is $1,461,925 and the resulting loss of $345,933 was included in the adjustment to liquidation basis in the statement of changes in net liabilities in liquidation for the period from July 1 to December 31, 1994.\n(b) On April 20, 1995 the Partnership received a modification from the Bear Canyon I first mortgage lender extending the maturity date from May 1, 1995 to May 1, 1996. The modification increased the interest rate from 8.875% to 10%. Interest is payable monthly and additional payments of 50% of annual cash flow, if any, calculated quarterly as of December 31, March 31, June 30 and September 30 shall be applied to the principal of the note.\nThe Bear Canyon I building is currently under contract for sale. As of December 31, 1995 and 1994, the carrying amount of the affected real estate pledged as collateral is $414,730 and the resulting loss of $344,452 was included in the adjustment to liquidation basis in the statement of changes in net liabilities in liquidation for the period July 1 to December 31, 1994.\nNOTES TO FINANCIAL STATEMENTS - (CONTINUED)\nIn the event that the current contract does not result in a sale of the property, the Partnership will request that the lender forebear from exercising its rights under the loan agreement until a sale is effected.\n(c) On August 19, 1994, the Partnership received a notice of default from the first mortgage lender. The notice stated that the default was a result of the Partnership's failure to make the interest payments of $18,065 due July 8, 1994 and August 8, 1994. The notice also stated that the Partnership had five business days from receipt of the notice to cure the default or the Lender would exercise its rights granted under the security documents by and between the Partnership and Finova Capital Corporation (\"the Lender\"). The Partnership decided not to cure the default and on October 19, 1994, agreed to a joint stipulation for entry of final judgment of foreclosure and for appointment of a receiver. The Partnership and Lender further agreed that if the Receiver is unsuccessful in liquidating the property by May 31, 1995, the Lender would immediately thereafter obtain a sale date for the property to be sold at a foreclosure sale which would take place no later than June 30, 1995. On May 31, 1995, a Certificate of Sale was filed in Brevard County, Florida and on June 13, 1995, title of the property was transferred to the Lender.\nAs of December 31, 1994, the carrying amount of the affected real estate pledged as collateral was written down to the related outstanding debt of $2,257,385 and the resulting loss of $1,093,098 was included in the adjustment to liquidation basis in the statement of changes in net liabilities in liquidation for the period from July 1 to December 31, 1994.\n(d) On May 26, 1995, the Partnership paid off the Bear Canyon II first mortgage as a result of the sale of the property to an unaffiliated third party for approximately $920,000.\nAs of December 31, 1994, the carrying amount of the affected real estate pledged as collateral was written down to $840,000, the sales contract amount less estimated costs to dispose. The resulting loss of $187,714 was included in the adjustment to liquidation basis in the statement of changes in net liabilities in liquidation for the period from July 1 to December 31, 1994.\nNOTES TO FINANCIAL STATEMENTS - (CONTINUED)\nThe Partnership paid interest on all of its mortgages of $205,266 for the year ended December 31, 1995 and $84,770 for the period July 1, 1994 to December 31, 1994 and $211,533 for the period January 1, 1994 to June 30, 1994; and $406,050 for the year ended December 31, 1993, respectively.\n(5) TRANSACTIONS WITH AFFILIATES:\nThe General Partners and other affiliates provide various services to support operating activities of the Partnership. Fees, commissions and other expenses incurred by the Partnership with respect to such services are as follows:\nYear ended July 1, 1994 to December 31, 1995 December 31, 1994\nLegal fees $ 300 $92,130\nManagement fees and reimbursable administrative services 80,884 60,282\nJanuary 1, 1994 Year ended to June 30, 1994 December 31, 1993\nLegal fees $ 1,800 $ 34,600\nManagment fees and reimbursable administrative services 60,282 115,732\nThe Partnership believes the amounts paid to affiliates are representative of amounts which would have been paid to independent parties for similar services. Management fees cannot exceed 6% of the gross operating revenues generated by the Partnership's properties. The Partnership had payables to affiliates for management fees and reimbursable administrative services of $230,662 and $433,015 at December 31, 1995, 1994, respectively. The Partnership had payables to affiliates for legal fees of $141,156 at December 31, 1994.\nNOTES TO FINANCIAL STATEMENTS - (CONTINUED)\n(6) OPERATING LEASES:\nRental income received from Florida Food & Drug of Country Club Plaza, approximated 11%, 18%, 18% and 20% of rental income for the Partnership for the year ended December 31, 1995; the period July 1, 1994 to December 31, 1994; January 1, 1994 to June 30, 1994; and the year ended December 31, 1993.\nEXHIBITS\nTO\nBRAUVIN REAL ESTATE FUND L.P. 3 FORM 10-K ANNUAL REPORT FOR THE YEAR ENDED DECEMBER 31, 1995\nEXHIBIT INDEX\nBRAUVIN REAL ESTATE FUND L.P. 3\nFORM 10-K\nFor the fiscal year ended December 31, 1995\nExhibit (10)(b)(1) Management Agreement\nExhibit (28) Pages 9-13 and A-8 to A-16 of the Prospectus, as supplemented, and the Articles\nEXHIBIT (10)(b)(1)\nEXHIBIT (28)","section_15":""}
{"filename":"811779_1995.txt","cik":"811779","year":"1995","section_1":"Item 1. DESCRIPTION OF BUSINESS. . . . . . . . . . . . . . . . . . . . . . . 4 Background of the Company . . . . . . . . . . . . . . . . . . . 4 Factors Which May Affect Future Results . . . . . . . . . . . . 5 Business of Exten. . . . . . . . . . . . . . . . . . . . . . . 8 Business of Xenogenex, Inc. . . . . . . . . . . . . . . . . 9 Patents & Proprietary Technology . . . . . . . . . . . . . . 9 Government Regulations . . . . . . . . . . . . . . . . . . . 9 Therapeutic Products . . . . . . . . . . . . . . . . . . . .10 Agreements for SYBIOL Development. . . . . . . . . . . . . .10 St. Louis University Health Sciences Center. . . . . . . . 10\nEmployees. . . . . . . . . . . . . . . . . . . . . . . . . . .11\nItem 2. DESCRIPTION OF PROPERTY. . . . . . . . . . . . . . . . . . . . . . .11\nItem 3. LEGAL PROCEEDINGS. . . . . . . . . . . . . . . . . . . . . . . . . .12\nItem 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES STOCKHOLDERS . . . . . . . . . . . . . . . . . . . . .13\nPART II - -------\nItem 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS. . . . . . . . . . . . . . . . . . .13\nItem 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS Results of Operations. . . . . . . . . . . . . . . . . . . . .14 Liquidity and Capital Resources . . . . . . . . . . .. . . . .16 Results of Operations - ADC. . . . . . . . . . . . . . . . . .16 Xenogenex, Inc.. . . . . . . . . . . . . . . . . . . . . . . .16\nItem 7. FINANCIAL STATEMENTS . . . . . . . . . . . . . . . . . . . . . . . .17\nItem 8. CHANGES IN AND DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE . . . . . . . . . . . . . . . . . . . . . . . . . . . . .17\nPART III - --------\nItem 9. DIRECTORS AND EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; REGISTRANT COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT. . . . 17\nItem 10. EXECUTIVE COMPENSATION. . . . . . . . . . . . . . . . . . . . . . . 18 Non-Cash Compensation . . . . . . . . . . . . . . . . . . . . . . . 19\nItem 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT . . . . . . . . . . . . . . . . . . . . . . . 19 Stock Options Outstanding . . . . . . . . . . . . . . . . . . 22\nItem 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS20\nItem 13. EXHIBITS AND REPORTS ON FORM 8-K. . . . . . . . . . . . . . . . . . 23 Exhibits . . . . . . . . . . . . . . . . . . . . . . . . 23 Reports on Form 8-K. . . . . . . . . . . . . . . . . . . . . . . 23 SIGNATURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 List of Subsidiaries. . . . . . . . . . . . . . . . . . . . . 25 Index of Exhibits . . . . . . . . . . . . . . . . . . . . . . 25\nPART I\nITEM 1. DESCRIPTION OF BUSINESS\nBACKGROUND OF THE COMPANY\nBetween 1985 and 1990 the Company provided merchant banking services for small businesses. As compensation for these services the Company received both cash and common stock in the companies. The Company distributed shares of stock in some of these companies to its shareholders as dividends in kind. The Company distributed stocks in Import International, Inc., Olympus Technology Corporation, Inc., Multiphonics Corporation, Dionne, Inc., Sun Harbor Financial Resources, Inc., U.S. Environmental, SDI Holdings, Inc. and Access HealthNet.\nIn October of 1990 the Company's Board of Directors decided on a major change in the Company's business. Due to the difficulty of raising capital for its small business merchant banking clients, the Company decided to change its business emphasis to that of becoming a diversified company. The merchant banking would be combined on a smaller scale with more substantial companies. The Company's merchant banking experience would be primarily directed to the acquisition of varied business for the Company.\nIn November 1990, the Company acquired all of the capital stock of ADC Industries Corporation, Inc. (\"ADC\"), a precision product machining house specializing in the custom manufacture of storage tank valves. The acquisition of ADC was accounted for as a pooling of interest. On September 30, 1993, ADC ceased operations. The Company sold its interests in ADC and on November 29, 1993 ADC filed for liquidation under Chapter 7 of the U.S. Bankruptcy Code.\nIn September of 1991 the Company acquired all of the outstanding stock of Xenogenex, Inc. (\"Xenogenex\"), formerly known as Ascot Close Research Institute, Ltd. At that time Xenogenex was funding research on xenogeneic transplants with a major West Coast medical center. Xenogenex had the rights to the commercial development of the research work.\nIn 1992, the Company acquired the rights to a hydraulic control technology with primary applications to computer control of hydraulic machine tools and to the control of helicopter rotor blades. The machine control is marketed under the name \"Navigator 360\"; the rotor control, in the early conceptual stage, is named the \"Smart Head\". In 1992, the Navigator 360 technology was sold to a company of which Malcolm D. Campbell is an officer.\nOn February 24, 1992 Exten purchased all rights to the technology for an innovative helicopter flight control system from the inventors. The concept, which involves loop hydraulic control of blade pitch, is known as the \"Smart Head\".\nOn May 19, 1992 Exten entered into a joint venture agreement with Navmatic Corporation for development of the Smart Head. Navmatic Corporation, which manufactures an unique electronic and mechanical interface for computer numerical control of hydraulic machine tools, and which employs the Smart Head inventors as consultants, has the technical ability and the business posture to pursue development of the concept. The Company has no plans to develop this technology. Under the joint venture agreement, a mechanical model to demonstrate the feasibility of the basic hydraulic control mechanisms proposed has been constructed and successfully operated.\nIn 1993, the Company divested itself of ADC Industries, Inc., leaving development of the synthetic bio-liver (\"SYBIOL\") through its subsidiary Xenogenex, Inc. as the Company's only proposed business.\nITEM 1a.","section_1A":"ITEM 1a. FACTORS WHICH MAY AFFECT FUTURE RESULTS\nAn investment in the Common Stock of the Company involves a high degree of risk. In addition to the other information contained in this Form 10-KSB, prospective investors should carefully consider the following risk factors:\n1. SIGNIFICANT AND REPEATED LOSSES. During fiscal 1995, the Company's most recent fiscal year, the Company's losses increased to ($3,076,538) from losses of ($1,351,477) in fiscal 1994. In addition, during fiscal 1992, 1993, and 1994 the Company lost ($880,844), ($1,355,531), and ($1,351,477) respectively. The Company faces all the risks inherent in a new business. The Company's Xenogenex subsidiary, is without any record of earnings and sales. There is no information at this time upon which to base an assumption that Xenogenex's business plans will either materialize or prove successful. There can be no assurance that any of the Company's business activities will result in any operating revenues or profits. Investors should be aware that they may lose all or substantially all of their investment.\n2. QUALIFIED OPINION. The Company's certified public accountant issued a qualified opinion on the Company's financial statements for the year ended November 30, 1995 and the year ended November 30, 1994 and the year ended November 30, 1995 with respect to uncertainties concerning the Company's ability to continue as a going concern.\n3. LACK OF REVENUES. The Company's only active business is the research and development activities of its subsidiary, Xenogenex, Inc. from which the Company generates little or no stream of revenues and there can be no assurance that the Company will ever generate any revenues from Xenogenex, Inc. in the near future. As a result, the Company may continue to incur losses and any investor who purchases or acquires any shares of the Company's Common Stock will likely incur further substantial dilution and loss in the value of their investment.\n4. SIGNIFICANT AND INCREASING CURRENT LIABILITIES. As of November 30, 1995, the Company had $743,629 in current debts and other obligations that are due and payable on or before November 30, 1996. Included in the amounts due by November 30, 1996 is $333,000 due in settlement of certain claims awarded Union Bank, $388,000 in loans payable in litigation, and the current portion of certain long term debt of $387,987 together with other current liabilities. Further, as of November 30, 1995, the Company had nearly 2.4 times as many current liabilities as it had current assets. In the event that the Company is not able to generate sufficient cash resources to pay these and other current liabilities on or before their due date, the Company will likely incur substantial additional costs and expenses and otherwise risk whatever claims creditors may assert against the Company in connection with any default thereby. This may result in an investor losing all or substantially all of their investment.\n5. NEED FOR ADDITIONAL FINANCING & LACK OF UNDERWRITING COMMITMENT. The Company's management recognizes that the Company needs to obtain additional external financing from the sale of the Company's debt, common stock, or preferred stock in order to support the Company and otherwise meet the Company's growing financial obligations. While the Company may attempt to obtain a commitment from an underwriter for a private placement or public offering of the Company's securities, there can be no guarantee that the Company will be successful. If the Company is not successful, the Company may suffer additional and continuing financial difficulties with consequent loss to any investor acquiring the Company's common stock.\n6. NEGATIVE WORKING CAPITAL & NEGATIVE CASH FLOW. As of November 30, 1995, the Company had Total Current Liabilities of $743,629 and Total Current Assets of $315,593 with the result that the Company had negative working capital of ($428,036) as Total Current Liabilities exceeded Total Current Assets by that amount. While the Company's management seeks additional financing for the Company to complete its business plan, there can be no assurance that the Company will obtain any additional financing or, if it is obtained, that it can be obtained on terms reasonable in view of the Company's current circumstances. In addition, the Company has experienced negative cash flow for the 1992, 1993, 1994, and 1995 fiscal years.\n7. POTENTIAL DILUTION. Funding of the Company's proposed business plan will result in substantial and on-going dilution of the Company's existing stockholders. During 1995, the Company issued 16,189,748 additional shares of its common stock in connection with its operations while incurring continuing and ever-increasing financial losses. While there can be no guarantee that the Company will be successful in raising additional capital, if the Company is successful in obtaining any additional capital, existing stockholders will incur substantial dilution.\n8. DEFAULT ON INDEBTEDNESS. The Company is currently in default on its repayment of a certain loan totalling $333,000 (as of November 30, 1995) (the \"Loan\") with Union Bank and a former officer of the Company, Robert H. Goldsmith, asserts that the Company has defaulted on approximately $388,000 in promissory notes. While Union Bank has sued the Company and has aggressively sought repayment of the Loan, together with interest, and fees due with the result that Union Bank has obtained a judgement against the Company, the Company's management has attempted, without success to negotiate an acceptable payment program with Union Bank and there is no guarantee that the Company will be able to pay the monies required to settle this matter. In addition, the Company had over $994,480 in liabilities which included $743,629 in Total Current Liabilities due and payable on or before November 30, 1996. In the event that the Company is not able to generate additional cash from the sale of the Company's securities or otherwise obtain funds on some other basis, the Company will remain in default on its obligations and likely default on obligations to other creditors with the result that any investor in the Company's common stock will lose all or substantially all of their investment.\n9. GOVERNMENT REGULATION AND PRODUCT APPROVALS. The Company's research, testing, preclinical development, clinical trials, manufacturing, and marketing of its proposed therapeutic products is subject to extensive and ever-changing regulation by numerous governmental authorities in the United States and other countries. Clinical trials, manufacturing, and marketing of products in the U.S. will be subject to the rigorous testing and approval processes of the U.S. Food and Drug Administration (the \"FDA\") and by comparable regulatory authorities in foreign countries. The testing and regulatory approval process will likely take several years and require the expenditure of substantial resources. Any testing of the Company's proposed products may not support the safety and efficacy of the Company's products. There can be no assurance that the Company will gain any regulatory approvals for the Company's proposed products or, if such approvals are obtained, that such approvals may be limited and far narrower than those sought by the Company. To the extent that the above information describes statutory or regulatory provisions, it is qualified in its entirety by reference to the particular statutory and regulatory provisions currently in effect. Any change in applicable law or regulation may have a material effect on the business and prospect of the Company's subsidiary, Xenogenex, Inc.\n10. LACK OF INDEPENDENT EVALUATION OF TECHNOLOGY & COMMERCIAL VIABILITY. The Company's current management does not possess any studies performed by an independent third party which demonstrate that the synthetic bio-liver technology has ever been rigorously evaluated. There can be no assurance that this technology offers safe, efficacious, and cost-effective therapeutic attributes relative to those provided by competing technologies or, if it does, that the technology is commercially viable.\n11. COSTS OF LITIGATION. The Company is likely to incur significant costs for litigation in connection with a dispute with Robert H. Goldsmith, a past officer and director and other litigation. While the Company seeks to resolve this dispute on terms favorable to the Company, there can be no assurance that the Company will be successful or that the costs incurred will not exceed any benefits that the Company may derive from this litigation.\n12. LIMITED MANAGEMENT. The Company currently has only one full time officer and two full-time employees. The Company's limited cash flow and financial resources do not allow the Company to increase or add to the Company's full time management and there can be no guarantee that the Company's cash flow and financial resources will increase in the near future. As a result, the Company continues to rely upon consultants and others for a large part of its operations and the research and development work conducted by its subsidiary, Xenogenex, Inc.\n13. LACK OF DIVIDENDS. The Company has never paid any cash dividends on its common stock. The Company's board of directors intends to retain profits, if any, to finance the Company's business.\n14. LIMITED MARKET FOR COMMON STOCK. The Company's Common Stock, traded on the Electronic Bulletin Board (OTC), has experienced significant price fluctuations and will likely remain highly volatile in the future. There can be no assurance that a meaningful trading market for the Company's Common Stock will be established, or, if established, that it can be maintained for any significant period.\n15. VALUATIONS & PRIOR ASSET ACQUISITIONS. The Company's current management has determined that the values accorded certain assets acquired in prior years be revalued to reflect lower carrying values in light of current market circumstances. While management believes that current carrying values for these assets more accurately reflect likely recovery values, there can be no assurance that the Company will not later revalue the Company's assets further.\n16. POSSIBLE RULE 144 STOCK SALES. As of November 30, 1995, the Company had a substantial amount of shares of the Company's outstanding Common Stock as \"restricted securities\" which may be sold only in compliance with Rule 144 adopted under the Securities Act of 1933 or other applicable exemptions from registration. Rule 144 provides that a person holding restricted securities for a period of two years may thereafter sell in brokerage transactions, an amount not exceeding in any three month period the greater of either (i) 1% of the Company's outstanding Common Stock, or (ii) the average weekly trading volume during a period of four calendar weeks immediately preceding any sale. Persons who are not affiliated with the Company and who have held their restricted securities for at least three years are not subject to the volume limitation. Possible or actual sales of the Company's Common Stock by present shareholders under Rule 144 may have a depressive effect on the price of the Company's Common Stock if any liquid trading market develops.\n17. POSSIBLE STOCK SALES - REGULATION S & FORM S-8 REGISTRATION STATEMENT. The Company has periodically issued shares to non-U.S. citizens under Regulation S. In addition, the Company has utilized the services of consultants and, in this connection, the Company has issued shares of the Company's Common Stock and registered these shares for sale on Form S-8. The shares issued under Regulation S become freely-tradeable 41 days after issuance. The shares registered on Form S-8 are immediately freely-tradeable. As a result, the Company's issuance of shares pursuant to Regulation S and Form S-8 likely depresses the market price of the Company's Common Stock. While the Company's management intends to carefully evaluate the need to issue shares of the Company's Common Stock on this basis, the Company's meager financial resources will likely prevent the Company from limiting its use of Regulation S and Form S-8, with the result that the market price of Company's Common Stock will likely be depressed by the registration and sale of shares on an on-going basis.\n18. RISKS OF LOW PRICED STOCKS. Trading in the Company's Common Stock is limited. Consequently, a shareholder may find it more difficult to dispose of, or to obtain accurate quotations as to the price of, the Company's securities. In the absence of a security being quoted on NASDAQ, or the Company having $2,000,000 in net tangible assets, trading in the Common Stock is covered by Rule 3a51-1 promulgated under the Securities Exchange Act of 1934 for non-NASDAQ and non-exchange listed securities.\nUnder such rules, broker\/dealers who recommend such securities to persons other than established customers and accredited investors (generally institutions with assets in excess of $5,000,000 or individuals with net worth in excess of $1,000,000 or an annual income exceeding $200,000 or $300,000 jointly with their spouse) must make a special written suitability determination for the purchaser and receive the purchaser's written agreement to a transaction prior to sale. Securities are also exempt from this rule if the market price is at least $5.00 per share, or for warrants, if the warrants have an exercise price of at least $5.00 per share. The Securities Enforcement and Penny Stock Reform Act of 1990 requires additional disclosure related to the market for penny stocks and for trades in any stock defined as a penny stock.\nThe Commission has recently adopted regulations under such Act which define a penny stock to be any NASDAQ or non-NASDAQ equity security that has a market price or exercise price of less than $5.00 per share and allow for the enforcement against violators of the proposed rules.\nIn addition, unless exempt, the rules require the delivery, prior to any transaction involving a penny stock, of a disclosure schedule prepared by the Commission explaining important concepts involving a penny stock market, the nature of such market, terms used in such market, the broker\/dealer's duties to the customer, a toll-free telephone number for inquiries about the broker\/dealer's disciplinary history, and the customer's rights and remedies in case of fraud or abuse in the sale.\nDisclosure also must be made about commissions payable to both the broker\/dealer and the registered representative, current quotations for the securities, and, if the broker\/dealer is the sole market-maker, the broker\/dealer must disclose this fact and its control over the market.\nMonthly statements must be sent disclosing recent price information for the penny stock held in the account and information on the limited market in penny stocks. While many NASDAQ stocks are covered by the proposed definition of penny stock, transactions in NASDAQ stock are exempt from all but the sole market-maker provision for (i) issuers who have $2,000,000 in tangible assets ($5,000,000 if the issuer has not been in continuous operation for three years), (ii) transactions in which the customer is an institutional accredited investor and (iii) transactions that are not recommended by the broker\/dealer. In addition, transactions in a NASDAQ security directly with the NASDAQ market- maker for such securities, are subject only to the sole market-maker disclosure, and the disclosure with regard to commissions to be paid to the broker\/dealer and the registered representatives.\nFinally, all NASDAQ securities are exempt if NASDAQ raised its requirements for continued listing so that any issuer with less than $2,000,000 in net tangible assets or stockholder's equity would be subject to delisting. These criteria are more stringent than the proposed increase in NASDAQ's maintenance requirements. The Company's securities are subject to the above rules on penny stocks and the market liquidity for the Company's securities could be SEVERELY AFFECTED by limiting the ability of broker\/dealers to sell the Company's securities.\nBUSINESS OF EXTEN\nThe Company's only active business is the proposed research and development activities of its subsidiary, Xenogenex, Inc.\nXENOGENEX, INC.\nBUSINESS OF XENOGENEX, INC.\nXenogenex, Inc. (\"Xenogenex\") was incorporated in California on July 30, 1991 for the purpose of funding biotech research. On September 11, 1991 the Company signed a research contract with Cedars-Sinai Medical Center in Los Angeles, California. The research contract was for the genetic manipulation of human to pig target antigens and xenogeneic transplants. Xenogeneic transplants involve the use of donor organs from species other than humans. The major objective of the research was to discover a way to transplant organs (heart, liver, lung and kidney) from a pig into a human.\nIn March of 1993 Xenogenex received all the rights to a synthetic bio- liver (\"SYBIOL\") developed for Xenogenex under contract with Cedars-Sinai Medical Center. A patent application is presently pending on the process utilized by the SYBIOL device and the Company has applied for trademark protection for the SYBIOL tradename.\nOn August 31, 1995, the Company entered into a license agreement (the \"GMI License\") with GroupMed International, Inc. (\"GMI\"). Under the terms of the GMI License, the Company granted GMI the exclusive right and license to manufacture, market, and sell the technology and patents held by Xenogenex in Mexico, Central America, and South America. Subsequently, the Company terminated the GMI License due to lack of consideration.\nIn addition to the other information contained in this Form 10-KSB, prospective investors should carefully consider the following risk factors:\n1. PATENTS AND PROPRIETARY TECHNOLOGY. Any proprietary protection of Xenogenex's technologies that the Company can obtain and maintain will be important to its proposed business. The Company has exchanged its U.S. patent application for a P.C.T. filing and has filed a patent application in China. The patent positions of bio-pharmaceutical and biotechnology firms, as well as academic and other research institutions, are uncertain and involve complex legal and factual questions. Accordingly, no firm predictions can be made regarding the bio-pharmaceutical and biotechnology patents or whether the Company will have the financial resources to aggressively protect its rights.\n2. INTENSE COMPETITION. Competition in Xenogenex's field from other biotechnology and pharmaceutical companies and from research and academic institutions is intense and is expected to increase. Competitors or potential competitors of the Company have filed applications for, or have been issued, certain patents, and may obtain additional patents and proprietary rights, relating to technologies competitive with those of the Company. Accordingly, there can be no assurance that the Company's patent applications will result in patents being issued or that, if issued, such patents will provide protection against competitive technology that circumvents such patents or will be held valid by a court of competent jurisdiction; nor can there be any assurance that others will not obtain patents that the Company would need to license or circumvent. Furthermore, there can be no assurance that licenses that might be required for the Company's processes or products would be available on reasonable terms, if at all. Xenogenex also intends to rely upon unpatented trade secrets, know-how and continuing technological innovation to develop and maintain its competitive position. No assurance can be given that others will not independently develop substantially equivalent proprietary information and technology, or otherwise gain access to Xenogenex's trade secrets or disclose such technology, or that Xenogenex can meaningfully protect its rights to its unpatented trade secrets.\n3. GOVERNMENT REGULATION. Xenogenex's present and proposed activities are subject to regulation by numerous governmental authorities in the United States and other countries. To the extent that the following information describes statutory or regulatory provisions, it is qualified in its entirety by reference to the particular statutory and regulatory provisions currently in effect. Any change in applicable law or regulation may have a material effect on the business and prospects of Xenogenex.\n4. THERAPEUTIC PRODUCTS. Xenogenex's products will be subject to regulation in the U.S. by the Food and Drug Administration (\"FDA\") and by comparable regulatory authorities in foreign jurisdictions. The products produced will be classified as \"biologics\" regulated under the Public Health Service Act and the Federal Food, Drug and Cosmetic Act. Development of a therapeutic product for human use is a multi-step process. First, animal or in vitro testing must establish the potential safety and efficacy of the experimental product in a given disease. Once the product has been found to be reasonably safe and potentially efficacious in animals, suggesting that human testing would be appropriate, an Investigational New Drug (\"IND\") application is submitted to the FDA. FDA approval is necessary before commencing clinical investigations. That approval may, in some circumstances, involve substantial delays.\nClinical investigations typically involve three phases. Phase I is conducted to evaluate the safety of the experimental product in humans, and if possible, to gain early evidence of effectiveness. Phase I studies also evaluate various routes, dosages and schedules of product administration. The demonstration of therapeutic benefit is not required in order to complete Phase I successfully. If acceptable product safety is demonstrated, the Phase II studies are initiated. The Phase II trials are designed to evaluate the effectiveness of the product in the treatment of a given disease and, typically, are well-controlled, closely monitored studies in a relatively small number of patients.\nThe optimal routes and schedules of administration are determined in these studies. As Phase II trials are successfully completed, Phase III studies will be commenced. Phase III studies are expanded, controlled and uncontrolled trials which are intended to gather additional information about safety and efficacy in order to evaluate the overall risk\/benefit relationship of the experimental product and provide an adequate basis for physician labeling. These studies also may compare the safety and efficacy of the experimental device with currently available products. It is not possible to estimate the time in which Phase I, II and III studies will be completed with respect to a given product, although the time period is often as long as several years.\nFollowing the successful completion of these clinical investigations, the preclinical and clinical evidence that has been accumulated is submitted to the FDA as part of a product license application (\"PLA\"). Approval of the PLA or IND is necessary before a company may market the product. The approval process can be very lengthy and depends upon the time it takes to review the submitted data and the FDA's comments on the application and the time required to provide satisfactory answers or additional clinical data when requested.\nIn addition to the regulatory framework for product approvals, the Company is and may be subject to regulation under state and federal law, including requirements regarding occupational safety, laboratory practices, the use, handling and disposition of radioactive materials, environmental protection and hazardous substance control, and may be subject to other present and possible future local state, federal and foreign regulation, including future regulation of the biotechnology field.\nAGREEMENTS FOR SYBIOL DEVELOPMENT\nST. LOUIS UNIVERSITY HEALTH SCIENCES CENTER\nXenogenex, entered into a sponsored research agreement with the St. Louis University Health Sciences Center to direct and document the research and development of its synthetic bio-liver, SYBIOL, into a clinical system.\nDr. Li was the Director of the Surgical Research Institute at St. Louis University and an internationally renowned expert in liver cell biology, toxicology and drug metabolism. Prior to joining SLU, he headed the Liver Biology Department at Monsanto Company in St. Louis. Dr. Li also served as Chief Scientific Officer of Xenogenex. St. Louis University Health Sciences Center is known for its excellence in providing medical care and medical research, especially in organ transplantation and artificial internal organ research. The medical center is one of the few institutions with a research institute dedicated to surgical research.\nOn November 30, 1995, the Company terminated its agreement with the St. Louis University Health Sciences Center and Dr. Albert Li and currently the Company is seeking the return of all documents and laboratory equipment. During the period of the sponsored research agreement, the Company spent approximately $452,000 on research and laboratory equipment.\nCHINA JOINT VENTURE\nThe Company and a Hong Kong business group have formed a Hong Kong corporation, TECA International, Ltd., under a joint venture agreement. TECA, which is 18.60% owned by the Company, is required to provide funding for the next five years. TECA is licensed to produce and sell Xenogenex's synthetic bio-liver in Asia, Australia and New Zealand.\nTECA has arranged, through a joint venture, for the manufacturing and distribution SYBIOL in China. A SYBIOL unit has been shipped to Number 301 Military Hospital in Beijing, China. The Company is not able to predict whether the venture in China will generate any revenues for the Company or whether it will be commercially viable. And although the Company believes the incidence of liver disease in Asia is far greater than in the United States, the Company has not conducted or received any third party research or evaluation of this market and there can be no assurance that the Company will gain any commercially profitable opportunities at any time in the near future.\nOverall, the Company intends to continue to re-evaluate the SYBIOL technology, the commercial viability of the SYBIOL technology, and the financial feasibility of further investment in SYBIOL.\nCOMPETITION\nXenogenex is engaged in businesses characterized by extensive research efforts, rapid technological change, and intense competition. Competition can be expected to increase as technological advances are made and commercial applications broaden. The industries in which Xenogenex seeks to compete are characterized by substantial competition involving biotechnology and major bio- pharmaceutical, chemical and biological testing companies. Many of Xenogenex's existing and potential competitors have substantially greater financial, research and development, clinical, regulatory, marketing and production resources than those of Xenogenex and may be better equipped than Xenogenex to develop, manufacture and market competitive therapeutic products or testing services. These companies may develop and introduce products and services competitive with, superior to, or less costly than those of Xenogenex, thereby rendering some of Xenogenex's technologies and products and services under development less competitive or obsolete.\nEMPLOYEES\nEXTEN. As of May 10, 1996, Exten had two employees.\nXENOGENEX. Xenogenex has no employees. The Company is managed by its officers and directors. The work of Xenogenex is carried out by contracts with third parties.\nGENERAL. All of the above companies consider their relations with their employees to be excellent and none are subject to any union contracts.\nITEM 2.","section_1B":"","section_2":"ITEM 2. DESCRIPTION OF PROPERTY EXTEN\nLEASE. Exten leases approximately 1,711 square feet of space, at $500 per month, in a modern office building. Exten's lease ends in August 31, 1997. Exten feels the space is adequate for the foreseeable future.\nARIZONA. On February 28, 1992 the Company exchanged 170,000 shares of common stock and 170 shares of preferred stock, convertible into 170,000 shares of common stock, for real estate in Arizona comprised of 240 buildable lots approximately 70 miles south of the Grand Canyon. This property is pledged to secure a $250,000 loan to Xenogenex, Inc., a subsidiary of the Company. In 1994 the Company sold four of these lots to pay property taxes. As a result and as of November 30, 1995, the Company owned 236 of these lots.\nThe Company is seeking to sell the Arizona property as part of an agreement with its creditors. However, there can be no assurance that the Company will successfully settle its creditors' claims or, if it is successful, that any settlement will be achieved on terms that are reasonable in light of the Company's current circumstances.\nXENOGENEX\nXenogenex is provided offices and clerical services by its parent Exten and does not have separate offices. Xenogenex believes that this arrangement will be sufficient during the next twelve months.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nAs of May 10, 1996, there were no pending legal proceedings involving the Company which, in the opinion of management, after discussion with legal counsel, were of a material nature except the following.\n1. Union Bank Litigation\n(1) Los Angeles County Superior Court, State of California (2) August 12, 1992 (3) Union Bank as plaintiff. Exten Industries, Inc. as a defendant. (4) Lawsuit to enforce a loan guarantee executed by Exten for a loan to its subsidiary ADC Industries, Inc. (5) Relief Sought: Monetary payment. Judgement entered against Exten Industries, Inc. on February 23, 1994 in the amount of $300,000. There are four other guarantors on this loan. The Company intends to aggressively pursue equitable indemnification from these parties. On July 20, 1994, the Company entered into a settlement with Union Bank that allows the Company to pay Union Bank $150,000 in full by November 30, 1995. If the Company does not pay $150,000 to Union Bank by February 2, 1996, then Union Bank is entitled to pursue the Company for the full $300,000 plus interest and other costs from the date of the February 23, 1994 judgement.\n2. Goldsmith Litigation with Exten\n(1) San Diego County Superior Court, State of California. (2) January 24, 1995. (3) Robert H. Goldsmith, former President of Exten Industries, Inc. as plaintiff. Exten Industries, Inc., as defendant. (4) Lawsuit for breach of employment contract, fraud and enforcement of security agreement. (5) Relief Sought: Damages, Declaration of rights and obligations, punitive damages, and costs of suit. The Company disputes the facts and has filed a cross-complaint for conversion, fraud, and breach of fiduciary responsibility.\n3. Goldsmith Litigation with Xenogenex\n(1) San Diego County Superior Court, State of California. (2) January 24, 1995. (3) Robert H. Goldsmith, former President of Exten Industries, Inc. as plaintiff. Xenogenex, Inc. as defendant. (4) Lawsuit for breach of promissory note. (5) Relief Sought: Damages and specific performance. The Company disputes the facts and has filed a cross-complaint against Mr. Goldsmith for fraud and conversion.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo meeting of the Company's shareholders was held in 1995.\nPART III\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANTS COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nThe Company's Common Stock was traded on the Philadelphia Stock Exchange (\"Exchange\") from May 5, 1989 to June 14, 1994. From June 14, 1994 to the present, the Company's Common Stock has traded OTC (Electronic Bulletin Board).\nAt the Annual Meeting of Shareholders held on July 11, 1990 the shareholders approved a reverse split of the Common Stock. The shareholders voted to exchange 7 old shares for 1 new share. The reverse split was effective midnight, August 31, 1990. The Company had a subsequent reverse split of 1 for 2 effective August 10, 1991, and a 1 for 10 reverse split effective November 30, 1992.\nThe table below shows the closing sales prices for Exten Common Stock as reported by the Exchange. All prices have been adjusted to reflect a 1 for 7 reverse split of Exten's outstanding Common Stock on August 31, 1990 and the 1 for 2 reverse split on August 10, 1991 and the 1 for 10 reverse split on November 30, 1992.\nPrices are not adjusted for six percent (6%) stock dividends for shareholders of record November 30, 1991 and November 30, 1992.\nCalendar Year ended December 31, High Low ------ ----- First Quarter . . . . . . . . . . . . . . . . . 6.00 3.50 Second Quarter. . . . . . . . . . . . . . . . . 3.75 1.125 Third Quarter . . . . . . . . . . . . . . . . . 2.00 .938 Fourth Quarter . . . . . . . . . . . . . . . . 1.56 .75\nFirst Quarter . . . . . . . . . . . . . . . . . 1.56 .75 Second Quarter. . . . . . . . . . . . . . . . . 1.19 .375 Third Quarter . . . . . . . . . . . . . . . . . .44 .0625 Fourth Quarter. . . . . . . . . . . . . . . . . .31 .1875\nFirst Quarter . . . . . . . . . . . . . . . . . .33 .07 Second Quarter. . . . . . . . . . . . . . . . . .27 .15 Third Quarter . . . . . . . . . . . . . . . . . .25 .09 Fourth Quarter. . . . . . . . . . . . . . . . . .18 .07\nNo cash dividends have been paid on Exten Common Stock and no change of this policy is under consideration by the Board of Directors.\nThe payment of cash dividends in the future will be determined by the Board of Directors in light of conditions then existing, including the Company's earnings, financial requirements, and condition, opportunities for reinvesting earnings, business conditions, and other factors. The number of shareholders of record of Common Stock on November 30, 1995 was approximately 1,032.\nITEM 6.","section_6":"ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS\nDuring the latter part of 1990 the Company revised its business plan and began its conversion from a merchant banker into a diversified company. In November of 1990 the Company acquired ADC Industries, Inc. a manufacturer of valves for storage tanks. In June of 1991 the Company acquired a 21% interest in Pacific International Indemnity, Ltd., on off-shore surplus line writer (\"Pacific\"). This transaction was rescinded in March 1992. During September of 1991 the Company acquired Xenogenex, Inc., a bio-medical research and development company. In 1992, the Company acquired hydraulic technology applicable to machine and helicopter rotor control. In 1992, the Company divested itself of the machine control technology. In 1993, the Company divested itself of its helicopter technology and sold its subsidiary, ADC Industries. The Company intends to focus its resources on further research and development efforts to be conducted within its subsidiary, Xenogenex.\nRESULTS OF OPERATIONS\nFISCAL 1995 VERSUS FISCAL 1994\nDuring the year ending November 30, 1995 (\"Fiscal 1995\") the Company recorded total revenues of $6,654 primarily from rental revenues on certain real estate compared to $90,594 in revenues earned during the fiscal year ending November 30, 1994 (\"Fiscal 1994\"). Fiscal 1994's revenues were composed of $63,483 in royalties,, $25,123 in rents in rental revenues from real estate, and $1,988 in sales revenue.\nDuring Fiscal 1995, the Company incurred $609,579 in Consulting Fees which were incurred primarily due to the Company's continued use and reliance on professional services from outside the Company.\nIn Fiscal 1995, the Company also incurred $1,043,543 in General and Administrative Expenses. This increased by nearly 59% in Fiscal 1994's level of $656,628 primarily due to increased administrative and consulting expenses.\nFiscal 1995 research and development costs declined by nearly 49% from $140,755 in Fiscal 1994 to $72,058 while depreciation expenses was $21,064 in Fiscal 1995 compared to $22,596 in Fiscal 1994. The decline in research and development costs during Fiscal 1995 reflected the Company's limited financial resources.\nAs a result, Total Operating Expenses in Fiscal 1995 were $1,746,244 compared to Total Operating Expenses of $1,403,671 in Fiscal 1994. This resulted in the Company recording a Loss from Continuing Operations of ($1,739,590) in Fiscal 1995 compared to a Loss from Continuing Operations of ($1,313,077) in Fiscal 1994.\nFor Fiscal 1995, the Company recorded a gain of $49,348 in connection with a liquidation of certain indebtedness compared to a similar gain of $83,027 in Fiscal 1994. Interest Expense declined by over 33% from $33,798 in Fiscal 1994 to $22,438 in Fiscal 1995.\nThe Company's Fiscal 1995 operations were greatly impacted by certain Other Income and Expenses. In Fiscal 1995, the Company's management re-evaluated the carrying value of the Company's real estate in Arizona given declining market trends in the market area and changing land use in surrounding real estate market adjoining the real estate parcels held by the Company. The Company plans to sell the Arizona real estate in connection with a contemplated settlement agreement with the Company's creditors. On this basis, the Company reduced the carrying value of the real estate from $1,617,667 to $354,000.\nIn addition, the Company reduced the carrying value of certain shares of GroupMed International, Inc. (\"GMI\") it received from GMI to reflect the limited liquidity and the current market value of the GMI stock it received in payment under a licensing agreement with GMI.\nThe Company also determined that the wrap notes and associated equity purchased during 1992 have an undeterminable value. The Company established a valuation allowance of $356,741 for the entire amounts relative to the wrap notes receivable and payable balances associated with the wrap notes in the amount of $356,741 for the year ended November 30, 1995. This increase for reserves of $356,741 has been reflected within general and administrative expenses for Fiscal 1995.\nThe Company also reduced the carrying value of its prior investment in helicopter control technology from $187,500 at the close of Fiscal 1994 to $0 at the close of Fiscal 1995. The Company has no plans to develop this technology. The Company also reduced the value of a timeshare investment from $9,000 at the close of Fiscal 1994 to $0 at the close of Fiscal 1995.\nAs a result of these re-evaluations of the carrying value of the Company's investments, the Company recorded an aggregate Loss on Disposition of Assets of $1,514,167 during Fiscal 1995 compared to a Loss on Disposition of Assets of $63,359 in Fiscal 1994. The Company also recorded a $60,000 gain from the sale of the License to GMI.\nOther Income and Expenses resulted in the Company recording $1,336,148 in Total Other Expenses (net of other income) in Fiscal 1995 from Fiscal 1994's Total Other Expenses (net of other income) of $37,600.\nAs a result, the Company recorded a Loss Before Income Taxes of $3,075,738 in Fiscal 1995 or an increase of nearly 128% from the Loss Before Income Taxes of $1,350,677 recorded during Fiscal 1994. This resulted in the Company recording a Net Loss of ($3,076,538) in Fiscal 1995 compared to a Net Loss of ($1,351,477) in Fiscal 1994 with Fiscal 1995 total Losses Per Share of Common (computed with Common Stock Equivalents and fully diluted) of ($0.20) compared to ($0.23) for the same period during Fiscal 1994.\nFISCAL 1994 VERSUS FISCAL 1993\nDuring the fiscal year ending November 30, 1994 (\"Fiscal 1994\"), the Company recorded revenues of $90,594 compared to $76,414 in revenues for the fiscal year ending November 30, 1993 (\"Fiscal 1993\"). Nearly all of Fiscal 1994's revenues were due to the Company's receipt of $62,313 from an officer of the Company who repaid short swing profits on the purchase and sale of the Company's Common Stock and the Company's receipt of $25,123 in rental revenues from the Company's real estate holdings.\nDuring Fiscal 1994 the Company also incurred $606,288 in consulting fees which represented an increase of about 41% from $429,522 in consulting fees during Fiscal 1993. During both Fiscal 1993 and 1994, the Company selectively paid consulting fees in cash and in shares of the Company's Common Stock (with the latter frequently registered on a Form S-8 Registration Statement to enable the payee to sell and transfer the shares in the open market). The increase in Consulting Fees arose primarily out of the increased need for consulting services to the Company and its subsidiary, Xenogenex, Inc. during the year.\nIn comparison, the Company reported 20.77% decline in General and Administrative Expenses during Fiscal 1994 as these costs decreased to $656,628 compared to $828,736 during Fiscal 1993. The decline in General and Administrative expenses was largely due to a reduction in of legal expenses and professional fees as the Company reduced legal and professional expenses by $242,373. For Fiscal 1994, these General and Administrative Expenses included $263,154 in legal expenses, $63,152 in directors' and officers' liability insurance premiums, $87,321 in salaries and wages, $24,908 in public relations costs, $22,906 in travel expenses, $22,596 in depreciation, $18,058 in accounting expenses, and payroll taxes of $11,748.\nHowever, the Company also incurred $140,755 in Research and Development expenses in fiscal 1994 whereas the Company did not incur any Research and Development Expenses in fiscal 1993.\nWith a 41% increase in Consulting Fees, a 20.77% decline in General and Administrative Expenses, and $140,755 in Research and Development expenses, the Company recorded a 8.12% increase in Total Operating Expenses as the Company incurred $1,403,671 in Total Operating Expenses during Fiscal 1994 compared to $1,298,258 in Total Operating Expenses in Fiscal 1993.\nAs a result, the Company recorded a Loss from Continuing Operations of ($1,313,077) in Fiscal 1994 compared to a loss of ($1,221,844) in Fiscal 1993.\nIn addition, the Company also recorded Other Income and Expenses for both Fiscal 1994 and 1993. For Fiscal 1994 the Company recorded $83,027 in debt forgiveness income, $33,798 in Interest expenses (net of Interest Income), $17,000 in bad debt expenses, and $63,359 in losses on the sale of certain shares of Princeton Electronics stock and the sale of certain parcels of real estate in Arizona. By comparison for Fiscal 1993, the Company did not record any income from debt relief, $11,431 in interest income (net of interest expense), $60,451 in bad debt expenses, and $38,929 in losses on disposition of assets. As a result, the Total Other Expenses showed a 57.25% decline from $87,949 in Total Other Expenses for Fiscal 1993 to $37,600 in Total Other Expenses for Fiscal 1994.\nThe Company's Loss From Continuing Operations Before Income Taxes declined by 3.12% from a loss of ($1,309,793) in Fiscal 1993 to a loss of ($1,350,677) in Fiscal 1994.\nIn addition and for Fiscal 1993, the Company recorded a Loss from Discontinued Operations of ($197,722) as the Company discontinued operations of its then subsidiary, ADC Industries Corporation (\"ADC\"). Subsequently the Company sold ADC to EFM Venture Group, Inc., an entity owned by Edward F. Myers, then an officer and director of the Company, for $1,000 and thereby recognized a gain of $152,784. The Company had no comparable transactions in Fiscal 1994.\nThis resulted in the Company recording a Net Loss of ($1,351,477) in Fiscal 1994 compared to a Net Loss of ($1,355,531) in Fiscal 1993 with Fiscal 1993 total Losses Per Share of Common (computed with Common Stock Equivalents and fully diluted) of ($0.35) compared to ($0.23) for the same period during Fiscal 1994.\nLIQUIDITY AND CAPITAL RESOURCES - THE COMPANY\nSeveral steps have been taken by the Company to reduce its liabilities, reduce cash requirements, and raise capital. The Company has been negotiating with the bank and its vendor creditors to settle its liabilities. Exten is also negotiating with investment bankers for raising of additional capital. The Company is also considering merger with other entities. No assurances can be given that any such activity will prove successful. The Company will require substantial working capital to continued synthetic bio-liver development of Xenogenex, Inc. and there can be no guarantee that the Company will be successful in obtaining any such needed financing.\nDuring Fiscal 1995, the Company took steps to control expenses and is attempting to reduce and negotiate outstanding indebtedness.\nDuring Fiscal 1994, the Company disposed of four real estate parcels (out of 240 then owned) in a subdivision known as the Grand Canyon Subdivision in Coconino County, Arizona. The sale was undertaken to satisfy outstanding property taxes. While this resulted in the Company recording a $28,333 loss on these sales, the action served to conserve the Company's cash and liquid resources.\nThe Company has also continued to pay salaries, consulting fees, and in some cases, legal fees through the issuance of the Company's Common Stock with the subsequent registration of the shares so issued on Form S-8. The Company has been forced to take these steps to conserve the Company's cash and liquid resources.\nRESULTS OF OPERATIONS - ADC\nDuring 1993 the operations of ADC Industries Corporation (\"ADC\") were wound up and the assets of ADC were sold by Union Bank to satisfy a portion of a loan with that bank. Subsequently, ADC was sold and later filed for bankruptcy under Chapter 7.\nXENOGENEX, INC.\nXenogenex is in the development stage and produces no revenue. However, Xenogenex incurred consulting and administrative costs in the last fiscal. Xenogenex will require substantial additional capital to continue its development of the synthetic bio-liver.\nITEM 7.","section_7":"ITEM 7. FINANCIAL STATEMENTS\nThe full text of the Company's audited financial statements for the fiscal year ended November 30, 1995 begins on page 26 of this Report.\nITEM 8.","section_7A":"","section_8":"ITEM 8. CHANGES IN AND DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nWithin the 24-month period prior to November 30, 1995, there has not been a change of accountants or a reported disagreement with accountants on any matter of accounting principles or practices or financial statement disclosure.\nPART III\nITEM 9.","section_9":"ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT\nThe Directors and Executive Officers of the Company were as of May 10, 1996:\nName Age Position Date Elected ---- --- -------- ------------ W. Gerald Newmin 58 President, CEO, Chairman Secretary & Director 12-01-95\nWilliam R. Hoelscher 59 Vice President & Director 10-25-94\nLarry Bedard 51 Director 12-08-95\nW. GERALD NEWMIN was retained as a consultant to the Board of Directors of the Company in June 1995. As an accommodation to the Board, Mr. Newmin was elected Acting Secretary of the Corporation on July 13, 1995, and had signature authority on checks in the absence of an officer or director. On December 1, 1995, Mr. Newmin was elected Chairman, Chief Executive Officer, and President of the Company. Mr. Newmin is a principal of Newmin Associates, specializing in mergers and acquisitions and the operational management of troubled companies. Mr. Newmin currently serves on the Board of Directors and is an investor in four companies, one of which, SYS, is a publicly-traded (OTC) on the Electronic Bulletin Board.\nMr. Newmin is currently Chairman of the Board of the International Forum of Corporate Directors, a non-profit organization which promotes corporate governance, and which is composed of over 100 Board members from companies in San Diego and all over California. From 1991 to present. Mr. Newmin has been a consultant, investor, and a director of Greene International West, Inc., an industrial manufacturing company located in Oceanside, California. From 1993 to present, Mr. Newmin has been an investor and director of Occu-Med, Inc., a managed healthcare company located in Denver, Colorado. Since 1994, Mr. Newmin has been an investor and director of SYS, a defense systems company in San Diego, California. From 1984 to 1987, Mr. Newmin was President of HealthAmerica Corporation, which was the nation's largest publicly-held HMO management company at the time. From 1977 to 1984,, Mr. Newmin was President of International Silver Company,a diversified multi-national manufacturing company which he restructured. From 1973 to 1977, Mr. Newmin was Vice President and Western Regional Director for American Medicorp, Inc. In this capacity, he was responsible for the management of 23 acute care hospitals located throughout the Western United States. From 1962 to 1973, Mr. Newmin was employed by Whittaker Corporation. Mr. Newmin was instrumental in Whittaker's entry into both the United States and International healthcare markets. At Whittaker, Mr. Newmin held various senior executive positions, including those of Chief Executive Officer of Whittaker's Production Steel Company, Whittaker Textiles Corporation, Bertram Yacht Corporation, Narmco Materials Corporation, and Anson Automotive Corporation. Mr. Newmin holds a Bachelor's degree in Accounting from Michigan State University.\nWILLIAM R. HOELSCHER was elected a Director on October 25, 1994. From August 1984 to the present, Mr. Hoelscher has been the owner of Hoelscher Engineering (\"HEC\"). HEC provides technical support to U.S. Elevator, other elevator companies, and consulting services to legal counsel in connection elevator litigation matters. Mr. Hoelscher also is part-time consultant to Cubic Corp and provides training seminars for Cubic's U.S. Elevator division in connection with elevator design. From July 1991 to the present, Mr. Hoelscher has been President of ETC Corp, a company involved in developing ideas and inventions. From August 1984 to July 1991, Mr. Hoelscher was Vice President, Secretary, and Treasurer of Tec-Matic Corp. - a company involved in building computer interface equipment for hydraulic milling machinery; and Mr. Hoelscher was also President of Photovoltaic Energy Development, Inc. - a company involved in the development of power inverters and other accessories for use in the conversion of solar and other natural energy. During this period Mr. Hoelscher was also President of Hypec Corp. - a company involved in the design and development of a thermal to electrical energy conversion unit. In July 1984 Mr. Hoelscher retired as Director of Research and Development at U.S. Elevator Corp. Mr. Hoelscher holds a B.S. Degree in Physics from San Diego State University (1959).\nMR. LARRY BEDARD was elected a Director on December 8, 1995. From November 1992 to the present Mr. Bedard has been President and CEO of La Roca International, a merchant banking firm. From June 1987 to October 1992, Mr. Bedard was a self-employed entrepreneur engaged in personal entrepreneurial activities. From 1985 to May 1987 Mr. Bedard was Chairman, Director, and Partner of Pacific International Securities of Vancouver, British Columbia. From 1982 to 1985, Mr. Bedard was Senior Vice President and Director of Corporate Finance and Partner of Dominick & Dominick of Toronto, Ontario. Mr. Bedard studied at the University of Alberta.\nAs per item 405 of SEC Regulation SB it should be noted that during the fiscal year ended November 30, 1995, the Company has no record of the timely filing of Statements of Changes in Beneficial Ownership of Securities forms (Form 3 and Form 4) on one or more occasions by the following: none.\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. EXECUTIVE COMPENSATION\nDuring fiscal 1995, the Company paid the following compensation to the Company's Officers and Directors:\nCASH COMPENSATION: Fiscal 1995 -----------\nW. Gerald Newmin $0 William R. Hoelscher $0 Larry Bedard $0\nSTOCK COMPENSATION:\nOfficer Date of Issue Number of Shares - ------- ------------- ----------------\nWilliam R. Hoelscher 08-17-96 36,000 W. Gerald Newmin, President 07-12-95(1) 486,000\n(1.) Date of initial issuance.\nSTOCK OPTION COMPENSATION\nIn addition to the cash and stock compensation reported above, the Company's Board of Directors voted to issue options to purchase shares of the Company's Common Stock (par value $0.01) to the following Officers and Directors of the Company in lieu of cash compensation during fiscal 1995:\nITEM 11.","section_11":"ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nAs of May 10, 1996, the Company's Directors, Officers and over 5% shareholders held beneficially the following shares of Common Stock or of beneficial interest. Numbers of shares have been adjusted for 1:7 reverse split effective August 31, 1990 and the reverse split of 1:2 August 10, 1991 and a reverse split of 1:10 on November 30, 1992.\nCommon % Name Title Shares Class1 - --------------------------------------------------------------------------------\nW. Gerald Newmin(2) President, CEO, Chairman & Secretary 586,000 2.50%\nWilliam R. Hoelscher Director & Treasurer 972,000 4.14%(3)\nLarry Bedard Director 0 0%\nAll Officers and Directors as a Group _________ _____ (3 persons) 1,558,000 6.64% ____________________ Footnotes:\n(1) Based on 23,462,205 shares of the Company's Common Stock outstanding as of November 30, 1995 and stock option shares currently executable by officers, directors, and affiliates within 60 days of May 10, 1996 without including the effect of any other stock options.\n(2) Includes shares held by Newmin & Associates, an entity owned by W. Gerald Newmin, the Company's President, CEO, Chairman and Secretary.\n(3) Includes 800,000 shares underlying 800,000 options granted William Hoelscher.\nSTOCK OPTIONS OUTSTANDING:1\nAmount of Exercise Expiration Name Position Stock Option Price Date - ---- -------- ------------ --------- ---------- Malcolm D. Campbell Past CFO, Secretary 300,000 $0.50 08\/26\/03 Arnold Hunsberger Former Director 400,000 $0.10 11\/13\/00 Arnold Hunsberger Former Director 400,000 $0.06 07\/24\/98 William R. Hoelscher Director 400,000 $0.10 11\/13\/00 William Hoelscher Director 400,000 $0.06 07\/24\/98\n- -------------------- 1. Does not include options granted to other holders, totalling an additional 2,090,000 shares at exercise prices ranging from $0.10 to $0.50 per share.\nAll of the options expire on the date shown, and there is no provision in the grant for any extension of the exercise period beyond the expiration date shown above.\nITEM 12.","section_12":"ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nAll share numbers in this section have been adjusted for the 1 for 7 reverse split effective August 31, 1990 and the 1 for 2 reverse split effective August 10, 1991 and the 1:10 reverse split effective November 30, 1992.\nOn February 24, 1992 the Company purchased certain helicopter technology from ETC Corporation for 50,000 shares of the Company's common stock (See \"Business\"). Mr. Arnold Hunsberger, who became a Company director on November 25, 1992 is an owner of ETC Corporation. The shares were valued at $5.00 per share.\nOn February 28, 1992, the Company exchanged 170,000 shares of common stock and 170 shares of preferred stock, convertible into 170,000 shares of common stock, for real estate in Arizona comprised of 240 buildable lots. The Company purchased the land from entities controlled by Mr. Louis Redondo. On April 30, 1992 Mr. Redondo became a member of the Company's Board of Directors. The shares were valued at an aggregate of $1,700,000.\nThe Company's Board of Directors on May 19, 1992 voted to issue to members of the Board of Directors options to purchase a total of 431,036 shares at $0.10 per share. These options may be exercised at any time prior to May 19, 1997.\nOn July 29, 1992 the Board of Directors voted to issue options to members of the Board to purchase a total of 3,600 shares of Xenogenex owned by the Company. The options are valid for five years from the time that Xenogenex is first publicly traded. The option price to be fifty percent (50%) of the initial public offering price. The Company valued these options at $0.75 per share.\nOn July 30, 1992 the Company sold 106,000 shares of common stock for $1.30 per share to St. Louis Fire and Marine. St. Louis Fire and Marine signed a note for $130,000 payable at $15,000 per month starting November 24, 1992. St. Louis Fire and Marine is controlled by Louis Redondo a past Company director.\nOn September 25, 1992 the Board of Directors voted to transfer a total of 125,000 shares of Xenogenex stock owned by the Company to members of the Company's Board of Directors as additional compensation. These shares were valued at $0.49 per share.\nOn January 12, 1993 the Board of Directors issued 25,000 shares of the Company's common stock to Carmine J. Bua, Esq., for legal services valued at $100,000.\nOn March 8, 1993 the Board issued to Malcolm D. Campbell, its president 50,000 shares of its common stock in lieu of salary. The shares were valued at $0.50 per share.\nOn April 20, 1993 the Board issued to Carmine J. Bua, Esq. 5,000 shares of its common stock for legal services. The shares were valued at $3.00 per share.\nIn May 7, 1993 the Company issued to Carmine J. Bua, Esq., 50,000 shares of common stock for legal services. The shares were valued at $1.75 per share.\nOn May 24, 1993 the Board issued to Malcolm D. Campbell, its president, 50,000 shares of common stock in lieu of salary. The shares were valued at $1.75 per share.\nOn August 26, 1993 Exten's Board of Directors awarded an option to its president, Malcolm D. Campbell, for 300,000 common shares exercisable at $0.50 until August 26, 1998.\nOn August 26, 1993 the Board issued to Carmine J. Bua, Esq., its then vice president, 100,000 shares of common stock for legal services. The shares were valued at $0.75 per share.\nOn September 23, 1993 the Board issued to Carmine J. Bua, Esq., its then vice president, 563,000 of the Company's common stock for legal services. The shares were valued at $0.50 per share.\nOn January 4, 1994, the Company's Board of Directors approved a loan of $250,000 to the Company's subsidiary, Xenogenex, Inc. by the Company's then President and CEO, Robert H. Goldsmith through the R. H. Goldsmith Living Trust. The Board also approved a Consulting Agreement with Goldsmith providing for the issuance of 288,333 shares of the Company's Common Stock for consulting services. These shares were valued at $0.875 per share with 144,167 shares to be issued on January 1, 1996 and 144,166 to be issued on January 1, 1997. All of these shares were valued at $0.875 per share.\nOn March 1, 1994, the Company's Board of Directors approved the issuance of: (i.) 94,476 shares of the Company's common stock to Malcolm D. Campbell, then an officer and director of the Company, in lieu of payment of $62,000 in cash salary payments; and (ii.) 38,095 shares of the Company's Common Stock to Robert H. Goldsmith, the Company's then President, in lieu of cash salary payments. All of these shares were valued at $0.65 per share.\nOn June 14, 1994, the Company's Board of Directors authorized the issuance of 160,000 shares of the Company's Common Stock to Carmine J. Bua, Esq., then an officer of the Company in exchange for legal services. The legal services were valued at $80,000.\nOn July 29, 1994, the Company's Board of Directors authorized the issuance of 10,000 shares of the Company's Common Stock to Arnold Hunsberger, then an officer and Director of the Company and 6,667 shares of the Company's Common Stock to Ken Krul, then a Director of the Company. The shares issued to Mr. Hunsberger were valued at $1,250 and the shares issued to Mr. Krul were valued at $8,333.\nOn October 25, 1994, the Company's Board of Directors approved an employment agreement with the Company's then President, Kevin G. Smith. Under the terms of the agreement, Mr. Smith receives 40,000 shares of the Company's Common Stock for each month of his employment for a period of up to twelve months from and after November 1, 1994. In addition, the Company also granted Mr. Smith the right to receive 250,000 Shares of the Company's common stock upon the Company's acceptance of the first three months of Mr. Smith's employment from November 1, 1994 and an additional 250,000 shares of the Company's Common Stock for an additional three months of employment from March 1, 1995. The Company is obligated to register (on Form S-8) all shares issued to Mr. Smith so as to ensure that the shares are freely-tradeable. All of the shares issued to Mr. Smith are valued at $0.10 per share.\nOn January 10, 1995, the Company's Board of Directors voted to: (i.) issue 500,000 shares of the Company's Common Stock to Kevin G. Smith, the Company's then President, in exchange for services rendered to the Company; and (ii.) 710,000 shares of the Company's Common Stock to Margaret Rawlinson for consulting services rendered. All of these shares were valued at $0.10 per share and the Company registered Mr. Smith's Shares on Form S-8 and Ms. Rawlinson's shares pursuant to Regulation S. In addition, the Company's Board of Directors voted to issue 350,000 shares of the Company's Common Stock to William E. Daniel in exchange for services rendered to the Company. These shares were valued at $0.10 per share and the Company registered the Shares on Form S-8.\nOn February 7, 1994, the Company's Board of Director's granted Robert H. Goldsmith, then President of the Company, an option to purchase a total of 1,000,000 shares of common stock at a price of eighty-one and one-quarter cents ($.8125) per share exercisable for the period beginning February 8, 1994 and ending February 7, 2004 for cash payment or a promissory note payable within ninety (90) days. On April 1, 1994 the option was exercised and one million (1,000,000) shares of the Company's common stock was issued. The shares were not paid for within the ninety (90) days set forth in the option agreement. As a result, the Company established a receivable for the amount due the Company for this exercised option. The Board also approved the issuance of 1,000,000 shares of the Company's Common Stock to Mr. Goldsmith subject to Mr. Goldsmith earning these shares for future services to be rendered to the Company and certain other conditions. These shares were valued at $0.8125 per share.\nOn April 7, 1995, the Company's Board of Directors voted to issue the following shares for services rendered to the Company: (i.) 200,000 shares to the Company's then President, Kevin G. Smith; (ii.) 150,000 shares to William E. Daniel; (iii.) 56,250 shares to Arnold Hunsberger, a then Director of the Company; and (iv.) 112,500 shares to William R. Hoelscher, a Director of the Company. All of these shares were valued at $0.15 per share. Subsequently, on August 17, 1995, Mr. Hunsberger and Mr. Hoelscher returned 56,250 and 112,500 shares respectively, in exchange for the grant an option to each of them, by the Company's Board of Directors on August 17, 1996.\nOn April 24, 1995, the Company's Board of Directors voted to issue the following shares for services rendered to the Company: (i.) 480,000 shares to the Company's then President, Kevin G. Smith; (ii.) 90,000 shares to Steven Broderson; (iii.) 180,000 shares to William E. Daniel; and (iv.) 75,000 shares to Craig J. Shaber, Esq. for legal services. All of these shares were valued at $0.19 per share.\nOn July 13, 1995, the Company's Board of Directors voted to issue 200,000 shares of the Company's Common Stock to Newmin Associates, an entity owned by the Company's President, for consulting services. These shares were valued at $0.109 per share.\nOn July 24, 1995, the Company's Board of Directors took the following actions:\n(i.) granted Edward F. Myers, a former officer and director, an option to purchase 400,000 shares of the Company's Common Stock at an exercise price of $0.10 per share upon shipment of the second SYBIOL unit to China and upon satisfaction of other terms of a consulting agreement with the Company;\n(ii.) granted Edward F. Myers, a former officer and director, an option to purchase 400,000 shares of the Company's Common Stock at an exercise price of $0.06 per share in payment of all monies past due and owing to Mr. Myers;\n(iii.) issued 240,000 shares of the Company's Common Stock (valued at $0.10 per share) to Edward F. Myers, a former officer and director, in exchange for services rendered;\n(iv.) issued 250,000 shares of the Company's Common Stock to Malcolm D. Campbell, a former officer and director, in exchange for $30,936.15 owed to him;\n(v.) granted Arnold Hunsberger an option to purchase 400,000 shares of the Company's Common Stock at $0.10 per Share and to expire on November 13, 2000 and an option to purchase 400,000 shares of the Company's Common Stock at $0.06 per Share and to expire on July 24, 1998; and\n(vi.) granted William Hoelscher an option to purchase 400,000 shares of the Company's Common Stock at $0.10 per Share and to expire on November 13, 2000 and an option to purchase 400,000 shares of the Company's Common Stock at $0.06 per Share and to expire on July 24, 1998.\nOn August 17, 1995, the Company's Board of Directors took the following actions:\n(i.) issued 236,000 shares of the Company's Common Stock to W. Gerald Newmin, the Company's President, CEO, Chairman, and Secretary in exchange for services valued at $28,910;\n(ii.) issued 52,000 shares of the Company's Common Stock to Arnold Hunsberger, a director of the Company in exchange for services valued at $6,370;\n(iii.) issued 36,000 shares of the Company's Common Stock to William R. Hoelscher, a director of the Company in exchange for services valued at $4,410;\n(iv.) granted Arnold Hunsberger, a then director, an option to purchase 400,000 shares of the Company's Common Stock at an exercise price of $0.06 per share at any time for a period of three years in exchange for Mr. Hunsberger's return of 412,500 shares of the Company's Common Stock to the Company;\n(v.) granted William R. Hoelscher, a director, an option to purchase 400,000 shares of the Company's Common Stock an exercise price of $0.06 per share at any time for a period of three years in exchange for Mr. Hoelscher's return of 465,000 shares of the Company's Common Stock to the Company; and\n(vi.) issued 720,000 shares of the Company's Common Stock to Margaret Rawlinson in exchange for consulting services valued at $0.14 per share.\nOn September 18, 1995, the Company's Board of Directors took the following actions:\n(i.) issued 1,000,000 shares of the Company's Common Stock to Ben Johnson in exchange for investment banking services valued at $120,000;\n(ii.) granted Edward F. Myers, a former officer and director an option to purchase 300,000 shares of the Company's Common Stock an exercise price of $0.10 per share at any time for a period of three years;\n(iii.) issued 136,000 shares of the Company's Common Stock to W. Gerald Newmin, subsequently, the Company's Chairman and President, in exchange for services rendered; and\n(iv.) issued 100,000 shares of the Company's Common Stock to Carmine J. Bua, Esq., in exchange for legal services.\nThe shares issued to Mr. Newmin and Mr. Bua were valued at $0.14 per share.\nOn November 13, 1995, the Company's Board of Directors voted to issue the following shares of the Company's Common Stock in payment for services rendered to the Company: 225,000 shares and 100,000 shares to W. Gerald Newmin and William Hoelscher, respectively. These shares were valued at $0.12 per share. The Company's Board of Directors also granted William Hoelscher and a former Director, Arnold Hunsberger, each an option to purchase up to 400,000 shares of the Company's Common Stock at an exercise price of $0.10 per share. Both options expire on November 13, 2000.\nNo current Officer or Director of the Company has been indebted to the Company or any of its subsidiaries in an amount in excess of $60,000.\nITEM 13.","section_13":"ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K\nExhibit No. Exhibit Description - ----------- -------------------\n10 Compensation\/Stock Option Agreement\n24 Consent of Harlan & Boettger\n27 Financial Data Schedule\nREPORTS ON FORM 8-K ITEM REPORTED\nOn March 30, 1995 the Company filed a report on Form 8-K relating to the Company's late filing of its 1994 Form 10-KSB.\nOn July 11, 1995 the Company filed a report on Form 8-K relating to the resignation of the Company's then President, Kevin G. Smith and the Company's entering into a consulting agreement with Newmin Associates, an entity owned by W. Gerald Newmin.\nOn September 29, 1995 the Company filed a report on Form 8-K relating to the grant of a license to GroupMed International.\nOn November 15, 1995 the Company filed a report on Form 8-K relating to a report and audit conducted by the Company's auditors, Harlan and Boettger, as of August 31, 1995.\nOn December 6, 1995 the Company filed a report on Form 8-K relating to the election of W. Gerald Newmin as Chairman, President and CEO of the Company.\nOn December 13, 1995 the Company filed a report on Form 8-K relating to the election of Larry Bedard as a Director of the Company.\nHARLAN & BOETTGER Certified Public Accountants 12626 High Bluff Drive, Suite 200 San Diego, California 92130 (619) 755-8113\nINDEPENDENT AUDITOR'S REPORT\nTO THE BOARD OF DIRECTORS AND STOCKHOLDERS OF EXTEN INDUSTRIES, INC. AND SUBSIDIARY:\nWe have audited the accompanying consolidated balance sheet of Exten Industries, Inc. (a Delaware corporation) and its subsidiary (Note A) as of November 30, 1995 and the related consolidated statements of operations, changes in stockholders' equity, and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Exten Industries, Inc. and subsidiary as of November 30, 1995, and the results of their operations and their cash flows for the year then ended 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 M to the consolidated financial statements, the Company's default on certain loan agreements, recurring losses, decreases in working capital, and negative cash flows raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are also described in Note M to the consolidated financial statements. The consolidated financial statements do not include any adjustments relating to the recoverability and classification of reported asset amounts or the amounts and classification of liabilities that might result from the outcome of this uncertainty.\n\/s\/ Harlan & Boettger\nSan Diego, California February 15, 1996\nHARLAN & BOETTGER Certified Public Accountants 12626 High Bluff Drive, Suite 200 San Diego, California 92130 (619) 755-8113\nINDEPENDENT AUDITOR'S REPORT\nTo the Board of Directors and Stockholders of Exten Industries, Inc. San Diego, California\nWe have audited the consolidated balance sheets of Exten Industries, Inc. and its subsidiaries as of November 30, 1994, and the related consolidated statements of operations, stockholders' equity, and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit and the report of other auditors 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 Exten Industries, Inc. and its subsidiaries as of November 30, 1994, and the results of their operations and cash flows for the year then ended in conformity with generally accepted accounting principles.\nThe accompanying 1994 consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 25 to the consolidated financial statements, the Company's default on certain loan agreements, recurring losses, decreases in working capital, and negative cash flows raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 25 to the consolidated financial statements. The 1994 consolidated financial statements do not include any adjustments relating to the recoverability and classification of reported asset amounts or the amounts and classification of liabilities that might result from the outcome of this uncertainty.\n\/s\/ Harlan & Boettger\nMarch 20, 1995\nEXTEN INDUSTRIES, INC. AND SUBSIDIARY\nCONSOLIDATED BALANCE SHEETS\nThe accompanying notes are an integral part of these consolidated financial statements.\nThe accompanying notes are an integral part of these consolidated financial statements.\nEXTEN INDUSTRIES, INC. AND SUBSIDIARY\nCONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY\nEXTEN INDUSTRIES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS\nEXTEN INDUSTRIES, INC.\nNOTES TO CONSOLIDATED BALANCE SHEET\nA. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:\nBASIS OF CONSOLIDATION\nThe consolidated financial statements includes the accounts of Exten Industries, Inc. and its 90 percent owned subsidiary Xenogenex, Inc. (together \"the Company\"). Minority interest represents the 10 percent minority shareholders' proportionate interest in the equity of the subsidiary. Investments in affiliated companies where the Company has the ability to exercise significant influence, are accounted for by the equity method. The Company's share of affiliates' earnings is included in the current periods profit and loss. All significant intercompany balances and transactions are eliminated.\nREVENUE RECOGNITION\nThe Company generally recognizes revenue when services are provided over the terms of the consulting contracts entered into and from sales related to various license agreements.\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.\nPROPERTY AND EQUIPMENT\nProperty and equipment are stated at cost less accumulated depreciation. Depreciation is provided principally on the straight-line method over the estimated useful lives of the assets ranging from five to ten years. Maintenance, repairs and minor renewals are charged to operations as incurred. Major replacements or betterments are capitalized when property and equipment are retired or otherwise disposed, the related cost and accumulated depreciation are eliminated and any gain or loss is reflected in current years income or loss.\nRESEARCH AND DEVELOPMENT\nResearch and development costs, consist principally of laboratory, design and development costs devoted to creating the liver technology are expensed as incurred.\nEXTEN INDUSTRIES, INC.\nNOTES TO CONSOLIDATED BALANCE SHEET (CONTINUED)\nA. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):\nREAL ESTATE\nReal estate held for sale has been considered impaired due to the Company's operating conditions and the Company's ability to fully recover the original carrying value of the asset. The basis as of November 30, 1994 of the property includes the allocation of original purchase price and other costs of development as incurred (see Note E). Real estate taxes and interest costs have been capitalized during the development period.\nINCOME TAXES\nIncome taxes are provided for the tax effects of transactions reported in the financial statements and consists of taxes currently due plus deferred taxes related primarily to differences between the basis of various assets for financial and income tax reporting. The deferred tax assets and liabilities represent the future tax return consequences of those differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled. Deferred taxes also are recognized for net operating losses that are available to offset future taxable income and tax credits that are available to offset future federal income taxes.\nRECLASSIFICATIONS\nCertain prior year balances have been reclassified to conform to the current year presentation.\nNET LOSS PER COMMON SHARE\nNet loss per share is calculated using the weighted average outstanding common and common stock equivalent shares. Company stock equivalents consist of all options granted at prices below fair market value in the previous twelve months which are considered to be outstanding for all periods presented.\nEXTEN INDUSTRIES, INC.\nNOTES TO CONSOLIDATED BALANCE SHEET (CONTINUED)\nB. NOTES RECEIVABLE:\nNotes receivable as of November 30, 1995 and 1994 consist of:\n1995 1994 -------- -------- Notes receivable with interest rates ranging from 9.5 to 10.0 percent. Each note has an underlying note payable whereby the note receivable and note payable are considered a wrap note unit. (See Notes F and K) $ -- $2,449,872\nTrust deeds, secured by real property, interest rate of10.5%, interest only monthly payments of $150, balance due April 1995. -- 18,998\nNote receivable, from Teca International, Ltd. (Teca), a related party, non-interest bearing, no formal repayment date. (Note D) 83,000 83,000\n83,000 2,551,870\nLess current portion -- 245,025 -------- ----------\n$ 83,000 $2,306,845 -------- ---------- -------- ----------\nC. RECEIVABLE FROM RELATED PARTY:\nOn February 7, 1994 the Company granted to a former President of the Company an option to purchase a total of one million (1,000,000) shares of common stock at a price of eighty-one and one-quarter cents ($.8125) per share exercisable for the period beginning February 8, 1994 and ending February 7, 2004 for cash payment or a promissory note payable within ninety (90) days.\nOn April 1, 1994 the option was exercised and one million (1,000,000) shares of the Company's common stock was issued. The shares were not paid for within the ninety (90) days set forth in the option agreement. As a result, a receivable has been established for the amount due the Company for this exercised option.\nEXTEN INDUSTRIES, INC.\nNOTES TO CONSOLIDATED BALANCE SHEET (CONTINUED)\nD. PROPERTY AND EQUIPMENT:\nProperty and equipment as of November 30, 1995 and 1994 consists of:\nE. INVESTMENTS:\nInvestments as of November 30, 1995 and 1994 are as follows:\nDuring January, 1994, the Company, together with an unaffiliated entity, formed Teca International, Ltd. (Teca), under Hong Kong laws. The business purpose of Teca is to manufacture, market and sell in Asia, Australia and New Zealand clinical devices licensed from Xenogenex, Inc. The Company's investment as of November 30, 1995 represents its 18.6% interest in Teca, which is accounted for under the equity method of accounting.\nDuring 1992, the Company issued shares of its common stock for all the rights, title, interest in the helicopter control technology recorded on its books. The Company as of November 30, 1995 has considered the helicopter control technology to be impaired as described within Statement Financial Accounting Standard (SFAS 121), \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of.\" The Company believes that changes in operating conditions raise doubt about the Company to fully recover the carrying value of the helicopter control technology and therefore has decided to write off the helicopter technology for the current period.\nEXTEN INDUSTRIES, INC.\nNOTES TO CONSOLIDATED BALANCE SHEET (CONTINUED)\nE. INVESTMENTS (CONTINUED):\nDuring August, 1995 the Company entered into a license agreement with GroupMed International (GMI), a publicly traded company, to manufacture, market, use, distribute and sell the Company's artificial liver technology in Mexico, Central and South America. In exchange for the license agreement, the Company received 250,000 share of GMI common stock and an ongoing royalty payment. The Company recorded the investment in GMI stock at the trading value on the date of execution ($4.00 per share), less a discount of $400,000 due to the restricted nature of the shares held by the Company.\nAs of November 30, 1995 GMI stock was trading at a price of $0.40 per share. The Company therefore adjusted the value of the investment accordingly to market value with a discount of 40% which approximates $40,000. Additionally, the Company has entered into negotiations for the rescission of the license agreement with GMI and the Company's return of the restricted shares for the liver technology agreement. The Company will continue to offer GMI the opportunity to purchase the license agreement for proper monetary payment if GMI so desires.\nAs of November 30, 1995 the company has written off $9,000 investment in timeshare. The Company believes that the timeshare has a net realizable value equal to zero and is properly accounting for the disposal as a loss.\nF. REAL ESTATE HELD FOR SALE:\nReal estate as of November 30, 1995 and 1994 consists of:\n1995 1994 --------- -----------\nReal estate - Grand Canyon area $ 354,000 $ 1,671,667 --------- -----------\n$ 354,000 $ 1,671,667 --------- ----------- --------- -----------\nThe Company believes that changes in operating conditions raise doubts about the company's ability to fully recover the carrying value of the real estate held for sale. It has been determined that the carrying value of the land will not be fully recovered, and therefore the asset is considered to be impaired under the requirements of SFAS 121.\nThe Company believes that there has been a significant decrease in the asset's market value in light of the Company's current operations and managements estimate of fair market value has changed because of the change in the lands use. The Company intends on the sale and disposition of the real estate in the most profitable and cost effective manner. Management of the Company believes that an impairment loss of approximately $1,300,000 should be recognized on the real estate held.\nEXTEN INDUSTRIES, INC.\nNOTES TO CONSOLIDATED BALANCE SHEET (CONTINUED)\nG. NOTES PAYABLE:\nNotes payable at November 30, 1995 and 1994 consist of the following:\nEXTEN INDUSTRIES, INC.\nNOTES TO CONSOLIDATED BALANCE SHEET (CONTINUED)\nG. NOTES PAYABLE (CONTINUED):\nA former President filed suit against the Company in January, 1995 seeking damages, declaratory relief and punitive damages arising out of the Company's alleged failure to pay the promissory notes, breach of employment contract and fraud. The Company is negotiating payment terms associated with the mediated judgement and settlement. The former President has subsequent to year end filed another injunction against the Company in the state of Arizona relative to the real estate for sale as satisfaction for the amounts due him. Approximately $350,000 of amount owed to the former President has common stock held in escrow by the Company relative to the obligation under the mediated judgement and settlement.\nAs of November 30, 1995, the Company is in default on its repayment of the loan agreement with a commercial bank. The bank received a judgement against the Company for $333,000, and for fees associated with the collection of the loans. The fees are estimated at $35,000, and are included in the accompanying financial statements as an accrued expense.\nH. SUBSCRIPTIONS RECEIVABLE:\nDuring the twelve months ended November 30, 1995, the Company sold under various stock purchase agreements 2,000,000 shares of its common stock and received promissory notes for $165,000. The notes call for payment to be made within 6 months of issuance, including interest accrued.\nAccordingly, the subscribed stock is reflected in the accompanying financial statements as of November 30, 1995 as a separate component of stockholders equity, net of any subscriptions receivable.\nEXTEN INDUSTRIES, INC.\nNOTES TO CONSOLIDATED BALANCE SHEET (CONTINUED)\nI. INCOME TAXES:\nThe Company's total deferred tax asset as of November 30, 1995 is as follows:\n------------ Net operating loss carryforwards $ 1,900,000 Valuation allowance (1,900,000) ------------\nNet deferred tax asset $ -- ------------ ------------\nAs of November 30, 1995 the Company had net operating loss carryforwards before any limitations which expires as follows:\nYear Ending November 30, Federal ------------ ----------- 2004 $ 259,000 2005 $ 56,000 2006 $ 931,000 2007 $ 820,000 2008 $ 1,584,000 2009 $ 1,580,000\nJ. STOCKHOLDERS' EQUITY:\nSTOCK FOR SERVICES\nDuring the twelve months ended November 30, 1995, the Company authorized and issued approximately 11,000,000 shares of common stock in exchange for consulting, payroll, directors fees and other services provided.\nApproximately 1,600,000 shares authorized and issued during the year ended November 30, 1995 is for future services to be performed under contractual agreements. The $160,000 is included as a prepaid expense as of November 30, 1995.\nIn April 1994 1,000,000 shares of common stock was issued to a former President of the Company as part of his employment agreement. The compensation of 1,000,000 shares was subject to certain conditions. Subsequent to termination it was determined that the conditions for the issuance of the common stock were not met. The Company is in the process of obtaining the 1,000,000 shares of common stock. The shareholder has agreed to return these shares and, accordingly, these shares are not included in the common stock outstanding.\nEXTEN INDUSTRIES, INC.\nNOTES TO CONSOLIDATED BALANCE SHEET (CONTINUED)\nJ. STOCKHOLDERS' EQUITY (CONTINUED):\nSTOCK OPTIONS\nThe Company has granted common stock options to various individuals, officers and directors of the Company in return for various services rendered to the Company.\nChanges during the twelve months ended November 30, 1995, of common stock options was as follows:\nShares Price Range ----------- -------------\nOutstanding at November 30, 1994 590,000 $.10 - $.50\nGranted 3,200,000 $.06 - $.10\nExercised 200,000 $0.06\nOutstanding at November 30, 1995 3,790,000 $.10 - $.50\nK. COMMITMENTS AND CONTINGENCIES:\nThe Company leases its office space under a year to year operating lease.\nThe Company has been named as defendant in several legal proceedings and litigation arising in the ordinary course of business. Significantly all of these proceedings are a result of non payment of accounts payable and notes payable. In the opinion of management, the outcome of such proceedings and litigation will not materially affect the company's results of operations or financial position. Based upon the opinion of legal counsel, all amounts represented in the legal proceedings and litigation have been reflected in the accounts payable and notes payable of the Company as of November 30, 1995.\nEXTEN INDUSTRIES, INC.\nNOTES TO CONSOLIDATED BALANCE SHEET (CONTINUED)\nL. WRAP NOTES:\nAs of November 30, 1995, the Company has determined that the wrap notes (Notes B & F) and associated equity purchased during 1992 have an undeterminable value. The Company believes that a valuation allowance should be established for the entire amounts relative to the wrap notes receivable and payable balances. The Company has recognized the loss associated with the wrap notes in the amount of $356,741 for the year ended November 30, 1995. This increase for reserves of $356,741 has been reflected within general and administrative expenses in the accompanying consolidated statement of operations for the year ended November 30, 1995.\nM. SUPPLEMENTAL CASH FLOW INFORMATION:\nSupplemental disclosures of cash flow information for the years ended November 30, 1995 and 1994 are summarized as follows:\n1995 1994 --------- ---------\nCash paid for interest and income taxes:\nInterest $ 14,752 $ 27,982 Income taxes $ 800 $ 800\nNoncash investing and financing activities: Sale of Sybiol license $(60,000) $ --\nEXTEN INDUSTRIES, INC.\nNOTES TO CONSOLIDATED BALANCE SHEET (CONTINUED)\nN. GOING CONCERN:\nThe Company has had recurring losses from operations, and as of November 30, 1995, the Company's current liabilities exceeded its current assets by approximately $400,000. In addition, the Company had negative cash flows for the year ended November 30, 1995 and significant continuing losses. Furthermore, a judgement against the Company, as one of five guarantors arising out of a loan obtained from a bank on the repayment of three loans, has been received in the amount of $333,000 (See Note G), the Company has a mediated judgement against itself from a former officer and director for approximately $388,000 and the Company is in arrears on accounts with creditors. These factors create an uncertainty as to the Company's ability to continue as a going concern.\nSeveral steps have been taken by the Company to reduce its liabilities, reduce its cash requirements, and raise capital. The Company is considering merging with other entities, and has been negotiating with the bank and creditors to settle its liabilities outstanding. The Company has also entered in various agreements to pay for services from consultants and others with common stock of the Company.\nThe ability of the Company to continue as a going concern is dependent upon its ability to settle the bank judgement, mediated judgement, and accounts payable to its creditors, its endeavors to seek additional sources of capital, and its attaining future profitable operations. The accompanying financial statements do not include any adjustments that might be necessary should the Company be unable to continue as a going concern.\nO. SUBSEQUENT EVENTS\nDuring February, 1996 the Company received notice that it was in default on the wrap notes (Notes B & F) and that payment was due in the amount of $135,000 to the holders of the notes. Numerous discussions with experts in the real estate field has left the Company to determine that at the present time proper accounting would require that the wrap notes be written off to a net realizable value of zero.\nP. ADJUSTMENT TO 1994\nSubsequent to the issuance of the 1994 financial statements the Company discovered that a stock option granted of 1,000,000 shares of common stock granted to a former President of the Company had been exercised on April 1, 1994. Accordingly, the Company has adjusted stockholders' equity $812,500 as a result of this transaction. (See Note C)\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 16th day of May 1996.\nEXTEN INDUSTRIES, INC.\nBy: \/s\/ W. GERALD NEWMIN -------------------------- W. Gerald Newmin President, CEO, Chairman, 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\/ W. GERALD NEWMIN - --------------------- W. Gerald Newmin President, CEO, Chairman & Secretary 05\/16\/96\n\/s\/ WILLIAM R. HOELSCHER - -------------------------- William R. Hoelscher Director & Treasurer 05\/16\/96\n\/s\/ LARRY BEDARD - ----------------- Larry Bedard Director 05\/16\/96\nLIST OF SUBSIDIARIES\nAs of May 10, 1996, the registrant had one subsidiary, Xenogenex, Inc.\nINDEX TO EXHIBITS\nExhibit No. Description of Exhibit - ----------- ----------------------\n10 Compensation\/Stock Option Agreement\n24 Consent of Harlan & Boettger\n27 Financial Data Schedule","section_14":"","section_15":""}
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{"filename":"789388_1995.txt","cik":"789388","year":"1995","section_1":"Item 1. Business\nOverview\nSunGard Data Systems Inc. (the \"Company\") is a computer services company that specializes in proprietary investment support systems and comprehensive computer disaster recovery services. The Company believes that it is the only large specialized provider of investment support systems to the financial services industry, as well as the pioneer and a leading provider of comprehensive computer disaster recovery services. The Company's business approach is to focus on markets in which it has opportunities to develop or acquire leading products and advantageous market positions.\nThe Company seeks to maximize recurring revenues by selling most of its computer services under fixed-term contracts and by emphasizing customer support and product quality in order to establish long-term relationships with customers. The Company's recurring revenues are derived primarily under contracts for remote processing services, disaster recovery services and software maintenance, which together accounted for approximately 84% of the Company's total revenues during the last three years (84% in 1994). Of the total number of the Company's remote processing and disaster recovery services contracts that were scheduled to expire during the last three years, approximately 84% were renewed or replaced with new contracts (81% in 1994). While there can be no assurance that this renewal rate will not decline, the Company believes that it will continue to renew a high percentage of these contracts. None of the Company's customers individually accounted for more than two percent of the Company's revenues in 1994.\nThe Company's operations are decentralized, and its management philosophy is one of \"controlled entrepreneurship.\" The Company's services are provided through separate business units, which are organized into five groups of related businesses, as follows:\nEach group is directed by its own management team and has its own sales, marketing, product development, operations and customer support personnel. Overall corporate control and coordination are achieved through centralized budgeting, financial and legal reporting, cash management and strategic planning. The Company believes that this approach has facilitated more focused marketing, specialized product development, responsive customer service and highly motivated management.\nThe Company is a Delaware corporation that was organized in 1982. The Company's principal executive offices are located at 1285 Drummers Lane, Wayne, Pennsylvania, 19087, and its telephone number is (610) 341-8700.\nInvestment Support Systems\nThe Company designs, markets and maintains a comprehensive family of proprietary investment support systems for the financial services industry. The fundamental purpose of these systems is to automate the complex accounting calculations, record keeping and reporting associated with investment operations. The Company markets its investment support systems throughout the United States, and many are marketed internationally as well.\nThe Company delivers its investment support systems primarily as remote data processing services using the Company's computer equipment and also through software licenses for use on its customers' computers. The Company provides investment support remote processing services primarily from its computer centers in Birmingham, Boston (two centers), Charlotte, Fairfield (New Jersey), London (two centers), Los Angeles, Minneapolis, Sydney and Voorhees (New Jersey) (see Properties on page 12). As of December 31, 1994, the Company had approximately 1,600 remote processing contracts in force. These contracts generally have initial terms of one or more years and then continue for successive, one-year renewal terms, although some allow the customer to terminate on relatively short notice.\nDuring the past four years, the Company's investment support systems business has increased significantly in both size and scope, due primarily to acquisitions (see Acquisitions and Offerings on page 10). During 1994, the Company continued consolidating its investment support products. This included ongoing product unification and enhancement to provide customers with access to multiple systems and data through common graphical interfaces and shared databases. The Company also continued evolving its mainframe computer systems by converting some systems to client-server technology and by developing sophisticated personal computer and workstation front-end products for others. Also during 1994, the Company continued to add multicurrency functionality to its systems and pursue opportunities to market more of its systems internationally.\nInvestment Accounting and Portfolio Management Systems. The Company's investment accounting and portfolio management systems maintain the books of record for all types of large investment portfolios such as those managed by banks, mutual funds, employee retirement plans and insurance companies. The primary functions of these systems are to accept investment transactions, value portfolios using transmissions of security prices received from various worldwide sources, perform complex accounting calculations and general ledger postings, and generate a variety of accounting, audit, tax and regulatory reports. In addition, some of these products are used by investment advisers and other portfolio managers to manage large investment portfolios. These systems track investment activities such as purchases and sales, combine these activities with outside market data such as security prices and quality ratings, and provide analytical models to assist with investment strategy and management decisions.\nThe following table lists the Company's principal investment accounting and portfolio management systems, the hardware systems they require, their modes of delivery to customers and their primary markets. Some of these products can process information in multiple foreign currencies.\nDuring 1994, the Company continued to market INVEST ONE internationally by licensing the system to financial institutions in Mexico, the Philippines and the United Kingdom and by developing a unit trust processing enhancement to support the mutual fund market in the United Kingdom. Also during 1994, the Company completed SERIES 1, a Windows version of SERIES 2 for the insurance market, and completed the conversion of MONEYMAX\/SERIES 2 processing to UNIX workstation technology. The Company expanded its portfolio management systems product line in 1994 with the addition of PAL, which provides portfolio valuation, management and record keeping services primarily to United Kingdom stockbroking firms and fund managers (see Acquisitions and Offerings on page 10).\nThe Company also markets certain accounting systems for insurance companies. The current products are ABC(TM) (Accounting Budget and Cost System) and CDS(TM) (Cash Disbursement System). In 1994, the Company signed a partnership agreement with four major insurance companies for the joint development of the ENTERPRISE ACCOUNTING SYSTEM(TM), a relational data base accounting system that will be a successor product to ABC and CDS.\nSecurities and Derivatives Trading and Accounting Systems. The Company's securities and derivatives trading and accounting systems are used primarily by the so-called \"sell side\" of the investment business. The users of these products generally are traders or dealers of securities or derivative instruments (including those trading for their own accounts) and their back- office operations. In addition to performing many investment accounting functions, the Company's securities and derivatives trading and accounting systems maintain inventories of unsold securities, process trade activities, provide risk management capabilities, and assist users in determining hedging strategies and monitoring compliance with audit limits, trading limits and government regulations. The Company's principal software products in this category are:\nIn 1994, the Company licensed GSM GLOBAL SECURITIES MANAGER(R), a multicurrency system for client-server environments designed to be used on several platforms, to a number of new customers and continued development work on the system. Also in 1994, the Company signed a multimillion dollar development, license and facilities management agreement for an enhanced version of the PHASE3 SYSTEM with a major Japanese brokerage firm (U.S. operations), which had been a remote processing customer. The Company also entered into an alliance with Goldman Sachs to offer mutual fund services to government, insurance and bank capital markets customers. In February 1995, the Company acquired the business of DML, a provider of securities lending and brokerage accounting systems (see Acquisitions and Offerings on page 10).\nThe Company directly markets the DEVON DERIVATIVES, FOREX, FUTURES AND SECURITIES SYSTEMS throughout the world, except in Japan where the systems are exclusively marketed by a representative that is entitled to certain percentages of the revenues generated from sales in Japan. The Company also markets DEVON CONNECT(TM), a global trade routing, market data distribution and dealer support system that incorporates Sybase SQL client-server technology.\nThe DEVON DERIVATIVES SYSTEM is comprised of one or more modules depending upon the types of derivative instruments traded. These modules include, among others, DEVON SWAPS(TM) for interest rate and currency swaps, DEVON OPTIONS(TM) for interest rate caps, floors, collars and debt options, DEVON BONDS(TM) for bonds and floating rate notes, DEVON FRAs(TM) for forward rate agreements, loans and deposits, and DEVON FX(TM) for spot and forward foreign currency trades and over-the-counter foreign currency options. Several modules, including those with Sybase SQL client-server functionality,\nincorporate certain software developed by third parties. The Company holds worldwide licensing rights to this software and in some cases is required to pay royalties.\nThe DEVON FOREX SYSTEM and INTAS are new products that were introduced in 1994. The DEVON FOREX SYSTEM is a deal capture and risk management system for high volume foreign exchange and money market trading. INTAS provides trading, risk management and processing for interest rate instruments. Also during 1994, the Company released a Windows version of the DEVON DERIVATIVES SYSTEM and several additional derivatives modules incorporating Sybase SQL client-server technology. In addition, the Company entered into an alliance with the Chicago Mercantile Exchange to create the world's first swaps collateral depository in conjunction with the Society for Worldwide Interbank Financial Telecommunication (\"SWIFT\").\nTrust and Global Custody Systems. The Company's trust systems automate the investment, administrative and operations areas unique to the bank trust business, including cash management, management and investment of assets, preparation of tax returns for taxable trusts, payment of trust expenses, payment of benefits to retirees, beneficiary distributions, customer statement production, and other customer service duties. The Company's global custody systems automate the functions associated with the worldwide custody and safekeeping of investment assets, such as trade settlement, investment income collection, preparation of client statements, tax reclamation, foreign exchange, and reconciliation of depository and sub-custodian positions. The Company's principal trust and global custody systems are:\nThe Company offers specialized trust asset custody services to its AUTOTRUST customers and other banks and trust companies. These services are provided under a master contract with The Bank of New York (the \"Bank\"). The Bank holds the customers' trust assets, and the Company handles account record keeping and customer communications. The Company is liable to the Bank for any unpaid obligations of the Company's custody services customers that exceed the value of their assets held in the Bank's custody.\nIn 1994, the Company introduced OMNI IC, a scalable, multiplatform, multicurrency, multilingual global custody system with SWIFT-access features. The Company obtained exclusive, worldwide marketing rights to OMNI IC from the original developer of the system and is obligated to pay certain percentages of the revenues generated by this system to the original developer.\nThe Company also markets EXPEDITER(TM), a product that facilitates the automated entry of mutual fund transactions. EXPEDITER was introduced in 1993 and, throughout 1994, it continued to expand its selection of mutual funds and to gain market acceptance.\nShareholder Accounting Systems. The Company's shareholder accounting systems automate the transfer agent process for stock, bond and mutual fund issues. These systems maintain shareholder and bondholder positions, process dividend and interest distributions, generate proxy materials,\ntabulate votes, and produce tax reports and periodic shareholder statements. The Company's principal software products in this category are:\nIn 1994, the Company put into production a significant enhancement to INVESTAR named the DEALER TRADE SYSTEM(SM), which further automates and improves the system's handling of mutual fund buy and sell orders. Additionally, the Company continued development of the UNIX version of SUNSTAR.\nParticipant Accounting Systems. The Company's participant accounting systems automate the investment operations associated with defined contribution retirement plans such as 401(k) plans. These systems maintain the books of record for each participant's share of the cash and securities in the plan, monitor compliance with government regulations and plan restrictions, process payments of benefits to retirees, and produce tax reports for plan sponsors and participants. The Company's principal participant accounting systems are:\nDuring 1994, the Company continued development of OMNIPLUS(TM), which will succeed OMNIPLAN and be the Company's next generation participant accounting system. Planned to be introduced during 1995, OMNIPLUS will support both defined contribution and defined benefit retirement plans.\nInvestment Reporting and Analysis Systems. The Company's investment reporting and analysis systems accept accounting data from other investment support systems and perform special analyses for fund managers and customers. These systems analyze the performance of portfolios, perform other types of investment measurement and analysis, and produce regulatory reports for retirement plan sponsors and participants. The Company's principal software products in this category are:\nDocument-Imaging and Work-Flow. During 1994, the Company acquired PowerImage(R), a document-imaging and work-flow software system (see Acquisitions and Offerings on page 10). PowerImage uses electronic document- imaging in a manner that enables improved work-flow and enhanced levels of service and efficiency. During 1994, this new product was marketed primarily to the Company's shareholder accounting system customers. The Company believes that document-imaging and work-flow capability is fast becoming an important tool that will be increasingly integrated into other investment support systems.\nDisaster Recovery Services\nMany businesses depend upon computers to perform critical tasks and use communications networks to transmit data between a centralized computer facility and distant offices. If a natural disaster, fire, power failure or other emergency disrupts a company's computer operations or interrupts communications between its data processing center and remote locations, its ability to stay in business may be jeopardized. To address this problem, the Company maintains alternate data processing sites for use by customers whenever they are unable to operate or communicate with their own computer systems.\nThe primary alternate sites provided by the Company are fully equipped and operational computer centers known as \"hotsites,\" where customers may restore their critical applications using the Company's installed computer equipment. The Company also provides environmentally prepared computer centers known as \"coldsites,\" in which customers may install and operate their own computer equipment, and remote operations centers for using the Company's alternate sites from long distance. In addition, the Company provides mobile recovery resources that are delivered or shipped directly to customer-specified locations.\nThe Company also provides general office space equipped with office equipment, which customers may use alone or in conjunction with the use of a hotsite or coldsite. This product line, known as Work Group Recovery(SM), also includes MegaVoice(SM), a centralized voice communications recovery service that backs up customers' automated telephone call distribution systems.\nMost of the Company's larger disaster recovery customers purchase a basic package of services that includes use of a hotsite for six weeks to recover from any computer center failure, use of a coldsite for six months if recovery operations must continue for more than six weeks, use of a hotsite to regularly test disaster recovery procedures, use of general office space during recovery operations and tests, technical assistance when conducting recovery operations and tests, and technical assistance with designing and implementing a backup communications network.\nThe Company provides disaster recovery services to users of IBM (and compatible) mainframe computers and also to users of DEC, Hewlett Packard, IBM midrange (AS\/400, RS\/6000 and Systems\/3X), NCR, Prime, Sequent, Stratus, Sun Microsystems, Tandem and Unisys computers. These services are marketed, directly and through representatives, primarily to IBM (and compatible), DEC and Unisys mainframe and midrange computer installations in North America. In 1994, the Company continued to expand its disaster recovery offerings to users of midrange computers and\nfurther enlarged its midrange sales force. This effort was enhanced by two acquisitions that increased the number of customer contracts for midrange computer facilities (see Acquisitions and Offerings on page 10). Also in 1994, the Company continued to expand its marketing partner program by establishing alliances with numerous hardware providers and others and by signing certain agreements with third parties to expand and enhance its recovery services and capabilities.\nDuring 1994, for the ninth consecutive year, the Company successfully supported all customers who experienced computer center failures.\nDisaster Recovery Facilities. The Company believes that it conceived and first implemented the concept of the MegaCenter(R), a multiple hotsite and coldsite facility that customers may use directly or remotely. The Company operates five MegaCenters, located in Atlanta, Chicago, Philadelphia, Scottsdale and Warminster (see Properties on page 12). During 1994, the Company completed major expansions of the Philadelphia and Chicago MegaCenters, including the addition of a mainframe command center and additional space for midrange product lines in each location. The Company believes that its Philadelphia MegaCenter, which houses DEC, Hewlett Packard, IBM mainframe, Sequent, Stratus and Tandem hotsites, and mobile Hewlett Packard, IBM midrange, NCR and Sun Microsystems computer systems, is the largest commercial disaster recovery facility in the world.\nThe Company also operates MetroCenters(R) in strategic locations throughout North America to provide Work Group Recovery services, enhanced remote operations capabilities, and recovery operations and testing support for mobile computer systems. MetroCenters are located in Boston, Dallas, Herndon (Virginia), Jersey City (New Jersey), Los Angeles, St. Louis, St. Paul and Toronto. The St. Paul and Toronto MetroCenters also have coldsites that can be used in conjunction with the remote operations capability.\nThe Company periodically opens new facilities or expands existing facilities to accommodate both the growth in its customer base and the addition of different types of computer systems. Also, the Company regularly upgrades its systems to offer the most advanced computer equipment generally used by its customers. During 1994, the Company opened two new MetroCenters (in Herndon and Jersey City), upgraded the central processing units of selected mainframe hotsites in its Atlanta, Chicago, Philadelphia and Scottsdale MegaCenters, and upgraded many mobile midrange systems at various facilities. New Hewlett Packard and Tandem (\"Himalaya\" model) hotsites were installed in Philadelphia, and new mobile systems were installed in Atlanta (IBM AS\/400 and RS\/6000, DEC and Hewlett Packard), Chicago (IBM AS\/400, Hewlett Packard and Sun Microsystems), Dallas (IBM AS\/400 and System\/3X), Jersey City (IBM AS\/400 and System\/3X), Philadelphia (DEC, NCR, IBM RS\/6000 and Sun Microsystems) and Los Angeles (Hewlett Packard and Sun Microsystems). The disk access, tape cartridge and other peripheral equipment at all facilities were upgraded or augmented, including the addition of a state-of-the-art storage and retrieval system for mainframe customers in Philadelphia.\nThe Company believes that, by operating a relatively small number of large facilities linked by a comprehensive communications network, it can provide superior disaster recovery services in the most effective manner. All MegaCenters and MetroCenters, as well as other remote operations centers, are linked by a communications network that is capable of handling a full range of digital and analog data transmission methods, including satellite and fiber optics applications. The Company regularly upgrades this network to offer the communications technology generally used by its customers. During 1994, the Company continued expanding its matrix switching capabilities to allow for more efficient and reliable communications during customer tests and recovery operations.\nThe Company markets its comprehensive disaster recovery facilities and services on a component pricing basis, allowing each customer to select the specific items of equipment and other recovery services needed to satisfy its individual disaster recovery requirements. The Company's disaster recovery equipment is covered by maintenance contracts to assure that it is properly functioning at all times.\nDisaster Recovery Contracts. As of December 31, 1994, the Company had approximately 5,400 disaster recovery contracts in force. These contracts generally require the payment of monthly fees and range in duration from one to five years. The amount of the monthly fees depends upon the type of facilities and services selected, contract duration and competitive factors.\nThe Company's disaster recovery contracts limit the number of computer centers that may be serviced by each of the Company's large IBM mainframe hotsites. As of December 31, 1994, the Company had a maximum capacity of 1,860 contracts for large IBM mainframe hotsites, with current contracts utilizing approximately 73% of such capacity.\nPlanning Services. The Company provides professional consulting and educational services for disaster recovery and business resumption planning, not only for computer operations, but also for company-wide purposes encompassing all important business operations. This includes the development of customized disaster recovery and business resumption plans for customers. The Company also performs risk analyses to determine customers' exposure to the disruption or loss of critical operations and resources, audits customers' disaster recovery and business resumption procedures, and recommends improvements. In addition, the Company conducts regular seminars on disaster recovery, business resumption and related topics.\nThe Company also markets a Windows-based microcomputer software product introduced during 1994, CBR(TM) Comprehensive Business Recovery, which automates the preparation and maintenance of disaster recovery and business resumption plans, including comprehensive company-wide planning capabilities. The Company also continues to support its DOS-based microcomputer disaster recovery planning software product known as DP\/90 PLUS(R). In March 1995, the Company acquired the disaster recovery planning software business of CHI\/COR Information Management, Inc. (see Acquisitions and Offerings on page 10).\nComputer Services\nThe Company provides remote-access computer services primarily to software developers and government agencies and also provides outsourcing services. In addition, the Company provides direct marketing computer services and automated mass mailing and printing services. These activities are supported at the Company's computer centers in Voorhees and Birmingham (see Properties on page 12), which also are used to provide remote processing services for several of the Company's investment support systems business units.\nIn 1994, the Company added a new IBM ES9000 model computer at its Voorhees facility, and implemented a centralized system for tracking requirements of its computer services customers. The Company also expanded its international network capabilities and implemented several improvements to its mailing and printing services.\nProduct Development\nThe investment support systems needs of the financial services industry are complex and substantial, and continually evolve as a result of changes in laws, introductions of new types of investment vehicles and increased competition. For these reasons, the Company believes that it is important to continually maintain, enhance and evolve its proprietary investment support systems. The Company funds most of its routine ongoing software maintenance and support activities through the software maintenance fees paid by its investment support systems license customers and a portion of the monthly fees paid by its investment support systems remote processing customers. As of December 31, 1994, the Company had in force approximately 1,800 software maintenance contracts for its investment support systems.\nThe Company's expenditures for software development during 1994, 1993 and 1992, including amounts that were capitalized, totalled approximately $38,684,000, $37,581,000 and $24,899,000, respectively. These amounts do not include routine software maintenance and support costs that are included in cost of sales, nor do they include costs incurred in performing certain custom development projects for individual customers in the ordinary course of business.\nDuring 1995, the Company plans to substantially complete UNIX versions of SUNSTAR and OMNIPLAN and Windows versions of AUTOTRUST, DEVON FOREX, MICROSHAW, ON-SITE and PMS\/APS. These developments are examples of the Company's strategy of using the established functionality of its existing systems to develop state- of-the-art systems for new technological environments.\nAlso in 1995, the Company plans to enhance the capabilities of INVEST ONE to improve the processing of mergers, exchanges, spin-offs and other corporate transactions, and to substantially complete the development of OMNIPLUS, its next generation participant accounting system for employee benefit plans. In 1995, the Company will continue to expand the application of EXPEDITER, which facilitates the automated entry of mutual fund transactions for users of AUTOTRUST, OMNITRUST ES, OMNIPLAN, BOLT and eventually other investment support systems. The Company will continue during 1995 to enhance the PHASE3 brokerage accounting product to support foreign securities processing and to better support retail brokerage. In addition, the Company plans to continue development of SUNDIAL(TM), a centralized, multi-vendor securities pricing database.\nThe Company expands its disaster recovery services by adding new hotsites at existing facilities, upgrading its computer equipment, developing new services and opening new facilities. In early 1995, the Company installed IBM's largest AS\/400 midrange computer and a Sequent computer in the Philadelphia MegaCenter. During 1995, the Company plans to add new command centers at its Chicago and Philadelphia MegaCenters and open new MetroCenters in the Chicago and Cleveland areas. Also during 1995, the Company plans to expand its electronic vaulting product offerings. The Company also plans to continue upgrading its disk storage, tape cartridge and other peripheral hotsite equipment and to continue opening new MetroCenters where the demand exists.\nThe Company expands its disaster recovery communications network by upgrading its communications equipment, adding new communications capabilities and establishing additional remote operations centers where the demand exists.\nAcquisitions and Offerings\nThe Company seeks to grow through both internal development and the acquisition of businesses that broaden or complement its existing product lines. Since its initial public offering in 1986, the Company has acquired sixteen investment support systems businesses, thirteen disaster recovery businesses and two computer services businesses. Also during this period, the Company completed two additional public offerings, a common stock offering in 1987 and a convertible debenture offering in 1990. The debentures were converted into common stock in 1993.\nDuring 1994, the Company spent approximately $27,927,000 in cash, net of cash acquired, to acquire two investment support systems businesses and two disaster recovery services businesses.\nAs additions to the Trust and Shareholder Systems Group, in August 1994, the Company purchased the business of Desktop Advantage, a Massachusetts-based provider of document-imaging and work-flow software systems, and, in September 1994, the Company purchased the business of Portfolio Administration Limited, a London-based provider of portfolio administration, valuation and record keeping software and services to United Kingdom stockbroking firms and fund managers. In February 1995, the Company acquired DML, a developer and provider of securities lending and brokerage accounting software systems.\nThe Recovery Services Group increased its presence in the midrange computer market with two acquisitions in 1994. In April 1994, the Company purchased the disaster recovery business of XL\/Datacomp, Inc., which consists primarily of recovery services for IBM midrange platforms. In October 1994, the Company acquired the disaster recovery business of Computervision Corporation. In March 1995, the Company acquired the disaster recovery software business of CHI\/COR Information Management, Inc.\nCompetition\nSince most of the Company's computer services and software are specialized and technical in nature, the various markets in which the Company competes have a relatively small number of significant competitors. Some of the Company's existing competitors and some potential competitors have substantially greater financial, technological and marketing resources than the Company. The Company believes that, for most of its businesses, service, quality and reliability are more important competitive factors than price.\nIn its investment support systems business, the Company competes with numerous other data processing and financial software vendors, which may be broadly categorized into two groups. One is comprised of specialized investment support systems companies, most of which are much smaller than the Company. The other is comprised of large computer services companies whose principal businesses are not in the investment support systems area. The Company also faces competition from the internal processing and development capabilities of its potential customers.\nThe key competitive factors in marketing investment support systems are the accuracy and timeliness of processed information provided to customers, features and adaptability of the software, level and quality of customer support, level of software development expertise and overall net cost. The Company believes that it competes effectively as to each of these factors and that its reputation and experience in these markets are important competitive advantages.\nThe computer disaster recovery business remains highly competitive. The Company's principal competitors in this business are Comdisco Disaster Recovery Services, Inc., Digital Equipment Corporation and IBM Corporation, all of which have substantially greater financial and other resources than the Company. The Company also faces potential competition from major companies that have computer facilities that could be made available for disaster recovery use. The Company believes that it competes effectively as to the key competitive factors in this market, namely quality of facilities, scope and quality of services, level and quality of customer support, level of technical expertise and price. The Company also believes that its experience and reputation as the innovator in this business are important competitive advantages.\nMarketing\nAll of the Company's specialized computer services and software are marketed throughout the United States, and many are marketed internationally as well. The Company's export sales during 1994, 1993 and 1992 totalled approximately $33,505,000, $29,061,000 and $32,501,000, respectively. In addition, the Company's foreign subsidiaries had sales that for those years totalled approximately $26,652,000, $18,437,000 and $3,211,000, respectively.\nThe Company develops and maintains proprietary marketing information by identifying prospective customers through a variety of data bases and other sources, and then canvassing the prospects by direct mail, telephone calls and personal visits. The Company also attempts to identify and attract customers by conducting seminars and participating in industry conferences. Customer references have been an important aid in obtaining new business.\nEmployees\nAt December 31, 1994, the Company had approximately 2,500 full-time employees. The Company believes that its success depends, in part, on its continuing ability to attract and retain skilled technical, marketing and management personnel. While data processing professionals and software developers are in high demand, the Company believes that, to date, it has been able to attract and retain highly qualified personnel. None of the Company's employees is covered by a collective bargaining contract. The Company believes that its employee relations are excellent.\nProprietary Protection\nThe Company owns registered marks for the SunGard name and owns or has applied for registered marks for many of its service and software names. The Company has few registrations of its copyrights and has no patents. The Company believes that registered copyrights and patents are of less significance in its business than software development skills, technological expertise and marketing capabilities. The Company relies primarily on contractual restrictions and trade secret laws for the protection of its proprietary services and software. The Company also has established policies requiring its personnel to maintain the confidentiality of the Company's proprietary property.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe following table indicates the location, purpose and size of the Company's principal offices, principal computer facilities, business unit headquarters and disaster recovery MegaCenters.\nThe Company leases all of the offices and facilities listed in the preceding table, with the exception of its Birmingham, Voorhees and Warminster facilities, which are owned, and its Hopkins facility, which consists of two connected buildings, one leased and the other owned. The Company also owns the MetroCenter in St. Paul, Minnesota. The Company also leases space, primarily for sales offices, customer support offices, MetroCenters and remote operations centers, in many locations in the United States and internationally. The Company believes that its leased and owned facilities are adequate for the Company's present operations.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe Company is presently a party to certain lawsuits arising in the ordinary course of its business. The Company believes that none of its current legal proceedings will be material to its business or financial condition.\nIn February 1995, a lawsuit was initiated against the Company and its construction contractor alleging that there have been illegal removals and releases of asbestos during renovations at the Company's Philadelphia MegaCenter. The suit seeks class action status and requests unspecified compensatory and punitive damages, as well as injunctive and other relief. Based upon testing by independent experts, the Company has determined that its Philadelphia MegaCenter is safe. The Company intends to vigorously defend itself and believes that this lawsuit will not be material to its business or financial condition.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNone.\nItem 4.1 Certain Executive Officers of the Registrant\nThe executive officers of the Company who are not also directors are listed below.\nMr. Adams has been Chairman and Chief Executive Officer of SunGard Recovery Services Inc. since 1988 and was its President from 1990 to 1992. From 1983 to 1988, Mr. Adams was President and a director of SunGard Trust Systems Inc.\nMr. Bronstein became Vice President and Controller of the Company in February 1994. Before that, he was Corporate Controller from 1992. From 1985 to 1992, he was a manager with Coopers & Lybrand L.L.P., Philadelphia, where he served as senior manager on the Company's account and as director of the firm's Philadelphia high technology group. Mr. Bronstein is a director and officer of most of the Company's domestic subsidiaries.\nMr. Conde has been Chief Executive Officer and a director of SunGard Capital Markets Inc. since 1991. He was one of the founders of that company in 1983 and was its Executive Vice President from 1983 to 1991. Before it was acquired by the Company in 1987, SunGard Capital Markets Inc., originally named Devon Systems International, Inc., was an independent software company. Mr. Conde is a director and\/or officer of many of the Company's foreign subsidiaries.\nMr. Dowd has been Chief Executive Officer of SunGard Investment Systems Inc. since 1990 and one of its directors since 1982. He was President of SunGard Investment Systems Inc. from 1982 to 1990. Mr. Dowd has been Chief Executive Officer and a director of SunGard Shareholder Systems Inc. since 1989, President-Software Divisions of SunGard Business Systems Inc. since 1990, Chief Executive Officer and a director of SunGard Trust Systems Inc. since 1991, and a director of Shaw Data Services, Inc. since 1992.\nMr. Gross has been Vice President and General Counsel of the Company since 1986 and Secretary of the Company since 1987. From 1979 to 1986, he was a lawyer with Blank, Rome, Comisky & McCauley, Philadelphia, and he has represented the Company since 1983. Mr. Gross is a director and officer of most of the Company's domestic subsidiaries and some of its foreign subsidiaries.\nMr. Muratore has been Chief Executive Officer and a director of SunGard Computer Services Inc. since 1989 and President-Processing Divisions of SunGard Business Systems Inc. since 1990. From 1985 to 1988, Mr. Muratore was President of the Company's Central Computer Facility, which was consolidated with SunGard Computer Services Inc. at the end of 1988.\nMr. Peterson has been Chief Executive Officer and a director of SunGard Financial Systems Inc. since October 1993. From 1990 to 1993, Mr. Peterson was Chief Executive Officer of EJV Partners, L.P., a financial information firm. Before that, he was an executive at SEI Corporation, a trust system and mutual fund company, for seven years, where his last position was Executive Vice President.\nMs. Pedrick has been Vice President-Human Resources of the Company since 1988. From 1983 to 1988, she was Director-Human Resources of the Company.\nMr. Ruane has been Chief Financial Officer, Vice President-Finance and Treasurer of the Company since April 1994. From 1992 until April 1994, Mr. Ruane was Chief Financial Officer and Vice President-Finance of SunGard Capital Markets Inc. Before that, he was Vice President-Controller of the Company from 1990 through 1992, and Corporate Controller of the Company from 1985 to 1990. Mr. Ruane is a director and officer of most of the Company's domestic and foreign subsidiaries.\nMr. Tarbox has been Vice President-Corporate Development of the Company since 1987. He is an officer of several of the Company's domestic subsidiaries.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters\nThis information is incorporated by reference to the section entitled Stock Information in the Company's 1994 Annual Report to Stockholders (included in Exhibit 13.1 to this Report on Form 10-K).\nItem 6.","section_6":"Item 6. Selected Financial Data\nThis information is incorporated by reference to the section entitled Selected Financial Information in the Company's 1994 Annual Report to Stockholders (included in Exhibit 13.1 to this Report on Form 10-K).\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 section entitled Management's Discussion and Analysis of Financial Condition and Results of Operations in the Company's 1994 Annual Report to Stockholders (included in Exhibit 13.1 to this Report on Form 10-K).\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe financial statements of the Company, financial statement schedule of the Company, supplementary data and related documents that are included in this Report on Form 10-K are listed in Item 14(a), Part IV, of this Report.\nItem 9.","section_9":"Item 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure\nNone.\nPART III\nThis Part incorporates certain information from the Company's definitive proxy statement for its 1995 Annual Meeting of Stockholders (\"1995 Proxy Statement\") to be filed with the Securities and Exchange Commission not later than 120 days after the end of the Company's fiscal year covered by this Report on Form 10-K. Notwithstanding such incorporation, the sections of the Company's 1995 Proxy Statement entitled Compensation Committee Report and Performance Graph shall not be deemed to be \"filed\" as part of this Report.\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nInformation concerning the directors of the Company is incorporated by reference to the Company's 1995 Proxy Statement including but not necessarily limited to the section of such proxy statement entitled Election of Directors.\nInformation concerning executive officers of the Company who are not also directors is included in Item 4.1, Part I, of this Report on Form 10-K.\nItem 11.","section_11":"Item 11. Executive Compensation\nThis information is incorporated by reference to the Company's 1995 Proxy Statement including but not necessarily limited to the section of such proxy statement entitled Executive Compensation.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThis information is incorporated by reference to the Company's 1995 Proxy Statement including but not necessarily limited to the section of such proxy statement entitled Beneficial Ownership of Common Stock.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThis information is incorporated by reference to the Company's 1995 Proxy Statement including but not necessarily limited to the sections of such proxy statement entitled Executive Compensation, Beneficial Ownership of Common Stock and Election of Directors.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(a)(1) Financial Statements\nThe following financial statements of the Company, supplementary data and related documents are incorporated by reference to the Company's 1994 Annual Report to Stockholders (included in Exhibit 13.1 to this Report on Form 10-K):\nReport of Independent Accountants on Financial Statements, dated February 8,\nConsolidated Statements of Income for each of the years ended December 31, 1994, 1993 and 1992\nConsolidated Balance Sheets as of December 31, 1994 and 1993\nConsolidated Statements of Cash Flows for each of the years ended December 31, 1994, 1993 and 1992\nConsolidated Statement of Stockholders' Equity for each of the years ended December 31, 1994, 1993 and 1992\nNotes to Consolidated Financial Statements\nQuarterly Financial Information (unaudited)\n(a)(2) Financial Statement Schedule\nThe following financial statement schedule of the Company and related documents are included in this Report on Form 10-K:\nThe Exhibits that are incorporated by reference in this Report on Form 10-K, or are filed with this Report, are listed in the List of Exhibits beginning on page 20 of this Report. Exhibits 10.9 through 10.17 are the management contracts and compensatory plans and arrangements that are required to be filed as Exhibits to 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.\nSunGard Data Systems Inc.\nDate: March 29, 1995 By: \/s\/ James L. Mann -------------------------------- James L. Mann, 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.\nLIST OF EXHIBITS\n_____________\n\/(1)\/ Incorporated by reference to the Exhibits filed with the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991 (Commission File No. 0-14232).\n\/(2)\/ Incorporated by reference to the Exhibits filed with the Company's Registration Statement on Form S-1 and Amendments No. 1, No. 2, and No. 3 thereto (Registration No. 33-3181).\n\/(3)\/ Incorporated by reference to the Exhibits filed with the Company's Registration Statement on Form S-1 and Amendment No. 1 thereto (Registration No. 33-12536).\n\/(4)\/ Incorporated by reference to the Exhibits filed with the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1987 (Commission File No. 0-14232).\n\/(5)\/ Incorporated by reference to the Exhibits filed with the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1988 (Commission File No. 0-14232).\n\/(6)\/ Incorporated by reference to the Exhibits filed with the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 (Commission File No. 0-14232).\n\/(7)\/ Incorporated by reference to the Exhibits filed with the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1992 (Commission File No. 0-14232).\n\/(8)\/ Incorporated by reference to the Exhibits filed with the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990 (Commission File No. 0-14232).\n\/(9)\/ Incorporated by reference to the Exhibits filed with the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993 (Commission File No. 0-14232).\n\/(10)\/ Management contract or compensatory plan or arrangement.\nExhibit 23.1\nCONSENT OF INDEPENDENT ACCOUNTANTS\nWe consent to the incorporation by reference into the Company's Registration Statements on Form S-8 (Registration Nos. 33-6425, 33-14984, 33-33602, 33-42345 and 33-69650) of our reports dated February 8, 1995 on our audits of the consolidated financial statements and consolidated financial statement schedules of SunGard Data Systems Inc. and subsidiaries as of December 31, 1994 and 1993, and for each of the years in the three-year period ended December 31, 1994, which report on the consolidated financial statements is incorporated by reference in this Report on Form 10-K.\nCOOPERS & LYBRAND L.L.P.\n2400 Eleven Penn Center Philadelphia, Pennsylvania March 24, 1995\n--------------------------------------------------------------------------------\nREPORT OF INDEPENDENT ACCOUNTANTS ON SCHEDULE\nTo the Board of Directors and Stockholders SunGard Data Systems Inc.\nOur report on the consolidated financial statements of SunGard Data Systems Inc. and subsidiaries is incorporated by reference in this Report on Form 10-K from page 46 of the 1994 Annual Report to Stockholders of SunGard Data Systems Inc. In connection with our audit of such consolidated financial statements, we also have audited the related consolidated financial statement schedule listed in Item 14(a)(2), Part IV, of this Report on Form 10-K.\nIn our opinion, the consolidated financial statement schedule referred to above, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information required to be included therein.\nCOOPERS & LYBRAND L.L.P.\n2400 Eleven Penn Center Philadelphia, Pennsylvania February 8, 1995\nSunGard Data Systems Inc. and Subsidiaries Financial Statement Schedule\nSCHEDULE II\nValuation and Qualifying Accounts\n\/(1)\/ Net impact of acquired companies, foreign currency translation, and, in 1993, the sale of a product line.\nINDEX OF EXHIBITS FILED WITH THIS REPORT\nNumber Document ------ ------------------------------------------------------------------------\n10.10 The Company's 1986 Stock Option Plan, Amendments thereto, dated January 1, 1987, November 1, 1988, February 6, 1990, November 8, 1991, February 16, 1993 and February 13, 1995, and United Kingdom Addendum thereto, dated February 12, 1991.\/(1)\/\n10.16 Summary Description of the Company's Long-Term Executive Incentive Compensation Plan.\/(1)\/\n11.1 Statement Re Computation of Per Share Earnings.\n13.1 Portions of the Company's Annual Report to Stockholders for the fiscal year ended December 31, 1994 expressly incorporated herein by reference.\n21.1 Subsidiaries of the Registrant.\n23.1 Consent of Independent Accountants, regarding the Company's consolidated financial statements and financial statement schedule (included at page 22 of this Report).\n27.1 Financial Data Schedule for the year ended December 31, 1994.\n----------------\n(1) Management contract or compensatory plan or arrangement.","section_15":""}
{"filename":"314661_1995.txt","cik":"314661","year":"1995","section_1":"ITEM 1. BUSINESS\nINTRODUCTION\nSanta Anita Realty Enterprises, Inc. (\"Realty\") and Santa Anita Operating Company (\"Operating Company\") are two separate companies, the stocks of which trade as a single unit under a stock-pairing arrangement on the New York Stock Exchange (symbol SAR). Realty and Operating Company were each incorporated in 1979 and are the successors of a corporation originally organized in 1934 to conduct thoroughbred horse racing in Southern California. As used herein, the terms \"Realty\" and \"Operating Company\" include wholly owned subsidiaries of Realty and Operating Company unless the context requires otherwise. References to \"The Santa Anita Companies\" or \"Companies\" refer to Realty and Operating Company, collectively. This document constitutes the annual report on Form 10- K for both Realty and Operating Company.\nGENERAL\nThe Companies own and operate the Santa Anita Racetrack (\"Racetrack\"), one of the premier thoroughbred horse racing venues in North America. Operating Company has conducted a winter live thoroughbred horse racing meet at the Racetrack each year since 1934 (except for three years during World War II). In addition, the Racetrack has been the site of a fall meet conducted by Oak Tree Racing Association (\"Oak Tree\") which has leased the Racetrack from Operating Company since 1969. The Racetrack was the location of the 1986 and 1993 Breeders' Cup Championships.\nThe 17-week 1995 Santa Anita winter meet, which concluded April 24, 1995, generated average daily wagering of $11.2 million, one of the highest daily wagering levels ever attained in North American thoroughbred horse racing. Further, average daily purses during the same meet were among the largest distributed in North American thoroughbred horse racing. Operating Company believes that its exceptional purse structure enables it consistently to attract top thoroughbred horses, owners, trainers and jockeys. Santa Anita's live races are simulcast to 16 satellite wagering sites in Southern California, 15 sites in Northern California and 851 sites in 38 other states and seven foreign countries. Approximately 75% of wagering at Santa Anita's 1995 winter meet was through off-site satellite wagering sites. Operating Company believes that it is well positioned to benefit from the continued industry trend toward satellite wagering, which has been driven by technological developments, legislative changes and customers' desire for convenience.\nA significant portion of thoroughbred horse racing wagering and purse distribution are concentrated at the industry's largest and best established racetracks. In 1995, approximately 50% of total wagering nationwide was attributable to the industry's ten largest racetracks. Santa Anita is part of the Southern California thoroughbred racing circuit which also includes Hollywood Park, Del Mar and Pomona Fairplex. Live racing is conducted at one of these racetracks from four to six days during each week in the year. During 1995, 279 total days of racing were held at these racetracks, comprising in sequential order, the Santa Anita winter meet (88 days), the Hollywood Park spring and summer meet (67 days), the Del Mar meet (43 days), the Pomona Fairplex meet (19 days), the Oak Tree fall meet at the Racetrack (32 days) and the Hollywood Park fall meet (30 days). Wagering at the Southern California race meets approximated 24% of estimated total wagering on thoroughbred horse racing nationwide in 1995. Wagering on race meets at the Racetrack ranked first nationwide with approximately 10% of the 1995 estimated total wagering. As an industry leader in thoroughbred horse racing and pari-mutuel wagering, Operating Company believes that it will continue to benefit as smaller racetracks and other wagering sites import satellite signals from larger racetracks that have stronger regional and national reputations.\nThe Racetrack is part of Santa Anita Park, the Companies' approximately 400- acre property located in Arcadia, California, 14 miles from downtown Los Angeles, and close to major Southern California freeways leading to Orange County and connecting to the San Fernando, San Gabriel and Pomona valleys. Santa Anita Park's location offers access to more than 13 million people within a fifty-mile radius and more than 5 million people within a twenty-mile radius. In addition to the Racetrack, Santa Anita Park also includes Santa Anita Fashion Park (\"Fashion Park\"), a one million square-foot regional mall in which Realty has a 50% interest. Fashion Park completed a significant expansion in August 1994, including the addition of Nordstrom as an anchor store, and upgraded its mall tenant mix. In addition to Santa Anita Park, Realty has a number of other commercial real estate investments including six neighborhood shopping centers, three office buildings and a partial interest in another major regional mall. In November 1995, Realty announced a program for the orderly disposition of the six neighborhood centers and two office buildings in order to reduce debt, improve financial flexibility and increase Realty's focus on the development of its Arcadia property.\nRealty has announced the proposed development of an Entertainment Center within Santa Anita Park. The initial phase of the development is expected to include a 25-screen AMC movie theater complex, a large screen theater, a book superstore and other specialty retail stores and restaurants. In March 1995, Realty submitted zoning and general plan amendment applications to the City of Arcadia to commence the entitlement process for the development of the Entertainment Center. While the applications provide for the development of as many as 1.5 million leasable square feet, Santa Anita presently plans to develop the Entertainment Center in a number of separate, independently viable phases. It is currently Realty's expectation to receive necessary governmental approvals by late 1996. Currently, plans for later phases of the development contemplate expanded entertainment, restaurant and retail uses.\nOn May 2, 1995, Realty entered into a 20-year lease (with two ten-year options) with AMC for an approximately 102,000 square-foot movie theater complex at the Entertainment Center. The theater complex is expected to be one of the largest developed by AMC, and is expected to include 25 screens and 5,500 seats and feature state-of-the art sound systems, stadium style seating and deluxe amenities. Santa Anita is currently in lease discussions with several other potential Entertainment Center tenants.\nREALTY\nRealty is incorporated under the laws of the State of Delaware. Realty's principal executive offices are located at 301 West Huntington Drive, Suite 405, Arcadia, California 91007.\nRealty operates as a real estate investment trust (\"REIT\") under the provisions of the Internal Revenue Code of 1986, as amended (the \"Code\"). As such, Realty is principally engaged in investing in and holding real property, including Santa Anita Racetrack, the real estate underlying the Santa Anita Fashion Park shopping center (\"Fashion Park\"), a 50 percent interest in the operation of Fashion Park and a 32.5 percent interest in Towson Town Center (major regional shopping centers) and a number of neighborhood shopping centers and office buildings. Until February 18, 1994, Realty also owned 2,654 apartment units and 185,000 square feet of industrial space and until October 1, 1994 an additional 622,000 square feet of industrial space. Realty is a self-administered equity REIT.\nSUMMARY FINANCIAL INFORMATIOn\nThe following table sets forth certain unaudited financial information with respect to Realty:\n- -------- (a) The decline in revenues was due primarily to the sale of properties to Pacific. See Item 1. \"Business--Realty--Pacific Gulf Properties Inc.\" (b) Net income (loss) for the years ended December 31, 1995, 1994 and 1993 each included several non-recurring items totaling a net charge of $36,070,000, $1,782,000 and $5,240,000. Net income excluding nonrecurring charges was $5,199,000, $7,327,000 and $7,859,000 for the years ended December 31, 1995, 1994 and 1993. (c) Calculated in accordance with the definition of funds from operations as defined by the National Association of Real Estate Investment Trusts (\"NAREIT\"), except 1993 which excludes $5,734,000 received from the California Franchise Tax Board related to the settlement of certain state tax issues. Net income (computed in accordance with generally accepted accounting principles), excluding gains (losses) from debt restructuring, sales of property and nonrecurring items, plus depreciation and amortization (including Realty's portion of depreciation from unconsolidated joint ventures).\nREAL ESTATE INVESTMENTS\nRealty's portfolio of real estate investments (excluding its interests in Pacific Gulf Properties Inc. and certain unconsolidated joint ventures) is outlined below.\nSUMMARY OF REAL ESTATE INVESTMENTS AS OF DECEMBER 31, 1995\n- -------- (a) Square feet except as indicated. (b) Net book value (total cost of project less accumulated depreciation) at December 31, 1995. (c) Amounts represent 100% of project encumbrances.\nSANTA ANITA RACETRACK\nSanta Anita Racetrack, which is leased by Realty to the Los Angeles Turf Club, Incorporated (\"LATC\"), a subsidiary of Operating Company, is located on approximately 312 acres, 14 miles northeast of downtown Los Angeles, adjacent to major transportation routes. LATC conducts one of the largest thoroughbred horse racing meets in the United States in terms of both average daily attendance and average daily pari-mutuel wagering.\nThe Santa Anita Racetrack was opened for thoroughbred horse racing in 1934 by a group of investors led by Dr. Charles H. Strub. The Santa Anita Meet has been held at Santa Anita Racetrack each year since its founding except for three years during World War II. The physical plant consists of a large grandstand structure occupying approximately 970,000 square feet, stalls for approximately 2,000 horses, and a parking area covering approximately 128 acres which can accommodate approximately 20,000 automobiles. The grandstand facilities include clubhouse accommodations, a general admission area, and food and beverage facilities, which range from fast food stands to restaurants, both at outdoor terrace tables and indoor dining areas. The grandstand has seating capacity for 25,000 as well as standing room for additional patrons. The structure also houses Operating Company's executive and administrative offices. The grounds surrounding the grandstand are extensively landscaped and contain a European-style paddock and infield accommodations, including picnic facilities for special groups and the general public.\nDuring 1995, the lease rental payable to Realty by LATC was 1.5% of total live on-track wagering at Santa Anita Racetrack, including live on-track wagering during the meet conducted by Oak Tree. In addition, Realty receives 26.5% of LATC's revenues from satellite wagering (not to exceed 1.5% of such wagering) and the simulcasting of races originating from Santa Anita Racetrack after mandated payments to the State, to horse owners and to breeders. When LATC operates as a satellite for Hollywood Park Racetrack and Del Mar Racetrack, Realty receives 26.5% of LATC's wagering commissions as additional rent. The lease with LATC which was scheduled to expire December 31, 1994, was amended and extended for an additional five years, through December 31, 1999. The previous lease provided for rent of 1.5% of the aggregate on-track wagering on live races at Santa Anita Racetrack and 40% of LATC's wagering commissions from satellite wagering on races originating at Santa Anita Racetrack. Accordingly, the rental income which Realty receives from Santa Anita Racetrack is directly affected by and dependent upon the racing activities and the wagering by patrons (see Item 1. \"Business--Operating Company--Santa Anita Racetrack\").\nBased upon the rental formula, for the year ended December 31, 1995, Realty received $11,342,000 in rental income from horse racing, compared with $13,070,000 received for the year ended December 31, 1994 (see Item 1. \"Business--Operating Company--Santa Anita Racetrack\"). If the amended lease terms had been in effect for the year ended December 31, 1994, racetrack rental revenues would have been $11,123,000.\nThe following table shows rental earned by Realty under the LATC lease for the last five years:\nFor a further description of thoroughbred horse racing operations, see Item 1. \"Business--Operating Company--Santa Anita Racetrack.\"\nREGIONAL MALLS\nSANTA ANITA FASHION PARK\nSanta Anita Fashion Park is a completely enclosed, climate-controlled regional mall located adjacent to Santa Anita Racetrack with 1,102,000 square feet of leasable area. Fashion Park, apart from space occupied by anchor tenants, is owned and operated by a partnership, Anita Associates, of which Realty is a 50% limited partner. The general partner of Anita Associates is Hahn-UPI, which in turn is a limited partnership of which The Hahn Company, a developer of shopping centers, is the general partner.\nFashion Park completed a significant expansion in August 1994, including the addition of a new 136,000 square foot Nordstrom store and an additional 40,000 square feet of mall stores. Other anchor tenants are Robinsons-May (165,000 square feet), J.C. Penney (215,000 square feet) and The Broadway (188,000 square feet). Since 1994, new mall tenants include The Disney Store, Williams Sonoma, Ann Taylor and California Pizza Kitchen. During 1993, the Robinsons- May store was expanded by approximately 40,000 square feet and a food court of approximately 13,000 square feet was completed and opened. Since 1994, each of the anchor department stores has completed a major remodeling of their stores.\nIn January 1994, Anita Associates refinanced its existing debt by entering into a secured loan agreement with an insurance company. Funding under the secured loan was made in two draws of $46,577,000 at 9.0% in January 1994 and $15,778,000 at 9.25% in December 1994. The secured loan is due in January 2003. At December 31, 1995, $61,196,000 was outstanding under the agreement.\nThere are currently 135 tenants operating mall stores. Leases are generally seven to ten years with clauses providing for escalation of the basic rent every three years. Typically, leases with mall tenants are structured to provide Anita Associates with overage rents upon attainment by the tenant of certain sales levels, which are specified under the individual leases of the various stores. Overage rents represent a fixed percentage of the gross sales of a tenant less its base rent. With the addition of Nordstrom, Fashion Park has been able to attract higher quality mall tenants at higher annual rental rates.\nRealty has leased the land underlying Fashion Park to Anita Associates and to three of the major tenants of Fashion Park until 2037, with two additional ten-year option periods and one additional five-year option period. The ground rent is $527,000 annually until October 1996 when the annual rent will increase to $795,000 through 2007. During the remaining 30-year term and the three additional option periods, the annual ground rent may be increased up to 25% based upon the appraised value of the land. Under the provisions of the ground leases, Anita Associates is responsible for real estate taxes and other operating expenses. Robinsons-May, J.C. Penney, The Broadway and Nordstrom pay their own real estate taxes.\nThe land underlying Fashion Park is security for a loan maturing in 2009 with a balance at December 31, 1995 of $3,831,000. Payments on this indebtedness, which is without recourse to Realty, are approximately $473,000 annually. The security to the lender also includes an assignment of the ground rents received by Realty and a collateral assignment of the ground leases.\nThe following table contains certain information pertaining to the mall stores in Fashion Park (excluding major tenants):\n- -------- (a) Decline due primarily to certain leases not being renewed in anticipation of the expansion completed in 1994.\nTOWSON TOWN CENTER\nTowson Town Center located in Towson, Maryland, is a 980,000 square-foot regional mall which opened in 1991. Realty is a 50% partner with The Hahn Company in H-T Associates, a joint venture which owns a 65% interest in a partnership which owns the Towson Town Center. The anchor tenants at Towson Town Center are Nordstrom (224,000 square feet) and Hecht's (193,000 square feet) department stores.\nThere are 171 other tenants operating mall stores with original lease terms varying up to 15 years. The average annual rental rate per square foot including overage rents was $32.61 per square foot for the operating mall stores. The mall tenant leases generally provide for escalation of the basic rent every three years and are structured to provide Towson Town Center with overage rents upon attainment by the tenant of certain sales levels, which are specified under the individual leases of the various stores. Overage rents represent a fixed percentage of the gross sales of a tenant less its base rent.\nRealty has executed joint and several guaranties of loans used to expand the Towson Town Center in the amount of $66,135,000 and property adjacent to the Towson Town Center in the amount of $8,247,000. Annually, the guarantors may request a reduction in the amount of the guaranty based on the economic performance of the regional mall (see \"Notes to Financial Statements--Note 6-- Investments in Unconsolidated Joint Ventures\").\nNEIGHBORHOOD SHOPPING CENTERS\nRealty owns six neighborhood shopping centers. The shopping centers typically consist of a major supermarket, retail store or drugstore as a major tenant and often include a variety or general merchandise store and smaller service store tenants. In two centers the major tenant owns its building and the underlying land, while in the four other centers, the land or improvements are leased to the major tenant. Leases on the properties range from two to ten years in duration but typically are from three to five years. They are generally triple net leases (tenant pays all operating costs, insurance and property taxes) and provide for future rental increases. At December 31, 1995, the average occupancy of the three shopping centers located in California was 96% and the average occupancy of the three shopping centers located in Arizona was 87%.\nIn November 1995, Realty announced its intention to dispose of the six neighborhood shopping centers.\nOFFICE BUILDINGS\nRealty owns three office buildings located in Arcadia, Santa Ana and Upland, California. The office buildings in Santa Ana and Upland are for general office use and the building in Arcadia is a medical office building. Office leases are typically for a period of five to ten years and are offered on a full-service gross basis. In addition, tenants are given a tenant improvement allowance and rental concessions in the form of additional tenant improvement allowances or free rent. At December 31, 1995, the average occupancy of the office buildings was 77%.\nIn November 1995, Realty announced its intention to dispose of the Santa Ana and Upland office buildings.\nLAND\nRealty is a 50% partner in French Valley Ventures, a partnership which acquired 24 acres of unimproved land located in Temecula, California. In December 1994, the partnership negotiated a reduction in the maturing mortgage on this property. Additionally, the carrying cost of the investment was written down to its estimated market value which equals the amount of the debt.\nIn November 1995, Realty announced its intention to dispose of its interest in this property.\nPACIFIC GULF PROPERTIES INC.\nIn November 1993, Realty entered into a Purchase and Sale Agreement to sell its multifamily and industrial operations to Pacific Gulf Properties Inc. (\"Pacific\"), in conjunction with Pacific's proposed public offering of common stock and debentures.\nOn February 18, 1994, Realty completed the first part of this transaction by selling to Pacific ten multifamily properties, containing 2,654 apartment units, located in Southern California, the Pacific Northwest, and Texas and three industrial properties, containing an aggregate of 185,000 leasable square feet of industrial space, located in the State of Washington (the \"Transferred Properties\"). Realty's corporate headquarters building and related assets were also acquired by Pacific.\nIn consideration of the sale of the Transferred Properties, Realty received approximately $44.4 million in cash and 150,000 shares of common stock of Pacific. In addition, Realty was relieved of approximately $44.3 million of mortgage debt on the Transferred Properties.\nIn connection with the sale, the executive officers, various managers and most other employees of Realty resigned and became officers and employees of Pacific on February 18, 1994.\nEffective October 1, 1994, Realty completed the second part of the transaction, the sale of its interest in Baldwin Industrial Park to Pacific. Effective October 31, 1994, Pacific delivered to Realty an additional 634,419 shares of Pacific common stock as consideration for the second part of the transaction and the corporate headquarters and other net assets.\nThe two parts of the above transaction resulted in a loss of $10,974,000, which was reflected in the Realty and The Santa Anita Companies statements of operations for the year ended December 31, 1993.\nAs a result of the February 18, 1994 and October 1, 1994 sales to Pacific, Realty owns 784,419 shares (or approximately 16.2%) of Pacific's outstanding common shares at December 31, 1995. Pacific trades on the American Stock Exchange (symbol PAG). On March 15, 1996, the closing price of Pacific's common stock was $18.00.\nOn February 2, 1996, Realty notified Pacific of Realty's intent to sell the Pacific shares in an orderly manner pursuant to privately negotiated or open market transactions. Realty also exercised its right to have Pacific register such shares pursuant to a Registration Rights Agreement dated as of February 1, 1994.\nMANAGEMENT OF PROPERTIES\nRealty manages its neighborhood shopping centers and office buildings directly.\nCOMPETITIVE AND OTHER CONDITIONS\nThe regional shopping malls, neighborhood shopping centers and office buildings owned by Realty encounter significant competition from similar or larger regional shopping malls, shopping centers and office buildings developed and owned by other companies.\nRealty's income from its real estate assets is also affected by general economic conditions. The recent recession adversely affected vacancy rates in office buildings generally. Recessionary measures could adversely impact vacancy rates, the nature of Realty's tenants, the rents Realty is able to obtain from its tenants and its financial results.\nSome of Realty's properties are located in Southern California, which is an area subject to earthquakes and, therefore, there can be no assurance that any earthquakes that may occur will not damage Realty's properties or negatively impact the financial position or results of Realty.\nENVIRONMENTAL MATTERS\nUnder various federal, state and local laws, ordinances and regulations, an owner of real estate is liable for the costs of removal or remediation of certain hazardous or toxic substances on or in such property. Such laws often impose such liability without regard to whether the owner knew of, or was responsible for, the presence of such hazardous or toxic substances. The costs of investigation, removal or remediation of such substances may be substantial, and the presence of such substances, or the failure to properly remediate such substances, may\nadversely affect the owner's ability to sell or rent such property or to borrow using such property as collateral. Persons who arrange for the disposal or treatment of hazardous or toxic substances may also be liable for the costs of removal or remediation of a release of such substances at a disposal treatment facility, whether or not such facility is owned or operated by such person. Certain environmental laws impose liability for release of asbestos- containing materials (\"ACMs\") into the air and third parties may seek recovery from owners or operators of real properties for personal injury associated with ACMs. In connection with the ownership (direct or indirect), operation, management and development of real properties, the Companies may be considered an owner or operator of such properties or as having arranged for the disposal or treatment of hazardous or toxic substances and therefore, potentially liable for removal or remediation costs, as well as certain other related costs, including governmental fines and injuries to persons and property.\nEMPLOYEES\nAt December 31, 1995, Realty employed 22 persons on a full-time basis.\nSEASONAL VARIATIONS IN BUSINESS\nRealty is subject to significant seasonal variation in revenues due primarily to the seasonality of thoroughbred horse racing. The following table presents unaudited quarterly results of operations for Realty during 1995 and 1994:\nOPERATING COMPANY\nOperating Company is organized under the laws of the State of Delaware. Operating Company's principal executive offices are located at Santa Anita Racetrack, 285 West Huntington Drive, Arcadia, California 91007.\nOperating Company is engaged in thoroughbred horse racing. The thoroughbred horse racing operation is conducted by a wholly owned subsidiary of Operating Company, Los Angeles Turf Club, Incorporated (\"LATC\"), which leases Santa Anita Racetrack from Realty.\nSANTA ANITA RACETRACK\nLATC conducts an annual 17-week thoroughbred horse racing meet which commences the day after Christmas and continues through mid-April (the \"Santa Anita meet\"). LATC conducts one of the largest thoroughbred horse racing meets in the United States in terms of both average daily attendance and average daily pari-mutuel wagering.\nLATC leases the racetrack from Realty for the full year for a fee of 1.5% of the on-track wagering on live races at Santa Anita Racetrack, which includes the Oak Tree meet. In addition, LATC pays to Realty 26.5% of its wagering commissions from satellite wagering (not to exceed 1.5% of such wagering). When LATC operates as a satellite for Hollywood Park and Del Mar, LATC pays 26.5% of its wagering commissions as additional rent to Realty. LATC has sublet the racetrack to Oak Tree to conduct Oak Tree's annual thoroughbred horse racing meet (32 days in 1995), which commences in late September or early October. Oak Tree races five weeks in even-numbered years and six weeks in odd-numbered years.\nUnder a sublease which expires December 31, 1999, Oak Tree makes annual rental payments to LATC equal to 1.5% of the total live on-track pari-mutuel wagering from its racing meet and 25% of its satellite and simulcast revenues after mandated payments to the State of California, to horse owners and to breeders. LATC pays to Realty 26.5% of all satellite and simulcast revenues received from Oak Tree. In addition, Oak Tree reimburses LATC an amount equal to 0.8% of its on-track pari-mutuel wagering for certain expenses of operating Santa Anita Racetrack on behalf of Oak Tree. LATC also receives supplemental rent representing Oak Tree's adjusted profits above an agreed-upon level and will rebate rent to Oak Tree if Oak Tree's adjusted profits fall below such level (see Item 1. \"Business--Operating Company--Santa Anita Racetrack-- Wagering Commissions\").\nWAGERING COMMISSIONS\nThe State has vested administrative authority for racing and wagering at horse racing meets with the California Horse Racing Board. The California Horse Racing Board, which consists of seven members appointed by the governor of the State, is charged with the responsibility of regulating the form of wagering, the length and conduct of meets and the distribution of the pari- mutuel wagering within the limits set by the California legislature. The California Horse Racing Board is also charged with the responsibility of licensing horse racing associations on an annual basis to conduct horse racing meets and of licensing directors, officers and persons employed by the associations to operate such meets.\nCalifornia law specifies the percentage distribution of pari-mutuel wagering with the percentage varying based upon the total wagering for the meet, breed of horse and type of wager. The following table sets forth the allocation of the total pari-mutuel wagering, on- and off-track, by percentage and dollar amount during the 1994-95 Santa Anita meet:\nOn-Track Wagering\nAll wagering on-track is pari-mutuel, meaning literally a mutual wager, or wagering by individuals against each other. The racetrack acts as the broker for the wagers made by the public and deducts a \"take-out\" or gross commission which is fixed by the State and shared with the State, the racetrack operator, the horse owners and breeders, and the municipality in which the racetrack is located. The racetrack operator has no interest in which horse wins a given race.\nSatellite Wagering--Southern California\nLATC and Oak Tree send televised racing signals to other racetracks in Southern California, non-racing fair sites in Southern California and wagering facilities on Indian reservation land in Southern California. Southern California satellite facilities commingle their wagering with the wagering on- track. LATC's and Oak Tree's share of this type of satellite wagering averages approximately 4.4%.\nDuring the Hollywood Park and Del Mar meets, LATC and other Southern California racing associations and fairs operate as satellite facilities. In addition to retaining about 1.9% of the pari-mutuel wagering at Santa Anita Racetrack as its commission, LATC receives income from admissions, parking and food and beverage sales. In 1995, Santa Anita Racetrack operated 140 days as a satellite for Hollywood Park and Del Mar.\nSatellite Wagering--Northern California\nIn the fall of 1993, California law permitted the limited exchange between Southern and Northern California of televised racing signals on races with purses exceeding $20,000. In the summer of 1994, a change in California law permitted the unlimited exchange of racing signals between the Southern California zone and the Northern California zone.\nRacetracks operating a live thoroughbred race meet in the southern zone and in the northern zone receive the out-of-zone racing signal and rebroadcast the signal within their respective southern or northern zones. Each zone commingles their wagering on the out-of-zone race with the other zone. While operating a live race meeting, LATC and Oak Tree receive approximately 4.5% of wagering on-track and at Southern California satellite facilities on Northern California races. Also, during the live race meeting, LATC and Oak Tree receive 1.25% of wagering in Northern California on Santa Anita races.\nSatellite Wagering--Out-of-State (Commingled Pools)\nLegislation has been enacted in certain states permitting the transmission of pari-mutuel wagers across state lines. This format permits patrons wagering in those states on races held at Santa Anita Racetrack to participate in the same pari-mutuel pool payouts available to LATC's on-track patrons and California satellite patrons. LATC currently participates in satellite wagering with numerous sites in Nevada and additional locations in Alabama, Arizona, Colorado, Connecticut, Delaware, Florida, Idaho, Illinois, Iowa, Kansas, Kentucky, Louisiana, Maryland, Massachusetts, Michigan, Montana, Nebraska, New Hampshire, New Jersey, North Dakota, Oregon, Pennsylvania, Rhode Island, Texas, Washington, West Virginia and Wisconsin and receives a negotiated percentage of the pari-mutuel wagering at such sites.\nOut-of-state satellite wagering started in 1991 with total pari-mutuel wagering of $39,445,000 which increased to $202,591,000 for 1995. LATC's share of the commissions from out-of-state satellite wagering was $3,528,000 for 1995, or approximately 1.7% of the out-of-state wagering.\nSatellite Wagering--Out-of-State (Separate Pools)\nLATC and Oak Tree transmit their live racing signals to numerous locations in the United States, Mexico, the Caribbean, Central America and Canada. LATC's share of the commissions for transmitting its racing signal was $1,599,000 in 1995 and $1,431,000 in 1994. During the Oak Tree meet, LATC receives a percentage of Oak Tree's share of simulcasting revenues. LATC is pursuing opportunities to transmit its signal to additional locations.\nThe following tables summarize key operating statistics for the 1991-1995 Santa Anita meets and the 1991-1995 Oak Tree meets, together with the attendance and wagering statistics relating to the transmission of the Del Mar and Hollywood Park signals to Santa Anita Racetrack.\n- -------- (a) Southern California satellite wagering expanded to include Hollywood Park and Los Alamitos effective with the 1991 Oak Tree meet. (b) Includes wagering on races originating at other racetracks. (c) Northern California satellite wagering began in October 1993 and expanded in August 1994. (d) Oak Tree races five weeks in even-numbered years and six weeks in odd- numbered years.\nTotal pari-mutuel wagering on the Santa Anita meet increased from $676.5 million in 1991 to $983.4 million in 1995. In 1991, $206.0 million of the total amount wagered was wagered at satellite locations with $470.5 million wagered on-track. In 1995, $739.1 million of the total amount wagered was wagered at satellite locations with $244.3 million wagered on-track.\nTotal attendance was 2,681,000 in 1991, of which 667,000 was at satellite locations. By 1995, total attendance had declined to 2,533,000. Although 1,388,000 and 1,523,000 patrons attended Southern California satellite locations during the Santa Anita meets in 1995 and 1994, LATC does not share in the revenues from admissions, parking and food and beverage sales at the satellite locations.\nManagement anticipates that the general trend of increases in off-track wagering will continue and the decrease experienced in on-track attendance and on-track wagering will also continue, albeit at a slower rate. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations--Santa Anita Operating Company.\"\n- -------- (a)Began in November 1991.\nDuring the last five years, 61% of the annual revenues of LATC resulted from pari-mutuel and other wagering commissions. The remaining revenues resulted from admissions, parking, food and beverage sales, sale of programs and interest and other income.\nThe following table sets forth certain unaudited financial information with respect to LATC:\nThe mix of revenues has changed significantly from 1991 to 1995 primarily as a result of the introduction of satellite wagering on races originating at Santa Anita Racetrack, operating as a satellite location for Del Mar and Hollywood Park, changes in average daily pari-mutuel wagering, selective price increases, the introduction of additional exotic wagering opportunities on which the retention amount is higher than on conventional wagering and a new lease with Oak Tree, all of which have largely offset declines in commissions from on-track wagering.\nLATC's total expenses decreased from $57.8 million in 1991 to $55.1 million in 1995. The majority of these expenses are pari-mutuel wagering or attendance-related, the result of operating as a satellite location for Del Mar and Hollywood Park and the aggregate effect of a new lease with Oak Tree. In 1991, costs and expenses included $1.1 million in earthquake damage. From 1991 to 1992, total costs and expenses increased primarily due to the fact that LATC operated as a satellite location for the first time for Hollywood Park's spring thoroughbred meet and the engagement of outside consultants in the amount of $660,000 to review LATC's operations. From 1992 to 1993, total costs and expenses decreased primarily due to fewer race days, lower on-track attendance and wagering and an ongoing cost reduction program begun in 1992. From 1993 to 1994, total costs and expenses increased primarily due to additional race days and increased wagering. Depreciation expense of $4.3 million in 1994 is higher than in previous years due to a $1.4 million accelerated depreciation charge on the Santa Anita turf course, which was replaced in 1995.\nIncluded in the results of operations are the revenues and expenses for five charity days. As a condition of the issuance of a racing license, California law requires that a certain number of days be conducted as charity days. The net proceeds from these charity days are distributed to beneficiaries through a nonprofit organization approved by the California Horse Racing Board. California law limits the net proceeds to an amount equal to two-tenths of one percent of the total on-track wagering on live races. Net proceeds in excess of two-tenths of one percent are retained by LATC. LATC is required to conduct five charity days.\nFor further information regarding operating results, see Item 7. \"Management's Discussion and Analysis of Financial Condition and Results of Operations--Santa Anita Operating Company.\"\nCOMPETITIVE AND OTHER CONDITIONS\nThe Southern California area offers a wide range of leisure time spectator activities, including professional and college teams which participate in all major sports. LATC and Oak Tree compete with such sporting events for their share of the leisure time market and with other numerous leisure time activities available to the community, some of which are broadcast on television.\nAs an outdoor activity, horse racing is more susceptible to inclement weather than some other leisure time activities. This is particularly true of the Santa Anita meet which is held during the winter. Between 1952 and 1992, LATC had never lost a racing day due to inclement weather. During the 1992- 1993 meet, LATC lost two full days and two partial days of racing because of inclement weather. During the 1994-1995 meet, LATC lost two days of racing because of inclement weather.\nA local Arcadia ordinance limits live horse racing to daylight hours but allows the importation of a horse racing broadcast signal two evenings per week.\nThe California Horse Racing Board has annually licensed LATC and Oak Tree to conduct racing meets at Santa Anita Racetrack. At present, the California Horse Racing Board has not licensed other thoroughbred racetracks in Southern California to conduct racing during these meets. Since 1972, however, night harness racing and night quarterhorse meets have been conducted at other racetracks in Southern California during portions of these meets. LATC and Oak Tree could be adversely affected by legislative or California Horse Racing Board action which would increase the number of competitive racing days, reduce the number of racing days available to LATC and Oak Tree, or authorize other forms of wagering.\nThe California State Lottery Act of 1984, which provided for the establishment of a state-operated lottery, was implemented in 1985. In the opinion of management, the State lottery has had an adverse impact and will continue to have an adverse impact on total attendance and pari-mutuel wagering at Santa Anita Racetrack (see Item 1 \"Business--Operating Company-- Santa Anita Racetrack\").\nIn the future, legislation could be enacted to allow casino gaming or other forms of gaming which are competitive with pari-mutuel wagering at Santa Anita Park. Under federal law, certain types of gaming are lawful on Indian lands if conducted in conformance with a Tribal-State compact, which the applicable state must negotiate with an Indian tribe in good faith. Certain Indian tribes seeking to establish gaming in California have instituted litigation against the State of California to compel the State to permit them to do so. In 1993, one federal district court held that California has a public policy prohibiting casino gaming and need not negotiate a compact with respect to casino gaming. In 1994, a federal appellate court generally affirmed the decision as to casino gaming but remanded the case to federal district court to determine whether the existing State lottery uses gaming machines in such a manner as to make gaming machines the proper subject of a compact. In March 1995, a State appellate court ruled that a provision of the State lottery's keno game is the legal equivalent of a slot machine. The full ramifications of these rulings at this time are unclear. However, federal law provides that states must allow Indian tribes within its borders to conduct gambling activities that are otherwise legal within the state, subject to the negotiated compact. If casino gaming or other forms of gaming are permitted in California, such gaming could have an adverse impact on LATC.\nDEPENDENCE ON LIMITED NUMBER OF CUSTOMERS\nNo material part of Operating Company's business is dependent upon a single customer or a few customers; therefore, the loss of any one customer would not have a materially adverse effect on the business of Operating Company.\nEMPLOYEE AND LABOR RELATIONS\nDuring the year ended December 31, 1995, LATC regularly employed approximately 1,600 employees. Substantially all are employed on a seasonal basis in connection with live thoroughbred horse racing or satellite meets at Santa Anita Racetrack. During the relatively short periods when live or satellite racing meets at Santa\nAnita Racetrack are not being conducted, LATC maintains a staff of approximately 260 employees, most of whom are engaged in maintaining or improving the physical facilities at Santa Anita Racetrack or are engaged in preparing for the next live or satellite meet.\nAll of LATC's employees, except for approximately 84 full-time management and clerical employees, are covered by collective bargaining agreements with labor unions. Fifteen of the seventeen labor agreements covering racetrack employees were renegotiated in 1995. The two remaining labor agreements are currently under renegotiation.\nSEASONAL VARIATIONS IN BUSINESS\nOperating Company is also subject to significant seasonal variation. LATC conducts an annual meet commencing the day after Christmas and continuing through mid-April. This seasonal variation is indicated by the following unaudited quarterly results of operations for Operating Company during 1995 and 1994:\nOperating Company records operating revenues associated with thoroughbred horse racing at Santa Anita Racetrack on a daily basis, except for season admissions which are recorded ratably over the racing season. Costs and expenses associated with thoroughbred horse racing revenues are charged against income in those interim periods in which the thoroughbred horse racing revenues are recognized. Other costs and expenses are recognized as they actually occur throughout the year. The rental fee paid by Operating Company to Realty is recognized by both Realty and Operating Company as it is earned.\nINCOME TAX MATTERS\nIn 1979, prior to the pairing of the stock of Realty and Operating Company, the IRS issued a private letter ruling (the \"Ruling\") in which the IRS held, in effect, that the stock-pairing arrangement between the Companies and the operation of the Racetrack by an Operating Company subsidiary would not preclude Realty's qualification as a REIT. Subsequent to the issuance of the Ruling, Congress amended the Internal Revenue Code (the \"Amendment\") to prohibit a stock-pairing arrangement between a REIT and an operating company. However, the Amendment does not apply to the Companies since they were paired prior to June 30, 1983, the\neffective date of the legislation. Furthermore, the Amendment does not affect Realty's Ruling. Realty is one of only three continuing REITs whose stock was paired with an operating company prior to 1983 and is thus not subject to the Amendment.\nREALTY\nIn the opinion of management, Realty has operated in a manner which has qualified it as a REIT under Sections 856 through 860 of the Code. Realty intends to continue to operate in a manner which will allow it to qualify as a REIT under the Code. If, as intended, Realty continues to qualify as a REIT, it generally will not be subject to federal corporate income taxes on its taxable income and gains that it distributes to its shareholders. This treatment substantially eliminates the \"double taxation\" (once at the corporate level and again at the stockholder level) that generally results from investment in a typical corporation. Income and gains that are not so distributed will be taxed to a REIT at regular corporate rates. In addition, a REIT is subject to certain taxes on net income from \"foreclosure property\" (which is, in general, property acquired on default of a lease of such property), income from the sale of property held primarily for sale to customers in the ordinary course of business and excessive unqualified income. In order to qualify as a REIT, among other things, the rental income received by Realty from LATC must qualify as \"rents from real property\" for REIT purposes. One requirement for such qualification is that Realty may not own, directly or constructively, 10% or more of the outstanding voting power or total number of shares of stock of LATC. Realty would be treated as owning shares of stock in LATC in violation of this 10% limit if any person owns, directly or constructively, 10% or more by value of the shares of stock of Realty and Operating Company. In such an event, the rent paid to Realty by LATC could not qualify as income of the type that can be received by a REIT.\nIn order to prevent such a situation, which would likely result in Realty's disqualification as a REIT, the by-laws of Realty and Operating Company preclude any transfer of shares which would cause any person to own, actually or constructively, shares of stock of the Companies in violation of the above limitation.\nOPERATING COMPANY\nOperating Company pays ordinary corporate income taxes on its taxable income. Any income, net of taxes, will be available for retention in Operating Company's business or for distribution to shareholders as dividends. Any dividends distributed by Operating Company will be subject to tax at ordinary rates and generally will be eligible for the dividends received deduction for corporate shareholders to the extent of Operating Company's current or accumulated earnings and profits. Distributions in excess of current or accumulated earnings and profits are treated first, as a return of investment and then, to the extent that such distribution exceeds a shareholder's investment, as gain from the sale or exchange of such shares. However, there is no tax provision which requires Operating Company to distribute any of its after-tax earnings and Operating Company does not expect to pay cash dividends in the foreseeable future.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nInformation concerning property owned by Realty and Operating Company required by this Item is incorporated by reference to the information contained in Item 1. \"Business\" of this Report.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nCertain claims, suits and complaints arising in the ordinary course of business have been filed or were pending against Realty and\/or Operating Company and its subsidiaries at December 31, 1995. In the opinion of the managements of Realty and Operating Company, all such matters are adequately covered by insurance or, if not so covered, are without merit or are of such kind, or involve such amounts, as would not have a significant effect on the financial position or results of operations of Realty and Operating Company if disposed of unfavorably.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNot applicable.\nITEM 4A. EXECUTIVE OFFICERS OF OPERATING COMPANY AND REALTY\n(a) The names, ages and business experience of Operating Company's executive officers during the past five years are set forth below:\nEach executive officer of Operating Company is appointed by the Board of Directors annually and holds office until a successor is duly appointed.\n(b) The names, ages and business experience of Realty's executive officers during the past five years are set forth below:\nEach executive officer of Realty is appointed by the Board of Directors annually and holds office until a successor is duly appointed.\n(c) Recent Developments\nEffective April 1, 1996, the Board of Directors of Realty elected William C. Baker Chairman and Chief Executive Officer of Realty. Mr. Baker has been a director of both Realty and Operating Company since 1991. Mr. Chillingworth will remain Vice Chairman of Realty and will also serve as Executive Vice President. Mr. Keller will remain Chairman and Chief Executive Officer of Operating Company.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANTS' COMMON EQUITY AND RELATED SHAREHOLDER MATTERS\nThe paired Common Stock of Realty and Operating Company is traded on the New York Stock Exchange as Santa Anita Realty Enterprises under the symbol SAR. The following table sets forth the high and low closing prices for the paired Common Stock on the New York Stock Exchange Composite Tape and the cash dividends declared by Realty for the periods indicated. Operating Company has not declared cash dividends.\n- -------- (a) $.60 of the dividends paid per share during 1994 represented a return of capital.\nA regular quarterly dividend of $.20 per share is payable on March 29, 1996 to shareholders of record on March 8, 1996. The closing price of the paired Common Stock on the New York Stock Exchange Composite Tape on March 15, 1996 was $13 3\/4 per share. As of March 15, 1996, there were approximately 22,000 holders of the paired Common Stock, including the beneficial owners of shares held in nominee accounts.\nThe current policy of the Board of Directors of Realty is to declare and pay regular quarterly dividends equal to the greater of (i) $.20 per share (provided sufficient funds are legally available and not required for other purposes and provided further that such dividend payments are not prohibited by the terms of any applicable credit agreements), or (ii) an amount calculated to maintain Realty's qualification as a REIT under the Code by effecting the distribution in each year of an amount approximating 95% of its taxable income (other than net capital gains) (see item 1. \"Business--Income Tax Matters--Realty\"). This policy is subject to review by the Board of Directors from time to time in light of Realty's results of operations, its financial condition, its cash requirements and such other factors as the Board of Directors deems relevant.\nRealty's revolving credit agreement contains restrictions on the payment of dividends (see Item 7. \"Management's Discussion and Analysis of Financial Condition and Results of Operations--Santa Anita Realty Enterprises, Inc.-- Realty\").\nIn order to retain earnings to finance its capital improvement program and for the growth of its business, Operating Company has not paid cash dividends since its formation and does not expect to pay cash dividends in the foreseeable future.\nThe statement on the face of this annual report on Form 10-K regarding the aggregate market value of paired voting stock of Realty and Operating Company held by nonaffiliates is based on the assumption that all directors and officers of Realty and Operating Company were, for purposes of this calculation only (and not for any other purpose), affiliates of Realty or Operating Company.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe financial data set forth on the following pages includes the information for The Santa Anita Companies, Realty and Operating Company, for each of the five years in the period ended December 31, 1995.\nThe separate results of operations and separate net income (loss) per share of Realty and Operating Company cannot usually be added together to total the results of operations and net income per share of The Santa Anita Companies, because of adjustments and eliminations arising from inter-entity transactions.\nThe following data should be read in conjunction with the information set forth elsewhere herein regarding income tax matters (see Item 1. \"Business-- Income Tax Matters\").\nThe statements of operations of The Santa Anita Companies, Realty and Operating Company for each of the five years in the period ended December 31, 1995 have been audited by Ernst & Young LLP, independent certified public accountants. The selected financial data should be read in conjunction with the other financial statements and related notes thereto included elsewhere in this Joint Annual Report.\nTHE SANTA ANITA COMPANIES\n- -------- (a) The decrease in total assets and loans payable in 1994 as compared with 1993 was due primarily to the sale of Realty's multifamily and industrial properties in 1994 (see Item 1. \"Business--Realty--Pacific Gulf Properties Inc.\"). (b) The decrease in total assets and shareholders' equity in 1995 as compared with 1994 was due primarily to the nonrecurring charge of $38,500,000 in 1995 relating to Realty's plan to dispose of its non-core real estate assets (see \"Notes to Financial Statements--Note 2--Disposition of Non- Core Real Estate Assets\").\nSANTA ANITA REALTY ENTERPRISES, INC.\nSANTA ANITA OPERATING COMPANY\nITEM 7.","section_7":"ITEM 7. MANAGEMENTS' DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nTHE SANTA ANITA COMPANIES\nCOMBINED RESULTS OF OPERATIONS--1995 COMPARED WITH 1994 AND 1993\nCombined results of operations before extraordinary gain for the year ended December 31, 1995 was a loss of $31,555,000 or $2.81 per share, compared with income for the year ended December 31, 1994 of $2,314,000 or $.21 per share and income of $401,000 or $.04 per share for the year ended December 31, 1993. All three years contained several nonrecurring charges and credits which make comparison of the results of operations difficult. Management believes that income before nonrecurring charges and extraordinary gain is a more meaningful measure of the results of operations of the combined companies.\nIncome, before nonrecurring items and extraordinary gain, was $7,047,000 or $0.63 per share in 1995, compared with $5,522,000, or $.50 per share in 1994 and $6,615,000 or $.59 per share in 1993, and reconciles to income (loss) before extraordinary gain as follows:\nFor additional information on the nonrecurring items, see separate Management's Discussion and Analysis of Realty and Operating Company below.\nSANTA ANITA REALTY ENTERPRISES, INC.\nThe following narrative discusses Realty's results of operations for the years ended December 31, 1995, 1994 and 1993, together with liquidity and capital resources as of December 31, 1995. Amounts for the years ended December 31, 1994 and 1993 have been restated to conform to the amounts reported for the year ended December 31, 1995 (see \"Notes to Financial Statements--Note 6--Investments in Unconsolidated Joint Ventures\").\nRESULTS OF OPERATIONS--1995 COMPARED WITH 1994\nRealty's revenues are derived principally from the rental of real property. Total revenues for the year ended December 31, 1995 were $22,426,000, compared with $26,232,000 for the year ended December 31, 1994, a decrease of $3,806,000. The lower 1995 revenues were due primarily to a decrease in Racetrack rental revenues\nand to Realty selling its multifamily and industrial operations to Pacific Gulf Properties Inc. (\"Pacific\"), formerly a wholly-owned subsidiary, in 1994 (see Item 1. \"Business--Realty--Pacific Gulf Properties Inc.\" and \"Notes to Financial Statements--Note 4--Disposition of Multifamily and Industrial Properties\").\nThe most significant source of rental revenue is the lease of Santa Anita Racetrack. Racetrack rental revenues for 1995 were $11,342,000, a decrease of 13.2% from rental revenues of $13,070,000 in 1994. The decrease in rental revenues resulted primarily from new lease terms with LATC. The lease with LATC for the Santa Anita Racetrack expired in December 1994 and was amended and extended through December 31, 1999. The new lease provides that Realty will receive 1.5% of the aggregate on-track wagering on live races at Santa Anita Racetrack and that the rental rate on wagering commissions from satellite wagering on races originating at Santa Anita Racetrack will be 26.5%. In addition, Realty receives 26.5% of the wagering commissions from satellite wagering on races originating from certain other racetracks. If the amended lease terms had been in effect for the year ended December 31, 1994, racetrack rental revenues would have been $11,123,000.\nRental revenues from other real estate investments for 1995 were $8,447,000, a decrease of 23.6% from other rental revenues of $11,054,000 in 1994. The decrease in 1995 was due primarily to Realty selling its multifamily and industrial operations in 1994.\nCosts and expenses for 1995 were $16,147,000, excluding nonrecurring costs and expenses totaling $41,200,000, a decrease of 14.6% from costs and expenses for 1994 of $18,905,000, excluding nonrecurring expenses of $1,782,000. The decrease in 1995 was due primarily to the disposition of the multifamily and industrial operations and a decrease in interest expense, partially offset by an increase in losses from unconsolidated joint ventures.\nRESULTS OF OPERATIONS--1994 COMPARED WITH 1993\nTotal revenues for the year ended December 31, 1994 were $26,232,000, compared with $41,961,000 for the year ended December 31, 1993, a decrease of 37.5%. The lower 1994 revenues were due primarily to Realty selling its multifamily and industrial operations to Pacific in 1994 and to nonrecurring interest earned on a California Franchise Tax Board refund received in 1993 and discussed below.\nRacetrack rental revenues for 1994 were $13,070,000, an increase of 12.3% over revenues of $11,634,000 in 1993. The increase in rental revenues resulted from an increase in average daily wagering and more racing days in 1994.\nRental revenues from other real estate investments for 1994 were $11,054,000, a decrease of 56.0% from other rental revenues of $25,105,000 in 1993. The decrease in 1994 was due primarily to the 1994 sale by Realty to Pacific of its multifamily and industrial operations.\nInterest and other income was $2,108,000 in 1994, compared with $5,222,000 in 1993, a decrease of 59.6%. The decrease was primarily attributable to interest income of $3,211,000 in 1993 related to a tax settlement with the California Franchise Tax Board. The settlement was for tax years prior to 1980 related to Realty's predecessor. In addition to interest earned on the settlement, there was an income tax benefit of $2,523,000 in 1993.\nCosts and expenses for 1994 were $18,905,000, excluding nonrecurring expenses totaling $1,782,000, a decrease of 38.8% from costs and expenses of $30,891,000 in 1993, excluding a nonrecurring loss of $10,974,000 on the disposition of multifamily and industrial operations. The decrease was due primarily to the disposition of the multifamily and industrial operations and was partially offset by increases in interest expense attributable to continuing operations. The increase in continuing interest expense was due to a steady increase in interest rates throughout 1994, an increase in borrowing levels in the 1994 and 1993 fourth quarters and debt repayment costs in 1994.\nLIQUIDITY AND CAPITAL RESOURCES\nRealty has funds available from a combination of short- and long-term sources. Short-term sources included cash of $167,000 at December 31, 1995.\nThe decrease in cash for the year ended December 31, 1995 was $2,084,000, compared with a decrease in cash of $4,459,000 in 1994. The decline in the decrease in cash of $2,375,000 was attributable to a decrease of $396,000 in cash provided by operating activities, a decrease of $62,873,000 in cash provided by investing activities and a decrease of $65,644,000 in cash used in financing activities.\nThe decrease in cash provided by operating activities of $396,000 in 1995 was due primarily to a decrease in apartment and industrial operating income of $997,000, due to the sale of the multifamily and industrial operations in 1994, a decrease in racetrack rental revenues of $1,728,000 in 1995, due to new lease terms with LATC, and $700,000 of equity offering costs and $480,000 of Irwindale development costs charged to 1995 operating earnings. These decreases in cash provided by operating activities were partially offset by a decrease in interest expense of $1,609,000 in 1995 and a decrease in other liabilities of $1,720,000 in 1994, compared with a decrease in other liabilities of $40,000 in 1995.\nThe decrease in cash provided by investing activities of $62,873,000 in 1995 was due primarily to proceeds from the disposition of the multifamily and industrial operations of $44,425,000 in 1994, a decrease in payments received on loans receivable of $9,732,000, primarily repayment of Fashion Park partnership advances in 1994, an increase in investments in and advances to unconsolidated joint ventures of $2,622,000, a decrease in distributions from unconsolidated joint ventures of $1,152,000 and an increase in additions to other assets of $5,415,000 in 1995, primarily the purchase of the option on the Bell casino and expenditures associated with the development of the Santa Anita Entertainment Center. These decreases in cash provided by investing activities were partially offset by an increase in dividends received from Pacific of $1,224,000 in 1995.\nThe decrease in cash used in financing activities of $65,644,000 in 1995 was due primarily to the repayment of bank loans payable of $77,913,000 in 1994, primarily from proceeds from the disposition of the multifamily and industrial operations. Other decreases in cash used in financing activities included additional borrowings of $6,350,000 in 1995, under the revolving credit agreement, a decrease in dividends paid of $3,061,000 in 1995 and the issuance of common stock to Operating Company in 1995, valued at $1,810,000, for its use in granting restricted stock awards. These decreases in cash used in financing activities were partially offset by proceeds from real estate loans payable of $24,400,000 in 1994, related to real estate loans on the six shopping centers and refinancing the mortgage on the medical office building and by a decrease in intercompany payables of $641,000 in 1995, compared with an increase in intercompany payables of $1,525,000 in 1994.\nIn November 1994, Realty entered into a one-year $30,000,000 revolving credit agreement with a commercial bank. In November 1995, the agreement was extended to January 26, 1996 and in January 1996, an amendment to the revolving credit agreement extended the term to June 30, 1996 and reduced available borrowings to $20,000,000. Borrowings under the revolving credit agreement bear interest, at Realty's option, at the prime rate, at LIBOR plus 1%, or at the 30-day, 60-day or 90-day certificate of deposit rate plus 1%. Realty is in discussions with the commercial bank and expects the credit agreement to be extended through December 31, 1996. Realty's Racetrack rental revenues have been pledged as collateral under the credit agreement.\nThe revolving credit agreement contains a restriction on the payment of dividends to the lesser of $.80 per share or $9,200,000 in any twelve-month period beginning on or after July 1, 1994. Realty's current dividend policy is in compliance with this dividend restriction. Additionally, at December 31, 1995, Realty was in compliance with the other financial ratio and maintenance restrictions, except for the net worth restriction. Realty has obtained a waiver of noncompliance from the commercial bank and has cured the noncompliance as of January 31, 1996.\nDuring 1995, Realty adopted a plan to dispose of its non-core real estate assets and, accordingly, reduced the book value of these assets to their estimated realizable values, resulting in a nonrecurring charge of $38,500,000, of which $34,500,000 was recorded in the third quarter and $4,000,000 was recorded in the fourth quarter. The disposition plan is being undertaken in an orderly manner and was influenced by Realty's increased focus on the development of its Arcadia property. The assets to be disposed of have an adjusted carrying value of $27,652,000 at December 31, 1995 and consist of six neighborhood shopping centers located in Southern California and Arizona; commercial office buildings in Santa Ana and Upland, California; and an investment in Joppa Associates, a partnership which owns a vacant retail facility and undeveloped land adjacent to the Towson Town Center regional shopping center in Maryland. Included in the results of operations for the year ended December 31, 1995 is a loss of $1,261,000 relating to the non-core real estate assets. Also included in the nonrecurring charge was a $2,500,000 reserve for loss on disposition of notes receivable.\nIn November 1995, Realty completed a negotiated, early and reduced payoff of the mortgage loan on the Santa Ana office building. The mortgage holder agreed to accept a cash payment of $7,500,000 as settlement in full of the 9.375% note due in 1998. The prepayment resulted in a gain of $4,050,000, net of miscellaneous closing expenses, which was reflected as an extraordinary gain on early retirement of debt in The Santa Anita Companies and Realty statements of operations.\nRealty has executed a joint and several guaranty of a loan issued to expand the Towson Town Center located in Towson, Maryland (owned 65% by H-T Associates) in the amount of $66,135,000. Realty's two partners in the venture have also each executed repayment guaranties, although one of the partners has a limited repayment guaranty. The loan balance to which the guaranties relate is $164,641,000. The repayment guaranties contain covenants which, among other matters, require the guarantors to maintain certain minimum levels of net worth. At December 31, 1995, Realty was in default under the minimum net worth covenant. Realty is currently in discussions with its partners and the lender to restructure the loan and modify the net worth requirement in the guaranty. If the discussions prove to be unsatisfactory, the lender may, among other things, foreclose on the assets of H-T Associates and pursue other remedies under the guaranties. The outcome of the discussions cannot presently be determined and no adjustment has been made in the financial statements.\nSince neither Realty nor either of its partners expects to have sufficient liquidity to pay the loan when due in 1999, it is expected that the loan will be refinanced. Ability to refinance the loan is dependent on several factors, including value of the property, interest rates and the credit environment at the time of refinancing. There can be no assurance that the loan can be refinanced when due.\nRealty has also executed a joint and several guaranty of a loan on property (owned 100% by Joppa Associates) adjacent to Towson Town Center in the amount of $8,247,000. One of Realty's other two partners, The Hahn Company, has executed a repayment guaranty for the full amount of the loan. The loan balance to which the guaranties relate is $16,494,000. At December 31, 1995, Realty was in compliance with the guaranty covenants.\nRealty has agreed to provide Operating Company with up to $10,000,000 in short-term advances, which is dependent upon Realty's liquidity and capital resources. At December 31, 1995, Realty has guaranteed an Operating Company capital lease in the amount of $1,735,000.\nAt December 31, 1995, Realty's secured real estate loans receivable were carried at $10,954,000, net of $2,500,000 of realization reserves, and had maturities ranging from 1996 to 2002. For the year ended December 31, 1995, secured real estate loans receivable earned interest income of $1,058,000.\nAt December 31, 1995, Realty's investment in 784,419 shares of Pacific common stock was carried at $12,967,000 and has a current annual dividend rate of $1.60 per share. On February 2, 1996, Realty notified Pacific of Realty's intent to sell the Pacific shares in an orderly manner pursuant to privately negotiated or open market transactions. Realty also exercised its right to have Pacific register such shares pursuant to a Registration Rights Agreement dated as of February 1, 1994.\nRealty expects that funds provided by operating activities and the sale of non-core real estate assets and Pacific common stock will provide sufficient liquidity to meet working capital needs and reduce outstanding borrowings under the revolving credit agreement.\nIMPACT OF INFLATION\nRealty's management believes that, for the foreseeable future, revenues and income from Santa Anita Racetrack and its other real estate investments should not be adversely affected in a material way by inflationary pressures. Certain leases include clauses enabling Realty to participate in tenants' future increases and gross revenues and other leases include provisions which tie the lease payments to the Consumer Price Index or include step-up provisions.\nSANTA ANITA OPERATING COMPANY\nThe following narrative discusses Operating Company's results of operations for the years ended December 31, 1995, 1994 and 1993 together with liquidity and capital resources as of December 31, 1995.\nRESULTS OF OPERATIONS--1995 COMPARED WITH 1994\nOperating Company derives its revenues from thoroughbred horse racing activities. Horse racing revenues were $69,647,000 in 1995, up 2.7% from $67,846,000 in 1994, primarily due to an increase in racing days and total wagering.\nIn 1995, live thoroughbred horse racing at Santa Anita Racetrack totaled 120 days compared with 117 days in 1994. Total on-track attendance at the live racing events in 1995 was down 9.7% from the prior year and average daily attendance declined 11.9%. Total and average daily wagering were up 12.0% and 9.2% in 1995 compared with 1994. On-track wagering decreased 6.3%, wagering at Southern California satellite locations increased 8.8%, wagering at out-of- state locations increased 20.3% and wagering at Northern California locations increased 106.6% in 1995 compared with 1994.\nManagement anticipates that the movement from on-track attendance and wagering to off-site is likely to continue. The growth rate in off-site wagering is dependent primarily upon such factors as Operating Company's ability to access new markets and the removal of various legal barriers which inhibit or restrict entry into such markets.\nAlso, Santa Anita Racetrack operated 140 days in 1995 and 145 days in 1994 as a satellite wagering facility for Hollywood Park and Del Mar. Total and average daily attendance as a satellite wagering facility were down 5.9% and 2.5% in 1995 compared with 1994. Total wagering was down 2.5%, while average daily wagering was up 1.0% in 1995 compared with 1994.\nHorse racing operating costs were $48,686,000 (or 69.9% of horse racing revenues) in 1995 versus $48,352,000 (or 71.3% of horse racing revenues) in 1994. The operating margin improvement was primarily due to the implementation of certain cost control measures.\nDepreciation expense was $3,196,000 in 1995, $1,055,000 lower than the $4,251,000 in 1994. Depreciation expense includes an accelerated depreciation charge of $432,000 in 1995 and $1,426,000 in 1994 on the Santa Anita Racetrack turf course, which was replaced in April 1995.\nGeneral and administrative expenses were $5,442,000 in 1995, a decrease of 2.5% from $5,583,000 in 1994 due to lower executive compensation expenses in 1995. Interest expense decreased to $401,000 in 1995 from $446,000 in 1994.\nRental expense to Realty was $11,342,000 in 1995 compared with $13,057,000 in 1994. The decrease in rental expense of 13.1% reflects the new lease terms with Realty. Under the new lease terms, LATC pays to Realty 1.5% of the on- track wagering on live races at Santa Anita Racetrack and 26.5% of its wagering commissions from all satellite wagering. The old lease required LATC to pay Realty the same 1.5% of the on-track wagering on live races at Santa Anita Racetrack but required 40% of its wagering commissions from satellite wagering during the live race meets.\nAn income tax benefit of $2,000,000 was recognized in 1995, as a result of various items, the most significant of which, related to a draw down of deferred taxes relating to an expected withdrawal of Franchise Tax Board assessments for 1986 through 1988.\nDue to the revenue and expense items previously discussed, Operating Company reported net income of $3,266,000, or $.29 per share in 1995, compared with a net loss of $3,278,000, or $.29 per share for the comparable period in 1994.\nRESULTS OF OPERATIONS--1994 COMPARED WITH 1993\nHorse racing revenues were $67,846,000 in 1994, up 5.6% from $64,270,000 in 1993, primarily due to an increase in racing days and total wagering.\nIn 1994, live thoroughbred horse racing at Santa Anita Racetrack totaled 117 days compared with 114 days in 1993. Total on-track attendance at the live racing events in 1994 was down 5.5% from the prior year and average daily attendance was down 7.9%. Total wagering and average daily wagering during the Santa Anita Meet were up 20.1% and 17.0% in 1994 compared with 1993. On-track wagering decreased 3.7%, wagering at Southern California satellite locations increased 12.4%, wagering at out-of-state locations increased 63.1% and wagering at Northern California satellite locations increased substantially in 1994 compared with 1993.\nManagement anticipates that the movement from on-track attendance and wagering to off-site is likely to continue. The growth rate in off-site wagering is dependent primarily upon such factors as Operating Company's ability to access new markets and the removal of various legal barriers which inhibit or restrict entry into such markets.\nAlso, Santa Anita Racetrack operated 102 days in 1994 and 99 days in 1993 as a satellite wagering facility for Hollywood Park and 43 days in 1994 and 42 days in 1993 as a satellite wagering facility for Del Mar. Total attendance as a satellite wagering facility was down 4.0%, while wagering was up 1.3% in 1994 compared with 1993. Average daily attendance and average daily wagering as a satellite wagering facility were down 6.7% and 1.5% in 1994 compared with 1993.\nHorse racing operating costs were $48,352,000 (or 71.3% of horse racing revenues) in 1994 versus $46,696,000 (or 72.7% of horse racing revenues) in 1993. The operating margin improvement was primarily due to the implementation of certain cost control measures.\nDepreciation expense was $4,251,000 in 1994, up 53.6% from the $2,768,000 in 1993. The $1,483,000 increase in depreciation expense was due primarily to the accelerated depreciation charge on the Santa Anita Racetrack turf course, which will be replaced in April 1995.\nGeneral and administrative expenses were $5,583,000 in 1994, a decrease of 3.8% from the $5,801,000 in 1993 due to the one-time charge of $759,000 in the prior year for the post retirement benefits payable as a result of the death of the former Chairman of the Board of Operating Company. Interest expense decreased to $446,000 in 1994 from $493,000 in 1993. Rental expense to Realty was $13,057,000 in 1994 compared with $11,315,000 in 1993. The increase in rental expense of 15.4% reflects the overall increase in racing days and wagering.\nDue to the revenue and expense items previously discussed, Operating Company reported a net loss of $3,278,000 or $.29 per share in 1994, compared with a net loss of $2,232,000 or $.20 per share in 1993.\nLIQUIDITY AND CAPITAL RESOURCES\nAt December 31, 1995, Operating Company's sources of liquidity included cash and short-term investments of $13,710,000, together with a verbal commitment from Realty to provide up to $10,000,000 in short-term advances. In addition, Realty has guaranteed an Operating Company capital lease of $1,735,000. Operating Company's ability to borrow from Realty is dependent upon Realty's liquidity and capital resources (see Item 7. \"Managements' Discussion and Analysis of Financial Condition and Results of Operations--Santa Anita Realty Enterprises, Inc.--Liquidity and Capital Resources\"). As of the date of this filing, Realty did not have sufficient liquidity and capital resources to advance Operating Company funds. For the year ended December 31, 1995, short- term investments earned interest income of $526,000.\nThe cash balances and related interest income from short-term investments reflect seasonal variations associated with the Santa Anita meet. During the meet, large cash balances and short-term investments are maintained by LATC, including amounts to be disbursed for payment of license fees payable to the state, purses payable to horse owners and un-cashed winning pari-mutuel tickets payable to the public.\nOperating Company generated $3,965,000 more cash from operations in 1995 than in 1994. Net cash provided by operating activities was $6,162,000 in 1995 compared with $2,197,000 in 1994. The increase in cash from operations was primarily due to increased operating income from horse racing operations and the non-cash charge resulting from the amortization of unearned compensation expense.\nNet cash used in investment activities was $5,142,000 in 1995 compared with $1,496,000 in 1994. The $3,646,000 increase in cash used in investment activities was attributable to a higher level of capital improvements at Santa Anita Racetrack and the purchase of common stock of Realty for the grant of restricted stock.\nNet cash used in financing activities was $153,000 in 1995 compared with $2,246,000 in 1994. In 1995, the repayment of a capital lease was partially offset by the increase in the amount due from Realty.\nIMPACT OF INFLATION\nLATC's expenses are heavily labor-intensive with labor rates being covered by negotiated contracts with labor unions. Labor contracts with the pari- mutuel, service and operational employees were successfully renegotiated in 1995. Management continues to address cost containment and labor productivity in all areas.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe information required by this Item is incorporated by reference to the information listed in the Index to Financial Statements filed with this Report.\nITEM 9.","section_9":"ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable.\nPART III\nPursuant to General Instruction G(3) to Form 10-K, the information called for by this Part of Form 10-K is incorporated herein by reference to such information contained in the registrants' definitive joint proxy statement to be filed, pursuant to Regulation 14A, with the Securities and Exchange Commission not later than 120 days after the end of the fiscal year ended December 31, 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) The following documents are filed as part of this report:\n1. Financial Statements See Index to Financial Statements\n2. Financial Statement Schedules See Index to Financial Statement Schedules\n3.Exhibits See Exhibit Index\n(b) Reports on Form 8-K. No reports on Form 8-K have been filed during the last quarter of the fiscal year ended December 31, 1995.\nSIGNATURES\nPURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934, REALTY AND OPERATING COMPANY HAVE DULY CAUSED THIS REPORT TO BE SIGNED ON THEIR BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.\nSANTA ANITA REALTY ENTERPRISES, INC. SANTA ANITA OPERATING COMPANY\nBy: \/s\/ William C. Baker By: \/s\/ Stephen F. Keller ----------------------------------- -------------------------------- William C. Baker Stephen F. Keller Chairman of the Board and Chairman of the Board, President Chief Executive Officer and Chief Executive Officer (Principal Executive Officer) (Principal Executive Officer)\nDate: April 1, 1996 Date: April 1, 1996\nBy: \/s\/ Brian L. Fleming By: \/s\/ Richard D. Brumbaugh ----------------------------------- -------------------------------- Brian L. Fleming Richard D. Brumbaugh Executive Vice President and Vice President--Finance and Chief Financial Officer Chief Financial Officer (Principal Financial and (Principal Financial and Accounting Officer) Accounting Officer)\nDate: April 1, 1996 Date: April 1, 1996\nPURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANTS AND IN THE CAPACITIES AND ON THE DATE INDICATED.\nDate: April 1, 1996\nSANTA ANITA REALTY ENTERPRISES, INC. AND SANTA ANITA OPERATING COMPANY AND SUBSIDIARIES\nSANTA ANITA REALTY ENTERPRISES, INC. AND SANTA ANITA OPERATING COMPANY AND SUBSIDIARIES\nINDEX TO FINANCIAL STATEMENT SCHEDULES\nThe schedules listed below relate to Realty and Operating Company as indicated:\nSchedules not listed above have been omitted because either the conditions under which they are required are absent, not applicable, or the required information is included in the financial statements and related notes thereto.\nINDEPENDENT AUDITORS' REPORT\nTo the Shareholders and Board of Directors Santa Anita Realty Enterprises, Inc. and Santa Anita Operating Company\nWe have audited the financial statements and schedules listed on pages 36 and 37 of:\n(a) The Santa Anita Companies\n(b) Santa Anita Realty Enterprises, Inc. (\"Realty\"); and\n(c) Santa Anita Operating Company and Subsidiaries.\nThese financial statements and schedules are the responsibility of the companies' management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the above-listed entities at December 31, 1995 and 1994 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles. Further, it is our opinion that the schedules referred to above, when considered in relation to the financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nAs discussed in Note 6, certain joint ventures previously consolidated by Realty have been reported in 1995 using the equity method and, accordingly, prior years' financial statements have been restated to conform to this presentation.\nErnst & Young LLP\nLos Angeles, California March 7, 1996\nTHE SANTA ANITA COMPANIES\nCOMBINED BALANCE SHEETS\nDECEMBER 31, 1995 AND 1994\nASSETS\nSee accompanying notes.\nTHE SANTA ANITA COMPANIES\nCOMBINED STATEMENTS OF OPERATIONS\nFOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSee accompanying notes.\nTHE SANTA ANITA COMPANIES\nCOMBINED STATEMENTS OF SHAREHOLDERS' EQUITY\nFOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSee accompanying notes.\nTHE SANTA ANITA COMPANIES\nCOMBINED STATEMENTS OF CASH FLOWS\nFOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSee accompanying notes.\nSANTA ANITA REALTY ENTERPRISES, INC.\nCONSOLIDATED BALANCE SHEETS\nDECEMBER 31, 1995 AND 1994\nASSETS\nSee accompanying notes.\nSANTA ANITA REALTY ENTERPRISES, INC.\nCONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSee accompanying notes.\nSANTA ANITA REALTY ENTERPRISES, INC.\nCONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSee accompanying notes.\nSANTA ANITA REALTY ENTERPRISES, INC.\nCONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSee accompanying notes.\nSANTA ANITA OPERATING COMPANY AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\nDECEMBER 31, 1995 AND 1994\nASSETS\nSee accompanying notes.\nSANTA ANITA OPERATING COMPANY AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSee accompanying notes.\nSANTA ANITA OPERATING COMPANY AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSee accompanying notes.\nSANTA ANITA OPERATING COMPANY AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993\nSee accompanying notes.\nSANTA ANITA REALTY ENTERPRISES, INC. AND SANTA ANITA OPERATING COMPANY AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS\nDECEMBER 31, 1995, 1994 AND 1993\nNOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBasis of Presentation\nSanta Anita Realty Enterprises, Inc. (\"Realty\") and Santa Anita Operating Company and Subsidiaries (\"Operating Company\") are two separate companies, the stocks of which trade as a single unit under a stock-pairing arrangement on the New York Stock Exchange (symbol SAR). Realty and Operating Company were each incorporated in 1979 and are the successors of a corporation originally organized in 1934 to conduct thoroughbred horse racing in Southern California.\nCurrently, Realty is principally engaged in holding and investing in retail and commercial property located primarily in Southern California, Phoenix, Arizona and Towson, Maryland. During 1994, Realty disposed of its multifamily and industrial properties. Realty operates as a real estate investment trust (\"REIT\") under the Internal Revenue Code of 1986 and, accordingly, pays no income taxes on earnings distributed to shareholders.\nOperating Company is engaged in thoroughbred horse racing. The thoroughbred horse racing operation is conducted by a subsidiary of Operating Company, Los Angeles Turf Club, Incorporated (\"LATC\"), which leases the Santa Anita Racetrack from Realty.\nSeparate financial statements have been presented for Realty and for Operating Company. Combined Realty and Operating Company financial statements have been presented as The Santa Anita Companies. Realty and The Santa Anita Companies use an unclassified balance sheet presentation.\nThe separate results of operations and the separate net income per share of Realty and Operating Company cannot usually be added together to total the combined results of operations and net income per share for The Santa Anita Companies because of adjustments and eliminations arising from inter-entity transactions. All significant intercompany and inter-entity balances and transactions have been eliminated in consolidation and combination.\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from these estimates.\nReal Estate Assets\nInvestment properties are carried at the lower of cost or estimated net realizable value and consist of land, buildings and related improvements. Depreciation is provided on a straight-line basis over the estimated useful lives of the properties, ranging primarily from 15 to 40 years.\nInvestments in Joint Ventures\nRealty consolidates only those joint ventures in which it exercises control.\nInvestments in unconsolidated joint ventures are accounted for using the equity method of accounting.\nCash and Cash Equivalents\nHighly liquid short-term investments, with remaining maturities of three months or less at the date of acquisition, are considered cash equivalents.\nSANTA ANITA REALTY ENTERPRISES, INC. AND SANTA ANITA OPERATING COMPANY AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED) NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)\nProperty, Plant and Equipment\nDepreciation of property, plant and equipment and the capital lease obligation is provided primarily on the straight-line method generally over the following estimated useful lives:\nExpenditures which materially increase property lives are capitalized. The cost of maintenance and repairs is charged to expense as incurred. When depreciable property is retired or disposed of, the related cost and accumulated depreciation is removed from the accounts and any gain or loss is reflected in current operations.\nIncome Taxes\nRealty and Operating Company adopted Financial Accounting Standard (\"FAS\") No. 109, \"Accounting for Income Taxes,\" issued by the Financial Accounting Standards Board (\"FASB\") effective January 1, 1993. FAS No. 109 replaces FAS No. 96, which the company adopted in 1988. The cumulative effect of adopting FAS No. 109 was immaterial for the year ended December 31, 1993.\nDeferred Revenues\nOperating Company's deferred revenues consist of prepaid admission tickets and parking, which are recognized as income ratably over the period of the related race meet. Also, deferred revenue includes prepaid rent from Oak Tree which is recognized over the remaining term of the lease.\nShareholders' Equity\nThe outstanding shares of Realty common stock and Operating Company common stock are only transferable and tradable in combination as a paired unit consisting of one share of Realty common stock and one share of Operating Company common stock.\nOperating Company's Revenues and Costs\nOperating Company records operating revenues associated with thoroughbred horse racing at Santa Anita Racetrack on a daily basis, except for season admissions which are recorded ratably over the racing season. Costs and expenses associated with thoroughbred horse racing revenues are charged against income in those periods in which the thoroughbred horse racing revenues are recognized. Other costs and expenses are recognized as they actually occur throughout the year. The rental fee paid by Operating Company to Realty is recognized by both Realty and Operating Company as it is earned.\nRental Property Revenues\nRental property revenues are recorded on a straight-line basis over the related lease term. As a result, deferred rent is created when rental income is recognized during free rent periods of a lease or when the lease provides for rent escalations during the lease term. Deferred rent is included in prepaid expenses and other assets, evaluated for collectibility and amortized over the remaining term of the lease.\nSANTA ANITA REALTY ENTERPRISES, INC. AND SANTA ANITA OPERATING COMPANY AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED) NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)\nHorse Racing Revenues and Direct Operating Costs\nOperating Company's horse racing revenues and direct operating costs are shown net of state and local taxes, stakes, purses and awards.\nConcentration of Credit Risk\nFinancial instruments which potentially subject Realty and Operating Company to concentrations of credit risk are primarily cash investments and receivables. Realty and Operating Company place their cash investments in investment grade short-term instruments and limit the amount of credit exposure to any one commercial issuer. Concentrations of credit risk with respect to accounts receivable are limited due to the number of retail and commercial tenants, satellite locations and Santa Anita group event patrons. Real estate receivables are secured by first trust deeds on commercial real estate located in Southern California and Phoenix, Arizona.\nFinancial Instruments with Off-Balance Sheet Risk\nRealty is an issuer of financial instruments with off-balance sheet risk in the normal course of business which exposes Realty to credit risks. These financial instruments include commitments to extend credit, financial guarantees and letters of credit.\nFair Value of Financial Instruments\nManagement has estimated the fair value of its financial instruments using available market information and appropriate valuation methodologies. Considerable judgment is required in interpreting market data to develop estimates of fair value. Accordingly, the estimated values for Realty and Operating Company as of December 31, 1995 and 1994 are not necessarily indicative of the amounts that could be realized in current market exchanges.\nFor those financial instruments for which it is practicable to estimate value, management has determined that the carrying amounts of Realty's and Operating Company's financial instruments approximate their fair value as of December 31, 1995 and 1994.\nCommon Stock and Net Income (Loss) Per Common Share\nNet income (loss) per common share is computed based upon the weighted average number of common shares outstanding during each period for each company. Stock options have not been included in the computation since they have no material dilutive effect.\nOperating Company holds shares of Realty's common stock which are unpaired pursuant to a stock option plan approved by the shareholders. The shares held totaled 112,500 as of December 31, 1995 and 1994 and 115,500 as of December 31, 1993. These shares affect the calculation of Realty's net income per common share but are eliminated in the calculation of net income per common share for The Santa Anita Companies.\nReclassifications\nCertain prior year amounts have been reclassified to conform to current year presentation.\nSANTA ANITA REALTY ENTERPRISES, INC. AND SANTA ANITA OPERATING COMPANY AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 2--DISPOSITION OF NON-CORE REAL ESTATE ASSETS\nDuring 1995, Realty adopted a plan to dispose of its non-core real estate assets and, accordingly, reduced the book value of these assets to their estimated realizable values, resulting in a nonrecurring charge of $38,500,000, of which $34,500,000 was recorded in the third quarter and $4,000,000 was recorded in the fourth quarter. The disposition plan is being undertaken in an orderly manner and was influenced by Realty's increased focus on the development of its Arcadia property. The assets to be disposed of have an adjusted carrying value of $27,652,000 at December 31, 1995 and consist of six neighborhood shopping centers located in Southern California and Arizona; commercial office buildings in Santa Ana and Upland, California; and an investment in Joppa Associates, a partnership which owns a vacant retail facililty and undeveloped land adjacent to the Towson Town Center regional shopping center in Maryland. Included in the results of operations for the year ended December 31, 1995 is a loss of $1,261,000 relating to the non-core real estate assets. Also included in the nonrecurring charge was a $2,500,000 reserve for loss on disposition of notes receivable.\nIn March 1995, the FASB issued FAS No. 121 \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of\". FAS No. 121 requires that impairment losses be recorded on long-lived assets used in operations when events or changes in circumstances indicate that the undiscounted cash flows to be generated by these assets are less than their carrying amount. FAS No. 121 also requires that long-lived assets to be disposed of be reported at the lower of their carrying amount or fair value, less cost to sell. FAS No. 121 requires adoption in the first quarter of 1996. Realty believes that adoption of the FAS No. 121 in 1996 will not have a material effect on its financial condition and results of operations.\nNOTE 3--CARD CLUB WRITE-OFFS\nIn August 1995, the management of Bell Jackpot Casino, which was not affiliated with Realty, citing intense competition from larger and more established nearby card clubs, closed the Bell Jackpot Casino in Bell, California. As a result of this action, during the 1995 third quarter, Realty wrote-off the $2,000,000 it paid for an option to acquire a 50% interest in the operation of the casino. Additionally, in the 1995 third quarter, Realty charged $480,000 of development costs for the proposed Irwindale Palace Casino, in Irwindale, California, to general and administrative expense. Realty discontinued its involvement in the card club following the defeat of an October 1995 Irwindale ballot measure to permit card clubs in Irwindale.\nNOTE 4--INVESTMENT IN PACIFIC GULF PROPERTIES INC.\nIn November 1993, Realty entered into a Purchase and Sale Agreement to sell its multifamily and industrial operations to Pacific Gulf Properties Inc. (\"Pacific\"), in conjunction with Pacific's proposed public offering of common stock and debentures.\nOn February 18, 1994, Realty completed the first part of this transaction by selling to Pacific ten multifamily properties, containing 2,654 apartment units, located in Southern California, the Pacific Northwest and Texas and three industrial properties, containing an aggregate of 185,000 leasable square feet of industrial space, located in the State of Washington (the \"Transferred Properties\"). Realty's corporate headquarters building and related assets were also acquired by Pacific.\nIn consideration of the sale of the Transferred Properties, Realty received $44,425,000 in cash and 150,000 shares of the common stock of Pacific. In addition, Realty was relieved of $44,290,000 of mortgage debt on the Transferred Properties.\nEffective October 1, 1994, Realty completed the second part of the transaction, the sale of its interest in Baldwin Industrial Park to Pacific. Effective October 31, 1994, Pacific delivered to Realty an additional 634,419 shares of Pacific common stock as consideration for the second part of the transaction and the corporate headquarters and other net assets.\nSANTA ANITA REALTY ENTERPRISES, INC. AND SANTA ANITA OPERATING COMPANY AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED) NOTE 4--INVESTMENT IN PACIFIC GULF PROPERTIES INC. (CONTINUED)\nThe above transactions resulted in a loss of $10,974,000, which was reflected in the Realty and The Santa Anita Companies statements of operations for the year ended December 31, 1993. If the transactions had occurred as of January 1, 1994, Realty and The Santa Anita Companies revenues would have decreased by $4,477,000, expenses would have decreased by $4,929,000 and net income would have increased by $452,000, for the year ended December 31, 1994.\nAs of December 31, 1995 and 1994, Realty owned 16.2% and 16.3% of Pacific's common stock and accounted for its investment by the equity method of accounting. The closing price of Pacific's common stock, on the American Stock Exchange, on the last trading day in 1995 was $16.25 per share.\nPacific's assets, liabilities and shareholders' equity at December 31, 1995 were $288,591,000, $216,611,000 and $71,980,000 and at December 31, 1994 were $202,519,000, $131,659,000 and $70,860,000. Pacific's assets consist primarily of real estate. Pacific's revenues and net income for the year ended December 31, 1995 were $37,091,000 and $8,403,000. Its revenues, income before extraordinary item and net loss for the period from February 18, 1994, date of inception, through December 31, 1994 were $23,857,000, $2,673,000 and $(317,000).\nOn February 2, 1996, Realty notified Pacific of Realty's intent to sell the Pacific shares in an orderly manner pursuant to privately negotiated or open market transactions. Realty also exercised its right to have Pacific register such shares pursuant to a Registration Rights Agreement dated as of February 1, 1994.\nNOTE 5--INVESTMENTS IN CONSOLIDATED JOINT VENTURES\nRealty's real estate properties include investments in the following consolidated real estate joint venture at December 31, 1995:\nThe financial condition and operations of the above joint venture are consolidated with the financial statements of Realty and The Santa Anita Companies.\nCombined condensed financial information for the consolidated joint ventures as of December 31, 1995, 1994 and 1993 and for the years then ended is as follows:\nSANTA ANITA REALTY ENTERPRISES, INC. AND SANTA ANITA OPERATING COMPANY AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED) NOTE 5--INVESTMENTS IN CONSOLIDATED JOINT VENTURES (CONTINUED)\nIn December 1994, a decrease in a maturing note payable secured by land held for development by French Valley Ventures was negotiated and the carrying cost of the related land was written down to its estimated market value. The resulting net charge of $1,043,000 has been reflected in \"Write-down of land held for development\" in the Realty and The Santa Anita Companies statements of operations.\nAmounts reported in 1993 also included a consolidated joint venture in which the minority interest was acquired in January 1994.\nNOTE 6--INVESTMENTS IN UNCONSOLIDATED JOINT VENTURES\nRealty's investments in unconsolidated joint ventures include investments in the following commercial real estate ventures at December 31, 1995:\nThe Anita Associates partnership comprises the property associated with the operations of Santa Anita Fashion Park in Arcadia, California. The H-T Associates and Joppa Associates partnerships comprise the properties associated with the operations of Towson Town Center in Towson, Maryland.\nDuring 1995, Realty reevaluated its consolidation policy with respect to 50% owned joint ventures that had been consolidated in prior years. Realty determined that it does not have sufficient involvement in these joint ventures to warrant consolidation and has reported these joint ventures on the equity method at December 31, 1995. All prior year financial statements and disclosures have been restated to conform to this presentation. The restatement had no effect on prior years reported net income or shareholders equity, but did have the effect of reducing Realty's assets and liabilities by $60,804,000 in 1994 and $43,493,000 in 1993 and of reducing Realty's revenues and expenses by $13,691,000 in 1994 and $13,352,000 in 1993.\nSANTA ANITA REALTY ENTERPRISES, INC. AND SANTA ANITA OPERATING COMPANY AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED) NOTE 6--INVESTMENTS IN UNCONSOLIDATED JOINT VENTURES (CONTINUED)\nCombined condensed financial statement information for the unconsolidated joint ventures as of December 31, 1995, 1994 and 1993 and for the years then ended is as follows:\nRealty has executed a joint and several guaranty of a loan issued to expand the Towson Town Center located in Towson, Maryland (owned 65% by H-T Associates) in the amount of $66,135,000. Realty's two partners in the venture have also each executed repayment guaranties, although one of the partners has a limited repayment guaranty. The loan balance to which the guaranties relate is $164,641,000. The repayment guaranties contain covenants which, among other matters, require the guarantors to maintain certain minimum levels of net worth. At December 31, 1995, Realty was in default under the minimum net worth covenant. Realty is currently in discussions with its partners and the lender to restructure the loan and modify the net worth requirement in the guaranty. If the discussions prove to be unsatisfactory, the lender may, among other things, foreclose on the assets of H-T Associates and pursue other remedies under the guaranties. The outcome of the discussions cannot presently be determined and no adjustment has been made in the financial statements.\nRealty has also executed a joint and several guaranty of a loan on property (owned 100% by Joppa Associates) adjacent to Towson Town Center in the amount of $8,247,000. One of Realty's other two partners, The Hahn Company, has executed a repayment guaranty for the full amount of the loan. The loan balance to which the guaranties relate is $16,494,000. At December 31, 1995, Realty was in compliance with the guaranty covenants.\nSANTA ANITA REALTY ENTERPRISES, INC. AND SANTA ANITA OPERATING COMPANY AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 7--REAL ESTATE LOANS RECEIVABLE\nRealty's real estate loans receivable as of December 31, 1995 and 1994 consist of the following:\nContractual principal repayments on real estate loans receivable as of December 31, 1995 are due as follows:\nNOTE 8--LOANS PAYABLE\nRealty's real estate loans payable as of December 31, 1995 and 1994 consist of the following:\nIn November 1995, Realty completed a negotiated, early and reduced payoff of the mortgage loan on the Santa Ana office building. The mortgage holder agreed to accept a cash payment of $7,500,000 as settlement in full of the 9.375% note due in 1998. The prepayment resulted in a gain of $4,050,000, net of miscellaneous closing expenses, which was reflected as an extraordinary gain on early retirement of debt in the Realty and The Santa Anita Companies statements of operations.\nIn December 1994, Realty obtained secured loans on each of its six neighborhood shopping centers. At December 31, 1995, these secured loans had an outstanding balance of $15,282,000. The secured loans had initial variable interest rates ranging from 8.25% to 9% and a 25-year amortization period. The interest rates are subject\nSANTA ANITA REALTY ENTERPRISES, INC. AND SANTA ANITA OPERATING COMPANY AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED) NOTE 8--LOANS PAYABLE (CONTINUED) to adjustment every six months based on the six-month certificate of deposit rate in the secondary market as currently published in The Wall Street Journal. The maximum interest rate adjustment over the life of the loans is 5% and the increase in the monthly payment at each adjustment date is limited to 3.75%.\nPrincipal payments due on real estate loans payable as of December 31, 1995 are as follows:\nBank loans payable consist of borrowings under the revolving credit agreement of $20,950,000 and $7,300,000 as of December 31, 1995 and 1994.\nIn November 1994, Realty entered into a one-year $30,000,000 revolving credit agreement with a commercial bank. In November 1995, the agreement was extended to January 26, 1996 and in January 1996, an amendment to the revolving credit agreement extended the term to June 30, 1996 and reduced available borrowings to $20,000,000. Borrowings under the revolving credit agreement bear interest, at Realty's option, at the prime rate, at LIBOR (London Interbank Offered Rate) plus 1%, or at the 30-day, 60-day or 90-day certificate of deposit rate plus 1%. At December 31, 1995, borrowings of $17,700,000 were at a rate of 6.9% which was based on the 30-day certificate of deposit rate plus 1% and borrowings of $3,250,000 were at the prime rate. At December 31, 1994, borrowings were at a rate of 7.25% which was based on the 30-day certificate of deposit rate plus 1%. Realty's Racetrack rental revenues have been pledged as collateral under the credit agreement.\nThe revolving credit agreement contains a restriction on the payment of dividends and certain other financial ratio and maintenance restrictions. Dividends are limited to the lesser of $.80 per share or $9,200,000 in any twelve-month period beginning on or after July 1, 1994. Realty's current dividend policy is in compliance with this dividend restriction. Additionally, at December 31, 1995, Realty was in compliance with the other financial ratio and maintenance restrictions, except for the net worth restriction. Realty has obtained a waiver of non-compliance from the commercial bank and has cured the non-compliance as of January 31, 1996.\nOperating Company entered into a sale-leaseback transaction related to the financing of certain television, video monitoring and production equipment under a five-year lease expiring in December 1997. This financing arrangement is accounted for as a capital lease. Accordingly, the equipment and related lease obligation are reflected as machinery and other equipment and bank loans payable in the Operating Company and The Santa Anita Companies balance sheets. Realty has guaranteed the capital lease obligation of $1,735,000.\nAssets relating to the capital lease are as follows:\nSANTA ANITA REALTY ENTERPRISES, INC. AND SANTA ANITA OPERATING COMPANY AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED) NOTE 8--LOANS PAYABLE (CONTINUED)\nTotal future minimum lease payments under the capital lease and the present value of the minimum lease payments as of December 31, 1995 are as follows:\nInterest costs for the years ended December 31, 1995, 1994 and 1993 are as follows:\nAt December 31, 1995, $121,000 of inter-entity interest was eliminated in The Santa Anita Companies financial statements.\nSANTA ANITA REALTY ENTERPRISES, INC. AND SANTA ANITA OPERATING COMPANY AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 9--OTHER LIABILITIES\nOther liabilities as of December 31, 1995 and 1994 consist of the following:\nNOTE 10--INCOME TAXES\nAs a REIT, Realty is taxed only on undistributed REIT income. During each of the years ended December 31, 1995, 1994 and 1993, Realty distributed at least 95% of its REIT taxable earnings to its shareholders. For the year ended December 31, 1995, 100% of the dividends distributed to shareholders represented ordinary income. For the years ended December 31, 1994 and 1993, 55.4% and 41.2%, of the dividends distributed to shareholders represented a return of capital. Pursuant to Internal Revenue Code Section 857(b)(3)(C) and the Regulations thereunder, for the year ended December 31, 1994, Realty designated 44.6% of the dividends distributed as capital gains dividends. None of the dividends distributed to shareholders during the year ended December 31, 1993 represented capital gains dividends.\nIn prior years, Realty had filed claims with the California Franchise Tax Board for refunds with respect to the 1970 through 1979 tax years; LATC was assessed California franchise tax and interest for the years 1980 through 1982; and, Operating Company was assessed additional franchise tax for the years 1983 through 1985. In 1993, a refund of interest and taxes in the amount of $6,082,000 was received from the California Franchise Tax Board in the settlement of the above claims. Realty recognized $3,211,000 of interest income, net of expenses of $120,000 and an income tax benefit of $2,523,000. Operating Company recorded additional deferred taxes payable of $228,000.\nSANTA ANITA REALTY ENTERPRISES, INC. AND SANTA ANITA OPERATING COMPANY AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED) NOTE 10--INCOME TAXES (CONTINUED)\nThe composition of Operating Company's income tax provision (benefit) and income taxes paid for the years ended December 31, 1995, 1994 and 1993 are as follows:\nDeferred income taxes arise from temporary differences in the recognition of certain items of revenues and expenses for financial statement and tax reporting purposes. The sources of temporary differences and their related tax effect for the years ended December 31, 1995, 1994 and 1993 are as follows:\nSANTA ANITA REALTY ENTERPRISES, INC. AND SANTA ANITA OPERATING COMPANY AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED) NOTE 10--INCOME TAXES (CONTINUED)\nA reconciliation of Operating Company's total income tax provision for the years ended December 31, 1995, 1994 and 1993 to the statutory federal corporate income tax rate of 34% and the state rate of 9.3% is as follows:\nThe deferred tax assets and liabilities as of December 31, 1995 and 1994 consist of the following:\nSANTA ANITA REALTY ENTERPRISES, INC. AND SANTA ANITA OPERATING COMPANY AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED) NOTE 10--INCOME TAXES (CONTINUED)\nThe Franchise Tax Board has audited the 1986 through 1988 tax years of Operating Company. Operating Company has protested the proposed assessments. These assessments have been accrued by Operating Company. In 1995, the Franchise Tax Board proposed a withdrawal of the assessments for 1986 through 1988. In February 1994, the Franchise Tax Board initiated an audit of Operating Company's 1989 through 1991 tax years. At December 31, 1994, the agent has completed his review and has not proposed any adjustments for the 1989 through 1991 tax years. However, these years remain open pending resolution of the proposed assessments for the 1986 through 1988 tax years.\nAt December 31, 1995, Operating Company's net operating loss carryforward, for federal income tax purposes, was $6,503,000 of which $1,197,000 expires in 2002, $99,000 in 2003, $41,000 in 2004, $103,000 in 2005, $440,000 in 2006, $3,000,000 in 2007 and $1,623,000 in 2009. Realty's net operating loss carryforward at December 31, 1995 was $8,736,000 and expires in 2009.\nNOTE 11--COMMITMENTS AND CONTINGENCIES\nRealty's owned real estate investments consist of Santa Anita Racetrack, various neighborhood shopping centers, and office buildings. The racetrack is leased to LATC; the land underlying Fashion Park has been ground leased for 65 years to Anita Associates; each of the various neighborhood shopping centers has been leased to non-anchor tenants with terms ranging from three to five years; and, the office buildings have been leased with terms generally ranging from two to ten years.\nThe minimum future lease payments to be received from Realty's owned real estate investments (excluding rentals relating to Santa Anita Racetrack which are paid by LATC to Realty) for the five years ended December 31, are as follows:\nSubstantially all of the retail leases provide for additional contingent rentals based upon the gross income of the tenants in excess of stipulated minimums. Realty's share of these contingent rentals totaled $104,000 in 1995, $69,000 in 1994 and $115,000 in 1993.\nRealty leases the Santa Anita Racetrack to Operating Company's subsidiary, LATC, pursuant to a lease which expires December 31, 1999. The lease rental amounts have been eliminated in The Santa Anita Companies statement of operations.\nRealty and Operating Company have entered into severance agreements with certain officers. Under certain circumstances, the severance agreements provide for a lump sum payment if there is a \"change in control\" of the entities. No provision under these severance agreements has been accrued or funded.\nCertain other claims, suits and complaints arising in the ordinary course of business have been filed or are pending against Realty and Operating Company. In the opinion of management, all such matters are adequately covered by insurance or, if not covered, are without merit or are of such kind or involve such amounts as would not have a significant effect on the financial position or results of operations if disposed of unfavorably.\nSANTA ANITA REALTY ENTERPRISES, INC. AND SANTA ANITA OPERATING COMPANY AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 12--STOCK OPTION PROGRAM, RESTRICTED STOCK AWARDS AND EMPLOYEE DEFINED BENEFIT PLANS\nStock Option Program\nDuring 1995, the shareholders approved the Realty 1995 Share Award Plan and the Operating Company 1995 Share Award Plan. These plans replace the Realty and Operating Company 1984 Stock Option Plans which expired on May 3, 1995. A maximum 230,000 shares of common stock may be issued under the Realty 1995 Share Award Plan and a maximum of 780,000 shares of common stock may be issued under the Operating Company 1995 Share Award Plan. For both Realty and Operating Company, the maximum number of options and stock appreciation rights that may be granted to an eligible person during any one-year period shall not exceed 150,000. Under the 1995 Share Award Plans, shares are to be issued either as options, dividend equivalents, stock appreciation rights, restricted stock awards, performance share awards or stock bonuses. At December 31, 1995, under the Realty and Operating Company 1995 Share Award Plans, 186,500 shares and 575,173 shares were available for future grant.\nExcept as may be provided in the award agreement, no award made under the 1995 Share Award Plans shall be exercisable or shall vest for a period of six months after the award date. Each award shall expire on such date as determined by the Compensation Committee of the Board of Directors (\"Committee\"), but in the case of options or other rights to acquire shares of paired common stock, not later than ten years after the award date. The Committee may authorize the deferral of any payment of cash or issuance of shares of paired common stock under the 1995 Share Award Plans at the election and request of a participant.\nOptions granted under the 1995 Share Award Plans and the 1984 Stock Option Plans are contingent upon continuous employment and are exercisable at any time once vested, for up to three years after the date of retirement or death and for up to 90 days after resignation. During 1995, all options granted were under the 1995 Share Award Plans. Options outstanding at December 31, 1995 expire in 1996 through 2005.\nInformation with respect to shares under option as of December 31, 1995, 1994 and 1993 is as follows:\nAt the time of exercise of Realty options, employees also have to buy directly from Operating Company shares of Operating Company stock at its fair market value per share to pair with Realty shares.\nIn addition, Operating Company is required to purchase Realty shares to pair with the Operating Company shares being purchased by its employees. Operating Company has purchased 112,500 shares of Realty stock for this purpose.\nSANTA ANITA REALTY ENTERPRISES, INC. AND SANTA ANITA OPERATING COMPANY AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED) NOTE 12--STOCK OPTION PROGRAM, RESTRICTED STOCK AWARDS AND EMPLOYEE DEFINED BENEFIT PLANS (CONTINUED) Restricted Stock Awards\nUnder the 1995 Share Award Plans, Realty granted none and Operating Company granted 126,647 shares of common stock as Restricted Stock Awards during 1995 at a value of $15.50 per paired share. Of the shares issued, 8,065 shares vested in 1995. The remaining Restricted Stock Awards vest in 1996 through 2001.\nRetirement Income Plan\nRealty and Operating Company have a defined benefit retirement plan for the year-round employees who are at least 21 years of age with one or more years of service and who are not covered by collective bargaining agreements. Plan assets consist of a group annuity contract with a life insurance company. Plan benefits are based primarily on years of service and qualifying compensation during the final years of employment. Funding requirements comply with federal requirements that are imposed by law.\nThe net periodic pension cost for Realty and Operating Company for 1995 was $59,000 and $325,000; for 1994 was $85,000 and $390,000; and for 1993 was $104,000 and $367,000. The provisions include amortization of past service cost over 30 years. The present value of accumulated plan benefits (calculated using a rate of return of 7.0%) at December 31, 1995 was $7,230,000 and the plan's net assets available for benefits were $5,929,000.\nCombined net periodic pension cost for the years ended December 31, 1995, 1994 and 1993 for the retirement income plan included the following components:\nSANTA ANITA REALTY ENTERPRISES, INC. AND SANTA ANITA OPERATING COMPANY AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED) NOTE 12--STOCK OPTION PROGRAM, RESTRICTED STOCK AWARDS AND EMPLOYEE DEFINED BENEFIT PLANS (CONTINUED)\nThe following table sets forth the funded status of Realty's and Operating Company's retirement income plan and amounts recognized in the balance sheets at December 31, 1995 and 1994.\nAssumptions used in determining the funded status of the retirement income plan are as follows:\nThe measurement date and related assumptions for the funded status of Realty's and Operating Company's retirement income plan were as of the end of the year.\nDeferred Compensation Plan\nRealty and Operating Company have defined benefit deferred compensation agreements which provide selected prior management employees with a fixed benefit at retirement age. During 1995, the outstanding agreements for active employees were curtailed and replaced by awards of restricted stock under the 1995 Share Award Plan. Plan benefits are based primarily on years of service and qualifying compensation.\nThe net periodic pension cost for 1995 for Realty and Operating Company was $91,000 and $300,000; for 1994 was $121,000 and $594,000; and for 1993 was $263,000 and $860,000. It is the policy of Realty and Operating Company to fund only amounts sufficient to cover current deferred compensation benefits payable to covered retirees. The present value of accumulated plan benefits (calculated using a rate of 7.0%) at December 31, 1995, was $4,817,000 and Realty's and Operating Company's combined accrued liability was $4,391,000. At December 31, 1995, there were no plan net assets available for benefits.\nSANTA ANITA REALTY ENTERPRISES, INC. AND SANTA ANITA OPERATING COMPANY AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED) NOTE 12--STOCK OPTION PROGRAM, RESTRICTED STOCK AWARDS AND EMPLOYEE DEFINED BENEFIT PLANS (CONTINUED)\nNet periodic pension cost for the years ended December 31, 1995, 1994 and 1993 for the deferred compensation plan included the following components:\nThe following table sets forth the funded status of Realty's and Operating Company's deferred compensation plan and amounts recognized in the balance sheets at December 31, 1995 and 1994:\nAssumptions used in determining the funded status of the deferred compensation plan are as follows:\nThe measurement date and related assumptions for the funded status of Realty's and Operating Company's deferred compensation plan were as of the end of the year.\nSANTA ANITA REALTY ENTERPRISES, INC. AND SANTA ANITA OPERATING COMPANY AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 13--SHAREHOLDER RIGHTS PLAN\nUnder a shareholder rights plan, one right was distributed in August 1989 for each outstanding share of common stock. Each right entitles the holder to purchase from Realty, initially, one one-hundredth of a share of junior participating preferred stock at a price of $100 per share, subject to adjustment. The rights are attached to all outstanding common shares, and no separate rights certificates will be distributed. The rights are not exercisable or transferable apart from the common stock until the earlier of ten business days following a public announcement that a person or group has acquired beneficial ownership of 10% or more of Realty's general voting power or ten business days following the commencement of, or announcement of the intention to commence, a tender or exchange offer that would result in a person or group beneficially owning 10% or more of Realty's general voting power.\nUpon the occurrence of certain other events related to changes in the ownership of Realty's outstanding common stock or business combinations involving a holder of more than 10% of Realty's general voting power, each holder of a right would be entitled to purchase shares of Realty's common stock, or an acquiring corporation's common stock, having a market value of two times the exercise price of the right.\nDuring such time as the stock-pairing arrangement between Realty and Operating Company shall remain in effect, Operating Company will issue, on a share-for-share basis, Operating Company common shares, or, as the case may be, Operating Company junior participating preferred shares to each person receiving Realty common shares or preferred shares upon exercise or in exchange for one or more rights.\nRealty is entitled to redeem the rights in whole, but not in part, at a price of $.001 per right prior to the earlier of the expiration of the rights in August 1999 or the close of business ten days after the announcement that a 10% position has been acquired.\nNOTE 14--RELATED PARTY TRANSACTIONS\nLATC leases the racetrack from Realty for the full year for a fee of 1.5% of the on-track wagering on live races at Santa Anita Racetrack, which includes the Oak Tree Racing Association (\"Oak Tree\") meet. In addition, LATC pays to Realty 26.5% of its wagering commissions from satellite wagering (not to exceed 1.5% of such wagering). When LATC operates as a satellite for Hollywood Park Racetrack and Del Mar Racetrack, LATC pays 26.5% of its wagering commissions as additional rent to Realty. LATC has sublet the racetrack to Oak Tree to conduct Oak Tree's annual thoroughbred horse racing meet (32 days in 1995), which commences in late September or early October. Oak Tree races five weeks in even-numbered years and six weeks in odd-numbered years. For the years ended December 31, 1995, 1994 and 1993, LATC paid Realty (including charity days) $11,342,000, $13,070,000, and $11,634,000 in rent. The lease arrangement between LATC and Realty requires LATC to assume costs attributable to taxes, maintenance and insurance.\nThe lease between LATC and Realty which was scheduled to expire December 31, 1994, was amended and extended through December 31, 1999. The previous lease terms required LATC to pay rent based upon 1.5% of the aggregate live on-track wagering and 40% of LATC's revenues received from simulcast and satellite wagering on races originating at Santa Anita Racetrack. If the amended lease terms had been in effect for the year ended December 31, 1994, LATC would have paid Realty (including charity days) $11,123,000 in rent.\nAt times Realty and Operating Company have notes receivable outstanding from certain officers and\/or directors resulting from their exercise of stock options. Such notes receivable as of December 31, 1995 and 1994, for Realty were none and for Operating Company were $61,000 and $75,000.\nSANTA ANITA REALTY ENTERPRISES, INC. AND SANTA ANITA OPERATING COMPANY AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS--(CONCLUDED)\nNOTE 15--SUPPLEMENTAL CASH FLOW INFORMATION\nThe disposition by Realty of the multifamily and industrial operations during 1994 involved the transfer of the following noncash items:\nNOTE 16--COMBINED QUARTERLY FINANCIAL INFORMATION--UNAUDITED\nCondensed unaudited combined quarterly results of operations for The Santa Anita Companies are as follows:\nThe quarter ended December 31, 1995 includes an extraordinary gain on early retirement of debt of $4,050,000 or $.36 per share.\nOperating Company records operating revenues associated with thoroughbred horse racing at Santa Anita Racetrack on a daily basis, except season admissions which are recorded ratably over the racing season. Costs and expenses associated with thoroughbred horse racing revenues are charged against income in those interim periods in which the thoroughbred horse racing revenues are recognized. Other costs and expenses are recognized as they actually occur throughout the year. The rental fee paid by Operating Company to Realty is recognized by both Realty and Operating Company as it is earned.\nThe total of the amounts shown as quarterly net income per common share may differ from the amount shown on The Santa Anita Companies statement of operations because the annual computation is made separately and is based upon the average number of shares outstanding for the year.\nThe Santa Anita Companies is subject to significant seasonal variations in revenues and net income (loss) due primarily to the seasonality of thoroughbred horse racing.\nSANTA ANITA REALTY ENTERPRISES, INC.\nSCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS DECEMBER 31, 1995 AND 1994\nSANTA ANITA REALTY ENTERPRISES, INC.\nSCHEDULE III--REAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1995\n- -------- (a) Initial costs December 31, 1979 book value\n(b) Component depreciation used.\n- --------\nIndependent Auditors' Report ----------------------------\nTo the General Partner Anita Associates:\nWe have audited the accompanying balance sheets of Anita Associates (a California limited partnership) as of December 31, 1995 and 1994, and the related statements of income, partners' deficit, and cash flows for each of the years in the three-year period ended December 31, 1995. These financial statements are the responsibility of Anita Associates' 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 Anita Associates as of December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 1995, in conformity with generally accepted accounting principles.\nKPMG Peat Marwick LLP\nSan Diego, California February 9, 1996\nANITA ASSOCIATES ---------------- (a California limited partnership)\nBALANCE SHEETS --------------\nSee accompanying notes to financial statements\nANITA ASSOCIATES ---------------- (a California limited partnership)\nSTATEMENTS OF INCOME --------------------\nSee accompanying notes to financial statements\nANITA ASSOCIATES ---------------- (a California limited partnership)\nSTATEMENTS OF PARTNERS' DEFICIT -------------------------------\nSee accompanying notes to financial statements\nANITA ASSOCIATES ---------------- (a California limited partnership)\nSTATEMENTS OF CASH FLOWS ------------------------\nSee accompanying notes to financial statements\nANITA ASSOCIATES ---------------- (a California limited partnership)\nSTATEMENTS OF CASH FLOWS (CONTINUED) ------------------------------------\nSUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION ------------------------------------------------\nSUPPLEMENTAL DISCLOSURE RELATED TO NON-CASH INVESTING ----------------------------------------------------- AND FINANCING ACTIVITIES ------------------------\nUpon completion of the development project in 1994, the Partnership transferred $30,924,057 from Property Under Development to Shopping Center Property.\nAt December 31, 1994, $997,233 of tenant improvements were completed but unpaid and are included in Shopping Center Property and Accounts Payable - Others.\nIn addition to the above, the following non-cash activities occurred:\nSee accompanying notes to financial statements\nANITA ASSOCIATES ---------------- (a California limited partnership)\nNOTES TO FINANCIAL STATEMENTS -----------------------------\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 --------------------------------------------\nA. Organization and Accounting Policies: ------------------------------------\nAnita Associates (the \"Partnership\") is a California limited partnership consisting of Hahn-UPI, the general partner, and Santa Anita Realty Enterprises, Inc. (the \"Limited Partner\"), formed to develop and operate a regional shopping center in Arcadia, California. Hahn-UPI is a limited partnership consisting of Ernest W. Hahn, Inc. (\"Hahn\"), the general partner, and UPI Associates (\"UPI\"), the limited partner. UPI does not have responsibility for, or participation in, any duties, obligations or rights of approval assumed by Hahn-UPI as general partner of Anita Associates. The partnership agreement provides that the Partnership shall continue from year to year until the partners elect to terminate the Partnership. Profits and losses are shared as follows:\nHahn-UPI: Ernest W. Hahn, Inc. 39.68% UPI Associates 10.32%\nSanta Anita Realty Enterprises, Inc. 50.00%\nCertain reclassifications of prior year amounts have been made in order to conform to the current year presentation.\nThe Partnership's accounting policies are as follows:\n1. Shopping center property and property under development are recorded at cost and include direct construction costs, interest, construction loan fees, property taxes and related expenses capitalized during the pre- opening period, as these amounts are expected to be recovered from operations.\n2. The costs of shopping center buildings and improvements, less a 5% salvage value, are depreciated using the straight-line method over the estimated useful life of 40 years.\n3. Direct costs of obtaining leases and permanent financing are deferred and are being amortized over the lease and loan periods, respectively.\n4. Maintenance and repairs are charged to operations as incurred.\n5. Expenditures for betterments are capitalized and depreciated over the remaining depreciable life of the property.\nANITA ASSOCIATES ---------------- (a California limited partnership)\nNOTES TO FINANCIAL STATEMENTS -----------------------------\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 --------------------------------------------\nA. Organization and Accounting Policies (Continued): ------------------------------------------------\n6. Costs incurred in connection with early termination of a tenant lease are amortized over the life of the lease with the replacement tenant. To the extent payments received from an incoming tenant do not represent future rentals or cost recoveries for tenant improvements, they are recorded as income when received.\n7. Taxable income or loss of the Partnership is reported by and is the responsibility of the respective partners. Accordingly, the Partnership makes no provision for income taxes.\n8. The Partnership recognizes scheduled rent increases on a straight-line basis. Accordingly, a deferred receivable and deferred payable for rents which are to be received or paid in subsequent years, respectively, are reflected in the accompanying balance sheets. The deferred payable is included in accounts payable to others.\n9. The Partnership considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.\n10. The Partnership agreement does not designate investment interests in units. Investment interests are calculated on a percentage basis. Accordingly, earnings or losses per unit is not presented in the accompanying financial statements.\n11. The Partnership has made a number of estimates and assumptions relating to the reporting of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period to prepare these financial statements in conformity with generally accepted accounting principles. Actual results could differ from those estimates.\n12. The Partnership financial instruments that are exposed to concentrations of credit risk consist primarily of cash and cash equivalents and trade and deferred receivables. The Partnership places its temporary cash investments with high credit quality institutions and cash accounts with federally insured institutions. Cash balances with any one institution may be in excess of federally insured limits. The Partnership has not experienced any losses in such investments or accounts and believes it is not exposed to any significant credit risk. Management routinely assesses the financial strength of its tenants and as a consequence, believes that its trade and deferred receivable credit risk exposure is limited.\nANITA ASSOCIATES ---------------- (a California limited partnership)\nNOTES TO FINANCIAL STATEMENTS -----------------------------\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 --------------------------------------------\nB. Fair Value of Financial Instruments: -----------------------------------\nStatement of Financial Accounting Standards No. 107 \"Disclosures about Fair Value of Financial Instruments\" requires that the fair values be disclosed for the Partnership's financial instruments. The carrying amount of cash and cash equivalents, accounts receivable, notes receivable and accounts payable are reasonable estimates of their fair values because of the short maturity of these instruments. The carrying amount of notes payable is a reasonable estimation of fair value based on management's belief that, on average, fixed interest rates are not materially different than market rates available to the Partnership.\nC. Notes Payable: -------------\nThe notes payable (collectively \"the loan\") at December 31, 1995 are payable in monthly payments of $527,338 including interest, with a balloon payment of $51,929,396 due January 2003. The loan was funded in two draws of $46,577,193 and $15,777,807, bearing interest at 9.0% and 9.25%, respectively. The loan is secured by a first lien on the leasehold estate and improvements. In connection with the funding of the final draw in December 1994, the Partnership executed a pledge agreement and deposited $638,933 in a restricted interest bearing account. This amount is included in other assets at December 31, 1995 and December 31, 1994.\nAs part of the extinguishment of the existing debt on January 25, 1994, the Partnership was required to pay a prepayment penalty of $1,364,054. This penalty, along with the write-off of unamortized finance costs related to the extinguished debt, was recognized as an extraordinary loss during 1994.\nAnnual principal payments are scheduled as follows:\nANITA ASSOCIATES ---------------- (a California limited partnership)\nNOTES TO FINANCIAL STATEMENTS -----------------------------\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 --------------------------------------------\nD. Commitments: -----------\nPartnership as Lessor: ---------------------\nThe Partnership leases space to tenants in the shopping center for which it charges minimum rents and receives reimbursement for real estate taxes and certain other operating expenses. The terms of the leases range from 4 to 25 years, and the majority of the leases also provide for additional overage rents during any year in which a tenant's gross sales exceed a stated amount.\nFuture minimum rental revenues to be received under leases in force at December 31, 1995 are as follows:\nIn the ordinary course of business, the Partnership is, from time to time, involved in various litigation. Although the final outcome of these legal matters cannot be determined, it is management's opinion, based in part upon advise from legal counsel, that the final resolution of these matters will not have a material adverse effect on the Partnership's financial position and results of operations.\nANITA ASSOCIATES ---------------- (a California limited partnership)\nNOTES TO FINANCIAL STATEMENTS -----------------------------\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 --------------------------------------------\nE. Partner Advances: ----------------\nIn 1994, the Partnership substantially completed a $32,000,000 expansion of the shopping center. The expansion included the addition of a major department store as well as other tenant leasable area.\nThe Partners made advances to fund the expansion cost until construction loan funds could be obtained. Such advances bore interest at 10% per annum, compounded monthly. Advances outstanding at December 31, 1995, 1994 and 1993 were $0, $551,787 and $22,239,266, respectively. Interest incurred on partner advances was $16,738, $1,671,528 and $1,211,718 for the years ended December 31, 1995, 1994 and 1993, respectively.\nInterest costs capitalized as part of the shopping center totaled $297,392, $2,189,255 and $1,396,033 during 1995, 1994 and 1993, respectively, of which $0, $1,262,587 and $1,211,718 related to advances from partners for 1995 and 1994, respectively.\nF. Related Party Transactions: --------------------------\nOperating Costs ---------------\nHahn and its wholly-owned subsidiary, Hahn Property Management Corporation (\"HPMC\"), provide property management, leasing and various legal services to the Partnership. A summary of costs and fees incurred by Hahn and HPMC during 1995, 1994 and 1993 is presented below:\nANITA ASSOCIATES ---------------- (a California limited partnership)\nNOTES TO FINANCIAL STATEMENTS -----------------------------\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 --------------------------------------------\nF. Related Party Transactions (Continued): --------------------------------------\nGround Lease ------------\nThe shopping center was developed on approximately 70 acres of land leased from the Limited Partner. The leased property consists of four parcels, each covered by a separate ground lease, requiring total annual rentals of $762,497, during 1995 and 1994. Three of the parcels are subleased to major department stores located in the shopping center for aggregate rentals of $257,032 annually. The sublease terms, which commenced with the opening of the shopping center and continue through October 2017 with two ten-year renewal options, are identical to the primary lease. The subleases to the major department stores are assigned to the Limited Partner. The Partnership remains the lessee on the fourth parcel. In 1993, the ground leases were amended and the area of the fourth parcel was increased by an additional 8.2 acres; consequently, the monthly rental increased from $18,321 to $22,488.\nNet rental expense amounted to $505,465 in 1995 and 1994, respectively and $228,193 in 1993. The minimum annual rental payments under the lease, net of sublease rentals, are as follows:\nCash Equivalents: ----------------\nAt December 31, 1995 and 1994, the Partnership had $1,193,598 and $1,900,000, respectively, invested in thirty day bank credit-enhanced commercial paper issued by an entity in which Hahn owns an interest.\nIndependent Auditors' Report ----------------------------\nTo the Partners H-T Associates:\nWe have audited the accompanying consolidated balance sheets of H-T Associates (a Maryland general partnership) and subsidiary (a Maryland general partnership) as of December 31, 1995 and 1994, and the related consolidated statements of operations, partners' capital (deficit) and cash flows for each of the years in the three-year period ended December 31, 1995. These consolidated financial statements are the responsibility of H-T Associates' management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as 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 H-T Associates and subsidiary as of December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1995 in conformity with generally accepted accounting principles.\nThe accompanying consolidated financial statements have been prepared assuming that the Partnership will continue as a going concern. As discussed in Note H to the consolidated financial statements, the Partnership's subsidiary, Towson Town Center Associates, is in technical default on its notes payable at December 31, 1995. As such, those notes may be callable at the lender's discretion. As Towson Town Center Associates is the primary subsidiary of the Partnership, this technical default raises substantial doubt about the Partnership's ability to continue as a going concern. Management's plan in regard to this matter is also described in Note H to the consolidated financial statements. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.\nKPMG Peat Marwick LLP\nSan Diego, California February 9, 1996\nH-T ASSOCIATES -------------- (a Maryland general partnership) AND SUBSIDIARY (a Maryland general partnership)\nCONSOLIDATED BALANCE SHEETS ---------------------------\nSee notes to consolidated financial statements.\nH-T ASSOCIATES -------------- (a Maryland general partnership) AND SUBSIDIARY (a Maryland general partnership)\nCONSOLIDATED STATEMENTS OF OPERATIONS -------------------------------------\nSee notes to consolidated financial statements.\nH-T ASSOCIATES -------------- (a Maryland general partnership) AND SUBSIDIARY (a Maryland general partnership)\nCONSOLIDATED STATEMENTS OF PARTNERS' CAPITAL (DEFICIT) -----------------------------------------------------\nYEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 --------------------------------------------\nSee notes to consolidated financial statements.\nH-T ASSOCIATES -------------- (a Maryland general partnership) AND SUBSIDIARY (a Maryland general partnership)\nCONSOLIDATED STATEMENTS OF CASH FLOWS -------------------------------------\n(continued)\nSee notes to consolidated financial notes.\nH-T ASSOCIATES -------------- (a Maryland general partnership) AND SUBSIDIARY (a Maryland general partnership)\nCONSOLIDATED STATEMENTS OF CASH FLOWS (Continued) -------------------------------------------------\nSUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION ------------------------------------------------\nSUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING ACTIVITIES -------------------------------------------------------\nDuring 1995 and 1994, the following non-cash activity occurred:\nSee notes to consolidated financial statements.\nH-T ASSOCIATES -------------- (a Maryland general partnership) AND SUBSIDIARY (a Maryland general partnership)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------\nDECEMBER 31, 1995, 1994 AND 1993 --------------------------------\nA. Organization and Accounting Policies: ------------------------------------\nH-T Associates (the \"Partnership\") is a Maryland general partnership formed on July 28, 1987. Its primary asset is a 65% ownership in Towson Town Center Associates (\"TTCA\"), formed to develop and operate a regional shopping center near Baltimore, Maryland. The general partners of the Partnership are Ernest W. Hahn, Inc. and Santa Anita Realty Enterprises, Inc. The Partnership is to continue until December 31, 2087, unless terminated earlier. Profits and losses are shared as follows:\nErnest W. Hahn, Inc. (\"Hahn\") 50% Santa Anita Realty Enterprises, Inc. (\"Santa Anita\") 50%\nThe consolidated financial statements of the Partnership include the accounts of the Partnership and TTCA. TTCA is a Maryland general partnership comprised of the Partnership and DeChiaro Associates (\"DeChiaro\") as 65% and 35% general partners, respectively. DeChiaro's interest is recorded as minority interest in the accompanying consolidated financial statements. All significant intercompany balances and transactions have been eliminated.\nCertain reclassifications of prior year amounts have been made in order to conform to the current year presentation.\nThe Partnership's accounting policies are as follows:\n1. Shopping center property is recorded at cost and includes direct construction costs, interest, construction loan fees, property taxes and related costs capitalized during the construction period, as these amounts are expected to be recovered from operations.\n2. The costs of shopping center buildings and improvements, less a 5% salvage value, are depreciated using the straight-line method over the estimated useful life of 40 years.\n3. Direct costs of obtaining leases and permanent financing are deferred and are being amortized over the lease and loan periods, respectively.\n4. Maintenance and repairs are charged to operations as incurred.\n5. Expenditures for betterments are capitalized and depreciated over the remaining depreciable life of the property. (continued)\nH-T ASSOCIATES -------------- (a Maryland general partnership) AND SUBSIDIARY (a Maryland general partnership)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) ------------------------------------------------------\nA. Organization and Accounting Policies (Continued): ------------------------------------------------\n6. Costs incurred in connection with the early termination of a tenant lease are amortized over the life of the lease with the replacement tenant. To the extent payments received from an incoming tenant do not represent future rentals or cost recoveries for tenant improvements, they are recorded as income when received.\n7. Taxable income or loss of the Partnership is reported by, and is the responsibility of, the respective partners. Accordingly, the Partnership makes no provision for income taxes.\n8. The Partnership recognizes scheduled rent increases on a straight-line basis. Accordingly, a deferred receivable for rents which are to be received in subsequent years is reflected in the accompanying consolidated balance sheets.\n9. The differential to be paid or received under interest rate swap agreements is accrued as interest rates change, and is recognized over the life of the agreements (Note C).\n10. The Partnership has made a number of estimates and assumptions relating to the reporting of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period to prepare these financial statements in conformity with generally accepted accounting principles. Actual results could differ from those estimates.\n11. The Partnership agreement does not designate investment interests in units. Investment interests are calculated on a percentage basis. Accordingly, earnings or losses per unit is not presented in the accompanying consolidated financial statements.\n12. The Partnership's financial instruments that are exposed to concentrations of credit risk consist primarily of cash and trade and deferred receivables. The Partnership places its temporary cash investments with high credit quality institutions and cash accounts with federally insured institutions. Cash balances with any one institution may be in excess of federally insured limits. The Partnership has not experienced any losses in such investments or accounts and believes it is not exposed to any significant credit risk. Management routinely assesses the financial strength of its tenants and as a consequence, believes that its trade and deferred receivable credit risk exposure is limited.\nH-T ASSOCIATES -------------- (a Maryland general partnership) AND SUBSIDIARY (a Maryland general partnership)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) ------------------------------------------------------\nB. Fair Value of Financial Instruments: ------------------------------------\nStatement of Financial Accounting Standards No. 107 \"Disclosures about Fair Value of Financial Instruments\" requires that the fair values be disclosed for the partnerships' financial instruments. The carrying amount of cash, accounts receivable, and accounts payable are reasonable estimates of their fair values due to the short-term nature of these instruments.\nThe carrying amount of the notes receivable is a reasonable estimation of fair value based on management's belief that the interest rates on which the notes bear interest is not materially different than interest rates that would be used on loans to tenants with similar credit ratings.\nThe carrying amount of the notes payable and advances from partners is a reasonable estimation of fair value as the notes and advances bear interest based on a variable market rate.\nThe fair value of interest rate swaps (used for hedging purposes) is the estimated amount that the Partnership would pay to terminate the swap agreements at the reporting date, taking into account current interest rates and the current credit worthiness of the swap counterparties. The fair value of the interest rate swaps as of December 31, 1995 is a net payable of approximately $9,100,000.\nC. Notes Payable: -------------\nIn 1990, TTCA entered into a building loan agreement with a commercial bank, secured by an indemnity deed of trust encumbering the property. TTCA can borrow up to $170,000,000. The agreement, as amended, requires principal payments of $1,741,000 in 1998, and $162,900,000 in 1999. The agreement provides that TTCA can: (1) obtain funds at the then current prime rate of the commercial bank; (2) obtain funds based on the then current London Interbank Offered Rate (\"LIBOR\") plus a spread (as defined); or, (3) obtain funds through the issuance of commercial paper at rates based upon the interest rates offered in the commercial paper market plus letter of credit fees. For the years ended December 31, 1995 and 1994, all funds were obtained under the commercial paper option for a total outstanding balance of $164,641,000. Interest is payable monthly. The variable interest rate in effect on the outstanding balance as of December 31, 1995 and 1994 was 6.0% and 5.8%, respectively.\nIn connection with the loan, Hahn and Santa Anita each executed a repayment guaranty of $66,135,000 and DeChiaro executed a limited repayment guaranty of $4,513,000. The repayment guaranties contain covenants which, among other matters, require the guarantors to maintain certain minimum levels of net worth (Note H).\nH-T ASSOCIATES -------------- (a Maryland general partnership) AND SUBSIDIARY (a Maryland general partnership)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) ------------------------------------------------------\nC. Notes Payable (Continued): -------------------------\nTTCA has also entered into interest rate swap agreements to reduce the impact of changes in interest rates on its loan (Note B). As of December 31, 1995 and 1994, TTCA had two interest rate swap agreements outstanding with a commercial bank which have a total notional principal amount of $82,000,000. The agreements provide for TTCA to pay fixed rates of interest of 9.3% and 8.8% on swaps of $45,000,000 and $37,000,000, respectively, and to receive floating interest based on 30 day commercial paper rates. The variable rate of interest in effect on the swap agreements as of December 31, 1995 was 5.8%. The interest rate swap agreements mature at the time the building loan matures. TTCA is exposed to credit loss in the event of nonperformance by the commercial bank with respect to the interest rate swap agreements.\nThe net effective interest rate on amounts outstanding under the building loan agreement at December 31, 1995, 1994 and 1992, after giving effect to the interest rate swaps, was 8.2%, 7.4% and 6.9%, respectively.\nThe differential between the amounts paid and received under the interest rate contract is included as either an addition to, or a reduction in, interest incurred. Total interest incurred was $13,557,828, $12,180,199 and $11,383,329, for the years ended December 31, 1995, 1994 and 1993, respectively.\nD. Commitments: -----------\nPartnership as Lessor: ---------------------\nTTCA leases space to tenants in the shopping center for which it charges minimum rents and receives reimbursement for real estate taxes and certain other operating expenses. The terms of the leases range from five to thirty years and generally provide for additional overage rents during any year that tenants' gross sales exceed stated amounts.\n(continued)\nH-T ASSOCIATES -------------- (a Maryland general partnership) AND SUBSIDIARY (a Maryland general partnership)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) ------------------------------------------------------\nD. Commitments (Continued): ------------------------\nPartnership as Lessor (Continued): ---------------------------------\nFuture minimum rental revenues to be received under leases in force at December 31, 1995 are as follows:\nIn the ordinary course of business, the Partnership is, from time to time, involved in various litigation. Although the final outcome of these legal matters cannot be determined, it is management's opinion, based in part upon advise from legal counsel, that the final resolution of these matters will not have a material adverse effect on the Partnership's financial position and results of operations.\nProperty Under Development: --------------------------\nDuring 1991, TTCA completed a major expansion and renovation of the previously existing shopping center. Pursuant to the Development Manager's Agreement between TTCA and Hahn, Hahn received $5,080,619 as compensation for managing the development of the project through 1993.\nE. Advances from Partners: ----------------------\nHahn and Santa Anita have both made advances to the Partnership to finance certain construction funding requirements and other cash flow needs. These advances bear interest at 1% above the prime rate and are required to be repaid prior to any distributions to the partners, other than distributions of Net Cash Flow from Operations (Note F). Interest incurred on the advances totaled $910,532, $684,469 and $540,553 for the years ended December 31, 1995, 1994 and 1993, respectively. The prime rate was 8.8%, 8.5% and 6.0% at December 31, 1995, 1994 and 1993, respectively.\nH-T ASSOCIATES -------------- (a Maryland general partnership) AND SUBSIDIARY (a Maryland general partnership)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) ------------------------------------------------------\nF. Partnership Distributions: -------------------------\nDistributions of Net Cash Flow from Operations of the Partnership (as defined by the Amended and Restated Partnership Agreement) are subject to certain priorities. The period from inception of the Partnership through October 16, 1992 (the Grand Opening Date of the shopping center) is referred to as the Initial Term. During the Initial Term, both partners were entitled to a cumulative, compounded return (at the Prime Rate, as defined) on their capital contributions. A $500,000 distribution was made during the Initial Term. The \"Primary Term\" follows the Initial Term, and ends when cash flow for a consecutive 12 month period exceeds the sum of $1,192,000 plus any unpaid cumulative returns. During the \"Primary Term\", Santa Anita receives a cumulative return of $447,000 for the first year, $521,500 for the second year, and $596,000 for each year thereafter. Hahn receives non-cumulative returns of the same amounts. Following the Primary Term, distributions of Net Cash Flow from Operations are made to the partners in accordance with their percentage interests.\nG. Related Party Transactions: --------------------------\nHahn and its wholly-owned subsidiary, Hahn Property Management Corporation (\"HPMC\"), provide property management, leasing and various legal services to TTCA. A summary of costs and fees incurred by Hahn and HPMC by TTCA during 1995, 1994 and 1993 is presented below:\nRelated Property: - ----------------\nCertain property adjacent to TTCA's regional shopping center is owned by Joppa Associates (\"Joppa\"). The partners of TTCA are also the partners of Joppa. TTCA has benefited from Joppa's ownership of the adjacent property.\nH-T ASSOCIATES -------------- (a Maryland general partnership) AND SUBSIDIARY (a Maryland general partnership)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) ------------------------------------------------------\nH. Ability to Continue as a Going Concern and Management's Plan: ------------------------------------------------------------\nAs discussed in Note C, the Partnership's repayment guaranty agreement contains restrictive covenants which include a requirement for the guarantors to maintain certain minimum levels of net worth. Santa Anita failed to meet this covenant requirement which has placed the Partnership in technical default. Consequently, the notes payable may be callable at the lender's discretion. The partners are currently negotiating with the lender to restructure the loan and modify the net worth requirement in the guaranty. There is no assurance that these negotiations will be completed on terms satisfactory to the Partnership.\nEXHIBIT INDEX","section_15":""}
{"filename":"2648_1995.txt","cik":"2648","year":"1995","section_1":"Item 1. Business.\nA. Organization of Business\nAetna Life and Casualty Company was organized in 1967 as a Connecticut insurance corporation. Aetna Life and Casualty Company and its subsidiaries (collectively, \"Aetna\" or the \"company\") constitute one of the nation's largest insurance\/financial services organizations based on its assets at December 31, 1994. Based on 1994 premium rankings, the company also is one of the nation's largest stock insurers of property- casualty lines and one of the largest writers of health care products, and group life, annuity and pension products. Although the company offers insurance and financial services products in foreign countries, 90% of its total revenue (including Discontinued Operations - see below) in 1995 was derived from domestic sources.\nThe company entered into a definitive agreement, dated November 28, 1995, to sell its property-casualty operations to The Travelers Insurance Group Inc. for $4.0 billion in cash, subject to various closing adjustments. The sale is subject to state regulatory approval and other customary conditions and is expected to be completed no later than midyear 1996. In light of the sale agreement, the company's property-casualty operations have been classified as Discontinued Operations. (For additional information regarding Discontinued Operations, see MD&A - Overview - - Sale of Property-Casualty Operations in the 1995 Annual Report.)\nThe agreement to sell the company's property-casualty business reflects the company's strategic decision to focus its resources on pursuing growth opportunities in its managed care business and other remaining businesses. The company is considering a variety of strategic options, and is looking for opportunities to make managed care investments or acquisitions to further strengthen the company's overall market position. The company also expects to evaluate opportunities for growth of its financial services businesses and strengthen their competitive position, and opportunities to develop its current international operations and enter selected new markets where suitable opportunities exist.\nThe company's reportable segments are Aetna Health Plans, Aetna Life Insurance & Annuity, International, Large Case Pensions, Corporate and Discontinued Operations - Property-Casualty Operations. The principal products included in such segments (other than Corporate) are:\nAetna Health Plans: Health Specialty health Group insurance\nAetna Life Insurance & Annuity: Retirement and investment products (including individual and group annuities) Financial and administrative services Life insurance (including universal life, variable universal life, interest-sensitive whole life and term products)\nInternational: Life insurance and financial services\nLarge Case Pensions: Group retirement and other savings products Investment management and advisory services\nDiscontinued Operations - Property-Casualty Operations: Automobile Fidelity and surety Fire and allied lines General liability Homeowners Marine Multiple peril Workers' compensation\nB. Financial Information about Industry Segments\nRevenue, income (loss) from continuing operations before income taxes, extraordinary item and cumulative effect adjustments, income from Discontinued Operations, net of tax, net income (loss), and assets, by industry segment are set forth in Note 15 to the Financial Statements, which is incorporated herein by reference to the Annual Report. Revenue, income (loss) from continuing operations before extraordinary item and cumulative effect adjustments and income (loss) from Discontinued Operations, attributable to each industry segment are incorporated herein by reference to the Selected Financial Data in the Annual Report.\nCertain reclassifications have been made to 1994 and 1993 financial information to conform to 1995 presentation.\nC. Description of Business Segments\n1. Aetna Health Plans\nPrincipal Products __________________\nThe Aetna Health Plans (\"AHP\") segment consists of Health, Specialty Health and Group Insurance businesses. The Health business provides a full spectrum of managed care and traditional indemnity plans. Specialty Health products include behavioral health, pharmacy and dental plans, which provide managed care or indemnity features.\nThe Group Insurance business provides life insurance, disability, including managed disability, and long-term care plans. Group life insurance consists principally of renewable term coverage, the amounts of which frequently are linked to individual employee wage levels. The company also offers group universal life and whole life products. Group disability insurance includes coverage for disabled employees' income replacement benefits.\nAHP products and services are marketed primarily to employers for the benefit of employees and their dependents. Plans may be insured (risk plans), whereby Aetna assumes all or a portion of health care cost and utilization risk, or self-funded (nonrisk plans), whereby employers assume all or a significant portion of such risks. AHP also provides administrative and claim services and, in many cases, partial insurance protection, for an appropriate fee or premium charge.\nContinuing concern over the rising costs of health care and the need for quality assurance have resulted in a continuation of a market shift away from traditional forms of health benefit coverage to a variety of managed care products. The company offers the following Health products:\nHealth Maintenance Organization (HMO) plans offer the most comprehensive form of managed care. Health care for the member is coordinated by a personally selected primary care physician in AHP's HMO network, with minimal out-of-pocket costs for the member and an emphasis on preventative care. Typically, no benefits are provided if the member chooses to seek nonemergency care without referral from the primary care physician.\nPreferred Provider Organization (PPO) plans offer the member a choice of any health care provider, but benefits are paid at a higher level when care is received from an AHP PPO network provider.\nPoint-of-Service (POS) plans blend PPO and HMO advantages. The member selects a primary care physician from AHP's POS network to provide or coordinate all necessary health care, including routine and preventative services. The member may also choose to seek care from any other provider, without referral from the primary care physician, at a reduced level of benefits.\nTraditional indemnity plans allow freedom of provider choice for covered services with no in-network discounts available. These plans are not considered managed care, although they may include some medical management features, such as inpatient certification, reasonable and customary charges and benefits for preventative services (e.g. cancer screening).\nAt year end 1995, the company operated various types of managed care networks in approximately 241 Standard Metropolitan Statistical Areas with aggregate enrollment of approximately 8 million members. AHP contracts with approximately 200,000 physicians and more than 2,200 hospitals in all 50 states. As described above, managed care products differ from traditional indemnity products primarily through the use of health care networks (physicians, hospitals and other health care professionals and facilities) and the implementation of medical management procedures designed to enhance the quality and affordability of medical services. Such procedures, including negotiated contracts with health care providers, development and implementation of guidelines for appropriate utilization of health care resources and working with health care providers to review treatment patterns in order to improve consistency and quality, are designed to enable managed care companies and their customers to control medical costs more effectively.\nWith an emphasis on promoting high quality, as well as affordable health care, the company is seeking accreditation for its HMO plans from the National Committee for Quality Assurance (NCQA), a national organization established to review the quality and medical management systems of its HMOs and other managed care plans. Accreditation by NCQA is a nationally recognized standard. As of the end of 1995, eight of AHP's HMOs have received accreditation.\nThe company's health care network physicians and hospitals have traditionally been independent contractors. Beginning in 1993, the company, in an effort to further contain health care costs and to improve quality and network access, initiated a program to acquire or develop ownership or management interests in primary care physician practices. At the end of 1995, the company owned and managed 62 physician practices in eight cities. AHP expects to continue to invest in the acquisition or development of physician practices and in other programs which the company believes will improve its ability to control health care costs and enhance quality.\nAHP continues to develop a wide range of products and services tailored to provide its members with choices to meet their individual needs and to help plan sponsors manage their benefit plan costs effectively. The number of AHP members covered under all managed and traditional indemnity health care plans was approximately 12.0 million at December 31, 1995. These members were distributed throughout all 50 states, with 3.8 million members in the northeast region of the country, 2.4 million in the southeast, 3.1 million in the central region and 2.7 million in the west.\nFor additional information regarding products offered by AHP, see Management's Discussion and Analysis of Financial Condition and Results of Operations (\"MD&A\") - Aetna Health Plans in the Annual Report.\nThe following table summarizes group Health and Specialty Health, and Group Insurance premiums for the years indicated:\nCompetition ___________\nThe markets in which AHP's products are sold are highly competitive. In addition to other insurance companies, AHP competes with local and regional HMOs and other types of medical and dental provider organizations, various specialty service providers, integrated health care delivery organizations and, in certain coverages, with programs sponsored by the federal or state governments. Additionally, in recent years, some large employers have moved to totally self-funded and self-administered benefit plans. Competition largely is based upon product features and prices and, in the case of managed health care plans, upon the quality of services provided, the geographic scope of the provider networks and the medical specialties available in such networks. Based on 1994 membership, Aetna is the third largest health care company in the United States and the fourth largest underwriter of group life insurance. In addition, Aetna is the largest commercial administrator of Medicare benefits, processing claims for over 7,300 hospitals, skilled nursing facilities and home health agencies, and for physicians in nine states.\nMethod of Distribution ______________________\nProducts are sold principally through salaried field representatives and home office marketing personnel who often work with independent consultants and brokers who assist in the production and servicing of business.\nReserves ________\nFor Group Insurance products, policy reserve liabilities are established as premiums are received to reflect the present value of expected future obligations net of the present value of expected future premiums. Policy reserves for group paid-up life insurance generally reflect long-term fixed obligations and are computed on the basis of assumed or guaranteed yield and benefit payments. Assumptions are based on Aetna's experience, which is periodically reviewed against published industry data. For long term disability products, reserves are established for (i) lives currently in payment status (using standard industry morbidity and interest rate assumptions), (ii) lives who have not satisfied the waiting period (using a percentage of premiums based on Aetna's experience) and (iii) claims that have been incurred but not reported. For Health and Specialty Health risk products, reserves reflect estimates of the ultimate cost of claims including (i) claims that have been reported but not settled, and (ii) claims that have been incurred but have not yet been reported. AHP claim reserves are based on factors derived from past experience. Reserves for most of these products reflect retrospective experience rating, except for smaller group insurance cases and HMOs, which generally are not retrospectively experience rated.\nReinsurance ___________\nAetna utilizes a variety of reinsurance agreements with nonaffiliated insurers to share insurance risks on Health, Specialty Health and Group Insurance businesses as directed by the insured and to control its exposure to large losses. Generally, these agreements are established on a case-by-case basis to reflect the circumstances of specific group insurance risks.\nGroup Life Insurance In Force and Other Statistical Data ________________________________________________________\nThe following table summarizes changes in group life insurance in force before deductions for reinsurance ceded to other companies for the years indicated:\n2. Aetna Life Insurance & Annuity\nPrincipal Products __________________\nAetna Life Insurance & Annuity (\"ALIAC\") markets and services two principal types of products: (1) financial services and (2) life insurance.\nThe financial services products include individual and group annuity contracts which offer a variety of funding and distribution options for personal and employer-sponsored retirement plans that qualify under IRC Sections 401, 403, 408 and 457, and individual and group nonqualified annuity contracts. These contracts may be immediate or deferred and are offered primarily to individuals, pension plans, small businesses and employer-sponsored groups in the health care, government, education (collectively \"not-for-profit\" organizations) and corporate markets. Financial services also include pension plan administrative services.\nThe life insurance products include universal life, variable universal life, interest-sensitive whole life and term insurance. These products are offered primarily to individuals, small businesses, employer-sponsored groups and executives of Fortune 2000 companies. ALIAC's universal life product accounted for approximately 92% of individual life sales in 1995.\nAnnuity products typically offer fixed (fully guaranteed and experience rated) investment options and variable investment options (discussed below). For fully guaranteed and experience rated options ALIAC earns a spread representing the difference between income on investments and interest credited to customer reserves.\nThe company's variable products (variable annuity and variable life contracts) utilize Separate Accounts to provide contractholders with a vehicle for investments under which the contractholders assume the investment risks as well as the benefit of favorable performance. Assets held under these products are invested, as designated by the contractholder or participant under a contract, in Separate Accounts which in turn invest in shares of mutual funds that are managed by ALIAC, where ALIAC receives fees for acting as investment advisor, or other selected mutual funds that are not managed by ALIAC.\nALIAC is compensated by the Separate Accounts for bearing mortality and expense risks pertaining to variable life and annuity contracts. ALIAC also receives fees for serving as investment advisor and providing administrative services, as well as sales charges on certain products. Various investment advisory services also are offered through a number of affiliates that are registered investment advisors.\nProduct retention is a key driver of profitability for annuity products. To encourage product retention, annuity contracts typically impose a surrender charge on policyholder balances withdrawn for a period of time after the contract's inception. The period of time and level of the charge vary by product. In addition, a new approach being incorporated into recent variable contracts with fixed interest account investment options allows contractholders to receive an incremental interest rate if withdrawals from the fixed account are spread over a period of five years. Further, more favorable credited rates may be offered after policies have been in force for a period of time. Existing tax penalties on annuity distributions prior to age 59-1\/2 provide an additional disincentive to premature surrenders of annuity balances, but do not impede transfers of those balances to products of other competitors.\nUniversal life products include a cash value component that is credited with interest at competitive rates. ALIAC earns the spread between investment income and interest credited on customer cash values. Universal life cash values are charged for cost of insurance coverage and for administrative expenses.\nLife insurance products typically require high costs to acquire business. Retention, an important driver of profitability, is encouraged through product features. For example, the company's universal and interest-sensitive whole life insurance contracts typically impose a surrender charge on policyholder balances withdrawn within 7 to 20 years of the contract's inception or for variable life within 10 years. The period of time and level of the charge vary by product. In addition, more favorable credited rates and policy loan terms may be offered after policies have been in force for a period of time. To further encourage retention, life insurance agents are typically paid renewal commissions or service fees.\nCertain of the ALIAC life insurance and annuity products allow customers to borrow against their policies. At December 31, 1995, approximately 25% of outstanding policy loans were on individual annuity policies and had fixed interest rates ranging from 1% to 3%. Approximately 63% of outstanding policy loans at December 31, 1995 were on individual life policies and had fixed interest rates ranging from 5% to 9%. The remaining 12% of outstanding policy loans had variable interest rates averaging 8% at December 31, 1995. Investment income from policy loans was $25 million for the year ended December 31, 1995.\nAt December 31, assets under management, including Separate Accounts and assets held and managed by unaffiliated mutual funds, were $25.9 billion in 1995, $20.0 billion in 1994, $18.8 billion in 1993, $15.0 billion in 1992 and $13.2 billion in 1991. Under Financial Accounting Standard No. 115, Accounting for Certain Investments in Debt and Equity Securities (FAS 115), assets under management at December 31, 1995, 1994 and 1993 included net unrealized gains (losses) of approximately $800 million, $(390) million and $750 million, respectively.\nThe following table summarizes premiums and deposits for the years indicated:\nCompetition ___________\nIn the financial services products markets, competition arises from other insurance companies, banks, mutual funds and other investment managers. Principal competitive factors are cost, service, level of investment performance and the perceived financial strength of the investment manager or sponsor.\nThe markets for life insurance products are highly competitive among insurance companies. Competition largely is based upon product features and prices.\nCompetition in financial services and life insurance markets may affect, among other matters, both business growth and the pricing of the company's products and services.\nMethod of Distribution ______________________\nFinancial services products generally are sold through pension professionals, brokers, third party administrators, banks and dedicated career agents.\nLife insurance products are marketed by independent agents and brokers and career agents.\nReserves ________\nReserves for limited payment contracts (immediate annuities with life contingent payout) are computed on the basis of assumed investment yield, mortality, morbidity and expenses (including a margin for adverse deviation), which generally vary by plan, year of issue and policy duration. Reserves for investment contracts (deferred annuities and immediate annuities without life contingent payouts) are equal to cumulative deposits plus credited interest less charges thereon. Reserves for experience rated contracts reflect cumulative deposits, less withdrawals and charges, plus credited interest thereon, plus\/less net realized capital gains\/losses (which ALIAC reflects through credited rates on an amortized basis). These reserves also reflect unrealized capital gains\/losses related to FAS No. 115.\nReserves for universal life and interest-sensitive whole life products (which are all experience rated) are equal to cumulative deposits less withdrawals and charges plus credited interest thereon, plus\/less net realized capital gains\/losses (which ALIAC reflects through credited rates on an amortized basis). These reserves also reflect unrealized capital gains\/losses related to FAS No. 115. Reserves for all other fixed individual life contracts are computed on the basis of assumed investment yield, mortality, morbidity and expenses (including a margin for adverse deviation), which generally vary by plan, year of issue and policy duration.\nThe above-indicated reserves are computed amounts that, with additions from premiums and deposits to be received, and with interest on such reserves compounded annually at assumed rates, are expected to be sufficient to meet the company's policy obligations at their maturities or to pay expected death or retirement benefits or other withdrawal requests.\nReinsurance ___________\nALIAC retains no more than $10 million of risk per individual life insured. Amounts in excess of the retention limit are reinsured with unaffiliated companies.\nLife Insurance In Force and Other Statistical Data __________________________________________________\nThe following table summarizes changes in life insurance in force before deductions for reinsurance ceded to other companies for the years indicated:\n3. International\nThe International segment (\"International\"), through subsidiaries and joint venture operations, sells primarily life insurance and financial services products in non-U.S. markets including Canada, Mexico, Taiwan, Chile, Malaysia, Hong Kong, New Zealand, Peru, Argentina and Indonesia. International operations are subject to regulation in the various jurisdictions in which they do business. In most of the geographic areas and markets in which International has operations, the competition is extensive. Methods of distribution vary by country and by product, and include direct sales, sales through agents and brokers, and sales through joint venture-related enterprises.\nOn June 30, 1993, the company completed the sale of its U.K. life and investment management operations. The company realized an after-tax capital loss of $12 million on the sale, as well as $37 million of tax benefits from prior year operating losses of the subsidiary not previously available for tax benefits.\nThe company completed the sale of its 43% interest in La Estrella S.A. de Seguros, a Spanish insurance company, to Banco Hispano Americano in May 1991. The company realized a net capital gain of $33 million (after tax) on the sale.\nConducting business and investing in international markets pose unique risks which vary from country to country. Such risks include, but are not limited to, political developments, including tax changes, nationalization and changes in regulatory policy, currency restrictions, currency fluctuations, as well as the consequences of hostilities and unrest. Management believes that its continued focus on entering new markets where suitable opportunities exist and development of existing operations will help to reduce the exposure to these risks through further diversification of its operations.\nThe following table sets forth International's premium revenue, net investment income, other income and net realized capital gains\/losses and life insurance in force, before deductions for reinsurance ceded to other companies:\nPremium growth in 1995 resulted primarily from increases in the volume of business sold in the Pacific Rim and Latin American markets.\nPremium reduction in 1994 resulted from the company's 1994 change in its accounting for an affiliate from the consolidated basis of accounting to the equity basis of accounting (recorded premiums were $79 million and $136 million in 1994 and 1993, respectively) which was substantially offset by growth in the Pacific Rim operations.\nPremium growth in 1992 included $128 million from the second quarter consolidation of a previously unconsolidated subsidiary as a result of an increase in the company's ownership percentage.\n4. Large Case Pensions\nPrincipal Products __________________\nThe Large Case Pensions segment manages a variety of retirement and other savings products (including pension and annuity products), and offers investment management and advisory services to nonpension customers. Certain of these products provide a variety of investment guarantees, funding and benefit payment distribution options and other services. (For additional information regarding the products offered by Large Case Pensions, see MD&A - Large Case Pensions in the Annual Report.)\nThe majority of Large Case Pensions' products that utilize Separate Accounts provide contractholders with a vehicle for investments under which the contractholders assume the investment risks as well as the benefit of favorable performance. Large Case Pensions earns a management fee on these Separate Accounts. Various investment advisory services also are offered through a number of wholly owned subsidiaries that are registered investment advisors.\nIn January 1994, the company announced its decision to discontinue the sale of its fully guaranteed large case pension products. (For additional information, see MD&A - Large Case Pensions in the Annual Report.)\nAt December 31, assets under management, including Separate Accounts, were $46.4 billion in 1995, $46.3 billion in 1994, $52.8 billion in 1993, $53.4 billion in 1992 and $52.8 billion in 1991. Under FAS 115, assets under management at December 31, 1995, 1994 and 1993 included net unrealized gains (losses) of approximately $790 million, $(540) million and $750 million, respectively.\nThe following table summarizes premiums and deposits for the years indicated:\nCompetition ___________\nIn the pension and annuity markets, competition arises from other insurance companies, banks, bank trust departments, mutual funds and other investment managers. Principal competitive factors are cost, service, level of investment performance and the perceived financial strength of the investment manager.\nMethod of Distribution ______________________\nGroup pension products are sold principally through salaried field representatives and home office marketing personnel, who often work with independent consultants and brokers who assist in the production and servicing of business.\nReserves ________\nAs a result of discontinuing fully guaranteed large case pension products, the company established a reserve that represents the present value of anticipated net cash flow shortfalls as the liabilities from such products are run off. Such net cash flow shortfalls include anticipated losses from negative interest margins (i.e., the amount by which interest credited to holders of such contracts exceeds interest earned on investment assets supporting the contracts), future capital losses, and operating expenses and other costs expected to be incurred as the liabilities are run off. For additional information on this reserve, see Note 3 of Notes to Financial Statements in the Annual Report.\nIn addition to the reserve described above, the company maintains reserves for guaranteed investment contracts equal to the amount on deposit for such contracts plus credited interest thereon. Reserves for annuity contracts reflect the present value of benefits based on actuarial assumptions established at the time of contract purchase. Such assumptions are based on Aetna's experience, which is periodically reviewed against published industry data. Reserves for experience rated contracts reflect cumulative deposits, less withdrawals and charges, plus credited interest thereon, plus\/less net realized capital gains\/losses (which the company seeks to recover through credited rates) and net unrealized capital gains\/losses.\n5. Corporate\nThe Corporate segment includes interest expense and other net corporate expenses which are not directly related to the company's business segments. \"Other net corporate expense\" includes items such as corporate staff areas, advertising and contributions, partially offset by net investment income.\n6. Discontinued Operations - Property-Casualty Operations\nPrincipal Products __________________\nFor additional information regarding Discontinued Operations, see Organization of Business on page 3 and MD&A - Overview - Sale of Property-Casualty Operations in the Annual Report.\nDiscontinued Operations provides most types of commercial and personal property-casualty insurance, bonds, and insurance-related services for businesses, government units and associations and individuals.\nCommercial and personal coverages accounted for 70% and 30%, respectively, of Aetna's 1995 property-casualty net written premiums. Commercial coverages are sold for risks of all sizes and include fire and allied lines, multiple peril, marine, workers' compensation, general liability (including product liability), commercial automobile, certain professional liability, and fidelity and surety bonds. In addition, Aetna offers various services to businesses that choose to self-insure certain exposures. Aetna also reinsures various property and liability risks, primarily through agreements with nonaffiliated insurers, on both a treaty and facultative basis. Personal coverages include auto and homeowners insurance.\nApproximately 94% of Aetna's 1995 net property-casualty business written was voluntary. The remainder was written by various assigned risk plans, facilities and pools of which Aetna is a member. These organizations are formed to meet statutory requirements relating to the writing of certain types of property-casualty risks or to spread particularly large loss exposures among insurers pursuant to a prearranged allocation formula. Participation is mandatory, and underwriting decisions are made by such facilities independent of their membership.\nFor a significant portion of the commercial lines, Aetna uses advisory or compulsory rate structures and, in some instances, forms that were developed by agencies and bureaus in which insurance companies are authorized to participate through state regulation. However, in recent years, Aetna has emphasized the development of independent coverages designed for sale to specific market segments.\nThe following table sets forth the premium revenue, underwriting results and net investment income, fees and other income and net realized capital gains of Discontinued Operations for the years indicated:\nDiscontinued Operations' underwriting profitability generally is expressed in terms of combined ratios. When the combined ratio is under 100%, underwriting results are considered profitable; when the ratio is over 100%, underwriting results are considered unprofitable. The combined ratio is the sum of (i) the percentage of earned premiums that is paid or reserved for losses and related loss adjustment expenses (the \"loss ratio\"), (ii) the percentage of earned premiums that is paid or reserved for dividends to policyholders, and (iii) the percentage of written premiums that is paid or reserved for sales commissions, premium taxes, administrative and other underwriting expenses (the \"expense ratio\"). The combined ratio does not reflect net investment income, fees and other income, net realized capital gains\/losses or federal income taxes. The statutory combined ratio does not reflect adjustments to underwriting results in accordance with GAAP.\nAdjusted underwriting loss reflects GAAP adjustments (primarily the establishment of a reserve for severance and facilities charges, deferred policy acquisition costs and pre-1992 salvage and subrogation) to underwriting results.\nThe following table sets forth for Discontinued Operations' major domestic coverages for the years indicated (a) the percentage of Discontinued Operations' statutory net written premiums (NWP) and (b) statutory combined ratios before policyholders' dividends:\nPERCENTAGE DISTRIBUTION OF STATUTORY NET WRITTEN PREMIUMS AND COMBINED RATIOS\nThe following table summarizes Discontinued Operations' statutory net written premiums for the years indicated:\nThe following table sets forth Aetna's percentage distributions of Discontinued Operations' direct written premiums in various jurisdictions for the years indicated:\nGEOGRAPHIC DISTRIBUTION OF DIRECT WRITTEN PREMIUMS\nCompetition ___________\nProperty-casualty insurance is highly competitive in the areas of price, service, agent relationships and, in the case of personal lines, method of distribution (i.e., use of independent agents, captive agents and\/or employees). There are approximately 3,300 property-casualty insurance companies in the United States. Of those companies, approximately 900 operate in all or most states and write the vast majority of the business, while over 2,400 offer one or more property-casualty products similar to those marketed by Aetna. In addition, an increasing amount of commercial risks are covered by purchaser self-insurance, risk- purchasing groups, risk-retention groups and captive companies. Based on 1994 written premiums, Aetna was one of the largest underwriters of commercial and personal property-casualty coverages in the United States.\nMethod of Distribution ______________________\nAetna's property-casualty coverages are sold through approximately 4,800 independent agents and brokers supervised and serviced by 22 district offices with over 70 other points of service throughout the country.\nReserves ________\nSee Reserves Related to Discontinued Operations on pages 21 through 24.\nReinsurance ___________\nApproximately one-third of the property-casualty reinsurance ceded by Aetna arises in connection with its servicing relationships with various pools (frequently involuntary pools). Aetna services or writes a portion of the pool's individual policies, handling all premium and loss transactions. These \"service\" premiums and losses are then 100% ceded (net of an expense reimbursement) to the pools, whose members are jointly liable to Aetna as a servicer.\nIn addition to the above, Aetna utilizes a variety of reinsurance agreements, primarily with nonaffiliated insurers, to control its exposure to large losses. These agreements, most of which are renegotiated annually as to coverage, limits and price, are structured either on a treaty basis (where all risks meeting prescribed criteria are automatically covered) or on a facultative basis (where the circumstances of specific individual insurance risks are reflected). The amount of risk retained by Aetna depends on the underwriter's evaluation of the specific risk, subject to maximum limits based on risk characteristics and the type of coverage. The principal catastrophe reinsurance agreement currently in force covers approximately 90% of specified property losses between $150 million and $325 million. The company also has in place an aggregate excess of loss arrangement with respect to all of its property-casualty lines for accident year 1995, providing up to approximately $250 million of additional net protection.\nFor additional information on reinsurance, see MD&A - Discontinued Operations' Reserves and Note 2 of Notes to Financial Statements in the Annual Report.\nAetna has internal property-casualty reinsurance arrangements under which the risks and premiums of virtually all coverages written by the company's Discontinued Operations' subsidiaries (other than fidelity and surety bonds) are redistributed among those subsidiaries on a percentage basis. The percentages are adjusted from time to time to reflect the relative underwriting capacities and other capital needs of participants in the reinsurance agreement.\n7. Reserves Related to Discontinued Operations\nAetna establishes liabilities designed to reflect estimates of the ultimate cost, to the extent reasonably estimable, of claims (including claim adjustment expenses). Certain of these liabilities are recorded on a discounted basis (see Note 2 of Notes to Financial Statements in the Annual Report). Estimating the ultimate cost of claims is a complex and uncertain process that relies on actuarial and statistical methods of analysis. The company's reserves include: (i) claims that have been reported but not settled (\"case\" reserves), and (ii) claim costs that have been incurred but have not been reported (\"IBNR\" reserves). The establishment of case reserves is dependent upon, among other things, the extent to which coverage was provided, the extent of injury or damage, and, in the case of a contested claim, an estimate of the likely outcome of the adjudication process (to the extent such outcome is estimable). IBNR reserves, established to reflect events and occurrences that are not known to the company but, based on actuarial and historical data (adjusted for the effects of current social, economic and legal developments, trends and factors), are likely to result in claims, also include provision for development on case reserves. As claims are reported and valued by the company, IBNR reserves are reduced by the amount of the reported claim cost. IBNR reserves also are adjusted as the estimates of losses for a given accident year develop. The length of time between occurrence and settlement of a claim varies depending on the coverage and type of claim involved. Estimates become more difficult to make (and are, therefore, more subject to change) as the length of time increases. Actual claim costs are dependent upon a number of complex factors including social and economic trends and changes in doctrines of legal liability and damage awards.\nReserves for Discontinued Operations coverage are recomputed periodically using a variety of actuarial and statistical techniques for producing current estimates of actual claim costs, claim frequency, and other economic and social factors. A provision for inflation in the calculation of estimated future claim costs is implicit since reliance is placed on both actual historical data that reflect past inflation and on other factors which are judged to be appropriate modifiers of past experience. Adjustments to reserves are reflected in the net income of the period in which such adjustments are made.\nAetna also establishes unearned premium reserves that are calculated on a pro rata basis and reserves for additional premiums or refunds on retrospectively rated policies based on experience. This means that when a loss which will produce an additional premium payment is incurred on a retrospectively rated policy, the premium is recorded at the same time. Likewise when loss experience is favorable, reserves for premium refunds are established.\nFor additional information on Discontinued Operations' reserves, including reserves for environmental-related claims, asbestos- related claims, and workers' compensation claims (including discounting), see MD&A - Discontinued Operations' Reserves in the Annual Report.\nThe following represents changes in aggregate reserves, net of reinsurance, for the combined Discontinued Operations' experience:(1)\nThe following table reconciles, as of year end, reserves determined in accordance with accounting principles and practices prescribed or permitted by insurance regulatory authorities (\"statutory basis reserves\") to reserves determined in accordance with generally accepted accounting principles (\"GAAP basis reserves\"), for the Discontinued Operations unpaid claims and claim adjustment expenses: (1)\nThe following reserve runoff table represents Aetna's combined Discontinued Operations' loss and loss expense experience, net of reinsurance recoverables and deductible amounts recoverable from policyholders. Each column shows, for the year indicated:\nthe reserve held at year end;\ncumulative data for payments made in each subsequent year for that reserve year;\nliability reestimates made in each subsequent year for that reserve year;\nthe redundancy (deficiency) represented by the difference between the original reserve held at the end of that year and the reestimated liability as of the end of 1995; and\nthe change in redundancy (deficiency) from the end of each reserve year shown to the end of each subsequent reserve year.\nThe majority of increases to prior accident year reserves were for losses and related expenses for (i) workers' compensation claims; (ii) environmental-related liability risks; and (iii) asbestos and other product liability risks.\nThe table represents historical data; it would not be appropriate to use such data to project the company's future reserving activity or its future performance generally.\n8. General Account Investments\nThe investment income and realized capital gains and losses from the investment portfolios of the company's insurance subsidiaries contribute to the results of the insurance operations described above. The company's investment objective for both continuing operations and Discontinued Operations is to fund policyholder and other liabilities in a manner which enhances shareholder and contractholder value, subject to appropriate risk constraints. It is the company's intention that this investment objective be met by a mix of investments which reflects the characteristics of the liabilities they support; diversifies the types of investment risks in its portfolios by interest rate, liquidity, credit and equity price risk; and achieves asset diversification by investment type, industry, issuer and geographic location. The company regularly projects duration and cash flow characteristics of its liabilities and makes appropriate adjustments in the asset portfolios.\nInterest rate risk is managed within a tight duration band, and credit risk is managed by maintaining high average bond ratings and diversified sector exposure. In pursuing its investment and risk management objectives, the company utilizes assets whose market value is at least partially determined by, among other things, levels of or changes in domestic and\/or foreign interest rates (short term or long term), exchange rates, prepayment rates, equity markets or credit ratings\/spreads. (See Note 16 of Notes to Financial Statements in the Annual Report for a discussion of the company's hedging activities).\nUsing financial modeling and other techniques, the company regularly evaluates the appropriateness of the investments relative to the company's management-approved investment guidelines and the business objectives of the portfolios (including evaluating the interest rate, liquidity, credit and equity price risk resulting from derivative and other portfolio activities). During 1995, the company operated within such investment guidelines by maintaining a mix of investments that diversifies its assets and reflects the characteristics of the liabilities which they support.\nSee MD&A - General Account Investments in the Annual Report for a further discussion of investments.\na. Investments Related to Continuing Operations\nConsistent with the nature of the contract obligations involved in the company's continuing operations which include health care, group life and disability, individual life, annuity and pension operations, the majority of the general account assets attributable to such operations have been invested in intermediate and long-term, fixed-income obligations such as Treasury obligations, mortgage-backed securities, corporate debt securities and mortgage loans.\nFor information concerning the valuation of investments, see Notes 1, 5, and 6 of Notes to Financial Statements in the Annual Report.\nThe following table sets forth the distribution of invested assets, cash and cash equivalents and accrued investment income as of the end of the years indicated: (1)\nThe following table summarizes investment results of the company's continuing operations: (1)\nb. Investments Related to Discontinued Operations\nThe investment strategies for assets related to Discontinued Operations are designed to maximize yield with appropriate liquidity and preservation of principal, and to permit periodic adjustment of the portfolio mix, in order to reflect changes in underwriting results and thus maximize after-tax income. In 1995, Discontinued Operations sold common stocks primarily due to the company's efforts to reduce volatility in its statutory surplus, and increase income, and in connection with the agreement to sell the property-casualty operations.\nFor information concerning the valuation of investments, see Notes 1, 5, and 6 of Notes to Financial Statements in the Annual Report.\nThe following table sets forth the distribution of invested assets, cash and cash equivalents and accrued investment income as of the end of the years indicated: (1)\nThe following table summarizes investment results of the company's Discontinued Operations: (1)\n9. Other Matters\na. Regulation\nGeneral\nAetna's insurance businesses (including Discontinued Operations) are subject to comprehensive, detailed regulation throughout the United States and the foreign jurisdictions in which they do business. The laws of the various jurisdictions establish supervisory agencies with broad authority to regulate, among other things, the granting of licenses to transact business, premium rates for certain coverages, trade practices, agent licensing, policy forms, underwriting and claims practices, reserve adequacy, insurer solvency, the maximum interest rates that can be charged on life insurance policy loans, and the minimum rates that must be provided for accumulation of surrender value. Many agencies also regulate investment activities on the basis of quality, distribution and other quantitative criteria. Aetna's operations and accounts are subject to examination at regular intervals by insurance regulators.\nAlthough the federal government does not directly regulate the business of insurance, many federal laws do affect that business. Existing or recently proposed federal laws that may significantly affect or would affect, if passed, the insurance business cover such matters as pensions and other employee benefits (including regulation of federally qualified HMOs), controls on medical care costs, medical entitlement programs (e.g., Medicare), environmental regulation and liability, product liability, civil justice procedural reform, earthquake insurance, removal of barriers preventing banks from engaging in the insurance and mutual fund businesses, the taxation of insurance companies (see Notes 1 and 10 of Notes to Financial Statements in the Annual Report), and the tax treatment of insurance products.\nMaterial changes in applicable federal and state laws and regulations could adversely affect the company's business operations, although the company is unable to predict whether any such changes will be implemented.\nHealth Care\nIn addition to regulations applicable to insurance companies generally (described above), Aetna's managed health care products are subject to varying levels of state insurance, HMO and\/or health department regulation. Among other things, these regulations address health care network composition, new product offerings, product and benefit contracts and the extent to which insurance companies and managed care plans may provide incentives to enrollees to use services from \"preferred\" health care service providers or pay contractual and noncontractual health care providers unequally for equivalent services. Some jurisdictions also regulate the extent to which managed health care plans may offer their enrollees the option of receiving health care services from noncontracting providers. Additionally, these plans are subject to state, and in some cases federal, regulation concerning solvency and other operational requirements.\nLegislative efforts to change the health insurance system have received increased attention in recent years at both the state and national levels. (For additional discussion, see MD&A - Aetna Health Plans in the Annual Report.)\nInsurance and Insurance Holding Company Laws\nSeveral states, including Connecticut, regulate affiliated groups of insurers such as Aetna under insurance holding company statutes. Under such laws, intercorporate asset transfers and dividend payments from insurance subsidiaries may require prior notice to or approval of the insurance regulators, depending on the size of such transfers and payments relative to the financial position of the affiliate making the transfer. These laws also regulate changes in control, as do Connecticut corporate laws (which also apply to insurance corporations). See Note 8 of Notes to Financial Statements in the Annual Report.\nAs a licensed Connecticut-domiciled insurer, the company is subject to Connecticut insurance laws. These laws, among other things, enable insurers to redeem their stock from any shareholder who fails, in the good faith determination of the insurer's board of directors, to (i) meet the qualifications prescribed under Connecticut law for licensure, or (ii) to secure the regulatory approvals required under Connecticut law for ownership of such stock.\nSecurities Laws\nThe Securities and Exchange Commission (\"SEC\") and, to a lesser extent, the states regulate the sales and investment management activities and operations of broker-dealer and investment advisory subsidiaries of the company. The SEC also regulates certain of the company's pension, annuity, life insurance and other investment and retirement products. These products involve Separate Accounts of Aetna Life Insurance and Annuity Company and mutual funds registered under the Investment Company Act of 1940. As a stock company, Aetna also is subject to extensive reporting obligations under the Securities Exchange Act of 1934.\nDiscontinued Operations - Property-Casualty Operations\nOver the past several years, the company's insurance businesses, particularly personal auto and property insurance and workers' compensation coverage, have been the target of various regulatory and legislative initiatives that management believes have limited the basis upon which the company conducts its activities. Such initiatives have, among other things, sought to (1) freeze or reduce rates that may be charged for certain insurance products, (2) force the company to issue and renew insurance in markets where the company cannot achieve an acceptable rate of return, and (3) restructure residual or involuntary markets. Many jurisdictions compel participation in, and regulate composition of, various residual market mechanisms. Residual or involuntary markets are established to provide coverage to insureds unable to obtain policies in the private marketplace. As state-mandated rates are frequently inadequate, these markets are in effect often subsidized by the insurance industry.\nInsurance Company Guaranty Fund Assessments\nUnder insurance guaranty fund laws existing in all states, insurers doing business in those states can be assessed (up to prescribed limits) for certain obligations of insolvent insurance companies to policyholders and claimants. The after-tax charges to earnings for guaranty fund obligations for the year ended December 31, 1995 was $13 million (of which $5 million related to Discontinued Operations) and for the year ended December 31, 1993 was $17 million (all of which related to Discontinued Operations). There were no such charges in 1994. The amounts ultimately assessed may differ from the amounts charged to earnings because such assessments may not be made for several years and will depend upon the final outcome of regulatory proceedings.\nWhile the company has historically recovered more than half of guaranty fund assessments through statutorily permitted premium tax offsets and policy surcharges, significant increases in assessments could jeopardize future efforts to recover such assessments.\nThe company has actively supported improved insurer solvency regulation, including measures that would facilitate earlier identification of troubled insurers, and amendments to guaranty fund laws that would reduce the costs of such insolvencies to solvent insurers such as Aetna.\nSee MD&A - Regulatory Environment in the Annual Report for additional discussion of regulatory matters.\nb. NAIC IRIS Ratios\nThe NAIC IRIS ratios cover 12 categories of financial data with defined usual ranges for each category. The ratios are intended to provide insurance regulators \"early warnings\" as to when a given company might warrant special attention. An insurance company may fall out of the usual range for one or more ratios and such variances may result from specific transactions that are in themselves immaterial or eliminated at the consolidated level. In 1994, two of Aetna Life and Casualty Company's significant subsidiaries had more than two IRIS ratios that were outside of the NAIC usual ranges, as discussed below.\nAetna Life Insurance Company (\"ALIC\") fell outside the usual ranges in 1994 for: (i) the Net Gain to Total Income Ratio which is calculated by dividing the net gain from operations (including realized capital gains and losses) by total income (including realized capital gains and losses); (ii) the Adequacy of Investment Income Ratio which compares investment income to credited interest; (iii) the Total Real Estate and Total Mortgage Loans to Cash and Invested Assets Ratio which measures the relative size of the real estate and mortgage loan portfolios; (iv) the Change in Premium Ratio which is calculated by dividing the current year change in total premiums, annuity considerations and other fund deposits by total premiums, annuity considerations and other fund deposits for the prior year; and (v) the Change in Reserving Ratio which represents the number of percentage points of difference between the reserving ratio for current and prior year. The reserving ratio is equal to the aggregate increase in reserves for individual life insurance taken as a percentage of renewal and single premiums for individual life insurance. The regulators were satisfied, after analysis, that ALIC did not warrant special attention.\nThe Aetna Casualty & Surety Company of America (\"ACSCA\") fell outside of the usual ranges in 1994 for: (i) the Two-year Overall Operating Ratio, which is a combination of a two-year combined ratio minus a two-year investment income ratio; (ii) the Change in Surplus which measures the improvement or deterioration in a company's financial condition during the year; and (iii) the Two-Year Reserve Development to Surplus Ratio which measures the change in prior years' estimates calculated as a percentage of policyholders' surplus two years previous. The regulators were satisfied that ACSCA did not warrant special attention.\nManagement expects that certain of the company's significant subsidiaries will have more than two IRIS ratios outside of the NAIC usual ranges for 1995, but expects to be able to satisfy the regulators that further attention is not warranted.\nc. Ratios of Earnings to Fixed Charges and Earnings to Combined Fixed Charges and Preferred Stock Dividends\nThe following table sets forth Aetna's ratio of earnings to fixed charges and ratio of earnings to combined fixed charges and preferred stock dividends for the years ended December 31:\nFor purposes of computing both the ratio of earnings to fixed charges and the ratio of earnings to combined fixed charges and preferred stock dividends, \"earnings\" represent consolidated earnings from continuing operations before income taxes, cumulative effect adjustments and extraordinary items plus fixed charges and minority interest. \"Fixed charges\" consist of interest (and the portion of rental expense deemed representative of the interest factor) and includes the dividends paid to preferred shareholders of a subsidiary. (See Note 11 of Notes to Financial Statements in the Annual Report.) For the years ended December 31, 1995, 1994, 1993, 1992 and 1991 there was no preferred stock outstanding. As a result, the ratios of earnings to combined fixed charges and preferred stock dividends were the same as the ratios of earnings to fixed charges.\nd. Miscellaneous\nAetna had approximately 40,200 domestic employees (approximately 11,300 of whom support Discontinued Operations) at December 31, 1995.\nManagement believes that the company's computer facilities, systems and related procedures are adequate to meet its business needs. The company's data processing systems and backup and security policies, practices and procedures are regularly evaluated by the company's management and its internal auditors and are modified as considered necessary.\nPortions of Aetna's insurance business are seasonal in nature. Reported claims under group health and certain property-casualty products are generally higher in the first quarter. Sales, particularly of individual life products, are generally lowest in the first quarter and highest in the fourth quarter.\nNo customer accounted for 10% or more of Aetna's consolidated revenues in 1995. In addition, no segment of Aetna's business is dependent upon a single customer or a few customers, the loss of which would have a significant effect on the segment. See Note 15 of Notes to Financial Statements regarding segment information in the Annual Report.\nThe loss of business from any one, or a few, independent brokers or agents would not have a material adverse effect on the company or any of its segments. In general, the company is not contractually obligated or committed to accept a fixed portion of business submitted by any of its property-casualty agents or brokers. The company generally reviews all of its policy applications, both new and renewal, for approval and acceptance. There are cases where the company has delegated limited underwriting authority to select agents generally for smaller business for specific classes of risks. The risks accepted by the company under these conditions are reviewed by company underwriters. This authority generally can be rescinded at any time at the discretion of the company and without prior notice to the agents.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nThe home office of Aetna, owned by Aetna Life Insurance Company, is a building complex located at 151 Farmington Avenue, Hartford, Connecticut, with approximately 1.6 million square feet. The company also owns or leases other space in the greater Hartford area as well as various field locations throughout the country. (Please see MD&A - Overview in the Annual Report.)\nThe foregoing does not include numerous investment properties held by Aetna in its general and separate accounts.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nThe company is continuously involved in numerous lawsuits arising, for the most part, in the ordinary course of its business operations either as a liability insurer defending third-party claims brought against its insureds or as an insurer defending coverage claims brought against itself, including lawsuits related to issues of policy coverage and judicial interpretation. One such area of coverage litigation involves legal liability for environmental and asbestos-related claims. These lawsuits and other factors make reserving for these claims subject to significant uncertainties. See MD&A - Discontinued Operations' Reserves in the Annual Report.\nWhile the ultimate outcome of such litigation cannot be determined at this time, such litigation, net of reserves established therefore and giving effect to reinsurance probable of recovery, is not expected to result in judgments for amounts material to the financial condition of the company, although it may adversely affect results of operations in future periods.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nNone.\nEXECUTIVE OFFICERS OF AETNA LIFE AND CASUALTY COMPANY*\nThe Chairman of Aetna Life and Casualty Company is elected and all other executive officers listed below are appointed by the Board of Directors of the company at its Annual Meeting each year to hold office until the next Annual Meeting of the Board or until their successors are elected or appointed. None of these officers have family relationships with any other executive officer or Director.\n(1) Mr. Compton has served as Chairman since March 1, 1992. He is also President, a position he has held since July 1988.\n(2) Mr. Huber has served in his current position since February 1995. From September 1994 to February 1995, he served as President and Chief Operating Officer of Grupo Wasserstein Perella. From 1990 to September 1994, he served as Vice Chairman of Continental Bank. From 1988 to 1990, he served as Executive Vice President and Head of Capital Markets and Foreign Exchange Sector, Chase Manhattan Bank.\n(3) Ms. Baird has served in her current position since April 1992. From July 1990 to April 1992 she served as Vice President and General Counsel.\n(4) Mr. Benanav has served in his current position since December 1993. From April 1992 to December 1993 he served as Group Executive responsible for International, individual life insurance, annuities, mutual funds, and small case pensions. From April 1990 through April 1992, he served as Senior Vice President, International Insurance.\n(5) Mr. Bolton has served in his current position since July 1995. He was with International Business Machines Corporation from March 1991 to June 1995, serving as Director of Communications, IBM Software Group, from March 1994 to June 1995, and as Director of Corporate Media Relations from March 1991 to March 1994. From February 1989 to March 1991, he served as Assistant Secretary for Public Affairs and Public Liaison, U.S. Department of Treasury.\n(6) Mrs. Champlin has served in her current position since November 1992. From February 1991 through November 1992 she served as Vice President, Aetna Human Resources. From June 1989 through January 1991 she served as Assistant Vice President, Corporate Management, Office of the Chairman.\n(7) Mr. Kearney has served in his current position since December 1993. From February 1991 to December 1993 he served as Group Executive responsible for investments and large case pensions. From 1990 to February 1991 he served as the principal of Daniel P. Kearney, Inc.\n(8) Mr. McLane has served in his current position since December 1993. From April 1992 to December 1993, he served as Group Executive responsible for group health and life insurance including managed care operations. From February 1991 through April 1992 he served as Chief Executive Officer, Aetna Health Plans; from 1985 through 1991 he served as Senior Vice President, Global Insurance Division, Citicorp.\n(9) Mr. McMurtry has served in his current position since November 1992. From February 1989 through November 1992 he served as Staff Director and Chief Counsel, Committee on Finance, United States Senate.\n(10) Mr. Broatch has served in his current position since December 1993. He also served as Corporate Controller from May 1988 to July 1995 and was a Vice President from May 1988 to December 1993.\n(11) Mr. Price was appointed to his current position on July 3, 1995, having served as Vice President and Deputy Controller since May 1989.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.\nAetna Life and Casualty Company's common stock is listed on the New York and Pacific Stock Exchanges, with unlisted trading privileges on other regional exchanges. Its symbol is AET. The common stock also is listed on the Swiss Stock Exchanges at Basel, Geneva and Zurich. Call and put options on the common stock are traded on the American Stock Exchange. As of January 31, 1996, there were 22,939 record holders of the common stock.\nThe dividends declared and the high and low sales prices with respect to Aetna Life and Casualty Company's common stock for each quarterly period for the past two years are incorporated herein by reference from \"Quarterly Data\" in the Annual Report.\nInformation regarding restrictions on the company's present and future ability to pay dividends is incorporated herein by reference from Note 8 of Notes to Financial Statements in the Annual Report.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nThe information contained in \"Selected Financial Data\" in 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 information contained in \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" in the Annual Report is incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nThe 1995 Consolidated Financial Statements and the report of the registrant's independent auditors and the unaudited information set forth under the caption \"Quarterly Data\" is incorporated herein by reference to the Annual Report.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.\nNone.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant.\nInformation concerning Executive Officers is included in Part I pursuant to General Instruction G to Form 10-K.\nInformation concerning Directors and concerning compliance with Section 16 (a) of the Securities Exchange Act of 1934 is incorporated herein by reference to the Proxy Statement.\nItem 11.","section_11":"Item 11. Executive Compensation.\nThe information under the caption \"Executive Compensation\" in the Proxy Statement is incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nThe information under the caption \"Security Ownership of Certain Beneficial Owners, Directors, Nominees and Executive Officers\" in the Proxy Statement is incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nThe information under the caption \"Certain Transactions and Relationships\" 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) The following documents are filed as part of this report:\n1. Financial statements:\nThe Consolidated Financial Statements and the report of the registrant's independent auditors are incorporated herein by reference to the Annual Report.\n2. Financial statement schedules:\nThe supporting schedules of the consolidated entity are included in this Item 14. See Index to Financial Statement Schedules on page 42.\n3. Exhibits: *\n(3) Articles of Incorporation and By-Laws.\nCertificate of Incorporation of Aetna Life and Casualty Company, incorporated herein by reference to the company's 1992 Form 10- K, filed on March 17, 1993 (the \"1992 Form 10-K\").\nBy-Laws of Aetna Life and Casualty Company, incorporated by reference to the company's 1993 Form 10-K filed on March 18, 1994 (the \"1993 Form 10-K\").\n(4) Instruments defining the rights of security holders, including indentures.\nConformed copy of Indenture, dated as of October 15, 1977, between Aetna Life and Casualty Company and Morgan Guaranty Trust Company of New York, Trustee, incorporated herein by reference to the 1992 Form 10-K.\nConformed copy of Indenture, dated as of October 15, 1986, between Aetna Life and Casualty Company and The First National Bank of Boston, Trustee, incorporated herein by reference to the 1992 Form 10-K.\nConformed copy of Indenture, dated as of August 1, 1993, between Aetna Life and Casualty Company and State Street Bank and Trust Company of Connecticut, National Association, as Trustee, incorporated herein by reference to the company's Registration Statement on Form S-3 (File No. 33-50427).\nConformed copy of Rights Agreement dated as of October 27, 1989, between Aetna Life and Casualty Company and First Chicago Trust Company of New York, incorporated herein by reference to the 1992 Form 10-K.\nConformed copy of Summary of Rights to Purchase Preferred Stock, incorporated herein by reference to the 1992 Form 10-K.\nConformed copy of Written Action dated as of November 15, 1994, establishing the terms of Series A Preferred Securities of Aetna Capital L.L.C., incorporated herein by reference to the company's Form 8-K filed on November 22, 1994.\nConformed copy of Subordinated Indenture dated as of November 1, 1994, between the company and The First National Bank of Chicago, as Trustee, incorporated herein by reference to the company's Form 8-K filed on November 22, 1994.\nConformed copy of Payment and Guarantee Agreement dated November 22, 1994, of the company with respect to Aetna Capital L.L.C., incorporated herein by reference to the company's Form 8-K filed on November 22, 1994.\n(10) Material contracts.\nStock Purchase Agreement dated as of November 28, 1995 between The Travelers Insurance Group Inc. and Aetna Life and Casualty Company relating to the purchase and sale of 100% of the Common Stock of The Aetna Casualty and Surety Company and The Standard Fire Insurance Company.\nLetter Agreement, dated January 19, 1995, between Aetna Life and Casualty Company and Richard L. Huber. **\nEmployment Agreement, dated as of October 27, 1995, between Aetna Life and Casualty Company and Gary G. Benanav. **\nEmployment Agreement, dated as of January 29, 1996, between Aetna Life and Casualty Company and Ronald E. Compton. **\nEmployment Agreement, dated as of December 19, 1995, between Aetna Life and Casualty Company and Daniel P. Kearney. **\nEmployment Agreement, dated as of January 19, 1996, between Aetna Life and Casualty Company and James W. McLane. **\nThe 1984 Stock Option Plan of Aetna Life and Casualty Company and amendments thereto, incorporated herein by reference to the 1992 Form 10-K. **\nAetna Life and Casualty Company's Supplemental Incentive Savings Plan, incorporated herein by reference to the 1992 Form 10-K. **\nAetna Life and Casualty Company's Supplemental Pension Benefit Plan, incorporated herein by reference to the 1992 Form 10-K. **\nAetna Life and Casualty Company's 1986 Management Incentive Plan, as amended effective February 25, 1994, incorporated herein by reference to the 1993 Form 10-K. **\nAetna Life and Casualty Company Directors' Deferred Compensation Plan, incorporated herein by reference to the 1992 Form 10-K. **\nAetna Life and Casualty Company 1994 Non-Employee Director Deferred Stock Plan, incorporated herein by reference to the company's 1994 proxy statement, filed on March 18, 1994 (the \"1994 Proxy Statement\"). **\nAetna Life and Casualty Company 1994 Stock Incentive Plan, incorporated herein by reference to the 1994 Proxy Statement. **\nLetter Agreement, dated December 18, 1993, between Aetna Life and Casualty Company and David A. Kocher, incorporated herein by reference to the 1993 Form 10-K. **\nLetter Agreement, dated September 20, 1994, between Aetna Life and Casualty Company and Patrick W. Kenny, incorporated by reference to the company's Form 10-Q filed on October 28, 1994. **\nThe Aetna Life and Casualty Company 1990 Non-Employee Director Deferred Stock Plan, incorporated herein by reference to the 1992 Form 10-K. **\nExtension Notice, dated July 17, 1995 of $500,000,000 Short-Term Credit Agreement dated July 27, 1994 among Aetna Life and Casualty Company, the banks listed therein, Deutsche Bank AG, as Co- Arranger, and Morgan Guaranty Trust Company of New York, incorporated by reference to the company's Form 10-Q filed on July 28, 1995.\n$500,000,000 Medium-Term Credit Agreement dated as of July 27, 1994 among Aetna Life and Casualty Company, the banks listed on the signature pages thereof, Morgan Guaranty Trust Company of New York, as Managing Agent, Deutsche Bank AG, as Co-Arranger, and The Chase Manhattan Bank, N.A., Citibank, N.A., and Credit Suisse, as Co- Agents, incorporated by reference to the company's Form 10-Q filed on August 15, 1994.\nDescription of certain arrangements not embodied in formal documents, as described with respect to Directors' fees and benefits, and under the caption \"Executive Compensation,\" are incorporated herein by reference to the Proxy Statement.\n(11) Statement re computation of per share earnings.\nIncorporated herein by reference to Note 1 of Notes to Financial Statements in the Annual Report.\n(12) Statement re computation of ratios.\nStatement re: computation of ratio of earnings to fixed charges.\nStatement re: computation of ratio of earnings to combined fixed charges and preferred stock dividends.\n(13) Annual Report to security holders.\nSelected Financial Data, Management's Discussion and Analysis of Financial Condition and Results of Operations, Consolidated Financial Statements and the report of the company's independent auditors, and unaudited Quarterly Data from the Annual Report.\n(21) Subsidiaries of the registrant.\nA listing of subsidiaries of Aetna Life and Casualty Company.\n(23) Consents of experts and counsel.\nConsent of Independent Auditors to Incorporation by Reference in the Registration Statements on Form S-3 and Form S-8.\n(24) Powers of attorney.\n(27) Financial data schedule.\n(28) Information from reports furnished to state insurance regulatory authorities.\n1995 Consolidated Schedule P of Annual Statements provided to state regulatory authorities. ***\n(b) Reports on Form 8-K\nThe company filed a report on Form 8-K filed on November 29, 1995, relating to the company entering into a definitive agreement, dated November 28, 1995, to sell its property-casualty operations to The Travelers Insurance Group Inc.\n* Exhibits other than those listed are omitted because they are not required or are not applicable. Copies of exhibits are available without charge by writing to the Office of the Corporate Secretary, Aetna Life and Casualty Company, 151 Farmington Avenue, Hartford, Connecticut 06156.\n** Management contract or compensatory plan or arrangement.\n*** Filed under cover of Form SE.\nINDEX TO FINANCIAL STATEMENT SCHEDULES\nAETNA LIFE AND CASUALTY COMPANY AND SUBSIDIARIES\nIndependent Auditors' Report Page ____\nI Summary of Investments - Other than 44 Investments in Affiliates as of December 31, 1995\nII Condensed Financial Information of the 45 Registrant as of December 31, 1995 and 1994 and for the years ended December 31, 1995, 1994 and 1993\nIII Supplementary Insurance Information as of 51 and for the years ended December 31, 1995, 1994 and 1993\nIV Reinsurance 54\nV Valuation and Qualifying Accounts and Reserves 55 for the years ended December 31, 1995, 1994 and 1993\nVI Supplemental Information Concerning 58 Property-Casualty Operations for the years ended December 31, 1995, 1994 and 1993\nCertain of the required information is shown in the Financial Statements or Notes thereto in the Annual Report. Certain information has been omitted from the schedules filed because the information is not applicable.\nCertain reclassifications have been made to 1994 and 1993 financial information to conform to 1995 presentation.\nINDEPENDENT AUDITORS' REPORT ____________________________\nThe Shareholders and Board of Directors Aetna Life and Casualty Company:\nUnder date of February 6, 1996, we reported on the consolidated balance sheets of Aetna Life and Casualty Company and Subsidiaries as of December 31, 1995 and 1994, 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, 1995, as contained in the 1995 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 1995. 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.\nAs discussed in Notes 1 and 2 to the consolidated financial statements, in 1993 the company changed its methods of accounting for certain investments in debt and equity securities, postemployment benefits, workers' compensation life table indemnity reserves and retrospectively rated reinsurance contracts.\nBy \/s\/ KPMG Peat Marwick LLP _________________________ (Signature)\nKPMG PEAT MARWICK LLP\nHartford, Connecticut February 6, 1996\nAETNA LIFE AND CASUALTY COMPANY AND SUBSIDIARIES\nSCHEDULE I\nSummary of Investments - Other than Investments in Affiliates\nAs of December 31, 1995\nAETNA LIFE AND CASUALTY COMPANY AND SUBSIDIARIES\nSCHEDULE II\nCondensed Financial Information\nAETNA LIFE AND CASUALTY COMPANY\nStatements of Income\nAETNA LIFE AND CASUALTY COMPANY AND SUBSIDIARIES\nSCHEDULE II\nCondensed Financial Information\nAETNA LIFE AND CASUALTY COMPANY\nBalance Sheets\nAETNA LIFE AND CASUALTY COMPANY AND SUBSIDIARIES\nSCHEDULE II\nCondensed Financial Information\nAETNA LIFE AND CASUALTY COMPANY\nStatements of Shareholders' Equity\nAETNA LIFE AND CASUALTY COMPANY AND SUBSIDIARIES\nSCHEDULE II\nCondensed Financial Information\nAETNA LIFE AND CASUALTY COMPANY\nStatements of Cash Flows\nAETNA LIFE AND CASUALTY COMPANY AND SUBSIDIARIES\nSCHEDULE II\nCondensed Financial Information\nAETNA LIFE AND CASUALTY COMPANY\nNotes to Condensed Financial Statements\nThe accompanying condensed financial statements should be read in conjunction with the Consolidated Financial Statements and Notes thereto in the Annual Report. Certain reclassifications have been made to 1994 and 1993 financial information to conform to 1995 presentation.\n1. Long-Term Debt\nSee Note 9 to the Consolidated Financial Statements in the Annual Report for a description of the long-term debt and aggregate maturities for 1996 to 2000 and thereafter.\n2. Dividends\nThe amounts of cash dividends paid to Aetna Life and Casualty Company by insurance affiliates for the years ended December 31, 1995, 1994 and 1993 were as follows:\nSee Note 8 to the Consolidated Financial Statements in the Annual Report for a description of dividend restrictions from the consolidated insurance subsidiaries to the company.\n3. Due to Affiliates\nSee Note 11 to the Consolidated Financial Statements in the Annual Report for a description of amounts due to Aetna Capital L.L.C., a subsidiary of the company.\nAETNA LIFE AND CASUALTY COMPANY AND SUBSIDIARIES\nSCHEDULE II\nCondensed Financial Information\nAETNA LIFE AND CASUALTY COMPANY\nNotes to Condensed Financial Statements (Continued)\n4. Accounting Changes\nSee Notes 1 and 2 to the Consolidated Financial Statements in the Annual Report for a description of accounting changes.\n5. Discontinued Products\nSee Note 3 to the Consolidated Financial Statements in the Annual Report for a description of discontinued products.\n6. Sales of Subsidiaries\nSee Note 2 to the Consolidated Financial Statements in the Annual Report for a description of the sales of subsidiaries.\n7. Severance and Facilities Charge\nSee Note 4 to the Consolidated Financial Statements in the Annual Report for a description of the severance and facilities charges.\n8. Federal and Foreign Income Taxes\nSee Note 10 to the Consolidated Financial Statements in the Annual Report for a description of federal and foreign income taxes.\nAETNA LIFE AND CASUALTY COMPANY AND SUBSIDIARIES\nSCHEDULE III\nSupplementary Insurance Information\nAs of and for the year ended December 31, 1995\nAETNA LIFE AND CASUALTY COMPANY AND SUBSIDIARIES\nSCHEDULE III\nSupplementary Insurance Information\nAs of and for the year ended December 31, 1994\nAETNA LIFE AND CASUALTY COMPANY AND SUBSIDIARIES\nSCHEDULE III\nSupplementary Insurance Information\nAs of and for the year ended December 31, 1993\nAETNA LIFE AND CASUALTY COMPANY AND SUBSIDIARIES\nSCHEDULE IV\nReinsurance*\nAETNA LIFE AND CASUALTY COMPANY AND SUBSIDIARIES\nSCHEDULE V\nValuation and Qualifying Accounts and Reserves\nAETNA LIFE AND CASUALTY COMPANY AND SUBSIDIARIES\nSCHEDULE V\nValuation and Qualifying Accounts and Reserves\nAETNA LIFE AND CASUALTY COMPANY AND SUBSIDIARIES\nSCHEDULE V\nValuation and Qualifying Accounts and Reserves\nAETNA LIFE AND CASUALTY COMPANY AND SUBSIDIARIES\nSCHEDULE VI\nSupplemental Information Concerning Property-Casualty Operations (1)\nSIGNATURES Pursuant 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.\nDate: February 26, 1996 AETNA LIFE AND CASUALTY COMPANY (Registrant)\nBy \/s\/ Robert J. Price _______________________________ (Signature) Robert J. Price Vice President and 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 the registrant and in the capacities indicated on February 26, 1996.\nSignature Title * Chairman, President and Director ________________________ Ronald E. Compton (Principal Executive Officer)\n* ________________________ Wallace Barnes Director\n* ________________________ William H. Donaldson Director\n* ________________________ Barbara Hackman Franklin Director\n* ________________________ Earl G. Graves Director\n* ________________________ Gerald Greenwald Director\n* ________________________ Ellen M. Hancock Director\n* ________________________ Michael H. Jordan Director\n* ________________________ Jack D. Kuehler Director\n* ________________________ Frank R. O'Keefe, Jr. Director\n* ________________________ Judith Rodin Director\n* ________________________ Richard L. Huber Vice Chairman for Strategy and Finance (Principal Financial Officer)\n\/s\/ Robert J. Price ________________________ Robert J. Price Vice President and Corporate Controller (Controller)\n* By \/s\/ Robert J. Price ________________________ Robert J. Price (Attorney-in-Fact)\nINDEX TO EXHIBITS","section_15":""}
{"filename":"10329_1995.txt","cik":"10329","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL DEVELOPMENT OF BUSINESS\nBassett Furniture Industries, Incorporated was incorporated under the laws of the Commonwealth of Virginia in 1930. The executive offices are located in Bassett, Virginia.\nIn 1995, four manufacturing plants were consolidated into two plants. The two closed plants will be sold. The closing of the two plants should have no material effect on the Company's net sales in the future but should reduce overhead costs related to the plants.\nThere have been no material changes in the mode of conducting business in the fiscal year beginning December 1, 1994.\nINDUSTRY SEGMENT\nIn accordance with the instructions for this item, Bassett Furniture Industries, Incorporated and its subsidiaries, all of which are wholly-owned (Company), is deemed to have been engaged in only one business segment, manufacture and sale of furniture, for the three years ended November 30, 1995.\nDESCRIPTION OF BUSINESS\nThe Company manufactures and sells a full line of furniture for the home: bedroom and dining suites and accent pieces; occasional tables, wall and entertainment units; home office systems and computer work stations; upholstered sofas, chairs and love seats (motion and stationary); recliners; and mattresses and box springs. The Company's products are distributed through a large number of retailers, principally in the United States. The retailers selling the Company's products include mass merchandisers, department stores, independent furniture stores, chain furniture stores, decorator showrooms, warehouse showrooms, specialty stores and rent-to-own stores.\nDue to the dramatic changes that took place in the retail home furnishings distribution network, the Company developed the Bassett Gallery Program in the mid-1980's. In late 1995, an effort was undertaken to rejuvenate the Program with a \"quick shipment\" inventory stocking system, advertising media development and new gallery design concepts. In addition, gallery space requirements were expanded from 5,000 to 8,000 square feet in each store. The Company is currently reviewing all existing galleries to ensure that they meet the standards of the Program. This has led to the elimination of certain galleries and there is the possibility of further deletions in the future.\nIn 1994, the Company introduced the Bassett Direct Plus Program. A Bassett Direct Plus (\"BDP\") store is a free standing exclusive Bassett store that will encompass between 18,000 and 25,000 square feet of space in the current prototype. The stores display, in gallerized settings, selected offerings from all Bassett product groups. These stores are independently owned and operated retail operations, displaying a full range of home fashions and carry no other furniture manufacturer's products. Bassett supports its \"BDP\" stores with a greater, more extensive level of service and support which includes fully planned exterior and interior designs, special financing terms, inventory warehousing Page 3 of 23\ncommitment, priority on cuttings and shipping, and access to Bassett's EDI link and BassNet. Currently there are eight \"BDP\" stores in operation and fifteen are scheduled to be opened in 1996. \"BDP\" stores are targeted to become one of the Company's largest customer segments.\nRaw materials used by the Company are generally available from numerous sources and are obtained principally from domestic sources. The cost pressures on raw materials continued to be experienced in 1995. Furthermore, it continued to be very difficult to pass through the incurred cost increases to retail dealers in the form of increased sales prices.\nThe Company's trademark \"Bassett\" and the names of its marketing divisions and product collections are significant to the conduct of its business. This importance is due to consumer recognition of the names and identification with the Company's broad range of products. The Company owns certain patents and licenses that are important in the conduct of the Company's business.\nThe furniture industry is not considered to be a seasonal industry.\nThere are no special practices in the furniture industry, or applicable to the Company, that would have a significant effect on working capital items.\nThe Company is not dependent upon a single customer, the loss of which would have a material adverse effect on the Company. Sales to one customer (J. C. Penney Company) amounted to approximately 14% of gross sales in 1995, 13% in 1994 and 12% in 1993.\nThe Company's backlog of orders believed to be firm was $56,000,000 at November 30, 1995 and $66,500,000 at November 30, 1994. It is expected that the November 30, 1995 backlog will be filled within the 1996 fiscal year.\nNone of the Company's business involves government contracts.\nThe furniture industry is very competitive as there are a large number of manufacturers both within the United States and offshore who compete in the marketplace on the basis of quality of the product, price, delivery and service. Based on annual sales revenue, the Company is one of the largest furniture manufacturers in the United States. The Company has been successful in this competitive environment because its products represent excellent values combining price and superior quality and styling; prompt delivery; and quality, courteous service. Competition from foreign manufacturers is not any more significant in the marketplace today than competition from domestic manufacturers.\nThe furniture industry is considered to be a \"fashion\" industry subject to constant change to meet the changing consumer preferences and tastes. As such, the Company is continuously involved in the development of new designs and products. Due to the nature of these efforts and the close relationship to the manufacturing operations, the costs thereof are considered normal operating costs and are not segregated.\nThe Company is not involved in \"traditional\" research and development activities. Neither are there any customer - sponsored research and development activities involving the Company. Page 4 of 23\nIn management's view, the Company has complied with all federal, state and local standards in the area of safety, health and pollution and environmental controls. Compliance with these standards has not had a material adverse effect on past earnings, capital expenditures or competitive position.\nThe Company anticipates increased regulation on the furniture industry from federal and state agencies particularly in the areas of emission of fumes from the furniture finishing processes and emission of particulates into the atmosphere (saw dust and boiler ash). The Company cannot at this time estimate the impact of compliance with these new, more stringent standards on the Company's operations or costs of compliance.\nThe Company had approximately 7,400 employees at November 30, 1995.\nFOREIGN AND DOMESTIC OPERATIONS AND EXPORT SALES\nThe Company has no foreign operations, and its export sales are insignificant.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company owns the following facilities:\nPage 5 of 23\nThe Company also owns its general office building in Bassett, Virginia (brick, concrete and steel), two warehouses in Bassett, Virginia (brick and concrete) and a showroom in High Point, North Carolina (brick, concrete and steel).\nIn general, these facilities are suitable and are considered to be adequate for the continuing operations involved. All facilities are in regular use, except the plants noted below.\n(A) Plant closed as part of the restructuring program announced in 1990.\n(B) The Weiman-Ramseur plant and a small Impact Furniture plant are the two aforementioned plants closed in 1995 and held-for-sale.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nNot applicable\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nThe information contained in the Annual Report under the caption \"Other Business Data\" - \"Market and Dividend Information\" with respect to number of stockholders, market prices and dividends paid is incorporated herein by reference thereto.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe information for the five years ended November 30, 1995, contained in the \"Other Business Data\" in the Annual Report is incorporated herein by reference thereto. Page 6 of 23\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe information contained in \"Other Business Data\" in the Annual Report is incorporated herein by reference thereto.\nThe change in the level of the Company's net sales has historically been principally due to the change in the volume of units sold, as contrasted to changes in unit prices. The Company's net sales have fluctuated in recent years owing to the discretionary spending habits of consumers and the consumer confidence level.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe following consolidated financial statements of the registrant and its subsidiaries, together with the independent auditors' report thereon of KPMG Peat Marwick LLP dated December 15, 1995, included in the annual report of the registrant to its stockholders for the year ended November 30, 1995 are incorporated herein by reference thereto:\nConsolidated Balance Sheet--November 30, 1995 and 1994\nConsolidated Statement of Income--Years Ended November 30, 1995, 1994 and 1993\nConsolidated Statement of Stockholders' Equity--Years Ended November 30, 1995, 1994 and 1993\nConsolidated Statement of Cash Flows--Years Ended November 30, 1995, 1994 and 1993\nNotes to Consolidated Financial Statements\nThe information contained in \"Other Business Data\" for \"Quarterly Results of Operations\" in the Annual Report is incorporated herein by reference thereto.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone PART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS OF THE REGISTRANT\nThe information contained on pages 2 through 5 of the Proxy Statement under the captions \"Principal Stockholders and Holdings of Management\" and \"Election of Directors\" is incorporated herein by reference thereto.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information contained on pages 6 through 12 of the Proxy Statement under the captions \"Organization and Compensation Committee Report\", \"Stockholder Return Performance Graph\", \"Executive Compensation\", and \"Supplemental Retirement Income Plan\" is incorporated herein by reference thereto. Page 7 of 23\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information contained on page 2 of the Proxy Statement under the heading \"Principal Stockholders and Holdings of Management\" is incorporated herein by reference thereto.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information contained on page 6 of the Proxy statement under the heading OOrganization and Compensation Committee Interlocks and Insider ParticipationO is incorporated herein by reference thereto.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON FORM 8-K\n(a) (1) The response to this portion of Item 14 is submitted as a separate section of this report.\n(2) All financial statement schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and, therefore, have been omitted.\n(3) Listing of Exhibits\n3. Articles of Incorporation as amended and By Laws are incorporated herein by reference to Form 10-Q for the fiscal quarter ended February 28, 1994.\n13. The registrant's Annual Report to Stockholders for the year ended November 30, 1995.*\n21. List of subsidiaries of the registrant\n23. Consent of experts and counsel\n27. Financial Data Schedule (EDGAR filing only)\n*With the exception of the information incorporated in this Form 10-K by reference thereto, the Annual Report shall not be deemed \"filed\" as a part of this Form 10-K.\n(b) No reports on Form 8-K have been filed during the last quarter of the registrant's 1995 fiscal year.\n(c) Exhibits: The response to this portion of Item 14. is submitted as a separate section of this report.\n(d) Financial Statement Schedules: All financial statement schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and, therefore, have been omitted. Page 8 of 23\nANNUAL REPORT ON FORM 10-K ITEM 14(a)(1) AND (c)\nLIST OF FINANCIAL STATEMENTS\nCERTAIN EXHIBITS\nYEAR ENDED NOVEMBER 30, 1995\nBASSETT FURNITURE INDUSTRIES, INCORPORATED AND SUBSIDIARIES\nBASSETT, VIRGINIA Page 9 of 23\nITEM 14(a)(1)\nLIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE\nThe following consolidated financial statements of the registrant and its subsidiaries, included in the annual report of the registrant to its stockholders for the year ended November 30, 1995 are incorporated herein by reference:\nConsolidated Balance Sheet--November 30, 1995 and 1994\nConsolidated Statement of Income--Years Ended November 30, 1995, 1994 and 1993\nConsolidated Statement of Stockholders' Equity--Years Ended November 30, 1995, 1994 and 1993\nConsolidated Statement of Cash Flows--Years Ended November 30, 1995, 1994 and 1993\nNotes to Consolidated Financial Statements Page 10 of 23\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nBASSETT FURNITURE INDUSTRIES, INCORPORATED (Registrant)\nPursuant to the requirements of the Securities Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nPage 11 of 23\nSIGNATURES -- CONTINUED\nPage 12 of 23\nIndex to Exhibits","section_15":""}
{"filename":"82628_1995.txt","cik":"82628","year":"1995","section_1":"ITEM 1. Business\n\tSymmetriCom, Inc. (the \"Company\") was incorporated in California in 1956. The Company conducts its business through two separate operations, Telecom Solutions and Linfinity Microelectronics Inc. (Linfinity). Each operates in a different industry segment. Telecom Solutions principally designs, manufactures and markets specialized transmission, synchronization and intelligent access systems for both domestic and international telecommunications service providers. Linfinity principally designs, manufactures and markets linear and mixed signal integrated circuits for use in intelligent power management, motion control and signal conditioning applications in commercial, industrial, and defense and space markets.\nTelecom Solutions\n\tTelecom Solutions offers a broad range of time reference, or synchronization, products and digital terminal products for the telecommunications industry. Reliable synchronization is fundamental to telecommunications services as the orderly and error free transmission of data would be impossible without it. The Company's core synchronization products consist principally of quartz and rubidium based Digital Clock Distributors (DCDs), which provide highly accurate and uninterruptible clocks that meet the synchronization requirements of digital networks. Telecom Solutions has established itself as a leader in telephone digital network synchronization and has introduced a series of DCDs and related products. These products provide the critical timing which enables telecommunications service providers to synchronize precisely such diverse telephone network elements as digital switches, digital cross-connect systems and multiplexers for customers who are dependent upon high quality data transmission.\n\tCustomer requirements for synchronization are increasing in complexity as telecommunications service providers implement new transmission technologies. During fiscal 1994, Telecom Solutions developed a new synchronization platform, the DCD500 Series, in response to evolving network requirements, such as new digital services being provided, the Synchronous Optical Network (SONET) and the Signaling System Seven (SS7) network. Additionally, the platform meets the international standards required for deployment in a Synchronous Digital Hierarchy network. During fiscal 1995, the Company significantly enhanced the DCD500 Series by adding network management functionality and performance monitoring capabilities. Such capabilities include network alarm surveillance, central location monitoring and additional clock functions.\n\tA second synchronization platform was also developed in fiscal 1994, the DCD Local Primary Reference (LPR), which provides the ability to cost effectively use Global Positioning System (GPS) and Long Range Navigation (LORAN-C) satellite and land navigation services to provide direct Stratum 1 traceable synchronization at offices equipped with DCD systems. The DCD Integrated Local Primary Reference (ILPR), introduced in fiscal 1995, integrates the LPR and the DCD in a single package. Additionally, a primary reference clock was introduced in fiscal 1994 as Telecom Solutions first Master Clock for telecommunications networks.\n\tTelecom Solutions synchronization systems are typically priced from $3,000 to $40,000.\n\tIn the first quarter of fiscal 1994, the Company acquired Navstar Limited, a United Kingdom company, and its U.S. affiliate (collectively \"Navstar\"). Navstar develops and manufactures systems that use global positioning technology to determine precise geographic locations and elevations to an accuracy of a few centimeters. GPS receivers are used internally in the Company's synchronization products, such as the LPR and ILPR. Navstar products are also sold in the survey, positioning and location markets. Navstar products are typically priced from $300 to $10,000.\n\tTelecom Solutions digital terminal products include the Integrated Digital Services Terminal (IDST) and Secure 7. The IDST is a network access system designed for use in telephone company central and end offices. Customers have deployed the IDST primarily as a transmission, monitoring and test access vehicle for SS7 networks, which provides maintenance personnel with flexible, centralized remote access to SS7 links for troubleshooting and performance verification, resulting in a comprehensive solution in the monitoring and transport of links requiring increased reliability. The IDST can also be deployed as an intelligent digital terminal, an intelligent network element providing connectivity between the transport network and customer-serving side of the network. The IDST enhances the network with distributed digital cross-connect functionality and provides subrate, multipoint, test and surveillance capabilities to the subscriber loop.\n\tSecure 7, a new product introduced in fiscal 1995, and to be shipped in fiscal 1996, is a multi-bandwidth digital transmission terminal designed for critical networks, such as SS7 data links, E911 services and customer data communications networks. By design, Secure 7 is highly reliable and provides network access and system automatic route diversity for these critical data applications.\n\tDigital terminal products are typically priced at less than $20,000 for a small system to more than $300,000 for a large system.\n\tThe Company supplies its synchronization systems and digital terminal products predominantly to the seven Regional Bell Operating Companies (RBOCs), independent telephone companies, interexchange carriers and international telecommunications service providers. Navstar predominantly sells it products to Telecom Solutions, the U.S. Government, original equipment manufacturers (OEMs) and international customers.\nLinfinity Microelectronics Inc.\n\tDuring July 1993, substantially all of the assets and liabilities of the Company's Semiconductor Group were transferred to Linfinity, a newly- formed subsidiary of the Company. Linfinity products principally include linear and mixed signal, standard and custom integrated circuits (ICs) primarily for use in intelligent power management, motion control and signal conditioning applications in the commercial, industrial, and defense and space markets. Linfinity derives a substantial portion of its sales from power management products including pulse width modulators which shape and manage the characteristics of voltage, linear voltage regulators which control the power supply output levels, supervisory circuits which monitor power supply and power factor correction ICs which reduce energy consumption in fluorescent lighting and other applications. Additionally, a significant portion of Linfinity sales is attributable to motion control ICs for the computer disk drive industry. These ICs control the rotation of the disk and the position of the read-write head. Signal conditioning ICs are a relatively new product line for Linfinity. Signal conditioning ICs translate and buffer analog signals from sensors in a variety of industrial, computer, communications and automotive systems.\n\tLinfinity manufactures linear and mixed signal ICs utilizing bipolar and bipolar complementary metal oxide silicon (BiCMOS) wafer fabrication processes. Linfinity also sells ICs utilizing CMOS wafer fabrication processes. Linfinity's strategy is to continue development of more market driven standard products which are primarily used in computer and data storage, lighting, automotive, communications equipment, test equipment, instrumentation, and defense and space equipment. Linfinity products are generally priced from $0.30 to $5.00 for commercial and industrial applications, $2.50 to $22.00 for defense applications and $200 to $500 for high reliability defense and space applications.\n\tLinfinity sells its products in the commercial, industrial, and defense and space markets to OEMs and distributors.\nIndustry Segment Information\n\tInformation as to net sales, operating income and identifiable assets attributable to each of the Company's two industry segments for each year in the three-year period ended June 30, 1995, is contained in Note L of the Notes to Consolidated Financial Statements included in the Company's 1995 Annual Report (the \"Annual Report\"), which Note is incorporated herein by reference to Excerpts of the Annual Report.\nMarketing\n\tIn the United States, Telecom Solutions markets and sells most of its products through its own sales force to telephone and telecommunications service providers. Internationally, Telecom Solutions markets and sells its products through its own sales operation in the United Kingdom and independent sales representatives and distributors elsewhere. In the United States and internationally, Linfinity sells its products through its own sales force and independent sales representatives to original equipment manufacturers and distributors.\nLicensing and Patents\n\tThe Company incorporates a combination of trademark, copyright and patent registration, contractual restrictions and internal security to establish and protect its proprietary rights. The Company has United States patents and patent applications pending covering certain technology used by its Telecom Solutions and Linfinity operations. In addition, both operations use technology licensed from others. However, while the Company believes that its patents have value, the Company relies primarily on innovation, technological expertise and marketing competence to maintain its competitive advantage. The telecommunications and semiconductor industries are both characterized by the existence of a large number of patents and frequent litigation based on allegations of patent infringement. The Company intends to continue its efforts to obtain patents, whenever possible, but there can be no assurance that any patents obtained will not be challenged, invalidated or circumvented or that the rights granted will provide any commercial benefit to the Company. Additionally, if any of the Company's processes or designs are identified as infringing upon patents held by others, there can be no assurances that a license will be available or that the terms of obtaining any such license will be acceptable to the Company.\nManufacturing\n\tThe Telecom Solutions manufacturing process consists primarily of in- house electrical assembly and test performed by the Company's wholly-owned subsidiary in Aguada, Puerto Rico. Additionally, the Company's wholly-owned subsidiary, Navstar, in England performs in-house electrical assembly and test of its GPS receivers.\n\tThe Linfinity manufacturing process consists primarily of bipolar and BiCMOS wafer fabrication, component assembly and final test. Its ICs are principally fabricated in the Company's wafer fabrication facility in Garden Grove, California. However, Linfinity also utilizes outside services to perform certain operations during the fabrication process. In addition, most of Linfinity's ICs utilizing CMOS wafer processes are currently manufactured by outside semiconductor foundries. Component assembly and final test are performed in the Far East by independent subcontract manufacturers or in Garden Grove by employees.\n\tThe Company primarily uses standard parts and components and standard subcontract assembly and test, which are generally available from multiple sources. The Company, to date, has not experienced any significant delays in obtaining needed standard parts, single source components or services from its suppliers but there can be no assurance that such problems will not develop in the future. Additionally, the Company believes that the semiconductor industry's IC production may not meet the demand for complex components from the telecommunications and automotive industries in the near future. However, the Company maintains a reserve of certain ICs, certain single source components and seeks alternative suppliers where possible. The Company believes that a lack of availability of ICs or single source components would have an adverse effect on the Company's operating results.\nBacklog\n\tThe Company's backlog was approximately $21,600,000 at June 30, 1995, compared to approximately $18,000,000 at June 30, 1994. Backlog consists of orders which are expected to be shipped within the next twelve months. However, the Company does not believe that current or future backlog levels are meaningful indicators of future revenue levels. Furthermore, most orders in backlog can be rescheduled or canceled without significant penalty. Telecom Solutions backlog was approximately $5,100,000 at both June 30, 1995 and 1994. Historically, a substantial portion of Telecom Solutions net sales in any fiscal period has been derived from orders received during that period. Linfinity backlog was approximately $16,500,000 and $12,900,000 at June 30, 1995 and 1994, respectively. Linfinity backlog is dependent on the cyclical nature of customer demand in each of its markets.\nKey Customers and Export Sales\n\tOne of Telecom Solutions' customers, Southwestern Bell Telephone, accounted for 11% of the Company's net sales in fiscal 1995. No customer accounted for 10% or more of net sales in fiscal years 1994 or 1993. Export sales, primarily to the Far East, Canada and Western Europe accounted for 24%, 19% and 13% of the Company's net sales in fiscal years 1995, 1994 and 1993, respectively.\nInternational sales may be subject to certain risks, including but not limited to, foreign currency fluctuations, export restrictions, longer payment cycles and unexpected changes in regulatory requirements or tariffs. Gains and losses on the conversion to U.S. dollars of foreign currency accounts receivable and accounts payable arising from international operations may in the future contribute to fluctuations in the Company's business and operating results. Sales and purchase obligations denominated in foreign currencies have not been significant. Accordingly, the Company does not currently engage in foreign currency hedging activities or derivative arrangements but may do so in the future to the extent that such obligations become more significant. Additionally, currency fluctuations could have an adverse effect on the demand for the Company's products in foreign markets.\nCompetition\n\tThe businesses in which the Company is engaged are highly competitive. A number of the Company's competitors or potential competitors have been in operation for a much longer period of time than the Company, have greater financial, manufacturing, technical and marketing resources, and are able to or could offer much broader lines of products than are presently marketed by the Company.\n\tTelecom Solutions competes primarily on product reliability and performance, adherence to standards, customer service and, to a lesser extent, price. The Company believes that Telecom Solutions generally competes favorably with respect to these factors.\n\tLinfinity competes primarily on price, product reliability and performance, delivery time, and customer service. Linfinity has a broad spectrum of customers predominantly in North America, the Far East and Europe. Large multinational companies as well as smaller, focused niche companies compete with Linfinity in North America. Primarily large multinational companies compete with Linfinity in the Far East and Europe. The Company believes that Linfinity generally competes favorably with respect to these factors.\n\tThere can be no assurance that either Telecom Solutions or Linfinity will be able to compete successfully in the future. The Company's ability to compete successfully is dependent upon its response to changing technology and customer requirements, development or acquisition of new products, continued improvement of existing products, cost effectiveness and market acceptance of the Company's products.\nResearch and Development\n\tThe Company has actively pursued the application of new technology in the industries in which it competes and has its own staff of engineers and technicians who are responsible for the design and development of new products. In fiscal years 1995, 1994 and 1993, the Company's overall research and development expenditures were $13,407,000, $11,454,000, and $8,355,000, respectively. All research and development expenditures were expensed as incurred. At June 30, 1995, 76 engineering and engineering support employees were engaged in development activities. Telecom Solutions focused its development efforts in fiscal year 1995 on enhancement of the DCD500 Series and related synchronization products. Network management functionality and monitoring capabilities were added to the DCD500 Series. Additionally, the new digital terminal product, Secure 7, was designed and introduced in fiscal 1995, and expected to be shipped in fiscal 1996. Telecom Solutions research and development expenditures were $8,457,000, $7,821,000 and $6,374,000 in fiscal years 1995, 1994 and 1993, respectively. Linfinity continued to focus its development efforts in fiscal year 1995 on improving its design capabilities, improving its bipolar and BiCMOS process technologies and new product development. New products, which include but are not limited to low drop out regulators, power factor correction circuits and spindle drivers for use in power management, motion control and signal conditioning applications are currently in the production stage. Enhancement of these products incorporating increased functionality, and additional new products are in the development stage. Linfinity research and development expenditures were $4,950,000, $3,633,000 and $1,981,000 in fiscal years 1995, 1994 and 1993, respectively. The Company will continue to make significant investments in product development, although there can be no assurance that the Company will be able to develop proprietary products in the future which will be accepted in its markets.\nGovernment Regulation\n\tThe telecommunications industry is subject to government regulatory policies regarding pricing, taxation and tariffs which may adversely impact the demand for the Company's telecommunications products. These policies are continuously reviewed and subject to change by the various governmental agencies. The Company is also subject to government regulations which set installation and equipment standards for newly installed hardware. Furthermore, there is certain legislation before the United States Congress which, if enacted, would remove the current legal restrictions on the RBOCs that prohibit them from manufacturing telecommunications equipment and providing certain interexchange and long-distance services.\nEnvironmental Regulation\n\tThe Company's operations are subject to numerous federal, state and local environmental regulations related to the storage, use, discharge and disposal of toxic, volatile or otherwise hazardous chemicals used in its manufacturing process. Failure to comply with such regulations could result in suspension or cessation of the Company's operations, could require significant capital expenditures, or could subject the Company to significant future liabilities.\nEmployees\n\tAt June 30, 1995, the Company had 651 employees, including 387 in manufacturing, 100 in engineering and 164 in sales, marketing and administration. At June 30, 1995, Telecom Solutions had 413 employees and Linfinity had 238 employees. The Company believes that its future success is highly dependent on its ability to attract and retain highly qualified management, sales, marketing and technical personnel. Accordingly, the Company maintains employee incentive and stock plans for certain of its employees. Additionally, Linfinity maintains a separate employee stock option plan for certain Linfinity employees. No Company employees are represented by a labor union, and the Company has experienced no work stoppages. The Company believes that its employee relations are good.\nOperating Results and Stock Price Volatility\n\tFuture Company operating results will largely depend upon (i) the Company's ability to implement new technologies and develop new products, (ii) the Company's ability to market and sell new products, (iii) the Company's response to increased competition, (iv) changes in product mix and (v) manufacturing efficiencies. Future Telecom Solutions operating results for a fiscal period will continue to be, as past results have been, highly dependent upon the receipt and shipment of customer orders during that fiscal period. Future Linfinity operating results will also be subject to the cyclical nature of the semiconductor industry.\n\tThe Company's stock price has been and may continue to be subject to significant volatility. Many factors, including any shortfall in sales or earnings from levels expected by securities analysts and investors could have an immediate and significant adverse effect on the trading price of the Company's common stock.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2.\t\tProperties\n\tThe following are the principal facilities of the Company as of June 30, 1995:\n\t\t\t\t\t\t \t\tApproximate\t\tOwned\/Lease \t\t\t\t Principal \t \tFloor Area\t \tExpiration Location\t\t \t\tOperations\t\t (Sq. Ft.)\t Date\nSan Jose, California Corporate Offices, \t\t\t\t\tand Telecom Solutions \t\t\t\t \tadministration, \t\t \t\t\tsales, engineering \t \t\t\tand manufacturing 47,000\t\t\tJuly 1997\nAguada, Puerto Rico Telecom Solutions \t \t\t\tmanufacturing 22,000\t\t\tSeptember 2000\nAguada, Puerto Rico\t Telecom Solutions \t\t\t\t manufacturing 23,000\t\t\tSeptember 1999\nNorthampton,\t Navstar administration, England\t\t\t sales, engineering and \t\t\t\t manufacturing 18,000\t\t\tApril 1999\nGarden Grove,\t Linfinity administration, California\t\t sales, engineering \t\t\t\t and manufacturing 96,000\t\t\tOwned\nGarden Grove,\t Linfinity wafer California\t\t fabrication\t 9,000\t\t Owned\n\tThe 96,000 square foot facility located in Garden Grove, California is subject to an encumbrance as described in Note E of the Notes to Consolidated Financial Statements which information is incorporated herein by reference to Excerpts of the Annual Report. The Company believes that its current facilities are well maintained and generally adequate to meet short-term requirements.\nITEM 3.","section_3":"ITEM 3.\t\tLegal Proceedings\n\tIn January 1994, a complaint was filed in the United States District Court for the Northern District of California against the Company and three of its officers, by one of the Company's shareholders. The plaintiff requested that the court certify him as representative of a class of persons who purchased shares of the Company's common stock during a specified period in 1993. The complaint alleges that false and misleading statements made during that period artificially inflated the price of the Company's common stock in violation of federal securities laws. There is no specific amount of damages requested in the complaint. Limited discovery has occurred and no trial date has been set. The Company and its officers believe that the complaint is entirely without merit, and intend to vigorously defend against the action. The Company is also a party to certain other claims which are normal in the course of its operations. While the results of such claims cannot be predicted with certainty, management, after consultation with counsel, believes that the final outcome 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.\t\tSubmission of Matters to a Vote of Security Holders\n\tNo matters were submitted to a vote of the security holders of the Company during the last quarter of the fiscal year ended June 30, 1995.\nExecutive Officers of the Company\n\tFollowing is a list of the executive officers of the Company and brief summaries of their business experience. All officers, including executive officers, are elected annually by the Board of Directors at its meeting following the annual meeting of shareholders. The Company is not aware of any officer who was elected to the office pursuant to any arrangement or understanding with another person.\nName\t\t \t\t\t\tAge\t\tPosition\nWilliam D. Rasdal\t\t62\t\tChairman of the Board and Chief Executive Officer\nPaul N. Risinger \t\t62\t\tVice Chairman and Assistant Secretary\nJ. Scott Kamsler\t\t\t47\t\tVice President, Finance, Chief Financial Officer and Secretary\nD. Ronald Duren \t\t52\t\tPresident and Chief Operating Officer, Telecom Solutions\nDale Pelletier\t \t\t44\t\tVice President, Operations, Telecom Solutions\nBrad P. Whitney \t\t41 \t\tPresident and Chief Operating Officer, Linfinity Microelectronics Inc.\n\tMr. Rasdal has served as Chairman of the Board of the Company since July 1989 and as Chief Executive Officer since joining the Company in November 1985. From November 1985 until July 1989, Mr. Rasdal was President and a Director of the Company. From March 1980 until March 1985, Mr. Rasdal was associated with Granger Associates, a manufacturer of telecommunications products. His last position with Granger Associates was President and Chief Operating Officer. From November 1972 to January 1980, Mr. Rasdal was employed by Avantek as Vice President and Division Manager for Avantek's microwave integrated circuit and semiconductor operations. For the thirteen years prior to joining Avantek, he was associated with TRW in various management positions.\n\tMr. Risinger has served as Vice Chairman of the Company since August 1990 and as a Director of the Company since March 1989. From November 1985, when Mr. Risinger joined the Company, until August 1990, he served as Executive Vice President, Advanced Marketing and Technology (AMAT). From April 1981 to May 1985, Mr. Risinger served as Executive Vice President, AMAT, for Granger Associates and was responsible for the development of new businesses for the Digital Signal Processing Division. For four years prior thereto, he served as Executive Vice President and Chief Operating Officer of the Safariland Companies, a manufacturer of equipment and accessories in the public safety field. Prior to joining Safariland, Mr. Risinger was associated with TRW in various management roles in marketing, research and development, and general management for seventeen years.\n\tMr. Kamsler has served as Vice President, Finance, Chief Financial Officer and Secretary since joining the Company in October 1989. Mr. Kamsler has also served as a Director of DSP Technology Inc., a manufacturer of computer automated measurement and control instrumentation, since November 1988. Prior to October 1989, Mr. Kamsler served as Vice President, Finance and Chief Financial Officer of Solitec, Inc. (January 1984 to September 1989), a manufacturer of semiconductor production equipment, DSP Technology Inc. (April 1984 to September 1989), a former affiliate of Solitec, and E-H International, Inc. (March 1982 to January 1984), a manufacturer of automatic test equipment, disk and tape drive controllers, and printed circuit boards. From November 1977 until January 1982, Mr. Kamsler held various finance positions with Intel Corporation.\n\tMr. Duren has served as President and Chief Operating Officer, Telecom Solutions since August 1990. From August 1988 until August 1990, Mr. Duren served as Vice President, Sales, Telecom Solutions. From July 1986, when Mr. Duren joined the Company, until August 1988, he held the position of Director of Marketing and Sales, Telecom Solutions. For three years prior to joining the Company, Mr. Duren served as Vice President, Telco Sales for Granger Associates. Previously, Mr. Duren served in various management positions with AT&T for seventeen years.\n\tMr. Pelletier has served as Vice President, Operations, Telecom Solutions since November 1993. From July 1993 until November 1993, Mr. Pelletier served as Vice President and General Manager, Telecom Solutions. From July 1992 until July 1993, Mr. Pelletier served as General Manager, Synchronization Division, Telecom Solutions. From August 1990 until July 1992, he served as Synchronization Division Manager, Telecom Solutions. From August 1989 until August 1990, Mr. Pelletier served as Operations Manager, Telecom and Analog Solutions Divisions. From August 1986, when Mr. Pelletier joined the Company, until August 1989, he held the position of Manufacturing Manager, Telecom Solutions. Previously, Mr. Pelletier served in various finance and manufacturing positions for nine years with several manufacturing companies.\n\tMr. Whitney joined the Company in November 1992 as President and Chief Operating Officer for Linfinity Microelectronics Inc. and has served in such capacity since that date. He joined the Company after twelve years with Texas Instruments (TI), an electronics company. From November 1990 to November 1992, Mr. Whitney was the Standard Linear Products Manager, Semiconductor Group at TI. From December 1985 to November 1990, Mr. Whitney was the Op Amps Product Manager, Semiconductor Group. From November 1983 through November 1985, Mr. Whitney held various positions within the Voltage Regulator Product Group at TI. For the three years prior to working in the Semiconductor Group, Mr. Whitney was associated with the Consumer Products Group. His last position in this Group was as IC Development Manager, Home Computer Division. Prior to joining TI, Mr. Whitney was an Engineering Supervisor and Instructor for the University of Southwestern Louisiana Departments of Computer Science and Electrical Engineering.\nPART II\nITEM 5.","section_5":"ITEM 5.\t\tMarket for the Registrant's Common Stock and Related Stockholder Matters\n\tThe information set forth under the caption \"Quarterly Results and Stock Market Data (unaudited)\" is incorporated herein by reference to Excerpts of the Annual Report.\nITEM 6.","section_6":"ITEM 6.\t\tSelected Financial Data\n\tThe information set forth under the captions \"Financial Highlights,\" \"Five Year Selected Financial Data\" and the fourth sentence of footnote A to the information set forth under the caption \"Quarterly Results and Stock Market Data (unaudited)\" is incorporated herein by reference to Excerpts of the Annual Report.\nITEM 7.","section_7":"ITEM 7.\t\tManagement's Discussion and Analysis of Financial Condition and Results of Operations\n\tThe information set forth under the caption \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" is incorporated herein by reference to Excerpts of the Annual Report.\nITEM 8.","section_7A":"","section_8":"ITEM 8.\t\tFinancial Statements and Supplementary Data\n\tThe Consolidated Financial Statements, together with the report thereon of Deloitte & Touche LLP dated July 25, 1995, are incorporated herein by reference to Excerpts of the Annual Report.\nITEM 9.","section_9":"ITEM 9.\t\tChanges in and Disagreements with Accountants on Accounting and Financial Disclosure\n\tNot applicable.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10.\t\tDirectors and Executive Officers of the Registrant\n\tInformation regarding directors appearing under the caption \"Proposal No. One - Election of Directors--Nominees\" on pages 2 and 3 of the Company's Proxy Statement for the 1995 Annual Meeting of Shareholders filed with the Commission on September 22, 1995, (the \"Proxy Statement\") is incorporated herein by reference.\n\tInformation regarding executive officers is included in Part I hereof under the heading \"Executive Officers of the Company\" immediately following Item 4 in Part I hereof.\n\tInformation regarding compliance with Section 16(a) of the Securities Exchange Act of 1934, as amended, is incorporated herein by reference from the section entitled \"Other Information--Compliance with Section 16 of the Securities Exchange Act of 1934\" appearing on page 15 of the Proxy Statement.\nITEM 11.","section_11":"ITEM 11.\t\tExecutive Compensation\n\tIncorporated herein by reference to the Proxy Statement under the captions \"Proposal No. One - Election of Directors--Nominees\" on pages 2 and 3, \"Executive Officer Compensation\" on pages 17, 18 and 19, \"Proposal No. One - Election of Directors--Director Compensation\" on page 4 and \"Certain Transactions\" on page 19.\nITEM 12.","section_12":"ITEM 12.\t\tSecurity Ownership of Certain Beneficial Owners and Management\n\tIncorporated herein by reference to the Proxy Statement under the caption \"Other Information--Share Ownership by Principal Shareholders and Management\" on pages 15 and 16.\nITEM 13.","section_13":"ITEM 13.\t\tCertain Relationships and Related Transactions\n\tIncorporated herein by reference to the Proxy Statement under the caption \"Certain Transactions\" on page 19.\nPART IV\nITEM 14.","section_14":"ITEM 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\n\t(a)\tFinancial Statements and Financial Statement Schedules\n\t\tThe following documents are filed as part of this report:\n\t\t\t1.\tFinancial Statements*:\n\t\t\t\tConsolidated Balance Sheets at June 30, 1995 and 1994 \t\t\t\tConsolidated Statements of Operations for the years ended June 30, 1995, 1994 and 1993 \t\t\t\tConsolidated Statements of Shareholders' Equity for the years ended June 30, 1995, \t\t\t\t1994 and 1993 \t\t\t\tConsolidated Statements of Cash Flows for the years ended June 30, 1995, 1994 and \t\t\t\tNotes to Consolidated Financial Statements \t\t\t\tIndependent Auditors' Report\n*\tIncorporated herein by reference to Excerpts of the Company's 1995 Annual Report\n\t\t\t2. \tFinancial Statement Schedules:\n\t\t\t\tIndependent Auditors' Report \t\t\t\tFor the three fiscal years ended June 30, 1995, Schedule II, Valuation and Qualifying Accounts and Reserves\n\tAll other schedules have been omitted because they are not applicable, not required, or the required information is included in the Consolidated Financial Statements or notes thereto.\n\t\t\t3.\tExhibits:\n\t\t\t\tSee Item 14(c) below.\n\t(b)\tReports on Form 8-K\n\t\t\t\tNo reports on Form 8-K were filed during the last quarter of the fiscal year ended June 30, 1995.\n\t(c)\tExhibits\n\t\t\t\tThe exhibits listed on the accompanying index immediately following the signature page are filed as a part of this report.\n\t(d)\tFinancial Statement Schedules\n\t\t\t\tSee Item 14(a) above.\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Shareholders SymmetriCom, Inc.\n\tWe have audited the consolidated financial statements of SymmetriCom, Inc. as of June 30, 1995 and 1994, and for each of the three years in the period ended June 30, 1995, and have issued our report thereon dated July 25, 1995; such financial statements and report are included in your 1995 Annual Report to Shareholders and are incorporated herein by reference. Our audits also included the financial statement schedule of SymmetriCom, Inc. listed in Item 14(a)2. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion 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.\n\/s\/ Deloitte & Touche LLP _________________________ DELOITTE & TOUCHE LLP\nSan Jose, California July 25, 1995\nSCHEDULE II\nSYMMETRICOM, INC.\nVALUATION AND QUALIFYING ACCOUNTS AND RESERVES (In thousands)\n\t\t\t\t\t\t\tBalance\t\t Charged \t\t\t\t\t\t\t at\t\t to Costs\t\t\t Balance \t\t\t \t\t\t\tBeginning\t and Deductions at \t\t\t\t\t\t\t of Year Expenses\t (1) End of Year Year ended June 30, 1995: Accrued warranty expense \t $ 2,071 $ 1,021 $ 572\t $ 2,520 Allowance for doubtful accounts\t$ 242 $ 122 $ 25 $ 339\nYear ended June 30, 1994: Accrued warranty expense\t $ 2,136 $ 386 $ 451 $ 2,071 Allowance for doubtful accounts\t$ 114 $ 155 $ 27 $ 242\nYear ended June 30, 1993: Accrued warranty expense $ 1,047 $ 1,646 $ 557 $ 2,136 Allowance for doubtful accounts\t$ 109 $ 8 $ 3 $ 114\n(1) Deductions represent amounts written off against the reserve or allowance.\nSIGNATURES\n\tPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\n\t\t\t\t\t\t\t\t\t\tSYMMETRICOM, INC.\nDate: September 22, 1995\t\t\t\tBy:\t\/s\/ J. Scott Kamsler ____________________ \t\t\t\t\t\t\t\t\t\t (J. Scott Kamsler) \t\t\t\t\t\t\t\t\t\t Vice President, Finance and \t\t\t\t\t\t\t\t\t\t Chief Financial Officer \t\t\t\t\t\t\t\t\t\t (Principal Financial and \t\t\t\t\t\t\t\t\t\t Accounting Officer)\n\tPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\n\tSignature\t\t\t Title\t\t\t Date\n\t\t\t\t\t\t\tChairman of the Board and \t\t\t\t\t\t\t Chief Executive Officer \/s\/ William D. Rasdal\t\t (Principal Executive Officer)\t September 22, 1995 (William D. Rasdal)\n\t\t\t\t\t\t\tVice President, Finance and \t\t\t\t\t\t\t Chief Financial Officer \/s\/ J. Scott Kamsler (Principal Financial (J. Scott Kamsler)\t\t\t and Accounting Officer)\t September 22, 1995\n\/s\/ Howard Anderson\t\t\t\t Director\t\t September 22, 1995 (Howard Anderson)\n\/s\/ Paul N. Risinger Director\t\t September 22, 1995 (Paul N. Risinger)\n\/s\/ Roger A. Strauch \t\t\t\t Director September 22, 1995 (Roger A. Strauch)\n\/s\/ Robert M. Wolfe Director\t\t September 22, 1995 (Robert M. Wolfe)\nExhibit Number\t\t\t\t\t\tIndex of Exhibits\n\t3.1(1)\t\t\tRestated Articles of Incorporation.\n\t3.2(2)\t\t\tCertificate of Amendment to Restated Articles of Incorporation filed December 11, 1990.\n\t3.3(10)\t\tCertificate of Amendment to Restated Articles of Incorporation filed October 27, 1993.\n\t3.4(10)\t\tBy-Laws, as amended July 21, 1993.\n\t4.1(3)\t\t\tCommon Shares Rights Agreement dated December 6, 1990, between Silicon General, Inc. and Manufacturers Hanover Trust Company of California, including the form of \t\t\t \t\t Rights Certificate and the Summary of Rights attached thereto as Exhibits A and B, respectively.\n\t4.2(4)\t\t\tAmendment to the Common Shares Rights Agreement dated February 5, 1993 between Silicon General, Inc. and Chemical Trust Company of California, formerly \t\t\t\t \t\t Manufacturers Hanover Trust Company of California, including the form of Rights Certificate and the Summary of Rights attached thereto as Exhibits A and B, respectively.\n\t10.1(5)(12)\tAmended and Restated Employees' Stock Option Plan (1980), with form of Stock Option Agreement (1980 Plan).\n\t10.2(5)(12)\tAmended and Restated Non-Qualified Stock Option Plan (1982), with form of Employee Non-Qualified Stock Option (1982 Plan).\n\t10.3(5)(12)\tAmended and Restated Employee Stock Option Plan (1983), with form of Stock Option Under Incentive Stock Option Plan 1983.\n\t10.4(12)\t\t1990 Director Option Plan (as amended through October 25, 1995).\n\t10.5(5)(12)\tForm of Director Option Agreement.\n\t10.6(12)\t\t1990 Employee Stock Plan (as amended through October 25, 1995).\n\t10.7(5)(12)\tForms of Stock Option Agreement, Restricted Stock Purchase Agreement, Tandem Stock Option\/SAR Agreement, and Stock Appreciation Right Agreement for use under \t\t\t\t \t the 1990 Employee Stock Plan.\n\t10.8(11)(12)\t1995 Employee Stock Purchase Plan, with form of Subscription Agreement.\n\t10.9(2)\t\tLoan Agreements between the Company and the John Hancock Mutual Life Insurance Company, dated October 18, 1990, including exhibits thereto.\n\t10.10(6)\t\tLease Agreement by and between the Company and Menlo Tasman Investment Company dated June 16, 1986, and Amendment to Lease dated March 27, 1987.\n\t10.11(2)\t\tLease Agreement by and between Zeltex Puerto Rico, Inc., a subsidiary of the Company, and Puerto Rico Industrial Development Company dated January 22, 1991.\n\t10.12(10)\t\tLease Agreement by and between Telecom Solutions Puerto Rico, Inc., a subsidiary of the Company, and Puerto Rico Industrial Development dated August 9, 1994.\n\t10.13(10)\t\tLease Agreement by and between Navstar Systems Limited, a subsidiary of the Company, and Baker Hughes Limited dated April 22, 1994.\n\t10.14(10)\t\tRevolving Credit Loan Agreement between the Company and Comerica Bank-Detroit dated December 1, 1993.\n\t10.15\t \t\tFirst Amendment to the Revolving Credit Loan Agreement between the Company and Comerica Bank-Detroit dated April 20, 1995.\n\t10.16(7)\t\tForm of Indemnification Agreement.\n\t10.17(9)\t\tLinfinity Microelectronics Inc. Common Stock and Series A Preferred Stock Purchase Agreement dated June 28, 1993.\n\t10.18(9)\t\tTax Sharing Agreement between Linfinity Microelectronics Inc. and the Company dated June 28, 1993.\n\t10.19(9)\t\tIntercompany Services Agreement between Linfinity Microelectronics Inc. and the Company dated June 28, 1993.\n\t10.20(9)(12)\tLinfinity Microelectronics Inc. 1993 Stock Option Plan with form of Stock Option Agreement.\n\t10.21(9)\t\tLinfinity Microelectronics Inc. Form of Indemnification Agreement.\n\t10.22(9)(12)\tEmployment offer letter by and between the Company and Brad P. Whitney, President and Chief Operating Officer, Linfinity Microelectronics Inc. dated November 20, 1992.\n\t10.23(8)\t\tAgreement for Sale and Purchase of the Navstar Business of Radley Services Limited.\n\t10.24(8)\t\tAgreement for the Sale and Purchase of Certain Assets of Navstar Electronics, Inc.\n\t13.1\t \t\tSymmetriCom, Inc. Excerpts of the 1995 Annual Report.\n\t21.1\t \t\tSubsidiaries of the Company.\n\t23.1\t\t Independent Auditors' Consent.\n\t27.1\t\t\t Financial Data Schedule.\nFootnotes to Exhibits\n\t(1)\t\t\t\tIncorporated by reference from Exhibits to Annual Report on Form 10-K for the fiscal year ended July 2, 1989.\n\t(2)\t\t\t\tIncorporated by reference from Exhibits to Annual Report on Form 10-K for the fiscal year ended June 30, 1991.\n\t(3)\t\t\t\tIncorporated by reference from Exhibits to Registration Statement on Form 8-A filed with the Securities and Exchange Commission on December 8, 1990.\n\t(4)\t\t\t\tIncorporated by reference from Exhibits to Registration Statement on Form 8-A filed with the Securities and Exchange Commission on February 11, 1993.\n\t(5)\t\t\t\tIncorporated by reference from Exhibits to Registration Statement on Form S-8 filed with the Securities and Exchange Commission on December 24, 1990.\n\t(6)\t\t\t\tIncorporated by reference from Exhibits to Annual Report on Form 10-K for the fiscal year ended June 28, 1987.\n\t(7)\t\t\t\tIncorporated by reference from Exhibits to the 1990 Proxy Statement.\n\t(8)\t\t\t\tIncorporated by reference from Exhibits to Current Report on Form 8-K filed with the Securities and Exchange Commission on September 2, 1993.\n\t(9)\t\t\t\tIncorporated by reference from Exhibits to Annual Report on Form 10-K for the fiscal year ended June 30, 1993.\n\t(10)\t\t\tIncorporated by reference from Exhibits to Annual Report on Form 10-K for the fiscal year ended June 30, 1994.\n\t(11)\t\t\tIncorporated by reference from Exhibits to Registration Statement on Form S-8 filed with the Securities and Exchange Commission on January 4, 1995.\n\t(12)\t\t\tIndicates a management contract or compensatory plan or arrangement.","section_15":""}
{"filename":"28385_1995.txt","cik":"28385","year":"1995","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"ITEM 3 - LEGAL PROCEEDINGS.\nDetroit Edison in the ordinary course of its business, is involved in a number of suits and controversies including claims for personal injuries and property damage and matters involving zoning ordinances and other regulatory matters. As of December 31, 1995, Detroit Edison was named as defendant in 129 lawsuits involving claims for personal injuries and property damage and had been advised of 25 other potential claims not evidenced by lawsuits.\nFrom time to time Detroit Edison has paid nominal penalties which were administratively assessed by the United States Coast Guard, United States Department of Transportation under the Federal Water Pollution Control Act, as amended, with respect to minor accidental oil spills at Detroit Edison's power plants into navigable waters of the United States. Payment of such penalties represents full disposition of these matters.\nDetroit Edison in its 1982 main electric rate case requested the MPSC to recognize the costs associated with the abandoned Greenwood Unit Nos. 2 and 3 for ratemaking purposes. In March 1983, the MPSC, consistent with past precedent, granted Detroit Edison authority to defer, amortize and recover these costs (over a period of 10 years) through the ratemaking process. The Michigan Attorney General appealed the MPSC's order. In August 1990, the Ingham County Circuit Court remanded this matter to the MPSC for additional findings of fact. On November 1, 1991, the MPSC issued its final order on remand affirming the earlier decision to allow rate recovery of the costs. The Ingham County Circuit Court has removed this case from the assigned judges docket pending resolution of issues determined favorable to Detroit Edison's position in a Michigan Supreme Court proceeding. Detroit Edison has amortized the costs associated with the abandoned Greenwood Unit Nos. 2 and 3 in accordance with the MPSC's order. The amortization was completed in 1993.\nSee Note 12.\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 listed on the New York Stock Exchange, which is the principal market for such stock, and the Chicago Stock Exchange. The following table indicates the reported high and low sales prices of the Company's Common Stock on the Composite Tape of the New York Stock Exchange and dividends paid per share for each quarterly period during the past two years:\nAt December 31, 1995, there were 145,119,875 shares of the Company's Common Stock outstanding. These shares were held by a total of 143,177 shareholders.\nThe Company's By-Laws provide that Chapter 7B of the Michigan Business Corporation Act (\"Act\") does not apply to the Company. The Act regulates shareholder rights when an individual's stock ownership reaches at least 20 percent of a Michigan corporation's outstanding shares. As a result of the amendment, a shareholder seeking control of the Company cannot require the Company's Board of Directors to call a meeting to vote on issues related to corporate control within 10 days, as stipulated by the Act.\nThe level of dividends is dependent on earnings and other business conditions, each of which is periodically reviewed by the Company's Board of Directors.\nITEM 6","section_6":"ITEM 6 - SELECTED FINANCIAL DATA.\nITEM 7","section_7":"ITEM 7 - MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS DTE ENERGY COMPANY, THE DETROIT EDISON COMPANY AND SUBSIDIARY COMPANIES\nThis discussion and analysis should be read in conjunction with the Consolidated Financial Statements and accompanying Notes thereto, contained herein.\nCORPORATE STRUCTURE Effective January 1, 1996, DTE Energy Company became the parent holding company of The Detroit Edison Company (\"Detroit Edison\"). On January 1, 1996, the holders of Detroit Edison's common stock exchanged such stock on a share-for-share basis for the common stock of DTE Energy Company (\"Company\"). In addition, certain non-utility subsidiaries of Detroit Edison were transferred to the Company. Detroit Edison is the principal subsidiary of the Company and, as such, this discussion explains material changes in results of operations of both the Company and Detroit Edison and identifies recent trends and events affecting both the Company and Detroit Edison. For the periods presented, the Company's operations and those of Detroit Edison are substantially the same.\nRESULTS OF OPERATIONS For the year ended December 31, 1995, the Company's net income was $405.9 million, or $2.80 per common share, up 4% from the $390.3 million, or $2.67 per common share earned in 1994. The increase in net income was due to higher sales of electricity in 1995. The sales increase was partially offset by higher operating expenses, including a non-cash loss of $42 million ($32 million after-tax), or $0.22 per common share, on Detroit Edison's steam heating business due to the Company's adoption in the fourth quarter of 1995 of Statement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of\" (\"SFAS No. 121\"). For the year ended December 31, 1994, the Company's net income was $390.3 million, or $2.67 per common share, a decrease of 20.5% from the $491.1 million, or $3.34 per common share earned in 1993. The decrease in net income was due in part to a January 21, 1994 order by the Michigan Public Service Commission (\"MPSC\"), which reduced Detroit Edison's rates by $78 million annually and increased depreciation and operation expenses by $84 million annually. In addition, accretion income decreased and amortization of the Fermi 2 nuclear power plant phase-in plan increased significantly in 1994. Also, Detroit Edison incurred additional one-time charges at the Fermi 2 nuclear power plant, which was out of service in 1994 due to equipment failure, for maintenance expenses and the establishment of a reserve for estimated Fermi 2 capacity factor performance disallowances in 1994-1998. The decrease in net income was limited by higher system sales and lower interest expense due to the early redemption and refinancing of higher cost debt and the redemption of maturing debt. For the year ended December 31, 1993, the Company's net income was $491.1 million, or $3.34 per common share, a decrease of 11.9% from the $557.5 million, or $3.79 per common share earned in 1992. The decrease in net income was due to a 5% reduction in Detroit Edison's rates, effective January 1, 1993, which reduced 1993 operating revenues by $169 million, or $0.75 per common share, higher operating expenses (including amortization of Fermi 2 nuclear power plant phase-in plan deferrals and higher federal income tax expense of $10.4 million for the full year 1993, or $0.07 per common share, due to an increase in the corporate income tax rate from 34% to 35% retroactive to January 1, 1993) and lower non-operating income, partially offset by higher sales and lower interest expense due to the early redemption and refinancing of higher cost debt and the redemption of maturing debt. The reduction in electric rates was due to reinstatement of the Power Supply Cost Recovery Clause, which was suspended for a four-year period, resulting in lower billings to customers of $106 million in 1993 due to lower fuel expenses, and the expiration of an expense stabilization procedure surcharge on January 1, 1993 which provided annual revenues of $63 million in 1992 for the effects of inflation. Warm summer weather and improved economic conditions in Southeastern Michigan contributed to the sales increase. At December 31, 1995, the book value of the Company's common stock was $23.62 per share, an increase of 3.2% since December 31, 1994. Return on average total common shareholders' equity was 11.8% in 1995, 11.6% in 1994 and 15.2% in 1993. Detroit Edison's ratio of earnings to fixed charges for 1995, 1994 and 1993 was 3.21, 3.13, and 3.25, respectively. Detroit Edison's ratio of earnings to fixed charges and preferred and preference stock dividends for 1995, 1994 and 1993 was 2.82, 2.73, and 2.88, respectively.\nRATE CHANGES The January 21, 1994 MPSC rate order reduced Detroit Edison's rates by $78 million annually. In keeping with the MPSC's recognition of the need for industrial customers to be competitive, the January 1994 rate reduction was allocated among the various classes of customers approximately as follows: Industrial-$43 million, Commercial-$24 million, Residential-$10 million and Governmental-$1 million.\nMANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS DTE ENERGY COMPANY, THE DETROIT EDISON COMPANY AND SUBSIDIARY COMPANIES\nOn March 23, 1995, the MPSC issued an order approving Detroit Edison's 10-year special manufacturing contracts with Chrysler Corporation, Ford Motor Company and General Motors Corporation. The revenue reductions from these contracts initially will amount to approximately $30 million annually and increase to $50 million annually in 1999-2004, which Detroit Edison expects to offset by further reducing its operating expenses.\nResidential and commercial sales increased due to substantially warmer summer weather increasing air conditioning and cooling-related loads and colder fall weather increasing heating-related loads in the fourth quarter. Improved economic conditions spurred higher sales to commercial, automotive and other industrial customers. Sales to other customers increased due to higher sales to wholesale for resale customers.\nResidential sales increased due to substantially warmer weather in the second quarter resulting in increased air conditioning and cooling-related loads, partially offset by lower cooling-related loads in the third quarter. The increased heating-related loads in the first quarter were offset by decreased heating-related loads in the fourth quarter. Commercial sales increased due primarily to improved economic conditions and increased cooling-related loads. Industrial sales increased as a result of higher sales to automotive, steel and other manufacturing customers reflecting the improvement in the economy. The decreased sales to other customers reflect lower sales to wholesale for resale customers.\nINTERCONNECTION SALES Interconnection sales represent sales between utilities to meet energy needs as a result of demand and\/or generating unit availability.\nInterconnection sales increased due to improved availability of energy for sale and lower dispatch prices in meeting the increased demand for energy during the warmer summer and colder fall period.\nInterconnection sales decreased due to the reduced availability of energy for sale as a result of the Fermi 2 outage and lower sales to Consumers Power Company.\nFERMI 2 CAPACITY FACTOR PERFORMANCE STANDARD RESERVE This reserve is discussed in Note 3 of the Notes to Consolidated Financial Statements.\nOPERATING EXPENSES\nFUEL AND PURCHASED POWER Fuel and purchased power expenses increased (decreased) due to the following factors:\nThe decrease in average unit cost was due to declining fuel prices resulting from greater use of lower-cost Western low-sulfur coal, lower coal contract buyout expense and increased lower-cost nuclear generation.\nThe increase in average unit cost resulted from replacing lower-cost nuclear generation with higher-cost fossil generation and purchased power due to the Fermi 2 outage in 1994 as a result of a turbine-generator failure in December 1993.\nOTHER OPERATION\nOther operation expense increased due primarily to higher incentive award expenses related to a shareholder value improvement plan ($14.5 million), higher storm expenses ($13.1 million), an increase in a reserve for the write-off of obsolete and excess stock material ($9 million), demand-side management expenses ($8.6 million) and a reserve for settlement of the Ludington fish mortality case ($8.4 million). These expenses were partially offset by lower nuclear plant expenses ($15.5 million), expenses recorded in the year-earlier period for service quality claims ($8.7 million) and lower uncollectible expense ($6.9 million).\nOther operation expense increased due primarily to other postretirement health care and life insurance benefits expense ($48.3 million), service quality claims expense ($8.7 million) and higher nuclear plant ($8.1 million), transmission and\ndistribution ($9.7 million) and demand-side management expenses ($4.3 million). These increases were partially offset by lower incentive award expenses related to a shareholder value improvement plan ($18.7 million), expenses recorded in the year-earlier period for the write-off of obsolete and excess stock material ($12.4 million) and a reserve for steam purchases under the agreement with the Greater Detroit Resource Recovery Authority ($11 million), lower uncollectible ($9.9 million) and employee reorganization ($6.5 million) expenses and lower injuries and damages expense ($8.1 million).\nMAINTENANCE\nMaintenance expense decreased due primarily to lower nuclear ($17 million) and fossil ($4.3 million) plant expenses.\nMaintenance expense increased due primarily to higher nuclear plant ($17.6 million) and storm ($8.9 million) expenses, partially offset by lower fossil plant ($8.7 million) and line clearance ($5.3 million) expenses. While Fermi 2 was down for repair in 1994, Detroit Edison elected to upgrade various plant facilities which resulted in higher nuclear plant maintenance expense.\nSTEAM PLANT IMPAIRMENT LOSS\nAs the result of continuing losses in the operation of its steam heating business, upon adoption of SFAS No. 121 in the fourth quarter of 1995, Detroit Edison wrote off the remaining net book value of its steam heating plant assets of $42 million.\nDEPRECIATION AND AMORTIZATION\n1995 AND 1994 Depreciation and amortization expense increased due to increases in plant in service, including internally developed software costs, and increased Fermi 2 decommissioning costs authorized by a January 1994 MPSC rate order.\nDEFERRED FERMI 2 AMORTIZATION\n1995 AND 1994 Deferred Fermi 2 amortization, a non-cash item of income, was recorded beginning with Detroit Edison's purchase of the Wolverine Power Supply Cooperative, Inc.'s ownership interest in Fermi 2 in February 1990. The annual amount deferred decreases each year through 1999.\nAMORTIZATION OF DEFERRED FERMI 2 DEPRECIATION AND RETURN\n1995 AND 1994 Deferred Fermi 2 depreciation and return, non-cash items of income, were recorded beginning with the implementation of the Fermi 2 rate phase-in plan in January 1988. The annual amounts of deferred depreciation and return decreased each year through 1992. Beginning in 1993 and continuing through 1998, these deferred amounts will be amortized to operating expense as the cash recovery is realized through revenues.\nTAXES OTHER THAN INCOME TAXES\nTaxes other than income taxes decreased due to lower payroll and property taxes.\nTaxes other than income taxes decreased due primarily to lower property taxes, partially offset by higher Michigan Single Business Tax (\"MSBT\").\nINCOME TAXES\nIncome taxes increased due primarily to higher pretax income.\nIncome taxes decreased due primarily to lower pretax income, partially offset by higher prior years' federal income tax accrual. In March 1994, the Company and the Internal Revenue Service (\"IRS\") reached a settlement of the Company's income tax returns for the years 1987 and 1988.\nOTHER INCOME AND (DEDUCTIONS) - NET\nOther deductions increased due to higher promotional practices expense ($8.3 million), expenses incurred in the formation of a holding company ($3.1 million) and joint-use contract costs ($2.7 million), partially offset by lower expenses related to the sale of accounts receivable and unbilled revenues ($6.1 million) and a decrease in the write-off of premiums and expenses related to the portion of Detroit Edison's 1989 Series A Mortgage Bonds not refinanced ($3.5 million).\nOther deductions increased slightly due primarily to the write-off of premiums and expenses related to the portion of Detroit Edison's 1989 Series A Mortgage Bonds not refinanced ($5.2 million) and an accrual for a contribution to the Detroit Edison Foundation ($5 million), partially offset by an expense recorded in 1993 for decommissioning of Fermi 1 ($7.6 million), an experimental nuclear unit that has been shut down since 1972.\nACCRETION INCOME\n1995 AND 1994 Accretion income, a non-cash item of income, was recorded beginning in January 1988 to restore to income, over the period 1988-1998, losses recorded due to discounting indirect disallowances for Greenwood Unit No. 1 for the period that plant was not allowed in rate base (1988-1993) and for $300 million of Fermi 2 plant costs being recovered from 1989 to 1998 with no return. The annual amount of accretion income recorded decreases each year through 1998. In January 1994, accretion income decreased due to the return to rate base of Greenwood Unit No. 1.\nLONG-TERM DEBT INTEREST CHARGES\nLong-term debt interest charges increased due to the issuance of Quarterly Income Debt Securities (\"QUIDS\") and the timing of the early redemption and refinancing of securities when economic.\nLong-term debt interest charges decreased due to the early redemption and refinancing of securities when economic and the redemption of maturing securities.\nMANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS DTE ENERGY COMPANY, THE DETROIT EDISON COMPANY AND SUBSIDIARY COMPANIES\nOTHER INTEREST CHARGES\nOther interest charges decreased due primarily to lower levels of short-term borrowings.\nOther interest charges increased due to higher levels of short-term borrowings, accruals for prior years' MSBT audits and the settlement of 1987 and 1988 IRS audits.\nPREFERRED AND PREFERENCE STOCK DIVIDENDS OF SUBSIDIARY\nPreferred stock dividends of subsidiary decreased due to the exchange of a portion of Cumulative Preferred Stock 7.75% Series for QUIDS and the conversion and redemption of Cumulative Preferred Stock 5 1\/2% Convertible Series.\nPreferred and preference stock dividends of subsidiary decreased slightly due to the optional and mandatory redemption of outstanding shares in 1993.\nLIQUIDITY AND CAPITAL RESOURCES\nCOMPETITION\nFORMATION OF A HOLDING COMPANY The business of energy supply is experiencing rapid change as competition, coupled with statutory reform, is being introduced into the public utility sector. Competition is viewed by legislators and regulators, at both the federal and state levels, as a method of reducing utility rates while stimulating overall economic growth. In order to position itself for potential changes in the electric utility industry, Detroit Edison adopted a holding company structure, effective January 1, 1996. The new holding company structure, under which Detroit Edison is a wholly-owned subsidiary of the Company, is designed to provide financial flexibility for the development of new energy-related businesses. It is also a mechanism for separating the regulated utility business of Detroit Edison from non-regulated businesses thereby protecting the utility business from the potential volatility of non-utility operations. The Company has no significant operations of its own. Detroit Edison is the Company's principal operating subsidiary, comprising substantially all of the Company's assets. Certain of the Company's wholly-owned subsidiaries are engaged in non-regulated energy-related businesses that are still in the formative stages. DTE Capital Corporation (\"DTE Capital\") was incorporated in 1995 to act as the financing vehicle for the Company's non-utility affiliates. DTE Capital is in the process of negotiating a $200 million bank revolving credit agreement. Since DTE Capital does not have an established credit history, the Company anticipates that it will be asked to provide credit support for DTE Capital's initial financing activities.\nTHE DETROIT EDISON COMPANY The electric utility industry is facing serious issues as legislators and regulators consider various proposals designed to reduce rates and promote economic growth through competition. Municipalization, deregulation, cogeneration, independent power production, open access to transmission lines, competitive bulk power supply markets and the unbundling of utility products and services are issues under consideration. There is also a recognition by legislators and regulators that the stranded costs of utilities must be addressed as deregulation proceeds. In March 1995, the Federal Energy Regulatory Commission (\"FERC\") issued a Notice of Proposed Rulemaking on Promoting Wholesale Competition Through Open Access Non-discriminatory Transmission Services by Public Utilities. According to the FERC, the goals of the proposed new rules are to facilitate the development of a competitive market by ensuring that wholesale buyers and sellers can reach each other and to eliminate anticompetitive and discriminatory practices in transmission services which, in turn, should lead to lower electric rates. On January 8, 1996, Michigan Governor John Engler forwarded to the MPSC a report on economic development recommendations for electric and gas utility reform in Michigan prepared by the Michigan Jobs Commission (\"MJC\"). The essential component of the MJC's recommended strategy for lowering energy costs is the promotion of competition and customer choice. The Governor strongly encouraged the MPSC to use the report as guiding principles in its continued efforts to promote competition within reasonably established time frames. The MJC's recommendations, if implemented would: (1) allow new industrial and commercial load to purchase energy from providers of their choice beginning January 1, 1997 assuming that the Michigan public utilities subject to the new rules would be permitted to sell power on a reciprocal basis, (2) establish a Michigan statewide power pool by January 1, 1998, and (3) permit all industrial and commercial customers to be able to choose their energy providers by January 1, 2001. The proposals recognize that the transition to a more competitive market requires that the recovery of stranded costs be addressed. In addition, the proposals favor the unbundling of rate tariffs into functional components. The MPSC has not yet taken action with respect to the MJC's recommendations. While Detroit Edison is unable to predict the outcome of the FERC rulemaking and the Michigan proposals, increased wholesale competition is anticipated. On June 19, 1995, the MPSC issued a final order finding that an experimental retail wheeling program is in the public interest and establishing rates and charges for the five-year experimental program. Under the program, retail wheeling customers would make their own arrangements to procure power. Implementation of the experimental program would be limited to 90 megawatts (\"MW\") for Detroit Edison and will be coordinated with Detroit Edison's next solicitation of new capacity. On July 19, 1995, Detroit Edison filed a claim of appeal with the Michigan Court of Appeals claiming that the MPSC does not have the authority to order Detroit Edison to participate in retail wheeling and that jurisdiction over transmission rates for wheeling resides with the FERC. In response to the changing market for electricity, Detroit Edison has developed a number of programs designed to increase its efficiency and competitive status and address customer needs, which include implementing an interruptible rate for large industrial customers. The January 21, 1994 MPSC rate order provided that up to 650 MW may be sold under this interruptible rate, with Detroit Edison absorbing revenue losses associated with 250 MW.\nCompetitive status and customer needs were also addressed when, Detroit Edison entered into 10-year special manufacturing contracts with Chrysler Corporation, Ford Motor Company and General Motors Corporation, covering 54 of the Big Three automakers' largest manufacturing locations in Southeastern Michigan. These special manufacturing contracts are available to customers with a total connected load of 100 MW or more for specific locations of 5 MW and over. Service under the special manufacturing contracts includes both firm and interruptible service, which is priced to provide customers with competitively-based electric rates. Detroit Edison continues to review potential energy services as a method of remaining competitive while diversifying within the scope of its core business. In addition, the Company anticipates that its affiliates may also assist in overall customer satisfaction by offering energy-related services.\nCASH GENERATION AND CASH REQUIREMENTS\nCONSOLIDATED STATEMENT OF CASH FLOWS The Company generates substantial cash flows from operating activities as shown in the Consolidated Statement of Cash Flows. Net cash from operating activities, which is the Company's primary source of liquidity, was $913 million in 1995, $923 million in 1994 and $1,110 million in 1993. Net cash from operating activities decreased slightly in 1995 as a result of the repurchase of $200 million of customer accounts receivable and unbilled revenues, partially offset by higher non-cash charges to income and higher net income. Net cash from operating activities decreased in 1994 due to lower net income and changes in current assets and liabilities, partially offset by higher non-cash charges to income for the Fermi 2 phase-in plan and depreciation and amortization. Net cash used for investing activities increased in 1995 due primarily to higher plant and equipment expenditures. Net cash used for investing activities increased in 1994 due primarily to increased funding of nuclear decommissioning trust funds, the purchase of leased equipment and non-utility investments, partially offset by lower plant and equipment expenditures. Detroit Edison has engaged in an extensive debt refinancing program in recent years. Assuming favorable economic conditions, Detroit Edison expects that it will continue to refinance existing higher-cost debt and equity securities. Also, in 1994, as a result of a plan change, Detroit Edison entered into the one-time purchase of common stock from the trustee of the Detroit Edison Savings & Investment Plans.\nADDITIONAL INFORMATION In May 1995, FERC issued its order authorizing the continuation of Detroit Edison's $1 billion of short-term borrowing authority. This authority will be in effect through May 31, 1997. An MPSC order permits Detroit Edison to issue approximately $3.5 billion of securities for the purpose of refinancing debt and preferred and\/or preference stock (issued prior to 1993) prior to maturity (when economic) and at maturity, and to replace funds used for those purposes. Detroit Edison also has MPSC authority to refinance substantially all non-taxable debt obligations. Detroit Edison has an effective Shelf Registration Statement on file with the Securities and Exchange Commission pursuant to which it may issue up to $350 million in debt securities. On February 13, 1996, Detroit Edison issued $185 million of 7 5\/8% Quarterly Income Debt Securities. Also, Detroit Edison called for redemption all of the outstanding Cumulative Preferred Stock, 7.68% Series, 7.45% Series and 7.36% Series, totaling $185 million, at per share redemption prices of $101 plus accrued dividends. Such redemption will occur on March 21, 1996. Cash requirements for scheduled long-term debt redemptions are expected to be $119 million, $144 million, $169 million, $219 million and $194 million for 1996, 1997, 1998, 1999 and 2000, respectively. Detroit Edison's cash requirements for capital expenditures are expected to be approximately $2.1 billion for the period 1996 through 2000. In 1996, cash requirements for capital expenditures are estimated at $478 million. Environmental expenditures are expected to approximate $102 million for the period 1996 through 2000, including expenditures for Clean Air Act compliance requirements. See \"Environmental Matters\" herein. Detroit Edison's internal cash generation is expected to be sufficient to meet cash requirements for capital expenditures as well as scheduled long-term debt redemption requirements. Detroit Edison had total short-term credit arrangements of approximately $432 million at December 31, 1995, under which $37 million of borrowings were outstanding.\nCAPITALIZATION The Company's capital structure ratios (excluding long-term debt due within one year) were as follows:\nFERMI 2 Detroit Edison's liquidity has improved since the 1988 commercial operation of Fermi 2, a nuclear generating unit comprising 27% of total assets and 9% of summer net rated capability, and lower levels of capital expenditures. The commercial operation of Fermi 2 completed Detroit Edison's power plant construction program. Detroit Edison has no current plans for additional generating plants. Ownership of an operating nuclear generating unit such as Fermi 2 subjects Detroit Edison to significant additional risks. Nuclear plants are highly regulated by a number of governmental agencies concerned with public health and safety as well as the environment, and consequently, are subject to greater risks and scrutiny than conventional fossil-fueled plants. Fermi 2 was out of service in 1994 and part of 1995 due to a December 1993 turbine-generator failure. Major repairs were completed in 1994 and early 1995. These repair costs are approximately $80 million for which to date Detroit Edison has received partial insurance payments of $55 million for property\nMANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS DTE ENERGY COMPANY, THE DETROIT EDISON COMPANY AND SUBSIDIARY COMPANIES\ndamage. In addition, Detroit Edison has received partial insurance payments of $74.2 million for replacement power costs through December 31, 1995. Fermi 2 was operating at 874 MW at the end of December 1995 and the unit's capacity factor was 51.4% for 1995. Detroit Edison is currently operating Fermi 2 without the large seventh and eighth stage turbine blades on the three low-pressure turbines. The new turbine shafts and blades for these low-pressure turbines are being manufactured and will be installed during the next refueling outage in 1996. The expected cost of replacing the major turbine components in 1996 is between $45 million and $50 million. These costs will not be covered by insurance. These costs will be capitalized and are expected to be recovered in rates because such costs are less than the cumulative amount available under the cap on Fermi 2 capital expenditures, a provision of the MPSC's December 1988 order. At December 31, 1995, Fermi 2 was insured for property damage in the amount of $2.75 billion and Detroit Edison had available approximately $8.5 billion in public liability insurance. To the extent that insurable claims for replacement power, property damage, decontamination, repair and replacement and other costs arising from a nuclear incident at Fermi 2 exceed the policy limits of insurance, or to the extent that such insurance becomes unavailable in the future, Detroit Edison will retain the risk of loss. The Financial Accounting Standards Board is reviewing the accounting for removal costs, including decommissioning of nuclear power plants. If current electric utility industry accounting practices for such decommissioning are changed: (1) annual provisions for decommissioning could increase, and (2) the estimated cost for decommissioning could be recorded as a liability rather than as accumulated depreciation.\nFUTURE SALES GROWTH Since 1980, the compound annual sales growth was 1.8% and peak demand growth was 2.4% (after adjusting for the effects of unusual weather). System sales are expected to grow at a compound annual rate of about 1.5% per year and system demand at about 1.3% per year for the next 15 years.\nMEETING ENERGY DEMANDS Detroit Edison expects to meet its near-term demand for energy through the implementation of new load management programs, and eventually through the return to service, subject to environmental regulations, of power plant units currently in economy reserve status when energy demand and consumption requirements provide economic justification. The return to service of these units is conditioned upon the outcome of a competitive bidding process which was established by an MPSC order issued in July 1992. On May 1, 1995, Detroit Edison filed its preliminary Request for Proposal to solicit bids for the acquisition of new capacity starting in the year 2004. Detroit Edison is proposing customer load management options which have the potential to provide an additional 500 MW of peak reduction by the year 2003. Detroit Edison has filed a proposed retail wheeling tariff and proposal for implementing the experimental retail wheeling program. See \"Competition\" herein. The need for capacity will determine the retail wheeling program start date. On October 13, 1995, the MPSC Staff submitted its direct testimony suggesting that Detroit Edison will need more capacity by 1997 and that the experiment should begin in 1998. On December 5, 1995, Detroit Edison filed rebuttal testimony indicating that the most recent resource plan still indicates that capacity will not be required prior to 2003.\nINFLATION Inflation is a measure of the purchasing power of the dollar. In 1995, the inflation rate, as defined by the Consumer Price Index, was 2.5%. Although the current inflation rate is relatively low, its compound effect through time can be significant, primarily in its effect on Detroit Edison's ability to replace its investment in utility plant. The regulatory process limits the amount of depreciation expense recoverable through revenues to the historical cost of Detroit Edison's investment in utility plant. Such amount produces cash flows which are inadequate to replace such property in future years. However, Detroit Edison believes that it will be able to recover the increased cost of replacement facilities when, and if, replacement occurs.\nENVIRONMENTAL MATTERS Protecting the environment from damage, as well as correcting past environmental damage, continues to be the focus of state and federal regulators. Committees at both the state and federal level are studying the effects of a wide array of chemicals and electromagnetic fields as well as global warming (as potentially affected by carbon dioxide emissions). Legislation and\/or rulemaking resulting from these and any future studies could further impact the electric utility industry including Detroit Edison. The Environmental Protection Agency and the Michigan Department of Environmental Quality have aggressive programs regarding the clean-up of contaminated property. Detroit Edison anticipates that it will be periodically included in these types of environmental proceedings. Further, additional environmental expenditures, although difficult to quantify, will be necessary as Detroit Edison prepares to comply with the phase-in of the 1990 Amendments to the federal Clean Air Act. Detroit Edison currently meets the first phase of sulfur dioxide emissions and nitrogen oxides emissions requirements. The second phase begins in the year 2000. Detroit Edison currently burns some level of low-sulfur coal (less than 1% sulfur) at all its coal-fired units and believes it can meet the second phase sulfur dioxide emission requirements by either increasing the amount of low-sulfur coal used at certain units, by purchasing sulfur dioxide emission allowances, or by doing some combination of both, depending upon which strategy proves to be the best economic choice. Current projections indicate that annual fuel costs may increase by $13 million to $20 million in the period 2000-2009 in order to comply with new sulfur dioxide emissions requirements. In addition, approximately $59 million in capital expenditures may be necessary for nitrogen oxides emissions requirements. Detroit Edison expects that substantially all of the costs of environmental compliance will be recovered through the ratemaking process. The Company has accrued for settlements in environmental matters discussed in Note 12 of the Notes to Consolidated Financial Statements.\nITEM 8","section_7A":"","section_8":"ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe following consolidated financial statements and schedules are included herein.\nNote: Detroit Edison's financial statements are presented here for ease of reference and are not considered to be part of Part II - Item 8 of the Company's report.\nINDEPENDENT AUDITORS' REPORT\nTo the Boards of Directors and Shareholders of DTE Energy Company and The Detroit Edison Company\nWe have audited the consolidated balance sheets of DTE Energy Company and subsidiary companies and of The Detroit Edison Company and subsidiary companies (together, the \"Companies\") as of December 31, 1995, and the related consolidated statements of income, cash flows, and common shareholders' equity for the year then ended. Our audits also included the financial statement schedule listed in the Index at Item 8. These financial statements and financial statement schedule are the responsibility of the Companies' management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, such consolidated financial statements referred to above present fairly, in all material respects, the financial position of DTE Energy Company and subsidiary companies and of The Detroit Edison Company and subsidiary companies at December 31, 1995, and the results of their operations and their cash flows for the year then ended in conformity with generally accepted accounting principles. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements of the Companies taken as a whole, presents fairly in all material respects the information set forth therein.\nDELOITTE & TOUCHE LLP Detroit, Michigan January 22, 1996\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholders of DTE Energy Company and The Detroit Edison Company\nIn our opinion, the consolidated balance sheet, and the related consolidated statements of income, common shareholders' equity and of cash flows present fairly, in all material respects, the financial position of DTE Energy Company and subsidiary companies and of The Detroit Edison Company and subsidiary companies at December 31, 1994 and the 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. 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. We have not audited the consolidated financial statements of DTE Energy Company and subsidiary companies and of The Detroit Edison Company and subsidiary companies for any period subsequent to December 31, 1994.\nPRICE WATERHOUSE LLP Detroit, Michigan January 23, 1995 except for Note 1, paragraph one and three, which is as of January 1, 1996.\nCONSOLIDATED STATEMENT OF INCOME (DOLLARS IN THOUSANDS) DTE ENERGY COMPANY AND SUBSIDIARY COMPANIES\n(See accompanying Notes to Consolidated Financial Statements.)\nCONSOLIDATED STATEMENT OF CASH FLOWS (DOLLARS IN THOUSANDS) DTE ENERGY COMPANY AND SUBSIDIARY COMPANIES\n(See accompanying Notes to Consolidated Financial Statements.)\nCONSOLIDATED BALANCE SHEET (DOLLARS IN THOUSANDS) DTE ENERGY COMPANY AND SUBSIDIARY COMPANIES\n(See accompanying Notes to Consolidated Financial Statements.)\nCONSOLIDATED BALANCE SHEET (DOLLARS IN THOUSANDS) DTE ENERGY COMPANY AND SUBSIDIARY COMPANIES\n(See accompanying Notes to Consolidated Financial Statements.)\nCONSOLIDATED STATEMENT OF COMMON SHAREHOLDERS' EQUITY (DOLLARS IN THOUSANDS) DTE ENERGY COMPANY AND SUBSIDIARY COMPANIES\n(See accompanying Notes to Consolidated Financial Statements.)\nCONSOLIDATED STATEMENT OF INCOME (DOLLARS IN THOUSANDS) THE DETROIT EDISON COMPANY AND SUBSIDIARY COMPANIES\n(See accompanying Notes to Consolidated Financial Statements.)\nCONSOLIDATED BALANCE SHEET (DOLLARS IN THOUSANDS) THE DETROIT EDISON COMPANY AND SUBSIDIARY COMPANIES\n(See accompanying Notes to Consolidated Financial Statements.)\nCONSOLIDATED BALANCE SHEET (DOLLARS IN THOUSANDS) THE DETROIT EDISON COMPANY AND SUBSIDIARY COMPANIES\n(See accompanying Notes to Consolidated Financial Statements.)\nCONSOLIDATED STATEMENT OF CASH FLOWS (DOLLARS IN THOUSANDS) THE DETROIT EDISON COMPANY AND SUBSIDIARY COMPANIES\n(See accompanying Notes to Consolidated Financial Statements.)\nCONSOLIDATED STATEMENT OF COMMON SHAREHOLDERS' EQUITY (DOLLARS IN THOUSANDS) THE DETROIT EDISON COMPANY AND SUBSIDIARY COMPANIES\n*At established rate for each series.\n(See accompanying Notes to Consolidated Financial Statements.)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS DTE ENERGY COMPANY, THE DETROIT EDISON COMPANY AND SUBSIDIARY COMPANIES\nNOTE 1 SIGNIFICANT ACCOUNTING POLICIES\nCORPORATE STRUCTURE AND PRINCIPLES OF CONSOLIDATION - DTE Energy Company (\"Company\") is a Michigan corporation, incorporated in 1995, and an exempt holding company under the Public Utility Holding Company Act. The Company has no significant operations of its own, holding instead the stock of an electric utility and other energy-related businesses. The Detroit Edison Company (\"Detroit Edison\"), a public utility incorporated in Michigan since 1967, is the Company's largest operating subsidiary. Detroit Edison represents substantially all of the Company's assets. As a regulated public utility, Detroit Edison is engaged in the generation, purchase, transmission, distribution and sale of electric energy in a 7,600 square mile area in Southeastern Michigan. The Company's service area includes about 13% of Michigan's total land area, and about half of its population (approximately five million people), electric energy consumption and industrial capacity. On January 1, 1996, the holders of Detroit Edison's common stock exchanged such stock on a share-for-share basis for the common stock of the Company. Also on January 1, 1996, Detroit Edison declared a dividend to the Company in the form of the stock of five subsidiaries: DE Energy Services, Inc., DTE Capital Corporation, Edison Development Corporation, Syndeco Realty Corporation and UTS Systems, Inc. Accordingly, the consolidated financial statements presented herein include the financial results of operations of the Company and its wholly-owned subsidiaries as if the Company's current holding company structure form had existed in all periods shown. For the periods presented, the Company's operations and those of Detroit Edison are substantially the same. All significant intercompany balances and transactions have been eliminated. Investments in 50%-owned limited liability corporations, partnerships and joint ventures are accounted for using the equity method. All non-utility operating transactions are included in the section titled Other Income and (Deductions) in the Consolidated Statement of Income. Certain amounts in prior years' consolidated financial statements have been reclassified to conform to the current year presentation.\nUSE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS - 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.\nREGULATION AND REGULATORY ASSETS AND LIABILITIES - Detroit Edison is subject to regulation by the Michigan Public Service Commission (\"MPSC\") and the Federal Energy Regulatory Commission (\"FERC\") with respect to accounting matters and maintains its accounts in accordance with Uniform Systems of Accounts prescribed by these agencies. As a regulated entity, taking into account the cost recovery restrictions contained in the December 1988 and January 21, 1994 MPSC rate orders and the provisions of the Energy Policy Act of 1992 (\"Energy Act\"), Detroit Edison meets the criteria of Statement of Financial Accounting Standards (\"SFAS\") No. 71, \"Accounting for the Effects of Certain Types of Regulation.\" This accounting standard recognizes the ratemaking process which results in differences in the application of generally accepted accounting principles between regulated and non-regulated businesses. Detroit Edison has recorded the regulatory assets listed below. These regulatory assets are deferred costs, which are normally treated as expenses in non-regulated businesses, and are being amortized to expense as these costs are included in rates and recovered from customers. Continued applicability of SFAS No. 71 requires that rates be designed to recover specific costs of providing regulated services and products, including regulatory assets, and that it be reasonable to assume that rates are set at levels that will recover a utility's costs and can be charged and collected from customers. If the criteria of SFAS No. 71 are no longer met due to various factors, including deregulation of all or part of the business, a change in the method of regulation or a change in the competitive environment for the regulated services, the regulatory assets would have to be written off to expense at that time. Detroit Edison anticipates that it will continue to recover costs associated with its regulatory assets and continue to apply SFAS No. 71. Detroit Edison has recorded the following regulatory assets at December 31:\nAt December 31, 1995 and 1994, Detroit Edison had the following regulatory liabilities: (1) $330 million and $346 million, respectively, for unamortized accumulated deferred investment tax credits, (2) $53 million and $31 million, respectively, for Fermi 2 capacity factor disallowances (see Note 3), and (3) $22 million at December 31, 1995 and 1994 for other liabilities.\nTEMPORARY CASH INVESTMENTS - For purposes of the Consolidated Statement of Cash Flows, the Company considers investments purchased with a maturity of three months or less to be cash equivalents.\nUNAMORTIZED LOSS ON REACQUIRED DEBT - In accordance with MPSC regulations applicable to Detroit Edison, the discount, premium and expense related to debt redeemed with refunding are amortized over the life of the replacement issue.\nRECOVERABLE INCOME TAXES - See Note 6.\nOTHER POSTRETIREMENT BENEFITS - See Note 13.\nFERMI 2 PHASE-IN PLAN - An MPSC authorized phase-in plan, effective in January 1988, for Fermi 2, a nuclear generating unit, provided for gradual rate increases in the early years of plant operation rather than a one-time substantial rate increase which conventional ratemaking would provide. SFAS No. 92, \"Regulated Enterprises - Accounting for Phase-in Plans,\" permits the capitalization of costs deferred for future recovery under a phase-in plan. Accordingly, Detroit Edison recorded non-cash income of deferred depreciation and deferred return totaling $506.5 million through 1992. Beginning in 1993 and continuing through 1998, these deferred amounts will be amortized to operating expense as the cash recovery is realized through revenues. Amortization of these deferred amounts totaled $93 million, $84.8 million and $30.9 million in 1995, 1994 and 1993, respectively.\nFERMI 2 DEFERRED AMORTIZATION - The December 1988 MPSC rate order provides for Detroit Edison's February 1990 purchase of Wolverine Power Supply Cooperative, Inc.'s (\"Cooperative\") ownership interest in Fermi 2 for $513 million with a 19-year principal amortization and associated interest of 8%, which is the composite average of the Cooperative debt assumed by Detroit Edison at the time of the purchase. Since the straight-line amortization of the asset exceeds the revenues provided for such amortization during the first 10 years of the recovery period, Detroit Edison is recording deferred amortization, a non-cash item of income, totaling $67.2 million through 1999. For 1995, 1994 and 1993, the amounts deferred were $6 million, $7.5 million and $9 million, respectively. The deferred amounts will be amortized to operating expense as the cash recovery is realized through revenues during the years 2000 through 2008. UNITED STATES DEPARTMENT OF ENERGY (\"DOE\") DECONTAMINATION AND DECOMMISSIONING - The Energy Act provided for a fund to be established for the decommissioning and decontamination of existing DOE uranium enrichment facilities. Utilities with nuclear units are required to pay for a portion of the cost by making annual payments into the fund over a 15-year period. The law directs state regulators to treat these payments as a necessary and reasonable cost of fuel. Detroit Edison recovers these costs through the Power Supply Cost Recovery (\"PSCR\") Clause. REVENUES - Detroit Edison records unbilled revenues for electric and steam heating services provided after cycle billings through month-end. PROPERTY, RETIREMENT AND MAINTENANCE, DEPRECIATION AND AMORTIZATION - Utility properties are recorded at original cost less regulatory disallowances and an impairment loss. In general, the cost of properties retired in the normal course of business is charged to accumulated depreciation. Expenditures for maintenance and repairs are charged to expense, and the cost of new property installed, which replaces property retired, is charged to property accounts. The annual provision for utility property depreciation is calculated on the straight-line remaining life method by applying annual rates approved by the MPSC to the average of year-beginning and year-ending balances of depreciable property by primary plant accounts. Provision for depreciation of Fermi 2, excluding decommissioning expense, was 3.26% of average depreciable property for 1995 and 1994 and 2.63% for 1993, except for $300 million being amortized over 10 years commencing in 1989 and $513 million being amortized over 19 years commencing in 1990. See Note 3. Provision for depreciation of all other utility plant, as a percent of average depreciable property, was 3.2% for 1995 and 1994 and 3.4% for 1993. SOFTWARE COSTS - Detroit Edison capitalizes internally developed software costs. These costs are amortized on a straight-line basis over a five-year period beginning with a project's completion. PROPERTY TAXES - Property taxes are accrued monthly during the fiscal period of the applicable taxing authority. INCOME TAXES - Deferred income taxes are provided for temporary differences between book and tax bases of assets or liabilities to the extent authorized by the MPSC. For federal income tax purposes, depreciation is computed using accelerated methods and shorter depreciable lives. Investment tax credits utilized which relate to utility property were deferred and are amortized over the estimated composite service life of the related property. See Note 6. ALLOWANCE FOR FUNDS USED DURING CONSTRUCTION (\"AFUDC\") - AFUDC, a non-operating non-cash item, is defined in the FERC Uniform System of Accounts to include \"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 involves an accounting procedure whereby the approximate interest expense and the cost of other (common, preferred and preference shareholders' equity) funds applicable to the cost of construction are transferred from the income statement to construction work in progress in the balance sheet. The cash recovery of AFUDC, as well as other costs of construction, occurs as completed projects are placed in service and related depreciation is authorized to be recovered through customer rates. Detroit Edison capitalized AFUDC at 7.66% in 1995 and 1994 and 9.65% in 1993. ACCRETION INCOME - In 1988, Detroit Edison adopted SFAS No. 90, \"Regulated Enterprises - Accounting for Abandonments and Disallowances of Plant Costs.\" As a result, indirect losses were recorded for Greenwood Unit No. 1 for the period that plant was not allowed in rate base (1988-1993), and for the indirect loss related to the $300 million of Fermi 2 plant costs recovered from 1989 to 1998 with no return. The net after-tax losses originally totaled $198 million based on the discounting required by SFAS No. 90. These amounts are being restored to income over the respective discount periods as Detroit Edison records a non-cash return (accretion income). The net after-tax income recorded was $7.2 million, $8.9 million and $29.5 million in 1995, 1994 and 1993, respectively. CAPITALIZATION - DISCOUNT, PREMIUM AND EXPENSE - The discount, premium and expense related to the issuance of long-term debt are amortized over the life of each issue. In accordance with MPSC regulations applicable to Detroit Edison, the discount, premium and expense related to debt redeemed without refunding are written off to other income and deductions. Capital stock premium and expense related to redeemed preferred and preference stock of Detroit Edison are written off against retained earnings used in the business. FERMI 2 REFUELING OUTAGES - Detroit Edison recognizes the cost of Fermi 2 refueling outages over periods in which related revenues are recognized. Under this procedure, it records a provision for incremental costs anticipated to be incurred during the next scheduled Fermi 2 refueling outage. See Note 2. LEASES - See Note 9. EMPLOYEE BENEFITS - See Note 13.\nNOTE 2\nFERMI 2\nGENERAL - Fermi 2, a nuclear generating unit, began commercial operation in January 1988. Fermi 2 has a design electrical rating (net) of 1,139 megawatts (\"MW\"). However, due to certain equipment limitations, Fermi 2 is rated at 1,116 MW until modifications can be made to achieve the design rating. This unit represents approximately 27% of total assets, 10% of total operation and maintenance expenses and 9% of summer net rated capability. MPSC rate orders issued in April 1986, January 1987, December 1988 and January 1994 contain provisions with respect to the recovery of Fermi 2 costs. See Note 3 for a discussion of Fermi 2 rate matters and the MPSC's treatment of Fermi 2's original project costs of $4.858 billion.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS DTE ENERGY COMPANY, THE DETROIT EDISON COMPANY AND SUBSIDIARY COMPANIES\nLICENSING AND OPERATION - The Nuclear Regulatory Commission (\"NRC\") maintains jurisdiction over the licensing and operation of Fermi 2. Fermi 2 was out of service in 1994 and part of 1995. On December 25, 1993, the reactor automatically shut down following a turbine-generator failure. Safety systems responded within design and regulatory specifications. The turbine suffered mechanical damage, the exciter and generator incurred mechanical and fire damage, and the condenser had some internal damage. The fire was contained in the turbine building, and there was no release of radioactive contaminants during the event. The nuclear part of the plant was not damaged. Major repairs were completed in 1994 and early 1995. These repair costs are approximately $80 million for which to date Detroit Edison has received partial insurance payments of $55 million for property damage. In addition, Detroit Edison has received partial insurance payments of $74.2 million for replacement power costs through December 31, 1995. The unit was operating at 874 MW at the end of December 1995 and the unit's capacity factor was 51.4% for 1995. Detroit Edison is currently operating Fermi 2 without the large seventh and eighth stage turbine blades on the three low-pressure turbines. The new turbine shafts and blades for these low-pressure turbines are being manufactured and will be installed during the next refueling outage in 1996. The expected cost of replacing the major turbine components in 1996 is between $45 million and $50 million. These costs will not be covered by insurance. These costs will be capitalized and are expected to be recovered in rates because such costs are less than the cumulative amount available under the cap on Fermi 2 capital expenditures, a provision of the MPSC's December 1988 order. See Note 3. INSURANCE - Detroit Edison insures Fermi 2 with property damage insurance provided by Nuclear Mutual Limited (\"NML\") and Nuclear Electric Insurance Limited (\"NEIL\"). The NML and NEIL insurance policies provide $500 million of composite primary coverage (with a $1 million deductible) and $2.25 billion of excess coverage, respectively, for stabilization, decontamination and debris removal costs, repair and\/or replacement of property and decommissioning. Accordingly, the combined limits provide total property damage insurance of $2.75 billion. Detroit Edison maintains an insurance policy with NEIL providing for extra expenses, including certain replacement power costs necessitated by Fermi 2's unavailability due to an insured event. This policy, which has a 21-week waiting period, provides for three years of coverage. Under the NML and NEIL policies, Detroit Edison could be liable for maximum retrospective assessments of up to approximately $28 million per loss if any one loss should exceed the accumulated funds available to NML or NEIL. As required by federal law, Detroit Edison maintains $200 million of public liability insurance for a nuclear incident. Further, under the Price-Anderson Amendments Act of 1988, deferred premium charges of $75.5 million could be levied against each licensed nuclear facility, but not more than $10 million per year per facility. On December 31, 1995, there were 110 licensed nuclear facilities in the United States. Thus, deferred premium charges in the aggregate amount of approximately $8.3 billion could be levied against all owners of licensed nuclear facilities in the event of a nuclear incident. Accordingly, public liability for a single nuclear incident is currently limited to approximately $8.5 billion. DECOMMISSIONING - The NRC has jurisdiction over the decommissioning of nuclear power plants. An NRC rule requires decommissioning funding based upon a site-specific estimate or a predetermined NRC formula. Using the NRC's formula, plus an additional allowance for decommissioning the non-nuclear portion of the plant, it is estimated that the cost of decommissioning Fermi 2 when its license expires in the year 2025 is $514 million in current 1995 dollars and $3 billion in future 2025 dollars. The assumed annual inflation rate used to increase the cost to decommission is 6%, compounded annually. The MPSC and FERC regulate the recovery of costs of decommissioning nuclear power plants and both require the use of external trust funds to finance the decommissioning of Fermi 2. The MPSC's January 1994 order includes an increase in rates for the decommissioning of Fermi 2. The FERC has approved the recovery of decommissioning expense in base rates in its June 1993 order. Detroit Edison believes that the MPSC and FERC orders will be adequate to fund the estimated cost of decommissioning using the NRC formula. See Note 3. Detroit Edison has established external trust funds to hold decommissioning and low-level radioactive waste disposal funds collected from customers. During 1995, 1994 and 1993, Detroit Edison collected $32.1 million, $26.9 million and $3.7 million, respectively, from customers for decommissioning Fermi 2. Also, in 1995 and 1994, Detroit Edison collected $4.1 million and $3.3 million, respectively, from customers for low-level radioactive waste disposal. Such amounts were recorded as components of depreciation and amortization expense in the Consolidated Statement of Income and accumulated depreciation and amortization in the Consolidated Balance Sheet. Earnings on the external decommissioning trust funds assets during 1995, 1994 and 1993 were $3.3 million, $1.3 million and $1.2 million, respectively. Earnings on the external low-level radioactive waste disposal trust funds assets were $0.6 million and $0.2 million in 1995 and 1994, respectively. Trust fund earnings are recorded as an investment with a corresponding credit to accumulated depreciation and amortization. Trust fund assets are assumed to earn an after-tax rate of return of 7%, compounded annually. In accordance with SFAS No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\", net unrealized gains of $4.6 million and $0.7 million in 1995 and 1994, respectively, were recorded as increases to the nuclear decommissioning trust funds and accumulated depreciation and amortization in the Consolidated Balance Sheet. During 1995 shipment of low-level radioactive waste to a permanent disposal site resumed. Detroit Edison incurred disposal costs of $5.7 million during 1995 which costs were reimbursed by the external trust funds. At December 31, 1995, Detroit Edison had a reserve of $91.5 million for the future decommissioning of Fermi 2 and $9.8 million for low-level radioactive waste disposal costs. These reserves are included in accumulated depreciation and amortization in the Consolidated Balance Sheet with a like amount deposited in external trust funds. Detroit Edison also had a reserve of $18.5 million at December 31, 1995 for the future decommissioning of Fermi 1, an experimental nuclear unit on the Fermi 2 site that has been shut down since 1972. This reserve is included in other deferred credits in the Consolidated Balance Sheet with a like amount deposited in an external trust fund. Detroit Edison estimates that the cost of decommissioning Fermi 1 in the year 2025 is $20 million in current 1995 dollars and $114 million in future 2025 dollars.\nThe Financial Accounting Standards Board is reviewing the accounting for removal costs, including decommissioning of nuclear power plants. If current electric utility industry accounting practices for such decommissioning are changed: (1) annual provisions for decommissioning could increase, and (2) the estimated cost for decommissioning could be recorded as a liability rather than as accumulated depreciation.\nNUCLEAR FUEL DISPOSAL COSTS - Detroit Edison has a contract with the DOE for the future storage and disposal of spent nuclear fuel from Fermi 2. Under the terms of the contract, Detroit Edison makes quarterly payments to the DOE based upon a fee of 1 mill per kilowatthour applied to the Fermi 2 electricity generated and sold. The spent nuclear fuel disposal cost is included as a component of Detroit Edison's nuclear fuel expense. The DOE has stated that it will be unable to store spent nuclear fuel at a permanent repository until after 2010. However, the DOE and utilities with nuclear units are pursuing other interim storage options. On September 7, 1995, Detroit Edison, along with two other utilities, filed a petition for review in the United States Court of Appeals for the District of Columbia Circuit. The petition seeks to overturn a decision of the DOE that it does not have a legal obligation to begin accepting spent nuclear fuel from nuclear utilities commencing January 31, 1998. The petition seeks to affirm that such an obligation exists and to establish court oversight of the development of a schedule by the DOE to accept spent nuclear fuel by that date. This action has been consolidated with existing litigation brought by a number of other utilities as well as a number of states. It is estimated that existing temporary storage capacity at Fermi 2 will be sufficient until the year 2001, or until 2019 with the expansion of such storage capacity.\nNOTE 3\nRATE MATTERS\nDetroit Edison is subject to the primary regulatory jurisdiction of the MPSC, which, from time to time, issues its orders pertaining to Detroit Edison's conditions of service, rates and recovery of certain costs including the costs of generating facilities. MPSC orders issued in December 1988 and on January 21, 1994 are currently in effect with respect to Detroit Edison's rates and certain other revenue and operating-related matters. On January 21, 1994, the MPSC issued an order reducing Detroit Edison's rates in the amount of $78 million annually. The rate reduction was determined by using a 1994 test year and an overall rate of return of 7.66%, incorporating an 11% return on common equity and a capital structure comprised of 40% common equity, 55.01% long-term debt and 4.99% preferred stock. The MPSC order includes the recovery of (1) increased Fermi 2 decommissioning costs of $28.1 million annually, which includes the recovery of low-level radioactive waste disposal costs, (2) full recovery of 1994 other postretirement benefit costs plus recovery and amortization of the 1993 deferred cost (see Note 13), (3) costs associated with the return to rate base of Greenwood Unit No. 1, (4) Fermi 2 phase-in plan revenue requirements of $70.8 million in 1994 and (5) costs associated with a three-year $41.5 million ($7.6 million in 1994, $14.9 million in 1995 and $19 million in 1996) demand-side management program. In keeping with the MPSC's recognition of the need for industrial customers to be competitive, the January 1994 rate reduction was allocated among the various classes of customers approximately as follows: Industrial-$43 million, Commercial-$24 million, Residential-$10 million and Governmental-$1 million. The order was effective for service rendered on and after January 22, 1994 and is the subject of various appeals before the Michigan Court of Appeals. INDUSTRIAL RATES - In August 1994, Detroit Edison entered into 10-year special manufacturing contracts which were approved by the MPSC on March 23, 1995. These contracts will lower costs for Detroit Edison's three largest customers (Chrysler Corporation, Ford Motor Company and General Motors Corporation). Annual revenue reductions will range in amounts from about $30 million in 1995 to $50 million for 1999 through 2004. Detroit Edison expects to offset these reductions by further reducing operating expenses. FERMI 2 - The December 1988 MPSC order established, for the period January 1989 through December 2003, (1) a cap on Fermi 2 capital additions of $25 million per year, in 1988 dollars adjusted by the Consumers Price Index (\"CPI\"), cumulative, (2) a cap on Fermi 2 non-fuel operation and maintenance expenses adjusted by the CPI and (3) a capacity factor performance standard based on a three-year rolling average commencing in 1991. For a capital investment of $200 million or more (in 1988 dollars adjusted by the CPI), Detroit Edison must obtain prior MPSC approval to be included in rate base. Under the cap on Fermi 2 capital expenditures, the cumulative amount available totals $54 million (in 1995 dollars) at December 31, 1995. Under the cap on non-fuel operation and maintenance expenses, the cumulative amount available totals $52 million (in 1995 dollars) at December 31, 1995. Under the capacity factor performance standard, a disallowance of net incremental replacement power cost will be imposed for the amount by which the Fermi 2 three-year rolling average capacity factor is less than the greater of either the average of the top 50% of U.S. boiling water reactors or 50%. For purposes of the capacity factor performance standard, the capacity for Fermi 2 for the period 1989-1993 shall be 1,093 MW, and 1,139 MW for each year thereafter until December 31, 2003. As discussed in Note 2, Fermi 2 was out of service in 1994 and part of 1995 and will operate at a reduced power output until the installation of major turbine components during the next refueling outage in 1996. Therefore, the three-year rolling average capacity factor utilized in the Fermi 2 performance standard calculation will be unfavorably affected in 1994-1998. The plant's three-year rolling average capacity factor was 53.7% for 1994 and 45.4% for 1995 utilizing a capacity of 1,093 MW for 1992 and 1993 and 1,139 MW for 1994 and 1995. The three-year rolling average capacity factor for the top 50% of U.S. boiling water reactors was 78.6% for 1994 and 81.2% for the 36-month period ending September 30, 1995. Detroit Edison incurred a capacity factor disallowance totaling $19.2 million for 1994. In accordance with an MPSC order, three times this amount was used to determine the net refund to customers in the 1994 PSCR reconciliation case, resulting in banked credits of $38.5 million which will reduce future capacity factor disallowance amounts owing to customers. It is estimated that a net liability in the range of $40 million to $60 million will be required for capacity factor disallowances in the period 1995-1998. At December 31, 1995, Detroit Edison had accrued $53 million (capacity factor disallowances of $91.5 million, less banked credits of $38.5\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS DTE ENERGY COMPANY, THE DETROIT EDISON COMPANY AND SUBSIDIARY COMPANIES\nmillion) for the Fermi 2 capacity factor performance standard disallowances that are expected to be imposed by the MPSC during the period 1995-1998, based on the following assumptions: a. Fermi 2 three-year rolling average capacity factor of 45.4% in 1995 and an estimated 35.6% in 1996, 65.1% in 1997 and 72.6% in 1998; b. Estimated three-year rolling average capacity factor for the top 50% of U.S. boiling water reactors of 80% in 1995-1998; c. Estimated incremental cost of replacement power of $8 per megawatthour in 1995 and increasing to $11 per megawatthour in 1998. In accordance with April 1986 and December 1988 MPSC rate orders, ratemaking treatment of Detroit Edison's Fermi 2 original project costs of $4.858 billion is as follows: (1) $3.018 billion in rate base with recovery and return, (2) $300 million amortized over 10 years with no return, (3) $513 million amortized over 19 years with associated interest of 8% and (4) $1.027 billion disallowed and written off in 1988. At December 31, 1995, Detroit Edison's net plant investment in Fermi 2 was $2.9 billion ($3.9 billion less accumulated depreciation and amortization of $1 billion). Under the December 1988 MPSC order, if nuclear operations at Fermi 2 permanently cease, amortization in rates of the $300 million and $513 million investments in Fermi 2 would continue and the remaining net rate base investment amount shall be removed from rate base and amortized in rates, without return, over 10 years with such amortization not to exceed $290 million per year. In this event, unamortized amounts of deferred depreciation and deferred return, recorded in the Consolidated Balance Sheet under the phase-in plan prior to the removal of Fermi 2 from rate base, will continue to be amortized, with a full return on such unamortized balances, so that all amounts deferred are recovered during the period ending no later than December 31, 1998. The December 1988 and January 1994 rate orders do not address the costs of decommissioning if operations at Fermi 2 prematurely cease. Detroit Edison has and believes it will continue to operate under the terms of all applicable MPSC orders with no significant adverse effects as a result of any cost recovery restrictions contained therein.\nNOTE 4 JOINTLY-OWNED UTILITY PLANT\nDetroit Edison's portion of jointly-owned utility plant is as follows:\n* Detroit Edison's undivided ownership interest is 62.78% in Unit No. 1, 81.39% of the portion of the facilities applicable to Belle River used jointly by the Belle River and St. Clair Power Plants, 49.59% in certain transmission lines and, at December 31, 1995, 75% in facilities used in common with Unit No. 2.\nBELLE RIVER - The Michigan Public Power Agency (\"MPPA\") has an undivided ownership interest in Belle River Unit No. 1 and certain other related facilities. MPPA is entitled to 18.61% of the capacity and energy of the entire plant and is responsible for the same percentage of the plant's operation and maintenance expenses and capital improvements. Detroit Edison is obligated to provide MPPA with backup power when either unit is out of service. Detroit Edison was required to purchase MPPA's capacity and energy entitlement through 1994. Such purchases were 20% for 1993 and 10% for 1994. The cost for the buyback of power was based on MPPA's plant-related investment, interest costs incurred by MPPA on its original project financing plus 2.5%, and certain other costs such as depreciation and operation and maintenance expenses. Buyback payments to MPPA were $12.5 million for 1993 and $6 million for 1994. LUDINGTON PUMPED STORAGE - Operation, maintenance and other expenses of the Ludington Pumped Storage Plant (\"Ludington\") are shared by Detroit Edison and Consumers Power Company (\"Consumers\") in proportion to their respective interests in the plant. See Note 12.\nNOTE 5\nSALE OF ACCOUNTS RECEIVABLE AND UNBILLED REVENUES\nDetroit Edison has an agreement providing for the sale, assignment and repurchase, from time to time, of an undivided ownership interest in $200 million of its customer accounts receivable and unbilled revenues. At December 31, 1994, customer accounts receivable and unbilled revenues in the Consolidated Balance Sheet were reduced by $200 million reflecting the sale. However, at December 31, 1995, customer accounts receivable and unbilled revenues increased as Detroit Edison repurchased the $200 million. Therefore at December 31, 1995, there were no sales under this agreement. All expenses associated with the program were charged to other income and (deductions) in the Consolidated Statement of Income.\nNOTE 6\nINCOME TAXES\nTotal income tax expense as a percent of income before tax varies from the statutory federal income tax rate for the following reasons:\nComponents of income taxes were applicable to the following: - ------------------------------------------------------------------------------\nThe Fermi 2 phase-in plan required Detroit Edison to record additional deferred income tax expense related to deferred depreciation totaling $33.5 million, with this amount amortized to income over the six-year period ending December 31, 1998. In January 1993, SFAS No. 109, \"Accounting for Income Taxes,\" which requires an asset and liability approach for financial accounting and reporting for income taxes was adopted. At January 1, 1993, an increase in accumulated deferred income tax liabilities of $740 million was recorded which represented (a) the tax effect of temporary differences not previously recognized and (b) the recomputing of its tax liability at the current tax rate. The liability increase was offset by a regulatory asset of equal value, titled \"Recoverable Income Taxes.\" This regulatory asset represents the future revenue recovery from customers for these taxes as they become payable, with no effect on net income. In August 1993, the Omnibus Budget Reconciliation Act of 1993 increased the federal corporate income tax rate from 34% to 35% retroactive to January 1, 1993. As a result, (1) an increase of $88.1 million in accumulated deferred income tax liabilities, offset by a corresponding increase in \"Recoverable Income Taxes,\" and (2) an increase of $10.4 million in income tax expense were recorded. In 1993, the MPSC issued an order, in a generic proceeding, authorizing accounting procedures consistent with SFAS No. 109 and providing assurance that the effects of previously flowed-through tax benefits will continue to be allowed rate recovery. Deferred income tax assets (liabilities) are comprised of the following at December 31:\nThe federal income tax returns of the Company are settled through the year 1988. The Company believes that adequate provisions for federal income taxes have been made through December 31, 1995.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS DTE ENERGY COMPANY, THE DETROIT EDISON COMPANY AND SUBSIDIARY COMPANIES\nNOTE 7\nCOMMON STOCK AND CUMULATIVE PREFERRED AND PREFERENCE STOCK At December 31, 1995, the Company had Cumulative Preferred Stock, without par value, 5,000,000 shares authorized with 5,000,000 shares unissued. At December 31, 1995, Detroit Edison had Cumulative Preference Stock of $1 par value, 30,000,000 shares authorized with 30,000,000 shares unissued. At December 31, 1995, Detroit Edison had Cumulative Preferred Stock of $100 par value, 6,747,484 shares authorized with 1,539,827 shares unissued, and 3,351,223 shares and 3,905,470 shares outstanding at December 31, 1995 and 1994, respectively. Cumulative Preferred Stock outstanding at December 31 was:\nOn October 15, 1995, Detroit Edison redeemed the remaining outstanding 9,539 shares of 5 1\/2% Series, $100 par value Convertible Cumulative Preferred Stock at a price of $100 per share plus accrued dividends. This series was convertible into shares of Detroit Edison Common Stock until the close of business on the date of the redemption. The number of shares converted during 1995, 1994 and 1993 was 45,931, 3,949 and 5,563, respectively. Detroit Edison's 7.68% Series, 7.45% Series and 7.36% Series Cumulative Preferred Stock are redeemable solely at the option of Detroit Edison at a per share redemption price of $101 plus accrued dividends. See Note 16. On August 15, 1995, Detroit Edison exchanged 1,995,108 depositary shares, each representing a one-quarter interest in a share of the Cumulative Preferred Stock, 7.75% Series, for $49,877,700 aggregate principal amount of Detroit Edison's Deeply Subordinated Quarterly Income Debt Securities (\"QUIDS\"), 8.50% Series. See Note 10 for further discussion on the QUIDS. Detroit Edison's 7.75% Series and 7.74% Series Cumulative Preferred Stock are redeemable solely at the option of Detroit Edison at a per share redemption price of $100 (equivalent to $25 per Depositary Share), plus accrued dividends, on and after April 15, 1998 and July 15, 1998, respectively. Apart from MPSC or FERC approval and the requirement that common, preferred and preference stock be sold for at least par value, there are no legal restrictions on the issuance of additional authorized shares of such stock by Detroit Edison. There are no legal restrictions on the issuance of additional authorized shares of the Company's common and preferred stock. In August 1994, Detroit Edison purchased 2,206,635 shares of its Common Stock at a price of $27.125 per share, totaling $59.9 million, from the trustee of the Detroit Edison Savings & Investment Plans. These shares were canceled and reverted to the status of authorized but unissued shares.\nNOTE 8\nSHORT-TERM CREDIT ARRANGEMENTS AND BORROWINGS\nAt December 31, 1995, Detroit Edison had total short-term credit arrangements of approximately $432 million. At December 31, 1995 and December 31, 1994, $37 million and $39.5 million, respectively, of short-term borrowings were outstanding with a weighted average interest rate of 6.2% in 1995 and 1994. Detroit Edison had bank lines of credit of $200 million, all of which had commitment fees in lieu of compensating balances. Commitment fees incurred in 1995 for bank lines of credit were approximately $0.3 million. Detroit Edison uses bank lines of credit to support the issuance of commercial paper and bank loans. All borrowings are at prevailing money market rates which are below the banks' prime lending rates. Detroit Edison has a nuclear fuel financing arrangement (heat purchase contract) with Renaissance Energy Company (\"Renaissance\"), an unaffiliated company. Renaissance may issue commercial paper or borrow from participating banks on the basis of promissory notes. To the extent the maximum amount of funds available to Renaissance (currently $400 million) is not needed by Renaissance to purchase nuclear fuel, such funds may be loaned to Detroit Edison for general corporate purposes pursuant to a separate Loan Agreement. At December 31, 1995, approximately $232 million was available to Detroit Edison under such Loan Agreement. See Note 9 for a discussion of Detroit Edison's heat purchase contract with Renaissance. Renaissance entered into five-year interest rate swap agreements, guaranteed by Detroit Edison, in December 1990, with five banks for a notional amount of $125 million. These agreements were used to reduce the potential impact of increases in interest rates on the variable rate debt by exchanging the receipt of variable rate amounts for fixed interest payments at rates ranging from 8.12% to 8.145% over the life of the agreements. The differential paid or received was recognized as an adjustment to the interest component included as part of nuclear fuel expense. In December 1995, all swap agreements expired and were not renewed.\nNOTE 9\nLEASES\nFuture minimum lease payments under long-term noncancellable leases, consisting of nuclear fuel ($170 million computed on a projected units of production basis), lake vessels ($42 million), locomotives and coal cars ($166 million), office space ($17 million) and computers, vehicles and other equipment ($5 million) at December 31, 1995 are as follows:\nDetroit Edison has a heat purchase contract with Renaissance which provides for the purchase by Renaissance for Detroit Edison of up to $400 million of nuclear fuel, subject to the continued availability of funds to Renaissance to purchase such fuel. Title to the nuclear fuel is held by Renaissance. Detroit Edison makes quarterly payments under the heat purchase contract based on the consumption of nuclear fuel for the generation of electricity. Renaissance's investment in nuclear fuel was $145 million and $193 million at December 31, 1995 and 1994, respectively. The decrease in 1995 from 1994 of $48 million includes additions of $6 million (purchases of $5 million and capitalized interest of $1 million) less $54 million for the amortization of nuclear fuel consumed in 1995. Under SFAS No. 71, amortization of Detroit Edison's leased assets is modified so that the total of interest on the obligation and amortization of the leased asset is equal to the rental expense allowed for ratemaking purposes. For ratemaking purposes, the MPSC has treated all leases as operating leases. Net income is not affected by capitalization of leases. Rental expenses for both capital and operating leases were $97 million (including $67 million for nuclear fuel), $49 million (including $8 million for nuclear fuel) and $126 million (including $89 million for nuclear fuel) for 1995, 1994 and 1993, respectively.\nNOTE 10\nLONG-TERM DEBT\nDetroit Edison's 1924 Mortgage and Deed of Trust (\"Mortgage\"), the lien of which covers substantially all of Detroit Edison's properties, provides for the issuance of additional bonds. At December 31, 1995, approximately $3.2 billion principal amount of Mortgage Bonds could have been issued on the basis of property additions, combined with an earnings test provision, assuming an interest rate of 7% on any such additional Mortgage Bonds. An additional $1.1 billion principal amount of Mortgage Bonds could have been issued on the basis of bond retirements.\nLong-term debt outstanding at December 31 was:\n* Weighted average interest rate at December 31, 1995. **Variable rate at December 31, 1995.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS DTE ENERGY COMPANY, THE DETROIT EDISON COMPANY AND SUBSIDIARY COMPANIES\nThe QUIDS (see Note 7) provide that interest will be payable quarterly provided that, so long as an event of default has not occurred and is not continuing with respect to the QUIDS, Detroit Edison will have the right, upon prior notice by public announcement given in accordance with New York Stock Exchange rules at any time, to extend the interest payment period at any time and from time to time on the QUIDS for up to 20 consecutive quarterly interest payment periods. As a consequence, quarterly interest payments on the QUIDS would be deferred but would continue to accrue during any deferral period. In the event that Detroit Edison exercises this right, Detroit Edison may not declare or pay dividends on, or redeem, purchase or acquire, any of its capital stock during such deferral period, other than redemptions of any series of capital stock of Detroit Edison pursuant to the terms of any sinking fund provisions with respect thereto. In addition, during any deferral period, Detroit Edison may not make any advance or loan to, or purchase any securities of, or make any other investment in, any affiliate of Detroit Edison, including DTE Energy Company, for the purpose of, or to enable the payment of, directly or indirectly, dividends on any equity securities of DTE Energy Company. In June 1992, Detroit Edison entered into a three-year interest rate swap agreement matched to a $31 million variable rate tax exempt revenue bond. This agreement was used to reduce the potential impact of increases in interest rates on the variable rate debt by exchanging the receipt of variable rate amounts for fixed interest payments at a rate of 4.32% over the life of the agreement. The differential paid or received was recognized as an adjustment to interest expense related to the debt. In June 1995, the swap agreement expired and was not renewed. In 1996, 1997, 1998, 1999 and 2000, Detroit Edison's long-term debt maturities consist of $119 million, $144 million, $169 million, $219 million and $194 million, respectively.\nNOTE 11\nFAIR VALUE OF FINANCIAL INSTRUMENTS\nThe estimated fair values of financial instruments at December 31 are as follows:\nThe investments in debt and equity securities are classified as \"available for sale.\" 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: OTHER INVESTMENTS - The carrying amount of other investments approximates fair value. NUCLEAR DECOMMISSIONING TRUST FUNDS - The fair value of nuclear decommissioning trust funds is estimated based on quoted market prices for securities and carrying amount for the cash equivalents. SALE OF ACCOUNTS RECEIVABLE AND UNBILLED REVENUES - The carrying amount approximates fair value because of the short maturity of accounts receivable and unbilled revenues pledged for sale. CUMULATIVE PREFERRED STOCK, LONG-TERM DEBT - The fair value of Detroit Edison's preferred stock outstanding and long-term debt is estimated based on the quoted market prices where available. The fair values of all other long-term debt are estimated using discounted cash flow analysis. The discount rates used are the Company's incremental borrowing costs for similar types of securities. SHORT-TERM BORROWINGS, CUSTOMER SURETY DEPOSITS - The carrying amount approximates fair value because of the short maturity of those instruments.\nNOTE 12\nCOMMITMENTS AND CONTINGENCIES\nCOMMITMENTS - Detroit Edison has entered into purchase commitments of approximately $561 million at December 31, 1995, which includes, among other things, line construction and clearance costs and the costs of major turbine components to be replaced at Fermi 2. Detroit Edison also has entered into substantial long-term fuel supply and transportation commitments. Detroit Edison has an Energy Purchase Agreement (\"Agreement\") for the purchase of steam and electricity from the Detroit Resource Recovery Facility. Under the Agreement, Detroit Edison will purchase steam through the year 2008 and electricity through June 30, 2024. Purchases of steam and electricity were $28.2 million, $24.5 million and $23.6 million for 1995, 1994 and 1993, respectively, and annual purchase commitments are approximately $32.6 million, $35 million, $36.1 million, $37.3 million and $38.5 million for 1996, 1997, 1998, 1999 and 2000, respectively. On October 25, 1995, the MPSC issued an order approving Detroit Edison's long-term capacity and energy purchase from Ontario Hydro. On November 27, 1995, the Michigan Attorney General filed an application for leave to appeal the order in the Michigan Court of Appeals. The purchase is for 300 MW, on a seasonal basis from mid-May through mid-September for the years 1996 through 2001. This purchase will offset a concomitant agreement to lease 312 MW, of Detroit Edison's 917 MW Ludington capacity entitlement, to the Toledo Edison Company for essentially the same time period. The net economic effect of the Ludington lease and the Ontario Hydro purchase will be to provide Detroit Edison's customers with an estimated reduction in PSCR expense of $74 million which will be passed through to customers through the PSCR clause.\nCONTINGENCIES - LUDINGTON PUMPED STORAGE PLANT - In 1986, the Michigan Attorney General and the Michigan Natural Resources Commission filed a state lawsuit against Detroit Edison and Consumers as co-owners of Ludington for claimed aquatic losses. Detroit Edison is a 49% co-owner of Ludington. The suit, which alleges violations of the Michigan Environmental Protection Act and the common law for claimed aquatic losses, seeks past damages (including interest) of approximately $148 million and future damages (from the time of the filing of the lawsuit) in the amount of approximately $89,500 per day (of which 49% would be applicable to Detroit Edison). In October 1994, Detroit Edison and all other parties to the state action except certain Indian tribes, reached a tentative settlement. On February 28, 1995, Detroit Edison and Consumers jointly submitted to FERC the Ludington Pumped Storage Project Settlement Agreement - FERC Offer of Settlement. In March 1995, the Circuit Court for Ingham County, Michigan entered an order adopting the settlement as final upon the receipt of regulatory approvals. On January 17, 1996, the FERC issued an order approving the settlement agreement. The settlement provides for damages and use of a barrier net around the plant intakes to protect fish. Also, the FERC order requires Detroit Edison and Consumers to examine new fish mortality abatement technologies, monitor local fish populations and create a scientific advisory team to review these matters. Detroit Edison is taking steps to implement the terms of the settlement and is waiving prior MPSC approval for the settlement to become effective. The net present value of Detroit Edison's portion of the settlement is estimated to be approximately $30 million which will be paid over a 24-year period, including $10 million to enhance recreational opportunities on Detroit Edison-owned and donated property. Detroit Edison has recorded a charge to other operation expense in the Consolidated Statement of Income in 1995 of $8.4 million for its share of the settlement through December 31, 1995. CARTER INDUSTRIALS - In January 1989, the Environmental Protection Agency (\"EPA\") issued an administrative order under the Comprehensive Environmental Response, Compensation and Liability Act ordering Detroit Edison and 23 other potentially responsible parties to begin removal activities at the Carter Industrials superfund site. In June 1993, a Consent Decree was entered by the U.S. District Court for the Eastern District of Michigan. Clean-up of the Carter Industrials site began in 1995 and is expected to be completed in 1996. There is the possibility that EPA may, through subsequent proceedings, require an additional clean-up of the sewer and sewer outfall emptying into the Detroit River. At December 1995, a remaining liability of $3.3 million is included in other deferred credits in the Consolidated Balance Sheet for completion of the Carter Industrials site clean-up costs in 1996 and the proposed clean-up of the sewer and sewer outfall. OTHER - The Energy Policy Act became effective in October 1992. While Detroit Edison is unable to predict the ultimate impact of this legislation on its operations, Detroit Edison expects that, over time, non-utility generation resources will be developed which will result in greater competition for power sales. On March 29, 1995, the FERC issued a Notice of Proposed Rulemaking seeking comment on several proposals for encouraging more competitive electric power markets. The proposals address several fundamental issues facing the electric power industry including transmission open access, stranded costs, jurisdiction over transmission in interstate commerce including retail wheeling and over local distribution, real-time information networks and implementation of open access. Final rules are expected to be issued early in 1996. While Detroit Edison is unable to predict the ultimate impact of this rulemaking on its operations, Detroit Edison expects that it will result in substantially increased wholesale competition. In addition to the matters reported herein, the Company and its subsidiaries are involved in litigation and environmental matters dealing with the numerous aspects of their business operations. The Company believes that such litigation and the matters discussed above will not have a material effect on its financial position or results of operations. See Notes 2 and 3 for a discussion of contingencies related to Fermi 2.\nNOTE 13\nEMPLOYEE BENEFITS\nRETIREMENT PLAN - Detroit Edison has a trusteed and non-contributory defined benefit retirement plan (\"Plan\") covering all eligible employees who have completed six months of service. The Plan provides retirement benefits based on the employee's years of benefit service, average final compensation and age at retirement. Detroit Edison's policy is to fund pension cost calculated under the projected unit credit actuarial cost method, provided that this amount is at least equal to the minimum funding requirement of the Employee Retirement Income Security Act of 1974, as amended, and is not greater than the maximum amount deductible for federal income tax purposes. Contributions were made to the Plan totaling $29.6 million, $45.8 million and $29.4 million for 1995, 1994 and 1993, respectively. Net pension cost included the following components:\nAssumptions used in determining net pension cost are as follows:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS DTE ENERGY COMPANY, THE DETROIT EDISON COMPANY AND SUBSIDIARY COMPANIES\nThe following reconciles the funded status of the Plan to the amount recorded in the Consolidated Balance Sheet:\nThe unrecognized net asset at date of initial application is being amortized over approximately 15.4 years, which was the average remaining service period of employees at January 1, 1987. In addition to the Plan, there are several supplemental non-qualified, non-contributory, retirement benefit plans for certain management employees. LONG-TERM INCENTIVE COMPENSATION PLAN - The Company has adopted a long-term incentive plan (\"Incentive Plan\"). Under the Incentive Plan, certain key employees may be granted stock options, stock appreciation rights, restricted common stock, performance shares and performance units. In 1995, 66,500 shares of restricted common stock, valued at approximately $1.9 million, were granted to officers of Detroit Edison. Compensation cost of $571,000 in 1995 was recorded based on the award that was expected to vest and recognized over the period to which the related employee services were to be rendered. The shares for officers are restricted for a period of approximately one to four years and all shares are subject to forfeiture if specified performance measures are not met. There are no exercise prices related to these shares. During the applicable restriction period, the officer-recipient has all the voting, dividends and other rights of a record holder except that the shares are nontransferable, and non-cash distributions paid upon the shares would be subject to transfer restrictions and risk of forfeiture to the same extent as the shares themselves. All shares awarded pursuant to this program were purchased on the open market. Common stock granted under the Incentive Plan may not exceed 7.2 million shares. Performance units (which have a face amount of $1) granted under the Incentive Plan may not exceed 25 million in the aggregate. No stock options, stock appreciation rights, performance shares or performance units have been granted under this plan. SAVINGS & INVESTMENT PLANS - Detroit Edison has contributory defined contribution plans qualified under Section 401 (a) and (k) of the Internal Revenue Code for all eligible employees. Matching contributions were $13.7 million, $12.5 million, $10.6 million for 1995, 1994 and 1993, respectively. OTHER POSTRETIREMENT BENEFITS - Detroit Edison provides certain postretirement health care and life insurance benefits for retired employees. Substantially all of Detroit Edison's employees will become eligible for such benefits if they reach retirement age while working for Detroit Edison. These benefits are provided principally through insurance companies and other organizations. Effective January 1, 1993, Detroit Edison adopted the provisions of SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" The standard required Detroit Edison to change its accounting for postretirement benefits from the pay-as-you-go (cash) basis to the accrual of such benefits during the active service periods of employees to the date they attain full eligibility for benefits. The transition obligation at the time of adoption is being amortized over 20 years. Detroit Edison's incremental cost upon adoption of the standard was $49 million for 1993 which is being deferred in accordance with the January 21, 1994 MPSC rate order. See Note 3. This amount is being amortized and recovered in rates over the estimated four-year period 1994-1997. Net other postretirement benefits cost included the following components:\nThe following reconciles the funded status to the amount recorded in the Consolidated Balance Sheet:\nAssumptions used in determining the accumulated benefit obligation are as follows:\nBenefit costs were calculated assuming health care cost trend rates beginning at 11.8% for 1995 and decreasing to 6% in 2008 and thereafter for persons under age 65 and decreasing from 7.2% to 6% for persons age 65 and over. For 1996, health care cost trend rates are assumed to begin at 10.5% and 6.5%, respectively, with both rates decreasing to 5.5% in 2008 and thereafter. A one-percentage-point increase in health care cost trend rates would increase the aggregate of the service cost and interest cost components of benefit costs by $8 million for 1995 and increase the accumulated benefit obligation by $69 million at December 31, 1995.\nNOTE 14\nNEW ACCOUNTING STANDARD\nIn March 1995, the Financial Accounting Standards Board issued SFAS No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.\" This statement requires that long-lived assets be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Company adopted SFAS No. 121 in the fourth quarter of 1995. As the result of continuing losses in the operation of its steam heating business, upon adoption of SFAS No. 121, Detroit Edison wrote off the remaining net book value of its steam heating plant assets. This resulted in a non-cash loss of $42 million ($32 million after-tax) or $0.22 per common share. Based on current market conditions, the steam heating operations continue to generate losses. Therefore, Detroit Edison will continue to review its steam heating operations to determine what actions, if any, may be necessary. The application of SFAS No. 121 to the electric plant and regulatory assets of Detroit Edison does not result in an impairment as of this time based on the existing MPSC and FERC regulations. However, this may change in the future as deregulation, competitive factors and restructuring take effect in the electric utility industry.\nNOTE 15\nSUPPLEMENTARY QUARTERLY FINANCIAL INFORMATION (UNAUDITED)\nThe fourth quarter of 1995 includes the write-off of the remaining net book value of Detroit Edison's steam heating plant assets when the Company adopted SFAS No. 121. This resulted in a non-cash loss of $42 million ($32 million after-tax) or $0.22 per common share. See Note 14. The fourth quarter of 1994 includes a decrease in operating revenues of $59 million, a decrease in operation expense of $65 million and a decrease in maintenance expense of $1 million related to a settlement agreement, with the parties intervening in the 1994 PSCR reconciliation case with the MPSC, for business interruption insurance proceeds associated with the December 25, 1993 outage at Fermi 2. See Note 2.\nNOTE 16\nSUBSEQUENT EVENTS (UNAUDITED)\nOn February 13, 1996, Detroit Edison issued $185 million of 7 5\/8% Quarterly Income Debt Securities. See Note 10 for information on the right of Detroit Edison to defer payment of interest on the QUIDS and the related consequences. Also, Detroit Edison called for redemption all of the outstanding Cumulative Preferred Stock, 7.68% Series, 7.45% Series and 7.36% Series, totaling $185 million, at per share redemption prices of $101 plus accrued dividends. Such redemption will occur on March 21, 1996.\nITEM 9","section_9":"ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nThe Board of Directors, upon the recommendation of the Board's Audit Committee, appointed Deloitte & Touche LLP as independent accountants for the year 1995. The appointment was ratified by the Common Stock Shareholders at the Annual Meeting of Common Stock Shareholders held on April 24, 1995. Deloitte & Touche LLP's report on the financial statements for the year ending December 31, 1995 did not contain an adverse opinion or a disclaimer of opinion, nor was it qualified or modified as to uncertainty, audit scope or accounting principles.\nIn prior years, Price Waterhouse LLP served as independent accountants of the Company. During the Company's two fiscal years ending December 31, 1994, there were no disagreements with Price Waterhouse LLP on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which, if not resolved to its satisfaction, would have caused Price Waterhouse LLP to make reference thereto in their report on the financial statements for such years. None of Price Waterhouse LLP's reports on the financial statements for the years ended December 31, 1994 and 1993 contained an adverse opinion or a disclaimer of opinion, or was qualified or modified as to uncertainty, audit scope or accounting principles.\nPART III\nITEM 10","section_9A":"","section_9B":"","section_10":"ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nInformation regarding the Company's executive officers is incorporated herein by reference to Items 1 and 2 - Business and Properties, \"Employees and Executive Officers\" on pages 23-24 hereof; information regarding compliance with section 16(a) of the Securities Exchange Act of 1934 is incorporated herein by reference to the data under the heading \"Compliance with Section 16(a) of the Securities Exchange Act of 1934\" on page 21 of the Company's definitive proxy statement dated March 15, 1996, in connection with its Annual Meeting of Shareholders to be held on April 22, 1996; and information regarding directors is incorporated herein by reference to the data under the heading \"The Election of Directors\" on pages 1-5 of the Company's definitive proxy statement dated March 15, 1996, in connection with its Annual Meeting of Shareholders to be held on April 22, 1996.\nITEM 11","section_11":"ITEM 11 - EXECUTIVE COMPENSATION.\nInformation regarding \"Executive Compensation\" is incorporated herein by reference to the data under the heading \"Board Compensation Committee Report on Executive Compensation\" on pages 8-15 of the Company's definitive proxy statement dated March 15, 1996, in connection with its Annual Meeting of Shareholders to be held on April 22, 1996.\nITEM 12","section_12":"ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nInformation regarding ownership of equity securities is incorporated herein by reference to the heading \"Security Ownership of Management\" on page 6 of the Company's definitive proxy statement dated March 15, 1996, in connection with its Annual Meeting of Shareholders to be held on April 22, 1996.\nITEM 13","section_13":"ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nInformation regarding certain relationships and related transactions is incorporated herein by reference to the heading \"Compensation Committee Interlocks and Insider Participation\" on page 15 of the Company's definitive proxy statement dated March 15, 1996, in connection with its Annual Meeting of Shareholders to be held on April 22, 1996.\nANNUAL REPORT ON FORM 10-K FOR THE DETROIT EDISON COMPANY PART I\nITEMS 1 AND 2 - BUSINESS AND PROPERTIES.\nSee the Company's \"Items 1 and 2 - Business and Properties\" (other than the paragraphs under the headings \"Non-Regulated Operations\" and \"Executive Officers\"), which is incorporated herein by this reference.\n(a) As of March 1, 1996\nUnder Detroit Edison By-Laws, the officers of Detroit Edison are elected annually by the Board of Directors at a meeting held for such purpose, each to serve until the next annual meeting of shareholders or until their respective successors are chosen and qualified. With the exception of Messrs. Anderson, Cockerham and Earley, all of the above officers have been employed by Detroit Edison in one or more management capacities during the past five years.\nGerard M. Anderson was a senior engagement manager at McKinsey & Company, Inc., a management consulting firm, from 1988 to 1993. Effective December 1, 1993, he was elected Vice President of Detroit Edison.\nHaven E. Cockerham, from 1991 until 1994, was president of Cockerham, McCain & Associates, Inc., a management, business development and human resources consulting firm in Columbia, South Carolina. From 1989 to 1991, Mr. Cockerham owned Cockerham Chevrolet-Oldsmobile, an automobile dealership in Newberry, South Carolina. Prior to 1989, Mr. Cockerham was employed by General Motors in various executive positions in the human resources area. Effective June 1, 1994, he was elected Vice President-Human Resources.\nAnthony F. Earley, Jr., from 1989 to 1994, was President and Chief Operating Officer of Long Island Lighting Company (\"LILCO\"), an electric and gas utility company serving Long Island, New York. He previously served in various executive capacities at LILCO from 1985 to 1989. Effective March 1, 1994, he was elected President and Chief Operating Officer and a member of the Board of Directors of Detroit Edison.\nITEM 3 - LEGAL PROCEEDINGS.\nSee the Company's \"Item 3 - Legal Proceedings,\" which is incorporated herein by this reference.\nITEM 4 -SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNot applicable.\nPART II\nITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nSee the Company's \"Item 5 - Market for Registrant's Common Equity and Related Stockholder Matters,\" which is incorporated herein by this reference. Detroit Edison's By-Laws contain this same provision with respect to the Michigan Business Corporation Act. All of Detroit Edison's Common Stock is held by the Company. The level of dividends paid by Detroit Edison to the Company is periodically reviewed by Detroit Edison's Board of Directors.\nITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nSee the Company's and Detroit Edison's \"Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations,\" which is incorporated herein by this reference to Part II - Item 7 of the Company.\nITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nSee pages 33 through 57.\nITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nSee the Company's \"Item 9 - Changes in and Disagreements with Accountants on Accounting and Financial Disclosure,\" which is incorporated herein by this reference.\nPART III\nITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nInformation regarding Detroit Edison's executive officers is incorporated herein by reference to \"Items 1 and 2 - Business and Properties, Executive Officers.\" Detroit Edison's directors are the same as the Company's directors. Information regarding directors is incorporated herein by reference to the data under the heading \"The Election of Directors\" on pages 1-5 of the Company's definitive proxy statement dated March 15, 1996, in connection with its Annual Meeting of Shareholders to be held on April 22, 1996.\nITEM 11 - EXECUTIVE COMPENSATION.\nInformation regarding \"Executive Compensation\" is incorporated herein by reference to the data under the heading \"Board Compensation Committee Report on Executive Compensation\" on pages 8-15 of the Company's definitive proxy statement dated March 15, 1996, in connection with its Annual Meeting of Shareholders to be held on April 22, 1996.\nITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nInformation regarding ownership of equity securities is incorporated herein by reference to the heading \"Security Ownership of Management\" on page 6 of the Company's definitive proxy statement dated March 15, 1996, in connection with its Annual Meeting of Shareholders to be held on April 22, 1996.\nITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nInformation regarding certain relationships and related transactions is incorporated herein by reference to the heading \"Compensation Committee Interlocks and Insider Participation\" on page 15 of the Company's definitive proxy statement dated March 15, 1996, in connection with its Annual Meeting of Shareholders to be held on April 22, 1996.\nANNUAL REPORTS ON FORM 10-K FOR DTE ENERGY COMPANY AND THE DETROIT EDISON COMPANY\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) Consolidated financial statements. See \"Item 8 - Financial Statements and Supplementary Data\" on page 33.\n(2) Financial statement schedules. See \"Item 8 - Financial Statements and Supplementary Data\" on page 33.\n(3) Exhibits (*Denotes management contract or compensatory plan or arrangement required to be filed as an exhibit to this report pursuant to Item 14 (c) of this report).\n(i) Exhibits filed herewith.\nExhibit Number ------- 3-3 - Amended and Restated By-Laws, dated as of February 26, 1996, of DTE Energy Company.\n3-4 - Amended and Restated By-Laws, dated as of February 26, 1996, of The Detroit Edison Company.\n4-14 - Fifth Supplemental Note Indenture, dated as of February 1, 1996.\n4-15 - Supplemental Indenture, dated as of April 1, 1991, establishing the 1991 Series AP Mortgage Bonds.\n*10-1 - Detroit Edison 1996 Shareholder Value Improvement Plan - A.\n*10-2 - Detroit Edison Key Employee Deferred Compensation Plan (January 1990).\n*10-3 - Detroit Edison Long-Term Incentive Plan.\nExhibit Number -------\n11-2 - DTE Energy Company and Subsidiary Companies Primary and Fully Diluted Earnings Per Share of Common Stock.\n12-2 - The Detroit Edison Company and Subsidiary Companies Computation of Ratio of Earnings to Fixed Charges.\n12-3 - The Detroit Edison Company and Subsidiary Companies Computation of Ratio of Earnings to Fixed Charges and Preferred and Preference Stock Dividends.\n16-1 - Letter regarding change in certifying accountant.\n23-7 - Consent of Deloitte & Touche LLP.\n23-8 - Consent of Price Waterhouse LLP.\n27-1 - Financial Data Schedule for the period ended December 31, 1995 for DTE Energy Company and Subsidiary Companies.\n27-2 - Financial Data Schedule for the period ended December 31, 1995 for The Detroit Edison Company and Subsidiary Companies.\n99-1 - The Detroit Edison Company Irrevocable Grantor Trust for The Detroit Edison Company Savings Reparation Plan.\n99-2 - The Detroit Edison Company Irrevocable Grantor Trust for The Detroit Edison Company Retirement Reparation Plan.\n99-3 - The Detroit Edison Company Irrevocable Grantor Trust for The Detroit Edison Company Management Supplemental Benefit Plan.\n99-4 - The Detroit Edison Company Irrevocable Grantor Trust for The Detroit Edison Company Benefit Equalization Plan.\n99-5 - The Detroit Edison Company Irrevocable Grantor Trust for The Detroit Edison Company Plan for Deferring the Payment of Directors' Fees.\nExhibit Number ------- 99-6 - The Detroit Edison Company Irrevocable Grantor Trust for The DTE Energy Company Retirement Plan for Non-Employee Directors.\n99-7 - DTE Energy Company Irrevocable Grantor Trust for The DTE Energy Company Plan for Deferring the Payment of Directors' Fees.\n99-8 - DTE Energy Company Irrevocable Grantor Trust for The DTE Energy Company Retirement Plan for Non-Employee Directors.\n(ii) Exhibits incorporated herein by reference.\n3(a) - Restated Articles of Incorporation of Detroit Edison, as filed December 10, 1991 with the State of Michigan, Department of Commerce - Corporation and Securities Bureau (Exhibit 4-117 to Form 10-Q for quarter ended March 31, 1993).\n3(b) - Certificate containing resolution of the Detroit Edison Board of Directors establishing the Cumulative Preferred Stock, 7.75% Series as filed February 22, 1993 with the State of Michigan, Department of Commerce - Corporation and Securities Bureau (Exhibit 4-134 to Form 10-Q for quarter ended March 31, 1993).\n3(c) - Certificate containing resolution of the Detroit Edison Board of Directors establishing the Cumulative Preferred Stock, 7.74% Series, as filed April 21, 1993 with the State of Michigan, Department of Commerce - Corporation and Securities Bureau (Exhibit 4-140 to Form 10-Q for quarter ended March 31, 1993).\n3(d) - Amended and Restated Articles of Incorporation of DTE Energy Company, dated December 13, 1995 (Exhibit 3A (3.1) to DTE Energy Form 8-B filed January 2, 1996, File No. 1-11607).\n3(e) - Agreement and Plan of Exchange (Exhibit 1(2) to DTE Energy Form 8-B filed January 2, 1996, File No. 1-11607).\nExhibit Number ------- 4(a) - Mortgage and Deed of Trust, dated as of October 1, 1924, between Detroit Edison (File No. 1-2198) and Bankers Trust Company as Trustee (Exhibit B-1 to Registration No. 2-1630) and indentures supplemental thereto, dated as of dates indicated below, and filed as exhibits to the filings as set forth below:\nSeptember 1, 1947 Exhibit B-20 to Registration No. 2-7136 October 1, 1968 Exhibit 2-B-33 to Registration No. 2-30096 November 15, 1971 Exhibit 2-B-38 to Registration No. 2-42160 January 15, 1973 Exhibit 2-B-39 to Registration No. 2-46595 June 1, 1978 Exhibit 2-B-51 to Registration No. 2-61643 June 30, 1982 Exhibit 4-30 to Registration No. 2-78941 August 15, 1982 Exhibit 4-32 to Registration No. 2-79674 October 15, 1985 Exhibit 4-170 to Form 10-K for year ended December 31, 1994 November 30, 1987 Exhibit 4-139 to Form 10-K for year ended December 31, 1992 July 15, 1989 Exhibit 4-171 to Form 10-K for year ended December 31, 1994 December 1, 1989 Exhibit 4-172 to Form 10-K for year ended December 31, 1994 February 15, 1990 Exhibit 4-173 to Form 10-K for year ended December 31, 1994 November 1, 1990 Exhibit 4-110 to Form 10-K for year ended December 31, 1990 May 1, 1991 Exhibit 4-112 to Form 10-Q for quarter ended June 30, 1991 May 15, 1991 Exhibit 4-113 to Form 10-Q for quarter ended June 30, 1991 September 1, 1991 Exhibit 4-116 to Form 10-Q for quarter ended September 30, 1991 November 1, 1991 Exhibit 4-119 to Form 10-K for year ended December 31, 1991\nExhibit Number -------\nJanuary 15, 1992 Exhibit 4-120 to Form 10-K for year ended December 31, 1991 February 29, 1992 Exhibit 4-121 to Form 10-Q for quarter ended March 31, 1992 April 15, 1992 Exhibit 4-122 to Form 10-Q for quarter ended June 30, 1992 July 15, 1992 Exhibit 4-123 to Form 10-Q for quarter ended September 30, 1992 July 31, 1992 Exhibit 4-124 to Form 10-Q for quarter ended September 30, 1992 November 30, 1992 Exhibit 4-130 to Registration No. 33-56496 January 1, 1993 Exhibit 4-131 to Registration No. 33-56496 March 1, 1993 Exhibit 4-141 to Form 10-Q for quarter ended March 31, 1993 March 15, 1993 Exhibit 4-142 to Form 10-Q for quarter ended March 31, 1993 April 1, 1993 Exhibit 4-143 to Form 10-Q for quarter ended March 31, 1993 April 26, 1993 Exhibit 4-144 to Form 10-Q for quarter ended March 31, 1993 May 31, 1993 Exhibit 4-148 to Registration No. 33-64296 June 30, 1993 Exhibit 4-149 to Form 10-Q for quarter ended June 30, 1993 (1993 Series AP) June 30, 1993 Exhibit 4-150 to Form 10-Q for quarter ended June 30, 1993 (1993 Series H) September 15, 1993 Exhibit 4-158 to Form 10-Q for quarter ended September 30, 1993. March 1, 1994 Exhibit 4-163 to Registration No. 33-53207. June 15, 1994 Exhibit 4-166 to Form 10-Q for quarter ended June 30, 1994. August 15, 1994 Exhibit 4-168 to Form 10-Q for quarter ended September 30, 1994. December 1, 1994 Exhibit 4-169 to Form 10-K for year ended December 31, 1994. August 1, 1995 Exhibit 4-174 to Form 10-Q for quarter ended September 30, 1995.\nExhibit Number -------\n4(b) - Collateral Trust Indenture (notes), dated as of June 30, 1993 (Exhibit 4-152 to Registration No. 33-50325).\n4(c) - First Supplemental Note Indenture, dated as of June 30, 1993 (Exhibit 4-153 to Registration No. 33-50325).\n4(d) - Second Supplemental Note Indenture, dated as of September 15, 1993 (Exhibit 4-159 to Form 10-Q for quarter ended September 30, 1993).\n4(e) - Third Supplemental Note Indenture, dated as of August 15, 1994 (Exhibit 4-169 to Form 10-Q for quarter ended September 30, 1994).\n4(f) - First Amendment, dated as of December 12, 1995, to Third Supplemental Note Indenture, dated as of August 15, 1994 (Exhibit 4-12 to Registration No. 333-00023).\n4(g) - Fourth Supplemental Note Indenture, dated as of August 15, 1995 (Exhibit 4-175 to Detroit Edison Form 10-Q for quarter ended September 30, 1995).\n4(h) - Fifth Supplemental Indenture, dated as of February 1, 1996 (Exhibit 4-1 to Detroit Edison Form 8-A dated March 11, 1996).\n4(i) - Standby Note Purchase Credit Facility, dated as of August 17, 1994, among The Detroit Edison Company, Barclays Bank PLC, as Bank and Administrative Agent, Bank of America, The Bank of New York, The Fuji Bank Limited, The Long-Term Credit Bank of Japan, LTD, Union Bank and Citicorp Securities, Inc. and First Chicago Capital Markets, Inc. as Remarketing Agents (Exhibit 99-18 to Form 10-Q for quarter ended September 30, 1994).\nExhibit Number -------\n*10(a) - Form of 1995 Indemnification Agreement between the Registrant and (1) Terence E. Adderley, (2) Lillian Bauder, (3) David Bing, (4) Anthony F. Earley, Jr., (5) Larry G. Garberding, (6) Allan D. Gilmour, (7) Theodore S. Leipprandt, (8) John E. Lobbia, (9) Patricia S. Longe, (10) Eugene A. Miller, (11) Dean E. Richardson, (12) Alan E. Schwartz, (13) William Wegner, (14) Christopher C. Arvani, (15) Susan M. Beale, (16) Elaine M. Godfrey, (17) Ronald J. Giaier, (18) Ronald W. Gresens, (19) Thomas A. Hughes, (20) Frederick S. Karwacki, (21) Leslie L. Loomans, (22) Peter A. Marquardt, (23) Christopher C. Nern, and (24) Albert J. Tack (Exhibit 3L (10-1) to DTE Energy Company Form 8-B dated January 2, 1996).\n*10(b) - Form of Indemnification Agreement between The Detroit Edison Company (\"Detroit Edison\") and (1) Frank E. Agosti, (2) Gerard M. Anderson, (3) Robert J. Buckler, (4) Ronald W. Gresens, (5) Leslie L. Loomans, (6) S. Martin Taylor, (7) Susan M. Beale, (8) Frederick S. Karwacki, (9) Douglas R. Gipson, (10) Thomas A. Hughes, (11) Christopher C. Nern, (12) Elaine M. Godfrey, (13) Christopher C. Arvani, (14) Michael E. Champley, (15) Haven E. Cockerham, (16) Ronald J. Giaier, (17) Peter A. Marquardt, and (18) Albert J. Tack (Exhibit 10-41 to Detroit Edison's Form 10-Q for quarter ended June 30, 1993).\n*10(c) - The Detroit Edison Company Shareholder Value Improvement Plan - A, as amended and restated effective January 1, 1996 (Exhibit 3L (10-3) to DTE Energy Form 8-B dated January 2, 1996).\n*10(d) - Certain arrangements pertaining to the employment of S. Martin Taylor (Exhibit 10-38 to Detroit Edison's Form 10-K for year ended December 31, 1992).\n*10(e) - Certain arrangements pertaining to the employment of Anthony F. Earley, Jr. (Exhibit 10-53 to Detroit Edison's Form 10-Q for quarter ended March 31, 1994).\n*10(f) - Third Restatement of The Detroit Edison Company Savings Reparation Plan, effective as of January 1, 1996 (Exhibit 3L (10-6) to DTE Energy Form 8-B dated January 2, 1996).\nExhibit Number ------- *10(g) - Certain arrangements pertaining to the employment of Haven E. Cockerham (Exhibit 10-55 to Detroit Edison's Form 10-Q for quarter ended September 30, 1994).\n*10(h) - Third Restatement of the Retirement Reparation Plan for Certain Employees of Detroit Edison, effective as of January 1, 1996 (Exhibit 3L (10-9) to DTE Energy Form 8-B dated January 2, 1996).\n*10(i) - Third Restatement of the Benefit Equalization Plan for Certain Employees of Detroit Edison, effective as of January 1, 1996 (Exhibit 3L (10-10) to DTE Energy Form 8-B dated January 2, 1996).\n*10(j) - Certain arrangements pertaining to the employment of Larry G. Garberding (Exhibit 28-52 to Detroit Edison's Form 10-Q for quarter ended June 30, 1990).\n*10(k) - Form of Indemnification Agreement, between Detroit Edison and (1) John E. Lobbia, (2) Larry G. Garberding and (3) Anthony F. Earley, Jr. (Exhibit 19-7 to Detroit Edison's Form 10-Q for quarter ended March 31, 1992).\n*10(l) - Form of Indemnification Agreement between Detroit Edison and (1) Terence E. Adderley, (2) Lillian Bauder, (3) David Bing, (4) Alan E. Schwartz , (5) William Wegner, (6) Theodore S. Leipprandt, (7) Patricia S. Longe, (8) Eugene A. Miller, (9) Dean E. Richardson, and (10) Alan D. Gilmour (Exhibit 19-8 to Detroit Edison's Form 10-Q for quarter ended March 31, 1992).\n*10(m) - Supplemental Long Term Disability Plan, dated November 5, 1991 (Exhibit 10-32 to Detroit Edison's Form 10-K for year ended December 31, 1991).\n*10(n) - Executive Vehicle Program, dated October 1, 1993 (Exhibit 10-47 to Detroit Edison's Form 10-Q for quarter ended September 30, 1993).\n*10(o) - Amendment No. 1 to Executive Vehicle Plan, November 1993 (Exhibit 10-58 to Detroit Edison's Form 10-K for year ended December 31, 1993).\nExhibit Number\n*10(p) - Certain arrangements pertaining to the employment of Gerard M. Anderson (Exhibit 10-40 to Detroit Edison's Form 10-K for year ended December 31, 1993).\n*10(q) - Third Restatement of The Detroit Edison Company Management Supplemental Benefit Plan, effective as of January 1, 1996 (Exhibit 3L (10-18) to DTE Energy Form 8-B dated January 2, 1996).\n*10(r) - Third Restatement of The Detroit Edison Company Plan for Deferring the Payment of Directors' Fees (January 1, 1996) (Exhibit 3L (10-19) to DTE Energy Form 8-B dated January 2, 1996).\n*10(s) - DTE Energy Company Retirement Plan for Non-Employee Directors (January 1, 1996) (Exhibit 3L (10-20) to DTE Energy Form 8-B dated January 2, 1996).\n*10(t) - DTE Energy Company Plan for Deferring the Payment of Directors' Fees (January 1, 1996) (Exhibit 3L (10-21) to DTE Energy Form 8-B dated January 2, 1996).\n21(a) - Subsidiaries of DTE Energy and Detroit Edison (Exhibit 3M (21) to DTE Energy Form 8-B dated January 2, 1996).\n99(a) - Belle River Participation Agreement between Detroit Edison and Michigan Public Power Agency, dated as of December 1, 1982 (Exhibit 28-5 to Registration No. 2-81501).\n99(b) - Belle River Transmission Ownership and Operating Agreement between Detroit Edison and Michigan Public Power Agency, dated as of December 1, 1982 (Exhibit 28-6 to Registration No. 2-81501.)\n99(c) - 1988 Amended and Restated Loan Agreement, dated as of October 4, 1988, between Renaissance Energy Company (an unaffiliated company) (\"Renaissance\") and Detroit Edison (Exhibit 99-6 to Registration No. 33-50325).\nExhibit Number -------\n99(d) - First Amendment to 1988 Amended and Restated Loan Agreement, dated as of February 1, 1990, between Detroit Edison and Renaissance (Exhibit 99-7 to Registration No. 33-50325).\n99(e) - Second Amendment to 1988 Amended and Restated Loan Agreement, dated as of September 1, 1993, between Detroit Edison and Renaissance (Exhibit 99-8 to Registration No. 33-50325).\n99(f) - Third Amendment, dated as of August 31, 1994, to 1988 Amended and Restated Nuclear Fuel Heat Purchase Contract, dated October 4, 1988, between The Detroit Edison Company and Renaissance Energy Company (Exhibit 99-21 to Form 10-Q for quarter ended September 30, 1994).\n99(g) - $200,000,000 364-Day Credit Agreement, dated as of September 1, 1993, among Detroit Edison, Renaissance and Barclays Bank PLC, New York Branch, as Agent (Exhibit 99-12 to Registration No. 33-50325).\n99(h) - First Amendment, dated as of August 31, 1994, to $200,000,000 364-Day Credit Agreement, dated September 1, 1993, among The Detroit Edison Company, Renaissance Energy Company, the Banks party thereto and Barclays Bank, PLC, New York Branch, as Agent (Exhibit 99-19 to Form 10-Q for quarter ended September 30, 1994).\n99(i) - $200,000,000 Three-Year Credit Agreement, dated September 1, 1993, among Detroit Edison, Renaissance and Barclays Bank PLC, New York Branch, as Agent (Exhibit 99-13 to Registration No. 33-50325).\n99(j) - 1988 Amended and Restated Nuclear Fuel Heat Purchase Contract, dated October 4, 1988, between Detroit Edison and Renaissance (Exhibit 99-9 to Registration No. 33-50325).\nExhibit Number -------\n99(k) - First Amendment to 1988 Amended and Restated Nuclear Fuel Heat Purchase Contract, dated as of February 1, 1990, between Detroit Edison and Renaissance (Exhibit 99-10 to Registration No. 33-50325).\n99(l) - Second Amendment, dated as of September 1, 1993, to 1988 Amended and Restated Nuclear Fuel Heat Purchase Contract between Detroit Edison and Renaissance (Exhibit 99-11 to Registration No. 33-50325).\n99(m) - First Amendment, dated as of September 1, 1994, to $200,000,000 Three-Year Credit Agreement, dated as of September 1, 1993, among The Detroit Edison Company, Renaissance Energy Company, the Banks party thereto and Barclays Bank, PLC, New York Branch, as Agent (Exhibit 99-20 to Form 10-Q for quarter ended September 30, 1994).\n99(n) - Master Trust Agreement (\"Master Trust\"), dated as of June 30, 1994, between Detroit Edison and Fidelity Management Trust Company relating to the Savings & Investment Plans (Exhibit 4-167 to Form 10-Q for quarter ended June 30, 1994).\n99(o) - First Amendment, effective as of February 1, 1995, to Master Trust.\n99(p) - Second Amendment, effective as of February 1, 1995 to Master Trust.\n99(q) - Third Amendment, effective January 1, 1996, to Master Trust.\n(b) Registrants did not file any reports on Form 8-K during the fourth quarter of 1995.\n(c) *Denotes management contract or compensatory plan or arrangement required to be filed as an exhibit to this report.\nDTE ENERGY COMPANY, THE DETROIT EDISON COMPANY AND SUBSIDIARY COMPANIES\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS\n- ------------------------------------------- (a) Collection of accounts previously written off.\n(b) Uncollectible 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.\nDate: March 25, 1996\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nDate: March 25, 1996\nANNUAL REPORTS ON FORM 10-K FOR DTE ENERGY COMPANY AND THE DETROIT EDISON COMPANY\nFile Nos. 1-11607 1-2198 EXHIBIT INDEX\nExhibit Page Number Number ------- ------\nExhibits filed herewith.\n3-3 - Amended and Restated By-Laws, dated as of February 26, 1996, of DTE Energy Company.\n3-4 - Amended and Restated By-Laws, dated as of February 26, 1996, of The Detroit Edison Company.\n4-14 - Fifth Supplemental Note Indenture, dated as of February 1, 1996.\n4-15 - Supplemental Indenture, dated as of April 1, 1991, establishing the 1991 Series AP Mortgage Bonds.\n*10-1 - Detroit Edison 1996 Shareholder Value Improvement Plan - A.\n*10-2 - Detroit Edison Key Employee Deferred Compensation Plan (January 1990).\n*10-3 - Detroit Edison Long-Term Incentive Plan.\nExhibit Page Number Number ------- ------\n11-2 - DTE Energy Company and Subsidiary Companies Primary and Fully Diluted Earnings Per Share of Common Stock.\n12-2 - The Detroit Edison Company and Subsidiary Companies Computation of Ratio of Earnings to Fixed Charges.\n12-3 - The Detroit Edison Company and Subsidiary Companies Computation of Ratio of Earnings to Fixed Charges and Preferred and Preference Stock Dividends.\n16-1 - Letter regarding change in certifying accountant.\n23-7 - Consent of Deloitte & Touche LLP.\n23-8 - Consent of Price Waterhouse LLP.\n27-1 - Financial Data Schedule for the period ended December 31, 1995 for DTE Energy Company and Subsidiary Companies.\n27-2 - Financial Data Schedule for the period ended December 31, 1995 for The Detroit Edison Company and Subsidiary Companies.\n99-1 - The Detroit Edison Company Irrevocable Grantor Trust for The Detroit Edison Company Savings Reparation Plan.\n99-2 - The Detroit Edison Company Irrevocable Grantor Trust for The Detroit Edison Company Retirement Reparation Plan.\n99-3 - The Detroit Edison Company Irrevocable Grantor Trust for The Detroit Edison Company Management Supplemental Benefit Plan.\n99-4 - The Detroit Edison Company Irrevocable Grantor Trust for The Detroit Edison Company Benefit Equalization Plan.\n99-5 - The Detroit Edison Company Irrevocable Grantor Trust for The Detroit Edison Company Plan for Deferring the Payment of Directors' Fees.\nExhibit Page Number Number ------- ------\n99-6 - The Detroit Edison Company Irrevocable Grantor Trust for The DTE Energy Company Retirement Plan for Non-Employee Directors.\n99-7 - DTE Energy Company Irrevocable Grantor Trust for The DTE Energy Company Plan for Deferring the Payment of Directors' Fees.\n99-8 - DTE Energy Company Irrevocable Grantor Trust for The DTE Energy Company Retirement Plan for Non-Employee Directors.\nExhibits incorporated herein by reference.\nSee Page Numbers ____ for location of Exhibits Incorporated By Reference\n3(a) - Restated Articles of Incorporation of Detroit Edison, as filed December 10, 1991 with the State of Michigan, Department of Commerce - Corporation and Securities Bureau (Exhibit 4-117 to Form 10-Q for quarter ended March 31, 1993).\n3(b) - Certificate containing resolution of the Detroit Edison Board of Directors establishing the Cumulative Preferred Stock, 7.75% Series as filed February 22, 1993 with the State of Michigan, Department of Commerce - Corporation and Securities Bureau (Exhibit 4-134 to Form 10-Q for quarter ended March 31, 1993).\n3(c) - Certificate containing resolution of the Detroit Edison Board of Directors establishing the Cumulative Preferred Stock, 7.74% Series, as filed April 21, 1993 with the State of Michigan, Department of Commerce - Corporation and Securities Bureau (Exhibit 4-140 to Form 10-Q for quarter ended March 31, 1993).\n3(d) - Amended and Restated Articles of Incorporation of DTE Energy Company, dated December 13, 1995 (Exhibit 3A (3.1) to DTE Energy Form 8-B filed January 2, 1996, File No. 1-11607).\n3(e) - Agreement and Plan of Exchange (Exhibit 1(2) to DTE Energy Form 8-B filed January 2, 1996, File No. 1-11607).\nExhibit Page Number Number ------- ------ 4(a) - Mortgage and Deed of Trust, dated as of October 1, 1924, between Detroit Edison (File No. 1-2198) and Bankers Trust Company as Trustee (Exhibit B-1 to Registration No. 2-1630) and indentures supplemental thereto, dated as of dates indicated below, and filed as exhibits to the filings as set forth below:\nSeptember 1, 1947 Exhibit B-20 to Registration No. 2-7136 October 1, 1968 Exhibit 2-B-33 to Registration No. 2-30096 November 15, 1971 Exhibit 2-B-38 to Registration No. 2-42160 January 15, 1973 Exhibit 2-B-39 to Registration No. 2-46595 June 1, 1978 Exhibit 2-B-51 to Registration No. 2-61643 June 30, 1982 Exhibit 4-30 to Registration No. 2-78941 August 15, 1982 Exhibit 4-32 to Registration No. 2-79674 October 15, 1985 Exhibit 4-170 to Form 10-K for year ended December 31, 1994 November 30, 1987 Exhibit 4-139 to Form 10-K for year ended December 31, 1992 July 15, 1989 Exhibit 4-171 to Form 10-K for year ended December 31, 1994 December 1, 1989 Exhibit 4-172 to Form 10-K for year ended December 31, 1994 February 15, 1990 Exhibit 4-173 to Form 10-K for year ended December 31, 1994 November 1, 1990 Exhibit 4-110 to Form 10-K for year ended December 31, 1990 May 1, 1991 Exhibit 4-112 to Form 10-Q for quarter ended June 30, 1991 May 15, 1991 Exhibit 4-113 to Form 10-Q for quarter ended June 30, 1991 September 1, 1991 Exhibit 4-116 to Form 10-Q for quarter ended September 30, 1991 November 1, 1991 Exhibit 4-119 to Form 10-K for year ended December 31, 1991\nExhibit Page Number Number ------- ------\nJanuary 15, 1992 Exhibit 4-120 to Form 10-K for year ended December 31, 1991 February 29, 1992 Exhibit 4-121 to Form 10-Q for quarter ended March 31, 1992 April 15, 1992 Exhibit 4-122 to Form 10-Q for quarter ended June 30, 1992 July 15, 1992 Exhibit 4-123 to Form 10-Q for quarter ended September 30, 1992 July 31, 1992 Exhibit 4-124 to Form 10-Q for quarter ended September 30, 1992 November 30, 1992 Exhibit 4-130 to Registration No. 33-56496 January 1, 1993 Exhibit 4-131 to Registration No. 33-56496 March 1, 1993 Exhibit 4-141 to Form 10-Q for quarter ended March 31, 1993 March 15, 1993 Exhibit 4-142 to Form 10-Q for quarter ended March 31, 1993 April 1, 1993 Exhibit 4-143 to Form 10-Q for quarter ended March 31, 1993 April 26, 1993 Exhibit 4-144 to Form 10-Q for quarter ended March 31, 1993 May 31, 1993 Exhibit 4-148 to Registration No. 33-64296 June 30, 1993 Exhibit 4-149 to Form 10-Q for quarter ended June 30, 1993 (1993 Series AP) June 30, 1993 Exhibit 4-150 to Form 10-Q for quarter ended June 30, 1993 (1993 Series H) September 15, 1993 Exhibit 4-158 to Form 10-Q for quarter ended September 30, 1993. March 1, 1994 Exhibit 4-163 to Registration No. 33-53207. June 15, 1994 Exhibit 4-166 to Form 10-Q for quarter ended June 30, 1994. August 15, 1994 Exhibit 4-168 to Form 10-Q for quarter ended September 30, 1994. December 1, 1994 Exhibit 4-169 to Form 10-K for year ended December 31, 1994. August 1, 1995 Exhibit 4-174 to Form 10-Q for quarter ended September 30, 1995.\nExhibit Page Number Number ------- ------\n4(b) - Collateral Trust Indenture (notes), dated as of June 30, 1993 (Exhibit 4-152 to Registration No. 33-50325).\n4(c) - First Supplemental Note Indenture, dated as of June 30, 1993 (Exhibit 4-153 to Registration No. 33-50325).\n4(d) - Second Supplemental Note Indenture, dated as of September 15, 1993 (Exhibit 4-159 to Form 10-Q for quarter ended September 30, 1993).\n4(e) - Third Supplemental Note Indenture, dated as of August 15, 1994 (Exhibit 4-169 to Form 10-Q for quarter ended September 30, 1994).\n4(f) - First Amendment, dated as of December 12, 1995, to Third Supplemental Note Indenture, dated as of August 15, 1994 (Exhibit 4-12 to Registration No. 333-00023).\n4(g) - Fourth Supplemental Note Indenture, dated as of August 15, 1995 (Exhibit 4-175 to Detroit Edison Form 10-Q for quarter ended September 30, 1995).\n4(h) - Fifth Supplemental Indenture, dated as of February 1, 1996 (Exhibit 4-1 to Detroit Edison Form 8-A dated March 11, 1996).\n4(i) - Standby Note Purchase Credit Facility, dated as of August 17, 1994, among The Detroit Edison Company, Barclays Bank PLC, as Bank and Administrative Agent, Bank of America, The Bank of New York, The Fuji Bank Limited, The Long-Term Credit Bank of Japan, LTD, Union Bank and Citicorp Securities, Inc. and First Chicago Capital Markets, Inc. as Remarketing Agents (Exhibit 99-18 to Form 10-Q for quarter ended September 30, 1994).\nExhibit Page Number Number ------- ------\n*10(a) - Form of 1995 Indemnification Agreement between the Registrant and (1) Terence E. Adderley, (2) Lillian Bauder, (3) David Bing, (4) Anthony F. Earley, Jr., (5) Larry G. Garberding, (6) Allan D. Gilmour, (7) Theodore S. Leipprandt, (8) John E. Lobbia, (9) Patricia S. Longe, (10) Eugene A. Miller, (11) Dean E. Richardson, (12) Alan E. Schwartz, (13) William Wegner, (14) Christopher C. Arvani, (15) Susan M. Beale, (16) Elaine M. Godfrey, (17) Ronald J. Giaier, (18) Ronald W. Gresens, (19) Thomas A. Hughes, (20) Frederick S. Karwacki, (21) Leslie L. Loomans, (22) Peter A. Marquardt, (23) Christopher C. Nern, and (24) Albert J. Tack (Exhibit 3L (10-1) to DTE Energy Company Form 8-B dated January 2, 1996).\n*10(b) - Form of Indemnification Agreement between The Detroit Edison Company (\"Detroit Edison\") and (1) Frank E. Agosti, (2) Gerard M. Anderson, (3) Robert J. Buckler, (4) Ronald W. Gresens, (5) Leslie L. Loomans, (6) S. Martin Taylor, (7) Susan M. Beale, (8) Frederick S. Karwacki, (9) Douglas R. Gipson, (10) Thomas A. Hughes, (11) Christopher C. Nern, (12) Elaine M. Godfrey, (13) Christopher C. Arvani, (14) Michael E. Champley, (15) Haven E. Cockerham, (16) Ronald J. Giaier, (17) Peter A. Marquardt, and (18) Albert J. Tack (Exhibit 10-41 to Detroit Edison's Form 10-Q for quarter ended June 30, 1993).\n*10(c) - The Detroit Edison Company Shareholder Value Improvement Plan - A, as amended and restated effective January 1, 1996 (Exhibit 3L (10-3) to DTE Energy Form 8-B dated January 2, 1996).\n*10(d) - Certain arrangements pertaining to the employment of S. Martin Taylor (Exhibit 10-38 to Detroit Edison's Form 10-K for year ended December 31, 1992).\n*10(e) - Certain arrangements pertaining to the employment of Anthony F. Earley, Jr. (Exhibit 10-53 to Detroit Edison's Form 10-Q for quarter ended March 31, 1994).\n*10(f) - Third Restatement of The Detroit Edison Company Savings Reparation Plan, effective as of January 1, 1996 (Exhibit 3L (10-6) to DTE Energy Form 8-B dated January 2, 1996).\nExhibit Page Number Number ------- ------ *10(g) - Certain arrangements pertaining to the employment of Haven E. Cockerham (Exhibit 10-55 to Detroit Edison's Form 10-Q for quarter ended September 30, 1994).\n*10(h) - Third Restatement of the Retirement Reparation Plan for Certain Employees of Detroit Edison, effective as of January 1, 1996 (Exhibit 3L (10-9) to DTE Energy Form 8-B dated January 2, 1996).\n*10(i) - Third Restatement of the Benefit Equalization Plan for Certain Employees of Detroit Edison, effective as of January 1, 1996 (Exhibit 3L (10-10) to DTE Energy Form 8-B dated January 2, 1996).\n*10(j) - Certain arrangements pertaining to the employment of Larry G. Garberding (Exhibit 28-52 to Detroit Edison's Form 10-Q for quarter ended June 30, 1990).\n*10(k) - Form of Indemnification Agreement, between Detroit Edison and (1) John E. Lobbia, (2) Larry G. Garberding and (3) Anthony F. Earley, Jr. (Exhibit 19-7 to Detroit Edison's Form 10-Q for quarter ended March 31, 1992).\n*10(l) - Form of Indemnification Agreement between Detroit Edison and (1) Terence E. Adderley, (2) Lillian Bauder, (3) David Bing, (4) Alan E. Schwartz , (5) William Wegner, (6) Theodore S. Leipprandt, (7) Patricia S. Longe, (8) Eugene A. Miller, (9) Dean E. Richardson, and (10) Alan D. Gilmour (Exhibit 19-8 to Detroit Edison's Form 10-Q for quarter ended March 31, 1992).\n*10(m) - Supplemental Long Term Disability Plan, dated November 5, 1991 (Exhibit 10-32 to Detroit Edison's Form 10-K for year ended December 31, 1991).\n*10(n) - Executive Vehicle Program, dated October 1, 1993 (Exhibit 10-47 to Detroit Edison's Form 10-Q for quarter ended September 30, 1993).\n*10(o) - Amendment No. 1 to Executive Vehicle Plan, November 1993 (Exhibit 10-58 to Detroit Edison's Form 10-K for year ended December 31, 1993).\nExhibit Page Number Number ------- ------\n*10(p) - Certain arrangements pertaining to the employment of Gerard M. Anderson (Exhibit 10-40 to Detroit Edison's Form 10-K for year ended December 31, 1993).\n*10(q) - Third Restatement of The Detroit Edison Company Management Supplemental Benefit Plan, effective as of January 1, 1996 (Exhibit 3L (10-18) to DTE Energy Form 8-B dated January 2, 1996).\n*10(r) - Third Restatement of The Detroit Edison Company Plan for Deferring the Payment of Directors' Fees (January 1, 1996) (Exhibit 3L (10-19) to DTE Energy Form 8-B dated January 2, 1996).\n*10(s) - DTE Energy Company Retirement Plan for Non-Employee Directors (January 1, 1996) (Exhibit 3L (10-20) to DTE Energy Form 8-B dated January 2, 1996).\n*10(t) - DTE Energy Company Plan for Deferring the Payment of Directors' Fees (January 1, 1996) (Exhibit 3L (10-21) to DTE Energy Form 8-B dated January 2, 1996).\n21(a) - Subsidiaries of DTE Energy and Detroit Edison (Exhibit 3M (21) to DTE Energy Form 8-B dated January 2, 1996).\n99(a) - Belle River Participation Agreement between Detroit Edison and Michigan Public Power Agency, dated as of December 1, 1982 (Exhibit 28-5 to Registration No. 2-81501).\n99(b) - Belle River Transmission Ownership and Operating Agreement between Detroit Edison and Michigan Public Power Agency, dated as of December 1, 1982 (Exhibit 28-6 to Registration No. 2-81501.)\n99(c) - 1988 Amended and Restated Loan Agreement, dated as of October 4, 1988, between Renaissance Energy Company (an unaffiliated company) (\"Renaissance\") and Detroit Edison (Exhibit 99-6 to Registration No. 33-50325).\nExhibit Page Number Number ------- ------\n99(d) - First Amendment to 1988 Amended and Restated Loan Agreement, dated as of February 1, 1990, between Detroit Edison and Renaissance (Exhibit 99-7 to Registration No. 33-50325).\n99(e) - Second Amendment to 1988 Amended and Restated Loan Agreement, dated as of September 1, 1993, between Detroit Edison and Renaissance (Exhibit 99-8 to Registration No. 33-50325).\n99(f) - Third Amendment, dated as of August 31, 1994, to 1988 Amended and Restated Nuclear Fuel Heat Purchase Contract, dated October 4, 1988, between The Detroit Edison Company and Renaissance Energy Company (Exhibit 99-21 to Form 10-Q for quarter ended September 30, 1994).\n99(g) - $200,000,000 364-Day Credit Agreement, dated as of September 1, 1993, among Detroit Edison, Renaissance and Barclays Bank PLC, New York Branch, as Agent (Exhibit 99-12 to Registration No. 33-50325).\n99(h) - First Amendment, dated as of August 31, 1994, to $200,000,000 364-Day Credit Agreement, dated September 1, 1993, among The Detroit Edison Company, Renaissance Energy Company, the Banks party thereto and Barclays Bank, PLC, New York Branch, as Agent (Exhibit 99-19 to Form 10-Q for quarter ended September 30, 1994).\n99(i) - $200,000,000 Three-Year Credit Agreement, dated September 1, 1993, among Detroit Edison, Renaissance and Barclays Bank PLC, New York Branch, as Agent (Exhibit 99-13 to Registration No. 33-50325).\n99(j) - 1988 Amended and Restated Nuclear Fuel Heat Purchase Contract, dated October 4, 1988, between Detroit Edison and Renaissance (Exhibit 99-9 to Registration No. 33-50325).\nExhibit Page Number Number ------- ------\n99(k) - First Amendment to 1988 Amended and Restated Nuclear Fuel Heat Purchase Contract, dated as of February 1, 1990, between Detroit Edison and Renaissance (Exhibit 99-10 to Registration No. 33-50325).\n99(l) - Second Amendment, dated as of September 1, 1993, to 1988 Amended and Restated Nuclear Fuel Heat Purchase Contract between Detroit Edison and Renaissance (Exhibit 99-11 to Registration No. 33-50325).\n99(m) - First Amendment, dated as of September 1, 1994, to $200,000,000 Three-Year Credit Agreement, dated as of September 1, 1993, among The Detroit Edison Company, Renaissance Energy Company, the Banks party thereto and Barclays Bank, PLC, New York Branch, as Agent (Exhibit 99-20 to Form 10-Q for quarter ended September 30, 1994).\n99(n) - Master Trust Agreement (\"Master Trust\"), dated as of June 30, 1994, between Detroit Edison and Fidelity Management Trust Company relating to the Savings & Investment Plans (Exhibit 4-167 to Form 10-Q for quarter ended June 30, 1994).\n99(o) - First Amendment, effective as of February 1, 1995, to Master Trust.\n99(p) - Second Amendment, effective as of February 1, 1995 to Master Trust.\n99(q) - Third Amendment, effective January 1, 1996, to Master Trust.\n(b) Registrants did not file any reports on Form 8-K during the fourth quarter of 1995.\n* Denotes management contract or compensatory plan or arrangement required to be filed as an exhibit to this report.","section_15":""}
{"filename":"9096_1995.txt","cik":"9096","year":"1995","section_1":"Item 1. Business\nBadger Paper Mills, Inc. (the Company) was incorporated under the laws of the State of Wisconsin in 1929. It has been producing sulphite pulp and paper for over 65 years. The industry segment in which the Company operates is in the production of paper products. The Company operates Plas-Techs, Inc., (Plas-Techs) a wholly-owned subsidiary in Oconto Falls, Wisconsin.\nProducts and Distribution\nThe Company operates an integrated sulphite pulp mill and a paper mill, consisting of two paper machines located in Peshtigo, Wisconsin. Converting facilities contiguous to the papermaking facilities include sheeting, trimming, sealing, packaging, perforating, printing presses, rewinders, waxers, paper drilling and die-cutting equipment. The Company also has a printing and converting operation in Oconto Falls, Wisconsin.\nIn 1995, the pulp mill produced 35,198 tons of bleached sulphite, of which the Peshtigo mill consumed 78 per cent; and the remaining 22 per cent was sold on the open market.\nThe fine paper division of the Company represented 77 per cent of the paper produced by the Company in 1995, and more than 64 per cent of the Company's 1995 revenue. This portion of the Company's business consists of papers manufactured on the Fourdrinier paper machine in Peshtigo. Fine paper grades are produced utilizing virgin pulp from the Company's pulp mill and purchased on the open market, and\/or pre and post consumer recycled fibers. These paper grades include bond, mimeograph, duplicating, electrostatic copier, text and cover, and technical and specialty papers. The Company sells a portion of these products under certain trademarks and trade names, including Ta-Non-Ka\/R\/, Copyrite\/R\/, BPM, ENVIROGRAPHIC\/R\/, and Northern Brights\/TM\/. These products are sold primarily through paper merchants and brokers who in turn sell to other value-adding entities or direct to the consumer. A portion of the product is sold directly to third party value-added converters. Although consumers of the Company's fine paper products are located primarily throughout the Midwest, purchasers of the Company's products can be found in principal cities from coast to coast in North America.\nThe MG specialty and packaging papers division represented 30 per cent of the Company's 1995 revenue, and 23 per cent of the paper manufactured by the Company's two paper machines in 1995. In addition, paper is purchased from other manufacturers to supplement the Company's production capacity in order to increase utilization of the converting facilities. These products, which include papers manufactured on the Company's Yankee paper machine, consist of converted plain or printed waxed papers, laminating grades, machine-glazed, colors and various other specialty papers. These products are sold to manufacturers, consumers and converters throughout the Eastern and Central United States by commissioned brokers and by the Company's own sales personnel.\nIn August, 1994, the Company sold its SHARPrint\/TM\/ computer paper product line, which included converting equipment, finished goods inventory and certain intangibles including the trademark, \"SHARPrint\/TM\/.\"\nThe Company's subsidiary, Plas-Techs, Inc., a printing and converting facility, compliments the Company's customer base. Plas-Techs is capable of processing various substrates of film and paper, enhancing the capabilities and flexibility of both the Company's printing paper operations and its flexible packaging paper operations, resulting in an expanded business growth for both. This facility also has rewinding and poly bagmaking equipment.\nIn December, 1993, the Company disposed of its Dayton Division. The division was originally purchased in 1992 for the purpose of augmenting innovated free-sheet production capacity and providing the Company with the ability to offer a greater variety of value-added products to the marketplace. Weak overall market activity and lack of support for additional capacity in the market segment served by this division prompted the sale of this facility.\nCompetition\nThe paper products manufactured are highly sensitive to competition from numerous sources, including other paper products and products of other composition. Price, volume, service and product quality influence competition.\nThe Company's production of fine papers from the Fourdrinier paper machine represents less than one percent of the production capacity in the United States. Competition for these papers comes from other specialty mills in North America and imports from other countries. Competition for MG specialty and packaging papers produced from the Yankee paper machine comes from other specialty mills; some of the mills are similarly constituted as the Company, while others have greater capacity. Backlogs are maintained by offering quality products, prompt service, technical assistance, and a research and development program, making new products available to meet customer product design specifications.\nInventories; raw materials\nThe principal raw material used in pulp production is poplar pulpwood. This is purchased directly from pulpwood producers within 150 miles of the mill. Sulphite pulp manufactured from the pulpwood provided approximately 40 per cent of the fiber requirements for the paper machines in 1995. The purchase of hardwood and softwood kraft pulp, along with pre-consumer and post-consumer recycled fibers, makes up the balance of the fiber requirements.\nOther raw materials are purchased directly from the manufacturers. The Company has at least two sources of supply for major items. Shortages of purchased pulp, pulpwood and certain chemicals (including petrochemicals) would have an adverse effect on product and\/or product mix. Although the price of purchased fiber has increased substantially in 1995, the increase was not accompanied by shortages.\nIn-process and finished goods inventory at the end of 1995 was equivalent to approximately 35 days of production on the paper machines.\nEnergy\nThe Company is a large user of electricity and natural gas. An on-site 2,000 kilowatt electrical co-generation system has the capability of producing approximately 15 per cent of the Company's current electrical requirements. The balance of the Company's electrical requirements are purchased from local public or municipal cooperative utilities. The Company's heat requirements come from two dual-fueled boilers capable of burning natural gas or fuel oil, and one natural gas boiler. Natural gas is purchased from various sources in the United States and Canada. The sources of natural gas, fuel oil and electricity are adequate to meet the needs of the Company.\nPatents\nThe Company owns certain patents and licenses used in connection with its business, none of which are individually considered material to its business.\nResearch and development\nA technical staff researches and develops new products. Expertise of outside consultants is also utilized from time to time. The amounts spent on product research and development activities were $300,000 in 1995, $200,000 in 1994, and $226,000 in 1993. The expenditures were focused primarily in Peshtigo on research and development of new products for flexible packaging and specialty printing papers.\nBacklog\nAs of December 31, 1995, the Company's backlog of orders was approximately $2,900,000, as compared to $10,500,000 and $3,200,000 at December 31, 1994 and 1993 respectively. Rising prices at the end of 1994 fueled the backlog, as customers anticipated further price increases. Conversly, as prices were falling rapidly at the end of 1995, customers delayed order commitments.\nCustomers\nSales to Alco Standard Corporation represented over 10 percent of the Company's net sales, or $10,732,000 in 1995. In 1994 and 1993, there were no customers which represented over 10 percent of the Company's net sales.\nEnvironmental matters\nEnvironmental regulations relating to air emissions, water discharges, and solid waste disposal continue to have a significant effect on the Company. The Environmental Protection Agency has indicated that they intend to have promulgated the \"cluster rules\" for the Company's category, \"Paper Grade Sulphite\", before Labor Day, 1996. Once these rules have been finalized, a compliance time line of three years will become effective, and the Company will be able to assess total impact on its operation.\nManagement believes the new \"Proposed\" regulations that will affect ammonia-based sulphite pulping facilities have been modified from their original form. It is expected that the modified proposed regulations will require the Company to change its bleaching sequence to eliminate elemental chlorine. This requirement could mean the installation of another primary delignification process such as chlorine dioxide or oxygen. Over the years, the Company has gathered data on the acceptability of alternative methods of bleaching. If these indications are true, the use of chlorine dioxide becomes a very good possibility for modification to the first stage of bleaching. The Company, however, will still be faced with the replacement of the sodium hypochlorite which is used in our third bleaching stage. This replacement is dictated by the chloroform emissions regulations that are in effect. Modifications to this system could allow for the use of hydrogen peroxide.\nThe Wisconsin Department of Natural Resources (WDNR) has not acted on the Title V Air Operating Permit application that was submitted in 1994. The Company will continue to evaluate changes and modifications based on the emissions factors as they are developed for the sulphite industry, and submit additional information to the WDNR as appropriate. The Company anticipates that sometime during 1996, the Department will start to review the applications for the Title V Air Operating permit. The Company discontinued use of the paper mill settling basins for effluent treatment in 1995. All effluents from paper manufacturing operations are now combined with the pulp mill's discharge and directed to the Joint Industrial Municipal Wastewater Treatment (JWWTP) facility jointly owned with the City of Peshtigo, Wisconsin, and operated by the Company. The additional loading to the JWWTP required the rebuilding of the underwater mechanisms and the installation of a baffle system in each of the three final clarifiers. These changes, along with the installation of a settling polymer system, allowed the system to handle the increased loading and still meet the effluent limits for the facility.\nFederal and state regulations require that a treatment facility have sufficient biological sludge storage for 180 days for storage of sludge when the ground is frozen and land spreading operations are suspended. The Company has negotiated an alternative approach to sludge storage with the City of Oconto, Wisconsin. The City of Oconto has installed extra sludge handling and storage capacity at its municipal disposal facility. The Company signed an agreement with the City of Oconto for the winter of 1995-1996 to provide sludge storage for the Company. This program is in lieu of installing the required 180 day storage equipment at the JWWTP facility.\nWith the combination of the paper mill and pulp mill effluents now being directed to the JWWTP, it was necessary to submit a closure plan for the paper mill lagoon system to the WDNR. On December 8, 1995, the WDNR approved the plan submitted by the Company. This closure will be completed by December 31, 1996. In regard to the Harbor Road solid waste disposal site, the Company is waiting for the WDNR to approve the closure plan for this facility. The site has been rough graded and is now ready for application of the final venting layer and cover. With the closure of the paper mill lagoon system during the summer of 1996, the sludge will be removed from the last basin and will be combined with bark from the pulp mill to form the compost for the final cover. The WDNR is aware of the conditions at the solid waste disposal site, and it is anticipated that they will respond to our final closure plan in 1996.\nThe Storm Water Pollution Prevention Plan for the Company was submitted to and accepted by the WDNR. During 1996, the Company will establish procedures and train employees in the implementation of this requirement. The Company does not anticipate any problems in complying with this regulation.\nManagement is currently evaluating all practical options with respect to compliance with applicable environmental regulations at the Company's sulphite pulping facilty.\nPlas-Techs\nOn October 31, 1995, Plas-Techs received an Air Pollution Control operating permit. The type of permit that was received is a Synthetic Minor Non-Part 70 which will allow Plas-Techs to grow and expand production within the limits established in the operating permit. This operating permit expires on October 31, the year 2000, and Plas-Techs does not anticipate any problems meeting all of the requirements as established in the permit.\nEmployees\nAs of December 31, 1995, the Company had 439 employees, of which 353 were covered by six-year collective bargaining contracts effective June 1, 1995.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company considers its manufacturing and converting facilities to be in good repair and suitable for the purpose intended.\nIn 1995, capital improvements included the installation of new combustion controls for the dual-fired boilers. The wastewater treatment facility had an upgrade to the disinfection\/dechlorination system, as well as a rebuild of the clarifiers underwater mechanisms, and installation of a baffle system.\nOther capital outlays were used to maintain or improve the current manufacturing processes.\nThe Company owns 15,600 acres of timber and pulpwood lands, where harvesting practices provide improved wildlife habitat and watershed protection. The majority of the lands are accessible to the general public for sporting and recreational facilities. Part of these timberlands are no longer compatible with the Company's current fiber requirements. They now provide less than 1 percent of the Company's annual wood requirements since the Company converted its pulp mill to 100 percent poplar for its pulpwood source. In September, 1995, the Company offered to sell 14,000 acres of timberland, representing 85 percent of the total land holdings and is currently negotiating the sale of such timberland with various parties whose bids for portions of such timberland have been accepted by the Company. The sale of the timberland is expected to be consummated prior to May 1, 1996.\nThe Company's headquarters and principal facilities are located in Peshtigo, Wisconsin. Its subsidiary, Plas-Techs, Inc., is located in Oconto Falls, Wisconsin.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe Company has no pending legal proceedings which are of material importance.\nItem 4.","section_4":"Item 4. Submission of matters to a vote of security holders\nNo such matters were submitted to a vote of security holders in the fourth quarter, 1995.\nPART II\nItem 5.","section_5":"Item 5. Market for the registrant's common stock and related security holder matters\nBadger Paper Mills, Inc. common shares are traded on the NASDAQ market under the symbol BPMI. Shareholders of record as of February 26, 1996, total 562. Stock price and dividend information is found on page 34 of this report, which is incorporated herein by reference.\nItem 6.","section_6":"Item 6. Selected financial data\nInformation regarding selected financial data of the Company is presented on page 2 of this report.\nItem 7.","section_7":"Item 7. Management's discussion and analysis of financial condition and results of operations\nResults of Operations\nThe year 1995 may be best described as a strong starter but a slow finisher. The fine paper division of our business saw its markets rise and fall in 1995. The demand for product remained strong through the first three quarters, at which time customers started to adjust inventories which slowed orders. The corresponding softening in prices reinforced the customers' decision to reduce inventory levels. Significant downtime by the industry failed to correct the oversupply at the mill level, which continued to erode prices through year end.\nSignificant inroads were made in securing specialty color business that is less sensitive to market fluctuations. The development of the seven-point reply copy grade was a significant portion of the new product production that showed excellent efficiency and runnability in the marketplace. The Company entered into an agreement to do additional customer roll sheeting for improved utilization of converting equipment as product mix was controlled to manufacture more rolls. This agreement was successfully processed through 1995 and continues into 1996.\nThe sale of all paper product inventory from the Company's former Dayton division was completed through a trade credit arrangement in the fourth quarter of 1995. Revenue recognition from this sale will be recognized as trade credits are used over the next three years.\nSimilar to the fine paper division, demand for value-added packaging and specialty papers produced by the Company's Yankee paper machine remained strong for the first three quarters of 1995, but weakened in the fourth quarter and into 1996. The MG specialty and packaging papers division kept pace with the rising costs of raw materials by instituting positive price adjustments for flexible packaging papers.\nThe Company's printing, waxing and specialty converting remains the backbone to the MG specialty and packaging papers division. Threatened by various substrates being offered to the packaging industry, the Company's ability to use its strong technical expertise to design custom-made products allows it to be competitive in the marketplace. Th Company is continually developing new applications and products that can fill limited product losses experienced each year.\nBecause of interest from current and prospective customers, the Company's Board of Directors approved plans for the Peshtigo operations to pursue ISO certification. ISO certification is looked upon in the industry as a major asset. This certification effort assures customers that the Company is committed to offer quality products to a global market well into the next century. Badger's quality policy is Badger Paper Mills, Inc. will continually meet our customer's needs in a responsible manner.\nThe Company's wholly-owned subsidiary, Plas-Techs, Inc., doubled the physical size of its existing facility. Construction of the project began during the first quarter, 1995, and was completed late in the second quarter, 1995. Plas-Techs, Inc. business has continually increased in excess of 30 percent annually since acquisition, and had outgrown its original physical dimensions. Additional equipment to support production demands was installed, existing equipment was relocated to provide for improved throughput, and off-site inventory was relocated to the facility.\n1995 vs. 1994\nNet sales for 1995 of $92,648,000 compared to $73,674,000 reported a year earlier, a 26 percent increase. The volume of shipments decreased by 6 percent while the strong market conditions fueled a 34 percent increase in average selling price. The cut size paper market was extremely strong through the first three quarters of 1995, but slowed in the fourth quarter. During 1995, the sale to unaffiliated customers of wet lap sulphite pulp produced in the pulp mill increased by $3,607,000 to $4,734,000 in 1995 from $1,127,000 in 1994. This was a result of both increased pricing and increased shipments.\nCost of sales of $83,890,000 for 1995 increased 15 percent from $72,949,000 for 1994. Production from operations remained constant from 1995 to 1994. Fiber pricing continued its upward trend with strong demand through the first half of 1995. Pulp prices have risen more than 140 percent over a period of sixteen months. The additional cost relating to pulp was in excess of $13,000,000.\nGross margins for 1995 of $8,758,000 compare to $725,000 a year earlier, and reflect the positive impact of rising paper prices to offset the increased pulp prices.\nSelling and administrative expenses totaled $3,852,000 and $3,872,000 for 1995 and 1994, respectively.\nChanges instituted in our manufacturing and converting facilities have resulted in increasing operating efficiencies and reducing production costs. The operating results include a charge in the amount of $504,000 taken as a result of the expense incurred from the voluntary early retirement incentive package offered to hourly workers in the first quarter, 1995. This program allowed the Company to reduce the overstaffing brought about by changes implemented in the manufacturing process during 1994.\nThe Company recognized an unrealized holding gain on trading securities of $549,000 in 1995 compared to an $846,000 unrealized holding loss in 1994. Because the Company's investment securities are accounted for as a trading account, unrealized gains and losses are included in the Company's statement of operations in accordance with FASB No. 115.\nInterest expense for 1995 decreased $10,000 to $1,305,000 from $1,315,000 reported in 1994. The reduction in short-term borrowings in 1995 was offset by rising interest rates. The Company's subsidiary, Plas-Techs, Inc., contributed approximately 3.2 percent to the consolidated revenue of the Company and was profitable for 1995.\nThe Company's effective tax rate was 32.3 percent in 1995 compared to a tax benefit of 40.4 percent in 1994. The 1994 tax benefit results from operating losses and exceeds the statutory rates due to research and development credits, and tax-exempt interest. Offsetting the 1994 tax benefits were state income taxes and other tax-affected items.\n1994 vs. 1993\nThe comparisons between 1994 and 1993 are substantially affected by the closure of the Company's Dayton Division. On August 3, 1993, the Company announced that it would close its facility in Dayton, Ohio, and that a conditional agreement had been signed to sell the assets of the Dayton Division to an acquisition arm of Crosse Pointe Paper Corporation, St. Paul, Minnesota. In the second quarter, 1993, the Company took a pre-tax restructuring charge of $3,400,000 to reflect the estimated loss on the sale of the Dayton Division based on an anticipated October 4, 1993, closing. A delay in the closing until December 30, 1993, resulted in additional costs incurred of $450,000, which amount was added to the restructuring provision. The restructuring charge totaled $3,850,000, and related primarily to operating losses at the Dayton Division prior to the actual disposal date and a write down of certain inventories to net realizable value, offset by the gain on the sale of the property, plant and equipment. The reserve for restructuring of $59,000 at December 31, 1994, was adequate to meet the remaining commitments related to the Dayton Division.\nNet sales for 1994 of $73,674,000 compared to $76,567,000 reported in 1993, a 4 percent decrease. The Dayton Division contributed $4,670,000 to net sales in 1993. Volume of shipments from operations other than Dayton decreased 3 percent while product mix and positive pricing adjustments improved average selling price by 4 percent compared to a year earlier. Weak demand in the domestic uncoated free sheet market reversed during the third quarter of 1994; however, the Company's order commitments hindered its ability to affect price increases intended to offset raw material costs and reflect the demand. Uncoated free sheet inventories increased into the third quarter of 1994 as production exceeded sales. Increased order activity for uncoated free sheet papers beginning in the third quarter of 1994 increased volume of shipments for the balance of the year, resulting in a 63 percent reduction of work in process and finished goods inventory to $3,286,000 at December 31, 1994 from $5,222,000 a year earlier. During 1994, the Company increased the sale of wet lap sulphite pulp produced in the pulp mill. Rising prices and increased demand for pulp fibers provided the opportunity for the Company to market its sulphite pulp. Shipments of sulphite pulp during 1994 were in excess of its internal needs in the papermaking process.\nCost of sales of $72,949,000 for 1994 decreased 2 percent from $74,272,000 for 1993. Dayton Division contributed $5,591,700 to cost of sales for the 1993 period. Production from operations other than Dayton in 1994 decreased 3 percent from a year earlier due to lower net productivity. Increased cost of pulpwood, purchased fiber and chemicals used in the pulp and paper processes, and increased operating and maintenance expenses incurred, adversely affected cost of sales. A 10% reduction in the cost of energy partially offset the other increases in cost. The cost of the Company's largest raw material ingredient, purchased fiber, increased 90 percent between December, 1993 and December, 1994, and continued to increase into 1995. The Company was unable to fully recover the rapidly escalating cost of this major raw material ingredient.\nGross margins for 1994 of $725,000 compare to $2,295,000 a year earlier, and reflect the negative impact of rising purchased fiber costs.\nSelling and administrative expenses total $3,872,000 and $4,715,000 for 1994 and 1993, respectively. The decrease in 1994 when compared to a year earlier is primarily attributable to the exclusion of the Dayton Division expenses after June 1, 1993. The Dayton Division contributed $633,000 to selling and administrative expenses in 1993.\nOperating losses for the year improved to $3,147,000 from a year earlier loss of $6,270,000. However, the 1993 operating loss included the Dayton Division restructuring costs in the amount of $3,850,000.\nOther income and expense includes interest income of $425,000 for 1994 compared to $517,000 reported a year earlier. The decrease in interest income is due to lower availability of funds invested during 1994 compared to a year earlier.\nInterest expense for 1994 increased $340,000 to $1,315,000 from $975,000 reported in 1993. The escalation in interest rates adversely affected the cost of borrowing, particularly on the Company's outstanding line of credit, as well as on the outstanding debt related to the Company's industrial development revenue bonds. On January 1, 1994, the Company adopted Financial Accounting Standards Board Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities (FASB No. 115). The Company recognized an unrealized holding loss on trading securities of $846,000 for 1994 in accordance with FASB No. 115. At December 31, 1993, the cost of these trading securities approximated market value. Miscellaneous income for 1994 of $643,000 compares to $279,000 a year earlier. The 1994 amount includes the value received in excess of book value on the disposition of the SHARPrint\/TM\/ portion of the business.\nThe Company's effective tax benefit was 40.4 percent in 1994 compared to 37.0 percent in 1993. The 1994 tax benefit results from operating losses and exceeds the statutory rates due to operating losses, research and development credit, and tax-exempt interest. Offsetting the 1994 tax benefits were state income taxes and other tax-affected items.\nThe Company's subsidiary, Plas-Techs, Inc., located in Oconto Falls, Wisconsin, contributed approximately 3.5 percent to the consolidated revenue of the Company and was profitable for 1994.\nLiquidity and Capital Resources\nCapital Expenditures\nCapital expenditures were $2,705,000 in 1995 compared to $1,654,000 for 1994 and $1,808,000 for 1993. Depreciation and depletion in 1995 totaled $3,224,000, and compares to $3,323,000 and $3,723,000 reported in 1994 and 1993, respectively.\nDuring 1995, capital expenditures included installation of new combustion controls for the dual-fired boilers. The waste water treatment facility disinfection\/dechlorination system was upgraded, as well as a rebuild of the clarifiers underwater mechanisms, and installation of a baffle system. Plas-Techs doubled its existing physical facility with a building addition to accommodate increased business activity and its new duplex rewinder that was installed.\nThe capital projects for 1996 are expected to approximate $6,670,000. The Company's 1996 projects are directed toward the upgrading and improvement of existing manufacturing and converting facilities, and will include approximately $500,000 to maintain the integrity and reliability of the Company's electrical system. The Company has begun the process of acquiring a metering size press for the Fourdrinier machine, which will expand the capabilities of such machine with respect to specialty-coated lightweight papers. The new size press will allow coating to be applied onto one or both sides of the sheet simultaneously, giving the Company capabilities to infiltrate new markets. The total cost of this project is estimated to be approximately $3,800,000 over the next two years.\nCapital Resources\nDuring 1995, the Company renegotiated a revolving credit agreement, reducing the credit line from $14,250,000 to $13,000,000, and reducing or eliminating certain financial covenants. The renegotiated agreement expires April 30, 1998. The agreement requires the Company to meet certain covenants, including the maintenance of tangible net worth of not less than $19,000,000 from the date of the agreement through November, 1995, and then not less than $20,000,000 from December, 1995 through November, 1996. Tangible net worth shall then be maintained at not less than $21,500,000 from December, 1996 through November, 1997, and from December 1997 thereafter shall not be less than $23,000,000. In addition, the Company must maintain a current ratio of not less than 1.90:1. Certain other covenants limit dividend and certain other restricted payments to amounts which do not result in a default and, after giving effect to any such payments, the aggregate amount of such payments commencing January 1, 1995 and thereafter cannot exceed 33 percent of the net income so accumulated from January 1, 1995. At December 31, 1995, the Company was in compliance with the renegotiated agreement.\nAt December 31, 1995, $8,000,000 was outstanding under the revolving credit agreement referenced above, a $4,000,000 reduction from the amount of such borrowings at December 31, 1994. On May 1, 1995, the Company redeemed $1,300,000 of the $4,000,000 aggregate principal amount of outstanding City of Oconto Falls, Wisconsin Variable Rate Demand Limited Obligate Industrial Revenue Funding Bonds Series 1992 (Plas-Techs, Inc. Project). The Company utilized surplus bond proceeds not needed to pay or reimburse project costs to reduce an equal amount of outstanding bonds. The remaining portion of the Restricted Fund from Industrial Revenue Bonds was used to reimburse qualified project costs.\nIn September, 1995, the Company issued notice of a proposed timberland sale of approximately 85 percent of the timberlands owned by the Company. The Company had determined that the timberlands no longer were compatible with the fiber requirements of the Company's pulpmaking facility. Bids were accepted through December 29, 1995, and on February 29, 1996, successful bidders were notified. The Company expects the sales transaction to be completed prior to May 1, 1996. The after-tax gain on sale of the timberlands is estimated at $2.00 per share on currently outstanding shares of the Company's common stock.\nCash Flows\nCash provided from operations was $6,586,000 in 1995 and $3,235,000 in 1994. The improved cash flow is attributable to the increased income generated, and $1,174,000 of net proceeds from sales of marketable securities. Cash used in investing activities was $1,290,000 in 1995, compared to $817,000 in 1994, as a result of the increased capital additions during the year, offset by the utilization of the restricted funds from Industrial Development Revenue Bonds.\nCash used in financing activities in 1995 was $5,836,000 compared to $2,108,000 in 1994. The 1995 amount included reduction in the amounts under the revolving credit agreements in the amount of $4,000,000, and the payment of $1,411,000 in long-term debt.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Stockholders and Board of Directors Badger Paper Mills, Inc. Peshtigo, Wisconsin\nWe have audited the accompanying consolidated balance sheets of Badger Paper Mills, Inc. and Subsidiary as of December 31, 1995 and 1994, 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, 1995. 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 Badger Paper Mills, Inc. and Subsidiary as of December 31, 1995 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, 1995, in conformity with generally accepted accounting principles.\nAs discussed in Note 1 to the consolidated financial statements, the Company adopted Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities in 1994.\nCOOPERS & LYBRAND, L.L.P.\nMilwaukee, Wisconsin February 5, 1996\nBADGER PAPER MILLS, INC. AND SUBSIDIARY\nCONSOLIDATED BALANCE SHEETS December 31, 1995 and 1994 (dollars in thousands)\nASSETS 1995 1994 Current assets: Cash and cash equivalents $ 835 $ 1,375 Marketable securities 3,138 3,397 Accounts receivable, net 6,955 6,771 Deferred income taxes 1,059 1,176 Inventories 7,314 6,319 Refundable income taxes 173 299 Prepaid expenses and other 560 192 ------ ------ Total current assets 20,034 19,529\nProperty, plant, equipment and timberland, net 30,340 30,894 Restricted funds from Industrial Development Revenue Bonds 34 1,974 Other assets 2,170 1,985 ------ ------- Total assets $52,578 $54,382 ====== ====== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Revolving credit notes payable $ -- $12,000 Current portion of long-term debt 115 111 Accounts payable 5,823 5,111 Accrued liabilities 3,637 3,583 ------- ------- Total current liabilities 9,575 20,805\nLong-term debt 17,236 10,651 Deferred income taxes 2,604 2,218 Other liabilities 1,720 1,588\nContingencies (Note 10) Shareholders' equity: Common stock, no par value; 4,000,000 shares authorized, 2,160,000 shares issued 2,700 2,700 Additional paid-in capital 168 168 Retained earnings 20,633 18,080 Treasury stock, at cost, 217,670 and 203,170 shares in 1995 and 1994, respectively (2,058) (1,828) ------ ------ Total shareholders' equity 21,443 19,120 ------- ------- Total liabilities and shareholders' equity $52,578 $54,382 ====== ======\nThe accompanying notes are an integral part of these consolidated financial statements.\nBADGER PAPER MILLS, INC. AND SUBSIDIARY\nCONSOLIDATED STATEMENTS OF OPERATIONS for the years December 31, 1995, 1994 and 1993 (dollars in thousands, except per share data)\n1995 1994 1993\nNet sales $92,648 $73,674 $76,567 Cost of sales 83,890 72,949 74,272 ------- ------- ------- Gross margin 8,758 725 2,295\nSelling and administrative expenses 3,852 3,872 4,715 Early retirement expense 504 -- -- Restructuring provision -- -- 3,850 ------- ------- ------- Operating Income (loss) 4,402 (3,147) (6,270) ------- ------- ------- Other income (expense): Interest and dividend income 375 425 517 Interest expense (1,305) (1,315) (975) Unrealized holding gain (loss) on trading securities 549 (846) -- Miscellaneous, net 39 643 279 ------- ------- ------- (342) (1,093) (179) ------- ------- ------- Income (loss) before income taxes 4,060 (4,240) (6,449) Provision (benefit) for income taxes 1,312 (1,713) (2,388) ------- ------- ------- Net income (loss) $ 2,748 $(2,527) $(4,061) ====== ======= ====== Net earnings (loss) per share $1.41 $(1.29) $(2.07) ===== ===== =====\nThe accompanying notes are an integral part of these consolidated financial statements.\nBADGER PAPER MILLS, INC. AND SUBSIDIARY\nCONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY for the years ended December 31, 1995, 1994 and 1993 (dollars in thousands)\n1995 1994 1993 Common stock: Balance, December 31 $ 2,700 $ 2,700 $ 2,700 ------ ------ ------ Additional paid-in capital Balance, December 31 168 168 168 ------ ------ ------ Retained earnings: Balance, January 1 18,080 20,607 25,060 Net income (loss) 2,748 (2,527) (4,061) Cash dividends of $.10 and $.20 in 1995 and 1993, respectively (195) -- (392) ------ ------ ------ Balance, December 31 20,633 18,080 20,607 ------ ------ ------ Treasury stock: Balance, January 1 (1,828) (1,825) (1,831) Acquired during the year (15,000 and 500 shares in 1995 and 1994, respectively) (233) (3) -- Issued during the year (500 and 1,000 shares in 1995 and 1993, respectively) 3 -- 6 ------- ------- ------- Balance, December 31 (2,058) (1,828) (1,825) ------- ------- ------- Shareholders' equity: Balance, December 31 $21,443 $19,120 $21,650 ======= ======= =======\nThe accompanying notes are an integral part of these consolidated financial statements.\nBADGER PAPER MILLS, INC. AND SUBSIDIARY\nCONSOLIDATED STATEMENTS OF CASH FLOWS for the years ended December 31, 1995, 1994 and 1993 (dollars in thousands)\n1995 1994 1993 Cash flows from operating activities Net income (loss) $2,748 $(2,527) $(4,061) Adjustments to reconcile to net cash provided by operating activities: Depreciation and depletion 3,224 3,323 3,723 Deferred income taxes 503 (1,537) (1,334) Net proceeds from sales of marketable securities, trading 1,174 320 -- Unrealized holding (gain) loss on marketable securities, trading (549) 846 -- Realized loss (gain) on sale of marketable securities 159 -- (190) Gain on sale of property, plant and equipment -- (460) (505) Changes in assets and liabilities: Accounts receivable, net (184) (663) (655) Inventories (995) 2,514 3,505 Accounts payable and accrued liabilities 801 1,269 (845) Refundable income taxes 126 557 1,960 Other (421) (407) 313 ------ ------ ------ Net cash provided by operating activities 6,586 3,235 1,911 ------ ------ ------ Cash flows from investing activities: Additions to property, plant and equipment (2,705) (1,654) (1,808) Proceeds from sale of property, plant and equipment (related to Dayton Division in 1993) -- 750 4,000 Purchases of marketable securities (870) -- (4,024) Proceeds from sale of marketable securities 345 -- 5,910 Restricted funds from Industrial Development Revenue Bond 1,940 87 4,579 ------ ------ ------- Net cash (used in) provided by investing activities (1,290) (817) 8,657 ------ ------ ------- Cash flows from financing activities: Payments on long-term debt (1,411) (108) (8,105) Payments on revolving notes payable (4,000) (2,000) (2,250) Dividends paid (195) -- (392) Acquisition of treasury stock, net (230) -- -- ------ ------ ------- Net cash used in financing activities (5,836) (2,108) (10,747) ------ ------ ------- Net (decrease) increase in cash and cash equivalents (540) 310 (179)\nCash and cash equivalents: Beginning of year 1,375 1,065 1,244 ------ ------ ------- End of year $ 835 $1,375 $ 1,065 ===== ===== ======\nThe accompanying notes are an integral part of these consolidated financial statements.\nBADGER PAPER MILLS, INC. AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. Summary of Significant Accounting Principles:\nBadger Paper Mills, Inc. and Subsidiary (the Company) operates in one industry segment which is the production of paper products. The following is a summary of significant accounting policies.\na. Consolidation Principles: The consolidated financial statements include the accounts of Badger Paper Mills, Inc. and its wholly-owned subsidiary. All significant intercompany accounts and transactions have been eliminated.\nb. Concentration of Credit Risk: Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of cash and cash equivalents and trade accounts receivable. The Company places its cash and cash equivalents with high quality financial institutions. The Company provides credit in the normal course of business to its customers. These customers are located in the Midwestern region of the United States. The Company performs ongoing credit evaluations of its customers and maintains allowances for potential credit losses and generally does not require collateral to support the accounts receivable balances.\nc. Estimates: Preparation of the consolidated 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 liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates.\nd. Cash Equivalents: For financial reporting purposes, the Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.\ne. Marketable Securities: In 1994, the Company adopted Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities. The Company has classified the majority of its investments as a trading portfolio at December 31, 1995 and 1994. The portfolio consists of debt and equity securities. This statement requires that trading portfolio marketable securities be reported at fair value, with unrealized gains and losses included in earnings. The remaining investments are classified as available for sale. This statement requires that available for sale portfolio marketable securities be reported at fair value, with unrealized gains and losses included as a component of equity.\nf. Receivables: Accounts receivable are stated net of an allowance for discounts and doubtful accounts of $190,000 and $286,000 at December 31, 1995 and 1994, respectively.\ng. Inventories: Substantially all inventories are valued at the lower of cost or market with cost being determined on the last-in, first-out (LIFO) basis.\nh. Property, Plant, Equipment and Timberland: These assets are stated at cost, less depreciation and depletion. Depreciation of plant and equipment is provided on the straight-line basis over the estimated useful lives of the assets, and depletion on timberland is determined on the cost method.\ni. Income Taxes: Deferred income taxes are recognized for the tax consequences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each year-end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Income tax expense is the tax payable for the period and the change during the period in deferred tax assets and liabilities.\nj. Revenue Recognition: Revenue is recognized by the Company when goods are shipped.\nk. Research and Product Development Costs: Research and product development costs related to potential new products and applications are expensed when incurred. These costs totaled $300,000, $200,000 and $226,000, for 1995, 1994 and 1993, respectively, and are included in cost of sales.\nl. Net Earnings Per Share: Net earnings per share are computed based on the weighted average number of shares of common stock outstanding during the year (1,953,868 shares, 1,957,163 shares and 1,957,176 shares in 1995, 1994 and 1993, respectively).\nm. Restructuring: During 1993, the Company recorded a restructuring charge of $3,850,000 which related to the disposition of its Dayton division. The restructuring charge related primarily to operating losses the plant incurred prior to the actual disposal date, and the writedown of certain inventories to net realizable value, offset by the gain on the sale of property, plant and equipment.\nn. Early Retirement: During 1995, the Company recorded a charge of $504,000 in connection with a voluntary early retirement incentive package offered to certain employees.\no. Reclassifications: Certain reclassifications have been made to the 1994 and 1993 financial statements to conform to the 1995 presentation.\n2. Inventories:\nThe major classes of inventories at December 31, 1995 and 1994 are as follows (in thousands):\n1995 1994\nRaw materials $3,483 $3,033 Work-in-process 3,831 3,286 ----- ----- $7,314 $6,319 ===== =====\nThe current cost of inventories valued on the LIFO cost method approximated $12,709,000 and $11,799,000 at December 31, 1995 and 1994, respectively. It is not practical to separate finished stock and work-in-process inventories.\n3. Property, Plant, Equipment, and Timberland:\nThe major classes of property, plant, equipment and timberland at December 31, 1995 and 1994 are as follows (in thousands):\n1995 1994 Land $ 117 $ 117 Buildings 7,440 6,970 Machinery, equipment and railroad siding 67,925 66,081 Timberland 533 533 Construction-in-progress 480 152 ------ ------ 76,495 73,853 Accumulated depreciation and depletion 46,155 42,959 ------ ------ $30,340 $30,894 ====== ======\nAt December 31, 1995 and 1994, $21,810,000 and $21,201,000, respectively, of fully depreciated assets were still in use.\n4. Accrued Liabilities:\nAccrued liabilities at December 31, 1995 and 1994 are as follows (in thousands):\n1995 1994 Compensation and related taxes $2,232 $2,117 Profit sharing 668 679 Other 737 787 ----- ----- $3,637 $3,583 ===== =====\n5. Debt:\nLong-term debt at December 31, 1995 and 1994 consists of the following (in thousands):\n1995 1994 Revolving credit agreement $ 8,000 $ - Industrial Development Revneue Bonds (IDRBs) 7,617 8,983 Urban Development Action Grant 1,734 1,779 ------- ------ 17,351 10,762 Current portion 115 111 ------ ------ $17,236 $10,651 ====== ======\nThe Company's revolving credit facility provides for borrowings up to $13 million and extends to April 30, 1998. A commitment fee of 3\/8% is payable for unused amounts. Interest on borrowings is at the LIBOR rate plus 1.5% (totaling 7.125% at December 31, 1995). Borrowings are collateralized by inventory, accounts receivable, marketable securities and certain property, plant and equipment.\nInterest on the IDRBs is payable monthly at floating rates determined by remarketing agents (5.2% at December 31, 1995) and may be converted to fixed rates at certain dates in the future, at the Company's option, as specified in the agreements. The average rate in 1995 for these bonds was 4.29%.\nThe IDRBs are collateralized by bank letters of credit expiring in 1998. The Company pays annual fees at 1% of the amount available under the letters of credit. As amended in April 1995, the letters of credit require, among other items, the Company to maintain minimum tangible net worth of $20,000,000 through November 1996 ($21,500,000 from December 1996 through November 1997 and $23,000,000 thereafter) and a current ratio of 1.9 to 1.0 or greater. Additionally, dividends and treasury stock purchases are limited to 33% of the Company's cumulative net income from January 1, 1995.\nThe Urban Development Action Grant is due in monthly installments of $15,437, including interest at an effective rate of approximately 6.5%, through maturity in April, 2000, at which time a final payment of $1,499,490 is due. This grant is collateralized by certain machinery and equipment.\nFuture maturities of long-term debt as of December 31, 1995, are as follows (in thousands):\nYear ending December 31, 1996 $ 115 1997 119 1998 8,123 1999 128 2000 1,627 Thereafter 7,239 ----- $17,351 ======\n6. Income Taxes:\nThe benefit for income taxes consists of the following (in thousands):\n1995 1994 1993 Currently payable (refundable): Federal $ 800 $ (188) $(1,063) State 9 12 9 ----- ------ ----- 809 (176) (1,054)\nDeferred: Federal 503 (1,538) (1,268) State - 1 (66) ----- ------ ------ 503 (1,537) (1,334) ----- ------ ------ $1,312 $(1,713) $(2,388) ===== ====== ======\nThe significant differences between the effective tax rate and the statutory federal tax rates for 1995, 1994 and 1993 are as follows:\n1995 1994 1993 Statutory Federal tax rate 34.0% (34.0)% (34.0)% Tax-exempt interest (1.3) (1.1) (1.1) State taxes 0.1 0.2 (0.5) Research & development credits, net - (6.4) - Other (0.5) 0.9 (1.4) ---- ---- ---- Effective tax rate 32.3% (40.4)% (37.0)% ==== ==== ====\nThe components of the deferred tax assets and liabilities as of December 31, 1995 and 1994, are as follows (in thousands):\n1995 1994 Deferred tax assets: Accounts receivable $ 51 $ 86 Inventories 287 62 Accrued expenses 657 919 Deferred compensation 174 193 Postretirement benefits 471 379 Unrealized loss on securities 110 313 Federal net operating loss carryforwards - 481 Tax credit carryforward 2,774 2,620 State net operating loss carryforwards 441 572 State credit carryforwards 1,003 859 Valuation allowance (1,079) (1,094) ----- ----- 4,889 5,390 Deferred tax liabilities: Fixed assets 6,434 6,432 ----- ----- Net liability $1,545 $1,042 ===== =====\nFor Federal income tax purposes, the Company has research and development credit carryovers and alternative minimum tax credit carryovers of $672,000 and $2,102,000, respectively. For state income tax purposes, the Company has net operating loss and tax credit carryovers of $11,136,000 and $1,519,000, respectively. Certain carryforwards expire at various times over the next 10-15 year period. For financial reporting purposes, a valuation allowance has been established to the extent the state carry-forwards may expire unused.\n7. Employee Benefits:\nThe Company has profit sharing plans covering substantially all employees. Contribution expenses associated with these plans were $668,000, $679,000 and $654,000 in 1995, 1994 and 1993, respectively.\n8. Supplemental Cash Flow Information:\nAt December 31, 1995, 1994 and 1993, accounts payable included $97,000, $132,000 and $111,000, respectively, for property and equipment additions.\nCash paid (received) for interest and income taxes during 1995, 1994 and 1993, was as follows (in thousands):\n1995 1994 1993 Interest $1,406 $1,340 $2,059 Income taxes 683 (733) (3,014)\n9. Major Customers:\nSales to a customer, which represents over 10% of the Company's net sales, were $10,732,000 in 1995. In 1994 and 1993, there were no customers which represented over 10% of the Company's net sales.\n10. Contingencies:\nThe Company operates in an industry which is subject to laws and regulations at both federal and state levels relating to the protection of the environment.\nThe Company is subject to proposed United States Environmental Protection Agency cluster rules which combine the requirements of the Clean Air and Water Acts. These proposed rules mandate compliance by 1999 and may substantially alter the operations of the Company's sulphite pulp mill. Due to the evolving nature of these rules and the related uncertainty, the Company is currently unable to quantify the cost of compliance or the cost of alternative operating options.\nThe Company is responsible for the closure of a solid waste landfill, estimated to occur in 1997. The Wisconsin Department of Natural Resources is presently considering the Company's proposed methods and materials to be used in closing the site. The range of the costs associated with this closure, depending upon the methods and materials used, is estimated to be $200,000 to $1,000,000. The Company is accruing the low end of the range over the remaining estimated life of the landfill.\nIn addition, the Company is subject to various claims, the ultimate outcomes of which management cannot predict. Management believes that the outcomes will not have a material adverse effect on the Company's consolidated financial position, results of operations or cash flows.\nPART III\nItem 9.","section_9":"Item 9. Changes in and disagreements with accountants on accounting and financial disclosure\nNo such disagreements have occurred.\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 required by this item is incorporated by reference from the information included under the captions, \"Election of Directors\" and \"Compliance with Section 16(a) of the Securities Exchange Act of 1934\" set forth in the Company's definitive proxy statement for its 1996 Annual Meeting of Shareholders.\n(b) Executive officers of registrant\nPeriod Served In Name Age Office This Office\nClaude L. Van Hefty 57 President 1-1\/3 Year Previously Vice President\/Lignin Sales & Fiber Procurement 1-1\/2 Year Previously Vice President, General Manager Dayton Division 1 Year Director of Purchasing 13-1\/4 Years\nRalph C. Kinzel 61 Vice President of Environmental Affairs and Technical Services 3-1\/4 Years Previously Manager of Environmental Affairs and Technical Services 12-3\/4 Years\nMiles L. Kresl, Jr. 56 Vice President\/ Administration 2-3\/4 Years Secretary 16-1\/4 Years Treasurer 14-3\/4 Years\nSteven A. Spangenberg 37 Vice President\/ Fine Paper Sales and Advertising 3-1\/4 Years Previously General Manager, Plas-Techs subsidiary 1-1\/2 Years Previously Director of Marketing 4-1\/4 Years\nMark C. Neumann 36 Vice President\/ MG Sales 3\/4 Year Director of Marketing 2-3\/4 Years Sales Representative 7-1\/2 Years\nOfficers are elected to hold office until the next annual meeting of shareholders following the annual meeting of shareholders or until their successors are elected and qualified. There is no arrangement or understanding between any of the above officers or any other person pursuant to which such officer was selected for the office held. No family relationship of any kind exists between the officers.\nITEM 11.","section_11":"ITEM 11. Executive compensation\nThe information required by this Item is incorporated by reference from the information included under the captions \"Executive Compensation\", \"Report of Compensation Committee on Annual Executive Management Compensation\", and \"Compensation Committee Interlocks and Insider Participation\" set forth in the Company's definitive proxy statement for its 1996 Annual Meeting of Shareholders.\nItem 12.","section_12":"Item 12. Security ownership of certain beneficial owners and management\n(a) Security ownership of certain beneficial owners The information required by this Item is incorporated by reference from the information included under the caption, \"Stock Ownership of Certain Beneficial Owners and Management\", set forth in the Company's definitive proxy statement for its 1996 Annual Meeting of Shareholders.\n(b) Security ownership of management The information required by this Item is incorporated by reference from the information included under the captions, \"Stock Ownership of Certain Beneficial Owners and Management,\" and \"Election of Directors\", set forth in the Company's definitive proxy statement for its 1996 Annual Meeting of Shareholders.\nItem 13.","section_13":"Item 13. Certain relationships and related transactions\nThe information required by this Item is incorporated by reference from the information included under the caption, \"Election of Directors\", set forth in the Company's definitive proxy statement for its 1996 Annual Meeting of Shareholders.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, financial statement schedules and reports on From 8-K\n(a) (1) List of financial statements:\nThe following is a list of the financial statements of Badger Paper Mills, Inc., together with the report of independent accountants, included in this report:\nPages\nReport of Independent Accountants . . . . . . . . . . . 16 Consolidated Balance Sheets, December 31, 1995 and 1994 . . . . . . . . . . . . 17 Consolidated Statements of Operations for the years ended December 31, 1995, 1994 and 1993. . . . . . . . . . . . . . . . . . . . . . 18 Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 1995, 1994 and 1993 . . . . . . . . . 19 Consolidated Statements of Cash Flows for the years ended December 31, 1995, 1994 and 1993 . . . 20 Notes to Financial Statements . . . . . . . . . . . . 21\n(a) (2) List of financial schedules:\nThe following is a listing of data submitted herewith:\nPage\nReport of Independent Accountants on Financial Statements Schedules . . . . . . . . . 32 Schedule for the years ended December 31, 1995, 1994 and 1993: II Valuation and Qualifying Accounts and Reserves . . . . . . . . . 33\nFinancial statement schedules other than that listed above are omitted for the reason that they are either not applicable, not required, or that equivalent information has been included in the financial statements, the notes thereto or elsewhere herein.\n(a) (3) Exhibits\n(2) Agreement for sale and purchase of assets of Dayton mill of Badger Paper Mills, Inc. by Dayton Paper Corporation dated August 3, 1993. (Incorporated by reference to Exhibit 2 to the Company's report on Form 10-Q for the quarter ended Sep- tember 30, 1993.) (3) (i) Articles of Incorporation (Incorporated by reference to Exhibit 3 to the Company's Annual Report on Form 10-K for the year ended, December 31, 1981) (ii) By-laws as amended through December 19, 1994 (Incorporated by reference to Exhibit 3(ii) to the Company's Annual Report on Form 10-K for the year ended December 31, 1994)(\"1994 10-K\"). (4) (i) U. S. $18,000,000 Credit Agreement by and among Badger Paper Mills, Inc., NEW Riverview Holdings, Inc., Plas- Techs, Inc., and Harris Trust and Savings Bank, indi- vidually and as agent and PNC Bank, Ohio National Association dated as of June 30, 1993. (Incorporated by reference to Exhibit 4 to the Company's report on Form 10-Q for the quarter ended September 30, 1993). (ii) Waiver and First Amendment thereto dated as of June 30, 1993 (Incorporated by reference to Exhibit 4(ii) to the 1994 10-K). (iii) Second Amendment thereto dated as of March 31, 1994 (Incorporated herein to Exhibit 4(a) to the Company's Report on Form 10-Q for the quarter ended March 31, 1994). (iv) Third Amendment thereto dated August 31, 1994 (Incorporated by reference to Exhibit 4(iv) to the 1994 10-K). (v) Fourth Amendment thereto dated February 17, 1995 (In- corporated by reference to Exhibit 4(v) to the 1994 10-K). (vi) Fifth Amendment thereto dated as of April 28, 1995 (Incorporated herein to Exhibit 4 to the Company's Report on Form 10-Q for the quarter ended June 30, 1995). (10) Material Contracts:** (i) Stock Purchase Agreement dated February 1, 1993, be- tween the Company and Robert Strasburg. (Incorporated by reference to Exhibit 10(i) to the Company's Annual Report on Form 10-K for the year ended December 31, 1992) (\"1992 10-K\"). (ii) Supplemental Executive Retirement Plan dated December 18, 1992. (Incorporated by reference to Exhibit 10 (ii) to the 1992 10-K). (iii) Employment Agreement dated January 25, 1993, between the Company and Robert Strasburg. (Incorporated by reference to Exhibit 10 (iv) to the 1992 10-K). (iv) Health Insurance Retirement Benefit Agreement dated July 22, 1992, between the Company and Edwin A. Meyer, Jr. (Incorporated by reference to Exhibit 10(iv) to the Company's Report on Form 10-K for the year ended December 31, 1993) (\"1993 10-K\"). (v) Health Insurance Retirement Benefit Agreement dated July 22, 1992, between the Company and Bennie C. Burish. (Incorporated by reference to Exhibit 10(v) to the 1993 10-K). (vi) Key Executive Employment and Severance Agreement dated August 1, 1994 between the Company and Robert Strasburg. (Incorporated by reference to Exhibit 10(a) to the Company's Report on Form 10-Q for the quarter ended September 30, 1994). (vii) Executive Employment Agreement dated March 1, 1995, between the Company and Claude L. Van Hefty (Incorpo- rated by reference to Exhibit 10(vii) to the 1994 10- K).\n(23) Consent of Independent Public Accountants (27) Financial Data Schedule (EDGAR version only) (99) Definitive Proxy Statement for 1996 Annual Meeting of Share- holders (to be filed with the Commission under Regulation 14A and incorporated by reference herein to the extent indicated in this Form 10-K)\n** Each of the \"material contracts\" represents a management compensatory agreement or arrangement.\n(b) Reports on Form 8-K:\nNone.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Stockholders and Board of Directors Badger Paper Mills, Inc. and Subsidiary Peshtigo, Wisconsin\nOur report on the financial statements of Badger Paper Mills, Inc. and Subsidiary is included on page 16 of this Form 10-K. In connection with our audits of such financial statements, we have also audited the related financial statement schedule listed in the index on page 30 of this Form 10-K.\nIn our opinion, the financial statement schedule referred to above, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information required to be included therein.\nCOOPERS & LYBRAND, L.L.P.\nMilwaukee, Wisconsin February 5, 1996.\nSchedule II - Valuation and Qualifying Accounts and Reserves for the years ended December 31, 1995, 1994 and 1993 (in thousands)\nSTOCKHOLDER INFORMATION\nMarket makers: Stock transfer agent: Robert W. Baird & Co., Inc. Harris Trust & Savings Bank Kemper Securities Group, Inc. 111 West Monroe Street Herzog, Heine, Geduld, Inc. Chicago, Illinois 60690 S. J. Wolfe & Co.\nStock price and dividend information: The following table presents high and low sales prices of the Company's Common Stock in the indicated calendar quarters, as reported on the NASDAQ National Market System.\nQuarterly Price Ranges of Stock:\n1995 1994 Quarter High Low High Low\nFirst $15.25 $ 9.25 $15.25 $11.00 Second 15.75 14.00 14.00 11.38 Third 16.25 14.44 12.50 11.00 Fourth 16.75 15.00 11.75 8.50\nQuarterly Dividends Per Share: Dividend rates are established by the Board of Directors. The Company's line of credit maintains certain covenants which control the payment of dividends. See \"Management's Discussion and Analysis -- Liquidity and Capital Resources -- Capital Resources.\"\nQuarter 1995 1994\nFirst $ - $ - Second - - Third .05 - Fourth .05 - ---- ---- Total $.10 $ - ==== ====\nAnnual meeting of shareholders: The annual meeting of shareholders of Badger Paper Mills, Inc. will be held at The Best Western Riverfront Inn, 1821 Riverside Avenue, Marinette, Wisconsin, on Tuesday, May 14, 1996, at 10:00 a.m.\nDIRECTORS AND OFFICERS\nBoard of directors: Corporate officers: Edwin A. Meyer, Jr. Claude L. Van Hefty Chairman of the Board President\/COO\/CEO Badger Paper Mills, Inc. Ralph C. Kinzel Bennie C. Burish Vice President of Retired, Former President Environmental and Former Chief Operating Technical Service Officer Badger Paper Mills, Inc. Miles L. Kresl, Jr. Vice President\/ Thomas J. Kuber Administration, President, Treasurer and K&K Warehousing; Corporate Secretary CEO, Great Lakes Pulp & Fibre, Inc. Mark C. Neumann Earl R. St. John, Jr. Vice President\/ Owner and President MG Sales Earl St. John Forest Products, Inc. Steven A. Spangenberg St. John Trucking, Inc. Vice President\/Fine Paper Sales and Ralph D. Searles Advertising President and CEO, Great Northern Corp.\nClaude L. Van Hefty President\/COO\/CEO Badger Paper Mills, Inc.\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nBADGER PAPER MILLS, INC.\n\/s\/ Claude L. Van Hefty Claude L. Van Hefty, President (Chief Executive Officer)\n\/s\/ Miles L. Kresl, Jr. Miles L. Kresl, Jr. Vice President\/Administration Corporate Secretary, Treasurer (Principal Financial Officer)\n\/s\/ George J. Zimmerman DATE: March 29, 1996 George J. Zimmerman Controller (Chief Accounting Officer)\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated:\n\/s\/ Edwin A. Meyer, Jr. Edwin A. Meyer, Jr. Chairman of the Board Date: March 29, 1996\n\/s\/ Bennie C. Burish Bennie C. Burish Director Date: March 29, 1996\n\/s\/ Thomas J. Kuber Thomas J. Kuber Director Date: March 29, 1996\n\/s\/ Earl R. St. John, Jr. Earl R. St. John, Jr. Director Date: March 29, 1996\n\/s\/ Ralph D. Searles Ralph D. Searles Director Date: March 29, 1996\n\/s\/ Claude L. Van Hefty Claude L. Van Hefty Director Date: March 29, 1996\nEXHIBIT INDEX\nBADGER PAPER MILLS, INC. ANNUAL REPORT ON FORM 10-K\nFOR THE FISCAL YEAR ENDED DECEMBER 31, 1995\nExhibit No. Description\n(2) Agreement for sale and purchase of assets of Dayton mill of Badger Paper Mills, Inc. by Dayton Paper Corporation dated August 3, 1993. (Incorporated by reference to Exhibit 2 to the Company's report on Form 10-Q for the quarter ended September 30, 1993.)\n(3) (i) Articles of Incorporation (Incorporated by reference to Exhibit 3 to the Company's Annual Report on Form 10-K for the year ended, December 31, 1981)\n(ii) By-laws as amended through December 19, 1994 (Incorporated by reference to Exhibit 3(ii) to the Company's Annual Report on Form 10-K for the year ended December 31, 1994)(\"1994 10-K\").\n(4) (i) U. S. $18,000,000 Credit Agreement by and among Badger Paper Mills, Inc., NEW Riverview Holdings, Inc., Plas- Techs, Inc., and Harris Trust and Savings Bank, indi- vidually and as agent and PNC Bank, Ohio National Association dated as of June 30, 1993. (Incorporated by reference to Exhibit 4 to the Company's report on Form 10- Q for the quarter ended September 30, 1993).\n(ii) Waiver and First Amendment thereto dated as of June 30, 1993 (Incorporated by reference to Exhibit 4(ii) to the 1994 10-K).\n(iii) Second Amendment thereto dated as of March 31, 1994 (In- corporated herein to Exhibit 4(a) to the Company's Report on Form 10-Q for the quarter ended March 31, 1994).\n(iv) Third Amendment thereto dated August 31, 1994 (Incorpo- rated by reference to Exhibit 4(iv) to the 1994 10-K).\n(v) Fourth Amendment thereto dated February 17, 1995 (In- corporated by reference to Exhibit 4(v) to the 1994 10-K).\n(vi) Fifth Amendment thereto dated as of April 28, 1995 (Incorporated herein to Exhibit 4 to the Company's Report on Form 10-Q for the quarter ended June 30, 1995).\n(10) Material Contracts:**\n(i) Stock Purchase Agreement dated February 1, 1993, between the Company and Robert Strasburg. (Incorporated by reference to Exhibit 10(i) to the Company's Annual Report on Form 10-K for the year ended December 31, 1992) (\"1992 10-K\").\n(ii) Supplemental Executive Retirement Plan dated December 18, 1992. (Incorporated by reference to Exhibit 10 (ii) to the 1992 10-K).\n(iii) Employment Agreement dated January 25, 1993, between the Company and Robert Strasburg. (Incorporated by reference to Exhibit 10 (iv) to the 1992 10-K).\n(iv) Health Insurance Retirement Benefit Agreement dated July 22, 1992, between the Company and Edwin A. Meyer, Jr. (Incorporated by reference to Exhibit 10(iv) to the Company's Report on Form 10-K for the year ended December 31, 1993) (\"1993 10-K\").\n(v) Health Insurance Retirement Benefit Agreement dated July 22, 1992, between the Company and Bennie C. Burish. (Incorporated by reference to Exhibit 10(v) to the 1993 10-K).\n(vi) Key Executive Employment and Severance Agreement dated August 1, 1994 between the Company and Robert Strasburg. (Incorporated by reference to Exhibit 10(a) to the Company's Report on Form 10-Q for the quarter ended September 30, 1994).\n(vii) Executive Employment Agreement dated March 1, 1995, between the Company and Claude L. Van Hefty (Incorporated by reference to Exhibit 10(vii) to the 1994 10-K).\n(23) Consent of Independent Public Accountants\n(27) Financial Data Schedule (EDGAR version only)\n(99) Definitive Proxy Statement for 1996 Annual Meeting of Share- holders (to be filed with the Commission under Regulation 14A and incorporated by reference herein to the extent indicated in this Form 10-K)\n** Each of the \"material contracts\" represents a management compensatory agreement or arrangement.","section_15":""}
{"filename":"801898_1995.txt","cik":"801898","year":"1995","section_1":"Item 1. Business\nSEGMENTS OF BUSINESS\nHarnischfeger Industries, Inc. (\"Harnischfeger Industries\" or the \"Company\") is a holding company for subsidiaries involved in the worldwide manufacture and distribution of: papermaking machinery (Beloit Corporation); surface mining equipment (P&H(R) Mining Equipment); material handling equipment (P&H Material Handling); and underground mining equipment (Joy Mining Machinery). In early fiscal 1996, the Company completed the acquisition of Dobson Park Industries plc (\"Dobson\"), an industrial engineering group with interests in underground mining equipment, industrial electronic control systems, toys and plastics. Dobson's principal subsidiary, Longwall International, is engaged in the manufacture, sale and service of mining equipment for the international underground coal mining industry and has been added to the Company's Mining Equipment Segment.\nHarnischfeger Industries is the direct successor to a business begun over 100 years ago which, at October 31, 1995, through its subsidiaries, manufactures and markets products classified into three industry segments: Papermaking Machinery and Systems, Mining Equipment, and Material Handling.\nPAPERMAKING MACHINERY AND SYSTEMS\nThe Papermaking Machinery and Systems Group is comprised of the Company's 80% interest in Beloit Corporation (\"Beloit\"). Mitsubishi Heavy Industries, Ltd. (\"Mitsubishi\") is the owner of the other 20% interest in Beloit. The Company and Mitsubishi have entered into certain agreements that provide Mitsubishi with the right to designate one of Beloit's five directors. These agreements also place certain restrictions on the transfer of Beloit stock. In the event of a change in control of the Company, Mitsubishi has the right to sell its 20% interest back to the Company for the greater of $60 million or the book value of its equity interest.\nBeloit is a leader in the design and manufacture of papermaking machinery and related products used in the pulp and paper industries. Beloit operates on a global basis with major manufacturing facilities in seven countries and sales and service offices located throughout the world. In addition, licensing arrangements exist with several major foreign companies.\nBeloit's activities are divided into the following categories: complete installations involving the design, manufacture and installation of integrated papermaking equipment and systems; major rebuilds and servicing of existing systems; and the sale of ancillary equipment and replacement parts. This machinery is custom designed to meet the specific needs of each customer. In 1995, Beloit expanded its service business through the acquisition of the roll-covering business of Rollin, S.A., a roll service and repair company located in France.\nBeloit is known for the quality and dependability of its products and is a leader in product innovation and development. Beloit has made a continuous commitment to research and development activities, and has been granted numerous patents on its designs. Beloit systems and equipment are used by a substantial number of paper producers, both domestic and foreign, and Beloit's installed base of equipment exceeds that of any of its competitors.\nA major factor in Beloit's success in the paper machinery industry has been its international manufacturing operations. Beloit's overseas facilities have been used to support both domestic and foreign sales and have provided Beloit with the flexibility to shift its manufacturing to more favorable locations as appropriate. In addition, Beloit has been able to take advantage of favorable export financing provided by certain foreign governments. Beloit's manufacturing facilities are supported by a domestic and international marketing network staffed by experienced sales engineers.\nFormerly, the Papermaking and Systems Group also included the Company's 20% interest in Measurex Corporation (\"Measurex\"). On December 29, 1994, Measurex repurchased 2,026,900 shares of its stock which had been held by the Company. On June 23, 1995, Measurex Corporation repurchased the remaining 1,613,100 shares of its stock. These transactions resulted in a gain of $29.7 million. Measurex continues to have cooperative agreements with Beloit.\nMINING EQUIPMENT\nP&H Mining Equipment is the world's largest producer of electric mining shovels and is a significant producer of electric and diesel-electric crawler and walking draglines, hydraulic mining excavators, blasthole drills, and electric shovel, dredge and dragline bucket products. Electric mining shovels range in capacity from 18 to 80 cubic yards, crawler draglines from 10 to 20 cubic yards, and hydraulic mining excavators from 12 to 27 cubic yards. Capacities for the walking draglines range from 20 to 150 cubic yards.\nIn 1991, P&H Mining Equipment expanded its product lines by acquiring the large rotary blasthole drill product line from the Gardner-Denver Mining and Construction Division of Cooper Industries, Inc. There are three drill models currently in the active product line, with drilling diameters ranging from 9 to 22 inches and bit load capacities from 70,000 to 150,000 pounds.\nThe products of P&H Mining Equipment are used in mines, quarries and earth-moving operations in the digging and loading of such minerals and other ores as coal, copper, gold, iron ore, lead, zinc, bauxite, uranium, phosphate, stone and clay.\nP&H Mining Equipment has a relationship in the mining shovel business with Kobe Steel, Ltd. (\"Kobe\") pursuant to which P&H Mining Equipment licenses Kobe to manufacture certain electric mining shovels and related replacement parts in Japan. Harnischfeger Corporation has the exclusive right to market Kobe-manufactured mining shovels and parts outside Japan (except in the case of certain government sales). In addition, Harnischfeger Corporation is party to an agreement, through 1996, with a corporate unit of the People's Republic of China, licensing the manufacture and sale of two models of electric mining shovels and related components. This relationship provides P&H Mining Equipment with an opportunity to sell component parts for shovels built in China.\nOn November 29, 1994, pursuant to an exchange of common stock, the Company completed its acquisition of Joy Technologies Inc. (\"JOY\" or \"Joy Mining Machinery\"), a world leader in underground mining equipment. JOY manufactures and services mining equipment for the underground extraction of coal and other bedded deposits and has facilities in Australia, South Africa, the United Kingdom and the United States, as well as sales offices in Poland and the People's Republic of China. Joy Mining Machinery designs, manufactures and distributes continuous miners, entry drivers and sump shearers; long-wall shearers; shuttle cars; and continuous haulage systems for use in underground mining. JOY products are not sold into the general construction industry, and demand for them is not tied to cycles in that industry. JOY also maintains an extensive network of service and spare parts distribution centers to rebuild and service equipment and sell spare parts in support of its installed base. This network includes six service centers in the United States and four outside of the United States, all of which are strategically located in major underground mining regions. The financial position and results of operations of Harnischfeger Industries and JOY were combined retroactively in fiscal 1995.\nIn early fiscal 1996, the Company completed the acquisition of Dobson Park Industries plc for a purchase price of approximately $330 million including acquisition costs.\nDobson, headquartered in the United Kingdom, is an industrial engineering group with interests in underground mining equipment, industrial electronic control systems, toys and plastics. Longwall International (\"Longwall\"), one of the main subsidiaries of Dobson, is engaged in the manufacture, sale and service of underground mining equipment for the international coal mining industry. Its products include electronically controlled roof support systems, armored face conveyors, pumps and belt conveyor components and systems. Longwall will be fully integrated into Joy Mining Machinery and will enable JOY to offer integrated underground longwall mining systems to the worldwide mining industry. The industrial electronic and toys\/plastics businesses are being evaluated in the context of the five characteristics required for consideration as a core business of this Company. As a result of this evaluation, it is likely that these businesses will be sold.\nFinancial information with respect to the acquisition of Dobson is presented in Note 17 to the Financial Statements of the 1995 Annual Report to Shareholders incorporated by reference from the Company's Current Report on Form 8-K dated December 8, 1995.\nP&H MATERIAL HANDLING\nP&H Material Handling produces lines of through-the-air material handling equipment designed for a variety of users as well as container handling cranes for use in ports. The Division is comprised of five business groups: P&H Equipment, P&H Aftermarket, P&H Distribution and Service, Morris - Engineered Products Division and Morris - Standard Products Division.\nP&H Equipment\nThe P&H Equipment group is comprised of the overhead crane and hoist product lines in the United States. It was formed from the core of what made up the Material Handling Equipment Division in prior years.\nThe new crane portion of the group is comprised of several product lines: engineered cranes, standard cranes, portal cranes and crane components. Cranes are designed for installation in a wide range of industrial settings. Each crane is engineered to the customer's specifications, using standard components wherever possible. Engineered cranes are marketed for moderate to severe duty cycle applications in capacities from 3 to 800 tons.\nStandard overhead cranes are available in capacities from 5 to 100 tons. Stacker cranes, ranging in capacities from 2 to 50 tons, are particularly suitable for factory automation projects. Portal cranes range in lifting capacities from 5 to 100 tons and are used outdoors for woodyard, scrap, and container handling.\nThe large installed base of cranes and increasing sensitivity of customers to opportunities for improved manufacturing efficiency from upgrading their material handling equipment provides this product line an opportunity for growth.\nThe component products portion of this group consists of electric wire rope and chain hoists, manual chain hoists, ratchet lever hoists, and electrical products. Hoists range in capacities from 1\/8 ton to 60 tons. These hoists use state-of-the-art materials and manufacturing techniques and feature a wide variety of controls.\nP&H Aftermarket\nThe P&H Aftermarket Group consists of: Product Support, which markets repair parts, and PHoenix(TM) which handles pre-owned and remanufactured cranes and parts.\nThe Product Support portion of the aftermarket group markets replacement products and parts through Material Handling Centers, both independent and company owned, in domestic markets and through licensees or agents in international markets. This group differentiates itself from the competition through reliable and responsive delivery performance.\nThe PHoenix portion of the aftermarket group markets pre-owned cranes under the PHoenix trademark which have been remanufactured and modernized to meet customer requirements. It also markets pre-owned parts to its customers. The PHoenix group also provides engineering services for the revitalization of crane and runway systems. The group's products are marketed direct and through both independent and company owned Material Handling Centers.\nP&H Distribution and Service\nThis group provides installation, erection and repair and maintenance services under the ProCare(R) trademark through the growing network of company owned Material Handling Centers. The group responds to customers' increased desire to outsource the repair and maintenance of overhead cranes and hoists.\nMorris - Engineered Products Division\nThe Morris - Engineered Products Division is the larger portion of the Morris Mechanical Handling business based in the United Kingdom. It manufactures high integrity special purpose heavy lifting equipment, principally container handling cranes. In addition, its operations in South Africa are involved in the manufacture and service of cranes and other lifting equipment. It also has a United Kingdom Crane Service Division that distributes and services overhead lifting equipment throughout the United Kingdom.\nMorris - Standard Products Division\nThe Morris - Standard Products Division manufactures hoists, cranes, linear motors, and controls. The hoist division manufactures a range of electric wire rope hoists and both electric and hand chain hoists. The industrial cranes division manufactures electric overhead cranes all to standardized designs. Linear Motors manufactures crane and general industrial controls and linear motors for special and general application. A recently acquired operation in Singapore will provide a base for distribution of standard products in that region.\nDISCONTINUED SEGMENTS\nEnvironmental\nThe Company completed the sale of Joy Environmental Technologies (\"JET\") in the first quarter of 1996. JET has been presented as a discontinued operation in the Company's Consolidated Financial Statements.\nJET supplies flue gas desulfurization systems for reducing levels of sulfur dioxide in smokestack emissions which otherwise might react with other chemicals in the atmosphere to form acid rain. JET also designs, fabricates, and installs systems for the collection and removal of ash accumulated at the bottom of coalburning boilers and ash carried up the exhaust flues of these boilers. These products and services are used worldwide by various electric utilities and industrial companies.\nSystems\nSyscon Corporation (\"Syscon\"), the remaining unit in the Company's Systems Group, was sold in February, 1995 to Logicon, Inc. Syscon is engaged principally in providing systems development, systems integration and systems services to the United States Government, government agencies and commercial enterprises.\nINTERNATIONAL OPERATIONS\nIn 1995, 1994 and 1993, Beloit's foreign sales (principally the United Kingdom, Italy, Canada, Brazil and Poland) amounted to 41%, 30% and 28%, respectively, of Beloit's consolidated net sales.\nForeign sales of the Mining Equipment segment (principally in Australia, South Africa, Brazil, Canada, United Kingdom and Germany) generated approximately 44% of the segment's consolidated net sales in 1995, 48% in 1994 and 49% in 1993.\nMore than 60% of Longwall's net sales in 1995 were derived from markets outside the United States (principally the United Kingdom, Continental Europe, Asia, Australia, South Africa and Canada).\nP&H Material Handling has been actively increasing its global operations and now has operations in the United Kingdom, South Africa, Canada, Mexico, and Singapore which offer a combination of manufacturing, distribution and service facilities. In addition, agents and distributors represent their products in other parts of the world. Foreign sales in 1995 amounted to 48% of the segment's consolidated net sales.\nBeloit has granted licensing agreements to serve certain foreign markets to companies located in Australia, Japan and Spain. The licensing agreement with Mitsubishi in Japan represents the majority of Beloit's license income. Beloit maintains sales and service offices throughout the world to remain competitive in foreign markets.\nIn general, sales of licensed mining products are managed within the country of manufacture by the foreign licensee. Licensee exports, together with exports from the United States, are sold through P&H Mining Equipment's and P&H Material Handling's subsidiaries, which directly or through subsidiaries or affiliates maintain regional sales offices in: Brisbane, Melbourne, Singleton, Mackay and Perth, Australia; North York and Vancouver, Canada; Hermosillo, Mexico; Belo Horizonte and Sao Paulo, Brazil; Santiago, Chile; Lima, Peru; Weiterstadt, Germany; Aylesbury, United Kingdom; Johannesburg, South Africa; and Puerto Ordaz, Venezuela.\nHarnischfeger Industries' international operations are subject to certain risks not generally applicable to its domestic businesses, including currency fluctuations, changes in tariff restrictions, restrictive regulations of foreign governments (including price and exchange controls), and other governmental actions. Harnischfeger Industries has entered into various foreign currency exchange contracts with major international financial institutions designed to minimize its exposure to exchange rate fluctuations on foreign currency transactions.\nGENERAL\nSeasonality\nNo significant portion of Harnischfeger Industries' business is subject to or influenced by seasonal factors; however, Harnischfeger Industries' business is influenced by the cyclical nature of the paper machinery, mining, and capital goods industries.\nDistribution\nSales of Beloit products are principally made directly to the end user. On a worldwide basis, each manufacturing facility is responsible for a designated market area. Beloit also maintains a worldwide marketing group to coordinate and support worldwide facilities in marketing strategies, technical sales support and participation in major projects including interface with engineering firms and financial institutions. Beloit offers systems and turnkey alternatives to assist in related business development throughout the world. Agents are used in certain foreign countries to augment Beloit's sales force stationed in the segment's manufacturing facilities and in sales offices worldwide.\nIn the United States, surface mining equipment, overhead cranes and certain electrical products are marketed principally directly from the segments' headquarters and regional sales offices. Electric wire rope and chain hoists and crane modernizations are sold through dealers and distributors, assisted and coordinated by corporate and regional office personnel. P&H Material Handling has a dealer network of regional distributorships (referred to as Material Handling Centers).\nJoy Mining Machinery and Longwall sales are made mostly through sales offices located in major coal-producing areas. JOY's and Longwall's worldwide sales forces have marketing responsibility for new machine sales, as well as for parts, components and rebuild services provided to customers. A segment of the sales forces in the United States is dedicated to manning a truck fleet which visits customer sites on a regular basis in order to deliver components and parts.\nThe manufacture and sale of repair and replacement parts and the servicing of equipment are important aspects of P&H Mining Equipment operations. P&H Mining Equipment maintains mining parts warehouses in Arizona, Minnesota, Nevada, Wisconsin, West Virginia and Wyoming and in Australia, Brazil, Canada, Chile, Germany, South Africa and Venezuela. These warehouses facilitate shipment of customers' orders for parts, and some also function as regional service centers.\nCompetition\nHarnischfeger Industries conducts its domestic and foreign operations under highly competitive market conditions, requiring that its products and services be competitive in price, quality, service and delivery.\nThe pulp and paper capital machinery market is globally competitive; Beloit's two major competitors are foreign-owned companies. The principal competitors are Valmet Paper Machinery, Inc., with controlling interest held by Valmet Corporation, Finland, and Voith Sulzer Papertech, with headquarters in Germany.\nP&H Mining Equipment's principal competitors in electric mining shovels are Bucyrus Erie Company and Marion, a division of Global Industrial Technologies. Harnischfeger Industries believes P&H Mining Equipment is the leading participant in this market. Its principal competitors in the hydraulic mining excavator market are Demag, Hitachi, Caterpillar and Orenstein & Koppel. In draglines, the main competitors are Bucyrus Erie Company and Marion. The Division's main competitors in drills are Ingersoll-Rand, Driltech and Bucyrus Erie Company.\nIn the underground coal mining industry, JOY competes primarily on the basis of the quality and reliability of its products and its ability to provide rapid, extensive and cost-effective repair and rebuild services and delivery of spare parts. JOY's primary competitors in the continuous mining machinery industry are EIMCO(a Tampella Tamrock Company), the Jeffrey division of Indresco Inc., Simmons- Rand Company(a subsidiary of Long Airdox Company), and Voest Alpine. In the longwall shearer new equipment market, JOY competes primarily with Anderson Longwall PLC, Eickhoff Corporation, and Mitsui Miike Machinery Company, Ltd. In the continuous haulage market, JOY competes with Long Airdox, Fairchild International, and Jeffrey. In the sale of spare parts for JOY's equipment, JOY competes with EIMCO and various small suppliers.\nLongwall competes globally. The primary competitors of Longwall are DBT and the Marmon Group.\nThe principal worldwide competitors for the P&H Material Handling Division are Demag and Konecranes International KCI. Harnischfeger Industries believes that P&H Material Handling is one of the largest worldwide participants in this market. When considering any specific geographic market, the competitors would normally be split into overhead cranes, dockside cranes, hoists, and service. There are significant numbers of competitors in each of the geographic markets and segments of those markets.\nCustomers\nDuring 1995, there were no sales or services made to an individual customer amounting to 10% or more of consolidated sales.\nBacklog\nBacklog by business segment for the Company's continuing operations (in thousands of dollars) as of the end of fiscal years 1995 and 1994 was as follows:\nSupply of Materials and Purchased Components\nThe Papermaking Machinery and Systems Group purchases raw materials used in its products which include: plates, sheets, shapes, carbon and alloy steel, stainless steel, brass and bronze, nickel alloy, and aluminum. Purchases of semi-processed and component parts include: castings, valves, filters, pumps, dryers, electrical equipment, and various vacuum, drying, hydraulic, combustion, material-handling and temperature control systems. Beloit has approximately 4,700 suppliers of which approximately 1,000 are most commonly used. No single source is dominant.\nP&H Mining Equipment Division and P&H Material Handling manufacture machines and heat-treated gears, pinions, shafts, structural fabrications, electrical motors, generators, and other electrical parts. They purchase raw and semi-processed steel, castings, forgings, copper and other materials for these parts and components from approximately 400 suppliers. In addition, component parts, such as engines, bearings, controls, hydraulic components, and a wide variety of mechanical and electrical items are purchased from approximately 1,500 suppliers. Purchases of materials and components are made on a competitive basis with no single source being dominant.\nJOY purchases electric motors, gears, hydraulic parts, electronic components, forgings, steel, clutches and other components and raw materials from outside suppliers. Although JOY purchases certain components and raw materials from a single supplier, alternative sources of supply are available for all such quantities. JOY believes that it has adequate sources of supplies of component parts and raw materials for its manufacturing requirements.\nLongwall purchases electric motors, gears, hydraulic parts, electronic components, steel and other components and raw materials from outside suppliers. Certain components and raw materials are purchased from a single supplier; however, alternative sources of supply are available for all such quantities. Longwall believes that it has adequate sources of supplies of component parts and raw materials for all its manufacturing requirements.\nPatents and Licenses\nPatents are quite important in the papermaking industry. All major machinery manufacturers use patents extensively to protect the technology base that results from research and development. Beloit has been granted numerous patents on its designs and more are pending. Most are registered in all of the major countries into which Beloit and its licensees sell.\nIn May, 1993, a Federal court jury in Madison, Wisconsin returned a verdict finding that J.M. Voith GmbH of Germany and its subsidiary, Voith, Inc. of Appleton, Wisconsin infringed upon Beloit's patent on its Bel- Champ(R) technology for the drying technology of large paper manufacturing machines. The verdict was appealed by Voith. In September, 1995, J.M. Voith GmbH, Voith, Inc., and Beloit reached an understanding concerning settlement of their outstanding patent litigation.\nIn addition, on November 23, 1994, a Federal court jury, in Madison, Wisconsin, returned a verdict finding Valmet Corporation of Finland guilty of infringing a key patent held by Beloit Corporation on the Bel-Champ paper machine drying technology. In connection with this suit, the jury awarded Beloit $7.9 million in damages. The verdict in this case has been appealed by Valmet and the award has not been recorded in the Company's financial statements.\nP&H Mining Equipment and P&H Material Handling have numerous domestic and foreign patents, patent applications and patent licensing agreements. Harnischfeger Corporation does not consider these businesses materially dependent upon any patent or patent license agreement.\nJOY, Longwall and their respective subsidiaries own numerous patents and trademarks and have patent licenses from others relating to their respective products and manufacturing methods. Also, patent and trademark licenses are granted to others throughout the world and royalties are received under most of these licenses. While JOY and Longwall do not consider any particular patent or license or group of patents or licenses to be essential to their respective business as a whole, both JOY and Longwall consider its patents and licenses significant to the conduct of its business in certain product areas.\nResearch and Development\nHarnischfeger Industries maintains a strong commitment to research and development with engineering staffs that are engaged in full-time research and development of new, and improvement of existing, products. Beloit maintains research and development facilities in Rockton, Illinois, Pittsfield, Massachusetts, Bolton, United Kingdom, Clarks Summit, Pennsylvania, Portland, Oregon and Waukesha, Wisconsin. Harnischfeger Corporation maintains research and development facilities in Milwaukee, Wisconsin. JOY and Longwall pursue technological development through the engineering of new products, systems and applications; the improvement and enhancement of licensed technology; and synergistic acquisitions of technology. Research and development expenses were $30.3 million in 1995, $28.9 million in 1994, and $26.7 million in 1993.\nEnvironmental and Health and Safety Matters\nThe activities of the Company are regulated by federal, state and local statutes, regulations and ordinances relating to both environmental protection and worker health and safety. These laws govern current operations, require remediation of environmental impacts associated with past or current operations, and under certain circumstances provide for civil and criminal penalties and fines, as well as injunctive and remedial relief. The Company's foreign operations are subject to similar requirements as established by their respective countries.\nThe Company has expended substantial managerial and financial resources in developing and implementing actions for continued compliance with these requirements. The Company believes that it has substantially satisfied these diverse requirements. However, because these requirements are complex and, in many areas, rapidly evolving, there can be no guarantee against the possibility of sizeable additional costs for compliance in the future. These same requirements must also be met by the Company's competitors and, therefore, the costs for present and future compliance with these laws should not create a competitive disadvantage. Further, these laws have not had, and are not presently expected to have, a material adverse effect on the Company.\nThe Company's operations or facilities have been and may become the subject of formal or informal enforcement actions or proceedings for alleged noncompliance with either environmental or worker health and safety laws or regulations. Such matters have typically been resolved through direct negotiations with the regulatory agency and have typically resulted in corrective actions or abatement programs. However, in some cases, fines or other penalties have been paid. Historically, neither such commitments nor such penalties have been material.\nEmployees\nAs of October 31, 1995, Harnischfeger Industries employed approximately 14,000 persons, of which approximately 8,800 were employed in the United States. Approximately 6,950 of the United States employees are represented by local unions under collective bargaining agreements with expiration dates from December 31, 1995 to August 4, 2000. Harnischfeger Industries believes that it maintains generally good relationships with its employees.\nFinancial Information about Industry Segments\nThe financial information on industry segments is presented in Note 15 to the Financial Statements incorporated by reference from the Company's Current Report on Form 8-K dated December 8, 1995.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nAs of October 31, 1995, the following principal properties were owned, except as indicated. All of these plants are generally suitable for operations.\nHarnischfeger Industries owns a 120,000 square foot office building in Brookfield, Wisconsin, which is used as its worldwide corporate headquarters and is currently constructing a new corporate headquarters in St. Francis, Wisconsin.\nMINING EQUIPMENT LOCATIONS\nThis segment operates warehouses in Casper and Green River, Wyoming; Hibbing, Minnesota; Charleston and Pineville, West Virginia; Milwaukee, Wisconsin; Phoenix, Arizona; Elco, Nevada; Birmingham, Alabama; Carlsbad, New Mexico; Norton, Virginia; Lovely and Henderson, Kentucky; Hinton, Sparwood, Cornwall and Vancouver, Canada; Bayswater, Mt. Thorley, Gracemere and Mackay, Australia; Belo Horizonte, Brazil; Weiterstadt, Germany; Johannesburg, Wadeville and Hendrina, South Africa; Stobswood, United Kingdom and Puerto Ordaz, Venezuela. The warehouses in Casper, Hibbing, Milwaukee, Mt. Thorley, Belo Horizonte and Johannesburg are owned; the others are leased. In addition, the segment leases sales offices throughout the United States and in principal locations in foreign countries.\nP&H MATERIAL HANDLING LOCATIONS\nThis division has leased facilities for its company owned Material Handling Centers in San Leandro, California; Pittsburg, California; Portland, Oregon; Reno, Nevada; Dallas, Texas; Houston, Texas; New Orleans, Louisiana; Chicago, Illinois; Detroit, Michigan; Pittsburgh, Pennsylvania; and Cleveland, Ohio. In addition, the division leases sales offices throughout the United States and in principal locations in foreign countries. It also has approximately 18 leased locations for service operations in the United Kingdom, Mexico and South Africa.\nPAPERMAKING MACHINERY AND SYSTEMS LOCATIONS\n- ------------------------- (1) Under a lease expiring in 2007. (2) Under a lease expiring in 2019.\nThe Papermaking Machinery and Systems business has warehouse space at the above facilities and in addition maintains leased facilities in Memphis, Tennessee; Swiecie, Poland; and Montreal, Canada. Sales offices are also maintained at various locations throughout the world.\nInformation relating to lease commitments is presented in Note 11 to the Financial Statements incorporated by reference from the Company's Current Report on Form 8-K dated December 8, 1995.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe Company is party to litigation matters and claims which are normal in the course of its operations and, while the results of litigation and claims cannot be predicted with certainty, management believes that the final outcome of such matters will not have a materially adverse effect on the Company's consolidated financial position or results of operations.\nThe Company is also involved in a number of proceedings and potential proceedings relating to environmental matters. Although it is difficult to estimate the potential exposure to the Company related to these environmental matters, the Company believes that these matters will not have a materially adverse effect on its consolidated financial position or results of operations.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNo matters were submitted to a vote of security holders during the fourth quarter of fiscal 1995.\nExecutive Officers of the Registrant\nThe following table sets forth, through the date of filing this 10-K report, the executive officers of Harnischfeger Industries and its major subsidiaries, their ages, their offices with Harnischfeger Industries and the period during which they have held such offices.\nMr. Lundgren joined the Company in September, 1991. Prior to joining the Company, Mr. Lundgren was a partner with the law firm of Michael, Best & Friedrich.\nMr. Podawiltz joined the Company in February, 1995. Prior to joining the Company, Mr. Podawiltz was Vice President of Human Resources with the A.O. Smith Automotive Products Company.\nThe business address of each such person is 13400 Bishops Lane, Brookfield, Wisconsin 53005. All officers listed above are citizens of the United States of America except for Mr. Lambert who is a citizen of the United Kingdom. Officers are elected annually but may be removed at any time at the discretion of the Board of Directors. There are no family relationships between the foregoing officers.\nPART II\nThe information required by Items 6 through 8 is incorporated by reference from the Company's Current Report on Form 8-K dated December 8, 1995.\nPART III\nAll information required by Items 10 through 13 of Part III, with the exception of information on the Executive Officers which appears in Part I of this report, is incorporated by reference from the Company's Proxy Statement for its 1996 Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission within 120 days after the close of the fiscal year.\nPART IV\nThe information required by Item 14 is incorporated by reference from the 1995 Annual Report to Shareholders reported on the Company's Current Report on Form 8-K dated December 8, 1995.\nAll other schedules are omitted because they are either not applicable or the required information is shown in the financial statements or notes thereto.\nFinancial statements of 50% or less-owned companies have been omitted because the proportionate share of their profit before income taxes and total assets are less than 20% of the respective consolidated amounts and investments in such companies are less than 20% of consolidated total assets.\n(3) Exhibits\n* Represents a management contract or compensatory plan or arrangement required to be filed as an exhibit pursuant to Item 14(c) of Form 10-K.\n(b) Reports on Form 8-K\n(1) Current Report on Form 8-K dated September 1, 1995 relating to the Company's discussions with Dobson Park Industries plc concerning the possible acquisition of Dobson's outstanding shares.\n(2) Current Report on Form 8-K dated October 11, 1995 relating to Harnischfeger and The First National Bank of Boston, as Rights Agent, amending the Rights Agreement dated as of February 8, 1989.\n(3) Current Report on Form 8-K dated October 26, 1995 relating to Harnischfeger Industries news release announcing that the Dobson board unanimously recommended that its shareholders approve an offer by Harnischfeger Industries to purchase all of Dobson's outstanding shares.\n(4) Current Report on Form 8-K dated December 4, 1995 relating to the pro forma financial information relative to the acquisition of Dobson required pursuant to Article 11 of Regulation S-X and the Company's five-year historical computation of Ratio of Earnings to Fixed Charges.\n(5) Current Report on Form 8-K dated December 4, 1995 relating to the 1995 financial statements of Dobson.\n(6) Current Report on Form 8-K dated December 8, 1995 relating to the Company's filing of its fiscal 1995 financial statements and notes thereto, Management's Discussion and Analysis, and related schedules 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, in the City of Brookfield, Wisconsin, on the 29th day of January, 1996.\nHARNISCHFEGER INDUSTRIES, INC. (Registrant)\n\/s\/FRANCIS M. CORBY, JR. Francis M. Corby, Jr. Executive Vice President for Finance and Administration\nPursuant to the requirements of the 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 January 29, 1996.\n- ------------------------- (1) Jeffery T. Grade, by signing his name hereto, does hereby sign and execute this report on behalf of each of the above-named Directors of Harnischfeger Industries, Inc. pursuant to powers of attorney executed by each of such Directors and filed with the Securities and Exchange Commission as an exhibit to this report.\nJanuary 29, 1996 By: \/s\/JEFFERY T. GRADE Jeffery T. Grade, Attorney-in-fact\nItem 5","section_5":"Item 5\nMARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nTHE ANNUAL MEETING\nThe annual meeting of the shareholders of Harnischfeger Industries, Inc. will be held at Milwaukee's Wyndham Hotel, 139 E. Kilbourn Ave., on Tuesday, April 9, 1996 at 10:00 a.m.\nANNUAL REPORT ON FORM 10-K\nCopies of the annual report on Form 10-K, filed with the Securities and Exchange Commission, will be available to shareholders after February 15, 1996 without charge on request to:\nSecretary Harnischfeger Industries, Inc. P.O. Box 554 Milwaukee, WI 53201-0554 Telephone: (414)797-6480\nTRANSFER AGENT AND REGISTRAR\nBank of Boston c\/o Boston EquiServe Mail Stop 45-02-09 P.O. Box 644 Boston, MA 02102-0644 Telephone:(617)575-3400\nMARKET AND OWNERSHIP OF COMMON STOCK\nThe principal market for the Company's Common Stock is the New York Stock Exchange, where its trading symbol is HPH. As of October 31, 1995, the approximate number of holders of record of the Company's Common Stock was 2,100. In addition, there were an estimated 10,000 beneficial owners of shares held of record by brokers and fiduciaries.\nCORPORATE HEADQUARTERS\n13400 Bishops Lane Brookfield, WI 53005\nMAILING ADDRESS\nP.O. Box 554 Milwaukee, WI 53201-0554\nSHAREHOLDER SERVICES\nAnnual Report Requests and General Information Corporate Communication: (414)797-6626\nFINANCIAL INFORMATION\nTo obtain fax copies of recent financial press releases and quarterly statements on request, please call 1-800-758-5804 and use access code 396450 at the prompt.\nOur press releases are available on the World Wide Web at http.\/\/www.prnewswire.com. Click on Company News On Call to find Harnischfeger.","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":"703701_1995.txt","cik":"703701","year":"1995","section_1":"ITEM 1. BUSINESS\nGENERAL\nWestbridge Capital Corp. (\"Westbridge\"), and together with its subsidiaries, the (\"Company\"), through its subsidiaries and affiliated companies, principally underwrites and sells specialized health insurance products and health plans to supplement or substitute for medical expense coverage usually provided by employers and government programs. The Company's wholly-owned subsidiaries and affiliated companies include National Foundation Life Insurance Company (\"NFL\"), National Financial Insurance Company (\"NFIC\"), American Insurance Company of Texas (\"AICT\"), Westbridge National Life Insurance Company (\"WNL\") and together with NFL, NFIC and AICT, the (\"Insurance Subsidiaries\"), Foundation Financial Services, Inc. (\"FFS\"), Westbridge Marketing Corporation (\"WMC\"), Precision Dialing Services, Inc., (\"PDS\"), Westbridge Printing Services, Inc. (\"WPS\"), Westbridge Funding Corporation \"(WFC\"), LifeStyles Marketing Group, Inc. (\"LifeStyles Marketing\"), Senior Benefits, LLC (\"Senior Benefits\"), American Senior Security Plans, LLC (\"ASSP\") and Health Care-One Insurance Agency, Inc. (\"Health Care-One\"). The Company's major product lines are Cancer and Specified Disease Products, Medical Expense Products and Medicare Supplement Products. Cancer and Specified Disease Products include policies designed to provide daily indemnity for hospital confinement and convalescent care for treatment of specified diseases, as well as \"event specific\" policies designed to provide daily indemnity for confinement in an intensive care unit, fixed benefits in the case of accidental death, or lump sum payments upon initial diagnosis of certain types of internal cancer. Medical Expense Products include policies providing reimbursement for various medical and hospital care, catastrophic nursing care and home health care. Medicare Supplement Products are designed to provide reimbursement for certain expenses not covered by the Medicare program.\nThe Company markets its products primarily through general agency networks. While the number of agency networks in the Company's system has grown substantially, five principal general agency networks accounted for over 90% of the Company's first-year premium revenues in 1995. These five general agencies include: LifeStyles Marketing, Senior Benefits, and three general agency networks controlled by individuals, the Locke Agency, Cornerstone National Marketing Corporation (\"Cornerstone\") and National Farm & Ranch Group, Inc. (\"Farm & Ranch\"). The Company has certain contractual arrangements with Locke expiring in 1998 which provide the terms and conditions on which the Locke Agency markets the Company's products and set forth coinsurance agreements between the Company and an entity controlled by Locke. Each agency network specializes in one of the Company's product lines and focuses on selling those products in small towns and rural areas to individuals who have medical expense coverage that they may consider inadequate. In late 1995, the Company, through Health-Care One, began marketing HMO and PPO products for Blue Cross of California to individuals and small groups. While results for this new venture were not significant in 1995, the Company intends to substantially increase marketing operations in Health Care-One. See \"MARKETING\".\nThe Company's strategy is to market its existing products; introduce new specialized supplemental products to respond to the changing health care environment; expand marketing of HMO and PPO products of other carriers, and, if and when opportunities arise, acquire blocks of business.\nThe Company believes that opportunities exist in the insurance industry to acquire health insurance companies and blocks of health insurance business at a lower cost than would be required to produce such business. Consequently, the Company has actively sought opportunities to acquire business with which it is very familiar, having underwritten or sold such policies in the past. In September 1992, NFL purchased a block of Medicare Supplement policies from American Integrity Insurance Company (\"AII\"), having annualized premium revenues of approximately $42.0 million. The purchase was accomplished through a combination of indemnity and assumption reinsurance agreements. Under the terms of the agreements, AII transferred assets to NFL and NFL assumed the risks associated with the policies acquired. The policies acquired by NFL are not subject to voluntary recapture by AII. Additionally, in March 1993, NFL purchased a similar block of Medicare Supplement policies from Life and Health Insurance Company of America (\"LHI\"), having annualized premium revenues of approximately $4.0 million. The purchase was accomplished through a combination of indemnity and assumption reinsurance agreements. Under the terms of the agreements, LHI transferred assets to NFL and NFL assumed the risks associated with the policies acquired in a manner similar to the AII transaction. The Medicare Supplement policies acquired from AII and from LHI were existing blocks of business from which the Company has derived additional revenue through renewal premiums.\nIn February 1994, the Company purchased a closed block of cancer indemnity insurance from Dixie National Life Insurance Company (\"DNL\"), with annualized premiums of approximately $4.5 million. The acquisition was completed by way of assumption reinsurance agreements and did not require additional financing. The transaction involved the transfer of cash by NFL and the assumption of certain DNL liabilities and reserves.\nOn April 12, 1994, the Company completed the acquisition of NFIC and AICT, (the \"Acquisition\"). At that time, the acquired companies' combined health insurance in force consisted of approximately 102,000 policies with approximately $45.0 million in annualized premiums in business lines substantially similar to those of the Company. Both acquired companies ceased writing new business in the first six months in 1992. In 1995, the Company resumed writing business through NFIC and AICT.\nThe Company has developed sophisticated administrative and database systems in order to provide high quality service to its agents and policyholders and to improve administrative efficiency. As a result, the Company has been able to absorb quickly and efficiently the business it has acquired and believes that it can support future growth while maintaining an efficient and cost effective operation.\nWestbridge's Insurance Subsidiaries and affiliates are licensed to sell their products in a combined total of 41 states, primarily in the western, middle western, southern and southeastern regions of the United States. These licenses are subject to renewal by the insurance regulatory authorities of each such state. The Company must file periodic financial statements with each state's insurance regulatory authority and conduct its business in accordance with such state's laws and regulations. A failure by the Company to comply with any state's financial or business conduct requirements could result in the future revocation of the Company's license to sell insurance products in such state. See \"REGULATION\". PRODUCT LINES\nPremiums by major product line for each of the periods indicated is set forth below:\nDESCRIPTION OF POLICIES\nThe Company's products are designed with flexibility as to benefits and premium payments and can be adapted to meet regional sales or competitive needs, as well as those of the individual policyholders. These products have fixed, capped or limited benefits and are designed to reduce the potential financial impact of covered illnesses and injuries.\nSet forth below is a brief description of the principal insurance products which the Company offers currently and those which have been discontinued with respect to new sales but are still being renewed.\nCANCER AND SPECIFIED DISEASE PRODUCTS\nThe Company's Cancer and Specified Disease Products make both immediate and subsequent payments directly to the policyholder following diagnosis of or treatment for a covered illness or injury. The payments are designed to help reduce the potential financial impact of these illnesses or injuries. Payments may be used at the policyholder's discretion for any purpose, including helping to offset non-medical expenses or medical-related expenses not paid by the policyholder's other health insurance. The amount of benefits provided under the Company's Cancer and Specified Disease Products is not necessarily reflective of the actual cost expected to be incurred by the insured as a result of the illness or injury. Cancer and Specified Disease Products are guaranteed renewable.\nCancer and Specified Disease Products are generally issued by the Company after an application form is filled out by the agent on behalf of the prospective insured. The application form asks the prospective insured whether he has had the disease for which insurance is sought. Policies are not available to anyone who has been diagnosed as having the disease prior to the date of policy issuance. The Company is currently marketing the following products:\nOrdinary Cancer and Specified Disease\nThe Company's Ordinary Cancer and Specified Disease policies generally pay according to a fixed, predetermined schedule of indemnities after the insured has been diagnosed as having cancer or one of 27 other covered diseases. Optional benefits include a first occurrence benefit, which pays a specified sum to the policyholder upon the initial diagnosis of internal cancer and an intensive care unit (\"ICU\") benefit which pays an additional benefit for each day an insured is confined in an ICU.\nWhile an insured is confined to a hospital for subsequent covered treatment, the benefits provided under the Company's policy generally include the following: (i) a specified payment for each day of hospital confinement, (ii) reimbursement for actual charges for in-patient drugs and diagnostic testing, subject to fixed, predetermined per diem limits, (iii) a specified payment for each day an insured is visited by an attending physician or receives special private nurse care, (iv) reimbursement for actual charges incurred for ambulance service in connection with hospital confinement, (v) reimbursement for actual charges for family member transportation to and from a hospital in which an insured is confined, subject to fixed, predetermined per trip limits and certain geographic and distance requirements, and (vi) reimbursement for actual charges for family member lodging while accompanying an insured confined to a hospital, subject to fixed, predetermined per diem limits and certain geographic and distance requirements.\nThe Company's Cancer policies also provide a range of medical, medical-related and non-medical benefits, regardless of whether an insured is hospitalized. These benefits generally include the following: (i) reimbursement for actual charges for breast prosthetic devices, subject to fixed, predetermined per device limits, (ii) a specified payment for each day of confinement in a skilled nursing facility, subject to a fixed, predetermined number of days, (iii) a specified payment for each day of hospice confinement or treatment, (iv) reimbursement for actual charges for transportation of an insured to and from a facility where covered cancer treatments are received, subject to fixed, predetermined per trip limits and certain geographic and distance requirements, (v) reimbursement for actual charges for radiation and chemotherapy treatment, subject to fixed, predetermined annual or lifetime limits, and (vi) specified payments for each surgical procedure which an insured undergoes, and for each administration of anesthesia to the insured, according to a fixed, predetermined schedule based upon the nature of the surgical procedure. The average annual premium for this policy (including riders) was approximately $188 with respect to new sales of such policies for the year ended December 31, 1995.\nFirst Occurrence\nThe Company's First Occurrence policies pay a specified lump sum to the policyholder or beneficiary under the policy immediately upon the initial diagnosis of malignant internal cancer. The First Occurrence policies are underwritten by Freedom Life Insurance Company of America (\"FLICA\"), and 90.0% coinsured with NFL. Benefits under these policies range from $10,000 to $50,000. The average annual premium for this policy (including riders) was approximately $311 with respect to new sales of such policies for the year ended December 31, 1995.\nCASH\nThe Company's CASH policies pay according to fixed, per diem amounts while the insured is confined to a hospital for the treatment of a covered illness or injury. Covered illness or injury consists of cancer, accident, stroke or heart attack. A majority of the policies are sold with an optional return of premium benefit which provides for the return after 20 years to the policyholder of all premiums paid under the policy less any claims paid to the policyholder. The CASH policies are underwritten by FLICA and 50.0% coinsured with NFL. The average annual premium for this policy (including riders) was approximately $206 with respect to new sales of such policies for the year ended December 31, 1995.\nThe Company has a number of older Cancer and Specified Disease Products which are not currently sold in material amounts, but which produce significant renewal premiums and consist of the following:\nCancer and Heart Attack\nThe Company offers two versions of its basic Cancer and Heart Attack policies, introduced in 1973 and 1977, respectively. One version provides insureds with predetermined daily benefits for each period of hospital confinement or convalescence for treatment of cancer or a heart attack. The other version contains maximum limits for scheduled benefits, but overall policy benefits are not limited. These products impose no limit on the number of days of hospitalization for which benefits may be payable. Intensive Care Unit\nThe Company also offers an ICU policy, introduced in 1978, which provides a fixed daily payment in the event of hospital confinement in an intensive care unit for any accident or sickness. Benefits are provided for a maximum of 15 days per confinement and are subject to a lifetime maximum per insured.\nAccidental Death\nIn 1981, the Company introduced an Accidental Death insurance policy which provides a fixed benefit when accidental injury causes the death of the insured. The policy also offers an optional rider which provides a daily benefit in the event of total disability caused by an accident.\nMEDICAL EXPENSE PRODUCTS\nThe Company's Medical Expense Products are designed to reimburse the insured for expenses incurred for hospital confinement, surgical expenses, physician services and the cost of medicines immediately following a hospital stay. Out-patient benefits and maternity benefits are also available. These policies are individually underwritten based upon medical information provided by the applicant prior to issue. Information in the application is verified with the applicant through a tape-recorded telephone conversation or through written correspondence. Based upon the state in which these policies are offered, these policies are issued either as guaranteed renewable for life or conditionally renewable at the Company's option. The Company's Medical Expense Products are marketed by LifeStyles Marketing, Cornerstone and Farm & Ranch, and are underwritten by NFL, NFIC and AICT. Medical Expense Products currently offered by the Company include the following:\nMM-95\nMM-95 provides major medical coverage for hospital, medical and surgical expenses, including certain out-patient coverages. The insured has a number of options with respect to deductibles, coinsurance percentages, and stop-loss limits. After the annual deductible is met, ranging from $500 to $20,000, the insured is reimbursed 60% - 80% of eligible expenses up to a stop-loss limit ranging from $5,000 to $10,000, after which 100% of eligible expenses are covered, up to certain maximum policy limits. MM95 also offers reduced deductibles and coinsurance amounts if the insured uses the services of a provider which is a member of a participating Preferred Provider Organization (\"PPO\") network.\nSuper Saver I\nSuper Saver I provides limited benefits for hospital, medical and surgical expenses. The policies reimburse 60.0% of the first $10,000 of eligible expenses which exceed the calendar year deductible and 100% of eligible expenses thereafter. The policy has a maximum benefit of $100,000 for each injury or sickness. Eligible expenses are similar to MedPlan IV eligible expenses except that out-patient benefits are limited to surgical, extended care, hospice care and home care.\nSuper Saver I also offers reduced deductibles and coinsurance amounts if the insured uses the services of a provider participating in a PPO network.\nMedPlan IV\nMedPlan IV policies reimburse 80.0% of the first $5,000 of eligible expenses which exceed a calendar year deductible and 100% of eligible expenses thereafter. Reimbursement is subject to specified aggregate per cause and lifetime maximums. Eligible expenses include usual and customary charges for hospital room expense; in-hospital expenses for drugs, x-rays, laboratory charges; surgical expenses (subject to limitation); in-hospital physicians, private duty nurses, pathologist, radiologist or physiotherapist expense (subject to limitation); and outpatient benefits, including surgical benefits, extended care, hospice care and home care. Benefits are also provided (subject to a calendar year maximum) for out-patient medical services including prescription drugs.\nHospital Surgical Expense Policies\nThese policies cover many of the expenses described as MedPlan IV eligible expenses, subject to inside limits. These limits take the form of maximum daily hospital benefits, maximum out-patient treatment benefits, and calendar year limits for miscellaneous hospital benefits, out-patient day surgery, out-patient x-rays and laboratory tests, and doctor visits. Surgical benefits are subject to a schedule of limits. Maximum benefits under the policies are limited to a maximum of $25,000 per confinement.\nThe Company has a number of older Medical Expense Products which are not currently sold in material amounts, but which produce significant renewal premiums and consist of the following:\nLifeStyles Products\nThese products consist of Limited Benefit Basic Hospital Medical Surgical Expense Insurance (the \"LBBH Policy\") and Medical Surgical Expense Insurance (the \"MSE Policy\") and were sold by LifeStyles Marketing. The LBBH Policy is designed to reimburse insureds for expenses incurred for hospital confinement, surgical expenses, physician services and the cost of medicines immediately following a hospital stay. Optional limited benefit out-patient and maternity benefit riders are also offered. The policy features a range of deductibles and copayment options. The MSE Policy is more limited and therefore less expensive than the LBBH Policy, and is designed to reimburse insureds for expenses incurred for hospital confinement, surgical expenses, physicians services and minor out-patient expenses. The policy contains \"inside limits\" on the separate benefits provided such as a limit on the daily room and board benefit, a fixed surgical schedule and a limit on the maximum miscellaneous hospital benefit payable. These limits make the benefits provided by the policy less subject to inflationary increases in the cost of medical care.\nPre-1987 Medical Expense Products\nThese products consist of major medical expense policies and general health care policies.\nNationalCare Products\nThese products consist of nursing care policies, catastrophic nursing care policies, home care policies, physician and out-patient care policies and hospital indemnity policies.\nMEDICARE SUPPLEMENT PRODUCTS\nThe Company's Medicare Supplement Products provide coverage for many of the medical expenses which the Medicare program does not cover, such as copayments, deductibles and specified losses which exceed the federal program's maximum benefits. The Omnibus Budget Reconciliation Act of 1990 mandated, among other things, standardized policy features in Medicare Supplement plans. In July 1991, the NAIC implemented regulations creating ten model Medicare Supplement plans (Plans A through J). Plan A provides the least coverage, while Plan J offers the most extensive coverage. The Company's Medicare Supplement Products are generally underwritten by NFL and are guaranteed renewable.\nDuring 1995, approximately 53% of the Company's Medicare Supplement Products premium revenues consisted of Medicare Supplement Products acquired by the Company from AII during 1992, from LHI during 1993, and from NFIC and AICT during 1994. These policies were existing blocks of business from which the Company expects to derive additional revenue through renewal premiums. In addition, the Company is currently marketing the following Medicare Supplement Products:\nMedicare Supplement Plans\nIn November 1993, the Company began offering four of the model plans (Plans A, B, C and F) through Senior Benefits. During 1995, the Company also marketed Medicare Supplement Plans through ASSP. The Company has declined to offer the other plans due in large part to their high benefit levels and consequently higher cost to the consumer.\nMedicare Select\nThe Company markets a Medicare Supplement Product called Medicare Select. Medicare Select is designed to provide benefits which supplement the Medicare program at attractive rates by taking advantage of arrangements with hospitals and other health care providers. These arrangements typically provide that a hospital or health care provider will agree to waive Medicare's Part A initial deductible, thereby reducing the total benefit expenses associated with a hospital stay. The Company has entered into Hospital Preferred Provider Network Agreements (\"PPO Agreements\") in 8 states.\nThe Company also has a number of older Medicare Supplement Products which are not currently sold in material amounts, but which produce significant renewal premiums. These products consist of certain pre-1987 Medical Expense Products and certain NationalCare Products.\nLIFE INSURANCE\nIn 1988, the Company reentered the life insurance market through the development of its Annually Renewable Term (\"ART\") policy. The ART policy was approved for sale in January 1988. It is an individually underwritten level term policy which is renewable to age 70. Premiums increase with advancing age. The policy is issued in face amounts ranging from $5,000 to $100,000, and an optional acci-dental death benefit rider is also available. This policy is currently sold exclusively, subject to territorial production requirements, through LifeStyles Marketing, but only nominal production of new business has occurred since 1991.\nThe Company began marketing its EZ-100 plan in 1995. EZ-100 is an individually underwritten whole life insurance product designed to serve as a compliment to other accident and health product offerings. EZ-100 is issued in face amounts ranging from $3,000 to $20,000, and may be offered by any of the Company's marketing organizations.\nThe Company continues to receive renewal premiums on ordinary life policies in force sold prior to 1979. The Company sold a substantial portion of this block of business during 1991 and 1992.\nMARKETING\nThe Company generally markets its products to individuals on a one-on-one basis primarily through agents who are independent contractors associated with general agency networks.\nThe initial sales contact is a result of leads generated either by the agency network or through outside sources. The agent's decision to sell one policy in preference to another and, more specifically, to associate with an agency network that markets one or a group of policies over those of competing carriers depends on several factors, assuming the basic marketability of the product. These factors include: (i) the commission to which the agent will be entitled upon the sale of the policy, (ii) the carrier's reputation for rapid processing of policyholder applications and inquiries, (iii) the rapid and equitable administration of claims, (iv) the willingness of the general agency to provide prospect leads, and (v) availability of sales brochures and other marketing materials (including information about the Company) to assist the agent's sales efforts.\nThe Company's five primary agency networks accounted for over 90% of its first-year premium revenues for the year ended December 31, 1995, and each specializes in marketing one of the Company's product lines. LifeStyles Marketing, Cornerstone and Farm & Ranch each market the Company's Medical Expense Products for NFL, NFIC and AICT, respectively. The Locke Agency markets the Company's Cancer and Specified Disease Products, and Senior Benefits markets the Company's Medicare Supplement Products. Each of these general agencies has a field force of \"career\" agents who depend on the general agency for leads and produce insurance sales exclusively for that general agency. In addition, the Locke Agency, Senior Benefits and LifeStyles Marketing have licensed a number of independent agents on a \"brokerage\" basis to sell the Company's products. These independent agents typically sell the products of other insurance companies and also sell the Company's products on an irregular basis.\nThe Company's agency networks focus on niche marketing of specialized policies in localized geographical markets, primarily in the western, middle western, southern and southeastern regions of the United States. The Company's policies are sold to individuals who are either not covered under group insurance protection normally available to employees of business organizations or who wish to supplement existing coverage. In many cases, these individuals are employed by small business groups. Generally, Medicare Supplement Products are targeted to individuals over 65, while Medical Expense Products and Cancer and Specified Disease Products are targeted to individuals under 65.\nThe general agency networks receive commissions equal to a percentage of premiums paid, varying with the type of policy and differing for first-year sales and policy renewals. Commissions for first-year sales range from 55.0% to 95.0% of premiums paid; commissions for policy renewals range from 0% to 25.0% of premiums paid.\nThe Company has entered into new relationships with established general agency networks specializing in the sale of products comparable to the Company's existing product lines and has begun offering several new products. The Company continues to seek additional similar relationships. The Company's decision to form a relationship with any general agency network has been and will continue to be based primarily on that general agency network's historical levels of sales and profitability, as well as its access to the Company's target markets. There can be no assurance that any additional agency relationships will be formed or, if formed, that such relationships will result in increased sales or be profitable for the Company. The chart below summarizes the marketing arrangements for the Company's Products.\nCancer and Specified Disease Agency Networks\nThe Company's Cancer and Specified Disease products are distributed primarily through the Locke agency, which has marketed the Company's products for over 17 years. John P. Locke owns 60.0% of Freedom Holding Company (\"Freedom\") and the Company owns the remaining 40.0%. Freedom owns 100% of FLICA, a Mississippi insurer licensed in 34 states, which specializes in the sale of cancer and specified disease insurance. Concurrently with the Company's investment in Freedom in November 1988, Locke agreed to sell Cancer and Specified Disease Products exclusively for Freedom Life Insurance Company of America, (\"FLICA\") and the Company for a period of ten years. Also at that time, FLICA and NFL entered into a ten-year coinsurance agreement under which the Company receives 50.0% of all insurance written by FLICA. Most of the new insurance policies written by the Locke Agency are written in FLICA and reinsured in NFL, however, some new business is written directly in NFL. The coinsurance agreement does not provide for termination prior to the expiration of its ten-year term.\nIn late 1993, the Locke Agency began writing a new cancer product, \"First Occurrence\", which is written in FLICA and 90.0% reinsured in NFL under a coinsurance agreement which expires in 1998. See \"DESCRIPTION OF POLICIES-Cancer and Specified Disease Products.\"\nThe Locke Agency maintains its sales headquarters in Louisville, Kentucky and currently consists of approximately 25 career agents and 3,000 independent agents operating in 15 states. Locke's agency network, directly through sales in NFL and indirectly through reinsurance assumed from FLICA, accounted for approximately 12.2% of NFL's first-year accident and health insurance premiums for the year ended December 31, 1995.\nThe loss of, or significantly reduced sales efforts by, the Locke Agency, and the failure by the Company to replace such agents or otherwise offset such losses, could materially affect the business of the Company. Management believes that its relations with the Locke Agency are good.\nIn general, Cancer and Specified Disease Products entail lower premiums than the Company's other products. The majority of premiums are collected from policyholders on a monthly basis. In order to attract agency networks to sell these products, the Company (as is the practice in the industry) advances a portion of a full year's commission at the time of each policy issuance.\nMEDICAL EXPENSE AGENCY NETWORK\nThe Company's Medical Expense Products are sold primarily through LifeStyles Marketing, Cornerstone and Farm & Ranch.\nLifeStyles Marketing Group, Inc.\nIn September 1987, the Company entered into an agency contract with an insurance agency granting it the exclusive right, subject to territorial production requirements, to sell the Medical Expense Products introduced by NFL in 1987 and 1988. Effective April 1, 1988, the Company and the owners of the agency agreed to restructure the insurance agency as a joint venture, creating LifeStyles Marketing. Under the terms of the joint venture agreement WMC, the Company's wholly-owned subsidiary, owns a 51.0% voting interest in LifeStyles Marketing, is entitled to 50.0% of the profits and losses of LifeStyles Marketing and is responsible for financing LifeStyles Marketing's operations. This venture allows the Company to share in the commission fees of products of other insurance carriers that are sold by LifeStyles Marketing, but which NFL has elected not to underwrite. LifeStyles Marketing is responsible for recruiting, supervising and compensating agents. All commissions paid by NFL and other insurance carriers are remitted to LifeStyles Marketing, which in turn pays the writing agent an agreed-upon amount. As is common in insurance marketing agencies, amounts paid to a writing agent at the time of a policy sale are generally a multiple of the commissions received by LifeStyles Marketing from the insurance carriers on such policy sale. These advanced or unearned amounts are generally deducted before any earned renewal amounts are paid to the writing agent on such policy. During a period of increasing sales, cash is required in order to finance agent advances. The LifeStyles Marketing agency network maintains its sales headquarters in Arlington, Texas and currently consists of approximately 957 career agents and 1,547 independent agents operating out of 18 branch sales offices in 14 states. LifeStyles Marketing accounted for 35.4% of the Company's first-year premium revenues for the year ended December 31, 1995. Cornerstone National Marketing Corp.\nIn October 1994, the Company entered into a Master General Agent's Contract with Cornerstone. Under this agreement, Cornerstone markets the Company's Medical Expense Products underwritten in NFIC.\nCornerstone maintains its sales headquarters in Arlington, Texas, and consists of 711 agents. Cornerstone specializes in the marketing of association group insurance programs, and accounted for approximately 7.4% of the Company's first-year premium revenues for the year ended December 31, 1995.\nNational Farm & Ranch Group, Inc.\nIn December 1994, the Company entered into a General Agent's Contract with Farm & Ranch. Under this agreement, Farm & Ranch markets the Company's Medical Expense Products underwritten in AICT.\nFarm & Ranch maintains its sales headquarters in Fort Worth, Texas, and consists of 403 agents. Farm & Ranch specializes in the marketing of insurance products to farmers, ranchers and others in the rural agricultural community. Farm & Ranch accounted for approximately 7.6% of the Company's first-year premium revenues for the year ended December 31, 1995.\nThe loss of, or significantly reduced sales efforts by either Cornerstone or Farm & Ranch, and the failure by the Company to replace such agents or otherwise offset such losses, could materially affect the business of the Company. Management believes that its relations with Cornerstone and Farm & Ranch are good.\nMEDICARE SUPPLEMENT AGENCY NETWORK\nIn November 1993, the Company and an Arizona-based agency specializing in the sale of Medicare supplement insurance, formed Senior Benefits. The Company acquired a 50.0% interest in Senior Benefits to establish a strong distribution network for its Medicare Supplement Products. Senior Benefits maintains its sales headquarters in Scottsdale, Arizona and currently consists of approximately 89 career and 2,468 independent agents. The Company entered into this relationship in order to better position itself in the Medicare supplemental segment of the insurance market and Senior Benefits accounted for approximately 31.6% of the Company's first-year accident and health insurance premiums for the year ended December 31, 1995.\nTo complement its new \"Medicare Select\" products and the agency contract with Senior Benefits, the Company has entered into PPO Agreements with Columbia\/HCA and other hospitals and health care providers, and is currently negotiating additional PPO Agreements. Accordingly, Senior Benefits intends to expand its marketing operations to additional states in which Medicare Select has been approved and NFL is currently licensed.\nHMO AGENCY NETWORK\nIn late 1995, the Company purchased a 50% ownership in Health Care-One, an insurance agency specializing in marketing HMO Products for Blue Cross of California and Foundation Health Plans in both California and Texas. Health Care-One maintains its sales headquarters in San Diego, California, and has a sales force consisting of 202 career agents.\nThe new business production by Health Care-One is not underwritten by the Insurance Subsidiaries of the Company, the Company entered into this arrangement to expand the marketing efforts to include HMO Products. This venture allows the Company to earn commission income through sales of products of other insurance carriers, without assuming underwriting risk. The operations of Health Care-One were not significant for the year ended December 31, 1995.\nHOME OFFICE OPERATIONS\nExcept for LifeStyles Marketing, Senior Benefits, WPS, ASSP, and Health Care-One, none of the Company's subsidiaries has any branch offices and, other than incidental travel by employees, the subsidiaries conduct their entire operations at the Fort Worth office (the \"Home Office\"). The functions carried out at the Home Office include policy issue and underwriting, policyowner service, claims processing, agency service and other administrative functions such as data processing, legal, accounting and actuarial. The Company also provides certain administrative and computer services on a fee for service basis to FLICA, including record keeping and reporting for their respective policies, claims and commissions.\nThe policy issue and underwriting department reviews policy applications. Although, as is common in the industry, physical examinations and tests are not required before a policy is issued, the Company's underwriting personnel will generally telephone an applicant for a Medical Expense Product to verify the information set forth in the policy application (which telephone calls are recorded as a matter of course) and will often contact the applicant's physician in the verification process. Applicants for the Company's Cancer and Specified Disease Products must certify in writing that they meet certain health standards established by the Company before the policy will be issued. Most applicants for the Company's Medicare Supplement Products fill out an application and, based on the historical health information certified therein, the Company makes its determination as to whether to issue the policy. Certain applicants, during a six month \"window\" after reaching age 65, are not required to provide historical health information.\nThe policyowner service department and agency service department are responsible for responding to policyowner and agent requests for information or services. The claims processing department reviews benefit claims submitted by policyowners, determines the benefits payable and processes the claim payments.\nRESERVE POLICY AND ADEQUACY\nThe Company's reserves consist of two separate components: the claim reserves and the policy benefit reserves. The claim reserves are established by the Company for benefit payments which have already been incurred by the policyholder but which have not been paid by the Company. The Company's actuaries estimate these reserves based upon analysis of claim inventories, loss ratios and claim lag studies. These estimates are developed in the aggregate for claims incurred (whether or not reported). The claim reserves include an amount which will not be paid out until subsequent reporting periods, but which is recorded in the current period for reporting purposes. Policy benefit reserves are established by the Company for benefit payments which have not been incurred but which are estimated to be incurred in the future. The policy benefit reserves accounted for approximately 54.4% of the Company's total reserves as of December 31, 1995. The policy benefit reserves are calculated according to the net level premium reserve method, and are equal to the discounted present value of the Company's expected future policyholder benefits, minus the discounted present value of its expected future net premiums. These present value determinations are based upon assumed fixed investment yields, the age of insured(s) under a policy at the time of policy issuance, expected morbidity and persistency rates, and expected future policyholder benefits. Except for purposes of reporting to insurance regulatory authorities and for tax filing, the Company's claim reserves and policy benefit reserves are determined in accordance with generally accepted accounting principles (\"GAAP\").\nIn determining the morbidity, persistency rate, claim cost and other assumptions used in determining the Company's policy benefit reserves, the Company relies primarily upon its own benefit payment history, and upon information developed in conjunction with actuarial consultants and industry data. The Company's persistency rates have a direct impact upon its policy benefit reserves, because the determinations for this reserve are, in part, a function of the number of policies in force and expected to remain in force to maturity. If persistency is higher or lower than expected, future policyholder benefits will also be higher or lower because of the different than expected number of policies in force, and accordingly, the policy benefit reserves will be increased or decreased.\nThe Company's reserve requirements are also interrelated with product pricing and profitability. The Company must price its products at a level sufficient to fund its policyholder benefits and still remain profitable. Because the Company's policyholder benefits represent the single largest category of its operating expenses, inaccuracies in the assumptions used to estimate the amount of such benefits can result in the Company failing to price its products appropriately and to generate sufficient premiums to fund the payment thereof. Because the discount factor used in calculating the Company's policy benefit reserves is based upon the rate of return of the Company's investments designed to fund this reserve, the amount of the reserve is dependent upon the yield on these investments. Provided that there is not material adverse experience with respect to these benefits, changes in future market interest rates will not have an impact on the profitability of policies already sold. Because fluctuations in future market interest rates affect the Company's yield on new investments, they also affect the discount factor used to establish, and thus the amount of, its policy benefit reserves for new sales. In addition, because an increase in the policy benefit reserves in any period is treated as an expense for income statement purposes, market interest rate fluctuations can directly affect the Company's profitability for policies sold in such period. It is not possible to predict future market interest rate fluctuations.\nIn accordance with GAAP, the Company's actuarial assumptions are generally fixed at the time they are made, and absent materially adverse benefit experience, they are not generally adjusted. Nonetheless, the Company monitors the adequacy of its policy benefit reserves on an ongoing basis by periodically analyzing the accuracy of its actuarial assumptions.\nThe adequacy of the Company's policy benefit reserves may also be impacted by the development of new medicines and treatment procedures which may alter the incidence rates of illness and the treatment methods for illness and accident victims (such as out-patient versus in-patient care) or prolong the life expectancy of such victims. Changes in coverage provided by major medical insurers or government plans may also affect the adequacy of the Company's reserves if, for example, such developments had the effect of increasing or decreasing the incidence rate and per claim costs of occurrences against which the Company insures. An increase in either the incidence rate or the per claim costs of such occurrences could result in the Company needing to post additional reserves, which could have a material adverse effect upon its business, results of operations and financial condition.\nThe Insurance Subsidiaries are required to report their results of operations and financial position to state regulatory agencies based upon statutory accounting practices (\"SAP\"). Under SAP, certain assumptions used in determining the policy benefit reserves, such as claim costs and investment result assumptions, are often more conservative than those appropriate for use by the Company under GAAP. In particular, SAP interest rate assumptions for investment results are fixed by statute and are generally lower than those used by the Company under GAAP. Another significant difference is that under SAP, unlike under GAAP, the Company is required to expense all sales and other policy acquisition expenses as they are incurred, rather than capitalizing and amortizing them over the expected life of the policy. Although the effect of this requirement is moderated by the allowance under SAP of an accounting procedure known as the \"two year preliminary term\" reserve valuation method, which allows the Company to defer any accumulation of policy benefit reserves until after the second policy year, the immediate charge off of sales and acquisition expenses and the claim cost and other valuation assumptions under SAP generally cause a lag between the sale of a policy and the emergence of reported earnings. Because this lag can reduce the Company's gain from operations on a SAP basis, it can have the effect of reducing the amount of funds available for dividend distributions to shareholders.\nREGULATION\nThe Company and its affiliates are subject to regulation and supervision in all jurisdictions in which they conduct business. In general, insurance laws establish supervisory agencies with broad administrative powers relating to, among other things, the granting and revoking of licenses to transact business, regulation of trade practices and premiums, licensing of agents, approval of content and form of policies, maintenance of specified reserves and capital and surplus, deposits of securities, form and content of required financial statements, nature of investments and limitations on dividends to stockholders. The purpose of such regulation and supervision is primarily to provide safeguards for policyholders rather than to protect the interests of stockholders. Such regulation delays the introduction of new products and may impede, or impose burdensome conditions on, rate increases or other actions that the Company may wish to take in order to enhance its operating results. In addition, federal or state legislation or regulatory pronouncements may be enacted that may prohibit or impose restrictions on the ability to sell certain types of insurance products or impose other restrictions on the Company's operations. No assurances can be given that future legislative or regulatory changes will not adversely affect the Company's business.\nGenerally, before the Company is permitted to market an insurance product in a particular state, it must obtain regulatory approval from that state and adhere to that state's insurance laws and regulations which include, among other things, specific requirements regarding the form, language, premium rates and policy benefits of that product. Consequently, although the Company's policies generally provide for the same basic types and levels of coverage in each of the states in which they are marketed, the policies are not precisely identical in each state or other jurisdiction in which they are sold. In addition, obtaining such approval can cause delays in the Company's ability to market new products.\nNearly all states in which the Company does business regulate loss ratios. The minimum loss ratios applicable to the Company's products range from 40.0% to 65.0%, with most falling in the range of 50.0% to 55.0%. The Company believes that it is within its minimum loss ratio requirements. Because these requirements mandate that the Company incur loss experience of not less than a specified percentage of its earned premiums over the life of a policy, they directly impact the profitability of the Company. Any increase in the Company's premiums must be justified to the relevant regulatory authority on the basis of the Company's conformance to the minimum loss ratio. This can have the effect of inhibiting the Company's ability to raise premiums on new sales, and thus its ability to generate additional cash from operations. Although the Company is not aware of any proposals by regulators to increase minimum loss ratios, states may increase minimum loss ratios from time to time. The National Association of Insurance Commissioners (\"NAIC\"), has in the past proposed model rules which would increase minimum loss ratios applicable to the Company's products. No assurance can be given that such a proposal will not be reintroduced in the future. Increases in minimum loss ratio requirements could have a material adverse effect upon the results of operations of the Company.\nThe NAIC has adopted a model law for adoption in the states requiring every life and health insurer licensed in a state to utilize an adopted RBC formula. The RBC formula establishes capital requirements for four categories of risk: asset risk, insurance risk, interest rate risk and business risk. The NAIC has pro-posed that the RBC formula may be used by regulators as an analytical tool to monitor the adequacy of capital of insurers. Under the model law, if an insurer's RBC, as determined under the RBC formula, falls below specified RBC levels, the insurer would be subject to different degrees of regulatory action depending upon the RBC level. At the initial problem level, the \"Company Action Level\", the insurer would be required to identify and propose actions to correct the risk-based capital deficiency and to provide the regulator with financial projections assuming both the absence and the presence of corrective action (collectively, an \"RBC Plan\"). At the second problem level, the \"Regulatory Action Level,\" the insurer would be required to submit an RBC Plan and would be subject to such examination or analysis and to such orders specifying required corrective action as the insurance regulator deems necessary. At the third problem level, the \"Authorized Control Level,\" the regulator may place the insurer under regulatory control if he decides that would be in the best interests of policyholders, creditors and the public. At the fourth problem level, the \"Mandatory Control Level,\" the model law requires the regulator to place the insurer under regulatory control. As of December 31, 1995 each Insurance Subsidiary's RBC exceeded the \"Company Action Level.\" This model law has been adopted in Delaware. Although it has not been formally adopted in Texas, it is used by regulators in Texas. The Company does not believe that the model law will have any material adverse effect on liquidity, capital resources or results of operations of the Company or cause the Company to change its business strategy.\nUnder applicable Delaware law, NFL must maintain minimum aggregate statutory capital and surplus of $550,000. Under applicable Texas law, each of NFIC and AICT must maintain minimum aggregate statutory capital and surplus of $1.4 million. The state of Georgia requires licensed out-of-state insurers to maintain minimum capital of $1.5 million and Kentucky requires minimum surplus of $2.0 million, which levels are higher than those of any other states in which the Insurance Subsidiaries are currently licensed. Accordingly, the minimum aggregate statutory capital and surplus which each of NFL, NFIC and AICT must maintain is $3.5 million. At December 31, 1995, aggregate statutory capital and surplus for NFL, NFIC and AICT was $14.1 million, $9.9 million and $8.3 million, respectively. According to SAP (as opposed to GAAP), costs in excess of first-year premiums associated with the issuance of new policies are charged to surplus through operations. These costs are primarily sales commissions and issuance costs and the establishment of statutory reserves. Increased first-year sales of insurance tend to reduce statutory surplus.\nOn the basis of statutory financial statements filed with state insurance regulators, the NAIC also calculates annually 13 financial ratios to assist state regulators in monitoring the financial condition of insurance companies. A \"usual range\" of results for each ratio is used as a benchmark. Departure from the \"usual range\" on four or more of the ratios could lead to inquiries from individual state insurance departments and increased regulatory oversight. Based on statutory financial statements for 1995, NFL and AICT fell within the \"usual range\" on 12 of the ratios. NFIC fell within the \"usual range\" on 11 of the ratios. NFL and NFIC fell outside the \"usual range\" for \"Net Income to Total Income\" (Ratio 2) as a result of recording statutory losses during 1995. Because continued production of new business may continue to cause strain during 1996, this event could recur in 1996. NFIC and AICT fell outside the \"usual range\" for Change in Reserving Ratio\" (Ratio 12) as a result of having life insurance reserves in 1995, when there were none in 1994. This resulted from production of life insurance business in 1995. Both NFIC and AICT are expected to return to the \"usual range\" for this ratio in 1996.\nIn 1995, an examination for NFL was concluded for the years 1990 through 1992 by the insurance departments of Delaware and Mississippi. Also in 1995, and examination for NFIC and AICT was concluded by the insurance department of Texas for the years 1991 through 1993. These examinations did not result in any significant adjustments to the statutory financial statements for the years under examination. Currently, the State of Delaware is conducting a statutory examination of NFL which covers the years 1993 through 1995.\nMany states have enacted insurance holding company laws that require registration and periodic reporting by insurance companies within their jurisdictions. Such legislation typically places restrictions on, or requires prior notice or approval of, certain transactions within the holding company system. For example, dividend payments from Westbridge's principal Insurance Subsidiaries, NFL, NFIC and AICT, are regulated by the insurance laws of their domiciliary states. Additionally, the terms of loans and transfers of assets within the holding company structure are also subject to state insurance holding company laws. Westbridge holds a surplus certificate issued by NFL the amount of $777,000. The unpaid aggregate principal under the surplus certificate bears interest at an agreed upon rate not to exceed 10.0% and is repayable, in whole or part, upon (i) NFL's surplus exceeding $7.0 million, exclusive of any surplus provided by reinsurance treaties, and (ii) NFL receiving prior approval from the Delaware State Insurance Commissioner.\nA majority of the states in the U.S., including those in which the Company is currently licensed and markets its policies, have adopted requirements that coverage provided by all accident and health policies contain prescribed minimum and maximum benefits and meet other minimum standards, and that specified dis-closure forms be provided to policyholders at the time of sale. Compliance with such requirements has not adversely affected NFL's marketing efforts in those states. Four states, Connecticut, Massachusetts, New Jersey and New York, have adopted statutes or insurance department regulations that either prohibit sales of policies that offer only \"specified or dread disease\" coverage (such as that provided by certain of the Company's Cancer and Specified Disease Products) or require that such coverage be offered in conjunction with other forms of health insurance. The Company has never written insurance in those states and does not currently intend to enter those markets. The Company has no knowledge of legislative initiatives which would limit or prohibit the sale of \"specified or dread disease\" policies in other states in which the Company operates.\nThe Company may be required, under the solvency or guaranty laws of most states in which it does business, to pay assessments (up to prescribed limits) to fund policyholder losses or liabilities of insurance companies that become insolvent. Recent insolvencies of insurance companies increase the possibility that such assessments may be required. These assessments may be deferred or forgiven under most guaranty laws if they would threaten an insurer's financial strength and, in certain instances, may be offset against future premium taxes. The incurrence and amount of such assessments may increase in the future without notice. The Company pays the amount of such assessments as they are incurred. Assessments which cannot be offset against future premium taxes are charged to expense. Assessments which qualify for offset against future premium taxes are capitalized, and are offset against such future premium taxes. The Company paid approximately $128,000 in the year ended December 31, 1994, and approximately $65,000 for the year ended December 31, 1995, as a result of such assessments. The likelihood and amount of any other future assessments cannot be estimated and are beyond the control of the Company.\nAlthough the U.S. Government generally does not directly regulate the insurance business, federal initiatives often impact the insurance business in a variety of ways. Current and proposed federal measures which may significantly affect the insurance business include controls on the cost of medical care, medical entitlement programs (e.g., Medicare), minimum solvency requirements for insurers and the development of a national health care system.\nOn the subject of assumption reinsurance, the NAIC has taken action. The Assumption Reinsurance Model Act was adopted in 1993. The Model Act provides a 25-month notice period and may allow a transfer after the expiration of such period even if the assuming insurer does not have a higher rating than the transferring insurer. The Model Act will have no legal effect until formally adopted by the states, although it can be expected to be relied upon by regulators in states without statutes, regulations or other defined rules expressly governing assumption reinsurance.\nCOMPETITION\nThe supplemental health and accident insurance industry in the United States is highly competitive. Although this market is fragmented, the Company competes with a large number of other insurers, some of which have been in business for a longer period of time and some of which have higher ratings by A.M. Best Company, Inc. (\"A.M. Best\") and substantially greater financial and other resources than the Company. A.M. Best, a nationally recognized insurance rating agency, assigns a rating which measures each company's relative financial strength and ability to meet its contractual obligations. In the markets in which the Company sells its products, the Company believes that its A.M. Best rating is not a significant factor affecting its ability to sell its insurance products.\nPrivate insurers and voluntary and cooperative plans, such as Blue Cross and Blue Shield, and Health Maintenance Organizations, provide various alternatives for meeting hospitalization and medical expenses. Much of this insurance is sold on a group basis to employer sponsored groups. The federal and state governments also provide insurance through the Medicare and Medicaid programs for the payment of the costs associated with medical care. These major medical programs generally cover a substantial amount of the medical expenses incurred as a result of accidents or illnesses. The Company's Cancer and Specified Disease Products are designed to provide coverage which is supplemental to major medical insurance and may be used to defray nonmedical as well as medical expenses. Since these policies are sold to complement major medical insurance, the Company competes only indirectly with these insurers. However, expansion of coverage by other insurers could adversely affect the Company's business.\nThe Company's Medical Expense Products are designed to provide coverage which is similar to the major medical insurance programs described above, but sold primarily to persons not covered in an employer sponsored group. The Company's Medicare Supplement Products are designed to supplement the Medicare program by reimbursing for expenses not covered by such program. To the extent that future government programs expand or contract the private insurance industry's participation, they could benefit or adversely affect the Company's business.\nThe Company competes directly with other insurers offering similar products and believes that its current benefits and premium rates are generally competitive with those offered by other companies. Management believes that service to policyholders and prompt and fair payment of claims continue to be important factors in the Company's ability to remain competitive.\nIn addition to product and service competition, there is also very strong competition within the supplemental health and accident insurance market for qualified, effective agents. The recruitment and retention of such agents is extremely important to the success and growth of the Company's business. Management believes that the Company's controlled agency network is competitive with respect to the recruitment and training of agents. However, there can be no assurance that the Company's controlled agency network will be able to continue to recruit or retain qualified, effective agents. The inability of the Company to adequately recruit and retain such agents could have a material adverse effect upon the Company's business, results of operations and financial condition.\nINVESTMENT POLICY AND RESULTS\nInvestment income is an important source of revenue and the Company's return on invested assets has a material effect on net income. The Company's investment policy is subject to the requirements of regulatory authorities regarding maintenance of minimum statutory reserves in order to meet future policy obligations under policies in force. Statutory reserves may consist only of certain types of admitted investments, the percentage mix of which is regulated by statute. In addition, certain assets are held on deposit in specified states and invested in specified securities in order to comply with state law and reduce premium tax assessments in such states. Although the Company closely monitors its investment portfolio, available yields on newly-invested funds and gains or losses on existing investments depend primarily on general market conditions.\nInvestment policy is determined by the Investment Committees of the Company and the Insurance Subsidiaries in accordance with guidelines set forth by their respective Boards of Directors. The current investment policy of the Company and the Insurance Subsidiaries is to invest primarily in fixed-income securities of the U.S. Government and its related agencies, investment grade fixed-income corporate securities and in mortgage-backed securities. Also up to 5% of the Company's assets may be invested in higher yielding non-investment grade securities. Current policy is also to balance the portfolio between long- and short-term investments so as to achieve long-term returns consistent with the preservation of capital and maintenance of adequate liquidity to meet the payment of the Company's policy benefits and claims, interest on the indebtedness and dividends on the Series A Preferred Stock. Although the balance sheet shows invested assets in real estate and mortgage loans, the Company's investment policy excludes the investment of new funds in real estate or mortgage loans and since prior to 1989 the Company has acquired no such assets in its portfolio.\nThe following table sets forth a summary of consolidated cash and invested assets of the Company for the dates indicated, valued in accordance with generally accepted accounting principles:\nIncluded in the invested assets of the Company outlined in the preceding table are certain high-yield debt securities which are below a \"BBB\" or equivalent rating. Although the Company owned no such assets at December 31, 1994, these high-yield debt securities amounted to less than 0.7% and 0.1% of the Company's total cash and invested assets at December 31, 1995 and December 31, 1994, respectively.\nThe significant increase in the investment portfolio during 1994 was primarily the result of the assets acquired by the Company in the Acquisition. See \"BUSINESS-GENERAL.\"\nThe following table summarizes consolidated investment results for the periods shown:\nThe following table summarizes the Company's fixed maturity securities, excluding short-term investments, as of December 31, 1995:\nThe Company's fixed maturity investment portfolio at December 31, 1995 was composed primarily of debt securities of the U.S. Government and corporations and of mortgage-backed securities. Investments in the debt securities of corporations are principally in publicly-traded bonds.\nMortgage-backed securities represented approximately 12.8% of the market or estimated fair value of the Company's total investment securities as of December 31, 1995. Investors are compensated primarily for reinvestment risk rather than credit quality risk. During periods of significant interest rate volatility, the underlying mortgages may prepay more quickly or more slowly than anticipated. If the repayment of principal occurs earlier than anticipated during periods of declining interest rates, investment income may decline due to the reinvestment of these funds at the lower current market rates.\nThe following table indicates by rating the composition of the Company's fixed maturity securities portfolio, excluding short-term investments, as of December 31, 1995:\nThe NAIC assigns securities quality ratings and uniform prices called \"NAIC Designations,\" which are used by insurers when preparing their annual statutory reports. The NAIC assigns designations to publicly- traded as well as privately-placed securities. The ratings assigned by the NAIC range from Class 1 to Class 6, with Class 1 as the highest quality rating. The following table sets forth the book and market or estimated fair value of the Company's fixed maturity securities, excluding short-term investments, according to NAIC Designations and Standard & Poor's ratings as of December 31, 1995:\nThe scheduled maturities of the Company's fixed maturity securities, excluding short-term investments, as of December 31, 1995 were as follows:\nREINSURANCE\nCeded\nAs is customary in the insurance industry, the Company cedes reinsurance to other insurance companies. Cession of reinsurance is utilized by an insurer to limit its maximum loss, thereby providing a greater diversification of risk and minimizing exposures on larger risks. Reinsurance does not discharge the primary liability of the original insurer with respect to such insurance (except for assumption reinsurance described below) but the Company, in accordance with prevailing insurance industry practice, reports reserves and claims after adjustment for reserves and claims ceded to other companies through reinsurance.\nThe Company generally does not cede risks associated with its Cancer and Specified Disease Products, Medicare Supplement Products or Life Insurance Products. However, 100% of the Company's risks under its Accidental Death policies currently in force are reinsured. The Company had an excess loss reinsurance agreement during 1995 which limited the Company's losses on the First Occurrence policies in the event that such losses exceeded a certain percentage of earned premiums. This reinsurance agreement was not renewed in 1996. The Company currently reinsures its risks under its Medical Expense Products so that its maximum payment to any one beneficiary during any one-year period is limited ($100,000 in 1995) for any accident or illness. In accordance with industry practice, the reinsurance agreements in force with respect to these policies are terminable by either party with respect to claims incurred after the termination date and the expiration dates.\nAssumed\nThe Company also assumes reinsurance (primarily in the form of coinsurance) as part of its ongoing operations. Assumption of reinsurance is utilized by insurers as an additional source of insurance business. In May 1987, NFL entered into a coinsurance treaty with FLICA. Under the terms of the treaty, NFL assumed a 50.0% share of all Cancer and Specified Disease policies written by FLICA, the ceding company, from January 1, 1987 through December 31, 1988. During 1988, the coinsurance treaty was amended to continue until December 31, 1998. See \"MARKETING\". For the year ended December 31, 1995, $4.3 million of assumed premiums under this coinsurance treaty were recorded as premiums. In March 1990, NFL entered into a coinsurance treaty with Paramount. Under the terms of the treaty, which was in effect from April 1, 1990 through May 31, 1995, NFL assumed 90.0% of the Cancer and Specified Disease policies written by Paramount. The treaty effectively ended upon the purchase of this block of business by NFL from Paramount. For the year ended December 31, 1995, $582,000 of assumed premiums under this coinsurance treaty were recorded as premiums. In December 1993, NFL entered into a coinsurance agreement with FLICA. Under the terms of this agreement, which expires in November 1998, the Company assumes 90.0% of the First Occurrence policies issued by FLICA. For the year ended December 31, 1995, $5.1 million of assumed premiums under this agreement were recorded as premiums.\nUse in Acquisitions\nOver the past four years, the Company has acquired blocks of policies in force from AII, LHI, and DNL, through the use of indemnity and assumption reinsurance. Using this process, the Company first acquires policies by insuring the risks of policies ceded by other insurers in the manner discussed above. Following such acquisition, the Company applies to each relevant state regulatory authority for approval to convert the indemnity reinsurance to assumption reinsurance. As regulatory approval from each state is obtained, the Company issues assumption certificates to policyholders in the approving state to provide notice of the Company's assumption of the primary obligation under the insurance policies assumed. There can be no assurance that regulatory approval will be granted by each relevant state, or as to the time required to obtain such approval. As of December 31, 1995, annualized premiums of $47,000, and $1,480,000, relating to the policies acquired from AII, and LHI, respectively, had not yet been approved for assumption.\nEMPLOYEES\nAt December 31, 1995, the Company employed 309 persons, of which 67 were management and supervisory personnel. The Company has not experienced any work stoppages, strikes or business interruptions as a result of labor disputes involving its employees, and the Company considers its relations with its employees to be good.\nHEALTH CARE REFORM\nOn September 22, 1993, President Clinton proposed the Health Security Act of 1993 (the \"HSA\"), legislation designed to reform the United States health care system. The HSA is primarily intended to (I) provide access to health care services for all United States residents and (ii) control the escalation of health care expenditures in the United States. Since the introduction of the HSA, several members of Congress have proposed alternative legislation which would provide varying degrees of coverage. On October 7, 1994, Congress adjourned without having enacted significant health care legislation. However, such legislation may be enacted in the future. The specific elements of the HSA, or other federal legislation enacted to reform the health care system, may include limitations on government spending for health care benefits, price controls, the creation of large purchasing groups and mandatory standard health care benefit programs. The HSA, or any other proposed legislation, is expected to undergo significant revision prior to congressional approval and implementation. In addition, state governments may propose and adopt health care plans.\nSuch federal or state legislation, if enacted, could, among other things, further restrict the Company's ability to implement rate increases, and could impose limitations on the profitability of certain of the Company's insurance products. Also, to the extent that such legislation guarantees major medical coverage to all United States residents and\/or expands the scope of basic coverage, the demand for specified disease and supplemental insurance may be reduced, and certain health insurance business currently in force could experience high lapse rates. The Company cannot predict what effect, if any, yet to be enacted health care legislation or proposals will have on the Company if and when enacted. The Company believes that the current political environment in which it operates will result in continued legislative scrutiny of health care reform and may lead to additional legislative initiatives. No assurance can be given that enactment of any federal and\/or state health care reforms will not have a material effect on the Company's business.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company maintains its principal offices at 777 Main Street, Fort Worth, Texas. Such offices were leased by NFL in July 1983 under a lease agreement which was subsequently amended and which expires in June 2001.\nWPS, the Company's wholly-owned printing subsidiary which prints all policies, forms and brochures of the Insurance Subsidiaries, maintains its manufacturing facility at 7333 Jack Newell Boulevard North, Fort Worth, Texas, under a lease agreement which expires in October, 2005.\nLifeStyles Marketing maintains its sales headquarters at 1161 Corporate Drive, Arlington, Texas, under a five year lease agreement which expires in August, 1997. LifeStyles Marketing also leases office space for certain of its 18 branch sales office locations under lease agreements which expire on various dates throughout the next twelve months. Senior Benefits maintains its offices in Scottsdale, Arizona, under a three-year lease expiring in September, 1996.\nAmerican Senior Security Plans maintains its offices in Dallas, Texas, under an annual lease agreement.\nHealth-Care One maintains its offices in San Diego, California, under a lease agreement expiring January, 1999.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nIn the normal course of its business operations, the Company is involved in various claims and other business related disputes. In the opinion of management, the Company is not party to any pending litigation the disposition of which would have a material adverse effect on the Company's consolidated financial position or its results of operations.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nThere were no matters submitted during the fourth quarter of the fiscal year covered by this report to a vote of security holders of the Company.\nEXECUTIVE OFFICERS OF REGISTRANT\nWestbridge's executive officers, who serve at the pleasure of the Board of Directors, are as follows:\nYears with Name Age Position with the Company the Company\nMartin E. Kantor 73 Chairman of the Board and Chief Executive Officer 19\nJames W. Thigpen 58 President and Chief Operating Officer 14\nPatrick J. Mitchell 37 Vice President, Chief Financial - Officer and Treasurer\nStephen D. Davidson 40 Vice President and Chief Marketing Officer 2\nMargaret A. Megless 44 Vice President 20\nMichael D. Norris 49 Vice President and Secretary 12\nDennis A. Weverka 51 Vice President 15\nMr. Kantor has served as Chairman of the Board and Chief Executive Officer of Westbridge since 1993 Mr. Kantor had served as Chairman of the Board, President and Chief Executive Officer of Westbridge since prior to 1990. Mr. Kantor has served as Chairman of the Board of NFL since prior to 1989, and also became Chief Executive Officer of NFL in 1985. Following the Acquisition of NFIC and AICT, Mr. Kantor was appointed Chairman of the Board of each of NFIC and AICT. Mr. Kantor may be deemed to be a control person of Westbridge by virtue of his ownership of 721,906 shares, or 12% of the outstanding shares of Westbridge's Common Stock at December 31, 1995. This amount does not include shares held in various trusts established by Mr. Kantor for the benefit of his children and grandchildren over which he has no voting or investment power and as to which Mr. Kantor disclaims beneficial ownership.\nMr. Thigpen has served as President and Chief Operating Officer of Westbridge since January 1993. Following the Acquisition of NFIC and AICT, Mr. Thigpen was appointed President and Chief Operating Officer of each of NFIC and AICT. Mr. Thigpen had served as Executive Vice President of Westbridge since prior to 1989. Mr. Thigpen has also served as President and Chief Operating Officer of NFL since prior to 1989. From March 1981 to April 1985, Mr. Thigpen served as Executive Vice President-Operations of NFL. Mr. Thigpen was Senior Vice President of Operations of Lone Star Life Insurance Company, Dallas, Texas for four years prior to his joining NFL in March 1981.\nMr. Mitchell has served as Vice President, Chief Financial Officer and Treasurer of Westbridge since August 1995. Mr. Mitchell is also Senior Vice President, Treasurer and Director of NFL, NFIC and AICT, and has served in that capacity since August 1995. Mr. Mitchell served as Vice President for Bankers Life & Casualty Company, Chicago, Illinois, for two years prior to joining Westbridge. Mr. Mitchell was an Assistant Vice President for Reliance Standard Life Insurance Company, Philadelphia, Pennsylvania, from 1989 to 1993.\nSteven D. Davidson, Vice President, has served as Chief Marketing Officer of Westbridge and as a Senior Vice President of NFL, NFIC and AICT since joining the Company in August 1994. Mr. Davidson served as President of Senior Benefits, L.L.C., from 1992 to 1994 and as Vice President of Marketing for Pioneer Life Insurance Company, Rockford, Illinois, from 1989 to 1992.\nMargaret A. Megless has served as Vice President, Information Systems of Westbridge since August 1994 and as Senior Vice President, Information Systems of NFL since 1992. Following the Acquisition of NFIC and AICT, Ms. Megless was appointed Senior Vice President of each of NFIC and AICT, and in June 1994, was appointed a director of NFL, NFIC and AICT. Ms. Megless joined the Company in January 1977, serving as Vice President, Information Systems of NFL from 1984 to 1992.\nMr. Norris is Vice President and Secretary of Westbridge and has served as Secretary since prior to 1990, and has served as Vice President since August 1994. Mr. Norris has also served as Senior Vice President, General Counsel and Secretary of NFL since prior to 1990. Following the Acquisition of NFIC and AICT,, Mr. Norris was appointed Senior Vice President and Secretary of each of NFIC and AICT, and in June 1994 was appointed a director of NFL, NFIC and AICT. Mr. Norris was Counsel for the Oklahoma Insurance Department, Oklahoma City, Oklahoma for two years prior to joining NFL in March 1983. Mr. Norris was an adjuster and attorney for Allstate Insurance Company, Oklahoma City, Oklahoma, from 1979 to 1981.\nDennis A. Weverka was appointed Vice President, of Westbridge in August 1994. Mr. Weverka joined the Company in August 1981 and has served as a Senior Vice President of NFL since 1984. Following the Acquisition of NFIC and AICT, Mr. Weverka was appointed Senior Vice President of NFIC and AICT, and in June 1994 was appointed a director of NFL, NFIC and AICT.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS.\nThe Common Stock trades on the New York Stock Exchange under the symbol \"WBC\". Prior to May 25, 1995, the Common Stock traded on the American Stock Exchange, under the same symbol. The following table sets forth the high and low sales price for the Common Stock, by quarter, for the periods indicated.\nHigh Low First Quarter 8 1\/2 6 3\/4 Second Quarter 8 3\/4 6 5\/8 Third Quarter 9 5\/8 7 7\/8 Fourth Quarter 9 3\/8 7 3\/8\nFirst Quarter 8 1\/8 5 7\/8 Second Quarter 7 1\/2 5 1\/2 Third Quarter 6 5\/8 5 3\/4 Fourth Quarter 6 5\/8 5 5\/8\nFirst Quarter (through March 11, 1996) 6 5\/8 6 1\/8\nOn March 11, 1996, the closing price of the Common Stock on the NYSE was $6 3\/8 per share.\nAs of March 11, 1996, there were 2,424 record holders of the Common Stock.\nWestbridge has not paid any cash dividends on the Common Stock and does not anticipate declaring or paying cash dividends on the Common Stock in the foreseeable future. Both the Preferred Stock Purchase Agreement related to the Series A Preferred Stock and the Indenture related to the 11% Senior Subordinated Notes, impose certain restrictions upon the Company with respect to the payment of dividends on the Common Stock. For information concerning statutory limitations on the payment of dividends by the Insurance Subsidiaries to Westbridge, see \"BUSINESS--REGULATION\" and NOTE 12 of \"Notes to the Consolidated Financial Statements\" herein.\nITEM 6.","section_6":"ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA.\nSelected financial data for each of the Company's last five years of operations is presented below (in thousands, except share data):\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION.\nOVERVIEW\nThe Company derives its revenue primarily from premiums from its insurance products and, to a significantly lesser extent, from fee and service income, income earned on investment assets and gains on the sales or redemptions of investment assets. The Company's primary expenses include benefits and claims in connection with its insurance products, amortization of deferred policy acquisition costs (\"DPAC\"), commissions paid on policy renewals, general and administrative expenses associated with policy and claims administration, taxes, licenses and fees, and interest on the indebtedness. In addition to the foregoing expenses, the Company is obligated to pay dividends on the Series A Preferred Stock if and when declared by the Board of Directors.\nFee and service income is generated primarily from (i) telemarketing services provided to unaffiliated insurance agencies, (ii) commissions received by marketing organizations from unaffiliated insurance companies, (iii) administrative and computer services provided to FLICA, and (iv) fees received by WPS for services provided to unaffiliated companies.\nBenefits and claims are comprised of (i) claims paid, (ii) changes in claim reserves for claims incurred (whether or not reported) and (iii) changes in policy benefit reserves based on actuarial assumptions of future benefit obligations not yet incurred on policies in force.\nDPAC consists of expenditures made for the production of new business. They consist principally of the amount by which first-year commission costs exceed commission costs paid in subsequent policy years. Also included in DPAC is the cost of insurance purchased relating to acquired blocks of business. The amortization of these costs is based on actuarially estimated future premium revenues. The amortization rate is adjusted periodically to reflect actual experience.\nOver the past four years, the Company has acquired seasoned blocks of business to supplement its revenue. These acquisitions included (i) a block of Medicare Supplement Products purchased from AII in September 1992, (ii) a block of Medicare Supplement Products purchased from LHI in March 1993, (iii) a block of Cancer and Specified Disease Products purchased from DNL in February 1994 and (iv) a block of policies in all of the Company's product lines purchased in the Acquisition.\nThe following table shows the premiums received by the Company through internal sales and through acquisitions during the periods indicated.\nAs demonstrated by the substantial increases in first-year premiums for company issued policies over the past three years, the Company has strived to produce revenue growth through marketing and sale of new insurance business. This successful marketing growth has resulted from expanded production at existing agency networks, such as LifeStyles Marketing and Senior Benefits, and from the development of relationships with new marketing organizations, such as Cornerstone and Farm & Ranch.\nRESULTS OF OPERATIONS\nYear Ended December 31, 1995 Compared with Year Ended December 31, 1994\nPremiums. Premiums increased $21.4 million, or 21.7%, from $98.7 million to $120.1 million. This was due to an increase in first-year premiums of $19.6 million, or 130.1 %, and an increase in renewal premiums of $1.7 million, or 2.1%.\nThe increase in first-year premiums resulted from a $7.9 million, or 199.1%, increase in first-year Medicare Supplement premium generated by Senior Benefits, a $4.6 million, or 63.1%, increase in first-year Medical Expense premiums generated by LifeStyles Marketing, an increase of $5.0 million in first-year Medical Expense premiums generated by Cornerstone and Farm & Ranch, which began marketing products for the Company in December 1994, and a $2.1 million, or 87.5%, increase in first-year premiums on policies reinsured from FLICA.\nThe increase in renewal premium is attributable to increases of $3.0 million from Senior Benefits, $1.0 million, or 26.1%, from policies reinsured from FLICA, and $701,000, or 7.6%, for LifeStyles Marketing Products. These increases were offset by decreases of $1.2 million, or 21.3%, from discontinued Medicare Supplement and Medical Expense Products, and $1.2 million in renewal premiums from Acquired Policies. The decrease in renewal premium from Acquired Policies is primarily attributable to a $3.4 million, or 25.7%, decrease from the AII block of business along with decreases of $556,000, or 14.4%, and $416,000, or 16.6%, in renewal premium from policies acquired from Dixie National and Life and Health, respectively, offset by a $3.2 million increase in renewal premium from NFIC and AICT acquired policies. Because NFIC and AICT were acquired in April, 1994, revenues from the policies were recorded for a full year in 1995 compared to approximately nine months in 1994.\nNet Investment Income. Net investment income increased $1.7 million, or 29.8%, from $5.7 million to $7.4 million due to a combination of slightly higher rates of return on the Company's invested assets and the results of having the invested assets acquired with NFIC and AICT earning income for the Company for a full year in 1995. Additionally, approximately $400,000 of interest on agents' debit balances was recorded in 1995, which was not present in 1994.\nFee and Service Income. Fee and service income increased $599,000, or 35.2%, from $1.7 million to $2.3 million due primarily to an increase of $442,000 of telemarketing services sold to non-affiliated agency operations.\nBenefits and Claims. Benefit and claim expense increased $16.9 million, or 31.5%, from $53.6 million to $70.5 million. This was due to increases of $11.5 million in benefit and claim expense on Medicare Supplement Products produced by Senior Benefits, $3.2 million, or 39.8%, on Medical Expense Products sold by LifeStyles Marketing, $4.0 million, or 211.0%, on policies reinsured from FLICA, $3.4 million in Medical Expense Products marketed by Cornerstone and Farm & Ranch, and $791,000, or 64.1%, on pre-1987 Medical Expense Products. Offsetting these increases were decreases in benefits and claims expense of $4.6 million, or 81.3%, for Cancer and Specified Disease Products issued directly by the Company and $491,000, or 1.5%, related to Acquired Products.\nBenefits and claims expense as a percentage of total premiums rose 4.3% in 1995 compared to 1994. This increase is primarily attributable to two factors. First, a shift in product mix from defined benefit policies such Cancer and Specified Disease Products, to Medical Expense Products and Medicare Supplement Products which have inherently higher benefit ratios. Second, increased medical provider claims industry-wide contributed to the increase.\nAmortization of DPAC. Amortization of DPAC increased $1.8 million, or 18.6%, from $9.7 million to $11.5 million. The increase in amortization of DPAC resulted from amortization increases of $2.9 million related to LifeStyles Marketing Products, $1.4 million from discontinued Medicare Supplement Products and $927,000 from pre-1987 Medical Expense Products. These increases are offset, in part, by decreases in amortization of DPAC related to Company-issued Cancer and Specified Disease Product of $2.0 million and Cancer and Specified Disease Product reinsured from FLICA of $1.1 million.\nCommissions. Commissions increased $135,000, or 1.2%, from $11.2 million to $11.3 million. Commissions increased $587,000 from policies reinsured with FLICA with an offsetting decrease of $510,000 from Acquired policies. Before elimination of intercompany revenues and expenses in consolidation, commissions increased $913,000, or 8.3%, in NFL, $847,000, or 35.1%, in NFIC and AICT, and $1.3 million, or 35.1%, in LifeStyles Marketing. An increase of $2.2 million, or 39.7%, in commissions paid to LifeStyles Marketing by NFL was eliminated in consolidation. An increase of $529,000 in commissions paid to Senior Benefits by NFL was also eliminated in consolidation.\nThe increase in commissions before consolidation eliminations for NFL resulted from increases of $1.3 million for products sold by Senior Benefits, $383,000, or 18.4%, for products sold by LifeStyles Marketing, and $587,000, or 39.9%, for policies reinsured from FLICA. These increase were offset, in part, by decreases of $959,000, or 32.8%, for Acquired Policies and $261,000, or 7.2%, for Company-issued Cancer and Specified Disease products. The increase in commissions before consolidation eliminations for NFIC and AICT is principally the result of two items. $449,000 of the increase resulted from recording NFIC and AICT commissions for a full year in 1995, as opposed to about nine months in 1994. $398,000 of the increase resulted from new product sales generated by Cornerstone and Farm & Ranch. These items were not present or were insignificant in the corresponding period in 1994.\nGeneral and Administrative Expenses. General and administrative expenses increased $5.1 million, or 30.1%, from $16.8 million to $21.9 million. This increase stems from expenses associated with developing marketing operations to maintain growth momentum and the effect of the first full fiscal year administering the NFIC and AICT acquisition.\nTaxes, Licenses and Fees. Taxes, licenses and fees increased $871,000, or 27.2%, from $3.2 million to $4.1 million due principally to the increase in collected premiums and the related tax thereon levied by state governments.\nInterest Expense. Interest expense decreased $635,000, or 21.2%, from $3.0 million to $2.4 million. This decrease is the result of the Company retiring $25.0 million of 11.7% Senior Subordinated Debentures effective March 30, 1995 along with the issuance of $20.0 million of 11.0% senior notes on February 28, 1995.\nProvision for Income Taxes. The provision for income taxes increased $49,000, or 1.8%, from $2,764,000 to $2,813,000. A decrease in pre-tax income of $648,000, or 7.3%, was offset by an increase of 300 basis points, or 10%, in the effective tax rate resulting in the relatively small increase in the provision for income taxes. The Company received little or no small company tax benefit in 1995 and consequently experienced an increase to the effective tax rate.\nYear Ended December 31, 1994 Compared with Year Ended December 31, 1993\nPremiums. Premiums increased $30.0 million, or 43.7%, from $68.7 million to $98.7 million. This increase was due primarily to an increase in total acquired policy premiums of $26.0 million, or 111.1%, and an increase in first-year premiums for Company-issued policies of $6.3 million, or 72.4%, offset, in part, by a decrease in renewal premiums (excluding renewal premiums on policies acquired in acquisitions) of $2.3 million, or 6.3%.\nThe increase in total acquired policy premiums resulted from premiums of $29.7 million from the policies obtained in the Acquisition and $3.9 million from the Cancer and Specified Disease Products acquired from DNL, which, in each case, were not present in the year ended December 31, 1993. In addition, premiums on the block of policies acquired from LHI in March 1993 increased $242,000, or 10.7%, from the corresponding prior year period. These increases were offset, in part, by a decrease in premiums on the block of policies acquired from AII in September 1992 of $7.9 million, or 37.4%, due to policy lapses or cancellations.\nThe increase in first-year premiums resulted primarily from $3.9 million in first-year premiums generated by Senior Benefits, which began writing the Company's Medicare Supplement Products in November 1993, and increases of $1.7 million, or 30.9%, in first-year premiums for Medical Expense Products sold by LifeStyles Marketing and $1.3 million, or 118.2%, in first-year premiums on policies reinsured from FLICA. These increases were offset, in part, by a decrease of $548,000, or 27.1% in first-year premiums on Cancer and Specified Disease Products written directly by the Company.\nThe decrease in renewal premiums (excluding renewal premiums on policies acquired in acquisitions) was primarily due to a decrease of $885,000, or 24.8%, for pre-1987 Medical Expense Products, a decrease of $479,000, or 4.9%, for LifeStyles Products and a decrease of $378,000, or 19.1%, in premiums for Cancer and Specified Disease Products reinsured from Paramount. Decreases in renewal premiums result from lapses or cancellations of existing policies which are not offset by the Company's acquisition or generation of new business. If the Company's efforts to increase the sales and marketing of its existing products do not offset future policy lapses or cancellations, premiums will decline over time.\nNet Investment Income. Net investment income increased $1.6 million, or 39.0%, from $4.1 million to $5.8 million due primarily to investment income of $2.6 million earned on the investment assets acquired in the Acquisition, offset, in part, by lower returns on the Company's other investment assets resulting from reinvestment, at lower interest rates, of the proceeds on bonds which were redeemed or matured during the year ended December 31, 1993.\nFee and Service Income. Fee and service income increased $300,000, or 21.4%, from $1.4 million to $1.7 million due primarily to increased commissions received through LifeStyles Marketing from non-affiliated insurers.\nBenefits and Claims. Benefits and claims increased $20.4 million, or 61.4%, from $33.2 million to $53.6 million. This increase was due primarily to benefits and claims of $19.4 million on the policies acquired in the Acquisition, $2.7 million on the Cancer and Specified Disease Products acquired from DNL in February 1994, and $1.5 million on the Medicare Supplement Products marketed by Senior Benefits following its formation in November 1993, each of which were not present or were insignificant in the corresponding period in 1993. Also contributing were increases in benefits and claims of $1.1 million, or 15.9%, for LifeStyles Products, $1.4 million, or 32.6%, for Cancer and Specified Disease Products issued directly by the Company, and $352,000 or 23.0%, for Cancer and Specified Disease Products reinsured from FLICA. These increases were offset, in part, by decreases in benefits and claims of $4.3 million, or 29.9%, for the previously acquired Medicare Supplement Products, and $1.3 million, or 46.4%, for pre-1987 Medical Expense Products.\nAmortization of DPAC. Amortization of DPAC increased $1.5 million, or 18.3%, from $8.2 million to $9.7 million. This increase was due primarily to $3.0 million of amortization expense attributable to the policies acquired in the Acquisition, and $520,000 of amortization expense relating to Medicare Supplement Products marketed by Senior Benefits, each of which were not present or were insignificant in the corresponding period in 1993. These increases were offset, in part, by decreases in amortization expense of $829,000, or 27.0%, for LifeStyles Products, $413,000, or 51.2%, for pre-1987 Medical Expense Products, and $458,000, or 41.3%, for previously acquired Medicare Supplement Products.\nCommissions. Commissions increased $1.6 million, or 16.7%, from $9.6 million to $11.2 million due primarily to $2.4 million of commissions on the policies acquired in the Acquisition, offset, in part, by a decrease of $800,000, or 8.3% in other commissions.\nBefore elimination of intercompany revenues and expenses in consolidation, commissions decreased $145,000, or 1.3%, in NFL and increased $816,000, or 28.9%, in LifeStyles Marketing. An increase of $1.2 million, or 27.3%, in commissions paid to LifeStyles Marketing by NFL was eliminated in consolidation.\nThe decrease in commissions paid by NFL resulted primarily from decreases of $1.3 million, or 37.1%, in commissions paid on the previously acquired Medicare Supplement Products and $157,000, or 4.1%, in commissions paid on Cancer and Specified Disease Products issued directly by the Company. These decreases were offset, in part, by $767,000 in commissions paid on the Cancer and Specified Disease Products acquired from DNL, and $205,000 of commission expense relating to Medicare Supplement Products marketed by Senior Benefits, each of which were not present in 1993, and increases of $234,000, or 12.6%, in commissions paid on LifeStyles Products and $269,000, or 22.4%, in commissions paid on Cancer and Specified Disease Products reinsured from FLICA. The increase in commissions paid by LifeStyles Marketing resulted from increased production of new business.\nGeneral and Administrative Expenses. General and administrative expenses increased $2.5 million, or 17.5%, from $14.3 million to $16.8 million due primarily to the costs associated with the administration of the policies acquired in the Acquisition.\nTaxes, Licenses and Fees. Taxes, licenses and fees increased $500,000, or 18.5%, from $2.7 million to $3.2 million due primarily to the additional taxes on the premiums associated with the policies acquired in the Acquisition.\nInterest Expense. Interest expense increased $600,000, or 24.0%, from $2.5 million to $3.1 million due primarily to the 25% increase in the Company's consolidated debt following NFL's sale in February 1994 of $5.0 million principal amount of Senior Subordinated Debentures previously held in its investment portfolio.\nProvision for Income Taxes. The provision for income taxes increased $1.2 million, or 75.0%, from $1.6 million to $2.8 million due primarily to the profitable operations acquired in the Acquisition as well as an increase in the pre-tax income of NFL.\nYear Ended December 31, 1993 Compared with Year Ended December 31, 1992\nPremiums. Premiums increased $12.0 million, or 21.2%, from $56.7 million to $68.7 million. This increase was due primarily to an increase in total acquired policy premiums of $16.5 million or 239.0%, offset, in part, by a decrease in renewal premiums (excluding renewal premiums on policies acquired in acquisitions) of $3.7 million, or 9.1% and a decrease in first-year premiums for Company-issued policies of $808,000, or 8.5%.\nThe increase in total acquired policy premiums resulted from an increase in premiums of $14.2 million for the Medicare Supplement Products acquired from AII in September 1992 and premiums of $2.3 million for the Medicare Supplement Products acquired from LHI in March 1993.\nThe decrease in first-year premiums was primarily due to a decrease of $361,000, or 6.1%, in first-year premiums generated for NFL by LifeStyles Marketing and a decrease of $471,000, or 13.3%, in first-year premiums for Cancer and Specified Disease Products. The decreases in first-year premiums followed decreases in production which occurred in response to rate increases implemented in the latter half of 1991. However, the decrease in first-year premiums for LifeStyles Products has since leveled off and, on a quarter-to-quarter basis during 1993, first-year premiums have increased. LifeStyles Products' first-year premiums were $1.1 million, $1.3 million, $1.5 million and $1.6 million in the first, second, third and fourth quarter of 1993, respectively.\nThe decrease in renewal premiums (excluding renewal premiums on policies acquired in acquisitions) was primarily due to a decrease of $1.0 million, or 5.1%, for Cancer and Specified Disease Products and a decrease of $1.3 million, or 11.9%, for LifeStyles Products. Also contributing to the decrease in renewal premiums was a decrease for certain pre-1987 Medical Expense Products of $602,000, or 14.4%, and a decrease for pre-1987 Medicare Supplement Products of $676,000, or 15.7%. Decreases in renewal premiums result from lapses or cancellations of existing policies which are not offset by the Company's acquisition or generation of new business. To the extent that the Company's efforts to increase the sales and marketing of its existing products do not offset future policy lapses or cancellations, renewal premiums will continue to decline over time.\nNet Investment Income. Net investment income increased $200,000, or 5.1%, from $3.9 million to $4.1 million due primarily to additional investment assets received in connection with the acquisition of Medicare Supplement Products from AII in September 1992 and from LHI in March 1993. This increase was offset, in part, by a decrease in the Company's average annual yield on investments from 8.5% to 7.4%.\nFee and Service Income. Fee and service income increased $5,000, or less than 1.0%, to remain at $1.4 million.\nNet Realized Gain on Investments. Net realized gain on investments increased $578,000, or 137.0%, from $422,000 to $1.0 million. This increase was due primarily to premium amounts received upon the redemption of bonds prior to their scheduled maturities. These redemptions resulted generally from the low interest rate environment during 1993.\nOther Income. Other income decreased $143,000, or 91.1%, from $157,000 to $14,000. This decrease, which represents a return to historical nominal levels, reflects the one-time gain of $133,000 recorded on the sale of a portion of the Company's life insurance business in 1992.\nBenefits and Claims. Benefits and claims increased $6.7 million, or 25.3%, from $26.5 million to $33.2 million. This increase was due primarily to an increase of $9.8 million, or 309.4%, in benefits and claims on the Medicare Supplement Products acquired from AII in September 1992, and benefits and claims of $1.3 million on the Medicare Supplement Products acquired from LHI in March 1993. This increase was offset, in part, by a decrease of $2.5 million, or 26.4%, for LifeStyles Products, a decrease of $886,000, or 11.5%, for Cancer and Specified Disease Products and a decrease of $1.0 million, or 18.2%, for pre-1987 Medical Expense Products.\nAmortization of DPAC. Amortization of DPAC decreased $300,000, or 3.5%, from $8.5 million to $8.2 million due primarily to a decrease for Cancer and Specified Disease Products of $486,000, or 16.4%, and a combined decrease for most of the Company's other product lines totaling $390,000. These decreases were offset, in part, by an increase for the Medicare Supplement Products acquired from AII in September 1992 of $583,000, or 111.0%, from $525,000 to $1.1 million.\nCommissions. Commissions increased $1.2 million, or 14.3%, from $8.4 million to $9.6 million. This increase was due primarily to an increase of $2.4 million, or 224.7%, in commissions paid on acquired policies, and a decrease of $505,000 in the consolidation elimination of commissions paid to LifeStyles Marketing by NFL. These changes were offset, in part, by a decrease of $1.7 million, or 13.8%, in other commissions (excluding commissions on policies acquired in acquisitions).\nThe increase in commissions paid on acquired policies resulted from an increase of $2.3 million, or 211.6%, in commissions paid on the Medicare Supplement Products acquired from AII in September 1992 and $139,000 in commissions paid on the Medicare Supplement Products acquired from LHI in March 1993.\nThe decrease in other commissions (excluding commissions on policies acquired in acquisitions) resulted from a decrease of $549,000, or 16.3%, in commissions paid by LifeStyles Marketing and a decrease of $1.1 million, or 12.9%, in other commissions paid by NFL (excluding commissions paid to LifeStyles Marketing).\nGeneral and Administrative Expenses. General and administrative expenses increased $1.6 million, or 12.6%, from $12.7 million to $14.3 million due primarily to an increase of $1.0 million, or 9.9%, for the general and administrative expenses of NFL, and an increase for LifeStyles Marketing of $451,000, or 17.1%. The increase for NFL resulted from the Medicare Supplement Products acquired from AII in September 1992. The increase for LifeStyles Marketing is attributable to expenses relating to expanded marketing efforts.\nTaxes, Licenses and Fees. Taxes, licenses and fees increased $600,000, or 28.6%, from $2.1 million to $2.7 million due primarily to additional premium taxes paid on increased premiums.\nInterest Expense. Interest expense increased $100,000, or less than 4.0%, from $2.5 million to $2.6 million.\nProvision for Income Taxes. The provision for income taxes increased $1.1 million, or 206.8%, from $532,000 to $1.6 million due to the increase in the pre-tax results of operations. Contributing to this increase was an increase in operating income and the adoption of SFAS 109 as of the beginning of 1992.\nLIQUIDITY, CAPITAL RESOURCES, AND STATUTORY CAPITAL AND SURPLUS\nWestbridge\nWestbridge is a holding company which conducts its principal operations through its Insurance Subsidiaries. Westbridge's primary assets consist of the outstanding capital stock of NFL and NFIC, of which it is the sole stockholder. NFL owns 100% of WNL and also owns a 40.0% interest in Freedom Holding. AICT is a wholly-owned subsidiary of NFIC. Westbridge's primary sources of funds are dividends from its Insurance Subsidiaries, advances due or dividends from non-insurance subsidiaries, principal and interest payments on a surplus certificate issued by NFL to Westbridge, lease payments on fixed assets, tax contributions under a tax sharing agreement among Westbridge and its subsidiaries, and receipt of principal and interest payments due on the Elkins' note (as defined below). During the year ended December 31, 1995, Westbridge received approximately $3.3 million, or 93.3%, of its funds (excluding proceeds from the issuance of securities) from its subsidiaries. Of the funds received from its subsidiaries, approximately $1.0 million, or 30.8%, was received from the insurance subsidiaries in the form of lease payments on fixed assets, payments of principal and interest on the surplus certificate issued by NFL and payments under a tax sharing agreement, and the remaining $2.3 million, or 69.2%, was received from LifeStyles Marketing and Senior Benefits in the form of repayments of advances from Westbridge. Westbridge's expenses and other obligations consist primarily of $2.2 million in annual interest payments on the Senior Subordinated Notes, $1.7 million in annual dividends on the Series A Preferred Stock, working capital requirements for its marketing subsidiaries and taxes. For the year ended December 31, 1995, Westbridge's cash requirements (exclusive of amounts paid in connection with the sale of the Common Stock and Senior Subordinated Notes) aggregated approximately $6.1 million. Westbridge used a substantial portion of the proceeds from the sale of the Common Stock and Senior Subordinated Notes to redeem the Senior Subordinated Debentures in March 1995. The Senior Subordinated Notes mature in March 2002 and the Series A Preferred Stock is subject to mandatory redemption in April 2004.\nDividend payments from Westbridge's principal Insurance Subsidiaries are regulated by the insurance laws of their domiciliary states. NFL is domiciled in Delaware. Under the Delaware Insurance Code, an insurer domiciled in Delaware may not declare or pay a dividend or other distribution from any source other than \"earned surplus\" without the state insurance commissioner's prior approval. \"Earned surplus\" is defined as an amount equal to the unassigned funds of an insurer as set forth on its most recent statutory annual statement, including all or part of the surplus arising from unrealized capital gains or revaluation of assets. WNL, which is domiciled in Arizona, has not contributed in the past, and is not expected to contribute in the foreseeable future, significant dividends to Westbridge. NFIC and AICT are domiciled in Texas. An insurer domiciled in Texas may pay dividends only out of \"surplus profits arising from its business.\" Moreover, insurers domiciled in either Delaware or Texas may not pay \"extraordinary dividends\" without first providing the state insurance commissioner with 30-days prior notice, during which time such commissioner may disapprove the payment. An \"extraordinary dividend\" is defined as a dividend whose fair market value together with that of other dividends made within the preceding twelve months exceeds the greater of (a) ten percent of the insurer's surplus as regards policyholders as of the preceding December 31 or (b) the net gain from operations of such insurer, not including realized capital gains, for the twelve-month period ending on the preceding December 31. In September 1994, NFL paid to Westbridge an \"extraordinary dividend\" in the amount of $2.0 million. The Company does not believe that receipt of this dividend is an indication of, and the Company is not in a position to assess, the likelihood of obtaining approval for the payment of \"extraordinary dividends\" or dividends from a source other than \"earned surplus.\" With respect to ordinary dividends payable by an insurer domiciled in Delaware, notice of any dividend must be provided to the state insurance commissioner within five business days following the declaration thereof and at least ten days prior to the payment thereof. As of December 31, 1995, NFL had negative statutory \"earned surplus\" as a result of historical statutory losses. For the foreseeable future, NFL has agreed to seek the approval of the Delaware insurance commissioner prior to making any dividend payments. As of December 31, 1995, AICT had the ability to pay to NFIC, without prior regulatory approval, $835,000 in dividends during 1996, none of which has been paid. As of December 31, 1995, NFIC had the ability to pay to Westbridge, without prior regulatory approval, $994,000 in dividends during 1996, none of which has been paid. In both Delaware and Texas, the state insurance commissioner reviews the dividends paid by each insurer domiciled in such commissioner's state at least once each year to determine whether they are reasonable in relation to the insurer's surplus as regards policyholders and quality of earnings. The state insurance commissioner may issue an order to limit or disallow the payment of ordinary dividends if such commissioner finds the insurer to be presently or potentially financially distressed or troubled.\nWestbridge periodically advances cash to its subsidiaries as their continuing operations require and, as of December 31, 1995, such advances due from subsidiaries totaled $4.8 million. Westbridge also holds a receivable from the surplus certificate issued by NFL which, as of December 31, 1995, totaled $777,000. Payments of principal due under the surplus certificate require the prior approval of the Delaware regulatory authorities. In addition, Westbridge holds a secured promissory note (the \"Elkins Note\") from NFC Marketing, Inc., an Arkansas corporation which is wholly-owned by Elkins. The balance of this note recorded on the books of Westbridge at December 31, 1995 was approximately $860,000. This note, which was renegotiated in October 1994, represents principal and accrued interest on a loan made by Westbridge to NFC Marketing, Inc. for the purpose of expanding its marketing efforts. The original loan was scheduled to be repaid in April 1993. However, due to certain financial difficulties, NFC Marketing, Inc., was in arrears on the full amount of this note and, as of October 10, 1994, owed Westbridge approximately $1.2 million. On such date, the Elkins Note was renewed and extended with terms which provide, among other things, for the payment to Westbridge of $20,000 per month until such time as the full amount of principal and interest thereunder has been paid. Under the terms of the Elkins Note, such amounts will be paid to Westbridge by NFL out of monthly commissions which would otherwise be payable to NFC Marketing, Inc., by NFL. Payment of principal and interest under the Elkins Note has been guaranteed by Elkins. In addition, under the terms of a Security Agreement delivered to Westbridge by NFC Marketing, Inc., following a default, Westbridge has the right to apply monies, balances, credits or collections which it may hold for NFC Marketing, Inc. on deposit, or which might otherwise be payable to NFC Marketing, Inc., by NFL (including, among other things, agents' commissions payable by NFL to NFC Marketing, Inc.), to offset the unpaid balance of the Elkins Note. Amounts available for such offset have averaged approximately $150,000 per month over the past twelve months and consist exclusively of commissions. Such commissions relate to and are paid by NFL out of premiums it receives from policyholders on previously written policies. Subject to policy lapses or cancellations, these premiums will continue to be received by NFL and commissions thereon will be available for offset by Westbridge whether or not Elkins' relationship with the Company continues. Following any exercise by Westbridge of its right of offset, management believes that the level of lapses and cancellations would gradually increase as a result of agents' efforts to transfer the policies to other insurers. However, management also believes that the rate at which such policies could be rewritten would not significantly affect the level of premiums received by NFL in the near term. As a result, management believes that following any future payment default Westbridge should be able to recover the full amount owed on this note. Westbridge does not know of, nor does it have any reason to believe that there is, any other of its general agency networks which is experiencing financial difficulty.\nWestbridge believes that its near-term cash requirements, including interest on the Senior Subordinated Notes and dividend payments on the Series A Preferred Stock, will be met through operating cash flows, repayments of advances due from subsidiaries, payments relating to the surplus certificate and dividends received from the Insurance Subsidiaries.\nInsurance Subsidiaries\nThe primary sources of cash for the Insurance Subsidiaries are premiums, income on investment assets and fee and service income. Additional cash is periodically provided from the sale of short-term investment assets and could, if necessary, be provided through the sale of long-term investment assets. However, the Company's investment policy is to hold its long-term securities to maturity. The Insurance Subsidiaries' primary uses for cash are benefits and claims, commissions, general and administrative expenses and taxes.\nIn the ordinary course of business, the Company advances first-year commissions on policies written by its general agency networks and their agents. The Company is reimbursed for these advances from commissions earned over the respective policy's life. In the event that policies lapse prior to the time the Company has been fully reimbursed, the agency network or the individual agents, as the case may be, are responsible for reimbursing the Company for the outstanding balance of the commission advance. There can be no assurance as to the occurrence or degree of any future losses. As of December 30, 1995, outstanding advances totaled $16.7 million.\nConsolidated\nThe Company's consolidated net cash used for operations totaled $21.3 million, $10.6 million, and $7.2 million in 1995, 1994 and 1993, respectively. The increase in 1995 resulted from increases to deferred policy acquisition costs and receivables from agents resulting from substantial increases in production of new business during 1995. The primary reasons for the increase in cash used for operations during 1994 and 1993 are increases to deferred policy acquisition costs and an increase in paid claims associated with the Medicare Supplement Products acquired in September 1992 and March 1993, the policies acquired from DNL in February 1994 and the policies obtained in the Acquisition. These increases have been offset, in part, by increases in collected premiums and a decrease in commissions paid.\nNet cash used for operations has been impacted by the Company's significant acquisitions of closed blocks of policies since September 1992. These acquisitions involve the transfer to the Company of cash or other investment assets and the assumption by the Company of policy liabilities. While the benefits and claims paid on the policies assumed are reflected directly in the statement of cash flows, the initial receipt of cash and\/or investment assets is reflected supplementally on the statement of cash flows through a schedule of non-cash investing activities. As a result, as the investment assets mature or are liquidated, and cash is paid out in the form of benefits and claims, the effect on the Company's statement of cash flows is an increase in net cash used. Such negative operating cash flows are planned, and are an inherent part of acquisitions of closed blocks of business. A review of operating cash flows should be considered in conjunction with the supplemental schedule of non-cash investing activities.\nNet cash provided by investing activities totaled $386,000 in 1995 and $5.4 million in 1993, compared to net cash used for investing activities of $11.5 million in 1994. The significant amount of net cash used in 1994 resulted primarily from the purchase of the common stock of NFIC in the Acquisition. For 1993, net cash provided by investing activities was principally the result of the excess of proceeds from investments sold and matured over the cost of investments acquired.\nNet cash provided by financing activities was $20.0 million, $24.9 million, and $34,000 for the years ended December 1995, 1994, and 1993, respectively. In February 1995, $29.3 million of cash was provided by the public sale of Common Stock and Senior Subordinated Notes. In December, 1995, $14.9 million of cash was provided by borrowing under a credit agreement with a bank, and approximately $1.0 million of cash was provided by the issuance of a senior note. See further discussion of these financing activities in NOTE 7 of \"Notes to the Consolidated Financial Statements\" therein. Also, in March 1995, $25.0 million in cash was used to redeem the Senior Subordinated Debentures. In the first six months of 1994, $20.0 million in cash was provided in the sale of the Series A Preferred Stock and the sale by NFL, to a non-affiliated party, of $5,000,000 principal amount of Senior Subordinated Debentures, which had previously been held by NFL in its investment portfolio. There were no significant financing activities during the year ended December 31, 1993.\nThe Company believes that its near-term cash requirements will be met through a combination of operating and investing cash flows. The Company anticipates that its longer-term cash requirements for the operation of the business will also be met through a combination of operating and investing cash flows. Additional capital may be necessary for future growth, whether internal or through acquisitions. There can be no assurance that such additional capital will be obtained, that opportunities for future acquisitions will arise or that additional capital to consummate such acquisitions will be available.\nThe Company had no significant high-yield, unrated or less than investment grade fixed maturity securities in its investment portfolio as of December 31, 1995 and it is the Company's policy not to exceed more than 5% of total investments in such assets. Changes in interest rates may affect the market value of the Company's investment portfolio. Absent redemptions of such investments prior to maturity, or loss experience materially in excess of, or at times materially sooner than expected, such changes should not impact the Company's ability to meet its future policyholder benefit obligations.\nIncluded in the assets of the Company at December 31, 1995 were $639,000 of real estate mortgage loans and $141,000 of real estate acquired through foreclosure. Approximately 98.0% of these assets are located in Oklahoma and Texas. Such regional concentration may have a higher investment risk than a more diversified portfolio. It is the Company's policy not to invest in such assets and, accordingly, the Company has made no mortgage loans or real estate purchases since 1989.\nInflation may affect, to a limited extent, claim costs on the Company's Medicare Supplement Products and Medical Expense Products. Costs associated with a hospital stay, and the amounts reimbursed by the Medicare program, are each determined, in part, based on the rate of inflation. If hospital and other medical costs which are reimbursed by the Medicare program increase, claim costs on the Medicare Supplement Products will increase. Similarly, as the hospital and other medical costs increase, claim costs on the Medical Expense Products will increase. However, with the approval of the relevant state regulatory authority, the Company has the ability, within the constraints of the loss ratios mandated by the regulatory authorities, to raise premium rates on its guaranteed renewable products in the event of adverse claims experience. In addition, the Company has limited its exposure to inflation by incorporating certain maximum benefits under its policies. See \"BUSINESS--PRODUCTS.\"\nThe NAIC has proposed certain risk-based capital (\"RBC\") statutory requirements for insurance companies. Under the proposed requirements, insurers whose capital and surplus fall below the specified level would be subject to remedial action. The proposed guidelines do not take effect until adopted on a state by state basis. Delaware has and Texas has not yet adopted such proposals. As of December 31, 1995, the RBC for each of the Insurance Subsidiaries exceeded the proposed threshold for required regulatory intervention. See \"BUSINESS--REGULATION.\"\nDuring 1995, the Company experienced rapid growth in product sales and first-year premium revenues. Such growth tends to produce cash flow strain, and statutory surplus strain for the Company's Insurance Subsidiaries. The Company could ease these strains by limiting marketing activities, by seeking additional equity or debt financing, or through reinsurance. No assurance can be given that the Company will be able to obtain additional financing or reinsurance, and if necessary, the Company will limit marketing operations as a means of reducing strain to cash flow and statutory surplus.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nIndex to Financial Statements and Financial Statement Schedules Covered by the Following Report of Independent Accountants.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo The Board of Directors and Stockholders of Westbridge Capital Corp.\nIn our opinion, the consolidated financial statements listed in the index appearing on page 42 of this Form 10-K present fairly, in all material respects, the financial position of Westbridge Capital Corp. and its subsidiaries at December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995, 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.\n\/s\/ Price Waterhouse, LLP\nPRICE WATERHOUSE LLP Fort Worth, Texas March 29, 1996\nWESTBRIDGE CAPITAL CORP. ------------------------------ CONSOLIDATED BALANCE SHEETS --------------------------------- (In thousands)\nWESTBRIDGE CAPITAL CORP. CONSOLIDATED BALANCE SHEETS (In thousands, except share data)\nLIABILITIES, REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY\nWESTBRIDGE CAPITAL CORP. CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except share data)\nWESTBRIDGE CAPITAL CORP. CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)\nWESTBRIDGE CAPITAL CORP. CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)\nSupplemental Schedule Of Non-Cash Investing Activities:\nThe Company purchased the outstanding capital stock of a health insurer and its subsidiary in the second quarter of 1994 for a cash purchase price of $20.1 million. This purchase resulted in the Company receiving assets and assuming liabilities as follows:\nAssets $61,293,000 Liabilities $72,199,000\nThe Company purchased a block of Supplemental Health insurance in the first quarter of 1994. This purchase resulted in the Company disbursing investments and assuming liabilities as follows:\nInvestments $ 545,000 Policy liabilities $ 2,626,000\nThe Company purchased a Medicare Supplement block of business in the first quarter of 1993. This purchase resulted in the Company receiving investments and assuming liabilities as follows:\nInvestments $ 2,526,000 Policy liabilities $ 2,445,000\nThe accompanying notes are an integral part of these financial statements.\nWESTBRIDGE CAPITAL CORP. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (In thousands, except share data)\nWESTBRIDGE CAPITAL CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND OTHER MATTERS\nPrinciples of Consolidation. The consolidated financial statements include accounts of Westbridge Capital Corp. (\"the Company\"), and its wholly-owned subsidiaries, National Foundation Life Insurance Company (\"NFL\"), National Financial Insurance Company (\"NFIC\"), American Insurance Company of Texas (\"AICT\"), Foundation Financial Services, Inc. (\"FFS\"), Westbridge Marketing Corporation (\"WMC\"), Westbridge Financial Corp. (\"Westbridge Financial\"), Westbridge Printing Services, Inc. (\"WPS\"), Precision Dialing Services, Inc. (\"PDS\") Westbridge National Life Insurance Company (\"WNL\"), Flex-Plan Systems, Inc. (\"FPS\"), and Westbridge Funding Corporation (\"WFC\"), (formerly known as National Legal Services Company, Inc.), as well as its 51%-owned subsidiary, LifeStyles Marketing Group, Inc. (\"LifeStyles Marketing\"), and its 50%-owned subsidiaries, Senior Benefits, LLC (\"Senior Benefits\"), American Senior Security Plans, LLC (\"ASSP\"), and Health Care-One Insurance Agency, Inc. (\"Health Care-One\"). The Company's decision to consolidate the accounts of Senior Benefits, ASSP, and Health Care-One, is based on the extent to which the Company exercises control over Senior Benefits, ASSP and Health Care-One. The Company has agreed to provide 100% of the financing required to support the marketing efforts of Senior Benefits, ASSP, and Health Care-One, and also has significant input in their management. All significant intercompany accounts and transactions have been eliminated.\nNature of Operations. The Company, through its subsidiaries and affiliates, principally underwrites and sells specialized health insurance products and health plans. The company's major product lines are Cancer and Specified Disease Products, Medical Expense Products and Medicare Supplement Products.\nAccounting Principles and Regulatory Matters. The consolidated financial statements have been prepared in accordance with generally accepted accounting principles (\"GAAP\"). These principles differ from statutory accounting principles, which must be used by the Company's Insurance Subsidiaries when reporting to state insurance departments. The Company's Insurance Subsidiaries are subject to oversight by insurance regulators of Delaware, Texas and other states in which they are authorized to conduct business. These regulators perform triennial examinations of the statutory financial statements and, as a result, may propose adjustment to such statements.\nInvestments. In 1994, the Company's fixed maturity portfolio was segregated into two components: fixed maturities held-to-maturity and fixed maturities available-for-sale. During 1995, the Company's held-to-maturity portfolio was reclassified as available-for-sale; therefore, fixed maturities available-for-sale are carried at market value. Changes in aggregate unrealized appreciation or depreciation on fixed maturities available for sale are reported directly in stockholders' equity, net of applicable deferred income taxes. Equity securities (common and nonredeemable preferred stocks) are carried at market value. The Company's 40% equity investment in Freedom Holding Company is accounted for on the equity basis (i.e., cost adjusted for equity in post-acquisition earnings and amortization of excess cost). Mortgage loans on real estate and policy loans are carried at the unpaid principal balance. Accrual of interest income ceases when loans are ninety days or more past due. Foreclosed assets are carried at the lower of fair value or unpaid principal balance, less necessary costs to effect foreclosure. Realized gains and losses on sales of investments are recognized in current operations on the specific identification basis. Changes in market values of equity securities, after deferred income tax effects, are reflected as unrealized appreciation or depreciation directly in stockholders' equity and, accordingly, have no effect on current operations. Deferred Policy Acquisition Costs. Policy acquisition costs consisting of commissions and other costs, which vary with and are primarily related to the production of new business, are deferred and amortized over periods not to exceed the estimated premium-paying periods of the related policies. Also included in deferred policy acquisition costs is the cost of insurance purchased on acquired business. Amortization is dynamically adjusted based on current and projected future levels of premium revenue. Such projected future levels of premium revenue are estimated using assumptions as to interest, mortality, morbidity and withdrawals consistent with those used in calculating liabilities for future policy benefits.\nLeasehold Improvements and Equipment. Leasehold improvements and equipment are stated at cost less accumulated depreciation and amortization. Depreciation of equipment is computed using the straight-line method over the estimated useful lives (three to seven years) of the assets. Leasehold improvements are amortized over the estimated useful lives of the related assets or the period of the lease, whichever is shorter. Maintenance and repairs are expensed as incurred and renewals and betterments are capitalized.\nFuture Policy Benefits and Claims. Liabilities for future policy benefits not yet incurred are computed primarily using the net level premium method including actuarial assumptions as to investment yield, mortality, morbidity and withdrawals.\nClaims represent the estimated liabilities on claims reported plus claims incurred but not yet reported. These liabilities are necessarily subject to the impact of future changes in claim experience and, as adjustments become necessary, they are reflected in current operations.\nRecognition of Revenue. Life insurance and accident and health premiums are recognized as revenue when received. Benefits and expenses are associated with related premiums so as to result in a proper matching of revenue with expenses.\nFee and service income and investment income are recognized when earned.\nUse of Estimates. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nIncome Taxes. The Company records income taxes based on the asset and liability approach. The asset and liaility approach requires the recognition of deferred tax liabilities and assets for the expected future tax consequence of temporary differences between the carrying amounts and the tax basis of assets and liabilities.\nEarnings Per Share. Primary net income per share of Common Stock is determined by dividing net income, less dividends on the Series A Preferred Stock, by primary weighted-average shares outstanding. Fully diluted net income per share is computed through dividing net income by fully diluted weighted average shares outstanding, which assumes conversion of the Series A Preferred Stock. At the December 31, 1994, the Series A Preferred Stock was convertible at $8.75 per share, resulting in 2,285,720 additional shares. The additional average shares outstanding were measured from the April 12, 1994 issue date, through December 31, 1994. At December 31, 1995, as a result of the February 28, 1995 common stock issuance, the conversion price was adjusted to $8.41 per share resulting in 2,378,120 additional shares.\nNew Accounting Pronouncements. During 1995, the Financial Accounting Standards Board (\"FASB\") issued Financial Accounting Standards (\"FAS\") No. 121, \"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of\". This statement requires that long-lived assets and certain identifiable intangibles to be held and used by an entity be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In addition, the statement requires that long-lived assets and certain identifiable intangibles to be disposed of, be reported at the lower of carrying amount of fair value less cost to sell.\nFAS No. 121 is effective for fiscal years beginning after 1995. The Company plans to adopt FAS No. 121 effective January 1, 1996. Management does not anticipate that adoption of this standard will have a material impact on the Company's financial statements.\nDuring 1995, the FASB also issued FAS No. 123 \"Accounting for Stock-Based Compensation\", which encourages companies to adopt the fair value based method of accounting for stock-based compensation. This method requires the recognition of compensation expense equal to the fair value of such equity securities at the date of the grant. This statement also allows companies to continue to account for stock-based compensation under the intrinsic value based method, as prescribed by Accounting Principles Board Opinion No. 25 \"Accounting for Stock Issued to Employees\", with footnote disclosure of the pro-forma effects of the fair value based method. The Company plans to adopt SFAS No. 123 during 1996 by continuing to account for stock-based compensation under the intrinsic value method and disclosing the pro-forma effects of the fair value method in the footnotes to the financial statements.\nNOTE 2 - INVESTMENTS\nMajor categories of investment income are summarized as follows:\nRealized gains (losses) on investments are summarized as follows:\nUnrealized appreciation (depreciation) on investments reflected directly in stockholders' equity is summarized as follows:\nEffective January 1, 1994, the Company adopted Statement of Financial Accounting Standard No. 115 \"Accounting for Certain Investments in Debt and Equity Securities\" (the \"Statement\"). This Statement requires all debt securities and certain equity securities to be classified in three categories and accounted for as follows:\n* Debt securities that the enterprise has the positive intent and ability to hold to maturity are classified as held-to-maturity securities and reported at amortized cost.\n* 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.\n* 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 in a separate component of stockholders' equity.\nThe Company does not engage in \"trading\" of securities, and accordingly, all of the applicable investments have been categorized as held-to-maturity securities or as available-for-sale securities at December 31, 1994 and as available-for-sale securities at December 31, 1995.\nIn accordance with the Statement, the cumulative effect of recording to a separate component of stockholders' equity the difference between market value and amortized cost at January 1, 1994 of securities classified as available-for-sale has been treated as a change in accounting principle, and no restatement of prior year financial statements has been made. Additionally, in accordance with the statement, all investments categorized as held-to-maturity, were transferred to the available-for-sale category at December 31, 1995.\nMarket values represent the closing sales prices of marketable securities. Estimated fair values are based on the credit quality and duration of marketable securities deemed comparable by the company, which may be of another issuer.\nThe amortized cost and estimated market values of investments in fixed maturities as of December 31, 1995 and 1994, are summarized by category as follows (in thousands):\nThe amortized cost and estimated market value of investments in available-for-sale fixed maturities as of December 31, 1995, are shown below, in thousands, summarized by year to maturity. Mortgage-backed securities are listed separately. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.\nEstimated Amortized Market Cost Value ------- -------- Due in one year or less $ 3,441 $ 3,441 Due after one year through five years 23,078 23,380 Due after five years through ten years 18,730 19,987 Due after ten years 27,155 28,897 Mortgage-backed securities 10,756 11,075 ------- ------- $83,160 $86,780 ======= =======\nA summary of unrealized appreciation (depreciation) reflected directly in stockholders' equity at December 31, 1995 and 1994, on investments in fixed maturities available-for-sale, is as follows (in thousands):\nYear Ended December 31, ------------------------------------- 1995 1994 ------------ ------------- Amortized cost $83,160 $11,310 Estimated market value 86,780 10,787 ------- ------ Excess (deficit) of market value to amortized cost 3,620 (523) Estimated tax 1,231 (178) ------- ------ Unrealized appreciation (depreciation), net of tax $ 2,389 $ (345) ======= ======\nA summary of unrealized appreciation (depreciation) on investments in fixed maturities held-to-maturity, is as follows (in thousands):\nYear Ended December 31, --------------------------------------- 1994 1993 -------- -------- Amortized cost $80,377 $49,737 Estimated Market Value 75,238 51,806 ------ ------ Unrealized appreciation (depreciation) $ (5,139) $ 2,069 ====== ======\nProceeds from sales of investments in fixed maturity securities were $9,682,000 in 1995 and $13,176,000 in 1994. Gross gains of $255,000 and gross losses of $73,000 were realized on 1995 sales. Gross gains of $372,000 and gross losses of $52,000 were realized on 1994 sales.\nIncluded in fixed maturities at December 31, 1995, are two high-yield, unrated or less than investment grade corporate debt securities. The Company's investment in the two securities comprises 0.7% of total cash and invested assets at December 31, 1995. The Company owned one high-yield, unrated or less than investment grade corporate debt security at December 31, 1994. The Company's investment in this security comprised 0.1% of total cash and invested assets at December 31, 1994.\nSecurities on deposit with insurance regulators in accordance with statutory requirements at December 31, 1995 and 1994 aggregated $19,920,000 and $19,820,000, respectively.\nNOTE 3 - ACQUISITIONS\nAcquisition of NFIC and AICT\nOn April 12, 1994, Westbridge consummated the acquisition (the \"Acquisition\") of all of the outstanding capital stock of NFIC and its wholly-owned subsidiary AICT. NFIC and AICT are health insurers which ceased marketing operations in the past, and currently administer closed blocks of health insurance policies. During the latter part of 1994, NFIC and AICT renewed marketing operations. The purchase price for the Acquisition approximated $20,100,000, which was paid in cash. The Acquisition has been accounted for under the purchase method and, accordingly, the operating results of NFIC and AICT have been included in the consolidated operating results since the date of acquisition.\nDuring 1995, the Company revised the assumptions used in calculating the future policy benefit and claims liabilities for NFIC and AICT. These changes resulted in a net purchase accounting adjustment of approximately $13.4 million.\nThe funds used to acquire NFIC and AICT were provided by the issuance of Series A Preferred Stock (see NOTE 9).\nThe following summary, prepared on a pro-forma basis, combines the consolidated results of operations of NFIC and AICT with the operations of the Company, after including the impact of certain adjustments, such as amortization of deferred acquisition costs, dividends on the Series A Preferred Stock, and factually supportable expense reductions resulting from the consolidation of administrative operations, which will have a continuing impact. The following results assume the acquisition occurred as of the beginning of the respective periods.\nPRO-FORMA FINANCIAL DATA (Unaudited) (In thousands, except share data) Year Ended December 31, -------------------------------- 1994 1993 --------- ----------- Total Revenues $115,466 $116,446 Income applicable to common stockholders 5,483 5,149 Net income per common share Primary $1.19 $1.13 Fully diluted $1.03 $0.99\nThe pro-forma financial information is presented for informational purposes only, and is not necessarily indicative of what actually would have occurred if the acquisition had been in effect for the entire periods presented. In addition, the pro forma financial information is not intended to be a projection of future results.\nAcquisition of a Block of Cancer and Specified Disease Insurance Business\nOn February 8, 1994, NFL completed its purchase of a block of Cancer and Specified Disease Insurance from Dixie National Life Insurance Company. The purchase price for the block was $2,125,000. This acquisition has been accounted for using the purchase method of accounting.\nAcquisition of Medicare Supplement Business\nOn March 29, 1993, NFL completed its purchase of a block of Medicare Supplement policies from Life and Health Insurance Company of America (\"LHI\"). Under the terms of the purchase, LHI transferred to NFL $2,526,000 in cash and NFL assumed the risks associated with those policies. The Company accounted for this transaction using the purchase method of accounting.\nNOTE 4 - INVESTMENT IN FREEDOM HOLDING COMPANY\nIn November 1988, the Company purchased a 40% equity interest in Freedom Holding Company of Louisville, Kentucky (\"Freedom\"). Freedom owns 100% of Freedom Life Insurance Company of America (\"FLICA\"), a Mississippi insurer licensed in 34 states and specializing in the sale of Cancer and Specified Disease Insurance products. Freedom's 60% principal owner is John P. Locke. Concurrent with the equity purchase in Freedom, Locke and his insurance marketing agencies also entered into a 10-year marketing agreement with FLICA and NFL for the sale of their products on an exclusive basis. Additionally, FLICA and NFL consummated a 10-year coinsurance agreement under which NFL or its affiliates will receive 50% of all insurance business written by FLICA.\nThe purchase price for the equity ownership in Freedom aggregated $4,200,000. The Company also made loans to Locke and Freedom in the amount of $2,400,000 and $1,086,000 respectively. The loans were each in the form of 10-year, 11.70% notes. Concurrent with the purchase, Locke made a $2,400,000 capital contribution to Freedom. This capital contribution together with the Company's loan to Freedom and $1,600,000 of the purchase price proceeds were utilized by Freedom to retire all of its then existing debt obligations. During 1994, both notes were repaid in full.\nThe Company utilizes the equity method of accounting for its 40% equity interest in Freedom. The Company's portion of Freedom's earnings was $348,000 in 1995, $345,000 in 1994 and $333,000 in 1993. The Company received a $120,000 dividend in 1995 from Freedom.\nNOTE 5 - MARKETING OPERATIONS\nLifeStyles Marketing Group, Inc. Joint Venture\nIn September 1987, NFL consummated an agency contract with LifeStyles Agency of Arlington, Texas (\"LifeStyles Marketing\") granting its agency force the exclusive right, subject to territorial production requirements, to sell NFL's Medical Expense Products developed in 1987 and 1988. During the second quarter of 1988, the Company agreed with the owners of LifeStyles Marketing to restructure the insurance agency as a joint venture. Under the terms of the definitive agreement consummated in November 1988, WMC, a wholly-owned subsidiary of the Company, holds a 51%-voting interest in the entity, LifeStyles Marketing.\nThe Company is providing financing to LifeStyles Marketing in its expansion efforts. LifeStyles Marketing's revenues and expenses during 1995 approximated $9,115,000 and $8,397,000, respectively. Revenues and expenses were $7,246,000 and $7,130,000 in 1994 and $5,395,000 and $6,014,000 in 1993, respectively. Of the revenues received, $7,664,000 were derived from NFL in the form of commission income on insurance products sold for NFL during 1995, $5,561,000 in 1994 and $4,386,000 in 1993. Through December 31, 1995, the Company loaned LifeStyles Marketing approximately $7,127,000 in the form of advances which accrue interest at prime plus 1% established at the beginning of each year, which equaled 8.5% during the year ended December 31, 1995, on the unpaid balance. There is not a scheduled repay-ment plan in place for amounts the Company has loaned to LifeStyles Marketing. No dividends are to be distributed to any shareholders until all advances and accrued interest due the Company have been repaid.\nUnder the terms of the joint venture agreement, profits and losses of LifeStyles Marketing are to be allocated 50% to WMC and 50% to the minority shareholders. However, because of the Company's voting and financial control, the operations of the joint venture are consolidated with the Company's operations and, accordingly, all significant intercompany accounts and transactions are eliminated.\nThrough December 31, 1995, the Company has recognized 100% of the cumulative losses of LifeStyles Marketing in its consolidated financial statements. The minority interest share in such losses recognized by the Company is $840,000 at December 31, 1995. The Company has, and will continue to, recognize 100% of LifeStyles Marketing's profits in the consolidated financial statements until all cumulative losses are recovered through future earnings.\nSenior Benefits, LLC\nIn November 1993, the Company acquired a 50% interest in Senior Benefits, which markets Medicare Supplement policies for NFL. The Company is providing financing to Senior Benefits during the start-up phase of the operations. Senior Benefits' revenue and expenses were $1,005,000 and $1,105,000 during 1995, and $278,000 and $547,000 during 1994, respectively. Of the revenues received, $982,000 were derived from NFL in the form of commission income on insurance products sold during 1995, and $271,000 in 1994. Through December 31, 1995, the Company loaned Senior Benefits approximately $980,000 in the form of advances. There is not a scheduled repayment plan in place for amounts the Company has loan Senior Benefits. No dividends are to be distributed to any shareholders until all advances due to the Company have been repaid. Through December 31, 1995, the Company has recognized 100% of the cumulative losses of Senior Benefits of which the minority interest share of such losses is approximately $175,000.\nNOTE 6 - FUTURE POLICY BENEFITS\nFuture policy benefits have been calculated using assumptions (which generally contemplate the risk of adverse deviation) for withdrawals, interest, mortality and morbidity appropriate at the time the policies were issued. The more material assumptions pertinent thereto are as follows:\nLIFE PRODUCTS\nWithdrawals Standard industry tables are used for issues through 1975; Company experience is used for issues subsequent to 1975.\nInterest Level 4% for issues through 1965; level 4.5% for 1966 through 1969 issues, and 6% graded to 4.5% in 25 years for 1970 through 1981 issues. Issues for 1982 through 1987 are 10% graded to 7% at year 10. ART issues in 1988 and later are 8.5% for 5 years graded to 7.5% in year 20. Participating policies are 4.5% for issues through 1965; 5% for 1966 through 1969 issues, and graded from 6% to 5% in 25 years for issues subsequent to 1969.\nMortality Based on modifications of the 1955-1960 Select and Ultimate Basic Tables and, for certain issues from 1975 through 1981, modifications of the 1958 CSO. Issues subsequent to 1981 use modifications of the 1965-1970 Select and Ultimate Basic Tables.\nACCIDENT AND HEALTH PRODUCTS\nWithdrawals Issues through 1980 are based on industry experience; 1981 through 1993 issues are based on industry experience and Company experience, where available. Policies acquired in acquisitions are based on recent experience of the blocks acquired.\nInterest Issues through 1980 are 6% graded to 4.5% in 25 years; most 1981 through 1992 issues are 10% graded to 7% in 10 years except for certain NationalCare and Supplemental Hospital Income issues which are 8% graded to 6% in 8 years and LifeStyles Products which are 9% graded to 7% in 10 years. 1993 issues are 7% level. Policies acquired from AII in 1992 are 6.4% level. Policies acquired from LHI in 1993 and DNL in 1994 are 6% level. Policies acquired in the Acquisition of NFIC and AICT are 7% level.\nMortality Issues through 1980 use the 1955-1960 Ultimate Table; issues subsequent to 1980 through 1992 use the 1965-1970 Ultimate Table. 1993 issues use the 1975-1980 Ultimate Table. Policies acquired in acquisitions use the 1965-1970 Ultimate Table.\nMorbidity Based on industry tables published in 1974 by Tillinghast, Nelson and Warren, Inc., as well as other population statistics and morbidity studies.\nNOTE 7 - FINANCING ACTIVITIES\nCommon Stock Offering\nOn February 28, 1995, the Company issued 1,500,000 shares of its Common Stock in an underwritten public offering. The Shares of Common Stock were issued at a price of $7.00 per share, less an underwriting discount of $.42 per share. As a result of the issuance of the Common Stock, the conversion rate of the Series A Preferred Stock has been adjusted. The Series A Preferred Stock is now convervitble into 2,378,120 shares of Common Stock at a conversion price of $8.41 per share.\nSubordinated Notes\nOn February 28, 1995, the Company issued $20,000,000 aggregate principal amount of its 11% Senior Subordinated Notes due 2002 (the \"Notes\"), in an underwritten public offering. The Notes were issued at par, less an underwriting discount of 4%.\nThe Company may redeem the Notes at any time on or after March 1, 1998, upon 30-days written notice, at par plus accrued interest. Following the death of any holder of the Notes and the request for repayment, the Company will repay such holder's Notes at par plus accrued interest. The Company is not obligated to redeem more than $50,000 in principal amount per holder per calendar year or in aggregate for all holders more than $250,000 in principal amount per calendar year. The Notes contain certain covenants which limit the Company's ability to, (i) incur certain types of indebtedness, (ii) pay dividends or make distributions to holders of the Company's equity securities, or (iii) consolidate, merge, or transfer all or substantially all of the Company's assets. The Notes also contain covenants which require the Company to maintain, (i) a minimum amount of liquid assets, (ii) a minimum consolidated net worth, and (iii) a minimum fixed charge ratio.\nSubordinated Debentures\nIn March 1986, the Company completed a public offering of 25,000 Units consisting of $25,000,000 principal amount of 11.70% Senior Subordinated Debentures due 1996 (the \"Debentures\") and warrants to purchase 800,000 shares of the Company's Common Stock (the \"Warrants\") at $12.25 per share. The Warrants expired unexercised on March 15, 1991.\nIn August 1987, NFL purchased, in an open market transaction, $5,000,000 par value of the Debentures. For GAAP reporting purposes, the purchased Debentures were no longer treated as part of the Company's consolidated debt.\nIn February 1994, NFL sold at par value, to an unrelated party, the $5,000,000 par value of the Debentures held in its portfolio. This transaction has been accounted for, on a consolidated basis as an issuance of debt.\nConcurrent with the Common Stock and Note offerings, on February 29, 1995, the Company placed funds in escrow sufficient to cover all remaining principal and interest payments on its outstanding 11.7% Senior Subordinated Debentures due 1996, which were called for redemption on March 30, 1995. The redemption price was par plus accrued interest. This redemption prior to scheduled maturity resulted in a loss from early extinguishment of debt. The loss related to amortization of the remaining original issue discount and write-off of deferred financing costs, offset in part by interest earned on the funds in escrow. This loss is reported as an extraordinary item on the accompanying statement of operations.\nSenior Note\nOn December 22, 1995, the Company issued a $1,000,000 principal amount 10% Senior Note due 2002 (the \"Senior Note\") to the Chairman of the Board of Directors, a related party. The Senior Note was issued at par. In connection with the Senior Note issuance, the Company also issued a common stock purchase Warrant for 135,501 shares of common stock at an exercise price of $7.38 per share.\nInterest payments on the Senior Note prior to the third anniversary of the commencement date are added to the principal amount of the Senior Note. Subsequent to the third anniversary date, interest payments on the accumulated interest and principal are due on a semi-annual basis. The Senior Note may be prepaid in whole or in part without premium or penalty. Following the death of the holder of the Senior Note and request for payment, the Company will repay the Senior Note within one year of notification provided that the Company is, or, after giving effect to such prepayment would not be in default under any Senior Indebtedness.\nCredit Arrangement\nThe Company has a $20,000,000 Credit Agreement (the \"Agreement\") which is secured by receivable balances from insurance agents which expires on December 28, 1997. There is a commitment fee of 1\/2 of 1% on the unused portion. At the Company's option, interest under the Agreement may be based on prime rate or LIBOR plus an applicable margin. The rate in effect at December 31, 1995, was approximately 8.7%. The Company borrowed approximately $14,880,000 under the Agreement at December 31, 1995. The Agreement required the Company, among other things, to maintain minimum levels of statutory surplus, tangible net worth and certain minimum financial ratios. Subsequent to December 31, 1995 the Company made an additional borrowing under the Agreement of approximately $2,200,000.\nNOTE 8 - CLAIM RESERVES\nThe following table provides a reconciliation of the beginning and ending claim reserve balances, on a gross-of-reinsurance basis, for 1995, 1994 and 1993, to the gross amounts reported in the Company's balance sheet.\nNOTE 9 - REDEEMABLE PREFERRED STOCK\nOn April 12, 1994, the Company issued 20,000 shares of Series A Cumulative Convertible Redeemable Exchangeable Preferred Stock (the \"Series A Preferred Stock\"), at a price of $1,000 per share. The Series A Preferred Stock was issued in a private placement, and was subsequently registered with the Securities and Exchange Commission under a registration statement which was declared effective in October 1994. The following summarizes the significant terms of the Series A Preferred Stock:\n* Liquidation preference of $1,000 per share.\n* Cumulative annual dividend rate of 8.25%, subject to increase upon non-compliance by the Company with certain restrictions.\n* At December 31, 1994, the Series A Preferred Stock was convertible by the holders thereof into the Company's common stock at a conversion price of $8.75 per share. At December 31, 1994, the 20,000 shares of Series A Preferred Stock were convertible into 2,285,720 shares of common stock. At December 31, 1995, as a result of the common stock offering, the conversion price was adjusted to $8.41 per share which equates to the Series A Preferred Stock being convertible into 2,378,120 shares of common stock.\n* On or after April 12, 1995, the Series A Preferred Stock may, at the option of the Company, be exchanged for an amount of Convertible Subordinated Notes due April 12, 2004, equal to the aggregate liquidation preference of the Series A Preferred Stock being exchanged. The Convertible Subordinated Notes would bear interest at 8.25% and be convertible into common stock at a price of $8.41 per share, in each case, subject to certain adjustments.\n* The Company is required to redeem all shares of Series A Preferred Stock, or any Convertible Subordinated Notes outstanding on April 12, 2004.\n* The Company may redeem any and all shares of Series A Preferred Stock outstanding on or after April 12, 1997.\nIn connection with the issuance of the Series A Preferred Stock, the placement agent was granted a warrant to purchase 120,000 shares at $8.75 per share, subject to certain adjustments. As a result of the February 28, 1995 Common Stock issuance, the conversion price of the Warrant was adjusted to $8.41 per share.\nNOTE 10 - DEFERRED POLICY ACQUISITION COSTS\nA summary of deferred policy acquisition costs by major product line of insurance follows:\nThe cost of insurance purchased in 1994 is related to the purchase of NFIC and is being amortized in relation to premium revenues over the remaining life of the business. Interest accrues on the unamortized balance at 7% per year. Amortization of this cost of insurance purchased was approximately $2.3 million and $3.0 million in 1995 and 1994, respectively, net of interest accretion of $1.3 million and $1.5 million.\nDuring 1995, the Company recorded Purchase Accounting adjustments to the purchase price of NFIC as these adjustments fell within the one-year \"look-back\" period following the acquisition, in accordance with Statement of Financial Accounting Standard No. 38 \"Accounting for Preacquisition Contingencies of Purchased Enterprises.\"\nFor each of the next five years, the estimated amortization of the cost of insurance purchased is 15% to 20% of each years' beginning balance.\nNOTE 11 - INCOME TAXES\nThe provision for income taxes is calculated as the amount of income taxes expected to be payable for the current year plus (or minus) the deferred income tax expense (or benefit) represented by the change in the deferred income tax accounts at the beginning and end of the year. The effect of changes in tax rates and federal income tax laws are reflected in income from continuing operations in the period such changes are enacted.\nThe tax effect of future taxable temporary differences (liabilities) and future deductible temporary differences (assets) are separately calculated and recorded when such differences arise. A valuation allowance, reducing any recognized deferred tax asset, must be recorded if it is determined that it is more likely than not that such deferred tax asset will not be realized.\nThe Company and its wholly-owned subsidiaries, other than NFIC and AICT, file a consolidated federal income tax return. NFIC and AICT file separate federal income tax returns.\nThe provision for U.S. federal income taxes charged to continuing operations was as follows:\nYear Ended December 31, ---------------------- 1995 1994 1993 ----- ------ ------ (In thousands)\nCurrent $1,032 $1,581 $ 321 Deferred 1,781 1,183 1,241 ----- ----- ----- Total provision for income taxes $2,813 $2,764 $1,562 ===== ===== =====\nProvision has not been made for state and foreign income tax expense since such expense is minimal.\nThe differences between the effective tax rate and the amount derived by multiplying the income (loss) before income tax expense by the Federal income tax rate for the Company's last three years follow:\nYear Ended December 31, ----------------------------- 1995 1994 1993 ------- ----- ------ Statutory tax rate 34% 34% 34% Small life insurance company deduction calculated as a percentage of life insurance company income -- (5%) (3%) Unutilized loss carryforwards of non-life companies -- 2% 4% Equity earnings of unconsolidated subsidiary (1%) (1%) (2%) Other items, net -- -- (2%) ---- ---- ---- Effective tax rate 33% 30% 31% ==== ==== ====\nDeferred taxes are recorded for temporary differences between the financial reporting basis and the federal income tax basis of the Company's assets and liabilities. The sources of these differences and the estimated tax effect of each are as follows:\nDecember 31, ------------------------------ 1995 1994 -------- --------- (In thousands) Deferred Tax Liabilities: Deferred policy acquisition costs $ 8,683 $11,817 Invested assets 604 63 Unrealized gain on investments 851 - Other deferred tax liabilities 2,399 1,890 ------ ------ Total deferred tax liability 12,537 13,770 ------ ------ Deferred Tax Assets: Policy reserves 3,296 8,668 Net operating loss carryforwards 6,960 6,292 Tax credit carryforwards 11 11 Unrealized depreciation of investments - 75 Other deferred tax assets 1,307 444 Valuation allowance (4,878) (4,951) ------ ------ Total deferred tax asset 6,696 10,539 ------ ------ Net deferred tax liability $ 5,841 $ 3,231 ------ ------\nA valuation allowance has been provided for 1995 and 1994, respectively, for the tax effect of a portion of the non-life loss carryovers since it is more likely than not that such benefits will not be realized. The change in the valuation allowance of $73,000 is due primarily to decreases in non-life net operating losses which are not expected to be utilized against life company income.\nUnder the provisions of pre-1984 life insurance tax regulations, NFL was taxed on the lesser of taxable investment income or income from operations, plus one-half of any excess of income from operations over taxable investment income. One-half of the excess (if any) of the income from operations over taxable investment income, an amount which was not currently subject to taxation, plus special deductions allowed in computing the income from operations, were placed in a special memorandum tax account known as the policyholders' surplus account. The aggregate accumulation in the account at December 31, 1995 approximated $2.5 million. Federal income taxes will become payable on this account at the then current tax rate when and to the extent that the account exceeds a specific maximum, or when and if distributions to stockholders, other than stock dividends and other limited exceptions, are made in excess of the accumulated previously taxed income. The Company does not anticipate any transactions that would cause any part of the amount to become taxable and, accordingly, deferred taxes which would approximate $875,000, have not been provided on such amount.\nAt December 31, 1995, NFL has approximately $12,209,000 in its shareholders surplus account from which it could make distributions to the Company without incurring any federal tax liability. The amount of dividends which may be paid by NFL to the Company is limited by statutory regulations.\nAt December 31, 1995, the Company and its wholly-owned subsidiaries have aggregate non-life net operating loss carryforwards of approximately $19,241,000 and $8,021,000 for regular tax and alternative minimum tax purposes, respectively, which expire in 2001 through 2010.\nNOTE 12 - STATUTORY CAPITAL AND SURPLUS\nUnder applicable Delaware law, NFL must maintain minimum aggregate statutory capital and surplus of $550,000. Under applicable Texas law, each of NFIC and AICT must maintain minimum aggregate statutory capital and surplus of $1.4 million. The state of Georgia requires licensed out-of-state insurers to maintain minimum capital of $1.5 million and Kentucky requires minimum surplus of $2.0 million, which levels are higher than those of any other states in which the Insurance Subsidiaries are currently licensed. Accordingly, the minimum aggregate statutory capital and surplus which each of NFL, NFIC and AICT must maintain is $3.5 million. At December 31, 1995, aggregate statutory capital and surplus for NFL, NFIC and AICT was $14.1 million, $9.9 million and $8.3 million, respectively. Statutory net income (loss) for NFL, NFIC and AICT for the year ended December 31, 1995, was $(5.5) million, $(0.8) million and $1.7 million, respectively. AICT is wholly-owned by NFIC. Accordingly, statutory capital and surplus of NFIC includes capital and surplus of AICT.\nDividend payments from Westbridge's principal Insurance Subsidiaries are regulated by the insurance laws of their domiciliary states. NFL is domiciled in Delaware. Under the Delaware Insurance Code, an insurer domiciled in Delaware may not declare or pay a dividend or other distribution from any source other than \"earned surplus\" without the state insurance commissioner's prior approval. \"Earned surplus\" is defined as an amount equal to the unassigned funds of an insurer as set forth on its most recent statutory annual statement, including all or part of the surplus arising from unrealized capital gains or revaluation of assets. NFIC and AICT are domiciled in Texas. An insurer domiciled in Texas may pay dividends only out of \"surplus profits arising from its business\". Moreover, insurers domiciled in either Delaware or Texas may not pay \"extraordinary dividends\" without first providing the state insurance commissioner with 30-days prior notice, during which time such commissioner may disapprove the payment. An \"extraordinary dividend\" is defined as a dividend whose fair market value together with that of other dividends made within the preceding 12 months exceeds the greater of (a) ten percent of the insurer's surplus as regards policyholders as of the preceding December 31 or (b) the net gain from operations of such insurer, not including realized capital gains, for the 12-month period ending on the preceding December 31. In September 1994, NFL paid to Westbridge an \"extraordinary dividend\" in the amount of $2.0 million. With respect to ordinary dividends payable by an insurer domiciled in Delaware, notice of any dividend must be provided to the state insurance commissioner within five (5) business days following the declaration thereof and at least ten (10) days prior to the payment thereof. As of December 31, 1994, NFL had negative statutory \"earned surplus\" as a result of historical statutory losses. For the foreseeable future, NFL has agreed to seek the approval of the Delaware insurance commissioner prior to making any dividend payments. As of December 31, 1995, AICT has the ability to pay to NFIC, without prior regulatory approval, $835,000 in dividends during 1996. As of December 31, 1995, NFIC has the ability to pay to Westbridge, without prior regulatory approval, $1.0 million during 1996. In both Delaware and Texas, the state insurance commissioner reviews the dividends paid by each insurer domiciled in such commissioner's state at least once each year to determine whether they are reasonable in relation to the insurer's surplus as regards policyholders and quality of earnings. The state insurance commissioner may issue an order to limit or disallow the payment of ordinary dividends if such commissioner finds the insurer to be presently or potentially financially distressed or troubled.\nIn December 1990, the Company and NFL entered into an agreement under which NFL issued a Surplus Certificate to the Company in the principal amount of $2,863,000 in exchange for $2,863,000 of the Company's assets. The unpaid aggregate principal under the Surplus Certificate bears interest at an agreed upon rate not to exceed 10% and is repayable, in whole or in part, upon (i) NFL's surplus exceeding $7,000,000, exclusive of any surplus provided by any reinsurance treaties, and (ii) NFL receiving prior approval for repayment from the Delaware State Insurance Commissioner. During 1993 and 1994, NFL received such approval and repaid $2,086,000 to the Company. No principle payments were made in 1995.\nThe statutory financial statements of the Company's insurance subsidiaries are prepared using accounting methods which are prescribed or permitted by the insurance department of the respective companies' state of domicile. Prescribed statutory accounting practices include a variety of publications of the NAIC as well as state laws, regulations and general administrative rules. Permitted statutory accounting practices encompass all accounting practices not so prescribed. The Company employed no permitted statutory accounting practices that individually or in the aggregate materially affected statutory surplus or risk-based capital at December 31, 1995 or 1994.\nNOTE 13 - EMPLOYEE BENEFIT PLANS\nThe Company adopted, as of July 1, 1982, an employee incentive stock option plan (the \"ISO Plan\"). The ISO Plan, as amended, authorizes the Company's Board of Directors to issue to key full-time employees of the Company, or any of its subsidiaries, non-transferrable options to purchase up to 580,000 (as adjusted to give effect for stock dividends paid in 1983) shares, in the aggregate, of the Company's Common Stock. Options granted under the ISO Plan are intended to qualify as either \"incentive stock options\" under Section 422A of the Internal Revenue Code of 1986, as amended (the \"Code\"), or as non-qualified stock options as defined under the Code. The ISO Plan provides that the option price per share will be no less than the fair market value for a share of the Company's Common Stock on the date of grant. To date, all option prices have been equal to the fair market value of the stock on the date of grant. The ISO plan also provides that shares available upon the exercise of options granted under the ISO Plan may be paid for with cash or by tendering shares of Common Stock owned by optionee(s), or a combination of the foregoing. All options outstanding are exercisable within ten years from the date the option was granted, except that no option is exercisable until at least one year after its grant. In addition, the ISO Plan provides that no one owning 10% of the total combined voting power of all classes of the Company's stock, or of the stock of any subsidiary, is eligible to be awarded options under the ISO Plan.\nThe Company also adopted, as of September 5, 1985, a second employee stock option plan (the \"1985 Plan\"). The 1985 Plan provides for the granting, to eligible employees of the Company or its subsidiaries, of stock options to purchase up to a total of 200,000 shares of the Company's Common Stock. Options granted under the 1985 Plan are treated as \"non-qualified stock options\" for purposes of the Code and the option price per share shall not be less than 90% of the fair market value of the Company's Common Stock on the date of grant. All options outstanding are exercisable within seven years from the date the option was granted, except that no option is exercisable until at least one year after its grant.\nA third employee stock option plan (the \"1992 Plan\"), was adopted as of March 26, 1992. The 1992 Plan provided for the granting, to eligible employees of the Company or its subsidiaries, of stock options to purchase up to a total of 300,000 shares of the Company's Common Stock. Options granted under the 1992 Plan are treated as \"non-qualified stock options\" for purposes of the Code and the option price per share shall not be less than 90% of the fair market value of the Company's Common Stock on the date of grant. All options outstanding are exercisable within seven years from the date the option was granted, except that no option is exercisable until at least one year after its grant.\nInformation regarding the Company's stock option plans is summarized as follows:\nYear Ended December 31, ------------------------------------- 1995 1994 1993 ------- ------- ------- Options outstanding at beginning of year 375,294 554,917 499,285 Options granted during the year: Price granted at $5.40 116,000 -- -- Price granted at $5.60 6,000 -- -- Price granted at $6.84 -- 5,000 -- Price granted at $7.20 -- 5,000 -- Price granted at $7.65 -- 25,000 -- Price granted at $7.71 -- 5,000 -- Price granted at $5.18 -- -- 92,000 Price granted at $5.75 -- -- 30,000 Price granted at $6.08 -- -- 10,000 Price granted at $2.50 -- -- -- Options exercised during the year: Price ranging from $1.63 to $5.75 (85,300) (219,623) (66,180) Options canceled during the year: Price ranging from $1.69 to $2.00 -- -- (10,188) ------- ------- ------- Options outstanding at end of year 411,994 375,294 554,917 ======= ======= =======\nAt December 31, 1995, options for 141,294 shares were exercisable under the stock options plans at a price ranging from $1.88 to $2.50; and options for 148,700 shares were exercisable at a price ranging from $5.18 to $7.71. Also, at December 31, 1995, 1994 and 1993, options for 6,000, 128,000 and 168,000 shares, respectively, remained available for future grant under the plans.\nIn September 1986, the Company established a retirement savings plan for its employees. The plan permits all employees who have been with the Company for at least one year to make contributions by salary reduction pursuant to section 401(k) of the Internal Revenue Code. The plan allows employees to defer up to 3% of their salary with partially matching discretionary Company contributions determined by the Company's Board of Directors. Employee contributions are invested in any of four investment funds at the discretion of the employee. Company contributions are in the form of the Company's Common Stock. The Company's contributions to the plan in 1995, 1994 and 1993 approximated $79,000, $98,000 and $45,000, respectively.\nNOTE 14 - REINSURANCE\nThe Insurance Subsidiaries cede insurance to other insurers and reinsurers on both its life and accident and health business. Reinsurance agreements are used to limit maximum losses and provide greater diversity of risk. The Company remains liable to policyholders to the extent the reinsuring companies are unable to meet their treaty obligations. Total accident and health premiums of $2,807,000, $1,703,000, and $495,000, were paid to reinsurers in 1995, 1994, and 1993, respectively. Face amounts of life insurance in force approximated $43,441,000, and $21,814,000 at December 31, 1995 and 1994, respectively. No life insurance was reinsured as of December 31, 1995 and 1994.\nIn late 1993, NFL entered into a coinsurance treaty with FLICA. FLICA is a wholly-owned subsidiary of Freedom. Under the terms of the treaty, NFL assumed a 90% pro-rata share of first occurrence cancer business. For the years ended December 31, 1995, 1994 and 1993, $5,058,000, $1,640,000, and zero, respectively, of assumed premiums under this coinsurance treaty are included as premium revenue in the Consolidated Financial Statements.\nIn May 1987, NFL entered into a coinsurance treaty with FLICA. Under the terms of the treaty, NFL assumed a 50% pro-rata share of all insurance business written by FLICA from January 1, 1987 through December 31, 1988. In November 1988 (see NOTE 4), the coinsurance treaty was amended to extend through 1997. For the years ended December 31, 1995, 1994 and 1993, $4,272,000, $4,607,000, and $4,856,000, respectively, of assumed premiums under the coinsurance treaty are included as premium revenues in the consolidated financial statements.\nIn March 1990, NFL entered into a coinsurance treaty with Paramount Life Insurance Company (\"Paramount\"). Paramount is controlled by one of NFL's managing general agents. Under the terms of the treaty, NFL assumes a quota-share of all insurance written by PLIC for a period of five years beginning in 1990. For 1990 and 1991 new business, NFL assumed a 90% quota-share. No new business was reinsured from Paramount during 1993 or 1992. For the years ended December 31, 1995, 1994 and 1993, $582,000, $1,601,000, and $1,977,000, respectively, of assumed premiums under the coinsurance treaty with Paramount is included as premium revenue in the consolidated financial statements.\nNOTE 15 - COMMITMENTS AND CONTINGENCIES\nThe Company's future minimum lease payments for non-cancelable operating leases, relating primarily to office facilities and data processing equipment having a remaining term in excess of one year, at December 31, 1995, aggregated $13,580,000. The amounts due by year are as follows: 1996-$2,750,000; 1997-$2,550,000; 1998- $2,260,000; 1999-$1,990,000; 2000-$1,760,000; and thereafter-$2,270,000. Aggregate rental expense included in the consolidated financial statements for all operating leases approximated $3,413,000, $2,953,000, and $1,908,000 in 1995, 1994 and 1993, respectively.\nIn the normal course of their business operations, the Insurance Subsidiaries, continue to be involved in various claims, lawsuits (alleging actual as well as substantial exemplary damages) and regulatory matters. In the opinion of management, the disposition of these or any other legal matters will not have a material adverse effect on the Company's consolidated financial position.\nIn the ordinary course of business, the Company has advanced commissions and made loans to agents collateralized by future commissions. Advances to agents are recorded as receivables from agents and consisted as of December 31, 1995 in amounts of $7,690,000 for LifeStyles Marketing's agents, $1,718,000 for agent balances reinsured from FLICA, $1,768,000 for Farm & Ranch's agents, $2,423,000 for Cornerstone's agents, $1,585,000 for Senior Benefit's agents, and $1,522,000 for other agent balances. Westbridge holds a secured promissory note (the \"Elkins Note\"), from NFC Marketing, Inc. (\"NFC\"), an Arkansas corporation which is wholly-owned by Elkins. The balance of this note recorded on the books of the Company at December 31, 1995 is approximately $860,000. The note, which was renegotiated in October 1994, represents principal and accrued interest on a loan made by Westbridge to NFC for the purpose of expanding its marketing efforts. The original loan was scheduled to be repaid in April 1993. However, due to certain financial difficulties, NFC was in arrears on the full amount of this note and in October 1994 the Elkins Note was renewed and extended with terms which provide, among other things, for the payment to Westbridge of $20,000 per month until such time as the full amount of principal and interest thereunder has been paid. Under the terms of the Elkins Note, such amounts have been paid to Westbridge by NFL from monthly commissions which would otherwise be payable to NFC by NFL. Payment of the principal and interest under the Elkins Note has been guaranteed by Elkins. In addition, under the terms of a Security Agreement delivered to Westbridge by NFC, following a default, Westbridge has the right to apply monies, balances, credit or collections which it may hold for NFC on deposit, or which might otherwise be payable to NFC by NFL (including, among other things, agents' commissions payable by NFL to NFC), to offset the unpaid balance of the Elkins Note. Following any exercise by the Company of its right of offset, management believes that the level of lapses and cancellations would gradually increase as a result of agents' efforts to transfer the policies to other insurers. However, management also believes that the rate at which such policies could be rewritten would not significantly affect the level of premiums received in the near term and, as a result, the Company should recover the full amount owed on this note.\nNOTE 16 - RECONCILIATION TO STATUTORY REPORTING\nA reconciliation of net income as reported by the Insurance Subsidiaries under practices prescribed or permitted by regulatory authorities and that reported herein by the Company on a consolidated GAAP basis follows:\nA reconciliation of capital and surplus reported by the Insurance Subsidiaries under regulatory practices to stockholders' equity as reported herein by Westbridge on a consolidated GAAP basis follows:\nNOTE 17 - QUARTERLY FINANCIAL INFORMATION (UNAUDITED)\nSummarized quarterly financial data for each of the Company's last two years of operations is as follows:\nSCHEDULE II\nCONDENSED FINANCIAL INFORMATION OF REGISTRANT WESTBRIDGE CAPITAL CORP. (PARENT COMPANY)\nSTATEMENTS OF OPERATIONS AND RETAINED EARNINGS (In thousands)\nSCHEDULE II\nCONDENSED FINANCIAL INFORMATION OF REGISTRANT WESTBRIDGE CAPITAL CORP. (PARENT COMPANY) BALANCE SHEETS (In thousands)\nSCHEDULE II CONDENSED FINANCIAL INFORMATION OF REGISTRANT WESTBRIDGE CAPITAL CORP. (PARENT COMPANY) STATEMENT OF CASH FLOWS (In thousands)\nSCHEDULE III\nWESTBRIDGE CAPITAL CORP.\nSUPPLEMENTARY INSURANCE INFORMATION (In thousands)\nWESTBRIDGE CAPITAL CORP.\nSCHEDULE IV\nREINSURANCE (In thousands)\nSCHEDULE V\nWESTBRIDGE CAPITAL CORP.\nVALUATION AND QUALIFYING ACCOUNTS AND RESERVES (In thousands)\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 relating to directors is incorporated herein by reference to Election of Directors\" from the Company's definitive proxy statement for the 1996 Annual Meeting of Stockholders. Information relating to executive officers is contained under the heading \"Executive Officers\" in PART I hereof.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nExecutive Compensation is incorporated herein by reference to \"Election of Directors -- Executive Compensation\" from the Company's definitive proxy statement for the 1996 Annual Meeting of Stockholders.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nInformation pertaining to security ownership of certain beneficial owners and management is incorporated herein by reference to \"Principal Stockholders\" and \"Election of Directors -- Security Ownership of Management\" from the Company's definitive proxy statement for the 1996 Annual Meeting of Stockholders.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nInformation pertaining to certain relationships and related transactions is incorporated herein by reference to \"Principal Stockholders\" and \"Election of Directors\" from the Company's definitive proxy statement for the 1996 Annual Meeting of Stockholders.\nPART IV\nITEM 14.","section_14":"ITEM 14. FINANCIAL STATEMENT SCHEDULES, EXHIBITS AND REPORTS ON FORM 8-K.\n(a) The documents set forth below are filed as part of this report.\n(1) Financial Statements:\nReference is made to ITEM 8, \"Index to Financial Statements and Financial Statement Schedules.\"\n(2) Financial Statement Schedules:\nReference is made to ITEM 8, \"Index to Financial Statements and Financial Statement Schedules.\" (3) Exhibits:\nThe following exhibits are filed herewith. Exhibits incorporated by reference are indicated in the parentheses following the description.\n2.1 Stock Purchase Agreement dated as of December 6, 1993 among Westbridge, National Group Corporation and C. Clifton Robinson (incorporated by reference to Exhibit 2.1 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993).\n2.2 Amendment No. 1 to Stock Purchase Agreement, dated as of April 12, 1994, by and among Westbridge, National Group Corporation and C. Clifton Robinson (incorporated by reference to Exhibit 2.2 to the Company's Current Report on Form 8-K dated April 26, 1994).\n3.1 Restated Certificate of Incorporation of Westbridge filed with the Secretary of State of Delaware on July 28, 1994 (incorporated by reference to Exhibit 3.1 to Amendment No. 1 to the Company's Registration Statement No. 33-31830 on Form S-1).\n3.2 By-Laws of Westbridge, effective as of June 24, 1994 (incorporated by reference to Exhibit 3.2 to Amendment No. 1 to the Company's Registration Statement No. 33-31830 on Form S-1).\n4.1 Specimen Certificate for Westbridge Common Stock (incorporated by reference to Exhibit 4.1 to Amendment No. 1 to the Company's Registration Statement No. 2-78200 on Form S-1).\n4.2** Specimen Certificate for Westbridge Series A Cumulative Convertible Exchangeable Preferred Stock $.10 Par Value, $1,000 Liquidation Preference.\n4.3** Form of Indenture between Westbridge and Liberty Bank and Trust Company of Oklahoma City, National Association, as Trustee, including form of Note.\n10.1 General Agent's Agreement with John P. Locke, as amended on November 7, 1988 (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1991). (Confidential Treatment for portions of this Exhibit has been requested).\n10.2 Description of Cash Bonus Plan (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1988).\n10.3 Westbridge 1985 Stock Option Plan (incorporated by reference to Exhibit 10.7 to the Company's Registration Statement No. 33-3577 on Form S-1).\n10.4 Amendment No. 1 to Employee Incentive Stock Option Plan of Westbridge (incorporated by reference to Exhibit 10.8 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1986).\n10.5 Amendment No. 2 to Employee Incentive Stock Option Plan of Westbridge (incorporated by reference to Exhibit 10.9 to the Company's Annual Report on Form 10-K for the year ended December 31, 1987).\n10.6 Amendment No. 3 to Employee Incentive Stock Option Plan of Westbridge (incorporated by reference to Exhibit 10.10 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1988).\n10.7 Stockholders' Agreement dated April 2, 1988, by and among the Company and the other stockholders of LifeStyles Marketing Group, Inc., named therein, as amended (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1988).\n10.8 Stockholders' Agreement dated September 30, 1988, by and among the Company, John P. Locke and Freedom Holding Company (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1988).\n10.9 Coinsurance Agreement between National Foundation Life Insurance Company and Paramount Life Insurance Company, as of March 1, 1990 (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1990).\n10.10 Coinsurance Agreement between National Foundation Life Insurance Company and Freedom Life Insurance Company of America, as of May 5, 1987 (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1990).\n10.11 Assumption Reinsurance Agreement, dated June 20, 1991, by and among National Foundation Life Insurance Company and Bankers Protective Life Insurance Company (incorporated by reference to Exhibit 2 to the Company's Report on Form 8-K dated August 27, 1991).\n10.12 Assumption Reinsurance Agreement dated September 16, 1992, by and among National Foundation Life Insurance Company and American Integrity Insurance Company (incorporated by reference to Exhibit 2 of the Company's Report on Form 8-K dated September 25, 1992).\n10.13 Westbridge 1992 Stock Option Plan (incorporated by reference to Exhibit 28.4 to the Company's Registration Statement No. 33-55192 on Form S-8).\n10.14 First Amendment to the 1992 Stock Option Plan (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1992).\n10.15 Second Amendment to the 1992 Stock Option Plan (incorporated by reference to Exhibit 10.21 to Amendment No. 1 to the Company's Registration Statement No. 33-31830 on Form S-1).\n10.16 Preferred Stock Purchase Agreement dated as of April 1, 1994 by and between Westbridge and each of the purchasers named on the signature pages thereto (incorporated by reference to Exhibit to Exhibit 10.1 to the Company's Current Report on Form 8-K dated April 26, 1994).\n10.17* Receivables Purchase and Sale Agreement dated November 15, 1995 between National Foundation Life Insurance Company, National Financial Insurance Company, American Insurance Company of Texas, Health Care-One Insurance Agency, Inc., and Westbridge Funding Corporation.\n10.18* Credit Agreement dated as of December 28, 1995 between Westbridge Funding Corporation and Fleet National Bank of Connecticut.\n10.19* Guaranty Agreement dated as of December 28, 1995 by Westbridge Capital Corp. in favor of Fleet National Bank of Connecticut.\n10.20* Security Agreement dated as of December 28, 1995 by Westbridge Funding Corporation for the benefit of Fleet National Bank of Connecticut.\n10.21* Westbridge Capital Corp. 10% Senior Note Due 2002 dated December 22, 1995.\n10.22* Warrant to Purchase Common Stock of Westbridge Capital Corp. (transfer restricted) dated December 22, 1995.\n21* List of Subsidiaries of Westbridge.\n24* Consent of Price Waterhouse LLP.\n27* Financial Data Schedule.\n(b) Report on Form 8-K.\nWestbridge filed no reports on Form 8-K during the last quarter of the year covered by this report.\n* Filed Herewith. ** Previously 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, on the 29th day of March, 1996.\nWESTBRIDGE CAPITAL CORP.\n\/s\/ Martin E. Kantor\n(Martin E. Kantor 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 date indicated.\nSIGNATURE TITLE DATE\n\/s\/ Martin E. Kantor Director, Chairman of the Board March 29, 1996 (Martin E. Kantor) and Chief Executive Officer (Principal Executive Officer)\n\/s\/ Marvin H. Berkeley Director March 29, 1996 (Marvin H. Berkeley)\n\/s\/ Arthur S. Feinberg Director March 29, 1996 (Arthur W. Feinberg)\n\/s\/ George M. Garfunkel Director March 29, 1996 (George M. Garfunkel)\n\/s\/ Glenn O. Phillips Director March 29, 1996 (Glenn O. Phillips)\n\/s\/ Joseph C. Sibigtroth Director March 29, 1996 (Joseph C. Sibigtroth)\n\/s\/ James W. Thigpen Director, President and March 29, 1996 (James W. Thigpen) Chief Operating Officer\n\/s\/ Barth P. Walker Director March 29, 1996 (Barth P. Walker)\n\/s\/ Patrick J. Mitchell Vice President, Chief Financial March 29, 1996 (Patrick J. Mitchell) Officer and Treasurer (Principal Financial and Accounting Officer)\nINDEX OF EXHIBITS\nExhibit 10.17\nRECEIVABLES PURCHASE AND SALE AGREEMENT\nThis Receivables Purchase and Sale Agreement, dated as of November 15, 1995 (this \"Agreement\"), is entered into by and between National Foundation Life Insurance Company, a Delaware corporation, National Financial Insurance Company, a Texas corporation, American Insurance Company of Texas, a Texas corporation, and Health Care-One Insurance Agency, Inc., a California corporation (each of which is referred to herein as a \"Seller\" and are collectively referred to herein as the \"Sellers\"), and Westbridge Funding Corporation, a Delaware corporation (the \"Purchaser\"). Capitalized terms not otherwise defined herein shall have the meanings set forth in Section 1.1.\nWHEREAS, the Sellers are in the business of underwriting and\/or selling insurance products, and in the ordinary course of such business (i) generate and receive premiums from insureds, a portion of which premiums represent commissions (the \"Commissions\") due or to become due to agents of the Sellers, including without limitation general agents of the Seller and other agents with whom said general agents have contracted (collectively, the \"Agents\") and (ii) generate accounts receivable resulting from advances of first-year Commissions paid to the Sellers' Agents (each, an \"Agent Obligor\") in respect of insurance policies sold by such Agent Obligors (the obligations of such Agent Obligors to repay the principal amount of, and interest and other finance charges on, such advances being referred to herein as \"Agent Receivables\");\nWHEREAS, the Sellers desire to sell to the Purchaser, and, subject to the terms and conditions set forth herein, the Purchaser agrees to purchase from the Sellers, from time to time on a non-recourse basis, all of each Seller's right, title and interest in, to and under their respective Agent Receivables; and WHEREAS, in connection with such sale of Agent Receivables and as collateral for the repayment thereof, the Sellers desire to assign to the Purchaser, and the Purchaser desires to assume, all of each Seller's rights in, to and under all guarantees thereof and all collateral security therefor, including, without limitation, the Assigned Commissions and Agent Contract Rights (each as defined below);\nNOW, THEREFORE, in consideration of the mutual covenants and agreements set forth in this Agreements, and for other good and valuable consideration, the receipt and sufficiency of which is are hereby acknowledged, the parties hereto agree as follows:\nARTICLE I\nCERTAIN DEFINITIONS\nSection 1.1. Definitions. The following terms shall have the definitions set forth below:\n\"Agent Contract Rights\" means all of each Seller's rights under each contract, financing agreement, note, instrument, or other agreement by which any Agent Obligor is bound to make payments to such Seller to repay advances of first-year Commissions made by such Seller to such Agent Obligor or any other Agent Obligor and to pay interest and\/or other finance charges to the Seller.\n\"Assigned Commissions\" means the Commissions due or to become due to the Agent Obligors with respect to Insurance Policies sold by such Agent Obligors, including without limitation all renewal Commissions, but only to the extent that such Commissions have been assigned by such Agent Obligors to a Seller as collateral to secure the payment of the Agent Receivables owing by such Agent Obligors.\n\"Business Day\" means any day on which commercial banks are open for business in the States of Connecticut and Texas.\n\"Collections\" means all the payments and collections received by a Seller, from time to time, under any Insurance Policies arising out of a sale of insurance products or services, which includes (i) premiums, (ii) Commissions, (iii) any interest or finance charges on such Commissions, and (iv) any other obligations of the insureds thereunder.\n\"Cut-Off Date\" means (i) November 30, 1995; and (ii) thereafter until the Purchase Termination Date, the last day of each subsequent calendar month.\n\"Insurance Policies\" means the insurance policies issued by any Seller and sold by any Agent Obligor.\n\"Person\" means any individual, partnership, corporation, limited liability company, business trust, joint stock company, trust, unincorporated association, joint venture, governmental authority or other entity of whatever nature.\n\"Purchase Termination Date\" means January 7, 1998 or such later date as the parties to this Agreement mutually agree. \"Quarterly Reconciliation Date\" means the Closing Date in January, April, July and October during the term of this Agreement, commencing on January 31, 1996.\nARTICLE II\nPURCHASE AND SALE; CLOSINGS\nSection 2.1. Purchase and Sale. On the terms and subject to the conditions of this Agreement, each Seller hereby agrees to sell to the Purchaser, and the Purchaser hereby agrees to purchase from each Seller, from time to time on a non-recourse basis, all of such Seller's right, title and interest in, to and under the Agent Receivables outstanding on November 30, 1995 and which arise prior to the last day of the calendar month immediately preceding the month in which the Purchase Termination Date occurs, and in connection therewith and as collateral therefor, the Seller agrees to assign to the Purchaser at the time of each sale, and the Purchaser agrees to assume from the Seller, all of the Sellers right, title and interest in, to and under including, without limitation, all interest accrued or accruing on such Agent Receivables, all monies due and to become due thereunder, all guarantees thereof, all collateral security therefor (including, without limitation, all Assigned Commissions and Agent Contract Rights), and all proceeds thereof. Each sale and purchase of Agent Receivables hereunder shall take place in the manner set forth in Section 2.2 below.\nSection 2.2. Closings. (a) A closing of the sale and purchase of Agent Receivables (each, a \"Closing\") shall take place (i) on the second Business Day following the satisfaction of all of the closing conditions specified in paragraph (c) below, and (ii) thereafter until the Purchase Termination Date, on the eighth Business Day of each subsequent calendar month (each, a \"Closing Date\").\n(b) On each Closing Date:\n(i) each Seller shall deliver to the Purchaser an Assignment substantially in the form of Exhibit A hereto, dated the Closing Date, which specifies in reasonable detail (A) each Agent Receivable outstanding as of the Cut-Off Date immediately prior to such Closing Date and being sold by such Seller on the applicable Closing Date, (B) the outstanding amount of such Agent Receivable as of such Cut-Off Date, and (C) the Assigned Commissions and Agent Contract Rights relating to such Agent Receivable which have not been previously assigned by each Seller; and\n(ii) the Purchaser shall deliver to each Seller, in immediately available funds, the aggregate purchase price for the Agent Receivables being purchased from such Seller on such date equal to 85% of the aggregate amount of such Agent Receivables as of the Cut-Off Date.\n(c) (i) the obligations of the Sellers and the Purchaser to consummate the sale and purchase of any Agent Receivables on each Closing Date shall be subject to the satisfaction of the following conditions: (A) the transactions contemplated by this Agreement not being prohibited by or in conflict with any applicable law, order, decree or governmental regulation; and (B) the receipt and continued effectiveness of all consents, approvals and actions of, filings with and notices to any third party, including, without limitation, any governmental or regulatory authority, necessary to permit the Sellers and the Purchaser to perform their respective obligations under this Agreement and to consummate the transactions contemplated hereby, all in form and substance reasonably satisfactory to the Purchaser and the Sellers, as applicable; and\n(ii) the obligations of the Purchaser to consummate the purchase of Agent Receivables on each Closing Date shall be subject to the Purchaser having available sufficient funds to pay the purchase price on such Closing Date.\n(d) Prior to the initial Closing Date, each Seller shall deliver to the Purchaser a UCC-1 financing statement of the Purchaser as secured party\/assignee and such Seller as the debtor\/assignor with respect to the Agent Receivables, and the Assigned Commissions and Agent Contract Rights relating thereto, to be assigned by such Seller hereunder.\nSection 2.3. Security Interest. The parties hereto agree that this Agreement is intended to constitute the sale of and shall transfer ownership to the Purchaser of all right, title and interest of each Seller in, to and under the Agent Receivables sold hereunder. In addition, the parties hereto agree that (a) this Agreement constitutes a grant by each Seller to the Purchaser of a perfected first priority security interest in all of such Seller's right, title and interest in, to and under each Agent Receivable sold hereunder, including, without limitation, all interest accrued or accruing thereon, all monies due and to become due thereunder, all guarantees thereof, all collateral security therefor (including, without limitation, all Assigned Commissions and Agent Contract Rights), and all \"proceeds\" (as defined in Section 9-306 of the Uniform Commercial Code as in effect in the applicable jurisdiction) thereof, in each case, whether now existing or hereafter arising, (b) such security interest is intended to secure, without limitation, all now and hereafter outstanding obligations of each Seller to the Purchaser and (c) this Agreement shall constitute a security agreement under applicable law.\nARTICLE III\nADDITIONAL COVENANTS\nSection 3.1. Appointment of Sellers as Servicing Agents. The Purchaser hereby appoints each Seller, and each Seller hereby accepts such appointment, as the Purchaser's agent to service, administer and collect the Agent Receivables sold by it hereunder and the Assigned Commissions assigned by it hereunder (in such capacity, each Seller is referred to herein as a \"Servicing Agent\") pursuant to the terms of this Section 3.1.\nSection 3.2. Rights and Duties of Servicing Agent. (a) Each Servicing Agent shall take or cause to be taken all such actions as may be necessary or advisable to service, administer, account, collect and remit to the Purchaser from time to time the Assigned Commissions relating to the Agent Receivables sold by it hereunder, all with reasonable care and diligence and in accordance with its sound credit and collection policies, which policies shall not be amended, modified or waived in any material respect without the prior written consent of the Purchaser. Unless and until otherwise specified by the Purchaser, each Servicing Agent shall enforce the Purchaser's rights and interests in and under the Agent Receivables sold by it hereunder and the related collateral security and guarantees (including the Assigned Commissions and Agent Contract Rights).\n(b) Each Servicing Agent shall collect, and hold in trust for the account of the Purchaser in an interest bearing account of the Servicing Agent, the portion of all Collections which represent Assigned Commissions (together with all interest and\/or other finance charges paid by the Agent Obligors thereon, the \"Collected Commissions\"). On each Closing Date, each Servicing Agent will (i) furnish or cause to be furnished to the Purchaser a statement setting forth a detailed itemization of the amounts which it has received in respect of the repayment of Agent Receivables and such other information as the Purchaser may reasonably request; and (ii) pay to the Purchaser such amounts, together with any and all interest received thereon during the period for which such amounts were held by such Servicing Agent.\n(c) Promptly following each calendar quarter, each Servicing Agent shall reconcile the aggregate Collected Commissions received by it to the amount of Assigned Commissions which should have been received by it in repayment of Agent Receivables. To the extent necessary and in accordance with the Agent Contract Rights relating to such Agent Receivables, each Servicing Agent shall take such steps as shall be necessary to recover from each Agent Obligor any shortfall in the repayment of Agent Receivables. On each Closing Date, each Servicing Agent will (i) furnish or cause to be furnished to the Purchaser a statement setting forth a detailed itemization of the amounts which it has recovered in respect of shortfalls in the repayment of Agent Receivables and such other information as the Purchaser may reasonably request; and (ii) pay to the Purchaser such recovered amounts, together with any and all interest received thereon during the period for which such recovered amounts were held by such Servicing Agent. The Purchaser hereby authorizes each Servicing Agent to enforce each Agent Obligor's obligations under the respective Agent Receivables and related Agent Contract Rights and to collect all amounts due under the Agent Receivables sold by it hereunder, including, without limitation, endorsing any instruments representing Collections.\nSection 3.3. Rights of the Purchaser. (a) At any time or from time to time, the Purchaser may notify (or cause each Servicing Agent to notify) the Agent Obligors of its ownership of the Agent Receivables purchased by it hereunder, and may direct such Agent Obligors to pay all amounts due or to become due thereunder directly to the Purchaser or its designee.\n(b) Each Servicing Agent shall, at the Purchaser's request, (i) assemble all of the documents, instruments and other records (including, without limitation, computer tapes and disks) which evidence the Agent Receivables purchased by the Purchaser hereunder and the related Agent Contract Rights and collateral security (and such other information which the Purchaser may reasonably request), and make the same available to the Purchaser or its designee, and (ii) segregate all cash, checks and other instruments received by it from time to time constituting Collections of Agent Receivables purchased by the Purchaser hereunder in a manner acceptable to the Purchaser and shall, remit all such cash, checks and instruments, duly endorsed or with duly executed instruments of transfer, to the Purchaser or its designee.\n(c) Anything herein to the contrary notwithstanding, the exercise by the Purchaser of any of its rights hereunder shall not relieve the Servicing Agent from any of its duties or obligations with respect to the Agent Contract Rights relating to the Agent Receivables sold by it hereunder.\nSection 3.4. Further Assurances. At any time or from time to time after the date hereof, at the Purchaser's request and without further consideration, each of the Sellers shall execute and deliver to the Purchaser such other instruments of sale, transfer, conveyance, assignment and confirmation, provide such materials and information and take such other actions as the Purchaser may reasonably deem necessary or desirable in order more effectively to transfer, convey and assign to the Purchaser, and to confirm the Purchaser's title to, all of the Agent Receivables and Assigned Commissions and Agent Contract Rights relating thereto, and, to the full extent permitted by law, to cause each of the Sellers to fulfill its obligations under this Agreement, including, without limitation, the execution of any financing statements or continuation statements relating to Agent Receivables or Assigned Commissions or Agent Contract Rights for filing under the provisions of the Uniform Commercial Code of any applicable jurisdiction.\nSection 3.5. Standard of Care. Each Seller will exercise and give the same care and attention to its obligations pursuant to Article III as it gives to all other corporate obligations of a comparable nature, provided, that it shall not be held responsible for any losses arising from any action taken by it hereunder in good faith absent willful misconduct or gross negligence.\nARTICLE IV\nREPRESENTATIONS, WARRANTIES AND COVENANTS\nSection 4.1. Representations, Warranties and Covenants. Each of the Sellers severally, and not jointly, hereby represents, warrants and covenants to the Purchaser as follows:\n(a) on the Cut-Off Date relating to the sale of Agent Receivables hereunder, each Insurance Policy giving rise to such Agent Receivables and the related Assigned Commissions will be in full force and effect in accordance with its terms and, to its knowledge free from any lien, security interest, encumbrance or other right, title or interest of any Person, and neither it nor, to its knowledge, any insured had or will have done or failed to do anything that would or might permit any such insured or it to terminate any such Insurance Policy or suspend or reduce any payments or obligations due or to become due thereunder.\n(b) on the Cut-Off Date relating to the sale of Agent Receivables hereunder, each Insurance Policy sold by such Seller giving rise to such Agent Receivables is a valid, binding and legally enforceable obligation of it and it had all requisite authority and capacity to issue or sell such Insurance Policy and no such Insurance Policy violates any applicable law or contravenes any other agreement to which it is subject.\n(c) the execution and delivery of this Agreement by it, and the performance by it of its obligations hereunder, have been duly authorized by all necessary corporate and other action and do not and, subject to the approval of the relevant state insurance commissioners and receipt of the consents set forth in Schedule 4.1(c), will not require any consent or approval not heretofore obtained of any governmental authority or other Person.\n(d) this Agreement is the valid, binding and enforceable obligation of it, and does not violate any applicable law or contravene any other agreement to which it is a party.\n(e) other than financing statements on file at any public office covering its security interests in Assigned Commissions and Agent Contract Rights which will be assigned to the Purchaser hereunder, there are no financing statements now on file, or intended so to be, and neither it nor any of its subsidiaries or affiliates will execute or consent to the filing in any public office of any financing statement under the laws of any jurisdiction, relating to the Agent Receivables and the Assigned Commissions, Agent Contract Rights and other collateral relating thereto.\n(f) on each Closing Date, Schedule I to the Assignment delivered on such Closing Date will contain a complete and correct statement of the Agent Receivables being sold on such Closing Date and the Assigned Commissions and Agent Contracts Rights relating thereto.\n(g) upon payment on each Closing Date of the dollar amount to be paid on such date as described in Section 2.2(b)(ii) hereof for the purchase of the Agent Receivables sold to the Purchaser on such date, the Purchaser will have at such time good title to the Agent Receivables set forth in Schedule I to the Assignment delivered on such Closing Date.\nARTICLE V\nMISCELLANEOUS\nSection 5.1. Termination. This Agreement will terminate on the Purchase Termination Date, or on such other date as the parties shall agree to in writing.\nSection 5.2 Notices. All notices, requests and other communications hereunder must be in writing and will be deemed to have been duly given only if delivered personally or by facsimile transmission or mailed (first class postage prepaid) to the other parties at the respective addresses set forth on the signature pages hereof. All such notices, requests and other communications will be deemed given upon receipt.\nSection 5.3. Waiver. Any term or condition of this Agreement may be waived at any time by the party that is entitled to the benefit thereof, but no such waiver shall be effective unless set forth in a written instrument duly executed by or on behalf of the party waiving such term or condition. No waiver by any party of any term or condition of this Agreement, in any one or more instances, shall be deemed to be or construed as a waiver of the same or any other term or condition of this Agreement on any future occasion. All remedies, either under this Agreement or by Law or otherwise afforded, will be cumulative and not alternative.\nSection 5.4. Amendment. This Agreement may be amended, supplemented or modified only by a written instrument duly executed by or on behalf of each party hereto.\nSection 5.5. No Third Party Beneficiary. The terms and provisions of this Agreement are intended solely for the benefit of each party hereto and their respective successors or permitted assigns, and except as set forth in Section 5.11 it is not the intention of the parties to confer third-party beneficiary rights upon any other Person.\nSection 5.6. Successors and Assigns. This Agreement shall inure to the benefit of and shall be binding upon the parties hereto and their respective successors, heirs, personal representatives and permitted assigns.\nSection 5.7. Entire Agreement. This Agreement supersedes all prior discussions and agreements between the parties with respect to the subject matter hereof between the parties, and contains the sole and entire agreement between the parties hereto with respect to the subject matter hereof.\nSection 5.8. Headings. The headings used in this Agreement have been inserted for convenience of reference only and do not define or limit the provisions hereof.\nSection 5.9. Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the State of New York.\nSection 5.10. Invalid Provisions. If any provision of this Agreement is held to be illegal, invalid or unenforceable under any present or future Law, and if the rights or obligations of any party hereto under this Agreement will not be materially and adversely affected thereby, (a) such provision will be fully severable, (b) this Agreement will be construed and enforced as if such illegal, invalid or unenforceable provision had never comprised a part hereof and (c) the remaining provisions of this Agreement will remain in full force and effect and will not be affected by the illegal, invalid or unenforceable provision or by its severance herefrom.\nSection 5.11. Sellers' Obligations. Notwithstanding that all sales of Agent Receivables pursuant to Section 2.1 of this Agreement will be on a non-recourse basis, nothing contained herein shall be construed to relieve any Seller from liability for any misrepresentation, breach of warranty or nonfulfillment of or failure to perform any covenant or agreement on its part contained in Article IV. Each Seller understands that the Purchaser intends to assign to and grant to a lending institution or institutions a security interest in all of its rights, title and interest to this Agreement. Each Seller hereby consents to such assignment and grant, and further agrees that all representations, warranties, covenants and agreements of such Seller made herein shall also be for the benefit of and inure to such lending institution or institutions and all holders from time to time of notes issued by Purchaser to such institution or institutions.\nSection 5.12. Counterparts. This Agreement may be executed in any number of counterparts, each of which will be deemed an original, but all of which together will constitute one and the same instrument.\nIN WITNESS WHEREOF, this Agreement has been duly executed and delivered by the duly authorized officer of each party as of the date first above written.\nSELLERS:\nNATIONAL FOUNDATION LIFE INSURANCE COMPANY\nBy:_\/s\/ Michael D Norris__ Name: Michael D. Norris Title: Senior Vice President\nAddress for Notices:\n777 Main Street Suite 900 Fort Worth, Texas 76102\nNATIONAL FINANCIAL INSURANCE COMPANY\nBy:__\/s\/ Michael D. Norris__ Name: Michael D. Norris Title: Senior Vice President\nAddress for Notices:\n777 Main Street Suite 900 Fort Worth, Texas 76102\nAMERICAN INSURANCE COMPANY OF TEXAS\nBy:__\/s\/ Michael D. Norris__ Name: Michael D. Norris Title: Senior Vice President\nAddress for Notices:\n777 Main Street Suite 900 Fort Worth, Texas 76102\nHEALTH CARE-ONE INSURANCE AGENCY, INC.\nBy:__\/s\/ Michael D. Norris__ Name: Michael D. Norris Title: Senior Vice President\nAddress for Notices:\n777 Main Street Suite 900 Fort Worth, Texas 76102\nPURCHASER:\nWESTBRIDGE FUNDING CORPORATION\nBy:__\/s\/ Patrick J. Mitchell__ Name: Patrick J. Mitchell Title: Vice President\nAddress for Notices:\n777 Main Street Suite 900 Fort Worth, Texas 76102\nEXHIBIT A\nFORM OF ASSIGNMENT\nFOR VALUE RECEIVED, the undersigned (the \"Seller\") does hereby sell, transfer, convey, assign and deliver to the Purchaser free and clear of all mortgages, pledges, assessments, security interests, leases, liens, adverse claims, levies, charges or other encumbrances of any kind (\"Liens\"), other than permitted Liens, on a non-recourse basis, all of the Seller's right, title and interest in, to and under the Agent Receivables listed in Schedule I hereto, together with all interest accrued or accruing thereon, all monies due and to become due thereunder, all guarantees thereof, all collateral security therefor (including, without limitation, all Assigned Commissions and Agent Contract Rights), and all proceeds thereof in each case, listed in Schedule I hereto (the \"Assigned Assets\"), TO HAVE AND TO HOLD the same unto the Purchaser, its successors and assigns, forever.\nThe terms Seller, Agent Receivables, Assigned Commissions and Agent Contract Rights shall have the respective meanings assigned thereto in the Receivables Purchase and Sale Agreement, dated as of ___________, between National Foundation Life Insurance Company, a Delaware corporation, National Financial Insurance Company, a Texas corporation, American Insurance Company of Texas, a Texas corporation, and Health Care-One Insurance Agency, a Delaware corporation, and Westbridge Funding Corporation, a Delaware corporation (the \"Purchaser\").\nThe Purchaser hereby accepts the sale, transfer, conveyance, assignment and delivery of the Assigned Assets.\nAt any time or from time to time after the date hereof, at the Purchaser's request and without further consideration, the Seller shall execute and deliver to the Purchaser such other instruments of sale, transfer, conveyance, assignment and confirmation, provide such materials and information and take such other actions as the Purchaser may reasonably deem necessary or desirable in order more effectively to transfer, convey and assign to the Purchaser, and to confirm the Purchaser's title to, all of the Assigned Assets, and, to the full extent permitted by law, to put the Purchaser in actual possession and operating control of the Assigned Assets and to assist the Purchaser in exercising all rights with respect thereto.\nThis Assignment shall be governed by and construed in accordance with the laws of the State of New York applicable to a contract executed and performed in such State without giving effect to the conflicts of laws principles thereof, except that if it is necessary in any other jurisdiction to have the law of such other jurisdiction govern this Assignment in order for this Assignment to be effective in any respect, then the laws of such other jurisdiction shall govern this Assignment to such extent.\nIN WITNESS WHEREOF, the undersigned has caused its duly authorized officer to execute this Assignment on this ______ day of _________, 199_.\n[SELLER]\nBy:____________________________ Name: Title:\nSCHEDULE 4.1(c)\n1. General Agent's Agreement, dated November 7, 1988 by and between National Foundation Life Insurance Company (\"NFL\"), and John P. Locke, d\/b\/a 1st Million. (Pursuant to Section 9, NFL must obtain prior written consent to assign this Agreement.)\n2. General Agent's Agreement, dated April 5, 1976 by and between NFL and Phillip David Elkins of Little Rock Arkansas. (Pursuant to section 10, NFL must obtain prior written consent to assign this Agreement.)\nExhibit 10.18\nCREDIT AGREEMENT\ndated as of December 28, 1995\nbetween\nWESTBRIDGE FUNDING CORPORATION\nand\nFLEET NATIONAL BANK OF CONNECTICUT\nARTICLE 1. DEFINITIONS; ACCOUNTING TERMS.. . . . . . . 1 Section 1.1.Definitions . . . . . . . . . . . . . . . . . . 1 Section 1.2. Accounting Terms . . . . . . . . . . . . . 12 Section 1.3. Rounding.. . . . . . . . . . . . . . . . . 12 Section 1.4. Exhibits and Schedules.. . . . . . . . . . 12 Section 1.5. References to \"Borrower and its Subsidiaries\". 12 Section 1.6. Miscellaneous Terms. . . . . . . . . . . . 13 Section 1.7. Uniform Commercial Code Definitions. . . . 13\nARTICLE 2. THE CREDIT.. . . . . . . . . . . . . . . . . . . . 13 Section 2.1. The Revolving Loans. . . . . . . . . . . . 13 Section 2.2. The Revolving Note . . . . . . . . . . . . 13 Section 2.3. Procedure for Borrowing. . . . . . . . . . 14 Section 2.4. Termination or Optional Reduction of Commitment 14 Section 2.5. Maturity of Revolving Loans. . . . . . . . 15 Section 2.6. Mandatory Prepayments. . . . . . . . . . . 15 Section 2.7. Optional Prepayments . . . . . . . . . . . 15 Section 2.8. Interest on the Revolving Loans. . . . . . 15 Section 2.9. Fees . . . . . . . . . . . . . . . . . . . 16 Section 2.10. Payments Generally . . . . . . . . . . . . 17 Section 2.11. Capital Adequacy. . . . . . . . . . . . . 17 Section 2.12. Increased Costs. . . . . . . . . . . . . . 18 Section 2.13. Illegality . . . . . . . . . . . . . . . . 18 Section 2.14. Payments to be Free of Deductions. . . . . 19 Section 2.15. Computations . . . . . . . . . . . . . . . 20 Section 2.16. Compensation . . . . . . . . . . . . . . . 20\nARTICLE 3. SECURITY.. . . . . . . . . . . . . . . . . . . . . 21 Section 3.1. Security Agreement and Guaranty. . . . . . 21 Section 3.2. Pledge Agreement.. . . . . . . . . . . . . 21 Section 3.3. Further Assurances.. . . . . . . . . . . . 21\nARTICLE 4. CONDITIONS PRECEDENT . . . . . . . . . . . . . . . 22 Section 4.1. Documentary Conditions Precedent . . . . . 22 Section 4.2. Additional Conditions Precedent to Each Loan. 25 Section 4.3. Deemed Representations . . . . . . . . . . 26\nARTICLE 5. REPRESENTATIONS AND WARRANTIES. . . . . . . . . . . 26 Section 5.1. Incorporation, Good Standing and Due Qualification 26 Section 5.2. Corporate Power and Authority; No Conflicts 27 Section 5.3. Legally Enforceable Agreements . . . . . . 27 Section 5.4. Litigation . . . . . . . . . . . . . . . . 27 Section 5.5. Disclosures. . . . . . . . . . . . . . . . 27 Section 5.6. Ownership and Liens. . . . . . . . . . . . 27 Section 5.7. Taxes. . . . . . . . . . . . . . . . . . . 28 Section 5.8. ERISA. . . . . . . . . . . . . . . . . . . 28 Section 5.9. Subsidiaries and Ownership of Stock. . . . 28 Section 5.10. Credit Arrangements. . . . . . . . . . . . 28 Section 5.11. Operation of Business. . . . . . . . . . . 29 Section 5.12. No Default on Outstanding Judgments or Orders 29 Section 5.13. No Defaults on Other Agreements. . . . . . 29 Section 5.14. Governmental Regulation. . . . . . . . . . 29 Section 5.15. Consents and Approvals.. . . . . . . . . . 29 Section 5.16. Partnerships . . . . . . . . . . . . . . . 29 Section 5.17. Environmental Protection . . . . . . . . . 29 Section 5.18. Copyrights, Patents, Trademarks, Etc . . . 30 Section 5.19. Compliance with Laws . . . . . . . . . . . 30 Section 5.20. Receivables. . . . . . . . . . . . . . . . 30 Section 5.21. Use of Proceeds. . . . . . . . . . . . . . 30\nARTICLE 6. AFFIRMATIVE COVENANTS. . . . . . . . . . . . . . . 31 Section 6.1. Maintenance of Existence . . . . . . . . . 31 Section 6.2. Conduct of Business. . . . . . . . . . . . 31 Section 6.3. Maintenance of Properties. . . . . . . . . 31 Section 6.4. Maintenance of Records . . . . . . . . . . 31 Section 6.5. Maintenance of Insurance . . . . . . . . . 31 Section 6.6. Compliance with Laws . . . . . . . . . . . 31 Section 6.7. Right of Inspection. . . . . . . . . . . . 31 Section 6.8. Reporting Requirements . . . . . . . . . . 32 (a) Annual GAAP Statements of Borrower. . . . . . . 32 (b) Quarterly GAAP Statements of Borrower.. . . . . 33 (c) Management Letters. . . . . . . . . . . . . . . 33 (d) SEC Filings.. . . . . . . . . . . . . . . . . . 33 (e) Notice of Litigation. . . . . . . . . . . . . . 33 (f) Notices of Default. . . . . . . . . . . . . . . 33 (g) Other Filings.. . . . . . . . . . . . . . . . . 34 (h) Additional Information. . . . . . . . . . . . . 34 Section 6.9. Certificates.. . . . . . . . . . . . . . . 34 (a) Officers' Certificate.. . . . . . . . . . . . . 34 (b) Accountant's Certificate. . . . . . . . . . . . 35 Section 6.10. Further Assurances . . . . . . . . . . . . 35 Section 6.11. Compliance with Agreements.. . . . . . . . 35 Section 6.12. Use of Proceeds. . . . . . . . . . . . . . 35\nARTICLE 7. NEGATIVE COVENANTS . . . . . . . . . . . . . . . . 35 Section 7.1. Debt . . . . . . . . . . . . . . . . . . . 35 Section 7.2. Guaranties, Etc. . . . . . . . . . . . . . 36 Section 7.3. Liens. . . . . . . . . . . . . . . . . . . 36 Section 7.4. Investments. . . . . . . . . . . . . . . . 36 Section 7.5. Mergers and Consolidations and Acquisitions of Assets 37 Section 7.6. Sale of Assets . . . . . . . . . . . . . . 37 Section 7.7. Stock of the Borrower, Subsidiaries, Etc.. 37 Section 7.8. Transactions with Affiliates . . . . . . . 37 Section 7.9. Capital Expenditures . . . . . . . . . . . 37 Section 7.10. Minimum Consolidated GAAP Net Worth. . . . 37 Section 7.11. Minimum Interest Coverage. . . . . . . . . 37 Section 7.12. Minimum Collateral Ratio . . . . . . . . . 37 Section 7.13. Distributions. . . . . . . . . . . . . . . 37 Section 7.14. Receivables Purchase Agreement.. . . . . . 38\nARTICLE 8. EVENTS OF DEFAULT. . . . . . . . . . . . . . . . . 38 Section 8.1. Events of Default. . . . . . . . . . . . . 38 Section 8.2. Remedies . . . . . . . . . . . . . . . . . 41\nARTICLE 9. MISCELLANEOUS. . . . . . . . . . . . . . . . . . . 41 Section 9.1. Amendments and Waivers . . . . . . . . . . 41 Section 9.2. Usury. . . . . . . . . . . . . . . . . . . 42 Section 9.3. Expenses; Indemnities. . . . . . . . . . . 42 Section 9.4. Term; Survival . . . . . . . . . . . . . . 43 Section 9.5. Assignment; Participations . . . . . . . . 43 Section 9.6. Notices. . . . . . . . . . . . . . . . . . 44 Section 9.7. Setoff . . . . . . . . . . . . . . . . . . 44 Section 9.8. Jurisdiction; Immunities . . . . . . . . . 44 Section 9.9. Table of Contents; Headings. . . . . . . . 45 Section 9.10. Severability . . . . . . . . . . . . . . . 45 Section 9.11. Counterparts . . . . . . . . . . . . . . . 45 Section 9.12. Integration. . . . . . . . . . . . . . . . 45 Section 9.13. Governing Law. . . . . . . . . . . . . . . 45 Section 9.14. Confidentiality. . . . . . . . . . . . . . 45 Section 9.15. Authorization of Third Parties to Deliver Opinions, Etc. . . . . . . . . . . . . . . 46 Section 9.16. Borrower's Waivers . . . . . . . . . . . . 46 Section 9.17. State of Making and Substantial Performance 46\nSchedule 1.1 Commitments and Lending Offices Schedule 5.4 Litigation Schedule 5.10 Credit Arrangements\nExhibit A Revolving Note Exhibit B-1 Forms of Eligible Agent Contract Exhibit B-2 Forms of Master General Agent Contract Exhibit C Schedule of Maximum Advance Percentages by Policy Type Exhibit D Eligible Receivable Eligibility Criteria Exhibit E Form of WCC Guaranty Exhibit F Notice of Borrowing Exhibit G Form of Pledge Agreement Exhibit H Form of Security Agreement Exhibit I Schedule of Master General Agents Exhibit J-1 Form of Opinion of Corporate Counsel to Borrower and Guarantor. Exhibit J-2 Form of Opinion of Corporate and Insurance Counsel to each Eligible Seller Exhibit J-3 Form of Opinion of Corporate Counsel to the Guarantor re Pledge Agreement Exhibit K Officer's Certificate Exhibit L Borrowing Base Certificate\nCREDIT AGREEMENT dated as of December 28, 1995 between WESTBRIDGE FUNDING CORPORATION, a Delaware corporation (the \"Borrower\"), and FLEET NATIONAL BANK OF CONNECTICUT (the \"Bank\").\nThe Borrower desires that the Bank extend credit as provided herein, and the Bank is prepared to extend such credit. Accordingly, the Borrower and the Bank agree as follows:\nARTICLE 1. DEFINITIONS; ACCOUNTING TERMS.\nSection 1.1.Definitions. As used in this Agreement, the following terms have the following meanings (terms defined in the singular to have a correlative meaning when used in the plural and vice versa):\n\"Affiliate\" means, as to any Person, any other Person which directly or indirectly controls, or is under common control with, or is controlled by, such Person. As used in this definition, \"control\" (including, with its correlative meanings, \"controlled by\" and \"under common control with\") shall mean possession, directly or indirectly, of power to direct or cause the direction of management or policies (whether through ownership of securities or partnership or other ownership interests, by contract or otherwise), provided that, in any event: (i) any Person which owns directly or indirectly 20% or more of the securities having ordinary voting power for the election of directors or other governing body of a corporation or 20% or more of the partnership or other ownership interests of any other Person (other than as a limited partner of such other Person) will be deemed to control such corporation or other Person; and (ii) each director and officer of such Person shall be deemed to be an Affiliate of the Person.\n\"Agreement\" means this Credit Agreement, as amended or supplemented from time to time. References to Articles, Sections, Exhibits, Schedules and the like refer to the Articles, Sections, Exhibits, Schedules and the like of this Agreement unless otherwise indicated.\n\"A.M. Best Rating\" means the most recent rating announced by A.M. Best (or any successor thereto) or, if such rating is no longer announced by A.M. Best (or its successor), the most recent rating announced by another rating agency selected by the Bank.\n\"AIC\" means American Insurance Company of Texas, a Texas corporation.\n\"Anniversary Date\" means December 28 of each calendar year, commencing December 28, 1996.\n\"Applicable Commitment Fee Percentage\" means, on any date, the per annum Applicable Rate specified in Column 2 below corresponding to the lowest A.M. Best Rating of any Insurance Affiliate in effect on such date: (1) (2) A.M. Best Rating Applicable Rate B++ or higher 0.400% B+ 0.450% B or below 0.500%.\nAny change in the Applicable Rate by reason of a change in the A.M. Best Rating shall become effective on the date of announcement or publication by the rating agency of a change in such rating, or in the absence of such announcement or publication, on the effective date of such changed rating.\n\"Applicable Interest Rate\" means for any Revolving Loan, the Base Rate or the Eurodollar Rate plus, in each case, the Applicable Margin, for such Revolving Loan.\n\"Applicable Margin\" means:\n(a) with respect to each Base Rate Loan on any date, 0.625%; and\n(b) with respect each Eurodollar Rate Loan on any date, the Applicable Margin per annum specified in Column 2 below corresponding to the lowest A.M. Best Rating of any Insurance Affiliate in effect on such date:\n(1) (2) A.M. Best Rating Applicable Margin B++ or higher 2.250% B+ 2.500% B 2.750% B- or below 3.000%\nAny change in the Applicable Margin by reason of a change in the A.M. Best Rating shall become effective on the date of announcement or publication by the rating agency of a change in such rating, or in the absence of such announcement or publication, on the effective date of such changed rating.\n\"Assigned Commissions\" has the meaning set forth in Section 1.1 of the Receivables Purchase Agreement.\n\"Base Rate\" means, for any Interest Period or any other period, a fluctuating interest rate per annum as shall be in effect from time to time, which rate per annum shall at all times be equal to the rate of interest announced publicly by the Bank in Hartford, Connecticut, from time to time, as the Bank's base rate or prime rate.\n\"Base Rate Loan\" means a Revolving Loan which bears interest at the Base Rate plus the Applicable Margin.\n\"Borrowing\" means a borrowing consisting of a Revolving Loan from the Bank under this Agreement.\n\"Borrowing Base\" means, as of any date of determination, an amount equal to 90% of the aggregate Eligible Agent Collateral Value attributable to each of the Eligible Agent Obligors.\n\"Business Day\" means any day (other than a Saturday, Sunday or legal holiday) on which commercial banks are not authorized or required to close in Connecticut or Texas, except that, with respect to Borrowings, notices, determinations and payments with respect to a Eurodollar Rate Loan, such day shall be a \"Business Day\" only if it is also a day for trading by and between banks in the London interbank Eurodollar market.\n\"Capital Expenditures\" means, for any period, the Dollar amount of gross expenditures (including payments in respect of Capital Lease Obligations) made for fixed assets, real property, plant and equipment, and all renewals, improvements and replacements thereto (but not repairs thereof) incurred during such period, all as determined in accordance with GAAP.\n\"Capital Lease\" means any lease which has been or should be capitalized on the books of the lessee in accordance with GAAP.\n\"Capital Lease Obligation\" means the obligation of the lessee under a Capital Lease. The amount of a Capital Lease Obligation at any date is the amount at which the lessee's liability under the related Capital Lease would be required to be shown on its balance sheet at such date in accordance with GAAP.\n\"Closing Date\" means the date this Agreement has been executed by the Borrower and the Bank.\n\"Code\" means the Internal Revenue Code of 1986, as amended from time to time.\n\"Commitment\" means the commitment of the Bank to make Revolving Loans hereunder as set forth in Schedule 1.1, as the same may be reduced from time to time pursuant to Sections 2.4.\n\"Commitment Period\" means the period from and including the date hereof to but not including the Revolving Loan Termination Date or such earlier date as the Commitment shall terminate as provided herein.\n\"Consolidated GAAP Net Worth\" means the sum of (a) the capital stock and additional paid-in capital of the Borrower and its Subsidiaries on a consolidated basis, plus (without duplication) (b) the amount of retained earnings (inclusive of deferred revenues) (or, in the case of a deficit, minus the deficit), minus (c) treasury stock, plus or minus (d) any other account which is customarily added or deducted in determining stockholders' equity (excluding SFAS No. 115), all of which shall be determined on a consolidated basis in accordance with GAAP.\n\"Debt\" means, with respect to any Person: (a) indebtedness of such Person for borrowed money; (b) indebtedness for the deferred purchase price of Property or services (except trade payables and accrued expenses, incurred in the ordinary course of business); (c) the face amount of any outstanding letters of credit issued for the account of such Person; (d) obligations arising under acceptance facilities; (e) guaranties, endorsements (other than for collection in the ordinary course of business) and other contingent obligations to purchase or to provide funds for payment of the obligations of another Person, to supply funds to invest in any Person to cause such Person to maintain a minimum working capital or net worth or otherwise assure the creditors of such Person against loss; (f) obligations secured by any Lien on Property of such Person; and (g) Capital Lease Obligations.\n\"Default\" means any event which with the giving of notice or lapse of time, or both, would become an Event of Default.\n\"Default Rate\" means a percentage per annum equal at all times to the lesser of 4% per annum above the Applicable Interest Rate in effect from time to time or the highest rate permitted by law.\n\"Distributions\" means (a) dividends or other distributions in respect of capital stock of a Person (except distributions in such stock) and (b) the redemption or acquisition of such stock or of warrants, rights or other options to purchase such stock (except when solely in exchange for such stock) unless made, contemporaneously, from the net proceeds of a sale of such stock.\n\"Dollars\" and the sign \"$\" mean lawful money of the United States of America.\n\"Earned Commissions\" with respect to any Eligible Agent Obligor, means, as of any date of determination, that portion of all payments and collections received by an Eligible Seller under any Insurance Policy that has been, or should have been, applied by such Eligible Seller under an Eligible Agent Contract to reduce the outstanding amount of any Eligible Receivable payable by such Eligible Agent Obligor.\n\"Eligible Agent Collateral Value\" with respect to any Eligible Agent Obligor, means, as of any date of determination, an amount equal to the aggregate outstanding amount of all Eligible Receivables payable by such Eligible Agent Obligor as of such determination date, which outstanding amount shall be determined in the same manner as used to calculate the purchase price described in Section 2.2(b)(ii) of the Receivables Purchase Agreement.\n\"Eligible Agent Contract\" means an agreement between an Eligible Seller and an Eligible Agent Obligor, substantially in one of the forms set forth in Exhibit B-1 or Exhibit B-2, as such Exhibits shall be amended from time to time in accordance with Section 9.1.\n\"Eligible Agent Obligor\" means a Master General Agent or a Sub-Agent of a Master General Agent authorized by an Eligible Seller to sell insurance policies of any of the types identified on Exhibit C.\n\"Eligible Receivable\" means, as of any date of determination, a Receivable as to which (a) each of the eligibility criteria set forth in Exhibit D is satisfied, (b) every representation and warranty set forth in the Receivables Purchase Agreement with respect to such Receivable is true, complete and correct, and (c) every covenant in the Receivables Purchase Agreement with respect to such Receivable has been complied with in all material respects.\n\"Eligible Seller\" means any of AIC, HCO, NFIC and NFL.\n\"ERISA\" means the Employee Retirement Income Security Act of 1974, as amended from time to time, including any rules and regulations promulgated thereunder.\n\"ERISA Affiliate\" means any corporation or trade or business which is a member of the same controlled group of corporations (within the meaning of Section 414(b) of the Code) as the Borrower or is under common control (within the meaning of Section 414(c) of the Code) with the Borrower.\n\"Eurodollar Rate\" means, for the Interest Period for each Eurodollar Rate Loan comprising part of the same Borrowing, an interest rate per annum equal to (x) the rate quoted by the Bank at 11:00 a.m. London time (or as soon thereafter as practical) at which deposits in Dollars are offered by prime commercial banks to prime commercial banks in the London interbank Eurodollar market two Business Days before the first day of such Interest Period for a period equal to such Interest Period and in an amount equal to the Borrowing, divided by (y) one (1) minus the Reserve Requirement, if any, for each such Eurodollar Rate Loan for such Interest Period.\n\"Eurodollar Rate Loan\" means a Revolving Loan which bears interest at the Eurodollar Rate, plus the Applicable Margin.\n\"Event of Default\" has the meaning given such term in Section 8.1.\n\"First-Year Commissions\" with respect to an Insurance Policy originated by any specified Eligible Agent Obligor pursuant to the terms of an Eligible Agent Contract, means the aggregate amount that would be paid by the issuing Eligible Seller to such Eligible Agent Obligor pursuant to the Eligible Agent Contract during the first twelve months that such Insurance Policy is in force, assuming such Insurance Policy remains in full force and effect for the entire twelve month period.\n\"Financing Statements\" means the UCC-1 financing statements signed by the Borrower in connection with the security interest granted to the Bank in the Receivables and other collateral pursuant to the Security Agreement.\n\"Funding Date\" means the date on which any Borrowing is made.\n\"GAAP\" means generally accepted accounting principles in the United States of America as in effect from time to time, applied on a basis consistent with those used in the preparation of the financial statements referred to in Section 5.5 (except for changes concurred in by the Borrower's independent public accountants).\n\"GAAP EBIT\" with respect to any Person, means, for any period, an amount equal to Net Income for such period, plus (without duplication, to the extent deducted in determining Net Income) the sum of (a) Interest Expense for such period, plus (b) income tax expense deducted in determining Net Income for such period, all of which shall be determined in accordance with GAAP and eliminating intercompany balances and transactions, as applicable.\n\"Guarantor\" means Westbridge Capital Corp., a Delaware corporation.\n\"Guaranty\" means the Guaranty Agreement in the form of Exhibit E hereto, duly executed and delivered by the Guarantor.\n\"HCO\" means Health Care-One Insurance Agency, Inc. a California corporation.\n\"Insurance Affiliate\" means any of AIC, NFIC and NFL.\n\"Insurance Commissioner\" means with respect to any Insurance Affiliate, the head of any insurance regulatory authority and\/or, if the context so requires, such insurance regulatory authority in the relevant place of domicile of such Insurance Affiliate at the relevant time.\n\"Insurance Policy\" means an Insurance Policy issued by or through an Eligible Seller and written or sold by an Eligible Agent Obligor.\n\"Interest Coverage Ratio\" at the end of any fiscal quarter means (a) prior to the fiscal quarter ending December 31, 1996, the ratio of (i) an amount equal to the consolidated GAAP EBIT of the Borrower and all Subsidiaries for all of the preceding fiscal quarters occuring in 1996, to (ii) total Interest Expense of the Borrower and its Subsidiaries on a consolidated basis for the same number of fiscal quarters as included in calculating clause (i) above, and (b) on and after the fiscal quarter ending December 31, 1996, (i) an amount equal to the consolidated GAAP EBIT of the Borrower and all Subsidiaries for the immediately preceding four fiscal quarters (ending on such date), to (ii) total Interest Expense of the Borrower and its Subsidiaries on a consolidated basis for the immediately succeeding four fiscal quarters (beginning on such date). For purposes of clauses (a)(ii) and (b)(ii) above, Interest Expense shall be calculated on the assumption that a Eurodollar Rate Loan for the full amount of the Commitment will be outstanding for the period contemplated in the calculation and the A.M. Best Ratings of the Insurance Affiliates on the date of the certification required by Section 6.9(a) with respect to the fiscal quarter being tested will remain in effect for the entire period contemplated by the calculation.\n\"Interest Expense\" with respect to any Person for any period, means, the consolidated interest expense, including the interest portion of rental payments under Capital Leases, as determined on a consolidated basis in accordance with GAAP.\n\"Interest Period\" means (a) for each Eurodollar Rate Loan, the period commencing on the date of such Eurodollar Rate Loan or on the last day of the preceding Interest Period, as the case may be, and ending on the numerically corresponding day of the last month of the period selected by the Borrower pursuant to the following provisions: the duration of each Eurodollar Rate Loan Interest Period shall be one (1), two (2), three (3) or six (6) months, in each case as the Borrower may select, upon notice received by the Bank not later than 11:00 a.m. (Connecticut time) on the third Business Day prior to the first day of such Interest Period; and (b) for each Base Rate Loan, the period commencing on the date of such Base Rate Loan or on the last day of the preceding Interest Period, as the case may be, pursuant to notice received by the Bank not later than 11:00 a.m. (Connecticut time) on any Business Day selected by the Borrower as the first day of such Interest Period, and ending on the thirtieth (30th) day after the date of such Base Rate Loan or the last day of the preceding Interest Period, as the case may be; provided, however, that:\n(i) whenever the last day of any Interest Period would otherwise occur on a day other than a Business Day, the last day of such Interest Period shall be extended to occur on the next succeeding Business Day; provided that, if such extension would cause the last day of such Interest Period to occur in the next following calendar month, the last day of such Interest Period shall occur on the next preceding Business Day; and\n(ii) no Interest Period for any Revolving Loan shall extend beyond the Revolving Loan Termination Date.\n\"Investment\" in any Person means (a) the acquisition (whether for cash, property, services or securities or by merger or otherwise) of capital stock, bonds, notes, debentures, partnership or other ownership interests or other securities of such Person and (b) any deposits with, or advance, loan or other extension of credit to, such Person and (without duplication) any amount committed to be advanced, lent or extended to such Person.\n\"Lending Office\" means, for each type of Revolving Loan, the lending office of the Bank (or of an affiliate of the Bank) designated as such for such type of Revolving Loan on Schedule 1.1 or such other office of the Bank (or of an affiliate of the Bank) as the Bank may from time to time specify to the Borrower as the office through which its Revolving Loans of such type are to be made and maintained.\n\"Lien\" means any lien (statutory or otherwise), security interest, mortgage, deed of trust, priority, pledge, charge, conditional sale, title retention agreement, financing lease or other encumbrance or similar right of others, or any agreement to give any of the foregoing.\n\"Loan Documents\" mean this Agreement, the Revolving Note, the Guaranty, the Security Agreement, the Pledge Agreement (if delivered) and any other documents, agreements, reports, and instruments now or hereafter executed in connection herewith or contemplated hereby.\n\"Master General Agent\" shall mean an agent of an Eligible Seller identified on Exhibit I, which agent shall be party to a Master General Agent Contract.\n\"Master General Agent Contract\" means an agreement between a Master General Agent and an Eligible Seller substantially in one of the forms set forth in Exhibit B-2.\n\"Materially Adverse Effect\" means any material adverse effect upon the business, assets, liabilities, financial condition, results of operations or, as far as the Borrower can reasonably foresee, prospects of the Borrower and its Subsidiaries taken as a whole, or the Guarantor and its Subsidiaries, taken as a whole, or upon the ability of the Borrower or the Guarantor to perform in all material respects its obligations under this Agreement or any other Loan Document, as applicable, resulting from any act, omission, situation, status, event, or undertaking, either singly or taken together.\n\"Multiemployer Plan\" means a Plan defined as such in Section 3(37) of ERISA to which contributions have been made by the Borrower or any ERISA Affiliate and which is covered by Title IV of ERISA.\n\"NFIC\" means National Financial Insurance Company, a Texas corporation.\n\"NFL\" means National Foundation Life Insurance Company, a Delaware corporation.\n\"Net Income\" means, as applied to any Person for any period, the aggregate amount of net income of such Person, after taxes, for such period, as determined in accordance with GAAP.\n\"Notice of Borrowing\" means the certificate, in the form of Exhibit F hereto, to be delivered by the Borrower to the Bank pursuant to Sections 2.3 and 4.2(g) and shall include any accompanying certifications or documents.\n\"Obligations\" means all indebtedness, obligations and liabilities of the Borrower and its Subsidiaries, if any, to the Bank under this Agreement, the Security Agreement or the Revolving Note.\n\"PBGC\" means the Pension Benefit Guaranty Corporation and any entity succeeding to any or all of its functions under ERISA.\n\"Permitted Investments\" means (a) direct obligations of the United States of America, or of any agency thereof, or obligations guaranteed as to principal and interest by the United States of America, or of any agency thereof, in either case maturing not more than 90 days from the date of acquisition thereof; (b) certificates of deposit issued by or other overnight deposits with any bank or trust company organized under the laws of the United States of America or any state thereof and having capital, surplus and undivided profits of at least $500,000,000 and having long term unsecured and unguaranteed debt rated \"BBB+\" or better or \"Baa1\" or better by Standard & Poor's Ratings Group, a division of McGraw Hill, Inc. or Moody's Investors Service, Inc., respectively, maturing not more than 90 days from the date of acquisition thereof; (c) commercial paper rated A-1 or better or P-1 by Standard & Poor's Ratings Group, a Division of McGraw Hill, Inc., or Moody's Investors Service, Inc., respectively, maturing not more than 90 days from the date of acquisition thereof; (d) repurchase agreements and reverse repurchase agreements with any bank having combined capital and surplus in an amount of not less than $500,000,000, or any primary dealer of United States government securities in each case, having long term unsecured and unguaranteed debt rated \"BBB+\" or better or \"Baa1\" or better by Standard & Poor's Ratings Group, a division of McGraw Hill, Inc. or Moody's Investors Service, Inc., respectively, relating to marketable direct obligations issued or unconditionally guaranteed or insured by the United States of America or any agency or instrumentality thereof and backed by the full faith and credit of the United States of America, in each case maturing within 60 days from the date of acquisition thereof; in each case so long as the same (x) provide for the payment of principal and interest (and not principal alone or interest alone) and (y) are not subject to any contingency regarding the payment of principal or interest; and (e) long-term debt rated \"BBB+\" or better or \"Baa1\" or better by Standard & Poor's Rating Group, a division of McGraw Hill, Inc. or Moody's Inverstors Services, Inc., respectively.\n\"Permitted Liens\" has the meaning specified in Section 7.3.\n\"Person\" means an individual, partnership, corporation, limited liability company, business trust, joint stock company, trust, unincorporated association, joint venture, governmental authority or other entity of whatever nature.\n\"Plan\" means any employee benefit or other plan established or maintained, or to which contributions have been made, by the Borrower or any ERISA Affiliate and which is covered by Title IV of ERISA, other than a Multiemployer Plan.\n\"Pledge Agreement\" means the Pledge Agreement, in the form of Exhibit G hereto, duly executed and delivered by the Guarantor.\n\"Pledge Approvals\" has the meaning specified in Section 3.4.\n\"Prohibited Transaction\" means any transaction set forth in Section 406 of ERISA or Section 4975 of the Code for which there is no applicable statutory or regulatory exemption (including a class exemption or an individual exemption).\n\"Property\" means any interest of any kind in property or assets, whether real, personal or mixed, and whether tangible or intangible.\n\"Receivable\" means rights under any Eligible Agent Contract by which (a) an Eligible Agent Obligor is bound to make payments to an Eligible Seller and (b) an Eligible Seller is permitted to offset amounts owed to such Eligible Agent Obligor, to repay advances of First-Year Commissions made by such Eligible Seller to such Eligible Agent Obligor or any other Eligible Agent Obligor and to pay interest and\/or other finance charges to the Eligible Seller.\n\"Receivables Purchase Agreement\" means the Receivables Purchase and Sale Agreement dated as of [November 15], 1995 by and between the Borrower and each of the Eligible Sellers, as amended.\n\"Regulations D, X and U\" means Regulations D, X and U of the Board of Governors of the Federal Reserve System, as amended or supplemented from time to time.\n\"Regulatory Change\" means any change after the date of this Agreement in United States federal, state or foreign laws or regulations (including Regulation D) or the adoption or making after such date of any orders, rulings, interpretations, directives, guidelines or requests applying to a class of banks including the Bank, of or under any United States federal, state, or foreign laws or regulations (whether or not having the force of law) by any court or governmental or monetary authority charged with the interpretation or administration thereof.\n\"Reportable Event\" means any of the events set forth in Section 4043(c) of ERISA as to which events the PBGC by regulation has not waived the requirement of Section 4043(a) of ERISA that it be notified within 30 days of the occurrence of such event, provided that a failure to meet the minimum funding standard of Section 412 of the Code or Section 302 of ERISA shall be a Reportable Event regardless of any waivers given under Section 412(d) of the Code.\n\"Reserve Requirement\" means for any Eurodollar Rate Loans for any Interest Period (or, as the case may be, shorter period), the average maximum rate at which reserves (including marginal, supplemental or emergency reserves, if any) are required to be maintained during such period under Regulation D by member banks of the Federal Reserve System in Boston, Massachusetts with deposits exceeding one billion Dollars against \"Eurocurrency liabilities\" (as such term is used in Regulation D). Without limiting the effect of the foregoing, the Reserve Requirement shall reflect any other reserves required to be maintained by such member banks by reason of any Regulatory Change against: (i) any category of liabilities which includes deposits by references to which the Eurodollar Rate is to be determined as provided in the definition of \"Eurodollar Rate\", as applicable, in this Article 1, or (ii) any category of extensions of credit or other assets which include Eurodollar Rate Loans.\n\"Revolving Loan\" or \"Revolving Loans\" has the meaning specified in Section 2.1. Each Revolving Loan shall be a Base Rate Loan or a Eurodollar Rate Loan.\n\"Revolving Loan Termination Date\" means December 28, 1997; provided, however, if not fewer than thirteen (13) months nor more than fifteen (15) months prior to any Anniversary Date, the Borrower requests the Bank to extend the Revolving Loan Termination Date for an additional year and if the Bank in its sole discretion in writing within thirty (30) days of such request, grants such request, the Revolving Loan Termination Date means the date to which the Revolving Loan Termination Date has been so extended. If such date is not a Business Day, the Revolving Loan Termination Date shall be the next preceding Business Day.\n\"Revolving Note\" means a promissory note of the Borrower, in the form of Exhibit A hereto, evidencing the Revolving Loans made by the Bank hereunder.\n\"Security Agreement\" means the Security Agreement in the form of Exhibit H, duly executed and delivered by the Borrower.\n\"Senior Officer\" means the (a) chief executive officer, (b) chief operating officer, (c) the president, or (d) chief financial officer of the person designated.\n\"SFAS No. 115\" means Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities, issued by the Financial Accounting Standards Board in May, 1993.\n\"Stock Pledge Financing Statements\" means UCC-1 financing statements signed by the Guarantor in connection with the stock of NFL, NFIC and the Borrower pledged to the Bank pursuant to the Pledge Agreement (if delivered).\n\"Sub-Agent\" has the meaning specified in any one of the forms of Master General Agent Contracts.\n\"Subordinated Debt\" means any unsecured Debt for money borrowed by the Borrower or its Subsidiaries, as applicable, in an amount and on terms and conditions satisfactory to the Bank and which is subordinated under terms satisfactory in form and substance to the Bank in its sole judgment, as evidenced by the Bank's written consent thereto given prior to the creation of such Debt, to the Borrower's Obligations.\n\"Subsidiary\" means with respect to any Person, any corporation, partnership or joint venture whether now existing or hereafter organized or acquired: (i) in the case of a corporation, of which a majority of the securities having ordinary voting power for the election of directors (other than securities having such power only by reason of the happening of a contingency) are at the time owned by such Person and\/or one or more Subsidiaries of such Person or (ii) in the case of a partnership or joint venture, in which such Person is a general partner or joint venturer or of which a majority of the partnership or other ownership interests are at the time owned by such Person and\/or one or more of its Subsidiaries. Unless the context otherwise requires, references in this Agreement to \"Subsidiary\" or \"Subsidiaries\" shall be deemed to be references to a Subsidiary or Subsidiaries of the Borrower or of a Subsidiary of the Borrower.\n\"Unfunded Vested Liabilities\" means, with respect to any Plan, the amount (if any) by which the present value of all vested benefits under the Plan exceeds the fair market value of all Plan assets allocable to such benefits, as determined on the most recent valuation date of the Plan and in accordance with the provisions of ERISA for calculating the potential liability of the Borrower or any ERISA Affiliate to the PBGC or the Plan under Title IV of ERISA.\nSection 1.2. Accounting Terms. All accounting terms not specifically defined herein shall be construed in accordance with GAAP, applied on a consistent basis, and all financial data required to be delivered hereunder shall be prepared in accordance with GAAP, applied on a consistent basis; except as otherwise specifically prescribed herein. In the event that GAAP changes during the term of this Agreement such that the financial covenants contained in Article 6 would then be calculated in a different manner or with different components (a) the Borrower and the Bank agree to enter into good faith negotiations to amend this Agreement in such respects as are necessary to conform those covenants as criteria for evaluating the Borrower's financial condition to substantially the same criteria as were effective prior to such change in GAAP and (b) the Borrower shall be deemed to be in compliance with the financial covenants contained in such Sections during the sixty (60) days following any such change in GAAP if and to the extent that the Borrower would have been in compliance therewith under GAAP as in effect immediately prior to such change; provided, however, if an amendment shall not be agreed upon within sixty (60) days or such longer period as shall be agreed to by the Bank, for purposes of determining compliance with such covenants until such amendment shall be agreed upon, such terms shall be construed in accordance with GAAP as in effect immediately prior to such change in GAAP.\nSection 1.3. Rounding. Any financial ratios required to be maintained by Borrower pursuant to this Agreement shall be calculated by dividing the appropriate component by the other component, carrying the result to one place more than the number of places by which such ratio is expressed in this Agreement and rounding the result up or down to the nearest number (with a round-up if there is no nearest number) to the number of places by which such ratio is expressed in this Agreement.\nSection 1.4. Exhibits and Schedules. All Exhibits and Schedules to this Agreement, either as originally existing or as the same may from time to time be supplemented, modified or amended, are incorporated herein by this reference. A matter disclosed on any Schedule shall be deemed disclosed on all Schedules.\nSection 1.5. References to \"Borrower and its Subsidiaries\". Any reference herein to \"Borrower and its Subsidiaries\" or the like shall refer solely to Borrower during such times, if any, as the Borrower shall have no Subsidiaries.\nSection 1.6. Miscellaneous Terms. The term \"or\" is disjunctive; the term \"and\" is conjunctive. The term \"shall\" is mandatory, the term \"may\" is permissive. Masculine terms also apply to females; feminine terms also apply to males. The term \"including\" is by way of example and not limitation.\nSection 1.7. Uniform Commercial Code Definitions. The non-capitalized terms used in this Agreement that are not otherwise defined in the Agreement and that are defined in Article 9 of the Uniform Commercial Code as in effect in the State of Connecticut are used herein as so defined.\nARTICLE 2. THE CREDIT.\nSection 2.1. The Revolving Loans. Subject to the terms and conditions of this Agreement, the Bank agrees to make revolving loans to the Borrower (hereinafter collectively referred to as the \"Revolving Loan\" or \"Revolving Loans\") from time to time from and including the date hereof until the earlier of the Revolving Loan Termination Date or the termination of the Commitment of the Bank, up to, but not exceeding in the aggregate principal amount at any one time outstanding, the lesser of (i) an amount equal to the Borrowing Base or (ii) the amount of TWENTY MILLION AND NO\/00 DOLLARS ($20,000,000). Each Borrowing under this Section 2.1 of (i) a Base Rate Loan shall be in the principal amount of not less than $200,000; or (ii) a Eurodollar Rate Loan shall be in the principal amount of not less than $200,000. During the Commitment Period and subject to the foregoing limitations, the Borrower may borrow, repay and reborrow Revolving Loans, all in accordance with the terms and conditions of this Agreement.\nSection 2.2. The Revolving Note.\n(a) The Revolving Loans of the Bank shall be evidenced by a single promissory note in favor of the Bank in the form of Exhibit A, dated the date of this Agreement, and duly completed and executed by the Borrower.\n(b) The Bank is authorized to record and, prior to any transfer of the Revolving Note, endorse on a schedule forming a part thereof appropriate notations evidencing the date, the type, the amount and the maturity of each Revolving Loan made by it which is evidenced by such Revolving Note and the date and amount of each payment of principal made by the Borrower with respect thereto; provided, that failure to make any such endorsement or notation shall not affect the Obligations of the Borrower hereunder or under the Revolving Note. The Bank is hereby irrevocably authorized by the Borrower to so endorse the Revolving Note and to attach to and make a part of the Revolving Note a continuation of any such schedule as and when required. The Bank may, at its option, record and maintain such information in its internal records rather than on such schedule.\nSection 2.3. Procedure for Borrowing.\n(a) The Borrower shall give the Bank a Notice of Borrowing, in the form of Exhibit F hereto, prior to 11:00 a.m. (Connecticut time), on the date of a Borrowing of a Base Rate Loan and at least three (3) Business Days before a Borrowing of a Eurodollar Rate Loan, specifying:\n(i) the date of such Borrowing, which shall be a Business Day,\n(ii) the principal amount of such Borrowing,\n(iii) whether the Revolving Loan comprising such Borrowing is to be a Base Rate Loan or a Eurodollar Rate Loan, and\n(iv) if a Eurodollar Rate Loan, the Interest Period with respect to such Borrowing.\n(b) No Notice of Borrowing shall be revocable by the Borrower.\n(c) There shall be no more than four (4) Interest Periods relating to Eurodollar Rate Loans outstanding at any time.\n(d) If the Bank makes a new Revolving Loan hereunder on a day on which the Borrower is to repay an outstanding Revolving Loan from the Bank, the Bank shall apply the proceeds of its new Revolving Loan to make such repayment and only an amount equal to the excess (if any) of the amount being borrowed over the amount being repaid shall be made available by the Bank to the Borrower.\n(e) Notwithstanding anything to the contrary herein contained, if, upon the expiration of any Interest Period applicable to any Borrowing of a Revolving Loan, the Borrower shall fail to give a new Notice of Borrowing and Borrowing Base Certificate as set forth in this Section, the Borrower shall be deemed to have given a Borrowing Base Certificate demonstrating a Borrowing Base in excess of the aggregate principal amount of Revolving Loans outstanding and a new Notice of Borrowing of a Base Rate Loan in principal amount equal to the outstanding principal amount of such Revolving Loan and the proceeds of the new Borrowing shall be applied directly to repay such outstanding principal amount on the day of such Borrowing.\nSection 2.4. Termination or Optional Reduction of Commitment. The Commitment shall terminate on the Revolving Loan Termination Date and any Revolving Loans then outstanding (together with accrued interest thereon) shall be due and payable on such date. No termination of the Commitment hereunder shall relieve the Borrower of any of its outstanding Obligations to the Bank hereunder or otherwise. The Borrower shall have the right, upon prior written notice of at least five (5) Business Days to the Bank, to terminate or, from time to time, reduce the Commitment, provided that (i) any such reduction of the Commitment shall be accompanied by the prepayment of the Revolving Note, together with accrued interest thereon to the date of such prepayment and any amount due pursuant to Section 2.7, to the extent, if any, that the aggregate unpaid principal amount thereof then outstanding exceeds the Commitment as then reduced and (ii) any such termination of the Commitment shall be accompanied by prepayment in full of the unpaid principal amount of the Revolving Note, together with accrued interest thereon to the date of such prepayment and any amount due pursuant to Section 2.7. Any such partial reduction of the Commitment shall be in an aggregate principal amount of $500,000 or any whole multiple of $250,000 in excess thereof and shall reduce permanently the Commitment then in effect hereunder.\nSection 2.5. Maturity of Revolving Loans. Each Revolving Loan shall mature, and the principal amount thereof shall be due and payable, on the last day of the Interest Period applicable to such Revolving Loan, or such earlier date as provided herein.\nSection 2.6. Mandatory Prepayments. If at any time the aggregate principal amount of the Revolving Loans exceeds the Borrowing Base, the Borrower shall immediately pay to the Bank, without premium or penalty (except as set forth in Section 2.16), the amount equal to said excess, accompanied by the payment of accrued interest on the amount of such payment to the date thereof.\nSection 2.7. Optional Prepayments.\n(a) The Borrower may, upon at least one (1) Business Day's notice to the Bank, prepay any Base Rate Loan, without premium or penalty, in whole at any time or from time to time in part by paying the principal amount being prepaid together with accrued interest thereon to the date of prepayment.\n(b) The Borrower may, upon at least three (3) Business Days' notice to the Bank, prepay any Eurodollar Rate Loan, in whole at any time or from time to time in part, without premium or penalty (except as set forth in Section 2.16), by paying the principal amount being prepaid together with accrued interest thereon to the date of prepayment.\nSection 2.8. Interest on the Revolving Loans.\n(a) Each Base Rate Loan shall bear interest on the outstanding principal amount thereof, for each day from the date such Base Rate Loan is made until it becomes due, at a rate per annum equal to the Base Rate for such day, plus the Applicable Margin. Interest shall be payable monthly in arrears on the first Business Day of each calendar month, commencing January 1, 1996. Such interest shall accrue from and including the date of such Borrowing to but excluding the date of any repayment thereof and shall be computed on the basis of a fraction, the numerator of which is the actual number of days elapsed from the date of Borrowing and the denominator of which is three hundred sixty (360). Overdue principal of and, to the extent permitted by law, overdue interest on the Base Rate Loans shall bear interest for each day overdue until paid at a percentage per annum equal to the Default Rate.\n(b) Each Eurodollar Rate Loan shall bear interest on the unpaid principal amount thereof, for each day from the date such Eurodollar Rate Loan is made until it becomes due, at a rate per annum equal to the Eurodollar Rate for the relevant Interest Period, plus the Applicable Margin. Interest shall be payable on the last day of the Interest Period applicable thereto; provided, that if such Interest Period is longer than ninety (90) days, interest shall be payable every ninety (90) days and on the last day of such Interest Period. Such interest shall accrue from and including the date of such Borrowing to but excluding the date of any repayment thereof and shall be computed on the basis of a fraction, the numerator of which is the actual number of days elapsed from the date of Borrowing and the denominator of which is three hundred sixty (360). Overdue principal of and, to the extent permitted by law, overdue interest on the Eurodollar Rate Loans shall bear interest for each day overdue until paid at a percentage per annum equal to the Default Rate.\nSection 2.9. Fees.\n(a) The Borrower shall pay a $200,000 initial facility fee to the Bank on the Closing Date.\n(b) The Borrower shall pay an additional facility fee to the Bank in an amount equal to the excess, if any, of (i) the market value (as quoted on the New York Stock Exchange) of 40,000 shares of common stock of the Guarantor as of the close of business on the earlier to occur of (X) the Revolving Loan Termination Date and (Y) the date the Bank elects to receive such additional facility fee over (ii) $240,000.00 (the \"Strike Price\"); provided, however, in the event that the Guarantor shall (x) issue additional shares of common stock as a dividend or other distribution on outstanding common stock or (y) subdivide or reclassify its outstanding shares of common stock, then, in each such event, the Strike Price shall, simultaneously with each such event, be adjusted by multiplying the then-current Strike Price by a fraction, the numerator of which shall be the number of shares of common stock outstanding immediately prior to such event and the denominator of which shall be the number of shares of common stock outstanding immediately after such event, and the product so obtained shall thereafter be the Strike Price then in effect. Such additional facility fee shall be payable by the Borrower (i) in two equal installments, the first installment to be due on the earlier to occur of (X) the Revolving Loan Termination Date and (Y) December 28, 2000, and the second installment to be due on the date occuring one year after the date the first installment was due, but not later than December 28, 2001, or (ii) upon an earlier demand by the Bank for payment, in two equal installments, the first installment to be due within 90 days after such demand for payment is made and the second installment to be due on the date occuring one year after such demand for payment is made; provided, however, if, on any date, the value of such additional facility fee equals or exceeds $200,000, the Borrower may, at its option, elect to pay on such date such additional facility fee immediately, which payment shall be in full satisfaction of the additional facility fee described herein.\n(c) The Borrower shall pay to the Bank an unused fee for the Commitment Period, payable in arrears at the Applicable Commitment Fee Percentage in effect from time to time on the daily unused portion of the Bank's Commitment with respect to the Revolving Loan. The unused fee shall be payable quarterly on the first Business Day of January, April, July and October of each year beginning in January, 1996.\n(d) The fees required by paragraphs (a), (b) and (c) of this Section shall not be refundable.\nSection 2.10. Payments Generally. All payments under this Agreement shall be made in Dollars in immediately available funds not later than 2:00 p.m.(Connecticut time) on the due date (each such payment made after such time on such due date to be deemed to have been made on the next succeeding Business Day) to the Bank at its address set forth on the signature pages hereof or at such other address as it may hereafter designate by notice to the Borrower for the account of the Lending Office of the Bank specified by the Bank on Schedule 1.1 hereto. The Borrower shall, at the time of making each payment under this Agreement, specify to the Bank the principal or other amount payable by the Borrower under this Agreement to which such payment is to be applied (and in the event that it fails to so specify, or if a Default or Event of Default has occurred and is continuing, the Bank may apply such payment as it may elect in its sole discretion). If the due date of any payment under this Agreement would otherwise fall on a day which is not a Business Day, such date shall be extended to the next succeeding Business Day and such extension of time shall in such case be included in the computation of such payment; provided that, if such extension would cause the last day of an Interest Period to occur in the next following calendar month, the last day of such Interest Period shall occur on the next preceding Business Day.\nSection 2.11. Capital Adequacy. (a) If after the date hereof, either (i) the introduction of, or any change in, or in the interpretation or enforcement of, any law, regulation, order, ruling, interpretation, directive, guideline or request or (ii) the compliance with any order, ruling, interpretation, directive, guideline or request from any central bank or other governmental authority (whether or not having the force of law) issued, announced, published, promulgated or made after the date hereof (including, in any event, any law, regulation, order, ruling, interpretation, directive, guideline or request contemplated by the report dated July, 1988 entitled \"International Convergence of Capital Measurement and Capital Standards\" issued by the Basle Committee on Banking Regulation and Supervisory Practices) affects or would affect the amount of capital required or expected to be maintained by the Bank or any corporation controlling the Bank and the Bank reasonably determines that the amount of such required or expected capital is increased by or based upon the existence of the Bank's Revolving Loans hereunder or the Bank's commitment to lend hereunder, then, upon demand by the Bank, the Borrower shall be liable for, and shall pay to the Bank, within thirty (30) days following demand from time to time by the Bank, additional amounts sufficient to compensate the Bank in the light of such circumstances for the effects of such law, regulation, order, ruling, interpretation, directive, guideline or request, to the extent that the Bank reasonably determines such increase in capital to be allocable to the existence of the Bank's Revolving Loans hereunder or of the Bank's commitment to lend hereunder. A certificate substantiating such amounts and identifying the event giving rise thereto, submitted to the Borrower by the Bank, shall be conclusive, absent manifest error.\n(b) The Bank shall notify the Borrower of any event occurring after the date hereof entitling the Bank to any compensation under paragraph (a) above as promptly as practicable, but in any event within 30 days after the Bank obtains actual knowledge thereof; provided that (i) if the Bank fails to give such notice within thirty (30) days after it obtains actual knowledge of such an event, the Bank shall, with respect to compensation payable pursuant to this Section in respect of any costs resulting from such event, only be entitled to payment under this Section for costs incurred from and after the date thirty (30) days prior to the date that the Bank does give such notice and (ii) the Bank will use reasonable efforts (consistent with its internal policy and legal and regulatory restrictions) to designate a different Lending Office for the Revolving Loans affected by such event if such designation will avoid the need for, or reduce the amount of, such compensation and will not, in the sole opinion of the Bank, be disadvantageous to the Bank.\nSection 2.12. Increased Costs.\n(a) If after the date hereof, due to either (i) the introduction of or any change in or in the interpretation or enforcement of, any law, regulation, order, ruling, directive, guideline or request, or (ii) the compliance with any order, ruling, directive, guideline or request from any central bank or other governmental authority (whether or not having the force of law) issued, announced, published, promulgated or made after the date hereof, there shall be any increase in the cost to the Bank of agreeing to make or making, funding or maintaining Eurodollar Rate Loans, then the Borrower shall be liable for, and shall from time to time, within thirty (30) days following a demand by the Bank, pay to the Bank for the account of the Bank additional amounts sufficient to compensate the Bank for such increased cost. A certificate substantiating the amount of such increased cost, submitted to the Borrower by the Bank, shall be conclusive, absent manifest error.\n(b) The Bank shall notify the Borrower of any event occurring after the date hereof entitling the Bank to any compensation under paragraph (a) above as promptly as practicable, but in any event within 30 days after the Bank obtains actual knowledge thereof; provided that (i) if the Bank fails to give such notice within thirty (30) days after it obtains actual knowledge of such an event, the Bank shall, with respect to compensation payable pursuant to this Section in respect of any costs resulting from such event, only be entitled to payment under this Section for costs incurred from and after the date thirty (30) days prior to the date that the Bank does give such notice and (ii) the Bank will use reasonable efforts (consistent with its internal policy and legal and regulatory restrictions) to designate a different Lending Office for the Revolving Loans affected by such event if such designation will avoid the need for, or reduce the amount of, such compensation and will not, in the sole opinion of the Bank, be disadvantageous to the Bank.\nSection 2.13. Illegality. Notwithstanding any other provision of this Agreement, if after the date hereof the introduction of, or any change in or in the interpretation or enforcement of, any law, regulation, order, ruling, directive, guideline or request shall make it unlawful, or any central bank or other governmental authority shall assert that it is unlawful, for the Bank or its Lending Office to perform its obligations hereunder to make Eurodollar Rate Loans or to continue to fund or maintain Eurodollar Rate Loans hereunder, then, on notice thereof by the Bank to the Borrower, (i) the obligation of the Bank to make Eurodollar Rate Loans shall terminate (and the Bank shall make all of its Revolving Loans as Base Rate Loans notwithstanding any election by the Borrower to have the Bank make Eurodollar Rate Loans) and (ii) if legally permissible, at the end of the current Interest Period for such Eurodollar Rate Loans, otherwise five (5) Business Days after such notice and demand, all Eurodollar Rate Loans of the Bank then outstanding will automatically convert into Base Rate Loans; provided, however, that before making any such demand, the Bank agrees to use reasonable efforts (consistent with its internal policy and legal and regulatory restrictions) to designate a different Lending Office if the making of such a designation would allow the Bank or its Lending Office to continue to perform its obligations to make Eurodollar Rate Loans and would not, in the judgment of the Bank, be otherwise disadvantageous to the Bank. A certificate describing such introduction or change in or in the interpretation or enforcement of such law, regulation, order, ruling, directive, guideline or request, submitted to the Borrower by the Bank, shall be conclusive evidence of such introduction, change, interpretation or enforcement, absent manifest error. The Bank and the Borrower agree to negotiate in good faith in order to agree upon a mutually acceptable mechanism to provide that Eurodollar Rate Loans made by the Bank as to which the foregoing conditions occur shall convert into Base Rate Loans.\nSection 2.14. Payments to be Free of Deductions. All payments by the Borrower under this Agreement shall be made without setoff or counterclaim and free and clear of, and without deduction for, any taxes (other than any taxes imposed on or measured by the gross income or profits of the Bank), levies, imposts, duties, charges, fees, deductions, withholdings, compulsory loans, restrictions or conditions of any nature now or hereafter imposed or levied by any country or any political subdivision thereof or taxing or other authority therein unless the Borrower is compelled by law to make such deduction or withholding. If any such obligation is imposed upon the Borrower with respect to any amount payable by it hereunder, it will pay to the Bank, on the date on which such amount becomes due and payable hereunder and in Dollars, such additional amount as shall be necessary to enable the Bank to receive the same net amount which it would have received on such due date had no such obligation been imposed upon the Borrower. If the Bank is at any time, or any permitted assignee of the Bank hereunder (an \"Assignee\"), is organized under the laws of any jurisdiction other than the United States or any state or other political subdivision thereof, the Bank or the Assignee shall deliver to the Borrower on the date it becomes a party to this Agreement, and at such other times as may be necessary in the determination of the Borrower in its reasonable discretion, such certificates, documents or other evidence, properly completed and duly executed by the Bank or the Assignee (including, without limitation, Internal Revenue Service Form 1001 or Form 4224 or any other certificate or statement of exemption required by Treasury Regulations Section 1.1441-4(a) or Section 1.1441-6(c) or any successor thereto) to establish that the Bank or the Assignee is not subject to deduction or withholding of United States Federal Income Tax under Section 1441 or 1442 of the Internal Revenue Code or otherwise (or under any comparable provisions of any successor statute) with respect to any payments to the Bank or the Assignee of principal, interest, fees or other amounts payable hereunder. Borrower shall not be required to pay any additional amount to the Bank or any Assignee under this Section if the Bank or such Assignee shall have failed to satisfy the requirements of the immediately preceding sentence; provided that if the Bank or any Assignee shall have satisfied such requirements on the date it became a party to this Agreement, nothing in this Section shall relieve Borrower of its obligation to pay any additional amounts pursuant to this Section in the event that, as a result of any change in applicable law, the Bank or such Assignee is no longer properly entitled to deliver certificates, documents or other evidence at a subsequent date establishing the fact that the Bank or the Assignee is not subject to withholding as described in the immediately preceding sentence.\nSection 2.15. Computations. All computations of interest and like payments hereunder on the Revolving Loans shall, in the absence of clearly demonstrable error, be considered correct and binding on the Borrower and the Bank, unless within thirty (30) Business Days after receipt of any notice by the Bank of such outstanding amount, the Borrower notifies the Bank to the contrary.\nSection 2.16. Compensation. In the event of any prepayment pursuant to Section 2.6 or 2.7(b), if such prepayment occurs on a date that is not the last day of the Interest Period applicable to the Revolving Loan being prepaid, the Borrower shall pay any amounts as shall be sufficient (in the reasonable opinion of the Bank) to compensate the Bank for any loss, cost or expense which the Bank may incur as a result of such prepayment, including without limitation, any loss, cost or expense incurred by reason of funds liquidation or reemployment of deposits or other funds acquired by the Bank to fund or maintain such Eurodollar Rate Loan and any administrative costs, expenses or charges of the Bank as a result thereof. Without limiting the effect of the preceding sentence, such compensation shall include an amount equal to the excess, if any, of (i) the amount of interest that otherwise would have accrued on the principal amount so prepaid for the period from the date of such prepayment to the last day of the then current Interest Period for such Eurodollar Rate Loan at the applicable rate of interest for such Eurodollar Rate Loan provided for herein over (ii) the amount of interest that otherwise would have accrued on such principal amount at a rate per annum equal to the interest component of the amount the Bank would have bid in the London interbank market for Dollar deposits of leading banks in amounts comparable to such principal amount and with maturities comparable to such period (as reasonably determined by the Bank), if the Bank has match-funded such Eurodollar Rate Loan, or the Bank's cost of funds, if the Bank has not match-funded. The Bank will furnish to the Borrower a certificate setting forth the basis and amount of each request by such Bank for compensation under this Section.\nARTICLE 3. SECURITY.\nSection 3.1. Security Agreement and Guaranty. In order to secure payment when due of the principal and interest under the Revolving Note and the other Obligations, the Borrower agrees to deliver to the Bank or cause to be delivered to the Bank on the Closing Date the following:\n(a) the Security Agreement duly executed by the Borrower;\n(b) the Receivables Purchase Agreement duly executed and delivered by the Borrower and each of the Eligible Sellers;\n(c) the Guaranty duly executed and delivered by the Guarantor; and\n(d) the Financing Statements.\nSection 3.2. Pledge Agreement. In order to further secure payment when due of the principal and interest under the Revolving Note and the other Obligations, subject to obtaining the Pledge Approvals, the Borrower agrees to cause to be delivered to the Bank within five (5) Business Days after the Pledge Approvals have been obtained the following:\n(a) the Pledge Agreement duly executed and delivered by the Guarantor;\n(b) stock certificates representing all of the outstanding capital stock of NFIC, NFL and the Borrower (with stock powers signed in blank);\n(c) the Stock Pledge Financing Statements duly executed and delivered by the Guarantor; and\n(d) favorable opinions of counsel to the Guarantor, dated as of the date of the Pledge Agreement, in substantially the form set forth in Exhibit J-3.\nSection 3.3. Further Assurances. At any time following the delivery of this Agreement, the Security Agreement, the Guaranty, or the Pledge Agreement to the Bank, at the request of the Bank, the Borrower will execute any certificate, instrument, statement or document and will procure any such certificate, instrument, statement or document (and pay all connected costs) which the Bank reasonably deems necessary to preserve the security interests of the Bank contemplated hereby.\nSection 3.4. Required Consents and Approvals. The Borrower agrees to use, or cause the Guarantor to use, reasonable efforts to obtain, or cause to be obtained, as soon as practicable, all necessary approvals and consents by the appropriate Insurance Commissioners permitting the pledge of all of the capital stock of NFL, NFIC and the Borrower to the Bank and the execution and delivery of the Pledge Agreement (collectively, the \"Pledge Approvals\"). The Bank acknowledges and agrees that receipt of the Pledge Approvals is not a condition to performance by the Bank of its obligations hereunder.\nARTICLE 4. CONDITIONS PRECEDENT.\nSection 4.1. Documentary Conditions Precedent. The Commitment of the Bank to make Revolving Loans under this Agreement is subject to the condition precedent that the Borrower shall have delivered to the Bank, on or prior to the Closing Date, the following, in form and substance satisfactory to the Bank:\n(a) the Revolving Note for the account of the Bank duly executed by the Borrower;\n(b) a certificate of the Secretary or Assistant Secretary of the Borrower, dated the Closing Date, attesting on behalf of the Borrower to all corporate action taken by the Borrower, including resolutions of its Board of Directors authorizing the execution, delivery and performance of this Agreement, the Security Agreement, the Revolving Note, the Receivables Purchase Agreement and each other document to be delivered by the Borrower pursuant to this Agreement, and attesting to the names and true signatures of the officers of the Borrower authorized to sign this Agreement, the Security Agreement, the Receivables Purchase Agreement, the Revolving Note, and the other documents to be delivered by the Borrower under this Agreement;\n(c) a certificate of the Secretary or Assistant Secretary of the Guarantor, dated the Closing Date, attesting on behalf of the Guarantor to all corporate action taken by the Guarantor, including resolutions of its Board of Directors authorizing the execution, delivery and performance of the Guaranty and the Pledge Agreement (following receipt of the Pledge Approvals) and each other document to be delivered by the Guarantor thereunder, and attesting to the names and true signatures of the officers of the Guarantor authorized to sign the Guaranty, the Pledge Agreement (following the receipt of the Pledge Approvals) and the other documents to be delivered by the Guarantor thereunder;\n(d) a certificate of the Secretary or Assistant Secretary of each Eligible Seller, dated the Closing Date, attesting on behalf of such Eligible Seller to all corporate action taken by such Eligible Seller, including resolutions of its Board of Directors authorizing the execution, delivery and performance of the Receivables Purchase Agreement and each other document to be delivered by the Eligible Seller thereunder, and attesting to the names and true signatures of the officers of the Eligible Seller authorized to sign the Receivables Purchase Agreement and the other documents to be delivered by the Eligible Seller thereunder;\n(e) a certificate of a Senior Officer of the Borrower, dated the Closing Date, certifying on behalf of the Borrower that (i) the representations and warranties of the Borrower in Article 5 of this Agreement and Section 4 of the Security Agreement are true, complete and correct in all material respects on such date as though made on and as of such date (or, if such representation or warranty is expressly stated to have been made as of a specific date, as of such specific date), (ii) no event has occurred and is continuing which constitutes a Default or Event of Default, (iii) the Borrower has performed and complied with all agreements and conditions contained in this Agreement which are required to be performed or complied with by the Borrower at or before the Closing Date, and (iv) since September 30, 1995, no event has occurred that has had, or could reasonably be expected to have, a Materially Adverse Effect;\n(f) a certificate of a Senior Officer of the Guarantor, dated the Closing Date, certifying on behalf of the Guarantor that (i) the representations and warranties of the Guarantor in Article 4 of the Guaranty are true, complete and correct in all material respects on such date as though made on and as of such date (or, if such representation or warranty is expressly stated to have been made as of a specific date, as of such specific date), (ii) no event has occurred and is continuing which constitutes a Default or Event of Default under this Agreement, (iii) the Guarantor has performed and complied with all agreements and conditions contained in the Guaranty which are required to be performed or complied with by the Guarantor at or before the Closing Date, and (iv) since September 30, 1995, no event has occurred that has had, or could reasonably be expected to have, a Materially Adverse Effect;\n(g) a certificate of a Senior Officer of each Eligible Seller, dated the Closing Date, certifying on behalf of such Eligible Seller that (i) the representations and warranties of such Eligible Seller in Article IV of the Receivables Purchase Agreement are true, complete and correct in all material respects on such date as though made on and as of such date (or, if such representation or warranty is expressly stated to have been made as of a specific date, as of such specific date), (ii) no event has occurred and is continuing which constitutes a default under the Receivables Purchase Agreement, and (iii) there has been no material adverse change in the financial condition, operations, Properties, business, or as far as the Eligible Seller can reasonably foresee, prospects of the Eligible Seller since September 30, 1995;\n(h) a certificate of a Senior Officer of the Borrower, substantially in the form of Exhibit K, which certificate shall include information required to establish that the Borrower will be in compliance with the covenants set forth in Sections 7.10 to 7.11 of this Agreement, after giving effect to the transactions contemplated herein;\n(i) a certificate of a Senior Officer of the Guarantor, substantially in the form of Attachment 4 to Exhibit A to the Guaranty, which certificate shall include information required to establish that the Guarantor will be in compliance with the covenants set forth in Sections 6.3 to 6.8 of the Guaranty, after giving effect to the transactions contemplated herein and in the Guaranty Agreement;\n(j) a certificate of good standing for the Borrower as of a recent date by the Secretary of State of its jurisdiction of incorporation and each state where the Borrower, by the nature of its business, is required to qualify to do business, except where the failure to be so qualified would not have a Materially Adverse Effect;\n(k) a certificate or similar instrument from the appropriate tax authority in the State of Delaware and, if different, its principal place of business, as to the payment by the Borrower of all taxes owed;\n(l) a certificate of good standing for the Guarantor as of a recent date by the Secretary of State of its jurisdiction of incorporation and each state where the Guarantor, by the nature of its business, is required to qualify to do business, except where the failure to be so qualified would not have a Materially Adverse Effect;\n(m) a certificate or similar instrument from the appropriate tax authority in the State of Delaware and, if different, its principal place of business, as to the payment by the Guarantor of all taxes owed;\n(n) a certificate of good standing for HCO as of a recent date by the Secretary of State of its jurisdiction of incorporation and each state where HCO, by the nature of its business, is required to qualify to do business, except where the failure to be so qualified would not have a Materially Adverse Effect;\n(o) with respect to each Eligible Seller, a certificate or similar instrument from the appropriate tax authority in its jurisdiction of incorporation as to the payment by such Eligible Seller of all taxes owed;\n(p) a certificate of authority from each Insurance Commissioner certifying that each Insurance Affiliate is duly licensed and in good standing with the applicable Insurance Commissioner;\n(q) a favorable opinion of counsel to the Borrower,the Eligible Sellers and the Guarantor dated the Closing Date, in substantially the form set forth in Exhibit J-1 hereto;\n(r) a favorable opinion of counsel to the Guarantor and each Eligible Seller, dated the Closing Date, in substantially the form set forth in Exhibit J-2 hereto;\n(s) a certificate of a Senior Officer of the Borrower certifying that each consent, license, approval and notice required by the Borrower in connection with the execution, delivery, performance, validity and enforceability of this Agreement, the Security Agreement, the Receivables Purchase Agreement and each other document and instrument required to be delivered in connection herewith is in full force and effect, except as otherwise provided in Section 5.15 of this Agreement;\n(t) a certificate of a Senior Officer of the Guarantor certifying that each consent, license, approval and notice required by the Guarantor in connection with the execution, delivery, performance, validity and enforceability of this Agreement, the Security Agreement, the Pledge Agreement (subject to the Pledge Approvals), the Guaranty, the Receivables Purchase Agreement and each other document and instrument required to be delivered in connection herewith, including the documents described in Article 3 hereof, is in full force and effect, except as otherwise provided in Section 5.15 of this Agreement;\n(u) a certificate of a Senior Officer of each Eligible Seller certifying that each consent, license, approval and notice required by such Eligible Seller in connection with the execution, delivery, performance, validity and enforceability of the Receivables Purchase Agreement and each other document and instrument required to be delivered in connection herewith is in full force and effect, except as otherwise provided in Section 5.15 of this Agreement;\n(v) a Master General Agent Contract for each Master General Agent, attached to a certificate of a Senior Officer of the Eligible Seller party thereto certifying that such Master General Agent Contract is a true, correct and complete copy, including all amendments and supplements thereto, and is in full force and effect on the Closing Date;\n(w) all corporate and legal proceedings and all instruments and agreements in connection with the transactions contemplated by this Agreement, the Security Agreement, the Pledge Agreement (subject to the Pledge Approvals), the Guaranty and the Receivables Purchase Agreement shall be satisfactory in form and substance to the Bank and the Bank shall have received any and all other information and documents with respect to the Borrower, the Guarantor and any Eligible Seller, which it may reasonably request;\n(x) payment to the Bank of the initial facility fee in the amount of $200,000; and\n(y) payment to Day, Berry & Howard, special counsel to the Bank, of its legal fees and disbursement.\nSection 4.2. Additional Conditions Precedent to Each Loan. The obligation of the Bank to make the Revolving Loans pursuant to a Borrowing (including the initial Borrowing), unless waived by the Bank, shall be subject to the further conditions precedent that on the date of such Revolving Loan:\n(a) the representations and warranties of the Borrower contained in Article 5 of this Agreement and Section 4 of the Security Agreement are true and correct in all material respects on and as of the date of such Revolving Loan as though made on and as of such date (or, if such representation or warranty is expressly stated to have been made as of a specific date, as of such specific date);\n(b) the representations and warranties of the Guarantor contained in Article 5 of the Guaranty and Section 2 of the Pledge Agreement (if in effect) are true and correct in all material respects on and as of the date of such Revolving Loan as though made on and as of such date (or, if such representation or warranty is expressly stated to have been made as of a specific date, as of such specific date);\n(c) the representations and warranties of each Eligible Seller contained in Article IV of the Receivables Purchase Agreement are true and correct in all material respects on and as of the date of such Revolving Loan as though made on and as of such date (or, if such representation or warranty is expressly stated to have been made as of a specific date, as of such specific date);\n(d) the Borrower has complied with all conditions contained in this Agreement that are required to be complied with by the Borrower, and the Borrower has performed in all material respects all agreements contained in this Agreement and the Security Agreement that are required to be performed by the Borrower;\n(e) there does not exist any Default or Event of Default under this Agreement;\n(f) since the date of the last Borrowing under this Agreement (or if no Borrowing has occurred, since September 30, 1995), there has occurred no event that could reasonably be expected to have a Materially Adverse Effect;\n(g) the Bank shall have received a duly executed Notice of Borrowing in the form of Exhibit F, and a duly executed Borrowing Base Certificate in the form of Exhibit L, except to the extent otherwise provided in Section 2.3(e);\n(h) the Bank shall have received a duly executed Assignment for each Receivable included in the calculation of the Borrowing Base;\n(i) the Bank shall have received evidenced, in form and substance satisfactory to it, that each consent, approval, order, license, or permit required from any Person, including without limitation any Insurance Commissioner, required to authorize, or required in connection with the performance by the Borrower, the Guarantor or any Eligible Seller of, or the legality, validity, binding effect or enforceability of, this Agreement, the Guaranty or the Receivables Purchase Agreement, including the use of proceeds of any Borrowing by the Borrower to acquire Eligible Receivables, shall have been received or given and remain in full force and effect, and the Bank shall have received updated legal opinions in form and substance satisfactory to the Bank relating to such matters.\nSection 4.3. Deemed Representations. Each Notice of Borrowing hereunder and acceptance by the Borrower of the proceeds of such Borrowing shall constitute a representation and warranty that the statements contained in Section 4.2, in the Notice of Borrowing and in the Borrowing Base Certificate are true and correct both on the date of such Notice of Borrowing and, unless the Borrower otherwise notifies the Bank prior to such Borrowing, as of the date of such Borrowing.\nARTICLE 5. REPRESENTATIONS AND WARRANTIES.\nThe Borrower hereby represents and warrants the following:\nSection 5.1. Incorporation, Good Standing and Due Qualification. The Borrower is duly incorporated, validly existing and in good standing under the laws of its jurisdiction of incorporation, has the power and authority to own its assets and to transact the business in which it is now engaged, and is duly qualified as a foreign corporation and in good standing under the laws of each other jurisdiction in which such qualification is required, except where the failure to be so qualified could not reasonably be expected to have a Materially Adverse Effect. The Borrower has all requisite power and authority to execute and deliver and to perform all of its obligations under this Agreement, the Revolving Note, the Security Agreement, the Receivables Purchase Agreement and the other writings contemplated hereby.\nSection 5.2. Corporate Power and Authority; No Conflicts. The execution, delivery and performance by the Borrower of this Agreement, the Security Agreement, the Receivables Purchase Agreement and the Revolving Note have been duly authorized by all necessary corporate action and do not and will not (a) require any consent or approval of its stockholders; (b) violate any provisions of its certificate of incorporation or by-laws; (c) violate any provision of, or require any filing, registration, consent or approval under, any law, rule, regulation (including without limitation, Regulation U and X), order, writ, judgment, injunction, decree, determination or award presently in effect having applicability to and binding upon the Borrower or any Subsidiary; (d) result in a breach of, or constitute a default or require any consent under, any indenture, mortgage or loan or credit agreement or any other material agreement, lease or instrument to which the Borrower or any Subsidiary is a party or by which it or its Properties may be bound; or (e) except as contemplated hereby, or by the Revolving Note or the Security Agreement, result in, or require, the creation or imposition of any Lien upon or with respect to any of the Properties now owned or hereafter acquired by the Borrower.\nSection 5.3. Legally Enforceable Agreements. This Agreement, the Security Agreement and the Revolving Note constitute the legal, valid and binding obligations of the Borrower enforceable against the Borrower in accordance with their respective terms, except to the extent that such enforcement may be limited by applicable bankruptcy, insolvency, reorganization, moratorium and other similar laws affecting creditors' rights generally and by general principles of equity (regardless of whether such enforceability is considered in a proceeding in equity or at law).\nSection 5.4. Litigation. Except as disclosed on Schedule 5.4, there are no actions, suits or proceedings or investigations (other than routine examinations performed by insurance regulatory authorities) pending or, to the knowledge of the Borrower, threatened against or affecting, the Borrower or any of its Subsidiaries, or any Property of any of them before any court, governmental agency or arbitrator, which if determined adversely to the Borrower or any Subsidiary would in any one case or in the aggregate, have a Materially Adverse Effect.\nSection 5.5. Disclosures. No written information, exhibit or report furnished by or on behalf of the Borrower to the Bank in connection with the negotiation of this Agreement, including the report entitled \"Agent Debit Balances - October, 1995\" of Westbridge Capital Corp., contained any material misstatement of fact or omitted to state any fact necessary to make the statements contained therein not materially misleading. All written financial projections furnished by or on behalf of the Borrower to the Bank in connection with the negotiation of this Agreement, have been prepared in good faith and on reasonable assumptions. Since September 30, 1995, no event or circumstance has occurred that could reasonably be expected to have a Materially Adverse Effect.\nSection 5.6. Ownership and Liens. Each of the Borrower and its Subsidiaries has good and valid title to, or valid leasehold interests in, its material Properties, and none of the material Properties owned by the Borrower or its Subsidiaries, and none of its leasehold interests is subject to any Lien, except any Permitted Liens.\nSection 5.7. Taxes. Each of the Borrower and its Subsidiaries has filed (or had filed on its behalf) all federal and all other material tax returns required to be filed, has paid all due and payable taxes, assessments and governmental charges and levies, including interest and penalties, imposed upon it or upon its Properties, and has made adequate provision for the payment of such taxes, assessments and other charges accruing but not yet due and payable, except with respect to taxes which are being contested in good faith by the Borrower or its Subsidiaries and for which such Person has established and maintains adequate reserves for payment. To the best knowledge of Borrower, there is no tax assessment contemplated or proposed by any governmental agency against the Borrower or any of its Subsidiaries that could reasonably be expected to have a Materially Adverse Effect, other than, as of each date subsequent to the Closing Date, such contemplated or proposed tax assessments with respect to which (i) Borrower has promptly notified Bank in writing of its knowledge and (ii) the Borrower or the appropriate Subsidiary of the Borrower has in good faith commenced, or intends to commence within the time period permitted by the applicable law or regulation, and thereafter diligently pursued or will pursue, as the case may be, appropriate proceedings in opposition to such assessment.\nSection 5.8. ERISA. Each of the Borrower and its Subsidiaries is in compliance in all material respects with all applicable provisions of ERISA. Within the three-year period prior to the date hereof, neither a Reportable Event nor a Prohibited Transaction has occurred with respect to any Plan; no notice of intent to terminate a Plan has been filed nor has any Plan been terminated; no circumstance exists which constitutes grounds under Section 4042 of ERISA entitling the PBGC to institute proceedings to terminate, or appoint a trustee to administer, a Plan, nor has the PBGC instituted any such proceedings; neither the Borrower nor any ERISA Affiliate has completely or partially withdrawn under Sections 4201 or 4204 of ERISA from a Multiemployer Plan; each of the Borrower and its ERISA Affiliates has met its minimum funding requirements under ERISA with respect to all of its Plans and there are no Unfunded Vested Liabilities and neither the Borrower nor any ERISA Affiliate has incurred any material liability to the PBGC under ERISA other than for premium payments incurred in the normal course of operating the Plans.\nSection 5.9. Subsidiaries and Ownership of Stock. The Borrower has no Subsidiaries.\nSection 5.10. Credit Arrangements. Schedule 5.10 is a complete and correct list of all credit agreements, indentures, guaranties, Capital Leases, mortgages, and other instruments, agreements and arrangements presently in effect providing for or relating to extensions of credit (including agreements and arrangements for the issuance of letters of credit or for acceptance financing) in respect of which the Borrower or any of its Subsidiaries is in any manner directly or contingently obligated, other than trade payables in the ordinary course of business; and the maximum principal or face amounts of the credit in question, which are outstanding and which can be outstanding, are therein set forth and are correctly stated as of the date hereof, and all Liens given or agreed to be given as security therefor are therein set forth and are correctly described or indicated in such Schedule.\nSection 5.11. Operation of Business. Each of the Borrower and its Subsidiaries possesses all licenses, permits and franchises, or rights thereto, necessary to conduct its business as now conducted and as presently proposed to be conducted, except where the absence of which could reasonably be expected to have a Materially Adverse Effect, and neither the Borrower nor any of its Subsidiaries is in violation in any material respect of any valid rights of others with respect to any of the foregoing.\nSection 5.12. No Default on Outstanding Judgments or Orders. Each of the Borrower and its Subsidiaries has satisfied all material judgments and neither the Borrower nor any Subsidiary is in default with respect to any judgment, writ, injunction, decree, rule or regulation of any court, arbitrator or federal, state, municipal or other governmental authority, commission, board, bureau, agency or instrumentality, domestic or foreign, which could, in any one case or in the aggregate, reasonably be expected to have a Materially Adverse Effect.\nSection 5.13. No Defaults on Other Agreements. Neither the Borrower nor any of its Subsidiaries is in default in any material respect in the performance, observance or fulfillment of any of the obligations, covenants or conditions contained in any agreement or instrument material to its business to which it is a party.\nSection 5.14. Governmental Regulation. Neither the Borrower nor any of its Subsidiaries is subject to regulation under the Investment Company Act of 1940, as amended, or any statute or regulation limiting its ability to incur indebtedness for money borrowed as contemplated hereby.\nSection 5.15. Consents and Approvals. No authorization, consent, approval, order, license or permit from, or filing, registration or qualification with, or exemption by, any governmental or public body or authority, or any subdivision thereof, or any other Person, including without limitation, any Insurance Commissioner, is required to authorize, or is required in connection with the execution, delivery and performance by the Borrower of, or the legality, validity, binding effect or enforceability with respect to the Borrower of, this Agreement, or the Receivables Purchase Agreement, except for (i) filings and recordings of Liens created pursuant to the Security Agreement, (ii) those consents, approvals or other similar actions that have been obtained and have not been modified, amended, rescinded or revoked and are in full force and effect, and (iii) consents, approvals or similar actions, the failure of which to obtain or perform could not reasonably be expected to have a Materially Adverse Effect.\nSection 5.16. Partnerships. Neither the Borrower nor any of its Subsidiaries is a partner in any partnership.\nSection 5.17. Environmental Protection. Each of the Borrower and its Subsidiaries has obtained all material permits, licenses and other authorizations which are required under all environmental laws, including laws relating to emissions, discharges, releases or threatened releases of pollutants, contaminants, chemicals or industrial, toxic or 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, chemicals, or industrial, toxic or hazardous substances or wastes, except to the extent failure to have any such permit, license or authorization could not reasonably be expected to have a Materially Adverse Effect. Each of the Borrower and its Subsidiaries is in compliance with all terms and conditions of the required permits, licenses and authorizations, and is also in compliance with all other limitations, restrictions, conditions, standards, prohibitions, requirements, obligations, schedules and timetables contained in the environmental laws or contained in any regulation, code, plan, order, decree, judgment, injunction, notice or demand letter issued, entered, promulgated or approved thereunder, except to the extent failure to comply could not reasonably be expected to have a Materially Adverse Effect. None of the Properties of the Borrower or its Subsidiaries, either owned or leased, have been included or, to the knowledge of the Borrower, proposed for inclusion on the National Priorities List adopted pursuant to the Comprehensive Environmental Response Compensation and Liability Act, as amended, or on any similar list or inventory of sites requiring response or cleanup actions adopted by any other federal, state or local agency.\nSection 5.18. Copyrights, Patents, Trademarks, Etc. Neither the Borrower nor any of its Subsidiaries uses in the operation of its business as presently conducted, any patents, trademarks, service marks, trade names, or copyrighted materials the loss by the Borrower or such Subsidiary of which would have a Materially Adverse Effect.\nSection 5.19. Compliance with Laws. Neither the Borrower nor any of its Subsidiaries is in violation of any laws, ordinances, rules or regulations, applicable to it, of any federal, state or municipal governmental authorities, instrumentalities or agencies, including without limitation, the United States Occupational Safety and Health Act of 1970, as amended, except where such violation could not reasonably be expected to have a Materially Adverse Effect.\nSection 5.20. Receivables. All Receivables and all books, records and documents relating thereto are and will be genuine and in all respects what they purport to be; the amount of each Receivable shown on the books and records of the Borrower (as adjusted on the books and records of the Borrower, from time to time, to reflect payments received by the Borrower with respect to such Receivable) represented as owing or to be owing at maturity by each Eligible Agent Obligor is and will be the correct amount actually owing or to be owing by such Eligible Agent Obligor at maturity. The Borrower has no knowledge of any fact which would impair the validity or collectibility of any Receivable, except to the extent that such impairment could not reasonably be expected to have a Materially Adverse Effect.\nSection 5.21. Use of Proceeds. Neither Borrower nor any of its Subsidiaries nor any Eligible Seller is engaged principally, or as one of its important activities, in the business of extending credit for the purpose of purchasing or carrying any such \"margin stock.\"\nARTICLE 6. AFFIRMATIVE COVENANTS\nDuring the term of this Agreement, and until performance, payment and\/or satisfaction in full of the Obligations, the Borrower covenants and agrees that it shall, and shall cause each of its Subsidiaries to, unless the Bank otherwise consents in writing:\nSection 6.1. Maintenance of Existence. Preserve and maintain its corporate existence and good standing in the jurisdiction of its incorporation, and qualify and remain qualified as a foreign corporation in each jurisdiction in which such qualification is required from time to time, except where failure to be so qualified would not have a Materially Adverse Effect.\nSection 6.2. Conduct of Business. Continue to engage in a business of the same general type as conducted by it on the date of this Agreement.\nSection 6.3. Maintenance of Properties. Maintain, keep and preserve all of its material Properties (tangible and intangible), necessary or useful in the conduct of its business, in good working order and condition, ordinary wear and tear excepted, except that the failure to maintain, preserve and protect a particular item of Property that is not of significant value, either intrinsically or to the operations of Borrower and its Subsidiaries, taken as a whole, shall not constitute a violation of this covenant.\nSection 6.4. Maintenance of Records. Keep accurate and complete records and books of account, in which complete entries will be made in accordance with GAAP, reflecting all financial transactions of the Borrower and its Subsidiaries.\nSection 6.5. Maintenance of Insurance. Maintain insurance (subject to customary deductibles and retentions) with financially sound and reputable insurance companies, in such amounts and with such coverages (including without limitation public liability insurance, fire, hazard and extended coverage insurance on all of its assets, necessary workers' compensation insurance and all other coverages as are consistent with industry practice) as are maintained by companies of established reputation engaged in similar businesses and similarly situated; provided that such insurance may be obtained from Affiliates of the Borrower.\nSection 6.6. Compliance with Laws. Comply in all respects with all applicable laws, rules, regulations and orders, except where the failure to so comply would not have a Materially Adverse Effect. Such compliance shall include, without limitation, paying all taxes, assessments and governmental charges imposed upon it or upon its Property (and all penalties and other costs, if any, related thereto), unless contested in good faith by appropriate proceedings and for which adequate reserves have been set aside.\nSection 6.7. Right of Inspection. From time to time upon prior notice and in accordance with customary standards and practices within the banking industry (including, without limitation, upon any Event of Default or whenever the Bank may have reasonable cause to believe that an Event of Default has occurred and is continuing), the Borrower shall permit the Bank or any agent or representative thereof, to examine and make copies and abstracts from the records and books of account of, and visit the Properties of, the Borrower and its Subsidiaries to discuss the affairs, finances and accounts of the Borrower and any such Subsidiaries with any of their respective officers and directors and the Borrower's independent accountants, and to make such verification concerning the Borrower and its Subsidiaries as may be reasonable under the circumstances, and upon request, furnish promptly to the Bank true copies of all financial information made available to Senior Officers of Borrower and its Subsidiaries; provided, that the Bank shall use reasonable efforts to not materially interfere with the business of the Borrower and its Subsidiaries and to treat as confidential any and all information obtained pursuant to this Section, except to the extent disclosure is required by any law, regulation, order, ruling, directive, guideline or request from any central bank or other government authority (whether or not having the force of law).\nSection 6.8. Reporting Requirements. The Borrower shall, and shall cause each of its Subsidiaries, as applicable, to, furnish to the Bank:\n(a) Annual GAAP Statements of Borrower. Within one hundred twenty (120) days following the end of Borrower's fiscal year copies of:\n(i) the consolidated and consolidating balance sheets of the Borrower and its Subsidiaries as at the close of such fiscal year, and\n(ii) the consolidated and consolidating statements of operations and statements of stockholders' equity and cash flows, in each case of the Borrower and its Subsidiaries for such fiscal year,\nin each case setting forth in comparative form the figures for the preceding fiscal year and prepared in accordance with GAAP, all in reasonable detail and accompanied by an opinion of Price Waterhouse LLP or other firm of independent public accountants of recognized national standing selected by the Borrower and reasonably acceptable to the Bank on such consolidated balance sheets and consolidated statements, to the effect that the financial statements have been prepared in accordance with GAAP (except for changes in application in which such accountants concur) and present fairly in all material respects in accordance with GAAP the financial condition of the Borrower and its Subsidiaries as of the end of such fiscal year and the results of its operations for the fiscal year then ended 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 under the circumstances.\n(b) Quarterly GAAP Statements of Borrower. As soon as available, and in any event within sixty (60) days after the end of each quarterly fiscal period of the Borrower (other than the fourth fiscal quarter of any fiscal year), copies of:\n(i) the consolidated and consolidating balance sheets of the Borrower and its Subsidiaries as at the end of such fiscal quarter, and\n(ii) the consolidated and consolidating statements of operations and consolidated statements of stockholders' equity and cash flows, in each case of the Borrower and its Subsidiaries for such fiscal quarter and the portion of such fiscal year ended with such fiscal quarter,\nin each case setting forth in comparative form the figures for the preceding fiscal year and prepared in accordance with GAAP all in reasonable detail and certified as presenting fairly in accordance with GAAP the financial condition of the Borrower and its Subsidiaries as of the end of such period and the results of operations for such period by a Senior Officer of such company, subject only to normal year-end accruals and audit adjustments and the absence of footnotes.\n(c) Management Letters. Promptly upon receipt thereof, copies of any reports or management letters relating to the internal financial controls and procedures delivered to the Borrower or any of its Subsidiaries by any independent certified public accountant in connection with examination of the financial statements of the Borrower or any such Subsidiary.\n(d) SEC Filings. Promptly after the same are available, copies of each annual report, proxy or financial statement or other report or communication, if any, sent to the stockholders of the Borrower generally and copies of all annual, regular, periodic and special reports and registration statements which the Borrower may file or be required to file with the Securities and Exchange Commission under Sections 13 and 15(d) of the Securities and Exchange Act of 1934.\n(e) Notice of Litigation. Promptly after the commencement thereof, notice of any action, suit and proceeding before any court or governmental department, commission, board, bureau, agency or instrumentality, domestic or foreign, against the Borrower or any of its Subsidiaries, (A) which, if determined adversely to the Borrower or such Subsidiary, would have a Materially Adverse Effect, or (B) commenced by any creditor or lessor under any written credit agreement with respect to borrowed money or material lease which asserts a default thereunder on the part of the Borrower or any of its Subsidiaries.\n(f) Notices of Default. As soon as practicable and in any event within fifteen (15) days after the occurrence of each Default or Event of Default, a written notice setting forth the details of such Default or Event of Default and the action which is proposed to be taken by the Borrower with respect thereto.\n(g) Other Filings. Promptly upon the filing thereof and at any time upon the reasonable request of the Bank, permit the Bank the opportunity to review copies of all reports, including annual reports, and notices which the Borrower or any Subsidiary files with or receives from the PBGC or the U.S. Department of Labor under ERISA; and as soon as practicable and in any event within fifteen (15) days after the Borrower or any if its Subsidiaries knows or has reason to know that any Reportable Event or Prohibited Transaction has occurred with respect to any Plan or that the PBGC or the Borrower or any such Subsidiary has instituted or will institute proceedings under Title IV of ERISA to terminate any Plan, the Borrower will deliver to the Bank a certificate of a Senior Officer of the Borrower setting forth details as to such Reportable Event or Prohibited Transaction or Plan termination and the action the Borrower proposes to take with respect thereto.\n(h) Additional Information. Such additional information as the Bank may reasonably request concerning the Borrower and its Subsidiaries and for that purpose all pertinent books, documents and vouchers relating to its business, affairs and Properties, including investments as shall from time to time be designated by the Bank.\nSection 6.9. Certificates.\n(a) Officers' Certificate. Simultaneously with each delivery of financial statements pursuant to Section 6.8(a) and 6.8(b), the Borrower shall deliver to the Bank a certificate of its Chief Financial Officer which will\n(i) certify on behalf of the Borrower that such officer has reviewed the Agreement and the other Loan Documents and the condition and transactions of the Borrower and its Subsidiaries for the period covered by such financial statements, and state that to the best of his knowledge the Borrower has observed or performed all of its covenants and other agreements, and satisfied every condition, contained in this Agreement and the other Loan Documents, and 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(ii) include information (with detailed calculations in the form set out in Exhibit K) required to establish whether the Borrower was in compliance with the covenants set forth in Sections 7.10, 7.11 and 7.12 of this Agreement during the period covered by the financial statements then being delivered, and\n(iii) include information (with detailed calculations in the form set out in Exhibit K) required to establish whether, as of the last day of each month during the prior calendar quarter, the Borrowing Base exceeded the aggregate principal amount of the Revolving Loans outstanding on each such date.\n(b) Accountant's Certificate. Simultaneously with each delivery of financial statements pursuant to Section 6.8(a), the Borrower will deliver to the Bank a certificate of the independent certified public accountants who certify such statements, stating whether, in the course of their audit of the financial statements, they obtained any knowledge of a condition or event which constitutes a Default or Event of Default and the nature thereof.\nSection 6.10. Further Assurances. The Borrower shall take all such further actions and execute and file or record, at its own cost and expense, all such further documents and instruments as the Bank may at any time reasonably determine may be necessary or advisable; and shall do, execute, acknowledge, deliver, record, file, re-file, record, register and re-register any and all such further acts, deeds, conveyances, estoppel certificates, transfers, certificates, assurances and other instruments as the Bank may reasonably require from time to time in order to carry out more effectively the purposes of this Agreement, the Security Agreement, the Guaranty, the Pledge Agreement, the Receivables Purchase Agreement or the Revolving Note.\nSection 6.11. Compliance with Agreements. Promptly and fully comply with all contractual obligations under all agreements, mortgages, indentures, leases and\/or instruments to which any one or more of the Borrower and its Subsidiaries is a party, whether such agreements, mortgages, indentures, leases or instruments are with the Bank or another Person, except where such failure to so comply would not have a Materially Adverse Effect.\nSection 6.12. Use of Proceeds. Use proceeds of the Revolving Loans solely to (i) acquire Eligible Receivables, (ii) repay Revolving Loans made hereunder, (iii) pay to the Bank interest accrued on the Revolving Loans made hereunder, (iv) pay to the Bank the fees described in Section 2.9, (v) pay costs, expenses and charges described in Section 9.3(a), and (vi) pay reasonable costs, expenses and charges of outside legal counsel to the Borrower, the Guarantor and each Eligible Seller incurred in connection with the preparation, negotiation and regulatory approval of this Agreement, the Security Agreement, the Pledge Agreement, the Guaranty, the Receivables Purchase Agreement and the Revolving Note. No part of such proceeds shall be used to purchase or carry, or to extend credit to others for the purpose of purchasing or carrying, any \"margin stock\" (as such term is defined in Regulation G of the Board of Governors of the Federal Reserve System) in violation of Regulations U and X.\nARTICLE 7. NEGATIVE COVENANTS.\nDuring the term of this Agreement, and until performance, payment and\/or satisfaction in full of the Obligations, the Borrower covenants and agrees that Borrower shall not, and shall not permit its Subsidiaries to, unless the Bank otherwise consents in writing:\nSection 7.1. Debt. Create, incur, assume or suffer to exist any Debt, except:\n(a) Debt of the Borrower under this Agreement and the Revolving Note;\n(b) Debt permitted under Section 7.2 hereof; and\n(c) Subordinated Debt of the Borrower or its Subsidiaries.\nSection 7.2. Guaranties, Etc. Assume, guarantee, endorse or otherwise be or become directly or contingently responsible or liable (including, but not limited to, an agreement to purchase any obligation, or to supply or advance any funds, or an agreement to cause such Person to maintain a minimum working capital or net worth or otherwise to assure the creditors of any Person against loss) for the obligations of any Person, except guaranties by endorsement of negotiable instruments for deposit or collection or similar transactions in the ordinary course of business.\nSection 7.3. Liens. Create, incur, assume or suffer to exist any Lien, upon or with respect to any of its Properties, now owned or hereafter acquired, except (the following being referred to herein as \"Permitted Liens\"):\n(a) Liens for taxes or assessments or other government charges or levies if not yet due and payable or if due and payable, if they are being contested in good faith by appropriate proceedings and for which appropriate reserves are maintained;\n(b) Liens imposed by law, such as mechanic's, materialmen's, landlord's, warehousemen's and carrier's Liens, and other similar Liens, securing obligations incurred in the ordinary course of business which are not past due for more than forty-five (45) days, or which are being contested in good faith by appropriate proceedings and for which appropriate reserves have been established;\n(c) Liens or deposits under workers' compensation, unemployment insurance, social security or similar legislation (other than ERISA);\n(d) judgment 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;\n(e) easements, rights-of-way, restrictions and other similar encumbrances which, in the aggregate, do not materially interfere with the occupation, use and enjoyment by the Borrower or any of its Subsidiaries of the Property or assets encumbered thereby in the normal course of its business or materially impair the value of the Property subject thereto; and\n(f) Liens created pursuant to the Security Agreement.\nSection 7.4. Investments. Neither the Borrower nor any of its Subsidiaries will make any Investment in any other Person, except for Permitted Investments.\nSection 7.5. Mergers and Consolidations and Acquisitions of Assets. Merge or consolidate with any Person (whether or not Borrower or any Subsidiary is the surviving entity), or acquire all or substantially all of the assets or any of the capital stock of any Person.\nSection 7.6. Sale of Assets. Sell, lease or otherwise dispose of any material assets, except in the ordinary course of business.\nSection 7.7. Stock of the Borrower, Subsidiaries, Etc. Issue any additional shares of the Borrower's capital stock to any Person or pledge, assign, hypothecate, transfer, convey, sell or otherwise dispose of, encumber or grant any security interest in, or deliver to any other Person, any shares of capital stock of its Subsidiaries, or permit any such Subsidiaries to issue any additional shares of its capital stock to any Person other than the Borrower or any Subsidiaries, except directors' qualifying shares.\nSection 7.8. Transactions with Affiliates. Enter into any transaction of any kind with any Affiliate of the Borrower, or any Person that owns or holds five percent (5%) or more of the outstanding common stock of the Borrower, other than (a) the Receivables Purchase Agreement, (b) transactions between or among Borrower and its wholly owned Subsidiaries or between or among its wholly owned Subsidiaries or (c) transactions on terms at least as favorable to the Borrower or its Subsidiaries as would be the case in an arm's-length transaction between unrelated parties of equal bargaining power.\nSection 7.9. Capital Expenditures. Make or permit to be made, or commit to make any Capital Expenditure.\nSection 7.10. Minimum Consolidated GAAP Net Worth. As of the end of any fiscal quarter, permit Consolidated GAAP Net Worth of the Borrower and its Subsidiaries to be less than an amount equal to the sum of (a) $1,000,000 plus (b) 50% of any cumulative positive Net Income of the Borrower and its Subsidiaries for each fiscal quarter following the fiscal quarter ending September 30, 1995, plus (c) the net amount after deducting cost of issuance of paid-in capital resulting from any issuance by the Borrower of its capital stock after the date of this Agreement.\nSection 7.11. Minimum Interest Coverage. As of the end of each fiscal quarter permit the Interest Coverage Ratio to be less than 1.10 to 1.00.\nSection 7.12. Minimum Collateral Ratio. At any time, permit the principal amount outstanding under this Agreement to exceed the Borrowing Base.\nSection 7.13. Distributions. Make any Distributions to any Person.\nSection 7.14. Receivables Purchase Agreement. Amend, modify or waive any material provision of the Receivables Purchase Agreement.\nARTICLE 8. EVENTS OF DEFAULT.\nSection 8.1. Events of Default. Any of the following events shall be an \"Event of Default\":\n(a) the Borrower shall fail to pay any principal amount when due, whether at stated maturity, by acceleration, by notice of prepayment or otherwise, or Borrower shall fail to pay any premium or interest, or any fees or other amounts payable hereunder, within five days after the date due;\n(b) any written statement, representation or warranty made by the Borrower in this Agreement, the Security Agreement or the Revolving Note, or which is contained in any certificate, document, financial or other written statement furnished at any time under or in connection with this Agreement or the Revolving Note shall prove to have been incorrect in any material respect on or as of the date made;\n(c) any written statement, representation or warranty made by the Guarantor in the Guaranty or the Pledge Agreement (if delivered), or which is contained in any certificate, document, financial or other written statement furnished at any time under or in connection with the Guaranty or the Pledge Agreement (if delivered) shall prove to have been incorrect in any material respect on or as of the date made;\n(d) the Borrower shall (i) fail to perform or observe any term, covenant, or agreement contained in Section 6.1, Section 6.8(f), Section 6.12 or Article 7; or (ii) fail to perform or observe any term, covenant, or agreement on its part to be performed or observed (other than the obligations specifically referred to elsewhere in this Section 8.1) in this Agreement (including without limitation any such term, covenant or agreement contained in Article 7 hereof), the Security Agreement, the Receivables Purchase Agreement or the Revolving Note and such failure shall continue unremedied for thirty (30) consecutive days after either (x) any Senior Officer of the Borrower has knowledge thereof or (y) the Bank has given notice thereof to the Borrower. The Bank shall use reasonable efforts to give the Borrower notice of any Default or Event of Default under this Section 8.1(c); provided, however, that failure to give any such notice shall not impair or otherwise adversely affect the Bank's rights and remedies hereunder;\n(e) the Guarantor shall (i) fail to perform or observe any term, covenant, or agreement contained in Section 5.1 Section 5.8(j), Section 5.12, Section 5.13 or Article 6 of the Guaranty; or (ii) fail to perform or observe any term, covenant, or agreement on its part to be performed or observed (other than the obligations specifically referred to elsewhere in this Section 8.1) in the Guaranty (including without limitation any such term, covenant or agreement contained in Article 6 thereof) or the Pledge Agreement (if delivered) and such failure shall continue unremedied for thirty (30) consecutive days after either (x) any Senior Officer of the Borrower has knowledge thereof or (y) the Bank has given notice thereof to the Borrower. The Bank shall use reasonable efforts to give the Borrower and the Guarantor notice of any Default or Event of Default under this Section 8.1(e); provided, however, that failure to give any such notice shall not impair or otherwise adversely affect the Bank's rights and remedies under this Agreement or the Guaranty;\n(f) any default by any Eligible Seller under the Receivables Purchase Agreement or any Eligible Agent Contract that has, or could reasonably be expected to have, a Materially Adverse Effect;\n(g) any material provision of the Receivables Purchase Agreement or any Eligible Agent Contract shall at any time for any reason have ceased to be valid and binding on any Eligible Seller or shall be declared to be null and void by any court or other Person having jurisdiction or any Eligible Seller shall deny that it has any further liability or obligation under the Receivables Purchase Agreement or any Eligible Agent Contract;\n(h) any default by any Eligible Agent Obligor under any Eligible Agent Contract that has, or could reasonably be expected to have, a Materially Adverse Effect;\n(i) any material provision of any Eligible Agent Contract shall at any time for any reason have ceased to be valid and binding on the Eligible Agent Obligor party thereto or any Eligible Agent Contract shall be declared to be null and void by any court or other Person having jurisdiction or the Eligible Agent Obligor party thereto shall deny that it has any or further liability or obligation under the Eligible Agent Contract, if the occurrence of such event has, or could reasonably be expected to have a Materially Adverse Effect;\n(j) the Guarantor or any Subsidiary (including the Borrower) shall (i) fail to pay any indebtedness, including but not limited to indebtedness for borrowed money (other than the payment Obligations described in (a) above), of the Guarantor or such Subsidiary, as the case may be, or any interest or premium thereon, when due (whether by scheduled maturity, required prepayment, acceleration, demand or otherwise); or (ii) fail to perform or observe any term, covenant or condition on its part to be performed or observed under any agreement or instrument relating to any such indebtedness, when required to be performed or observed and such failure continues after any applicable notice and grace period, if the effect of such failure to perform or observe is to accelerate, or to permit the acceleration of the maturity of such indebtedness, or (iii) any such indebtedness shall be declared to be due and payable, or required to be prepaid (other than by a regularly scheduled required prepayment), prior to the stated maturity thereof; provided, however, that it shall not be a Default or Event of Default under this Section 7.1(j) unless the aggregate principal amount of indebtedness described in clauses (i) through (iii) above shall exceed $20,000;\n(k) the Guarantor or any of its Subsidiaries, including the Borrower, (i) shall generally not, or be unable to, or shall admit in writing its inability to, pay its debts as such debts become due; or (ii) shall make an assignment for the benefit of creditors or petition or apply to any tribunal for the appointment of a custodian, receiver or trustee for it or a substantial part of its assets; or (iii) shall commence any proceeding under any bankruptcy, reorganization, arrangement, readjustment of debt, dissolution or liquidation law or statute of any jurisdiction, whether now or hereafter in effect; or (iv) shall have had any such petition or application filed or any such proceeding shall have been commenced against it in which an adjudication or appointment is made or order for relief is entered, or which petition, application or proceeding remains undismissed for a period of sixty (60) consecutive days or more; or (v) shall be the subject of any proceeding under which all or substantially all of its assets may be subject to seizure, forfeiture or divestiture (other than a proceeding in respect of a Lien permitted under this Agreement); or (vi) by any act or omission shall indicate its consent to, approval of or acquiescence in any such petition, application or proceeding or order for relief or the appointment of a custodian, receiver or trustee for all or any substantial part of its Property; or (vii) shall suffer any such custodianship, receivership or trusteeship to continue undischarged for a period of sixty (60) consecutive days or more;\n(l) (A) Any Insurance Commissioner shall apply for an order pursuant to any section of the applicable insurance code, directing the rehabilitation, conservation or liquidation of any Insurance Affiliate, and any such application shall not be dismissed or otherwise terminated during a period of sixty (60) consecutive days, or a court of competent jurisdiction shall enter an order granting the relief sought; or (B) any Insurance Commissioner shall file a complaint or petition pursuant any applicable insurance code seeking the dissolution of any Insurance Affiliate, and such complaint or petition is not dismissed or otherwise terminated for a period of sixty (60) consecutive days, or a court of competent jurisdiction shall order the dissolution of any Insurance Affiliate;\n(m) one or more judgments, decrees or orders for the payment of money in excess of $20,000 in the aggregate shall have been rendered against the Borrower or any of its Subsidiaries (excluding judgments which are covered by insurance other than self-insurance) and such judgments, decrees or orders shall continue unsatisfied and in effect for a period of sixty (60) consecutive days without being vacated, discharged, satisfied or stayed or bonded pending appeal;\n(n) any of the following events shall occur or exist with respect to the Guarantor or any ERISA Affiliate, including the Borrower: (i) any Prohibited Transaction involving any Plan; (ii) any Reportable Event shall occur with respect to any Plan; (iii) the filing under Section 4041 of ERISA of a notice of intent to terminate any Plan or the termination of any Plan (other than in a \"standard termination\" referred to in Section 4041 of ERISA); (iv) any event or circumstance exists which would constitute grounds entitling the PBGC to institute proceedings under Section 4042 of ERISA for the termination of, or for the appointment of a trustee to administer any Plan, or the institution by the PBGC of any such proceedings; (v) complete or partial withdrawal under Section 4201 or 4204 of ERISA from a Multiemployer Plan or the reorganization, insolvency or termination of any Multiemployer Plan; and in each case above, such event or condition, together with all other such events or conditions, if any, would in the reasonable opinion of the Bank subject the Borrower to any tax, penalty or other liability to a Plan, Multiemployer Plan, the PBGC or otherwise (or any combination thereof), or subject the Guarantor or any Subsidiary (other than the Borrower) to any tax, penalty or other liability to a Plan, Multiemployer Plan, the PBGC or otherwise (or any combination thereof) which in the aggregate exceed or may exceed $200,000;\n(o) any material provision of the Guaranty or the Pledge Agreement (if delivered) shall at any time for any reason have ceased to be valid and binding on the Guarantor or shall be declared to be null and void by any court or other Person having jurisdiction;\n(p) any material provision of this Agreement or the Security Agreement shall at any time for any reason have ceased to be valid and binding on the Borrower or shall be declared to be null and void by any court or other Person having jurisdiction; or\n(q) the validity or enforceability of this Agreement, the Security Agreement, the Guaranty or the Pledge Agreement (if delivered) shall be contested by the Guarantor or any of its Subsidiaries, including the Borrower, or the Guarantor or any of its Subsidiaries, including the Borrower, shall deny it has any further liability or obligation thereunder.\nSection 8.2. Remedies. Without limiting any other rights or remedies of the Bank provided for elsewhere in this Agreement, the Security Agreement, the Pledge Agreement, the Guaranty or the Revolving Note, or by applicable law, or in equity, or otherwise, if any Event of Default shall occur and be continuing, the Bank may by notice to the Borrower, (i) declare the Commitment to be terminated, whereupon the same shall forthwith terminate, (ii) declare all amounts owing under this Agreement and the Revolving Note (whether or not such Obligations be contingent or unmatured) to be forthwith due and payable, whereupon all such amounts shall become and be forthwith due and payable, without presentment, demand, protest or further notice of any kind, all of which are hereby expressly waived by the Borrower; provided that, in the case of an Event of Default referred to in Section 8.1(k) above with respect to the Borrower, the Commitment shall be immediately terminated, and all such amounts shall be immediately due and payable without notice, presentment, demand, protest or other formalities of any kind, all of which are hereby expressly waived by the Borrower.\nARTICLE 9. MISCELLANEOUS.\nSection 9.1. Amendments and Waivers. No amendment or waiver of any provision of this Agreement, the Security Agreement, or the Revolving Note nor consent to any departure by the Borrower therefrom, shall in any event be effective unless the same shall be in writing and signed by the Bank and the Borrower, and then such waiver or consent shall be effective only in the specific instance and for the specific purpose for which given. No failure on the part of the Bank to exercise, and no delay in exercising, any right hereunder shall operate as a waiver thereof or preclude any other or further exercise thereof or the exercise of any other right. The remedies herein provided are cumulative and not exclusive of any remedies provided by law.\nSection 9.2. Usury. Anything herein to the contrary notwithstanding, the Obligations of the Borrower with respect to this Agreement and the Revolving Note shall be subject to the limitation that payments of interest shall not be required to the extent that receipt thereof would be contrary to provisions of law applicable to the Bank limiting rates of interest which may be charged or collected by the Bank.\nSection 9.3. Expenses; Indemnities.\n(a) Unless otherwise agreed in writing, the Borrower shall reimburse the Bank on demand for all reasonable costs, expenses and charges (including without limitation reasonable fees and charges of its attorneys) incurred by the Bank in connection with the preparation and negotiation of this Agreement, the Security Agreement, the Pledge Agreement, the Guaranty, the Receivables Purchase Agreement and the Revolving Note. The Borrower further agrees to pay the Bank on demand for all reasonable costs, expenses and charges(including without limitation, reasonable fees and charges of external legal counsel for the Bank) incurred by the Bank in connection with the performance, modification and amendment of this Agreement, the Security Agreement, the Pledge Agreement, the Guaranty, the Receivables Purchase Agreement and the Revolving Note. The Borrower further agrees to pay on demand all reasonable costs and expenses (including reasonable counsel fees and expenses), if any, in connection with the enforcement, including without limitation the enforcement of judgments (whether through negotiations, legal proceedings or otherwise) of this Agreement, the Security Agreement, the Pledge Agreement, the Guaranty, the Receivables Purchase Agreement or the Revolving Note or any other document to be delivered hereunder or thereunder. Until paid, the amount of any cost, expense or charge shall constitute, together with all accrued interest thereon, part of the Obligations.\n(b) The Borrower hereby agrees to indemnify the Bank upon demand at any time, against any and all losses, costs or expenses which the Bank may at any time or from time to time sustain or incur as a consequence of (i) any failure by the Borrower to pay, punctually on the due date thereof, any amount payable by the Borrower to the Bank or (ii) the acceleration, in accordance with the terms of this Agreement, of the time of payment of any of the Obligations of the Borrower. Such losses, costs or expenses may include, without limitation, (i) any commercially reasonable costs incurred by the Bank in carrying funds to cover any overdue principal, overdue interest, or any other overdue sums payable by the Borrower to the Bank or (ii) any losses incurred or sustained by the Bank in liquidating or reemploying funds acquired by the Bank from third parties, except to the extent caused by the Bank's gross negligence or willful misconduct.\n(c) The Borrower agrees to indemnify the Bank and its directors, officers, employees, agents and Affiliates from, and hold each of them harmless against, any and all losses, liabilities, claims, damages, costs or expenses incurred by any of them arising out of or by reason of any investigation or litigation or other proceedings (including any threatened investigation or litigation or other proceedings) relating to any transaction contemplated by this Agreement, the Security Agreement, the Pledge Agreement, the Guaranty or the Receivables Purchase Agreement, any actions or omissions of the Borrower, the Guarantor or any of its Subsidiary or any of their respective directors, officers, employees or agents in connection with this Agreement, the Security Agreement, the Pledge Agreement, the Guaranty or the Receivables Purchase Agreement, or any actual or proposed use by the Borrower or any Subsidiary of the proceeds of the Revolving Loans, including without limitation, the reasonable fees and disbursements of counsel incurred in connection with any such investigation or litigation or other proceedings (but excluding any such losses, liabilities, claims, damages or expenses incurred by reason of the gross negligence or willful misconduct of the Person to be indemnified).\n(d) The Borrower agrees to indemnify the Bank and its directors, officers, employees, agents and Affiliates from, and hold each of them harmless against, any and all losses, liabilities, claims, damages, costs or expenses (including without limitation, reasonable fees and disbursements of counsel, engineers or similar professionals) which may be incurred by or asserted against the Bank or any such party in connection with or arising out of or relating to (i) the Bank's compliance with any environmental law with respect to the Properties or operations of the Borrower or its Subsidiaries, (ii) any natural resource damages, governmental fines or penalties or other amounts mandated by any governmental authority, court order, demand or decree in connection with the disposal by the Borrower or its Subsidiaries either on-site or off-site (including leakage or seepage from any such site including third party treatment facilities) of pollutants, contaminants or hazardous wastes and (iii) any personal injury or property damage to third parties resulting from such pollutants, contaminants or hazardous wastes.\nSection 9.4. Term; Survival. This Agreement shall continue in full force and effect as long as any Obligations are owing by the Borrower to the Bank. No termination of this Agreement or any other Loan Document shall in any way affect or impair the rights and obligations of the parties hereto relating to any transactions or events prior to such termination date, and all warranties and representations of the Borrower shall survive such termination. All representations and warranties made hereunder and in any document, certificate, or statement delivered pursuant hereto or in connection herewith shall survive the execution and delivery of this Agreement or the Revolving Note. The obligations of the Borrower under Sections 2.11, 2.12 and 9.3 shall survive the repayment of the Revolving Loans and the termination of the Commitment.\nSection 9.5. Assignment; Participations. This Agreement shall be binding upon, and shall inure to the benefit of, the Borrower, the Bank and their respective successors and assigns, except that the Borrower may not assign or transfer its rights or obligations hereunder. Subject to the consent of the Insurance Commissioner, if required, the Bank may (i) sell Participations in, (ii) upon ten (10) days' notice to the Borrower may assign all, but not a part, of any Revolving Loan to another lender, (iii) without notice to the Borrower may assign all or any part of any Revolving Loan to any Affiliate of the Bank, or (iv) with the prior written consent of the Borrower, which consent will not unreasonably be withheld, may assign less than all of any Revolving Loan to another lender, in which event (a) in the case of an assignment, the assignee shall have, to the extent of such assignment (unless otherwise provided therein), the same rights, benefits and obligations as it would have if it were the Bank hereunder; and (b) in the case of a participation, the participant shall have no rights under this Agreement or the Revolving Note. The agreement executed by the Bank in favor of any participant shall not give such participant the right to require the Bank to take or omit to take any action hereunder except action directly relating to (i) the extension of a regularly scheduled payment date with respect to any portion of the principal of or interest on any amount outstanding hereunder allocated to such participant, (ii) the reduction of the principal amount allocated to such participant or (iii) the reduction of the rate of interest payable on such amount or any amount of fees payable hereunder to a rate or amount, as the case may be, below that which the participant is entitled to receive under its agreement with the Bank. The Bank may furnish any information concerning the Borrower in the possession of the Bank from time to time to assignees and participants (including prospective assignees and participants); provided that the Bank shall require any such prospective assignee or such participant (prospective or otherwise) to agree in writing to maintain the confidentiality of such information in accordance with the provisions set forth in Section 9.14.\nSection 9.6. Notices. All notices, requests, demands and other communications provided for herein shall be in writing and shall be (i) hand delivered; (ii) sent by certified, registered or express United States mail, return receipt requested, or reputable next-day courier service; or (iii) given by telex, telecopy, telegraph or similar means of electronic communication. All such communications shall be effective upon the receipt thereof. Notices shall be addressed to the Borrower and the Bank at their respective addresses set forth on the signature pages of this Agreement, or to such other address as the Borrower or the Bank shall theretofore have transmitted to the other party in writing by any of the means specified in this Section.\nSection 9.7. Setoff. The Borrower agrees that, in addition to (and without limitation of) any right of setoff, banker's lien or counterclaim the Bank may otherwise have, the Bank shall be entitled, at its option, to offset balances (general or special, time or demand, provisional or final, and regardless of whether such balances are then due to the Borrower) held by it for the account of the Borrower at any of the Bank's offices, in Dollars or in any other currency, against any amount payable by the Borrower under this Agreement or the Revolving Note that is not paid when due, taking into account any applicable grace period, in which case it shall promptly notify the Borrower thereof; provided that the Bank's failure to give such notice shall not affect the validity thereof.\nSection 9.8. Jurisdiction; Immunities.\n(a) The Borrower hereby irrevocably submits to the jurisdiction of any Connecticut State or United States Federal court sitting in Connecticut over any action or proceeding arising out of or relating to this Agreement, the Security Agreement, the Pledge Agreement, the Guaranty, the Receivables Purchase Agreement or the Revolving Note, and the Borrower hereby irrevocably agrees that all claims in respect of such action or proceeding may be heard and determined in such Connecticut State or Federal court. The Borrower irrevocably consents to the service of any and all process in any such action or proceeding by the mailing of copies of such process to the Borrower at its address specified in Section 9.6. The Borrower agrees that a final judgment in any such action or proceeding shall be conclusive and may be enforced in other jurisdictions by suit on the judgment or in any other manner provided by law. The Borrower further waives any objection to venue in such State and any objection to an action or proceeding in such State on the basis of forum non conveniens. The Borrower further agrees that any action or proceeding brought against the Bank shall be brought only in Connecticut State or United States Federal courts sitting in Connecticut.\n(b) Nothing in this Section shall affect the right of the Bank to serve legal process in any other manner permitted by law or affect the right of the Bank to bring any action or proceeding against the Borrower or its Property in the courts of any other jurisdictions.\nSection 9.9. Table of Contents; Headings. Any table of contents and the headings and captions hereunder are for convenience only and shall not affect the interpretation or construction of this Agreement.\nSection 9.10. Severability. The provisions of this Agreement are intended to be severable. If for any reason any provision of this Agreement shall be held invalid or unenforceable in whole or in part in any jurisdiction, such provision shall, as to such jurisdiction, be ineffective to the extent of such invalidity or unenforceability without in any manner affecting the validity or enforceability thereof in any other jurisdiction or the remaining provisions hereof in any jurisdiction.\nSection 9.11. Counterparts. This Agreement may be executed in any number of counterparts, all of which taken together shall constitute one and the same instrument, and any party hereto may execute this Agreement by signing any such counterpart.\nSection 9.12. Integration. This Agreement, the Security and the Revolving Note set forth the entire agreement between the parties hereto relating to the transactions contemplated hereby and thereby and supersede any prior oral or written statements or agreements with respect to such transactions.\nSection 9.13. Governing Law. This Agreement shall be governed by, and interpreted and construed in accordance with, the laws of the State of Connecticut.\nSection 9.14. Confidentiality. Subject to the following sentence, the Bank (on behalf of itself and each of its Affiliates, directors, officers, employees and representatives) and any assignee of the Bank becoming a party to this Agreement agrees to use its best efforts, consistent with its normal procedures for handling confidential information in accordance with safe and sound bank practices, to retain in confidence and not disclose without the prior written consent of the Borrower any written information about the Borrower and its Subsidiaries obtained pursuant to the requirements of this Agreement, except as permitted under Section 9.5 of this Agreement. Notwithstanding the foregoing, the Bank (a) may disclose or otherwise use such information to the extent that such information is required in any application, report, statement or testimony submitted to any governmental agency having or claiming to have jurisdiction over the Bank, (b) may disclose or otherwise use such information to the extent that such information is required in response to any summons or subpoena or in connection with any litigation affecting the Bank, (c) may disclose or otherwise use such information to the extent that such information is reasonably believed by the Bank (after notification to the Borrower, unless such notification is prohibited by law) to be required in order to comply with any law, order, regulation, or ruling applicable to the Bank, and (d) may disclose or otherwise use such information to the extent that such information becomes publicly available.\nSection 9.15. Authorization of Third Parties to Deliver Opinions, Etc. The Borrower hereby authorizes and directs each Person whose preparation or delivery to the Bank of any opinion, report or other information is a condition or covenant under this Agreement (including under Articles 5, 6 and 7) to so prepare or deliver such opinion, report or other information for the benefit of the Bank. The Borrower agrees to confirm such authorizations and directions provided for in this Section 9.15 from time to time as may be requested by the Bank.\nSection 9.16. Borrower's Waivers. THE BORROWER ACKNOWLEDGES THAT IT HAS BEEN ADVISED BY COUNSEL OF ITS CHOICE WITH RESPECT TO THIS TRANSACTION AND THIS AGREEMENT AND THAT IT MAKES THE FOLLOWING WAIVERS KNOWINGLY AND VOLUNTARILY:\n(a) THE BORROWER IRREVOCABLY WAIVES TRIAL BY JURY IN ANY COURT AND IN ANY SUIT, ACTION OR PROCEEDING OR ANY MATTER ARISING IN CONNECTION WITH OR IN ANY WAY RELATED TO THE TRANSACTIONS CONTEMPLATED BY THIS AGREEMENT, THE REVOLVING NOTE, THE SECURITY AGREEMENT OR ANY OF THE BORROWER'S DOCUMENTS RELATED THERETO AND THE ENFORCEMENT OF ANY OF THE BANK'S RIGHTS AND REMEDIES; AND\n(b) THE BORROWER EXPRESSLY ACKNOWLEDGES THAT THIS AGREEMENT IS DELIVERED AS PART OF A COMMERCIAL TRANSACTION AS SUCH TERM IS USED AND DEFINED IN CHAPTER 903a OF THE CONNECTICUT GENERAL STATUTES AND VOLUNTARILY AND KNOWINGLY WAIVES ANY AND ALL RIGHTS WHICH ARE OR MAY BE CONFERRED UPON IT UNDER CHAPTER 903a OF SAID STATUTES (OR ANY OTHER STATUTE AFFECTING PREJUDGMENT REMEDIES) TO ANY NOTICE OR HEARING OR PRIOR COURT ORDER OR THE POSTING OF ANY BOND PRIOR TO ANY PREJUDGMENT REMEDY WHICH THE BANK MAY USE.\nSection 9.17. State of Making and Substantial Performance. The parties hereto agree that this Agreement is being made and is to be substantially performed in the State of Connecticut.\n[Remainder of page intentionally left blank]\nIN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed as of the day and year first above written.\nWESTBRIDGE FUNDING CORPORATION\nBy: \/s\/ Patrick J. Mitchell Name: Patrick J. Mitchell Title: CFO\nAddress for Notices:\n777 Main Street Fort Worth, TX 76102 Attn: Chief Financial Officer Telecopier No.: (817) 878-3880\nWith a copy to:\nMilbank, Tweed, Hadley & McCloy 1 Chase Manhattan Plaza New York, NY 10005-1413 Attn: Jonathan R. Rod, Esq. Telecopier No.: (212) 530-5219\nFLEET NATIONAL BANK OF CONNECTICUT\nBy: \/s\/ David A. Wilkie Name: David A. Wilkie Title: A.V.P.\nAddress for Notices:\nInsurance Industry Department 777 Main Street, MSN 250 Hartford, CT 06115 Attn: David Wilkie Telecopier No.: (860) 986-1264\nWith a copy to:\nRichard C. MacKenzie, Esq. Day, Berry & Howard CityPlace I Hartford, CT 06103-3499 Telecopier No.: (860) 275-0343\nSCHEDULE 1.1\nCOMMITMENTS AND LENDING OFFICES\nName and Address of Bank\nCommitment Amount Percentage of Aggregate Commitments\nType of Loans\nFleet National Bank of Connecticut 777 Main Street Hartford, CT 06115 $20,000,000 100% Base Rate, Eurodollar Rate\nSCHEDULE 5.4\nLITIGATION\nNONE\nSCHEDULE 5.6\nLIENS\nNONE\nSCHEDULE 5.10\nCREDIT ARRANGEMENTS\nNONE\nEXHIBIT A\nREVOLVING NOTE\n$20,000,000.00 Hartford, Connecticut December __, 1995\nWESTBRIDGE FUNDING CORPORATION (the \"Borrower\"), for value received, hereby unconditionally promises to pay to the order of FLEET NATIONAL BANK OF CONNECTICUT, a national banking association (the \"Bank\") at its office located at 777 Main Street, Hartford, Connecticut 06115, for the account of the appropriate Lending Office of the Bank, the principal sum of TWENTY MILLION AND NO\/100 Dollars ($20,000,000) or, if less, the unpaid principal amount loaned by the Bank to the Borrower pursuant to the Agreement referred to below, in lawful money of the United States of America and in immediately available funds, on the date(s) and in the manner provided in said Agreement. The Borrower also promises to pay interest on the unpaid principal balance hereof, for the period such balance is outstanding, at said principal office for the account of said Lending Office, in like money, at the rates of interest, on the date(s) and in the manner provided in said Agreement; and to pay interest on any overdue principal and interest at the Default Rate.\nThe date, type, amount and maturity date for each Revolving Loan made by the Bank to the Borrower under the Agreement referred to below, and each payment of principal thereof, shall be recorded by the Bank on its books and, prior to any transfer of this Revolving Note (or, at the discretion of the Bank, at any other time), endorsed by the Bank on the schedule attached hereto or any continuation thereof or otherwise recorded and maintained in its internal records.\nThis is the Revolving Note referred to in that certain Credit Agreement (as amended from time to time, the \"Agreement\") dated as of December 28, 1995 between the Borrower and the Bank and evidences the Revolving Loans made by the Bank thereunder and is secured by a Security Agreement and a Guaranty as set forth in the Agreement, and may be secured by a Pledge Agreement as set forth in the Agreement, and is entitled to the benefits thereof. All terms not defined herein shall have the meanings given to them in the Agreement.\nThe Agreement provides for the acceleration of the maturity of this Revolving Note upon the occurrence of certain Events of Default and for prepayments on the terms and conditions specified therein.\nThe Borrower waives presentment, notice of dishonor, protest and any other notice or formality with respect to this Revolving Note.\nNo waiver of any right or remedy under this Revolving Note shall in any event be effective unless the same shall be in writing and signed by the waiving party, and then such waiver or consent shall be effective only in the specific instance and for the specific purpose for which given.\nIn accordance with the provisions of the Agreement, the Borrower shall reimburse the Bank on demand for all reasonable costs, expenses and charges (including without limitation, reasonable fees and charges of external legal counsel for the Bank) incurred by the Bank in connection with the preparation, performance or enforcement of this Revolving Note.\nThis Revolving Note shall be binding on the Borrower and its permitted successors and assigns and shall inure to the benefit of the Bank and its permitted successors and assigns, provided that the Borrower may not delegate any obligations hereunder without the prior written consent of the Bank.\nThis Revolving Note shall be governed by, and interpreted and construed in accordance with, the laws of the State of Connecticut.\nTHE BORROWER EXPRESSLY ACKNOWLEDGES THAT THE REVOLVING LOANS EVIDENCED HEREBY ARE PART OF A COMMERCIAL TRANSACTION AS SUCH TERM IS USED AND DEFINED IN CHAPTER 903a OF THE CONNECTICUT GENERAL STATUTES AND HEREBY VOLUNTARILY AND KNOWINGLY WAIVES ANY AND ALL RIGHTS WHICH ARE OR MAY BE CONFERRED UPON IT UNDER CHAPTER 903a OF SAID STATUTES (OR ANY OTHER STATUTE AFFECTING PREJUDGMENT REMEDIES) TO ANY NOTICE OR HEARING OR PRIOR COURT ORDER OR THE POSTING OF ANY BOND PRIOR TO ANY PREJUDGMENT REMEDY WHICH THE BANK MAY USE. THE BORROWER ACKNOWLEDGES THAT IT HAS BEEN ADVISED BY COUNSEL OF ITS CHOICE WITH RESPECT TO THIS TRANSACTION AND THE REVOLVING LOANS.\nIN WITNESS WHEREOF, the undersigned has caused this Revolving Note to be duly executed as of the day and year first above written.\nWESTBRIDGE FUNDING CORPORATION\nBy: Print Name: Print Title:\nSchedule to Revolving Note\nREVOLVING LOANS AND PAYMENTS\nAmount and Payments Unpaid Type of Maturity Principal\/ Principal Notation Date Loan Date Interest Balance By\n____ ________ ________ _________ _______________ ________\nEXHIBIT B-1\nFORMS OF ELIGIBLE AGENT CONTRACT\nEXHIBIT B-2\nFORMS OF MASTER GENERAL AGENT CONTRACT\nEXHIBIT C\nSchedule of Maximum Advance Percentage By Policy Type\nType of Policy Maximum Advance Percentage\nMEDICAL EXPENSE HSC, HSG, SSC, SSG, MM95, LMGMM1, AGMM1, MSE, NFLS92 75%\nMEDICARE SUPPLEMENT NCMSA, NCMSB, NCMSD, NCMSF, NCDMA, NCMDB, AMSSA, AMSSB, AMSSC 150%*\nHOME HEALTH CARE\/ LONG TERM CARE HHCP, LTC 75%\nCANCER LSMCS, CSD-92 100%\nLIFE EZ-100, TERM70 100%\nCHAMPUS SUPPLEMENT CHMPS 75%\nACCIDENT ACCT-C 75%\n* Level Commission states only, in all other states the Maximum Advance Percentage is 100%.\nEXHIBIT D\nEligible Receivable ELIGIBILITY CRITERIA\nAs of any date of determination, each Receivable that is included in the Borrowing Base calculation as an \"Eligible Receivable\" shall have all of the following characteristics:\n1. has been purchased by the Borrower pursuant to the terms of the Receivables Purchase Agreement, and is identified on a duly executed Assignment substantially in the form of Exhibit A to the Receivables Purchase Agreement, a copy of which Assignment shall have been delivered to the Bank;\n2. has a Cut-Off Date (as defined in the Receivables Purchase Agreement) relating to the sale of such Receivable not later than six months prior to the Revolving Loan Termination Date;\n3. has not been outstanding for more than six (6) months prior to the Cut-Off Date (as defined in the Receivables Purchase Agreement) relating to the sale of such Receivable, except for Receivables sold on the first Closing Date under the Receivables Purchase Agreement, which may be outstanding for up to fifteen (15) months prior to the applicable Cut-Off Date;\n4. is evidenced by an Eligible Agent Contract (substantially in the form of Exhibit B-1 or Exhibit B-2) properly completed and executed, a copy of which Eligible Agent Contract (a) shall have been delivered to the Borrower on or prior to the date such Receivable is acquired and (b) shall be the genuine, legal, valid and binding obligation of the Eligible Agent Obligor and Eligible Seller parties thereto, enforceable by the Borrower and its assignee in accordance with its terms, except as enforceability may be limited by applicable bankruptcy, insolvency, reorganization, moratorium or similar laws affecting the enforcement of creditors' rights generally, at law or in equity;\n5. has not been sold, transferred, assigned or pledged by the selling Eligible Seller to any Person other than the Borrower, and the Borrower has good title to such Receivable free and clear of any Lien other than Liens created pursuant to the Security Agreement;\n6. arises in connection only with origination of an Insurance Policy offered by an Insurance Affiliate or Blue Cross \/ Blue Shield of California which:\n(a) is of a type set forth on Exhibit C,\n(b) has been originated in the United States of America by an Eligible Agent Obligor in the ordinary course of such Person's business of selling insurance as an independent insurance agent or broker,\n(c) as of the Cut-Off Date (as defined in the Receivables Purchase Agreement) relating to the sale of the related Receivable, is a valid, binding and legally enforceable obligation of the issuing insurance company, and such issuing insurance company had the requisite authority and capacity to sell and issue such Insurance Policy and such Insurance Policy does not violate any applicable law or contravene any other agreement to which the issuing insurance company is subject, and\n(d) as of (X) the Cut-Off Date (as defined in the Receivables Purchase Agreement) relating to the sale of such Receivable and (Y) on at least one (1) day during the ninety (90) day period immediately preceding any date of determination, is not terminated by the insured or the insurer and is in full force and effect in accordance with its terms enforceable by the issuing insurance company against the insured in accordance with its terms, except as enforceability may be limited by applicable bankruptcy, insolvency, reorganization, moratorium or similar laws affecting the enforcement of creditors' rights generally, at law or in equity; and\n(e) should generate premium revenue that, if paid by the insured in accordance with the terms of the Insurance Policy, will, in accordance with the terms of the related Eligible Agent Contract, result in the payment to the Eligible Agent Obligor on or prior to the Revolving Loan Termination Date, but not later than the date that is fifteen (15) months after the date of issuance of such Insurance Policy, of 100% of the First-Year Commissions associated with such Insurance Policy.\n7. complies at all times in all material respects with all requirements of applicable federal, State and local laws, and regulations thereunder,\n8. has not been satisfied, subordinated or rescinded, nor has the security interest securing such Receivable been released from the Lien granted by the related Eligible Agent Obligor in whole or in part;\n9. has not been discharged under a bankruptcy proceeding and the Eligible Agent Obligor is not in a bankruptcy or insolvency proceeding;\n10. has no right of rescission, setoff, counterclaim or defense which has been asserted or threatened with respect to such Receivable by any party to the related Eligible Agent Contract, except any right of setoff exercisable by an Eligible Seller party thereto against the related Eligible Agent Obligor as contemplated by the Receivables Purchase Agreement or otherwise;\n11. has not been originated in, nor is such Receivable subject to the laws of, any jurisdiction under which the sale, transfer and assignment of such Receivable to the Borrower or under the Security Agreement would be unlawful, void or voidable;\n12. bears interest at a minimum rate per annum of 7%, provided that at least 75% of the aggregate outstanding Receivables shall bear interest at a minimum rate per annum of 12%, and provided, further, that Receivables in an aggregate amount not to exceed $2,000,000 relating to advances made by NFL prior to November 1, 1995 in respect of insurance policies sold by Freedom Life Insurance Company of America shall not be required to bear interest;\n13. with respect to which the First-Year Commissions advanced to the related Eligible Agent Obligor do not exceed the Maximum Advance Percentage (as set forth on Exhibit C) of annual premium payments required to be made by the insured under the related Insurance Policy.\nEXHIBIT E\nFORM OF WCC GUARANTY\nEXHIBIT F\nNotice of Borrowing\n, 19\nFleet National Bank of Connecticut 777 Main Street Hartford, Connecticut 06115\nAttention: Insurance Industry Department\nRe: Credit Agreement dated as of December 28, 1995 (the \"Agreement\") between Westbridge Funding Corporation (the \"Borrower\") and Fleet National Bank of Connecticut\nLadies and Gentlemen:\nPursuant to Section 2.3 of the Agreement, the undersigned Borrower hereby gives you irrevocable notice that the Borrower requests a Revolving Loan under the Agreement, and in that connection Borrower sets forth below the information relating to such Revolving Loan:\nBorrowing Date:\nAggregate Principal Amount:\nType of Loan (Base Rate or Eurodollar Rate):\nEurodollar Interest Period:\nAs required by Section 4.2 of the Agreement, the undersigned officer on behalf of the Borrower hereby certifies that:\n(a) the representations and warranties of the Borrower contained in Article 5 of the Agreement and Section 4 of the Security Agreement are true and correct in all material respects on and as of the date hereof (or, if such representation or warranty is expressly stated to have been made as of a specific date, as of such specific date);\n(b) the Borrower has complied with all conditions contained in the Agreement that are required to be complied with by the Borrower as of this date, and the Borrower has performed in all material respects all agreements contained in the Agreement and the Security Agreement that are required to be performed by the Borrower;\n(c) there does not exist any Default or Event of Default under the Agreement;\n(d) attached hereto is a true, complete and correct Borrowing Base Certificate in the form of Exhibit L to the Agreement;\n(e) attached hereto is a form of Assignment substantially in the form of Exhibit A to the Receivables Purchase Agreement (including Schedule I thereto) covering any Receivables not previously included in the Borrowing Base, which Assignment will be duly executed and delivered to the Borrower by each Eligible Seller, as applicable, on or prior to the Borrowing Date; and\n(f) each of the other conditions precedent set forth in Section 4.2 have been satisfied and complied with.\nAll capitalized terms used in this notice not otherwise defined herein shall have the same meaning as assigned to them in the Agreement.\nWESTBRIDGE FUNDING CORPORATION\nBy: Print Name: Print Title:\nEXHIBIT G\nFORM OF PLEDGE AGREEMENT\nEXHIBIT H\nFORM OF SECURITY AGREEMENT EXHIBIT I\nLIST OF MASTER GENERAL AGENTS\nMaster General Agent\nEligible Seller\nAmerican Senior Security Plans, LLC\nNFIC\nCornerstone National Marketing Corp.\nNFIC NFL AIC\nNational Farm & Ranch Group, Inc.\nNFIC NFL AIC\nLife styles Marketing Group, Inc.\nNFL AIC\nSenior Benefits, L.L.C.\nNFL AIC\nHealthCare One Insurance Agency Inc.\nAIC\nTim McCoy & Associates, Inc.\nAIC\nFreedom Life Insurance Company of America\nNFL\nEXHIBIT J-1\nEXHIBIT J-2\nEXHIBIT J-3\n(Description of Opinion of Counsel to the Guarantor regarding the Pledge Agreement)\nThe opinions of one or more counsel to the Guarantor, which is called for by Section 3.2(d) of the Agreement, shall be dated the date of the Pledge Agreement and addressed to the Bank, shall be in form and substance reasonably satisfactory to the Bank, and shall, when taken together, be substantially to the effect that:\n1. The Guarantor has all requisite corporate power to (i) execute, deliver and perform the Pledge Agreement, (ii) execute and deliver the documents and certificates delivered in connection therewith, and (iii) carry out the transactions contemplated thereby.\n2. The execution, delivery and performance by the Guarantor of the Pledge Agreement (a) has been duly authorized by all necessary corporate action on its part, and (b) does not and will not (i) violate any provisions of its certificate of incorporation or by-laws, (ii) violate any applicable law, rule or regulation of the United States of America or the States of Texas or Delaware, or any order, writ, judgment, injunction, decree, determination or award presently in effect having applicability to and binding upon the Guarantor or any of its Subsidiaries (including the Borrower and each Eligible Seller) of which such counsel is aware (after due inquiry), (iii) to such counsel's knowledge, result in a breach of, or constitute a default or require any consent under, any loan or credit agreement or any other agreement, mortgage, indenture, lease or instrument known to it, after due inquiry, to which the Guarantor or any Subsidiary (including the Borrower and each Eligible Seller) is a party or by which the Properties of the Guarantor or any of its Subsidiaries (including the Borrower and each Eligible Seller) is bound or affected; or (iv) to such counsel's knowledge (after due inquiry), result in, or require, the creation or imposition of any Lien upon any of the Properties now owned or hereafter acquired by the Guarantor or any of its Subsidiaries (including the Borrower and each Eligible Seller) pursuant to the terms of such agreement, mortgage, indenture , lease or instrument, except as created by the Security Agreement or the Pledge Agreement.\n3. The Pledge Agreement has been duly executed and delivered by duly authorized officers of the Guarantor. If the Pledge Agreement were stated to be governed by and construed in accordance with the law of the State of New York or the State of Texas, the Pledge Agreement would constitute the legal, valid and binding obligation of the Guarantor, enforceable against it in accordance with its terms, except as may be limited by bankruptcy, insolvency, reorganization, moratorium, fraudulent conveyenace or transfer or other similar laws relating to or affecting the rights of creditors generally and except as the enforceability of the Pledge Agreement is subject to the application of general principles of equity (regardless of whether considered in a proceeding in equity or at law), including, without limitation, (a) the possible unavailability of specific performance, injunctive relief or any other equitable remedy and (b) concepts of materiality, reasonableness, good faith and fair dealing.\n4. No authorization, approval or consent of, and no filing or registration with, any governmental or regulatory authority or agency of the United States of America or the State of Texas of Delaware is required on the part of the Guarantor for the execution, delivery or performance by the Guarantor of, or for the incurrence by the Guarantor of any liabilities under, the Pledge Agreement, except (i) the consents, approvals, or similar actions described in clause (ii) of Section 5.15 of the Credit Agreement and in clause (ii) of Section 4.13 of the Guaranty, which have been obtained and are in full force and effect, and (ii) the consents, approvals, or similar actions, the failure of which to obtain or perform could not reasonably be expected to have a Materially Adverse Effect.\n5. All of the issued and outstanding shares of capital stock of each of the Insurance Subsidiaries, which are being pledged and delivered to you in the date hereof pursuant to the Pledge Agreement, represent all of the issued and outstanding shares of capital stock of each of the Insurance Subsidiaries.\n6. If the Pledge Agreement were stated to be governed by and construed in accordance with the law of the State of New York or the State of Texas, of if a Connecticut court were to apply the law of the State of New York or the State of Texas to the Pledge Agreement, the Pledge Agreement would be effective to create, in favor of the holder of the Revolving Note, a valid security interest under the Uniform Commercial Code in the State of New York or the State of Texas (the \"UCC\") in all of the right, title and interest of the Guarantor in, to and under the shares of capital stock of the Insurance Subsidiaries as collateral security for the payment when due of the Obligations (as defined in the Security Agreement), except that (a) such security interest will continue in Collateral after its sale, exchange or other disposition and in any \"proceeds\" within the meaning of Section 9-306(1) of the UCC thereof only to the extent provided in Sections 9-306 of the UCC, and (b) such security interest in any portion of the Collateral in which the Borrower acquires rights after the commencement of a case under the Bankruptcy Code in respect of the Borrower may be limited by Section 552 of the Bankruptcy Code.\n7. The security interest referred to in paragraph 6 above in the shares of capital stock of the Insurance Subsidiaries shall be created and perfected by the holder of the Revolving Note taking possession of the certificates representing such shares, and such security interest will remain perfected thereafter so long as such certificates is retained by such holder in its possession, except that it may be advisable to file duly executed financing statements in the forms attached as Schedule A hereto in the jurisdiction in which the Guarantor's chief executive office is located and thereafter to file continuation statements for such financing statements within six months prior to the expiration of five years following the date of original filing.\nThe opinions expressed shall be solely for your benefit and may not be relied upon by any other person or entity without such counsels' consent.\nEXHIBIT K\nOFFICER'S CERTIFICATE WESTBRIDGE FUNDING CORPORATION\n______ __, 199\nPursuant to Section 6.9(a) of the Credit Agreement dated as of December 28, 1995 (the \"Credit Agreement\") between Westbridge Funding Corporation (the \"Borrower\") and Fleet National Bank of Connecticut (the \"Bank\"),\nI, _______________, DO HEREBY CERTIFY on behalf of the Borrower that:\n1. I am the duly elected, qualified and acting Chief Financial Officer of the Borrower; and\n2. Attached hereto as Attachment 1 is a true and correct copy of the consolidated GAAP financial statements of the Borrower and its Subsidiaries as of the close of the fiscal [year\/quarter] ending __________, 199_; and\n3. I have reviewed the Credit Agreement and Security Agreement and the condition and transactions of the Borrower and its Subsidiaries for the fiscal [year\/quarter] ending _____, 199_, and to the best of my knowledge the Borrower has observed and performed all of its covenants and other agreements, and satisfied every condition contained in the Credit Agreement, the Security Agreement and the Revolving Note, and I have not obtained knowledge of any condition or event which constitutes a Default or an Event of Default, except as set forth on Attachment 2 attached hereto;\n4. Attached hereto as Attachment 3 is true and correct information (with detailed calculations) establishing that the Borrower was in compliance with the covenants set forth in Sections 7.10 and 7.11 of the Credit Agreement during the fiscal [year\/quarter] ending __________ ___, 199_; and\n5. Attached hereto as Attachment 4 is true and correct information (with detailed calculations) establishing that as of the last day of each calendar month during the fiscal [year\/quarter] ending __________ ___, 199_, the Borrowing Base exceeded the aggregate principal amount of Revolving Loans outstanding on such dates.\nExcept as otherwise defined herein, terms used herein shall have the meanings set forth in the Credit Agreement, pursuant to which this certificate is delivered.\nIN WITNESS WHEREOF, I have signed this certificate as of the date hereof on behalf of.\nBy: Print Name: Title: Chief Financial Officer\nFinancial Statements for the period ending _____________ __, 199_\nDefaults and Events of Default\nNote: If a Default or Event of Default has occurred and is continuing, a statement as to the nature thereof and the action proposed to be taken by the Borrower with respect thereto as required.\nComputations and Information Showing Compliance with Sections 7.10 to 7.11 of the Credit Agreement\nExcept as otherwise defined herein, terms used herein shall have the meanings set forth in the Credit Agreement.\nSection 7.10. Minimum Consolidated GAAP Net Worth\n1. Consolidated GAAP Net Worth as of the fiscal quarter ending ______________, 199__. = ________________\n2. Consolidated positive Net Income for each fiscal quarter following the fiscal quarter ending September 30, 1995 was:\n[Include data for each quarter, as applicable]\n2a. The sum of the positive Net Income for each of the quarters set forth in Line 2 above = ________________\n2b. 50% of line 2a = ________________\n3. Paid-in capital resulting from any issuance by Borrower of its capital stock = ________________\n4. The sum of $1,000,000 and line 2b and line 3 = ________________\n5. Line 1 is not less than line 4.\nSection 7.11. Minimum Interest Coverage.\n1. Consolidated GAAP EBIT of the Borrower and Subsidiaries for the immediately preceding four fiscal quarters (ending on [fill in ending date for fiscal quarter]) = ________________\n2. Total Interest Expense of the Borrower and its Subsidiaries for the immediately succeeding four fiscal quarters ending on [fill in ending date for fiscal quarter] = ________________\n3. The ratio of line 1 to line 2 = ___ : ___\n4. The ratio in line 3 is not less than 1.10 to 1.00.\n[******ADD ATTACHMENT 4<*******]\nEXHIBIT L\nFORM OF BORROWING BASE CERTIFICATE\nExhibit 10.19* GUARANTY AGREEMENT\ndated as of December 28, 1995\nby\nWESTBRIDGE CAPITAL CORP.\nin favor of\nFLEET NATIONAL BANK OF CONNECTICUT\nARTICLE 1. DEFINITIONS; ACCOUNTING TERMS.. . . . . . . . . .-1- Section 1.1. General. . . . . . . . . . . . . . . . . .-1- Section 1.2. Other Definitions. . . . . . . . . . . . .-1- Section 1.3. Accounting Terms . . . . . . . . . . . . .-5- Section 1.4. Rounding.. . . . . . . . . . . . . . . . .-5- Section 1.5. Exhibits and Schedules.. . . . . . . . . .-6- Section 1.6. References to \"Guarantor and its Subsidiaries\". . . . . . . . . . . . . . .-6- Section 1.7. Miscellaneous Terms. . . . . . . . . . . .-6- Section 1.8. Uniform Commercial Code Definitions. . . .-6-\nARTICLE 2. THE GUARANTY.. . . . . . . . . . . . . . . . . . .-6- Section 2.1. Guaranty of Payment and Performance of Obligations. . . . . . . . . . . . . . . .-6- Section 2.2. Guaranty Continuing and Liability Unlimited. . . . . . . . . . . . . . . . .-7- Section 2.3. Unconditional Nature of Guarantor's Obligations and Liabilities. . . . . . . .-7- Section 2.4. Guarantor's Waiver.. . . . . . . . . . . .-8-\nARTICLE 3. SECURITY.. . . . . . . . . . . . . . . . . . . . .-9- Section 3.1. Pledge Agreement.. . . . . . . . . . . . .-9- Section 3.2. Further Assurances.. . . . . . . . . . . .-9-\nARTICLE 4. REPRESENTATIONS AND WARRANTIES.. . . . . . . . . -10- Section 4.1. Incorporation, Good Standing and Due Qualification. . . . . . . . . . . . . . -10- Section 4.2. Corporate Power and Authority; No Conflicts. . . . . . . . . . . . . . . . -10- Section 4.3. Legally Enforceable Agreements . . . . . -10- Section 4.4. Litigation . . . . . . . . . . . . . . . -10- Section 4.5. Financial Statements . . . . . . . . . . -11- Section 4.6. Ownership and Liens. . . . . . . . . . . -11- Section 4.7. Taxes. . . . . . . . . . . . . . . . . . -11- Section 4.8. ERISA. . . . . . . . . . . . . . . . . . -12- Section 4.9. Subsidiaries and Ownership of Stock. . . -12- Section 4.10. Operation of Business. . . . . . . . . . -13- Section 4.11. No Default on Outstanding Judgments or Orders . . . . . . . . . . . . . . . . . -13- Section 4.12. No Defaults on Other Agreements. . . . . -13- Section 4.13. Consents and Approvals.. . . . . . . . . -13- Section 4.14. Partnerships . . . . . . . . . . . . . . -13- Section 4.15. Environmental Protection . . . . . . . . -14- Section 4.16. Copyrights, Patents, Trademarks, Etc . . -14- Section 4.17. Compliance with Laws . . . . . . . . . . -14- Section 4.18. Events of Default. . . . . . . . . . . . -14- Section 4.19. No Adverse Change. . . . . . . . . . . . -14- Section 4.20. Ordinary Course Transaction. . . . . . . -15- Section 4.21. No Other Agreements with Respect to Receivables. . . . . . . . . . . . . . . -15-\nARTICLE 5. AFFIRMATIVE COVENANTS. . . . . . . . . . . . . . -15- Section 5.1. Maintenance of Existence and Domicile of Eligible Sellers . . . . . . . . . . . . -15- Section 5.2. Conduct of Business. . . . . . . . . . . -16- Section 5.3. Maintenance of Properties. . . . . . . . -16- Section 5.4. Maintenance of Records . . . . . . . . . -16- Section 5.5. Maintenance of Insurance . . . . . . . . -16- Section 5.6. Compliance with Laws . . . . . . . . . . -16- Section 5.7. Right of Inspection. . . . . . . . . . . -16- Section 5.8. Reporting Requirements . . . . . . . . . -17- (a) Annual GAAP Statements of Guarantor.. . . . . -17- (b) Annual SAP Financial Statements . . . . . . . -17- (c) Quarterly GAAP Statements of Guarantor. . . . -18- (d) Quarterly SAP Statements. . . . . . . . . . . -18- (e) Annual Convention Statements. . . . . . . . . -18- (f) Annual\/Quarterly Reports. . . . . . . . . . . -18- (g) Management Letters. . . . . . . . . . . . . . -18- (h) SEC Filings.. . . . . . . . . . . . . . . . . -19- (i) Notice of Litigation. . . . . . . . . . . . . -19- (j) Notices of Default. . . . . . . . . . . . . . -19- (k) Other Filings.. . . . . . . . . . . . . . . . -19- (l) Risk-based Capital Calculation. . . . . . . . -19- (m) Additional Information. . . . . . . . . . . . -20- Section 5.9. Certificates.. . . . . . . . . . . . . . -20- (a) Officers' Certificate.. . . . . . . . . . . . -20- (b) Accountant's Certificate. . . . . . . . . . . -20- Section 5.10. Further Assurances . . . . . . . . . . . -20- Section 5.11. Compliance with Agreements.. . . . . . . -20- Section 5.12. Use of Proceeds. . . . . . . . . . . . . -21- Section 5.13. Compliance with Receivables Purchase Agreement. . . . . . . . . . . . . . . . -21- Section 5.14. Distributions. . . . . . . . . . . . . . -21-\nARTICLE 6. NEGATIVE COVENANTS . . . . . . . . . . . . . . . -21- Section 6.1. Mergers and Consolidations . . . . . . . -21- Section 6.2. Stock of Subsidiaries, Etc.. . . . . . . -21- Section 6.3. Minimum Consolidated GAAP Net Worth. . . -22- Section 6.4. Minimum Interest Coverage. . . . . . . . -22- Section 6.5. Investment Grade Assets. . . . . . . . . -22- Section 6.6. Risk-Based Capital Ratio . . . . . . . . -22- Section 6.7. Minimum A.M. Best Rating . . . . . . . . -22- Section 6.8. Minimum Statutory Surplus of Insurance Subsidiaries . . . . . . . . . . . . . . -22- Section 6.9. Credit and Collection Policy . . . . . . -23- Section 6.10. Eligible Agent Contracts . . . . . . . . -23-\nARTICLE 7. MISCELLANEOUS. . . . . . . . . . . . . . . . . . -23- Section 7.1. Amendments and Waivers . . . . . . . . . -23- Section 7.2. Expenses; Indemnities. . . . . . . . . . -23- Section 7.3. Successors and Assigns . . . . . . . . . -24- Section 7.4. Notices. . . . . . . . . . . . . . . . . -24- Section 7.5. Setoff . . . . . . . . . . . . . . . . . -24- Section 7.6. Jurisdiction; Immunities . . . . . . . . -24- Section 7.7. Waiver of Rights to Subrogation and Reimbursement. . . . . . . . . . . . . . -25- Section 7.8. Subordination of Obligations to Guarantor. . . . . . . . . . . . . . . . -25- Section 7.9. Table of Contents; Headings. . . . . . . -25- Section 7.10. Severability . . . . . . . . . . . . . . -25- Section 7.11. Governing Law. . . . . . . . . . . . . . -25- Section 7.12. Authorization of Third Parties to Deliver Opinions, Etc. . . . . . . . . . -25- Section 7.13. Guarantor's Waivers. . . . . . . . . . . -26-\nSchedule 4.2 Corporate Power and Authority; No Conflicts Schedule 4.4 Litigation Schedule 4.9 Subsidiaries Schedule 4.14 Partnerships Schedule 5.3 Maintenance of Properties Schedule 6.8 Annual Base Statutory Surplus\nExhibit A Officer's Certificate\nGUARANTY AGREEMENT\nThis GUARANTY AGREEMENT (this \"Guaranty Agreement\") dated as of December 28, 1995 is by WESTBRIDGE CAPITAL CORP., a Delaware corporation (the \"Guarantor\"), for the benefit of FLEET NATIONAL BANK OF CONNECTICUT (the \"Bank\"), its successors and assigns and any and all other \"Beneficiaries\" (as such term is defined in Section 7.3 hereof).\nRECITALS\nA. Pursuant to the Credit Agreement dated as of December 28, 1995 (the \"Credit Agreement\") between Westbridge Funding Corporation (the \"Debtor\") and the Bank, the Bank has agreed, on certain terms and conditions to make one or more revolving loans to the Debtor in an aggregate principal amount not to exceed $20,000,000 (the \"Revolving Loans\").\nB. The Revolving Loans are evidenced by a single promissory note in favor of the Bank dated the date of the Credit Agreement, in the principal amount of $20,000,000, due and payable in accordance with the terms of the Credit Agreement.\nC. The Debtor is an indirect wholly-owned subsidiary of the Guarantor.\nD. As a condition to making the Revolving Loans, the Bank has required that the Guarantor execute and deliver this Guaranty Agreement.\nNOW, THEREFORE, the Guarantor hereby agrees, as follows:\nARTICLE 1. DEFINITIONS; ACCOUNTING TERMS.\nSection 1.1. General. Unless otherwise defined herein, capitalized terms used herein which are defined in the Credit Agreement shall have the meanings therein assigned.\nSection 1.2. Other Definitions. As used in this Agreement, the following additional terms have the following meanings (terms defined in the singular to have a correlative meaning when used in the plural and vice versa):\n\"AIC\" means American Insurance Company of Texas, a Texas corporation.\n\"Available Dividends\" at the end of any fiscal quarter means, in the aggregate, the portion of Statutory Surplus of each Insurance Subsidiary that is permitted by applicable laws and regulations to be distributed to shareholders.\n\"Beneficiaries\" has the meaning specified in Section 7.3.\n\"Credit Agreement\" has the meaning specified in the Recitals.\n\"Consolidated GAAP Net Worth\" means the sum of (a) the capital stock and additional paid-in capital of the Guarantor and its Subsidiaries on a consolidated basis, plus (without duplication) (b) the amount of retained earnings (or, in the case of a deficit, minus the deficit), minus (c) treasury stock, plus or minus (d) any other account which is customarily added or deducted in determining shareholders' equity (excluding SFAS No. 115), all of which shall be determined on a consolidated basis in accordance with GAAP.\n\"Debtor\" has the meaning specified in the Recitals.\n\"Eligible Account\" means an interest-bearing deposit account established in the name of the Borrower with an Eligible Depository, which account may include only cash or Eligible Investments.\n\"Eligible Depository\" means the Bank or any other commercial bank or trust company having capital, surplus and undivided profits aggregating at least Five Hundred Million Dollars ($500,000,000) and having a long term deposit or long-term C.D. rating of \"BBB+\" or better by Standard and Poor's Ratings Group, a division of McGraw Hill, Inc., or \"Baa1\" or better by Moody's Investor Service, Inc.\n\"Eligible Investments\" means (a) direct obligations of the United States of America, or of any agency thereof, or obligations guaranteed as to principal and interest by the United States of America, or of any agency thereof, in either case maturing not more than 90 days from the date of acquisition thereof; (b) certificates of deposit issued by or other overnight deposits with any bank or trust company organized under the laws of the United States of America or any state thereof and having capital, surplus and undivided profits of at least $500,000,000 and having long term unsecured and unguaranteed debt rated \"BBB+\" or better or \"Baa1\" or better by Standard & Poor's Ratings Group, a division of McGraw Hill, Inc. or Moody's Investors Service, Inc., respectively, maturing not more than 90 days from the date of acquisition thereof; (c) commercial paper rated A-1 or better or P-1 by Standard & Poor's Ratings Group, a Division of McGraw Hill, Inc., or Moody's Investors Service, Inc., respectively, maturing not more than 90 days from the date of acquisition thereof; (d) repurchase agreements and reverse repurchase agreements with any bank having combined capital and surplus in an amount of not less than $500,000,000, or any primary dealer of United States government securities in each case, having long term unsecured and unguaranteed debt rated \"BBB+\" or better or \"Baa1\" or better by Standard & Poor's Ratings Group, a division of McGraw Hill, Inc. or Moody's Investors Service, Inc., respectively, relating to marketable direct obligations issued or unconditionally guaranteed or insured by the United States of America or any agency or instrumentality thereof and backed by the full faith and credit of the United States of America, in each case maturing within 60 days from the date of acquisition thereof; in each case so long as the same (x) provide for the payment of principal and interest (and not principal alone or interest alone) and (y) are not subject to any contingency regarding the payment of principal or interest; and (e) long-term debt rated \"BBB+\" or better or \"Baa1\" or better by Standard & Poor's Rating Group, a division of McGraw Hill, Inc. or Moody's Inverstors Services, Inc., respectively.\n\"Financing Statements\" means the UCC-1 financing statements to be signed by the Guarantor in connection with the security interest to be granted to the Bank in the stock of NFL, NFIC and the Borrower, pursuant to the Pledge Agreement (if and when delivered).\n\"GAAP\" means generally accepted accounting principles in the United States of America as in effect from time to time, applied on a basis consistent with those used in the preparation of the financial statements referred to in Section 4.5 (except for changes concurred in by the Guarantor's independent public accountants).\n\"Guaranty Agreement\" means this Guaranty Agreement, as amended or supplemented from time to time. References to Articles, Sections, Exhibits, Schedules and the like refer to the Articles, Sections, Exhibits, Schedules and the like of this Guaranty Agreement unless otherwise indicated.\n\"HCO\" means Health Care-One Insurance Agency, Inc. a California corporation.\n\"Insurance Commissioner\" means with respect to any Insurance Subsidiary, the head of any insurance regulatory authority and\/or, if the context so requires, such insurance regulatory authority in the relevant place of domicile of such Insurance Subsidiary at the relevant time.\n\"Insurance Subsidiary\" means any of AIC, NFIC and NFL.\n\"Interest Coverage Ratio\" at the end of any fiscal quarter, means the ratio of (a) the sum of (i) Available Dividends for the immediately preceding four fiscal quarters, plus (ii) total cash and cash equivalents of the Guarantor and the Insurance Subsidiaries on a consolidated basis, minus (iii) dividends paid by each Insurance Subsidiary to the Guarantor, plus (iv) total taxes paid by the Insurance Subsidiaries to the Guarantor pursuant to any intercorporate tax sharing agreement, plus (v) an amount equal to the consolidated GAAP EBIT of the Guarantor and its Subsidiaries for the immediately preceding four fiscal quarters (ending on such date), minus (vi) total taxes paid by the Guarantor on a consolidated basis for the immediately preceding four fiscal quarters (ending on such date) to (b) total Interest Expense of the Guarantor and its Subsidiaries on a consolidated basis for the immediately succeeding four fiscal quarters (beginning on such date). For purposes of clause (b) above, Interest Expense shall be calculated on the assumption that a Eurodollar Rate Loan for the full amount of the Commitment will be outstanding for the succeeding four fiscal quarters and the A.M. Best Rating of the Insurance Subsidiaries on the date of the certification required by Section 6.9(a) of the Credit Agreement with respect to the fiscal quarter being tested will remain in effect for the succeeding four fiscal quarters.\n\"Interest Expense\" means, with respect to any Person for any period, the consolidated interest expense, including the interest portion of rental payments under Capital Leases, as determined on a consolidated basis in accordance with GAAP.\n\"Investment\" means, with respect to any Person, any investment by or of such Person, whether by means of purchase or other acquisition of capital stock or other Securities of any other Person or by means of loan, advance (other than advances to employees for moving and travel expenses, drawing accounts and similar expenditures made in the ordinary course of business), capital contribution or other debt or equity participation or interest, in any other Person, including any partnership and joint venture interests of such Person in any other Person.\n\"Investment Grade Securities\" means any Securities having a fixed maturity which have a rating by the NAIC of 1 or 2 or, if the NAIC rating categories in effect on the Closing Date change, such other rating or ratings of such Securities determined by the NAIC to be symbolic of investment grade quality.\n\"Materially Adverse Effect\" means any material adverse effect upon the business, assets, liabilities, financial condition, results of operations or, as far as the Guarantor can reasonably foresee, prospects of the Guarantor and its Subsidiaries taken as a whole, or upon the ability of the Debtor or the Guarantor to perform in all material respects its obligations under this Guaranty Agreement, the Credit Agreement, the Pledge Agreement, the Security Agreement or the Revolving Note, as applicable, resulting from any act, omission, situation, status, event, or undertaking, either singly or taken together.\n\"NAIC\" means the National Association of Insurance Commissioners or any successor thereto, or in lieu thereof, any other association, agency or other organization performing substantially similar advisory, coordination or other like functions among insurance departments, insurance commissions and similar governmental authorities of the various states of the United States of America toward the promotion of uniformity in the practices of such governmental authorities.\n\"Net Income\" means, as applied to any Person for any period, the aggregate amount of net income of such Person, after taxes, for such period, as determined in accordance with GAAP.\n\"NFL\" means National Foundation Life Insurance Company, a Delaware corporation.\n\"NFIC\" means National Financial Insurance Company, a Texas corporation.\n\"Obligations\" has the meaning specified in Section 2.1(b).\n\"Pledge Approvals\" has the meaning specified in Section 3.3.\n\"Revolving Loans\" has the meaning specified in the Recitals.\n\"Risk-Based Capital Ratio\" of any Person means, as at any fiscal year-end, the ratio of \"Total Adjusted Capital\" of such Person as at such date to \"Authorized Control Level RBC\" of such Person as at such date, as such terms are defined by the NAIC Risk-Based Capital (RBC) for Insurers Model Act, as amended from time to time. Using the annual SAP Financial Statements form prescribed for the year ended December 31, 1994 (the \"Convention Blank\"), the Risk-Based Capital Ratio as of December 31, 1994 is equal to the quotient of (a) the amount that appears on line 28, column (1) on page 23 of the Convention Blank divided by (b) the amount that appears on line 27, column (1) on page 23 of the Convention Blank .\n\"SAP\" means, for each Insurance Subsidiary, the statutory accounting practices permitted or prescribed by the applicable Insurance Commissioner for the preparation of annual statements and other financial reports by insurance corporations of the same type as such Insurance Subsidiary.\n\"SAP Financial Statements\" means, for each Insurance Subsidiary, the financial statements which have been submitted or are required to be submitted to the applicable Insurance Commissioner.\n\"Securities\" means any capital stock, share, voting trust certificate, bonds, debentures, notes or other evidences of indebtedness, limited partnership interests, or any warrant, option or other right to purchase or acquire any of the foregoing.\n\"Statutory Net Income\" with respect to any Insurance Subsidiary, means, for any period the consolidated net income of such Insurance Subsidiary that appears, or should appear, on the SAP Financial Statements. On the annual SAP Financial Statements form prescribed for the year ended December 31, 1994, the net income amount appears on line 33, column (1) on page 4 thereof.\n\"Statutory Surplus\" with respect to any Insurance Subsidiary, means, for any period, the surplus that appears, or should appear, on the SAP Financial Statements of such Insurance Subsidiary. On the annual SAP Financial Statements form prescribed for the year ended December 31, 1994, such amount appears on line 48, column (1) on page 4 thereof.\n\"Total Invested Assets\" means, as at any date of determination, the aggregate value of all the Eligible Sellers' portfolio of Securities having a fixed maturity classified as invested assets under and valued in accordance with SAP as at such date.\nSection 1.3. Accounting Terms. All accounting terms not specifically defined herein shall be construed in accordance with GAAP, applied on a consistent basis, and all financial data required to be delivered hereunder shall be prepared in accordance with GAAP, applied on a consistent basis; except as otherwise specifically prescribed herein. In the event that GAAP changes during the term of this Guaranty Agreement such that the financial covenants contained in Article 6 would then be calculated in a different manner or with different components (a) the Guarantor and the Bank agree to enter into good faith negotiations to amend this Guaranty Agreement in such respects as are necessary to conform those covenants as criteria for evaluating the Guarantor's financial condition to substantially the same criteria as were effective prior to such change in GAAP and (b) the Guarantor shall be deemed to be in compliance with the financial covenants contained in such Sections during the sixty (60) days following any such change in GAAP if and to the extent that the Guarantor would have been in compliance therewith under GAAP as in effect immediately prior to such change; provided, however, if an amendment shall not be agreed upon within sixty (60) days or such longer period as shall be agreed to by the Bank, for purposes of determining compliance with such covenants until such amendment shall be agreed upon, such terms shall be construed in accordance with GAAP as in effect immediately prior to such change in GAAP.\nSection 1.4. Rounding. Any financial ratios required to be maintained by Guarantor pursuant to this Guaranty Agreement shall be calculated by dividing the appropriate component by the other component, carrying the result to one place more than the number of places by which such ratio is expressed in this Guaranty Agreement and rounding the result up or down to the nearest number (with a round-up if there is no nearest number) to the number of places by which such ratio is expressed in this Guaranty Agreement.\nSection 1.5. Exhibits and Schedules. All Exhibits and Schedules to this Guaranty Agreement, either as originally existing or as the same may from time to time be supplemented, modified or amended, are incorporated herein by this reference. A matter disclosed on any Schedule shall be deemed disclosed on all Schedules.\nSection 1.6. References to \"Guarantor and its Subsidiaries\". Any reference herein to \"Guarantor and its Subsidiaries\" or the like shall refer solely to Guarantor during such times, if any, as the Guarantor shall have no Subsidiaries.\nSection 1.7. Miscellaneous Terms. The term \"or\" is disjunctive; the term \"and\" is conjunctive. The term \"shall\" is mandatory, the term \"may\" is permissive. Masculine terms also apply to females; feminine terms also apply to males. The term \"including\" is by way of example and not limitation.\nSection 1.8. Uniform Commercial Code Definitions. The non-capitalized terms used in this Guaranty Agreement that are not otherwise defined in the Guaranty Agreement and that are defined in Article 9 of the Uniform Commercial Code as in effect in the State of Connecticut are used herein as so defined.\nARTICLE 2. THE GUARANTY.\nSection 2.1. Guaranty of Payment and Performance of Obligations.\n(a) The Guarantor unconditionally guarantees to each of the Beneficiaries the full and punctual payment when due and performance of the Obligations (as defined in subsection (b) below). This Guaranty Agreement is an absolute, unconditional and continuing guaranty of the full and punctual payment and performance by the Debtor of each of the Obligations, and not of collectibility only, and is in no way conditioned upon any requirement that any Beneficiary first attempt to collect payment from the Debtor or any other guarantor or surety or resort to any security or other means of obtaining payment of all or any part of the Obligations or upon any other contingency. Upon any default by the Debtor in the full and punctual payment or performance of any of the Obligations, the liabilities and obligations of the Guarantor hereunder shall at the option of any Beneficiary become forthwith due and payable without demand or notice of any nature, all such demands and notices being expressly waived by the Guarantor.\n(b) As used herein, the term \"Obligations\" means any and all indebtedness, obligations and liabilities of any kind of the Debtor to any or all of the Beneficiaries, howsoever incurred, arising or evidenced, whether now or hereafter existing, direct or indirect, absolute or contingent, secured or unsecured, joint or several, due or to become due or of payment or performance, and including without limitation the Debtor's obligation to pay (i) all principal of, interest on and premium, if any, with respect to all sums advanced to the Debtor under the Credit Agreement and the Revolving Note when and as the same shall become due and payable (whether at maturity or by declaration or otherwise), (ii) all fees and expenses due and payable under the terms of the Credit Agreement, and (iii) all costs and expenses (including court costs, reasonable attorneys' fees and other legal expenses) incurred by any Beneficiary in exercising and enforcing any of its rights, powers and remedies under the Credit Agreement, the Security Agreement or any other Obligation Agreement including without limitation its rights and remedies following the Debtor's default thereunder. With respect to Beneficiaries other than the Bank or its affiliates, the term \"Obligations\" is limited to the Debtor's obligations and liabilities, whether now or hereafter existing, arising under or in connection with any of the Obligation Agreements (as defined below). The term \"Obligation Agreements\" means the Revolving Note, the Credit Agreement, the Security Agreement and any other agreement, document or instrument referred to therein.\nSection 2.2. Guaranty Continuing and Liability Unlimited.\n(a) This is a continuing guaranty and shall be binding upon the Guarantor regardless of (i) how long after the date hereof any part of the Obligations is incurred by the Debtor and (ii) the amount of the Obligations at any time outstanding (whether more or less than the original principal amount of the Revolving Note). This Guaranty Agreement may be enforced by any or all of the Beneficiaries from time to time and as often as occasion for such enforcement may arise.\n(b) If after receipt of any payment of, or the proceeds of any collateral for, all or any part of the Obligations, the Beneficiaries are compelled to surrender or voluntarily surrender such payment or proceeds to any person because such payment or application of proceeds is or may be avoided, invalidated, recaptured, or set aside as a preference, fraudulent conveyance, impermissible setoff or for any other reason, whether or not such surrender is the result of (i) any judgment, decree or order of any court or administrative body having jurisdiction over the Beneficiaries, or (ii) any settlement or compromise by the Beneficiaries of any claim as to any of the foregoing with any person (including the Debtor), then the Obligations or part thereof affected shall be reinstated and continue and this Guaranty Agreement shall be reinstated and continue in full force as to such Obligations or part thereof as if such payment or proceeds had not been received, notwithstanding any previous cancellation of any instrument evidencing any such Obligation or any previous instrument delivered to evidence the satisfaction thereof. The provisions of this Section 2.2(b) shall survive the termination of this Guaranty Agreement and any satisfaction and discharge of the Debtor by virtue of any payment, court order or any federal or state law.\nSection 2.3. Unconditional Nature of Guarantor's Obligations and Liabilities. The obligations and liabilities of the Guarantor hereunder shall be absolute and unconditional, shall not be subject to any counterclaim, set-off, deduction or defense based upon any claim the Guarantor may have against the Debtor, any other guarantor, or any other person or entity, and shall remain in full force and effect until all of the Obligations have been fully satisfied, without regard to, or release or discharge by, any event, circumstance or condition (whether or not the Guarantor shall have knowledge or notice thereof) which but for the provisions of this Section might constitute a legal or equitable defense or discharge of a guarantor or surety or which might in any way limit recourse against the Guarantor, including without limitation: (a) any amendment or modification of, or supplement to, the terms of the Credit Agreement, the Security Agreement, the Revolving Note or any other Obligation Agreement; (b) any waiver, consent or indulgence by any Beneficiary, or any exercise or non-exercise by any Beneficiary of any right, power or remedy, under or in respect of this Guaranty Agreement, the Credit Agreement, the Security Agreement, the Revolving Note or any other Obligation Agreement (whether or not the Guarantor or the Debtor has or have notice or knowledge of any such action or inaction); (c) the invalidity or unenforceability, in whole or in part, of the Credit Agreement, the Security Agreement, the Revolving Note or any other Obligation Agreement, or the termination (except pursuant to its terms or by written agreement between the Beneficiaries and the Debtor), cancellation or frustration of any thereof, or any limitation or cessation of the Debtor's liability under any thereof (other than any limitation or cessation expressly provided for therein), including without limitation any invalidity, unenforceability or impaired liability resulting from the Debtor's lack of capacity, power and\/or authority to enter into the Credit Agreement, the Security Agreement or any other Obligation Agreement and\/or to incur any or all of the Obligations, or from the execution and delivery of any Obligation Agreement by any person acting for the Debtor without or in excess of authority; (d) any actual, purported or attempted sale, assignment or other transfer by any or all of the Beneficiaries or by the Debtor of any Obligation Agreement or of any of its rights, interests or obligations thereunder; (e) any defect in the Debtor's title to any item(s) of the \"Collateral\" (as defined in the Security Agreement), or the failure of any such item to meet the requirements of any law, regulation, judgment, administrative order or decision or of any agreement between the Debtor and any other party; (f) any actual, purported or attempted sale, assignment, transfer, encumbrance, redelivery or other temporary or permanent disposition of any item(s) of the Collateral, or any damage to or destruction, seizure condemnation, theft, repossession or any other partial or total loss or loss of use of any thereof; (g) the Debtor's failure to obtain, protect, preserve or enforce any rights in any item(s) of the Collateral against any party, or the invalidity or unenforceability of any such rights; (h) the taking or holding by any or all of the Beneficiaries of a security interest, lien or other encumbrance in or on any other property as security for any or all of the Obligations or any exchange, release, non-perfection, loss or alteration of, or any other dealing with, any such security; (i) the addition of any party as a guarantor or surety of all or any part of the Obligations, or any limitation of the liability of any additional guarantor or surety of all or any part of the Obligations under any other agreement; (j) any merger, amalgamation or consolidation of the Debtor into or with any other entity, or any sale, lease, transfer or other disposition of any or all of Debtor's assets or any sale, transfer or other disposition of any or all of the shares of capital stock or other securities of the Debtor to any other person or entity; (k) any change in the financial condition of the Debtor or (as applicable) of any subsidiary, affiliate, partner or controlling shareholder thereof, or the Debtor's entry into an assignment for the benefit of creditors, an arrangement or any other agreement or procedure for the restructuring of its liabilities, or the Debtor's insolvency, bankruptcy, reorganization, dissolution, liquidation or any similar action by or occurrence with respect to the Debtor.\nSection 2.4. Guarantor's Waiver. The Guarantor unconditionally waives, to the fullest extent permitted by law: (a) notice of any of the matters referred to in Section 2.3 hereof; (b) any right to the enforcement, assertion or exercise by any or all of the Beneficiaries of any of its rights, powers or remedies under, against or with respect to (i) the Credit Agreement, the Security Agreement, the Revolving Note or any other Obligation Agreement, (ii) any other guarantor or surety, or (iii) any security for all or any part of the Obligations; (c) any requirement of diligence and any defense based on a claim of laches; (d) all defenses which may now or hereafter exist by virtue of any statute of limitations, or of any stay, valuation, exemption, moratorium or similar law, except the sole defense of full and indefeasible payment; (e) any requirement that the Guarantor be joined as a party in any action or proceeding against the Debtor to enforce any of the provisions of the Credit Agreement, the Security Agreement, the Revolving Note or any other Obligation Agreement; (f) any requirement that any Beneficiary mitigate or attempt to mitigate damages resulting from a default by the Guarantor hereunder or from a default by the Debtor under any of the Obligation Agreements; (g) acceptance of this Guaranty Agreement by any Beneficiary; and (h) all presentments, protests, notices of dishonor, demands for performance and any and all other demands upon and notices to the Debtor, and any and all other formalities of any kind, the omission of or delay in performance of which might but for the provisions of this Section constitute legal or equitable grounds for relieving or discharging the Guarantor in whole or in part from its irrevocable, absolute and continuing obligations hereunder, it being the intention of the Guarantor that its obligations hereunder shall not be discharged except by payment and performance and then only to the extent thereof.\nARTICLE 3. SECURITY.\nSection 3.1. Pledge Agreement. In order to secure payment when due of the obligations and liabilities of the Guarantor hereunder, subject to obtaining the Pledge Approvals, the Guarantor agrees to deliver, or cause to be delivered, to the Bank within five (5) Business Days after the Pledge Approvals have been obtained the following:\n(a) the Pledge Agreement duly executed by the Guarantor;\n(b) stock certificates representing all of the outstanding capital stock of NFL, NFIC and the Debtor (with stock powers signed in blank);\n(c) the Stock Pledge Financing Statements duly executed by the Guarantor;\n(d) favorable opinions of counsel to the Guarantor, dated as of such Pledge Agreement, in substantially the form set forth in Exhibit J-3 to the Credit Agreement;\nSection 3.2. Further Assurances. At any time following the delivery of the Guaranty Agreement or the Pledge Agreement to the Bank, at the request of the Bank, the Guarantor will execute any certificate, instrument, statement or document and will procure any such certificate, instrument, statement or document (and pay all connected costs) which the Bank reasonably deems necessary to preserve the security interests of the Bank contemplated hereby.\nSection 3.3. Required Consents and Approvals. The Guarantor agrees to use reasonable efforts to obtain, as soon as practicable, all necessary approvals and consents by the Insurance Commissioners permitting the pledge of all of the capital stock of NFL, NFIC and the Debtor to the Bank and the execution and delivery of the Pledge Agreement (collectively, the \"Pledge Approvals\").\nARTICLE 4. REPRESENTATIONS AND WARRANTIES.\nThe Guarantor hereby represents and warrants the following:\nSection 4.1. Incorporation, Good Standing and Due Qualification. The Guarantor is duly incorporated, validly existing and in good standing under the laws of its jurisdiction of incorporation, has the power and authority to own its assets and to transact the business in which it is now engaged, and is duly qualified as a foreign corporation and in good standing under the laws of each other jurisdiction in which such qualification is required, except where the failure to be so qualified could not reasonably be expected to have a Materially Adverse Effect. The Guarantor has all requisite power and authority to execute and deliver and to perform all of its obligations under this Guaranty Agreement, the Pledge Agreement and the other writings contemplated hereby.\nSection 4.2. Corporate Power and Authority; No Conflicts. The execution, delivery and performance by the Guarantor of this Guaranty Agreement and the Pledge Agreement have been duly authorized by all necessary corporate action and do not and will not (a) require any consent or approval of its stockholders; (b) violate any provisions of its certificate of incorporation or by-laws; (c) subject to obtaining the Pledge Approvals and any limitations provided therein with respect to the Pledge Agreement, violate any provision of, or require any filing, registration, consent or approval under, any law, rule, regulation, order, writ, judgment, injunction, decree, determination or award presently in effect having applicability to and binding upon the Guarantor or any Subsidiary, except the Pledge Approvals; (d) except as set forth in Schedule 4.2, result in a breach of, or constitute a default or require any consent under, any indenture, mortgage or loan or credit agreement or any other material agreement, lease or instrument to which the Guarantor or any Subsidiary is a party or by which it or its Properties may be bound; or (e) except as contemplated hereby, result in, or require, the creation or imposition of any Lien upon or with respect to any of the Properties now owned or hereafter acquired by the Guarantor.\nSection 4.3. Legally Enforceable Agreements.\n(a) This Guaranty Agreement constitutes the legal, valid and binding obligations of the Guarantor enforceable against the Guarantor in accordance with its respective terms, except to the extent that such enforcement may be limited by applicable bankruptcy, insolvency, reorganization, moratorium or other similar laws affecting creditors' rights generally and by general principles of equity (regardless of whether such enforceability is considered in a proceeding in equity or at law).\n(b) The Receivables Purchase Agreement constitutes the legal, valid and binding obligation of each of the Eligible Sellers enforceable against each of them in accordance with its terms, except to the extent that such enforcement may be limited by applicable bankruptcy, insolvency, reorganization, moratorium or other similar laws affecting creditors' rights generally and by general principles of equity (regardless of whether such enforceability is considered in a proceeding in equity or at law).\nSection 4.4. Litigation. Except as disclosed on Schedule 4.4, there are no actions, suits or proceedings or investigations (other than routine examinations performed by insurance regulatory authorities) pending or, to the knowledge of the Guarantor, threatened against or affecting , the Guarantor or any of its Subsidiaries, or any Property of any of them before any court, governmental agency or arbitrator, which if determined adversely to the Guarantor or any Subsidiary would in any one case or in the aggregate, have a Materially Adverse Effect, other than individual cases pending for which the amount of damages claimed against the Guarantor or any Subsidiary is not more than $100,000.\nSection 4.5. Financial Statements. The consolidated and consolidating balance sheets of the Guarantor and its Subsidiaries as of December 31, 1994 and December 31, 1993 and the related consolidated and consolidating statements of operations, stockholders' equity, and cash flows of the Guarantor and its Subsidiaries for the fiscal years then ended, and the accompanying footnotes, together with the opinion on the consolidated balance sheets and statements of Price Waterhouse LLP, independent certified public accountants, and the unaudited interim consolidated and consolidating balance sheet of the Guarantor and its Subsidiaries as at September 30, 1995 and the related consolidated statements of operations, stockholders' equity and cash flows for the nine-month period then ended, copies of which have been furnished to the Bank, fairly present the financial condition of the Guarantor and its Subsidiaries, taken as a whole, as at such dates and the results of the operations of the Guarantor and its Subsidiaries, taken as a whole, for the periods covered by such statements, all in accordance with GAAP consistently applied (subject to year-end adjustments in the case of the interim financial statements). There are no liabilities of the Guarantor or any Subsidiary, fixed or contingent, which are material but are not reflected in the financial statements or in the notes thereto, other than liabilities arising in the ordinary course of business since September 30, 1995, and other than this Guaranty Agreement, the Credit Agreement and the Revolving Note. No written information, exhibit or report furnished by or on behalf of the Guarantor to the Bank in connection with the negotiation of the Credit Agreement or this Guaranty Agreement, including a report entitled \"Agent Debit Balances - October, 1995\" of Westbridge Capital Corp., contained any material misstatement of fact or omitted to state any fact necessary to make the statements contained therein not materially misleading. All written financial projections furnished by or on behalf of the Guarantor to the Bank in connection with the negotiation of this Agreement, have been prepared in good faith and on reasonable assumptions. Since September 30, 1995 no event or circumstance has occurred that could reasonably be expected to have a Materially Adverse Effect.\nSection 4.6. Ownership and Liens. Each of the Guarantor and its Subsidiaries has good and valid title to, or valid leasehold interests in, its material Properties, including the material Properties reflected in the financial statements referred to in Section 4.5 (other than any Properties disposed of in the ordinary course of business), and none of the material Properties and assets owned by the Guarantor or its Subsidiaries, and none of its leasehold interests is subject to any Lien, except as disclosed in such financial statements or in Schedule 4.6 and except Permitted Liens.\nSection 4.7. Taxes. Each of the Guarantor and its Subsidiaries has filed (or had filed on its behalf) all federal tax returns and all other material tax returns required to be filed, has paid all due and payable taxes, assessments and governmental charges and levies, including interest and penalties, imposed upon it or upon its Properties, and has made adequate provision for the payment of such taxes, assessments and other charges accruing but not yet due and payable, except with respect to taxes which are being contested in good faith by the Guarantor or its Subsidiaries and for which such Person has established and maintains adequate reserves for payment. To the best knowledge of Guarantor, there is no tax assessment contemplated or proposed by any governmental agency against the Guarantor or any of its Subsidiaries that could reasonably be expected to have a Materially Adverse Effect, other than, as of each date subsequent to the Closing Date, such contemplated or proposed tax assessments with respect to which (i) Guarantor has promptly notified the Bank in writing of its knowledge and (ii) the Guarantor or the appropriate Subsidiary of the Guarantor has in good faith commenced, or intends to commence within the time period permitted by the applicable law or regulation, and thereafter diligently pursued or will pursue, as the case may be, appropriate proceedings in opposition to such assessment.\nSection 4.8. ERISA. Each of the Guarantor and its Subsidiaries is in compliance in all material respects with all applicable provisions of ERISA. Within the three-year period prior to the date hereof, neither a Reportable Event nor a Prohibited Transaction has occurred with respect to any Plan; no notice of intent to terminate a Plan has been filed nor has any Plan been terminated; no circumstance exists which constitutes grounds under Section 4042 of ERISA entitling the PBGC to institute proceedings to terminate, or appoint a trustee to administer, a Plan, nor has the PBGC instituted any such proceedings; neither the Guarantor nor any ERISA Affiliate has completely or partially withdrawn under Sections 4201 or 4204 of ERISA from a Multiemployer Plan; each of the Guarantor and its ERISA Affiliates has met its minimum funding requirements under ERISA with respect to all of its Plans and there are no Unfunded Vested Liabilities and neither the Guarantor nor any ERISA Affiliate has incurred any material liability to the PBGC under ERISA other than for premium payments incurred in the normal course of operating the Plans.\nSection 4.9. Subsidiaries and Ownership of Stock.\n(a) Schedule 4.9 correctly sets forth the names of all Subsidiaries of the Guarantor. All of the outstanding shares of capital stock, or all of the units of equity interest, as the case may be, of each Subsidiary are owned of record and beneficially by the Guarantor or a Subsidiary of the Guarantor, except as disclosed on said Schedule; there are no outstanding options, warrants or other rights to purchase capital stock of any such Subsidiary; and all such shares or equity interests so owned are duly authorized, validly issued, fully paid, non-assessable, and were issued in compliance with all applicable state and federal securities and other laws, and are free and clear of all Liens, except for restrictions imposed upon the sale of stock of the Insurance Subsidiaries by the Insurance Commissioner or other insurance regulatory authorities.\n(b) Each Subsidiary of the Guarantor is a corporation or a limited liability company duly organized, validly existing and in good standing under the laws of its jurisdiction of incorporation, has the power and authority to own its assets and to transact the business in which it is now engaged, and is duly qualified as a foreign corporation and in good standing under the laws of each other jurisdiction in which such qualification is required, except where the failure to be so qualified could not reasonably be expected to have a Materially Adverse Effect.\n(c) Each Subsidiary of the Guarantor is in compliance with all laws and other requirements applicable to its business and has obtained all authorizations, consents, approvals, orders, licenses, and permits from, and each Subsidiary has accomplished all filings, registrations, and qualifications with, or obtained exemptions from any of the foregoing from, any governmental or public agency that are necessary for the transaction of its business, except where the failure to be in such compliance, obtain such authorizations, consents, approvals, orders, licenses, and permits, accomplish such filings, registrations, and qualifications, or obtain such exemptions, could not reasonably be expected to have a Materially Adverse Effect.\nSection 4.10. Operation of Business. Each of the Guarantor and its Subsidiaries possesses all licenses, permits and franchises, or rights thereto, necessary to conduct its business as now conducted and as presently proposed to be conducted, except where the absence of which could not reasonably be expected to have a Materially Adverse Effect, and neither the Guarantor nor any of its Subsidiaries is in violation in any material respect of any valid rights of others with respect to any of the foregoing.\nSection 4.11. No Default on Outstanding Judgments or Orders. Each of the Guarantor and its Subsidiaries has satisfied all material judgments and neither the Guarantor nor any Subsidiary is in default with respect to any judgment, writ, injunction, decree, rule or regulation of any court, arbitrator or federal, state, municipal or other governmental authority, commission, board, bureau, agency or instrumentality, domestic or foreign, which could reasonably be expected to, in any one case or in the aggregate, have a Materially Adverse Effect.\nSection 4.12. No Defaults on Other Agreements. Neither the Guarantor nor any of its Subsidiaries is in default in any material respect in the performance, observance or fulfillment of any of the obligations, covenants or conditions contained in any agreement or instrument material to its business to which it is a party.\nSection 4.13. Consents and Approvals. No authorization, consent, approval, order, license or permit from, or filing, registration or qualification with, or exemption by, any governmental or public body or authority, or any subdivision thereof, or any other Person, including without limitation, any Insurance Commissioner, is required to authorize, or is required in connection with the execution, delivery and performance by the Guarantor, the Borrower or any Eligible Seller of, or the legality, validity, binding effect or enforceability of, this Guaranty Agreement, the Pledge Agreement, the Credit Agreement, the Security Agreement, the Revolving Note or the Receivables Purchase Agreement, other than Pledge Approvals required in connection with the grant and perfection of security interests granted pursuant to the Pledge Agreement, and except for (i) filings and recordings of Liens created pursuant to the Security Agreement, (ii) those consents, approvals or other similar actions that have been obtained and have not been modified, amended, rescinded or revoked and are in full force and effect, and (iii) consents, approvals or similar actions, the failure of which to obtain or perform could not reasonably be expected to have a Materially Adverse Effect. Except for the Pledge Approvals, such consents, approvals or other similar actions have been obtained and have not been modified, amended, rescinded or revoked, and are in full force and effect.\nSection 4.14. Partnerships. Except as set forth in Schedule 4.14, neither the Guarantor nor any of its Subsidiaries is a partner in any partnership.\nSection 4.15. Environmental Protection. Each of the Guarantor and its Subsidiaries has obtained all material permits, licenses and other authorizations which are required under all environmental laws, including laws relating to emissions, discharges, releases or threatened releases of pollutants, contaminants, chemicals or industrial, toxic or 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, chemicals, or industrial, toxic or hazardous substances or wastes, except to the extent failure to have any such permit, license or authorization could not reasonably be expected to have a Materially Adverse Effect. Each of the Guarantor and its Subsidiaries is in compliance with all terms and conditions of the required permits, licenses and authorizations, and is also in compliance with all other limitations, restrictions, conditions, standards, prohibitions, requirements, obligations, schedules and timetables contained in the environmental laws or contained in any regulation, code, plan, order, decree, judgment, injunction, notice or demand letter issued, entered, promulgated or approved thereunder, except to the extent failure to comply could not reasonably be expected to have a Materially Adverse Effect. None of the Properties of the Guarantor or its Subsidiaries, either owned or leased, have been included or, to the knowledge of the Guarantor, proposed for inclusion on the National Priorities List adopted pursuant to the Comprehensive Environmental Response Compensation and Liability Act, as amended, or on any similar list or inventory of sites requiring response or cleanup actions adopted by any other federal, state or local agency.\nSection 4.16. Copyrights, Patents, Trademarks, Etc. Each of the Guarantor and its Subsidiaries is duly licensed or otherwise entitled to use all patents, trademarks, service marks, trade names, and copyrighted materials which are used in the operation of its business as presently conducted, except where the failure to be so licensed or entitled could not reasonably be expected to have a Materially Adverse Effect. No claim is pending or, to the knowledge of the Guarantor, threatened against the Guarantor or any of its Subsidiaries contesting the use of any such patents, trademarks, service marks, trade names or copyrighted materials, nor does the Guarantor know of any valid basis for any such claims, other than claims which, if adversely determined, could not reasonably be expected to have a Materially Adverse Effect.\nSection 4.17. Compliance with Laws. Neither the Guarantor nor any of its Subsidiaries is in violation of any laws, ordinances, rules or regulations, applicable to it, of any federal, state or municipal governmental authorities, instrumentalities or agencies, including without limitation, the United States Occupational Safety and Health Act of 1970, as amended, except where such violation would not have a Materially Adverse Effect.\nSection 4.18. Events of Default. No Default or Event of Default has occurred and is continuing under the Credit Agreement .\nSection 4.19. No Adverse Change. Since September 30, 1995, there has occurred no event which could reasonably be expected to have a Materially Adverse Effect.\nSection 4.20. Ordinary Course Transaction.\n(a) The transactions contemplated by this Guaranty Agreement are being consummated by the Guarantor in furtherance of the Guarantor's ordinary business purposes, with no contemplation of insolvency and with no intent to hinder, delay or defraud any of its present or future creditors. Neither before or as a result of the transactions contemplated by this Guaranty Agreement will the Guarantor be insolvent or have an unreasonably small capital for the conduct of its business and the payment of its anticipated obligations. The Guarantor's assets and cash flow enable it to meet its present obligations in the ordinary course of business as they become due, and the Guarantor does not believe that it will incur debts beyond its ability to pay.\n(b) The transactions contemplated by the Receivables Purchase Agreement are being consummated by the Debtor and each of the Eligible Sellers in furtherance of their ordinary business purposes, with no contemplation of insolvency and with no intent to hinder, delay or defraud any of its present or future creditors of the Eligible Sellers. Neither before or as a result of the transactions contemplated by the Receivables Purchase Agreement will any Eligible Sellers be insolvent or have an unreasonably small capital for the conduct of its business and the payment of its anticipated obligations. Each of the Eligible Seller's assets and cash flow enable it to meet its present obligations in the ordinary course of business as they become due, and the Guarantor does not believe that any such Eligible Seller will incur debts beyond its ability to pay.\nThe Guarantor shall be deemed to have made and reaffirmed each of the foregoing representations and warranties on and as of the date of each Borrowing under the Credit Agreement.\nSection 4.21. No Other Agreements with Respect to Receivables. Other than the Eligible Agent Contracts, neither the Guarantor nor any Subsidiary has entered into any agreement with any Eligible Agent Obligor relating to any Eligible Receivable or the Assigned Commissions.\nARTICLE 5. AFFIRMATIVE COVENANTS\nOn and after the execution of this Guaranty Agreement, and until performance, payment and\/or satisfaction in full of Revolving Note, amounts due under the Credit Agreement and all other Obligations, the Guarantor covenants and agrees that it shall, and shall cause each of its Subsidiaries to, unless the Bank otherwise consents in writing:\nSection 5.1. Maintenance of Existence and Domicile of Eligible Sellers. Preserve and maintain its corporate existence and good standing in the jurisdiction of its incorporation, and qualify and remain qualified as a foreign corporation in each jurisdiction in which such qualification is required from time to time, except where failure to be so qualified would not have a Materially Adverse Effect; and preserve and maintain the domicile of each of its Eligible Sellers as in effect on the date hereof.\nSection 5.2. Conduct of Business. Continue to engage in a business of the same general type as conducted by it on the date of this Guaranty Agreement.\nSection 5.3. Maintenance of Properties. Except as set forth in Schedule 5.3, maintain, keep and preserve all of its material tangible Properties, which are necessary or useful in the conduct of its business, in good working order and condition, ordinary wear and tear excepted, except that the failure to maintain, preserve and protect a particular item of Property that is not of significant value, either intrinsically or to the operations of the Guarantor or its Subsidiaries, taken as a whole, shall not constitute a violation of this covenant.\nSection 5.4. Maintenance of Records. Keep accurate and complete records and books of account, in which complete entries will be made in accordance with GAAP and SAP, as applicable, reflecting all financial transactions of the Guarantor and its Subsidiaries.\nSection 5.5. Maintenance of Insurance. Maintain insurance (subject to customary deductibles and retentions) with financially sound and reputable insurance companies, in such amounts and with such coverages (including without limitation public liability insurance, fire, hazard and extended coverage insurance on all of its assets, necessary workers' compensation insurance and all other coverages as are consistent with industry practice) as are maintained by companies of established reputation engaged in similar businesses and similarly situated; provided that such insurance may be obtained from Affiliates of the Guarantor.\nSection 5.6. Compliance with Laws. Comply in all respects with all applicable laws, rules, regulations and orders, except where the failure to so comply would not have a Materially Adverse Effect. Such compliance shall include, without limitation, paying all taxes, assessments and governmental charges imposed upon it or upon its Property (and all penalties and other costs, if any, related thereto), unless contested in good faith by appropriate proceedings and for which adequate reserves have been set aside.\nSection 5.7. Right of Inspection. From time to time upon prior notice and in accordance with customary standards and practices within the banking industry (including, without limitation, upon any Event of Default or whenever the Bank may have reasonable cause to believe that an Event of Default has occurred and is continuing), the Guarantor shall permit the Bank or any agent or representative thereof, to examine and make copies and abstracts from the records and books of account of, and visit the Properties of, the Guarantor and its Subsidiaries to discuss the affairs, finances and accounts of the Guarantor and any such Subsidiaries with any of their respective officers and directors and the Guarantor's and its Subsidiaries' independent accountants, and to make such verification concerning the Guarantor and its Subsidiaries as may be reasonable under the circumstances, and upon request, furnish promptly to the Bank true copies of all financial information made available to Senior Officers of Guarantor and its Subsidiaries; provided, that the Bank shall use reasonable efforts to not materially interfere with the business of the Guarantor and its Subsidiaries and to treat as confidential any and all information obtained pursuant to this Section, except to the extent disclosure is required by any law, regulation, order, ruling, directive, guideline or request from any central bank or other government authority (whether or not having the force of law).\nSection 5.8. Reporting Requirements. The Guarantor shall, and shall cause each of its Insurance Subsidiaries, as applicable, to, furnish to the Bank:\n(a) Annual GAAP Statements of Guarantor. Within one hundred twenty (120) days following the end of Guarantor's fiscal year (or such earlier date as the Guarantor's Form 10-K is filed with the Securities and Exchange Commission) copies of:\n(i) the consolidated and consolidating balance sheets of the Guarantor and its Subsidiaries as at the close of such fiscal year, and\n(ii) the consolidated and consolidating statements of operations and statements of stockholders' equity and cash flows, in each case of the Guarantor and its Subsidiaries for such fiscal year,\nin each case setting forth in comparative form the figures for the preceding fiscal year and prepared in accordance with GAAP, all in reasonable detail and accompanied by an opinion on the consolidated balance sheets and statements of Price Waterhouse LLP or other firm of independent public accountants of recognized national standing selected by the Guarantor and reasonably acceptable to the Bank, to the effect that the financial statements have been prepared in accordance with GAAP (except for changes in application in which such accountants concur) and present fairly in all material respects in accordance with GAAP the financial condition of the Guarantor and its Subsidiaries as of the end of such fiscal year and the results of its operations for the fiscal year then ended 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 under the circumstances.\n(b) Annual SAP Financial Statements. As soon as available, and in any event within one hundred fifty (150) days following the end of the fiscal year of each Insurance Subsidiary (or such earlier date as such are filed with the applicable insurance regulatory authority), copies of audited SAP Financial Statements for each such Insurance Subsidiary, in each case setting forth in comparative form the figures for the preceding fiscal year and prepared in accordance with SAP, all in reasonable detail and accompanied by an opinion on the consolidated balance sheet and statements of Price Waterhouse LLP or other firm of independent public accountants of recognized national standing selected by the Guarantor and reasonably acceptable to the Bank, to the effect that the financial statements have been prepared in accordance with SAP (except for changes in application in which such accountants concur) and present fairly in all material respects in accordance with SAP the financial condition of such Insurance Subsidiary as of the end of such fiscal year and the results of its operations for the fiscal year then ended 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 under the circumstances.\n(c) Quarterly GAAP Statements of Guarantor. As soon as available, and in any event within sixty (60) days after the end of each quarterly fiscal period of the Guarantor (other than the fourth fiscal quarter of any fiscal year), copies of:\n(i) the consolidated and consolidating balance sheets of the Guarantor and its Subsidiaries as at the end of such fiscal quarter, and\n(ii) the consolidated and consolidating statements of operations and consolidated statements of shareholders' equity and cash flows, in each case of the Guarantor and its Subsidiaries for such fiscal quarter and the portion of such fiscal year ended with such fiscal quarter,\nin each case setting forth in comparative form the figures for the preceding fiscal year and prepared in accordance with GAAP all in reasonable detail and certified as presenting fairly in accordance with GAAP the financial condition of the Guarantor and its Subsidiaries as of the end of such period and the results of operations for such period by a Senior Officer of such company, subject only to normal year-end accruals and audit adjustments and the absence of footnotes.\n(d) Quarterly SAP Statements. As soon as available, and in any event within sixty (60) days following the end of each fiscal quarter of each Insurance Subsidiary (or such earlier date as such are filed with the applicable insurance regulatory authority), copies of the unaudited SAP Financial Statements for each quarterly fiscal period of each such Insurance Subsidiary, in each case setting forth in comparative form the figures for the preceding fiscal year and prepared in accordance with SAP, all in reasonable detail and represented as presenting fairly in accordance with SAP the financial condition of such Insurance Subsidiary, as of the end of such period and results of operations for such period by a Senior Officer of such Insurance Subsidiary, subject to normal year-end accruals and audit adjustments.\n(e) Annual Convention Statements. As soon as available, and in any event by March 1 following the end of each fiscal year of each Insurance Subsidiary (or such date as such are filed with the applicable insurance regulatory authority), copies of the Annual Convention Statement for such Insurance Subsidiary, in the form prescribed by the NAIC.\n(f) Annual\/Quarterly Reports. Concurrently with the delivery of the financial statements required pursuant to subsections (c) and (d) of this Section, copies of all reports required to be filed with the Insurance Commissioner in connection with the filing of such financial statements.\n(g) Management Letters. Promptly upon receipt thereof, copies of any reports or management letters relating to the internal financial controls and procedures delivered to the Guarantor or any of its Subsidiaries by any independent certified public accountant in connection with examination of the financial statements of the Guarantor or any such Subsidiary.\n(h) SEC Filings. Promptly after the same are available, copies of each annual report, proxy or financial statement or other report or communication sent to the public shareholders generally of the Guarantor and copies of all annual, regular, periodic and special reports and registration statements which the Guarantor may file or be required to file with the Securities and Exchange Commission under Sections 13 and 15(d) of the Securities and Exchange Act of 1934.\n(i) Notice of Litigation. Promptly after the commencement thereof, notice of any action, suit and proceeding before any court or governmental department, commission, board, bureau, agency or instrumentality, domestic or foreign, against the Guarantor or any of its Subsidiaries (A) not arising out of an insurance policy issued by the Guarantor or any of its Subsidiaries, which, if determined adversely to the Guarantor or such Subsidiary, would have a Materially Adverse Effect, (B) arising out of an insurance policy issued by any Subsidiary of the Guarantor, which demands relief, net of reinsurance obtained by the Subsidiary with respect to such insurance policy, which, if determined adversely to such Subsidiary would have a Materially Adverse Effect, or (C) commenced by any creditor or lessor under any written credit agreement with respect to borrowed money or material lease which asserts a default thereunder on the part of the Guarantor or any of its Subsidiaries.\n(j) Notices of Default. As soon as practicable and in any event within fifteen (15) days after the occurrence of each Default or Event of Default, a written notice setting forth the details of such Default or Event of Default and the action which is proposed to be taken by the Guarantor or the Debtor with respect thereto.\n(k) Other Filings. Promptly upon the filing thereof and at any time upon the reasonable request of the Bank, permit the Bank the opportunity to review copies of all reports, including annual reports, and notices which the Guarantor or any Subsidiary files with or receives from the PBGC or the U.S. Department of Labor under ERISA; and as soon as practicable and in any event within fifteen (15) days after the Guarantor or any of its Subsidiaries knows or has reason to know that any Reportable Event or Prohibited Transaction has occurred with respect to any Plan or that the PBGC or the Guarantor or any such Subsidiary has instituted or will institute proceedings under Title IV of ERISA to terminate any Plan, the Guarantor will deliver to the Bank a certificate of a Senior Officer of the Guarantor setting forth details as to such Reportable Event or Prohibited Transaction or Plan termination and the action the Guarantor proposes to take with respect thereto.\n(l) Risk-based Capital Calculation. As soon as available, and in any event by March 1 following the end of each fiscal year of each Insurance Subsidiary (or such date as such are filed with the applicable insurance regulatory authority), statements showing the Risk-Based Capital Ratio for each of Insurance Subsidiary as of each fiscal year-end..\n(m) Additional Information. Such additional information as the Bank may reasonably request concerning the Guarantor and its Subsidiaries and for that purpose all pertinent books, documents and vouchers relating to its business, affairs and Properties, including investments as shall from time to time be designated by the Bank.\nSection 5.9. Certificates.\n(a) Officers' Certificate. Simultaneously with each delivery of financial statements pursuant to Section 5.8(a) and 5.8(c), the Guarantor shall deliver to the Bank a certificate of its Chief Financial Officer which will\n(i) certify on behalf of the Guarantor that such officer has reviewed the Guaranty Agreement, the Credit Agreement, the Security Agreement and the Pledge Agreement and the condition and transactions of the Guarantor and its Subsidiaries for the period covered by such financial statements, and state that to the best of his knowledge the Guarantor and the Debtor has observed or performed all of its covenants and other agreements, and satisfied every condition, contained in this Guaranty Agreement, the Credit Agreement, the Security Agreement and the Pledge Agreement, and 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, and\n(ii) include information (with detailed calculations in the form set out in Exhibit A) required to establish whether the Guarantor was in compliance with the covenants set forth in this Guaranty Agreement during the period covered by the financial statements then being delivered.\n(b) Accountant's Certificate. Simultaneously with each delivery of financial statements pursuant to Section 5.8(a) and 5.8(e), the Guarantor will deliver to the Bank a certificate of the independent certified public accountants who certify such statements, stating whether, in the course of their audit of the financial statements, they obtained any knowledge of a condition or event which constitutes a Default or Event of Default and the nature thereof.\nSection 5.10. Further Assurances. The Guarantor shall take all such further actions and execute and file or record, at its own cost and expense, all such further documents and instruments as the Bank may at any time reasonably determine may be necessary or advisable; and shall do, execute, acknowledge, deliver, record, file, re-file, record, register and re-register any and all such further acts, deeds, conveyances, estoppel certificates, transfers, certificates, assurances and other instruments as the Bank may reasonably require from time to time in order to carry out more effectively the purposes of this Guaranty Agreement or the Pledge Agreement.\nSection 5.11. Compliance with Agreements. Promptly and fully comply with all contractual obligations under all agreements, mortgages, indentures, leases and\/or instruments to which any one or more of the Guarantor and its Subsidiaries is a party, whether such agreements, mortgages, indentures, leases or instruments are with the Bank or another Person, except where such failure to so comply would not have a Materially Adverse Effect.\nSection 5.12. Use of Proceeds. Cause the Debtor to use proceeds of the Revolving Loans solely to (i) acquire Eligible Receivables, (ii) repay Revolving Loans made under the Credit Agreement, (iii) pay to the Bank interest accrued on the Revolving Loans made under the Credit Agreement, (iv) pay to the Bank the fees described in Section 2.9 of the Credit Agreement, (v) pay costs, expenses and charges described in Section 9.3(a) of the Credit Agreement, and (vi) pay reasonable costs, expenses and charges of outside legal counsel to the Borrower, the Guarantor and each Eligible Seller incurred in connection with the preparation, negotiation and regulatory approval of the this Agreement, Credit Agreement, the Security Agreement, the Pledge Agreement, the Receivables Purchase Agreement and the Revolving Note.\nSection 5.13. Compliance with Receivables Purchase Agreement. To the extent permitted by law, cause each Eligible Seller to (a) upon thirty (30) days prior written request to the Debtor and the Guarantor by the Bank, hold in trust for the Debtor, in an Eligible Account separate from the other assets of such Eligible Seller, the portion of all Collections (as defined in the Receivables Purchase Agreement) which represents Assigned Commissions (\"Collected Commissions\"), (b) to pay over to the Debtor the Collected Commissions not later than one (1) month after such amounts are received by the Eligible Seller, and (c) comply with all of the other terms and conditions of the Receivables Purchase Agreement.\nSection 5.14. Distributions. To the extent permitted by law, cause each of its Subsidiaries and Affiliates to make such Distributions to the Guarantor or the Debtor as may be necessary to assure timely payment of the Obligations.\nARTICLE 6. NEGATIVE COVENANTS.\nOn and after the execution of this Guaranty Agreement, and until performance, payment and\/or satisfaction in full of Revolving Note, amounts due under the Credit Agreement and all other Obligations, the Guarantor covenants and agrees that it shall not, and shall not permit any of its Subsidiaries to, unless the Bank otherwise consents in writing:\nSection 6.1. Mergers and Consolidations. Merge or consolidate with any Person; provided that any Subsidiary (other than the Debtor) may merge into the Guarantor or any other Subsidiary, if after giving effect to such transaction, (a) the Guarantor or, in the event a Subsidiary is merging or consolidating with any Person other than the Guarantor, such Subsidiary is the corporation which survives such merger or acquisition, and (b) no Default or Event of Default would exist.\nSection 6.2. Stock of Subsidiaries, Etc. Pledge, assign, hypothecate, transfer, convey, sell or otherwise dispose of, encumber or grant any security interest in, or deliver to any other Person, any shares of capital stock of (a) the Insurance Subsidiaries or the Borrower, or permit any such Insurance Subsidiaries or the Borrower to issue any additional shares of its capital stock to any Person or (b) any other Person, any shares of capital stock of any other Subsidiary, or permit any such Subsidiary to issue any additional shares of its capital stock to any Person, other than the Guarantor or any Subsidiary.\nSection 6.3. Minimum Consolidated GAAP Net Worth. As of the end of any fiscal quarter, permit Consolidated GAAP Net Worth of the Guarantor and its Subsidiaries to be less than an amount equal to the sum (without giving effect to the increase or decrease to Consolidated GAAP Net Worth attributable to the application of SFAS No. 115) of (a) $36,000,000 plus (b) 50% of any cumulative positive Net Income of the Guarantor and its Subsidiaries for each fiscal quarter following the fiscal quarter ending September 30, 1995 plus (c) the amount of paid-in capital resulting from any issuance by the Guarantor of its capital stock after the date of this Guaranty Agreement.\nSection 6.4. Minimum Interest Coverage. As of the end of each fiscal quarter, permit the Interest Coverage Ratio to be less than 2.00 to 1.00.\nSection 6.5. Investment Grade Assets. Permit total consolidated Investment of the Eligible Sellers in Investment Grade Securities, as of the end of any fiscal quarter, to be less than ninety five percent (95%) of the aggregate amount of Total Invested Assets.\nSection 6.6. Risk-Based Capital Ratio. As at any date, permit the Risk-Based Capital Ratio of any Insurance Subsidiary to be less than (i) as of the fiscal year ending December 31, 1995, 200% and (ii) as of any fiscal year ending on and after December 31, 1996, 210%. In the event of any change after the date of this Guaranty Agreement in the NAIC Risk Based Capital (RBC) for Insurers Model Act or NAIC's interpretations thereof affecting the calculation of the Risk-Based Capital Ratio, (a) the Guarantor and the Bank agree to enter into good faith negotiations to amend this Guaranty Agreement in such respects as are necessary to conform this Section as a measurement of the sufficiency of the risk-based capital of each Insurance Subsidiary to substantially the same measurement as was effective prior to such change and (b) the Guarantor shall be deemed to be in compliance with this Section during the sixty (60) days following any such change if and to the extent that the Guarantor would have been in compliance therewith under said Act and interpretations as in effect immediately prior to such change, provided, however, if an amendment shall not be agreed upon within such sixty (60) days or such longer period as shall be agreed to by the Bank, for purposes of determining compliance with this Section until such amendment shall be agreed upon, compliance shall be determined in accordance with said Act and interpretations as in effect on the date hereof.\nSection 6.7. Minimum A.M. Best Rating. Permit the A.M. Best Rating of any Insurance Subsidiary to be less than (a) at any time, \"C++\" or (b) for a period in excess of 12 consecutive months, \"B-\".\nSection 6.8. Minimum Statutory Surplus of Insurance Subsidiaries. As of the end of any fiscal quarter, permit the Statutory Surplus of any Insurance Subsidiary to be less than an amount equal to the sum of (a) the Annual Base Statutory Surplus for such Insurance Subsidiary as specified in Schedule 6.8 for the applicable fiscal year, plus (b) 50% of any cumulative positive Statutory Net Income for each fiscal quarter following the fiscal quarter ending September 30, 1995, minus (c) an amount equal to 5% of the Eligible Agent Collateral Value as of such date.\nSection 6.9. Credit and Collection Policy. Amend, modify or waive, in any material respects, any of its credit or collection policies with respect to any Eligible Receivables as in effect on the Closing Date.\nSection 6.10. Eligible Agent Contracts. Amend, modify or waive any provision of any Eligible Agent Contract, if such amendment, modification or waiver could reasonably be expected to adversely affect the likelihood of realization by the Bank of payment in full of any Eligible Receivable under such Eligible Agent Contract, or enter into any other agreement with any Eligible Agent Obligor, if the entering into such other agreement could reasonably be expected to adversely affect the likelihood of realization by the Bank of payment in full of any Eligible Receivable under any Eligible Agent Contract.\nARTICLE 7. MISCELLANEOUS.\nSection 7.1. Amendments and Waivers. No amendment or waiver of any provision of this Guaranty Agreement or the Pledge Agreement nor consent to any departure by the Guarantor therefrom, shall in any event be effective unless the same shall be in writing and signed by the Beneficiaries and the Guarantor, and then such waiver or consent shall be effective only in the specific instance and for the specific purpose for which given. No failure on the part of any Beneficiary to exercise, and no delay in exercising, any right hereunder shall operate as a waiver thereof or preclude any other or further exercise thereof or the exercise of any other right.\nSection 7.2. Expenses; Indemnities.\n(a) Unless otherwise agreed in writing, the Guarantor shall reimburse the Bank on demand for all reasonable costs, expenses and charges (including without limitation reasonable fees and charges of its attorneys) incurred by the Bank in connection with the preparation and negotiation of this Guaranty Agreement, the Pledge Agreement, the Credit Agreement, the Security Agreement, the Receivables Purchase Agreement and the Revolving Note. The Guarantor further agrees to pay on demand for all reasonable costs, expenses and charges (including without limitation, reasonable fees and charges of external legal counsel for the Bank) incurred in connection with the performance, modification and amendment of this Guaranty Agreement, the Pledge Agreement, the Security Agreement, the Receivables Purchase Agreement and the Revolving Note. The Guarantor further agrees to pay on demand all reasonable costs and expenses (including reasonable counsel fees and expenses), if any, in connection with the enforcement, including without limitation the enforcement of judgments (whether through negotiations, legal proceedings or otherwise) of this Guaranty Agreement, the Pledge Agreement, the Credit Agreement, the Security Agreement, the Receivables Purchase Agreement or the Revolving Note or any other document to be delivered under this Guaranty Agreement.\n(b) The Guarantor hereby agrees to indemnify the Beneficiaries upon demand at any time, against any and all losses, costs or expenses which the Beneficiaries may at any time or from time to time sustain or incur as a consequence of any failure by the Guarantor to pay, punctually on the due date thereof, any amount payable by the Guarantor hereunder. Such losses, costs or expenses may include, without limitation, (i) any costs incurred by the Bank in carrying funds to cover any overdue principal, overdue interest, or any other overdue sums payable by the Guarantor or (ii) any losses incurred or sustained by any Beneficiary in liquidating or reemploying funds acquired by such Beneficiary from third parties, except to the extent caused by such Beneficiary's gross negligence or willful misconduct.\nSection 7.3. Successors and Assigns. This Guaranty Agreement shall be binding upon the Guarantor and its successors and assigns, and shall inure to the benefit of and be enforceable by the Bank, its successors and assigns, and each successive holder of the Revolving Note (collectively, the \"Beneficiaries\"). The Bank may furnish any information concerning the Guarantor or its Subsidiaries in the possession of the Bank from time to time to assignees of, and participants in, the Revolving Note (including prospective assignees and participants); ; provided that the Bank shall require any such prospective assignee or such participant (prospective or otherwise) to agree in writing to maintain the confidentiality of such information in accordance with the provisions set forth in Section 7.3.\nSection 7.4. Notices. All notices, requests, demands and other communications provided for herein shall be in writing and shall be (i) hand delivered; (ii) sent by certified, registered or express United States mail, return receipt requested, or reputable next-day courier service; or (iii) given by telex, telecopy, telegraph or similar means of electronic communication. All such communications shall be effective upon the receipt thereof. Notices shall be addressed to the Guarantor at the addresses set forth on the signature pages of this Guaranty Agreement and to the Bank at the address specified in Section 9.6 of the Credit Agreement, or to such other address as the Guarantor or the Bank shall theretofore have transmitted to the other party in writing by any of the means specified in this Section.\nSection 7.5. Setoff. The Guarantor agrees that, in addition to (and without limitation of) any right of setoff, banker's lien or counterclaim the Beneficiaries may otherwise have, the Beneficiaries shall be entitled, at their option, to offset balances (general or special, time or demand, provisional or final, and regardless of whether such balances are then due to the Guarantor) held by it for the account of the Guarantor at any of the Beneficiaries' offices, in Dollars or in any other currency, against any amount payable by the Guarantor under this Guaranty Agreement that is not paid when due, taking into account any applicable grace period, in which case it shall promptly notify the Guarantor thereof; provided that the Bank's failure to give such notice shall not affect the validity thereof.\nSection 7.6. Jurisdiction; Immunities.\n(a) The Guarantor hereby irrevocably submits to the jurisdiction of any Connecticut State or United States Federal court sitting in Connecticut over any action or proceeding arising out of or relating to this Guaranty Agreement, the Security Agreement, the Pledge Agreement, the Guaranty Agreement, the Receivables Purchase Agreement or the Revolving Note, and the Guarantor hereby irrevocably agrees that all claims in respect of such action or proceeding may be heard and determined in such Connecticut State or Federal court. The Guarantor irrevocably consents to the service of any and all process in any such action or proceeding by the mailing of copies of such process to the Guarantor at its address specified in Section 7.4. The Guarantor agrees that a final judgment in any such action or proceeding shall be conclusive and may be enforced in other jurisdictions by suit on the judgment or in any other manner provided by law. The Guarantor further waives any objection to venue in such State and any objection to an action or proceeding in such State on the basis of forum non conveniens. The Guarantor further agrees that any action or proceeding brought against the Bank shall be brought only in Connecticut State or United States Federal courts sitting in Connecticut.\n(b) Nothing in this Section shall affect the right of the Guarantor to serve legal process in any other manner permitted by law or affect the right of the Bank to bring any action or proceeding against the Guarantor or its Property in the courts of any other jurisdictions.\nSection 7.7. Waiver of Rights to Subrogation and Reimbursement. Until the payment and performance in full of all Obligations and any and all obligations of Debtor to the Beneficiaries, the Guarantor shall not exercise any rights against the Debtor arising as a result of payment by the Guarantor hereunder, by way of subrogation or otherwise, and will not prove any claim in competition with the Beneficiaries or their Affiliates in respect of any payment hereunder in bankruptcy or insolvency proceedings of any nature; the Guarantor will not claim any set-off or counterclaim against the Debtor in respect of any liability of the Guarantor to the Debtor and the Guarantor waives any benefit of any right to participate in any collateral which may be held by the Beneficiaries or any such Affiliate.\nSection 7.8. Subordination of Obligations to Guarantor. Any and all indebtedness and other obligations of the Debtor to the Guarantor (including without limitation any such obligations resulting from any rights of subrogation on the part of the Guarantor as a result of any payment by the Guarantor hereunder) shall during the term of this Guaranty Agreement be subordinated to the Obligations and to any other indebtedness of the Debtor to any or all of the Beneficiaries.\nSection 7.9. Table of Contents; Headings. Any table of contents and the headings and captions hereunder are for convenience only and shall not affect the interpretation or construction of this Guaranty Agreement.\nSection 7.10. Severability. The provisions of this Guaranty Agreement are intended to be severable. If for any reason any provision of this Guaranty Agreement shall be held invalid or unenforceable in whole or in part in any jurisdiction, such provision shall, as to such jurisdiction, be ineffective to the extent of such invalidity or unenforceability without in any manner affecting the validity or enforceability thereof in any other jurisdiction or the remaining provisions hereof in any jurisdiction.\nSection 7.11. Governing Law. This Guaranty Agreement shall be governed by, and interpreted and construed in accordance with, the laws of the State of Connecticut.\nSection 7.12. Authorization of Third Parties to Deliver Opinions, Etc. The Guarantor hereby authorizes and directs each Person whose preparation or delivery to the Bank of any opinion, report or other information is a condition or covenant under this Guaranty Agreement (including under Articles 3 and 5) to so prepare or deliver such opinion, report or other information for the benefit of the Beneficiaries. The Guarantor agrees to confirm such authorizations and directions provided for in this Section from time to time as may be requested by any Beneficiary.\nSection 7.13. Guarantor's Waivers. THE GUARANTOR ACKNOWLEDGES THAT IT HAS BEEN ADVISED BY COUNSEL OF ITS CHOICE WITH RESPECT TO THIS GUARANTY AGREEMENT AND THAT IT MAKES THE FOLLOWING WAIVERS KNOWINGLY AND VOLUNTARILY:\n(a) THE GUARANTOR IRREVOCABLY WAIVES TRIAL BY JURY IN ANY COURT AND IN ANY SUIT, ACTION OR PROCEEDING OR ANY MATTER ARISING IN CONNECTION WITH OR IN ANY WAY RELATED TO THE TRANSACTIONS CONTEMPLATED BY THIS GUARANTY AGREEMENT, THE PLEDGE AGREEMENT, THE CREDIT AGREEMENT, THE SECURITY AGREEMENT, THE REVOLVING NOTE OR ANY DOCUMENTS RELATED THERETO AND THE ENFORCEMENT OF ANY OF THE BENEFICIARIES' RIGHTS AND REMEDIES; AND\n(b) THE GUARANTOR EXPRESSLY ACKNOWLEDGES THAT THE OBLIGATIONS GUARANTEED HEREBY ARE PART OF A COMMERCIAL TRANSACTION AS SUCH TERM IS USED AND DEFINED IN CHAPTER 903a OF THE CONNECTICUT GENERAL STATUTES AND VOLUNTARILY AND KNOWINGLY WAIVES ANY AND ALL RIGHTS WHICH ARE OR MAY BE CONFERRED UPON IT UNDER CHAPTER 903a OF SAID STATUTES (OR ANY OTHER STATUTE AFFECTING PREJUDGMENT REMEDIES) TO ANY NOTICE OR HEARING OR PRIOR COURT ORDER OR THE POSTING OF ANY BOND PRIOR TO ANY PREJUDGMENT REMEDY WHICH ANY BENEFICIARY MAY USE.\n[Remainder of page intentionally left blank]\nIN WITNESS WHEREOF, the Guarantor has caused this Guaranty Agreement to be duly executed on its behalf by an officer or other person thereunto duly authorized on the day and year first above written.\nWESTBRIDGE CAPITAL CORP.\nBy: \/s\/ Patrick J. Mitchell Name: Patrick J. Mitchell Title: CFO\nAddress for Notices:\n777 Main Street Fort Worth, Texas 76102 Attn: Chief Financial Officer Telecopier No.: (817) 878-3880\nWith a copy to:\nMilbank, Tweed, Hadley & McCloy 1 Chase Manhattan Plaza New York, NY 10005-1413 Attn: Jonathan R. Rod, Esq. Telecopier No.: (212) 530-5219\nSCHEDULE 4.2\nCORPORATE POWER AND AUTHORITY; NO CONFLICTS\nNONE\nSCHEDULE 4.4\nLITIGATION\n[See attached.]\nSCHEDULE 4.9\nSubsidiaries\n[See attached]\nSCHEDULE 4.14\nPARTNERSHIPS\nNONE\nSCHEDULE 5.3\nEXCEPTIONS TO MAINTENANCE OF PROPERTIES\nNONE\nSCHEDULE 6.8\nANNUAL BASE STATUTORY SURPLUS\nInsurance Subsidiary 1995 1996 1997 1998\nNFL $14.0MM $14.0MM $14.0MM $14.0MM\nNFIC $ 8.0MM $ 4.0MM $ 3.0MM $ 4.0MM\nAIC $ 6.5MM $ 6.5MM $ 6.5MM $ 6.5MM\nEXHIBIT A\nOFFICER'S CERTIFICATE\nWESTBRIDGE CAPITAL CORP.\n______ __, 199\nPursuant to Section 5.9(a) of the Guaranty Agreement dated December 28, 1995 (the \"Guaranty Agreement\") by Westbridge Capital Corp. (the \"Guarantor\") in favor of Fleet National Bank of Connecticut (the \"Bank\") and its successors and assigns,\nI, _______________, DO HEREBY CERTIFY on behalf of the Guarantor that:\n1. I am the duly elected, qualified and acting Chief Financial Officer of the Guarantor; and\n2. Attached hereto as Attachment 1 is a true and correct copy of the consolidated and consolidating GAAP financial statements of the Guarantor and its Subsidiaries as of the close of the fiscal [year\/quarter] ending __________, 199_; and\n3. Attached hereto as Attachment 2 is a true and correct copy of the SAO Financial Statements of the NFL, NFIC and AIC as of the close of the fiscal [year\/quarter] ending __________, 199_; and\n4 I have reviewed the Guaranty Agreement and Credit Agreement and the condition and transactions of the Guarantor and its Subsidiaries for the fiscal [year\/quarter] ending _____, 199_, and to the best of my knowledge each of the Guarantor and the Debtor have observed and performed all of its covenants and other agreements, and satisfied every condition contained in the Guaranty Agreement, the Credit Agreement and the Revolving Note, and I have not obtained knowledge of any condition or event which constitutes a Default or an Event of Default, except as set forth on Attachment 3 attached hereto; and\n5 Attached hereto as Attachment 4 is true and correct information (with detailed calculations) establishing that the Guarantor was in compliance with the covenants set forth in the Credit Agreement during the fiscal [year\/quarter] ending __________ ___, 199_; and\n6 Attached hereto as Attachment 5 is true and correct information (with detailed calculations) establishing the Risk-Based Capital calculations for NFL, NFIC and AIC as of the fiscal year ending __________ ___, 199_; and\nExcept as otherwise defined herein, terms used herein shall have the meanings set forth in the Guaranty Agreement, pursuant to which this certificate is delivered.\nIN WITNESS WHEREOF, I have signed this certificate as of the date hereof on behalf of .\nBy: Print Name: Title: Chief Financial Officer\nGAAP Financial Statements for the period ending _____________ __, 199_\nSAP Financial Statements for the period ending _____________ __, 199_\nDefaults and Events of Default\nNote: If a Default or Event of Default has occurred and is continuing, a statement as to the nature thereof and the action proposed to be taken by the Guarantor or the Debtor with respect thereto as required.\nRisk-Based Capital Calculations for the period ending _____________ __, 199_\nComputations and Information Showing Compliance with Sections 6.3 to 6.8 of the Guaranty Agreement\nExcept as otherwise defined herein, terms used herein shall have the meanings set forth in the Guaranty Agreement.\nSection 6.3. Minimum Consolidated GAAP Net Worth\n1. Consolidated GAAP Net Worth as of the Guarantor the fiscal quarter ending ______________, 199__. = ________________\n2. Consolidated positive Net Income of the Guarantor for each fiscal quarter following the fiscal quarter ending September 30, 1995 was:\n[Include data for each quarter, as applicable]\n2a. The sum of the positive Net Income for each of the quarters set forth in Line 2 above = ________________\n2b. 50% of line 2a = ________________\n3. Paid-in capital resulting from any issuance by Guarantor of its capital stock = ________________\n4. The sum of $36,000,000 and line 2b and line 3 = ________________\n5. Line 1 is not less than line 4.\nSection 6.4. Minimum Interest Coverage.\n1. Available Dividends for the immediately preceding four fiscal quarters ending on [fill in ending date for fiscal quarter] = ________________\n2. Total cash and cash equivalents of the Guarantor and the Insurance Subsidiaries = ________________\n3. Dividends paid to the Guarantor by each Insurance Subsidiary for the immediately preceding four quarters ending on [fill in ending date for fiscal quarter] = ________________\n4. Total taxes paid by the Insurance Subsidiaries to the Guarantor pursuant to any intercorporate tax sharing agreement for the fiscal quarters (ending on [fill in ending date for fiscal quarter]) = ________________\n5. Consolidated GAAP EBIT of the Guarantor and Subsidiaries for the immediately preceding four fiscal quarters (ending on [fill in ending date for fiscal quarter]) = ________________\n6. The sum of lines 1, 2, 4 and line 5, less line 3 = ________________\n7. Interest Expense for the immediately succeeding four fiscal quarters = ________________\n8. The ratio of line 6 to line 7 = ___ : ___\n7. The ratio in line 5 is not less than 2.0 to 1.0.\nSection 6.5. Investment Grade Assets.\n1. Total consolidated Investment of the Insurance Subsidiaries and HCO in Investment Grade Securities: =________________\n2. Total Invested Assets: =________________\n3. The ratio of line 1 to line 2: = ___ : ___\n4. The ratio in line 3 is at least .95 to 1.00.\nSection 6.6. Risk-Based Capital Ratio.\nNFL NFIC AIC ___________|____________|__________ 1. Adjusted Capital and Surplus as of the fiscal [quarter\/year] ending [_____,], 199_: ___________|____________|__________ 2. Authorized Control Level RBC as of the fiscal year ending [_____,], 199_: ___________|____________|__________ 3. The ratio of line 1 to line 2. ___________|____________|__________ 4. The ratio in line 3 is at least 2.0 to 1.0. ___________|____________|__________\nSection 6.7. Minimum Credit Ratings.\nNFL NFIC AIC ___________|____________|__________ 1. The A.M. Best Rating for each Insurance Subsidiary: ___________|____________|__________ 2. The effective date for each of the above ratings is: ___________|____________|__________ 3. The Ratings in line 1 are not less than \"C++\", and if any is less than \"B-\", such rating has not been in effect for more than 12 consecutive months. ___________|____________|__________\nSection 6.8. Minimum Statutory Surplus of Insurance Subsidiaries\nNFL NFIC AIC __________|____________|__________ 1. Positive Statutory Capital and Surplus of Insurance Subsidiary as of the fiscal quarter ending ____ __, 199__ __________ ____________ __________\n2. Positive Statutory Net Income for each fiscal quarter following the fiscal quarter ending September 30, 1995 was: __________ ____________ __________\n[Include data for each quarter, as applicable]\n2a. The sum of positive Statutory Net Income for each of the quarters set forth in Line 2 above __________ ____________ __________\n2b. 50% of line 2a __________ ____________ __________\n3. Contributions to surplus made by Debtor to the Insurance Subsidiaries during each fiscal quarter following the fiscal quarter ending September 30, 1995 were: __________ ____________ __________\n[Include data for each quarter, as applicable]\n3a. The sum of the contributions to surplus for each of the quarters __________ ____________ __________\n4. Applicable Annual Base Statutory Surplus from Schedule 6.8 __________ ____________ __________\n5. The sum of line 2b, line 3a and line 4 __________ ____________ __________\n6. Line 1 is not less than line 5. __________ ____________ __________\nExhibit 10.20*\nSECURITY AGREEMENT\nSECURITY AGREEMENT, dated as of December 28, 1995, made by Westbridge Funding Corporation (the \"Debtor\"), a Delaware corporation, for the benefit of Fleet National Bank of Connecticut (the \"Secured Party\"), a national banking association, and its successors and assigns.\nPRELIMINARY STATEMENT. The Secured Party has entered into a Credit Agreement dated as of December 28, 1995 (the \"Credit Agreement\") with the Debtor. Capitalized terms defined in the Credit Agreement and not otherwise defined herein are used herein as defined in the Credit Agreement.\nNOW, THEREFORE, in consideration of the premises and in order to induce the Secured Party to extend the financing contemplated by the Credit Agreement, the Debtor hereby agree as follows:\nSection 1. Grant of Security. The Debtor hereby assigns and pledges to the Secured Party and hereby grants to the Secured Party a continuing security interest in, all of the Debtor's right, title and interest in and to the following assets (the \"Collateral\"):\n(a) all Agent Receivables (as hereinafter defined) now owned or hereafter acquired by the Debtor wherever located,\n(b) the Assigned Commissions now or hereafter existing, and all of Debtor's rights in, to and under all other collateral security therefor and all guarantees thereof,\n(c) amounts deposited from time to time by any Eligible Seller in any deposit account maintained by such Eligible Seller in the name of the Debtor pursuant to the terms of the Receivables Purchase Agreement,\n(d) all other accounts, contract rights, chattel paper, instruments, general intangibles and other obligations of any kind now or hereafter acquired by the Debtor pursuant to the terms of the Receivables Purchase Agreement,\n(e) all rights now or hereafter existing in and to all security agreements, and other contracts securing or otherwise relating to any property described in clauses (a), (b), (c) and (d) above,\n(f) the Receivables Purchase Agreement,\n(g) all moneys and property of any kind, now or at any time or times hereafter, in the possession or under the control of the Secured Party, any bank or a bailee of Secured Party or any bank, or otherwise;\n(h) all accessions, to, substitutions for and all replacements, products and proceeds of the property described in clauses (a), (b), (c), (d), (e), (f) and (g) above, including without limitation, proceeds or insurance policies insuring the Collateral; and\n(i) all books and records (including, without limitation, computer programs, printouts, and other computer materials and records) of the Debtor pertaining to any of the property described in clauses (a), (b), (c), (d), (e), (f), (g) and (h) above.\nAnything in the foregoing description of Collateral to the contrary notwithstanding, the Collateral shall not include any contract right the assignment of which, for collateral purposes, would require or cause a forfeiture of rights thereunder.\n\"Agent Obligor\" means an agent of an Eligible Seller, including without limitation a general agent of an Eligible Seller and any other agent with whom said general agent has contracted, to whom such Eligible Seller has advanced First-year Commissions.\n\"Agent Receivable\" means the obligation of an Agent Obligor to repay the principal amount of, and interest and other finance charges on, advances made by an Eligible Seller to such Agent Obligor with respect to First-year Commissions.\nSection 2. Security for Obligations. This Agreement secures the payment and performance of all indebtedness, liabilities and obligations of any kind of the Debtor to the Secured Party, (whether directly as principal or maker or indirectly as guarantor, surety, endorser or otherwise), now or hereafter existing, due or to become due, howsoever incurred, arising or evidenced, whether of principal or interest or payment or performance, and all obligations of the Debtor now or hereafter existing under this Agreement (all such obligations of the Debtor being collectively referred to as the \"Obligations\").\nSection 3. Debtor Remain Liable. Anything herein to the contrary notwithstanding, (a) the Debtor shall remain liable under the contracts and agreements included in the Collateral to the extent set forth therein to perform all of its duties and obligations thereunder to the same extent as if this Agreement had not been executed, (b) the exercise by the Secured Party of any of the rights hereunder shall not release the Debtor from any of its duties or obligations under the contracts and agreements included in the Collateral, and (c) the Secured Party shall not have any obligation or liability under the contracts and agreements included in the Collateral by reason of this Agreement, nor shall the Secured Party be obligated to perform any of the obligations or duties of the Debtor thereunder or to take any action to collect or enforce any claim for payment assigned hereunder.\nSection 4. Representations and Warranties. The Debtor represents and warrants as follows:\n(a) The chief places of business and chief executive offices of the Debtor and the offices where the Debtor keeps its records concerning the Agent Receivables, the Assigned Commissions, and all originals of all documents which evidence the Agent Receivables, is at 777 Main Street, Fort Worth, Texas 76102. There is no chattel paper which evidences Agent Receivables. No Agent Receivables are evidenced by a promissory note or other instrument;\n(b) Except as acknowledged or authorized by the Credit Agreement and except for the security interest created by this Agreement, the Debtor owns the Collateral free and clear of any lien, security interest, charge or encumbrance. No effective financing statement or other instrument similar in effect covering all or any part of the Debtor's right, title or interest in the Collateral is on file in any recording office, except such as may have been filed in favor of the Secured Party relating to this Agreement. The Debtor has no trade names and has not had or operated under any other name during the last 5 years, except that prior to November 15, 1995 it was formerly known as \"National Legal Services Company, Inc.\";\n(c) Except as acknowledged or authorized by the Credit Agreement, this Agreement creates a valid first priority security interest in the Collateral, securing the payment of the Obligations, and all filings and other actions necessary or desirable to perfect and protect such security interest have been or will be duly taken; and\n(d) No authorization, approval or other action by, and no notice to or filing with, any governmental authority or regulatory body is required either (i) for the grant by the Debtor of the security interests granted hereby or for the execution, delivery or performance of this Agreement by the Debtor or (ii) for the perfection of or the exercise by the Secured Party of its rights and remedies hereunder, except UCC financing statements on Form UCC-l which have been previously made or are being made in connection with this Agreement.\nSection 5. Further Assurances. (a) The Debtor agrees from time to time, at its own expense, to promptly execute and deliver all further instruments and documents, and take all further action, that may be reasonably necessary or desirable or that the Secured Party may request, in order to perfect and protect any security interest granted or purported to be granted hereby or to enable the Secured Party to exercise and enforce its rights and remedies hereunder with respect to any Collateral. Without limiting the generality of the foregoing, the Debtor will: (i) if any Agent Receivable shall be evidenced by a promissory note or other instrument, deliver to the Secured Party and conditionally pledge to the Secured Party hereunder such note or instrument and accompanied by duly executed instruments of conditional transfer or assignment, all in form and substance satisfactory to the Secured Party, and (ii) execute and file such financing, or continuation statements, or amendments thereto, and such other instruments or notices, as may be necessary or desirable as the Secured Party may request, in order to perfect and preserve the security interests granted or purported to be granted hereby.\n(b) The Debtor hereby authorizes the Secured Party to file one or more financing or continuation statements and amendments thereto, relative to all or any part of the Collateral without the signature of the Debtor where permitted by law.\n(c) The Debtor will furnish to the Secured Party from time to time statements and schedules further identifying and describing the Collateral and such other reports in connection with the Collateral as the Secured Party may reasonably request, all in reasonable detail.\nSection 6. Transfers and Other Liens. Except as otherwise provided in the Credit Agreement, the Debtor shall not:\n(a) Sell, transfer (by operation of law or otherwise) or otherwise dispose of any of the Collateral; or\n(b) Create or suffer to exist any lien, security interest or other charge or encumbrance upon or with respect to any of the Collateral to secure Debt of any person or entity, except for the security interest created by this Agreement or authorized pursuant to the Credit Agreement.\nSection 7. Other Covenants.\n(a) Without the prior written consent of the Secured Party, the Debtor will not change the location of its chief executive office, its principal place of business, or the Collateral or any part thereof; provided, however, that Debtor may, upon not less than thirty days' prior written notice to the Secured Party, relocate its chief executive offices to any location in Texas or to any other jurisdiction in the United States in which the Uniform Commercial Code, as from time to time amended or revised, is then in effect (Texas and each such other jurisdiction being hereinafter called a \"Permitted Jurisdiction\");\n(b) The Debtor will, with respect to each and every relocation of Debtor's chief executive offices or any item(s) of the Collateral, take such action, at Secured Party's request and direction and at Debtor's expense as provided in Section 5 hereof (and including without limitation the preparation and filing where appropriate of new or amended financing statements), as may then be necessary or desirable to ensure the uninterrupted continuation of the Secured Party's security interest in all of the Collateral with the same priority as it had prior to any such relocation.\n(c) In addition to any other notices required pursuant to this Agreement or the Credit Agreement, the Debtor will promptly advise the Secured Party in reasonable detail (i) of the assertion or imposition of any claim, lien, security interest or other encumbrance against any or all of the Collateral; (ii) of any material adverse change in the composition of the Collateral; (iii) concerning the commencement of or any material development in any investigation of the Debtor, or any administrative or judicial proceeding against Debtor, by any governmental authority if such investigation or proceeding may result in the imposition of any Lien against the Collateral or any part thereof (whether or not any such Lien has then been claimed or asserted); and (iv) concerning any other event reasonably likely to have a material adverse effect on the aggregate value of the Collateral and\/or on the perfection and\/or priority of the Secured Party's security interest therein.\nSection 8. Secured Party Appointed Attorney-in-Fact. The Debtor hereby irrevocably appoints the Secured Party the Debtor's attorney-in-fact, with full authority in the place and stead of the Debtor and in the name of the Debtor, the Secured Party or otherwise, from time to time in the Secured Party's discretion, to take any action and to execute any instrument which the Secured Party may deem necessary or advisable to accomplish the purposes of this Agreement, including, without limitation:\n(i) to ask, demand, collect, sue for, recover, compound, receive and give acquittance and receipts for moneys due and to become due under or in respect of any of the Collateral;\n(ii) to receive, endorse, and collect any drafts or other instruments, documents and chattel paper, in connection with Section 5(a) of this Agreement; and\n(iii) to file any claims or take any action or institute any proceedings which the Secured Party may deem necessary or desirable for the collection of any of the Collateral or otherwise to enforce the rights of the Secured Party with respect to any of the Collateral.\nSo long as no Event of Default has occurred, the Secured Party agrees to give the Debtor five business days prior notice of its intention to exercise the power of attorney granted hereby.\nSection 9. Secured Party May Perform. If the Debtor fails to perform any agreement contained herein, the Secured Party may upon notice to the Debtor, itself perform, or cause performance of, such agreement, and the expenses of the Secured Party incurred in connection therewith shall be payable by the Debtor pursuant to Section 12(b) herein.\nSection 10. The Secured Party's Duties. The powers conferred on the Secured Party hereunder are solely to protect its interest in the Collateral and shall not impose any duty upon the Secured Party to exercise any such powers. Except for the safe custody of any Collateral in its possession and the accounting for moneys actually received by it hereunder, the Secured Party shall have no duty as to any Collateral or as to the taking of any necessary steps to preserve rights against prior parties or any other rights pertaining to any Collateral.\nSection 11. Remedies. If any Event of Default shall have occurred and be continuing:\n(a) The Secured Party may exercise in respect of the Collateral, in addition to other rights and remedies provided for herein or otherwise available, all the rights and remedies of a secured party on default under the Uniform Commercial Code (the \"Code\") (whether or not the Code applies to the affected Collateral) and also may (i) require the Debtor to, and the Debtor hereby agrees that it will at its expense and upon request of the Secured Party forthwith, assemble all or part of the Collateral as directed by the Secured Party and make it available to the Secured Party at a place to be designated by the Secured Party which is reasonably convenient to both parties and (ii) without notice except as specified below, sell the Collateral or any part thereof in one or more parcels at public or private sale, at any of the Secured Party's offices or elsewhere, for cash, on credit or for future delivery, and upon such other terms as the Secured Party may deem commercially reasonable. The Debtor agrees that, to the extent notice of sale shall be required by law, at least ten days' notice to the Debtor of the time and place of any public sale or the time after which any private sale is to be made shall constitute reasonable notification. The Secured Party shall not be obligated to make any sale of Collateral regardless of notice of sale having been given. The Secured Party may adjourn any public or private sale from time to time by announcement at the time and place fixed therefor, and such sale may, without further notice, be made at the time and place to which it was so adjourned.\n(b) All cash proceeds received by the Secured Party in respect of any sale of, collection from, or other realization upon all or any part of the Collateral may, in the discretion of the Secured Party, be held by the Secured Party as collateral for, and\/or then or at any time thereafter applied (after payment of any amounts payable to the Secured Party pursuant to Section 12) in whole or in part by the Secured Party against, all or any part of the Obligations in such order as the Secured Party shall elect. Any surplus of such cash or cash proceeds held by the Secured Party and remaining after payment in full of all the Obligations shall be paid over to the Debtor or to whomsoever may be lawfully entitled to receive such surplus.\nSection 12. Indemnity and Expenses.\n(a) The Debtor agrees to indemnify the Secured Party from and against any and all claims, losses and liabilities arising out of or resulting from this Agreement (including, without limitation, enforcement of this Agreement), except claims, losses or liabilities resulting from the Secured Party's gross negligence or willful misconduct.\n(b) The Debtor will upon demand pay to the Secured Party the amount of any and all reasonable expenses, including the reasonable fees and disbursements of its counsel and of any experts and agents, which the Secured Party may incur in connection with (i) the exercise or enforcement of any of the rights hereunder or (ii) the failure by the Debtor to perform or observe any of the provisions hereof.\nSection 13. Amendments, Etc. No amendment or waiver of any provision of this Agreement nor consent to any departure by the Debtor herefrom shall in any event be effective unless the same shall be in writing and signed by the Secured Party and the Debtor, and then such waiver or consent shall be effective only in the specific instance and for the specific purpose for which given. No release of any amount of Collateral shall be effective unless the same shall be in writing and signed by the Secured Party and the Debtor, and then such release shall be effective only in the specific instance and for the specific purpose for which given.\nSection 14. Addresses for Notices. All notices and other communications provided for hereunder shall be in writing and mailed, telecopied, or telegraphed or delivered to the appropriate party hereto, addressed to it as stated on the signature page herein, or at such other address as shall be designated by such party in a written notice to each other party complying as to delivery with the terms of this Section. All such notices and other communications shall, when mailed, telecopied, or telegraphed, respectively, be effective when deposited in the mails, confirmed received by telecopy, or delivered to the telegraph company, respectively, addressed as aforesaid.\nSection 15. Continuing Security Interest; Transfer of Note; Conflicting Security Interests. This Agreement shall create a continuing security interest in the Collateral and shall (A) remain in full force and effect until payment in full of the Obligations, (B) be binding upon the Debtor, its successors and assigns, and (C) inure to the benefit of the Secured Party and its successors, transferees and assigns. Without limiting the generality of the foregoing clause (C), the Secured Party may assign or otherwise transfer the Revolving Note (or any substitute or replacement therefor) to any other person or entity with or without notice upon the occurrence of any event which constitutes an Event of Default or would constitute an Event of Default but for the requirement that notice be given or time elapse or both, and such other person or entity shall thereupon become vested with all the benefits in respect thereof granted to the Secured Party herein or otherwise. Upon termination of the Commitment under the Credit Agreement and the payment in full of the Obligations, this Agreement and the security interest granted hereby shall terminate and all rights to the Collateral shall revert to the Debtor. Upon any such termination, the Secured Party will, at the Debtor's expense, deliver UCC termination statements and execute and deliver to the Debtor such documents as the Debtor shall reasonably request to evidence such termination. To the extent that there exist conflicting security interests in the Collateral that suggest a different priority than provided in this Agreement, this Agreement shall prevail.\nSection 16. Governing Law; Terms. This Agreement shall be governed by and construed in accordance with the laws of the State of Connecticut, except as required by mandatory provisions of law and except to the extent that the validity or perfection of the security interest hereunder, or remedies hereunder, in respect of any particular Collateral are governed by the laws of a jurisdiction other than the State of Connecticut. Unless otherwise defined herein, or mandated by the preceding sentence, terms used in Article 9 of the Code in the State of Connecticut are used herein as therein defined.\nIN WITNESS WHEREOF, the Debtor has caused this Agreement to be duly executed and delivered by its officer thereunto duly authorized as of the date first above written.\nWESTBRIDGE FUNDING CORPORATION\nBy: \/s\/ Patrick J. Mitchell Name: Patrick J. Mitchell Title: CFO\nAddress for Notices:\n777 Main Street Fort Worth, Texas 76102 Attn: Chief Financial Officer Telecopier No.: (817 -878-3880\nWith a copy to:\nMilbank, Tweed, Hadley & McCloy 1 Chase Manhattan Plaza New York, NY 10005-1413 Attn: Jonathan R. Rod, Esq. Telecopier No.: (212) 530-5219\nFLEET NATIONAL BANK OF CONNECTICUT\nBy: \/s\/ David A. Wilkie\nName: David A. Wilkie Title: A.V.P.\nAddress for Notices:\nInsurance Industry Department 777 Main Street, MSN 250 Hartford, CT 06115 Attn: David Wilke Telecopier No.: (860) 986-1264\nWith a copy to:\nRichard C. MacKenzie, Esq. Day, Berry & Howard CityPlace I Hartford, CT 06103-3499 Telecopier No.: (860) 275-0343\nExhibit 10.21*\nWESTBRIDGE CAPITAL CORP.\n10% SENIOR NOTE DUE 2002\n$1,000,000.00 December 22, 1995\nFOR VALUE RECEIVED, Westbridge Capital Corp., a Delaware corporation having its principal office at 777 Main Street, Fort Worth, Texas 76102 (the \"Company\"), hereby promises to pay to the order of Martin E. Kantor, residing at 28 Shore Cliff Place, Great Neck, New York 11023 (including any transferee of this Note, the \"Holder\"), on December 22, 2002 (the \"Maturity Date\") the principal sum of one million dollars ($1,000,000.00), and to pay to the Holder interest on the unpaid principal amount of this Note as provided in Section 1.2 hereof. Capitalized terms used but not otherwise defined herein have the respective meanings given to such terms in Article V hereof.\nARTICLE I\nPRINCIPAL AND INTEREST\nSection 1.1 Principal. The entire unpaid principal amount of this Note shall be paid on the Maturity Date. Promptly following the payment in full of this Note, the Holder shall surrender this Note to the Company for cancellation.\nSection 1.2 Interest. Interest shall accrue on the daily unpaid principal amount of this Note, for each day during the period from and including December 22, 1995 (the \"Commencement Date\") to but excluding the date such Note shall be paid in full, at the rate of ten percent (10%) per annum (the \"Interest Rate\"), and shall be payable as provided in this Section 1.2. On each six-month anniversary of the Commencement Date (each, an \"Interest Accrual Date\") occurring on or prior to the third anniversary of the Commencement Date, the amount of such interest accrued to but excluding such Interest Accrual Date shall be added to the principal amount of this Note, and the principal amount of this Note as so increased shall thereafter bear interest as provided herein. On each Interest Accrual Date occurring after the third anniversary of the Commencement Date, the amount of such interest accrued to but excluding such Interest Accrual Date shall be paid to the Holder. On the date on which the outstanding principal amount of this Note is paid in full and on each date on which any principal hereof is prepaid, the Company shall also pay the Holder interest accrued from and including the immediately preceding Interest Accrual Date to but excluding the date of such payment (in the case of prepayment hereof, only on the amount so prepaid). Interest on this Note shall be computed on the basis of a year of 360 days consisting of twelve 30-day months.\nSection 1.3 Default Interest. Without duplication of any interest payable under Section 1.2 hereof, the Company hereby unconditionally promises to pay to the Holder interest on any principal or interest payable by the Company under this Note that shall not be paid in full when due (whether at stated maturity, by acceleration, upon prepayment or otherwise), for the period from and including the due date of such payment to but excluding the date the same is paid in full, at a rate per annum equal to the Interest Rate plus 2%, which interest shall be payable from time to time on demand of the Holder.\nARTICLE II\nPAYMENTS AND PREPAYMENTS\nSection 2.1 Payments Generally. All payments of principal and interest in respect of this Note shall be made by delivery to the Holder at the address written above, or such other address that the Holder provides to the Company, of a certified or official bank check payable in Dollars to the order of the Holder, not later than 12:00 p.m., New York time, on the date on which such payment shall become due (each such payment made after such time on such due date to be deemed to have been made on the next succeeding Business Day). If the due date of any payment in respect of this Note would otherwise fall on a day that is not a Business Day, such due date shall be extended to the next succeeding Business Day, and interest shall be payable on any principal so extended for the period of such extension. All amounts payable under this Note shall be paid free and clear of, and without reduction by reason of, any deduction, set-off or counterclaim.\nSection 2.2 Prepayment. The Company may at any time or from time to time, at its option, prepay this Note (in an amount up to but not exceeding the unpaid principal amount hereof), in whole or in part, without premium or penalty. Interest shall be payable in connection with any such prepayment as provided in Section 1.2 hereof.\nARTICLE III\nREPAYMENT AT OPTION OF HOLDER\nSection 3.1 Repayment Option upon Death of Holder. If the Holder is an individual, the Company shall prepay the outstanding principal amount of this Note (together with interest accrued hereon as provided in Section 1.2 hereof) within one (1) year after an Authorized Representative of such Holder has notified the Company of the death of the Holder; provided that the Company shall not be required to prepay this Note pursuant to this Section 3.1 unless the Company has received within six (6) months following the date of death of such Holder (i) a written request for prepayment signed by the Authorized Representative, which request shall set forth the date of death of the deceased Holder, (ii) this Note and (iii) evidence reasonably satisfactory to the Company of the authority of the Authorized Representative. Notwithstanding anything to the contrary contained in this Section 3.1, the Company shall not be required to make any payment pursuant to this Section 3.1 to the extent that (a) the Company is, or, after giving effect to such repayment would be, in default under any Senior Indebtedness or (b) the Company is subject to any law, regulation, agreement or administrative directive preventing such payment. If the Company is permitted to defer payment of any amount otherwise due and payable pursuant to this Section 3.1 by reason of the existence of any condition referred to in clause (a) or (b) of the immediately preceding sentence, such payment shall be due and payable on the first Business Day on which such condition no longer exists, but in no event later than the Maturity Date.\nARTICLE IV\nEVENTS OF DEFAULT\nSection 4.1 Event of Default. \"Event of Default\", wherever used herein, means any one of the following events (whatever the reason for such Event of Default and whether it shall be voluntary or involuntary or be effected by operation of law or pursuant to any judgment, decree or order of any court or any order, rule or regulation of any administrative or governmental body):\n(a) default in the payment of any interest in respect of this Note within five (5) Business Days after it becomes due and payable; or\n(b) default in the payment of the outstanding principal amount of this Note at its Maturity Date; or\n(c) a default with respect to the Indenture or any other instrument evidencing indebtedness of the Company or any of its Subsidiaries which results in any indebtedness of the Company or any of its Subsidiaries of at least $1,000,000 becoming or being declared due and payable prior to its scheduled maturity date; or\n(d) the entry of a decree or order by a court having jurisdiction in the premises adjudging the Company or any of its Subsidiaries a bankrupt or insol- vent, or approving as properly filed a petition seeking reorganization, arrangement, adjustment or composition of or in respect of the Company or any of its Subsidiaries under Federal bankruptcy law or any other applicable Federal or state law, or appointing a receiver, liquidator, assignee, trustee, sequestrator or other similar official of the Company or any of its Subsidiaries or of any substantial part of the property of the Company or any of its Subsidiaries, or ordering the winding up or liquidation of the affairs of the Company or any of its Subsidiaries, and the continuance of any such decree or order unstayed and in effect for a period of sixty (60) consecutive days; or\n(e) the institution by the Company or any of its Subsidiaries of proceedings to be adjudicated a bankrupt or insolvent, or the consent by the Company or any of its Subsidiaries to the institution of bankruptcy or insolvency proceedings against it, or the filing by the Company or any of its Subsidiaries of a petition or answer or consent seeking reorganization or relief under Federal bankruptcy law or any other applicable Federal or state law, or the consent by the Company or any of its Subsidiaries to the filing of such petition or to the appointment of a receiver, liquidator, assignee, trustee, sequestrator or similar official of the Company or any of its Subsidiaries or of any substantial part of the property of the Company or any of its Subsidiaries, or the making by the Company or any of its Subsidiaries of an assignment for the benefit of creditors, or the admission by the Company or any of its Subsidiaries in writing of its inability to pay its debts generally as they become due, or the taking of corporate action by the Company or any of its Subsidiaries in furtherance of any such action; or\n(f) a judgment or order for the payment of at least $1,000,000 is rendered against the Company or any of its Subsidiaries and is not vacated, discharged, stayed or bonded pending appeal within sixty (60) days after notice of such judgment or order to the Company or any of its Subsidiaries.\nSection 4.2 Acceleration of Note. If an Event of Default occurs and is continuing, then and in every such case the Holder may declare the outstanding principal amount of this Note (including accrued interest as provided in Section 1.2 hereof) to be due and payable immediately, by a notice in writing to the Company, and upon any such declaration such principal shall become immediately due and payable. Notwithstanding the foregoing, if an Event of Default referenced in paragraph (d) or paragraph (e) of this Section 4.1 occurs, the outstanding principal amount of this Note (including accrued interest as provided in Section 1.2 hereof) shall automatically become due and payable immediately without any declaration or other action on the part of the Holder. At any time after the outstanding principal amount of this Note shall become immediately due and payable and before a judgment or decree for payment of the money due has been obtained, the Holder, by written notice to the Company, may rescind and annul an acceleration and its consequences.\nARTICLE V\nDEFINITIONS\nSection 5.1 Definitions. The following terms shall have the meanings set forth below:\n\"Authorized Representatives\" of any Holder mean such Holder's executors, administrators or other legal representatives of an estate, trustees of a trust, custodians, conservators, guardians, attorneys-in-fact and other persons generally recognized as having legal authority to act on behalf of another.\n\"Business Day\" means a day other than Saturday, Sunday or any day on which banks located in the State of New York or the State of Texas are authorized or obligated to close.\n\"Commencement Date\" has the meaning ascribed to it in Section 1.2.\n\"Company\" has the meaning ascribed to it in the forepart of this Note.\n\"Dollars\" and \"$\" means lawful money of the United States of America.\n\"Event of Default\" has the meaning ascribed to in Section 4.1\n\"Holder\" has the meaning ascribed to it in the forepart of this Note.\n\"Indenture\" means the Indenture dated as of February 15, 1995 by and between the Company and Liberty Bank and Trust Company of Oklahoma City, National Association, trustee, as the same may be amended from time to time.\n\"Interest Accrual Date\" has the meaning ascribed to it in Section 1.2.\n\"Interest Rate\" has the meaning ascribed to it in Section 1.2.\n\"Maturity Date\" has the meaning ascribed to it in the forepart of this Note.\n\"Note\" means this Promissory Note, as modified and supplemented and in effect from time to time.\n\"Senior Indebtedness\" has the meaning ascribed to such term in the Indenture.\n\"Subsidiary\" means any corporation or other entity in which the Company, directly or indirectly through Subsidiaries or otherwise, beneficially owns more than fifty percent (50%) of either the equity interests in, or the voting control of, such corporation or other entity.\nARTICLE VI\nMISCELLANEOUS\nSection 6.1 Rank. The Company expressly acknowledges that the indebtedness evidenced by this Note constitutes Senior Indebtedness.\nSection 6.2 Delay or Omission Not Waiver. No failure or delay on the part of the Holder in the exercise of any power, right or privilege hereunder shall operate as a waiver thereof, nor shall any single or partial exercise of any such power, right or privilege preclude other or further exercise thereof or of any right, power or privilege. All rights and remedies existing hereunder are cumulative to, and not exclusive of, any rights or remedies otherwise available.\nSection 6.3 Governing Law. This Note shall be governed by, and construed in accordance with, the laws of the State of New York, without regard to the conflicts of laws principles thereof.\nSection 6.4 Successors. All agreements of the Company in this Note shall bind its successors and assigns.\nSection 6.5 Waivers. The Company waives demand, presentment for payment, notice of dishonor, protest, notice of protest and notice of non-payment of this Note.\nIN WITNESS WHEREOF, the Company has caused this Note to be duly executed by an authorized officer thereof as of the date and year first above written.\nWESTBRIDGE CAPITAL CORP.\nBy: \/s\/ James W. Thigpen Name: James W. Thigpen Title: President and Chief Operating Officer\nExhibit 10.22*\nTHE SECURITIES REPRESENTED BY THIS CERTIFICATE MAY NOT BE OFFERED FOR SALE, SOLD OR OTHERWISE DISPOSED OF EXCEPT PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT FILED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR PURSUANT TO AN EXEMPTION FROM REGISTRATION UNDER SUCH ACT.\nVOID AT 5:00 P.M., NEW YORK TIME, ON DECEMBER 22, 2002, OR IF NOT A BUSINESS DAY, AS DEFINED HEREIN, AT 5:00 P.M., NEW YORK TIME, ON THE NEXT FOLLOWING BUSINESS DAY.\nWARRANT TO PURCHASE 135,501 SHARES OF COMMON STOCK\nNO. 1\nWARRANT TO PURCHASE COMMON STOCK OF WESTBRIDGE CAPITAL CORP.\nTRANSFER RESTRICTED -- SEE SECTION 5.02\nThis certifies that, for good and valuable consideration, the receipt of which is hereby acknowledged, Martin E. Kantor and his permitted assigns is entitled to purchase from Westbridge Capital Corp., a Delaware corporation (the \"Company\"), subject to the terms and conditions hereof, at any time on or after 9:00 A.M., New York time, on December 22, 1995, and before 5:00 P.M., New York time, on December 22, 2002 (or, if such day is not a Business Day (as defined below), before 5:00 P.M., New York time, on the next following Business Day), the number of fully paid and nonassessable shares of Common Stock stated above at the Exercise Price (as defined below); provided that this Warrant may not be exercised so long as the restrictions on exercise set forth in Section 2.01 hereof would prohibit such exercise. The Exercise Price and the number of shares purchasable hereunder are subject to adjustment from time to time as provided in Article III.\nARTICLE I\nSection 1.01: Definition of Terms. As used in this Warrant, the following capitalized terms shall have the following respective meanings:\n(a) Board of Directors: The Board of Directors of the Company.\n(b) Business Day: A day other than a Saturday, Sunday or other day on which banks in the State of New York or the State of Texas are authorized or required by law to remain closed.\n(c) Common Stock: Common Stock, par value $.10 per share, of the Company.\n(d) Common Stock Equivalents: Securities that are convertible into or exercisable for shares of Common Stock.\n(e) Demand Registration: See Section 6.02.\n(f) Exchange Act: The Securities Exchange Act of 1934, as amended.\n(g) Exercise Price: $7.38 per Warrant Share, as such price may be adjusted from time to time pursuant to Article III.\n(h) Expiration Date: 5:00 P.M., New York time, on December 22, 2002, or if such day is not a Business Day, the next succeeding day which is a Business Day.\n(i) Holder: A holder of Registrable Securities.\n(j) 25% Holders: At any time at which a Demand Registration is requested, holders of Warrants and\/or holders of Registrable Securities who have the right to acquire or hold, as the case may be, not less than 25% of the combined total of Warrant Shares issuable upon exercise of Warrants and Registrable Securities outstanding at the time such Demand Registration is requested.\n(k) NASD: National Association of Securities Dealers, Inc., and NASDAQ: NASD Automatic Quotation System.\n(l) Note: The 10% Senior Note due 2002 in the principal amount of $1,000,000.00 issued by the Company to Martin E. Kantor.\n(m) Oppenheimer Warrant: The Warrant to Purchase Common Stock of the Company expiring on April 12, 1999 issued by the Company to Oppenheimer & Co. Inc. in connection with the consummation of the transactions contemplated by the Preferred Stock Purchase Agreement.\n(n) Person: An individual, partnership, limited liability company, joint venture, corporation, trust, unincorporated organization or government or any department or agency thereof.\n(o) Piggyback Registration: See Section 6.01.\n(p) Preferred Stock Purchase Agreement: The Preferred Stock Purchase Agreement dated as of April 1, 1994 by and among the Company and the purchasers named on the signature pages thereto, as the same may be amended from time to time. (q) Prospectus: Any prospectus included in any Registration Statement, as amended or supplemented by any prospectus supplement, with respect to the terms of the offering of any portion of the Registrable Securities covered by such Registration Statement and all other amendments and supplements to the Prospectus, including post-effective amendments and all material incorporated by reference in such Prospectus.\n(r) Public Offering: A public offering of any of the Company's securities pursuant to a registration statement under the Securities Act.\n(s) Registration Expenses: Any and all expenses incurred in connection with any registration or action incident to performance of or compliance by the Company with Article VI, including, without limitation, (i) all SEC, national securities exchange and NASD registration and filing fees, all listing fees and all transfer agent fees, (ii) all fees and expenses of complying with state securities or blue sky laws (including the fees and disbursements of counsel for the underwriters in connection with blue sky qualifications of the Registrable Securities), (iii) all printing, mailing, messenger and delivery expenses and (iv) all fees and disbursements of counsel for the Company and of its accountants, including the expenses of any special audits and\/or \"cold comfort\" letters required by or incident to such performance and compliance, but excluding underwriting discounts and commissions, brokerage fees and transfer taxes, if any, and fees of counsel or accountants retained by the holders of Registrable Securities to advise them in their capacity as Holders.\n(t) Registrable Securities: Any Warrant Shares and\/or other securities that may be or are issued or issuable by the Company upon exercise of any Warrant, including those which may thereafter be issued by the Company in respect of any such securities by means of any stock splits, stock dividends, recapitalizations, reclassifications or the like, and as adjusted pursuant to Article III; provided, however, that any particular security shall cease to be a Registrable Security when (i) a Registration Statement with respect to the sale of such security shall have become effective under the Securities Act and such security shall have been disposed of in accordance with such Registration Statement, or (ii) such security shall have been sold to the public pursuant to Rule 144 (or any successor provision) under the Securities Act.\n(u) Registration Statement: Any registration statement of the Company filed or to be filed with the SEC which covers any of the Registrable Securities pursuant to the provisions of this Warrant, including all amendments (including post-effective amendments) and supplements thereto, all exhibits thereto and all material incorporated therein by reference.\n(v) SEC: The Securities and Exchange Commission or any other federal agency at the time administering the Securities Act or the Exchange Act.\n(w) Securities Act: The Securities Act of 1933, as amended.\n(x) Transfer: Any transfer, sale, assignment, pledge, encumbrance, hypothecation, conveyance or any other disposition of any Warrant, Warrant Share or any interest of either thereof.\n(y) Warrant Shares: Common Stock, Common Stock Equivalents and other securities purchased or purchasable upon exercise of the Warrants.\n(z) Warrantholder: The Person to whom this Warrant is originally issued, or any successor in interest thereto, or any assignee or transferee thereof, in whose name this Warrant is registered upon the books to be maintained by the Company for that purpose.\n(aa) Warrants: This Warrant and all other warrants that may be issued in its place.\nARTICLE II\nDuration and Exercise of Warrant\nSection 2.01: Duration of Warrant. The Warrantholder may exercise this Warrant at any time and from time to time after 9:00 A.M., New York time, on December 22, 1995, and before 5:00 P.M., New York time, on the Expiration Date; provided that this Warrant may not be exercised unless (i) the restrictions on issuance of shares of Common Stock upon exercise of the Warrant set forth in section4.11(iv) of the Preferred Stock Purchase Agreement shall have ceased to apply or shall have been waived, (ii) the holders of Common Stock have consented to the issuance of shares of Common Stock upon the exercise of this Warrant, if and to the extent required by the rules of the NYSE, and (iii) all applicable insurance laws and regulations have been satisfied or complied with in respect of the issuance of shares of Common Stock upon the exercise of this Warrant. If this Warrant is not exercised prior to the Expiration Date, it shall become void, and all rights hereunder shall thereupon cease.\nSection 2.02: Exercise of Warrant. (a) The Warrantholder may exercise this Warrant, in whole or in part, as follows:\n(i) The Warrantholder may exercise this Warrant, in whole or in part, by presentation and surrender of this Warrant to the Company at its principal executive offices or at the office of its stock transfer agent, if any, with the Subscription Form annexed hereto duly executed and accompanied by the full Exercise Price for each Warrant Share to be purchased, with the full Exercise Price payable, at the Warrantholder's option, (A) in cash or by check, (B) if the Warrantholder is the holder of the Note, by the Warrantholder agreeing to a reduction of the outstanding principal amount of the Note equal to the Exercise Price or (C) any combination of (A) and (B). In connection with any such reduction in the principal amount of the Note, the Warrantholder will present the Note to the Company for the purpose of permitting the Company to note any such reduction on the fare of the Note.\n(ii) By presentation and surrender of this Warrant to the Company at its principal executive offices with a Cashless Exercise Form annexed hereto duly executed (a \"Cashless Exercise\"). In the event of a Cashless Exercise, the Warrantholder shall exchange its Warrant for that number of shares of Common Stock determined by multiplying the number of Warrant Shares by a fraction, the numerator of which shall be the difference between the current market price per share of Common Stock on the Business Day prior to the date of the Cashless Exercise and the Exercise Price, and the denominator of which shall be the then current market price per share of Common Stock. For purposes of any computation under this Section 2.02(a)(ii), the current market price per share of Common Stock at the applicable date shall be determined pursuant to Section 3.01(f).\n(b) Upon receipt of this Warrant, in the case of Section 2.02(a)(i), with the Subscription Form duly executed and accompanied by payment of the aggregate Exercise Price for the Warrant Shares for which this Warrant is then being exercised, or, in the case of Section 2.02(a)(ii), with the Cashless Exercise Form duly executed, the Company shall cause to be issued certificates for the total number of whole shares of Common Stock for which this Warrant is being exercised in such denominations as are requested for delivery to the Warrantholder, and the Company shall thereupon deliver such certificates to the Warrantholder. The Warrantholder shall be deemed to be the holder of record of the shares of Common Stock issuable upon such exercise, notwithstanding that the stock transfer books of the Company shall then be closed or that certificates representing such shares of Common Stock shall not then be actually delivered to the Warrantholder. If at the time this Warrant is exercised, a Registration Statement is not in effect to register under the Securities Act the Warrant Shares issuable upon exercise of this Warrant, the Company may require the Warrantholder to make such representations, and may place such legends on certificates representing the Warrant Shares, as may be reasonably required in the opinion of counsel to the Company to permit the Warrant Shares to be issued without such registration.\n(c) In case the Warrantholder shall exercise this Warrant with respect to less than all of the Warrant Shares that may be purchased under this Warrant, the Company shall execute a new Warrant in the form of this Warrant for the balance of such Warrant Shares and deliver such new Warrant to the Warrantholder.\n(d) The Company shall pay any and all stock transfer and similar taxes which may be payable in respect of the issue of this Warrant or in respect of the issue of any Warrant Shares.\nSection 2.03: Reservation of Shares. The Company hereby agrees that at all times there shall be reserved for issuance and delivery upon exercise of this Warrant such number of shares of Common Stock or other shares of capital stock of the Company from time to time issuable upon exercise of this Warrant. All such shares shall be duly authorized, and when issued upon such exercise, shall be validly issued, fully paid and nonassessable, free and clear of all liens, security interests, charges and other encumbrances or restrictions on sale (other than under the Securities Act or state securities or blue sky laws) and free and clear of all preemptive rights.\nSection 2.04: Fractional Shares. The Company shall not be required to issue any fraction of a share of its capital stock in connection with the exercise of this Warrant, and in any case where the Warrantholder would, except for the provisions of this Section 2.04, be entitled under the terms of this Warrant to receive a fraction of a share upon the exercise of this Warrant, the Company shall, upon receipt of the Exercise Price, issue the largest number of whole shares purchasable upon exercise of this Warrant. The Company shall not be required to make any cash or other adjustment in respect of such fraction of a share to which the Warrantholder would otherwise be entitled.\nSection 2.05: Listing. Prior to the issuance of any shares of Common Stock upon exercise of this Warrant, the Company shall secure the listing of such shares of Common Stock upon each national securities exchange or automated quotation system, if any, upon which shares of Common Stock are then listed (subject to official notice of issuance upon exercise of this Warrant) and shall maintain, so long as any other shares of Common Stock shall so be listed, such listing of all shares of Common Stock from time to time issuable upon the exercise of this Warrant; and the Company shall so list on each national securities exchange or automated quotation system, and shall maintain such listing of, any other shares of capital stock of the Company issuable upon the exercise of this Warrant if and so long as any shares of the same class shall be listed on such national securities exchange or automated quotation system.\nARTICLE III\nAdjustment of Shares of Common Stock Purchasable and of Exercise Price\nThe Exercise Price and the number and kind of Warrant Shares shall be subject to adjustment from time to time upon the happening of certain events as provided in this Article III.\nSection 3.01: Mechanical Adjustments. (a) If at any time prior to the exercise of this Warrant in full, the Company shall (i) declare a dividend or make a distribution on the Common Stock payable in shares of Common Stock, (ii) subdivide, reclassify or recapitalize outstanding Common Stock into a greater number of shares, or (iii) combine, reclassify or recapitalize its outstanding Common Stock into a smaller number of shares, the Exercise Price in effect at the time of the record date of such dividend, distribution, subdivision, combination or reclassification shall be adjusted by multiplying such Exercise Price by a fraction, the numerator of which is the number of shares of Common Stock outstanding immediately prior to such event and the denominator of which is the number of shares of Common Stock outstanding immediately after such event. Any adjustment required by this Section 3.01(a) shall be made successively immediately after the record date, in the case of a dividend or distribution, or the effective date, in the case of a subdivision, combination or reclassification.\n(b) If at any time prior to the exercise of this Warrant in full, the Company shall (i) issue or sell any Common Stock or Common Stock Equivalents without consideration or for consideration per share (in cash, property or other assets) less than the current market price per share of the Common Stock on the date of such issuance or sale as determined pursuant to Section 3.01(f) or (ii) fix a record date for the issuance of subscription rights, options or warrants to all holders of Common Stock entitling them to subscribe for or purchase Common Stock (or Common Stock Equivalents) at a price (or having an exercise or conversion price per share) less than the current market price of the Common Stock (as determined pursuant to Section 3.01(f)) on the record date described below, the Exercise Price shall be adjusted so that the Exercise Price shall equal the price determined by multiplying the Exercise Price in effect immediately prior to the date of such sale or issuance (which date in the event of distribution to shareholders shall be deemed to be the record date set by the Company to determine shareholders entitled to participate in such distribution) by a fraction, the numerator of which shall be (i) the number of shares of Common Stock outstanding on the date of such issuance or sale, plus (ii) the number of additional shares of Common Stock which the aggregate consideration received by the Company upon such issuance or sale (plus the aggregate of any additional amount to be received by the Company upon the exercise of such subscription rights, options or warrants) would purchase at such current market price per share of the Common Stock; and the denominator of which shall be (i) the number of shares of Common Stock outstanding on the date of such issuance or sale, plus (ii) the number of additional shares of Common Stock offered for subscription or purchase (or into which the Common Stock Equivalents so offered are exercisable or convertible). Any adjustments required by this Section 3.01(b) shall be made immediately after such issuance or sale or record date, as the case may be. Such adjustments shall be made successively whenever such event may occur. To the extent that shares of Common Stock (or Common Stock Equivalents) are not delivered after the expiration of such subscription rights, options or warrants, the Exercise Price shall be readjusted to the Exercise Price which would then be in effect had the adjustments made upon the issuance of such rights, options or warrants been made upon the basis of delivery of only the number of shares of Common Stock (or Common Stock Equivalents) actually delivered.\n(c) If at any time prior to the exercise of this Warrant in full, the Company shall fix a record date for the issuance or making a distribution to all holders of Common Stock (including any such distribution to be made in connection with a recapitalization of the Common Stock or a consolidation or merger in which the Company is to be the continuing corporation) of (i) evidences of its indebtedness, (ii) any other securities of the Company or any cash, property or other assets (excluding a combination or reclassification referred to in Section 3.01(a), regular cash dividends or cash distributions paid out of net profits legally available therefor and in the ordinary course of business, or (iii) any subscription rights, options or warrants for Common Stock or Common Stock Equivalents (excluding those referred to in Section 3.01(b)) (any such non-excluded event under clause (i), (ii) or (iii) being herein called a \"Special Dividend\"), the Exercise Price shall be decreased immediately after the record date for such Special Dividend to a price determined by multiplying the Exercise Price then in effect by a fraction, the numerator of which shall be the then current market price of the Common Stock (as determined pursuant to Section 3.01(f)) on such record date less the fair market value (as determined by the Board of Directors) of the evidences of indebtedness, securities or property, or of the other assets issued or distributed in such Special Dividend applicable to one share of Common Stock or of such subscription rights, options or warrants applicable to one share of Common Stock, and the denominator of which shall be such then current market price per share of Common Stock (as so determined). Any adjustment required by this Section 3.01(c) shall be made successively whenever such a record date is fixed and in the event that such distribution is not made, the Exercise Price shall again be adjusted to be the Exercise Price that was in effect immediately prior to such record date.\n(d) If at any time prior to the exercise of this Warrant in full, the Company shall make a distribution to all holders of the Common Stock of stock of a subsidiary or securities convertible into or exercisable for such stock, then in lieu of an adjustment in the Exercise Price or the number of Warrant Shares purchasable upon the exercise of this Warrant, each Warrantholder, upon the exercise hereof at any time after such distribution, shall be entitled to receive from the Company, such subsidiary or both, as the Company shall determine, the stock or other securities to which such Warrantholder would have been entitled if such Warrantholder had exercised this Warrant immediately prior thereto, all subject to further adjustment as provided in this Article III, and the Company shall reserve, for the life of the Warrant, such securities of such subsidiary or other corporation; provided, however, that no adjustment in respect of dividends or interest on such stock or other securities shall be made during the term of this Warrant or upon its exercise.\n(e) Whenever the Exercise Price payable upon exercise of this Warrant is adjusted pursuant to one or more of paragraphs (a), (b) and (c) of this Section 3.01, the Warrant Shares issuable upon exercise of each Warrant shall simultaneously be adjusted by multiplying (i) the number of Warrant Shares issuable immediately prior to such adjustment by (ii) the Exercise Price in effect immediately prior to such adjustment, and dividing the product so obtained by the Exercise Price as so adjusted.\n(f) For the purpose of any computation under this Section 3.01, the current market price per share of Common Stock at any date shall be deemed to be the average of the daily closing prices for twenty (20) consecutive trading days commencing 30 trading days before such date. The closing price for each day shall be the last sale price regular way or, in case no such reported sales take place on such day, the average of the last reported bid and asked prices regular way, in either case on the principal national securities exchange on which the Common Stock is admitted to trading or listed, or if not listed or admitted to trading on any such exchange, the representative closing bid price as reported by NASDAQ, or other similar organization if NASDAQ is no longer reporting such information, or if not so available, the fair market price as determined by the Board of Directors.\n(g) No adjustment in the Exercise Price shall be required unless such adjustment would require an increase or decrease of at least ten cents ($.10) in such price; provided, however, that any adjustments which by reason of this paragraph (g) are not required to be made shall be carried forward and taken into account in any subsequent adjustment. All calculations under this Section 3.01 shall be made to the nearest cent or to the nearest one-hundredth of a share, as the case may be. Notwithstanding anything in this Section 3.01 to the contrary, the Exercise Price shall not be reduced to less than the then existing par value of the Common Stock as a result of any adjustment made hereunder.\n(h) In the event that at any time, as a result of any adjustment made pursuant to Section 3.01, the Warrantholder thereafter shall become entitled to receive any shares of the Company other than Common Stock, thereafter the number of such other shares so receivable upon exercise of any Warrant shall be subject to adjustment from time to time in a manner and on terms as nearly equivalent as practicable to the provisions with respect to the Common Stock contained in Section 3.01(a).\n(i) In the case of an issue of additional Common Stock or Common Stock Equivalents for cash, the consideration received by the Company therefor, after deducting therefrom any discount or commission or other expenses paid by the Company for any underwriting of, or otherwise in connection with, the issuance thereof, shall be deemed to be the amount received by the Company therefor. The term \"issue\" shall include the sale or other disposition of shares held by or on account of the Company or in the treasury of the Company but until so sold or otherwise disposed of such shares shall not be deemed outstanding.\nSection 3.02: Notice of Adjustment. Whenever the number of Warrant Shares or the Exercise Price is adjusted as herein provided, the Company shall prepare and deliver forthwith to the Warrantholder a certificate signed by its Chairman of the Board, President, any Vice President, Treasurer or Secretary, setting forth (x) the adjusted number of shares purchasable upon the exercise of this Warrant and the Exercise Price of such shares after such adjustment, (y) a brief statement of the facts requiring such adjustment and (z) the computation by which such adjustment was made.\nSection 3.03: No Adjustment for Dividends. Except as provided in Section 3.01, no adjustment in respect of any cash dividends shall be made during the term of this Warrant or upon the exercise of this Warrant.\nSection 3.04: Preservation of Purchase Rights in Certain Transactions. In case of any reclassification, capital reorganization or other change of outstanding shares of Common Stock (other than a subdivision or a combination of the outstanding Common Stock and other than a change in the par value of the Common Stock), or in case of any consolidation or merger of the Company with or into another corporation (other than a merger with a subsidiary in which the Company is the continuing corporation and that does not result in any reclassification, capital reorganization or other change of outstanding shares of Common Stock of the class issuable upon exercise of this Warrant), or in case of any sale, lease, transfer or conveyance to another corporation of the property and assets of the Company as an entirety or substantially as an entirety, the Company shall, as a condition precedent to such transaction, cause such successor or purchasing corporation, as the case may be, to execute with the Warrantholder an agreement granting the Warrantholder the right thereafter, upon payment of the Exercise Price in effect immediately prior to such action, to receive upon exercise of this Warrant the kind and amount of shares and other securities and property which he would have owned or have been entitled to receive after the happening of such reclassification, change, consolidation, merger, sale or conveyance had this Warrant been exercised immediately prior to such action. Such agreement shall provide for adjustments in respect of such shares of stock and other securities and property, which shall be as nearly equivalent as may be practicable to the adjustments provided for in this Article III. The provisions of this Section 3.04 shall similarly apply to successive reclassifications, capital reorganizations, consolidations, mergers, sales or conveyances.\nSection 3.05: Form of Warrant After Adjustments. The form of this Warrant need not be changed because of any adjustments in the Exercise Price or the number or the kind of the Warrant Shares, and Warrants theretofore or thereafter issued may continue to express the same price and number and kind of shares as are stated in this Warrant, as initially issued.\nSection 3.06: Treatment of Warrantholder. Prior to due presentment for registration of transfer of this Warrant, the Company may deem and treat the Warrantholder as the absolute owner of this Warrant (notwithstanding any notation of ownership or other writing hereon) for all purposes and shall not be affected by any notice to the contrary.\nARTICLE IV\nOther Provisions Relating to Rights of Warrantholder\nSection 4.01: No Rights as Shareholders; Notice to Warrantholders. Nothing contained in this Warrant shall be construed as conferring upon the Warrantholder or his or its transferees the right to vote or to receive dividends or to consent or to receive notice as a shareholder in respect of any meeting of shareholders for the election of directors of the Company or of any other matter, or any rights whatsoever as shareholders of the Company. The Company shall give notice to the Warrantholder by registered mail if at any time prior to the expiration or exercise in full of the Warrants, any of the following events shall occur:\n(a) the Company shall authorize the payment of any dividend payable in any securities upon shares of Common Stock or authorize the making of any distribution (other than a cash dividend subject to the parenthetical set forth in Section 3.01(c)) to all holders of Common Stock;\n(b) the Company shall authorize the issuance to all holders of Common Stock of any additional shares of Common Stock or Common Stock Equivalents or of rights, options or warrants to subscribe for or purchase Common Stock or Common Stock Equivalents or of any other subscription rights, options or warrants;\n(c) a dissolution, liquidation or winding up of the Company (other than in connection with a consolidation, merger or sale or conveyance of the property of the Company as an entirety or substantially as an entirety) shall be proposed; or\n(d) a capital reorganization or reclassification of the Common Stock (other than a subdivision or combination of the outstanding Common Stock and other than a change in the par value of the Common Stock), or any consolidation or merger of the Company with or into another corporation (other than a consolidation or merger in which the Company is the continuing corporation and that does not result in any reclassification or change of Common Stock outstanding), or in the case of any sale or conveyance to another corporation of the property of the Company as an entirety or substantially as an entirety.\nSuch giving of notice shall be initiated at least 10 Business Days prior to the date fixed as a record date or effective date or the date of closing of the Company's stock transfer books for the determination of the shareholders entitled to such dividend, distribution or subscription rights, or for the determination of the shareholders entitled to vote on such proposed merger, consolidation, sale, conveyance, dissolution, liquidation or winding up. Such notice shall specify such record date or the date of closing the stock transfer books, as the case may be. Failure to provide such notice shall not affect the validity of any action taken in connection with such dividend, distribution or subscription rights, or proposed merger, consolidation, sale, conveyance, dissolution, liquidation or winding up.\nSection 4.02: Lost, Stolen, Mutilated or Destroyed Warrants. If this Warrant is lost, stolen, mutilated or destroyed, the Company may, on such terms as to indemnity or otherwise as it may in its discretion impose (which shall, in the case of a mutilated Warrant, include the surrender thereof), issue a new Warrant of like denomination and tenor as, and in substitution for, this Warrant.\nARTICLE V\nSplit-Up, Combination, Exchange and Transfer of Warrants\nSection 5.01: Split-Up, Combination, Exchange and Transfer of Warrants. Subject to the provisions of Section 5.02, this Warrant may be split up, combined or exchanged for another Warrant or Warrants containing the same terms to purchase a like aggregate number of Warrant Shares. If the Warrantholder desires to split up, combine or exchange this Warrant, he or it shall make such request in writing delivered to the Company and shall surrender to the Company this Warrant and any other Warrants to be so split up, combined or exchanged. Upon any such surrender for a split-up, combination or exchange, the Company shall execute and deliver to the person entitled thereto a Warrant or Warrants, as the case may be, as so requested. The Company shall not be required to effect any split-up, combination or exchange which will result in the issuance of a Warrant entitling the Warrantholder to purchase upon exercise a fraction of a share of Common Stock or a fractional Warrant. The Company may require such Warrantholder to pay a sum sufficient to cover any tax or governmental charge that may be imposed in connection with any split-up, combination or exchange of Warrants.\nSection 5.02: Restrictions on Transfer. (a) This Warrant and the Warrant Shares shall not be Transferred, in whole or in part, unless the conditions specified in this Section 5.02 are satisfied. The Warrantholder, by acceptance of this Warrant, agrees to be bound by the provisions of this Section 5.02.\n(b) Except as otherwise provided in this Section 5.02, each Warrant and each certificate for Warrant Shares bear a legend containing the following words:\nTHE SECURITIES REPRESENTED BY THIS CERTIFICATE MAY NOT BE OFFERED FOR SALE, SOLD OR OTHERWISE DISPOSED OF EXCEPT PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT FILED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR PURSUANT TO AN EXEMPTION FROM REGISTRATION UNDER SUCH ACT.\nThe requirement that the above legends be placed upon certificates evidencing any Warrant or Warrant Shares shall cease and terminate upon the earliest of the following events: (i) when the Warrant Shares are sold in an underwritten public offering, (ii) when such Warrant or Warrant Shares are sold pursuant to Rule 144 under the Securities Act, (iii) when the Warrant or Warrant Shares are Transferred in any other transaction if the seller delivers to the Company an opinion of its counsel, which counsel and opinion shall be reasonably satisfactory to the Company, to the effect that such legend is no longer necessary in order to protect the Company against a violation by it of the Securities Act upon any sale or other disposition of such shares without registration thereunder. Upon the occurrence of such event, the Company, upon the surrender of certificates containing such legend, shall, at its own expense, deliver to the holder of any such Warrant or Warrant Shares as to which the requirement for such legend shall have terminated, one or more new certificates evidencing such Warrant or Warrant Shares not bearing such legend.\nARTICLE VI\nRegistration Under the Securities Act\nSection 6.01: Piggyback Registration.\n(a) Right to Include Registrable Securities. If at any time or from time to time after December 22, 1995, the Company proposes to register any of its equity securities under the Securities Act, whether or not for its own account (other than by a registration statement on Form S-4 or Form S-8 or other form which does not include substantially the same information as would be required in a form for the general registration of securities or would not be available for the Registrable Securities) (a \"Piggyback Registration\"), it shall as expeditiously as possible give written notice to all Holders of its intention to do so and of their rights under this Section 6.01. Such rights are referred to hereinafter as \"Piggyback Registration Rights.\" Upon the written request of any such Holder made within twenty (20) days after receipt of any such notice (which request shall specify the Registrable Securities intended to be disposed of by such Holder), the Company shall include in the Registration Statement the Registrable Securities which the Company has been so requested to register by the Holders thereof and the Company shall keep such Registration Statement in effect and maintain compliance with each Federal and state law or regulation for the period necessary for such Holder to effect the proposed sale or other disposition (but in no event for a period greater than ninety (90) days).\n(b) Withdrawal of Piggyback Registration by Company. If, at any time after giving written notice of its intention to register any securities in a Piggyback Registration but prior to the effective date of the related Registration Statement, the Company shall determine for any reason not to register such securities, the Company shall give written notice of such determination to each Holder and, thereupon, shall be relieved of its obligation to register any Registrable Securities in connection with such Piggyback Registration.\n(c) Piggyback Registration of Underwritten Public Offerings. If a Piggyback Registration involves an offering by or through underwriters, then, (i) all Holders requesting to have their Registrable Securities included in the Company's Registration Statement must sell their Registrable Securities to the underwriters selected by the Company on the same terms and conditions as apply to other selling shareholders and (ii) any Holder requesting to have his or its Registrable Securities included in such Registration Statement may elect in writing, not later than three (3) Business Days prior to the effectiveness of the Registration Statement filed in connection with such registration, not to have his or its Registrable Securities so included in connection with such registration.\n(d) Payment of Registration Expenses for Piggyback Registration. The Company shall pay all Registration Expenses in connection with each registration of Registrable Securities requested pursuant to a Piggyback Registration Right contained in this Section 6.01.\n(e) Priority in Piggyback Registration. If a Piggyback Registration involves an offering by or through underwriters, the Company shall not be required to include Registrable Shares therein if and to the extent the underwriter managing the offering reasonably believes in good faith and advises each Holder requesting to have Registrable Securities included in the Company's Registration Statement that such inclusion would materially adversely affect such offering; provided that (i) subject to the provisions of Section 6.01 of the Oppenheimer Warrant, if other selling shareholders have requested registration of securities in the proposed offering, the Company will reduce or eliminate on a pro rata basis to all holders of the securities of the Company exercising Piggyback Registration Rights similar to those set forth herein in proportion to the respective number of shares they have requested to be registered, and (ii) in such event, such Holders may delay any offering by them of all Registrable Shares requested to be included or that portion of such Registrable Shares eliminated for such period, not to exceed sixty (60) days, as the managing underwriter shall request and the Company shall file such supplements and post-effective amendments and take such other action necessary to permit such Holders to make their proposed offering for a period of ninety (90) days following such period of delay.\nSection 6.02: Demand Registration.\n(a) Request for Registration. If, at any time subsequent to December 22, 1995, any 25% Holders request that the Company file a Registration Statement under the Securities Act, the Company as soon as practicable shall use its best efforts to file a Registration Statement with respect to all Registrable Securities that it has been so requested to include and obtain the effectiveness thereof, and to take all other action necessary under any Federal or state law or regulation to permit the Registrable Securities that are then held and\/or that may be acquired upon the exercise of the Warrants specified in the notice of the 25% Holders to be sold or otherwise disposed of, and the Company shall maintain such compliance with each such Federal and state law and regulation for the period necessary for such Holders to effect the proposed sale or other disposition (but in no event for more than ninety (90) days); provided, however, the Company shall be entitled to defer such registration for a period of up to ninety (90) days if and to the extent that its Board of Directors shall determine that such registration would interfere with a pending corporate transaction. The Company shall also promptly give written notice to all other holders of any Registrable Securities who or that have not made a request to the Company pursuant to the provisions of this paragraph (a) of its intention to effect any required registration and shall use its best efforts to effect as expeditiously as possible such registration of all other such Warrant Shares that are then held and\/or that may be acquired upon the exercise of the Warrants, the Holder or holders of which have requested such registration, within fifteen (15) days after such notice has been given by the Company, as provided in the preceding sentence. The Company shall be required to effect a registration pursuant to this subsection (a) on one occasion only, such registration being referred to herein as a \"Demand Registration\".\n(b) Payment of Registration Expenses for Demand Registration. The Company shall pay all Registration Expenses in connection with the Demand Registration.\n(c) Selection of Underwriters. If any Demand Registration is requested to be in the form of an underwritten offering, the managing underwriter, the co-manager (if any) and the independent pricer required under the rules of the NASD (if any) shall be selected and retained by the Company. Such selection shall be subject to the consent of the Holders who requested the Demand Registration, which consent shall not be unreasonably withheld. All fees and expenses (other than Registration Expenses otherwise required to be paid) of any managing underwriter, any co-manager or any independent underwriter or other independent pricer required under the rules of the NASD shall be paid for by such underwriters or by the Holders or holders whose shares are being registered.\nSection 6.03: Buy-outs of Registration Demand. In lieu of carrying out its obligations to effect a Piggyback Registration or Demand Registration of any Registrable Securities pursuant to this Article VI, the Company may carry out such obligation by offering to purchase and purchasing such Registrable Securities requested to be registered at an amount in cash per share equal to the difference between (a) 95% of the last sale price of the Common Stock on the day the request for registration is made and (b) the Exercise Price in effect on such day.\nSection 6.04: Registration Procedures. If and whenever the Company is required to use its best efforts to take action pursuant to any Federal or state law or regulation to permit the sale or other disposition of any Warrant Shares that are then held or that may be acquired upon exercise of the Warrants in order to effect or cause the registration of any Registrable Securities under the Securities Act as provided in this Article VI, the Company shall, as expeditiously as practicable:\n(a) furnish to each selling Holder of Registrable Securities and the underwriters, if any, without charge, as many copies of the Registration Statement, the Prospectus or the Prospectuses (including each preliminary prospectus) and any amendment or supplement thereto as they may reasonably request;\n(b) enter into such agreements (including an underwriting agreement) and take all such other actions reasonably required in connection therewith in order to expedite or facilitate the disposition of such Registrable Securities and in such connection, if the registration is in connection with an underwritten offering (i) make such representations and warranties to the underwriters in such form, substance and scope as are customarily made by issuers to underwriters in underwritten offerings and confirm the same if and when requested; (ii) obtain opinions of counsel to the Company and updates thereof (which counsel and opinions in form, scope and substance shall be reasonably satisfactory to the underwriters) addressed to the underwriters and the Holders covering the matters customarily covered in opinions requested in underwritten offerings and such other matters as may be reasonably requested by such underwriters; (iii) obtain \"cold comfort\" letters and updates thereof from the Company's accountants addressed to the underwriters, such letters to be in customary form and covering matters of the type customarily covered in \"cold comfort\" letters in connection with offerings; (iv) set forth in full in any underwriting agreement entered into the indemnification provisions and procedures of Section 6.05 hereof with respect to all parties to be indemnified pursuant to said Section; and (v) deliver such documents and certificates as may be reasonably requested by the underwriters to evidence compliance with clause (i) above and with any customary conditions contained in the underwriting agreement or other agreement entered into by the Company; the above shall be done at each closing under such underwriting or similar agreement or as and to the extent required thereunder;\n(c) make available for inspection by one or more representatives of the Holders of Registrable Securities being sold, any underwriter participating in any disposition pursuant to such registration, and any attorney or accountant retained by such Holders or underwriter, all financial and other records, pertinent corporate documents and properties of the Company, and cause the Company's officers, directors and employees to supply all information reasonably requested by any such representatives, in connection with such, subject to customary confidentiality arrangements; and\n(d) otherwise use its best efforts to comply with all applicable Federal and state regulations, and take such other action as may be reasonably necessary or advisable to enable each such Holder and each such underwriter to consummate the sale or disposition in such jurisdictions or jurisdictions in which any such Holder or underwriter shall have requested that the Registrable Securities be sold; provided that the Company shall not be required (i) to qualify generally to do business as a foreign corporation in any jurisdiction wherein it would not but for the requirements of this paragraph (d) be obligated to be so qualified, (ii) to subject itself to taxation in any such jurisdiction solely by reason of such registration or qualification or (iii) to consent to general service of process in any jurisdiction.\nExcept as otherwise provided in this Agreement, the Company shall have sole control in connection with the preparation, filing, withdrawal, amendment or supplementing of each Registration Statement, the selection of underwriters, and the distribution of any preliminary prospectus included in the Registration Statement, and may include within the coverage thereof additional shares of Common Stock or other securities for its own account or for the account of one or more of its other security holders.\nEach seller of Registrable Securities as to which any registration is being effected shall furnish to the Company such information regarding the distribution of such securities and such other information as may otherwise be required by the Securities Act to be included in such Registration Statement.\nSection 6.05: Indemnification.\n(a) Indemnification by Company. In connection with each Registration Statement relating to disposition of Registrable Securities, the Company shall indemnify and hold harmless each Holder and each underwriter of Registrable Securities and each Person, if any, who controls such Holder or underwriter (within the meaning of Section 15 of the Securities Act or Section 20 of the Exchange Act) against any and all losses, claims, damages and liabilities, joint or several (including any reasonable investigation, legal and other expenses incurred in connection with, and any amount paid in settlement of any action, suit or proceeding or any claim asserted), to which they, or any of them, may become subject under the Securities Act, the Exchange Act or other Federal or state law or regulation, at common law or otherwise, insofar as such losses, claims, damages or liabilities arise out of or are based upon any untrue statement or alleged untrue statement of a material fact contained in any Registration Statement, Prospectus or preliminary prospectus, or such amendment or supplement thereto, or arise out of or are based upon any omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading; provided, however, that such indemnity shall not inure to the benefit of any Holder or underwriter (or any Person controlling such Holder or underwriter within the meaning of Section 15 of the Securities Act or Section 20 of the Exchange Act) on account of any losses, claims, damages or liabilities arising from the sale of the Registrable Securities if such untrue statement or omission or alleged untrue statement or omission was made in such Registration Statement, Prospectus or preliminary prospectus, or such amendment or supplement, in reliance upon and in conformity with information furnished in writing to the Company by the Holder or underwriter specifically for use therein. The Company shall also indemnify selling brokers, dealer managers and similar securities industry professionals participating in the distribution, their officers and directors and each Person who controls such Persons (within the meaning of Section 15 of the Securities Act or Section 20 of the Exchange Act) to the same extent as provided above with respect to the indemnification of the Holders of Registrable Securities, if requested. This indemnity agreement shall be in addition to any liability which the Company may otherwise have.\n(b) Indemnification by Holder. In connection with each Registration Statement, each Holder shall indemnify, to the same extent as the indemnification provided by the Company in Section 6.05(a), the Company, its directors and each officer who signs the Registration Statement and each Person who controls the Company (within the meaning of Section 15 of the Securities Act and Section 20 of the Exchange Act), but only insofar as such losses, claims, damages and liabilities arise out of or are based upon any untrue statement or omission or alleged untrue statement or omission which was made in the Registration Statement, the Prospectus or preliminary prospectus or any amendment thereof or supplement thereto, in reliance upon and in conformity with information furnished in writing by such Holder to the Company specifically for use therein. In no event shall the liability of any selling Holder of Registrable Securities hereunder be greater in amount than the dollar amount of the net proceeds received by such Holder upon the sale of the Registrable Securities giving rise to such indemnification obligation. The Company shall be entitled to receive indemnities from underwriters, selling brokers, dealer managers and similar securities industry professionals participating in the distribution, to the same extent as provided above, with respect to information so furnished in writing by such Persons specifically for inclusion in any Prospectus, Registration Statement or preliminary prospectus or any amendment thereof or supplement thereto.\n(c) Conduct of Indemnification Procedure. Any party that proposes to assert the right to be indemnified hereunder will, promptly after receipt of notice of commencement of any action, suit or proceeding against such party in respect of which a claim is to be made against an indemnifying party or parties under this Section, notify each such indemnifying party of the commencement of such action, suit or proceeding, enclosing a copy of all papers served. No indemnification provided for in Section 6.05(a) or 6.05(b) shall be available to any party who shall fail to give notice as provided in this Section 6.05(c) if the party to whom notice was not given was unaware of the proceeding to which such notice would have related and was prejudiced by the failure to give such notice, but the omission so to notify such indemnifying party of any such action, suit or proceeding shall not relieve it from liability that it may have to any indemnified party for contribution or otherwise than under this Section. In case any such action, suit or proceeding shall be brought against any indemnified party and it shall notify the indemnifying party of the commencement thereof, the indemnifying party shall be entitled to participate in, and, to the extent that it shall wish, jointly with any other indemnifying party similarly notified, to assume the defense thereof, with counsel reasonably satisfactory to such indemnified party, and after notice from the indemnifying party to such indemnified party of its election so to assume the defense thereof and the approval by the indemnified party of such counsel, the indemnifying party shall not be liable to such indemnified party for any legal or other expenses, except as provided below and except for the reasonable costs of investigation previously incurred by such indemnified party in connection with the defense thereof. The indemnified party shall have the right to employ its counsel in any such action, but the fees and expenses of such counsel shall be at the expense of such indemnified party unless (i) the employment of counsel by such indemnified party has been authorized in writing by the indemnifying parties, (ii) the indemnified party shall have reasonably concluded, based on advice of counsel, that there may be a conflict of interest between the indemnifying parties and the indemnified party in the conduct of the defense of such action (in which case the indemnifying parties shall not have the right to direct the defense of such action on behalf of the indemnified party) or (iii) the indemnifying parties shall not have employed counsel to assume the defense of such action within a reasonable time after notice of the commencement thereof, in each of which cases the fees and expenses of counsel shall be at the expense of the indemnifying parties. An indemnifying party shall not be liable for any settlement of any action, suit, proceeding or claim effected without its written consent.\n(d) Contribution. In connection with each Registration Statement relating to the disposition of Registrable Securities, if the indemnification provided for in subsection (a) hereof is unavailable to an indemnified party thereunder in respect of any losses, claims, damages or liabilities referred to therein, then the Company shall, in lieu of indemnifying such indemnified party, contribute to the amount paid or payable by such indemnified party as a result of such losses, claims, damages or liabilities. The amount to be contributed by the Company hereunder shall be an amount which is in the same proportionate relationship to the total amount of such losses, claims, damages or liabilities as the total net proceeds from the offering (before deducting expenses) of the Registrable Securities bears to the total price to the public (including underwriters' discounts) for the offering of the Registrable Securities covered by such registration.\n(e) Specific Performance. The Company and the Holder acknowledge that remedies at law for the enforcement of this Section 6.05 may be inadequate and intend that this Section 6.05 shall be specifically enforceable.\nARTICLE VII\nOther Matters\nSection 7.01: Amendments and Waivers. The provisions of this Warrant, including the provisions of this sentence, may not be amended, modified or supplemented, and waiver or consents to departures from the provisions hereof may not be given unless the Company has obtained the written consent of holders of at least a majority of the outstanding Registrable Securities. Holders shall be bound by any consent authorized by this Section whether or not certificates representing such Registrable Securities have been marked to indicate such consent.\nSection 7.02: Counterparts. This Warrant may be executed in any number of counterparts and by the parties hereto in separate counterparts, each of which so executed shall be deemed to be an original and all of which taken together shall constitute one and the same agreement.\nSection 7.03: Governing Law. This Warrant shall be governed by and construed in accordance with the laws of the State of New York without regard to the conflict of laws principles thereof.\nSection 7.04: Severability. In the event that any one or more of the provisions contained herein, or the application thereof in any circumstances, is held invalid, illegal or unenforceable, the validity, legality and enforceability of any such provisions in every other respect and of the remaining provisions contained herein shall not be affected or impaired thereby.\nSection 7.05: Attorneys' Fees. In any action or proceeding brought to enforce any provisions of this Warrant, or where any provisions hereof or thereof is validly asserted as a defense, the successful party shall be entitled to recover reasonable attorneys' fees and disbursements in addition to its costs and expenses and any other available remedy.\nSection 7.06: Computations of Consent. Whenever the consent or approval of Holders of a specified percentage of Registrable Securities is required hereunder, Registrable Securities held by the Company or its affiliates (other than the original Warrantholder and other than subsequent Holders if such subsequent Holders are deemed to be such affiliates solely by reason of their holdings of such Registrable Securities) shall not be counted in determining whether such consent or approval was given by the Holders of such required percentage.\nSection 7.07: Notice. Any notices or certificates by the Company to the Holder and by the Holder to the Company shall be deemed delivered if in writing and delivered in person or by registered mail (return receipt requested), if to the original Holder, addressed to him at 28 Shore Cliff Place, Great Neck, New York 11023, or, if the original Holder has designated by notice in writing to the Company any other address, to such other address, or, if to a subsequent Holder, to such address as appears on the books of the Company or such other address Holder shall have designated by notice in writing to the Company, and if to the Company, addressed to it at Westbridge Capital Corp., 777 Main Street, Fort Worth, Texas 76702. The Company may change its address by written notice to the Holder.\nIN WITNESS WHEREOF, this Warrant has been duly executed by the Company under its corporate seal as of December 22, 1995.\nWESTBRIDGE CAPITAL CORP.\nBy: \/s\/James W. Thigpen _ Name: James W.Thigpen Title: President and Chief Operating Officer\nAttest: \/s\/ Michael D. Norris Secretary\nASSIGNMENT\n(To be executed only upon assignment of Warrant Certificate)\nFor value received, hereby sells, assigns and transfers unto the within Warrant Certificate, together with all right, title and interest therein, and does hereby irrevocably constitute and appoint attorney, to transfer said Warrant Certificate on the books of the within-named Company with respect to the number of Warrants set forth below, with full power of substitution in the premises:\nName (s) of Assignees (s) Address No. of Warrants\nAnd if said number of Warrants shall not be all the Warrants represented by the Warrant Certificate, a new Warrant Certificate is to be issued in the name of said undersigned for the balance remaining of the Warrants represented by said Warrant Certificate\nDated: __________ _____, _______\nNote: The above signature should correspond exactly with the name on the face of this Warrant Certificate.\nSUBSCRIPTION FORM (To be executed upon exercise of Warrant pursuant to Section 2.02(a)(i))\nThe undersigned hereby irrevocably elects to exercise the right of purchase represented by the within Warrant Certificate for, and to purchase thereunder shares of Common Stock, as provided for therein. To the extent applicable, the undersigned herewith makes payment, in cash or by check or by reduction in the principal amount of the Note or a combination thereof, in full of the Exercise Price thereof ($________ in the aggregate).\nPlease issue a certificate or certificates for such Common Stock in the name of, and pay any cash for any fractional share to:\nName (Please Print Name, Address and Social Security Number)\nSignature\nNOTE: The above signature should respond exactly with the name on the first page of this Warrant Certificate or with the name of the assignee appearing in the assignment form above.\nAnd if said number of shares shall not be all the shares purchasable under the within Warrant Certificate, a new Warrant Certificate is to be issued in the name of said undersigned for the balance remaining of the shares purchasable thereunder rounded up to the next higher number of shares.\nCASHLESS EXERCISE FORM\n(To be executed upon exercise of Warrant pursuant to Section 2.02(a)(ii))\nThe undersigned hereby irrevocably elects to exchange its Warrant for such shares of Common Stock pursuant to the Cashless Exercise provisions of the within Warrant Certificate, as provided for in Section 2.02(a)(ii) of such Warrant Certificate.\nPlease issue a certificate or certificates for such Common Stock in the name of, and pay cash for fractional share to:\nName (Please Print Name, Address and Social Security Number)\nSignature_______________________\nNOTE: The above signature should correspond exactly with the name on the first page of this Warrant Certificate or with the name of the assignee appearing in the assignment form above.\nAnd if said number of shares shall not be all the shares exchangeable or purchasable under the within Warrant Certificate, a new Warrant Certificate is to be issued in the name of the undersigned for the balance remaining of the shares purchasable rounded up to the next higher number of shares.\nExhibit 21\nSUBSIDIARIES OF WESTBRIDGE CAPITAL CORP.\nPercentage Subsidiary Ownership\n1. National Foundation Life Insurance Company (Delaware) 100%\n2. American Insurance Company of Texas (Texas) 100%\n3. National Financial Insurance Company (Texas) 100%\n4. Westbridge Funding Corporation (Delaware) (Formerly National Legal Services Company, Inc.) 100%\n5. Foundation Financial Services, Inc. (Nevada) 100%\n6. Westbridge Marketing Corporation (Delaware) 100%\n7. Westbridge Printing Services, Inc. (Delaware) 100%\n8. Flex-Plan Systems, Inc. (Delaware) 100%\n9. Westbridge Financial Corp. (Delaware) 100%\n10. Precision Dialing Services, Inc. (Delaware) 100%\n11. Westbridge National Life Insurance Company (Arizona) 100%\n12. LifeStyles Marketing Group, Inc. (Delaware) 51%\n13. Senior Benefits, LLC (Arizona) 50%\n14. American Senior Security Plans, LLC (Delaware) 50%\n15. Health Care-One Insurance Agency, Inc. (California) 50%\nExhibit 24\nCONSENT OF INDEPENDENT ACCOUNTANTS\nWe hereby consent to the incorporation by reference in the Prospectus constituting part of the Registration Statement on Form S-8 (No. 33-55192) of Westbridge Capital Corp. and its subsidiaries of our report dated March 29, 1996, appearing on page 43 of this Form 10-K.\n\/s\/ Price Waterhouse, LLP\nPRICE WATERHOUSE LLP Fort Worth, Texas March 29, 1996","section_15":""}
{"filename":"793322_1995.txt","cik":"793322","year":"1995","section_1":"ITEM 1 - BUSINESS\nPSS, Inc. (\"PSS\"), through its wholly owned subsidiary, PNS Inc. (\"PNS\"), owns PSSC Inc. (\"PSSC\"); together, PSS, PNS and PSSC are referred to collectively as the \"Company\".\nThe Company owns pass-through and participation certificates issued by the Federal Home Loan Mortgage Corporation backed by whole pool real estate mortgages (\"Mortgage Certificates\"), and as a result, is primarily engaged in the business of owning mortgages and other liens on and interests in real estate. At October 28, 1995, the Company's principal assets consisted of approximately $5.8 million of Mortgage Certificates from which interest income is earned. The Mortgage Certificates are financed with borrowings, payable on demand, secured by the Mortgage Certificates (the \"Mortgage Financing\"). The principal obligations of the Company are the Mortgage Financing borrowings, the PSS 7-1\/8% Convertible Debentures due July 15, 2006 (the \"Debentures\"), and the PNS 12- 1\/8% Senior Subordinated Notes due July 15, 1996 (the \"Senior Notes\"), upon which interest expense is incurred.\nFrom July 1986, when the Company was organized, until June 1988, subsidiaries of PNS (the \"Sellers\") operated retail stores that sold a variety of traditional drugstore and general merchandise items. In June 1988, pursuant to an Agreement for the Purchase and Sale of Assets the Sellers sold substantially all of their assets, comprising the Sellers' entire retail operations, to Thrifty Corporation (a subsidiary of Pacific Enterprises). In consideration for such sale of assets (the \"Asset Sale\"), the Sellers received 5.2 million shares of Pacific Enterprises common stock (the \"PET Shares\"). During 1990 through 1993, the Company sold its PET Shares for the purpose of servicing and repurchasing some of the Debentures and Senior Notes.\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2 - PROPERTIES\nAs a result of the Asset Sale, the Company disposed of all its properties.\nITEM 3","section_3":"ITEM 3 - LEGAL PROCEEDINGS\nIn the opinion of management, there are no material legal proceedings pending to which the Company is a party or of which any of its assets is the 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 THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nMARKET INFORMATION\nThe Company's common stock is traded over-the-counter. The high and low prices for the stock by quarter for the two years ended October 28, 1995 were as follows:\nThe high and low prices for each quarter are the high and low bids as reported by National Quotation Bureau, Incorporated, which are those quoted by dealers to each other, exclusive of markups, markdowns or commissions, and do not represent actual transactions.\nHOLDERS\nAs of November 1, 1995, there were 940 holders of record of the Company's common stock.\nDIVIDENDS ON COMMON STOCK\nThe Company has never paid a dividend and does not anticipate paying dividends for the foreseeable future. Any determination as to the payment of dividends will depend upon future earnings, results of operations, capital requirements, the financial condition of the Company and such other factors as the Board of Directors of the Company may consider. The indentures governing the Company's Senior Notes and Debentures contain covenants which restrict the ability of the Company to pay dividends (see Note 5 to the financial statements).\nITEM 6","section_6":"ITEM 6 - SELECTED FINANCIAL DATA\nThe following selected financial data should be read in conjunction with the financial statements and related notes and \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" included elsewhere herein. As explained in Note 2 to the financial statements, information relating to October 28, 1995 is presented on a liquidation basis, which reports an excess of liabilities over assets. Presentation of per share information on a liquidation basis is not considered meaningful and has been omitted.\n(1) Includes net realized and unrealized losses on Pacific Enterprises common stock of approximately $37 million and $68 million during the years ended October 31, 1992 and November 2, 1991, respectively.\n(2) Includes pre-tax extraordinary gains on early extinguishment of debt of approximately $13 million, $49 million, $77 million and $20 million during the years ended October 29, 1994, October 30, 1993, October 31, 1992, and November 2, 1991, respectively.\nITEM 7","section_7":"ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nLIQUIDITY AND CAPITAL RESOURCES\nAt October 28, 1995, the Company's principal assets consisted of approximately $5.8 million of Mortgage Certificates from which interest income is earned and its principal obligations consisted of Mortgage Financing borrowings, Debentures and Senior Notes upon which interest expense is incurred.\nPNS is restricted by terms of its Senior Notes Indenture from paying dividends or making other payments to PSS, except that PNS may pay dividends to PSS in amounts sufficient to enable PSS to meet its obligation on its Debentures when due. PNS, like its parent company, has a stockholder's deficit.\nAt October 28, 1995, the Company had tangible assets of approximately $5.92 million and liabilities secured by such assets of approximately $5.37 million, thus having a net difference of approximately $550,000 available for holders of Senior Notes and Debentures. At October 28, 1995, approximately $5.26 million of Senior Notes and $22.92 million of Debentures remain outstanding and annual interest thereon, in the absence of additional repurchases, approximates $638,000 and $1.63 million, respectively.\nThe Company failed to pay the interest due January 15, 1995 and July 15, 1995 on its Convertible Debentures and such default has continued beyond the 30 day \"grace\" period. However, the trustee for the Convertible Debentures has indicated to the holders of the Debentures that it does not intend to accelerate payment of the Debentures \"because it is unlikely that the Debenture holders would receive any payment if the Debentures were accelerated.\"\nAlthough the Company's subsidiary, PNS, paid the interest due on January 15, 1995 on its Senior Notes within the 30 day \"grace\" period, it failed to make the interest payment due on July 15, 1995 and such default has continued beyond the 30 day \"grace\" period. Claiming that PNS is in default because it is \"unable to pay its debts as the same become due\" and due to its failure to make the July 15, 1995 interest payment, the trustee for the Senior Notes has accelerated and declared the principal and interest on the Senior Notes immediately due and payable. The trustee has since been advised by a representative of the holders of a substantial portion of the Senior Notes that such holders are in the process of developing a proposal to reorganize the Company and PNS and has asked the trustee to forbear from taking any action for so long as discussions are pending with the Company. Although the Company has not yet received a proposal, it has been contacted by the representative of such holders and anticipates that such a proposal will be forthcoming. In the interim, the trustee has taken no legal action with respect to the default.\nThe Company's future operating results, liquidity, capital resources and requirements are primarily dependent upon actions which may be taken by the trustees for the Senior Notes and the Debentures to collect amounts due thereunder, the payment of amounts due on and purchases of Senior Notes and Debentures and, to a lesser extent, interest rate fluctuations as they relate to the market value of Mortgage Certificates and to the spread of interest income therefrom over interest expense on related borrowings. The Company is exclusively invested in Mortgage Certificates, and, accordingly, is presently relying solely on such as its source of cash funds. It has not been determined what course of action the Company may pursue with respect to debt service on Senior Notes and Debentures.\nRESULTS OF OPERATIONS\nINTEREST INCOME\nInterest income for each of the years ended October 28, 1995, October 29, 1994 and October 30, 1993 decreased as compared to the immediate preceding year as a result of lower balances of investments in Mortgage Certificates, and for the years ended October 29, 1994 and October 30, 1993 lower annual interest income rates earned on the adjustable rate Mortgage Certificates. Included in investment income for the year ended October 28, 1995 is approximately $100,000 of unrealized gains resulting from mark-to-market adjustments. The weighted average interest income rate earned on the Mortgage Certificates, net of amortization of premiums, approximated 7.3%, 5.0% and 5.8% during the years ended October 28, 1995, October 29, 1994 and October 30, 1993, respectively.\nINTEREST EXPENSE\nInterest expense for each of the years ended October 28, 1995, October 29, 1994 and October 30, 1993 decreased as compared to the immediate preceding year primarily due to lower investments in Mortgage Certificates and related borrowings upon which interest expense is incurred. The weighted average interest expense rate on Mortgage Certificate related borrowings approximated 6.0%, 3.9% and 3.4% during the years ended October 28, 1995, October 29, 1994 and October 30, 1993, respectively. Interest expense also decreased during each of the years ended October 28, 1995, October 29, 1994 and October 30, 1993 as compared to the preceding year as a result of having fewer Debentures and Senior Notes outstanding due to bond repurchases.\nREALIZED AND UNREALIZED LOSS\nDuring the year ended October 30, 1993, the Company disposed of its remaining PET Shares and recorded a realized loss of approximately\n$40 million and a decrease in unrealized loss of approximately $42 million, representing the previously recognized unrealized loss for PET Shares sold during the year.\nWRITE OFF OF DEFERRED FINANCING COSTS AND ORIGINAL ISSUE DISCOUNT\nAs a result of the continued default due to the non-payment of interest on the Convertible Debentures and Senior Notes, the Company has expensed remaining deferred financing costs and original issue discount.\nEXTRAORDINARY ITEMS\nDuring the year ended October 29, 1994, the Company purchased approximately $14 million and $6 million of its Senior Notes and Debentures, respectively, and as a result, after the write-off of related deferred financing costs, recorded an extraordinary gain on early extinguishment of debt, before income taxes, of approximately $13 million.\nDuring the year ended October 30, 1993, the Company purchased approximately $65 million and $14 million of its Senior Notes and Debentures, respectively, and as a result, after the write-off of related deferred financing costs, recorded an extraordinary gain on early extinguishment of debt, before income taxes, of approximately $49 million.\nITEM 8","section_7A":"","section_8":"ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nFINANCIAL STATEMENTS Page\nReport of Independent Accountants 9 Consolidated Statement of Net Liabilities (Liquidation Basis) 10 Consolidated Balance Sheet (Going Concern Basis) 10 Consolidated Statement of Change in Net Liabilities (Liquidation Basis) 11 Consolidated Statements of Operations (Going Concern Basis) 11 Consolidated Statements of Cash Flows 12 Notes to Financial Statements 13\nFINANCIAL STATEMENT SCHEDULES\nFinancial statement schedule information is presented in the financial statements.\nSUPPLEMENTARY FINANCIAL INFORMATION\nSELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) 21\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Stockholders of PSS, Inc.:\nWe have audited the consolidated balance sheet of PSS, Inc. as of October 29, 1994, the related consolidated statements of operations, and cash flows for each of the two years in the period ended October 29, 1994. In addition, we have audited the consolidated statement of net liabilities (liquidation basis) as of October 28, 1995, and the related consolidated statement of changes in net liabilities (liquidation basis) and cash flows (liquidation basis) for the period from October 30, 1994 to October 28, 1995. 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 described in Note 2 to the financial statements, effective October 28, 1995 the Company adopted the liquidation basis of accounting for presenting its consolidated financial statements. As a result, the Company has changed its basis of accounting for periods subsequent to October 29, 1994 from the going concern basis to a liquidation basis.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of PSS, Inc. and its subsidiaries as of October 29, 1994, the results of their operations and their cash flows for each of the two years then ended and their net liabilities in liquidation as of October 28, 1995, and the changes in their net liabilities (liquidation basis) and cash flows (liquidation basis) for the period from October 30, 1994 to October 28, 1995, in conformity with generally accepted accounting principles applied on the basis described in the preceding paragraph.\nPRICE WATERHOUSE LLP\n\/s\/ Price Waterhouse LLP\nSeattle, Washington January 25, 1996\nThe accompanying notes are an integral part of these financial statements.\nThe accompanying notes are an integral part of these financial statements.\nPSS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (thousands of dollars)\nThe accompanying notes are an integral part of these financial statements.\nPSS, INC. NOTES TO FINANCIAL STATEMENTS\nNOTE 1 - THE COMPANY\nThe consolidated financial statements of PSS, Inc. (\"PSS\"), includes its direct subsidiary PNS Inc. (\"PNS\") and its subsidiary PSSC, Inc. (\"PSSC\"), collectively, the \"Company\". The Company is principally owned by Seacorp, Inc. (\"Seacorp\") and Zimmerman Retailing Group Limited (\"Zimco\"). Seacorp and Zimco own approximately 41% and 38%, respectively, of the Company's outstanding common stock, with the remainder publicly owned.\nThe Company, through PSSC, owns pass-through and participation certificates issued by the Federal Home Loan Mortgage Corporation backed by whole pool real estate mortgages (\"Mortgage Certificates\"), and as a result, is primarily engaged in the business of owning mortgages and other liens on and interests in real estate. The principal obligations of the Company are PSSC borrowings secured by Mortgage Certificates, PNS 12-1\/8% Senior Subordinated Notes due July 15, 1996 (the \"Senior Notes\") and PSS 7-1\/8% Convertible Debentures due July 15, 2006 (the \"Debentures\").\nThe Company failed to pay the interest due January 15, 1995 and July 15, 1995 on its Debentures and such default has continued beyond the 30 day \"grace\" period. The Company has also failed to make the January 15, 1996 interest payment. However, the trustee for the Debentures has indicated to the holders of the Debentures that it does not intend to accelerate payment of the Debentures \"because it is unlikely that the Debenture holders would receive any payment if the Debentures were accelerated.\"\nAlthough PNS paid the interest due on January 15, 1995 on its Senior Notes within the 30 day \"grace\" period, it failed to make the interest payment due on July 15, 1995 and such default has continued beyond the 30 day \"grace\" period. The Company has also failed to make the January 15, 1996 interest payment. Claiming that PNS is in default because it is \"unable to pay its debts as the same become due\" and due to its failure to make the July 15, 1995 interest payment, the trustee for the Senior Notes has accelerated and declared the principal and interest on the Senior Notes immediately due and payable. The trustee has since been advised by a representative of the holders of a substantial portion of the Senior Notes that such holders are in the process of developing a proposal to the Company and PNS and has asked the trustee to forbear from taking any action for so long as discussions are pending with the Company. Although the Company has not yet received a proposal, it has been contacted by the representative of such holders and anticipates that such a proposal will be forthcoming. In the interim, the trustee has taken no legal action with respect to the default.\nNOTE 1 - THE COMPANY (continued)\nAt October 28, 1995, the Company had tangible assets of approximately $5.92 million and liabilities secured by such assets of approximately $5.37 million, thus having a net difference of approximately $550,000 available for holders of Senior Notes and Debentures. At October 28, 1995, approximately $5.26 million of Senior Notes and $22.92 million of Debentures remain outstanding and, annual interest thereon, in the absence of additional repurchases, approximates $638,000 and $1.63 million, respectively. The Company's future operating results, liquidity, capital resources and requirements are primarily dependent upon actions which may be taken by the trustees for the Senior Notes and the Debentures to collect amounts due thereunder, the payment of amounts due on and purchases of Senior Notes and Debentures and, to a lesser extent, interest rate fluctuations as they relate to the market value of Mortgage Certificates and to the spread of interest income therefrom over interest expense on related borrowings. The Company is exclusively invested in Mortgage Certificates, and, accordingly, is presently relying solely on such as its source of cash funds. It has not been determined what course of action the Company may pursue with respect to debt service on the Senior Notes and Debentures.\nNOTE 2 - LIQUIDATION BASIS OF ACCOUNTING\nThe consolidated financial statements for fiscal 1994 and 1993 were prepared on a going concern basis of accounting which contemplates realization of assets and satisfaction of liabilities in the normal course of business. Effective October 28, 1995, the Company has adopted the liquidation basis of accounting for presenting its consolidated financial statements. This basis of accounting is considered appropriate when, among other things, liquidation of a company appears imminent and the net realizable value of assets are reasonably determinable. Under this basis of accounting, assets and liabilities are stated at their net realizable value and estimated costs through the liquidation date are provided to the extent reasonably determinable.\nThe net effect of converting from the going concern basis to the liquidation basis of accounting was an increase in net liabilities of approximately $1.7 million, as a result of recording estimated costs and interest expense to the liquidation date. No adjustment to the reported value of assets was required. Under the liquidation basis, the Company has accrued future liabilities and estimated future net revenues from interest or other income associated with mortgage certificates.\nNOTE 2 - LIQUIDATION BASIS OF ACCOUNTING (CONTINUED)\nThe conversion from the going concern to liquidation basis of accounting has required the determination of significant estimates and judgments. A summary of significant estimates and judgments utilized in preparation of the October 28, 1995 consolidated financial statements on a liquidation basis follows:\n* The Senior Notes July 15, 1996 due date has been utilized as the liquidation date.\n* Mortgage Certificates and related interest receivable are stated at estimated market value.\n* Borrowings secured by Mortgage Certificates are stated at face value.\n* The reserve for estimated costs during the period of liquidation represents estimates of costs (primarily legal and trustee fees) to be incurred in the future to the liquidation date.\n* Net estimated interest income to be earned on Mortgage Certificates in excess of interest expense on related borrowings is considered in determining the reserve for estimated costs during the period of liquidation.\n* Senior Notes and Debentures and related interest accrued through October 28, 1995 are stated at face value.\n* The reserve for interest during the period of liquidation represents interest on Senior Notes and Debentures for the period from October 29, 1995 to July 15, 1996.\nAll of the above estimates and judgments may be subject to change as facts and circumstances change. Similarly, actual costs and expenses may differ significantly depending on a number of factors, particularly the length of the liquidation period.\nNOTE 3 - SUMMARY OF ACCOUNTING PRINCIPLES\nCASH AND SHORT-TERM INVESTMENTS\nCash and short-term investments, having maturities of three months or less when purchased, are primarily comprised of interest-bearing short-term bank deposits.\nINVESTMENT IN MORTGAGE CERTIFICATES\nThe investment in Mortgage Certificates is recorded at estimated fair value, based upon market prices obtained from traders. Gains and losses realized on sale are determined utilizing the specific identification method. Premiums paid are amortized utilizing the interest method. Gains and losses realized upon sale of Mortgage Certificates and unrealized gains and losses resulting from mark-to-market adjustments are included in investment income.\nINCOME (LOSS) PER COMMON SHARE\nAs explained in Note 2, effective October 28, 1995, the Company adopted the liquidation basis of accounting, which reports an excess of liabilities over assets. Accordingly, the presentation of per common share information on a liquidation basis is not considered meaningful and has been omitted.\nIncome (loss) per common share data for periods prior to October 28, 1995 have been computed on the basis of 19,473,728 shares outstanding. For purposes of calculating income (loss) per common share, the conversion of the PSS 7-1\/8% Convertible Debentures would be antidilutive and thus was not assumed.\nRECLASSIFICATIONS\nCertain reclassifications have been made in prior years' financial statements.\nNOTE 4 - INVESTMENT IN MORTGAGE CERTIFICATES\nMortgage Certificates are financed with borrowings provided by an investment bank pursuant to a letter agreement (the \"Financing Agreement\"). Borrowings pursuant to the Financing Agreement (the \"Mortgage Financing\") are secured by the Mortgage Certificates. In the event of a decrease in the aggregate market value of the Mortgage Certificates below the requirements of the Financing Agreement, additional collateral is required. Principal and interest payments received on Mortgage Certificates are maintained in an interest earning account and are released to the Company, at its request, after all interest and any \"mark-to-market\" indebtedness then due have been paid. The Mortgage Financing is payable on demand and generally bears interest at rates approximating LIBOR plus 10 basis points. Mortgage Financing borrowings and related interest rates approximated $5.3 million and 6.0% at October 28, 1995 and $10 million and 5.1% at October 29, 1994, respectively. During the years ended October 28, 1995, October 29, 1994 and October 30, 1993, the average balance of mortgage related borrowings outstanding approximated $5 million, $91 million and $143 million, and the weighted annual average interest expense rates approximated 6.0%, 3.9%, and 3.4%, respectively.\nAt October 28, 1995, the average annual interest rate to be earned on the Mortgage Certificates approximated 8.0% as determined on a basis that interest rates do not change. The rate of interest on the Mortgage Certificates is adjustable based on general interest rate trends with certain maximums, including limits of 2% for annual interest rate changes and interest rate maximums of approximately 13%. The weighted average interest income rates earned on the Mortgage Certificates, net of amortization of premiums, approximated 7.4%, 5.0% and 5.8% during the years ended October 28, 1995, October 29, 1994 and October 30, 1993, respectively.\nThe Company sold approximately $1 million, $99 million and $13 million of Mortgage Certificates during the years ended October 28, 1995, October 29, 1994 and October 30, 1993, respectively.\nNOTE 5 - SUBORDINATED DEBT\nSubordinated debt and related interest payable through the balance sheet dates are summarized as follows (thousands of dollars):\nIn July 1986, the Company completed three public securities offerings (the \"Public Offerings\"). PNS issued $150 million of Senior Notes (at a price of 98.6%) and PSS sold 3.25 million shares of its common stock and issued at par $150 million of Debentures convertible to PSS common stock at $19.68 per share (the conversion price is subject to adjustment in the case of dilution). Debt financing costs and the discount on the Senior Notes have been amortized over the term of the borrowings. PSS invested the net proceeds from its two offerings in PNS, in the form of a contribution to capital and an intercompany debenture between PNS and PSS (the \"Intercompany Debenture\") in the amount of $150 million with substantially the same interest rate and redemption provisions as the Debentures. At October 28, 1995, the Intercompany Debenture approximated $9 million.\nAs explained in Note 1, the Company is in default due to the non-payment of interest on the Senior Notes and Debentures. As a result, during the year ended October 28, 1995 the Company expensed remaining deferred financing costs and original issue discount.\nThe indenture governing the Senior Notes restricts the ability of PNS and its subsidiaries to pay dividends or make other payments to PSS. The Senior Notes indenture permits PNS to pay dividends to PSS in amounts sufficient to enable PSS to meet its obligations on the Debentures when due (to the extent payments are not made to PSS when due pursuant to the Intercompany Debenture), provided that no event of default (as defined in the Senior Notes indenture) has occurred and is continuing. PNS, like its parent company, has a stockholder's deficit.\nThe Senior Notes and Debentures provide for semiannual interest payments and are unsecured. Principal repayment on the Senior Notes is due in full on July 15, 1996. The Debentures require annual principal payments of approximately $11 million commencing July 15, 1996 until July 15, 2006 when the balance is due; by utilizing Debentures which the Company has previously acquired, there will be no scheduled maturity payments required before 2006.\nNOTE 5 - SUBORDINATED DEBT (continued)\nThe indentures for the Senior Notes and Debentures contain certain restrictive covenants which, among other things, limit dividends and similar distributions to stockholders, redemptions and retirements of the Company's equity, essentially prohibiting such transactions as of October 28, 1995, limit the Company's ability to incur debt, and restrict action and agreements by the Company that would prohibit dividends and similar distributions to the Company from its subsidiaries, and under certain conditions, require accelerated redemption payments.\nDuring the year ended October 29, 1994, the Company purchased approximately $14 million of Senior Notes and $6 million of Debentures and, as a result, after the write-off of related deferred financing costs, recorded an extraordinary gain on early extinguishment of debt of approximately $13 million.\nDuring the year ended October 30, 1993, the Company purchased approximately $64 million of Senior Notes and $14 million of Debentures in exchange for 500,000 PET Shares and approximately $23 million cash (such total price including accrued interest), and as a result, after the write-off of related deferred financing costs, recorded an extraordinary gain on early extinguishment of debt of approximately $49 million.\nInterest paid approximated $319,000, $8 million and $14 million during the years ended October 28, 1995, October 29, 1994 and October 30, 1993, respectively.\nNOTE 6 - INVESTMENT IN PACIFIC ENTERPRISES COMMON STOCK\nIn June 1988, pursuant to an Agreement for the Purchase and Sale of Assets, subsidiaries of PNS (the \"Sellers\") sold substantially all of their assets, comprising the Sellers' entire retail operations, to Pacific Enterprises. In consideration for the sale of such assets, the Sellers received approximately 5.2 million shares of Pacific Enterprises common stock (the \"PET Shares\").\nDuring the year ended October 30, 1993, the Company disposed of its remaining PET Shares and recorded a realized loss of approximately $40 million and a decrease in unrealized loss of approximately $42 million, representing the previously recognized unrealized loss for PET Shares sold during the year.\nNOTE 7 - RELATIONSHIP WITH AFFILIATES\nPrior to fiscal 1995, affiliates of Seacorp provided the Company with accounting, legal, tax and other services. Fees for services approximated $56,000 and $167,000 for the years ended October 29, 1994 and October 30, 1993, respectively.\nNOTE 8 - INCOME TAXES\nDue to losses reported for the year ended October 28, 1995, there was no provision for income taxes recorded. During each of the years ended October 29, 1994 and October 30, 1993, the Company recognized an income tax benefit as a result of income taxes provided on the extraordinary gain on early extinguishment of debt. The Company also recorded a provision for income taxes representing a charge in lieu of income taxes that would have been provided in the absence of net operating loss carryforwards. The income tax benefit resulting from utilization of net operating loss carryforwards is presented as an extraordinary item.\nFor income tax purposes, net operating loss carryforwards, which begin to expire in 2001, approximate $137 million, and capital loss carryforwards approximate $120 million, $115 million of which expire in 1997 and 1998. If certain substantial changes in the Company's ownership should occur, there would be an annual limitation on the amount of the carryforwards which could be utilized.\nNOTE 9 - STOCKHOLDERS' DEFICIT\nThere have been no changes in common stock or additional paid in capital since October 29, 1994. As a result of presenting October 28, 1995 financial statements on the liquidation basis, changes in components of stockholders' deficit are not presented. The Company's stockholders' deficit and the changes therein during the two years ended October 29, 1994, are summarized as follows (thousands of dollars):\nNOTE 10 - Selected Quarterly Financial Data (Unaudited)\nSelected quarterly financial data are as follows (thousands of dollars, except per share data):\n(a) As explained in Note 3, per share information has not been presented on a liquidation basis.\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 Company\nThe following table sets forth certain information concerning each of the directors of the Company. All directors will serve until the next Annual Meeting of Shareholders and until his respective successor is elected or appointed. Each director of the Company is also a director of PNS.\nPresent Principal Occupation or Employment Name and Position and Five Year with the Company Age Employment History - ----------------- --- --------------------------\nLarry Chroman 44 Director of the Company since July 1991. President of Director USA Global Link since July 1995 Co-manages investments for the William Zimmerman family for more than five years.\nJames M. Lieb 45 Director of the Company since May 1989. Executive Vice Director President of The Trump Group (a private investment group) since October 1995 and Senior Vice President thereof for more than five years.\nGerald P. Nathanson 58 Director of the Company since October 1986. Chief Director Executive Officer, L.Luria (a retail company) since January 1996. Chief Executive Officer, US Holographics (marketing company for holographic products) from April 1992 to December 1995. Managing Director, C4 Marketing (an import company) until January 1992.\nEddie Trump 49 Director of the Company since May 1986. President of Director The Trump Group for more than five years.\nPursuant to the terms of the Subscription and Stockholders' Agreement, dated May 7, 1986 (the \"Stockholders' Agreement\"), as amended as of November 25, 1987 (the \"November 1987 Agreement\" and, as amended, the \"Amended Stockholders' Agreement\"), between the Company's two major stockholders, Zimco and Seacorp, Seacorp was, subject to certain conditions, entitled to nominate as directors one-half the Company's Nonindependent Directors (as defined in the Company's Restated Certificate of Incorporation) plus one, and Zimco was entitled to nominate one-half the Nonindependent Directors minus one. Messrs. Lieb and Trump were nominees of Seacorp; Mr. Chroman was the nominee of Zimco. The Amended Stockholders' Agreement terminated in accordance with its terms on October 31, 1995. See the discussion under Item 13 - Certain Relationships and Related Transactions.\nThe Trump Group, of which Mr. Trump is a director and officer and Mr. Lieb is an officer, through affiliates controls Seacorp. See the discussion under Item 12 - Security Ownership of Certain Beneficial Owners and Management.\nEXECUTIVE OFFICERS OF THE COMPANY\nSince January 1995, the Company has no executive officers.\nITEM 11","section_11":"ITEM 11 - EXECUTIVE COMPENSATION\nCOMPENSATION OF DIRECTORS AND EXECUTIVE OFFICERS\nThe Company has no employees or executive officers. There are currently no arrangements under which any officer or director of the Company will receive compensation for serving as such; however, other arrangements may be made in the future.\nITEM 12","section_12":"ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following table sets forth, as of December 1, 1995, information concerning the beneficial ownership of the common stock of the Company by (i) persons known by the Company to own beneficially more than 5% of its outstanding common stock, (ii) each of the directors of the Company and (iii) all directors and executive officers of the Company as a group. Except as set forth in the footnotes to the table, the stockholders have sole voting and investment power over such shares. Unless otherwise specified, the address for all directors is the address of the Company's executive offices. The address for Messrs. Julius and Eddie Trump is the address set forth below for Seacorp. The address for Messrs. Larry Chroman and Christopher Podoll is the address set forth below for Zimmerman Retailing Group Limited.\n(a) According to the Schedule 13D, as amended (the \"Zimco Amended 13D\"), filed with the Securities and Exchange Commission (the \"Commission\"), Zimco is an Iowa limited partnership, the sole general partner of which is Soma 2 L.P., a Delaware limited partnership (\"Soma 2\"). Soma 2 has as its general partner ZRG Co., Inc., a Delaware corporation (\"ZRG\"), for which Mr. Podoll serves as the sole executive officer and director. Mr. Podoll is a manager of investments of the William Zimmerman family. Amounts include 8,079 shares issuable upon conversion of Debentures beneficially owned by Zimco. Amounts do not include the ownership of 6,000 shares and 3,810 shares issuable upon conversion of Debentures owned by the Surya Financial Inc. Retirement Plan, a retirement plan for the benefit of various employees of Surya Financial Inc., an affiliate of Zimco.\n(b) According to the Schedule 13D, as amended, filed with the Commission by Julius Trump, Eddie Trump and Seacorp, Seacorp is, and Messrs. Julius and Eddie Trump may be deemed to be, the beneficial owner(s) of 8,014,705 shares of common stock. Such amount includes 8,079 shares issuable upon conversion of Debentures beneficially owned by an affiliate of Seacorp. As set forth in the Schedule 13D, Seacorp is a Delaware corporation and does not presently have any business other than the ownership of shares of common stock of the Company. Seacorp is indirectly controlled by Messrs. Julius and Eddie Trump.\n(c) Assumes the conversion of all Debentures beneficially owned by an affiliate of Seacorp. Does not include shares owned by Zimco. Mr. Chroman, who is a director of the Company, is co- manager of investments for the William Zimmerman family and Mr. Podoll, who is also such a manager, is, as noted above, the sole executive officer and director of affiliates of Zimco.\nITEM 13","section_13":"ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nSTOCKHOLDERS' AGREEMENT\nGENERAL. On May 7, 1986, Zimco, Seacorp and the Company entered into the Stockholders' Agreement. Under the Stockholders' Agreement, Zimco and Seacorp exchanged all of their common stock in Pay'n Save for all of the issued and outstanding Common Stock of the Company. Subsequently, in consideration of Seacorp causing to be made available short-term borrowing facilities aggregating $20 million to the Company, Seacorp, Zimco and certain related parties entered into an agreement amending the Stockholders' Agreement (the \"November 1987 Amendment\") in certain respects. In connection with the November 1987 Amendment, the parent of Seacorp guaranteed Company borrowings by Pay'n Save under such short-term borrowing facilities (which have since expired) in an amount up to $15 million.\nThe Stockholders' Agreement and the November 1987 Amendment were entered into by Seacorp and Zimco and certain of its related parties on their own behalf and on behalf of their respective permitted transferees, for the exclusive benefit of Seacorp and its permitted transferees (the \"Seacorp Group\"), and Zimco and its permitted transferees and certain of its related parties (the \"Zimco Group\"). The Stockholders' Agreement, as amended by the November 1987 Amendment, terminated in accordance with its terms on October 31, 1995.\nThe November 1987 Amendment contains certain indemnities in favor of (and for the benefit of) the Company which remain effective.\nPursuant to separate agreements, the Company has granted certain registration rights to each group and certain of each group's transferees, including Zimco, with respect to the shares of common stock acquired pursuant to the Stockholders' Agreement.\nNOMINATION OF DIRECTORS. The Stockholders' Agreement had provided that each group would nominate and vote for an equal number of nominees on the Company's Board of Directors and vote as stockholders in favor of each matter previously approved by a majority of the directors nominated by Zimco and Seacorp and vote against each matter not so approved. The November 1987 Amendment amended the Stockholders' Agreement to provide that so long as Julius or Eddie Trump or their affiliates or certain related parties and certain other designated parties (collectively, the \"Trump Group\") remained the beneficial owners, directly or indirectly, of at least a majority of the shares of common stock owned by Seacorp as of November 25, 1987, Seacorp would be entitled to nominate as directors one-half the number of Nonindependent Directors plus one and Zimco would be entitled to nominate one-half the number of Nonindependent Directors minus one, and that at all times at least four seats on the Company's Board of Directors would be reserved for Nonindependent Directors. The Stockholders' Agreement, as amended, terminated in accordance with its terms on October 31, 1995. Consequently, the Company's two major stockholders, Zimco and Seacorp, are no longer obligated to nominate and vote for each other's nominees to the Company's Board of Directors, or to vote as stockholders in favor of each matter previously approved by a majority of the directors nominated by Zimco and Seacorp.\nThe Company's Certificate of Incorporation provides that actions by the Company's Board of Directors generally require the affirmative vote of that number of directors equal to the sum of (i) the number of Independent Directors (as defined) plus (ii) a majority of the Nonindependent Directors.\nCERTAIN VOTING ARRANGEMENTS. The November 1987 Amendment provided that Seacorp and the Zimco Group would use their best efforts to cause the Seacorp Directors and the Zimco Directors to vote against any issuance of capital stock of the Company or its subsidiaries (i) to any affiliate of Seacorp unless the Zimco Group was first offered the opportunity to purchase a portion of such shares pro rata in accordance with their then ownership of shares of common stock, for the same consideration that was to be paid by such affiliate, or (ii) to any entity not affiliated with Seacorp without the consent or approval of the holders of a majority of the outstanding shares of common stock, subject in each case to waiver by the Zimco Directors. This voting arrangement terminated on October 31, 1995.\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\nThe Company does not have a compensation or similar committee.\nPART IV. OTHER INFORMATION\nITEM 14","section_14":"ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) See the section entitled \"Index to Financial Statements\" appearing under Item 8 of this Annual Report on Form 10-K.\n(b) Not applicable\n(c) Exhibits:\n3.1 Restated Certificate of Incorporated by reference Incorporation of Pay'n Save Inc. from Exhibit 3.1 to the Registration Statement on Form S-1 (File No. 33-5560) of the Company (the \"Registration Statement\").\n3.2 Certificate of Amendment of Incorporated by reference Certificate of Incorporation from Exhibit 3.2 to the of Pay'n Save Inc. Registration Statement.\n3.3 Certificate of Amendment of Incorporated by reference Certificate of Incorporation from Exhibit 3.1 to of Pay'n Save Inc. Quarterly Report on Form 10-Q for the quarter ended July 30, 1988.\n3.4 Certificate of Amendment of Incorporated by reference Certificate of Incorporation from Exhibit 3.4 to the of PSS, Inc. Annual Report on Form 10-K for the year ended October 31, 1992.\n3.5 By-Laws of Pay'n Save Inc. Incorporated by reference from Exhibit 3.3 to the Registration Statement.\n4.1 Indenture between Pay'n Save Incorporated by reference Inc. and United States Trust from Exhibit 4.1 Company of New York, as Trustee, to the\nrelating to the 7-1\/8% Con- Registration Statement. vertible Debentures due July 15, 2006 (including the form of Convertible Debenture).\n4.2 First Supplemental Indenture be- Incorporated by reference tween Pay'n Save Inc., and from Exhibit 4.1 to the United States Trust Company of Quarterly Report on Form New York as Trustee, relating 10-Q for the quarter ended to the 7-1\/8% Convertible De- April 30, 1988. bentures due July 15, 2006.\n4.3 Indenture between PNS Inc. and Incorporated by reference Norwest Bank Minneapolis, Nat- from Exhibit 4.1 to the ional Association as Trustee, Registration Statement on relating to the 12-1\/8% Senior Form S-1 (File No. 33-5591) Subordinated Notes due July 15, of PNS Inc. 1996 (including the form of Senior Subordinated Note).\n4.4 First Supplemental Indenture be- Incorporated by reference tween PNS Inc., and Norwest Bank from Exhibit 4.2 to the Minnesota, National Association Quarterly Report on Form as Trustee, relating to the 10-Q for the quarter ended 12-1\/8% Senior Subordinated April 30, 1988. Notes due July 15, 1996.\n10.1 Subscription and Stockholders' Incorporated by reference Agreement, dated as of May 7, from Exhibit 2.3 to the 1986, by and among Zimmerman Registration Statement. Retailing Group Limited, Seacorp, Inc. and Pay'n Save Inc.\n10.2 Amended Stockholders' Agreement Incorporated by reference between Pay'n Save Inc., Seacorp, from Exhibit 10.25 to the Inc., Zimmerman Retailing Group Annual Report on Form 10-K Limited and related parties dated for the year ended October November 25, 1987. 31, 1987.\n10.3 Registration Rights Agreement, Incorporated by reference dated as of May 7, 1986, by from Exhibit 10.7 to the and among Pay'n Save Inc., Registration Statement. Seacorp, Inc. and Zimmerman Retailing Group Limited.\n10.4 Agreement for purchase and sale Incorporated by reference of assets by and among Pay'n from Exhibit 2.1 to Save Stores, Inc., The Bi-Mart\nCompany, Pay'n Save Drugs Inc. Form 8-K dated May 13, 1988. and Thrifty Corporation, dated as of May 12, 1988.\n10.5 Letter Agreement dated Incorporated by reference February 9, 1990 by and among from Exhibit (i) to the PSSC Inc. and Bear Stearns & Quarterly Report on Form Co., Inc. for the purchase and 10-Q for the quarter ended financing of adjustable-rate February 3, 1990. mortgages.\n10.6 Agreements dated as of Incorporated by reference January 14, 1993 with respect from Exhibit 10.7 to the to the acquisition by PSS, Inc. Annual Report on Form and PNS Inc. of up to $64.475 10-K for the year ended million of Senior Notes and October 31, 1992. $14 million of Debentures.\n22.1 Subsidiaries of the Registrant. Incorporated by reference from Exhibit 22.1 to the Annual Report on Form 10-K for the year ended October 31, 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.\nPSS, INC. (Registrant)\nDate: January 26, 1996 By: \/s\/ James Lieb ----------------- ------------------- James M. Lieb, Director\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nDate Title Signature --- January 26, 1996 Director By: \/s\/ Larry Chroman --------------------------- Larry Chroman\nJanuary 26, 1996 Director By: \/s\/ James M. Lieb --------------------------- James M. Lieb\nJanuary 26, 1996 Director By: \/s\/ Gerald Nathanson --------------------------- Gerald Nathanson\nJanuary 26, 1996 Director By:\/s\/ Eddie Trump --------------------------- Eddie Trump","section_15":""}
{"filename":"733590_1995.txt","cik":"733590","year":"1995","section_1":"ITEM 1. BUSINESS (Continued)\nBusiness Plan and Investment Policy (Continued)\nmaking property renovations and\/or improvements where appropriate. While such expenditures increase the amount of revenue required to cover operating expenses, the Company's management believes that such expenditures are necessary to maintain or enhance the value of the Company's properties.\nThe Company has determined that it will no longer seek to fund or acquire new mortgage loans. It may, however, originate mortgage loans in conjunction with providing purchase money financing of a property sale. The Company does intend, however, to service and hold for investment the mortgage notes currently in its portfolio. The Company also intends to pursue its rights vigorously with respect to mortgage notes that are in default. The Company's Articles of Incorporation impose no limitations on the Company's investment policy with respect to mortgage loans and do not prohibit the Company from investing more than a specified percentage of its assets in any one mortgage loan.\nThe Company's Board of Directors currently intends to continue its policy of prohibiting the Company from incurring aggregate secured and unsecured indebtedness in excess of 300% of the Company's net asset value (defined as the book value of all assets of the Company minus all of its liabilities); however, the Board of Directors may alter such policy at any time.\nManagement of the Company\nAlthough the Company's Board of Directors is directly responsible for managing the affairs of the Company and for setting the policies which guide it, the day-to-day operations of the Company are performed by Basic Capital Management, Inc. (\"BCM\" or the \"Advisor\"), a contractual advisor under the supervision of the Company's Board of Directors. The duties of the Advisor include, among other things, locating, investigating, evaluating and recommending real estate and mortgage note investment and sales opportunities, as well as financing and refinancing sources for the Company. The Advisor also serves as a consultant in connection with the Company's business plan and investment decisions made by the Company's Board of Directors.\nBCM is a company owned by a trust for the benefit of the children of Gene E. Phillips. Mr. Phillips served as a Director of the Company until December 31, 1992. Mr. Phillips also served as a director of BCM until December 22, 1989 and as Chief Executive Officer of BCM until September 1, 1992. Mr. Phillips serves as a representative of his children's trust which owns BCM and, in such capacity, has substantial contact with the management of BCM and input with respect to its performance of advisory services to the Company. BCM is more fully described in ITEM 10. \"DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT - The Advisor.\"\nBCM has been providing advisory services to the Company since March 28, 1989. Renewal of BCM's advisory agreement with the Company was approved\nITEM 1. BUSINESS (Continued)\nManagement of the Company (Continued)\nby the Company's stockholders at the Company's annual meeting of stockholders held on March 7, 1995. BCM also serves as advisor to Continental Mortgage and Equity Trust (\"CMET\") and Income Opportunity Realty Investors, Inc., formerly Income Opportunity Realty Trust (collectively \"IORI\"). The Directors of the Company are also trustees or directors of CMET and IORI and the officers of the Company are also officers of CMET and IORI. Mr. Phillips is a general partner of Syntek Asset Management, L.P. (\"SAMLP\"), the general partner of National Realty, L.P. (\"NRLP\") and National Operating, L.P. (\"NOLP\"), the operating partnership of NRLP. BCM performs certain administrative functions for NRLP and NOLP on a cost-reimbursement basis. BCM also serves as advisor to American Realty Trust, Inc. (\"ART\"). Mr. Phillips served as Chairman of the Board and as a director of ART until November 16, 1992. Randall M. Paulson, President of the Company, also serves as President of BCM, CMET and IORI, and as the President and a director of Syntek Asset Management, Inc. (\"SAMI\"), which is the managing general partner of SAMLP. The officers of the Company are also officers of ART. As of March 15, 1996, the Company owned approximately 22% of IORI's shares of common stock and ART owned approximately 29% of the outstanding shares of the Company's Common Stock and approximately 27% of IORI's outstanding shares of common stock.\nSince February 1, 1990, affiliates of BCM have provided property management services to the Company. Currently, Carmel Realty Services, Ltd. (\"Carmel, Ltd.\") provides such property management services. Carmel, Ltd. subcontracts with other entities for the provision of the property-level management services to the Company. The general partner of Carmel, Ltd. is BCM. The limited partners of Carmel, Ltd. are (i) Syntek West, Inc. (\"SWI\"), of which Mr. Phillips is the sole shareholder, (ii) Mr. Phillips and (iii) a trust for the benefit of the children of Mr. Phillips. Carmel, Ltd. subcontracts the property-level management and leasing of 24 of the Company's commercial properties and its hotel and the commercial properties owned by a real estate partnership in which the Company and IORI are partners to Carmel Realty, Inc. (\"Carmel Realty\"), which is a company owned by SWI. Carmel Realty is entitled to receive property and construction management fees and leasing commissions in accordance with the terms of its property-level management agreement with Carmel, Ltd.\nCarmel Realty is also entitled to receive real estate brokerage commissions in accordance with the terms of a non-exclusive brokerage agreement as discussed in ITEM 10. \"DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT - The Advisor.\"\nThe Company has no employees. Employees of the Advisor render services to the Company.\nCompetition\nThe real estate business is highly competitive and the Company competes with numerous entities engaged in real estate activities (including\nITEM 1. BUSINESS (Continued)\nCompetition (Continued)\ncertain entities described in ITEM 13. \"CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - Related Party Transactions\"), some of which may have greater financial resources than those of the Company. The Company's management believes that success against such competition is dependent upon the geographic location of the property, the performance of property managers in areas such as marketing, collections and the ability to control operating expenses, the amount of new construction in the area and the maintenance and appearance of the property. Additional competitive factors with respect to commercial properties are the ease of access to the property, the adequacy of related facilities, such as parking, and sensitivity to market conditions in setting rent levels. With respect to apartments, competition is also based upon the design and mix of the units and the ability to provide a community atmosphere for the tenants. The Company's management believes that general economic circumstances and trends and new or renovated properties in the vicinity of each of the Company's properties are also competitive factors.\nTo the extent that the Company seeks to sell any of its properties, the sales prices for such properties may be affected by competition from other real estate entities and financial institutions also attempting to sell their properties located in areas in which the Company's properties are located.\nAs described above and in ITEM 13. \"CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - Related Party Transactions\", the officers and Directors of the Company also serve as officers or trustees or directors of certain other entities, each of which is also advised by BCM, and each of which has business objectives similar to the Company's. The Company's Directors, officers and Advisor owe fiduciary duties to such other entities as well as to the Company under applicable law. In determining to which entity a particular investment opportunity will be allocated, the officers, directors or trustees and the Advisor consider the respective investment objectives of each such entity and the appropriateness of a particular investment in light of each such entity's existing real estate portfolio. To the extent that any particular investment opportunity is appropriate to more than one of such entities, such investment opportunity will be allocated to the entity which has had funds available for investment for the longest period of time or, if appropriate, the investment may be shared among all or some of such entities.\nIn addition, as also described in ITEM 13. \"CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - Certain Business Relationships,\" the Company also competes with other entities which are affiliates of the Advisor and which may have investment objectives similar to the Company's and that may compete with the Company in purchasing, selling, leasing and financing real estate and real estate related investments. In resolving any potential conflicts of interest which may arise, the Advisor has informed the Company that it intends to continue to exercise its best judgment as to what is fair and reasonable under the circumstances in accordance with applicable law.\nITEM 1. BUSINESS (Continued)\nCertain Factors Associated with Real Estate and Related Investments\nThe Company is subject to all the risks incident to ownership and financing of real estate and interests therein, many of which relate to the general illiquidity of real estate investments. These risks include, but are not limited to, changes in general or local economic conditions, changes in interest rates and the availability of permanent mortgage financing which may render the acquisition, sale or refinancing of a property difficult or unattractive and which may make debt service burdensome, changes in real estate and zoning laws, increases in real estate taxes, federal or local economic or rent controls, floods, earthquakes, hurricanes and other acts of God and other factors beyond the control of the Company's management or Advisor. The illiquidity of real estate investments may also impair the ability of the Company to respond promptly to changing circumstances. The Company's management believes that such risks are partially mitigated by the diversification by geographic region and property type of the Company's real estate and mortgage notes receivable portfolios. However, to the extent new property investments are concentrated in any particular region, the advantages of geographic diversification may be mitigated.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's principal offices are located at 10670 North Central Expressway, Suite 300, Dallas, Texas 75231. In the opinion of the Company's management, the Company's offices are suitable and adequate for its present operations.\nDetails of the Company's real estate and mortgage notes receivable portfolios at December 31, 1995, are set forth in Schedules III and IV, respectively, to the Consolidated Financial Statements included at ITEM 8. \"FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\" The discussions set forth below under the headings \"Real Estate\" and \"Mortgage Loans\" provide certain summary information concerning the Company's real estate and mortgage notes receivable portfolios.\nThe Company's real estate portfolio consists of properties held for investment, investments in real estate entities and properties held for sale, primarily obtained through foreclosure of the collateral securing mortgage notes receivable. The discussion set forth below under the heading \"Real Estate\" provides certain summary information concerning the Company's real estate and further summary information with respect to the Company's properties held for investment, properties held for sale and investments in real estate entities.\nAt December 31, 1995, none of the Company's properties, mortgage notes receivable or investments in real estate entities exceeded 10% or more of the Company's total assets. At December 31, 1995, 85% of the Company's assets consisted of properties held for investment, 2% consisted of properties held for sale, 4% consisted of mortgage notes and interest receivable and 2% consisted of investments in real estate entities. The remaining 7% of the Company's assets at December 31, 1995 were invested in cash, cash equivalents and other assets. The percentage of the Company's assets invested in any one category is sub-\nITEM 2. PROPERTIES (Continued)\nject to change and no assurance can be given that the composition of the Company's assets in the future will approximate the percentages listed above.\nThe Company's real estate is geographically diverse. At December 31, 1995, the Company held investments in apartments and commercial properties in each of the geographic regions of the continental United States, although its apartments and commercial properties are concentrated in the Southeast and Southwest regions, as shown more specifically in the table under \"Real Estate\" below. At December 31, 1995, the Company held mortgage notes receivable secured by real estate located in each of the geographic regions, other than the Mountain and Pacific regions, of the continental United States, with a concentration in the Southeast region, as shown more specifically in the table under \"Mortgage Loans\" below.\nTo continue to qualify for federal taxation as a REIT under the Internal Revenue Code of 1986, as amended, the Company is required, among other things, to hold at least 75% of the value of its total assets in real estate assets, government securities, cash and cash equivalents at the close of each quarter of each taxable year.\n[THIS SPACE INTENTIONALLY LEFT BLANK.]\nITEM 2. PROPERTIES (Continued)\nGeographic Regions\nThe Company has divided the continental United States into the following six geographic regions.\nNortheast region comprised of the states of Connecticut, Delaware, Maryland, Massachusetts, New Hampshire, New Jersey, New York, Pennsylvania, Rhode Island and Vermont, and the District of Columbia. The Company owns 3 apartments and 1 commercial property in this region.\nSoutheast region comprised of the states of Alabama, Florida, Georgia, Mississippi, North Carolina, South Carolina, Tennessee and Virginia. This Company owns 3 apartments and 10 commercial properties in this region.\nSouthwest region comprised of the states of Arizona, Arkansas, Louisiana, New Mexico, Oklahoma and Texas. The Company owns 6 apartments and 9 commercial properties in this region.\nMidwest region comprised of the states of Illinois, Indiana, Iowa, Kansas, Kentucky, Michigan, Minnesota, Missouri, Nebraska, North Dakota, Ohio, South Dakota, West Virginia and Wisconsin. The Company owns 1 apartment and 3 commercial properties in this region.\nMountain region comprised of the states of Colorado, Idaho, Montana, Nevada, Utah and Wyoming. The Company owns 1 commercial property in this region.\nPacific region comprised of the states of California, Oregon and Washington. The Company owns 1 apartment, 1 hotel and 3 commercial properties in this region.\nExcluded from the above are five parcels of unimproved land as described below.\nReal Estate\nAt December 31, 1995, approximately ninety percent of the Company's assets were invested in real estate. The Company invests in real estate located throughout the continental United States, either on a leveraged or nonleveraged basis. The Company's real estate portfolio consists of properties held for investment, investments in real estate entities and properties held for sale (which were primarily obtained through foreclosure of the collateral securing mortgage notes receivable).\nTypes of Real Estate Investments. The Company's real estate consists of commercial properties (a hotel, office buildings, industrial facilities and shopping centers) and apartments or similar properties having established income- producing capabilities. In selecting new real estate investments, the location, age and type of property, gross rentals,\nITEM 2. PROPERTIES (Continued)\nReal Estate (Continued)\nlease terms, financial and business standing of tenants, operating expenses, fixed charges, land values and physical condition are among the factors considered. The Company may acquire properties subject to or assume existing debt and may mortgage, pledge or otherwise obtain financing for its properties. The Company's Board of Directors may alter the types of and criteria for selecting new real estate investments and for obtaining financing without a vote of stockholders.\nAlthough the Company has typically invested in developed real estate, and has no current intentions to do otherwise, the Company may also invest in new construction or development either directly or in partnership with nonaffiliated parties or affiliates (subject to approval by the Company's Board of Directors). To the extent that the Company invests in construction and development projects, the Company would be subject to business risks, such as cost overruns and construction delays, associated with such higher risk projects.\nAt December 31, 1995, the Company had one office building on which significant capital improvements were in process. The improvements commenced in 1995 and are scheduled for completion in the first quarter of 1996. Expenditures through December 31, 1995 totaled $252,000 with $56,000 expected to be expended by the Company in the first quarter of 1996.\nIn the opinion of the Company's management, the properties owned by the Company are adequately covered by insurance.\nThe following table sets forth the percentages, by property type and geographic region, of the Company's real estate (other than a hotel in the Pacific region and unimproved land, as described below) at December 31, 1995.\nThe foregoing table is based solely on the number of apartment units and amount of commercial square footage owned by the Company and does not reflect the value of the Company's investment in each region. The Company also owns 5 parcels of unimproved land - 3 parcels containing a total of 784 acres in the Southeast region, a parcel of 7 acres in the Mountain region and a parcel containing 70 lots in the Southwest region, all of which are held for sale. See Schedule III to the Consolidated Financial Statements included at ITEM 8. \"FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\" for a more detailed description of the Company's real estate portfolio.\nITEM 2. PROPERTIES (Continued)\nReal Estate (Continued)\nA summary of activity in the Company's owned real estate portfolio during 1995 is as follows:\nProperties Held for Investment. Set forth below are the Company's properties held for investment and the monthly rental rate for apartments and the average annual rental rate for commercial properties and occupancy thereof at December 31, 1995, 1994 and 1993:\nITEM 2. PROPERTIES (Continued)\nReal Estate (Continued)\n_________________________________\n* Property was acquired in either 1994 or 1995.\nOccupancy presented here and throughout this ITEM 2. is without reference to whether leases in effect are at, below or above market rates.\nIn December 1995, the Company's management made its annual review of the Company's real estate portfolio and reclassified the Majestic Inn, a hotel in San Francisco, California, from properties held for sale to properties held for investment. The Company also reclassified the Park Forest Apartments, an apartment complex in Dearborn Heights, Michigan, from properties held for investment to properties held for sale as the property was under contract for sale at December 31, 1995. See \"Properties Held for Sale,\" below.\nIn March 1994, the Company borrowed $1.4 million from a Northtown Mall tenant, secured by a second lien on the shopping center. The loan proceeds were used primarily for specified renovations and repairs to the shopping center. In October 1994, the tenant loaned the Company an additional $1.9 million, the proceeds of which were used in part to repay the first mortgage secured by the property. At funding of the second loan, the two loans were combined into a new first mortgage. The new first mortgage, in the amount of $3.3 million, matured December\nITEM 2. PROPERTIES (Continued)\nReal Estate (Continued)\n31, 1995. The Company did not payoff the mortgage at maturity. The Company is in negotiations with the lender to extend the loan. The Company expects to be successful in such negotiations, but if it is not, it intends to payoff the loan.\nIn December 1994, NCPO Texas, Ltd., a Texas limited partnership, purchased the North Central Plaza One Building, a 198,061 square foot office building in Dallas, Texas for $12.4 million, consisting of $4.2 million in cash and new mortgage financing of $8.2 million.\nThe Company was the sole limited partner of the partnership with a 97.5% limited partner interest. The partnership was consolidated for financial statement purposes. The general partner of the partnership, with a 2.5% general partner interest, was Ensearch Holding Company, a corporation controlled by an adult son of A. Bob Jordan, a Director of the Company until March 7, 1995. In December 1995, the Company sold its partnership interest in NCPO Texas, Ltd. for $4.8 million in cash. The Company recognized no gain or loss on the transaction.\nThe Company owns Institute Place Lofts, a 142,215 square foot office building in Chicago, Illinois. The Company did not payoff the $6.3 million mortgage secured by the property on its June 1, 1993 maturity, as the Company determined further investment in the property could not be justified without a substantial modification of the mortgage. In July 1994, the property was placed in bankruptcy. In January 1995, the Bankruptcy Court approved a plan of reorganization which provides for a reduction in the mortgage's secured principal balance to $4.1 million, reduces the pay rate to 6% per annum in the first year, increasing to 10.25% per annum in the fourth year, with interest accruing at 10.25% per annum. In February 1995, the Company funded required escrows of $500,000 to satisfy outstanding real estate taxes and to cover projected negative cash flow of the property. The Company recorded no gain or loss as a result of the debt restructuring.\nEffective January 1, 1995, the other 50% general partners in both Twinbrook Village Associates, which owns Woods Edge Apartments in Rockville, Maryland, and Gate Laurel Associates, which owns the Westgate of Laurel Apartments in Laurel, Maryland, conveyed their interests in the partnerships to the Company in exchange for a release from their general partner liability.\nIn April 1995, the Company purchased the remaining general partner interest in Shadow Run Associates, which owns the Shadow Run Apartments, an apartment complex in Pinellas Park, Florida, for $50,000 in cash. In January 1995, the partnership had refinanced the mortgage debt secured by the Shadow Run Apartments. The new first mortgage of $7.2 million bears interest at 10.21% per annum, requires monthly payments of principal and interest of $64,305 and matures February 1, 2002. The partnership used the refinancing proceeds and a $300,000 advance from the Company to pay the existing mortgage of $7.0 million, accrued but unpaid interest, financing fees\nITEM 2. PROPERTIES (Continued)\nReal Estate (Continued)\nand real estate taxes. The partnership paid a mortgage brokerage and equity refinancing fee of $72,000 to BCM based on the $7.2 million refinancing.\nIn February 1995, the Company purchased a 48.18% interest in 8,153 square feet of land in proximity to the Republic Towers Office Building (\"Republic Towers\") in Dallas, Texas for $166,000 in cash. In December 1995, the Company purchased a 43,560 square foot parking lot also in proximity to Republic Towers for $1.1 million in cash. The Company paid a real estate brokerage commission of $45,000 to Carmel Realty and an acquisition fee of $11,000 to BCM based on the $1.1 million purchase price.\nIn March 1995, the Company refinanced the mortgage debt secured by the Fountain Village Apartments in Tucson, Arizona, in the amount of $6.2 million. The Company received net cash of $1.1 million after the payoff of $4.9 million in existing mortgage debt. The remainder of the refinancing proceeds were used to fund required repair and tax escrows and the payment of various closing costs associated with the refinancing. In November 1995, the Company again refinanced the mortgage debt in the amount of $8.2 million. The Company received net cash of $2.0 million after the payoff of $6.2 million on the then existing mortgage debt. The new mortgage bears interest at 7.875%, requires monthly payments of principal and interest of $62,611 and matures December 1, 2005. The Company paid total mortgage brokerage and equity refinancing fees of $82,000 to BCM based on the $8.2 million refinancing.\nIn April 1995, the Company obtained mortgage financing of $1.2 million secured by the previously unencumbered Venture Centre Office Building in Atlanta, Georgia. The Company received net cash of $1.1 million after funding required tax and insurance escrows and the payment of various closing costs associated with the financing. The mortgage bears interest at 9.79% per annum, requires monthly payments of principal and interest of $10,405 and matures May 1, 2005. The Company guaranteed repayment of the mortgage. The Company paid a mortgage brokerage and equity refinancing fee of $12,000 to BCM based on the $1.2 million financing.\nAlso in April 1995, the Company modified and extended three of the mortgage loans secured by the Dunes Plaza Shopping Center in Michigan City, Indiana. The three loans, totaling $4.6 million after a principal reduction payment of $185,000, were consolidated into one new loan. In consideration of the Company's principal paydown, the lender forgave $48,000 of the consolidated loan's principal balance. The consolidated loan provides that for every $3.86 of principal prepayments made by the Company during the first year, the lender will forgive $1.00 of indebtedness, up to $191,632. Also, for each $3.86 of certain capital and tenant improvement expenditures approved by the lender, the lender shall forgive an additional $1.00 of indebtedness, up to $323,507. The consolidated loan bears interest at 9.5% per annum, requires monthly payments of principal and interest of $42,505 and matures March 10,\nITEM 2. PROPERTIES (Continued)\nReal Estate (Continued)\n2000. Through December 31, 1995, the Company has made additional principal payments of $370,000 and the lender has forgiven an additional $96,000 of the debt.\nIn May 1995, the Company obtained mortgage financing of $3.0 million secured by the previously unencumbered Plaza Tower Office Building in St. Petersburg, Florida. The Company received net cash of $2.2 million after funding required tax and repair escrows and the payment of various closing costs associated with the financing. The mortgage bears interest at a variable rate of 3.25% over the London Interbank Offered Rate (\"LIBOR\") three month rate, adjusted quarterly, (8.905% per annum at December 31, 1995), requires monthly payments of principal and interest of $27,964, and matures May 2000. The Company paid a mortgage brokerage and equity refinancing fee of $30,000 to BCM based on the $3.0 million financing.\nA mortgage principal paydown of $1.6 million was due in June 1995 on the mortgage secured by the Spa Cove Apartments, in Annapolis, Maryland. The lender agreed to an extension of such payment until July 31, 1995, in exchange for the Company's agreement to increase its pay down by $300,000. The Company made the required $1.9 million paydown. Upon payment, all of the Company's shareholdings of IORI which had been pledged to the lender as additional collateral for the mortgage were released.\nIn June 1995, the Company obtained the Gladstell Forest Apartments, a 136 unit apartment complex in Conroe, Texas through foreclosure of a note receivable. In conjunction with the foreclosure, the Company refinanced the property's $2.7 million mortgage for a like amount with the Company receiving no net refinancing proceeds. See \"Mortgage Loans,\" below.\nIn July 1995, the Company obtained mortgage financing of $5.5 million secured by the previously unencumbered Chesapeake Ridge Office Park in San Diego, California. The Company received net cash of $4.6 million after funding required tax, insurance, repair and tenant finish escrows and the payment of various closing costs associated with the financing. The mortgage bears interest at 9.0% per annum, requires monthly payments of principal and interest of $46,156 and matures August 2002. The Company paid a mortgage brokerage and equity refinancing fee of $55,000 to BCM based on the $5.5 million financing.\nIn October 1995, the Company obtained first mortgage financing of $750,000 secured by the previously unencumbered Parkway Center Shopping Center in Dallas, Texas. The Company received net cash of $712,000 after funding required tax and insurance escrows and the payment of various closing costs associated with the financing. The mortgage bears interest at a variable rate of prime plus 1% adjusted daily, (9.5% at December 31, 1995), requires monthly payments of principal and interest of $7,114 and matures November 10, 2000. The Company paid a mortgage brokerage and equity refinancing fee of $7,500 to BCM based on the $750,000 refinancing.\nITEM 2. PROPERTIES (Continued)\nReal Estate (Continued)\nIn November 1995, the Company sold the Summerchase Apartments, a 240 unit apartment complex in Norcross, Georgia, for $12.1 million, receiving net cash of $3.1 million after paying off the first mortgage of $8.7 million and a prepayment penalty of $390,000. The Company recognized a gain on the sale of $4.1 million. The Company paid a real estate sales commission of $301,000 to Carmel Realty based on the $12.1 million sales price.\nIn December 1995, the Company sold the Heritage Shopping Center, a 16,446 square foot shopping center in Tulsa, Oklahoma, for $418,000 in cash. The Company recognized a gain on the sale of $76,000.\nIn December 1995, the Company refinanced the mortgage debt secured by the Woodland Hills Apartments in San Antonio, Texas, in the amount of $1.2 million. The Company received net cash of $775,000 after the payoff of $352,000 in existing mortgage debt, tax and insurance escrows and various closing costs associated with the refinancing. The new mortgage bears interest at 8.0%, requires monthly payments of principal and interest of $9,262 and matures December 1, 2005. The Company paid a mortgage brokerage and equity refinancing fee of $12,000 to BCM based on the $1.2 million refinancing.\nPartnership Properties. Set forth below are the properties owned by partnerships which the Company accounts for using the equity method and the monthly rental rate for apartments and the average annual rental rate for commercial properties and occupancy thereof at December 31, 1995, 1994 and 1993:\nThe Company owns a combined 55% limited and general partnership interest in Jor-Trans Investors Limited Partnership (\"Jor-Trans\") which owns the Lincoln Court Apartments.\nThe Company owns a combined 63.7% limited and general partner interest and IORI owns a 36.3% general partner interest in Tri-City Limited Partnership (\"Tri-City\") which owns the five other properties in the table above. In July 1995, Tri-City obtained first mortgage financing of $1.4 million secured by the previously unencumbered MacArthur Mills\nITEM 2. PROPERTIES (Continued)\nReal Estate (Continued)\nOffice Park. The mortgage bears interest at 9.32% per annum, requires monthly payments of principal and interest of $12,186 and matures August 1, 2005. The Company received $853,000 of the net financing proceeds. In conjunction with the financing, Tri-City paid a mortgage brokerage and equity refinancing fee of $14,000 to BCM, based on the $1.4 million financing. In 1995, the Company made no advances to the partnership but did receive $382,000 in operating distributions from the partnership. See ITEM 13. \"CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - Related Party Transactions.\"\nProperties Held for Sale. Set forth below are the Company's properties held for sale, primarily obtained through foreclosure.\nIn January 1996, the Company sold the Cheyenne Mountain land, a 7 acre parcel in Colorado Springs, Colorado for $330,000 in cash. The Company recognized a gain of $218,000 on the sale.\nIn January 1996, the Company purchased the Las Colinas land, a 4.7 acre parcel in Las Colinas, Texas for $941,000 in cash. The Company paid a real estate brokerage commission of $38,000 to Carmel Realty and an acquisition fee of $9,000 to BCM based on the $941,000 purchase price.\nIn March 1996, the Company sold the Park Forest Apartments, a 44 unit apartment complex in Dearborn Heights, Michigan, for $4.7 million, receiving net cash of $1.6 million after paying off the first mortgage of $2.9 million and the payment of various closing costs associated with the sale. The Company will recognize a gain of approximately $1.3 million on the sale. The Company paid a real estate sales commission of $160,000 to Carmel Realty based on the $4.7 million sales price. See \"Properties Held for Investment,\" above.\nMortgage Loans\nIn addition to investments in real estate, a substantial portion of the Company's assets are invested in mortgage notes receivable, principally secured by income-producing real estate. The Company expects that the percentage of its assets invested in mortgage loans will decrease, as it has determined that it will no longer seek to fund or acquire mortgage loans, other than those which it may originate in conjunction with\nITEM 2. PROPERTIES (Continued)\nMortgage Loans (Continued)\nproviding purchase money financing of a property sale. The Company does intend, however, to service and hold for investment the mortgage notes currently in its portfolio. The Company's mortgage notes receivable consist of first, wraparound and junior mortgage loans.\nTypes of Mortgage Activity. In the past the Company has originated its own mortgage loans, as well as acquired existing mortgage notes either directly from builders, developers or property owners, or through mortgage banking firms, commercial banks or other qualified brokers. The Company is not considering new mortgage lending, except in connection with purchase money financing offered to facilitate the sale of Company owned properties. BCM, in its capacity as a mortgage servicer, services the Company's mortgage notes. The Company's investment policy is described in ITEM 1. \"BUSINESS - Business Plan and Investment Policy.\"\nTypes of Properties Securing Mortgage Notes. The properties securing the Company's mortgage notes receivable portfolio at December 31, 1995, consisted of an office building, a shopping center, 3 apartment complexes, a single-family residence, a hotel, 36.3 acres of commercial land, 12 developed residential lots and a 34,847 square foot parcel of unimproved land. The Company's Board of Directors may alter the types of properties securing or collateralizing mortgage loans in which the Company invests without a vote of stockholders. The Company's Articles of Incorporation impose certain restrictions on transactions with related parties, as discussed in ITEM 13. \"CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\"\nAt December 31, 1995, the Company's mortgage notes receivable portfolio included seven mortgage loans with an aggregate outstanding balance of $10.2 million secured by income-producing real estate located throughout the United States, 22 loans with an aggregate outstanding balance of $1.6 million which are secured by collateral other than income-producing real estate and two unsecured notes. At December 31, 1995, 4% of the Company's assets were invested in notes and interest receivable (2% in first mortgage notes, 2% in wraparound mortgage notes and less than 1% in junior and other mortgage notes).\nThe following table sets forth the percentages (based on the outstanding mortgage note balance) by property type and geographic region, of the properties (other than a hotel, a residence and unimproved land) that serve as collateral for the Company's outstanding mortgage notes receivable at December 31, 1995. See Schedule IV to the Consolidated Financial Statements included at ITEM 8. \"FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\" for further details of the Company's mortgage notes receivable portfolio.\nITEM 2. PROPERTIES (Continued)\nMortgage Loans (Continued)\nA summary of the activity in the Company's mortgage notes receivable portfolio during 1995 is as follows:\nDuring 1995, mortgage notes receivable totaling $2.8 million were collected in full and $85,000 in mortgage principal payments were received.\nAt December 31, 1995, less than 1% of the Company's assets were invested in mortgage notes secured by non-income-producing real estate, comprised of a first mortgage note secured by 36.3 acres of commercial land in Maumelle, Arkansas, a first mortgage note secured by 34,847 square feet of unimproved land in Milwaukee, Wisconsin, twelve first mortgage notes secured by developed residential lots in Greensboro, North Carolina and a first mortgage note secured by a residence in Phoenix, Arizona.\nFirst Mortgage Loans. The Company has invested in first mortgage notes, with short, medium or long-term maturities. First mortgage loans generally provide for level periodic payments of principal and interest sufficient to substantially repay the loan prior to maturity, but may involve interest-only payments or moderate amortization of principal and a \"balloon\" principal payment at maturity. With respect to first mortgage loans, the Company's general policy was to require that the borrower provide a mortgagee's title policy or an acceptable legal title opinion as to the validity and the priority of the mortgage lien over all other obligations, except liens arising from unpaid property taxes and other exceptions normally allowed by first mortgage lenders in the relevant area. The Company may grant to other lenders participations in first mortgage loans originated by the Company.\nThe following discussion briefly describes the events that affected previously funded first mortgage loans during 1995.\nIn February 1994, the Company provided $6.7 million of purchase money financing in conjunction with the sale of 1,406 acres of land in sixteen developed residential and commercial subdivisions located in Maumelle, Arkansas. The borrower did not make the scheduled February 1995 principal and interest payments. In September 1995, the Company reached a settlement with the borrower that provided the following: (i) the payment by the borrower of $2.5 million in cash; (ii) the Company's release of all land securing the note; (iii) the Company's acceptance of a new $1.4 million note secured by 36.3 acres of commercial land, such note bore interest at 9.0% and matured in January 1996 and (iv) the Company's receipt of 700,000 shares of the borrower's capital stock, which the borrower has the option to repurchase at $5.00 per share for two years from closing. The original sale had been recorded under the\nITEM 2. PROPERTIES (Continued)\nMortgage Loans (Continued)\ncost recovery method with gain being deferred until the note was collected. With the Company's receipt of $2.5 million in cash on September 12, 1995, it recognized $1.6 million of the gain previously deferred. The $1.4 million note was not paid at maturity. The Company has commenced negotiations with the borrower in an effort to correct the default and has also begun foreclosure proceedings. The Company does not expect to incur a loss on the note as the fair value of the property exceeds the carrying value of the note.\nIn April, May and October 1995, four mortgage notes receivable with a total principal balance of $43,000 plus accrued interest were paid in full.\nIn June 1995, the Company obtained the Gladstell Forest Apartments, a 136 unit apartment complex in Conroe, Texas through foreclosure of a note receivable which the Company had received in December 1991 in satisfaction of a debtor's guarantee of another obligation to the Company. The Company had assigned no value to the note receivable. See \"Real Estate - Properties Held for Investment,\" above.\nIn June and December 1991, in an effort to develop a potential future financing source, the Company entered into an asset sales agreement whereby the Company sold a participation in one of its mortgage notes in the amount of $1.3 million in exchange for the assignment of a first mortgage note of $1.1 million and a $181,000 participation in another first mortgage note (the \"loan participation\") from an insurance company. In conjunction with these transactions, the Company entered into a put and guaranty agreement.\nBoth the mortgage note and the loan participation received by the Company were in default at December 31, 1991. In April 1992, the property securing the first mortgage note in the amount of $1.1 million was deeded to the Company in lieu of foreclosure. In the first quarter of 1992, the Company recorded a provision for loss of $366,000 to reduce the carrying value of the mortgage note to the estimated fair value of the collateral property. In September 1993, the Company sold the property for $850,000, receiving $125,000 in cash and providing purchase money financing of $725,000. The Company recognized no loss on the sale beyond the amount previously provided. In the third quarter of 1992, the Company recorded a provision for loss of $184,000 to fully reserve for the carrying value of the loan participation.\nIn March 1992, the insurance company was placed in receivership and in June 1992, the Company provided notice to the insurance company, under the terms of the put and guaranty agreement, of its desire to divest itself of all assets received. The Receiver refused to allow the enforcement of the terms of the put and guaranty agreement.\nA settlement between the Company and the Receiver was approved by the court on February 15, 1995. Under the terms of the settlement, the Company paid the insurance company a total of $1.1 million in July 1995. In exchange, the Company retained the assets transferred to it by the\nITEM 2. PROPERTIES (Continued)\nMortgage Loans (Continued)\ninsurance company as well as received back from the insurance company the loan participation that the insurance company had received from the Company. The Company incurred no loss on the settlement.\nIn March 1996, the Company accepted a discounted payoff of $825,000 in settlement of a first mortgage note receivable with a principal balance of $875,000. The Company recorded no loss on the note settlement in excess of the reserve previously established.\nWraparound Mortgage Loans. A wraparound mortgage loan, sometimes called an all-inclusive loan, is a mortgage loan having an original principal balance equal to the outstanding balance under the prior existing mortgage loan(s) plus the amount actually advanced under the wraparound mortgage loan. Wraparound mortgage loans may provide for full, partial or no amortization of principal. The Company's policy was to make wraparound mortgage loans in amounts and on properties as to which it would otherwise make first mortgage loans.\nThe Company did not originate or acquire any wraparound mortgage loans in 1995.\nJunior Mortgage Loans. The Company has invested in junior mortgage loans. Such loans are secured by mortgages that are subordinate to one or more prior liens either on the fee or a leasehold interest in real estate. Recourse on such loans ordinarily includes the real estate on which the loan is made, other collateral and personal guarantees by the borrower. The Company's Board of Directors restricts investment in junior mortgage loans, excluding wraparound mortgage loans, to not more than 10% of the Company's assets. At December 31, 1995, less than 1% of the Company's assets were invested in junior mortgage loans.\nThe Company did not originate or acquire any junior mortgage loans in 1995.\nLoans Secured by Collateral Other than Real Estate. In June 1992, the Company received ten notes receivable secured by collateral other than real estate in satisfaction of a $622,000 obligation to the Company. At December 31, 1995, seven of the notes with a combined principal balance of $440,000 remained outstanding. The Company's investment policy precludes the origination of loans secured by collateral other than real estate. In January 1995, the Company received $11,000 in settlement of a note receivable with a principal balance of $20,000. The Company recorded no loss on the settlement in excess of the reserve previously established.\nPartnership mortgage loans. The Company owns a 60% general partner interest and IORI owns a 40% general partner interest in Nakash Income Associates (\"NIA\"). NIA in turn owns two wraparound mortgage notes receivable, one of which is secured by the Green Hills Shopping Center (\"Green Hills\") in Onandaga, New York. The shopping center in turn is owned by Green Hills Associates (\"GHA\"). In July 1995, GHA informed NIA that it had determined that further investment in Green Hills was not\nITEM 2. PROPERTIES (Continued)\nMortgage Loans (Continued)\njustified, and further that it has offered to deed the property back to the first lienholder in lieu of foreclosure. As GHA has no other assets, the wraparound note receivable held by NIA will become uncollectible, and therefore, NIA recorded a provision for loss of $1.5 million to write its wraparound note receivable down to the balance of the first lien mortgage. The Company's equity share of the loss was $901,000. The property has been placed in receivership and foreclosure is anticipated to occur on or about March 29, 1996.\nIn September 1995, the Company received notice from NIA that its other wraparound note receivable had been modified in conjunction with the modification of the underlying note payable. NIA recorded a provision for loss of $212,000 on such modification of which the Company's equity share was $127,000.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nOlive Litigation\nIn February 1990, the Company, together with CMET, IORI and National Income Realty Trust (\"NIRT\"), three real estate entities with, at the time, the same officers, directors or trustees and advisor as the Company, entered into a settlement of a class and derivative action entitled Olive et al. v. National Income Realty Trust et al., in the United States District Court for the Northern District of California relating to the operation and management of each such entities. On April 23, 1990, the Court granted final approval of the terms of the settlement.\nOn May 4, 1994, the parties entered into a Modification of Stipulation of Settlement dated April 27, 1994 (the \"Modification\") which settled subsequent claims of breaches of the settlement which were asserted by the plaintiffs and modified certain provisions of the April 1990 settlement. The Modification was preliminarily approved by the court on July 1, 1994. Final court approval of the Modification was entered on December 12, 1994. The effective date of the Modification was January 11, 1995.\nThe Modification, among other things, provided for the addition of three new unaffiliated members to the Company's Board of Directors and set forth new requirements for the approval of any transactions with affiliates until April 28, 1999. In addition, BCM, the Company's advisor, Gene E. Phillips and William S. Friedman, who served as President and Director of the Company until February 24, 1994, President of BCM until May 1, 1993 and director of BCM until December 22, 1989, agreed to pay a total of $1.2 million to CMET, IORI, NIRT and the Company, of which the Company's share is $150,000. As of March 1, 1996, the Company had received payments totaling $128,000. The remaining $22,000 is being paid in monthly installments through August 1, 1996.\nUnder the Modification, the Company, CMET, IORI and NIRT and their shareholders released the defendants from any claims relating to the\nITEM 3. LEGAL PROCEEDINGS (Continued)\nOlive Litigation (Continued)\nplaintiffs' allegations. The Company, CMET, IORI and NIRT also agreed to waive any demand requirement for the plaintiffs to pursue claims on behalf of each of them against certain persons or entities. The Modification also requires that any shares of the Company held by Messrs. Phillips, Friedman or their affiliates shall be (i) voted in favor of the reelection of all current members of the Company's Board of Directors that stand for reelection during the two calendar years following the effective date of the Modification and (ii) voted in favor of all new members of the Company's Board of Directors appointed pursuant to the terms of the Modification that stand for reelection during the three calendar years following the effective date of the Modification.\nPursuant to the terms of the Modification, certain related party transactions which the Company may enter into prior to April 28, 1999, require the unanimous approval, with the exceptions noted below, of the Company's Board of Directors. In addition, such related party transactions are to be discouraged and may only be entered into in exceptional circumstances and after a determination by the Company's Board of Directors that the transaction is in the best interests of the Company and that no other opportunity exists that is as good as the opportunity presented by such transaction.\nFor purposes of the Modification requirements, the term \"related party transaction\" means and includes: (i) any transaction between or among the Company or CMET, IORI or NIRT or any of their affiliates or subsidiaries; (ii) any transaction between or among the Company, its affiliates or subsidiaries and the Advisor, Mr. Phillips, Mr. Friedman or any of their affiliates; and (iii) any transaction between or among the Company or any of its affiliates or subsidiaries and a third party with whom the Advisor, Mr. Phillips, Mr. Friedman or any of their affiliates has an ongoing or contemplated business or financial transaction or relationship of any kind, whether direct or indirect, or has had such a transaction or relationship in the preceding one year.\nThe Modification requirements for related party transactions do not apply to direct contractual agreements for services between the Company and the Advisor or one of its affiliates (including the Advisory Agreement, the Brokerage Agreement and the property management contracts). These agreements, pursuant to the specific terms of the Modification, require the prior approval by two-thirds of the Directors of the Company, and if required, approval by a majority of the Company's stockholders. The Modification requirements for related party transactions also do not apply to joint ventures between or among the Company and CMET, IORI or NIRT or any of their affiliates or subsidiaries and a third party having no prior or intended future business or financial relationship with Mr. Phillips, Mr. Friedman, the Advisor, or any affiliate of such parties. Such joint ventures may be entered into on the affirmative vote of a majority of the Directors of the Company.\nThe Modification also terminated a number of the provisions of the settlement, including the requirement that the Company, CMET, IORI and\nITEM 3. LEGAL PROCEEDINGS (Continued)\nOlive Litigation (Continued)\nNIRT maintain a Related Party Transaction Committee and a Litigation Committee of their respective Boards. The court retained jurisdiction to enforce the Modification.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNot applicable.\n____________________________\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Company's Common Stock is traded on the New York Stock Exchange using the symbol \"TCI\". The following table sets forth the high and low sales prices as reported in the consolidated reporting system of the New York Stock Exchange.\n* Restated for the three for two forward stock split effected February 15, 1996.\nAs of March 15, 1996, the closing price of the Company's Common Stock on the New York Stock Exchange was $10.00 per share.\nAs of March 15, 1996, the Company's Common Stock was held by 7,633 holders of record.\nBased on the performance of the Company's properties, in November 1995 the Company's Board of Directors approved the Company's resumption of\nITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS (Continued)\nthe payment of regular quarterly dividends. The Company paid dividends in 1995 as follows:\n* Restated for the three for two forward stock split effected February 15, 1996.\nThe Company reported to the Internal Revenue Service that 100% of the dividends paid in 1995 represented a return of capital.\nOn December 5, 1989, the Company's Board of Directors approved a program for the Company to repurchase its shares of Common Stock. The Company's Board of Directors has authorized the Company to repurchase a total of 687,000 shares of its Common Stock pursuant to such program. As of March 15, 1996, the Company had repurchased 350,588 shares pursuant to such program at a cost to the Company of $1.7 million. None of such shares were repurchased in 1995 or 1996, through March 15, 1996.\nOn March 24, 1989, the Company distributed one share purchase right for each outstanding share of Common Stock. The rights were terminated effective March 24, 1992 upon the Company's Board of Directors having determined that the rights were no longer necessary to protect the Company from coercive tender offers. In connection with this determination, Messrs. Phillips and Friedman and their affiliates agreed not to acquire more than 49% of the outstanding shares of the Company's Common Stock without prior action by the Company's Independent Directors to the effect that they do not object to such increased ownership.\nIn August 1994, the Company's Board of Directors reviewed the limitation and determined that, due to the fact that Mr. Friedman is no longer affiliated with the stockholder group, and had disposed of any shares of the Company's Common Stock which he or his affiliates may have owned, the limitation should no longer apply to Mr. Friedman or his affiliates. On August 23, 1994, the Company's Board of Directors adopted a resolution to the effect that in determining total ownership, shares of the Company's Common Stock owned by Mr. Friedman and his affiliates are no longer to be included. As of March 15, 1996, Mr. Phillips and his affiliates, primarily ART, owned approximately 38% of the Company's outstanding shares of Common Stock.\nOn March 21, 1996, the Company's Board of Directors reconsidered its share ownership limitation and determined that there was no reason to object to the purchase by Mr. Phillips and his affiliates of additional shares in excess of 49% of the Company's outstanding shares of Common Stock. Accordingly, there is no longer any limitation on the percentage of shares of Common Stock of the Company which may be acquired by Mr. Phillips and his affiliates.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nShares and per share data have been restated for the three for two forward stock split effected February 15, 1996.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nIntroduction\nTranscontinental Realty Investors, Inc. (the \"Company\") invests in real estate through acquisitions, leases and partnerships and in mortgage loans on real estate, including first, wraparound and junior mortgage loans. The Company is the successor to a California business trust organized on September 6, 1983 which commenced operations on January 31, 1984.\nLiquidity and Capital Resources\nCash and cash equivalents at December 31, 1995 aggregated $9.6 million compared with $563,000 at December 31, 1994. The principal reasons for this increase in cash are discussed in the paragraphs below.\nThe Company's principal sources of cash have been and will continue to be from property operations, proceeds from property and mortgage note sales, the collection of mortgage notes receivable, borrowings and to a lesser extent, distributions from partnerships. The Company expects that its cash balance at December 31, 1995, and cash that will be generated in 1996 from the collection of mortgage notes receivable, sales of properties, borrowings against certain of the Company's unencumbered properties and refinancing or extension of certain of its mortgage debt will be sufficient to meet all of the Company's cash requirements, including debt service obligations coming due in 1996, dividend payments and property maintenance and improvements, as more fully discussed in the paragraphs below.\nThe Company's cash flow from property operations (rents collected less payments for property operating expenses) has increased over the past three years from $8.7 million in 1993 and 1994 to $15.3 million in 1995. Of this $6.6 million net increase from 1993 to 1995, $3.9 million is the result of the Company having acquired additional income producing properties, both through purchase and foreclosure, and the remainder of the $2.8 million increase is due to increased occupancy and rents, primarily at its apartments, and the Company's control of operating expenses. The Company's management believes that this trend will continue, as a result of increased rents at the Company's apartments and increased occupancy of its commercial properties.\nThe Company owns a combined 63.7% limited and general partner interest in Tri-City Limited Partnership which owns five properties in Texas. In 1995, the Company received distributions of $382,000 from the partnership's operating cash flow, and $853,000 from its financing cash flow. See NOTE 5. \"INVESTMENTS IN EQUITY METHOD REAL ESTATE ENTITIES.\"\nIn June 1995, the Company received a $500,000 settlement from one of the defendants in a lawsuit brought by the Company against the former owners of the RCA Building and their agents. The Company made a loan secured by the building in 1987 and filed a foreclosure action which was subsequently amended in 1990, to include claims of negligent misrepresentation against the borrowers, their legal counsel, architect and engineers.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nLiquidity and Capital Resources (Continued)\nIn 1995, the Company received cash of $2.9 million from the payoff or collection of mortgage notes receivable. The Company also received a total of $25.4 million from new mortgage financings and refinancings during 1995. In 1995, the Company expended $1.1 million in cash on real estate acquisitions and made a total of $18.5 million in principal payoffs or paydowns on its mortgage debt.\nScheduled principal payments on notes payable of $26.0 million are due in 1996. It is the Company's intention to either pay the mortgages that mature in 1996 when due, or seek to extend the due dates one or more years, or refinance the debt on a long-term basis. The Company's management believes it will continue to be successful in obtaining loan extensions or refinancings.\nAs discussed in NOTE 3. \"REAL ESTATE AND DEPRECIATION,\" during 1995 the Company funded $3.2 million for operating cash deficits, including tenant improvements of $2.0 million, of the Republic Towers Office Building in Dallas, Texas due to minimal occupancy and operating expenses far exceeding rents. The Company expects to fund a lesser amount for this property in 1996.\nPursuant to a repurchase program originally announced by the Company on December 5, 1989, the Company's Board of Directors has authorized the repurchase of a total of 687,000 shares of the Company's Common Stock. As of March 15, 1996, the Company had purchased 350,588 shares of its common stock at a total cost to the Company of $1.7 million. None of such shares were repurchased in 1995 or 1996, through March 15, 1996.\nDuring 1995, the Company resumed the payment of regular quarterly dividends. The Company declared and paid dividends of $267,000 or $.07 per share in 1995.\nOn a quarterly basis, the Company's management reviews the carrying value of the Company's mortgage notes receivable, properties held for investment and properties held for sale. Generally accepted accounting principles require that the carrying value of an investment cannot exceed the lower of its cost or its estimated net realizable value. In those instances in which estimates of net realizable value of the Company's properties or notes are less than the carrying value thereof at the time of evaluation, a provision for loss is recorded by a charge against operations. Estimated net realizable value of mortgage notes receivable is based on the Company's management's review and evaluation of the collateral properties securing such notes. The property review generally includes selective property inspections, a review of the property's current rents compared to market rents, a review of the property's expenses, a review of the maintenance requirements, discussions with the manager of the property and a review of the surrounding area.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nResults of Operations\n1995 compared to 1994. The Company's net loss for 1995 was $3.7 million compared to a net loss of $3.4 million in 1994. The Company's 1995 net loss includes extraordinary gains of $1.4 million and a gain on sale of real estate of $5.8 million and its 1994 net income includes a gain on sale of partnership interests of $2.5 million, a gain on sale of real estate of $2.2 million and an extraordinary gain of $1.2 million. Fluctuations in the components of the Company's revenues and expenses between the 1994 and 1995 are described below.\nRents increased $10.3 million in 1995 compared to 1994. Of this increase in rents, $4.5 million is due to the acquisition of the remaining partnership interest in three partnerships in 1995; $5.1 million is due to property acquisitions in late 1994; and $1.6 million is due to increases in occupancy at several of the Company's commercial properties: Chesapeake Ridge Office Building, a 24% increase; Forum Office Building, a 10% increase; President's Square Shopping Center, a 19% increase; and 74 New Montgomery Office Building, a 41% increase. These increases are partially offset by a decrease of $1.1 million in rents due to properties sold.\nProperty operating expenses increased $3.3 million in 1995 as compared to 1994. Of this increase, $2.1 million is due to the acquisition of the remaining partnership interest in three partnerships in 1995 and $3.8 million is due to property acquisitions in late 1994. These increases are partially offset by a decrease of $1.6 million due to decreases in replacements, utilities and administrative expenses, primarily at Republic Towers Office Building as well as a decrease of $800,000 due to the buyout of a tenant lease in 1994, and a decrease of $524,000 due to property sales.\nRents and property operations expenses both are expected to increase in 1996 due to anticipated increases in rents at the Company's apartments and increased occupancy of its commercial properties.\nInterest income for 1995 of $1.5 million was comparable to the $1.5 million in 1994.\nEquity in losses of investees was $1.1 million in 1995 compared to $90,000 in 1994. The increased equity loss is primarily due to the modification of a wraparound mortgage note receivable and underlying note payable by Nakash Income Associates (\"NIA\"), a partnership in which the Company has a 60% general partner interest, and the writedown of a wraparound mortgage note receivable to the balance of an underlying first lien mortgage also by NIA. The Company's equity share of the loss on the note modification was $127,000 and its equity share of the note writedown was $901,000. See NOTE 5. \"INVESTMENTS IN EQUITY METHOD REAL ESTATE ENTITIES.\" The Company expects its equity investees to be profitable in 1996.\nInterest expense increased to $16.1 million in 1995 as compared to $10.6 million in 1994. Of this increase, $1.8 million is attributable to the\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nResults of Operations (Continued)\nthe acquisition of the remaining partnership interests in three partnerships during 1995, $1.9 milion is attributable to properties acquired in late 1994 $1.8 million is attributable to property financings and refinancings during 1995, and $459,000 is attributable to increases in the interest rates on variable rate mortgage debt. These increases are partially offset by a decrease of $431,000 due to properties sold. Interest expense is expected to increase in 1996 due to anticipated property acquisitions and refinancings.\nDepreciation expense increased to $8.6 million in 1995 as compared to $6.1 million in 1994. An increase of $638,000 is attributable to the acquisition of the remaining partnership interests in three partnerships during 1995, an increase of $787,000 is attributable to properties acquired in late 1994 and an increase of $1.3 million is due to increased depreciation from property additions and tenant improvements. These increases are partially offset by a decrease of $230,000 due to properties sold and $84,000 due to assets becoming fully depreciated. Depreciation expense is expected to increase in 1996 due to anticipated property acquisitions.\nThe advisory fee increased to $1.8 million in 1995 as compared to $1.7 million in 1994. The increase is due to the increase in the Company's gross assets, the basis for such fee. Such fee is expected to increase as the Company's asset base increases.\nGeneral and administrative expenses increased to $2.0 million in 1995 from $1.8 million in 1994. The increase is due to an increase in advisory cost reimbursements.\nAs described in \"Liquidity and Capital Resources\" above, in 1995 the Company received a litigation settlement of $500,000. Also in 1995, the Company recognized a gain of $1.6 million on the collection of the note receivable secured by the Maumelle land and a gain of $4.1 million on the sale of the Summerchase Apartments. See NOTE 2. \"NOTES AND INTEREST RECEIVABLE\" and NOTE 3. \"REAL ESTATE AND DEPRECIATION.\"\nThe Company recognized extraordinary gains totaling $1.4 million in 1995, on the payoff of the mortgage debt secured by the Fountain Village Apartments and a principal pay down and modification of the mortgage debt secured by the Dunes Plaza Shopping Center. See NOTE 6. \"NOTES PAYABLE.\" In 1994, the Company recognized a gain of $2.5 million on the sale of its interests in two partnerships and a gain of $2.2 million on the sale of Cedar Creek Apartments, and an extraordinary gain of $1.2 million on the disposition of a limited partnership interest.\n1994 compared to 1993. The Company's net loss for 1994 was $3.4 million as compared to a net loss of $8.6 million in 1993. The Company's 1994 net loss includes a gain on the sale of partnership interests of $2.5 million, gain on sale of real estate of $2.2 million and an extraordinary gain of $1.2 million. Included in the Company's 1993 net loss is a gain on sale of real estate of $24,000 and an extraordinary gain of $1.6 million. The primary factors contributing to the Company's net loss are discussed in the following paragraphs.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nResults of Operations (Continued)\nNet rental income (rents less property operating expenses) was $9.6 million in 1994 compared to $6.7 million in 1993. Rents increased by $6.1 million in 1994 as compared to 1993. Of this increase, $4.4 million is due to property acquisitions in late 1993 and in 1994 and $1.3 million is due to increases in occupancy at several of the Company's commercial properties: Plaza Towers Office Building, a 16% increase; 74 New Montgomery Office Building, a 26% increase; and Waterstreet Office Building, a 8% increase. Property operating expenses increased $3.3 million in 1994 as compared to 1993. Of this increase, $2.0 million is due to property acquisitions in late 1993 and in 1994, $623,000 is due to increased replacements, primarily at Venture Center Office Building, and 74 New Montgomery Office Building and $800,000 is attributable to a lease buyout at one of the Company's shopping centers.\nInterest income decreased to $1.5 million in 1994 compared to $1.9 million in 1993. The decrease is attributable to the payoff or modification of notes receivable during 1994 and 1993.\nEquity in results of operations of investees was a loss of $90,000 in 1994 compared to a loss of $262,000 in 1993. A reduction in equity loss of $444,000 is attributable to the Company ceasing to record equity losses on the One Penn Square Associates Limited Partnership (\"One Penn Square\"). The Company's interest in the partnership was conveyed to the lender on the partnership's office building to settle litigation. See NOTE 5. \"INVESTMENT IN EQUITY METHOD REAL ESTATE ENTITIES.\" This reduction in loss is partially offset by an increase of $251,000 attributable to lower net income of Income Opportunity Realty Investors, Inc., a real estate investment trust in which the Company had an approximate 22% interest in 1994.\nInterest expense increased to $10.6 million in 1994 compared to $8.7 million in 1993. An increase of $2.2 million is attributable to properties acquired or properties upon which debt financing or debt refinancing was obtained during 1993 and 1994. An increase of $232,000 is attributable to increased interest rates on variable rate loans. These increases are partially offset by a decrease of $318,000 attributable to loans paid off and properties sold during 1993 and 1994.\nDepreciation expense increased to $6.1 million in 1994 as compared to $5.4 million in 1993. This increase is attributable to properties acquired by the Company in late 1993 and 1994.\nThe Company recorded no provision for losses in 1994 compared to $873,000 in 1993. The 1993 provision for losses includes $731,000 to reduce the carrying value of a property held for sale to its then estimated fair value and $142,000 to record the transfer of a note pool to a third party.\nThe advisory fee increased to $1.7 million in 1994 as compared to $1.5 million in 1993, such increase is attributable to an increase in the Company's gross assets, the basis for such fee.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nResults of Operations (Continued)\nGeneral and administrative expenses of $1.8 million in 1994 decreased from $2.0 million in 1993. The decrease is primarily related to a decrease in fees related to the Olive Litigation which was settled in 1994. See NOTE 15. \"COMMITMENTS AND CONTINGENCIES - Olive Litigation.\"\nIn 1994, the Company realized a gain of $2.2 million on the sale of the Cedar Creek Apartments and a gain of $2.5 million on the sale of its interest in two partnerships. In 1993, the Company realized a gain of $24,000 on the sale of its interest in a property which the Company was to have received in a litigation settlement.\nIn 1994, the Company recognized an extraordinary gain of $1.2 million on the conveyance of its limited partner interest in One Penn Square to the lender on the partnership's office building to settle litigation. In 1993, the Company recognized extraordinary gains of $1.1 million as a result of the forgiveness of debt related to the modification of a mortgage and $500,000 as a result of the early payoff of the mortgage secured by the Plaza Towers Office Building in St. Petersburg, Florida.\nEnvironmental Matters\nUnder various federal, state and local environmental laws, ordinances and regulations, the Company may be potentially liable for removal or remediation costs, as well as certain other potential costs relating to hazardous or toxic substances (including governmental fines and injuries to persons and property) where property-level managers have arranged for the removal, disposal or treatment of hazardous or toxic substances. In addition, certain environmental laws impose liability for release of asbestos-containing materials into the air, and third parties may seek recovery from the Company for personal injury associated with such materials.\nThe Company's management is not aware of any environmental liability relating to the above matters that would have a material adverse effect on the Company's business, assets or results of operations.\nInflation\nThe effects of inflation on the Company's operations are not quantifiable. Revenues from property operations fluctuate proportionately with inflationary increases and decreases in housing costs. Fluctuations in the rate of inflation also affect sale values of properties, and correspondingly, the ultimate realizable value of the Company's real estate and notes receivable portfolios. Inflation also has an effect on the Company's earnings from short-term investments.\nTax Matters\nFor the years 1995, 1994 and 1993, the Company elected and in the opinion of the Company's management, qualified to be taxed as a Real Estate Investment Trust (\"REIT\") as defined under Sections 856 through\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nTax Matters (Continued)\n860 of the Internal Revenue Code of 1986, as amended (the \"Code\"). To continue to qualify for federal taxation as a REIT under the Code, the Company is required to hold at least 75% of the value of its total assets in real estate assets, government securities, cash and cash equivalents at the close of each quarter of each taxable year. The Code also requires a REIT to distribute at least 95% of its REIT taxable income, plus 95% of its net income from foreclosure property, all as defined in Section 857 of the Code, on an annual basis to stockholders.\nRecent Accounting Pronouncements\nIn March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (\"SFAS\") No. 121 - \"Accounting for the Impairment of Long-lived Assets and for Long-lived Assets to Be Disposed Of\". The statement requires that long-lived assets be considered impaired \"...if the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of the asset.\" If impairment exists, an impairment loss shall be recognized, by a charge against earnings, equal to \"...the amount by which the carrying amount of the asset exceeds the fair value of the asset.\" If impairment of a long-lived asset is recognized, the carrying amount of the asset shall be reduced by the amount of the impairment, shall be accounted for as the asset's \"new cost\" and such new cost shall be depreciated over the asset's remaining useful life.\nSFAS No. 121 further requires that long-lived assets held for sale \"...be reported at the lower of carrying amount or fair value less cost to sell.\" If a reduction in a held for sale asset's carrying amount to fair value less cost to sell is required, a provision for loss shall be recognized by a charge against earnings. Subsequent revisions, either upward or downward, to a held for sale asset's fair value less cost to sell shall be recorded as an adjustment to the asset's carrying amount, but not in excess of the asset's carrying amount when originally classified or held for sale. A corresponding charge or credit to earnings is to be recognized. Long-lived assets held for sale are not to be depreciated. SFAS No. 121 is effective for fiscal years beginning after December 15, 1995.\nThe Company's management estimates that if the Company had adopted SFAS No. 121 effective January 1, 1995, the Company would have recorded no depreciation in 1995 applicable to Park Forest Apartments, which is the Company's only income producing property held for sale, the Company's net loss would have decreased by $105,000 and that a provision for loss for either impairment of its properties held for investment or for a decline in estimated fair value less cost to sell of its properties held for sale would not have been required. The Company adopted SFAS No. 121 effective January 1, 1996.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS\nAll other schedules are omitted because they are not required, are not applicable or the information required is included in the Consolidated Financial Statements or the notes thereto.\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nBoard of Directors of Transcontinental Realty Investors, Inc.\nWe have audited the accompanying consolidated balance sheets of Transcontinental Realty Investors, Inc. and Subsidiaries as of December 31, 1995 and 1994 and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1995. We have also audited the schedules listed in the accompanying index. These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and schedules are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements and schedules. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements and schedules. We believe our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Transcontinental Realty Investors, Inc. and Subsidiaries as of December 31, 1995 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, 1995, in conformity with generally accepted accounting principles.\nAlso, in our opinion, the schedules referred to above present fairly, in all material respects, the information set forth therein\nBDO SEIDMAN, LLP\nDallas, Texas March 20, 1996\nTRANSCONTINENTAL REALTY INVESTORS, INC. CONSOLIDATED BALANCE SHEETS\nThe accompanying notes are an integral part of these Consolidated Financial Statements.\nTRANSCONTINENTAL REALTY INVESTORS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS\nThe accompanying notes are an integral part of these Consolidated Financial Statements.\nTRANSCONTINENTAL REALTY INVESTORS, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY\nThe accompanying notes are an integral part of these Consolidated Financial Statements.\nTRANSCONTINENTAL REALTY INVESTORS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS\nThe accompanying notes are an integral part of these Consolidated Financial Statements.\nTRANSCONTINENTAL REALTY INVESTORS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)\nThe accompanying notes are an integral part of these Consolidated Financial Statements.\nTRANSCONTINENTAL REALTY INVESTORS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)\nThe accompanying notes are an integral part of these Consolidated Financial Statements.\nTRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nThe accompanying Consolidated Financial Statements of Transcontinental Realty Investors, Inc. and consolidated entities (the \"Company\") have been prepared in conformity with generally accepted accounting principles, the most significant of which are described in NOTE 1. \"SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES.\" These, along with the remainder of the Notes to Consolidated Financial Statements, are an integral part of the Consolidated Financial Statements. The data presented in the Notes to Consolidated Financial Statements are as of December 31 of each year and for the year then ended, unless otherwise indicated. Dollar amounts in tables are in thousands, except per share amounts.\nCertain balances for 1994 and 1993 have been reclassified to conform to the 1995 presentation. Shares and per share data have been restated for the three for two forward stock split effected February 15, 1996.\nNOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nOrganization and Company business. Transcontinental Realty Investors, Inc. (\"TCI\"), a Nevada corporation, is successor to a California business trust, Transcontinental Realty Investors, which was organized on September 6, 1983. The Company invests in real estate through direct equity ownership and investments in real estate entities. It also has invested in mortgage loans on real estate, including first, wraparound and junior mortgage loans.\nBasis of consolidation. The Consolidated Financial Statements include the accounts of TCI and subsidiaries and partnerships which it controls. All intercompany transactions and balances have been eliminated. Minority interests (which are not significant) are included in other liabilities.\nAccounting estimates. In the preparation of the Company's Consolidated Financial Statements in conformity with generally accepted accounting principles it was necessary for the Company's 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 Consolidated Financial Statements and the reported amounts of revenues and expense for the year then ended. Actual results could differ from these estimates.\nInterest recognition on notes receivable. It is the Company's policy to cease recognizing interest income on notes receivable that have been delinquent for 60 days or more. In addition, accrued but unpaid interest income is only recognized to the extent that the net realizable value of the underlying collateral exceeds the carrying value of the receivable.\nAllowance for estimated losses. Valuation allowances are provided for estimated losses on notes receivable and properties held for sale to the extent that the investment in the notes or properties exceeds the\nTRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)\nCompany's estimate of net realizable value of the property or collateral securing each such note, or fair value of the collateral if foreclosure is probable. In estimating net realizable value, consideration is given to the current estimated collateral or property value adjusted for costs to complete or improve, hold and dispose. The provision for losses is based on estimates, and actual losses may vary from current estimates. Such estimates are reviewed periodically and any additional provision determined to be necessary is charged against earnings in the period in which it becomes reasonably estimable.\nForeclosed real estate held for sale. Foreclosed real estate is initially recorded at new cost, defined as the lower of original cost or fair value minus estimated costs of sale. If a reduction in a held for sale asset's carrying amount to fair value less cost to sell is required, a provision for loss is recognized by a charge against earnings. After foreclosure, the excess of new cost, if any, over fair value minus estimated costs of sale is recognized in a valuation allowance. Subsequent revisions in fair value less cost to sell either increase or decrease such valuation allowance, but not in excess of the assets carrying amount when originally classified as held for sale. See \"Allowance for estimated losses,\" above. Properties held for sale are depreciated in accordance with the Company's established depreciation policies. See \"Real Estate and Depreciation,\" below.\nAnnually, all foreclosed properties held for sale are reviewed by the Company's management and a determination is made if the held for sale classification remains appropriate. The following are among the factors considered in determining that a change in classification to held for investment is appropriate: (i) Company management has no intent to dispose of the property within the next twelve months; (ii) the property is a \"qualifying asset\" as defined in the Internal Revenue Code of 1986, as amended; (iii) property improvements have been funded; and (iv) the Company's financial resources are such that the property can be held long-term. The subsequent classification of property previously held for sale to held for investment does not result in a restatement of previously reported revenues, expenses or net (loss).\nReal estate and depreciation. Real estate is carried at the lower of cost or estimated net realizable value, except for foreclosed properties held for sale, which are recorded initially at the lower of original cost or fair value minus costs of sale. Depreciation is provided for by the straight-line method over the estimated useful lives of the assets, which range from 2 to 40 years. Real estate held for sale is not depreciated.\nPresent value discounts. The Company provides for present value discounts on notes receivable or payable that have interest rates that differ substantially from prevailing market rates and amortizes such\nTRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)\ndiscounts by the interest method over the lives of the related notes. The factors considered in determining a market rate for notes receivable include the borrower's credit standing, nature of the collateral and payment terms of the note.\nRevenue recognition on the sale of real estate. Sales of real estate are recognized when and to the extent permitted by Statement of Financial Accounting Standards No. 66, \"Accounting for Sales of Real Estate\" (\"SFAS No. 66\"). Until the requirements SFAS No. 66 for full profit recognition have been met, transactions are accounted for using either the deposit, the installment, the cost recovery or the financing method, whichever is appropriate.\nInvestment in noncontrolled partnerships and equity investees. The Company uses the equity method to account for investments in partnerships which it does not control and for its investment in the shares of common stock of Income Opportunity Realty Investors, Inc., formerly Income Opportunity Realty Trust (collectively \"IORI\"). Under the equity method, the Company's initial investment, recorded at cost, is increased by the Company's proportionate share of the investee's operating income and additional advances and decreased by the Company's proportionate share of the investee's operating losses and distributions received.\nFair value of financial instruments. The Company used the following assumptions in estimating the fair value of its notes receivable, marketable equity securities and notes payable. For performing notes receivable, the fair value was estimated by discounting future cash flows using current interest rates for similar loans. For nonperforming notes receivable, the estimated fair value of the Company's interest in the collateral property was used. For marketable equity securities, fair value was based on the year end closing market price of the security. The estimated fair value presented does not purport to present the amounts to be ultimately realized by the Company. The amounts ultimately realized may vary significantly from the estimated fair value presented. For notes payable, the fair value was estimated using current rates for mortgages with similar terms and maturities.\nCash equivalents. For purposes of the Consolidated Statements of Cash Flows, the Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.\nEarnings per share. Loss per share is computed based upon the weighted average number of shares of Common Stock outstanding during each year adjusted for the three for two forward stock split effected February 15, 1996.\nTRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 2. NOTES AND INTEREST RECEIVABLE\nNotes and interest receivable consisted of the following:\nThe Company does not recognize interest income on nonperforming notes receivable. For the years 1995, 1994 and 1993, unrecognized interest income on nonperforming notes receivable aggregated $231,000, $256,000 and $423,000, respectively.\nNotes receivable at December 31, 1995, mature from 1996 through 2016 with interest rates ranging from 3.9% to 12.5%, with a weighted average rate of 11.36%. Discounts are based on imputed interest rates of 10.0%. Notes receivable are generally nonrecourse and are generally collateralized by real estate. Scheduled principal maturities of $1.2 million are due in 1996.\nIn February 1993, the Company purchased two first lien mortgage notes secured by notes and 1,900 acres of land in improved residential and commercial subdivisions in Maumelle, Arkansas for $2.6 million in cash. The notes, with a principal balance of $7.8 million, were in default at the date of purchase. In May 1993, the Company completed foreclosure proceedings. In July 1993, the Company transferred the notes acquired through the foreclosure proceedings to a third party, in exchange for the assumption of debt secured by the notes. The Company recognized a loss of $421,000 on the transfer, $279,000 of which had previously been provided.\nIn February 1994, the Company provided $6.7 million of purchase money financing in conjunction with the sale of 1,406 acres of the land in sixteen developed residential and commercial subdivisions secured by a first lien on the properties sold. The note receivable bore interest at 8.0% per annum, required annual payments of principal of $850,000 plus accrued interest and matured in February 1998. The note was guaranteed by companies affiliated with the borrower. The borrower did not make the scheduled February 1995 principal and interest payments. In September 1995, the Company reached a settlement with the borrower that provided the following: (i) the payment by the borrower of $2.5 million\nTRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 2. NOTES AND INTEREST RECEIVABLE (Continued)\nin cash; (ii) the Company's release of all land securing the note; (iii) the Company's acceptance of a new $1.4 million note secured by 36.3 acres of commercial land, such note bore interest at 9.0% and matured in January 1996 and (iv) the Company's receipt of 700,000 shares of the borrower's capital stock, which the borrower has the option to repurchase at $5.00 per share for two years from closing. The original sale had been recorded under the cost recovery method with gain being deferred until the note was collected. With the Company's receipt of $2.5 million on September 12, 1995, it recognized $1.6 million of the gain previously deferred. The $1.4 million note was not paid at maturity. The Company has commenced negotiations with the borrower in an effort to correct the default and has also begun foreclosure proceedings. The Company does not expect to incur a loss on the note as the fair value of the property exceeds the carrying value of the note.\nIn January 1995, the Company received $11,000 in settlement of a note receivable with a principal balance of $20,000. In April, May and October 1995, four mortgage notes receivable, secured by developed residential lots in Greensboro, North Carolina, in the total amount of $43,000 were paid in full.\nIn June 1995, the Company obtained the Gladstell Forest Apartments, a 136 unit apartment complex in Conroe, Texas through foreclosure of a note receivable which the Company had received in December 1991 in satisfaction of a debtor's guarantee of another obligation to the Company. The Company had assigned no value to the note receivable. In conjunction with the foreclosure, the Company refinanced the property's $2.7 million mortgage for a like amount with the Company receiving no net refinancing proceeds.\nIn June 1994, a mortgage note receivable with a principal balance of $2.7 million and secured by the Lincoln Court Apartments, a 53 unit apartment complex in Dallas, Texas, was paid down and modified. The apartment complex is owned by Jor-Trans Investors Limited Partnership (\"Jor-Trans\"), in which the Company has a combined 55% general and limited partner interest. The Company accounts for its investment in Jor-Trans using the equity method. The Company received $1.3 million in cash and the remaining note balance of $1.4 million was split into two new notes and subordinated to a new first mortgage secured by the property.\nAlso in June 1994, the Company sold the RCA Building, a vacant 100,800 square foot office building in Mt. Laurel, New Jersey, for $100,000. The Company provided purchase money financing for the entire sales price. The note was paid in full at its April 1995 maturity.\nIn July, August and October 1994, the Company received $120,000, $105,000 and $74,000, respectively, from the payoff of three notes receivable at their respective maturities.\nTRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 2. NOTES AND INTEREST RECEIVABLE (Continued)\nIn September 1994, the Company received $30,000 in settlement of a note receivable with a principal balance of $72,000. The Company recorded no loss on the settlement in excess of the reserve previously established.\nIn 1992, the Company purchased, from a financial institution, two mortgage notes secured by first liens on an office building and a parcel of undeveloped land and a mortgage note secured by a second lien on three commercial properties for $680,000 in net cash. At December 31, 1993, the notes were in default. In January 1994, the Company instituted foreclosure proceedings on the first mortgage note secured by the office building. In June 1994, the Company wrote off the note receivable secured by the office building as uncollectible. In October 1995, the Company recovered $101,000 from the local taxing authority that had foreclosed on the office building. At December 31, 1995, the remaining two notes with a carrying value of $152,000 were in default and fully reserved.\nIn June 1991 and December 1991, in an effort to develop a potential future financing source, the Company entered into an asset sales agreement whereby the Company sold a participation in one of its mortgage notes in the amount of $1.3 million in exchange for the assignment of a first mortgage note of $1.1 million and a $181,000 participation in another first mortgage note (the \"loan participation\") from an insurance company. In conjunction with these transactions, the Company entered into a put and guaranty agreement.\nBoth the mortgage loan and the loan participation received by the Company were in default at December 31, 1991. In April 1992, the property securing the first mortgage note in the amount of $1.1 million was deeded to the Company in lieu of foreclosure. In the first quarter of 1992, the Company recorded a provision for losses of $366,000 to reduce the carrying value of the mortgage note to the estimated fair value of the collateral property. In September 1993, the Company sold the collateral property for $850,000, receiving $125,000 in cash and providing purchase money financing of $725,000. The Company recognized no loss on the sale beyond the amount previously provided. In the third quarter of 1992, the Company recorded a provision for losses of $184,000 to fully reserve for the carrying value of the loan participation.\nIn March 1992, the insurance company was placed in receivership. In June 1992, the Company provided notice to the insurance company under the terms of the put and guaranty agreement, of its desire to divest itself of all assets received. The Receiver refused to allow the enforcement of the terms of the put and guaranty agreement.\nA settlement between the Company and the Receiver was approved by the court on February 15, 1995. Under the terms of the settlement, the Company paid the insurance company a total of $1.1 million in July 1995. In exchange, the Company retained the assets transferred to it by the\nTRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 2. NOTES AND INTEREST RECEIVABLE (Continued)\ninsurance company as well as received back from the insurance company the loan participation that the insurance company had received from the Company. The Company incurred no loss on the settlement.\nNOTE 3. REAL ESTATE AND DEPRECIATION\nIn December 1995, the Company's management made its annual review of the Company's real estate portfolio and reclassified the Majestic Inn, a hotel in San Francisco, California from properties held for sale to properties held for investment. The Company also reclassified the Park Forest Apartments, 44 unit apartment complex in Dearborn Heights, Michigan, from properties held for investment to properties held for sale, the Company having entered into a contract to sell the property. See NOTE 17. \"SUBSEQUENT EVENTS.\"\nIn February 1995, the Company purchased a 48.18% interest in 8,153 square feet of land in proximity to the Republic Towers Office Building (\"Republic Towers\") in Dallas, Texas for $166,000 in cash. In December 1995, the Company purchased a 43,560 square foot parking lot also in proximity to Republic Towers for $1.1 million in cash.\nAs discussed in NOTE 2. \"NOTES AND INTEREST RECEIVABLE,\" in June 1995, the Company obtained the Gladstell Forest Apartments through foreclosure.\nIn November 1995, the Company sold the Summerchase Apartments, a 240 unit apartment complex in Norcross, Georgia for $12.1 million, receiving net cash of $3.1 million after the payment of the first mortgage of $8.7 million and a prepayment penalty of $390,000. The Company recognized a gain on the sale of $4.1 million.\nIn December 1995, the Company sold the Heritage Shopping Center, a 16,446 square foot shopping center in Tulsa, Oklahoma for $418,000 in cash. The Company recognized a gain on the sale of $76,000.\nDuring 1994, the Company purchased six commercial properties at a total cost of $34.2 million and one apartment complex for $5.6 million. In connection with the acquisitions, the Company either assumed existing mortgage debt or obtained new mortgage debt totaling $31.0 million with the remainder of the purchase prices having been paid in cash. Also during 1994, the Company sold one apartment complex for $10.1 million, one office building for $100,000 and two parcels of land, one parcel containing 1,406 acres of commercial and residential land and the other parcel consisting of 44 residential lots for a total of $8.4 million. The Company received net cash of $4.3 million from the sales after the payoff of $7.7 million in mortgage debt. In conjunction with such sales the Company provided $6.8 million of purchase money financing and recognized a gain of $2.2 million.\nTRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 4. ALLOWANCE FOR ESTIMATED LOSSES\nActivity in the allowance for estimated losses was as follows:\nThe provision for losses in the accompanying Consolidated Statement of Operations includes $142,000, in 1993, for the writeoff of notes receivable transferred to a third party in exchange for assumption of debt.\nNOTE 5. INVESTMENT IN EQUITY METHOD REAL ESTATE ENTITIES\nThe Company's investment in equity method real estate entities consists of the following:\nThe Company owns an approximate 22% interest in IORI, a publicly held Real Estate Investment Trust (\"REIT\") with a market value of $3.4 million at December 31, 1995. IORI owns five apartments (three in Texas and one each in California and Wisconsin) and two office buildings (one in California and the other in Florida).\nThe Company owns a combined 63.7% general and limited partner interest in Tri-City which owns five properties in Texas. The Tri-City partnership agreement requires the consent of both the Company and IORI (a 36.3% general partner) for any material changes in the operations of Tri-City's properties, including sales, refinancings and changes in property management. The Company, as a noncontrolling partner, accounts for its investment in Tri-City using the equity method.\nIn July 1995, Tri-City obtained first mortgage financing of $1.4 million secured by a previously unencumbered office building in Dallas, Texas. The Company received $853,000 of the net financing proceeds.\nThe Company owns 60% general partner interest and IORI owns a 40% general partner interest in NIA. The NIA partnership agreement requires the consent of both the Company and IORI for any material changes in the operations of NIA. The Company, as a noncontrolling partner, accounts\nTRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 5. INVESTMENT IN EQUITY METHOD REAL ESTATE ENTITIES (Continued)\nfor its investment in NIA on the equity method. NIA owns two wraparound mortgage notes receivable, one of which is secured by a shopping center in Onandaga, New York. In July 1995, the owner of the shopping center informed NIA that it had determined that further investment in the shopping center was not justified, and further that it has offered to deed the property back to the first lienholder in lieu of foreclosure making the wraparound note receivable held by NIA uncollectible. The property has been placed in receivership and foreclosure is anticipated on or about March 29, 1996. NIA recorded a provision for loss of $1.5 million to write its wraparound note receivable down to the balance of the first lien mortgage. The Company's equity share of the loss is $901,000. In September 1995, the Company received notice from NIA that the other of its wraparound notes receivable had been modified in conjunction with the modification of the underlying note payable. NIA recorded a provision for loss of $212,000 on such modification of which the Company's share is $127,000.\nIn April 1995, the Company purchased the remaining general partner interest in Shadow Run Associates, which owns the Shadow Run Apartments, an apartment complex in Pinellas Park, Florida for $50,000 in cash. In January 1995, the partnership had refinanced the mortgage debt secured by the Shadow Run Apartments. The partnership used the refinancing proceeds and a $300,000 advance from the Company to pay the existing mortgage of $7.0 million, accrued but unpaid interest, financing fees and real estate taxes.\nEffective January 1, 1995, the other 50% general partners in both Twinbrook Village Associates, which owns Woods Edge Apartments in Rockville, Maryland, and Gate Laurel Associates, which owns the Westgate of Laurel Apartments in Laurel, Maryland, conveyed their interests in the partnerships to the Company in exchange for a release from their general partner liability.\nThe Company owned a 55% limited partner interest in a partnership which owned an office building in Philadelphia, Pennsylvania. An affiliate of the lender owned the remaining 45% limited partner interest. In May 1993, the lender filed a foreclosure action against the office building. The lender also filed an action against the partnership and the Company to set aside, as a fraudulent conveyance, payments from the partnership to the Company in 1992 and in 1993 of $1.8 million made to repay the Company's mortgage note secured by a second lien on the office building. The Company and the lender reached an agreement which provided that the Company pay $575,000 to the lender and convey the Company's interest in the partnership to the lender. In August 1994, the Company made the required $575,000 payment, conveyed its partnership interest to the lender and the parties executed mutual releases and all litigation between the parties was dismissed. The Company recognized an extraordinary gain of $1.2 million as the carrying value of its investment in the partnership was less than the debt secured by the office building due to previously recognized equity losses.\nTRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 5. INVESTMENT IN EQUITY METHOD REAL ESTATE ENTITIES (Continued)\nIn March 1994, the Company sold its 50% general partner interests in Pilgrim Village Associates and Pilgrim Village Associates II to the co-general partner for $2.6 million in cash. The partnerships owned the Pilgrim Village Apartments I and II, respectively, in Canton Township, Michigan. The Company recognized a gain of $2.5 million on the sale.\nSet forth below are summary financial data for the real estate entities accounted for using the equity method:\nThe Company's equity share of the above net losses for 1995, 1994 and 1993 was $1.1 million, $46,000 and $254,000, respectively, before amortization of property acquisition costs discussed below. The Company's share of the above equity investee capital was $10.5 million in 1995 and $13.0 million in 1994.\nThe excess of the Company's investment over its respective share of the equity in the underlying net assets of equity investees relates primarily to unamortized property acquisition costs of $119,000 in 1995 and $715,000 in 1994. These amounts are being amortized over the estimated useful lives of the properties.\nTRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 6. NOTES AND INTEREST PAYABLE\nNotes and interest payable consisted of the following:\nIn 1995, the Company obtained mortgage financing totaling $10.5 million secured by four previously unencumbered commercial properties. The Company received net cash of $8.7 million after the funding of various tax and insurance escrows and the payment of various closing costs associated with the financings. The mortgages bear interest at rates ranging from 9% to 9.8% per annum and mature from May 2000 to May 2005. Also in 1995, the Company refinanced the mortgage debt secured by two apartment complexes, in the total amount of $9.4 million. The Company received net refinancing proceeds of $3.9 million after the payoff of $6.6 million in existing mortgage debt and the funding of various tax and insurance escrows and the payment of various closing costs associated with the refinancings. The mortgages bear interest at rates of 7.9% and 8.0% per annum and mature in December 2005. The Company also modified and extended three mortgage loans, combining them into one loan with a principal balance of $4.6 million, bearing interest at 9.5% with the lender forgiving $144,000 of the mortgage principal balance.\nThe mortgage loan secured by the Northtown Mall in Dallas, Texas matured on December 31, 1995. The Company did not payoff the mortgage at maturity. The Company is in negotiations with the lender to extend the loan. The Company expects to be successful in such negotiations, but if it is not, the Company intends to payoff the loan.\nIn 1994, the Company obtained mortgage financing totaling $2.8 million secured by two previously unencumbered apartment complexes. The Company received net cash of $2.6 million after the funding of various tax and insurance escrows and the payment of various closing costs associated with the financings. The mortgages bear interest at variable rates and mature from December 2001 to October 2004. Also in 1994, the Company\nTRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 6. NOTES AND INTEREST PAYABLE (Continued)\nrefinanced the mortgage debt secured by two commercial properties and one apartment complex, in the total amount of $14.0 million. The Company received net refinancing proceeds of $4.0 million after the funding of various tax and insurance escrows and the payment of various closing costs associated with the refinancings. The mortgages bear interest at rates ranging from 9.25% to 12% per annum and mature from October 1995 to May 2001.\nThe Company owns Institute Place Lofts, a 142,215 square foot office building in Chicago, Illinois. The Company did not payoff the $6.3 million mortgage secured by the property on its June 1, 1993 maturity, as the Company determined further investment in the property could not be justified without a substantial modification of the mortgage. In July 1994, the property was placed in bankruptcy. In January 1995, the Bankruptcy Court approved a plan of reorganization which provided for a reduction in the mortgage's secured principal balance to $4.1 million, reduced the pay rate to 6% per annum in the first year, increasing to 10.25% per annum in the fourth year, with interest accruing at 10.25% per annum. In February and March 1995, the Company funded required escrows of $500,000 to satisfy outstanding property taxes and to cover projected negative cash flow of the property. The Company recorded no gain or loss as a result of the debt restructuring.\nAs discussed in NOTE 2. \"NOTES AND INTEREST RECEIVABLE\", in 1995, the Company acquired an apartment complex through foreclosure, concurrently refinancing the property's $2.7 million mortgage for a like amount. As discussed in NOTE 5. \"INVESTMENT IN EQUITY METHOD REAL ESTATE ENTITIES\", effective January 1, 1995, the other 50% general partners in two partnerships, each of which owns an apartment complex, conveyed their interests in the partnerships to the Company. The two properties were encumbered by $13.8 million in mortgage debt at the date of acquisition. Also as discussed in NOTE 5. \"INVESTMENTS IN EQUITY METHOD REAL ESTATE ENTITIES\", in April 1995, the Company purchased the remaining general partner interest in a partnership which owns an apartment complex encumbered by $7.2 million in mortgage debt.\nAs discussed in NOTE 3. \"REAL ESTATE AND DEPRECIATION\", in 1994 the Company purchased one apartment complex, one industrial facility, and four office buildings which were financed in part by $31.0 million of new or assumed mortgage debt.\nMortgage notes payable at December 31, 1995 bear interest at rates ranging from 6% to 13.2% per annum, and mature between 1996 and 2024. The mortgages are collateralized by deeds of trust on real estate with a net carrying value of $208.0 million.\nIn 1993, $72,000 of interest was capitalized. No interest was capitalized in 1994 or 1995.\nTRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 7. DIVIDENDS\nIn November 1995, based on the performance of the Company's properties, the Company's Board of Directors approved the Company's resumption of the payment of regular quarterly dividends.\nIn 1995, the Company declared and paid dividends of $.07 per share, or a total of $267,000. No dividends were declared or paid in 1994 and 1993.\nThe Company reported to the Internal Revenue Service that 100% of the dividends paid in 1995 represented a return of capital.\nNOTE 8. RENTS UNDER OPERATING LEASES\nThe Company's operations include the leasing of office buildings, industrial facilities and shopping centers. The leases thereon expire at various dates through 2008. The following is a schedule of minimum future rents on non- cancelable operating leases at December 31, 1995:\nNOTE 9. ADVISORY AGREEMENT\nBasic Capital Management, Inc. (\"BCM\" or the \"Advisor\") has served as advisor to the Company since March 28, 1989. BCM is a company owned by a trust for the benefit of the children of Gene E. Phillips. Mr. Phillips served as a Director of the Company until December 31, 1992, as a director of BCM until December 22, 1989 and as Chief Executive Officer of BCM until September 1, 1992. Mr. Phillips serves as a representative of his children's trust which owns BCM and, in such capacity, has substantial contact with the management of BCM and input with respect to its performance of advisory services to the Company.\nAt the Company's annual meeting of stockholders held on March 7, 1995, the Company's stockholders approved the renewal of the Company's Advisory Agreement with BCM through the next annual meeting of the Company's stockholders. Subsequent renewals of the Advisory Agreement with BCM, do not require the approval of the Company's stockholders but do require the approval of the Company's Board of Directors.\nUnder the Advisory Agreement, the Advisor is required to formulate and submit annually for approval by the Company's Board of Directors a budget and business plan for the Company containing a twelve-month forecast of operations and cash flow, a general plan for asset sales and\nTRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 9. ADVISORY AGREEMENT (Continued)\nacquisitions, lending, foreclosure and borrowing activity and other investments. The Advisor is required to report quarterly to the Company's Board of Directors on the Company's performance against the business plan. In addition, all transactions or investments by the Company shall require prior approval by the Company's Board of Directors unless they are explicitly provided for in the approved business plan or are made pursuant to authority expressly delegated to the Advisor by the Company's Board of Directors. The Advisory Agreement also requires prior approval of the Company's Board of Directors for the retention of all consultants and third party professionals, other than legal counsel.\nThe Advisory Agreement provides for BCM to be responsible for the day-to-day operations of the Company and to receive an advisory fee comprised of a gross asset fee of .0625% per month (.75% per annum) of the average of the gross asset value of the Company (total assets less allowance for amortization, depreciation or depletion and valuation reserves) and an annual net income fee equal to 7.5% per annum of the Company's net income.\nThe Advisory Agreement also provides for BCM to receive an annual incentive sales fee. BCM or an affiliate of BCM is to receive an acquisition commission for supervising the acquisition, purchase or long-term lease of real estate for the Company. BCM or an affiliate of BCM is to receive a mortgage or loan acquisition fee with respect to the acquisition or purchase of any existing mortgage loan by the Company. BCM or an affiliate of BCM is also to receive a mortgage brokerage and equity refinancing fee for obtaining loans to the Company or refinancing on Company properties and BCM is to receive reimbursement of certain expenses incurred by it, in the performance of advisory services to the Company.\nThe Advisory Agreement requires BCM or any affiliate of BCM to pay to the Company one-half of any compensation received from third parties with respect to the origination, placement or brokerage of any loan made by the Company.\nUnder the Advisory Agreement, all or a portion of the annual advisory fee must be refunded by the Advisor to the Company if the Operating Expenses of the Company (as defined in the Advisory Agreement) exceed certain limits specified in the Advisory Agreement. The effect of this limitation was to require that BCM refund $246,000 of the annual advisory fee for 1995. The operating expenses of the Company did not exceed such limitation in 1993 and 1994.\nAdditionally, if the Company were to request that BCM render services to the Company other than those required by the Advisory Agreement, BCM or an affiliate of BCM will be separately compensated for such additional services on terms to be agreed upon from time to time. As discussed in NOTE 10. \"PROPERTY MANAGEMENT,\" the Company has hired Carmel Realty\nTRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 9. ADVISORY AGREEMENT (Continued)\nServices, Ltd. (\"Carmel, Ltd.\"), an affiliate of BCM, to perform property management for the Company's properties and as discussed in NOTE 11. \"REAL ESTATE BROKERAGE,\" has engaged, on a non-exclusive basis, Carmel Realty, Inc. (\"Carmel Realty\"), also an affiliate of BCM, to provide brokerage services for the Company.\nNOTE 10. PROPERTY MANAGEMENT\nCarmel, Ltd. provides property management services to the Company for a fee of 5% or less of the monthly gross rents collected on the properties under its management. Carmel, Ltd. subcontracts with other entities for the property-level management services to the Company at various rates. The general partner of Carmel, Ltd. is BCM. The limited partners of Carmel, Ltd. are (i) Syntek West, Inc. (\"SWI\"), of which Mr. Phillips is the sole shareholder, (ii) Mr. Phillips and (iii) a trust for the benefit of the children of Mr. Phillips. Carmel, Ltd. subcontracts the property-level management and leasing of 24 of the Company's commercial properties and its hotel and the commercial properties owned by Tri-City in which the Company and IORI are partners to Carmel Realty, which is a company owned by SWI. Carmel Realty is entitled to receive property and construction management fees and leasing commissions in accordance with the terms of its property-level management agreement with Carmel, Ltd.\nNOTE 11. REAL ESTATE BROKERAGE\nCarmel Realty, also an affiliate of BCM, provides brokerage services to the Company on a non-exclusive basis. Carmel Realty is entitled to receive a commission for property acquisitions and sales, in accordance with a sliding scale of total fees to be paid by the Company.\nNOTE 12. ADVISORY FEES, PROPERTY MANAGEMENT FEES, ETC.\nFees and cost reimbursements to BCM, the Company's advisor, and its affiliates:\n____________________________\nTRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 12. ADVISORY FEES, PROPERTY MANAGEMENT FEES, ETC. (Continued)\n* Net of property management fees paid to subcontractors, other than Carmel Realty.\nNOTE 13. INCOME TAXES\nFor the years 1995, 1994 and 1993, the Company has elected and qualified to be treated as a REIT, as defined in Sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the \"Code\"), and as such, will not be taxed for federal income tax purposes on that portion of its taxable income which is distributed to stockholders, provided that at least 95% of its REIT taxable income, plus 95% of its taxable income from foreclosure property as defined in Section 857 of the Code, is distributed. See NOTE 7. \"DIVIDENDS.\"\nThe Company had a loss for federal income tax purposes in 1995, 1994 and 1993; therefore, the Company recorded no provision for income taxes.\nThe Company's tax basis in its net assets differs from the amount at which its net assets are reported for financial statement purposes, principally due to the accounting for gains and losses on property sales, the difference in the allowance for estimated losses, depreciation on owned properties and investments in joint venture partnerships. At December 31, 1995, the Company's tax basis in its net assets exceeded its basis for financial statement purposes by $11.2 million. As a result, aggregate future income for income tax purposes will be less than such amount for financial statement purposes, and the Company would be able to maintain its REIT status without distributing 95% of its financial statement income. Additionally, at December 31, 1995, the Company had tax net operating loss carryforwards of $47.3 million expiring through the year 2010.\nAs a result of the Company's election to be treated as a REIT for income tax purposes and of its intention to distribute its taxable income, if any, in future years, no deferred tax asset, liability or valuation allowance was recorded.\nNOTE 14. EXTRAORDINARY GAIN\nIn 1995, the Company recognized extraordinary gains totaling $1.4 million on the payoff of the mortgage debt secured by the Fountain Village Apartments and a principal pay down and modification of the mortgage debt secured by the Dunes Plaza Shopping Center.\nIn August 1994, the Company recognized an extraordinary gain of $1.2 million on the conveyance of it's limited partner interest in a partnership owning an office building in Philadelphia, Pennsylvania to the lender on a mortgage secured by the property owned by the partnership, in settlement of all litigation between the Company and the lender. See \"NOTE 5. INVESTMENT IN EQUITY METHOD REAL ESTATE ENTITIES\".\nTRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 14. EXTRAORDINARY GAIN (Continued)\nIn May 1993, the Company recognized an extraordinary gain of $1.1 million on the modification of the mortgage debt secured by an apartment complex in Tucson, Arizona. In August 1993, the Company recognized an extraordinary gain of $500,000 on the early payoff of the mortgage debt secured by an office building in St. Petersburg, Florida.\nNOTE 15. COMMITMENTS AND CONTINGENCIES\nOlive Litigation. In February 1990, the Company, together with CMET, IORI and National Income Realty Trust (\"NIRT\"), three real estate entities with, at the time, the same officers, directors or trustees and advisor as the Company, entered into a settlement of a class and derivative action entitled Olive et al. v. National Income Realty Trust et al., relating to the operation and management of each of the entities. On April 23, 1990, the court granted final approval of the terms of the settlement.\nOn May 4, 1994, the parties entered into a Modification of Stipulation of Settlement dated April 27, 1994 (the \"Modification\") which settled subsequent claims of breaches of the settlement which were asserted by the plaintiffs and modified certain provisions of the April 1990 settlement. The Modification was preliminarily approved by the court on July 1, 1994. Final court approval of the Modification was entered on December 12, 1994. The effective date of the Modification was January 11, 1995.\nThe Modification, among other things, provided for the addition of three new unaffiliated members to the Company's Board of Directors and set forth new requirements for the approval of any transactions with affiliates until April 28, 1999. In addition, BCM, the Company's advisor, Gene E. Phillips and William S. Friedman, who served as President and Director of the Company until February 24, 1994, President of BCM until May 1, 1993 and director of BCM until December 22, 1989, agreed to pay a total of $1.2 million to CMET, IORI, NIRT and the Company, of which the Company's share is $150,000. As of March 1, 1996, the Company has received payments totaling $128,000. The remaining $22,000 is to be paid in monthly installments through August 1, 1996.\nUnder the Modification, the Company, CMET, IORI and NIRT and their shareholders released the defendants from any claims relating to the plaintiffs' allegations. The Company, CMET, IORI and NIRT also agreed to waive any demand requirement for the plaintiffs to pursue claims on behalf of each of them against certain persons or entities. The Modification also requires that any shares of the Company held by Messrs. Phillips, Friedman or their affiliates shall be (i) voted in favor of the reelection of all current members of the Company's Board of Directors that stand for reelection during the two calendar years following the effective date of the Modification and (ii) voted in favor of all new members of the Company's Board of Directors appointed\nTRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 15. COMMITMENTS AND CONTINGENCIES (Continued)\npursuant to the terms of the Modification that stand for reelection during the three calendar years following the effective date of the Modification.\nPursuant to the terms of the Modification, certain related party transactions which the Company may enter into prior to April 28, 1999, require the unanimous approval of the Company's Board of Directors. In addition, such related party transactions are to be discouraged and may only be entered into in exceptional circumstances and after a determination by the Company's Board of Directors that the transaction is in the best interests of the Company and that no other opportunity exists that is as good as the opportunity presented by such transaction.\nFor purposes of the Modification requirements, the term \"related party transaction\" means and includes: (i) any transaction between or among the Company or CMET, IORI or NIRT or any of their affiliates or subsidiaries; (ii) any transaction between or among the Company, its affiliates or subsidiaries and the Advisor, Mr. Phillips, Mr. Friedman or any of their affiliates; and (iii) any transaction between or among the Company or any of its affiliates or subsidiaries and a third party with whom the Advisor, Mr. Phillips, Mr. Friedman or any of their affiliates has an ongoing or contemplated business or financial transaction or relationship of any kind, whether direct or indirect, or has had such a transaction or relationship in the preceding one year.\nThe Modification requirements for related party transactions do not apply to direct contractual agreements for services between the Company and the Advisor or one of its affiliates, (including the Advisory Agreement, the Brokerage Agreement and the property management contracts). These agreements, pursuant to the specific terms of the Modification, require the prior approval by two-thirds of the Directors of the Company, and if required, approval by a majority of the Company's stockholders. The Modification requirements for related party transactions also do not apply to joint ventures between or among the Company and CMET, IORI or NIRT or any of their affiliates or subsidiaries and a third party having no prior or intended future business or financial relationship with Mr. Phillips, Mr. Friedman, the Advisor, or any affiliate of such parties. Such joint ventures may be entered into on the affirmative vote of a majority of the Directors of the Company.\nThe Modification also terminated a number of the provisions under the settlement, including the requirement that the Company, CMET, IORI and NIRT maintain a Related Party Transaction Committee and a Litigation Committee of their respective Boards. The court retained jurisdiction to enforce the Modification.\nOther Litigation. The Company is also involved in various other lawsuits arising in the ordinary course of business. Management of the\nTRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 15. COMMITMENTS AND CONTINGENCIES (Continued)\nCompany is of the opinion that the outcome of these lawsuits will have no material impact on the Company's financial condition, results of operations or liquidity.\nLitigation settlement. In June 1995, the Company received a $500,000 settlement from one of the defendants in a lawsuit brought by the Company against the former owners of the RCA Building and their agents. The Company made a loan secured by the building in 1987 and filed a foreclosure action which was subsequently amended in 1990, to include claims of negligent misrepresentation against the borrowers, their legal counsel, architect and engineers.\nNOTE 16. QUARTERLY RESULTS OF OPERATIONS\nThe following is a tabulation of the Company's quarterly results of operations for the years 1995 and 1994:\nIn the first quarter of 1995, an extraordinary gain of $1.3 million was recognized on the payoff of the mortgage debt secured by the Fountain Village Apartments. In the second and fourth quarters of 1995, extraordinary gains totaling $144,000 were recognized on the modification of the mortgage debt secured by the Dunes Plaza Shopping Center. In the third quarter of 1995, a gain on sale of real estate of $1.6 million was recognized on the paydown of the mortgage note receivable secured by land in Maumelle, Arkansas, such gain having been previously deferred. In the fourth quarter of 1995, a gain on sale of real estate of $4.1 million was recognized on the sale of the Summerchase Apartments and a gain on sale of real estate of $76,000 was recognized on the sale of the Heritage Shopping Center.\nTRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 16. QUARTERLY RESULTS OF OPERATIONS (Continued)\nIn the first quarter of 1994, a gain on sale of partnership interest of $2.5 million was recognized on the sale of the Company's general partnership interest in two partnerships. In the third quarter of 1994, a gain on sale of real estate of $2.2 million was recognized on the sale of an apartment complex, and an extraordinary gain of $1.2 million was recognized on the conveyance of the Company's limited partner interest in a partnership to the lender on a mortgage secured by the property owned by the partnership in settlement of litigation between the Company and the lender.\nNOTE 17. SUBSEQUENT EVENTS\nIn January 1996, the Company sold the Cheyenne Mountain land, a 7 acre parcel of land in Colorado Springs, Colorado for $330,000 in cash. The Company recognized a gain of $218,000 on the sale.\nIn January 1996, the Company purchased a 4.7 acre parcel of land in Las Colinas, Texas for $941,000 in cash.\nIn March 1996, the Company accepted a discounted payoff of $825,000 in settlement of a mortgage note receivable with a principal balance of $875,000. The Company recorded no loss on the settlement in excess of the reserve previously established.\nIn March 1996, the Company completed the sale of the Park Forest Apartments for $4.7 million, receiving net cash of $1.6 million after paying off the first mortgage of $2.9 million and the payment of various closing costs associated with the sale. The Company recognized a gain of approximately $1.3 million on the sale. See NOTE 3. \"REAL ESTATE AND DEPRECIATION.\"\nSCHEDULE III\nTRANSCONTINENTAL REALTY INVESTORS, INC. SCHEDULE III REAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1995\nSCHEDULE III (Continued)\nTRANSCONTINENTAL REALTY INVESTORS, INC. REAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1995\nSCHEDULE III (Continued) TRANSCONTINENTAL REALTY INVESTORS, INC. REAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1995\n(1) The aggregate cost for federal income tax purposes is $255,462.\n(2) Writedown of property to estimated net realizable value.\n(3) Escrow deposits deducted from the basis of the property.\n(4) Construction period interest and taxes.\n(5) Cash from receiver deducted from the basis of the property, offset by land acquired in 1992.\n(6) Adjustment to purchase price.\n(7) Adjustment to purchase price, offset by the proceeds from the sale of all but 114 residential lots.\n(8) Sale of 29 lots and option payments on sale of stable facilities.\nSCHEDULE III (Continued)\nTRANSCONTINENTAL REALTY INVESTORS, INC. REAL ESTATE AND ACCUMULATED DEPRECIATION\nTRANSCONTINENTAL REALTY INVESTORS, INC. SCHEDULE IV MORTGAGE LOANS ON REAL ESTATE December 31, 1995\nTRANSCONTINENTAL REALTY INVESTORS, INC. SCHEDULE IV MORTGAGE LOANS ON REAL ESTATE (Continued) December 31, 1995\nTRANSCONTINENTAL REALTY INVESTORS, INC. SCHEDULE IV MORTGAGE LOANS ON REAL ESTATE (Continued) December 31, 1995\n- ------------------------\n(1) The aggregate cost for federal income tax purposes is $11,834. (2) An allowance for loss has been provided to reduce the carrying value of this loan to the Company's estimate of fair value of the underlying collateral minus estimated costs of sale.\nSCHEDULE IV (Continued)\nTRANSCONTINENTAL REALTY INVESTORS, INC. MORTGAGE LOANS ON REAL ESTATE\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable.\n___________________________________\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT\nDirectors\nThe affairs of Transcontinental Realty Investors, Inc. (the \"Company\" or the \"Registrant\") are managed by a Board of Directors which is divided into three classes serving for staggered three year terms. The Directors are elected at the annual meeting of stockholders or appointed by the incumbent Board of Directors and serve until their respective terms expire or until a successor has been elected or appointed.\nThe Directors of the Company are listed below, together with their ages, terms of service, all positions and offices with the Company or its advisor, Basic Capital Management, Inc. (\"BCM\" or the \"Advisor\"), their principal occupations, business experience and directorships with other companies during the last five years or more. The designation \"Affiliated\", when used below with respect to a Director, means that the Director is an officer, director or employee of the Advisor or an officer or employee of the Company. The designation \"Independent\", when used below with respect to a Director, means that the Director is neither an officer or employee of the Company nor a director, officer or employee of the Advisor, although the Company may have certain business or professional relationships with such Director as discussed in ITEM 13. \"CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - Certain Business Relationships.\"\nJOHN P. PARSONS: Age 67, Director (Class II) (Independent) (since January 1995).\nChairman and Chief Executive Officer (since 1984) of Pierpont Corporation; Director of Zentrum Holdings Limited (NZ) (since 1984), the Pickford Foundation (since 1980), International Divertissments, Ltd. (since 1986), and Lifehouse International, Ltd.(since 1990); Trustee (since January 1995) of Continental Mortgage and Equity Trust (\"CMET\"); and Director (since January 1995) of Income Opportunity Realty Investors, Inc., formerly Income Opportunity Realty Trust (collectively \"IORI\").\nITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nDirectors (Continued)\nBENNETT B. SIMS: Age 63, Director (Class III) (Independent) (since April 1990).\nProducer (since January 1994) for Blue Train Pictures; Author (since 1964); Screen and Television Writer (since 1960); Independent Marketing Consultant (since 1980) for various companies; Professor of Dramatic Writing (since September 1987) at Tisch School of the Arts, New York University; Trustee (April 1990 to August 1994) of National Income Realty Trust (\"NIRT\"); Trustee (December 1992 to August 1994) of Vinland Property Trust (\"VPT\"); Trustee (since April 1990) of CMET; and Director (since April 1990) of IORI.\nTED P. STOKELY: Age 62, Director (Class II) (Independent) (since April 1990) and Chairman of the Board (since January 1995).\nGeneral Manager (since January 1995) of ECF Senior Housing Corporation, a nonprofit corporation; General Manager (since January 1993) of Housing Assistance Foundation, Inc., a nonprofit corporation; Part-time unpaid Consultant (since January 1993) and paid Consultant (April 1992 to December 1992) of Eldercare Housing Foundation (\"Eldercare\"), a nonprofit corporation engaged in the acquisition of low income and elderly housing; President (April 1992 to April 1994) of PSA Group (real estate management and consulting); Executive Vice President (1987 to 1991) of Key Companies Inc., a publicly traded company that develops, acquires and sells water and minerals; Trustee (April 1990 to August 1994) of NIRT; Trustee (since April 1990) and Chairman of the Board (since January 1995) of CMET; and Director (since April 1990) and Chairman of the Board (since January 1995) of IORI.\nMARTIN L. WHITE: Age 56, Director (Class I) (Independent) (since January 1995).\nChairman and Chief Executive Officer (since 1993) of North American Trading Company Ltd.; President and Chief Operating Officer (since 1992) of Community Based Developers, Inc.; Development Officer and Loan Manager (1986 to 1992) of the City of San Jose, California; Vice President and Director of Programs (1967 to 1986) of Arpact, Inc., a government contractor for small business development and trade; Trustee (since January 1995) of CMET; and Director (since January 1995) of IORI.\nEDWARD G. ZAMPA: Age 61, Director (Class I) (Independent) (since January 1995).\nGeneral Partner (since 1976) of Edward G. Zampa and Company; and Trustee (since January 1995) of CMET; and Director (since January 1995) of IORI.\nITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nBoard Committees\nThe Company's Board of Directors held 13 meetings during 1995. For such year, no incumbent Director attended fewer than 75% of the aggregate of (i) the total number of meetings held by the Company's Board of Directors during the period for which he had been a Director and (ii) the total number of meetings held by all committees of the Board of Directors on which he served during the period that he served.\nThe Company's Board of Directors has an Audit Committee, the function of which is to review the Company's operating and accounting procedures. The current members of the Audit Committee, all of whom are Independent Directors, are Messrs. Parsons (Chairman), Stokely and White. The Audit Committee met twice during 1995.\nIn June 1995, the Company's Board of Directors authorized the creation of a Relationship with Advisor Committee, Board Development Committee and a Corporate Vision Committee. The current members of the Relationship with Advisor Committee are Messrs. Parsons and Zampa. The Relationship with Advisor Committee reviews and reports to the Company's Board of Directors on the services provided to the Company by the Advisor and its affiliates and the terms of any engagement or compensation of the Advisor or its affiliates. The Relationship with Advisor Committee met once in 1995. The Board Development Committee reviews and reports to the Company's Board of Directors on the membership, compensation and functions of the Board of Directors. The current members of the Board Development Committee are Messrs. Sims and White. The Board Development Committee held no meetings in 1995. The Corporate Vision Committee is to review and report to the Company's Board of Directors on the Company's short-term and long-term strategic objectives. As of March 15, 1996, the members had not been appointed to the Corporate Vision Committee.\nThe Company's Board of Directors does not have Nominating or Compensation Committees.\nExecutive Officers\nThe following persons currently serve as executive officers of the Company: Randall M. Paulson, President; Bruce A. Endendyk, Executive Vice President; and Thomas A. Holland, Executive Vice President and Chief Financial Officer. Their positions with the Company are not subject to a vote of stockholders. Their ages, terms of service, all\n[THIS SPACE INTENTIONALLY LEFT BLANK.]\nITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nExecutive Officers (Continued)\npositions and offices with the Company or BCM, other principal occupations, business experience and directorships with other companies during the last five years or more are set forth below.\nRANDALL M. PAULSON: Age 49, President (since August 1995)and Executive Vice President (January 1995 to August 1995).\nPresident (since August 1995) of BCM, IORI and CMET and Executive Vice President (January 1995 to August 1995) of CMET, IORI and Syntek Asset Management, Inc. (\"SAMI\"), the managing general partner of Syntek Asset Management, L.P. (\"SAMLP\"), which is the general partner of National Realty, L.P. and National Operating, L.P. (\"NOLP\") and (October 1994 to August 1995) of BCM; Director (since August 1995) of SAMI; Executive Vice President (since January 1995) of American Realty Trust, Inc. (\"ART\"); Vice President (1993 to 1994) of GSSW, LP, a joint venture of Great Southern Life and Southwestern Life; Vice President (1990 to 1993) of Property Company of America Realty, Inc.; President (1990) of Paulson Realty Group; President (1983 to 1989) of Johnstown Management Company; and Vice President (1979 to 1982) of Lexton-Ancira.\nBRUCE A. ENDENDYK: Age 47, Executive Vice President (since January 1995).\nPresident (since January 1995) of Carmel Realty, Inc. (\"Carmel Realty\"), a company owned by Syntek West, Inc. (\"SWI\"); Executive Vice President (since January 1995) of BCM, SAMI, ART, CMET and IORI; Management Consultant (November 1990 to December 1994); Executive Vice President (January 1989 to November 1990) of Southmark Corporation (\"Southmark\"); President and Chief Executive Officer (March 1988 to January 1989) of Southmark Equities Corporation; and Vice President\/Resident Manager (December 1975 to March 1988) of Coldwell Banker Commercial\/Real Estate Services in Houston, Texas.\n[THIS SPACE INTENTIONALLY LEFT BLANK.]\nITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nExecutive Officers (Continued)\nTHOMAS A. HOLLAND: Age 53, Executive Vice President and Chief Financial Officer (since August 1995) and Senior Vice President and Chief Accounting Officer (June 1990 to August 1995).\nExecutive Vice President and Chief Financial Officer (since August 1995) and Senior Vice President and Chief Accounting Officer (July 1990 to August 1995) of BCM, SAMI, ART, CMET and IORI; Senior Vice President and Chief Accounting Officer (July 1990 to February 1994) of NIRT and VPT; Vice President and Controller (December 1986 to June 1990) of Southmark; Vice President- Finance (January 1986 to December 1986) of Diamond Shamrock Chemical Company; Assistant Controller (May 1976 to January 1986) of Maxus Energy Corporation (formerly Diamond Shamrock Corporation); Trustee (August 1989 to June 1990) of Arlington Realty Investors; and Certified Public Accountant (since 1970).\nOfficers\nAlthough not executive officers of the Company, the following persons currently serve as officers of the Company: Robert A. Waldman, Senior Vice President, General Counsel and Secretary and Drew D. Potera, Treasurer. Their positions with the Company are not subject to a vote of stockholders. Their ages, terms of service, all positions and offices with the Company or BCM, other principal occupations, business experience and directorships with other companies during the last five years or more are set forth below.\nROBERT A. WALDMAN: Age 43, Senior Vice President and General Counsel (since January 1995), Vice President (December 1990 to January 1995) and Secretary (since December 1993).\nSenior Vice President and General Counsel (since January 1995), Vice President (December 1990 to January 1995) and Secretary (since December 1993) of CMET and IORI; Vice President (December 1990 to February 1994) and Secretary (December 1993 to February 1994) of NIRT and VPT; Senior Vice President and General Counsel (since January 1995), Vice President (January 1993 to January 1995) and Secretary (since December 1989) of ART; Senior Vice President and General Counsel (since November 1994), Vice President and Corporate Counsel (November 1989 to November 1994), and Secretary (since November 1989) of BCM; Senior Vice President and General Counsel (since January 1995), Vice President (April 1990 to January 1995) and Secretary (since December 1990) of SAMI; Director (February 1987 to October 1989) and General Counsel and Secretary (1985 to October 1989) of Red Eagle Resources Corporation (oil and gas); Assistant General Counsel, Senior Staff Attorney and Staff Attorney (1981 to 1985) of Texas International Company (oil and gas); and Staff Attorney (1979 to 1981) of Iowa Beef Processors, Inc.\nITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nOfficers (Continued)\nDREW D. POTERA: Age 36, Treasurer (since December 1990).\nTreasurer (since December 1990) of CMET and IORI; Treasurer (December 1990 to February 1994) of NIRT and VPT; Treasurer (since August 1991) and Assistant Treasurer (December 1990 to August 1991) of ART; Vice President, Treasurer and Securities Manager (since July 1990) of BCM; Vice President and Treasurer (since February 1992) of SAMI; and Financial Consultant with Merrill Lynch, Pierce, Fenner & Smith Incorporated (June 1985 to June 1990).\nIn addition to the foregoing officers, the Company has several vice presidents and assistant secretaries who are not listed herein.\nCompliance with Section 16(a) of the Securities Exchange Act of 1934\nUnder the securities laws of the United States, the Company's Directors, executive officers, and any persons holding more than ten percent of the Company's shares of Common Stock are required to report their ownership of the Company's shares and any changes in that ownership to the Securities and Exchange Commission (the \"Commission\"). Specific due dates for these reports have been established and the Company is required to report any failure to file by these dates during 1995. All of these filing requirements were satisfied by the Company's Directors and executive officers and ten percent holders. In making these statements, the Company has relied on the written representations of its incumbent Directors and executive officers and its ten percent holders and copies of the reports that they have filed with the Commission.\nThe Advisor\nAlthough the Company's Board of Directors is directly responsible for managing the affairs of the Company and for setting the policies which guide it, the day-to-day operations of the Company are performed by a contractual advisor under the supervision of the Company's Board of Directors. The duties of the advisor include, among other things, locating, investigating, evaluating and recommending real estate and mortgage note investment and sales opportunities and financing and refinancing sources to the Company. The advisor also serves as a consultant to the Company's Board of Directors in connection with the business plan for the Company and investment policy decisions.\nBCM has served as the Company's advisor since March 1989. BCM is a corporation of which Messrs. Paulson, Endendyk, and Holland serve as executive officers. BCM is a company owned by a trust for the benefit of the children of Gene E. Phillips. Mr. Phillips served as a director of BCM until December 22, 1989, and as Chief Executive Officer of BCM until September 1, 1992. Mr. Phillips serves as a representative of his children's trust which owns BCM and, in such capacity, has substantial contact with the management of BCM and input with respect to its performance of advisory services to the Company.\nITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nThe Advisor (Continued)\nAt the Company's annual meeting of stockholders held on March 7, 1995, the Company's stockholders approved the renewal of the Company's advisory agreement with BCM through the next annual meeting of the Company's stockholders. Subsequent renewals of the Advisory Agreement with BCM do not require the approval of the Company's stockholders but do require the approval of the Company's Board of Directors.\nUnder the Advisory Agreement, the Advisor is required to formulate and submit annually for approval by the Company's Board of Directors a budget and business plan for the Company containing a twelve-month forecast of operations and cash flow, a general plan for asset sales or acquisitions, lending, foreclosure and borrowing activity, and other investments, and the Advisor is required to report quarterly to the Company's Board of Directors on the Company's performance against the business plan. In addition, all transactions or investments by the Company shall require prior approval by the Company's Board of Directors unless they are explicitly provided for in the approved business plan or are made pursuant to authority expressly delegated to the Advisor by the Company's Board of Directors.\nThe Advisory Agreement also requires prior approval of the Company's Board of Directors for the retention of all consultants and third party professionals, other than legal counsel. The Advisory Agreement provides that the Advisor shall be deemed to be in a fiduciary relationship to the Company's stockholders; contains a broad standard governing the Advisor's liability for losses by the Company; and contains guidelines for the Advisor's allocation of investment opportunities as among itself, the Company and other entities it advises.\nThe Advisory Agreement provides for BCM to be responsible for the day-to-day operations of the Company and to receive an advisory fee comprised of a gross asset fee of .0625% per month (.75% per annum) of the average of the gross asset value of the Company (total assets less allowance for amortization, depreciation or depletion and valuation reserves) and an annual net income fee equal to 7.5% per annum of the Company's net income.\nThe Advisory Agreement also provides for BCM to receive an annual incentive sales fee equal to 10% of the amount, if any, by which the aggregate sales consideration for all real estate sold by the Company during such fiscal year exceeds the sum of: (i) the cost of each such property as originally recorded in the Company's books for tax purposes (without deduction for depreciation, amortization or reserve for losses), (ii) capital improvements made to such assets during the period owned by the Company, and (iii) all closing costs, (including real estate commissions) incurred in the sale of such real estate; provided, however, no incentive fee shall be paid unless (a) such real estate sold in such fiscal year, in the aggregate, has produced an 8% simple annual return on the Company's net investment including capital improvements, calculated over the Company's holding period before depreciation and\nITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nThe Advisor (Continued)\ninclusive of operating income and sales consideration and (b) the aggregate net operating income from all real estate owned by the Company for each of the prior and current fiscal years shall be at least 5% higher in the current fiscal year than in the prior fiscal year.\nAdditionally, pursuant to the Advisory Agreement BCM or an affiliate of BCM is to receive an acquisition commission for supervising the acquisition, purchase or long-term lease of real estate for the Company equal to the lesser of (i) up to 1% of the cost of acquisition, inclusive of commissions, if any, paid to nonaffiliated brokers or (ii) the compensation customarily charged in arm's-length transactions by others rendering similar property acquisition services as an ongoing public activity in the same geographical location and for comparable property, provided that the aggregate purchase price of each property (including acquisition fees and real estate brokerage commissions) may not exceed such property's appraised value at acquisition.\nThe Advisory Agreement requires BCM or any affiliate of BCM to pay to the Company, one-half of any compensation received from third parties with respect to the origination, placement or brokerage of any loan made by the Company; provided, however, that the compensation retained by BCM or any affiliate of BCM shall not exceed the lesser of (i) 2% of the amount of the loan committed by the Company or (ii) a loan brokerage and commitment fee which is reasonable and fair under the circumstances.\nThe Advisory Agreement also provides that BCM or an affiliate of BCM is to receive a mortgage or loan acquisition fee with respect to the acquisition or purchase of any existing mortgage loan by the Company equal to the lesser of (i) 1% of the amount of the loan purchased or (ii) a brokerage or commitment fee which is reasonable and fair under the circumstances. Such fee will not be paid in connection with the origination or funding by the Company of any mortgage loan.\nUnder the Advisory Agreement, BCM or an affiliate of BCM is also to receive a mortgage brokerage and equity refinancing fee for obtaining loans to the Company or refinancing on Company properties equal to the lesser of (i) 1% of the amount of the loan or the amount refinanced or (ii) a brokerage or refinancing fee which is reasonable and fair under the circumstances; provided, however, that no such fee shall be paid on loans from BCM or an affiliate of BCM without the approval of the Company's Board of Directors. No fee shall be paid on loan extensions.\nUnder the Advisory Agreement, BCM is to receive reimbursement of certain expenses incurred by it in the performance of advisory services to the Company.\nUnder the Advisory Agreement, all or a portion of the annual advisory fee must be refunded by the Advisor to the Company if the Operating Expenses of the Company (as defined in the Advisory Agreement) exceed certain limits specified in the Advisory Agreement based on the book value, net asset value and net income of the Company during such fiscal\nITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nThe Advisor (Continued)\nyear. The effect of the limitation was to require that BCM refund $246,000 of the annual advisory fee for 1995. The operating expenses of the Company did not exceed such limitation in 1993 and 1994.\nAdditionally, if the Company were to request that BCM render services to the Company other than those required by the Advisory Agreement, BCM or an affiliate of BCM will be separately compensated for such additional services on terms to be agreed upon from time to time. As discussed below, under \"Property Management\", the Company has hired Carmel Realty Services, Ltd. (\"Carmel, Ltd.\"), an affiliate of BCM, to provide property management services for the Company's properties. Also as discussed below, under \"Real Estate Brokerage\" the Company has engaged, on a non-exclusive basis, Carmel Realty, also an affiliate of BCM, to perform brokerage services for the Company.\nBCM may only assign the Advisory Agreement with the prior consent of the Company.\nThe directors and principal officers of BCM are set forth below.\nMICKEY N. PHILLIPS: Director\nRYAN T. PHILLIPS: Director\nRANDALL M. PAULSON: President\nMARK W. BRANIGAN: Executive Vice President\nOSCAR W. CASHWELL: Executive Vice President\nBRUCE A. ENDENDYK: Executive Vice President\nTHOMAS A. HOLLAND: Executive Vice President and Chief Financial Officer\nCOOPER B. STUART: Executive Vice President\nCLIFFORD C. TOWNS, JR.: Executive Vice President, Finance\nROBERT A. WALDMAN: Senior Vice President, Secretary and General Counsel\nDREW D. POTERA: Vice President, Treasurer and Securities Manager\nMickey N. Phillips is Gene E. Phillips' brother and Ryan T. Phillips is Gene E. Phillips' son. Gene E. Phillips serves as a representative of the trust established for the benefit of his children which owns BCM and, in such capacity, has substantial contact with the management of BCM and input with respect to BCM's performance of advisory services to the Company.\nITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nProperty Management\nSince February 1, 1990, affiliates of BCM have provided property management services to the Company. Currently, Carmel, Ltd. provides such property management services for a fee of 5% or less of the monthly gross rents collected on the properties under its management. Carmel, Ltd. subcontracts with other entities for the provision of the property- level management services to the Company at various rates. The general partner of Carmel, Ltd. is BCM. The limited partners of Carmel, Ltd. are (i) SWI, of which Mr. Phillips is the sole shareholder, (ii) Mr. Phillips and (iii) a trust for the benefit of the children of Mr. Phillips. Carmel, Ltd. subcontracts the property-level management and leasing of 24 of the Company's commercial properties and its hotel and the commercial properties owned by a real estate partnership in which the Company and IORI are partners to Carmel Realty, which is a company owned by SWI. Carmel Realty is entitled to receive property and construction management fees and leasing commissions in accordance with the terms of its property-level management agreement with Carmel, Ltd.\nReal Estate Brokerage\nSince December 1, 1992, Carmel Realty has been engaged, on a non-exclusive basis, to provide brokerage services for the Company. Carmel Realty is entitled to receive a real estate commission for property acquisitions and sales by the Company in accordance with the following sliding scale of total fees to be paid by the Company: (i) maximum fee of 5% on the first $2.0 million of any purchase or sale transaction of which no more than 4% would be paid to Carmel Realty or affiliates; (ii) maximum fee of 4% on transaction amounts between $2.0 million - $5.0 million of which no more than 3% would be paid to Carmel Realty or affiliates; (iii) maximum fee of 3% on transaction amounts between $5.0 million - $10.0 million of which no more than 2% would be paid to Carmel Realty or affiliates; and, (iv) maximum fee of 2% on transaction amounts in excess of $10.0 million of which no more than 1.5% would be paid to Carmel Realty or affiliates.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe Company has no employees, payroll or benefit plans and pays no compensation to the executive officers of the Company. The executive officers of the Company who are also officers or employees of BCM, the Company's Advisor, are compensated by the Advisor. Such executive officers of the Company perform a variety of services for the Advisor and the amount of their compensation is determined solely by the Advisor. BCM does not allocate the cash compensation of its officers among the various entities for which it serves as advisor. See ITEM 10. \"DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT - The Advisor\" for a more detailed discussion of the compensation payable to BCM by the Company.\nThe only remuneration paid by the Company is to the Directors who are not officers or directors of BCM or its affiliated companies. The Independent Directors (i) review the investment policies of the Company\nITEM 11. EXECUTIVE COMPENSATION (Continued)\nto determine that they are in the best interest of the Company's stockholders, (ii) review the Company's contract with the advisor, (iii) supervise the performance of the Company's advisor and review the reasonableness of the compensation which the Company pays to its advisor in terms of the nature and quality of services performed, (iv) review the reasonableness of the total fees and expenses of the Company and (v) select, when necessary, a qualified independent real estate appraiser to appraise properties purchased by the Company. Until January 1, 1995, the Company's Independent Directors received compensation in the amount of $6,000 per year, plus reimbursement for expenses. In addition, each Independent Director received (i) $3,000 per year for each committee of the Board of Directors on which he served, (ii) $2,500 per year for each committee chairmanship, and (iii) $1,000 per day for any special services rendered by him to the Company outside of his ordinary duties as Director, plus reimbursement of expenses.\nOn June 9, 1995, the Company's Board of Directors revised the compensation to be paid to Independent Directors effective as of January 1, 1995. Each Independent Director receives compensation in the amount of $15,000 per year, plus reimbursement for expenses and the Chairman of the Board receives an additional $1,500 per year for serving in such position. In addition, each Independent Director shall receive an additional fee of $1,000 per day for any special services rendered by him to the Company outside of his ordinary duties as Director, plus reimbursement of expenses.\nDuring 1995, $96,554 was paid to the Independent Directors in total Directors' fees for all services, including the annual fee for service during the period January 1, 1995 through December 31, 1995, and 1995 special service fees as follows: Geoffrey C. Etnire, $7,708; Harold Furst, Ph.D., $15,000; John P. Parsons, $16,275; Bennett B. Sims, $9,327; Ted P. Stokely, $11,500; Martin L. White, $21,744; and Edward G. Zampa, $15,000.\n[THIS SPACE INTENTIONALLY LEFT BLANK.]\nITEM 11. EXECUTIVE COMPENSATION (Continued)\nPerformance Graph\nThe following performance graph compares the cumulative total stockholder return on the Company's shares of Common Stock with the Standard & Poor's 500 Stock Index (\"S&P 500 Index\") and the National Association of Real Estate Investment Trusts, Inc. Hybrid REIT Total Return Index (\"REIT Index\"). The comparison assumes that $100 was invested on December 31, 1990 in the Company's shares of Common Stock and in each of the indices and further assumes the reinvestment of all dividends. Past performance is not necessarily an indicator of future performance.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nSecurity Ownership of Certain Beneficial Owners. The following table sets forth the ownership of the Company's Common Stock, both beneficially and of record, both individually and in the aggregate, for those persons or entities known by the Company to be beneficial owners of more than 5% of its shares of Common Stock as of the close of business on March 15, 1996.\n___________________________\n(1) Percentage is based upon 4,012,275 shares of Common Stock outstanding at March 15, 1996.\nSecurity Ownership of Management. The following table sets forth the ownership of the Company's Common Stock, both beneficially and of record, both individually and in the aggregate, for the Directors and executive officers of the Company as of the close of business on March 15, 1996.\n___________________________\n(1) Percentage is based upon 4,012,275 shares of Common Stock outstanding at March 15, 1996.\n(2) Includes 79,500 shares owned by CMET of which the Company's Directors may be deemed to be beneficial owners by virtue of their positions as trustees of CMET. The Directors of the Company disclaim beneficial ownership of such shares.\n(3) Includes 26,475 shares owned by SAMLP, 256,413 shares owned by BCM and 1,144,021 shares owned by ART, of which the executive officers of the Company may be deemed to be beneficial owners by virtue of their positions as executive officers or directors of SAMI, BCM and ART. The executive officers of the Company disclaim beneficial ownership of such shares. Each of the directors of ART may be deemed to be beneficial owners of the shares owned by ART by virtue of their positions as directors of ART. Each of the\nITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT (Continued)\ndirectors of BCM may be deemed to be beneficial owners by virtue of their positions as directors of BCM. The directors of ART and BCM disclaim such beneficial ownership.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nCertain Business Relationships\nIn February 1989, the Company's Board of Directors voted to retain BCM as the Company's advisor. See ITEM 10. \"DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR TO THE REGISTRANT - The Advisor.\" BCM is a corporation of which Messrs. Paulson, Endendyk and Holland serve as executive officers. Gene E. Phillips served as a director of BCM until December 22, 1989 and as Chief Executive Officer of BCM until September 1, 1992. BCM is owned by a trust for the benefit of the children of Mr. Phillips. Mr. Phillips serves as a representative of his children's trust which owns BCM and, in such capacity, has substantial contact with the management of BCM and input with respect to BCM's performance of advisory services to the Company.\nSince February 1990, affiliates of BCM have provided property management services to the Company. Currently, Carmel, Ltd. provides such property management services. The general partner of Carmel, Ltd. is BCM. The limited partners of Carmel, Ltd. are (i) SWI, of which Mr. Phillips is the sole shareholder, (ii) Mr. Phillips and (iii) a trust for the benefit of the children of Mr. Phillips. Carmel, Ltd. subcontracts the property-level management and leasing of 24 of the Company's commercial properties and its hotel and the commercial properties owned by a real estate partnership in which the Company and IORI are partners to Carmel Realty, which is a company owned by SWI.\nPrior to December 1, 1992, affiliates of BCM provided brokerage services to the Company and received brokerage commissions in accordance with the advisory agreement. Since December 1, 1992, the Company has engaged, on a non- exclusive basis, Carmel Realty to perform brokerage services for the Company. Carmel Realty is a company owned by SWI.\nThe Directors and officers of the Company also serve as trustees or directors and officers of CMET and IORI. The Directors owe fiduciary duties to such entities as well as to the Company under applicable law. CMET and IORI have the same relationship with BCM as the Company. The Company owned approximately 22% of the outstanding shares of common stock of IORI at December 31, 1995. Gene E. Phillips is a general partner of SAMLP, the general partner of NRLP and NOLP. BCM performs certain administrative functions for NRLP and NOLP on a cost-reimbursement basis. BCM also serves as advisor to ART. Mr. Phillips served as Chairman of the Board and director of ART until November 16, 1992. In addition, Messrs. Paulson, Endendyk and Holland serve as executive officers of ART.\nFrom April 1992 to December 31, 1992, Mr. Stokely was employed as a paid Consultant and since January 1, 1993 as a part-time unpaid Consultant for Eldercare, a nonprofit corporation engaged in the acquisition of low\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS (Continued)\nCertain Business Relationships (Continued)\nincome and elderly housing. Eldercare has a revolving loan commitment from SWI, of which Mr. Phillips is the sole shareholder. Eldercare filed for bankruptcy protection in July 1993, and was dismissed from bankruptcy on October 12, 1994. Eldercare filed again for bankruptcy protection in May 1995.\nRelated Party Transactions\nHistorically, the Company has engaged in and may continue to engage in business transactions, including real estate partnerships, with related parties. The Company's management believes that all of the related party transactions represented the best investments available at the time and were at least as advantageous to the Company as could have been obtained from unrelated third parties.\nIn December 1994, NCPO Texas, Ltd., a Texas limited partnership, purchased the North Central Plaza One Building, a 197,848 square foot office building in Dallas, Texas for $12.4 million, consisting of $4.2 million in cash and new mortgage financing of $8.2 million. The Company was the sole limited partner of the partnership with a 97.5% limited partner interest. The general partner of the partnership, with a 2.5% general partner interest, was Ensearch Holding Company, a corporation controlled by an adult son of A. Bob Jordan, a Director of the Company until March 7, 1995. In November 1995, the Company sold its partnership interest for $4.8 million in cash. The Company recognized no gain or loss on the sale of its limited partner interest.\nAt December 31, 1995, the Company owned a combined 63.7% general and limited partner interest in Tri-City Limited Partnership, a limited partnership in which IORI is a 36.3% general partner. The Company owns 170,750 shares of the common stock of IORI, an approximate 22% interest.\nIn 1995, the Company paid BCM and its affiliates $1.8 million in advisory fees, $104,000 in mortgage brokerage and equity refinancing fees, $56,000 in property acquisition fees, $301,000 in real estate brokerage commissions and $2.9 million in property and construction management fees and leasing commissions, net of property management fees paid to subcontractors, other than Carmel Realty. In addition, as provided in the Advisory Agreement, BCM received cost reimbursements from the Company of $877,000 in 1995.\nRestrictions on Related Party Transactions\nArticle FOURTEENTH of the Company's Articles of Incorporation provides that the Company shall not, directly or indirectly, contract or engage in any transaction with (i) any director, officer or employee of the Company, (ii) any director, officer or employee of the advisor, (iii) the advisor or (iv) any affiliate or associate (as such terms are defined in Rule 12b-2 under the Securities Exchange Act of 1934, as amended) of any of the aforementioned persons, unless (a) the material facts as to the relationship among or financial interest of the relevant individuals or persons and as to the contract or transaction are\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS (Continued)\nRestrictions on Related Party Transactions (Continued)\ndisclosed to or are known by the Board of Directors or the appropriate committee thereof and (b) the Board of Directors or committee thereof determines that such contract or transaction is fair to the Company and simultaneously authorizes or ratifies such contract or transaction by the affirmative vote of a majority of independent directors of the Company entitled to vote thereon.\nArticle FOURTEENTH defines an \"Independent Director\" as one who is neither an officer or employee of the Company nor a director, officer or employee of the Company's advisor.\nPursuant to the terms of the Modification of Stipulation of Settlement (the \"Modification\") in the Olive Litigation, as more fully discussed in ITEM 3. \"LEGAL PROCEEDINGS - Olive Litigation,\" which became effective on January 11, 1995, certain related party transactions which the Company may enter into prior to April 28, 1999, require the unanimous approval of the Company's Board of Directors. In addition, such related party transactions are to be discouraged and may only be entered into in exceptional circumstances and after a determination by the Company's Board of Directors that the transaction is in the best interests of the Company and that no other opportunity exists that is as good as the opportunity presented by such transaction.\nThe Modification requirements for related party transactions do not apply to direct contractual agreements for services between the Company and the Advisor or one of its affiliates (including the Advisory Agreement, the Brokerage Agreement and the property management contracts). These agreements, pursuant to the specific terms of the Modification, require the prior approval by two-thirds of the Directors of the Company, and if required, approval by a majority of the Company's stockholders. The Modification requirements for related party transactions also do not apply to joint ventures between or among the Company and CMET, IORI or NIRT or any of their affiliates or subsidiaries and a third party having no prior or intended future business or financial relationship with Mr. Phillips, William S. Friedman, the Advisor, or any affiliate of such parties. Such joint ventures may be entered into on the affirmative vote of a majority of the Directors of the Company.\n[THIS SPACE INTENTIONALLY LEFT BLANK.]\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES, AND REPORTS ON FORM 8-K\n(a) The following documents are filed as part of this Report:\n1. Consolidated Financial Statements\nReport of Independent Certified Public Accountants\nConsolidated Balance Sheets - December 31, 1995 and 1994\nConsolidated Statements of Operations - Years Ended December 31, 1995, 1994 and 1993\nConsolidated Statements of Stockholders' Equity - Years Ended December 31, 1995, 1994 and 1993\nConsolidated Statements of Cash Flows - Years Ended December 31, 1995, 1994 and 1993\nNotes to Consolidated Financial Statements\n2. Financial Statement Schedules\nSchedule III - Real Estate and Accumulated Depreciation\nSchedule IV - Mortgage Loans on Real Estate\nAll other schedules are omitted because they are not applicable or because the required information is shown in the Consolidated Financial Statements or the Notes thereto.\n3. Incorporated Financial Statements\nConsolidated Financial Statements of Income Opportunity Realty Trust (Incorporated by reference to Item 8 of Income Opportunity Realty Trust's Annual Report on Form 10-K for the year ended December 31, 1995).\n4. Exhibits\nThe following documents are filed as Exhibits to this Report:\nITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES, AND REPORTS ON FORM 8-K (Continued)\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nTRANSCONTINENTAL REALTY INVESTORS, INC.\nPursuant to the requirements of the Securities Exchange Act 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.\nTRANSCONTINENTAL REALTY INVESTORS, INC.\nEXHIBITS TO ANNUAL REPORT ON FORM 10-K\nFor the Year Ended December 31, 1995","section_15":""}
{"filename":"835324_1995.txt","cik":"835324","year":"1995","section_1":"ITEM 1. BUSINESS\nS. Y. Bancorp, Inc. (\"Bancorp\"), a Kentucky corporation headquartered in Louisville, Kentucky, is a bank holding company registered with, and subject to supervision, regulation and examination by, the Board of Governors of the Federal Reserve System. Stock Yards Bank & Trust Company (\"the Bank\") is the wholly-owned subsidiary of Bancorp. Bancorp has no subsidiary other than the Bank. Bancorp conducts no active business operations; accordingly, the business of Bancorp is substantially the same as that of the Bank.\nThe Bank was originally chartered and began operations as a state bank under the name \"Stockyards Bank\" in 1904. In 1972, the Bank was granted full trust powers and changed its name to \"Stock Yards Bank & Trust Company.\"\nWhile primarily serving Jefferson County, Kentucky, the Bank also serves customers residing in the adjacent Kentucky counties of Oldham, Shelby and Bullitt and in Southern Indiana.\nThe Bank engages in a wide range of commercial and personal banking activities, including the usual acceptance of deposits for checking, savings and time deposit accounts; making of secured and unsecured loans to corporation, individuals and others; issuance of letters of credit; leasing activities and rental of safe deposit boxes. The Bank's lending services include the making of commercial, industrial, real estate, installment and guaranteed student loans. Interest and fees on consumer, real estate and commercial loans constitute the largest contribution to the Bank's operating revenues. In addition, the Bank offers Visa credit card services through an agreement with a non-affiliated bank. Customers of the Bank also have access to automatic teller machines through a regional network.\nIn 1992, Stock Yards Bank Mortgage Company, a division of the Bank, began operations. This division originates residential mortgage loans and sells the loans in the secondary market. The Mortgage division provides customers with a variety of options for home mortgages, including VA and FHA financing.\nThe Bank provides a wide range of personal and corporate trust services. Assets under management in the Trust Department totaled approximately $343,000,000 at December 31, 1995.\nThe Bank actively competes on the local and regional levels with other commercial banks and financial institutions for all types of deposits, loans, trust accounts, and providing financial and other services offered by the Bank. Many of the banks and other financial institutions with which the Bank competes have capital and resources substantially in excess of the capital and resources of the Bank.\nAfter being a unit bank for 85 years, the Bank opened its first branch facility in 1989. Two additional suburban offices opened in 1992, a fourth branch opened in January, 1993, a fifth opened in February, 1994 and a sixth opened in 1995. All branch offices are full service financial centers. See \"ITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe principal offices of Bancorp and the Bank are located at 1040 East Main Street, Louisville, Kentucky, in a two story building containing approximately 28,000 square feet. The Bank also operates a drive-through facility, an operations center containing approximately 6,000 square feet adjacent to its main offices, a garage of approximately 5,000 square feet, and parking for approximately 100 customers and employees. The Bank also owns land and buildings at 4016 Poplar Level Road and 4537 Outer Loop which are used as branch facilities. Furthermore, in February, 1996 the Bank purchased a building adjacent to its main office. This building will be remodeled to house non customer contact departments of the Bank. Properties owned by the Bank are not presently encumbered.\nAt December 31, 1995, the Bank leased the following four branch facilities in Louisville, Kentucky: 214 South Fifth Street- approximately 10,000 square feet; Lexington Road- approximately 6,000 square feet; Shelbyville Road- approximately 3,000 square feet; Dixie Highway- approximately 7,200 square feet with 3,600 feet sub-leased; The latter three offices have drive through facilities.\nSee Notes 5 and 13 to Bancorp's consolidated financial statements for the year ended December 31, 1995, included at pages 21 and 23 in Bancorp's Annual Report to Shareholders for the year ended December 31, 1995, incorporated herein by reference, for additional information relating to amounts invested in premises, equipment and lease commitments.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nSee Note 13 to Bancorp's consolidated financial statements for the year ended December 31, 1995, included at page 23 in Bancorp's Annual Report to Shareholders for the year ended December 31, 1995, incorporated herein by reference, for information relating to legal proceedings.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe following table lists the names, and ages (as of December 31, 1995) of all current executive officers of Bancorp and all persons who it is anticipated will be chosen as executive officers at the organization meeting of Bancorp's Board of Directors following the 1996 Annual Meeting of Shareholders of Bancorp to be held on April 24, 1996. Each executive officer is appointed by the Bancorp's Board of Directors to serve at the pleasure of the Board. There is no arrangement or understanding between any executive officer of Bancorp and any other person(s) pursuant to which he\/she was or is to be selected as an officer.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nInformation captioned \"Market Data\" on page 14 of Bancorp's Annual Report to Shareholders for the year ended December 31, 1995, is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nInformation captioned \"Selected Financial Data\" on page 14 of Bancorp's Annual Report to Shareholders for the year ended December 31, 1995, is incorporated herein by reference.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nManagement's Discussion and Analysis of Results of Operations and Financial Condition on pages 5 through 13 of Bancorp's Annual Report to Shareholders for the year ended December 31, 1995, is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe following Consolidated Financial Statements of Bancorp and the Bank and Report of Independent Auditors included on pages 15 through 26 in Bancorp's Annual Report to Shareholders for the year ended December 31, 1995, are incorporated herein by reference:\nConsolidated Balance Sheets--December 31, 1995 and 1994 Consolidated Statements of Income--years ended December 31, 1995, 1994, and 1993. Consolidated Statements of Changes in Stockholders' Equity--years ended December 31, 1995, 1994, and 1993. Consolidated Statements of Cash Flows--years ended December 31, 1995, 1994, and 1993 Notes to Consolidated Financial Statements Report of Independent Auditors\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 and executive officers of Bancorp is incorporated herein by reference to the discussion under the heading, \"ELECTION OF DIRECTORS,\" on pages 4 through 9 of Bancorp's definitive Proxy Statement for the 1996 Annual Meeting of Shareholders and the section captioned EXECUTIVE OFFICERS OF THE REGISTRANT on page 12 of form 10-K.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation regarding the compensation of Bancorp's executive officers and directors is incorporated herein by reference to the discussion under the heading, \"COMPENSATION OF EXECUTIVE OFFICERS AND DIRECTORS\" on pages 12 through 18 of Bancorp's definitive Proxy Statement for the 1996 Annual Meeting of Shareholders.\nInformation appearing under the headings \"REPORT OF COMPENSATION COMMITTEE ON EXECUTIVE COMPENSATION\" on pages 10 through 12 and \"Shareholder Return Performance Graph\" in the section entitled \"COMPENSATION OF EXECUTIVE OFFICERS AND DIRECTORS\" contained on page 17 in Bancorp's definitive Proxy Statement for the 1996 Annual Meeting of Shareholders shall not be deemed to be incorporated by reference in this report, notwithstanding any general statement contained herein incorporating portions of such Proxy Statement by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required by this item is incorporated herein by reference to the discussion under the headings, \"ELECTION OF DIRECTORS\" on pages 4 through 9 and \"PRINCIPAL HOLDERS OF BANCORP'S COMMON STOCK,\" on pages 3 and 4 of Bancorp's definitive Proxy Statement for the 1996 Annual Meeting of Shareholders.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by this item is incorporated herein by reference to the discussion under the heading, \"TRANSACTIONS WITH MANAGEMENT AND OTHERS,\" on page 18 of Bancorp's definitive Proxy Statement for the 1996 Annual Meeting of Shareholders.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) 1. LIST OF FINANCIAL STATEMENTS\nThe following Consolidated Financial Statements of Bancorp and the Bank and Report of Independent Auditors included in Bancorp's Annual Report to Shareholders for the year ended December 31, 1995 were incorporated by reference in Part II, Item 8. on page 13.\nConsolidated Balance Sheets--December 31, 1995 and 1994 Consolidated Statements of income--years ended December 31, 1995, 1994, and 1993. Consolidated Statements of Changes in Stockholders' Equity--years ended December 31, 1995, 1994, and 1993 Consolidated Statements of Cash Flows--years ended December 31, 1995, 1994, and 1993. Notes to Consolidated Financial Statements Report of Independent Auditors\n(a) 2. LIST OF FINANCIAL STATEMENT SCHEDULES\nSchedules to the consolidated financial statements of Bancorp are omitted since they are either not required under the related instructions, are inapplicable, or the required information is shown in the consolidated financial statements or notes thereto.\n(a) 3. LIST OF EXHIBITS\n3.1 Articles of Incorporation of Bancorp filed with the Secretary of State of Kentucky on January 12, 1988. Exhibit 3 to Registration Statement on Form S-4 of Bancorp, File No. 33-22517, is incorporated by reference herein.\n3.2 Articles of Amendment to the Articles of Incorporation of Bancorp filed with the Secretary of State of Kentucky on May 8, 1989. Exhibit 19 to Annual Report on Form 10-K for the year ended December 31, 1989, of Bancorp is incorporated by reference herein.\n3.3 Articles of Amendment to the Articles of Incorporation of Bancorp filed with the Secretary of State of Kentucky on June 30, 1994. Exhibit 3.3 to Annual Report on Form 10-K for the year ended December 31, 1994, of Bancorp is incorporated by reference herein.\n3.4 Bylaws of Bancorp, as amended, currently in effect. Exhibit 3.4 to Annual Report on Form 10-K for the year ended December 31, 1994, of Bancorp is incorporated by reference herein.\n10.1 S.Y. Bancorp, Inc. Stock Option Plan as amended. Exhibit 4 to Registration Statement on Form S-8 of Bancorp, File No. 33-25885, is incorporated by reference herein.\n10.2 Stock Yards Bank & Trust Company Senior officers Security Plan adopted December 23, 1980. Exhibit 10 to Annual Report on Form 10-K for the year ended December 31, 1988, of Bancorp is incorporated by reference herein.\n10.3 Form of Indemnification Agreement between Stock Yards Bank & Trust Company, S.Y. Bancorp, Inc. and each member of the Board of Directors. Exhibit 10.3 to Annual Report on Form 10-K for the year ended December 31, 1994, of Bancorp is incorporated by reference herein.\n10.4 Senior Executive Severance Agreement executed in July 1994 between Stock Yards Bank & Trust Company and David H. Brooks. Exhibit 10.4 to Annual Report on Form 10-K for the year ended December 31, 1994, of Bancorp is incorporated by reference herein.\n10.5 Senior Executive Severance Agreement executed in July 1994 between Stock Yards Bank & Trust Company and David P. Heintzman. Exhibit 10.5 to Annual Report on Form 10-K for the year ended December 31, 1994, of Bancorp is incorporated by reference herein.\n10.6 Senior Executive Severance Agreement executed in July 1994 between Stock Yards Bank & Trust Company and Kathy C. Thompson. Exhibit 10.6 to Annual Report on Form 10-K for the year ended December 31, 1994, of Bancorp is incorporated by reference herein.\n10.7 S.Y. Bancorp, Inc. 1995 Stock Incentive Plan.\n11 Statement re: computation of per share earnings.\n13 Annual Report to Shareholders for the year ended December 31, 1995. This annual report shall not be deemed to be filed with the Commission except to the extent that information is specifically incorporated herein by reference.\n21 Subsidiaries of the Registrant.\n23 Independent Auditors' Consent.\n27 Financial Data Schedule\nCopies of the foregoing Exhibits will be furnished to others upon request and payment of Bancorp's reasonable expenses in furnishing the exhibits.\n(b) REPORTS ON FORM 8-K\nNone\n(c) EXHIBITS\nThe exhibits listed in response to Item 14(a)3 are filed as a part of this report.\n(d) FINANCIAL STATEMENT SCHEDULES\nNone\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nMarch 26, 1996 S.Y. BANCORP, INC.\nBY: \/s\/ David H. Brooks ------------------- David H. Brooks Chairman and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\n\/s\/ David H. Brooks Chairman and Chief March 26, 1996 - --------------------------- Executive Officer David H. Brooks and Director (principle executive officer)\n\/s\/ David P. Heintzman President March 26, 1996 - --------------------------- and Director David P. Heintzman\n\/s\/ Nancy B. Davis Vice President, March 26, 1996 - --------------------------- Treasurer Nancy B. Davis and Chief Financial Officer (principal financial and accounting officer)\n\/s\/ James E. Carrico Director March 26, 1996 - --------------------------- James E. Carrico\n\/s\/ Jack M. Crowner Director March 26, 1996 - --------------------------- Jack M. Crowner\n\/s\/ Charles R. Edinger, III Director March 26, 1996 - --------------------------- Charles R. Edinger, III\n\/s\/ Carl T. Fischer, Jr. Director March 26, 1996 - --------------------------- Carl T. Fischer, Jr.\n\/s\/ Stanley A. Gall - --------------------------- Director March 26, 1996 Stanley A. Gall, M.D.\n\/s\/ Leonard Kaufman Director March 26, 1996 - --------------------------- Leonard Kaufman\n\/s\/ George R. Keller Director March 26, 1996 - --------------------------- George R. Keller\n\/s\/ Bruce P. Madison Director March 26, 1996 - --------------------------- Bruce P. Madison\n\/s\/ Henry A. Meyer Director March 26, 1996 - --------------------------- Henry A. Meyer\n\/s\/ Norman Tasman Director March 26, 1996 - --------------------------- Norman Tasman\n\/s\/ Kathy C. Thompson Senior Vice President, March 26, 1996 - --------------------------- Secretary and Kathy C. Thompson Director\n\/s\/ Bertrand A. Trompeter Director March 26, 1996 - --------------------------- Bertrand A. Trompeter\nINDEX OF EXHIBITS\nEXHIBIT NUMBER - ------\nEXHIBIT\n3.1 Articles of Incorporation of Bancorp filed with the Secretary of State of Kentucky on January 12, 1988. Exhibit 3 to Registration Statement on Form S-4 of Bancorp, File No. 33-22517, is incorporated by reference herein.\n3.2 Articles of Amendment to the Articles of Incorporation of Bancorp filed with the Secretary of State of Kentucky on May 8, 1989. Exhibit 19 to Annual Report on Form 10-K for the year ended December 31, 1989, of Bancorp is incorporated by reference herein.\n3.3 Articles of Amendment to the Articles of Incorporation of Bancorp filed with the Secretary of State of Kentucky on June 30, 1994. Exhibit 3.3 to Annual Report on Form 10-K for the year ended December 31, 1994, of Bancorp is incorporated by reference herein.\n3.4 Bylaws of Bancorp, as amended, currently in effect. Exhibit 3.4 to Annual Report on Form 10-K for the year ended December 31, 1994, of Bancorp is incorporated by reference herein.\n10.1 S.Y. Bancorp, Inc. Stock Option Plan as amended. Exhibit 4 to Registration Statement on Form S-8 of Bancorp, File No. 33-25885, is incorporated by reference herein.\nEXHIBIT NUMBER - ------\nEXHIBIT\n10.2 Stock Yards Bank & Trust Company Senior Officers Security Plan adopted December 23, 1980. Exhibit 10 to the Annual Report on Form 10-K for the year ended December 31, 1989, of Bancorp, is incorporated by reference herein.\n10.3 Form of Indemnification Agreement between Stock Yards Bank & Trust Company, S.Y. Bancorp, Inc. and each member of the Board of Directors. Exhibit 10.3 to the Annual Report on Form 10-K for the year ended December 31, 1994, of Bancorp is incorporated by reference herein.\n10.4 Senior Executive Severance Agreement executed in July 1994 between Stock Yards Bank & Trust Company and David H. Brooks. Exhibit 10.4 to the Annual Report on Form 10-K for the year ended December 31, 1994, of Bancorp is incorporated by reference herein.\n10.5 Senior Executive Severance Agreement executed in July 1994 between Stock Yards Bank & Trust Company and David P. Heintzman. Exhibit 10.5 to the Annual Report on Form 10-K for the year ended December 31, 1994, of Bancorp is incorporated by reference herein.\n10.6 Senior Executive Severance Agreement executed in July 1994 between Stock Yards Bank & Trust Company and Kathy C. Thompson. Exhibit 10.6 to the Annual Report on Form 10-K for the year ended December 31, 1994, of Bancorp is incorporated by reference herein.\n10.7 S.Y. Bancorp, Inc. 1995 Stock Incentive Plan\n11 Statement re: computation of per share earnings.\nEXHIBIT NUMBER - ------\nEXHIBIT\n13 Annual Report to Shareholders for the year ended December 31, 1995. This annual report shall not be deemed to be filed with the Commission except to the extent that information is specifically incorporated herein by reference.\n21 Subsidiaries of the Registrant.\n23 Independent Auditors' Consent.\n27 Financial Data Schedule","section_15":""}
{"filename":"83679_1995.txt","cik":"83679","year":"1995","section_1":"ITEM 1. BUSINESS\nBACKGROUND\nAn important event, the Recapitalization (defined below), occurred during Rhodes, Inc.'s (\"Rhodes\" or the \"Company\") fiscal year ended February 28, 1994 which affects its comparison with this year's financial statements. The results of operations for the year ended February 28, 1995 are best analyzed by comparison with the pro forma results of operations for the prior year ended February 28, 1994 which have been adjusted to reflect the Recapitalization, in addition to comparison with the historical financial statements presented herein.\nRECAPITALIZATION\nOn June 24, 1993, the Company completed a series of transactions (described below) constituting a recapitalization of the Company (the \"Recapitalization\"). The Recapitalization enhanced the Company's strategic, financial and operating flexibility by increasing shareholders' equity and reducing indebtedness and interest expense. Each component of the Recapitalization was consummated on June 24, 1993, except for the 17% Debenture Redemption (defined below) which was consummated on July 26, 1993.\nCOMMON STOCK OFFERING\nThe Company offered 4,167,000 shares of Common Stock for sale to the public at $12.00 per share in an initial public offering (the \"Offering\"), of which Green Capital Investors, L.P. (\"Green Capital\") purchased 250,000 shares. Green Capital is controlled by Holcombe T. Green, Jr., who was Chairman of the Board of the Company until July, 1994. Mr. Green is currently a Director of the Company and Chairman of the Executive Committee of the Board of Directors. The net proceeds from the Offering (after deducting underwriting discounts and expenses paid by the Company) were approximately $45.5 million.\nSENIOR SECURED FINANCING\nCertain institutional investors purchased $40.0 million principal amount of long-term indebtedness (the \"Senior Secured Financing\") concurrently with the closing of the Offering. The Senior Secured Financing consists of two tranches, with a $30.0 million aggregate principal amount maturing in 1999 and bearing interest at a rate of 9% per annum and a $10.0 million aggregate principal amount maturing in 2000 and bearing interest at a rate of 10% per annum. The net proceeds to the Company from the Senior Secured Financing were approximately $38.7 million. The Senior Secured Financing is secured by liens on all of the real estate owned by the Company.\nTHE EXCHANGE\nOn the terms and subject to the conditions contained in an exchange agreement between the Company and Green Capital (the \"Exchange Agreement\"), the Company issued 2,859,115 shares of Common Stock to Green Capital in exchange for approximately 78.1% of the Company's 17% Junior Discount Subordinated Redeemable Debentures Due 2000 (the \"17% Debentures\"), at their accreted value ($34.3 million as of June 24, 1993), owned by Green Capital. Additionally, pursuant to the Exchange Agreement, the Company issued 1,221,666 shares of Common Stock to Green Capital in exchange for all of the shares of the Company's Class A Preferred Stock (1,000 shares with a stated value of $10.0 million and accumulated, unpaid dividends aggregating approximately $4.7 million as of June 24, 1993).\nREPAYMENT OF INDEBTEDNESS\n12% SECURED TERM LOAN\nAs part of the Recapitalization, the Company repaid the $36.2 million principal amount of its 12% Secured Term Loan with Jackson National Life Insurance Co. (\"Jackson National\"). The 12% Secured Term Loan, which was scheduled to mature on April 1, 1997, was prepaid by the Company without penalty.\n15% NOTES\nAs part of the Recapitalization, on June 24, 1993 the Company redeemed the $40.0 million principal amount of the Company's 15% Senior Subordinated Notes due September 20, 1998 (the \"15% Notes\"). Although the 15% Notes were not redeemable at that date, the consent of the holders thereof to early redemption was obtained. In connection with the redemption of the 15% Notes, the Company incurred $2.6 million of prepayment penalties, $2.3 million of which was payable to Jackson National, the holder of $35.0 million principal amount of the 15% Notes.\n17% DEBENTURES\nUpon consummation of the other components of the Recapitalization, the Company called for redemption of all the 17% Debentures that were not subject to the Exchange in accordance with the provisions of the indenture under which the 17% Debentures were issued (the \"17% Debenture Redemption\"). The 17% Debenture Redemption was completed at a redemption price equal to the aggregate accreted value of the 17% Debentures of approximately $9.7 million on July 26, 1993.\nMISCELLANEOUS\nIn order to consummate the Recapitalization, the Company borrowed approximately $4.0 million under a committed, unsecured line of credit maintained with Green Capital. Borrowings under this line of credit had an annual interest rate of 8.0%. All amounts outstanding under this line of credit have been repaid and the line of credit was terminated prior to the end of fiscal 1994.\nEffective upon consummation of the Recapitalization, the Company terminated the management arrangement with Green Capital pursuant to which Rhodes paid to Green Capital a $400,000 annual management fee for certain management services.\nGENERAL INFORMATION\nBACKGROUND\nRhodes is one of the largest specialty furniture retailers in the United States. Founded in 1875, the Company operates 80 stores in metropolitan areas of 11 contiguous Southeastern and Midwestern states and for many years has focused on selling brand name residential furniture to middle-income customers.\nThe Rhodes retailing philosophy is to provide value to its customers through a combination of quality, price and service. Each of the Company's stores offers a broad line of brand name merchandise, emphasizing good quality and an extensive selection. The Company employs an aggressive pricing policy, under which it guarantees to sell each item at the lowest advertised price in the market. Rhodes emphasizes superior service through in-store credit, prompt delivery of merchandise, professionally trained salespeople and convenient locations.\nIn September, 1988 Rhodes was acquired (the \"Acquisition\") by a group of investors led by Holcombe T. Green, Jr., who was Chairman of the Board of Directors of the Company until July, 1994. Mr. Green is currently a Director of the Company and Chairman of the Executive Committee of the Board of Directors. As of April 28, 1995, Mr. Green beneficially owned approximately 31.2% of the outstanding shares of Common Stock.\nSTORE BASE\nIn fiscal 1993, the Company initiated a store remodeling and refurbishing program designed to significantly upgrade its existing stores and increase sales per store. This program is designed to provide a more attractive in-store atmosphere by professionally redesigning and redecorating existing display space in order to improve the consumer's shopping experience and enhance the appearance of displayed merchandise. Through the end of fiscal 1995, thirty-six stores had been remodeled or refurbished pursuant to the program. An additional fifteen stores are scheduled to be remodeled or refurbished in fiscal 1996.\nRemodeling a store typically involves redesigning the store's display space and reconfiguring its model room settings, replacing its carpet and wallpaper, repainting its interior walls, and replacing or updating its lighting. Remodeling a store may include work on its exterior (such as paint, lighting and signage), but does not typically increase the store's existing display space. The cost for the complete remodeling of a store in fiscal 1996 is anticipated to be approximately $400,000. Refurbishing a store typically involves replacing carpet and wallpaper, repainting and making minor improvements to the store's lighting. The cost to refurbish a store in fiscal 1996 is anticipated to be approximately $125,000. Stores generally remain open during a remodeling or refurbishing and the event is advertised as an opportunity for customers to enjoy increased savings.\nThe Company also has a program designed to increase its store base by adding stores in existing markets and, when possible, new markets. In pursuing this program, the Company seeks to add new cluster stores that may be served from existing regional distribution centers (\"RDCs\"). In fiscal 1995, seven new stores were opened, all in existing markets, including a replacement store in Columbia, South Carolina. Single stores were opened in Chattanooga and Knoxville, Tennessee in fiscal 1994. New markets were opened in the metropolitan areas of Nashville, Tennessee in fiscal 1990 and Birmingham, Alabama in fiscal 1991, with the Company currently operating four stores in Nashville and five stores in Birmingham.\nIn evaluating the feasibility of entering a new market, the Company would typically consider (a) the size of the market, focusing on locations that have a local population base of more than 100,000 people, (b) existing competitive conditions and (c) the feasibility of serving the new stores from an existing RDC. Expansion or opening of new RDC's will be considered as needed to support the expansion. The Company would generally seek to enter a new market by acquiring or opening two or more stores that may operate as a cluster, although the Company believes that single stores may be operated profitably in certain markets.\nThe table below summarizes as of May 1, 1995 openings, closings and remodelings or refurbishings of stores during the fiscal years indicated and the Company's current plans for fiscal years 1996 and 1997.\n(1) Proposed (2) On August 24, 1992, Hurricane Andrew destroyed one of the Company's four Miami stores. (3) Remodelings and refurbishings prior to fiscal 1993 were not part of the Company's current remodeling and refurbishing program and therefore are not comparable. (4) Includes refurbishment of one store that subsequently was destroyed by fire. (5) Includes relocation of one store. (6) The status of the Company's 14 stores that have not been remodeled, or scheduled for remodeling in fiscal 1996, has not been determined. Whether or not individual stores will be remodeled, refurbished or relocated will depend on a number of factors such as the lease terms, availability of expansion space in some cases, or suitable relocation space to lease.\nSTORE OPERATIONS\nTARGET MARKET\nFor many years, the Company has focused its retailing strategy on selling good quality furniture to a broad base of middle-income customers. The Company intends to maintain this focus both in its existing markets and as it enters new markets. The Company carefully tracks the demographic profile of its customer base, designs its merchandising and promotions to appeal to its targeted market, and evaluates programs by analyzing changes in the profile of the resulting customer base. The Company has identified its target group as between the ages of 25 and 54 with an annual family income of $30,000\nto $75,000. An extensive marketing study commissioned by the Company as of October 13, 1994 confirmed that the majority of Rhodes' customers fit the target profile.\nSTORE FORMAT AND SITE SELECTION\nThe Company's stores average 31,387 square feet of display space. Furniture typically is displayed in model room settings, complete with accessories. Stores are open 362 days each year and at least five evenings per week.\nThe Company continuously assesses retail trade areas and specific sites in its existing markets and targeted metropolitan areas to evaluate the feasibility of opening new stores. Within a trade area, the Company carefully analyzes prospective sites for new stores with respect to traffic-count levels along contiguous roadways, visibility of the site and ingress\/egress characteristics, proximity to competitors and other retail trade generators, zoning restrictions, availability of suitable leasable space and other factors.\nMERCHANDISING AND PURCHASING\nThe Company's merchandising strategy is to offer a broad selection of affordably priced home furnishings. Each of the Company's stores offers a full line of residential furniture, including upholstered furniture, recliners and occasional tables for dens and living rooms; bedroom suits and bedding; dinettes and more formal dining room suits; and desks, lamps, and other accessories. The table below sets forth the percentage of sales derived from the types of merchandise indicated during each of the last three fiscal years.\nThe Company's centralized merchandising and buying group selects all lines of merchandise, negotiates purchase prices and terms with suppliers and places orders for each of the Company's stores and RDCs. The Company purchases merchandise from a large number of manufacturers, including well-known brands such as Alan White, Armstrong, Bassett, Berkline, Broyhill, Dunmore, Kincaid, Klaussner, La-Z-Boy, Natuzzi, Peoplounger, River Oaks, Sealy, Samuel Lawrence, Simmons and Universal. As of February 28, 1995, one manufacturer, making products under the brand names La-Z-Boy and Kincaid, accounted for approximately 14.5% of the Company's total purchases. The Company's inventory control system provides its headquarters group with merchandising information, and the group also receives information from regional and store managers regarding local preferences and market conditions.\nPROMOTIONS AND ADVERTISING\nThe Company relies to a considerable extent upon promotions and advertising to produce sales, with much of the Company's marketing featuring the availability of in-store credit and special credit plans. The Company conducts over 40 Company-wide promotional events each year. Sales are generally related to holidays and other promotional events. The Company's headquarters staff develops a monthly calendar of Company-wide promotional events.\nThe Company advertises extensively throughout the year in newspapers and by use of radio and television in each of its markets. Color circulars also are issued several times a year in special mailings or newspaper inserts. In the year ended February 28, 1995, newspaper and print media advertising accounted for approximately 38.9% of the Company's total advertising expense. Regional managers along with the Company's headquarters staff and advertising agency are responsible for determining the appropriate media mix for the monthly advertising budget in each market. All advertising is prepared by the Company's headquarters staff in conjunction with an outside advertising agency.\nMANAGEMENT INFORMATION SYSTEM\nThe Company has developed and installed an inventory control and point-of-sale information system. This system expedites the processing of customer transactions and credit approval, controls inventory levels and is designed to support future growth. Specifically, the Company accounts for merchandise in each store and RDC, and the movement of items, by inventory stock identification numbers known as SKU numbers. Management and each store manager are furnished with daily sales and gross margins by SKU category and for each salesperson. The Company has completed a successful test of bar coding in one RDC, which it will be adding to all RDC's in fiscal 1996.\nThe Company believes that the centralization and standardization of its operating systems, and the present successful operation of these systems in all its existing stores, will allow the Company to support the operation of new stores without major capital expenditures or substantial increases in its corporate overhead. Although entering a new market will require the expansion of certain systems, the Company believes that its existing merchandising, promotional, inventory and training systems will allow it to add new stores in existing or new markets in a cost-effective manner.\nMANAGEMENT AND TRAINING\nThe Company's senior management is supported through the Company's seven operating regions, each of which has a regional manager and multiple area managers. The seven regional managers and one divisional vice president have a combined 109 years of experience with Rhodes.\nStore management personnel undergo extensive and regular training, which is designed to keep managers and employees informed of all standardized Company operating policies, including procedures for sales, inventory maintenance, credit extension, advertising, store administration and merchandise display. Training programs are conducted both at the Company's stores and at the Company's headquarters in Atlanta. Through the training process, management believes it has identified employees whose experience and training will qualify them to be store managers in all stores expected to be opened in the current fiscal year.\nDISTRIBUTION AND DELIVERY\nInventories are maintained in RDCs, from which merchandise is shipped to the appropriate store for delivery to the customer's home. The seven RDCs, which collectively had more than 600,000 square feet at year end, have cantilever racking and computer-controlled inventory storage. An additional 98,000 square feet is being added to the Powder Springs facility, which will be completed in May, 1995.\nTypically, each store is within 200 miles of one of the RDCs. Substantially all of the Company's merchandise is distributed to its stores through its RDCs. The Company operates a fleet of trucks which delivers merchandise from an RDC to each store several times each week.\nDeliveries to customers are made from the Company's stores by Company-operated trucks or, in certain markets, by independent contractors. In certain of its major metropolitan markets, the Company guarantees next-day delivery for all in-stock purchases and the Company believes that this program, and its prompt delivery for all stores, provides it with a competitive advantage.\nCREDIT OPERATIONS\nThe Company offers its customers the option to purchase furniture using cash, the Rhodes credit card or other major nationally recognized credit cards. Approximately 71.9% of the Company's sales in the year ended February 28, 1995 were made through the Rhodes credit card, which operates as a revolving charge account. All credit applications, sales and many payments on account are processed electronically through the Company's point-of-sale system. The terms for the Rhodes credit card purchases are flexible and on most purchases allow up to 48 months to pay. The Company also provides promotional credit plans to its customers in which no interest is charged on purchases made under the plan or in which monthly payments are deferred.\nOn June 18, 1992, the Company sold its portfolio of customer installment receivables (the \"Receivables Sale\") to Beneficial National Bank U.S.A. (\"BNB\") in the amount of approximately $174.3 million (including an advance of $4.3 million against future revenue to be earned by the Company under a related merchant agreement (the \"Merchant Agreement\")). Under the Merchant Agreement, the Company also contracted to sell all future receivables for three years following the Receivables Sale and received approximately $4.3 million, net of a $0.5 million contingency deposit, in advance against future revenue to be earned by the Company under the Merchant Agreement. Repayment of the advance was completed in fiscal 1995. The Company derives income under the Merchant Agreement from commissions earned from BNB on certain credit transactions. The Merchant Agreement is subject to early termination by BNB in the event of a bankruptcy filing by or against Rhodes or upon 30 days notice in the event of a material change in any law or regulation or in the operation, assets, condition (financial or otherwise), business or ownership of Rhodes. After the initial three-year term, the Merchant Agreement remains in effect unless terminated by either party on 180 days notice. Upon termination of the Merchant Agreement, Rhodes may, at its option, repurchase the total portfolio of outstanding consumer installment receivables for 106% of the outstanding principal balances, including accrued interest, subject to certain rights of BNB to securitize and sell the portfolio. It is the Company's intention to continue with the Merchant Agreement.\nCOMPETITION\nThe retail home furnishings business is highly competitive and fragmented. The Company competes with a large number of independent furniture stores which operate in single markets, other regional and national furniture store chains, and various department stores and mass merchandisers. Based on statistics published by Furniture\/Today for calendar 1994, the Company was the third largest conventional furniture retailer in the United States; however, the 10 largest conventional furniture retailers accounted for less than 13.3% of industry sales in 1994. Some of the furniture store chains, department stores and mass merchandisers with which the Company competes have greater financial and other resources than the Company.\nThe retail furniture industry competes primarily on the basis of quality, price and service. Each of the Company's stores offers a broad line of brand name merchandise, emphasizing good quality and an extensive selection. The Company employs an aggressive pricing policy, under which it guarantees to sell each item at the lowest advertised price in the market. Rhodes emphasizes superior service through in-store credit, prompt delivery of merchandise, professionally trained salespersons, convenient locations and a 30 day unconditional return policy.\nSERVICE MARKS\nThe Company conducts its business under the names \"Rhodes,\" \"Crossroads\" (in Kentucky and Missouri), \"Marks-Fitzgerald\" (in Birmingham, Alabama) and \"Fowler's Furniture Center\" (in Knoxville, Tennessee). The Company holds service marks for each of these names and believes that the names are well-recognized in their markets and of great value to the Company.\nEMPLOYEES\nAs of March 31, 1995 the Company employed 2,690 persons, including 2,337 in sales and store operations, 210 in its RDCs and 143 in its corporate office. The Company has never experienced a work stoppage due to labor difficulties. The Company is not a party to any collective bargaining agreements and considers its relations with employees to be good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nPROPERTIES\nThe Company's stores are free-standing units or are located in shopping centers, and have display space ranging from approximately 17,000 square feet to approximately 78,000 square feet (with an average of approximately 31,000 square feet). As of February 28, 1995, the Company owned 13 of its stores and leased the remaining 67, of which nine were leased pursuant to sale\/leaseback arrangements. See Notes 5 and 6 to Consolidated Financial Statements.\nStore leases have initial terms which will expire at various dates through 2023, with an average lease term, including renewal options, of approximately 13 years. The Company's leases generally provide for fixed monthly rentals, although some provide for fixed minimum rentals with a percentage rental based on sales.\nThe Company's principal executive offices are located in a 30,366 square foot leased facility located in Atlanta, Georgia. The facility is leased by the Company pursuant to two leases, one of which extends to July 2005 and the other of which extends to May 2002 and which the Company has an option to extend for an additional 10 year term. Management believes that the Company has adequate expansion opportunities to accommodate its needs for the foreseeable future.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nOn April 17, 1995, several individuals, as members of a purported plaintiff class of customers, filed suit in the Circuit Court of Jefferson County, Alabama against the Company and certain other defendants, including Sears, Roebuck & Company, Inc., Service Merchandise Company, Inc., Friedman's Inc., Alabama Power Company, Lowe's Home Centers, Inc., and Rex Radio and Television, Inc., alleging violations of the Code of Alabama and fraud and conspiracy arising from the sale of \"extended service contracts\" in connection with the credit purchase of consumer goods. In their prayer for relief, the plaintiffs seek damages equal to all principal and finance charges under the credit agreements in question, a judgment voiding the credit agreements, injunctive relief, the reimbursement of all costs associated with the action, other compensatory damages and unspecified punitive damages. The Company believes that its practices with respect to extended service contracts comply with Alabama law and it intends to vigorously defend this action.\nDue to the nature of the Company's business, it is from time to time a party to other legal proceedings arising in the ordinary course of its business, none of which, in the judgment of management, would have a material adverse effect on its operations or financial condition if adversely determined.\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 1995.\nITEM X. EXECUTIVE OFFICERS OF THE REGISTRANT\nThe following table sets forth certain information with respect to each person who is an executive officer of the Company, as indicated below.\nIrwin L. Lowenstein joined the Company in 1972 and has served as President, Chief Operating Officer and Director of the Company since 1977. Effective in 1989, Mr. Lowenstein was elected Chief Executive Officer of the Company. In 1994 he was elected Chairman of the Board and Chief Executive Officer.\nJoel T. Lanham joined the Company in 1976. For the past five years he has served as Senior Vice President and Executive Vice President, Operations and in 1994 he was elected President and Chief Operating Officer. He is a director of the National Home Furnishings Association.\nJoel H. Dugan joined the Company in 1985. Mr. Dugan, a certified public accountant formerly with Price Waterhouse & Co., was elected Vice President, Accounting and Information Services in 1985 and Senior Vice President, Finance and Administration in 1988.\nJames A. Welch joined the Company in 1986. For the past five years he has served as Regional Manager and Division Manager and in 1994 he was elected Senior Vice President, Operations.\nJack A. Hurst joined the Company in 1957 and has served as Senior Vice President, Training & Human Resources since 1986. Mr. Hurst has informed the Company he will tender his resignation for retirement effective July 31, 1995.\nDonald M. Parker joined the Company in 1987 as the Regional Manager for the Atlanta area stores, and served in that capacity until being named Senior Vice President Merchandising in May 1993. Prior to joining the Company, Mr. Parker served as General Manager for Maxwell Furniture, a furniture retailer.\nBarbara W. Snow joined the Company in 1981 and has served as Corporate Controller since 1988. Ms. Snow, a certified public accountant, served in the capacity of Accounting Manager prior to being elected to Corporate Controller. In 1994 Ms. Snow was elected to the additional office of Vice President.\nAll executive officers of the Company are elected by the Board of Directors and serve for a one-year term and until their successors have been elected and qualified.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Company's Common Stock was quoted on The Nasdaq Stock Market from June 17, 1993, the date of the Recapitalization, through March 23, 1994. Beginning March 24, 1994 the Common Stock was listed on the New York Stock Exchange. The following table sets forth the high and low sales prices of the Common Stock as reported by The Nasdaq Stock Market or the New York Stock Exchange, as applicable, for the periods indicated:\nAs of April 28, 1995, there were approximately 253 holders of record of the Company's common stock.\nThe Company has paid no cash dividends since the Acquisition in 1988 and it has no plans to commence payment of cash dividends on its Common Stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following information with respect to the Company's consolidated financial statements for the fiscal years ended February 28, 1995, 1994, 1993, February 29, 1992 and February 28, 1991 has been derived from, and should be read in conjunction with, the Company's audited consolidated financial statements.\nThe following financial information should be read in conjunction with \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and the consolidated financial statements of the Company appearing elsewhere in this Annual Report.\nCERTAIN DEFINITIONS\nINVENTORY TURNOVER: Cost of Goods Sold on a FIFO basis for the fiscal year divided by the average of FIFO inventory levels at the beginning of the fiscal year and at the end of each month during the fiscal year.\nAVERAGE DISPLAY SQUARE FOOTAGE: Average of the total square feet of display area open at the beginning of the fiscal year and at the end of each month during the fiscal year.\nCOMPARABLE STORE SALES GROWTH: Growth in furniture and services sold and delivered by stores open for the same months in each comparative period.\nSALES PER SQUARE FOOT: Net sales for the fiscal year divided by the average square feet of display area of those stores open at the beginning of the fiscal year and at the end of each month during the fiscal year.\nSALES PER NON-SALES EMPLOYEE: Net sales for the fiscal year divided by the average number of non-selling forty hour units at the end of each month during the fiscal year. A forty-hour unit is the equivalent of one employee working forty hours each work. Sales employees, who work on commission only, are excluded.\nSALES PER STORE: Net sales for the fiscal year divided by the average number of stores open at the end of each month during the fiscal year.\n(1) In fiscal 1992, the Company sold, without recourse, a portion of its written-off accounts to an affiliate. The effect of these transactions was to reduce the provision for credit losses by $1,001,000 and increase selling, general and administrative expenses by $494,000.\n(2) In the year ended February 28, 1994, the Company recorded an extraordinary charge, net of taxes, against net income of $2,727,000, or $(0.38) per share, which resulted from the early retirement of debt principally in connection with the Recapitalization.\n(3) Comparable store sales growth for fiscal 1994, excluding the results of three Florida stores that were favorably impacted in fiscal 1993 by increased sales following Hurricane Andrew, was 12.2% compared with fiscal 1993.\n(4) Comparable store sales growth for fiscal 1993, excluding the three Florida stores that were favorably impacted in fiscal 1993 by increased sales following Hurricane Andrew, was 6.2% for fiscal 1993 compared with fiscal 1992.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nGENERAL\nThe following table sets forth the unaudited pro forma results of operations as if the Recapitalization had been completed as of the beginning of fiscal 1994 and 1993. Additionally, fiscal 1993 was adjusted to reflect the Receivables Sale. There are no pro forma adjustments to the financial statements for year ended February 28, 1995. Management believes that these pro forma results present the most meaningful comparison of historical operating performance as a basis for understanding future operations.\nThe pro forma information for fiscal 1993 and 1994 does not purport to represent what the Company's results of operations would actually have been if such transactions had occurred on such dates or project the Company's results of operations for future periods. The pro forma adjustments are based upon currently available information and upon certain assumptions that management of the Company believes are reasonable under the circumstances.\nPRO FORMA RESULTS OF OPERATIONS (UNAUDITED)\nRESULTS OF OPERATIONS\nThe following table sets forth certain financial data expressed as a percentage of net sales for the fiscal years ended February 28, 1995, 1994 and 1993.\nFISCAL YEARS 1995 AND 1994 COMPARED - PRO FORMA BASIS\nNet sales increased 11.1% to $361,238,000 from $325,255,000 for fiscal 1995 compared with the prior fiscal year. Comparable store sales growth was 7.1% for fiscal 1995. Comparable store sales represent furniture and services sold and delivered by stores open for the same months in each comparative period. Operating income for fiscal 1995 of $25,632,000 (7.1% of net sales) increased 15.3% compared with $22,233,000 (6.8% of net sales) for the prior fiscal year. Net income for fiscal 1995 increased 26.5% to $11,519,000, or $1.18 per share, compared with $9,105,000, or $.92 per share for the prior year.\nDuring fiscal 1995 Rhodes opened three new stores in Atlanta, Georgia, one in Birmingham, Alabama, one in St. Louis, Missouri and one in Eustis, Florida, which was acquired in an exchange for the Company's three Miami stores. One store was also opened in Columbia, South Carolina to replace a store that was closed at the same time. The Company also lost one store to a fire in Jacksonville, Florida, bringing the total stores in operation at February 28, 1995 to 80, compared to 78 stores in operation at February 28, 1994. After fiscal year end, one new store was opened in the Jacksonville, Florida market and one of the two Jackson, Mississippi stores was closed and the real estate owned by the Company was sold. The Company plans to replace the Jackson, Mississippi store as soon as practical. The Company has leases signed on six additional stores and is in final lease negotiations for five more new stores, all of which are expected to open in the next fiscal year. Three of these six stores with completed leases will be located in Atlanta, Georgia, two in Charlotte, North Carolina, and one in Memphis, Tennessee (a new market). The Company plans to close several stores in fiscal 1996, most of which are stores in Atlanta which will be too close to new, larger stores. Sixteen stores were remodeled or refurbished in fiscal 1995 and the Company plans to remodel or refurbish approximately\nfifteen stores in fiscal 1996. The status of fourteen stores that have not been remodeled or scheduled for remodeling in fiscal 1996 has not yet been determined. Whether or not individual stores will be remodeled, refurbished or relocated will depend on a number of factors such as the lease terms, availability of expansion space in some cases, or suitable relocation space to lease.\nGross profit as a percentage of net sales for the year increased to 48.5% from 48.2%, compared with last year. The gross profit improvement is attributable to improved gross profit on furniture sales and improved sales penetration of extended warranties which have a higher gross profit.\nFinance charge and insurance commission income derives from commissions earned from BNB on new credit sales under the Merchant Agreement and from commissions on credit insurance on credit customer balances. Income increased due to additional insurance commissions earned on customers' accounts, partially offset by lower commissions earned from BNB.\nSelling expense for fiscal 1995 increased slightly as a percentage of net sales to 16.0% compared with 15.9% last year due to an increase in advertising expenses, which were offset, in part, by lower net costs on credit promotions charges. Selling expense varies as a percentage of sales due to a number of factors including the level of advertising, credit promotions and the opening of new stores.\nGeneral and administrative expenses for the year increased to $93,391,000 (25.9% of net sales) from $84,285,000 (25.9% of net sales) last year. The increased expense for the year is due to having seven new stores this year, less the three Miami stores sold in the second quarter plus increases in employee expenses. The net increases were the same percentage of sales due to increased sales volume.\nOther expense for fiscal 1995 includes an accrual of $375,000 in anticipation of the losses expected to be incurred upon closing two stores in fiscal 1996.\nInterest expense on the Company's indebtedness is generally fixed and is expected to decline slightly in future periods as such debt is reduced from internal cash flow.\nFISCAL YEARS 1995 AND 1994 COMPARED - HISTORICAL BASIS\nOn a historical basis, the results of fiscal 1995 are not comparable with the prior year due to the Recapitalization which took place on June 24, 1993. As a result of the Recapitalization, interest expense has been substantially reduced. The following information describes results of operations on a historical basis to the extent that the historical information differs significantly from the pro forma information set forth under \"Fiscal Years 1995 and 1994 Compared - Pro Forma Basis\".\nInterest expense for the year ended February 28, 1995 decreased to $6,109,000 compared with $11,545,000 for last year as a result of the Recapitalization and the related reduction in the Company's indebtedness.\nFISCAL YEARS 1994 AND 1993 COMPARED--PRO FORMA BASIS\nNet sales increased 13.5% to $325,255,000 from $286,527,000 for fiscal 1994 compared with the prior fiscal year. Comparable store sales growth was 10.0% for fiscal 1994. Comparable store sales growth, excluding the three stores that were favorably impacted in fiscal 1993 by increased sales following Hurricane Andrew, was 12.2% for fiscal 1994. Pro forma operating income for fiscal 1994 of $22,233,000 (6.8% of net sales) increased 68.6% compared with $13,186,000 (4.6% of net sales ) for fiscal 1993 on a net sales increase of $38,728,000. Pro forma net income before extraordinary item for fiscal 1994 increased 214% to $9,105,000, or $.92 per share, compared with $2,897,000, or $.30 per share, for the prior fiscal year.\nDuring fiscal 1994, Rhodes opened one new store in Chattanooga, Tennessee, acquired one new store in Knoxville, Tennessee and opened a new store in Clarksville, Indiana (a suburb of Louisville, Kentucky), to bring the total stores in operation to 78 compared with 76 stores in operation at February 28, 1993. The Company closed one store in Sarasota, Florida in January 1994, which closing had no adverse impact on the Company.\nGross profit as a percentage of net sales for fiscal 1994 increased to 48.2% from 47.5%, compared with fiscal 1993. Gross margin improvement is partially attributable to improved sales penetration of extended warranties, which have a higher gross profit. Also, the credit promotions discussed below permitted less discounting of selling prices, contributing to the higher gross profit percentage. Inventory turnover on a FIFO basis was 3.8x for each of the fiscal years 1994 and 1993. Inventories were approximately $10.9 million higher at February 28, 1994 than February 28, 1993 due to three more stores in operation and management's anticipation of an improved economic climate.\nFinance charge and insurance commission income derives from commissions earned from BNB under the Merchant Agreement and from commissions on credit insurance on credit customer balances. The amounts earned were down due to lower net yields on credit insurance commissions.\nSelling expense for fiscal 1994 declined substantially as a percentage of net sales to 15.9%, compared with 16.7% for fiscal 1993. The expense of interest-free and deferred payment credit promotions was more than off-set by reduced net advertising expenditures and reduced sales commissions compared with the prior year. Sales commissions have decreased as a percentage of net sales as a result of revisions made to the commission structure at the beginning of fiscal 1994.\nPro forma general and administrative expenses for fiscal 1994 increased to $84,285,000 (25.9% of net sales) from $77,218,000 (26.9% of net sales) for fiscal 1993. The increased expense is due to adding three new stores plus increases in employee expenses. The improvement in the percentage of net sales is due to the increased sales volume.\nInterest expense on the Company's indebtedness is generally fixed and is expected to decline slightly in future periods as such debt is reduced from internal cash flow.\nFISCAL YEARS 1994 AND 1993 COMPARED--HISTORICAL BASIS\nOn a historical basis, results for fiscal 1994 are not comparable with the prior fiscal year due to the Receivables Sale, which took place on June 18, 1992 and the completion of the Recapitalization, which took place on June 24, 1993. As a result of the Receivables Sale, the Company no longer earns finance charge income, and general and administrative expenses, credit losses and interest expense related to the credit operation have been eliminated. Also, as a result of the Recapitalization, interest expense has been substantially reduced. The following information describes results of operations on a historical basis to the extent that the historical information differs from the pro forma information set forth under \"Fiscal Years 1994 and 1993 Compared--Pro Forma Basis.\"\nFinance charges and insurance commissions income was $4,892,000 for fiscal 1994, compared with $13,853,000 for fiscal 1993. As a result of the Receivables Sale, the related finance charge income is no longer earned by the Company.\nGeneral and administrative expenses for the year ended February 28, 1994 increased to $84,404,000 (26.0% of net sales) from $81,432,000 (28.4% of net sales) for fiscal 1993 due to the cost of adding three new stores plus increases in employee expenses, partially offset by the elimination of the Company's credit operations following the Receivables Sale. The improvement in general and administrative expenses as a percentage of net sales is due principally to the increased sales volume.\nThe provision for credit losses of $4,803,000 reported for fiscal 1993 decreased to $213,000 for fiscal 1994 due to the Receivables Sale, which eliminated the Company's risk of credit losses on the customer credit accounts sold to BNB under the Merchant Agreement. As a result, the only credit loss expenses to the Company are write-offs associated with bankcard and check transactions.\nInterest expense for fiscal 1994 decreased to $11,545,000, compared with $24,306,000 for fiscal 1993 as a result of the Recapitalization and Receivables Sale and related reduction in the Company's indebtedness.\nIn fiscal 1994 the Company expensed certain charges incurred principally in connection with the Recapitalization. These extraordinary items represent non-recurring prepayment penalties of $2,624,000 for early retirement of debt and the write-off of $903,000 in related deferred loan costs, less income tax benefit of $800,000.\nSEASONALITY\nThe Company typically experiences its strongest sales in its third quarter. Gross profit margin is generally lower in the Company's second and fourth quarters, during which the Company conducts its clearance sales.\nEFFECTS OF INFLATION ON OPERATIONS\nAlthough the rate of inflation has remained low and has had little impact on the Company during the last three fiscal years ended February 28, 1995, the Company's operating results could be adversely affected by high rates of inflation. The area which could be most affected is the Company's cost to replenish inventory. An increase in the cost of inventory would be mitigated, however, to the extent the Company was able to pass along such costs to its customers through price increases. The Company's interest rate risk is limited to the variable rate of interest paid under the Revolving Credit Agreement.\nLIQUIDITY AND CAPITAL RESOURCES\nCurrently, the Company's principal sources of liquidity are cash flow from operations and additional borrowing capacity under its Revolving Credit Agreement. The Company had net cash provided by operating activities of approximately $25.9 million, $19.4 million and $6.2 million (adjusted for the short-term debt paydown related to the Receivables Sale), in fiscal years 1995, 1994 and 1993, respectively. The Company's principal uses of cash are capital expenditures, working capital needs and debt service obligations.\nOn June 24, 1993, the Company completed the Recapitalization to enhance the Company's strategic, financial and operating flexibility by increasing shareholders' equity and reducing indebtedness and interest expense. Management believes that the new capital structure provides sufficient cash flow to fund its planned expansion, remodeling, and refurbishing programs and debt service requirements. On June 18, 1992, the Company completed the Receivables Sale. The Company also contracted to sell all future receivables until June 1995, unless extended, under the Merchant Agreement (the term of which is extended automatically unless terminated by one of the parties), whereby BNB provides credit to customers under the Rhodes credit card name for future credit sales. This arrangement removed the need for Rhodes to fund that portion of the accounts receivable not financed by the commercial paper facility.\nAt the end of fiscal years 1995, 1994, and 1993, LIFO inventories were $54.4 million, $48.2 million, and $37.3 million, respectively. FIFO inventory turns in these years have decreased to 3.6x for fiscal 1995 from 3.8x in fiscal years 1994 and 1993. Inventories have been increased due to addition of new, larger stores and due to management's anticipation of a continued favorable economic climate. Also, accessory inventories were increased during fiscal 1995 from $6.8 million to $11.2 million to enhance the appearance of the furniture in the stores, which management believes has stimulated both furniture and accessory sales. The Company has historically had low or negative working capital, primarily as a result of its tight inventory controls, low cash balances and the inclusion in current liabilities of deferred revenues, such as merchandise sold but not delivered and deferred warranty revenue.\nThe Company made additions to property and equipment of approximately $14.1 million, $6.9 million and $3.4 million for fiscal years 1995, 1994 and 1993, respectively. These expenditures have been both for the opening of new stores and capital replacements in existing stores, including the remodeling completed for sixteen stores in fiscal 1995, sixteen stores in fiscal 1994 and four stores in fiscal 1993. Prior to the Recapitalization, the Company's capital expenditures were restricted by covenants contained in the various loan agreements and by the significant financial constraints imposed\nby its high debt and interest expense levels. Upon completion of the Recapitalization, the Company substantially increased its capital expenditures in fiscal 1994 (although capital expenditure funding continues to be subject to restrictions in the Senior Notes and Revolving Credit Agreement), and plans to spend approximately $17.0 million in fiscal 1996 and $14.0 million in 1997. Capital expenditures in excess of $15.0 million in any one year will require aproval under the Company's Revolving Credit Agreement. These increases reflect the cost of remodeling or refurbishing fifteen stores in 1996 and the addition of twenty-two new stores over the two year period. The Company does not plan to purchase any real estate in acquiring and opening new stores. The Company anticipates that these increased capital expenditures will be funded primarily from cash flow from operations. If the Company's cash flow from operations were insufficient to fund such capital expenditures, the Company would consider additional means to finance its remodeling and refurbishing and expansion programs or delaying or limiting such programs.\nIn connection with its previously announced intent to repurchase up to $5.0 million of its common stock from time to time, the Company had expended $3.7 million to repurchase 311,400 shares of its common stock as of February 28, 1995. The repurchase program was completed on March 20, 1995 with an aggregate of 436,000 shares of common stock repurchased at an aggregate cost of $5.0 million.\nThe Company's consolidated funded indebtedness at February 28, 1995 including obligations under capital leases, was $55.0 million, down from $60.8 million at February 28, 1994 and $145.7 million at February 28, 1993 due to the Recapitalization and the Receivables Sale and the payments previously described. Set forth below are the scheduled principal payments required under the Company's existing debt agreements.\nFiscal 1996 $0 Fiscal 1997 $7.5 million Fiscal 1998 $7.5 million\nThe maximum availability of funds under the Revolving Credit Agreement is the lesser of $30.0 million or 50% of eligible inventory. The Revolving Credit Agreement is secured by substantially all of the inventory of the Company. As of May 10, 1995, borrowings under the Revolving Credit Agreement were approximately $9.0 million and approximately $16.0 million remained available for borrowing. Loans outstanding under the Revolving Credit Agreement generally will bear interest at one of two interest rate options selected by the Company: (i) Prime Rate + .5% per annum or (ii) a quoted LIBOR + 2.375% per annum for specified interest periods. The \"Prime Rate\" is the rate of interest announced publicly by the lender, from time to time, as its prime rate. The Company is required to pay a commitment fee of 0.375% per annum of the average daily unused portion of the lender's commitment under the Revolving Credit Agreement. The Revolving Credit Agreement was scheduled to terminate in February 1996, but was renewed until February 27, 1997.\nThe Senior Notes consist of two tranches: (i) Tranche A Notes in the aggregate principal amount of $30 million which mature in June 1999 (subject to mandatory annual redemption payments of $7.5 million per year commencing in June 1996) and bear interest at a rate of 9% per annum, payable semiannually; and (ii) Tranche B Notes in the aggregate principal amount of $10 million, which mature in June 2000 and bear interest at a rate of 10% per annum, payable semiannually. The Senior Notes are secured by all real property owned by the Company.\nThe terms of the Revolving Credit Agreement and the Senior Notes impose restrictions that affect, among other things, the Company's ability to (i) incur certain additional indebtedness, (ii) create liens on assets, (iii) sell assets, (iv) engage in mergers or consolidations, (v) make investments, (vi) pay dividends and make distributions and (vii) engage in certain transactions with affiliates and subsidiaries. The Revolving Credit Agreement and the Senior Notes also require the Company to comply with certain specified financial ratios and tests.\nThe Company expects to continue to finance inventories, future expansion, debt service requirements and other cash needs with cash flow from operations supplemented by other potential sources of capital, principally the sources described above. Although there can be no assurance as to the availability of other sources of funding, management believes that internally generated funds and amounts available under the Company's existing credit facility will be sufficient to fund the Company's present and proposed operations and capital expenditure program.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nFinancial statements of the Company are set forth herein beginning on page.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nSee Item X hereof and incorporated herein by reference to the annual proxy statement relating to the 1995 annual meeting of shareholders of the Company.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nIncorporated by reference to the annual proxy statement relating to the 1995 annual meeting of shareholders of the Company.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nIncorporated by reference to the annual proxy statement relating to the 1995 annual meeting of shareholders of the Company.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND TRANSACTIONS\nIncorporated by reference to the annual proxy statement relating to the 1995 annual meeting of shareholders of 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\nThe following financial statements (beginning on page -) are filed under Item 8 of this Annual Report:\nReport of Independent Public Accountants\nConsolidated balance sheets as of February 28, 1995 and February 28, 1994\nConsolidated statements of operations for the years ended February 28, 1995, February 28, 1994 and February 28, 1993\nConsolidated statements of shareholders' equity for the years ended February 28, 1995, February 28, 1994 and February 28,\nConsolidated statements of cash flows for the years ended February 28, 1995, February 28, 1994 and February 28, 1993\nNotes to consolidated financial statements for the years ended February 28, 1995, February 28, 1994 and February 28, 1993\n2. The following financial statement schedules (beginning on page -) are filed as part of this Annual Report:\nReport of Independent Public Accountants\nSchedule II - Valuation and qualifying accounts for the three years ended February 28, 1995\n3. Exhibits.\nThe Exhibits listed in (c) below are filed as part of this Annual Report.\n(b) Reports on Form 8-K\nNone\n(c) Exhibits\nEXHIBIT NUMBER DESCRIPTION - ------ ----------- 3.1 -- Restated and Amended Articles of Incorporation of the Registrant dated as of April 8, 1993 (incorporated by reference to Exhibit 3.1 to Registrant's Registration Statement on Form S-1, as amended (File No. 33-60962)).\n3.2 -- Amended Bylaws of the Registrant dated as of April 7, 1993 (incorporated by reference to Exhibit 3.2 to Registrant's Registration Statement on Form S-1, as amended (File No. 33-60962)).\n4.1 -- Loan and Security Agreement (the \"Loan and Security Agreement\") dated as of February 24, 1994 between the the Registration and Wachovia Bank of Georgia, N.A. and Master Note between the Registrant payable to Wachovia Bank of Georgia, N.A. as of February 24, 1994 (incorporated by reference to Exhibit 4.2 to Registrant's Annual Report on Form 10-K for the fiscal year ended February 28, 1994).\n4.2 -- Letter of Extension, dated November 9, 1994, of Loan and Security Agreement and First Amendment to the Loan and Security Agreement, dated January 4, 1995.\n4.3 -- Form of Note Purchase Agreement between the Company, Sun Life Insurance Company of America, The Equitable Private Income and Equity Partnership II, L.P., The Life Insurance Company of Virginia and Protective Life Insurance Company (incorporated by reference to Exhibit 10.25 to the Registrant's Registration Statement on Form S-1, as amended (File No. 33-60962)).\n10.1 -- Rhodes, Inc. Employees' Savings Plan (incorporated by reference to Exhibit 10.6 to Registrant's Annual Report on Form 10-K for the year ended February 28, 1986).\n10.2 -- Form of Exchange Agreement by and between Rhodes, Inc. and Green Capital Investors, L.P. (incorporated by reference to Exhibit 10.9 to Registrant's Registration Statement on Form S-1, as amended (File No. 33-60962)).\n10.3 -- Rhodes, Inc. 1991 Stock Option Plan (incorporated by reference to Exhibit 10.35 to Registrant's Annual Report on Form 10-K for the year ended February 28, 1991).\n10.4 -- Master Note by RHD Holdings Corp. (predecessor to the Registrant) payable to Green Capital Investors, L.P., dated as of December 15, 1989 (incorporated by reference to Exhibit 10.37 to Registrant's Annual Report on Form 10-K for the year ended February 28, 1991).\n10.5 -- First Amendment to Master Note by RHD Holdings Corp. (incorporated by reference to Exhibit 10.14 to Registrant's Registration Statement on Form S-1, as amended (File No. 33-60962)).\nEXHIBIT NUMBER DESCRIPTION - ------ -----------\n10.6 -- Policy issued by Life Insurance Company of North America, dated March 1, 1989 covering the Rhodes, Inc. Employee Disability Plan (incorporated by reference to Exhibit 10.38 to Registrant's Annual Report on Form 10-K for the year ended February 28, 1991).\n10.7 -- Form of Compensation (changes and controls) Agreement between Irwin L. Lowenstein and Rhodes, Inc.\n10.8 -- Merchant Agreement by and between Beneficial National Bank USA and Rhodes, Inc., dated as of May 15, 1992 (incorporated by reference to Exhibit 10.42 to Registrant's Annual Report on Form 10-K for the year ended February 29, 1992).\n10.9 -- Form of Option Agreement between the Registrant and James V. Napier (incorporated by reference to Exhibit 10.23 to the Registrant's Registration Statement on Form S-1, as amended (File No. 33-60962))\n10.10 -- Form of Option Agreement between the Registrant and Don L. Chapman (incorporated by reference to Exhibit 10.24 to the Registrant's Registration Statement on Form S-1, as amended (File No. 33-60962))\n11 -- Rhodes, Inc. Computation of Net Income Per Share\n21 -- List of subsidiaries of the Registrant (incorporated by reference to Exhibit 22 to Registrant's Registration Statement on Form S-1, as amended (File No. 33-60962))\n23(a) -- Consent of Independent Public Accountants\n27 -- Financial Data Schedule (for SEC use 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.\nRHODES, INC.\nBy: \/s\/ JOEL H. DUGAN ------------------ Joel H. Dugan Senior Vice President, Finance and Administration Date: May 25, 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:\nPRINCIPAL EXECUTIVE OFFICER:\n\/s\/ IRWIN L. LOWENSTEIN - ---------------------------- Irwin L. Lowenstein Chairman of the Board and Chief Executive Officer Date: May 25, 1995\nPRINCIPAL OPERATING OFFICER:\n\/s\/ JOEL T. LANHAM - ---------------------------- Joel T. Lanham President and Chief Operating Officer Date: May 25, 1995\nPRINCIPAL FINANCIAL OFFICER:\n\/s\/ JOEL H. DUGAN - ---------------------------- Joel H. Dugan Senior Vice President, Finance and Administration Date: May 25, 1995\nPRINCIPAL ACCOUNTING OFFICER:\n\/s\/ BARBARA SNOW - ---------------------------- Barbara Snow Vice President and Corporate Controller Date: May 25, 1995\nDIRECTORS:\n\/s\/ IRWIN L. LOWENSTEIN - ---------------------------- Irwin L. Lowenstein Date: May 25, 1995\n\/s\/ HOLCOMBE T. GREEN, JR. - ---------------------------- Holcombe T. Green, Jr. Date: May 25, 1995\n\/s\/ JAMES R. KUSE - ---------------------------- James R. Kuse Date: May 25, 1995\n\/s\/ JAMES V. NAPIER - ---------------------------- James V. Napier Date: May 25, 1995\n\/s\/ DON L. CHAPMAN - ---------------------------- Don L. Chapman Date: May 25, 1995\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTO THE BOARD OF DIRECTORS AND THE SHAREHOLDERS OF RHODES, INC.\nWe have audited the accompanying consolidated balance sheets of Rhodes, Inc. (a Georgia corporation) and subsidiaries as of February 28, 1995 and 1994 and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended February 28, 1995. 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 Rhodes, Inc. and subsidiaries as of February 28, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended February 28, 1995 in conformity with generally accepted accounting principles.\nARTHUR ANDERSEN LLP\nAtlanta, Georgia April 21, 1995\nRHODES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)\nThe accompanying notes are an integral part of these consolidated balance sheets.\nRHODES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA)\nThe accompanying notes are an integral part of these consolidated statements.\nRHODES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (IN THOUSANDS)\nThe accompanying notes are an integral part of these consolidated statements.\nRHODES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)\nThe accompanying notes are an integral part of these consolidated statements.\nRHODES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FEBRUARY 28, 1995, 1994 AND 1993\n1. STATEMENT OF SIGNIFICANT ACCOUNTING POLICIES AND OTHER MATTERS\nINTRODUCTION\nOn September 20, 1988, Rhodes Acquisition Corp., a wholly owned subsidiary of RHD Holdings Corp. (\"RHD Holdings\" or \"RHD\"), was merged with and into Rhodes, Inc. (\"Rhodes\" or the \"Company\"), in which merger (the \"Acquisition\") Rhodes was the surviving corporation. As a result of the Acquisition, Rhodes became a wholly owned subsidiary of RHD Holdings. For financial statement purposes, the Acquisition was accounted for by the purchase method of accounting effective September 21, 1988. Upon approval by the board of directors of the Company and RHD Holdings on June 11, 1991, the Company and RHD Holdings entered into an Agreement and Plan of Merger, which provided for the merger of RHD Holdings with and into the Company. Rhodes was the surviving corporation in the 1991 Merger.\nINITIAL PUBLIC OFFERING\nIn April 1993, the Company's board of directors approved a plan of recapitalization (the \"Recapitalization\") whereby it would offer a certain number of shares of Common Stock for sale to the public (the \"Offering\") and Green Capital Investors, L.P. (\"Green Capital\") would exchange its Class A Preferred Stock (including accumulated, unpaid dividends) and Junior Discount Subordinated Redeemable Debentures Due 2000 for Common Stock of the Company (the \"Exchange\"), at an exchange price equal to the stock price in an initial public offering. The Company effected a 1.8-for-1 stock split of the Company's Common Stock prior to the Offering. As a part of the Recapitalization, the Company also refinanced and repaid certain of its outstanding debt.\nAs a result of the Recapitalization, the Company recorded the accumulated, unpaid Class A Preferred Stock dividends of $4,181,000 as of February 28, 1993 in the accompanying financial statements. Because of the Company's accumulated deficit, the dividends were recorded as a reduction of Paid-in Capital. Also, all share and per share amounts in the accompanying financial statements were restated to reflect the 1.8-for-1 stock split.\nIn conjunction with the above, the Company also increased the number of authorized shares of Common Stock to 20,000,000.\nBASIS OF PRESENTATION\nThe consolidated financial statements of Rhodes include the accounts of the Company and all subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures 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.\nRECLASSIFICATION\nCertain reclassifications of prior years' amounts have been made to conform with the current year's presentation.\nBUSINESS SEGMENT\nThe Company has one business segment consisting of the retail sale of home furnishings.\nINSTALLMENT RECEIVABLES AND REVENUE RECOGNITION\nAll merchandise sales are recorded upon delivery of furniture. As a result of the Receivables Sale (see Note 10), accounts receivable consists primarily of miscellaneous receivables from customers and amounts awaiting funding.\nFinance commissions following the sale of installment receivables are recognized for the sale of certain installment contracts to Beneficial National Bank USA (\"BNB\") (see Note 10). Finance charge income previously earned by the Company on installment receivables is no longer earned following the Receivables Sale.\nThe Company offers credit insurance coverage through third parties in connection with its furniture sales and earns monthly commissions.\nINVENTORIES\nInventories are stated at the lower of cost (last in, first out method - -- LIFO) or market.\nFAIR VALUE OF FINANCIAL INSTRUMENTS\nThe Company's financial instruments are stated at their fair value in the accompanying financial statements at February 28, 1994; at February 28, 1995 the Company's financial instruments are stated at their fair value with the exception of long-term debt (see Note 3).\nPROPERTY AND EQUIPMENT\nDepreciation is provided using the straight-line method for financial reporting and accelerated methods for income tax purposes. The ranges of annual depreciation percentages, which reflect estimated useful lives, are as follows: buildings--2% to 4% and equipment and other assets--10% to 25%. Capitalized real estate leases are amortized on a straight-line basis over the terms of the leases which range from 18 to 25 years. Leasehold improvements are amortized over the life of the asset or the lease term, whichever is shorter. Repair and maintenance costs are expensed as incurred.\nProperty and equipment are summarized as follows:\nCapitalized real estate leases are summarized as follows:\nINTANGIBLE ASSETS\nGoodwill represents the excess of the purchase price over identifiable assets acquired at the time of the Acquisition and is being amortized on a straight-line basis over 40 years. Amortization expense for goodwill totaled $1,798,000 for fiscal 1995, 1994, and 1993. Accumulated amortization for goodwill totaled $11,590,000 and $9,792,000 as of February 28, 1995 and 1994, respectively. Subsequent to the Acquisition, the Company continually evaluates whether events and circumstances have occurred which would indicate the remaining estimated useful life of goodwill may warrant revision. When factors indicate that goodwill should be evaluated for possible impairment, the Company uses an estimate of undiscounted net income over the remaining life of the goodwill in measuring whether the goodwill is recoverable.\nFavorable leases represent the difference between market rates and contract rates of store leases as of the time of the Acquisition and are being amortized over the remaining terms of the leases. Amortization expense for favorable leases totaled $953,000, $1,091,000 and $1,149,000 for fiscal 1995, 1994, and 1993, respectively. Accumulated amortization for favorable leases totaled $7,646,000 and $6,752,000 as of February 28, 1995 and 1994, respectively.\nOther intangibles include deferred loan costs incurred in connection with the Acquisition and subsequent refinancing, which are being amortized over the terms of the applicable debt. Amortization expense for these items (exclusive of the fiscal 1994 write-off of loan costs related to the Recapitalization (see Note 11)) for fiscal 1995, 1994, and 1993, totaled approximately $323,000, $190,000 and $306,000, respectively. Accumulated amortization for deferred loan costs totaled $690,000 and $367,000 as of February 28, 1995 and 1994, respectively.\nWARRANTY CONTRACTS\nThe Company markets extended warranty contracts to its customers on certain merchandise at the time of the initial sale. Extended warranty contract revenue is deferred and recognized over the contract period on a straight-line or other reasonable basis. The Company is recognizing such income based on its historical data on service and repair claims. Historical data on service and repair claims is updated periodically and the income recognition on warranties is adjusted accordingly. As a result, net warranty sales of $1,878,000, $1,587,000, and $1,272,000 less net direct expenses of $413,000, $349,000, and $280,000, respectively, were deferred to future periods in fiscal 1995, 1994, and 1993, respectively.\nEARNINGS PER SHARE\nThe historical net income (loss) per common share is calculated by dividing net income (loss) applicable to Common Stock by the weighted average shares of Common Stock outstanding. All stock options were antidilutive for earnings per share calculations for fiscal 1995, fiscal 1994 and fiscal 1993.\nUnaudited pro forma earnings per share in the consolidated statement of operations are presented on a pro forma basis assuming the Recapitalization and the Receivables Sale had taken place at the beginning of the periods for February 28, 1994 and 1993.\n2. FEDERAL AND STATE INCOME TAXES\nThe Company follows Statement of Financial Accounting Standards (\"SFAS\") No. 109, \"Accounting for Income Taxes\". SFAS No. 109 requires the determination of deferred income taxes using the liability method under which deferred tax assets and liabilities are determined based on the differences between the financial accounting and tax basis of assets and liabilities. Deferred tax assets or liabilities at the end of each period are determined using the currently enacted tax rate expected to apply to taxable income in the periods in which the deferred tax asset or liability is expected to be settled or realized.\nThe components of the net deferred tax liability are as follows:\nThe net deferred tax liabilities are classified on the Company's balance sheets as follows:\nThe sources of the difference between the financial accounting and tax basis of the Company's assets and liabilities which give rise to the deferred tax liabilities and deferred tax assets and the tax effects of each are as follows:\nThe Company has established a valuation allowance of $2.9 million as of February 28, 1995 and 1994 because of the uncertainty regarding the realizability of certain deferred tax assets.\nThe consolidated provision (benefit) for income taxes before extraordinary item consists of the following:\nThe tax provision (benefit) differed from the amounts resulting from multiplying the income (loss) before income taxes and extraordinary item by the statutory federal income tax rates. The reasons for these differences were as follows:\nAs of February 28, 1995, the Company had net operating losses available to be carried forward or carried back of approximately $6,200,000, which expire beginning in the year 2006.\n3. LONG-TERM DEBT\nThe aggregate annual payments required for the above notes during each of the next five fiscal years are as follows:\nFAIR VALUE OF DEBT\nIn accordance with SFAS No. 107, \"Disclosures About Fair Value of Financial Investments,\" the fair value of short-term debt is estimated to be its carrying value. The fair value of long-term debt is estimated based on approximate market interest rates for similar issues. The estimated fair value of long-term debt at February 28, 1995 was approximately $41,300,000 and at February 28, 1994 the estimated fair value of long-term debt was equal to the carrying amount included in the accompanying balance sheet.\nTERMS\nThe Senior Secured Notes consist of two tranches: (i) Tranche A Notes in the aggregate principal amount of $30 million which mature in June 1999 (subject to mandatory annual redemption payments of $7.5 million per year commencing in June 1996) and bear interest at a rate of 9% per annum, payable semiannually; and (ii) Tranche B Notes in the aggregate principal amount of $10 million, which mature in June 2000 and bear interest at a rate of 10% per annum, payable semiannually. The Senior Secured Notes are secured by all real property owned by the Company.\nOn November 20, 1991, the Company signed an agreement of renewal and extension of the 10% mortgage note. The new repayment terms called for 24 consecutive quarterly installments in the amount of $125,000 payable beginning September 1, 1992 and a final payment of $145,000 due September 1, 1998. The note was secured by property having an original cost of $3,700,000. The 10% mortgage note was prepaid in full on July 22, 1994.\nThe terms of the revolving loan (see Note 8) and the Senior Secured Notes impose restrictions that affect, among other things, the Company's ability to (i) incur certain additional indebtedness, (ii) create liens on assets, (iii) sell assets, (iv) engage in mergers or consolidations, (v) make investments, (vi) pay dividends and make distributions, and (vii) engage in certain transactions with affiliates and subsidiaries. The revolving loan and the Senior Secured Notes also require the Company to comply with certain specified financial ratios and tests. The Company was in compliance with the restrictive covenants at February 28, 1995.\n4. INVENTORIES\nThe Company uses the LIFO method for valuing inventories in order to more closely match current costs with related revenue. Under this method, current costs are charged to cost of sales through application of Department Store Price Indices published by the Bureau of Labor Statistics. If LIFO inventories were valued at current costs, the inventory amounts would have been $2,383,000 and $1,282,000 higher than those reported as of February 28, 1995 and 1994, respectively.\nAs discussed in Note 8, the Company has a revolving loan with a bank, which is secured by a priority lien on the Company's inventories.\n5. COMMITMENTS AND CONTINGENCIES\nOPERATING LEASES\nThe Company leases certain store locations under operating lease agreements with various expiration dates through 2023. Rentals under all store leases were approximately $11,901,000, $10,464,000, and $9,651,000 for fiscal 1995, 1994, and 1993, respectively. As of February 28, 1995, the minimum obligations under lease commitments with original terms beyond one year are as follows:\nCertain of the leases above are renewable at the Company's option, and some contain clauses requiring payment of contingent rentals based upon sales in excess of specified amounts. Contingent rental amounts based on sales are immaterial.\nCONTINGENCIES\nOn April 17, 1995, several individuals, as members of a purported plaintiff class of customers, filed suit in the Circuit Court of Jefferson County, Alabama against the Company and certain other defendants alleging improper practices relating to extended warranty contracts. In their prayer for relief, the plaintiffs seek damages equal to all principal and finance charges under the credit agreements in question, a judgment voiding the credit agreements, injunctive relief, the reimbursement of all costs associated with the action, other compensatory damages and unspecified punitive damages. The Company believes that its practices with respect to extended service contracts comply with Alabama law and it intends to vigorously defend this action.\nThe Company is subject to claims and lawsuits arising in the normal course of business. It is the opinion of management that any such claims will not have a material adverse effect on the financial position or results of operations of the Company.\nThe Company has a compensation (change in control) agreement with its Chairman and Chief Executive Officer. Under such agreement, severance payments and benefits would become payable under certain events, such as change of control (as defined) of the Company. The maximum contingent liability of the Company at February 28, 1995 is approximately $3 million.\n6. CAPITAL LEASES\nCertain of the property and equipment used in the Company's business is leased under capital leases. In prior years, the Company completed sale and leaseback agreements on nine stores previously owned and operated by the Company with terms ranging from 18 to 25 years and options to renew for additional periods. Equipment leases are for terms of up to seven years.\nThe following is a schedule by fiscal year of the future minimum lease payments on these leases together with the present value of net minimum lease payments as of February 28, 1995:\n7. EMPLOYEE BENEFIT PLANS\nThe Company has a defined benefit pension plan covering substantially all employees. The Company's policy is to fund amounts necessary to satisfy the requirements of the Employee Retirement Income Security Act of 1974.\nThe pension cost for the defined benefit plan for fiscal 1995, 1994, and 1993 includes the following components:\nThe funded status of the defined benefit plan as of February 28, 1995 and February 28, 1994 is as follows:\nThe projected benefit obligation was calculated using an 8.75% and 8.0% assumed discount rate as of February 28, 1995 and 1994, respectively, and an assumed long-term compensation increase rate of 4.9% in fiscal 1995 and fiscal 1994. Pension expense was determined using an 8% and 9% assumed long-term rate of return on plan assets for the years ended February 28, 1995 and 1994, respectively. At February 28, 1995, plan assets consisted primarily of equity securities (54%), fixed income securities (29%) and money market instruments (17%).\nThe Company has an employees' savings plan. Under the provisions of this plan, the Company will match 50% of employee contributions which are limited to a maximum of 6% of pay. The Company's savings plan expense was $400,000, $345,000 and $365,000 in fiscal 1995, 1994 and 1993, respectively.\nPrior to the consummation of the Acquisition, the board of directors and stockholders of RHD Holdings adopted a non-qualified restricted stock option plan (the \"Stock Option Plan\") which provided for the granting of options to officers and key employees of RHD Holdings and its subsidiaries to acquire an aggregate of up to 300,000 shares of RHD Holdings' common stock at an exercise price of not less than $0.01 per share. Upon consummation of the 1991 Merger, all options outstanding under the Stock Option Plan (options to purchase 284,800 shares of RHD common stock (the \"Plan Options\")), along with options to purchase an aggregate of 23,095 shares of RHD common stock granted outside the Stock Option Plan (the \"Substitution Options\"; the Substitution Options and the Plan Options are referred to collectively as the \"Options\") at an exercise price of $0.08 per share, were assumed by the Company and converted into options to purchase an adjusted amount of 53,702 shares of Common Stock at an exercise price of $0.04 per share. No additional options may be granted under the Stock Option Plan. An expense in the amount of $150,000, net of canceled options, is recorded for the accretion of the value of these Plan Options in each year over the five-year period during which they become exercisable. All options under the Stock Option Plan were exercised during fiscal 1994.\n1991 STOCK OPTION PLAN\nOn June 11, 1991, the Company's board of directors adopted the Rhodes, Inc. Stock Option Plan (the \"1991 Stock Option Plan\"), pursuant to which options to purchase Common Stock (\"1991 Options\") may be granted to eligible employees. The purpose of the 1991 Stock Option Plan is to provide an incentive for such employees to work to increase the value of the Company's capital stock and to provide such employees with a stake in the future of the Company which corresponds to the stake of each of the Company's stockholders.\nAs of February 28, 1995, a maximum of 700,000 shares of Common Stock may be issued under the 1991 Stock Option Plan. The Plan allows for the grant of either qualified incentive stock options (\"ISO\", as defined by the Internal Revenue Code) or non-qualified options (\"Non-ISO\"). At February 28, 1995, options to acquire 694,000 shares of common stock were outstanding under the 1991 Stock Option Plan.\nThe option price of each 1991 Option is set by a committee of the Board of Directors subject to certain limitations. The option price for an ISO may not be less than the fair market value (or for a stockholder holding stock possessing more than 10% of the total combined voting power of all classes of stock of the company (a \"Ten Percent Stockholder\"), 110% of the fair market value) of Common Stock on the date the ISO is granted. The option price for a Non-ISO may be more than, less than or equal to the fair market value of such stock on the date the Non-ISO is granted but may not be less than an amount which the Committee determines to be adequate consideration. The options carry a 5 year vesting period.\nAlso, options to purchase an additional 15,000 shares of Common Stock have been granted to certain directors of the Company.\nThe following table details the Company's stock option activity for the past three fiscal years:\n8. SHORT-TERM DEBT\nNOTES AND LOANS PAYABLE\nAt February 28, 1993, the Company had a revolving credit facility with Security Pacific Business Credit, Inc. (\"SPBC\"), which was secured by a priority lien on the Company's inventory. Effective December 7, 1992, the Company and SPBC agreed to the extension of the revolving loan agreement until November 30, 1994 with automatic annual renewals thereafter unless 60 days' written notice of non-renewal was given by either party.\nOn February 24, 1994, the Company cancelled its revolving credit facility with SPBC and entered into a revolving credit agreement (\"Revolving Credit Agreement\") with Wachovia Bank of Georgia, N.A. (the \"Senior Lender\"). The maximum availability of funds under the Revolving Credit Agreement is the lesser of $30 million or 50% of eligible inventory. The Revolving Credit Agreement is secured by substantially all of the inventory of the Company. Loans outstanding under the Revolving Credit Agreement generally will bear interest at one or two interest rate options selected by the Company: (i) Prime Rate + .5% per annum or (ii) a quoted LIBOR + 2.375% per annum for specified interest periods. The Company is required to pay a commitment fee of 0.375% per annum of the average daily unused portion of the Senior Lender's commitment under the Revolving Credit Agreement. The Revolving Credit Agreement was scheduled to terminate in February 1996, but has been extended to February 24, 1997. At February 28, 1995 the Company had no loans outstanding under the Revolving Credit Agreement. The amount available under the Revolving Credit Agreement at February 28, 1995 is $21,783,000.\nThe revolving loan has, among other restrictions, covenants whereby the Company must meet certain goals with respect to cash interest coverage, fixed charge coverage, and profit after taxes plus amortization of intangibles. These goals, expressed in terms of defined minimum ratios and amounts, become more restrictive over the term of the loan agreement. The agreement also provides, among other things, limitations on the Company's ability to incur debt (including lease obligations); to make capital expenditures; to enter into transactions involving mergers, consolidations, acquisitions or sales; or to declare, pay or make any dividend or other distribution of property with respect to its capital stock.\nIncluded in interest expense for fiscal 1995, 1994, and 1993 is interest of $294,000, $506,000, and $2,796,000, respectively, related to short-term debt.\n9. RELATED-PARTY TRANSACTIONS\nIn June 1993, the Company consummated the Recapitalization, pursuant to which the Company issued 2,859,115 shares of Common Stock to Green Capital, an affiliate of Holcombe T. Green, Jr., in exchange for outstanding indebtedness of the Company to Green Capital having an accreted value of $34.3 million. The Company also issued 1,221,666 shares of Common Stock to Green Capital in exchange for preferred stock of the Company with a stated value of $10.0 million and accrued and unpaid dividends aggregating $4.7 million. In addition, Green Capital purchased 250,000 shares in the public offering which was part of the Recapitalization.\nGreen Capital previously maintained an unsecured line of credit for the Company of up to $10.0 million for working capital purposes, and has advanced funds to the Company from time to time to meet short-term cash needs. Interest is payable monthly at a floating interest rate equal to the prime rate plus 2%. The line of credit was terminated upon execution by the Company of the Revolving Credit Agreement on February 24, 1994. The maximum amount outstanding in the period beginning March 1, 1991 and ending February 24, 1994 was $7.8 million and total interest paid to Green Capital during such period was $478,000.\nIn December, 1993, January, February, and December, 1994 and January, 1995, the Company had outstanding advances to Green Capital in varying amounts, with the largest principal amount outstanding at any time being $3.0 million. Interest accrued on outstanding principal at a rate of 8% or 10% per annum, and total interest paid by Green Capital to the Company for these advances was approximately $22,000. No advances were outstanding as of February 28, 1995 or 1994.\nOn June 28, 1990, the Company entered into a $40.0 million secured term loan with Jackson National Life Insurance Company (\"Jackson National\"), secured by all real estate and certain other personal property of the Company, excluding inventories. Interest accrued on the outstanding principal at a rate of 12% per annum. At the time of the loan, Jackson National owned more than 5% of the common stock of the Company and $35.0 million of the $40.0 million outstanding 15% Senior Subordinated Notes due September 20, 1998 of the Company (the \"15% Notes\"). In connection with the Recapitalization, the 12% Secured Term Loan and 15% Notes were repaid and Jackson National and the other holders of the 15% Notes consented to the prepayment of the 15% Notes in consideration of $2.6 million of prepayment penalties, $2.3 million of which was paid to Jackson National (see Note 11).\nPursuant to an agreement dated November 15, 1991 between the Company and Bankers Fidelity, an affiliate of Atlantic American Corporation, Bankers Fidelity exchanged 17% Junior Discount Subordinated Debentures due 2000 (the \"17% Debentures\") owned by it having an aggregate stated face amount of $10.2 million for an aggregate of 485,398 newly issued shares of Common Stock (an exchange rate of 47.7613 shares of Common Stock for each $1,000 stated face amount of 17% Debentures). On November 18, 1991, Green Capital acquired all such shares of Common Stock from Bankers Fidelity for a purchase price of $3.0 million, thereby increasing the beneficial ownership by Holcombe T. Green, Jr. and Green Capital of the outstanding Common Stock of the Company at that time to 80.2% and 56.6%, respectively. During June and July 1992, Green Capital purchased from Atlantic American Corporation and affiliates 17% Debentures having an aggregate face value of $20.1 million for an aggregate purchase price of $6.0 million.\nFor the period from July 1990 through the date of the Recapitalization, the Company had paid RHD Investors a monthly fee of $33,333 for management services, including financial and strategic planning. Prior to July 1990, the monthly management fee was $20,833. Although Holcombe T. Green, Jr., who through affiliates controls RHD Investors, personally devoted substantial efforts on the Company's behalf in his capacity as Chairman of the Board of the Company, Mr. Green received no directors' fees or other compensation from the Company. Payment of the monthly management fee terminated effective upon consummation of the Recapitalization. Upon Mr. Lowenstein becoming Chairman of the Board of Directors in July, 1994, Mr. Green began to receive the same remuneration as the other outside directors.\nOn March 24, 1994 affiliates of Mr. Holcombe T. Green, Jr., Chairman of the Board and beneficial owner of 52.8% of the outstanding common stock of the Company, sold 2,240,494 shares in a secondary offering at $18.50 per share. Jackson National Life sold 248,880 shares in the same offering. Consummation of the sale reduced Mr. Green's beneficial ownership to 29.8%. No shares were sold by the Company in this offering. Upon consummation of the secondary offering, the Company became listed on the New York Stock Exchange.\n10. SALE OF INSTALLMENT RECEIVABLES PORTFOLIO\nOn May 15, 1992, Rhodes and its wholly owned subsidiary, Rhodes Financial Services Corp. (\"Rhodes Financial\"), entered into a definitive agreement to sell to Beneficial National Bank USA all outstanding customer installment receivables in the approximate amount of $174,000,000 (the \"Receivables Sale\"). The Receivables Sale was completed on June 18, 1992 (the \"Closing Date\"). The Company also contracted to sell all future receivables for the next three years in an on-going merchant agreement (\"Merchant Agreement\") whereby BNB will provide Rhodes with its private label credit facility for future credit sales. This arrangement removed the need for Rhodes to fund that portion of the accounts receivable not financed by the commercial paper facility and eliminated the risks from credit losses and interest rate fluctuations on its accounts receivable portfolio. The Merchant Agreement is subject to early termination by BNB in the event of a bankruptcy filing by or against Rhodes or upon 30 days notice in the event of a material change in any law or regulation or in the operation, assets, condition (financial or otherwise), business or ownership of Rhodes. After the initial three-year term, the Merchant Agreement remains in effect unless terminated by either party on 180 days notice. BNB has no recourse against the Company for the accounts receivable acquired under the Receivables Sale or under the Merchant Agreement.\nRhodes received $170,006,000 or approximately 97.77% of the balance of the outstanding accounts receivable in cash on the Closing Date and, in addition, received approximately $4,262,000, net of a $500,000 contingency deposit, in advances against future revenue to Rhodes to be earned under the on-going Merchant Agreement. Under the Merchant Agreement, Rhodes continues to receive the credit insurance commission income and a commission on certain classes of credit sales sold to BNB.\nThe net proceeds of the Receivables Sale are set forth below:\nThe net proceeds were used to pay down the Company's existing lines of credit and to repay the outstanding balance of an industrial revenue bond.\nThe effect of the Receivables Sale on fiscal 1993 loss before income taxes is set forth below:\nUnder its on-going Merchant Agreement with BNB, Rhodes continues to offer the Rhodes Credit Card on substantially the same terms to customers.\nThe following provides the historical results of the Company's credit operations for the fiscal year 1993 before the Receivables Sale:\n11. EXTRAORDINARY ITEM\nDuring fiscal 1994, the Company expensed certain charges incurred principally in connection with the Recapitalization (see Note 1). These extraordinary items represent nonrecurring prepayment penalties of $2,624,000 for early retirement of debt and write-off of $903,000 in related deferred loan costs, less an income tax benefit of $800,000.\n12. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)\nThe following table sets forth a summary of the quarterly unaudited results of operations for the years ended February 28, 1995 and 1994:\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTO THE BOARD OF DIRECTORS AND THE SHAREHOLDERS OF RHODES, INC.\nWe have audited in accordance with generally accepted auditing standards the consolidated financial statements of Rhodes, Inc. and subsidiaries included in this Form 10-K and have issued our report thereon dated April 21, 1995. Our audits were made for the purpose of forming opinions on the basic financial statements taken as a whole. The schedule listed in Item 14(a)(2) in this Form 10-K is the responsibility of the Company's management and is presented for purposes of complying with the Security and Exchange Commission's Rules and Regulations and is not a required part of the basic financial statements. This information has been subjected to the auditing procedures applied in our audits of the basic financial statements and, in our opinion, is fairly stated in all material respects in relation to the basic financial, statements taken as a whole.\nARTHUR ANDERSEN LLP\nAtlanta, Georgia April 21, 1995\nRHODES, INC. AND SUBSIDIARIES SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS FOR THE THREE YEARS ENDED FEBRUARY 28, 1995 (IN THOUSANDS)\n(A) Charges to the allowance for purposes for which the allowance was created.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nRHODES, INC. 1994 EMPLOYEE STOCK PURCHASE PLAN:\nWe have audited the accompanying statement of net assets available for purchase of stock of Rhodes, Inc. 1994 Employee Stock Purchase Plan as of February 28, 1995 and the related statement of changes in net assets available for purchase of stock for the period from September 1, 1994 (date of inception) to February 28, 1995. These financial statements are the responsibility of the Plan's management. Our responsibility is to express an opinion on these financial statements based on our 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 net assets available for purchase of stock of Rhodes, Inc. 1994 Employee Stock Purchase Plan at February 28, 1995 and the changes in net assets available for purchase of stock for the period from September 1, 1994 (date of inception) to February 28, 1995 in conformity with generally accepted accounting principles.\nARTHUR ANDERSEN LLP\nAtlanta, Georgia April 21, 1995\nRHODES, INC. 1994 EMPLOYEE STOCK PURCHASE PLAN\nSTATEMENT OF NET ASSETS AVAILABLE FOR PURCHASE OF STOCK\nSTATEMENT OF CHANGES IN NET ASSETS AVAILABLE FOR PURCHASE OF STOCK\nThe accompanying notes are an integral part of these financial statements.\nRHODES, INC.\n1994 EMPLOYEE STOCK PURCHASE PLAN\nNOTES TO FINANCIAL STATEMENTS\nFEBRUARY 28, 1995\nNOTE 1 - PLAN DESCRIPTION\nThe Rhodes, Inc. 1994 Employee Stock Purchase Plan (the \"Plan\") was created to encourage employees (each a \"Participant\") of Rhodes, Inc. (the \"Company\") to invest in the Company's common stock. All employees of Rhodes, Inc. who have at least one year of service, who customarily work more than 20 hours a week and who are customarily employed for more than five (5) months in any calendar year are eligible to participate.\nThe Plan, which was approved by the Board of Directors of the Company on May 11, 1994 and will continue for an indefinite period, is administered by the Company. All expenses of administering the Plan are paid by the Company.\nTwo hundred fifty thousand (250,000) shares of the Company's common stock have been reserved for issuance under the Plan. As of February 28, 1995, no shares had been issued under the Plan.\nEligible employees may commence participation in the Plan on the first investment date (March 1 and September 1) after they have become eligible to participate. Participant contributions to the Plan can only be made by authorized payroll deductions. Deductions must be in whole dollar amounts of not less than $150 nor more than $12,500 for the entire purchase period. The Company accumulates payroll deductions in the name of each Participant during each purchase period. All funds collected by the Plan are held by the Company in individual accounts established in the name of each Participant until expiration of the applicable investment period. The Plan does not pay interest on funds held in any Participant's investment account.\nOn the first day of each purchase period, each Participant is granted an option to purchase the number of shares of stock determined by the plan administrator by dividing the total payroll deductions which the Participant has elected to make for such purchase period by the option price for a share of Company common stock as of such date, rounding down to the nearest whole number. Each such option is exercisable by the Participant in accordance with the terms of the Plan on the last day of the purchase period.\nShares purchased under the Plan are distributed to the Participants as soon as practical after the end of the investment period.\nSTOCK PURCHASE PRICE\nThe purchase price for each share of stock is the lesser of 85% of the fair market value of the stock on the first or last day of the purchase period.\nThe fair market value of the stock on each investment date is the closing price of the stock as quoted in the Wall Street Journal.\nTERMINATION OF PARTICIPATION\nA Participant may elect to withdraw from participation in the Plan with respect to any purchase period by so notifying the plan administrator prior to the end of the purchase period. After receipt of notice, the payroll deductions credited to the Participant's account with respect to the purchase period will be paid to him or her promptly (without interest) and no further payroll deductions will be made on behalf of the Participant during the purchase period.\nLIMITATION ON STOCK PURCHASES\nNo Participant may purchase stock under the Plan if such Participant, immediately after an option is granted to purchase stock, would own stock possessing 5% or more of the total combined voting power or value of all classes of stock of the Company or its subsidiaries.\nNo Participant will be granted options under the Plan to purchase stock with a fair market value in excess of $25,000 in any calendar year.\nNOTE 2 - FEDERAL INCOME TAXES\nManagement believes the Plan meets the requirements of Section 423 of the Internal Revenue Code and is not subject to any provisions of the Employee Retirement Income Security Act of 1974.\nNOTE 3 - SUBSEQUENT EVENT\nOn March 1, 1995, 21,265 shares of the Company's common stock were purchased under the Plan for $178,477. The net assets available for purchase of stock at February 28, 1995 represent the $178,477 purchase price of the stock, refunds due of $1,230 and contributions made for the next purchase period. These shares were subsequently distributed to the participants. The price per share of $8.39 is equal to 85% of the September 1, 1994 fair market value of the Company's common stock. Subsequent to the purchase, 228,735 shares remained available for purchase under the Plan.","section_15":""}
{"filename":"742102_1995.txt","cik":"742102","year":"1995","section_1":"Item 1. Business.\n(a) General Development of Business\nAMERICAN INCOME 2 LIMITED PARTNERSHIP (the \"Partnership\") was organized as a limited partnership under the Massachusetts Uniform Limited Partnership Act (the \"Uniform Act\") on December 30, 1983 for the purpose of acquiring and leasing to third parties a diversified portfolio of capital equipment. Partners' capital initially consisted of contributions of $1,000 from the General Partner (AFG Leasing Associates) and $99 from the Initial Limited Partner. The sole General Partner of the Partnership is wholly-owned by American Finance Group (\"AFG\" or \"Manager\"), a Massachusetts partnership. On June 28, 1985, the Partnership issued 55,263 limited partnership units (the \"Units\") to 1,498 investors, including four Units purchased by the Initial Limited Partner. The General Partner contributed $50,000 in consideration of its general partner interest. The General Partner is not required to make other capital contributions.\n(b) Financial Information About Industry Segments\nThe Partnership was engaged in only one industry segment: the business of acquiring capital equipment and leasing the equipment to creditworthy lessees on a full-payout or operating lease basis. (Full-payout leases are those in which aggregate noncancellable rents exceed the purchase price of the leased equipment. Operating leases are those in which the aggregate noncancellable rental payments are less than the purchase price of the leased equipment.) Industry segment data is not applicable.\n(c) Narrative Description of Business\nThe Partnership was organized to acquire a diversified portfolio of capital equipment subject to various full payout and operating leases and to lease the equipment to third parties as income-producing investments. More specifically, the Partnership's primary investment objectives were to acquire and lease equipment which would:\n1. Generate quarterly cash distributions; and\n2. Maintain substantial residual value for ultimate sale.\nThe Partnership had the additional objective of providing certain federal income tax benefits.\nThe Closing Date of the Offering of Units of the Partnership was June 28, 1985. The initial purchase of equipment and the associated lease commitments occurred on July 2, 1985. The Partnership completed the disposition of its equipment portfolio in 1994 and dissolution of the Partnership occurred on December 29, 1995.\nThe Partnership has no employees; however, it entered into a Management Agreement with the Manager coincident with the commencement of operations. The Manager's role, among other things, was to (i) evaluate, select, negotiate, and consummate the acquisition of equipment, (ii) manage the leasing, re-leasing, financing, and refinancing of equipment, and (iii) arrange the resale of equipment. The Manager was compensated for such services as described in the Partnership's Amended and Restated Agreement and Certificate of Limited Partnership (the \"Restated Agreement, as amended\"), Item 13 herein, and in Note 4 to the financial statements included in Item 14, herein.\nThe Partnership's investment in equipment was subject to various risks, including physical deterioration and technological obsolescence. A principal business risk of owning and leasing equipment is the possibility that aggregate lease revenue and equipment sale proceeds will be insufficient to provide an acceptable rate of return on invested capital after payment of all debt service costs and operating expenses. Consequently, the success of the Partnership was largely dependent upon the ability of the General Partner and its Affiliates to forecast technological advances, the ability of the lessees to fulfill their lease obligations and the quality and marketability of the equipment at the time of sale. Revenue from major individual lessees which accounted for 10% or more of lease revenue during the years ended December 31, 1995, 1994 and 1993 is incorporated herein by reference to Note 2 to the financial statements in the 1995 Annual Report. Refer to Item 14(a)(3) for lease agreements filed with the Securities and Exchange Commission.\nAFG is a successor to the business of American Finance Group, Inc., a Massachusetts corporation engaged since its inception in 1980 in various aspects of the equipment leasing business. In 1990, certain members of AFG's management, principally Geoffrey A. MacDonald, Chief Executive Officer and co-founder of AFG, established AFG Holdings (Massachusetts) Limited Partnership (\"Holdings Massachusetts\") to acquire ownership and control of AFG. Holdings Massachusetts effected this event by acquiring all of the equity interests of AFG's two partners, AFG Holdings Illinois Limited Partnership (\"Holdings Illinois\") and AFG Corporation. Holdings Massachusetts incurred significant indebtedness to finance this acquisition, a significant portion of which was scheduled to mature in 1995.\nOn December 16, 1994, the senior lender to Holdings Massachusetts (the \"Senior Lender\") assumed control of its security interests in Holdings Illinois and AFG Corporation and sold all such interests to GDE Acquisitions Limited Partnership, a Massachusetts limited partnership owned and controlled entirely by Gary D. Engle, President and member of the Executive Committee of AFG. As a result of this transaction, GDE Acquisitions Limited Partnership acquired all of the assets, rights and obligations of AFG from the Senior Lender and assumed control of AFG. Geoffrey A. MacDonald remains as Chief Executive Officer of AFG and member of its Executive Committee.\n(d) Financial Information About Foreign and Domestic Operations and Export Sales\nNot applicable.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nNone.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nIncorporated herein by reference to Note 6 to the financial statements in the 1995 Annual Report.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nNone.\nPART II\nItem 5.","section_5":"Item 5. Market for the Partnership's Securities and Related Security Holder Matters.\n(a) Market Information\nThere is no public market for the resale of the Units and it is not anticipated that a public market for resale of the Units will develop.\n(b) Approximate Number of Security Holders\nAt December 31, 1995, there were no recordholders of Units in the Partnership.\n(c) Dividend History and Restrictions\nPursuant to Article VI of the Restated Agreement, as amended, the Partnership's Distributable Cash From Operations and Distributable Cash From Sales or Refinancings was determined and distributed to the Partners quarterly.\nDistributions in 1995 and 1994 were as follows:\nDistributions payable were $62,799 at December 31, 1994. There were no distributions payable at December 31, 1995.\n\"Distributable Cash From Operations\" means the net cash provided by the Partnership's normal operations after general expenses and current liabilities of the Partnership are paid, reduced by any reserves for working capital and contingent liabilities to be funded from such cash, to the extent deemed reasonable by the General Partner, and increased by any portion of such reserves deemed by the General Partner not to be required for Partnership operations and reduced by all accrued and unpaid Equipment Management Fees and, after Payout, further reduced by all accrued and unpaid Subordinated Remarketing Fees. Distributable Cash From Operations does not include any Distributable Cash From Sales or Refinancings.\n\"Distributable Cash From Sales or Refinancings\" means Cash From Sales or Refinancings as reduced by (i)(a) amounts realized from any loss or destruction of equipment which the General Partner determines shall be reinvested in similar equipment for the remainder of the original lease term of the lost or destroyed equipment, or in isolated instances, in other equipment, if the General Partner determines that investment of such proceeds will significantly improve the diversity of the Partnership's equipment portfolio, and subject in either case to satisfaction of all existing indebtedness secured by such equipment to the extent deemed necessary or appropriate by the General Partner, and (b) the proceeds from the sale of an interest in equipment pursuant to any agreement governing a joint venture which the General Partner determines will be invested in additional equipment or interests in equipment and which ultimately are so reinvested and (ii) any accrued and unpaid Equipment Management Fees and, after Payout, any accrued and unpaid Subordinated Remarketing Fees.\n\"Cash From Sales or Refinancings\" means cash received by the Partnership from sale or refinancing transactions, as reduced by (i)(a) all debts and liabilities of the Partnership required to be paid as a result of sale or refinancing transactions, whether or not then due and payable (including any liabilities on an item of equipment sold which are not assumed by the buyer and any remarketing fees required to be paid to persons not affiliated with the General Partner, but not including any Subordinated Remarketing Fees whether or not then due and payable) and (b) any reserves for working capital and contingent liabilities funded from such cash to the extent deemed reasonable by the General Partner and (ii) increased by any portion of such reserves deemed by the General Partner not to be required for Partnership operations. In the event the Partnership accepts a note in connection with any sale or refinancing transaction, all payments subsequently received in cash by the Partnership with respect to such note shall be included in Cash From Sales or Refinancings, regardless of the treatment of such payments by the Partnership for tax or accounting purposes. If the Partnership receives purchase money obligations in payment for equipment sold, which are secured by liens on such equipment, the amount of such obligations shall not be included in Cash From Sales or Refinancings until the obligations are fully satisfied.\nEach distribution of Distributable Cash From Operations and Distributable Cash From Sales or Refinancings of the Partnership shall be made 99% to the Limited Partners and 1% to the General Partner before Payout and 85% to the Limited Partners and 15% to the General Partner after Payout.\n\"Payout\" is defined as the first time when the aggregate amount of all distributions to the Limited Partners of Distributable Cash From Operations and Distributable Cash From Sales or Refinancings equals the aggregate amount of the Limited Partners' original capital contributions plus a cumulative annual return of 12% (compounded daily and calculated beginning with the last day of the month of the Partnership's Closing Date) on their aggregate unreturned capital contributions. For purposes of this definition, capital contributions shall be deemed to have been returned only to the extent that distributions of cash to the Limited Partners exceed the amount required to satisfy the cumulative annual return of 12% (compounded daily) on the Limited Partners' aggregate unreturned capital contributions, such calculation to be based on the aggregate unreturned capital contributions outstanding on the first day of each fiscal quarter. The Partnership did not achieve Payout.\nDistributable Cash From Operations and Distributable Cash From Sales or Refinancings (\"Distributions\") were distributed within 60 days after the completion of each quarter, beginning with the first full fiscal quarter following the Partnership's Closing. The Partnership has distributed $14,956,922 to the Limited Partners and $151,080 to the General Partner since inception. Substantially all of the distributions to the Limited Partners represent a return of capital.\nOn October 31, 1995, the General Partner as trustee (the \"Trustee\") executed a Declaration of Trust establishing a Liquidating Trust (the \"Trust\") to satisfy any unforeseen expenses of the Partnership that may arise after the dissolution date as a result of the Partnership's equipment leasing activities. Organization of the Trust has the additional benefit of terminating the Partnership's income tax reporting obligations after 1995. On December 29, 1995, the General Partner transferred all undistributed cash of $292,716 held by the Partnership, into a non-interest bearing custodian account (the \"Account\") of the Trust. The transferred amount included $29,329 of accrued expenses which were paid in 1996. Amounts held in the Account will be reserved for a period not to exceed seven years (or such shorter time as counsel for the Partnership advises will be sufficient to assure that all claims against the Partnership have been presented). To the extent that such funds exceed the ultimate liabilities of the Partnership, the Trustee will distribute such remaining balance to the beneficiaries of the Trust, which beneficiaries will consist of the General Partner and the Limited Partners in accordance with their respective percentage ownership interests in the Partnership as of the dissolution date.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nIncorporated herein by reference to the section entitled \"Selected Financial Data\" in the 1995 Annual Report.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nIncorporated herein by reference to the section entitled \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" in the 1995 Annual Report. Item 8.","section_7A":"","section_8":"","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.\nNone.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Partnership.\n(a-b) Identification of Directors and Executive Officers\nThe Partnership has no Directors or Officers. As indicated in Item 1 of this report, AFG Leasing Associates is the sole General Partner of the Partnership. Under the Restated Agreement, as amended, the General Partner is solely responsible for the operation of the Partnership's properties and the Limited Partners have no right to participate in the control of such operations. The names, titles and ages of the Directors and Executive Officers of the corporate General Partner of the General Partner as of March 15, 1996 were as follows:\nDIRECTORS AND EXECUTIVE OFFICERS OF THE CORPORATE GENERAL PARTNER OF THE GENERAL PARTNER (See Item 13)\n(c) Identification of Certain Significant Persons\nNone.\n(d) Family Relationship\nNo family relationship exists among any of the foregoing Partners, Directors or Executive Officers.\n(e) Business Experience\n(f) Involvement in Certain Legal Proceedings\nNone.\n(g) Promoters and Control Persons\nSee Item 10 (a-b) above.\nItem 11.","section_11":"Item 11. Executive Compensation.\n(a) Cash Compensation\nCurrently, the Partnership has no employees. However, under the terms of the Restated Agreement, as amended, the Partnership is obligated to pay all costs of personnel employed full or part-time by the Partnership, including officers or employees of the General Partner or its Affiliates. There is no plan at the present time to make any officers or employees of the General Partner or its Affiliates employees of the Partnership. The Partnership has not paid and does not propose to pay any options, warrants or rights to the officers or employees of the General Partner or its Affiliates.\n(b) Compensation Pursuant to Plans\nNone.\nAlthough the Partnership has no employees, as discussed in Item 11(a), pursuant to Section 9.4 of the Restated Agreement, as amended, the Partnership incurred a monthly charge for personnel costs of the Manager for persons engaged in providing administrative services to the Partnership. A description of the remuneration paid by the Partnership to the Manager for such service is included in Item 13, herein and in Note 4 to the financial statements included in Item 14, herein.\n(d) Compensation of Directors\nNone.\n(e) Termination of Employment and Change of Control Arrangement\nThere exists no remuneration plan or arrangement with any partners of the General Partner or its Affiliates which results or may result from their resignation, retirement or any other termination.\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 possessing traditional voting rights. However, as provided in Section 11.2(a) of the Restated Agreement, as amended (subject to Sections 11.2(b) and 11.3), a majority interest of the Limited Partners have voting rights with respect to:\n1. Amendment of the Restated Agreement;\n2. Termination of the Partnership;\n3. Removal of the General Partner; and\n4. Approval or disapproval of the sale of all, or substantially all, the assets of the Partnership (except in the orderly liquidation of the Partnership upon its termination and dissolution).\nThe ownership and organization of AFG is described in Item 1 of this report.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nThe General Partner of the Partnership is AFG Leasing Associates, an affiliate of AFG.\n(c) Other Compensation\n(a) Transactions with Management and Others\nAll operating expenses incurred by the Partnership are paid by AFG on behalf of the Partnership and AFG is reimbursed at its actual cost for such expenditures. Fees and other costs incurred during each of the three years in the period ended December 31, 1995, which were paid or accrued by the Partnership to AFG or its Affiliates, are as follows:\nAs provided under the terms of the Management Agreement, AFG was compensated for its services to the Partnership. Such services included all aspects of acquisition and management of equipment. For acquisition services, AFG was compensated by an amount equal to 4.75% of Equipment Base Price paid by the Partnership. For management services, AFG was compensated by an amount equal to the lesser of (i) 5% of gross lease rental revenue or (ii) fees which the General Partner reasonably believed to be competitive for similar equipment. Both of these fees were subject to certain limitations defined in the Management Agreement. As Payout was not achieved, AFG received no compensation for services connected to the sale of equipment, under its subordinated remarketing agreement. Interest expense - affiliate represents interest incurred on legal costs in connection with a state sales tax dispute involving certain equipment owned by the Partnership and other affiliated investment programs sponsored by AFG. Legal costs incurred by AFG to resolve this matter and the interest thereon was allocated to the Partnership and other affected investment programs. Administrative charges represent amounts owed to AFG, pursuant to Section 9.4 of the Restated Agreement as amended, for persons employed by AFG who are engaged in providing administrative services to the Partnership. Reimbursable operating expenses due to third parties represent costs paid by AFG on behalf of the Partnership which are reimbursed to AFG.\nAll equipment was acquired from AFG, one of its affiliates, including other equipment leasing programs sponsored by AFG, or from third-party sellers. The Partnership's Purchase Price was determined by the method described in Note 2 to the financial statements, included in Item 14, herein.\nAll rents and proceeds from the sale of equipment were paid directly to either AFG or to a lender. AFG temporarily deposited collected funds in a separate interest bearing escrow account prior to remittance to the Partnership.\n(b) Certain Business Relationships\nNone.\n(c) Indebtedness of Management to the Partnership\nNone.\n(d) Transactions with Promoters\nSee Item 13(a) above.\nExhibit 23\nCONSENT OF INDEPENDENT AUDITORS\nWe consent to the incorporation by reference in this Annual Report (Form 10-K) of American Income 2 Limited Partnership of our report dated March 12, 1996, included in the 1995 Annual Report to Partners of American Income 2 Limited Partnership.\nERNST & YOUNG LLP\nBoston, Massachusetts March 12, 1996\nSUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT TO SECTION 15(D) OF THE ACT BY REGISTRANTS WHICH HAVE NOT REGISTERED SECURITIES PURSUANT TO SECTION 12 OF THE ACT.\nNo annual report has been sent to the Limited Partners. A report will be furnished to the Limited Partners subsequent to the date hereof.\nNo proxy statement has been or will be sent to the Limited Partners.","section_14":"","section_15":""}
{"filename":"726958_1995.txt","cik":"726958","year":"1995","section_1":"ITEM 1. BUSINESS\nThe Company\nCasey's General Stores, Inc. (\"Casey's\") and its two wholly-owned subsidiaries, Casey's Marketing Company (the \"Marketing Company\") and Casey's Services Company (the \"Services Company\") (Casey's, together with the Marketing Company and the Services Company, shall be referred to herein as the \"Company\"), operate convenience stores under the name \"Casey's General Store\" in nine Midwestern states, primarily Iowa, Missouri and Illinois. The stores carry a broad selection of food (including freshly prepared foods such as pizza, donuts and sandwiches), beverages, tobacco products, health and beauty aids, automotive products and other non-food items. In addition, all stores offer gasoline for sale on a self-service basis. On April 30, 1995, there were a total of 927 Casey's General Stores in operation, of which 741 were operated by the Company (\"Company Stores\") and 186 stores were operated by franchisees (\"Franchised Stores\"). There were 60 Company Stores and 3 Franchised Stores newly opened in fiscal 1995. The Company operates a central warehouse, the Casey's Distribution Center, adjacent to its Corporate Headquarters facility in Ankeny, Iowa through which it supplies grocery and general merchandise items to Company and Franchised Stores. The Company also operates a commissary in Creston, Iowa where it prepares sandwiches for sale through Company and Franchised Stores.\nApproximately 74% of all Casey's General Stores are located in areas with populations of fewer than 5,000 persons, while approximately 6% of all stores are located in communities with populations exceeding 20,000 persons. The Company competes on the basis of price, as well as on the basis of traditional features of convenience store operations such as location, extended hours and quality of service.\nCasey's, with executive offices at One Convenience Blvd., Ankeny, Iowa 50021-8045 (telephone 515\/965-6100) was incorporated in Iowa in 1967. The Marketing Company and the Services Company also operate from the Corporate Headquarters facilities, and were incorporated in Iowa in March 1995.\nGeneral\nCasey's General Stores seek to meet the needs of residents of small towns by combining features of both general store and convenience store operations. Smaller communities\n- 1 -\noften are not served by national-chain convenience stores. The Company has been successful in operating Casey's General Stores in small towns by offering, at competitive prices, a broader selection of products than a typical convenience store.\nIn each of the past two fiscal years, the Company derived approximately 94% of its gross profits from retail sales by Company Stores. It also derives income from continuing monthly royalties based on sales by Franchised Stores, wholesale sales to Franchised Stores, sign and facade rental fees and the provision of certain maintenance, transportation and construction services to the Company's franchisees. Sales at Casey's General Stores historically have been strongest during the Company's first and second quarters and relatively weaker during its fourth quarter. In the warmer months of the year (which comprise the Company's first two fiscal quarters), customers tend to purchase greater quantities of gasoline and certain convenience items such as beer, soft drinks and ice. Due to the continuing emphasis on higher-margin, freshly prepared food items, however, Casey's net sales and net income (with the exception of the fourth quarter) have become somewhat less seasonal in recent years.\nThe following table shows the number of Company Stores and Franchised Stores in each state on April 30, 1995:\n- 2 -\nThe Company has operational responsibility for all Company Stores. Franchised Stores generally follow the same operating policies as Company Stores and are subject to Company supervision pursuant to its franchise agreements. Franchised Stores and Company Stores offer substantially the same products and conform to the same basic store design.\nThe following table shows the number of Company and Franchised Stores opened, Franchised Stores converted to Company Stores and total stores in operation during each of the last five fiscal years:\n______________\n(1) Four Company Stores and two Franchised Stores were closed in 1991.\n(2) Seven Company Stores and one Franchised Store were closed in 1992.\n(3) Four Company Stores and six Franchised Stores were closed in 1993.\n- 3 -\n(4) Nine Company Stores and one Franchised Store were closed in 1994.\n(5) Six Company Stores and six Franchised Stores were closed in 1995.\nEleven Company Stores were opened in May and June 1995 and 39 Company Stores and one Franchised Store were under construction at June 30, 1995. On June 30, 1995, the Company had purchased or had the right to purchase 56 additional store sites. All but two of the 96 stores under construction or planned for construction on such sites will be Company Stores. Management anticipates opening approximately 65 new Company Stores during fiscal 1996, substantially all of which will be located in Iowa, Illinois and Minnesota. Seven such stores are expected to be located in Indiana, continuing the Company's 1994 expansion of its market area into that state.\nThe Company intends to continue to increase the number of Company Stores, and the proportion of Company Stores relative to Franchised Stores, because of the greater profitability of Company Stores and the Company's greater operating control over such stores. The Company anticipates it will increase the number of Company Stores through construction of new stores and the acquisition of existing Franchised Stores. During fiscal 1993, 1994 and 1995, the Company converted 10, 1 and 0 stores, respectively, from Franchised Stores to Company Stores.\nManagement believes that its current market area presents substantial opportunities for continued growth, and the Company intends to concentrate its expansion efforts in this area before pursuing expansion in other geographic markets. In the opinion of management, the Casey's Distribution Center in Ankeny, Iowa can adequately supply the general merchandise requirements of 1,000 to 1,500 stores located within a 500-mile radius of the Casey's Distribution Center, which would include the additional store sites being planned for Indiana.\nIn its expansion, the Company intends to follow its traditional store site selection criteria and to locate most new stores in small towns. Management believes that satisfaction of such criteria will provide opportunities for a better return on investment than could be realized from the opening of stores in larger communities.\nCorporate Subsidiaries\nThe Marketing Company and the Services Company were organized as Iowa corporations in March 1995, and both are wholly-owned subsidaries of Casey's. Certain Casey's employees became employees of the Marketing Company or the Services\n- 4 -\nCompany on May 1, 1995, and both of those subsidiaries assumed certain responsibilities and functions formerly held by Casey's on that date.\nCasey's now operates Company Stores in the States of Illinois, Kansas, Minnesota, Nebraska and South Dakota. Casey's also holds the rights to the Casey's trademark and trade name, and serves as franchisor in connection with the operation of Franchised Stores. Effective May 1, 1995, the Marketing Company assumed responsibility for the operation of Company Stores in the States of Iowa, Indiana and Missouri. The Marketing Company also has responsibility for all Company wholesale operations, including the operation of the Casey's Distribution Center. The Services Company provides a variety of construction and transportation services for all Company Stores. Both the Marketing Company and Services Company personnel utilize the Corporate Headquarters facility for their base of operations.\nStore Operations\nProducts Offered\nEach Casey's General Store typically carries over 2,500 food and non-food items. The products offered are those normally found in a supermarket, except that the stores do not sell produce or fresh meats, and selection is generally limited to one or two well-known brands of each item stocked. Most staple foodstuffs carried are of nationally advertised brands. Stores sell regional brands of dairy and bakery products, and approximately 93% of the stores offer beer. The non-food items carried include tobacco products, health and beauty aids, school supplies, housewares, pet supplies, photo supplies, ammunition and automotive products.\nAll of the Casey's General Stores offer gasoline or gasohol for sale on a self-service basis. Stores in Iowa, Illinois and Nebraska sell primarily gasohol and are therefore able to avail themselves of a tax incentive for such sales provided in those states. The gasoline and gasohol offered by the stores generally are sold under the Casey's name, although some Franchised Stores sell gasoline under a major oil company brand name.\nIt is management's policy to experiment with additions to the Company's product line, especially products with higher gross profit margins. As a result of this policy, the Company has added various prepared food items to its product line over the years. In 1980, the Company initiated the installation of \"snack centers\" which now are in approximately 99% of the stores. The snack centers sell sandwiches, fountain drinks, and\n- 5 -\nother items that have gross profit margins higher than those of general staple goods. The Company also has introduced the sale of donuts prepared on store premises, available in approximately 99% of the stores as of April 30, 1995, as well as cinnamon rolls and cookies, and is installing donut-making facilities in all newly constructed stores.\nSince 1986, the Company has operated a commissary at which it prepares sandwiches for sale in Casey's General Stores. Management expects the commissary to produce approximately 2 million sandwiches during fiscal 1996, for delivery to both Company and Franchised Stores through the Casey's Distribution Center.\nThe Company began marketing made-from-scratch pizza in 1984, expanding its availability to 877 (95%) stores as of April 30, 1995. Management believes pizza is the Company's most popular prepared food product, although the Company continues to expand its prepared food product line, which now includes ham and cheese, beef, and hot and mild sausage and tenderloin sandwiches, pizza bread, garlic bread, breakfast croissants, quarter-pound hamburgers and cheeseburgers. In addition, Casey's Crispy Fried Chicken was available for take-out at 38 (4%) stores as of April 30, 1995.\nThe pizza and other prepared food products are made on store premises with ingredients delivered from the Casey's Distribution Center. Pizza generally is available in three sizes with ten different toppings and is sold for take-out between the hours of 4:00 P.M. and 11:00 P.M. In addition, at selected store locations a luncheon menu consisting of pizza-by-the-slice, sandwiches, pizza bread, and garlic bread is available.\nAn important part of the Company's marketing strategy is to increase sales volume by pricing competitively on price-sensitive items. On less price-sensitive items, it is the Company's policy to maintain, or in the case of Franchised Stores to recommend, a Company-wide pricing structure in each store that is generally comparable to that of other convenience, gasoline or grocery stores located in the area and competing for the same customers.\nManagement attributes the Company's ability to offer competitive prices to a number of factors, including the Company's central distribution system, its purchasing practices which avoid dependence upon jobbers and vendors by relying on a few large wholesale companies and its success in minimizing land, construction and equipment costs.\n- 6 -\nManagement's decision to add snack center items, freshly prepared donuts and pizza to the Company's product selection reflects its strategy to promote high profit margin products that are compatible with convenience store operations. Although retail sales of non-gasoline items during the last three fiscal years have generated approximately 42% of the Company's retail sales, such sales resulted in approximately 76% of the Company's gross profits from retail sales. Gross profit margins for prepared foods items, which have averaged approximately 53% during the last three fiscal years, are significantly higher than the gross profit margin for retail sales of gasoline, which has averaged approximately 9% during such period.\nStore Design\nCasey's General Stores are free-standing and, with a few exceptions to accommodate local conditions, conform to standard construction specifications. During the fiscal year ended April 30, 1995, the aggregate investment in the land, building, equipment and initial inventory for a typical Company Store averaged approximately $650,000. The standard building designed by the Company is a pre-engineered steel frame building mounted on a concrete slab. The current store design measures 36 feet by 66 feet, with approximately 1,300 square feet devoted to sales area, 500 square feet to kitchen space and 575 square feet to storage. Store lots have sufficient frontage and depth to permit adequate drive-in parking facilities on one or more sides of each store. Each store typically includes two islands of gasoline dispensers and storage tanks having a capacity of 20,000 to 30,000 gallons of gasoline. The merchandising display in each store follows a standard layout designed to encourage a flow of customer traffic through all sections of the store. All stores are air conditioned and have modern refrigeration facilities. The store locations feature the Company's bright red and yellow pylon sign and facade, both of which display the name and service mark of the Company.\nAll Casey's General Stores remain open at least 16 hours per day, seven days a week. Most store locations are open from 6:00 a.m. to 11:00 p.m., although hours of operation may be adjusted on a store-by-store basis to accommodate customer traffic patterns. The Company requires that all stores maintain a bright, clean store interior and provide prompt check-out service. It is the Company's policy not to permit the installation of electronic games or sale of adult magazines on store premises.\n- 7 -\nStore Locations\nThe Company traditionally has located its stores in small towns not served by national-chain convenience stores. Approximately 74% of all stores operate in areas with populations of fewer than 5,000 persons, while approximately 6% of all stores are located in communities with populations exceeding 20,000 persons. Management believes that a Casey's General Store provides a service not otherwise available in small towns, and that a convenience store in an area with limited population can be profitable if it stresses sales volume and competitive prices. The Company's store site selection criteria emphasize the population of the immediate area and daily highway traffic volume. Management believes that, if there is no competing store, a Casey's General Store may operate profitably at a highway location in a community with a population of as few as 500 persons.\nGasoline Operations\nGasoline sales are an important part of the Company's sales and earnings. Approximately 54% of Casey's net sales for the year ended April 30, 1995 were derived from the retail sale of gasoline. The following table summarizes gasoline sales by Company Stores for the three fiscal years ended April 30, 1995:\n- 8 -\n______________\n* Includes only those stores that had been in operation for at least one full year before commencement of the periods indicated.\nRetail prices of gasoline increased during the year ended April 30, 1995. The total number of gallons sold by the Company during this period also increased, primarily as the result of the increased number of Company Stores in operation and the Company's efforts to price its retail gasoline competitively in the market area served by the particular store. See \"BUSINESS--Store Operations--Competition\" and \"LEGAL PROCEEDINGS\" herein. As a result of these conditions, total retail gasoline sales by the Company increased during the period, as did the percentage of such sales to the Company's total net sales.\nRetail gasoline profit margins have a substantial impact on the Company's net income. Profit margins on gasoline sales can be adversely affected by factors beyond the control of the Company, including over-supply in the retail gasoline market, uncertainty or volitility in the wholesale gasoline market (such as that experienced during 1991 as a result of the Persian Gulf crisis) and price competition from other gasoline marketers. Any substantial decrease in profit margins on gasoline sales or number of gallons sold could have a material adverse effect on the Company's earnings.\nThe Company purchases its gasoline from independent national and regional petroleum distributors. Although in recent years the Company's suppliers have not experienced any difficulties in obtaining sufficient amounts of gasoline to meet the Company's needs, unanticipated national and international events could result in a reduction of gasoline supplies available for distribution to the Company. A substantial curtailment in gasoline supplied to the Company could adversely affect the Company by reducing gasoline sales. Further, management believes that a significant amount of the Company's business results from the patronage of customers primarily desiring to purchase gasoline and, accordingly, reduced gasoline supplies could adversely affect the sale of non-gasoline items. These factors could have a material adverse impact upon the Company's earnings and operations.\n- 9 -\nDistribution and Wholesale Arrangements\nThe Marketing Company supplies all Company Stores and over 90% of the Franchised Stores with groceries, food (including sandwiches prepared at the Company's commissary), health and beauty aids and general merchandise from the Casey's Distribution Center. The stores place orders for merchandise through a telecommunications link-up to the computer at the Company's headquarters in Ankeny, and weekly shipments are made from the Casey's Distribution Center by 40 Company-owned delivery trucks. The Marketing Company charges Franchised Stores processing and shipping fees for each order filled by the Casey's Distribution Center. The efficient service area of the Casey's Distribution Center is approximately 500 miles, which encompasses all of the Company's existing and proposed stores.\nThe Marketing Company's only wholesale sales are to Franchised Stores, to which it sells groceries, prepared sandwiches, ingredients and supplies for donuts, sandwiches and pizza, health and beauty aids, general merchandise and gasoline. Although the Company derives income from this activity, it makes such sales, particularly gasoline sales, at narrow profit margins in order to promote the competitiveness and increase the sales to Franchised Stores.\nIn fiscal 1995, the Company purchased directly from manufacturers approximately 90% of the food and non-food items sold from the Casey's Distribution Center. The Company has not entered into contracts with any of the suppliers of products sold by Casey's General Stores. Management believes that the absence of such contracts is customary in the industry for purchasers such as the Company and enables the Company to respond flexibly to changing market conditions.\nFranchise Operations\nCasey's has franchised Casey's General Stores since 1970. In addition to generating income for Casey's, franchising historically enabled Casey's to obtain desirable store locations from persons who have preferred to become franchisees rather than to sell or lease their locations to Casey's. Franchising also enabled Casey's to expand its system of stores at a faster rate, thereby achieving operating efficiencies in its warehouse and distribution system as well as greater identification in its market area. As the Company has grown and strengthened its financial resources, the advantages of franchising have decreased in importance and management currently expects to grant new franchises only to existing franchisees operating in states other than Iowa on a limited basis. See \"BUSINESS - Government Regulation\" herein. From April 30, 1983 to April 30,\n- 10 -\n1995, the percentage of Company Stores increased from 44% to 80%. From inception to April 30, 1995, the Company had converted 135 Franchised Stores to Company Stores by leasing or purchasing such stores.\nAll franchisees pay Casey's a royalty fee equal to 3% of gross receipts derived from total store sales excluding gasoline, subject to a minimum monthly royalty of $300. Casey's currently assesses a royalty fee of $.018 per gallon on gasoline sales, although it has discretion to increase this amount to 3% of retail gasoline sales. In addition, franchisees pay Casey's a sign and facade rental fee. The franchise agreements do not authorize Casey's to establish the prices to be charged by franchisees. Further, except with respect to certain supplies and items provided in connection with the opening of each store, each franchisee has unlimited authority to purchase supplies and inventory from any supplier, provided the products meet the Company's quality standards. Franchise agreements typically contain a non-competition clause that restricts the franchisee's ability to operate a convenience-style store in that area for a period of two or three years following termination of the agreement. See \"BUSINESS - Government Regulation\" herein for a discussion of recent legislation in Iowa concerning franchise agreements.\nPersonnel\nOn April 30, 1995, the Company had 3,252 full-time employees and 4,783 part-time employees. The Company has not experienced any work stoppages. There are no collective bargaining agreements between the Company and any of its employees.\nThe Company's supervisory personnel are responsible for monitoring and assisting all stores, including Franchised Stores. Centralized control of store operations is primarily maintained by the Chief Operating Officer of the Company, who is assisted by the Vice President of Store Operations. Reporting directly to the Vice President of Store Operations are four regional operations managers. Reporting directly to the regional managers are 16 district managers, each with responsibility over approximately equal numbers of stores. Each district manager is generally in charge of seven supervisors. Each of the 113 supervisors in turn is responsible for the operations of approximately eight individual stores.\nThe majority of store managers and store personnel live in the community in which their Casey's store is located. Training of store managers and store personnel is conducted through the Store Operations Training Department overseen by the Director of\n- 11 -\nStore Operations Training. The Company operates a central training facility at its Headquarters facility in Ankeny and provides continuing guidance and training in the areas of merchandising, advertising and promotion, administration, record keeping, accounting, inventory control and other general operating and management procedures.\nAs an incentive to the Company's employees and those of franchisees, management stresses an internal promotion philosophy. Most district managers and store supervisors previously worked as store managers. At the senior management level, one of the Company's executive officers has been employed by the Company for more than nineteen years, one has been employed for more than twenty-three years and one has been employed for more than twenty-seven years.\nIn addition to its four executive officers, the Company currently has Vice Presidents of Store Operations, Property Management, Transportation, Food Service and Marketing. The Company also has 33 other employees with managerial responsibilities in the areas of store operations, gasoline marketing, real estate development, construction, equipment maintenance, merchandising, advertising, Distribution Center operations, payroll, accounting and data processing. The Company believes that such employees are capable of carrying out their responsibilities without substantial supervision by the executive officers.\nCompetition\nThe Company's business is highly competitive. Food, including prepared foods, and non-food items similar or identical to those sold by the Company are generally available from various competitors in the communities served by Casey's General Stores. Management believes that its stores located in small towns compete principally with local convenience stores, grocery stores and similar retail outlets and, to a lesser extent, with prepared food outlets or restaurants and expanded gasoline stations offering a more limited selection of grocery and food items for sale. Stores located in more heavily populated communities may compete with local and national grocery and drug store chains, expanded gasoline stations, supermarkets, discount food stores and traditional convenience stores. Convenience store chains competing in the larger towns served by Casey's General Stores include 7-Eleven, Kwik Shops, and regional chains. Some of the Company's competitors have greater financial and other resources than the Company.\nGasoline sales, in particular, are intensely competitive. The Company competes with both independent and national brand\n- 12 -\ngasoline stations, some of which may have access to more favorable arrangements for gasoline supply than do the Company or the firms that supply its stores. Management believes that the most direct competition for gasoline sales comes from other self-service installations in the vicinity of individual store locations, some of whom regularly offer non-cash discounts on self-service gasoline purchases such as a \"free\" car wash or \"mini-service.\" Company Stores generally do not offer such discounts. In addition, management believes that Company Stores compete for gasoline customers who regularly travel outside of their relatively smaller community for shopping or employment purposes, and who therefore are able to purchase gasoline while in nearby larger communities where retail gasoline prices generally are lower. For this reason, the Company attempts to offer gasoline for sale at prices comparable to those prevailing in nearby larger communities. See \"LEGAL PROCEEDINGS\" herein.\nThe Company believes that the competitiveness of Casey's General Stores is based on price (particularly in the case of gasoline sales) as well as on a combination of store location, extended hours, a wide selection of name brand products, self-service gasoline facilities and prompt check-out service. The Company also believes it is important to its business to maintain a bright, clean store and to offer quality products for sale.\nService Marks\nThe name \"Casey's General Store\" and the service mark consisting of the Casey's design logo (with the words \"Casey's General Store\") are registered service marks of Casey's under federal law. Management believes that these service marks are of material importance in promoting and advertising the Company's business.\nGovernment Regulation\nThe United States Environmental Protection Agency and several states, including Iowa, have established requirements for owners and operators of underground gasoline storage tanks (\"USTs\") with regard to (i) maintenance of leak detection, corrosion protection and overfill\/spill protection systems, (ii) upgrade of existing tanks, (iii) actions required in the event of a detected leak, (iv) prevention of leakage through tank closings and (v) required gasoline inventory recordkeeping. Since 1984, new Company Stores have been equipped with non-corroding fiberglass USTs, including some with double-wall construction, over-fill protection and electronic tank monitoring, and the Company has an active inspection and renovation program with respect to its older USTs. The Company\n- 13 -\ncurrently has 1,566 USTs of which 1,166 are fiberglass and 400 are steel. Management believes that its existing gasoline procedures and planned capital expenditures will continue to keep the Company in substantial compliance with all current federal and state UST regulations.\nSeveral of the states in which the Company does business have trust fund programs with provisions for sharing or reimbursing corrective action or remediation costs incurred by UST owners, including the Company. These programs, other than the State of Iowa's, generally are in the early stages of operation and the extent of available coverage or reimbursement under such programs for costs incurred by the Company is not fully known at this time. In each of the years ended April 30, 1994 and 1995, the Company spent approximately $1,814,000 and $2,137,000, respectively, for assessments and remediation. Substantially all of these expenditures have been submitted for reimbursement from state-sponsored trust fund programs, and, as of June 30, 1995, approximately $3,800,000 has been received from such programs. The Company has accrued a liability at April 30, 1995, of approximately $3,300,000 for estimated expenses related to anticipated corrective actions or remediation efforts, including relevant legal and consulting costs. Management believes the Company has no material joint and several environmental liability with other parties.\nManagement of the Company currently estimates that aggregate capital expenditures for electronic monitoring, cathodic protection and overfill\/spill protection will approximate $1,000,000 in fiscal 1996 through December 23, 1998, in order to comply with the existing UST regulations. Additional regulations, or amendments to the existing UST regulations, could result in future revisions to such estimated expenditures.\nThe Federal Trade Commission and some states have adopted laws regulating franchise operations. Existing laws generally require certain disclosures and\/or registration in connection with the sale of the franchises, and regulate certain aspects of the relationship with franchisees, such as rights of termination, renewal and transfer. Management believes that the Company is duly registered in all states where its present operations require such registration. Management does not believe that the existing state registration and disclosure requirements, or the federal disclosure requirements, have a material effect on the Company's operations.\nDuring the 1992 legislative session, the Iowa General Assembly enacted legislation relating to franchise agreements and their enforcement and establishing certain duties and\n- 14 -\nlimitations on franchisors. The legislation, which became effective July 1, 1992, applies to all new or existing franchises that are operated in the State of Iowa, including those of Casey's. The legislation contains, among other things, provisions regarding the transfer of franchises, the termination or nonrenewal of franchises, and the encroachment on existing franchises. Several such provisions conflict with those contained in existing franchise agreements entered into by Casey's with respect to stores located in the State of Iowa. As a result, several provisions of Casey's existing franchise agreements may not be enforceable under the legislation.\nOn May 14, 1993, in an unrelated proceeding brought by other franchisors operating in Iowa, the United States District Court for the Southern District of Iowa ruled that certain provisions of the legislation (those which make the legislation applicable to franchises existing before its effective date and those provisions governing the transfer of franchises, encroachment, termination, and non-renewal) substantially impair, in violation of the United States and Iowa Constitutions, the franchisor-plaintiffs' contractual rights under their license agreements with certain Iowa franchisees. The Court made no ruling on the constitutionality of the legislation as applied to franchise agreements entered into or renewed after the effective date of the legislation. The Company understands that the Court's ruling has been affirmed by the Eighth Circuit Court of Appeals. Management does not expect Casey's to enter into new franchise agreements in Iowa under the current legislation, and does not expect the legislation to have a material effect on the Company's business.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company owns and has consolidated its Corporate Headquarters and Distribution Center operations on a 36-acre site in Ankeny, Iowa. This facility consists of approximately 255,000 square feet, including a central Corporate Headquarters office building, expanded Distribution Center and vehicle service\/maintenance center. The facility was completed in February 1990 and placed in full service at that time.\nThe Company owns an approximately 10,000 square-foot building on an eight-acre site in Creston, Iowa that it utilizes as a sandwich commissary center for the preparation of sandwiches sold in Casey's General Stores.\nOn April 30, 1995, Casey's owned the land at 611 locations and the buildings at 629 locations, and leased the land at 130 locations and the buildings at 112 locations. Most of the leases provide for the payment of a fixed rent, plus property\n- 15 -\ntaxes and insurance and maintenance costs. Generally, the leases are for terms of 10 to 20 years, with options to renew for additional periods or options to purchase the leased premises at the end of the lease period.\nThe Company leases approximately 16,800 square feet of office and warehouse space at 1299 N.E. Broadway Avenue, Des Moines, Iowa, which was used as its principal offices and corporate headquarters until the new Corporate Headquarters facility became available in February 1990. Additional information concerning the Company's lease of such space is set forth under the caption \"Other Information Relating to Directors and Executive Officers - Certain Transactions\" in the Company's definitive Proxy Statement to be filed with the Commission pursuant to Regulation 14A within 120 days after April 30, 1995 and to be used in connection with the Company's Annual Meeting of shareholders on September 15, 1995.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is the sole defendant in a class action lawsuit brought by five Iowa retail gasoline dealers and a trade association representing independent distributors and retailers of gasoline products within the State of Iowa, acting on behalf of a class of such dealers. The Amended and Substituted Complaint - Class Action (the \"Bathke Complaint\"), filed in the United States District Court for the Southern District of Iowa (Gilbert Bathke, et. al. v. Casey's General Stores, Inc., Civil No. 4-90-CV-80658), alleged that by selling gasoline at \"very low prices which are supported by higher prices charged for the same petroleum products in other markets,\" the Company violated federal anti-trust laws (specifically, Section 2(a) of the Robinson-Patman Act and Section 2 of the Sherman Act) and State of Iowa unfair price discrimination laws. The Bathke Complaint sought as relief a permanent injunction enjoining such practices, unspecified monetary damages (to be trebled as provided by law) and attorneys' fees.\nFollowing the completion of formal discovery activities, the District Court granted the Company's motion for summary judgment seeking the dismissal of all counts of the Bathke Complaint in an Order entered on October 14, 1994. The District Court dismissed the federal antitrust claims with prejudice and dismissed the State unfair price discrimination claim without prejudice, concluding that there was an \"insuffucient basis in economic reality and substantive federal law for the plaintiffs' theories.\"\nPlaintiffs have appealed the dismissal of the Bathke Complaint to the Eighth Circuit Court of Appeals in St. Louis,\n- 16 -\nMissouri. Briefs have been filed with that Court and oral argument on the appeal was held on May 15, 1995. A decision is currently not expected until late 1995. Management does not believe that the Company is liable to plaintiffs for the conduct complained of and intends to contest the matter vigorously.\nThe Company from time to time is a party to other legal proceedings arising from the conduct of its business operations, including proceedings relating to personal injury and employment claims, disputes under franchise agreements and claims by state and federal regulatory authorities relating to the sale of products pursuant to state or federal licenses or permits. Management does not believe that the potential liability of the Company with respect to such other proceedings pending as of the date of this Form 10-Q is material in the aggregate.\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 in response to this Item is incorporated herein by reference from the section entitled \"Common Stock Data\" set forth on page 24 of the Company's Annual Report to shareholders for the year ended April 30, 1995.\nThe cash dividends declared by the Company (adjusted to give effect to the two-for-one stock split distributed on February 15, 1994) during the periods indicated have been as follows:\n- 17 -\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe information required in response to this Item is incorporated herein by reference from the section entitled \"Selected Financial Data\" set forth on page 23 of the Company's Annual Report to shareholders for the year ended April 30, 1995.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe information required in response to this Item is incorporated herein by reference from pages 18 through 22 of the Company's Annual Report to shareholders for the year ended April 30, 1995.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe information required in response to this Item is incorporated herein by reference from pages 8 through 17 and page 24 of the Company's Annual Report to shareholders for the year ended April 30, 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\nThat portion of the Company's definitive Proxy Statement appearing under the caption \"Election of Directors\", to be filed with the Commission pursuant to Regulation 14A within 120 days after April 30, 1995 and to be used in connection with the Company's Annual Meeting of shareholders to be held on September 15, 1995, is hereby incorporated by reference.\n- 18 -\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThat portion of the Company's definitive Proxy Statement appearing under the caption \"Executive Compensation\", to be filed with the Commission pursuant to Regulation 14A within 120 days after April 30, 1995 and to be used in connection with the Company's Annual Meeting of shareholders to be held on September 15, 1995, is hereby incorporated by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThat portion of the Company's definitive Proxy Statement appearing under the captions \"Shares Outstanding\" and \"Voting Procedures\", to be filed with the Commission pursuant to Regulation 14A within 120 days after April 30, 1995 and to be used in connection with the Company's Annual Meeting of shareholders to be held on September 15, 1995, is hereby incorporated by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThat portion of the Company's definitive Proxy Statement appearing under the caption \"Other Information Relating to Directors and Executive Officers\", to be filed with the Commission pursuant to Regulation 14A within 120 days after April 30, 1995 and to be used in connection with the Company's Annual Meeting of shareholders to be held on September 15, 1995, is hereby incorporated by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) DOCUMENTS FILED\nThe documents listed below are filed as a part of this Report on Form 10-K and are incorporated herein by reference:\n(1) The following financial statements, shown on pages 8 through 17 of the Company's Annual Report to shareholders for the year ended April 30, 1995:\n- 19 -\nBalance Sheets, April 30, 1995 and 1994 Statements of Income, Three Years Ended April 30, 1995 Statements of Shareholders' Equity, Three Years Ended April 30, 1995 Statements of Cash Flows, Three Years Ended April 30, 1995 Notes to Financial Statements Independent Auditors' Report\n(2) The exhibits set forth in Item 14(c) of this report. The management contracts or compensatory plans or arrangements required to be filed as an exhibit to this Form 10-K pursuant to Item 14(c) consist of the following:\n____________________ (j) Incorporated by reference from the Registration Statement on Form S-8 (33-42907) filed September 23, 1991.\n- 20 -\n(l) Incorporated by reference from the Quarterly Report on Form 10-Q for the fiscal quarter ended January 31, 1992.\n(o) Incorporated by reference from the Quarterly Report on Form 10-Q for the fiscal quarter ended January 31, 1994.\n(t) Incorporated by reference from the Annual Report on Form 10-K for the fiscal year ended April 30, 1994.\n(b) REPORTS ON FORM 8-K\nThere were no reports on Form 8-K filed during the fiscal quarter ended April 30, 1995.\n(c) EXHIBITS\n- 21 -\n__________________________________\n(a) Incorporated herein by reference from the Registration Statement on Form S-1 (2-82651) filed August 31, 1983.\n(b) Incorporated herein by reference from the Annual Report on Form 10-K for the fiscal year ended April 30, 1986 (0-12788).\n(c) Reserved.\n(d) Incorporated herein by reference from the Quarterly Report on Form 10-Q for the fiscal quarter ended January 31, 1988 (0-12788).\n(e) Incorporated herein by reference from the Registration Statement on Form 8-A filed June 19, 1989 (0-12788).\n(f) Incorporated by reference from the Quarterly Report on Form 10-Q for the fiscal quarter ended October 31, 1989.\n(g) Incorporated by reference from the Annual Report on Form 10-K for the fiscal year ended April 30, 1989.\n(h) Incorporated by reference from the Quarterly Report on Form 10-Q for the fiscal quarter ended July 31, 1989.\n(i) Incorporated by reference from the Form 8 (Amendment No. 1 to the Registration Statement on Form 8-A filed June 19, 1989) filed September 10, 1990.\n- 22 -\n(j) Incorporated by reference from the Registration Statement on Form S-8 (33-42907) filed September 23, 1991.\n(k) Incorporated by reference from the Annual Report on Form 10-K for the fiscal year ended April 30, 1991.\n(l) Incorporated by reference from the Quarterly Report on Form 10-Q for the fiscal quarter ended January 31, 1992.\n(m) Incorporated by reference from the Annual Report on Form 10-K for the fiscal year ended April 30, 1992.\n(n) Incorporated by reference from the Current Report on Form 8-K filed February 18, 1993.\n(o) Incorporated by reference from the Quarterly Report on Form 10-Q for the fiscal quarter ended January 31, 1994.\n(p) Incorporated by reference from the Form 8-A\/A (Amendment No. 3 to the Registration Statement on Form 8-A filed June 19, 1989) filed March 30, 1994.\n(q) Incorporated by reference from the Form 8-A12G\/A (Amendment No. 2 to the Registration Statement on Form 8-A filed June 19, 1989) filed July 29, 1994.\n(r) Incorporated by reference from the Quarterly Report on Form 10-Q for the fiscal quarter ended January 31, 1995.\n(s) Incorporated by reference from the Quarterly Report on Form 10-Q for the fiscal quarter ended July 31, 1994.\n(t) Incorporated by reference from the Annual Report on Form 10-K for the fiscal year ended April 30, 1994.\n- 23 -\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.\nCASEY'S GENERAL STORES, INC. (Registrant)\nDate: July 20, 1995 By \/s\/ Donald F. Lamberti -------------------------- Donald F. Lamberti, Chief Executive Officer and Chairman of the Board (Principal Executive Officer)\n- 24 -\nPursuant to the requirements of the Securities Exchange Act of 1934, 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- 25 -\nEXHIBIT INDEX","section_15":""}